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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM
--------------- TO
---------------
COMMISSION FILE NUMBER 1-12889
LONG BEACH FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C>
DELAWARE 33-0739843
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
1100 TOWN & COUNTRY ROAD, SUITE 1650, ORANGE, CALIFORNIA 92868
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE)
(714) 835-5743
(REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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<S> <C>
COMMON STOCK, PAR VALUE $0.001 NASDAQ NATIONAL MARKET
PREFERRED STOCK PURCHASE RIGHTS NASDAQ NATIONAL MARKET
</TABLE>
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ].
The aggregate market value of the voting stock held by non-affiliates of
Registrant, as of March 15, 1998, was $321,667,000, based upon the closing price
of Registrant's Common Stock on that date. For purposes of this disclosure,
shares of common stock held by directors and executive officers of Registrant
are assumed to be "held by affiliates"; this assumption is not to be deemed to
be an admission by such persons that they are affiliates of Registrant.
As of March 15, 1998, Registrant had outstanding 24,407,318 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement relating to its 1998 Annual
Meeting of Stockholders are incorporated by reference into Part III of this
report.
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LONG BEACH FINANCIAL CORPORATION
TABLE OF CONTENTS
TO FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997
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PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 21
Item 3. Legal Proceedings........................................... 21
Item 4. Submission of Matters to a Vote of Security Holders......... 22
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 22
Item 6. Selected Financial Data..................................... 23
Item 7. Management's Discussion and Analysis of Financial Condition,
Results of Operations, Liquidity and Capital Resources...... 24
Item 8. Financial Statements and Supplementary Data................. 34
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 34
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 34
Item 11. Executive Compensation...................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 34
Item 13. Certain Relationships and Related Transactions.............. 34
PART IV
Item 14. Financial Statement Schedules, Exhibits, and Reports of Form
8-K......................................................... 35
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LONG BEACH FINANCIAL CORPORATION
PART I
ITEM 1. BUSINESS
GENERAL
Long Beach Financial Corporation ("LBFC"), through its subsidiary, Long
Beach Mortgage Company (collectively, the "Company"), is a specialty finance
company engaged in the business of originating, purchasing and selling subprime
residential mortgage loans secured by one-to-four family residences. The
Company's core borrower base consists of individuals who do not qualify for
traditional "A" credit because their credit histories, debt to income ratios or
other factors cause them not to conform to standard agency lending criteria. The
Company's primary operating strategy is to originate, purchase and sell loans on
a basis that exposes the Company to less default and prepayment risk than is
normally inherent in a mortgage lender's business. A key element in this
strategy is the Company's sales of its loans for cash to institutional
purchasers at a premium above the outstanding principal balance of the loans. As
a result, the Company has historically generated positive cash flow and
substantially reduced the risk of holding residual interests in the loans sold
by the Company.
The Company sources loans through approximately 10,000 independent mortgage
loan brokers approved by the Company and located in 48 states. The large number
of brokers reflects the Company's strategy of utilizing a large and diverse
group of small brokers to avoid becoming dependent on a few primary producers.
In 1997, the Company's single largest wholesale producing broker was responsible
for less than 1% of the Company's wholesale originations during the year. The
Company maintains a close working relationship with brokers through its sales
force of approximately 232 account executives located in 66 offices. Having
account executives geographically close to the independent brokers enables the
Company to deliver a high level of customer service to the brokers with whom the
Company does business. The primary elements of the Company's customer service
are actively assisting the broker in identifying the appropriate product for the
borrower, applying lending criteria in a consistent manner, promptly processing
loan applications and providing any other assistance that the broker may require
to complete the loan transaction. A high level of customer service, together
with the account executive's processing team's knowledge of the local market and
the Company's products, is a key part of the Company's origination strategy.
As a result, the Company has experienced significant growth in loan
originations, with approximately $1.7 billion of originations in 48 states
during calendar 1997 compared to approximately $1.1 billion in 43 states during
calendar 1996 and approximately $592.5 million in 35 states during calendar
1995. This growth in originations has resulted in the Company's net earnings
increasing to $24.6 million in 1997 compared to net earnings of $9.4 million and
$5.8 million in 1996 and 1995, respectively. See Corporate History for further
information regarding the Company's net earnings in 1997.
The Company follows a strategy of selling substantially all of its loan
originations in the secondary market through loan sales in which the Company
disposes of its entire economic interest in the loan (except for the related
servicing rights, which it has generally retained) for a cash price that
represents a premium over the principal balance of the loans sold. This
strategy, as opposed to selling or securitizing loans in a transaction in which
a residual interest is retained in future payments on the loans, provides the
Company with certain benefits. The Company receives cash revenue, thereby
avoiding the risk of having to adjust revenue in future periods should there be
lower realization on the residual interest because actual prepayments or
defaults exceeded the levels assumed at the time of securitization. By not
retaining a residual interest, the Company reduces its exposure to the default
risk (other than certain first payment defaults) and prepayment risk that are
normally inherent in a mortgage lender's business. The Company is required,
however, to make certain representations and warranties to the buyer regarding
such loans and could be required to repurchase or substitute loans in the event
of a breach of those representations and warranties. Cash from loan sales is
used by the Company to repay borrowings previously made under its warehouse
financing facility to fund the loans
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sold. These loan sales have been an important factor in generating the Company's
historic earnings and creating consistent positive cash flow to further its
operations.
Growth Strategy
The Company actively originated loans during 1997 in 139 of the
approximately 330 metropolitan statistical areas ("MSAs") in the United States
having populations in excess of 100,000 as compared to loan originations in 112
of these MSAs during 1996. The Company seeks to profitably expand its
broker-sourced business through increased penetration in its existing markets
and expansion into new geographic markets. Elements in achieving these
objectives include the following: (i) expanding the account executive network to
reach new brokers; (ii) increasing coordination between the Company's
centralized marketing efforts and the account executives in the field; (iii)
developing and implementing electronic broker support systems (including
electronic loan application submission and risk classification through the
Company's wide-area network); and (iv) expanding the automation of the
underwriting process in order to increase the number of loan applications
processed by each underwriter in a given day.
Another important step in this expansion is the commencement during the
fourth quarter of 1997 of direct-sourced loan origination activities (i.e.,
where the lender deals directly with the borrower rather than indirectly through
an independent broker), which provides the Company with an additional
origination channel for its products. In connection with the opening of its
first retail center in Orange County, California, the Company has recruited and
deployed management and staff for the operation, has tested its direct marketing
methodologies and systems, and has obtained or has taken steps to obtain
licenses in over 30 states. The Company has scheduled the opening of two
additional retail origination centers in the first half of 1998. The retail loan
operations will be conducted under the name "Financing USA" and will offer the
same products as those of the broker-sourced operations and will be sourced
primarily through technology-based, direct mail and electronic media marketing,
rather than on a network of branch sales offices. This strategy will enable the
Company to commence these operations more rapidly and with less overhead than a
direct-sourced loan business that operates through a branch sales office
network.
Corporate History
The Company's broker-sourced mortgage business was begun in 1988 by Long
Beach Savings and Loan Association (later known as Long Beach Bank, F.S.B.). In
order to gain greater operating flexibility and improve its ability to compete
against other financial services companies, Long Beach Bank, F.S.B. voluntarily
surrendered its federal thrift charter in October 1994 and transferred the
broker-sourced business, along with its direct-sourced business and loan
servicing operations, to "Long Beach Mortgage Company."
LBFC was incorporated in January 1997. At the time of incorporation, LBFC
was a wholly-owned subsidiary of a company now known as Ameriquest Mortgage
Company ("AMC"). AMC conducted its mortgage lending business through four
divisions: (i) the direct-sourced lending division, (ii) the broker-sourced
lending division, (iii) the automobile loan lending division, and (iv) the loan
servicing division. LBFC was formed to facilitate the public sale of AMC's
broker-sourced lending division. All references to the "Wholesale Division"
herein shall be deemed to include the operations of the broker-sourced lending
division of AMC prior to the Reorganization (defined below).
On April 28, 1997, LBFC's Registration Statement (No. 333-22013) on Form
S-1 under the Securities Act of 1933, as amended (the "Registration Statement"),
relating to the initial public offering of its common stock was declared
effective. The initial public offering of 22,504,000 shares of common stock
closed at a price of $6.50 per share on May 2, 1997. On May 14, 1997, the
underwriters, Friedman, Billings, Ramsey and Co., Inc. ("FBR"), purchased an
additional 2,496,000 shares of common stock at a price of $6.50 per share
following their exercise of the overallotment option, resulting in a total of
25,000,000 shares sold in the initial public offering (the "Offering") for a
total aggregate price of $162.5 million.
On May 2, 1997, immediately prior to the closing of the initial public sale
of LBFC's common stock, AMC reorganized its business operations (the
"Reorganization") by transferring certain assets (including furniture, leasehold
improvements and equipment) and personnel relating to the broker-sourced lending
and
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the loan sales divisions and approximately $40.0 million in cash (less
approximately $2.0 million in related expenses) to the Company in exchange for
24,999,999 shares of common stock. The assets transferred to the Company
included loans in process as of May 2, 1997, but did not include loans funded or
servicing rights with respect to loans funded prior to May 2, 1997. The rights
to loans which were originated by the Wholesale Division but remained unsold at
May 2, 1997 were retained by AMC (the "Retained Loans"). The costs relating to
the production of these loans were incurred and recorded by the Wholesale
Division and are included in the Company's consolidated results of operations
for 1997. These loans are included in loan production amounts reported for the
Company for the year ended December 31, 1997. Subsequent to the Reorganization,
the Company purchased the Retained Loans from AMC at the same price and at the
same time that the Company sold these loans to independent, third-party
purchasers. Because the gain from the sale of the Retained Loans was recorded
after the Reorganization, and because the Company's stockholders did not receive
any of the benefit of this gain, the Company did not include the gain from the
sale of the Retained Loans as part of the Company's net earnings in 1997. The
principal amount of the Retained Loans was approximately $33.8 million and the
after-tax gain from the sale of these loans was approximately $807,000. The
gains from the sale of the Retained Loans are not reflected either as income
from the Wholesale Division of AMC or as income from the Company.
Additionally, as part of the Reorganization, the Company acquired the
going-concern value of the existing and established approved customer base of
independent brokers and the sole right to the "Long Beach Mortgage Company"
name. The Company did not assume any liabilities of AMC other than certain
liabilities associated with equipment and property leases acquired by the
Company and accrued vacation and other employee benefits for personnel
transferred to the Company. The Reorganization has been accounted for in a
manner similar to a pooling of interests; therefore, the historical cost basis
of the assets and liabilities transferred to the Company was carried over from
the Wholesale Division.
The transfer of the assets and personnel described above by AMC to the
Company was treated for federal income tax purposes as a taxable sale of assets.
As a result, the tax basis of the assets transferred from AMC to the Company in
the Reorganization was increased to their fair market value (determined by
reference to the initial public offering price.) In general, Section 197 of the
Internal Revenue Code allows for the amortization over a 15-year period of
intangible assets (including goodwill and going concern value) acquired in a
transaction such as the Reorganization. The so-called "anti-churning rules set
forth in Section 197(f)(9) of the Internal Revenue Code, however, prohibit the
amortization of goodwill, going concern value and intangible assets, the useful
lives of which cannot be determined with reasonable accuracy where such assets
are transferred between related parties and the transferor held or used such
intangible assets at any time on or after July 25, 1991, and on or before August
10, 1993.
The Company believes that the anti-churning rules should not apply to any
intangible assets (whether goodwill, going concern value or otherwise)
transferred from AMC to the Company in the Reorganization. Because the IRS could
assert that the anti-churning rules apply to the Reorganization, the Company
will limit the value of the deferred tax asset that is recorded, solely for
financial accounting and reporting purposes, to the amount that would be
recorded assuming the application of the anti-churning rules. The Company, using
an independent third party, has appraised the value of certain intangible assets
transferred in the Reorganization that are of a type not subject to the
anti-churning rules -- i.e., assets that can be valued and to which the Company
can reasonably ascertain useful lives ("Amortizable Intangibles"). Based in part
upon such valuation, the Company recorded a $36.0 million net deferred tax asset
solely for financial accounting and reporting purposes. No assurance can be
given, however, that the IRS will not challenge the value of the Amortizable
Intangibles. If such a challenge were successful, the Company may be prevented
from realizing all or a portion of the future tax benefits reflected by the net
deferred tax asset. Any adjustment to the net deferred tax asset, arising from
IRS challenge or other ruling concerning the deductibility of the deferred tax
asset or the valuation of the Amortizable Intangibles, will be charged or
credited to additional paid in capital and will have no impact on earnings.
For income tax purposes, the Company is amortizing over a 15-year period
the intangible assets acquired from AMC in the Reorganization. Based upon
historical earnings levels it is probable that the Company will generate
sufficient taxable income to realize the benefits associated with the net
deferred tax asset through
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future tax deductions. As the Company realizes the benefits associated with the
deferred tax asset, there will be a corresponding reduction in income taxes
payable by the Company. The deferred tax benefit is realized through a reduction
in the current tax payable resulting in no effect on net income. If the Company
determines that estimated future earnings are not sufficient to realize the
deferred tax benefit, the Company will establish a valuation allowance for the
impairment of the deferred tax assets, through a charge to the income tax
provision, which will result in a reduction of net earnings.
As part of the Reorganization, the Company and AMC entered into several
agreements which include: (i) two administrative services agreements, (ii) a
loan sub-servicing agreement and (iii) a contribution agreement. Under the first
administrative services agreement, AMC agreed to provide various services to the
Company, including certain employee benefits administration services,
information services and data processing functions. The agreement had a one-year
term from the effective date of the Reorganization unless earlier terminated by
the Company upon 30 days written notice. In February 1998, the Company
terminated the administrative services agreement, effective March 1, 1998.
Under an additional administrative services agreement, the Company agreed
to assist AMC in selling the mortgage loans originated by AMC and to provide
investor coordination and information for the existing loan portfolio as well as
new loan originations. The agreement had a one-year term from the effective date
of the Reorganization, unless earlier terminated by AMC upon 30 days written
notice. In February 1998, AMC terminated the second administrative service
agreement, effective March 1, 1998.
Under the loan sub-servicing agreement, AMC agreed, for a three-year
period, to sub-service mortgage loans originated or purchased by the Company
after the Reorganization. Sub-servicing activities include collecting and
remitting loan payments, accounting for principal and interest, holding escrow
or impound funds for payment of taxes and insurance, if applicable, making
required inspections of the mortgaged property, contacting delinquent borrowers,
and supervising foreclosures and property dispositions. The agreement provides
that either party has the right to terminate the agreement effective at any time
after November 2, 1998, upon six months prior written notice to the other party.
The Company has agreed to pay AMC a 45 basis points annual servicing fee on the
declining principal balance of each loan sub-serviced.
Under the contribution agreement, AMC agreed to indemnify and hold the
Company harmless from any tax liability attributable to periods ending on or
before the Reorganization. For periods ending after the Reorganization, the
Company will pay its tax liability directly to the appropriate taxing
authorities.
The agreements between the Company and AMC were developed in the context of
a related party relationship and, therefore, may not necessarily reflect the
same business terms as might have been obtained in arm's length negotiations
between independent parties.
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LOAN ORIGINATION AND PURCHASING
The Company originates loans through Company approved independent mortgage
loan brokers and, to a lesser extent, purchases loans from other mortgage
banking companies. The following table shows certain combined data regarding the
Company's loan originations and purchases for the periods indicated:
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FOR THE YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
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(DOLLARS IN THOUSANDS)
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Aggregate principal balance..................... $1,685,742 $1,058,122 $592,542
Number of loans................................. 14,892 10,041 6,008
Average principal balance per loan.............. $ 113 $ 105 $ 99
Combined weighted average loan-to-value(1)(3)... 75.1% 75.0% 72.2%
Weighted average fixed interest rate(3)......... 10.2% 10.5% 11.3%
Weighted average six-month adjustable interest
rate(3)....................................... 9.0% 9.6% 10.4%
Weighted average fixed/adjustable interest
rate(3)....................................... 9.7% 10.0% 11.3%
"A-" and "B+" loans as a percentage of total
loans(2)(3)................................... 71.6% 69.2% 55.0%
</TABLE>
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(1) Determined by dividing the amount of the loan by the lesser of the purchase
price or the appraised value of the mortgaged property at origination.
(2) Based on original principal balance.
(3) For 1996 and 1995, amounts were calculated based on raw data from the loan
origination system which did not consider timing differences between the
time various loans actually funded and the date such loans were uploaded
into the Company's system. Although these amounts differ from the "true"
origination and purchase amounts recorded in 1996 and 1995, the calculated
amounts above are not materially affected by such differences.
Substantially all loans originated or purchased by the Company are secured
by a first priority mortgage on the subject property.
Geographic Markets
The approximately 10,000 approved independent mortgage loan brokers with
whom the Company has a relationship are located in 48 states. The following
table shows geographic distribution of (i) the aggregate principal balance of
loan originations and purchases for the periods shown, and (ii) Company-approved
independent mortgage loan brokers for the year ended December 31, 1997:
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LOAN ORIGINATIONS INDEPENDENT
YEAR ENDED DECEMBER 31, MORTGAGE BROKERS
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1997 1996 1995 DECEMBER 31, 1997
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States(1)(3):
California............................ 34.4% 37.1% 43.1% 4,406
Colorado.............................. 8.4 7.3 2.9 494
Michigan.............................. 6.0 3.7 3.9 184
Oregon................................ 5.3 4.3 4.0 214
Florida............................... 5.1 3.5 1.5 714
Illinois.............................. 4.1 6.2 8.7 344
Utah.................................. 3.8 5.1 6.6 216
Texas................................. 3.7 3.8 1.5 663
Washington............................ 2.7 3.7 5.3 340
All other States(2)................... 26.5 25.3 22.5 2,872
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Total....................... 100.0% 100.0% 100.0% 10,447
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(Footnotes continued on following page)
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(1) States are listed in order of percentage of loan originations and purchases
for the year ended December 31, 1997.
(2) For the year ended December 31, 1997, loan originations and purchases in
each state were less than 2.8% of total originations and purchases for the
year.
(3) For 1996 and 1995, amounts were calculated based on raw data from the loan
origination system which did not consider timing differences between the
time various loans actually funded and the date such loans were uploaded
into the Company's system. Although these amounts differ from the "true"
origination and purchase amounts recorded in 1996 and 1995, the calculated
amounts above are not materially affected by such differences.
The Company currently originates loans in 139 of the approximately 330 MSAs
in the United States having populations in excess of 100,000, as compared to
loan originations in 112 of these MSAs in 1996. Another 12 MSAs were identified
as expansion opportunities for 1997 and the Company expected to add
approximately 110 new account executives during the year in order to more
effectively enter these new markets as well as further penetrate the Company's
existing markets.
The Company's geographic markets are divided into 17 regions plus one
correspondent lending region. Each team is headed up by a regional manager and
includes dedicated account executives, underwriters, appraisers and other
production personnel so that the team can originate and produce loans in that
region. The 18 teams are deployed into 7 Regional Processing Centers. When a
Regional Processing Center is first established, the team is physically located
at the Company's headquarters. Once the Company determines that the level of
current and projected business from a region warrants the deployment of the
Regional Processing Center, the Company moves a Processing Center in or near the
region and relocates the relevant regional teams to the new center. These
centers enable the Company to more effectively anticipate and respond to broker
and borrower needs in each region. The concept also appeals to independent
brokers who may be reluctant to deal with a larger, more remote lender. Each
regional team is connected to senior management and the corporate headquarters
by a wide area network that enables management to monitor the quality of all
regional functions on a real time basis. The Company intends to establish four
additional Regional Processing Centers in 1998.
Products and Marketing
The Company offers both fixed rate and adjustable rate loans. The
adjustable rate loans begin with an interest rate that is initially fixed for a
period of time after which the interest rate converts to an adjustable rate. The
Company's borrowers, who use the loans primarily to consolidate other debt or
purchase homes, fall into four subprime risk classifications, and products are
available at different interest rates and with different origination and
application points and fees depending on the particular borrower's risk
classification. The Company's adjustable rate loans primarily consist of (i)
loans that bear a fixed interest rate for the first two years that convert to an
adjustable rate thereafter ("fixed/adjustable rate loans") and (ii) loans that
bear a fixed interest rate for the first six months that convert to an
adjustable rate thereafter ("six-month adjustable rate loans"). The Company has
established interest rate caps for its adjustable rate loans which limit changes
in the interest rate on such loans to 1% during any six month period.
The following table presents the Company's loan production by product type
for the periods indicated (dollars in thousands):
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YEAR ENDED DECEMBER 31,
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1997 1996
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Fixed rate loans.................................... $ 428,793 $ 392,251
Fixed/adjustable rate loans......................... 756,853 97,962
Six-month adjustable rate loans..................... 500,096 567,909
---------- ----------
Total loan production..................... $1,685,742 $1,058,122
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Many of the Company's borrowers utilize funds from loans to pay-off
existing debts. During 1997, approximately 65% of the Company's loan production
was made for the purpose of providing funds for refinancing, and in
approximately 63% of these refinancings, the respective borrowers received cash
to pay-off other debts.
While the Company's core loan products allow for maximum loan amounts of up
to $500,000 with a loan-to-value ratio of up to 85%, actual core product
originations in 1997 had an average loan amount of $113,000 with an average
loan-to-value ratio of 75%. The Company also offers a "jumbo" product allowing
balances of up to $1,000,000 with lower loan-to-value ratios than the core
products, and products that permit a loan-to-value ratio of up to 90% for
selected borrowers with a risk classification of "A-."
The Company's primary means of marketing its products is direct contact
between its account executives and the independent mortgage loan brokers. Each
account executive is responsible for maintaining and expanding existing broker
relationships through "cold calls" and following up on inquiries made by brokers
to a toll-free number.
A key element in developing, maintaining and expanding its independent
mortgage loan broker relationships is to provide the highest possible level of
product knowledge and customer service to its brokers. Each account executive
receives comprehensive training prior to being assigned to a territory. In most
cases, training includes experience in the loan processing department so that
the account executive will be familiar with all phases of loan origination and
production. This training enables the account executive to quickly review a loan
application in order to identify the borrower's probable risk classification and
then assist the broker in identifying the appropriate product for the borrower,
thereby enhancing the likelihood that the loan will be approved at the rate and
on the terms anticipated by the broker. After a loan package is submitted to the
Company, the account executive provides assistance to the broker throughout the
process to complete the loan transaction. The account executive does not have
approval authority on the transaction. Account executives are compensated based
on the number and the dollar volume of loans funded.
The marketing department designs and produces the Company's marketing
materials in-house. Marketing materials are delivered through the account
executives as well as through regional and national advertising outlets, daily
faxing, fax-on-demand, direct mail and the Company's recently established
interactive internet website. The Company has a presence at and sponsors most
national industry conventions and trade shows, as well as most state and
regional industry conventions and trade shows in states where the Company has an
operating location. The Company conducts free seminars at its operating
locations designed to target new and existing independent brokers.
Technology
The Company utilizes computer technology to maximize its loan originations.
Most of the account executives are linked to the Company's computer systems by a
wide area network. Through this network, an account executive receives daily
status reports regarding pending loans so that he or she can direct efforts to
those cases that require attention to complete the processing. Certain account
executives, who are not on the network, receive the same data by daily fax
communication. The Company has an established internet website through which
brokers can access information about the Company and its products. Brokers also
can use the website to submit requests for loan prequalification. The website
address is http://www.lbmcwholesale.com.
The Company makes extensive use of computer technology in its underwriting
process. Each loan application file is computerized so that it can be accessed
immediately by the appropriate persons, thereby eliminating delay that would be
caused by not having physical access to the file. The system also reduces the
time required for an underwriter to make certain essential calculations by
enabling the underwriter to input specified raw data after which the computer
will automatically make such calculations.
The Company regularly reviews its computer capabilities in order to better
utilize and expand those capabilities. The Company also expanded the automation
of its underwriting process in order to increase the number of loan applications
processed by each underwriter in a given day.
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Correspondent Loan Purchasing
The Company augments its loan production by purchasing loans on a
correspondent basis from smaller mortgage companies and commercial banks after
such loans have been funded by the originator. The Company typically purchases
the servicing rights to the loans as well. Purchasing loans from such
originators is attractive because the Company is able to acquire a pool of loans
in a single transaction on a cost-efficient basis. The cost efficiency is due to
the Company not having to incur origination and processing costs with respect to
the loans it purchases from an established originator such as a bank or smaller
mortgage company.
When it first begins buying loans from an originator, the Company works
closely with the originator's personnel to familiarize them with the process
necessary to produce loans that the Company is willing to purchase. This ensures
that the Company will be able to include these loans in its loan sales. In this
initial phase with a new originator, the Company processes the loan applications
as if they were the Company's own originations. Once the Company is comfortable
that the originator has developed the capability to originate and process loans
that comply with the Company's guidelines, the Company's active involvement in
the processing of the originator's loans is reduced. At this point, the Company
simply reviews loans submitted by the originator prior to accepting them,
confirming compliance with the Company's underwriting guidelines and
documentation standards. From this point on, the Company begins to recognize the
increased cost efficiency of purchasing loans.
When the Company purchases loans, it receives representations and
warranties and first payment default and fraud protections from the originators
that are similar to those that the Company provides to its loan purchasers.
The loan purchase program accounted for approximately 9.0% of the Company's
total loan volume by principal amount during 1997, compared to 3.1% and 0.9% in
1996 and 1995, respectively. Such increase is due to the expansion of the loan
purchase program which was accomplished through better integration of the loan
purchasing process into the Company's regional team structure.
Direct-Sourced Loan Operations
During the fourth quarter of 1997, the Company established a retail loan
origination channel. In connection with the opening of its first retail center
in Orange County, California, the Company has recruited and deployed management
and staff for the operation during the quarter, has tested its direct marketing
methodologies and systems, and has obtained or has taken steps to obtain
licenses in over 30 states. The Company has scheduled the opening of two
additional retail origination centers in 1998. The Company expects that the net
gain on sales of direct-sourced loans will be greater than the gain on sales of
broker-sourced loans because, unlike in the case of broker-sourced originations,
a third party does not share in the fees and points paid by the borrower, and
because the Company typically pays the originating broker a premium of the loan
balance.
Direct-sourced loan operations will offer the same products as those of the
broker-sourced operations and are sourced primarily through technology-based
marketing, relying to a great extent on telemarketing (direct mail and
electronic media advertising) rather than a network of branch sales offices.
This enables the Company to commence these operations more rapidly and with less
overhead than a direct-sourced loan business that operates through a branch
office network. The Company's senior management is experienced in both
direct-sourced and broker-sourced loan originations, since several of the senior
executives were involved in creating the direct-sourced lending operations of
AMC prior to the Reorganization. The Company filled a portion of the staffing
needs of the direct-sourced loan operations with experienced personnel
previously working in the broker-sourced loan operations.
Underwriting
The Company trains its account executives and underwriters to evaluate loan
application and supporting documentation (a "loan package") against the
Company's underwriting guidelines. The Company utilizes experienced underwriters
who have been provided comprehensive training. Underwriters are educated
8
<PAGE> 11
regarding the Company's underwriting guidelines and the implementation of the
Company's underwriting procedures. The Company's training program enables its
underwriters to review and evaluate loan packages while understanding and
adhering to the Company's underwriting guidelines. The Company's underwriters
are required to have one or more years of subprime underwriting experience
gained from either a finance company or other subprime lender. Underwriting
experience may be substituted with one or more years experience acquired by
performing other Company subprime lending functions prior to entering into the
Company's underwriter training program.
The Company's underwriting guidelines are primarily intended to evaluate
the applicant's credit profile, repayment ability, and the value and adequacy of
the property offered as mortgage collateral. Loan applications meeting the
Company's core product guidelines may be approved by regional service managers,
who are required to have a minimum of five years subprime underwriting lending
experience. On occasion, with the approval of a regional service manager and a
divisional service manager or regional vice president, a prospective borrower
not strictly adhering to the Company's underwriting guidelines may be granted an
underwriting exception. Divisional service managers and regional vice presidents
are required to have a minimum of seven years subprime lending experience.
Underwriting exceptions are granted based upon compensating factors which may
include, but are not limited to, good credit history (mortgage and/or consumer),
low debt-to-income and loan-to-value ratios, stable employment and residency at
the borrower's current address.
All of the wholesale loans originated by the Company are based on loan
packages submitted through mortgage brokers directly or through Company account
executives, directly from a borrower or purchased from a Company-approved
originator. Loan packages submitted through mortgage brokers are required to
include information relevant to credit, the property offered as collateral and
any additional related facts for underwriting purposes. This information is
compiled by the submitting broker and submitted to the Company for underwriting
approval and funding authorization. The mortgage broker receives a portion of
the loan origination fee charged to the borrower at the time the loan is funded.
The Company reviews loan packages submitted by originators prior to
accepting them to confirm each complies with the Company's underwriting
guidelines and documentation standards. The Company's underwriting procedures
comply with applicable state and federal laws and regulations. Each prospective
borrower is required to complete a loan application which includes information
related to the borrower's liabilities, assets, income, employment history and
other relevant personal information. When the loan package is received, it is
entered into the Company's underwriting system. The underwriters from the
appropriate regional team, including those reviewing loans submitted for
purchase, typically re-verify the borrower's information for compliance with the
Company's underwriting guidelines. Information re-verified includes: (i) sources
of income, (ii) credit history, (iii) debt-to-income ratios, (iv) sources of
down payment funds, and (v) value of the property offered as collateral.
The prospective applicant generally provides to the Company or the
originator of a purchased loan, a letter explaining all late payments on
mortgage, consumer installment and revolving debt with local and national
merchants and lenders, records of defaults, bankruptcies, repossessions, suits
and judgments. Prior to funding a loan and as a function of its quality control
system, the Company re-verifies the information that has been provided by the
submitting mortgage broker. Additionally, the Company performs a random post
funding audit on 5% of all originations that re-evaluates all of the factors
previously identified.
The Company utilizes three different income documentation programs to which
prospective borrower's income is evaluated and determined for underwriting
purposes. Each imposes specific documentation requirements and standards. The
full income documentation program may include and be based on W-2's, tax
returns, verifications of employment and current paycheck stubs. Alternatively,
a less rigorous documentation standard is the limited documentation program
where income may be determined and based on cash flow over an extended period
based on bank statements. The third source is the stated income program in which
the borrowers provide the Company with their source and amount of monthly
earnings. The stated amount is then assessed to determine whether or not it is
reasonable as it relates to the occupation and source. Additionally, employment
of the applicant is verbally re-verified.
9
<PAGE> 12
The Company's guidelines are less stringent with respect to the borrower's
credit and repayment ability than the standards generally acceptable to the
Federal National Mortgage Association ("FNMA") and the Federal Home Loan
Mortgage Corporation ("FHLMC"). However, in those cases, the Company's loan-to-
value ratio requirements are more stringent than those of the agencies.
Borrowers who qualify under the Company's guidelines generally have payment
histories which would not satisfy FNMA and FHLMC underwriting guidelines. Their
credit reports may exhibit major derogatory credit items, such as outstanding
judgments or previous bankruptcies.
The Company has formed risk classifications with respect to each
prospective borrower's credit profile and ability to repay. The Company's
guidelines establish maximum permitted loan-to-value ratios for each loan type
risk based upon these and other factors. These classifications are indications
of the likelihood of the borrower satisfying the repayment condition of the
mortgage loan. Each prospective borrower is identified by one of five letter
ratings ("A-", "B", "B-", "C", and "D"). Other factors that are evaluated during
the underwriting process and affect the final lending decision are the property
value and type, loan-to-value ratio, loan amount, and subject property's
occupancy status.
Mortgaged properties that are offered as security for underwriting purposes
are appraised by qualified independent appraisers. These appraisers are
qualified and accepted by the Company's internal valuation staff or chief
appraiser. The Company requires an appraisal of the mortgage property offered as
collateral that conforms to agency standards. Every appraisal includes a market
data analysis based on recent sales in the market area of the offered property
of comparable homes. Where deemed appropriate, replacement cost analysis based
on current cost of constructing a similar home is provided.
An appraisal review is conducted on each appraisal submitted. These reviews
may be performed by a Company trained underwriter, a Company valuation manager,
or a Company approved independent appraiser. Additionally, depending upon the
original principal balance or the loan-to-value ratio of the mortgaged property,
a drive-by review appraisal may be performed. Properties that are identified to
be in below average condition and have below average marketability (including
properties requiring major deferred maintenance) are considered unacceptable
collateral for a Company's mortgage loan program.
The Company strives to process each loan package in compliance with its
underwriting guidelines as quickly as possible. Accordingly, most underwriting
decisions are rendered in 24 to 48 hours, and approved packages are funded on
average within 20 calendar days from submission date.
Upon completion of the underwriting process and subsequent approval, the
closing of the loan is scheduled with a Company approved closing attorney or
agent. The closing attorney or agent is responsible for completing the loan
closing in accordance with applicable law and the Company's operating
procedures. The closing attorney or agent is typically selected by the mortgage
broker. The Company audits the selected closing attorney or agent to ensure the
attorney or agent is a fully licensed, experienced professional from an
established firm or company. In addition, the Company generally requires closing
attorneys and agents utilized to close loans, to maintain insurance against
errors and omissions.
The Company requires each mortgage loan to be covered by title insurance
and secured by a lien on single-family real property. The Company also requires
fire and extended coverage casualty insurance to be maintained on the secured
property. Flood insurance is also required for all properties located in a
defined flood zone. The dollar amount of insurance coverage on the secured
property is to be at least equal to the principal balance of the related loan.
The Company monitors the existence of insurance coverage through an outside
insurance vendor. If the borrower's coverage is subsequently canceled or not
renewed at any time during the loan period, and the borrower fails to obtain new
coverage, the outside vendor will provide coverage on the borrower's behalf
under policies insuring the Company's collateral interest. The amount, type of
insurance and circumstances under which the Company can force place insurance
are subject to state and federal regulations, with which the Company believes
that it complies.
10
<PAGE> 13
The chart below summarizes the general criteria currently used by the
Company in classifying prospective borrowers of its core loan products who have
provided the basic documentation described above:
<TABLE>
<CAPTION>
UNDERWRITING
CRITERIA/RISK
CLASSIFICATION "A-" RISK "B" RISK "B-" RISK "C" RISK "D" RISK
-------------- --------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
Loan-to-Value
Ratio 90% for owner 85% for owner 80% for owner 75% for owner 70% for owner
occupied purchases occupied purchases occupied purchases occupied purchases occupied purchases
of single family of single family or refinances of of single family or refinances of
residences, planned residences, planned single family residences, planned single family
unit developments, unit developments, residences, planned unit developments, residences, planned
and condominiums; and condominiums; unit developments, and condominiums; unit developments,
80% for owner 80% for owner and condominiums; 70% for owner and condominiums;
occupied purchases occupied purchases 75% for owner occupied purchases 65% for owner
or refinances of 2 or refinances of 2 occupied purchases or refinances of 2 occupied purchases
to 4 unit dwellings to 4 unit dwellings or refinances of 2 to 4 unit dwellings or refinances of 2
and second homes, and second homes, to 4 unit dwellings and second homes, to 4 unit dwellings
80% for non-owner 80% for non-owner and second homes, 70% for non-owner and second homes,
occupied single occupied single 75% for non-owner occupied single 65% for non-owner
family residences, family residences, occupied single family residences, occupied single
planned unit planned unit family residences, planned unit family residences,
developments or developments or planned unit developments or planned unit
condominiums; 70% condominiums; 70% developments or condominiums; 60% developments or
for non-owner for non-owner condominiums; 65% for non-owner condominiums; 55%
occupied 2 to 4 occupied 2 to 4 for non-owner occupied 2 to 4 for non-owner
unit dwellings. unit dwellings. occupied 2 to 4 unit dwellings. occupied 2 to 4
unit dwellings. unit dwellings.
Maximum Debt Ratio(1) LTV's greater than
85% = 45%
LTV's less than
85% = 47% 50% 55% 55% 55%
Consumer LTV's less than
Credit(2) 85% 30 day 30 & 60 days late 30 & 60 days late Other derogatory Other derogatory
late in the past 12 in the past 12 in the past 12 credit items are credit items are
months; derogatory months; derogatory months; derogatory considered on a considered on a
credit items are credit items are credit items are case-by-case basis; case-by-case basis.
less than 25% of less than 35% of less than 50% of no bankruptcies in
total items on total items on total items on the last 12 months.
credit report, no credit report, no credit report, no
bankruptcies in the bankruptcies in the bankruptcies in the
last 24 months. last 24 months. last 18 months.
Mortgage
Credit(3) Maximum of (2) Maximum of (3) Maximum of (1) Maximum of (2) All mortgage and
30-day late 30-day late 60-day late 60-day late consumer credit
payments in the payments in the payments in the payments and (1) including
past 12 months; no past 12 months; no past 12 months; 90-day late payment bankruptcies and
notices of default notices of default maximum 30 days or (3) 60- day late foreclosures may be
or foreclosures in or foreclosures in late at time of payments and no waived if
the last 36 months. the last 36 months. application or 90-day late reasonable
funding, no notices payments in the explanation is
of default or last 12 months; provided and
foreclosures in the maximum of a 60 problem no longer
last 24 months. days late at time exists.
of funding; no
notices of default
or foreclosures in
the last 24 months.
</TABLE>
- ---------------
(1) Debt ratios may be increased if the loan-to-value ratio is decreased for
respective loan programs A-, B, and B-.
(2) Non-mortgage and consumer-related credit, collections or judgments (i.e.,
dental and/or medical) may be disregarded on a case-by-case basis. Thirty
day credit may be disregarded and not included in the percentage of
derogatory credit items.
(3) Consecutive rolling consumer and mortgage 30-day delinquencies up to six
months reported on a credit report may be counted as one late payment.
11
<PAGE> 14
The following table sets forth certain information with respect to the
Company's loan purchases and originations by product and risk classification,
also with weighted average interest rates and margins, for the years ended
December 31 (dollars in thousands):
<TABLE>
<CAPTION>
1997(3) 1996(4) 1995(4)
------------------------------------------ ------------------------------------------ ----------
WEIGHTED WEIGHTED
AVERAGE WEIGHTED AVERAGE WEIGHTED
% OF INTEREST AVERAGE % OF INTEREST AVERAGE
PRODUCT/ RISK CLASSIFICATIONS VOLUME TOTAL RATE(1) MARGIN(2) VOLUME TOTAL RATE(1) MARGIN(2) VOLUME
- ----------------------------- ---------- ------ -------- --------- ---------- ------ -------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
FIXED RATE:
A-...................... $ 281,828 65.73% 9.83% $ 231,792 59.23% 10.20% $ 38,896
B+...................... 33,302 7.77 10.20 53,184 13.59 10.43 18,577
B....................... 43,830 10.22 10.45 36,257 9.26 10.76 6,365
B-...................... 28,507 6.65 10.73 28,699 7.33 10.97 4,359
C....................... 35,806 8.35 11.43 39,594 10.12 11.66 9,598
C-...................... 3,064 0.71 11.77 1,820 0.47 11.36 219
D....................... 2,456 0.57 12.26
---------- ------ ---------- ------ ----------
Totals............ $ 428,793 100.00% 10.16% $ 391,346 100.00% 10.49% $ 78,014
SIX-MONTH ADJUSTABLE RATE:
A-...................... $ 319,045 63.80% 8.58% 6.34% $ 293,519 51.82% 8.98% 6.09% $ 207,152
B+...................... 35,204 7.04 8.88 6.16 67,306 11.88 9.30 6.15 42,811
B....................... 42,641 8.53 9.12 6.42 51,770 9.14 9.90 6.39 42,050
B-...................... 33,758 6.75 9.44 6.54 45,080 7.96 10.00 6.49 63,324
C....................... 46,932 9.38 10.18 6.63 86,778 15.32 10.73 6.64 100,768
C-...................... 18,077 3.61 10.96 6.73 22,001 3.88 11.89 6.85 24,378
D....................... 4,439 0.89 11.49 7.02
---------- ------ ---------- ------ ----------
Totals............ $ 500,096 100.00% 8.97% 6.40% $ 566,454 100.00% 9.57% 6.27% $ 480,483
FIXED/ADJUSTABLE RATE:
A-...................... $ 487,351 64.39% 9.46% 6.29% 70,949 73.08 9.84 5.58 $ 11,804
B+...................... 50,048 6.61 9.72 6.20 13,462 13.86 10.30 6.00 2,854
B....................... 75,780 10.01 9.95 6.50 6,649 6.85 10.46 6.17 2,878
B-...................... 53,037 7.01 9.99 6.59 1,987 2.05 10.72 6.41 3,921
C....................... 73,489 9.71 10.62 6.60 3,521 3.63 11.19 6.77 4,826
C-...................... 10,171 1.35 11.28 6.79 518 0.53 11.11 6.87 1,196
D....................... 6,977 0.92 11.70 7.04
---------- ------ ---------- ------ ----------
Totals............ $ 756,853 100.00% 9.73% 6.37% $ 97,086 100.00% 10.02% 5.75% $ 27,479
ALL PRODUCTS
A-...................... $1,088,224 64.56% $ 596,260 56.52% $ 257,852
B+...................... 118,554 7.03 133,952 12.70 64,242
B....................... 162,251 9.62 94,675 8.98 51,293
B-...................... 115,302 6.84 75,766 7.18 71,604
C....................... 156,227 9.27 129,893 12.31 115,192
C-...................... 31,312 1.86 24,340 2.31 25,793
D....................... 13,872 0.82
---------- ------ ---------- ------ ----------
Totals............ $1,685,742 100.00% $1,054,886 100.00% $ 585,976
<CAPTION>
1995(4)
-----------------------------
WEIGHTED
AVERAGE WEIGHTED
% OF INTEREST AVERAGE
PRODUCT/ RISK CLASSIFICATIONS TOTAL RATE(1) MARGIN(2)
- ----------------------------- ------ -------- ---------
<S> <C> <C> <C>
FIXED RATE:
A-...................... 49.86% 10.95%
B+...................... 23.81 11.25
B....................... 8.16 11.23
B-...................... 5.59 11.74
C....................... 12.30 12.46
C-...................... 0.28 12.83
D.......................
------
Totals............ 100.00% 11.28%
SIX-MONTH ADJUSTABLE RATE:
A-...................... 43.11% 9.70% 5.80%
B+...................... 8.91 10.13 5.84
B....................... 8.75 10.50 6.29
B-...................... 13.18 10.64 6.29
C....................... 20.97 11.28 6.58
C-...................... 5.08 12.33 6.87
D.......................
------
Totals............ 100.00% 10.40% 6.13%
FIXED/ADJUSTABLE RATE:
A-...................... 42.96% 10.61% 5.24%
B+...................... 10.39 10.78 5.35
B....................... 10.47 11.17 5.18
B-...................... 14.27 11.57 5.58
C....................... 17.56 12.53 5.74
C-...................... 4.35 13.37 6.10
D.......................
------
Totals............ 100.00% 11.28% 5.42%
ALL PRODUCTS
A-...................... 44.01%
B+...................... 10.96
B....................... 8.75
B-...................... 12.22
C....................... 19.66
C-...................... 4.40
D.......................
------
Totals............ 100.00%
</TABLE>
- ---------------
(1) Each Fixed Rate loan bears interest at a fixed rate set on its date of
funding and lasting through the term of the loan. Loans bearing interest at
the Six-Month Adjustable Rate adjust every six months to a new rate through
the term of the loan. The Weighted Average Interest Rate for loans bearing
interest at a Six-Month Adjustable Rate is the weighted average of the rates
of such loans during the initial six month period. Loans bearing interest at
the Fixed/Adjustable Rate bear interest at a fixed rate for the first two
years commencing on the date of funding and thereafter adjust to new rates
every six months for the remaining term of the loans. The Weighted Average
Interest Rate for loans bearing interest at a Fixed/ Adjustable Rate is the
weighted average of the rates of such loans during the initial period.
(2) The Margin for a loan is a fixed amount set for the life of the loan, which
when added to the Index (as described below) determines the interest rate on
the loan (subject to interest rate floors, ceilings and caps). The Index
used by the Company is the six-month London Inter Bank Offered Rate, as
published each Monday in The Wall Street Journal. Fixed Rate loans have no
Margin because such loans are not tied to an index.
(3) Underwriting guidelines were revised effective 10/1/97, eliminating B+ and
C- categories and adding D category.
(4) For 1996 and 1995, amounts were compiled based on raw data from the loan
origination system which did not consider timing differences between the
time various loans actually funded and the date such loans were uploaded
into the Company's system. As a result, origination and purchase amounts
differ from the "true" origination and purchase amounts recorded in 1996 and
1995.
12
<PAGE> 15
FINANCING AND SALE OF LOANS
Warehouse Financing Facility
The Company finances its origination and purchase of loans primarily with
the proceeds of borrowings under its Warehouse Financing Facility, which
initially provided for a borrowing capacity of $200 million and was increased to
$250 million in January 1998. The Warehouse Financing Facility is provided by a
syndicate of banks led by Chase Bank of Texas. Borrowings under the Warehouse
Financing Facility for a particular loan may remain outstanding for no more than
120 days, except for an aggregate amount not to exceed $10 million, which may
remain outstanding for up to 180 days. Borrowings under the Warehouse Financing
Facility are permitted up to 98% of the principal balance of the originated and
purchased loans and bear interest at rates ranging from 1.375% to 1.625% over
the 30-day reserve-adjusted LIBOR (i.e., the London Inter Bank Offered Rate),
depending on the level of loan documentation the Company has delivered to the
agent for the syndicate of banks providing credit under the Warehouse Financing
Facility. The Warehouse Financing Facility also includes a $60 million subline
for loans not covered by a forward purchase commitment, a $15 million subline
for principal and interest advances and a $10 million subline for other
servicing advances made primarily to securityholders in connection with
securitizations by purchasers of the Company's loans in which the Company serves
as the master servicer, and a $5 million subline which may be used to finance
mortgage loans owned by the Company that are in the process of collection or
resale to investors. The sublines bear interest at rates ranging from 1.875% to
2.0% over the 30-day reserve-adjusted LIBOR. The Warehouse Financing Facility
will expire on March 31, 1999, unless earlier terminated or extended in
accordance with its terms. The Warehouse Financing Facility contains a number of
financial covenants including: (i) the Company maintain tangible net worth equal
to at least $25 million, plus 25% of cumulative positive net earnings, (ii)
delinquencies on the Company's mortgage servicing portfolio not exceed 12% and
(iii) the ratio of total liabilities to adjusted tangible net worth not exceed
9:1. The Warehouse Financing Facility also contains other affirmative, negative
and financial covenants typical of similar credit facilities. The Company was in
compliance with all such covenants at December 31, 1997.
Loan Sales
The Company follows a strategy of selling for cash substantially all of its
loan originations and purchased loans in the secondary market through loan sales
in which the Company disposes of its entire economic interest in the loans. The
Company sold $1.7 billion, $1.0 billion and $580.4 million of loans through loan
sales during 1997, 1996 and 1995, respectively. The Company did not sell any
loans directly through securitizations during the period; however, substantially
all of the loans sold during the period were ultimately securitized by the
purchasers thereof.
Loans generally are sold to institutional purchasers on a quarterly basis.
Upon the consummation of loan sales, the Company receives a "premium,"
representing a cash payment in excess of the par value of the loans (par value
representing the unpaid balance of the loan amount). Cash gains from loan sales
represented 88% of the Company's total revenues in 1997. The Company maximizes
its premium on loan sale revenue by closely monitoring institutional purchasers'
requirements and focusing on originating or purchasing the types of loans that
meet those requirements and for which institutional purchasers tend to pay
higher premiums. During 1997, the Company sold loans to a number of
institutional purchasers. The Company's loan purchasers typically securitize the
loans and sell major portions of the economic interest through mortgage backed
securities.
The Company makes loan sales by obtaining commitments from its loan
purchasers 30 to 120 days in advance of funding the loans to be purchased. These
commitments are obtained through a competitive bidding process among four to
nine potential purchasers who in most cases have purchased loans from the
Company in the past. The successful bidder is committed to a minimum quantity of
loans at a determined price, and may be granted the option to purchase more than
the minimum quantity at a negotiated price. The Company continuously monitors
its loan production and purchasing against its unfilled purchase commitments to
identify potential shortfalls or overages in loans available for delivery. As
loans are funded, the Company packages them and delivers them to the purchaser
on a periodic basis.
13
<PAGE> 16
Loan sales are made on a non-recourse basis pursuant to a purchase
agreement containing customary representations and warranties regarding the
underwriting criteria and the origination process. The Company, therefore, may
be required to repurchase or substitute loans in the event of a breach of its
representations and warranties. In addition, the Company sometimes commits to
repurchase or substitute a loan if a payment default occurs within the first
month following the date the loan is funded, unless other arrangements are made
between the Company and the purchaser. The Company is also required in some
cases to repurchase or substitute a loan if the loan documentation is alleged to
contain fraudulent misrepresentations made by the borrower.
The Company's gain on sale of loans is determined by the excess of the
premiums that the Company receives over the cost of acquiring the loan. The gain
on sale for each of the Company's channels of production differs due to
differences in the cost of acquisition and loan fees. The cost of acquiring a
broker-sourced loan are the fees paid to the originating broker. This results in
a broker-sourced loan having a lower gain on sale than a retail loan, in which
no broker fees are paid. However, the cost of acquiring a retail generated loan
reflects higher general and administrative expenses as compared to a
broker-sourced loan. Additionally, because the originating broker typically
retains all origination points and fees, the gain on sale of broker-sourced
loans have substantially smaller fee components than retail generated loans.
Loans originated through correspondents have a higher cost of acquisition and no
fee component. Correspondent loans require little, if any, incremental general
and administrative expenditures by the Company.
The following table illustrates the current economics of the gain on sale
of loans originated from the Company's various channels:
<TABLE>
<CAPTION>
BROKER-SOURCED RETAIL CORRESPONDENT
PRODUCTION PRODUCTION PRODUCTION
-------------------- -------------------- --------------
<S> <C> <C> <C>
5 - 7 1/2
Gross premium................ 5 - 7 1/2 points 5 - 7 1/2 points points
Less broker costs (PYA)...... 1 - 2 points N/A N/A
Less purchase costs.......... N/A N/A 3 - 5 points
Plus points and fees......... 40 - 60 basis points 2 - 5 points N/A
Less capitalized direct
origination costs.......... 40 - 50 basis points 50 - 70 basis points N/A
Net gain on sale of loans.... 4 - 5 1/2 points 7 - 10 points 2 - 4 points
</TABLE>
The above table does not reflect general and administrative expenses of
each of these channels. During 1997, the Company's net gain on sale of loans, as
a percentage of loans sold, totaled 5.28%. This represents an increase from
4.92% in 1996 and a decrease from 5.46% in 1995. The recent decline in interest
rates for mortgage loans has resulted in a higher perception of prepayment risk
by investors in mortgage loans. A higher perception of prepayments and the
increased level of competition may negatively affect the gross premium that the
Company may receive on the sale of its loans in the near future. There can be no
assurance provided that the Company will be able to sell its loans at historical
premiums or at the levels indicated in the above table.
SERVICING
The Company entered into a three-year agreement with a sub-servicer under
which the sub-servicer will sub-service loans originated or purchased by the
Company. Sub-servicing will be provided by the sub-servicer at an agreed-upon
rate and with default terms comparable to industry standards. The agreement
contains other customary terms and conditions and either party has the right to
terminate the agreement at any time effective after November 2, 1998 upon six
months' prior written notice to the other party. In the event of a termination,
either party may request that the loans that were sub-serviced by the
sub-servicer be transferred to the Company or its designee for servicing,
subject to obtaining any required consents to such transfer. The Company expects
to conduct its own servicing operations or select an alternate servicer
following termination or expiration of the agreement with the sub-servicer.
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<PAGE> 17
COMPETITION
As an originator of mortgage loans, the Company faces intense competition,
primarily from mortgage banking companies, commercial banks, credit unions,
thrift institutions and finance companies. Many of these competitors are
substantially larger and have more capital resources than the Company and may
have lower costs of funds than the Company. Furthermore, the current level of
gains realized by the Company and its competitors on the sale of the type of
loans they originate and purchase is attracting, and may continue to attract,
additional competitors into this market. Establishing a broker-sourced loan
business requires a substantially smaller commitment of capital and personnel
resources compared to a direct-sourced loan business. Such relatively low
barriers to entry permit potential new competitors with an easy entrance into
the market, in particular, existing direct-sourced lenders who can draw upon
existing branch networks and personnel in seeking to add product through broker
sources.
In the future, the Company may also face competition from, among others,
government-sponsored entities who may enter the subprime mortgage market.
Existing or new loan purchase programs may be expanded by FNMA, FHLMC or the
Government National Mortgage Association to include subprime mortgages,
particularly those in the "A-" category, which constitute a significant portion
of the Company's loan production. Increased competition could have the possible
effect of (i) lowering gains that may be realized on the Company's loan sales,
(ii) reducing the volume of the Company's loan originations and loan sales,
(iii) increasing the demand for the Company's experienced personnel and the
potential that such personnel will be recruited by the Company's competitors,
and (iv) broadening the industry standard for subprime underwriting guidelines
(for example, by providing for less stringent loan-to-value ratios) as
competitors attempt to maintain market share in the face of increased
competition.
Competition also may be affected by fluctuations in interest rates, general
economic conditions, and localized economic conditions. During periods of rising
interest rates, competitors that have "locked in" low borrowing costs may have a
competitive advantage. During periods of declining rates, competitors may
solicit the Company's customers to refinance their loans. Such "prepayment
risk", while having no immediate impact on the Company since it does not retain
any residual value in the loans it sells, may have a long-term impact, affecting
the Company's ability to sell its loans in the future. During economic slowdowns
or recessions, the Company's borrowers may have new financial difficulties and
may be receptive to offers by the Company's competitors. In addition, in periods
of economic slowdown the Company may experience an increase in default rates and
loss experience. Again, since the Company does not retain residual value in the
loans it sells, such economic slowdown would not have an immediate impact on the
Company, but could affect it's ability to sell loans in the future.
REGULATION
The Company's consumer lending activities are subject to the Federal
Truth-in-Lending Act ("TILA") and Regulation Z (including the Home Ownership and
Equity Protection Act of 1994), the Equal Credit Opportunity Act of 1974, as
amended ("ECOA") and Regulation B, the Fair Credit Reporting Act of 1970, as
amended, the Real Estate Settlement Procedures Act of 1974, as amended ("RESPA")
and Regulation X, the Home Mortgage Disclosure Act ("HMDA") and Regulation C,
the Federal Debt Collection Practices Act and the Fair Housing Act, as well as
other federal and state statutes and regulations affecting the Company's
activities. Failure to comply with these requirements can lead to loss of
approved status, termination or suspension of servicing contracts without
compensation to the servicer, demands for indemnification or mortgage loan
repurchases, certain rights of rescission for mortgage loans, class action
lawsuits and administrative enforcements actions.
The Company is subject to the rules and regulations of, and examinations
by, the Department of Housing and Urban Development ("HUD"), the Federal Housing
Administration and other federal and state regulatory authorities with respect
to originating, underwriting, funding, acquiring, selling and servicing mortgage
loans. In addition, there are other federal and state statutes and regulations
affecting such activities. These rules and regulations, among other things,
impose licensing obligations on the Company, establish eligibility criteria for
loans, prohibit discrimination, provide for inspection and appraisals of
properties, require
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<PAGE> 18
credit reports on prospective borrowers, regulate payment features and, in some
cases, fix maximum interest rates, fees and loan amounts. The Company is
required to submit annual audited financial statements to various governmental
regulatory agencies that require the maintenance of specified net worth levels.
The Company is a FNMA approved seller/servicer and is subject to the
supervision of FNMA. In addition, the Company's operations are subject to
supervision by state authorities (typically state banking or consumer credit
authorities), many of which generally require that the Company be licensed to
conduct its business. This normally requires state examinations and reporting
requirements on an annual basis.
TILA requires a written statement showing an annual percentage rate of
finance charges and requires that other information be presented to debtors when
consumer credit contracts are executed. RESPA requires written disclosure
concerning settlement fees and charges, mortgage servicing transfer practices
and escrow or impound account practices. It also prohibits the payment or
receipt of kickbacks or referral fees in connection with the performance of
settlement services. The Fair Credit Reporting Act requires certain disclosures
to applicants concerning information that is used as a basis for denial of
credit. HMDA requires collection and reporting of statistical data concerning
the loan transaction. ECOA prohibits discrimination against applicants with
respect to any aspect of a credit transaction on the basis of sex, marital
status, race, color, religion, national origin, age, derivation of income from
public assistance programs, or the good faith exercise of a right under the
Federal Consumer Credit Protection Act. The Fair Housing Act prohibits
discrimination in mortgage lending on the basis of race, color, religion, sex,
handicap, familial status or national origin.
In October 1997, HUD issued proposed regulations regarding the treatment
and disclosure of fees charged and collected by mortgage brokers providing
certain safe harbors for the payment of fees by lenders to mortgage brokers and
setting forth standards to determine whether payments to mortgage brokers
violate RESPA. Whether such regulations will be adopted and the form and content
of any final regulations is unknown.
The interest rates which the Company may charge on its loans are subject to
state usury laws, which specify the maximum rate which may be charged to
consumers. In addition, both federal and state truth-in-lending regulations
require that the Company disclose to its borrowers prior to execution of the
loans all material terms and conditions of the financing, including the payment
schedule and total obligation under the loans. The Company believes that it is
in compliance in all material respects with such regulations.
As a condition to funding of its loans, the Company requires each borrower
to obtain and maintain in force a policy of insurance providing coverage for
improvements on any real property securing the borrower's loan. If the borrower
fails to provide fire and extended coverage insurance (and flood insurance if
required) prior to closing of the borrower's loan or if the borrower's coverage
is subsequently canceled or not renewed at any time during the loan period and
the borrower fails to obtain new coverage, the Company, through an outside
insurance vendor who monitors whether insurance is maintained, will provide
coverage on the borrower's behalf under policies insuring the Company's interest
in the collateral. Such practice is commonly referred to as a "forced placement"
of insurance. The insurance which can be required and insurance which is forced
placed is subject to regulation under TILA, the National Flood Insurance Act,
and state insurance regulatory and lender statutes. Such laws and regulations
generally impose disclosure and notice requirements which must be satisfied in
connection with insurance requirements and the forced placement of coverage,
limitations on the amount of coverage that a lender may obtain to protect its
interest in the collateral and restrictions on fees and charges that the Company
may assess in connection with such insurance.
Failure to comply with any of the foregoing federal and state laws and
regulations could result in the imposition of civil and criminal penalties on
the Company, class action lawsuits and administrative enforcement actions.
DEPARTMENT OF JUSTICE SETTLEMENT AGREEMENT
In September 1996, AMC entered into a settlement agreement with the U.S.
Department of Justice (the "DOJ") arising out of a DOJ investigation and
complaint which alleged that Long Beach Bank, F.S.B., during the period from
January 1991 through June 1994, charged certain African-American, Hispanic,
female and
16
<PAGE> 19
older borrowers more than younger, white male borrowers in violation of fair
lending laws. AMC denied all allegations in the complaint and all claims of
discrimination. AMC also disputed the validity of the statistical analysis
relied upon by the DOJ as the principal basis for its claims and further
maintained that the DOJ theories of liability regarding broker-sourced lending
were legally unsupportable. Nonetheless, to avoid costly, protracted litigation,
AMC agreed to establish a $3 million fund to reimburse up to 1,200 borrowers
identified by the DOJ as the maximum number of individuals who may have been
affected by the alleged fair lending violations. AMC asserted that the better
solution to the issues raised by the DOJ was an intensive national effort in
consumer education and industry-wide initiatives directed at employee and broker
education and training. For this reason, AMC also agreed to contribute an
additional $1 million (payable over 3 years) to fund consumer education programs
in conjunction with civil rights groups. AMC has established all funds required
by the settlement agreement.
Pursuant to the settlement agreement, the Company, as a successor to AMC,
is required to (i) document any price exceptions from the Company's rate sheet
on broker-sourced loans, (ii) periodically review the results of its
broker-sourced lending operations for its compliance with fair lending laws (but
in no event shall the Company be required to disclose any documents or
information therewith, including the identities of any brokers with whom it does
business), (iii) retain all loan application files submitted for mortgage loans
and all loan-rider documents and notices relevant to any pricing decisions until
September 1999 and report to the DOJ semi-annually on compliance with the
settlement agreement, and (iv) provide to brokers information about the
Company's fair-lending and pricing procedures and an opportunity to participate
in fair-lending training. Any failure of the Company to comply with the
requirements of the DOJ settlement agreement could allow the DOJ to seek
injunctive relief against the Company.
In addition, in connection with the Company's direct-sourced mortgage
lending, the Company is required to provide certain training courses for Company
employees involved in direct-sourced mortgage loan pricing, use its best efforts
to place mortgage loan applicants in appropriate risk classifications based on
objective credit and risk-related criteria, and implement a direct-sourced
mortgage loan monitoring system of mortgage loan prices.
ENVIRONMENTAL MATTERS
In the course of its business, the Company has acquired, and may acquire in
the future, properties securing loans that are in default. It is possible that
hazardous substances or waste, contaminations, pollutants or sources thereof
could be discovered on such properties after acquisition by the Company. In such
event, the Company may be required by law to remove such substances from the
affected properties at its sole cost and expense. There can be no assurance that
(i) the cost of such removal would not substantially exceed the value of the
affected properties or the loans secured by the properties, (ii) the Company
would have adequate remedies against the prior owner or other responsible
parties, or (iii) the Company would not find it difficult or impossible to sell
the affected properties either prior to or following such removal.
EMPLOYEES
As of February 28, 1998, the Company had a total of 579 employees. None of
the Company employees is covered by a collective bargaining agreement. The
Company considers its relations with its employees to be good.
CERTAIN FACTORS AND TRENDS AFFECTING THE COMPANY AND ITS BUSINESS
Certain disclosures made by the Company in this report and in other reports
and statements released by the Company are and will be forward-looking in
nature, such as comments which express the Company's opinion about trends and
factors which may impact future operating results. Disclosures which use words
such as the Company "believes," "anticipates," "expects" and similar expressions
are intended to identify forward-looking statements. Such statements are subject
to certain risks and uncertainties which could cause actual results to differ
materially from expectations. Any such forward-looking statements, whether made
in this
17
<PAGE> 20
report or elsewhere, should be considered in context with the various
disclosures made by the Company about its business including the factors
discussed below.
Economic Slowdown and Decline in Collateral Value May Adversely Affect Volume
of Loans
Periods of economic slowdown may reduce the demand for mortgage loans as
people elect not to purchase new homes due to economic uncertainty and also may
adversely affect the financial condition of potential borrowers so that they do
not meet the Company's underwriting criteria. In addition, economic slowdowns
may cause a decline in real estate values. Any material decline in real estate
values will reduce the ability of borrowers to use home equity to support
borrowings by negatively affecting loan-to-value ratios of the home equity
collateral. To the extent that the loan-to-value ratios of prospective
borrowers' home equity collateral do not meet the Company's underwriting
criteria, the volume of loans originated by the Company could decline. A decline
in loan origination volumes could have a material adverse effect on the
Company's operations and financial condition.
Focus on Credit Impaired Borrowers May Result in Increased Delinquency Rates,
Foreclosures and Losses
The Company is a lender in the subprime mortgage banking industry, which
means that the Company focuses its marketing efforts on borrowers who may be
unable to obtain mortgage financing from conventional mortgage sources.
Approximately 2.68% of the total principal amount of loans originated or
purchased by the Company in 1997 were to borrowers with a Company risk
classification of "C-" or "D," which includes borrowers with numerous derogatory
credit items up to and including a bankruptcy in the most recent twelve month
period. Loans made to such borrowers may entail a higher risk of delinquency and
higher losses than loans made to borrowers who utilize conventional mortgage
sources. Delinquencies, foreclosures and losses generally increase during
economic slowdowns or recessions. Further, any material decline in real estate
values increases the loan-to-value ratios of loans previously made by the
Company, thereby weakening collateral coverage and increasing the possibility of
a loss in the event of a borrower default. Any sustained period of increased
delinquencies, foreclosures or losses after the loans are sold could adversely
affect the pricing of the Company's future loan sales and the ability of the
Company to sell its loans in the future.
Loss of Funding Sources Could Adversely Affect Results of Operations
The Company funds substantially all of the loans it originates or purchases
through borrowings under its Warehouse Financing Facility. These borrowings will
be repaid with the proceeds received by the Company from selling such loans. Any
failure to renew or obtain adequate funding under the Warehouse Financing
Facility, or other borrowings, or any substantial reduction in the size of, or
prices received in, the markets for the Company's loans, could have a material
adverse effect on the Company's results of operations and financial condition.
In the long term, to the extent that the Company is not successful in
maintaining or replacing the Warehouse Financing Facility, it would likely have
to curtail its loan production activities, thereby having a material adverse
effect on the Company's results of operations and financial condition. See
"Management's Discussion and Analysis of Financial Condition, Results of
Operations, Liquidity and Capital Resources." See "Business -- Financing and
Sale of Loans -- Warehouse Financing Facility."
Reliance on Secondary Purchasers of Loans Could Adversely Affect Results of
Operations
Gain on sales of loans generated by the Company's loan sales represents the
primary source of the Company's revenues and net income. Furthermore, the
Company relies almost entirely on proceeds from loan sales to generate cash for
repayment of borrowings under the Warehouse Financing Facility. The Company has
historically sold substantially all of its loan originations in the secondary
market to a limited number of institutional purchasers. There can be no
assurance that such purchasers will continue to purchase loans or will be
willing to purchase loans on the terms under which such purchasers have
historically purchased the Company's loans. To the extent that the Company could
not successfully replace such loan purchasers or negotiate favorable terms for
such loan purchases, the Company's results of operations and financial condition
could be materially and adversely affected.
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<PAGE> 21
Elimination of Lender Payments to Brokers Could Adversely Affect Results of
Operations
Lawsuits have been filed against several mortgage lenders, alleging that
such lenders have made certain payments to independent mortgage brokers in
violation of RESPA. These lawsuits have generally been filed on behalf of a
purported nationwide class of borrowers alleging that payments made by a lender
to a broker in addition to payments made by the borrower to a broker are
prohibited by RESPA and are therefore illegal. If these cases are resolved
against the lenders, it may cause an industry-wide change in the way independent
mortgage brokers are compensated. The Company's broker compensation programs
permit such payments. Although the Company believes that its broker compensation
programs comply with all applicable laws and are consistent with long-standing
industry practice and regulatory interpretations, in the future new regulatory
interpretations or judicial decisions may require the Company to change its
broker compensation practices. Such a change may have a material adverse effect
on the Company and the entire mortgage lending industry.
Elimination of Deductibility of Mortgage Interest Could Adversely Affect
Results of Operations
Members of Congress and government officials have from time to time
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower income, type of loan
or principal amount. Because many of the Company's loans are made to borrowers
for the purpose of consolidating consumer debt or financing other consumer
needs, the competitive advantages of tax deductible interest, when compared with
alternative sources of financing, could be eliminated or seriously impaired by
such government action. Accordingly, the reduction or elimination of these tax
benefits could have a material adverse effect on the demand for the kind of
loans offered by the Company.
Risk of Variations in Quarterly Operating Results
Several factors affecting the Company's business can cause significant
variations in its quarterly results of operations. In particular, variations in
the volume of the Company's loan originations and purchases, the differences
between the Company's costs of funds and the average interest rates of
originated or purchased loans, the inability of the Company to complete
significant loan sales transactions in a particular quarter, and problems
generally affecting the mortgage loan industry can result in significant
increases or decreases in the Company's revenues from quarter to quarter. A
delay in closing a particular loan sale transaction during a particular quarter
would postpone recognition of gain on sale of loans. In addition, unanticipated
delays in closing a particular loan sale transaction would also increase the
Company's exposure to interest rate fluctuations by lengthening the period
during which its variable rate borrowings under its Warehouse Financing Facility
are outstanding. If the Company were unable to sell a sufficient number of its
loans at a premium in a particular reporting period, the Company's revenues for
such period would decline, resulting in lower net income and possibly a net loss
for such period, which could have a material adverse effect on the Company's
results of operations and financial condition. See "Management's Discussion and
Analysis of Financial Condition, Results of Operations, Liquidity and Capital
Resources."
Risk of Competition in New Markets
As the Company expands its retail origination and broker-sourced operations
into new geographic markets, it may face competition from lenders with
established positions in these locations. There can be no assurance that the
Company will be able to successfully compete with such established lenders.
Risks of Contracted Services
The Company typically retains servicing rights upon the sale of loans
originated or purchased by the Company and agrees to certain servicing
performance criteria. If the Company does not meet such servicing performance
criteria, the loan purchaser may terminate the servicing rights of the Company.
The Company has entered into an agreement with AMC pursuant to which it
sub-services loans originated or purchased by the Company after the
Reorganization. If AMC fails to meet the servicing performance criteria set
forth in the relevant servicing agreements governing the loans, the Company's
servicing rights could be terminated. Any
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<PAGE> 22
termination of servicing rights could have a material adverse effect on the
Company's results of operations and financial condition.
Impairment of Value of Loan Servicing Rights; Declining Interest Rates
The Company records gain on sales of loans based in part on the fair value
of retained servicing rights related to such loans. The fair value of such
servicing rights are in turn based in part on projected loan prepayment and
credit loss rates. Higher than anticipated rates of loan prepayment or credit
loss may be caused by, among other factors, a material decline in the level of
interest rates and could require the Company to write down the value of such
servicing rights which could have a material adverse effect on the Company's
results of operations and financial condition.
Dependence Upon Independent Mortgage Brokers
The Company depends on independent mortgage brokers, and, to a lesser
extent, smaller mortgage companies and commercial banks, for a substantial
portion of its originations and purchases of mortgage loans. Substantially all
of the independent mortgage brokers with whom the Company does business deal
with multiple loan originators for each prospective borrower. Such originators,
including the Company, compete for business based upon pricing, service, loan
fees and costs and other factors. The Company's competitors also seek to
establish relationships with such independent mortgage brokers, mortgage
companies and commercial banks, most of whom are not obligated by contract or
otherwise to continue to do business with the Company. In addition, the Company
expects the volume of broker-sourced loans purchased by the Company to increase.
The Company's future operating and financial results may be more susceptible to
fluctuations in the volume and cost of its broker-sourced loans resulting from,
among other things, competition from other purchasers of such loans.
Risks Related to Representations and Warranties in Loan Sales
The Company engages in bulk loan sales pursuant to agreements that
generally require the Company to repurchase or substitute loans in the event of
a breach of a representation or warranty made by the Company to the loan
purchaser, any misrepresentation during the mortgage loan origination process
or, in some cases, upon any fraud or first payment default on such mortgage
loans.
For loans the Company purchases from mortgage companies, banks and other
originators, the Company generally limits the potential remedies of the
institutions to which the Company later sells the loans to the potential
remedies the Company receives from the parties from whom the Company purchased
the loans. However, in some cases, the remedies available to a purchaser of
loans from the Company may be broader than those available to the Company
against the originators of such loans, and, even where this is not the case,
should a purchaser enforce its remedies against the Company, the Company may not
always be able to enforce its remedies against the related originators.
Any claims asserted against the Company in the future by one of its loan
purchasers may result in liabilities or legal expenses that could have a
material adverse effect on the Company's results of operations and financial
condition.
Concentration of Operations in California
Approximately 34% of the dollar volume of loans originated or purchased by
the Company during 1997 was secured by properties located in California. No
other state contained properties securing more than 10% of the dollar volume of
loans originated or purchased by the Company during 1997. Although the Company
has a nationwide independent broker network, developing nationwide retail
operations and a regional processing center network, the Company is likely to
continue to have a significant amount of its loan originations and purchases in
California for the foreseeable future, primarily because California represents a
significant portion of the national mortgage marketplace. Consequently, the
Company's results of operations and financial condition are dependent upon
general trends in the California economy and its residential real estate market.
The California economy experienced a slowdown or recession in recent years that
has been accompanied by a
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<PAGE> 23
sustained decline in the California real estate market. Residential real estate
market declines may adversely affect the values of the properties securing loans
such that the principal balances of such loans will equal or exceed the value of
the mortgaged properties. Reduced collateral value will adversely affect the
volume of the Company's loans as well as the pricing of the Company's loans and
the Company's ability to sell its loans. See "-- Economic Slowdown and Decline
in Collateral Value May Adversely Affect Volume of Loans" and "-- Focus on
Credit Impaired Borrowers May Result in Increased Delinquency Rates,
Foreclosures and Losses."
In addition, California historically has been vulnerable to certain natural
disaster risks, such as earthquakes and erosion-caused mudslides, which are not
typically covered by the standard hazard insurance policies maintained by
borrowers. Uninsured disasters may adversely impact borrowers' ability to repay
loans made by the Company. Because the Company sells its loans on a forward
basis, it is not exposed to the risk of loan delinquencies and defaults (except
to the extent they affect servicing rights) unless the Company is required to
repurchase or substitute a loan due to a breach of a representation or warranty
in connection with a loan sale, or, under certain circumstances, due to fraud or
default on the first payment due after sale. However, any sustained period of
increased delinquencies or defaults could adversely affect the pricing of the
Company's loan sales and the ability of the Company to sell its loans. The
existence of adverse economic conditions or the occurrence of such natural
disasters in California could have a material adverse effect on the Company's
results of operations and financial condition.
Ability of the Company to Implement its Growth Strategy
The Company's growth strategy involves expanding its broker-sourced loan
business through increased penetration into existing markets and expansion into
new markets and growing its direct-sourced loan origination business while
maintaining its customary premiums on sale, interest rate spreads and
underwriting criteria. Implementation of this strategy will depend in large part
on the Company's ability to (i) expand its independent mortgage broker network
and its direct-sourced origination activities in markets with a sufficient
concentration of borrowers meeting the Company's underwriting criteria, (ii)
hire, train and retain skilled employees, and (iii) continue to expand in the
face of increasing competition from other mortgage lenders. There can be no
assurance that the Company will be able to implement these growth strategies, or
that such strategies will be effective. See "Business."
ITEM 2. PROPERTIES
The Company's corporate headquarters are located at 1100 Town & Country
Road, Orange, California, 92868, where it leases approximately 39,000 square
feet of office space. The facilities are covered by several leases that, in
general, expire in 2001 and 2002, and have an option to renew for five years.
The current annual rent of such space is approximately $729,000 and the related
leases provide for certain scheduled increases in annual rent. The Company also
leases approximately 7,700 square feet of office space that is located in
buildings adjacent to 1100 Town & Country Road. The annual rent for these leases
is approximately $99,600. These leases expire in 2001.
The Company also leases or subleases space for seven Regional Processing
Centers and 66 account executive field offices. The Regional Processing Centers
range in size from 2,388 to 7,036 square feet and the account executive field
offices are between approximately 130 and 1,676 square feet.
The Company believes its facilities are both suitable and adequate for the
current business activities conducted at its existing corporate headquarters,
Regional Processing Centers and account executive field offices. As part of the
Company's geographic expansion, the Company anticipates leasing additional
office space in the future.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various routine legal proceedings arising out of
the ordinary course of its business. Management believes that none of these
actions, individually or in the aggregate, will have a material adverse effect
on the consolidated financial condition or results of operations of the Company.
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<PAGE> 24
When the Company operated as a division of AMC, it was involved in various
lawsuits incidental to its business, none of which had a material adverse effect
on the Company. In connection with the Reorganization, the Company did not
assume any liabilities that arose out of the lending activities of AMC,
including liabilities related to the broker-sourced mortgage loan operations,
nor has the Company agreed to indemnify AMC against any such liabilities.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders
during the quarter ended December 31, 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
In April 1997, the Company's common stock began trading under the symbol
LBFC on the Nasdaq National Market. The following table sets forth the range of
high and low closing sale prices of the Company's common stock for the periods
indicated:
<TABLE>
<CAPTION>
HIGH LOW
------- ------
<S> <C> <C>
1997
Second Quarter................................ $ 8.875 $6.500
Third Quarter................................. 13.563 8.750
Fourth Quarter................................ 15.063 9.875
</TABLE>
No dividends were declared during the period covered by the above table.
The Company does not anticipate declaring dividends in the near future. Any
decision made by the Company's Board of Directors to declare dividends in the
future will depend upon the Company's future earnings, capital requirements,
financial condition and other factors deemed relevant by the Company's Board of
Directors.
On March 15, 1998, the Company had approximately 32 stockholders of record
of its common stock. The Company believes its common stock is beneficially held
by more than 3,500 stockholders.
On April 28, 1997, the Company's Registration Statement with respect to the
initial public offering of its common stock was declared effective. See
"Business -- Corporate History." All proceeds from the sale of shares were
received by AMC, who was the sole stockholder of LBFC prior to the initial
public offering. Total underwriting discounts and commission of approximately
$11.4 million were also recognized by AMC, bringing the total net proceeds from
the sale of stock to approximately $151.1 million.
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<PAGE> 25
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues............................ $ 92,666 $ 51,160 $ 31,873 $ 22,364 $24,715
Total expenses............................ 50,833 35,188 21,912 22,328 12,823
Net earnings.............................. $ 24,644 $ 9,392 $ 5,792 $ 22 $ 5,612
Basic earnings per share:
Net earnings............................ $ 0.99 n/a n/a n/a n/a
Average number of common shares......... 24,976 n/a n/a n/a n/a
Diluted earnings per share:
Net earnings............................ $ 0.96 n/a n/a n/a n/a
Average number of common shares......... 25,653 n/a n/a n/a n/a
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF FINANCIAL CONDITION DATA:
Cash and cash equivalents................. $ 38,782 $ -- $ -- $ -- $ --
Loans held for sale....................... 17,241 49,580 21,342 10,364 9,950
Capitalized mortgage servicing rights..... 3,054 -- -- -- --
Deferred income taxes..................... 34,400 2,120 882 -- --
Total assets.............................. 248,088 79,750 24,778 12,529 10,887
Warehouse financing facility.............. 146,271 72,829 20,613 11,483 --
Total liabilities......................... 157,343 78,613 23,046 13,391 11,014
Stockholders' and divisional equity
(deficit)............................... 90,745 1,137 1,732 (862) (127)
OPERATING DATA:
Loans originated and purchased............ $1,685,742 $1,058,122 $592,542 $565,547 (a)
Loan sales................................ 1,679,522 1,029,789 580,366 562,054 (a)
G&A as a % of originations................ 2.72% 3.29% 3.70% 3.95% (a)
Gain on sale as a % of loans sold......... 5.28% 4.92% 5.46% 3.86% (a)
States in which loans were originated..... 48 43 35 27 (a)
Account Executives at year end............ 232 120 64 79 (a)
Independent broker relationships.......... 10,000 7,000 5,000 4,000 (a)
</TABLE>
- ---------------
(a) Such amounts are not available from AMC. See Management's Discussion and
Analysis of Financial Condition, Results of Operations, Liquidity and
Capital Resources regarding AMC as the source of historical data.
23
<PAGE> 26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION, RESULTS OF
OPERATIONS, LIQUIDITY AND CAPITAL RESOURCES
Management's discussion and analysis of financial condition, results of
operations, liquidity and capital resources contained within this report should
be read in conjunction with the Company's Consolidated Financial Statements. The
Notes to the Consolidated Financial Statements define certain terms that are
used throughout this discussion and provide information on the Company's initial
public offering and the basis of presentation.
GENERAL
The Company is a specialty finance company engaged in the business of
originating, purchasing and selling subprime residential mortgage loans secured
by one- to four-unit family residences. The Company's core borrower base
consists of individuals who do not qualify as traditional "A" credit borrowers
because their credit history, debt to income ratio or other factors do not
conform to standard agency lending criteria. The Company originates loans
through independent mortgage brokers and, to a lesser extent, purchases loans
from mortgage companies and commercial banks. Substantially all of the Company's
loan originations and purchases are sold in the secondary market through loan
sales in which the Company disposes of its economic interest in the loans for
cash, except for the related servicing rights, which it has generally retained.
There may be some instances when all servicing rights are sold. As a result of
this overall strategy, the Company receives cash revenue, rather than
recognizing non-cash revenue attributable to residual interests in future
payments on the loans, as is the case with securitizations. See "Business."
Prior to May 1997, the Company operated as the Wholesale Division of a
company now known as Ameriquest Mortgage Company ("AMC"). In May of 1997, AMC
reorganized (the "Reorganization") its business operations by transferring
certain assets, liabilities and personnel relating to the Company and
approximately $40.0 million in cash (less approximately $2.0 million in related
expenses) to the Company in exchange for 24,999,999 shares of common stock.
Immediately after the Reorganization, the initial public offering of 25,000,000
shares of LBFC common stock was completed. The Reorganization has been accounted
for in manner similar to a pooling of interests and therefore, the historical
cost basis of the assets and liabilities transferred to the Company was carried
over from AMC.
The assets transferred to the Company included loans in process as of May
2, 1997, but did not include loans funded or servicing rights with respect to
loans funded prior to May 2, 1997. The rights to loans which were originated by
the Wholesale Division but remained unsold at May 2, 1997 were retained by AMC
(the "Retained Loans"). The costs relating to the production of these loans were
incurred and recorded by the Wholesale Division and are included in the
Company's consolidated results of operations for 1997. These loans are included
in loan production amounts reported for the Company for the year ended December
31, 1997. Subsequent to the Reorganization, the Company purchased the Retained
Loans from AMC at the same price and at the same time that the Company sold
these loans to independent, third-party purchasers. Because the gain from the
sale of the Retained Loans was recorded after the Reorganization, and because
the Company's stockholders did not receive any of the benefit of this gain, the
Company did not include the gain from the sale of the Retained Loans as part of
the Company's net earnings in 1997. The principal amount of the Retained Loans
was approximately $33.8 million and the after-tax gain from the sale of these
loans was approximately $807,000. The gains from the sale of the Retained Loans
are not reflected either as income of the Wholesale Division of AMC or as income
of the Company.
Because the Reorganization was accounted for in a manner similar to a
pooling of interests, the information contained within this report includes the
following: (i) for the year ended December 31, 1997, combined results of
operations represent activity for the Wholesale Division of AMC from January 1,
1997 through May 1, 1997 and activity for the Company from May 2, 1997 through
December 31, 1997; and (ii) for the years ended December 31, 1996 and 1995,
results of operations represent activity solely for the Wholesale Division of
AMC. All of the benefits, rights and obligations relating to the operations and
net earnings of the Wholesale Division of AMC, up to the date of the
Reorganization, remained with AMC.
The financial statements of the Company, up to the date of the
Reorganization, have been prepared in part from records maintained by AMC. The
historical financial statements of the Company, up to the date of
24
<PAGE> 27
the Reorganization, may not necessarily be indicative of the conditions that
would have existed if the Company had operated as an independent entity. The
financial statements, up to the date of the Reorganization, reflect key
assumptions regarding the allocation of certain revenue and expense items and
certain balance sheet accounts, many of which could be material. In particular,
in cases involving assets, liabilities, revenues and expenses not specifically
identifiable to any particular division of AMC, certain allocations were made to
reflect the operations of the Company. These allocations were based on a variety
of factors which management believes provide a reliable basis for the financial
statements. A summary of the combined net earnings for the year ended December
31, 1997 follows:
<TABLE>
<CAPTION>
WHOLESALE THE COMPANY
DIVISION OF MAY 2 THROUGH
AMC DEC. 31, 1997 COMBINED
----------- ------------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Total revenues........................... $25,772 $66,894 $92,666
Total expenses........................... 15,841 34,992 50,833
Net earnings............................. 5,947 18,697 24,644
Basic earnings per share................. 0.24 0.75 0.99
Diluted earnings per share............... 0.24 0.72 0.96
Pro forma net earnings inclusive of gain
on sale of Retained Loans.............. 6,754 18,697 25,451
Pro forma basic earnings per share....... 0.27 0.75 1.02
Pro forma diluted earnings per share..... 0.27 0.72 0.99
</TABLE>
The primary components of the Company's revenues are gain on sales of loans
and net interest income. Gain on sales of loans consists of: (i) the excess of
the cash selling price over the outstanding principal balance of the loan (the
"Gross Sales Premium"), minus (ii) the fees and other compensation paid to
independent mortgage brokers and other lenders (the "Broker Fees"), plus (iii)
capitalized servicing rights, and plus (iv) points and fees received from the
borrower, offset by incremental direct loan origination costs. Gross Sales
Premiums are affected by market conditions, loan type, credit quality, interest
rate and other factors as negotiated between the Company and independent
purchasers. The recorded net gain on sale of loans, as expressed as a percentage
of loans sold, is the "Net Premium" realized for that period.
Net interest income represents the difference between the interest that is
earned on loans and other interest earning assets over the interest that is paid
under the revolving warehouse credit facility. Net interest income can be
affected by the volatility of interest rates, the level of interest earned on
interest earning assets, the cost of interest on the revolving warehouse credit
facility, the average amount of interest earning assets outstanding, and the
average amount of borrowings outstanding. The Company received approximately
$40.0 million in cash (less approximately $2.0 million in related expenses) as
part of the Reorganization. The Company has adopted an investment policy which
limits its investment activities to high-quality, short-term investments.
Expenses include general and administrative expenses, provisions for
losses, sub-servicing costs and income tax expense. Prior to the Reorganization,
certain expenses, not specifically identifiable to any particular division of
AMC, were allocated to AMC's various divisions, including the Wholesale
Division. These allocations were prepared by AMC and, according to AMC, were
based on a variety of factors which took into consideration loan origination
volume, employee headcount, and historical ratios of direct expenses incurred by
the divisions to total direct expenses. No assurance can be provided that future
expenses incurred by the Company, as an independent entity, will be comparable
to the historical levels allocated by AMC to the Wholesale Division.
The following table presents the Company's loan originations and purchases
and loan sales for the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- --------
<S> <C> <C> <C>
Loan originations and purchases......... $1,685,742 $1,058,122 $592,542
Loan sales.............................. 1,679,522 1,029,789 580,366
</TABLE>
25
<PAGE> 28
The Company's primary channel of loan production is through its
relationship with a network of approved independent mortgage brokers. The
Company has established a sales force ("Account Executives") to serve as the
principal contact between the Company and the independent mortgage brokers. The
Company offers a variety of loan programs and products; however, substantially
all loans originated by the Company are secured by first-lien mortgages on
residential properties consisting of one- to four-unit family residences. In
addition to originating loans through independent mortgage brokers, the Company
purchases loans on a correspondent basis from other lenders. Loan purchases
totaled $151.8 million or 9.0% of production for the year ended December 31,
1997, as compared to $32.3 million or 3.1% and $5.4 million or 0.9% for the
years ended December 31, 1996 and 1995, respectively.
The Company's geographic markets are divided into various regions. Once the
Company determines that the level of current and projected business from a
region warrants creation of a local presence, the Company establishes a Regional
Processing Center in or near the region.
The Company follows the practice of entering into forward commitments to
sell its production. These forward commitments are typically made for the next
30 to 120 days of production. Prior to entering into a forward commitment, the
Company evaluates prospective purchasers in order to assess their ability to
fulfill the terms of the agreement. In the event that the coupon rate or margin
of the loans originated and delivered to the purchaser are materially different
from the terms of the forward commitment, the sales price of the loans will be
adjusted accordingly.
Loan sales are made to institutional purchasers on a nonrecourse basis
pursuant to a purchase agreement containing customary representations and
warranties regarding underwriting criteria and the origination process. The
Company has not retained residual interests in the loans that it sells other
than servicing rights. In addition, in the event of a breach of a representation
or a warranty, the Company may be required to repurchase or substitute a new
loan. The Company may also be required to repurchase or substitute a loan if the
borrower defaults on the first payment due after the loan is funded or if the
loan documentation contains fraudulent misrepresentations made by the borrower.
Such repurchase or substitution may result in the Company recording a reduction
in the gain on sale that it previously recognized and/or a loss. The Company
realizes that such repurchases are inherent in its operations and that the
Company may realize a reduction in the previously recognized gain on sale or
sustain a loss from such repurchases. The Company provides allowances for losses
to cover all such activities that arise in connection with originating loans and
subsequently selling them to investors.
RESULTS OF OPERATIONS
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
The Company had substantial growth in 1997 as a result of increased loan
originations and purchases in both existing and new markets. Net earnings
increased by $15.3 million or 162.4% to $24.6 million in 1997 from $9.4 million
in 1996.
The primary factors that led to the improvement in net earnings recorded
during 1997 as compared to 1996 include:
- Increased loan production. Loan production increased by $627.6 million or
59.3% to $1.7 billion during the year ended December 31, 1997 as compared
to the same period of 1996.
- Increased loan sales. Loans sold during the year ended December 31, 1997
totaled $1.7 billion, an increase of $649.7 million or 63.1% over the
same period of 1996.
- Higher premiums received on the sale of loans. Net Premiums on the sale
of loans during the year ended December 31, 1997 totaled 5.28% as
compared to 4.92% for the same period of 1996.
- Improved operational efficiencies. General and administrative expenses as
a percent of loan production declined to 2.72% during the year ended
December 31, 1997, from 3.29% during the same period in 1996.
26
<PAGE> 29
Revenues. The following table sets forth the components of the Company's
revenues for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-----------------
1997 1996
------- -------
(IN THOUSANDS)
<S> <C> <C>
Gain on sale of loans....................................... $88,597 $50,699
Loan servicing and other fees, net.......................... 715 --
Net interest income......................................... 3,354 461
------- -------
Total revenues.................................... $92,666 $51,160
======= =======
</TABLE>
Total revenues increased by $41.5 million or 81.1% in 1997, compared to
1996, as a direct result of an increase in gain on sales of loans of $37.9
million or 74.8% in 1997, compared to 1996. The primary factors contributing to
this increase are: (i) an increase in loan sales of 63.1% to $1.7 billion in
1997, as compared to 1996, and (ii) an increase in the Net Premiums on the sale
of loans to 5.28% in 1997 from 4.92% in 1996.
The increase in loan sales resulted from an increase in loan originations
and purchases to $1.7 billion in 1997 from $1.1 billion in 1996, which reflects
the Company's goal to profitably expand its broker-sourced business through
penetration in its existing markets and expansion into new geographic markets.
The number of Account Executives increased to approximately 232 at December 31,
1997 compared to approximately 120 at December 31, 1996. The Company's efforts
to expand the number of approved independent mortgage brokers resulted in
approximately 10,000 approved brokers at December 31, 1997 compared to
approximately 7,000 approved brokers at December 31, 1996. During 1997, the
Company originated loans in 48 states compared to 43 states during 1996. Loan
originations in California during 1997 represented 34.4% of total loan
production for the year.
Net Premiums on the sale of loans increased in 1997 as a result of higher
Gross Sales Premiums negotiated on loans sold, partially offset by both higher
Broker Fees paid and a reduced level of capitalized mortgage servicing rights
recognized at the time of sale. Gross Sales Premiums on loans sold increased to
6.03% in 1997 compared to 4.77% in 1996, while at the same time, Broker Fees
increased to 1.36% of loans sold compared to 0.93% in 1996. Capitalized mortgage
servicing rights recognized at the time of sale dropped to 0.43% in 1997 from
0.90% in 1996, primarily due to an increase in the estimated cost to service
loans resulting from the need to contract with a sub-servicer immediately
following the Reorganization.
Investor demand for the type of product originated, the number of sources
from which investors can obtain such products and the direction of mortgage
interest rates all have a direct impact on the negotiated Gross Sales Premiums.
A recent decline in interest rates for mortgage loans has resulted in a higher
perception of prepayments which, coupled with an increase in the level of
competition in the sub-prime sector, may negatively impact the Gross Sales
Premiums the Company will be able to receive on future loan sales. Planned
expansion in the retail loan origination channel, however, should result in a
favorable impact on the Company's gain on sale since such originations do not
result in any broker or correspondent fees paid. There can be no assurance
provided that the Company will be able to maintain its historical level of Gross
Sales Premiums and Net Premiums or that it will be able to generate sufficient
volume in retail loan originations.
Loan servicing and other fees totaled $715,000 in 1997, net of amortization
of mortgage servicing rights totaling $231,000. The Company generally earns an
annual 50 basis points on the outstanding principal balance of each loan it
services, and retains the right to receive late fees and other charges in
connection with the servicing of such loans. At December 31, 1997, the
outstanding balance of the servicing portfolio totaled $896.2 million, including
certain loans serviced on an interim basis until servicing is transferred to the
purchasing investor. Prior to the Reorganization, all related loan servicing
revenues were recognized by an affiliated division of AMC.
Net interest income totaled $3.4 million in 1997, an increase of $2.9
million or 627.5%, compared to 1996. Such increase resulted from a higher level
of loans held for sale during the period, partially offset by a higher level of
advances under the revolving warehouse financing facility, coupled with
investment returns
27
<PAGE> 30
from the Company's short-term investment securities. During 1997, the Company
began utilizing its excess liquidity to fund a portion of its loan originations.
This strategy resulted in higher levels of return on investments and allowed the
Company the flexibility to transfer such loans to its warehouse line on a
same-day basis.
Expenses. The following table sets forth the components of the Company's
expenses for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-----------------
1997 1996
------- -------
(IN THOUSANDS)
<S> <C> <C>
Compensation............................................... $32,229 $17,168
Premises and equipment..................................... 4,141 3,870
Other general and administrative........................... 7,206 4,900
------- -------
Total direct expenses................................. 43,576 25,938
Allocated expenses from AMC................................ 2,294 8,900
------- -------
Total general and administrative...................... 45,870 34,838
Provision for losses....................................... 4,028 350
Sub-servicing costs........................................ 935 --
------- -------
Total expenses................................... $50,833 $35,188
======= =======
</TABLE>
Compensation expense increased 87.7% or $15.1 million in 1997 as compared
to 1996. The increased level of compensation expense represents 85.4% of the
total increase in direct general and administrative expenses in 1997 as compared
to 1996. The primary reason for such increase is growth in the number of
employees resulting from the Company's expansion of its loan production
capabilities. The number of employees totaled 578 at December 31, 1997, up from
338 at December 31, 1996. The increase in compensation expense is also
attributable to increases in commissions paid to production employees. Both the
growth in the employee base and the increased commissions are directly related
to increased loan production during 1997 as compared to 1996. Although total
general and administrative expenses increased in 1997, as compared to 1996, such
expenses declined as a percentage of loan production to 2.72% in 1997, as
compared to 3.29% in 1996.
Premises and equipment expenses increased by $271,000 or 7.0%, to $4.1
million in 1997, as compared to $3.9 million in 1996, reflecting an increase in
occupancy costs related to growth in personnel forces to support the increased
loan production as well as an increase in headquarters' space to support the
Company as an independent entity since the Reorganization.
Other general and administrative expenses increased by $2.3 million or
47.1% to $7.2 million in 1997, as compared to $4.9 million in 1996. The increase
in other general and administrative expenses is primarily the result of
increased infrastructure and indirect costs incurred in support of the Company's
loan production. As more fully discussed in the Notes to the Company's
Consolidated Financial Statements, since the Reorganization, the Company had
entered into several agreements with AMC, pursuant to which AMC provided data
processing, human resources and, through August 1997, mail room services to the
Company. The Company has paid $1.1 million to AMC for such services during 1997
since the Reorganization. The Company has developed an internal capacity for
these functions and has given AMC notice to curtail those agreements. Expenses
as a percent of production may increase due to the development of those
independent capabilities to replace contracted services initially being provided
by AMC. In addition, the Company provided certain services to AMC, as described
in Note 11 to the Company's Consolidated Financial Statements. The Company has
received $440,000 from AMC for such services during 1997 since the
Reorganization. The Company has received notice from AMC to curtail those
services.
Prior to the Reorganization, the Wholesale Division received an allocation
of expenses from AMC, as detailed in Note 1 to the Company's Consolidated
Financial Statements. Immediately following the
28
<PAGE> 31
Reorganization, such allocations ceased as the Company now incurs all of its
expenses directly. In 1997, such allocated expenses from AMC totaled $2.3
million compared to $8.9 million in 1996.
Provision for losses increased to $4.0 million in 1997 compared to $350,000
in 1996. Prior to the Reorganization, the Wholesale Division received an
allocation from AMC based on the total provision for losses recorded by AMC.
Such allocation totaled $2.8 million in 1997 and is primarily the result of a
loss recorded by AMC related to the repurchase of certain loans in 1997.
Provision for losses totaling $1.2 million has been recorded by the Company
since the Reorganization to provide for any future losses resulting from
breaches of representations and warranties, first payment defaults, and other
factors.
As more fully discussed in Note 11 to the Company's Consolidated Financial
Statements, since the Reorganization, the Company has entered into an agreement
with AMC pursuant to which AMC agreed to sub-service mortgage loans originated
or purchased by the Company after the Reorganization. The Company has agreed to
pay AMC a 45 basis point annual servicing fee on the outstanding principal
balance of each loan sub-serviced. Such sub-servicing costs in 1997 amounted to
$935,000.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
The Company had substantial growth in 1996 as a result of increased loan
originations and purchases in both existing and new markets. Total revenues
increased $19.3 million or 60.5% to $51.2 million in 1996 from $31.9 million in
1995. During the same period, The Company's total expenses increased $13.3
million or 60.6% to $35.2 million in 1996 compared to $21.9 million in 1995. As
a result, net earnings increased $3.6 million or 62.2% to $9.4 million in 1996
from $5.8 million in 1995.
Revenues. The following table sets forth the components of the Company's
revenues for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-----------------
1996 1995
------- -------
(IN THOUSANDS)
<S> <C> <C>
Gain on sale of loans...................................... $50,699 $31,691
Net interest income........................................ 461 182
------- -------
Total revenues................................... $51,160 $31,873
======= =======
</TABLE>
The increase in revenues was due primarily to an increase of $465.6 million
or 78.6% in loan originations and purchases to $1.1 billion in 1996 compared to
$592.5 million in 1995, which resulted in increased loan sales. The increase in
loan originations and purchases was due to both increased production in existing
markets and expansion into new markets.
Gain on sale of loans increased $19.0 million or 60.0% to $50.7 million in
1996 from $31.7 million in 1995. The increase was due primarily to the 78.6%
increase in loan originations and purchases during 1996. Loan sales totaled $1.0
billion in 1996 with a weighted average gain on sale of 4.92%. During 1995, loan
sales totaled $580.4 million with a weighted average gain on sale of 5.46%. The
decline in weighted average gain on sale was attributable to fixed rate loans,
which typically yield a lower average gain on sale than adjustable rate loans,
constituting 37.1% of the loans sold in 1996 compared to 13.3% of the loans sold
in 1995.
Net interest income increased $279,000 or 153.3% to $461,000 in 1996 from
$182,000 in 1995. This increase was due to a higher balance of loans held for
sale during 1996 as a result of the increase in loan originations and purchases
during the year, partially offset by greater short-term borrowings under the
warehouse financing facility to fund the increased loan originations and
purchases.
29
<PAGE> 32
Expenses. The following table sets forth the components of the Company's
expenses for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
1996 1995
------- -------
(IN THOUSANDS)
<S> <C> <C>
Compensation............................................. $17,168 $ 9,352
Premises and equipment................................... 3,870 3,009
Other general and administrative......................... 4,900 2,591
------- -------
Total direct expenses............................... 25,938 14,952
Allocated expenses from AMC.............................. 8,900 6,960
------- -------
Total general and administrative.................... 34,838 21,912
Provision for losses..................................... 350 --
------- -------
Total expenses................................. $35,188 $21,912
======= =======
</TABLE>
Compensation expense increased $7.8 million or 83.6% to $17.2 million in
1996 from $9.4 million in 1995. The primary reason for the increase was due to
an increase in the number of employees from 175 at December 31, 1995 to 338 at
December 31, 1996. Also contributing to the increase was an increase in
commissions paid to employees in 1996. Both of such increases were due to an
increase in loan volume to $1.1 billion in 1996 from $592.5 million in 1995.
Premises and equipment expenses increased $861,000 or 28.6% to $3.9 million
in 1996 compared to $3.0 million in 1995. Such increase was due to the
establishment of 18 new loan origination offices and two regional processing
centers and the relocation of the corporate headquarters to a larger facility
during 1996. New computer and office equipment was also added during 1996 to
support the Company's expanded work force.
Other general and administrative expenses increased $2.3 million or 89.1%
to $4.9 million in 1996 compared to $2.6 million in 1995. Such increase was due
to the expansion of the Company's loan origination office network and increased
loan originations during 1996 which resulted in increased marketing, office
supplies, courier services and other related costs. In addition, a higher level
of legal and professional services were required during 1996 to complete the DOJ
settlement in September 1996.
Allocated expenses from AMC increased $1.9 million or 27.9% to $8.9 million
in 1996 compared to $7.0 million in 1995. Such increase was primarily the result
of $1.1 million of DOJ settlement costs allocated in 1996 compared to $0.3
million of settlement cost allocated in 1995.
Allocated provision for losses from AMC totaled $350,000 in 1996, with no
comparable allocation in 1995.
Income Taxes
The effective income tax rates for 1997, 1996 and 1995 were 41.1%, 41.2%
and 41.9%, respectively. Prior to the Reorganization, the Wholesale Division was
not a separate legal entity for tax purposes. Because the Wholesale Division was
part of AMC until the Reorganization, AMC is responsible for payment of federal
and state income taxes attributable to income earned by the Wholesale Division
of AMC prior to the Reorganization.
As discussed in Note 7 to the Company's Consolidated Financial Statements,
the amortization of the deferred tax asset has no impact on the Company's
provision for income taxes, rather it reduces the amount of income taxes payable
to the Internal Revenue Service ("IRS"). In 1997, the Company recorded $1.6
million of amortization related to the deferred tax asset.
30
<PAGE> 33
FINANCIAL CONDITION
The Company's financial position gained strength in 1997 as a result of its
profitable operating results along with completion of the Reorganization and
initial public offering of its common stock.
The Reorganization was accounted for in a manner similar to a pooling of
interests. Therefore, for financial reporting purposes, the Company recorded the
assets transferred from AMC at their historical cost basis. The assets
transferred from AMC to the Company included approximately $40.0 million in cash
(less approximately $2.0 million in related expenses) and $1.7 million in
furniture, equipment and other fixed assets. The Company assumed certain
liabilities relating to lease obligations associated with equipment and property
acquired by the Company and accrued vacation and other employee benefit
obligations associated with personnel transferred to the Company. The Company
did not acquire or assume any of the rights or obligations relating to: (i)
loans funded prior to the Reorganization, (ii) servicing rights related to loans
funded prior to the Reorganization, or (iii) any other liability arising from
operations of the Wholesale Division of AMC prior to the Reorganization.
Additionally, the Company acquired a number of intangible assets at the
time of the Reorganization. These intangible assets include: (i) the sole right
to the Long Beach Mortgage name, (ii) the going-concern value of the existing
and established approved customer base of independent mortgage brokers that had
been developed by the Wholesale Division of AMC, (iii) the employees of the
Wholesale Division, and (iv) other intangible assets. As discussed in Note 7 to
the Consolidated Financial Statements, for federal income tax purposes, the
transfer of assets at the time of the Reorganization was treated as a taxable
sale of assets. Based upon the offering price of $6.50 per share, the excess of
the tax basis of the Company's net assets over their book value was
approximately $117.5 million, resulting in a gross deferred tax asset of $47.0
million. The Company recorded a net deferred asset of $36.0 million to take into
account the potential that the IRS may disallow some portion of the resulting
deduction. The Company is amortizing the deferred asset over a 15-year period.
Such amortization will have no impact on the Company's reported net earnings,
but will reduce the amount of taxable liability due to the IRS. The Company
currently believes that it is probable that the Company will generate sufficient
taxable income to realize the benefits associated with the net deferred tax
asset through future tax deductions. However, if the Company determines that
estimated future earnings are not sufficient to realize the deferred tax
benefit, the Company will establish a valuation allowance for the impairment of
the deferred tax assets, through a charge to the income tax provision, which
will result in a reduction of net earnings.
A substantial portion of the Company's cash and cash equivalents are
maintained in an account with its warehouse lender. The Company earns interest
on these funds at a yield that approximates the 30 day reserve adjusted London
Inter-Bank Offered Rate ("LIBOR"). At December 31, 1997, cash and cash
equivalents included $9.0 million in funds which were borrowed from its
warehouse lender for the funding of loans. Such advances were not needed and
were repaid to the warehouse lender the following day.
As discussed in more detail in Liquidity and Capital Resources, the
Company's investment securities consists of high-quality, short-term securities.
At December 31, 1997, the largest component of the Company's investment
securities consisted of a money market mutual fund, which limits it holdings to
government securities. These securities are available for sale, and their market
value approximated their historical cost basis at December 31, 1997.
Loans held for sale decreased $32.3 million from the prior year level,
reflecting the increase in loan sales activity over the same period and the
increase in receivable from the sales of loans, as discussed below. Loans held
for sale are valued at the lower of their historical cost basis or market value,
determined on an aggregate basis. At December 31, 1997, the market value of
these loans exceeded their historical cost basis.
Receivable from the sales of loans represents the proceeds from the sales
of loans that have not been received by the Company from the purchaser.
Receivable from the sales of loans increased $118.0 million from the prior year
level, reflecting the increase in loan sales activity over the same period. As
of February 28, 1998, all proceeds related the receivable from the sales of
loans had been collected.
31
<PAGE> 34
At December 31, 1997, the Company had recorded $3.1 million of capitalized
servicing rights, net of amortization which totaled $231,000 in 1997. The
Company, in its capacity as a master servicer, has contracted with a
sub-servicer, AMC, to provide loan servicing in exchange for an annual fee of 45
basis points on the outstanding principal balance of each loan sub-serviced.
When the Company sells its loans, it typically retains approximately 50 basis
points of servicing. Additionally, the Company generally retains the right to
receive late fees and other charges in connection with the servicing of the
loans. The Company anticipates that it will develop an internal capacity to
service its loans in the future. Its current arrangement with AMC may be
terminated at any time after November 2, 1998, upon six months prior written
notice or in the event AMC defaults on its obligation as a sub-servicer.
Capitalized servicing rights are subject to downward valuation in the event that
the market value of the servicing is lower than the recorded amounts, which
typically occurs when the related loans have higher ratios of loss (charge-offs)
and/or rates of prepayment than had been predicted at the time of sale. Prior to
the Reorganization, immediately after sale of the loans, the Company transferred
the related servicing rights to an affiliated division of AMC at their carrying
value.
The Company's capitalization is as follows, for the periods indicated
(dollars in thousands):
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------------------
1997 1996
--------------- --------------
<S> <C> <C> <C> <C>
Warehouse financing facility.............. $146,271 62% $72,829 98%
Divisional equity......................... -- -- 1,137 2
Stockholders' equity...................... 90,745 38 -- --
-------- --- ------- ---
Total capitalization............ $237,016 100% $73,966 100%
======== === ======= ===
</TABLE>
Warehouse financing facility increased $73.4 million over the prior year
level as a result of the increase in loan originations and purchases over the
same period. However, as a percentage of total capitalization, warehouse
financing facility reflects a significant decrease over the prior year
percentage. Stockholders' and divisional equity increased $89.6 million over
1996, reflecting profitable operating results for the current year along with
the completion of the Reorganization and initial public offering of common stock
during 1997. These increases were partially offset by treasury stock purchases
of $3.3 million during 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company had $38.8 million in cash and cash equivalents at December 31,
1997, reflecting positive cash flows generated since the Reorganization. Prior
to the Reorganization, all cash generated by the Wholesale Division of AMC was
collected by AMC, and as such, cash and cash equivalents for the Company reflect
zero balances for the years ending December 31, 1996 and 1995. Nonetheless, the
Company has historically generated positive cash flow. Sources of cash flow
include loan sales, net interest income and borrowings. Uses of cash include the
funding of loan originations and purchases, repayment of borrowings and related
interest expenses, operating and administrative expenses, income taxes and
capital expenditures.
The Company funds its operations through its cash reserves, loan sales, net
earnings and a revolving warehouse credit facility under which it borrows money
to finance the origination and purchase of loans. Additionally, the Company may
utilize its cash reserves to fund its loan production in order to maximize the
return on its excess liquidity. The Company repays borrowings with the proceeds
from its loan sales. During the years ended December 31, 1997, 1996 and 1995,
the Company used cash in the amount of $1.7 billion, $1.1 billion and $592.5
million, respectively, for new loan originations and purchases. During the same
periods, the Company received cash proceeds from the sale of loans of $1.7
billion, $1.0 billion and $580.4 million, respectively, representing the
principal balance of loans sold. The Company received cash proceeds from the
premiums on such loans sales of $96.5 million, $48.7 million and $31.3 million,
respectively, for 1997, 1996 and 1995.
Prior to the Reorganization, the Wholesale Division funded loans by
borrowing under AMC's revolving warehouse credit facility. Since the date of the
Reorganization, the Company has in place a $200.0 million warehouse financing
facility provided by a syndicate of banks led by Chase Bank of Texas which
expires on March 31, 1999, unless earlier terminated or extended in accordance
with its terms. The facility was increased
32
<PAGE> 35
to $250 million in January 1998 and an increase to $300 million is pending. The
Company was in compliance with all of its covenants surrounding its warehouse
financing at December 31, 1997. The weighted-average interest rate on the
warehouse line was 7.23% at December 31, 1997.
Subsequent to the Reorganization, the Company adopted an investment program
for its available liquidity. The objectives of this program are to preserve the
capital of the Company while maintaining flexibility for strategic
opportunities. The Company's investment strategy seeks to maximize its returns
within the policy's objectives. The weighted-average yield on the Company's
investment portfolio at December 31, 1997 was 5.86%.
The Company will also be using its available liquidity to repurchase shares
of its stock on the open market. Pursuant to a stock repurchase plan adopted by
the Board of Directors in October 1997, the Company is authorized to repurchase
up to 2.5 million shares of the Company's common stock through the end of
September 1999. During 1997, the Company used $3.3 million of available
liquidity to purchase 300,000 shares of its common stock. In January 1998, the
Company used $3.0 million of available liquidity to purchase an additional
292,682 shares of its common stock.
The Company's desire to retain its flexibility, with respect to its
available liquidity, is due, in part, to certain of the Company's strategic
plans for the future. The Company is evaluating various strategies for expanding
its retail loan production operation as well as developing a loan servicing
operation. The development of an internal computer data center was in process
during 1997 and completed in February 1998. Additionally, new Regional
Processing Centers will be established to support the Company's capacity for
increased wholesale loan production. Each of these strategies require capital
investment.
The Company is aware of ensuing issues involving the upcoming date change
from December 31, 1999 to January 1, 2000 ("Year 2000") and the effect of such
change on the Company's information systems. In order to identify and minimize
any impact that Year 2000 may have on the Company, a task force was established
to evaluate operational activities that could be affected by such date change.
As part of the evaluation, both internal and external systems were identified as
critical to the Company's operations. As a result, the task force is currently
developing a detailed operational plan to resolve any issues and risks
identified in the initial examination. The task force has estimated that the
majority of the primary issues surrounding Year 2000 will be resolved by the end
of 1998. The Company does not believe that the cost of addressing all of the
issues associated with becoming Year 2000 compliant will have a material impact
on its results of operations or financial condition.
The Company believes that it will generate sufficient cash from its
operations and borrowings to fund its operations. However, the Company's ability
to continue to originate and purchase loans is dependent in large part upon its
ability to sell the loans at a premium in order to generate cash proceeds to
repay borrowings under the warehouse financing facility, thereby creating
borrowing capacity to fund new originations and purchases. The value of and
market for the Company's loans are dependent upon a number of factors, including
the loan-to-value ratios and interest rates on the loans, general economic
conditions, interest rates and governmental regulations. Adverse changes in such
factors may affect the Company's ability to sell loans for acceptable prices
within a reasonable period of time. A prolonged, substantial reduction in the
size of the secondary market for loans of the type originated or purchased by
the Company may adversely affect the Company's ability to sell loans in the
secondary market with a consequent adverse impact on the Company's results of
operations, financial condition and ability to fund future originations and
purchases.
ACCOUNTING CONSIDERATIONS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 130, "Reporting
Comprehensive Income," which is effective for annual periods beginning after
December 15, 1997. This statement requires that all items that are required to
be recognized under accounting standards as comprehensive income be reported in
a financial statement that is displayed with the same prominence as other items
reported in a financial statement. The adoption of SFAS No. 130 will not have a
material impact on the Company's financial statements.
33
<PAGE> 36
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which is effective for annual and
interim periods beginning after December 15, 1997. This statement established
standards for the method in which public entities report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about product and services, geographical areas, and major
customers. The adoption of SFAS No. 131 will not have a material impact on the
Company's financial statements.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which is effective for annual
and interim periods beginning after December 15, 1997. This statement revises
employers' disclosures about pensions and other postretirement benefit plans. It
does not change the measurement or recognition of those plans but instead
standardizes the disclosure requirements to the extent practicable, requiring
additional information on changes in the benefit obligations and fair values of
plan assets that will facilitate financial analysis, and eliminating certain
disclosures that are no longer deemed useful. The adoption of SFAS No. 132 will
not have a material impact on the Company's financial statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Consolidated Financial Statements beginning on Page F-1 of this Annual
Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is set forth under the caption
"Executive Compensation and Other Information" in the Company's definitive Proxy
Statement (the "Proxy Statement"), which will be filed with the Securities and
Exchange Commission pursuant to Regulation 14A under the Securities and Exchange
Act of 1934 and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the caption
"Executive Compensation and Other Information" in the Proxy Statement, which
will be filed with the Securities and Exchange Commission pursuant to Regulation
14A under the Securities and Exchange Act of 1934 and is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is set forth under the caption
"Security Ownership of Certain Beneficial Owners and Management" in the Proxy
Statement, which will be filed with the Securities and Exchange Commission
pursuant to Regulation 14A under the Securities and Exchange Act of 1934 and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is set forth under the caption
"Certain Relationships and Related Transactions" in the Proxy Statement, which
will be filed with the Securities and Exchange Commission pursuant to Regulation
14A under the Securities and Exchange Act of 1934 and is incorporated herein by
reference.
34
<PAGE> 37
PART IV
ITEM 14. FINANCIAL STATEMENT SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K
(a) 1. Financial Statements:
<TABLE>
<S> <C>
Consolidated Statements of Financial Condition:
As of December 31, 1997 and 1996.......................... F-2
Consolidated Statements of Operations:
For each of the three years in the period ended December
31, 1997............................................... F-3
Consolidated Statements of Stockholders' and Divisional
Equity:
For each of the three years in the period ended December
31, 1997............................................... F-4
Consolidated Statements of Cash Flows:
For each of the three years in the period ended December
31, 1997............................................... F-5
Notes to the Consolidated Financial Statements:
For each of the three years in the period ended December
31, 1997............................................... F-6
Independent Auditors' Report................................ F-25
</TABLE>
2. Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
<S> <C>
* 3.1 Amended and Restated Certificate of Incorporation of Long
Beach Financial Corporation. (Incorporated by reference to
Exhibit 3.1 to the Company's Registration Statement on Form
S-1, Commission File No. 333-22013)
* 3.2 Bylaws of Long Beach Financial Corporation. (Incorporated by
reference to Exhibit 3.2 to the Company's Registration
Statement on Form S-1, Commission File No. 333-22013)
* 4.1 Specimen of the Common Stock of Long Beach Financial
Corporation. (Incorporated by reference to Exhibit 4.1 to
the Company's Registration Statement on Form S-1, Commission
File No. 333-22013)
*10.1 Administrative Services Agreement among Long Beach Mortgage
Company, Long Beach Financial Corporation and Ameriquest
Mortgage Company. (Incorporated by reference to Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q filed with
the Securities and Exchange Commission on June 12, 1997)
*10.2 Form of Master Sub-Servicing Agreement, between Long Beach
Mortgage Company and Ameriquest Mortgage Corporation
Company. (Incorporated by reference to Exhibit 10.2 to the
Company's Registration Statement on Form S-1, Commission
File No. 333-22013)
*10.3 4/97 Senior Secured Credit Agreement, among Ameriquest
Mortgage Corporation and Texas Commerce Bank National
Association, as Lender and Agent. (Incorporated by reference
to Exhibit 10.3 to the Company's Registration Statement on
Form S-1, Commission File No. 333-22013)
*10.4 Form of Director/Officer Indemnification Agreement.
(Incorporated by reference to Exhibit 10.4 to the Company's
Registration Statement on Form S-1, Commission File No.
333-22013)
*10.5 Contribution Agreement, between Ameriquest Capital
Corporation, Long Beach Mortgage Company, Long Beach
Financial Corporation and Ameriquest Mortgage Corporation
Company. (Incorporated by reference to Exhibit 10.5 to the
Company's Quarterly Report on Form 10-Q filed with the
Securities and Exchange Commission on June 12, 1997)
</TABLE>
35
<PAGE> 38
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
<S> <C>
*10.6 1997 Stock Incentive Plan. (Incorporated by reference to
Exhibit 10.6 to the Company's Registration Statement on Form
S-1, Commission File No. 333-22013)
*10.7 Employment Agreement, between Long Beach Financial
Corporation, Ameriquest Mortgage Corporation and M. Jack
Mayesh. (Incorporated by reference to Exhibit 10.7 to the
Company's Registration Statement on Form S-1, Commission
File No. 333-22013)
*10.8 Employment Agreement, between Long Beach Financial
Corporation, Ameriquest Mortgage Corporation and Edward
Resendez. (Incorporated by reference to Exhibit 10.8 to the
Company's Registration Statement on Form S-1, Commission
File No. 333-22013)
*10.9 Employment Agreement, between Long Beach Financial
Corporation, Ameriquest Mortgage Corporation and Frank J.
Curry. (Incorporated by reference to Exhibit 10.9 to the
Company's Registration Statement on Form S-1, Commission
File No. 333-22013)
*10.10 Employment Agreement, between Long Beach Financial
Corporation, Ameriquest Mortgage Corporation and James H.
Leonetti. (Incorporated by reference to Exhibit 10.10 to the
Company's Registration Statement on Form S-1, Commission
File No. 333-22013)
*10.11 Employment Agreement, between Long Beach Financial
Corporation, Ameriquest Mortgage Corporation and James J.
Sullivan. (Incorporated by reference to Exhibit 10.11 to the
Company's Registration Statement on Form S-1, Commission
File No. 333-22013)
*10.12 Department of Justice Settlement Agreement. (Incorporated by
reference to Exhibit 10.12 to the Company's Registration
Statement on Form S-1, Commission File No. 333-22013)
*10.13 Employment Agreement, between Long Beach Financial
Corporation, Long Beach Mortgage Company and William K.
Komperda. (Incorporated by reference to Exhibit 10.13 to the
Company's Quarterly Report on Form 10-Q filed with the
Securities and Exchange Commission on June 12, 1997)
*10.14 Form of Amendment to Employment Agreement, among Long Beach
Financial Corporation, Long Beach Mortgage Company and each
of M. Jack Mayesh, Edward Resendez, Frank J. Curry, James H.
Leonetti, and James J. Sullivan. (Incorporated by reference
to Exhibit 10.14 to the Company's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on
November 12, 1997)
27 Financial Data Schedule.
</TABLE>
- ---------------
* Previously filed.
(b) Reports on Form 8-K
Long Beach Financial Corporation filed the following Current Reports on Form
8-K during the quarterly period ended December 31, 1997:
<TABLE>
<CAPTION>
FINANCIAL
DATE OF REPORT ITEMS REPORTED STATEMENTS FILED
-------------- -------------- ----------------
<S> <C> <C>
November 18, 1997 5, 7 None
</TABLE>
36
<PAGE> 39
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 30, 1998
LONG BEACH FINANCIAL CORPORATION
By: /s/ M. JACK MAYESH
------------------------------------
M. Jack Mayesh
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ M. JACK MAYESH Chairman of the Board of March 30, 1998
- -------------------------------------------------------- Directors and Chief Executive
M. Jack Mayesh Officer (Principal Executive
Officer)
/s/ EDWARD RESENDEZ President, Director March 30, 1998
- --------------------------------------------------------
Edward Resendez
/s/ JAMES H. LEONETTI Chief Financial Officer, March 30, 1998
- -------------------------------------------------------- Senior Vice President
James H. Leonetti (Principal Financial Officer)
/s/ DAVID E. ENGELMAN Director March 30, 1998
- --------------------------------------------------------
David S. Engelman
/s/ RICHARD A. KRAEMER Director March 30, 1998
- --------------------------------------------------------
Richard A. Kraemer
/s/ C. STEPHEN MANSFIELD Director March 30, 1998
- --------------------------------------------------------
C. Stephen Mansfield
</TABLE>
37
<PAGE> 40
LONG BEACH FINANCIAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Statements of Financial Condition:
As of December 31, 1997 and 1996.......................... F-2
Consolidated Statements of Operations:
For each of the three years in the period ended December
31, 1997............................................... F-3
Consolidated Statements of Stockholders' and Divisional
Equity:
For each of the three years in the period ended December
31, 1997............................................... F-4
Consolidated Statements of Cash Flows:
For each of the three years in the period ended December
31, 1997............................................... F-5
Notes to the Consolidated Financial Statements:
For each of the three years in the period ended December
31, 1997............................................... F-6
Independent Auditors' Report................................ F-25
</TABLE>
F-1
<PAGE> 41
LONG BEACH FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF DECEMBER 31, 1997 AND 1996
ASSETS
<TABLE>
<CAPTION>
1997 1996
------------ -----------
<S> <C> <C>
Cash and cash equivalents................................... $ 38,782,000 $ --
Investment securities available for sale.................... 3,793,000 --
Loans held for sale (Note 6)................................ 17,241,000 49,580,000
Receivable from the sales of loans.......................... 143,088,000 25,103,000
Premises and equipment, net (Note 4)........................ 3,620,000 2,033,000
Deferred income taxes (Note 7).............................. 34,400,000 2,120,000
Capitalized mortgage servicing rights (Note 5).............. 3,054,000 --
Prepaid expenses and other assets........................... 4,110,000 914,000
------------ -----------
Total assets...................................... $248,088,000 $79,750,000
============ ===========
LIABILITIES AND STOCKHOLDERS' AND DIVISIONAL EQUITY
Liabilities:
Warehouse financing facility (Note 6)....................... $146,271,000 $72,829,000
Accounts payable and accrued liabilities.................... 8,280,000 5,784,000
Accrued income taxes payable (Note 7)....................... 2,792,000 --
------------ -----------
Total liabilities...................................... 157,343,000 78,613,000
Commitments and contingencies (Note 12)..................... -- --
Stockholders' and divisional equity (Notes 2 and 8):
Common stock, $.001 par value; 150.0 million shares
authorized; 25.0 million shares issued with 24.7 million
shares outstanding........................................ 25,000 --
Additional paid in capital.................................. 75,307,000 --
Divisional equity........................................... -- 1,137,000
Retained earnings........................................... 18,697,000 --
Treasury stock, at cost; 300,000 shares for 1997............ (3,284,000) --
------------ -----------
Total stockholders' and divisional equity.............. 90,745,000 1,137,000
------------ -----------
Total liabilities and stockholders' and divisional
equity.......................................... $248,088,000 $79,750,000
============ ===========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-2
<PAGE> 42
LONG BEACH FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
1997 1996 1995
----------- -------------- --------------
<S> <C> <C> <C>
REVENUES:
Gain on sale of loans......................... $88,597,000 $50,699,000 $31,691,000
Loan servicing and other fees on loans........ 946,000 -- --
Amortization of mortgage servicing rights..... (231,000) -- --
Interest income............................... 10,492,000 3,275,000 2,494,000
Interest expense.............................. (7,138,000) (2,814,000) (2,312,000)
----------- ----------- -----------
Net interest income........................... 3,354,000 461,000 182,000
----------- ----------- -----------
Net operating income.......................... 92,666,000 51,160,000 31,873,000
EXPENSES:
Compensation expense.......................... 32,229,000 17,168,000 9,352,000
Premises and equipment expenses............... 4,141,000 3,870,000 3,009,000
Other general and administrative expenses..... 7,206,000 4,900,000 2,591,000
Corporate administrative charges (Note 1)..... 2,294,000 8,900,000 6,960,000
Provision for losses.......................... 4,028,000 350,000 --
Sub-servicing costs (Note 11)................. 935,000 -- --
----------- ----------- -----------
Total expenses................................ 50,833,000 35,188,000 21,912,000
----------- ----------- -----------
Earnings before income taxes.................. 41,833,000 15,972,000 9,961,000
Provision for income taxes (Note 7)........... 17,189,000 6,580,000 4,169,000
----------- ----------- -----------
Net earnings (Note 2)......................... $24,644,000 $ 9,392,000 $ 5,792,000
=========== =========== ===========
Basic earnings per share (Note 9)............. $ 0.99 Not Applicable Not Applicable
===========
Diluted earnings per share (Note 9)........... $ 0.96 Not Applicable Not Applicable
===========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-3
<PAGE> 43
LONG BEACH FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' AND DIVISIONAL EQUITY
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
ADDITIONAL DIVISIONAL
COMMON PAID IN (DEFICIT) RETAINED TREASURY
STOCK CAPITAL EQUITY EARNINGS STOCK TOTAL
------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1995.... $ -- $ -- $ (862,000) $ -- $ -- $ (862,000)
Net change in divisional
deficit arising from
intracompany transactions
(Note 1).................. -- -- (3,198,000) -- -- (3,198,000)
Net earnings................ -- -- 5,792,000 -- -- 5,792,000
------- ----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31,
1995...................... -- -- 1,732,000 -- -- 1,732,000
Net change in divisional
deficit arising from
intracompany transactions
(Note 1).................. -- -- (9,987,000) -- -- (9,987,000)
Net earnings................ -- -- 9,392,000 -- -- 9,392,000
------- ----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31,
1996...................... -- -- 1,137,000 -- -- 1,137,000
Net earnings (Note 2)....... -- -- 5,947,000 18,697,000 -- 24,644,000
Purchase of treasury
stock..................... -- -- -- -- (3,284,000) (3,284,000)
Net change in divisional
equity arising from
intracompany transactions
(Note 1).................. -- -- (3,852,000) -- -- (3,852,000)
Reorganization of Long Beach
Financial Corporation
(Note 1).................. 25,000 75,307,000 (3,232,000) -- -- 72,100,000
------- ----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31,
1997...................... $25,000 $75,307,000 $ -- $18,697,000 $(3,284,000) $90,745,000
======= =========== =========== =========== =========== ===========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-4
<PAGE> 44
LONG BEACH FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- -------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net earnings............................... $ 24,644,000 $ 9,392,000 $ 5,792,000
Adjustments to reconcile net earnings to
net cash used in operating activities:
Depreciation and amortization of
premises, equipment and warehouse
financing facility issuance costs..... 1,106,000 1,270,000 900,000
Loans originated and purchased for
sale.................................. (1,685,742,000) (1,058,122,000) (592,542,000)
Proceeds from sales of loans held for
sale.................................. 1,679,522,000 1,029,789,000 580,366,000
Noncash gain recognized on capitalization
of mortgage servicing rights.......... (7,259,000) (9,225,000) (4,144,000)
Amortization of capitalized mortgage
servicing rights...................... 231,000 -- --
Deferred income taxes.................... 2,131,000 (1,238,000) (562,000)
Changes in:
Receivable from sale of loans......... (143,872,000) (25,103,000) --
Accounts payable and accrued
liabilities......................... 5,894,000 3,351,000 523,000
Accrued income taxes payable.......... 2,792,000 -- --
Other.................................... (5,018,000) (91,000) 545,000
--------------- --------------- -------------
Net cash used in operating
activities....................... (125,571,000) (49,977,000) (9,122,000)
Cash Flows from Investing Activities:
Purchases of premises and equipment...... (2,278,000) (1,232,000) (721,000)
Purchase of investment securities
available for sale.................... (163,869,000) -- --
Maturity of investment securities
available for sale.................... 160,094,000 -- --
--------------- --------------- -------------
Net cash used in investing
activities....................... (6,053,000) (1,232,000) (721,000)
Cash Flows from Financing Activities:
Net change in warehouse financing
facility.............................. 135,568,000 51,971,000 8,897,000
Cash provided to AMC prior to the
Reorganization........................ (3,852,000) (9,987,000) (3,198,000)
Proceeds from mortgage servicing rights
transferred to AMC.................... 3,974,000 9,225,000 4,144,000
Reorganization and capitalization of
LBFC.................................. 38,000,000 -- --
Purchase of treasury stock............... (3,284,000) -- --
--------------- --------------- -------------
Net cash provided by financing
activities....................... 170,406,000 51,209,000 9,843,000
Net increase in cash and cash
equivalents.............................. 38,782,000 -- --
Cash and cash equivalents, beginning of
the year.............................. -- -- --
--------------- --------------- -------------
Cash and cash equivalents, end of the
year.................................. $ 38,782,000 $ -- $ --
=============== =============== =============
</TABLE>
See accompanying notes to the consolidated financial statements.
F-5
<PAGE> 45
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
NOTE 1. DESCRIPTION OF THE BUSINESS, INITIAL PUBLIC OFFERING AND BASIS OF
PRESENTATION
Description of the Business
Long Beach Financial Corporation ("LBFC"), through its wholly-owned
subsidiary, Long Beach Mortgage Company ("LBMC") (collectively, the "Company"),
is currently engaged in the business of originating, purchasing and selling
subprime residential mortgage loans secured by one- to four-unit family
residences. The Company originates loans primarily through independent mortgage
loan brokers. The Company's core borrower base consists of individuals who do
not qualify as traditional "A" credit borrowers because their credit history,
debt to income ratio or other factors do not conform to standard agency lending
criteria.
The Company follows a strategy of selling substantially all of its loan
originations in the secondary market through loan sales for cash. Prior to each
fiscal quarter, the Company generally obtains a purchase commitment from one or
more loan purchasers for the volume of loans expected to be originated during
such quarter. As a result, the Company endeavors to have a buyer for each loan
at the time it is funded and, therefore, can deliver loans and receive payments
for the loans shortly after funding.
LBFC was incorporated in January 1997. At the time of incorporation, LBFC
was a wholly-owned subsidiary of a company now known as Ameriquest Mortgage
Company ("AMC"). AMC conducted its mortgage lending business through four
divisions: (i) the direct-sourced lending division, (ii) the broker-sourced
lending division, (iii) the automobile loan lending division, and (iv) the loan
servicing division. LBFC was formed to facilitate the public sale of AMC's
broker-sourced lending division. All references to the "Wholesale Division"
herein shall be deemed to include the operations of the broker-sourced lending
division of AMC prior to the Reorganization (defined below).
Initial Public Offering
On April 28, 1997, LBFC's Registration Statement on Form S-1 under the
Securities Act of 1933, as amended (the "Registration Statement"), relating to
the initial public offering of its common stock, was declared effective. The
initial public offering of 22,504,000 shares of common stock closed at a price
of $6.50 per share on May 2, 1997. On May 14, 1997, the underwriters purchased
an additional 2,496,000 shares of common stock at a price of $6.50 per share
following their exercise of the overallotment option, resulting in a total of
25,000,000 shares sold in the initial public offering (the "Offering").
On May 2, 1997, immediately prior to the closing of the initial public sale
of LBFC's common stock, AMC reorganized its business operations (the
"Reorganization") by transferring certain assets (including furniture, leasehold
improvements and equipment) and personnel relating to the broker-sourced lending
division and the loan sales division and approximately $40.0 million in cash
(less approximately $2.0 million in related expenses) to the Company in exchange
for 24,999,999 shares of common stock. The assets transferred to the Company
included loans in process as of May 2, 1997, but did not include loans funded or
servicing rights with respect to loans funded prior to May 2, 1997.
Additionally, the Company acquired the going-concern value of the existing
and established approved customer base listing of independent brokers and the
sole right to the "Long Beach Mortgage Company" name. The Company did not assume
any liabilities of AMC other than certain liabilities associated with equipment
and property leases acquired by the Company and accrued vacation and other
employee benefits for personnel transferred to the Company. The Reorganization
has been accounted for in a manner similar to a pooling of interests; therefore,
the historical cost basis of the assets and liabilities transferred to the
Company was carried over from the Wholesale Division of AMC.
F-6
<PAGE> 46
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
The transfer of the assets and personnel described above by AMC to the
Company was treated for federal income tax purposes as a taxable sale of assets.
As a result, the tax basis of the assets transferred from AMC to the Company in
the Reorganization was increased to their fair market value (determined by
reference to the initial public offering price.) As discussed more fully in Note
7 to the Consolidated Financial Statements, such tax basis is generally expected
to produce a tax benefit to the Company in future tax years. Accordingly, the
Company recorded a deferred tax asset of $36.0 million (with a corresponding
credit to additional paid-in capital) for the tax effect of the excess of the
tax basis of the Company's assets following the Reorganization and the Offering,
over their net book value.
Basis of Presentation
The consolidated financial statements include the accounts of LBFC and its
subsidiary LBMC and are prepared in accordance with generally accepted
accounting principles. All significant intercompany accounts and transactions
have been eliminated in consolidation.
The Company had no separate operations through the date of the
Reorganization and all rights, benefits and obligations relating to the
operations and net earnings of the Wholesale Division of AMC, up to the date of
the Reorganization, remained with AMC. However, because the Reorganization has
been accounted for in a manner similar to a pooling of interests, the results of
operations reported for the year ended December 31, 1997 include: (i) the
operating results of the Wholesale Division of AMC from January 1, 1997 through
May 1, 1997 (the "1997 Operating Results of the Wholesale Division of AMC"), and
(ii) the operating results of the Company from May 2, 1997 to December 31, 1997
(the "Company's Results of Operations"). Collectively, the combination of the
1997 Operating Results of the Wholesale Division of AMC and the Company's
Results of Operations represent the "Consolidated Results of Operations for the
Year Ended December 31, 1997."
Cash flows for the year ended December 31, 1997 include: (i) cash flows of
the Wholesale Division of AMC from January 1, 1997 through May 1, 1997 (the
"1997 Cash Flows of the Wholesale Division of AMC"), and (ii) the Company's cash
flows from May 2, 1997 through December 31, 1997 (the "Company's Cash Flows").
Collectively, the combination of the 1997 Cash Flows of the Wholesale Division
of AMC and the Company's Cash Flows represent the "Consolidated Cash Flows for
the Year Ended December 31, 1997."
Also included in the accompanying financial statements are: (i) the results
of operations for the Wholesale Division of AMC for the years ended December 31,
1996 and 1995, (ii) the financial condition of the Wholesale Division of AMC as
of December 31, 1996, and (iii) the cash flows of the Wholesale Division of AMC
for the years ended December 31, 1996 and 1995. All such information included or
used in the preparation of this report has been prepared from records maintained
by AMC and provided to the Company by AMC.
In connection with the Reorganization described above, AMC transferred to
the Company certain assets and liabilities relating to the Wholesale Division.
AMC, however, retained certain assets and liabilities reflected on the books of
the Wholesale Division as of May 1, 1997 including: (i) loans held for sale
totaling $39.3 million, (ii) receivables from the sales of loans totaling $25.9
million, (iii) servicing rights and (iv) borrowings under the warehouse
financing facility totaling $62.0 million. Accordingly, the balances of these
assets and liabilities at May 1, 1997 are not reflected in the beginning
balances of the Company as of May 2, 1997. The Consolidated Statements of
Stockholders' and Divisional Equity and Cash Flows reflect an adjustment to
eliminate these assets and liabilities retained by AMC. The Consolidated
Statements of Cash Flows include changes in balances from January 1, 1997
through May 1, 1997 combined with changes in balances from May 2, 1997 through
December 31, 1997.
F-7
<PAGE> 47
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
In the normal course of business prior to the reorganization on May 2,
1997, the Wholesale Division had various transactions with other divisions of
AMC that are material in amount. The financial statements and financial data of
the Wholesale Division of AMC included in the accompanying financial statements
reflect key assumptions regarding the allocation of certain revenue and expense
items and certain balance sheet accounts, many of which could be material. The
financial data of the Wholesale Division of AMC included in the accompanying
consolidated financial statements may not necessarily be indicative of the
conditions that would have existed if the Wholesale Division of AMC had operated
as an independent entity.
The accompanying consolidated financial statements include financial data
of the Wholesale Division of AMC and reflect the assets, liabilities, revenues
and expenses that were directly related to the continuing operations of the
Wholesale Division as they were operated by AMC prior to the Reorganization. In
cases involving assets, liabilities, revenues and expenses not specifically
identifiable to any particular division of AMC, certain allocations were made to
reflect the operations of the Wholesale Division. Allocations have been made
for, among other things, accounting, information services, legal, compliance,
and other executive and administrative services. These allocations were based on
a variety of factors which take into consideration the loan origination volume,
employee head count, and historical ratios of direct expenses incurred by the
divisions to total direct expenses. Management believes these allocations
provide a reliable basis for the accompanying consolidated financial statements,
which are also based on the following assumptions:
1. No cash balances were recorded as part of these historical financial
statements as it was the practice of AMC not to maintain separate cash
balances for the various divisions.
2. The net change in divisional equity (deficit) arising from intracompany
transactions, as reflected in the Consolidated Statements of
Stockholders' and Divisional Equity, includes: (i) the aggregate
intracompany allocations of costs and expenses incurred by the Wholesale
Division and paid by AMC, (ii) cash generated by the Wholesale Division
and collected by AMC during the periods presented, and (iii) cash
advanced by AMC on behalf of the Wholesale Division. The net change in
divisional equity (deficit) arising from intracompany transactions also
includes all liabilities of the Wholesale Division, such as income taxes
payable, that are not separate legal obligations of the Wholesale
Division but have been charged to the Wholesale Division.
The cash generated by the Company and collected by AMC consisted primarily
of proceeds from the sales of loans of $471.0 million, $1.0 billion and $580.4
million for the years ended December 31, 1997, 1996 and 1995, respectively.
Advances by AMC on behalf of the Company consisted primarily of the cash used to
pay operating expenses and fund loans. Also, AMC allocated a portion of the net
borrowings under its warehouse financing facility to the Company. Cash used to
fund loans was $458.9 million, $1.1 billion and $592.5 million for the years
ended December 31, 1997, 1996 and 1995, respectively.
Total costs allocated to the Company by AMC for the years ended December
31, 1997, 1996 and 1995 were $2.3 million, $8.9 million and $7.0 million,
respectively. While the Company believes that expenses reflected in the
accompanying statements of operations would not have been materially affected if
it had operated as a stand alone entity, no assurance can be given that such
expenses are indicative of expenses to be incurred in the future.
NOTE 2. STATEMENT OF OPERATIONS, PRESENTATION AND ANALYSIS OF PRO FORMA
OPERATIONS
The consolidated statement of operations for the year ended December 31,
1997, presented in the accompanying financial statements includes the 1997
Operating Results of the Wholesale Division of AMC and the Company's Results of
Operations. All rights, benefits and obligations relating to the 1997 Operating
Results of the Wholesale Division of AMC up to the time of the Reorganization
remain with AMC.
F-8
<PAGE> 48
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
The rights to loans which were originated by the Wholesale Division but
remained unsold at May 2, 1997 were retained by AMC (the "Retained Loans"). The
costs relating to the production of these loans were incurred and recorded by
the Wholesale Division of AMC and are included in the 1997 Operating Results of
the Wholesale Division of AMC. These loans are included in loan production
amounts reported for the Company for the year ended December 31, 1997.
Subsequent to the Reorganization, the Company purchased the Retained Loans from
AMC at the same price and at the same time that the Company sold these loans to
independent, third-party purchasers. Because the gain from the sale of the
Retained Loans was recorded after the Reorganization, and because the Company's
stockholders did not receive any of the benefit of this gain, the Company did
not include the gain from the sale of the Retained Loans as part of the
Company's Results of Operations. The principal amount of the Retained Loans was
approximately $33.8 million and the after-tax gain from the sale of these loans
was approximately $807,000. The gains from the sale of the Retained Loans are
not reflected either as income from the Wholesale Division of AMC or as income
from the Company.
The following table presents separately the operations of the Wholesale
Division of AMC and the Company, and the combined effect of their results of
operations for the year ended December 31, 1997. Additionally, the gain from the
sale of the Retained Loans is presented for informational purposes, with
corresponding earnings and per share data presented on a pro forma basis.
<TABLE>
<CAPTION>
WHOLESALE THE
DIVISION OF AMC COMPANY COMBINED
--------------- ----------- -----------
<S> <C> <C> <C>
REVENUES:
Gain on sale of loans............................. $25,604,000 $62,993,000 $88,597,000
Loan servicing and other fees on loans............ -- 946,000 946,000
Amortization of mortgage servicing rights......... -- (231,000) (231,000)
Interest income................................... 2,306,000 8,186,000 10,492,000
Interest expense.................................. (2,138,000) (5,000,000) (7,138,000)
----------- ----------- -----------
Net interest income.......................... 168,000 3,186,000 3,354,000
----------- ----------- -----------
Net operating income.............................. 25,772,000 66,894,000 92,666,000
EXPENSES:
Compensation expense.............................. 8,242,000 23,987,000 32,229,000
Premises and equipment expenses................... 1,106,000 3,035,000 4,141,000
Other general and administrative expenses......... 1,391,000 5,815,000 7,206,000
Corporate administrative charges.................. 2,294,000 -- 2,294,000
Provision for losses.............................. 2,808,000 1,220,000 4,028,000
Sub-servicing costs............................... -- 935,000 935,000
----------- ----------- -----------
Total expenses............................... 15,841,000 34,992,000 50,833,000
----------- ----------- -----------
Earnings before income taxes...................... 9,931,000 31,902,000 41,833,000
Provision for income taxes........................ 3,984,000 13,205,000 17,189,000
----------- ----------- -----------
Net earnings...................................... $ 5,947,000 $18,697,000 $24,644,000
=========== =========== ===========
Basic net earnings per share...................... $ 0.24 $ 0.75 $ 0.99
=========== =========== ===========
Diluted net earnings per share.................... $ 0.24 $ 0.72 $ 0.96
=========== =========== ===========
Pro forma net gain from sale of Retained Loans net
of taxes........................................ 807,000 -- 807,000
----------- ----------- -----------
Pro forma net earnings inclusive of gain from sale
of Retained Loans............................... $ 6,754,000 $18,697,000 $25,451,000
=========== =========== ===========
Pro forma basic net earnings per share............ $ 0.27 $ 0.75 $ 1.02
=========== =========== ===========
Pro forma diluted net earnings per share.......... $ 0.27 $ 0.72 $ 0.99
=========== =========== ===========
</TABLE>
F-9
<PAGE> 49
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents -- Highly liquid investments with maturities of
three months or less when purchased are considered to be cash equivalents.
Because of the short maturities of these instruments, the carrying amount is a
reasonable estimate of fair value.
Investment Securities -- The Company has adopted an investment policy which
limits its investment activities to high-quality, short-term investments,
largely consisting of money market mutual funds, which limit their holdings to
government securities. The Company neither has the positive intent and/or
ability to always hold securities to maturity, nor does it engage in trading
acitivites, and as such, the Company's investment securities are classified as
available for sale and reported at fair value, with unrealized gains and losses
excluded from earnings and reported as a separate component of stockholders'
equity, net of deferred taxes. Gains or losses on the sales of investment
securities available for sale are determined on the specific identification
method. Premiums and discounts on investment securities are amortized or
accreted using the interest method over the expected lives of the related
securities. Quoted market prices, which approximated acquisition cost as of the
balance sheet dates, are reasonable estimates of the securities' fair value.
Loans Held for Sale -- Loans held for sale are carried at the lower of
aggregate cost or market value. Loan origination fees and related direct
origination costs are deferred until the related loan is sold. Market value is
determined by outstanding commitments from investors, if any, or current
investor yield requirements on the aggregate basis.
Receivable from Sales of Loans -- Receivable from sales of loans represents
proceeds due from certain sales transactions which were recorded in December
1997 and 1996. All amounts due to the Company have subsequently been collected.
Premises and Equipment -- Premises and equipment are stated at cost and
depreciated over the estimated useful lives of the assets using the
straight-line method. Useful lives generally range from three to five years.
Leasehold improvements are amortized on the straight-line method over the lesser
of the useful lives of the assets or the terms of the related leases.
Income Taxes -- The Company accounts for taxes under Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," which
requires an asset and liability approach to financial accounting for income
taxes. Under SFAS No. 109, deferred income tax assets and liabilities result
from revenues and expenses being recognized in different time periods for
financial reporting purposes than for income tax purposes. Deferred income taxes
arise from temporary differences and carryforwards which are tax-effected at the
enacted tax rates and subsequently adjusted for changes in tax laws and rates.
For more information on the Company's deferred tax asset, see Note 7 to the
Consolidated Financial Statements.
Capitalized Mortgage Servicing Rights -- Effective January 1, 1997, the
Company adopted SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinquishments of Liabilities," as amended by SFAS No.
127, which superseded SFAS No. 122, "Accounting for Mortgage Servicing Rights."
SFAS No. 125 provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities based on
consistent application of a financial-components approach that focuses on
control. It distinguishes transfers of financial assets that are sales from
transfers that are secured borrowings. Under the financial-components approach,
after a transfer of financial assets, an entity recognizes all financial and
servicing assets it controls and liabilities it has incurred and derecognizes
financial assets it no longer controls and liabilities that have been
extinguished. The financial-components approach focuses on the assets and
liabilities that exist after the transfer. Many of these assets and liabilities
are components of financial assets that existed prior to the transfer. If a
transfer does not meet the criteria for a sale, the transfer is accounted for as
a secured borrowing with pledge of collateral.
F-10
<PAGE> 50
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
Under SFAS No. 125, servicing assets (the excess of benefits to be received
from servicing less the costs associated with such servicing) are initially
valued based their relative fair values, if practicable, at the date of sale of
the related assets. Servicing assets are required to be subsequently measured by
(a) amortization in proportion to and over the period of estimated net servicing
income, and (b) assessment for asset impairment based on their fair values.
Retroactive application of this statement was not permitted. The adoption of
SFAS No. 125 did not have a material impact on the Company's operating results
or financial condition.
The Company recognizes the amortization of capitalized mortgage servicing
rights as an offsetting component of revenues, against loan servicing and other
fees on loans. Impairment, if it occurs, is recognized in a valuation allowance
for such pool in the period of impairment. At December 31, 1997, fair value was
measured using the following significant assumptions: discount rate of 14.0% and
a range of CPR from 18% to 30%, depending upon the product. No impairment
existed at December 31, 1997.
Prior to adopting SFAS No. 125, the Company adopted SFAS No. 122, effective
January 1, 1995, which required that upon sale of servicing retained mortgages,
companies capitalize the cost associated with the right to service mortgage
loans based on their relative fair values. Retroactive implementation of SFAS
No. 122 was not permitted. The impact of adopting SFAS No. 122 resulted in an
increase in pretax income of $4.1 million for the year ended December 31, 1995.
During 1995, 1996 and through May 1, 1997, immediately after sale of the
loans, the Wholesale Division of AMC transferred its servicing rights to an
affiliated division of AMC at their carrying value.
Allowance for Losses -- The Company provides allowances for losses that
arise in connection with activities surrounding the origination and sales of
mortgage loans. These activities include breaches of representation and
warranties, first payment defaults and other miscellaneous activities. The
Company reviews its level of allowances for adequacy on a quarterly basis. At
December 31, 1997, the allowance for losses totaled $838,000.
Revenue Recognition -- Gain on sale of loans, representing the difference
between the total sales price received for the loans and the allocated cost of
the loans, is recognized when mortgage loans are sold and delivered to the
purchasers.
Loan servicing and other fees on loans, representing servicing fee income,
late fees and other ancillary charges related to the Company's servicing
portfolio, are recorded as earned.
Interest income, representing the interest earned on loans during the
warehousing period (the period prior to their sale) and the interest earned on
the Company's investment securities, is recorded as earned.
Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
Reclassifications -- Certain reclassifications have been made to conform
the 1996 and 1995 consolidated financial statements to the 1997 presentation.
Recent Accounting Developments -- In June 1997, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income,"
which is effective for annual periods beginning after December 15, 1997. This
statement requires that all items that are required to be recognized under
accounting standards as comprehensive income be reported in a financial
statement that is displayed with the same prominence as other items reported in
a financial statement. The adoption of SFAS No. 130 will not have a material
impact on the Company's financial statements.
F-11
<PAGE> 51
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which is effective for annual and
interim periods beginning after December 15, 1997. This statement established
standards for the method in which public entities report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about product and services, geographical areas, and major
customers. The adoption of SFAS No. 131 will not have a material impact on the
Company's financial statements.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which is effective for annual
and interim periods beginning after December 15, 1997. This statement revises
employers' disclosures about pensions and other postretirement benefit plans. It
does not change the measurement or recognition of those plans but instead
standardizes the disclosure requirements to the extent practicable, requiring
additional information on changes in the benefit obligations and fair values of
plan assets that will facilitate financial analysis, and eliminating certain
disclosures that are no longer deemed useful. The adoption of SFAS No. 132 will
not have a material impact on the Company's financial statements.
NOTE 4. PREMISES AND EQUIPMENT
Premises and equipment at December 31 consists of the following:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Furniture and equipment............................... $3,804,000 $2,947,000
Leasehold improvements................................ 414,000 149,000
---------- ----------
4,218,000 3,096,000
Less accumulated depreciation and amortization........ (598,000) (1,063,000)
---------- ----------
$3,620,000 $2,033,000
========== ==========
</TABLE>
NOTE 5. CAPITALIZED MORTGAGE SERVICING RIGHTS
The following is a summary of capitalized mortgage servicing rights
activity during the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Balance at January 1.................... $ -- $ -- $ --
Capitalization of mortgage servicing
rights................................ 7,259,000 9,225,000 4,144,000
Amortization of mortgage servicing
rights................................ (231,000) -- --
Transfer of mortgage servicing rights to
AMC................................... (3,974,000) (9,225,000) (4,144,000)
----------- ----------- -----------
Balance at December 31.................. $ 3,054,000 $ -- $ --
=========== =========== ===========
</TABLE>
NOTE 6. WAREHOUSE FINANCING FACILITY
The Company utilizes a warehouse financing facility funded by a national
banking association and a syndicate of lenders. This facility, which commenced
in April 1997, initially provided for a borrowing capacity of $200 million and
was increased to $250 million in January 1998. The facility expires on March 31,
1999 and is collaterized by loans held for sale. The facility bears interest at
either a fixed rate, a floating rate based on the London Interbank Offered Rate
("LIBOR") for U.S. dollar deposits, or a combination of the two, at the option
of the Company.
F-12
<PAGE> 52
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
The following table presents data on the warehouse financing facility of
the Company for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Weighted-average interest rate for
the period......................... 7.17% 7.28% 7.77%
Weighted-average interest rate at the
end of the period.................. 7.23% 7.25% 7.51%
Weighted-average amount outstanding
for the period..................... $ 90,184,000 $ 97,714,000 $ 78,588,000
Maximum amount outstanding at any
month-end.......................... $146,271,000 $170,102,000 $108,735,000
</TABLE>
The Warehouse Financing Facility contains a number of financial covenants
including: (i) the Company maintain tangible net worth equal to at least $25
million, plus 25% of cumulative positive net earnings, (ii) delinquencies on the
Company's mortgage servicing portfolio not exceed 12% and (iii) the ratio of
total liabilities to adjusted tangible net worth may not exceed 9:1. The
Warehouse Financing Facility also contains other affirmative, negative and
financial covenants typical of similar credit facilities. The Company was in
compliance with all such covenants at December 31, 1997.
The Company recorded interest expense related to the amortization of
warehouse financing issuance costs of $415,000, $245,000, and $233,000 for the
years ended December 31, 1997, 1996 and 1995, respectively. Unamortized
warehouse financing issuance costs were $280,000 at December 31, 1997 and are a
component of other assets on the consolidated statement of financial condition.
There were no unamortized warehouse financing issuance costs at December 31,
1996.
NOTE 7. INCOME TAXES
In connection with the Reorganization, AMC transferred certain tangible and
intangible assets to the Company, and immediately thereafter sold shares of the
Company's common stock in the Offering. The transfer of these assets and
personnel was treated, for federal income tax purposes, as a taxable sale of
assets. As a result, the tax basis of the assets transferred from AMC to the
Company in the Reorganization was increased to their fair market value
(determined by reference to the initial public offering price.) In general,
Section 197 of the Internal Revenue Code ("IRC") allows for the amortization
over a 15-year period of intangible assets (including goodwill and going concern
value) acquired in a transaction such as the Reorganization. The so-called
"anti-churning" rules set forth in Section 197(f)(9) of the IRC, however,
prohibit the amortization of goodwill, going concern value and intangible
assets, the useful lives of which cannot be determined with reasonable accuracy
where such assets are transferred between related parties and the transferor
held or used such intangible assets at any time on or after July 25, 1991, and
on or before August 10, 1993.
The Company believes that the anti-churning rules should not apply to any
intangible assets (whether goodwill, going concern value or otherwise)
transferred from AMC to the Company in the Reorganization. Because the Internal
Revenue Service ("IRS") could assert that the anti-churning rules apply to the
Reorganization, the Company will limit the value of the deferred tax asset that
is recorded, solely for financial accounting and reporting purposes, to the
amount that would be recorded assuming the application of the anti-churning
rules. The Company, using an independent third party, has appraised the value of
certain intangible assets transferred in the Reorganization that are of a type
not subject to the anti-churning rules -- i.e., assets that can be valued and to
which the Company can reasonably ascertain useful lives ("Amortizable
Intangibles"). Based in part upon such valuation, the Company recorded a $36.0
million net deferred tax asset solely for financial accounting and reporting
purposes. No assurance can be given, however, that the IRS will
F-13
<PAGE> 53
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
not challenge the value of the Amortizable Intangibles. If such a challenge were
successful, the Company may be prevented from realizing all or a portion of the
future tax benefits reflected by the net deferred tax asset. Any adjustment to
the net deferred tax asset, arising from IRS challenge or other ruling
concerning the deductibility of the deferred tax asset or the valuation of the
Amortizable Intangibles, will be charged or credited to additional paid-in
capital and will have no impact on earnings.
Based upon the offering price of $6.50 per share, the excess of the tax
basis of the Company's net assets over their net book value was approximately
$117.5 million, resulting in a gross deferred tax asset of $47.0 million. The
Company recorded a net deferred tax asset of $36.0 million to take into account
the potential that the IRS may disallow some portion of the resulting deduction.
For income tax purposes, the Company is amortizing over a 15-year period the
intangible assets acquired from AMC in the Reorganization. The Company believes
that based upon historical earnings levels it is probable that the Company will
generate sufficient taxable income to realize the benefits associated with the
net deferred tax asset through future tax deductions. As the Company realizes
the benefits associated with the deferred tax asset, there will be a
corresponding reduction in income taxes payable by the Company. As the deferred
tax benefit is realized through a reduction in the current tax payable, the
statement of operations will reflect an offsetting charge to the amount of the
deferred tax benefit, resulting in no effect on net income. If the Company
determines that estimated future earnings are not sufficient to realize the
deferred tax benefit, the Company will establish a valuation allowance for the
impairment of the deferred tax assets, through a charge to the income tax
provision, which will result in a reduction of net earnings.
The income tax provision (benefit) consists of the following, for the years
ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Current:
Federal................................. $12,622,000 $5,895,000 $3,606,000
State................................... 2,436,000 1,923,000 1,125,000
----------- ---------- ----------
15,058,000 7,818,000 4,731,000
Deferred:
Federal................................. 605,000 (1,135,000) (562,000)
State................................... 1,526,000 (103,000) --
----------- ---------- ----------
2,131,000 (1,238,000) (562,000)
----------- ---------- ----------
Provision for income taxes................ $17,189,000 $6,580,000 $4,169,000
=========== ========== ==========
</TABLE>
The reconciliation of statutory tax rates to the Company's effective income
tax rate follows, for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Federal income tax at statutory rates.................. 35.0% 35.0% 35.0%
State taxes, net of federal tax benefits............... 6.0 7.4 7.4
Other.................................................. 0.1 (1.2) (0.5)
---- ---- ----
41.1% 41.2% 41.9%
==== ==== ====
</TABLE>
F-14
<PAGE> 54
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The significant
components of the net deferred tax assets (liabilities) are as follows, at
December 31:
<TABLE>
<CAPTION>
1997 1996
----------- ----------
<S> <C> <C>
Deferred tax assets:
Mark to market................................... $ 427,000 $ 998,000
Goodwill......................................... 33,689,000 --
Vacation accrual................................. 186,000 --
Reserves......................................... 371,000 646,000
State taxes...................................... 32,000 634,000
Other............................................ 95,000 --
----------- ----------
34,800,000 2,278,000
Deferred tax liabilities:
Depreciation..................................... -- (158,000)
Other............................................ (400,000) --
----------- ----------
(400,000) (158,000)
----------- ----------
Net deferred tax asset............................. $34,400,000 $2,120,000
=========== ==========
</TABLE>
NOTE 8. STOCKHOLDERS' EQUITY
Preference Share Purchase Rights -- In October 1997, the Board of Directors
authorized a stockholder rights plan, which provides for the distribution to the
Company's stockholders of one preferred stock purchase "right" for each
outstanding share of common stock owned. The rights will trade with the
Company's common stock and will not be exercisable until the occurrence of
certain takeover related events. The rights can be redeemed by the Company at
any time, and will otherwise expire on November 9, 2007.
Preferred Stock -- The Company is authorized to issue 25.0 million shares
of $0.001 par value preferred stock. No preferred shares are outstanding and the
Company has no current plan to issue any such shares.
Common Stock -- The Company is authorized to issue 150.0 million shares of
$0.001 par value common stock.
Common Stock Repurchase Plan -- In October 1997, the Board of Directors
authorized a stock repurchase plan which permits the repurchase on the open
market of up to 2.5 million shares of the Company's common stock, or 10% of the
current shares outstanding, through the end of September 1999. During 1997, the
Company purchased 300,000 shares, which are included in treasury stock. In
January 1998, the Company purchased an additional 292,682 shares.
NOTE 9. EARNINGS PER SHARE
In December 1997, the Company adopted SFAS No. 128 ,"Earnings per Share,"
which supersedes Accounting Principles Board ("APB") Opinion No. 15, "Earnings
per Share." All prior periods presented have been restated to reflect the
computation of earnings per share under SFAS No. 128.
SFAS No. 128 requires computation of earnings per share ("EPS") using basic
and diluted methodologies. Basic EPS excludes any dilution and is computed by
dividing income available to common stockholders by the weighted-average number
of common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if common stock equivalents were exercised and
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity.
F-15
<PAGE> 55
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
A reconciliation of the numerators and denominators used in basic and
diluted EPS computations for the year ended December 31, 1997 follows:
<TABLE>
<CAPTION>
EARNINGS SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
BASIC EPS:
Earnings available to common stockholders... $24,644,000 24,975,781 $0.99
=====
EFFECT OF STOCK EQUIVALENTS:
Options............................... -- 677,257
----------- ----------
DILUTED EPS:
Earnings available to common
stockholders plus assumed
conversions......................... $24,644,000 25,653,038 $0.96
=========== ========== =====
</TABLE>
The Company did not have any independent operations through the date of the
Reorganization, and all rights, benefits and obligations relating to the net
earnings of the Wholesale Division up to the date of the Reorganization remained
with AMC. Additionally, only one share of LBFC's common stock was issued and
outstanding until the Reorganization and no shares were issued or outstanding at
any time during 1996 or 1995.
The earnings per share data presented in the following table was prepared
under the assumption that the Company's 25,000,000 shares of common stock were
issued and outstanding as of January 1, 1997 through December 31, 1997, less the
impact of stock repurchases during the fourth quarter of 1997, and by using the
common stock equivalents for all stock options issued by the Company from the
Reorganization through December 31, 1997.
<TABLE>
<CAPTION>
WHOLESALE THE
DIVISION OF AMC COMPANY COMBINED
JANUARY 1 THROUGH MAY 2 THROUGH RESULTS OF
MAY 1, 1997(A) DEC. 31, 1997 OPERATIONS
----------------- ------------- -----------
<S> <C> <C> <C>
Net earnings..................... $5,947,000 $18,697,000 $24,644,000
========== =========== ===========
Weighted-average common stock
outstanding.................... 25,000,000 24,771,135 24,975,781
Common stock equivalents:
Employee stock options......... -- 998,716 677,257
---------- ----------- -----------
Total common stock equivalents... 25,000,000 25,769,851 25,653,038
========== =========== ===========
Basic earnings per share......... $ 0.24 $ 0.75 $ 0.99
========== =========== ===========
Diluted earnings per share....... $ 0.24 $ 0.72 $ 0.96
========== =========== ===========
</TABLE>
- ---------------
(a) Represents per share data on the assumption that the Company's shares of
common stock were issued and outstanding during the entire period from
January 1, 1997 through May 1, 1997.
NOTE 10. EMPLOYEE BENEFITS
Defined Contribution Plan -- The Company has a 401(k) defined contribution
plan for all eligible employees. Employees may generally contribute up to 15% of
qualifying contribution each year, and the Company, at its discretion, may match
up to the first 6% of qualifying compensation. Employees become vested in the
Company's contribution at a rate of 25% per year after the second year of
service, with complete vesting after five years. There was no contribution
expense recognized during 1997. The Company's cost for the plan amounted to
$149,000 and $84,000 for the years ended December 31, 1996 and 1995.
F-16
<PAGE> 56
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
Deferred Compensation -- The Company has established a deferred
compensation plan which permits certain officers and key employees of the
Company to elect to defer portions of their compensation. There was no liability
related to this plan as of December 31, 1997.
Stock Options -- The Company's 1997 Stock Incentive Plan (the "Plan")
provides for a total of 3.0 million shares for issuance. Options granted under
the Plan may be incentive stock options or non-qualified stock options. The
exercise price of both types of options will be equal to 100% of the fair market
value of the shares on the date of grant.
The options issued to officers and other employees vest 20% per year over a
five year period and expire on the earlier of ten years from the date of grant
or thirty days after a holder's termination of service. Options issued to
non-employee directors vest ratably each year over a three year period.
The following is a summary of stock option information and weighted-average
exercise prices for the Company's stock option plan during the year ended
December 31, 1997:
<TABLE>
<CAPTION>
NUMBER PRICE
--------- -----
<S> <C> <C>
Outstanding at January 1, 1997............................. -- $ --
Options granted.......................................... 2,808,000 6.84
Options exercised........................................ -- --
Options canceled......................................... (20,000) 6.50
---------
Outstanding at December 31, 1997........................... 2,788,000 $6.84
=========
Exercisable at December 31, 1997........................... -- --
=========
</TABLE>
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." This Statement establishes a new fair value based accounting
method for stock-based compensation plans and encourages (but does not require)
employers to adopt the new method in place of the provisions of APB Opinion No.
25, "Accounting for Stock Issues to Employees." The Company has elected to adopt
the disclosure-only provisions of SFAS No. 123 and will, therefore, continue to
account for its stock incentive plan based on the methodologies presented in APB
Opinion No. 25. No compensation expense has been recognized in 1997 for options
granted under the Company's stock incentive plan.
Had compensation cost for the stock incentive plan been determined based on
the new fair value provisions of SFAS No. 123, pro forma net earnings and pro
forma basic and diluted earnings per share for the year ended December 31, 1997
would have been reduced to $18.2 million and $0.73 and $0.71, respectively. The
fair value of each option grant, $3.89 for options granted in 1997, is estimated
on the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions used for grants in 1997: no dividend
yield; expected volatility of 60.0%; risk-free interest rate of 5.86%; and
expected lives of 5 years.
NOTE 11. AGREEMENTS WITH RELATED PARTIES
Administrative Services Agreements -- On April 28, 1997, the Company and
AMC entered into an administrative services agreement under which AMC agreed to
provide various services to the Company, including certain employee benefits
administration services, information services and data processing functions and,
through August 1997, mail room services. The agreement had a one year term from
the effective date of the Reorganization, unless earlier terminated by the
Company upon 30 days written notice. In February 1998, the Company terminated
this agreement, effective March 1, 1998. The Company incurred charges of $1.1
million for the year ended December 31, 1997, pursuant to this agreement.
F-17
<PAGE> 57
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
In addition, on April 28, 1997, the Company and AMC entered into a second
administrative services agreement pursuant to which the Company agreed to assist
AMC in selling the mortgage loans originated by AMC and provide investor
coordination and information for the existing loan portfolio as well as new loan
originations. The agreement had a one-year term from the effective date of the
Reorganization, unless earlier terminated by AMC upon 30 days written notice. In
February 1998, AMC terminated this agreement, effective March 1, 1998. The
Company received $440,000 during the year ended December 31, 1997, pursuant to
this agreement.
Loan Sub-servicing Agreement -- On April 28, 1997, the Company and AMC
entered into a three year loan sub-servicing agreement pursuant to which AMC
agreed to sub-service mortgage loans originated or purchased by the Company
after the Reorganization. Sub-servicing activities include collecting and
remitting loan payments, accounting for principal and interest, holding escrow
or impound funds for payment of taxes and insurance, if applicable, making
required inspections of the mortgaged property, contacting delinquent borrowers,
and supervising foreclosures and property dispositions. The agreement provides
that either party has the right to terminate the agreement effective at any time
after November 2, 1998, upon six months prior written notice to the other party.
The Company has agreed to pay AMC a 45 basis points annual servicing fee on the
outstanding principal balance of each loan sub-serviced. The Company has
incurred charges of $935,000 during the year ended December 31, 1997, pursuant
to this agreement. The balance of the sub-serviced loan portfolio at December
31, 1997 totaled $896.2 million.
Income Taxes -- In connection with the Reorganization, AMC agreed to
indemnify and hold the Company harmless from any tax liability attributable to
periods ending on or before the Reorganization. For periods ending after the
Reorganization, the Company pays its tax liability directly to the appropriate
taxing authorities.
The agreements between the Company and AMC were developed in the context of
a related party relationship and, therefore, may not necessarily reflect the
same business terms as might have been obtained in arm's length negotiations
between independent parties.
NOTE 12. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF RISK
Leases -- The Company's operations are conducted from leased facilities
located in various areas of the United States. These leases have clauses which
provide for increases in rent based on increases in the cost of living index and
options for renewal. Rental expense for the years ended December 31, 1997, 1996
and 1995 was $1.7 million, $1.4 million and $1.3 million, respectively.
The future minimum lease payments are as follows:
<TABLE>
<S> <C>
Year ending December 31:
1998................................................... $1,792,000
1999................................................... 1,438,000
2000................................................... 1,171,000
2001................................................... 671,000
2002................................................... 241,000
Thereafter............................................. --
----------
$5,313,000
==========
</TABLE>
F-18
<PAGE> 58
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
The Company routinely enters into noncancelable lease agreements for
furniture and equipment used in the normal course of business. The following
table sets forth the minimum lease obligations under lease commitments in effect
at December 31, 1997:
<TABLE>
<CAPTION>
CAPITALIZED OPERATING
----------- ----------
<S> <C> <C>
Year ending December 31:
1998....................................... $134,000 $ 671,000
1999....................................... 134,000 673,000
2000....................................... 134,000 531,000
2001....................................... 75,000 1,000
2002....................................... 12,000 --
Thereafter................................. -- --
-------- ----------
489,000 $1,876,000
----------
Less amounts representing interest........... (88,000)
--------
$401,000
========
</TABLE>
The capital lease obligations are included in accrued liabilities in the
accompanying consolidated statement of financial condition. As of December 31,
1997, the net book value of furniture and equipment under capital lease was
$471,000.
The Company has negotiated employment agreements with certain officers.
These agreements provide for the payment of base salaries, performance bonuses
subject to certain restrictions, and the payment of severance benefits upon
termination.
In the ordinary course of business, the Company has liability under
representations and warranties made to purchasers and insurers of mortgage
loans. Under certain circumstances, the Company may be liable for the unpaid
principal and interest on defaulted loans or other loans if there has been a
breach of representations or warranties.
The Company is party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments primarily represent commitments to fund and sell
loans. These instruments involve, to varying degrees, elements of interest rate
risk and credit risk in excess of the amount recognized in the consolidated
statement of financial condition. The credit risk is mitigated by the Company's
evaluation of the creditworthiness of potential borrowers on a case-by-case
basis.
Commitments to fund and sell loans generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Also, external
market forces impact the probability of commitments being exercised; therefore,
commitments outstanding do not necessarily represent future cash requirements.
The Company had commitments to fund loans of $331.0 million and $165.4
million at December 31, 1997 and 1996, respectively. The Company's loan purchase
commitments totaled $19.7 million and $7.0 million at December 31, 1997 and
1996, respectively. The Company has entered into forward loan sale contracts
under which it has committed to deliver $716.0 million in loans, with the
related commitment expiration dates varying from April 30, 1998 through May 31,
1998.
Contingencies
In September 1996, AMC entered into a settlement agreement with the U.S.
Department of Justice ("DOJ") arising out of a DOJ investigation and complaint
which alleged that AMC during the period from January 1991 through June 1994
charged certain African-American, Hispanic, female and older borrowers
F-19
<PAGE> 59
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
more than younger, white male borrowers in violation of fair lending laws. AMC
denied all allegations in the complaint and all claims of discrimination. AMC
also disputed the validity of the statistical analysis relied upon by the DOJ as
the principal basis for its claims and further maintained that the DOJ theories
of liability regarding broker-sourced lending were legally insupportable.
Nonetheless, to avoid costly, protracted litigation, AMC agreed to establish a
$3 million fund to reimburse up to 1,200 borrowers identified by the DOJ as the
maximum number of individuals who may have been affected by the alleged fair
lending violations. AMC asserted that the better solution to the issues raised
by the DOJ was an intensive national effort in consumer education and
industry-wide initiatives directed at employee and broker education and
training. For this reason, AMC also agreed to contribute an additional $1
million (payable over 3 years) to fund consumer education programs in
conjunction with civil rights groups. AMC has established all funds required by
the settlement agreement. Pursuant to the settlement agreement, the Company, as
successor to AMC, has agreed to (i) document any price exceptions from the
Company's rate sheet on broker-sourced loans, (ii) periodically review the
results of its broker-sourced lending operations for its compliance with fair
lending laws but in no event shall the Company be required to disclose any
documents or information therewith, including the identities of any brokers with
whom it does business, (iii) retain all loan application files submitted for
mortgage loans and all loan-rider documents and notices relevant to any pricing
decisions until September 1999 and report to the DOJ semi-annually on compliance
with the settlement agreement and (iv) provide to brokers information about the
Company's fair-lending and pricing procedures and an opportunity to participate
in fair-lending training.
While the Company believes it is in compliance with the broker-sourced
provisions of the settlement agreement, there can be no assurance that the DOJ
will not take a contrary position in the future and seek to compel compliance by
the Company. The Company was allocated $1,065,000 and $267,000 in 1996 and 1995,
respectively, of the settlement costs on the basis of the portion of the
settlement pertaining to broker-sourced loans, as stipulated in the settlement
agreement, which is included in other expenses in the accompanying consolidated
statement of operations.
When the Company operated as a division of AMC, it was involved in various
lawsuits incidental to its business, none of which had a material adverse effect
on the Company. However, in the Reorganization, the Company did not assume any
liabilities that arose out of the lending activities of AMC, including
liabilities related to the broker-sourced mortgage loan operations, nor has the
Company agreed to indemnify AMC against any such liabilities.
The Company is a party to various routine legal proceedings arising out of
the ordinary course of its business. Management believes that none of these
actions, individually or in the aggregate, will have a material adverse effect
on the consolidated financial condition or results of operations of the Company.
The Company is aware of ensuing issues involving the upcoming date change
from December 31, 1999 to January 1, 2000 ("Year 2000") and the effect of such
change on the Company's information systems. In order to identify and minimize
any impact that Year 2000 may have on the Company, a task force was established
to evaluate operational activities that could be affected by such date change.
As part of the evaluation, both internal and external systems were identified as
critical to the Company's operations. As a result, the task force is currently
developing a detailed operational plan to resolve any issues and risks
identified in the initial examination. The task force has estimated that the
majority of the primary issues surrounding Year 2000 will be resolved by the end
of 1998. The Company does not believe that the cost of addressing all of the
issues associated with becoming Year 2000 compliant will have a material impact
on its consolidated results of operations or financial condition.
F-20
<PAGE> 60
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
Concentrations of Risk
The Company funds substantially all of the loans which it originates or
purchases through borrowings under the warehouse financing facility (see Note 6)
and internally generated funds. These borrowings are in turn repaid with the
proceeds received by the Company from selling such loans. Any failure to renew
or obtain adequate funding under those warehouse financing facilities, or other
borrowings, or any substantial reduction in the size of or pricing in the
markets for the Company's loans, could have a material adverse effect on the
Company's consolidated results of operations and financial condition. To the
extent that the Company is not successful in maintaining or replacing existing
financing, it would have to curtail its loan production activities, thereby
having a material adverse effect on the Company's consolidated results of
operations and financial condition.
Periods of economic slowdown may reduce the demand for mortgage loans as
people elect not to purchase new homes due to economic uncertainty and also may
adversely affect the financial condition of potential borrowers so that they do
not meet the Company's underwriting criteria. In addition, economic slowdowns
may cause a decline in real estate values. Any material decline in real estate
values will reduce the ability of borrowers to use home equity to support
borrowings by negatively affecting loan-to-value ratios of the home equity
collateral. To the extent that the loan-to-value ratios of prospective
borrowers' home equity collateral do not meet the Company's underwriting
criteria, the volume of loans originated by the Company could decline.
The Company began originating sub-prime mortgage loans in Southern
California in 1988 and started to expand its business outside California on a
limited basis in 1992. In 1994, the Company began to focus its attention on more
aggressive expansion outside California. For the year ended December 31, 1997,
approximately 34.4% of the dollar volume of loans originated or purchased by the
Company were secured by properties located in California. No other state
contained properties securing more than 10% of the dollar volume of loans
originated or purchased by the Company during the year ended December 31, 1997.
Although the Company has a nationwide independent broker network and Regional
Processing Center network, the Company is likely to continue to have a
significant amount of its loan originations and purchases in California for the
foreseeable future, primarily because California represents a significant
portion of the national mortgage marketplace. Consequently, the Company's
results of operations and financial condition are dependent upon the general
trends in the California economy and its residential real estate market.
Residential real estate market declines may adversely affect the values of
properties securing loans such that the principal balances of such loans will
equal or exceed the value of the mortgaged properties. Reduced collateral value
will adversely affect the volume of the Company's loans as well as the pricing
of the Company's loans and the Company's ability to sell its loans.
The Company focuses its marketing efforts on borrowers who may be unable to
obtain mortgage financing from conventional mortgage sources. Loans made to such
borrowers may entail a higher risk of delinquency and higher losses than loans
made to borrowers who utilize conventional mortgage sources. Accordingly, the
actual rates of delinquencies, foreclosures and losses on such loans could be
higher under adverse economic conditions than those currently experienced by the
mortgage lending industry in general. Any sustained period of increased
delinquencies, foreclosures or losses after the loans are sold could adversely
affect the pricing of the Company's loan sales and the ability of the Company to
sell its loans.
The Company has historically sold substantially all of its loan
originations in the secondary market to a limited number of institutional
purchasers. There can be no assurance that such purchasers of the Company's
loans will continue to purchase loans or be willing to purchase loans under
terms which such purchasers have historically purchased the Company's loans. To
the extent that the Company could not successfully replace such loan purchasers
or negotiate favorable terms for such loan purchasers, the Company's
consolidated results of operations and financial condition could be materially
adversely affected.
F-21
<PAGE> 61
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
The Company depends largely on independent mortgage brokers, and to a
lesser extent, smaller mortgage companies and commercial banks for its
originations and purchases of loans. The Company's competitors also seek to
establish relationships with such independent mortgage brokers, mortgage
companies and commercial banks, none of whom is obligated by contract or
otherwise to continue to do business with the Company. The Company's future
operating and financial results may be more susceptible to fluctuations in the
volume and costs of its broker-sourced loans resulting from, among other things,
competition from other purchasers of such loans.
The Company's business is subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities and is subject to
various laws and judicial and administrative decisions imposing requirements and
restrictions on a substantial portion of its operations. These rules and
regulations, among other things, impose licensing obligations on the Company,
establish eligibility criteria for mortgage loans, prohibit discrimination,
provide for inspections and appraisals of properties, require credit reports on
loan applicants, regulate assessment, collection, foreclosure and claims
handling, investment and interest payments on escrow balances and payment
features, mandate certain disclosures and notices to borrowers and, in some
cases, fix maximum interest rates, fees and mortgage loan amounts. Failure to
comply with these requirements can lead to loss of approved status, termination
or suspension of servicing contracts without compensation to the servicer,
demands for indemnifications or mortgage loan repurchases, certain rights of
recission for borrowers, class action lawsuits and administrative enforcement
actions. Although the Company believes that it has systems and procedures to
facilitate compliance with these requirements and believes that it is in
compliance in all material respects with applicable local, state and federal
laws, and rules and regulations, in the future more restrictive laws, rules and
regulations or the judicial interpretation of existing laws, rules and
regulations could make compliance more difficult or expensive.
Lawsuits have been filed against several mortgage lenders, including AMC,
alleging that such lenders have made certain payments to independent mortgage
brokers in violation of RESPA. These lawsuits have generally been filed on
behalf of a purported nationwide class of borrowers alleging that payments made
by a lender to a broker in addition to payments made by the borrower to a broker
are prohibited by RESPA and are therefore illegal. If these cases are resolved
against the lenders, it may cause an industry-wide change in the way independent
mortgage brokers are compensated. The Company's broker compensation programs
permit such payments. Although the Company believes that its broker compensation
programs comply with all applicable laws and are consistent with long-standing
industry practice and regulatory interpretations, in the future, new regulatory
interpretations or judicial decisions may require the Company to change its
broker compensation practices. Such a change may have a material adverse effect
on the Company and the entire mortgage lending industry.
NOTE 13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures of the estimated fair value of the financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosure About Fair Value of Financial Instruments." The estimated fair value
amounts have been determined by the Company using available market information
and appropriate valuation methodologies. However, considerable judgment is
necessarily required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange.
F-22
<PAGE> 62
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
The use of different market assumptions and/or estimation methodologies may
have a material effect on the estimated fair value amounts at December 31
(dollars in thousands):
<TABLE>
<CAPTION>
1997 1996
---------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents...................... $ 38,782 $ 38,782 $ -- $ --
Investment securities available for sale....... $ 3,793 $ 3,793 $ -- $ --
Loans held for sale............................ $ 17,241 $ 17,429 $49,580 $52,122
Receivable from the sales of loans............. $143,088 $143,088 $25,103 $25,103
Liabilities:
Warehouse financing facility................... $146,271 $146,271 $72,829 $72,829
Off-Balance sheet unrealized gains(losses):
Loan origination commitments................... $ -- $ -- $ -- $ --
</TABLE>
Because of the short maturities of cash and cash equivalents, management
believes that their carrying amount is a reasonable estimate of fair value. The
estimated fair value of investment securities available for sale is based upon
quoted market prices. Outstanding commitments from investors are used to
determine fair value of loans held for sale. Due to their short turnover rate,
management believes that the carrying amount of receivable from the sales of
loans is a reasonable estimate of fair value. Warehouse financing facility is
valued at par as management believes that the terms of the warehouse financing
facility represent current market rates.
The fair value of loan origination commitments is estimated using the fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
counterparts.
The fair value estimates are based on pertinent information available to
management as of December 31, 1997 and 1996. Although management is not aware of
any factors that would significantly affect the estimated fair value amounts,
such amounts have not been comprehensively revalued for purposes of these
financial statements since that date and, therefore, current estimates of fair
value may differ significantly from the amounts presented herein.
F-23
<PAGE> 63
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
NOTE 14. SELECTED QUARTERLY DATA (UNAUDITED)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1997
Gain on sale of loans............................... $17,238 $19,941 $24,829 $26,589
Net interest income................................. 472 145 1,151 1,586
Net operating income................................ 17,710 20,104 26,200 28,652
Total general and administrative expenses........... 9,639 9,581 11,947 14,703
Provision for losses................................ 438 2,490 500 600
Sub-servicing costs................................. -- 46 294 595
Earnings before income taxes........................ 7,633 7,987 13,459 12,754
Net earnings........................................ $ 4,568 $ 4,872 $ 7,859 $ 7,345
Basic earnings per share:
Net earnings...................................... $ 0.18 $ 0.19 $ 0.31 $ 0.29
Average number of common shares................... 25,000 25,000 25,000 24,904
Diluted earnings per share:
Net earnings...................................... $ 0.18 $ 0.19 $ 0.30 $ 0.28
Average number of common and equivalent shares.... 25,000 25,310 26,075 26,126
YEAR ENDED DECEMBER 31, 1996
Gain on sale of loans............................... $10,101 $11,482 $15,158 $13,958
Net interest income................................. 112 110 74 165
Net operating income................................ 10,213 11,592 15,232 14,123
Total general and administrative expenses........... 6,759 8,296 9,028 10,755
Provision for losses................................ -- -- 150 200
Earnings before income taxes........................ 3,454 3,296 6,054 3,168
Net earnings........................................ $ 2,031 $ 1,938 $ 3,560 $ 1,863
Basic earnings per share............................ N/A N/A N/A N/A
Diluted earnings per share.......................... N/A N/A N/A N/A
</TABLE>
NOTE 15. SUPPLEMENTAL FINANCIAL INFORMATION
The following table presents supplemental financial information for the
Company's Consolidated Statements of Cash Flows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
---------------------------------------
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Supplemental Disclosures of Cash Flow
Information:
Cash paid during the year for
interest on warehouse financing
facility......................... $ 3,524,000 $2,569,000 $1,581,000
Cash paid during the year for income
taxes............................ $ 8,812,000 $ -- $ --
Supplemental Schedule of Non-Cash
Activities:
Deferred tax asset.................. $36,000,000 $ -- $ --
Amortization of deferred tax
asset............................ $ 1,600,000 $ -- $ --
</TABLE>
F-24
<PAGE> 64
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Long Beach Financial Corporation:
We have audited the accompanying consolidated statements of financial
condition of Long Beach Financial Corporation and subsidiary (the "Company") as
of December 31, 1997 and 1996, and the related consolidated statements of
operations, stockholders' and divisional 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
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Long Beach Financial
Corporation and subsidiary as of December 31, 1997 and 1996, the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
As more fully described in Note 1, the Company was a part of Ameriquest
Mortgage Company ("AMC") and had no separate legal status or existence through
May 1, 1997. The Company had various transactions with AMC, including various
expense allocations and reimbursements, that are material in amount. The
consolidated financial statements of the Company have been prepared from
separate records maintained by the Company, as well as from the records of AMC,
and may not necessarily be indicative of the conditions that would have existed
if the Company had operated as an independent entity.
DELOITTE & TOUCHE LLP
Costa Mesa, California
January 27, 1998
F-25
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 38,782
<SECURITIES> 3,793
<RECEIVABLES> 160,329
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 4,218
<DEPRECIATION> 598
<TOTAL-ASSETS> 248,088
<CURRENT-LIABILITIES> 0
<BONDS> 146,271
0
0
<COMMON> 25
<OTHER-SE> 90,720
<TOTAL-LIABILITY-AND-EQUITY> 248,088
<SALES> 0
<TOTAL-REVENUES> 99,804
<CGS> 0
<TOTAL-COSTS> 46,805
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 4,028
<INTEREST-EXPENSE> 7,138
<INCOME-PRETAX> 41,833
<INCOME-TAX> 17,189
<INCOME-CONTINUING> 24,644
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 24,644
<EPS-PRIMARY> 0.99
<EPS-DILUTED> 0.96
</TABLE>
