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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, 1998
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.)
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1100 TOWN & COUNTRY ROAD, SUITE 1600, 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:
<TABLE>
<CAPTION>
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, 1999, was $223,270,000, 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, 1999, Registrant had outstanding 22,609,618 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement relating to its 1999 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, 1998
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PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 22
Item 3. Legal Proceedings........................................... 23
Item 4. Submission of Matters to a Vote of Security Holders......... 23
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 23
Item 6. Selected Financial Data..................................... 24
Item 7. Management's Discussion and Analysis of Financial Condition,
Results of Operations, Liquidity and Capital Resources...... 25
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 37
Item 8. Financial Statements and Supplementary Data................. 38
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 38
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 38
Item 11. Executive Compensation...................................... 38
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 38
Item 13. Certain Relationships and Related Transactions.............. 39
PART IV
Item 14. Financial Statement Schedules, Exhibits, and Reports of Form
8-K......................................................... 39
Signatures.................................................. 42
Index to Financial Statements......................................... F-1
</TABLE>
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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 has been 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 has been 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 12,500 independent mortgage
loan brokers that generate loans in all 50 states. The large number of brokers
reflects the Company's strategy of utilizing a diverse group of small brokers to
avoid becoming dependent on a few primary producers. In 1998, 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
325 account executives located in 72 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.
The Company originates loans through wholesale and retail channels of
production. The wholesale channel is comprised of broker-sourced production and
production from correspondents. Through the retail production channel the
Company directly interacts with the customer through direct mail, telemarketing,
the internet and other sources. See Management's Discussion and Analysis of
Financial Condition, Results of Operations, Liquidity and Capital Resources and
Note 16 to the Consolidated Financial Statements for financial information about
the Company's business segments.
The Company historically has followed 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. Cash from
loan sales has been used by the Company to repay borrowings previously made
under its warehouse financing facility. 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. The Company may utilize
alternative strategies to maximize the value it receives on its loan sales. Such
strategies may include securitization. The Company's focus in utilizing such a
strategy would be to retain a positive cash flow operating model.
Growth Strategy
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
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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); and (iv) expanding the automation of the underwriting process.
The retail loan operations conducted under the name "Financing USA" offers
the same products as those of the broker-sourced operations and are sourced
primarily through technology-based direct mail and electronic media marketing,
rather than on a network of branch sales offices. This strategy is designed to
enable the Company to operate with less overhead than a direct-sourced loan
business that operates through a branch sales office network.
In accordance with the strategic plan, the Company successfully launched an
independent servicing operation in November 1998. The Company was approved as a
residential subprime loan servicer by Standard & Poor's during the fourth
quarter of 1998. Additionally, the Company is approved as a seller for Fannie
Mae, and as a non-supervised mortgagee by the United States Department of
Housing and Urban Development.
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) loan sales division, and (iv) the loan servicing
division. LBFC was formed to facilitate the public sale of AMC's broker-sourced
lending and loan sales divisions. 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 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.
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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.
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 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. During the third quarter
of 1998, the Company and AMC modified the sub-servicing agreement to accommodate
the establishment of the Company's independent servicing operations. Under the
modified sub-
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servicing agreement, AMC no longer is required to sub-service loans originated
by the Company on or after November 2, 1998 and the Company is no longer
required to engage AMC to sub-service its loans.
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.
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,
negotiate better terms on their existing mortgage, 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 or three 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):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
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1998 1997 1996
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<S> <C> <C> <C>
Fixed rate loans....................... $ 588,794 $ 428,793 $ 392,251
Fixed/adjustable rate loans............ 1,594,738 756,853 97,962
Six-month adjustable rate loans........ 392,433 500,096 567,909
---------- ---------- ----------
Total loan production........ $2,575,965 $1,685,742 $1,058,122
========== ========== ==========
</TABLE>
Many of the Company's borrowers utilize funds from loans to pay-off
existing debts. During 1998, approximately 62% of the Company's loan production
was made for the purpose of providing funds for refinancing, and in
approximately 71% 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%. During 1998, core product
origination totaled $2.2 billion and represented 86.8% of total production. 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-."
Broker-Sourced Loan Operations
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,
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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
thereby enhance the likelihood that the loan will be approved at the rate and on
the terms submitted 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.
Correspondent Loan Purchasing
The Company augments its loan production by purchasing loans on a
correspondent basis from smaller mortgage companies and other financial
institutions 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 economies of scale in larger transactions.
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
re-underwrites loans submitted by the originator prior to accepting them,
confirming compliance with the Company's underwriting guidelines and
documentation standards.
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 11.5% of the
Company's total loan volume by principal amount during 1998, compared to 9.0%
and 3.1% in 1997 and 1996, 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 correspondent team structure.
Direct-Sourced Loan Operations
Direct-sourced loan operations 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 operate 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.
The direct-sourced loan origination channel accounted for approximately
2.3% of the Company's total loan volume by principal amount during 1998.
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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:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
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1998 1997 1996
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(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Aggregate principal balance:
Broker-sourced................................. $2,220,096 $1,531,266 $1,026,390
Correspondent.................................. 296,283 151,768 31,732
Retail......................................... 59,586 2,708 --
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Total.................................. $2,575,965 $1,685,742 $1,058,122
Average principal balance per loan
Broker-sourced................................. $ 113 $ 112 $ 107
Correspondent.................................. 119 124 94
Retail......................................... 110 129 --
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Total.................................. $ 113 $ 113 $ 105
Combined weighted average loan-to-value(2)
Broker-sourced................................. 77.8% 77.0% 75.1%
Correspondent.................................. 77.3% 77.4% 74.3%
Retail......................................... 76.5% 76.6% --%
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Total.................................. 77.7% 77.1% 75.1%
Weighted average interest rate(2)
Broker-sourced................................. 9.6% 9.6% 9.9%
Correspondent.................................. 9.9% 9.9% 10.1%
Retail......................................... 9.6% 9.1% --%
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Total.................................. 9.6% 9.5% 10.0%
"A-" through "B-" loans as a percentage of total
loans(1)(2).................................... 85.2% 88.1% 85.4%
</TABLE>
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(1) Based on original principal balance.
(2) For 1996, 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, the calculated amounts
above are not materially affected by such differences. See the tables on
pages 11 and 12 for more information.
All loans originated or purchased by the Company are secured by a first
priority mortgage on the subject property.
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Geographic Markets
The approximately 12,500 independent mortgage loan brokers with whom the
Company has had a relationship originate loans in all 50 states. The following
table shows geographic distribution of the aggregate principal balance of loan
originations and purchases for the periods shown.
<TABLE>
<CAPTION>
LOAN ORIGINATIONS
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996 1995
----- ----- ----- -----
<S> <C> <C> <C> <C>
States(1)(3):
California.......................................... 33.8% 34.4% 37.1% 43.1%
Colorado............................................ 7.8 8.4 7.3 2.9
Michigan............................................ 5.3 6.0 3.7 3.9
Texas............................................... 4.9 3.7 3.8 1.5
Florida............................................. 4.6 5.1 3.5 1.5
Oregon.............................................. 4.0 5.3 4.3 4.0
Illinois............................................ 3.8 4.1 6.2 8.7
New York............................................ 3.5 2.0 1.5 0.3
Minnesota........................................... 3.0 2.7 2.2 --
All other States (41 other states)(2)............... 29.3 28.3 30.4 34.1
----- ----- ----- -----
Total..................................... 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
</TABLE>
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(1) States are listed in order of percentage of loan originations and purchases
for the year ended December 31, 1998.
(2) For the year ended December 31, 1998, loan originations and purchases in
each state were less than 2.7% 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's geographic markets are divided among 19 regional teams and
one national correspondent lending team. 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 20 teams are deployed into 11 regional processing centers. When
a regional processing center is first established, the staff responsible for
underwriting and funding 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 the 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 opened four regional processing centers during 1998 and
intends to establish two additional regional processing centers in 1999.
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
regarding the Company's underwriting guidelines and the implementation of the
Company's underwriting
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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.
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,
divisional operations manager or regional vice president, a prospective borrower
not strictly adhering to the Company's underwriting guidelines may be granted an
underwriting exception. Divisional operations 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 fully
disclosed 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.
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
8
<PAGE> 11
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 borrower's credit-worthiness. 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 exhibiting major deferred maintenance) are considered unacceptable
collateral for the 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 the
closing attorneys and agents 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 a bonded
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.
9
<PAGE> 12
The chart below summarizes the general criteria used by the Company at
February 28, 1999, in classifying prospective borrowers 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 85% for owner 85% for owner 80% for owner 75% for owner 65% 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 60% 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 60% 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; 50%
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(A) LTV's .85% = 45%
LTV's ,85% = 47% 50% 55% 55% 55%
Consumer
Credit(B) LTV's ,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.
LTV's .85% (3)
30-day revolving
lates and (3)
30-day installment
lates.
Mortgage
Credit(C) 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 12 months.
</TABLE>
- ---------------
(A) Debt ratios may be increased to 55% if the net disposable income minimum
requirement is doubled on loan programs A- and B, where LTV's are ,85%.
(B) For LTV's ,85% 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.
(C) Consecutive rolling consumer and mortgage 30-day delinquencies up to six
months reported on a credit report may be counted as one late payment.
10
<PAGE> 13
The following table sets forth certain information with respect to the
Company's loan purchases and originations by product and risk classification,
for the years ended December 31 (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997(3)
--------------------------------------------- ---------------------------------------------
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)
- ----------------------------- ---------- ------ -------- --------- ---------- ------ -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
FIXED RATE:
A-....................... $ 374,953 63.68% 9.50% $ 281,828 65.73% 9.83%
B+....................... NA NA NA 33,302 7.77 10.20
B........................ 67,742 11.51 10.18 43,830 10.22 10.45
B-....................... 61,576 10.46 10.49 28,507 6.65 10.73
C........................ 56,531 9.60 11.38 35,806 8.35 11.43
C-....................... NA NA NA 3,064 0.71 11.77
D........................ 27,992 4.75 12.23 2,456 0.57 12.26
---------- ------ ---------- ------
Totals............. $ 588,794 100.00% 9.99% $ 428,793 100.00% 10.16%
SIX-MONTH ADJUSTABLE RATE:
A-....................... $ 276,691 70.50% 8.54% 6.46% $ 319,045 63.80% 8.58% 6.34%
B+....................... NA NA NA NA 35,204 7.04 8.88 6.16
B........................ 37,507 9.56 8.88 6.50 42,641 8.53 9.12 6.42
B-....................... 32,213 8.21 9.41 6.52 33,758 6.75 9.44 6.54
C........................ 28,173 7.18 10.07 6.58 46,932 9.38 10.18 6.63
C-....................... NA NA NA NA 18,077 3.61 10.96 6.73
D........................ 17,849 4.55 11.47 6.67 4,439 0.89 11.49 7.02
---------- ------ ---------- ------
Totals............. $ 392,433 100.00% 8.89% 6.49% $ 500,096 100.00% 8.97% 6.40%
FIXED/ADJUSTABLE RATE:
A-....................... $ 910,886 57.12% 9.30% 6.61% $ 487,351 64.39% 9.46% 6.29%
B+....................... NA NA NA NA 50,048 6.61 9.72 6.20
B........................ 225,212 14.12 9.64 6.67 75,780 10.01 9.95 6.50
B-....................... 208,907 13.10 9.96 6.70 53,037 7.01 9.99 6.59
C........................ 165,626 10.39 10.55 6.73 73,489 9.71 10.62 6.60
C-....................... NA NA NA NA 10,171 1.35 11.28 6.79
D........................ 84,107 5.27 11.51 6.81 6,977 0.92 11.70 7.04
---------- ------ ---------- ------
Totals............. $1,594,738 100.00% 9.68% 6.65% $ 756,853 100.00% 9.73% 6.37%
ALL PRODUCTS:
A-....................... $1,562,530 60.66% $1,088,224 64.56%
B+....................... NA NA 118,554 7.03
B........................ 330,461 12.83 162,251 9.62
B-....................... 302,696 11.75 115,302 6.84
C........................ 250,330 9.72 156,227 9.27
C-....................... NA NA 31,312 1.86
D........................ 129,948 5.04 13,872 0.82
---------- ------ ---------- ------
Totals............. $2,575,965 100.00% $1,685,742 100.00%
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
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)
- ----------------------------- ---------- ------ -------- --------- ---------- ------ -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
FIXED RATE:
A-....................... $ 231,792 59.23% 10.20% $ 38,896 49.86% 10.95%
B+....................... 53,184 13.59 10.43 18,577 23.81 11.25
B........................ 36,257 9.26 10.76 6,365 8.16 11.23
B-....................... 28,699 7.33 10.97 4,359 5.59 11.74
C........................ 39,594 10.12 11.66 9,598 12.30 12.46
C-....................... 1,820 0.47 11.36 219 0.28 12.83
D........................ NA NA NA NA NA NA
---------- ------ ---------- ------
Totals............. $ 391,346 100.00% 10.49% $ 78,014 100.00% 11.28%
SIX-MONTH ADJUSTABLE RATE:
A-....................... $ 293,519 51.82% 8.98% 6.09% $ 207,152 43.11% 9.70% 5.80%
B+....................... 67,306 11.88 9.30 6.15 42,811 8.91 10.13 5.84
B........................ 51,770 9.14 9.90 6.39 42,050 8.75 10.50 6.29
B-....................... 45,080 7.96 10.00 6.49 63,324 13.18 10.64 6.29
C........................ 86,778 15.32 10.73 6.64 100,768 20.97 11.28 6.58
C-....................... 22,001 3.88 11.89 6.85 24,378 5.08 12.33 6.87
D........................ NA NA NA NA NA NA NA NA
---------- ------ ---------- ------
Totals............. $ 566,454 100.00% 9.57% 6.27% $ 480,483 100.00% 10.40% 6.13%
FIXED/ADJUSTABLE RATE:
A-....................... 70,949 73.08 9.84 5.58 $ 11,804 42.96% 10.61% 5.24%
B+....................... 13,462 13.86 10.30 6.00 2,854 10.39 10.78 5.35
B........................ 6,649 6.85 10.46 6.17 2,878 10.47 11.17 5.18
B-....................... 1,987 2.05 10.72 6.41 3,921 14.27 11.57 5.58
C........................ 3,521 3.63 11.19 6.77 4,826 17.56 12.53 5.74
C-....................... 518 0.53 11.11 6.87 1,196 4.35 13.37 6.10
D........................ NA NA NA NA NA NA NA NA
---------- ------ ---------- ------
Totals............. $ 97,086 100.00% 10.02% 5.75% $ 27,479 100.00% 11.28% 5.42%
ALL PRODUCTS:
A-....................... $ 596,260 56.52% $ 257,852 44.01%
B+....................... 133,952 12.70 64,242 10.96
B........................ 94,675 8.98 51,293 8.75
B-....................... 75,766 7.18 71,604 12.22
C........................ 129,893 12.31 115,192 19.66
C-....................... 24,340 2.31 25,793 4.40
D........................ NA NA NA NA
---------- ------ ---------- ------
Totals............. $1,054,886 100.00% $ 585,976 100.00%
</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 "reportable amount of" origination and purchase amounts
recorded in 1996 and 1995.
12
<PAGE> 15
FINANCING AND SALE OF LOANS
Warehouse Financing Facility
The Company finances originations and purchases of loans primarily with the
proceeds of borrowings under a committed warehouse financing facility, which
initially provided for a borrowing capacity of $250 million and was increased to
$300 million in April 1998 (the "Facility"). This Facility is provided by a
syndicate of banks led by Chase Bank of Texas. Borrowings under this 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 this Facility are permitted up to 98% of
the principal balance of the originated and purchased loans and bear interest at
rates ranging from 1.25% to 1.50% 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 Facility. The Facility also includes a $15 million
subline for principal and interest advances and a $10 million subline for other
servicing advances made primarily to security holders in connection with
securitizations by purchasers of the Company's loans in which the Company serves
as the master servicer, and a $15 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 2.0% over the 30-day
reserve-adjusted LIBOR. The Facility will expire on April 16, 2000, unless
earlier terminated or extended in accordance with its terms. The Facility
contains a number of financial covenants including: (i) the Company maintain
tangible net worth equal to at least $30 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 10:1. The 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, 1998.
At December 31, 1998 the Company had access to a $100 million uncommitted
warehouse line from an investment banking firm. This line bears interest at
LIBOR plus 0.75%. The line expires in September 1999. During February 1999, the
Company obtained an additional $100 million warehouse line from another
investment banker. This line bears interest at LIBOR plus 1.25% and expires
January 2000. The Company was in compliance with all of its debt and equity
covenants at December 31, 1998.
Loan Sales
The Company has followed a strategy of selling for cash substantially all
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 $2.5 billion, $1.7 billion and $1.0 billion of loans through loan
sales during 1998, 1997 and 1996, respectively. The Company did not issue any
securities during the period; however, substantially all of the loans sold
during the period were ultimately securitized by the purchasers thereof.
Loans generally have been 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 93% of the Company's total revenues in 1998. 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 1998, 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 has historically engaged in 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 potential purchasers who in most cases have purchased loans from the
Company previously. 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
13
<PAGE> 16
Company continuously monitors its loan production and purchases 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.
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 the borrower defaults on the first payment
due after 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 includes 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 incremental general and
administrative expenditures by the Company.
The following table illustrates the historical economics of the gain on
sale of loans from the Company's various channels (general and administrative
expenses are not included):
<TABLE>
<CAPTION>
BROKER-SOURCED RETAIL CORRESPONDENT
PRODUCTION PRODUCTION PRODUCTION
-------------------- -------------------- --------------
<S> <C> <C> <C>
Gross sales premiums......... 4 - 6 points 4 - 6 points 4 - 6 points
Less broker fees (PYA)....... 0 - 2 points N/A N/A
Less purchase costs.......... N/A N/A 1 - 4 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>
During 1998, the Company's net gain on sale of loans, as a percentage of
loans sold, totaled 4.87%. This represents a decrease from 5.28% in 1997 and
from 4.92% in 1996. The reduction in net gain on sale resulted from a decline in
the prices of subprime loans in the secondary market, negatively impacting the
gross sales premiums that the Company has realized from the sale of its loans.
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. As a
result of the recent decline in whole loan prices, the Company may consider
alternatives to whole loan sales, including securitizations, depending on market
conditions and available levels of whole loan executions. The Company's focus in
utilizing such strategy would be to retain a positive cash flow operating model.
SERVICING
At the time of the Reorganization, the Company entered into a sub-servicing
agreement with AMC under which AMC agreed to sub-service loans originated or
purchased by the Company following the Reorganization. Sub-servicing has been
provided by AMC at an agreed-upon rate and with default terms comparable to
industry standards. The agreement contains other customary terms and conditions.
Either AMC or the Company has the right to terminate the agreement at any time
upon six months' prior written notice to the other party, provided that all
required approvals of investors, rating agencies and other parties have been
obtained. During the third quarter of 1998, the Company and AMC modified the
sub-servicing agreement to accommodate the establishment of the Company's
independent servicing operations. Under the
14
<PAGE> 17
modified sub-servicing agreement, AMC no longer is required to sub-service loans
originated by the Company on or after November 2, 1998, and the Company is no
longer required to engage AMC to sub-service its loans.
The Company's objective in establishing a proprietary loan servicing
platform was to continue its evolution into a fully integrated mortgage banking
organization. The Company's loan service function is a critical component in
managing the loan collection process, generating recurring revenues, and
providing full service to its customers. In developing its loan servicing
operation, the Company sought seasoned professionals and a platform that was
year 2000 compliant.
In accordance with the strategic plan, the Company successfully launched an
independent servicing operation in November 1998. The Company was approved as a
residential subprime loan servicer by Standard & Poor's during the fourth
quarter of 1998. Additionally, the Company is an approved FNMA seller/servicer
and is licensed as a non-supervised mortgagee by the United States Department of
Housing and Urban Development.
At December 31, 1998, the Company was directly servicing loans with an
aggregate principal balance of $546.6 million. An additional $972.9 million of
loans were serviced by AMC at December 31, 1998 pursuant to the sub-servicing
agreement. During January 1999, the Company transferred $550 million of loans
from AMC to its own servicing operation.
TECHNOLOGY
During the first quarter of 1998, the Company completed the development and
deployment of its independent data processing center. The implementation of the
data center enabled the Company to terminate the utilization of AMC's data
center on March 1, 1998.
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. Long Beach Mortgage 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.longbeachmortgage.com. Financing USA, the
Company's retail lending division, also has established an internet website
through which borrowers can access information about the Company's retail
products and submit data to simplify the application process. Financing USA's
website address is http://www.financingusa.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.
COMPETITION
The Company continues to anticipate 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. 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-
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<PAGE> 18
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
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"
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.
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 enforcement 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 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
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<PAGE> 19
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 a proposed rule which would create a qualified
"safe harbor" under RESPA for lender payments to mortgage brokers (such as yield
spread premiums). Under the proposal, fees paid by a lender to a mortgage broker
would not be prohibited under RESPA if the broker enters into a contract with
the consumer explaining the broker's relationship and total compensation. In
July 1998, HUD and the Board of Governors of the Federal Reserve System
delivered to Congress a joint report containing legislative proposals to reform
RESPA and TILA. This report proposed an exemption from the fee restrictions of
RESPA for mortgage brokers that offer a package of settlement services for
mortgage loans at a guaranteed price and follow other requirements. In March
1999, HUD issued a policy statement setting forth its position on lender-paid
broker compensation under RESPA. In the policy statement, HUD asserts that
lender payments to mortgage brokers are not per se illegal, but rather must be
analyzed on a case-by-case basis. In determining whether lender-paid
compensation is permissible under RESPA, the policy statement sets forth a
two-part test: (i) whether the broker actually provided compensable goods,
facilities or services and (ii) whether the broker's total compensation is
reasonably related to the value of the goods, facilities or services it
provided. In the policy statement, HUD also stated that legislation to improve
RESPA is needed and that a reform package along the lines specified in the HUD
and Federal Reserve Board report remains the most effective way to resolve the
legal uncertainties under that statute. It is unknown at this time whether HUD's
October 1997 proposal or reform legislation will be adopted.
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 older borrowers more than younger, white male borrowers in violation
of fair lending laws. AMC denied all
17
<PAGE> 20
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's
wholesale division, 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. 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. The Company believes
that it is in compliance in all material respects with the settlement agreement.
The Company's obligations under the settlement agreement terminate in September
1999.
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, 1999, the Company had a total of 866 employees. None of
the Company's 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
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<PAGE> 21
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 5% of the total principal amount of loans originated or purchased
by the Company in 1998 were to borrowers with a Company risk classification of
"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 default
frequency 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 default after the loans are sold could adversely
affect the pricing of the Company's future loan sales, the ability of the
Company to sell its loans in the future, and the market value of the Company's
loans held for sale.
Loss of Funding Sources Could Adversely Affect Results of Operations
The Company funds substantially all of the loans it originates or purchases
through the Facility and other borrowings. These borrowings will be repaid with
the proceeds received by the Company from selling such loans. Banks and other
creditors offering financing to mortgage lenders, such as the Company, have been
concerned over financial difficulties experienced by certain specialty finance
companies during 1998 and 1999. These difficulties include a lack of liquidity
caused by secondary market conditions and other factors and have led to the
bankruptcy filings of a few mortgage lenders. As a result, mortgage warehouse
lenders have been more cautious with respect to borrowings offered to mortgage
lenders, especially those specializing in subprime loans. Any failure to renew
or obtain adequate funding under the 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 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 has
represented the primary source of the Company's revenues and net income.
Furthermore, the Company has relied 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 number of
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<PAGE> 22
institutional purchasers. During 1998, prices received by the Company in its
whole loan sale transactions declined from levels previously realized. This
decline resulted in part from widening spreads in the asset-backed capital
markets and excess inventory of subprime loans. There can be no assurance that
the Company will be able to sell its loans in the secondary market at prices
near the levels achieved during 1998 or 1997. 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.
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. In a majority of these cases,
courts have declined to grant class certification, holding that it is necessary
to analyze the facts of each transaction to determine whether the lender-paid
fee, either alone or in combination with borrower-paid fees, constitutes a
reasonable payment for goods, facilities or services provided. In March 1999,
HUD clarified its position on lender payments to mortgage brokers further
undermining class action lawsuits alleging that all lender-paid fees are per se
illegal. See "Business -- Regulation." 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 legislation, 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 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,
financial condition and liquidity. See "Management's Discussion and Analysis of
Financial Condition, Results of Operations, Liquidity and Capital Resources."
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<PAGE> 23
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 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 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.
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<PAGE> 24
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 1998 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 1998. 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 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, (iii) continue to expand in the face
of increasing competition from other mortgage lenders, and (iv) finance
increased loan production with additional warehouse lines or other borrowing.
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 in Orange, California,
where it leases approximately 80,600 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 $1.5 million and the related leases provide for certain scheduled
increases in annual rent. The Company also
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leases or subleases space for eleven Regional Processing Centers and 72 account
executive field offices all in the United States.
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
Although the Company is currently not a party to any material litigation it
may be subject to various routine legal proceedings arising out of the ordinary
course of its business.
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, 1998.
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>
1998
Fourth Quarter....................................... $ 8.125 $ 4.625
Third Quarter........................................ 11.188 6.688
Second Quarter....................................... 14.125 10.250
First Quarter........................................ 13.313 9.875
1997
Fourth Quarter....................................... $15.063 $ 9.875
Third Quarter........................................ 13.563 8.750
Second Quarter....................................... 8.875 6.500
</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 5, 1999, the Company had approximately 33 stockholders of record
of its common stock. The Company believes its common stock is beneficially held
by more than 3,000 stockholders.
The Company is authorized to repurchase up to 2.5 million shares of the
Company's common stock through the end of September 1999 pursuant to a stock
repurchase plan adopted by the Board of Directors in October 1997. During 1998,
the Company used $21.2 million of available liquidity to purchase an additional
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2.1 million shares of common stock. The Company has spent $24.5 million and has
repurchased 2.4 million shares since the plan's inception.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................ $ 132,650 $ 92,666 $ 51,160 $ 31,873 $ 22,364
Expenses............................ 82,618 50,833 35,188 21,912 22,328
Net earnings........................ $ 30,019 $ 24,644 $ 9,392 $ 5,792 $ 22
Basic earnings per share:
Net earnings...................... $ 1.27 $ 0.99 n/m n/m n/m
Average number of common shares... 23,706 24,976 n/m n/m n/m
Diluted earnings per share:
Net earnings...................... $ 1.22 $ 0.96 n/m n/m n/m
Average number of common shares... 24,613 25,653 n/m n/m n/m
Return on average assets............ 32.15% n/m n/m n/m n/m
Return on average equity............ 12.94% n/m n/m n/m n/m
Loans originated and purchased...... $2,575,965 $1,685,742 $1,058,122 $592,542 $565,547
Loan sales.......................... 2,521,606 1,679,522 1,029,789 580,366 562,054
G&A as a % of originations.......... 2.82% 2.72% 3.29% 3.70% 3.95%
Gain on sale as a % of loans sold... 4.87% 5.28% 4.92% 5.46% 3.86%
Net earnings as a % of production... 1.17% 1.46% 0.89% 0.98% 0.00%
</TABLE>
- ---------------
n/m -- Not meaningful as this includes periods prior to the initial public
offering.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF FINANCIAL CONDITION
DATA:
Cash and cash equivalents........... $ 24,941 $ 38,782 $ -- $ -- $ --
Loans held for sale................. 59,148 17,241 49,580 21,342 10,364
Capitalized mortgage servicing
rights............................ 9,806 3,054 -- -- --
Deferred income taxes............... 32,523 34,400 2,120 882 --
Total assets........................ 328,595 248,088 79,750 24,778 12,529
Warehouse financing facility........ 211,787 146,271 72,829 20,613 11,483
Total liabilities................... 228,969 157,343 78,613 23,046 13,391
Stockholders' and divisional equity
(deficit)......................... 99,626 90,745 1,137 1,732 (862)
OPERATING DATA:
States in which loans were
originated........................ 50 48 43 35 27
Account Executives at year end...... 327 232 120 64 79
Independent broker relationships.... 12,500 10,000 7,000 5,000 4,000
Book value per share at year-end.... $ 4.41 $ 3.67 n/m n/m n/m
Equity to Asset Ratio at year-end... 30.32% 36.58% n/m n/m n/m
</TABLE>
24
<PAGE> 27
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 have been 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. 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.
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 year ended December 31, 1996, 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.
25
<PAGE> 28
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 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 revenues, expenses and net earnings for the years
ended December 31, 1998, 1997 and 1996 follows:
<TABLE>
<CAPTION>
1997
----------------------------------------
WHOLESALE THE COMPANY
DIVISION OF MAY 2 THROUGH
1998 AMC DEC. 31, 1997 COMBINED 1996
-------- ----------- ------------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenues..................... $132,650 $25,772 $66,894 $92,666 $51,160
Expenses..................... 82,618 15,841 34,992 50,833 35,188
Net earnings................. 30,019 5,947 18,697 24,644 9,392
Basic earnings per share..... 1.27 0.24 0.75 0.99 n/a
Diluted earnings per share... 1.22 0.24 0.72 0.96 n/a
</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 Cash Premium"), minus (ii) the fees and other compensation paid to
independent mortgage brokers and other lenders, plus (iii) capitalized servicing
rights, and plus (iv) points and fees received from the borrower, offset by
incremental direct loan origination costs. The Gross Cash Premium plus
capitalized servicing rights equals the "Gross Sales Premium." 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,
non-performing loans and the average amount of borrowings outstanding.
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.
The Company generates its loan production through three channels:
broker-sourced, correspondent and consumer direct. The broker-sourced and
correspondent channels comprise wholesale production and the consumer direct
channel represents retail production (the "Retail Channel").
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, 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 the
Company purchases loans on a correspondent basis from other lenders. Loan
purchases totaled $296.3 million or 11.5% of production for the year ended
December 31, 1998, as compared to $151.8 million or 9.0% and $32.3 million or
3.1% for the years ended December 31, 1997 and 1996, respectively. In the fourth
quarter of 1997, the Company initiated its retail channel. The Company created
the retail channel in order to diversify its
26
<PAGE> 29
production and to have direct interaction with borrowers at the time of
origination. During 1998, the retail channel generated $59.6 million of loans.
The following table presents the Company's loan production by channel for
the years presented (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Broker-sourced................................. $2,220,096 $1,531,266 $1,026,390
Correspondent.................................. 296,283 151,768 31,732
---------- ---------- ----------
Wholesale.................................... 2,516,379 1,683,034 1,058,122
Retail......................................... 59,586 2,708 --
---------- ---------- ----------
Total................................ $2,575,965 $1,685,742 $1,058,122
========== ========== ==========
</TABLE>
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. At December 31, 1998 the Company had 11
regional processing centers located throughout the United States.
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 180 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 are
adjusted.
The following table presents the Company's loan sales for the periods
indicated (dollars in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Loan sales (principal balance)................. $2,521,606 $1,679,522 $1,029,789
Gain on sale of loans.......................... 122,704 88,597 50,699
Gross Sales Premiums as a % of loans sold...... 6.11% 6.47% 5.63%
Net gain on sale as a % of loans sold.......... 4.87% 5.28% 4.92%
</TABLE>
Loan sales have been 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. As of
December 31, 1998, the Company has not retained residual interests in the loans
that it sells other than servicing rights. In the future, however, the Company
may consider alternatives to whole loan sales, including securitizations,
depending on market conditions and available levels of whole loan executions.
The Company's focus in utilizing such a strategy would be to retain a positive
cash flow operating model. 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 reserves to cover
such activities that arise in connection with originating loans and subsequently
selling them to investors. During 1998 the Company repurchased $81 million of
loans.
27
<PAGE> 30
RESULTS OF OPERATIONS
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
During 1998, net earnings increased $5.4 million, to $30.0 million, an
increase of 21.8% over $24.6 million of net earnings for the same period in
1997. The Company's net earnings per diluted share was $1.22 for the year ended
December 31, 1998, an increase of 27.1% over net earnings per diluted share of
$0.96 for the year ended 1997.
The primary factors that led to the improvement in net earnings and net
earnings per share during 1998 as compared to 1997 included:
- Increased loan production. Loan production increased by $890.2 million or
52.8% to $2.6 billion during the year ended December 31, 1998 as compared
to $1.7 billion for 1997.
- Increased loan sales. Loans sold during the year ended December 31, 1998
totaled $2.5 billion, an increase of $842.1 million or 50.1% over the
same period of 1997.
- Lower effective income tax rate. The income tax rate was 40.0% during the
year ended December 31, 1998 as compared to 41.1% during the same period
of 1997.
- Lower level of shares outstanding. The decline in the average number of
shares outstanding positively impacted net earnings per share. The
average number of diluted shares outstanding declined to 24.6 million for
year ended December 31, 1998, a decline of 1.1 million shares from the
same period of 1997. The primary reason for the decline in the average
number of shares is due to the Company repurchasing 2.4 million shares of
its common stock, pursuant to its stock repurchase program.
Revenues. The table below presents the Company's revenues by primary
component for the years indicated.
<TABLE>
<CAPTION>
1998 1997
---------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Gain on sale of loans................................... $122,704 $88,597
Net interest income..................................... 6,787 3,354
Loan servicing and other fees on loans.................. 4,922 946
Amortization of mortgage servicing rights............... (1,763) (231)
-------- -------
Total revenues................................ $132,650 $92,666
======== =======
</TABLE>
Total revenues increased by approximately $40.0 million or 43.2% in 1998,
compared to 1997, primarily as a result of an increase in gain on sales of loans
of $34.1 million or 38.5% as compared to 1997. The primary factor contributing
to this increase was an increase in the amount of loans sold of 50.1% to $2.5
billion during 1998, as compared to the same period in 1997. Such increase was
partially offset by a decrease in Net Premiums on the sale of loans to 4.87%
during 1998, from 5.28% in 1997.
The increase in the amount of loans sold resulted from an increase in loan
originations and purchases to $2.6 billion during year ended December 31, 1998,
from $1.7 billion during 1997. This trend reflects the Company's continued
growth of its broker-sourced business through penetration in existing markets
and expansion into new geographic markets. During 1998 the Company originated
loans in all 50 states compared to 48 states in 1997. Additionally, the Company
expanded its sales force to 327 at December 31, 1998, an increase of 40.9% over
the level in 1997.
The table below presents the Company's revenues by reportable segment for
the years indicated. For 1997 the Company made certain estimates in order to
compute the revenues by using actual results from the Reorganization date to
December 31, 1997 to allocate revenues.
28
<PAGE> 31
<TABLE>
<CAPTION>
1998 1997
---------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Broker-sourced.......................................... $106,956 $82,208
Correspondent........................................... 10,832 6,159
-------- -------
Subtotal Wholesale................................. 117,788 88,367
-------- -------
Other................................................... 14,862 4,299
-------- -------
Total revenues..................................... $132,650 $92,666
======== =======
</TABLE>
Gain on sale of loans increased to $122.7 million during 1998, an increase
of $34.1 million over gain on sale of $88.6 million during 1997. The increase in
gain on sale during 1998 is due to an increase in the amount of loans sold,
partially offset by a decline in Gross Sales Premiums. The table below presents
the premiums received and fees paid by the Company and such amounts expressed as
a percentage of loans sold during the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1998 1997
----------------- -----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Gross Sales Premium....................... $154,068 6.11% $108,585 6.47%
Fees paid to brokers...................... (28,682) (1.14)% (17,927) (1.07)%
Fees paid to correspondents............... (8,194) (0.32)% (4,849) (0.29)%
Points, fees and other.................... 5,512 0.22% 2,788 0.17%
-------- --------
Net Premium............................... $122,704 4.87% $ 88,597 5.28%
======== ========
</TABLE>
Net Premiums on the sale of loans decreased to 4.87% for the year ended
December 31, 1998, as compared to 5.28% in 1997. The decrease is the result of
lower Gross Sales Premiums, higher fees paid to brokers, and a larger volume of
correspondent business.
The table below presents the premiums received and fees paid by reportable
segment of the Company and such amounts expressed as a percentage of loans sold
during 1998, dollars in thousands.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1998
-----------------
<S> <C> <C>
BROKER-SOURCED
Gross Sales Premium....................................... $131,784 6.05%
Fees paid to brokers...................................... (28,682) (1.32)%
Points, fees and other.................................... 3,854 0.18%
--------
Net Premium............................................... $106,956 4.91%
========
CORRESPONDENT
Gross Sales Premium....................................... $ 19,063 6.60%
Fees paid to correspondents............................... (8,194) (2.84)%
Points, fees and other.................................... (37) (0.01)%
--------
Net Premium............................................... $ 10,832 3.75%
========
RETAIL
Gross Sales Premium....................................... $ 3,221 5.70%
Points, fees and other.................................... 1,695 3.01%
--------
Net Premium............................................... $ 4,916 8.70%
========
</TABLE>
Investor demand for the Company's loans, the level of available supply of
such products and the direction of mortgage interest rates all have a direct
impact on the negotiated Gross Cash Premiums. A recent decline in market pricing
for subprime mortgage loans has negatively affected the Gross Cash Premiums that
the Company will be able to receive on future loan sales. Planned expansion in
the retail loan origination channel, however, may mitigate this 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
29
<PAGE> 32
maintain its historical level of Gross Cash Premiums and Net Premiums or that it
will be able to generate sufficient volume in retail loan originations for the
Retail Channel to generate profitable operations.
Loan servicing and other fees totaled $3.2 million during 1998, net of
amortization of mortgage servicing rights totaling $1.8 million. 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, 1998,
the outstanding balance of the servicing portfolio, including the loans
sub-serviced by AMC totaled $1.5 billion. Prior to the Reorganization, all
related loan servicing revenues were recognized by an affiliated division of
AMC. During the third quarter, the Company and AMC modified the existing loan
sub-servicing agreement, which provides the Company the right to begin servicing
its loans. The Company began its independent servicing operations on November 2,
1998. As of December 31, 1998, the Company was directly servicing loans with an
aggregate outstanding principal amount of $547 million.
Net interest income totaled $6.8 million during 1998, an increase of $3.4
million compared to the same period in 1997. Such increase resulted from a
higher level of average loans held for sale during the period, partially offset
by a higher level of average borrowings under the revolving warehouse financing
facility. During 1997 the Company began utilizing its excess liquidity to fund a
portion of its loan originations. This strategy has resulted in higher levels of
return on its excess liquidity and has 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,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Compensation expense..................................... $50,025 $32,229
Premises and equipment expenses.......................... 11,487 4,141
Other general and administrative expenses................ 11,039 7,206
------- -------
Total direct expenses.................................... 72,551 43,576
Allocated expenses from AMC.............................. -- 2,294
------- -------
Total general and administrative expenses................ 72,551 45,870
Provision for losses..................................... 5,247 4,028
Sub-servicing costs...................................... 4,820 935
------- -------
Total expenses................................. $82,618 $50,833
======= =======
</TABLE>
The following table presents certain data and statistics on the Company's
general and administrative expenses for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
1998 1997*
--------------------- ---------------------
% OF % OF
PER UNIT PRODUCTION PER UNIT PRODUCTION
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Broker-sourced................................... $2,404 2.14% $ 2,425 2.17%
Correspondent.................................... 822 0.69 951 0.74
------ ---- ------- -----
Wholesale...................................... 2,227 1.97 2,292 2.02
Retail........................................... 8,998 8.17 43,425 33.68
------ ---- ------- -----
Total Production............................... $2,388 2.11% $ 2,372 2.09%
------ ---- ------- -----
Corporate support................................ 1,232 1.09 1,153 1.02
------ ---- ------- -----
Net general and administrative expenses.......... $3,188 2.82% $ 3,080 2.72%
====== ==== ======= =====
</TABLE>
- ---------------
* 1997 Production data is from the date of the Reorganization to December 31,
1997.
30
<PAGE> 33
The total dollar amount of general and administrative expenses increased by
$26.7 million or 58.2% to $72.6 million during 1998, compared to the same period
in 1997. Additionally, the percentage of total general and administrative
expense to loan production increased to 2.82% during 1998 compared to 2.72%
during the same period 1997. The increase in general and administrative expenses
is due to: (i) costs relating to the increase in volume of loan production, (ii)
an increase in corporate infrastructure, (iii) the costs of initiating a retail
production channel, and (iv) the costs of initiating a loan servicing function.
During 1998 the Company added regional processing centers in Denver, Dallas,
Chicago and Portland in order to support loan production.
Compensation expense increased by $17.8 million or 55.2% to $50.0 million
during 1998, compared to the same period in 1997. The primary reason for such
increase is attributable to increases in commissions paid to production
employees. Additionally, compensation expenses increased during 1998 as a result
of the increase in corporate staff to support the infrastructure of the Company
as an independent entity. The number of employees totaled 819 at December 31,
1998, versus 578 at December 31, 1997.
Premises and equipment expenses increased by $7.3 million or 177.4% to
$11.5 million during 1998, compared to the same period in 1997. Such increases
reflect an increase in occupancy costs related to growth in personnel to support
the increased volume of loan production, initiating a loan servicing function as
well as an increase in headquarters space to support the Company's
infrastructure as an independent entity since the Reorganization.
Other general and administrative expenses increased by $3.8 million or
53.2% to $11.0 million during 1998, compared to the same period in 1997. The
increase in other general and administrative expenses is primarily the result of
increased infrastructure and costs incurred in support of the Company's loan
production.
Provision for losses increased to $5.2 million compared to $4.0 million for
the same period in 1997. The Company provides market valuation adjustments for
loans held for sale and for liabilities associated with (i) breaches of
representations and warranties, (ii) first payment defaults, and (iii)
repurchases of loans recorded as sold. At December 31, 1998, the Company had
$3.2 million of market valuation adjustments on loans held for sale and $2.0
million of liabilities for potential repurchases of loans. Prior to the
Reorganization, AMC allocated $2.8 million of provision for losses to the
Wholesale Division. This allocation related to losses sustained by the Wholesale
Division during April 1997 from the repurchase and sale of certain loans which
were originated by the Wholesale Division in previous years.
As more fully discussed in Note 13 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 for 1998 and 1997
totaled $4.8 million and $935,000, respectively. The Company and AMC modified
the sub-servicing agreement during the third quarter of 1998. The Company
anticipates that its future sub-servicing cost will decline commensurate with
the decline in the volume of loans serviced by the sub-servicer.
The table below presents the Company's expenses by reportable segment for
the years indicated. For 1997 the Company made certain estimates in order to
compute the expenses by using actual results from the Reorganization date to
December 31, 1997 to allocate expenses.
<TABLE>
<CAPTION>
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Broker-sourced.......................................... $42,673 $33,228
Correspondent........................................... 2,253 1,123
------- -------
Subtotal Wholesale................................. 44,926 34,351
------- -------
Other................................................... 37,692 16,482
------- -------
Total Expenses..................................... $82,618 $50,833
======= =======
</TABLE>
31
<PAGE> 34
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
The Company had substantial growth during 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.
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 Cash Premiums on loans sold increased to
6.03% in 1997 compared to 4.77% in 1996, while at the same time, Broker and
Correspondent 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.
32
<PAGE> 35
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 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
33
<PAGE> 36
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 13
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 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 13 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.
Income Taxes
The effective income tax rates for 1998, 1997 and 1996 were 40.0%, 41.1%
and 41.2%, 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 9 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").
FINANCIAL CONDITION
A substantial portion of the Company's cash and cash equivalents are
maintained in accounts 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, 1998, cash and cash
equivalents included $17.5 million in funds which were borrowed from its
warehouse lender for the funding of loans. Such advances were not utilized to
fund loans and were repaid to the warehouse lender the following business day.
As discussed in more detail in Liquidity and Capital Resources, the Company
invests in securities which consist of high-quality, short-term securities.
Loans held for sale totaled $59.1 million which is an increase of $41.9
million as of December 31, 1998, as compared to December 31, 1997. This increase
is a result of the increase in loan origination activity during 1998. Loans held
for sale is composed of recently originated loans that have not yet been
presented to an investor, and/or loans that have been repurchased from
investors. At December 31, 1998, $37.3 million of loans held for sale were
performing in accordance with their contractual terms. The aggregate principal
balance of loans held for sale at December 31, 1998 is net of a market valuation
adjustment of $3.2 million. The Company believes that these loans are carried at
the lower of aggregate cost or market.
34
<PAGE> 37
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. At
December 31, 1998, receivable from the sales of loans totaled $186.8 million
compared to $143.1 million at December 31, 1997. Such balances normally are
collected within a 30-day period from month-end. All of the proceeds related to
the receivable from the sales of loans at December 31, 1998 have been collected.
At December 31, 1998, the Company had recorded $9.8 million of capitalized
servicing rights, net of amortization. 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.
The warehouse financing facility increased $65.5 million over the 1997
year-end level as a result of an increase in the receivable from the sales of
loans over the same comparative period and increased origination volume.
Borrowings under the Facility are short-term and typically are repaid within 60
days.
LIQUIDITY AND CAPITAL RESOURCES
The Company had $24.9 million in cash and cash equivalents at December 31,
1998 reflecting continued 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 at any point prior to the Reorganization reflects a zero balance. At
December 31, 1998, the Company had borrowed $17.5 million on loans which had not
yet funded. These borrowings were repaid the following business day. At December
31, 1998, the Company had utilized $52.1 million of its liquidity to fund loans.
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, purchases of treasury stock, and capital expenditures.
The Company funds its operations through its loan sales, revolving
warehouse credit facility, cash reserves and net earnings. Additionally, the
Company may utilize cash reserves to fund loan production in order to maximize
the return on excess liquidity. The Company repays borrowings with the proceeds
from loan sales. During the years ended December 31, 1998, 1997 and 1996, the
Company used cash in the amount of $2.6 billion, $1.7 billion and $1.1 billion,
respectively, for new loan originations and purchases. During the same periods,
the Company received cash proceeds from the sale of loans of $2.5 billion, $1.7
billion and $1.0 billion, respectively, representing the principal balance of
loans sold. The Company received cash proceeds from the premiums on such loans
sales of $137.4 million, $96.5 million and $48.7 million, respectively, for the
years ended December 31, 1998, 1997 and 1996.
The Company has a number of sources for funding its loans: (i) a committed
$300 million revolving warehouse facility provided by a syndicate of banks, (ii)
an uncommitted $100 million repurchase facility, (iii) proceeds from the sale of
loans, and (iv) the Company's excess liquidity. These facilities bear interest
at a specified margin over one month LIBOR. The weighted average cost of funds
for these facilities was 6.86% at December 31, 1998. During February 1999, the
Company obtained an additional $100 million warehouse line from an investment
banker. This line bears interest at LIBOR plus 1.25%. The Company's borrowing
facilities have a variety of financial and compliance covenants and the Company
exceeded all of these covenants at December 31, 1998.
The Company has adopted an investment program for 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 returns within the policy's objectives.
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 1998,
the Company used $21.2 million of available liquidity to purchase an additional
2.1 million shares of its common stock. The Company has spent $24.5 million and
has repurchased 2.4 million shares since the plan's inception.
35
<PAGE> 38
The Company believes that sufficient cash from operations and borrowings
will be generated to fund 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.
During the third quarter of 1998, the Company entered into a forward sales
contract with an investment banking firm to sell $1.3 billion of its future loan
production to be delivered to the purchaser on or before March 31, 1999. At
December 31, 1998, the Company had delivered $1.0 billion of loans on this
commitment. The Gross Sales Premium that the Company will realize from this
commitment is dependent upon the type, quality, interest rate and other terms of
the loans delivered to the purchaser. Additionally the prices in secondary
market for subprime mortgage have recently constricted. Excess inventory of
subprime loans and widening spreads in the asset-backed capital markets have
caused pricing for loans, similar to those originated by the Company, to
substantially decline. There can be no assurance provided that after the
expiration of its forward sales commitment, that the Company will be able to
sell its loans in the secondary market at a price near levels achieved during
1998 or 1997. A material decline in such prices could have a material adverse
impact on the Company's profitability and liquidity.
Year 2000
The Company is aware on 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. The Company established a task
force to evaluate the internal information technology (IT) and non-IT systems
that could be affected by such date change and also identified the external
systems that are critical to the Company's operations. An assessment of the
readiness of the Company's suppliers is ongoing.
During 1998, the Company implemented and upgraded several of its core
systems in its effort to establish fully independent operations from its
predecessor company. The discontinuation of the Administrative Services
Agreements was made possible by building an in-house IT infrastructure. This
infrastructure was designed to be fully compliant with the Year 2000 date
change. The software packages selected by the Company as part of establishing
independent operations was chosen in part based on being Year 2000 compliant.
This software includes the Company's accounting, treasury, human resources,
payroll, and network management software. The total expenditures during 1998
related to establishing independent IT systems approximate $2.5 million, of
which $1.0 million has been capitalized.
The Company's plan for Year 2000 readiness has three phases. Phase one
involves identifying and remediating the internal systems and processes that
must be Year 2000 compliant. Phase one has been completed. Phase two consists of
testing both the internal and external systems as a whole, and has been
scheduled to be fully implemented by the end of first quarter 1999. The Company
intends to test its systems throughout 1999 to ensure that system and software
upgrades are fully compliant. Phase three consists of developing a contingency
plan for those external systems or suppliers that are critical for the Company
to operate, but are not yet Year 2000 compliant. The Company will finalize these
contingency plans during the second quarter of 1999.
The Company does not anticipate the cost of addressing all the issues
associated with becoming Year 2000 compliant will have a material impact on its
financial condition, results of operations or liquidity in any single year. The
Company's estimates are based upon the assumption that its major third party
suppliers are or become Year 2000 compliant within the time frame outlined
above. The Company has requested that its
36
<PAGE> 39
major third party suppliers provide details of their Year 2000 compliance
program and schedule of testing. In the event any of these vendors are unable to
become compliant the Company may incur additional costs.
Although the Company has taken steps to identify, evaluate and remediate
its Year 2000 compliance issues, it is possible that certain of its suppliers
and/or systems may not be Year 2000 compliant by January 1, 2000. These
suppliers provide the Company with computer processing systems, banking and
financial systems, and utility infrastructure. In the event that any of these
suppliers and/or systems are not Year 2000 compliant as of January 1, 2000, the
Company may be exposed to an impairment of its: (i) operations, (ii) business
processes, (iii) ability to meet its financial obligations. The impairment in
any of these areas could have a material adverse effect on the Company's
financial condition, results of operations and liquidity. The Company is
assessing these risks and is creating contingency plans intended to address such
risks, and expects to have such plans in place by the end of the second quarter
of 1999.
ACCOUNTING CONSIDERATIONS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, which is effective
for annual periods beginning after June 15, 1999. This statement establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
The Company is currently evaluating the effect this standard may have on the
Company's financial condition, results of operations and cash flows.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The table below presents information about the Company's financial
instruments subject to market risk at December 31, 1998 including market value
and interest rate of these instruments. In addition, the table presents the
expected cash flows from these instruments. The contractual terms, accounting
policies, and other data concerning these instruments is disclosed in the
consolidated financial statements and accompanying notes. The Company's
receivable from the sales of loans and mortgage warehouse line of credit are
subject to interest rate risk; however, such obligations reprice frequently and
are short-term in duration and accordingly the risk is not material.
<TABLE>
<CAPTION>
Market Risk Sensitive DECEMBER 31, 1998 YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 THEREAFTER
Instruments ----------------- ------- ------- ------- ------- ------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Loans Held for Sale(a)
Fair Value............. $59,148
Weighted average
interest rate....... 10.41% 10.41% -- -- -- -- --
Expected cash flows.... $59,148 $ -- $ -- $ -- $ -- $ --
Capitalized mortgage
servicing rights(b)
Fair Value............. $ 9,806
Weighted average
interest rate....... 14.00% 14.00% 14.00% 14.00% 14.00% 14.00% 14.00%
Expected cash flows.... $ 2,119 $ 2,306 $ 1,762 $ 1,204 $ 814 $ 1,601
</TABLE>
- ---------------
(a) See Notes 3, 6, and 15 to the consolidated financial statements for detailed
information on the basis of determining fair value and for further
information on this financial instrument.
(b) See Notes 3 and 5 to the consolidated financial statements for detailed
information on the basis of determining fair value and for further
information on this asset. The Company has provided its estimate of
cashflows consistent with the assumptions that are utilized to value this
asset. The interest rate for this asset represents the discount rate
utilized to value the asset.
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<PAGE> 40
The Company has exposure to market risk in a number of areas, including:
(1) the secondary market for subprime loans; (2) the origination market for
subprime mortgages; (3) the market for residential one-to four-unit
single-family real estate in those geographic regions where the Company
originates loans; (4) the interest rate environment for subprime mortgages and
the interest expense on the Company's borrowings; and (5) other markets risks
that are discussed in Item of 1 of the 1998 Report on Form 10-K under the
heading "Certain Factors and Trends Affecting the Company and Its Business", in
Management's Discussion and Analysis of Financial Condition, Results of
Operations, Liquidity and Capital Resources, and in Note 14 to the Company's
consolidated financial statements.
The Company manages its market risks by entering into forward sale
commitments of loans 30-120 days in advance of funding the loans. At the time of
the forward sales commitment, the Company estimates its expected volume of loan
production and closely monitors the level of production against the amount of
the unfilled purchase commitments. The objective of this strategy is to have a
purchase commitment for each loan at the time of origination. The Company has
sought to mitigate its exposure to regional real estate recessions by expanding
its operations throughout the United States.
During the latter part of 1998, the prices for subprime mortgages in the
secondary market constricted. Excess inventories and widening spreads in the
asset-backed capital markets caused the secondary market pricing for loans
similar to those originated by the Company to decline. During the third quarter
of 1998, the Company entered into forward sales contract with an investment
banking firm to sell $1.3 billion of its future loan production to be delivered
to the purchasor on or before March 31, 1999. At December 31, 1998, the Company
had delivered $1.0 billion of loans on this commitment; the Company delivered
the balance of the loans during the first quarter of 1999. There can be no
assurance provided that the Company will be able to sell its loans in the
secondary market at a price near historical levels. A material decline in such
prices could have a material adverse impact on the Company's profitability and
liquidity.
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.
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<PAGE> 41
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.
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, 1998 and 1997.......................... F-2
Consolidated Statements of Operations:
For each of the three years in the period ended December
31, 1998............................................... F-3
Consolidated Statements of Stockholders' and Divisional
Equity:
For each of the three years in the period ended December
31, 1998............................................... F-4
Consolidated Statements of Cash Flows:
For each of the three years in the period ended December
31, 1998............................................... F-5
Notes to the Consolidated Financial Statements:
For each of the three years in the period ended December
31, 1998............................................... F-6
Independent Auditors' Report................................ F-27
</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)
</TABLE>
39
<PAGE> 42
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
<S> <C>
*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)
*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)
*10.15 4/98 Amended and Restated Senior Secured Credit Agreement,
among Long Beach Mortgage Company and Chase Bank of Texas,
as Lender and Agent.
*10.16 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
M. Jack Mayesh.
</TABLE>
40
<PAGE> 43
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
<S> <C>
*10.17 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
Edward Resendez.
*10.18 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
Frank J. Curry.
*10.19 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
William K. Komperda.
*10.20 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
James H. Leonetti.
*10.21 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
James J. Sullivan.
*10.22 Employment Agreement, between Long Beach Financial
Corporation, Long Beach Mortgage Company and Elizabeth A.
Wood.
*10.23 Supplement Agreement to Master Sub-Servicing Agreement
between Long Beach Mortgage Company and Ameriquest Mortgage
Company.
*10.24 Master Repurchase Agreement between Merrill Lynch Mortgage
Capital Inc., Merrill Lynch Credit Corporation and Long
Beach Mortgage Company.
10.25 Purchase and Sale Agreement between Salomon Brothers Realty
Corp. and Long Beach Mortgage Company.
27 Financial Data Schedule.
</TABLE>
- ---------------
* Previously filed.
(b) No reports on Form 8-K were filed during the quarter ended December 31,
1998.
41
<PAGE> 44
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 26, 1999
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 26, 1999
- -------------------------------------------------------- Directors and Chief Executive
M. Jack Mayesh Officer (Principal Executive
Officer)
/s/ EDWARD RESENDEZ President, Director March 26, 1999
- --------------------------------------------------------
Edward Resendez
/s/ JAMES H. LEONETTI Chief Financial Officer, March 26, 1999
- -------------------------------------------------------- Senior Vice President
James H. Leonetti (Principal Financial Officer)
/s/ DAVID E. ENGELMAN Director March 26, 1999
- --------------------------------------------------------
David S. Engelman
/s/ RICHARD A. KRAEMER Director March 26, 1999
- --------------------------------------------------------
Richard A. Kraemer
/s/ C. STEPHEN MANSFIELD Director March 26, 1999
- --------------------------------------------------------
C. Stephen Mansfield
</TABLE>
42
<PAGE> 45
EXHIBIT INDEX
<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)
*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)
</TABLE>
<PAGE> 46
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
<S> <C>
*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)
*10.15 4/98 Amended and Restated Senior Secured Credit Agreement,
among Long Beach Mortgage Company and Chase Bank of Texas,
as Lender and Agent.
*10.16 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
M. Jack Mayesh.
*10.17 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
Edward Resendez.
*10.18 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
Frank J. Curry.
*10.19 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
William K. Komperda.
*10.20 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
James H. Leonetti.
*10.21 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
James J. Sullivan.
*10.22 Employment Agreement, between Long Beach Financial
Corporation, Long Beach Mortgage Company and Elizabeth A.
Wood.
*10.23 Supplement Agreement to Master Sub-Servicing Agreement
between Long Beach Mortgage Company and Ameriquest Mortgage
Company.
*10.24 Master Repurchase Agreement between Merrill Lynch Mortgage
Capital Inc., Merrill Lynch Credit Corporation and Long
Beach Mortgage Company.
10.25 Purchase and Sale Agreement between Salomon Brothers Realty
Corp. and Long Beach Mortgage Company.
27 Financial Data Schedule.
</TABLE>
- ---------------
* Previously filed.
<PAGE> 47
LONG BEACH FINANCIAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Statements of Financial Condition:
As of December 31, 1998 and 1997.......................... F-2
Consolidated Statements of Operations:
For each of the three years in the period ended December
31, 1998............................................... F-3
Consolidated Statements of Stockholders' and Divisional
Equity:
For each of the three years in the period ended December
31, 1998............................................... F-4
Consolidated Statements of Cash Flows:
For each of the three years in the period ended December
31, 1998............................................... F-5
Notes to the Consolidated Financial Statements:
For each of the three years in the period ended December
31, 1998............................................... F-6
Independent Auditors' Report................................ F-27
</TABLE>
F-1
<PAGE> 48
LONG BEACH FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
-------- --------
<S> <C> <C>
Cash and cash equivalents................................... $ 24,941 $ 38,782
Investment securities available for sale.................... -- 3,793
Loans held for sale (Note 6)................................ 59,148 17,241
Receivable from the sales of loans.......................... 186,786 143,088
Premises and equipment, net (Note 4)........................ 4,824 3,620
Deferred income taxes, net (Note 9)......................... 32,523 34,400
Capitalized mortgage servicing rights (Note 5).............. 9,806 3,054
Prepaid expenses and other assets........................... 10,567 4,110
-------- --------
Total assets...................................... $328,595 $248,088
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Warehouse financing facility (Note 7)....................... $211,787 $146,271
Accounts payable and accrued liabilities.................... 17,182 8,280
Accrued income taxes payable (Note 9)....................... -- 2,792
-------- --------
Total liabilities...................................... 228,969 157,343
Commitments and contingencies (Note 14)..................... -- --
Stockholders' equity (Notes 2 and 10):
Common stock, $.001 par value; 150.0 million shares
authorized; 25.0 million shares issued: 22.6 million and
24.7 million shares outstanding for 1998 and 1997,
respectively.............................................. 25 25
Additional paid in capital.................................. 75,360 75,307
Retained earnings........................................... 48,716 18,697
Treasury stock, at cost; 2,400,682 and 300,000 shares for
1998 and 1997, respectively............................... (24,475) (3,284)
-------- --------
Total stockholders' equity............................. 99,626 90,745
-------- --------
Total liabilities and stockholders' equity........ $328,595 $248,088
======== ========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-2
<PAGE> 49
LONG BEACH FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- ----
<S> <C> <C> <C>
REVENUES:
Gain on sale of loans.................................. $122,704 $88,597 $50,699
Interest income, net of interest expense (Note 8)...... 6,787 3,354 461
Loan servicing and other fees on loans................. 4,922 946 --
Amortization of mortgage servicing rights.............. (1,763) (231) --
-------- ------- -------
Net operating income................................... 132,650 92,666 51,160
EXPENSES:
Compensation expense................................... 50,025 32,229 17,168
Premises and equipment expenses........................ 11,487 4,141 3,870
Other general and administrative expenses.............. 11,039 7,206 4,900
Corporate administrative charges (Note 1).............. -- 2,294 8,900
Provision for losses................................... 5,247 4,028 350
Sub-servicing costs (Note 13).......................... 4,820 935 --
-------- ------- -------
Total expenses......................................... 82,618 50,833 35,188
-------- ------- -------
Earnings before income taxes........................... 50,032 41,833 15,972
Provision for income taxes (Note 9).................... 20,013 17,189 6,580
-------- ------- -------
Net earnings (Note 2).................................. $ 30,019 $24,644 $ 9,392
======== ======= =======
Basic earnings per share (Note 11)..................... $ 1.27 $ 0.99 Not Applicable
======== =======
Diluted earnings per share (Note 11)................... $ 1.22 $ 0.96 Not Applicable
======== =======
</TABLE>
See accompanying notes to the consolidated financial statements.
F-3
<PAGE> 50
LONG BEACH FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' AND DIVISIONAL EQUITY
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NUMBER OF
SHARES ADDITIONAL DIVISIONAL
OF COMMON COMMON PAID IN (DEFICIT) RETAINED TREASURY
STOCK STOCK CAPITAL EQUITY EARNINGS STOCK TOTAL
---------- ------ ---------- ---------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1996................ $-- $ -- $ 1,732 $ -- $ -- $ 1,732
Net change in divisional deficit arising
from intracompany transactions (Note
1).................................... -- -- (9,987) -- -- (9,987)
Net earnings............................ -- -- 9,392 -- -- 9,392
---------- --- ------- ------- ------- -------- --------
BALANCE, DECEMBER 31, 1996.............. -- -- 1,137 -- -- 1,137
Net earnings (Note 2)................... -- -- 5,947 18,697 -- 24,644
Net change in divisional equity arising
from intracompany transactions (Note
1).................................... -- -- (3,852) -- -- (3,852)
Reorganization of Long Beach Financial
Corporation (Note 1).................. 25,000,000 25 75,307 (3,232) -- -- 72,100
Purchase of treasury stock.............. (300,000) -- -- -- -- (3,284) (3,284)
---------- --- ------- ------- ------- -------- --------
BALANCE, DECEMBER 31, 1997.............. 24,700,000 25 75,307 -- 18,697 (3,284) 90,745
Net earnings............................ -- -- -- -- 30,019 -- 30,019
Exercise of stock options............... 8,200 -- 53 -- -- -- 53
Purchase of treasury stock.............. (2,100,982) -- -- -- -- (21,191) (21,191)
---------- --- ------- ------- ------- -------- --------
BALANCE, DECEMBER 31, 1998.............. 22,607,218 $25 $75,360 $ -- $48,716 $(24,475) $ 99,626
========== === ======= ======= ======= ======== ========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-4
<PAGE> 51
LONG BEACH FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net earnings........................................ $ 30,019 $ 24,644 $ 9,392
Adjustments to reconcile net earnings to net cash
used in operating activities:
Depreciation and amortization of premises,
equipment and warehouse financing facility
issuance costs................................. 2,537 1,106 1,270
Loans originated and purchased for sale........... (2,575,965) (1,685,742) (1,058,122)
Proceeds from sales of loans held for sale........ 2,521,606 1,679,522 1,029,789
Noncash gain recognized on capitalization of
mortgage servicing rights...................... (8,515) (7,259) (9,225)
Amortization of capitalized mortgage servicing
rights......................................... 1,763 231 --
Deferred income taxes............................. 1,877 2,131 (1,238)
Changes in:
Receivable from sales of loans................. (43,698) (143,872) (25,103)
Accounts payable and accrued liabilities....... 8,902 5,894 3,351
Accrued income taxes payable................... (2,792) 2,792 --
Other............................................. 5,123 (5,018) (91)
----------- ----------- -----------
Net cash used in operating activities........ (59,143) (125,571) (49,977)
Cash Flows from Investing Activities:
Purchases of premises and equipment............... (2,868) (2,278) (1,232)
Purchase of investment securities available for
sale........................................... (26,810) (163,869) --
Maturity of investment securities available for
sale........................................... 30,602 160,094 --
----------- ----------- -----------
Net cash provided by (used in) investing
activities................................ 924 (6,053) (1,232)
Cash Flows from Financing Activities:
Net change in warehouse financing facility........ 65,516 135,568 51,971
Cash provided to AMC prior to the
Reorganization................................. -- (3,852) (9,987)
Proceeds from mortgage servicing rights
transferred to AMC (Note 1).................... -- 3,974 9,225
Reorganization and capitalization of LBFC (Note
1)............................................. -- 38,000 --
Purchase of treasury stock (Note 10).............. (21,191) (3,284) --
Proceeds from exercise of stock options........... 53 -- --
----------- ----------- -----------
Net cash provided by financing activities.... 44,378 170,406 51,209
Net increase (decrease) in cash and cash
equivalents....................................... (13,841) 38,782 --
Cash and cash equivalents, beginning of the
year........................................... 38,782 -- --
----------- ----------- -----------
Cash and cash equivalents, end of the year........ $ 24,941 $ 38,782 $ --
=========== =========== ===========
Supplemental Disclosures of Cash Flow Information:
Cash paid during the year for interest on
warehouse financing facility................... $ 12,664 $ 3,524 $ 2,569
Cash paid during the year for federal and state
income taxes................................... 20,546 8,812 --
Supplemental Disclosures of Non-Cash Activities:
Deferred tax asset................................ -- 36,000 --
</TABLE>
See accompanying notes to the consolidated financial statements.
F-5
<PAGE> 52
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
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 has followed 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 historically has obtained a purchase commitment
from one or more loan purchasers for the volume of loans expected to be
originated during such quarter.
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 loan sales 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.
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
F-6
<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, 1998
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 9 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 year ended December 31,
1996, and (ii) the cash flows of the Wholesale Division of AMC for the year
ended December 31, 1996. 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.
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
F-7
<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, 1998
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 and $1.0 billion for the
years ended December 31, 1997 and 1996, 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 and $1.1 billion for the years ended December 31, 1997 and 1996,
respectively.
Total costs allocated to the Company by AMC for the years ended December
31, 1997 and 1996 were $2.3 million and $8.9 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. 1997 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.
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
F-8
<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, 1998
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>
1997
-----------------------------------------------
WHOLESALE THE
DIVISION OF AMC COMPANY COMBINED
------------------ ---------- -----------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
REVENUES:
Gain on sale of loans................................... $25,604 $62,993 $88,597
Interest income, net of interest expense................ 168 3,186 3,354
Loan servicing and other fees on loans.................. -- 946 946
Amortization of mortgage servicing rights............... -- (231) (231)
------- ------- -------
Net operating income.................................... 25,772 66,894 92,666
EXPENSES:
Compensation expense.................................... 8,242 23,987 32,229
Premises and equipment expenses......................... 1,106 3,035 4,141
Other general and administrative expenses............... 1,391 5,815 7,206
Corporate administrative charges........................ 2,294 -- 2,294
Provision for losses.................................... 2,808 1,220 4,028
Sub-servicing costs..................................... -- 935 935
------- ------- -------
Total expenses..................................... 15,841 34,992 50,833
------- ------- -------
Earnings before income taxes............................ 9,931 31,902 41,833
Provision for income taxes.............................. 3,984 13,205 17,189
------- ------- -------
Net earnings............................................ $ 5,947 $18,697 $24,644
======= ======= =======
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 -- 807
------- ------- -------
Pro forma net earnings inclusive of gain from sale of
Retained Loans........................................ $ 6,754 $18,697 $25,451
======= ======= =======
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>
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.
F-9
<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, 1998
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. At December 31, 1998 and 1997 the Company did not intend
to hold securities to maturity, nor did it engage in trading activities, 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 management's
estimate of value that the Company could reasonably expect to obtain from a
sale, that is, other than in a forced or liquidation sale of the loans on an
aggregate basis.
Provision for losses -- The Company provides market valuation adjustments
for loans held for sale and for liabilities associated with (i) breaches of
representations and warranties, (ii) first payment defaults, and (iii)
repurchases of loans recorded as sold.
Receivable from Sales of Loans -- Receivable from sales of loans represents
proceeds due from certain sales transactions which were recorded in December
1998 and 1997. All amounts due to the Company have subsequently been collected.
Real Estate Owned -- Real estate acquired in settlement of loans ("REO")
generally results when property collateralizing a loan is foreclosed upon or
otherwise acquired by the Company in satisfaction of the loan. Real estate
acquired through foreclosure is carried at fair value less costs to dispose.
Fair value is based on the net amount that the Company could reasonably expect
to receive for the asset in a sale between a willing buyer and a willing seller,
that is, other than in a forced or liquidation sale. Included in other assets at
December 31, 1998 is REO of approximately $1.5 million. The Company did not have
any REO at December 31, 1997.
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 -- 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 9 to the
Consolidated Financial Statements.
Capitalized Mortgage Servicing Rights -- Effective January 1, 1997, the
Company adopted Statement of Financial Accounting Standards ("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
F-10
<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, 1998
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.
Under SFAS No. 125, servicing assets (the excess of benefits to be received
from servicing less adequate compensation to the servicer associated with such
servicing) are initially valued based on 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. No impairment existed at December 31,
1998 or 1997.
During 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.
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 may differ from those estimates.
Reclassifications -- Certain reclassifications have been made to conform
the 1997 and 1996 consolidated financial statements to the 1998 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 did not have a material
impact on the Company's financial statements. The Company does not have any
Other Comprehensive Income and therefore Comprehensive Income equals Net
Earnings.
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
F-11
<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, 1998
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.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which is effective for annual periods
beginning after June 15, 1999. This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. The Company
is currently evaluating the effect this standard may have on the Company's
financial condition, results of operations and cash flows.
NOTE 4. PREMISES AND EQUIPMENT
Premises and equipment at December 31 consists of the following:
<TABLE>
<CAPTION>
1998 1997
--------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Furniture and equipment................................. $ 4,503 $3,804
Leasehold improvements.................................. 2,583 414
------- ------
7,086 4,218
Less accumulated depreciation and amortization.......... (2,262) (598)
------- ------
$ 4,824 $3,620
======= ======
</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>
1998 1997 1996
-------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance at January 1.......................... $ 3,054 $ -- $ --
Capitalization of mortgage servicing rights... 8,515 7,259 9,225
Amortization of mortgage servicing rights..... (1,763) (231) --
Transfer of mortgage servicing rights to AMC
(Note 1).................................... -- (3,974) (9,225)
-------- -------- -------
Balance at December 31........................ $ 9,806 $ 3,054 $ --
======== ======== =======
Principal balance of loans serviced by the
Company..................................... $546,581 $ -- $ --
Principal balance of loans serviced by
sub-servicer................................ $972,893 $896,233 $ --
</TABLE>
Primary assumptions utilized in determining the value of servicing rights at
December 31, 1998 and 1997:
Range of CPR 18% - 35% depending on product type
Discount rate 14%
Servicing fees 50 basis points
NOTE 6. LOANS HELD FOR SALE
Loans held for sale are comprised of three types of loans: (i) loans which
the Company anticipates delivering in satisfaction of its forward sale
commitments, which totalled $4.5 million at December 31, 1998 (ii) other
performing loans that it anticipates selling to a second tier investor outside
of its forward sale commitment, and which totalled $32.8 million at December 31,
1998, (iii) non-performing loans. At December 31, 1998 and 1997 $23.9 million
and $2.1 million of loans held for sale were non-performing. The Company
anticipates that its expected resolution of non-performing loans may include:
(i) cure and/or sale, (ii) repayment by the borrower, (iii) negotiated
settlement between the Company and borrower and,
F-12
<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, 1998
(iv) foreclosure of the related collateral by the Company. Loans held for sale
are valued at the lower of aggregate cost or market value. At December 31, 1998,
loans held for sale are presented net of a $3.2 million market valuation
adjustment.
NOTE 7. WAREHOUSE FINANCING FACILITY
The Company utilizes a committed 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 and to $300 million in
April 1998. The facility expires on April 16, 2000 and is collateralized 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.
The following table presents data on the warehouse financing facility of
the Company for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Weighted-average interest rate for the period...... 6.91% 7.17% 7.28%
Weighted-average interest rate at the end of the
period........................................... 6.47% 7.23% 7.25%
Weighted-average amount outstanding for the
period........................................... $179,457 $ 90,184 $ 97,714
Maximum amount outstanding at any month-end........ $299,535 $146,271 $170,102
</TABLE>
The Warehouse Financing Facility contains a number of financial covenants
including: (i) the Company must maintain adjusted tangible net worth equal to at
least $30 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 10:1. 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, 1998.
The Company has access to a $100 million uncommitted warehouse line from an
investment banking firm. The line expires in September 1999 and at December 31,
1998 the Company had no outstanding balance on this line. The maximum
outstanding balance at any month-end during 1998 was $95 million. The
uncommitted facility contains several financial covenants including: (i) the
Company maintains tangible net worth equal to a least $35 million, and (ii) the
ratio of total debt to tangible net worth may not exceed 10:1. The uncommitted
facility also contains other affirmative, negative and financial covenants
typical of similar credit facilities. The Company was in compliance with all of
its debt covenants at December 31, 1998.
The Company recorded interest expense related to the amortization of
warehouse financing issuance costs of $901,000, $415,000, and $245,000 for the
years ended December 31, 1998, 1997 and 1996, respectively. Unamortized
warehouse financing issuance costs were $157,000 and $280,000 at December 31,
1998 and 1997 respectively, and are a component of other assets on the
consolidated statements of financial condition.
F-13
<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, 1998
NOTE 8. INTEREST INCOME, NET OF INTEREST EXPENSE
The components of interest income, net of interest expense for the years
ended December 31, are presented in the table that follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Interest on loans.................................... $ 19,959 $ 9,456 $ 3,275
Interest on investments.............................. 947 1,036 --
-------- ------- -------
Subtotal interest income................... 20,906 10,492 3,275
Interest expense..................................... (14,119) (7,138) (2,814)
-------- ------- -------
Interest income, net of interest expense............. $ 6,787 $ 3,354 $ 461
======== ======= =======
</TABLE>
NOTE 9. 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 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
F-14
<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, 1998
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>
1998 1997 1996
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal......................................... $14,725 $12,622 $ 5,895
State........................................... 3,411 2,436 1,923
------- ------- -------
18,136 15,058 7,818
Deferred:
Federal......................................... 1,506 605 (1,135)
State........................................... 371 1,526 (103)
------- ------- -------
1,877 2,131 (1,238)
------- ------- -------
Provision for income taxes........................ $20,013 $17,189 $ 6,580
======= ======= =======
</TABLE>
The reconciliation of statutory tax rates to the Company's effective income
tax rate follows, for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Federal income tax at statutory rates.............. 35.0% 35.0% 35.0%
State taxes, net of federal tax benefits........... 5.0 6.0 7.4
Other.............................................. -- 0.1 (1.2)
---- ---- ----
40.0% 41.1% 41.2%
==== ==== ====
</TABLE>
F-15
<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, 1998
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>
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Mark to market......................................... $ -- $ 428
Goodwill............................................... 32,855 37,557
Vacation accrual....................................... 300 186
Reserves............................................... 1,182 371
State taxes............................................ 85 32
Depreciation........................................... 323 122
------- -------
34,745 38,696
Deferred tax liabilities:
Deferred state taxes................................... (2,185) (3,690)
Other.................................................. (37) (606)
------- -------
(2,222) (4,296)
------- -------
Deferred tax asset, net.................................. $32,523 $34,400
======= =======
</TABLE>
NOTE 10. STOCKHOLDERS' EQUITY
Common Stock -- The Company is authorized to issue 150.0 million shares of
$0.001 par value common stock. At December 31, 1998 and 1997, the Company had
22.6 million and 24.7 million shares outstanding, respectively.
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. The Company had
repurchased a total of 2.4 million and 300,000 shares of stock as of December
31, 1998 and 1997 respectively, which are included in treasury stock.
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.
NOTE 11. EARNINGS PER SHARE
SFAS No. 128, Earnings per Share, 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-16
<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, 1998
The Company did not have 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 prior to 1997.
Earnings per share data for 1997 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.
A reconciliation of the numerators and denominators used in basic and
diluted EPS computations for the periods indicated follows:
<TABLE>
<CAPTION>
WHOLESALE THE COMBINED
YEAR ENDED DIVISION OF AMC COMPANY RESULTS OF
DECEMBER 31, JANUARY 1 THROUGH MAY 2 THROUGH OPERATIONS
1998 MAY 1, 1997(A) DEC. 31, 1997 DEC. 31, 1997
------------- ----------------- ------------- -------------
<S> <C> <C> <C> <C>
COMPUTATION OF BASIC EARNINGS PER SHARE
Net earnings available to common
shareholder............................ $30,019,000 $ 5,947,000 $18,697,000 $24,644,000
=========== =========== =========== ===========
Average common shares outstanding........ 23,706,357 25,000,000 24,771,135 24,975,781
=========== =========== =========== ===========
Basic earnings per share................. $ 1.27 $ 0.24 $ 0.75 $ 0.99
=========== =========== =========== ===========
COMPUTATION OF DILUTED EARNINGS PER SHARE
Net earnings available to common
shareholder............................ $30,019,000 $ 5,947,000 $18,697,000 $24,644,000
=========== =========== =========== ===========
Average common shares outstanding........ 23,706,357 25,000,000 24,771,135 24,975,781
Common stock equivalents -- stock
options................................ 907,126 -- 998,716 677,257
----------- ----------- ----------- -----------
Average diluted common shares............ 24,613,483 25,000,000 25,769,851 25,653,038
=========== =========== =========== ===========
Diluted earnings per share............... $ 1.22 $ 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 12. 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 compensation each year, and the Company, at its discretion, may make
employer contributions to participants. Employees become vested in the Company's
contribution at a rate of 20% each year, with complete vesting after five years.
The Company made no contributions to the plan during 1998 or 1997 and therefore,
no contribution expense was recognized. The Company's cost for the plan was not
material for the years ended December 31, 1998, 1997 and 1996.
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, 1998 and 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 may not be less than 100% of the fair
market value of the shares on the date of grant.
F-17
<PAGE> 64
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
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 as of December 31, 1998 and
1997 and changes during the years then ended are as follows:
<TABLE>
<CAPTION>
NUMBER PRICE
--------- ------
<S> <C> <C>
Outstanding at January 1, 1997.......................... -- $ --
Options granted....................................... 2,808,000 6.84
Options canceled...................................... (20,000) 6.50
---------
Outstanding at December 31, 1997........................ 2,788,000 $ 6.84
=========
Outstanding at January 1, 1998.......................... 2,788,000 $ 6.84
Options granted....................................... 155,600 12.04
Options exercised..................................... (8,200) 6.50
Options canceled...................................... (41,000) 8.80
---------
Outstanding at December 31, 1998........................ 2,894,000 $ 7.09
=========
</TABLE>
The number of options exercisable at December 31, 1998, was 550,160 with a
weighted average exercise price of $6.84. There were no exercisable options at
December 31, 1997.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." This Statement establishes a 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 was recognized during 1998 or 1997 for
options granted under the Company's stock incentive plan.
Had compensation cost for the stock incentive plan been determined based on
the fair value provisions of SFAS No. 123, pro forma net earnings and pro forma
basic and diluted earnings per share for the periods indicated would have been
reduced to the amounts that follow:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Net Earnings
As reported.................................... $30,019 $24,644
Pro forma...................................... 28,752 23,460
Basic earnings per share
As reported.................................... 1.27 0.99
Pro forma...................................... 1.21 0.94
Diluted earnings per share
As reported.................................... 1.22 0.96
Pro forma...................................... 1.17 0.91
</TABLE>
F-18
<PAGE> 65
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
The fair value of each option grant, $3.65 and $3.60 for options granted in
1998 and 1997 respectively, is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
1998 1997
------- -------
<S> <C> <C>
Dividend yield.................................... -- --
Expected volatility............................... 50.0% 49.4%
Risk-free interest rate........................... 5.66% 6.75%
Expected life of option........................... 5 years 5 years
</TABLE>
NOTE 13. 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
$250,000 and $1.1 million for the years ended December 31, 1998 and 1997,
respectively, pursuant to this agreement.
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 $110,000 and $440,000 during the years ended December 31, 1998
and 1997, respectively, 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.
During the third quarter of 1998, the Company and AMC modified the existing loan
sub-servicing agreement, which provided the Company the right to begin its
servicing operations, on November 2, 1998. The Company has incurred charges of
$4.8 million and $935,000 during the years ended December 31, 1998 and 1997,
respectively, pursuant to this agreement. The balance of the sub-serviced loan
portfolio at December 31, 1998 and 1997 totaled $972.9 million and $896.2
million, respectively. In January 1999, the Company transferred $550 million of
loans from the subservicer to its own servicing operation.
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.
F-19
<PAGE> 66
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
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 14. 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, 1998, 1997
and 1996 was $2.9 million, $1.7 million and $1.4 million, respectively.
The future minimum lease payments are as follows (in thousands):
<TABLE>
<S> <C>
Year ending December 31:
1999...................................................... $2,845
2000...................................................... 2,510
2001...................................................... 2,040
2002...................................................... 1,110
2003...................................................... 222
------
$8,727
======
</TABLE>
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, 1998:
<TABLE>
<CAPTION>
CAPITALIZED OPERATING TOTAL
----------- --------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Year ending December 31:
1999.................................... $170 $1,733 $1,903
2000.................................... 170 1,342 1,512
2001.................................... 111 446 557
2002.................................... 46 17 63
2003.................................... 2 -- 2
---- ------ ------
499 3,538 4,037
Less amounts representing interest........ (66) -- (66)
---- ------ ------
$433 $3,538 $3,971
==== ====== ======
</TABLE>
The capital lease obligations are included in accrued liabilities in the
accompanying consolidated statements of financial condition. As of December 31,
1998, the net book value of furniture and equipment under capital lease was
$411,000.
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
F-20
<PAGE> 67
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
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 $460.2 million and $331.0
million at December 31, 1998 and 1997, respectively. The Company's loan purchase
commitments totaled $54.3 million and $19.7 million at December 31, 1998 and
1997, respectively. The Company has entered into forward loan sale contracts
under which it has committed to deliver $1.3 billion in loans, with the related
commitment expiration dates varying from February 28, 1999 through March 31,
1999. At December 31, 1998, the Company had delivered $1.0 billion of loans on
this commitment.
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 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 who 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 in 1996, 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.
F-21
<PAGE> 68
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
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.
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 7)
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.
Approximately 33.8% and 34.4% of the dollar volume of loans originated or
purchased by the Company were secured by properties located in California for
the years ended December 31, 1998 and 1997, respectively. No other state
contained properties securing more than 10% of the dollar volume of loans
originated or purchased by the Company during the years ended December 31, 1998
and 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
F-22
<PAGE> 69
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
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. Additionally, the secondary market for subprime
loans is volatile and prices for subprime loans have been depressed,
particularly since the beginning of the fourth quarter of 1998. In the event
that the secondary market for the Company's loans remains in a depressed state,
the sales premiums that the Company has historically received from the sale of
its loans may not be achievable. Such a decrease in pricing could have a
material adverse effect on the Company's profitability, liquidity and operating
performance.
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, 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. In a majority of these cases,
courts have declined to grant class certification, holding that it is necessary
to analyze the facts of each transaction to determine whether the lender-paid
fee, either alone or in combination with borrower-paid fees, constitutes a
reasonable payment for goods, facilities or services provided. In March 1999,
HUD clarified its position on lender payments to mortgage brokers further
undermining class action lawsuits alleging that all lender-paid fees are per se
illegal. See "Business -- Regulation." 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 legislation, 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.
F-23
<PAGE> 70
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
NOTE 15. 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.
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>
1998 1997
---------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents..................... $ 24,941 $ 24,941 $ 38,782 $ 38,782
Investment securities available for sale...... $ -- $ -- $ 3,793 $ 3,793
Loans held for sale........................... $ 59,148 $ 59,148 $ 17,241 $ 17,429
Receivable from the sales of loans............ $186,786 $186,786 $143,088 $143,088
Liabilities:
Warehouse financing facility.................. $211,787 $211,787 $146,271 $146,271
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. The estimated fair value of loans held for sale is
determined by outstanding commitments from investors, if any, or management's
estimate of value that the Company could reasonably expect to obtain from a
sale, that is, other than in a forced or liquidation sale of the loans on an
aggregate basis. 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, 1998 and 1997. 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.
NOTE 16. SEGMENT AND RELATED INFORMATION
The Company has adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information", which changes the way a company reports
information about its operating segments. The Company has two reportable
operating segments: Broker-sourced and Correspondent.
The summarized financial information concerning the Company's reportable
segments is shown in the following table. "Other" represents corporate
administration, the retail segment, and other related items and
F-24
<PAGE> 71
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
results of ancillary operations. The Company made certain estimates in order to
compute revenues and expenses by reportable segment. Prior to the Reorganization
date in 1997, and for 1996, the Company utilized actual results from the
Reorganization date to December 31, 1997 to allocate revenues and expenses. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies described in Note 3.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Revenues:
Broker-sourced............................... $ 106,956 $ 82,208 $ 47,175
Correspondent................................ 10,832 6,159 3,524
---------- ---------- ----------
Subtotal Wholesale........................ 117,788 88,367 50,699
Other........................................ 14,862 4,299 461
---------- ---------- ----------
Total Revenues....................... $ 132,650 $ 92,666 $ 51,160
========== ========== ==========
Expenses:
Broker-sourced............................... $ 42,673 $ 33,228 $ 22,273
Correspondent................................ 2,253 1,123 235
---------- ---------- ----------
Subtotal Wholesale................... 44,926 34,351 22,508
Other........................................ 37,692 16,482 12,680
---------- ---------- ----------
Total Expenses....................... $ 82,618 $ 50,833 $ 35,188
========== ========== ==========
</TABLE>
<TABLE>
Earnings (Loss) Before Income Taxes:
<S> <C> <C> <C>
Broker-sourced............................... $ 64,283 $ 48,980 $ 24,902
Correspondent................................ 8,579 5,036 3,289
---------- ---------- ----------
Subtotal Wholesale........................ 72,862 54,016 28,191
Other........................................ (22,830) (12,183) (12,219)
---------- ---------- ----------
Earnings before income taxes......... $ 50,032 $ 41,833 $ 15,972
========== ========== ==========
Net Earnings (Loss):
Broker-sourced............................... $ 38,570 $ 28,854 $ 14,643
Correspondent................................ 5,147 2,967 1,934
---------- ---------- ----------
Subtotal Wholesale........................ 43,717 31,821 16,577
Other........................................ (13,698) (7,177) (7,185)
---------- ---------- ----------
Net Earnings......................... $ 30,019 $ 24,644 $ 9,392
========== ========== ==========
Loan Production:
Broker-sourced............................... $2,220,096 $1,531,266 $1,026,390
Correspondent................................ 296,283 151,768 31,732
---------- ---------- ----------
Subtotal Wholesale........................ 2,516,379 1,683,034 1,058,122
Other........................................ 59,586 2,708 --
---------- ---------- ----------
Total Production..................... $2,575,965 $1,685,742 $1,058,122
========== ========== ==========
Assets:
Broker-sourced............................... $ 53,270 $ 15,491
Correspondent................................ 6,832 755
---------- ----------
Subtotal Wholesale........................ 60,102 16,246
Other........................................ 268,493 231,842
---------- ----------
Total Assets......................... $ 328,595 $ 248,088
========== ==========
</TABLE>
F-25
<PAGE> 72
LONG BEACH FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
NOTE 16. 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, 1998
Gain on sale of loans............................... $23,925 $31,630 $31,098 $36,051
Net interest income................................. 1,370 1,666 1,996 1,755
Net operating income................................ 25,861 34,102 34,298 38,389
General and administrative expenses................. 14,491 19,183 18,426 20,451
Provision for losses................................ 1,400 1,000 1,100 1,747
Sub-servicing costs................................. 646 1,138 1,542 1,494
Earnings before income taxes 9,324 12,781 13,230 14,697
Net earnings........................................ $ 5,410 $ 7,408 $ 8,257 $ 8,944
Basic earnings per share:
Net earnings...................................... $ 0.22 $ 0.31 $ 0.35 $ 0.40
Average number of common shares................... 24,498 24,236 23,506 22,607
Diluted earnings per share:
Net earnings...................................... $ 0.21 $ 0.29 $ 0.34 $ 0.39
Average number of common and equivalent shares.... 25,674 25,478 24,433 22,767
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
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
</TABLE>
F-26
<PAGE> 73
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, 1998 and 1997, 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, 1998. 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, 1998 and 1997, the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998, 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 25, 1999
F-27
<PAGE> 74
INDEX TO 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)
*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)
</TABLE>
<PAGE> 75
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
<S> <C>
*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)
*10.15 4/98 Amended and Restated Senior Secured Credit Agreement,
among Long Beach Mortgage Company and Chase Bank of Texas,
as Lender and Agent.
*10.16 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
M. Jack Mayesh.
*10.17 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
Edward Resendez.
*10.18 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
Frank J. Curry.
*10.19 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
William K. Komperda.
*10.20 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
James H. Leonetti.
*10.21 Amended and Restated Employment Agreement, between Long
Beach Financial Corporation, Long Beach Mortgage Company and
James J. Sullivan.
*10.22 Employment Agreement, between Long Beach Financial
Corporation, Long Beach Mortgage Company and Elizabeth A.
Wood.
*10.23 Supplement Agreement to Master Sub-Servicing Agreement
between Long Beach Mortgage Company and Ameriquest Mortgage
Company.
*10.24 Master Repurchase Agreement between Merrill Lynch Mortgage
Capital Inc., Merrill Lynch Credit Corporation and Long
Beach Mortgage Company.
10.25 Purchase and Sale Agreement between Salomon Brothers Realty
Corp. and Long Beach Mortgage Company.
27 Financial Data Schedule.
</TABLE>
- ---------------
* Previously filed.
<PAGE> 1
EXHIBIT 10.25
PURCHASE AND SALE AGREEMENT
This purchase and sale agreement, dated as of February 11, 1999
(the "Agreement") is between Salomon Brothers Realty Corp. ("SBRC") and Long
Beach Mortgage Company (the "Seller"). From time to time SBRC may engage in
purchase and sale transactions (each, a "Transaction") whereby the Seller sells
to SBRC fixed and adjustable rate one- to-four family first lien mortgage loans
acceptable to SBRC in its sole discretion ("Eligible Mortgage Loans"), any
related prepayment charges payable in connection with any voluntary principal
prepayment in full on related Eligible Mortgage Loans (the "Prepayment Charges")
and related servicing rights at a price equal to the Purchase Price (as defined
in the Letter Agreement) and whereby, on a date fixed by agreement between SBRC
and the Seller (the "Repurchase Date"), the Seller agrees to repurchase such
Eligible Mortgage Loans, Prepayment Charges and related servicing rights from
SBRC, and SBRC agrees to resell such Mortgage Loans, Prepayment Charges and
related servicing rights to the Seller, at the repurchase price, which is based
on the Purchase Price and reflects the agreed upon return to SBRC as provided in
Paragraph 1 of the Letter Agreement (the "Repurchase Price"), all subject to and
in accordance with the terms and conditions set forth below. The Repurchase Date
shall be 30 days after the related Purchase Date, or such shorter period of time
if the related Purchase Date is not a "Roll Date". A "Roll Date" is the date
each month on which all of the Mortgage Loans subject to the Aggregation Line
are repurchased by the Seller. All such Eligible Mortgage Loans, Prepayment
Charges and related servicing rights which shall at any time have been purchased
by SBRC and not yet repurchased by the Seller hereunder, together with all
rights related thereto, shall hereinafter be referred to as the "Mortgage Loans"
and the date on which SBRC purchases each such Mortgage Loan shall be referred
to as the "Purchase Date". Capitalized terms used but not defined herein shall
have the meanings set forth in the letter agreement dated February 11, 1999
between SBRC and the Seller (the "Letter Agreement"). The Purchase Prices for
the Mortgage Loans are as set forth in the Letter Agreement.
The Seller will from time to time offer to enter into
Transactions with SBRC. SBRC agrees to enter into such Transactions, provided
the following conditions have been met:
1. As the Seller and SBRC enter into a Transaction, then on the
same day the Seller shall sell and deliver to SBRC or its agent the agreed upon
Eligible Mortgage Loans including any applicable Prepayment Charges, together
with all rights related thereto (including the servicing rights), against the
crediting of the Purchase Price for such Transaction to an account of the Seller
in immediately available funds. The Seller represents and warrants that it has
the unqualified right to sell, transfer, assign or pledge the Eligible Mortgage
Loans (any related servicing rights) that will become Mortgage Loans and that
such Mortgage Loans, upon delivery to SBRC, will be free and clear of any lien,
claim or encumbrance (other than the Seller's obligation to resell such Mortgage
Loan to the Seller on the related Repurchase Date). The Seller further
represents that this Agreement is legally entered into by the Seller, does not
violate any ordinance, charter, rule or statute applicable to it and that the
person executing this Agreement on behalf of the Seller has been duly and
properly authorized to do so. The Seller hereby represents and warrants that as
of the Purchase Date of any Mortgage Loan, each of the representations and
warranties specified on Exhibit A attached hereto are true and correct and each
of the representations and warranties specified on Exhibit B attached hereto are
true and correct as to
<PAGE> 2
each of the Mortgage Loans delivered to SBRC on such date. If the Seller
breaches a representation or warranty specified on Exhibit A attached hereto
such breach shall be deemed a Seller Event of Default under Section 6(d) hereof
and SBRC shall have the remedies provided for in Section 7. If the Seller
breaches a representation or warranty specified on Exhibit B attached hereto,
SBRC shall have the right to accelerate to a date designated by SBRC the
Repurchase Date of the directly affected Mortgage Loan.
2. No later than the business day on which each Transaction as
described in paragraph 1 is effected, SBRC shall send to the Seller a
confirmation (the "Confirmation") setting forth with respect to such
Transaction: the Eligible Mortgage Loans subject thereto; the Purchase Price of
such Eligible Mortgage Loans (including the related servicing rights); the
Aggregation Cost Rate; the Repurchase Date; and the Repurchase Price. Each
Confirmation shall be binding upon the parties hereto unless written notice of
objection is given by the objecting party within two (2) business days after the
objecting party's receipt of such confirmation. In addition, the Seller shall
deliver to SBRC on each Purchase Date a Bill of Sale with respect to the related
Mortgage Loans in the form of Exhibit C hereto.
3. On the Repurchase Date for any Mortgage Loan, such repurchase
will be effected by delivery to the Seller or its agent of the Mortgage Loans
against the crediting of the Repurchase Price to an account of SBRC in
immediately available funds.
4. Upon a Seller Event of Default (as defined herein) or upon
the failure of the Seller to repurchase the Mortgage Loans on a Repurchase Date,
SBRC may reregister any of the Mortgage Loans in its name or the name of its
agent and may resell the Mortgage Loans, with the right to reregister given to
the purchaser in accordance with the provisions of Section 7.
5. The Seller has delivered to SBRC its most recent financial
statements and represents that such statements fairly represent its financial
condition as to the date of such statements. The Seller also represents that
there has been no material adverse change in its financial condition since that
date. During the term of this Agreement, the Seller shall promptly deliver to
SBRC all monthly financial statements, including but not limited to, balance
sheets, income statements and cashflow statements. The Seller agrees that its
agreement to enter into each Transaction shall constitute a representation that
there has been no material adverse change in its financial condition since the
date of the latest such statement.
6. The occurrence of any of the following shall constitute a
"Seller Event of Default":
(a) the judgment by SBRC in good faith that a material
adverse change has occurred with respect to the
business, properties, assets or condition (financial
or otherwise) of the Seller;
(b) SBRC shall reasonably request, specifying the reasons
for such request, information, and/or written responses
to such requests, regarding the financial well-being of
the Seller and such information and/or responses shall
not have been provided within three business days of
such request;
-2-
<PAGE> 3
(c) A change in control of the Seller shall have occurred
without the consent of SBRC, other than in connection
with and as a result of the issuance and sale by the
Seller of registered, publicly offered common stock;
(d) There is (A) a material breach by the Seller of any
representation and warranty contained in this Agreement
or the Letter Agreement, other than a representation or
warranty relating to a particular Mortgage Loan, and
SBRC has reason to believe in good faith either that
such breach is not curable within 30 days or that such
breach may not have been cured in all material respects
at the expiration of 30 days following discovery thereof
by the Seller or (B) a failure by the Seller to make any
payment payable by it hereunder or -- -- (C) any other
failure by the Seller to observe and perform in any
material respect its material covenants, agreements and
obligations with SBRC, including without limitation
those contained in this Agreement or any other agreement
between SBRC and the Seller, and SBRC has reason to
believe in good faith that such failure may not have
been cured in all material respects at the expiration of
30 days following discovery thereof by the Seller;
(e) If the Seller shall fail to provide written notification
to SBRC of any material change in its loan origination,
acquisition or appraisal guidelines or practices, or the
Seller, without the prior consent of SBRC (which shall
not be unreasonably withheld), shall amend in any
material respect its loan origination, acquisition or
appraisal guidelines or practices;
(f) If the Seller shall fail to fully and timely perform any
obligation to SBRC or to any broker, dealer, bank or
other financial institution in respect of a transaction
involving securities, commodities or other instruments
("Instruments") (regardless of whether SBRC has any
right, title or interest therein);
(g) If the Seller admits its inability or SBRC reasonably
believes the Seller is unable to perform fully when such
performance will become due any obligation on the
Seller's part to any broker, dealer, bank or other
financial institution in respect of a transaction
involving Instruments not then due (regardless of
whether SBRC has any right, title or interest therein);
(h) If the Seller shall make an assignment for the benefit
of creditors, or admit in writing its inability to pay
debts as they become due, or generally not pay its debts
as they become due, or file any petition, application or
answer seeking for itself any entry of an order for
relief, protective decree, reorganization, arrangement,
composition, readjustment, liquidation, dissolution or
similar relief under the Bankruptcy Code or any other
federal, state or foreign, present or future, statute,
law or regulation, or be subject to any such order for
relief or protective decree entered by a court,
-3-
<PAGE> 4
or file any answer admitting or not controverting the
material allegations of such a petition or application
filed against the Seller, or seek or acquiesce in the
appointment or designation of, on taking possession by,
any trustee, receiver, liquidator or agent in respect of
all or a substantial part of the Seller's property, or
the Seller's trustees, directors, majority shareholders,
partners or other principals, as the case may be, shall
take any action looking to the dissolution or
liquidation of the Seller or to the taking of any action
described in this paragraph (h), or any of the foregoing
shall occur in respect of any one or more of the
Seller's general partners, principals or parent entities
or other persons exercising control over the Seller;
(i) If an action shall be commenced or a petition or
application shall be filed against the Seller seeking
any order for relief, protective decree, reorganization,
arrangement, composition, readjustment, liquidation,
dissolution or similar relief under the Bankruptcy Code,
Securities Investor Protection Act or any federal, state
or foreign present or future statute, law or regulation
and such action, petition or application shall not have
been dismissed or all orders or proceedings thereunder
stayed or vacated, or such stay shall be set aside, or
any trustee, receiver, liquidator or agent of all or a
substantial part of the Seller's property shall be
appointed or designated and such appointment or
designation shall not have been vacated, or any of the
foregoing shall occur in respect of any one or more of
the Seller's general partners, principals or parent
entities or other persons exercising control over the
Seller;
(j) If a material judgment for the payment of money or
affecting all or a substantial part of the Seller's
business or property shall be entered or rendered
against the Seller, and such judgment shall not have
been discharged in full or effectively stayed as to
enforcement and execution;
(k) If the Seller shall default (as principal, guarantor or
surety) in the performance of any material contract or
in the material payment of any principal or interest on
any indebtedness or in the performance of or compliance
with any material agreement, instrument or other writing
evidencing such indebtedness or delivered pursuant
thereto or in connection therewith, which default shall
have continued beyond any applicable period of grace
and, in the case of a default in respect of
indebtedness, would permit the holder of such
indebtedness to accelerate payment of the principal
thereof;
(l) If any statement of the Seller's financial condition
prepared by the Seller or at its request shall indicate
that, or it shall have acknowledged that, the Seller has
a negative net worth or is insolvent;
-4-
<PAGE> 5
(m) If the Securities and Exchange Commission, Commodity
Futures Trading Commission, any securities or
commodities exchange or association, any banking
department or authority, or any other business
association or governmental entity or authority shall
revoke, cancel, enjoin, suspend or fail to renew the
Seller's registration, licensing, qualification or other
authorization to do business in respect of any type of
business or any geographic area, or any of the foregoing
shall occur in respect of any one or more of the
Seller's general partners, principals or parent entities
or other persons exercising control over the Seller to
the extent such event has a material adverse effect on
the Seller;
(n) If the Seller shall fail to maintain, or acknowledge
that it has failed to maintain, sufficient net capital
or any other indicia of financial condition as required
by any rule or regulation applicable to the Seller of
the Securities and Exchange Commission, Commodity
Futures Trading Commission, any securities or
commodities exchange or association, any banking
department or authority, or any other business
association or governmental entity or authority to the
extent such event has a material adverse effect on the
Seller;
(o) If any securities or commodities exchange or association
or other business association shall revoke, cancel,
enjoin, suspend or fail to renew the Seller's membership
to the extent such event has a material adverse effect
on the Seller;
(p) If there shall have occurred any outbreak or material
escalation of hostilities, declaration by the United
States of a national emergency or war or other calamity
or crisis, the effect of which on the financial markets
is such as to make it, in the judgment of SBRC,
impracticable to continue this Agreement; or
(q) If the Seller or any of its affiliates shall default in
respect of any transaction with SBRC or any of its
affiliates.
Notwithstanding any other provision of this Agreement, any grace
or notice period provided herein in respect of a notice to be given or action to
be taken by SBRC may be shortened or eliminated by SBRC if, in its sole good
faith discretion, it is reasonable to do so under the circumstances, taking into
consideration, among other things, the volatility of the market for the
collateral involved, the extent and nature of any Seller Events of Default (or
events which with the giving of such notice and passage of time would constitute
Seller Events of Default), and the risks inherent in deferring the exercise of
remedies for the otherwise applicable grace or notice period.
7. If a Seller Event of Default shall have occurred and be
continuing, SBRC may, upon notice to the Seller (which notice shall not be
required to be given in advance in the case of a Seller Event of Default of a
type described in paragraph 6(h) or (i)), (a) terminate or
-5-
<PAGE> 6
accelerate to a date designated by SBRC the date fixed for termination of the
directly affected Transaction or all of the Transactions hereunder and (b) sell
a sufficient amount of the Mortgage Loans and related servicing rights in a
commercially reasonable manner or elect to be deemed to have sold to the Seller
such Mortgage Loans and related servicing rights, and in either event apply the
proceeds of such sale (excluding any reasonable expenses incurred in connection
therewith) or, in the case of a deemed sale, the market value of such Mortgage
Loans as of the date of such deemed sale, against the payment of the Purchase
Price and any other amounts owing by the Seller under this Agreement, upon which
application the Purchase Price or any such other amounts shall be reduced by the
amount as applied and SBRC shall be released from any obligation to sell, return
or redeliver such Mortgage Loans. If any Mortgage Loans remain after all
obligations of the Seller under this Agreement have been satisfied, SBRC or its
agent shall promptly return to the Seller or its agent the balance of the
Mortgage Loans. If the Mortgage Loans are not sufficient to satisfy all such
obligations, the Seller shall be liable to SBRC for the amount of remaining
obligations plus interest at the then prevailing effective Federal Funds Rate as
determined by SBRC in its sole discretion. Notwithstanding anything contained in
this Agreement, except as expressly provided for in this paragraph 7, SBRC shall
under no circumstances whatsoever have any obligation or liability to the Seller
in respect of any Transaction following the failure of the Seller to pay the
applicable Repurchase Price or deliver the applicable Mortgage Loans as and when
required by the terms of this Agreement.
8. The occurrence of any of the following shall constitute a
"SBRC Event of Default":
(a) If the Purchase Price is not paid as specified in the
Letter Agreement;
(b) If SBRC shall make a general assignment for the benefit
of creditors; admit in writing its inability to pay its
debts as they become due; file a petition in bankruptcy
or a petition seeking any reorganization, arrangement,
composition, readjustment, liquidation, dissolution or
similar relief under any present or future bankruptcy,
reorganization, insolvency or similar statute, law or
regulation or seek the appointment of any trustee,
receiver, custodian or liquidator of SBRC or of all or
substantially all of its properties;
(c) If a proceeding is commenced against SBRC seeking relief
or an appointment of a type described in paragraph 8(b)
above and such proceeding is not dismissed within 30
days after the commencement thereof;
(d) If a final judgment for the payment of money shall be
rendered against SBRC, and such judgment shall not have
been discharged or its execution stayed pending appeal
within 60 days of entry or such judgment shall not have
been discharged within 60 days of expiration of any such
stay;
-6-
<PAGE> 7
(e) If SBRC shall have defaulted under this Agreement by
operation of clause (a) of the second sentence of
paragraph 16 below, and such default is not cured within
three business days after notice; or
(f) If SBRC or any of its affiliates shall default in
respect of any transaction with the Seller or any of its
affiliates.
9. If an SBRC Event of Default shall have occurred and be
continuing, the Seller may, upon one business day's prior notice to SBRC, which
notice shall not be required to be given in advance in the case of an SBRC Event
of Default of a type described in paragraph 8(b) or (c)), (a) terminate or
accelerate to a date designated by the Seller the date fixed for termination of
the directly affected Transaction or all Transactions hereunder and (b) either
(x) purchase in a commercially reasonable manner Eligible Mortgage Loans with a
market value equal to any Mortgage Loans required to be returned or delivered by
SBRC but not so returned or delivered and apply the cost of such purchase
(including any reasonable expenses incurred in connection therewith) against the
Repurchase Price and any other amounts owing by the Seller under this Agreement,
upon which application the Repurchase Price and any such other amounts shall be
reduced by the amount so applied and SBRC shall be released from any obligation
to sell, return or deliver such Mortgage Loans or (y) pay to SBRC the Repurchase
Price and repurchase the related Mortgage Loans. If the Seller chooses the
remedy available in clause 9(b)(x) above, after all obligations of SBRC under
this Agreement have been satisfied, the Seller shall promptly pay SBRC any
portion of such positive amount (after such reduction) which has not previously
been paid or SBRC shall promptly pay to the Seller any excess of such cost of
purchase of replacement Eligible Mortgage Loans (including expenses as
aforesaid) over the amount of the Repurchase Price (prior to reduction), plus
interest on such excess for the period from the date of such purchase until the
date of full payment by SBRC at the then prevailing effective Federal Funds
Rate.
10. The market value of the Mortgage Loans shall be determined
by SBRC acting in good faith.
11. The Seller represents that it will have the authority to
enter into and perform any Transactions under this Agreement. Each party
represents that the person executing this Agreement and the persons executing
Transactions under this Agreement on its behalf have and will have the authority
to do so and that this Agreement does not conflict with any other agreement
binding on such party.
12. The Mortgage Loans shall be identified on a detailed listing
to be provided by the Seller to SBRC (a "Mortgage Loan Schedule") by diskette or
via modem. The Mortgage Loan Schedule must be received by SBRC not less than two
(2) business days prior to each transfer of Mortgage Loans and must be in a
format acceptable to SBRC, consisting of the loan characteristics set forth in
the definition of "Mortgage Loan Schedule" in the Custodial Agreement. The
Confirmation shall be sent by SBRC to the Seller and the documents contained in
the Mortgage File (as defined herein) shall be delivered to Chase Bank of Texas,
National Association (the "Custodian") and held by the Custodian pursuant to the
terms of a Custodial
-7-
<PAGE> 8
Agreement, dated as of February 11, 1999 (the "Custodial Agreement"), among the
Seller, SBRC and the Custodian pursuant to which the Custodian shall, among
other things, issue trust receipts, as defined therein (the "Trust Receipts").
As a condition to closing any Transaction on any Purchase Date, the Custodian
must deliver to SBRC a Trust Receipt in form and substance acceptable to SBRC.
The transfer of such Mortgage Loans for the purposes of this paragraph 12 shall
include the delivery to the Custodian of the following documents (the "Mortgage
File") with respect to each Mortgage Loan, as set forth in the Custodial
Agreement:
(a) the original Mortgage Note, endorsed in the following form: "Pay to
the order of ____________________, without recourse", with all prior and
intervening endorsements showing a complete chain of endorsement from the
originator to the Seller;
(b) the original Mortgage with evidence of recording thereon, and the
original recorded power of attorney, if the Mortgage was executed pursuant to a
power of attorney, with evidence of recording thereon;
(c) an executed original Assignment of Mortgage, in blank, from the
Seller, which assignment shall be in form and substance acceptable for
recording;
(d) the original recorded Assignment or Assignments of the Mortgage
showing a complete chain of assignment from the originator to the Seller;
(e) the original or copies of each assumption, modification, written
assurance or substitution agreement, if any; and
(f) the original lender's title insurance policy, together with all
endorsements or riders which when issued with or subsequent to the issuance of
such policy, insuring the priority of the Mortgage as a first lien on the
Mortgaged Property represented therein as a fee interest vested in the
Mortgagor, or in the event such original title policy is unavailable, a written
commitment or uniform binder or preliminary report of title issued by the title
insurance or escrow company.
Notwithstanding anything to the contrary contained in this
Section 12, in those instances where either (x) the public recording office has
not returned the original Mortgage, power of attorney or Assignment or (y) the
public recording office retains the original Mortgage, power of attorney or
Assignment after it has been recorded or such document has been lost, the
obligations of the Seller hereunder and under the Custodial Agreement shall be
deemed to have been satisfied upon (1) delivery by the Seller to the Custodian
of a copy of such Mortgage, power of attorney or Assignment certified by the
Seller in the case of (x) above or the public recording office in the case of
(y) above to be a true and complete copy of the recorded original thereof and
(2) if such copy is certified by the Seller, delivery to the Custodian, promptly
upon receipt thereof of either the original or a copy of such document certified
by the public recording office to be a true and complete copy of the original.
Upon delivery to the Seller (x) by the public recording office of any recorded
original Mortgage, power of attorney or Assignment or (y) by a title insurance
or escrow company of any lender's title insurance policy, the Seller promptly
shall (and
-8-
<PAGE> 9
in no event later than five business days following such receipt) deliver such
document to the Custodian.
In addition to the documents contained in the Mortgage File, the Seller
shall deliver to SBRC on or prior to the Purchase Date for such Transaction a
security release certification acceptable to SBRC, certifying the release of any
security interest of a third party which may have existed with respect to any of
the Mortgage Loans subject to such Transaction during the 45-day period prior to
the related Purchase Date and a Bill of Sale in the form of Exhibit C.
13. Unless otherwise agreed to between SBRC and the Seller, SBRC
hereby covenants and agrees to hire the Seller to service; and the Seller hereby
covenants and agrees to service each Mortgage Loan for a term beginning on the
related Purchase Date of such Mortgage Loan and ending on the related Repurchase
Date; provided that if a Seller Event of Default shall have occurred and be
continuing, the Seller shall immediately be terminated as servicer. The Mortgage
Loans shall be serviced in accordance with Accepted Servicing Practices.
"Accepted Servicing Practices" shall mean that in performing its servicing
duties, the Seller must comply with all applicable state and federal laws and
shall exercise the degree of skill and care consistent with the highest degree
of skill and care that the Seller exercises with respect to similar Mortgage
Loans serviced by it for its own account or others but in no event shall
Accepted Servicing Practices mean any duties less than those set forth in the
Pooling and Servicing Agreement, Series 1997-LB5, dated as of November 1, 1997
(the "1997-LB5 PSA") among Salomon Brothers Mortgage Securities VII, Inc., the
Borrower and Norwest Bank Minnesota, National Association; provided, however
that Accepted Servicing Practices shall not include the advance of any
delinquent principal or interest payments on the Mortgage Loans. Any payments
received by the Seller on the Mortgage Loans (including any Prepayment Charges)
must be placed into a collection account for the benefit of SBRC. The collection
account must meet the requirements of an Eligible Account, as such term is
defined in the 1997-LB5 PSA. After payment of all funds due to SBRC on each
Repurchase Date, SBRC will instruct the bank holding the collection account to
release any funds in the collection account to the Seller. Notwithstanding the
foregoing, if the Seller fails to repurchase the Mortgage Loans on a Repurchase
Date or upon a Seller Event of Default, all funds held in the collection account
will be released to SBRC by such Bank.
As part of its servicing duties, the Seller enforce "due-on-sale"
provisions to the extent permitted by law, shall administer all escrow/impound
deposits and shall make all servicing advances (not including the advances of
delinquent principal and interest) on the Mortgage Loans. The Mortgage Loans
shall be serviced for a servicing fee equal to 0.50% per annum payable monthly
on the then-outstanding principal balance of each Mortgage Loan (the "Servicing
Fee"). Such Servicing Fee will be deemed to be paid to Long Beach out of the
funds delivered on each Repurchase Date from the collection account to Long
Beach. If the Seller is terminated as servicer hereunder, its entitlement to
such fee is subordinate to any rights and interests of SBRC under this
Agreement. Notwithstanding the foregoing, in the event the Seller fails to
repurchase a Mortgage Loan on the related Repurchase Date or if a Seller Event
of Default has occurred and is continuing, the Seller will no longer be servicer
with respect to such Mortgage Loan or Mortgage Loans, unless the term of
servicing is extended by SBRC in its sole discretion. In such event, SBRC shall
have the right to transfer such servicing to another servicer without payment of
any
-9-
<PAGE> 10
fee to the Seller. The Seller will cooperate in good faith to effect such
servicing transfer and shall pay all costs associated with such servicing
transfer.
14. All notices, deliveries and payments under this Agreement
shall be sufficient if in writing and delivered to the party entitled to receive
such notices, deliveries or payments, or if transmitted to such party by
facsimile transfer, at the following address or facsimile number: (i) if to
SBRC: Salomon Brothers Realty Corp., Seven World Trade Center, New York, New
York 10048, Attention: Secretary (facsimile no.: (212) 783-3895); (ii) if to the
Seller: Long Beach Mortgage Company, 1100 Town & Country Road, Suite 1650,
Orange, California 92868, Attention: Treasurer (telecopy number: (714)
560-0508), or to such other addresses as either party may furnish the other
party by written notice under this paragraph.
15. It is the intention of the parties to this Agreement that
Transactions entered into hereunder be considered purchases and sales of
Mortgage Loans notwithstanding their treatment for certain accounting purposes
as financing transactions. Notwithstanding any other provision of this
Agreement, in the event that a Transaction hereunder is deemed not to constitute
a purchase and sale (a) the Seller shall be deemed to have hereby pledged to
SBRC the Mortgage Loans applicable to such Transaction as security for the
performance by the Seller of its obligations in respect of such Transaction and
any other Transaction between SBRC and the Seller and (b) the existence of such
pledge shall be deemed not to violate the representations and warranties in
respect of such Mortgage Loans made by the Seller in paragraph 1 above.
16. SBRC and the Seller hereby acknowledge that they consider
each Transaction hereunder and all other transactions under this Agreement or
any other agreement between the parties, either party and any affiliate of the
other party or any affiliates of the parties to constitute a single business and
contractual relationship and to have been made in consideration of each other.
Therefore, (a) each party and each affiliate of each party hereby agrees to
fulfill all of its obligations to the other party and any affiliate of the other
party with respect to any transaction or agreement between them or any of their
affiliates, and agrees that a default in the performance of any such obligations
shall constitute a default hereunder, (b) each party and any of its affiliates
shall have a right of setoff against the other party and any of its affiliates
of amounts owing hereunder and any other amounts or obligations owing in respect
of any other agreement or transaction whatsoever and (c) payments and deliveries
made by either party or any of either party's affiliates hereunder shall be
considered to have been made in consideration of payments and deliveries made by
the other party or any of the other party's affiliates with respect to any other
agreement or transaction between them, and the obligations to make any such
payments and deliveries may be applied against each other and netted. In order
to secure any obligation of either party to the other party or to any affiliate
of the other party under this Agreement or any other agreement, each party
grants to the other party and the affiliates of the other party a security
interest in all property heretofore or hereafter held by or for the benefit of
such other party or the affiliates of such other party.
17. In the event, for any reason, any purchase by SBRC hereunder
on any Purchase Date is construed by a court as a secured loan rather than a
purchase and sale, the parties intend that SBRC shall have a perfected first
priority security interest in all of the related Mortgage
-10-
<PAGE> 11
Loans. The Seller shall pay all fees and expenses associated with perfecting
such security interest, including, without limitation, the cost of filing
financing statements under the Uniform Commercial Code to the extent required by
SBRC.
18. The most recent Confirmation by SBRC to the Seller of each
Transaction delivered pursuant to paragraph 2, as supplemented by this
Agreement, shall constitute a binding agreement between SBRC and the Seller. In
the event of any conflict between the provisions of this Agreement and any other
agreement, confirmation, instrument or other document, the provisions of this
Agreement shall govern; provided that, in the event of any conflict between the
terms of this Agreement and any Confirmation duly executed pursuant to Section 2
of this Agreement, such Confirmation shall govern. This Agreement shall not be
assignable by the Seller without prior written consent of SBRC, shall be binding
upon and inure to the benefit of the parties and their respective successors and
assigns, shall not be changed except by an instrument in writing signed by each
of the parties, and shall be governed by the laws of the State of New York. This
Agreement may be executed in any number of counterparts, each of which
counterparts shall constitute but one and the same instrument. The Seller shall
promptly provide such further assurances or agreements as SBRC may request in
order to effect the purposes of this Agreement.
19. In connection with each Transaction entered into between the
Seller and SBRC, the Seller and SBRC agree as follows:
(a) In the case of any Transaction for which the
Repurchase Date is other than the business day immediately
following the Purchase Date and with respect to which Seller
does not have any existing right to substitute substantially the
same mortgage loans for the Mortgage Loans, Seller shall have
the right, subject to the proviso to this sentence, upon notice
to SBRC, which notice shall be given at or prior to 10 A.M. New
York time on such business day, to substitute substantially the
same mortgage loans for any Mortgage Loans; provided, however,
that SBRC may elect, by the close of business on the business
day notice is received, or by the close of the next business day
if notice is given after 10 A.M. New York time on such day, not
to accept such substitution. In the event such substitution is
accepted by SBRC, such substitution shall be made by Seller's
transfer to SBRC of such other mortgage loans and SBRC's
transfer to Seller of such Mortgage Loans, and after such
substitution, the substituted mortgage loans shall be deemed to
be Mortgage Loans. In the event SBRC elects not to accept such
substitution, SBRC shall offer Seller the right to terminate
such Transaction.
(b) In the event Seller exercises its right to
substitute or terminate under sub-paragraph (a), Seller shall be
obligated to pay to SBRC, by the close of the business day of
such substitution or termination, as the case may be, an amount
equal to (A) SBRC's actual cost (including all fees, expenses
and commissions) of (i) entering into replacement transactions;
(ii) entering into or terminating hedge transactions; and/or
(iii) terminating transactions or substituting mortgage loans in
like transactions with third parties in connection with or as a
result of such
-11-
<PAGE> 12
substitution or termination, and (B) to the extent SBRC
determines not to enter into replacement transactions, the loss
incurred by SBRC directly arising or resulting from such
substitution or termination. The foregoing amounts shall be
solely determined and calculated by SBRC in good faith.
-12-
<PAGE> 13
IN WITNESS WHEREOF, SBRC and the Seller have caused their names
to be signed hereto by their respective officers thereunto duly authorized as of
February 11, 1999.
SALOMON BROTHERS REALTY CORP.
By:
-------------------------------------
Name:
Title:
LONG BEACH MORTGAGE COMPANY
By:
-------------------------------------
Name:
Title:
<PAGE> 14
EXHIBIT A
The Seller represents, warrants and covenants to SBRC as of each
Purchase Date or as of such other date as specifically provided herein:
(a) The Seller is a corporation duly organized, validly existing and
in good standing under the laws of the State of Delaware and is
duly authorized and qualified to transact any and all business
contemplated by this Agreement to be conducted by the Seller in
any state in which a Mortgaged Property is located or is
otherwise not required under applicable law to effect such
qualification and, in any event, is in compliance with the doing
business laws of any such State, to the extent necessary to
ensure its ability to enforce each Mortgage Loan and to service
the Mortgage Loans in accordance with the terms of this
Agreement;
(b) The Seller has the full corporate power and authority to
originate, hold, sell and service each Mortgage Loan, and to
execute, deliver and perform, and to enter into and consummate
the Transactions contemplated by this Agreement and has duly
authorized by all necessary corporate action on the part of the
Seller the execution, delivery and performance of this
Agreement; and this Agreement, assuming the due authorization,
execution and delivery thereof by SBRC, constitutes a legal,
valid and binding obligation of the Seller, enforceable against
the Seller in accordance with its terms, except to the extent
that (a) the enforceability thereof may be limited by
bankruptcy, insolvency, moratorium, receivership and other
similar laws relating to creditors' rights generally and (b) the
remedy of specific performance and injunctive and other forms of
equitable relief may be subject to the equitable defenses and to
the discretion of the court before which any proceeding therefor
may be brought;
(c) The execution and delivery of this Agreement by the Seller, the
servicing of the Mortgage Loans by the Seller hereunder, the
consummation of any other of the Transactions herein
contemplated, and the fulfillment of or compliance with the
terms hereof are in the ordinary course of business of the
Seller and will not (A) result in a breach of any term or
provision of the charter or by-laws of the Seller or (B)
conflict with, result in a breach, violation or acceleration of,
or result in a default under, the terms of any other material
agreement or instrument to which the Seller is a party or by
which it may be bound, or any statute, order or regulation
applicable to the Seller of any court, regulatory body,
administrative agency or governmental body having jurisdiction
over the Seller; and the Seller is not a party to, bound by, or
in breach or violation of any indenture or other agreement or
instrument, or subject to or in violation of any statute, order
or regulation of any court, regulatory body, administrative
agency or governmental body having jurisdiction over it, which
materially and adversely affects or, to the Seller's knowledge,
would in the future materially and adversely affect, (x) the
ability of the Seller to perform its obligations under this
Agreement or (y) the business, operations, financial condition,
properties or assets of the Seller taken as a whole;
<PAGE> 15
(d) The Seller is an approved seller/servicer for Fannie Mae or
Freddie Mac in good standing and is a HUD approved mortgagee
pursuant to Section 203 of the National Housing Act;
(e) No litigation is pending against the Seller that would
materially and adversely affect the execution, delivery or
enforceability of this Agreement or the ability of the Seller to
service the Mortgage Loans or to perform any of its other
obligations hereunder in accordance with the terms hereof;
(f) No consent, approval, authorization or order of any court or
governmental agency or body is required for the execution,
delivery and performance by the Seller of, or compliance by the
Seller with, this Agreement or the consummation of the
Transactions contemplated hereby, or if any such consent,
approval, authorization or order is required, the Seller has
obtained the same;
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<PAGE> 16
EXHIBIT B
Any capitalized terms used in this Exhibit B but not otherwise defined
in the Purchase and Sale Agreement shall have the meanings assigned to them in
the Master Mortgage Loan Purchase and Servicing Agreement, dated and effective
as of June 1, 1997 between the Seller and SBRC.
The Seller hereby represents and warrants to SBRC that, as to each
Mortgage Loan, as of the related Purchase Date, or as of such date specifically
provided herein:
(i) The information set forth in the Mortgage Loan Schedule (as defined
in the Custodial Agreement) is complete, true and correct as of the related
Purchase Date;
(ii) The Mortgage Loan is in compliance with all requirements set forth
in the applicable Confirmation, and the characteristics of the Mortgage Loans as
set forth in such Confirmation are true and correct;
(iii) [intentionally omitted];
(iv) Each Mortgage is a valid and enforceable first lien on the
Mortgaged Property, including all improvements thereon, subject only to (a) the
lien of nondelinquent current real property taxes and assessments, (b)
covenants, conditions and restrictions, rights of way, easements and other
matters of public record as of the date of recording of such Mortgage, such
exceptions appearing of record being acceptable to mortgage lending institutions
generally or specifically reflected in the appraisal made in connection with the
origination of the related Mortgage Loan, and (c) other matters to which like
properties are commonly subject which do not materially interfere with the
benefits of the security intended to be provided by such Mortgage;
(v) Immediately prior to the assignment of the Mortgage Loans to SBRC,
the Seller had good title to, and was the sole legal and beneficial owner of,
each Mortgage Loan free and clear of any pledge, lien, encumbrance or security
interest and has full right and authority, subject to no interest or
participation of, or agreement with, any other party to sell and assign the
same;
(vi) To the best of the Seller's knowledge, there is no delinquent tax
or assessment lien against any Mortgaged Property;
(vii) There is no valid offset, defense or counterclaim to any Mortgage
Note or Mortgage, including the obligation of the Mortgagor to pay the unpaid
principal of or interest on such Mortgage Note, nor will the operation of any of
the terms of the Mortgage Note and the Mortgage, or the exercise of any right
thereunder, render the Mortgage unenforceable, in whole or in part, or subject
to any right of rescission, set-off, counterclaim or defense, including the
defense of usury and no such right of rescission, set-off, counterclaim or
defense has been asserted with respect thereto;
(viii) To the best of the Seller's knowledge, there are no mechanics'
liens or claims for work, labor or material affecting any Mortgaged Property
which are or may be a lien prior to, or
<PAGE> 17
equal with, the lien of the related Mortgage, except those which are insured
against by the title insurance policy referred to in (xii) below;
(ix) To the best of the Seller's knowledge, each Mortgaged Property is
free of material damage and is in good repair;
(x) Each Mortgage Loan at origination complied in all material respects
with applicable local, state and federal laws, including, without limitation,
usury, equal credit opportunity, real estate settlement procedures,
truth-in-lending and disclosure laws, and consummation of the transactions
contemplated hereby will not involve the violation of any such laws;
(xi) Neither the Seller nor any prior holder of any Mortgage has
modified the Mortgage in any material respect (except that a Mortgage Loan may
have been modified by a written instrument which has been recorded, if
necessary, to protect the interests of SBRC and which has been delivered to the
Custodian); satisfied, cancelled or subordinated such Mortgage in whole or in
part; released the related Mortgaged Property in whole or in part from the lien
of such Mortgage; or executed any instrument of release, cancellation,
modification or satisfaction with respect thereto;
(xii) A lender's policy of title insurance together with a condominium
endorsement and extended coverage endorsement, if applicable, and, with respect
to each Adjustable Rate Mortgage Loan, an adjustable rate mortgage endorsement
in an amount at least equal to the balance of the Mortgage Loan as of the
related Purchase Date or a commitment (binder) to issue the same was effective
on the date of the origination of each Mortgage Loan, each such policy is valid
and remains in full force and effect, the transfer of the related Mortgage Loan
to SBRC will not affect the validity or enforceability of such policy and each
such policy was issued by a title insurer qualified to do business in the
jurisdiction where the Mortgaged Property is located and acceptable to FNMA or
FHLMC and in a form acceptable to FNMA or FHLMC, which policy insures the Seller
and successor owners of indebtedness secured by the insured Mortgage, as to the
first priority lien of the Mortgage; to the best of the Seller's knowledge, no
claims have been made under such mortgage title insurance policy and no prior
holder of the related Mortgage, including the Seller, has done, by act or
omission, anything which would impair the coverage of such mortgage title
insurance policy;
(xiii) Each Mortgage Loan was originated by the Seller (or, if generated
on behalf of the Seller by a Person other than the Seller, is subject to the
same standards and procedures used by the Seller in originating mortgage loans
directly) or by a savings and loan association, savings bank, commercial bank,
credit union, insurance company or similar institution which is supervised and
examined by a federal or state authority, or by a mortgagee approved by the
Secretary of Housing and Urban Development pursuant to sections 203 and 211 of
the National Housing Act;
(xiv) With respect to each Adjustable Rate Mortgage Loan on each
adjustment date, the Mortgage Interest Rate will be adjusted to equal the Index
plus the Margin, rounded to the nearest 0.125%, subject to the Periodic Rate
Cap, the Maximum Rate and the Minimum Rate. Except for Balloon Loans, the
related Mortgage Note is payable on the first day of each month in self-
-2-
<PAGE> 18
amortizing monthly installments of principal and interest, with interest payable
in arrears, and requires a Monthly Payment which is sufficient to fully amortize
the outstanding principal balance of the Mortgage Loan over its remaining term
and to pay interest at the applicable Mortgage Interest Rate. No Mortgage Loan
is subject to negative amortization;
(xv) To the best of the Seller's knowledge, all of the improvements
which were included for the purpose of determining the Appraised Value of the
Mortgaged Property lie wholly within the boundaries and building restriction
lines of such property, and no improvements on adjoining properties encroach
upon the Mortgaged Property;
(xvi) All inspections, licenses and certificates required to be made or
issued with respect to all occupied portions of the Mortgaged Property and, with
respect to the use and occupancy of the same, including but not limited to
certificates of occupancy, have been made or obtained from the appropriate
authorities and the Mortgaged Property is lawfully occupied under applicable
law;
(xvii) All parties which have had any interest in the Mortgage, whether
as mortgagee, assignee, pledgee or otherwise, are (or, during the period in
which they held and disposed of such interest, were) in compliance with any and
all applicable licensing requirements of the laws of the state wherein the
Mortgaged Property is located;
(xvii) The Mortgage Note and the related Mortgage are genuine, and each
is the legal, valid and binding obligation of the maker thereof, enforceable in
accordance with its terms and with applicable laws. All parties to the Mortgage
Note and the Mortgage had legal capacity to execute the Mortgage Note and the
Mortgage and each Mortgage Note and Mortgage have been duly and properly
executed by such parties;
(xviii) The proceeds of each Mortgage Loan have been fully disbursed,
there is no requirement for future advances thereunder and any and all
requirements as to completion of any on-site or off-site improvements and as to
disbursements of any escrow funds therefor have been complied with. All costs,
fees and expenses incurred in making, closing or recording the Mortgage Loans
were paid;
(xix) The related Mortgage contains customary and enforceable provisions
which render the rights and remedies of the holder thereof adequate for the
realization against the Mortgaged Property of the benefits of the security,
including, (i) in the case of a Mortgage designated as a deed of trust, by
trustee's sale, and (ii) otherwise by judicial foreclosure. There is no
homestead or other exemption available to the Mortgagor which would interfere
with the right to sell the Mortgaged Property at a trustee's sale or the right
to foreclose the Mortgage;
(xx) With respect to each Mortgage constituting a deed of trust, a
trustee, duly qualified under applicable law to serve as such, has been properly
designated and currently so serves and is named in such Mortgage, and no fees or
expenses are or will become payable by SBRC to the trustee under the deed of
trust, except in connection with a trustee's sale after default by the
Mortgagor;
-3-
<PAGE> 19
(xxi) There exist no deficiencies with respect to escrow deposits and
payments, if such are required, for which customary arrangements for repayment
thereof have not been made, and no escrow deposits or payments of other charges
or payments due the Seller have been capitalized under the Mortgage or the
related Mortgage Note;
(xxii) The origination, underwriting and collection practices used by
the Seller with respect to each Mortgage Loan have been in all respects legal,
proper, prudent and customary in the mortgage servicing business;
(xxiii) There is no pledged account or other security other than real
estate securing the Mortgagor's obligations;
(xxiv) No Mortgage Loan has a shared appreciation feature, or other
contingent interest feature;
(xxv) No Mortgage Loan provides for primary mortgage insurance;
(xxvi) The improvements upon each Mortgaged Property are covered by a
valid and existing hazard insurance policy with a generally acceptable carrier
that provides for fire extended coverage and such other hazards as are customary
in the area where the Mortgaged Property is located representing coverage not
less than the lesser of the outstanding principal balance of the related
Mortgage Loan or the minimum amount required to compensate for damage or loss on
a replacement cost basis. All individual insurance policies and flood policies
referred to in clause (xxvii) below contain a standard mortgagee clause naming
the Seller or the original mortgagee, and its successors in interest, as
mortgagee, and the Seller has received no notice that any premiums due and
payable thereon have not been paid; the Mortgage obligates the Mortgagor
thereunder to maintain all such insurance, including flood insurance, at the
Mortgagor's cost and expense, and upon the Mortgagor's failure to do so,
authorizes the holder of the Mortgage to obtain and maintain such insurance at
the Mortgagor's cost and expense and to seek reimbursement therefor from the
Mortgagor;
(xxvii) If the Mortgaged Property is in an area identified in the
Federal Register by the Federal Emergency Management Agency as having special
flood hazards, a flood insurance policy in a form meeting the requirements of
the current guidelines of the Flood Insurance Administration is in effect with
respect to such Mortgaged Property with a generally acceptable carrier in an
amount representing coverage not less than the least of (A) the original
outstanding principal balance of the Mortgage Loan, (B) the minimum amount
required to compensate for damage or loss on a replacement cost basis or (C) the
maximum amount of insurance that is available under the Flood Disaster
Protection Act of 1973;
(xxviii) Other than with respect to any failure of a Mortgagor to make
timely payments of principal and interest due on the related Mortgage Note,
there is no default, breach, violation or event of acceleration existing under
the Mortgage or the related Mortgage Note; and the Seller has not waived any
default, breach, violation or event of acceleration;
-4-
<PAGE> 20
(xxix) Each Mortgaged Property is improved by a one- to four-family
residential dwelling, including condominium units and dwelling units in planned
unit developments, which, to the best of the Seller's knowledge, does not
include cooperatives or mobile homes and does not constitute other than real
property under state law;
(xxx) There is no obligation on the part of the Seller or any other
party under the terms of the Mortgage or related Mortgage Note to make payments
in addition to those made by the Mortgagor;
(xxxi) Any future advances made prior to the related Purchase Date have
been consolidated with the outstanding principal amount secured by the Mortgage,
and the secured principal amount, as consolidated, bears a single interest rate
and single repayment term reflected on the related Mortgage Loan Schedule. The
consolidated principal amount does not exceed the original principal amount of
the Mortgage Loan;
(xxxii) Each Mortgage Loan was underwritten in accordance with the
Seller's underwriting guidelines;
(xxxiii) The Mortgage File contains an appraisal which was performed by
an appraiser who satisfied, and which was conducted in accordance with, all of
the applicable requirements of the Financial Institutions Reform, Recovery and
Enforcement Act of 1989, as amended;
(xxxiv) None of the Mortgage Loans is a graduated payment mortgage loan,
nor is any Mortgage Loan subject to a temporary buydown or similar arrangement;
(xxxv) With respect to each Mortgage Loan, no loan junior in lien
priority to such Mortgage Loan and secured by the related Mortgaged Property was
originated by the Seller at the time of origination of such Mortgage Loan;
(xxxvi) The Mortgage contains an enforceable provision for the
acceleration of the payment of the unpaid principal balance of the Mortgage Loan
in the event that the Mortgaged Property is sold or transferred without the
prior written consent of the mortgagee thereunder.
-5-
<PAGE> 21
Schedule 1
-6-
<PAGE> 22
EXHIBIT C
BILL OF SALE
On this ____ day of __________, 199__, Long Beach Mortgage
Company ("Long Beach") does hereby sell, transfer, assign, set over and convey
to Salomon Brothers Realty Corp. ("SBRC"), without recourse, all of the right,
title and interest of Long Beach in and to each of the fixed rate and adjustable
rate one-to-four family residential first and second lien mortgage loans
identified on the Mortgage Loan Schedule attached hereto as Exhibit One (the
"Mortgage Loans"), and the related Mortgage Loan Files. Such Mortgage Loans are
sold to SBRC pursuant to the Purchase and Sale Agreement dated as of February
11, 1999 between SBRC and Long Beach (the "Agreement").
Long Beach hereby represents and warrants that Long Beach is the
sole legal, beneficial and equitable owner of each Mortgage Loan and has full
power and authority to transfer and sell each Mortgage Loan to SBRC free and
clear of any encumbrance, equity, lien, pledge, charge, claim or security
interest that Long Beach had or created in the Mortgage Loans or the related
Mortgage Loan Files and that as of the date hereof the representations and
warranties specified in Exhibits A and B to the Agreement are true and correct
as to Long Beach and the Mortgage Loans.
This Bill of Sale shall be governed by, and construed in
accordance with, the laws of the State of New York.
LONG BEACH MORTGAGE COMPANY
By:
-------------------------------------
Name:
Title:
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EXHIBIT ONE
MORTGAGE LOAN SCHEDULE
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SALOMON BROTHERS REALTY CORP.
SEVEN WORLD TRADE CENTER
NEW YORK, NEW YORK 10048
February 11, 1999
Long Beach Mortgage Company
1100 Town & Country Road, Suite 1650
Orange, California 92868
Attention: General Counsel
Ladies and Gentlemen:
This letter agreement (the "Letter Agreement") confirms the
understanding and agreements between Long Beach Mortgage Company ("Long Beach")
and Salomon Brothers Realty Corp. ("SBRC"), under the terms set forth herein,
regarding SBRC's agreement to provide an Aggregation Line (as defined herein) to
Long Beach in connection with certain fixed-rate and adjustable-rate, first lien
mortgage loans (the "Mortgage Loans") that are originated or purchased by Long
Beach, its affiliates and/or subsidiaries and any related prepayment charges
payable in connection with any voluntary principal prepayment in full on the
related Mortgage Loans (the "Prepayment Charges").
1. Aggregation Line.
SBRC shall make available to Long Beach an aggregation line (the
"Aggregation Line") from February 11, 1999 until January 31, 2000 pursuant to
which SBRC shall simultaneously purchase from, and sign a forward commitment to
resell to, Long Beach, Mortgage Loans, Prepayment Charges and the related
servicing rights that are deemed acceptable for such Aggregation Line as set
forth below. The Aggregation Line shall be more fully documented pursuant to the
Mortgage Loan Purchase and Sale Agreement (the "Purchase and Sale Agreement")
being entered into on the date hereof between Long Beach and SBRC. Under the
Purchase and Sale Agreement, Long Beach will make standard secondary market
corporate representations and warranties as of the date such Purchase and Sale
Agreement is executed and as of any Purchase Date (as defined herein) for the
purchase and sale of any Mortgage Loans pursuant to such Purchase and Sale
Agreement and Long Beach shall make standard secondary market representations
and warranties with respect to each Mortgage Loan as of the Purchase Date on
which such Mortgage Loan is sold to SBRC.
The "Purchase Price" with respect to each Mortgage Loan,
Prepayment Charge and related servicing rights shall be equal to the lesser of
(i) the market value of such Mortgage Loan, Prepayment Charge and related
servicing rights as determined by SBRC acting in good faith and (ii) the greater
of (a)(I) 100% of the unpaid principal balance of such Mortgage Loan as of the
date
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Long Beach Mortgage Company
February 11, 1999 Page 2.
of purchase if such Mortgage Loan is current or delinquent one payment or (II)
100% of the unpaid principal balance of such Mortgage Loan, minus an additional
10% of the unpaid principal balance of such Mortgage Loan for each additional
delinquent payment (after the first delinquent payment) and (b) 65% of the
Broker's Price Opinion obtained by Long Beach at its expense regarding the real
property subject to the Mortgage Loan. The vendor providing such Broker's Price
Opinion must be approved by SBRC.
The repurchase price (the "Repurchase Price") shall reflect the
agreed upon return to SBRC for providing the Aggregation Line (the "Aggregation
Cost Rate"). With respect to any Mortgage Loan, the Aggregation Cost Rate shall
equal One Month LIBOR (as defined herein) plus 1.25% per annum, calculated on
the basis of a 360-day year and the actual number of days between the Purchase
Date and the Repurchase Date (as defined herein) and rounded up to the nearest
0.0625%. The Repurchase Price shall equal the sum of (i) the Purchase Price and
(ii) the Purchase Price multiplied by the Aggregation Cost Rate.
"One Month LIBOR" means as of the related Settlement Date, the
30 day London Interbank Offered Rate as of 11:00 a.m. (London time) on such
date, as indicated on page number 3750 of the Telerate Service. If One Month
LIBOR cannot be so determined, then One Month LIBOR shall mean the rate
determined by SBRC in its sole discretion.
The Aggregation Line at any one time shall be limited to $100
million in amount of Mortgage Loans and shall have a term of one month or
shorter period of time if the related Purchase Date is not a "Roll Date". A
"Roll Date" is the date each month on which all of the Mortgage Loans subject to
the Aggregation Line are repurchased by Long Beach and then purchased again by
SBRC.
Long Beach shall have the right to add Mortgage Loans to the
Aggregation Line up to twice each month. Long Beach may remove Mortgage Loans
from the Aggregation Line twice a month (one of which shall be on the Roll
Date).
SBRC shall provide not less than twenty eight days' prior notice
to Long Beach in the event that SBRC elects to not renew the Aggregation Line
for any month.
2. Servicing of the Mortgage Loans. The purchase by SBRC of a
Mortgage Loan pursuant to the Aggregation Line shall include the purchase of any
related Prepayment Charge and the related servicing rights for such Mortgage
Loan and the repurchase by Long Beach shall also include the repurchase of the
related Prepayment Charge and the related servicing rights. Unless otherwise
agreed to between SBRC and Long Beach, SBRC hereby covenants and agrees to hire
Long Beach to service; and Long Beach hereby covenants and agrees to service the
Mortgage Loans for a term beginning on the related purchase date (each such
date, a "Purchase Date") and ending on the related date fixed for repurchase
(the "Repurchase Date"); provided that if a Seller Event of Default (as defined
herein) has occurred, Long Beach shall immediately be terminated as servicer.
The Mortgage Loans shall be serviced in accordance with Accepted Servicing
Practices (as defined in the Purchase and Sale Agreement). Any payments received
by
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Long Beach Mortgage Company
February 11, 1999 Page 3.
Long Beach on the Mortgage Loans (including any Prepayment Charges) must be
placed into a collection account for the benefit of SBRC. The collection account
must meet the requirements of an Eligible Account, as such term is defined in
the Pooling and Servicing Agreement, Series 1997-LB5 dated as of November 1,
1997 among Norwest Bank Minnesota, National Association, SBMSVII and Long Beach.
After the payment of all funds due to SBRC on each Repurchase Date, SBRC will
instruct the bank holding the collection account to release any funds in the
collection account to Long Beach. Notwithstanding the foregoing, if Long Beach
fails to repurchase the Mortgage Loans on a Repurchase Date or upon a Seller
Event of Default, all funds held in the collection account will be released to
SBRC by such bank.
As part of its servicing duties, Long Beach shall enforce
"due-on-sale" provisions to the extent permitted by law, shall administer all
escrow/impound deposits, and shall make all servicing advances (not including
advances of delinquent principal and interest) on the Mortgage Loans. The
Mortgage Loans shall be serviced for a servicing fee equal to 0.50% per annum
payable monthly on the then-outstanding principal balance of each Mortgage Loan
(the "Servicing Fee"). Such Servicing Fee will be deemed to be paid to Long
Beach out of the funds delivered on each Repurchase Date from the collection
account to Long Beach. If the Seller is terminated as Servicer hereunder, the
entitlement to such Servicing Fee is subordinate to any rights and interests of
SBRC under this Letter Agreement. Notwithstanding the foregoing, in the event
Long Beach fails to repurchase a Mortgage Loan on the related Repurchase Date or
if a Seller Event of Default occurs, Long Beach will no longer be servicer with
respect to such Mortgage Loan or Mortgage Loans, unless the term of servicing is
extended by SBRC in its sole discretion. In such event, SBRC shall have the
right to transfer such servicing to another servicer without payment of any fee
to Long Beach. Long Beach will cooperate in good faith to effect such servicing
transfer and shall pay all costs associated with such servicing transfer.
3. Conditions Precedent to Mortgage Loan Purchases. SBRC's
obligation to purchase any Mortgage Loans and related servicing rights which it
accepts for its Aggregation Line shall be subject to each of the following
conditions:
(i) there shall have been delivered to SBRC a Trust Receipt
issued by Chase Bank of Texas, National Association
("Chase") with a mortgage loan schedule attached thereto
and an exception report which is acceptable to SBRC in
its sole discretion;
(ii) SBRC shall have had an opportunity to perform a due
diligence review of each Mortgage Loan and shall have
arranged for reappraisals of value with respect to each
Mortgage Loan if desired by SBRC; and
(iii) Long Beach shall have provided to SBRC such other
documents which are then required to have been delivered
under the Purchase and Sale Agreement or which are
reasonably requested by SBRC, which other documents may
include UCC financing statements, a
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Long Beach Mortgage Company
February 11, 1999 Page 4.
favorable opinion or opinions of counsel with respect to
matters which are reasonably requested by SBRC
(including a perfection opinion), and/or an officer's or
secretary's certificate.
4. Custodial Agreement. Long Beach will pay all expenses in
connection with the custodial agreement, dated as of February 11, 1999 (the
"Custodial Agreement"), among SBRC, Long Beach and Chase, which Custodial
Agreement will be used to hold the mortgage files relating to the Mortgage
Loans.
5. Information. Long Beach will furnish, in a timely manner, to
SBRC all financial and other information (including historical loan information)
concerning Long Beach as SBRC deems reasonably appropriate in connection with
the performance of the services contemplated by this letter. In addition, Long
Beach will provide SBRC reasonable access during normal business hours to Long
Beach's officers, directors, employees, accountants, and other representatives.
Long Beach acknowledges and confirms that SBRC (i) will rely on such information
in the performance of the services contemplated by this letter without
independently investigating or verifying any of it, (ii) assumes no
responsibility for the accuracy or completeness of such information and (iii)
will not disclose such information to any third party (other than its
affiliates, its counsel or its independent accountants) without the prior
written consent of Long Beach; provided, however, SBRC can use such information
if necessary in connection with a Seller Event of Default under the Purchase and
Sale Agreement to market the Mortgage Loans for sale.
6. Unfundings. In the event any Mortgage Loan subject to the
Aggregation Line unfunds, the Repurchase Date with respect to such Mortgage Loan
will immediately accelerate to the next business day and Long Beach with
repurchase the Mortgage Loan at the Repurchase Price (including interest only
for the actual number of days since the Purchase Date).
7. Mortgage Loan Schedule. No Mortgage Loan shall be included in
the Aggregation Line unless Long Beach shall have delivered to SBRC at least two
(2) business days prior to such inclusion, a magnetic tape, in a format
acceptable to SBRC, consisting of the loan characteristics set forth in the
definition of "Mortgage Loan Schedule" in the Custodial Agreement. In addition,
Long Beach shall deliver to SBRC, a magnetic tape, in a format acceptable to
SBRC, with updated loan characteristics agreed upon by SBRC and Long Beach with
respect to each Mortgage Loan.
8. Hedging. Long Beach will have the option to establish one or
more securities or commodities accounts at Salomon Smith Barney Inc. and to
enter into transactions in such accounts (and only in such accounts) that are
intended to hedge the interest rate risk on Mortgage Loans included in the
Aggregation Line.
9. Third party whole loan sales. During the course of the
Aggregation Line, Long Beach may sell mortgage loans to third parties; provided,
that SBRC is given the "last look" in order to match the whole loan offer on the
Mortgage Loans from the third party.
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Long Beach Mortgage Company
February 11, 1999 Page 5.
10. Financing of REO Properties. In the event there is a
foreclosure sale for any Mortgage Loan, simultaneously with the occurrence of
such foreclosure, Long Beach will repurchase such Mortgage Loan from SBRC on
such date.
11. Termination.
(a) Long Beach shall have the right to terminate this Letter
Agreement upon the occurrence of any of the SBRC Events of Default under the
Purchase and Sale Agreement and shall be afforded any of the remedies provided
thereunder.
(b) SBRC shall have the right to terminate this Letter Agreement
upon the occurrence of any of the Seller Events of Default under the Purchase
and Sale Agreement and shall be afforded any of the remedies provided
thereunder.
(c) Subject to the provisions of this Paragraph 11, this Letter
Agreement shall terminate upon January 31, 2000.
12. General Provisions.
(a) SBRC's Discretion. It is understood that SBRC shall have the
right to approve or disapprove any Mortgage Loan for this Aggregation Line. In
addition, unless SBRC consents, it will not allow any Mortgage Loan with an
unpaid principal balance in excess of $500,000 onto the Aggregation Line.
(b) Governing Law. This Letter Agreement shall be governed by
and construed in accordance with the laws of the State of New York (without
regard to its conflicts of laws principles).
(c) Amendment or Waiver. This Letter Agreement may not be
amended or modified except in writing signed by each of the parties hereto.
(d) Counterparts. This Letter Agreement may be executed
simultaneously in any number of counterparts. Each counterpart shall be deemed
to be an original, and all such counterparts shall constitute one and the same
instrument.
(e) Severability Clause. Any part, provision, representation or
warranty of this Letter Agreement which is prohibited or which is held to be
void or unenforceable shall be ineffective to the extent of such prohibition or
unenforceability without invalidating the remaining provisions hereof. Any part,
provision, representation or warranty of this Letter Agreement which is
prohibited or unenforceable or is held to be void or unenforceable in any
jurisdiction shall be ineffective, as to such jurisdiction, to the extent of
such prohibition or unenforceability without invalidating the remaining
provisions hereof. To the extent permitted by applicable law, the parties hereto
waive any provision of law which prohibits or renders void or unenforceable any
provision hereof. If the invalidity of any part, provision, representation or
warranty of this Letter
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Long Beach Mortgage Company
February 11, 1999 Page 6.
Agreement shall deprive any party of the economic
benefit intended to be conferred by this Letter Agreement, the parties shall
negotiate, in good-faith, to develop a structure the economic effect of which is
nearly as possible the same as the economic effect of this Letter Agreement
without regard to such invalidity.
(f) No Partnership. Nothing herein contained shall be deemed or
construed to create a co-partnership or joint venture between the parties
hereto.
(g) Further Agreements. Long Beach and SBRC each agree to
execute and deliver to the other such reasonable and appropriate additional
documents, instruments or agreements as may be necessary or appropriate to
effectuate the purposes of this Letter Agreement.
(h) Expenses. Each party hereto shall pay its own expenses in
connection with any amendment hereto.
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Long Beach Mortgage Company
February 11, 1999 Page 7.
Please confirm that the foregoing is in accordance with your
understanding by signing this letter of agreement and two enclosed copies and
returning to us the enclosed copies. The letter signed by you shall constitute a
binding agreement between us as of the date first above written.
Yours sincerely,
SALOMON BROTHERS REALTY CORP.
By:
-------------------------------------
Name:
Title:
ACCEPTED AND AGREED TO
AS OF THE DATE FIRST ABOVE WRITTEN:
LONG BEACH MORTGAGE COMPANY
By:
-------------------------------------
Name:
Title:
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