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, 1997 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, 1997, 5,836,517 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, 1997 (Unaudited) and March 31, 1997 3 Unaudited Statements of Income Three Months and Nine Months Ended December 31, 1997 and 1996 4 Unaudited Statements of Cash Flows Nine Months Ended December 31, 1997 and 1996 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, 1997 March 31, 1997 (Unaudited) ASSETS Cash $6,208,000 $5,903,000 Mortgage loans held for sale 36,880,000 27,286,000 Other receivables and servicing advances 9,787,000 9,623,000 Capitalized servicing rights 7,737,000 6,709,000 Property and equipment, net 657,000 592,000 Prepaid expenses and other assets 379,000 546,000 Due from affiliates - 134,000 Notes receivable 130,000 130,000 TOTAL ASSETS $61,778,000 $50,923,000 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Notes payable, banks $31,633,000 $20,172,000 Note payable, officer - 1,500,000 Sight drafts payable 341,000 954,000 Accounts payable and accrued liabilities 814,000 816,000 Deferred income taxes 2,144,000 1,833,000 Total Liabilities 34,932,000 25,275,000 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 - 5,836,517 at December 31, 1997 and 5,859,117 at March 31, 1997 5,067,000 5,147,000 Retained earnings 21,779,000 20,501,000 Total Stockholders' Equity 26,846,000 25,648,000 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $61,778,000 $50,923,000 See accompanying notes FIRST MORTGAGE CORPORATION UNAUDITED STATEMENTS OF INCOME Three Months Ended Nine Months Ended December 31, December 31, 1997 1996 1997 1996 REVENUES: Loan origination income $716,000 $991,000 $2,228,000 $2,666,000 Loan servicing income 1,959,000 1,799,000 5,688,000 5,291,000 Gain on sale of mortgage loans 2,186,000 1,675,000 5,384,000 4,220,000 Interest income 661,000 485,000 1,824,000 1,671,000 Other income - - - 2,000 Total revenues 5,522,000 4,950,000 15,124,000 13,850,000 EXPENSES: Compensation and benefits 2,022,000 2,165,000 6,075,000 6,130,000 General and administrative expenses 1,637,000 1,456,000 4,393,000 4,427,000 Amortization of capitalized servicing rights 776,000 502,000 1,917,000 1,166,000 Interest expense 180,000 129,000 535,000 539,000 Total expenses 4,615,000 4,252,000 12,920,000 12,262,000 INCOME BEFORE INCOME TAXES 907,000 698,000 2,204,000 1,588,000 INCOME TAX EXPENSE 380,000 296,000 926,000 672,000 NET INCOME $527,000 $402,000 $1,278,000 $916,000 Basic and Diluted Earnings Per Share $ 0.09 $ 0.07 $ 0.22 $ 0.16 Weighted Average Of Common Shares Outstanding 5,856,000 5,877,000 5,856,000 5,877,000 See accompanying notes FIRST MORTGAGE CORPORATION UNAUDITED STATEMENTS OF CASH FLOWS Nine Months Ended December 31, 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $1,278,000 $916,000 Adjustments to reconcile net income to net cash provided by operating activities: Provision for deferred income taxes 311,000 122,000 Provision for losses on foreclosure (490,000) 102,000 Amortization of capitalized servicing rights 1,989,000 1,254,000 Depreciation and amortization of property and equipment 159,000 149,000 Originations and purchases of mortgage loans held for sale (315,330,000) (274,638,000) Sales and principal repayments of mortgage loans held for sale 305,736,000 262,561,000 Changes in other receivables and servicing advances 326,000 (203,000) Change in prepaid expenses and other assets 167,000 529,000 Change in accounts payable and accrued liabilities (2,000) 160,000 Net cash used in operating activities (5,856,000) (9,048,000) CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of mortgage servicing rights (605,000) (354,000) Origination of mortgage servicing rights (2,412,000) (3,000,000) Note receivable - (500,000) Sale of commercial paper - 9,955,000 Purchase of furniture and equipment and leasehold improvements (224,000) (191,000) Change in due to affiliates 134,000 60,000 Net cash provided by (used in) investing activities (3,107,000) 5,970,000 CASH FLOWS FROM FINANCING ACTIVITIES: Change in notes payable, banks 11,461,000 4,235,000 Change in sight drafts payable (613,000) (2,345,000) Change in notes payable, other (1,500,000) - Repurchase of Common Stock (80,000) (114,000) Net cash provided by financing activities 9,268,000 1,776,000 INCREASE (DECREASE) IN CASH 305,000 (1,302,000) CASH, BEGINNING OF PERIOD 5,903,000 5,948,000 CASH, END OF PERIOD $6,208,000 $4,646,000 SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 406,000 $ 432,000 Income taxes 455,000 30,000 See accompanying notes FIRST MORTGAGE CORPORATION NOTES TO UNAUDITED FINANCIAL STATEMENTS December 31, 1997 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, 1997. 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 Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 125) requires the recording of Capitalized Servicing Rights (CSRs) on the date of sale of a mortgage loan as opposed to the previous practice of recording CSRs on the date loans are originated. Additionally, under FAS 125, excess servicing fees is included in CSRs for balance sheet presentation. Activities in CSRs are summarized as follows: Capitalized Servicing Rights Balance at March 31, 1997 $6,709,000 Additions 3,017,000 Amortizations and write offs (1,980,000) Impairment (9,000) Balance at December 31, 1997 $7,737,000 3. NOTES PAYABLE At December 31, 1997, the Company had line of credit agreements with two nonaffiliated banks, which provided for borrowings up to $40,000,000 and $20,000,000 with annual interest payable monthly at 1.25% to 1.40% or the bank's reference rate, depending on the level of borrowings and the compensating balances maintained. At December 31, 1997, borrowings under these lines of $31,633,000 were collateralized by mortgage loans held for sale. The line of credit agreements are subject to renewal on September 1, 1998 and August 31, 1998, 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, 1997. 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, 1997. 4. EARNINGS PER SHARE In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, Earnings per Share. Statement 128 replaced the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants, and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been restated where necessary to conform to the Statement 128 requirements. 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, 1997 compared to three months ended December 31, 1996. GENERAL First Mortgage reported net income of $527,000 or $0.09 per share for the quarter ended December 31, 1997, compared to net income of $402,000 or $0.07 per share for the comparable 1996 quarter. The increase of 31.1% in net income was primarily attributable to larger gains on mortgage sales as interest rates became more favorable; and to higher servicing income as the mortgage servicing portfolio grows; and also to an increase in interest income due to stronger loan production. The improvement in earnings was, however, offset partially by greater general and administrative expenses from start-up cost of several new production offices and increase in amortization expense of mortgage servicing rights. REVENUES For the quarter ended December 31, 1997, the volume of new mortgage loans closed increased by 12% to $114.99 million from $102.64 million in the prior year quarter. The increase is a reflection of lower long- term interest rates, which significantly increased the volume of refinancing loans in the market place, and the robust recovery of the California real estate market. For the three months ended December 31, 1997, loan origination revenue decreased by approximately 27.7% to $716,000 from the December 1996 quarter, due primarily to the higher volume of wholesale and refinance loans, which carry lower front-end origination fees. 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 8.9% to $1.96 million for the three months ended December 31, 1997 from $1.80 million for the same period in 1996. The increase is primarily due to a larger mortgage servicing portfolio. As of December 31, 1997, the Company serviced $1.70 billion in loans compared to $1.67 billion at December 31, 1996, a net gain of 1.9% 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 a portion of new 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. 1997 1996 (Dollars in thousands except average loan balance) Beginning loan service portfolio $1,613,942 $1,533,601 Add: Loans originated 114,987 102,641 Less: Prepayment and amortization 117,418 66,094 Ending loan servicing portfolio 1,611,511 1,570,148 Sub-Servicing 90,196 99,053 Total servicing portfolio $1,701,707 $1,669,201 Average loan balance (end of period) $ 95,963 $ 96,519 Due to a favorable trend in long-term mortgage interest rates during the quarter, the gain on sale of mortgage loans was $2.19 million for the three months ended December 31, 1997, an increase of 30.5% over the 1996 period. Interest income, which reflects the interest received on mortgage loans held for sale, increased to $661,000 for the three months ended December 31, 1997 from $485,000 for the comparable prior year quarter. This increase was due primarily to the larger mortgage inventory carried by the Company during the December 1997 quarter, partially offset by lower interest rates. 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 expense. Total expenses for the three months ended December 31, 1997 increased by 8.5% to $4.62 million from the three months ended December 31, 1996. Compensation and benefits were $2.02 million for the December 1997 quarter, a decrease of 6.6% over the year-ago quarter. The main reason for the drop is the implementation of cost reduction measures taken by the Company. General and administrative expense increased by $181,000, or 12.4% over prior year. These higher expenses were a direct result of expenses associated with branch closing, and expanding the production operations in the quarter. Amortization expense of capitalized servicing rights increased by $274,000 over the 3rd quarter of last fiscal year, due mainly to the Company's larger investment in mortgage servicing rights and higher volume of loan prepayments over the comparable period of prior year. Interest expense increased 39.5% to $180,000 for quarter ended December 31 1997 from $129,000 for the same period in 1996. The higher expense was due to an increase in use of warehouse lines for loan fundings. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS: Nine months ended December 31, 1997 compared to nine months ended December 31, 1996. GENERAL In the nine months ended December 31, 1997, the Company reported net income of $1.28 million or $0.22 per share, compared to net income of $916,000 or $0.16 per share for the same period of 1996. Total revenue increased by 9.2% to $15.12 million from $13.85 million in the year earlier nine months. The increase in net income was largely due to higher loan servicing income and a greater gain on sale of mortgage loans for the nine month period as compared to 1996. REVENUES For the nine months ended December 31, 1997, loan origination revenue decreased 16.4% to $2.23 million from $2.67 million for the nine months ended December 31, 1996. The lower loan origination revenue was largely due to a higher proportion of wholesale and refinance loans, which carry much lower front-end origination revenue than retail loans. The volume of new mortgage loan originations increased 14.8% to $315.33 million from $274.64 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 7.5% to $5.69 million for the nine months ended December 31, 1997 from $5.29 million for the same period in 1996 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, 1997 1996 (Dollars in thousands except average loan balance) Beginning loan service portfolio $1,583,837 $1,477,161 Add: Loans originated 315,330 274,638 Less: Prepayment and amortization 287,656 181,651 Ending loan servicing portfolio 1,611,511 1,570,148 Sub-Servicing 90,196 99,053 Total servicing portfolio $1,701,707 $1,669,201 Average loan balance (end of period) $95,693 $96,519 The sale of mortgages for the nine months ended December 31, 1997 resulted in a gain of $5.38 million compared to a gain of $4.22 million for the 1996 period. The gain is primarily attributable to the favorable trend in long-term interest rates in 1997. Interest income, which reflects the interest earned on mortgage loans held for sale for the nine months ended December 31, 1997, increased 9.2% to $1.82 million from $1.67 million for the nine months ended December 31, 1996. 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, 1997 increased by $658,000 or 5.4% from the nine months ended December 31, 1996. Compensation and benefits fell 0.9% to $6.08 million compared to $6.13 million in the first nine months of fiscal year 1996. The decrease in compensation expense reflects the success in cost control measures adopted by the Company. General and administrative expenses decreased slightly by $34,000 from the comparable period in 1996 despite higher loan originations in 1997. It represents the effective implementation of tight cost controls by the Company. Amortization expense of capitalized servicing rights increased by $751,000 over the nine months period of last fiscal year due primarily to the Company's larger investment of mortgage servicing rights and higher volume of loan prepayments over the comparable prior year 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 with banks, its own capital, and also cash flows from operations. At December 31, 1997, maximum permitted borrowings under the warehouse line of credit agreements with two nonaffiliated banks totaled $60 million and the amount outstanding was $31.63 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, 1997. The Company believes that the warehouse agreements will be renewed when the current terms expire. The Company had stockholders' equity of $26.85 million at December 31, 1997. Management believes that its current financing arrangements are adequate to meet its projected operational needs. PROSPECTIVE TRENDS Between April 1997 and December 1997, long-term mortgage interest rates fell approximately 1/2%, contributing to a 14.8% increase in new loan originations over the immediate preceding nine months ended December 31, 1996. Loan production will continue to grow unless long- term interest rates unexpectedly increase. The surge in activity should help produce positive results for the Company going forward. Pricing of most traditional mortgage products, however, remains uneconomical and as previously discussed, the Company still 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, home equity loans and other mortgage products with much greater profit potential for the Company. During this year we introduced, for example, a 125% second mortgage equity loan which is being originated through direct consumer mailing, telemarketing, and our traditional retail branch operations. As a continuing part of the Company's long-term plan, we are opening new retail production offices as the opportunity presents itself in the appropriate markets for the loan products we wish to originate. Net of offices which have been closed, we have opened three new retail offices thus far this year. Although slower to ramp up, retail production originations have better margins than wholesale. We have also greatly increased the size and scope of our Consumer Direct Marketing operation, with the result thus far of nearly doubling the production over the comparable period last year. Margins in this division are far better than other channels of loan origination and we will continue expansion of these operations. Conversely, the poor to nearly non-existent margins available in wholesale originations have dictated a withdrawal from much of this market, and we have closed our Diamond Bar, California and Bellevue, Washington wholesale offices in order to direct resources towards our other more profitable channels. With mortgage interest rates recently falling to new lows, we believe we are appropriately positioned to take advantage of the resulting surge of both purchase and refinance business. 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, 1997. 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, 1998 By S/Clement Ziroli Clement Ziroli Chairman of the Board of Directors, Chief Executive Officer Date: February 13, 1998 By S/Pac W. Dong Pac W. Dong Chief Financial Officer, Executive Vice President