-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UuviYBrE2i5nyEgVKD4Kd5SB2SsWNzDgFu5WVn7imu6oxe60zl5/M0sJhBJ6DiUf EQxY9CoM8QhDra3rHn2Vlg== 0001017062-99-000663.txt : 19990416 0001017062-99-000663.hdr.sgml : 19990416 ACCESSION NUMBER: 0001017062-99-000663 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19990415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LIFE FINANCIAL CORP CENTRAL INDEX KEY: 0001028918 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 330743196 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 000-22193 FILM NUMBER: 99595139 BUSINESS ADDRESS: STREET 1: 10540 N MAGNOLIA ACE STREET 2: UNIT B CITY: RIVERSIDE STATE: CA ZIP: 92503 BUSINESS PHONE: 9098869751 MAIL ADDRESS: STREET 1: 1598 EAST HIGHLAND AVENUE CITY: SAN BERNADINO STATE: CA ZIP: 92404 10-Q/A 1 FORM 10-Q/A United States Securities and Exchange Commission Washington, DC 20549 FORM 10-Q/A (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 Commission File Number 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, RIVERSIDE, CALIFORNIA 92505 - -------------------------------------------------------------------------------- (909) 637 - 4000 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days. (X ) Yes ( ) No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 6,562,396 shares of common stock, par value $0.01 per share, were outstanding as of November 13, 1998. This Amendment on Form 10-Q/A amends the Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 1998, as filed by the Registrant on November 13, 1998 and is being filed to reflect the restatement of the Registrant's consolidated financial statements (the "Restatement"). The Restatement reflects the revaluation of residual assets retained in certain of the Company's 1997 and 1996 Securitization transactions. See Note 7 of Notes to Consolidated Financial Statements. LIFE FINANCIAL CORPORATION AND SUBSIDIARIES FORM 10-Q/A INDEX
PART I FINANCIAL INFORMATION PAGE Item 1 Consolidated Statements of Financial Condition: September 30, 1998 (restated) and December 31, 1997 (unaudited)........... 1 Consolidated Statements of Operations: For the Nine months ended September 30, 1998 (restated) and 1997(restated) and for the Three months ended September 30, 1998 (restated) and 1997 (restated) (unaudited)........................................... 2 Consolidated Statements of Cash Flows: For the Nine months ended September 30, 1998 (restated) and 1997 (restated) (unaudited)............................................... 3 Notes to Consolidated Financial Statements (unaudited).................... 4 Item 2 Management's Discussion and Analysis of Results of Operations and Financial Condition............................. 7 Item 3 Quantitative and Qualitative Disclosures About Market Risk................ 19 PART II OTHER INFORMATION Item 1 Legal Proceedings......................................................... 19 Item 2 Changes in Securities and Use of Proceeds................................. 19 Item 3 Defaults Upon Senior Securities........................................... 19 Item 4 Submission of Matters to a Vote of Security Holders....................... 19 Item 5 Other Information......................................................... 19 Item 6 Exhibits and Reports on Form 8-K.......................................... 20
ii Item 1. Financial Statements. LIFE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Dollars in thousands, except share data) (UNAUDITED)
September 30, December 31, 1998 1997 ---- ---- (As restated, See Note 7) ASSETS Cash and cash equivalents ................................................... $ 22,589 $ 3,467 Securities held to maturity, estimated fair value of $3,023 and $5,030 at September 30, 1998 and December 31, 1997....................................................... 3,007 5,012 Residual assets, at fair value............................................... 56,035 45,352 Loans held for sale.......................................................... 215,331 289,268 Loans held for investment - net of allowance for loan losses of $1,751 and $2,573 at September 30, 1998 and December 31, 1997................................ 16,074 29,076 Mortgage servicing rights, net............................................... 13,235 8,526 Accrued interest receivable 2,207 2,638 Foreclosed real estate, net.................................................. 2,002 1,440 Premises and equipment - net................................................. 6,979 4,764 Federal Home Loan Bank stock................................................. 2,427 1,067 Other assets................................................................. 22,908 6,461 -------------- -------------- TOTAL ASSETS............................................................ $ 362,794 $ 397,071 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposit accounts............................................................. $ 254,684 $ 211,765 Federal Home Loan Bank advances.............................................. - 9,000 Other borrowings............................................................. 13,787 100,170 Subordinated debentures...................................................... 10,000 10,000 Accounts payable and other liabilities....................................... 25,612 15,250 -------------- -------------- Total liabilities....................................................... 304,083 346,185 ============== ============== STOCKHOLDERS' EQUITY Preferred stock, $.01 par value; 5,000,000 shares authorized; no shares outstanding...................................................... - - Common stock, $.01 par value; 25,000,000 shares authorized; 6,562,396 (1998) and 6,546,716 (1997) shares issued and outstanding.......... 66 65 Additional paid-in capital................................................... 42,223 42,171 Retained earnings, partially restricted...................................... 16,422 8,650 -------------- -------------- Total stockholders' equity.............................................. 58,711 50,886 -------------- -------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.............................. $ 362,794 $ 397,071 ============== ==============
See accompanying notes to unaudited consolidated financial statements. 1 LIFE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except share data) (UNAUDITED)
Three Months Ended Nine Months Ended September 30, September 30, -------------------- --------------------------- 1998 1997 1998 1997 ---- ---- ---- ---- (As restated, (As restated, (As restated, (As restated, see Note 7) see Note 7) see Note 7) see Note 7) INTEREST INCOME: Loans $ 9,610 $ 4,781 $ 25,050 $ 10,001 Residual assets 1,742 619 4,892 1,265 Securities held to maturity 60 115 208 334 Other interest-earning assets 430 148 1,217 504 ----------- ----------- ------------ ------------ Total interest income 11,842 5,663 31,367 12,104 ----------- ----------- ------------ ------------ INTEREST EXPENSE: Deposit accounts 3,513 2,259 10,393 5,440 Federal Home Loan Bank advances and other borrowings 3,085 468 6,407 888 Subordinated debentures 353 353 1,045 774 ----------- ----------- ------------ ------------ Total interest expense 6,951 3,080 17,845 7,102 ----------- ----------- ------------ ------------ Net Interest Income Before Provision for loan losses 4,891 2,583 13,522 5,002 Provision for loan losses 736 400 2,366 900 ----------- ----------- ------------ ------------ Net Interest Income After Provision for loan losses 4,155 2,183 11,156 4,102 NON-INTEREST INCOME: Loan servicing and other fees 1,162 218 4,129 414 Service charges on deposit accounts 50 34 123 94 Net gains from mortgage financing operations 6,047 8,292 16,349 12,216 Other income 125 107 607 265 ----------- ----------- ------------ ------------ Total non-interest income 7,384 8,651 21,208 12,989 ----------- ----------- ------------ ------------ NON-INTEREST EXPENSE: Compensation and benefits 3,076 2,477 8,602 5,534 Premises and occupancy 962 332 2,444 805 Data processing 406 229 1,054 524 Net loss on foreclosed real estate 32 25 217 94 FDIC insurance premiums 39 31 100 69 Marketing 788 72 1,786 195 Telephone 321 222 814 439 Professional services 360 111 1,172 243 Other expense 1,135 680 2,670 1,247 ----------- ----------- ------------ ------------ Total non-interest expense 7,119 4,179 18,859 9,150 ----------- ----------- ------------ ------------ Income Before Provision for tax expense 4,420 6,655 13,505 7,941 Provision for tax expense 1,885 2,775 5,734 3,333 ----------- ----------- ------------ ------------ NET INCOME $ 2,535 $ 3,880 $ 7,771 $ 4,608 =========== =========== ============ ============ Basic earnings per share $ 0.39 $ 0.59 $ 1.10 $ 1.07 =========== =========== ============ ============ Basic weighted average shares outstanding 6,558,997 6,537,377 6,552,192 4,320,270 =========== =========== ============ ============ Diluted earnings per share $ 0.37 $ 0.57 $ 1.14 $ 1.04 =========== =========== ============ ============ Diluted weighted average shares outstanding 6,773,454 6,853,584 6,841,217 4,436,353 =========== =========== ============ ============
See accompanying notes to unaudited consolidated financial statements. 2 LIFE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (UNAUDITED)
Nine months ended --------------------------------- September 30, 1998 1997 --------- --------- (As restated, (As restated, see Note 7) see Note 7) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 7,771 $ 4,608 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 1,244 358 Provision for estimated loan losses 2,366 900 Accretion of deferred fees (4) (435) Provision for estimated losses of foreclosed real estate 32 68 Loss (gain) on sale of foreclosed real estate, net 87 (46) Gain on sale and securitization of loans held for sale (23,007) (11,324) Unrealized (gain) loss on residual assets 6,658 (892) Net accretion of residual assets (4,892) (1,265) Valuation allowance on mortgage servicing rights 381 248 Amortization of mortgage servicing rights 1,909 698 Purchase and origination of loans held for sale, net of loan fees (930,884) (435,041) Proceeds from sales and securitization of loans held for sale 963,526 282,360 Decrease (increase) in accrued interest receivable 431 (1,177) Deferred income taxes 110 Increase in accounts payable and other liabilities 10,362 2,118 Federal Home Loan Bank stock dividend (63) (41) Increase in other assets (16,347) (649) --------- --------- Net cash provided by (used in) operating activities 19,570 (159,402) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Net decrease (increase) in loans 52,847 (17,558) Proceeds from sale of foreclosed real estate 1,882 619 Purchase of securities held to maturity - (1,000) Proceeds from maturities of securities held to maturity 2,000 2,000 Additions to premises and equipment (3,416) (2,541) Purchase of Federal Home Loan Bank stock (1,297) (195) --------- --------- Net cash provided (used) by investing activities 52,016 (18,675) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposit accounts 42,919 74,129 (Repayments of) proceeds from other borrowings (86,383) 58,245 Net proceeds from issuance of common stock 32,509 Repayment of Federal Home Loan Bank advances (9,000) Net proceeds from issuance of subordinated debentures 9,644 --------- --------- Net cash (used) provided by financing activities (52,464) 174,527 --------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 19,122 (3,550) CASH AND CASH EQUIVALENTS, beginning of period 3,467 12,575 --------- --------- CASH AND CASH EQUIVALENTS, end of period $ 22,589 $ 9,025 ========= ========= SUPPLEMENTAL CASH FLOW DISCLOSURES: Interest paid $ 18,963 $ 5,446 ========= ========= Income taxes paid $ - $ 3,524 ========= ========= NONCASH INVESTING ACTIVITIES DURING THE PERIOD: Transfers from loans to foreclosed real estate $ 3,066 $ 1,221 ========= ========= Loans to facilitate sales of foreclosed real estate $ - $ 166 ========= =========
See accompanying notes to unaudited consolidated financial statements. LIFE FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (UNAUDITED) 1. Basis of Presentation: ---------------------- The consolidated financial statements include the accounts of LIFE Financial Corporation (the "Company") and its subsidiaries, LIFE Bank (formerly Life Savings Bank, Federal Savings Bank), (the "Bank") and Life Investment Holdings, Inc. All material intercompany accounts and transactions have been eliminated in consolidation. The Company is a savings and loan holding company, incorporated in the State of Delaware, that was initially organized for the purpose of acquiring all of the capital stock of the Bank through the holding company reorganization (the "Reorganization") of the Bank, which was consummated on June 27, 1997. Pursuant to the Reorganization, the Company issued 3,211,716 shares of common stock in exchange for the 1,070,572 shares of the Bank's outstanding common stock. Such business combination was accounted for at historical cost in a manner similar to a pooling of interests. On June 30, 1997, the Company completed its sale of 2,900,000 additional shares of its common stock through an initial public offering (the "IPO"). On July 2, 1997, the Company issued 435,000 shares of common stock to the public through the exercise of the underwriter's over- allotment option, bringing the total shares outstanding to 6,546,716. The consolidated financial condition and results of operations of the Company for the periods prior to the date of Reorganization consist of those of the Bank. Since the Reorganization and the IPO, the Company has purchased residual assets and the subordinated debentures from the Bank. The Bank is a federally chartered stock savings bank whose primary business is the origination and sale of high loan-to-value second trust deeds, sub-prime one-to-four family residential mortgage loans and, to a much lesser extent, multi-family residential and commercial real estate loans. The Company's revenues are derived from gains from mortgage financing operations and net interest on its loans and residual assets. The primary sources of funds for the Company have been from deposits, Federal Home Loan Bank ("FHLB") advances, $275 million in lines of credit from two major investment banks, a $40 million residual financing line of credit, as well as from loan sales and securitizations. As of September 30, 1998, the Bank had three depository branch offices in San Bernardino, Riverside and Redlands, California, nine retail lending offices in Southern California, four regional loan centers located in Riverside, California, Jacksonville, Florida, the Boston, Massachusetts area and the Denver, Colorado metropolitan area, a telemarketing center located in Riverside, California and a capital markets group located in Seattle, Washington. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all necessary adjustments, consisting only of normal recurring adjustments necessary for a fair presentation, have been included. Certain reclassifications have been made to the consolidated financial statements for 1997 to conform to the 1998 presentation. The results of operations for the three and nine month periods ended September 30, 1998 are not necessarily indicative of the results that may be expected for the entire fiscal year. 4 2. Approved Stock Compensation Plans --------------------------------- On November 21, 1996, the Board of Directors of the Bank adopted the Life Bank 1996 Stock Option Plan (the "1996 Option Plan") which was approved by the stockholders of the Bank at the Annual Meeting of Stockholders of the Bank, held on May 21, 1997. The 1996 Option Plan authorizes the granting of options equal to 321,600 (adjusted for the three for one exchange) shares of common stock for issuance to executives, key employees, officers and directors. The 1996 Option Plan will be in effect for a period of ten years from the adoption by the Board of Directors. Options granted under the 1996 Option Plan will be made at an exercise price equal to the fair market value of the stock on the date of grant. Awards granted to officers and employees may include incentive stock options, non-statutory stock options and limited rights which are exercisable only upon change in control of the Bank which change in control did not include the reorganization of the Bank into the holding company. Awards granted to non- employee directors are non-statutory options. All 1996 options were granted at an exercise price of $3.33 per share (adjusted for the three for one exchange). Stock options will become vested and exercisable in the manner specified by the Board of Directors. The options granted under the 1996 Option Plan will vest at a rate of 33.3% per year, beginning on November 21, 1999. At December 31, 1997, there were 27,540 options held by three retired directors which were exercisable. On May 20, 1998, 9,180 options were exercised; the remaining 18,360 options are held by two retired directors as of September 30, 1998. The Board of Directors of the Company has adopted the LIFE Financial Corporation 1997 Stock Option Plan (the "1997 Option Plan"), which became effective upon the Reorganization (the 1996 Option Plan and the 1997 Option Plan will sometimes hereinafter be referred to as the "Option Plans"). The Board of Directors of the Company has reserved shares equal to 10% of the issued and outstanding shares of the Company giving effect to the Reorganization and the Public Offering, including Company options that were exchanged for Bank options pursuant to the 1996 Option Plan for issuance under the Option Plans. Stock options with respect to shares of the Bank's Common Stock granted under the 1996 Option Plan and outstanding prior to completion of the Reorganization automatically became options to purchase three shares of the Company's Common Stock upon identical terms and conditions. Through September 30, 1998, 201,000 shares of the 1997 Option Plan were granted at exercise prices ranging from $11.00 to $18.50 per share. The options granted under the 1997 Option Plan will vest at a rate of 33.3% per year, beginning on June 30, 2000. Under the 1997 Option Plan, there were 17,500 options at December 31, 1997 and September 30, 1998 held by one retired director which were exercisable. 3. Comprehensive Income -------------------- The Company adopted Statement Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income" effective with the fiscal year beginning January 1, 1998. SFAS No. 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS No. 130 requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings, paid-in capital in the equity section of the statement of financial position. The Company has no differences between net income and comprehensive income for the nine months ended September 30, 1998. 4. Earnings Per Share ------------------ The Company adopted SFAS No. 128 "Earnings Per Share" effective as of December 31, 1997. The Statement establishes standards for computing and presenting earnings per share ("EPS") and applies to entities with publicly-held common stock or potential common stock. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS calculation to the numerator and denominator of the diluted EPS computation. The adoption of SFAS No. 128 did not have a significant impact on the Company's earnings per share. Earnings per share has been adjusted retroactively to reflect the three- for-one stock exchange effected pursuant to the Reorganization and the stock split effected in the form of a dividend during 1996. 5 The following table is a reconciliation of the numerators and denominators of the basic and diluted EPS computations for the net earnings for the Company (dollars in thousands, except share data):
For the nine months ended September 30, ---------------------------------------------- 1998 1997 ------------------------------------ ------------------------------------- Earnings Shares Per Share Earnings Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount ----------- ------------- --------- ----------- ------------- --------- Net Earnings $ 2,535 $ 3,880 ======== =========== Basic EPS Earnings available to common stockholders $ 2,535 6,558,997 $ 0.39 $ 3,880 6,537,377 $ 0.59 ========= ========= Effect of Dilutive Securities Options - 214,457 - 316,207 -------- --------- ----------- --------- Diluted EPS Earnings available to common stockholders plus assumed conversions $ 2,535 6,773,454 $ 0.37 $ 3,880 6,853,584 $ 0.57 ======== ========= ========= =========== ========= =========
For the three months ended September 30, ---------------------------------------------- 1998 1997 ------------------------------------ ------------------------------------- Earnings Shares Per Share Earnings Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount ----------- ------------- --------- ----------- ------------- --------- Net Earnings $ 7,771 $ 4,608 =========== ============ Basic EPS Earnings available to common stockholders $ 7,771 6,552,192 $ 1.19 $ 4,608 4,320,270 $ 1.07 ========= ========= Effect of Dilutive Securities Options - 289,025 - 116,083 ----------- --------- ----------- --------- Diluted EPS Earnings available to common stockholders plus assumed conversions $ 7,771 6,841,217 $ 1.14 $ 4,608 4,436,353 $ 1.04 =========== ========= ========= =========== ========= =========
5. FIRSTPLUS Financial Group merger -------------------------------- 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. Under the Merger Agreement, at the effective date of the merger, each outstanding share of Company common stock would have been converted into the right to receive between 0.500 and 0.667 share of FIRSTPLUS common stock. On October 9, 1998, the Company advised FIRSTPLUS that it was terminating the Merger Agreeement 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. 6 6. Recent Accounting Pronouncements -------------------------------- In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS No. 131 establishes standards of reporting by publicly held business enterprises and requires disclosures for each segment that are similar to those required under current standards with the addition of quarterly disclosure requirements and a finer partitioning of geographic disclosures. It requires limited segment data on a quarterly basis. It also requires geographic data by country, as opposed to broader geographic regions, as permitted under current standards. SFAS No. 131 is effective for the fiscal years beginning after December 15, 1997 with earlier application permitted. The Company does not anticipate the adoption of SFAS No. 131 will have a material impact on its financial reporting. In June 1998, FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which is effective for fiscal years beginning after June 15, 1999. This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The adoption of this standard is not expected to have a material effect on the Company's financial condition, results of operation and cash flows. In October 1998, FASB issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage-Banking Enterprise", which is effective for the first fiscal quarter beginning after December 15, 1998. This statement amends SFAS No. 65, "Accounting for Certain Mortgage-Backed Activities" to require that after securitization of the mortgage loans held for sale, an entity engaged in mortgage-banking activities classify the resulting mortgage-backed securities or retained interest based on its ability and intent to sell or hold those investments. Management does not anticipate that adoption of this statement will have a material impact on the Company's financial condition, results of operation and cash flows. 7. Restatement ----------- Subsequent to the issuance of the Company's Quarterly Report on Form 10-Q for the three and nine month period ended September 30, 1998, the Company's management determined that residual assets retained in certain of the Company's 1997 and 1996 securitization transactions had not been determined using the cash-out method, as required by the Financial Accounting Standards Board's (FASB) Special Report, A Guide to Implementation of Statement 125 on Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, Second Edition, dated December 1998, and related guidance set forth in statements made by the staff of the Securities and Exchange Commission (SEC) on December 8, 1998. From December 1996 through June 1997, the Company completed two securitizations, which total $155 million of original loan balance securitized, that are effected by this restatement. The Company's other securitization transactions have been properly measured and accounted for using the cash-out method. Initial deposits to restricted cash accounts and subsequent cash flows received by securitization trusts sponsored by the Company accumulate as credit enhancement assets until certain targeted levels are achieved, after which cash is distributed to the Company on an unrestricted basis. Under the method previously used by the Company, (i) the assumed discount period for measuring the present value of credit enhancement assets ended when cash flows were received by the securitization trusts and (ii) interest-bearing initial deposits to restricted cash accounts were recorded at face value. Under the cash-out method required by the FASB and SEC, the assumed discount period for measuring the fair value of credit enhancement assets ends when cash, including return of the initial deposits, is distributed to the Company on an unrestricted basis. As a result, the financial statements as of September 30, 1998 and for the three and nine months ended September 30, 1998 and 1997, have been restated from amounts previously reported to properly reflect the pretax fair values of the residual assets, including restricted cash, and the resulting pretax gains and income tax provision as computed on the cash-out basis. The tax impact of the restatement is reflected as a reduction in deferred tax liabilities, included within accounts payable and other liabilities, of $2.0 million at September 30, 1998. 7 A summary of the significant effects of the restatement is as follows: _________________________________________________________________________ 1998 ------ _________________________________________________________________________ As Previously As Reported Restated - ------------------------------------------------------------------------- AT SEPTEMBER 30, - ------------------------------------------------------------------------- Restricted cash $ 12,920 $ - - ------------------------------------------------------------------------- Residual assets, as fair value 47,932 56,035 - ------------------------------------------------------------------------- Retained earnings, partially restricted 19,255 16,422 - -------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------- 1998 1997 ---- ---- - ---------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------- As As Previously As Previously As Reported Restated Reported Restated - ---------------------------------------------------------------------------------------------------------------- FOR THE THREE MONTHS ENDED SEPTEMBER 30, - ---------------------------------------------------------------------------------------------------------------- Total interest income $ 11,568 $ 11,842 $ 5,697 $ 5,663 - ---------------------------------------------------------------------------------------------------------------- Net gains from mortgage financing operations 4,890 6,047 8,344 8,292 - ---------------------------------------------------------------------------------------------------------------- Income before income tax provision 3,180 4,420 6,740 6,655 - ---------------------------------------------------------------------------------------------------------------- Income tax provision 1,357 1,885 2,809 2,775 - ---------------------------------------------------------------------------------------------------------------- Net income 1,805 2,535 3,931 3,880 - ---------------------------------------------------------------------------------------------------------------- Net income per share - Basic $ 0.28 $ 0.39 $ 0.60 $ 0.59 - ---------------------------------------------------------------------------------------------------------------- Net income per share - Diluted $ 0.27 $ 0.27 $ 0.57 $ 0.57 - ---------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------- FOR THE NINE MONTHS ENDED SEPTEMBER 30, - ---------------------------------------------------------------------------------------------------------------- Total interest income $ 31,048 $ 31,367 $ 12,152 $ 12,104 - ---------------------------------------------------------------------------------------------------------------- Net gains from mortgage financing operations 14,807 16,349 17,413 12,216 - ---------------------------------------------------------------------------------------------------------------- Income before income tax provision 11,644 13,505 13,186 7,941 - ---------------------------------------------------------------------------------------------------------------- Income tax provision 4,969 5,734 5,491 3,333 - ---------------------------------------------------------------------------------------------------------------- Net income 6,675 7,771 7,695 4,608 - ---------------------------------------------------------------------------------------------------------------- Net income per share - Basic $ 1.02 $ 1.19 $ 1.78 $ 1.07 - ---------------------------------------------------------------------------------------------------------------- Net income per share - Diluted $ 0.98 $ 1.14 $ 1.73 $ 1.04 - ----------------------------------------------------------------------------------------------------------------
8 Item 2. Management's Discussion and Analysis of Results of Operations and ----------------------------------------------------------------- Financial Condition ------------------- This Management's Discussion and Analysis should be read in conjunction with the Management's Discussion and Analysis contained in the Company's Annual Report on Form 10-K/A which focuses upon relevant matters occurring during the year ended December 31, 1997. Accordingly, the ensuing discussion focuses upon the material matters at and for the three months and nine months ended September 30, 1998. GENERAL - ------- The Company is involved in the origination, purchase, sale and servicing of non-conventional mortgage loans principally secured by first and second mortgage loans on one- to four-family residences. The Company has focused on Liberator Series loans which are for the purchase or refinance of residential real property by borrowers who may have had prior credit problems or who do not have an adequate credit history, and are considered "sub-prime borrowers," or loans which have other non-conforming features. In addition, the Company has originated a substantial number of Portfolio Series loans which are debt consolidation loans for borrowers whose credit history qualify for Federal National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC") loans ("Agency Qualified Borrowers"). The Company purchases and originates mortgage loans and other real estate secured loans through a network of approved correspondents and independent mortgage brokers ("Originators") throughout the country. The Company funds substantially all of the loans which it originates or purchases through deposits, internally generated funds, FHLB advances and various lines of credit. In the immediate and foreseeable future, the Company will also fund loans from the cash proceeds, if any, received from securitizations. Deposit flows and cost of funds are influenced by prevailing market rates of interest primarily on competing investments, account maturities and the levels of savings in the Company's market area. The Company's ability to purchase or sell loans is influenced by the general level of product available from its correspondent relationships and the willingness of investors to purchase the loans at an acceptable price to the Company. Due to substantial activity in the purchase and sale of loans in recent years, the net gains from mortgage financing operations have been significant. The Company's results of operations are also affected by the Company's provision for loan losses and the level of operating expenses. The Company's operating expenses primarily consist of employee compensation and benefits, premises and occupancy expenses, and other general expenses. The Company's results of operations are also affected by prevailing economic conditions, competition, government policies and actions of regulatory agencies. Subsequent to the issuance of the Company's Quarterly Report on Form 10-Q for the three and nine month period ended September 30, 1998, the Company's management determined that residual assets retained in certain of the Company's 1997 and 1996 securitization transactions had not been determined using the cash-out method, as required by the Financial Accounting Standards Board's (FASB) Special Report, A Guide to Implementation of Statement 125 on Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, Second Edition, dated December 1998, and related guidance set forth in statements made by the staff of the Securities and Exchange Commission (SEC) on December 8, 1998. From December 1996 through June 1997, the Company completed two securitizations, which total $155 million of original loan balance securitized, that are effected by this restatement. The Company's other securitization transactions have been properly measured and accounted for using the cash-out method. Initial deposits to restricted cash accounts and subsequent cash flows received by securitization trusts sponsored by the Company accumulate as credit enhancement assets until certain targeted levels are achieved, after which cash is distributed to the Company on an unrestricted basis. Under the method previously used by the Company, (i) the assumed discount period for measuring the present value of credit enhancement assets ended when cash flows were received by the securitization trusts and (ii) interest-bearing initial deposits to restricted cash accounts were recorded at face value. Under the cash-out method required by the FASB and SEC, the assumed discount period for measuring the fair value of credit enhancement assets ends when cash, including return of the initial deposits, is distributed to the Company on an unrestricted basis. As a result, the financial statements as of September 30, 1998 and for the three and nine months ended September 30, 1998 and 1997, have been restated from amounts previously reported to properly reflect the pretax fair values of the residual assets, including restricted cash, and the resulting pretax gains and income tax provision as computed on the cash-out basis. The effects of the restatement are presented in Note 7 of Notes to Consolidated Financial Statements and have been reflected herein. 9 RESULTS OF OPERATIONS - --------------------- Net income was $2.5 million for the three months ended September 30, 1998 compared to $3.9 million for the three months ended September 30, 1997, a decrease of $1.4 million. For the nine months ended September 30, 1998, the Company recorded net income of $7.8 million compared to $4.6 million for the nine months ended September 30, 1997. The decline in net income for the three month period ending September 30, 1998 is primarily due to the pre-tax write- down on the residual assets for $4.0 million for the three months ended September 30, 1998. The increase for 9 months was due to gain on sale of 1998-1 and partially offset by pre-tax write-down of $6.7 million. For the three months ended September 30, 1998 and September 30, 1997, the diluted earnings per share were $0.37 and $0.57, respectively. The diluted earnings per share for the nine months ended September 30, 1998 were $1.14 compared to $1.04 for the nine months ended September 30, 1997. The increase in earnings per share for the nine months was partially attributable to net gain from mortgage financing. Interest Income - --------------- Interest income was $11.8 million for the three months ended September 30, 1998 compared to $5.7 million for the three months ended September 30, 1997 due primarily to an increase in the average balance of interest-earning assets offset partially by a slight decline in the yield on those assets. Average interest-earning assets increased to $484.6 million for the three months ended September 30, 1998 compared to $230.6 million for the three months ended September 30, 1997. The yield on interest-earning assets decreased to 9.77% for the three months ended September 30, 1998 compared to 9.82% for the three months ended September 30, 1997. The largest single component of interest-earning assets was loans receivable, net, which were $398.5 million with a yield of 9.65% for the three months ended September 30, 1998 compared to $194.8 million with a yield of 9.82% for the three months ended September 30, 1997. The increase in average loans receivable, net was due to an increase in loans held- for-sale. Interest income for the nine months ended September 30, 1998 was $31.4 million, compared to $12.1 million for the nine months ended September 30, 1997, due to an increase in the average balance of interest-earning assets, combined with an increase in the yield on those assets. Average interest-earning assets increased to $424.8 million for the nine months ended September 30, 1998 compared to $170.1 million for the nine months ended September 30, 1997. The yield on interest-earning assets increased to 9.85% for the nine months ended September 30, 1998 compared to 9.49% for the nine months ended September 30, 1997. The largest single component of interest-earning assets was loans receivable, net, which were $341.3 million with a yield of 9.79% for the nine months ended September 30, 1998, compared to $140.6 million with a yield of 9.49% for the nine months ended September 30, 1997. Interest Expense - ---------------- Interest expense increased to $7.0 million for the three months ended September 30, 1998 compared to $3.1 million for the three months ended September 30, 1997 due primarily to an increase in the average interest-bearing liabilities. Average interest-bearing liabilities were $451.0 million for the three months ended September 30, 1998 compared to $200.4 million for the three months ended September 30, 1997. The largest component of average interest- bearing liabilities was certificate accounts, which averaged $225.9 million with a cost of 5.87% for the three months ended September 30, 1998, compared to $142.5 million with a cost of 5.97% for the three months ended September 30, 1997. The second largest component of average interest-bearing liabilities is borrowings, which increased to an average balance of $196.3 million with a cost of 6.95% for the three months ended September 30, 1998 compared to $39.7 million with a cost of 8.21% for the three months ended September 30, 1997. In addition to the subordinated debentures (Debentures) which were issued during 1997, the Company began utilizing two warehouse lines of credit and a residual financing line for total lines of $315 million which are indexed to London Interbank Offering Rate index ("LIBOR"). For the nine months ended September 30, 1998, interest expense was $17.8 million compared to $7.1 million for the nine months ended September 30, 1997 due to an increase in the average interest-bearing liabilities combined with an increase in the rate paid on those liabilities. On March 14, 1997, the Company issued $10 million in Debentures through a private placement and pursuant to a Debenture Purchase Agreement. The Debentures mature on March 15, 2004 and bear interest at a rate of 13.5% per annum, payable semi-annually. The Debentures are redeemable at the option of the Company, in whole or in part, at any time after September 15, 1998 at the aggregate principal amount thereof, plus accrued and unpaid interest, if any. By September 15, 1998, $7.0 million of this debentures were called for payment on or before December 15, 1998. This issuance of debentures, combined with an increased reliance on certificate accounts and other borrowings, resulted in an increase in the average interest-bearing liabilities to $390.4 million for the nine months ended September 30, 1998 compared to $161.0 million for the 10 nine months ended September 30, 1997. The average cost on borrowings increased to 6.11% for the nine months ended September 30, 1998 compared to 5.90% for the nine months ended September 30, 1997. The largest component of average interest-bearing liabilities was certificate accounts, which averaged $224.6 million with a cost of 5.92% for the nine months ended September 30, 1998 compared to $116.0 million with a cost of 5.89% for the nine months ended September 30, 1997. The second largest component of average interest-bearing liabilities is borrowings, which increased to an average balance of $139.4 million with a cost of 7.15% for the nine months ended September 30, 1998 compared to $27.3 million with a cost of 8.13% for the nine months ended September 30, 1997. This decline in the cost of borrowings is reflective of the higher proportional average balance of the warehouse lines of credit to the average balance of the subordinated debt during the nine months ended September 30, 1998. Net Interest Income Before Provision for Loan Losses - ---------------------------------------------------- Net interest income before provision for loan losses for the three months ended September 30, 1998 was $4.9 million compared to $2.6 million for the three months ended September 30, 1997. This increase is the result of an increase in average interest-earning assets and average interest-bearing liabilities. Average interest-earning assets increased to $484.6 million with a yield of 9.77% for the three months ended September 30, 1998 compared to $230.6 million with a yield of 9.82% for the three months ended September 30, 1997. Average interest-bearing liabilities increased to $451.0 million with a cost of 6.11% for the three months ended September 30, 1998 compared to $200.4 million with a cost of 6.10% for the three months ended September 30, 1997. Net interest income before provision for loan losses for the nine months ended September 30, 1998 was $13.5 million compared to $5.0 million for the nine months ended September 30, 1997. This increase is the net effect of an increase in average interest-earning assets and average interest-bearing liabilities, an increase in the net interest margin and the ratio of interest-earning assets to interest-bearing liabilities. Average interest-earning assets increased to $424.8 million with a yield of 9.85% for the nine months ended September 30, 1998 compared to $170.1 million with a yield of 9.49% for the nine months ended September 30, 1997. Average interest-bearing liabilities increased to $390.4 million with a cost of 6.11% for the nine months ended September 30, 1998 compared to $161.0 million with a cost of 5.90% for the nine months ended September 30, 1997. The net interest margin was 3.18% for the nine months ended September 30, 1998 compared to 3.92% for the nine months ended September 30, 1997. The ratio of interest-earning assets to interest-bearing liabilities was 108.79% for the nine months ended September 30, 1998 compared to 105.61% for the nine months ended September 30, 1997. 11 Average Balance Sheets. The following tables set forth certain information relating to the Company for the three month and nine month periods ended September 30, 1998 and 1997. The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Unless otherwise noted, average balances are measured on a daily basis. The yields and costs include fees which are considered adjustments to yields.
Three months ended Three months ended Nine months ended September 30, 1998 September 30, 1997 September 30, 1998 ----------------------------- ---------------------------- ----------------------------- (Dollars in Thousands) Assets: Average Average Average Average Average Average Interest-earning assets: Balance Interest Yield/Cst Balance Interest Yield/Cst Balance Interest Yield/Cst -------- -------- --------- ------- -------- --------- -------- -------- --------- Interest-earning deposits and short- term investments $ 29,349 $ 384 5.19% $ 9,430 $ 132 5.55% $ 28,811 $ 1,130 5.24% Investment securities(1) 6,406 106 6.56 9,043 131 5.75 6,534 294 6.02 Loans receivable, net(2) 398,497 9,610 9.65 194,776 4,781 9.82 341,298 25,051 9.79 Mortgage-backed securities, net(1) 8 - 0.00 9 - 0.00 9 - 0.00 Residual assets 50,366 1,742 13.83 17,383 619 14.21 48,103 4,892 13.56 -------- -------- --------- -------- -------- ------- -------- Total interest-earning assets 484,626 11,842 9.77 230,641 5,663 9.82 424,755 31,367 9.85 Non-interest-earning assets(3) 38,559 28,320 35,778 -------- -------- ------- Total assets(3) $523,185 $258,961 $ 460,533 ======== ======== ======= Liabilities and Equity: Interest-bearing liabilities: Passbook accounts 4,355 27 2.46 $ 4,031 21 2.07 $ 4,144 76 2.45 Money market accounts 5,226 67 5.09 2,959 22 2.95 3,834 141 4.92 Checking accounts 19,295 76 1.56 11,212 70 2.48 18,455 238 1.72 Certificate accounts 225,861 3,343 5.87 142,517 2,146 5.97 224,565 9,938 5.92 -------- -------- -------- -------- ------- -------- Total deposit accounts 254,737 3,513 5.47 160,719 2,259 5.58 250,998 10,393 5.54 Borrowings 196,272 3,438 6.95 39,661 821 8.21 139,440 7,452 7.15 -------- -------- -------- -------- ------- -------- Total interest-bearing liabilities 451,009 6,951 6.11 200,380 3,080 6.10 390,438 17,845 6.11 -------- -------- Non-interest-bearing liabilities(3) 15,064 23,069 15,229 -------- -------- ------- Total liabilities(3) 466,073 223,449 405,667 Equity(3) 57,112 35,512 $ 54,866 -------- -------- ------- Total liabilities and equity(3) $523,185 $258,961 $460,533 ======== ======== ======= Net interest income before provision for loan losses $ 4,891 $ 2,583 13,522 ======== ======== ======== Net interest rate spread(4) 3.66 3.72 3.74 Net interest margin(5) 4.04 4.48 3.18 Ratio of interest-earning assets to interest-bearing liabilities 107.45% 115.10% 108.79% Nine months ended September 30,1997 ---------------------------- Assets: Average Average Interest-earning assets: Balance Interest Yield/Cst -------- -------- --------- Interest-earning deposits and short- term investments $ 8,780 $ 462 7.04% Investment securities(1) 8,901 376 5.65 Loans receivable, net(2) 140,551 10,001 9.49 Mortgage-backed securities, net(1) 9 - 0.00 Residual assets 11,835 1,265 14.25 -------- ------- -------- Total interest-earning assets 170,076 12,104 9.49 ------- -------- Non-interest-earning assets(3) 20,015 -------- Total assets(3) 190,091 ======== Liabilities and Equity: Interest-bearing liabilities: Passbook accounts $ 4,027 63 2.09 Money market accounts 2,978 67 3.01 Checking accounts 10,691 201 2.51 Certificate accounts 116,035 5,109 5.89 -------- ------- Total deposit accounts 133,731 5,440 5.44 Borrowings 27,308 1,662 1.13 -------- ------- Total interest-bearing liabilities 161,039 7,102 5.90 ------- Non-interest-bearing liabilities(3) 10,292 -------- Total liabilities(3) 171,331 Equity(3) 18,760 -------- Total liabilities and equity(3) 190,091 ======== Net interest income before provision for loan losses $ 5,002 ======== Net interest rate spread(4) 3.59 Net interest margin(5) 3.92 Ratio of interest-earning assets to interest-bearing liabilities 105.61%
(1) Includes unamorized discounts and premiums. (2) Amounts is net of deferred loan origination fees, unamorized discounts, premiums and allowance for loan losses and includes loans held-for-sale, non-performing loans and warehouse financing receivable. (3) Average balances are measured on a month-end basis. (4) Net interest rate spread represents the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. (5) Net interest margin represents an interest income divided by average interest-earning assets. 12 Provision for Loan Losses - ------------------------- The allowance for loan losses is based upon a number of factors, including current economic conditions, actual loss experience and industry trends. The Company's non-performing loans consist of one- to-four family residential mortgage loans and consumer loans. Management believes that the allowance for loan losses at September 30, 1998 and 1997 was adequate to absorb known and inherent risks in the Company's loan portfolio. Based upon management's analysis, there were provisions for loan losses of $736,000 and $400,000 for the three month periods ended September 30, 1998 and 1997, respectively. Provisions for loan losses were $2.4 million for the nine months ended September 30, 1998 compared to $900,000 for the nine months ended September 30, 1997. The increase in provisions was based on charge offs for the nine months ended September 30, 1998 combined with a re-evaluation of the composition of the Company's loan portfolio. (See "Financial Condition") Non-Interest Income - ------------------- Net gains from mortgage financing operations for the three months ended September 30, 1998 totaled $6.0 million, compared to $8.3 million for the quarter ended September 30, 1997. This decrease was attributable to a pre-tax $4.0 million mark-to-market write down of residual assets partially offset by an increase in the level of mortgage financing operations, with loans sold and securitized totaling $466.1 million (including $154.8 million in whole loan sales) during the three months ended September 30, 1998, compared to loans securitized totaling $100.9 million for the three months ended September 30, 1997. The write down of residual assets was directly the result of a decline in interest rates and a corresponding increase in prepayments speeds associated with the 1996-1, 1997-1 and 1997-2 securitizations which were issued respectively in December 1996, March 1997 and September 1997. At September 30, 1998, the Company utilized prepayment assumptions ranging from 17% to 50%, an estimated loss factor assumption ranging from 1.00% to 2.50% and a weighted average discount rate of 13.5% to value residual assets. The residual asset valuation associated with the 1998-1 securitization completed during the three months ended September 30, 1998 utilized prepayment assumptions of 35% on adjustable rates and a 36.6% ramped CPR on fixed rates, an estimated loss factor assumption of 1%, and a weighted average discount rate of 13.5%. During the three months ended September 30, 1998, there were no loans sold to FIRSTPLUS of Dallas, Texas. Loans originated and purchased totaled $368.3 million for the three months ended September 30, 1998, compared to $194.4 million for the three months ended September 30, 1997. For the nine months ended September 30, 1998, net gains from mortgage financing operations totaled $16.3 million compared to $12.2 million for the nine months ended September 30, 1997. This increase was primarily attributable to the increase in the level of mortgage financing operations, with loans sold or securitized totaling $961.7 million (including $577.2 million in whole loans sales) during the nine months ended September 30, 1998, compared to loans sold or securitized totaling $277.3 million (including $73.3 million in whole loans sales) for the nine months ended September 30, 1997, partially offset by write down on residuals of $6.7 million. For the nine months ended September 30, 1998, $210.5 million of the $961.7 million (or 21.9%) was sold to FIRSTPLUS for a gain of $6.6 million. Loans originated and purchased totaled $930.9 million for the nine months ended September 30, 1998 compared to $435.0 million for the nine months ended September 30, 1997. Non-Interest Expense - -------------------- Non-interest expense was $7.1 million for the three months ended September 30, 1998 compared to $4.2 million for the three months ended September 30, 1997. For the nine months ended September 30, 1998, non-interest expense was $18.9 million compared to $9.2 million for the nine months ended September 30, 1997. The increase was due primarily to an increase in compensation and benefits and other operating expenses resulting from the expansion of mortgage financing operations. Compensation and benefits increased to $3.1 million for the three months ended September 30, 1998 from $2.5 million for the three months ended September 30, 1997. For the nine months ended September 30, 1998, compensation and benefits were $8.6 million compared to $5.5 million for the nine months ended September 30, 1997. These costs are directly related to the expansion of the mortgage financing operations and the corresponding increase in personnel, to an average of 343 employees for the three months ended September 30, 1998 compared to 180 employees for the three months ended September 30, 1997. Average number of employees for the nine months ended September 30, 1998 were 302 compared to 163 for the nine months ended September 30, 1997. 13 Premises and occupancy expenses increased to $962,000 for the three months ended September 30, 1998 compared to $332,000 for the three months ended September 30, 1997, and were $2.4 million for the nine months ended September 30, 1998 compared to $805,000 for the nine months ended September 30, 1997 due to the expansion of the mortgage financing operation and the addition of the regional operating centers in Denver, Colorado, Attleboro, Massachusetts, and San Jose, California, as well as the opening of the new Corporate Headquarters and regional lending center located in Riverside, California, and the relocation of the Florida regional office, the addition of nine low cost retail lending offices in California, the opening of retail bank branches in Riverside and Redlands, California and additional office space for the expansion of the loan servicing operations in March 1998. The Company anticipates that premises and occupancy expense will continue to increase as the Company expands into new retail lending and retail banking offices as evidenced by the opening of a 67 seat national telemarketing center in May, 1998 in Riverside and the Huntington Beach, California branch opening anticipated in the fourth quarter of 1998. As a result of the expansion noted, other operating expenses increased as well. Data processing increased to $406,000 for the three months ended September 30, 1998 compared to $229,000 for the three months ended September 30, 1997, and was $1.1 million for the nine months ended September 30, 1998 compared to $524,000 for the nine months ended September 30, 1997. Marketing increased to $788,000 for the three months ended September 30, 1998 compared to $72,000 for the three months ended September 30, 1997, and was $1.8 million for the nine months ended September 30, 1998 compared to $195,000 for the nine months ended September 30, 1997. The increase in marketing reflects an increased emphasis on radio and mail advertising in order to increase demand for mortgage banking operations. Professional services increased to $360,000 for the three months ended September 30, 1998 compared to $111,000 for the three months ended September 30, 1997, and was $1.2 million for the nine months ended September 30, 1998 compared to $243,000 for the nine months ended September 30, 1997. The increase in professional services was partially related to the merger-related costs incurred inconjunction with the FIRSTPLUS transaction. Telephone and other expense increased to $321,000 and $1.1 million, respectively, for the three months ended September 30, 1998 compared to $222,000 and $680,000 for the three months ended September 30, 1997 and were $814,000 and $2.7 million for the nine months ended September 30, 1998 compared to $439,000 and $1.2 million for the nine months ended September 30, 1997. Income Taxes - ------------ The provision for income taxes decreased to $1.9 million for the three months ended September 30, 1998 compared to $2.8 million for the three months ended September 30, 1997 due to a decrease in income before income tax provision. Income before income tax provision decreased to $4.4 million for the three months ended September 30, 1998 from $6.7 million for the three months ended September 30, 1997. The effective tax rate increased to 42.6% for the three months ended September 30, 1998 from 41.7% for the three months ended September 30, 1997 due to $94,000 of non-tax deductible merger-related costs expensed during the quarter. The provision for income taxes increased to $5.7 million for the nine months ended September 30, 1998 compared to $3.3 million for the nine months ended September 30, 1997. Income before income tax provision increased to $13.5 million for the nine months ended September 30, 1998 compared to $7.9 million for the nine months ended September 30, 1997. The effective tax rate increased to 42.5% for the nine months ended September 30, 1998 compared to 42.0% for the nine months ended September 30, 1997 due to the inclusion of merger-related costs of $300,000 during the period. 14 COMPARISON OF FINANCIAL CONDITION AS OF SEPTEMBER 30, 1998 AND DECEMBER 31, 1997 - -------------------------------------------------------------------------------- Total assets decreased to $362.8 million as of September 30, 1998 compared to $397.1 million as of December 31, 1997. This increase was attributable to the decrease in loans held-for-sale during the period ended September 30, 1998 due to a $322.1 million securitization during the quarter ending September 30, 1998. Loans held-for-sale totaled $215.3 million as of September 30, 1998 compared to $289.3 million as of December 31, 1997. Loans held-for-investment decreased to $16.1 million as of September 30, 1998 compared to $29.1 million as of December 31, 1997 due to a whole loan sale and normal loan payment activity. Residual assets increased to $56.0 million as of September 30, 1998 compared to $45.4 as of December 31, 1997. This increase reflects the additional residuals from the pre-fund on the 1997-3 securitization during the first quarter and the residual from the 1998-1 securitization during the third quarter offset by the residual asset write down as described previously. Mortgage servicing rights increased as a result of the loan sales with servicing retained to $13.2 million as of September 30, 1998 compared to $8.5 million as of December 31, 1997. Cash and cash equivalents were $22.6 million as of September 30, 1998 compared to $3.5 million as of December 31, 1997. Cash and cash equivalents increased by $19.1 million as of September 30, 1998 due to execution of 1998-1 in September, 1998. Premises and equipment increased to $7.0 million as of September 30, 1998 compared to $4.8 million as of December 31, 1997. This increase of $2.2 million is primarily due to the loan servicing department moving to a new location and retrofitting their previous facility in order to house the new Call Center operation which opened in May, 1998. Real estate owned increased to $2.0 million as of September 30, 1998 compared to $1.4 million as of December 31, 1997 as part of the Company's continuing effort to resolve problem assets. Other assets were $22.9 million as of September 30, 1998 compared to $6.4 million as of December 31, 1997. The increase was due primarily to a $16.5 million receivable with the cash received on October 1. The Company increased its liabilities by increasing deposit accounts to $254.7 million as of September 30, 1998 compared to $211.8 million as of December 31, 1997. The major component of deposit accounts is certificates of deposit, which increased to $230.7 million as of September 30, 1998 compared to $193.8 million as of December 31, 1997. The Company decreased FHLB advances and borrowings from $109.2 million at December 31, 1997 to $13.8 million at September 30, 1998 due to the increase in deposit accounts of $42.9 million and a reduction in the loan receivable balance as of September 30, 1998 of $86.9 million due to loans sales. Accounts payable and other liabilities increased to $25.6 million as of September 30, 1998 compared to $15.3 million as of December 31, 1997 due to an increase in loans serviced for other investors and the corresponding increase in amounts due investors between the time the borrowers make payments to the Company and the time the Company remits payments to the investors. Stockholders' equity increased to $58.7 million as of September 30, 1998 from $50.9 million as of December 31, 1997 primarily due to the earnings of $6.7 million. The Company's non-performing assets increased to $8.6 million as of September 30, 1998 compared to $6.6 million as of December 31, 1997. The increase of $2.0 million is due primarily to non-accrual loans with an increase of $2.9 million in one- to-four family residential loans offset by a decrease of $1.4 million in consumer loans. Non-performing loans as a percent of gross loans receivable increased to 2.95% as of September 30, 1998 from 1.64% as of December 31, 1997. Non-performing assets as a percent of total assets increased to 2.38% as of September 30, 1998 from 1.65% as of December 31, 1997. 15 The following table sets forth the non-performing assets at September 30, 1998 and December 31, 1997:
As of As of September 30, December 31, 1998 1997 ------------ ----------- (Dollars in thousands) Non-accrual loans $6,645 $5,126 Foreclosed real estate, net (1) 2,002 1,440 ------ ------ Total non-performing assets $8,647 $6,566 ====== ====== Allowance for loan losses as a percent of gross loans receivable(2) 0.78% 0.88% Allowance for loan losses as a percent of total non-performing loans(3) 26.35 50.20 Non-performing loans as a percent of gross loans receivable(2) 2.95 1.64 Non-performing assets as a percent of total assets(4) 2.38 1.65
_______________ (1) Foreclosed real estate balances are shown net of related loss allowances. (2) Gross loans receivable is comprised of loans held-for-sale and loans held- for-investment. (3) Non-performing loans consisted of all loans 90 days or more past due and all other non-accrual loans. (4) Non-performing assets is comprised of non-accrual loans and foreclosed real estate. The Company, in consideration of the current economic environment and the condition of the loan portfolio, has established an allowance for loan losses as of September 30, 1998 of $1.8 million compared to $2.6 million as of December 31, 1997. The allowance is based upon a number of factors, including current economic conditions, actual loss experience and industry trends. The Company's non-performing loans consist of one- to-four family residential mortgage loans and consumer loans. Management believes that the allowance for loan losses at September 30, 1998 was adequate to absorb known and inherent risks in the Company's loan portfolio. No assurances can be given, however, that economic conditions which may adversely affect the Company's or the Bank's service area or other circumstances will not be reflected in increased losses in the loan portfolio. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance or to take charge-offs (reductions of the allowance) in anticipation of losses. The following table sets forth the activity in the Company's allowance for loan losses for the nine months ended September 30, 1998: (Dollars in thousands) Balance as of December 31, 1997 $2,573 Add: Provision for loan losses 2,366 Recoveries of previous charge-offs 68 Less: Charge-offs 3,256 ------ Balance as of September 30, 1998 $1,751 ====== LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- During the three months ended September 30, 1998, current market conditions have effected the liquidity of numerous mortgage lenders. The Company's warehouse lines of credit as of September 30, 1998 remain at a balance of $275 million with one of lenders evaluating the possibility of increasing the limit. The lines were paid off as of September 30, 1998. The Company has other sources of funds which continue to lessen the impact of current market conditions on its liquidity. The Company's other primary sources of funds are deposits, FHLB advances, principal and interest payments on loans, cash proceeds from the sale of loans and securitizations, and to a lesser extent, interest payments on investment securities and proceeds from the maturation of investment securities. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. However, the Company has continued to maintain the required minimum levels of liquid assets as defined by OTS regulations. This requirement, which may be varied at the direction of the OTS depending upon economic conditions and deposit flows, is based upon a percentage of deposits and short-term borrowings. The required ratio is currently 4.00. The Bank's average liquidity ratios were 11.18% and 9.23% for the nine months ended September 30, 1998 and September 30, 1997, respectively. The Bank had $30.8 million in deposits maturing within one month as of September 30, 1998. The Bank anticipates that it will retain a portion of these accounts. The Company's cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities and financing activities. Cash flows provided by (used in) operating activities were $19.6 million and $(159.4) million for the nine months ended September 30, 1998 and 1997, respectively. Such cash flows primarily consisted of loans originated and purchased for sale (net of loan fees), of $930.9 million and $435.0 million, net of proceeds from the sale and securitization of loans held-for-sale of $963.5 million and $282.4 million for the nine months ended September 30, 1998 and 1997, respectively. Net cash provided by (used from) investing activities were $52.0 million and $(18.7) million for the nine months ended September 30, 1998 and 1997, respectively, and consisted primarily of principal collections on loans. Proceeds from the principal collections were $52.8 million and $(17.6) million for the 16 nine months ended September 30, 1998 and 1997, respectively. Net cash provided from financing activities consisted primarily of net activity in deposit accounts and borrowings. The net increase in deposits and borrowings was $52.5 million and $174.5 million for the nine months ended September 30, 1998 and 1997, respectively. The Company made repayments on the lines of credit of $86.4 million for the nine months ended September 30, 1998 and were provided funds from these lines of $58.2 million for the nine months ended September 30, 1997. Net deposits increased by $42.9 million and $74.1 million for the nine months ended September 30, 1998 and 1997, respectively. During the nine months ended September 30, 1998, the Company reduced its FHLB advances by $9.0 million and had no outstanding advances at the period end. During the quarter ended March 31, 1997, the Company received the proceeds of $9.6 million on the issuance of subordinated debentures. The Company received net proceeds from the IPO of the Company's Common Stock of $32.5 million as of September 30, 1997. The Company's most liquid assets are unrestricted cash and short-term investments. The levels of these assets are dependent on the Company's operating, lending and investing activities during any given period. At September 30, 1998, cash and short-term investments totaled $22.6 million. The Company has other sources of liquidity if a need for additional funds arises, including the utilization of FHLB advances. Other sources of liquidity include investment securities maturing within one year. The Bank also has two warehouse lines of credit available in the amount of $275 million, has a zero balance at September 30, 1998. The Company has a residual financing line of credit in the amount of $40.0 million, with an outstanding balance of $13.8 million as of September 30, 1998. The OTS capital regulations require savings institutions to meet three minimum capital requirements: a 1.5% tangible capital ratio, a 3.0% leverage (core capital) ratio and an 8.0% risk-based capital ratio. The core capital requirement has been effectively increased to 4.0% because the prompt corrective action legislation provides that institutions with less than 4.0% core capital will be deemed "undercapitalized". In addition, the OTS, under the prompt corrective action regulation, can impose various constraints on institutions depending on their level of capitalization ranging from well-capitalized to critically undercapitalized. As of September 30, 1998, the Bank was considered "adequately capitalized". The Bank was in compliance with the minimum capital requirements in effect as of September 30, 1998. The following table reflects the required ratios and the actual capital ratios of the Bank as of September 30, 1998:
Actual Required Excess Actual Required Capital Capital Amount Percent Percent(a) -------- ----------- --------- ------- -------- (Dollars in thousands) Tangible $29,446 $ 7,366 $22,080 6.00% 1.50% Core $29,446 $19,643 $ 9,803 6.00% 4.00% Risk-based $31,129 $28,134 $ 2,995 8.83% 8.00%
(a) The percentages and ratios to be well-capitalized under prompt and corrective action provisions as issued by the OTS are 10.00% for risk-based assets, 5% for core capital and 6% for Tier I capital. At September 30, 1998, the Bank's ratios were 8.58%, 5.88% and 8.14%, respectively. The Bank has been required by the OTS since the Bank's examination completed August 9, 1996 to compute its regulatory capital ratios based upon the higher of (1) the average of total assets based on month-end results or (2) total assets as of quarter-end. Under the framework, the Bank's capital levels at September 30, 1998 do not allow the Bank to accept brokered deposits without the prior approval from the regulators. The Bank had approximately $2.7 million of brokered deposits at September 30, 1998. This is not expected to materially impact the Bank as it has other sources of funds. As of September 30, 1998, the Bank had outstanding commitments to originate or purchase mortgage loans of $24.3 million compared to $29.2 million as of December 31, 1997 due to the expansion of the mortgage financing operations. Other than commitments to originate or purchase mortgage loans, there were no material changes to the Company's commitments or contingent liabilities as of September 30, 1998 compared to the period ended December 31, 1997 as discussed in the notes to the audited consolidated financial statements of LIFE Financial Corporation for the year 17 ended December 31, 1997 included in the Company's Annual Report on Form 10K. YEAR 2000 COMPLIANCE: As a financial institution operating in multiple --------------------- states, the Company is dependent on computer systems and applications to conduct its business. The Year 2000 (Y2K) issue is the result of computer programs being written using two digits rather than four digits to define the applicable year. Many of the Company's computer programs that are data sensitive may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruption of operations, including, among other things, a temporary inability to process transactions or engage in normal business activities for both the Company and its customers who rely on its financial products and services. The Company is activity engaged in, and is currently executing, a comprehensive risk-based plan designed to make its computer systems, applications and facilities Y2K ready. The plan covers five stages including: (i) awareness, (ii) assessment, (iii) renovation, (iv) validation and (v) implementation. During the awareness phase, the Company identified the project team and responsibilities, prepared and allocated the project budget, defined the project scope and established program and management policies. This phase although complete continues to be reviewed. The assessment phase, which entailed an inventory of software, hardware, vendors, material customers, and facilities has been completed. The renovation phase is currently in process and the Company is utilizing internal resources to test all major missions critical systems (deposit, loan and general ledger) which are provided by a service bureau. The renovation process is targeted to be largely completed by December 31, 1998 through the use of internal resources. Inventoried systems have been prioritized. All of the Company's computer hardware and software is being tested, as well as network and telecommunications equipment. Non-compliant systems are being reviewed for replacement. All equipment with date-sensitive operating controls have been identified and are being tested. The Company's mission critical business financial software was Y2K compliant as of May 15, 1998 and compliance testing was completed during the end of September and the beginning of October. This test work is currently in the validation stage but initial results reflected minimal Y2K issues. Another mission critical system is the Federal Reserve software system, this system is scheduled for testing during November 1998. The software uses a combination of methodologies for date fields. Where possible, date fields were expanded to a full eight digits. For those date fields that were retained in a six-digit format, a windowing technique was used. If the last two digits of the date are 00-49, the century is 2000. If the last two digits are 50-99, the century is 1999. The validation phase is using a variety of test strategies, including (but not limited to) testing of internal systems as they relate to each other, as well as testing external interfaces with business partners. Where appropriate, the testing is using an aged environment. Testing of all mission critical systems by simulating various date scenarios is scheduled to be completed by December 31, 1998 with the remainder of systems scheduled to be tested by March 31, 1999. The final phase is implementation, which involves the replacement of the remainder of the hardware and software that is not compliant or requires updates. An institution-wide contingency plan is in process and anticipated to be completed by the first quarter of 1999, with the Y2K issues incorporated as part of the business continuation planning. These plans, which are intended to enable the Company to continue to operate to the extent that it can do so safely, include performing certain processes manually, repairing or obtaining replacement systems, and changing suppliers. The Company believes, however, that due to the widespread nature of the potential Y2K issues, the contingency planning process is an ongoing one which will require further modifications as the Company obtains additional information regarding (1) the Company's internal systems and equipment during the renovation and testing phases of its Y2K program, and (2) the status of third party Y2K readiness. To date, the amounts incurred and expensed for developing and implementing the plan have not had a material effect on the Company's operations. The total remaining cost for addressing Y2K compliance, is not expected to be material to the Company's operations. All remaining Y2K costs will be funded through operating cash flows and will be funded by reallocating existing resources rather than incurring incremental costs. The Company is initiating communications with its critical external relationships to determine the extent to which the Company will assess and attempt to mitigate its risks with respect to the failure of these entities to be Year 2000 ready. The effect, if any, on the Company's results of operations from the failure of such parties to be Year 2000 ready, is not reasonably estimable. The Company believes that completed modifications and conversions of its internal systems and equipment will allow it to be Y2K compliant in a timely manner. There can be no assurances, however, that the Company's internal systems or equipment, or those of third parties on which the Company relies, will be Y2K compliant in a timely manner or that the Company's or third parties contingency plans will mitigate the effects of noncompliance. The Company is a part of a regulated industry which has issued standards for Y2K and is conducting audits to ensure compliance with Y2K guidelines. To date, the Company has satisfied its regulators as to its compliance with Y2K guidelines. The Company believes its most likely worst case scenario is that customers could experience some manual processes or an inability to access their cash immediately. Although, the Company does not believe that this scenario will occur, it is assessing the effect of such scenarios by using current financial data. In the event that these scenarios do occur, the Company does not expect that it would have a material adverse effect on the Company's financial position, liquidity and results of operation. 18 The preceding Y2K issue discussion contains various forward-looking statements which represent the Company's belief or expectations regarding future events. When used in the Y2K issue discussion, the words "believes," "expects," "estimates" and similar expressions are intended to identify forward-looking statements. Forward-looking statements include, without limitation, the Company's expectations as to when it will complete the renovation and testing phases of its Y2K program as well as its Y2K contingency plans; its estimated cost of achieving Y2K readiness; and the Company's belief that its internal systems and equipment will be Y2K compliant in a timely manner. All forward- looking statements involve a number of risks and uncertainties that could cause the actual results to differ materially from the projected results. Factors that may cause these differences include, but are not limited to, the availability of qualified personnel and other information technology resources; the ability to identify and renovate all data sensitive lines of computer code or to replace embedded computer chips in affected systems and equipment; and the actions of government agencies and other third parties with respect to Y2K problems. Item 3. Quantitative and Qualitative Disclosure About Market Risk --------------------------------------------------------- Management of Interest Rate Risk: The principal objective of the -------------------------------- Company's interest rate risk management function is to evaluate the interest rate risk included in certain balance sheet accounts, determine the level of appropriate risk given the Company's business focus, operating environment, capital and liquidity requirements and performance objectives and manage the risk consistent with Board approved guidelines through the establishment of prudent asset concentration guidelines. Through such management, management of the Company seeks to reduce the vulnerability of the Company's operations to changes in interest rates. Management of the Company monitors its interest rate risk as such risk relates to its operating strategies. The Company's Board of Directors reviews on a quarterly basis the Company's asset/liability position, including simulations of the effect on the Company's capital of various interest rate scenarios. The extent of movement in interest rates, higher or lower, is an uncertainty that could have a negative impact on the earnings of the Company. Between the time the Company originates loans and purchase commitments are issued, the Company is exposed to both upward and downward movements in interest rates which may have a material adverse effect on the Company. The Board of Directors of the Company has implemented a hedge management policy primarily for the purpose of hedging the risks associated with loans held for sale in the Company's mortgage pipeline. In a flat or rising interest rate environment, this policy enables management to utilize mandatory forward commitments to sell fixed rate assets as the primary hedging vehicles to shorten the maturity of such assets. In a declining interest environment, the policy enables management to utilize put options. The hedge management policy also permits management to extend the maturity of its liabilities through the use of short financial futures positions, purchase of put options, interest rate caps or collars, and entering into "long" interest rate swap agreements. Management may also utilize "short" interest rate swaps to shorten the maturity of long-term liabilities when the net cost of funds raised by using such a strategy is attractive, relative to short-term CD's or borrowings. Management is continuing to evaluate and refine its hedging policies. No hedging positions were outstanding as of September 30, 1998 or December 31, 1997. 19 PART II. OTHER INFORMATION Item 1. Legal Proceedings ----------------- The Company is involved as plaintiff or defendant in various legal actions incident to its business, none of which is believed by management to be material to the financial condition of the Company. Item 2. Changes in Securities and Use of Proceeds ----------------------------------------- None. Item 3. Defaults Upon Senior Securities ------------------------------- None. Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- None. Item 5. Other Information ----------------- None. Item 6. Exhibits and Reports on Form 8-K -------------------------------- (a) The following exhibits are filed as part of this report: 3.1 Certificate of Incorporation of Life Financial Corp. * 3.2 Bylaws of Life Financial Corp. * (b) Reports on Form 8-K ___________ * Incorporated herein by reference to Exhibits of the same number from the Company's Registration Statement on Form S-4 (filed initially on Form S-1), filed on January 27, 1997, as amended on March 27, 1997, and as further amended on May 29, 1997 and June 11, 1997 ( Registration No. 333-20497). 20 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LIFE FINANCIAL CORPORATION April 15, 1999 By:/s/ Daniel L. Perl - -------------- ------------------------------------ Date Daniel L. Perl President and Chief Executive Officer (principal executive officer) April 15, 1999 /s/ Jeffrey L. Blake - -------------- ------------------------------------ Date Jeffrey L. Blake Chief Financial Officer and Treasurer (principal financial and accounting officer) 21 -----END PRIVACY-ENHANCED MESSAGE-----