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| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||
For the year ended December 31, 2002 | ||||
| OR | ||||
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||
Commission File No.: 0-22353
FLAGSTAR CAPITAL CORPORATION
| Michigan | 38-3386801 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| Incorporation or organization) | Identification No.) | |
| 5151 Corporate Drive, Troy, Michigan | 48098-2639 | |
| (Address of principal executive offices) | (Zip Code) | |
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: None.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days.
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 registrants 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. x
As of March 19, 2003, 1,000,000 shares of the registrant’s Common Stock, $1.00 par value, were issued and outstanding and 2,300,000 shares of the registrant’s Series A Preferred Shares, $25.00 par value, were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
NONE.
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TABLE OF CONTENTS
| PART I | ||||
| Item 1. | Business | 3 | ||
| Item 2. | Properties | 4 | ||
| Item 3. | Legal Proceedings | 4 | ||
| Item 4. | Submission of Matters to a Vote of Security Holders | 4 | ||
| PART II | ||||
| Item 5. | Market for Company’s Common Equity and Related Stockholder Matters | 5 | ||
| Item 6. | Selected Financial Data | 6 | ||
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 6 | ||
| Item 7a. | Market Risk | 10 | ||
| Item 8. | Financial Statements and Supplementary Data | 12 | ||
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 24 | ||
| PART III | ||||
| Item 10. | Directors and Executive Officers of the Corporation | 24 | ||
| Item 11. | Executive Compensation | 25 | ||
| Item 12. | Security Ownership of Certain Beneficial Owners and Management | 25 | ||
| Item 13. | Certain Relationships and Related Transactions | 25 | ||
| PART IV | ||||
| Item 14. | Exhibits, Financial Statement Schedules and Reports on Form 8-K | 26 | ||
| Signatures | 27 | |||
When used in this Form 10-K or future filings by the Company with the Securities and Exchange Commission, in the Company’s press releases or other public or stockholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases “would be”, “will allow”, “intends to”, “will likely result”, “are expected to”, “will continue”, “is anticipated”, “estimate”, “project”, or similar expressions are intended to identify “forward looking statement” within the meaning of the Private Securities Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and to advise readers that various factors, including regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of lending and investment activities and competitive and regulatory factors, could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from those anticipated or projected.
The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.
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General
Flagstar Capital Corporation (the “Company”) was incorporated in Michigan in June 1995 and remained dormant until reorganized in December 1997. The Company was formed by Flagstar Bank, FSB (the “Bank”), a federally chartered savings bank, to provide the Bank and its parent holding company and sole stockholder, Flagstar Bancorp, Inc. (“Flagstar”), with a means of raising capital for bank regulatory purposes in a cost-effective manner.
The principal business of the Company is to acquire and hold residential mortgage loans (“Mortgage Loans”) that will generate net income for distribution to stockholders. The Company intends to acquire all its Mortgage Loans from the Bank, consisting of whole loans secured by first mortgages on single-family residential real estate properties. The residential mortgage loans consist of Adjustable Rate Mortgages (“ARMs”) and Fixed Rate Mortgages (“FRMs”).
On February 24, 1998, the Company offered to the public and sold 2,000,000 shares of the Company’s 8.50%, noncumulative, Series A Preferred Shares, $25 par value per share, providing gross proceeds totaling $50.0 million (the “Series A Preferred Shares”), and sold to the Bank, 499,900 shares of the Company’s common stock, $1.00 par value providing proceeds totaling $65.5 million (the “Common Stock”).
On May 24, 1998, in response to the underwriters exercising their over-allotment option, the Company issued an additional 300,000 shares of its Series A Preferred Shares to the public and 500,000 shares of Common Stock to the Bank, providing additional gross proceeds totaling $17.0 million.
The Company used the net proceeds raised from the initial public offering of the Series A Preferred Shares and the sale of the Common Stock to the Bank to purchase from the Bank the Company’s initial portfolio of $113.5 million of Mortgage Loans (“Initial Portfolio”). The Company’s Initial Portfolio consisted of ARMs and FRMs. Reinvestments made in Mortgage Loans have been and will continue to be made with a composition of Mortgage Loans that will allow the Company to maintain the original composition of approximately 70% ARMs and 30% FRMs. Mortgage Loans are purchased from the Bank on a fair value basis.
The Company removed its preferred stock listing from the Nasdaq Stock Market on July 12, 2001. On July 13, 2001, the Company moved those same shares to the New York Stock Exchange. The securities, which formerly traded under the symbol “FLGSP”, now trade under the symbol “FBC-P”.
In September 2001, the Bank contributed its common stock investment in the Company to Flagstar Intermediate Holding Company (“IHC”), a newly formed, wholly-owned subsidiary. The purpose of the transaction was to allow the Bank greater flexibility in the manner in which the common stock of the Company is held. The change also increased the mortgage investments the Company is allowed to invest in while still complying with various federal tax requirements. At the same time, IHC contributed $150 million of equity to the Company. The Company then invested the proceeds in a 15% interest in mortgage securities that are owned by Flagstar LLC.
On March 20, 2003, Flagstar notified the public in a press release that they would redeem all of the Series A Preferred Shares on June 30, 2003.
In order to preserve its status as a real estate investment trust (“REIT”) under the Internal Revenue Service Code (“Code”), the Company must distribute annually at least 90% (95% in taxable years prior to January 1, 2001) of its “REIT taxable income” (excluding capital gains) to stockholders and meet certain capital ownership and administrative tests as defined by the Code. The Company must also annually satisfy three gross income requirements. First, at least 75% of the Company’s gross income for each taxable year must be derived directly or indirectly from investments relating to real property or mortgages on real property or from certain types of temporary investments. Second, at least 95% of the Company’s gross income for each taxable year must be derived from the above described real property investments and from dividends, interest,
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The Company must also satisfy three tests relating to the nature of its assets at the close of each quarter of its taxable year. First, real estate assets must represent at least 75% of the value of the Company’s total assets. Second, not more than 25% of the Company’s total assets may be represented by securities other than those in the 75% asset class. Third, of the investments included in the 25% asset class, the value of any one issuer’s securities owned by the Company may not exceed 5% of the value of the Company’s total assets and the Company may not own more than 10% of any one issuer’s outstanding voting securities.
The Company does not anticipate that it will engage in the business of originating Mortgage Loans and does not expect to compete with mortgage conduit programs, investment banking firms, savings and loan associations, banks, thrift and loan associations, finance companies, mortgage bankers or insurance companies in acquiring its Mortgage Loans. As noted above, the Company has purchased all of its Mortgage Loans from the Bank and intends on making all of its future purchases from the Bank.
The Company has entered into an Advisory Agreement (the “Advisory Agreement”) with the Bank (the “Advisor”) requiring an annual payment of $250,000. The Bank provides advice to the Board of Directors and manages the operations of the Company as defined in the Advisory Agreement. The Advisory Agreement has an initial term of five years which commenced on February 24, 1998 and will automatically renew for additional five year periods, unless the Company delivers prior notice to the Advisor as defined in the Advisory Agreement.
The Company also entered into a Servicing Agreement (the “Servicing Agreement”) with the Bank for the servicing of the Mortgage Loans. Pursuant to the Servicing Agreement, the Bank services the Mortgage Loans held by the Company, in accordance with normal industry practices. The Servicing Agreement can be terminated without cause upon a thirty-day advance notice and payment of a termination fee equal to 2% of the aggregate outstanding principal amount of the loans then serviced under the Servicing Agreement. The servicing fee is 0.375% per annum of the outstanding principal balance of the Mortgage Loans.
The Company operations are conducted in a manner that will not subject it to regulation under the Investment Company Act of 1940. The Company may, under certain circumstances, purchase the Series A Preferred Shares and other shares of its capital stock in the open market or otherwise, provided, however, that the Company will not redeem or repurchase any shares of its Common Stock for so long as any Series A Preferred Shares are outstanding without the approval of a majority of the Independent Directors. The Company has no present intention of repurchasing any shares of its capital stock, and any such action would be taken only in conformity with applicable federal and state laws and the regulations and the requirements for qualifying as a REIT.
The Company has no foreign operations.
The principal executive offices of the Company are located at 5151 Corporate Drive, Troy, Michigan 48098 and its telephone number is (248) 312-2000.
The Company is not the subject to any litigation. The Company is not currently involved in or, to the Company’s knowledge, currently threatened with any litigation with respect to the Mortgage Loans included in the portfolio.
None
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| ITEM 5: | MARKET FOR COMPANY’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS |
The Company is authorized to issue up to 1,000,000 shares of Common Stock and 2,300,000 shares of Preferred Stock, $25 par value per share (“Preferred Stock”). All of the 1,000,000 shares of Common Stock and all of the 2,300,000 shares of Preferred Stock have been issued. IHC owns 100% of the Company’s 1,000,000 shares of Common Stock outstanding at December 31, 2002 and, accordingly, there is no trading market for the Company’s Common Stock. In addition, IHC intends that, as long as any Series A Preferred Shares are outstanding, it will maintain ownership of the outstanding Common Stock of the Company. All voting rights are vested in the Common Stock. The holder of Common Stock is entitled to one vote per share. Holders of Common Stock are entitled to receive dividends when, and if declared by the Board of Directors of the Company out of funds legally available. No dividends or other distributions may be made with respect to the Common Stock as long as any shares of Preferred Stock are outstanding and the full dividends on those shares have been paid. The Company must distribute annually at least 90% (95% in taxable years prior to January 1, 2001) of its annual “REIT taxable income” to stockholders. In the event of the liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, after there have been set aside for the holders of Preferred Stock the full preferential amounts to which such holders are entitled, the holders of Common Stock will be entitled to any assets remaining after the payment of all debts and liabilities.
Restrictions on Ownership and Transfer:
The Company’s Certificate of Incorporation contains certain restrictions on the number of shares of Common Stock and Preferred Stock that individual stockholders may own. For the Company to qualify as a REIT under the Code, no more than 50% in number or value of its outstanding shares of capital stock may be owned, directly or indirectly, by five or fewer individuals during the last half of a taxable year or during a proportionate part of a shorter taxable year (the “Five or Fewer Test”). The capital stock of the Company must also be beneficially owned by 100 or more persons during at least 335 days of a taxable year or during a proportionate part of a shorter taxable year (the “One Hundred Person Test”). IHC’s ownership of 100% of the shares of Common Stock of the REIT will not adversely affect the Company’s REIT qualification because each stockholder of Flagstar Bancorp, Inc. (the sole stockholder of the Bank, IHC’s parent) counts as a separate beneficial owner for purposes of the Five or Fewer Test and the capital stock of Flagstar Bancorp, Inc. is widely held. Further, the Certificate of Incorporation of the Company contains restrictions on the acquisition of Preferred Stock intended to ensure compliance with the One Hundred Persons Test. Such provisions include a restriction that if any transfer of shares of capital stock of the Company would cause the Company to be beneficially owned by fewer than 100 persons, such transfer shall be null and void and the intended transferee will acquire no rights to the stock.
Common Stock
There is no established public trading market in the Common Stock of the Company. As of March 19, 2003, there were 1,000,000 issued and outstanding shares of Common Stock held by one stockholder, IHC. The following table reflects the distributions paid or payable by the Company on the Common Stock for each quarter during the years ended December 31, 2002, 2001, and 2000.
| For the Quarters ended: | 2002 | 2001 | 2000 | |||||||||
| March 31 | $ | 2,029,657 | $ | 670,046 | $ | 438,526 | ||||||
| June 30 | $ | 1,345,557 | $ | 568,702 | $ | 535,188 | ||||||
| September 30 | $ | 1,860,652 | $ | 506,576 | $ | 692,077 | ||||||
| December 31 | $ | 2,000,851 | $ | 2,789,353 | $ | 629,915 | ||||||
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Preferred Stock
The Series A Preferred Shares are listed on the New York Stock Exchange, under the trading symbol “FBC-P”. As of March 19, 2003, there were 2,300,000 issued and outstanding Series A Preferred Shares held by approximately 133 shareholders. The following table reflects the respective high and low sales prices for the Series A Preferred Shares for each quarter of 2002, 2001, and 2000. The table also indicates the distributions paid by the Company for each quarter.
| Quarter ended | High Price | Low Price | Closing Price | Distribution | ||||||||||||
| December 31, 2002 | $ | 25.350 | $ | 24.500 | $ | 25.200 | $ | 1,221,875 | ||||||||
| September 30, 2002 | $ | 25.750 | $ | 24.750 | $ | 25.120 | $ | 1,221,875 | ||||||||
| June 30, 2002 | $ | 25.450 | $ | 24.800 | $ | 25.120 | $ | 1,221,875 | ||||||||
| March 31, 2002 | $ | 25.500 | $ | 24.750 | $ | 25.000 | $ | 1,221,875 | ||||||||
| December 31, 2001 | $ | 25.600 | $ | 24.650 | $ | 25.200 | $ | 1,221,875 | ||||||||
| September 30, 2001 | $ | 25.400 | $ | 24.150 | $ | 24.750 | $ | 1,221,875 | ||||||||
| June 30, 2001 | $ | 25.100 | $ | 24.150 | $ | 24.700 | $ | 1,221,875 | ||||||||
| March 31, 2001 | $ | 25.000 | $ | 22.500 | $ | 24.500 | $ | 1,221,875 | ||||||||
| December 31, 2000 | $ | 22.625 | $ | 20.500 | $ | 22.125 | $ | 1,221,875 | ||||||||
| September 30, 2000 | $ | 22.250 | $ | 18.188 | $ | 22.250 | $ | 1,221,875 | ||||||||
| June 30, 2000 | $ | 19.375 | $ | 17.875 | $ | 18.250 | $ | 1,221,875 | ||||||||
| March 31, 2000 | $ | 20.125 | $ | 18.250 | $ | 19.000 | $ | 1,221,875 | ||||||||
| At or for the years ended December 31, | |||||||||||||
| 2002 | 2001 | 2000 | |||||||||||
| (In thousands) | |||||||||||||
Summary of Statement of Earnings: | |||||||||||||
| Net interest income | $ | 12,509 | $ | 9,888 | $ | 7,572 | |||||||
| Net earnings | $ | 12,124 | $ | 9,422 | $ | 7,183 | |||||||
| Net earnings available to common stockholders | $ | 7,237 | $ | 4,534 | $ | 2,296 | |||||||
| Net earnings per common share | $ | 7.24 | $ | 4.53 | $ | 2.29 | |||||||
Summary of Statement of Financial Condition: | |||||||||||||
| Mortgage loans, net | $ | 109,672 | $ | 119,532 | $ | 123,012 | |||||||
| Investment in mortgage securities | $ | 125,883 | $ | 117,612 | $ | — | |||||||
| Total assets | $ | 279,898 | $ | 283,152 | $ | 129,746 | |||||||
| Total stockholder’s equity | $ | 279,077 | $ | 279,077 | $ | 129,077 | |||||||
Other data: | |||||||||||||
| Dividends paid on preferred stock | $ | 4,887 | $ | 4,887 | $ | 4,887 | |||||||
| Shares of preferred stock outstanding | 2,300 | 2,300 | 2,300 | ||||||||||
| Shares of common stock outstanding | 1,000 | 1,000 | 1,000 | ||||||||||
| Average yield on mortgage loans | 6.282% | 6.876% | 7.114% | ||||||||||
| Average yield on investment in mortgage securities | 6.136% | 7.126% | —% | ||||||||||
| ITEM 7: | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview
Flagstar Capital Corporation was formed by Flagstar Bank, FSB, a federally chartered savings bank, to provide the Bank and its parent holding company and sole stockholder, Flagstar Bancorp, Inc., with a means of raising capital for bank regulatory purposes in a cost-effective manner.
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The principal business of the Company is to acquire and hold residential mortgage loans that will generate net income for distribution to stockholders. The Company intends to acquire all its Mortgage Loans from the Bank, consisting of whole loans secured by first mortgages on single-family residential real estate properties. The residential mortgage loans consist of Adjustable Rate Mortgages (“ARMs”), and Fixed Rate Mortgages (“FRMs”).
On February 24, 1998, the Company sold in a public offering 2,000,000 shares of the Company’s 8.50%, noncumulative, Series A Preferred Shares, $25 par value per share, providing gross proceeds totaling $50.0 million (the “Series A Preferred Shares”), and sold to the Bank, 499,900 shares of the Company’s common stock, $1.00 par value providing proceeds totaling $65.5 million (the “Common Stock”).
On May 24, 1998, in response to the underwriters exercising their over-allotment option, the Company issued an additional 300,000 shares of its Series A Preferred Shares, to the public and 500,000 shares of Common Stock to the Bank, providing additional gross proceeds totaling $17.0 million, gross.
The Company removed its preferred stock listing from the Nasdaq Stock Market on July 12, 2001. On July 13, 2001, the Company moved those same shares to the New York Stock Exchange. The securities, which formerly traded under the symbol “FLGSP”, now trade under the symbol “FBC-P”.
In September 2001, the Bank contributed its common stock investment in the Company to Flagstar Intermediate Holding Company, a newly formed, wholly-owned subsidiary. The purpose of the transaction is to allow the Bank greater flexibility in the manner in which the common stock of the Company is held. The change will also increase the mortgage investments the Company is allowed to invest in while still complying with various federal tax requirements. At the same time, IHC contributed $150 million of equity to the Company. The Company then invested the proceeds in a 15% interest in mortgage securities 100% owned by Flagstar LLC.
On March 20, 2003, Flagstar notified the public that they would redeem all of the Series A Preferred Shares on June 30, 2003. The Series A Preferred Shares will be redeemed for cash, at a redemption price of $25.00 per share, plus the accrued and unpaid dividends for the most recent quarter, if any. The Series A Preferred Shares will not be convertible into any other securities of the Company or Flagstar. The Company will ensure sufficient cash flow, through the collection of payments on the Mortgage Loans and Investment Securities, to meet this financial commitment.
Results of Operations
The Company reported net earnings for the year ended December 31, 2002 of $12.1 million, compared to $9.4 million and $7.2 million for the years ended December 31, 2001 and 2000, respectively. For the year ended December 31, 2002, interest income totaled $12.5 million of which $5.8 million was from mortgage loans and $6.7 million was from investments in mortgage securities. Offsetting expenses were comprised of $250,000 in advisory fees, $11,000 in outside director fees and $124,000 in administrative expenses. In comparison, interest income totaled $9.9 million of which $7.4 million was from mortgage loans and $2.5 million was from investments in mortgage securities for the year ended December 31, 2001, which was offset by $250,000 in advisory fees, $3,000 in outside director fees and $213,000 in other administrative expenses. For the year ended December 31, 2000, interest income from mortgage loans was $7.6 million, which was offset by $250,000 in advisory fees, $6,000 in outside director fees and $133,000 in other administrative expenses. The Company reported earnings per common share of $7.24, $4.53 and $2.29 per share for the years ended December 31, 2002, 2001 and 2000, respectively.
The Company declared and paid $4,887,000 in preferred stock dividends for each of the years ended December 31, 2002, 2001 and 2000, respectively.
The Company declared and paid or accrued common stock distributions of $7,237,000, $4,535,000, and $2,296,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
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Mortgage Loans
As of December 31, 2002, the Company owned Mortgage Loans with a principal balance of $109,413,000. This amount represents the principal amount of mortgage loans purchased with the Initial Portfolio remaining plus the principal amount of mortgage loans purchased during the period beginning at February 24, 1998 to December 31, 1998 and for the years ended December 31, 1999, 2000, 2001 and 2002. Purchases were made to replace principal amortizations and payoffs in the portfolio. All Mortgage Loans were purchased from the Bank. In conjunction with the purchase of these Mortgage Loans the Company paid a premium amount equal to $475,000, $270,000 and $109,000 for the years ended December 31, 2002, 2001 and 2000, respectively. This premium amount is recorded by the Company as an adjustment to the basis of the Mortgage Loans.
The following table reflects the composition of Mortgage Loans at December 31, 2002:
| Principal | Average | Average | |||||||||||||||||||||||||||
| Product Type | Loans | Balance | Balance | Yield | WAM | WARM | % of Total | ||||||||||||||||||||||
| 3 year ARM | 95 | $ | 22,629,000 | $ | 238,196 | 5.943 | % | 360 | 337 | 20.7 | % | ||||||||||||||||||
| 5 year ARM | 258 | 56,221,000 | 217,910 | 6.179 | 359 | 343 | 51.4 | ||||||||||||||||||||||
| 7 year ARM | 50 | 16,704,000 | 334,091 | 6.736 | 360 | 332 | 15.3 | ||||||||||||||||||||||
| 15 year Fixed | 86 | 6,571,000 | 77,474 | 6.526 | 180 | 130 | 6.0 | ||||||||||||||||||||||
| 30 year Fixed | 62 | 7,288,000 | 123,812 | 6.917 | 360 | 317 | 6.6 | ||||||||||||||||||||||
| Total | 551 | $ | 109,413,000 | $ | 198,572 | 6.282 | % | 348 | 325 | 100.0 | % | ||||||||||||||||||
The following table reflects the composition of Mortgage Loans at December 31, 2001:
| Principal | Average | Average | |||||||||||||||||||||||||||
| Product Type | Loans | Balance | Balance | Yield | WAM | WARM | % of Total | ||||||||||||||||||||||
| 3 year ARM | 114 | $ | 36,362,000 | $ | 318,965 | 6.817 | % | 360 | 342 | 30.6 | % | ||||||||||||||||||
| 5 year ARM | 81 | 23,607,000 | 291,445 | 7.197 | 360 | 332 | 19.9 | ||||||||||||||||||||||
| 7 year ARM | 108 | 33,556,000 | 310,714 | 6.800 | 357 | 339 | 28.2 | ||||||||||||||||||||||
| 15 year Fixed | 125 | 10,272,000 | 82,176 | 6.522 | 180 | 142 | 8.6 | ||||||||||||||||||||||
| 30 year Fixed | 122 | 15,105,000 | 123,812 | 6.917 | 360 | 317 | 12.7 | ||||||||||||||||||||||
| Total | 550 | $ | 118,902,000 | $ | 216,185 | 6.876 | % | 343 | 318 | 100.0 | % | ||||||||||||||||||
Allowance for Loan Losses
The Company’s allowance for loan losses remained the same at $250,000 at December 31, 2002. Management has based the allowance on assessments of relevant factors including the types and amount of delinquent loans, historical loss experience on such types of loans experienced by the Bank, and current economic conditions. Management is of the opinion that the allowance for loan losses is adequate to meet potential losses in the portfolio. The Company’s non-performing assets consisted of three mortgage loans totaling $790,000 or 0.8% of the portfolio, at December 31, 2002. The Company, in accordance with applicable disclosure requirements, defines an asset as non-performing if it meets any of the following criteria: 1) a loan more than 90 days past due; 2) real estate acquired in a settlement of a loan; or 3) a restructured loan whose terms have been modified due to the borrower’s inability to pay as contractually specified including loans the Company has classified as impaired. Loans are generally placed into non-accrual status when they become 90 days delinquent. Gross interest income of approximately $52,000 would have been recorded in 2002 on non-accrual loans if the loans had performed in accordance with their original terms.
The Company had a $250,000 allowance for loan losses at December 31, 2001. The Company’s non-performing assets consisted of three mortgage loans totaling $1,250,000, or 1.05% of the portfolio, at December 31, 2001. The Company has certain representations and warranties from the Bank, which are related to the performance of the Mortgage Loans. Gross interest income of approximately $32,000 would have been recorded in 2001 on non-accrual loans if the loans had performed in accordance with their original terms.
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The Bank, in its role as Advisor, has implemented comprehensive internal asset review systems to provide for early detection of problem assets. Although this system will not eliminate future losses due to unanticipated declines in the real estate market or economic downturns, it should provide for timely identification of any losses created from problem loans.
| Activity within the Allowance for Loan Losses | |||||
| Balance, January 1, 2002 | $ | 250,000 | |||
| Provision for loan losses | — | ||||
| Charge-offs, net of recoveries | — | ||||
| Balance, December 31, 2002 | $ | 250,000 | |||
Investment in Mortgage Securities
During September 2001, the Company invested in mortgage securities owned by Flagstar, LLC, a second-tier subsidiary of the Bank. The Company currently has a 15% interest in these mortgage securities, which is equal to $125.9 million. The mortgage securities currently have a yield of 6.136% and interest payments are made monthly to the Company. The mortgage securities are managed and serviced by the Bank.
Interest Rate Risk
The Company’s income consists primarily of interest payments on Mortgage Loans and mortgage securities. Currently, the Company does not use any derivative products to manage interest rate risk. If there is a decline in interest rates (as measured by the indices upon which the interest rates of the ARMs are based), then the Company will experience a decrease in income available to be distributed to its stockholders. There can be no assurance that an interest rate environment in which there is a significant decline in interest rates, over an extended period of time, would not adversely affect the Company’s ability to pay dividends on the Series A Preferred Shares.
Significant Concentration of Credit Risk
Concentration of credit risk arises when a number of customers engage in similar business activities, or activities in the same geographical region, or have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions. Concentration of credit risk indicates the relative sensitivity of the Company’s performance to both positive and negative developments affecting a particular industry. The geographic concentrations within the Mortgage Loans directly affects the overall credit risk of the Company.
The following table shows Mortgage Loans by geographic area as of December 31, 2002:
| Principal | Percent | ||||||||
| Location | Balance | Of Total | |||||||
| Colorado | $ | 13,983,000 | 12.6 | % | |||||
| Michigan | 13,034,000 | 11.7 | |||||||
| Washington | 11,743,000 | 10.6 | |||||||
| Texas | 11,166,000 | 10.0 | |||||||
| Illinois | 5,194,000 | 4.7 | |||||||
| Florida | 4,843,000 | 4.4 | |||||||
| Oregon | 4,712,000 | 4.2 | |||||||
| Arizona | 4,475,000 | 4.0 | |||||||
| Other | 40,263,000 | 37.8 | * | ||||||
| Total | $ | 109,413,000 | 100.0 | % | |||||
| * | No other state has more than 3% of the total Mortgage Loan portfolio |
Approximately 44.9% of the Company’s total Mortgage Loans are secured by residential real estate properties located in Michigan, Washington, Colorado and Texas. Consequently, a high concentration of
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Liquidity Risk Management
The objective of liquidity management is to ensure the availability of sufficient cash flows to meet all of the Company’s financial commitments. In managing liquidity, the Company takes into account various legal limitations placed on a REIT as discussed below in REIT QUALIFICATION.
The Company’s principal liquidity needs are to maintain the current portfolio size through the acquisition of additional mortgage loans as Mortgage Loans currently in the portfolio mature or prepay, and to pay dividends on the Series A Preferred Shares and Common Shares issued. The Company does not have and does not anticipate having any material capital expenditures.
To the extent that the Board of Directors determines that additional funding is required, the Company may raise such funds through additional equity offerings, debt financing or retention of cash flow (after consideration of provisions of the Code pertaining to a REIT), or a combination of these methods. The Company, however, may not, without the approval of a majority of the Independent Directors, incur debt in excess of 20% of the aggregate amount of the net proceeds received from the sale of the Series A Preferred Shares and Common Stock of the Company. This limitation includes intercompany advances made by the Bank to the Company.
The Company may also issue additional series of Preferred Stock. However, the Company may not issue additional shares of Preferred Stock senior to the Series A Preferred Shares without the consent of holders of at least 66 2/3% of the shares of Preferred Stock outstanding at that time. The Company also may not issue additional shares of Preferred Stock on a parity with the Series A Preferred Shares without the approval of a majority of the Company’s Independent Directors.
On March 20, 2003, Flagstar notified the public that they would redeem all of the Series A Preferred Shares on June 30, 2003. The Series A Preferred Shares will be redeemed for cash, at a redemption price of $25.00 per share, plus the accrued and unpaid dividends for the most recent quarter, if any. The Series A Preferred Shares will not be convertible into any other securities of the Company or Flagstar. The Company will ensure sufficient cash flow, through the collection of payments on the Mortgage Loans and Investment Securities, to meet this financial commitment.
The Company considers that its primary business objective is to ensure the availability of sufficient cash flows to meet the obligations mandated by the Series A Preferred Shares. In managing its investments, the Company accepts a certain credit risk exposure and assumes some interest rate risk.
Interest rate risk generally refers to the potential volatility in net interest income resulting from changes in interest rates. The Company’s risk occurs when it must replace amortized loans with current production mortgages. These replacement loans are chosen in a manner to maintain an interest rate risk posture similar to the Initial Portfolio. The Company must monitor the ratio of fixed costs (the Series A Preferred Shares’ dividends, advisory fees, and servicing costs) to the interest income potential of the Mortgage Loans. When, in management’s opinion, the coverage ratio is at risk of being depleted, the Company must look to its parent company, IHC, for support or utilize the investment powers of the Company.
The Company will record higher levels of interest income in a rising interest rate environment and will experience declining interest income during periods of falling interest rates. This happens because the Company’s assets reprice while the Series A Preferred Shares have a fixed cost of 8.5%.
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At December 31, 2002 the Company had a coverage ratio (Projected interest income divided by REIT dividends plus Advisory fees plus Servicing Fees) of 2.85 compared to 3.19 at December 31, 2001 and 1.69 at December 31, 2000.
REIT Qualification
As of December 31, 2002, the Company believed that it was in compliance with the REIT tax rules and that it will continue to qualify as a REIT under the provisions of the Code. The Company calculates:
| • | its Qualified REIT Assets, as defined in the Code, to be 100% of its total assets, as compared to the federal tax requirements that at least 75% of its total assets must be Qualified REIT assets. | |
| • | that 100% of its revenues qualify for the 75% source of income test and 100% of its revenues qualify for the 95% source of income test under the REIT rules. | |
| • | none of the revenues were subject to the 30% income limitation under the REIT rules. |
The Company also met all REIT requirements regarding the ownership of its common and preferred stocks.
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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
We have audited the accompanying balance sheets of Flagstar Capital Corporation as of December 31, 2002 and 2001 and the related statements of earnings, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Flagstar Capital Corporation as of December 31, 2002 and December 31, 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with auditing standards generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
Southfield, Michigan
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FLAGSTAR CAPITAL CORPORATION
BALANCE SHEETS
| At December 31, | |||||||||
| 2002 | 2001 | ||||||||
| ASSETS | |||||||||
| Cash | $ | 10,658 | $ | 2,022 | |||||
| Mortgage loans | 109,922 | 119,782 | |||||||
| Allowance for loan losses | 250 | 250 | |||||||
| Net mortgage loans | 109,672 | 119,532 | |||||||
| Investment in mortgage securities | 125,883 | 117,612 | |||||||
| Other investments | 24,117 | 32,388 | |||||||
| Accrued interest receivable | 485 | 1,897 | |||||||
| Loan payments in process — due from parent | 8,459 | 8,980 | |||||||
| Other assets | 624 | 721 | |||||||
| Total assets | $ | 279,898 | $ | 283,152 | |||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||
Liabilities | |||||||||
| Due to parent | $ | 709 | $ | 2,789 | |||||
| Other liabilities | 112 | 1,286 | |||||||
| Total liabilities | 821 | 4,075 | |||||||
Stockholders’ equity | |||||||||
| Series A preferred stock — $25.00 liquidation value, 2,300,000 shares authorized and issued at December 31, 2002 and 2001 | 57,500 | 57,500 | |||||||
| Common stock — $1.00 par value, 1,000,000 shares authorized and issued at December 31, 2002 and 2001 | 1,000 | 1,000 | |||||||
| Additional paid in capital | 220,577 | 220,577 | |||||||
| Retained earnings | — | — | |||||||
| Total stockholders’ equity | 279,077 | 279,077 | |||||||
| Total liabilities and stockholders’ equity | $ | 279,898 | $ | 283,152 | |||||
The accompanying notes are an integral part of these statements.
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FLAGSTAR CAPITAL CORPORATION
STATEMENTS OF EARNINGS
| For the years ended | ||||||||||||||
| December 31, | ||||||||||||||
| 2002 | 2001 | 2000 | ||||||||||||
Interest income | ||||||||||||||
| Interest on mortgage loans | $ | 5,777 | $ | 7,371 | $ | 7,572 | ||||||||
| Interest on mortgage securities | 6,732 | 2,517 | — | |||||||||||
| Total interest income | 12,509 | 9,888 | 7,572 | |||||||||||
| Net interest income | 12,509 | 9,888 | 7,572 | |||||||||||
Expenses | ||||||||||||||
| Advisory fee expense — paid to parent | 250 | 250 | 250 | |||||||||||
| Other general and administrative expenses | 135 | 216 | 139 | |||||||||||
| Total expenses | 385 | 466 | 389 | |||||||||||
Net earnings | $ | 12,124 | $ | 9,422 | $ | 7,183 | ||||||||
Preferred stock dividends | 4,887 | 4,887 | 4,887 | |||||||||||
Net earnings available to common stockholders | $ | 7,237 | $ | 4,535 | $ | 2,296 | ||||||||
Earnings per common share | $ | 7.24 | $ | 4.53 | $ | 2.29 | ||||||||
The accompanying notes are an integral part of these statements.
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FLAGSTAR CAPITAL CORPORATION
STATEMENT OF STOCKHOLDERS’ EQUITY
| Series A | Additional | Total | ||||||||||||||||||
| Preferred | Common | Paid in | Retained | Stockholders’ | ||||||||||||||||
| Stock | Stock | Capital | Earnings | Equity | ||||||||||||||||
Balance at December 31, 1999 | $ | 57,500 | $ | 1,000 | $ | 70,577 | $ | — | $ | 129,077 | ||||||||||
| Net earnings | 7,183 | 7,183 | ||||||||||||||||||
| Dividends paid on the 8.50% Non Cumulative Series A Preferred Shares | (4,887 | ) | (4,887 | ) | ||||||||||||||||
| Distributions paid or payable to common stockholder ($2.29 per share) | (2,296 | ) | (2,296 | ) | ||||||||||||||||
Balance at December 31, 2000 | 57,500 | 1,000 | 70,577 | — | 129,077 | |||||||||||||||
| Additional investment from parent | 150,000 | 150,000 | ||||||||||||||||||
| Net earnings | 9,422 | 9,422 | ||||||||||||||||||
| Dividends paid on the 8.50% Non Cumulative Series A Preferred Shares | (4,887 | ) | (4,887 | ) | ||||||||||||||||
| Distributions paid or payable to common stockholder ($4.53 per share) | (4,535 | ) | (4,535 | ) | ||||||||||||||||
Balance at December 31, 2001 | 57,500 | 1,000 | 220,577 | — | 279,077 | |||||||||||||||
| Net earnings | 12,124 | 12,124 | ||||||||||||||||||
| Dividends paid on the 8.50% Non Cumulative Series A Preferred Shares | (4,887 | ) | (4,887 | ) | ||||||||||||||||
| Distributions paid or payable to common stockholder ($7.24 per share) | (7,237 | ) | (7,237 | ) | ||||||||||||||||
Balance at December 31, 2002 | $ | 57,500 | $ | 1,000 | $ | 220,577 | $ | — | $ | 279,077 | ||||||||||
The accompanying notes are an integral part of these statements.
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FLAGSTAR CAPITAL CORPORATION
STATEMENTS OF CASH FLOWS
| For the years ended December 31, | ||||||||||||||
| 2002 | 2001 | 2000 | ||||||||||||
Operating activities | ||||||||||||||
| Net earnings | $ | 12,124 | $ | 9,422 | $ | 7,183 | ||||||||
| Adjustments to reconcile net earnings to net cash provided by operating activities | ||||||||||||||
| Decrease (increase) in accrued interest receivable | 1,411 | (363 | ) | (133 | ) | |||||||||
| Decrease (increase) in other assets | 86 | (721 | ) | — | ||||||||||
| (Decrease) increase in other liabilities | (1,173 | ) | 1,247 | 4 | ||||||||||
| Net cash provided by operating activities | 12,448 | 9,585 | 7,054 | |||||||||||
Investing activities | ||||||||||||||
| Net change in investment in mortgage securities | (8,271 | ) | (117,612 | ) | — | |||||||||
| Net change in other investments | 8,271 | (32,388 | ) | — | ||||||||||
| Purchase of mortgage loans | (74,652 | ) | (56,574 | ) | (24,521 | ) | ||||||||
| Principal repayments received on mortgage loans | 85,034 | 52,538 | 20,911 | |||||||||||
| Net cash provided by (used in) investing activities | 10,382 | (154,036 | ) | (3,610 | ) | |||||||||
Financing activities | ||||||||||||||
| Additional investment in parent | — | 150,000 | — | |||||||||||
| Dividends paid to common stockholder | (9,307 | ) | (2,376 | ) | (2,277 | ) | ||||||||
| Dividends paid to preferred stockholders | (4,887 | ) | (4,887 | ) | (4,887 | ) | ||||||||
| Net cash (used in) provided by financing activities | (14,194 | ) | 142,737 | (7,164 | ) | |||||||||
| Net increase (decrease) in cash | 8,636 | (1,714 | ) | (3,720 | ) | |||||||||
| Beginning cash | 2,022 | 3,736 | 7,456 | |||||||||||
| Ending cash | $ | 10,658 | $ | 2,022 | $ | 3,736 | ||||||||
The accompanying notes are an integral part of these statements
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FLAGSTAR CAPITAL CORPORATION
Notes to the Financial Statements
Note 1 — Nature of Business
Flagstar Capital Corporation (the “Company”) is a wholly-owned operating subsidiary of Flagstar Intermediate Holding Company (“IHC”). IHC is a wholly-owned subsidiary of Flagstar Bank, FSB (the “Bank”) a federally chartered stock savings bank, which itself is a wholly-owned subsidiary of Flagstar Bancorp, Inc (“Flagstar”) a financial services holding company. The Company is a Michigan corporation, which commenced operations on February 24, 1998. The Company’s primary business consists of acquiring, holding, and managing residential mortgage loans.
On February 24, 1998, the Company offered to the public and sold 2,000,000 shares of the Company’s 8.50% noncumulative Series A, $25 liquidation value per share, preferred stock. The sale provided gross proceeds totaling $50.0 million (the “Series A Preferred Shares”). The Company also sold to the Bank, 499,900 shares of the Company’s common stock (the “Common Stock”), $1.00 par value, providing proceeds totaling $65.5 million
On May 24, 1998, in response to the underwriters exercising their over-allotment option, the Company issued additional 300,000 shares of its Series A Preferred Shares to the public and 500,000 shares of Common Stock to the Bank, providing additional gross proceeds of $17.0 million.
The Company used the net proceeds raised from the initial public offering of the Series A Preferred Shares and the sale of the Common Stock to the Bank to purchase, from the Bank, the Company’s Initial Portfolio of $113.5 million of residential mortgage loans (“Mortgage Loans”), at their estimated fair values.
The Company removed its preferred stock listing from the Nasdaq Stock Market on July 12, 2001. On July 13, 2001, the Company moved those same shares to the New York Stock Exchange. The securities, which formerly traded under the symbol “FLGSP”, now trade under the symbol “FBC-P”.
In September 2001, the Bank contributed its common stock investment in the Company to Flagstar Intermediate Holding Company (“IHC”), a newly formed, wholly-owned subsidiary. The purpose of the transaction is to allow the Bank greater flexibility in the manner in which the common stock of the Company is held. The change will also increase the mortgage investments the Company is allowed to invest in while still complying with various federal tax requirements. At the same time IHC contributed $150 million of equity to the Company. The Company then invested $150 million, a 15% interest, in mortgage securities and other net assets of Flagstar LLC, an 85% owned subsidiary of IHC.
On March 20, 2003, Flagstar notified the public in a press release that they would redeem all of the Series A Preferred Shares on June 30, 2003.
Note 2 — Summary of Significant Accounting Policies
Mortgage loans:
Mortgage loans are carried at the principal amount outstanding, net of any purchase discount or premium. The amortization of premiums or discounts is recorded as an adjustment to interest income using a method, which approximates the interest method.
Non-accrual loans are those loans on which the accrual of interest has ceased. Loans are placed on non-accrual status immediately if, in the opinion of management, principal or interest is not likely to be paid in accordance with the terms of the loan agreement, or when principal or interest is past due 90 days or more and collateral is insufficient to cover principal and interest. Interest income on non-accrual loans is recognized only to the extent of cash receipts. However, where there is doubt regarding the ultimate collectibility of the loan principal, cash receipts, whether designated as principal or interest, are thereafter applied to reduce the carrying value of the loan. Loans are restored to accrual status only when interest and principal payments are brought current and future payments are reasonably assured.
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Notes to the Financial Statements — (Continued)
The Statement of Financial Accounting Standards No. 114, entitled “Accounting by Creditors for Impairment of a Loan” (“SFAS 114”), requires that the carrying value of an impaired loan be based on the present value of expected future cash flows, discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price, or the fair value or the collateral, if the loan is collateral dependent. Under SFAS 114, a loan is considered impaired when, based on current information, it is probable that the borrower will be unable to pay contractual interest or principal payments as scheduled in the loan agreement. SFAS 114 applies to all loans except smaller-balance homogeneous consumer loans, loans carried at fair value or the lower of cost or fair value, debt securities and leases. The Company will apply SFAS 114 to non-accrual mortgage loans. In addition, SFAS 114 modifies the accounting for in-substance foreclosures (“ISF”). A collateralized loan is considered an ISF and is reclassified to Assets Acquired as Loan Satisfactions only when the Company has taken physical possession of the collateral regardless of whether formal foreclosure proceedings have taken place. The Company did not have any non-accrual loans classified as impaired.
The Statement of Financial Accounting Standards No. 118, entitled “Accounting by Creditors for Impairment of a Loan — Income Recognition and Disclosure” (“SFAS 118”), permits a creditor to use existing methods for recognizing interest revenue on impaired loans. The Company recognizes interest income on impaired loans pursuant to the discussion above for non-accrual loans.
Allowance for loan losses:
An allowance for loan losses is provided when a risk of loss is inherent in the credit extension process. An allowance is a general allowance and is based on a periodic review and analysis of the Mortgage Loans. The periodic analysis will include consideration of such factors as the risk rating of individual credits, the size and diversity of the portfolio, economic conditions and market conditions, prior loss experience, results of periodic credit reviews of the portfolio, and any guarantees provided by the seller of the loans. The allowance for loan losses is increased by provisions for losses charged against income and is reduced by charge-offs, net of recoveries. Charge-offs are recorded when, in the judgment of management, an extension of credit is deemed uncollectible, in whole or in part. As of December 31, 2002 and 2001 the allowance for loan losses totaled $250,000.
The Company also has certain representations and warranties from the Bank which are related to the performance of the mortgage loans.
Investment in mortgage securities:
The Company’s investment in mortgage securities represents a 15% interest in mortgage loans owned by Flagstar LLC. This investment is carried at the principal amount of the outstanding underlying mortgage loans net of unearned purchase discount or premium. These mortgages are similar in characteristics to the mortgage loans owned directly by the Company.
Other investments:
These investments represent the 15% interest in accrued interest receivable and other net assets of Flagstar LLC.
Cash:
The Company considers all short-term, highly liquid investments that are both readily convertible to cash and have a maturity of generally three months or less at the time of purchase to be cash equivalents. At December 31, 2002 and 2001, the Company’s cash was held in the custody of the Bank.
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Notes to the Financial Statements — (Continued)
Offering costs:
Costs incurred in connection with the raising of capital through the sale of preferred stock were recorded as an adjustment to the additional paid in capital of the Company.
Dividends:
Preferred stock
Dividends on the Series A Preferred Shares are non-cumulative. The stock was issued on February 24, 1998. Quarterly dividends are payable on the last business day of March, June, September and December at a rate of 8.50% per annum of the initial liquidation preference ($25.00 per share).
Common stock
Stockholders are entitled to receive dividends when, and if declared by the Board of Directors, out of funds available after the preferred dividends have been paid.
Earnings per common share:
Earnings per common share are computed by dividing net income after preferred dividends by the weighted average number of common shares outstanding. There are no dilutive securities, which would require a diluted earnings per share computation. The Company had 1,000,000 weighted average shares outstanding during 2002, 2001 and 2000, respectively.
Income taxes:
The Company has elected for Federal income tax purposes, to be treated as a Real Estate Investment Trust (“REIT”) and intends to comply with the provisions of the Internal Revenue Code of 1986 (the “Code”), as amended. Accordingly, the Company will not be subject to federal income tax to the extent it distributes its income to shareholders and as long as certain asset, income and stock ownership tests are met in accordance with the Code. As the Company expects to qualify as a REIT for federal income tax purposes, no provision for income taxes is included in the accompanying financial statements.
Use of estimates:
The preparation of financial statements in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Recently issued accounting standards:
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses financial accounting and reporting for costs associated with exit or disposal activities. Under SFAS No. 146, such costs will be recognized when the liability is incurred, rather than at the date of commitment to an exit plan. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002, with early application permitted. Management is currently evaluating the impact of the adoption of SFAS No. 146 on its financial statements.
In October 2002, the FASB issued SFAS No. 147, “Acquisitions of Certain Financial Institutions, an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9,” which addresses accounting for purchases of certain financial institutions. SFAS No. 147 is effective October 1, 2002, with
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Notes to the Financial Statements — (Continued)
early application permitted. The Company does not have any goodwill that was subject to Statement No. 72 and therefore the provisions of Statement No. 147 required no change in classification or treatment of recorded goodwill.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123,” which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has adopted the requirements of SFAS No. 123 in January 2000 and SFAS No. 148 effective December 31, 2002 with no material effect on its financial statements.
Note 3 — Mortgage Loans
The following reflects the composition of Mortgage Loans at December 31,:
| 2002 | 2002 | 2001 | 2001 | |||||||||||||||||
| Product Type | Balance | % of Total | Balance | % of Total | ||||||||||||||||
| 3 year ARM | $ | 22,629,000 | 20.7 | % | $ | 36,362,000 | 30.6 | % | ||||||||||||
| 5 year ARM | 56,221,000 | 51.4 | 23,607,000 | 19.9 | ||||||||||||||||
| 7 year ARM | 16,704,000 | 15.3 | 33,556,000 | 28.2 | ||||||||||||||||
| Subtotal ARM | 95,554,000 | 87.4 | 93,525,000 | 78.7 | ||||||||||||||||
| 15 year Fixed | 6,571,000 | 6.0 | 10,272,000 | 8.6 | ||||||||||||||||
| 30 year Fixed | 7,288,000 | 6.6 | 15,105,000 | 12.7 | ||||||||||||||||
| Subtotal Fixed | 13,859,000 | 12.6 | 25,377,000 | 21.3 | ||||||||||||||||
| Total Mortgage Loans | $ | 109,413,000 | 100.0 | % | $ | 118,902,000 | 100.0 | % | ||||||||||||
| Unamortized premium | 509,000 | 880,000 | ||||||||||||||||||
| Allowance for loan losses | (250,000 | ) | (250,000 | ) | ||||||||||||||||
| Total | $ | 109,672,000 | $ | 119,532,000 | ||||||||||||||||
Loans on which interest has been discontinued totaled $790,000 at December 31, 2002 and $1,250,000 at December 31, 2001. Interest that would have been accrued on such loans totaled approximately $52,000, $32,000 and $22,000 during 2002, 2001 and 2000, respectively.
There were no impaired loans at December 31, 2002 and 2001.
Properties collateralizing Mortgage Loans are geographically disbursed throughout the United States. As of December 31, 2002, approximately 11.7% of these properties are located in Michigan (measured by principal balance), 10.6% are located in the state of Washington and another 12.6% are located in the state of Colorado. No other state contains more than 10% of the properties collateralizing these loans.
Note 4 — Related Party Transactions
The Company has entered into an Advisory Agreement (the “Advisory Agreement”) with the Bank (the “Advisor”) requiring an annual payment of $250,000. The Bank provides advice to the Board of Directors and manages the operations of the Company as defined in the Agreement. The Agreement has an initial term of five years commencing on February 24, 1998 and automatically renews for additional five year periods, unless the Company delivers a notice of non-renewal to the Bank as defined in the Advisory Agreement. Advisory
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Notes to the Financial Statements — (Continued)
fees incurred for the years ended December 31, 2002, 2001 and 2000 totaled approximately $250,000 for each year.
The Company also entered into a servicing agreement with the Bank for the servicing of the Mortgage Loans. Pursuant to the servicing agreement, the Bank performs the servicing for the Mortgage Loans, in accordance with normal industry practices. The servicing agreement can be terminated without cause upon a thirty-day advance notice given to the Bank. The servicing fee is 0.375% of the outstanding principal balance of the Mortgage Loans. The servicing fee is withheld by the Bank and netted from interest income proceeds received on the Mortgage Loans.
Note 5 — Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, entitled “Disclosures About Fair Value of Financial Instruments” (“SFAS 107”), requires the Company to disclose fair value information about financial instruments for which it is practicable to estimate the value, whether or not such financial instruments are recognized on the balance sheet. Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by a quoted market price, if one exists. The calculation of estimated fair value is based on market conditions at a specific point in time and may not be reflective of future fair values.
Certain financial instruments and all non-financial instruments are excluded from the scope of SFAS 107. Accordingly, the fair value disclosures required by SFAS 107 provide only a partial estimate of the fair value of the Company. Fair values among REITs are not comparable due to the wide-range of limited valuation techniques and numerous estimates, which must be made. This lack of an objective valuation standard introduces a great degree of subjectivity to these derived or estimated fair values. Therefore, readers are cautioned in using this information for purposes of evaluating the financial condition of the Company compared with other REITs.
Mortgage loans:
The fair value of the Company’s residential mortgage loans is estimated by comparing values for similar residential mortgages sold in the secondary market.
At December 31, 2002 and 2001, the estimated fair value of the Mortgage Loans was $111,148,000 and $121,334,000, respectively, based on the valuation technique described in the preceding paragraph.
Investment in mortgage securities:
The fair value of the Company’s investment in mortgage securities is estimated by comparing values for similar mortgage securities sold in the secondary market.
At December 31, 2002 and 2001, the estimated fair value of the Investment in mortgage securities was $128,702,000 and $119,621,000, respectively, based on the valuation technique described in the preceding paragraph.
Assets and liabilities in which fair value approximates carrying value:
The fair values of certain financial assets and liabilities carried at cost, including cash, accrued interest receivable, loan payments in process-due from parent, due to parent, and other liabilities are considered to approximate their respective carrying value due to their short-term nature and negligible credit losses.
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Notes to the Financial Statements — (Continued)
Note 6 — Quarterly Financial Data (Unaudited)
The following table represents summarized data for each of the quarters in 2002, 2001 and 2000 (in thousands, except earnings per share data):
| 2002 | ||||||||||||||||||
| Fourth | Third | Second | First | |||||||||||||||
| Quarter | Quarter | Quarter | Quarter | |||||||||||||||
| Interest income | $ | 3,325 | $ | 3,175 | $ | 2,666 | $ | 3,343 | ||||||||||
| Provision for losses | — | — | — | — | ||||||||||||||
| Net interest income | 3,325 | 3,175 | 2,666 | 3,343 | ||||||||||||||
| Outside director fees | 8 | 1 | 1 | 1 | ||||||||||||||
| Management fees | 62 | 62 | 63 | 63 | ||||||||||||||
| Non-interest expense | 33 | 29 | 35 | 27 | ||||||||||||||
| Total expenses | 103 | 92 | 99 | 91 | ||||||||||||||
| Net earnings | 3,222 | 3,083 | 2,567 | 3,252 | ||||||||||||||
| Preferred stock dividends | 1,222 | 1,222 | 1,222 | 1,222 | ||||||||||||||
| Net earnings available to common stockholders | $ | 2,000 | $ | 1,861 | $ | 1,345 | $ | 2,030 | ||||||||||
| Earnings per common share | $ | 2.00 | $ | 1.86 | $ | 1.35 | $ | 2.03 | ||||||||||
| 2001 | |||||||||||||||||
| Fourth | Third | Second | First | ||||||||||||||
| Quarter | Quarter | Quarter | Quarter | ||||||||||||||
| Interest income | $ | 4,142 | $ | 1,820 | $ | 1,889 | $ | 2,037 | |||||||||
| Provision for losses | — | — | — | — | |||||||||||||
| Net interest income | 4,142 | 1,820 | 1,889 | 2,037 | |||||||||||||
| Outside director fees | 1 | 1 | — | 1 | |||||||||||||
| Management fees | 63 | 62 | 63 | 62 | |||||||||||||
| Non-interest expense | 67 | 29 | 35 | 82 | |||||||||||||
| Total expenses | 131 | 92 | 98 | 145 | |||||||||||||
| Earnings before income taxes | 4,011 | 1,728 | 1,791 | 1,892 | |||||||||||||
| Preferred stock dividends | 1,222 | 1,222 | 1,222 | 1,222 | |||||||||||||
| Net earnings available to common stockholders | $ | 2,789 | $ | 506 | $ | 569 | $ | 670 | |||||||||
| Earnings per common share | $ | 2.79 | $ | 0.51 | $ | 0.57 | $ | 0.67 | |||||||||
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Notes to the Financial Statements — (Continued)
| 2000 | |||||||||||||||||
| Fourth | Third | Second | First | ||||||||||||||
| Quarter | Quarter | Quarter | Quarter | ||||||||||||||
| Interest income | $ | 1,945 | $ | 2,006 | $ | 1,857 | $ | 1,764 | |||||||||
| Provision for losses | — | — | — | — | |||||||||||||
| Net interest income | 1,945 | 2,006 | 1,857 | 1,764 | |||||||||||||
| Outside director fees | 2 | 3 | 1 | 1 | |||||||||||||
| Management fees | 63 | 63 | 62 | 62 | |||||||||||||
| Non-interest expense | 28 | 27 | 37 | 40 | |||||||||||||
| Total expenses | 93 | 93 | 100 | 103 | |||||||||||||
| Earnings before income taxes | 1,852 | 1,914 | 1,757 | 1,660 | |||||||||||||
| Preferred stock dividends | 1,222 | 1,222 | 1,222 | 1,222 | |||||||||||||
| Net earnings available to common stockholders | $ | 630 | $ | 692 | $ | 535 | $ | 433 | |||||||||
| Earnings per common share | $ | 0.63 | $ | 0.69 | $ | 0.53 | $ | 0.44 | |||||||||
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| ITEM 9: | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
| ITEM 10: | DIRECTORS AND EXECUTIVE OFFICERS OF THE CORPORATION |
The persons who are directors and executive officers of the Company are as follows:
| Director | Term | |||||||||||||
| Name | Age | Position(s) Held with Company during 2002 | Since | Expires | ||||||||||
| Thomas J. Hammond | 59 | Chairman of the Board | 1997 | 2005 | ||||||||||
| Mark T. Hammond | 37 | Vice Chairman of the Board, President and Chief Executive Officer | 1997 | 2004 | ||||||||||
| Michael W. Carrie | 48 | Director, Executive Vice President and Chief Financial Officer | 1997 | 2003 | ||||||||||
| Joan H. Anderson | 52 | Director and Executive Vice President | 1997 | 2005 | ||||||||||
| Mary Kay McGuire | 45 | Director and Secretary | 1997 | 2003 | ||||||||||
The independent directors of the Company are as follows:
| Director | Term | |||||||||||||
| Name | Age | Position(s) Held with the Company during 2002 | Since | Expires | ||||||||||
| Jack Christenson | 61 | Director | 1997 | 2004 | ||||||||||
| Robert W. DeWitt | 61 | Director | 1997 | 2005 | ||||||||||
The following sets forth the business experience and other information for each of the current directors of the Company:
Company Directors
Thomas J. Hammondhas served as Chairman of the Board of Directors of the Company since its formation in 1997. Mr. Hammond serves as Chairman of the Board of Directors and the Chief Executive Officer of Flagstar Intermediate Holding Company, the parent company of Flagstar Capital Corporation.
Mark T. Hammondhas been Vice-Chairman of the Board of Directors and President of the Company since its formation in 1997 and Chief Executive Officer as of December 2002. Mr. Hammond serves as Vice-Chairman of the Board of Directors and President of Flagstar Intermediate Holding Company, the parent company of Flagstar Capital Corporation. Mr. Hammond is the son of Thomas J. Hammond.
Joan H. Andersonhas been a Director and an Executive Vice President since the Company’s formation in 1997. Ms. Anderson also serves as a Director and Executive Vice President of Flagstar Intermediate Holding Company, the parent company of Flagstar Capital Corporation.
Michael W. Carriehas served as Director, Executive Vice-President, and Chief Financial Officer since the Company’s formation in 1997. Mr. Carrie also serves as a Director, Executive Vice-President and Chief Financial Officer of Flagstar Intermediate Holding Company, the parent company of Flagstar Capital Corporation.
Mary Kay McGuirehas served as Director and Secretary of the Company since its formation in 1997. Ms. McGuire also serves as Director, Senior Vice President, and Secretary of Flagstar Intermediate Holding Company, the parent company of Flagstar Capital Corporation.
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Independent Directors
The Company’s Certificate of Designation establishing the Series A Preferred Shares requires that, so long as any Series A Preferred Shares are outstanding, certain actions by the Company be approved by a majority of the Independent Directors of the Company. Messrs. Christenson and DeWitt are the Company’s Independent Directors. For as long as there are only two Independent Directors, any action that requires the approval of a majority of Independent Directors must be approved by both Independent Directors. Additionally, the audit committee is comprised of the independent directors.
If at any time the Company fails to declare and pay a quarterly dividend on the Series A Preferred Shares, the number of directors constituting the Board of Directors of the Company will be increased by two at the Company’s next annual meeting. The holders of Series A Preferred Shares, voting together with the holders of any other outstanding series of Preferred Stock as a single class, will be entitled to elect the two additional directors to serve on the Company’s Board of Directors. Any member of the Board of Directors elected by holders of the Company’s Preferred Stock will be deemed to be an Independent Director for purposes of the actions requiring the approval of a majority of the Independent Directors.
The following sets forth the business experience and other information for each of the Independent Directors of the Company.
Jack Christensonhas served as a Director since 1997. He is the President and owner of Jack Christenson, Inc., a residential brokerage company that is based in Troy, Michigan.
Robert W. DeWitthas served as a Director since 1997. He is the President and owner of DeWitt Building Co., Inc., a residential and commercial building company based in Lathrup Village, Michigan founded in 1979.
The Company pays the Independent Directors of the Company fees for their services as directors. The Independent Directors receive a fee of $1,200 for attendance at each meeting of the Board of Directors and $100 for each telephone meeting of the Board of Directors. The Independent Directors were paid a total of $11,000 for the year ended December 31, 2002. However, multiple fees are not paid for two or more meetings attended on the same day. The Company does not pay any compensation to its officers or employees of the Bank, or to directors who are not Independent Directors.
| ITEM 12: | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT |
None.
| ITEM 13: | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS |
Set forth below are certain transactions between the Company and its directors, affiliates, a related parties. Management believes that the transactions with related parties described herein have been conducted on substantially the same terms as similar transactions with unrelated parties.
The Bank administers the day-to-day operations of the Company and is entitled to receive fees in connection with the Advisory Agreement. Advisory fees paid to parent equaled $250,000 for each of the years ended December 31, 2002, 2001 and 2000, respectively.
The Bank services the Mortgage Loans included in the Company’s portfolio and is entitled to receive fees in connection with the Servicing Agreement.
The Company’s cash balance of approximately $10.7 million as of December 31, 2002 and $2.0 million as of December 31, 2001 is held in a demand deposit account with the Bank.
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| ITEM 14: | EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K |
| (a)(1) | The following financial statements of the Company are included in this Form 10-K under Item 8: | |
| Report of Independent Certified Public Accountants | ||
| Balance Sheets at December 31, 2002 and 2001 | ||
| Statements of Earnings for the years ended December 31, 2002, 2001, and 2000 | ||
| Statements of Stockholders’ Equity for the years ended December 31, 2002, 2001, and 2000 | ||
| Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000 | ||
| Notes to Financial Statements | ||
| (a)(2) | All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instruction or are inapplicable and therefore have been omitted. | |
| (a)(3) | Exhibits: | |
| 99.1 Section 906 Certification, as furnished by the Chief Executive Officer pursuant to SEC. Release No. 34-47551 | ||
| 99.2 Section 906 Certification, as furnished by the Chief Financial Officer pursuant to SEC. Release No. 34-47551 | ||
| (b) | Reports on Form 8-K | |
| The Company filed a Form 8-K on August 7, 2002 for the purpose of reporting that its Principal Executive Officer and its Principal Financial Officer each submitted to the Securities and Exchange Commission on August 7, 2002 the certifications required by Section 906 of the Sarbanes-Oxley Act of 2002 in connection with the Company’s filing on August 7, 2002 of its Quarterly Report on Form-10Q for the quarter ended June 30, 2002. | ||
| The Company filed a Form 8-K on November 12, 2002 for the purpose of reporting that its Principal Executive Officer and its Principal Financial Officer each submitted to the Securities and Exchange Commission on November 12, 2002 the certifications required by Section 906 of the Sarbanes-Oxley Act of 2002 in connection with the Company’s filing on November 12, 2002 of its Quarterly Report on Form-10Q for the quarter ended September 30, 2002. | ||
| The Company filed a Form 8-K on March 20, 2003 for the purpose of reporting that its Principal Executive Officer and its Principal Financial Officer each submitted to the Securities and Exchange Commission on March 20, 2003 the certifications required by Section 906 of the Sarbanes-Oxley Act of 2002 in connection with the Company’s filing of a press release announcing the redemption of the Series A Preferred Shares on June 30, 2003. | ||
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Pursuant to the requirements of the section 13 and 15(d) of the Securities Exchange Act of 1934, the Registrant as duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| FLAGSTAR CAPITAL CORPORATION |
Date: March 28, 2003
| /s/ MARK T. HAMMOND | |
| Mark T. Hammond | |
| Vice Chairman of the Board and | |
| Chief Executive Officer | |
| (Duly Authorized Officer) |
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 28, 2003.
| Signature | Title | |
| By: /s/ THOMAS J. HAMMOND Thomas J. Hammond | Chairman of the Board | |
| By: /s/ MARK T. HAMMOND Mark T. Hammond | Vice Chairman of the Board President and Chief Executive Officer | |
| By: /s/ MICHAEL W. CARRIE Michael W. Carrie | Director, Executive Vice President and Chief Financial Officer | |
| By: /s/ JOAN H. ANDERSON Joan H. Anderson | Director, Executive Vice President | |
| By: /s/ MARY KAY MCGUIRE Mary Kay McGuire | Director and Secretary | |
| By: /s/ JACK CHRISTENSON Jack Christenson | Director | |
| By: /s/ ROBERT W. DEWITT Robert W. DeWitt | Director |
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I, Mark T. Hammond certify that:
1) I have reviewed this annual report on Form 10-K of Flagstar Capital Corp;
2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4) The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
| a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; | |
| b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and | |
| c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
5) The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
| a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and | |
| b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and |
6) The registrant’s other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
| /s/ MARK T. HAMMOND _______________________________________ Signature President and CEO Title |
Date: March 28, 2003
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SECTION 302 CERTIFICATION
I, Michael W. Carrie certify that:
1) I have reviewed this annual report on Form 10-K of Flagstar Capital Corp;
2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4) The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
| a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; | |
| b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and | |
| c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
5) The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):
| a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and | |
| b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and |
6) The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
| /s/ MICHAEL W. CARRIE _______________________________________ Signature Chief Financial Officer and EVP Title |
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EXHIBIT INDEX
| Exhibit | ||||
| No. | Description | |||
| 1 | The following consolidated financial statements of the Company are included in this Form 10-K under Item 8: | |||
| Management’s Report | ||||
| Report of Independent Certified Public Accountant | ||||
| Consolidated Statements of Financial Condition — December 31, 2002 and 2001 | ||||
| Consolidated Statements of Earnings for the years ended December 31, 2002, 2001, and 2000 | ||||
| Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000 | ||||
| Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2002, 2001, and 2000 | ||||
| Notes to Consolidated Financial Statements | ||||
| 99.1 | Section 906 Certification, as furnished by the Chief Executive Officer pursuant to SEC. Release No. 34-47551 | |||
| 99.2 | Section 906 Certification, as furnished by the Chief Financial Officer pursuant to SEC. Release No. 34-47551 | |||
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