<PAGE>
FILED PURSUANT TO RULE 424(b)(4)
REGISTRATION NO. 333-03633
PROSPECTUS
3,500,000 SHARES
FIRST ALLIANCE CORPORATION
CLASS A COMMON STOCK
----------------
All of the shares of the Class A Common Stock, $.01 par value per share (the
"Class A Common Stock"), offered hereby (the "Public Offering") are being sold
by First Alliance Corporation (together with its subsidiaries, the "Company").
Prior to the Public Offering, there has been no public market for the Class
A Common Stock. See "Underwriting" for information relating to the factors
considered in determining the Public Offering price. The Class A Common Stock
has been approved for quotation on the Nasdaq National Market under the symbol
"FACO."
The Company has two classes of common stock. The Class A Common Stock, which
is offered hereby, has one vote per share, and the Class B common stock, $.01
par value per share (the "Class B Common Stock"), has four votes per share.
See "Description of Capital Stock." Upon completion of the Public Offering and
assuming the Underwriters' over-allotment option is not exercised, the issued
and outstanding shares of Class A Common Stock and Class B Common Stock that
will be held by certain of the executive officers and directors of the Company
and related parties will have approximately 92.5% of the combined voting power
of all outstanding shares of capital stock of the Company.
SEE "RISK FACTORS" ON PAGES 7 THROUGH 14 FOR INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE PURCHASERS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
----------------
THE ATTORNEY GENERAL OF THE STATE OF NEW YORK HAS NOT
PASSED ON OR ENDORSED THE MERITS OF THIS OFFERING. ANY
REPRESENTATION TO THE CONTRARY IS UNLAWFUL.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS(1) COMPANY(2)
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share...................................... $17.00 $1.02 $15.98
Total(3)....................................... $59,500,000 $3,570,000 $55,930,000
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
</TABLE>
(1) See "Underwriting" for information relating to indemnification of the
Underwriters.
(2) Before deducting expenses payable by the Company estimated to be $920,000.
(3) The Company has granted the Underwriters an option, exercisable within 30
days of the date hereof, to purchase from the Company up to 525,000
additional shares of Class A Common Stock solely to cover over-allotments,
if any. To the extent that the option is exercised, the Underwriters will
offer the additional shares at the Price to Public shown above. If the
option is exercised in full, the total Price to Public, Underwriting
Discounts and Commissions and Proceeds to Company will be $68,425,000,
$4,105,500 and $64,319,500, respectively. See "Underwriting."
The shares of Class A Common Stock are offered by the Underwriters, subject
to prior sale, when, as and if delivered to and accepted by them, and subject
to the right of the Underwriters to reject any order in whole or part. It is
expected that delivery of the shares of Class A Common Stock will be made
against payment therefor at the offices of Friedman, Billings, Ramsey & Co.,
Inc., Arlington, Virginia, the representative of the several Underwriters (the
"Representative"), or in book entry form through the book entry facilities of
the Depository Trust Company on or about July 31, 1996.
----------------
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
The date of this Prospectus is July 25, 1996.
<PAGE>
FIRST ALLIANCE CORPORATION
RETAIL BRANCH OFFICE LOCATIONS
[UNITED STATES MAP SHOWING BRANCH OFFICE LOCATIONS]
Irvine, CA; Long Beach, CA; Oakland, CA; Encino, CA; West Covina, CA; San
Jose, CA; Atlanta, GA; Bellevue, WA; Denver, CO; Oakbrook Terrace, IL;
Arlington Heights, IL; Miami, FL; Ft. Lauderdale, FL; Portland, OR; Beachwood,
OH; Phoenix, AZ; Salt Lake City, UT; Wayne, PA; Little Falls, NJ
----------------
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE OVER THE
COUNTER MARKET, OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
----------------
2
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN
THIS PROSPECTUS. EXCEPT AS OTHERWISE SPECIFIED, ALL INFORMATION IN THIS
PROSPECTUS ASSUMES NO EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION. SEE
"UNDERWRITING". CERTAIN CAPITALIZED FINANCIAL TERMS USED HEREIN ARE DEFINED IN
THE FINANCIAL GLOSSARY ON PAGE 67. THIS PROSPECTUS GIVES EFFECT TO THE
REORGANIZATION OF THE COMPANY, PURSUANT TO WHICH, IMMEDIATELY PRIOR TO THE
CLOSING OF THE PUBLIC OFFERING, FIRST ALLIANCE MORTGAGE COMPANY, A CALIFORNIA
CORPORATION ("FAMCO"), WILL BECOME A WHOLLY-OWNED SUBSIDIARY OF A NEWLY-FORMED
DELAWARE CORPORATION, FIRST ALLIANCE CORPORATION (THE "COMPANY"). ALL
REFERENCES TO THE COMPANY SHALL BE DEEMED TO INCLUDE THE COMPANY AND ITS
SUBSIDIARIES.
The Company originates, purchases, sells and services non-conventional
mortgage loans secured primarily by first mortgages on single family
residences. The Company focuses on a distinct segment of the home equity
lending market by narrowly targeting its marketing efforts at homeowners
believed by management of the Company, based on historic customer profiles, to
be pre-disposed to using the Company's products and services while satisfying
its underwriting guidelines. The Company originates loans through its
centralized telemarketing operations, its direct mailing campaigns and its
expanding retail branch network of 19 offices located in 12 states. Since
January 1, 1996, the Company has opened 3 new retail branch offices in
Pennsylvania, Ohio and New Jersey. The Company intends to continue to expand
its retail branch network in selected states on a nationwide basis and
currently plans to open at least four new retail branches per year. The Company
has also recently organized a subsidiary to pursue retail and wholesale loan
originations and purchases in the United Kingdom. The Company also purchases
loans from other originators.
The Company's customers, who principally use the loans from the Company to
consolidate indebtedness or to finance other consumer needs rather than to
purchase homes, consist of two primary groups. The first category of the
Company's customers are individuals who are unable to obtain mortgage financing
from banks, savings and loan institutions and other companies that have
historically provided loans to individuals with favorable credit
characteristics ("Conventional Lending Institutions"). These individuals often
have impaired or unsubstantiated credit characteristics and/or unverifiable
income and respond favorably to the Company's marketing. The Company's second
category of customers consists of individuals who could qualify for loans from
Conventional Lending Institutions but instead choose to use the Company's
products and services. See "Business--Underwriting." The Company's experience
has shown that these individuals are attracted by the Company's high degree of
personalized service and timely response to loan applications. Each category of
customers has historically been willing to pay the Company's loan origination
fees and interest rates that are typically higher than the fees and rates
charged by Conventional Lending Institutions.
The Company has historically generated positive cash flow due principally to
the magnitude of its retail loan origination fees. For the quarter ended March
31, 1996 and the years ended December 31, 1995, 1994 and 1993, the Company's
weighted average retail loan origination and processing fees as a percentage of
gross loans originated in the retail branches were 14.8%, 15.3%, 15.6% and
17.8%, respectively. The loan origination fee charged to the borrower is
included in the principal balance of the loan originated. The Company then
borrows approximately the principal amount of the loan (subject to collateral
valuation) under its Warehouse Financing Facility and disburses to the borrower
the loan amount less the loan origination fee. Thus, the Company generally
receives cash in the amount of the loan origination and processing fee at the
time of the Warehouse Financing Facility borrowing and prior to the time the
Company recognizes such fee for accounting purposes as a component of loan
origination and sale revenue, which occurs upon the sale of the loan.
The Company's ability to fund and subsequently Securitize loans has
significantly improved its financial performance and enabled it to offer new
and enhanced loan products. The Company's significant expansion of its retail
branch network and the ability to Securitize its loans have contributed
significantly to the increase in the Company's loan origination volume to
$216.6 million in 1995 from $93.6 million in 1992. Since 1992, the Company has
Securitized $826.8 million of loans through ten public and two private
"AAA/Aaa" rated Securitizations. While the Company anticipates Securitizing a
majority of its loan originations in 1996 and thereafter, the Company will
continue to sell those loans which are originated through its proprietary
marketing system that do not satisfy the Company's criteria for Securitization.
Such loans are sold on a servicing released basis to unaffiliated wholesale
purchasers on either a bulk or flow-through basis. These wholesale loan sales
enable the Company to realize a return on all loans generated by its marketing
efforts by retaining loan origination fees without the associated credit risk.
Additionally, the Company continues to sell a small number of loans to private
investors and service the loans that it has previously sold through
Securitizations as well as those to private investors. As of March 31, 1996,
the Servicing Portfolio consisted of 8,787 loans with an outstanding balance of
$611.7 million.
3
<PAGE>
THE PUBLIC OFFERING
<TABLE>
<C> <S>
Class A Common Stock offered by the Company: 3,500,000 shares
Capital Stock to be Outstanding after the Public Offering:
Class A Common Stock....................... 3,500,000 shares(1)
Class B Common Stock....................... 10,750,000 shares(2)
------------
Total.................................... 14,250,000 shares
------------
------------
Voting Rights............................... Each share of Class A Common
Stock is entitled to one vote and
each share of Class B Common
Stock is entitled to four votes
on most matters requiring a
shareholder vote. See
"Description of Capital Stock-
Common Stock."
Use of Proceeds............................. The Company intends to use
between $42 million and $47
million of the net proceeds to
repay, immediately after the
Closing Date (or as soon
thereafter as is practicable),
the principal and interest
outstanding under the
S Distribution Notes. See "Prior
S Corporation Status." To the
extent that the balance of the
net proceeds exceeds the amount
due under the S Distribution
Notes, such excess will be used
initially to repay any
outstanding borrowings on the
Company's Warehouse Financing
Facility, then to fund costs
associated with the Company's
retail branch network and United
Kingdom expansions and for
general corporate purposes. See
"Use of Proceeds."
Nasdaq National Market Symbol for the
Class A Common Stock....................... FACO
Risk Factors................................ See "Risk Factors" for a
discussion of certain material
factors that should be considered
in connection with an investment
in the Class A Common Stock
offered hereby.
</TABLE>
- --------
(1) Excludes 750,000 shares of Class A Common Stock reserved for issuance upon
the exercise of options available for grants under the Company's Stock
Incentive Plan. See "Management-1996 Stock Incentive Plan" and "Description
of Capital Stock."
(2) Class B Common Stock is convertible into Class A Common Stock on a one for
one basis at the option of the holder and in certain other circumstances.
See "Description of Capital Stock."
4
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
The financial data set forth below should be read in conjunction with the
Financial Statements of the Company and related notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere herein.
<TABLE>
<CAPTION>
QUARTERS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------- ------------------
1993 1994 1995 1995(5) 1996
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Revenue:
Loan origination and sale.... $ 22,489 $ 27,902 $ 35,493 $ 1,086 $ 9,371
Loan servicing and other
fees........................ 8,989 9,106 8,543 1,977 2,243
Interest..................... 4,452 8,650 14,668 2,871 3,158
Other........................ 20 144 176 29 38
-------- -------- -------- -------- --------
Total revenue............... 35,950 45,802 58,880 5,963 14,810
Total expense................ 24,987 30,568 27,860 6,263 6,950
-------- -------- -------- -------- --------
Income (loss) before income
tax provision (benefit)..... 10,963 15,234 31,020 (300) 7,860
Income tax provision
(benefit)................... 222 363 478 (5) 118
-------- -------- -------- -------- --------
Net income (loss)............ $ 10,741 $ 14,871 $ 30,542 $ (295) $ 7,742
======== ======== ======== ======== ========
Dividends declared(1)........ $ 5,853 $ 17,341 $ 12,205 $ 2,874 $ 15,101
PRO FORMA INCOME STATEMENT
DATA(2):
Income (loss) before income
tax provision (benefit)..... $ 10,963 $ 15,234 $ 31,020 $ (300) $ 7,860
Income tax provision
(benefit)................... 4,403 6,200 12,772 (123) 3,233
-------- -------- -------- -------- --------
Net income (loss)............ $ 6,560 $ 9,034 $ 18,248 $ (177) $ 4,627
======== ======== ======== ======== ========
LOANS ORIGINATED OR
PURCHASED(6):
Retail Branch Originations... $148,718 $151,338 $200,371 $ 32,298 $ 56,693
Portfolio Refinancing
Originations................ 47,189 70,501 16,195 9,045 5,586
Wholesale purchases.......... 84,034 91,826 24,078 10,602 13,455
-------- -------- -------- -------- --------
Total....................... $279,941 $313,665 $240,644 $ 51,945 $ 75,734
======== ======== ======== ======== ========
LOANS SOLD(6):
Securitizations.............. $141,795 $350,331 $167,974 $ -- $ 52,420
Wholesale.................... -- -- 51,542 3,528 21,536
Private...................... 70,554 22,857 13,709 4,032 438
-------- -------- -------- -------- --------
Total....................... $212,349 $373,188 $233,225 $ 7,560 $ 74,394
======== ======== ======== ======== ========
SERVICING PORTFOLIO(3):
Private investor loans....... $150,657 $ 87,659 $ 65,404 $ 78,422 $ 61,431
Securitized loans(7)......... 234,913 468,026 548,387 497,560 550,287
-------- -------- -------- -------- --------
Total....................... $385,570 $555,685 $613,791 $575,982 $611,718
======== ======== ======== ======== ========
FINANCIAL RATIOS AND OTHER
DATA:
Number of retail branch
offices(3).................. 11 13 17 14 18
Weighted average interest
rate on loan originations
and purchases............... 9.5% 8.7% 10.3% 10.8% 9.2%
Weighted average initial
combined loan-to-value
ratio:
Retail Branch and Portfolio
Refinancing Originations... 52.4% 54.4% 58.6% 55.4% 60.4%
Wholesale purchases......... 61.6% 60.5% 66.5% 64.0% 70.4%
Average retail loan size..... $ 53.6 $ 66.1 $ 68.8 $ 58.3 $ 80.5
Weighted average loan
origination and processing
fees as a percent of gross
loans originated as
applicable:
Retail Branch Originations.. 17.8% 15.6% 15.3% 16.1% 14.8%
Portfolio Refinancing
Originations:.............. 2.5% 7.5% 13.0% 13.3% 5.6%
Total delinquencies as a
percentage of Servicing
Portfolio at end of period . 4.0% 4.3% 5.8% 4.7% 6.3%
Real estate acquired through
foreclosure ("REO") as a
percentage of Servicing
Portfolio at end of
period(4)................... .9% .6% 1.3% .7% 1.4%
REO losses as a percentage of
average Servicing Portfolio
during the period(4)........ .02% .01% .03% -- .08%
Pre-tax income (loss) as a
percentage of total revenue. 30.5% 33.3% 52.7% (5.0)% 53.1%
</TABLE>
5
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA (CONTINUED)
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF MARCH 31,
----------------------- ---------------
1993 1994 1995 1995(5) 1996
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.............. $ 4,387 $ 5,298 $ 4,019 $ 1,809 $ 2,206
Loans held for sale(5)................. 74,196 18,676 24,744 58,631 26,325
Residual Interests..................... 6,879 11,645 19,705 12,283 20,732
Total assets........................... 99,855 48,226 66,987 86,792 71,355
Total borrowings(5).................... 68,773 14,839 19,356 59,733 22,038
Stockholders' equity................... 26,454 23,984 42,321 20,815 34,962
</TABLE>
- --------
(1) Historical dividends are not necessarily indicative of dividends expected
to be declared in the future. See "Dividend Policy."
(2) Amounts reflect adjustments for Federal and state income taxes as if the
Company had been taxed as a C corporation rather than as an S corporation.
(3)As of the end of the applicable period.
(4) Includes REO of the Company as well as REO of the REMIC Trusts and serviced
by the Company; however, excludes private investor REO not serviced by the
Company.
(5) The Company did not close a Securitization during the quarter ended March
31, 1995. As such, Loan origination and sale revenue for the quarter is
significantly lower and the balance of Loans held for sale and total
borrowings are significantly higher than if a Securitization were closed
within the quarter.
(6) Principal balance of loans.
(7) Includes Loans held for sale and loans receivable held for investment of
the Company.
6
<PAGE>
RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING
FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING AN INVESTMENT IN THE
SHARES OF CLASS A COMMON STOCK OFFERED BY THIS PROSPECTUS.
DECLINE OF COLLATERAL VALUE MAY ADVERSELY AFFECT LOAN-TO-VALUE RATIOS
The Company's business may be adversely affected by declining real estate
values. Any material decline in real estate values reduces the ability of
borrowers to use home equity to support borrowings and 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. Further, delinquencies, foreclosures and losses generally
increase during economic slowdowns or recessions. Because of the Company's
focus on borrowers who are unable to obtain mortgage financing from
conventional mortgage sources, the actual rates of delinquencies, foreclosures
and losses on such loans could be higher under adverse economic conditions
than those currently experienced in the mortgage lending industry in general.
Any sustained period of such increased delinquencies, foreclosures or losses
could adversely affect the Company's results of operations and financial
condition.
CREDIT IMPAIRED BORROWERS MAY RESULT IN INCREASED DELINQUENCY RATES
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. As of March
31, 1996 and December 31, 1995, total delinquent loans as a percentage of the
Company's Servicing Portfolio were 6.3% and 5.8%, respectively, as compared to
4.2% and 4.5% for the portfolios of the mortgage banking industry as a whole
according to the Mortgage Bankers Association. While the Company employs
underwriting criteria and collection methods to mitigate the higher risks
inherent in loans made to these borrowers, no assurance can be given that such
criteria or methods will afford adequate protection against such risks. In the
event that pools of loans sold and serviced by the Company experience higher
delinquencies, foreclosures or losses than anticipated, the Company's results
of operations or financial condition could be adversely affected.
IMPACT OF REGULATION AND LEGISLATION
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, regulations and judicial and administrative decisions
imposing requirements and restrictions on part or all of its operations. The
Company's consumer lending activities are subject to the Truth-in-Lending Act
(including the Home Ownership and Equity Protection Act of 1994), the Fair
Housing Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act,
the Real Estate Settlement Procedures Act ("RESPA"), the Home Mortgage
Disclosure Act and the Fair Debt Collection Practices Act and regulations
promulgated thereunder, as well as other Federal and state statutes and
regulations affecting the Company's activities. The Company is also subject to
the rules and regulations of, and examinations by, state regulatory
authorities with respect to originating, processing, underwriting, selling,
Securitizing and servicing loans. These rules and regulations, among other
things, (i) impose licensing obligations on the Company, (ii) establish
eligibility criteria for mortgage loans, (iii) prohibit discrimination, (iv)
provide for inspections and appraisals of properties, (v) require credit
reports on loan applicants, (vi) regulate assessment, collection, foreclosure
and claims handling, investment and interest payments on escrow balances and
payment features, (vii) mandate certain disclosures and notices to borrowers
and (viii) in some cases, fix maximum interest rates, fees and mortgage loan
amounts. Failure to comply with these requirements can lead to termination or
suspension of the Company's servicing rights without compensation to the
Company, demands for indemnifications or mortgage loan repurchases, certain
rights of rescission for mortgage loans, class action lawsuits and
administrative enforcement actions.
Recent Federal legislation, the Riegle Community Development and Regulatory
Improvement Act (the "Riegle Act"), has focused additional regulation on
mortgage loans having relatively higher origination fees
7
<PAGE>
and interest rates, such as those made by the Company, and the Company expects
its business to be the focus of additional Federal and state legislation,
regulation and possible enforcement in the future.
The Company's placement of insurance covering improvements on real property
that secures the Company's loan to a borrower is subject to state and federal
statutes and regulations applicable to "force placed" insurance. The Company
receives a fee in connection with its placement of such insurance in
California, which activity is not required to be licensed. Historically the
Company also received a fee in connection with the placement of such insurance
outside California. While the Company does not believe, based on the advice of
regulatory counsel, that it was required to be licensed in connection with
such activity, a state insurance regulator or a court could take a different
interpretation. The rules and regulations governing force placed insurance
impose certain disclosure and notice requirements on the Company prior to
effecting such insurance coverage, impose limitations on the Company's ability
to accept or reject insurance coverage offered by a borrower and impose
restrictions on the fees and costs which the Company may charge the borrower
with respect to such insurance. The Company's sale of credit life insurance
and credit disability insurance in the state of California is subject to
statutes and regulations in that state applicable to insurance producers.
Failure to comply with any of the foregoing state and federal requirements
could lead to imposition of civil penalties on the Company, class action
lawsuits and administrative enforcement actions.
The laws and regulations described above are subject to legislative,
administrative and judicial interpretation, and certain of these laws and
regulations have been infrequently interpreted or only recently enacted.
Infrequent interpretations of these laws and regulations or an insignificant
number of interpretations of recently enacted regulations can result in
ambiguity with respect to permitted conduct under these laws and regulations.
Any ambiguity under the regulations to which the Company is subject may lead
to regulatory investigations or enforcement actions and private causes of
action, such as class action lawsuits, with respect to the Company's
compliance with the applicable laws and regulations. As a mortgage lender, the
Company has been, and expects to continue to be, subject to regulatory
enforcement actions and private causes of action from time to time with
respect to its compliance with applicable laws and regulations.
Although the Company utilizes systems and procedures to facilitate
compliance with these legal requirements and believes that it is in compliance
in all material respects with applicable Federal, state and local laws, rules
and regulations, there can be no assurance that more restrictive laws, rules
and regulations will not be adopted in the future, or that existing laws and
regulations will not be interpreted in a more restrictive manner, that could
make compliance more difficult or expensive. See "Business--Regulation."
ELIMINATION OF DEDUCTIBILITY OF MORTGAGE INTEREST COULD ADVERSELY AFFECT
RESULTS OF OPERATIONS
Members of Congress, government officials and political candidates 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 loans of the kind offered by the Company.
RISK OF LITIGATION
In the ordinary course of its business, the Company is subject to claims
made against it by borrowers and investors who have purchased loans from the
Company arising from, among other things, losses that are claimed to have been
incurred as a result of alleged breaches of fiduciary obligations,
misrepresentations, errors and omissions of employees, officers and agents of
the Company (including its appraisers), incomplete documentation and failures
by the Company to comply with various laws and regulations applicable to its
business. The Company believes that liability with respect to any currently
asserted claims or legal actions is not likely to be material to the Company's
consolidated results of operations or financial condition; however, any
8
<PAGE>
claims asserted in the future may result in legal expenses or liabilities that
could have a material adverse effect on the Company's results of operations
and financial condition and could distract members of management from the
operations of the Company.
FLUCTUATIONS IN INTEREST RATES MAY ADVERSELY AFFECT PROFITABILITY
The profitability of the Company is likely to be adversely affected during
any period of rapid changes in interest rates. A substantial and sustained
increase in interest rates could adversely affect the spread between the rate
of interest received by the Company on its loans and the interest rates
payable under the Warehouse Financing Facility during the Warehousing Period
or the pass-through rate for Regular Interests issued in Securitizations. Such
rate increases could also affect the ability of the Company to originate and
purchase loans. A significant decline in interest rates could decrease the
size of the Company's Servicing Portfolio by increasing the level of loan
prepayments.
An effective hedging strategy is complex and no hedging strategy can
completely insulate the Company from interest rate risks. The nature and
timing of hedging transactions may impact the effectiveness of hedging
strategies. Poorly designed strategies or improperly executed transactions may
increase rather than mitigate risk. In addition, hedging involves transaction
and other costs, and such costs could increase as the period covered by the
hedging protection increases or in periods of rising and fluctuating interest
rates. Therefore, the Company may be prevented from effectively hedging its
interest rate risks, which could have a material adverse effect on the
Company's results of operations and financial condition. See "Business--
Financing and Sale of Loans--Interest Rate Risk Management."
DEPENDENCE ON SECURITIZATIONS AND IMPACT ON QUARTERLY OPERATING RESULTS
Gain on sale of loans generated by the Company's Securitizations represents
a significant portion of the Company's revenues and net income. Furthermore,
the Company relies significantly on Securitizations to generate cash proceeds
for repayment of its Warehouse Financing Facility and enable the Company to
originate and purchase additional loans. Several factors affect the Company's
ability to complete Securitizations, including conditions in the securities
markets generally, conditions in the Asset-Backed Securities markets
specifically, the credit quality of the Company's Servicing Portfolio and the
Company's ability to obtain credit enhancement. Any substantial reductions in
the size or availability of the Securitization market for the Company's loans
could have a material adverse effect on the Company's results of operations
and financial condition.
The Company's revenues and net income have fluctuated in the past and are
expected to fluctuate in the future principally as a result of the timing and
size of its Securitizations. 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 cost of funds and the average
interest rates of originated or purchased loans, the effectiveness of the
Company's hedging strategies, the pass-through rate for Regular Interests
issued in Securitizations, and the timing and size of Securitizations can
result in significant increases or decreases in the Company's revenues from
quarter to quarter. A delay in closing a Securitization during a particular
quarter would postpone recognition of gain on sale of loans. In addition,
unanticipated delays in closing a Securitization could also increase the
Company's exposure to interest rate fluctuations by increasing the Warehousing
Period for its loans. If the Company were unable to profitably Securitize a
sufficient number of its loans in a particular reporting period, the Company's
revenues for such period would decline and would result in lower net income
and possibly a net loss for such period, and could have a material adverse
effect on the Company's results of operations and financial condition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
LOSS OF HISTORICAL LOAN ORIGINATION FEES COULD ADVERSELY AFFECT RESULTS OF
OPERATIONS
The Company has historically generated positive cash flow due, in large
part, to its customary loan origination fees. Net loan origination fees
constituted 52.3%, 43.1%, 61.9% and 51.6% of the Company's total
9
<PAGE>
revenues for the first quarter of 1996 and for the years 1995, 1994 and 1993,
respectively. Weighted average loan origination and processing fees as a
percentage of gross loans originated in the retail branches for those periods
were 14.8%, 15.3%, 15.6% and 17.8%, respectively. Any reduction in the amount
of the Company's loan origination fees, whether by reason of regulation,
competition or otherwise, will negatively impact the Company's cash flow and
could have a material adverse effect on the Company's results of operations
and financial condition. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
LOSS OF FUNDING SOURCES COULD ADVERSELY AFFECT RESULTS OF OPERATIONS
The Company funds substantially all of the loans which it originates or
purchases through borrowings under the Warehouse Financing Facility and
internally generated funds. These borrowings are in turn repaid with the
proceeds received by the Company from selling such loans through loan sales or
Securitizations. Any failure to renew or obtain adequate funding under the
Warehouse Financing Facility, 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 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 or sell loans earlier than is optimal, 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
and Results of Operations--Liquidity and Capital Resources."
IMPAIRMENT OF VALUE OF RESIDUAL INTERESTS AND MORTGAGE SERVICING RIGHTS
The Company records gains on sale of loans through Securitization based in
part on the fair value of the Residual Interests received in the REMIC Trust
by the Company and on the fair value of retained mortgage servicing rights
related to such loans. The fair values of such Residual Interests and retained
mortgage servicing rights are in turn based in part on market interest rates
and projected loan prepayment and credit loss rates. Increases in interest
rates or higher than anticipated rates of loan prepayments or credit losses of
these or similar securities may require the Company to write down the value of
such Residual Interests and mortgage servicing rights and result in a material
adverse impact on the Company's results of operations and financial condition.
The Company is not aware of an active market for the Residual Interests. No
assurance can be given that the Residual Interests could in fact be sold at
their carrying value, if at all. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Certain Accounting
Considerations."
LOSS OF CREDIT ENHANCEMENT COULD RESULT IN INCREASED INTEREST COSTS
In order to gain access on favorable terms to the public Securitization
market, the Company has relied on credit enhancement to achieve a "AAA/Aaa"
rating for the Regular Interests in its Securitizations. The credit
enhancement has generally been in the form of an insurance policy issued by
the Certificate Insurer insuring the repayment of Regular Interests in each of
the REMIC Trusts sponsored by the Company. The Certificate Insurer is not
required to insure future Securitizations nor is the Company restricted in its
ability to obtain credit enhancement from providers other than the Certificate
Insurer or to use other forms of credit enhancement. There can be no assurance
that the Company will be able to obtain credit enhancement in any form from
the Certificate Insurer or any other provider of credit enhancement on
acceptable terms or that future Securitizations will be similarly rated. A
downgrading of Regular Interests already outstanding or the Certificate
Insurer's credit rating or its withdrawal of credit enhancement could result
in higher interest costs for future Securitizations. Such events could have a
material adverse effect on the Company's results of operations and financial
condition.
STRONG OR INCREASED COMPETITION COULD ADVERSELY AFFECT RESULTS OF OPERATIONS
Competition in the mortgage financing business is intense. The mortgage
financing market is highly fragmented and has been serviced by mortgage
brokers, mortgage banking companies, commercial banks, credit unions, thrift
institutions, and finance companies. Many of these competitors have greater
financial resources and
10
<PAGE>
may have significantly lower costs of funds than the Company. Even after the
Company has made a loan to a borrower, the Company's competitors may seek to
refinance the Company's loan in order to take additional cash out of the
property or reduce payments. Furthermore, the profitability of the Company and
other similar lenders is attracting additional competitors into this market,
with the possible effect of reducing the Company's ability to charge its
customary origination fees and interest rates. In addition, as the Company
expands into new geographic markets, it will face competition from lenders
with established positions in these locations. There can be no assurance that
the Company will be able to continue to compete successfully in the markets it
serves. Such an event could have a material adverse effect on the Company's
results of operations and financial condition. See "Business--Competition."
CONCENTRATION OF OPERATIONS IN CALIFORNIA
Approximately 85.8% of the dollar volume of the Servicing Portfolio at, and
approximately 43.0% of the dollar volume of loans originated or purchased by
the Company during the year ended, December 31, 1995 were secured by
properties located in California. Although the Company is expanding its retail
branch network outside California, the Company's Servicing Portfolio and loan
originations and purchases are likely to remain concentrated in California for
the foreseeable future. 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 has
experienced a slowdown or recession over the last several 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,
together with any primary financing on the mortgaged properties, will equal or
exceed the value of the mortgaged properties. 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. 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 is dependent upon its ability to increase its
loan origination volume through the growth of its retail branch network while
maintaining its customary origination fees, interest rate spreads and
underwriting criteria with respect to such increased loan origination and
purchase volume. Implementation of this strategy, which includes nationwide
and international geographic expansion, will depend in large part on the
Company's ability to: (i) expand its retail branch network in markets with a
sufficient concentration of borrowers meeting the Company's underwriting
criteria; (ii) obtain adequate financing on favorable terms to fund its growth
strategy; (iii) profitably Securitize its loans in the secondary market on a
regular basis; (iv) hire, train and retain skilled employees; and (v) continue
to expand in the face of increasing competition from other mortgage lenders.
The Company's failure with respect to any or all of these factors could impair
its ability to successfully implement its growth strategy which could have a
material adverse effect on the Company's results of operations and financial
condition. See "Business--Current Markets and Expansion Plans."
LOAN DELINQUENCIES AND DEFAULTS MAY REDUCE VALUE OF RESIDUAL INTERESTS
After a loan has been originated or purchased by the Company, the loan is
held as part of the Servicing Portfolio and is subject to sale or
Securitization. During the period a loan is so held, the Company is at risk
for loan delinquencies and defaults. Following the sale of the loan on a
servicing released basis, the Company's loan delinquency and default risk with
respect to such loan is limited to those circumstances in which it is required
to repurchase such loan due to a breach of a representation or warranty in
connection with the loan sale. On Securitized loans, the Company also has this
risk of loan delinquency or default to the extent that losses are paid out of
reserve accounts or by reducing the over-collateralization to the extent that
funds are available. Such
11
<PAGE>
losses may result in a reduction in the value of the Residual Interests held
by the Company and could have a material adverse effect on the Company's
results of operations and financial condition. See "Business--Loans--Loan
Sales."
TERMINATION OF SERVICING RIGHTS MAY ADVERSELY AFFECT RESULTS OF OPERATIONS
At March 31, 1996, approximately 84.8% of the dollar volume of the Company's
Servicing Portfolio consisted of loans Securitized by the Company and sold to
REMIC Trusts. The Company's form of pooling and servicing agreement for each
of these REMIC Trusts provides that the Certificate Insurer insuring the
senior interests in the related REMIC Trust may terminate the Company's
servicing rights under particular circumstances. With respect to six of the
Company's Securitizations (with loan balances of $280.5 million at March 31,
1996), the Certificate Insurer may terminate the servicing rights of the
Company if, among other things, the number of loans in the REMIC Trust that
are delinquent 91 days or more (including foreclosures and REO properties)
exceeds 10.0% of the total number of loans in the REMIC Trust for four
consecutive months.
With respect to the Company's five most recent Securitizations, the
Certificate Insurer may terminate the servicing rights of the Company if,
among other things, (i) the three month average of the quotient of the
principal balance of all loans that are delinquent 91 days or more (including
foreclosures and REO properties) divided by the pool principal balance for the
related period exceeds 7.0%; (ii) the annual cumulative realized losses for
any year exceed 2.0% of the average pool principal balance for the same year;
or (iii) with respect to the two transactions completed in 1995, if within the
first five years of the REMIC Trust, the cumulative losses exceed 5.75% of the
original principal balance of the REMIC Trust or if cumulative losses after
year five exceed 8.63% of the original principal balance of the REMIC Trust.
The Company's two most recent Securitizations include language that modifies
the cumulative loss figures to 6.63% within the first five years and 9.94%
after year five.
At March 31, 1996, none of the REMIC Trusts exceeded the foregoing
delinquency or loss calculations. There can be no assurance that delinquency
and loss rates with respect to the Company's Securitized loans will not exceed
these rates in the future or, if exceeded, that the servicing rights would not
be terminated. Any termination of servicing rights could have a material
adverse effect on the Company's results of operations and financial condition.
See "Business--Loan Servicing."
ANTI-TAKEOVER EFFECT OF CAPITAL STRUCTURE; VOTING CONTROL OF COMPANY
The Company has two classes of authorized Common Stock, Class A Common
Stock, which is offered hereby, and Class B Common Stock. While the holder of
each share of Class A Common Stock is entitled to one vote per share, the
holder of each share of Class B Common Stock is entitled to four votes per
share. The Class A Common Stock and the Class B Common Stock generally vote
together as a single class. Brian Chisick and his wife, Sarah Chisick, and the
grantor trusts for which they have the beneficial voting interests
(collectively, the "Chisick Family") are the beneficial owners of
substantially all of the outstanding Class B Common Stock. As a result, upon
completion of the Public Offering (assuming the Underwriters' over-allotment
option is not exercised), the Chisick Family will hold approximately 91.5% of
the aggregate voting power of the Company, which will allow it to control all
actions to be taken by the stockholders, including the election of all
directors to the Board of Directors. The Board of Directors is expected to be
comprised entirely of designees of the Chisick Family. This voting control may
have the effect of discouraging offers to acquire the Company because the
consummation of any such acquisition would require the consent of the Chisick
Family. In addition, the Board of Directors is authorized to issue shares of
preferred stock from time to time with such rights and preferences as the
Board may determine; such preferred stock could be issued in the future with
terms and conditions that could further discourage offers to acquire the
Company. See "Principal Stockholders" and "Description of Capital Stock."
12
<PAGE>
ANTI-TAKEOVER EFFECT OF DELAWARE LAW
The Company is a Delaware corporation and is subject to the anti-takeover
provisions of Section 203 of the Delaware General Corporation Law. In general,
Section 203 prevents an "interested stockholder" (defined generally as a
person owning 15% or more of the Company's outstanding voting stock) from
engaging in a "business combination" with the Company for three years
following the date that person became an interested stockholder unless the
business combination is approved in a prescribed manner. This statute could
make it more difficult for a third party to acquire control of the Company.
See "Description of Capital Stock--Certain Provisions of Delaware Law."
DEPENDENCE ON KEY PERSONNEL
The Company's growth and development to date have been largely dependent
upon the services of Brian Chisick, Chief Executive Officer and President of
the Company. Although the Company has been able to hire and retain other
qualified and experienced management personnel, the loss of Brian Chisick's
services for any reason could have a material adverse effect on the Company.
The Company has entered into an employment agreement with Brian Chisick. The
Company does not carry "key man" life insurance on the life of Brian Chisick.
See "Management--Executive Compensation--Employment Agreements."
ENVIRONMENTAL LIABILITIES
In the course of its business, the Company has acquired, and may acquire in
the future, properties securing loans that are in default. There is a risk
that hazardous substances or waste, contaminants, 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.
NO PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE
Prior to the Public Offering, there has been no public market for the Class
A Common Stock. There can be no assurance that an active trading market will
develop or that the purchasers of the Class A Common Stock will be able to
resell their Class A Common Stock at prices equal to or greater than the
Public Offering price. The Public Offering price of the Class A Common Stock
was determined through negotiations between the Company and the Representative
of the Underwriters and may not reflect the market price of the Class A Common
Stock after the Public Offering. See "Underwriting" for a discussion of
factors considered in determining the Public Offering price. The trading price
of the Class A Common Stock could be subject to wide fluctuations in response
to quarterly variations in changes in financial estimates by securities
analysts and other events or facts. These broad market fluctuations may
adversely affect the market price of the Class A Common Stock. See
"Underwriting."
RESTRICTIONS ON FUTURE SALES BY STOCKHOLDERS; EFFECT ON SHARE PRICE OF SHARES
AVAILABLE FOR FUTURE SALE
Shares of Class B Common Stock are not being offered hereby. The Chisick
Family is the record and beneficial holder of substantially all of the
outstanding shares of Class B Common Stock and will be subject to certain
lock-up restrictions with respect to its ability to sell or otherwise dispose
of any of its shares of Class B Common Stock (which shares, upon transfer by
the Chisick Family to unrelated parties, convert to Class A Common Stock)
without the prior written consent of the Representative. When such lock-up
restrictions lapse (180 days after the date of this Prospectus), such shares
of Class B Common Stock may be sold in the public market or otherwise disposed
of, subject to compliance with applicable securities laws. The Company's
Certificate of Incorporation authorizes the issuance of 25,000,000 shares of
Class A Common Stock and
13
<PAGE>
15,000,000 shares of Class B Common Stock. Upon completion of the Public
Offering, there will be outstanding 3,500,000 shares of Class A Common Stock
and 10,750,000 shares of Class B Common Stock (assuming no exercise of the
Underwriters' over-allotment option). Sales of a substantial number of shares
of Class B Common Stock, or the perception that such sales could occur, could
adversely affect prevailing market prices for the Class A Common Stock. See
"Shares Eligible for Future Sale."
DILUTION
Purchasers of the Class A Common Stock will experience immediate and
substantial dilution in net tangible book value per share of Class A Common
Stock of $12.82 per share based upon the Public Offering price of $17.00 per
share. See "Dilution."
NO CASH DIVIDENDS
Following the Public Offering, the Company intends to retain its earnings, if
any, for use in its business and does not anticipate declaring or paying any
cash dividends in the foreseeable future. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Liquidity and Capital
Resources" and "Dividend Policy."
14
<PAGE>
THE COMPANY
FAMCO was founded in 1971 and was incorporated in California in 1975.
Immediately prior to the consummation of the Public Offering, FAMCO will
become a wholly-owned subsidiary of the Company (the "Reorganization"). The
Company has been actively involved in the mortgage lending business since its
founding. The Company is owned by the Chisick Family and Mark K. Mason.
Approximately 186 of the Company's 322 employees are located at the corporate
headquarters. The balance of the employees work in 19 retail branch offices,
six of which are located in California, two of which are located in each of
Illinois and Florida and one of which is located in each of Oregon,
Washington, Colorado, Utah, Arizona, Georgia, New Jersey, Pennsylvania and
Ohio.
The Company maintains its principal office at 17305 Von Karman Avenue,
Irvine, California 92714-6203. Its telephone number is (714) 224-8500.
PRIOR S CORPORATION STATUS
Since May 1, 1988, the Company has elected to be treated for Federal income
and certain state tax purposes as an S corporation under Subchapter S of the
Internal Revenue Code of 1986, as amended (the "Code"), and comparable state
laws. As a result, earnings of the Company during such period have been
included in the taxable income of the Chisick Family for Federal and state
income tax purposes, and the Company has not been subject to income tax on
such earnings, other than California franchise tax. Prior to the date of the
consummation of the Public Offering (the "Closing Date"), the Chisick Family
expects to revoke the Company's S corporation status. The Company has made
distributions to its shareholders of notes (the "S Corporation Distribution")
which includes all of its previously earned and undistributed S corporation
earnings through the Closing Date (estimated to be between $42.0 million and
$47.0 million prior to considering the S Corporation Distribution). The
S Corporation Distribution was comprised of promissory notes bearing interest
rates ranging from 5.61% to 5.88% per annum (the "S Distribution Notes"). See
"Use of Proceeds." On and after the Closing Date, the Company will no longer
be treated as an S corporation and, accordingly, will be fully subject to
Federal and state income taxes.
The Chisick Family has agreed to reimburse the Company for any increase in
the Company's Federal or state(s) income tax liability for 1996 and future
years that may be triggered as a result of possible Internal Revenue Service
and state taxing authority audit adjustments ("Audit Adjustments") to the
Company's taxable income for the years during which the Company was an S
corporation. Conversely, the Company has agreed to reimburse the Chisick
Family for any decrease in the Company's Federal or state(s) income tax
liability for 1996 and future years that may be triggered as a result of
possible Audit Adjustments to the Company's taxable income for the years
during which the Company was an S corporation. The Company's reimbursement
right is embodied in the Reimbursement Agreement, and the Chisick Family's
reimbursement right is embodied in the S Distribution Notes.
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 3,500,000 shares of
Class A Common Stock offered by the Company hereby are estimated to be
approximately $55.0 million, based on the Public Offering price of $17.00 per
share. The Company intends to use between $42.0 million and $47.0 million of
such net proceeds to repay, immediately after the Closing Date (or as soon
thereafter as is practicable), the principal and interest outstanding under
the S Distribution Notes. The S Distribution Notes bear interest at rates
ranging from 5.61% to 5.88% per annum and have maturity dates ranging from
March 30, 1999 through April 30, 1999. The S Distribution Notes were issued by
the Company to distribute to the shareholders the previously earned and
undistributed S corporation earnings. To the extent that the balance of the
net proceeds exceeds the amount due under the S Distribution Notes, such
excess will be used initially to repay any outstanding borrowings on the
15
<PAGE>
Company's Warehouse Financing Facility, the Company's $125 million secured 90-
day revolving line of credit used to finance loan originations and purchases
which matures on September 30, 1996 and then to fund costs associated with the
Company's retail branch network and United Kingdom expansions and for general
corporate purposes. The annual interest rate currently applicable to borrowing
under the Company's Warehouse Financing Facility is equal to the sum of 0.875%
plus the 30 day London Interbank Offered Rate ("LIBOR"). See "Prior
S Corporation Status."
DIVIDEND POLICY
The Company intends, after payment of the S Distribution Notes, to retain
its earnings, if any, for use in its business and does not anticipate
declaring or paying any cash dividends in the foreseeable future. Purchasers
of shares of Class A Common Stock in the Public Offering will not receive any
portion of the S Distribution Notes. See "Management's Discussion and Analysis
of Financial Condition and Results of Operation-Liquidity and Capital
Resources."
DILUTION
The net tangible book value of the Company's Common Stock (which, for
purposes of this discussion, shall include both the Class A Common Stock and
the Class B Common Stock) as of March 31, 1996 was $35 million or
approximately $2.45 per share. Net tangible book value per share represents
the amount of the Company's stockholders' equity, less intangible assets,
divided by shares of Common Stock outstanding.
Dilution per share to new investors represents the difference between the
amount per share paid by purchasers of shares of Common Stock in the Public
Offering and the pro forma net tangible book value per share of Common Stock
immediately after completion of the Public Offering. Shares used in the
computation of per share amounts below include 10,642,500 shares outstanding
at March 31, 1996, 107,500 shares of restricted stock issued to an officer of
the Company and 3,500,000 shares to be issued in the Offering. See
"Management-- Executive Compensation." After giving effect to the
S Distribution Notes, the establishment of net deferred tax assets upon
conversion to a C Corporation and the sale by the Company of 3,500,000 shares
of Class A Common Stock in the Public Offering and the application of the
estimated net proceeds therefrom, the pro forma net tangible book value of the
Company at March 31, 1996 would have been $59.6 million or $4.18 per share.
This represents an immediate increase in net tangible book value of $3.86 per
share to existing stockholders and an immediate dilution in net tangible book
value of $12.82 per share to purchasers of Class A Common Stock in the Public
Offering, as illustrated in the following table:
<TABLE>
<S> <C> <C>
Initial Public Offering price per share (1)..................... $17.00
Net tangible book value per share as of March 31, 1996........ $ 2.45
Decrease attributable to issuance of S Distribution Notes..... (2.36)
Increase attributable to establishment of net deferred tax
assets....................................................... 0.23
------
Net tangible book value per share before the Public Offering.. 0.32
Increase per share attributable to new investors.............. 3.86
------
Pro forma net tangible book value per share after the Public
Offering (2)................................................... 4.18
------
Dilution per share to new investors............................. $12.82
======
</TABLE>
- --------
(1) Before deducting estimated underwriting discounts and commissions and
estimated expenses of the Public Offering payable by the Company.
(2) Excludes 750,000 shares of Common Stock issuable upon exercise of options
to be granted pursuant to the Stock Incentive Plan. See "Management--1996
Stock Incentive Plan."
16
<PAGE>
The following table summarizes, on a pro forma as adjusted basis as of March
31, 1996, the number of shares of Common Stock purchased from the Company, the
total consideration paid to the Company and the average price per share of
Common Stock paid by the existing stockholders and the new investors in the
Public Offering:
<TABLE>
<CAPTION>
SHARES OWNED AVERAGE
AFTER THE PUBLIC OFFERING TOTAL CONSIDERATION PRICE
------------------------------------------------ PER
NUMBER PERCENT AMOUNT PERCENT SHARE
--------------- ------------------------ ------- -------
<S> <C> <C> <C> <C> <C>
Existing Stockholders... 10,750,000 75.4% $ 2,936,000 4.7% $ 0.27
New Investors........... 3,500,000 24.6 59,500,000 95.3 17.00
--------------- ---------- ----------- -----
Total................. 14,250,000 100.0% $62,436,000 100.0%
=============== ========== =========== =====
</TABLE>
17
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization and Warehouse Financing
Facility of FAMCO at March 31, 1996 and as adjusted as of that date to give
effect to (i) an S corporation distribution of notes with total principal
amounts equal to the FAMCO's previously earned and undistributed S corporation
earnings at March 31, 1996; (ii) $3,237,000 of net deferred tax assets that
would have been recorded had FAMCO's S corporation status been revoked as of
March 31, 1996; and (iii) the grant of 107,500 shares of restricted Class B
Common Stock of the Company to an officer of the Company; and as further
adjusted to reflect (i) the reorganization pursuant to which FAMCO will become
a wholly-owned subsidiary of the Company; (ii) the sale of 3,500,000 shares of
Class A Common Stock by the Company in the Public Offering and the application
of the estimated net proceeds therefrom; and (iii) the vesting of 24.6% of the
restricted Class B Common Stock. See "Prior S Corporation Status," "Use of
Proceeds" and "Management--Executive Compensation." This information below
should be read in conjunction with the Company's audited Financial Statements
and the Notes thereto which are included elsewhere herein. See also "Selected
Consolidated Financial Data," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Description of Capital
Stock."
<TABLE>
<CAPTION>
AT MARCH 31, 1996
-------------------------------
AS FURTHER
ACTUAL AS ADJUSTED ADJUSTED
------- ----------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Warehouse Financing Facility................... $20,015 $20,015 --
------- ------- -------
Long-term debt:
S Distribution Notes......................... -- 33,626 --
Notes payable................................ 1,023 1,023 $ 1,023
------- ------- -------
Total...................................... 1,023 34,649 1,023
------- ------- -------
Stockholders' equity:
Preferred Stock, $.01 par value per share;
1,000,000 shares authorized; no shares
outstanding................................. -- -- --
Common Stock, no par value; 15,000,000 shares
authorized; 10,642,500 shares issued and
outstanding (actual); 10,750,000 shares
issued and outstanding (as adjusted)........ 42 2,936 --
Class A Common Stock, $.01 par value per
share; 25,000,000 shares authorized; no
shares issued and outstanding (actual and as
adjusted); 3,500,000 shares issued and
outstanding (as further adjusted)(1)........ -- -- 35
Class B Common Stock, $.01 par value per
share; 15,000,000 shares authorized; no
shares issued and outstanding (actual and as
adjusted); 10,750,000 shares issued and
outstanding (as further adjusted)........... -- -- 107
Additional paid in capital................... 57,804
Retained earnings(2)......................... 34,920 3,237 2,844
Deferred stock compensation.................. (1,600) (1,207)
------- ------- -------
Total stockholders' equity................. 34,962 4,573 59,583
------- ------- -------
Total capitalization....................... $35,985 $39,222 $60,606
======= ======= =======
</TABLE>
- --------
(1) Does not include 750,000 shares of Class A Common Stock issuable upon
exercise of options available to be granted pursuant to the Stock
Incentive Plan. See "Management--1996 Stock Incentive Plan."
(2) No adjustment has been made to give effect to the Company's previously
earned and undistributed S corporation earnings for the period April 1,
1996 through the Closing Date, which earnings were distributed as part of
the S Corporation Distribution. See "Prior S Corporation Status."
18
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
QUARTERS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------------------------------ -------------------
1991 1992 1993 1994 1995 1995(5) 1996
-------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF INCOME:
Revenue:
Loan origination and
sale................... $ 16,661 $ 20,006 $ 22,489 $ 27,902 $ 35,493 $ 1,086 $ 9,371
Loan servicing and other
fees................... 5,344 7,145 8,989 9,106 8,543 1,977 2,243
Interest................ 2,038 2,285 4,452 8,650 14,668 2,871 3,158
Other................... 116 32 20 144 176 29 38
-------- -------- -------- -------- -------- -------- --------
Total revenue.......... 24,159 29,468 35,950 45,802 58,880 5,963 14,810
Total expense........... 14,885 18,805 24,987 30,568 27,860 6,263 6,950
-------- -------- -------- -------- -------- -------- --------
Income (loss) before
income tax provision
(benefit).............. 9,274 10,663 10,963 15,234 31,020 (300) 7,860
Income tax provision
(benefit).............. 262 268 222 363 478 (5) 118
-------- -------- -------- -------- -------- -------- --------
Net income (loss)....... $ 9,012 $ 10,395 $ 10,741 $ 14,871 $ 30,542 $ (295) $ 7,742
======== ======== ======== ======== ======== ======== ========
Dividends declared(1)... $ 4,991 $ 3,987 $ 5,853 $ 17,341 $ 12,205 $ 2,874 $ 15,101
PRO FORMA INCOME
STATEMENT DATA(2):
Income (loss) before
income tax provision
(benefit).............. $ 9,274 $ 10,663 $ 10,963 $ 15,234 $ 31,020 $ (300) $ 7,860
Income tax provision
(benefit).............. 3,724 4,282 4,403 6,200 12,772 (123) 3,233
-------- -------- -------- -------- -------- -------- --------
Net income (loss)....... $ 5,550 $ 6,381 $ 6,560 $ 9,034 $ 18,248 $ (177) $ 4,627
======== ======== ======== ======== ======== ======== ========
LOANS ORIGINATED OR
PURCHASED(6):
Retail Branch
Originations........... $ 88,249 $ 93,596 $148,718 $151,338 $200,371 $ 32,298 $ 56,693
Portfolio Refinancing
Originations........... -- -- 47,189 70,501 16,195 9,045 5,586
Wholesale purchases..... -- 13,622 84,034 91,826 24,078 10,602 13,455
-------- -------- -------- -------- -------- -------- --------
Total.................. $ 88,249 $107,218 $279,941 $313,665 $240,644 $ 51,945 $ 75,734
======== ======== ======== ======== ======== ======== ========
LOANS SOLD(6):
Securitizations......... $ -- $ 39,024 $141,795 $350,331 $167,974 $ -- $ 52,420
Wholesale............... -- -- -- -- 51,542 3,528 21,536
Private................. 86,217 69,298 70,554 22,857 13,709 4,032 438
-------- -------- -------- -------- -------- -------- --------
Total.................. $ 86,217 $108,322 $212,349 $373,188 $233,225 $ 7,560 $ 74,394
======== ======== ======== ======== ======== ======== ========
SERVICING PORTFOLIO(3):
Private investor loans.. $194,024 $191,497 $150,657 $ 87,659 $ 65,404 $ 78,422 $ 61,431
Securitized loans(7).... 14,988 48,724 234,913 468,026 548,387 497,560 550,287
-------- -------- -------- -------- -------- -------- --------
Total.................. $209,012 $240,221 $385,570 $555,685 $613,791 $575,982 $611,718
======== ======== ======== ======== ======== ======== ========
FINANCIAL RATIOS AND
OTHER DATA:
Number of retail branch
offices(3)............. 10 11 11 13 17 14 18
Weighted average
interest rate on loan
originations and
purchases.............. 14.1% 13.6% 9.5% 8.7% 10.3% 10.8% 9.2%
Weighted average initial
combined loan-to-value
ratio:
Retail Branch and
Portfolio Refinancing
Originations.......... 49.0% 46.6% 52.4% 54.4% 58.6% 55.4% 60.4%
Wholesale purchases.... -- 61.4% 61.6% 60.5% 66.5% 64.0% 70.4%
Average retail loan
size................... $ 35.6 $ 35.9 $ 53.6 $ 66.1 $ 68.8 $ 58.3 $ 80.5
Weighted average loan
origination and
processing fees as a
percent of gross loans
originated as
applicable:
Retail Branch
Originations.......... 21.7% 22.2% 17.8% 15.6% 15.3% 16.1% 14.8%
Portfolio Refinancing
Originations.......... -- -- 2.5% 7.5% 13.0% 13.3% 5.6%
Total delinquencies as a
percentage of Servicing
Portfolio at end of
period................. 2.7% 5.0% 4.0% 4.3% 5.8% 4.7% 6.3%
REO as a percentage of
Servicing Portfolio at
end of period(4)....... .3% .6% .9% .6% 1.3% .7% 1.4%
REO losses as a
percentage of average
Servicing Portfolio
during the period(4)... -- .02% .02% .01% .03% -- .08%
Pre-tax income (loss) as
a percentage of total
revenue................ 38.4% 36.2% 30.5% 33.3% 52.7% (5.0)% 53.1%
</TABLE>
19
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA (CONTINUED)
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF MARCH 31,
--------------------------------------- ---------------
1991 1992 1993 1994 1995 1995(5) 1996
------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash
equivalents............ $ 2,777 $ 1,111 $ 4,387 $ 5,298 $ 4,019 $ 1,809 $ 2,206
Loans held for sale(5).. 10,914 10,080 74,196 18,676 24,744 58,631 26,325
Residual Interests...... -- 2,792 6,879 11,645 19,705 12,283 20,732
Total assets............ 20,973 24,517 99,855 48,226 66,987 86,792 71,355
Total borrowings(5)..... 4,319 966 68,773 14,839 19,356 59,733 22,038
Stockholders' equity.... 15,158 21,566 26,454 23,984 42,321 20,815 34,962
</TABLE>
- --------
(1) Historical dividends are not necessarily indicative of dividends expected
to be declared in the future. See "Dividend Policy."
(2) Amounts reflect adjustments for Federal and state income taxes as if the
Company had been taxed as a C corporation rather than as an S corporation.
(3) As of the end of the applicable period.
(4) Includes REO of the Company as well as REO of the REMIC Trusts and
serviced by the Company; however, excludes private investor REO not
serviced by the Company.
(5) The Company did not close a Securitization during the quarter ended March
31, 1995. As such, Loan origination and sale revenue for the quarter is
significantly lower and the balance of Loans held for sale and total
borrowings are significantly higher than if a Securitization were closed
within the quarter.
(6) Principal balance of loans.
(7) Includes Loans held for sale and loans receivable held for investment of
the Company.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with "Selected
Financial Data," the financial statements of the Company and the notes thereto
included elsewhere in this Prospectus.
GENERAL
Overview
The Company originates, purchases, sells and services non-conventional
mortgage loans secured primarily by first mortgages on single family
residences. The Company focuses on a distinct segment of the home equity
lending market by narrowly targeting its marketing efforts at homeowners
believed by management of the Company, based on historic customer profiles, to
be pre-disposed to using the Company's products and services while satisfying
its underwriting guidelines. The Company originates loans through its retail
branch network of 19 offices, six of which are located in California, two of
which are located in each of Illinois and Florida and one of which is located
in each of Oregon, Washington, Colorado, Utah, Arizona, New Jersey, Ohio,
Georgia and Pennsylvania. In addition, the Company purchases loans from
affiliated and qualified mortgage bankers that the Company has selected based
upon the quality of their origination process and has recently begun to
originate loans referred by unaffiliated brokers.
Prior to 1992, the Company sold its loans to private investors on a
servicing retained basis. Since that time, the Company has sold the majority
of its loans in the secondary market primarily through Securitization and
recently, to a lesser extent, through wholesale loan sales in which the
Company does not retain servicing rights. The Company's underwriting
guidelines require threshold credit criteria and combined loan-to-value limits
for loans sold through Securitizations. Accordingly, the Company sells on a
servicing released loan basis those loans which do not meet its risk criteria
for Securitization. The Company retains the right to service loans which it
has Securitized.
The Company's strategy of originating, as compared to purchasing, the
majority of its loan volume results in the generation of a significant amount
of loan origination fees. This income has allowed the Company to generate
positive operating cash flow. There can be no assurance, however, that the
Company's operating cash flow will continue to be positive in the future.
Certain Accounting Considerations
As a fundamental part of its business and financing strategy, the Company
sells the majority of its loans in Securitizations to REMIC Trusts in exchange
for Regular and Residual Interests. A significant portion of the Company's
income is derived by recognizing gains on sales of loans made pursuant to
these Securitizations. The Company records gains on sales of loans differently
for wholesale servicing released loan sales and for servicing retained sales
of loans through Securitization or to private investors.
Purchased loans are carried on the books of the Company at their acquisition
cost, while the net carrying value on the Company's books of originated loans
is equal to their principal balance less Net Deferred Origination Fees.
Gains on wholesale servicing released loan sales equal the difference
between the net proceeds to the Company from such sales and the loans'
acquisition cost (for purchased loans) or net carrying value (for originated
loans).
Gains on servicing retained sales of loans through Securitizations equal the
difference between the net proceeds to the Company in the Securitization and
the allocated cost of loans Securitized. Such net proceeds received in
Securitizations consist of the fair value of Regular Interests (determined by
the cash price for which they are then sold to the public) and the fair value
of the Residual Interests retained by the Company (determined
21
<PAGE>
as described below), net of transaction costs. The allocated cost of the loans
Securitized is determined by taking their acquisition cost (for purchased
loans) or net carrying value (for originated loans), and allocating such cost
or carrying value between the loans Securitized and the mortgage servicing
rights retained with respect thereto based upon their relative fair values.
The net proceeds of a Securitization consist of the Regular and Residual
Interests received by the Company. The Regular Interests are immediately sold
for cash by the Company. As the holder of the Residual Interests, the Company
is entitled to receive certain excess cash flows. These excess cash flows are
calculated as the difference between (a) principal and interest paid by
borrowers and (b) the sum of (i) pass-through interest and principal to be
paid to the holders of the Regular Interests, (ii) trustee fees, (iii) third-
party credit enhancement fees, (iv) servicing fees and (v) estimated loan pool
losses. The Company's right to receive this excess cash flow begins after
certain reserve requirements have been met, which are specific to each
Securitization and are used as a means of credit enhancement.
The Company carries Residual Interests at fair value. As such, the carrying
value of these securities is impacted by changes in market interest rates and
prepayment and loss experiences of these and similar securities. The Company
determines the fair value of the Residual Interests utilizing prepayment and
credit loss assumptions appropriate for each particular Securitization. To the
Company's knowledge, there is no active market for the sale of these Residual
Interests. The range of values attributable to the factors used in determining
fair value is broad. Accordingly, the Company's estimate of fair value is
subjective. Prepayments are expressed through a market convention known as a
constant prepayment rate ("CPR"). In its past Securitizations, the Company has
experienced a CPR on the Securitized loans ranging from 4.1% to 37.9%. Non-
conventional mortgage loans, and the Company's loans, historically prepay at a
faster rate than conventional mortgage loans. For the three years ended March
31, 1996, conventional fixed rate mortgage loans in the form of Federal
National Mortgage Association 30 year fixed rate mortgage pools have had CPRs
ranging from below 1.0% to almost 10.0%. At origination the Company utilized
prepayment assumptions ranging from 25.0% to 30.0%, estimated loss factor
assumptions of 0.5% and weighted average discount rates of 18.0%, 23.6% and
26.6%, for the years ended December 31, 1995, 1994 and 1993, respectively, to
value Residual Interests. Based upon the historical performance of its loans,
the Company expects its Securitized pools to have average lives of three to
five years. As of March 31, 1996, the Company's investments in Residual
Interests totaled $20.7 million.
To determine the fair value of the mortgage servicing rights, the Company
projects net cash flows expected to be received over the life of the loans.
Such projections assume certain servicing costs, prepayment rates and credit
losses. These assumptions are similar to those used by the Company to value
the Residual Interests. As of March 31, 1996, mortgage servicing rights
totaled $4.6 million.
There can be no assurance that the Company's estimates used to determine the
fair value of mortgage servicing rights will remain appropriate for the life
of each Securitization. If actual loan prepayments or credit losses exceed the
Company's estimates, the carrying value of the Company's mortgage servicing
rights may have to be written down through a charge against earnings. The
Company will not write up such assets to reflect slower than expected
prepayments, although slower prepayments may increase future earnings as the
Company will receive cash flows in excess of those anticipated. Fluctuations
in interest rates may also result in a write- down of the Company's mortgage
servicing rights in subsequent periods. The Company has never written down the
book value of its mortgage servicing rights for such reasons.
The three primary components of the Company's revenues are loan origination
and sale revenue, loan servicing and other fees and interest income. Loan
origination and sale revenue consists of gain on sale of loans and other fees.
A significant portion of gain on sale of loans is the recognition of Net
Deferred Origination Fees, which equaled $25.4 million, or 71.5% of loan
origination and sale revenue, during the year ended December 31, 1995.
22
<PAGE>
Loan servicing and other fee income represents fee income and other
ancillary fees received for servicing the loans. Mortgage servicing rights are
amortized against loan servicing and other fees over the period of estimated
net future servicing fee income.
As such, the carrying value of these securities is impacted by changes in
market interest rates and prepayment and loss experiences of these securities
and the overall market.
Interest income is comprised of two primary components: (i) interest on
loans held for sale during the Warehousing Period and (ii) the effective yield
on the Residual Interests. The Company recognizes interest income on a level
yield basis over the expected lives of the Securitized loans. As of each
reporting date the Company analyzes Residual Interests and new effective
yields are calculated which are used to accrue interest income in the
subsequent period.
Loan Origination and Purchases
The Company's ability to Securitize loans in the secondary market, and to
utilize the associated Warehouse Financing Facility pending such
Securitization, has allowed it to increase the overall return on loans sold.
Additionally, secondary market acceptance of 30 year fully amortizing fixed
and adjustable rate mortgages for the Company's customer base has allowed the
Company to offer loan products with more favorable payment terms to borrowers.
The Company believes that the wider array of loan products allowed by
increased secondary market liquidity, in conjunction with the expansion of its
retail branch network, have contributed significantly to the Company's
increased loan origination volume since 1992.
Retail Branch Originations have increased 127.1% to $200.4 million for 1995
from $88.2 million for 1991, and, in conjunction with Portfolio Refinancing
Originations and wholesale purchases, total loan originations and purchases
increased by 255.4% to a high of $313.0 million in 1994 from $88.2 million in
1991. In 1995, the Company ceased purchasing loans from one affiliated lender,
due to the lender's termination of lending operations. This lender was
providing the majority of the Company's wholesale loan purchase volume at that
time. See "Business-Loan Origination and Acquisition Through Brokers and
Lenders."
The Company's Portfolio Refinancing Originations consist primarily of loans
originated by the Company's centralized marketing and sales efforts. Such
efforts focus on preserving the Company's existing portfolio through
refinancing loans to borrowers who have inquired about prepaying their
existing loans. Loan origination fees for Portfolio Refinancing Originations
are less than fees for Retail Branch Originations as customary fees are waived
or reduced as an incentive to refinance with the Company. The Company does not
earn loan origination fees on loan purchases.
23
<PAGE>
<TABLE>
<CAPTION>
QUARTERS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------------------------------ ------------------
1991 1992 1993 1994 1995 1995 1996
-------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Loan originations and
purchases:
Retail Branch
Originations......... $ 88,249 $ 93,596 $148,718 $151,338 $200,371 $ 32,298 $ 56,693
Portfolio Refinancing
Originations......... -- -- 47,189 70,501 16,195 9,045 5,586
Wholesale purchases... -- 13,622 84,034 91,826 24,078 10,602 13,455
-------- -------- -------- -------- -------- -------- --------
Total originations.. $ 88,249 $107,218 $279,941 $313,665 $240,644 $ 51,945 $ 75,734
======== ======== ======== ======== ======== ======== ========
Number of retail
branches as of the end
of the period
California.............. 10 11 11 11 7 10 7
Other States............ -- -- -- 2 10 4 11
-------- -------- -------- -------- -------- -------- --------
Total............... 10 11 11 13 17 14 18
======== ======== ======== ======== ======== ======== ========
Weighted average loan
origination and
processing fees as a
percent of gross loans
originated as
applicable:
Retail Branch
Originations......... 21.7% 22.2% 17.8% 15.6% 15.3% 16.1% 14.8%
Portfolio Refinancing
Originations......... -- -- 2.5% 7.5% 13.0% 13.3% 5.6%
Wholesale purchases... -- -- -- -- -- -- --
Average retail loan
size................... $ 35.6 $ 35.9 $ 53.6 $ 66.1 $ 68.8 $ 58.3 $ 80.5
Weighted average
interest rate.......... 14.1% 13.6% 9.5% 8.7% 10.3% 10.8% 9.2%
Servicing Portfolio as
of the end of the
period................. $209,012 $240,221 $385,570 $555,685 $613,791 $575,982 $611,718
</TABLE>
Loan Sales
The Company sells substantially all of the loans it originates or purchases,
either through loan sales or Securitizations. During the 1996 quarter, 1995,
1994, 1993 and 1992, the Company sold $74.4 million, $233.2 million, $373.2
million, $212.3 million and $108.3 million of loans, respectively. The volume
of loans sold decreased $140.0 million, or 37.5%, in 1995 from 1994 primarily
because of decreased Portfolio Refinancing Originations and wholesale loan
purchases due to curtailment of certain loan origination and purchase programs
as well as the timing of loan sales during such years. Of the loan sales in
such periods, 70.5%, 72.0%, 93.9%, 66.8%, and 36.0 %, respectively, were
through Securitizations.
Loan Servicing
Since its inception, the Company has generally sold loans, whether to
private investors or through Securitizations, and retained the right to
service the loans. Additionally, in 1995, the Company began selling loans on a
servicing released basis to other mortgage bankers. At December 31, 1995, the
Servicing Portfolio consisted of 8,809 loans with an aggregate principal
balance of $613.8 million. Revenue associated with loan servicing amounted to
14.5% of total revenues for the year ended December 31, 1995.
24
<PAGE>
Composition of Revenue and Expense
The following table summarizes certain components of the Company's
statements of operations set forth as a percentage of total revenue for the
periods indicated.
<TABLE>
<CAPTION>
YEARS ENDED QUARTERS ENDED
DECEMBER 31, MARCH 31,
-------------------- -----------------
1993 1994 1995 1995 1996
----- ----- ----- ------- -------
<S> <C> <C> <C> <C> <C>
Revenue:
Loan Origination and Sale:
Gain (loss) on sale of loans
(excluding net loan origination
and other fees).................. 5.7% (3.4)% 15.3% -- % 9.5%
Net loan origination and other
fees............................. 56.8 64.3 45.0 18.2 53.8
Loan servicing and other fees....... 25.0 19.9 14.5 33.2 15.1
Interest............................ 12.4 18.9 24.9 48.1 21.3
Other............................... 0.1 0.3 0.3 0.5 0.3
----- ----- ----- ------- -------
Total revenue..................... 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ------- -------
Expense:
Compensation and benefits........... 30.2 20.9 17.7 46.6 21.6
Professional services............... 3.6 3.3 1.2 4.4 1.8
Advertising......................... 8.2 7.2 7.4 18.0 6.3
Subservicing and other fees......... 1.8 2.2 2.1 4.5 1.3
Rents............................... 2.3 2.1 2.2 4.8 2.5
Supplies............................ 2.2 1.8 1.7 4.1 2.3
Depreciation and amortization of
property........................... 1.3 1.1 1.5 2.4 0.9
Interest............................ 5.9 8.2 7.1 10.3 5.2
Legal............................... 8.5 15.6 2.5 3.5 1.0
Other............................... 5.5 4.3 3.9 6.4 4.0
----- ----- ----- ------- -------
Total expense..................... 69.5 66.7 47.3 105.0 46.9
----- ----- ----- ------- -------
Net income (loss) before income tax
provision (benefit).................. 30.5 33.3 52.7 (5.0) 53.1
Income tax provision (benefit)........ 0.6 0.8 0.8 (0.1) 0.8
----- ----- ----- ------- -------
Net income (loss)..................... 29.9% 32.5 % 51.9% (4.9)% 52.3%
===== ===== ===== ======= =======
</TABLE>
RESULTS OF OPERATIONS FOR THE QUARTERS ENDED MARCH 31, 1996 AND 1995
Revenue
The following table sets forth the components of the Company's revenue for
the periods indicated:
<TABLE>
<CAPTION>
QUARTERS ENDED
MARCH 31,
--------------
1995 1996
------ -------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Loan origination and sale:
Gain (loss) on sale of loans(1)............................... $ -- $ 1,404
Net loan origination and other fees........................... 1,086 7,967
Loan servicing and other fees................................... 1,977 2,243
Interest........................................................ 2,871 3,158
Other........................................................... 29 38
------ -------
Total revenue............................................... $5,963 $14,810
====== =======
</TABLE>
- --------
(1) Excluding net loan origination and other fees.
25
<PAGE>
Total revenue increased to $14.8 million for the quarter ended March 31,
1996 from $6.0 million for the quarter ended March 31, 1995. The increase was
principally in loan origination and sale revenue due to the closing of a
Securitization of $52.4 million in loans in the quarter ended March 31, 1996.
No Securitizations were closed in the quarter ended March 31, 1995.
Loan origination and sale revenue increased to $9.4 million for the quarter
ended March 31, 1996 from $1.1 million for the quarter ended March 31, 1995.
For the quarter ended March 31, 1995, the Company did not realize any gain
(loss) on sale of loans (excluding net loan origination and other fees) on
loan sales of $7.6 million. For the quarter ended March 31, 1996, loan sales
totaled $74.4 million and the weighted average gain on sales of loans as a
percentage of loan principal balances was 1.9%, including recognition of $1.0
million of capitalized mortgage servicing rights. The increase in loan sales
was primarily due to an increase in volume of wholesale loan sales, which
increased from $3.5 million in the quarter ended March 31, 1995, to $21.5
million in the quarter ended March 31, 1996, and the closing of a
Securitization of $52.4 million in the quarter ended March 31, 1996. No
Securitizations were closed in the quarter ended March 31, 1995. Loans held
for sale totaled $26.3 million and $58.6 million at March 31, 1996 and March
31, 1995, respectively.
Loan origination fees are deferred and recognized only upon sale of the
loan. Net loan origination and other fees increased $6.9 million from $1.1
million for the quarter ended March 31, 1995 to $8.0 million for the quarter
ended March 31, 1996 due to the increased volume of loan sales.
Loan servicing and other fees increased $0.3 million in the quarter ended
March 31, 1996 as compared to the quarter ended March 31, 1995, primarily due
to an increase in prepayment penalties of $0.5 million, or 88.1%, resulting
from an increase in overall portfolio prepayments for which the Company
receives prepayment penalties. This increase in prepayments is the result of
an increasing servicing portfolio and a change in 1994 in the terms of loans
originated by the Company that has enabled the Company to collect prepayment
fees on a greater percentage of adjustable rate loans.
Interest income represents the recognition of the yield on Residual
Interests in securities retained by the Company, interest earned on loans
originated or purchased during the Warehousing Period from their origination
or purchase until their sale, and interest earned on loans receivable held for
investment. Interest income increased $0.3 million in the quarter ended March
31, 1996 as compared to the quarter ended March 31, 1995 primarily due to an
increase in interest income from Residual Interests of $0.8 million, offset by
a decrease in interest earned on loans held for sale of $0.4 million and
interest earned on loans receivable held for investment of $0.3 million. The
58.7% increase in interest income from Residual Interests was primarily due to
the growth of the Company's portfolio of Residual Interests from an average of
$12.0 million in the quarter ended March 31, 1995 to $20.2 million for the
quarter ended March 31, 1996 as a result of net Residual Interests originated.
Interest income on loans held for sale decreased 35.8% in the quarter ended
March 31, 1996, as a result of a decrease in average interest rates on loans
held for sale and a decrease in the average balance of loans held for sale.
The decrease in the interest income from loans receivable held for investment
was principally the result of a decrease of 37.6% in the average gross balance
of loans held for investment.
26
<PAGE>
Expense
The following table sets forth the components of the Company's expenses for
the periods indicated:
<TABLE>
<CAPTION>
QUARTERS ENDED
MARCH 31,
-----------------------
1995 1996
----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Compensation and benefits............................... $2,780 $3,196
Professional services................................... 264 269
Advertising............................................. 1,071 940
Subservicing and other fees............................. 266 192
Rent.................................................... 285 370
Supplies................................................ 246 335
Depreciation and amortization of property............... 144 139
Interest................................................ 613 763
Legal................................................... 206 146
Other................................................... 388 600
----------- -----------
Total expense......................................... $6,263 $6,950
=========== ===========
</TABLE>
Total expense increased 11.0% to $7.0 million for the quarter ended March
31, 1996 from $6.3 million for the quarter ended March 31, 1995. The increase
is primarily due to expenses associated with the increases in the Company's
loan origination volume.
Compensation and benefits increased by $0.4 million and advertising expense
decreased by $0.1 million in the quarter ended March 31, 1996 as compared to
the the quarter ended March 31, 1995, primarily as a result of the increased
loan origination volume in the quarter ended March 31, 1996 and the Company's
decisions to reduce the use of outside telemarketing services in 1996 and
increase the number of employees in its internal telemarketing operations.
Interest expense increased 24.5% to $0.8 million in the quarter ended March
31, 1996 as compared to the quarter ended March 31, 1995, primarily as a
result of a 47.8% increase in the average outstanding balance of the Warehouse
Financing Facility, offset by a 15.2% decrease in the average interest rate
charged on such Facility.
Other expenses increased by $0.2 million in the quarter ended March 31, 1996
as compared to the quarter ended March 31, 1995, primarily as a result of
expenses incurred in the moving of the Company's administrative offices in
February 1996 and increased travel and employee relocation expenses as the
Company continues to expand its retail branch operations outside of
California.
Income Taxes
Since May 1, 1988, the Company has elected to be treated for Federal income
and certain state tax purposes as an S corporation under Subchapter S of the
Code and comparable state laws. As a result, the Company's provisions for
income taxes have in the past reflected modest corporate level state income or
franchise taxes for those states in which the Company operates. The taxable
income of the Company during such periods has been included in the individual
taxable income of its shareholders for Federal and state income tax purposes.
Immediately prior to the Closing Date, the Chisick Family will revoke the
Company's S corporation status and, after the Closing Date, the Company will
be fully subject to Federal and state taxes. At that time, the Company's
effective income tax rate will approximate the Federal and composite state
income and franchise tax rates (net of Federal benefit).
A corporation will be treated as a Personal Holding Company ("PHC") if (i)
five or fewer individuals own more than 50% of the value of the stock of such
corporation (the "PHC Ownership Test"), and (ii) at least 60% of such
corporation's adjusted ordinary gross income is from dividends, interest,
rents, royalties, annuities and certain other sources (the "PHC Income Test").
Under the Code, a PHC will be subject to tax (the "PHC Tax") equal to 39.6% of
such PHC's undistributed income. The PHC Tax is in addition to the corporate
income tax imposed on a PHC.
27
<PAGE>
Prior to the Closing, the Company was an S corporation and therefore was not
subject to the PHC Tax. After the Closing, as a result of the Chisick Family's
ownership in the Company, the Company will meet the PHC Ownership Test. The
Company does not anticipate that it will meet the PHC Income Test in the
future, and therefore does not anticipate being treated as a PHC.
Additionally, the Company intends to monitor carefully its sources of income
and to structure its affairs so as to avoid being a PHC.
RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1995
Revenue
The following table sets forth the components of the Company's revenue for
the periods indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1993 1994 1995
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Loan origination and sale:
Gain (loss) on sale of loans(1)..................... $ 2,056 $(1,547) $ 8,982
Net loan origination and other fees................. 20,433 29,449 26,511
Loan servicing and other fees......................... 8,989 9,106 8,543
Interest.............................................. 4,452 8,650 14,668
Other................................................. 20 144 176
------- ------- -------
Total revenue..................................... $35,950 $45,802 $58,880
======= ======= =======
</TABLE>
- --------
(1) Excluding net loan origination and other fees.
Total revenues increased 28.6% to $58.9 million for 1995 from $45.8 million
for 1994, which in turn represented an increase of 27.4% from $36.0 million
for 1993. The increases in both years were primarily due to increased loan
origination and sale revenue and increased interest income from Residual
Interests.
Loan origination and sale revenue increased 27.2% to $35.5 million for 1995
from $27.9 million for 1994, which in turn represented an increase of 24.1%
from $22.5 million in 1993.
Gain (loss) on sales of loans (excluding net loan origination and other
fees) increased to a gain of $9.0 million in 1995 from a loss of $1.5 million
in 1994. This increase was due primarily to increased premiums on loan sales
which was partially offset by a decrease in the volume of loans sold. The
weighted average gain (loss) on sales of loans as a percentage of loan
principal balances increased to a weighted average gain on sale of loans of
3.9% in 1995 from a weighted average loss on sale of loans in 1994 of 0.4%.
Such increase was primarily the combined result of (i) increased interest rate
spreads (the difference between the weighted average loan interest rates for
the Securitized pools and the weighted average pass-through rates paid to
holders of the Regular Interests less servicing, trustee and insurance fees
and estimated credit losses) in Residual Interests created in 1995
Securitizations over 1994 Securitizations, which increased to 2.04% in 1995
from a weighted average initial interest rate spread of 1.20% in 1994
primarily as a result of more stable interest rates during 1995; (ii)
decreased levels of initial required REMIC overcollateralization, which
decreased from $2.8 million, or .81% of the related Regular Interests
balances, in 1994 to $0.1 million or .04% of the related Regular Interests
balances in 1995 Securitizations; and (iii) recognition of $3.9 million of
capitalized mortgage servicing rights originated during 1995 due to the
adoption of Statement of Financial Accounting Standards ("SFAS") No. 122 in
1995 (accordingly no such assets were recognized in 1994). The 1995 volume of
loans sold decreased $140.0 million, or 37.5%, to $233.2 million, from $373.2
million in 1994 primarily as a result of decreased Portfolio Refinancing
Originations and wholesale loan purchases due to the curtailment of certain
loan
28
<PAGE>
origination programs and the timing of loan sales during such years. At
December 31, 1995, 1994 and 1993, loans held for sale totaled $24.7 million,
$18.7 million and $74.2 million, respectively.
Gain (loss) on sales of loans (excluding net loan origination and other
fees) decreased in 1994 by $3.6 million to a loss of $1.5 million from a gain
of $2.1 million in 1993 due primarily to decreased premiums received over the
principal balance recognized on loan sales which was partially offset by a
increase in the volume of loans sold. The weighted average gain (loss) on
sales of loans as a percentage of loan principal balances decreased to a
weighted average loss on sale of loans of 0.4% in 1994 from a weighted average
gain on sale of loans in 1993 of 1.0%. Such decrease was primarily the
combined result of (i) decreased interest rate spreads in Residual Interests
created in 1994 Securitizations from 1993 Securitizations, which decreased
from a weighted average initial interest spread of 3.24% in 1993 to 1.20% in
1994 primarily as a result of sharply rising interest rates during 1994; (ii)
increased levels of initial required REMIC Trust overcollateralization, which
increased from $0.7 million, or .52% of the related Regular Interests
balances, in 1993 Securitizations to $2.8 million, or .81% of related Regular
Interests balances, in 1994 Securitizations; and (iii) recognition of
$1.0 million of capitalized excess servicing receivables associated with sales
of loans to private investors originated in 1993 (no such assets were
recognized in 1994).
Included in gain on sales of loans (excluding net loan origination and other
fees) in 1995 and 1994 are losses of $255,000 and gains of $800,000,
respectively, resulting from the Company's hedging of interest rate risk
related to loans held for sale during such periods. The Company did not
initiate its hedging activities until 1994. The Company from time to time
hedges against the impact of rapid changes in interest rates on the value of
such loans from the time the Company commits to fund or purchase such loans
until the date of their securitization or sale. During 1995 and 1994, hedging
transactions were limited to selling short United States Treasury securities
and prefunding loan originations in its Securitizations. The timing, nature
and quantity of such hedging transactions is determined by the management of
the Company based on various factors, including market conditions and the
expected volume of commitments to fund or purchase mortgage loans.
Loan origination fees are deferred and recognized only upon sale of the
loan. While Retail Branch Originations increased in 1995 over 1994 net loan
origination and other fees decreased $2.9 million, or 10.0%, to $26.5 million
for 1995 primarily due to lower sales of Retail Branch Originations in 1995.
The volume of sales of such loans decreased in 1995 due to the postponement
until 1994 of a significant volume of 1993 Retail Branch Originations held for
sale at year end 1993. Retail Branch Originations generally carry higher loan
origination fees than Portfolio Refinancing Originations. The Company does not
earn loan origination fees on wholesale loan purchases.
Net loan origination and other fees increased $9.0 million, or 44.1%, to
$29.4 million for 1994 due to higher sales of Retail Branch Originations in
1994. Retail loan originations did not increase materially in 1994 over 1993,
however, the volume of retail loan sales increased in 1994 due to the sale in
1994 of a significant volume of 1993 retail loan originations held for sale at
year end 1993.
Loan servicing and other fees decreased $0.6 million, or 6.2%, in 1995 as
compared to 1994 primarily due to a decrease in loan servicing fees of $0.4
million and an increase of $0.2 million in compensating interest paid by the
Company as servicer with respect to prepayments of Securitized loans. This
decrease was partially offset by an increase in prepayment penalty fees of
$0.2 million. Loan servicing fees decreased in 1995 due to a decrease in the
weighted average servicing rate earned on the Company's Servicing Portfolio
which was partially offset by an increase in the dollar volume of the
Company's Servicing Portfolio. The weighted average servicing rate decreased
from 1.10% in 1994 to 0.82% in 1995 primarily as a result of the amortization
of prepayments of the portfolio of loans sold to private investors that
generally carry higher servicing rates than Securitized loans. The Company's
average outstanding Servicing Portfolio balance increased to $584.7 million in
1995 from $470.6 million in 1994. In conjunction with the servicing of
Securitized loan pools, the Company is required to remit one entire month's
interest to the REMIC Trust for all loans which are paid off prior to their
maturity. This amount includes both actual interest collected and
"compensating interest" which together equal one full month of interest on the
prior month's loan balance. The increase in compensating interest offsetting
loan servicing
29
<PAGE>
revenue is due to the 75.3% increase in Securitized loans paid off during 1995
as compared to 1994. Prepayment penalties increased during 1995 due to an
increase in overall portfolio prepayments.
Loan servicing and other fees increased $0.1 million, or 1.3%, in 1994 as
compared to 1993. This increase was primarily due to an increase in prepayment
penalties of $0.4 million which was partially offset by an increase in
compensating interest of $0.2 million. Prepayment penalties increased during
1994, notwithstanding an aggregate decrease in Servicing Portfolio
prepayments, due to an increase in the proportion of prepayments of
Securitized loans versus private investor loans. The Company retains all
prepayment penalties for Securitized loans serviced and only a portion of such
for private investor serviced loans. In 1994, prepayments of Securitized loans
comprised 46.7% of total prepayments as compared to 17.2% in 1993. The
increase in compensating interest offsetting loan servicing revenue is due to
the 152.6% increase in Securitized loans paid off during 1994 as compared to
1993.
Interest income increased $6.0 million, or 69.6%, in 1995 as compared to
1994. Interest income from Residual Interests in securities increased $4.0
million in 1995 due to the combined effect of growth in the Company's
portfolio of Residual Interests, which increased from an average of $10.3
million in 1994 to $14.5 million in 1995, and an increase in the weighted
average effective yield on Residual Interests. The increase in the effective
yield in Residual Interests is primarily due to the favorable performance of
the Residual Interests acquired in 1993 and 1994 as compared to assumptions
for loss, prepayment and delinquency rates used in computing their fair value
at origination. Interest income from loans held for sale increased $0.9
million in 1995 due to an increase in the weighted average interest rate on
loans originated and purchased which increased from approximately 8.7% in 1994
to 10.3% in 1995. The average balance of loans held for sale did not change
significantly, even though total loan originations decreased, due to a longer
Warehousing Period in 1995. Interest on loans receivable held for investment
increased $1.0 million from 1994 to 1995 due to increases in the average
balance of loans receivable held for investment and the accretion of related
purchase discounts.
Interest income increased $4.2 million, or 94.3%, in 1994 as compared to
1993. Interest income from Residual Interests increased $2.2 million in 1994
due to growth of Residual Interests, which increased from an average of $4.1
million in 1993 to $10.3 million in 1994, and an increase in the weighted
average effective yield on Residual Interests. Interest income from loans held
for sale increased $1.5 million in 1994 primarily due to a 43.2% increase in
the average balance of loans held for sale. This increase was partially offset
by a decrease in the weighted average interest rate on loans held for sale as
the weighted average interest rate on loans originated and purchased decreased
from approximately 9.5% in 1993 to 8.7% in 1994. Interest on loans receivable
held for investment increased $0.3 million from 1993 to 1994 due primarily to
increases in the average balance of loans receivable held for investment.
Expense
The following table sets forth the components of the Company's expenses
during the periods indicated:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
-----------------------
1993 1994 1995
------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Compensation and benefits.............................. $10,847 $ 9,559 $10,395
Professional services.................................. 1,288 1,521 697
Advertising............................................ 2,958 3,316 4,345
Subservicing and other fees............................ 659 1,019 1,212
Rent................................................... 815 974 1,278
Supplies............................................... 791 831 992
Depreciation and amortization of property.............. 483 514 907
Interest............................................... 2,106 3,744 4,167
Legal.................................................. 3,044 7,162 1,491
Other.................................................. 1,996 1,928 2,376
------- ------- -------
Total expense........................................ $24,987 $30,568 $27,860
======= ======= =======
</TABLE>
30
<PAGE>
Total expense decreased 8.9% to $27.9 million for 1995 from $30.6 million in
1994, which in turn represented an increase of 22.3% from $25.0 million for
1993. The decrease in 1995 was primarily due to decreases in legal expense and
professional services offset by increases in compensation and benefits,
advertising and interest expense. The increase in 1994 was due primarily to
increases in legal and interest expense offset by a decrease in compensation
and benefits.
Compensation and benefits expense increased by 8.7% to $10.4 million for
1995 from $9.6 million for 1994, which in turn represented a decrease of 11.9%
from $10.8 million in 1993. The 1995 increase primarily relates to an 11%
increase in average employee headcount, which was partially offset by a $0.2
million decrease in health insurance costs related to the Company's conversion
of employee coverage to a more affordable health maintenance organization
program. The 1994 decrease in compensation and benefits expense is primarily
due to a bonus paid to Mr. Chisick of $3.0 million in 1993 and was offset by
an increase in other compensation and benefits that was the combined result of
a 10% increase in average employee headcount during 1994 and compensation
increases for existing employees.
Professional services expense decreased $0.8 million, or 54.2%, in 1995 as
compared to 1994. In 1994, certain of the Company's Portfolio Refinancing
Origination programs included the utilization of outside consultants.
Advertising expense increased $1.0 million, or 31.0%, in 1995 over 1994
primarily as a result of the increase in the number of retail branch offices.
Retail Branch Originations increased $49.0 million, or 32.4%, in 1995 over
1994.
Sub-servicing and other fees incurred by the Company increased by $0.2
million, or 18.9%, during 1995 as compared to 1994, and by $0.4 million, or
54.6%, during 1994 as compared to 1993. From the introduction of adjustable
rate mortgages in 1993 until February 1996, the Company contracted with a
third party to sub-service such loans. In the first quarter of 1996, the
Company terminated the third party and now services all adjustable and fixed
rate loans in its Servicing Portfolio. In 1995, 1994 and 1993, the Company's
average portfolio of adjustable rate loans serviced was $275.1 million, $242.3
million and $33.6 million, respectively.
Rent expense increased by $0.3 million, or 31.2%, during 1995 as compared to
1994. In addition to scheduled rent increases on existing properties, the
Company entered into leases on nine new retail branch offices related to the
national expansion of the retail branch network during 1995.
Depreciation and amortization of property increased $0.4 million, or 76.5%,
in 1995 over 1994. This increase is primarily related to the write off in 1995
of the remaining book value of the Company's loan servicing system of $0.2
million due to implementation of a new software system.
Interest expense increased $0.4 million, or 11.3%, in 1995 as compared to
1994 due to increases in interest expense on the Warehouse Financing Facility
of $0.3 million and interest expense related to stockholder notes payable of
$0.2 million. Increased interest expense associated with the Warehouse
Financing Facility was due to an increase in the weighted average interest
rate on the Warehouse Financing Facility, which increased to 7.10% in 1995
from 5.96% in 1994 and which was partially offset by a decrease in the average
balance outstanding. Increased interest expense associated with stockholder
notes payable was due to an increase in the average balance outstanding during
1995.
Interest expense increased $1.6 million, or 77.8%, in 1994 as compared to
1993 due to an increase in interest expense on the Warehouse Financing
Facility of $2.1 million which was partially offset by a decrease in interest
expense related to stockholder notes payable of $0.6 million. Increased
interest expense associated with the Warehouse Financing Facility was due to a
140.9% increase in the average balance outstanding. Decreased interest expense
associated with stockholder notes payable was due to an decrease in the
average balance outstanding during 1994.
31
<PAGE>
Legal expense decreased $5.7 million during 1995 as compared to 1994, and
increased $4.1 million in 1994 as compared to 1993. The Company was named as
the defendant in a class action suit filed in December of 1989. During 1994
and 1993, the Company recorded legal expenses and estimated settlement costs
of $7.0 million and $2.3 million, respectively, related to this matter. See
"Legal Proceedings." Additionally the Company incurred approximately $0.4
million in legal fees in 1994 as the plaintiff in litigation which fees were
offset by a $1.3 million judgment in favor of the Company.
Other expense increased $0.4 million, or 23.2%, during 1995 as compared to
1994. Such increase is primarily due to an increase in travel expenses of $0.3
million during 1995 related to the Company's national retail branch network
expansion.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically generated positive cash flow. The Company's
sources of cash flow include loan sales, loans sold through Securitizations,
net interest income and borrowings under its Warehouse Financing Facility. At
origination of a loan, the Company includes the loan origination fee in the
principal balance. The Company then borrows approximately the principal amount
of the loan (subject to collateral valuation limitations) under the Warehouse
Financing Facility and disburses to the borrower the loan amount less the loan
origination fee. Thus, the Company receives cash in the amount of the loan
origination fee at the time of the Warehouse Financing Facility funding and
prior to the time the Company recognizes such fee as a component of gain on
sale of loans, which occurs upon the sale of the loan. The magnitude of the
Company's loan origination fees is a significant factor in the Company's
historical positive operating cash flow.
The Company's uses of cash include the funding of loan originations and
purchases, payment of interest expenses, repayment of the Warehouse Financing
Facility, funding of initial overcollateralization requirements for
Securitizations, operating and administrative expenses, income taxes and
capital expenditures. Capital expenditures totaled $1.0 million, $0.9 million
and $0.6 million for the years ended December 31, 1995, 1994 and 1993,
respectively. Prepaid expenses and other assets increased $2.3 million from
$1.6 million at December 31, 1994 to $3.9 million at December 31, 1995. A $0.5
million balance outstanding under a line of credit extended to a related party
loan broker at December 31, 1995 did not exist at December 31, 1994 and
receivables related to Residual Interest distributions and interest on loans
increased by $0.9 million. In addition, refundable deposits and deposits on
property acquisitions increased by $0.5 million.
The Company's sale of loans through Securitizations has generally resulted
in gains on Securitization recognized by the Company. Substantially all of the
proceeds of a Securitization, net of fees and costs of the Securitization, are
used to repay the Warehouse Financing Facility. Additionally, in a
Securitization, the Company receives Residual Interests and capitalizes
mortgage servicing rights, each of which creates non-cash taxable income. The
value of the mortgage servicing rights capitalized represents the present
value of estimated net cash flows to be received in the future and constitutes
a non-cash gain on which the Company is required to pay income tax. Therefore,
the income tax payable and the expenses related to the Securitization on these
factors negatively impact the Company's cash flow. For the years ended
December 31, 1995, 1994, and 1993, the Company recognized gain on sale of
loans through Securitization, including the recognition of Net Deferred
Origination Fees, of $26.7 million, $25.0 million and $14.0 million,
respectively. The Company anticipates that the majority of future loan sales
will be through Securitization.
Adequate credit facilities and other sources of funding, including the
ability of the Company to sell loans, are essential to the continuation of the
Company's ability to originate and purchase loans. During 1995, 1994 and 1993,
the Company used cash in the approximate amounts of $213.9 million, $289.3
million and $257.9 million, respectively, for new loan originations and
purchases. During the same periods, the Company received cash of proceeds from
the sale of loans and Regular Interests in securities of $232.3 million,
$368.0 million and $209.5 million, respectively. After utilizing available
working capital, the Company borrows money to fund its loan originations and
purchases, and repays these borrowings as the loans are sold. Upon the sale of
loans and the subsequent repayment of borrowings, the Company's working
capital and Warehouse
32
<PAGE>
Financing Facility then become available to fund additional loan originations
and purchases. The Company's Warehouse Financing Facility is secured by loans
originated or purchased by the Company and currently bears interest at the
rate of .875% over 30 day LIBOR. Amounts borrowed under the Warehouse
Financing Facility and not used to originate or purchase loans that are
included in a Securitization in which the lender under the Warehouse Financing
Facility is the underwriter are subject to an additional fee equal to 25 basis
points of such borrowings. The Warehouse Financing Facility contains
affirmative, negative and financial covenants typical of such credit
facilities. This Warehouse Financing Facility is renewable by the lender on a
quarterly basis and currently expires on the sooner of the closing of a
Securitization or September 30, 1996. This Warehouse Financing Facility was
originated in 1993 and has been renewed in varying amounts over the last 3
years. Management expects, although there can be no assurance, that the
Company will be able to maintain this Warehouse Financing Facility (or obtain
replacement or additional financing) in the future.
As indicated above, the Company's ability to continue to originate and
purchase loans is dependent, in part, upon its ability to sell the loans in
the secondary market in order to generate cash proceeds for new originations
and purchases. The value of and market for the Company's loans are dependent
upon a number of factors, including general economic conditions, interest
rates and governmental regulations. Adverse changes in such factors may affect
the Company's ability to sell loans for acceptable prices within a reasonable
period of time. A prolonged, substantial reduction in the size of the
secondary market for loans of the type originated or purchased by the Company
may adversely affect the Company's ability to sell loans in the secondary
market with a consequent adverse impact on the Company's results of
operations, financial condition and ability to fund future originations and
purchases.
As a result of the Company's treatment as an S corporation for Federal and
state income tax purposes, the Company historically has made distributions to
its shareholders for the payment of income taxes on the earnings of the
Company and to provide them with a return on their investment. The Company
paid dividends, including amounts for taxes of $12.2 million, $17.3 million
and $5.9 million for the years ended December 31, 1995, 1994 and 1993,
respectively. Prior to the Closing Date, the Chisick Family will revoke the
Company'sS corporation status. The Company anticipates that, after payment of
the S Distribution Notes, any earnings will be retained for the foreseeable
future in the operations of the business. "See Prior S Corporation Status" and
"Dividend Policy."
The Company believes that cash flow from operations, the net proceeds of the
Public Offering, the net proceeds from Securitizations and the availability
under the Warehouse Financing Facility will be sufficient to fund operating
needs, capital expenditures and payment of the S Distribution Notes for the
ensuing 12 months.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
In May 1995, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 122 "Accounting for Mortgage Servicing Rights." SFAS No. 122 amends SFAS
No. 65 "Accounting for Certain Mortgage Banking Activities," to require that
mortgage banking entities recognize as a separate asset rights to service
mortgage loans for others. Mortgage banking entities that acquire or originate
loans and subsequently sell or Securitize those loans with retained servicing
rights are required to allocate the total cost of the loans to the mortgage
servicing rights and the mortgage loans. As a result of the adoption of SFAS
No. 122, in the future the Company will recognize a greater amount of revenue
at the time a loan is sold and a lesser amount of revenue during the time such
loan is serviced. The Company is also required on an ongoing basis to assess
the servicing rights for impairment based upon the fair value of those rights.
SFAS No. 122 was adopted by the Company as of January 1, 1995, and resulted in
additional income of approximately $3.9 million, included in loan origination
and sale revenue, for the year ended December 31, 1995.
In 1995, the FASB issued SFAS No. 123 "Accounting for Stock-Based
Compensation," which encourages companies to account for stock compensation
awards based on their fair value at the date the awards are granted. SFAS No.
123 does not require the application of the fair value method and allows for
the continuance of current accounting method, which requires accounting for
stock compensation awards based on their intrinsic value as
33
<PAGE>
of the grant date. However, SFAS No. 123 requires proforma disclosure of net
income and, if presented, earnings per share, as if the fair value based
method of accounting defined in this Statement had been applied. The
accounting and disclosure requirements of this statement are effective for
financial statements for fiscal years beginning after December 15, 1995,
though earlier adoption is encouraged. The Company, at this time, has not
determined whether or not to adopt the recognition provisions of SFAS No. 123
with respect to the Stock Incentive Plan.
34
<PAGE>
BUSINESS
GENERAL
The Company originates, purchases, sells and services non-conventional
mortgage loans secured primarily by first mortgages on single family
residences. The Company focuses on a distinct segment of the home equity
lending market by narrowly targeting its marketing efforts at homeowners
believed by management of the Company, based on historic customer profiles, to
be pre-disposed to using the Company's products and services and satisfying
its underwriting guidelines. The Company does not market to individuals
seeking to buy a home because it is unlikely such individuals would meet the
Company's loan-to-value requirements. The Company originates loans through its
centralized telemarketing operations, its direct mailing campaigns and its
expanding retail branch network of 19 offices currently located in 12 states.
The Company also purchases loans from certain related party originators, and
has recently begun to originate loans referred by other third party brokers.
The Company's customers, who principally use the loans from the Company to
consolidate indebtedness or to finance other consumer needs rather than to
purchase homes, consist of two primary groups. The first category of the
Company's customers are individuals who are unable to obtain mortgage
financing from banks, savings and loan institutions and other companies that
have historically provided loans to individuals with favorable credit
characteristics ("Conventional Lending Institutions"). These individuals often
have impaired or unsubstantiated credit characteristics and/or unverifiable
income and respond favorably to the Company's marketing. The Company's second
category of customers consists of individuals who could qualify for loans from
Conventional Lending Institutions but instead choose to use the Company's
products and services. The Company's experience has shown that these
individuals are attracted to the Company's high degree of personalized service
and timely response to loan applications. Each category of customers has
historically been willing to pay the Company's loan origination fees and
interest rates, which are typically higher than the fees and rates charged by
Conventional Lending Institutions.
The Company believes its concentrated marketing effort on a potential
customer pool that, based on historic customer profiles, displays a
statistical pre-disposition for being consumers of the Company's products and
services and satisfying the Company's underwriting guidelines provides a more
efficient use of its marketing expenditures and leads to a higher marketing
success rate than a broad indiscriminate marketing approach aimed at a wide
array of homeowners. To produce these potential customer pools, the Company
utilizes a proprietary marketing methodology that generally consists of the
subjective analysis and comparison of certain statistical characteristics of
its traditional customers. See "Business--Marketing and Sales--Marketing."
Management of the Company applies this analysis to information obtained from a
number of outside sources with respect to new or existing markets to develop a
list of homeowners who display characteristics that make them likely customers
for the Company's products and services and acceptable underwriting risks. The
Company then focuses its telemarketing and mailing efforts on these identified
homeowners.
The Company's ability to fund and subsequently Securitize loans in the
secondary market has significantly improved its financial performance and
allowed it to offer new and enhanced loan products. These benefits of
Securitization, in conjunction with the Company's retail branch network
expansion, have contributed significantly to the increase in the Company's
loan origination volume to $216.6 million in 1995 from $93.6 million in 1992.
The Company sells substantially all of its loans in the secondary market
either through Securitization or, to a lesser extent, loan sales. Since the
Company's initial use of Securitization in 1992 and through June 30, 1996, the
Company has effected the majority of its loan sales through Securitizations;
during such period $826.8 million of loans were Securitized and sold by the
Company. The Company anticipates selling a significant portion of its loan
origination volume during 1996 and thereafter through Securitizations. The
Company intends to hold the residual interests in its Securitizations until
their maturity. Accordingly, the Company's policy has been to require
threshold credit criteria and combined loan-to-value limits for loans included
in the REMIC Trusts. The Company sells a smaller amount of its loans through
servicing released sales of whole loans that do not meet the Company's risk
criteria for inclusion in the REMIC Trusts. When the marketing representatives
of the Company originate a potential loan that does not meet the underwriting
35
<PAGE>
guidelines of the Company, the Company sells the loan to unaffiliated
companies on a servicing-released basis, allowing the Company to generate
origination fees without incurring credit risk. The Company continues to
service the loans that it has sold through Securitizations and to private
investors.
The Company's loan originations during the years ended December 31, 1995,
1994 and 1993 were $216.6 million, $221.8 million and $ 195.9 million,
respectively. The Company's retail loan originations during the year ended
December 31, 1995 had an average principal balance of $68,800, a weighted
average initial interest rate of 10.3%, and a weighted average initial
combined loan-to-value ratio of 58.6%.
The Company is a holding company that owns, directly or indirectly, all of
the outstanding capital stock of (i) FAMCO, (ii) First Alliance Services,
Inc., a company recently formed to provide financial, accounting and computer
services to the Company and others, and (iii) two corporations recently
organized under the laws of the United Kingdom to facilitate the Company's
proposed expansion. Immediately prior to the consummation of the Public
Offering, the Chisick Family will contribute to the Company the newly-formed
corporations described above and will receive no consideration therefor,
except as a stockholder of the Company.
MARKETING AND SALES
Marketing
The Company's marketing efforts are designed to identify, locate and focus
on individuals who, based on the Company's historic customer profiles, display
a statistical pre-disposition for being a consumer of the Company's products
and services and satisfying the Company's underwriting guidelines. Based on
the experience of management, the Company believes its focused marketing
effort provides a more efficient use of its marketing expenditures and leads
to a higher marketing success rate than a broad indiscriminate marketing
approach aimed at a wide array of homeowners.
The Company utilizes a proprietary marketing methodology. Under this
proprietary marketing methodology, management subjectively analyzes the
Company's historical customer base to find characteristics common to its
customers. These common characteristics are integrated with information
obtained from a number of outside sources with respect to the homeowner pool
in new or existing markets. The characteristics of individual homeowners and
their properties in the homeowner pool are compared with the characteristics
common to the Company's historical base to identify and locate homeowners and
their properties ("Targeted Homeowners") displaying characteristics that make
them likely to be customers for the Company's products and services and to
satisfy its underwriting guidelines.
In general, the factors analyzed by the Company in identifying Targeted
Homeowners include prior consumer finance borrowing, home value, the amount of
equity in the home and the length of time a homeowner has owned the home.
Credit problems, a lack of a significant credit history and prior borrowings
from consumer finance companies indicate a homeowner is unlikely to be able to
obtain loans from Conventional Lending Institutions, and thus is a more likely
candidate for the Company's products and services. Similarly, the Company's
experience indicates that a longer ownership period usually results in
significant equity in the home for the homeowner, creating an opportunity for
a loan that will satisfy the Company's conservative loan-to-value
requirements.
Management continually refines the Company's proprietary marketing
methodology. The Company uses statistical models from time to time, but
management may adjust the variables to more accurately identify potential
customers in a given market. The Company continually monitors the performance
of its marketing campaigns in evaluating the effectiveness of its methodology
in identifying Targeted Homeowners in each market.
36
<PAGE>
While the Company has utilized mass marketing in the past, management has
decided that focusing its marketing efforts on Targeted Homeowners produces a
greater yield for its marketing expenditures and leads to more opportunities
for loan origination. The majority of the Targeted Homeowners who become
customers of the Company generally use the proceeds of their loans from the
Company to consolidate outstanding mortgage and consumer debt, lower their
monthly payments or make home improvements, and rarely purchase homes with the
proceeds of such loans.
Targeted Marketing
By focusing its marketing efforts on Targeted Homeowners who, based on the
Company's historic customer profile, are statistically pre-disposed to satisfy
the Company's underwriting guidelines, the Company eliminates from its
marketing efforts many homeowners and subject properties that would not
satisfy such guidelines. The Company's marketing personnel, including
telemarketing staff, appraisers, loan officers, branch managers and
headquarters personnel are trained to be aware of the Company's underwriting
guidelines and, as described below, review each loan lead to eliminate
Targeted Homeowners whose overall qualifications and properties would not
satisfy such guidelines.
Mailing Campaigns and Telemarketing
The Company's mailing and telemarketing campaigns focus on the Targeted
Homeowners generated by the Company's proprietary marketing methodology. The
Company targets the communities surrounding its 19 retail branch offices by
utilizing many different mailing campaigns focusing on the multiple benefits
of the Company's services and loan products. The Company distributes over 1
million pieces of mail monthly. All of the Company's mailing campaigns
originate from its mail processing center in Orange, California. The Company's
mailing campaigns result in over 4,000 inbound loan inquiry calls from
Targeted Homeowners monthly. The Company continually monitors the
effectiveness of each of its mailing campaigns and will continue, modify or
discontinue a particular mailing campaign based on the results of such
monitoring.
The Company's telemarketing department handles both inbound and outbound
calls from and to Targeted Homeowners and existing customers. Substantially
all of the inbound calls are from Targeted Homeowners responding to the
Company's mailing campaigns. The Company monitors the effectiveness of each
mailing campaign by tracking which campaign is the source of each inbound
call. The outbound telemarketing department uses computerized predictive
dialers to continually solicit the Targeted Homeowners and the Company's
current customers. Telemarketing representatives also place follow up calls to
prospective borrowers who have previously set and canceled appointments to
have a Company appraiser visit and inspect the subject property and obtain
information about the applicant (an "Appraisal Appointment"), failed to show
up for an appointment with a loan officer in a retail branch office to prepare
loan documents (a "Sales Appointment") or declined a loan program offered to
them by the Company.
The Company understands its practice to be different from that of its
competitors in that the centralized telemarketing department at the Company's
facilities in southern California handles all screening and produces all
initial Appraisal Appointments with the Targeted Homeowners. The centralized
telemarketing department, not the retail branch office personnel, is
responsible for converting loan inquiries into appointments. The Company
believes its centralized telemarketing practice creates greater operating
efficiencies by allowing task specialization and periodic reallocation of
telemarketing resources to meet geographic needs.
The telemarketing representative's responsibility is to sell the benefits of
the Company's products and services, obtain information from the Targeted
Homeowner about themselves, the subject property, the equity in the subject
property and the purpose of the loan, and, assuming this initial information
satisfies the Company's underwriting guidelines, to schedule an Appraisal
Appointment. By focusing on the equity in the subject property, the
telemarketing phase screens out Targeted Homeowners and properties whose
characteristics would not satisfy the Company's underwriting guidelines.
37
<PAGE>
Individual telemarketing representatives are rated and compensated based on
the number of Appraisal Appointments set. The Company monitors the performance
of its telemarketing staff on a weekly and monthly basis.
Appraisal
The Company's valuation process occurs throughout the loan application
process. In some cases, the first stage valuation occurs immediately after a
telemarketing representative sets an Appraisal Appointment. Staff at the
Company's headquarters gathers publicly available information with respect to
recent sales of comparable properties in the same area as the subject
property. The value of the subject property is verified by the comparable
sales data. Only inquiries of applicants that satisfy this stage of the
initial underwriting process will be verified and forwarded to the respective
branches for Appraisal Appointments.
The property is appraised typically within two days of the initial
telemarketing contact and provides a valuable marketing opportunity. This
appraisal is the applicant's first face-to-face contact with the Company's
representatives and the Company stresses to its appraisers the importance of
the marketing aspect of their positions. The appraiser's responsibilities are
to obtain additional information and required documentation about the
applicant, perform a complete appraisal of the subject property, and schedule
a Sales Appointment. The appraiser gathers and delivers to the branch office
the applicant's relevant documents, including the current mortgage documents,
if any, evidence of ownership to the subject property and information
regarding other bills to be refinanced with the new loan.
Appraisers at the Company's headquarters, not third party fee appraisers,
perform a review of the property appraisal on the following loan applications:
(i) all properties with a market value above $150,000, (ii) all loans with a
loan-to-value ratio of equal to or greater than 62%, (iii) all loan
applications prepared by a new branch office for the first 90 days of its
existence, (iv) all income properties, and (v) all non-California loans with a
loan-to-value ratio equal to or greater than 55% or with values less than
$100,000 not otherwise reviewed.
Unlike many of its competitors, the Company does not use independent fee-
based appraisers. Instead, the Company recruits, hires and trains its own
field and desk appraisers. In connection with the Securitization of the
Company's loans, independent appraisers have conducted appraisals of a sample
of the subject properties that are the collateral for the Securitized loans.
The appraisals performed by the Company's appraisers have been within 1.5% of
the aggregate appraisal values on Securitization pools to date as calculated
by the independent appraisers.
The Company hires certified appraisers in those states which require such
designation. Individual appraisers are rated and incented based on the number
of Sales Appointments set and the ongoing quality of the appraisals performed.
The Company monitors the performance of its appraisers on a weekly and monthly
basis.
Loan Production
The retail branch offices are responsible for the sales process that, if
successful, converts the Sales Appointments set by the appraisers into
packaged and underwritten loan files to be submitted to the Company's quality
control department. Each Sales Appointment allows the sales personnel to
clearly determine the applicant's need for financing, tailor a loan program to
fit the applicant's financial needs, continue to underwrite the loan package
and provide to the applicant a choice of loan products and a detailed
explanation thereof.
The loan officer utilizes a loan origination software system developed by
the Company to preliminarily determine an applicant's qualification for the
various products of the Company, and the terms that will be applicable to such
products. The loan origination system incorporates the Company's underwriting
guidelines with respect to the relevant collateral, credit quality, character,
and capacity to repay. For over a decade, the Company has relied upon a
proprietary credit scoring system in its underwriting process. Prior to each
Sales Appointment, the retail branch loan officer or branch manager will run a
credit report for each applicant and determine the applicant's overall credit
score. All accounts on an applicant's credit report, including mortgage
38
<PAGE>
loans, are reviewed and assigned a value based on the performance of the
account. Based upon applicants' credit scores, they are preliminarily
designated as an "A", "B", "C" or "D" risk. This designation is reviewed by
the Company's centralized quality control department before the final
underwriting phase. See "Business--Underwriting."
Once an applicant has agreed to the terms of the proposed loan, loan
documents reflecting such terms are executed by such applicant in two distinct
phases in accordance with the requirements of the Home Ownership Equity
Protection Act of 1994 and forwarded to the Company's centralized quality
control department.
The typical retail branch office consists of a branch manager, one to two
loan officers, one to two appraisers and one to two loan processors. The
Company generally recruits and hires its managers and loan officers in the
location of the branch office. The Company focuses on the professional sales
experience of candidates for loan officer positions. Candidates are required
to submit evidence of substantial recent personal income from sales
employment. The interviewing process includes a panel interview that requires
candidates to perform a simulated loan presentation utilizing the Company's
proprietary sales script. Loan officer and branch manager candidates are
required to successfully complete four weeks of sales and technical
underwriting training to learn the Company's sales presentation and procedures
prior to their placement in a retail branch. Existing retail branch office
sales personnel return to corporate headquarters quarterly for continuing
sales training.
Loan officers and branch managers are rated and compensated based on the
number of loans signed, approved by the loan committee and closed. The Company
strives to develop its loan officers and to promote the most qualified loan
officers to branch managers. The Company monitors the performance of its loan
officers and branch managers on a weekly and monthly basis.
Repeat Business and Preservation of Loan Portfolio
A significant number of the Company's borrowers are repeat borrowers of the
Company. Once a loan is funded, the Company maintains a relationship with its
borrowers to ensure borrower satisfaction and to respond to any future
borrowing needs. For the quarter ended March 31, 1996 and the full year 1995,
34.3% and 13.4%, respectively, of the total volume of loan originations were
to repeat borrowers.
Many competitors in the Company's markets obtain publicly available
information with respect to the Company's borrowers and solicit such borrowers
for additional borrowing or refinancing. The Company's portfolio refinancing
programs have allowed it to retain a significant number of borrowers who might
otherwise have obtained additional borrowing or refinanced their existing
mortgages with the Company's competitors.
LOAN ORIGINATION AND ACQUISITION THROUGH BROKERS AND LENDERS
The Company has historically augmented its loan production by purchasing
loans from other affiliated, unaffiliated and related party brokers and
lenders. Currently, the Company purchases loans originated by Nationscapital
Mortgage Corporation ("Nationscapital") and Coast Security Mortgage ("Coast
Security"), which are beneficially owned by the sons of Brian and Sarah
Chisick. Additionally, the Company funds loans originated by unaffiliated loan
brokers. The Company has entered into mortgage loan purchase agreements with
each originator which require specified minimum levels of experience in
origination of non-conventional mortgage loans and provide representations,
warranties and buy-back provisions identical to the representations and
warranties required of the Company for the Securitization of its own loan
originations.
Historically, the Company has made wholesale loan purchases from other
affiliated, unaffiliated and related party brokers and lenders to augment the
volume of the Company's loan sales and securitization activity. Recently, the
Company has decided to limit its acquisition of loans from brokers and lenders
to those loans which meet its criteria for Securitization due to
dissatisfaction with the profitability of wholesale purchase and sales of
loans.
39
<PAGE>
During 1994 and 1995, the Company purchased the majority of its wholesale
loan purchase volume from a subsidiary of First Alliance Securities
Corporation, a company wholly-owned by Brian and Sarah Chisick. These
purchases were made pursuant to agreements similar to those entered into with
unaffiliated sellers of loans to the Company. In 1995, First Alliance
Securities Corporation and its subsidiary permanently terminated their lending
operations.
UNDERWRITING
The Company believes its underwriting process begins with the marketing of
its products and services. The Company has designed its marketing programs to
screen out each time information is gathered during its marketing efforts
those homeowners and subject properties that do not meet the Company's
underwriting guidelines. As an integral part of its marketing programs, the
Company trains its telemarketing representatives, appraisers and loan officers
to assess each loan application and subject property against the Company's
underwriting guidelines.
The main underwriting and quality control functions are centralized at the
Company's headquarters. The most significant of the Company's underwriting
functions at headquarters are performed by senior management. The Company
maintains a quality control department and a loan committee. Each loan
application file is reviewed by the Company's loan committee. The loan
committee works in conjunction with the quality control department to provide
a final review of the underwriting and the terms of the potential loan. The
Company strives to process each loan application received from its retail
branch network as quickly as possible in accordance with the Company's loan
application approval procedures. Accordingly, most loan applications receive
decisions within three days of receipt and are funded within ten days of
approval.
Each retail branch office submits executed initial applications to the
quality control department. The quality control department reviews in its
entirety every loan file originated by the retail branch offices as well as
wholesale originators. Loan files are reviewed for completeness, accuracy, and
compliance with the Company's underwriting criteria and applicable
governmental regulations. Based on their initial review, quality control
personnel inform branch office personnel of additional requirements that must
be fulfilled to complete the loan file, such as additional proof of income.
After a full review by quality control personnel, each initial loan
application file is forwarded to the loan committee for approval. These
documents are again subjected to a full review. Loans that clearly conform to
the Company's underwriting guidelines are approved at the first level. Loans
that present certain underwriting issues are forwarded to senior underwriting
personnel.
The decision of the loan committee to approve a loan is based upon a number
of factors, including the appraised value of the property, the applicant's
creditworthiness and the Company's perception of the applicant's ability to
repay the loan. With respect to the value of the collateral, generally, loans
secured by first mortgages are limited to a maximum of 75% loan-to-value
ratio; however, the Company will originate loans with a loan-to-value ratio of
up to 85% for loans expected to be sold. Loans secured by second mortgages are
limited to a maximum of 70% loan-to-value ratio. With respect to
creditworthiness, the Company has established classifications with respect to
the credit profiles of loans and subject properties based on certain of the
applicant's characteristics. Each loan application is placed into one of the
Company's four ratings ("A" through "D," with subratings within those
categories), depending upon the following three primary factors: (i) an
applicant's credit score under the Company's proprietary credit scoring
system, which uses information obtained from national credit bureau reports,
(ii) loan-to-value ratios and (iii) debt-to-income ratios. Terms of loans made
by the Company vary depending upon the classification of the application.
Applications with lower classifications generally are subject to higher
interest rates. A loan application must obtain the following thresholds with
respect to each of the three primary factors to be included in the particular
ratings shown below:
<TABLE>
<CAPTION>
"A" "B" "C" "D"
------ ----- ----- ----
<S> <C> <C> <C> <C>
Borrower Credit Score 100-87 86-64 63-36 35-0
Maximum of Loan-to-Value 75% 73% 72% 65%
Maximum of Debt-to-Income Ratio 40% 49% 59% 65%
</TABLE>
40
<PAGE>
While the Company primarily analyzes the three factors noted above, the
Company also reviews other factors to determine whether an application will be
subject to a higher interest rate than the interest rate applicable to the
rating under which such application has initially been placed. These include
factors such as an unsubstantiated employment history, a recent foreclosure
proceeding, a number of recent delinquent payments on an existing mortgage, a
recent bankruptcy filing, the presence of a senior mortgage or zoning
restrictions on the subject property or a loan-to-value ratio in excess of
71%. Based on this analysis, the loan committee approves, rejects or
restructures the proposed loan.
The following table reflects the risk classification for the Company's loan
originations and purchases for the periods indicated.
CLASSIFICATION OF LOAN ORIGINATIONS AND PURCHASES FOR THE QUARTER ENDED
MARCH 31, 1996
<TABLE>
<CAPTION>
LOAN TOTAL % OF WEIGHTED
CLASSIFICATION (AMOUNT IN THOUSANDS) TOTAL AVERAGE COUPON
-------------- --------------------- ----- --------------
<S> <C> <C> <C>
"A" Risk......................... $41,065 54.2% 8.6%
"B" Risk......................... 16,382 21.6 9.3
"C" Risk......................... 12,345 16.3 10.0
"D" Risk......................... 5,942 7.9 11.1
------- -----
Total.......................... $75,734 100.0% 9.2%
======= =====
</TABLE>
CLASSIFICATION OF LOAN ORIGINATIONS AND PURCHASES FOR THE YEAR ENDED
DECEMBER 31, 1995
<TABLE>
<CAPTION>
LOAN TOTAL % OF WEIGHTED
CLASSIFICATION (AMOUNT IN THOUSANDS) TOTAL AVERAGE COUPON
-------------- --------------------- ----- --------------
<S> <C> <C> <C>
"A" Risk......................... $129,922 54.0% 9.8%
"B" Risk......................... 48,793 20.3 10.4
"C" Risk......................... 42,488 17.7 11.3
"D" Risk......................... 19,441 8.0 11.9
-------- -----
Total.......................... $240,644 100.0% 10.3%
======== =====
</TABLE>
LOAN ORIGINATIONS AND PURCHASES
The following table highlights certain selected information relating to the
origination of loans by the Company during the periods shown.
LOAN ORIGINATIONS AND PURCHASES
<TABLE>
<CAPTION>
FOR THE
QUARTER
FOR THE YEAR ENDED ENDED MARCH
DECEMBER 31, 31,
-------------------- ------------
1994 1995 1995 1996
--------- --------- ----- -----
<S> <C> <C> <C> <C>
Type of property securing loan:
Single family.................. 92.4% 95.0% 96.3% 95.9%
Multi family................... 5.4 2.7 2.4 2.2
Planned Unit Development and
Other......................... 2.2 2.3 1.3 1.9
--------- --------- ----- -----
Total............................ 100.0% 100.0% 100.0% 100.0%
========= ========= ===== =====
Type of mortgage securing loan:
First mortgage................. 95.4% 94.5% 90.2% 98.6%
Second mortgage................ 4.4 5.4 9.4 1.4
Third mortgage................. .2 .1 0.4 --
--------- --------- ----- -----
Total............................ 100.0% 100.0% 100.0% 100.0%
========= ========= ===== =====
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
FOR THE
QUARTER
FOR THE YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
-------------------- ----------
1994 1995 1995 1996
--------- --------- ---- ----
<S> <C> <C> <C> <C>
Weighted average interest rate..... 8.7% 10.3% 10.8% 9.2%
Weighted average initial combined
loan-to-value ratio(1)............ 56.2% 59.4% 57.1% 62.2%
</TABLE>
- --------
(1) The loan-to-value ratio of a loan secured by a senior mortgage is
determined by dividing the amount of the loan by the appraised value of
the mortgaged property at origination. The combined loan-to-value ratio of
a loan secured by any junior mortgage is determined by taking the sum of
the loan secured by such mortgage and any senior mortgages and dividing by
the appraised value of the mortgaged property at origination.
FINANCING AND SALE OF LOANS
The Company finances the origination and purchase of loans with borrowings
under the Warehouse Financing Facility and internally generated cash flows.
See "Liquidity and Capital Resources" for a discussion of the basis for
positive operating cash flows. Securitization allows the Company to manage its
credit risk and cash flow and diversify its exposure to the potential
volatility of the capital markets. In addition, the Company sells on a
servicing released basis those loans that do not meet its criteria for
Securitization. Following the Public Offering, the Company will continue to
rely on these sources of capital, in addition to the proceeds of the Public
Offering, to finance its operations.
Warehouse Financing Facilities
The Company has a secured revolving line of credit of up to $125 million.
Under the Warehouse Financing Facility, the Company may borrow and repay
during the 90-day revolving period up to $125 million. Advances under the
Warehouse Financing Facility bear interest at 0.875% over 30 day LIBOR.
Amounts borrowed under the Warehouse Financing Facility and not used to
originate or purchase loans that are included in a Securitization in which the
lender under the Warehouse Financing Facility is the underwriter are subject
to an additional fee equal to 25 basis points of such borrowings. The
Warehouse Financing Facility contains affirmative, negative and financial
covenants typical of such credit facilities.
The Company recently executed a letter of intent with another lender with
respect to a supplemental warehousing facility (the "Supplemental Warehousing
Facility") in the amount of $25 million. Advances under the Supplemental
Warehousing Facility will bear interest at 0.80 % over 30 to 90 day LIBOR.
Securitization
The Company's Securitization program is an integral part of the Company's
business plan because it allows the Company to increase its loan origination
and purchase volume, more efficiently service its Servicing Portfolio and
reduce the risks associated with interest rate fluctuations. Since the
Company's initial use of Securitization in 1992 and up through June 30, 1996,
the Company has sold $826.8 million of loans through ten publicly underwritten
and two privately placed Securitizations, all of which were rated "AAA/Aaa."
For the quarter ended March 31, 1996 and for the year ended December 31, 1995,
the Company Securitized $52.4 million and $168.0 million or 69.2% and 69.8% of
its loan origination and purchase volume, respectively, representing 68.1% and
75.4% of the Company's loan origination and sale revenue for those periods.
The Company currently intends to complete quarterly Securitizations either in
private placements or in public offerings.
In a Securitization, the Company sells a pool of loans to a REMIC Trust in
exchange for Residual Interests and Regular Interests. While the Company
retains the Residual Interests, it immediately sells the Regular Interests and
uses the proceeds to repay borrowings under the Warehouse Financing Facility
to finance the pool of loans. The holders of the Regular Interests are
entitled to receive scheduled principal collected on the pool of Securitized
loans and interest at the pass-through interest rate on the certificate
balance. The Residual Interests held by the Company represent the subordinated
right to receive cash flows from the pool of Securitized loans
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<PAGE>
after payment of the required amounts to the holders of the Regular Interests
and the costs associated with the Securitization. See "Management's Discussion
and Analysis of Results of Operations and Financial Condition--Certain
Accounting Considerations" for a discussion of the Company's accounting
treatment of the gain on sale of loans and other aspects of its
Securitizations.
To improve the level of profitability from the sale of Securitized loans,
the Company arranges for credit enhancement to achieve an improved credit
rating on the Regular Interests issued. This credit enhancement generally
takes the form of an insurance policy, issued by a monoline insurance company,
insuring the holders of the Regular Interests of timely payment of the
scheduled pass-through interest and principal. In addition, the pooling and
servicing agreements that govern the distribution of cash flows from the loan
pool included in the REMIC Trusts typically require overcollateralization as
an additional means of credit enhancement. Overcollateralization requires an
initial deposit, the sale of loans at less than par or retention in the REMIC
Trust of collections from the pool until a specified overcollateralization
amount has been attained. This retention of excess cash flow creates a faster
amortization of the scheduled balance of the Regular Interests than the
amortization of the principal balance of the Securitized loan pool. The
purpose of the overcollateralization is to provide a source of payment in the
event of higher than anticipated credit loss. Losses resulting from defaults
by borrowers on the payment of principal or interest on the loans in the
Securitized pool will reduce the overcollateralization to the extent that
funds are available and may result in a reduction in the value of the Residual
Interests held by the Company. If payment defaults exceed the amount of
overcollateralization and current excess cash flow, the insurance policy will
pay any further losses experienced by holders of the Regular Interests in the
related REMIC Trust. In the event of a shortfall, the insurance policy for
such Securitization pays interest when due and all principal.
Generally, the Company sells to the REMIC Trust, the loans at face value
except when it sells loans at less than par for overcollateralization purposes
and without recourse except that certain representations and warranties with
respect to the loans are provided by the Company. The Company may be required
either to repurchase or to replace loans that do not conform to such
representations and warranties. To date, the Company has not been required
under the pooling and servicing agreements to substitute or repurchase any
loans sold in completed Securitizations.
The Company retains the servicing rights to the loans it Securitizes. The
Company also receives prepayment and other fees on Securitized loans.
Interest Rate Risk Management
The Company's profitability is in part determined by the difference, or
"spread," between the effective rate of interest received on the loans
originated or purchased by the Company and the interest rates payable under
its Warehouse Financing Facility during the Warehousing Period or for Regular
Interests issued in Securitizations. The spread can be adversely affected
after a loan is originated or purchased and while it is held during the
Warehousing Period by increases in the interest rate demanded by investors in
Securitizations. In addition, because the loans originated or purchased by the
Company have fixed and variable rates, the Company bears the risk of narrowing
of the spread because of interest rate increases during the period from the
date the loans are originated or purchased until the closing of the sale or
Securitizations of such loans.
The Company has implemented a hedging program designed to provide a level of
protection against the impact of rapid changes in interest rates on the value
of fixed rate loans from the time the Company commits to fund or purchase such
loans to the date of their Securitization or sale. The Company does not hedge
the interest rate risk associated with holding adjustable rate mortgages
pending their sale or Securitization due to the decreased significance of such
risk because the pass-through rates for Regular Interests related to the
Company's adjustable rate mortgage pools are also adjustable although not
necessarily in the same period.
43
<PAGE>
The Company's hedging program was initiated in 1994. During the first
quarter of 1996, 1995 and 1994, hedging transactions were limited to selling
short United States Treasury securities and prefunding loan originations in
its Securitizations. United States Treasury securities are utilized by the
Company due to the liquidity of the market for such securities and the high
degree of correlation between such securities and the pass-through interest
rates for Regular Interests in the Company's fixed rate mortgage pools.
Prefunding accounts are structured in some of the Company's Securitizations
from time to time. Prefunding allows the Company to deliver loans to a REMIC
Trust after the date of its closing, allowing the Company to fix the
relationship between the interest rates charged on loans and the pass-through
rates for Regular Interests in the mortgage pools.
The Company may from time to time utilize various financial instruments in
its hedging activities. The nature and quantity of hedging transactions are
determined by the Company's management based on various factors, including
market conditions and the expected volume of mortgage loan originations and
purchases. To decrease market risk, only highly liquid instruments are
utilized in the Company's hedging activities. By their nature, however, all
such instruments involve risk, and the maximum potential loss may exceed the
value at which such instruments are carried. As is customary for these types
of instruments, the Company does not require collateral or other security from
counterparties to these instruments. The Company manages its credit exposure
to counterparties through credit approvals, credit limits and other monitoring
procedures.
Wholesale Loan Sales
Certain loans originated or purchased by the Company are not chosen for
inclusion in a REMIC Trust. These loans may include loans with higher than
acceptable loan-to-value ratios or loans that have unacceptable credit risk.
The Company will originate these loans because it earns the origination fees
and will sell such loans on a servicing released basis in order to avoid
credit risk related to such loans. During the quarter endedMarch 31, 1996 and
the year ended December 31, 1995, the Company sold $21.5 million and $51.5
million, or 28.4% and 21.4%, respectively, of its loan origination and
purchase volume through loan sales in which servicing rights are transferred.
The Company anticipates that it will continue to sell certain loans on a
wholesale basis.
Private Investor Sales
Prior to 1992, the Company sold its loan origination volume to private
investors. Since the Company's utilization of Securitization in 1992, its use
of loan sales to private investors has declined. The Company has retained the
servicing rights to the loans it has sold to private investors. The Company
does not anticipate selling more than an insignificant amount of its loan
origination or purchase volume to private investors in the future.
SERVICING
The Company retains the right to service the loans it originates and
purchases (other than loans sold through wholesale loan sales). Loan servicing
includes collecting payments from borrowers, remitting payments to investors
who have purchased the loans, investor reporting, accounting for principal and
interest, contacting delinquent borrowers, conducting foreclosure proceedings
and disposing of foreclosed properties. The Company's Servicing Portfolio
includes 8,787 loans with an outstanding balance of $611.7 million as of March
31, 1996. The Company receives servicing fees ranging from .50% to 2.5% per
annum for fixed rate loans and .50% to 1.0% per annum for adjustable rate
loans, based upon the outstanding balance of the pool of loans in a REMIC
Trust for its duties relating to the accounting for and collection of the
loans. The Company currently services only Company originated or purchased
loans and does not service outside loans. Revenue generated from loan
servicing amounted to 15.1% of total revenues for the quarter ended March 31,
1996.
The Company has recently installed a sophisticated computer-based loan
servicing software that it believes enables it to provide effective and
efficient processing of loans. The system, which is able to service fixed and
adjustable rate loans, provides the Company with, among other things, payment-
processing, cashiering, collection and reporting functions.
44
<PAGE>
The Company believes its aggressive collection practices contribute to the
relatively low loss rates on its Servicing Portfolio. The following table
illustrates the time line of the Company's collection practices, assuming (i)
the loan is originated in California and (ii) a ten day grace period applies
by contract or under applicable law:
<TABLE>
<CAPTION>
TIME EVENT
---- -----
<C> <S>
1st day of the month Borrower loan payments
due
11th day of the month Payment not received is
late
13th day of the month Notice of past due
payment mailed to
borrower
20th day of the month Foreclosure notice
mailed to borrower
26th day of the month Final notice mailed to
borrower
42 days after due date File forwarded to
foreclosure department
which records notice of
default on 45th day of
delinquency
After notice of default or similar notice is recorded Borrower informed of
status and the Company's
reinstatement period
dates
During the Company's reinstatement period Pre-foreclosure
appraisal performed
End of the Company's reinstatement period Notice of sale recorded
and trustee's sale date
scheduled Property sold
to third party or
acquired on behalf of
the Company
</TABLE>
The borrower is contacted by telephone subsequent to recording the notice of
default to inform the borrower of the situation and of the date that will
permit a sale of the subject property by the trustee. If the borrower does not
bring the loan current within the the Company's reinstatement period, a notice
of sale is published and a trustee's sale date is scheduled. During this
period of time, the Company performs a pre-foreclosure appraisal of the
property to determine whether changes in the value of the property have
occurred since the date of origination. If the loan is not reinstated, the
property is either sold to a third party at the trustee's sale or acquired on
behalf of the Company. The Company forecloses as quickly as state regulations
allow. The Company contracts on a nationwide basis with an independent
foreclosure service to facilitate the foreclosure process on properties
located outside of California. For delinquent loans originated within
California, the Company performs foreclosure procedures internally. Properties
acquired by the Company ("REO") are managed by the Company with the objective
of immediate refurbishment and sale.
In other states, the Company's collection procedures described above may
occur sooner or later depending upon state specific foreclosure regulations.
In September 1993, the Company began originating adjustable rate loans. At
that time, the Company contracted with a third party to sub-service all
adjustable rate loan originations. Over the past year, the Company's
acquisition of loan servicing software has enabled the Company to service
adjustable rate loans and, as of October 1995, the Company terminated its sub-
servicing contract with the third party. Effective February 1, 1996, the
portion of the Company's loan portfolio previously sub-serviced was
transferred to the Company.
The Company's loan servicing software also allows the Company to track and
maintain hazard insurance information. Periodic expiration reports list all
policies scheduled to expire within 30 days. When policies lapse, a letter is
issued advising the borrower of the lapse and that the Company will obtain
force placed insurance at the borrower's expense. Additionally, the Company
has a blanket insurance policy in place that provides coverage for the Company
in the event that the Company fails to obtain force placed insurance in a
timely manner upon expiration of the homeowner's policy.
45
<PAGE>
The following table provides data on delinquency experience and REO
Properties for the Company's Servicing Portfolio.
<TABLE>
<CAPTION>
AS OF
--------------------------------------------------------------
DECEMBER 31, 1994 DECEMBER 31, 1995 MARCH 31, 1996
-------------------- -------------------- --------------------
(DOLLARS % OF (DOLLARS % OF (DOLLARS % OF
IN SERVICING IN SERVICING IN SERVICING
THOUSANDS) PORTFOLIO THOUSANDS) PORTFOLIO THOUSANDS) PORTFOLIO
---------- --------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Servicing Portfolio..... $555,685 100.00% $613,791 100.00% $611,718 100.00%
-------- ------ -------- ------ -------- ------
30-59 days delinquent... $ 6,084 1.1% $ 8,339 1.4% $ 11,800 1.9%
60-89 days delinquent... 4,471 0.8 6,538 1.0 5,166 0.8
90 days or more 13,589 2.4 21,002 3.4 21,800 3.6
delinquent............. -------- ------ -------- ------ -------- ------
Total delinquencies..... $ 24,144 4.3% $ 35,879 5.8% $ 38,766 6.3%
REO (1)................. $ 3,386 0.6% $ 7,854 1.3% $ 8,677 1.4%
</TABLE>
- --------
(1) Includes REO of the Company as well as REO of the REMIC Trusts and
serviced by the Company; however, excludes private investor REO not
serviced by the Company.
The following table provides data on loan loss experience on the Company's
loans (in thousands).
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE QUARTER
DECEMBER 31, 1994 DECEMBER 31, 1995 ENDED MARCH 31, 1996
------------------ ------------------ --------------------
<S> <C> <C> <C>
Average Servicing
Portfolio balance
outstanding (1) $470,628 $584,738 $612,755
Net losses (2).......... 44 169 465
As a percent of average
Servicing Portfolio
balance outstanding.... .01% .03% .08%
</TABLE>
- --------
(1) Average Servicing Portfolio balance equals the average of the Servicing
Portfolio balance at the beginning and ending period.
(2) Net losses means actual net losses realized with respect to the
disposition of the REO.
Foreclosure
Regulation and practices in the United States regarding the liquidation of
properties (e.g., foreclosure) and the rights of the mortgagor in default vary
greatly from state to state. Loans originated by the Company are secured by
mortgages, deeds of trust, trust deeds, security deeds or deeds to secure
debt, depending upon the prevailing practice in the state in which the
property securing the loan is located. Depending on local law, foreclosure is
effected by judicial action and/or non-judicial sale, and is subject to
various notice and filing requirements. If foreclosure is effected by judicial
action, the foreclosure proceedings may take several months.
In general, the borrower, or any person having a junior encumbrance on the
real estate, may cure a monetary default by paying the entire amount in
arrears plus other designated costs and expenses incurred in enforcing the
obligation during a statutorily prescribed reinstatement period. Generally,
state law controls the amount of foreclosure expenses and costs, including
attorneys' fees, which may be recovered by a lender.
There are a number of restrictions that may limit the Company's ability to
foreclose on a property. A lender may not foreclose on the property securing a
junior mortgage loan unless it forecloses subject to each senior mortgage, in
which case the junior lender or purchaser at such a foreclosure sale will take
title to the property subject to the lien securing the amount due on the
senior mortgage. Moreover, if a borrower has filed for bankruptcy protection,
a lender may be stayed from exercising its foreclosure rights. Also, certain
states provide a homestead exemption that may restrict the ability of a lender
to foreclose on residential property. In such states, the Company requires the
borrower to waive his or her right of homestead. Such waivers of homestead
rights may not be enforceable in certain states.
46
<PAGE>
Although foreclosure sales are typically public sales, frequently no third
party purchaser bids in excess of the amount of the lender's lien. Such a lack
of bidding is due to several factors, including the difficulty of determining
the exact status of title to the property, the possible deterioration of the
property during the foreclosure proceedings and the requirement that the
purchaser pay for the property in cash or by cashier's check. Thus, the
foreclosing lender often purchases the property from the trustee or referee
for an amount equal to the principal amount outstanding under the loan,
accrued and unpaid interest and the expenses of foreclosure. Depending upon
market conditions, the proceeds of the subsequent resale by the Company may
not be adequate to cover the Company's investment in the property. If, after
determining that purchasing a property securing a loan will minimize the loss
associated with the defaulted loan, the Company may bid at the foreclosure
sale for such property or accept a deed in lieu of foreclosure.
Prior to a foreclosure, the Company performs a foreclosure analysis with
respect to the mortgaged property to determine the value of the mortgaged
property and the bid that the Company will make at the foreclosure sale. This
is based on (i) a current valuation of the property obtained through a drive-
by appraisal conducted by an appraiser, (ii) an estimate of the sales price of
the mortgaged property, (iii) an evaluation of the amount owed, if any, to a
senior mortgagee and for real estate taxes and (iv) an analysis of marketing
time, required repairs and other costs, such as real estate broker fees, that
will be incurred in connection with the foreclosure sale.
All foreclosures (except California) are managed by independent contractors
located in the same state as the mortgaged property. Bankruptcies filed by
borrowers are managed by local counsel retained by the Company for loans
originated in California. For those loans originated outside California,
bankruptcies filed by borrowers are managed by appropriate local counsel who
are required to provide monthly reports on each loan file.
CURRENT MARKETS AND EXPANSION PLANS
Current Markets
The Company is licensed or registered to originate loans in twelve states
through its 19 retail branch offices. The Company believes that its strategy
of originating loans through an extensive retail branch office network
represents the most profitable loan origination strategy due to the
significant level of loan origination fees earned by the Company.
Additionally, such a strategy allows the Company to maintain its underwriting
quality standards when compared to competitors using independent mortgage
brokers. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Although the Company is licensed to originate loans in twelve states, it has
historically concentrated its business in California. While this concentration
has declined, California remains a significant part of the Company's business
and has contributed 44.0% and 43.0% of the Company's total loan originations
and purchases for the quarter ended March 31, 1996 and year ended December 31,
1995, respectively. Six of the retail branch offices are in California's major
metropolitan areas. Expansion outside California began in late 1994. The
number of retail branch offices within California has declined from a
historical high of 11 in 1992 to six at June 30, 1996.
47
<PAGE>
The following table shows the geographic distribution of the Company's loan
originations and purchases for the periods indicated.
GEOGRAPHIC DISTRIBUTION OF LOAN ORIGINATIONS AND PURCHASES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, QUARTER ENDED MARCH 31,
----------------------- -----------------------
1994 1995 1995 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
States
California......... 94.3% 43.0% 51.0% 44.0%
Illinois........... -- 14.1 8.7 14.7
Washington......... 3.4 14.9 23.1 11.3
Florida............ 0.1 8.1 0.4 8.2
Colorado........... 0.4 6.7 6.6 5.4
Oregon............. 0.2 5.9 5.2 6.1
Utah............... -- 2.5 0.1 4.9
Arizona............ 0.1 1.7 -- 2.8
Georgia............ 0.2 2.7 3.6 1.7
Others............. 1.3 0.4 1.3 0.9
----------- ----------- ----------- -----------
Total: .......... 100.0% 100.0% 100.0% 100.0%
=========== =========== =========== ===========
</TABLE>
Nationwide and International Geographic Expansion
The Company intends to expand its existing retail branch network in selected
states on a nationwide basis. The Company currently plans to open at least
four new retail branches per year. The Company has also recently organized a
subsidiary under the laws of the United Kingdom to pursue retail originations
and wholesale purchases in the United Kingdom. The Company's expansion
strategy involves (i) identifying areas with demographic statistics that are
comparable to existing markets where the Company has been successful in
originating loans, (ii) understanding each new market's regulatory
requirements and tailoring the Company's loan programs and practices to comply
with such requirements and (iii) identifying and training branch managers and
loan officers for each new retail branch office.
The Company believes that its products and services are best suited for
those housing markets with home values near the national averages. After
identifying a potential new market, the Company contracts with regional or
national companies to gather publicly available information with respect to
such market and to integrate such information with the Company's proprietary
marketing methodology. These companies produce a list of Targeted Homeowners
that the Company believes, based on its historic customer profile, are more
likely to utilize the Company's products and services and satisfy the
Company's underwriting guidelines than the average homeowner. The Company then
focuses its marketing efforts in the new market on the Targeted Homeowners
identified on the list.
The Company has generally entered short term leases for the offices and
purchased the equipment and materials necessary to start a new retail branch.
The Company has usually recruited and hired the personnel required to staff
the retail branch office from the new market. Managers of new branches are
generally managers of existing branches or loan officers promoted from
existing retail branch offices. Personnel from headquarters or individuals
with previous experience at the Company's branches spend some time at the new
branch training the new personnel. The Company plans to continue these
practices in any future expansion.
COMPETITION
As a consumer finance company, the Company faces intense competition.
Traditional competitors in the financial services business include other
mortgage banking companies, mortgage brokers, commercial banks, credit unions,
thrift institutions, credit card issuers and finance companies. Many of these
competitors in the consumer finance business are substantially larger and have
considerably greater financial, technical and
48
<PAGE>
marketing resources than the Company. Competition can take many forms
including convenience in obtaining a loan, customer service, marketing and
distribution channels, amount and term of the loan, loan origination fees, and
interest rates. In addition, the current level of gains realized by the
Company and its existing competitors on the sale of loans could attract
additional competitors into this market with the possible effect of lowering
gains on future loan sales owing to increased loan origination competition.
The Company believes that it is able to compete on the basis of providing
prompt and responsive service, consistent underwriting and competitive loan
programs to borrowers whose needs are not met by Conventional Leading
Institutions.
REGULATION
The Company's business is subject to extensive regulation at both the
Federal and state level. Regulated matters include loan origination, credit
activities, maximum interest rates and finance and other charges, disclosure
to customers, the terms of secured transactions, the collection, repossession
and claims handling procedures utilized by the Company, multiple qualification
and licensing requirements for doing business in various jurisdictions and
other trade practices.
TRUTH IN LENDING. The Truth in Lending Act ("TILA") and Regulation Z
promulgated thereunder contain certain disclosure requirements designed to
provide consumers with uniform, understandable information with respect to the
terms and conditions of loans and credit transactions in order to give them
the ability to compare credit terms. TILA also guarantees consumers a three
day right to cancel certain credit transactions including loans of the type
originated by the Company. Management of the Company believes that it is in
compliance with TILA in all material respects. If the Company were found not
to be in compliance with TILA, aggrieved borrowers could have the right to
rescind their loans and to demand, among other things, the return of finance
charges and fees paid to the Company.
In September 1994, the Riegle Act was enacted. Among other things, the
Riegle Act makes certain amendments to TILA (the "TILA Amendments"). The TILA
Amendments generally apply to mortgage loans (other than mortgage loans to
finance the acquisition or initial construction of a dwelling) with (i) total
loan origination fees and other fees upon origination in excess of the greater
of eight percent of the total loan amount or a certain dollar amount
(currently $400) or (ii) an annual percentage rate of more than ten percentage
points higher than comparably maturing U.S. treasury securities ("Covered
Loans"). The Company estimates that substantially all of the loans currently
originated or purchased by the Company are Covered Loans.
The TILA Amendments impose additional disclosure requirements on lenders
originating Covered Loans and prohibit lenders from engaging in a pattern or
practice of originating Covered Loans that are underwritten solely on the
basis of the borrower's home equity without regard to the borrower's ability
to repay the loan. As the Riegle Act became effective on October 1, 1995, the
Company believes, based on a review of its loan portfolio, that only a small
portion of loans originated in fiscal year 1995 are of the type that, unless
modified, are prohibited by the TILA Amendments. The Company will, consistent
with its practices with respect to all loans, apply to all Covered Loans
underwriting criteria that take into consideration the borrower's ability to
repay.
The TILA Amendments also prohibit lenders from including prepayment fee
clauses in Covered Loans to borrowers with a monthly debt-to-income ratio in
excess of 50% or Covered Loans used to refinance existing loans originated by
the same lender or an affiliate of such lender. The Company reported $3.2
million, $3.1 million and $2.6 million in prepayment fee revenue in fiscal
year 1995, 1994 and 1993, respectively. The Company will continue to collect
prepayment fees on loans originated prior to the October 1995 effectiveness of
the TILA Amendments and on non-Covered Loans as well as on Covered Loans in
permitted circumstances. Because compliance with the TILA Amendments was not
required until October 1995, the level of prepayment fee revenue is unlikely
to be substantially affected in fiscal year 1996, but the level of prepayment
fee revenue may decline in future years. The TILA Amendments impose other
restrictions on Covered Loans, including
49
<PAGE>
restrictions on balloon payments and negative amortization features, which the
Company does not believe will have a material impact on its operations.
OTHER LENDING LAWS. The Company is also required to comply with the Equal
Credit Opportunity Act of 1974, as amended ("ECOA"), which prohibits creditors
from discriminating against applicants on certain prohibited bases, including
race, color, religion, national origin, sex, age or marital status. Regulation
B promulgated under ECOA restricts creditors from obtaining certain types of
information from loan applicants. Among other things, it also requires certain
disclosures by the lender regarding consumer rights and requires lenders to
advise applicants of the reasons for any credit denial. In instances where the
applicant is denied credit or the rate or charge for loans increases as a
result of information obtained from a consumer credit agency, another statute,
the Fair Credit Reporting Act of 1970, as amended, requires lenders to supply
the applicant with the name and address of the reporting agency. In addition,
the Company is subject to the Fair Housing Act and regulations thereunder,
which broadly prohibit certain discriminatory practices in connection with the
Company's business. The Company is also subject to the Real Estate Settlement
Procedures Act of 1974, as amended, and the Home Mortgage Disclosure Act.
In addition, the Company is subject to various other Federal and state laws,
rules and regulations governing, among other things, the licensing of, and
procedures that must be followed by, mortgage lenders and servicers, and
disclosures that must be made to consumer borrowers. Failure to comply with
such laws, as well as with the laws described above, may result in civil and
criminal liability.
INSURANCE REGULATORY LAWS. 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 such coverage prior to
closing of the borrower's loan or if the borrower's coverage is subsequently
cancelled or nonrenewed at any time during the loan period and the borrower
fails to obtain new coverage, the Company will provide coverage on the
borrower's behalf under policies insuring the Company's interest in the
collateral. Such practice is commonly referred to a "forced placement" of
insurance. The Company receives a fee in connection with its placement of such
insurance in California, which activity is not required to be licensed.
Historically, the Company also received a fee in connection with the placement
of such insurance outside California. While the Company does not believe,
based on the advice of regulatory counsel, that it was required to be licensed
in connection with such activity, a state insurance regulator or a court could
take a different interpretation.
Insurance which is force placed is subject to regulation under TILA, the
National Flood Insurance Act, and state insurance regulatory and lender
statutes. Such laws and regulations generally impose disclosure and notice
requirements which must be satisfied prior to forced placement of coverage,
limitations on the amount of coverage that a lender may obtain to protect its
interest in the collateral and restrictions on fees and charges that the
Company may assess in connection with such insurance.
In addition, in the state of California only, the Company provides insurance
agency services with respect to credit life insurance and credit disability
insurance. The Company's sale of these insurance products in California is
subject to statutes and regulations in that state applicable to insurance
producers.
Failure to comply with any of the foregoing federal and state laws and
regulations could result in the imposition of civil penalties on the Company,
class action lawsuits and administrative enforcement actions.
UNITED KINGDOM REGULATIONS. A portion of the Company's mortgage banking
business in the United Kingdom is subject to regulations promulgated under the
United Kingdom Consumer Credit Act 1974 (the "CCA") applicable to loans made
to individuals or partnerships with principal balances of (Pounds)15,000 or
less. Loans with principal balances in excess of (Pounds)15,000 are not
currently regulated within the United Kingdom. The CCA and regulations
promulgated thereunder, among other things, impose licensing obligations on
the Company's English subsidiaries, set down certain requirements relating to
the form, content, legibility, execution and delivery of loan documents,
restrict communication with the borrower prior to completion of a transaction,
require information and notice of enforcement to be given to the borrower,
require rebates to the borrower on
50
<PAGE>
early settlement and create a cause of action for "extortionate credit
bargains." A license is required to service loans in the United Kingdom
irrespective of the size of the loan. Failure to comply with the requirements
of these rules and regulations can result in the revocation or suspension of
the license to do business and render the mortgage unenforceable in the
absence of a court order.
The Company's planned operations in the United Kingdom will involve loans
with principal balances in excess of (Pounds)15,000 and will therefore be
largely unregulated.
ENVIRONMENTAL MATTERS
To date, the Company has not been required to perform any investigation or
clean up activities, nor has it been subject to any environmental claims.
There can be no assurance, however, that this will remain the case in the
future.
In the course of its business, the Company has acquired and may acquire in
the future properties securing loans that are in default. Although the Company
primarily lends to owners of residential properties, there is a risk that the
Company could be required to investigate and clean up hazardous or toxic
substances or chemical releases at such properties after acquisition by the
Company, and may be held liable to a governmental entity or to third parties
for property damage, personal injury and investigation and cleanup costs
incurred by such parties in connection with the contamination. In addition,
the owner or former owners of a contaminated site may be subject to common law
claims by third parties based on damages and costs resulting from
environmental contamination emanating from such property.
EMPLOYEES
As of May 31, 1996, the Company had a total of 322 employees. The Company
has 186 employees working at its corporate headquarters. None of the Company
employees are covered by a collective bargaining agreement. The Company
considers its relations with its employees to be good.
PROPERTIES
The Company's corporate headquarters are located at 17305 Von Karman Avenue,
Irvine, California 92714-6203, where the Company leases from a partnership
beneficially owned by Brian and Sarah Chisick approximately 40,000 square feet
of office space. See "Certain Transactions--Lease of Corporate Headquarters."
The lease expires on January 31, 2003, and the Company has an option to renew
the lease for five years. The Company also leases office space for its 19
retail branch offices in 12 states. The average size of these retail branch
offices is approximately 1,700 square feet, with an annual average base rent
of approximately $32,000. The Company believes its facilities are both
suitable and adequate for the current business activities conducted at its
corporate headquarters and at its existing retail branch offices.
LEGAL PROCEEDINGS
The Company is a party to various routine legal proceedings arising out of
the ordinary course of its business. Management believes that none of these
actions, individually or in the aggregate, will have a material adverse affect
on the results of operations or financial condition of the Company.
In December 1989, Edward and Rosa Dunning filed on behalf of certain
borrowers a class action suit related to the origination of loans by the
Company. The suit was filed in the Superior Court of California in the County
of Alameda. The plaintiffs alleged that disclosure statements given to them by
the Company were insufficient under the Truth-in-Lending Act. Plaintiffs
sought declaratory and injunctive relief as well as monetary damages. The
Company, in order to avoid the cost of continued litigation and without
admitting to any wrong-doing, agreed to settle the case in December 1994. The
terms of the settlement provide cash distributions to the plaintiffs in the
amount of $6,850,000, which is to be paid out over a three-year period and
secured by a pledge of cash collateral. As of March 31, 1996, remaining future
payments to plaintiffs totaled approximately $1,833,000.
51
<PAGE>
On August 10, 1988, the California Department of Corporations filed a civil
action against the Company and certain of its officers and directors that
alleged, among other things, that the Company discriminated in its loan terms
based on the racial composition of the area in which a subject property was
located. The action sought to revoke certain licenses of the Company. The
Company settled the action without a finding or admission of wrongdoing and
the Company's licenses were not impacted. The settlement provided for total
payments by the Company of $436,000 and provided for a permanent injunction
requiring the Company to abide by the Holden Act. In February 1992, the
Department of Corporations confirmed in writing that the Company had fully
complied with the terms of the settlement.
In August 1988, the California Department of Real Estate (the "DRE") filed
an action that incorporated the allegations made by the Department of
Corporations, sought to revoke the real estate licenses of Brian Chisick and
the Company and also alleged that the Company had commingled funds. The DRE
specifically noted that the alleged commingling did not result in any loss to
any borrower or investor. The action was settled in July 1989 with no finding
or admission of wrongdoing in consideration of the payment of a total of
$20,000 to the State of California.
52
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The Board of Directors of the Company is divided into three classes: Class
I, Class II and Class III. After his or her initial term, each director serves
for a term ending following the third annual meeting following the annual
meeting at which such director is elected and until his or her successor is
elected. The terms of office of directors in Class I, Class II and Class III
end after the annual meetings of stockholders of the Company in 1997, 1998 and
1999, respectively. The following table sets forth the name, age and position
with the Company of each person who is an executive officer or director of the
Company or FAMCO, as the case may be. An asterisk beside an individual's title
denotes that such individual is an executive officer of FAMCO and not of First
Alliance Corporation.
<TABLE>
<CAPTION>
NAME AGE POSITIONS WITH THE COMPANY CLASS
---- --- -------------------------- -----
<C> <C> <S> <C>
Brian Chisick......................... 57 President, Chief Executive
Officer and Director of
First Alliance Corporation
and FAMCO II
Sarah Chisick......................... 55 Vice President* and
Director of First Alliance
Corporation and FAMCO II
Jeffrey W. Smith...................... 34 Executive Vice President,
Sales and Marketing
and Future Director of
First Alliance
Corporation and FAMCO I
Mark K. Mason......................... 37 Executive Vice President,
Chief Financial Officer
and Future Director of
First Alliance
Corporation and FAMCO I
Randall K. McPhillips................. 38 Vice President, Portfolio
Refinancing Operations*
John M. Michel........................ 37 Vice President, Finance*
Peggy A. Tom.......................... 54 Vice President,
Foreclosure, Legal and
Collections*
Bruce Bollong......................... 48 Vice-President,
Administration*
Patricia G. Sullivan.................. 50 Vice President, Staff
Development*
Catalina Alvarez...................... 44 Vice President, Processing
and Disbursement*
Beverly Allen......................... 43 Vice President, Loan
Servicing*
Merrill Butler........................ 71 Future Director of First
Alliance Corporation and
FAMCO III
George Gibbs, Jr. .................... 65 Future Director of First
Alliance Corporation and
FAMCO III
Albert L. Lord........................ 50 Future Director of First
Alliance Corporation and
FAMCO III
</TABLE>
Each individual named as a Future Director in the foregoing table has been
elected as a Director of the Company effective upon the completion of the
Public Offering and has consented to be named as such herein.
The name and business experience during the past five years of each director
and executive officer of the Company are described below.
Brian Chisick has been the Chairman of the Board, Chief Executive Officer
and President of the Company since its founding in 1971. Mr. Chisick has held
a real estate broker's license since 1971. In 1985, Mr. Chisick was Vice
President of the Mortgage Brokers Institute, a statewide trade association of
over 120 mortgage brokers and served as a member of the legislative committee
of the Mortgage Brokers Institute.
Sarah Chisick has been Vice President and a Director of the Company since
1971. Her duties have in the past included projects in the loan servicing,
foreclosure, marketing and investment departments. She is not currently
involved in the day to day operations of the Company.
53
<PAGE>
Jeffrey W. Smith has been Executive Vice President, Sales and Marketing, of
the Company since 1995. From 1984 to 1995, Mr. Smith held various positions in
the Company including, Assistant Director of Marketing, Director of Marketing
and Vice President of Marketing. Mr. Smith has agreed to become a Director of
the Company effective upon the completion of the Public Offering.
Mark K. Mason, a certified public accountant, has been Executive Vice
President and Chief Financial Officer of the Company since November 1995. From
1994 to 1995, Mr. Mason was Executive Vice President and Chief Financial
Officer of Fidelity Federal Bank, a Federal Savings Bank, where he remains a
member of the Board of Directors. From 1993 to 1994, Mr. Mason was a Senior
Manager with the international accounting firm of Deloitte & Touche LLP. From
1990 to 1993, Mr. Mason was Executive Vice President and Chief Financial
Officer of the Eadington Companies. Mr. Mason has agreed to become a Director
of the Company effective upon the completion of the Public Offering.
Randall K. McPhillips has been with the Company since 1982. Mr. McPhillips
has worked as a Loan Officer, Branch Manager, Regional Sales Manager, and
became a Vice President in 1987. Currently, Mr. McPhillips is responsible for
the Portfolio Refinancing Operations of the Company.
John M. Michel, a certified public accountant, has been Vice President,
Finance of the Company since April 1996. From 1995 to April 1996, Mr. Michel
was Senior Vice President and Director of Corporate Planning for Fidelity
Federal Bank. From 1989 to 1995, he was Vice President of Finance and
Accounting for Akins Companies, a diversified company in the residential
property development business.
Peggy A. Tom has been Vice President of the Foreclosure, Legal and
Collections departments of the Company since 1982. From 1982 to 1996, Ms. Tom
was a Director of the Company.
Bruce Bollong has been Vice President, Administration of the Company since
1995. From 1985 to 1995, Mr. Bollong was Vice President, Finance of the
Company.
Patricia G. Sullivan has been Vice President, Staff Development since
September 1993. From 1990 to 1993, Ms. Sullivan was the Company's Sales
Manager.
Catalina Alvarez has been Vice President, Processing and Disbursement, of
the Company, since 1993. From 1982 to 1993, Ms. Alvarez was manager of the
Company's Processing and Disbursement Department.
Beverly Allen has been Vice President, Loan Servicing of the Company since
1993. From 1976 to 1993, Ms. Allen was Manager, Loan Servicing.
The following future directors, Merrill Butler, George Gibbs, Jr. and Albert
L. Lord, are not affiliated with the Company.
Merrill Butler has agreed to become a Director of the Company effective upon
the completion of the Public Offering. Mr. Butler formed Merrill Butler, Inc.,
in 1983 to consult with savings and loans on real estate matters. During 1995,
Mr. Butler served on the Volunteer Executive Team organized to advise Orange
County, California after the County had declared bankruptcy. Mr. Butler was a
co-creator of the Butler Popejoy Group, a general partnership, which, from
1992 to 1994, capitalized home builders with equity funds to develop entry
level housing projects. Mr. Butler served from 1986 to 1989 as the President,
Chief Executive Officer, and, in 1988, as the Chairman of the American Real
Estate Group. From 1955 to 1983, Mr. Butler was President of his own home
building and development companies, which developed 12,500 homes, apartments,
etc., in Southern California and Arizona. Mr. Butler is also a past director
of the Federal National Mortgage Association (Fannie Mae) and a former member
of both the Advisory Committee of the Federal Home Loan Mortgage Corporation
(Freddie Mac) and the Federal Savings & Loan Advisory Council to the Federal
Home Loan Bank Board. Mr. Butler was also a United States delegate to the
United Nations for the European Economic Commission on Housing. Mr. Butler has
previously served on the Boards of Directors of Financial Corporation of
America, American Savings and Loan, The Commodore Corporation, Far Western
Bank, National Association of Home Builders and the Building Industry
Association of Southern California.
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George Gibbs, Jr. has agreed to become a Director of the Company effective
upon the completion of the Public Offering. Mr. Gibbs has been Principal and
Senior Vice President of Johnson & Higgins since 1987. Mr. Gibbs has been a
director of Fidelity Federal Bank, a Federal Savings Bank, since August 1994.
Mr. Gibbs is a past Vice President and Executive Committee member of the Los
Angeles Chamber of Commerce.
Albert L. Lord has agreed to become a Director of the Company effective upon
the completion of the Public Offering. Since January 1994, Mr. Lord has been
the President of LCL, Ltd., a financial consulting and equity investment
management company. From October 1981 to January 1994, Mr. Lord was Chief
Operating Officer and Executive Vice President for the Student Loan Marketing
Association (Sallie Mae). Mr. Lord is a director of the Student Loan Marketing
Association.
COMMITTEES OF THE BOARD OF DIRECTORS
Audit Committee. Promptly following the closing of the Public Offering, the
Board of Directors will establish an audit committee (the "Audit Committee").
The Audit Committee, among other things, will make recommendations to the
Board concerning the engagement of independent public accountants; monitor and
review the quality and activities of the Company's internal audit function and
those of its independent accountants; and monitor the adequacy of the
Company's operating and internal controls as reported by management and the
independent or internal auditors. The members of the Audit Committee are
anticipated to be Messrs. Lord, Gibbs and Smith.
Compensation Committee. Promptly following the closing of the Public
Offering, the Board of Directors will establish a compensation committee (the
"Compensation Committee"). The Compensation Committee, among other things,
will review salaries, benefits and other compensation, excluding stock based
compensation, of Directors, officers and other employees of the Company and
make recommendations to the Board. The members of the Compensation Committee
are anticipated to be Messrs. Gibbs, Butler and Chisick. Mr. Chisick will not
vote on any matters affecting his or Mrs. Chisick's compensation.
Stock Incentive Committee. Immediately prior to the effective date of the
Registration Statement of which this Prospectus constitutes a part, the Board
of Directors established a stock incentive committee (the "Stock Incentive
Committee"). The Stock Incentive Committee is authorized to make stock based
compensation grants under the Company's stock incentive plan (See
"Management--1996 Stock Incentive Plan"). The members of the Stock Incentive
Committee are Mr. and Mrs. Chisick. Except for grants that are approved by a
majority of the disinterested members of the Compensation Committee, no member
of the Stock Incentive Committee is eligible to participate in the Stock
Incentive Plan.
NON-EMPLOYEE DIRECTORS COMPENSATION
Non-employee directors of the Company receive an annual retainer of $15,000,
a committee chair retainer of $1,500, a meeting fee of $1,000 and are
reimbursed for reasonable expenses incurred in connection with attendance at
Board of Directors' meetings or committee meetings. A meeting fee of $500 will
be paid to non-employee directors for telephonic meetings of 30 minutes or
less. On the date of this Prospectus, the Company granted options to its non-
employee directors under the 1996 Stock Incentive Plan to purchase an
aggregate of 112,500 shares of Class A Common Stock at an exercise price equal
to the Public Offering price. See "Management--1996 Stock Incentive Plan."
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<PAGE>
EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth information concerning the annual and long-
term compensation earned by the Company's chief executive officer and each of
the four other most highly compensated executive officers whose annual salary
and bonus during the fiscal years presented exceeded $100,000 (the "Named
Executive Officers").
ANNUAL COMPENSATION
<TABLE>
<CAPTION>
FISCAL
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS
--------------------------- ------ -------- ----------
<S> <C> <C> <C>
Brian Chisick.................................... 1995 $288,000 $ 500,000
President & CEO 1994 288,000 --
1993 288,000 3,000,000
Randall K. McPhillips............................ 1995 332,118 10,000
Vice President, Portfolio Refinancing 1994 373,920 110,000
1993 245,536 50,000
Jeffrey W. Smith................................. 1995 167,259 30,000
Executive Vice President, Marketing 1994 155,780 45,000
1993 122,984 20,000
Patricia G. Sullivan............................. 1995 166,232 10,000
Vice President, Staff Development 1994 166,232 20,000
1993 157,003 26,000
Bruce E. Bollong................................. 1995 120,083 10,000
Vice President, Administration 1994 133,356 20,000
1993 109,808 20,000
</TABLE>
- --------
Employment Agreements
Chisick Agreement
The Company has entered into an employment agreement with Mr. Chisick
providing for an initial term of three years, subject to automatic three-year
renewal unless either party provides notice of an intention not to renew.
Under this Agreement, Mr. Chisick will receive an annual salary of $395,000,
subject to annual increases (but not decreases) and bonuses as may be
determined by the Board of Directors, as well as certain other benefits
including medical, insurance, death and disability benefits, use of an
automobile and reimbursement of employment related expenses.
Mason Agreement
The Company has entered into an employment agreement with Mr. Mason. The
employment agreement provides for an indefinite employment term beginning on
October 1, 1995. The Company or Mr. Mason may terminate the employment
agreement at any time. Under the terms of the employment agreement, Mr. Mason
is entitled to receive an annual salary of at least $240,000, subject to
annual increases (but not decreases) as determined by the Board of Directors.
Pursuant to the employment agreement Mr. Mason was granted, on June 29, 1996,
107,500 shares of Class B Common Stock under the Company's Stock Incentive
Plan (after giving effect to a May 1996 stock split), representing 1% of the
total issued and outstanding shares of Class B Common Stock, subject to
vesting. Approximately 24.6% of these shares will vest upon the closing of the
Public Offering and the remaining shares, to the extent not vested, will vest
in 20% increments over 5 years beginning October 1, 1995 (subject to
acceleration upon certain conditions). In the event that Mr. Mason's vested
shares of Class B Common Stock are not freely tradeable under applicable
Federal and state securities laws, Mr. Mason is entitled
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<PAGE>
to sell such vested shares of Class B Common Stock to the Company for the fair
value of such stock at that time. Additionally, in the event that vested
shares are not publicly traded at the termination date of the agreement, the
Company has a right of first refusal to purchase such shares for the fair
value of such stock at that time.
1996 STOCK INCENTIVE PLAN
The Company has established a stock incentive plan (the "Stock Incentive
Plan") to enable directors, executive officers, independent contractors and
other key employees of the Company, to participate in the ownership of the
Company. The Stock Incentive Plan covers 750,000 shares of Class A Common
Stock. The initial issuance under the Stock Incentive Plan consisted of
107,500 shares of Class B Common Stock issued to Mark K. Mason. See
"Management--Executive Compensation--Mason Employment Agreement." On the date
of this Prospectus, the Company granted options to acquire an aggregate of
510,000 shares of Class A Common Stock. These options vest 25% six months from
the date of grant and 25% each year thereafter until fully vested and expire
on the earlier of ten years from the date of grant or 90 days after a holder's
termination of service. The Stock Incentive Plan is designed to attract and
retain directors, executive officers, independent contractors and other key
employees of the Company. The Stock Incentive Plan provides for the award to
eligible employees of the Company of a broad variety of stock-based
compensation alternatives such as non-qualified stock options, incentive stock
options, restricted stock and performance awards.
The Stock Incentive Plan is administered by the Stock Incentive Committee,
which is authorized to select from among the eligible participants the
individuals to whom options, restricted stock purchase rights and performance
awards are to be granted and to determine the number of shares to be subject
thereto and the terms and conditions thereof. The Stock Incentive Committee is
also authorized to adopt, amend and rescind the rules relating to the
administration of the Stock Incentive Plan. Except for grants that are
approved by a majority of the disinterested members of the Compensation
Committee, no member of the Stock Incentive Committee will be eligible to
participate in the Stock Incentive Plan.
Non-qualified stock options granted to the employee directors, officers and
employees will provide for the right to purchase shares of Class A Common
Stock at a specified price which may be less than fair market value on the
date of grant, and usually will become exercisable in installments after the
grant date. Non-qualified stock options may be granted to employee directors,
officers, employees and consultants for any reasonable term.
Incentive stock options will be designed to comply with the provisions of
the Code and will be subject to restrictions contained in the Code, including
a requirement that exercise prices are equal to at least 100% of fair market
value of the shares of Class A Common Stock on the grant date and a ten-year
restriction on the option term, but may be subsequently modified to disqualify
them from treatment as incentive stock options. Under the Stock Incentive Plan
and the Code, non-employee directors are not permitted to receive incentive
stock options.
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<PAGE>
CERTAIN TRANSACTIONS
LEASE OF CORPORATE HEADQUARTERS
The Company leases approximately 40,000 square feet of office space for its
corporate headquarters from MJB Associates, a California limited partnership
of which Borgi-Hesis, Inc. is the general partner. Brian Chisick is the
President of Borgi-Hesis, Inc., and Brian and Sarah Chisick are the beneficial
owners of Borgi-Hesis, Inc. The lease agreement provides for an aggregate
annual rent payment in 1996 of approximately $464,000. The term of the lease
expires on January 31, 2003, at which time the Company has an option to renew
the lease for additional period of five years.
STOCKHOLDER NOTES
During 1995, the Company paid $223,000 in interest payments to Brian and
Sarah Chisick, under the terms of a note with a principal amount of $4.5
million. The interest rate on such note was 10% per annum. Such note was paid
in full in 1995.
In addition, the Company borrowed $1.5 million from Brian and Sarah Chisick
on January 30, 1996. The note evidencing this debt, which was repaid in full
in May 1996, had an interest rate of 10% per annum.
The Company has from time to time borrowed from affiliates to fund certain
distributions to shareholders, however, the Company does not intend to borrow
from its affiliates in the future.
TRANSACTIONS WITH NATIONSCAPITAL MORTGAGE CORPORATION AND COAST SECURITY
MORTGAGE, INC.
Primarily to increase the volume of its Securitizations, the Company
purchases loans originated by certain brokers that are controlled by the sons
of Brian and Sarah Chisick.
Pursuant to an agreement between the Company and Nationscapital Mortgage
Corporation ("Nationscapital"), the Company purchased on a servicing released
basis, $215,000 of loans from Nationscapital during 1995. Jamie Chisick and
Brad Chisick are the President and majority shareholder, and the Vice
President and minority shareholder, of Nationscapital, respectively, and the
sons of Brian and Sarah Chisick.
Pursuant to an agreement between the Company and Coast Security Mortgage
Inc. ("Coast Security"), the Company purchased on a servicing released basis,
$9.8 million of loans from Coast Security during 1995. Mark Chisick and Brad
Chisick are the President and majority shareholder, and the Vice President and
a minority shareholder, of Coast Security, respectively, and the sons of Brian
and Sarah Chisick.
The Company's purchases of the loans originated by Nationscapital and Coast
Security are documented by agreements similar to those entered into with
unaffiliated entities. In the future, the Company intends to purchase from
such related parties only loans that meet the Company's criteria for
Securitization. Certain deferred premiums on such loans remain payable by the
Company to Nationscapital and Coast Security and will become due upon the
Securitization by the Company of such loans.
Coast Security's outstanding balance pursuant to a line of credit with the
Company was $335,000 and $525,000 at March 31, 1996 and December 31, 1995
respectively. The line of credit bears an interest rate of 10.0% per annum.
The line of credit was terminated on June 30, 1996.
During the 1996 quarter and the 1995 year, the Company received fees of
$72,000 and $234,000 from Nationscapital and $72,000 and $481,000 from Coast
Security, respectively, from the sale of marketing lists. The fees, which were
consistent with those charged to unaffiliated third-parties, reflected
payments to the Company for customer lists developed by the Company in its
marketing efforts but with respect to which the potential customers did not
fit the Company's lending criteria or the Company had not been able to
originate
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loans. Nationscapital and Coast Security may utilize this information and
originate loans, and, if such loans satisfy the Company's underwriting
guidelines, the Company may purchase such loans.
SERVICING OF CERTAIN LOANS
During 1995, the Company serviced mortgage loans for certain related parties
for which no service fees were charged. At March 31, 1996, the outstanding
balances of such loans serviced on behalf of Brian Chisick, Brad Chisick, Mark
Chisick, Jamie Chisick and Randall K. McPhillips were $7.2 million, $716,000,
$311,000, $345,000 and $145,000, respectively. Brad, Mark and Jamie Chisick
are the sons of Brian and Sarah Chisick. In order to avoid any appearance of
impropriety, upon the completion of the Public Offering, the Company will
charge such related parties servicing fees consistent with the servicing fees
charged to third parties for such services.
OTHER TRANSACTIONS
During 1995, the Company purchased on a servicing released basis, $15.1
million of loans from a subsidiary of First Alliance Securities Corporation, a
company wholly owned by Brian and Sarah Chisick. These affiliate purchases
were made pursuant to written agreements similar to those entered into with
unaffiliated entities. The Company ceased purchasing loans from this entity in
May 1995 due to the permanent cessation of lending operation by First Alliance
Securities Corporation and that subsidiary.
The Company paid $76,000 during 1995 to Orange Coast Computer Services as
reimbursement for expenses advanced on behalf of the Company during 1995.
Brian and Sarah Chisick beneficially own Orange Coast Computer Services.
During 1995, the Company received fees of $146,000 from the sale of
marketing lists to a corporation that is no longer in existence and that was
beneficially owned by Brian and Sarah Chisick. The fees were consistent with
those charged to unaffiliated third parties.
During the quarter ended March 31, 1996 and the year 1995, the Company sold
loans in the amounts of $0.3 million and $3.2 million, respectively, to Brian
Chisick. Due to the procedures required to be taken in order to approve such
related party transactions and the relatively insignificant amount earned by
the Company on such loan sales, upon the completion of the Public Offering,
the Company will no longer sell loans to Brian Chisick or any of his
affiliates.
Brian and Sarah Chisick have recently formed two corporations in the United
Kingdom for the purposes of initiating retail and wholesale loan operations,
and a California corporation for the purpose of providing accounting,
financial and computer services to the Company. All outstanding shares of
capital stock of such corporations will be contributed to the Company
immediately prior to the consummation of the Public Offering.
FUTURE AFFILIATED OR RELATED PARTY TRANSACTIONS
At this time, the Company anticipates that following the completion of the
Public Offering, its transactions with affiliated or related parties will be
limited to the Company's relationships with Nationscapital and Coast Security.
The Company's Bylaws require that all transactions between the Company, on the
one hand, and the immediate family of Brian Chisick, or their affiliates, on
the other hand, must be approved by a majority of the independent directors.
INDEMNITY AGREEMENTS
Prior to the completion of the Public Offering, the Company will enter into
separate but identical indemnity agreements (the "Indemnity Agreements") with
each director and executive officer of the Company and expects to enter into
Indemnity Agreements with persons who become directors or executive officers
in the future. The Indemnity Agreements provide that the Company will
indemnify the director or officer (the "Indemnitee")
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<PAGE>
against any expenses or liabilities in connection with any proceeding in which
such Indemnitee may be involved as a party or otherwise, by reason of the fact
that such Indemnitee is or was a director or officer of the Corporation or by
reason of any action taken by or omitted to be taken by such Indemnitee while
acting as an officer or director of the Corporation, provided that such
indemnity shall only apply if (i) the Indemnitee was acting in good faith and
in a manner the Indemnitee reasonably believed to be in the best interests of
the Corporation, and, with respect to any criminal action, had no reasonable
cause to believe the Indemnitee's conduct was unlawful, (ii) the claim was not
made to recover profits made by such Indemnitee in violation of Section 16(b)
of the Securities Exchange Act of 1934, as amended, or any successor statute,
(iii) the claim was not initiated by the Indemnitee, or (iv) the claim was not
covered by applicable insurance. Each Indemnitee has undertaken to repay the
Company for any costs or expenses paid by the Company if it shall ultimately
be determined by a court of competent jurisdiction in a final, nonappealable
adjudication that such Indemnitee is not entitled to indemnification under the
Indemnity Agreements. In addition to the Indemnity Agreements, the Company
anticipates obtaining a policy of directors and officers liability insurance
prior to the completion of the Public Offering.
PRINCIPAL STOCKHOLDERS
The following table sets forth security ownership information regarding the
Company's Common Stock as of the date of this Prospectus (except as otherwise
noted), and as adjusted to reflect the sale of shares offered by the Company
hereby, by (i) each person who is known by the Company to own beneficially
more than 5% of the Company's common stock, (ii) each director, (iii) each of
the Named Executive Officers and (iv) all directors and executive officers of
the Company as a group.
<TABLE>
<CAPTION>
SHARES SHARES
BENEFICIALLY OWNED BENEFICIALLY OWNED
PRIOR TO PUBLIC AFTER PUBLIC
OFFERING OFFERING(4)
------------------ ------------------
NAME OF BENEFICIAL OWNER(1) NUMBER PERCENT NUMBER PERCENT
- --------------------------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C>
Brian and Sarah Chisick (2).............. 10,642,500 99.0% 10,642,500 74.7%
Mark K. Mason (3)........................ 107,500 1.0% 107,500 .7%
All directors and executive officers as a
group................................... 10,750,000 100.0% 10,750,000 75.4%
</TABLE>
- --------
(1) Unless otherwise indicated and subject to community property laws where
applicable, each of the stockholders named in this table has sole voting
and investment power with respect to the shares shown as beneficially
owned by it. A person is deemed to be the beneficial owner of securities
that can be acquired by such person within 60 days from the date of this
Prospectus upon the exercise of options and warrants. Each beneficial
owner's percentage ownership is determined by assuming that options that
are held by such person (but not those held by any other person) and that
are exercisable within 60 days from the date of this Prospectus have been
exercised.
(2) Includes shares held by The Chisick Trust No. 1 U/D/T 3-30-96 and The
Chisick Trust No. 2 U/D/T 3-30-96, of which Brian Chisick is the sole
trustee, and the Brian and Sarah Chisick Revocable Trust U/A 3-7-79, of
which Brian and Sarah Chisick are the trustees.
(3) Represents restricted shares of Class B Common Stock subject to a vesting
schedule. See Management-- Executive Compensation--Mason Employment
Agreement."
(4) Assumes no exercise of the Underwriters' over-allotment option and gives
no effect to any purchases that may be made in the Public Offering.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
GENERAL
The authorized capital stock of the Company consists of (i) 1,000,000 shares
of preferred stock, $.01 par value ("Preferred Stock"), (ii) 25,000,000 shares
of Class A common stock, $.01 par value (the "Class A Common Stock") and
15,000,000 shares of Class B common stock, $.01 par value (the "Class B Common
Stock" or, together with the Class A Common Stock, the "Common Stock").
COMMON STOCK
As of the date hereof, there are no shares of Class A Common Stock
outstanding and 10,750,000 shares of Class B Common Stock outstanding. All of
the outstanding Class B Common Stock is beneficially owned by the Chisick
Family and Mark K. Mason. Upon completion of the Public Offering, there will
be 3,500,000 shares of Class A Common Stock and 10,750,000 shares of Class B
Common Stock outstanding (assumes no exercise of the Underwriters' over-
allotment option). The issued and outstanding shares of Class A Common Stock
and Class B Common Stock have been, and the shares of Class A Common Stock
offered hereby will be, duly authorized, validly issued, fully paid and
nonassessable.
Holders of Class A Common Stock are entitled to one vote for each share held
of record, and holders of Class B Common Stock are entitled to four votes for
each share held of record. The Class A Common Stock and the Class B Common
Stock vote together as a single class on all matters submitted to a vote of
stockholders (including the election of directors which will be by proxy),
except that, (i) in the case of a proposed amendment to the Company's
Certificate of Incorporation that would alter the powers, preferences or
special rights of either the Class A Common Stock or the Class B Common Stock,
the class of Common Stock to be altered shall vote on the amendment as a
separate class and (ii) in the case of a proposed issuance of Class B Common
Stock, such issuance will require the affirmative vote of the holders of a
majority of the outstanding shares of Class B Common Stock. Shares of Common
Stock do not have cumulative voting rights with respect to the election of
directors. Immediately after the Public Offering, the Chisick Family will hold
shares of Class B Common Stock constituting approximately 91.5% of the voting
power of the outstanding Common Stock, which will allow them to control all
actions to be taken by the stockholders, including the election of all
directors to the Board of Directors. While the Chisick Family will have the
voting power to control the votes on any matter requiring stockholder
approval, the Company intends to submit all such matters to a vote of all
stockholders. However, because the Company's Certificate of Incorporation
provides that any action that can be taken at a meeting of the stockholders
may be taken by written consent in lieu of the meeting if the Board of
Directors of the Company has approved the action and the Company receives
consents signed by stockholders having the minimum number of votes that would
be necessary to approve the action at a meeting at which all shares entitled
to vote on the matter were present, the Chisick Family, assuming approval by
the Board of Directors, may take all actions required to be taken by the
stockholders without providing the other stockholders the opportunity to make
nominations or raise other matters at a meeting. See "Principal Stockholders"
and "Risk Factors-Anti-Takeover Effect of Capital Structure; Voting Control of
Company."
Each share of Class A Common Stock and Class B Common Stock will be equal in
respect of dividends and other distributions in cash, stock or property
(including distributions upon liquidation of the Company and consideration to
be received upon a merger or consolidation of the Company or a sale of all or
substantially all of the Company's assets), except that in the case of
dividends or other distributions pursuant to stock splits or dividends, only
shares of Class A Common Stock will be distributed with respect to the Class A
Common Stock and only shares of Class B Common Stock will be distributed with
respect to Class B Common Stock, except if the Board of Directors determines
that shares of Class A Common Stock shall be distributed with respect to the
Class B Common Stock. In no event will either Class A Common Stock or Class B
Common Stock be split, divided or combined unless the other class is
proportionately split, divided or combined.
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Holders of Common Stock do not have any preemptive rights or rights to
subscribe for additional securities of the Company. Shares of Common Stock are
not redeemable and there are no sinking fund provisions.
While the shares of Class A Common Stock are not convertible into any other
series or class of the Company's securities, each share of Class B Common
Stock is freely convertible into one share of Class A Common Stock at the
option of the Class B stockholder. All shares of Class B Common Stock shall
automatically convert to an equal number of shares of Class A Common Stock on
the earliest record date for an annual meeting of the Company's stockholders
on which the number of shares of Class B Common Stock outstanding is less than
10% of the total number of shares of Common Stock outstanding. Shares of Class
B Common Stock may not be transferred to third parties (except for transfers
to certain family members and in other limited circumstances). Any
impermissible transfer of shares of Class B Common Stock will result in the
automatic conversion of such shares.
Subject to the preferences applicable to Preferred Stock outstanding at the
time, holders of shares of Common Stock are entitled to dividends if, when and
as declared by the Board of Directors from funds legally available therefor,
and are entitled, in the event of liquidation, to share ratably in all assets
remaining after payment of liabilities and Preferred Stock preferences, if
any.
The Company's Board of Directors will have seven members following
completion of the Public Offering. Either the directors or the stockholders
may amend the Bylaws to change the size of the Board, subject to the
requirement in the Certificate of Incorporation that the entire Board must
consist of at least three and no more than 11 directors. After the initial
term, each director serves for a term ending following the third annual
meeting following the annual meeting at which such director is elected and
until his or her successor is elected. Any stockholder entitled to vote at a
meeting regarding the election of directors may nominate a person for election
as a director, provided that the stockholder gives the Company written notice
of the nomination at least 90 days before the meeting (or if later, the
seventh day after the first public announcement of the date of such meeting),
which notice must contain specified information about the stockholder and the
nominee.
The Class A Common Stock has been approved for inclusion on the Nasdaq
National Market under the symbol "FACO."
PREFERRED STOCK
Pursuant to the Company's Certificate of Incorporation, the Board of
Directors has the authority to issue up to 1,000,000 shares of Preferred Stock
in one or more series with such designations, rights, preferences and voting
rights as may be determined from time to time by the Board of Directors.
Accordingly, the Board of Directors is empowered, without stockholder
approval, to issue Preferred Stock with dividend, liquidation, conversion,
voting or other rights that adversely affect the voting power or other rights
of the holders of the Company's Common Stock. In the event of issuance, the
Preferred Stock could be utilized, under certain circumstances, as a way of
discouraging, delaying or preventing an acquisition or change in control of
the Company. The Company does not currently intend to issue any shares of its
Preferred Stock.
CERTAIN PROVISIONS OF DELAWARE LAW
The Company is a Delaware corporation and is subject to Section 203 of the
Delaware General Corporation Law. In general, Section 203 prevents an
"interested stockholder" (defined generally as a person owning 15% or more of
the Company's outstanding voting stock) from engaging in a "business
combination" (as defined in Section 203) with the Company for three years
following the date that person became an interested stockholder unless: (i)
before that person became an interested stockholder, the Board approved the
transaction in which the interested stockholder became an interested
stockholder or approved the business combination; (ii) upon completion of the
transaction that resulted in the interested stockholders becoming an
interested stockholder, the interested stockholder owned at least 85% of the
voting stock of the Company outstanding at the time the transaction commenced
(excluding stock held by directors who are also officers of the Company and by
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<PAGE>
employee stock plans that do not provide employees with the right to determine
confidentially whether shares held subject to the plan will be tendered in a
tender or exchange offer); or (iii) on or following the date on which that
person became an interested stockholder, the business combination is approved
by the Company's Board and authorized at a meeting of stockholders by the
affirmative vote of the holders of at least 66 2/3% of the outstanding voting
stock of the Company not owned by the interested stockholder.
Under Section 203, these restrictions also do not apply to certain business
combinations proposed by an interested stockholder following the announcement
or notification of one of certain extraordinary transactions involving the
Company and a person who was not an interested stockholder during the previous
three years or who became an interested stockholder with the approval of a
majority of the Company's directors, if that extraordinary transaction is
approved or not opposed by a majority of the directors (but not less than one)
who were directors before any person became an interested stockholder in the
previous three years or who were recommended for election or elected to
succeed such directors by a majority of such directors then in office.
Pursuant to Section 162 of the Delaware General Corporation Law, the Board
of Directors of the Company can, without stockholder approval, issue shares of
capital stock, which may have the effect of delaying, deferring or preventing
a change of control of the Company. Other than pursuant to the Public
Offering, the Company has no plan or arrangement for the issuance of any
shares of capital stock other than in the ordinary course pursuant to the
Stock Incentive Plan.
CERTAIN CHARTER AND BYLAW PROVISIONS
The Company's Certificate of Incorporation provides that the stockholders
may act only in a meeting that has been duly called and noticed, except that
stockholders may approve by written consent any proposal that has already been
approved by the Board of Directors.
The Company's Bylaws require stockholders to provide advance notice of any
stockholder nominations for director and of any business to be brought before
any meeting of stockholders. Stockholders are not entitled to cumulative
voting in connection with the election of directors. As a result, a person or
a group controlling the majority of shares of Common Stock can elect all of
the directors. Following the Public Offering, the Chisick Family will
beneficially own shares of Class B Common Stock constituting 91.5% of the
voting power of the issued and outstanding Common Stock. See "Principal
Stockholders" and "Risk Factors-Anti-Takeover Effect of Capital Structure."
The Certificate of Incorporation of the Company contains certain provisions
permitted under the Delaware General Corporation Law relating to the liability
of directors. These provisions eliminate the directors' liability for monetary
damages for a breach of fiduciary duty, except in certain circumstances
involving wrongful acts, including the breach of a director's duty of loyalty
or acts or omissions which involve intentional misconduct or a knowing
violation of a law. The Company's Certificate of Incorporation also contains
provisions to indemnify its directors and officers to the fullest extent
permitted by the Delaware General Corporation Law.
TRANSFER AGENT
The transfer agent and registrar for the Class A Common Stock is American
Stock Transfer and Trust Company.
63
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
The Company's Certificate of Incorporation authorizes the issuance of
25,000,000 shares of Class A Common Stock and 15,000,000 shares of Class B
Common Stock. Upon completion of the Public Offering, there will be
outstanding 3,500,000 shares of Class A Common Stock and 10,750,000 shares of
Class B Common Stock (assuming no exercise of the Underwriters' over-allotment
option).
The 3,500,000 shares of Class A Common Stock to be sold in the Public
Offering, which will constitute all of the outstanding shares of Class A
Common Stock (4,025,000 shares if the Underwriters' over-allotment option is
exercised in full) will be available for resale in the public market without
restriction or further registration under the Securities Act, except for
shares purchased by affiliates of the Company (in general, any person who has
a control relationship with the Company), which shares will be subject to the
resale limitations of Rule 144 promulgated under the Securities Act ("Rule
144"). All outstanding shares of Class B Common Stock are deemed to be
"restricted securities," as that term is defined in Rule 144, and are eligible
for sale in the public market in compliance with Rule 144. The Chisick Family
and Mark Mason have agreed, subject to certain exceptions, that they will not
offer, sell or otherwise dispose of any of the shares of Class B Common Stock
owned by them for a period of 180 days after the date of this Prospectus
without the prior written consent of the Representative of the Underwriters;
provided that Mark Mason may sell, after December 29, 1996, up to 13,700
shares of Class B Common Stock, in order to pay certain Federal and state
income taxes. The Company has agreed, subject to certain limited exceptions,
not to offer, sell or otherwise dispose of any shares of Class A Common Stock
for a period of 180 days after the date of this Prospectus without the prior
written consent of the Representative of the Underwriters.
In general, under Rule 144 as currently in effect, any person (or persons
whose shares are aggregated) who has beneficially owned shares for at least
two years is entitled to sell, within any three-month period, a number of
shares which does not exceed the greater of 1% of the then-outstanding shares
of the Company's Class A Common Stock (35,000 shares immediately after the
Public Offering assuming no exercise of the Underwriters' over-allotment
option) or the average weekly trading volume of the Company's Class A Common
Stock during the four calendar weeks preceding the date on which notice of the
sale is filed with the Commission. Sales under Rule 144 may also be subject to
certain manner of sale provisions, notice requirements and the availability of
current public information about the Company. Any person (or persons whose
shares are aggregated) who is not deemed to have been an affiliate of the
Company at any time during the three months preceding a sale, and who has
beneficially owned shares within the definition of "restricted securities"
under Rule 144 for at least three years, is entitled to sell such shares under
Rule 144(k) without regard to the volume limitation, manner of sale
provisions, public information requirements or notice requirements.
64
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below (the "Underwriters") through their Representative,
have severally agreed to purchase from the Company the following respective
number of shares of Class A Common Stock at the Public Offering price less the
underwriting discounts and commissions set forth on the cover page of this
Prospectus:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ---------
<S> <C>
Friedman, Billings, Ramsey & Co., Inc. ............................ 2,825,000
Alex. Brown & Sons Incorporated.................................... 50,000
Bear, Stearns & Co. Inc. .......................................... 50,000
Goldman, Sachs & Co. .............................................. 50,000
Lehman Brothers Inc. .............................................. 50,000
Montgomery Securities.............................................. 50,000
Salomon Brothers Inc............................................... 50,000
Advest, Inc. ...................................................... 25,000
Chicago Corporation (The).......................................... 25,000
Crowell, Weedon & Co. ............................................. 25,000
Equitable Securities Corporation................................... 25,000
EVEREN Securities, Inc. ........................................... 25,000
Interstate/Johnson Lane Corporation................................ 25,000
J.C. Bradford & Co. ............................................... 25,000
Janney Montgomery Scott Inc. ...................................... 25,000
Legg Mason Wood Walker, Inc. ...................................... 25,000
McDonald & Company Securities, Inc. ............................... 25,000
Morgan Kegan & Company, Incorporated............................... 25,000
Raymond James & Associates, Inc. .................................. 25,000
Scott & Stringfellow, Inc. ........................................ 25,000
Stifel, Nicolaus & Company, Incorporated........................... 25,000
Sutro & Co. Incorporated........................................... 25,000
---------
Total Underwriters............................................... 3,500,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will
purchase all of the shares of the Class A Common Stock offered hereby if any
of such shares are purchased.
The Company has been advised by the Underwriters that the Underwriters
propose to offer the shares of Class A Common Stock to the public at the
Public Offering price set forth on the cover page of this Prospectus and to
certain dealers at such price less a concession not in excess of $0.61 per
share. The Underwriters may allow, and such dealers may reallow, a concession
not in excess of $0.10 per share to certain other dealers. After the Public
Offering, the offering price and other selling terms may be changed by the
Representative of the Underwriters.
The Company has granted to the Underwriters an option, exercisable not later
than 30 days after the date of this Prospectus, to purchase up to 525,000
additional shares of Class A Common Stock at the Public Offering price less
the underwriting discounts and commissions set forth on the cover page of this
Prospectus. To the extent that the Underwriters exercise such option, each of
the Underwriters will have a firm commitment to purchase approximately the
same percentage thereof that the number of shares of Class A Common Stock to
be purchased by it shown in the above table bears to 3,500,000 and the Company
will be obligated, pursuant to the option, to sell such shares to the
Underwriters. The Underwriters may exercise such option only to cover over-
allotments made in connection with the sale of Class A Common Stock offered
hereby. If purchased, the Underwriters will offer such additional shares on
the same terms as those on which the 3,500,000 shares are being offered.
65
<PAGE>
The Company has agreed to indemnify the Underwriters against certain
liabilities including liabilities under the Securities Act of 1933, as amended
(the "Securities Act"). The Company has been advised that in the opinion of
the Commission such indemnification is against public policy as expressed in
the Securities Act and is, therefore, unenforceable. In the event that a claim
for indemnification against such liabilities is asserted by the Underwriters
in connection with the shares of Class A Common Stock offered hereby, the
Company will, unless in the opinion of its counsel the matter has been settled
by controlling precedent, submit to a court of competent jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.
The Chisick Family and Mark K. Mason have agreed, subject to certain
exceptions, that they will not offer, sell or otherwise dispose of any of the
shares of Class B Common Stock owned by them for a period of 180 days after
the date of this Prospectus without the prior written consent of the
Representative of the Underwriters; provided, however, that Mark Mason may
sell, after December 29, 1996, up to 13,700 shares of Class B Common Stock, in
order to pay certain Federal and State income taxes. See "Shares Eligible for
Future Sale."
The Representative of the Underwriters have advised the Company that the
Underwriters do not intend to confirm sales to any account over which they
exercise discretionary authority.
LEGAL MATTERS
Certain legal matters will be passed upon for the Company by Gibson, Dunn &
Crutcher LLP, Los Angeles, California. Certain legal matters will be passed
upon for the Underwriters by Brobeck, Phleger & Harrison LLP, Newport Beach,
California.
EXPERTS
The statement of financial condition of First Alliance Corporation as of
June 30, 1996 included in this Prospectus, has been audited by Deloitte &
Touche LLP, independent auditors, as stated in their report appearing herein,
and is included in reliance upon the report of such firm given upon their
authority as experts in accounting and auditing.
The financial statements of First Alliance Mortgage Company as of December
31, 1995 and 1994 and for each of the three years in the period ended December
31, 1995 included in this Prospectus, have been audited by Deloitte & Touche
LLP, independent auditors, as stated in their report appearing herein, and are
included in reliance upon the report of such firm given upon their authority
as experts in accounting and auditing.
66
<PAGE>
FINANCIAL GLOSSARY
ASSET-BACKED SECURITIES: A general reference to securities that are backed
by financial assets, such as home equity, credit card or trade receivables,
equipment or automobile loans or leases.
CERTIFICATE INSURER: Monoline insurance company providing credit enhancement
by issuing insurance in favor of holders of Regular Interests in the REMIC
Trusts sponsored by the Company.
NET DEFERRED ORIGINATION FEES: Loan origination fees net of direct loan
origination costs which are deferred until the sale of the related loans.
PORTFOLIO REFINANCING ORIGINATIONS: Loan originations associated with
centralized marketing and sales efforts focused on the preservation of the
Company's existing portfolio through refinancing loans to borrowers who have
made inquiries of the Company regarding prepayment of existing loans.
REGULAR INTEREST: The senior interest in a REMIC Trust that represents the
right to receive scheduled pass-through interest and principal.
REMIC TRUST: A real estate mortgage investment conduit trust.
RESIDUAL INTERESTS: The subordinated interest in a REMIC Trust that
represents the right to receive certain excess cash flow generated by the
Securitized loans.
RETAIL BRANCH ORIGINATIONS: Loans originated through the Company's retail
branch network.
SECURITIZATION OR SECURITIZED: The process through which loans are pooled
and sold to a REMIC Trust that issues Regular Interests and the Residual
Interests to the Company in exchange for loans sold to the Trust.
SERVICING PORTFOLIO: The aggregate of all loans serviced by the Company.
WAREHOUSE FINANCING FACILITY: The Company's $125 million secured 90-day
revolving line of credit used to finance loan originations and purchases.
WAREHOUSING PERIOD: The period of time between the funding or purchase of a
mortgage loan and its sale.
67
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-1 (File No. 333-3633) under the Securities Act with respect to the Class A
Common Stock offered hereby. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to the Company and the
Class A Common Stock, reference is hereby made to such Registration Statement
and the exhibits and schedules thereto. Statements contained in this
Prospectus as to the contents of any contract or other document are not
necessarily complete and, in each instance, reference is made to the copy of
such contract or document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference. Copies
of the Registration Statement, including all exhibits thereto, can be
inspected and copied at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
regional offices of the Commission located at 500 West Madison Street, Room
1400, Chicago, Illinois 60606 and at 7 World Trade Center, Suite 1300, New
York, New York 10048. Copies of such material can be obtained from the Public
Reference Section of the Commission at 450 Fifth Street, Washington, D.C.
20549, at prescribed rates. The Commission also maintains a web site that
contains reports, proxy and information statements and other information
regarding Registrants that file electronically with the Commission, including
the Company, and the address is http://www.SEC.GOV.
The Company intends to furnish to its stockholders annual reports containing
audited consolidated financial statements and an opinion thereon expressed by
the Company's independent auditors as well as quarterly reports for the first
three fiscal quarters of each fiscal year containing unaudited consolidated
condensed financial statements. The Company also intends to provide annual
financial statements to each person to whom a copy of this Prospectus has been
delivered, upon the request of such person.
68
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FIRST ALLIANCE CORPORATION:
Independent Auditors' Report........................................... F-2
Statement of Financial Condition as of June 30, 1996................... F-3
Note to Financial Statement............................................ F-4
FIRST ALLIANCE MORTGAGE COMPANY:
Independent Auditors' Report........................................... F-5
Statements of Financial Condition as of December 31, 1994 and 1995 and
March 31, 1996 (unaudited)............................................ F-6
Statements of Income for each of the three years in the period ended
December 31, 1995 and for the quarters ended March 31, 1995 and 1996
(unaudited)........................................................... F-7
Statements of Stockholders' Equity for each of the three years in the
period ended
December 31, 1995 and for the quarter ended March 31, 1996
(unaudited)........................................................... F-8
Statements of Cash Flows for each of the three years in the period
ended December 31, 1995 and for the quarters ended March 31, 1995 and
1996 (unaudited)...................................................... F-9
Notes to Financial Statements.......................................... F-11
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Stockholder of
First Alliance Corporation:
We have audited the accompanying statement of financial condition of First
Alliance Corporation (the Company) as of June 30, 1996. This financial
statement is the responsibility of the Company's management. Our
responsibility is to express an opinion on this financial statement based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of financial condition
is free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the statement of
financial condition. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall statement of financial condition presentation. We
believe that our audit of the statement of financial condition provides a
reasonable basis for our opinion.
In our opinion, such statement of financial condition presents fairly, in
all material respects, the financial position of First Alliance Corporation as
of June 30, 1996, in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Costa Mesa, California
June 30, 1996
F-2
<PAGE>
FIRST ALLIANCE CORPORATION
STATEMENT OF FINANCIAL CONDITION
JUNE 30, 1996
<TABLE>
<S> <C>
ASSETS
Cash...................................................................... $100
====
LIABILITIES AND STOCKHOLDER'S EQUITY
Stockholder's equity:
Preferred stock, $.01 par value;
1,000,000 shares authorized; no shares outstanding......................
Class A common stock, $.01 par value; 25,000,000 shares authorized; no
shares issued and outstanding...........................................
Class B common stock, $.01 par value; 15,000,000 shares authorized;
one share issued and outstanding........................................
Additional paid in capital............................................... $100
----
Total stockholder's equity............................................ $100
====
</TABLE>
See notes to financial statements.
F-3
<PAGE>
FIRST ALLIANCE CORPORATION
NOTE TO FINANCIAL STATEMENT
AS OF JUNE 30, 1996
NOTE 1. GENERAL
First Alliance Corporation (the Company) was formed to be a holding company
whose assets will consist entirely of all of the outstanding capital stock of
First Alliance Mortgage Company (FAMCO), and First Alliance Services, Inc.,
each of which are California corporations, and First Alliance Mortgage
Company, Limited, and First Alliance Company, Limited, each of which are
United Kingdom corporations.
The Company is contemplating an initial public offering (the Offering)
whereby the Company intends to acquire all of the outstanding shares of FAMCO
in exchange for 10,750,000 shares of Class B Common Stock. Shares of Class A
Common Stock are being offered for sale in the Offering. Holders of Class A
Common Stock will be entitled to one vote for each share held of record and
holders of Class B Common Stock will be entitled to four votes for each share
held of record. Each share of Class B Common Stock will be freely convertible
into one share of Class A Common Stock at the option of the Class B
stockholder. With limited exception, shares of Class B Common Stock may not be
transferred to third parties.
The acquisition will be accounted for similar to a pooling of interests. The
consolidated financial position and consolidated results of operations of the
Company will substantially consist of FAMCO.
F-4
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
First Alliance Mortgage Company:
We have audited the accompanying statements of financial condition of First
Alliance Mortgage Company (the Company) as of December 31, 1994 and 1995, and
the related statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1995. 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 financial statements present fairly, in all material
respects, the financial position of First Alliance Mortgage Company as of
December 31, 1994 and 1995, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1995, in
conformity with generally accepted accounting principles.
As described in Note 2, on January 1, 1995, the Company adopted Statement of
Financial Accounting Standards No. 122, Accounting for Mortgage Servicing
Rights.
As described in Note 2, the accompanying 1994 and 1995 financial statements
have been restated.
Deloitte & Touche LLP
Costa Mesa, California
March 18, 1996 (June 24, 1996 as to Note 2)
F-5
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31, PRO FORMA
----------------------- MARCH 31, MARCH 31,
1994 1995 1996 1996
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents..... $ 5,298,000 $ 4,019,000 $ 2,206,000 $ 2,206,000
Receivable from trusts........ 3,906,000 4,722,000 7,467,000 7,467,000
Loans held for sale........... 18,676,000 24,744,000 26,325,000 26,325,000
Loans receivable held for
investment................... 2,521,000 2,261,000 2,075,000 2,075,000
Residual interests in
securities--at fair value ... 11,645,000 19,705,000 20,732,000 20,732,000
Mortgage servicing rights..... 763,000 4,021,000 4,641,000 4,641,000
Real estate owned, net........ 1,635,000 1,474,000 1,904,000 1,904,000
Property, net................. 2,080,000 2,141,000 2,154,000 2,154,000
Deferred taxes................ 73,000 3,237,000
Prepaid expenses and other
assets....................... 1,629,000 3,900,000 3,851,000 3,851,000
----------- ----------- ----------- -----------
Total assets................ $48,226,000 $66,987,000 $71,355,000 $74,592,000
=========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Warehouse financing facility.. $13,390,000 $18,233,000 $20,015,000 $20,015,000
Accounts payable and accrued
liabilities.................. 9,403,000 5,310,000 5,355,000 5,355,000
Dividends payable............. 9,000,000 9,000,000
Notes payable................. 1,449,000 1,123,000 1,023,000 1,023,000
Notes payable to stockholders. 1,000,000 1,000,000
S distribution notes.......... 33,626,000
----------- ----------- ----------- -----------
Total liabilities........... 24,242,000 24,666,000 36,393,000 70,019,000
----------- ----------- ----------- -----------
Commitments and contingencies
Stockholders' equity:
Common stock--no par value;
15,000,000 shares authorized;
10,642,500 shares issued and
outstanding.................. 42,000 42,000 42,000 1,336,000
Retained earnings............. 23,942,000 42,279,000 34,920,000 3,237,000
----------- ----------- ----------- -----------
Total stockholders' equity.. 23,984,000 42,321,000 34,962,000 4,573,000
----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity..... $48,226,000 $66,987,000 $71,355,000 $74,592,000
=========== =========== =========== ===========
</TABLE>
See notes to financial statements.
F-6
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
QUARTERS ENDED MARCH
YEARS ENDED DECEMBER 31, 31,
----------------------------------- -----------------------
1993 1994 1995 1995 1996
----------- ----------- ----------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUE:
Loan origination and
sale................. $22,489,000 $27,902,000 $35,493,000 $1,086,000 $ 9,371,000
Loan servicing and
other fees........... 8,989,000 9,106,000 8,543,000 1,977,000 2,243,000
Interest.............. 4,452,000 8,650,000 14,668,000 2,871,000 3,158,000
Other................. 20,000 144,000 176,000 29,000 38,000
----------- ----------- ----------- ---------- -----------
Total revenue....... 35,950,000 45,802,000 58,880,000 5,963,000 14,810,000
----------- ----------- ----------- ---------- -----------
EXPENSE:
Compensation and
benefits............. 10,847,000 9,559,000 10,395,000 2,780,000 3,196,000
Professional services. 1,288,000 1,521,000 697,000 264,000 269,000
Advertising........... 2,958,000 3,316,000 4,345,000 1,071,000 940,000
Subservicing and other
fees................. 659,000 1,019,000 1,212,000 266,000 192,000
Rent.................. 815,000 974,000 1,278,000 285,000 370,000
Supplies.............. 791,000 831,000 992,000 246,000 335,000
Depreciation and
amortization of
property............. 483,000 514,000 907,000 144,000 139,000
Interest.............. 2,106,000 3,744,000 4,167,000 613,000 763,000
Legal................. 3,044,000 7,162,000 1,491,000 206,000 146,000
Other................. 1,996,000 1,928,000 2,376,000 388,000 600,000
----------- ----------- ----------- ---------- -----------
Total expense....... 24,987,000 30,568,000 27,860,000 6,263,000 6,950,000
----------- ----------- ----------- ---------- -----------
INCOME (LOSS) BEFORE
INCOME TAX PROVISION
(BENEFIT).............. 10,963,000 15,234,000 31,020,000 (300,000) 7,860,000
INCOME TAX PROVISION
(BENEFIT) ............. 222,000 363,000 478,000 (5,000) 118,000
----------- ----------- ----------- ---------- -----------
NET INCOME (LOSS)....... $10,741,000 $14,871,000 $30,542,000 $ (295,000) $ 7,742,000
=========== =========== =========== ========== ===========
PRO FORMA (unaudited):
Historical income
(loss) before income
tax provision
(benefit)............ $10,963,000 $15,234,000 $31,020,000 $ (300,000) $ 7,860,000
Pro forma income tax
provision (benefit).. 4,403,000 6,200,000 12,772,000 (123,000) 3,233,000
----------- ----------- ----------- ---------- -----------
PRO FORMA NET INCOME
(LOSS)................. $ 6,560,000 $ 9,034,000 $18,248,000 $ (177,000) $ 4,627,000
=========== =========== =========== ========== ===========
PRO FORMA NET INCOME PER
SHARE.................. $ 1.38 $ 0.37
=========== ===========
WEIGHTED AVERAGE SHARES
USED IN PRO FORMA
COMPUTATION............ 13,225,971 12,633,912
=========== ===========
</TABLE>
See notes to financial statements.
F-7
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK TOTAL
------------------ RETAINED STOCKHOLDERS'
SHARES AMOUNT EARNINGS EQUITY
---------- ------- ------------ -------------
<S> <C> <C> <C> <C>
BALANCE, January 1, 1993........ 10,642,500 $42,000 $ 21,524,000 $ 21,566,000
Dividends....................... (5,853,000) (5,853,000)
Net income...................... 10,741,000 10,741,000
---------- ------- ------------ ------------
BALANCE, December 31, 1993...... 10,642,500 42,000 26,412,000 26,454,000
Dividends....................... (17,341,000) (17,341,000)
Net income...................... 14,871,000 14,871,000
---------- ------- ------------ ------------
BALANCE, December 31, 1994...... 10,642,500 42,000 23,942,000 23,984,000
Dividends....................... (12,205,000) (12,205,000)
Net income...................... 30,542,000 30,542,000
---------- ------- ------------ ------------
BALANCE, December 31, 1995...... 10,642,500 42,000 42,279,000 42,321,000
Dividends (Unaudited)........... (15,101,000) (15,101,000)
Net income (Unaudited).......... 7,742,000 7,742,000
---------- ------- ------------ ------------
BALANCE, March 31, 1996
(Unaudited).................... 10,642,500 $42,000 $ 34,920,000 $ 34,962,000
========== ======= ============ ============
</TABLE>
See notes to financial statements.
F-8
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31 QUARTERS ENDED MARCH 31
------------------------------------------- --------------------------
1993 1994 1995 1995 1996
------------- ------------- ------------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM
OPERATING ACTIVITIES:
Net income (loss)....... $ 10,741,000 $ 14,871,000 $ 30,542,000 $ (295,000) $ 7,742,000
Adjustments to reconcile
net income (loss) to
net cash (used in)
provided by operating
activities:
Depreciation and
amortization of
property............. 483,000 514,000 907,000 144,000 139,000
Amortization of
mortgage servicing
rights............... 988,000 683,000 638,000 107,000 340,000
Deferred income taxes. (184,000) (63,000) 73,000
Provision for
estimated losses on
real estate owned.... 240,000 8,000 74,000
Gain on sale of loans
held for sale ....... (16,423,000) (25,976,000) (24,539,000) (823,000) (7,094,000)
Noncash gain
recognized on
capitalization of
residual interests in
securities and
mortgage servicing
rights............... (4,171,000) (807,000) (9,833,000) (2,060,000)
Loss (gain) on sales
of real estate owned. 76,000 (109,000) 65,000 (94,000)
Loss (gain) on sales
of property.......... 75,000 23,000 (19,000)
Accretion of discounts
on loan receivable... (1,022,000) (256,000) (56,000)
Net accretion of
residual interests in
securities........... (128,000) (1,128,000) (2,048,000) (638,000) 74,000
Loans originated or
purchased for sale,
net of loan fees..... (257,928,000) (289,338,000) (213,903,000) (46,692,000) (68,412,000)
Proceeds from sale of
loans................ 68,440,000 20,503,000 64,400,000 7,560,000 21,318,000
Sale of regular
interests in
securities........... 141,056,000 347,500,000 167,899,000 52,419,000
Changes in assets and
liabilities:
Receivable from
trusts............. (788,000) 163,000 (816,000) (300,000) (2,745,000)
Prepaid expenses and
other assets....... (1,418,000) 802,000 (2,271,000) (633,000) 49,000
Accounts payable and
accrued
liabilities........ 2,643,000 4,775,000 (4,093,000) (3,159,000) 45,000
------------- ------------- ------------- ------------ ------------
Net cash (used in)
provided by
operating
activities....... (56,298,000) 72,421,000 5,980,000 (44,985,000) 1,739,000
------------- ------------- ------------- ------------ ------------
CASH FLOWS FROM
INVESTING ACTIVITIES:
Loans receivable issued. (789,000) (1,949,000) (1,579,000) (785,000)
Collections on loans
receivable............. 519,000 1,341,000 2,880,000 395,000 242,000
Capital expenditures.... (610,000) (851,000) (978,000) (156,000) (443,000)
Proceeds from sales of
property............... 723,000 29,000 31,000
Additions to real estate
owned.................. (200,000) (355,000) (16,000)
Proceeds from sales of
real estate owned...... 1,028,000 3,566,000 523,000 64,000 37,000
------------- ------------- ------------- ------------ ------------
Net cash provided
by investing
activities....... 671,000 2,107,000 520,000 (498,000) (133,000)
------------- ------------- ------------- ------------ ------------
CASH FLOWS FROM
FINANCING ACTIVITIES:
Net borrowings
(repayments) on
warehouse financing
facility............... 66,835,000 (53,445,000) 4,843,000 40,414,000 1,782,000
Proceeds from issuance
of notes payable....... 19,000 18,000
Payments on notes
payable................ (2,079,000) (2,831,000) (436,000) (64,000) (100,000)
Cash dividends.......... (5,853,000) (17,341,000) (12,205,000) (2,874,000) (6,101,000)
Proceeds from issuance
of notes payable to
stockholder............ 11,000,000 3,000,000 4,500,000 4,500,000 1,000,000
Payments on notes
payable to stockholder. (11,000,000) (3,000,000) (4,500,000)
------------- ------------- ------------- ------------ ------------
Net cash provided
by (used in)
financing
activities....... 58,903,000 (73,617,000) (7,779,000) 41,994,000 (3,419,000)
------------- ------------- ------------- ------------ ------------
NET INCREASE (DECREASE)
IN CASH AND CASH
EQUIVALENTS............ 3,276,000 911,000 (1,279,000) (3,489,000) (1,813,000)
CASH AND CASH
EQUIVALENTS, beginning
of year................ 1,111,000 4,387,000 5,298,000 5,298,000 4,019,000
------------- ------------- ------------- ------------ ------------
CASH AND CASH
EQUIVALENTS, end of
year................... $ 4,387,000 $ 5,298,000 $ 4,019,000 $ 1,809,000 $ 2,206,000
============= ============= ============= ============ ============
</TABLE>
See notes to financial statements.
F-9
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
STATEMENTS OF CASH FLOWS--(CONTINUED)
<TABLE>
<CAPTION>
QUARTERS ENDED
YEARS ENDED DECEMBER 31 MARCH 31
-------------------------------------- -----------------------
1993 1994 1995 1995 1996
------------ ------------ ------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
SUPPLEMENTAL INFORMA-
TION:
Interest paid........... $ 1,805,000 $ 3,605,000 $ 4,114,000 $ 442,000 $ 801,000
============ ============ ============ =========== ===========
Income taxes paid....... $ 698,000 $ 100,000 $ 486,000 $ 30,000
============ ============ ============ ===========
SUPPLEMENTAL INFORMATION
ON NONCASH INVESTING
AND FINANCING
ACTIVITIES:
Loans funded in connec-
tion with sales of real
estate owned........... $ 390,000 $ 290,000 $ 19,000
============ ============ ============
Assumption of debt
through acquisition of
real estate through
foreclosure............ $ 3,051,000 $ 2,342,000 $ 91,000 $ 26,000
============ ============ ============ ===========
Exchange of loans for
regular and residual
interests in
securities............. $141,795,000 $350,331,000 $167,974,000 $52,420,000
============ ============ ============ ===========
Dividends declared and
unpaid................. $ 9,000,000
===========
Transfer of property to
real estate owned...... $ 260,000
===========
Acquisition of real es-
tate through foreclo-
sure of loans.......... $ 113,000
===========
</TABLE>
See notes to financial statements.
F-10
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 AND FOR THE
QUARTERS ENDED MARCH 31, 1995 AND 1996 (UNAUDITED)
NOTE 1. GENERAL
First Alliance Mortgage Company (the Company) is engaged in the origination,
purchase, sale and servicing of home-equity loans collateralized by deeds of
trust. The majority of the Company's loans are made to owners of single family
residences who use the loan proceeds for such purposes as debt consolidation
and financing of home improvements, among others. The Company sells loans to
investors or securitizes them in the form of a Real Estate Mortgage Investment
Conduit (REMIC). A significant portion of the mortgages are sold on a
servicing retained basis. The Company is currently licensed or registered to
do business in ten states. The Company's business may be affected by many
factors including real estate and other asset values, the level of and
fluctuations in interest rates, changes in the securitization market and
competition.
Interim Unaudited Financial Information--In the opinion of management, the
accompanying unaudited financial statements contain all adjustments
(consisting only of various normal accruals) necessary to present fairly the
Company's financial position, results of operations and cash flows. The
financial position at March 31, 1996 is not necessarily indicative of the
financial position to be expected at December 31, 1996 and results of
operations for the three months ended March 31, 1996 are not necessarily
indicative of the results of operations to be expected for the year ending
December 31, 1996.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
In accordance with Statement of Financial Accounting Standards (SFAS) No.
115 Accounting for Certain Investments in Debt and Equity Securities, the
Company has restated its 1994 and 1995 financial statements to present its
Residual Interests in Securities (Residual Interests) as trading securities.
As a result, the Company has reestimated the fair value of such securities.
The restatement did not result in any changes to previously reported results
of operations or financial condition as of and for the years ended December
31, 1995 and 1994.
Cash and Cash Equivalents--The Company considers all highly liquid debt
instruments purchased with an original maturity of no more than three months
to be cash equivalents.
Receivable From Trusts--In the normal course of servicing loans previously
sold or securitized, the Company may advance payments and other costs to
REMICs or private investor trusts on behalf of borrowers. In such cases, funds
advanced are reflected in the balance sheet as receivable from trusts.
Advances are recovered through subsequent collections from trusts or
borrowers.
Loans--Loans held for sale are loans the Company plans to sell or securitize
which are carried at the lower of aggregate cost or market value. Loan
origination and processing fees and related direct origination costs are
deferred until the related loan is sold. Loans receivable held for investment
are notes the Company has purchased or originated and has the intent and
ability to hold to maturity. Loan origination and commitment fees and direct
loan origination costs are deferred and offset against the related notes, and
the net fee or cost is amortized into interest income over the contractual
lives of the related notes. When a loan becomes over 90 days contractually
delinquent, it is placed on non-accrual status and unpaid interest income is
reversed. While a loan is on non-accrual status, interest is recognized only
as cash is received.
Allowances for Estimated Losses on Loans and Real Estate Owned--The
allowances for estimated losses on loans and real estate owned (REO) represent
the Company's estimate of identified and unidentified losses in the Company's
portfolios. These estimates, while based upon historical loss experience and
other relevant data, are ultimately subjective and inherently uncertain. The
Company has established valuation allowances for estimated losses on specific
loans and REO. When these estimated losses are determined to be permanent,
such
F-11
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995
AND FOR THE QUARTERS ENDED MARCH 31, 1995 AND 1996 (UNAUDITED)
as when a loan is foreclosed and the related property is transferred to REO,
specific valuation allowances are charged off and are then reflected as
writedowns.
Effective January 1, 1995, the Company adopted SFAS No. 114, Accounting by
Creditors for Impairment of a Loan and SFAS No. 118, Accounting by Creditors
for Impairment of a Loan--Income Recognition and Disclosures. SFAS No. 114
prescribes the recognition criteria for loan impairment and the measurement
methods for certain impaired loans and loans whose terms are modified in
troubled debt restructurings. SFAS No. 114 states that a loan is impaired when
it is probable that a creditor will be unable to collect all principal and
interest amounts due according to the contractual terms of the loan agreement.
SFAS No. 118 amends the disclosure requirements of SFAS No. 114 to require
information about the recorded investment in certain impaired loans and how a
creditor recognizes interest income related to those impaired loans. There was
no impact on the Company's financial condition or results of operations upon
adoption of such statements.
Residual Interests in Securities--The Company securitizes a majority of
loans held for sale into the form of a REMIC. A REMIC is a multi-class
security with certain tax advantages to investors and which derives its cash
flow from a pool of underlying mortgages. The senior classes of the REMICs are
sold, and the subordinated classes are retained by the Company. The
subordinated classes are in the form of residual certificates and are
classified as Residual Interests. The documents governing the Company's
securitizations require the Company to establish initial overcollateralization
or build overcollateralization levels through retention of distributions by
the REMIC trust otherwise payable to the Company as the Residual Interest
holder. This overcollateralization causes the aggregate principal amount of
the loans in the related pool and/or cash reserves to exceed the aggregate
principal balance of the outstanding investor certificates. Such excess
amounts serve as credit enhancement for the related REMIC trust. To the extent
that borrowers default on the payment of principal or interest on the loans,
losses will reduce the overcollateralization to the extent that funds are
available. If payment defaults exceed the amount of overcollateralization, as
applicable, the insurance policy maintained by the related REMIC trust will
pay any further losses experienced by holders of the senior interests in the
related REMIC trust. The Company does not have any recourse obligations for
credit losses in the REMIC trust. The Residual Interests are amortized to
operations over the contractual lives of the loans, considering future
estimated prepayments utilizing an amortization method which approximates the
level yield method.
In 1994, the Company adopted SFAS No. 115, and, in accordance with
provisions of SFAS No. 115, the Company classifies Residual Interests as
trading securities which are recorded at fair value with any unrealized gains
or losses recorded in the results of operations in the period of the change in
fair value. Valuations at origination and at each reporting period are based
on discounted cash flow analyses. The cash flows are estimated as the excess
of the weighted average coupon on each pool of loans sold over the sum of the
pass-through interest rate, a servicing fee, a trustee fee, an insurance fee
and an estimate of annual future credit losses related to the loans
securitized, over the life of the loans. These cash flows are projected over
the life of the loans using prepayment, default, loss, and interest rate
assumptions that market participants would use for similar financial
instruments subject to prepayment, credit and interest rate risk and are
discounted using an interest rate that a purchaser unrelated to the seller of
such a financial instrument would demand. At origination, the Company utilized
prepayment assumptions ranging from 25.0% to 30.0%, estimated loss factor
assumptions of 0.5% and weighted average discount rates of 18.0%, 23.6% and
26.6% for the years ended December 31, 1995, 1994 and 1993, respectively, to
value Residual Interests. The valuation includes consideration of
characteristics of the loans including loan type and size, interest rate,
origination date, term and geographic location. The Company also uses other
available information such as externally prepared reports on prepayment rates,
collateral value, economic forecasts and historical default and prepayment
rates of the portfolio under review. To the Company's knowledge, there is no
active market for the sale of these Residual Interests. The range of values
attributable to the factors used in determining fair value is broad.
Accordingly, the Company's estimate of fair value is subjective.
F-12
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995
AND FOR THE QUARTERS ENDED MARCH 31, 1995 AND 1996 (UNAUDITED)
In 1993, the Company valued Residual Interests at amortized cost which
approximated fair value in accordance with Emerging Issues Task Force No. 89-4
Collateralized Mortgage Obligation Residuals. The adoption of SFAS No. 115 did
not have a material impact on the financial position or results of operation
of the Company.
Mortgage Servicing Rights--Effective January 1, 1995, the Company adopted
SFAS No. 122, Accounting for Mortgage Servicing Rights, which requires that
upon sale or securitization of servicing retained mortgages, companies
capitalize the cost associated with the right to service mortgage loans based
on their relative fair values. The Company determines fair value based on the
present value of estimated net future cash flows related to servicing income.
The cost allocated to the servicing rights is amortized in proportion to and
over the period of estimated net future servicing fee income.
The Company capitalized, at fair value, $3,896,000 of mortgage servicing
rights for the year ended December 31, 1995. During the same period, related
amortization of such mortgage servicing rights was $208,000. At December 31,
1995, the capitalized servicing rights approximated fair value. The Company
periodically reviews capitalized servicing fees receivable to evaluate for
impairment. This review is performed on a disaggregated basis based on loan
type. The Company generally makes loans to credit impaired borrowers whose
borrowing needs may not be met by traditional financial institutions due to
credit exceptions. The Company has found that credit impaired borrowers are
payment sensitive rather than interest rate sensitive. Therefore, the Company
does not consider interest rates a predominant risk characteristic for
purposes of evaluating impairment. Impairment is recognized in a valuation
allowance for each pool in the period of impairment.
Property--Property is stated at cost and depreciated over the estimated
useful lives of the assets using accelerated methods. Leasehold improvements
are amortized on the straight-line method over the lesser of the useful lives
of the assets or the terms of the related leases. Useful lives generally range
from three to seven years.
Real Estate Owned--Real estate acquired in settlement of loans generally
results when property collateralizing a loan is foreclosed upon or otherwise
acquired by the Company in satisfaction of the loan. Real estate acquired
through foreclosure is carried at either the lower of fair value less costs to
dispose or the recorded investment in the loan. Fair value is based on the net
amount that the Company could reasonably expect to receive for the asset in a
current sale between a willing buyer and a willing seller, that is, other than
in a forced or liquidation sale. Adjustments to the carrying value of REO are
made through valuation allowances and charge-offs, recognized through a charge
to earnings.
Income Taxes--For federal and state income tax purposes, the Company has
elected to be taxed as an S corporation whereby its taxable income is included
in the individual returns of the stockholders. As an S corporation, the
Company is subject to certain state taxes, primarily in the State of
California.
The Company accounts for taxes under SFAS No. 109, Accounting for Income
Taxes, which requires an asset and liability approach to financial accounting
for income taxes. Deferred tax assets arise from temporary differences on
which the Company has paid income taxes or recognized income tax benefits that
will be realized as a reduction of future tax liabilities.
Revenue Recognition--The Company derives its revenue principally from fees
for the origination of loans, other fees, interest income, insurance
commissions, loan servicing fees and fees charged for services such as
appraisals and underwriting. The Company sells its loans through
securitization and other loan sales. Revenue
F-13
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995
AND FOR THE QUARTERS ENDED MARCH 31, 1995 AND 1996 (UNAUDITED)
from loans pooled and securitized or sold in the secondary market is
recognized when such loan pools are sold. The Company retains the right to
service all loans it originates and securitizes. The Company receives a fee
for servicing loans based on a fixed percentage of the declining balance of
securitized loan pools. Through securitizations, the Company retains a
Residual Interest in the excess of the weighted average coupons on loans
securitized over the sum of pass-through interest rates on regular interests,
a servicing fee, a trustee fee, an insurance fee and credit losses.
Loan origination and sale revenue includes all mortgage related income other
than loan servicing and other fees, interest and other income.
Loan servicing and other fees are recorded as earned.
Interest income is recorded as earned. Interest income represents the
interest earned on loans held for sale during the period prior to their
securitization or sale, loans receivable held for investment, Residual
Interests and cash equivalents. In accordance with Emerging Issues Task Force
Issue number No. 89-4, the Company computes an effective yield based on the
carrying amount of each Residual Interest and its estimated future cash flows.
This yield is then used to accrue interest income on the Residual Interests.
Use of Estimates in the Preparation of Financial Statements--The preparation
of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting periods. Actual
results could differ from those estimates.
Stock split--As described in Note 15, on May 11, 1996, the Company's Board
of Directors approved a stock split of its common stock whereby approximately
710 shares of common stock were issued for each outstanding share of common
stock. All share and per share amounts included in the accompanying financial
statements and footnotes have been restated to reflect the stock split.
Reclassifications--Certain reclassifications have been made to conform the
1993 and 1994 financial statements to the 1995 presentation.
NOTE 3. UNAUDITED PRO FORMA INFORMATION
The pro forma financial information has been presented to show what the
significant effects on the historical financial position might have been had
the distribution of S Distribution Notes and the revocation of the Company's S
corporation status occurred as of March 31, 1996, and to show what the
significant effects on the historical results of operations might have been
had the Company not been treated as an S corporation for income tax purposes
as of the beginning of the earliest period presented.
Pro Forma Net Income and Pro Forma Statement of Financial Condition--Pro
forma net income represents the results of operations adjusted to reflect a
provision for income taxes which gives effect to the intended change in the
Company's income tax status from an S corporation to a C corporation. The
principal difference between the pro forma income tax rate and the federal
statutory rate of 35% relates to state income tax expense, net of the federal
income tax benefit. The pro forma statement of financial condition represents
the statement of financial condition as of March 31, 1996 adjusted to give
effect to (i) an S corporation distribution of notes with total principal
amounts of $33,626,000 equal to the Company's previously earned and
undistributed taxable S corporation earnings at March 31, 1996; (ii) the
reclassification of $1,294,000 of undistributed retained earnings to Common
Stock in accordance with Topic 4.B of the Compilation of Staff Accounting
Bulletins of the Securities and Exchange Commission; and, (iii) the
establishment of $3,237,000 of net deferred tax assets
F-14
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995
AND FOR THE QUARTERS ENDED MARCH 31, 1995 AND 1996 (UNAUDITED)
that would have been recorded had the Company's S corporation status been
revoked as of March 31, 1996. The amount of the benefit to be recorded will be
dependent upon temporary differences existing at the date of revocation of the
Company's S corporation status. The principal components of the net deferred
tax assets relate to mark to market adjustments, legal reserves and
differences in accounting for residual interests in REMICs.
Pro Forma Net Income Per Share--Historical net income per common share is
not presented because it is not indicative of the ongoing entity.
Pro forma net income per share has been computed by dividing pro forma net
income by the weighted average number of shares of common stock outstanding
during the year. In accordance with a regulation of the Securities and
Exchange Commission, pro forma net income per share data have been presented
to reflect the effect of the assumed issuance (at a price of $17.00 per share)
of that number of shares of common stock that would generate sufficient cash
to pay an S corporation distribution in an amount equal to undistributed S
corporation taxable earnings.
NOTE 4. LOAN ORIGINATION AND SALE REVENUE
Loan origination and sale revenue are comprised of the following:
<TABLE>
<CAPTION>
QUARTER
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
---------------------------------------- ------------------------
1993 1994 1995 1995 1996
------------ ------------ ------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net proceeds from the
sale of loans.......... $213,455,000 $371,641,000 $238,311,000 $ 7,560,000 $74,838,000
------------ ------------ ------------ ----------- -----------
Cost of loans sold...... 212,349,000 373,188,000 233,225,000 7,560,000 74,394,000
Allocated to mortgage
servicing rights....... (950,000) (3,896,000) (960,000)
------------ ------------ ------------ ----------- -----------
211,399,000 373,188,000 229,329,000 7,560,000 73,434,000
Origination fees........ (23,574,000) (33,601,000) (31,157,000) (1,010,000) (9,198,000)
Origination costs....... 5,037,000 5,271,000 5,767,000 187,000 1,448,000
------------ ------------ ------------ ----------- -----------
Net cost of loans sold.. 192,862,000 344,858,000 203,939,000 6,737,000 65,684,000
------------ ------------ ------------ ----------- -----------
Gain on sale of loans... 20,593,000 26,783,000 34,372,000 823,000 9,154,000
Other fees.............. 1,896,000 1,119,000 1,121,000 263,000 217,000
------------ ------------ ------------ ----------- -----------
Loan origination and
sale
revenue................ $ 22,489,000 $ 27,902,000 $ 35,493,000 $ 1,086,000 $ 9,371,000
============ ============ ============ =========== ===========
</TABLE>
NOTE 5. LOANS RECEIVABLE HELD FOR INVESTMENT
Loans receivable held for investment are secured principally by single
family residences. The loans bear interest at fixed rates ranging up to 15.95%
per annum and are due in monthly installments of principal and interest
through August 2024.
F-15
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995
AND FOR THE QUARTERS ENDED MARCH 31, 1995 AND 1996 (UNAUDITED)
NOTE 6. PROPERTY
Property at December 31 consists of the following:
<TABLE>
<CAPTION>
1994 1995
----------- -----------
<S> <C> <C>
Office equipment................................... $ 3,496,000 $ 4,245,000
Vehicles........................................... 288,000 388,000
Leasehold improvements............................. 152,000 160,000
Computer software.................................. 1,119,000 1,119,000
Building........................................... 406,000 406,000
Land............................................... 98,000 98,000
----------- -----------
5,559,000 6,416,000
Less accumulated depreciation and amortization..... (3,479,000) (4,275,000)
----------- -----------
Property, net...................................... $ 2,080,000 $ 2,141,000
=========== ===========
</TABLE>
NOTE 7. SERVICING PORTFOLIO
Trust and other custodial funds, relating to loans serviced for others,
amounted to approximately $8,517,000, $5,783,000, $2,387,000 and $2,878,000 at
March 31, 1996 and December 31, 1995, 1994 and 1993, respectively. Such funds,
which are maintained in separate bank accounts, are excluded from the
Company's assets and liabilities.
Total loans serviced amounted to $611,718,000, $613,791,000, $555,685,000
and $385,570,000 as of March 31, 1996 and December 31, 1995, 1994 and 1993,
respectively. Included in such amounts are adjustable rate mortgage loans
totaling approximately $251,349,000, $281,551,000 and $153,224,000 as of
December 31, 1995, 1994 and 1993, respectively, for which the Company has
subcontracted servicing through an outside agency through February 1, 1996.
NOTE 8. WAREHOUSE FINANCING FACILITY
The Company has a revolving line of credit with a secured asset-based
lender. At December 31, 1995, the Company may borrow and repay during a 90 day
revolving period up to $125,000,000. This line of credit bears interest at a
variable rate based upon the London Interbank Offered Rate (LIBOR) payable
monthly. This line of credit is renewable by the lender on a quarterly basis
and currently expires on the sooner of the closing of a loan securitization or
June 28, 1996. Outstanding borrowings under this line of credit are
collateralized by loans held for sale. Upon the sale or securitization of
loans, borrowings are repaid. This line of credit contains certain
affirmative, negative and financial covenants, with which the Company was in
compliance at December 31, 1995.
The following table presents data on the line of credit for the periods
indicated
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31 THREE MONTHS
--------------------------------------- ENDED
1993 1994 1995 MARCH 31, 1996
----------- ------------ ------------ --------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Weighted average inter-
est rate for the peri-
od..................... 5.81% 5.96% 7.10% 6.31%
Interest rate at the end
of the period.......... 5.75% 7.38% 6.56% 6.31%
Weighted average amount
outstanding for the
period................. $24,138,000 $ 58,139,000 $ 52,610,000 $45,693,000
Maximum amount
outstanding at any
month-end.............. $77,351,000 $110,551,000 $108,217,000 $55,347,000
</TABLE>
F-16
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995
AND FOR THE QUARTERS ENDED MARCH 31, 1995 AND 1996 (UNAUDITED)
NOTE 9. NOTES PAYABLE
Notes payable principally represent amounts owed related to senior liens on
properties foreclosed upon by the Company. The notes bear fixed and variable
interest at rates ranging from 7% to 15.45% per annum at December 31, 1995 and
are payable in aggregate annual amounts as follows:
<TABLE>
<S> <C>
Year ending December 31:
1996............................................................ $ 95,000
1997............................................................ 54,000
1998............................................................ 54,000
1999............................................................ 49,000
2000............................................................ 49,000
Thereafter...................................................... 822,000
----------
$1,123,000
==========
</TABLE>
NOTE 10. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF RISK
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. The future minimum lease payments are as follows:
<TABLE>
<S> <C>
Year ending December 31:
1996........................................................... $1,258,000
1997........................................................... 1,155,000
1998........................................................... 870,000
1999........................................................... 649,000
2000........................................................... 601,000
Thereafter..................................................... 1,240,000
----------
$5,773,000
==========
</TABLE>
In the ordinary course of business, the Company has liability under
representations and warranties made to purchasers and insurers of mortgage
loans. Under certain circumstances, the Company may become liable for the
unpaid principal and interest on defaulted loans or other loans if there has
been a breach of representation or warranties.
The Company has negotiated an employment agreement with an officer. This
agreement provides for the payment of a base salary, the issuance of common
stock subject to certain restrictions and the payment of severance benefits
upon termination.
In December 1989, a class action suit was filed on behalf of certain
borrowers related to the origination of their loans by the Company. The
Company, without admitting to any wrong-doing, agreed to settle the case in
December 1994. The terms of the settlement provide for cash distributions to
the plaintiffs in the amount $6,850,000, which is to be paid out over a three-
year period. Remaining future payments to plaintiffs of $1,833,000 and
$2,308,000 are included in accrued liabilities at March 31, 1996 and December
31, 1995, respectively.
F-17
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995
AND FOR THE QUARTERS ENDED MARCH 31, 1995 AND 1996 (UNAUDITED)
The Company is involved in certain litigation arising in the normal course
of business. The Company believes that any liability with respect to such
legal actions, individually or in the aggregate, is not likely to be material
to the Company's financial position or results of operations.
At December 31, 1995, the State of California accounted for approximately
86% of the total serviced loan portfolio while no other state accounted for
more than 6%.
Availability of Funding Sources--The Company funds substantially all of the
loans which it originates or purchases through borrowings under its warehouse
financing facility and internally generated funds. These borrowings are in
turn repaid with the proceeds received by the Company from selling such loans
through loan sales or securitizations. Any failure to renew or obtain adequate
funding under this warehouse financing facility, or other borrowings, or any
substantial reduction in the size of or pricing in the markets for the
Company's loans, could have a material adverse effect on the Company's
operations. To the extent that the Company is not successful in maintaining or
replacing existing financing, it would have to curtail its loan production
activities or sell loans earlier than is optimal, thereby having a material
adverse effect on the Company's results of operations and financial condition.
Dependence on Securitizations--Since 1992, the Company has pooled and sold
through securitizations an increasing percentage of the loans which it
originates. The Company derives a significant portion of its income by
recognizing gains upon the sale of loans through securitizations which are due
in part to the fair value, recorded at the time of sale, of residual interests
received. Adverse changes in the securitization market could impair the
Company's ability to purchase and sell loans through securitizations on a
favorable or timely basis. Any such impairment could have a material adverse
effect upon the Company's results of operations and financial condition.
The Company has relied on credit enhancement to achieve a "AAA/aaa" rating
for the regular interests in its securitizations. The credit enhancement has
generally been in the form of an insurance policy issued by an insurance
company insuring the timely repayment of regular interests in each of the
REMIC trusts. There can be no assurance that the Company will be able to
obtain credit enhancement in any form from the current insurer or any other
provider of credit enhancement on acceptable terms or that future
securitizations will be similarly rated. A downgrading of the insurer's credit
rating or its withdrawal of credit enhancement could have a material adverse
effect on the Company's results of operations and financial condition.
NOTE 11. RELATED PARTY TRANSACTIONS
During the years ended December 31, 1995, 1994 and 1993, the Company
purchased approximately $15,126,000, $91,501,000 and $69,995,000,
respectively, in loans from a company in which a principal stockholder has a
controlling ownership.
During 1995, 1994 and 1993, the Company serviced mortgage loans for
employees and other related parties for which no service fees were charged.
The aggregate balances of such loans were approximately $11,470,000,
$12,909,000, $8,763,000 and $6,800,000 at March 31, 1996, and December 31,
1995, 1994 and 1993, respectively.
Interest expense related to notes payable to stockholders amounted to
approximately $7,000, $223,000, $10,000, and $561,000 for the three months
ended March 31, 1996 and the years ended December 31, 1995, 1994 and 1993
respectively.
F-18
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995
AND FOR THE QUARTERS ENDED MARCH 31, 1995 AND 1996 (UNAUDITED)
During the years ended December 31, 1995, 1994 and 1993, the Company paid
consulting fees of approximately $76,000, $161,000 and $223,000, respectively,
to a company owned by the stockholders and received fees of approximately
$146,000, $514,000 and $705,000, respectively, from a company in which the
stockholders have a controlling ownership interest.
During the three months ended March 31, 1996 and the years ended December
31, 1995, 1994 and 1993, the Company sold, at par, loans held for sale of
$285,000, $3,188,000, $6,783,000 and $7,061,000, respectively, to a principal
stockholder. Additionally, in 1993, the Company sold certain real property to
this principal stockholder for $600,000.
The Company leases facilities from a principal stockholder on a term and
month-to-month basis. Rent expense amounted to $2,000 for the three months
ended March 31, 1996 and to $18,000 for each of the years ended December 31,
1995, 1994 and 1993. In October 1995, the Company entered into a lease with a
principal stockholder for its corporate headquarters facility. For the years
ending December 31, 1996 through 2003, such lease requires annual lease
payments of $464,000, $521,000, $536,000, $552,000, $569,000, $586,000,
$603,000, and $50,000, respectively.
In 1995, companies owned by family members of the Company's stockholders had
lines of credit with the Company which had outstanding balances of $335,000
and $525,000 at March 31, 1996 and December 31, 1995, respectively. Fees
received in the 1996 quarter and in 1995 from companies owned by the
stockholders' family members were $144,000 and $715,000, respectively. In
1995, the Company also paid premiums of $193,000 to companies owned by the
principal stockholders' family members as these companies included loans in
the Company's securitizations. Additionally, in 1995, the Company purchased
approximately $9,841,000 in loans from a company owned by the principal
stockholders' family members.
NOTE 12. INCOME TAXES
The income tax provision (benefit) for the periods indicated is as follows:
<TABLE>
<CAPTION>
QUARTERS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------- -----------------
1993 1994 1995 1995 1996
--------- -------- -------- ------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Current provision (benefit).... $ 406,000 $426,000 $405,000 $(5,000) $118,000
Deferred taxes (principally
resulting from the accrual and
payment of legal settlement
costs and reserves)........... (184,000) (63,000) 73,000
--------- -------- -------- ------- --------
$ 222,000 $363,000 $478,000 $(5,000) $118,000
========= ======== ======== ======= ========
</TABLE>
NOTE 13. FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET ACTIVITIES
Financial Instruments--SFAS No. 105, Disclosure of Information about
Financial Instruments with Concentrations of Credit Risk and SFAS No. 119,
Disclosure about Derivative Financial Instruments and Fair Value of Financial
Instruments requires the disclosure of the notional amount or contractual
amounts of financial instruments.
The Company regularly securitizes and sells fixed and variable rate mortgage
loans. As part of its interest rate risk management strategy, the Company may
from time to time hedge its interest rate risk related to its loans held for
sale and origination commitments by selling short United States Treasury
Securities. The Company
F-19
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995
AND FOR THE QUARTERS ENDED MARCH 31, 1995 AND 1996 (UNAUDITED)
classifies these transactions as hedges of specific loans receivable and
commitments. The gains and losses derived from these financial futures are
deferred and included in the carrying amounts of the related hedged items and
are recognized in earnings upon sale of the related items. There were no
deferred gains or losses on hedging activities at March 31, 1996 and December
31, 1995, 1994 and 1993. Realized gains and (losses) on hedging activities
were $(255,000) and $800,000 for the years ended December 31, 1995 and 1994.
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:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 MARCH 31, 1996
----------------------- -----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
----------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents.... $ 4,019,000 $ 4,019,000 $ 2,206,000 $ 2,206,000
Loans held for sale.......... 24,744,000 25,610,000 26,325,000 30,159,000
Loans receivable held for
investment.................. 2,261,000 2,340,000 2,075,000 2,521,000
Residual Interests........... 19,705,000 19,705,000 20,732,000 20,732,000
Liabilities:
Warehouse financing facility. 18,233,000 18,233,000 20,015,000 20,015,000
Notes payable................ 1,123,000 1,174,000 2,023,000 2,023,000
</TABLE>
The estimated fair value of loans is based upon quoted market prices.
The fair value of Residual Interests is determined based on estimates of the
market value using discounted cash flows.
Rates currently available to the Company for debt with similar terms and
remaining maturities were used to estimate the fair value of the warehouse
financing facility and notes payable.
The fair value estimates presented herein are based on pertinent information
available to management as of March 31, 1996 and December 31, 1995. 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.
Off-Balance Sheet Activities--The Company is exposed to on-balance sheet
credit risk related to its loans held for sale, Residual Interests and loans
receivable held for investment. The Company is exposed to off-balance sheet
credit risk related to loans which the Company has committed to originate or
buy.
The Company is party to financial instruments with off-balance sheet credit
risk in the normal course of business. These financial instruments include
commitments to extend credit to borrowers and commitments to
F-20
<PAGE>
FIRST ALLIANCE MORTGAGE COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995
AND FOR THE QUARTERS ENDED MARCH 31, 1995 AND 1996 (UNAUDITED)
purchase loans from others. The Company has a first or second lien position on
substantially all of its loans, and the maximum combined loan-to-value (LTV)
permitted by the Company's underwriting guidelines is 85%. The LTV represents
the combined mortgage balances as a percentage of the appraised value of the
mortgaged property. A title insurance policy is required for all loans.
As of March 31, 1996 and December 31, 1995, the Company had outstanding
commitments to extend credit or purchase loans in the amounts of $7,469,000
and $4,181,000 respectively.
NOTE 14. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) defined contribution plan, which was established in
1994, available to all employees who have been with the Company for one year
and have reached the age of 21. Employees may generally contribute up to 15%
of their salary each year; and the Company, at its discretion, may match up to
25% of the first 7% contributed by the employee. The Company's contribution
expense was $32,000, $97,000 and $45,000 for the three months ended March 31,
1996 and the years ended December 31, 1995 and 1994, respectively.
NOTE 15. SUBSEQUENT EVENTS
First Alliance Corporation, a Delaware Corporation owned by the stockholders
of the Company, intends to acquire the Company in exchange for 10,750,000
shares of its Class B Common Stock. First Alliance Corporation is also
contemplating an initial public offering of 3,500,000 shares of its Class A
Common Stock (the "Offering").
In 1996, the Company entered into an employment agreement (the "Agreement")
with its president and chief executive officer. The Agreement provides for a
three year term ending July 1, 1999, and shall be automatically renewed for
successive three year terms unless terminated by either party. Under the
Agreement, this officer has agreed to serve as a consultant to the Company for
a period of three years after termination at the discretion of the Board of
Directors (except for a termination due to cause, death or disability). This
officer shall receive an annual salary of $395,000, which salary may be
increased at the discretion of the Board of Directors. This officer will
receive an annual fee of $248,500 during the three year consulting period.
On May 2, 1996, the Company distributed S distribution notes totalling
$40,000,000 to the Company's stockholders. Additional S distribution notes
will be distributed prior to consummation of the Offering.
On May 11, 1996, the Company's Board of Directors approved a split of its
common stock whereby approximately 710 shares of common stock were issued for
each outstanding share of common stock. All share and per share amounts
included in the accompanying financial statements and footnotes have been
restated to reflect this stock split.
In June 1996, the Company granted 107,500 shares of common stock to an
officer of the Company. A value of approximately $1,600,000 has been ascribed
to such shares by the Company. Upon consummation of the Offering 24.6% of
these shares will vest with the balance vesting over a five year period. For
purposes of computing pro forma net income per share information, 18,628 of
these shares have been treated as outstanding.
F-21
<PAGE>
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NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE PUBLIC OFFERING MADE
HEREBY TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN
THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON OR BY ANYONE IN
ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL,
UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
----------------
TABLE OF CONTENTS
----------------
<TABLE>
<CAPTION>
PAGE
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 7
The Company............................................................... 15
Prior S Corporation Status................................................ 15
Use of Proceeds........................................................... 15
Dividend Policy........................................................... 16
Dilution.................................................................. 16
Capitalization............................................................ 18
Selected Consolidated Financial Data...................................... 19
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 21
Business.................................................................. 35
Management................................................................ 53
Certain Transactions...................................................... 58
Principal Stockholders.................................................... 60
Description of Capital Stock.............................................. 61
Shares Eligible for Future Sale........................................... 64
Underwriting.............................................................. 65
Legal Matters............................................................. 66
Experts................................................................... 66
Financial Glossary........................................................ 67
Available Information..................................................... 68
Index to Financial Statements............................................. F-1
</TABLE>
UNTIL AUGUST 19, 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS) ALL DEALERS
EFFECTING TRANSACTIONS IN THE CLASS A COMMON STOCK OFFERING HEREBY, WHETHER OR
NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPEC-
TUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
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3,500,000 SHARES
FIRST ALLIANCE
CORPORATION
CLASS A COMMON STOCK
----------------
PROSPECTUS
----------------
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
JULY 25, 1996
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