<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 six months ended June 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
-------
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 July 30, 1999, the registrant had outstanding, net of treasury
shares, 18,139,488 shares of Class A Common Stock.
================================================================================
<PAGE>
<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
June 30, 1999 and December 31, 1998 .............................................. 1
Consolidated Statements of Income (Unaudited) for the quarters
and six months ended June 30, 1999 and 1998....................................... 2
Consolidated Statements of Comprehensive Income (Unaudited)
for the quarters and six months ended June 30, 1999 and 1998...................... 3
Consolidated Statements of Cash Flows (Unaudited) for the quarters
and six months ended June 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").................................................... 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................. 18
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 ................................................................ 20
b. Reports on Form 8-K ..................................................... 21
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
---------------- ----------------
(UNAUDITED)
ASSETS
<S> <C> <C>
Cash and cash equivalents............................................................... $ 21,961 $ 18,052
Restricted cash......................................................................... 1,965 1,281
Receivable from trusts.................................................................. 3,682 4,652
Loans held for sale..................................................................... 16,501 24,421
Loans receivable held for investment.................................................... 42,706 57,667
Residual interests in securities - at fair value........................................ 46,104 48,720
Mortgage servicing rights............................................................... 9,142 10,033
Property, net........................................................................... 8,591 9,733
Prepaid expenses and other assets....................................................... 1,779 3,044
---------------- ----------------
Total assets......................................................................... $ 152,431 $ 177,603
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Warehouse financing facilities.......................................................... $ 8,334 $ 17,539
Secured term loan facility - related party.............................................. 51,174 64,720
Other borrowings........................................................................ 6,545
Accounts payable and accrued liabilities................................................ 9,488 5,757
Deferred taxes/income taxes payable..................................................... 3,286 8,441
Notes payable........................................................................... 3,684 14
---------------- ----------------
Total liabilities.................................................................... $ 75,966 $ 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 June 30, 1999 and at December 31, 1998............... 223 223
Additional paid in capital.............................................................. 65,813 65,298
Retained earnings....................................................................... 63,949 61,326
Treasury stock - at cost: 4,046,800 shares at June 30, 1999 and at December 31, 1998... (51,582) (51,582)
Accumulated other comprehensive income.................................................. (1,938) (678)
---------------- ----------------
Total stockholders' equity........................................................... 76,465 74,587
---------------- ----------------
Total liabilities and stockholders' equity......................................... $ 152,431 $ 177,603
================ ================
</TABLE>
See notes to consolidated financial statements.
1
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<CAPTION>
FOR THE QUARTERS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------- -------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUE:
Loan origination and sale.................................$ 10,895 $ 8,969 $ 24,956 $ 26,271
Interest.................................................. 3,728 5,176 8,170 11,367
Loan servicing and other fees............................. 1,832 1,665 2,947 3,542
--------------- --------------- --------------- ---------------
Total revenue........................................... 16,455 15,810 36,073 41,180
--------------- --------------- --------------- ---------------
EXPENSE:
Compensation and benefits................................. 5,530 5,873 10,731 11,763
Advertising............................................... 2,092 2,245 3,771 4,101
Professional services and other fees ..................... 570 931 1,369 2,043
Facilities and insurance.................................. 1,021 1,165 1,967 2,142
Supplies.................................................. 413 841 813 1,546
Depreciation and amortization............................. 470 486 954 898
Interest.................................................. 3,321 1,810 6,876 3,632
Legal..................................................... 1,445 515 3,712 875
Travel and training....................................... 344 428 662 795
Other..................................................... 277 260 846 462
--------------- --------------- --------------- ---------------
Total expense........................................... 15,483 14,554 31,701 28,257
--------------- --------------- --------------- ---------------
INCOME BEFORE INCOME TAX PROVISION........................... 972 1,256 4,372 12,923
INCOME TAX PROVISION......................................... 389 475 1,749 4,880
--------------- --------------- --------------- ---------------
NET INCOME...................................................$ 583 $ 781 $ 2,623 $ 8,043
=============== =============== =============== ===============
NET INCOME PER SHARE:
Basic.....................................................$ .03 $ .04 $ .14 $ .39
=============== =============== =============== ===============
Diluted...................................................$ .03 $ .04 $ .14 $ .39
=============== =============== =============== ===============
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:
Basic..................................................... 18,139,488 20,104,670 18,139,488 20,440,311
Diluted................................................... 18,152,679 20,160,781 18,164,935 20,544,280
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS)
<CAPTION>
FOR THE QUARTERS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------- -------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
(UNAUDITED)
<S> <C> <C> <C> <C>
NET INCOME...................................................$ 583 $ 781 $ 2,623 $ 8,043
OTHER COMPREHENSIVE INCOME, NET OF TAX:
Foreign currency translation adjustment net of income
taxes of $259 and $5 and $840 and $27 for the quarters
and six months ended June 30, 1999 and 1998,
respectively.............................................. (388) (8) (1,260) 45
--------------- --------------- --------------- ---------------
COMPREHENSIVE INCOME.........................................$ 195 $ 773 $ 1,363 $ 8,088
=============== =============== =============== ===============
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<CAPTION>
FOR THE QUARTERS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------------- -----------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income...............................................................$ 583 $ 781 $ 2,623 $ 8,043
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Capitalized residual interests and mortgage servicing rights.......... (3,230) (1,889) (7,695) (9,203)
Accretion of residual interests in securities......................... (1,055) (2,137) (2,126) (4,957)
Collection of residual interests in securities........................ 5,037 5,311 10,022 11,055
Amortization of mortgage servicing rights............................. 1,592 1,864 3,306 2,717
Amortization of debt issuance costs................................... 679 1,358
Depreciation and amortization ........................................ 470 486 954 898
Deferred stock compensation........................................... 42
Accretion of discounts on loans receivable............................ (11) (22)
Recognition of deferred fees on loans receivable held for investment.. (334) (797)
Provision for loan losses............................................. 118 313
Foreign currency transaction gain..................................... (25) (35)
Loss on sales of property............................................. 60 5 66 5
Changes in assets and liabilities:
Restricted cash....................................................... (489) (454) (684) (626)
Receivable from trusts................................................ 648 (470) 967 (1,990)
Loans held for sale................................................... (2,690) (7,536) 7,701 (12,935)
Prepaid expenses and other assets..................................... 282 722 400 1,053
Accounts payable and accrued liabilities.............................. 1,846 (916) 3,787 5,890
Deferred taxes/income taxes payable................................... (4,815) 323 (4,391) 2,865
-------------- -------------- -------------- --------------
Net cash provided by (used in) operating activities................. (1,298) (3,946) 15,804 2,800
-------------- -------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayments (advances) on warehouse financing receivable.................. (3,686) 5,872
Capital expenditures..................................................... (34) (818) (56) (2,980)
Proceeds from sale of property........................................... 50 22 50
Collections on loans receivable held for investment...................... 7,054 234 13,340 310
-------------- -------------- -------------- --------------
Net cash provided by (used in) investing activities................. 7,020 (4,220) 13,306 3,252
-------------- -------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) on warehouse financing facilities............ (442) 18,428 (22,751) 3,739
Repayments to other borrowings........................................... (6,545)
Purchase of treasury stock............................................... (11,173) (19,279)
Proceeds from issuance of stock.......................................... 294 521
Net borrowings (repayments) on notes payable............................. (23) (1) 3,670 (10)
-------------- -------------- -------------- --------------
Net cash provided by (used in) financing activities................. (465) 7,548 (25,626) (15,029)
-------------- -------------- -------------- --------------
Effect of exchange rate changes on cash.................................. 282 (3) 425 18
-------------- -------------- -------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS.............................................................. 5,539 (621) 3,909 (8,959)
CASH AND CASH EQUIVALENTS, beginning of period........................... 16,422 5,694 18,052 14,032
-------------- -------------- -------------- --------------
CASH AND CASH EQUIVALENTS, end of period.................................$ 21,961 $ 5,073 $ 21,961 $ 5,073
============== ============== ============== ==============
</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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------------- -----------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C>
SUPPLEMENTAL INFORMATION:
Interest paid....................................................$ 1,399 $ 1,819 $ 3,509 $ 3,649
============== ============== ============== ==============
Income taxes paid................................................$ 5,204 $ 152 $ 6,139 $ 2,055
============== ============== ============== ==============
SUPPLEMENTAL INFORMATION ON NON-CASH
INVESTING AND FINANCING ACTIVITIES:
Transfer of loans held for sale to loans receivable held for
investment....................................................$ - $ - $ 219 $ -
============== ============== ============== ==============
Transfer of loans held for investment to real estate owned.......$ - $ - $ 55 $ -
============== ============== ============== ==============
Stock warrants issued as debt issuance costs.....................$ - $ - $ 515 $ -
============== ============== ============== ==============
Cancellation of restricted stock.................................$ - $ 543 $ - $ 543
============== ============== ============== ==============
COMPONENTS OF EFFECT OF EXCHANGE RATE
CHANGES ON CASH:
Receivable from trusts........................................ $ 3
Loans held for sale........................................... $ 105 $ (441)
Loans receivable held for investment..........................$ 907 2,482
Property...................................................... (2) (2) (6)
Prepaid expenses and other assets............................. 9 22 (6)
Warehouse financing facilities................................ (117) 416
Accounts payable and accrued liabilities...................... (26) (6) (56) 3
Deferred taxes/income taxes payable........................... (218) (2) (764) (28)
Foreign currency transaction gain............................. 25 35
Accumulated other comprehensive income........................ (388) (8) (1,260) 45
-------------- -------------- -------------- --------------
Net effect of exchange rate changes on cash...............$ 282 $ (3) $ 425 $ 18
============== ============== ============== ==============
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTERS AND SIX MONTHS ENDED JUNE 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 six months ended June 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 (see
Risk Factors below). 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. Gains
recognized on hedging activities were $462,000 and $1,092,000 for the quarter
and six months ended June 30, 1999, respectively, as compared to losses of
$106,000 and $16,000 for the corresponding periods in 1998. The notional amount
of forward sales of United States Treasury Securities was $15 million at June
30, 1999.
The Company bears a foreign currency risk related to its $66 million
secured term loan facility, which provides long-term financing for its United
Kingdom subsidiary, whose portfolio was sold in July 1999. The following
discussion relates to the period prior to such sale. This risk is a result of
the Company's obligation to repay the facility in US denominated currency, while
the underlying collateral represents loans denominated in British Pounds. The
Company has hedged this risk by entering into 21 individual foreign currency put
options and 21 individual foreign currency call options of (pound)1 million
each, which mature monthly. The put options provide the Company the option to
sell the foreign currency to a third party at a strike price of 1.542 dollars to
the British Pound. Therefore, the Company has protected itself, to the extent of
the hedged amount, against the foreign currency exchange rate falling below the
strike price of 1.542. The call options, however, provide the third party the
option to buy the foreign currency from the Company at a strike price of 1.687
dollars to the British Pound.
6
<PAGE>
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 June 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 six
months of 1999. The Company has no specific timetable or amount of shares
scheduled to be repurchased in the future.
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 QUARTERS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------- -------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Net income: Basic and diluted (dollars in thousands)........$ 583 $ 781 $ 2,623 $ 8,043
=============== =============== =============== ===============
Weighted average number of common shares:
Basic...................................................... 18,139,488 20,104,670 18,139,488 20,440,311
Effect of dilutive securities - stock options.............. 13,191 56,111 25,447 103,969
--------------- --------------- --------------- ---------------
Diluted.................................................... 18,152,679 20,160,781 18,164,935 20,544,280
=============== =============== =============== ===============
Net income per share:
Basic $ .03 $ .04 $ .14 $ .39
Effect of dilutive securities - stock options.............. - - - -
--------------- --------------- --------------- ---------------
Diluted....................................................$ .03 $ .04 $ .14 $ .39
=============== =============== =============== ===============
</TABLE>
SUBSEQUENT EVENTS
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.
In July 1999, the Company sold its portfolio of United Kingdom mortgages.
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 expects to record a minimal gain on sale, after
recognition of net deferred fees and foreign currency loss.
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 to the Company of any securitization, would likely have a material
adverse effect on the Company's results of operations and financial condition.
7
<PAGE>
In December 1998, the Company entered into a $150 million warehouse
financing facility and a secured term loan facility of approximately $66
million. In March 1999, the Company entered into an additional $20 million
warehouse financing facility. The $150 million warehouse financing facility is
secured by loans originated or purchased by the Company, expires in December
1999, and 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). As
partial consideration for the $150 million warehouse financing facility, the
Company granted the warehouse lender stock warrants that may be exercised by the
lender to purchase one percent (1%) of the Company's Common Stock on a diluted
basis in February 1999. The $66 million secured term loan facility, which was
entered into with a company owned by the majority stockholders of FACO, Brian
and Sarah Chisick, and is secured by United Kingdom mortgages held for
investment, bears a fixed interest rate of 8.5%, and was repaid in full during
July 1999 in conjunction with the mortgage loan sale (see Item 2., Recent
Developments below). The $20 million warehouse financing facility, which is
secured by loans originated or purchased by the Company, and bears interest at a
rate of 2.25% over the 30-day US dollar denominated LIBOR, expires in September
1999. These facilities contain certain affirmative and negative covenants with
which the Company was in compliance as of June 30, 1999.
Although management expects that the Company will be able to maintain
these financing agreements, 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 agreements, 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.
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 bears a foreign currency risk related to its $66 million
secured term loan facility, which provides long-term financing for its United
Kingdom subsidiary. This risk is a result of the Company's obligation to repay
the facility in US denominated currency, while the underlying collateral
represents loans denominated in British Pounds. The Company has hedged this risk
(see Note 1., Hedging Activities, above) by entering into 21 individual foreign
currency put options and 21 individual foreign currency call options of (pound)1
million each, which mature monthly. The put options provide the Company the
option to sell the foreign currency to a third party at a strike price of 1.542
dollars to the British Pound. Therefore, the Company has protected itself, to
the extent of the hedged amount, against the foreign currency exchange rate
falling below the strike price of 1.542. The call options, however, provide the
third party the option to buy the foreign currency from the Company at a strike
price of 1.687 dollars to the British Pound. Consequently, the Company bears the
risk between any market fluctuation ranging from 1.687 to 1.542.
The Company's average loan-to-value (LTV) for loan originations and
purchases has historically ranged between 60% and 65%. 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. 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. No new credit
cards are being issued. However, there is no assurance that the Company will
either be successful in selling the credit card portfolio of approximately $23.0
million by the obligation date or be able to have the appropriate capital or
financing in place to purchase such assets.
8
<PAGE>
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. 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).
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 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 adoption
of this standard did not have a material effect on the Company's financial
reporting.
9
<PAGE>
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 June 30, 1999, is comprised of 30
active offices in the United States (nine 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, Ohio and Maryland, and one of which is
located in each of Arizona, Colorado, Florida, Minnesota, Oregon, Pennsylvania,
Utah and Washington (see Recent Developments). The Company has scheduled the
opening of two additional retail branches during the month of August 1999, one
in California and the other in Pennsylvania. Currently, the Company has leases
signed for three other branch offices, one of which is located in each of
Georgia, Virginia and Ohio. The Company expects to re-open these offices during
the third or fourth quarter of 1999 when adequate and experienced personnel are
recruited. 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. 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.
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.
10
<PAGE>
RECENT DEVELOPMENTS
In June 1999, the Company announced the creation of an E-Commerce division
in order to establish a presence in the Internet mortgage origination arena. The
E-Commerce division will be comprised of two channels. The first is E-Commerce
Direct, which will be a consumer direct lending program, whereby borrowers may
apply for a loan through the Company's web site. The second will be E-Commerce
Wholesale, which will allow mortgage brokers to submit loans to the Company also
through its web site.
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 $4 million was finalized subject to customary indemnification, monetary
holdbacks and an independent third party evaluation regarding the merits,
pricing and terms of the transaction.
In July 1999, the Company sold its portfolio of United Kingdom mortgages.
The sale of such assets was an opportunity presented to the Company in a manner
that allowed the Company to completely exit its United Kingdom operations. The
proceeds from the mortgage sale were used to repay the related secured term loan
facility. The Company expects to record a minimum gain on sale, after
recognition of net deferred fees and foreign currency loss.
LOAN ORIGINATIONS AND PURCHASES
The following table summarizes loan origination and purchase activity for
the periods indicated:
<TABLE>
<CAPTION>
AT OR FOR THE QUARTERS AT OR FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------------------- -------------------------------
1999 1998 1999 1998
---------------- -------------- --------------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Loan originations and purchases:
Retail originations....................................$ 99,494 $ 99,968 $ 186,822 $ 220,768
Loans by mail.......................................... 1,396 1,396
Wholesale purchases.................................... 4,791 19,215 8,458 47,878
---------------- -------------- -------------- --------------
Total................................................$ 105,681 $ 119,183 $ 196,676 $ 268,646
================ ============== ============== ==============
Number of active retail branches as of the end of the
period:
United States:
California........................................... 9 8
Other states......................................... 21 24
United Kingdom......................................... - 3
-------------- --------------
Total................................................ 30 35
============== ==============
Weighted average initial interest rate.................... 9.0% 9.5% 9.1% 9.5%
Weighted average initial combined loan-to-value ratio..... 65.8% 63.8% 65.2% 63.8%
Average loan size.........................................$ 104.9 $ 88.4 $ 99.9 $ 88.1
</TABLE>
Originations and purchases decreased 11% and 27% for the quarter and six
months ended June 30, 1999, respectively, as compared with the corresponding
periods in the prior year. While retail origination volume for the quarter ended
June 30, 1999 remained consistent with that of the prior year quarter, retail
originations for the six months ended June 30, 1999 decreased by 15% when
compared to the corresponding prior year period. The decrease of retail
originations for the six months ended June 30, 1999 primarily resulted from a
reduction in retail branch offices and tightening of the Company's underwriting
guidelines. Wholesale purchases decreased 75% and 82% for the quarter and six
months ended June 30, 1999, respectively, as compared to the corresponding
periods in the prior year, primarily due to the discontinuation of the Company's
wholesale low LTV purchase program.
11
<PAGE>
LOAN SALES
<TABLE>
<CAPTION>
FOR THE QUARTERS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------- -------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Securitizations..............................................$ 89,985 $ 100,001 $ 204,986 $ 210,002
Whole loan sales............................................. 12,831 23,617 25,410 64,903
--------------- --------------- --------------- ---------------
Total...................................................$ 102,816 $ 123,618 $ 230,396 $ 274,905
=============== =============== =============== ===============
</TABLE>
Loan sales, including securitization of loans, decreased 17% and 16% for
the quarter and six months ended June 30, 1999, respectively, as compared to the
corresponding prior year period. The decreases in loan sales resulted from
decreased loan origination and purchases volume.
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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------- -------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
REVENUE:
Loan origination and sale:
Gain on sale of loans................................ 16.0% (0.6)% 18.2% 12.2%
Net loan origination and other fees.................. 50.2 57.4 50.9 51.6
Interest .............................................. 22.7 32.7 22.6 27.6
Loan servicing and other fees.......................... 11.1 10.5 8.3 8.6
--------------- --------------- --------------- ---------------
Total revenue........................................ 100.0 100.0 100.0 100.0
--------------- --------------- --------------- ---------------
EXPENSE:
Compensation and benefits.............................. 33.6 37.1 29.7 28.6
Advertising............................................ 12.7 14.2 10.5 10.0
Professional services and other fees .................. 3.5 5.9 3.8 5.0
Facilities and insurance............................... 6.2 7.4 5.5 5.2
Supplies............................................... 2.5 5.3 2.3 3.8
Depreciation and amortization.......................... 2.9 3.1 2.6 2.2
Interest............................................... 20.2 11.4 19.1 8.8
Legal.................................................. 8.8 3.3 10.3 2.1
Travel and training.................................... 2.1 2.7 1.8 1.9
Other.................................................. 1.6 1.7 2.3 1.0
--------------- --------------- --------------- ---------------
Total expense........................................ 94.1 92.1 87.9 68.6
--------------- --------------- --------------- ---------------
Income before income tax provision........................ 5.9 7.9 12.1 31.4
Income tax provision...................................... 2.4 3.0 4.8 11.9
--------------- --------------- --------------- ---------------
Net income................................................ 3.5% 4.9% 7.3% 19.5%
=============== =============== =============== ===============
</TABLE>
12
<PAGE>
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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------- -------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Loan origination and sale:
Gain on sale of loans (1)..................................$ 2,631 $ (102) $ 6,578 $ 5,041
Net loan origination and other fees........................ 8,264 9,071 18,378 21,230
Interest..................................................... 3,728 5,176 8,170 11,367
Loan servicing and other..................................... 1,832 1,665 2,947 3,542
--------------- --------------- --------------- ---------------
Total revenue...........................................$ 16,455 $ 15,810 $ 36,073 $ 41,180
=============== =============== =============== ===============
</TABLE>
(1) Excludes net loan origination and other fees.
Total revenues increased 4% or $0.6 million and decreased 12% or $5.1
million for the quarter and six months ended June 30, 1999, respectively, as
compared to the corresponding periods in 1998.
Loan origination and sale revenue increased $1.9 million and decreased
$1.3 million for the quarter and six months ended June 30, 1999, respectively,
from $9.0 million and $26.3 million for the corresponding periods in 1998.
Excluding the $4.5 million negative adjustment related to residual
interest which was recorded during the second quarter of 1998, gain on sale of
loans decreased $1.8 million and $3.0 million for the quarter and six months
ended June 30, 1999. The decrease in gain on sale during 1999 is primarily
related to a decrease in the value of residual interest and mortgage servicing
rights, and lower gain on sale from whole loan sales. These decreases were
partially offset by an increase in hedging gains and lower premiums paid on
whole loans purchased.
The value of residual interest and mortgage servicing rights decreased by
$3.2 million and $6.0 million for the quarter and six months ended June 30,
1999, respectively, as compared to the corresponding prior year period. Residual
interest and mortgage servicing rights as a percent of loans securitized
decreased from 6.4% and 6.5% for the quarter and six months ended June 30, 1998
as compared to 3.6% and 4.0% for the corresponding current year period. The
decrease in the value of residual interest and mortgage servicing rights was
primarily related to an increase in the CPR assumptions, which are based on
empirical data, and an increase in the discount rate. The Company has
experienced higher than anticipated prepayment levels during the current year.
The increase in prepayments is a result of a recent decline in the interest
rates charged to borrowers and also due to the Company's historically low LTVs.
Accordingly, the Company increased its weighted average CPR assumptions for the
six months ended June 30, 1999 to 30% for fixed and 63% for adjustable rate
mortgages, from 26% and 43% for fixed and adjustable rate mortgages,
respectively, in the corresponding prior year period. Additionally, the Company
increased its discount rate to 18% during 1999 as compared to a discount rate of
15% during the prior year period.
Gain on sale of whole loans decreased by $0.3 million and $1.0 million for
the quarter and six months ended June 30, 1999 primarily due to lower wholesale
loan sales and lower premiums available in the secondary market. Whole loan
sales decreased to $25 million for the six months ended June 30, 1999 from $65
million for the corresponding prior year period.
The decrease in the value of residual interest and mortgage servicing
rights and gain on sale of whole loan sales was partially offset by an increase
of $0.6 million and $1.1 million in the hedging gain for the quarter and six
months ended June 30, 1999, coupled with a $1.1 million and $3.0 million
reduction in premiums paid on wholesale purchases for the same periods.
13
<PAGE>
Net loan origination fees and other fees decreased $0.8 million or 9% and
$2.9 million or 13% for the quarter and six months ended June 30, 1999,
respectively, when compared to the corresponding prior year periods. This
decrease is primarily due to a decrease in weighted average origination fees
experienced during the current year. Weighted average origination fees decreased
to 10.2% and 11.2% for the quarter and six months ended June 30, 1999,
respectively, as compared to 14.5% and 14.0% for the corresponding prior year
period.
Interest income decreased $1.5 million or 28% and $3.2 million or 28% for
the quarter and six months ended June 30, 1999 as compared to the corresponding
prior year periods. This decrease was primarily related to decreases in interest
revenue derived from residual interest and loans held for sale, partially offset
by an increase in interest earned on loans held for investment. Interest revenue
related to residual interest decreased $1.0 million and $2.8 million for the
quarter and six months ended June 30, 1999, as compared to the corresponding
prior year period, primarily due to greater than expected prepayment rates
experienced during the current year. Interest revenue related to loans held for
sale decreased by $0.8 million and $1.3 million for the quarter and six months
ended June 30, 1999 as a result of lower average balances of loans outstanding
during the current year, when compared to the prior year periods. The increase
in interest revenue related to loans held for investment of $0.3 million and
$0.9 million for the quarter and six months ended June 30, 1999 was due to an
increase in the average balance of the United Kingdom portfolio.
Loan servicing and other fees decreased $0.6 million or 17% for the six
months ended June 30, 1999 as compared to the corresponding prior year period,
primarily as a result of an increase in the amortization of mortgage servicing
rights. The increased amortization was due to an increase in CPRs experienced
during 1999 when compared to the corresponding period in 1998.
EXPENSE
The following table sets forth the components of the Company's expense for
the periods indicated:
<TABLE>
<CAPTION>
FOR THE QUARTERS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------- -------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Compensation and benefits....................................$ 5,530 $ 5,873 $ 10,731 $ 11,763
Advertising.................................................. 2,092 2,245 3,771 4,101
Professional services and other fees......................... 570 931 1,369 2,043
Facilities and insurance..................................... 1,021 1,165 1,967 2,142
Supplies..................................................... 413 841 813 1,546
Depreciation and amortization................................ 470 486 954 898
Interest..................................................... 3,321 1,810 6,876 3,632
Legal........................................................ 1,445 515 3,712 875
Travel and training.......................................... 344 428 662 795
Other........................................................ 277 260 846 462
--------------- --------------- --------------- ---------------
Total expense..............................................$ 15,483 $ 14,554 $ 31,701 $ 28,257
=============== =============== =============== ===============
</TABLE>
Total expense increased 6% or $0.9 million and 12% or $3.4 million for
the quarter and six months ended June 30, 1999, respectively, as compared with
the corresponding periods in 1998.
Compensation and benefits, advertising, professional services, and
supplies decreased $1.3 million or 13% and $2.8 million or 14% during the
quarter and six months ended June 30, 1999, respectively, as compared with the
corresponding prior year period. This decrease in expenses is primarily due to
the discontinuation of the Company's affinity credit card and United Kingdom
operations in December of 1998 and the Company's overall cost reduction
strategy.
14
<PAGE>
The increase in legal expenses of $0.9 million and $2.8 million during the
quarter and six months ended June 30, 1999, respectively, as compared to the
corresponding prior year periods, is related to certain ongoing legal matters
(see Part II, Item 1. Legal Proceedings) commenced primarily during the second
half of 1998.
The increase in interest expense of $1.5 million and $3.2 million for the
quarter and six months ended June 30, 1999, respectively, as compared with the
corresponding prior year periods is primarily due to (1) an increase in debt
issuance costs, (2) foreign currency losses related to its United States
denominated secured term loan facility with respect to payoffs of the Company's
United Kingdom loans, and (3) an increase in the average balance of the United
Kingdom and credit card portfolios. Debt issuance costs increased by $0.7
million and $1.4 million during the quarter and six months ended June 30, 1999,
respectively, as compared to the corresponding prior year. The Company incurred
foreign currency losses of $0.4 million and $0.6 million for the quarter and six
months ended June 30, 1999 with respect to its United States denominated secured
term loan facility associated with its United Kingdom portfolio. The increase in
the average balance of United Kingdom loans financed and credit cards serviced
resulted in a $0.4 million and $1.2 million increase in cost of funds during the
quarter and six months ended June 30, 1999, respectively, when compared to the
corresponding prior year periods.
INCOME TAXES
The Company's estimated tax rate for the quarters ended June 30, 1999 and
1998 was 40.0% and 37.8%, respectively. The increase in the Company's estimated
tax rate is primarily due to a change in geographical concentration of the
Company's business.
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
-----------------------------------------------------------------------------------
JUNE 30, 1999 DECEMBER 31, 1998 JUNE 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..................... $ 859,599 $ 865,663 $ 852,030
============= ============= =============
30-59 days delinquent................... $ 8,169 0.9% $ 11,565 1.3% $ 9,234 1.1%
60-89 days delinquent................... 5,999 0.7 7,794 0.9 6,675 0.8
90 days or more delinquent.............. 28,899 3.4 22,464 2.6 22,488 2.6
------------- ------------- ------------- ------------- ------------- -------------
Total delinquencies.................. $ 43,067 5.0% $ 41,823 4.8% $ 38,397 4.5%
============= ============= ============= ============= ============= =============
REO (1) ............................... $ 933 0.1% $ 2,063 0.2% $ 1,565 0.2%
============= ============= ============= ============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
FOR THE QUARTERS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------------------- ---------------------------------
1999 1998 1999 1998
---------------- ---------------- ---------------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Average servicing portfolio (2)...........................$ 862,739 $ 846,284 $ 864,255 $ 833,048
Net losses (3)............................................$ 380 $ 170 $ 753 $ 400
Percentage of average servicing portfolio - annualized.... .18% .08% .17% .10%
</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.
15
<PAGE>
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 December 1998, the Company entered into a $150 million warehouse
financing facility and a secured term loan facility of approximately $66
million. In March 1999, the Company entered into an additional $20 million
warehouse financing facility. The $150 million warehouse financing facility is
secured by loans originated or purchased by the Company, expires in December
1999, and bears interest at a rate ranging between 1.25% to 1.75% over 30-day
United States dollar denominated LIBOR. As partial consideration for the $150
million warehouse financing facility, the Company agreed to grant the warehouse
lender stock warrants that may be exercised by the lender to purchase one
percent (1%) of the Company's Common Stock on a diluted basis, with an effective
date in February 1999. The $66 million secured term loan facility, which was
entered into with a company owned by the majority stockholders of FACO, Brian
and Sarah Chisick, and is secured by United Kingdom mortgages held for
investment, bears a fixed interest rate of 8.5%, and was repaid in July 1999.
The $20 million warehouse financing facility, which is secured by loans
originated or purchased by the Company, and currently bears interest at a rate
of 2.25% over the 30-day US dollar denominated LIBOR, expires in September 1999.
These facilities contain certain affirmative and negative covenants with which
the Company was in compliance at June 30, 1999.
Although management expects that the Company will be able to maintain
these financing agreements, 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 agreements, 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.
The Company bears a foreign currency risk related to its $66 million
secured term loan facility, which provides long-term financing for its United
Kingdom subsidiary. This risk is a result of the Company's obligation to repay
the facility in US denominated currency, while the underlying collateral
represents loans denominated in British Pounds. The Company has hedged this risk
by entering into 21 individual foreign currency put options and 21 individual
foreign currency call options of (pound)1 million each, which mature monthly.
The put options provide the Company the option to sell the foreign currency to a
third party at a strike price of 1.542 dollars to the British Pound. Therefore,
the Company has protected itself, to the extent of the hedged amount, against
the foreign currency exchange rate falling below the strike price of 1.542. The
call options, however, provide the third party the option to buy the foreign
currency from the Company at a strike price of 1.687 dollars to the British
Pound. Consequently, the Company bears the risk between any market fluctuation
ranging from 1.687 to 1.542.
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. 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. No new credit
cards are being issued. However, there is no assurance that the Company will
either be successful in selling the credit card portfolio of approximately $23.0
million by the obligation date or be able to have the appropriate capital or
financing in place to purchase these assets.
16
<PAGE>
As of June 30, 1999 the Company had commitments to fund loans of $7.4
million. Historically, approximately 55% of such commitments have ultimately
been funded. Capital expenditures totaled $34,000 and $56,000 for the quarter
and six months ended June 30, 1999, as compared to $0.8 million and $3.0 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 six months ended June 30, 1998, the
Company incurred a non-recurring $1.4 million of improvements related to its
telemarketing facility in Irvine, California.
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 does not expect its costs to be material in addressing the Year 2000
issue.
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. A
contingency plan for outside vendors has not yet been completed for dealing with
the most reasonably likely worst case scenario. The Company expects to complete
its analysis and contingency plan by September 30, 1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of June 30, 1999, no material changes with regard to market risk from
the preceding fiscal year were noted.
17
<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 Columbia. The plaintiffs in these class action suits are seeking an
unspecified amount of damages. The federal action, which was only recently
served on June 3, 1999, is being reviewed by counsel for the Company. 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 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. 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. 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 has filed a motion to vacate
the injunction. A hearing is scheduled for August 18, 1999.
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 alleges violations of the Minnesota Uniform Deceptive Trade Practices Act,
the Consumer Fraud Act, Truth in Lending Act and related federal regulations.
The Attorney General is seeking an injunction, restitution, civil penalties,
attorneys' fees and costs. The Company has agreed to discontinue writing ARMs in
Minnesota. A mediation conducted on July 21 and 22, 1999 resulted in a proposed
settlement, which is currently under review by the parties.
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.
18
<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
Effective June 7, 1999 the Company appointed Jerry Hager as Vice President
and General Counsel of the Company.
Effective May 3, 1999 the Company appointed Don Kasle as a member of the
Board of Directors of the Company.
19
<PAGE>
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 10.6 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)
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)
20
<PAGE>
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, dated July 2, 1999, was filed by First
Alliance Corporation. Under Item 5, Other Events, First Alliance
reported the consummation of the Coast Security Mortgage acquisition.
21
<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: August 9, 1999 /S/ BRIAN CHISICK
---------------------- ----------------------------------------
Brian Chisick
President and Chief Executive Officer
Date: August 9, 1999 /S/ FRANCISCO NEBOT
---------------------- ----------------------------------------
Francisco Nebot
Executive Vice President
Principal Financial Officer
22
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 21,961
<SECURITIES> 0
<RECEIVABLES> 3,682
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 43,923
<PP&E> 8,591
<DEPRECIATION> 0
<TOTAL-ASSETS> 152,431
<CURRENT-LIABILITIES> 17,822
<BONDS> 0
0
0
<COMMON> 223
<OTHER-SE> 76,242
<TOTAL-LIABILITY-AND-EQUITY> 152,431
<SALES> 24,956
<TOTAL-REVENUES> 36,073
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 24,825
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,876
<INCOME-PRETAX> 4,372
<INCOME-TAX> 1,749
<INCOME-CONTINUING> 2,623
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,623
<EPS-BASIC> 0.14
<EPS-DILUTED> 0.14
</TABLE>
