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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File No.: 0-22193
LIFE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 33-0743196
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
10540 Magnolia Avenue, Suite B, Riverside, California 92505
(Address of principal executive offices)
(909) 637-4000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of class)
The registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
The aggregate market value of the voting stock held by non-affiliates of the
registrant, i.e., persons other than directors and executive officers of the
registrant is $3.38 and is based upon the last sales price as quoted on The
Nasdaq Stock Market for March 26, 1999.
As of March 26, 1999, the Registrant had 6,562,396 shares outstanding
(excluding treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1999 Annual Meeting of Stockholders
are incorporated by reference into Part III of this Form 10-K.
INDEX
Page
PART I
======
Item 1. Business................................................................................. 1
Additional Item. Executive Officers of the Registrant.................................... 46
Item 2. Properties............................................................................... 47
Item 3. Legal Proceedings........................................................................ 48
Item 4. Submission of Matters to a Vote of Security Holders...................................... 48
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................... 49
Item 6. Selected Financial Data.................................................................. 49
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 51
Item 8. Financial Statements and Supplementary Data.............................................. 64
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..... 101
PART III
Item 10. Directors and Executive Officers of the Registrant....................................... 101
Item 11. Executive Compensation................................................................... 101
Item 12. Security Ownership of Certain Beneficial Owners and Management........................... 101
Item 13. Certain Relationships and Related Transactions........................................... 101
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................... 101
SIGNATURES 102
5
ITEM 1. BUSINESS
General
LIFE Financial Corporation (the "Company") is a Delaware chartered savings
and loan holding company, headquartered in Riverside, California. The Company
became the parent company of Life Bank (formerly "Life Savings Bank, Federal
Savings Bank") (the "Bank") pursuant to the holding company reorganization of
the Bank (the "Reorganization") undertaken in connection with the Company's
initial public offering of its Common Stock (the "IPO"). The Company completed
the IPO on June 30, 1997. Together with shares issued subsequent to that date
pursuant to the exercise of the underwriter's overallotment option, the Company
issued a total of 3,335,000 shares of Common Stock in the IPO at a price of
$11.00 per share. Net proceeds from the IPO amounted to $32.8 million.
The Company originates, purchases, sells, securitizes and services primarily
alternative mortgage loans principally secured by first and second mortgages on
one- to four-family residences. The Company makes Liberator Series loans, which
are for the purchase or refinance of residential real property by borrowers who
could generally qualify for Fannie Mae ("FNMA") or Freddie Mac ("FHLMC")
loans ("alternative borrowers") but required relief from the more stringent
documentation that those quasi-governmental agencies require. Through October
1998, the Company also made portfolio series loans, which are debt consolidation
loans for borrowers whose credit history qualifies them for FNMA and FHLMC loans
("Agency Qualified Borrowers") with loan-to-value ratios up to 125%. The
Liberator Series of loans is now the Company's "core product." The Company
also originates primarily on a retail basis through the Income Capital Group
multi-family residential, commercial and construction loans. A new division, the
Consumer Finance Group, was introduced in the fourth quarter of 1998 with the
express mandate to create private label and joint venture relationships to
finance various direct to the consumer lending products.
The Company conducts its business from thirteen locations: the Company's
corporate headquarters and Western regional lending center in Riverside,
California, four additional regional lending centers located in Jacksonville,
Florida, the Denver, Colorado metropolitan area, San Jose, California, as well
as the Boston metropolitan area. The national servicing center is located in
Riverside, California adjacent to the corporate headquarters with the Consumer
Finance Group domiciled in a company owned facility in Riverside, California.
LIFE bank branch offices are located in the Southern California cities of San
Bernardino, Riverside, Redlands and Huntington Beach.. In addition, the Company
has recently entered into a lease for an additional Southern California bank
branch in the Orange County community of Seal Beach that is expected to open in
May of 1999.
At December 31, 1998, the Company had consolidated total assets of $428.1
million, total deposits of $323.4 million and total stockholders' equity of
$52.0 million. During the year ended December 31, 1998, the Company originated
or purchased, through a network of approved correspondents and independent
mortgage brokers (the "Originators"), $1.2 billion of mortgage loan products,
and sold or securitized $1.1 billion of such products. The Bank's deposits are
insured up to the maximum allowable amount by the Savings Association Insurance
Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The
Company's headquarters are located at 10540 Magnolia Avenue, Suite B, Riverside,
California 92505, and its telephone number at that location is (909) 637-4000.
Historical Strategy of the Company
During the early 1990's, as a result of reduced employment levels and
corporate relocations in Southern California and the general weakness of the
national economy, the Company's market area experienced a weakening of real
estate values and a reduction in home sales and construction. When confronted
with increased competition and nominal growth during this same period, the
Company's results of operations were adversely impacted and the Company began to
experience increases in total non-performing loans held for investment. In
response, in 1994, the Company retained new management experienced in mortgage
lending to redirect its business focus, revise its underwriting policies and
procedures and enhance its related servicing capabilities. A plan was developed
pursuant
6
to which the Company reorganized its lending operations from that of a thrift
solely emphasizing mortgage banking and portfolio lending to that of a
diversified financial services operation focusing on the origination for sale or
securitization, with servicing retained, of various alternative loan products to
include Liberator Series of residential mortgage loans, as well as the Income
Capital Group which provides commercial, multi-family and real estate
construction loans. The Company also adopted revised underwriting policies and
instituted more aggressive procedures for resolving problem loans and for
reducing the level of non-performing assets. As a result of these steps, the
Company improved its profitability.
As part of the Company's strategic plan, the Bank developed an internal
structure of operating divisions, each with distinct objectives and management
focus. The six divisions include (i) the Financial Services Division which
emphasizes the wholesale origination of the Bank's core products; (ii) the
Income Capital Services Group which originates and sells commercial, multi-
family and construction loans; (iii) the Retail Loan Division which concentrates
on offering loan products directly to the public primarily in the Bank's primary
market area; (iv) the Consumer Finance Group which provides financing for a
variety of private label and joint venture consumer products; (v) Asset
Management Division which services loans and REO for both the Bank and for Loan
Purchasers; and (vi) the Banking Division which offers depository services to
the public. These divisions do not necesarrily represent the operating segments
of the company.
On March 11, 1998, the Company entered into an agreement and plan of merger
("Merger Agreement") with FIRSTPLUS Financial Group, Inc. ("FIRSTPLUS"). The
Merger Agreement provided for the merger of the Company with and into FIRSTPLUS,
with FIRSTPLUS as the surviving corporation. On October 9, 1998, the Company
advised FIRSTPLUS that it was terminating the Merger Agreement based upon, among
other reasons, certain breaches of the Merger Agreement by FIRSTPLUS. On October
19, 1998, the Company filed a lawsuit against FIRSTPLUS arising out of the
Merger Agreement in the United States Federal District Court for Dallas, Texas.
Corporate Structure
The Company and the Bank consummated the Reorganization in June of 1997
whereby the Bank became a wholly owned subsidiary of the Company. Management
believes that the holding company form of organization provides the Company with
more flexibility and a greater ability to compete with other financial services
companies in the market place. In addition, due to regulatory capital
limitations, the Bank is limited in the amount of investments in residuals
resulting from securitizations that it can retain. The Company is not subject to
such limitations, and thus will reduce the restrictions on the Bank's regulatory
capital by acquiring loans and creating the residuals as part of a
securitization.
Core Lending Products
General. The Company originates, purchases, sell, securitizes and services
primarily non-conventional mortgage loans principally secured by first and
second mortgages on one- to four-family residences. The Company makes Liberator
Series loans, which are for the purchase or refinance of residential real
property by alternative borrowers, and Portfolio Series loans, which are debt
consolidation loans for Agency-Qualified Borrowers with loan-to-value ratios
generally up to 125%. The Company is currently emphasizing the origination of
Liberator Series loans and has eliminated the Portfolio Series loan product
effective October 1998. In addition, to a much lesser extent, the Company
originates multi-family residential, commercial real estate and construction
loans.
The Company purchases and originates mortgage loans and other real estate
secured loans primarily through a network of Originators on a nationwide basis.
Beginning in 1998, the Company began to originate a limited number of loans
specifically for retention in the Bank's portfolio as loans held for investment.
Loans originated or purchased since 1994 through the Company's regional lending
centers are generally originated for sale in the
7
secondary mortgage market and, since the fourth quarter of 1996, in asset
securitizations with servicing retained by the Company.
Adjustable-Rate Mortgages. The Company's adjustable rate mortgage ("ARM")
products consist of both first and second mortgages. The repayment and
amortization terms on first mortgage ARMs are 360 months. The repayment and
amortization terms on second mortgage ARMs may be 300, 240 or 180 months.
Interest rates adjust every six or twelve months, and are tied to the six-month
LIBOR or to the 1-Year U.S. Treasury Index, respectively. The periodic rate caps
vary between 1% and 3% on each rate change date. All ARM products are assumable,
subject to new borrower qualification, assumption agreements and fees. The
lifetime rate cap on ARMs is 6% to 7% above the initial rate. None of the ARM
products permit negative amortization. There are no fixed-rate conversion
options on any of the ARM products. Certain ARM products impose prepayment
penalties and others do not.
Marketing. The Company's primary means of marketing its products is direct
contact between its account executives and Originators. Each of the Company's 27
account executives is responsible for maintaining and expanding existing
Originator relationships within the account executive's assigned territory
through personal contact and promotional materials. Each account executive is
typically responsible for approximately 20 key Originators and is expected to
have weekly contact with each of these Originators. In addition, each account
executive is responsible for up to 30 additional Originators with whom the
account executive will have frequent contact. Each account executive also works
to develop Originator relationships through "cold calls" and following up on
inquiries made by Originators to the Company's toll-free number. Each account
executive works as part of a team with one of the Company's loan coordinators
and assistant coordinators. Each loan coordinator and assistant loan coordinator
works with three or four account executives. The loan coordinators and their
assistants are responsible for inputting the new loans into the Company's data
systems and for shepherding the loans from the point of origination through
funding. After origination, the whole loan coordinators and their assistants are
available to talk to Originators on a daily basis. Whole loan coordinators and
their assistants are located in each of the Company's regional lending centers.
The Company believes that the key element in developing, maintaining and
expanding its relationships with Originators is to provide the highest possible
level of product knowledge and customer service. Each account executive receives
comprehensive training prior to being assigned to a territory. In most cases,
training includes experience in the loan production department so that the
account executive will be familiar with all phases of loan origination and
production and will also become acquainted with the whole loan coordination
team. This training enables the account executive to quickly review a loan
application in order to identify the borrower's probable risk classification and
then assist the Originator in identifying the appropriate product for the
borrower, thereby enhancing the likelihood that the loan will be approved at the
rate and on the terms anticipated by the borrower. After a loan package is
submitted to the Company, the loan coordination team provides assistance to the
Originator throughout the process to complete the loan transaction. Account
executives and loan coordinators are compensated based on the number and the
dollar volume of loans funded. A significant portion of a regional manager's
compensation is tied to the profitability of his or her regional lending center
and includes a component based on loan performance.
Origination and Purchase of Loans. Loans are originated both through the
Company's wholesale network of Originators and on a retail basis through the
Company's Retail Lending Division. The Company has also made bulk purchases of
loans from time to time and hired a senior management employee experienced in
bulk purchases to expand the Company's loan purchases.
The Company's mortgage financing and servicing operations are conducted
primarily through regional lending centers located in Riverside, California,
Jacksonville, Florida, the Denver, Colorado metropolitan area, Boston
Massachuetts and San Jose, California. From its present locations, the Company
is able to originate or purchase its core products in the District of Columbia
and all 50 states with the exception of Alaska and Hawaii.
8
The following table sets forth for the periods shown the aggregate dollar
amounts and the percentage of core products originated or purchased by the
Company in each state where 5.0% or more of the loans were originated or
purchased during the years ended December 31, 1998 and 1997:
December 31, December 31,
------------ ------------
1998 1997
---- ----
$ % $ %
------ ------ ------- ------
(Dollars in thousands)
California............................ $ 200,964 18.5% $159,385 22.3%
Michigan.............................. 67,995 6.3 20,853 2.9
Virginia.............................. 65,202 6.0 42,722 6.0
Utah.................................. 61,844 5.7 35,735 5.0
Maryland.............................. 55,801 5.1 39,545 5.5
Florida............................... 53,532 4.9 37,009 5.2
North Carolina........................ 51,694 4.8 38,011 5.3
Other................................. 529,338 48.7 342,292 47.8
---------- ----- -------- -----
Total............................... $1,086,370 100.0% $715,552 100.0%
========== ===== ======== =====
The Company's geographic markets are currently divided into three regions,
with a completely self-contained mortgage banking team assigned to each region.
Each team is headed up by a regional manager and includes dedicated account
executives, loan coordinators and assistant coordinators, underwriters, and
other production personnel so that the team can originate and produce loans in
that region. This concept of regional processing teams, which the Company
believes is efficient but quite rare in the industry, enables the Company to
more effectively anticipate and respond to Originator and borrower needs in each
region. Management believes that the concept also appeals to independent brokers
who may be reluctant to deal with a larger, more remote lender. Each regional
team is connected to senior management in Riverside, California by a computer
link that enables senior management to monitor all regional functions on a real
time basis.
Management personnel staffing a regional lending center are trained in the
Company's Riverside office. For a period of six to twelve months after the
establishment of a regional lending center all loans originated through that
office are reunderwritten by staff at the Riverside office to assure quality
control. In addition, the quality control department and the Company's internal
auditor regularly visit the regional lending centers for quality control
purposes.
In recent years, the Company has focused on both Liberator Series loans and
Portfolio Series loans. The Company is currently emphasizing the origination of
Liberator Series loans, as the Portfolio Series loans were phased out as of
October 1998.
Liberator Series loans are loans for the purchase or refinance of one- to
four-family residential real property by alternative borrowers and loans which
otherwise do not conform to FHLMC or FNMA guidelines ("conforming loans").
Loans to alternative borrowers are perceived by management as being advantageous
to the Company because they generally have higher interest rates and origination
and servicing fees and generally lower loan-to-value ratios than conforming
loans. In addition, management believes the Company has the resources to
adequately service loans acquired pursuant to this program as well as the
experience to resolve loans that become non-performing. The Company has
established specific underwriting policies and procedures, invested in
facilities and systems and developed correspondent relationships with
Originators throughout the country enabling it to develop its niche as an
originator and purchaser of one-to four-family residential loans to alternative
borrowers. Since the beginning of 1997, the Company has widely advertised its
NINA loan product and in 1998 began the enhanced NINA, which is a limited
documentation, lower loan-to-value loan product within the Liberator Series loan
portfolio. The Company intends to continue to expand the volume of Liberator
Series loans which it originates to market areas throughout the country to
alternative borrowers who meet its niche lending criteria. Loans to alternative
borrowers present a higher level of risk of default than conforming loans
because of the increased potential for default by borrowers who may have had
previous credit problems or who do not have an adequate credit history. Loans to
alternative borrowers also involve additional liquidity risks, as these loans
generally have a
9
more limited secondary market than conventional loans. The actual rates of
delinquencies, foreclosures and losses on loans to alternative borrowers could
be higher under adverse economic conditions than those currently experienced in
the mortgage lending industry in general. While the Company believes that the
underwriting procedures and appraisal processes it employs enable it to somewhat
mitigate the higher risks inherent in loans made to these borrowers, no
assurance can be given that such procedures or processes will afford adequate
protection against such risks.
As of October 1998, the Portfolio Series loans were discontinued as a product
line. Portfolio Series loans, which are debt consolidation loans for Agency
Qualified Borrowers, were originated both on a wholesale basis through the
Company's Life Financial Services Division, and through its Retail Lending
Division. These loans are consumer-oriented loans secured by real estate,
primarily home equity lines of credit and second deeds of trust, generally for
up to 125% of the appraised value of the real estate underlying the aggregate
loans on the property. Although the loan-to-value ratio on Portfolio Series
loans is higher than that offered by other mortgage products, management
believes that the higher yield and the low level of credit risk of the borrowers
offsets the risks involved. In the event of a default on a Portfolio Series loan
by a borrower, there generally would be insufficient collateral to pay off the
balance of such loan and the Company, as holder of a second position on the
property, would likely lose a substantial portion, if not all, of its
investment. While the Company believes that the underwriting procedures it
employs enable it to somewhat mitigate the higher risks inherent in such loans,
no assurance can be given that such procedures will afford adequate protection
against such risks.
The following table sets forth the principal balance of each of the Company's
core loan products originated during the years ended December 31, 1998 and 1997:
December 31, December 31,
------------ ------------
1998 1997
---- ----
(Dollars in thousands)
Liberator Series (full documentation).............. $ 421,616 $186,964
Liberator Series (NINA)............................ 262,210 55,932
Portfolio Series................................... 402,544 472,656
---------- --------
Total............................................ $1,086,370 $715,552
========== ========
The following table sets forth selected information relating to originations
of Liberator Series loans during the years ended December 31, 1998 and 1997:
For the YearEnded For the Year Ended
--------------------------- --------------------------
December 31, 1998 December 31, 1997
--------------------------- --------------------------
Full Full
---- ----
Documentation NINA Documentation NINA
-------------- ---------- -------------- ---------
(Dollars in thousands)
Principal balance............................................. $421,616 $262,210 $186,964 $55,932
Average principal balance per loan 8.3 113 90 112
Combined weighted average initial loan-to-value ratio......... 78.2% 75.2% 76.6% 72.2%
Percent of first mortgage loans............................... 94.8 97.4 89.6 99.4
Property securing loans:
Owner occupied.............................................. 94.6 93.4 88.5 94.3
Non-owner occupied.......................................... 5.4 6.6 11.5 5.7
Percentage fixed-rate......................................... 66.9 51.5 38.5 24.6
Percentage ARMs............................................... 33.1 48.5 61.5 75.4
Weighted average interest rate:
Fixed-rate.................................................. 9.5 9.7 10.7 10.9
ARMs........................................................ 9.3 9.3 9.5 9.3
The following table sets forth selected information relating to originations
of Portfolio Series loans during the years ended December 31, 1998 and 1997:
10
For the For the
------- -------
Year Ended Year Ended
---------- ----------
December 31, December 31,
------------ ------------
1998 1997
---- ----
Principal balance.......................................................... $402,544 $472,656
Average principal balance per loan......................................... 33 33
Combined weighted average initial loan-to-value ratio...................... 111.0 109.0
Percent of first mortgage loans............................................ 0.0 0.2
Property securing loans:
Owner occupied........................................................... 100.0 100.0
Non-owner occupied....................................................... 0.0 0.0
Percentage fixed-rate...................................................... 95.6 95.4
Percentage ARMs............................................................ 4.4 4.6
Weighted average interest rate:
Fixed-rate............................................................... 13.4 14.0
ARMs..................................................................... 11.1 11.0
Use and Qualifications of Originators. The Company purchases loans from select
Originators throughout the country. Such Originators must be approved by the
Company prior to submitting loans to the Company. Pursuant to the Company's
approval process, each Originator is generally required to have a specified
minimum level of experience in originating non-conforming loans, and provide
representations, warranties, and buy-back provisions to the Company.
The Company provides clear and concise criteria regarding its well-defined
core products to Originators with whom it may do business. If, following a
period of training and relationship building, Originators consistently fail to
present a high level of loans meeting the Company's underwriting criteria, the
Company will cease to do business with them. As a result, the Company has
developed, since 1994, a core group of Originators who form its nationwide
network of Originators. The Company generally classifies the Originators with
which it does business into four classes with descending priority with regard to
the terms and the pricing of the loans the Company purchases from such
Originators.
Junior Third Party Mortgage
------ ----------- --------
Correspondents Correspondents Originators Brokers(1)
-------------- -------------- ----------- ----------
Net Worth(2)..................................... $250,000 $100,000 $50,000 N/A
Years in Business................................ 2 2 2 N/A
Warehouse Credit Facility........................ Yes Yes No No
Errors and Omissions Insurance................... $1.0 million No No No
Number Doing Business with the Company at
December 31, 1998............................... 129 53 72 1,118
(1) Mortgage brokers are those persons who do not meet the specific foregoing
criteria but have demonstrated to the Company, or have a reputation for, the
ability to originate real estate secured loans and have acceptable credit
and finance industry references.
(2) Correspondents provide audited financial statements prepared in accordance
with GAAP from which net worth is determined. Junior Correspondents and
Third Party Originators provide unaudited financial information from which
net worth is obtained.
The Company purchases substantially all loans on an individual basis from
qualified Originators. No single Originator accounted for more than 3.1% of
the loans originated by the Company for the year ended December 31,
11
1998. It is the Company's general policy to limit the percentage of loans closed
by any single Originator to approximately 5.0% of loans closed in any given
period.
Underwriting. The underwriting and quality control functions are managed
through the Company's administrative offices in Riverside, California. The
Company believes that its underwriting process begins with the experience of its
staff, the education of its network of Originators, the quality of its
correspondent relationships and its loan approval procedures. As an integral
part of its lending operation, the Company ensures that its underwriters assess
each loan application and subject property against the Company's underwriting
guidelines.
Personnel in the Company's regional lending centers review in its entirety
each loan application submitted by the Company, Originators or through bulk
purchases for approval. The Company conducts its own underwriting review of each
loan, including those loans originated for or purchased by it from its
Originators. Loan files are reviewed for completeness, accuracy and compliance
with the Company's underwriting criteria and applicable governmental
regulations. This underwriting process is intended to assess both the
prospective borrower's ability to repay the loan and the adequacy of the real
property security as collateral for the loan granted, tailored to the general
nature of the Portfolio Series and the Liberator Series loans, respectively.
Based on the initial review, the personnel in the regional lending center will
inform the Originators of additional requirements that must be fulfilled to
complete the loan file. The Company strives to process each loan application
received from its network of Originators as quickly as possible in accordance
with the Company's loan application approval procedures. Accordingly, most loan
applications receive decisions within 48 hours of receipt and generally are
funded within one day following satisfaction of all conditions for approval of
the loan which is typically seven business days after the initial approval.
Each prospective borrower is required to complete a mortgage loan application
that may include (depending on the program requirement) information detailing
the applicant's liabilities, income, credit history, employment history and
personal information. Since most of the loan applications are presented through
the Company's network of Originators, the Company completes an additional credit
report on all applications received. Such report typically contains information
relating to such matters as credit history with local and national merchants and
lenders, installment debt payments and any record of defaults, bankruptcies,
repossessions or judgments. This credit report is obtained through a
sophisticated computer program that accesses what management believes to be the
most appropriate credit bureau in a particular zip code and combines that
information with the Company's own credit risk score.
This application and review procedure is used by the Company to analyze the
applicant's creditworthiness (i.e., a determination of the applicant's ability
to repay the loan). Creditworthiness is assessed by examination of a number of
factors, including calculating a debt-to-income ratio obtained by dividing a
borrower's fixed monthly debt by the borrower's gross monthly income. Fixed
monthly debt generally includes (i) the monthly payment under any related senior
mortgages which will include calculations for insurance and real estate taxes,
(ii) the monthly payment on the loan applied for and (iii) other installment
debt, including, for revolving debt, the required monthly payment thereon, or,
if no such payment is specified, 3% of the balance as of the date of
calculation. Fixed monthly debt may not include any debt (other than revolving
credit debt) described above that matures within less than 10 months of the date
of calculation.
Prior to funding a loan, several procedures are used to verify information
obtained from an applicant. The applicant's outstanding balance and payment
history on any senior mortgage may be verified by calling the senior mortgage
lender. If the senior mortgage lender cannot be reached by telephone to verify
this information, the Originators may rely upon information provided by the
applicant, such as a recent statement from the senior lender and verification of
payment, such as canceled checks, or upon information provided by national
credit bureaus. In order to verify an applicant's employment status, the
Originators may obtain from the applicant recent tax returns or other tax forms
(e.g., W-2 forms) or current pay stubs or may telephone the applicant's employer
or obtain written verification from the employer. As in the case of the senior
mortgage lender verification procedures, if the employer will not verify
employment history over the telephone, the Company or other Originators may rely
solely on the
12
other information provided by the applicant. The Company does offer NINA loans
at reduced loan-to-value ratios in lieu of documenting cash flow and/or assets
of the borrower. See "--Liberator Series (NINA)" for further information on NINA
loans.
Debt to income ratios for Portfolio Series mortgage loans generally did not
exceed 45%, but in certain instances where deemed appropriate by the Company,
the ratio may have gone as high as 50%. For Liberator Series mortgage loans,
debt to income ratios may vary depending upon a number of other factors used to
ascertain the creditworthiness of the borrower.
The general criteria currently used by the Company in classifying prospective
borrowers of its core loan products are summarized in the charts below.
Liberator Series
"Ax" Risk "A-" Risk "B" Risk
---------------------- ---------------------- ------------------------
Maximum Loan-to-Value
Ratio:
Primary residence(1)........... 97% 95% 85%
Secondary residence............ 90% 90% 80%
Investor property.............. 90% 90% 80%
Home equity line of
credit........................ 90% 90% 80%
Debt Service to Income
Ratio......................... 50% 50% 50-55%
Mortgage Credit.................. No more than 30-days No more than 30-days No more than 30 days
late in the last 12 Late in the last 12 late in last 12 months
months months for Liberator Plus
and no more than
60-days late in last 12
months for Liberator.
Bankruptcy Filings............... No bankruptcy in last No bankruptcy in last No bankruptcy in last
24 months 24 months 18 months
Minimum Credit Score
Liberator 620/600 600/575 550/530
Liberator Plus 620 501 575
"C" Risk "Cx" Risk
------------------------- ----------------------
Maximum Loan-to-Value
Ratio:
Primary residence(1)........... 75% 65%
Secondary residence............ 70% 65%
Investor property.............. 70% 65%
Home equity line of
credit........................ -- --
Debt Service to Income
Ratio......................... 50-60% 60%
Mortgage Credit.................. No more than two 60 Currently delinquent
days late payments and
one 90 days late
payments in last 12
months
Bankruptcy Filings............... No bankruptcy in last Discharged within 12
12 months months preceding
application; current
Chapter 13 or
foreclosure
acceptable when paid
in full or cured from
loan proceeds
Minimum Credit Score
Liberator 450 less than 450
Liberator Plus
(1) The NINA product is exactly the same except Loan-to-Value is 90% on primary
residence.
13
Loan Production by Borrower Risk Classification. The Company classifies
borrowers according to credit risk from A+ to Cx; however, the predominant
amount of its lending is to borrowers in categories A- or higher. The following
table sets forth information concerning the Company's principal balance of fixed
rate and adjustable rate loan production by borrower risk classification for the
years ended December 31, 1998 and 1997:
For the Year Ended For the Year Ended
------------------ -------------------
December 31, 1998 December 31, 1997
----------------- -----------------
Weighted Weighted
-------- --------
Average Weighted Average Weighted
------- -------- ------- --------
Product/Risk % of Interest Average % of Interest Average
------------ ---- -------- ------- ---- -------- -------
Classifications Volume Total Rate(1) Margin(2) Volume Total Rate(1) Margin(2)
--------------- ------ ----- ------- --------- ------ ----- ------- ---------
(Dollars in thousands)
Liberator Series (Full documentation)
A+..................................... $ 4,450 1.1% 9.10% 5.32% $ 964 0.5% 9.31% 5.16%
Ax..................................... 264,782 62.8 9.10 5.34 81,706 43.7 9.46 4.48
A-..................................... 69,818 16.5 9.47 5.68 52,488 28.1 9.77 5.24
A...................................... 1,118 0.3 9.21 5.72 -- -- -- --
-------- ----- ------- -----
Total A- or better................... 340,168 80.7 -- -- 135,158 72.3 9.58 4.78
-------- ----- ------- -----
B+..................................... 5,409 1.3 9.75 6.17 143 0.1 10.42 --
B...................................... 54,833 13.0 10.47 6.36 25,423 13.6 10.11 4.95
C...................................... 14,018 3.3 11.18 7.00 11,229 6.0 11.00 5.64
Cx..................................... 7,188 1.7 11.87 7.22 15,011 8.0 12.32 6.83
-------- ----- ------ -----
Totals............................... $421,616 100.0% 9.46 5.63 $186,964 100.0% 9.96 5.02
======== ===== ======== =====
Liberator Series (NINA)
A+ $ 3,172 1.2% 9.47 5.65 -- -- -- --
Ax..................................... 197,930 75.5 9.39 5.25 $ 38,404 68.7% 9.20 5.47
A-..................................... 20,761 7.9 9.83 5.71 8,460 15.1 9.93 6.18
A...................................... 340 0.1 8.34 -- -- -- -- --
A1..................................... 5,795 2.2 7.70 -- -- -- -- --
A2..................................... 1,996 0.8 7.97 -- -- -- -- --
A3..................................... 2,921 1.1 8.41 -- -- -- -- --
A4..................................... 1,666 0.6 9.11 -- -- -- -- --
-------- ----- ------ ----
Total A- or better................... 234,581 89.4 -- -- 46,864 83.8 9.33 5.59
-------- ----- ------ ----
B+..................................... 294 0.1 10.27 6.14 -- -- -- --
B...................................... 15,935 6.1 10.60 6.43 4,325 7.7 10.74 6.26
C...................................... 7,298 2.8 10.91 6.19 1,909 3.4 11.35 6.92
Cx..................................... 4,102 1.6 12.09 7.50 2,834 5.1 12.56 6.83
-------- ----- ----- ---
Totals............................... $262,210 100.0% 9.52 5.43 $ 55,932 100.0% 9.67 5.75
======== ===== ======== =====
Portfolio Series
A+..................................... $116,139 28.9% 12.78 2.79 $101,777 21.5% 13.09 5.00
Ax..................................... 128,068 31.8 13.20 3.90 171,206 36.2 13.72 5.26
A-..................................... 149,992 37.3 13.75 4.58 161,112 34.1 14.23 6.20
A...................................... 134 0..0 13.17 -- -- -- -- --
-------- ----- -------- -----
Total A- or better................... 394,333 98.0 13.29 3.83 434,095 91.8 13.76 5.55
-------- ----- -------- -----
B+..................................... 8,112 2.0 14.09 6.97 38,167 8.1 14.32 6.40
B...................................... 29 0.0 16.99 -- 394 0.1 12.74 3.23
36 0.0 12.50 -- -- -- -- --
B...................................... 34 0.0 13.99 -- -- -- -- --
-------- ----- -------- -----
Total................................ $402,544 100.0% 13.30 3.90 $472,656 100.0% 13.81 5.62
======== ===== ======== =====
(1) Weighted average interest rate includes both ARM loan products and fixed
rate loan products.
(2) Weighted average margin is based solely on ARM products.
Appraisal. All mortgaged properties relating to mortgage loans where
collateral assessment is an integral part of the evaluation process are
appraised by state licensed or certified appraisers. All of the appraisals are
either performed or reviewed by appraisers or appraisal firms approved by the
Company's senior management. These appraisers are screened and actively reviewed
on a regular basis. Each approved appraiser must have a minimum of $1.0 million
of errors and omissions insurance. All appraisers are required to assess the
valuation of the property pursuant to U.S. Government Property Analysis
guidelines and conduct an economic analysis of the geographic region in which
the property is located. Once a loan application file is complete, the file is
reviewed to determine
14
whether the property securing the loan should undergo a desk or field review.
This determination is made based on the loan-to-value ratio of the underlying
property and the type of loan or loan program. If after the initial desk review,
the underwriter requires additional information with regard to the appraised
value of the property, a field review may also be conducted. The Company
requires the appraiser to address neighborhood conditions, site and zoning
status and the condition and valuation of improvements. Following each
appraisal, the appraiser prepares a report which (when appropriate) includes a
reproduction cost analysis based on the current cost of constructing a similar
building and a market value analysis based on recent sales of comparable homes
in the area. Title insurance policies are required on all first mortgage liens
and second liens $100,000 and over, with a limited judgment lien report required
on all second lien loans under $100,000.
For Liberator Series loans, because of the alternative creditworthiness of the
borrowers, the evaluation of the value of the property securing the loans and
the ratio of loans secured by such property to its value become of greater
importance in the underwriting process. The specific procedures and criteria
utilized in the appraisal process range from a desk review, a field review, to a
second appraisal, depending on the size of the loan and its loan-to-value ratio.
The value of the mortgaged property has lesser importance with respect to the
Portfolio Series loans in light of their high loan-to-value ratios. As a result,
Portfolio Series loans generally have little or no equity in the mortgaged
property available to repay the loan if it is in default. For Portfolio Series
loans, the Company accepted the homeowner/mortgagee's "as stated" value on
loans to $35,000. On loans in excess of $35,000 to a maximum of $50,000, the
Company required a current tax assessment, a statistical appraisal or a HUD-1
conformed closing statement where purchase of the subject property has occurred
within the previous 12 months. For loans in excess of $50,000, a drive-by
appraisal including comparable analysis on a FHLMC Form 704 was required.
Qualified property inspection firms are also utilized for annual property
inspections on all properties 45 days or more delinquent. Property inspections
are intended to provide updated information concerning occupancy, maintenance
and changes in market conditions.
Loan Approval Procedures and Authority. The Board of Directors establishes the
lending policies of the Company and delegates authority and responsibility for
loan approvals to the Loan Committee and specified officers of the Company. All
real estate loans must be approved by a quorum of the designated committee or by
the designated individual or individuals.
All loans underwritten by the Company require the approval and signature of
two underwriters. Where there are exceptions to the Company's underwriting
criteria, the loan must be unanimously approved by the underwriter, supervisory
underwriter and the Senior Vice President of the Company or, if not unanimously
approved, by the Company's President and Chief Executive Officer. It has been
the Bank's policy to adhere strictly to its underwriting standards with few
exceptions. Additionally, the following committees, groups of officers and
individual officers are granted the authority to approve and commit the Company
to the funding of the following categories of loans:
Level of Approval
--------------------------------------------------------------------
Loan Committee
One Staff Two Staff Loan --------------
--------- --------- ---- and Board of
Underwriter Underwriters Committee -----------
Type of Loan ----------- ------------ --------- Directors
----------------------- ---------
Mortgage loans held for sale........... -- $1.0 million -- More than $1.0
or less(1) million
Mortgage loans held for investment..... -- $250,000 or less More than $250,000 $550,000 or more
but less than
$550,000
Other loans............................ Personal loans All other loans All other loans more All other loans in
secured by Bank $25,000 or less than $25,000 but less excess of $50,000
deposits than $50,000
15
(1) Loans in excess of $500,000 require approval by an executive officer in
addition to approval by two underwriters.
The Bank will not make loans-to-one borrower that are in excess of regulatory
limits. Pursuant to Office of Thrift Supervision ("OTS") regulations, loans-
to-one borrower cannot exceed 15% of the Bank's unimpaired capital and surplus.
At December 31, 1998, the Bank's loans to one borrower limit equaled $4.5
million. See "--Regulation--Federal Savings Institution Regulation--Loans-to-
One Borrower."
Loan Sales and Asset Securitizations
Loans are sold by the Company through securitizations and whole loan sales.
With the exception of customary provisions relating to breaches of
representations and warranties, loans securitized or sold by the Company are
sold without recourse to the Company and generally are sold with servicing
retained. For the years ended December 31, 1998, 1997 and 1996, the Company sold
$610.5 million, $94.7 million, and $154.6 million in loans, respectively. For
the years ended December 31, 1998, 1997 and 1996, the Company securitized $462.1
million, $415.4 million and $51.9 million, respectively.
In a securitization, the Company will generally transfer a pool of loans to a
trust with the Company retaining the excess cash flows, known as residuals, from
the securitization which consist of the difference between the interest rate of
the mortgages and the coupon rate of the securities after adjustment for
servicing and other costs such as trustee fees and credit enhancement fees. The
cash generally will be used to repay advances on lines of credit used to finance
the pool of loans that were acquired by the Company. Generally, the holders of
the securities from the asset securitization 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 asset represents
the subordinated right to receive cash flows from the pool of securitized loans
after payment of the required amounts to the holders of the securities and the
costs associated with the securitization. The Company recognizes gain on sale of
the loans in the securitization, which represents the excess of the estimated
fair value of the residuals, net of closing and underwriting costs, less the
allocated cost basis of the loans sold in the fiscal quarter in which such loans
are sold. Management believes that it has made reasonable estimates of the fair
value of the residual interests on its balance sheets. Concurrent with
recognizing such gain on sale, the Company records the residual interests as
assets on its balance sheet. The recorded value of these residual interests are
amortized as cash distributions are received from the trust holding the
respective loan pool and are marked to market on a quarterly basis. The fair
values of such residuals are 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
residuals and result in a material adverse effect on the Company's results of
operations and financial condition. The Company revalued the residuals and
recorded a pre-tax unrealized loss of $16.6 million for the year ended December
31, 1998, due to a combination of higher-than-expected prepayment speeds and
credit losses. The Company is not aware of an active market for the residuals.
No assurance can be given that the residuals could in fact be sold at their
carrying value, if at all.
The Company may arrange for credit enhancement for a transaction to achieve an
improved credit rating on the securities issued if this improves the level of
profitability or cash flow generated by such transaction. This credit
enhancement may take the form of an insurance and indemnity policy, insuring the
holders of the securities of timely payment of the scheduled pass-through of
interest and principal. In addition, the pooling and servicing agreements that
govern the distribution of cash flows from the loan pool included in a
transaction typically require over-collateralization as an additional means of
credit enhancement. Over-collateralization may in some cases also require an
initial deposit, the sale of loans at less than par or retention in the trust of
collections from the pool until a specified over-collateralization amount has
been attained. The purpose of the over-collateralization is to provide a source
of payment to investors in the event of certain shortfalls in amounts due to
investors. These amounts are subject to increase up to a reserve level as
specified in the related securitization documents. Cash amounts on
17
deposit are invested in certain instruments as permitted by the related
securitization documents. To the extent amounts on deposit exceed specified
levels, distributions are made to the holders of the residual interest; and at
the termination of the related trust, any remaining amounts on deposit are
distributed to the holders of the residual interest. Losses resulting from
defaults by borrowers on the payment of principal or interest on the loans in a
securitization will reduce the over-collateralization to the extent that funds
are available and may result in a reduction in the value of the residual
interest.
The Company has completed five securitizations, one during the fourth quarter
of 1996, one during the first quarter of 1997, one during the third quarter of
1997, one during the fourth quarter of 1997 and one during the thrid quarter of
1998. The characteristics and results of these securitizations are as follows:
1996-1 1997-1A 1997-1B
-------------------------- --------------------------- ------------------------------
Type of loan securitized Fixed Rate Liberator Adjustable Rate Fixed Rate Liberator
Series and Portfolio Liberator Series Series and Portfolio Series
Series
Weighted average coupon....... 13.32% 9.45% 13.02%
Amount of certificates issued. $55.0 million $38.5 million $61.5 million
Pass-through rate............. 6.95% 1 month LIBOR plus 21 7.49%
21 bp
Amount of loans
securitized(1)............... $51.9 million $33.6 million $46.5 million
Credit enhancement............ MBIA Insurance MBIA Insurance MBIA Insurance
Corporation Corporation Corporation
Initial funding of reserve
Accounts..................... $1.6 million $941,000 $3.1 million
Required reserve level to be
Funded....................... 9.0% of original 5.5% of original 10.6% of original
outstanding balance of outstanding balance of outstanding balance of
loans loans loans
Gain on sale of loans......... $4.3 million $5.7 million(2) $5.7 million(2)
Gain on sale of loans as a
percent of loans sold........ 8.29% 7.12%(2) 7.12%(2)
Estimated prepayment speed.... 17.0% H.E.P.(3) 25.0% C.P.R.(3)(4) 17.0% H.E.P.
Discount factor............... 13.5% 13.5% 13.5%
Annual estimated loss
Assumption................... 1.5% 0.5% 0.5% of Liberator Series
loans; 1.5% of Portfolio
Series loans
Servicing fees................ 0.50% for the first six 0.65% for the first 1.00% on fixed rate loans sold
months and 1.00% twelve months and 1.00%
thereafter thereafter
Rating........................ AAA/Aaa (S&P/Moody's) AAA/Aaa (S&P/Moody's) AAA/Aaa (S&P/Moody's)
1997-2 1997-3
---------------------------- ----------------------
Type of loan securitized Fixed Rate Portfolio Fixed Rate
Series Portfolio Series
Weighted average coupon....... 13.64% 13.86%
Amount of certificates issued. $123.8 million $250.0 million
Pass-through rate............. 7.12%(5) 7.62%
Amount of loans
securitized(1)............... $100.9 million $187.4 million
Credit enhancement............ Loan Loan
overcollateralization overcollateralization
Initial funding of reserve
Accounts..................... $1.3 million None
Required reserve level to be
Funded....................... 7.0% of original 6.3% of original
outstanding outstanding
balance of loans balance of loans
Gain on sale of loans......... $9.4 million $10.7 million
Gain on sale of loans as a
percent of loans sold........ 9.33% 5.69%
Estimated prepayment speed.... 12.0% H.E.P. 14.0% H.E.P.
Discount factor............... 13.5% 13.5%
Annual estimated loss
Assumption................... 2.0% 2.5%
Servicing fees................ 1.00% 1.00%
Rating........................ (6) (7)
(1) For 1996-1, an additional $3.1 million was funded during quarter ended March
31, 1997 which created a gain on sale of loans of $ . For 1997-1A, $4.9
million was funded in April 1997. For 1997-1B, $15.0 million was funded in
April 1997. For 1998-1, $ was funded in November , 1998. All of these
prefunded amounts were sold under the same terms and conditions as set forth
in the table above.
(2) The combined gain on sales of loans for 1997-1A and 1997-1B was $ million.
The percentages are based on the combined 1997-1A and 1997-1B
securitizations.
(3) Home Equity Prepayment ("H.E.P.") and Constant Prepayment Rate ("C.P.R.")
are methods of estimating prepayment speeds.
(4) This prepayment assumption was revised during the third quarter of 1997
resulting in an unrealized loss to the Company of $ ,000.
(5) Weighted average rate.
(6) Each of the Senior Notes were rated AAA/Aaa (Fitch/Moody's), the Class M-1
Notes were rated AA/A2, the Class M-2 Notes were rated A/A2 and the Class B
notes were rated BBB/Baa3.
17
(7) Each of the Senior Notes were rated AAA/Aaa (Fitch/Moody's), the Class M-1
Notes were rated AA/Aa2, the Class M-2 Notes were rated A/A2 and the Class B
Notes were rated BBB/Baa2.
The following table presents the actual loss and prepayment history as of
December 31, 1998 and 1997 for the securitizations conducted by the Company.
The 1997 data does not reflect the 1997-3 securitization, which was completed
during December 1997 and for which meaningful data was not available as of that
date:
December 31, 1998 1996-1 1997-1A 1997-1B 1997-2 1997-3 1998-1A 1998-1B
------ ------- ------- ------ ------ ------- -------
Lifetime actual loss percentage................................ 4.969% 4.13% 2.609% 2.39% 1.54% -- % -- %
Lifetime prepayments as a percentage of loans securitized
annualized................................................... 24.59 46.32 19.36 15.07 11.75 20.45% 7.14%
December 31, 1997 1996-1 1997-1A 1997-1B 1997-2
------ ------- ------- ------
Lifetime actual loss percentage................................ 0.75% -- % 0.43% 0.08%
Lifetime prepayments as a percentage of loans securitized
annualized................................................... 14.45 43.72 8.18 5.53
The actual loss and prepayment history information provided above are not
necessarily indicative of loss and prepayment results that may be experienced
over the duration of the securitization.
As market conditions warrant, loans will be either sold as securitizations or
on a whole loan basis, whole loans will be sold pursuant to purchase, sale and
servicing agreements negotiated with Loan Purchasers to purchase loans meeting
the Company's underwriting criteria. At December 31, 1998 there were no
outstanding commitments to deliver mortgage loans. The Company retains the
servicing rights on the majority of loans sold. However, the Company also sells
loans on a servicing released basis and may continue to subservice the loans for
a fee for a period of time. The Company sells loans to a number of different
investors with which it does business. As such, management believes that no one
relationship with a Loan Purchaser constitutes the predominant source of sales
for the Company and the Company does not rely on any specific entities for sales
of its loans.
Commercial Real Estate and Multi-Family Real Estate Lending
Consistent with its strategy of developing niche lending markets, the Company
increased its efforts to originate and purchase multi-family and commercial real
estate loans both in its primary market area and throughout the United States.
Specifically, the Company has targeted the market for borrowers seeking loans in
the range of $50,000 to $2.0 million, subject to the Bank's loans-to-one
borrower limit, currently $4.5 million, which are secured by multi-family
properties or properties used for commercial business purposes such as small
office buildings, light industrial or retail facilities. Since the Company has
been able to acquire such loans at a discount and expects to be able to continue
to acquire such loans at a discount or low premium, management believes that the
origination and subsequent sale of commercial and multi-family real estate loans
will increase the Company's cash flow. The Company has streamlined and
standardized its processing of commercial and multi-family real estate loans
with a view to sale in the secondary market or securitization. Since 1994,
substantially all commercial and multi-family real estate loans originated by
the Company have been sold in the secondary market without recourse. Although
there can be no assurances in this regard, management intends to gradually
expand these operations, thereby adding a source of revenue for the Company as
well as providing loans for future securitizations. There can be no assurances,
however, that any such securitization will be completed in the future.
Securitization of commercial and multi-family real estate loans is significantly
less standardized and streamlined than securitization of one- to four-family
residential mortgage loans.
Management believes that it has the infrastructure in place to safely
diversify its product line into this niche market. Two of the Company's senior
executive officers, Daniel L. Perl and Joseph R. L. Passerino, have combined
experience of approximately 29 years in commercial and multi-family real estate
lending and have developed substantial relationships with commercial and multi-
family real estate originators throughout the United States. In addition, the
Company works primarily with a select group of approximately 100 mortgage
brokers nationwide with
18
specifically delineated credentials. The Company also works with eleven
correspondents and expects to expand that number of approved correspondents to
15 in the near future. Commercial and multi-family real estate loan
correspondents in the Company's network must have a net worth of at least $1.0
million, a two to three year history of funding and servicing multi-family and
commercial real estate loans and errors and omissions insurance of at least $1.0
million. Where loans are originated by other than this pre-approved group of
correspondents, the Company will underwrite the loan. The Company also works
with a contract appraiser with nationwide experience in appraising commercial
and multi-family real estate loans who appraises or reviews the appraisals on
all such properties.
The Company's policy is to not make commercial or multi-family real estate
loans to borrowers who are in bankruptcy, foreclosure, have loans more than 30
days delinquent or other combinations of credit weaknesses unacceptable to the
Company. The Company targets high to medium credit quality borrowers. The
Company's underwriting procedures provide that commercial real estate loans may
be made in amounts up to 75% of the appraised value of the property depending on
the borrower's creditworthiness. Multi-family real estate loans may be made in
amounts up to 80% of the appraised value of the property. Commercial real estate
loans and multi-family real estate loans may be either fixed rate or adjustable
rate loans. These loans include prepayment penalties if repaid within the first
three to five years. When evaluating a commercial or multi-family real estate
loan, the Company considers the net operating income of the property and the
borrower's expertise, credit history and personal cash flows. The Company has
generally required that the properties securing commercial real estate and
multi-family real estate loans have debt service coverage ratios (the ratio of
net operating income to debt service) of at least 120%. The largest commercial
real estate loan in the Company's held for sale portfolio at December 31, 1998
was $1.2 million and is secured by an eight-retail unit and a 38 office space
building in Great Falls, Montana while the largest multi-family real estate loan
in the Company's held for sale portfolio at December 31, 1998 was $1.6 million
secured by a 90 unit multi-family property located in Pompano Beach, Florida. At
December 31, 1998 the Company's commercial real estate portfolio was $14.2
million, or 4.21% of total gross loans, $9.2 million of which were held for
sale. The Company's multi-family real estate portfolio at that same date was
$17.4 million, or 5.15% of total gross loans, $15.4 million of which were held
for sale.
Repayment of multi-family and commercial real estate loans generally is
dependent, in large part, on sufficient income from the property to cover
operating expenses and debt service. The Company attempts to offset the risks
associated with multi-family and commercial real estate lending by primarily
lending to individuals who will be actively involved in the management of the
property and generally to individuals who have proven management experience, and
by making such loans with lower loan-to-value ratios than one- to four-family
loans.
Construction Lending
The Company orignates construction loans for owner occupied single-family
homes, single-family homes on a speculative basis, single family tract, retail,
industrial, apartment and office product. Those projects built on a speculative
basis are to builders and borrowers who have shown by past performance to be
able to construct and effectively market the completed product and where
management is comfortable with the underlying economic conditions. The
Company`s loan to value maximum policy on a speculative residental project or a
commerical project is not to exceed 75% of completed value. All construction
loans at the time are priced on a variable rate, which is adjusted daily with a
spread over Wall Street Journal Prime. The Company generally requires some
tangible form of equity in each construction project.
As of December 31, 1998, the cumulative loan to value of the construction
portfolio was below 70% and the portfolio was concentrated in residential
product. Presently, the Company lends construction funds only in California
with a concentration in Southern California due to its proximity and familiarity
to management.
Construction lending affords the Company the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than does single family
permanent mortgage lending. However, construction loans involve risks different
from completed project lending because loan funds are advanced upon security of
the project under
19
construction, and if the loan goes into default, additional funds may have to be
advanced to complete the project before it can be sold. Moveover, construction
projects are subject to uncertainties inherent in estimating construction costs,
potential delays in construction time, market demand and accuracy of the
estimate of value upon completion. The Company requires the borrower's to carry,
among other things, liability insurance equal to certain prescribed minimum
amounts, and of course construction insurance. The Company disburses its own
funds internaly via bank checks issued to control the physical completion to
disbursed funds ratio along with on-site inspection for each draw.
Consumer and Other Lending
The Company's consumer and other loans generally consist of overdraft lines of
credit, commercial business loans and unsecured personal loans. At December 31,
1998, the Company's consumer and other loan portfolio was $3.0 million or .87%
of total gross loans.
Loan Servicing
Through December 31, 1993, the Company's loan servicing portfolio consisted
solely of loans originated directly by the Company and retained for investment
or sold, primarily as participations, to others. Commencing in January of 1994
through June of 1995, the Company purchased mortgage servicing rights on FNMA
and FHLMC loans in order to expand the size of its loan servicing department and
to further develop its loan servicing capabilities. The entire FHLMC servicing
portfolio was resold in December 1995. During 1995, the Company began to retain
substantially all servicing rights on loans sold. In addition, the Company
intends to retain the servicing rights to the loans it securitizes. The pooling
and servicing agreements related to the securitizations completed to date
contain provisions with respect to the maximum permitted loan delinquency rates
and loan default rates which, if exceeded, could allow the termination of the
Company's right to service the related loans. At December 31, 1998, the
cumulative losses and/or annual default rate on two of the Company's
securitization transactions exceeded the permitted limit in the related pooling
and servicing agreements. Servicing rights were $13.1 million at December 31,
1998. At December 31, 1998, the Company serviced $1.3 billion of loans of which
$1.0 billion were serviced for others. 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 the loans sold or the
securitizations. If actual loan prepayments or delinquencies 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 cannot 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. During 1998 and 1997, the Company recorded write-downs of
$1.2 million and $1.3 million, respectively, on mortgage servicing rights as a
result of higher than anticipated prepayment speeds on adjustable rate mortgage
loans.
The loan servicing and collections department has increased in size from four
persons at December 31, 1994 to 62 persons at December 31, 1998. Within this
department, personnel have experience in both alternative lending and also in
managing the Company's non-performing loans in its historical local lending
portfolio. This experience was gained in part during the economic downturn in
Southern California and resulted in a low loss experience for the Company. See
"--Lending Overview--Allowance for Loan Losses." The head of the servicing
department has more than 25 years of experience in loan servicing and
collections, including responsibility for a $10.0 billion portfolio of
approximately 255,000 loans and a staff of 70 people. During the second quarter
of 1998, substantial space in Riverside, California was leased for the loan
servicing and collections operations and the space was occupied during that same
quarter. The Company has enhanced its telephonic systems by purchasing a power
dialing system, which became operational in the first quarter of 1998. During
the second quarter of 1998, the Company enhanced its computer systems by adding
document imaging, which creates an image of each document in a loan file
accessible through the Company's wide area network.
20
The Company's loan servicing activities include (i) the collection and
remittance of mortgage loan payments, (ii) accounting for principal and interest
and other collections and expenses, (iii) holding and disbursing escrow or
impounding funds for real estate taxes and insurance premiums, (iv) inspecting
properties when appropriate, (v) contacting delinquent borrowers, and (vi)
acting as fiduciary in foreclosing and disposing of collateral properties. The
Company receives a servicing fee for performing these services for others.
While most of the Company's servicing portfolio is generated through its
origination and purchase activities, when economically attractive, the Company
has, from time to time, made bulk purchases of mortgage servicing rights from
financial institutions. The Company does not intend to make significant bulk
purchases of servicing rights in the near future but may do so depending on
market opportunities. The mortgage loans underlying the servicing rights
retained by the Company have been historically underwritten by the Company.
These servicing rights were either originated by mortgage brokers or purchased
through various programs from correspondents or junior correspondents. The costs
to acquire servicing are based on the present value of the estimated future
servicing revenues, net of the expected servicing expenses, for each
acquisition. Major factors impacting the value of servicing rights include
contractual service fee rates, projected mortgage prepayment speed, projected
delinquencies and foreclosures, projected escrow, agency and fiduciary funds to
be held in connection with such servicing and the projected benefit to be
realized from such funds.
In addition to weekly loan delinquency meetings which are attended by members
of senior management, the loan committee of the Board of Directors generally
performs a monthly review of all delinquent loans 90 days or more past due. In
addition, management reviews on an ongoing basis all delinquent loans. The
procedures taken by the Company with respect to delinquencies vary depending on
the nature of the loan and period of delinquency. When a borrower fails to make
a required payment on a loan, the Company takes a number of steps to have the
borrower cure the delinquency and restore the loan to current status. The
Company generally sends the borrower a written notice of non-payment within ten
days after the loan is first past due. In the event payment is not then
received, additional letters and phone calls generally are made. If the loan is
still not brought current, the Company generally sends a notice of the intent to
foreclose 35 days after the loan is first past due. If a loan remains delinquent
on the 45th day, a property inspection will be made to verify occupancy,
determine the condition of the property and as an attempt to contact the
borrower in person. If the borrower does not cure the delinquency and it becomes
necessary for the Company to take legal action, which typically occurs after a
loan is delinquent at least 60 days or more, the Company will commence
foreclosure proceedings against any real property that secures the loan. If a
foreclosure action is instituted and the loan is not brought current, paid in
full, or refinanced before the foreclosure sale, the real property securing the
loan generally is sold at foreclosure. The Company's procedures for repossession
and sale of consumer collateral are subject to various requirements under state
consumer protection laws.
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 or purchased 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
21
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.
Credit Quality of Servicing Portfolio. The following table illustrates the
Company's delinquency and default experience with respect to its loan servicing
portfolio:
22
At December 31,
------------------------------------------
1998 1997
-------------------- -----------------
Number Number
------ ------
of % of % of of % of
-- ---- ---- -- ----
Loans/ Loans Principal Servicing Loans/ Loans
----- ----- --------- --------- ------ -----
Properties Serviced Balance Portfolio Properties Serviced
---------- -------- ------- --------- ---------- --------
(Dollars in thousands)
Delinquency percentage(1)(2)
30-59 days..................... 292 1.19% $ 11,419 0.85% 282 1.46%
60-89 days..................... 126 0.51 3,795 0.28 148 0.76
90 days and over............... 263 1.07 9,847 0.74 333 1.72
------ ---- ---------- ---- ------ ----
Total delinquency.............. 681 2.77% $ 25,061 1.87% 763 3.94%
====== ==== ========== ==== ====== ====
Default percentage(3)
Foreclosure.................... 144 0.57% $ 12,489 0.93% 52 0.27%
Bankruptcy..................... 157 0.64 8,213 0.61 49 0.25
Real estate owned(4)........... 17 0.07 1,998 0.15 33 0.17
------ ---- ---------- ---- ------ ----
Total default.................. 318 1.28% $ 22,700 1.69% 134 0.69%
====== ==== ========== ==== ====== ====
Total servicing portfolio........ 24,634 $1,339,003 19,359
====== ========== ======
At December 31,
-----------------------------------------------------
1996
-----------------------
Number
------
% of of % of % of
---- -- ---- ----
Principal Servicing Loans/ Loans Principal Servicing
--------- --------- ------ ----- --------- ---------
Balance Portfolio Properties Serviced Balance Portfolio
------- --------- ---------- -------- ------- ---------
(Dollars in thousands)
Delinquency percentage(1)(2)
30-59 days..................... $ 9,356 1.12% 10 0.26% $ 860 0.36%
60-89 days..................... 3,664 0.44 -- -- -- --
90 days and over............... 3,128 0.38 3 0.08 143 0.06
-------- ---- ----- ---- -------- ----
Total delinquency.............. $ 16,148 1.94% 13 0.34% $ 1,003 0.42%
======== ==== ===== ==== ======== ====
Default percentage(3)
Foreclosure.................... $ 6,269 0.75% 56 1.48% $ 6,279 2.64%
Bankruptcy..................... 2,814 0.34 9 0.24 778 0.33
Real estate owned(4)........... 3,509 0.42 9 0.24 1,197 0.50
-------- ---- ----- ---- -------- ----
Total default.................. $ 12,592 1.51% 74 1.96% $ 8,254 3.47%
======== ==== ===== ==== ======== ====
Total servicing portfolio........ $832,393 3,781 $237,958
======== ===== ========
23
(1) The delinquency percentage represents the number and outstanding principal
balance of loans for which payments are contractually past due, exclusive
of loans in foreclosure, bankruptcy, real estate owned or forbearance.
(2) The past due period is based on the actual number of days that a payment is
contractually past due. A loan as to which a monthly payment was due 60-89
days prior to the reporting period is considered 60-89 days past due, etc.
(3) The default percentage represents the number and outstanding principal
balance of loans in foreclosure, bankruptcy or real estate owned.
(4) An "REO Property" is a property acquired and held as a result of
foreclosure or deed in lieu of foreclosure.
24
Lending Overview
Loan Portfolio Composition. At December 31, 1998, the Company's gross loans
outstanding totaled $337.6 million, of which $238.7 million, or 70.7%, were held
for sale and $98.9 million, or 29.3%, were held for investment. The types of
loans that the Company may originate are subject to federal and state law and
regulations. Interest rates charged by the Company on loans are affected by the
demand for such loans and the supply of money available for lending purposes and
the rates offered by competitors. These factors are, in turn, affected by, among
other things, economic conditions, monetary policies of the federal government,
including the Federal Reserve Board, and legislative tax policies.
The following table sets forth the composition of the Company's loan
portfolio in dollar amounts and as a percentage of the portfolio at the dates
indicated.
At December 31,
--------------------------------------------------------------------
1998 1997 1996 1995
--------------------- ------------------ ---------------- -----------------
Percent Percent Percent Percent
------- ------- -------- --------
of of of of
-- -- -- --
Amount Total Amount Total Amount Total Amount Total
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Real estate(1):
Residential:
One- to four-
Family.................... $294,033 87.11% $278,205 89.02% $54,275 78.67% $54,007 84.04%
Multi-family............... 17,380 5.15 10,653 3.41 4,752 6.89 2,412 3.75
Commercial.................. 14,225 4.21 16,763 5.36 9,659 14.00 7,522 11.71
Construction................ 8,571 2.54 -- -- -- -- -- --
Other loans:
Loans secured by
Deposit accounts........... 270 0.08 165 0.05 177 0.25 186 0.29
Unsecured commercial
Loans...................... 124 0.04 63 0.02 67 0.10 70 0.11
Unsecured consumer
Loans...................... 2,951 0.87 6,675 2.14 65 0.09 63 0.10
-------- ------ -------- ----- ------- ------ ------- ------
Total gross
337,554 100.00% 312,524 100.00% 68,995 100.00% 64,260 100.00%
loans................... -------- ====== -------- ===== ------- ====== ------- ======
Less (plus):
Undisbursed loan funds...... 6,399 -- -- --
Deferred loan
Origination (costs)
Fees and (premiums)
Discounts.................. (5,946) (8,393) (543) (298)
Allowance for
Estimated loan
Losses..................... 2,777 2,573 1,625 1,177
-------- -------- ------- -------
Loans
Receivable,
net..................... $334,324 $318,344 $67,913 $63,381
======== ======== ======= =======
1994
----------------
Percent
--------
Amount of
------ --
Total
-----
Real estate(1):
Residential:
One- to four-
Family.................... $53,755 82.62%
Multi-family............... 2,685 4.12
Commercial.................. 8,131 12.50
Construction -- --
Other loans:
Loans secured by
Deposit accounts........... 213 0.33
Unsecured commercial
Loans...................... 197 0.30
Unsecured consumer
84 0.13
Loans...................... ------- ------
Total gross
65,065 100.00%
loans................... ------- ======
Less (plus):
Undisbursed loan funds --
Deferred loan
Origination (costs)
Fees and (premiums)
Discounts.................. 56
Allowance for
Estimated loan
Losses..................... 832
-------
Loans
Receivable,
net..................... $64,177
=======
(1) Includes second trust deeds.
25
Loan Maturity. The following table shows the contractual maturity of the
Bank's gross loans at December 31, 1998. There were $237.9 million of loans held
for sale, gross, at December 31, 1998. The table does not reflect prepayment
assumptions.
At December 31, 1998
----------------------------------------
One- to Total
------- -----
Four- Multi- Other Loans
----- ------ ----- -----
Family Family Commercial Construction Loans Receivable
------ ------ ---------- ------------ ----- ----------
Amounts due:
One year or less............................ $ 895 $ -- $ -- $8,571 $ 720 $ 10,186
After one year:
More than one year to three years.......... 257 42 3,225 -- 1,025 4,549
More than three years to five years........ 305 -- 803 -- 1,600 2,708
More than five years to 10 years........... 1,322 8,136 5,919 -- -- 15,377
More than 10 years to 20 years............. 106,671 8,594 3,205 -- -- 118,470
More than 20 years......................... 184,583 608 1,073 -- -- 186,264
-------- ------- ------- ------ ------ --------
Total amount due........................ 294,033 17,380 14,225 8,571 3,345 337,554
-------- ------- ------- ------ ------ --------
Less (plus):
Undisbursed loan funds..................... -- -- -- 6,399 -- 6,399
Unamortized discounts (premiums), net...... (4,499) (4) -- -- -- (4,503)
Deferred loan origination fees (costs)..... (2,343) 168 173 84 -- (1,918)
Lower of Cost or Market.................... 475 475
Allowance for estimated loan losses........ 1,984 68 250 60 415 2,777
-------- ------- ------- ------ ------ --------
Total loans, net........................ 298,416 17,148 13,802 2,028 2,930 334,324
-------- ------- ------- ------ ------ --------
Loans held for sale, net................... 216,645 15,262 8,980 -- 2,610 243,497
-------- ------- ------- ------ ------ --------
Loans held for investment, net............. $ 81,771 $ 1,886 $ 4,822 $2,028 $ 320 $ 90,827
======== ======= ======= ====== ====== ========
The following table sets forth at December 31, 1998, the dollar amount of
gross loans receivable contractually due after December 31, 1998, and whether
such loans have fixed interest rates or adjustable interest rates. The Company's
adjustable-rate mortgage loans require that any payment adjustment resulting
from a change in the interest rate be made to both the interest and payment in
order to result in full amortization of the loan by the end of the loan term,
and thus, do not permit negative amortization.
Due After December 31, 1999
---------------------------------------
Fixed Adjustable Total
----------- ----------- -----------
(Dollars in thousands)
Real estate loans:
Residential:
One- to four-family..................... $190,765 $102,374 $293,139
Multi-family............................ 15,306 2,074 17,380
Commercial............................... 8,598 5,626 14,225
Other loans.............................. 2,625 -- 2,625
-------- -------- --------
Total gross loans receivable......... $217,294 $110,074 $327,369
======== ======== ========
26
The following tables set forth the Company's loan originations, purchases,
sales and principal repayments for the periods indicated:
For the Year Ended December 31,
------------------------------------------------
1998 1997 1996
-------------- -------------- --------------
(Dollars in thousands)
Gross loans(1):
Beginning balance.............................. $ 312,524 $ 68,995 $ 64,260
Loans originated:
One-to four-family(2)....................... 440,685 341,294 100,745
Multi-family................................ 34,596 18,019 2,976
Commercial.................................. 22,274 13,631 7,172
Construction................................ 8,571 -- --
Other loans................................. 309 837 126
---------- -------- --------
Total loans originated................... 506,435 373,781 111,019
Loans purchased(3)........................... 674,117 399,326 111,534
---------- -------- --------
Total loans originated and purchased........ 1,180,552 773,107 222,553
---------- -------- --------
Total.................................... 1,493,076 842,102 286,813
Less:
Principal repayments......................... 79,085 17,289 9,184
Sales of loans............................... 610,468 94,705 154,620
Securitizations of loans..................... 462,067 415,350 51,944
Transfer to REO.............................. 3,902 2,234 2,070
---------- -------- --------
Total loans.............................. 337,554 312,524 68,995
Loans held for sale.......................... 238,664 280,859 30,454
---------- -------- --------
Ending balance loans held for investment....... $ 98,890 $ 31,665 $ 38,541
========== ======== ========
- --------------
(1) Gross loans includes loans held for investment and loans held for sale.
(2) Includes second trust deeds.
(3) Loans purchased consist predominantly of one- to four-family residential
Liberator Series and Portfolio Series loans.
Delinquencies and Classified Assets. Federal regulations and the Bank's
Classification of Assets Policy require that the Bank utilize an internal asset
classification system as a means of reporting problem and potential problem
assets. The Bank has incorporated the OTS internal asset classifications as a
part of its credit monitoring system. The Bank currently classifies problem and
potential problem assets as "Substandard," "Doubtful" or "Loss" assets. An
asset is considered "Substandard" if it is inadequately protected by the
current net worth and paying capacity of the obligor or of the collateral
pledged, if any. "Substandard" assets include those characterized by the
"distinct possibility" that the insured institution will sustain "some loss"
if the deficiencies are not corrected. Assets classified as "Doubtful" have
all of the weaknesses inherent in those classified "Substandard" with the
added characteristic that the weaknesses present make "collection or
liquidation in full," on the basis of currently existing facts, conditions, and
values, "highly questionable and improbable." Assets classified as "Loss"
are those considered "uncollectible" and of such little value that their
continuance as assets without the establishment of a specific loss allowance is
not warranted. Assets which do not currently expose the insured institution to
sufficient risk to warrant classification in one of the aforementioned
categories but possess weaknesses are required to be designated "Special
Mention."
When an insured institution classifies one or more assets, or portions
thereof, as Substandard or Doubtful, under current OTS policy the Bank is
required to consider establishing a general valuation allowance in an amount
deemed prudent by management. The general valuation allowance, which is a
regulatory term, represents a loss
27
allowance which has been established to recognize the inherent credit risk
associated with lending and investing activities, but which, unlike specific
allowances, has not been allocated to particular problem assets. When an insured
institution classifies one or more assets, or portions thereof, as "Loss," it is
required either to establish a specific allowance for losses equal to 100% of
the amount of the asset so classified or to charge off such amount.
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies,
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of
adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation allowances. Generally, the policy
statement recommends that institutions have effective systems and controls to
identify, monitor and address asset quality problems; that management has
analyzed all significant factors that affect the collectibility of the portfolio
in a reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
As a result of the declines in local and regional real estate market values and
the significant losses experienced by many financi