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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934.
For the transition period from_________ to _________
Commission file number 0-28706
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FIRST ALLIANCE CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 33-0721183
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
17305 VON KARMAN AVENUE, IRVINE, CALIFORNIA 92614
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(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code (949) 224-8500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Class A Common Stock, $0.01 par value NASDAQ National Market System
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 and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of this
Form 10-K. [ ]
As of February 1, 2000, the aggregate market value of voting stock held by
nonaffiliates of the registrant was approximately $12.5 million.
As of February 1, 2000, the registrant had outstanding, net of treasury
shares, 17,949,288 shares of Class A Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE:
The information required by Part III, Items 10, 11, 12 and 13 is
incorporated by reference to First Alliance Corporation's proxy statement which
will be filed with the Commission not more than 120 days after December 31,
1999.
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PART I
FORWARD LOOKING STATEMENTS
Certain statements in this Annual Report on Form 10-K are "forward looking
statements" within the meaning of the Private Securities Litigation Report of
1995. You can identify forward looking statements by the use of such words as
"expect," "estimate," "intend," "project," "budget," "forecast," "anticipate,"
"plan," "in the process of," and similar expressions. Forward looking statements
include all statements regarding the Corporation's expected financial position,
results of operations, cash flows, financing plans, business strategies,
budgets, capital and other expenditures, competitive positions, plans and
objectives of management and markets for stock. All forward looking statements
involve risks and uncertainties. In particular, any statements contained herein
regarding expectations with respect to future sales, resolution of regulatory
actions and other litigation, operating efficiencies and product and product
expansion, are subject to known and unknown risks, uncertainties and
contingencies, many of which are beyond the control of the Corporation, which
may cause actual results, performance or achievements to differ materially from
anticipated results, performance or achievements. Factors that might affect such
forward looking statements include, among other things, overall economic and
business conditions, the demand for the Corporation's services, competitive
factors in the industry in which the Corporation competes, changes in government
regulation, future regulatory actions and litigation, continuing tightening of
credit availability to the sub-prime mortgage industry, early termination of
credit agreements with credit providers, increased yield requirements by
asset-backed investors, lack of continued availability of the Corporation's
credit facilities, reduction in real estate values, reduced demand for
non-conforming loans, changes in underwriting criteria applicable to such loans,
prepayment speeds, delinquency and default rates of mortgage loans owned or
serviced by the Corporation, rapid fluctuation in interest rates, risks related
to not hedging against loss of value of the Corporation's mortgage loan
inventory, changes which influence the loan securitization and the net interest
margin securities (excess cash flow trust) markets generally, lower than
expected performance of companies acquired by the Corporation, market forces
affecting the price of the Corporation's common stock and other uncertainties
associated with the Corporation's current financial difficulties and other risks
identified in the Corporation's Securities and Exchange Commission filings.
ITEM 1. BUSINESS
GENERAL
First Alliance Corporation ("FACO"), together with its subsidiaries (the
"Company"), is a financial services organization principally engaged in mortgage
loan origination, purchases, sales and servicing. Loans originated by the
Company primarily consist of fixed and adjustable rate loans secured by first
mortgages on single family residences. The majority of the Company's loans are
made to borrowers who use the loan proceeds for such purposes as debt
consolidation and financing of home improvements. Typically, the Company's
borrowers are individuals who do not qualify for conventional loans because of
impaired or unsubstantiated credit characteristics and/or unverifiable income,
and whose borrowing needs are not met by conventional lending institutions.
Other borrowers include individuals who may qualify for a conventional loan but
find the Company's loans attractive due to the Company's personalized service
and rapid funding capability. The Company either securitizes the loans in a
trust or sells them to wholesale purchasers. A significant portion of the
mortgages are securitized with the Company retaining the right to service the
loans. Loans sold to wholesale purchasers are sold on a servicing released
basis. As of December 31, 1999, the Company serviced 10,581 loans, representing
a balance of approximately $892 million. Of such balance, 44% represent loans
secured by California properties. The Company is currently licensed to engage in
the mortgage finance business in 18 states and the District of Columbia.
The Company originates loans through its retail branch network and its Loan
by Mail division which, as of December 31, 1999, are comprised of 25 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, and one of which is located in each of Arizona,
Colorado, Maryland, Oregon, Utah and Washington). Additionally, as of December
31, 1999 the Company maintained ten small offices (two of which are located in
California and Maryland, 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 ("Coast") (see "Recent
Developments").
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The Company is primarily an originator of loans, with 98% of its 1999 loan
volume coming from its branch operations. Besides a strong emphasis placed on
its marketing and sales efforts, the Company provides a high degree of
personalized service and timely response to loan applications. Historically, the
Company's customers have been willing to pay the Company's loan origination fees
and interest rates which are typically higher than those charged by conventional
lending institutions.
The Company believes it has maintained conservative underwriting guidelines
when originating and purchasing loans. The predominant portion of the Company's
loan originations carry relatively low loan-to-value ("LTV") ratios, which
mitigates the credit risk associated with such obligations. In conjunction with
the Company's disciplined collection and foreclosure practices, this approach
has allowed the Company to maintain low delinquency and loan losses relative to
others in the industry. In addition, the Company originates loans with higher
levels of credit risk to earn origination fees, however, it generally sells such
loans on a servicing released basis to companies with higher LTV risk tolerance.
RECENT DEVELOPMENTS
In February 1999, the Company refinanced its 40,000 square foot office
building in Irvine, California, and received proceeds of approximately $3.7
million. The loan bears an interest rate of 6.9% and matures on March 1, 2009,
at which time a balloon payment of $2.5 million is due.
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
24, 2000. The Company is currently disputing the terms of the obligation to
purchase the outstanding balance of the credit cards, and the parties have
sought arbitration of the dispute. Nevertheless, the Company is pursuing the
sale of the credit card portfolio and has discontinued the issuance of new
credit cards. There is, however, no assurance that the Company will either be
successful in its dispute against Fidelity or in selling the credit card
portfolio, which currently has an available credit line of approximately $22
million and an outstanding balance of approximately $16 million, or be able to
have the appropriate capital or financing in place to purchase these assets.
In June 1999, the Company implemented the concept of a centralized retail
operation by establishing a Loan by Mail division.
In June 1999, the Company announced the creation of an E-Commerce initiative
to establish a presence in the Internet mortgage origination arena. The
E-Commerce initiative will be comprised of two channels. The first is E-Commerce
Consumer Direct, which is currently utilizing banner advertising campaigns
located on various web sites as a mechanism to obtain loan leads. In addition,
the Company is currently developing its own web site portal. These loan leads
are eventually converted into loans or sold to a third party loan originator.
The second initiative is E-Commerce Wholesale, which will allow the Company to
build national wholesale lending and whereby mortgage brokers may apply for a
loan through the Company's web site. The E-Commerce Wholesale initiative is
expected to be operational in April 2000. The utilization of these E-Commerce
initiatives will allow the Company to originate, approve, process and fund
mortgage loans at a lower cost and with greater efficiency and convenience.
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 $4.1 million was finalized
subject to customary indemnification, monetary holdbacks and an independent
third party evaluation regarding 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. In connection with the acquisition of Coast, the
Company gained ten small offices (two of which are located in California and
Maryland, and one of which is located in each of Colorado, Illinois, Ohio,
Oregon, Pennsylvania and Utah).
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In July 1999, the Company sold its portfolio of United Kingdom loans. The
sale of such assets was an opportunity presented to the Company, which 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.
In October 1999, the Company extended its $150 million warehouse financing
facility, which was due to expire in December 1999, to December 2000. As partial
consideration for this facility, the Company agreed to grant the warehouse
lender stock warrants to purchase 4.90% of the shares outstanding, with an
effective date of January 15, 2000. 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"). Additionally, in December
1999, the Company amended the effective date of the stock warrants granted the
warehouse lender in 1998, which represent the option to purchase 1% of the
shares outstanding. The effective date was changed from February 15, 1999 to
January 15, 2001.
In September 1999, the Company settled a lawsuit with the State of
Minnesota, which was filed by the Attorney General of Minnesota on behalf of the
State in Ramsey County District Court in November 1998. 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 settlement
agreement did 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 involved 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.
During 1999, the Company closed ten unprofitable retail branch offices and
opened two retail branch offices.
MARKETING AND SALES
MARKETING
The Company's primary marketing efforts are designed to identify individuals
who, based on the Company's historic customer profiles, display a statistical
likelihood for becoming a consumer of the Company's products and services and,
at the same time, satisfy the Company's underwriting guidelines. The Company
believes its focused marketing approach results in a lower overall marketing
cost per funded loan as compared to a broad indiscriminate marketing approach
aimed at a wide range of homeowners.
The Company utilizes a proprietary marketing methodology to subjectively
analyze the Company's historical customer base to identify characteristics
common to its customers. These common characteristics are integrated with
information obtained from a number of outside sources, including credit bureaus,
related to the homeowner pool in new or existing markets. The characteristics of
individual homeowners and their properties in the homeowner pool are compared
with characteristics common to the Company's historical customer base to
identify and locate a list of homeowners ("Homeowners") with characteristics
that make them likely to become customers for the Company's products and
services and to satisfy its underwriting guidelines. The Company then focuses
its telemarketing and mailing efforts on these identified Homeowners. Any new
regulation limiting the Company's access to data relating to the homeowner pool
may have a material adverse effect on the Company's results of operations and
financial condition.
Additionally, the Company has created an E-Commerce marketing strategy,
which is comprised of two channels.
The first is E-Commerce Consumer Direct, which is currently utilizing banner
advertising located on various web sites as a mechanism to obtain loan leads. In
addition to the web banner advertising, the Company is developing four consumer
web sites in which potential customers can obtain and shop on-line for loan
information. The largest of the sites will be a portal and will be branded and
marketed as an avenue to the Company's loan products and services. Each site
will contain general consumer information and will contain a loan inquiry form
from which leads can be generated. These loan leads are eventually converted
into loans or sold to a third party loan originator. The Company expects to
complete its web sites by April 2000.
The second initiative is E-Commerce Wholesale, which will allow the Company
to build national wholesale lending and whereby mortgage brokers may apply for a
loan through the Company's web site. The E-Commerce Wholesale initiative is
expected to be fully operational in April 2000.
3
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The utilization of these E-Commerce initiatives will allow the Company to
originate, approve, process and fund mortgage loans at a lower cost with greater
efficiency and convenience.
MAILING CAMPAIGNS AND TELEMARKETING
The Company's mailing and telemarketing campaigns focus primarily on
Homeowners in the communities surrounding its branch offices. Additionally,
mailing campaigns are conducted in communities in which the Company does not
have a branch office presence, from which leads are generated for its Loan by
Mail division. These campaigns focus on the multiple benefits of the Company's
services and loan products. The Company distributes an average of over 1.9
million pieces of mail monthly. All of the Company's mailing campaigns originate
from its mail processing center in Irvine, California. The Company's mailing
campaigns result in an average of over 4,000 inbound loan inquiry calls from
Homeowners monthly. The Company continually monitors the effectiveness of each
of its mailing and telemarketing campaigns and continues, modifies or
discontinues a particular campaign based on the results of such monitoring.
The Company's telemarketing department handles both inbound and outbound
calls from and to Homeowners and existing customers. Substantially all of the
inbound calls are from Homeowners responding to the Company's mailing campaigns.
The Company monitors the effectiveness of each mailing campaign by tracking
which campaign is the source of each inbound call. The outbound telemarketing
department uses computerized predictive dialers to continually solicit
Homeowners.
The telemarketing representative's responsibility is to describe the
benefits of the Company's products and services, obtain information about the
Homeowner, the subject property and the purpose of the loan and schedule an
appointment to have a Company appraiser or a third party appraiser visit and
inspect the subject property. The Company monitors the performance of its
telemarketing staff on a weekly and monthly basis.
APPRAISAL
The Company's property valuation process continues throughout the loan
application process. In many instances, the first stage of valuation occurs
immediately after a telemarketing representative sets an appraisal appointment.
Staff at the Company's headquarters gather publicly available information with
respect to recent sales of comparable properties in the same area as the subject
property. The estimated value of the subject property is verified to the
comparable sales data. Only properties that satisfy this stage of the initial
underwriting process will be verified and forwarded to either the Company's
in-house or third party appraiser.
Branch appraisals are typically completed by in-house appraisers within two
days of the initial telemarketing contact. This appraisal, which provides a
valuable marketing opportunity, is the applicant's first face-to-face contact
with the branch representatives. Loan by Mail and Coast appraisals are completed
by a third party appraiser due to the centralized nature of their operations.
Senior appraisers at the Company's headquarters perform a desk review of the
property appraisal on the following loan applications: (i) all properties with a
market value above $250,000 or less than $100,000, (ii) all loans with a loan
amount of $150,000 or greater, (iii) all loan applications with a combined LTV
equal to or greater than 69%, (iv) all loan applications prepared by a new
branch office for the first 90 days of its existence, (v) all income properties,
and (vi) approximately 10% of the loan applications not otherwise reviewed.
The Company hires certified or licensed appraisers in those states which
require such designations. Individual branch office appraisers are rated and
compensated based on the ongoing quality of appraisals performed and the number
of sales appointments set. The Company monitors the performance of its
appraisers on a weekly and monthly basis.
In connection with each securitization of the Company's loans, independent
appraisers have conducted appraisals on a randomly selected sample of the
subject properties that are the collateral for the securitized loans. The
valuations of the sample properties determined by the Company's appraisers have,
on an average, been 0.69% more conservative than the valuations determined by
such independent appraisers.
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LOAN ORIGINATION OPERATIONS
The branch offices, Loan by Mail and Coast are responsible for completing
the sales process. It is the responsibility of the Company's staff to determine
the applicant's needs for financing, tailor a loan program to fit the
applicant's financial needs, perform preliminary underwriting and provide the
applicant a choice of loan products and detailed explanation of the various loan
terms. All loan officers of the Company utilize a loan origination software
system to determine an applicant's qualifications for the various products
offered by the Company. The loan origination software system incorporates the
Company's underwriting guidelines with respect to collateral, credit quality,
character, and capacity to repay. The loan officer or branch manager will run a
credit report for each applicant. The Company utilizes a mortgage rating and/or
credit score ("FICO Score") derived from a credit score model developed by an
independent third party. Based upon such factors, an applicant is preliminarily
designated as an "A" through "C" risk, with sub-ratings within each category.
The designation is reviewed by the Company's centralized quality control and
underwriting department before final approval.
The typical retail branch office consists of a branch manager, one or two
loan officers, one or two appraisers and one or two loan processors. Loan by
Mail is a centralized retail operation with an operations manager and several
loan officers. The operation of Coast is a hybrid of the retail branch and Loan
by Mail operations, whereby small branch offices are maintained with branch
managers and field representatives, yet the loan officers are centralized
similar to Loan by Mail.
Loan officers and branch managers are rated and compensated based on loans
funded. The Company strives to develop its loan officers and to promote the most
qualified loan officers to branch managers. The Company monitors the performance
of its loan officers and branch managers on a weekly and monthly basis.
LOAN ORIGINATION AND ACQUISITION THROUGH THIRD PARTY ORIGINATORS
The Company has historically augmented its loan production by purchasing
loans from other affiliated and unaffiliated originators. The Company and these
originators have entered into mortgage loan purchase agreements which require
specified minimum levels of experience in origination of non-conforming mortgage
loans and provide representations, warranties and buy-back provisions which are
substantially similar to the representations and warranties required of the
Company for the securitization of its own loan originations.
UNDERWRITING
The main underwriting and quality control functions are centralized at the
Company's headquarters. The most significant of the Company's underwriting
functions are performed by senior management. The Company maintains quality
control and underwriting departments. The Company strives to process each loan
application received from its branch office network as quickly as possible in
accordance with the Company's loan application approval procedures. Accordingly,
most loan applications receive decisions within three days of receipt and are
funded within 20 business days of approval.
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After a full review by the quality control department, each initial loan
application file is forwarded to the underwriting department for approval. Loans
that clearly conform to the Company's underwriting guidelines are approved at
the first level of review. Other loans that present more complicated
underwriting issues are reviewed by either the senior underwriting personnel or
the loan committee.
The decision of the underwriter to approve, decline or modify a loan is
based upon a number of factors, including the appraised value of the property,
the applicant's credit quality and the Company's perception of the applicant's
ability to repay the loan. With respect to the value of the collateral, loans
secured by first mortgages are generally limited to a maximum 85% combined LTV;
however, the Company will originate loans with a combined LTV of up to 100% for
loans expected to be sold on a whole loan basis. Loans secured by second
mortgages are limited to a maximum 75% combined LTV. The Company has established
classifications with respect to the credit profiles of loans and subject
properties based on certain of the applicant's characteristics. Each loan
application is placed into one of the Company's five ratings ("A" through "C,"
with subratings within those categories), depending upon the following primary
factors: (i) an applicant's mortgage rating, (ii) an applicant's FICO Score,
(iii) an applicant's derogatory and bankruptcy history, if any, and (iv)
combined LTVs. Terms of loans made by the Company vary depending upon the
classification of the application, the debt to income ratio, income verification
and other factors. Applications with lower classifications generally are subject
to higher interest rates due to the increased risk inherent in the loan.
The Company's underwriting staff has extensive experience in the
non-conforming loan origination industry. The management of the Company believes
that such experience provides the Company with the infrastructure to sustain and
maintain its commitment to a high standard of loan underwriting. The Company is
committed to applying consistent underwriting procedures and to training and
retaining experienced underwriting staff.
The table below indicates the minimum credit ratings and FICO score, and
maximum LTV by credit risk:
<TABLE>
<CAPTION>
"A" "A-" "B" "B-" "C"
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<S> <C> <C> <C> <C> <C>
Minimum Mortgage Rating (1) 0 x 30 2 x 30 2 x 30 4 x 30 1 x 120
0 x 60 1 x 60 1 x 60 or
or 1 x 90 12 x 30
4 x 30 or 12 x 60
0 x 60 4 x 30 12 x 90
2 x 60
0 x 90
Minimum FICO Score 650 620 590 550 500
Maximum LTV 85 85 85 80 70
</TABLE>
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(1) The mortgage rating is comprised of two components. The first component
represents the number of times the borrower has been delinquent,
whereas the second component represents the number of days delinquent.
For example, 2 x 30 represents a borrower who has been 30 days
delinquent twice.
In addition to the above criteria, the Company requires higher interest
rates on loans with certain risk factors. These factors include, among others,
an unsubstantiated employment history, a recent foreclosure proceeding, a number
of recent delinquent payments on an existing mortgage, a recent bankruptcy
filing, non-owner occupied properties, rural properties or the presence of a
senior mortgage or zoning restrictions on the subject property.
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The following table reflects the risk classifications of the Company's loan
originations and purchases in 1999:
<TABLE>
<CAPTION>
TOTAL WEIGHTED
(DOLLARS IN % OF AVERAGE INITIAL
LOAN CLASSIFICATION THOUSANDS) TOTAL INTEREST RATE
------------------------------------------------------ --------------- -------------- --------------
<S> <C> <C> <C>
"A" Risk (1)......................................... $ 317,793 65% 8.6%
"B" Risk (2)......................................... 119,141 25% 9.0%
"C" Risk............................................. 38,656 8% 10.0%
"D" Risk (3)......................................... 7,949 2% 10.9%
--------------- -------------- --------------
Total............................................ $ 483,539 100% 9.1%
=============== ============== ==============
</TABLE>
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(1) "A" risk includes categories of "A" and "A-"
(2) "B" risk includes categories of "B" and B-"
(3) During 1999, the Company originated certain loans which it classified
under a "D" credit risk rating. A "D" credit risk rating represented an
applicant with a minimum mortgage rating of 1 x 150, a minimum FICO
score of zero, and a maximum LTV of 65%. This credit risk rating is no
longer used by the Company.
LOAN ORIGINATIONS AND PURCHASES
The following table presents selected information relating to the
origination and purchase of loans by the Company for the years ended December
31:
<TABLE>
<CAPTION>
1999 1998 1997
-------------- ------------- -------------
<S> <C> <C> <C>
Type of property securing loan:
Single-family........................................................ 90% 89% 91%
Multi-family and other............................................... 10% 11% 9%
-------------- ------------- -------------
100% 100% 100%
============== ============= =============
Type of mortgage securing loan:
First lien........................................................... 99% 99% 99%
Junior lien.......................................................... 1% 1% 1%
-------------- ------------- -------------
Total.................................................................... 100% 100% 100%
============== ============= =============
Weighted average interest rate........................................... 9.1% 9.3% 9.5%
Weighted average initial combined LTV (1) ............................... 67.3% 65.3% 62.5%
</TABLE>
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(1) The LTV of a loan secured by a senior mortgage is determined by dividing
the amount of the loan by the appraised value of the mortgaged property
at origination. The combined LTV of a loan secured by any junior
mortgage is determined by taking the sum of the loans secured by such
mortgage and any senior mortgages and dividing by the appraised value of
the mortgaged property at origination.
LOAN SALES
SECURITIZATION
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, referred to as regular interest, 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.
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As the holder of the residual interest certificates, the Company is entitled
to receive certain excess cash flows. These excess cash flows are the difference
between (a) the principal and interest paid by borrowers and (b) the sum of (i)
scheduled principal and interest paid to holders of the regular interest
certificates, (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.
The Company arranges for credit enhancement to achieve an improved credit
rating on the regular interest certificates issued. This credit enhancement
generally takes the form of an insurance policy, issued by a monoline insurance
company, ensuring the holders of the regular interest certificates of timely
payment of scheduled principal and ultimate payment of scheduled interest at the
pass-through rate. In addition, the securitization trust structure typically
includes overcollateralization as an additional means of credit enhancement. The
purpose of the overcollateralization is to provide a source of payment in the
event of higher than anticipated loan losses. Overcollateralization requirements
may include an initial deposit, the sale of loans at less than par or retention
of distribution to the residual interest certificate holder until a specified
overcollateralization amount has been attained. This retention of excess cash
flow creates a faster amortization of the scheduled balance of the regular
interest certificates than the amortization of the principal balance of the
mortgage loans in the securitization pool. Losses resulting from defaults by
borrowers on a payment of principal or interest on the loans in the securitized
pool will reduce the overcollateralization to the extent that funds are
available and may result in a reduction in the value of the residual interest
certificates held by the Company. If payment defaults exceed the amount of
overcollateralization and excess cash flows, the insurance policy will pay any
further losses experienced by holders of the regular interest certificates in
the related securitization trust.
Generally, the Company sells loans to a securitization trust at face value,
except when it sells loans at less than par for overcollateralization purposes.
Loans are sold without recourse except for certain representations and
warranties provided by the Company. Under the terms of the pooling and servicing
agreements entered into in connection with a securitization, the Company may be
required either to repurchase or to replace loans that do not conform to such
representations and warranties. To date, the Company has not been required to
substitute or repurchase any such loans.
The Company retains the right to service loans it securitizes. In addition
to management servicing fees, the Company also receives prepayment penalties and
other ancillary servicing fees, such as late charges, NSF and reconveyance fees
on loans serviced.
WHOLE LOAN SALES
Certain loans originated by the Company are not chosen for inclusion in a
securitization. These loans may include loans with higher combined LTVs and/or
loans that have higher credit risk. The Company will originate these loans to
earn the origination fees and will then sell such loans to wholesale purchasers
with higher LTV risk tolerance on a servicing released basis. The Company
anticipates that it will continue to sell certain loans on a whole loan basis.
INTEREST RATE RISK MANAGEMENT
The Company's profitability is in part determined by the difference, or
"spread," between the interest rate on the loans originated or purchased by the
Company and the pass-through interest rates payable to regular interest
certificates issued in securitizations. Between the time of loan origination or
purchase 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 has implemented a hedging program designed to provide a level of
protection against the impact of rapid changes in interest rates on the value of
fixed rate loans from the time the Company commits to fund or purchase such
loans to the date of their securitization or sale. The Company does not hedge
the interest rate risk associated with holding adjustable rate mortgages pending
their securitization or sale due to the decreased significance of such risk as
the pass-through rates for regular interest certificates related to the
Company's adjustable rate mortgage pools are also adjustable.
8
<PAGE>
The Company may utilize various financial instruments in its hedging
activities. The nature and quantity of hedging transactions are determined by
the Company's management based on various factors, including market conditions
and the expected volume of mortgage loan originations and purchases. To decrease
market risk, only highly liquid instruments are utilized in the Company's
hedging activities. By their nature, however, all such instruments involve
risks, and the maximum potential loss may exceed the value at which such
instruments are carried. As is customary for these types of instruments, the
Company does not require collateral or other security from counterparties to
these instruments. The Company manages its credit exposure to counterparties
through credit approvals, credit limits and other monitoring procedures.
The Company's hedging program has been limited to selling short or forward
sales of United States Treasury securities and prefunding loan originations in
its securitizations. United States Treasury securities are utilized by the
Company due to the liquidity of the market for such securities and the high
degree of correlation between such securities and the pass-through interest
rates for regular interest certificates in the Company's fixed rate mortgage
pools. Prefunding allows the Company to fix the relationship between the
interest rates charged on the loans and the pass-through rates for the regular
interest certificates by permitting the Company to deliver loans to a
securitization trust after the date of its closing.
See Statement of Financial Accounting Standard No. 133, "Accounting for
Derivative Instruments and Hedging Activities," under the effects of recent
accounting pronouncements section.
SECURITIZATION RISK
A significant portion of the Company's revenues, income and cash flow is
generated through securitizations. The value of and market for the Company's
loans are dependent upon a number of factors, including general economic
conditions, interest rates and governmental regulations. Adverse changes in such
factors may affect the Company's ability to securitize loans for acceptable
prices within a reasonable period of time. A prolonged, substantial reduction in
the size of the securitization market for loans of the type originated or
purchased by the Company may adversely affect the Company's ability 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.
During the current year, less favorable market conditions led investors to
demand higher yields, which in turn reduced the Company's spread on its
securitizations. Consequently, the Company was required to provide up-front
overcollateralization in the form of cash of approximately $4.5 million related
to its two most recent securitizations. There can be no assurance that future
transactions will not require up-front overcollateralization.
The Company has relied on credit enhancement to achieve a "AAA/aaa" rating
for the regular interests of the trusts in its securitizations. The credit
enhancement has generally been in the form of an insurance policy issued by an
insurance company insuring the timely repayment of the regular interests in each
of the securitization trusts. There can be no assurance that the Company will be
able to obtain credit enhancement in any form from the current insurer or any
other provider of credit enhancement on acceptable terms or that future
securitizations will be similarly rated. A downgrading of the insurer's credit
rating or its withdrawal of credit enhancement could have a material adverse
effect on the Company's consolidated financial condition and consolidated
results of operations.
CREDIT FACILITY RISK
The Company funds substantially all of the loans it originates or purchases
through borrowings under its warehouse financing facilities and internally
generated funds. These borrowings are in turn repaid with the proceeds received
by the Company from selling such loans through loan sales or securitizations.
Any failure to renew or obtain adequate funding under those warehouse financing
facilities, or other borrowings, or any substantial reduction in the size of or
pricing in the markets for the Company's loans, could have a material adverse
effect on the Company's operations. To the extent that the Company is not
successful in maintaining or replacing existing financing, it would have to
curtail its loan production activities or sell loans earlier than is optimal,
thereby having a material adverse effect on the Company's consolidated financial
condition and consolidated results of operations.
9
<PAGE>
In October 1999, the Company extended its $150 million warehouse financing
facility, which was due to expire in December 1999, to December 2000. This
facility contains certain affirmative and negative covenants with which the
Company was in compliance as of December 31, 1999. 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.
LITIGATION RISK
In addition to being party to various legal proceedings arising out of the
ordinary course of business, the Company has also been involved with several
lawsuits, which have targeted its lending practices (see Item 3. Legal
Proceedings, below). Any substantial judgment against the Company in connection
therewith could have a material adverse effect on the Company's results of
operations and financial condition.
COMMITMENT RISK
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
24, 2000. The Company is currently disputing the terms of the obligation to
purchase the outstanding balance of the credit cards, and the parties have
sought arbitration of the dispute. Nevertheless, the Company is pursuing the
sale of the credit card portfolio and has discontinued the issuance of new
credit cards. There is, however, no assurance that the Company will either be
successful in its dispute against Fidelity or in selling the credit card
portfolio, which currently has an available credit line of approximately $22
million and an outstanding balance of approximately $16 million, or be able to
have the appropriate capital or financing in place to purchase these assets.
LOAN SERVICING
The Company retains the right to service the loans on behalf of the
different trusts established at the time of securitization. Loan servicing
includes collecting payments from borrowers, remitting payments to investors who
have purchased the certificates issued by the trusts, advancing delinquent
payments, and other advances as needed to protect the certificate holders,
investor reporting, accounting for principal and interest, contacting delinquent
borrowers, conducting foreclosure proceedings and disposing of foreclosed
properties. The Company's servicing portfolio included 10,581 loans with an
outstanding balance of approximately $892 million as of December 31, 1999. The
Company receives management servicing fees ranging from 0.5% to 2.0% per annum
for fixed rate loans and 0.5% to 1.0% per annum for adjustable rate loans, based
upon the outstanding principal balance of loans serviced.
10
<PAGE>
The following table reflects the classification of the Company's loan
service portfolio by state as of December 31, 1999:
<TABLE>
<CAPTION>
% OF TOTAL
NUMBER OF LOANS PRINCIPAL BALANCE PRINCIPAL BALANCE
------------------------ ------------------------- -------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
California........................ 4,575 $ 396,653 44%
New York.......................... 1,183 107,919 12
New Jersey........................ 919 79,249 9
Illinois.......................... 684 52,531 6
Washington........................ 458 40,924 5
Oregon............................ 331 28,493 3
Florida........................... 372 26,814 3
Others states..................... 2,059 159,744 18
------------------------ ------------------------- -------------------------
Total........................... 10,581 $ 892,327 100.00%
======================== ========================= =========================
</TABLE>
The Company has a computer-based loan servicing system that enables it to
provide effective and efficient processing of loans. The system, which is able
to service fixed and adjustable rate loans, provides the Company with, among
other things, payment processing, cashiering, collection and reporting
functions, as well as tracking and maintaining impound accounts and hazard and
flood insurance information. The Company's loan servicing software also allows
the Company to track and maintain impound accounts and hazard and flood
insurance information.
The Company believes its disciplined collection practices contribute to the
relatively low delinquency and loss rates on its servicing portfolio. The
following table illustrates the timeline of the Company's collection practices,
assuming (i) the loan is originated in California, and (ii) a ten-day grace
period applies by contract or under applicable law:
<TABLE>
<CAPTION>
TIME (1) EVENT
------------------------------------------------- -----------------------------------------------------------------
<S> <C>
1st day of the month............................ Borrower loan payment due.
11th day of the month........................... Payment not received is late.
12th day of the month........................... Notice of past due payment mailed to borrower.
20th day of the month........................... Notice of foreclosure mailed to borrower.
26th day of the month........................... Final notice mailed to borrower.
42 days after due date.......................... File forwarded to foreclosure department which records notice
of default after 45th day of delinquency.
After notice of default or similar notice is Borrower informed of status and Company's reinstatement period
recorded........................................ dates.
During the reinstatement period................. Pre-foreclosure property inspection and valuation performed.
End of the reinstatement period................. Notice of trustee's sale recorded and trustee's sale date
scheduled. Property sold to third party or acquired on behalf
of the Company or a securitization trust.
</TABLE>
- ----------------------
(1) In other states, the Company's collection procedures described above
may occur sooner or later depending upon applicable foreclosure
regulations.
The borrower is contacted by telephone prior to recording the notice of
default to inform the borrower of the situation. If the borrower does not bring
the loan current within the reinstatement period, a notice of sale is published
and a trustee's sale date is scheduled. During this period of time, the Company
performs a pre-foreclosure inspection and valuation of the property to determine
whether changes in the value of the property have occurred since the date of
origination. If the loan is not reinstated, the property is either sold to a
third party at the trustee's sale or acquired on behalf of the Company. The
Company forecloses as quickly as state regulations allow. The Company contracts
on a nationwide basis with several independent foreclosure service companies to
facilitate the foreclosure process for properties located outside California.
For loans originated within California, the Company performs all foreclosure
procedures internally. Properties acquired by the Company are managed with the
objective of immediate disposal.
11
<PAGE>
Regulation and practices regarding the foreclosure of properties and the
rights of the borrower in default vary greatly from jurisdiction to
jurisdiction. Loans originated by the Company are secured by mortgages, deeds of
trust, trust deeds, security deeds or deeds to secure debt, depending upon the
prevailing practice in the state in which the property securing the loan is
located. Depending on local law, foreclosure is effected by judicial action
and/or non-judicial sale, and is subject to various notice and filing
requirements. If foreclosure is effected by judicial action, the foreclosure
proceedings may take several months.
In general, the borrower, or any person having a junior encumbrance on the
real estate, may cure a monetary default by paying the entire amount in arrears
plus other costs and expenses incurred in enforcing the obligation during a
statutorily prescribed reinstatement period.
There are a number of restrictions that may limit the Company's ability to
foreclose on a property. A lender may not foreclose on the property securing a
junior mortgage loan unless it forecloses subject to each senior mortgage.
Moreover, if a borrower has filed for bankruptcy protection, a lender may be
stayed from exercising its foreclosure rights. Also, certain states provide a
homestead exemption that may restrict the ability of a lender to foreclose on
residential property. In such states, the Company requires the borrower to waive
his or her right of homestead as a requirement of the loan. Such waivers of
homestead rights may not be enforceable in certain states.
Although foreclosure sales are typically public sales, frequently no third
party purchaser bids in excess of the amount of the lender's lien. Such a lack
of bidding is due to several factors, including the possible deterioration of
the property during foreclosure proceedings and the requirement that the
purchaser pay for the property in cash or by cashier's check. Thus, the
foreclosing lender often purchases the property from the trustee and
subsequently re-markets the property. Depending upon market conditions, the
proceeds of the subsequent resale by the Company may not be adequate to cover
the investment in the loan.
CURRENT MARKETS AND EXPANSION PLANS
CURRENT MARKETS
The Company originates loans through its retail branch network, its Loan by
Mail division, and its newly acquired subsidiary, Coast. In all, as of December
31, 1999 the Company originated loans through 34 branch offices. Recently, the
Company implemented the concept of a centralized retail operation by
establishing a Loan by Mail division. This concept allows the Company to
maintain its retail loan origination strategy without having the overhead costs
associated with operating a traditional retail branch office. The Company
believes that originating loans through an extensive retail branch office
network not only results in the most profitable loan origination strategy due to
the significant level of loan origination fees earned by the Company, but also
results in low delinquencies and losses due to the Company's conservative
underwriting criteria.
Although the Company is licensed to originate loans in 18 states and the
District of Columbia, its business has historically been concentrated in
California. California remains a significant part of the Company's business and
contributed 39% of the Company's total loan originations and purchases for 1999.
12
<PAGE>
The following table shows the geographic distribution of the Company's loan
originations and purchases for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
United States:
California............................................................. 39% 26% 21%
New York............................................................... 13 10 13
Illinois............................................................... 7 8 11
New Jersey............................................................. 12 12 9
Washington............................................................. 4 4 7
Oregon................................................................. 3 4 5
Florida................................................................ 2 2 4
Colorado............................................................... 4 3 4
Others states.......................................................... 16 23 20
United Kingdom (1)......................................................... 0 8 6
------------ ------------ ------------
Total................................................................ 100% 100% 100%
============ ============ ============
</TABLE>
(1) The Company discontinued its United Kingdom loan origination operation
in 1998.
NATIONAL GEOGRAPHIC EXPANSION
The Company intends to continue to expand its existing branch office network
in markets that will provide the Company the possibility of growth and
profitability. The Company's expansion strategy involves (i) identifying areas
with demographic statistics comparable to existing markets in which the Company
has been successful in originating loans, (ii) understanding each new market's
regulatory requirements and tailoring the Company's loan programs and practices
to comply with such requirements, and (iii) identifying and training branch
managers and loan officers for each new branch office. Expansion in the future
may not only be accomplished through an increase in branch office presence, but
the Company also intends to reach expansion through its centralized Loan by Mail
division. In addition, the Company is in the process of expanding its
origination volume by accessing brokers through its E-Wholesale division, which
is expected to be operational in April 2000.
The Company believes that its products and services are best suited for
those housing markets with home values near the nation's averages. After
identifying a potential new market, the Company contracts with regional or
national companies to gather publicly available information with respect to that
market and to integrate such information with the Company's proprietary
marketing methodology. The Company produces a list of Homeowners whom the
Company believes, based on its historic customer profile, are likely to utilize
the Company's products and services and satisfy the Company's underwriting
guidelines. The Company then focuses its marketing efforts on these Homeowners
in each new market.
The Company has generally entered into short-term leases for its branch
offices. Additionally, the Company generally recruits and hires the personnel
required to staff its branch offices from the area near the new market. Branch
managers of new branch offices are generally branch managers of existing offices
or loan officers promoted from existing branch offices.
The Company's branch office expansion strategy is dependent upon the
Company's ability to obtain new and renew state lending licenses.
COMPETITION
As a consumer finance company, the Company faces intense competition from
other mortgage banking companies, mortgage brokers, commercial banks, credit
unions, thrift institutions, credit card issuers and finance companies. Many of
these competitors in the consumer finance business are substantially larger and
have considerably greater financial, technical and marketing resources than the
Company. Competition can take many forms including convenience in obtaining a
loan, customer service, marketing and distribution channels, amount of the loan,
loan origination fees and interest rates. Such competition increases the
likelihood of earlier prepayments through refinancing and could have a material
effect on the Company's results of operations and financial condition. In
addition, competition could also result in the origination or purchase of loans
with lower interest rates and higher LTVs, which could have a material adverse
effect on the Company's results of operations and financial condition.
13
<PAGE>
The Company believes that its 1999 record has proven that it is able to
compete on the basis of providing prompt and responsive service, consistent
underwriting and competitive loan programs to borrowers whose needs are not met
by conventional lending institutions.
REGULATION
The Company's business is subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities, and is subject
to various laws, judicial and administrative decisions imposing regulation on
all or part of its operations. Regulated matters include loan origination,
credit activities, maximum interest rates and finance and other charges,
disclosure to customers, terms of secured transactions, the collection,
repossession and claims handling procedures utilized by the Company, multiple
qualification and licensing requirements for doing business in various
jurisdictions and other trade practices.
Failure to comply with these regulations can lead to loss of approved
status, termination or suspension of servicing contracts (potentially without
compensation to the servicer), class action lawsuits and administrative
enforcement action. The Company believes, however, that it is in compliance with
applicable federal and state laws and regulations.
TRUTH IN LENDING
The Truth in Lending Act ("TILA") and Regulation Z promulgated thereunder
contain certain disclosure requirements designed to provide consumers with
uniform, understandable information with respect to the terms and conditions of
loans and credit transactions in order to give them the ability to compare
credit terms. TILA also guarantees consumers a three day right to cancel certain
credit transactions including loans of the type originated by the Company.
Management of the Company believes that it is in compliance with TILA in all
material respects. If the Company were found not to be in compliance with TILA,
aggrieved borrowers could have the right to rescind their loans and to demand,
among other things, the return of finance charges and fees paid to the Company.
In September 1994, the Riegle Act was enacted. Among other things, the
Riegle Act makes certain amendments to TILA (the "TILA Amendments"). The TILA
Amendments generally apply to mortgage loans (other than mortgage loans to
finance the acquisition or initial construction of a dwelling) with (i) total
loan origination fees and other fees upon origination in excess of the greater
of eight percent of the total loan amount or a certain dollar amount (currently
$435) or (ii) an annual percentage rate of more than ten percentage points
higher than comparably maturing U.S. Treasury securities ("Covered Loans"). The
Company estimates that the majority of the loans currently originated and a
portion of the loans purchased by the Company are Covered Loans.
The TILA Amendments impose additional disclosure requirements on lenders
originating Covered Loans and prohibits lenders from engaging in a pattern or
practice of originating Covered Loans that are underwritten solely on the basis
of the borrower's home equity without regard to the borrower's ability to repay
the loan. Consistent with its underwriting practices with respect to all loans,
the Company applies to all Covered Loans underwriting criteria that take into
consideration the borrower's ability to repay.
The TILA Amendments also prohibit lenders from including prepayment fee
clauses in Covered Loans to borrowers with a monthly debt-to-income ratio in
excess of 50% or Covered Loans used to refinance existing loans originated by
the same lender or an affiliate of such lender. The Company reported $3.3
million, $4.3 million and $3.5 million in prepayment fee revenue in fiscal year
1999, 1998 and 1997, respectively. The Company will continue to collect
prepayment fees on loans originated prior to the October 1995 effectiveness of
the TILA Amendments and on non-Covered Loans as well as on Covered Loans in
permitted circumstances. Compliance with the TILA Amendments may cause the level
of prepayment fee revenue to decline in future years. The TILA Amendments impose
other restrictions on Covered Loans, including restrictions on balloon payments
and negative amortization features, which the Company does not believe will have
a material impact on its operations.
14
<PAGE>
OTHER LENDING LAWS
The Company is also required to comply with the Equal Credit Opportunity Act
of 1974, as amended ("ECOA"), which prohibits creditors from discriminating
against applicants on certain prohibited bases, including race, color, religion,
national origin, sex, age or marital status. Regulation B promulgated under ECOA
restricts creditors from obtaining certain types of information from loan
applicants. Among other things, it also requires certain disclosures by the
lender regarding consumer rights and requires lenders to advise applicants of
the reasons for any credit denial. In instances where the applicant is denied
credit or the rate or charge for loans increases as a result of information
obtained from a consumer credit agency, another statute, the Fair Credit
Reporting Act of 1970, as amended, requires lenders to supply the applicant with
the name and address of the reporting agency. In addition, the Company is
subject to the Fair Housing Act, which broadly prohibits certain discriminatory
practices in connection with the Company's business. The Company is also subject
to the Real Estate Settlement Procedures Act of 1974, as amended, and
regulations thereunder.
There is currently pending new proposed legislation in certain states
related to limiting the amount of origination fees and interest rates that a
lender may assess a borrower. The passage of this proposed legislation may have
a material adverse effect on the Company's results of operations and financial
condition.
In addition, the Company is subject to various other federal and state laws,
rules and regulations governing among other things, the licensing of, and
procedures that must be followed by, mortgage lenders and servicers, and
disclosures that must be made to consumer borrowers. Failure to comply with such
laws, as well as with the laws described above, may result in civil and criminal
liability. These laws are constantly changing. As a mortgage lender, the Company
has been, and expects to continue to be, subject to regulatory enforcement
actions and private causes of action from time to time with respect to its
compliance with applicable laws and regulations. The Company's lending practices
have in the past been and currently are under regulatory review by various state
authorities. Although the Company utilizes systems and procedures to facilitate
compliance with these legal requirements and believes that it is in compliance
in all material respects with applicable laws, rules and regulations, there can
be no assurance that more restrictive laws, rules and regulations will not be
adopted in the future, or that existing laws and regulations will not be
interpreted in a more restrictive manner, which could make compliance more
difficult or expensive.
INSURANCE REGULATORY LAWS
As a condition to funding its loans, the Company requires each borrower to
obtain and maintain a policy of insurance providing coverage, at an amount equal
to the greater of the replacement cost or loan amount, for improvements on any
real property securing the borrower's loan. If the borrower fails to provide
such coverage prior to closing of the borrower's loan or if the borrower's
coverage is subsequently canceled or not renewed at any time during the loan
period and the borrower fails to obtain new coverage, the Company will provide
coverage on the borrower's behalf under policies insuring the Company's interest
in the collateral. Such practice is commonly referred to as "forced placement"
of insurance.
Insurance which is force placed is subject to regulation under TILA, the
National Flood Insurance Act, and state insurance regulatory and lender
statutes. Such laws and regulations generally impose disclosure and notice
requirements which must be satisfied prior to forced placement of coverage,
limitations on the amount of coverage that a lender may obtain to protect its
interest in the collateral.
Failure to comply with any of the foregoing federal and state laws and
regulations could result in the imposition of civil penalties on the Company,
class action lawsuits and administrative enforcement actions.
ENVIRONMENTAL MATTERS
To date, the Company has not been required to perform any investigation or
clean up activities, nor has it been subject to any environmental claims. There
can be no assurance, however, that this will remain the case in the future.
15
<PAGE>
In the ordinary course of its business, the Company, generally on behalf of
the REMIC trusts, has acquired and may acquire in the future properties securing
loans that are in default. Although the Company primarily lends to owners of
residential properties, there is a risk that the Company could be required to
investigate and clean up hazardous or toxic substances or chemical releases at
such properties after acquisition by the Company, and may be held liable to a
governmental entity or to third parties for property damage, personal injury and
investigation and cleanup costs incurred by such parties in connection with the
contamination. In addition, the owner or former owners of a contaminated site
may be subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from such property.
EMPLOYEES
As of December 31, 1999 the Company had a total of 482 employees, of which
264 employees were located at its corporate headquarters and its telemarketing
facility, which are both located in Irvine, California. None of the Company
employees is covered by a collective bargaining agreement. The Company considers
its relations with its employees to be good.
ITEM 2. PROPERTIES
The Company's corporate headquarters are located at 17305 Von Karman Avenue,
Irvine, California 92614-6203, where the Company leases from a partnership
beneficially owned by Brian and Sarah Chisick approximately 40,000 square feet
of office space. The lease expires on January 31, 2003, and the Company has an
option to renew the lease for five years. The Company also leases office space
for its 45 branch offices. Ten of such branches are non-operating, for which the
Company is in the process of sub-leasing or completing a lease buy-out. The
average size of these branch offices is approximately 1,700 square feet, with an
annual average base rent of approximately $37,000. In 1997 the Company purchased
an office building located at 17200 Jamboree Road, Irvine, California 92614,
with approximately 40,000 square feet of office space, for use as a
telemarketing center and a mail processing center, and subsequently refinanced
the building in February 1999. The annual principal and interest payment related
to this property is approximately $342,000. The loan matures on March 21, 2009,
at which time a balloon payment of $2.5 million is due. The Company believes its
facilities are both suitable and adequate for the current business activities
conducted at its corporate headquarters and at its existing branch offices.
ITEM 3. 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.
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, which is cooperating with the
investigation.
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.
16
<PAGE>
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. The Company and the
State are currently discussing settlement.
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, and the
parties are discussing settlement.
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
24, 2000. The Company is currently disputing the terms of the obligation to
purchase the outstanding balance of the credit cards, and the parties have
sought arbitration of the dispute.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the quarter ended December 31, 1999.
17
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
In July 1996, the Company's Class A Common Stock began trading under the
symbol FACO on the NASDAQ National Market. The following table sets forth the
range of high and low closing sale prices of the Company's Class A Common Stock
for the periods indicated:
<TABLE>
<CAPTION>
High Low
---------------------- ----------------------
1999
<S> <C> <C>
First Quarter........................................................... 5 11/16 2 11/16
Second Quarter.......................................................... 4 3/8 2 15/16
Third Quarter........................................................... 3 7/16 1 3/4
Fourth Quarter......................................................... 3 7/16 1 5/16
1998
First Quarter........................................................... 18 1/2 12 7/8
Second Quarter.......................................................... 17 3/8 7
Third Quarter........................................................... 10 3/8 6
Fourth Quarter......................................................... 6 1/4 2 3/8
1997
First Quarter.......................................................... 20 1/6 15
Second Quarter......................................................... 19 1/2 12 1/6
Third Quarter.......................................................... 21 11/12 18 1/6
Fourth Quarter......................................................... 23 43/64 15 1/2
</TABLE>
No cash dividends were declared during the period covered by the above
table. On October 31, 1997, the Company paid a stock dividend of 1 share for
every 2 shares of Class A and Class B Common Stock held by holders of record on
October 15, 1997. The above sales prices of Class A Common Stock have been
retroactively adjusted to reflect this stock dividend as a stock split. The
Company does not anticipate declaring cash dividends in the near future.
In July 1998, the Company announced that its majority stockholders, Brian
and Sarah Chisick, converted all of their Class B Common Stock, to which four
votes per share applies in matters requiring a stockholder vote, into Class A
Common Stock, which carries one vote per share. The Company, subject to
shareholder approval on April 27, 2000, will amend its Certificate of
Incorporation, which will convert the Class A and Class B Common Stock to one
class, referred to as "Common Stock."
As partial consideration for obtaining its $150 million warehouse financing
facility, the Company granted the warehouse lender stock warrants during both
1998 and 1999. The stock warrants granted in 1998 provide the lender the option
to purchase 1% of the Company's then outstanding common stock, with an effective
date of January 15, 2001. The original effective date of the 1998 warrants was
amended in 1999 from February 15, 1999. These warrants have a 10-year exercise
period and were granted at an exercise price of $3 5/16. The stock warrants
granted in 1999 provide the warehouse lender the option to purchase 4.9% of the
Company's then outstanding common stock, with an effective date of January 15,
2000. These warrants have a 10-year exercise period and were granted at an
exercise price of $2.00.
In July 1996, the shareholders of the Company approved a Stock Incentive
Plan for directors, officers and other key employees of the Company, under which
2,125,000 shares of Class A Common Stock were available for grant. Subject to
shareholder approval on April 27, 2000, the Company will increase its number of
shares available for grant by 1,000,000, thereby increasing the total shares to
3,125,000. Under the plan, Options vest 25% six months from the date of grant,
and 25% each year thereafter until fully vested, and expire on the earlier of
ten years from the date of grant or 90 days after an optionee's termination of
service. The Company granted 1,298,877 shares under this plan during 1999 at an
average exercise price of $3.26. The balance of outstanding and unexercised
options as of December 31, 1999 was 1,996,289, with an average exercise price of
$6.04.
18
<PAGE>
As of December 31, 1999, Brian Chisick, Chairman of the Board and chief
executive officer and a director of the Company, and Sarah Chisick, a director
of the Company, are the beneficial owners of 12,391,867 outstanding shares of
Class A Common Stock, constituting approximately 69.0% of the Company's
outstanding voting power.
In April 1997, the Board of Directors approved a share repurchase program
under which the Company was authorized to purchase up to 1.5 million shares of
its Class A Common Stock. In January 1998 and July 1998, the Board of Directors
authorized the purchase of an additional 2.0 million shares and 4.0 million
shares of Class A Common Stock, respectively. Of the 7.5 million shares
authorized, the Company had repurchased approximately 4.2 million shares as of
December 31, 1999.
On February 1, 2000, the Company had approximately 17 stockholders of record
of its Class A Common Stock. The Company believes its Class A Common Stock is
beneficially held by more than 1,200 stockholders.
19
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
FIRST ALLIANCE CORPORATION
SELECTED CONSOLIDATED FINANCIAL DATA
<CAPTION>
1999 1998 1997 1996(1) 1995
----------- ----------- ----------- ----------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Gain (loss) on sale of loans..........................$ 12,288 $ 10,699 $ 22,644 $ 10,965 $ 8,982
Net loan origination and other fees................... 41,239 44,252 44,034 37,206 26,484
Interest revenue...................................... 14,024 21,754 21,396 13,562 14,624
Loan servicing and other fees revenue................. 2,388 7,103 7,575 8,854 8,614
Total revenue......................................... 69,939 83,808 95,649 70,871 58,880
Interest expense...................................... 11,180 8,382 3,164 2,655 4,167
Non-interest expense.................................. 52,381 52,473 39,840 29,977 23,693
Income before income tax provision.................... 6,378 22,953 52,645 38,239 31,020
Net income............................................ 3,828 14,216 32,772 32,139 30,542
Basic net income per share............................ 0.21 0.73 1.50 1.72 1.91
Diluted net income per share.......................... 0.21 0.73 1.49 1.72 1.91
Pro forma net income (2).............................. 22,562 18,302
Pro forma diluted net income per share (2) ........... 1.02 0.83
Income before income tax provision as a % of revenue.. 9.1% 27.4% 55.0% 54.0% 52.7%
Dividends declared (3) ............................... $ 60,080 $ 12,205
STATEMENT OF FINANCIAL CONDITION DATA:
Cash and cash equivalents ............................$ 15,086 $ 18,052 $ 14,032 $ 27,414 $ 4,019
Loans held for sale .................................. 19,782 24,421 54,872 11,023 24,744
Loans receivable held for investment (4).............. 1,521 57,667 2,082 2,432 2,261
Residual interests.................................... 48,222 48,720 50,238 29,253 19,705
Mortgage servicing rights............................. 8,673 10,033 9,240 6,025 4,021
Total assets.......................................... 112,154 177,603 158,147 87,457 66,911
Total borrowings...................................... 18,748 88,818 57,767 131 19,356
Stockholders' equity ................................. 79,105 74,587 91,277 77,978 42,321
OTHER DATA:
Loan originations and purchases:
Retail originations.................................$ 410,040 $ 458,788 $ 398,359 $ 291,807 $ 216,566
Coast Security Mortgage............................. 47,855
Loan by Mail........................................ 16,012
Wholesale purchases................................. 9,632 74,805 130,151 32,681 24,078
----------- ----------- ----------- ----------- -----------
Total ...........................................$ 483,539 $ 533,593 $ 528,510 $ 324,488 $ 240,644
=========== =========== =========== =========== ===========
Average origination loan size.........................$ 108 $ 94 $ 88 $ 83 $ 70
Number of operating branches.......................... 35 32 33 23 17
Weighted average interest rate on loan originations
and purchases....................................... 9.1% 9.3% 9.5% 9.6% 10.3%
Weighted average initial combined loan-to-value ratio 67.3% 65.3% 62.5% 62.2% 59.3%
Loan sales:
Securitizations......................................$ 429,990 $ 430,003 $ 339,005 $ 267,661 $ 167,974
Whole loan sales..................................... 130,872 154,111 144,633 71,864 65,251
----------- ----------- ----------- ----------- -----------
Total ...........................................$ 560,862 $ 584,114 $ 483,638 $ 339,525 $ 233,225
=========== =========== =========== =========== ===========
Servicing portfolio (5) ..............................$ 892,327 $ 865,663 $ 799,085 $ 641,191 $ 613,791
Total delinquencies as a % of the servicing portfolio. 3.5% 4.8% 4.1% 5.5% 5.8%
Real estate owned (6).................................$ 1,141 $ 2,063 $ 1,688 $ 3,951 $ 7,854
Real estate owned as a % of the servicing portfolio... 0.1% 0.2% 0.2% 0.6% 1.3%
Losses on real estate owned as a % of the average
servicing portfolio during the period................ 0.15% 0.12% 0.24% 0.35% 0.03%
</TABLE>
- ----------------------
(1) During 1996, the Company completed the IPO whereby 6,037,500 shares of
Class A Common Stock were issued and the Company changed its tax status
from that of an S corporation to that of a C corporation. The Company
received $63 million of net proceeds from the IPO, of which $45 million was
used to pay the S distribution notes.
(2) Pro forma amounts reflect adjustments for federal and state income taxes as
if the Company had been taxed as a C corporation rather than an S
corporation. The Company ceased to be an S corporation concurrent with the
IPO in July 1996.
(3) Included in dividends in 1996 is $45 million of S distribution dividends
made in the form of the S distribution notes. Historical dividends include
dividends used by the stockholders to pay income taxes on the Company's S
corporation earnings and are not indicative of the Company's present
dividend policy.
(4) During 1998, the Company discontinued its United Kingdom loan originations.
Accordingly, the Company had reclassified approximately $57 million of such
loans from loans held for sale to loans receivable held for investment at
December 31, 1998. In July 1999, the Company sold its entire portfolio of
United Kingdom loans.
(5) In July 1999, the Company sold its entire servicing portfolio of United
Kingdom loans of approximately $48.7 million. The United Kingdom portfolio
represents approximately $29.4 million and $63.6 million of the total
servicing portfolio balance at December 31, 1997 and 1998, respectively.
(6) 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.
20
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
GENERAL
The Company is a financial services organization principally engaged in
mortgage loan origination, purchases, sales and servicing. Loans originated by
the Company primarily consist of fixed and adjustable rate loans secured by
first mortgages on single family residences. The Company originates loans
through its retail branch network and its Loan by Mail division which, as of
December 31, 1999, are comprised of 25 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, and
one of which is located in each of Arizona, Colorado, Maryland, Oregon, Utah and
Washington. Additionally, as of December 31, 1999, the Company maintained ten
small offices (two of which are located in California and Maryland, and one of
which is located in each of Colorado, Illinois, Ohio, Oregon, Pennsylvania and
Utah) with respect to its newly acquired subsidiary, Coast (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.
During 1999, the Company implemented several initiatives in line with its
strategic objectives. These initiatives included the acquisition of Coast,
implementation of a Loan by Mail division, and the creation of an E-Commerce
operation. Additionally, the Company completely exited the United Kingdom
origination operations by selling its portfolio of United Kingdom loans, and is
currently pursuing the sale of its credit card portfolio.
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 $4.1 million was finalized
subject to customary indemnification, monetary holdbacks and an independent
third party evaluation regarding 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 Loan by Mail concept, which was implemented in June 1999, allows the
Company to function as a centralized retail operation, while maintaining its
retail loan origination strategy. The Company has not incurred significant
implementation costs associated with this division.
The E-Commerce initiative will establish a presence in the Internet mortgage
origination arena and will be comprised of two channels. The first is E-Commerce
Consumer Direct, which is currently utilizing banner advertising campaigns
located on various web sites as a mechanism to obtain loan leads. In addition,
the Company is currently developing its own web site portal. These loan leads
are eventually converted into loans or sold to a third party loan originator.
The second initiative is E-Commerce Wholesale, which will allow the Company to
build national wholesale lending and whereby mortgage brokers may apply for a
loan through the Company's web site. The E-Commerce Wholesale initiative is
expected to be operational in April 2000. The utilization of these E-Commerce
initiatives will allow the Company to originate, approve, process and fund
mortgage loans at a lower cost with greater efficiency and convenience. The
Company incurred approximately $667,000 in implementation costs associated with
these initiatives.
In July 1999, the Company sold its portfolio of United Kingdom loans. The
sale of such assets was an opportunity presented to the Company, which 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.
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
24, 2000. The Company is currently disputing the terms of the obligation to
purchase the outstanding balance of the credit cards, and the parties have
sought arbitration of the dispute. Nevertheless, the Company is pursuing the
sale of the credit card portfolio and has discontinued the issuance of new
credit cards. There is, however, no assurance that the Company will either be
21
<PAGE>
successful in its dispute against Fidelity or in selling the credit card
portfolio, which currently has an available credit line of approximately $22
million and an outstanding balance of approximately $16 million, by the
obligation date or be able to have the appropriate capital or financing in place
to purchase these assets. During 1999, the Company incurred a net loss,
including a $1.6 million negative valuation adjustment, of $2.5 million
associated with this program.
During 1999, the Company closed ten unprofitable retail branch offices and
opened two retail branch offices. Accordingly, the Company has recorded lease
obligation reserves related to such properties. Additionally, the Company
experienced a significant increase in legal expenses during the year related to
legal settlement agreements, and an increase in attorneys' fees and reserves
related to the ongoing legal matters.
REVENUE
The three primary components of the Company's revenues are loan origination
and sale, loan servicing and other fees and interest income.
Loan origination and sale revenue consists of gain on sale of loans and the
recognition of net origination fees. Gain on sale from securitizations
represents approximately 23% of total loan origination and sale revenue, while
recognition of net origination fees represents the remaining 77%. 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. The Company has reduced its weighted average origination fees from 14.8%
during 1997 to 13.5% during 1998, and 10.4% during 1999. 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 be positive in the future.
Loan servicing and other fee income represent management servicing fees and
other ancillary fees, including prepayment penalties, received from servicing
loans and income generated from the Company's credit card operations, which was
discontinued in late 1998. Mortgage servicing rights are amortized against loan
servicing and other fee income over the period of estimated net future servicing
fee income.
Interest and other income is primarily comprised of three components: (i)
interest on loans held for sale during the warehousing period and loans
receivable held for investment, (ii) interest on residual interests, and (iii)
interest from investments.
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, referred to as regular interest, 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.
RESIDUAL INTEREST
As the holder of the residual interest certificates, the Company is entitled
to receive certain excess cash flows. These excess cash flows are the difference
between (a) the principal and interest paid by borrowers and (b) the sum of (i)
scheduled principal and interest paid to holders of the regular interest
certificates, (ii) trustee fees, (iii) third-party credit enhancement fees, (iv)
servicing fees and (v) loan losses. The Company begins receiving these excess
cash flows after certain overcollateralization requirements, which are specific
to each securitization and are used as a means of credit enhancement, have been
met.
Gains on servicing retained sales of loans through securitization represent
the difference between the net proceeds to the Company in the securitization and
the allocated cost of loans securitized. In accordance with SFAS No. 125, the
allocated cost of the loans securitized is determined by allocating their
acquisition cost (for purchased loans) or net carrying value (for originated
loans) between the loans securitized and the residual interests and the mortgage
servicing rights retained by the Company based upon their relative fair values.
At origination, the Company classifies the residual interests as trading
securities, which are carried at fair value.
22
<PAGE>
As the holder of the residual interest, the Company is entitled to receive
certain excess cash flows. These excess cash flows ("spread") 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 fair 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. To the Company's
knowledge, there is no active market for the sale of the residual interest. As
of December 31, 1999, the Company's investment in residual interest totaled
$48.2 million.
The Company utilized the following key assumptions to value its residual
interest certificates originated during 1999 and 1998:
<TABLE>
<CAPTION>
----------------------------------------- -------------------------------------------
1999 1998
----------------------------------------- -------------------------------------------
Fixed Rate Adjustable Fixed Rate Adjustable
Loans Rate Loans Total Loans Rate Loans Total
----------------------------------------- -------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Weighted average CPR.................... 29% 39% 34% 26% 40% 30%
Weighted average discount rate.......... 18% 18% 18% 17% 16% 17%
Weighted average annualized credit
losses - in basis points............. 50 50 50 56 48 53
Weighted average life (in years)........ 2.90 1.99 2.43 3.30 1.94 2.86
</TABLE>
The Company utilized the following assumptions to re-value its residual
interest for all outstanding securitization at year end:
<TABLE>
<CAPTION>
----------------------------------------- -------------------------------------------
1999 1998
----------------------------------------- -------------------------------------------
Fixed Rate Adjustable Fixed Rate Adjustable
Loans Rate Loans Total Loans Rate Loans Total
----------------------------------------- --------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Weighted average CPR.................... 28% 44% 34% 27% 49% 35%
Weighted average discount rate.......... 17% 17% 17% 16% 15% 15%
Weighted average annualized credit
Losses - in basis points............. 51 86 64 57 76 64
Weighted average life (in years)........ 3.03 1.83 2.58 3.19 1.59 2.63
Fair value of residual interest at year
end.................................. $24,927 $23,295 $48,222 $25,341 $23,379 $48,720
</TABLE>
23
<PAGE>
A sensitivity analysis as to an adverse impact on the 1999 year end fair
value of residual interest based on certain changes to the key assumptions is as
follows:
<TABLE>
<CAPTION>
---------------------------------------------
1999
---------------------------------------------
Fixed Rate Adjustable
Loans Rate Loans Total
------------- ------------- -------------
<S> <C> <C> <C>
SENSITIVITY AS TO WEIGHTED AVERAGE CPRS
Adverse impact on fair value as to a 5% increase in weighted average CPR...... $ 1,602 $ 1,307 $ 2,909
Adverse impact on fair value as to a 10% increase in weighted average CPR..... 2,823 2,389 5,212
SENSITIVITY AS TO DISCOUNT RATES
Adverse impact on fair value as to a weighted average discount rate of 18%.... 838 664 1,502
Adverse impact on fair value as to a weighted average discount rate of 20%.... 1,845 1,644 3,489
SENSITIVITY AS TO ANNUALIZED CREDIT LOSSES
Adverse impact on fair value as to a 10 basis point increase in weighted
average credit losses..................................................... 1,211 537 1,748
Adverse impact on fair value as to a 20 basis point increase in weighted
average credit losses..................................................... 2,292 964 3,256
SENSITIVITY AS TO LIBOR
Adverse impact on fair value as to a 0.5% increase in LIBOR................... N/A 1,351 1,351
Adverse impact on fair value as to a 1.0% increase in LIBOR................... N/A 2,670 2,670
</TABLE>
MORTGAGE SERVICING RIGHTS
Upon securitization or sale of servicing retained loans, the Company
capitalizes the cost associated with the right to service mortgage loans based
on a fair value analysis of the mortgage servicing rights. The Company
determines the fair value of mortgage servicing rights based on the present
value of estimated net future cash flows related to servicing income. Such cash
flow projections incorporate assumptions, including servicing costs, prepayment
rates and discount rates, consistent with those an unrelated third party would
utilize to value such mortgage servicing rights. These assumptions are similar
to those used by the Company to value residual interests. The Company
periodically evaluates capitalized mortgage servicing rights for impairment,
which is measured as the excess of unamortized cost over fair value. This review
is performed on a disaggregated basis by loan type. As of December 31, 1999,
mortgage servicing rights totaled $8.7 million.
Gains on servicing released whole loan sales equal the difference between
the net proceeds to the Company from the sale and the loans acquisition cost
(for purchased loans) or net carrying value (for originated loans). The net
carrying value of originated loans is equal to the principal balance less net
deferred origination fees.
24
<PAGE>
<TABLE>
LOAN ORIGINATION AND PURCHASES
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1997
------------- ------------- -------------
(Dollars in thousands)
<S> <C> <C> <C>
Loan originations and purchases:
Retail originations....................................................$ 410,040 $ 458,788 $ 398,359
Coast Security Mortgage................................................ 47,855
Loan by Mail........................................................... 16,012
Wholesale purchases.................................................... 9,632 74,805 130,151
------------- ------------- -------------
Total originations and purchases..................................$ 483,539 $ 533,593 $ 528,510
============= ============= =============
Number of operating branches as of the end of the period:
United States:
California .......................................................... 12 8 7
Other States......................................................... 23 24 22
United Kingdom......................................................... 0 0 4
------------- ------------- -------------
Total ............................................................ 35 32 33
============= ============= =============
Weighted average initial interest rate..................................... 9.1% 9.3% 9.5%
Weighted average initial combined loan-to-value ratio...................... 67.3% 65.3% 62.5%
Weighted average loan origination and processing fees
as a percent of originations........................................... 10.4% 13.5% 14.8%
Average origination loan size..............................................$ 108 $ 94 $ 88
</TABLE>
Total originations and purchases decreased 9% in 1999 and increased by 1% in
1998. Originations increased 3% in 1999 and 15% in 1998, and were partially
offset by decreases of 87% and 43% in wholesale purchases during the same
periods. The increase in originations in 1999 was primarily due to volume
generated by Coast, a subsidiary purchased by the Company during the year, while
the increase in originations during 1998 was primarily attributable to new
retail branch offices during 1998 and 1997. The decrease in wholesale purchases
in 1999 and 1998 is due to the discontinuation of the Company's low LTV purchase
program in 1998.
<TABLE>
LOAN SALES
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------
1999 1998 1997
------------- ------------- -------------
(Dollars in thousands)
<S> <C> <C> <C>
Securitizations............................................................$ 429,990 $ 430,003 $ 339,005
United Kingdom whole loan sales............................................ 47,028
Domestic whole loan sales ................................................ 83,844 154,111 144,633
------------- ------------- -------------
Total .................................................................$ 560,862 $ 584,114 $ 483,638
============= ============= =============
</TABLE>
Loan sales, including securitization, decreased 4% in 1999 and increased 21%
in 1998. The decrease in loan sales during 1999 is attributable to lower
purchases volume. The increase in loan sales during 1998 is due to a large
balance of loans held for sale at the end of 1997, as well as higher origination
and purchases volume.
25
<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 years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
-------------- -------------- --------------
<S> <C> <C> <C>
REVENUE:
Loan origination and sale:
Gain (loss) on sale of loans........................................ 17.6% 12.8% 23.7%
Net loan origination and other fees................................. 59.0 52.8 46.0
Interest.............................................................. 20.1 26.0 22.4
Loan servicing and other fees......................................... 3.3 8.4 7.9
-------------- -------------- --------------
Total revenue....................................................... 100.0 100.0 100.0
-------------- -------------- --------------
EXPENSE:
Compensation and benefits............................................. 32.7 27.3 20.2
Advertising .......................................................... 10.3 11.2 6.4
Professional services and other fees.................................. 4.1 5.7 3.3
Facilities and insurance.............................................. 7.5 5.2 3.5
Supplies.............................................................. 2.5 3.0 2.5
Depreciation and amortization......................................... 3.5 2.6 1.0
Interest.............................................................. 16.0 10.0 3.3
Legal ................................................................ 10.3 4.6 2.1
Travel and training................................................... 1.9 1.8 1.8
Other ................................................................ 2.1 1.2 0.9
-------------- -------------- --------------
Total expense....................................................... 90.9 72.6 45.0
-------------- -------------- --------------
Income before income tax provision......................................... 9.1 27.4 55.0
Income tax provision....................................................... 3.6 10.4 20.7
-------------- -------------- --------------
Net income ................................................................ 5.5% 17.0% 34.3%
============== ============== ==============
</TABLE>
RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1999
REVENUE
The following table sets forth the components of the Company's revenue for
the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
-------------- -------------- --------------
(Dollars in thousands)
<S> <C> <C> <C>
Loan origination and sale:
Gain on sale of loans (1).............................................$ 12,288 $ 10,699 $ 22,644
Net loan origination and other fees................................... 41,239 44,252 44,034
Interest................................................................... 14,024 21,754 21,396
Loan servicing and other fees.............................................. 2,388 7,103 7,575
-------------- -------------- --------------
Total revenue.........................................................$ 69,939 $ 83,808 $ 95,649
============== ============== ==============
</TABLE>
- ----------------------
(1) Excluding net loan origination and other fees.
Total revenues decreased 17% or $13.9 million in 1999 and decreased 12% or
$11.8 million in 1998. The decrease during both years was primarily due to lower
loan origination and sale revenue, combined with lower loan servicing and other
fees and, during 1999, lower interest revenue.
Loan origination and sale revenue decreased 3% or $1.4 million in 1999 and
decreased 18% or $11.7 million in 1998. The decrease during 1999 is attributable
to lower net loan origination fees, partially offset by higher gain on sale,
while the decrease during 1998 is primarily due to lower gain on sale.
26
<PAGE>
Despite a 9% and 14% increase in retail loan sales (excluding the United
Kingdom loan sale) during 1999 and 1998, respectively, net loan origination fees
decreased $3.0 million or 7% in 1999 and remained consistent in 1998 as compared
to 1997. Net loan origination and other fees did not fluctuate in the same
proportion as retail loan sales primarily due to a decrease in weighted average
origination fees during 1999 and 1998. Weighted average origination fees
decreased from 14.8% during 1997 to 13.5% during 1998 and to 10.4% during 1999.
Gain on sale of loans increased $1.6 million or 15% in 1999 as compared to
the prior year. The increase in gain on sale is primarily attributable to the
absence of a $5.0 million negative valuation adjustment related to residual
interest which was recognized in 1998, and a $1.3 million gain related to the
sale of the Company's United Kingdom portfolio during the current year. Such
increases in gain on sale were partially offset by an approximately $2.0 million
decrease in gain from domestic whole loan sales, as well as a $2.7 million
decrease in gain from securitizations. The decrease in gain from domestic whole
loan sales is primarily due to lower domestic whole loan sales volume in the
current year coupled with lower premiums available in the secondary market.
The decrease in gain from securitizations during 1999 as compared to 1998 is
primarily related to a decrease in value of residual interest, mortgage
servicing rights and higher securitization costs, all of which were partially
offset by less premiums paid on wholesale purchases and increased hedging gains.
The value of residual interest and mortgage servicing rights decreased $8.5
million as compared to 1998. Residual interest and mortgage servicing rights as
a percent of loans securitized decreased to 3.5% during 1999 as compared to 5.4%
for the prior year. The decrease in the value of residual interest was primarily
due to lower spreads and upfront collateralization resulting from less favorable
market conditions. In addition, the value of residual interest and mortgage
servicing rights was also affected by an increase in the weighted average CPR
assumption utilized to value such assets. The Company increased its weighted
average CPR assumptions during 1999 to 34% from 30% during 1998. Furthermore,
costs related to securitization increased by $0.6 million in 1999. The decrease
in the value of residual interest, mortgage servicing rights and increased
securitization costs was partially offset by a $3.7 million reduction in
premiums paid on wholesale purchases, coupled with a reduction in hedging losses
of $2.7 million during the current year, when compared to the prior year.
(See table of key assumptions used under Item 7. General.)
Gain on sale of loans decreased $11.9 million or 53% in 1998 as compared to
1997. This decrease is primarily attributable to a $5.0 million write down of
residual interest, and a reduction of gain on sale related to whole loan sales
and securitizations of approximately $3.8 million. Additionally, during 1997 the
Company recognized as gain approximately $3.1 million related to an increase in
the fair value of residual interest. (See table of key assumptions used under
Item 7. General.)
The write down during 1998 was the result of an increase in the Company's
prepayment rates primarily related to its adjustable rate loans. In addition,
gain on sale as a percent of loans sold decreased to 1.8% in 1998 from 4.7% in
1997. Gain on sale related to whole loan sales decreased by $3.1 million during
1998 as compared to 1997. Gain on sale as a percent of whole loan sales
decreased to 1.1% during 1998 from 3.3% in 1997 resulting from a reduction in
premiums available in the secondary market for the Company's loans. Gain on sale
related to securitizations decreased $0.7 million during 1998 as compared to
1997. Gain on sale as a percent of securitized loans decreased to 3.3% during
1998 from 4.3% during 1997. Such was primarily the result of increased
prepayment rates experienced by the Company during 1998.
Interest revenue decreased $7.7 million or 36% in 1999 as compared to an
increase of $0.4 million or 2% in 1998. The decrease in interest revenue in 1999
is primarily related to a decrease in interest from residual interest, loans
held for sale, the Company's United Kingdom loan portfolio, and other
investments. Interest revenue derived from residual interest decreased $3.8
million in 1999, primarily due to greater than expected prepayments experienced
during the current year. Interest revenue related to loans held for sale
decreased $1.5 million as compared to 1998 due to lower average balances of
loans outstanding. Interest revenue related to the Company's United Kingdom
portfolio decreased by $1.9 million as a result of the sale of the loan
portfolio in July 1999. Furthermore, interest revenue related to other
investments decreased $0.5 million as compared to 1998, primarily as a result of
the absence of a warehouse financing receivable in 1999, which existed in 1998.
27
<PAGE>
The increase in interest revenue in 1998 is primarily related to a $4.0
million net increase in interest from loans held for sale and loans receivable
held for investment, partially offset by a $3.7 million decrease in interest
from residual interest. The decrease in interest from residual interest is a
result of higher than expected prepayments, while the increase in interest from
loans held for sale is due to an increase in the average balances of loans held
for sale as compared to 1997.
Loan servicing and other fee income decreased $4.7 million or 66% in 1999
and $0.5 million or 6% in 1998. The decrease in 1999 is primarily attributable
to a $2.6 million decrease in income from the Company's credit card operations,
and an approximately $2.1 million decrease in loan servicing income. The
decrease in income derived from the credit card operations was a result of
higher charge-offs experienced during the year, as well as a $1.6 million
negative valuation adjustment related to the credit card portfolio. The negative
valuation adjustment relates to the Company's affinity real estate secured
credit card program, which was entered into with Fidelity in February 1997 (see
Recent Developments). The agreement stipulated that following termination of the
program by Fidelity, the Company would be obligated to purchase the then
outstanding balance on the credit card portfolio at par. In June 1999, Fidelity
notified the Company of its intent to terminate the program by February 24,
2000. Although the Company is currently disputing the terms of the obligation
and has sought arbitration, it has also pursued the sale of the credit card
portfolio in the event it is not successful in its dispute. Accordingly, the
Company recorded a negative valuation adjustment to reflect the difference
between the market value of the credit card portfolio and its potential
obligation to purchase the portfolio. The decrease in loan servicing income
during 1999 is attributable to lower prepayment penalties, combined with an
increase in mortgage servicing amortization and reserves for servicing advances.
The decrease in loan servicing and other fee revenue in 1998 is primarily due to
an acceleration in amortization of mortgage servicing rights, partially offset
by an increase in income from the Company's credit card operations, which
commenced operation in the fourth quarter of 1997. The increased acceleration in
amortization of mortgage servicing rights was primarily due to higher than
expected prepayments.
EXPENSE
The following table sets forth the components of the Company's expenses for
the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
-------------- -------------- --------------
(Dollars in thousands)
<S> <C> <C> <C>
Compensation and benefits..................................................$ 22,864 $ 22,857 $ 19,341
Advertising................................................................ 7,193 9,357 6,099
Professional services and other fees....................................... 2,839 4,762 3,196
Facilities and insurance................................................... 5,258 4,332 3,362
Supplies................................................................... 1,782 2,498 2,416
Depreciation and amortization............................................. 2,448 2,157 924
Interest................................................................... 11,180 8,382 3,164
Legal...................................................................... 7,230 3,851 2,009
Travel and training........................................................ 1,331 1,521 1,710
Other ..................................................................... 1,436 1,138 783
-------------- -------------- --------------
Total expense..........................................................$ 63,561 $ 60,855 $ 43,004
============== ============== ==============
</TABLE>
Total expense increased 4% or $2.7 million in 1999 and 42% or $17.9 million
in 1998.
Compensation and benefits, advertising, professional services, supplies, and
travel and training decreased by 12% or $5.0 million in 1999 and increased 25%
or $8.2 million in 1998. The decrease in such expenses during 1999 is primarily
due to discontinuation of the Company's affinity credit card program and United
Kingdom operations in December 1998, partially offset by an increase in expenses
due to the acquisition of Coast and the development of the Company's E-commerce
and Loan by Mail divisions. The increase in the mentioned expenses during 1998,
however, is primarily attributable to increased personnel and marketing activity
to support the Company's retail branch expansion, increased activity related to
the Company's credit card operations, and costs associated with the
discontinuation of the Company's United Kingdom operations.
28
<PAGE>
Facilities and insurance increased 21% or $0.9 million in 1999 and increased
29% or $1.0 million in 1998. The increase in facilities and insurance in 1999 is
primarily related to an increase in lease obligation reserves related to
non-operating branches. The increase in 1998, however, is due to the Company's
retail branch expansion and costs related to the centralized telemarketing
facility in Irvine, California, which became operational during 1998.
Depreciation and amortization increased $0.3 million in 1999 and increased
$1.2 million in 1998. The increase during 1999 is primarily due to acceleration
of depreciation related to property located in non-operating branches and
amortization of goodwill related to the Coast acquisition. The increase during
1998 is due to acceleration of depreciation of property related to the
discontinuation of the United Kingdom operations, an increase in the average
balance of fixed assets due to the Company's retail branch expansion, credit
card operations, and the centralized telemarketing facility in Irvine,
California, which became operational during 1998.
Interest expense increased 33% or $2.8 million in 1999 and increased 165% or
$5.2 million in 1998. The increase in 1999 is attributable to (i) an increase in
debt issuance costs, (ii) an increase in costs of funds related to the Company's
credit card operations, (iii) an increase in foreign currency loss related to a
secured term loan facility denominated in United States dollars, and (iv) an
increase in interest on notes, all of which is partially offset by a decrease in
interest from the Company's credit facilities. Debt issuance cost increased $2.6
million and relates to the Company's $150 million warehouse financing facility.
Cost of funds related to the Company's credit card operations increased $0.9
million due to an increase in the average balance of credit cards serviced.
Foreign currency loss which relates to the Company's secured term loan facility,
denominated in United States dollars, increased $0.6 million due to foreign
currency devaluation. Interest on notes payable increased $0.3 million during
1999 due to the financing of the building where the Company's telemarketing
facilities are located in Irvine, California. Interest expense from the
Company's credit facilities decreased $1.6 million primarily due to a 33%
decrease in the average balance outstanding during the year.
The increase in interest in 1998 is primarily due to an increase in interest
expense related to the Company's warehouse financing facility. This increase was
the result of a 130% increase in the average balance of loans warehoused in 1998
as compared to 1997. Additionally, the weighted average interest rate on the
warehouse financing facility increased in 1998. The increase in the weighted
average interest rate is due to an increase in the proportion of United Kingdom
loans, which carry a higher cost of funds, warehoused during 1998 as compared to
1997.
Legal expense increased $3.4 million in 1999 and increased $1.8 million in
1998. The increase in both years is primarily related to legal settlement
agreements and an increase in attorneys' fees and reserves related to the
ongoing legal matters (see Item 3. Legal Proceedings). In addition, during 1998,
the Company also incurred legal costs related to the discontinuation of the
United Kingdom operations.
Other expenses increased $0.3 million during 1999, primarily due to an
increase in provision for loan losses for real estate owned ("REO") and loans
held for investment.
INCOME TAXES
The Company's actual tax rates for 1999 and 1998 were 40.0% and 38.06%,
respectively.
During the first two quarters of 1998, the Company began securitizing its
loans in the form of owners' trusts. By utilizing this securitization structure,
the Company's securitization of loans were treated as a borrowing for State and
Federal tax purposes rather than as a sale. In the third and fourth quarters of
1998, however, the Company decided to securitize its loans in the form of a real
estate mortgage investment conduit ("REMIC"), under which the securitization of
loans will be treated as a sale for State and Federal tax purposes. During 1999,
all securitizations were consummated in the form of a REMIC.
29
<PAGE>
SERVICING
The following tables provide data on loan delinquency, REO and net losses
for the Company's servicing portfolio, which includes Company-owned loans:
<TABLE>
<CAPTION>
UNITED STATES AS OF DECEMBER 31,
------------------------------------------------------------------------------------
1999 1998 1997
---------------------------- --------------------------- ---------------------------
% of % of % of
(Dollars in Servicing (Dollars in Servicing (Dollars in Servicing
Thousands) Portfolio Thousands) Portfolio Thousands) Portfolio
-------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Servicing portfolio.....................$ 892,327 $ 802,034 $ 769,733
============== ============= =============
30-59 days delinquent...................$ 5,889 0.7% $ 9,144 1.1% $ 7,719 1.0%
60-89 days delinquent................... 3,320 0.4% 6,097 0.8% 7,520 1.0%
90 days or more delinquent.............. 21,699 2.4% 18,449 2.3% 16,935 2.2%
-------------- ------------- ------------- ------------- ------------- -------------
Total delinquencies..................$ 30,908 3.5% $ 33,690 4.2% $ 32,174 4.2%
============== ============= ============= ============= ============= =============
REO (1) $ 1,141 0.1% $ 2,063 0.2% $ 1,688 0.2%
============== ============= ============= ============= ============= =============
UNITED KINGDOM AS OF DECEMBER 31,
------------------------------------------------------------------------------------
1999 1998 1997
---------------------------- --------------------------- ---------------------------
% of % of % of
(Dollars in Servicing (Dollars in Servicing (Dollars in Servicing
Thousands) Portfolio Thousands) Portfolio Thousands) Portfolio
-------------- ------------- ------------- ------------- ------------- -------------
Servicing portfolio (4)................. - $ 63,629 $ 29,352
============== ============= =============
30-59 days delinquent................... - % $ 2,421 3.8% $ 276 0.9%
60-89 days delinquent................... - % 1,697 2.7% 133 0.5%
90 days or more delinquent.............. - % 4,015 6.3% 443 1.5%
-------------- ------------- ------------- ------------- ------------- -------------
Total delinquencies.................. - % $ 8,133 12.8% $ 852 2.9%
============== ============= ============= ============= ============= =============
REO (1) - % - 0.0% - 0.0%
============== ============= ============= ============= ============= =============
COMBINED AS OF DECEMBER 31,
------------------------------------------------------------------------------------
1999 1998 1997
---------------------------- --------------------------- ---------------------------
% of % of % of
(Dollars in Servicing (Dollars in Servicing (Dollars in Servicing
Thousands) Portfolio Thousands) Portfolio Thousands) Portfolio
-------------- ------------- ------------- ------------- ------------- -------------
Servicing portfolio (4).................$ 892,327 $ 865,663 $ 799,085
============== ============= =============
30-59 days delinquent...................$ 5,889 0.7% $ 11,565 1.3% $ 7,995 1.0%
60-89 days delinquent................... 3,320 0.4% 7,794 0.9% 7,653 0.9%
90 days or more delinquent.............. 21,699 2.4% 22,464 2.6% 17,378 2.2%
-------------- ------------- ------------- ------------- ------------- -------------
Total delinquencies..................$ 30,908 3.5% $ 41,823 4.8% $ 33,026 4.1%
============= ============= ============= ============= ============= =============
REO (1) $ 1,141 0.1% $ 2,063 0.2% $ 1,688 0.2%
============= ============== ============= ============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------------
1999 1998 1997
-------------------- ------------------ -----------------
(Dollars in thousands)
<S> <C> <C> <C>
Average servicing portfolio (2) ...................................$ 867,884 $ 845,607 $ 705,928
Net losses (3)..................................................... 1,288 983 1,705
Percentage of average servicing portfolio.......................... 0.15% 0.12% 0.24%
</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 balance at the
beginning and end of each quarter.
(3) Net losses represent losses realized with respect to disposition of REO.
(4) During 1999, the Company sold its portfolio of United Kingdom loans.
30
<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 interest certificates,
borrowings under its warehouse financing facilities, distributions received from
residual interests, origination fees, 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 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 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 though its warehouse financing facilities. For loans
financed through available cash, the Company receives its loan origination and
processing fees in cash upon sale of the loan. For loans financed through the
warehouse financing facilities, the Company generally receives substantially all
of the loan origination and processing fees in cash at the time of the warehouse
financing facility borrowing.
As 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) regular
interest backed by the loans in the trust, and (ii) a residual interest in the
trust. The Company then sells the regular interest to the public. A significant
portion of the Company's revenues, income and cash flow is generated through
these securitizations. There can be no assurances 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 be likely to have a material adverse
effect on the Company's results of operations and financial conditions.
During 1999, the Company implemented several initiatives, which required
significant use of capital. These initiatives included the acquisition of Coast
for a purchase price of $4.1 million, which included a $1.0 million holdback.
This holdback will be paid in three equal annual installments, beginning in
2000, and bears a fixed interest rate of 8.5%. In addition, the Company
implemented a Loan by Mail division, as well as the creation of an E-Commerce
operation. Implementation costs associated with the Loan by Mail division were
not considered to be material during 1999; however, the Company incurred
approximately $667,000 with respect to its costs associated with the
implementation of the E-Commerce operations.
During 1999, less favorable market conditions led investors to demand higher
yields, which in turn reduced the Company's spread on its securitization.
Consequently, the Company was required to provide up-front overcollateralization
in the form of cash of approximately $4.5 million related to its two most recent
securitizations. The purpose of the overcollateralization is to provide a source
of payment in the event of higher than anticipated losses. There can be no
assurance, however, that future transactions will not require up-front
overcollateralization.
In October 1999, the Company extended its $150 million warehouse financing
facility, which bears interest at a rate ranging between 1.25% to 1.75% over one
month U.S. Dollar denominated LIBOR, to December 2000. This facility contains
certain affirmative and negative covenants with which the Company was in
compliance as of December 31, 1999. 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.
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
31
<PAGE>
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
24, 2000. The Company is currently disputing the terms of the obligation to
purchase the outstanding balance of the credit cards, and the parties have
sought arbitration of the dispute. Nevertheless, the Company is pursuing the
sale of the credit card portfolio and has discontinued the issuance of new
credit cards. There is, however, no assurance that the Company will either be
successful in its dispute against Fidelity or in selling the credit card
portfolio, which currently has an available credit line of approximately $22
million and an outstanding balance of approximately $16 million, or be able to
have the appropriate capital or financing in place to purchase these assets.
In April 1997, the Board of Directors approved a share repurchase program
under which the Company was authorized to purchase up to 1.5 million shares of
its Class A Common Stock. In January 1998 and July 1998, the Board of Directors
authorized the purchase of an additional 2.0 million shares and 4.0 million
shares of Class A Common Stock, respectively. Of the 7.5 million shares
authorized, the Company had repurchased approximately 4.2 million shares as of
December 31, 1999.
As of December 31, 1999, the Company had commitments to fund loans of $3.6
million. Historically, approximately 55% of such commitments have ultimately
been funded. Capital expenditures totaled $0.3 million, $3.4 million and $6.7
million in 1999, 1998 and 1997, respectively. In 1997, the Company purchased an
office building for $3.4 million to house the Company's telemarketing
operations. The decrease in capital expenditures during the current year was
partially due to the Company's overall cost reduction strategy.
In February 1999, the Company refinanced its 40,000 square foot office
building in Irvine, California, and received proceeds of approximately $3.7
million. The loan bears an interest rate of 6.9% and matures on March 1, 2009,
at which time a balloon payment of $2.5 million is due.
The Company has experienced a significant increase in legal expenses over
the last two years, which have had a material adverse effect on the Company's
results of operations and financial condition. Such legal expenses have related
to legal settlement agreements, and an increase in attorneys' fees and reserves
for ongoing legal matters. There is no assurance that legal expenses will be
reduced in the future.
The Company believes that cash flows from operations, net proceeds from
securitizations and whole loan sales and the availability of funds under the
warehouse financing facilities will be sufficient to fund operating needs and
capital expenditures for the ensuing 12 months.
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.
The Company had initiated formal communications with its significant outside
vendors to determine the extent to which the Company may be vulnerable in the
event that those parties fail to properly address their own Year 2000 issue.
Although a contingency plan for outside vendors had been completed for dealing
with the most reasonably likely worst case scenario, no significant Year 2000
problems were experienced by the Company.
Overall, the Year 2000 issue did not have a material effect on the Company's
operations, as the Company did not experience significant problems associated
with this computer problem. No assurance, however, is given that such problems
may not occur in the future.
32
<PAGE>
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which, as amended by SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities," 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 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following information presented reflects the expected cash flows of the
primary categories by year, including the related weighted average interest
rate. The cash flows for loans held for sale are based on the expectancy of
liquidating or securitizing them. The cash flows for residual interest in
securities, loans held for investment and mortgage servicing rights are based on
maturity date and are adjusted for expected prepayments which are based on
historical information. Cash flows for warehouse financing, notes payable and
other borrowings are based on the expectancy of liquidating or securitizing the
assets to repay the financing, and are also based on the maturity date and
adjusted for expected prepayments which are based on historical information. For
purposes of cash flow presentation, premiums or discounts on purchased assets,
interest earned or payable, mark-to-market adjustments and loans on non-accrual
are excluded from the amounts presented. See Item 1. Interest Rate Risk
Management, for a discussion of risk related to hedging.
33
<PAGE>
The following table provides information as of December 31, 1999 with
respect to the Company's primary categories of assets and liabilities which are
sensitive to changes in interest rates:
<TABLE>
<CAPTION>
YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 THEREAFTER
(DOLLARS IN THOUSANDS)
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Trading
Loans held for sale - excluding
net deferred fees $ 21,300
Average interest rate 9.57%
Residual interests in securities $ 14,101 $ 11,468 $ 10,831 $ 5,025 $ 3,156 $ 3,641
Average interest rate 16.85% 16.85% 16.85% 16.85% 16.85% 16.85%
Non-trading
Loans receivable held for investment,
gross $ 536 $ 375 $ 262 $ 184 $ 129 $ 300
Average interest rate 10.79% 10.79% 10.79% 10.79% 10.79% 10.79%
Mortgage servicing rights $ 4,236 $ 2,282 $ 1,169 $ 530 $ 215 241
Average interest rate 17.09% 17.09% 17.09% 17.09% 17.09% 17.09
LIABILITIES:
Warehouse financing facility $ 14,122
Average interest rate 7.72%
Notes payable $ 428 $ 434 $ 441 $ 115 $ 123 $ 3,085
Average interest rate 7.24% 7.24% 7.24% 7.24% 7.24% 7.24%
The following table provides information as of December 31, 1998 with
respect to the Company's primary categories of assets and liabilities, which are
sensitive to changes in interest rates:
YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 THEREAFTER
(DOLLARS IN THOUSANDS)
------------------------------------------------------------------------------------
ASSETS:
Trading
Loans held for sale - excluding
net deferred fees $ 26,116
Average interest rate 9.01%
Residual interests in securities $ 18,590 $ 12,712 $ 7,091 $ 3,780 $ 2,146 $ 4,401
Average interest rate 15.81% 15.81% 15.81% 15.81% 15.81% 15.81%
Non-trading
Loans receivable held for investment,
gross $ 13,064 $ 12,828 $ 12,828 $ 12,827 $ 12,827 $ 352
Average interest rate 10.61% 10.60% 10.60% 10.60% 10.60% 11.30%
Mortgage servicing rights $ 5,342 $ 2,416 $ 1,465 $ 744 $ 66
Average interest rate 15.96% 15.96% 15.96% 15.96% 15.96%
LIABILITIES:
Warehouse financing facility and
secured term loan $ 30,247 $ 12,709 $ 12,709 $ 12,708 $ 12,708 $ 1,178
Average interest rate 7.56% 8.50% 8.50% 8.50% 8.50% 8.50%
Other borrowings $ 6,545
Average interest rate 8.34%
</TABLE>
34
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Consolidated Financial Statements beginning on Page F-1 of this Annual
Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
35
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is set forth under the caption
"Management" in the Company's definitive Proxy Statement (the "Proxy
Statement"), which will be filed with the Securities and Exchange Commission
pursuant to Regulation 14A under the Securities and Exchange Act of 1934 and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the caption
"Executive Compensation" in the Proxy Statement, which will be filed with the
Securities and Exchange Commission pursuant to Regulation 14A under the
Securities and Exchange Act of 1934 and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is set forth under the caption
"Security Ownership of Certain Beneficial Owners and Management" in the Proxy
Statement, which will be filed with the Securities and Exchange Commission
pursuant to Regulation 14A under the Securities and Exchange Act of 1934 and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is set forth under the caption
"Certain Relationships and Related Transactions" in the Proxy Statement, which
will be filed with the Securities and Exchange Commission pursuant to Regulation
14A under the Securities and Exchange Act of 1934 and is incorporated herein by
reference.
36
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
Consolidated Statements of Financial Condition
As of December 31, 1999 and 1998 F-1
Consolidated Statements of Income
For each of the three years in the period ended December 31, 1999 F-2
Consolidated Statements of Comprehensive Income
For each of the three years in the period ended December 31, 1999 F-3
Consolidated Statements of Stockholders' Equity
For each of the three years in the period ended December 31, 1999 F-4
Consolidated Statements of Cash Flows
For each of the three years in the period ended December 31, 1999 F-5
Notes to Consolidated Financial Statements
For each of the three years in the period ended December 31, 1999 F-7
Independent Auditors' Report F-24
</TABLE>
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<CAPTION>
DECEMBER 31,
-----------------------------
1999 1998
------------- -------------
<S> <C> <C>
ASSETS
Cash and cash equivalents.................................................................... $ 15,086 $ 18,052
Restricted cash.............................................................................. 2,648 1,281
Receivable from trusts....................................................................... 3,607 4,652
Loans held for sale, net..................................................................... 19,782 24,421
Loans receivable held for investment (net of allowance of $263 at December 31, 1999)......... 1,521 57,667
Residual interests in securities - at fair value............................................. 48,222 48,720
Mortgage servicing rights.................................................................... 8,673 10,033
Property, net................................................................................ 8,099 9,733
Goodwill (net of accumulated amortization of $157)........................................... 3,019
Prepaid expenses and other assets............................................................ 1,497 3,044
------------- -------------
Total assets............................................................................. $ 112,154 $ 177,603
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Warehouse financing facility................................................................. $ 14,122 $ 17,539
Secured term loan facility - related party................................................... 64,720
Other borrowings............................................................................. 6,545
Accrued contingent liabilities............................................................... 7,535 2,274
Accounts payable and accrued liabilities..................................................... 3,135 3,483
Income taxes payable......................................................................... 3,631 1,142
Notes payable................................................................................ 4,626 14
Deferred tax liabilities..................................................................... 7,299
------------- -------------
Total liabilities........................................................................ 33,049 103,016
------------- -------------
Commitments and contingencies (Notes 1 and 9)
Stockholders' equity:
Preferred Stock, $0.01 par value; 1,000,000 shares authorized: no shares outstanding........
Class A Common Stock, $0.01 par value; 75,000,000 shares authorized; shares issued and
outstanding: 22,186,288 at December 31, 1999 and at December 31,1998.................... 223 223
Additional paid in capital................................................................... 65,813 65,298
Retained earnings............................................................................ 65,154 61,326
Treasury stock - at cost: 4,237,000 shares at December 31, 1999 and 4,046,800 shares at
December 31, 1998........................................................................ (52,085) (51,582)
Accumulated other comprehensive income....................................................... (678)
------------- -------------
Total stockholders' equity............................................................... 79,105 74,587
------------- -------------
Total liabilities and stockholders' equity............................................... $ 112,154 $ 177,603
============= =============
See notes to consolidated financial statements.
F-1
</TABLE>
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
REVENUE:
Loan origination and sale................................................ $ 53,527 $ 54,951 $ 66,678
Interest................................................................. 14,024 21,754 21,396
Loan servicing and other fees............................................ 2,388 7,103 7,575
------------- ------------- -------------
Total revenue.......................................................... 69,939 83,808 95,649
------------- ------------- -------------
EXPENSE:
Compensation and benefits................................................ 22,864 22,857 19,341
Advertising.............................................................. 7,193 9,357 6,099
Professional services and other fees..................................... 2,839 4,762 3,196
Facilities and insurance................................................. 5,258 4,332 3,362
Supplies................................................................. 1,782 2,498 2,416
Depreciation and amortization............................................ 2,448 2,157 924
Interest................................................................. 11,180 8,382 3,164
Legal 7,230 3,851 2,009
Travel and training...................................................... 1,331 1,521 1,710
Other ................................................................... 1,436 1,138 783
------------- ------------- -------------
Total expense......................................................... 63,561 60,855 43,004
------------- ------------- -------------
INCOME BEFORE INCOME TAX PROVISION........................................... 6,378 22,953 52,645
INCOME TAX PROVISION......................................................... 2,550 8,737 19,873
------------- ------------- -------------
NET INCOME................................................................... $ 3,828 $ 14,216 $ 32,772
============= ============= =============
NET INCOME PER SHARE:
Basic.................................................................... $ 0.21 $ 0.73 $ 1.50
============= ============= =============
Diluted.................................................................. $ 0.21 $ 0.73 $ 1.49
============= ============= =============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES:
OUTSTANDING:
Basic.................................................................... 18,110,214 19,380,119 21,851,732
Diluted.................................................................. 18,124,202 19,431,219 22,030,438
See notes to consolidated financial statements.
F-2
</TABLE>
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS)
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
NET INCOME................................................................... $ 3,828 $ 14,216 $ 32,772
OTHER COMPREHENSIVE INCOME
Foreign currency translation adjustment net of income taxes of
$1,140, $375 and $18 for 1999, 1998 and 1997, respectively............... (1,710) (611) (29)
Less: Reclassification adjustment for realized foreign currency
transaction loss, net of income taxes of $1,592 for 1999............... 2,388
------------- ------------- -------------
COMPREHENSIVE INCOME......................................................... $ 4,506 $ 13,605 $ 32,743
============= ============= =============
See notes to consolidated financial statements.
F-3
</TABLE>
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<CAPTION>
Class A Class B Additional
Common Stock Common Stock Paid in Retained
Shares Amount Shares Amount Capital Earnings
------------ ------ ------------ ------ --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997.............. 6,037,500 $ 60 16,125,000 $ 161 $ 64,570 $ 14,338
Net income.............................. 32,772
Issuance of stock....................... 59,145 1 670
Tax benefit from exercise
of stock options.................... 81
Purchase of treasury stock..............
Conversion of Class B Stock
to Class A Stock................... 5,168,730 51 (5,168,730) (51)
Amortization of deferred
stock compensation.................
Foreign currency translation
adjustment.........................
------------ ------ ------------ ------ --------- ----------
Balance at December 31, 1997............ 11,265,375 $ 112 10,956,270 $ 110 $ 65,321 $ 47,110
Net income.............................. 14,216
Issuance of stock....................... 45,913 1 520
Tax benefit from exercise
of stock options.................... 263
Purchase of treasury stock..............
Conversion of Class B Stock
to Class A Stock.................... 10,875,000 110 (10,875,00) (110)
Forfeitures of Class B Stock............ (81,270) (806)
Amortization of deferred
stock compensation..................
Foreign currency translation
adjustment..........................
------------ ------ ------------ ------ --------- ----------
Balance at December 31, 1998............ 22,186,288 $ 223 $ 65,298 $ 61,326
Net income.............................. 3,828
Issuance of stock warrants.............. 515
Purchase of treasury stock..............
Foreign currency translation
Adjustment..........................
------------ ------ ------------ ------ --------- ----------
Balance at December 31, 1999 22,186,288 $ 223 $ 65,813 $ 65,154
============ ====== ============ ====== ========= ==========
continued on next page.........
See notes to consolidated financial statements.
</TABLE>
F-4
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - Continued
(Dollars in thousands)
<CAPTION>
Deferred Accumulated Total
Treasury Stock Stock Compensation Stockholders'
Shares Amount Compensation Income Equity
------------ ----------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1997.............. $ (1,113) $ (38) $ 77,978
Net income.............................. 32,772
Issuance of stock....................... 671
Tax benefit from exercise
of stock options.................... 81
Purchase of treasury stock.............. 1,169,300 $ (20,544) (20,544)
Conversion of Class B Stock
to Class A Stock...................
Amortization of deferred
stock compensation................. 348 348
Foreign currency translation
adjustment......................... (29) (29)
------------ ----------- ------------ ------------ -------------
Balance at December 31, 1997............ 1,169,300 $ (20,544) $ (765) $ (67) $ 91,277
Net income.............................. 14,216
Issuance of stock....................... 521
Tax benefit from exercise
of stock options.................... 263
Purchase of treasury stock.............. 2,877,500 (31,038) (31,038)
Conversion of Class B Stock
to Class A Stock.................... ---
Forfeitures of Class B Stock............ 806 ---
Amortization of deferred
stock compensation.................. (41) (41)
Foreign currency translation
adjustment.......................... (611) (611)
------------ ----------- ------------ ------------ -------------
Balance at December 31, 1998............ 4,046,800 $ (51,582) $ (678) $ 74,587
Net income.............................. 3,828
Issuance of stock warrants.............. 515
Purchase of treasury stock.............. 190,200 (503) (503)
Foreign currency translation
Adjustment.......................... 678 678
------------ ----------- ------------ ------------ -------------
Balance at December 31, 1999 4,237,000 $ (52,085) $ --- $ 79,105
============ =========== ============ ============ =============
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................................. $ 3,828 $ 14,216 $ 32,772
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Capitalized residual interests and mortgage servicing rights........... (19,303) (18,395) (26,120)
Accretion of residual interest in securities........................... (4,507) (8,260) (12,130)
Collection of residual interest in securities.......................... 19,552 21,652 11,193
Deferred income taxes.................................................. (7,829) 6,886 3,774
Amortization of mortgage servicing rights.............................. 6,116 5,728 2,857
Amortization of debt issuance costs.................................... 2,716
Amortization of goodwill............................................... 157
Depreciation and amortization.......................................... 2,291 2,157 923
Deferred stock compensation............................................ (41) 348
Accretion of discounts on loan receivable.............................. 51 (143)
Recognition of deferred fees on loans receivable held for investment... (796) (118)
Provision for loan losses.............................................. 492
Foreign currency transaction (gain) loss .............................. (155) 146
Loss on sales of property.............................................. 42 22 70
Gain on sale of United Kingdom loan portfolio.......................... (1,267)
Changes in assets and liabilities:
Receivable from trusts................................................. 970 (1,567) (414)
Loans held for sale.................................................... 3,130 (26,450) (44,416)
Prepaid expenses and other assets...................................... (68) 645 (1,562)
Accounts payable and accrued liabilities............................... (849) (1,088) 2,115
Accrued contingent liabilities......................................... 5,261 2,074 (1,299)
Income taxes payable................................................... 2,489 (2,522) (1,651)
------------- ------------- -------------
Net cash provided by (used in) operating activities................. 12,425 (5,165) (33,537)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash deposited for restricted cash.......................................... (1,367) (1,281)
Repayments (advances) on warehouse financing receivable..................... 12,324 (12,324)
Capital expenditures........................................................ (288) (3,355) (6,653)
Collections on loans receivable held for investment......................... 13,663 1,606 954
Proceeds from sale of United Kingdom loan portfolio......................... 44,156
Proceeds from sales of property............................................. 70 98 645
Cash paid for acquisition, less cash acquired............................... (2,641)
------------- ------------- -------------
Net cash provided by (used in) investing activities.................. 53,593 9,392 (17,378)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) on warehouse financing facilities............... (3,417) 24,321 57,641
Repayment of secured term loan facility..................................... (64,720)
Proceeds from (repayments of) other borrowings.............................. (6,545) 6,545
Purchase of treasury stock.................................................. (503) (31,038) (20,544)
Proceeds from exercise of stock options..................................... 521 671
Net borrowings (repayments) on notes payable................................ 3,612 (11) (188)
------------- ------------- -------------
Net cash (used in) provided by financing activities.................. (71,573) 338 37,580
------------- ------------- -------------
Effect of exchange rate changes on cash..................................... 2,589 (545) (47)
------------- ------------- -------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........................ (2,966) 4,020 (13,382)
CASH AND CASH EQUIVALENTS, beginning of period.............................. 18,052 14,032 27,414
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, end of period ................................... $ 15,086 $ 18,052 $ 14,032
============= ============= =============
See notes to consolidated financial statements.
</TABLE>
F-5
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED)
(DOLLARS IN THOUSANDS)
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
SUPPLEMENTAL INFORMATION:
Interest paid............................................................... $ 9,815 $ 8,395 $ 2,694
============= ============= =============
Income taxes paid........................................................... $ 7,803 $ 3,831 $ 17,764
============= ============= =============
SUPPLEMENTAL INFORMATION ON NON-CASH INVESTING
AND FINANCING ACTIVITIES:
Transfer of loans held for sale to loans receivable held for investment..... $ 1,320 $ 57,050 $ 594
============= ============= =============
Transfer of loans held for investment to real estate owned.................. $ 55
=============
Stock warrants issued as debt issuance costs................................ $ 515
=============
Transfer of loans held for sale to real estate owned........................ $ 189
=============
Notes payable issued in connection with Coast Security Mortgage acquisition $ 1,000
=============
DETAIL OF BUSINESS ACQUIRED IN PURCHASE BUSINESS COMBINATION (Note 1):
On July 2, 1999, the Company acquired the net assets of Coast Security
Mortgage. A summary of the transaction is as follows:
Cash paid................................................................. $ 3,085
Note issued............................................................... 1,000
Fair market value of tangible and identifiable assets acquired (1)........ (1,312)
Fair market value of liabilities assumed.................................. 403
-------------
Excess of cost over identifiable assets acquired (goodwill)............... $ 3,176
=============
- ----------------------
(1) Includes cash acquired of $444.
See notes to consolidated financial statements.
</TABLE>
F-6
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The consolidated financial statements include the
accounts of First Alliance Corporation ("FACO") and its subsidiaries
(collectively the "Company"). The Company is a financial services organization
principally engaged in mortgage loan origination, purchases, sales and
servicing. The majority of the Company's loans are made to owners of single
family residences who use the loan proceeds for such purposes as debt
consolidation and financing of home improvements. The Company securitizes the
loans in a trust or sells loans to wholesale purchasers. A significant portion
of the loans are securitized with the Company retaining the right to service the
loans. The Company is currently licensed as a consumer finance lender in 18
states and the District of Columbia. As of December 31, 1998, however, the
Company discontinued its United Kingdom loan origination operations and
subsequently sold its loan portfolio in July 1999. The discontinuation of this
program did not have a material effect on the Company's net assets, results of
operations or cash flows. The Company's business may be affected by many factors
including real estate and other asset values, the level of and fluctuations in
interest rates, changes in the securitization market and competition.
The consolidated financial statements are prepared in accordance with
generally accepted accounting principles. All significant intercompany accounts
and transactions have been eliminated in consolidation.
In July and August 1996, FACO completed an initial public offering (the
"Offering") whereby 6,037,500 shares of its Class A Common Stock were sold to
the public resulting in gross proceeds of $68.4 million. Concurrently,
16,125,000 shares of the Class B Common Stock of FACO were issued in exchange
for all of the issued and outstanding shares of First Alliance Mortgage Company
("FAMCO") as part of a reorganization whereby FAMCO became a wholly owned
subsidiary of FACO. The acquisition of FAMCO has been accounted for similar to a
pooling of interests. The consolidated financial position and results of
operations of the Company for periods prior to the date of the reorganization
substantially consist of those of FAMCO. After deducting underwriting discounts
and offering costs of $5.3 million, net proceeds from the Offering were $63.1
million. By August 1998, all Class B Common Stock of FACO was converted to Class
A Common Stock.
CASH AND CASH EQUIVALENTS - The Company considers all highly liquid debt
instruments purchased with an original maturity of three months or less to be
cash equivalents.
RESTRICTED CASH - As part of the Company's credit card program, the Company
is required to maintain a cash balance restricted for the purpose of reserving
for credit losses. The Company had a restricted cash balance of $2.6 million as
of December 31, 1999.
ESTIMATED LOSSES ON CREDIT CARD ACCOUNTS - Estimated net losses on credit
card accounts represent the Company's estimate of net losses to be realized.
This estimate is based on historical charge-off ratios, recoveries and the
current condition of the portfolio. The Company's policy is to charge-off any
credit card accounts greater than 90 days delinquent. During 1999, the Company
recorded a provision of $5.3 million, which included a negative valuation
adjustment of $1.6 million, and recognized net charge-offs of $2.3 million. The
negative valuation adjustment relates to the Company's affinity real estate
secured credit card program, which was entered into with Fidelity Federal Bank,
a Federal Savings Bank ("Fidelity") in February 1997. The agreement stipulates
that following termination of the program by Fidelity, the Company would be
obligated to purchase the then outstanding balance on the credit card portfolio
at par. In June 1999, Fidelity notified the Company of its intent to terminate
the program by February 24, 2000. Although the Company is currently disputing
the terms of the obligation and has sought arbitration, it has also pursued the
sale of the credit card portfolio in the event it is not successful in its
dispute. Accordingly, the Company recorded a negative valuation adjustment to
reflect the difference between the market value of the credit card portfolio and
its potential obligation to purchase the portfolio. The Company had a reserve
for estimated net losses of $3.8 million and $0.8 million related to credit card
accounts of approximately $18 million and $26 million at December 31, 1999 and
December 31, 1998, respectively.
F-7
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
RECEIVABLE FROM TRUSTS - In the normal course of servicing loans previously
securitized, the Company advances payments and other costs to the securitization
trusts. In such cases, funds advanced are reflected in the consolidated
statements of financial condition as receivable from trusts and are netted
against any related reserves. Advances are recovered through subsequent
collections from the trusts or borrowers.
LOANS - Loans held for sale are loans the Company plans to sell or
securitize which are carried at the lower of aggregate cost or market value.
Loan origination and processing fees and related direct origination costs are
deferred until the related loan is sold. Loans receivable held for investment
are loans the Company has purchased or originated and has the intent and ability
to hold to maturity. Loan origination and processing fees and related direct
origination costs associated with loans receivable held for investment are
deferred and offset against the related loans, and the net fee or cost is
amortized into income over the contractual lives of the related loans. Loans
transferred from loans held for sale to loans receivable held for investment are
transferred at the lower of cost or market value. When a loan becomes over 90
days contractually delinquent, it is placed on non-accrual status and unpaid
interest income is reversed. While a loan is on non-accrual status, interest is
recognized only as cash is received.
ALLOWANCES FOR ESTIMATED LOSSES ON LOANS AND REAL ESTATE OWNED - The
allowances for estimated losses on loans and real estate owned ("REO") represent
the Company's estimate of identified and unidentified losses. These estimates,
while based upon historical loss experience and other relevant data, are
ultimately subjective and inherently uncertain. Loans are collectively evaluated
for impairment and when the estimated losses are determined to be permanent, as
in the case of an REO, the Company then establishes a special allowance for
estimated losses.
RESIDUAL INTERESTS IN SECURITIES - The Company securitizes a majority of
loans held for sale in a trust. The trust is a multi-class security which
derives its cash flow from a pool of mortgages. The regular interests of the
securitization trusts are sold and the residual interests are retained by the
Company. The documents governing the Company's securitizations require the
Company to establish initial overcollateralization or build
overcollateralization levels through retention of distributions by the
securitization trust otherwise payable to the Company as the residual interest
holder. This overcollateralization causes the aggregate principal amount of the
loans in the related pool and/or cash reserves to exceed the aggregate principal
balance of the outstanding regular interests. Such excess amounts serve as
credit enhancement for the regular interests of the related securitization
trust. To the extent that borrowers default on the payment of principal or
interest on the loans, losses will reduce the overcollateralization to the
extent that funds are available. If payment defaults exceed the amount of
overcollateralization, as applicable, the insurance policy maintained by the
related securitization trust will pay any further losses experienced by holders
of the regular interests in the related securitization trust. The Company does
not have any recourse obligations for credit losses in the securitization trust.
The Company classifies residual interests as trading securities which are
carried at fair value with any unrealized gains or losses recorded in the
results of operations in the period of the change in fair value. Valuations at
origination and at each reporting period are based on discounted cash flow
analyses. The cash flows are estimated as the excess of the weighted average
coupon on each pool of underlying mortgages over the sum of the pass-through
interest rates on the regular interests of the related securitization trust,
servicing fees, trustee fees, insurance fees, and an estimate of annual future
loan losses. These cash flows are projected over the life of the loans using
prepayment, default, loss, and interest rate assumptions that market
participants would use for similar financial instruments and are discounted
using an interest rate that a purchaser unrelated to the seller of such a
financial instrument would demand. To value residual interest at the time of
securitization, the Company used historical prepayment experience assumptions.
To value the residual interest at each reporting period, the Company arrives at
its prepayment assumptions by using the actual six-month prepayment average,
which is applied to the first 18 months of cash flows, and the actual life to
date prepayment average to the remaining months of cash flows. To the Company's
knowledge, there is no active market for the sale of these residual interests.
The range of possible values attributable to the factors used in determining
fair value is broad. Accordingly, the Company's estimate of fair value is
subjective. The Company capitalized $14.5 million, $16.4 million and $17.1
million in residual interest certificates in 1999, 1998 and 1997, respectively.
During the same periods, cash collections related to residual interest
certificates totaled $19.6 million, $21.7 million and $11.2 million,
respectively. During 1999, 1998 and 1997, the Company recorded aggregate
unrealized gains/(losses) in the value of its residual interests of $0.9
million, ($3.3) million, and $5.4 million, respectively. These unrealized
gains/(losses) are included in loan origination and sale revenue.
F-8
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
The Company utilized the following key assumptions to value its residual
interest certificates originated during 1999 and 1998:
<TABLE>
<CAPTION>
--------------------------------------- -----------------------------------------
1999 1998
--------------------------------------- -----------------------------------------
Fixed Rate Adjustable Fixed Rate Adjustable
Loans Rate Loans Total Loans Rate Loans Total
--------------------------------------- -----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Weighted average CPR.................... 29% 39% 34% 26% 40% 30%
Weighted average discount rate.......... 18% 18% 18% 17% 16% 17%
Weighted average annualized credit
losses - in basis points............. 50 50 50 56 48 53
Weighted average life (in years)........ 2.90 1.99 2.43 3.30 1.94 2.86
</TABLE>
The Company utilized the following assumptions to revalue its residual
interest for all outstanding securitizations at year end:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------
1999 1998
---------------------------------------------------------------------------------
Fixed Rate Adjustable Fixed Rate Adjustable
Loans Rate Loans Total Loans Rate Loans Total
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Weighted average CPR....................... 28% 44% 34% 27% 49% 35%
Weighted average discount rate............. 17% 17% 17% 16% 15% 15%
Weighted average annualized credit
Losses - in basis points................ 51 86 64 57 76 64
Weighted average life (in years)........ .. 3.03 1.83 2.58 3.19 1.59 2.63
Fair value of residual interest at year end $24,927 $23,295 $48,222 $25,341 $23,379 $48,720
</TABLE>
MORTGAGE SERVICING RIGHTS - Upon the sale or securitization of servicing
retained loans, the Company capitalizes the costs associated with the right to
service mortgage loans based on their relative fair values. The Company
determines the fair value of the servicing rights based on the present value of
estimated net future cash flows related to servicing income. Assumptions used to
value mortgage servicing rights are consistent with those used to value residual
interests. The value allocated to the mortgage servicing rights is amortized in
proportion to and over the period of estimated net future servicing fee income.
The Company capitalized $4.8 million, $7.0 million and $6.1 million of
mortgage servicing rights for the years ended December 31, 1999, 1998 and 1997,
respectively. During the same periods, related amortization of such mortgage
servicing rights was $6.1 million, $5.7 million and $2.9 million, respectively.
The Company periodically evaluates capitalized mortgage servicing rights for
impairment, which represents the excess of unamortized cost over fair value.
This review is performed on a disaggregated basis based on loan type.
Impairment, if it occurs, is recognized in a valuation allowance for each pool
in the period of impairment. The estimated fair value of mortgage servicing
rights was $8.7 million and $10.0 million at December 31, 1999 and December 31,
1998, respectively, and no valuation allowance existed at either year end.
PROPERTY - Property is stated at cost and depreciated over the estimated
useful lives of the assets using straight line or accelerated methods. Leasehold
improvements are amortized on the straight-line method over the lesser of the
useful lives of the assets or the terms of the related leases. Useful lives
generally range from three to seven years.
F-9
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
REAL ESTATE OWNED - Real estate acquired in settlement of loans generally
results when property collateralizing a loan is foreclosed upon or otherwise
acquired by the Company in satisfaction of the loan. Real estate acquired
through foreclosure is carried at fair value less costs to dispose. Fair value
is based on the net amount that the Company could reasonably expect to receive
for the asset in a current sale between a willing buyer and a willing seller,
that is, other than in a forced or liquidation sale. Adjustments to the carrying
value of REO are made through valuation allowances and charge-offs recognized
through a charge to earnings. The balance of REOs is included in the Company's
property line item of the Consolidated Statements of Financial Condition. The
Company's net REO balance was $149,000 as of December 31, 1999, and no REOs
existed as of December 31, 1998.
GOODWILL - In July 1999, the Company acquired Coast Security Mortgage, Inc.
("Coast"), a retail mortgage company. 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 $4.1 million
was finalized subject to customary indemnification, monetary holdbacks and an
independent third party evaluation regarding 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.
REVENUE RECOGNITION - The Company derives its revenue principally from gains
on sales of loans, fees for the origination of loans, loan servicing fees and
interest income. The Company sells its loans through securitization and whole
loan sales. Origination fees from loans pooled and securitized or sold in the
secondary market are recognized when such loan pools are sold. The Company
retains the right to service all loans it securitizes. The Company receives a
management fee for servicing loans based on a fixed percentage of the declining
principal balance of securitized loan pools and other ancillary and prepayment
fees associated with the servicing of such loans. The Company has historically
retained a residual interest in the securitization trusts.
Gains on servicing retained sales of loans through securitization represent
the difference between the net proceeds to the Company in the securitization and
the allocated cost of loans securitized. The allocated cost of the loans
securitized is determined by allocating their acquisition cost (for purchased
loans) or net carrying value (for originated loans) between the loans
securitized and the residual interests and the mortgage servicing rights
retained by the Company based upon their relative fair values. The net carrying
value of originated loans is equal to their principal balance less net deferred
origination fees. At origination, the Company classifies the residual interests
as trading securities, which are carried at fair value. The difference between
the fair value of residual interests and their allocated cost is recorded as
gain on securitization and is included in loan origination and sale revenue.
Gains on servicing released whole loan sales equal the difference between the
net proceeds to the Company from such sales and the loans' acquisition costs or
net carrying values.
Loan servicing and other fees are recorded as earned.
Interest income is recorded as earned. Interest income represents the
interest earned on loans held for sale during the period prior to their
securitization or sale, loans receivable held for investment, residual interests
and cash equivalents.
INCOME TAXES - Deferred tax assets and liabilities are determined based on
temporary differences between financial reporting and tax basis of assets and
liabilities and are measured by applying enacted tax rates and laws to taxable
years in which such temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
STOCK SPLIT - In October 1997 the Board of Directors authorized a
three-for-two stock split to be effected in the form of a stock dividend. The
stock dividend was distributed on October 31, 1997, to holders of record on
October 15, 1997. All balances and transactions in common stock and additional
paid in capital and all share and per share data, including shares issued and
outstanding, shares repurchased and net income per share, have been restated to
reflect the stock dividend. All outstanding options under the Company's stock
incentive plan have been adjusted for the effect of the stock dividend.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS - The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
F-10
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
FOREIGN CURRENCY TRANSLATION - The financial statements of the Company's
United Kingdom subsidiary were prepared in pounds sterling, its functional
currency, and translated into dollars at the current exchange rate at the end of
the period for the statements of financial condition and at a weighted average
rate for the period for the statements of income. Translation adjustments are
reflected as foreign currency translation adjustments in stockholders' equity
and accordingly have no effect on income. Foreign currency transaction gains and
losses for the Company's United Kingdom subsidiary are included in income.
In July 1999, the Company sold its portfolio of United Kingdom loans. 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 foreign currency risk exposure.
RECENT ACCOUNTING PRONOUNCEMENTS - In June 1998, FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is, as
amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities," 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.
RECLASSIFICATIONS - Certain reclassifications have been made to conform the
1998 and 1997 consolidated financial statements to the 1999 presentation.
NOTE 2. LOANS RECEIVABLE HELD FOR INVESTMENT
Loans receivable held for investment are collateralized principally by
single family residences. The loans bear interest at fixed and variable rates
ranging up to 15.6% per annum and are due in monthly installments of principal
and interest through May 2029. The Company recorded a provision for loss related
to loans receivable held for investment of $492,000, and had an allowance for
estimated losses of $263,000 at December 31, 1999. The Company did not record a
provision for loss related to loans receivable held for investment during 1998
or 1997, nor was there an allowance for estimated losses at December 31, 1998 or
December 31, 1997.
F-11
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
NOTE 3. PROPERTY
<TABLE>
<CAPTION>
Property consists of the following at December 31: 1999 1998
------------- -------------
(Dollars in thousands)
<S> <C> <C>
Office equipment................................................ $ 7,400 $ 8,251
Land............................................................ 2,100 2,100
Building........................................................ 1,280 1,391
Building Improvements........................................... 1,401 1,431
Computer software............................................... 1,006 923
Vehicles........................................................ 376 292
Leasehold improvements.......................................... 279 282
Real estate owned............................................... 149
------------- -------------
Property....................................................... 13,990 14,670
Less accumulated depreciation and amortization.................. (5,891) (4,937)
------------- -------------
Property, net................................................... $ 8,099 $ 9,733
============= =============
</TABLE>
NOTE 4. SERVICING PORTFOLIO
Trust and other custodial funds, relating to loans serviced for others,
totaled $19 million and $41 million at December 31, 1999 and 1998, respectively.
Such funds, which are maintained in separate bank accounts, are excluded from
the Company's assets and liabilities.
Total loans serviced amounted to $892 million, $866 million and $799 million
at December 31, 1999, 1998 and 1997, respectively.
Approximately 96% of the servicing portfolio relates to loans serviced on
behalf of the trust, with the remaining 4% relating to loans serviced on behalf
of private lenders or loans held for sale. At December 31, 1999, loans serviced
related to property located in California comprised of approximately 44% of the
total serviced loan portfolio, while no other state comprised more than 12%.
Total delinquencies greater than 30 days as a percentage of the total servicing
portfolio were 3.5%, 4.8% and 4.1% at December 31, 1999, 1998 and 1997,
respectively. Delinquencies greater than 30 days related to the United States
portfolio were 3.5%, 4.2% and 4.2% at December 31, 1999, 1998 and 1997,
respectively. Delinquencies greater than 30 days as a percentage of the total
United Kingdom portfolio were 12.8% at December 31, 1998.
NOTE 5. WAREHOUSE FINANCING FACILITY
The Company has one warehouse financing facility as of December 31, 1999.
This $150 million warehouse financing facility 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 dollar denominated London Interbank Offered
Rate ("LIBOR"), and expires in December 2000. As partial consideration for this
facility, the Company agreed to grant the warehouse lender stock warrants
equaling 4.90% of the shares outstanding, with an effective date of January 15,
2000. The Company will account for these warrants by recording the fair value of
the warrants to debt issuance costs and additional paid in capital. Debt
issuance costs will be amortized over 12 months. The facility contains certain
affirmative and negative covenants with which the Company was in compliance at
December 31, 1999. Additionally, during 1998 the Company had a $66 million
secured term loan facility, which was entered into by a company owned by the
majority stockholder of FACO. The loan was repaid in full in 1999.
F-12
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
The following table presents data on the lines of credit for the years ended
December 31:
<TABLE>
<CAPTION>
1999 1998 1997
------------- ------------- -------------
(Dollars in thousands)
<S> <C> <C> <C>
Weighted average interest rate for the period........................... 7.40% 6.82% 6.67%
Weighted average interest rate at the end of the period................. 7.72% 8.15% 7.20%
Average amount outstanding for the period............................... $ 72,085 $ 107,362 $ 46,596
Maximum amount outstanding at any month-end............................. $ 145,772 $ 150,252 $ 124,702
</TABLE>
NOTE 6. OTHER BORROWINGS AND NOTES PAYABLE
At December 31, 1998, the Company had a borrowing of $6.5 million with an
interest rate of 8.3%. This borrowing was collateralized by certain real estate
loans with an aggregate principal balance of $6.5 million. The borrowing was
repaid in January of 1999.
As of December 31, 1999, the Company's notes payable balance consisted of
two notes. The first note, which as of December 31, 1999 had a balance of $3.6
million and bears a fixed interest rate of 6.9%, relates to the financing of the
Company's telemarketing facility. This note matures on March 1, 2009, at which
time a balloon payment of $2.5 million is due. The second note, which as of
December 31, 1999 had a balance of $1.0 million and bears a fixed interest rate
of 8.5%, relates to the acquisition of Coast during 1999. This note is due in
three equal annual installments beginning in 2000.
The following represents the future principal payment schedule as of
December 31, 1999:
(Dollars in thousands)
2000................................................... $ 428
2001................................................... 434
2002................................................... 441
2003................................................... 115
2004................................................... 123
Years Thereafter....................................... 3,085
-----------
$ 4,626
===========
NOTE 7. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) defined contribution plan, which was established in
1994, available to all employees who have been with the Company for six months
and have reached the age of 18. Employees may generally contribute up to 15% of
their salary each year and the Company, at its discretion, may match up to 25%
of the first 7% contributed by the employee. The Company's contribution expense
was $211,000, $248,000 and $175,000 for the years ended December 31, 1999, 1998
and 1997, respectively. As of December 31, 1999, the assets of the plan totaled
$5.4 million.
F-13
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
NOTE 8. INCOME TAXES
The reconciliation of income tax computed at the Federal statutory tax rate
to the Company's effective income tax rate is as follows for the years ended
December 31:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Tax at Federal statutory rate............................. 35.0% 35.0% 35.0%
State income taxes, net of Federal benefit................ 4.3 5.1 4.0
Other..................................................... 0.7 (2.0) (1.2)
------------ ------------ ------------
Effective rate............................................ 40.0% 38.1% 37.8%
============ ============ ============
</TABLE>
The components of the provision for income taxes are as follows for the
years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Current: (Dollars in thousands)
Federal............................................... $ 8,054 $ 2,605 $ 14,299
State................................................. 2,243 473 1,805
------------ ------------ ------------
Total current............................................. 10,297 3,078 16,104
------------ ------------ ------------
Deferred:
Federal............................................... $ (7,939) 6,028 3,778
State................................................. (1,820) 1,178 703
Foreign............................................... 2,012 (1,547) (712)
------------ ------------ ------------
Total deferred ........................................... $ (7,747) 5,659 3,769
------------ ------------ ------------
Total..................................................... $ 2,550 $ 8,737 $ 19,873
============ ============ ============
</TABLE>
F-14
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
Deferred tax assets and liabilities reflect the temporary differences
between financial reporting and tax basis of assets and liabilities and are
measured by applying enacted tax rates and laws to taxable years in which such
temporary differences are expected to be recovered or settled. The following are
the significant components of the Company's deferred tax assets and liabilities
as of December 31:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
(Dollars in thousands)
<S> <C> <C>
Deferred tax assets:
Foreign loss carry forward..................................... $ -- $ 2,451
State taxes.................................................... 614 797
Mark-to-market on loans held for sale.......................... 731 634
Legal expenses................................................. 1,000 469
Reserve for bad debts.......................................... 1,728 333
Other.......................................................... 1,648 440
------------- -------------
Total.............................................................. $ 5,721 $ 5,124
============= =============
Deferred tax liabilities:
Residual interest.............................................. $ 1,589 $ 7,402
Mortgage servicing rights...................................... 3,469 4,452
Other ......................................................... 613 569
------------- -------------
Total.............................................................. $ 5,671 $ 12,423
============= =============
</TABLE>
NOTE 9. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF RISK
The Company's operations are conducted from leased facilities located in
various areas of the United States. Additionally, the Company maintains two
non-operating facilities in the United Kingdom. These leases have clauses which
provide for increases in rent based on increases in the cost of living index and
options for renewal.
The future minimum lease payments are as follows:
YEARS ENDING DECEMBER 31: (Dollars in thousands)
2000................................................ $ 2,171
2001................................................ 2,049
2002................................................ 1,790
2003................................................ 712
2004................................................ 152
In the ordinary course of business, the Company has liability under
representations and warranties made to purchasers and insurers of mortgage
loans. Under certain circumstances, the Company may become liable for the unpaid
principal and interest on defaulted loans or other loans if there has been a
breach of representation or warranties.
F-15
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
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.
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, which is cooperating with the
investigation.
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. The Company and the
State are currently discussing settlement.
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, and the
parties are discussing settlement.
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
24, 2000. The Company is currently disputing the terms of the obligation to
purchase the outstanding balance of the credit cards, and the parties have
sought arbitration of the dispute.
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.
F-16
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
The Company's legal accrual related to the above matters is included as a
component of the accrued contingent liabilities line item of the Consolidated
Statements of Financial Condition.
OTHER COMMITMENTS AND CONTINGENCIES
The Company has negotiated employment agreements with certain officers.
These agreements provide for the payment of base salaries, the issuance of
common stock via incentive stock option program subject to certain restrictions
and the payment of severance benefits upon termination.
At December 31, 1999, loans related to property located in the state of
California comprised approximately 44% of the total serviced loan portfolio
while no other state comprised more than 12%.
The Company funds substantially all of the loans it originates or purchases
through borrowings under its warehouse financing facilities and internally
generated funds. These borrowings are in turn repaid with the proceeds received
by the Company from selling such loans through loan sales or securitizations.
Any failure to renew or obtain adequate funding under those warehouse financing
facilities, or other borrowings, or any substantial reduction in the size of or
pricing in the markets for the Company's loans, could have a material adverse
effect on the Company's operations. To the extent that the Company is not
successful in maintaining or replacing existing financing, it would have to
curtail its loan production activities or sell loans earlier than is optimal,
thereby having a material adverse effect on the Company's consolidated financial
condition and consolidated results of operations.
The value of and market for the Company's loans are dependent upon a number
of factors, including general economic conditions, interest rates and
governmental regulations. Adverse changes in such factors may affect the
Company's ability to sell loans for acceptable prices within a reasonable period
of time. A prolonged, substantial reduction in the size of the secondary market
for loans of the type originated or purchased by the Company may adversely
affect the Company's ability to sell loans in the secondary market with a
consequent adverse impact on the Company's results of operations, financial
condition and ability to fund future originations and purchases.
Since 1992, the Company has pooled and sold through securitizations an
increasing percentage of the loans which it originates. The Company derives a
significant portion of its income by recognizing gains upon the sale of loans
through securitizations. These gains are due in part to the value recorded at
the time of sale of residual interests and retained mortgage servicing rights.
Adverse changes in the securitization market could impair the Company's ability
to purchase and sell loans through securitizations on a favorable or timely
basis. Any such impairment could have a material adverse effect upon the
Company's consolidated financial condition and consolidated results of
operations.
The Company has relied on credit enhancement to achieve a "AAA/aaa" rating
for the regular interests of the trusts in its securitizations. The credit
enhancement has generally been in the form of an insurance policy issued by an
insurance company insuring the timely repayment of the regular interests in each
of the securitization trusts. There can be no assurance that the Company will be
able to obtain credit enhancement in any form from the current insurer or any
other provider of credit enhancement on acceptable terms or that future
securitizations will be similarly rated. A downgrading of the insurer's credit
rating or its withdrawal of credit enhancement could have a material adverse
effect on the Company's consolidated financial condition and consolidated
results of operations.
F-17
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
NOTE 10. STOCKHOLDERS' EQUITY
The Company's shares of Class A and Class B Common Stock are identical,
except with respect to voting rights and the right to convert Class B Common
Stock to Class A Common Stock. Holders of Class A Common Stock are entitled to
one vote for each share held of record, and holders of Class B Common Stock are
entitled to four votes for each share held of record. Each share of Class B
Common Stock is freely convertible into one share of Class A Common Stock at the
option of the Class B stockholder. In July of 1998, the majority stockholders of
FACO converted all of their Class B Common Stock into Class A Common Stock. As
of December 31, 1999, the Company did not have any Class B Common Stock
outstanding.
In June 1996, FAMCO granted 161,250 shares of restricted common stock to an
officer of the Company. These shares, which were exchanged for 161,250 shares of
FACO Class B Common Stock in conjunction with the Offering, vest over a period
of five years or earlier upon the occurrence of certain events. A value of $1.6
million was ascribed to such shares by the Company. This amount has been
recorded in the accompanying financial statements as increases to Class B Common
Stock and paid in capital with an offsetting amount included in deferred stock
compensation. In 1997 and 1996, 36,053 and 43,927 shares of Class B Common Stock
had vested, respectively. During 1997 and 1996, compensation expense of $0.3
million and $0.5 million, respectively, was recognized. In 1998, however, the
remaining 81,270 shares of restricted stock were forfeited due to the officer's
termination.
In July 1996, the shareholders approved a stock incentive plan for
directors, officers and other key employees of the Company, under which
2,125,000 shares of Class A Common Stock were available for grant. Under the
plan, options vest 25% six months from the date of grant and 25% each year
thereafter until fully vested and expire on the earlier of ten years from the
date of grant or 90 days after an optionee's termination of service.
The following is a summary of changes in the stock incentive plan during the
years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
-------------------------- ----------------------------- ----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE
OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE
------------ ------------ ------------ --------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Beginning of period..... 1,011,417 $ 10.65 825,021 $ 12.16 793,625 $ 11.33
Grants.................. 1,298,877 3.26 525,210 9.38 117,779 17.04
Exercises............... --- --- (47,014) 11.47 (59,145) 11.33
Cancellations........... (314,005) 9.38 (291,800) 12.46 (27,238) 11.33
------------ ------------ ------------ --------------- ------------- -------------
End of period........... 1,996,289 $ 6.04 1,011,417 $ 10.65 825,021 $ 12.16
============= ============ ============ =============== ============= =============
Options Exercisable..... 633,741 $ 8.76 309,275 $ 12.17 144,755 $ 11.40
============= ============ ============ =============== ============= =============
</TABLE>
F-18
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
Summary information related to stock options outstanding as of December 31,
1999 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
ACTUAL RANGE ---------------------------------------------------------------- --------------------------------------
OF EXERCISE NUMBER WEIGHTED-AVERAGE NUMBER
PRICES - 150% OUTSTANDING REMAINING WEIGHTED-AVERAGE EXERCISABLE WEIGHTED-AVERAGE
INCREMENT AT 12/31/99 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/99 EXERCISE PRICE
- ----------------- --------------- --------------------- --------------------- ---------------- -------------------
<S> <C> <C> <C> <C> <C>
$1.72- 2.50 363,986 9.9 $ 2.44 0
$3.28- 4.44 1,016,324 9.2 3.72 249,364 $ 3.73
$6.88- 9.25 57,340 8.5 7.54 15,010 7.62
$11.33- 16.75 547,714 7.0 12.24 363,665 12.04
$21.92- 21.92 10,925 7.8 21.92 5,702 21.92
- ----------------- --------------- --------------------- --------------------- ---------------- -------------------
$1.72- 21.92 1,996,289 8.7 $ 6.04 633,741 $ 8.76
================= =============== ===================== ===================== ================ ===================
</TABLE>
The Company accounts for its stock incentive plan based on the intrinsic
value of a grant as of the date of the grant in accordance with Accounting
Principles Board Opinion No. 25. Accordingly, no compensation expense has been
recognized in 1999, 1998 or 1997 for options granted under the Company's stock
incentive plan. Had compensation cost been recognized in accordance with the
fair value provisions of SFAS No. 123, pro forma net income would have been $2.5
million, $13.1 million and $31.6 million in 1999, 1998 and 1997, respectively,
and net income per diluted share would have been $0.14, $0.67 and $1.44 in 1999,
1998 and 1997, respectively. The fair value of each option grant, a weighted
average of $2.16, $4.99 and $9.84 for options granted in 1999, 1998 and 1997,
respectively, was estimated as of the date of grant using the Black-Scholes
option pricing model. The Company's calculations are based on a single option
valuation approach and forfeitures are recognized as they occur.
The weighted average assumptions used for the 1999, 1998 and 1997 grants are
as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------------- -------------------- -------------------
<S> <C> <C> <C>
Dividend yield.............................. None None None
Expected volatility......................... 78% 55% 33%
Risk-free interest rate..................... 5.48% 5.11% 6.12%
Expected lives.............................. 5 years 5 years 10 years
</TABLE>
In April 1997, the Board of Directors approved a share repurchase program
under which the Company is authorized to purchase up to 1.5 million shares of
its Class A Common Stock. In January 1998 and July 1998, the Board of Directors
authorized the purchase of an additional 2.0 million shares and 4.0 million
shares of Class A Common Stock, respectively. Of the 7.5 million shares
authorized, the Company had repurchased approximately 4.2 million shares as of
December 31, 1999.
As partial consideration for obtaining its $150 million warehouse financing
facility, the Company granted the warehouse lender stock warrants during both
1998 and 1999. The stock warrants granted in 1998 provide the lender the option
to purchase 1% of the Company's then outstanding common stock, with an effective
date of January 15, 2001. The original effective date of the 1998 warrants was
amended in 1999 from February 15, 1999. These warrants have a ten-year exercise
period, were granted at an exercise price of $3 5/16, and were valued at $2.32
per warrant using the Black-Scholes option pricing model. The stock warrants
granted in 1999 provide the warehouse lender the option to purchase 4.9% of the
Company's then outstanding Common Stock, with an effective date of January 15,
2000. These warrants have a ten-year exercise period, were granted at an
exercise price of $2.00, and were valued at $1.66 per warrant using the
Black-Scholes pricing model.
F-19
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
NOTE 11. NET INCOME PER SHARE
A reconciliation of the numerator and denominator used in basic and diluted
net income per share are as follows for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Net income (dollars in thousands):................................... $ 3,828 $ 14,216 $ 32,772
============= ============= =============
Weighted average number of common shares:
Basic............................................................ 18,110,214 19,380,119 21,851,732
Effect of dilutive securities - stock options.................... 13,988 51,100 178,706
------------- ------------- -------------
Diluted.......................................................... 18,124,202 19,431,219 22,030,438
============= ============= =============
Net income per share:
Basic............................................................ $ 0.21 $ 0.73 $ 1.50
Effect of dilutive securities - stock options.................... 0.01
------------- ------------- -------------
Diluted.......................................................... $ 0.21 $ 0.73 $ 1.49
============= ============= =============
</TABLE>
NOTE 12. RELATED-PARTY TRANSACTIONS
For the three years ended December 31, 1999, the Company entered into
transactions with the following related parties: the majority stockholder of the
Company, entities in which the majority stockholder of the Company has a
controlling interest and companies owned by family members of the majority
stockholder of the Company. The following amounts represent related-party
transactions for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
------------- ------------- -------------
(Dollars in thousands)
<S> <C> <C> <C>
Acquisition of a related company:
Coast Security Mortgage Company, Inc.......................... $ 4,000
Loans purchased from related parties:
Loans purchased............................................... 7,082 $ 50,353 $ 68,668
Premiums paid ................................................ 140 1,534 2,658
Payments to related parties:
Rent payments................................................. 506 581 521
Interest received from related parties............................ 590 688
</TABLE>
The following amounts represent related-party balances as of December 31:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
(Dollars in thousands)
<S> <C> <C>
Loans serviced for related parties...................................................... $ 2,209 $ 3,298
Receivables from officers and directors of the Company.................................. 22
Loan facility due to majority stockholder............................................... 64,720
Notes payable due to former shareholders of Coast Security Mortgage, Inc................ 1,000
Accrued interest due to former shareholders of Coast Security Mortgage, Inc............. 42
</TABLE>
F-20
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
NOTE 13. FINANCIAL INSTRUMENTS
The Company regularly securitizes and sells fixed and variable rate mortgage
loans. As part of its interest rate risk management strategy, the Company hedges
its interest rate risk related to its loans held for sale and origination
commitments by selling short or selling forward United States Treasury
Securities. For accounting purposes, selling short United States Treasury
Securities is not considered to be a hedge. Therefore, when selling short United
States Treasury Securities, the Company has recognized 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 or commitments to fund loans held for sale. The
gains and losses derived from these transactions are deferred and included in
the carrying amounts of loans held for sale and are recognized in earnings upon
the sale of loans hedged. Net gains and (losses) recognized on hedging
activities were $961,000, ($1,743,000) and ($161,000) for the years ended
December 31, 1999, 1998 and 1997, respectively. The notional amount of forward
sales of United States Treasury Securities at December 31, 1999 was $4.0
million, with a related unrealized gain of $9,000.
The following disclosures of the estimated fair value of financial
instruments as of December 31, 1999 and 1998 are made in accordance with the
requirements of SFAS No. 107, "Disclosure About Fair Value of Financial
Instruments." The estimated fair value amounts have been determined by the
Company using available market information and appropriate valuation
methodologies. However, considerable judgment is necessarily required to
interpret market data to develop the estimates of fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts.
<TABLE>
<CAPTION>
1999 1998
------------------------- --------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------ ------------ --------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents................................... $ 15,086 $ 15,086 $ 18,052 $ 18,052
Restricted cash............................................. 2,648 2,648 1,281 1,281
Loans held for sale......................................... 19,782 21,606 24,421 26,116
Loans receivable held for investment........................ 1,521 1,521 57,667 64,726
Residual interests.......................................... 48,222 48,222 48,720 48,720
Liabilities:
Warehouse financing facilities.............................. 14,122 14,122 17,539 17,539
Secured term loan facility - related party.................. 64,720 64,720
Other borrowings............................................ 6,545 6,545
Notes payable .............................................. 4,626 4,626 14 14
</TABLE>
The fair value of loans is estimated based upon prices received by the
Company for loans it sells.
The fair value of residual interests is estimated based upon discounted cash
flows.
Rates currently available to the Company for debt with similar terms and
remaining maturities, were used to estimate the fair value of warehouse
financing facilities, other borrowings and the notes payable.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 1999 and 1998. Although management is
not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these consolidated financial statements since that date and, therefore,
current estimates of fair value may differ significantly from the amounts
presented herein.
F-21
<PAGE>
FIRST ALLIANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
The Company is exposed to on-balance sheet credit risk related to its loans
held for sale, residual interests and loans receivable held for investment. The
Company is exposed to off-balance sheet credit risk related to loans which the
Company has committed to originate. The Company is party to financial
instruments with off-balance sheet credit risk in the normal course of business.
These financial instruments include a commitment to purchase on February 24,
2000 the outstanding balance of the credit card portfolio under the Affinity
Credit Card Program, which had an outstanding balance of approximately $18
million at December 31, 1999. Additionally, at December 31, 1999 and 1998, the
Company had outstanding commitments to extend credit in the amounts of $3.6
million and $7.8 million, respectively.
NOTE 14. DOMESTIC AND FOREIGN OPERATIONS
Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker, or decision making group, in deciding how to
allocate resources in assessing performance. The Company has one reporting
segment with two geographical areas: United States area and United Kingdom area.
GEOGRAPHIC AREA - During 1999 and 1998, the Company operated in two
geographical areas consisting of the United States and the United Kingdom. There
were no significant transfers between geographical areas during such periods.
The following table represents revenue and income before income tax
provisions for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
(Dollars in thousands)
<S> <C> <C>
Revenue:
United States.................................................... $ 64,822 $ 78,383
United Kingdom................................................... 5,117 5,425
------------- -------------
Total........................................................ $ 69,939 $ 83,808
============= ==============
Income (loss) before income tax provision:
United States.................................................... $ 4,855 $ 26,314
United Kingdom................................................... 1,523 (3,361)
------------- -------------
Total........................................................ $ 6,378 $ 22,953
============= =============
</TABLE>
The following table represents identifiable assets of the Company as of
December 31:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
(Dollars in thousands)
<S> <C> <C>
Identifiable assets:
United States.................................................... $ 112,154 $ 119,202
United Kingdom (1)............................................... 58,401
------------- -------------
Total........................................................ $ 112,154 $ 177,603
============= =============
</TABLE>
- ----------------------
(1) The Company discontinued its United Kingdom origination operation in
1998. In 1999, the Company sold its portfolio of United Kingdom loans,
and has completely exited the United Kingdom loan origination operation
as of December 31, 1999.
F-22
<PAGE>
<TABLE>
NOTE 15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<CAPTION>
FIRST SECOND THIRD FOURTH
(Dollars in thousands except per share amounts) QUARTER QUARTER QUARTER QUARTER
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1999
Total revenue......................................... $ 19,617 $ 16,455 $ 18,553 $ 15,314
Income before income tax provision.................... 3,399 972 2,441 (434)
Net income (loss)..................................... 2,039 583 1,465 (259)
Comprehensive income (loss)........................... 1,167 195 3,480 (336)
Basic net income (loss) per share..................... 0.11 0.03 0.08 (0.01)
Diluted net income (loss) per share................... 0.11 0.03 0.08 (0.01)
1998
Total revenue......................................... $ 25,370 $ 15,810 $ 22,560 $ 20,068
Income before income tax provision.................... 11,667 1,256 6,212 3,818
Net income............................................ 7,262 781 3,833 2,340
Comprehensive income.................................. 7,315 773 3,851 1,666
Basic net income per share............................ 0.35 0.04 0.21 0.13
Diluted net income per share.......................... 0.35 0.04 0.21 0.13
1997
Total revenue......................................... $ 21,437 $ 23,244 $ 23,395 $ 27,573
Income before income tax provision.................... 12,860 13,168 12,106 14,511
Net income............................................ 7,684 7,866 8,188 9,034
Comprehensive income.................................. 7,722 7,863 8,092 9,066
Basic net income per share............................ 0.35 0.36 0.38 0.41
Diluted net income per share.......................... 0.34 0.36 0.37 0.42
</TABLE>
During the third quarter of 1999, the Company sold its portfolio of United
Kingdom loans and recorded a gain on sale, net of deferred fees and foreign
currency loss, of approximately $1.3 million.
During the fourth quarter of 1999, the Company recorded charges related to
the establishment of lease obligation reserves with respect to branches closed
in the quarter. Additionally, the Company recorded a $1.6 million negative
valuation adjustment related to the credit card portfolio (see Note 1).
F-23
<PAGE>
INDEPENDENT AUDITORS' REPORT
----------------------------
To the Board of Directors and Stockholders of
First Alliance Corporation
We have audited the accompanying consolidated statements of financial condition
of First Alliance Corporation and subsidiaries (the Company) as of December 31,
1999 and 1998, and the related consolidated statements of income, comprehensive
income, stockholders' equity and cash flows for each of the three years in the
period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of First Alliance Corporation and
subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States of America.
/s/ Deloitte & Touche LLP
Costa Mesa, California
January 25, 2000
<PAGE>
PART IV
ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES, REPORTS ON FORM 8-K
(a) 1. Financial Statements:
Consolidated Statements of Financial Condition:
December 31, 1999 and 1998 F-1
Consolidated Statements of Income: For each of
The three years in the period Ended December 31, 1999 F-2
Consolidated Statements of Comprehensive Income:
For each of the three years in the period ended
December 31, 1999 F-3
Consolidated Statements of Stockholders' Equity:
For each of the three years in the period ended
December 31, 1999 F-4
Consolidated Statements of Cash Flows:
For each of the three years in the period ended
December 31, 1999 F-5
Notes to Consolidated Financial Statements:
For each of the three years in the period ended
December 31, 1999 F-7
Independent Auditors' Report F-24
2. Financial Statement Schedules:
None Required
3. Exhibits
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
--- ----------------------
3.1 Amended Certificate of Incorporation of the Company
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 S-1, Commission File
No. 333-3633)
10.5.1 Mason Loan (Incorporated by reference to Exhibit 10.5.1 of the
Company's Annual Report on Form 10-K for the year ended December 31,
1996, Commission File No. 0-28706)
10.6 Form of Directors' and Officers' Indemnity Agreement (Incorporated by
reference to Exhibit 10.7 to the Company's Registration Statement on
Form S-1, Commission File No. 333-3633)
10.7 Master Repurchase Agreement dated as of October 31, 1997 between
Nationscapital Mortgage Corporation and the Company
<PAGE>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
--- ----------------------
10.8 Master Repurchase Agreement dated as of October 31, 1997 between Coast
Security Mortgage Inc. and the Company
10.9 Chisick Employment Agreement (Incorporated by reference to Exhibit
10.10 to the Company's Registration Statement on Form S-1, Commission
File No. 333-3633)
10.10 Reimbursement Agreement (Incorporated by reference to Exhibit 10.11 to
the Company's Registration Statement on Form S-1, Commission File No.
333-3633)
10.11 Warehouse Financing Facility dated September 5, 1996 (Incorporated by
reference to Exhibit 10.12 to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1996, Commission File No.
0-28706)
10.12 Interim Warehouse and Security Agreement dated as of February 15, 1997
between Nationscapital Mortgage Corporation and the Company
(Incorporated by reference to Exhibit 10.12 to the Company's Quarterly
Report on Form 10-Q for the period ended March 31, 1997, Commission
File No. 0-28706)
10.13 Interim Warehouse and Security Agreement dated as of February 15, 1997
between Coast Security Mortgage Inc. and the Company (Incorporated by
reference to Exhibit 10.13 to the Company's Quarterly Report on Form
10-Q for the period ended March 31, 1997, Commission File No. 0-28706)
10.14 Smith Loan (Incorporated by reference to Exhibit 10.14 to the Company's
Quarterly Report on Form 10-Q for the period ended March 31, 1997,
Commission File No. 0-28706)
10.15 Building Purchase and Sale Agreement between Amresco Residential
Mortgage Corporation and the Company (Incorporated by reference to
Exhibit 10.15 to the Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1997, Commission File No. 0-28706)
10.16 (pound)25,000,000 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
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 30, 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
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)
21 Subsidiaries of the Registrant *
27 Financial Data Schedule *
- ----------------
* Filed herewith
(a) 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.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 13, 2000
---------------------
FIRST ALLIANCE CORPORATION
By: /S/ BRIAN CHISICK
--------------------------------------
Brian Chisick
Chairman and
Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/S/ BRIAN CHISICK Chairman and Chief Executive Officer, Director March 13, 2000
- ------------------------ PRINCIPAL EXECUTIVE OFFICER
Brian Chisick
/S/ FRANCISCO NEBOT President and Chief Financial Officer, Director March 13, 2000
- ------------------------ PRINCIPAL ACCOUNTING OFFICER
Francisco Nebot
/S/ JEFFREY W. SMITH Executive Vice President and Chief Operating Officer, March 13, 2000
- ------------------------ Director
Jeffrey W. Smith
/S/ SARAH CHISICK Director March 13, 2000
- ------------------------
Sarah Chisick
/S/ MERRILL BUTLER Director March 13, 2000
- ------------------------
Merrill Butler
/S/ DONALD H. KASLE Director March 13, 2000
- ------------------------
Donald H. Kasle
/S/ DANIEL K. STEVENSON Director March 13, 2000
- ------------------------
Daniel K. Stevenson
</TABLE>
EXHIBIT 21. SUBSIDIARIES OF THE REGISTRANT
FIRST ALLIANCE CORPORATION
SUBSIDIARIES OF THE REGISTRANT
First Alliance Mortgage Company
Incorporated in California
First Alliance Mortgage Company
Incorporated in Minnesota
First Alliance Services
Incorporated in California
First Alliance Portfolio Services Inc.
Incorporated in Nevada
First Alliance Mortgage Company, Limited
Incorporated in the United Kingdom
Electroloan.com, Inc.
Incorporated in California
Coast Security Mortgage, Inc.
Incorporated in California
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 15,086
<SECURITIES> 0
<RECEIVABLES> 3,607
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 39,972
<PP&E> 8,099
<DEPRECIATION> 0
<TOTAL-ASSETS> 112,154
<CURRENT-LIABILITIES> 28,423
<BONDS> 0
0
0
<COMMON> 223
<OTHER-SE> 78,882
<TOTAL-LIABILITY-AND-EQUITY> 112,154
<SALES> 53,527
<TOTAL-REVENUES> 69,939
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 52,381
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11,180
<INCOME-PRETAX> 6,378
<INCOME-TAX> 2,550
<INCOME-CONTINUING> 3,828
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,828
<EPS-BASIC> .21
<EPS-DILUTED> .21
</TABLE>
