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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Mark One
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No.: 0-22353
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FLAGSTAR BANCORP, INC.
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(Exact name of registrant as specified in its charter)
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MICHIGAN 38-3150651
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2600 TELEGRAPH ROAD, BLOOMFIELD HILLS, MICHIGAN 48302-0953
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(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (248) 338-7700
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Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety days. Yes X No .
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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 registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
form 10-K. [X]
The registrants voting stock is traded on the NASDAQ Stock Market. The aggregate
market value of the voting stock held by non-affiliates of the registrant,
computed by reference to the last sale price ($22.5 per share) at which the
stock was sold on March 10, 1998 was approximately $185.0 million. For purposes
of this calculation, the term "affiliate" refers to all executive officers and
directors of the registrant and all stockholders beneficially owning more than
10% of the registrant's Common Stock.
As of March 27, 1998, 13,670,000 shares of the registrant's Common Stock, $0.01
par value, were issued and outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
NONE.
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TABLE OF CONTENTS
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PART I
Item 1. Business................................................ 4
Item 2. Properties.............................................. 15
Item 3. Legal Proceedings....................................... 15
Item 4. Submission of Matters to a Vote of Security Holders..... 15
PART II
Item 5. Market for the Stock and Related
Stockholder Matters................................... 15
Management's Report..................................... 16
Item 6. Selected Financial Data................................. 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 18
Item 8. Financial Statements and Supplementary Data............. 33
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................... 62
PART III
Item 10. Directors and Executive Officer of the Registrant....... 62
Item 11. Executive Compensation.................................. 64
Item 12. Security Ownership of Certain Beneficial Owners and
Management............................................ 67
Item 13. Certain Relationships and Related Transactions.......... 68
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports
on Form 8-K........................................... 69
Signatures.............................................. 70
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When used in this Form 10-K or future filings by the Company with the Securities
and Exchange Commission, in the Company's press releases or other public or
stockholder communications, or in oral statements made with the approval of an
authorized executive officer, the words or phrases "would be", "will allow",
"intends to", "will likely result", "are expected to", "will continue", "is
anticipated", "estimate", "project", or similar expressions are intended to
identify "forward looking statement" within the meaning of the Private
Securities Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors, including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investment activities and competitive and regulatory
factors, could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected.
The Company does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
3
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PART I
ITEM 1. BUSINESS
GENERAL
Flagstar Bancorp, Inc. ("Flagstar" or the "Company"), is the holding company for
Flagstar Bank, FSB (the "Bank"), a federally chartered stock savings bank
founded in 1987. With $1.9 billion in assets at December 31, 1997, Flagstar is
the largest independent savings institution headquartered in Michigan.
Flagstar's primary business consists of attracting deposits from the general
public and originating or acquiring residential mortgage loans. The Company also
acquires funds on a wholesale basis from a variety of sources, services a
significant volume of loans for others, and to a lesser extent makes consumer
loans, commercial real estate loans, and non-real estate commercial loans.
Flagstar serves as a financial intermediary by gathering funds from a variety of
sources and investing such funds primarily in mortgage loans with the objective
of securitizing the mortgage loans while retaining the servicing rights. The
Company also invests in a significant amount of loans in order to maximize the
leverage ability of the Company. The Company invests in these loans in order to
receive the interest spread between earning assets and paying liabilities.
The Bank is a member of the Federal Home Loan Bank System ("FHLB") and is
subject to regulation, examination and supervision by the Office of Thrift
Supervision ("OTS") and the Federal Deposit Insurance Corporation ("FDIC"). The
Bank's deposits are insured by the FDIC through the Savings Association
Insurance Fund ("SAIF").
The Company's executive office is located at 2600 Telegraph, Bloomfield Hills,
Michigan 48302, and its telephone number at such office is (248) 338-7700.
4
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LENDING ACTIVITIES
Flagstar Bank is primarily a consumer-oriented financial services organization.
The Bank's principal business is obtaining funds in the form of deposits and
borrowings and investing those funds in various types of loans. The acquisition
or origination of mortgage loans is the Bank's primary lending activity. During
1997, Flagstar was the eighteenth largest originator in the United States. In
1996 and 1995, the Bank was also one of the twenty largest mortgage originators
in the United States. To a much lesser extent, the Bank makes consumer loans and
commercial real estate loans and commercial loans.
Flagstar Bank currently conducts its retail operations from 19 full-service bank
branches and 35 loan origination centers located in Michigan, California,
Florida and Ohio. The Bank's largest concentration of offices is in southern and
western Michigan, where all of its branches and 23 of its loan centers are
located. The Bank also has nine loan centers in southern California, two loan
centers in central Florida, and one loan center in central Ohio. At December 31,
1997, the largest percentage of loans held or serviced by the Bank related to
properties located in southern and western Michigan. The Bank also maintains 16
wholesale lending offices which conduct business with correspondents nationwide.
Flagstar Bank offers all of its mortgage loan services throughout its market
areas from its full-service bank branches, retail loan origination offices, and
wholesale lending offices. Its loan officers are made available at each of the
bank branches and retail loan centers to process loan applications.
MORTGAGE LOANS
The origination or acquisition of residential mortgage loans constitutes the
most significant lending activity of the Bank. The Bank originated or acquired
approximately $7.9 billion, $6.8 billion and $5.2 billion of mortgage loans
during the years ended December 31, 1997, 1996 and 1995, respectively. Each loan
originated or acquired is for the purpose of acquiring or refinancing a single-
family residence and is secured by a first mortgage on the property. The Bank
offers traditional fixed-rate and adjustable-rate mortgage loans with terms
ranging from one to 30 years. The majority of the Bank's products conform to the
respective underwriting guidelines established by the Federal Home Loan Mortgage
Corporation ("FHLMC") and the Federal National Mortgage Association ("FNMA").
The Bank also offers larger residential mortgage loans which meet the Bank's
underwriting guidelines but which may have other terms and conditions customized
to meet the needs of the borrower.
In order to help expand home ownership opportunities to a larger number of
potential borrowers, the Bank also offers government-sponsored mortgage programs
in the form of Federal Housing Administration ("FHA") loans and Veterans
Administration ("VA") loans. FHA and VA loans feature lower down payment
requirements and expanded income qualification guidelines; although, certain
maximum loan amounts may apply.
The Bank, as a part of its overall mortgage banking strategy securitizes,
through FHLMC or FNMA, mortgage loans which satisfy their individual
requirements (i.e., conforming loans), including the current maximum purchase
limitation for mortgages of $214,600. Securitization is the process by which
mortgage loans owned by the Bank are exchanged for marketable securities
collateralized by mortgage loans that are guaranteed by either FHLMC or FNMA.
The Bank generally sells its longer-term, fixed-rate loans while investing in
the shorter duration and adjustable rate product. The servicing related to the
sold loans is generally retained by the Bank and later sold in bulk sales to
secondary market investors. The Bank, for the most part, does not sell the
servicing rights to loans originated within its retail market area. See Notes 3,
4, and 7 of the Notes to Consolidated Financial Statements in Item 8. Financial
Statements and Supplementary Data, herein.
5
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MORTGAGE LOANS (CONTINUED)
The Bank's written underwriting guidelines employ a system of internal controls
designed to maintain the quality of the loan portfolio. All mortgage loans are
reviewed by an underwriter at the Bank's national headquarters or at one of the
Bank's wholesale lending centers. The Bank also employs contract underwriters to
underwrite loans in areas outside the state of Michigan. Additionally, certain
correspondents of the Bank have been issued delegated underwriting. If the loan
amount exceeds the maximum purchase limitation of FHLMC and FNMA, but is less
than $500,000, a senior bank officer must also approve the loan. If the loan
exceeds $500,000, the Bank's Chief Executive Officer or President must also
approve the loan.
The Bank requires that any loan with a loan-to-value ratio in excess of 80% must
carry mortgage insurance. A loan-to-value ratio is the ratio that the original
principal amount of a loan bears to the appraised value of the mortgaged
property or, in the case of a purchase money mortgage, the lower of the
appraised value of the property or the purchase price of the property securing
the loan. The Bank requires a lower loan-to-value ratio for non-owner-occupied
loans. In addition, all home mortgage loans originated by the Bank are subject
to requirements for title, fire and hazard insurance. Real estate taxes are
generally collected and held in escrow for disbursement by the Bank. The Bank is
further protected against fire or casualty loss on home mortgage loans by a
blanket mortgage impairment insurance policy covering a lack or inadequacy of
the mortgagor's required insurance.
CONSUMER LOANS
At December 31, 1997, Flagstar's consumer loan portfolio totaled $34.0 million,
or 2% of its total loan portfolio. The largest component of the Bank's consumer
loan portfolio was adjustable-rate equity line loans which totaled approximately
$24.2 million, representing 71% of the total consumer loan portfolio. The
remaining balance of consumer loans, or approximately $10.8 million, consisted
of loans such as home improvement, fixed-rate home equity, and automobile loans.
Flagstar's underwriting standards for a consumer loan include an analysis of the
applicant's payment history on other indebtedness and an assessment of the
applicant's ability to meet existing obligations as well as payments on the
proposed loan. Equity line loans are secured by a mortgage on the borrower's
home.
COMMERCIAL REAL ESTATE LOANS
At December 31, 1997, Flagstar Bank's commercial real estate loan portfolio
totaled $31.8 million, or 2% of the Bank's total loan portfolio.
The Bank's commercial real estate loans generally range from $500,000 to
$10,000,000, and are typically fixed-rate loans for up to five-year terms or
adjustable-rate loans for up to ten-year terms, with payment schedules based on
amortization periods of up to 30 years. Applications for commercial real estate
loans are reviewed and approved by a committee of senior management.
All loans on income-producing properties are evaluated by a qualified, certified
appraiser to ensure that the appraised value of the property to be mortgaged
satisfies the Bank's loan-to-value ratio requirements of no higher than 80%. The
Bank also generally requires a minimum debt-service ratio of 1.1 to 1. In
addition, the Bank considers the experience of the prospective borrower with
similar properties, the creditworthiness and managerial ability of the borrower,
the enforceability and collectibility of any relevant guarantees and the quality
of the asset to be mortgaged. The Bank officer processing the loan also
generally performs various feasibility and income absorption studies in
connection with the loan, and also review the independent appraisal obtained on
the property.
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NON-REAL ESTATE COMMERCIAL LOANS
The Bank offers a variety of non-real estate commercial loans, including demand,
term and line-of-credit loans. At December 31, 1997, the Bank's non-real estate
commercial loan portfolio was $80.3 million, or 5% of its total loan portfolio.
Included in this loan category is the balances relating to the Bank's warehouse
lending program. These loans are granted for terms of one day to 30 days.
Warehouse lines of credit are used by correspondents to fund production of loans
which for the most part are acquired by the Company. At December 31, 1997, the
aggregate amount of warehouse lines of credit granted by the Company to its
correspondents was $139.8 million of which $77.5 million was outstanding. Each
borrowing consummated under the warehouse lending division is fully
collateralized by a mortgage loan. These lines of credit are also personally
guaranteed by the borrower. Each correspondent who applies for a warehouse line
of credit is approved under a different set of standards from those standards
used to grant correspondent status.
The Bank's underwriting policy with respect to non-real estate commercial loans
is based primarily upon the financial stability of the borrower and the
borrower's business.
LOAN MATURITIES BY TYPE
The following table sets forth the Bank's total loans at December 31, 1997,
categorized as having fixed interest rates or adjustable interest rates.
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Fixed Adjustable
Rate Rate Total
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(In Thousands)
Mortgage loans available for sale $607,153 $589,999 $1,197,152
Mortgage loans held for investment 159,957 122,267 282,224
Commercial real estate 25,181 6,570 31,751
Construction 35,373 -- 35,373
Consumer 9,124 24,880 34,004
Non-real estate commercial 883 79,372 80,255
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Total $837,671 $823,088 $1,660,759
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LOAN REPAYMENT SCHEDULE
The following table sets forth the scheduled principal payments of Flagstar's
loan portfolio at December 31, 1997, assuming that principal repayments are made
in accordance with the contractual terms of the loans.
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Within 1 Year 2 Years 3 Years 5 Years 10 years Over
1 year to 2 years to 3 years to 5 years to 10 years to 15 years 15 years Totals
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( In Thousands )
Mortgage loans available for sale $104,071 $ 96,735 $ 89,908 $167,081 $324,649 $201,654 $213,054 $1,197,152
Mortgage loans held for investment 32,620 30,307 28,119 43,589 65,364 37,052 45,173 282,224
Commercial real estate 5,817 5,339 4,895 8,962 6,738 -- -- 31,751
Construction 35,373 -- -- -- -- -- -- 35,373
Consumer 4,223 3,826 3,466 6,280 12,647 3,562 -- 34,004
Non-real estate commercial 80,255 -- -- -- -- -- -- 80,255
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Total $262,359 $136,207 $126,388 $225,912 $409,398 $242,268 $258,227 $1,660,759
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ASSET QUALITY
Flagstar has implemented comprehensive internal asset review systems to provide
for early detection of problem assets. The Bank's asset classifications and the
adequacy of its allowances for losses are analyzed quarterly based on, among
other things, historical loss experience and current economic conditions.
Although this system will not eliminate future losses due to unanticipated
declines in the real estate market or economic downturns, it should provide for
timely identification of those losses. Refer to four schedules included
hereafter (Tables 10 and 11), on pages 29-30, which set forth certain
information about the Bank's non performing assets.
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ASSET QUALITY (CONTINUED)
DELINQUENT LOANS. Residential property loans are considered by the Bank to be
delinquent when any payment of principal and/or interest is past due. While it
is the goal of management to work out a satisfactory repayment schedule with a
delinquent borrower, the Bank will undertake foreclosure proceedings if the
delinquency is not satisfactorily resolved. The Bank's procedures regarding
delinquent loans are designed to assist borrowers in meeting their contractual
obligation. The Bank customarily mails notices of past due payments to the
borrower approximately 15, 30 and 45 days after the due date, and late charges
are assessed in accordance with Bank parameters. The Bank's Collection
Department makes telephone and/or personal contact with borrowers after a 30-day
delinquency. In certain cases, the Bank recommends that the borrower seek credit
counseling assistance and may grant forbearance if the Bank determines that the
borrower is likely to correct loan delinquencies within a reasonable period of
time. The Bank ceases the accrual of interest on loans which are more than 90
days delinquent. Such interest is recognized as income when collected.
REPOSSESSED ASSETS. Real property which the Bank acquires as a result of
foreclosure proceedings is classified as "real estate owned" until it is sold or
otherwise disposed of. The Bank's Foreclosure Committee decides whether to
rehabilitate the property or sell it "as is," and whether to list the property
with a broker, sell the property directly to a third party, or sell it at
auction. Generally, the Bank is able to dispose of a substantial portion of this
type of real estate and other repossessed assets during each year, but the Bank
invariably acquires additional real estate and other assets through repossession
in the ordinary course of its business. At December 31, 1997, the Bank held
approximately $18.3 million of repossessed assets.
SOURCES OF FUNDS
Customer deposits, which totaled $1.1 billion at December 31, 1997, represent
the principal funding source for Flagstar's lending and investing activities. In
addition, the Company derives funds from operations, loan principal payments,
loan sales, advances from the FHLB, and customer escrow accounts.
DEPOSIT ACTIVITIES. Flagstar has developed a variety of deposit products
ranging in maturity from demand-type accounts to certificates with maturities of
up to ten years, including regular and statement passbook accounts, checking and
NOW accounts, and various money market accounts. Flagstar primarily relies upon
its network of branches, the quality and efficiency of its customer service and
its pricing policies to attract deposits.
The following table sets forth information relating to the Bank's deposit flows
for each of the years indicated:
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Year Ended December 31,
1997 1996 1995 1994 1993
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(In Thousands)
Total deposits at the beginning of the year $ 624,485 $526,974 $307,624 $190,761 $181,171
Interest credited 50,143 30,431 25,123 9,037 7,431
Deposits acquired in merger - - - 197,181 -
Net deposit increase / (decrease) 435,305 67,080 194,227 (89,355) 2,159
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Total deposits at the end of the year $1,109,933 $624,485 $526,974 $307,624 $190,761
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BORROWINGS. The FHLB provides credit for savings institutions and other member
financial institutions. As a member of the FHLB, Flagstar is required to own
stock in the FHLB. Flagstar is authorized to apply for advances from the FHLB
using its mortgage loans as collateral. The FHLB generally permits advances up
to 50% of the Bank's "adjusted assets", which are defined as assets reduced by
outstanding advances and borrowings. At December 31, 1997, advances to the Bank
by the FHLB totaled $482.4 million, or 34% of adjusted assets. Of the $482.4
million outstanding at year-end, $79.9 million, or 17% of the Bank's total FHLB
advances, consisted of daily borrowings which may be "put" back or paid off at
the Bank's option without penalty. Refer to Note 9 of the Notes to Consolidated
Financial Statements, in Item 8. Financial Statements and Supplementary Data,
herein for further discussion of the Bank's FHLB advances.
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SOURCES OF FUNDS (CONT'D)
LOAN PRINCIPAL PAYMENTS. Payments totaled $317.2 million during 1997,
representing an increase of $81.1 million, or 34.3%, compared to 1996. This
increase, was attributable to the increased asset base and the lower interest
rate environment experienced in 1997, which increased the amount of loan
refinancings or payoffs.
LOAN SALES. Sales of mortgage loans totaled $7.3 billion in 1997, compared to
$6.6 billion sold in 1996. The sales recorded during 1997 were higher than in
1996 primarily because of the increased loan origination volume. Only a portion
of loans originated were retained by the Bank and held for investment.
CUSTOMER ESCROW ACCOUNTS. Escrow accounts on mortgage loans decreased from
$61.0 million at December 31, 1996 to 43.4 million at December 31,1997. This
decrease was caused by a decrease in total loans serviced at December 31, 1997
from $9.5 billion at December 31, 1996 to $8.0 billion.
SUBSIDIARY ACTIVITIES
The Company conducts business through a number of wholly-owned subsidiaries in
addition to the Bank. The additional subsidiaries of the Company include Douglas
Insurance Agency, Inc. ("DIA"), FSSB Real Estate Development Corporation
("REDC"), Mortgage Video Network, Inc. ("Video") and First Security Investment
Group, Inc. ("Investment"). Of the additional subsidiaries, DIA and Investment
are presently active. DIA acts as an agent for life insurance and property and
casualty insurance companies and Investment offer a full-service brokerage
service.
The Bank, the Company's primary subsidiary, is a federally chartered, stock
savings bank headquartered in Bloomfield Hills, Michigan. The Bank owns five
subsidiaries: FSSB Mortgage Corporation ("Mortgage"), Boston Credit Corporation
("BCC"), Mortgage Affiliated Services, Inc. ("MAS"), Mid-Michigan Service
Corporation ("Mid-Michigan") and SSB Funding Corporation ("Funding"). Mortgage,
BCC, Mid-Michigan, and Funding are currently inactive subsidiaries. MAS provides
appraisal and document preparation services, primarily in conjunction with the
Bank's loan closings.
REGULATION
GENERAL
The Bank is chartered as a federal savings bank under the Home Owners' Loan Act,
as amended (the "HOLA"), which is implemented by regulations adopted and
administered by the OTS. As a federal savings bank, the Bank is subject to
regulation, supervision and regular examination by the OTS. The OTS also has
extensive enforcement authority over all savings institutions and their holding
companies, including the Bank and the Company. Federal banking laws and
regulations control, among other things, the Bank's required reserves,
investments, loans, mergers and consolidations, payment of dividends and other
aspects of the Bank's operations. The deposits of the Bank are insured by the
SAIF administered by the FDIC to the maximum extent provided by law (up to
$100,000 for each depositor). In addition, the FDIC has certain regulatory and
examination authority over OTS-regulated savings institutions and may recommend
enforcement actions against savings institutions to the OTS. The supervision and
regulation of the Bank is intended primarily for the protection of the deposit
insurance fund and depositors rather than for the Company, the holder of the
Bank stock.
The following discussion is intended to be a summary of certain statutes, rules
and regulations affecting the Bank. A number of other statutes and regulations
have an impact on its operations. The following summary of applicable statutes
and regulations does not purport to be complete and is qualified in its entirety
by reference to such statutes and regulations.
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REGULATION (CONT'D)
REGULATION OF THE BANK
PROPOSED LEGISLATION. Legislation currently pending before the United States
Congress would, if enacted, require all federal savings institutions (such as
the Bank) to convert to a national bank or a state bank or savings bank charter.
In addition, the proposed changes would require the Company to be regulated as a
bank holding company or a "Financial Services" holding company. If the pending
legislation were to be adopted in its current form, it would eliminate certain
advantages now enjoyed by federal savings institutions, such as unrestricted
interstate branching.
The Bank cannot predict whether or in what form the proposed legislation will be
enacted. However, based upon the provisions of the currently pending
legislation, the management of the Bank does not believe that the enactment of
such legislation would have a material adverse effect on its financial condition
or results of operations.
BUSINESS ACTIVITIES. The Bank derives its lending and investment powers from
the HOLA and the regulations of the OTS thereunder. Under these laws and
regulations, the Bank may invest in mortgage loans secured by residential and
commercial real estate, commercial and consumer loans, certain types of
commercial paper and debt securities, and certain other assets. The Bank may
also establish service corporations that may engage in activities not otherwise
permissible for the Bank, including certain real estate equity investments and
securities and insurance brokerage. These investment powers are subject to
various limitations.
BRANCHING. Subject to certain limitations, OTS regulations currently permit a
federally chartered savings institution like the Bank to establish branches in
any state of the United States, provided that the federal savings institution
qualifies as a "domestic building and loan association" under the Internal
Revenue Code. See "--Qualified Thrift Lender Test." The authority for a federal
savings institution to establish an interstate branch network would facilitate a
geographic diversification of the institution's activities. However, recently
proposed federal legislation could, if enacted, restrict the Bank's ability to
open branches in states other than Michigan. See "--Proposed Legislation."
REGULATORY CAPITAL. The OTS has adopted capital adequacy regulations that
require savings institutions such as the Bank to meet three minimum capital
standards: a "core" capital requirement of 3% of adjusted total assets, a
"tangible" capital requirement of 1.5% of adjusted total assets, and a "total
risk-based" capital requirement of 8% of total risk-weighted assets. In
addition, the OTS has adopted regulations imposing certain restrictions on
savings institutions that have a total risk-based capital ratio of less than 8%,
a ratio of Tier 1 capital to risk-weighted assets of less than 4% or a ratio of
Tier 1 capital to total assets of less than 4% (or 3% if the institution is
rated Composite 1 under the CAMEL examination rating system). See "--Prompt
Corrective Regulatory Action." As of December 31, 1997, the Bank satisfied the
three minimum capital standards of the OTS. See Note 13 of the Notes to
Consolidated Financial Statements, in Item 8. Financial Statements and
Supplementary Data, herein.
PROMPT CORRECTIVE REGULATORY ACTION. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), all financial institutions are
categorized as either "well-capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized," or "critically
undercapitalized". Federal banking regulators are required to take prompt
corrective action in respect of depository institutions that do not meet certain
minimum capital requirements, including a leverage limit and a risk-based
capital requirement. All institutions, regardless of their capital levels, are
restricted from making any capital distribution or paying any management fees
that would cause the institution to become undercapitalized. As required by
FDICIA, banking regulators, including the OTS, have issued regulations that
classify insured depository institutions by capital levels and provide that the
applicable agency will take various prompt corrective actions to resolve the
problems of any institution that fails to satisfy the capital standards.
As of December 31, 1997, the Bank was "well-capitalized" as defined by the
regulations. See Note 13 of the Notes to Consolidated Financial Statements, in
Item 8. Financial Statements and Supplementary Data, herein.
10
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REGULATION (CONT'D)
FEDERAL DEPOSIT INSURANCE. The Bank is required to pay assessments, based on a
percentage of its insured deposits, to the FDIC for insurance of its deposits by
the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
insurance assessment rate for an insured depository institution depends on the
assessment risk classification assigned to the institution. Institutions are
assigned by the FDIC to one of three capital groups--well-capitalized,
adequately capitalized, or undercapitalized--and, within each capital category,
to one of three supervisory subgroups.
In order to recapitalize the SAIF and to equalize the deposit insurance premiums
paid by SAIF-insured institutions and institutions with deposits insured by the
Bank Insurance Fund ("BIF"), Congress enacted the Deposit Insurance Funds Act of
1996 (the "1996 Act"), which authorized the FDIC to impose a one-time special
assessment on all institutions with SAIF-assessable deposits in the amount
necessary to recapitalize the SAIF to the statutorily designated reserve ratio
of 1.25% of insured deposits. Institutions were assessed at the rate of 65.7
basis points per $100 of each institution's SAIF-assessable deposits as of March
31, 1995. The 1996 Act provided that the amount of the special assessment was
deductible for federal income tax purposes for the taxable year in which the
special assessment was paid.
As a result of the recapitalization of the SAIF by the 1996 Act, the FDIC
reduced the insurance assessment rate for SAIF-assessable deposits for periods
beginning on October 1, 1996. For 1997, the FDIC set the effective insurance
assessment rates for SAIF-insured institutions, such as the Bank, at zero to 27
basis points. In addition, SAIF-insured institutions will be required, until
December 31, 1999, to pay assessments to the FDIC at an annual rate of between
6.0 and 6.5 basis points to help fund interest payments on certain bonds issued
by the Financing Corporation ("FICO"), an agency of the federal government
established to recapitalize the predecessor to the SAIF. During this period, BIF
member banks will be assessed for payment of the FICO obligations at one-fifth
the annual rate applicable to SAIF member institutions. After December 31, 1999,
BIF and SAIF members will be assessed at the same rate (currently estimated at
approximately 2.4 basis points) to service the FICO obligations.
The 1996 Act also provides that the FDIC may not assess regular insurance
assessments for the SAIF unless required to maintain or to achieve the
designated reserve ratio of 1.25%, except for such assessments on those
institutions that are not classified as "well-capitalized" or that have been
found to have "moderately severe" or "unsatisfactory" financial, operational or
compliance weaknesses. The Bank is classified as "well-capitalized" and has not
been found by the OTS to have such supervisory weaknesses.
QUALIFIED THRIFT LENDER TEST. The HOLA and OTS regulations require all savings
institutions to satisfy one of two Qualified Thrift Lender ("QTL") tests or to
suffer a number of sanctions, including restrictions on activities. To qualify
as a QTL, a savings institution must either (i) be deemed a "domestic building
and loan association" under the Internal Revenue Code (the "Code") by
maintaining at least 60% of its total assets in specified types of assets,
including cash, certain government securities, loans secured by and other assets
related to residential real property, educational loans, and investments in
premises of the institution or (ii) satisfy the HOLA's QTL test by maintaining
at least 65% of "portfolio assets" in certain "Qualified Thrift Investments."
A savings institution must maintain its status as a QTL on a monthly basis in at
least nine out of every 12 months. An initial failure to qualify as a QTL
results in a number of sanctions, including the imposition of certain operating
restrictions and a restriction on obtaining additional advances from its Federal
Home Loan Bank. If a savings institution does not requalify under the QTL test
within the three-year period after it fails the QTL test, it would be required
to terminate any activity not permissible for a national bank and repay as
promptly as possible any outstanding advances from its Federal Home Loan Bank.
In addition, the holding company of such a Bank would similarly be required to
register as a bank holding company with the Federal Reserve Board. At
December 31, 1997, the Bank qualified as a QTL.
11
<PAGE>
REGULATION (CONT'D)
SAFETY AND SOUNDNESS STANDARDS. FDICIA, as amended by the Riegle Community
Development and Regulatory Improvement Act of 1994, requires the OTS, together
with the other federal bank regulatory agencies, to prescribe standards, by
regulation or guideline, relating to internal controls, information systems and
internal audit systems, loan documentation, credit underwriting, interest rate
risk exposure, asset growth, asset quality, earnings, stock valuation, and
compensation, fees and benefits and such other operational and managerial
standards as the agencies deem appropriate. The OTS and the federal bank
regulatory agencies have adopted a set of guidelines prescribing safety and
soundness standards pursuant to the statute. The safety and soundness guidelines
establish general standards relating to internal controls and information
systems, internal audit systems, loan documentation, credit underwriting,
interest rate exposure, asset growth, and compensation, fees and benefits. In
general, the guidelines require, among other things, appropriate systems and
practices to identify and manage the risks and exposures specified in the
guidelines. The guidelines prohibit excessive compensation as an unsafe and
unsound practice and describe compensation as excessive when the amounts paid
are unreasonable or disproportionate to the services performed by an executive
officer, employee, director or principal stockholder.
In addition, on July 10, 1995, the OTS and the federal bank regulatory agencies
proposed guidelines for asset quality and earnings standards. Under the proposed
standards, a savings institution would be required to maintain systems,
commensurate with its size and the nature and scope of its operations, to
identify problem assets and prevent deterioration in those assets as well as to
evaluate and monitor earnings and ensure that earnings are sufficient to
maintain adequate capital and reserves. Management believes that the asset
quality and earnings standards, in the form proposed by banking agencies, would
not have a material effect on the operations of the Bank.
LIMITATIONS ON CAPITAL DISTRIBUTIONS. OTS regulations impose limitations upon
capital distributions by all savings institutions, including the Bank.
Limitations are imposed on cash dividends, payments to repurchase or otherwise
acquire its shares, payments to stockholders of another institution in a cash-
out merger and other distributions charged against capital. A savings
institution must give notice to the OTS at least 30 days before declaration of a
proposed capital distribution to its holding company, and capital distributions
in excess of specified earnings or by certain institutions are subject to prior
approval by the OTS. A savings institution that has capital in excess of all
regulatory capital requirements before and after a proposed capital distribution
and that is not otherwise restricted in making capital distributions, may, after
prior notice but without the approval of the OTS, make capital distributions
during a calendar year equal to the greater of (a) 100% of its net income to
date during the calendar year plus the amount that would reduce by one-half its
"surplus capital ratio" (the excess capital over its fully phased-in capital
requirements) at the beginning of the calendar year, or (b) 75% of its net
income for the previous four quarters. Any additional capital distributions
would require prior OTS approval. The OTS has proposed regulations that would
simplify the existing procedures governing capital distributions by savings
institutions. See "--Prompt Corrective Regulatory Action."
In addition to the foregoing, earnings of the Bank appropriated to bad debt
reserves and deducted for federal income tax purposes are not available for
payment of dividends or other distributions to the Bank without payment of taxes
at the then current tax rate by the Bank on the amount of earnings removed from
the reserves for such distributions.
CONSUMER CREDIT REGULATION. The Bank's mortgage lending activities are subject
to the provisions of various federal and state statutes, including, among
others, the Truth in Lending Act, the Equal Credit Opportunity Act, the Real
Estate Settlement Procedures Act, the Fair Housing Act, and the regulations
promulgated thereunder. These statutes and regulations, among other provisions,
prohibit discrimination, prohibit unfair and deceptive trade practices, require
the disclosure of certain basic information to mortgage borrowers concerning
credit terms and settlement costs, and otherwise regulate terms and conditions
of credit and the procedures by which credit is offered and administered. Many
of the above regulatory requirements are designed to protect the interests of
consumers, while others protect the owners or insurers of mortgage loans.
Failure to comply with these requirements can lead to administrative enforcement
actions, class action lawsuits and demands for restitution or loan rescission.
12
<PAGE>
REGULATION (CONT'D)
TRANSACTIONS WITH AFFILIATES. The Bank is subject to restrictions imposed by
Sections 23A and 23B of the Federal Reserve Act on extensions of credit to, and
certain other transactions with, its holding company and other affiliates, and
on investments in the stock or other securities thereof. Such restrictions
prevent Flagstar and such other affiliates from borrowing from the Bank unless
the loans are secured by specified collateral, and require such transactions to
have terms comparable to terms of arm's-length transactions with third persons.
Further, such secured loans and other transactions and investments by the Bank
are generally limited in amount as to Flagstar and as to any other affiliate to
10% of the Bank's capital and surplus and as to Flagstar and all other
affiliates to an aggregate of 20% of the Bank's capital and surplus.
LOANS TO DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS. The Bank's
ability to extend credit to its directors, executive officers, and 10%
stockholders, as well as to entities controlled by such persons, is governed by
the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and
Regulation O of the Federal Reserve Board thereunder. Among other things, these
provisions require that an institution's extensions of credit to insiders (a) be
made on terms that are substantially the same as, and follow credit underwriting
procedures that are not less stringent than, those prevailing for comparable
transactions with unaffiliated persons and that do not involve more than the
normal risk of repayment or present other unfavorable features and (b) not
exceed certain limitations on the amount of credit extended to such persons,
individually and in the aggregate, which limits are based, in part, on the
amount of the institution's capital. In addition, extensions of credit in excess
of certain limits must be approved by the institution's Board of Directors.
RESERVE REQUIREMENTS. Pursuant to regulations of the Federal Reserve Board, all
FDIC-insured depository institutions must maintain average daily reserves
against their transaction accounts. No reserves are required to be maintained on
the first $4.7 million of transaction accounts, and reserves equal to 3% must be
maintained on the next $47.8 million of transaction accounts, plus reserves
equal to 10% on the remainder. These percentages are subject to adjustment by
the Federal Reserve Board. Because required reserves must be maintained in the
form of vault cash or in a non-interest-bearing account at a Federal Reserve
Bank, the effect of the reserve requirement is to reduce the amount of the
institution's interest-earning assets. As of December 31, 1997, the Bank met its
reserve requirements.
LIQUIDITY REQUIREMENTS. The Bank is required by OTS regulation to maintain an
average daily balance of liquid assets (cash, certain time deposits, bankers'
acceptances, highly rated corporate debt and commercial paper, qualifying
mortgage-related securities and mortgage loans, securities of certain mutual
funds, and specified United States government, state or federal agency
obligations) equal to the monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable short-term savings deposits
plus short-term borrowings. The average daily liquidity ratio of the Bank for
the month ended December 31, 1997 was 14.6%.
FEDERAL HOME LOAN BANK SYSTEM. The Federal Home Loan Bank System consists of
12 district Federal Home Loan Banks subject to supervision and regulation by the
Federal Housing Finance Board ("FHFB"). The Federal Home Loan Banks provide a
central credit facility primarily for member institutions. As a member of the
FHLB, the Bank is required to acquire and hold shares of capital stock in the
FHLB in an amount at least equal to 1% of the aggregate unpaid principal of its
home mortgage loans, home purchase contracts, and similar obligations at the
beginning of each year, or 1/20 of its advances (borrowings) from the FHLB,
whichever is greater. The Bank was in compliance with this requirement, with an
investment in FHLB stock at December 31, 1997 of $40.0 million.
REGULATION OF THE COMPANY
The Company is a savings and loan holding company under the HOLA and, as such,
is subject to OTS regulation, supervision and examination. In addition, the OTS
has enforcement authority over the Company and its non-savings institution
subsidiaries and may restrict or prohibit activities that are determined to
represent a serious risk to the safety, soundness or stability of the Bank or
any other subsidiary savings institution.
Under the HOLA, a savings and loan holding company may not (i) acquire, with
certain exceptions, more than 5% of a non-subsidiary savings institution or a
non-subsidiary savings and loan holding company; or (ii) acquire or retain
control of a depository institution that is not insured by the FDIC.
13
<PAGE>
REGULATION (CONT'D)
As a unitary savings and loan holding company, the Company generally is not
subject to any restriction as to the types of business activities in which it
may engage, provided that the Bank continues to satisfy the QTL test. See
"--Regulation and Supervision of the Bank--Qualified Thrift Lender Test." Upon
any non-supervisory acquisition by the Company of another savings institution
that is held as a separate subsidiary, the Company would become a multiple
savings and loan holding company and would be subject to limitations on the
types of business activities in which it could engage. The HOLA limits the
activities of a multiple savings and loan holding company and its non-insured
institution subsidiaries primarily to activities permissible for bank holding
companies under the Bank Holding Company Act, subject to the prior approval of
the OTS, and to other activities authorized by OTS regulation.
COMPETITION
Based on total assets at December 31, 1997, the Company is the largest
independent savings institution headquartered in Michigan. The Company faces
substantial competition in attracting deposits at its bank branches. Its most
direct competition for deposits has historically come from other savings
institutions, commercial banks and credit unions. Money market funds and full-
service securities brokerage firms also provide competition in this area. The
primary factors in competing for deposits are the rates offered, the quality of
service, the hours of service, and the location of branch offices.
The Company's competition for lending products comes principally from other
savings institutions, commercial banks, mortgage companies, and other lenders.
The primary factors in competing are the rates and fees charged, the efficiency
and speed of the service provided, and the quality of the services provided.
PERSONNEL
At December 31, 1997, the Company had 1,184 full-time equivalent employees. The
employees are not represented by a collective bargaining unit. The Company
provides its employees with a comprehensive program of benefits, some of which
are on a contributory basis, including comprehensive medical and dental plans,
life insurance, disability insurance, and a 401K savings and investment plan.
Flagstar's management considers its employee relations to be excellent.
EXECUTIVE OFFICERS
The executive officers of the Bank and the Company are as follows:
<TABLE>
<CAPTION>
Name and Age Position(s) Held with Bank and Company
- --------------------------------------------------------------------------------
<S> <C>
Thomas J. Hammond, 54 Chief Executive Officer
Mark T. Hammond, 32 President
Joan H. Anderson, 47 Executive Vice President
Michael W. Carrie, 43 Executive Vice President and Chief Financial Officer
</TABLE>
THOMAS J. HAMMOND has served as Chief Executive Officer since 1987. Mr. Hammond
is the founder of the Bank.
MARK T. HAMMOND has served as President since December 1995. He has been
employed by the Bank since 1987. Mr. Hammond is the son of Thomas J. Hammond,
the Chief Executive Officer.
JOAN H. ANDERSON has been an Executive Vice President since 1988. She has been
employed by the Bank since 1987.
MICHAEL W. CARRIE has served as an Executive Vice President since 1995 and Chief
Financial Officer since 1993.
14
<PAGE>
ITEM 2. PROPERTIES
The Bank operates from 19 full-service bank branches and 35 retail loan
origination offices in Michigan, California, Florida, and Ohio. The Bank also
maintains sixteen wholesale Loan Production Offices which conduct business with
correspondents nationwide. Flagstar owns the buildings and land for 6 of its
offices, owns the building but leases the land for one of its offices and leases
the remaining 63 offices, with lease expiration dates ranging from 1998 to 2003.
At December 31, 1997, the total net book value of all of the Bank's offices was
approximately $6.6 million.
The Bank leases two adjacent buildings in Bloomfield Hills, Michigan, which
house its executive offices. Substantially all of its operational and support
functions for its mortgage lending activities are housed in this facility. The
Bank houses its retail banking operation from its owned facility in Jackson,
Michigan.
The Bank utilizes a highly sophisticated PC-based data processing system. At
December 31, 1997, the net book value of the Bank's computer related equipment
(including both hardware and software) was approximately $7.7 million.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company and its subsidiaries are parties to various legal
proceedings incident to their business. At December 31, 1997, there were no
legal proceedings which management anticipates would have a material adverse
effect on the Company. See Note 12 of Notes to Consolidated Financial
Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No items were submitted during the fourth quarter of the year covered by this
report for inclusion to be voted on by security holders through a solicitation
of proxies or otherwise.
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
COMMON STOCK
The Company's common stock is traded on the NASDAQ Stock Market. The trading
symbol is FLGS. At March 27, 1998, there were 13,670,000 shares of the Company's
common stock outstanding.
QUARTERLY STOCK PRICE/DIVIDEND INFORMATION
The following table summarizes the Company's common stock price and dividend
activity for:
<TABLE>
<CAPTION>
Quarter Ended
<S> <C> <C> <C>
12/31/97 9/30/97 6/30/97 IPO (1)
High price during the period
$22.25 $ 21.88 $ 16.75 $ 13.00
Low price during the period
16.25 15.88 12.93 --
Closing price at the end of the period
19.80 20.75 16.25 --
Price/earnings ratio (1)
11.6X 11.5X 13.9X 7.6X
Dividends per common share declared during the period
$0.06 -- -- --
</TABLE>
(1) The Company's common stock began trading on a "when-issued" basis on
April 30, 1997.
(2) Based on most recent twelve-month earnings per share and end-of-period
stock prices.
15
<PAGE>
MANAGEMENT'S REPORT
FINANCIAL STATEMENTS
The management of the Company and the Bank are responsible for the preparation,
integrity, and fair presentation of its published financial statements and all
other information presented in this Form 10-K. The financial statements have
been prepared in accordance with generally accepted accounting principles and,
as such, include amounts based on informed judgements and estimates made by
management.
INTERNAL CONTROL
Management is responsible for establishing and maintaining an effective internal
control structure over financial reporting presented in conformity with both
generally accepted accounting principles ("GAAP") and the regulatory reporting
completed for the Office of Thrift Supervision through the compilation of the
quarterly Thrift Financial Report ("TFR"). The structure contains monitoring
mechanisms, and actions are taken to correct any deficiencies which are
identified.
There are inherent limitations in the effectiveness of any structure of internal
controls, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even an effective internal control
structure can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the
effectiveness of an internal control structure may vary over time.
Management assessed the Company's internal control structure over financial
reporting presented in conformity with both GAAP and in the creation of the TFR
at of December 31, 1997. This assessment was based on criteria for effective
internal control over financial reporting described in "Internal Control-
Integrated Framework" issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this assessment, management believes that the
Company maintained an effective internal control structure over the financial
reporting presented for both GAAP and the TFR, as of December 31, 1997.
The Audit Committee of the Company's Board of Directors consists entirely of
outside directors who are independent of the Company's management. It includes
members with financial management expertise, has access to its own outside
counsel or other advisors it deems necessary to fulfill its responsibilities,
and does not include any large customers of the Company. The Audit Committee is
responsible for recommending to the Board of Directors the selection of
independent auditors. It meets periodically with management, the independent
auditors and the internal auditors to ensure that they are carrying out their
responsibilities. The Audit Committee is also responsible for performing an
oversight role by reviewing and monitoring the financial, accounting and
auditing procedures of the Company in addition to reviewing the Company's
financial reports. The independent auditors and the internal auditors have full
and free access to the Audit Committee, with or without the presence of
management, to discuss the adequacy of the internal control structure for
financial reporting and any other matters which they believe should be brought
to the attention of the Audit Committee.
COMPLIANCE WITH LAWS AND REGULATIONS
Management is also responsible for ensuring compliance with the federal laws and
regulations concerning loans to insiders and the federal and state laws and
regulations concerning dividend restrictions, which are the laws and regulations
relating to safety and soundness which have been designated by the Federal
Deposit Insurance Corporation.
Management assessed its compliance with the designated safety and soundness laws
and regulations and has maintained records of its determinations and assessments
as required by the Federal Deposit Insurance Corporation. Based on this
assessment, management believes that the Company has complied, in all material
respects, with the designated safety and soundness laws and regulations for the
year ended December 31, 1997.
<TABLE>
<CAPTION>
<S> <C> <C>
THOMAS J. HAMMOND MARK T. HAMMOND MICHAEL W. CARRIE
Thomas J. Hammond Mark T. Hammond Michael W. Carrie
Chairman of the Board Vice Chairman Executive Vice President
and Chief Executive Officer and President and Chief Financial Officer
</TABLE>
March 28, 1998
16
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
Summary of Consolidated Statements of Earnings: At or For the Year Ended December 31,
1997 1996 (1) 1995 1994 1993
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In Thousands, Except Share Data)
Interest income $ 122,752 $ 76,179 $ 71,304 $ 35,112 $ 29,760
Interest expense 80,033 45,967 41,443 14,486 12,052
-----------------------------------------------------------------------
Net interest income 42,719 30,212 29,861 20,626 17,708
Provisions for losses 5,015 2,604 238 290 644
-----------------------------------------------------------------------
Net interest income after provisions for losses 37,704 27,608 29,623 20,336 17,064
Other income 59,836 58,534 36,988 42,732 33,654
Operating and administrative expenses 62,503 58,820 41,716 37,619 21,292
-----------------------------------------------------------------------
Earnings before federal income tax provision 35,037 27,322 24,895 25,449 29,426
Provision for federal income taxes 13,265 10,299 9,419 9,318 10,405
Net earnings $ 21,772 $ 17,023 $ 15,476 $ 16,131 $ 19,021
=======================================================================
Basic earnings per share: $ 1.70 $ 1.51 $ 1.37 $ 1.42 $ 1.65
Diluted earnings per share: $ 1.68 $ 1.51 $ 1.37 $ 1.42 $ 1.65
Dividends per common share $ 0.06 $ 0.09 $ 0.18 $ 0.04 $ 0.07
Dividend payout ratio 3.77% 5.87% 12.92% 2.48% 4.21%
SUMMARY OF CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION:
Total assets $ 1,901,084 $ 1,297,226 $ 1,045,094 $ 723,150 $ 467,629
Loans receivable 1,655,259 1,110,836 923,933 633,409 415,078
Mortgage servicing rights 83,845 30,064 27,957 18,179 17,563
Deposits 1,109,933 624,485 526,974 307,624 190,761
FHLB advances 482,378 389,801 191,156 200,750 55,000
Stockholders' equity 126,617 78,468 62,445 49,419 35,114
OTHER FINANCIAL AND STATISTICAL DATA:
Tangible capital ratio 5.40% 5.58% 5.19% 5.54% 7.41%
Core capital ratio 5.62% 6.01% 5.84% 6.63% 7.41%
Total risk-based capital ratio 11.74% 10.91% 10.12% 12.08% 13.84%
Equity-to-assets ratio (at the end of the period) 6.66% 6.05% 5.98% 6.83% 7.51%
Equity-to-assets ratio (average for the period) 6.22% 6.19% 5.54% 8.91% 6.32%
Book value per share $ 9.26 $ 6.97 $ 5.55 $ 4.37 $ 3.05
Shares outstanding 13,670 11,250 11,250 11,309 11,527
Average shares outstanding 12,837 11,250 11,274 11,389 11,527
Mortgage loans originated or purchased $ 7,873,099 $ 6,791,665 $ 5,195,605 $ 3,720,173 $ 6,220,415
Mortgage loans sold $ 7,222,394 $ 6,581,897 $ 4,760,806 $ 3,551,319 $ 6,034,828
Mortgage loans serviced for others $ 6,412,797 $ 4,801,581 $ 6,788,530 $ 5,691,421 $ 6,198,311
Capitalized value of mortgage servicing rights 1.31% 0.63% 0.41% 0.32% 0.28%
Interest rate spread 2.10% 2.13% 2.36% 3.37% 3.39%
Net interest margin 2.74% 3.07% 3.46% 4.63% 4.55%
Return on average assets 1.29% 1.53% 1.63% 3.19% 4.39%
Return on average equity 20.69% 24.68% 29.42% 35.78% 69.56%
Efficiency ratio 59.7% 64.8% 60.4% 58.3% 41.5%
Ratio of non performing assets to total assets 3.29% 3.16% 1.25% 0.42% 0.60%
Number of bank branches 19 15 13 9 1
Number of correspondent offices 16 10 9 6 5
</TABLE>
1. Included in the 1996 operating and administrative expenses is a one-time
assessment to recapitalize the SAIF. The Company's pre-tax portion of which
totaled $3.4 million, ($.20 per share on an after-tax basis). Without this
assessment, return on average assets would have been 1.73%, return on
average equity would have been 27.87%, and the efficiency ratio would have
been 61.0%.
17
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
PROFILE AND INTRODUCTION
In November 1993, Flagstar Bancorp, Inc., became the holding company for
Flagstar Bank, FSB, a federally chartered stock savings bank founded in 1987.
Flagstar completed an initial public offering ("IPO") of common stock in May
1997. Since 1994, the Company has worked to increase its banking franchise.
This growth has been achieved by aggressively developing the Company's core
businesses. Through a consistent focus on retail and wholesale mortgage
lending, retail deposit gathering, and mortgage loan servicing, the Company has
been able to increase net interest income, increase recurring fee income, and
control its operating expenses. As a result, Flagstar has continued to be a
highly profitable company over the years. With $1.9 billion in assets at
December 31, 1997, Flagstar is the largest independent savings institution
headquartered in Michigan. Flagstar is also the largest independently owned
thrift mortgage originator in the United States with $7.9 billion in mortgage
originations. For purposes of federal Prompt Corrective Action ("PCA")
regulations, the Bank's capital levels categorize it as "well-capitalized" at
December 31, 1997.
RESULTS OF OPERATIONS
Flagstar's net income totaled $21.8 million ($1.70 per share - basic) for the
year ended December 31, 1997, compared to $17.0 million ($1.51 per share -
share) in 1996 and $15.5 million ($1.37 per share - basic) in 1995. The 1997
earnings constitute a 28.2% increase in profitability over 1996. The 1996
earnings reflect the after-tax cost of the one-time assessment, mandated by
federal law, of $2.2 million, or $.20 per share, for the recapitalization of the
SAIF of the FDIC. Without the one-time assessment, the 1997 increase would have
been 13.5%. The increased level of earnings in each period was attributable to a
variety of factors but primarily from an increase each year in the Company's
average earning assets due to increased leverage ability, increasing levels of
mortgage loan production, along with the Company's continued growth in its
retail banking operation.
NET INTEREST INCOME
Net interest income is the Company's largest source of earnings. The level of
net interest income is impacted primarily by the volume of average earning
assets and the general level of interest rates. During 1997, the Company earned
$42.7 million in net interest income, which represents an increase of 41.4%
compared to the amount reported in 1996 and represented 41.7% of the Company's
total revenue in 1997. This increase is primarily attributable to a $573.5
million increase in average earning assets. During 1996, the Company earned
$30.2 million in net interest income, which represents an increase of 1.0%
compared to the $29.9 million reported in 1995 and 34.0% of 1996 revenue. This
increase was primarily attributable to an $121.3 million increase in average
earning assets.
The Company's net interest spread decreased to 2.10% during the year ended
December 31, 1997, compared to 2.13% during the prior year. The Company
typically originates long term assets and funds these assets with short term
liabilities. The Company then sells these assets upon their conversion to a
mortgage-backed security, usually within 90 days. The yield earned on the
Company's earning assets increased by 0.14%, from 7.73% during 1996 to 7.87%
during 1997, while the cost of interest-bearing liabilities increased by 0.17%,
from 5.60% during 1996 to 5.77% during 1997.
The Company's net interest margin decreased to 2.74% of average earning assets
during the year ended December 31, 1997, compared to 3.07% during the prior
year, due to a increase of $573.5 million of earning assets funded by $566.0
million in interest-bearing liabilities.
In 1996, the yield earned on the Company's earning assets decreased by 0.52%
from 8.25% during 1995 to 7.73%. However, the cost of interest-bearing
liabilities also decreased by 0.29%, from 5.89% during 1995 to 5.60% during
1996. The Company's net interest margin decreased to 3.07% of average earning
assets during the year ended December 31, 1996, compared to 3.46% during the
prior year, due to the decrease in the interest rate spread.
18
<PAGE>
Table 1 presents interest income from average earning assets, expressed in
dollars and yields, and interest expense on average interest-bearing
liabilities, expressed in dollars and rates. Interest income from earning assets
includes the amortization of net premiums and the amortization of net deferred
loan origination costs. Nonaccruing loans were included in the average loan
amounts outstanding.
TABLE 1
AVERAGE YIELDS EARNED AND RATES PAID
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------- ------------------------------- -----------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-----------------------------------------------------------------------------------------------
INTEREST-EARNING ASSETS: ( In Millions )
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans receivable, net $1,526,873 $120,214 7.87% $ 964,257 $74,588 7.74% $835,600 $69,543 8.32%
FHLB stock 30,685 2,471 8.05 18,776 1,471 7.83 16,304 1,285 7.88
Other 1,238 67 5.41 2,230 120 5.38 12,098 476 3.93
----------- --------------------- -------------------
Total 1,558,796 $122,752 7.87% 985,263 $76,179 7.73% 864,002 $71,304 8.25%
Other assets 133,963 129,005 85,686
Total assets $1,692,759 $1,114,268 $949,688
=========== =========== =========
INTEREST-BEARING LIABILITIES:
Deposits $ 878,064 $ 50,143 5.71% $ 552,391 $30,431 5.15% $445,719 $25,123 5.64%
FHLB advances 480,062 28,709 5.98 247,204 14,291 5.78 237,535 15,072 6.35
Other 28,671 1,181 4.12 21,227 1,245 5.87 19,703 1,248 6.33
--------------------- -------------------
Total interest-bearing liabilities 1,386,797 $ 80,033 5.77% 820,822 $45,967 5.60% 702,957 $41,443 5.89%
Other liabilities 200,721 224,484 194,128
Stockholders equity 105,241 68,962 52,603
----------- ----------- ---------
Total liabilities and
stockholders equity $1,692,759 $1,114,268 $949,688
=========== =========== =========
Net interest-earning assets $ 171,999 $ 164,441 $161,045
=========== =========== =========
Net interest income $ 42,719 $30,212 $29,861
=========== ========== ==========
Interest rate spread 2.10% 2.13% 2.36%
======== ======== ========
Net interest margin 2.74% 3.07% 3.46%
======== ======== ========
Ratio of average interest-
earning assets to
interest-bearing liabilities 112% 120% 123%
======== ======== ========
</TABLE>
19
<PAGE>
Table 2 presents the dollar amount of changes in interest income and interest
expense for the components of earning assets and interest-bearing liabilities
which are presented in Table 1. Table 2 distinguishes between the changes
related to average outstanding balances (changes in volume while holding the
initial rate constant) and the changes related to average interest rates
(changes in average rates while holding the initial balance constant).
TABLE 2
RATE/VOLUME ANALYSIS
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------------------------------
1997 versus 1996 1996 versus 1995
Increase (Decrease) Due To: Increase (Decrease) Due To:
Volume Rate Total Volume Rate Total
----------------------------------- ------------------------------------
EARNING ASSETS: (In Millions)
<S> <C> <C> <C> <C> <C> <C>
Loans receivable, net $44.6 $1.1 $45.7 $ 10.7 $ (5.6) $ 5.1
FHLB stock 1.0 - 1.0 .2 - .2
Other (.1) - (.1) (.4) - ( .4)
----------------------------------- ------------------------------------
Total $45.5 $1.1 $46.6 $ 10.5 $ (5.6) $ 4.9
INTEREST-BEARING LIABILITIES:
Deposits $18.8 $ .9 $19.7 $ 5.5 $ (.2) $ 5.3
FHLB advances 13.9 .5 14.4 .6 (1.3) ( .7)
Other .3 (.3) - .1 ( .1) -
----------------------------------- ------------------------------------
Total $33.0 $1.1 $34.1 $ 6.2 $ (1.6) $ 4.6
----------------------------------- ------------------------------------
Change in net interest income $12.5 $ - $12.5 $ 4.3 $ (4.0) $ .3
=================================== ====================================
</TABLE>
NON-INTEREST INCOME
The Company's loan servicing operation produced net fees on loans serviced for
others of $6.1 million for the year ended December 31, 1997, compared to net
fees of $11.9 million recorded in 1996 and $14.2 million recorded in 1995. These
decreases in net revenues resulted due to the large volume of loan servicing
sales completed, which decreased the average balance of mortgage loan servicing
for others.
Net gains on the loan sales totaled $21.8 million, $4.5 million and $2.9 million
for the years ended December 31, 1997, 1996 and 1995, respectively. The
comparatively higher levels of gains recorded in 1997 is attributable to the
relatively favorable interest rate environment that characterized the period and
the record-setting levels of loan production and the resultant loan sales. Loan
sales in the 1997 period were $7.2 billion in principal balance versus $6.6
billion in 1996, and $4.8 billion in 1995.
For 1997, net gain on sales of mortgage servicing rights decreased $8.0 million
to $27.1 million, from $35.1 million for the same period in 1996. The gain on
sale of mortgage servicing rights decreased due to a $3.1 billion, or 41.6%,
decrease in the underlying principal balance of the mortgage servicing rights
sold, from $7.4 billion sold during the 1996, versus $4.3 billion sold during
1997. For 1995, net gain on sales of mortgage servicing rights totaled $13.4
million based on $2.8 billion of mortgage servicing rights sold.
Other fees and charges, which include certain loan fees and charges, deposit-
related fees and escrow waiver fees totaled $4.8 million, $7.0 million, and $6.5
million in 1997, 1996, and1995, respectively. In each period the total fees
earned were affected by loan production volumes and the type of loan production
generated.
20
<PAGE>
NON-INTEREST EXPENSE
Operating expenses, before the capitalization of direct costs of loan closings,
totaled $99.9 million, $92.2 million, and $69.4 million for the years ended
December 31, 1997, 1996, and 1995, respectively. Included in the operating
expenses for the year ended December 31, 1996, is the payment of the $3.4
million pre-tax FDIC special assessment discussed previously herein. Gross
operating and administrative expenses excluding this nonrecurring charge totaled
$88.8 million for 1996. The 12.5% increase in various overhead expense items in
1997 versus 1996 and the 28.0% increase in expenses between 1996 versus 1995
were due to general increases in the price levels for goods and services, higher
mortgage loan origination volume, and the growth of the retail banking
franchise.
During the year ended December 31, 1997, Flagstar opened 4 bank branches,
bringing the branch network total to 19 bank branches. As the Company shifts its
funding sources to more retail in nature and increases the size of the branch
network, management expects that the operating expenses associated with the
branch network will continue to increase while the cost of funds will decrease.
The Company's gross compensation and benefits expense, before the capitalization
of direct costs of loan closings, totaled $42.1 million, $40.5 million and $30.8
million for the years ended December 31, 1997, 1996, and 1995, respectively. The
3.9% increase in 1997 is primarily attributable to normal salary increases, the
staffing hired at the new bank branches, the employees hired to accommodate the
Company's record mortgage loan production, offset by the staffing reductions
allowed by the Company's implementation of new technology. Total Company
staffing decreased by 126 full-time equivalents at December 31, 1997, versus
December 31, 1996.
Commission expense, which is a variable cost associated with mortgage loan
production, totaled $14.2 million, $12.4 million, and $11.1 million during the
years ended December 31, 1997, 1996, and 1995, respectively. Commission expense
totaled .18%, .18%, and .21% of total mortgage production in 1997, 1996, and
1995, respectively.
Occupancy and equipment expense totaled $12.8 million, $12.1 million, and $8.9
million during the years ended December 31, 1997, 1996, and 1995, respectively.
The continued increase in this expense category is reflective of the expansion
undertaken in the bank branch network along with the Company's continuing
investment in computer technology.
Advertising expense, which totaled $1.6 million during the year ended
December 31, 1997, increased $.7 million, or 77.8%, over the $.9 million of
expense incurred during the prior year. Advertising expense totaled $.6 million
in 1995. The continued increase in this expense category is reflective of the
expansion undertaken in the bank branch network. The increased advertising
expense is to a limited extent reflective of management's strategy to increase
name recognition since the Company's May 1997 initial public offering.
The Company's FDIC premiums decreased by $3.9 million, to $.5 million during
1997 compared to $4.4 million in 1996, and $1.1 million during 1995. In each
successive year, Flagstar has paid higher insurance premiums due to its
increased deposit base. As previously discussed, during 1996 the Bank was
required by federal law to pay a one-time, industrywide deposit premium
assessment, the Bank's portion of which totaled $3.4 million. This assessment
was used to fully recapitalize the SAIF. Payment of this special assessment
reduced the Bank's annual FDIC insurance premium rate from 23 basis points of
insured deposit liabilities to 6.5 basis points, or by approximately 72%,
prospectively.
Other expense is a collection of non-specific expenses incurred during the
respective years. Other expense totaled $27.3 million, $20.5 million, and $15.3
million during the years ended December 31, 1997, 1996, and 1995, respectively.
The continued increase in this expense category is reflective of the expansion
undertaken in the bank branch network, the increased levels of mortgage
production, the increased costs associated with the enlarged real estate owned
portfolio, the increased amount of loans pending foreclosure, and the increased
amount of loans in a delinquency status.
21
<PAGE>
NON-INTEREST EXPENSE (CONT'D)
TABLE 3
NON-INTEREST EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
1997 1996 1995
---------------------------------------
<S> <C> <C> <C>
(In thousands)
Compensation and benefits $ 42,132 $ 40,524 $ 30,809
Commissions 14,231 12,367 11,102
Occupancy and equipment 12,810 12,125 8,873
Advertising 1,637 943 597
Core deposit amortization 1,290 1,290 1,330
Federal insurance premium 477 4,435 1,122
Other 27,305 20,474 15,536
---------------------------------------
Total 99,882 92,158 69,369
Less: capitalized direct costs of loan (37,379) (33,338) (27,653)
closings
Total, net $ 62,503 $ 58,820 $ 41,716
=======================================
Efficiency ratio(1) 59.7% 64.8% 60.4%
</TABLE>
(1) Total operating and administrative expenses (excluding the amortization of
the core deposit premium) divided by the sum of net interest income and non
interest income.
In accordance with generally accepted accounting principles, certain loan
origination costs are capitalized and added as an adjustment of the basis of the
individual loans originated. These cost are amortized as an adjustment of the
loan yield over the life of the loan or expensed when the loan is sold.
Accordingly, during 1997 Flagstar deferred $37.4 million of loan origination
costs, while during 1996 and 1995 such deferred expenses totaled $33.3 million
and $27.7 million, respectively. On a per loan basis, the cost deferral totaled
$541, $503, and $496 during 1997, 1996, and 1995, respectively. The increase in
the costs per loan recorded reflect normal cost increases associated with
inflation and in 1997 the increased costs reflect the Company's increased shift
to correspondent funding versus wholesale funding.
FEDERAL INCOME TAXES
For the year ended December 31, 1997, the Company's provision for federal income
taxes as a percentage of pretax earnings was 37.9%, compared to 37.7% in 1996
and 37.8% in 1995. For all periods presented in the Consolidated Statements of
Earnings, the provision for federal income taxes varies from statutory rates due
primarily to the non deductibility of the core deposit premium amortization.
Refer to Note 10 of the Notes to the Consolidated Financial Statements, in Item
8. Financial Statements and Supplementary Data, herein for further discussion of
the Company's federal Income taxes.
FINANCIAL CONDITION
The Company's assets totaled $1.9 billion at December 31, 1997, reflecting an
increase of $.6 billion over December 31, 1996. Loans receivable, net increased
$544.5 million, reflecting the retention of a portion of the Bank's mortgage
loan closings. During 1997, mortgage loan originations totaled a record $7.9
billion, compared to $6.8 billion in 1996 and $5.2 billion in 1995. Table 4, 5,
6 and 7 set forth the Company's loan portfolio and the activity within the
different loan categories, for the past five years.
22
<PAGE>
FINANCIAL CONDITION (CONT'D)
TABLE 4
LOAN PORTFOLIO SCHEDULE
<TABLE>
<CAPTION>
At December 31,
DESCRIPTION: 1997 1996 1995 1994 1993
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In Thousands)
Mortgage loans available for sale $1,197,152 $ 840,767 $620,455 $205,480 $389,073
Loans held for investment:
Mortgage loans 282,224 120,924 178,246 354,554 24
Consumer loans 34,004 33,608 39,331 19,271 11
Commercial loans 80,255 46,202 8,566 7,546 6,167
Construction loans 35,373 59,270 48,933 25,499 19,864
Commercial real estate loans 31,751 13,565 30,504 22,930 840
----------------------------------------------------------------------
Total loans held for investment 463,607 273,569 305,580 429,800 26,906
Allowance for losses (5,500) (3,500) (2,102) (1,871) (901)
----------------------------------------------------------------------
Total loans receivable (net) $1,655,259 $1,110,836 $923,933 $633,409 $415,078
======================================================================
</TABLE>
TABLE 5
LOANS AVAILABLE FOR SALE ACTIVITY SCHEDULE
<TABLE>
<CAPTION>
Year Ended December 31,
DESCRIPTION: 1997 1996 1995 1994
-------------------------------------------------------
<S> <C> <C> <C> <C>
(In Thousands)
Beginning mortgage loans available for sale $ 840,767 $ 620,455 $ 205,480 $ 389,073
Mortgage loans originated 7,950,098 6,850,277 5,251,510 3,752,650
Mortgage loans repurchased 58,516 54,788 4,477 2,683
Mortgage loans transferred from held for investment -- -- 185,111 --
Mortgage loans sold servicing retained 6,559,893 5,651,216 4,239,777 3,421,784
Mortgage loans sold servicing released 736,235 948,352 540,421 248,218
Mortgage loan amortization / prepayments 273,969 74,683 244,144 161,225
Mortgage loans transferred to held for investment 82,132 10,502 1,781 107,699
-------------------------------------------------------
Ending mortgage loans available for sale $1,197,152 $ 840,767 $ 620,455 $ 205,480
=======================================================
</TABLE>
23
<PAGE>
FINANCIAL CONDITION (CONT'D)
TABLE 6
LOANS HELD FOR INVESTMENT ACTIVITY SCHEDULE
<TABLE>
<CAPTION>
Year Ended December 31,
DESCRIPTION: 1997 1996 1995 1994
----------------------------------------------------
<S> <C> <C> <C> <C>
(In Thousands)
Beginning loans held for investment $273,569 $305,580 $429,800 $ 26,906
Loans originated 127,576 129,436 162,137 236,700
Increase in lines of credit 38,859 - - -
Loans transferred from available for sale 82,132 10,502 1,781 107,699
Loans acquired in merger - - - 140,302
Loan amortization / prepayments 43,239 161,372 101,246 79,002
Loans transferred to available for sale - - 185,111 -
Loans transferred to repossessed assets 15,290 10,577 1,781 2,805
----------------------------------------------------
Ending mortgage loans held for investment $463,607 $273,569 $305,580 $429,800
====================================================
</TABLE>
TABLE 7
LOANS SERVICED FOR OTHERS ACTIVITY SCHEDULE
<TABLE>
<CAPTION>
Year Ended December 31,
DESCRIPTION: 1997 1996 1995 1994
-----------------------------------------------------
<S> <C> <C> <C> <C>
(In Thousands)
Beginning loans serviced for others $4,801,581 $6,788,530 $5,691,421 $6,198,311
Loans servicing originated 6,530,243 5,633,545 4,220,385 3,303,101
Loans servicing acquired in merger - - - 44,340
Loan servicing amortization / prepayments 1,283,336 1,146,564 851,188 1,277,049
Loans servicing sales 3,635,691 6,473,930 2,272,088 2,577,282
Ending loans serviced for others $6,412,797 $4,801,581 $6,788,530 $5,691,421
=====================================================
</TABLE>
LOANS RECEIVABLE. Mortgage loans available for sale and mortgage loans held for
investment increased, in the aggregate, $517.7 million from $961.7 million at
December 31, 1996 to $1.5 billion at December 31, 1997. Mortgage loans available
for sale increased $356.4 million, or 42.4%, to $1.2 billion at December 31,
1997, from $840.8 million at December 31, 1996. Loans held for investment
increased $190.0 million, or 69.4%, from $273.6 million at December 31, 1996 to
$463.6 million at December 31, 1997. In each case management retained more loans
to maximize the earnings power available because of the leverage available to
the Company.
ALLOWANCE FOR LOSSES. The allowance for losses totaled $5.5 million at
December 31, 1997, an increase of $2.0 million, or 57.1%, from $3.5 million at
December 31, 1996. The allowance for losses as a percentage of non-performing
loans was 12.41% and 11.43% at December 31, 1997 and 1996, respectively. The
Company's non-performing loans totaled $44.3 million and $30.6 million at
December 31, 1997 and 1996, respectively, and, as a percentage of total loans,
were 2.67% and 2.75% at December 31, 1997 and 1996, respectively. The increase
in the allowance for losses was based upon management's assessment of relevant
factors, including the types and amounts of non-performing loans, historical and
anticipated loss experience on such types of loans, and current and projected
economic conditions.
24
<PAGE>
FINANCIAL CONDITION (CONT'D)
FHLB STOCK. Holdings of FHLB stock increased from $19.7 million at December 31,
1996 to $40.0 million at December 31, 1997 since the Company's FHLB advances
increased to fund the increased mortgage loan portfolio. As a member of the
FHLB, the Bank is required to hold shares of FHLB stock in an amount at least
equal to 1% of the aggregate unpaid principal balance of its mortgage loans,
home purchase contracts and similar obligations at the beginning of each year,
or 1/20th of its FHLB advances, whichever is greater. See "Regulation--Federal
Home Loan Bank System."
PREMISES AND EQUIPMENT. Premises and equipment, net of accumulated
depreciation, totaled $29.1 million at December 31, 1997, an increase of $8.2
million, or 39.2%, from $20.9 million at December 31, 1996. This increase
reflects the Company's investment in technology, along with the expansion of the
bank branches, the increased national presence in the mortgage acquisition area,
and the Company's acquisition of land to be used in building a national
headquarters.
MORTGAGE SERVICING RIGHTS. Mortgage servicing rights totaled $83.8 million at
December 31, 1997, an increase of $53.7 million, from $30.1 million at
December 31, 1996. For the year ended December 31, 1997, $6.5 billion of loans
underlying mortgage servicing rights were originated and purchased, and $4.9
billion were reduced through sales, prepayments, and amortization resulting in a
net increase in mortgage loans serviced for others of $1.6 billion from $4.8
billion to $6.4 billion at December 31, 1997.
OTHER ASSETS. Other assets decreased $18.1 million, or 33.7%, to $35.6 million
at December 31, 1997, from $53.7 million at December 31, 1996. The majority of
this decrease was attributable to the receipt of receivables recorded in
conjunction with a $700 million sale of mortgage servicing rights during
September 1996 and a $3.0 billion sale of mortgage servicing rights in December
1996 which were received in 1997. Upon a sale of mortgage servicing rights, the
Company receives a down payment from the purchaser equivalent to approximately
20% of the total purchase price and records a receivable account for the balance
of the purchase price due.
LIABILITIES. The Company's total liabilities increased $555.7 million, or
45.6%, to $1.8 billion at December 31, 1997, from $1.2 billion at December 31,
1996. This increase was primarily attributable to an increase in the Company's
deposit portfolio and the amount of FHLB advances, offset in part by a decrease
in the amount of undisbursed payments on loans serviced for others, the amount
of escrow accounts held, and the amount of liability for checks issued.
DEPOSITS. Deposit accounts increased $485.4 million, or 77.7%, to $1.1 billion
at December 31, 1997, from $624.5 million at December 31, 1996. This increase
reflects the Company's deposit growth strategy through its branch network and
its pricing strategy. The number of bank branches has increased from 15 at
December 31, 1996 to 19 at December 31, 1997. The Company's aggressive pricing
strategy attracts one-year certificates of deposit and brokered funds. The
Company relies upon both its retail customer base and nationwide advertising of
its deposit rates to attract deposits. At December 31, 1997, the Company's
certificates of deposit totaled $966.3 million, with an average balance of
$44,136 and a weighted average cost of 6.04%. Of such amount, approximately
$600.8 million were brokered deposits with a weighted average cost of 6.01%.
FHLB ADVANCES. FHLB advances increased $92.6 million, or 23.8%, to $482.4
million at December 31, 1997, from $389.8 million at December 31, 1996. The
Company relies upon such advances as a source of funding for the origination or
purchase of loans for sale in the secondary market. The outstanding balance of
FHLB advances fluctuates from time to time depending upon the Company's current
inventory of loans available for sale and the availability of lower cost funding
from its retail deposit base and its escrow accounts.
UNDISBURSED PAYMENTS. Undisbursed payments on loans serviced for others
decreased $15.5 million, or 25.2%, to $45.9 million at December 31, 1997, from
$61.4 million at December 31, 1996. The month-end average amount of these funds
was $40.6 million and $67.3 million during 1997 and 1996, respectively. These
amounts represent payments received from borrowers for interest, principal and
related loan charges, which have not been remitted to loan investors. These
balances fluctuate with the size of the servicing portfolio and increase during
a time of high payoff or refinance volume. Total loans serviced at December 31,
1996 equaled $9.5 billion versus $8.0 billion at December 31, 1996.
25
<PAGE>
FINANCIAL CONDITION (CONT'D)
ESCROW ACCOUNTS. The amount of funds in escrow accounts decreased $17.6
million, or 28.9%, to $43.4 million at December 31, 1997, from $61.0 million at
December 31, 1996. The average of the month end balances in these accounts was
$58.5 million and $82.3 million during 1997 and 1996, respectively. These
accounts are maintained on behalf of mortgage customers and include funds
earmarked for real estate taxes, homeowner's insurance, and other insurance
product liabilities. These balances fluctuate with the size of the servicing for
others portfolio and also depend upon the scheduled payment dates for the
related expenses. Total loans serviced at December 31, 1996 equaled $9.5 billion
versus $8.0 billion at December 31, 1996.
LIABILITY FOR CHECKS ISSUED. The liability for checks issued increased $6.1
million, or 15.3%, to $45.9 million at December 31, 1997, from $39.8 million at
December 31, 1996. This liability reflects the outstanding amount of checks the
Company has written in conjunction with acquiring mortgage loans. This account
grows or contracts in conjunction with the amount of loans that are in the
Company's mortgage pipeline.
FEDERAL INCOME TAXES PAYABLE. Federal income taxes payable decreased $1.7
million, or 7.6%, to $20.8 million at December 31, 1997, from $22.5 million at
December 31, 1996. This decrease was primarily attributable to the timing of
payments and a decrease in the current tax liability. See Note 10 of Notes to
the Consolidated Financial Statements.
OTHER LIABILITIES. Other liabilities decreased $1.2 million, or 7.1%, to $15.7
million at December 31, 1997, from $16.9 million at December 31, 1996. This
liability primarily reflects amounts received in conjunction with acquiring
mortgage loans, but not yet applied. This account grows or contracts in
conjunction with the amount of loans that are in the Company's mortgage
pipeline.
SEGMENT REPORTING
RETAIL BANKING OPERATIONS
The Company provides a full range of banking services to consumers and small
businesses in southern and western Michigan. The Bank operates a network of 19
bank branches. Throughout 1997, the Company has focused on expanding its branch
network in these markets in order to increase its access to retail deposit
funding sources. This provides cross-marketing opportunities of consumer banking
services to the Company's mortgage customers in Michigan.
MORTGAGE BANKING OPERATIONS
Flagstar's mortgage banking activity consists of the origination of mortgage
loans or the purchase of mortgage loans from the originating lender. Flagstar
conducts the wholesale portion of its mortgage banking operation through a
network of correspondent lenders consisting of banks, thrifts, mortgage
companies, and mortgage brokers. This mortgage banking network conducts mortgage
lending operations nationwide. These mortgage loans, the majority of which are
subsequently sold in the secondary mortgage market, conform to the underwriting
standards of FHLMC or FNMA.
The following tables present certain financial information concerning the
results of operations of Flagstar's retail banking and mortgage banking
operation. See Note 16 of Notes to the Consolidated Financial Statements.
TABLE 7
RETAIL BANKING OPERATIONS
<TABLE>
<CAPTION>
At or for the year ended December 31,
1997 1996 (1) 1995
---------------------------------------
<S> <C> <C> <C>
( In thousands )
Revenues $ 30,202 $ 13,791 $ 12,390
Earnings before taxes 19,341 3,305 3,549
Identifiable assets 564,551 387,201 307,620
</TABLE>
26
<PAGE>
SEGMENT REPORTING (CONT'D)
TABLE 8
MORTGAGE BANKING OPERATIONS
<TABLE>
<CAPTION>
At or for the year ended December 31,
1997 1996 (1) 1995
-----------------------------------------
<S> <C> <C> <C>
( In thousands )
Revenues $ 72,353 $ 74,955 $ 54,459
Earnings before taxes 15,696 24,017 21,346
Identifiable assets 1,463,288 1,112,676 782,802
</TABLE>
(1) Included in the 1996 operating and administrative expenses is a one-time
assessment to recapitalize the SAIF. The Company's pre-tax portion of which
totaled $3.4 million.
ASSET AND LIABILITY MANAGEMENT
Flagstar considers that its primary business objective is to provide
shareholders the highest return possible on their investment while maintaining a
certain risk posture. This objective includes the management of credit risk and
interest rate risk.
Interest rate risk generally refers to the potential volatility in net interest
income resulting from changes in interest rates. Flagstar's interest rate risk
management focuses on interest rate sensitivity through the use of simulation
models, in an attempt to measure and project the potential effects of various
market interest-rate scenarios on the Company's balance sheet. Unlike most
savings institutions, Flagstar will record higher levels of net interest income
in a rising interest rate environment and will experience declining net interest
income during periods of falling interest rates. This happens because the Bank's
assets reprice or are sold faster than the majority of the Bank's funding
sources will reset.
Any difference between the amount of assets and liabilities repricing or
maturing within one year is referred to as the "one-year repricing gap." A
positive one-year repricing gap indicates that more assets reprice than
liabilities. Conversely, a negative one-year repricing gap indicates that more
liabilities reprice than assets. The Company's one-year repricing gap stood at a
positive $556 million, or 29% of total assets at December 31, 1997.(See
Table 9 -- Asset/Liability Repricing Schedule, December 31, 1997).
While gap analysis is the most commonly used indicator of interest rate risk in
the savings and loan industry, there is no single interest rate risk measurement
system that takes into consideration all of the factors which influence the net
interest margin. Other significant factors which impact reported net interest
margins include changes in the shape of the U.S. Treasury yield curve, the
volume and composition of loan originations and repayment rates on loans.
27
<PAGE>
ASSET AND LIABILITY MANAGEMENT (CONT'D)
Table 9 sets forth the repricing of the Company's earning assets and interest-
bearing liabilities at December 31, 1997, based on the interest rate scenario at
that date. The principal amounts of each asset and liability are shown in the
period in which they are anticipated to mature or reprice. Based on available
published statistics, average prepayment rates with respect to mortgage loans
have been estimated at 20.33%. The decay rate used for passbook savings accounts
was 15%.
TABLE 9
ASSET/LIABILITY REPRICING SCHEDULE
<TABLE>
<CAPTION>
Maturing/Repricing In: FMV
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1998 1999 2000 2001 2002 Thereafter Total Rate Total
----------------------------------------------------------------------------------
EARNING ASSETS: (In Millions)
Mortgage loans available for sale $ 625 $ 73 $ 60 $ 51 $ 66 $ 322 $1,197 7.70% $1,213
Loans held for investment 349 16 15 10 27 41 458 7.72 460
Other earning assets 40 1 -- -- -- -- 41 5.01 41
------------------------------------------------------------------ -------
Total $1,014 $ 90 $ 75 $ 61 $ 93 $ 363 $1,696 7.64% $1,714
INTEREST-BEARING LIABILITIES:
Deposits $ 584 $ 244 $ 119 125 $ 8 30 $1,110 5.71% $1,113
FHLB advances 382 100 -- -- -- -- 482 5.93 482
------------------------------------------------------------------ -------
Total $ 966 $ 344 $ 119 $ 125 $ 8 30 $1,592 5.78% $1,595
OFF-BALANCE SHEET:
Commitment to sell loans $ 834 ($ 12) ($ 14) ($ 15) ($ 20) ($ 773)
Commitment to originate loans (326) 5 6 6 7 302
--------------------------------------------------------
Total $ 508 ($ 7) ($ 8) ($ 9) ($ 13) ($ 471)
-----
Interest rate spread 1.86%
=====
Excess (Deficiency) of
earning assets over (to) ------------------------------------------------------------------
interest-bearing liabilities $ 556 $ (261) ($ 52) ($ 73) $ 72 ($ 138) $ 104 (1)
==================================================================
</TABLE>
(1) The excess of earning assets over paying liabilities has the effect of
increasing the indicated spread by .36%.
ASSET QUALITY
The Company has consistently maintained a conservative posture with respect to
credit risk. Mortgage lending, the Company's primary lending focus, has
historically resulted in minimal charge offs. At December 31, 1997,
approximately 87.2% of the Company's earning assets consisted of mortgage loans.
The credit quality of the Company's commercial, consumer, and commercial real
estate loan portfolio, which in the aggregate comprise only 8.6% of total
earning assets (8.8% of total loans) at December 31, 1997, remains good. During
the past two years, the Company has begun emphasizing commercial real estate
lending. Management plans to increase the size of these loan portfolios. As has
been the Company's historical practice, such growth will be achieved with
adherence to sound underwriting and credit standards.
The Company's level of non performing assets, which totaled $62.6 million at
December 31, 1997, continues to represent a modest level of credit exposure for
Flagstar. The Company, in accordance with applicable disclosure requirements,
defines an asset as non performing if it meets any of the following criteria:
1) a loan more than 90 days past due; 2) real estate acquired in a settlement of
a loan; or 3) a restructured loan whose terms have been modified due to the
borrower's inability to pay as contractually specified ("troubled debt
restructurings"). Loans are generally placed into non accrual status when they
become 90 days delinquent.
28
<PAGE>
ASSET QUALITY (CONT'D)
Gross interest income of approximately $4.8 million, $2.7 million and $.9
million would have been recorded in 1997, 1996, and 1995, respectively, on non
accrual loans if the loans had performed in accordance with their original
terms.
The Company implemented Financial Accounting Standards No. 118, "Accounting by
Creditors for Impairment of a Loan -- Income Recognition and Disclosures,"
("SFAS 118") during 1994. In accordance with the provisions of SFAS 118, the
Company has classified $3.6 million of delinquent commercial loans as impaired
loans at December 31, 1997. See Note 4 of the Notes to Consolidated Financial
Statements, in Item 8. Financial Statements and Supplementary Data, herein. All
impaired loans are carried at fair value.
TABLE 10
NONPERFORMING ASSETS
<TABLE>
<CAPTION>
December 31,
1997 1996 1995 1994 1993
--------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In Thousands)
Non accrual loans $44,329 $30,621 $10,686 $ 1,739 $1,549
Real estate and other repossessed assets 18,262 10,363 2,359 1,271 1,249
--------------------------------------------------
Total non performing assets 62,591 40,984 13,045 3,010 2,798
Less allowance for losses (5,500) (3,500) (2,102) (1,871) (901)
--------------------------------------------------
Total non performing assets (net of allowances) $57,091 $37,484 $10,943 $ 1,139 $1,897
==================================================
Ratio of non performing assets to total assets 3.29% 3.16% 1.25% 0.42% 0.60%
Ratio of non performing loans to total loans 2.67% 2.75% 1.15% 0.27% 0.37%
Ratio of allowances to non performing loans 12.41% 11.43% 19.67% 107.59% 58.17%
Ratio of allowances to total loans 0.33% 0.31% 0.23% 0.29% 0.22%
Ratio of net charge-offs to average loans 0.20% 0.13% 0.00% 0.08% 0.08%
</TABLE>
The Company's 1997 year-end ratio of non performing assets to total assets was
3.29%. The adequacy of the allowance for losses is evaluated regularly and is
based upon judgements concerning the amount of risk inherent in the Company's
portfolio. At December 31, 1997, $42.4 million, or 95.6% of total non performing
loans were secured by residential real estate.
Management is of the opinion that the allowance for losses at December 31, 1997
is adequate to meet potential losses in the portfolio. It must be understood,
however, that these allowances are dependent upon estimates and appraisals and
the possibility exists that changes in such estimates, appraisals and
evaluations might be required because of changing economic conditions.
The increase in the allowance for losses in 1997, 1996, and 1995 was due to the
higher volume of loans outstanding and the increase in the amount of charge-offs
made in each respective year. See Table 11, 12, and 13 for additional
information on the Company's loan loss allowance and non performing loans.
Refer to Notes 1 and 4 of Notes to Consolidated Financial Statements in Item 8.
Financial Statements and Supplementary Data, herein for further discussion of
the Company's policies regarding provisions for losses and allowances for
uncollected interest.
29
<PAGE>
TABLE 11
NON-ACCRUAL LOANS AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
NON PERFORMING AS A % OF AS A % OF
LOAN PORTFOLIO LOAN LOAN PORTFOLIO NON PERFORMING
BALANCE BALANCE BALANCE LOANS
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In Thousands)
One- to four-family $1,479,376 $42,394 2.55% 95.64%
Commercial 80,255 33 -- 0.07
Construction 35,373 1,377 .09 3.11
Consumer 34,004 525 .03 1.18
Commercial real estate 31,751 -- -- --
-----------------------------------------------------------------------------
Total loans 1,660,759 44,329 2.67% 100.00%
Less allowances for losses (5,500) (5,500)
----------------------------------
Total loans (net of allowances) $1,655,259 $38,829
==================================
</TABLE>
TABLE 12
LOSS ALLOWANCE ALLOCATION
<TABLE>
<CAPTION>
AT DECEMBER 31,
1997 1996 1995 1994 1993
----------------------------------------------------------------------------------------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS
IN EACH IN EACH IN EACH IN EACH IN EACH
CATEGORY CATEGORY CATEGORY CATEGORY CATEGORY
TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Mortgage loans :
Available for sale $1,500 72.1% $1,000 75.4% $ 248 67.0% $ 289 32.3% $356 93.5%
Held for investment 700 17.0% 200 10.9% 78 19.2% 531 55.8% -- -- %
Construction 300 2.1% 400 5.3% 367 5.3% 191 4.0% 149 4.8%
Consumer 300 2.0% 300 3.0% 393 4.3% 193 3.0% -- -- %
Commercial 200 4.9% 200 4.2% 43 0.9% 38 1.2% 31 1.5%
Commercial real estate 700 1.9% 100 1.2% 305 3.3% 234 3.7% 9 0.2%
Unallocated 1,800 -- % 1,300 -- % 668 -- % 395 -- % 356 -- %
----------------------------------------------------------------------------------------------------
Total $5,500 100.0% $3,500 100.0% $2,102 100.0% $1,871 100.0% $901 100.0%
====================================================================================================
</TABLE>
TABLE 13
LOSS ALLOWANCE ACTIVITY
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
---------------------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance at the beginning of the period $ 3,500 $ 2,102 $1,871 $ 901 $ 550
Provision for losses 5,015 2,604 238 290 644
Allowances of acquired institution -- -- -- 1,001 --
Charge-offs, net of recoveries (3,015) (1,206) (7) (321) (293)
---------------------------------------------
Balance at the end of the period $ 5,500 $ 3,500 $2,102 $1,871 $ 901
=============================================
</TABLE>
30
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The standard measure of liquidity in the thrift industry is the ratio of cash
and eligible investments, as defined by regulation, to the sum of net
withdrawable savings and borrowings due within one year. The OTS has established
the current minimum liquidity requirement at 5%. The Company, as a component of
its overall asset and liability management strategy, maintains qualifying liquid
assets at levels which exceed regulatory requirements. For the month ending
December 31, 1997, the Company's liquidity ratio was 14.6%.
The Company's primary sources of funds are customer deposits, loan repayments
and sales, advances from the FHLB, and cash generated from operations, and
customer escrow accounts. While these sources are expected to continue to be
available to provide funds in the future, the mix and availability of funds will
depend upon future economic and market conditions. Flagstar does not foresee any
difficulty in meeting its liquidity requirements.
Loan principal repayments totaled $317.2 million during 1997, representing an
increase of $81.1 million, or 34.3%, compared to 1996. This increase, was
attributable to an increased asset base and a lower interest rate environment in
1997 which increased the amount of loan refinancings or payoffs.
Sales of mortgage loans totaled $7.2 billion in principal balance during 1997,
compared to $6.6 billion in 1996. The sales recorded during 1997 were higher
than in 1996 due to the increased loan origination volume. Only a portion of
loans originated are retained by the Bank and held for investment.
Customer deposits increased $485.4 million, or 77.7%, and totaled $1.1 billion
at December 31, 1997. The increase is directly attributable to the Company's
aggressive approach to increasing retail deposits. During 1997, the Company
increased its borrowings from the FHLB by $92.6 million, or 23.8%. The Company
utilizes FHLB advances to assist in funding mortgage loan production.
In May 1997, the Company completed an initial public offering of its common
stock. The net proceeds received by the Company totaled $27.3 million.
In November 1997, the Company paid an initial quarterly cash dividend on its
common stock of $0.06 per share. On February 13, 1998, the Company's Board of
Directors paid a quarterly cash dividend of $0.06 per share.
Stockholders' equity increased $48.1 million to $126.6 million at December 31,
1997, an increase of 61.3%. This level of stockholders' equity represented 6.66%
of total assets at December 31, 1997.
At December 31, 1997, the Company had outstanding rate-lock commitments to lend
$498.8 million in mortgage loans, along with outstanding commitments to make
other types of loans totaling $25.9 million. Because such commitments may expire
without being drawn upon, they do not necessarily represent future cash
commitments. Also, as of December 31, 1997, the Company had outstanding
commitments to sell $853.0 million of mortgage loans. These commitments will be
funded within 90 days. Total commercial and consumer unused collateralized lines
of credit totaled $99.5 million at December 31, 1997. Such commitments include
$139.8 million in warehouse lines of credit to various mortgage companies, of
which $77.5 million was drawn upon as of December 31, 1997.
31
<PAGE>
ACCOUNTING AND REPORTING DEVELOPMENTS
In June 1997, the FASB issued SFAS No. 130, "Reporting of Comprehensive Income,"
which establishes standards for reporting and display of comprehensive income
and its components (revenues, expenses, gains, and losses) in a full set of
financial statements. This statement also requires that all items that are
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. This statement is effective
for fiscal years beginning after December 15, 1997. Earlier application is
permitted. Reclassification of financial statements for earlier periods provided
for comparative purposes is required. The Bank does not anticipate that adoption
of SFAS No. 130 will have a material effect on the Bank.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
stockholders. This statement also establishes standards for related disclosures
about products and services, geographic areas, and major customers. This
statement requires the reporting of financial and descriptive information about
an enterprise's reportable operating segments. This statement is effective for
financial statements for periods beginning after December 15, 1997. In the
initial year of application, comparative information for earlier years is to be
restated. The Bank does not anticipate that the adoption of SFAS No. 131 will
have a material effect on the Bank.
IMPACT OF INFLATION AND CHANGING PRICES. The Consolidated Financial Statements
and Notes thereto presented herein have been prepared in accordance with
generally accepted accounting principles, which require the measurement of
financial position and operating results in terms of historical dollars without
considering the changes in the relative purchasing power of money over time due
to inflation. The impact of inflation is reflected in the increased cost of the
Bank's operations. Unlike most industrial companies, nearly all the assets and
liabilities of the Bank are monetary in nature. As a result, interest rates have
a greater impact on the Bank's performance than do the effects of general levels
of inflation. Interest rates do not necessarily move in the same direction or to
the same extent as the prices of goods and services.
YEAR 2000 PROBLEM. The Bank is aware of the current concerns throughout the
business community of reliance upon computer software programs that do not
properly recognize the year 2000 in date formats, often referred to as the "Year
2000 Problem." The Year 2000 Problem is the result of software being written
using two digits rather than four digits to define the applicable year (i.e.,
"98" rather than "1998"). A failure by a business to properly identify and
correct a Year 2000 Problem in its operations could result in system failures or
miscalculations. In turn, this could result in disruptions of operations,
including among other things a temporary inability to process transactions, send
invoices or otherwise engage in routine business transactions on a day-to-day
basis.
Operations of the Bank depend upon the successful operation on a daily basis of
its computer software programs. The Bank relies upon software purchased from
third party vendors rather than internally generated software. In its analysis
of the software, and based upon its ongoing discussions with these vendors,
management believes that most of its software already reflects changes necessary
to avoid the Year 2000 Problem. The Bank expects to update during 1998 any
remaining software that could be affected by the Year 2000 Problem to eliminate
remaining concerns. This update is not expected to have any adverse material
financial impact on the Bank.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information set for the under Item 7, "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" Asset/Liability Management"
is incorporated herein.
32
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Certified Public Accountants....................... F-2
Consolidated Statements of Financial Condition as of
December 31, 1997 and 1996............................................. F-3
Consolidated Statements of Earnings for the Years Ended
December 31, 1997, 1996 and 1995....................................... F-4
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1997, 1996, and 1995...................................... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996, and 1995...................................... F-6
Notes to the Consolidated Financial Statements........................... F-7
</TABLE>
33
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Flagstar Bancorp, Inc.
We have audited the accompanying consolidated statements of financial condition
of Flagstar Bancorp, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of earnings, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
a reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Flagstar Bancorp, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the results of their consolidated operations and their consolidated cash flows
for each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
/s/ Grant Thornton LLP
Detroit, Michigan
February 27, 1998
34
<PAGE>
FLAGSTAR BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
AT DECEMBER 31,
ASSETS 1997 1996
-------------------------------------------
<S> <C> <C>
Cash and cash equivalents $ 21,928 $ 44,187
Loans receivable
Mortgage loans available for sale 1,197,152 840,767
Loans held for investment 463,607 273,569
Less: allowance for losses (5,500) (3,500)
------------------- -------------------
Loans receivable, net 1,655,259 1,110,836
Federal Home Loan Bank stock 40,025 19,725
Other investments 538 887
------------------- -------------------
Total earning assets 1,695,822 1,131,448
Accrued interest receivable 16,492 6,626
Repossessed assets 18,262 10,363
Premises and equipment 29,131 20,866
Mortgage servicing rights 83,845 30,064
Other assets 35,604 53,672
------------------- -------------------
Total assets $1,901,084 $1,297,226
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIEs
Deposit accounts $1,109,933 $ 624,485
Federal Home Loan Bank advances 482,378 389,801
------------------- -------------------
Total interest bearing liabilities 1,592,311 1,014,286
Accrued interest payable 10,555 2,712
Undisbursed payments on
loans serviced for others 45,852 61,445
Escrow accounts 43,368 61,009
Liability for checks issued 45,896 39,813
Federal income taxes payable 20,808 22,548
Other liabilities 15,677 16,945
------------------- -------------------
Total liabilities 1,774,467 1,218,758
Commitments and Contingencies (Notes 4, 6, 7, 12 and 16) -- --
STOCKHOLDERS' EQUITY
Common stock - $.01 par value,
40,000,000 shares authorized,
13,670,000 and 11,250,000 shares issued at
December 31, 1997 and 1996, respectively 137 112
Additional paid in capital 29,988 2,816
Retained earnings 96,492 75,540
------------------- -------------------
Total stockholders' equity 126,617 78,468
------------------- -------------------
Total liabilities and stockholders' equity $1,901,084 $1,297,226
=================== ===================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
35
<PAGE>
FLAGSTAR BANCORP, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
----------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME
Loans $120,214 $74,588 $69,543
Other 2,538 1,591 1,761
------------------- ----------------- -----------------
Total 122,752 76,179 71,304
INTEREST EXPENSE
Deposits 50,143 30,431 25,123
FHLB advances 28,709 14,291 15,072
Other 1,181 1,245 1,248
------------------- ----------------- -----------------
Total 80,033 45,967 41,443
------------------- ----------------- -----------------
Net interest income 42,719 30,212 29,861
Provision for losses 5,015 2,604 238
------------------- ----------------- -----------------
Net interest income after provision for losses 37,704 27,608 29,623
NON-INTEREST INCOME
Loan administration 6,127 11,859 14,248
Net gain on loan sales 21,775 4,511 2,872
Net gain on sales of mortgage servicing rights 27,095 35,129 13,356
Other fees and charges 4,839 7,035 6,512
------------------- ----------------- -----------------
Total 59,836 58,534 36,988
NON-INTEREST EXPENSE
Compensation and benefits 25,930 25,553 19,665
Occupancy and equipment 12,810 12,126 9,062
General and administrative 23,763 21,141 12,989
------------------- ----------------- -----------------
Total 62,503 58,820 41,716
------------------- ----------------- -----------------
Earnings before federal income taxes 35,037 27,322 24,895
Provision for federal income taxes 13,265 10,299 9,419
------------------- ----------------- -----------------
NET EARNINGS $ 21,772 $17,023 $15,476
=================== ================= =================
EARNINGS PER SHARE - BASIC $1.70 $1.51 $1.37
=================== ================= =================
EARNINGS PER SHARE - DILUTED $1.68 $1.51 $1.37
=================== ================= =================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
36
<PAGE>
FLAGSTAR BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ADDITIONAL TOTAL
COMMON PAID IN RETAINED STOCKHOLDERS'
STOCK CAPITAL EARNINGS EQUITY
-------------- ----------------- --------------- -------------------
<S> <C> <C> <C> <C>
Balance at January 1, 1995 $113 $ 2,829 $46,477 $ 49,419
Net earnings - - 15,476 15,476
Stock repurchase (1) (13) (436) (450)
Dividend paid ($0.18 per share) - - (2,000) (2,000)
-------------- ----------------- --------------- -------------------
Balance at December 31, 1995 112 2,816 59,517 62,445
Net earnings - - 17,023 17,023
Dividend paid ($0.09 per share) - - (1,000) (1,000)
-------------- ----------------- --------------- -------------------
Balance at December 31, 1996 112 2,816 75,540 78,468
Net earnings - - 21,772 21,772
Initial public offering of common shares 25 27,172 - 27,197
Dividend paid ($ 0.06 per share) - - (820) (820)
-------------- ----------------- --------------- -------------------
Balance at December 31, 1997 $137 $29,988 $96,492 $126,617
============== ================= =============== ===================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
37
<PAGE>
FLAGSTAR BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
---------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net earnings $ 21,772 $ 17,023 $ 15,476
Adjustments to reconcile net earnings to net cash used in operating activities
Provision for losses 5,015 2,604 238
Depreciation and amortization 17,161 17,287 11,072
Net gain on the sale of assets (1,100) (187) (493)
Net gain on loan sales (21,775) (4,511) (2,872)
Gain on sales of mortgage servicing rights (27,095) (35,129) (13,356)
Provision (benefit) for deferred federal income taxes 16,813 (773) 3,415
Proceeds from sales of loans available for sale 7,225,460 6,604,080 4,783,070
Originations and repurchases of loans available for sale, net of principal (7,578,375) (6,830,382) (5,011,843)
repayments
Increase in accrued interest receivable (9,866) (2,319) (1,214)
Decrease (increase) in other assets 16,250 (34,369) (8,896)
Increase in accrued interest payable 7,843 497 1,254
Increase (decrease) in liability for checks issued 6,083 (46,037) 46,496
(Decrease) increase in federal taxes payable (18,553) 8,666 3,750
(Decrease) increase in other liabilities (1,268) 4,020 8,326
------------- ---------- -----------
Net cash used in operating activities (341,635) (299,530) (165,577)
INVESTING ACTIVITIES
Maturity of other investments 349 431 32
Purchase of other investments - (500) -
Originations of loans held for investment, net of principal repayments (190,040) 31,936 (60,891)
Purchase of Federal Home Loan Bank Stock (20,300) (1,925) (5,034)
Proceeds from the disposition of repossessed assets 8,205 1,813 675
Acquisitions of premises and equipment (16,306) (7,596) (6,632)
Proceeds from the disposition of premises and equipment 2,733 - -
Proceeds from the disposition real estate held for investment 735 - -
Increase in mortgage servicing rights (92,441) (63,499) (31,106)
Proceeds from the sale of mortgage servicing rights 55,273 85,203 29,040
------------- ---------- -----------
Net cash (used in) provided by investing activities (251,792) 45,863 (73,916)
FINANCING ACTIVITIES
Net increase in deposit accounts 485,448 97,511 218,984
Net increase (decrease) in Federal Home Loan Bank advances 92,577 198,645 (9,594)
Net (disbursement) receipt of payments of loans serviced for others (15,593) 1,433 25,023
Net (disbursement) receipt of escrow payments (17,641) (27,854) 10,993
Stock repurchase - - (450)
Proceeds from the initial public offering 27,197 - -
Dividends paid to stockholders (820) (1,000) (2,000)
------------- ---------- -----------
Net cash provided by financing activities 571,168 268,735 242,956
------------- ---------- -----------
Net (decrease) increase in cash and cash equivalents (22,259) 15,068 3,463
Beginning cash and cash equivalents 44,187 29,119 25,656
------------- ---------- -----------
Ending cash and cash equivalents $ 21,928 $ 44,187 $ 29,119
============= =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Loans receivable transferred to repossessed assets $ 15,290 $ 10,577 $ 1,781
============= =========== ===========
Total interest payments made on deposits and other borrowings $ 72,189 $ 45,470 $ 40,189
============= =========== ===========
Federal income taxes paid $ 15,000 $ 2,300 $ 2,500
============= =========== ===========
Loans held for investment transferred to loans available for sale $ - $ - $ 185,111
============= =========== ===========
Loans available for sale transferred to loans held for investment $ 63,827 $ - $ -
============= =========== ===========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
38
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1 - NATURE OF BUSINESS
Flagstar Bancorp, Inc. ("Flagstar" or the "Company"), is the holding company for
Flagstar Bank, FSB (the "Bank"), a federally chartered stock savings bank
founded in 1987. Flagstar's primary business consists of attracting deposits
from the general public and originating or acquiring residential mortgage loans.
The Company also acquires funds on a wholesale basis from a variety of sources,
services a significant volume of loans for others, and to a lesser extent makes
consumer loans, commercial real estate loans, and non-real estate commercial
loans.
The Bank is a member of the Federal Home Loan Bank System ("FHLB") and is
subject to regulation, examination and supervision by the Office of Thrift
Supervision ("OTS") and the Federal Deposit Insurance Corporation ("FDIC"). The
Bank's deposits are insured by the FDIC through the Savings Association
Insurance Fund ("SAIF").
In January 1996, the Bank changed its name from First Security Savings Bank, FSB
to Flagstar Bank, FSB.
NOTE 2 - CORPORATE STRUCTURE
The following is a listing of the subsidiaries of the Company and the Bank:
The Company owns four subsidiaries besides the Bank, FSSB Real Estate
Development Corporation ("REDC"), Douglas Insurance Agency ("DIA"), Mortgage
Video Network, Inc. ("Video"), and First Security Investment Group, Inc.
("Investment") whose results of operations are not significant.
The Bank acquired the stock of Security Savings Bank, F.S.B. ("Security") a
federally chartered stock savings bank on June 30, 1994. This acquisition was
accounted for using the purchase method of accounting. Security was held as a
subsidiary of the Bank from June 30, 1994 to February 1, 1996. On February 1,
1996, Security was merged with and into the Bank.
The Bank owns five subsidiaries, Mid Michigan Service Corporation ("MMSC") and
SSB Funding Corporation ("Funding"), Boston Credit Corporation ("BCC"),
Mortgage Affiliated Services, Inc. ("MAS"), and FSSB Mortgage Corporation
("Mortgage"). MMSC is a Michigan corporation engaged in leasing and sub-
leasing commercial real estate and Funding is a finance subsidiary; both
subsidiaries are currently inactive. BCC and Mortgage are also currently
inactive and MAS is a document preparation company. During the first quarter
of 1996, FSSB Mortgage Corporation was acquired by the Bank from Flagstar.
During the first quarter of 1998, MAS was merged with and into the Bank.
During 1997, the Bank formed two additional subsidiaries Flagstar Capital
Corporation ("Capital") and Flagstar Credit Corporation ("Credit"). Capital
will purchase mortgage loans from the Bank and hold them for investment
purposes. Credit is expected to enter into agreements with various private
mortgage insurance companies for the purpose of participating in mortgage
reinsurance or similar transactions.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following summarizes the significant accounting policies of the Company
applied in the preparation of the accompanying consolidated financial
statements.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company. All
significant intercompany balances and transactions have been eliminated.
39
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STATEMENT OF CASH FLOWS
For purposes of the statements of cash flows, the Company considers its
investment in overnight deposits to be cash equivalents.
LOANS RECEIVABLE
The Company originates loans which are designated to be held for investment or
sale during the origination process. Mortgage loans available for sale are
carried at the lower of aggregate cost or estimated market value. Management
periodically reviews the portfolio and makes necessary adjustments for market
value. Net unrealized losses are recognized in a valuation allowance by charges
to earnings. Gains or losses recognized upon the sale of loans are determined
using the specific identification method. Mortgage loans held for investment
are carried at amortized cost. The Company has both the intent and the ability
to hold all mortgage loans held for investment for the foreseeable future.
ALLOWANCE FOR LOSSES
The allowance is maintained at a level adequate to absorb losses inherent in the
loan portfolio. Management determines the adequacy of the allowance by applying
projected loss ratios to the risk ratings of loans both individually and by
category. The projected loss ratios incorporate such factors as recent loss
experience, current economic conditions, the risk characteristics of the various
categories and concentrations of loans, transfer risk and other pertinent
factors.
Loans which are deemed uncollectible are charged off and deducted from the
allowance. The provision for losses and recoveries on loans previously charged
off are added to the allowance. In addition, a specific provision is made for
expected loan losses to reduce the recorded balances of loans receivable to
their estimated net realizable value. Such specific provision is based on
management's estimate of net realizable value considering the current and
anticipated operating or sales environment. These estimates of collateral value
are particularly susceptible to market changes that could result in adjustments
to the results of earnings in the future. Recovery of the carrying value of
such loans or such loan or the underlying collateral is dependent to a great
extent on economic, operating and other conditions that may beyond the Company's
control. The Company adopted Statement of Financial Accounting Standards
("SFAS") No. 114 (as amended by SFAS No. 118), "Accounting by Creditors for
Impairment of a Loan", effective January 1, 1995, which addresses the accounting
by creditors for the impairment of certain loans. The provisions of SFAS 114 do
not apply to large groups of smaller-balance homogeneous loans that are
collectively evaluated for impairment and loans that are measured at fair value
or at the lower of cost or fair value. The Company considers its residential
mortgage loan portfolio to represent a pool of smaller balance homogeneous
loans. Commercial, commercial real estate, construction and consumer loan
portfolios are specifically reviewed for impairment. The adoption had no effect
on the recorded allowance for losses.
The Company considers a loan impaired when it is probable, in the opinion of
management, that interest and principal may not be collected according to the
contractual terms of the loan agreement. Consistent with this definition, the
Company considers all non-accrual loans (with exception of residential
mortgages) to be impaired. Impaired loans which have risk characteristics that
are unique to an individual borrower, are evaluated on a loan-by-loan basis.
However, impaired loans that have risk characteristics in common with other
impaired loans, (such as loan type, geographical location, or other
characteristics that would cause the ability of the borrowers to meet
contractual obligations to be similarly affected by changes in economic or other
conditions), are aggregated and historical statistics, such as average recovery
period and average amount recovered, along with a composite effective interest
rate are used as a means of measuring those impaired loans. Loan impairment is
measured by estimating the expected future cash flows and discounting them at
the respective effective interest rate or by valuing the underlying collateral.
40
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOAN ORIGINATION FEES, COMMITMENT FEES AND RELATED COSTS
Loan fees received are accounted for in accordance with SAFS No. 91, "Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans
and Initial Direct Costs of Leases". Mortgage loan fees and certain direct
origination costs are capitalized. On loans available for sale, the net fee or
cost is recognized at the time the loan is sold. For mortgage loans held for
investment, the deferred amount is accounted for as an adjustment to interest
income using a method that approximates the interest method.
REPOSSESSED ASSETS
Repossessed assets include one-to-four family residential property, commercial
property, and one-to-four family homes under construction. At the date of
foreclosure, real estate properties acquired in settlement of loans are recorded
at the lower of cost or net realizable value. Valuations are periodically
performed by management, and a charge to earnings is made if the carrying value
of a property exceeds its estimated fair value. Costs of holding repossessed
assets, principally taxes and legal fees, are expensed as incurred.
FEDERAL INCOME TAXES
The Company accounts for income taxes on the asset and liability method.
Deferred tax assets and liabilities are recorded based on the difference between
the tax bases of assets and liabilities and their carrying amounts for financial
reporting purposes. Current taxes are measured by applying the provisions of
enacted tax laws to taxable income to determine the amount of taxes receivable
or payable.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation. Land
is carried at historical cost. Depreciation is calculated on the straight-line
method over the estimated useful lives of the assets as follows:
Office buildings - 31 years
Computer hardware and software - 3 to 5 years
Furniture, fixtures and equipment - 5 to 7 years
Automobiles - 3 years
During March 1995, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of". This Statement requires that long-lived assets and
goodwill related to those assets to be held and used by an entity and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. The Company adopted SFAS No. 121 effective January 1, 1996.
Adoption of this Statement did not have an impact on the financial condition or
results of operations of the Company.
41
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MORTGAGE SERVICING RIGHTS
Mortgage servicing rights ("MSR") represent the cost of acquiring the right to
service mortgage loans. These costs are initially capitalized and subsequently
amortized in proportion to, and over the period of, the estimated net loan
servicing income.
In May 1995 , the Company adopted SFAS No. 122, "Accounting for Mortgage
Servicing Rights". This requires the capitalization of a mortgage servicing
asset for every origination whether it be originated or purchased. SFAS No. 122
also dictates prescribed rules for the amortization, periodic valuation, and the
required valuation adjustment. Prior to adoption, a value was capitalized for
purchased mortgage servicing rights. This capitalization was in accordance with
SFAS No. 65, "Accounting for Certain Mortgage Banking Practices".
The value of the mortgage servicing rights are periodically evaluated in
relation to the estimated discounted net future servicing revenues. The
portfolio is aggregated into stratifications based on loan term and type, and
note rate. Estimates of remaining loan lives and prepayment rates are
incorporated into this analysis. Changes in these estimates could materially
change the estimated fair value and any valuation allowance. Valuation
adjustments are recorded when the fair value of the servicing asset is less than
the amortized book value on a stratum basis. Any valuation adjustment is
recorded as an offset to the asset.
LOAN SALES
The Bank sells its available for sale mortgage loans to secondary market
investors on a non-recourse basis. At the time of the sale, the Bank makes
certain representations and warranties to the investors. Should an investor
determine that a breach of such representations or warranties occurred, the Bank
may be required to repurchase loans from the investor. Such representations and
warranties generally relate to the fact that the loans have been underwritten in
accordance with the investor's guidelines and that the loans conform to the laws
of the state of origination. Gain or loss on the sale of such loans is
recognized upon consummation of the sale.
STOCK BASED COMPENSATION
The FASB has issued SFAS No. 123, "Accounting for Stock Based Compensation,"
which is effective for transactions entered into during 1996 and thereafter.
The statement establishes a fair market value method of accounting for employee
stock options and similar instruments such as warrants, and encourages all
companies to adopt that method of accounting for all employee stock option
plans. However, the statement allows companies to continue measuring
compensation costs for such plans using accounting guidance in place prior to
SFAS No. 123. Companies that elect to remain with the former method of
accounting must make pro forma disclosures of net earnings and earnings per
share as if the fair value method provided for in SFAS No.123 had been adopted.
The Company has not adopted the fair value provisions of SFAS No. 123 but has
disclosed the pro forma effects in accordance with the pronouncement.
42
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS PER SHARE
The FASB has issued SFAS No. 128, "Earnings Per Share," which is effective for
financial statements issued after December 15, 1997. The standard eliminates
primary and fully diluted earnings per share and requires presentation of basic
and diluted earnings per share together with disclosure of how the per share
amounts were computed. Basic earnings per share excludes dilution and is
computed by dividing earnings available to common shareholders by the weighted
average common shares outstanding. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised and converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the Company. The
Company adopted SFAS No. 128 at December 31, 1997. All per share data has been
restated to reflect application of this new pronouncement.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The financial condition of a financial services company, and to some extent, its
operating performance, is dependent to a significant degree upon estimates and
appraisals of value, evaluations of creditworthiness and assumptions about
future events and economic conditions. Recent history has demonstrated that
these estimates, appraisals, evaluations and assumptions are subject to rapid
change, and that such changes can materially affect the reported financial
condition of a financial services company and its financial performance, and may
result in restrictions on an institution's ability to continue to operate in its
customary manner.
RECLASSIFICATIONS
Certain amounts within the accompanying consolidated financial statements and
the related notes have been reclassified to conform to the 1997 presentation.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting of Comprehensive Income"
("SFAS 130"), which establishes standards for reporting and display of
comprehensive income and its components (revenues, expense, gains, and losses)
in a full set of financial statements. This statement also requires that all
items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. This
statement is effective for fiscal years beginning after December 15, 1997.
Earlier application is permitted. Reclassification of financial statements for
earlier periods provided for comparative purposes is required. The Company does
not anticipate that adoption of SFAS 130 will have a material effect on the
Company.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"), which establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to stockholders. This statement also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. This statements requires the reporting of financial and descriptive
information about an enterprise's reportable operating segments. This statement
is effective for financial statements for periods beginning after December 15,
1997. In the initial year of adoption, comparative information for earlier
years is to be restated. The Company does not anticipate that the adoption of
SFAS 131 will have a material effect on the Company.
43
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 4 - LOANS RECEIVABLE
The loan portfolio is summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------
1997 1996
----------------------------------
<S> <C> <C>
Available for sale - mortgage loans $1,197,152 $ 840,767
Held for investment
Mortgage loans 282,224 120,924
Commercial real estate loans 31,751 13,565
Commercial loans 80,255 46,202
Construction loans 35,373 59,270
Consumer loans 34,004 33,608
----------------------------------
Total 463,607 273,569
----------------------------------
Total loans 1,660,759 1,114,336
Less allowance for losses (5,500) (3,500)
----------------------------------
Total $1,655,259 $1,110,836
==================================
</TABLE>
In 1994, the Company classified a number of loans as held for investment in a
manner similar to SFAS No. 115 ("SFAS 115"), "Accounting for Certain
Investments in Debt and Equity Securities". In 1995, the FASB released the
"Guide to Implementation of Statement 115" (the "Guide"). Upon review of the
Guide, the Company reassessed the prior classifications and reclassified
approximately $185.0 million of mortgage loans to available for sale from held
for investment.
Activity in the allowance for losses is summarized as follows (in thousands):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
--------------------------------------------------
<S> <C> <C> <C>
Balance, beginning of period $ 3,500 $ 2,102 $1,871
Provision charged to earnings 5,015 2,604 238
Charge-offs, net of recoveries (3,015) (1,206) (7)
--------------------------------------------------
Balance, end of period $ 5,500 $ 3,500 $2,102
==================================================
</TABLE>
The Company has no commitments to make additional advances on restructured or
other non performing loans. Loans on which interest accruals have been
discontinued totaled approximately $44.3 million at December 31, 1997 and $30.6
million at December 31, 1996. Interest that would have been accrued on such
loans totaled approximately $4.8 million, $2.7 million, and $.9 million during
1997, 1996, and 1995, respectively.
At December 31, 1997 the recorded investment in impaired loans, pursuant to SFAS
No. 114, totaled $3.6 million and the average outstanding balance for the year
ended December 31, 1997 was $3.5 million. No allowance for losses was required
on these loans because the measured values of the loans exceeded the recorded
investments in the loans. Interest income recognized on impaired loans during
the year ended December 31, 1997, was not significant. At December 31, 1996,
the recorded investment in impaired loans totaled $3.9 million and the average
outstanding balance for the year ended December 31, 1996 was $3.1 million.
44
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 5 - REPOSSESSED ASSETS
Repossessed assets include the following (in thousands):
<TABLE>
<CAPTION>
December 31,
1997 1996
-----------------------------
<S> <C> <C>
One-to-four family $18,082 $10,133
Commercial properties 180 230
-----------------------------
Repossessed assets, net $18,262 $10,363
=============================
</TABLE>
NOTE 6 - PREMISES AND EQUIPMENT
Premises and equipment balances are as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
1997 1996
-----------------------------
<S> <C> <C>
Land $ 9,119 $ 3,330
Office buildings 7,090 2,643
Computer hardware and software 16,827 15,421
Furniture, fixtures and equipment 11,813 11,045
Automobiles 434 571
-----------------------------
Total 45,283 33,010
Less accumulated depreciation (16,152) (12,144)
-----------------------------
Premises and equipment, net $ 29,131 $ 20,866
=============================
</TABLE>
Depreciation expense amounted to approximately $5.2 million, $4.6 million, and
$3.1 million for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company conducts a portion of its business from leased facilities. Lease
rental expense totaled approximately $3.9 million, $4.1 million and $3.3 million
for the years ended December 31, 1997, 1996 and 1995, respectively. The
following outlines the Bank's minimum contractual lease obligations as of
December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
<S> <C>
1998 $3,305
1999 2,915
2000 1,941
2001 305
2002 165
Thereafter 657
-------------
Total $9,288
=============
</TABLE>
45
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 7 - MORTGAGE SERVICING RIGHTS
Not included in the accompanying consolidated financial statements are mortgage
loans serviced for others. The unpaid principal balances of these loans,
including subservicing of $3.6 billion at December 31, 1996, are summarized as
follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
MORTGAGE LOANS SERVICED FOR: 1997 1996
---------------------------------
<S> <C> <C>
FHLMC and FNMA $6,081,885 $4,658,056
MSHDA 57,695 47,505
GNMA 4,970 6,458
Other investors 268,247 3,708,935
---------------------------------
Total $6,412,797 $8,420,954
=================================
</TABLE>
Custodial accounts maintained in connection with the above mortgage servicing
rights were approximately $81.2 million and $106.3 million at December 31, 1997
and 1996, respectively. These amounts include payments for principal, interest,
taxes, and insurance collected on behalf of the individual investor.
The following is an analysis of the changes in mortgage servicing rights (in
thousands):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
-----------------------------------------------
<S> <C> <C> <C>
Balance, beginning of period $ 30,064 $ 27,957 $ 18,179
Additions 92,441 63,499 31,106
Sales (28,178) (50,075) (15,684)
Amortization (10,482) (11,317) (5,644)
-----------------------------------------------
Balance, end of period $ 83,845 $ 30,064 $ 27,957
===============================================
</TABLE>
At December 31, 1997 and 1996, the estimated fair value of the mortgage loan
servicing portfolio was $92.4 and $54.0 million, respectively.
46
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 8 - DEPOSIT ACCOUNTS
The deposit accounts are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
-------------------------------
<S> <C> <C>
Demand, NOW and money market accounts $ 63,662 $ 66,661
Passbook savings 79,951 57,211
Certificates of deposit 966,320 500,613
-------------------------------
Total deposit accounts $1,109,933 $624,485
===============================
</TABLE>
Non interest-bearing deposits included in the demand, NOW and money market
accounts balances at December 31, 1997 and 1996 were approximately $28.9 million
and $36.7 million, respectively.
The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 was approximately $621.8 million and $279.5 million at December 31,
1997 and 1996, respectively.
The following indicates the scheduled maturities of the Company's certificates
of deposit as of December 31, 1997:
<TABLE>
<CAPTION>
DECEMBER 31,
1997
-------------------
<S> <C>
Three months or less $174,696
Over three through six months 121,311
Over six through twelve months 211,933
One to two years 234,328
Thereafter 224,052
-------------------
Total $966,320
===================
</TABLE>
Interest expense on deposit accounts is summarized as follows (in thousands):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
------------------------------------
<S> <C> <C> <C>
Demand, NOW and money market accounts $ 1,346 $ 2,499 $ 1,824
Passbook savings 3,193 428 228
Certificates of deposit 45,604 27,504 23,071
------------------------------------
Total $50,143 $30,431 $25,123
====================================
</TABLE>
47
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 9 - FHLB ADVANCES
The following indicates certain information related to the FHLB advances (in
thousands):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
----------------------------------------------
<S> <C> <C> <C>
Maximum outstanding at any month end $718,878 $389,801 $315,000
Average balance 480,062 247,204 237,535
Average interest rate 5.98% 5.78% 6.35%
</TABLE>
The Bank has the authority and approval from the FHLB to utilize a total of $850
million in collateralized borrowings. Advances at December 31, 1997 totaled
$482.4 million and carried a weighted rate of 5.93%. Advances totaling $150.0
million, and $252.5 million mature during 1999 and 1998, respectively. The
remaining $79.9 million were daily adjustable rate advances. Pursuant to
collateral agreements with the FHLB, advances are collateralized by non-
delinquent single-family residential mortgage loans.
NOTE 10 - FEDERAL INCOME TAXES
Components of the provision for federal income taxes consists of the following
(in thousands):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
----------------------------------------
<S> <C> <C> <C>
Current provision/(benefit) $ (3,548) $ 11,072 $ 6,004
Deferred provision/(benefit) 16,813 (773) 3,415
----------------------------------------
$ 13,265 $ 10,299 $ 9,419
========================================
</TABLE>
The Company's effective tax rates differ from the statutory federal tax rates.
The following is a summary of such differences (in thousands):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
-------------------------------------------
<S> <C> <C> <C>
Provision at statutory federal income tax
rate $12,263 $ 9,563 $8,713
Increase (decrease) resulting from:
Amortization of deposit premium 450 450 450
Other, net 552 286 256
-------------------------------------------
Provision at effective federal income tax
rate $13,265 $10,299 $9,419
===========================================
</TABLE>
48
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 10 - FEDERAL INCOME TAXES (CONTINUED)
The details of the net tax liability are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
-----------------------------------
<S> <C> <C>
DEFERRED TAX ASSETS:
Mark-to-market adjustments on earning assets $ 1,050 $ 1,130
Interest not accrued 1,589 934
Other 455 218
-----------------------------------
Total 3,094 2,282
DEFERRED TAX LIABILITIES:
Deferred fees (1,033) (1,112)
Bad debt reserves - (704)
Mortgage loan servicing rights (29,029) (10,199)
Purchase accounting valuation adjustments (252) (555)
Premises and equipment (1,034) (885)
Other - (268)
-----------------------------------
Total (31,348) (13,723)
-----------------------------------
Net deferred tax liability (28,254) (11,441)
Currently (payable)/receivable 7,446 (11,107)
-----------------------------------
Net tax liability ($ 20,808) ($ 22,548)
===================================
</TABLE>
Flagstar files a consolidated federal income tax return on a calendar year
basis. Through its tax year ended December 31, 1995, the Bank has determined
its deduction for bad debts based on the reserve method in lieu of the specific
charge-off method. Under the reserve method, the Bank has established and
maintained a reserve for bad debts against which actual loan losses are charged.
As a qualifying thrift institution, the Bank has calculated its addition to its
bad debt reserve under either, (1) the "percentage of taxable income" method or
(2) the "experience" method. The Bank used the percentage of taxable income
method in determining its bad debt reserve addition for its 1995 tax year.
During August 1996, the President signed the Small Business Job Protection Act
of 1996 ("the Jobs Act") which contains certain provisions that require all
savings banks and thrifts to account for bad debts for income tax reporting
purposes in the same manner as banks. The effect on a large thrift such as the
Bank is that it must change its tax method of accounting for determining its
allowable bad debt deduction from the reserve method to the specific charge-off
method. Consequently, the bad debt deduction based on a percentage of taxable
income or the experience method is no longer allowed for years beginning after
December 31, 1995.
49
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 10 - FEDERAL INCOME TAXES (CONTINUED)
The bad debt reserves maintained for tax purposes and accumulated after 1987 are
subject to recapture as part of the change. Base year reserves (generally pre-
1987 bad debt reserves) will not be recaptured unless the Bank, or a successor
institution, liquidates, redeems shares or pays a dividend in excess of earnings
and profits. The recapture will generally be taken into account ratably over
six years beginning with the 1996 tax year. The Bank may defer the recapture up
to an additional two years if it meets certain residential lending requirements
during tax years beginning before January 1, 1998.
Income taxes have been provided for the temporary difference between the
allowance for losses and the increase in the bad debt reserve maintained for tax
purposes since the 1987 base year. The cumulative amount of this difference at
December 31, 1995 was approximately $3.5 million for the Bank. As a result of
the Jobs Act, the cumulative difference of $3.5 million will be recaptured.
Management believes that the Bank has met the conditions to defer the recapture
of the reserve during 1996 and 1997. The Jobs Act had no effect on the base
year reserves of the Bank. Consequently, the Bank has not provided deferred
taxes of approximately $1.4 million on the balance of its tax bad debt reserves
as of the 1987 base year.
NOTE 11- EMPLOYEE BENEFITS
The Company maintains a 401(k) plan for its employees. Under the plan, eligible
employees may contribute up to 6% of their compensation up to a maximum of
$9,600 annually. The Company currently provides a matching contribution up to
3% of an employee's annual compensation up to a maximum of $4,800. The
Company's contributions vest at a rate such that an employee is fully vested
after seven years of service. The Company's contributions to the plan for the
years ended December 31, 1997, 1996 and 1995 were approximately $590,000,
$594,000, and $493,000, respectively. The Company may also make discretionary
contributions to the plan; however, none have been made.
NOTE 12 - CONTINGENCIES
The Company is involved in certain lawsuits incidental to its operations.
Management, after review with its legal counsel, is of the opinion that
settlement of such litigation will not have a material effect on the Company's
financial condition.
A substantial part of the Bank's business has involved the origination,
purchase, and sale of mortgage loans. During the past several years, numerous
individual claims and purported consumer class action claims were commenced
against a number of financial institutions, their subsidiaries and other
mortgage lending institutions generally seeking civil statutory and actual
damages and rescission under the federal Truth in Lending Act (the "TILA"), as
well as remedies for alleged violations of various state unfair trade practices
laws restitution or unjust enrichment in connection with certain mortgage loan
transactions.
The Bank has a substantial mortgage loan servicing portfolio and maintains
escrow accounts in connection with this servicing. During the past several
years, numerous individual claims and purported consumer class action claims
were commenced against a number of financial institutions, their subsidiaries
and other mortgage lending institutions generally seeking declaratory relief
that certain of the lenders' escrow account servicing practices violate the Real
Estate Settlement Practices Act and breach the lenders' contracts with
borrowers. Such claims also generally seek actual damages and attorney's fees.
50
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 12 - CONTINGENCIES (CONTINUED)
In addition to the foregoing, mortgage lending institutions have been subjected
to an increasing number of other types of individual claims and purported
consumer class action claims that relate to various aspects of the origination,
pricing, closing, servicing, and collection of mortgage loans and that allege
inadequate disclosure, breach of contract, or violation of state laws. Claims
have involved, among other things, interest rates and fees charged in connection
with loans, interest rate adjustments on adjustable-rate loans, timely release
of liens upon payoffs, the disclosure and imposition of various fees and charge,
and the placing of collateral protection insurance.
While the Bank has had various claims similar to those discussed above asserted
against it, management does not expect these claims to have a material adverse
effect on the Bank's financial condition, results of operations, or liquidity.
NOTE 13 - REGULATORY MATTERS
The Financial Institutions Reform Recovery and Enforcement Act of 1989
("FIRREA"), which instituted major reforms in the operation and supervision of
the savings and loan industry, contains provisions for capital standards. These
standards require savings institutions to have a minimum regulatory tangible
capital (as defined in the regulation) equal to 1.50% of adjusted total assets
and a minimum 3.00% core capital (as defined) of adjusted total assets.
Additionally, savings institutions are required to meet a total risk-based
capital requirement of 8.00%.
The Bank is also subject to the provisions of the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"). FDICIA includes significant
changes to the legal and regulatory environment for insured depository
institutions, including reductions in insurance coverage for certain kinds of
deposits, increased supervision by the Federal regulatory agencies, increased
reporting requirements for insured institutions, and new regulations concerning
reporting on internal controls, accounting and operations.
FDICIA's prompt corrective action regulations define specific capital categories
based on an institutions' capital ratios. The capital categories, in declining
order, are "well" capitalized, "adequately capitalized", "undercapitalized",
"significantly undercapitalized", and "critically undercapitalized."
Institutions categorized as "undercapitalized" or worse are subject to certain
restrictions, including the requirement to file a capital plan with OTS, and
increased supervisory monitoring, among other things. Other restrictions may be
imposed on the institution either by the OTS or by the FDIC, including
requirements to raise additional capital, sell assets, or sell the entire
institution.
The following chart delineates the categories as defined in the FDICIA
legislation:
<TABLE>
<CAPTION>
TIER 1 TOTAL
RISK- RISKED-
CORE BASED BASED
CAPITAL CAPITAL CAPITAL
--------------------------------------------------------
<S> <C> <C> <C>
"Well capitalized" 5.0% 6.0% 10.0%
"Adequately capitalized" 4.0% 4.0% 8.0%
"Undercapitalized" Less than 4.0% Less than 4.0% Less than 8.0%
"Significantly undercapitalized" Less than 3.0% Less than 3.0% Less than 6.0%
</TABLE>
51
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 13 - REGULATORY MATTERS (CONTINUED)
At December 31, 1997, Bank's consolidated Core, Tier 1 risk-based, and Total
risk-based capital ratios were 5.62%, 11.22% and 11.74%, respectively. These
ratios place the Bank in the "well capitalized" category.
The following is a calculation of Bank's consolidated regulatory capital (in
thousands) at December 31, 1997:
<TABLE>
<CAPTION>
TIER 1 TOTAL
RISK- RISK-
GAAP TANGIBLE CORE BASED BASED
CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
GAAP CAPITAL, AS REPORTED $126,410 $126,410 $126,410 $126,410 $126,410
NON ALLOWABLE ASSETS:
Core deposit premium (4,515)
Mortgage servicing value (20,640) (20,640) (20,640) (20,640)
Other assets (310)
ADDITIONAL CAPITAL ITEMS:
General valuation allowance 5,500
--------------------------------------------------------------
Regulatory capital 101,255 105,770 105,770 110,960
Minimum capital requirement % 1.50% 3.00% 4.00% 8.00%
Minimum capital requirement $ 28,138 56,412 37,700 75,594
--------------------------------------------------------------
Regulatory capital - excess $ 73,117 $ 49,358 $ 68,070 $ 35,366
==============================================================
</TABLE>
At December 31, 1996, Bank's consolidated Core, Tier 1 risk-based, and Total
risk-based capital ratios were 6.01%, 10.48% and 10.91%, respectively. Those
ratios placed the Bank in the "well capitalized" category.
The following is a calculation of Bank's consolidated regulatory capital (in
thousands) at December 31, 1996:
<TABLE>
<CAPTION>
TIER 1 TOTAL
RISK- RISK-
GAAP TANGIBLE CORE BASED BASED
CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL
--------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
GAAP CAPITAL, AS REPORTED $77,899 $77,899 $77,899 $77,899 $77,899
NONALLOWABLE ASSETS:
Core deposit premium (5,805)
Other assets (313)
ADDITIONAL CAPITAL ITEMS:
General valuation allowance 3,500
-------------------------------------------------------
Regulatory capital 72,094 77,899 77,899 81,086
Minimum capital requirement % 1.50% 3.00% 4.00% 8.00%
Minimum capital requirement $ 19,365 38,904 51,872 59,458
-------------------------------------------------------
Regulatory capital - excess $52,729 $38,995 $26,027 $21,628
=======================================================
</TABLE>
52
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 13 - REGULATORY MATTERS (CONTINUED)
The OTS risk-based capital regulation also includes an interest rate risk (IRR)
component that requires savings institutions with greater than normal IRR, when
determining compliance with the risk-based capital requirements, to maintain
additional total capital. The OTS has, however, indefinitely deferred
enforcement of its IRR requirements. Under the regulation, a savings
institution's IRR is measured in terms of the sensitivity of its "net portfolio
value" to changes in interest rates. A savings institution is considered to
have a "normal" level of IRR exposure if the decline in its net portfolio value
after an immediate 200 basis point increase or decrease in market interest rates
is less than 2% of the current estimated economic value of its assets. If the
OTS determines in the future to enforce the regulation's IRR requirements, a
savings institution with a greater than normal IRR would be required to deduct
from total capital, for purposes of calculating its risk-based capital
requirement, an amount equal to one half the difference between the
institution's measured IRR and 2%, multiplied by the economic value of the
institution's total assets. Management does not believe that this regulation,
when enforced, will have a material impact on Bank.
The United States Congress passed legislation that resulted in an assessment on
all Savings Association Insurance Fund ("SAIF") insured deposits in order to
recapitalize the SAIF Fund. This one-time assessment amounted to approximately
66 basis points on SAIF assessable deposits held as of March 31, 1995. The
assessment was paid in November 1996 and amounted to $3.4 million for Bank.
Such amount was charged to earnings in 1996.
NOTE 14 - CONCENTRATIONS OF CREDIT
Properties collateralizing loans receivable are geographically disbursed
throughout the United States. As of December 31, 1997, approximately 25.7% of
these properties are located in Michigan (measured by principal balance), and
another 55.3% are located in the states of California, Colorado, Ohio, Florida,
Illinois, Texas, Maryland, Washington, Oregon, New York, Utah, and Georgia. No
other state contains more than 2% of the properties collateralizing these loans.
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 issued by the Financial Accounting Standards Board, "Disclosures
about Fair Value of Financial Instruments", requires the disclosure of fair
value information about financial instruments, whether or not recognized in the
statement of financial condition, where it is practicable to estimate that
value. In cases where quoted market prices are not available, fair values are
based on estimates using present value or other valuation techniques. Because
assumptions used in these valuation techniques are inherently subjective in
nature, the estimated fair values cannot always be substantiated by comparison
to independent market quotes and, in many cases, the estimated fair values could
not necessarily be realized in an immediate sale or settlement of the
instrument.
The fair value estimates presented herein are based on relevant information
available to management as of December 31, 1997 and 1996. Management is not
aware of any factors that would significantly affect these estimated fair value
amounts. As these reporting requirements exclude certain financial instruments
and all non-financial instruments, the aggregate fair value amounts presented
herein do not represent management's estimate of the underlying value of the
Company. Additionally, such amounts exclude intangible asset values such as the
value of core deposit intangibles.
The following methods and assumptions were used by the Company to estimate the
fair value of each class of financial instruments and certain non-financial
instruments for which it is practicable to estimate that value:
Cash and cash equivalents: The carrying amount of cash and cash equivalents
approximates fair value.
53
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Loans receivable: This portfolio consists of mortgage loans available for sale
and investment, collateralized commercial lines of credit, commercial real
estate loans, builder development project loans, consumer credit obligations,
and single family home construction loans. Mortgage loans available for sale
and investment are valued using fair values attributable to similar mortgage
loans. The fair value of the other loans are valued based on the fair value of
obligations with similar credit characteristics.
Other investments: The carrying amount of other investments approximates fair
value.
FHLB stock: No secondary market exists for FHLB stock. The stock is bought and
sold at par by the FHLB. The recorded value, therefore, is the fair value. The
amount of stock required to be purchased is based on total assets and is
determined annually.
Deposit Accounts: The fair value of demand deposits and savings accounts
approximates the carrying amount. The fair value of fixed-maturity certificates
of deposit is estimated using the rates currently offered for deposits with
similar remaining maturities.
FHLB Advances: Rates currently available to the Company for debt with similar
terms and remaining maturities are used to estimate the fair value of the
existing debt.
Mortgage Servicing Rights: See Note 3 for a description of the method used to
value the mortgage servicing rights.
Financial instruments with off-balance-sheet risk: The fair value of financial
futures contracts, forward delivery contracts and fixed rate commitments to
extend credit are based on current market prices.
The following tables set forth the fair value of the Company's financial
instruments:
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-----------------------------------------------------------------------
<S> <C> <C> <C> <C>
FINANCIAL INSTRUMENTS:
ASSETS:
Cash and cash equivalents $ 21,928 $ 21,928 $ 44,187 $ 44,187
Mortgage loans available for sale 1,197,152 1,212,364 840,767 850,455
Loans held for investment 458,107 459,759 270,069 274,158
Other investments 538 538 887 887
FHLB stock 40,025 40,025 19,725 19,725
LIABILITIES:
Deposits:
Demand deposits and
Demand deposits and savings accounts (143,613) (143,613) (123,872) (123,872)
Certificates of deposit (966,320) (969,111) (500,613) (500,718)
FHLB advances (482,378) (481,723) (389,801) (389,635)
OFF-BALANCE SHEET ITEMS:
Financial futures - - - -
Forward delivery contracts - (8,028) - (9,868)
Commitments to extend credit - 5,159 5,362
NON-FINANCIAL INSTRUMENTS:
Unrealized gains on mortgage
servicing rights (see Note 7) - 8,516 - 23,900
</TABLE>
54
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The Company enters into certain financial instruments with off-balance-sheet
risk in the ordinary course of business to reduce its exposure to changes in
interest rates. The Company utilizes only traditional financial instruments for
this purpose and does not enter into instruments such as leveraged derivatives
or structured notes. The financial instruments used for hedging interest rate
risk include financial futures contracts and forward delivery contracts. A
hedge is an attempt to reduce risk by creating a relationship whereby any losses
on the hedged asset or liability are expected to be counterbalanced in whole or
part by gains on the hedging financial instrument. Thus, market risk resulting
from a particular off-balance-sheet instrument is normally offset by other on or
off-balance-sheet transactions. The Company seeks to manage credit risk by
limiting the total amount of arrangements outstanding, both by counterparty and
in the aggregate, by monitoring the size and maturity structure of the financial
instruments, by assessing the creditworthiness of the counterparty, and by
applying uniform credit standards for all activities with credit risk.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
Notional principal amounts indicated in the following table represent the extent
of the Company's involvement in particular classes of financial instruments and
generally exceed the expected future cash requirements relating to the
instruments.
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
----------------------
<S> <C> <C>
(IN MILLIONS)
Forward delivery contracts $ 853 $ 665
Commitments to extend credit 624 695
</TABLE>
All of the Company's financial instruments with off-balance sheet risk expire
within one year.
Financial Futures Contracts: There were no Treasury futures contracts
outstanding at December 31, 1997 or 1996. Gains or losses on futures
transactions are recorded on the specific identification method in response to
adjustments in the fair market value of the instruments. During 1997, 1996, and
1995, the Company recorded losses on financial futures amounting to
approximately $128,000, $90,000 and $1.3 million, respectively.
Forward Delivery Contracts: Forward delivery contracts are entered into to sell
mortgage loans:
FORWARD DELIVERY CONTRACTS
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
----------------------
<S> <C> <C>
(IN MILLIONS)
MORTGAGE LOAN TYPE:
Fixed $ 836 $ 633
Balloon 10 23
Variable 7 9
----------------------
Total $ 853 $ 665
======================
</TABLE>
Substantially all forward delivery contracts are entered into with the FHLMC,
FNMA or GNMA.
55
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (CONTINUED)
Commitments to Extend Credit: The Company's exposure to credit loss for
commitments to extend credit is represented by the contractual amount of those
agreements. The Company uses the same credit policies in making funding
commitments as it does for on-balance-sheet instruments. These commitments
generally have fixed expiration dates or other termination clauses. Because
commitments may expire without being drawn upon, the total contract amounts do
not necessarily represent future cash requirements.
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
-----------------------------
<S> <C> <C>
(IN MILLIONS)
Single family $ 499 $ 585
Other 125 110
-----------------------------
Total $ 624 $ 695
=============================
Fixed $ 515 $ 670
Variable 109 25
-----------------------------
Total $ 624 $ 695
=============================
</TABLE>
NOTE 16 - SEGMENT INFORMATION
The Company operations can be segmented into mortgage banking and retail
banking. Following is a presentation of financial information by business for
the period indicated.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997
------------------------------------------------------------------
RETAIL MORTGAGE
BANKING BANKING
OPERATION OPERATION ELIMINATIONS COMBINED
------------------------------------------------------------------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
Revenues $ 30,202 $ 72,353 $ - $ 102,555
Earnings before income taxes 19,341 15,696 - 35,037
Depreciation and amortization 2,021 15,140 - 17,161
Capital expenditures 409 15,897 - 16,306
Identifiable assets 564,551 1,463,288 (126,755) 1,901,084
Intersegment income (expense) 8,873 (8,873) - -
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1996
------------------------------------------------------------------
RETAIL MORTGAGE
BANKING BANKING
OPERATION OPERATION ELIMINATIONS COMBINED
------------------------------------------------------------------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
Revenues $ 13,791 $ 74,955 $ - $ 88,746
Earnings before income taxes 3,305 24,017 - 27,322
Depreciation and amortization 1,589 15,698 - 17,287
Capital expenditures 312 7,284 - 7,596
Identifiable assets 387,201 1,112,676 (202,651) 1,297,226
Intersegment income (expense) 14,186 (14,186) - -
</TABLE>
56
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 16 - SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1995
-----------------------------------------------------------------
RETAIL MORTGAGE
BANKING BANKING
OPERATION OPERATION ELIMINATIONS COMBINED
-----------------------------------------------------------------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
Revenues $ 12,390 $ 54,459 $ - $ 66,849
Earnings before income taxes 3,549 21,346 - 24,895
Depreciation and amortization 1,728 9,344 - 11,072
Capital expenditures 1,665 4,967 - 6,632
Identifiable assets 307,620 782,802 (45,328) 1,045,094
Loans transferred to (from) (185,111) 185,111 - -
Intersegment income (expense) (4,153) 4,153 - -
</TABLE>
Revenues are comprised of net interest income (before the provision for credit
losses) and non-interest income. Non-interest expenses are fully allocated to
each segment. The intersegment income (expense) consists of interest expense
incurred or charged by the mortgage banking segment on intersegment borrowing.
NOTE 17 - EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominator of the basic
and diluted earnings per share calculation for the year ended December 31, 1997
(in thousands):
<TABLE>
<CAPTION>
EARNINGS SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------- --------------- -----------
<S> <C> <C> <C>
Basic earnings $21,772 12,837 $1.70
Effect of options - 103 -
------------- --------------- -----------
Diluted earnings $21,772 12,940 $1.68
============= =============== ===========
</TABLE>
The weighted average shares outstanding for computing earnings per share in 1996
and 1995 was 11,250,000 and 11,274,047, respectively. Because there were no
options outstanding in 1996 and 1995, basic and diluted earnings per share were
identical each year.
57
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 18 - INITIAL PUBLIC OFFERING
STOCK OFFERING
The Company completed an initial public offering in May 1997 of 5,500,000 shares
of common stock; including 2,800,000 shares being sold by the shareholders of
Flagstar. Such sale resulted in proceeds to the Company of $27.2 million.
NOTE 19 - STOCK OPTION AND PURCHASE PLANS, AND OTHER COMPENSATION PLANS
In 1997, Flagstar 's Board of Directors adopted resolutions to implement various
stock option and purchase plans and deferred and incentive compensation plans
effective upon the completion of the common stock offering.
STOCK OPTION PLAN
The purpose of the Stock Option Plan ("Option Plan") is to provide an additional
incentive to directors and employees by facilitating their purchase of Common
Stock. The Option Plan has a term of 10 years from the date of its approval in
April 1997, after which no awards may be made. Pursuant to the Option Plan,
1,148,458 shares were issued on May 5, 1997. An additional 218,542 shares have
been reserved for future issuance by the Company.
The Option Plan is accounted for in accordance with the provisions of APB
No. 25, "Accounting for Stock Issued to Employees" and the Company has adopted
the disclosure requirements of SFAS No. 123.
No compensation has been recognized for the plan. Had compensation costs for
the plan been determined based on the fair value of the options at the grant
date consistent with the method of SFAS No. 123, the Company's earnings per
share for the year ended December 31, 1997 would have been as follows (in
thousands, except per share data):
<TABLE>
<CAPTION>
Basic earnings Diluted earnings
Net Income per share per share
<S> <C> <C> <C>
As reported $21,772 $1.70 $1.68
Pro forma $19,299 $1.50 $1.49
</TABLE>
The fair value of each option grant is estimated using the Black-Scholes
options-pricing model with the following weighted average assumptions used for
grants in 1997: dividend yield of 2%; expected volatility of 39.00%; risk free
rate of 7.00%; and expected lives of 6.0 years.
STOCK PURCHASE PLAN
Under the Employee Stock Purchase Plan ("Purchase Plan"), eligible participants,
upon providing evidence of a purchase of Flagstar's common shares from any third
party on the open market, would receive a payment from Flagstar equal to 15% of
the share price. The Purchase Plan includes limitations on the maximum
reimbursement to a participant during a year. The Purchase Plan has not been
designed to comply with the requirements of the Internal Revenue Code with
respect to employee stock purchase plans.
58
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 19 - STOCK OPTION AND PURCHASE PLANS, AND OTHER COMPENSATION PLANS
(CONTINUED)
INCENTIVE COMPENSATION PLAN
The Incentive Compensation Plan ("Incentive Plan") is administered by a
committee which decides from year to year which employees of Flagstar will be
eligible to participate in the Incentive Plan and the size of the bonus pool.
DEFERRED COMPENSATION PLAN
The Deferred Compensation Plan allows employees to defer up to 25% of their
annual compensation and directors to defer all of their compensation. Funds
deferred remain the property of Flagstar and are placed in a trust.
Participants may direct that their deferred amounts be invested in stock of
Flagstar. Upon withdrawal, the participant has the option of receiving the
stock or the proceeds of its sale at the market price at the time of withdrawal.
NOTE 20 - QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table represents summarized data for each of the quarters in
1997 and 1996 (in thousands except earnings per share data).
<TABLE>
<CAPTION>
1997 1996
FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income.................. $37,965 $30,711 $28,085 $25,991 $18,500 $18,603 $19,558 $19,518
Interest expense................. 25,437 21,012 18,338 15,246 11,846 10,579 11,820 11,722
-----------------------------------------------------------------------------------
Net interest income.............. 12,528 9,699 9,747 10,745 6,654 8,024 7,738 7,796
Provision for losses............. 1,261 1,416 1,676 662 1,464 488 344 308
-----------------------------------------------------------------------------------
Net interest income after
provision for losses............ 11,267 8,283 8,071 10,083 5,190 7,536 7,394 7,488
Non-interest income.............. 16,109 15,266 15,875 12,586 16,700 8,936 24,514 8,384
Non-interest expense............. 17,284 13,822 15,833 15,565 12,326 19,460 14,554 12,480
-----------------------------------------------------------------------------------
Earnings (loss) before
income taxes.................... 10,092 9,727 8,113 7,104 9,564 (2,988) 17,354 3,392
Provision for federal
income taxes.................... 4,176 3,533 2,973 2,583 3,881 (949) 6,225 1,142
-----------------------------------------------------------------------------------
Net earnings (loss).............. $ 5,916 $ 6,194 $ 5,141 $ 4,521 $ 5,683 $(2,039) $11,129 $ 2,250
===================================================================================
Basic earnings (loss) per share $ 0.45 $ 0.45 $ 0.40 $ 0.40 $ 0.50 $ (0.18) $ 0.99 $ 0.20
===================================================================================
Diluted earnings (loss) per share $ 0.44 $ 0.44 $ 0.40 $ 0.40 $ 0.50 $ (0.18) $ 0.99 $ 0.20
===================================================================================
</TABLE>
59
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 20--HOLDING COMPANY ONLY FINANCIAL STATEMENTS
The following are unconsolidated financial statements for the Company. These
condensed financial statements should be read in conjunction with the
Consolidated Financial Statements and Notes thereto (in thousands).
FLAGSTAR BANCORP, INC.
CONDENSED UNCONSOLIDATED STATEMENTS OF FINANCIAL POSITION
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
-------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents............................ $ 98 $ 122
Investment in subsidiaries........................... 126,493 78,308
Other assets......................................... 37 38
-------------------------
Total assets...................................... $126,628 $78,468
=========================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Other liabilities.................................... $ 11 $ --
-------------------------
Total liabilities................................. 11 --
STOCKHOLDERS' EQUITY
Common stock......................................... 137 112
Additional paid in capital........................... 29,988 2,816
Retained earnings.................................... 96,492 75,540
-------------------------
Total stockholders' equity........................ 126,617 78,468
-------------------------
Total liabilities and stockholders' equity........ $126,628 $78,468
=========================
</TABLE>
FLAGSTAR BANCORP, INC.
CONDENSED UNCONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
----------------------------------
<S> <C> <C> <C>
Income
Dividends from subsidiaries............................. $ 690 $ 1,000 $ 2,450
Expenses
General and administrative.............................. 104 8 13
----------------------------------
Earnings before undistributed earnings of subsidiaries..... 586 992 2,437
Equity in undistributed earnings of subsidiaries........... 21,186 16,031 13,039
----------------------------------
Net earnings............................................... $21,772 $17,023 $15,476
==================================
</TABLE>
60
<PAGE>
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 20--HOLDING COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
FLAGSTAR BANCORP, INC.
CONDENSED UNCONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net earnings....................................................... $ 21,772 $ 17,023 $ 15,476
Adjustments to reconcile net earnings to net cash provided by
operating activities
Equity in undistributed earnings................................ (21,186) (15,982) (13,004)
Change in other assets.......................................... 1 38 (21)
Change in other liabilities..................................... 11 (1) 1
Change in unrealized gains...................................... -- -- --
------------------------------------------------
Net cash provided by operating activities.................... 598 1,078 2,452
INVESTING ACTIVITIES
Net increase in investment in subsidiaries (26,999) -- --
------------------------------------------------
Net cash used in investment activities....................... (26,999) -- --
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid..................................................... (820) (1,000) (2,000)
Additional capital provided by initial public offering 27,197 -- --
Stock repurchase................................................... -- -- (450)
------------------------------------------------
Net cash provided by financing activities.................... 26,377 (1,000) (2,450)
Net (decrease) increase in cash and cash equivalents............... (24) 78 2
Cash and cash equivalents at beginning of period................... 122 44 42
------------------------------------------------
Cash and cash equivalents at end of period......................... $ 98 $ 122 $ 44
================================================
</TABLE>
61
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS:
The directors of the Company are as follows:
<TABLE>
<CAPTION>
Current
Director Term
Name Age Position(s) Held with Company Since Expires
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
James D. Coleman 50 Director 1993 2000
Richard S. Elsea 68 Director 1997 2000
C. Michael Kojaian 36 Director 1997 1999
James D. Isbister 60 Director 1997 1998
Mark T. Hammond 32 Vice Chairman of the Board and President 1993 1998
Thomas J. Hammond 54 Chairman of the Board and Chief Executive Officer 1993 1999
Michael W. Carrie 43 Executive Vice President, Chief Financial Officer and Director 1997 2000
Joan H. Anderson 47 Executive Vice President and Director 1997 1999
John Kersten 55 Director 1997 1998
</TABLE>
The directors of the Bank are as follows:
<TABLE>
<CAPTION>
Current
Director Term
Name Age Position(s) Held with Bank Since Expires
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Ronald I. Nichols Sr. 63 Director 1988 2000
William B. Bortels 63 Director 1991 1998
Mary Kay McGuire 41 Senior Vice President, Secretary and Director 1987 2000
Harry S. Ellman 50 Director 1990 1999
Thomas J. Hammond 54 Chairman of the Board and Chief Executive Officer 1987 1999
Mark T. Hammond 32 Vice Chairman of the Board and President 1991 1998
Charles Bazzy 68 Director 1988 1998
</TABLE>
The following sets forth the business experience and other information for each
of the current directors of the Company and the Bank:
COMPANY DIRECTORS
THOMAS J. HAMMOND has served as Chairman of the Board of Directors and Chief
Executive Officer since its formation in 1987.
MARK T. HAMMOND has been Vice-Chairman of the Board of Directors since 1993 and
President since December 1995. Mr. Hammond is the son of Thomas J. Hammond, the
Chairman and Chief Executive Officer.
JOAN H. ANDERSON has been a Director since 1987 and an Executive Vice President
since 1988.
62
<PAGE>
DIRECTORS (CONT'D)
MICHAEL W. CARRIE has served as a Director since 1997, an Executive Vice
President since 1995 and Chief Financial Officer since 1993.
RICHARD S. ELSEA has served as a Director since 1997. He is President and Owner
of Real Estate One, which is Michigan's largest real estate brokerage company.
JAMES D. ISBISTER has served as a Director since 1997. He is the Vice Chairman
of Shire Laboratories. Mr. Isbister is the father-in-law of Mark T. Hammond.
JOHN KERSTEN has served as a Director since 1997. He owns and is President of
Century 21 Town and Country Real Estate since 1980.
C. MICHAEL KOJAIAN has served as a Director since 1997. He serves as President
and a Director of the Kojaian Companies, a real estate development and asset
management organization.
DR. JAMES D. COLEMAN has been a Director since 1993. He also serves as Vice-
Chief of the Foundation Board of Directors of Oakwood Hospital located in
Dearborn, Michigan.
BANK DIRECTORS
CHARLES BAZZY has served as a Director since 1988. He is retired from Ford Motor
Company where he served as a planning and development manager for 33 years.
WILLIAM B. BORTELS has been a Director since 1991. He has been a self-employed
single-family home builder in Brighton, Michigan since 1964.
MARY KAY MCGUIRE has been a Director and Secretary since 1987 and Senior Vice
President since 1994.
HARRY S. ELLMAN has served as a Director since 1990. He has been a title
insurance agent and attorney with Fidelity Title Co. located in Bingham Farms,
Michigan since 1987.
RONALD I. NICHOLS, SR. has served as a Director since 1988. He has been
President of Nichols Sales Associates, Inc., located in Bloomfield Hills,
Michigan since 1969.
63
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
DIRECTOR COMPENSATION
Directors of the Company who are not employees of the Company or the Bank
("Outside Directors") are currently paid a monthly fee of $1,200 for attendance
at each Board meeting. Outside Directors are also reimbursed for reasonable
travel expense incurred in connection with Board and committee meetings.
EXECUTIVE COMPENSATION
The following tables sets forth information with respect to the compensation
paid or accrued by Flagstar or the Bank during the last three years ended
December 31, 1997, to or on behalf of each executive officer of the Company
including the Chief Executive Officer (the "Named Officers"), in all capacities
in which they served:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long - Term
Annual Compensation Compensation
---------------------------------------------------- -------------
Other Other
Incentive Annual Annual Stock
Name and Principal Position(s) Year Salary($) Compensation($) $(1) (2) Options (3)
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Thomas J. Hammond 1997 $ 733,333 $1,000,000 $32,400 $36,560 400,000 shs.
Chairman and 1996 1,000,000 780,000 31,280 31,600
Chief Executive Officer 1995 529,600 723,345 43,457 26,640
Mark T. Hammond 1997 405,002 250,000 36,936 7,807 250,000 shs.
Vice Chairman and 1996 405,002 -- 30,219 5,799
President 1995 298,369 -- 41,168 3,791
Michael W. Carrie 1997 205,076 226,000 24,304 9,600 65,000 shs.
Director, Executive Vice President 1996 194,314 -- 23,068 7,200
and Chief Financial Officer 1995 160,640 -- 22,142 4,800
Joan H. Anderson 1997 156,838 -- 29,280 10,800 45,000 shs.
Director and Executive Vice 1996 149,450 -- 28,980 8,400
President 1995 137,169 -- 28,967 6,000
</TABLE>
1) Includes board fees, holiday bonuses, and 401k matching contributions.
2) Includes the value of the contribution made by the Company on behalf of the
officer for life insurance premiums.
3) Stock options were issued to the named officer at the time of the initial
public offering. The options have a two year vesting period and are priced
at $13 per share.
64
<PAGE>
STOCK OPTIONS
The following table contains information concerning the grant of stock options
under the Company's Option Plan to the persons named in the Summary Compensation
Table set forth above.
<TABLE>
<CAPTION>
Number of Percent of Total
Securities Options Granted
Underlying to Employees in Exercise Price Expiration Grant Date
Options Granted(a) Current Year ($ per share) Date Present Value(b)
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Thomas J. Hammond 400,000 36.1% $13.00 May 5, 2004 $1,388,000
Mark T. Hammond 250,000 22.6 13.00 May 5, 2004 867,500
Michael W. Carrie 65,000 5.9 13.00 May 5, 2004 225,550
Joan H. Anderson 45,000 4.1 13.00 May 5, 2004 156,150
</TABLE>
(a) Options granted under the Option Plan are incentive stock options with an
exercise price equal to the fair market value at the time of issuance. The
options in the above table vest on May 5, 1999.
(b) Represents the present value of the option at the date of grant as
determined using the Black-Scholes option pricing model. In calculating
the present value of the option grant, the following assumptions were
utilized: (i) the current market price of the underlying Common Stock at
the date of grant was $2.25; (ii) the continuously compounded risk-free
rate of return expressed on an annual basis was 7.00%; (iii) expected
volatility of the underlying Common Stock was 39.0%; and (iv) dividends on
the underlying Common Stock increased at an annual rate of 2.00%. These
assumptions are used for illustrative purposes only. No assurance can be
given that actual experience will correspond to the assumptions utilized.
The following table sets forth information concerning the value of options held
by the named executive officers at the end of the fiscal year.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options at
Shares Acquired Value Options at Year End Year End (a)
Name on Exercise (#) Realized ($) (Exercised / Unexercised) (Exercised / Unexercised)
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Thomas J. Hammond - - - / 400,000 - / 2,720,000
Mark T. Hammond - - - / 250,000 - / 1,700,000
Michael W. Carrie - - - / 65,000 - / 442,000
Joan H. Anderson - - - / 45,000 - / 306,000
</TABLE>
(a) Represents the difference between fair market value of underlying Common
Stock at year-end (based on the last reported sales price on December 31,
1997) and the exercise price. Options are in-the-money if the fair market
value of the underlying securities exceeds the exercise price of the Option
and out-of-the-money if the exercise price of unexercisable options exceeds
current fair market value.
No stock options were granted to the Named Officers in 1997, other than those
distributed in conjuction with the IPO.
65
<PAGE>
EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT ARRANGEMENTS
The Bank and the Company entered into separate employment agreements pursuant to
which Thomas J. Hammond will serve as Chief Executive Officer and Mark T.
Hammond will serve as President. In such capacities, Messrs. Hammond and Hammond
are responsible for overseeing all operations of the Bank and the Company, and
for implementing the policies adopted by the Board of Directors. In addition,
the Bank and the Company entered into separate employment agreements with Mr.
Carrie in his capacity as Executive Vice President and Chief Financial Officer
and Ms. Anderson in her capacity as Executive Vice President. All such
employment agreements are referred to herein collectively as "Employment
Agreements" and all persons who have entered into such Employment Agreements are
referred to herein as "Employees."
The Board of Directors of the Bank and the Company each believe that the
Employment Agreements assure fair treatment of the Employees in relation to
their career providing them with a limited form of financial security while
committing such persons to future employment for the term of their respective
agreements. In the event that any Employee prevails over the Bank and the
Company in a legal dispute as to an Employment Agreement, he or she will be
reimbursed for his or her legal and other expenses.
The terms of the agreements are three years for Messrs. Hammond, Hammond and
Carrie and Ms. Anderson. The agreements provide for an annual base salary. On
each anniversary date from the date of commencement of the Employment
Agreements, the term of the Employee's employment under the Employment
Agreements will be extended for an additional one-year period beyond the then
effective expiration date, upon a determination by the Board of Directors that
the performance of the Employee has met the required performance standards and
that such Employment Agreements should be extended. The Employment Agreements
provide the Employee with a salary review by the Board of Directors not less
often than annually, as well as with inclusion in any discretionary bonus plans,
retirement and medical plans, customary fringe benefits, vacation, and sick
leave.
The Employment Agreements terminate upon the Employee's death or disability, and
are terminable by the Bank for "just cause" as defined in the Employment
Agreements. In the event of termination for just cause, no severance benefits
are available. If the Bank terminates the Employee without just cause, the
Employee will be entitled to a continuation of his or her salary and benefits
from the date of termination through the remaining term of such Employee's
Employment Agreement, plus an additional 12-month period, and, at the Employee's
election, either cash in an amount equal to the cost to the Employee of
obtaining health, life, disability, and other benefits which the Employee would
have been eligible to participate in through the Employment Agreement's
expiration date or continued participation in such benefit plans through the
agreement's expiration date, provided the Employee continued to qualify for
participation therein. If the Employment Agreements are terminated due to the
Employee's "disability" (as defined in the Employment Agreements), the Employee
will be entitled to a continuation of his or her salary and benefits for up to
180 days following such termination. In the event of the Employee's death during
the term of the Employment Agreement, his or her estate will be entitled to
receive his or her salary through the last day of the calendar month in which
the Employee's death occurred. The Employee is able to terminate voluntarily his
or her Employment Agreement by providing 90 days' written notice to the Board of
Directors, in which case the Employee is entitled to receive only his
compensation, vested rights and benefits up to the date of termination.
66
<PAGE>
EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT ARRANGEMENTS (CONT'D)
The Employment Agreements contain provisions stating that in the event of the
Employee's involuntary termination of employment in connection with, or within
one year after, any change in control of the Bank or the Company, other than for
"just cause," the Employee will be paid within 10 days of such termination an
amount equal to the difference between (i) 2.99 times his or her "base amount,"
as defined in Section 280G(b)(3) of the Code, and (ii) the sum of any other
parachute payments, as defined under Section 280G(b)(2) of the Code, that the
Employee receives on account of the change in control. "Control" generally
refers to the acquisition, by any person or entity, of the ownership or power to
vote more than 50% of the Bank's or Flagstar's voting stock, the control of the
election of a majority of the Bank's or Flagstar's directors, or the exercise of
a controlling influence over the management or policies of the Bank or Flagstar.
In addition, under the Employment Agreements, a change in control occurs when,
during any consecutive two-year period, directors of the Bank or Flagstar at the
beginning of such period cease to constitute at least a majority of the Board of
Directors of the Bank or Flagstar. The amount determined using the forgoing
formula would also be paid (a) in the event of an Employee's involuntary
termination of employment within 30 days following a change in control, or
(b) in the event of the Employee's voluntary termination of employment within
one year following a change in control, upon the occurrence, or within 90 days
thereafter, of certain specified events following the change in control, which
have not been consented to in writing by the Employee, including (i) the
requirement that the Employee perform his or her principal executive functions
more than 50 miles from his or her primary office, (ii) a reduction in the
Employee's base compensation as then in effect, (iii) the failure of Flagstar or
the Bank to continue to provide the Employee with contractual compensation and
benefits, including material vacation, fringe benefits, stock option and
retirement plans, (iv) the assignment to the Employee of duties and
responsibilities which are other than those normally associated with his or her
position with the Bank and Flagstar, (v) a material reduction in the Employee's
authority and responsibility, and (vi) in the case of an employee who is also a
director, the failure to re-elect the Employee to Flagstar's or the Bank's Board
of Directors. The aggregate payments that would be made to Messrs. Thomas J.
Hammond, Mark T. Hammond and Carrie and Ms. Anderson, assuming termination of
employment, other than for just cause, within one year of the change in control
at January 1, 1998, would be approximately as follows: Mr. Thomas J. Hammond --
$3,283,000; Mr. Mark T. Hammond -- $1,025,000; Mr. Carrie -- $648,000; Mrs.
Anderson -- $481,000.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
PRINCIPAL SHAREHOLDERS
The following table sets forth certain information, as of December 31, 1997,
with respect to the only persons known by the Company to have filed a beneficial
ownership report with the SEC pursuant to Section 13(d) of the Securities
Exchange Act of 1934 (the "Exchange Act") with respect to 5% or more of the
Company's outstanding Common Stock.
<TABLE>
<CAPTION>
Amount
of Beneficial Percent
Name of Beneficial Owner Ownership of Class
- ---------------------------------------------------------------
<S> <C> <C>
Thomas J. Hammond 5,207,245(1) 38.6%
Mark T. Hammond 971,451(1) 7.1%
Janet G. Hammond 5,207,245(1) 38.6%
Catherine H. Rondeau 972,600(1) 7.1%
Carrie C. Langdon. 966,955(1) 7.1%
</TABLE>
(1) Includes stock owned by the respective shareholder's spouse.
67
<PAGE>
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth information as to Common Stock beneficially
owned, as of the Record Date, by directors and executive officers of the
Company, and by the directors and executive officers as a group.
<TABLE>
<CAPTION>
Number
of Percent
Name Shares (1) of Class
- ----------------------------------------------- ---------------- -----------
<S> <C> <C>
C. Michael Kojaian 75,000 *
Michael W. Carrie 7,692 *
John D. Kersten 3,800 *
James D. Isbister 1,500 *
Richard S. Elsea - *
Joan H. Anderson 250 *
Ronald I. Nichols, Sr. - *
Thomas J. Hammond 4,307,332(2) 31.5%
Mark T. Hammond 971,451 7.1%
Mary Kay McGuire 1,000 *
William B. Bortels - *
James D. Coleman 61,000 *
Harry S. Ellman 1,000 *
Charles Bazzy 3,000 *
All directors and executive officers as a group
(13 persons) 5,448,844 39.9%
</TABLE>
* Less than 0.1%
(1) Based on information provided by the respective directors and executive
officers. Unless otherwise indicated, the amounts shown include shares
owned jointly with family members with whom the person shares voting and
dispositive powers, or as custodian or trustee over which shares the person
effectively exercises voting and dispositive powers. These amounts also
include certain shares held in the person's Savings and Investment Plan
(the "Plan") account, as of December 31, 1997, with respect to which the
person has sole dispositive power and a right to vote. However, the Trustee
under the Plan may vote the shares, in accordance with a formula set forth
in the Plan, if the Plan participant does not vote the shares.
(2) Does not include 962,913 shares of Common Stock held by Mr. Hammond's wife,
Janet G. Hammond, and as to which Mr. Hammond disclaims beneficial
ownership.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
CERTAIN TRANSACTIONS
Flagstar has a policy of making mortgage and consumer loans to its employees,
officers and directors. These loans are made in the ordinary course of business
and do not involve more than the normal risk of collectibility or present other
unfavorable features. These loans are made on substantially the same terms as
those prevailing at the time for comparable transactions with members of the
general public.
Flagstar offers all officers and employees, except the Company's executive
officers, mortgage loans at prevailing market rates, and maintains a policy of
waiving a portion of the application and closing fees. Currently, executive
officers are eligible to receive loans only at the rates and on the terms as are
made available by the Bank to the general public.
68
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
(a) The following documents are filed as a part of this report:
1. The following consolidated financial statements of the Company are
included this Form 10-K under Item 8:
Management's Report
Independent Auditors' Report
Consolidated Statements of Financial Condition - December 31, 1997 and
1996
Consolidated Statements of Earnings - Years Ended December 31, 1997,
1996, and 1995
Consolidated Statements of Cash Flows - Years Ended December 31, 1997,
1996, and 1996
Consolidated Statements of Stockholders' Equity - Years Ended
December 31, 1997, 1996, and 1995
Notes to Consolidated Financial Statements
2. All of the schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
either not required under the related instructions, the required
information is contained elsewhere in this Form 10-K, or the schedules
are inapplicable and, therefore, have been omitted.
3. The following exhibits are required to be filed with this report by
Item 14(c):
3.1 Restated Articles of Incorporation of the Company (previously filed as
Exhibit 3.1 to the Company's Form S-1
Registration Statement and incorporated herein by reference).
4.1 Specimen Common Stock Certificate (previously filed as Exhibit 4 to the
Company's Form S-1 Registration Statement and incorporated herein
by reference).
10.1* Form of Employment Agreements separately entered into between
Flagstar Bank and each of Messrs. Thomas Hammond, Mark Hammond, and
Carrie and Ms Anderson (previously filed as Exhibit 10.4 to the
Company's Form S-1 Registration Statement and incorporated herein by
reference).
10.2* First Amended Employee Stock Option and Appreciation Rights Plan of
Flagstar Bank, as amended and restated (previously filed as Exhibit
10.5 to the Company's Form S-1 Registration Statement and incorporated
herein by reference).
10.3* Deferred Compensation Plan of Flagstar Bank (previously filed as Exhibit
10.7 to the Company's Form S-1 Registration Statement and incorporated
herein by reference).
21. Subsidiaries of the Registrant (filed herewith).
23. Consent of Grant Thornton LLP (filed herewith).
27. Financial Data Schedule (Edgar filing only).
* Denotes management contract, a compensatory arrangement required to be filed
as an exhibit in which Company's executive officers participate.
Flagstar Bancorp, Inc., will furnish to any stockholder a copy of any of the
exhibits listed above upon written request and upon payment of a specified
reasonable fee, which fee shall be equal to the Company's reasonable expenses in
furnishing the exhibit to the stockholder. Requests for exhibits and information
regarding the applicable fee should be directed to: Michael W. Carrie, Executive
Vice President, at the address of the principal executive offices set forth on
the cover of this Report on Form 10-K.
69
<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, on March 24, 1998.
FLAGSTAR BANCORP, INC.
By: /s/ THOMAS J. HAMMOND
---------------------------
Thomas J. Hammond
Chairman of the Board
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on March 24, 1998.
<TABLE>
<CAPTION>
SIGNATURE TITLE
<S> <C>
By: /s/ THOMAS J. HAMMOND Chairman of the Board
----------------------------- and Chief Executive Officer
Thomas J. Hammond
By: /s/ MARK T. HAMMOND Vice Chairman of the Board
----------------------------- and President
Mark T. Hammond
By: /s/ MICHAEL W. CARRIE Director, Executive Vice President and
----------------------------- Chief Financial Officer
Michael W. Carrie (Principal Financial and
Accounting Officer)
By: /s/ JOAN H. ANDERSON Executive Vice President
----------------------------- and Director
Joan H. Anderson
By: /s/ JAMES D. COLEMAN Director
-----------------------------
James D. Coleman
By: /s/ RICHARD S. ELSEA. Director
-----------------------------
Richard S. Elsea
By: /s/ C. MICHAEL KOJAIAN Director
-----------------------------
C. Michael Kojaian
By: /s/ JAMES D. ISBISTER Director
-----------------------------
James D. Isbister
By: /s/ JOHN R. KERSTEN Director
-----------------------------
John R. Kersten
</TABLE>
70
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<S> <C>
1 The following consolidated financial statements of the Company are
included in this Form 10-K under Item 8:
Management's Report
Independent Auditors' Report
Consolidated Statements of Financial Condition -
December 31, 1997 and 1996
Consolidated Statements of Earnings - Years Ended December 31,
1997, 1996, and 1995
Consolidated Statements of Cash Flows - Years Ended
December 31, 1997, 1996, and 1996
Consolidated Statements of Stockholders' Equity - Years Ended
December 31, 1997, 1996, and 1995
Notes to Consolidated Financial Statements
2. All of the schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission
are either not required under the related instructions, the
required information is contained elsewhere in this Form 10-K, or
the schedules are inapplicable and, therefore, have been omitted.
3. The following exhibits are required to be filed with this report
by Item 14(c):
3.1 Restated Articles of Incorporation of the Company (previously
filed as Exhibit 3.1 to the Company's Form S-1 Registration
Statement and incorporated herein by reference).
4.1 Specimen Common Stock Certificate (previously filed as Exhibit 4
to the Company's Form S-1 Registration Statement and
incorporated herein by reference).
10.1* Form of Employment Agreements separately entered into between
Flagstar Bank and each of Messrs. Thomas Hammond, Mark Hammond,
and Carrie and Ms Anderson (previously filed as Exhibit 10.4 to
the Company's Form S-1 Registration Statement and incorporated
herein by reference).
10.2* First Amended Employee Stock Option and Appreciation Rights Plan
of Flagstar Bank, as amended and restated (previously filed as
Exhibit 10.5 to the Company's Form S-1 Registration Statement and
incorporated herein by reference).
10.3* Deferred Compensation Plan of Flagstar Bank (previously filed as
Exhibit 10.7 to the Company's Form S-1 Registration Statement and
incorporated herein by reference).
21. Subsidiaries of the Registrant (filed herewith).
23. Consent of Grant Thornton LLP (filed herewith).
27. Financial Data Schedule (Edgar filing only).
</TABLE>
* Denotes management contract, a compensatory arrangement required to be filed
as an exhibit in which Company's executive officers participate.
71
<PAGE>
EXHIBIT 21
Subsidiaries of the Registrant
PARENT
- ------
Flagstar Bancorp, Inc.
STATE OR OTHER
JURISDICTION OF PERCENTAGE
SUBSIDIARIES INCORPORATION OWNERSHIP
- ------------ --------------- ----------
Flagstar Bank, FSB United States 100%
Douglas Insurance Agency, Inc. Michigan 100%
FSSB Real Estate Development Corporation Michigan 100%
Mortgage Video Network, Inc. Michigan 100%
First Security Investment Group, Inc. Michigan 100%
SUBSIDIARIES OF FLAGSTAR BANK, FSB
- ----------------------------------
FSSB Mortgage Corporation Michigan 100%
Boston Credit Corporation Michigan 100%
Mortgage Affiliated Services, Inc. Michigan 100%
Mid-Michigan Service Corporation Michigan 100%
SSB Funding Corporation Michigan 100%
Flagstar Capital Corporation Michigan 100% (a)
Flagstar Credit Corporation Michigan 100%
- --------------
(a) Common stock ownership only Nonvoting Preferred Stock is publicly held.
<PAGE>
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference into the Flagstar Bancorp, Inc.
Registration Statement on Forms S-8 of our report dated February 27, 1998,
appearing in this Annual Report on Form 10-K of Flagstar Bancorp, Inc. for the
year ended December 31, 1997.
/s/ Grant Thornton LLP
Detroit, Michigan
March 24, 1998
1
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-END> JAN-01-1997 JAN-01-1996
<CASH> 21,928 44,187
<INT-BEARING-DEPOSITS> 0 0
<FED-FUNDS-SOLD> 0 0
<TRADING-ASSETS> 0 0
<INVESTMENTS-HELD-FOR-SALE> 0 0
<INVESTMENTS-CARRYING> 0 0
<INVESTMENTS-MARKET> 0 0
<LOANS> 1,660,259 1,114,336
<ALLOWANCE> 5,500 3,500
<TOTAL-ASSETS> 1,901,084 1,297,226
<DEPOSITS> 1,109,933 624,485
<SHORT-TERM> 482,378 389,801
<LIABILITIES-OTHER> 182,156 204,472
<LONG-TERM> 0 0
0 0
0 0
<COMMON> 137 112
<OTHER-SE> 126,480 78,356
<TOTAL-LIABILITIES-AND-EQUITY> 1,901,084 1,297,226
<INTEREST-LOAN> 120,214 74,588
<INTEREST-INVEST> 0 0
<INTEREST-OTHER> 2,538 1,591
<INTEREST-TOTAL> 122,752 76,179
<INTEREST-DEPOSIT> 50,143 30,431
<INTEREST-EXPENSE> 80,033 45,967
<INTEREST-INCOME-NET> 42,719 30,212
<LOAN-LOSSES> 5,015 2,604
<SECURITIES-GAINS> 0 0
<EXPENSE-OTHER> 62,503 58,820
<INCOME-PRETAX> 35,037 27,322
<INCOME-PRE-EXTRAORDINARY> 21,772 17,023
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 21,772 17,023
<EPS-PRIMARY> 1.70 1.51
<EPS-DILUTED> 1.68 1.51
<YIELD-ACTUAL> 2.74 3.07
<LOANS-NON> 44,329 30,621
<LOANS-PAST> 0 0
<LOANS-TROUBLED> 0 0
<LOANS-PROBLEM> 0 0
<ALLOWANCE-OPEN> 3,500 2,102
<CHARGE-OFFS> 3,015 1,206
<RECOVERIES> 0 0
<ALLOWANCE-CLOSE> 5,500 3,500
<ALLOWANCE-DOMESTIC> 0 0
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 5,500 3,500
</TABLE>
