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, 1996 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 of (I.R.S. Employer Identification incorporation or organization) 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 X NO____ As of December 31, 1996, 5,859,117 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 December 31, 1996 (Unaudited) and March 31, 1996 3 Unaudited Statements of Income Three Months and Nine Months Ended December 31, 1996 and 1995 4 Unaudited Statements of Cash Flows Nine Months Ended December 31, 1996 and 1995 5 Notes to Unaudited Financial Statements 6-7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8-12 Part II - Other Information Item 6. Exhibits and Reports on Form 8-K 13 Signatures 14 PART I. FINANCIAL INFORMATION Item 1. Financial Statements FIRST MORTGAGE CORPORATION BALANCE SHEETS December 31, 1996 March 31, 1996 (Unaudited) ASSETS Cash $4,646,000 $5,948,000 Mortgage loans held for sale 31,956,000 19,879,000 Investment in commercial paper - 9,955,000 Other receivables and servicing 9,646,000 9,545,000 advances Originated mortgage servicing 5,193,000 3,133,000 rights, net Excess service fee, net 326,000 414,000 Purchased servicing rights, net 558,000 430,000 Property and equipment, net 654,000 612,000 Prepaid expenses and other assets 362,000 891,000 Due from affiliates 134,000 194,000 Notes receivable 630,000 130,000 TOTAL ASSETS $54,105,000 $51,131,000 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Notes payable, banks $24,888,000 $20,653,000 Note payable, officer 1,500,000 1,500,000 Sight drafts payable 354,000 2,699,000 Accounts payable and accrued 925,000 765,000 liabilities Deferred income taxes 989,000 867,000 Total Liabilities 28,656,000 26,484,000 STOCKHOLDERS' EQUITY Preferred stock, no par value: Authorized shares - 1,000,000 Issued and outstanding shares - None - - Common stock, no par value: Authorized shares - 10,000,000 Issued and outstanding shares - 5,859,117 at December 31, 1996 and 5,883,117 at March 31, 1996 5,147,000 5,261,000 December 31, 1996 and Retained earnings 20,302,000 19,386,000 Total Stockholders' Equity 25,449,000 24,647,000 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $54,105,000 $51,131,000 See accompanying notes FIRST MORTGAGE CORPORATION UNAUDITED STATEMENTS OF INCOME Three Months Ended Nine Months Ended December 31, December 31, 1996 1995 1996 1995 REVENUES: Loan origination income $991,000 $658,000 $2,666,000 $2,838,000 Loan servicing income 1,799,000 1,680,000 5,291,000 5,045,000 Gain on sale of mortgage loans 1,675,000 1,718,000 4,220,000 6,053,000 Interest income 485,000 553,000 1,671,000 1,607,000 Other income - 10,000 2,000 20,000 Total revenues 4,950,000 4,619,000 13,850,000 15,563,000 EXPENSES: Employees' salaries and commissions 2,165,000 1,836,000 6,130,000 5,788,000 General and administrative expenses 1,958,000 1,623,000 5,593,000 4,772,000 Interest expense 129,000 203,000 539,000 607,000 Total expenses 4,252,000 3,662,000 12,262,000 11,167,000 INCOME BEFORE INCOME TAXES 698,000 957,000 1,588,000 4,396,000 INCOME TAX EXPENSE 296,000 374,000 672,000 1,827,000 NET INCOME $402,000 $583,000 $916,000 $2,569,000 NET INCOME PER SHARE $ 0.07 $ 0.10 $ 0.16 $ 0.44 WEIGHTED AVERAGE OF COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING 5,886,000 5,883,000 5,886,000 5,883,000 See accompanying notes FIRST MORTGAGE CORPORATION UNAUDITED STATEMENTS OF CASH FLOWS Nine Months Ended December 31, 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 916,000 $2,569,000 Adjustments to reconcile net income to net cash provided by operating activities: Provision for deferred income taxes 122,000 723,000 Provision for losses on foreclosure 102,000 238,000 Amortization of originated mortgage servicing rights, excess service fee and purchased servicing rights 1,254,000 760,000 Depreciation and amortization of property and equipment 149,000 156,000 Originations and purchases of mortgage loans held for sale (274,638,000) (241,374,000) Sales and principal repayments of mortgage loans held for sale 262,561,000 250,465,000 Loss on sale of assets - 2,000 Changes in other receivables and servicing advances (203,000) (894,000) Change in excess service fee - (2,000) Change in prepaid expenses and other assets 529,000 (1,326,000) Change in accounts payable and accrued liabilities 160,000 509,000 Change in income taxes payable - 1,100,000 Net cash provided by (used in) operating activities (9,048,000) 12,926,000 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of mortgage servicing rights (354,000) (2,000) Origination of mortgage servicing rights (3,000,000) (2,817,000) Note receivable (500,000) 120,000 Sale of commercial paper 9,955,000 - Purchase of furniture and equipment and leasehold improvements (191,000) (59,000) Proceeds from sale of assets - 4,000 Change in due to affiliates 60,000 - Net cash provided by (used in) investing activities 5,970,000 (2,754,000) CASH FLOWS FROM FINANCING ACTIVITIES: Change in notes payable, banks 4,235,000 (231,000) Change in sight drafts payable (2,345,000) (128,000) Change in notes payable, other - (9,493,000) Repurchase of Common Stock (114,000) - Net cash provided by (used in) financing activities 1,776,000 (9,852,000) INCREASE (DECREASE) IN CASH (1,302,000) 320,000 CASH, BEGINNING OF PERIOD 5,948,000 4,748,000 CASH, END OF PERIOD $4,646,000 $5,068,000 SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 213,000 $ 535,000 Income taxes 30,000 1,360,000 See accompanying notes FIRST MORTGAGE CORPORATION NOTES TO UNAUDITED FINANCIAL STATEMENTS December 31, 1996 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, 1996. 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. MORTGAGE SERVICING ASSETS Mortgage servicing assets consist of excess servicing fees, purchased servicing rights and originated servicing rights. Activities in each category are summarized as follows: Excess Purchased Originated Servicing Servicing Servicing Fees, Net Rights, Net Rights, Net Balance at March 31, 1996 $ 414,000 $ 430,000 $ 3,133,000 Additions - 354,000 3,000,000 Amortizations and write offs (88,000) (226,000) (1,015,000) Impairment - - 75,000 (1) Balance at December 31, 1996 $ 326,000 $ 558,000 $ 5,193,000 <FN> <F1> (1) Figure includes $350,000 of originated servicing rights relating to mortgage loans held for sale to investors. Since the underlying loans have not yet been sold, no revenues have been recognized on these originated servicing rights for the nine months ended December 31, 1996. </FN> 3. NOTES PAYABLE At December 31, 1996, the Company had line of credit agreements with two nonaffiliated banks, which provided for borrowings up to $30,000,000 and $15,000,000 with 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, 1996, borrowings under these lines of $24,888,000 were collateralized by mortgage loans held for sale. The line of credit agreements are subject to renewal on September 1, 1997 and August 31, 1997, respectively. Both agreements 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 two lines of credit agreements will be renewed prior to their expiration. The Company has a presale funding facility with a nonaffiliated investment banking firm for borrowings under reverse repurchase arrangements, collateralized by mortgage loans held for sale pooled to form GNMA securities. There was no amount outstanding on December 31, 1996. The Company also has an unsecured line of credit of $2,000,000 with a nonaffiliated bank. The line was not utilized on December 31, 1996. 4. NET INCOME PER SHARE Net income per share is computed on the basis of the weighted average number of common shares outstanding during each period plus the effect of common shares contingently issuable from stock options in periods in which they have a dilutive effect. 5. 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 RESULTS OF OPERATIONS: Three months ended December 31, 1996 compared to three months ended December 31, 1995. GENERAL The Company reported net income of $402,000 or $0.07 per share for the quarter ended December 31, 1996, compared to net income of $583,000 or $0.10 per share for the comparable 1995 quarter. The decrease in net income was attributable to expenditures due to the expanding of our loan production operations and higher foreclosure expenses during the quarter. REVENUES LOAN ORIGINATION INCOME For the quarter ended December 31, 1996, the volume of new mortgage loans closed increased by 44.9% to $102.64 million from $70.84 million in the prior year quarter. The increase is a reflection of our expansion of loan production capabilities over this fiscal year. For the three months ended December 31, 1996 loan origination revenue increased by 50.6% to $991,000 from the December 1995 quarter, due primarily to the higher volume of new loan originations. LOAN SERVICING INCOME 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, rose 7.1% to $1.80 million for the three months ended December 31, 1996 from $1.68 million for the same period in 1995. The increase resulted from growth in the Company's servicing portfolio. As of December 31, 1996, the Company serviced $1.669 billion in loans compared to $1.567 billion at December 31, 1995, an increase of 6.5% after prepayments and scheduled amortization of mortgage loans. The growth in the servicing portfolio reflects the Company's long-term plan of retaining the servicing rights on most loan originations. The following table sets forth certain information pertaining to the servicing portfolio of the Company for the period indicated. Three Months Ended December 31, 1996 1995 (Dollars in thousands except average loan balance) Beginning loan service portfolio $1,533,601 $1,477,951 Add: Loans originated 102,641 70,849 Less: Prepayment and amortization 66,094 62,121 Ending loan servicing portfolio 1,570,148 1,486,679 Sub-Servicing 99,053 80,202 Total servicing portfolio $1,669,201 $1,566,881 Average loan balance (end of period) $ 96,519 $ 94,402 GAIN ON SALE OF MORTGAGE LOANS Due to intense price competition during the quarter, the gain on sale of mortgage loans was $1.67 million for the three months ended December 31, 1996, a decrease of 2.5% over the 1995 period. INTEREST INCOME Interest income, which reflects the interest received on mortgage loans held for sale and short-term investment in commercial paper, decreased to $485,000 for the three months ended December 31, 1996 from $553,000 for the comparable prior year quarter. This decrease was due primarily to less funds available for investment as more working capital was utilized for mortgage loan funding. EXPENSES The major components of the Company's total expenses are (i) employees' salaries and commissions, (ii) general and administrative expenses and (iii) interest expense. Total expenses for the three months ended December 31, 1996 increased by 16.1% to $4.25 million from the three months ended December 31, 1995. Salaries and commissions were $2.16 million for the December 1996 quarter, an increase of 17.9% over the year-ago quarter. General and administrative expense increased by $335,000, or 20.6% over prior year. These higher expenses were a direct result of expanding production operations in the quarter and higher foreclosure expenses, partially offset by cost reduction measures taken by the Company. INTEREST EXPENSE Interest expense decreased 36.5% to $129,000 for quarter ended December 1996 from $203,000 for the same period in 1995. The decrease was due to an increase in use of working capital for loan fundings, resulting in lower warehouse line interest expense. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS: Nine months ended December 31, 1996 compared to nine months ended December 31, 1995. GENERAL In the nine months ended December 31, 1996, the Company reported net income of $916,000 or $0.16 per share, compared to net income of $2.57 million or $0.44 per share for the same period of 1995. Total revenue decreased by 11.0% to $13.85 million from $15.56 million in the year earlier nine months. The lower operating results were largely due to a lower gain on sale of mortgage loans and higher operating expenses. REVENUES For the nine months ended December 31, 1996, loan origination revenue decreased 6.1% to $2.67 million from $2.84 million for the nine months ended December 31, 1995. The lower loan origination revenue was largely due to a higher proportion of wholesale loans, which carry much lower front-end origination revenue than retail loans. The volume of new mortgage loan originations increased to $274.64 million from $241.37 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, rose 4.9% to $5.29 million for the nine months ended December 31, 1996 from $5.05 million for the same period in 1995 after prepayments and scheduled amortization of mortgage loans. The following table sets forth certain information pertaining to the servicing portfolio of the Company for the period indicated: Nine Months Ended December 31, 1996 1995 (Dollars in thousands except average loan balance) Beginning loan service portfolio $1,477,161 $1,401,832 Add: Loans originated 274,638 241,374 Less: Prepayment and amortization 181,651 156,527 Ending loan servicing portfolio 1,570,148 1,486,679 Sub-Servicing 99,053 80,202 Total servicing portfolio $1,669,201 $1,566,881 Average loan balance (end of period) $ 96,519 $ 94,402 Weighted average interest rate 7.98% 8.18% The sale of mortgages for the nine months ended December 31, 1996 resulted in a gain of $4.22 million compared to a gain of $6.05 million for the 1995 period. The gain is adversely impacted by the escalating price competition. Interest income, which reflects the interest received on mortgage loans held for sale and short-term investment in commercial paper, increased 4.0% to $1.67 million for the nine months ended December 31, 1996 from $1.61 million for the 1995 period. This increase was due primarily to a larger mortgage inventory carried by the Company. EXPENSES The major components of the Company's total expenses are (i) employees' salaries and commissions, (ii) general and administrative expenses and (iii) interest expenses. Total expenses for the nine months ended December 31, 1996 increased by $1.10 million or 9.8% from the nine months ended December 31, 1995. Salaries and commission expenses increased to $6.13 million compared to $5.79 million in the first nine months of fiscal year 1995. General and administrative expenses increased by 17.2% to $5.59 million from the comparable period in 1995. The increase was partly attributable to expenditure resulted from ongoing implementation of our production expansion plan, and higher foreclosure losses. Interest expense decreased 11.2% to $539,000 compared to $607,000 in the prior year. The drop was due to the increase in use of working capital in loan funding, hence incurring lower warehouse interest expense. LIQUIDITY AND CAPITAL RESOURCES The Company's primary liquidity requirement is the funding of its new mortgage loans and origination expenses. To meet these needs, the Company relies on warehouse lines of credit with banks, its own capital, cash flows from operations and short-term reverse repurchase agreements with other investment banking firms. The Company's mortgage loans held for sale increased from $19.88 million at March 31, 1996 to $31.96 million at December 31, 1996. At December 31, 1996, maximum permitted borrowings under the warehouse line of credit agreements with two nonaffiliated banks totaled $45 million and the amount outstanding was $24.89 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, 1996. The Company believes that the warehouse agreements will be renewed when the current terms expire in September 1997. In addition to the warehouse lines of credit, the Company may use the short -term reverse repurchase agreements provided by other investment banking firms in connection with its inventory of mortgage loans and mortgage- backed securities. There was no amount outstanding under the agreements at December 31, 1996. The Company had stockholders' equity of $25.45 million at December 31, 1996. Management believes that its current financing arrangements are adequate to meet its projected operation needs. PROSPECTIVE TRENDS The increase in long-term interest rates during the first four months of the fiscal year had a negative impact on new loan originations, particularly those for refinance loans. Although our new loan originations increased to $275 million for the nine months ended December 31, 1996 compared to $241 million for the nine months ended December 31, 1995, the mix of new originations tilted more to wholesale rather than retail. Wholesale originations are price driven and carry very slim margins for origination revenue. We completed the wholesale expansion phase of our production growth plan, and have now moved to the retail branch expansion phase. Retail originations, although having better potential for origination revenue margins, are much slower to develop momentum and volume of new originations. Competition is more intense than at any time in the past, as the industry continues consolidation and downsizing. Pricing practices remain cut- throat in most of our markets, particularly at the wholesale level in which several of the major banks appear to be engaged in a virtual price war for mortgages originated through wholesale sources. Despite the challenges, however, we are confident that with our multiple origination channels, the Company remains poised to take advantage of whichever channel emerges as the most productive in the future. But competition at all levels is formidable and very price intensive, and likely to continue so over the coming year. Therefore, in the absence of a substantial reduction in long- term interest rates, we expect to operate at marginal returns at least for the near term. Nevertheless, we intend to remain focused on continuing the incremental implementation of our long-range growth plan. PART II. OTHER INFORMATION. Item 6. Exhibits and Reports on 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, 1996. 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 13, 1997 By S/Clement Ziroli Clement Ziroli Chairman of the Board of Directors, Chief Executive Officer Date: February 13, 1997 By S/Pac W. Dong Pac W. Dong Chief Financial Officer, Executive Vice President