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, 1999 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 95-2960716 (State or other jurisdiction (I.R.S. Employer of incorporation or Identification No.) organization) 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 X NO____ As of December 31, 1999, 5,270,897 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 Sheet December 31, 1999 (Unaudited) and March 31, 1999 3 Unaudited Statement of Operations Three Months and Nine Months Ended December 31, 1999 and 1998 4 Unaudited Statement of Cash Flows Nine Months Ended December 31, 1999 and 1998 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 PART I. FINANCIAL INFORMATION Item 1. Financial Statements FIRST MORTGAGE CORPORATION BALANCE SHEET December 31, March 31, 1999 1999 (Unaudited) ASSETS Cash $12,217,000 $14,839,000 Mortgage loans and mortgage-backed securities held for sale 65,061,000 45,463,000 Other receivables and servicing advances 4,935,000 7,378,000 Capitalized servicing rights, net 12,619,000 12,475,000 Property and equipment, net 611,000 761,000 Prepaid expenses and other assets 2,226,000 765,000 TOTAL ASSETS $97,669,000 $81,681,000 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Notes payable, banks $17,592,000 $35,469,000 Note payable, other 44,368,000 - Sight drafts payable 58,000 9,450,000 Accounts payable and accrued liabilities 943,000 2,967,000 Deferred income taxes 5,476,000 4,065,000 Total Liabilities 68,437,000 51,951,000 STOCKHOLDERS' EQUITY Preferred stock, no par value: Authorized shares - 1,000,000 Issued and outstanding shares - None - - Common stock, no par value: Authorized shares - 10,000 Issued and outstanding shares - 5,270,897 at December 31, 1999 and 5,347,197 at March 31, 1999 2,613,000 2,924,000 Retained earnings 26,619,000 26,806,000 Total Stockholders' Equity 29,232,000 29,730,000 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $97,669,000 $81,681,000 See accompanying notes FIRST MORTGAGE CORPORATION UNAUDITED STATEMENT OF OPERATIONS Three Months Ended Nine Months Ended December 31, December 31, 1999 1998 1999 1998 REVENUES: Loan origination income $395,000 $958,000 $1,799,000 $3,058,000 Loan servicing income 1,950,000 1,954,000 5,823,000 5,835,000 Gain on sale of mortgage loans 13,000 5,455,000 2,664,000 13,915,000 Interest income 1,305,000 1,072,000 3,613,000 3,038,000 Other Income 7,000 - 11,000 - Total revenues 3,670,000 9,439,000 13,910,000 25,846,000 EXPENSES: Compensation and benefits 1,392,000 3,072,000 5,365,000 8,075,000 General and Administrative expenses 937,000 2,144,000 3,830,000 6,778,000 Amortization of capitalized servicing rights 1,041,000 1,118,000 3,434,000 2,818,000 Interest expense 697,000 468,000 1,592,000 993,000 Total expenses 4,067,000 6,802,000 14,221,000 18,664,000 INCOME (LOSS) BEFORE INCOME TAXES (397,000) 2,637,000 (311,000) 7,182,000 INCOME TAX (BENEFITS) (163,000) 1,092,000 (124,000) 2,977,000 NET INCOME (LOSS) $(234,000) 1,545,000 (187,000) 4,205,000 BASIC AND DILUTED EARNINGS (LOSS) PER SHARE $ (0.04) $ 0.29 $ (0.04) $ 0.76 See accompanying notes FIRST MORTGAGE CORPORATION UNAUDITED STATEMENT OF CASH FLOWS Nine Months Ended December 31, 1999 1998 CASH FLOWS FROM OPERATING ACTIVITIES Net income $(187,000) $4,205,000 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for deferred income taxes 1,411,000 1,278,000 Provision for losses on foreclosure (325,000) (217,000) Amortization of capitalized servicing rights 3,434,000 2,818,000 Depreciation and amortization of property and equipment 196,000 197,000 Change in excess service fee 27,000 58,000 Loss on sale of assets 19,000 - Originations and purchases of mortgage loans held for sale (216,824,000) (696,031,000) Sales and principal repayments of mortgage loans held for sale 197,226,000 688,881,000 Change in other receivables and servicing advances 2,768,000 3,037,000 Change in prepaid expenses and other assets (1,461,000) 245,000 Change in accounts payable and accrued liabilities (2,024,000) 1,420,000 Change in income taxes payable - (413,000) Net cash provided by (used in) operating activities (15,740,000) 5,478,000 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of mortgage servicing rights (518,000) (23,000) Originated mortgage servicing rights (3,087,000) (6,731,000) Purchase of furniture, equipment and leasehold improvements (79,000) (205,000) Proceeds from sale of assets 14,000 - Net cash used in investing activities (3,670,000) (6,959,000) CASH FLOWS FROM FINANCING ACTIVITIES: Change in notes payable, banks (17,877,000) 1,374,000) Change in sight drafts payable (9,392,000) 2,805,000 Change in note payable, other 44,368,000 - Repurchase of common stock (311,000) (2,007,000) Net cash provided by financing activities 16,788,000 2,172,000 INCREASE (DECREASE) IN CASH (2,622,000) 691,000 CASH, BEGINNING OF PERIOD 14,839,000 8,182,000 CASH, END OF PERIOD $12,217,000 $8,873,000 SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for: Interest $1,274,000 $714,000 Income taxes - 1,850,000 See accompanying notes FIRST MORTGAGE CORPORATION NOTES TO UNAUDITED FINANCIAL STATEMENTS December 31, 1999 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, 1999. 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. 2. CAPITALIZED SERVICING RIGHTS Activities in capitalized servicing rights are summarized as follows: Nine Months ended December 31 1999 1998 Beginning balance $12,475,000 $ 7,490,000 Additions 3,605,000 6,754,000 Amortizations and write offs (3,461,000) (2,876,000) Ending balance $12,619,000 $11,368,000 3. NOTES PAYABLE At December 31, 1999, the Company had mortgage loan warehousing agreements with two nonaffiliated banks, which provided for borrowings up to $50,000,000 and $35,000,000 with annual interest payable monthly at 1.25% or the bank's reference rate, depending on the level of borrowings and the compensating balances maintained. At December 31, 1999, borrowings under these lines of $17.59 million were collateralized by mortgage loans and mortgage-backed securities held for sale. The mortgage loan warehousing agreements are subject to renewal on August 31, 2000, and both contain 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 restrict the Company's ability to pay dividends. The Company believes its warehousing agreements will be renewed prior to their expiration. In addition to the warehousing agreements, the Company makes use of the short-term reverse repurchase agreements provided by two investment banking firms in connection with its inventory of mortgage-backed securities. These facilities tend to carry lower interest rates and also allow the Company to better utilize its warehousing lines when mortgage production increases. Borrowings outstanding under these facilities totaled $44.37 million at December 31, 1999 and were collateralized by GNMA mortgage-backed securities. 4. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share: Three Months Ended Nine Months December 31, Ended December 31, 1999 1998 1999 1998 Numerator: Net income $(234,000) $1,545,000 $(187,000) $4,205,000 Denominator: Shares used in computing basic earnings per share 5,270,897 5,357,529 5,296,130 5,557,524 Effect of stock options treated as equivalents under the treasury stock method - 729 6,358 9,378 Denominator for diluted earnings per share 5,270,897 5,358,258 5,302,488 5,566,902 Basic earnings per share $(.04) $.29 $(.04) $.76 Diluted earnings per share $(.04) $.29 $(.04) $.76 5. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS 133, Accounting for Derivative Instruments and Hedging Activities. This Statement provides guidance for the way public enterprises report information about derivatives and hedging in annual financial statements and in interim financial reports. The derivatives and hedging disclosure is required for financial statements for fiscal years beginning after June 15, 2000. The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedged must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The Company is in the process of evaluating the effect of Statement 133, if any, will have on the earnings and financial position of the Company. 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. 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, 1999 compared to three months ended December 31, 1998. GENERAL First Mortgage reported a net loss of $234,000 or ($0.04) per share for the quarter ended December 31, 1999, compared to net income of $1.545 million or $0.29 per share for the comparable 1998 quarter. The loss was attributable to substantial increases in interest rates which dramatically reduced new loan originations for us and throughout the industry. In turn, this led to steep reductions in loan origination and gain on sale of mortgage revenues, two of the primary sources of revenue for the Company. The reduction in earnings was, however, offset partially by lower compensation; general and administrative expenses and amortization of capitalized servicing rights. REVENUES For the quarter ended December 31, 1999, the volume of new mortgage loans closed decreased by 83.5% to $43.33 million from $262.52 million in the prior year quarter. The decrease is a direct reflection of higher long-term interest rates, which significantly reduced the volume of loans in the market place, particularly refinance loans, upon which much of last year's business was based. For the three months ended December 31, 1999, loan origination revenue decreased by approximately 58.8% to $395,000 from the December 1998 quarter, due primarily to the decline in mortgage production. As of December 31, 1999, the Company serviced $1.543 billion in loans compared to $1.643 billion at December 31, 1998, a decrease of 6.1% compared to the year-ago quarter. The run-off in the Company's own servicing portfolio was due to heavy refinances during the first half of calendar 1999, prior to the increase in interest rates. Total loan servicing income, including late charges and other miscellaneous fees, declined marginally to $1.950 million in the December 1999 quarter, from $1.954 million in the prior year quarter. The following table sets forth certain information pertaining to the servicing portfolio of the Company for the period indicated. Three Months Ended December 31 1999 1998 (Dollars in thousands except average loan balance) Beginning loan service portfolio $1,559,165 $1,573,950 Add: Loans originated 43,331 262,522 Less: Prepayment and amortization 67,492 278,259 Ending loan servicing portfolio 1,535,004 1,558,213 Sub-Servicing 7,657 84,836 Total servicing portfolio $1,542,661 $1,643,049 Average loan balance (end of period) $ 91,045 $ 92,954 The Company's sub-servicing portfolio experienced a drop of about $69 million in the December 1999 quarter due to one of the Company's sub-servicing clients sold its entire servicing portfolio, and the new purchaser did not require any sub- servicing. The net revenue impact on the Company, however, is quite insignificant. Due to the higher long-term mortgage interest rates during the quarter and the reduction in new loan production, the gain on sale of mortgage loans was virtually eliminated for the three months ended December 31, 1999, as compared to $5.44 million over the 1998 period. Interest income increased to $1.31 million for the three months ended December 31, 1999 from $1.07 million for the comparable prior year quarter. This increase was due primarily to the larger mortgage inventory and mortgage-backed securities carried by the Company during the December 1999 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, 1999 decreased by 40.2% to $4.07 million from the $6.80 million for the three months ended December 31, 1998. Compensations and benefits were $1.39 million for the December 1999 quarter, a decrease of 54.7% over the year-ago quarter. General and administrative expense decreased by $1.21 million, or 56.3% over prior year. These lower expenses were a direct result of reduced production operations in the quarter, along with cost reduction measures taken by the Company during the quarter. Amortization of capitalized servicing rights decreased by 6.9% over prior year quarter due mainly to the reduction of prepayments from refinances over the comparable prior period. Interest expense increased 48.9% to $697,000 for quarter ended December 31, 1999 from $468,000 for the same period in 1998. The increase was due to the larger mortgage inventory and mortgage- backed securities carried during the quarter. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS: Nine months ended December 31, 1999 compared to nine months ended December 31, 1998. GENERAL In the nine months ended December 31, 1999, the Company reported a net loss of $187,000 or ($0.04) per share, compared to net income of $4.21 million or $0.76 per share for the same period of 1998. Total revenue decreased by 46.2% to $13.91 million from $25.85 million in the comparable prior period. The decrease in net income was due to substantial increases in interest rates over the course of the year, which dramatically reduced new loan originations for us and throughout the industry. In turn, this led to steep reductions in loan origination and gain on sale of mortgage revenues, two of the primary sources of revenue for the Company. The reduction in earnings was, however, offset partially by lower compensation; general and administrative expenses and amortization of capitalized servicing rights. REVENUES For the nine months ended December 31, 1999, loan origination revenue decreased 41.2% to $1.80 million from $3.06 million for the nine months ended December 31, 1998. The lower loan origination revenue was primarily due to the lower volume of new loans originated by the Company. The volume of new mortgage loan originations decreased 68.8% to $216.82 million from $696.03 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 0.2% to $5.82 million for the nine months ended December 31, 1999 from $5.84 million for the same period in 1998. The slight decrease in servicing income is primarily due to the lower volume of loans currently serviced by the Company. The following table sets forth certain information pertaining to the servicing portfolio of the Company for the period indicated: Nine Months Ended December 31, 1999 1998 (Dollars in thousands except average loan balance) Beginning loan service portfolio $1,527,507 $1,570,143 Add: Loans originated 216,824 696,031 Less: Prepayment and amortization 209,327 707,961 Ending loan servicing portfolio 1,535,004 1,558,213 Sub-Servicing 7,657 84,836 Total servicing portfolio $1,542,661 $1,643,049 Average loan balance (end of period) $91,045 $92,954 The Company's sub-servicing portfolio experienced a drop of about $69 million in the December 1999 quarter due to one of the Company's sub-servicing clients sold its entire servicing portfolio, and the new purchaser did not require any sub- servicing. The sale of mortgages for the nine months ended December 31, 1999 resulted in a gain of $2.66 million compared to a gain of $13.92 million for the 1998 period. The decrease is primarily attributable to the lower volume of loan originations coupled with the unfavorable trend in long-term interest rates in 1999. Interest income increased to $3.61 million, an increase of 18.9% over the comparable 1998 period. The increase was as a result of the larger mortgage inventory and mortgage-backed securities carried by the Company in the 1999 period. 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, 1999 decreased by $4.44 million or 23.8% from the nine months ended December 31, 1998. Compensation and benefits decreased 33.6% to $5.37 million compared to $8.08 million in the first nine months of fiscal year 1998. General and administrative expenses decreased by 43.5% to $3.83 million from $6.78 million in the comparable period in 1998. The decreases in these expenses were a direct result of reduction in loan originations and cost cutting measures taken by the Company during the year. The increase in amortization of capitalized servicing rights was mainly due to larger investment in servicing rights and higher volume of loan prepayments over last fiscal year. Interest expense increased 60.3% to $1.59 million as compared to $993,000 in the year earlier nine months, due primarily to higher interest rates and the larger mortgage inventory and mortgage- backed securities carried by the Company during the period. 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, 1999, maximum permitted borrowings under the warehouse line of credit agreements with two nonaffiliated banks totaled $85 million and the amount outstanding was $17.59 million. Borrowings under these facilities are secured by mortgage loans. The agreements contain various covenants, including minimum net worth, current ratio, net income, servicing portfolio balances, debt to net worth ratio, and restrict the Company's ability to pay dividends. The Company was in compliance with all debt covenants at December 31, 1999. The Company believes that the warehouse agreements will be renewed when the current terms expire. In addition to warehousing agreements, the Company makes use of the reverse repurchase agreements offered by two investment firms in connection with its mortgage-backed securities. Borrowings under these facilities totaled $44.37 million at December 31, 1999. In the first nine months in fiscal year 2000, the Company repurchased in open market transactions 76,300 shares of its common stock at an aggregate cost of $311,000. The Company had stockholders' equity of $29.23 million at December 31, 1999. Management believes that its current financing arrangements are adequate to meet its projected operational needs. DISCLOSURE ABOUT MARKET RISK The Company's earnings can be impacted significantly by the movement of interest rates, which is the primary component of the market risk to the Company. The interest rate risk affects value of the capitalized mortgage servicing rights, volume of loan production and total net interest income earned on its mortgage inventory. 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. The overall objective is to offset changes in the values of the following items, such as the committed pipeline, mortgage loan inventory, mortgage-backed securities held for sale and mortgage servicing rights. The Company does not speculate on the direction or movement of the interest rates. Based on the information available and the interest environment as of December 31, 1999, the Company believes that a 100 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 net income by approximately $2.0 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 used as forecast. YEAR 2000 ISSUES The Company has experienced very few problems after its systems and programs were converted into the new millennium on midnight December 31, 1999. The Company, however, will continue to invest and monitor all the hardware and software to ensure smooth uninterrupted operations. The estimated total pre-tax cost of the Year 2000 Plan, including upgrades for hardware and software, was approximately $200,000, of which $190,000 has been incurred through December 31, 1999. PROSPECTIVE TRENDS During the second and third quarters of fiscal 2000, long-term mortgage interest rates began to rise to the highest levels of the past two years, reversing the trend which produced all time results for the Company during fiscal 1999. The increase in interest rates has practically eliminated the demand for refinance loans, particularly the popular 30 year fixed-rate loan, upon which the majority of our business is based. The industry is widely reporting new loan volume decreases of 50% or more, with ours off even more at a 70% decrease year-to-date compared to the record volume of last year. We were particularly impacted because of the larger percentage of refinance loans we were doing last year, which were very profitable for the Company. Now we are once again faced with too much industry capacity for the present volume, and too many lenders chasing too few loans. Pricing pressures on many traditional mortgage products is even more severe and remains uneconomical, and the Company faces intense competition from many directions, particularly for the standard conforming conventional mortgage loans so coveted by many of the major commercial banks. Our strategy is to instead emphasize the origination of FHA and VA loans and other mortgage products with better profit margin potential for the Company. As a continuing part of the Company's long-term plan, we are opening additional retail offices wherever such opportunity presents itself. The retail channel is focused on loan production for the purchase of housing rather than refinance loans, and thus is a viable alternative to the direct marketing channel, which is nearly all refinance driven. We had a serious set-back to our retail plan when four of our retail office managers left the Company to pursue greener pastures, but we are recovering with the opening of new retail production offices in Phoenix, Arizona, Sacramento and Long Beach, California. We are also in negotiations to open several others in the near future. We believe we are appropriately positioned to take advantage of the market niches within which we can competitively operate, but we still face formidable competition and, as always, our business is greatly influenced by the level of interest rates. Should long- term interest rates remain at these higher levels, it isn't likely that operating results will improve at any time in the near future. 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, 1999. 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 10, 2000 By S/Clement Ziroli Clement Ziroli Chairman of the Board of Directors, Chief Executive Officer Date: February 10, 2000 By S/Pac W. Dong Pac W. Dong Executive Vice President, Chief Financial Officer