SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________
FORM 10-Q
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended December 31, 2001
Or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ___________________ to __________________
Commission File Number 0-19847
FIRST MORTGAGE CORPORATION
(Exact name of registrant as specified in its charter)
California
(State or other jurisdiction of incorporation or organization)
95-2960716
(I.R.S. Employer Identification No.)
3230 Fallow Field Drive
Diamond Bar, California 91765
(Address, including zip code, of principal executive offices)
(909) 595-1996
(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 filing requirements for the past 90 days.
YES XNO____
As of December 31, 2001, 5,201,002 shares of the registrant's common stock were outstanding.
_________________________________________
FIRST MORTGAGE CORPORATION
FORM 10-Q
INDEX
Part I - Financial Information | Page |
Item 1. Financial Statements |
|
Balance Sheets | 3 |
Unaudited Statements of Income | 4 |
Unaudited Statements of Cash Flows | 5 |
Notes to Unaudited Financial Statements | 6-7 |
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | 8-13 |
Part II - Other Information |
|
Item 6. Exhibits and Reports on Form 8-K | 14 |
Signatures | 15 |
2.
_________________________________________
PART I. FINANCIAL INFORMATION
Item 1.Financial Statements
FIRST MORTGAGE CORPORATION
BALANCE SHEETS
| December 31, 2001 |
| March 31, 2001 | |||||
| (Unaudited) |
|
| |||||
ASSETS |
|
|
| |||||
Cash | $18,252,000 |
| $16,202,000 | |||||
Mortgage loans and mortgage-backed |
|
|
| |||||
Other receivables and servicing advances | 7,114,000 |
| 5,340,000 | |||||
Capitalized servicing rights, net | 13,729,000 |
| 9,928,000 | |||||
Property and equipment, net | 946,000 |
| 847,000 | |||||
Prepaid expenses and other assets | 158,000 |
| 615,000 | |||||
Prepaid income taxes | 265,000 |
| - | |||||
TOTAL ASSETS | $144,448,000 |
| $120,927,000 | |||||
|
|
|
| |||||
LIABILITIES |
|
|
| |||||
Notes payable, banks | $94,546,000 |
| $83,255,000 | |||||
Note payable, other | 3,739,000 |
| - | |||||
Sight drafts payable | 5,520,000 |
| 3,784,000 | |||||
Accounts payable and accrued liabilities | 2,987,000 |
| 1,460,000 | |||||
Deferred income taxes | 4,527,000 |
| 3,103,000 | |||||
|
|
|
| |||||
Total Liabilities | 111,319,000 |
| 91,602,000 | |||||
|
|
|
| |||||
STOCKHOLDERS' EQUITY |
|
|
| |||||
Preferred stock, no par value: |
|
|
| |||||
Common stock, no par value: |
|
|
| |||||
Authorized shares - 10,000,000 | 2,407,000 |
| 2,430,000 | |||||
Retained earnings | 30,722,000 |
| 26,895,000 | |||||
Total Stockholders' Equity | 33,129,000 |
| 29,325,000 | |||||
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $144,448,000 |
| $120,927,000 |
See accompanying notes
3.
_________________________________________
FIRST MORTGAGE CORPORATION
UNAUDITED STATEMENTS OF INCOME
| Three Months Ended | Nine Months Ended | ||||||||||||||||||
| 2001 |
| 2000 |
| 2001 |
| 2000 | |||||||||||||
REVENUES: |
|
|
|
|
|
|
| |||||||||||||
Loan origination income | $ 2,024,000 |
| $581,000 |
| $5,454,000 |
| $1,592,000 | |||||||||||||
Loan servicing income | 1,799,000 |
| 1,804,000 |
| 5,311,000 |
| 5,462,000 | |||||||||||||
Gain on sale of mortgage loans | 6,663,000 |
| 1,711,000 |
| 16,216,000 |
| 4,233,000 | |||||||||||||
Interest income | 1,696,000 |
| 1,110,000 |
| 4,394,000 |
| 3,611,000 | |||||||||||||
Other income | 7,000 |
| 1,000 |
| 17,000 |
| 9,000 | |||||||||||||
Total revenues | 12,189,000 |
| 5,207,000 |
| 31,392,000 |
| 14,907,000 | |||||||||||||
EXPENSES: |
|
|
|
|
|
|
| |||||||||||||
Compensation and benefits | 3,984,000 |
| 1,737,000 |
| 11,015,000 |
| 5,187,000 | |||||||||||||
General and administrative expenses | 1,992,000 |
| 956,000 |
| 5,867,000 |
| 2,837,000 | |||||||||||||
Amortization of capitalized servicing |
|
|
|
|
|
|
| |||||||||||||
Interest expense | 764,000 |
| 883,000 |
| 2,184,000 |
| 2,009,000 | |||||||||||||
Total expenses | 9,019,000 |
| 4,711,000 |
| 24,993,000 |
| 13,568,000 | |||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Income before income taxes and cumulative effect of a change in accounting principle |
|
|
|
|
|
|
| |||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Income tax expense | 1,314,000 |
| 209,000 |
| 2,650,000 |
| 561,000 | |||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Income before cumulative effect of a change in accounting principle | 1,856,000 |
| 287,000 |
| 3,749,000 |
| 778,000 | |||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
Cumulative effect of a change in accounting principle, net of tax |
|
|
|
|
|
|
| |||||||||||||
|
|
|
|
|
|
|
| |||||||||||||
NET INCOME | $ 1,856,000 |
| $ 287,000 |
| $3,827,000 |
| $ 778,000 | |||||||||||||
EARNINGS PER SHARE - BASIC |
|
|
|
|
|
|
| |||||||||||||
Income before cumulative effect of a change in accounting principle | $ 0.36 |
| $ 0.06 |
| $ 0.72 |
| $ 0.15 | |||||||||||||
Cumulative effect of a change in accounting principle |
|
|
|
|
|
|
| |||||||||||||
|
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EARNINGS PER SHARE - DILUTED |
|
|
|
|
|
|
| |||||||||||||
Income before cumulative effect of a change in accounting principle | $ 0.36 |
| $ 0.06 |
| $ 0.71 |
| $ 0.15 | |||||||||||||
Cumulative effect of a change in accounting principle |
|
|
|
|
|
|
|
See accompanying notes
4.
_________________________________________
FIRST MORTGAGE CORPORATION
UNAUDITED STATEMENTS OF CASH FLOWS
| Nine Months Ended | ||
| 2001 |
| 2000 |
CASH FLOWS FROM OPERATING ACTIVITIES |
|
|
|
Net income | $ 3,827,000 |
| $ 778,000 |
Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
|
|
|
Provision for deferred income taxes | 1,424,000 |
| (872,000) |
Provision for losses on foreclosure | (11,000) |
| (185,000) |
Amortization of capitalized servicing rights | 5,927,000 |
| 3,535,000 |
Depreciation and amortization of property and equipment | 177,000 |
| 174,000 |
(Loss) gain on sale of assets | (3,000) |
| 2,000 |
Originations and purchases of mortgage loans held for sale | (807,118,000) |
| (162,940,000) |
Sales and principal repayments of mortgage loans held for sale | 791,129,000 |
| 213,903,000 |
Change in other receivables and servicing advances | (1,763,000) |
| 1,826,000 |
Change in prepaid expenses and other assets | 457,000 |
| 531,000 |
Change in accounts payable and accrued liabilities | 1,527,000 |
| 242,000 |
Change in prepaid income taxes | (265,000) |
| - |
Net cash (used in) provided by operating activities | (4,692,000) |
| 56,994,000 |
CASH FLOWS FROM INVESTING ACTIVITIES |
|
|
|
Purchase of mortgage servicing rights | - |
| (23,000) |
Originated mortgage servicing rights | (9,728,000) |
| (1,797,000) |
Purchase of furniture, equipment and leasehold improvements | (276,000) |
| (316,000) |
Proceeds from sale of assets | 3,000 |
| 3,000 |
Net cash used in investing activities | (10,001,000) |
| (2,133,000) |
CASH FLOWS FROM FINANCING ACTIVITIES |
|
|
|
Change in notes payable, banks | 11,291,000 |
| (5,128,000) |
Change in note payable, other | 3,739,000 |
| (43,787,000) |
Change in sight drafts payable | 1,736,000 |
| 601,000 |
Repurchase of common stock | (23,000) |
| (123,000) |
Net cash provided by (used in) financing activities | 16,743,000 |
| (48,437,000) |
INCREASE IN CASH | 2,050,000 |
| 6,424,000 |
CASH, BEGINNING OF PERIOD | 16,202,000 |
| 11,264,000 |
CASH, END OF PERIOD | $ 18,252,000 |
| $ 17,688,000 |
SUPPLEMENTAL CASH FLOW INFORMATION |
|
|
|
Cash paid during the period for: |
|
|
|
Interest | $ 1,863,000 |
| $ 2,071,000 |
Income taxes | 1,078,000 |
| 915,000 |
See accompanying notes
5.
_________________________________________
FIRST MORTGAGE CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
December 31, 2001
1.BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Regulation S-X. In the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results for the interim periods have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. In addition, this document should be read in conjunction with the financial statements and footnotes included in the Company's annual report on Form 10-K for fiscal year ended March 31, 2001.
The preparation of the financial statements of the Company requires management to make estimates and assumptions that affect reported amounts. These estimates are based on information available as of the date of the financial statements. Therefore, actual results could differ from those estimates.
2CAPITALIZED SERVICING RIGHTS
Activities in capitalized servicing rights are summarized as follows:
Nine Months ended December 31 | |||
| 2001 | 2000 | |
Beginning balance | $ 9,928,000 | $ 11,555,000 | |
Additions | 9,728,000 | 1,820,000 | |
Amortization | (5,927,000) | (3,535,000) | |
Ending balance |
|
|
3.NOTES PAYABLE
At December 31, 2001, the Company had a syndicated warehousing line of credit agreement with five nonaffiliated banks, which provided for borrowings up to $195,000,000 with annual interest payable monthly at 1.05% or LIBOR plus 1.05%, depending on the level of borrowings and the compensating balances maintained. At December 31, 2001, borrowings under the credit agreement of $94,546,000 were collateralized by mortgage loans and mortgage-backed securities held for sale.
The warehousing line of credit agreement is subject to renewal on August 28, 2002, and contains certain requirements, including but not limited to, the maintenance of minimum net worth, debt to net worth ratio, current ratio, net income and servicing portfolio, and payment of dividends by the Company. The Company was in compliance with all debt covenants at December 31, 2001. The Company believes its syndicated warehousing agreement will be renewed prior to its expiration.
In addition to the warehousing line of credit agreement, the Company makes use of a short-term reverse repurchase agreement provided by a nonaffiliated bank in connection with its inventory of mortgage-backed securities. This facility tends to carry lower interest rates and also allow the Company to better utilize its warehousing line. The balance outstanding under this facility at December 31, 2001 was $3,739,000, and it was collateralized by mortgage-backed securities.
6.
_________________________________________
4.EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share:
| Three Months Ended December 31, | Nine Months Ended December 31, | |||||
| 2001 | 2000 |
| 2001 | 2000 | ||
Numerator: |
|
|
|
|
| ||
Net income | $1,856,000 | $287,000 |
| $3,827,000 | $778,000 | ||
|
|
|
|
|
| ||
Denominator: |
|
|
|
|
| ||
Shares used in computing basic earnings | 5,201,002 | 5,210,502 |
| 5,202,600 | 5,226,396 | ||
Effect of stock options treated as equivalents under the treasury stock method | 5,916 | - |
| 13,646 | - | ||
Denominator for diluted earnings per share | 5,206,918 | 5,210,502 |
| 5,216,246 | 5,226,396 | ||
Basic earnings per share | $.36 | $.06 |
| $.74 | $.15 | ||
Diluted earnings per share | $.36 | $.06 |
| $.73 | $.15 |
5.RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
Statement of Financial Accounting Standards No. 133,"Accounting for Derivative Instruments and Hedging Activities," as amended, generally requires the Company to recognize all freestanding and embedded derivative instruments as either assets or liabilities on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. Statement No. 133 allows for hedge accounting treatment for derivatives used to hedge various risks and sets the specific documentation requirements and qualifying criteria to be used to determine when hedge accounting can be applied. Depending on the nature of the hedging relationship, hedge accounting treatment provides for changes in the fair value of derivatives to be either offset against the change in fair value of assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings.
On April 1, 2001, the Company adopted the provisions of Statement No. 133 resulting in the recognition of a non-cash gain of $135,000 ($78,000, net after tax) in the Statements of Income to account for the cumulative effect of the accounting change relating to derivative, including best effort forward commitments to sell loans and loan origination commitments (interest rate locks). During the quarter ended December 31, 2001, the Company recorded a gain of $242,000 on derivative instruments which is included in the gain on sale of mortgage loans.
In September 2000, the FASB issued Statement No. 140,"Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," that replaces, in its entirety, FASB Statement No. 125. Statement No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures. Statement No. 140 is effective for transfers occurring after March 31, 2001, and the expanded disclosure requirements regarding securitizations and collateral were effective for fiscal years ended after December 15, 2000. The Company adopted Statement No. 140 on April 1, 2001, and the adoption had no material impact on net income for the quarter ended December 31, 2001.
6.CONTINGENCIES
The Company is currently a defendant in certain litigation arising in the ordinary course of business. It is management's opinion that the outcome of these actions will not have a material effect on the financial position or results of operations of the Company.
7.
_________________________________________
Item 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
Certain statements in this Form 10-Q are forward-looking statements, including those that discuss strategies, goals, outlook, projected revenues, income, return and other financial measures. These forward-looking statements are subject to risk and uncertainties that may cause actual results to differ materially from those contained in the statements, including the following factors: (i) the direction of interest rates; (ii) the demand for mortgage credits; (iii) the ability to obtain sufficient financial sources for liquidity and working capital; (iv) changes in laws or regulations governing mortgage banking operations; and (v) level of competition within the mortgage banking industry. In addition, the words "believe," "expect," "anticipate," "intend," "will" and similar words identify forward-looking statements in this Form 10-Q.
RESULTS OF OPERATIONS:
Three months ended December 31, 2001 compared to three months ended December 31, 2000.
GENERAL
First Mortgage reported a net profit of $1,856,000 or $0.36 per share for the quarter ended December 31, 2001, compared to net profit of $287,000 or $0.06 per share for the comparable 2000 quarter. The profit was attributable to decreases in interest rates which substantially boosted new loan originations for the Company and the industry. In turn, this led to increases in loan origination and gain on sale of mortgages, two of the primary sources of revenue for the Company. The increase in earnings was, however, offset partially by higher compensation; general and administrative expenses and amortization of capitalized servicing rights.
REVENUES
For the quarter ended December 31, 2001, the volume of new mortgage loans closed increased by 449.7% to $327.8 million from $59.6 million in the prior year quarter. The increase is a direct reflection of lower interest rates, which increased the volume of loans in the market place, coupled with the expansion of the retail and wholesale branches.
For the three months ended December 31, 2001, loan origination revenue increased by approximately 248.4% to $2.02 million from the December 2000 quarter, due primarily to the increase in mortgage production.
As of December 31, 2001, the Company serviced $1.571 billion in loans compared to $1.487 billion at December 31, 2000, an increase of 5.6% compared to the year-ago quarter. The increase in the Company's servicing portfolio was due to the higher loan production during most of calendar 2001, partially offset by amortization and run off due to heavy refinancing during the year. Total loan servicing income, including late charges and other miscellaneous fees, declined slightly to $1.799 million in the December 2001 quarter, from $1.804 million in the prior year quarter. The decline was the result of historically low delinquency rates in the portfolio, reducing late charge fees to the Company.
8.
_________________________________________
The following table sets forth certain information pertaining to the servicing portfolio of the Company for the period indicated.
| Three Months Ended December 31 | ||
| 2001 |
| 2000 |
| (Dollars in thousands except average loan balance) | ||
Beginning loan service portfolio | $ 1,523,310 |
| $ 1,487,214 |
Add: Loans originated | 327,765 |
| 59,622 |
|
|
|
|
Less: Prepayment and amortization | 280,613 |
| 80,381 |
|
|
|
|
Ending loan servicing portfolio | 1,570,462 |
| 1,466,455 |
Sub-Servicing | 234 |
| 8,637 |
Total servicing portfolio | $ 1,570,696 |
| $ 1,475,092 |
Average loan balance (end of period) | $ 98,730 |
| $ 91,479 |
Due to the declining long-term mortgage interest rates during the quarter and the record increase in new loan production, the gain on sale of mortgage loans increased dramatically to $6.66 million for the three months ended December 31, 2001, as compared to $1.71 million for the same 2000 period.
Interest income increased to $1.70 million for the three months ended December 31, 2001 from $1.11 million for the comparable prior year quarter. This increase was due primarily to the larger volume of loan inventory carried in this quarter as compared to the December 2000 quarter.
EXPENSES
The major components of the Company's total expenses are (i) compensations and benefits, (ii) general and administrative expenses, (iii) amortization of capitalized servicing rights, and (iv) interest expense. Total expenses for the three months ended December 31, 2001 increased by 91.4% to $9.02 million from $4.71 million for the three months ended December 31, 2000. Compensations and benefits were $3.98 million for the December 2001 quarter, an increase of 129.4% over the year-ago quarter. General and administrative expense increased by $1.04 million, or 108.4% over the prior year quarter. These higher expenses were a direct result of expanded production operations in the quarter.
Amortization of capitalized servicing rights increased by 100.8% over prior year quarter due mainly to higher volume of loan prepayments over the prior fiscal year.
Interest expense decreased 13.5% to $764,000 for quarter ended December 31, 2001 from $883,000 for the same period in year 2000. The decrease was primarily due to substantial lower interest rates charged on the mortgage warehouse lines.
9.
_________________________________________
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS:
Nine months ended December 31, 2001 compared to nine months ended December 31, 2000.
GENERAL
In the nine months ended December 31, 2001, the Company reported a net profit of $3.83 million or $0.74 per share, compared to a net profit of $778,000 or $0.15 per share for the same period of year 2000. Total revenue increased by 110.6% to $31.39 million from $14.91 million in the comparable prior period. The increase in net income was due to decreases in interest rates during the course of the year, which increased new loan originations for the Company and the industry. In turn, this led to a steep increase in loan origination and gain on sale of mortgages, two of the primary sources of revenue for the Company.
REVENUES
For the nine months ended December 31, 2001, loan origination revenue increased 242.6% to $5.45 million from $1.59 million for the nine months ended December 31, 2000. The higher loan origination revenue was primarily due to the record high volume of new loans originated by the Company during the course of the fiscal year.
The volume of new mortgage loan originations increased 395.3% to $807.12 million from $162.94 million in the comparable period last year.
Loan servicing income, representing the loan servicing fees, late charges and other fees earned by the Company for administering the loans in its servicing portfolio, fell 2.8% to $5.31 million for the nine months ended December 31, 2001 from $5.46 million for the same period in 2000. The slight decrease in servicing income is primarily due to lower delinquency rates which reduced late charges and other fees.
The following table sets forth certain information pertaining to the servicing portfolio of the Company for the period indicated:
| Nine Months Ended December 31, | ||
| 2001 |
| 2000 |
| (Dollars in thousands except average loan balance) | ||
Beginning loan service portfolio | $ 1,514,807 |
| $ 1,497,616 |
Add: Loans originated | 807,118 |
| 162,940 |
|
|
|
|
Less: Prepayment and amortization | 751,463 |
| 194,101 |
|
|
|
|
Ending loan servicing portfolio | 1,570,462 |
| 1,466,455 |
Sub-Servicing | 234 |
| 8,637 |
Total servicing portfolio | $ 1,570,696 |
| $ 1,475,092 |
Average loan balance (end of period) | $98,730 |
| $91,479 |
The sale of mortgages for the nine months ended December 31, 2001 resulted in a gain of $16.22 million compared to a gain of $4.23 million for the 2000 period. The increase is primarily attributable to the reduction in interest rates over the course of the year, enabling the Company to make a substantial gain on mortgages held for sale.
10.
_________________________________________
Interest income increased to $4.39 million compared to $3.61 million in the year earlier period. This was due primarily to the large volume of loan inventory carried by the Company as a result of record origination levels.
EXPENSES
The major components of the Company's total expenses are (i) compensation and benefits, (ii) general and administrative expenses, (iii) amortization of capitalized servicing rights, and (iv) interest expenses. Total expenses for the nine months ended December 31, 2001 increased by 84.2% from the nine months ended December 31, 2000. Compensation and benefits increased 112.4% to $11.02 million compared to $5.19 million in the first nine months of fiscal year 2000. General and administrative expenses increased by 106.8% to $5.87 million from $2.84 million in the comparable period in 2000. The increases in these expenses were a direct result of record loan originations.
The 67.7% increase in amortization of capitalized servicing rights to $5.93 million was mainly due to higher volume of loan prepayments over the course of the year.
Interest expense increased 8.7% to $2.18 million as compared to $2.01 million in the year earlier nine months, due primarily to the larger mortgage inventory and mortgage-backed securities carried by the Company during the period, partially offset by lower interest rates charged on the mortgage warehousing lines.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal liquidity requirement is the funding of its new mortgage loans and loan origination expenses. To meet these funding needs, the Company relies on warehouse lines of credit, reverse repurchase agreements, its own capital and also cash flows from operations.
At December 31, 2001, maximum permitted borrowings under the syndicated warehouse line of credit agreement with five nonaffiliated banks totaled $195 million and the amount outstanding was $94.55 million. Borrowings under this facility is secured by mortgage loans. The agreement contains various covenants, including the maintaining of minimum net worth, current ratio, net income, servicing portfolio balances, debt to net worth ratio, and prior approval to make dividend payments. The Company was in compliance with all debt covenants at December 31, 2001. However, if there is any material negative event affecting the economy or substantial increase in the interest rates, the Company's operating results could be adversely impacted, which could lead to the non-compliance of the debt covenants. Absent the preceding scenario, the Company believes that the syndicated warehouse agreement will be renewed when the current term expires.
In addition to the syndicated warehousing agreement, the Company regularly makes use of the reverse repurchase agreements offered by a nonaffiliated bank in connection with its mortgage-backed securities. The balance outstanding under this facility was $3.74 million at December 31, 2001.
In the first nine months in fiscal year 2002, the Company repurchased in open market transactions and retired 7,500 shares of its common stock at an aggregate cost of $23,000.
The Company had stockholders' equity of $33.13 million at December 31, 2001. Management believes that its current financing arrangements are adequate to meet its projected operational needs.
11.
_________________________________________
DISCLOSURE ABOUT INTEREST RATE RISK
The Company manages many risks in its normal course of business, however, the management considers interest rate risk to be the most significant market risk which could materially impact its financial position and results of operations. The movements in interest rates affect the value of capitalized mortgage servicing rights, the mortgage inventory held for sale, volume of loan production and total net interest income earned.
The Company has been managing this risk by striving to balance its loan origination and loan servicing segments, which generally are counter cyclical in nature. In an environment of raising interest rates, loan production will slow down, but the drop in origination income is mitigated by decrease in the loan prepayment rate in its servicing portfolio and hence write-offs, amortization and impairment charges against income will fall. Conversely, the opposite scenario is true during a period of declining interest rates. The overall objective is to offset changes in the values of the following items arising from fluctuations in interest rates, such as the production pipeline, mortgage loan inventory, mortgage-backed securities held for sale and capitalized mortgage servicing rights. The Company does not speculate on the direction or movement of the interest rates.
Based on the information available and on the estimates quantified by various interest rate calculations, and also based on the interest environment as of December 31, 2001, the Company believes that a 50 basis point change in long-term interest rates over a twelve month period, up or down and all else being constant, would increase or decrease the Company's gross income by approximately $3.5 million dollars. These estimates are limited by the fact that they are performed at a particular point in time and do not incorporate many other factors and, consequently, should not be relied on as a forecast of actual results.
DISCLOSURE OF DERIVATIVES
The Company does not participate in any speculative derivative trading, however, it does hold derivative financial instruments, including best effort forward commitments to sell loans, loan origination commitments and mortgage-backed securities, to minimize interest rate exposure of its mortgage pipeline and inventory. Hedge accounting results when the Company designs and documents the hedging relationships involving these instruments. If the hedges are not highly effective, the changes in the fair value of the derivatives used as hedges would be reflected in earnings, as discussed in Note 5 of the financial statements. The Company does not believe that it is exposed to more than a nominal amount of credit risk in its derivative financial instruments.
PROSPECTIVE TRENDS
During most of calendar year 2001 interest rates fell to historic lows from the higher levels of recent years, and new loan applications increased in record amounts. The decrease in interest rates, coupled with the continuing expansion of both our retail division and wholesale divisions, enabled us to increase our business from all channels while refinance loan activity was boosted in our Direct Marketing Division.
The Federal Reserve Board had reversed itself and was reducing interest rates in order to soften any recessionary effects for the economy. For our industry, which is counter-cyclical to others, this is usually good news. We engaged in a record volume refinance surge.
The competitive pressures we have talked about so often are still there, but their effect is greatly reduced when we are in this boom part of the mortgage cycle.
We continue to pursue opportunities to expand our retail division, which is now at fifteen offices, and we are aggressively recruiting for more. We have added personnel to our Direct Marketing Division so as to
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take advantage of the refinance loan market, and our Santa Ana, San Jose and Phoenix wholesale offices are producing large volumes of new originations.
Our consumer website (www.firstmortgage.com) is also contributing. Although we have no illusions about becoming a big "dot com" lender, mortgage consumer websites can be a good supplemental source for refinance loans when we are in a low interest rate environment, such as now. The Company has a big advantage over many others in that we also have retail offices, enabling us to offer both "clicks and bricks," to potential borrowers.
We were positioned with the necessary channels and tools to take advantage of the opportunities which are opened up as a result of the recent reduction in interest rates. If rates stay at this level, or fall even lower, and remain that way for calendar year 2002, the Company has the potential to experience another good year in fiscal 2003.
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PART II. OTHER INFORMATION.
Item 6. Exhibits and Reports of Form 8-K.
(a) No exhibits are filed with this report.
(b) The Company did not file any reports on Form 8-K during the quarter ended December 31, 2001.
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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.
| FIRST MORTGAGE CORPORATION |
Date: February 12, 2002 | By S/Clement Ziroli Clement Ziroli Chairman of the Board of Directors, Chief Executive Officer |
Date: February 12, 2002 | By S/Pac W. Dong Pac W. Dong Executive Vice President, Chief Financial Officer |
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