AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 4, 1997
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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LIFE FINANCIAL CORPORATION LIFE FINANCIAL CAPITAL TRUST
(EXACT NAME OF REGISTRANT AS (EXACT NAME OF REGISTRANT AS
SPECIFIED IN ITS CERTIFICATE OF SPECIFIED IN ITS CERTIFICATE OF
INCORPORATION) INCORPORATION)
DELAWARE DELAWARE
(STATE OR OTHER JURISDICTION OF (STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION) INCORPORATION OR ORGANIZATION)
33-0743196 APPLIED FOR
(IRS EMPLOYER IDENTIFICATION NO.) (IRS EMPLOYER IDENTIFICATION NO.)
6035 N/A
(PRIMARY STANDARD INDUSTRIAL (PRIMARY STANDARD INDUSTRIAL
CLASSIFICATION CODE NUMBER) CLASSIFICATION CODE NUMBER)
10540 NORTH MAGNOLIA AVENUE 10540 NORTH MAGNOLIA AVENUE
UNIT B UNIT B
RIVERSIDE, CALIFORNIA 92503 RIVERSIDE, CALIFORNIA 92503
(909) 637-4000 (909) 637-4000
(ADDRESS, INCLUDING ZIP CODE, AND (ADDRESS, INCLUDING ZIP CODE, AND
TELEPHONE NUMBER, INCLUDING AREA TELEPHONE NUMBER, INCLUDING AREA
CODE, OF REGISTRANT'S PRINCIPAL CODE, OF REGISTRANT'S PRINCIPAL
EXECUTIVE OFFICES) EXECUTIVE OFFICES)
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DANIEL L. PERL
PRESIDENT AND CHIEF EXECUTIVE OFFICER
LIFE FINANCIAL CORPORATION
10450 NORTH MAGNOLIA AVENUE, UNIT B
RIVERSIDE, CALIFORNIA 92505
(909) 637-4000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
COPIES TO:
JOSEPH G. PASSAIC, JR., ESQUIRE ROGER M. COHEN, ESQUIRE
MARY M. SJOQUIST, ESQUIRE ETHAN D. FEFFER, ESQUIRE
GEOFFREY W. RYAN, ESQUIRE NEEL GROVER, ESQUIRE
MULDOON, MURPHY & FAUCETTE BROBECK PHLEGER & HARRISON LLP
5101 WISCONSIN AVENUE, N.W. 4675 MACARTHUR COURT, SUITE 1000
WASHINGTON, D.C. 20016 NEWPORT BEACH, CALIFORNIA 92660
(202) 362-0840 (714) 752-7535
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
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PROPOSED PROPOSED
TITLE OF EACH CLASS OF AMOUNT MAXIMUM MAXIMUM
SECURITIES TO BE TO BE OFFERING PRICE AGGREGATE REGISTRATION
REGISTERED REGISTERED PER SHARE OFFERING PRICE FEE
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% Convertible Trust
Preferred Securities of
LIFE Financial Capital
Trust.................. 1,150,000 Shares $25.00 $28,750,000 $8,482
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Junior Convertible
Subordinated Debentures
of LIFE Financial
Corporation(1)......... -- -- -- --
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Common Stock, par value
$0.01 per share, of
LIFE Financial
Corporation............ (2) -- -- --
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LIFE Financial
Corporation Guarantee
with respect to the
Capital Securities(3).. -- -- -- --
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Total(4)............ 1,150,000 $25.00 $28,750,000(5) $8,482
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(1) The Junior Convertible Subordinated Debentures (the "Junior Subordinated
Debentures") to be issued by LIFE Financial Corporation (the "Company")
will be purchased by LIFE Financial Capital Trust (the "Trust") with the
proceeds of the sale of the Convertible Trust Preferred Securities (the
"Capital Securities"). No separate consideration will be received for the
Junior Subordinated Debentures distributed upon any liquidation of the
Trust.
(2) Such indeterminate number of shares of common stock, par value $0.01 per
share, of the Company (the "Common Stock") as may be issuable upon
conversion of the Capital Securities registered hereunder. Shares of
Common Stock issued upon conversion of the Capital Securities will be
issued without the payment of additional consideration. This Registration
Statement also covers such shares as may be issuable upon such conversion
pursuant to anti-dilution adjustments.
(3) No separate consideration will be received for the Company's Guarantee
with respect to the Capital Securities (the "Guarantee").
(4) This Registration Statement is deemed to cover the Junior Subordinated
Debentures, the rights of holders of Junior Subordinated Debentures under
the Indenture, the rights of holders of Capital Securities under the
Amended and Restated Declaration of Trust and the rights of holders of
Capital Securities under the Guarantee, which together guarantee the
obligations of the Trust with respect to the Capital Securities to the
extent set forth in the Guaranty.
(5) Such amount represents the aggregate liquidation amount of the Capital
Securities to be issued hereunder and the principal amount of Junior
Subordinated Debentures that may be distributed to holders of Capital
Securities upon any liquidation of the Trust.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO
SECTION 8(a), MAY DETERMINE.
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++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED IN THE OFFERING DESCRIBED IN THIS PROSPECTUS PRIOR +
+TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS +
+SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY +
+NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH +
+OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR +
+QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
PROSPECTUS
SUBJECT TO COMPLETION, DATED DECEMBER , 1997
CAPITAL SECURITIES
LIFE FINANCIAL CAPITAL TRUST
% CONVERTIBLE TRUST PREFERRED SECURITIES
(LIQUIDATION AMOUNT $ . PER CAPITAL SECURITY)
GUARANTEED, AS DESCRIBED HEREIN, BY
[LOGO OF LIFE FINANCIAL CORPORATION]
The % Convertible Trust Preferred Securities (the "Capital Securities")
offered hereby represent preferred undivided beneficial interests in the assets
of LIFE Financial Capital Trust, a statutory business trust created under the
laws of the State of Delaware (the "Trust"). LIFE Financial Corporation
(formerly known as Life Financial Corp.), a Delaware corporation (the
"Company"), will be the owner of all the beneficial interests represented by
the common securities of the Trust (the "Common Securities" and, together with
the Capital Securities, the "Trust Securities"). The Trust exists for the sole
purpose of issuing the Trust Securities and investing the proceeds thereof
in . % Junior Convertible Subordinated Debentures (the "Junior Subordinated
Debentures") to be issued by the Company. The Junior Subordinated Debentures
will mature on , 2027 (the "Stated Maturity Date"). The Capital Securities
will have a preference over the Common Securities under certain circumstances
with respect to cash distributions and amounts payable on liquidation,
redemption or otherwise. See "Description of Capital Securities--Subordination
of Common Securities." The Company has applied to have the Capital Securities
approved for quotation on the National Market System of the Nasdaq Stock Market
("Nasdaq"), subject to official notice of issuance.
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FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE
INVESTORS IN EVALUATING AN INVESTMENT IN THE CAPITAL SECURITIES, SEE "RISK
FACTORS RELATED TO THE CAPITAL SECURITIES" AND "RISK FACTORS RELATED TO THE
COMPANY" BEGINNING ON PAGES 15 AND 20, RESPECTIVELY, OF THIS PROSPECTUS.
----------
THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS OR DEPOSITS AND ARE
NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER
GOVERNMENTAL AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION (THE "COMMISSION"), OR ANY STATE SECURITIES COMMISSION,
NOR HAS THE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
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UNDERWRITING DISCOUNTS PROCEEDS TO THE
PRICE TO PUBLIC AND COMMISSIONS(1) COMPANY(2)
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Per Capital Security.... $ $ (3) $
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Total(4)................ $ $ (3) $
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(1) See "The Offering" for information concerning indemnification of the
Underwriter and other matters.
(2) Before deducting expenses of the Offering payable by the Company, estimated
to be $ .
(3) As the proceeds of the sale of the Capital Securities will be invested in
the Junior Subordinated Debentures, the Company has agreed to pay the
Underwriter a fee for its services in the Offering. For a discussion of the
fees to be paid to the Underwriter, see "Underwriting."
(4) The Trust and the Company have granted the Underwriter an option,
exercisable for a period of 30 days from the date of this Prospectus, to
purchase up to additional Capital Securities solely to cover over-
allotments, if any. If the option is exercised in full, the total Price to
the Public, Underwriting Discounts and Commissions and Proceeds to the
Trust will be $ , $ and $ , respectively. See "Underwriting."
The Capital Securities offered hereby are offered subject to prior sale,
when, as and if delivered to and accepted by the Underwriter, and subject to
its right to withdraw, modify, correct and reject orders in whole or in part.
It is expected that delivery of the Capital Securities will be made against
payment therefor in immediately available funds at the offices of Keefe,
Bruyette & Woods, Inc., (the "Underwriter"), Two World Trade Center, New York,
New York, on or about December , 1997.
KEEFE, BRUYETTE & WOODS, INC.
THE DATE OF THIS PROSPECTUS IS DECEMBER , 1997
Each Capital Security is convertible in the manner described herein at the
option of the holder thereof, at any time prior to the earlier of (i) 5:00
p.m. (Pacific time) on the Business Day (as defined herein) immediately
preceding the date of repayment of such Capital Security, whether at maturity
or upon redemption, and (ii) 5:00 p.m. (Pacific time) on the Conversion
Termination Date (as defined herein), if any, into shares of the Company's
common stock, par value $.01 per share (the "Common Stock") at a conversion
rate of shares of Common Stock for each Capital Security (equivalent to a
conversion price of $ per share of Common Stock), subject to adjustment in
certain circumstances. See "Description of Capital Securities--Conversion
Rights." The Common Stock is quoted on the Nasdaq under the symbol "LFCO." On
December , 1997, the last reported sale price of the Common Stock was $ .
per share. The Company has applied to have the Capital Securities approved for
quotation on the Nasdaq, subject to official notice of issuance, under the
symbol "LFCOP." See "Underwriting."
The Capital Securities are being offered hereby in a public offering (the
"Offering") by the Underwriter. See "Underwriting."
Except as described herein, the Capital Securities to be issued in the
Offering will be represented by global Capital Securities in fully registered
form, deposited with a custodian for and registered in the name of a nominee
of The Depository Trust Company ("DTC"). Beneficial interests in such Capital
Securities will be shown on, and transfers thereof will be effected through,
records maintained by DTC and its participants.
All Capital Securities will be offered at the "Offering Price," equal to the
liquidation amount of $ per Capital Security (the "Liquidation Amount").
See "Underwriting."
Holders of the Capital Securities will be entitled to receive cumulative
cash distributions, accumulating from the original date of issuance of the
Capital Securities (the "Issue Date") and payable quarterly in arrears on
March 15, June 15, September 15 and December 15 of each year, commencing March
15, 1998, at the annual rate of . % of the Liquidation Amount of $ . per
Capital Security ("Distributions"). So long as no Debenture Event of Default
(as defined herein) has occurred and is continuing, the Company will have the
right to defer payments of interest on the Junior Subordinated Debentures at
any time and from time to time for a period not exceeding 20 consecutive
quarters with respect to each deferral period (each, an "Extension Period"),
provided that no Extension Period may end on a day other than an Interest
Payment Date (as defined herein) or extend beyond the Stated Maturity Date.
Upon the termination of any such Extension Period and the payment of all
amounts then due, the Company may elect to begin a new Extension Period,
subject to the requirements set forth herein. If and for so long as interest
payments on the Junior Subordinated Debentures are so deferred, Distributions
on the Trust Securities also will be deferred and the Company will not be
permitted, subject to certain exceptions described herein, to declare or pay
any cash distributions with respect to the Company's capital stock or to make
any payment with respect to debt securities of the Company that rank pari
passu with or junior to the Junior Subordinated Debentures. During an
Extension Period, interest on the Junior Subordinated Debentures will continue
to accrue (and the amount of Distributions to which holders of the Trust
Securities are entitled will continue to accumulate) at the rate of . % per
annum, compounded quarterly (to the extent permitted by applicable law), and
holders of Trust Securities will be required to accrue interest income for
United States federal income tax purposes prior to receipt of cash payments
attributable to such interest income. See "Description of Junior Convertible
Subordinated Debentures--Option to Extend Interest Payment Date" and "Certain
Federal Income Tax Considerations--Interest, Original Issue Discount, Premium
and Market Discount."
The Company will, through the Guarantee, the Common Guarantee, the
Declaration, the Junior Subordinated Debentures and the Indenture (each as
defined herein), taken together, fully, irrevocably and unconditionally
guarantee on a subordinated basis all of the Trust's obligations under the
Trust Securities. See "Relationship Among the Capital Securities, the Junior
Subordinated Debentures and the Guarantee--Full and Unconditional Guarantee."
The Guarantee and the Common Guarantee will guarantee payments of
distributions and payments on liquidation or redemption of the Trust
Securities, but in each case only to the extent that the Trust holds funds on
hand legally available therefor and has failed to make such payments, as
described herein.
ii
See "Description of the Guarantee." If the Company fails to make a required
payment on the Junior Subordinated Debentures, the Trust will not have
sufficient funds to make the related payments, including distributions, on the
Trust Securities. The Guarantee and the Common Guarantee will not cover any
such payment when the Trust does not have sufficient funds on hand legally
available therefor. In such event, a holder of Capital Securities may
institute a legal proceeding directly against the Company to enforce payment
to such holder of accrued but unpaid interest on the Junior Subordinated
Debentures with a principal amount equal to the Liquidation Amount of the
Capital Securities held by such holder. See "Description of Junior Convertible
Subordinated Debentures--Enforcement of Certain Rights by Holders of Capital
Securities." The obligations of the Company under the Junior Subordinated
Debentures, the Guarantee and the Common Guarantee will be unsecured and
subordinate and rank junior in right of payment to all Senior Indebtedness (as
defined herein) of the Company to the extent and in the manner set forth in
the Indenture and the Guarantees. See "Description of Junior Convertible
Subordinated Debentures--Subordination."
The Trust Securities will be subject to mandatory redemption in a Like
Amount (as defined herein), (i) in whole but not in part, on the Stated
Maturity Date upon repayment of the Junior Subordinated Debentures at a
redemption price equal to the principal amount of, plus accrued and unpaid
interest on, the Junior Subordinated Debentures (the "Maturity Redemption
Price"), (ii) in whole but not in part, at any time, contemporaneously with
the optional prepayment of all of the Junior Subordinated Debentures, upon the
occurrence and continuation of a Special Event (as defined herein), at a
redemption price equal to the Special Event Prepayment Price (as defined
herein) (the "Special Event Redemption Price"), and (iii) in whole or in part,
on or after , (the "Initial Optional Prepayment Date"),
contemporaneously with the optional prepayment by the Company of all or a part
of the Junior Subordinated Debentures, at a redemption price equal to the
Optional Prepayment Price (as defined herein) (the "Optional Redemption
Price"). Any of the Maturity Redemption Price, the Special Event Redemption
Price and the Optional Redemption Price may be referred to herein as the
"Redemption Price." See "Description of Capital Securities--Redemption."
The Junior Subordinated Debentures will be prepayable prior to the Stated
Maturity Date at the option of the Company (i) on or after the Initial
Optional Prepayment Date, in whole or in part, at a prepayment price (the
"Optional Prepayment Price") equal to 100% of the principal amount thereof
plus accrued and unpaid interest thereon to the date of prepayment, or (ii) at
any time, in whole but not in part, upon the occurrence and continuation of a
Special Event, at a prepayment price (the "Special Event Prepayment Price")
equal to 100% of the principal amount thereof plus accrued and unpaid interest
thereon to the date of prepayment. Either of the Optional Prepayment Price or
the Special Event Prepayment Price may be referred to herein as the
"Prepayment Price." See "Description of Junior Convertible Subordinated
Debentures--Optional Prepayment" and "--Special Event Prepayment."
In addition to the rights of the Company to redeem the Capital Securities
under the circumstances described in this Prospectus, the Company also will
have the right to terminate the convertibility of the Capital Securities into
Common Stock as described in this paragraph. If for at least 20 trading days
within any period of 30 consecutive trading days ending on or after , ,
including the last trading day of such period, the Closing Price (as defined
herein) of the Common Stock exceeds % of the then applicable Conversion Price
of the Capital Securities, the Company may, at its option, terminate the right
to convert the Junior Subordinated Debentures into Common Stock, in which case
the right to convert the Capital Securities into Common Stock will likewise
terminate. To exercise this conversion termination option, the Company must
cause the Trust to issue a press release announcing the date upon which
conversion rights will expire (the "Conversion Termination Date"), prior to
the opening of business on the second trading day after a period in which the
condition in the preceding sentence has been met, but in no event may such
press release be issued prior to , . Notice of termination of conversion
rights will be given by first-class mail to the holders of the Capital
Securities not more than four business days after the Trust issues the press
release. The Conversion Termination Date shall be a Business Day not less than
30 and not more than 60 days following the date of the press release. See
"Description of Capital Securities--Conversion Rights."
iii
The Company, as the holder of the outstanding Common Securities, will have
the right at any time to dissolve the Trust and after satisfaction of or
provision for liabilities to creditors of the Trust as required by applicable
law, cause a Like Amount of the Junior Subordinated Debentures to be
distributed to the holders of the Trust Securities in liquidation of the
Trust, subject to the Company having received an opinion of counsel to the
effect that such distribution will not be a taxable event to holders of the
Capital Securities. No application has been made to have the Junior
Subordinated Debentures approved for listing on the Nasdaq or on an exchange.
However, under the terms of the Indenture, the Company must use its best
efforts to have the Junior Subordinated Debentures listed on the Nasdaq or on
an exchange at the time that they are distributed to the holders of the Trust
Securities. See "Risk Factors Related to the Capital Securities--Absence of
Public Market and Transfer Restrictions." Unless the Junior Subordinated
Debentures are distributed to the holders of the Trust Securities, in the
event of a liquidation of the Trust as described herein, after satisfaction of
or provision for liabilities to creditors of the Trust as required by
applicable law, the holders of the Capital Securities generally will be
entitled to receive a Liquidation Amount of $ . per Capital Security plus
accumulated and unpaid Distributions thereon to the date of payment. See
"Description of Capital Securities--Liquidation of the Trust and Distribution
of Junior Subordinated Debentures" and "Certain Federal Income Tax
Considerations--Receipt of Junior Subordinated Debentures Upon Liquidation of
the Trust" and "--Sale or Redemption of Capital Securities."
As used herein, (i) the "Indenture" means the Indenture, to be dated on or
prior to the Issue Date, as amended and supplemented from time to time,
between the Company and State Street Bank and Trust Company ("State Street"),
as trustee (the "Debenture Trustee"), relating to the Junior Subordinated
Debentures, (ii) the "Declaration" means the Amended and Restated Declaration
of Trust relating to the Trust, to be dated on or prior to the Issue Date,
among the Company, as Sponsor, State Street, as Property Trustee (the
"Property Trustee"), Delaware Trust Capital Management, Inc. ("Delaware
Trust"), as Delaware Trustee (the "Delaware Trustee" and, collectively with
the Property Trustee, the "Issuer Trustees"), the Administrators named therein
(the "Administrators") and the holders from time to time of the Trust
Securities, (iii) the "Guarantee" means the Guarantee Agreement relating to
the Capital Securities, to be dated on or prior to the Issue Date, between the
Company and State Street, as trustee (the "Guarantee Trustee") and (iv) the
"Common Guarantee" means the Guarantee Agreement relating to the Common
Securities by the Company, to be dated on or prior to the Issue Date.
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CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE CAPITAL SECURITIES
AND THE COMPANY'S COMMON STOCK. SUCH TRANSACTIONS MAY INCLUDE STABILIZING BIDS
AND PURCHASES, SYNDICATE SHORT COVERING TRANSACTIONS AND PENALTY BIDS. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
iv
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN
THIS PROSPECTUS. UNLESS OTHERWISE INDICATED ALL REFERENCES TO THE COMPANY SHALL
BE DEEMED TO INCLUDE THE COMPANY AND ITS SUBSIDIARIES.
THIS PROSPECTUS CONTAINS CERTAIN STATEMENTS OF A FORWARD-LOOKING NATURE
RELATING TO FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY.
THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES AND ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE PROJECTED OR IMPLIED IN THE FORWARD-
LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES
INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED UNDER "RISK FACTORS RELATED TO
THE CAPITAL SECURITIES," "RISK FACTORS RELATED TO THE COMPANY," "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND
"BUSINESS." FURTHER, CERTAIN FORWARD-LOOKING STATEMENTS ARE BASED UPON
ASSUMPTIONS AS TO FUTURE EVENTS THAT MAY NOT PROVE TO BE ACCURATE.
LIFE FINANCIAL CORPORATION
The Company is a Delaware chartered savings and loan holding company
headquartered in Riverside, California. The Company became the parent company
of Life Bank (formerly Life Savings Bank, Federal Savings Bank) (the "Bank")
pursuant to the holding company reorganization of the Bank (the
"Reorganization") undertaken in connection with the Company's initial public
offering of its Common Stock (the "IPO"). The Company completed the IPO on June
30, 1997. Together with shares issued subsequent to that date pursuant to the
exercise of the underwriter's overallotment option, the Company issued a total
of 3,335,000 shares of Common Stock in the IPO at a price of $11.00 per share.
Net proceeds from the IPO amounted to $32.5 million.
The Company originates, purchases, sell, securitizes and services primarily
non-conventional mortgage loans principally secured by first and second
mortgages on one- to four-family residences. The Company makes Liberator Series
loans, which are for the purchase or refinance of residential real property by
borrowers who generally would not qualify for Fannie Mae ("FNMA") or Freddie
Mac ("FHLMC") loans ("sub-prime borrowers"), and Portfolio Series loans, which
are debt consolidation loans for borrowers whose credit history qualifies them
for FNMA and FHLMC loans ("Agency-Qualified Borrowers") with loan-to-value
ratios of up to 135%. The Company has recently increased the permitted loan-to-
value ratio on Portfolio Series loans to 135% from 125%. While the Company is
currently emphasizing the origination of Portfolio Series loans, it intends to
market both products as demand permits. Liberator Series and Portfolio Series
loans are the Company's "core products." In addition, to a much lesser extent,
the Company originates multi-family residential and commercial loans.
The Company conducts its business from six locations: the Company's corporate
headquarters and Western regional lending center in Riverside, California, two
additional regional lending centers, one in Jacksonville, Florida and one in
the Denver, Colorado metropolitan area, the national servicing center located
in Riverside, California, and two bank branch offices in San Bernardino and
Riverside, California. In addition, the Company has recently opened two low
cost retail lending offices, and has entered into leases for an additional four
retail lending offices to be opened by the end of 1997. In addition, the
Company intends to open two retail lending offices in the first quarter of
1998. With the exception of one planned office expected to be opened in
Northern California, the Company's two current and five of the six planned
retail lending offices will be located in Southern California. See "Recent
Developments."
At September 30, 1997, the Company had total assets of $294.1 million, total
deposits of $159.8 million and stockholders' equity of $49.5 million. During
the nine months ended September 30, 1997, the Company originated or purchased,
through a network of approved correspondents and independent mortgage brokers
(the "Originators"), $433.4 million of non-conventional mortgage products, and
sold or securitized $277.1 million
1
of such products. The Bank's deposits are insured up to the maximum allowable
amount by the Savings Association Insurance Fund ("SAIF") of the Federal
Deposit Insurance Corporation ("FDIC"). The Company's headquarters are located
at 10540 Magnolia Avenue, Suite B, Riverside, California 92505, and its
telephone number at that location is (909) 637-4000.
During the early 1990's, as a result of reduced employment levels and
corporate relocations in Southern California and the general weakness of the
national economy, the Company's market area experienced a weakening of real
estate values and a reduction in home sales and construction. When confronted
with increased competition and nominal growth during this same period, the
Company's results of operations were adversely impacted and the Company began
to experience increases in total non-performing loans held for investment. In
response, in 1994, the Company retained new management experienced in sub-prime
lending to redirect its business focus, revise its underwriting policies and
procedures and enhance its related servicing capabilities. A plan was developed
pursuant to which the Company reorganized its lending operations from that of a
thrift emphasizing traditional mortgage banking and portfolio lending to that
of a diversified financial services operation focusing on the origination for
sale or securitization, with servicing retained, of various loan products to
include Liberator Series loans, Portfolio Series loans, and, to a much lesser
extent, commercial and multi-family real estate loans. The Company also adopted
revised underwriting policies and instituted more aggressive procedures for
resolving problem loans and for reducing the level of non-performing assets. As
a result of these steps, the Company improved its profitability.
As part of the Company's strategic plan, the Company developed an internal
structure of operating divisions within the Bank, each with distinct objectives
and management focus. The five divisions include (i) the Financial Services
Division which emphasizes the wholesale origination of the Company's core
products; (ii) the Income Capital Services Division which originates and sells
commercial and multi-family mortgage loans; (iii) the Retail Loan Division
which concentrates on offering loan products directly to the public primarily
in the Bank's primary market area; (iv) the Asset Management Division which
services loans and REO for both the Company and for Loan Purchasers; and (v)
the Banking Division which offers depository services to the public. In 1994,
the Company began to implement its plan which resulted in:
. An increase in total purchases and originations of loans by 171.5% from
$82.0 million for the year ended December 31, 1993 to $222.6 million for
the year ended December 31, 1996. For the nine month period ended
September 30, 1997, loans originated and purchased totalled $433.4
million.
. An increase in loan sales and securitizations by 191.0% from $71.0
million for the year ended December 31, 1993 to $206.6 million for the
year ended December 31, 1996. For the nine month period ended September
30, 1997, loan sales and securitizations totalled $277.1 million.
. An increase in net income of 1,518.3% from $93,000 for the year ended
December 31, 1993, to $1.5 million for the year ended December 31, 1996.
For the nine month period ended September 30, 1997, net income was $7.7
million.
. An increase in net gains from mortgage financing operations by 663.6%
from $1.1 million for the year ended December 31, 1993, to $8.4 million
for the year ended December 31, 1996. For the nine month period ended
September 30, 1997, net gains from mortgage financing operations totalled
$17.4 million.
. An increase in deposits from $72.0 million at December 31, 1993 to $85.7
million at December 31, 1996. Deposits increased further to $159.8
million at September 30, 1997. The Bank also obtained warehouse lines of
credit with two national investment banking firms aggregating $250.0
million, of which $54.6 million has been drawn upon at September 30,
1997. In addition, the Company obtained a line of credit in the amount of
$40.0 million secured by residual assets created by the Company's
securitization activities. See "Recent Developments."
. An increase in stockholders' equity from $4.4 million at December 31,
1993 to $9.3 million at December 31, 1996, due to an increase in retained
earnings and to the proceeds from the issuance of
2
Bank common stock in a private placement during 1996 totaling $3.5
million. Stockholders' equity increased further to $49.5 million at
September 30, 1997, due to an increase in retained earnings and to the net
proceeds from the issuance of Common Stock in the IPO totaling $32.5
million during 1997. The Bank also issued $10.0 million of subordinated
debentures (the "Debentures") during 1997 to increase its risk based
capital.
COMPETITIVE STRENGTHS
Management believes that it enjoys a competitive advantage when compared to
most other finance companies competing in its product areas as a result of the
following factors:
Expertise of Management. The change in direction of the Company's business
focus commenced with the hiring in 1994 of Daniel L. Perl, currently the
Company's and the Bank's President and Chief Executive Officer. Mr. Perl has
more than twenty years of experience in the financial services industry,
including the areas of sub-prime lending, commercial real estate lending,
mortgage banking and investment banking. Additional management expertise
includes:
. Mr. Bruce Mills has more than 15 years in banking and regulatory
experience including service at the Federal Home Loan Bank, the
predecessor of the OTS and ten years as chief financial officer of the
Bank.
. Ms. Mary Darter has more than 13 years of lending experience including
sub-prime, bulk acquisition and warehouse lending. She joined the Bank in
March of 1994 having previously worked with Mr. Perl from 1988 to 1991.
. Mr. Joseph R. L. Passerino has been in the financial services industry
for more than 20 years. His areas of expertise have included conventional
and sub-prime residential loans as well as commercial lending. Mr.
Passerino previously worked with Mr. Perl from 1985 to 1988.
. Mr. Stephen Sandoval has more than 24 years of extensive experience in
the servicing and collection of mortgage and consumer loans with a
primary focus on loss mitigation including workout alternatives,
bankruptcy and foreclosure processing in addition to traditional day to
day loan servicing functions.
. Mr. Robert K. Riley joined the Company's Board of Directors after the
IPO. Mr. Riley is the co-founder and Chief Executive Officer of Millenium
Asset Management, L.L.C., a registered investment advisory firm. From
1992 to 1996, Mr. Riley worked for the Millenium Group, a consulting firm
focused on designing asset securitization systems and developing risk
management programs for European banks.
The Board has implemented competitive management incentives to attract and
retain qualified executives. See "The Board of Directors and Management of the
Bank--Benefits--Cash Bonus Plan" and "--Stock Option Plans."
Efficiency of Operations. Management believes that the efficiency of its
operations allows the Company to offer to its Originators very competitively
priced products. Management believes that this competitive pricing will
increase the volume of loans originated. The efficiency of the Company's
operations results from:
. Providing Originators with clear, concise and consistent underwriting
standards;
. Well defined core products;
. Low cost, strategically located loan facilities;
. Rapid turnaround time on loan applications;
. Limited number of strong and productive relationships with Originators;
and
. Originations of loans at low premiums or at a discount from par.
Internal Controls. Management believes that the significant internal controls
that have been established help preserve and assure the overall quality of
loans originated by the Company. These internal controls include:
. Dual signatures on all loan originations;
3
. Unanimous approval by two persons, including a member of senior
management, of any exceptions to the Company's underwriting policies;
. Exceptions to the Company's underwriting policies are kept to a minimum;
. A limited number of appraisers approved by the Company's senior
management perform or review appraisals on all loans originated or
purchased by the Company;
. For all loans on first payment default or 60 days overdue, a quality
control review is completed by the quality control department;
. Internal quality-control underwriting review of not less than 10.0% of
all Liberator Series loans and 5.0% of all Portfolio Series loans
originated, post-funding; and
. Regularly-scheduled underwriting and delinquency meetings are held to
review and update procedures and controls.
Flexible Funding Sources and Structure. The Company has multiple sources of
liquidity. As a federally-chartered savings bank, the Bank has additional
funding avenues at a lower cost than its non-regulated finance company
competitors. This advantage is derived from the Bank's ability to:
. Access a long-term stable unsecured funding base through the Bank's
deposits which are insured by the FDIC;
. Increase its deposit base through competitive pricing and possible branch
acquisitions or acquisitions of other depository institutions; and
. Access funding through the Federal Home Loan Bank of San Francisco
("FHLB").
In addition, both the Bank and the Company have access to lines of credit
from major financial institutions. The Bank has two warehouse lines of credit
available in the aggregate amount of $250.0 million to fund loan originations,
of which $54.6 million has been drawn upon at September 30, 1997, and is in the
process of negotiating a third warehouse line of credit in the amount of $250.0
million. The Company has a line of credit in the amount of $40.0 million
secured by residual assets created by the Company's securitizations. See "--
Recent Developments."
Diversification Opportunities. The Company is a unitary savings and loan
holding company which generally is not restricted in the types of business
activities which it may conduct provided that the Bank continues to be a
qualified thrift lender ("QTL"). See "Regulation--Federal Savings Institution
Regulation--QTL Test." The Reorganization provided the Company with:
. The opportunity to expand its current product line and enter into
possible new product areas;
. Broader investment opportunities than the Bank; and
. Alternative access, if necessary, to the capital markets.
GROWTH AND OPERATING STRATEGIES
Management believes that, as a result of its competitive strengths, the Bank
and the Company will be able to implement the following growth and operating
strategies:
. Expanding Core Products Through a National Originator Network. The
Company will continue to emphasize and to expand the origination of its
core products, Liberator Series loans and Portfolio Series loans, for
sale through securitizations and in the secondary market. Continued
growth in the origination of core products will result primarily from
geographic expansion and greater penetration in existing markets. In
particular, since the beginning of 1997, the Company has widely
advertised its no income, no asset ("NINA") loan product, which is a
limited documentation, lower loan-to-value loan program within the
Liberator Series. NINA loans constituted $29.2 million of the $152.9
million of Liberator Series loans
4
originated during the nine months ended September 30, 1997. In order to
improve its ability to service its expanding network of Originators, the
Company has established strategically located, low cost regional lending
centers in Riverside, California, Jacksonville, Florida and in the Denver,
Colorado metropolitan area. The Company intends to open three additional
regional lending centers to better serve its Originators over the next
nine months. These regional lending centers are likely to be strategically
located in Northern California and in the Northeast and Midwest sectors of
the United States.
. Expanding Retail Lending Production. The Company's retail lending
operations currently focuses on retail loans located in the Company's
primary market area of Southern California. The retail lending offices
will focus on the origination of Liberator Series and Portfolio Series
loans. In addition, the retail lending offices will originate non-core
product loans to Agency-Qualified Borrowers. Non-core product loans
originated by the retail lending offices will be sold to Loan Purchasers.
The Company intends to gradually and selectively expand its retail
lending operations. As part of this process, the Company has opened two
low cost retail offices and has entered into leases for an additional
four retail offices to be opened by the end of 1997. In addition, the
Company intends to open two retail lending offices in January of 1998.
With the exception of one planned office expected to be opened in
Northern California, the Company's two existing and five of the six
planned retail lending offices will be located in Southern California. In
addition, the Company intends to further expand by opening additional
retail offices outside of Southern California. The Company believes that
expanding its retail lending operations will reduce the possibility that
its borrowers will refinance their loans with other lenders.
. Expanding Multi-Family and Commercial Lending. In continuing with its
tradition as a niche market lender and in an effort to diversify product
offerings, the Company has begun to focus its efforts on the origination
and purchase of multi-family and commercial real estate loans in the
range of $50,000 to $1.5 million both in its primary market area and
throughout the United States through a selected group of originators. The
Company is currently purchasing such loans at a discount and, although
there can be no assurances, expects to be able to continue to purchase
such loans at a discount or low premium. The Company employs underwriters
who specialize in commercial and multi-family real estate lending and
utilizes a select group of appraisers experienced in these products. In
addition, two members of senior management have considerable expertise in
multi-family and commercial real estate lending. The Company was
primarily limited in its ability to originate multi-family and commercial
real estate loans by its level of available capital. The Company is
gradually expanding such originations as its available capital has
increased. For the nine months ended September 30, 1997, the Company
originated $25.1 million of multi-family and commercial loans, as
compared to $7.1 million for the nine months ended September 30, 1996.
The Company believes that it has the infrastructure in place to
accommodate this expansion. All multi-family and commercial real estate
loans are originated for sale in the secondary market and are currently
being sold as whole loans. In the future, they may also be sold through
securitizations.
. Consistently Refining Operating Procedures. The Company intends to
maintain loan quality by continuing to refine its underwriting criteria.
Regularly-scheduled meetings of the Company's underwriting personnel are
held in part to discuss operational issues as well as refinements to the
Company's underwriting policies. In addition, the Company conducts
regular loan delinquency meetings to discuss problem areas in the
Company's servicing portfolio in order to reduce the likelihood of the
recurrence of such problems in future loans. As necessary, the Company
adds personnel to its loan processing staff and continues to utilize
advancements in computer technology to provide prompt turnaround on
loans, efficient underwriting procedures and accurate credit
verification. In addition, the Company has a quality control department
that is dedicated to maintaining quality control, reviews loan files to
assure that each complies with the Company's underwriting policies,
reviews all loans upon first payment default and loans sixty days
delinquent, provides feedback and training to the underwriters to
minimize future defaults and delinquencies, and investigates all
fraudulent loans.
5
. Enhancing Servicing Capabilities. As the Bank has transitioned from a
traditional thrift to a diversified financial services operation, it has
expanded its servicing department from a total of four persons at
December 31, 1994 to 20 persons at September 30, 1997. The head of the
servicing department has 24 years of experience in loan servicing and
collections including responsibility for a $10.0 billion portfolio of
approximately 255,000 loans and a staff of 70 people. In anticipation of
its future servicing needs, the Company has dedicated substantial space
in its current Riverside facility to house loan servicing operations. The
Company is in the process of implementing a power dialing system in its
servicing facility and intends to implement computer imaging in the
future.
. Diversifying Funding Sources. In addition to its traditional thrift
funding sources of deposits and loans from the FHLB, the Company has
diversified its funding sources in recent periods. During the nine months
ended September 30, 1997, net cash received from the Company's
securitizations and sales provided a significant source of funding to the
Company, aggregating $277.6 million for that period. The Bank has two
warehouse lines of credit available in the aggregate amount of $250.0
million to fund loan originations, of which $54.6 million has been drawn
upon at September 30, 1997, and is in the process of negotiating a third
warehouse line of credit in the amount of $250.0 million. The Company has
a line of credit in the amount of $40.0 million secured by residual
assets created by the Company's securitizations.
CORPORATE STRUCTURE
The Company and the Bank consummated the Reorganization in June of 1997
whereby the Bank became a wholly-owned subsidiary of the Company. Management
believes that the holding company form of organization provides the Company
with more flexibility and a greater ability to compete with other financial
services companies in the market place. In addition, due to regulatory capital
limitations, the Bank is limited in the amount of investments in residuals and
restricted cash resulting from securitizations that it can retain. The Company
is not subject to such limitations, and thus will reduce the restrictions on
the Bank's regulatory capital by acquiring and holding the residuals upon
completion of a securitization.
RECENT DEVELOPMENTS
Recent Loan Origination Volume. The Company originated and purchased
approximately $132.0 million in mortgage loans during the two months ended
November 30, 1997, exclusive of loans acquired in a bulk purchase discussed
below, see "--Bulk Purchases," as compared to $194.4 million of mortgage loans
originated and purchased during the three months ended September 30, 1997. Of
the loans originated during this period, $34.2 million were Liberator Series
(full documentation) loans, $12.9 million were Liberator Series (NINA) loans,
$75.9 million were Portfolio Series loans and $9.0 million were multi-family
and commercial real estate loans.
Bulk Purchases. During the two months ended November 30, 1997, the Company
purchased $91.1 million of loans in a bulk purchase. The loans are high loan-
to-value ratio loans similar in terms to the Company's Portfolio Series loans.
These loans were originated by approximately 100 correspondents of the seller.
The Company had previously purchased loans from approximately 30 of such
entities and consequently the Company had reviewed their underwriting
guidelines, in the manner specified under "Business--Core Lending Products--
Underwriting." With respect to the approximately 70 other entities, the Company
performed a limited review of their underwriting guidelines. The Company
reviewed a significant sample of the acquired loans, with an emphasis on loans
originated by those entities with whom the Company had no prior relationship,
to determine, among other things, whether they complied with the Company's
underwriting standards, and, based on such review, the Company believes that
the acquired loans conform in all material respects with the Company's
underwriting guidelines. The purchase is subject to standard loan repurchase or
substitution obligations on the part of the seller, and the Company
additionally has the right to enforce such repurchase or substitution
obligations against the initial originators of the loans. The Company intends
to include the $91.1 million of bulk purchase loans in the securitization
discussed below.
6
Recent Securitization Activities. The Company is in the process of issuing
$250.0 million in home loan asset-backed notes through a securitization. The
notes will be backed by Portfolio Series loans. The initial funding will be
approximately $190.0 million. The Company expects to complete this
securitization by December 31, 1997.
Lines of Credit. As a means of increasing its access to borrowed funds, the
Bank is currently in the process of negotiating an additional $250.0 million
warehouse line of credit with a national investment banking firm. The warehouse
line of credit is expected to be secured by loans originated and purchased by
the Company. The Company has recently entered into a $40.0 million line of
credit with a national investment banking firm secured by residuals generated
by the Company's securitization activities. Management anticipates that such
lines of credit will provide the Company with the ability to increase its loan
production activities, as well as providing the Company with the ability to
borrow against the residuals; however, one of the lines of credit is still
being negotiated, and there can be no assurances that a definitive agreement
will be reached, or if an agreement is reached, that it will conform to the
terms outlined above.
Low Cost Retail Offices. As part of the Company's efforts to expand its
retail lending operations, the Company recently opened two low cost retail
lending offices, and has entered into leases for an additional four retail
lending offices to be opened by the end of 1997. In addition, the Company
intends to open two retail lending offices in the first quarter of 1998. With
the exception of one planned office expected to be opened in Northern
California, the Company's two current and five of the six planned retail
lending offices will be located in Southern California.
LIFE FINANCIAL CAPITAL TRUST
The Trust is a statutory business trust created under Delaware law pursuant
to (i) a declaration of trust, executed by the Company, as Sponsor, State
Street, as Property Trustee, Delaware Trust Capital Management (Delaware), as
Delaware Trustee and an executive officer of the Company, as Initial Trustee,
and (ii) the filing of a certificate of trust with the Delaware Secretary of
State on December 2, 1997. The Trust's affairs will be conducted by the
Property Trustee and the Delaware Trustee, and by the Administrators who are
employees or officers of or affiliated with the Company. The Trust exists for
the exclusive purposes of (i) issuing and selling the Trust Securities, (ii)
using the proceeds from the sale of the Trust Securities to acquire the Junior
Subordinated Debentures, and (iii) engaging in only those other activities
necessary, advisable or incidental thereto (such as registering the transfer of
the Capital Securities). Accordingly, the Junior Subordinated Debentures will
be the sole assets of the Trust, and payments under the Junior Subordinated
Debentures will be the sole revenue of the Trust. All of the Common Securities
will be owned by the Company.
THE CAPITAL SECURITIES
Securities Offered............. Up to % Capital Securities (Liquidation
Amount $ per Capital Security), which rep-
resent preferred undivided beneficial inter-
ests in the assets of the Trust. The Junior
Subordinated Debentures held by the Trust will
mature on , 2027. All Capital Securities
are being offered hereby to the public in the
Offering by the Underwriter.
Offering Price................. $ per Capital Security.
Distribution Dates............. March 15, June 15, September 15 and December
15 of each year, commencing March 15, 1998.
Extension Periods.............. So long as no Debenture Event of Default has
occurred and is continuing, Distributions on
Capital Securities may be deferred
7
for the duration of any Extension Period
elected by theCompany with respect to the pay-
ment of interest on the Junior Subordinated
Debentures. No Extension Period will exceed
20 consecutive quarters or extend beyond the
Stated Maturity Date. See "Description of Ju-
nior Convertible Subordinated Debentures--Op-
tion to Extend Interest Payment Date" and
"Certain Federal Income Tax Considerations--
Interest, Original Issue Discount, Premium and
Market Discount."
Ranking........................ The Capital Securities will rank pari passu,
and payments thereon will be made pro rata,
with the Common Securities except as described
under "Description of Capital Securities--Sub-
ordination of Common Securities." The Junior
Subordinated Debentures will rank pari passu
with all other junior subordinated debentures
issued by the Company ("Other Debentures"),
which will be issued and sold (if at all) to
other trusts established by the Company (if
any), in each case similar to the Trust
("Other Trusts"), and will be unsecured and
subordinate and rank junior in right of pay-
ment to all Senior Indebtedness of the Company
to the extent and in the manner set forth in
the Indenture. See "Description of Junior Con-
vertible Subordinated Debentures." There are
currently no other securities that would con-
stitute Other Debentures. The Guarantee will
constitute an unsecured obligation of the Com-
pany and will be subordinate and rank junior
in right of payment to all Senior Indebtedness
of the Company to the extent and in the manner
set forth in the Guarantee Agreement. In addi-
tion, because the Company is a holding compa-
ny, the Company's obligations under the Junior
Subordinated Debentures and the Guarantee ef-
fectively will be subordinated to all existing
and future liabilities, including indebted-
ness, of the Company's subsidiaries, including
the Bank's deposit liabilities. See "Descrip-
tion of the Guarantee" and "Risk Factors Re-
lated to the Capital Securities--Ranking of
Subordinate Obligations Under the Guarantee
and Junior Subordinated Debentures."
Conversion into Common Stock... Each Capital Security is convertible at the
option of the holder thereof, at any time
prior to the earlier of (i) 5:00 p.m. Pacific
time) on the Business Day immediately preced-
ing the date of repayment of such Capital Se-
curity, whether at maturity or upon redemp-
tion, and (ii) 5:00 p.m. (Pacific time) on the
Conversion Termination Date (if any) into
shares of Common Stock at a conversion rate of
shares of Common Stock of the Company for
each Capital Security (equivalent to a conver-
sion price of $ per share of Common Stock)
(the "Conversion Price"). On December , 1997,
the last reported sales price of the Common
Stock on the Nasdaq was $ per share. In
connection with any conversion of a Capital
Security, the Conversion Agent (as defined
herein) will exchange such Capital Security
for the appropriate principal amount of Junior
8
Subordinated Debentures held by the Trust and
immediately convert such Junior Subordinated
Debentures into shares of Common Stock. No
fractional shares of Common Stock will be is-
sued as a result of conversion, but in lieu
thereof such fractional interest will be paid
by the Company in cash. See""Description of
Capital Securities--Conversion Rights." Hold-
ers of Capital Securities at 5:00 p.m. (Pa-
cific time) on a Distribution Record Date (as
defined herein) will be entitled toreceive the
Distribution payable upon such Capital Securi-
ties on the corresponding Distribution Date
notwithstanding the conversion of such Capital
Securities following such Distribution Record
Date but on or prior to such Distribution
Date.
Termination of Conversion
Rights........................ In addition to the rights of the Company to
redeem the Capital Securities under the cir-
cumstances described in this Prospectus, the
Company also will have the right to terminate
the convertibility of the Capital Securities
into Common Stock as described in this para-
graph. If for at least 20 trading days within
any period of 30 consecutive trading days end-
ing on or after , , including the last
trading day of such period, the Closing Price
of the Common Stock exceeds % of the then ap-
plicable Conversion Price of the Capital Secu-
rities, the Company may, at its option, termi-
nate the right to convert the Junior Subordi-
nated Debentures into Common Stock, in which
case the right to convert the Capital Securi-
ties into Common Stock will likewise termi-
nate. To exercise this conversion termination
option, the Company must cause the Trust to
issue a press release announcing the Conver-
sion Termination Date, prior to the opening of
business on the second trading day after a pe-
riod in which the condition in the preceding
sentence has been met, but in no event may
such press release be issued prior to ,
. Notice of termination of conversion rights
will be given by first-class mail to the hold-
ers of the Capital Securities not more than
four Business Days after the Trust issues the
press release. The Conversion Termination Date
shall be a Business Day not less than 30 and
not more than 60 days following the date of
the press release described above. See "De-
scription of Capital Securities--Conversion
Rights."
Redemption..................... The Trust Securities will be subject to manda-
tory redemption in a Like Amount, (i) in whole
but not in part, on the Stated Maturity Date
upon repayment of the Junior Subordinated
Debentures, (ii) in whole but not
in part, at any time, contemporaneously with
the optional prepayment of all of the Junior
Subordinated Debentures by the Company upon
the occurrence and continuation of a Special
Event and (iii) in whole or in part, on or af-
ter the Initial Optional Prepayment Date, con-
temporaneously with the optional prepayment by
the Company of all or a part of the Junior
Subordinated Debentures, in each case at the
applicable Redemption Price. See "Description
of CapitalSecurities--Redemption."
9
ERISA Considerations........... Prospective purchasers should consider the re-
strictions on purchase set forth under "ERISA
Considerations."
Absence of Market for the
Capital Securities............
The Capital Securities will be a new issue of
securities for which there currently is no
market. Although the Company has applied to
have the Capital Securities approved for quo-
tation on the Nasdaq, there can be no assur-
ance that such application will be approved,
that an active trading market for the Capital
Securities will develop or, if one does
develop, that it will be maintained. Accord-
ingly, there can be no assurance as to the de-
velopment or liquidity of any market for the
Capital Securities.
USE OF PROCEEDS
All of the proceeds to the Trust from the sale of the Trust Securities will
be invested by the Trust in the Junior Subordinated Debentures. The net
proceeds from the sale of the Junior Subordinated Debentures will be available
to the Company for general corporate purposes, which may include, but not be
limited to, the refinancing or prepayment of existing debt obligations, which
may be of shorter maturity or higher coupon rate; the downstreaming of capital
to the Bank, and the financing of future residuals resulting from
securitizations; the acquisition of loan portfolios from other depository
institutions or finance companies; and possible acquisitions of depository
institutions or branches of depository institutions. The Company has not
entered into any arrangement, agreement or understanding with respect to future
acquisitions and there can be no assurances that it will do so in the future.
No determination has been made as to the amount of proceeds, if any, that will
be allocated to any of the above-mentioned potential uses. Initially, the net
proceeds may be used to make short-term investments. Under current policy, the
Office of Thrift Supervision (the "OTS") does not impose any capital adequacy
requirements on the Company, but does impose such capital adequacy requirements
on the Bank. To the extent the Company contributes a portion of the net
proceeds received from the sale of the Capital Securities to the Bank, such
proceeds would qualify as Tier 1 capital at the Bank level under the current
capital adequacy guidelines of the OTS. See "Use of Proceeds."
RISK FACTORS
Prospective investors should carefully consider the matters set forth under
"Risk Factors Related to the Capital Securities" and "Risk Factors Related to
the Company."
10
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial and other data of the Company at or for
the years ended December 31, 1996, 1995, 1994, 1993 and 1992 and at or for the
nine months ended September 30, 1997 and 1996, set forth below is derived in
part from, and should be read in conjunction with, the Financial Statements of
the Company and Notes thereto as of December 31, 1996 and 1995 and for each of
the three years in the period ended December 31, 1996 presented elsewhere in
this Prospectus. Financial information at September 30, 1997, and for the nine
month periods ended September 30, 1997 and 1996 is derived from unaudited
financial data, but in the opinion of management, reflects all adjustments
(consisting only of normal recurring adjustments) which are necessary to
present fairly the results for such interim periods. Interim results at and for
the nine months ended September 30, 1997 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1997. The Company
and the Bank did not pay any cash dividends in any of the periods set forth.
AT AT DECEMBER 31,
SEPTEMBER 30, -------------------------------------------------
1997 1996 1995 1994 1993 1992
------------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
SELECTED BALANCE SHEET
DATA:
Total assets............ $ 294,102 $ 104,010 $ 74,136 $ 71,402 $ 78,256 $ 78,788
Securities held-to-
maturity and FHLB
stock.................. 8,065 8,837 2,700 2,860 3,883 4,829
Loans held for sale..... 191,555 31,018 21,688 17,070 2,348 4,499
Loans held for
investment............. 33,992 38,520 42,870 47,939 64,820 61,182
Allowance for estimated
loan losses............ 1,859 1,625 1,177 832 436 308
Residual asset at fair
value.................. 24,533 5,700 -- -- -- --
Mortgage servicing
rights................. 5,713 2,645 683 -- -- --
Deposit accounts........ 159,840 85,711 67,535 65,689 72,008 71,719
Borrowings.............. 71,523 -- -- 1,250 1,200 2,000
Stockholders' equity.... 49,477 9,273 4,268 3,748 4,419 4,326
Book value per
share(1)............... $ 7.56 $ 2.89 $ 2.29 $ 2.01 $ 2.37 $ 2.55
Shares outstanding(1)... 6,546,716 3,211,716 1,866,216 1,866,216 1,866,216 1,696,410
FOR THE NINE
MONTHS ENDED
SEPTEMBER 30, FOR THE YEAR ENDED DECEMBER 31,
------------------- --------------------------------------------------
1997 1996 1996 1995 1994 1993 1992
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
SELECTED OPERATING DATA:
Interest income......... $ 12,152 $ 4,922 $ 6,929 $ 5,825 $ 4,824 $ 5,445 $ 6,143
Interest expense........ 7,101 2,699 3,766 3,448 2,721 3,045 3,687
--------- --------- --------- --------- --------- --------- ---------
Net interest income.... 5,051 2,223 3,163 2,377 2,103 2,400 2,456
Provision for estimated
loan losses............ 900 359 963 1,194 1,306 404 129
--------- --------- --------- --------- --------- --------- ---------
Net interest income
after provision for
estimated loan
losses................ 4,151 1,864 2,200 1,183 797 1,996 2,327
Net gains from mortgage
financing operations... 17,413 3,759 8,352 3,575 1,428 1,144 1,380
Other non-interest
income................. 772 505 760 445 260 253 352
Non-interest expense:
Compensation and
benefits.............. 5,534 3,206 5,233 2,544 1,575 1,403 1,426
Net loss on foreclosed
real estate........... 94 171 158 53 280 228 78
SAIF special
assessment............ -- 448 448 -- -- -- --
Other expense.......... 3,522 1,993 2,842 1,792 1,601 1,562 2,045
--------- --------- --------- --------- --------- --------- ---------
Total non-interest
expense............... 9,150 5,818 8,681 4,389 3,456 3,193 3,549
--------- --------- --------- --------- --------- --------- ---------
Income (loss) before
income tax provision
(benefit).............. 13,186 310 2,631 814 (971) 200 510
Income tax provision
(benefit).............. 5,491 142 1,126 294 (300) 107 148
--------- --------- --------- --------- --------- --------- ---------
Net income (loss)....... $ 7,695 $ 168 $ 1,505 $ 520 $ (671) $ 93 $ 362
========= ========= ========= ========= ========= ========= =========
Earnings (loss) per
share(2)............... $ 1.70 $ 0.08 $ 0.63 $ 0.28 $ (0.36) $ 0.05 $ 0.22
========= ========= ========= ========= ========= ========= =========
Weighted average shares
outstanding(2)......... 4,522,251 2,090,466 2,370,779 1,866,216 1,866,216 1,823,765 1,644,886
========= ========= ========= ========= ========= ========= =========
(continued on following page)
11
AT OR FOR THE
NINE MONTHS ENDED
SEPTEMBER 30, AT OR FOR THE YEAR ENDED DECEMBER 31,
------------------ ----------------------------------------------
1997 1996 1996 1995 1994 1993 1992
-------- -------- -------- -------- ------- ------- -------
(DOLLARS IN THOUSANDS)
SELECTED FINANCIAL
RATIOS AND OTHER
DATA(3):
PERFORMANCE RATIOS:
Return on average
assets................ 5.07% 0.27% 1.74% 0.69% (0.89)% 0.12% 0.46%
Return on average
equity................ 44.25 4.30 24.99 13.64 (17.01) 2.11 8.92
Average equity to
average assets........ 11.46 6.28 6.98 5.04 5.22 5.51 5.17
Equity to total assets
at end of period...... 16.82 9.40 8.92 5.76 5.25 5.65 5.49
Average interest rate
spread(4)............. 3.16 3.72 3.76 3.09 2.79 3.02 3.04
Net interest
margin(5)............. 3.76 3.86 3.94 3.25 2.88 3.14 4.29
Average interest-
earning assets to
average interest-
bearing liabilities... 111.35 102.96 103.90 103.50 102.27 103.08 103.64
Efficiency Ratio(6).... 38.97 87.05 69.43 67.78 83.78 78.09 82.88
Ratio of Earnings to
Fixed Charges:
Excluding interest on
deposits.............. 7.82 1.88 6.53 3.05 (2.11) 1.54 2.67
Including interest on
deposits.............. 2.79 1.11 1.66 1.23 0.66 1.06 1.13
LOAN ORIGINATIONS AND
PURCHASES.............. $433,408 $148,389 $222,553 $134,772 $72,815 $82,015 $90,870
BANK REGULATORY CAPITAL
RATIOS(7):
Tangible capital....... 6.19% 9.40% 8.90% 5.68% 5.25% 5.65% 5.49%
Core capital........... 6.19 9.40 8.90 5.68 5.25 5.65 5.49
Risk-based capital..... 13.49 16.06 9.43 10.17 10.00 10.87 10.56
ASSET QUALITY RATIOS:
Non-performing assets
as a percent of total
assets(8)............. 1.38% 3.36% 2.86% 3.00% 3.42% 5.05% 4.15%
Allowance for estimated
loan losses as a
percent of non-
performing loans...... 60.49 55.66 67.26 84.25 44.04 20.02 16.29
- --------
(1) Book value per share is based upon the shares outstanding at the end of
each period, adjusted for a 100% stock dividend which occurred during 1996.
Book value per share is then adjusted for the exchange of three shares of
Company Common Stock for one share of Bank common stock in the
Reorganization.
(2) Earnings per share is based upon the weighted average shares outstanding
during the period, adjusted for a 100% stock dividend which occurred during
1996. Earnings per share is then adjusted for the exchange of three shares
of Company Common Stock for one share of Bank common stock in the
Reorganization.
(3) Asset Quality Ratios and Regulatory Capital Ratios are end of period
ratios. With the exception of end of period ratios, all ratios are based on
average daily or average month-end balances during the indicated periods.
(4) The average interest rate spread represents the difference between the
weighted average yield on interest-earning assets and the weighted average
cost of interest-bearing liabilities.
(5) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(6) The efficiency ratio represents noninterest expense less (gain) loss on
foreclosed real estate divided by noninterest income plus net interest
income before provision for estimated loan losses.
(7) For definitions and further information relating to the Bank's regulatory
capital requirements, see "Regulation--Federal Savings Institution
Regulation--Capital Requirements."
(8) Non-performing assets consist of non-performing loans and REO. See
"Business--Lending Overview--Non-Accrual and Past-Due Loans" and "--REO."
12
QUARTERLY OPERATING AND OTHER DATA
Financial information of the Company at September 30, June 30, and March 31,
1997 and December 31 and September 30, 1996 and for the quarters ended
September 30, June 30, and March 31, 1997, and December 31 and September 30,
1996 is derived from unaudited financial data, but in the opinion of
management, reflects all adjustments (consisting of only normal recurring
adjustments) which are necessary to present fairly the results of such interim
periods. Interim results at or for the quarters ended September 30, June 30,
and March 31, 1997 are not necessarily indicative of the results for the year
ending December 31, 1997.
AT OR FOR THE QUARTER ENDED
------------------------------------------------------------
SEPTEMBER 30, JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30,
1997 1997 1997 1996 1996
------------- -------- --------- ------------ -------------
(DOLLARS IN THOUSANDS)
SELECTED OPERATING DATA:
Interest income......... $ 5,697 $ 4,151 $ 2,304 $ 2,007 $ 1,569
Interest expense........ 3,080 2,460 1,561 1,067 844
-------- -------- ------- ------- -------
Net interest income... 2,617 1,691 743 940 725
Provision for estimated
loan losses............ 400 -- 500 604 251
-------- -------- ------- ------- -------
Net interest income
after provision for
estimated loan
losses............... 2,217 1,691 243 336 474
Net gains from mortgage
financing operations... 8,344 3,192 5,877 4,593 1,599
Other non-interest
income................. 358 206 208 256 192
Non-interest expense:
Compensation and
benefits............. 2,477 1,475 1,582 2,026 1,056
Net loss (gain) on
foreclosed real
estate............... 25 6 63 (13) 71
SAIF Special
Assessment........... -- -- -- -- 448
Other expense......... 1,677 998 847 851 671
-------- -------- ------- ------- -------
Total non-interest
expense............ 4,179 2,479 2,492 2,864 2,246
-------- -------- ------- ------- -------
Income before income tax
provision.............. 6,740 2,610 3,836 2,321 19
Income tax provision.... 2,809 1,088 1,594 984 17
-------- -------- ------- ------- -------
Net income.............. $ 3,931 $ 1,522 $ 2,242 $ 1,337 $ 2
======== ======== ======= ======= =======
Earnings per share(1)... $ 0.57 $ 0.47 $ 0.70 $ 0.42 $ 0.00
======== ======== ======= ======= =======
SELECTED FINANCIAL
RATIOS AND OTHER
DATA(2):
PERFORMANCE RATIOS:
Return on average
assets............... 5.41% 3.45% 6.32% 5.56% 0.01%
Return on average
equity............... 33.32 48.91 90.48 61.35 0.12
Average equity to
average assets....... 16.24 7.05 6.99 8.77 8.42
Equity to total assets
at end of period..... 16.82 21.38 7.30 8.92 9.40
Average interest rate
spread(3)............ 3.15 3.97 2.32 4.09 3.93
Net interest
margin(4)............ 4.27 4.08 2.44 4.22 3.95
Average interest-
earning assets to
average interest-
bearing liabilities.. 122.31 101.78 102.43 104.64 103.25
Efficiency Ratio(5)... 36.70 48.59 35.57 49.70 86.45
LOAN ORIGINATIONS AND
PURCHASES.............. $194,447 $152,230 $86,731 $74,164 $44,536
BANK REGULATORY CAPITAL
RATIOS(6):
Tangible capital...... 6.19% 7.47% 7.19% 8.90% 9.40%
Core capital.......... 6.19 7.47 7.19 8.90 9.40
Risk-based capital.... 13.49 18.61 10.51 9.43 16.06
ASSET QUALITY RATIOS:
Non-performing assets
as a percent of total
assets(7)............ 1.38 1.86 1.85 2.86 3.36
Allowance for
estimated loan losses
as a percent of
non-performing
loans................ 60.49 63.29 103.62 67.26 55.66
(footnotes on following page)
13
- --------
(1) Earnings per share is based on the weighted average shares outstanding
during the period, adjusted for a 100% stock dividend which occurred during
1996. Earnings per share is then adjusted for the exchange of three shares
of Company Common Stock for one share of Bank common stock in the
Reorganization.
(2) Asset Quality Ratios and Regulatory Capital Ratios are end of period
ratios. With the exception of end of period ratios, all ratios are based on
average closing or average month-end balances during the indicated periods
and are annualized where appropriate.
(3) The average interest rate spread represents the difference between the
weighted average yield on interest-earning assets and the weighted average
cost of interest-bearing liabilities.
(4) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(5) The efficiency ratio represents noninterest expense less (gain) loss on
foreclosed real estate divided by noninterest income plus net interest
income before provision for estimated loan losses.
(6) For definitions and further information relating to the Bank's regulatory
capital requirements, see "Regulation--Federal Savings Institution
Regulation--Capital Requirements."
(7) Non-performing assets consist of non-performing loans and REO. See
"Business--Lending Overview--Non-Accrual and Past-Due Loans" and "--REO."
14
RISK FACTORS RELATED TO THE CAPITAL SECURITIES
Prospective purchasers of Capital Securities should carefully review the
information contained elsewhere in this Prospectus and should particularly
consider the following matters.
RANKING OF SUBORDINATE OBLIGATIONS UNDER THE GUARANTEE AND JUNIOR SUBORDINATED
DEBENTURES
The obligations of the Company under the Guarantee and under the Junior
Subordinated Debentures will be unsecured and subordinate and rank junior in
right of payment to all present and future Senior Indebtedness of the Company
to the extent and in the manner set forth in the Guarantee and the Indenture,
respectively. No payment may be made of the principal of, or premium, if any,
or interest on the Junior Subordinated Debentures, or in respect of any
redemption, retirement, purchase or other acquisition of any of the Junior
Subordinated Debentures, or under the Guarantee, at any time when (i) there
shall have occurred and be continuing a default in any payment in respect of
any Senior Indebtedness, or there has been an acceleration of the maturity
thereof because of a default or (ii) in the event of the acceleration of the
maturity of the Junior Subordinated Debentures, until payment has been made on
all Allocable Amounts (as defined herein) of Senior Indebtedness. At September
30, 1997, the Company had no Senior Indebtedness. None of the Guarantee, the
Indenture, the Common Guarantee or the Declaration places any limitation on
the amount of secured or unsecured debt, including Senior Indebtedness, that
may be incurred by the Company in the future. The Company may from time to
time to incur additional indebtedness constituting Senior Indebtedness. See
"Description of Junior Subordinated Debentures--Subordination" and
"Description of the Guarantee--Status."
The ability of the Trust to pay amounts due on the Capital Securities is
wholly dependent upon the Company making payments on the Junior Convertible
Subordinated Debentures as and when required.
HOLDING COMPANY STRUCTURE
Because the Company is a holding company, the right of the Company to
participate in any distribution of assets of any subsidiary upon such
subsidiary's liquidation or reorganization or otherwise (and thus the ability
of holders of the Capital Securities to benefit indirectly from such
distribution) is subject to the prior claims of creditors of that subsidiary
(including depositors in the case of the Bank), except to the extent that the
Company may itself be recognized as a creditor of that subsidiary. At
September 30, 1997, the subsidiaries of the Company had total liabilities
(excluding liabilities owed to the Company) of approximately $242.6 million,
including deposits, in the case of the Bank. Accordingly, the Capital
Securities will be effectively subordinated to all existing and future
liabilities of the Company's subsidiaries, and holders of Capital Securities
should look only to the assets of the Company for payments on the Capital
Securities. None of the Guarantee, the Indenture, the Common Guarantee or the
Declaration places any limitation on the amount of secured or unsecured debt
that may be incurred by the Company's subsidiaries in the future. See
"Description of Junior Convertible Subordinated Debentures--General" and
"Description of the Guarantee--General."
In addition, as the Company is a holding company, a majority of the
operating assets of the Company are owned by the Company's subsidiaries. The
Company may rely on dividends from such subsidiaries to meet its obligations
for payment of principal and interest on its outstanding debt obligations and
corporate expenses. To the extent that the Company becomes dependent on the
Bank for such payments, the Bank will be subject to certain restrictions
imposed by federal law on any extensions of credit to, and certain other
transactions with, the Company and certain other affiliates, and on
investments in stock or other securities thereof. Such restrictions prevent
the Company and such other affiliates from borrowing from the Bank unless the
loans are secured by various types of collateral. Further, such secured loans,
other transactions and investments by the Bank are generally limited in amount
as to the Company and as to each of such other affiliates to 10% of the Bank's
capital and surplus and as to the Company and all of such other affiliates to
an aggregate of 20% of the Bank's capital and surplus. In addition, payment of
dividends to the Company by the Bank is subject to ongoing review by banking
regulators and is subject to various statutory limitations and in certain
circumstances requires prior approval by banking regulatory authorities.
Federal regulatory agencies also have the authority to limit further
15
the Bank's payment of dividends based on other factors, such as the
maintenance of adequate capital for the Bank, which could reduce the amount of
dividends otherwise payable to the Company.
OPTION TO EXTEND INTEREST PAYMENT PERIOD; TAX CONSIDERATIONS
So long as no Debenture Event of Default shall have occurred and be
continuing, the Company will have the right under the Indenture to defer
payments of interest on the Junior Subordinated Debentures at any time or from
time to time for a period not exceeding 20 consecutive quarters with respect
to each Extension Period, provided that no Extension Period may extend beyond
the Stated Maturity Date. Upon any such deferral, quarterly Distributions on
the Capital Securities by the Trust will be deferred (and the amount of
Distributions to which holders of the Capital Securities are entitled will
accumulate additional Distributions thereon at the rate of % per annum,
compounded quarterly (to the extent permitted by applicable law)) from the
relevant payment date for such Distributions during any such Extension Period.
The Company may extend any existing Extension Period, provided that such
extension does not cause such Extension Period to exceed 20 consecutive
quarters or to extend beyond the Stated Maturity Date. Upon the expiration of
any Extension Period and the payment of all interest then accrued and unpaid
on the Junior Subordinated Debentures (together with interest thereon at the
annual rate of %, compounded quarterly, to the extent permitted by applicable
law), the Company may elect to begin a new Extension Period, subject to the
above requirements. There is no limitation on the number of times that the
Company may elect to begin an Extension Period. See "Description of Capital
Securities--Distributions" and "Description of Junior Convertible Subordinated
Debentures--Option to Extend Interest Payment Period."
The Company believes that, as a result of its inability to pay any dividends
or distributions on, or redeem, purchase, acquire or make a liquidation
payment with respect to, its Common Stock during an Extension Period and the
additional restrictions imposed upon it to the extent described under
"Description of Junior Convertible Subordinated Debentures--Option to Extend
Interest Payment Date," the likelihood of its exercising its right to defer
payments of interest is remote. However, should the Company exercise its
rights to defer payments of interest by extending the interest payment period
or should the Junior Subordinated Debentures be deemed to have been issued
with original issue discount ("OID"), each holder of Capital Securities will
be required to accrue income (as OID) for federal income tax purposes in
respect of the deferred interest allocable to its Capital Securities. As a
result, holders of Capital Securities will recognize income for federal income
tax purposes in advance of the receipt of cash and will not receive the cash
from the Trust related to such income if such holder disposes of its Capital
Securities prior to the record date for the date on which Distributions of
such amounts are made. The Company has no current intention of exercising its
right to defer payments of interest by extending the interest payment period
on the Junior Subordinated Debentures. However, should the Company determine
to exercise such right in the future, the market price of the Capital
Securities is likely to be affected. A holder that disposes of its Capital
Securities during an Extension Period, therefore, might not receive the same
return on its investment as a holder that continues to hold its Capital
Securities. In addition, as a result of the existence of the Company's rights
to defer interest payments, the market price of the Capital Securities (which
represents a preferred undivided beneficial interest in the Junior
Subordinated Debentures) may be more volatile than other securities on which
OID accrues that do not have such rights. See "Certain Federal Income Tax
Considerations--Interest, Original Issue Discount, Premium and Market
Discount" and "--Sales or Redemption of Capital Securities."
REDEMPTION OR DISTRIBUTION
Upon the occurrence and continuation of a Special Event (including a Tax
Event, a Regulatory Capital Event or an Investment Company Event, in each case
as defined under "Description of Junior Convertible Subordinated Debentures--
Special Event Prepayment"), the Company will have the right to prepay the
Junior Subordinated Debentures, in whole, but not in part, at the Special
Event Prepayment Price within 90 days following the occurrence of such Special
Event and therefore cause a mandatory redemption of the Capital Securities at
the Special Event Redemption Price. On or after the Initial Optional
Prepayment Date, the Company
16
may prepay the Junior Subordinated Debentures, in whole or in part, for any
reason and thereby cause an optional redemption of the Capital Securities, in
whole or in part, at the Optional Redemption Price. See "Description of
Capital Securities--Redemption" and "--Liquidation of the Trust and
Distribution of Junior Subordinated Debentures."
The Company will have the right at any time to dissolve the Trust and, after
satisfaction of or provision for liabilities to creditors of the Trust as
required by applicable law, cause the Junior Subordinated Debentures to be
distributed to the holders of the Trust Securities in liquidation of the
Trust. Such right is subject to the Company having received an opinion of
counsel to the effect that such distribution will not be a taxable event to
holders of Capital Securities. Under current federal income tax law, a
distribution of Junior Subordinated Debentures upon the dissolution of the
Trust would not be a taxable event to holders of the Capital Securities. If,
however, the Trust is characterized for federal income tax purposes as an
association taxable as a corporation at the time of dissolution of the Trust,
the distribution of the Junior Subordinated Debentures may constitute a
taxable event to holders of Capital Securities. Moreover, upon the occurrence
of a Special Event, a dissolution of the Trust in which holders of the Capital
Securities receive cash would be a taxable event to such holders. See "Certain
Federal Income Tax Considerations--Receipt of Junior Subordinated Debentures
Upon Liquidation of the Trust."
The Company believes that under current law it is entitled to deduct the
interest accruing on the Junior Subordinated Debentures. Under the Taxpayer
Relief Act of 1997, enacted on August 5, 1997, issuers of certain convertible
debt instruments are not entitled to deduct interest thereon. For example,
interest is not deductible if the debt instrument is convertible into equity
of the issuer (or a related party) at the option of the holder and there is a
substantial certainty that the holder will exercise the conversion option.
Similarly, interest is not deductible if the debt instrument is part of an
arrangement which is reasonably expected to result in a conversion at the
option of the issuer (or a related party). The Company believes that this
legislation should not apply to the Junior Subordinated Debentures. The
Internal Revenue Service (the "Service"), however, has not yet issued any
guidance regarding its interpretation of the new legislation. There can be no
assurance that the Service will not take the position that interest on the
Junior Subordinated Debentures is not deductible. Accordingly, there can be no
assurance that an audit or future interpretation by the Service of the new
legislation will not result in a Tax Event and an early redemption of the
Capital Securities before, or after, , at the Special Event
Redemption Price.
In addition, in recent years, there have been several proposals to adopt
legislation which, if enacted and made applicable to the Junior Subordinated
Debentures, would preclude the Company from deducting interest thereon. The
most recent proposal was made by the Clinton Administration on March 19, 1997.
Such proposals have not been adopted by Congress, but there can be no
assurance that similar proposals will not be adopted in the future and made
applicable to the Junior Subordinated Debentures. Accordingly, there can be no
assurance that any such legislation will not result in a Tax Event which would
permit the Company to cause a redemption of the Capital Securities before, or
after, , at the Special Event Redemption Price.
Under current law, the Bank is a federal savings association, and the
Company is a savings and loan holding company that is not subject to
regulation as a bank holding company under the Bank Holding Company Act of
1956, as amended. However, legislation currently pending in Congress, known as
the Financial Services Competition Act of 1997, provides for the termination
of federal savings association charters and their conversion into bank
charters. This legislation also provides for the registration of the holding
companies of converted federal savings associations as bank holding companies,
with certain grandfathered rights not available to other bank holding
companies. In the event that this legislation is adopted, the Company could be
required to register, and become subject to regulation, as a bank holding
company. The currently pending legislation would grandfather the manner of
regulation of regulatory capital currently applicable to savings and loan
holding companies, subject to certain conditions. However, the grandfather
protection would be lost under certain circumstances such as a change in
control of the holding company. Bank holding companies, unlike savings and
loan holding companies such as the Company, are subject to consolidated
regulatory capital adequacy
17
requirements. Currently, the Company is not subject to any consolidated
regulatory capital adequacy requirements. A bank holding company would only be
able to include the amount of the proceeds received from the Offering in
calculating the company's consolidated capital adequacy requirements to an
amount not exceeding 25% of the Company's Tier 1 capital. There can be no
assurance that the adoption of this or any other similar legislation in the
future will not result in a Regulatory Capital Event (as defined herein) which
would permit the Company to cause a redemption of the Capital Securities at
any time before, or after, , at the Special Event Redemption Price.
See "Description of Capital Securities--Redemption," "Description of Junior
Convertible Subordinated Debentures--Special Event Prepayment" and "Certain
Federal Income Tax Considerations--Sale or Redemption of Capital Securities."
See also "--Absence of Public Market and Transfer Restrictions" for
information concerning the listing of the Junior Subordinated Debentures.
TERMINATION OF CONVERSION RIGHTS
On and after , , the Company may, subject to certain conditions
including advance public notice, at its option, cause the conversion rights of
holders of Junior Subordinated Debentures to terminate, provided that the
Closing Price of the Common Stock exceeds % of the then applicable Conversion
Price of the Capital Securities for a specified period, in which case the
right to convert the Capital Securities into Common Stock will likewise
terminate thereby limiting the rights of the holders to those of a creditor of
the Company. See "Description of Capital Securities--Conversion Rights--
Termination of Conversion Rights."
POSSIBLE ADVERSE EFFECT ON MARKET PRICES
There can be no assurance as to the market prices for the Capital Securities
or, if a termination of the Trust were to occur, for the Junior Subordinated
Debentures distributed to the holders of Capital Securities. Accordingly, the
Capital Securities or the Junior Subordinated Debentures may trade at a
discount from the price that the investor paid to purchase the Capital
Securities offered hereby. Because holders of Capital Securities may receive
Junior Subordinated Debentures in liquidation of the Trust and because
Distributions are otherwise limited to payments on the Junior Subordinated
Debentures, prospective purchasers of Capital Securities are also making an
investment decision with regard to the Junior Subordinated Debentures and
should carefully review all the information regarding the Junior Subordinated
Debentures contained herein. See "Description of Junior Convertible
Subordinated Debentures."
RIGHTS UNDER THE GUARANTEE
State Street will act as Guarantee Trustee and will hold the Guarantee for
the benefit of the holders of the Capital Securities. State Street also will
act as Property Trustee and as Debenture Trustee under the Indenture. Delaware
Trust will act as Delaware Trustee under the Declaration. The Guarantee will
guarantee to the holders of the Capital Securities the following payments, to
the extent not paid by the Trust: (i) any accumulated and unpaid Distributions
required to be paid on the Capital Securities, to the extent that the Trust
has funds on hand legally available therefor; (ii) the applicable Redemption
Price with respect to any Capital Securities called for redemption, to the
extent that the Trust has funds on hand legally available therefor; and (iii)
upon a voluntary or involuntary dissolution, winding up or liquidation of the
Trust (unless the Junior Subordinated Debentures are distributed to holders of
the Capital Securities), the lesser of (a) the aggregate of the Liquidation
Amount and all accumulated and unpaid Distributions to the date of payment, to
the extent that the Trust has funds on hand legally available therefor on such
date and (b) the amount of assets of the Trust remaining available for
distribution to holders of the Capital Securities on such date. The holders of
a majority in Liquidation Amount of the Capital Securities will have the right
to direct the time, method and place of conducting any proceeding for any
remedy available to the Guarantee Trustee in respect of the Guarantee or to
direct the exercise of any trust power conferred upon the Guarantee Trustee.
Any holder of the Capital Securities may institute a legal proceeding directly
against the Company to enforce its rights under the Guarantee without first
instituting a legal proceeding against the Trust, the Guarantee Trustee or any
other person or entity. If the Company defaults on its
18
obligation to pay amounts payable under the Junior Subordinated Debentures, the
Trust will not have sufficient funds for the payment of Distributions or
amounts payable on redemption of the Capital Securities or otherwise, and, in
such event, holders of the Capital Securities will not be able to rely upon the
Guarantee for payment of such amounts. Instead, in the event a Debenture Event
of Default shall have occurred and be continuing and such event is attributable
to the failure of the Company to pay principal of or premium, if any, or
interest on the Junior Subordinated Debentures on the payment date on which
such payment is due and payable, then a holder of Capital Securities may
institute a legal proceeding directly against the Company for enforcement of
payment to such holder of the principal of or premium, if any, or interest on
such Junior Subordinated Debentures having a principal amount equal to the
Liquidation Amount of the Capital Securities of such holder (a "Direct
Action"). Notwithstanding any payments made to a holder of Capital Securities
by the Company in connection with a Direct Action, the Company shall remain
obligated to pay the principal of and premium, if any, and interest on the
Junior Subordinated Debentures, and the Company shall be subrogated to the
rights of the holder of such Capital Securities with respect to payments on the
Capital Securities to the extent of any payments made by the Company to such
holder in any Direct Action. Except as described herein, holders of Capital
Securities will not be able to exercise directly any other remedy available to
the holders of the Junior Subordinated Debentures or to assert directly any
other rights in respect of the Junior Subordinated Debentures. See "Description
of Junior Convertible Subordinated Debentures--Enforcement of Certain Rights by
Holders of Capital Securities" and "--Debenture Events of Default" and
"Description of the Guarantee." The Declaration will provide that each holder
of Capital Securities by acceptance thereof agrees to the provisions of the
Indenture.
LIMITED VOTING RIGHTS
Holders of Capital Securities generally will have voting rights relating only
to the modification of the terms of the Capital Securities and the exercise of
the Trust's rights as holder of the Junior Subordinated Debentures. Holders of
Capital Securities will not be entitled to vote to appoint, remove or replace,
or to increase or decrease the number of, the Issuer Trustees or
Administrators, which voting rights are vested exclusively in the holder of the
Common Securities, except as described under "Description of Capital
Securities--Removal of Issuer Trustees and Administrators." See "Description of
Capital Securities--Voting Rights; Amendment of the Declaration."
TRADING PRICE
The Capital Securities may trade at a price that does not fully reflect the
value of accrued but unpaid interest with respect to the underlying Junior
Subordinated Debentures. A holder using the accrual method of accounting (and a
cash method holder, during and after an Extension Period or if the Junior
Subordinated Debentures are deemed to have been issued with OID) who disposes
of its Capital Securities between Distribution Record Dates (as defined herein)
will be required to include accrued but unpaid interest (or OID) on the Junior
Subordinated Debentures through the date of disposition in income as ordinary
income and to add such amount to its adjusted tax basis in its share of the
underlying Junior Subordinated Debentures deemed disposed of. To the extent the
selling price is less than the holder's adjusted tax basis, a holder will
recognize a capital loss. Subject to certain limited exceptions, capital losses
cannot be applied to offset ordinary income for federal income tax purposes.
See "Certain Federal Income Tax Considerations--Interest, Original Issue
Discount, Premium and Market Discount" and "--Sale or Redemption of Capital
Securities."
ABSENCE OF PUBLIC MARKET AND TRANSFER RESTRICTIONS
There is no existing market for the Capital Securities and there can be no
assurance as to the liquidity of any markets that may develop for the Capital
Securities, the ability of the holders to sell their Capital Securities or at
what price holders of the Capital Securities will be able to sell their Capital
Securities, as the case may be. Future trading prices of the Capital Securities
will depend on many factors including, among other things, prevailing interest
rates, the Company's operating results, and the market for similar securities.
Although the Company has applied to have the Capital Securities approved for
quotation on the Nasdaq, there can be no assurance that such application will
be approved, that an active trading market for the Capital Securities will
develop or, if one does develop, that it will be maintained. In addition,
notwithstanding the registration of the Capital Securities, holders who are
"affiliates" of the Company or the Trust as defined under Rule 405 of the
19
Securities Act may publicly offer for sale or resell the Capital Securities
only in compliance with the provisions of Rule 144 under the Securities Act of
1933, as amended (the "Securities Act"). In addition, in the event that the
Trust is terminated by the Company and Junior Subordinated Debentures are
distributed to holders of Capital Securities, the Company, under the terms of
the Indenture, will use its best efforts to have the Junior Subordinated
Debentures approved for quotation on the Nasdaq or an exchange. There can be
no assurance that such application will be approved, that an active trading
market for the Junior Subordinated Debentures will develop, or if one does
develop, that it will be maintained.
RISK FACTORS RELATED TO THE COMPANY
ABILITY OF THE COMPANY TO IMPLEMENT ITS BUSINESS STRATEGY
The Company's business strategy is dependent upon its ability to increase
its loan volume through the nationwide growth of its network of Originators,
while maintaining its existing levels of origination costs, interest rate
spreads and underwriting criteria. Implementation of this strategy will depend
in large part on the Company's ability to: (i) expand its network of
Originators in markets with a sufficient concentration of borrowers meeting
the Company's underwriting criteria; (ii) obtain adequate financing on
favorable terms to fund its growth strategy; (iii) profitably sell its loans
through securitizations or in the secondary market on a regular basis;
(iv) attract and retain skilled employees; and (v) continue to expand in the
face of increasing competition from other mortgage lenders. The Company's
failure with respect to any of these factors could impair its ability to
successfully implement its business strategy, which would have a material
adverse effect on the Company's results of operations, financial condition and
cash flows. In addition, there can be no assurance that the Company will
achieve its planned expansion in a timely and cost-effective manner or, if
achieved, that the expansion will result in profitable operations. Although
the Company has no current plans to modify its current strategy, because of
the dynamic changes occurring in the financial services industry, the Company
may revise its business plan by developing new consumer or commercial loan
products or expanding into new markets. There can be no assurance that any
such revised strategy would be as profitable or successful as the existing
strategy has been historically. See "Business."
RISKS ASSOCIATED WITH MORTGAGE ORIGINATION, PURCHASE AND SALE ACTIVITIES
The Company has been actively involved in the origination, purchase and sale
to Loan Purchasers and, since the fourth quarter of 1996, in securitizations
of real estate secured loans. Generally, the profitability of such mortgage
financing operations depends on maintaining a sufficient volume of loans for
sale and the availability of Loan Purchasers. Changes in the level of interest
rates and economic factors may affect the amount of loans originated or
available for purchase by the Company, and thus the availability of net gains
from mortgage financing operations and servicing fee income. Changes in the
purchasing policies of Loan Purchasers or increases in defaults after funding
could substantially reduce the amount of loans sold to such Loan Purchasers or
through asset securitizations. Any such changes could have a material adverse
effect on the Company's results of operations, financial condition and cash
flows. Therefore, between the time the Company originates loans and purchase
commitments are issued or securitizations are completed, the Company is
exposed to downward movements in the market price of such loans due to upward
movements in interest rates. In order to reduce these risks, the Company has
recently adopted a hedging policy. There can be no assurances, however, that
the Company's exposure to such risks will be reduced by pursuing this policy.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operation--Management of Interest Rate Risk." See "Business--Core Lending
Products--Origination and Purchase of Loans" and "--Loan Sales and Asset
Securitizations" and "--Sources of Funds."
In addition to its lending activity in California, the Company has
originated or purchased a significant number of one- to four-family
residential mortgage loans on a nationwide basis through its network of
Originators. Management believes that originating and purchasing loans secured
by properties located across the country results in a geographically
diversified lending operation which reduces certain risks associated with loan
20
concentrations in a single area. However, there are certain other risks
involved in nationwide lending. The Company may not have the same depth of
experience or knowledge about particular markets in which it lends as other
lenders with the staff physically located in such market areas. Some of the
properties may be located in states which are experiencing adverse economic
conditions, including a general softening in real estate markets and the local
economies, which may result in increased loan delinquencies and loan losses.
Additionally, regulations and practices regarding the liquidation of properties
(e.g., foreclosure) and the rights of mortgagors in default vary greatly from
state to state, and these restrictions may limit the Company's ability to
foreclose on a property or seek other recovery. See "Business--Core Lending
Products--Origination and Purchase of Loans" and "--Lending Overview--
Delinquencies and Classified Assets."
DEPENDENCE ON ASSET SECURITIZATIONS AND IMPACT ON QUARTERLY OPERATING RESULTS
Since the fourth quarter of 1996, the Company completed three
securitizations, which involved an aggregate of $255.9 million of loans and
generated total net gains from securitizations of approximately $21.3 million.
A significant component of management's business strategy is to generate
revenue and net income and provide funding for future originations and
purchases of loans through securitizations on a regular basis. There can be no
assurance, however, that the Company will be able to successfully implement
this strategy. Several factors will affect the Company's ability to complete
securitizations, including conditions in the securities markets generally and
in the asset-backed securities markets specifically, the credit quality of the
Company's loan portfolio and the Company's ability to obtain credit
enhancements. In addition, although the Company has tracked the performance of
its portfolio of loans, it did not, prior to the fourth quarter of 1996, have
the ability to track loans by core products. As a result, if loans do not
perform up to original expectations, the Company may not be able to securitize
loans on economic terms as favorable as those conducted to date. Although the
Company obtained a credit enhancement in the securitizations completed to date
which facilitated an investment grade rating for the securitization interests
in each instance, there can be no assurance that the Company will be able to
obtain future credit enhancements on acceptable terms or that future
securitizations will be similarly rated. Any substantial reduction in the
ability of the Company to complete securitizations could have a material
adverse effect on the Company's results of operations, financial condition and
cash flows.
The Company's future revenues and net income are expected to fluctuate in
large part as a result of the timing and size of its future securitizations. A
delay in closing a scheduled securitization during a particular quarter would
postpone recognition of net gains from mortgage financing operations. In
addition, unanticipated delays in closing a securitization could also increase
the Company's exposure to credit risks and interest rate fluctuations by
increasing the period during which the Company holds its loans. If the Company
were unable to profitably securitize a sufficient number of its loans in a
particular reporting period, the Company's revenues for such period would
decline and would result in lower net income and possibly a net loss for such
period, and could have a material adverse effect on the Company's results of
operations, financial condition, and cash flows and the Bank's capital ratios.
In addition, the Company projects the expected cash flows over the life of the
residual interests, using prepayment and default assumptions that market
participants would use for similar financial instruments that are subject to
prepayment, credit and interest rate risks. The Company then determines the
present value of these cash flows using an interest rate commensurate with the
risks involved. If the Company's actual experience differs materially from the
assumptions used in the determination of the present value of the residual
interests, future cash flows and earnings could be negatively impacted. See
"Business--Loan Sales and Asset Securitizations."
RISKS RELATED TO MORTGAGE SERVICING RIGHTS AND RESIDUAL ASSETS
To determine the fair value of its mortgage servicing rights, the Company
projects net cash flows expected to be received over the life of the underlying
loans. Such projections assume certain servicing costs, prepayment rates and
delinquencies. As of September 30, 1997, the carrying value of the Company's
mortgage servicing rights totalled $5.7 million, up from $2.6 million at
December 31, 1996. In addition, the pooling and servicing agreements relating
to the Company's securitizations contain provisions with respect to the maximum
permitted loan delinquency rates and loan default rates, which, if exceeded,
would allow the termination of the Company's
21
right to service the related loans. The mortgage servicing rights on the loans
securitized during the fourth quarter of 1996, the first quarter of 1997, and
the third quarter of 1997 totalled approximately $4.7 million.
There can be no assurance that the Company's estimates used to determine the
fair value of mortgage servicing rights will remain appropriate for the life of
the loans sold or the securitizations. If actual loan prepayments or
delinquencies exceed the Company's estimates, the carrying value of the
Company's mortgage servicing rights may have to be written down through a
charge against earnings. The Company cannot write up such assets to reflect
slower than expected prepayments, although slower prepayments may increase
future earnings as the Company will receive cash flows in excess of those
anticipated. Fluctuations in interest rates may also result in a write-down of
the Company's mortgage servicing rights in subsequent periods.
The Company records net gains from mortgage financing operations through
securitizations based in part on the fair value of the residuals received by
the Company related to such loans, which are classified as trading securities.
The fair values of such residuals are in turn based in part on market interest
rates and projected loan prepayment and credit loss rates. Increases in
interest rates or higher than anticipated rates of loan prepayments or credit
losses of these or similar securities may require the Company to write down the
value of such residuals and result in a material adverse effect on the
Company's results of operations and financial condition. During the three
months ended September 30, 1997, the Company revalued the 1997-1A residual and
recorded a pre-tax unrealized loss of $787,000 due to higher-than-expected
prepayment speeds. See "Business--Loan Sales and Asset Securitizations." The
Company is not aware of an active market for the residuals. No assurance can be
given that the residuals could in fact be sold at their carrying value, if at
all.
LACK OF HISTORICAL EXPERIENCE DATA ON CORE PRODUCT LOANS
Although the Company has typically monitored the delinquency, loss and
prepayment experience in its total loan portfolio, prior to its first
securitization in December 1996, the Company did not separately track the
delinquency, loss and prepayment experience of core product loans by product
type. Consequently, segregated performance data which would be used by the
Company, analysts and rating agencies for purposes of estimating the future
delinquency, loss and prepayment experience of its core product loans is of
limited duration and therefore not as meaningful as data outstanding for a
longer period of time. In view of the Company's lack of segmented core product
loan performance data, the Company relied on a third party evaluation of its
core product loan portfolio and therefore the Company's loss or prepayment
assumptions used to calculate its gain on sale in connection with its
securitizations or with future securitizations may be subject to fluctuations.
Any material difference between these assumptions and actual performance could
have a material adverse impact on the timing and/or receipt of the Company's
future revenues, the value of the residual interests held on the Company's
balance sheet and the Company's cash flow.
RISKS ASSOCIATED WITH SUB-PRIME LENDING
Through its Liberator Series program, the Company has developed a lending
niche for the origination and purchase of mortgage loans to sub-prime borrowers
(e.g. borrowers who do not qualify for credit under traditional FHLMC, FNMA or
Government National Mortgage Association ("GNMA") guidelines). Loans to sub-
prime borrowers present a higher level of risk of default than conforming loans
because of the increased potential for default by borrowers who may have had
previous credit problems or who do not have an adequate credit history. Loans
to sub-prime borrowers also involve additional liquidity risks, as these loans
generally have a more limited secondary market than conventional loans. The
actual rates of delinquencies, foreclosures and losses on loans to sub-prime
borrowers could be higher under adverse economic conditions than those
currently experienced in the mortgage lending industry in general. The FDIC
issued a letter to all FDIC-insured institutions highlighting the special risks
associated with sub-prime lending and the need for management controls. While
the Company believes that the underwriting procedures and appraisal processes
it employs enable it to somewhat mitigate the higher risks inherent in loans
made to these borrowers, no assurance can be given that such procedures or
processes will afford adequate protection against such risks. See "Business--
Core Lending Products--Origination and Purchase of Loans" and "--Underwriting."
22
HIGH LOAN TO VALUE RATIOS OF PORTFOLIO SERIES LOANS
Through its Portfolio Series program, the Company originates debt
consolidation loans for Agency Qualified Borrowers. Portfolio Series loans are
primarily home equity lines of credit and second deeds of trust generally up to
135% of the appraised value of the real estate underlying the loans. The
Company recently increased the permissible loan-to-value ratio for Portfolio
Series loans from 125% to 135% which may have the effect of increasing the loss
rates on such loans. In the event of a default on a Portfolio Series loan by a
borrower, there generally would be insufficient collateral to pay off the
balance of such loan and the Company, as holder of a second position on the
property, would likely lose a substantial portion, if not all, of its
investment. While the Company believes that the underwriting procedures it
employs enable it to somewhat mitigate the higher risks inherent in such loans,
no assurance can be given that such procedures will afford adequate protection
against such risks. During the fourth quarter of 1996 and the first, second and
third quarters of 1997, of the core product loans originated by the Company,
42.9%, 55.3%, 64.9% and 61.3%, respectively, consisted of Portfolio Series
loans. See "Business--Core Lending Products--Origination and Purchase of
Loans," "--Underwriting," and "--Loan Sales and Asset Securitizations."
CONTINGENT RISKS
Although the Company sells substantially all of the mortgage loans it
originates or purchases without recourse, the Company retains some degree of
credit risk on substantially all of the loans it sells. In addition, during the
period of time that the loans are held for sale, the Company is subject to
various business risks associated with the lending business, including borrower
default, foreclosure and the risk that a rapid increase in interest rates would
result in a decline of the value of loans held for sale to potential
purchasers.
In connection with its securitizations, the Company is required to repurchase
or substitute loans in the event of a breach of a representation or warranty
made by the Company. While the Company may have recourse to the sellers of
loans it purchased, there can be no assurance of the sellers' abilities to
honor their respective obligations to the Company. Likewise, in connection with
its whole loan sales, the Company enters agreements which generally require the
Company to repurchase or substitute loans in the event of a breach of a
representation or warranty made by the Company to the Loan Purchaser, any
misrepresentation during the mortgage loan origination process or, in some
cases, upon any fraud or early default on such mortgage loans. The remedies
available to a Loan Purchaser from the Company are generally broader than those
available to the Company against the sellers of such loans, and if a Loan
Purchaser enforces its remedies against the Company, the Company may not be
able to enforce whatever remedies the Company may have against such sellers. If
the loans were originated directly by the Company, the Company will be solely
responsible for any breaches of representations and warranties.
In addition, borrowers, Loan Purchasers, monoline insurance carriers and
trustees in the Company's securitizations may make claims against the Company
arising from alleged breaches of fiduciary obligations, misrepresentations,
errors and omissions of employees, officers and agents of the Company,
including appraisers, incomplete documentation and failure by the Company to
comply with various laws and regulations applicable to its business. Any claims
asserted in the future may result in liabilities or legal expenses that could
have a material adverse effect on the Company's results of operations,
financial condition, cash flows and business prospects.
DEPENDENCE ON KEY PERSONNEL
The Company depends to a considerable degree on the contributions of a
limited number of key management personnel who have had, and will continue to
have, a significant role in the development and management of the Company's
mortgage financing operations. The continued development of the Company's
business strategy depends to a large extent upon the continued employment of
Daniel L. Perl, President and Chief Executive Officer of both the Company and
the Bank. In addition, many members of senior management have had working
relationships with Mr. Perl prior to joining the Company. The loss of such
personnel, Mr. Perl or
23
other key personnel could materially adversely affect the Bank's and the
Company's business. The Company and the Bank have each entered into three year
employment agreements with Mr. Perl. See "The Board of Directors and Management
of the Bank Agreements."
RISKS RELATED TO DEBENTURES
In March 1997, the Bank issued the Debentures in an amount of $10.0 million
through a private placement and pursuant to a Debenture Purchase Agreement (the
"Debenture Offering"). In the event that the Company and the Bank elect to
substitute the Company as obligor on the Debentures (the "Substitution"), the
holders of the Debentures will have the option, at September 15, 1998 or at
such later time as the Substitution occurs, to require the Company to purchase
all or part of their Debentures. In the event that all of the holders of the
Debentures opt to require the Company to purchase their Debentures at September
15, 1998, the Company would be required to fund $10.0 million plus accrued
interest to holders of the Debentures. Such an event would have a material
adverse effect on the Company's liquidity. Furthermore, in the event that the
Company has insufficient funds available to repurchase the Debentures, the
Company may be required to borrow funds at more expensive rates than the
interest rate on the Debentures, which would have a material adverse effect on
the Company's results of operations. See "Business--Sources of Funds--
Borrowings."
COMPETITION
As a purchaser and originator of mortgage loans, the Company faces intense
competition, primarily from mortgage banking companies, commercial banks,
credit unions, thrift institutions, credit card issuers and finance companies.
Many of these competitors in the financial services business are substantially
larger and have more capital and other resources than the Company. Certain
large national finance companies and conforming mortgage originators have
announced their intention to adapt their conforming origination programs and
allocate resources to the origination of non-conforming loans. Certain of these
larger mortgage companies and commercial banks have begun to offer products
similar to those offered by the Company, targeting customers similar to those
of the Company. In addition, it is anticipated that the participation of
government-sponsored entities with substantial capital resources in the
origination of non-conforming loans will further intensify competition. The
FHLMC recently announced its intention to support such originations by
purchasing, guaranteeing and securitizing non-conforming loans originated by
qualified institutions. Other government-sponsored entities, such as the FNMA
or GNMA, may also enter into the market for non-conforming loans. The offering
by these competitors of products similar to those of the Company's could have a
material adverse effect on the Company's results of operations, financial
condition and cash flows. The Company depends largely on Originators with whom
the Company's competitors also seek to establish relationships. The Company's
future results may become increasingly sensitive to fluctuations in the volume
and cost of its wholesale loan purchases resulting from competition from other
purchasers for such loans. In addition, as the Company expands into new
geographic markets, it will face competition from lenders with established
positions in these locations. There can be no assurance that the Company will
be able to continue to compete successfully in the markets it serves. See
"Business--Competition."
AVAILABILITY OF FUNDING SOURCES
The Company funds a substantial portion of the loans which it originates or
purchases through deposits, lines of credit, internally generated funds or FHLB
advances. The Company competes for deposits primarily on the basis of rates,
and as a consequence the Company could experience difficulties in attracting
deposits to fund its operations if it does not continue to offer deposit rates
at levels that are competitive with other financial institutions. Certificate
of deposit accounts constituted $140.9 million or 88.1% of total deposits at
September 30, 1997, of which $134.3 million mature in one year or less. Further
increases in short-term certificate accounts, which tend to be more sensitive
to movements in market interest rates than core deposits, may result in the
Company's deposit base being less stable than if it had a large amount of core
deposits which in turn, may result in further increases in the Company's cost
of deposits. The Company also uses the cash proceeds generated by the Company
in selling loans in the secondary market or pools of loans in asset
securitizations to fund subsequent
24
originations or purchases. The Bank has two warehouse lines of credit available
in the aggregate amount of $250.0 million to fund loan originations, of which
$54.6 million has been drawn upon at September 30, 1997, and is in the process
of negotiating a third warehouse line of credit in the amount of $250.0
million. The Company has a line of credit in the amount of $40.0 million
secured by residual assets created by the Company's securitizations. The lines
of credit do not obligate the lenders to advance any amount of funds, and may
be terminated by the lenders at will. See "Business--Sources of Funds--
Borrowings." To the extent that the Company is not able to maintain its
currently available funding sources or to access new funding sources, it would
have to curtail its loan production activities or sell loans earlier than is
optimal. Any such event would have a material adverse effect on the Company's
results of operations and financial condition. See "Business--Sources of
Funds."
MULTI-FAMILY AND COMMERCIAL REAL ESTATE RISKS
As part of its lending strategy, the Company has targeted borrowers seeking
loans secured by multi-family properties or properties used for commercial
business purposes such as small office buildings or light industrial or retail
facilities. Although such loans are generally originated for sale, the Company
anticipates that its multi-family and commercial real estate portfolios will
increase as a percentage of total assets in future periods. Multi-family and
commercial real estate loans are generally considered to involve a higher
degree of credit risk, be more vulnerable to deteriorating economic conditions
and involve higher loan principal amounts than one- to four-family residential
mortgage loans. Income producing property values are also subject to greater
volatility than owner-occupied residential property values. Economic events and
government regulations, which are outside the control of the borrower or
lender, could impact the value of the security for such loans or the future
cash flows of the affected properties. Further, any material decline in real
estate values, such as the declines experienced in southern California in
recent years, generally reduces the ability of borrowers to use equity to
support borrowings and increases the loan-to-value ratios of loans previously
made, thereby weakening collateral coverage and increasing the possibility of a
loss in the event of a borrower default.
POTENTIAL IMPACT OF CHANGES IN INTEREST RATES
The Company's profitability is dependent to a certain extent upon its net
interest income, which is the difference between its interest income on
interest-earning assets, such as loans and investments, and its interest
expense on interest-bearing liabilities, such as deposits and borrowings. The
Company's ability to originate, purchase and sell loans through its mortgage
financing operations is significantly impacted by changes in interest rates.
Increases in interest rates may also reduce the amount of loan and commitment
fees received by the Company. A significant decline in interest rates could
also decrease the size of the Company's servicing portfolio and the related
servicing income by increasing the level of loan prepayments. Additionally, the
interest rate adjustments with respect to the Company's investment securities
lag rate adjustments to the Company's deposit accounts. Accordingly, the yield
on the Company's investment securities may adjust more slowly than the cost of
the Company's interest-bearing liabilities in a rising interest rate
environment. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Management of Interest Rate Risk."
FINANCIAL INSTITUTION REGULATION AND POSSIBLE LEGISLATION
The Company, as a savings and loan holding company, and the Bank, as a
federal savings association, are subject to extensive federal laws, regulations
and supervision. Such laws and regulations, which affect operations on a daily
basis, may be changed at any time, and the interpretation of the relevant
existing law and regulations is also subject to change by the federal
regulatory authorities. Any failure of the Bank to comply with any of the laws
and regulations to which it is subject or any change in the regulatory
structure or the applicable statutes or regulations whether by the OTS, the
FDIC or the Congress, could have a material adverse impact on the Company, the
Bank, their respective operations. See "Regulation."
Recently enacted legislation provides that the BIF and SAIF will merge on
January 1, 1999 if there are no more savings associations as of that date.
Several bills have been introduced in Congress that would eliminate
25
the federal thrift charter and the OTS. A bill reported in July 1997 by the
House Banking Committee and in October 1997 by the House Commerce Committee
would require federal thrifts to become national banks or state chartered
commercial banks or savings banks within two years after enactment or they
would, by operation of law, become national banks. A national bank resulting
from a converted federal thrift could continue to engage in activities,
including holding any assets, in which it was lawfully engaged on the day
before the date of enactment. Branches operated on the day before enactment
could be retained regardless of their permissibility for national banks.
Subject to a grandfathering provision, all savings and loan holding companies
would become subject to the same regulation and activities restrictions as
bank holding companies. The grandfathering could be lost under certain
circumstances, such as a change in control of the holding company. The
legislative proposal would also abolish the OTS and transfer its functions to
the federal bank regulators with respect to the depository institutions and to
the Board of Governors of the Federal Reserve System ("Federal Reserve Board")
with respect to the regulation of holding companies. The Bank is unable to
predict whether the legislation will be enacted or, given such uncertainty,
determine the extent to which the legislation, if enacted, would affect its
business. The Bank is also unable to predict whether the SAIF and BIF will
eventually be merged.
Legislation regarding bad debt recapture was signed into law in August 1996
effective for tax years beginning on or after January 1, 1996. The legislation
requires recapture of reserves accumulated after 1987. The recapture tax on
post-1987 reserves must be paid over a six-year period starting in 1996. The
payment of the tax can be deferred in each of 1996 and 1997 if an institution
originates at least the same average annual principal amount of purchased
mortgage loans that it originated in the six years prior to 1996. The Bank has
previously recorded a deferred tax liability related to such legislation;
therefore, such recapture is expected to have no effect on net income or
federal income tax expense. See "Federal and State Taxation--Federal
Taxation--Bad Debt Reserve."
Recent federal legislation known as the Riegle Community Development and
Regulatory Improvement Act (the "Riegle Act"), imposed additional regulatory
requirements on mortgage loans having relatively higher origination fees and
interest rates, such as some of the loans made by the Bank, and the Bank
expects its business to be the focus of additional federal and state
legislation, and regulation in the future.
IMPACT OF LAWS AND REGULATIONS AFFECTING CERTAIN LENDING OPERATIONS
In addition to federal regulations on its banking operations, the Bank's
consumer lending activities are subject to consumer protection and other
statutes including the Federal Truth-in-Lending Act and Regulation Z
(including the Home Ownership and Equity Protection Act of 1994), the Federal
Equal Credit Opportunity Act and Regulation B, as amended, the Fair Credit
Reporting Act of 1970, as amended, the Federal Real Estate Settlement
Procedures Act of 1974, as amended ("RESPA"), and Regulation X, the Fair
Housing Act, the Home Mortgage Disclosure Act and Regulation C and the Federal
Debt Collection Practices Act.
These rules and regulations, among other things, establish eligibility
criteria for mortgage loans, prohibit discrimination, provide for inspections
and appraisals of properties, require credit reports on loan applicants,
regulate assessment, collection, foreclosure and claims handling, investment
and interest payments on escrow balances and payment features, mandate certain
disclosures and notices to borrowers and, in some cases, fix maximum interest
rates, fees and mortgage loan amounts. Failure to comply with these
requirements can lead to loss of status as an approved FNMA/FHLMC seller-
solicitor, termination or suspension of servicing contracts without
compensation to the servicer, demands for indemnifications or mortgage loan
repurchases, certain rights of rescission for borrowers, class action lawsuits
and administrative enforcement actions.
Although the Company believes that it has systems and procedures to
facilitate compliance with these requirements and believes that it is in
compliance in all material respects with applicable local, state and federal
laws, rules and regulations, in the future more restrictive laws, rules and
regulations or the judicial interpretation of existing laws, rules and
regulations could make compliance more difficult or expensive. See
"Regulation."
26
ELIMINATION OF LENDER PAYMENTS TO BROKERS COULD ADVERSELY AFFECT RESULTS OF
OPERATIONS
Lawsuits have been filed against several mortgage lenders alleging that such
lenders have made certain payments to independent mortgage brokers in violation
of RESPA. These lawsuits have generally been filed on behalf of a purported
nationwide class of borrowers alleging that payments made by a lender to a
broker in addition to payments made by the borrower to a broker are prohibited
by RESPA and are therefore illegal. If these cases are resolved against the
lenders, it may cause an industry-wide change in the way independent mortgage
brokers are compensated. The Bank's broker compensation programs permit such
payments. Although the Bank believes that its broker compensation programs
comply with all applicable laws and are consistent with long-standing industry
practice and regulatory interpretations, in the future new regulatory
interpretations or judicial decisions may require the Bank to change its broker
compensation practices. Such a change may have a material adverse effect on the
Bank and the entire mortgage lending industry.
YEAR 2000 COMPLIANCE
As the year 2000 approaches, a critical business issue has emerged regarding
how existing application software programs and operating systems can
accommodate this date value. In brief, many existing application software
products were designed to only accommodate a two digit date position which
represents the year (e.g., '95 is stored on the system and represents the year
1995). The Company has implemented a program designed to ensure that all
software used in connection with the Company's business will manage and
manipulate data involving the transition from 1999 to 2000 without functional
or data abnormality and without inaccurate results related to such data.
However, there can be no assurances that such program will be effective. To the
extent the Company's systems are not fully year 2000 compliant, there can be no
assurance that potential systems interruptions or the cost necessary to update
software would not have a material adverse effect on the Company's business,
financial condition, results of operations and business prospects. In addition,
the Company has limited information concerning the compliance status of its
suppliers and customers. In the event that any of the Company's significant
suppliers do not successfully and timely achieve year 2000 compliance, the
Company's business or operations could be adversely affected.
ENVIRONMENTAL RISKS
In the course of its business, the Company has acquired, and may acquire in
the future, properties securing loans that are in default. There is a risk that
hazardous substances or waste, contaminants, pollutants or sources thereof
could be discovered on such properties after acquisition by the Company. In
such event, the Company may be required by law to remove such substances from
the affected properties at its sole cost and expense. There can be no assurance
that (i) the cost of such removal would not substantially exceed the value of
the affected properties or the loans secured by the properties, (ii) the
Company would have adequate remedies against the prior owner or other
responsible parties or (iii) the Company would not find it difficult or
impossible to sell the affected properties either prior to or following such
removal.
27
USE OF PROCEEDS
The proceeds to the Trust from the Offering of the Capital Securities will
be $ . All of the proceeds from the sale of Capital Securities (together
with the proceeds of the issuance of the Common Securities) will be invested
by the Trust in the Junior Subordinated Debentures. The estimated net proceeds
from the sale of the Junior Subordinated Debentures of approximately $ ,
after deducting the underwriting discount and estimated offering expenses,
will be available to the Company for general corporate purposes, which may
include, but not be limited to, the refinancing or prepayment of existing debt
obligations, which may be of shorter maturity or higher coupon rate; the
downstreaming of capital to the Bank, and the financing of future residuals
resulting from securitizations; the acquisition of loan portfolios from other
depository institutions or finance companies; and possible acquisitions of
depository institutions or branches of depository institutions. The Company
has not entered into any arrangement, agreement or understanding with respect
to future acquisitions and there can be no assurances that it will do so in
the future. No determination has been made as to the amount of proceeds, if
any, that will be allocated to any of the above-mentioned potential uses.
Initially, the net proceeds may be used to make short-term investments. Under
current policy, the OTS does not impose any capital adequacy requirements on
the Company, but rather imposes such capital adequacy requirements on the
Bank. To the extent the Company contributes a portion of the net proceeds
received from the sale of the Capital Securities to the Bank, such proceeds
would qualify as Tier 1 capital at the Bank level under the current capital
adequacy guidelines of the OTS.
PRICE RANGE OF COMMON STOCK AND DIVIDENDS
The Common Stock of the Company has been quoted on the Nasdaq National
Market under the symbol "LFCO" since the Company's IPO on June 30, 1997. The
following table summarizes the range of the high and low closing sale prices
per share of Common Stock as quoted by Nasdaq for the periods indicated.
HIGH LOW
------- -------
MONTH ENDED
June 30, 1997................................................ $13.50 $13.375
July 31, 1997................................................ 18.875 13.625
August 31, 1997.............................................. 18.675 15.875
September 30, 1997........................................... 19.25 17.00
October 31, 1997............................................. 21.875 16.625
November 30, 1997............................................ 18.375 14.875
As of September 16, 1997, there were approximately 348 holders of record of
the Common Stock. The last reported sale price of the Common Stock on the
Nasdaq as of a recent date is set forth on the cover pages of this Prospectus.
The Company presently intends to retain all future earnings, if any, for use
in its business and does not anticipate declaring or paying any cash dividends
on its Common Stock in the foreseeable future. In the event that the Board of
Directors does determine to pay dividends in the future, any such payment will
depend upon a number of factors, including investment opportunities available
to the Company or the Bank, capital requirements, regulatory limitations, the
Company's or the Bank's financial condition and results of operations, tax
considerations and general economic conditions. For information concerning
federal regulations regarding the Bank's ability to make capital distributions
to the Company, see "Regulation--Federal Savings Institution Regulation--
Limitation on Capital Distributions."
The Company is subject to the requirements of Delaware law, which generally
limit dividends to an amount equal to the excess of the net assets of the
Company (the amount by which total assets exceed total liabilities) over its
statutory capital, or if there is no such excess, to its net profits for the
current and/or immediately preceding fiscal year. For a discussion of certain
circumstances under which the Company may become subject to certain provisions
of the California Corporation Code, see "Description of Capital Stock--Certain
Anti-takeover Provisions."
28
RATIOS OF EARNINGS TO FIXED CHARGES
The following table sets forth for the respective periods indicated the
ratios of the Company's consolidated earnings to fixed charges. For purposes
of computing the ratio, earnings represent pretax income before extraordinary
item and cumulative effect of change in accounting principles plus fixed
charges. Fixed charges, excluding interest on deposits, include interest
expense (other than on deposits) and the proportion deemed representative of
the interest factor of rent expense, net of income from subleases. Fixed
charges, including interest on deposits, include all interest expense and the
proportion deemed representative of the interest factor of rent expense, net
of income from subleases.
NINE
MONTHS
ENDED
SEPTEMBER
30, YEARS ENDED DECEMBER 31,
--------- --------------------------
1997 1996 1996 1995 1994 1993 1992
---- ---- ---- ---- ----- ---- ----
Ratio of Earnings to Fixed Charges:
Excluding interest on deposits.......... 7.82 1.88 6.53 3.05 (2.11) 1.54 2.67
Including interest on deposits.......... 2.79 1.11 1.66 1.23 0.66 1.06 1.13
ACCOUNTING TREATMENT
The financial statements of the Trust will be reflected in the Company's
consolidated financial statements, with the Capital Securities shown as
Company-Obligated Mandatorily Redeemable Convertible Preferred Securities of
Subsidiary Trust Holding Solely Subordinated Debentures of the Company. A
footnote to such consolidated financial statements will indicate that the sole
assets of the Trust are % Convertible Subordinated Debentures due 2027 of the
Company with an original principal amount of $ ($ if the Underwriter's
over-allotment option is exercised in full) and that the Guarantee, when taken
together with the Company's obligations under the Convertible Debentures, the
Indenture and the Declaration, provide a full and unconditional guarantee on a
subordinated basis by the Company of the Trust's obligations under the Capital
Securities. See "Capitalization."
29
CAPITALIZATION
The following table sets forth, at September 30, 1997, the unaudited
consolidated capitalization of the Company and its consolidated subsidiaries,
and the pro forma capitalization of the Company as adjusted to give effect to
the sale of the Capital Securities offered hereby and the application of the
estimated net proceeds therefrom as described under "Use of Proceeds." The
information below should be read in conjunction with the Financial Statements
and the Notes thereto which are included elsewhere herein.
AT SEPTEMBER 30,
1997
--------------------
ACTUAL AS ADJUSTED
------- -----------
(DOLLARS IN
THOUSANDS)
Subordinated debt due in fiscal 2004..................... $10,000 $10,000
------- -------
Total long-term debt................................... $10,000 $10,000
======= =======
Company obligated, mandatorily redeemable, convertible
preferred securities of subsidiary trust holding solely
subordinated debentures of the Company.................. --
------- -------
Stockholders' equity.....................................
Preferred stock, $.01 par value (5,000,000 shares
authorized; no shares outstanding)......................
Common stock, $.01 par value (25,000,000 shares
authorized and 6,546,716 shares issued and
outstanding)............................................ 65 65
Additional paid-in capital............................... 41,834
Retained earnings........................................ 7,578
-------
Total stockholders' equity............................. 49,477
-------
Total capitalization................................. $59,477
=======
Bank Regulatory Capital Ratios:
Tangible Capital....................................... 6.19%
Core (leverage) capital................................ 6.19
Total risk-based capital............................... 13.49
Stockholders' equity to total assets..................... 16.82
30
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The consolidated operating data presented below is derived in part from, and
should be read in conjunction with, the Financial Statements and related notes
of LIFE Financial Corporation, presented elsewhere in this Prospectus. The
consolidated operating data for the nine-month periods ended September 30,
1997 and 1996 is derived from unaudited financial data, but, in the opinion of
management reflects all adjustments (consisting of only normal recurring
adjustments) which are necessary to present fairly the results for such
interim periods. The results of operations for the nine months ended September
30, 1997 are not necessarily indicative of the results of operations that may
be expected for the year ending December 31, 1997.
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------- -----------------------------
1997 1996 1996 1995 1994
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest income:
Loans..................... $ 10,001 $ 4,674 $ 6,542 $ 5,433 $ 4,530
Securities held to
maturity................. 334 55 56 159 138
Other interest-earning
assets................... 1,817 193 331 233 156
--------- --------- --------- --------- ---------
Total interest income... 12,152 4,922 6,929 5,825 4,824
--------- --------- --------- --------- ---------
Interest expense:
Deposit accounts.......... 5,440 2,507 3,514 3,192 2,534
FHLB advances and other
borrowings............... 888 192 252 256 187
Subordinated debentures... 773 -- -- -- --
--------- --------- --------- --------- ---------
Total interest expense.. 7,101 2,699 3,766 3,448 2,721
--------- --------- --------- --------- ---------
Net interest income
before provision for
estimated loan
losses............... 5,051 2,223 3,163 2,377 2,103
Provision for estimated loan
losses..................... 900 359 963 1,194 1,306
--------- --------- --------- --------- ---------
Net interest income
after provision for
estimated loan
losses............... 4,151 1,864 2,200 1,183 797
--------- --------- --------- --------- ---------
Non-interest income:
Loan servicing and other
fees..................... 413 321 496 231 164
Service charges on deposit
accounts................. 94 93 128 111 84
Net gains from mortgage
financing operations..... 17,413 3,759 8,352 3,575 1,428
Other income.............. 265 91 136 103 12
--------- --------- --------- --------- ---------
Total non-interest
income................. 18,185 4,264 9,112 4,020 1,688
--------- --------- --------- --------- ---------
Non-interest expense:
Compensation and
benefits................. 5,534 3,206 5,233 2,544 1,575
Premises and occupancy.... 805 538 746 471 418
Data processing........... 524 281 390 208 167
Net loss on foreclosed
real estate.............. 94 171 158 53 280
FDIC insurance premiums... 69 136 174 184 186
SAIF special assessment... -- 448 448 -- --
Marketing................. 195 119 189 65 55
Telephone................. 439 159 246 143 128
Professional services..... 243 137 218 92 86
Other expense............. 1,247 623 879 629 561
--------- --------- --------- --------- ---------
Total non-interest
expense................ 9,150 5,818 8,681 4,389 3,456
--------- --------- --------- --------- ---------
Income (loss) before income
tax provision (benefit).... 13,186 310 2,631 814 (971)
Income tax provision
(benefit).................. 5,491 142 1,126 294 (300)
--------- --------- --------- --------- ---------
Net income (loss)....... $ 7,695 $ 168 $ 1,505 $ 520 $ (671)
========= ========= ========= ========= =========
Earnings (loss) per
share(1)................... $ 1.70 $ 0.08 $ 0.63 $ 0.28 $ (0.36)
========= ========= ========= ========= =========
Weighted average shares
outstanding................ 4,522,251 2,090,466 2,370,779 1,866,216 1,866,216
========= ========= ========= ========= =========
- --------
(1) Earnings per share is based on the weighted average shares outstanding
during the period, adjusted for a 100% stock dividend which occurred
during 1996. Earnings per share is then adjusted for the exchange of three
shares of Company Common Stock for one share of Bank common stock in the
Reorganization.
31
AVERAGE BALANCE SHEETS
The following tables set forth certain information relating to the Company
at September 30, 1997, and for the nine months ended September 30, 1997 and
1996 and for the years ended December 31, 1996, 1995 and 1994. The yields and
costs are derived by dividing income or expense by the average balance of
assets or liabilities, respectively, for the periods shown. Unless otherwise
noted, average balances are measured on a daily basis. The yields and costs
include fees which are considered adjustments to yields.
AT SEPTEMBER 30, NINE MONTHS ENDED NINE MONTHS ENDED
1997 SEPTEMBER 30, 1997 SEPTEMBER 30, 1996
------------------- ---------------------------- ---------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE YIELD/COST BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
-------- ---------- -------- -------- ---------- ------- -------- ----------
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Interest-earning
deposits and short-
term investments...... $ 14,970 5.15% $ 16,065 $ 719 5.97% $ 4,651 $ 162 4.64%
Investment
securities(1)......... 8,056 5.85 8,901 376 5.63 2,227 85 5.09
Loans receivable,
net(2)................ 223,688 10.23 143,487 10,001 9.29 69,944 4,674 8.91
Mortgage-backed
securities(1)......... 9 7.50 9 -- -- 11 1 12.12
Residual assets........ 24,533 13.50 10,854 1,056 12.97 -- -- --
-------- -------- ------ ------- ------
Total interest-earning
assets................ 271,256 10.11 179,316 12,152 9.04 76,833 4,922 8.54
------ ------
Non-interest-earning
assets(3).............. 22,846 23,049 6,200
-------- -------- -------
Total assets(3)........ $294,102 $202,365 $83,033
======== ======== =======
LIABILITIES AND EQUITY:
Interest-bearing
liabilities:
Passbook accounts...... $ 3,968 2.10 $ 4,027 63 2.09 $ 4,479 71 2.11
Money market accounts.. 3,794 2.99 2,978 67 3.00 3,939 90 3.05
Checking accounts...... 11,197 2.46 10,691 201 2.51 7,076 73 1.38
Certificate accounts... 140,881 5.95 116,035 5,109 5.87 54,811 2,273 5.53
-------- -------- ------ ------- ------
Total deposit
accounts.............. 159,840 5.54 133,731 5,440 5.42 70,305 2,507 4.75
Borrowings............. 71,523 7.35 27,308 1,661 8.11 4,318 192 5.93
-------- -------- ------ ------- ------
Total interest-bearing
liabilities........... 231,363 6.10 161,039 7,101 5.88 74,623 2,699 4.82
------ ------
Non-interest-bearing
liabilities(3)......... 13,262 18,139 3,195
-------- -------- -------
Total liabilities(3)... 244,625 179,178 77,818
Equity(3)............... 49,477 23,187 5,215
-------- -------- -------
Total liabilities and
equity(3)............. $294,102 $202,365 $83,033
======== ======== =======
Net interest income
before provision for
estimated loan losses.. $5,051 $2,223
====== ======
Net interest rate
spread(4).............. 4.01 3.16 3.72
Net interest margin(5).. 3.76 3.86
Ratio of interest-
earning assets to
interest-bearing
liabilities............ 117.24 111.35 102.96
- --------
(1) Includes unamortized discounts and premiums.
(2) Amount is net of deferred loan origination fees, unamortized discounts,
premiums and allowance for estimated loan losses and includes loans held
for sale and non-performing loans. See "Business--Lending Overview."
(3) Average balances are measured on a month-end basis.
(4) Net interest rate spread represents the difference between the yield on
interest-earning assets and the cost of interest-bearing liabilities.
(5) Net interest margin represents net interest income divided by average
interest-earning assets.
32
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
1996 1995 1994
------------------------ ------------------------ ------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
------- -------- ------- ------- -------- ------- ------- -------- -------
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Interest-earning
deposits and
short-term
investments........... $ 5,618 $ 257 4.57% $ 4,225 $ 203 4.80% $ 3,736 $ 124 3.32%
Investment
securities(1)......... 1,912 100 5.23 3,458 188 5.44 3,763 169 4.49
Loans receivable,
net(2)................ 72,556 6,542 9.02 65,521 5,433 8.29 65,566 4,530 6.91
Mortgage-backed
securities(1)......... 11 1 9.09 12 1 8.33 14 1 7.14
Residual assets........ 199 29 14.57 -- -- -- -- -- --
------- ------ ------- ------ ------- ------
Total interest-
earning assets...... 80,296 6,929 8.63 73,216 5,825 7.96 73,079 4,824 6.60
------ ------ ------
Non-interest-earning
assets(3).............. 6,035 2,465 2,517
------- ------- -------
Total assets(3)...... $86,331 $75,681 $75,596
======= ======= =======
LIABILITIES AND EQUITY:
Interest-bearing
liabilities:
Passbook accounts...... $ 4,401 92 2.09 $ 5,090 127 2.50 $ 7,048 157 2.23
Money market accounts.. 4,233 118 2.79 5,493 144 2.62 6,512 163 2.50
Checking accounts...... 7,048 112 1.59 6,434 92 1.43 6,180 95 1.54
Certificate accounts... 57,333 3,192 5.57 50,608 2,829 5.59 49,851 2,119 4.25
------- ------ ------- ------ ------- ------
Total deposit
accounts.............. 73,015 3,514 4.81 67,625 3,192 4.72 69,591 2,534 3.64
Borrowings(4).......... 4,268 252 5.90 3,112 256 8.23 1,863 187 10.04
------- ------ ------- ------ ------- ------
Total interest-
bearing
liabilities......... 77,283 3,766 4.87 70,737 3,448 4.87 71,454 2,721 3.81
------ ------ ------
Non-interest-bearing
liabilities(3)......... 3,026 1,131 197
------- ------- -------
Total liabilities(3). 80,309 71,868 71,651
Equity(3).............. 6,022 3,813 3,945
------- ------- -------
Total liabilities
and equity(3)....... $86,331 $75,681 $75,596
======= ======= =======
Net interest income
before provision
for estimated loan
losses................. $3,163 $2,377 $2,103
====== ====== ======
Net interest rate
spread(5).............. 3.76 3.09 2.79
Net interest margin(6).. 3.94 3.25 2.88
Ratio of interest-
earning assets to
interest-bearing
liabilities............ 103.90 103.50 102.27
- --------
(1) Includes unamortized discounts and premiums.
(2) Amount is net of deferred loan origination fees, unamortized discounts,
premiums and allowance for estimated loan losses and includes loans held
for sale and non-performing loans. See "Business--Lending Overview."
(3) Average balances are measured on a month-end basis.
(4) The average yield on borrowings for the years ending December 31, 1995 and
1994 included the effects of $52,000 and $96,000, respectively, in
interest expense on swap transactions with a notional principal balance of
$2.0 million in 1995 and 1994. Without this added expense, the average
yield on borrowings for the years ending December 31, 1995 and 1994 would
have been 6.56% and 4.88%, respectively. The yield on total interest-
bearing liabilities for the years ending December 31, 1995 and 1994 would
have been 4.80% and 3.67%, respectively. The $2.0 million in swap
contracts matured on November 7, 1995.
(5) Net interest rate spread represents the difference between the yield on
interest-earning assets and the cost of interest-bearing liabilities.
(6) Net interest margin represents net interest income divided by average
interest-earning assets.
33
Rate/Volume Analysis. The following table presents the extent to which
changes in interest rates and changes in the volume of interest-earning assets
and interest-bearing liabilities have affected the Company's interest income
and interest expense during the periods indicated. Information is provided in
each category with respect to: (i) changes attributable to changes in volume
(changes in volume multiplied by prior rate); (ii) changes attributable to
changes in rate (changes in rate multiplied by prior volume); and (iii) the
net change. The changes attributable to the combined impact of volume and rate
have been allocated proportionately to the changes due to volume and the
changes due to rate.
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
COMPARED TO COMPARED TO COMPARED TO
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, 1996 DECEMBER 31, 1995 DECEMBER 31, 1994
---------------------- ------------------- -------------------
INCREASE INCREASE INCREASE
(DECREASE) (DECREASE) (DECREASE)
DUE TO DUE TO DUE TO
-------------- ----------- -----------
VOLUME RATE NET VOLUME RATE NET VOLUME RATE NET
------ ------ ------ ------ ---- ------ ------ ---- ------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Interest-earning
deposits and short-
term investments...... $ 498 $ 59 $ 557 $ 64 $(10) $ 54 $ 18 $ 60 $ 78
Investment securities,
net................... 281 10 291 (81) (7) (88) (14) 34 20
Loans receivable,
net(1)................ 5,119 208 5,327 609 500 1,109 (2) 905 903
Residual assets........ -- 1,056 1,056 29 -- 29 -- -- --
Mortgage-backed
securities............ -- (1) (1) -- -- -- -- -- --
------ ------ ------ ---- ---- ------ ---- ---- ------
Total interest-earning
assets................ 5,898 1,332 7,230 621 483 1,104 2 999 1,001
INTEREST-BEARING
LIABILITIES:
Money market accounts.. (21) (2) (23) (35) 9 (26) (27) 8 (19)
Passbook accounts...... (7) (1) (8) (16) (19) (35) (47) 17 (30)
Checking accounts...... 50 78 128 9 11 20 4 (7) (3)
Certificate accounts... 2,688 148 2,836 374 (11) 363 33 677 710
Borrowings............. 1,374 95 1,469 80 (84) (4) 108 (39) 69
------ ------ ------ ---- ---- ------ ---- ---- ------
Total interest-bearing
liabilities........... 4,084 318 4,402 412 (94) 318 71 656 727
------ ------ ------ ---- ---- ------ ---- ---- ------
Change in net interest
income................. $1,814 $1,014 $2,828 $209 $577 $ 786 $(69) $343 $ 274
====== ====== ====== ==== ==== ====== ==== ==== ======
- --------
(1) Includes interest on loans held for sale.
SUMMARY
The Company originates, purchases, sell, securitizes and services primarily
non-conventional mortgage loans principally secured by first and second
mortgages on one- to four-family residences. The Company makes Liberator
Series loans, which are for the purchase or refinance of residential real
property by sub-prime borrowers and Portfolio Series loans, which are debt
consolidation loans for Agency-Qualified Borrowers with loan-to-value ratios
of up to 135%. The Company has recently increased the permitted loan-to-value
ratios on Portfolio Series loans to 135% from 125%. While the Company is
currently emphasizing the origination of Portfolio Series loans, it intends to
market both products as demand permits. In addition, to a much lesser extent,
the Company originates multi-family residential and commercial loans. The
Company purchases and originates mortgage loans and other real estate secured
loans through a network of Originators throughout the country. The Company
funds substantially all of the loans which it originates or purchases through
deposits, other borrowings, internally generated funds and FHLB advances. In
the immediate and foreseeable future, the Company will also fund loans from
the cash proceeds, if any, received from securitizations. Deposit flows and
cost of funds are influenced by prevailing market rates of interest primarily
on competing investments, account maturities and the levels of savings in the
Company's market area. The Company's ability to purchase or sell loans is
influenced by the general level of product available from its correspondent
relationships and the willingness of investors to purchase the loans at an
acceptable price to the Company. Due to substantial activity in the purchase
and sale of loans in recent years, the net gains from mortgage financing
operations have been significant. The Company's
34
results of operations are also affected by the Company's provision for loan
losses and the level of operating expenses. The Company's operating expenses
primarily consist of employee compensation and benefits, premises and
occupancy expenses, and other general expenses. The Company's results of
operations are also affected by prevailing economic conditions, competition,
government policies and actions of regulatory agencies. See "Regulation."
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
AND SEPTEMBER 30, 1996
GENERAL
For the nine months ended September 30, 1997 the Company recorded net income
of $7.7 million compared to $168,000 for the nine months ended September 30,
1996. The net earnings per share for the nine months ended September 30, 1997
were $1.70 compared to $0.08 for the nine months ended September 30, 1996. The
increase in net income was due to the expansion of the mortgage financing
operations, the increase in gains with respect to such operations, increases
in net interest income and the absence of a special SAIF assessment.
INTEREST INCOME
Interest income for the nine months ended September 30, 1997 was $12.2
million, compared to $4.9 million for the nine months ended September 30,
1996, due to an increase in the average balance of interest earning assets,
combined with an increase in the yield on those assets. Average interest
earning assets increased to $176.1 million for the nine months ended September
30, 1997 compared to $78.0 million for the nine months ended September 30,
1996. The yield on interest earning assets increased to 9.20% for the nine
months ended September 30, 1997 compared to 8.41% for the nine months ended
September 30, 1996. The largest single component of interest earning assets
was average loans receivable, net, which were $140.9 million with a yield of
9.46% for the nine months ended September 30, 1997, compared to $71.2 million
with a yield of 8.75% for the nine months ended September 30, 1996.
INTEREST EXPENSE
For the nine months ended September 30, 1997, interest expense was $7.1
million compared to $2.7 million for the nine months ended September 30, 1996
due to an increase in the average balance of interest bearing liabilities
combined with an increase in the cost of those liabilities. At the end of the
quarter ended March 31, 1997, the Company issued subordinated debentures with
an interest rate of 13.5%. This issuance of debentures, combined with an
increased use of borrowed funds as well as a heavier reliance on certificate
accounts, resulted in an increase in the average cost of interest bearing
liabilities to 5.88% for the nine months ended September 30, 1997 compared to
4.82% for the nine months ended September 30, 1996. Average interest bearing
liabilities were $161.0 million for the nine months ended September 30, 1997
compared to $74.6 million for the nine months ended September 30, 1996.
The largest component of average interest bearing liabilities was
certificate accounts, which averaged $116.0 million with an average cost of
5.87% for the nine months ended September 30, 1997 compared to $54.8 million
with an average cost of 5.53% for the nine months ended September 30, 1996.
The second largest component of average interest bearing liabilities is
borrowings, which increased to an average balance of $27.3 million with an
average cost of 8.11% for the nine months ended September 30, 1997 compared to
$4.3 million with an average cost of 5.93% for the nine months ended September
30, 1997.
NET INTEREST INCOME BEFORE PROVISION FOR ESTIMATED LOAN LOSSES
Net interest income before provision for estimated loan losses for the nine
months ended September 30, 1997 was $5.1 million compared to $2.2 million for
the nine months ended September 30, 1996. This increase is the net effect of
an increase in average interest earning assets and average interest bearing
liabilities, as well as an increase in the net interest margin and the ratio
of interest earning assets to interest bearing liabilities. Average interest
earning assets increased to $176.1 million for the nine months ended September
30, 1997 compared to
35
$78.0 million for the nine months ended September 30, 1996. Average interest
bearing liabilities increased to $161.0 million with an average cost of 5.88%
for the nine months ended September 30, 1997 compared to $74.6 million with an
average cost of 4.82% for the nine months ended September 30, 1996. The net
interest margin was 3.83% for the nine months ended September 30, 1997 compared
to 3.80% for the nine months ended September 30, 1996. The ratio of interest
earning assets to interest bearing liabilities was 109.33% for the nine months
ended September 30, 1997 compared to 104.59% for the nine months ended
September 30, 1996.
PROVISION FOR ESTIMATED LOAN LOSSES
Provisions for estimated loan losses were $900,000 for the nine months ended
September 30, 1997 compared to $359,000 for the nine months ended September 30,
1996. The increase in provisions was based on an evaluation of the composition
of the Company's loan portfolio. Charge-offs for the nine months ended
September 30, 1997 were $673,000, with recoveries for the same period of
$7,000, leaving the Company with net charge offs of $666,000 for the period.
Charge-offs for the nine months ended September 30, 1996 were $632,000. While
management believes it has adequately provided for losses and does not expect
any material loss on its loans in excess of allowances already recorded, no
assurance can be given that additional loans will not become delinquent or that
the collateral for such loans will be sufficient to prevent losses in the event
of foreclosure. Management believes that the allowance for loan losses at
September 30, 1997 was adequate to absorb known and inherent risks in the
Company's loan portfolio. No assurance can be given, however, that economic
conditions which may adversely affect the Company's or the Bank's service areas
or other circumstances will not be reflected in increased losses in the loan
portfolio. In addition, regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses.
Such agencies may require the Bank to recognize additions to the allowance or
to take charge-offs (reductions in the allowance) in anticipation of losses.
See "Business--Lending Overview--Delinquencies and Classified Assets" and "--
Lending Overview--Allowance for Loan Losses."
NON-INTEREST INCOME
For the nine months ended September 30, 1997, net gains from mortgage
financing operations totaled $17.4 million compared to $3.8 million for the
nine months ended September 30, 1996. The net gain includes a pre-tax
unrealized loss of $787,000, due to an adjustment to the valuation of the
residual asset related to the 1997-1A securitization, as a result of higher-
than-estimated prepayment speeds. See "Business--Loan Sales and Asset
Securitizations." This increase was attributable to the increase in the level
of mortgage financing operations, with loans sold or securitized totaling
$277.1 million (including $73.1 million in whole loans sales) during the nine
months ended September 30, 1997, compared to loans sold totaling $140.8 million
for the nine months ended September 30, 1996. There were no loans securitized
during the nine months ended September 30, 1996. Net gains from mortgage
financing operations as a percent of loans sold and securitized was 6.28% for
the nine months ended September 30, 1997 compared to 2.67% for the nine months
ended September 30, 1996. This increase in percentage reflected the effects of
the securitization of loans compared to whole loan sales. Loans originated and
purchased totaled $433.4 million for the nine months ended September 30, 1997
compared to $148.4 million for the nine months ended September 30, 1996.
NON-INTEREST EXPENSE
For the nine months ended September 30, 1997, non-interest expense was $9.2
million compared to $5.8 million for the nine months ended September 30, 1996.
The increase was due primarily to an increase in compensation and benefits and
other operating expenses resulting from the expansion of the mortgage financing
operations. New loans originated and purchased were $433.4 million for the nine
months ended September 30, 1997 compared to $148.4 million for the nine months
ended September 30, 1996.
For the nine months ended September 30, 1997, compensation and benefits were
$5.5 million compared to $3.2 million for the nine months ended September 30,
1996. These costs are directly related to the expansion of
36
the mortgage financing operations and the corresponding increase in personnel,
to an average of 163 employees for the nine months ended September 30, 1997
compared to 87 for the nine months ended September 30, 1996.
Premises and occupancy expenses were $805,000 for the nine months ended
September 30, 1997 compared to $538,000 for the nine months ended September
30, 1996 due to the expansion of the mortgage financing operation and the
addition of the regional operating center in the Denver, Colorado metropolitan
operating area, as well as the opening of the new corporate headquarters in
Riverside, California. As a result of leasing office space for the Company's
and the Bank's executive offices and the western regional office of Life
Financial Services, combined with the relocation of the Florida regional
office, the addition of two new retail lending offices in California and the
anticipated leasing of space for an additional four retail lending offices
during the quarter ending December 31, 1997 and two retail lending offices
during the first quarter of 1998, premises and occupancy expenses are expected
to increase to approximately $594,000 per quarter beginning with the first
quarter of 1998.
As a result of the expansion of the mortgage financing operations, other
operating expenses increased as well. Data processing increased to $524,000
for the nine months ended September 30, 1997 compared to $281,000 for the nine
months ended September 30, 1996. The increase in non-interest expense was
partially offset by a reduction in FDIC insurance premiums in the 1997 period.
During the quarter ended September 30, 1996, the Bank paid a one time
assessment to the FDIC of $448,000 for the recapitalization of the SAIF.
Telephone, professional services and other expense were $439,000, $243,000 and
$1,247,000 for the nine months ended September 30, 1997 compared to $159,000,
$137,000 and $623,000 for the nine months ended September 30, 1996.
INCOME TAXES
The provision for income taxes increased to $5.5 million for the nine months
ended September 30, 1997 compared to $142,000 for the nine months ended
September 30, 1996. Income before income tax provision increased to $13.2
million for the nine months ended September 30, 1997 compared to $310,000 for
the nine months ended September 30, 1996. The effective tax rate decreased to
41.6% for the nine months ended September 30, 1997 compared to 45.8% for the
nine months ended September 30, 1997.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 1997 AND DECEMBER 31, 1996
Total assets increased to $294.1 million as of September 30, 1997 compared
to $104.0 million as of December 31, 1996 due to the expansion of the mortgage
financing operations. Loans held for sale totaled $191.6 million as of
September 30, 1997 compared to $31.0 million as of December 31, 1996. This
increase was partially offset by a decrease in loans held for investment to
$32.1 million as of September 30, 1997 compared to $36.9 million as of
December 31, 1996. During the nine months ended September 30, 1997, the
Company originated or purchased $433.4 million of loans. During the same nine
month period, the Company sold or securitized $277.1 million of loans
(including $73.1 million in whole loan sales). The increase in loans held for
sale also resulted in an increase in accrued interest receivable to $1.7
million as of September 30, 1997 compared to $537,000 as of December 31, 1996.
As a result of the Company's loan securitization activities, residual assets
and restricted cash increased to $24.5 million and $10.9 million,
respectively, as of September 30, 1997 compared to $5.7 million and $1.6
million as of December 31, 1996. Mortgage servicing rights also increased to
$5.7 million as of September 30, 1997 compared to $2.6 million as of
December 31, 1996 as a result of the securitization of loans with servicing
retained.
Cash and cash equivalents were $12.9 million as of September 30, 1997
compared to $13.3 million as of December 31, 1996. During the nine months
ended September 30, 1997, the Company began leasehold improvements on the new
corporate headquarters as well as adding the Denver, Colorado regional lending
center, increasing premises and equipment to $3.8 million as of September 30,
1997 compared to $1.6 million as of
37
December 31, 1996. Real estate owned increased to $975,000 as of September 30,
1997 compared to $561,000 as of December 31, 1996 as part of the Company's
continuing effort to resolve problem loans.
During the nine months ended September 30, 1997, the Company issued $10.0
million in Subordinated Debentures in order to increase its risk based
capital. The additional funds, net of debt issuance costs, were used to fund
loans during the nine months ended September 30, 1997. In addition, the
Company increased its liabilities by increasing deposit accounts to $159.8
million as of September 30, 1997 compared to $85.7 million as of December 31,
1996. The major component of deposit accounts is certificates of deposit,
which increased to $140.9 million as of September 30, 1997 compared to $69.4
million as of December 31, 1996. The additional funds were used to fund loans
during the nine months ended September 30, 1997.
The Company also increased its use of FHLB advances and other borrowings to
fund loans held for sale. The Company has added two warehouse lines of credit
with a combined credit limit of $250.0 million. The availability of such
borrowings permits the Company to access sufficient cash to originate and hold
loans pending securitization or sale and to thereafter repay the lines of
credit following securitization or sale of the loans. FHLB advances and other
borrowings increased to $61.5 million as of September 30, 1997 compared to
$3.3 million as of December 31, 1996. The warehouse lines of credit have a
total aggregate limit of $250.0 million, and range in interest rates from
LIBOR plus 50 basis points to LIBOR plus 100 basis points.
Accounts payable and other liabilities increased to $13.3 million as of
September 30, 1997 compared to $5.7 million as of December 31, 1996 due to an
increase in loans serviced for other investors and the corresponding increase
in amounts due investors between the time the borrowers make payments to the
Company and the time the Company remits payments to the investors.
Stockholders' equity increased to $49.5 million as of September 30, 1997
from $9.3 million as of December 31, 1996 due to the issuance of 2,900,000
shares of Company common stock to the public in the Company's initial public
offering, completed on June 30, 1997 and the issuance of an additional 435,000
shares to the public pursuant to the exercise of the underwriter's
overallotment option. The initial offering price to the public was $11.00 per
share, which resulted in $32.5 million in net proceeds after expenses.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1996 AND
DECEMBER 31, 1995
GENERAL
Net income increased by $985,000 from $520,000 for the year ended December
31, 1995 to $1.5 million for the year ended December 31, 1996. Net income for
the year ended December 31, 1996 was adversely impacted by a non-recurring
expense for compensation and benefits of $354,000 which was incurred during
the quarter ended June 30, 1996, and a non-recurring SAIF special assessment
of $448,000 which was incurred during the quarter ended September 30, 1996.
The non-recurring expense for compensation and benefits is an accrual of the
present value of a portion of the future payments due pursuant to a consulting
agreement entered into with a former officer of the Bank. See "The Board of
Directors and Management of the Bank--Consultation Agreement." Net income for
the year ended December 31, 1996 would have been $2.0 million if these charges
had not been incurred.
Net gains from mortgage financing operations for the year ended December 31,
1995 totaled $3.6 million compared to $8.4 million for the year ended December
31, 1996 due to the expansion of the mortgage financing operations and
increased marketing effort therefrom, along with the completion of the Bank's
first securitization during the quarter ended December 31, 1996. The expansion
of the mortgage financing operations resulted in an increase in loan
originations and purchases from $134.8 million for the year ended December 31,
1995 to $222.6 million for the year ended December 31, 1996. The related sales
of loans increased from $126.9 million for the year ended December 31, 1995 to
$206.6 million (including $51.9 million sold through the fourth quarter
securitization) for the year ended December 31, 1996. As a result of this
securitization, the Bank recognized a gain on sale of $4.3 million. See
"Business--Loan Sales and Asset Securitizations."
38
The Company currently intends to conduct securitizations on a regular basis
either through private placements or public offerings. There can be no
assurance, however, that the Company will be able to successfully implement
this strategy. See "Risk Factors Related to the Company--Dependence on Asset
Securitizations and Impact on Quarterly Operating Results."
In addition, during the year ended December 31, 1996, the Bank acquired the
Riverside, California property it had been leasing by exercising its lease
option at a price of $375,000. The Bank also increased its personnel from an
average of 50 for the year ended December 31, 1995 to an average of 97 for the
year ended December 31, 1996. The additional staff allowed for increased
marketing, processing and underwriting efforts and the ability to increase the
number of broker and correspondent relationships, but also added to non-
interest expense for the period.
INTEREST INCOME
Interest income increased from $5.8 million for the year ended December 31,
1995 to $6.9 million for the year ended December 31, 1996, due to an increase
in the yield on interest-earning assets as well as in the average balances of
those assets. The Bank's yield on average interest-earning assets increased
from 7.96% for the year ended December 31, 1995 to 8.63% for the year ended
December 31, 1996. Total average interest-earning assets increased from $73.2
million for the year ended December 31, 1995 to $80.3 million for the year
ended December 31, 1996. The largest single component of interest-earning
assets was loans receivable, net, which increased from an average of $65.5
million for the year ended December 31, 1995 to $72.6 million for the year
ended December 31, 1996. The increase in average loans receivable, net was due
to an increase in loans held for sale from the expansion of the mortgage
financing operations. Loans held for sale increased from $21.7 million at
December 31, 1995 to $31.0 million at December 31, 1996, while loans held for
investment, net decreased from $41.7 million at December 31, 1995 to $36.9
million at December 31, 1996. Generally, all loans are originated or purchased
for sale in the secondary market or through securitizations. See "Business--
Core Lending Products" and "--Loan Sales and Asset Securitizations." The yield
on loans receivable increased from 8.29% for the year ended December 31, 1995
to 9.02% for the year ended December 31, 1996.
INTEREST EXPENSE
Interest expense increased from $3.4 million for the year ended December 31,
1995 to $3.8 million for the year ended December 31, 1996 due to an increase
in average interest-bearing liabilities. Average interest-bearing liabilities
increased from $70.7 million for the year ended December 31, 1995 to $77.3
million for the year ended December 31, 1996. Interest expense for the year
ended December 31, 1995 was adversely impacted by the effects of an interest
rate swap which matured on November 7, 1995 which resulted in an increase in
interest expense on borrowings of $52,000 for the year ended December 31,
1995. Without this expense, average cost of borrowings for the year ended
December 31, 1995 would have been 6.56%, and the average cost of total
interest-bearing liabilities would have been 4.80%. The increase in interest
expense also reflects a change in the composition of interest-bearing
liabilities. Average certificate accounts increased from $50.6 million for the
year ended December 31, 1995 to $57.3 million for the year ended December 31,
1996. Average borrowings increased from $3.1 million for the year ended
December 31, 1995 to $4.3 million for the year ended December 31, 1996.
NET INTEREST INCOME BEFORE PROVISION FOR ESTIMATED LOAN LOSSES
Net interest income before provision for estimated loan losses for the year
ended December 31, 1995 was $2.4 million compared to $3.2 million for the year
ended December 31, 1996. This increase was primarily due to the increase in
the net interest margin from 3.25% for the year ended December 31, 1995 to
3.94% for the year ended December 31, 1996, and an increase in the ratio of
average interest-earning assets to average interest-bearing liabilities from
103.50% for the year ended December 31, 1995 to 103.90% for the year ended
December 31, 1996.
39
PROVISION FOR ESTIMATED LOAN LOSSES
The provision for estimated loan losses was $963,000 for the year ended
December 31, 1996 compared to $1.2 million for the year ended December 31,
1995. The decrease in the provision resulted from the Bank's quarterly
analysis of its loan portfolio, the decrease in charge-offs of loans and the
increase in recoveries and management's belief that property values in the
southern California market had stopped deteriorating.
Charge-offs for the year ended December 31, 1995 were $914,000 compared to
$734,000 for the year ended December 31, 1996. For the year ended December 31,
1995, the ratio of net charge-offs to average loans outstanding was 1.30%
compared to 0.71% for the year ended December 31, 1996. Recoveries increased
from $65,000 for the year ended December 31, 1995 to $219,000 for the year
ended December 31, 1996. Non-performing assets as a percent of total assets
decreased from 3.0% at December 31, 1995 to 2.86% at December 31, 1996. At
December 31, 1995 the allowance for estimated loan losses was $1.2 million
compared to $1.6 million at December 31, 1996. The allowance for estimated
loan losses as a percent of non-performing loans was 84.25% at December 31,
1995 compared to 67.26% at December 31, 1996.
NON-INTEREST INCOME
Gains from mortgage financing operations for the year ended December 31,
1995 were $3.6 million compared to $8.4 million for the year ended December
31, 1996. This increase was attributable to the increase in the level of
mortgage financing operations, with loans sold totaling $126.9 million for the
year ended December 31, 1995 compared to $206.6 million (including $51.9
million sold through the securitization completed in the quarter ended
December 31, 1996) for the year ended December 31, 1996. Loans originated and
purchased totalled $134.8 million for the year ended December 31, 1995
compared to $222.6 million for the year ended December 31, 1996, which also
resulted in an increase in loan servicing and other fees from $231,000 for the
year ended December 31, 1995 to $496,000 for the year ended December 31, 1996.
Gains from mortgage financing operations as a percent of loans sold and
securitized increased from 2.82% for the year ended December 31, 1995 to 4.04%
for the year ended December 31, 1996. This increase is a direct result of the
Bank's securitization during the quarter ended December 31, 1996. As a result
of this securitization, the Bank generated a gain on sale of $4.3 million.
Consistent with management's business strategy, it is anticipated that
mortgage financing operations will constitute an even greater portion of the
Company's business in future periods. The inability of the Company to
implement its business strategy would have a material adverse effect on the
Company's financial condition and results of operations. See "Risk Factors
Related to the Company--Ability of the Bank to Implement its Business
Strategy" and "Business--Background of the Company" and "--Growth and
Operating Strategies."
NON-INTEREST EXPENSE
Non-interest expense was $4.4 million for the year ended December 31, 1995
compared to $8.7 million for the year ended December 31, 1996. The increase
was due primarily to the expansion of the mortgage financing operations, a
non-recurring increase in compensation and benefits and the non-recurring SAIF
special assessment. New loans originated and purchased increased from $134.8
million for the year ended December 31, 1995 to $222.6 million for the year
ended December 31, 1996, which resulted in increased employee commissions and
bonuses.
Compensation and benefits increased from $2.5 million for the year ended
December 31, 1995 to $5.2 million for the year ended December 31, 1996. These
costs are directly related to the expansion of the mortgage financing
operations and the corresponding increase in personnel, from an average of 50
for the year ended December 31, 1995 to 97 for the year ended December 31,
1996, combined with a non-recurring expense for compensation and benefits of
$354,000 during the quarter ended June 30, 1996. The non-recurring expense for
compensation and benefits is an accrual of the present value of a portion of
the future payments due pursuant to a consulting agreement entered into with a
former officer of the Bank. See "The Board of Directors and Management of the
Bank--Consultation Agreement."
40
Premises and occupancy increased from $471,000 for the year ended December
31, 1995 to $746,000 for the year ended December 31, 1996 due to the addition
of the Riverside, California mortgage financing office. The financing office
is approximately 7,500 square feet, with additional space being utilized for
the increase in personnel and the expansion of the mortgage financing
operations. With the increase in loans originated and purchased, combined with
the increase in personnel, data processing expense increased from $208,000 for
the year ended December 31, 1995 to $390,000 for the year ended December 31,
1996.
As a result of the expansion of the mortgage financing operations, marketing
expense increased from $65,000 for the year ended December 31, 1995 to
$189,000 for the year ended December 31, 1996. In addition, telephone expense
increased from $143,000 for the year ended December 31, 1995 to $246,000 for
the year ended December 31, 1996, and professional services increased from
$92,000 for the year ended December 31, 1995 to $218,000 for the year ended
December 31, 1996.
The Bank incurred a charge of $448,000 due to the non-recurring SAIF special
assessment during the year ended December 31, 1996. No similar charge was
assessed for the year ended December 31, 1995. In addition, other expenses
also increased due to the expansion of the mortgage financing operations,
although no single item exceeded 1.0% of gross income.
INCOME TAXES
The provision for income taxes increased from $294,000 for the year ended
December 31, 1995 to $1.1 million for the year ended December 31, 1996. The
increase in income taxes is the result of the increase in income before tax,
which increased from $814,000 for the year ended December 31, 1995 to $2.6
million for the year ended December 31, 1996. The effective tax rate increased
from 36.1% for the year ended December 31, 1995 to 42.8% for the year ended
December 31, 1996. The change in effective tax rate is due to a reduction in
the deferred tax valuation allowance for state tax purposes in 1995.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1996 AND DECEMBER 31, 1995
Total assets increased from $74.1 million as of December 31, 1995 to $104.0
million as of December 31, 1996, which was attributable to an increase in
loans held for sale, an increase in cash and cash equivalents, an increase in
securities held-to-maturity and FHLB stock and an investment in residuals and
restricted cash created as a result of the securitization completed in the
quarter ended December 31, 1996. Loans held for sale, net, increased from
$21.7 million as of December 31, 1995 to $31.0 million as of December 31,
1996, which was partially offset by a decrease in loans held for investment
from $41.7 million as of December 31, 1995 to $36.9 million as of December 31,
1996. During the year ended December 31, 1996, the Bank originated and
purchased $222.6 million in loans, which were offset by prepayments, sales and
securitizations totaling $206.6 million. Cash and cash equivalents were $3.9
million at December 31, 1995, compared to $13.3 million at December 31, 1996
due to an increase in deposits from $67.5 million at December 31, 1995 to
$85.7 million at December 31, 1996. Securities held-to-maturity and FHLB stock
increased from $2.7 million at December 31, 1995 to $8.8 million at December
31, 1996. Securities held-to-maturity consist of U.S. Treasury bills and U.S.
Treasury notes with staggered maturities ranging from three months to 24
months. During the quarter ended December 31, 1996, the Bank securitized $51.9
million in loans. This was the first loan securitization completed by the
Bank, which recorded a gain on sale of $4.3 million.
Deposit accounts increased from $67.5 million as of December 31, 1995 to
$85.7 million as of December 31, 1996 due to an increased use of wholesale
deposits to fund lending activity. While core deposits remained fairly stable,
certificates of deposits increased from $51.8 million at December 31, 1995 to
$69.4 million at December 31, 1996.
Stockholders' equity increased from $4.3 million at December 31, 1995 to
$9.3 million at December 31, 1996 due to net income of $1.5 million for the
year ended December 31, 1996 and due to proceeds from the issuance of common
stock in the Private Placement during the third quarter of 1996 totaling $3.5
million.
41
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1995 AND
DECEMBER 31, 1994
GENERAL
The Bank reported net income of $520,000 for the year ended December 31,
1995, which represented a $1.2 million increase from the net loss of $671,000
for the year ended December 31, 1994. The increase in net income for the year
ended December 31, 1995 compared to the year ended December 31, 1994 was
attributable to the increase in mortgage financing operations and an increase
in net interest income. Loans originated and purchased totalled $134.8 million
for the year ended December 31, 1995 compared to $72.8 million for the year
ended December 31, 1994. The increase in loans originated and purchased is due
to the restructuring and expansion of the mortgage financing operations during
1994 and 1995.
During 1994, the Bank hired new management to restructure the mortgage
financing operations, changing the lending strategy from traditional mortgage
banking and portfolio lending to focusing on sub-prime mortgage financing.
During the period of restructuring in the first half of 1994, loan
originations and purchases declined as new lending products were being
developed and new personnel skilled in originating, processing underwriting
and servicing the new products were being hired. Loan originations and
purchases increased during the latter half of 1994 and 1995 as a result of the
restructuring.
Gains from mortgage financing operations were $3.6 million for the year
ended December 31, 1995 compared to $1.4 million for the year ended December
31, 1994 due to the expansion of the mortgage financing operations and the
increase in sales of loans which were generated as a result of this expansion.
Loan sales were $126.9 million for the year ended December 31, 1995 compared
to $65.7 million for the year ended December 31, 1994. In addition, based on
the change in the loans generated and therefore the change in the market
demand for these loans, gains on sale as a percentage of loans sold increased
from 2.17% for the year ended December 31, 1994 to 2.82% for the year ended
December 31, 1995.
In addition, interest income increased due to the types of loans being
generated. Net interest income before provision for estimated loan losses for
the year ended December 31, 1995 was $2.4 million compared to $2.1 million for
the year ended December 31, 1994. The Bank's net interest margin increased to
3.25% for the year ended December 31, 1995 compared to 2.88% for the year
ended December 31, 1994. The Bank's yield on loans receivable, the single
largest component of interest-earning assets, increased from 6.91% for the
year ending December 31, 1994 to 8.29% for the year ending December 31, 1995.
As a result of these events, the Bank's return on average assets and return
on average equity increased to 0.69% and 13.64%, respectively, for the year
ended December 31, 1995, compared to (0.89%) and (17.01%), respectively, for
the year ended December 31, 1994.
INTEREST INCOME
Interest income increased from $4.8 million for the year ended December 31,
1994 to $5.8 million for the year ended December 31, 1995 due to an increase
in the yield on interest earning assets as well as the average balances of
those assets. The Bank's yield on average interest earning assets increased to
7.96% for the year ended December 31, 1995 compared to 6.60% for the year
ended December 31, 1994 due to the increase in loans held for sale from $17.1
million at December 31, 1994 to $21.7 million at December 31, 1995 as compared
to loans held for investment which decreased from $47.1 million at December
31, 1994 to $41.7 million at December 31, 1995. The total average interest
earning assets increased from $73.1 million for the year ended December 31,
1994 to $73.2 million for the year ended December 31, 1995. The largest single
component of interest-earning assets was loans receivable, net. The yield on
loans receivable increased from 6.91% for the year ended December 31, 1994 to
8.29% for the year ended December 31, 1995. Except for loans specifically
originated to be held for investment, all loans are originated or purchased
for sale in the secondary market or through securitizations.
42
INTEREST EXPENSE
Interest expense increased from $2.7 million for the year ended December 31,
1994 to $3.4 million for the year ended December 31, 1995. Total average
interest-bearing liabilities decreased from $71.5 million with an average
yield of 3.81% for the year ended December 31, 1994 to $70.7 million with an
average cost of 4.87% for the year ended December 31, 1995. The cost of
certificate accounts increased from 4.25% for the year ended December 31, 1994
to 5.59% for the year ended December 31, 1995. The level of certificate
accounts averaged $50.6 million for the year ended December 31, 1995 compared
to $49.9 million for the year ended December 31, 1994. The interest expense
increase also reflects the rise in average borrowings, which were $3.1 million
for the year ended December 31, 1995, compared to $1.9 million for the year
ended December 31, 1994. The cost of borrowings was adversely affected by
interest rate swaps which matured on November 7, 1995. During the years ended
December 31, 1995 and December 31, 1994, the interest on swaps totalled
$52,000 and $96,000, respectively, which increased the cost of borrowings for
the years ended December 31, 1995 and December 31, 1994 to 8.23% and 10.04%,
respectively. Without the interest on the swaps, the cost of borrowings would
have been 6.56% for the year ended December 31, 1995 and 4.88% for the year
ended December 31, 1994. Furthermore, the cost of total interest-bearing
liabilities for the years ended December 31, 1995 and December 31, 1994 would
have been 4.80% and 3.67% without the interest on the swaps.
NET INTEREST INCOME BEFORE PROVISION FOR ESTIMATED LOAN LOSSES
Net interest income before provision for estimated loan losses for the year
ended December 31, 1995 was $2.4 million compared to $2.1 million for the year
ended December 31, 1994. The Bank's net interest margin increased to 3.25% for
the year ended December 31, 1995 compared to 2.88% for the year ended December
31, 1994. Average interest-earning assets to interest-bearing liabilities
increased from 102.27% at December 31, 1994 to 103.50% at December 31, 1995.
PROVISION FOR ESTIMATED LOAN LOSSES
The provision for estimated loan losses was $1.2 million for the year ended
December 31, 1995 compared to $1.3 million for the year ended December 31,
1994. The decrease in the provision resulted from the Bank's analysis of its
loan portfolio and an increase in the recoveries of the loans previously
charged off. Recoveries for the year ended December 31, 1995 were $65,000
compared to $3,000 for the year ended December 31, 1994.
Charge-offs for the 1995 and 1994 periods remained relatively constant as
management continued to charge-off problem assets and improve its collection
procedures pursuant to its strategy which was revised during the year ended
December 31, 1994. See "Business--Background of the Bank." Charge-offs net of
recoveries, however, totalled $849,000 for the year ended December 31, 1995
exceeding the Bank's allowance for estimated loan losses of $832,000
established at December 31, 1994, which reflected management's loss
expectation for the year ended December 31, 1995.
Non-performing assets as a percent of total assets declined from 3.42% at
December 31, 1994 to 3.00% at December 31, 1995. The Bank's allowance for
estimated loan losses increased from $832,000 at December 31, 1994 to $1.2
million at December 31, 1995. The allowance for estimated loan losses as a
percent of non-performing loans increased to 84.25% at December 31, 1995
compared to 44.04% at December 31, 1994.
NON-INTEREST INCOME
Gains from mortgage financing operations for the year ended December 31,
1995 were $3.6 million compared to $1.4 million for the year ended December
31, 1994. This increase was attributable to the increase in the level of
mortgage financing operations, with loans sold totaling $126.9 million for the
year ended December 31, 1995 compared to $65.7 million for the year ended
December 31, 1994. Loans originated and purchased totaled $134.8 million for
the year ended December 31, 1995 compared to $72.8 million for the year ended
December 31, 1994. During 1994, the Bank hired new management to restructure
the mortgage financing operations, changing the lending strategy from a
traditional mortgage banking and portfolio lending operation to
43
a strategy of a sub-prime mortgage financing operations. During the period of
restructuring in the first six months of 1994, loan originations and purchases
declined as new lending products were being developed and new personnel
skilled in originating, processing, underwriting and servicing the new
products were being hired. Loan originations and purchases increased during
the latter half of 1994 and 1995 as a result of the restructuring.
Loan servicing and other fees were $231,000 for the year ended December 31,
1995 compared to $164,000 for the year ended December 31, 1994 due to the
expansion of the mortgage financing operations and the increase in the loan
servicing portfolio. With the adoption of SFAS No. 122 in July of 1995, the
Bank retained a greater portion of its servicing, which resulted in an
increase in servicing for other investors from $48.2 million as of December
31, 1994 to $189.5 million as of December 31, 1995. See "--Impact of New
Accounting Standards."
NON-INTEREST EXPENSE
Total non-interest expense totalled $4.4 million for the year ended December
31, 1995 compared to $3.5 million for the year ended December 31, 1994. This
increase is primarily attributable to the expenses related to compensation and
benefits increasing from $1.6 million for the year ended December 31, 1994 to
$2.5 million for the year ended December 31, 1995. These costs are directly
related to the expansion of the mortgage financing operations and the
corresponding increase in personnel. Loans originated and purchased increased
from $72.8 million for the year ended December 31, 1994 to $134.8 million for
the year ended December 31, 1995, which resulted in increased employee
commissions.
Premises and occupancy, data processing and other expense increased as a
result of the addition of the Riverside loan center in November 1995 and the
increased loan activity during the year ended December 31, 1995 compared to
the year ended December 31, 1994.
INCOME TAXES
The provision for income taxes increased from a benefit of $300,000 for the
year ended December 31, 1994 to an expense of $294,000 for the year ended
December 31, 1995. This increase is a result of income before income taxes of
$814,000 for the year ended December 31, 1995 compared to a loss before income
taxes of $971,000 for the year ended December 31, 1994 and the resulting
increase in the Bank's effective rate from 30.9% to 36.1% for the year ended
December 31, 1995.
MANAGEMENT OF INTEREST RATE RISK
The principal objective of the Company's interest rate risk management
function is to evaluate the interest rate risk included in certain balance
sheet accounts, determine the level of appropriate risk given the Company's
business focus, operating environment, capital and liquidity requirements and
performance objectives and manage the risk consistent with Board approved
guidelines through the establishment of prudent asset concentration
guidelines. Through such management, management of the Company seeks to reduce
the vulnerability of the Company's operations to changes in interest rates.
Management of the Company monitors its interest rate risk as such risk relates
to its operational strategies. The Company's Board of Directors reviews on a
quarterly basis the Company's asset/liability position, including simulations
of the effect on the Company's capital of various interest rate scenarios. The
extent of the movement of interest rates, higher or lower, is an uncertainty
that could have a negative impact on the earnings of the Company.
Between the time the Company originates loans and purchase commitments are
issued, the Company is exposed to both upward and downward movements in
interest rates which may have a material adverse effect on the Company. The
Board of Directors of the Company recently implemented a hedge management
policy primarily for the purpose of hedging the risks associated with loans
held for sale in the Company's mortgage pipeline. In a flat or rising interest
rate environment, this policy enables management to utilize mandatory forward
commitments to sell fixed rate assets as the primary hedging vehicles to
shorten the maturity of such assets. In a declining interest rate environment,
the policy enables management to utilize put options. The hedge
44
management policy also permits management to extend the maturity of its
liabilities through the use of short financial futures positions, purchase of
put options, interest rate caps or collars, and entering into "long" interest
rate swap agreements. Management may also utilize "short" interest rate swaps
to shorten the maturity of long-term liabilities when the net cost of funds
raised by using such a strategy is attractive, relative to short-term CD's or
borrowings. Since this policy was implemented after March 31, 1997, the Company
has engaged in only a limited amount of hedging activities. Management is
continuing to evaluate and refine its hedging policies. No hedging positions
were outstanding at September 30, 1997. See "Risk Factors Related to the
Company--Risks Associated with Mortgage Origination, Purchase and Sales
Activities."
Net Portfolio Value. The Bank's interest rate sensitivity is monitored by
management through the use of a model which estimates the change in net
portfolio value ("NPV") over a range of interest rate scenarios. NPV is the
present value of expected cash flows from assets, liabilities and off-balance
sheet contracts. An NPV Ratio, in any interest rate scenario, is defined as the
NPV in that scenario divided by the market value of assets in the same
scenario. The sensitivity measure is the decline in the NPV Ratio, in basis
points, caused by a 2% increase or decrease in rates, whichever produces a
larger decline (the "Sensitivity Measure"). The higher an institution's
Sensitivity Measure is, the greater its exposure to interest rate risk is
considered to be. The Bank utilizes a market value model prepared by the OTS
(the "OTS NPV model"), which is prepared quarterly, based on the Bank's
quarterly Thrift Financial Reports filed with the OTS. The OTS NPV model
measures the Bank's interest rate risk by approximating the Bank's NPV, which
is the net present value of expected cash flows from assets, liabilities and
any off-balance sheet contracts, under various market interest rate scenarios
which range from a 400 basis point increase to a 400 basis point decrease in
market interest rates. The interest rate risk policy of the Bank provides that
the maximum permissible change at a 400 basis point increase or decrease in
market interest rates is a 45% change in the net portfolio value. The OTS has
incorporated an interest rate risk component into its regulatory capital rule.
Under the rule, an institution whose Sensitivity Measure in the event of a 200
basis point increase or decrease in interest rates exceeds 2% would be required
to deduct an interest rate risk component in calculating its total capital for
purpose of the risk-based capital requirement. See "Regulation--Federal Savings
Institution Regulation." As of September 30, 1997, the most recent date for
which the relevant data is available, the Bank's Sensitivity Measure, as
measured by the OTS, resulting from a 200 basis point increase in interest
rates was 116 basis points and would result in a $3.7 million reduction in the
NPV of the Bank. As of September 30, 1997, the Bank's Sensitivity Measure is
below the threshold at which the Bank could be required to hold additional
risk-based capital under OTS regulations. The OTS has postponed indefinitely
the date the component will first be deducted from an institution's total
capital. See "Regulation--Federal Savings Institution Regulation."
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in NPV requires the making of
certain assumptions that may tend to oversimplify the manner in which actual
yields and costs respond to changes in market interest rates. First, the models
assume that the composition of the Bank's interest sensitive assets and
liabilities existing at the beginning of a period remains constant over the
period being measured. Second, the models assume that a particular change in
interest rates is reflected uniformly across the yield curve regardless of the
duration to maturity or repricing of specific assets and liabilities. Third,
the model does not take into account the impact of the Bank's business or
strategic plans on the structure of interest-earning assets and interest-
bearing liabilities. In particular, the Bank's core products and residual
assets which are directly related to the Bank's core products do not behave in
a manner which the OTS model projects. Borrowers of Portfolio Series loans are
less likely to refinance or prepay such loans because of the high cost of
obtaining a high loan to value loan. In addition, management believes that
borrowers of Liberator Series loans are less likely to refinance or prepay such
loans because of their lack of an adequate credit rating or possible prior
credit problems. Accordingly, although the NPV measurement provides an
indication of the Bank's interest rate risk exposure at a particular point in
time, such measurement is not intended to and does not provide a precise
forecast of the effect of changes in market interest rates on the Bank's net
interest income and will differ from actual results. The results of this
modeling are monitored by management and presented to the Board of Directors,
quarterly.
45
The following table shows the NPV and projected change in the NPV of the
Bank at September 30, 1997 assuming an instantaneous and sustained change in
market interest rates of 100, 200, 300 and 400 basis points ("bp").
INTEREST RATE SENSITIVITY OF NET PORTFOLIO VALUE (NPV)
NPV AS % OF PORTFOLIO
NET PORTFOLIO VALUE VALUE OF ASSETS
--------------------------- -----------------------
CHANGE IN RATES $ AMOUNT $ CHANGE % CHANGE NPV RATIO % CHANGE (bp)
- --------------- -------- -------- -------- --------- -------------
(DOLLARS IN THOUSANDS)
+400 bp..................... $14,614 (11,567) (44)% 5.75% (394)
+300 bp..................... 18,941 (7,240) (28) 7.30 (239)
+200 bp..................... 22,520 (3,662) (14) 8.53 (116)
+100 bp..................... 24,895 (1,286) (5) 9.30 (39)
Static...................... 26,181 9.68
-100 bp..................... 27,659 1,478 6 10.13 44
-200 bp..................... 30,308 4,127 16 10.94 125
-300 bp..................... 34,034 7,853 30 12.06 238
-400 bp..................... 38,448 12,267 47 13.35 367
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds are deposits, FHLB advances, other
borrowings, principal and interest payments on loans, cash proceeds from the
sale of loans and securitizations, and to a lesser extent, interest payments
on investment securities and proceeds from the maturation of investment
securities. See "Risk Factors Related to the Company--Availability of Funding
Sources." While maturities and scheduled amortization of loans are a
predictable source of funds, deposit flows and mortgage prepayments are
greatly influenced by general interest rates, economic conditions and
competition. However, the Bank has continued to maintain the required minimum
levels of liquid assets as defined by OTS regulations. This requirement, which
may be varied at the direction of the OTS depending upon economic conditions
and deposit flows, is based upon a percentage of deposits and short-term
borrowings. The required ratio is currently 4%. The Bank's average liquidity
ratios were 8.5%, 9.4% and 8.9% for the years ended December 31, 1996, 1995
and 1994, respectively, and 11.3% and 7.8% for the nine months ended September
30, 1997 and 1996, respectively. Management currently attempts to maintain a
minimum liquidity ratio of 5.0%.
The Company's cash flows are comprised of three primary classifications:
cash flows from operating activities, investing activities and financing
activities. Cash flows used in operating activities were $184.5 million and
$10.3 million for the nine months ended September 30, 1997 and 1996,
respectively, and were $18.7 million, $5.3 million and $6.9 million for the
years ended December 31, 1996, 1995 and 1994, respectively. Such cash flows
primarily consisted of loans originated and purchased for sale (net of loan
fees) of $450.1 million, $151.2 million, $227.2 million, $135.6 million and
$72.6 million, net of proceeds from the sale and securitization of loans held
for sale of $277.6 million, $143.0 million, $212.2 million, $130.1 million and
$66.4 million for the nine months ended September 30, 1997 and 1996 and the
years ended December 31, 1996, 1995 and 1994, respectively. Net cash provided
by investing activities consisted primarily of investment purchases offset by
principal collections on loans and proceeds from maturation of investment
purchases. Proceeds from the maturation of investment securities were $3.0
million and $2.0 million for the nine months ended September 30, 1997 and
1996, respectively, and $2.0 million, $9.2 million and $2.0 million for the
years ended December 31, 1996, 1995 and 1994, respectively. Net cash provided
by (used in) financing activities consisted primarily of net activity in
deposit accounts and borrowings. The net increase (decrease) in deposits and
borrowings was $132.4 million and $5.8 million for the nine months ended
September 30, 1997 and 1996, respectively, and $18.2 million, $596,000 and
$(6.3) million for the years ended December 31, 1996, 1995 and 1994,
respectively. The Company received net proceeds from the IPO of the Company's
Common Stock of $32.5 million. The Bank
46
also received proceeds from the issuance of common stock in the Private
Placement of $3.5 million in August 1996 and $10.0 million from the sale of the
Debentures in March 1997.
At September 30, 1997, the Bank exceeded all of its regulatory capital
requirements with a tangible capital level of $16.3 million, or 6.19% of total
adjusted assets, which is above the required level of $3.9 million, or 1.50%;
core capital of $16.0 million, or 6.19% of total adjusted assets, which is
above the required level of $7.9 million, or 3.0%, and risk-based capital of
$27.9 million, or 13.49% of risk-weighted assets, which is above the required
level of $16.6 million, or 8.0%. See "Regulation--Federal Savings Institution
Regulation--Capital Requirements."
The Company's most liquid assets are cash and short-term investments. The
levels of these assets are dependent on the Company's operating, financing,
lending and investing activities during any given period. At September 30,
1997, cash and short-term investments totalled $12.9 million. The Company has
other sources of liquidity if a need for additional funds arises, including the
utilization of FHLB advances. At September 30, 1997, the Bank had $6.9 million
in advances outstanding from the FHLB. Other sources of liquidity include
investment securities maturing within one year. The Bank also has two warehouse
lines of credit available in the amount of $250.0 million of which $54.6
million had been drawn upon at September 30, 1997, and is in the process of
negotiating a third warehouse line of credit in the amount of $250.0 million to
fund loan originations. The Company has a residual financing line of credit in
the amount of $40.0 million. See "Risk Factors Related to the Company--
Availability of Funding Sources."
The Company had no material contractual obligations or commitments for
capital expenditures at September 30, 1997. At September 30, 1997 the Company
had outstanding commitments to originate or purchase mortgage loans of $37.9
million compared to $9.2 million at December 31, 1996. The Company anticipates
that it will have sufficient funds available to meet its current loan
origination commitments. See "Business--Background of the Company."
Certificates of deposit which are scheduled to mature in one year or less from
September 30, 1997, totalled $134.3 million. The Company expects that a
substantial portion of the maturing certificates of deposit will be retained by
the Company at maturity.
IMPACT OF INFLATION AND CHANGING PRICES
The Financial Statements and Notes thereto presented herein have been
prepared in accordance with Generally Accepted Accounting Principles ("GAAP"),
which require the measurement of financial position and operating results in
terms of historical dollar amounts without considering the changes in the
relative purchasing power of money over time due to inflation. The impact of
inflation is reflected in the increased cost of the Bank's operations. Unlike
industrial companies, nearly all of the assets and liabilities of the Company
are monetary in nature. As a result, interest rates have a greater impact on
the Company's performance than do the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the price of goods and services.
IMPACT OF NEW ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long Lived Assets and for Long Lived Assets to be Disposed
Of" ("SFAS No. 121"). SFAS No. 121 requires that long lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or
circumstances indicate that the carrying amount of an asset may not be
recoverable. However, SFAS No. 121 does not apply to financial instruments,
core deposit intangibles, mortgage and other servicing rights or deferred tax
assets. The adoption of SFAS No. 121 in 1996 did not have a material effect on
the Company's results of operations or financial condition.
Effective July 1, 1995, the Bank adopted SFAS No. 122, "Accounting for
Mortgage Servicing Rights" ("SFAS No. 122"), which amended SFAS No. 65,
"Accounting for Certain Mortgage Banking Activities." SFAS No. 122 requires an
institution that purchases or originates mortgage loans and sells or
securitizes those loans with servicing rights retained to allocate the total
cost of the mortgage loans to the mortgage servicing rights and the loans
(without the mortgage servicing rights) based on their relative fair values.
The impact of
47
adopting SFAS No. 122 was an increase in pretax earnings of $594,000, net
income of $438,000 and earnings per share of $0.23, as adjusted for the
Reorganization, for the year ended December 31, 1995.
In 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"), which encourages companies to account for
stock compensation awards based on their fair value at the date the awards are
granted. SFAS No. 123 does not require the application of the fair value
method and allows for the continuance of current accounting methods, which
require accounting for stock compensation awards based on their intrinsic
value as of the grant date. However, SFAS No. 123 requires proforma disclosure
of net income and, if presented, earnings per share, as if the fair value
based method of accounting defined in this Statement had been applied. The
accounting and disclosure requirements of this Statement are effective for
financial statements for fiscal years beginning after December 15, 1995. The
Company did not adopt the recognition provisions of SFAS No. 123 with respect
to its Stock Option Plans.
In June 1996 the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No.
125"), which was amended by SFAS No. 127. This Statement provides accounting
and reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities based on consistent application of a financial-
components approach that focuses on control. It distinguishes transfers of
financial assets that are sales from transfers that are secured borrowings.
Under the financial-components approach, after a transfer of financial assets,
an entity recognizes all financial and servicing assets it controls and
liabilities it has incurred and derecognizes financial assets it no longer
controls and liabilities that have been extinguished. The financial-components
approach focuses on the assets and liabilities that exist after the transfer.
Many of these assets and liabilities are components of financial assets that
existed prior to the transfer. If a transfer does not meet the criteria for a
sale, the transfer is accounted for as a secured borrowing with pledge of
collateral. The Statement is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after December
31, 1996. This Statement supercedes SFAS No. 122, "Accounting for Mortgage
Servicing Rights." The adoption of SFAS No. 125 did not have a material impact
on the Company's results of operations or financial condition.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share" ("SFAS
No. 128"), which is effective for financial statements issued for periods
ending after December 15, 1997. It replaces the presentation of primary
earnings per share with a presentation of basic earnings per share. It also
requires the presentation of diluted earnings per share for entities with
complex capital structures. Diluted earnings per share takes into account the
potential dilution that could occur if securities or other contracts to issue
common stock, such as options, were exercised or converted into common stock.
The Company does not believe that SFAS No. 128 will have a material impact on
its financial statements.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and display
of comprehensive income and its components (revenues, expenses, gains, and
losses) in a full set of general purpose financial statements. SFAS No. 130
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. SFAS No. 130 requires that an enterprise (a) classify items of
other comprehensive income by their nature in a financial statement and (b)
display the accumulated balance of other comprehensive income separately from
net worth and additional paid-in capital in the equity section of a statement
of financial position. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. Reclassification of financial statements for earlier
periods provided for comparative purposes is required. Management is in the
process of determining the impact, if any, this statement will have on the
Company.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information." SFAS No. 131 requires disclosures for
each segment that are similar to those required under current standards with
the addition of quarterly disclosure requirements and a finer partitioning of
geographic disclosures. It requires limited segment data on a quarterly basis.
It also requires geographic data by country, as opposed to broader geographic
regions as permitted under current standards. SFAS No. 131 is effective for
fiscal year beginning after December 15, 1997 with earlier application
permitted. Management is in the process of determining the impact, if any,
this statement will have on the Company.
48
BUSINESS
BACKGROUND OF THE COMPANY
In connection with the Reorganization and the IPO, LIFE Financial
Corporation became the holding company of the Bank. The Company originates,
purchases, sell, securitizes and services primarily non-conventional mortgage
loans principally secured by first and second mortgages on one- to four-family
residences. The Company makes Liberator Series loans, which are for the
purchase or refinance of residential real property by sub-prime borrowers, and
Portfolio Series loans, which are debt consolidation loans for Agency-
Qualified Borrowers with loan-to-value ratios of up to 135%. The Company has
recently increased the permitted loan-to-value ratios on Portfolio Series
loans to 135% from 125%. While the Company is currently emphasizing the
origination of Portfolio Series loans, it intends to market both products as
demand permits. In addition, to a much lesser extent, the Company originates
multi-family residential and commercial loans.
The Bank was originally chartered in 1983 as a stock savings and loan
association under the laws of the State of California and became a federally
chartered stock savings bank in 1991. The Company conducts its business from
six locations: the Company's corporate headquarters and Western Regional
Lending Center in Riverside, California, two additional regional lending
centers, one in Jacksonville, Florida and one in the Denver, Colorado
metropolitan area, the national servicing center located in Riverside,
California, and two bank branch officers in San Bernardino and Riverside,
California. In addition, the Company has recently opened two low-cost retail
lending offices, and has entered into leases for an additional four retail
lending offices to be opened by the end of 1997. In addition, the Company
intends to open two retail lending offices in the first quarter of 1998. With
the exception of one planned office expected to be opened in Northern
California, the Company's two current and five of the six planned retail
lending offices will be located in Southern California. See "Recent
Developments."
At September 30, 1997, the Company had consolidated total assets of $294.1
million, total deposits of $159.8 million and total stockholders' equity of
$49.5 million. During the nine months ended September 30, 1997, the Company
originated or purchased, through its Originators, $433.4 million of non-
conventional mortgage products and sold or securitized $277.1 million of such
products. The Bank's deposits are insured up to the maximum allowable amount
by the SAIF of the FDIC.
During the early 1990's, as a result of reduced employment levels and
corporate relocations in Southern California and the general weakness of the
national economy, the Company's market area experienced a weakening of real
estate values and a reduction in home sales and construction. When confronted
with increased competition and nominal growth during this same period, the
Company's results of operations were adversely impacted and the Company began
to experience increases in total non-performing loans held for investment. In
response, in 1994, the Company retained new management experienced in sub-
prime lending to redirect its business focus, revise its underwriting policies
and procedures and enhance its related servicing capabilities. A plan was
developed pursuant to which the Company reorganized its lending operations
from that of a thrift emphasizing traditional mortgage banking and portfolio
lending to that of a diversified financial services operation focusing on the
origination for sale or securitization, with servicing retained, of various
loan products to include Liberator Series loans, Portfolio Series loans, and,
to a much lesser extent, commercial and multi-family real estate loans. The
Company also adopted revised underwriting policies and instituted more
aggressive procedures for resolving problem loans and for reducing the level
of non-performing assets. As a result of these steps, the Company improved its
profitability.
As part of the Company's strategic plan, the Company developed an internal
structure of operating divisions within the Bank, each with distinct
objectives and management focus. The five divisions include (i) the Financial
Services Division which emphasizes the wholesale origination of the Company's
core products; (ii) the Income Capital Services Division which originates and
sells commercial and multi-family mortgage loans; (iii) the Retail Loan
Division which concentrates on offering loan products directly to the public
primarily in the Company's primary market area; (iv) the Asset Management
Division which services loans and REO for both the Company
49
and for Loan Purchasers; and (v) the Banking Division which offers depository
services to the public. In 1994, the Bank began to implement its plan which
resulted in:
. An increase in total purchases and originations of loans by 171.5% from
$82.0 million for the year ended December 31, 1993 to $222.6 million for
the year ended December 31, 1996. For the nine month period ended
September 30, 1997, loans originated and purchased totalled $433.4
million.
. An increase in loan sales and securitizations by 191.0% from $71.0
million for the year ended December 31, 1993 to $206.6 million for the
year ended December 31, 1996. For the nine month period ended September
30, 1997, loan sales and securitizations totalled $277.1 million.
. An increase in net income of 1,518.3% from $93,000 for the year ended
December 31, 1993, to $1.5 million for the year ended December 31, 1996.
For the nine month period ended September 30, 1997, net income was $7.7
million.
. An increase in net gains from mortgage financing operations by 663.6%
from $1.1 million for the year ended December 31, 1993, to $8.4 million
for the year ended December 31, 1996. For the nine month period ended
September 30, 1997, net gains from mortgage financing operations
totalled $17.4 million.
. An increase in deposits from $72.0 million at December 31, 1993 to $85.7
million at December 31, 1996. Deposits increased further to $159.8
million at September 30, 1997. The Bank also obtained warehouse lines of
credit with two national investment banking firms aggregating $250.0
million, of which $54.6 million has been drawn upon at September 30,
1997. In addition, the Company obtained a line of credit in the amount
of $40.0 million secured by residual assets created by the Company's
securitization activities. See "Recent Developments."
. An increase in stockholders' equity from $4.4 million at December 31,
1993 to $9.3 million at December 31, 1996, due to an increase in
retained earnings and to the proceeds from the issuance of Bank common
stock in a private placement during 1996 totaling $3.5 million.
Stockholders' equity increased further to $49.5 million at September 30,
1997, due to an increase in retained earnings and to the net proceeds
from the issuance of Common Stock in the IPO totaling $32.5 million
during 1997. The Bank also issued $10.0 million of the Debentures during
1997 to increase its risk based capital.
COMPETITIVE STRENGTHS
Management believes that it enjoys a competitive advantage when compared to
most other finance companies competing in its product areas as a result of the
following factors:
Expertise of Management. The change in direction of the Company's business
focus commenced with the hiring in 1994 of Daniel L. Perl, currently the
Company's and the Bank's President and Chief Executive Officer. Mr. Perl has
more than twenty years of experience in the financial services industry,
including the areas of sub-prime lending, commercial real estate lending,
mortgage banking and investment banking. Additional management expertise
includes:
. Mr. Bruce Mills has more than 15 years in banking and regulatory
experience including service at the Federal Home Loan Bank, the
predecessor of the OTS and ten years as chief financial officer of the
Bank.
. Ms. Mary Darter has more than 13 years of lending experience including
sub-prime, bulk acquisition and warehouse lending. She joined the Bank
in March of 1994 having previously worked with Mr. Perl from 1988 to
1991.
. Mr. Joseph R. L. Passerino has been in the financial services industry
for more than 20 years. His areas of expertise have included
conventional and sub-prime residential loans as well as commercial
lending. Mr. Passerino previously worked with Mr. Perl from 1985 to
1988.
. Mr. Stephen Sandoval has more than 24 years of extensive experience in
the servicing and collection of mortgage and consumer loans with a
primary focus on loss mitigation including workout alternatives,
bankruptcy and foreclosure processing in addition to traditional day to
day loan servicing functions.
50
. Mr. Robert K. Riley joined the Company's Board of Directors after the
IPO. Mr. Riley is the co-founder and Chief Executive Officer of
Millenium Asset Management, L.L.C., a registered investment advisory
firm. From 1992 to 1996, Mr. Riley worked for the Millenium Group, a
consulting firm focused on designing asset securitization systems and
developing risk management programs for European banks.
The Board has implemented competitive management incentives to attract and
retain qualified executives. See "The Board of Directors and Management of the
Bank--Benefits--Cash Bonus Plan" and "--Stock Option Plans."
Efficiency of Operations. Management believes that the efficiency of its
operations allows the Company to offer to its Originators very competitively
priced products. Management believes that this competitive pricing will
increase the volume of loans originated. The efficiency of the Company's
operations results from:
. Providing Originators with clear, concise and consistent underwriting
standards;
. Well defined core products;
. Low cost, strategically located loan facilities;
. Rapid turnaround time on loan applications;
. Limited number of strong and productive relationships with Originators;
and
. Originations of loans at low premiums or at a discount from par.
Internal Controls. Management believes that the significant internal
controls that have been established help preserve and assure the overall
quality of loans originated by the Company. These internal controls include:
. Dual signatures on all loan originations;
. Unanimous approval by two persons, including a member of senior
management, of any exceptions to the Company's underwriting policies;
. Exceptions to the Company's underwriting policies are kept to a minimum;
. A limited number of appraisers approved by the Company's senior
management perform or review appraisals on all loans originated or
purchased by the Company;
. For all loans on first payment default or 60 days overdue, a quality
control review is completed by the quality control department;
. Internal quality-control underwriting review of not less than 10.0% of
all Liberator Series loans and 5% of all Portfolio Series loans
originated, post-funding; and
. Regularly-scheduled underwriting and delinquency meetings are held to
review and update procedures and controls.
Flexible Funding Sources and Structure. The Company has multiple sources of
liquidity. As a federally-chartered savings bank, the Bank has additional
funding avenues at a lower cost than its non-regulated finance company
competitors. This advantage is derived from the Bank's ability to:
. Access a long-term stable unsecured funding base through the Bank's
deposits which are insured by the FDIC;
. Increase its deposit base through competitive pricing and possible
branch acquisitions or acquisitions of other depository institutions;
and
. Access funding through the FHLB.
In addition, both the Bank and the Company have access to lines of credit
from major financial institutions. The Bank has two warehouse lines of credit
available in the aggregate amount of $250.0 million to fund loan originations,
of which $54.6 million has been drawn upon at September 30, 1997, and is in
the process of negotiating a third warehouse line of credit in the amount of
$250.0 million. The Company has a line of credit in the amount of $40.0
million secured by residual assets created by the Company's securitizations.
See "Recent Developments."
51
Diversification Opportunities. The Company is a unitary savings and loan
holding company which generally is not restricted in the types of business
activities which it may conduct provided that the Bank continues to be a QTL.
See "Regulation--Federal Savings Institution Regulation--QTL Test." The
Reorganization provided the Company with:
. The opportunity to expand its current product line and enter into
possible new product areas;
. Broader investment opportunities than the Bank; and
. Alternative access, if necessary, to the capital markets.
GROWTH AND OPERATING STRATEGIES
Management believes that, as a result of its competitive strengths, the Bank
and the Company will be able to implement the following growth and operating
strategies:
. Expanding Core Products Through a National Originator Network. The
Company will continue to emphasize and to expand the origination of its
core products, Liberator Series loans and Portfolio Series loans, for
sale through securitizations and in the secondary market. Continued
growth in the origination of core products will result primarily from
geographic expansion and greater penetration in existing markets. In
particular, since the beginning of 1997, the Company has widely
advertised its NINA loan product, which is a limited documentation,
lower loan-to-value loan program within the Liberator Series. NINA loans
constituted $29.2 million of the $152.9 million of Liberator Series
loans originated during the nine months ended September 30, 1997. In
order to improve its ability to service its expanding network of
Originators, the Company has established strategically located, low cost
regional lending centers in Riverside, California, Jacksonville, Florida
and in the Denver, Colorado metropolitan area. Over the next nine
months, the Company intends to open three additional regional lending
centers, which are likely to be strategically located in Northern
California and in the Northeast and Midwest sectors of the United
States, to better serve its Originators.
. Expanding Retail Lending Production. The Company's retail lending
operations currently focuses on retail loans located in the Company's
primary market area of Southern California. The retail lending offices
will focus on the origination of Liberator Series and Portfolio Series
loans. In addition, the retail lending offices will originate non-core
product loans to Agency-Qualified Borrowers. Non-core product loans
originated by the retail lending offices will be sold to Loan
Purchasers. The Company intends to gradually and selectively expand its
retail lending operations. As part of this process, the Company has
opened two low cost retail offices and has entered into leases for an
additional four retail offices to be opened by the end of 1997. In
addition, the Company intends to open two retail lending offices in the
first quarter of 1998. With the exception of one planned office expected
to be opened in Northern California, the Company's two current and five
of the six planned retail lending offices will be located in Southern
California. Such offices are expected to become operational in the first
quarter of 1998. In addition, the Company intends to further expand by
opening additional retail offices outside of Southern California. The
Company believes that expanding its retail lending operations will
reduce the possibility that its borrowers will refinance their loans
with other lenders.
. Expanding Multi-Family and Commercial Lending. In continuing with its
tradition as a niche market lender and in an effort to diversify product
offerings, the Company has begun to focus its efforts on the origination
and purchase of multi-family and commercial real estate loans in the
range of $50,000 to $1.5 million both in its primary market area and
throughout the United States through a selected group of originators.
The Company is currently purchasing such loans at a discount and,
although there can be no assurances, expects to be able to continue to
purchase such loans at a discount or low premium. The Company employs
underwriters who specialize in commercial and multi-family real estate
lending and utilizes a select group of appraisers experienced in these
products. In addition, two members of senior management have
considerable expertise in multi-family and commercial real estate
lending. The Company was primarily limited in its ability to originate
multi-family and commercial real estate loans by its level of available
capital. The Company is gradually expanding such originations
52
as its available capital has increased. For the nine months ended
September 30, 1997, the Company originated $25.1 million of multi-family
and commercial loans, as compared to $7.1 million for the nine months
ended September 30, 1996. The Company believes that it has the
infrastructure in place to accommodate this expansion. All multi-family
and commercial real estate loans are originated for sale in the
secondary market and are currently being sold as whole loans. In the
future, they may also be sold through securitizations.
. Consistently Refining Operating Procedures. The Company intends to
maintain loan quality by continuing to refine its underwriting criteria.
Regularly-scheduled meetings of the Company's underwriting personnel are
held in part to discuss operational issues as well as refinements to the
Company's underwriting policies. In addition, the Company conducts
regular loan delinquency meetings to discuss problem areas in the
Company's servicing portfolio in order to reduce the likelihood of the
recurrence of such problems in future loans. As necessary, the Company
adds personnel to its loan processing staff and continues to utilize
advancements in computer technology to provide prompt turnaround on
loans, efficient underwriting procedures and accurate credit
verification. In addition, the Company has a quality control department
that is dedicated to maintaining quality control, reviews loan files to
assure that each complies with the Company's underwriting policies,
reviews all loans upon first payment default and loans sixty days
delinquent, provides feedback and training to the underwriters to
minimize future defaults and delinquencies, and investigates all
fraudulent loans.
. Enhancing Servicing Capabilities. As the Bank has transitioned from a
traditional thrift to a diversified financial services operation, it has
expanded its servicing department from a total of four persons at
December 31, 1994 to 20 persons at September 30, 1997. The head of the
servicing department has 24 years of experience in loan servicing and
collections including responsibility for a $10.0 billion portfolio of
approximately 255,000 loans and a staff of 70 people. In anticipation of
its future servicing needs, the Company has dedicated substantial space
in its current Riverside facility to house loan servicing operations.
The Company is in the process of implementing a power dialing system and
intends to implement computer imaging in the future.
. Diversifying Funding Sources. In addition to its traditional thrift
funding sources of deposits and loans from the FHLB, the Company has
diversified its funding sources in recent periods. During the nine
months ended September 30, 1997, net cash received from the Company's
securitizations and sales provided a significant source of funding to
the Company, aggregating $277.6 million for that period. The Bank has
two warehouse lines of credit available in the aggregate amount of
$250.0 million to fund loan originations, of which $54.6 million has
been drawn upon at September 30, 1997, and is in the process of
negotiating a third warehouse line of credit in the amount of $250.0
million. The Company has a line of credit in the amount of $40.0 million
secured by residual assets created by the Company's securitizations.
CORPORATE STRUCTURE
The Company and the Bank consummated the Reorganization in June of 1997
whereby the Bank became a wholly-owned subsidiary of the Company. Management
believes that the holding company form of organization provides the Company
with more flexibility and a greater ability to compete with other financial
services companies in the market place. In addition, due to regulatory capital
limitations, the Bank is limited in the amount of investments in residuals and
restricted cash resulting from securitizations that it can retain. The Company
is not subject to such limitations, and thus will reduce the restrictions on
the Bank's regulatory capital by acquiring and holding the residuals upon
completion of a securitization.
CORE LENDING PRODUCTS
General. The Company originates, purchases, sell, securitizes and services
primarily non-conventional mortgage loans principally secured by first and
second mortgages on one- to four-family residences. The
53
Company makes Liberator Series loans, which are for the purchase or refinance
of residential real property by sub-prime borrowers, and Portfolio Series
loans, which are debt consolidation loans for Agency-Qualified Borrowers with
loan-to-value ratios of up to 135%. The Company has recently increased the
permitted loan-to-value ratios on Portfolio Series loans to 135% from 125%.
For the three months ended September 30, 1997, $305,000, or 0.3% of the $104.2
million of Portfolio Series loans originated by the Company had loan to value
ratios between 125% and 135%. While the Company is currently emphasizing the
origination of Portfolio Series loans, it intends to market both products as
demand permits. In addition, to a much lesser extent, the Company originates
multi-family residential and commercial loans.
The Company purchases and originates mortgage loans and other real estate
secured loans primarily through a network of Originators on a nationwide
basis. In addition, the Company has begun to open low-cost retail lending
offices. Except for a limited number of loans specifically originated for
retention in the Bank's portfolio as loans held for investment, loans
originated or purchased since 1994 through the Company's regional lending
centers are generally originated for sale in the secondary mortgage market
and, since the fourth quarter of 1996, in asset securitizations with servicing
retained by the Company.
Adjustable Rate Mortgages. The Company's adjustable rate mortgage ("ARM")
products consist of both first and second mortgages. The repayment and
amortization terms on first mortgage ARMs are 360 months. The repayment and
amortization terms on second mortgage ARMs may be 300, 240 or 180 months.
Interest rates adjust every six or twelve months, and are tied to the six-
month LIBOR or to the 1-Year U.S. Treasury Index, respectively. The periodic
rate caps vary between 1% and 3% on each rate change date. All ARM products
are assumable, subject to new borrower qualification, assumption agreements
and fees. The lifetime rate cap on ARMs is 6% to 7% above the initial rate.
None of the ARM products permit negative amortization. There are no fixed rate
conversion options on any of the ARM products. Certain ARM products impose
prepayment penalties and others do not.
Marketing. The Company's primary means of marketing its products is direct
contact between its account executives and Originators. Each of the Company's
27 account executives is responsible for maintaining and expanding existing
Originator relationships within the account executive's assigned territory
through personal contact and promotional materials. Each account executive is
typically responsible for approximately 20 key Originators and is expected to
have weekly contact with each of these Originators. In addition, each account
executive is responsible for up to 30 additional Originators with whom the
account executive will have frequent contact. Each account executive also
works to develop Originator relationships through "cold calls" and following
up on inquiries made by Originators to the Company's toll-free number. Each
account executive works as part of a team with one of the Company's loan
coordinators and assistant coordinators. Each loan coordinator and assistant
loan coordinator works with three or four account executives. The loan
coordinators and their assistants are responsible for inputting the new loans
into the Company's data systems and for shepherding the loans from the point
of origination through funding. After origination, the whole loan coordinators
and their assistants are available to talk to Originators on a daily basis.
Whole loan coordinators and their assistants are located in each of the
Company's regional lending centers.
The Company believes that the key element in developing, maintaining and
expanding its relationships with Originators is to provide the highest
possible level of product knowledge and customer service. Each account
executive receives comprehensive training prior to being assigned to a
territory. In most cases, training includes experience in the loan production
department so that the account executive will be familiar with all phases of
loan origination and production and will also become acquainted with the whole
loan coordination team. This training enables the account executive to quickly
review a loan application in order to identify the borrower's probable risk
classification and then assist the Originator in identifying the appropriate
product for the borrower, thereby enhancing the likelihood that the loan will
be approved at the rate and on the terms anticipated by the borrower. After a
loan package is submitted to the Company, the loan coordination team provides
assistance to the Originator throughout the process to complete the loan
transaction. Account executives, loan coordinators and assistant coordinators
are compensated based on the number and the dollar volume of loans funded. A
significant portion of a regional manager's compensation is tied to the
profitability of his or her regional lending center and includes a component
based on loan performance.
54
Origination and Purchase of Loans. Loans are originated both through the
Company's wholesale network of Originators and on a retail basis through the
Company's Retail Lending Division. The Company has also made bulk purchases of
loans from time to time and has recently hired a senior management employee
experienced in bulk purchases to gradually expand the Company's loan
purchases.
The Company's mortgage financing and servicing operations are conducted
primarily through regional lending centers located in Riverside, California,
Jacksonville, Florida and the Denver, Colorado metropolitan area. Over the
next nine months the Company intends to open three additional low cost
regional lending centers to better serve its Originators. These regional
lending centers are likely to be strategically located in Northern California
and in the Northeast and Midwest sectors of the United States. From its
present locations, the Company is able to originate or purchase its core
products in the District of Columbia and all 50 states with the exception of
Louisiana, Mississippi and Alaska.
The following table sets forth for the periods shown the aggregate dollar
amounts and the percentage of core products originated or purchased by the
Company in each state where 5.0% or more of the loans were originated or
purchased during the three months ended September 30, 1997:
FOR THE THREE MONTHS ENDED
------------------------------------------------------------
DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1996 1997 1997 1997
------------- ------------- -------------- --------------
$ % $ % $ % $ %
------- ----- ------- ----- -------- ----- -------- -----
(DOLLARS IN THOUSANDS)
California....... $20,434 29.5% $26,421 29.8% $ 32,827 24.3% $ 33,614 19.8%
Utah............. 6,208 9.0 7,958 9.0 6,202 4.6 9,280 5.5
Virginia......... 5,961 8.6 5,884 6.6 7,489 5.5 9,575 5.6
Maryland......... 4,878 7.1 4,492 5.1 6,839 5.1 9,851 5.8
Alabama.......... 1,607 2.3 1,195 1.3 7,752 5.7 9,022 5.3
Other............ 30,072 43.5 42,689 48.2 74,098 54.8 98,795 58.0
------- ----- ------- ----- -------- ----- -------- -----
Total.......... $69,160 100.0% $88,639 100.0% $135,207 100.0% $170,137 100.0%
======= ===== ======= ===== ======== ===== ======== =====
The Company's geographic markets are currently divided into three regions,
with a completely self-contained mortgage banking team assigned to each
region. Each team is headed up by a regional manager and includes dedicated
account executives, loan coordinators and assistant coordinators,
underwriters, and other production personnel so that the team can originate
and produce loans in that region. This concept of regional processing teams,
which the Company believes is efficient but quite rare in the industry,
enables the Company to more effectively anticipate and respond to Originator
and borrower needs in each region. Management believes that the concept also
appeals to independent brokers who may be reluctant to deal with a larger,
more remote lender. Each regional team is connected to senior management in
Riverside, California by a computer link that enables senior management to
monitor all regional functions on a real time basis.
Personnel staffing a regional lending center are trained in the Company's
Riverside office. For a period of six to twelve months after the establishment
of a regional lending center all loans originated through that office are
reunderwritten by staff at the Riverside office to assure quality control. In
addition, staff of the quality control department and the Company's internal
auditor regularly visit the regional lending centers for quality control
purposes.
In recent years, the Company has focused on both Liberator Series loans and
Portfolio Series loans. While the Company is currently emphasizing the
origination of Portfolio Series loans, it intends to originate both types of
loans as demand permits.
Liberator Series loans are loans for the purchase or refinance of one- to
four-family residential real property by sub-prime borrowers and loans which
otherwise do not conform to FHLMC or FNMA guidelines ("conforming loans").
Loans to sub-prime borrowers are perceived by management as being advantageous
to
55
the Company because they generally have higher interest rates and origination
and servicing fees and generally lower loan-to-value ratios than conforming
loans. In addition, management believes the Company has the resources to
adequately service loans acquired pursuant to this program as well as the
experience to resolve loans that become non-performing. The Company has
established specific underwriting policies and procedures, invested in
facilities and systems and developed correspondent relationships with
Originators throughout the country enabling it to develop its niche as an
originator and purchaser of one- to four-family residential loans to sub-prime
borrowers. Since the beginning of 1997, the Company has widely advertised its
NINA loan product, which is a limited documentation, lower loan-to-value loan
product within the Liberator Series loan portfolio. The Company intends to
continue to expand the volume of Liberator Series loans which it originates to
market areas throughout the country, to sub-prime borrowers who meet its niche
lending criteria. See "Risk Factors Related to the Company--Risks Associated
with Sub-Prime Lending."
Portfolio Series loans, which are debt consolidation loans for Agency
Qualified Borrowers, are originated both on a wholesale basis through the
Company's Life Financial Services Division, and through its Retail Lending
Division. These loans are consumer-oriented loans secured by real estate,
primarily home equity lines of credit and second deeds of trust, for up to
135% of the appraised value of the real estate underlying the aggregate loans
on the property. The Company recently increased the permitted loan-to-value
ratio on Portfolio Series loans to 135% from 125%. Although the loan-to-value
ratio on Portfolio Series loans is higher than that offered by other mortgage
products, management believes that the higher yield and the low level of
credit risk of the borrowers offsets the risks involved. See "--Underwriting"
and "Risk Factors Related to the Company--High Loan to Value Ratios of
Portfolio Series Loans."
The following table sets forth the principal balance of each of the
Company's core loan products originated and purchased during the periods
shown:
FOR THE THREE MONTHS ENDED
-----------------------------------------------------------------
DECEMBER 31, 1996 MARCH 31, 1997 JUNE 30, 1997 SEPTEMBER 30, 1997
----------------- -------------- ------------- ------------------
(IN THOUSANDS)
Liberator Series (full
documentation)......... $39,465 $39,629 $ 39,589 $ 44,484
Liberator Series
(NINA)(1).............. -- -- 7,803 21,410
Portfolio Series........ 29,695 49,010 87,815 104,243
------- ------- -------- --------
Total................. $69,160 $88,639 $135,207 $170,137
======= ======= ======== ========
- -------
(1) The Company did not originate a material amount of Liberator Series (NINA)
loans during the three months ended December 31, 1996 and March 31, 1997.
The following table sets forth selected information relating to originations
of Liberator Series loans during the periods shown:
FOR THE THREE FOR THE THREE FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED
MONTHS ENDED MONTHS ENDED JUNE 30, 1997 SEPTEMBER 30, 1997
DECEMBER 31, MARCH 31, --------------------------------- --------------------------
1996 1997 FULL DOCUMENTATION NINA FULL DOCUMENTATION NINA
------------- ------------- -------------------- ------------ ------------------ -------
(DOLLARS IN THOUSANDS)
Principal balance....... $39,465 $39,629 $ 39,589 $ 7,803 $44,484 $21,410
Average principal
balance per loan....... 85 100 81 103 91 114
Combined weighted
average initial loan-
to-value ratio......... 73.4% 72.8% 78.2% 69.0% 77.3% 73.1%
Percent of first
mortgage loans......... 85.4 91.8 88.8 100 87.4 98.5
Property securing loans:
Owner occupied........ 86.4 77.3 90.5 92.9 91.5 93.6
Non-owner occupied.... 13.6 22.7 9.5 7.1 8.5 6.4
Percentage fixed-rate... 44.2 35.6 42.4 24.1 33.4 23.1
Percentage ARMs......... 55.8 64.4 57.6 75.9 66.6 76.9
Weighted average
interest rate:
Fixed-rate............ 11.3 10.8 10.9 11.2 11.2 11.2
ARMs.................. 9.6 9.1 10.0 10.0 9.4 9.3
56
The following table sets forth selected information relating to originations
of Portfolio Series loans during the periods shown:
FOR THE FOR THE
FOR THE THREE FOR THE THREE THREE MONTHS THREE MONTHS
MONTHS ENDED MONTHS ENDED ENDED ENDED
DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1996 1997 1997 1997
------------- ------------- ------------ -------------
(DOLLARS IN THOUSANDS)
Principal balance....... $29,695 $49,010 $87,815 $104,243
Average principal
balance per loan....... 31 32 33 32
Combined weighted
average initial loan-
to-value ratio......... 108.4% 107.7% 110.0% 109.5%(1)
Percent of first
mortgage loans......... 0.1 0.5 0.1 --
Property securing loans:
Owner occupied........ 99.5 99.8 100.0 100.0
Non-owner occupied.... 0.5 0.2 -- --
Percentage fixed-rate... 96.3 96.0 98.0 94.5
Percentage ARMs......... 3.7 4.0 2.0 5.5
Weighted average
interest rate:
Fixed-rate............ 14.1 13.8 14.0 13.8
ARMs.................. 11.2 10.3 11.3 11.3
- --------
(1) For the three months ended September 30, 1997, approximately $18.5
million, $54.0 million and $305,000 of Portfolio Series loans originated
had initial loan-to-value ratios of 100%-110%, 110%-125% and 125%-135%,
respectively.
Use and Qualifications of Originators. The Company purchases loans from
select Originators throughout the country. Such Originators must be approved
by the Company prior to submitting loans to the Company. Pursuant to the
Company's approval process, each Originator is generally required to have a
specified minimum level of experience in originating non-conforming loans, and
provide representations, warranties, and buy-back provisions to the Company.
The Company provides clear and concise criteria regarding its well-defined
core products to Originators with whom it may do business. If, following a
period of training and relationship building, Originators consistently fail to
present a high level of loans meeting the Company's underwriting criteria, the
Company will cease to do business with them. As a result, the Company has
developed, since 1994, a core group of Originators who form its nationwide
network of Originators. The Company generally classifies the Originators with
which it does business into four classes with descending priority with regard
to the terms and the pricing of the loans the Company purchases from such
Originators.
JUNIOR THIRD PARTY MORTGAGE
CORRESPONDENTS CORRESPONDENTS ORIGINATORS BROKERS(1)
-------------- -------------- ----------- ----------
Net Worth(2)............. $250,000 $100,000 $50,000 N/A
Years in Business........ 2 2 2 N/A
Warehouse Credit
Facility................ Yes Yes No No
Errors and Omissions
Insurance............... $1.0 million No No No
Number Doing Business
with the Company at
September 30, 1997...... 85 94 104 903
- --------
(1) Mortgage brokers are those persons who do not meet the specific foregoing
criteria but have demonstrated to the Company, or have a reputation for,
the ability to originate real estate secured loans and have acceptable
credit and finance industry references.
(2) The net worth of Correspondents is provided by audited financial
statements prepared in accordance with GAAP. Net worth of Junior
Correspondents and Third Party Originators is provided through unaudited
financial information.
57
The Company purchases substantially all loans on an individual basis from
qualified Originators. No single Originator accounted for more than 4.0% of
the loans originated by the Company for the nine months ended September 30,
1997. It is the Company's general policy to limit the percentage of loans
closed by any single Originator to approximately 5.0% of loans closed in any
given period.
Underwriting. The underwriting and quality control functions are managed
through the Company's regional lending center in Riverside, California. The
Company believes that its underwriting process begins with the experience of
its staff, the education of its network of Originators, the quality of its
correspondent relationships and its loan approval procedures. As an integral
part of its lending operation, the Company ensures that its underwriters
assess each loan application and subject property against the Company's
underwriting guidelines.
Personnel in the Company's regional lending centers review in its entirety
each loan application submitted by the Company, Originators or through bulk
purchases for approval. The Company conducts its own underwriting review of
each loan, including those loans originated for or purchased by it from its
Originators. Loan files are reviewed for completeness, accuracy and compliance
with the Company's underwriting criteria and applicable governmental
regulations. This underwriting process is intended to assess both the
prospective borrower's ability to repay the loan and the adequacy of the real
property security as collateral for the loan granted, tailored to the general
nature of the Portfolio Series and the Liberator Series loans, respectively.
Based on the initial review, the personnel in the regional lending center will
inform the Originators of additional requirements that must be fulfilled to
complete the loan file. The Company strives to process each loan application
received from its network of Originators as quickly as possible in accordance
with the Company's loan application approval procedures. Accordingly, most
loan applications receive decisions within 48 hours of receipt and generally
are funded within one day following satisfaction of all conditions for
approval of the loan which is typically seven business days after the initial
approval.
Each prospective borrower is required to complete a mortgage loan
application that may include (depending on the program requirement)
information detailing the applicant's liabilities, income, credit history,
employment history and personal information. Since most of the loan
applications are presented through the Company's network of Originators, the
Company completes an additional credit report on all applications received.
Such report typically contains information relating to such matters as credit
history with local and national merchants and lenders, installment debt
payments and any record of defaults, bankruptcies, repossessions or judgments.
This credit report is obtained through a sophisticated computer program that
accesses what management believes to be the most appropriate credit bureau in
a particular zip code and combines that information with the Company's own
credit risk score.
This application and review procedure is used by the Company to analyze the
applicant's creditworthiness (i.e., a determination of the applicant's ability
to repay the loan). Creditworthiness is assessed by examination of a number of
factors, including calculating a debt-to-income ratio obtained by dividing a
borrower's fixed monthly debt by the borrower's gross monthly income. Fixed
monthly debt generally includes (i) the monthly payment under any related
prior mortgages which will include calculations for insurance and real estate
taxes, (ii) the monthly payment on the loan applied for and (iii) other
installment debt, including, for revolving debt, the required monthly payment
thereon, or, if no such payment is specified, 3% of the balance as of the date
of calculation. Fixed monthly debt does not include any debt (other than
revolving credit debt) described above that matures within less than 10 months
of the date of calculation.
Prior to funding a loan, several procedures are used to verify information
obtained from an applicant. The applicant's outstanding balance and payment
history on any senior mortgage may be verified by calling the senior mortgage
lender. If the senior mortgage lender cannot be reached by telephone to verify
this information, the Originators may rely upon information provided by the
applicant, such as a recent statement from the senior lender and verification
of payment, such as canceled checks, or upon information provided by national
credit bureaus. In order to verify an applicant's employment status, the
Originators may obtain from the applicant recent tax returns or other tax
forms (e.g., W-2 forms) or current pay stubs or may telephone the applicant's
58
employer or obtain written verification from the employer. As in the case of
the senior mortgage lender verification procedures, if the employer will not
verify employment history over the telephone, the Company or other Originators
may rely solely on the other information provided by the applicant. However,
the Company does offer NINA loans at reduced loan-to-value ratios in lieu of
documenting cash flow and assets of the borrower. See "--Liberator Series
(NINA)" for further information on NINA loans.
Debt to income ratios for Portfolio Series mortgage loans generally do not
exceed 45%, but in certain instances where deemed appropriate by the Company,
the ratio may go as high as 50%. For Liberator Series mortgage loans, debt to
income ratios may vary depending upon a number of other factors used to
ascertain the creditworthiness of the borrower.
59
The general criteria currently used by the Company in classifying prospective
borrowers of its core loan products are summarized in the charts below.
LIBERATOR SERIES (FULL DOCUMENTATION)(1)
"Ax" RISK "A-" RISK "B" RISK "C" RISK "Cx" RISK
------------- ------------- ------------- ------------- -------------
Maximum
Loan-to-Value Ratio:
Primary residence...... 95% 95% 80% 75% 65%
Secondary residence.... 90% 90% 70% 70% 65%
Investor property...... 90% 85% 70% 70% 65%
Home equity line of
credit(1)............. 90% 90% 80% -- --
Debt Service to Income
Ratio.................. 42-50% 42-50% 50-55% 50-60% 60%
Mortgage Credit......... Maximum one Maximum two Maximum four Maximum six Currently
30-day late 30-day late 30-day late 30-day late delinquent
payment in payments in payments payments, two
the last 12 the last 12 and/or one 60-day late
months months 60-day late payments
payment in and/or one
the last 12 90-day late
months payment in
last 12
months
Installment Credit...... Maximum one No more than No more than No more than Sporadic
30-day late 30 days late 60 days late 90 days late payment
payment in in last 12 on any on any pattern;
the last 12 months; account in account in apparent
months; overall good last 12 last 12 disregard
maximum two credit; months; months; toward timely
30-day late maximum 25% overall overall fair payments or
payments in of credit average credit credit
the last 24 accounts credit standing
months delinquent in
last 24
months
Revolving Credit........ Maximum two No more than No more than No more than Sporadic
30-day late 30 days late 60 days late 90 days late payment
payments in in last 12 on any on any pattern;
the last 12 months; account in account in apparent
months; isolated 60- last 12 last 12 disregard
maximum three day late months; months; toward timely
30-day late payment isolated isolated late payments or
payments in allowed with minor 90-day payment over credit
last 24 compensating late payment 90 days standing
months factors; allowed with allowed with
maximum 25% compensating compensating
of credit factors factors
accounts
delinquent in
last 24
months
Bankruptcy Filings...... No bankruptcy No bankruptcy No bankruptcy No bankruptcy Discharged
in last 36 in last 24 in last 18 in last 12 within 12
months months months months months
preceding
application;
current
Chapter 13 or
foreclosure
acceptable
when paid in
full or cured
from loan
proceeds
Minimum Credit Score.... 670/650 620 550 500 Less than 500
- --------
(1) Also includes Portfolio Series home equity lines of credit which are fully
collateralized by the underlying property and which have a loan-to-value
ratio of 90% or less.
60
LIBERATOR SERIES (NINA)
"Ax" RISK "A-" RISK "B" RISK "C" RISK "Cx" RISK
------------- ------------- ------------- ------------- -------------
Loan-to-Value Ratio:
Primary residence...... 90%(1) 75% 70% 70% 65%
Secondary residence.... 75% 70% 65% 65% 60%
Investor property...... 75% 70% 65% 65% 60%
Mortgage Credit......... Maximum one Maximum two Maximum four Maximum six Currently
30-day late 30-day late 30-day late 30-day late delinquent
payment in payments in payments payments, two
the last 12 the last 12 and/or one 60-day late
months; no 30 months 60-day late payments
days late payment in and/or one
payments in the last 12 90-day late
last 24 months payment in
months for 90% last 12
months
Installment Credit...... Maximum one No more than No more than No more than Sporadic
30-day late 30 days late 60 days late 90 days late payment
payment in in last 12 on any on any patterns;
the last 12 months; account account in apparent
months; overall good within last last 12 disregard
maximum two credit; 12 months; months; toward timely
30-day late maximum 25% overall overall fair payments or
payments in of credit average credit credit
the last 24 accounts credit standing
months; no 30 delinquent in
days late last 24
payments in months
last 12
months for 90%
Revolving Credit........ Maximum two No more than No more than No more than Sporadic
30-day late 30 days late 60 days late 90 days late payment
payments in in last 12 on any on any patterns;
the last 12 months, account in account in apparent
months; isolated 60- last 12 last 12 disregard
maximum three day late months; months; toward timely
30-day late payment isolated isolated late payments or
payments in allowed with minor 90-day payment over credit
last 24 compensating late payment 90 days standing
months; no 30 factors; allowed with allowed with
days late maximum 25% compensating compensating
payments in of credit factors factors
last 24 accounts
months for delinquent in
90% last 24
months
Bankruptcy Filings...... No bankruptcy No bankruptcy No bankruptcy No bankruptcy Discharged
in last 36 in last 24 within last in last 12 within 12
months, none months 18 months months months
in last 7 preceding
years for 90% application;
LTV current
Chapter 13 or
foreclosure
acceptable
when paid in
full or cured
from loan
proceeds
Minimum Credit Score.... 670/650 620 550 500 Less than 500
- --------
(1) Purchase or rate term only, A+ credit required, credit score minimum of
670; all others maximum LTV at 80%.
61
PORTFOLIO SERIES(1)
"A+" RISK "AX" RISK "A-" RISK "B+" RISK
------------- ------------- ------------- -------------
Loan-to-Value Ratio:
100% Second Mortgage... 100% 100% 100% 100%
135% Second Mortgage... 135% 135% 135% 135%
100% Home Equity Line
of Credit............. 100% 100% 100% 100%
Debt Service to Income
Ratio:
100% Second Mortgage... 45-50% 45-50% 45-50% 45%
135% Second Mortgage... 45-50% 45-50% 45-50% 45%
100% Home Equity Line
of Credit............. 45-50% 45-50% 45-50% 45%
Mortgage History:
100% Second Mortgage... No 30-day No 30-day No 30-day One 30-day
late payments late payments late payments late payment
in last in last in last 12 in last 12
36 months 36 months months; one months or two
30-day late 30-day late
payment in payments in
last 24 last 24
months months
135% Second Mortgage... No 30-day No 30-day No 30-day One 30-day
late payments late payments late payments late payment
in last in last in last in last
36 months 36 months 24 months 24 months
100% Home Equity Line
of Credit............. No 30-day No 30-day No 30-day One 30-day
late payments late payments late payments late payment
in last in last in last 12 in last 12
36 months 36 months months; one months or two
30-day late 30-day late
payment in payments in
last 24 last 24
months months
Bankruptcy Filings:
100% Second Mortgage... None in last None in last None in last None in last
5 years 5 years 3 years 3 years
135% Second Mortgage... None in last None in last None in last None in last
5 years 5 years 3 years 3 years
100% Home Equity Line
of Credit............. None in last None in last None in last None in last
5 years 5 years 3 years 3 years
Minimum Credit Score:
100% Second Mortgage... 700 670 640 620
135% Second Mortgage... 700 670 640 620
100% Home Equity Line
of Credit............. 700 670 640 620
- --------
(1) Excludes Portfolio Series home equity lines of credit which are fully
collateralized by the underlying property and which have a loan-to-value
ratio of 90% or less.
62
Loan Production by Borrower Risk Classification. The Company classifies
borrowers according to credit risk from A+ to Cx; however, the predominant
amount of its lending is to borrowers in categories A- or higher. The
following table sets forth information concerning the Company's principal
balance of fixed rate and adjustable rate loan production by borrower risk
classification for the periods shown:
FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED
DECEMBER 31, 1996 MARCH 31, 1997
--------------------------------- ---------------------------------
WEIGHTED WEIGHTED
AVERAGE WEIGHTED AVERAGE WEIGHTED
PRODUCT/RISK % OF INTEREST AVERAGE % OF INTEREST AVERAGE
CLASSIFICATIONS VOLUME TOTAL RATE(1) MARGIN(2) VOLUME TOTAL RATE(1) MARGIN(2)
- --------------- ------- ----- -------- --------- ------- ----- -------- ---------
(DOLLARS IN THOUSANDS)
Liberator Series (Full
documentation)
Ax...................... $18,925 48.0% 9.94% 5.24% $17,159 43.3% 9.35% 5.11%
A-...................... 8,790 22.3 10.16 5.52 9,241 23.3 9.85 5.52
------- ----- ------- -----
Total A- or better.... 27,715 70.3 -- -- 26,400 66.6 -- --
------- ----- ------- -----
B....................... 6,806 17.2 10.26 5.33 7,992 20.2 9.39 4.91
C....................... 2,026 5.1 11.16 5.68 2,555 6.4 10.98 5.77
Cx...................... 2,918 7.4 13.07 7.06 2,682 6.8 11.74 6.62
------- ----- ------- -----
Total.................. $39,465 100.0% 10.34 5.46 $39,629 100.0% 9.74 5.31
======= ===== ======= =====
Portfolio Series........
A+...................... $ 2,669 9.0% 13.58 2.50 $ 9,980 20.4 13.22 1.74
Ax...................... 14,452 48.7 13.87 2.18 18,733 38.2 13.53 1.83
A-...................... 9,866 33.2 14.35 3.24 15,193 31.0 14.05 3.27
------- ----- ------- -----
Total A- or better.... 26,987 90.9 -- -- 43,906 89.6 -- --
------- ----- ------- -----
B+...................... 2,708 9.1 14.10 3.73 5,104 10.4 14.07 2.7
------- ----- ------- -----
Total.................. $29,695 100.0% 14.03 2.74 $49,010 100.0% 13.68 2.32
======= ===== ======= =====
FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED
JUNE 30, 1997 SEPTEMBER 30, 1997
--------------------------------- ---------------------------------
WEIGHTED WEIGHTED
AVERAGE WEIGHTED AVERAGE WEIGHTED
PRODUCT/RISK % OF INTEREST AVERAGE % OF INTEREST AVERAGE
CLASSIFICATIONS VOLUME TOTAL RATE(1) MARGIN(2) VOLUME TOTAL RATE(1) MARGIN(2)
- --------------- ------- ----- -------- --------- ------- ----- -------- ---------
(DOLLARS IN THOUSANDS)
Liberator Series (Full
documentation)
A+...................... $ 47 0.1% 12.38% 7.00% $ 120 0.3% 9.67% 4.63%
Ax...................... 18,778 47.4 9.88 5.47 15,797 35.5 9.48 5.77
A-...................... 9,663 24.4 10.03 6.05 16,059 36.1 9.76 6.17
------- ----- ------- -----
Total A- or better.... 28,488 71.9 -- -- 31,976 71.9 -- --
------- ----- ------- -----
B+...................... 119 0.3 9.75 -- 24 0.1 13.75 --
B....................... 4,303 10.9 10.82 6.06 5,911 13.3 10.31 6.32
C....................... 2,776 7.0 11.48 6.53 3,297 7.4 10.64 6.41
Cx...................... 3,903 9.9 12.59 8.15 3,276 7.3 12.18 7.28
------- ----- ------- -----
Total................. $39,589 100.0% 10.40 6.08 $44,484 100.0% 9.98 6.14
======= ===== ======= =====
Liberator Series (NINA)
(3)
Ax...................... $ 3,772 48.3% 9.56% 5.33% $13,789 64.4% 9.20% 5.54%
A-...................... 2,325 29.8 10.14 6.05 3,188 14.9 9.81 6.3
------- ----- ------- -----
Total A- or better.... 6,097 78.1 -- -- 16,977 79.3 -- --
------- ----- ------- -----
B....................... 1,102 14.1 11.78 6.35 2,088 9.7 10.2 5.97
C....................... 332 4.3 12.27 6.83 592 2.8 11.09 7.07
Cx...................... 272 3.5 12.49 6.92 1,753 8.2 12.72 6.43
------- ----- ------- -----
Total................. $ 7,803 100.0% 10.27 5.82 $21,410 100.0% 9.73 5.77
======= ===== ======= =====
63
FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED
JUNE 30, 1997 SEPTEMBER 30, 1997
--------------------------------- ----------------------------------
WEIGHTED WEIGHTED
AVERAGE WEIGHTED AVERAGE WEIGHTED
PRODUCT/RISK % OF INTEREST AVERAGE % OF INTEREST AVERAGE
CLASSIFICATIONS VOLUME TOTAL RATE(1) MARGIN(2) VOLUME TOTAL RATE(1) MARGIN(2)
- --------------- ------- ----- -------- --------- -------- ----- -------- ---------
(DOLLARS IN THOUSANDS)
Portfolio Series
A+...................... $19,086 21.7% 13.30% 8.02% $ 23,250 22.3% 12.98% 5.79%
Ax...................... 27,954 31.8 13.85 6.50 31,914 30.6 13.49 6.50
A-...................... 31,234 35.6 14.28 7.22 38,521 37.0 14.00 6.99
------- ----- -------- -----
Total A- or better.... 78,274 89.1 -- -- 93,685 89.9 -- --
------- ----- -------- -----
B+...................... 9,435 10.8 14.69 7.18 10,472 10.0 14.38 7.51
B....................... 106 0.1 13.99 -- 86 0.1 12.27 6.88
------- ----- -------- -----
Total................. $87,815 100.0% 13.98 7.38 $104,243 100.0% 13.66 6.64
======= ===== ======== =====
- --------
(1) Weighted average interest rate includes both ARM loan products and fixed
rate loan products.
(2) Weighted average margin is based solely on ARM products.
(3) The Company did not originate a material amount of Liberator Series (NINA)
loans during the three months ended December 31, 1996 and March 31, 1997.
Appraisal. All mortgaged properties relating to mortgage loans where
collateral assessment is an integral part of the evaluation process are
appraised by state licensed or certified appraisers. All of the appraisals are
either performed or reviewed by appraisers or appraisal firms approved by the
Company's senior management. These appraisers are screened and actively
reviewed on a regular basis. Each approved appraiser must have a minimum of
$2.0 million of errors and omissions insurance. All appraisers are required to
assess the valuation of the property pursuant to U.S. Government Property
Analysis guidelines and conduct an economic analysis of the geographic region
in which the property is located. Once a loan application file is complete,
the file is reviewed to determine whether the property securing the loan
should undergo a desk or field review. This determination is made based on the
loan-to-value ratio of the underlying property and the type of loan or loan
program. If after the initial desk review, the underwriter requires additional
information with regard to the appraised value of the property, a field review
may also be conducted. The Company requires the appraiser to address
neighborhood conditions, site and zoning status and the condition and
valuation of improvements. Following each appraisal, the appraiser prepares a
report which (when appropriate) includes a reproduction cost analysis based on
the current cost of constructing a similar building and a market value
analysis based on recent sales of comparable homes in the area. Title
insurance policies are required on all first mortgage liens, with a limited
judgment lien report required on all second lien loans under $100,000.
For Liberator Series loans, because of the sub-prime creditworthiness of the
borrowers, the evaluation of the value of the property securing the loans and
the ratio of loans secured by such property to its value become of greater
importance in the underwriting process. The specific procedures and criteria
utilized in the appraisal process range from a desk review, a field review, to
a second appraisal, depending on the size of the loan and its loan-to-value
ratio.
The value of the mortgaged property has lesser importance with respect to
the Portfolio Series loans in light of their high loan-to-value ratios. As a
result, Portfolio Series loans generally have little or no equity in the
mortgaged property available to repay the loan if it is in default. For
Portfolio Series loans, the Company accepts the homeowner/mortgagee's "as
stated" value on loans to $35,000. On loans in excess of $35,000 to a maximum
of $50,000, the Company requires a current tax assessment, a statistical
appraisal or a HUD-1 conformed closing statement where purchase of the subject
property has occurred within the previous 12 months. For loans in excess of
$50,000, a drive-by appraisal including comparable analysis on a FHLMC Form
704 is required.
Qualified property inspection firms are also utilized for annual property
inspections on all properties 45 days or more delinquent. Property inspections
are intended to provide updated information concerning occupancy, maintenance
and changes in market conditions.
64
Loan Approval Procedures and Authority. The Board of Directors establishes
the lending policies of the Company and delegates authority and responsibility
for loan approvals to the Loan Committee and specified officers of the
Company. All real estate loans must be approved by a quorum of the designated
committee or by the designated individual or individuals.
All loans underwritten by the Company require the approval and signature of
two underwriters. Where there are exceptions to the Company's underwriting
criteria, the loan must be unanimously approved by the underwriter,
supervisory underwriter and the Senior Vice President of the Company or, if
not unanimously approved, by the Company's President and Chief Executive
Officer. It has been the Company's policy to adhere strictly to its
underwriting standards with few exceptions. Additionally, the following
committees, groups of officers and individual officers are granted the
authority to approve and commit the Company to the funding of the following
categories of loans:
LEVEL OF APPROVAL
--------------------------------------------------------------
LOAN COMMITTEE
ONE STAFF TWO STAFF LOAN AND BOARD OF
TYPE OF LOAN UNDERWRITER UNDERWRITERS COMMITTEE DIRECTORS
------------ -------------- -------------- ---------------- --------------
Mortgage loans held for
sale................... -- $1.0 million -- More than $1.0
or less(1) million
Mortgage loans held for
investment............. -- $250,000 or More than $550,000 or
less $250,000 but more
less than
$550,000
Other loans............. Personal loans All other All other loans All other
secured by loans $25,000 more than loans
Bank deposits or less $25,000 but less in excess of
than $50,000 $50,000
- --------
(1) Loans in excess of $500,000 require approval by an executive officer in
addition to approval by two underwriters.
The Bank will not make loans-to-one borrower that are in excess of
regulatory limits. Pursuant to OTS regulations, loans-to-one borrower cannot
exceed 15% of the Bank's unimpaired capital and surplus. At September 30,
1997, the Bank's loans to one borrower limit equaled $2.7 million. See
"Regulation--Federal Savings Institution Regulation--Loans-to-One Borrower."
LOAN SALES AND ASSET SECURITIZATIONS
Loans are sold by the Company through securitizations and whole loan sales.
With the exception of customary provisions relating to breaches of
representations and warranties, loans securitized or sold by the Company are
sold without recourse to the Company and generally are sold with servicing
retained. See "Risk Factors Related to the Company--Contingent Risks." For the
nine months ended September 30, 1997 and 1996 and the years ended December 31,
1996, 1995 and 1994, the Company sold $277.1 million, $140.8 million, $154.6
million, $126.9 million and $65.7 million in loans, respectively. For the nine
months ended September 30, 1997 and the year ended December 31, 1996, the
Company securitized $204.0 million and $51.9 million, respectively. No loans
were securitized for the nine months ended September 30, 1996 or the years
ended December 31, 1995 or 1994.
In a securitization, the Company will generally transfer a pool of loans to
a trust with the Company retaining the excess cash flows, known as residuals,
from the securitization which consist of the difference between the interest
rate of the mortgages and the coupon rate of the securities after adjustment
for servicing and other costs such as trustee fees and credit enhancement
fees. The cash generally will be used to repay advances on lines of credit
used to finance the pool of loans that were acquired by the Company.
Generally, the holders of the securities from the asset securitization are
entitled to receive scheduled principal collected on the pool of
65
securitized loans and interest at the pass-through interest rate on the
certificate balance. The residual asset represents the subordinated right to
receive cash flows from the pool of securitized loans after payment of the
required amounts to the holders of the securities and the costs associated
with the securitization. The Company recognizes gain on sale of the loans in
the securitization, which represents the difference between the net proceeds
to the Company in the securitization and the allocated cost of loans
securitized. Management believes that it has made reasonable estimates of the
present value of the residual interests on its balance sheets. Concurrent with
recognizing such gain on sale, the Company records the residual interests as
assets on its balance sheet. The recorded value of these residual interests
are amortized as cash distributions are received from the trust holding the
respective loan pool and are marked to market on a quarterly basis.
The Company may arrange for credit enhancement for a transaction to achieve
an improved credit rating on the securities issued if this improves the level
of profitability or cash flow generated by such transaction. This credit
enhancement may take the form of an insurance and indemnity policy, insuring
the holders of the securities of timely payment of the scheduled pass-through
of interest and principal. In addition, the pooling and servicing agreements
that govern the distribution of cash flows from the loan pool included in a
transaction typically require over-collateralization as an additional means of
credit enhancement. Over-collateralization may in some cases also require an
initial deposit, the sale of loans at less than par or retention in the trust
of collections from the pool until a specified over-collateralization amount
has been attained. In the case of the Company's securitizations to date, the
over-collateralization has been in the form of a cash deposit. The purpose of
the over-collateralization is to provide a source of payment to investors in
the event of certain shortfalls in amounts due to investors. These amounts are
subject to increase up to a reserve level as specified in the related
securitization documents. Cash amounts on deposit are invested in certain
instruments as permitted by the related securitization documents. To the
extent amounts on deposit exceed specified levels, distributions are made to
the holders of the residual interest; and at the termination of the related
trust, any remaining amounts on deposit are distributed to the holders of the
residual interest. Losses resulting from defaults by borrowers on the payment
of principal or interest on the loans in a securitization will reduce the
over-collateralization to the extent that funds are available and may result
in a reduction in the value of the residual interest. See "Risk Factors
Related to the Company--Dependence on Asset Securitizations and Impact on
Quarterly Operating Results."
66
The Bank has completed three securitizations, one during the fourth quarter
of 1996, one during the first quarter of 1997 and one during the third quarter
of 1997. The characteristics and results of these securitizations are as
follows:
1996-1 1997-1A 1997-1B 1997-2
--------------- --------------- --------------- ---------------------
Type of loan
securitized............ Fixed Rate Adjustable Rate Fixed Rate Fixed Rate Portfolio
Liberator Liberator Liberator Series
Series and Series Series and
Portfolio Portfolio
Series Series
Weighted average
coupon................. 13.32% 9.45% 13.02% 13.64%
Amount of certificates
issued................. $55.0 million $38.5 million $61.5 million $123.8 million
Pass-through rate....... 6.95% 1 month LIBOR 7.49% 7.12%(5)
plus 21 bp
Amount of loans
securitized(1)......... $51.9 million $33.6 million $46.5 million $100.9 million
Credit enhancement...... MBIA Insurance MBIA Insurance MBIA Insurance Loan
Corporation Corporation Corporation overcollateralization
Initial funding of
reserve accounts....... $1.6 million $941,000 $3.1 million $1.3 million
Required reserve level
to be funded........... 9.0% of 5.5% of 10.6% of 7.0% of original
original original original outstanding balance
outstanding outstanding outstanding of loans
balance of balance of balance of
loans loans loans
Gain on sale of loans... $4.3 million $5.7 million(2) $5.7 million(3) $9.4 million
Gain on sale of loans as
a percent of loans
sold................... 8.29% 7.12%(2) 7.12%(3) 9.33%
Estimated prepayment
speed.................. 17.0% H.E.P.(3) 25.0% 17.0% H.E.P. 12.0% H.E.P.
C.P.R.(3)(4)
Discount factor......... 13.5% 13.5% 13.5% 13.5%
Annual estimated loss
assumption............. 1.5% 0.5% 0.5% of 2.0%
Liberator
Series loans;
1.5% of
Portfolio
Series loans
Servicing fees.......... 0.50% for the 0.65% for the 1.00% on fixed 1.00%
first six first twelve rate loans sold
months and months and
1.00% 1.00%
thereafter thereafter
Rating.................. AAA/Aaa AAA/Aaa AAA/Aaa (6)
(S&P/Moody's) (S&P/Moody's) (S&P/Moody's)
- --------
(1) For 1996-1, an additional $3.1 million was funded during quarter ended
March 31, 1997 which created a gain on sale of loans of $267,000. For
1997-1A, $4.9 million was funded in April 1997. For 1997-1B, $15.0 million
was funded in April 1997. All of these prefunded amounts were sold under
the same terms and conditions as set forth in the table above.
(2) The combined gain on sales of loans for 1997-1A and 1997-1B was $5.7
million. The percentages are based on the combined 1997-1A and 1997-1B
securitizations.
(3) Home Equity Prepayment ("H.E.P.") and Constant Prepayment Rate ("C.P.R.")
are methods of estimating prepayment speeds.
(4) This prepayment assumption was revised during the third quarter of 1997
resulting in an unrealized loss to the Company of $787,000. See "Risk
Factors Related to the Company--Risks Related to Mortgage Servicing Rights
and Residual Assets."
(5) Weighted average rate.
(6) Each of the Senior Notes were rated AAA/Aaa (Fitch/Moody's), the Class M-1
notes were rated AA/A2, the Class M-2 Notes were rated A/A2 and the Class
B notes were rated BBB/Baa3.
67
The following table presents the actual loss and prepayment history as of
September 30, 1997 for the securitizations conducted by the Company:
1996-1 1997-1A 1997-1B 1997-2
------ ------- ------- ------
Actual loss percentage...................... 0.56% 0.00% 0.17% 0.00%
Prepayments as a percentage of loans
securitized annualized..................... 10.45% 43.92% 4.72% 2.44%
The actual loss and prepayment history information provided above are not
necessarily indicative of loss and prepayment results that may be experienced
over the duration of the securitization.
Although the Company will continue to sell whole loans, it plans to sell
most loans in the future through securitizations. Securitizations are expected
to increase the Company's cash flow thereby allowing the Company to increase
its loan acquisition and origination volume. Securitizations are also expected
to reduce the risks associated with interest rate fluctuations and provide
access to longer term funding sources. The Company currently intends to
conduct regular securitizations either through private placements or in public
offerings. There can be no assurance that the Company will be able to
successfully implement this strategy in the future. See "Risk Factors Related
to the Company--Dependence on Asset Securitizations and Impact on Quarterly
Operating Results."
To the extent that loans are not sold in securitizations, whole loans will
be sold pursuant to purchase, sale and servicing agreements negotiated with
Loan Purchasers to purchase loans meeting the Company's underwriting criteria.
At September 30, 1997 there were outstanding commitments to deliver mortgage
loans in the amount of $21.3 million. The Company retains the servicing rights
on the majority of loans sold. However, the Company also sells loans on a
servicing released basis and may continue to subservice the loans for a fee
for a period of time. The Company sells loans to a number of different
investors with which it does business. As such, management believes that no
one relationship with a Loan Purchaser constitutes the predominant source of
sales for the Company and the Company does not rely on any specific entities
for sales of its loans.
COMMERCIAL REAL ESTATE AND MULTI-FAMILY REAL ESTATE LENDING
Consistent with its strategy of developing niche lending markets, the
Company has begun to increase its efforts to originate and purchase multi-
family and commercial real estate loans both in its primary market area and
throughout the United States. Specifically, the Company has begun to target
the market for borrowers seeking loans in the range of $50,000 to $1.5
million, subject to the Bank's loans-to-one borrower limit, currently $2.7
million, which are secured by multi-family properties or properties used for
commercial business purposes such as small office buildings, light industrial
or retail facilities. Since the Company has been able to acquire such loans at
a discount and expects to be able to continue to acquire such loans at a
discount or low premium, management believes that the origination and
subsequent sale of commercial and multi-family real estate loans will increase
the Company's cash flow. The Company has streamlined and standardized its
processing of commercial and multi-family real estate loans with a view to
sale in the secondary market or securitization. Since 1994, substantially all
commercial and multi-family real estate loans originated by the Company have
been sold in the secondary market without recourse. Although there can be no
assurances in this regard, management intends to gradually expand the
operations of this subsidiary, thereby adding a source of revenue for the
Company as well as providing loans for future securitizations. There can be no
assurances, however, that any such securitization will be completed in the
future. Securitization of commercial and multi-family real estate loans is
significantly less standardized and streamlined than securitization of one- to
four-family residential mortgage loans.
Management believes that it has the infrastructure in place to safely
diversify its product line into this niche market. Two of the Company's senior
executive officers, Daniel L. Perl and Joseph R. L. Passerino, have combined
experience of approximately 27 years in commercial and multi-family real
estate lending and have developed substantial relationships with commercial
and multi-family real estate originators throughout the United States. In
addition, the Company works primarily with a select group of approximately 100
mortgage
68
brokers nationwide with specifically delineated credentials. The Company also
works with two correspondents and expects to expand that number of approved
correspondents to 15 in the near future. Commercial and multi-family real
estate loan correspondents in the Company's network must have a net worth of
at least $1.0 million, a two to three year history of funding and servicing
multi-family and commercial real estate loans and errors and omissions
insurance of at least $1.0 million. In addition, an on-site inspection of the
facilities of each of these correspondents is conducted by the Bank's Senior
Vice President. Where loans are originated by other than this pre-approved
group of correspondents, the Company will underwrite the loan. The Company
also works with a contract appraiser with nationwide experience in appraising
commercial and multi-family real estate loans who appraises or reviews the
appraisals on all such properties.
The Company's policy is not to make commercial or multi-family real estate
loans to borrowers who are in bankruptcy, foreclosure, have loans more than 30
days delinquent or other combinations of credit weaknesses unacceptable to the
Company. The Company targets high to medium credit quality borrowers. The
Company's underwriting procedures provide that commercial real estate loans
may be made in amounts up to 70% of the appraised value of the property
depending on the borrower's creditworthiness. Multi-family real estate loans
may be made in amounts up to 75% of the appraised value of the property.
Commercial real estate loans and multi-family real estate loans may be either
fixed rate or adjustable rate loans. These loans include prepayment penalties
if repaid within the first three to five years. When evaluating a commercial
or multi-family real estate loan, the Company considers the net operating
income of the property and the borrower's expertise, credit history and
personal cash flows. The Company has generally required that the properties
securing commercial real estate and multi-family real estate loans have debt
service coverage ratios (the ratio of net operating income to debt service) of
at least 120%. The largest commercial real estate loan in the Company's held
for sale portfolio at September 30, 1997 was $778,000 and is secured by an
office building in Venice, California while the largest multi-family real
estate loan in the Company's held for sale portfolio at September 30, 1997 was
$709,000 secured by a 38 unit multi-family property located in Miami, Florida.
At September 30, 1997 the Company's commercial real estate portfolio was $21.9
million, or 9.9% of total gross loans, $14.2 million of which were held for
sale. The Company's multi-family real estate portfolio at that same date was
$16.4 million, or 7.4% of total gross loans, $16.0 million of which were held
for sale.
Repayment of multi-family and commercial real estate loans generally is
dependent, in large part, on sufficient income from the property to cover
operating expenses and debt service. The Company attempts to offset the risks
associated with multi-family and commercial real estate lending by primarily
lending to individuals who will be actively involved in the management of the
property and generally to individuals who have proven management experience,
and by making such loans with lower loan-to-value ratios than one- to four-
family loans. See "Risk Factors Related to the Company--Multi-family and
Commercial Real Estate Risks."
HISTORICAL AND LOCAL LENDING PORTFOLIO
The Company's portfolio of loans held for investment (the "historical loan
portfolio") was primarily originated prior to 1994. Such loans generally
consist of adjustable rate one- to four-family loans and adjustable rate
multi-family and commercial real estate loans. The Company's gross historical
loan portfolio has decreased in size from $48.0 million at December 31, 1994
to $38.5 million at December 31, 1996 and was $34.0 million at September 30,
1997. The largest loan in the Company's held for investment portfolio at
September 30, 1997 was $461,000 secured by a hotel located in San Bernardino,
California. At September 30, 1997, substantially all of the Company's
historical loan portfolio was secured by properties located in California. For
a discussion of loss experience on the historical and local lending portfolio,
see "--Lending Overview--Allowance for Loan Losses" and "--Non-Accrual and
Past Due Loans."
CONSUMER AND OTHER LENDING
The Company's consumer and other loans generally consist of overdraft lines
of credit, commercial business loans and unsecured personal loans. At
September 30, 1997, the Company's consumer and other loan portfolio
69
was $6.9 million or 3.1% of total gross loans. Of this amount, $6.7 million
consisted of unsecured home improvement loans purchased from a single
originator in March 1997. These loans were purchased as part of management's
evaluation of new product lines for possible future growth.
LOAN SERVICING
Through December 31, 1993, the Company's loan servicing portfolio consisted
solely of loans originated directly by the Company and retained for investment
or sold, primarily as participations, to others. Commencing in January of 1994
through June of 1995, the Company purchased mortgage servicing rights to FNMA
and FHLMC loans in order to expand the size of its loan servicing department
and to further develop its loan servicing capabilities. The entire FHLMC
servicing portfolio was resold in December 1995. Effective July 1, 1995, with
the adoption of SFAS No. 122, which required the Company to capitalize the
value of originated mortgage servicing rights, the Company began to retain
substantially all servicing rights on loans sold. In addition, the Company
intends to retain the servicing rights to the loans it securitizes. The
pooling and servicing agreements related to the securitizations completed to
date contain provisions with respect to the maximum permitted loan delinquency
rates and loan default rates which, if exceeded, would allow the termination
of the Company's right to service the related loans. See "Risk Factors Related
to the Company--Risks Related to Mortgage Servicing Rights and Residual
Assets." Servicing rights with an allocated fair value of $722,000,
$1.6 million, and $2.0 million were retained in the securitizations completed
during the fourth quarter of 1996, the first quarter of 1997, and the third
quarter of 1997, respectively. At September 30, 1997, the Company serviced
$554.8 million of loans of which $334.1 million were serviced for others.
The loan servicing and collections department has increased in size from
four persons at December 31, 1994 to 20 persons at September 30, 1997. Within
this department, personnel have experience in both sub-prime lending and also
in managing the Company's non-performing loans in its historical local lending
portfolio. This experience was gained in part during the economic downturn in
Southern California and resulted in a low loss experience for the Company. See
"--Lending Overview--Allowance for Loan Losses." The head of the servicing
department has more than 24 years of experience in loan servicing and
collections, including responsibility for a $10.0 billion portfolio of
approximately 255,000 loans and a staff of 70 people. Substantial space in the
Riverside, California facility has been allocated to the loan servicing and
collections operations upon the opening of the newer Riverside facility and
the transfer of the origination and administrative functions to this facility
during the third quarter of 1997. In order to provide the infrastructure to
increase productivity, the Company is in the process of enhancing its
telephonic systems by purchasing a power dialing system, which is intended to
become operational in the first quarter of 1998. In addition, the Company
intends to enhance its computer systems by adding imaging, which creates an
image of each document in a loan file accessible through the Company's wide
area network, which is expected to become operational in the second quarter of
1998.
The Company's loan servicing activities include (i) the collection and
remittance of mortgage loan payments, (ii) accounting for principal and
interest and other collections and expenses, (iii) holding and disbursing
escrow or impounding funds for real estate taxes and insurance premiums, (iv)
inspecting properties when appropriate, (v) contacting delinquent borrowers,
and (vi) acting as fiduciary in foreclosing and disposing of collateral
properties. The Company receives a servicing fee for performing these services
for others.
While most of the Company's servicing portfolio is generated through its
origination and purchase activities, when economically attractive, the Company
has, from time to time, made bulk purchases of mortgage servicing rights from
financial institutions. The Company does not intend to make significant bulk
purchases of servicing rights in the near future but may do so depending on
market opportunities. The mortgage loans underlying the servicing rights
retained by the Company have been historically underwritten by the Company.
These servicing rights were either originated by mortgage brokers or purchased
through various programs from correspondents or junior correspondents. The
costs to acquire servicing are based on the present value of the estimated
future servicing revenues, net of the expected servicing expenses, for each
acquisition. Major factors impacting the value of servicing rights include
contractual service fee rates, projected mortgage prepayment speed, projected
70
delinquencies and foreclosures, projected escrow, agency and fiduciary funds
to be held in connection with such servicing and the projected benefit to be
realized from such funds. See "Risk Factors Related to the Company--Risks
Related to Mortgage Servicing Rights and Residual Assets."
In addition to weekly loan delinquency meetings which are attended by
members of senior management, the loan committee of the Board of Directors
generally performs a monthly review of all delinquent loans 90 days or more
past due. In addition, management reviews on an ongoing basis all delinquent
loans. The procedures taken by the Company with respect to delinquencies vary
depending on the nature of the loan and period of delinquency. When a borrower
fails to make a required payment on a loan, the Company takes a number of
steps to have the borrower cure the delinquency and restore the loan to
current status. The Company generally sends the borrower a written notice of
non-payment within ten days after the loan is first past due. In the event
payment is not then received, additional letters and phone calls generally are
made. If the loan is still not brought current, the Company generally sends a
notice of the intent to foreclose 25 days after the loan is first past due. If
the borrower does not cure the delinquency and it becomes necessary for the
Company to take legal action, which typically occurs after a loan is
delinquent at least 30 days or more, the Company will commence foreclosure
proceedings against any real property that secures the loan. If a loan remains
delinquent on the 45th day, a property inspection will be made to verify
occupancy, determine the condition of the property and as an attempt to
contact the borrower in person. If a foreclosure action is instituted and the
loan is not brought current, paid in full, or refinanced before the
foreclosure sale, the real property securing the loan generally is sold at
foreclosure. The Company's procedures for repossession and sale of consumer
collateral are subject to various requirements under state consumer protection
laws.
Regulation and practices in the United States regarding the liquidation of
properties (e.g., foreclosure) and the rights of the mortgagor in default vary
greatly from state to state. Loans originated or purchased by the Company are
secured by mortgages, deeds of trust, trust deeds, security deeds or deeds to
secure debt, depending upon the prevailing practice in the state in which the
property securing the loan is located. Depending on local law, foreclosure is
effected by judicial action and/or non-judicial sale, and is subject to
various notice and filing requirements. If foreclosure is effected by judicial
action, the foreclosure proceedings may take several months.
In general, the borrower, or any person having a junior encumbrance on the
real estate, may cure a monetary default by paying the entire amount in
arrears plus other designated costs and expenses incurred in enforcing the
obligation during a statutorily prescribed reinstatement period. Generally,
state law controls the amount of foreclosure expenses and costs, including
attorneys' fees, which may be recovered by a lender.
There are a number of restrictions that may limit the Company's ability to
foreclose on a property. A lender may not foreclose on the property securing a
junior mortgage loan unless it forecloses subject to each senior mortgage, in
which case the junior lender or purchaser at such a foreclosure sale will take
title to the property subject to the lien securing the amount due on the
senior mortgage. Moreover, if a borrower has filed for bankruptcy protection,
a lender may be stayed from exercising its foreclosure rights. Also, certain
states provide a homestead exemption that may restrict the ability of a lender
to foreclose on residential property.
71
Credit Quality of Servicing Portfolio. The following table illustrates the
Bank's delinquency and default experience with respect to its loan servicing
portfolio:
AT SEPTEMBER 30,
1997
---------------------------------------
NUMBER OF % OF % OF
LOANS/ LOANS PRINCIPAL SERVICING
PROPERTIES SERVICED BALANCE PORTFOLIO
---------- -------- --------- ---------
(DOLLARS IN THOUSANDS)
Delinquency
percentage(1)(2)
30-59 days...... 226 1.85% $ 5,393 0.97%
60-89 days...... 91 0.74 932 0.17
90 days and
over............ 109 0.89 858 0.15
------ ---- --------- ----
Total
delinquency..... 426 3.48% $ 7,183 1.29
====== ==== ========= ====
Default
percentage(3)
Foreclosure..... 77 0.63% $ 8,182 1.47%
Bankruptcy...... 28 0.23 1,840 0.33
Real estate
owned(4)........ 22 0.18 2,379 0.43
------ ---- --------- ----
Total default... 127 1.04% $ 12,401 2.24%
====== ==== ========= ====
Total servicing
portfolio at
period end....... 12,229 $ 554,779
====== =========
AT DECEMBER 31,
-------------------------------------------------------------------------------
1996 1995
--------------------------------------- ---------------------------------------
NUMBER OF % OF % OF NUMBER OF % OF % OF
LOANS/ LOANS PRINCIPAL SERVICING LOANS/ LOANS PRINCIPAL SERVICING
PROPERTIES SERVICED BALANCE PORTFOLIO PROPERTIES SERVICED BALANCE PORTFOLIO
---------- -------- --------- --------- ---------- -------- --------- ---------
(DOLLARS IN THOUSANDS)
Delinquency
percentage(1)(2)
30-59 days...... 10 0.26% $ 860 0.36% 22 0.74% $ 2,118 0.83%
60-89 days...... -- -- -- -- 9 0.30 482 0.19
90 days and
over............ 3 0.08 143 0.06 10 0.33 762 0.30
----- ---- -------- ---- ----- ---- -------- ----
Total
delinquency..... 13 0.34% $ 1,003 0.42% 41 1.37% $ 3,362 1.32%
===== ==== ======== ==== ===== ==== ======== ====
Default
percentage(3)
Foreclosure..... 56 1.48% $ 6,279 2.64% 7 0.23% $ 793 0.32%
Bankruptcy...... 9 0.24 778 0.33 2 0.07 288 0.11
Real estate
owned(4)........ 9 0.24 1,197 0.50 8 0.27 1,221 0.48
----- ---- -------- ---- ----- ---- -------- ----
Total default... 74 1.96% $ 8,254 3.47% 17 0.57% $ 2,301 0.91%
===== ==== ======== ==== ===== ==== ======== ====
Total servicing
portfolio at
period end....... 3,781 $237,958 2,986 $253,711
===== ======== ===== ========
- ----
(1) The delinquency percentage represents the number and outstanding principal
balance of loans for which payments are contractually past due, exclusive
of loans in foreclosure, bankruptcy, real estate owned or forbearance.
(2) The past due period is based on the actual number of days that a payment
is contractually past due. A loan as to which a monthly payment was due
60-89 days prior to the reporting period is considered 60-89 days past
due, etc.
(3) The default percentage represents the number and outstanding principal
balance of loans in foreclosure, bankruptcy or real estate owned.
(4) An "REO Property" is a property acquired and held as a result of
foreclosure or deed in lieu of foreclosure.
72
LENDING OVERVIEW
Loan Portfolio Composition. At September 30, 1997, the Company's gross loans
outstanding totalled $220.7 million, of which $186.6 million, or 84.6%, were
held for sale and $34.0 million, or 15.4%, were held for investment. The types
of loans that the Company may originate are subject to federal and state law
and regulations. Interest rates charged by the Company on loans are affected
by the demand for such loans and the supply of money available for lending
purposes and the rates offered by competitors. These factors are, in turn,
affected by, among other things, economic conditions, monetary policies of the
federal government, including the Federal Reserve Board, and legislative tax
policies.
The following table sets forth the composition of the Company's loan
portfolio in dollar amounts and as a percentage of the portfolio at the dates
indicated.
AT DECEMBER 31,
AT SEPTEMBER 30, -------------------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992
----------------- ---------------- ---------------- --------------- --------------- ---------------
PERCENT PERCENT PERCENT PERCENT PERCENT PERCENT
OF OF OF OF OF OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Real estate(1):
Residential:
One- to four-
family.......... $175,386 79.48% $54,275 78.67% $54,007 84.04% $53,755 82.62% $55,841 83.01% $53,816 81.68%
Multi-family.... 16,416 7.44 4,752 6.89 2,412 3.75 2,685 4.12 2,296 3.41 2,338 3.55
Commercial........ 21,866 9.91 9,659 14.00 7,522 11.71 8,131 12.50 8,389 12.47 8,930 13.55
Other loans:
Loans secured by
deposit accounts.. 128 0.06 177 0.25 186 0.29 213 0.33 396 0.59 381 0.58
Unsecured
commercial loans.. 64 0.03 67 0.10 70 0.11 197 0.30 190 0.28 224 0.34
Unsecured consumer
loans............. 6,805 3.08 65 0.09 63 0.10 84 0.13 162 0.24 200 0.30
-------- ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total gross
loans........... $220,665 100.00% 68,995 100.00% 64,260 100.00% 65,065 100.00% 67,274 100.00% 65,889 100.00%
-------- ====== ------- ====== ------- ====== ------- ====== ------- ====== ------- ======
Less (plus):
Deferred loan
origination
(costs) fees and
(premiums)
discounts......... (4,882) (543) (298) 56 109 209
Allowance for
estimated loan
losses............ 1,859 1,625 1,177 832 436 308
-------- ------- ------- ------- ------- -------
Loans
receivable,
net............. $223,688 $67,913 $63,381 $64,177 $66,729 $65,372
======== ======= ======= ======= ======= =======
- ----
(1) Includes second trust deeds.
73
Loan Maturity. The following table shows the contractual maturity of the
Bank's gross loans at September 30, 1997. There were $186.6 million of loans
held for sale at September 30, 1997. The table does not reflect prepayment
assumptions.
AT SEPTEMBER 30, 1997
------------------------------------------------
TOTAL
ONE- TO MULTI- OTHER LOANS
FOUR-FAMILY FAMILY COMMERCIAL LOANS RECEIVABLE
----------- ------- ---------- ------ ----------
(DOLLARS IN THOUSANDS)
Amounts due:
One year or less............. $ 11,883 $ -- $ 215 $ 227 $ 12,325
After one year:
More than one year to three
years...................... 1,282 -- 1,087 401 2,770
More than three years to
five years................. 1,283 627 3,992 2,557 8,459
More than five years to 10
years...................... 1,553 1,668 3,521 3,441 10,183
More than 10 years to 20
years...................... 40,721 1,155 3,005 59 44,940
More than 20 years.......... 118,664 12,966 10,046 312 141,988
-------- ------- ------- ------ --------
Total amount due.......... $175,386 $16,416 $21,866 $6,997 $220,665
======== ======= ======= ====== ========
Less (plus):
Unamortized discounts (pre-
miums), net................ (4,933) -- (1) -- (4,934)
Deferred loan origination
fees (costs)............... (289) 170 171 -- 52
Allowance for estimated loan
losses..................... 1,433 66 151 209 1,859
-------- ------- ------- ------ --------
Total loans, net.......... 179,175 16,180 21,545 6,788 223,688
Loans held for sale, net.... 154,992 15,858 14,023 6,682 191,555
-------- ------- ------- ------ --------
Loans held for investment,
net........................ $ 24,183 $ 322 $ 7,522 $ 106 $ 32,133
======== ======= ======= ====== ========
The following table sets forth at September 30, 1997, the dollar amount of
gross loans receivable contractually due after September 30, 1998, and whether
such loans have fixed interest rates or adjustable interest rates. The
Company's adjustable-rate mortgage loans require that any payment adjustment
resulting from a change in the interest rate be made to both the interest and
payment in order to result in full amortization of the loan by the end of the
loan term, and thus, do not permit negative amortization.
DUE AFTER SEPTEMBER 30, 1998
------------------------------
FIXED ADJUSTABLE TOTAL
-------- ---------------------
(DOLLARS IN THOUSANDS)
Real estate loans:
Residential:
One- to four-family........................ $ 69,558 $ 93,945 $ 163,503
Multi-family............................... 2,555 13,861 16,416
Commercial.................................. 7,625 14,026 21,651
Other loans................................. 6,753 17 6,770
-------- --------- ---------
Total gross loans receivable............. $ 86,491 $ 121,849 $ 208,340
======== ========= =========
74
The following tables set forth the Company's loan originations, purchases,
sales and principal repayments for the periods indicated:
FOR THE NINE
MONTHS ENDED FOR THE YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
----------------- --------------------------
1997 1996 1996 1995 1994
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Gross loans(1):
Beginning balance................ $ 68,995 $ 64,260 $ 64,260 $ 65,065 $ 67,274
Loans originated:
One- to four-family(2)......... 214,722 61,481 100,745 38,259 34,740
Multi-family................... 11,373 1,613 2,976 -- 85
Commercial..................... 10,074 5,546 7,172 -- 266
Other loans.................... 581 117 126 358 452
-------- -------- -------- -------- --------
Total loans originated....... 236,750 68,757 111,019 38,617 35,543
Loans purchased(3).............. 196,658 79,632 111,534 96,155 37,272
-------- -------- -------- -------- --------
Total loans originated and
purchased..................... 433,408 148,389 222,553 134,772 72,815
-------- -------- -------- -------- --------
Total........................ 502,403 212,649 286,813 199,837 140,089
Less:
Principal repayments............ 3,185 7,028 9,184 6,719 7,440
Sales of loans.................. 73,089 140,755 154,620 126,875 65,713
Securitizations of loans........ 203,968 -- 51,944 -- --
Transfer to REO................. 1,496 1,983 2,070 1,983 1,871
-------- -------- -------- -------- --------
Total loans.................. 220,665 62,883 68,995 64,260 65,065
Loans held for sale............. 186,638 24,426 30,454 21,397 17,097
-------- -------- -------- -------- --------
Ending balance loans held for
investment...................... $ 34,027 $ 38,457 $ 38,541 $ 42,863 $ 47,968
======== ======== ======== ======== ========
- --------
(1) Gross loans includes loans held for investment and loans held for sale.
(2) Includes second trust deeds.
(3) Loans purchased consist predominantly of one- to four-family residential
Liberator Series and Portfolio Series loans.
Delinquencies and Classified Assets. Federal regulations and the Bank's
Classification of Assets Policy require that the Bank utilize an internal
asset classification system as a means of reporting problem and potential
problem assets. The Bank has incorporated the OTS internal asset
classifications as a part of its credit monitoring system. The Bank currently
classifies problem and potential problem assets as "Substandard," "Doubtful"
or "Loss" assets. An asset is considered "Substandard" if it is inadequately
protected by the current net worth and paying capacity of the obligor or of
the collateral pledged, if any. "Substandard" assets include those
characterized by the "distinct possibility" that the insured institution will
sustain "some loss" if the deficiencies are not corrected. Assets classified
as "Doubtful" have all of the weaknesses inherent in those classified
"Substandard" with the added characteristic that the weaknesses present make
"collection or liquidation in full," on the basis of currently existing facts,
conditions, and values, "highly questionable and improbable." Assets
classified as "Loss" are those considered "uncollectible" and of such little
value that their continuance as assets without the establishment of a specific
loss allowance is not warranted. Assets which do not currently expose the
insured institution to sufficient risk to warrant classification in one of the
aforementioned categories but possess weaknesses are required to be designated
"Special Mention."
When an insured institution classifies one or more assets, or portions
thereof, as Substandard or Doubtful, under current OTS policy the Bank is
required to consider establishing a general valuation allowance in an amount
deemed prudent by management. The general valuation allowance, which is a
regulatory term, represents
75
a loss allowance which has been established to recognize the inherent credit
risk associated with lending and investing activities, but which, unlike
specific allowances, has not been allocated to particular problem assets. When
an insured institution classifies one or more assets, or portions thereof, as
"Loss," it is required either to establish a specific allowance for losses
equal to 100% of the amount of the asset so classified or to charge off such
amount.
A savings institution's determination as to the classification of its assets
and the amount of its valuation allowances is subject to review by the OTS
which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies,
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment
of adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation allowances. Generally, the
policy statement recommends that institutions have effective systems and
controls to identify, monitor and address asset quality problems; that
management has analyzed all significant factors that affect the collectibility
of the portfolio in a reasonable manner; and that management has established
acceptable allowance evaluation processes that meet the objectives set forth
in the policy statement. As a result of the declines in local and regional
real estate market values and the significant losses experienced by many
financial institutions in prior years, there has been a greater level of
scrutiny by regulatory authorities of the loan portfolios of financial
institutions undertaken as part of the examination of institutions by the OTS
and the FDIC. While the Bank believes that it has established an adequate
allowance for estimated loan losses, there can be no assurance that
regulators, in reviewing the Bank's loan portfolio, will not request the Bank
to materially increase at that time its allowance for estimated loan losses,
thereby negatively affecting the Bank's financial condition and earnings at
that time. Although management believes that an adequate allowance for
estimated loan losses has been established, actual losses are dependent upon
future events and, as such, further additions to the level of allowances for
estimated loan losses may become necessary.
The Bank's Internal Asset Review Committee reviews and classifies the Bank's
assets quarterly and reports the results of its review to the Board of
Directors. The Bank classifies assets in accordance with the management
guidelines described above. REO is classified as Substandard. The following
table sets forth information concerning loans, REO and total assets classified
as substandard at September 30, 1997. At September 30, 1997 the Bank had $1.0
million of assets classified as Special Mention, $5.1 million of assets
classified as Substandard, no assets classified as Doubtful and $246,000 of
assets classified as Loss. As of September 30, 1997, assets classified as
Special Mention include four loans totaling $506,000 secured by one- to four-
family residential properties and three commercial real estate loans totaling
$488,000. At September 30, 1997, the largest loan classified as Special
Mention had a loan balance of $297,000 and is secured by commercial real
estate. As set forth below, as of September 30, 1997, assets classified as
Substandard, Doubtful and Loss include 162 loans totaling $4.3 million.
AT SEPTEMBER 30, 1997
--------------------------------------------------------------------------------------
TOTAL SUBSTANDARD, DOUBTFUL
LOANS REO AND LOSS ASSETS
--------------------------- ----------------------------- ----------------------------
GROSS NET NUMBER GROSS NET NUMBER OF GROSS NET NUMBER
BALANCE BALANCE(1) OF LOANS BALANCE BALANCE(1) PROPERTIES BALANCE BALANCE(1) OF ASSETS
------- ---------- -------- ------- ---------- ---------- ------- ---------- ---------
(DOLLARS IN THOUSANDS)
Residential:
One- to four-family.... $3,541 $3,313 44 $1,002 $ 983 12 $4,543 $4,296 56
Multi-family........... 47 47 1 48 48 1 95 95 2
Commercial.............. 131 131 1 -- -- -- 131 131 1
Other loans............. 618 618 116 -- -- -- 618 618 116
------ ------ --- ------ ------ --- ------ ------ ---
Total loans........... $4,337 $4,109 162 $1,050 $1,031 13 $5,387 $5,140 175
====== ====== === ====== ====== === ====== ====== ===
- --------
(1) Net balances are reduced for specific loss allowances established against
substandard loans and real estate.
76
Non-Accrual and Past-Due Loans. The following table sets forth information
regarding non-accrual loans, troubled-debt restructurings and REO in the
Company's loans held for investment. There was one troubled-debt restructured
loan within the meaning of SFAS 15, and 13 REO properties at September 30,
1997. Until September 30, 1996 it was the policy of the Company to cease
accruing interest on loans at the time foreclosure proceedings commenced,
which typically occurred when a loan is 45 days past due or possibly longer
depending on the circumstances, which period will not exceed 90 days past due.
Subsequent to March 31, 1996, the Company adopted a policy to cease accruing
interest on loans 90 days or more past due. For the nine months ended
September 30, 1997 and 1996 and the years ended December 31, 1996, 1995, 1994,
1993 and 1992, respectively, the amount of interest income that would have
been recognized on nonaccrual loans if such loans had continued to perform in
accordance with their contractual terms was $272,000, $100,000, $150,000,
$66,000, $106,000, $117,000 and $84,000, none of which was recognized. For the
same periods, the amount of interest income recognized on troubled debt
restructurings was $9,000, $9,000, $12,000, $11,000, $10,000, $1,000, and $0.
AT SEPTEMBER 30, AT DECEMBER 31,
------------------ --------------------------------------
1997 1996 1996 1995 1994 1993 1992
-------- -------- ------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
Non-accrual loans:
Residential real
estate:
One- to four-
family............. $ 2,332 $ 1,837 $2,361 $1,305 $1,766 $1,919 $1,606
Multi-family........ -- -- 45 -- -- -- --
Commercial............ 131 -- -- 82 78 197 283
Other loans........... 610 10 10 10 45 62 2
-------- -------- ------ ------ ------ ------ ------
Total............. 3,073 1,847 2,416 1,397 1,889 2,178 1,891
REO, net(1)............. 975 991 561 827 555 1,772 1,377
-------- -------- ------ ------ ------ ------ ------
Total non-
performing
assets........... $ 4,048 $ 2,838 $2,977 $2,224 $2,444 $3,950 $3,268
======== ======== ====== ====== ====== ====== ======
Restructured loans...... $ 131 $ 131 $ 131 $ 131 $ -- $ 15 $ --
Classified assets,
gross.................. 5,387 4,603 4,829 3,929 3,951 4,165 4,827
Allowance for estimated
loan losses as a
percent of gross loans
receivable(2).......... 0.84% 1.63% 2.36% 1.83% 1.28% 0.65% 0.47%
Allowance for estimated
loan losses as a
percent of total non-
performing loans(3).... 60.49 55.66 67.26 84.25 44.04 20.02 16.29
Non-performing loans as
a percent of gross
loans
receivable(2)(3)....... 1.39 2.94 3.50 2.17 2.90 3.24 2.87
Non-performing assets as
a percent of total
assets(3).............. 1.38 3.36 2.86 3.00 3.42 5.05 4.15
- --------
(1) REO balances are shown net of related loss allowances.
(2) Gross loans include loans receivable held for investment and loans
receivable held for sale.
(3) Non-performing assets consist of non-performing loans and REO. Prior to
April 1, 1996, non-performing loans consisted of all loans 45 days or more
past due and all other non-accrual loans. Following March 31, 1996, non-
performing loans consisted of all loans 90 days or more past due and all
other non-accrual loans.
77
The following table sets forth delinquencies in the Company's loan portfolio
as of the dates indicated:
AT SEPTEMBER 30, 1997 AT DECEMBER 31, 1996
-------------------------------------- -------------------------------------
60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE
------------------- ------------------ ------------------ ------------------
PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL
NUMBER OF BALANCE NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE
LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS
--------- --------- -------- --------- -------- --------- -------- ---------
(DOLLARS IN THOUSANDS)
One- to four-family..... 5 $ 645 27 $2,254 3 $354 21 $2,361
Multi-family............ -- -- -- -- -- -- 1 45
Commercial.............. -- -- 2 149 -- -- -- --
Other loans............. 85 449 110 670 -- -- 1 10
--- ------ --- ------ --- ---- --- ------
Total................. 90 $1,094 139 $3,073 3 $354 23 $2,416
=== ====== === ====== === ==== === ======
Delinquent loans to to-
tal gross loans........ 0.50% 1.39% 0.51% 3.50%
====== ====== ==== ======
AT DECEMBER 31, 1995 AT DECEMBER 31, 1994
------------------------------------- -------------------------------------
60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE
------------------ ------------------ ------------------ ------------------
PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL
NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE
OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS
-------- --------- -------- --------- -------- --------- -------- ---------
(DOLLARS IN THOUSANDS)
One- to four-family..... 8 $446 13 $1,286 5 $375 8 $1,728
Multi-family............ -- -- -- -- -- -- -- --
Commercial.............. -- -- -- -- -- -- 1 77
Other loans............. -- -- 1 10 -- -- -- --
--- ---- --- ------ --- ---- --- ------
Total................. 8 $446 14 $1,296 5 $375 9 $1,805
=== ==== === ====== === ==== === ======
Delinquent loans to to-
tal gross loans........ 0.69% 2.01% 0.58% 2.78%
==== ====== ==== ======
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in its loan portfolio and the general economy. The allowance
for loan losses is maintained at an amount management considers adequate to
cover estimated losses in loans receivable which are deemed probable and
estimable. The allowance is based upon a number of factors, including current
economic conditions, actual loss experience and industry trends. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to make additional provisions for loan losses based upon
information available at the time of the review. As of September 30, 1997, the
Company's allowance for loan losses was 0.84% of gross loans compared to 2.36%
as of December 31, 1996. The Company had non-accrual loans of $3.1 million and
$2.4 million at September 30, 1997 and December 31, 1996, respectively. The
Company will continue to monitor and modify its allowances for loan losses as
conditions dictate.
78
The following table sets forth activity in the Company's allowance for loan
losses for the periods set forth in the table.
AT OR FOR THE NINE
MONTHS ENDED
SEPTEMBER 30, AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------- -------------------------------------------
1997 1996 1996 1995 1994 1993 1992
--------- --------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Balance at beginning of
period................. $ 1,625 $ 1,177 $ 1,177 $ 832 $ 436 $ 308 $ 299
Provision for loan
losses................. 900 359 963 1,194 1,306 404 129
Charge-offs:
Real Estate:
One- to four-
family............. 673 577 668 736 771 301 60
Multi-family........ -- 45 45 -- -- -- --
Commercial.......... -- -- 11 111 47 -- --
Other loans........... -- 10 10 67 95 -- 60
--------- -------- ------- ------- ------- ------- -------
Total............. 673 632 734 914 913 301 120
Recoveries.............. 7 124 219 65 3 25 --
--------- -------- ------- ------- ------- ------- -------
Balance at end of
period................. $ 1,859 $ 1,028 $ 1,625 $ 1,177 $ 832 $ 436 $ 308
========= ======== ======= ======= ======= ======= =======
Average net loans
outstanding............ $ 143,487 $ 69,944 $72,556 $65,521 $65,566 $68,511 $62,522
========= ======== ======= ======= ======= ======= =======
Net charge-offs to
average net loans
outstanding............ 0.46% 0.73% 0.71% 1.30% 1.39% 0.40% 0.19%
79
The following table sets forth the amount of the Company's allowance for
loan losses, the percent of allowance for loan losses to total allowance and
the percent of gross loans to total gross loans in each of the categories
listed at the dates indicated.
AT SEPTEMBER 30,
-----------------------------------------------------------------
1997 1996
-------------------------------- --------------------------------
PERCENT OF PERCENT OF
GROSS LOANS IN GROSS LOANS IN
PERCENT OF EACH PERCENT OF EACH
ALLOWANCE CATEGORY ALLOWANCE CATEGORY
TO TOTAL TO TOTAL TO TOTAL TO TOTAL
AMOUNT ALLOWANCE GROSS LOANS AMOUNT ALLOWANCE GROSS LOANS
------ ---------- -------------- ------ ---------- --------------
(DOLLARS IN THOUSANDS)
One- to four-family..... $1,433 77.08% 79.48% $ 887 86.28% 81.05%
Multi-family............ 66 3.55 7.44 20 1.95 5.41
Commercial.............. 151 8.13 9.91 112 10.89 13.00
Other................... 209 11.24 3.17 9 0.88 0.54
------ ------ ------ ------ ------ ------
Total allowance for
loan losses........... $1,859 100.00% 100.00% $1,028 100.00% 100.00%
====== ====== ====== ====== ====== ======
AT DECEMBER 31,
---------------------------------------------------------------------------------
1996 1995 1994
-------------------------- -------------------------- --------------------------
PERCENT PERCENT PERCENT
OF GROSS OF GROSS OF GROSS
LOANS IN LOANS IN LOANS IN
EACH EACH EACH
PERCENT OF CATEGORY PERCENT OF CATEGORY PERCENT OF CATEGORY
ALLOWANCE TO TOTAL ALLOWANCE TO TOTAL ALLOWANCE TO TOTAL
TO TOTAL GROSS TO TOTAL GROSS TO TOTAL GROSS
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
------ ---------- -------- ------ ---------- -------- ------ ---------- --------
(DOLLARS IN THOUSANDS)
One- to four-
family........... $1,462 89.97% 78.67% $1,001 85.05% 84.04% $604 72.60% 82.62%
Multi-family..... 20 1.23 6.89 14 1.19 3.75 10 1.20 4.12
Commercial....... 124 7.63 14.00 143 12.15 11.71 164 19.71 12.5
Other............ 19 1.17 0.44 19 1.61 0.50 54 6.49 0.76
------ ------ ------ ------ ------ ------ ---- ------ ------
Total allowance
for loan
losses.......... $1,625 100.00% 100.00% $1,177 100.00% 100.00% $832 100.00% 100.00%
====== ====== ====== ====== ====== ====== ==== ====== ======
------------------------------------------------------
1993 1992
-------------------------- --------------------------
PERCENT PERCENT
OF GROSS OF GROSS
LOANS IN LOANS IN
EACH EACH
PERCENT OF CATEGORY PERCENT OF CATEGORY
ALLOWANCE TO TOTAL ALLOWANCE TO TOTAL
TO TOTAL GROSS TO TOTAL GROSS
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
------ ---------- -------- ------ ---------- --------
One- to four-
family........... $287 65.83% 83.01% $225 73.05% 81.68%
Multi-family..... 10 2.29 3.41 6 1.95 3.55
Commercial....... 98 22.48 12.47 57 18.51 13.55
Other............ 41 9.40 1.11 20 6.49 1.22
---- ------ ------ ---- ------ ------
Total allowance
for loan
losses.......... $436 100.00% 100.00% $308 100.00% 100.00%
==== ====== ====== ==== ====== ======
80
REO
At September 30, 1997, the Company had $975,000 of REO, net of allowances.
Real estate properties acquired through or in lieu of loan foreclosure are
initially recorded at the lower of fair value or the balance of the loan at
the date of foreclosure through a charge to the allowance for estimated loan
losses. After foreclosure, valuations are periodically performed by management
and an allowance for losses is established by a charge to operations if the
carrying value of a property exceeds its fair value less estimated cost to
sell. It is the policy of the Company to obtain an appraisal on all REO at the
time of possession and every six months thereafter.
INVESTMENT ACTIVITIES
Federally chartered savings institutions, such as the Bank, have the
authority to invest in various types of liquid assets, including United States
Treasury obligations, securities of various federal agencies, certificates of
deposit of insured banks and savings institutions, bankers' acceptances, and
federal funds. Subject to various restrictions, federally chartered savings
institutions may also invest their assets in commercial paper, investment-
grade corporate debt securities and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly. Additionally, the Bank must maintain minimum
levels of investments that qualify as liquid assets under OTS regulations. See
"Regulation--Federal Savings Institution Regulation--Liquidity." Historically,
the Bank has maintained liquid assets above the minimum OTS requirements and
at a level considered to be adequate to meet its normal daily activities.
The investment policy of the Company as established by the Board of
Directors attempts to provide and maintain liquidity, generate a favorable
return on investments without incurring undue interest rate and credit risk,
and complement the Company's lending activities. Specifically, the Company's
policies generally limit investments to government and federal agency-backed
securities and non-government guaranteed securities, including corporate debt
obligations, that are investment grade. The Company's policies provide the
authority to invest in marketable equity securities meeting the Company's
guidelines and in mortgage-backed securities guaranteed by the U.S. government
and agencies thereof and other financial institutions.
At September 30, 1997 the Company had $9,000 in its mortgage-backed
securities portfolio, all of which were insured or guaranteed by the FHLMC and
are being held-to-maturity. The Company may increase its investment in
mortgage-backed securities in the future depending on its liquidity needs and
market opportunities. Investments in mortgage-backed securities involve a risk
that actual prepayments will be greater than estimated prepayments over the
life of the security which may require adjustments to the amortization of any
premium or accretion of any discount relating to such instruments thereby
reducing the net yield on such securities. There is also reinvestment risk
associated with the cash flows from such securities. In addition, the market
value of such securities may be adversely affected by changes in interest
rates.
At September 30, 1997, the residual assets, which resulted from the
Company's asset securitizations conducted during the fourth quarter of 1996,
the first quarter of 1997 and the third quarter of 1997, of $24.5 million were
classified as trading securities. For regulatory reasons, the residual assets
and restricted cash are held by the Parent Company. Future residuals and
related assets generated by asset securitizations will be held by the Bank
only until they can be sold to the Company or disposed of in some other
transaction. The residual assets and any future residuals generated by future
asset securitizations and held by the Company will be marked to market on a
quarterly basis with unrealized gains and losses recorded in operations. See
"Risk Factors Related to the Company--Dependence on Asset Securitizations and
Impact on Quarterly Operating Results" and "--Loan Sales and Asset
Securitizations."
81
The following table sets forth certain information regarding the carrying
and fair values of the Company's securities at the dates indicated. There were
no securities available-for-sale at the dates indicated:
AT DECEMBER 31,
AT SEPTEMBER 30, -----------------------------------------------
1997 1996 1995 1994
------------------ --------------- --------------- ---------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE VALUE VALUE VALUE VALUE
--------- -------- -------- ------ -------- ------ -------- ------
(DOLLARS IN THOUSANDS)
Securities:
Held-to-maturity:
U.S. Treasury and
other agency
securities........ $ 8,056 $ 8,070 $8,827 $8,785 $2,689 $2,689 $2,846 $2,838
Mortgage-backed
securities........ 9 9 10 10 11 11 13 13
-------- -------- ------ ------ ------ ------ ------ ------
Total securities
held-to-
maturity........ $ 8,065 $ 8,079 $8,837 $8,795 $2,700 $2,700 $2,859 $2,851
======== ======== ====== ====== ====== ====== ====== ======
The table below sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of the Company's securities
as of September 30, 1997. There were no securities available for sale at
September 30, 1997.
AT SEPTEMBER 30, 1997
-----------------------------------------------------------------------------------------
MORE THAN MORE THAN
ONE YEAR ONE YEAR TO FIVE YEARS MORE THAN
OR LESS FIVE YEARS TO TEN YEARS TEN YEARS TOTAL
----------------- ----------------- ----------------- ----------------- -----------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Securities:
Held-to-maturity:
U.S. Treasury and other
agency securities..... $4,008 5.88% $2,998 6.00% $ -- -- % $ -- -- % $7,006 5.93%
Mortgage-backed
securities............ -- -- -- 9 6.88 9 6.88
------ ------ ----- ----- ------
Total held-to-
maturity............. 4,008 5.88% 2,998 6.00 -- 9 6.88 7,015 5.93
FHLB stock............. 1,050 -- -- -- 1,050
------ ------ ----- ----- ------
Total securities held-
to-maturity.......... $5,058 $2,998 $ -- $ 9 $8,065
====== ====== ===== ===== ======
82
SOURCES OF FUNDS
General. Deposits, lines of credit, loan repayments and prepayments,
proceeds from sales and securitization of loans, cash flows generated from
operations and borrowings are the primary sources of the Company's funds for
use in lending, investing and for other general purposes.
Deposits. The Company offers a variety of deposit accounts with a range of
interest rates and terms. The Company's deposits consist of passbook savings,
checking accounts, money market savings accounts and certificates of deposit.
For the nine months ended September 30, 1997, certificates of deposit
constituted 86.8% of total average deposits. The term of the fixed-rate
certificates of deposit offered by the Company vary from 30 days to eighteen
years and the offering rates are established by the Company on a weekly basis.
Specific terms of an individual account vary according to the type of account,
the minimum balance required, the time period funds must remain on deposit and
the interest rate, among other factors. The flow of deposits is influenced
significantly by general economic conditions, changes in money market rates,
prevailing interest rates and competition. At September 30, 1997, the Company
had $134.3 million of certificate accounts maturing in one year or less.
The Company relies primarily on customer service and long-standing
relationships with customers to attract and retain local deposits; however,
market interest rates and rates offered by competing financial institutions
significantly affect the Company's ability to attract and retain deposits. In
addition, the Company seeks to attract deposits from outside of its market
area by using nationwide advertising. In order to meet its liquidity needs for
the purchase of loans, from time to time the Company offers above market
interest rates on short term certificate accounts and may utilize brokered
deposits. At September 30, 1997, the Company had no brokered deposits.
Although the Company has a significant portion of its deposits in shorter
term certificates of deposit, management monitors activity on the Company's
certificate of deposit accounts and, based on historical experience, and the
Company's current pricing strategy, believes that it will retain a large
portion of such accounts upon maturity. Further increases in short-term
certificate of deposit accounts, which tend to be more sensitive to movements
in market interest rates than core deposits, may result in the Company's
deposit base being less stable than if it had a large amount of core deposits
which, in turn, may result in further increases in the Company's cost of
deposits. Notwithstanding the foregoing, the Company believes that it will
continue to have access to sufficient amounts of certificates of deposit
accounts which, together with other funding sources, will provide it with the
necessary level of liquidity to continue to implement its business strategies.
The following table presents the deposit activity of the Company for the
periods indicated:
FOR THE NINE MONTHS FOR THE YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
---------------------- ------------------
1997 1996 1996 1995 1994
------- ------ ------- ------- -------
(DOLLARS IN THOUSANDS)
Net deposits (withdrawals)... $68,761 $3,272 $15,700 $(1,329) $(8,880)
Interest credited on deposit
accounts.................... 5,368 2,519 2,476 3,175 2,561
------- ------ ------- ------- -------
Total increase (decrease)
in deposit accounts...... $74,129 $5,791 $18,176 $1,846 $(6,319)
======= ====== ======= ======= =======
At September 30, 1997, the Company had $44.5 million in certificate accounts
in amounts of $100,000 or more maturing as follows:
CERTIFICATE ACCOUNTS OF CERTIFICATE ACCOUNTS OF
$100,000 TO $499,000 $500,000 OR GREATER
---------------------------- ---------------------------
WEIGHTED WEIGHTED
MATURITY PERIOD AMOUNT AVERAGE RATE AMOUNT AVERAGE RATE
--------------- ------------- -------------- ------------ --------------
(DOLLARS IN THOUSANDS)
Three months or less.... $ 7,873 5.91% $ -- -- %
Over three through 12
months................. 32,169 6.00 1,000 6.20
Over 12 months.......... 3,448 6.01 -- --
------- ------
Total................. $43,490 5.99 $1,000 6.20%
======= ======
83
The following table sets forth the distribution of the Company's average
deposit accounts for the periods indicated and the weighted average interest
rates on each category of deposits presented. For balances and weighted
average interest rates at September 30, 1997 and December 31, 1996 and 1995,
see "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Average Balance Sheets," and "Notes to Financial Statements"
provided elsewhere herein.
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, FOR THE YEAR ENDED DECEMBER 31,
-------------------------- -----------------------------------------------------------------------------
1997 1996 1995 1994
-------------------------- ------------------------- ------------------------- -------------------------
PERCENT PERCENT PERCENT PERCENT
OF TOTAL WEIGHTED OF TOTAL WEIGHTED OF TOTAL WEIGHTED OF TOTAL WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE
-------- -------- -------- ------- -------- -------- ------- -------- -------- ------- -------- --------
(DOLLARS IN THOUSANDS)
Passbook
accounts......... $ 4,027 3.01% 2.09% $ 4,401 6.03% 2.09% $ 5,090 7.53% 2.50% $ 7,048 10.13% 2.23%
Money market
accounts......... 2,978 2.23 3.00 4,233 5.80 2.79 5,493 8.12 2.62 6,512 9.36 2.50
Checking
accounts......... 10,691 7.99 2.51 7,048 9.65 1.59 6,434 9.51 1.43 6,180 8.88 1.54
-------- ------ ------- ------ ------- ------ ------- ------
Total........... 17,696 13.23 2.58 15,682 21.48 2.05 17,017 25,16 2.13 19,740 28.37 2.10
Certificate
accounts:
Three months or
less............ 18,631 13.93% 5.50 3,994 5.47 5.66 11,570 17.11 5.09 16,952 24.36 3.60
Four through 12
months.......... 74,001 55.34 5.99 36,519 50.01 5.23 20,762 30.71 5.44 21,768 31.28 4.19
13 through 36
months.......... 17,578 13.14 5.63 10,204 13.98 6.25 11,188 16.54 5.93 7,218 10.37 5.11
37 months or
greater......... 5,825 4.36 6.21 6,616 9.06 6.36 7,088 10.48 6.32 3,913 5.62 5.86
-------- ------ ------- ------ ------- ------ ------- ------
Total
certificate
accounts........ 116,035 86.77 5.87 57,333 78.52 5.57 50,608 74.84 5.59 49,851 71.63 4.25
-------- ------ ------- ------ ------- ------ ------- ------
Total average
deposits......... $133,731 100.00% 5.42 $73,015 100.00% 4.81 $67,625 100.00% 4.72 $69,591 100.00% 3.64
======== ====== ======= ====== ====== ======= ======
84
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at September 30, 1997.
PERIOD TO MATURITY FROM SEPTEMBER 30, 1997 AT DECEMBER 31,
------------------------------------------------------------------------------- -----------------------
ONE YEAR OVER ONE TO OVER TWO TO OVER THREE TO OVER FOUR TO MORE THAN
OR LESS TWO YEARS THREE YEARS FOUR YEARS FIVE YEARS FIVE YEARS TOTAL 1996 1995 1994
-------- ----------- ----------- ------------- ------------ ---------- -------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Certificate
accounts:
0 to 4.00%........ $ -- $ -- $ -- $-- $-- $-- $ -- $ -- $ 477 $ 9,674
4.01 to 5.00%..... 990 364 5 4 1 67 1,431 3,504 5,710 16,098
5.01 to 6.00%..... 66,238 2,404 368 277 474 102 69,863 60,145 32,298 15,282
6.01 to 7.00%..... 66,880 539 436 6 27 76 67,964 3,891 10,676 5,481
7.01 to 8.00%..... 173 512 481 164 42 251 1,623 1,890 2,641 1,487
8.01 to 9.00%..... -- -- -- -- -- -- -- -- -- 2
Over 9.01%........ -- -- -- -- -- -- -- -- -- --
-------- ------ ------ ---- ---- ---- -------- ------- ------- -------
Total........... $134,281 $3,819 $1,290 $451 $544 $496 $140,881 $69,430 $51,802 $48,044
======== ====== ====== ==== ==== ==== ======== ======= ======= =======
85
Borrowings. From time to time the Bank has obtained advances from the FHLB
as an alternative to retail deposit funds and internally generated funds and
may do so in the future as part of its operating strategy. FHLB advances may
also be used to acquire certain other assets as may be deemed appropriate for
investment purposes. These advances are collateralized primarily by certain of
the Bank's mortgage loans and mortgage-backed securities and secondarily by
the Bank's investment in capital stock of the FHLB. See "Regulation--Federal
Home Loan Bank System." Such advances are made pursuant to several different
credit programs, each of which has its own interest rate and range of
maturities. The maximum amount that the FHLB will advance to member
institutions, including the Bank, fluctuates from time-to-time in accordance
with the policies of the OTS and the FHLB. At September 30, 1997, the Bank had
outstanding advances in the amount of $6.9 million from the FHLB.
Both the Company and the Bank have the ability to enter into lines of credit
to finance mortgage originations and purchases or for other corporate
purposes. At September 30, 1997, the Bank's warehouse lines of credit
consisted of two separate lines of credit aggregating $250.0 million, of which
$54.6 million has been drawn at September 30, 1997. The lines of credit are
secured by loans originated or purchased by the Company and range in interest
rates from LIBOR plus 50 basis points to LIBOR plus 100 basis points. The Bank
is in the process of negotiating a third warehouse line of credit in the
amount of $250.0 million. In addition, the Company has a line of credit in the
amount of $40.0 million secured by residual assets created by the Company's
securitizations. All of the lines of credit are uncommitted and may be
terminated by the lenders at will. See "Risk Factors Related to the Company--
Availability of Funding Sources."
On March 14, 1997, the Bank issued Debentures in the aggregate principal
amount of $10.0 million through the Debenture Offering. The Debentures will
mature on March 15, 2004 and bear interest at the rate of 13.5% per annum,
payable semi-annually. The Debentures qualify as supplementary capital under
regulations of the OTS which capital may be used to satisfy the risk-based
capital requirements in an amount up to 100% of the Bank's core capital. See
"Regulation--Federal Savings Institution Regulation--Capital Requirements." By
enhancing the Bank's capital position the Debentures provide support for the
Bank's current operations. The Debentures are direct, unconditional
obligations of the Bank ranking with all other existing and future unsecured
and subordinated indebtedness of the Bank. They are subordinated on
liquidation, as to principal and interest, and premium, if any, to all claims
against the Bank having the same priority as savings account holders or any
higher priority.
The Debentures are redeemable at the option of the Bank, in whole or in
part, at any time after September 15, 1998, at the aggregate principal amount
thereof, plus accrued and unpaid interest, if any. The Bank may substitute the
Company in its place as obligor on the Debentures. If such Substitution
occurs, holders of the Debentures will have the option, at September 15, 1998
or at such later time as the Substitution occurs, to require the Company to
purchase all or part of the holder's outstanding Debentures at a price equal
to 100% of the principal amount repurchased plus accrued interest through the
repurchase date. If the Substitution occurs, upon a change in control of the
Company holders of the Debentures will have the option to require the Company
to purchase all or part of the holder's outstanding Debenture at a price equal
to 101% of the principal amount repurchased plus accrued interest through the
repurchase date. Any such repurchase would have a material adverse impact on
the Company's liquidity after September 15, 1998. See "Risk Factors Related to
the Company--Risks Related to Debentures" and "Use of Proceeds."
86
The following table sets forth certain information regarding the Company's
borrowed funds at or for the periods ended on the dates indicated:
AT OR FOR THE
NINE MONTHS
ENDED SEPTEMBER AT OR FOR THE YEAR
30, ENDED DECEMBER 31,
---------------- -----------------------
1997 1996 1996 1995 1994
------- ------- ------- ------ ------
(DOLLARS IN THOUSANDS)
FHLB advances:
Average balance outstanding....... $ 9,230 $ 3,885 $ 4,259 $3,112 $1,863
Maximum amount outstanding at any
month-end during the period...... 19,950 13,900 13,900 7,600 7,000
Balance outstanding at end of
period........................... -- -- -- -- 1,250
Weighted average interest rate
during the period................ 5.69% 5.92% 5.93% 6.55% 4.87%
Debentures:
Average balance outstanding....... $ 7,326 -- -- -- --
Maximum amount outstanding at any
month-end during the period...... $10,000 -- -- -- --
Balance outstanding at end of
period $10,000 -- -- -- --
Weighted average interest rate
during the period................ 13.50% -- -- -- --
Lines of credit:
Average balance outstanding....... $ 9,757 -- -- -- --
Maximum amount outstanding at any
month-end during the period...... 54,623 -- -- -- --
Balance outstanding at end of
period........................... 54,623 -- -- -- --
Weighted average interest rate
during the period................ 6.24% -- -- -- --
Total borrowings:
Average balance outstanding....... $26,313 $ 3,885 $ 4,259 $3,112 $1,863
Maximum amount outstanding at any
month-end during period.......... 84,573 13,900 13,900 7,600 7,000
Balance outstanding at end of
period........................... 64,623 -- -- -- 1,250
Weighted average interest rate
during the period................ 8.07% 5.92% 5.93% 6.55% 4.87%
Asset Securitizations. The Company completed three asset securitizations,
one during the fourth quarter of 1996, one during the first quarter of 1997
and one during the third quarter of 1997. Net gains to the Company from these
asset securitizations aggregated $21.3 million. As the Company anticipates
that it will conduct regular asset securitizations in the future, it is
expected that gain on sale of loans securitized will constitute a substantial
source of cash flow for the Company's future loan originations, although there
can be no assurance in this regard. See "Risk Factors Related to the Company--
Dependence on Asset Securitizations and Impact on Quarterly Operating
Results."
COMPETITION
As a purchaser and originator of mortgage loans, the Company faces intense
competition, primarily from mortgage banking companies, commercial banks,
credit unions, thrift institutions, credit card issuers and finance companies.
Many of these competitors in the financial services business are substantially
larger and have more capital and other resources than the Company.
Furthermore, certain large national finance companies and conforming mortgage
originators have announced their intention to adapt their conforming
origination programs and allocate resources to the origination of non-
conforming loans. In addition, certain of these larger mortgage companies and
commercial banks have begun to offer products similar to those offered by the
Company targeting customers similar to those of the Company. Also, the FHLMC
recently announced its intention to support such originations by purchasing,
guaranteeing and securitizing non-conforming loans originated by qualifying
institutions. The entrance of these competitors into the Company's market
could have a material adverse effect on the Company's results of operations
and financial condition. See "Risk Factors Related to the Company--
Competition."
87
Competition can take many forms, including convenience in obtaining a loan,
service, marketing and distribution channels and interest rates. Furthermore,
the current level of gains realized by the Company and its competitors on the
sale of the type of loans purchased and originated is attracting additional
competitors, including at least one quasi-governmental agency, into this
market with the effect of lowering the gains that may be realized by the
Company on future loan sales. Competition may be affected by fluctuations in
interest rates and general economic conditions. During periods of rising
rates, competitors which have "locked in" low borrowing costs may have a
competitive advantage. During periods of declining rates, competitors may
solicit the Company's borrowers to refinance their loans. During economic
slowdowns or recessions, the Company's borrowers may have new financial
difficulties and may be receptive to offers by the Company's competitors.
The Company depends largely on Originators for its purchases and
originations of new loans. The Company's competitors also seek to establish
relationships with the Company's Originators. The Company's future results may
become more exposed to fluctuations in the volume and cost of its wholesale
loans resulting from competition from other purchasers of such loans, market
conditions and other factors.
In addition, the Bank faces increasing competition for deposits and other
financial products from non-bank institutions such as brokerage firms and
insurance companies in such areas as short-term money market funds, corporate
and government securities funds, mutual funds and annuities. In order to
compete with these other institutions with respect to deposits and fee
services, the Bank relies principally upon local promotional activities,
personal relationships established by officers, directors and employees of the
Bank and specialized services tailored to meet the individual needs of the
Bank's customers.
88
PROPERTIES
As of September 30, 1997, the Company conducted its business through six
offices.
NET BOOK
VALUE OF
ORIGINAL PROPERTY OR
YEAR LEASEHOLD
LEASED LEASED DATE OF IMPROVEMENTS
OR OR LEASE AT SEPTEMBER
LOCATION OWNED ACQUIRED EXPIRATION 30, 1997
- ---------------------------- ------ -------- ---------- ------------
Corporate Headquarters and Leased 1997 2002 $1,175,000
Regional Lending Center:
10540 Magnolia Ste B
Riverside, CA
Regional Lending Center: Leased 1997 2000 79,000
Parker Place
Aurora, CO
Regional Lending Center: (1) Leased 1997 2002 --
8031 Philips Highway
Jacksonville, FL
Branch Office: Leased 1986 2001 229,000
1598 E. Highland Avenue
San Bernardino, CA
Branch Office: Leased 1997 2002 3,000
10540 Magnolia Ste A
Riverside, CA
National Servicing Center: Owned 1996 -- 534,000
4110 Tigris Way
Riverside, CA
- --------
(1) The Company's lease on its previously leased Jacksonville property expired
September 30, 1997. Although the Company moved into its new Jacksonville
property on October 1, 1997, payments on the lease on the new property did
not begin until November 1, 1997. Leasehold improvements on the new
property are not expected to be a material expense.
The Company has opened two low-cost retail lending offices, and has entered
into leases for an additional four retail lending offices which are expected
to open by the end of 1997. In addition, the Company intends to open two
retail lending offices in the first quarter of 1998. With the exception of one
planned office expected to open in Northern California, the Company's two
current and five of the six planned retail lending offices will be located in
Southern California. In addition, the Company intends to further expand by
opening additional retail offices outside of Southern California. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Comparison of Operating Results for the Nine Months Ended
September 30, 1997 and September 30, 1996--Non-Interest Expense."
SUBSIDIARIES
As of September 30, 1997, the Company had two subsidiaries: the Bank and
Life Investment Holdings, Inc. Life Investment Holdings, Inc. was incorporated
in Delaware in 1997 as a bankruptcy-remote entity for use in the Company's
asset securitization activities. The Bank had no subsidiaries at September 30,
1997.
89
LEGAL PROCEEDINGS
The Company and the Bank are not involved in any pending legal proceedings
other than legal proceedings occurring in the ordinary course of business.
Management believes that none of these legal proceedings, individually or in
the aggregate, will have a material adverse impact on the results of
operations or financial condition of the Company and the Bank.
PERSONNEL
As of September 30, 1997, the Company had 206 full-time employees and 8
part-time employees. The employees are not represented by a collective
bargaining unit and the Company considers its relationship with its employees
to be good. See "The Board of Directors and Management of the Bank--Benefits"
for a description of certain compensation and benefit programs offered to the
Company's and the Bank's employees.
FEDERAL AND STATE TAXATION
General. The Company and the Bank will report their income on a calendar
year basis using the accrual method of accounting and will be subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary
and does not purport to be a comprehensive description of the tax rules
applicable to the Bank or the Company. The statute of limitations has closed
for federal tax purposes through the 1992 tax year and for California
Franchise Tax Board purposes through the 1991 tax year.
Bad Debt Reserve. Historically, savings institutions such as the Bank which
met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrifts") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have
been deducted in arriving at their taxable income. The Bank's deduction with
respect to "qualifying real property loans," which are generally loans secured
by certain interests in real property, were computed using an amount based on
the Bank's actual loss experience, or a percentage equal to 8% of the Bank's
taxable income, computed with certain modifications and reduced by the amount
of any permitted addition to the non-qualifying reserve.
In August, 1996, the provisions repealing the current thrift bad debt rules
were passed by Congress as part of "The Small Business Job Protection Act of
1996." The new rules eliminate the 8% of taxable income method for deducting
additions to the tax bad debt reserves for all thrifts for tax years beginning
after December 31, 1995. These rules also require that all thrift institutions
recapture all or a portion of their bad debt reserves added since the base
year (last taxable year beginning before January 1, 1988). The Bank has
previously recorded a deferred tax liability equal to the bad debt recapture
and as such, the new rules will have no effect on net income or federal income
tax expense.
For tax years beginning after December 31, 1995, the Bank is permitted to
maintain a tax reserve equal to the greater of the base year reserve of the
reserve calculated using the experience method available to small (average
assets less than $500 million) commercial banks as of the year of the change.
Any excess of the reserve as of the year of the change over the allowable
reserves must be recaptured into taxable income evenly over a period of six
years beginning in the 1996 taxable year subject to the suspension rule
described below. As of September 30, 1997, the Bank has an excess amount
subject to recapture equal to $330,000.
The experience method allows an institution to maintain a bad debt reserve
equal to the ratio of the net charge-offs for the last six years divided by
total loans for those years multiplied by the total loans outstanding at the
end of the current year. However, this method permits the institution to
maintain a minimum reserve balance equal to its reserve balance at the end of
its base year, adjusted for declines in the loan portfolio for the base year.
Although deductions are allowed for the calculated addition to the bad debt
reserve, net recoveries are not taken into taxable income. The Bank is
currently using the "6-year moving average" method to calculate its bad debt
reserve. The Bank anticipates that it will continue this practice.
90
Distributions. To the extent that the Bank makes "non-dividend
distributions" to the Company that are considered as made (i) from the reserve
for losses on qualifying real property loans, to the extent the reserve for
such losses exceeds the amount that would have been allowed under the
experience method, or (ii) from the supplemental reserve for losses on loans
("Excess Distributions"), then an amount based on the amount distributed will
be included in the Bank's taxable income. Non-dividend distributions include
distributions in excess of the Bank's current and accumulated earnings and
profits, distributions in redemption of stock, and distributions in partial or
complete liquidation. However, dividends paid out of the Bank's current or
accumulated earnings and profits, as calculated for federal income tax
purposes, will not be considered to result in a distribution from the Bank's
bad debt reserve. Thus, any dividends to the Company that would reduce amounts
appropriated to the Bank's bad debt reserve and deducted for federal income
tax purposes would create a tax liability for the Bank. The amount of
additional taxable income created from an Excess Distribution is an amount
that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Thus, if the Bank makes a "non-dividend
distribution," then approximately one and one-half times the amount so used
would be includible in gross income for federal income tax purposes, assuming
a 34% corporate income tax rate (exclusive of state and local taxes). See
"Regulation" and "Dividend Policy" for limits on the payment of dividends of
the Bank. The Bank does not intend to pay dividends that would result in a
recapture of any portion of its bad debt reserve.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as
amended (the "Code"), imposes a tax on alternative minimum taxable income
("AMTI") at a rate of 20%. Only 90% of AMTI can be offset by net operating
loss carryovers of which the Bank currently has none. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current
earnings exceeds its AMTI (determined without regard to this preference and
prior to reduction for net operating losses). In addition, for taxable years
beginning after December 31, 1986 and before January 1, 1996, an environmental
tax of .12% of the excess of AMTI (with certain modifications) over $2.0
million is imposed on corporations, including the Bank, whether or not an
Alternative Minimum Tax ("AMT") is paid. The Bank does not expect to be
subject to the AMT.
Dividends Received Deduction and Other Matters. The Company may exclude from
its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction
is generally 70% in the case of dividends received from unaffiliated
corporations with which the Company and the Bank will not file a consolidated
tax return, except that if the Company or the Bank own more than 20% of the
stock of a corporation distributing a dividend then 80% of any dividends
received may be deducted.
STATE AND LOCAL TAXATION
State of California. The California franchise tax rate applicable to the
Bank equals the franchise tax rate applicable to corporations generally, plus
an "in lieu" rate approximately equal to personal property taxes and business
license taxes paid by such corporations (but not generally paid by banks or
financial corporations such as the Bank); however, the total tax rate cannot
exceed 11.3%. Under California regulations, bad debt deductions are available
in computing California franchise taxes using a three or six year weighted
average loss experience method. The Company, as a savings and loan holding
company commercially domiciled in California, will generally be treated as a
financial corporation and subject to the general corporate tax rate plus the
"in lieu" rate as discussed previously for the Bank.
State of Delaware Taxation. As a Delaware holding company not earning income
in Delaware, the Company is exempt from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
91
REGULATION
GENERAL
The Bank is subject to extensive regulation, examination and supervision by
the OTS, as its chartering agency, and the FDIC, as the insurer of the Bank's
deposit accounts. The Bank is a member of the FHLB System. The Bank's deposit
accounts are insured up to applicable limits by the SAIF managed by the FDIC.
The Bank must file reports with the OTS and the FDIC concerning its activities
and financial condition in addition to obtaining regulatory approvals prior to
entering into certain transactions such as mergers with, or acquisitions of,
other financial institutions. There are periodic examinations by the OTS and
the FDIC to test the Bank's compliance with various regulatory requirements.
This regulation and supervision establishes a comprehensive framework of
activities in which an institution can engage and is intended primarily for
the protection of the insurance fund and depositors. The regulatory structure
also gives the regulatory authorities extensive discretion in connection with
their supervisory and enforcement activities and examination policies,
including policies with respect to the classification of assets and the
establishment of adequate loan loss reserves for regulatory purposes. Any
change in such policies, whether by the OTS, the FDIC or the Congress, could
have a material adverse impact on the Company, the Bank or their operations.
The Company, as a savings and loan holding company, will also be required to
file certain reports with, and otherwise comply with the rules and regulations
of, the OTS and the SEC under the federal securities laws.
Any change in the regulatory structure or the applicable statutes or
regulations, whether by the OTS, the FDIC or the Congress, could have a
material impact on the Company, the Bank or their operations. Congress
considered in 1997 and is expected to consider again in 1998 the elimination
of the federal thrift charter and the abolition of the OTS. The results of
such consideration, including possible enactment of legislation, is uncertain.
Therefore, the Company and the Bank are unable to determine the extent to
which the results of such consideration or possible legislation, if enacted,
would affect their business. See "Risk Factors Related to the Company--
Financial Institution Regulation and Possible Legislation."
Certain of the regulatory requirements applicable to the Bank and to the
Company are referred to below or elsewhere herein. The description of
statutory provisions and regulations applicable to savings associations set
forth in this Prospectus does not purport to be complete descriptions of such
statutes and regulations and their effects on the Bank and the Company and is
qualified in its entirety by reference to such statutes and regulations.
FEDERAL SAVINGS INSTITUTION REGULATION
Business Activities. The activities of federal savings institutions are
governed by the HOLA and, in certain respects, the Federal Deposit Insurance
Act ("FDI Act") and the regulations issued by the OTS and FDIC to implement
these statutes. These laws and regulations delineate the nature and extent of
the activities in which federal associations may engage. In particular, many
types of lending authority for federal associations, e.g., commercial, non-
residential real property loans and consumer loans, are limited to a specified
percentage of the institutions's capital or assets. Specifically, commercial
loans are limited to 20% of total assets and amounts in excess of 10% of
assets may only be used for small business loans. Consumer loans are limited
to 35% of assets.
Loans-to-One Borrower. Under the HOLA, savings institutions are generally
subject to the national bank limit on loans-to-one borrower. Generally, this
limit is 15% of the Bank's unimpaired capital and surplus, plus an additional
10% of unimpaired capital and surplus, if such loan is secured by readily-
marketable collateral, which is defined to include certain financial
instruments and bullion but excludes real estate. At September 30, 1997, the
Bank's general limit on loans-to-one borrower was $2.7 million. At September
30, 1997, the Bank's largest aggregate amount of loans-to-one borrower
consisted of $778,000.
QTL Test. The HOLA requires savings institutions to meet a QTL test. Under
the QTL test, a savings association is required to maintain at least 65% of
its "portfolio assets" (total assets less: (i) specified liquid
92
assets up to 20% of total assets; (ii) intangibles, including goodwill; and
(iii) the value of property used to conduct business) in certain "qualified
thrift investments" (primarily residential mortgages and related investments,
including certain mortgage-backed and related securities and 50% of the dollar
amount of residential mortgages originated by the institution and sold within
90 days) in at least 9 months out of each 12 month period. A savings
association that fails the QTL test must either convert to a bank charter or
operate under certain restrictions. As of September 30, 1997, the Bank
maintained 99.9% of its portfolio assets in qualified thrift investments and,
therefore, met the QTL test. Recent legislation has expanded the extent to
which education loans, credit card loans and small business loans may be
considered as "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations upon
all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to
stockholders of another institution in a cash-out merger and other
distributions charged against capital. The rule establishes three tiers of
institutions, which are based primarily on an institution's capital level. An
institution that exceeds all fully phased-in regulatory capital requirements
before and after a proposed capital distribution ("Tier 1 Bank") and has not
been advised by the OTS that it is in need of more than normal supervision,
could, after prior notice to, but without the approval of the OTS, make
capital distributions during a calendar year equal to the greater of: (i) 100%
of its net earnings to date during the calendar year plus the amount that
would reduce by one-half its "surplus capital ratio" (the excess capital over
its fully phased in capital requirements) at the beginning of the calendar
year; or (ii) 75% of its net earnings for the previous four quarters. Any
additional capital distributions would require prior OTS approval. In the
event the Bank's capital fell below its capital requirements or the OTS
notified it that it was in need of more than normal supervision, the Bank's
ability to make capital distributions could be restricted. In addition, the
OTS could prohibit a proposed capital distribution by any institution, which
would otherwise be permitted by the regulation, if the OTS determines that
such distribution would constitute an unsafe or unsound practice.
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a
specified percentage (currently 4%) of its net withdrawable deposit accounts
plus short-term borrowings. Monetary penalties may be imposed for failure to
meet these liquidity requirements. The Bank's average liquidity ratio for the
nine months ended September 30, 1997 was 11.3%, which exceeded the applicable
requirements. The Bank has never been subject to monetary penalties for
failure to meet its liquidity requirements. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
Assessments. Savings institutions are required by regulation to pay
assessments to the OTS to fund the agency's operations and supervision of the
Bank. The general assessment, paid on a semi-annual basis, is based upon the
savings institution's total assets, including consolidated subsidiaries, as
reported in the Bank's latest quarterly Thrift Financial Report. The
assessments paid by the Bank for the nine months ended September 30, 1997 and
the year ended December 31, 1996 totalled $26,000 and $27,000, respectively.
Branching. OTS regulations permit federally chartered savings associations
to branch nationwide under certain conditions. Generally, federal savings
associations may establish interstate networks and geographically diversify
their loan portfolios and lines of business. The OTS authority preempts any
state law purporting to regulate branching by federal savings associations.
For a discussion of the impact of proposed legislation, see "Risk Factors
Related to the Company--Financial Institution Regulation and Possible
Legislation."
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (i.e., any company that
controls or is under common control with the Bank, including the Company and
any non-savings institution subsidiaries that the Company may establish) is
limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section
23A restricts the aggregate amount of covered transactions with any individual
affiliate to 10% of the capital and surplus of the savings institution and
also limits the aggregate amount of covered transactions with all affiliates
to 20% of the savings institution's capital and surplus. Certain transactions
with affiliates are required to be secured by collateral in an amount and of a
type described
93
in Section 23A, and the purchase of low quality assets from affiliates is
generally prohibited. Section 23B generally requires that certain transactions
with affiliates, including loans and asset purchases, must be on terms and
under circumstances, including credit standards, that are substantially the
same or at least as favorable to the institution as those prevailing at the
time for comparable transactions with non-affiliated companies.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring action
against all "institution-affiliated parties," including stockholders who
participate in the conduct of the affairs of the institution, and independent
contractors (including attorneys, appraisers and accountants) who knowingly or
recklessly participate in a wrongful action likely to have a significant
adverse effect on an insured institution. Formal enforcement action may range
from the issuance of a capital directive or cease and desist order to removal
of officers or directors, receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and can
amount to $25,000 per day, or $1 million per day in especially egregious
cases. Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS that enforcement action be taken with respect to a
particular savings institution. If action is not taken by the Director, the
FDIC has authority to take such action itself under certain circumstances.
Federal and state law also establishes criminal penalties for certain
violations.
Standards for Safety and Soundness. The FDI Act requires each federal
banking agency to prescribe for all insured depository institutions standards
relating to, among other things, internal controls, information systems and
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, and compensation, fees and benefits and such other
operational and managerial standards as the agency deems appropriate. The
federal banking agencies have adopted final regulations and Interagency
Guidelines Establishing Standards for Safety and Soundness ("Guidelines") to
implement these safety and soundness standards. The Guidelines set forth the
safety and soundness standards that the federal banking agencies use to
identify and address problems at insured depository institutions before
capital becomes impaired. The Guidelines address internal controls and
information systems; internal audit system; credit underwriting; loan
documentation; interest rate risk exposure; asset growth; asset quality;
earnings; and compensation, fees and benefits. If the appropriate federal
banking agency determines that an institution fails to meet any standard
prescribed by the Guidelines, the agency may require the institution to submit
to the agency an acceptable plan to achieve compliance with the standard, as
required by the FDI Act. The final regulations establish deadlines for the
submission and review of such safety and soundness compliance plans.
Capital Requirements. The OTS capital regulations require savings
institutions to meet three capital standards: a 1.5% tangible capital
standard, a 3% leverage (core capital) ratio and an 8% risk based capital
standard. Core capital is defined as common stockholder's equity (including
retained earnings), certain non-cumulative perpetual preferred stock and
related surplus and minority interests in equity accounts of consolidated
subsidiaries less intangibles other than certain mortgage servicing rights and
credit card relationships. The OTS regulations require that, in meeting the
leverage ratio, tangible and risk-based capital standards institutions
generally must deduct investments in and loans to subsidiaries engaged in
activities not permissible for a national bank. In addition, the OTS prompt
corrective action regulation provides that a savings institution that has a
leverage capital ratio of less than 4% (3% for institutions receiving the
highest CAMEL examination rating) will be deemed to be "undercapitalized" and
will be subject to certain restrictions. See "--Prompt Corrective Regulatory
Action."
The risk-based capital standard for savings institutions requires the
maintenance of a ratio of total capital (which is defined as core capital plus
supplementary capital) to risk-weighted assets of 8%. In determining the
amount of risk-weighted assets, all assets, including certain off-balance
sheet assets, are multiplied by a risk-weight of 0% to 100%, as assigned by
the OTS capital regulation based on the risks the OTS believes are inherent in
the type of asset. The components of core capital are equivalent to those
discussed earlier under the 3% leverage standard. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate term
94
preferred stock and, within specified limits, the general allowance for loan
and lease losses. Overall, the amount of supplementary capital included as
part of total capital cannot exceed 100% of core capital.
The OTS has incorporated an interest rate risk component into its regulatory
capital rule. The final interest rate risk rule also adjusts the risk-
weighting for certain mortgage derivative securities. Under the rule, savings
associations with "above normal" interest rate risk exposure would be subject
to a deduction from total capital for purposes of calculating their risk-based
capital requirements. A savings association's interest rate risk is measured
by the decline in the net portfolio value of its assets (i.e., the difference
between incoming and outgoing discounted cash flows from assets, liabilities
and off-balance sheet contracts) that would result from a hypothetical 200-
basis point increase or decrease in market interest rates, divided by the
estimated economic value of the association's assets, as calculated in
accordance with guidelines set forth by the OTS. A savings association whose
measured interest rate risk exposure exceeds 2% must deduct an interest rate
component in calculating its total capital under the risk-based capital rule.
The interest rate risk component is an amount equal to one-half of the
difference between the institution's measured interest rate risk and 2%,
multiplied by the estimated economic value of the association's assets. That
dollar amount is deducted from an association's total capital in calculating
compliance with its risk-based capital requirement. Under the rule, there is a
two quarter lag between the reporting date of an institution's financial data
and the effective date for the new capital requirement based on that data. A
savings association with assets of less than $300 million and risk-based
capital ratios in excess of 12% is not subject to the interest rate risk
component, unless the OTS determines otherwise. The rule also provides that
the Director of the OTS may waive or defer an association's interest rate risk
component on a case-by-case basis. The OTS has postponed indefinitely the date
that the component will first be deducted from an institution's total capital.
At September 30, 1997, the Bank met each of its capital requirements. Due to
the fluctuations in the Bank's total assets as a result of its mortgage
banking operations, the Bank has been required by the OTS since the Bank's
examination completed August 9, 1996 to compute its regulatory capital ratios
based upon the higher of (1) the average of total assets based on month-end
results; or (2) total assets as of the quarter end. Total assets at the end of
the quarter ended September 30, 1997 were lower than the month end averages,
and therefore the OTS capital averaging requirement was applied. See
"Capitalization" for a table which sets forth in terms of dollars and
percentages the OTS tangible, leverage and risk-based capital requirements,
the Bank's historical capital and percentages at September 30, 1997 and pro
forma capitalization of the Company upon the issuance of the Capital
Securities.
PROMPT CORRECTIVE REGULATORY ACTION
Under the OTS prompt corrective action regulations, the OTS is required to
take certain supervisory actions against undercapitalized institutions, the
severity of which depends upon the institution's degree of
undercapitalization. Generally, a savings institution that has a total risk-
based capital of less than 8.0% or a leverage ratio or a Tier 1 capital ratio
that is less than 4.0% is considered to be undercapitalized (Tier 1 capital is
equivalent to core capital). A savings institution that has a total risk-based
capital ratio less than 6.0%, a Tier 1 risk-based capital ratio of less than
3.0% or a leverage ratio that is less than 3.0% is considered to be
"significantly undercapitalized" and a savings institution that has a tangible
capital to assets ratio equal to or less than 2.0% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the banking regulator is
required to appoint a receiver or conservator for an institution that is
critically undercapitalized. The regulation also provides that a capital
restoration plan must be filed with the OTS within 45 days of the date an
association receives notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." Compliance with the plan
must be guaranteed by each parent holding company, subject to an aggregate
limit on liability. In addition, numerous mandatory supervisory actions may
become immediately applicable to the institution depending upon its category,
including, but not limited to, increased monitoring by regulators,
restrictions on growth, and capital distributions and limitations on
expansion. The OTS could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
95
INSURANCE OF DEPOSIT ACCOUNTS
Deposits of the Bank are presently insured by the SAIF. Both the SAIF and
the BIF (the deposit insurance fund that covers most commercial bank deposits)
are statutorily required to be recapitalized to a 1.25% of insured reserve
deposits ratio. Until recently, members of the SAIF and BIF were paying
average deposit insurance premiums of between 24 and 25 basis points. The BIF
met the required reserve in 1995, whereas the SAIF was not expected to meet or
exceed the required level until 2002 at the earliest. This situation was
primarily due to the statutory requirement that SAIF members make payments on
bonds issued in the late 1980s by the Financing Corporation ("FICO") to
recapitalize the predecessor to the SAIF.
In view of the BIF's achieving the 1.25% ratio, the FDIC ultimately adopted
a new assessment rate schedule of from 0 to 27 basis points under which 92% of
BIF members paid an annual premium of only $2,000. With respect to SAIF member
institutions, the FDIC adopted a final rule retaining the previously existing
assessment rate schedule applicable to SAIF member institutions of 23 to 31
basis points. As long as the premium differential continued, it could have had
adverse consequences for SAIF members, including reduced earnings and an
impaired ability to raise funds in the capital markets. In addition, SAIF
members such as the Bank could have been placed at a substantial competitive
disadvantage to BIF members with respect to pricing of loans and deposits and
the ability to achieve lower operating costs.
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 (the "Funds Act") which, among other things, imposed a
special one-time assessment on SAIF member institutions, including the Bank,
to recapitalize the SAIF. As required by the Funds Act, the FDIC imposed a
special assessment of 65.7 basis points on SAIF assessable deposits held as of
March 31, 1995, payable November 27, 1996 (the "SAIF Special Assessment"). The
SAIF Special Assessment was recognized by the Bank as an expense in the
quarter ended September 30, 1996 and is generally tax deductible. The SAIF
Special Assessment recorded by the Bank amounted to $448,000 on a pre-tax
basis and $256,000 on an after-tax basis.
The Funds Act also spreads the obligations for payment of the FICO bonds
across all SAIF and BIF members. Beginning on January 1, 1997, BIF deposits
will be assessed for FICO payment at a rate of 1.3 basis points, while SAIF
deposits will pay 6.48 basis points. Full pro rata sharing of the FICO
payments between BIF and SAIF members will occur on the earlier of January 1,
2000 or the date the BIF and SAIF are merged. The Funds Act specifies that the
BIF and SAIF will be merged on January 1, 1999, provided no savings
associations remain as of that time.
As a result of the Funds Act, the FDIC voted to lower SAIF assessments to 0
to 27 basis points as of January 1, 1997, a range comparable to that of BIF
members and subsequently voted to maintain the same rate range for the second
half of 1997. However, SAIF members will continue to make the FICO payments
described above. The FDIC also lowered the SAIF assessment schedule for the
fourth quarter of 1996 to 18 to 27 basis points. Management cannot predict the
level of FDIC insurance assessments on an on-going basis, whether the savings
association charter will be eliminated or whether the BIF and SAIF will
eventually be merged.
The Bank's assessment rate for the nine months ended September 30, 1997 and
the year ended December 31, 1996 was 9 and 26 basis points, respectively, and
the premium paid for these periods was $69,000 and $622,000 (including the
SAIF Special Assessment), respectively. A significant increase in SAIF
insurance premiums would likely have an adverse effect on the operating
expenses and results of operations of the Bank.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon
a finding that the institution has engaged in unsafe or unsound practices, is
in an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or
the OTS. The management of the Bank does not know of any practice, condition
or violation that might lead to termination of deposit insurance.
96
THRIFT RECHARTERING LEGISLATION
The Funds Act provides that the BIF and SAIF will merge on January 1, 1999 if
there are no more savings associations as of that date. That legislation also
requires that the Department of Treasury submit a report to Congress by March
31, 1999 that makes recommendations regarding a common financial institutions
charter, including whether the separate charters for thrifts and banks should
be abolished. Various proposals to eliminate the federal thrift charter, create
a uniform financial institutions charter and abolish the OTS have been
introduced in the Congress. However, the Bank is unable to predict whether such
legislation would be enacted and, if so, the extent to which the legislation
would restrict the Bank's ability to engage in certain activities or otherwise
disrupt its operations.
TRUTH IN LENDING
The Truth in Lending Act ("TILA") and Regulation Z promulgated thereunder
requires lenders, such as the Bank, to provide a disclosure statement to
borrowers which explains the terms and cost of credit, including, but not
limited to, the amount financed, finance charges, other charges and prepayment
terms. Regulation Z applies to a wide variety of lending transactions,
including mortgage loans and credit cards. The TILA provides borrowers with a
three day right to cancel certain credit transactions, including certain
residential mortgage loans and other loans where a customer pledges his or her
principal dwelling as security for the loan. Failure to comply with the
provisions of the TILA could subject a lender to criminal and civil sanctions.
The TILA was amended effective October 1, 1995 to impose new disclosure
requirements and substantive limitations on closed-end home equity mortgage
loans bearing rates or fees above a certain percentage or amount ("TILA
Amendments"). Specifically, the TILA Amendments apply to loans secured by a
customer's principal dwelling (other than a residential mortgage loan to
acquire or construct a borrower's principal dwelling, a reverse mortgage
transaction or home equity lines of credit) with (i) an annual percentage rate
which exceeds by more than ten percentage points the yield on U.S. Treasury
securities having comparable periods of maturity; or (ii) total loan
origination fees and other fees payable by the customer which exceed the
greater of 8% of the loan amount or $400 ("Covered Loans"). Additional
disclosures are required to be provided to the customer under the TILA
Amendments for all Covered Loans not less than three business days prior to the
consummation of the transaction.
OTHER LENDING LAWS
The Bank is also required to comply with the Equal Credit Opportunity Act of
1974, as amended ("ECOA"), which prohibits creditors from discriminating
against applicants on certain prohibited bases, including race, color,
religion, national origin, sex, age or marital status. Regulation B promulgated
under ECOA restricts creditors from obtaining certain types of information from
loan applicants. Among other things, it also requires certain disclosures by
the lender regarding consumer rights and requires lenders to advise applicants
of the reasons for any credit denial. In instances where the applicant is
denied credit or the rate or charge for loans increases as a result of
information obtained from a consumer credit agency, another statute, the Fair
Credit Reporting Act of 1970, as amended, requires lenders to supply the
applicant with the name and address of the reporting agency. In addition, the
Bank is subject to the Fair Housing Act and regulations thereunder, which
broadly prohibit certain discriminatory practices in connection with the Bank's
business. The Bank is also subject to the RESPA and the Home Mortgage
Disclosure Act.
In addition, the Bank is subject to various other Federal and state laws,
rules and regulations governing, among other things, procedures which must be
followed by mortgage lenders and servicers, and disclosures which must be made
to consumer borrowers. Failure to comply with such laws, as well as with the
laws described above, may result in civil and criminal liability.
97
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB System, which consists of 12 regional
FHLBs. The FHLB provides a central credit facility primarily for member
institutions. The Bank, as a member of the FHLB, is required to acquire and
hold shares of capital stock in the FHLB in an amount at least equal to 1% of
the aggregate principal amount of its unpaid residential mortgage loans and
similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB, whichever is greater. The Bank was in compliance
with this requirement with an investment in FHLB stock at September 30, 1997
of $1.1 million. FHLB advances must be secured by specified types of
collateral and all long-term advances may only be obtained for the purpose of
providing funds for residential housing finance. At September 30, 1997, the
Bank had $6.9 million in outstanding FHLB advances.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest
on advances to their members. For the years ended December 31, 1996, 1995 and
1994, dividends from the FHLB to the Bank amounted to $34,000, $30,000 and
$20,000, respectively. If dividends were reduced, the Bank's net interest
income would likely also be reduced. Further, there can be no assurance that
the impact of recent or future legislation on the FHLBs will not also cause a
decrease in the value of the FHLB stock held by the Bank.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to
maintain non-interest-earning reserves against their transaction accounts. The
Federal Reserve Board regulations generally require that reserves be
maintained against aggregate transaction accounts as follows: for accounts
aggregating $49.3 million or less (subject to adjustment by the Federal
Reserve Board) the reserve requirement is 3%; and for accounts greater than
$49.3 million, the reserve requirement is $1.5 million plus 10% (subject to
adjustment by the Federal Reserve Board between 8% and 14%) against that
portion of total transaction accounts in excess of $49.3 million. Effective
December 16, 1997, the Federal Reserve Board has reduced the amount of
transaction accounts subject to the 3% ratio from $49.3 million to $47.8
million and increased from $4.4 million to $4.7 million the amount of
reservable liabilities that is exempted from reserve requirements. The Bank is
in compliance with the foregoing requirements. Because required reserves must
be maintained in the form of either vault cash, a non-interest-bearing account
at a Federal Reserve Bank or a pass-through account as defined by the Federal
Reserve Board, the effect of this reserve requirement is to reduce the Bank's
interest-earning assets. FHLB System members are also authorized to borrow
from the Federal Reserve "discount window," but Federal Reserve Board
regulations require institutions to exhaust all FHLB sources before borrowing
from a Federal Reserve Bank.
HOLDING COMPANY REGULATION
The Company is a non-diversified unitary savings and loan holding company
within the meaning of the HOLA. As such, the Company is registered with the
OTS and is subject to OTS regulations, examinations, supervision and reporting
requirements. In addition, the OTS has enforcement authority over the Company
and its non-savings institution subsidiaries. Among other things, this
authority permits the OTS to restrict or prohibit activities that are
determined to be a serious risk to the subsidiary savings institution. The
Bank must notify the OTS 30 days before declaring any dividend to the Company.
As a unitary savings and loan holding company, the Company generally is not
restricted under existing laws as to the types of business activities in which
it may engage, provided that the Bank continues to be a QTL. See "--Federal
Savings Institution Regulation--QTL Test" for a discussion of the QTL
requirements. Upon any non-supervisory acquisition by the Company of another
savings association, the Company would become a
98
multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would be subject to extensive limitations on the
types of business activities in which it could engage. The HOLA limits the
activities of a multiple savings and loan holding company and its non-insured
institution subsidiaries primarily to activities permissible for bank holding
companies under Section 4(c)(8) of the Bank Holding Company ("BHC") Act,
subject to the prior approval of the OTS, and to other activities authorized
by OTS regulation. Proposed legislation would treat all savings and loan
holding companies as bank holding companies and limit, with narrow
"grandfather" rights for existing savings and loan holding companies such as
the Company, the activities of such companies to those permissible for bank
holding companies. See "Risk Factors Related to the Company--Financial
Institution Regulation and Possible Legislation."
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5%
of the voting stock of another savings institution, or holding company
thereof, without prior written approval of the OTS; from acquiring or
retaining, with certain exceptions, more than 5% of a non-subsidiary holding
company or savings association; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS
must consider the financial and managerial resources and future prospects of
the company and institution involved, the effect of the acquisition on the
risk to the insurance funds, the convenience and needs of the community and
competitive factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, except: (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies, and (ii) the acquisition
of a savings institution in another state if the laws of the state of the
target savings institution specifically permit such acquisitions. The states
vary in the extent to which they permit interstate savings and loan holding
company acquisitions.
FEDERAL SECURITIES LAWS
The Company's Common Stock is registered with the SEC under the Exchange
Act. The Company is subject to the information, proxy solicitation, insider
trading restrictions and other requirements under the Exchange Act.
Shares held by affiliates of the Company are subject to the resale
restrictions of Rule 144 under the Securities Act. If the Company meets the
current public information requirements of Rule 144 under the Securities Act,
each affiliate of the Company who complies with the other conditions of Rule
144 (including those that require the affiliate's sale to be aggregated with
those of certain other persons) would be able to sell in the public market,
without registration, a number of shares not to exceed, in any three-month
period, the greater of (i) 1% of the outstanding shares of the Company or (ii)
the average weekly volume of trading in such shares during the preceding four
calendar weeks. Provision may be made in the future by the Company to permit
affiliates to have their shares registered for sale under the Securities Act
under certain circumstances.
99
THE BOARD OF DIRECTORS AND MANAGEMENT OF THE COMPANY
The following table sets forth certain information regarding executive
officers and directors of the Company.
NAME AGE(1) POSITION(S) HELD WITH COMPANY
---- ----- -----------------------------
Daniel L. Perl 48 Director, President and Chief
Executive Officer
L. Bruce Mills, Jr. 40 Executive Vice President, Chief
Financial
Officer and Corporate Secretary
Ronald G. Skipper 56 Chairman of the Board
Richard C. Caldwell 56 Director
John D. Goddard 58 Director
Milton E. Johnson 60 Director
Robert K. Riley 36 Director
- --------
(1)As of September 30, 1997.
BIOGRAPHICAL INFORMATION
Daniel L. Perl joined the Bank in 1994 as the Senior Vice President and
Chief Loan Officer. Mr. Perl was recently promoted to the position of
President and Chief Executive Officer of the Bank. Mr. Perl has over twenty
years of continuous experience in real estate finance. Prior to joining the
Bank, Mr. Perl served in management positions with various mortgage finance
companies and banking institutions. From 1991 to 1993, Mr. Perl was a Senior
Vice President with WCP Trading Corporation.
L. Bruce Mills, Jr. joined the Bank in 1987 as the Chief Financial Officer.
Mr. Mills currently serves as the Executive Vice President and Chief Financial
Officer of the Bank. Prior to joining the Bank, Mr. Mills served as an
examiner with the Federal Home Loan Bank of San Francisco.
Ronald G. Skipper is the Chairman of the Board of the Company and has served
as a Director of the Bank since 1983. Mr. Skipper is a self-employed attorney
and has been practicing law for 31 years.
Richard C. Caldwell is the Chairman of the Board of the Bank. Mr. Caldwell
was elected to the Board of Directors of the Bank in 1983 and has served as
Chairman of the Board since 1983. Mr. Caldwell has been a partner of Caldwell
& Moreland Insurance Brokers since 1995. From 1982 to 1995, Mr. Caldwell has
been President and sole owner of Caldwell & Hunt Insurance Brokers.
John D. Goddard has served as a Director of the Bank since 1988. Mr. Goddard
is a Certified Public Accountant. Mr. Goddard has been President of Goddard
Accountancy Corporation since 1962.
Milton E. Johnson has served as a Director of the Bank since 1983. Mr.
Johnson has been the President of Home Lumber Company, a building materials
supplier, since 1960. In addition, Mr. Johnson has been a partner in Central
Nevada Hay Company since 1987.
Robert K. Riley became a member of the Board following the Reorganization.
Mr. Riley is the co-founder and Chief Executive Officer of Millenium Asset
Management, L.L.C., an SEC-registered investment advisory firm, and also
serves on the Board of Directors of MBIC, an American subsidiary of a large
Belgian bank. From 1992 to 1996, Mr. Riley worked for the Millenium Group, a
consulting firm focused on designing asset securitization systems and
developing risk management programs for European banks.
The Board of Directors of the Company is divided into three classes, each of
which contains approximately one-third of the Board. The directors shall be
elected by the stockholders of the Company for staggered three year terms, or
until their successors are elected and qualified. One class of directors,
consisting of Messrs.
100
Richard C. Caldwell and Milton E. Johnson, has a term of office expiring at
the first annual meeting of stockholders; a second class, consisting of
Messrs. Ronald G. Skipper and Daniel L. Perl, has a term of office expiring at
the second annual meeting of stockholders; and a third class, consisting of
Messrs. John D. Goddard and Robert K. Riley, has a term of office expiring at
the third annual meeting of stockholders.
The officers of the Company are elected annually and hold office until their
respective successors have been elected and qualified or until death,
resignation or removal by the Board of Directors. Since the formation of the
Company, none of the executive officers or other personnel has received
remuneration from the Company.
COMMITTEES OF THE BOARD OF DIRECTORS OF THE COMPANY
The Company has established an Audit Committee consisting of Messrs.
Skipper, Caldwell and Goddard and a Personnel/Compensation Committee
consisting of Messrs. Skipper, Goddard and Johnson.
DIRECTORS' COMPENSATION
The directors of the Company who are not also employees of the Company
receive a monthly retainer for acting in such capacity. The monthly retainer
for the Chairman of the Board of the Company is $2,000 while the fee for other
non-employee directors of the Company is $1,500. In addition, each non-
employee director received fees for each month preceding the Reorganization
starting with February 1997 for services performed on behalf of the Company.
101
THE BOARD OF DIRECTORS AND MANAGEMENT OF THE BANK
DIRECTORS
The following table sets forth certain information regarding the Board of
Directors of the Bank.
DIRECTOR TERM
NAME AGE(1) POSITION(S) HELD WITH THE BANK SINCE EXPIRES
---- ------ ------------------------------ -------- -------
Richard C. Caldwell 56 Chairman of the Board 1983 2000
Director, President and Chief
Daniel L. Perl(2) 48 Executive Officer 1996 2000
John D. Goddard 58 Director 1988 1999
Milton E. Johnson 60 Director 1983 1997
Edgar C. Keller 76 Director 1983 1999
Ronald G. Skipper 56 Director 1983 1998
- --------
(1) As of September 30, 1997.
(2) Mr. Perl was elected by the Board of Directors to fill the vacancy created
by the resignation of a director in June 1996.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following table sets forth certain information regarding the executive
officers of the Bank who are not also directors.
NAME AGE(1) POSITION(S) HELD WITH THE BANK
---- ----- -------------------------------------------------
L. Bruce Mills, Jr. 40 Executive Vice President, Secretary and Treasurer
Joseph R.L. Passerino 42 Senior Vice President
Mary E. Darter 37 Executive Vice President
- --------
(1) As of September 30, 1997.
BIOGRAPHICAL INFORMATION
DIRECTORS AND EXECUTIVE OFFICERS OF THE BANK WHO ARE NOT DIRECTORS AND
EXECUTIVE OFFICERS OF THE COMPANY
Edgar C. Keller has been a Director of the Bank since 1983. Mr. Keller was a
partner with the law firm of Keller & Holt from 1963 until 1994. After such
time, Mr. Keller was a partner with the law firm of Keller & Keller until his
retirement in 1996.
Joseph R. L. Passerino joined the Bank in February 1994. He was named senior
vice president in September 1996 and is responsible for all loans originated
by the Bank nationally. Prior to that, from 1988 to 1994, Mr. Passerino was in
charge of loan production for St. Thomas Capital Corp.
Mary E. Darter joined the Bank in March 1994. She was named executive vice
president in October 1997. Ms. Darter is primarily responsible for mortgage
financing operations. Prior to joining the Bank, Ms. Darter was employed by
Imperial Credit Industries/Southern Pacific Thrift and Loan from 1991 to 1994
in charge of the warehouse line of credit division and bulk acquisitions.
102
COMMITTEES AND MEETINGS OF THE BOARD OF DIRECTORS OF THE BANK
The Board of Directors meets on a monthly basis and may have additional
special meetings upon the request of the Chairman of the Board. During the
year ended December 31, 1996, the Board of Directors had 12 regular meetings
and 6 special meetings. No director attended fewer than 75% of the total
number of Board meetings held during this period.
The Board of Directors of the Bank has established the following Board and
management committees:
The Audit Committee consists of Messrs. Keller and Goddard. The Bank's
Internal Auditors report to this committee. The purpose of this committee is
to review the audit function and management actions regarding the
implementation of audit findings. The committee also maintains a liaison with
the outside auditors and reviews the adequacy of internal controls. The
committee meets quarterly or as necessary.
The Loan Committee consists of Messrs. Skipper, Caldwell, Johnson and Perl.
This Committee exercises the authority of the Board pertaining to loan matters
and approves or rejects all loans presented by management. This Committee also
reviews the workout solutions of problem loans, and approves the
classification of assets and the establishment of adequate valuation
allowances. The Committee meets monthly.
The Executive Committee consists of Messrs. Caldwell, Goddard and Skipper.
This committee exercises the authority of the Board of Directors with respect
to matters requiring action between meetings of the Board of Directors. Any
actions by this committee require subsequent ratification by the Board of
Directors at the next regular meeting. The Executive Committee meets as
needed.
The Investment Committee consists of Messrs. Goddard, Caldwell, Johnson and
Mills. The purpose of this committee is to adopt and maintain policies
regarding the investment portfolio and to monitor the interest rate and the
credit risks of liquidity portfolio investments. This committee meets semi-
annually or as needed.
The Personnel/Compensation Committee consists of Messrs. Keller, Johnson,
Caldwell and Goddard. This Committee is responsible for all matters regarding
compensation and benefits, hiring, termination and affirmative action issues.
The committee meets semi-annually or as needed.
The Asset Classification Committee consists of Messrs. Mills and Perl. The
purpose of this committee is to review the Bank's loan portfolio and monitor
the classification of assets. This committee meets quarterly.
The Bank also maintains a Budget Committee consisting of Messrs. Caldwell,
Goddard and Mills.
DIRECTORS' COMPENSATION
Directors' Fees. Directors of the Bank who are not also employees of the
Bank receive a retainer of $950 per month for serving on the Bank's Board of
Directors except the Chairman of the Board who receives $1200 per month.
103
EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth, for the year
ended December 31, 1996, the cash compensation paid by the Bank, as well as
certain other compensation paid or accrued for those years, to the chief
executive officer, the former chief executive officer and the other most
highly compensated executive officer of the Bank whose salary and bonus
exceeded $100,000 in fiscal year 1996 (the "Named Executive Officers").
LONG-TERM COMPENSATION
------------------------------
COMPENSATION AWARDS PAYOUTS
------------------------------------ ---------------------- -------
RESTRICTED SECURITIES
OTHER STOCK UNDERLYING LTIP ALL OTHER
NAME AND PRINCIPAL COMPENSATION AWARDS OPTIONS PAYOUTS COMPENSATION
POSITIONS(1) YEAR SALARY($) BONUS($) ($) ($) (#) ($) ($)
------------------ ---- --------- ---------- ------------ ---------- ----------- ------- ------------
Daniel L. Perl
President and Chief
Executive Officer 1996 $75,000 $1,464,374(2) $ -- $ -- 192,960 $ -- $2,370(3)
Nora Vineyard
Former President and
Chief Executive
Officer 1996 76,083 -- -- -- -- -- 88,300(4)
Joseph R.L. Passerino
Senior Vice President 1996 29,000 217,199 -- -- 12,540 -- 2,300(3)
- --------
(1) Ms. Vineyard retired from the position of President and Chief Executive
Officer in July 1996 at which time Mr. Perl was elected to fill these
positions.
(2) Includes $1,079,185 earned by Mr. Perl during 1996 which was paid in 1997.
See "--Previous Employment Agreement."
(3) Represents amount contributed by the Bank pursuant to the Bank's 401(k)
Plan.
(4) Includes $500 contributed by the Bank pursuant to the Bank's 401(k) Plan.
Also includes a cash payment of $60,000 plus title to a 1996 automobile
with a market value of $27,800 pursuant to an agreement reached between
Mrs. Vineyard and the Bank upon her retirement from her position with the
Bank. See "--Consultation Agreement."
EMPLOYMENT AGREEMENTS
Upon the consummation of the Reorganization and the IPO, the Bank and the
Company entered into employment agreements (collectively, the "Employment
Agreements") with Mr. Perl. The Employment Agreements are intended to ensure
that the Bank and the Company will be able to maintain a stable and competent
management base after the IPO. The continued success of the Bank and the
Company depends to a significant degree on the skills and competence of Mr.
Perl.
The Employment Agreements provide for three-year terms for Mr. Perl. The
Bank Employment Agreement provides that, commencing on the first anniversary
date and continuing each anniversary date thereafter, the Board of Directors
may extend the agreement for an additional year so that the remaining term
shall be three years, unless written notice of non-renewal is given by the
Board of Directors after conducting a performance evaluation of Mr. Perl. The
term of the Company Employment Agreement shall be extended on a daily basis
unless written notice of non-renewal is given by the Board of the Company. The
Bank and Company Employment Agreements provide that Mr. Perl's salary will be
reviewed annually. The Bank Employment Agreement provides that Mr. Perl will
receive a Base Salary of $150,000 per year while the Company Employment
Agreement provides that he will receive a Base Salary of $250,000 per year
(together, the "Base Salary"), plus a bonus equal to 8.0% of the average of
the after tax net income of the Company in excess of 10% return on average
equity, as defined in the Employment Agreements ("Bonus"). Such Base Salary is
pro rated between the Bank and the Company depending upon the duties performed
for and the obligations to each
104
of the Bank and the Company, respectively, while the Bonus shall be paid by
the Company. The Bonus for each year shall be payable by the Company no later
than March 15 of the following year. In addition to the Base Salary and Bonus,
the Employment Agreements provide for, among other things, participation in
stock benefits plans and other fringe benefits substantially equivalent to
those in which Mr. Perl was participating or otherwise deriving benefit from
immediately prior to the beginning of the terms of the Employment Agreements.
The Employment Agreements provide for termination by the Bank or the Company
for cause as defined in the Employment Agreements at any time. In the event
the Bank or the Company chooses to terminate Mr. Perl's employment for reasons
other than for cause, or in the event of Mr. Perl's resignation from the Bank
or the Company upon: (i) failure to re-elect Mr. Perl to his current offices;
(ii) a material change in Mr. Perl's functions, duties or responsibilities;
(iii) a relocation of Mr. Perl's principal place of employment by more than 30
miles; (iv) a material reduction in the benefits or perquisites to Mr. Perl
from those being provided at the effective date of the Employment Agreement,
unless consented to by Mr. Perl or such reduction is part of a
nondiscriminatory reduction applicable to all employees; (v) liquidation or
dissolution of the Bank or the Company; or (vi) a breach of the Employment
Agreement by the Bank or the Company, Mr. Perl or, in the event of death, his
beneficiary would be entitled to receive, pursuant to the Bank Employment
Agreement, those payments due to Mr. Perl for the remaining term of the
Employment Agreement or, pursuant to the Company Employment Agreement, an
amount equal to three times his Base Salary under that Employment Agreement
for the preceding year plus two times his Bonus for the preceding year;
provided, however, that in the event that the Boards of Directors determine
that such payment would have a material adverse affect on the Company's
financial condition or results of operations, then the Company and the Bank
shall pay Mr. Perl two times the previous year's Base Salary under that
Employment Agreement, Common Stock of the Company having a fair market value
equal to one times the previous year's Base Salary under that Employment
Agreement and two times the previous year's Bonus. In the event that Mr. Perl
is terminated without cause during 1997, he will be entitled to two times Base
Salary and a Bonus equal to $2.2 million. The Bank and the Company would also
continue to pay for Mr. Perl's life, health, dental and disability coverage
for the remaining term of the Employment Agreement. Under certain
circumstances, upon any termination of Mr. Perl, he is subject to a non-
compete and liquidated damages provision and a confidentiality provision
relating to information in his possession regarding the Company or the Bank.
In the event that Mr. Perl thereafter breaches the non-compete provision, the
Employment Agreements provide that he shall pay the Bank and the Company, in
the aggregate, $500,000, as liquidated damages, in which event the non-compete
provision will expire.
Under the Employment Agreements, if voluntary or involuntary termination
follows a change in control of the Bank or the Company, Mr. Perl or, in the
event of his death, his beneficiary, would be entitled to a severance payment
equal to the greater of: (i) the payments due for the remaining terms of the
agreement; or (ii) three times the average of the five preceding taxable
years' annual compensation. The Bank and the Company would also continue Mr.
Perl's life, health, and disability coverage for thirty-six months.
Payments to Mr. Perl under the Bank's Employment Agreement are guaranteed by
the Company in the event that payments or benefits are not paid by the Bank.
In the event the Bank is not in compliance with its minimum capital
requirements or if any payment under the Bank Employment Agreement would cause
the Bank's capital to be reduced below minimum regulatory capital
requirements, such payments shall be deferred until such time as the Bank or
Successor thereto is in capital compliance. Payment under the Company's
Employment Agreement would be made by the Company. All reasonable costs and
legal fees paid or incurred by Mr. Perl pursuant to any dispute or question of
interpretation relating to the Employment Agreements shall be paid by the Bank
or Company, respectively, if Mr. Perl is successful on the merits pursuant to
a legal judgment, arbitration or settlement. The Employment Agreements also
provide that the Bank and Company shall indemnify Mr. Perl to the fullest
extent allowable under federal and Delaware law, respectively. In the event of
a change in control of the Bank or the Company during 1997, the total amount
of payments due under the Agreements, based on Base Salary to be paid to Mr.
Perl and Bonus would be $3.0 million.
CONSULTATION AGREEMENT
The Bank entered into a five year consulting agreement with Mrs. Nora L.
Vineyard commencing on July 15, 1996 (the "Agreement"). Mrs. Vineyard will
receive compensation in the amount of $120,000 for a
105
period of three years and $90,000 for the remaining two years of the
Agreement. The Agreement provides Mrs. Vineyard with medical insurance during
the term of the Agreement. Pursuant to the terms of the Agreement, Mrs.
Vineyard will be available to provide advisory and consulting services and
will give the Company and the Bank the benefit of her special knowledge,
skills, contacts and business experience. A portion of the future payments due
pursuant to this Agreement were accrued and expensed during the year ended
December 31, 1996. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Comparison of Operating Results for the
Year Ended December 31, 1996 and December 31, 1995."
BENEFITS
Insurance Plans. All full-time employees are covered as a group for
comprehensive hospitalization, including major medical, long-term disability,
accidental death and dismemberment insurance and group term life insurance.
Cash Bonus Plan. The Bank adopted a cash bonus plan (the "Bonus Plan")
effective February 1996. All employees except for commissioned employees and
employees with employment contracts are eligible to participate. The Bonus
Plan paid an aggregate of approximately $100,000 in 1996. For 1997, the Bonus
Plan will pay bonuses in the aggregate of 15% of the after tax profits of the
Bank in excess of a 15% return on average equity, as defined in the Bonus
Plan.
401(k) Plan. The Bank maintains the Life Savings Bank Employee's Savings
Plan ("401(k) Plan"), a tax-qualified cash or deferred arrangement (i.e.,
401(k) feature), under Section 401(a) of the Code. The 401(k) Plan provides
participants with benefits upon retirement, death, disability or termination
of employment with the Bank. Employees are eligible to participate in the plan
following the completion of 6 months of service with the Bank and the
attainment of age 21.
Participants may authorize the Bank to contribute to the 401(k) Plan, on
their behalf, from 1% to 15% of their compensation, not to exceed certain
legally permissible limits, including an overall dollar limit of $9,500 for
1997. The 401(k) Plan provides for discretionary matching and profit sharing
contributions by the Bank. The Bank currently matches 25% of the first 8% of
the deferral by a Participant under the 401(k) Plan each year. Each plan year,
the Bank may also make an additional contribution to the 401(k) Plan (a
"profit sharing contribution"). The profit sharing contribution, if made by
the Bank, is allocated to each Participant's account based on the
Participant's compensation for the year relative to the compensation of all
participants for the year.
Participants are always 100% vested in their deferral contributions.
Participants become 20% vested in the Bank's matching contributions and profit
sharing contributions after the completion of two year of service with the
Bank. Their vested interest in the matching contributions and profit sharing
contributions increases by 20% for each year of service completed, so that
after the completion of 6 years of service, the Participant is 100% vested in
the Bank's matching contributions and profit sharing contributions.
A Participant's vested portion of his or her 401(k) Plan account is
distributable from the 401(k) Plan upon termination of the participant's
employment, death, disability or retirement. Participants may also receive
hardship distributions and loans from the 401(k) Plan. Any distribution made
to a Participant prior to the Participant's attainment of age 59 1/2 is
subject to a 10% tax penalty. The Board of Directors may at any time
discontinue the Bank's contributions to employee accounts. For the years ended
December 31, 1996, 1995 and 1994, the Bank's matching contributions to the
401(k) Plan were $21,000, zero and $7,000 respectively.
The 401(k) Plan permits Participants to direct the investment of their
401(k) plan account into various investment alternatives. The investment
accounts are valued daily and participants are provided with information
regarding the market value of the participant's investments and all
contributions made on his or her behalf on at least an annual basis. The Bank
is in the process of amending the 401(k) Plan to permit Participants to invest
in an Employer Stock Fund as one of the investment alternatives. The Employer
Stock Fund will be invested primarily in shares of Common Stock.
106
Employee Stock Purchase Plan. The Company adopted, as of January 1997, the
Life Financial Employee Stock Purchase Plan ("ESPP"), pursuant to which the
Company may make available for sale to employees shares of its Common Stock at
a price equal to no less than 85% of the fair market value of the Common Stock
on the date of purchase. The ESPP is designed to give eligible employees the
opportunity to purchase shares of Company Common Stock through payroll
deductions of up to a specified amount of their total compensation. The ESPP
is expected to become effective in January 1998.
STOCK OPTION PLANS
The Board of Directors of the Bank adopted the Life Savings Bank, Federal
Savings Bank 1996 Stock Option Plan (the "Bank Option Plan"), a stock-based
benefit plan which provides for the granting of stock options to eligible
officers, employees and directors of the Bank, on November 21, 1996. The Board
of Directors of the Bank has reserved 321,600 shares for issuance under the
Bank Option Plan. The Bank Option Plan was approved by stockholders of the
Bank at an annual meeting held on May 21, 1997. Upon completion of the
Reorganization, the Bank Option Plan, by operation of law and pursuant to the
Bank Option Plan, became an option plan of the Company.
The Board of Directors of the Company has adopted the Life Financial Corp.
1997 Stock Option Plan (the "Company Option Plan") which became effective upon
the completion of the IPO (The Bank Option Plan and the Company Option Plan
will sometimes hereinafter be referred to as the "Option Plans"). The Board of
Directors of the Company has reserved shares equal to 10% of the issued and
outstanding shares of the Company giving effect to the Reorganization and the
IPO, including Company options that were exchanged for Bank options pursuant
to the Bank Option Plan for issuance under the Option Plans. Stock options
with respect to shares of the Bank's Common Stock granted under the Bank
Option Plan and outstanding prior to completion of the Reorganization
automatically became options to purchase three shares of the Company's Common
Stock upon identical terms and conditions. The Company has assumed all of the
Bank's obligations with respect to the Bank Option Plan. The Option Plans are
available to directors, officers and employees of the Company and to
directors, officers and employees of its direct or indirect subsidiaries,
including the Bank, as selected pursuant to the Option Plans and all
references to the Bank's Common Stock under the Bank Option Plan are deemed
references to the Company's Common Stock.
The stock option benefits provided under the Option Plans are designed to
attract and retain qualified directors and personnel in key positions, provide
directors, officers and key employees with a proprietary interest in the
Company, and as an incentive to contribute to the success of the Bank and the
Company and reward key employees for outstanding performance. The Option Plans
provides for the grant of: (i) options to purchase the Company's Common Stock
intended to qualify as incentive stock options under Section 422 of the Code
("Incentive Stock Options"); (ii) options that do not so qualify ("Non-
Statutory Stock Options"); and (iii) Limited Rights. Limited Rights are
exercisable only upon a change in control of the Bank or the Company. Upon
exercise of "Limited Rights" in the event of a change in control, the employee
will be entitled to receive a lump sum cash payment equal to the difference
between the exercise price of the related option and the fair market value of
the shares of common stock subject to the option on the date of exercise of
the right in lieu of purchasing the stock underlying the option. Except for
options granted to directors, all options granted contemporaneously with
adoption of the Option Plans are intended to be Incentive Stock Options to the
extent permitted under Section 422 of the Code. The Option Plans will be in
effect for a period of ten years from the dates of adoption by the Boards of
Directors of the Bank and the Company, respectively. It is intended that the
Option Plans will be revised to include a per person, per year grant limit in
order to prevent compensation attributable to options from being included in
the $1 million tax-deductible compensation cap of Section 162(m) of the Code.
Under the Option Plans, the Personnel/Compensation Committee determines
which officers and employees will be granted options and Limited Rights,
whether such options are to be incentive or non-statutory stock options, the
number of shares subject to each option, the exercise price of each stock
option, whether such options may be exercised by delivering other shares of
Common Stock and when such options become
107
exercisable. The per share exercise price of a stock option is required to be
at least equal to the fair market value of a share of Common Stock on the date
the option is granted under the Option Plan. The Bank Committee has granted
options to purchase 192,960, and 12,540 shares respectively to Messrs. Perl
and Passerino and has granted options to purchase an aggregate of 25,080
shares to two other executive officers as a group at an exercise price of
$3.33, as of December 31, 1996. An additional 25,000, 15,000 and 30,000
options have been granted to Messrs. Perl and Passerino and two other
executive officers as a group, respectively, under the Company Option Plan at
an exercise price of $11.00 effective as of the IPO.
An optionee will not be deemed to have received taxable income upon grant or
exercise of any Incentive Stock Option, provided that such shares received
through the exercise of such option are not disposed of by the employee for at
least one year after the date the stock is received in connection with the
option exercise and two years after the date of grant of the option. No
compensation deduction would be able to be taken by the Company as a result of
the grant or exercise of Incentive Stock Options, provided such shares are not
disposed of before the expiration of the period described above (a
"disqualifying disposition"). In the case of a Non-Statutory Stock Option and
in the case of a disqualifying disposition of an Incentive Stock Option, an
optionee will be deemed to receive ordinary income upon exercise of the stock
option in an amount equal to the amount by which the exercise price is
exceeded by the fair market value of the Common Stock purchased by exercising
the option on the date of exercise. The amount of any ordinary income deemed
to be received by an optionee upon the exercise of a Non-Statutory Stock
Option or due to a disqualifying disposition of an Incentive Stock Option
would be a deductible expense for tax purposes for the Company. In the case of
Limited Rights, upon exercise, the option holder would have to include the
amount paid to him or her upon exercise in his gross income for federal income
tax purposes in the year in which the payment is made and the Company would be
entitled to a deduction for federal income tax purposes of the amount paid.
Stock options will become vested and exercisable in the manner specified by
the Company. The options granted by the Bank in connection with the adoption
of the Bank Option Plan will vest at a rate of 33.3% per year, beginning on
November 21, 1999. Options granted by the Company in connection with the
Reorganization and the IPO under the Company Option Plan will vest at a rate
of 33.3% per year beginning on the third anniversary of the date of the IPO.
Incentive Stock Options granted in connection with the Option Plans could be
exercisable for three months following the date on which the employee ceases
to perform services for the Bank or the Company, except that in the event of
death, disability, retirement or termination of an employee's service
following change in control of the Bank or the Company, options accelerate and
become fully vested and could be exercisable for up to one year thereafter or
such longer period as determined by the Company. However, any Incentive Stock
Options exercised more than three months following the date the employee
ceases to perform services as an employee would be treated as a Non-Statutory
Stock Option as described above. In the event of retirement, if the optionee
continues to perform services as a director on behalf of the Bank, the Company
or an affiliate, unvested options would continue to vest in accordance with
their original vesting schedule until the optionee ceases to serve as a
director. Non-Statutory Stock Options granted in connection with the Option
Plans could be exercisable for one year following the date on which the
employee ceases to perform services for the Bank or the Company, except that
in the case of death, disability, retirement or termination of the optionee's
service following a change in control, options accelerate and become fully
vested and could be exercisable for up to one year thereafter or such longer
period as determined by the Committee.
All Options granted by the Bank to outside directors under the Bank Option
Plan were Non-Statutory Stock Options and will vest and become exercisable
commencing three years after the date of adoption of the Bank Option Plan at
the rate of 33.3% per year, and will expire upon the earlier of ten years
following the date of grant or one year following the date the optionee ceases
to be a director or consulting director. The Committee has granted options to
purchase 9,180 shares to each of the outside directors of the Bank at an
exercise price of $3.33, as of December 31, 1996. Options granted by the
Company in connection with the Reorganization and the IPO will vest at a rate
of 33.3% per year beginning on the third anniversary date of the
Reorganization and the IPO. The Compensation Committee of the Company has
granted options to purchase 17,500 shares to each of the outside directors
under the Company Option Plan at an exercise price of $11.00 effective upon
the IPO. In
108
the event of the death or disability of a participant or termination of a
participant's service following a change in control of the Company or the
Bank, all previously granted options would immediately vest and become fully
exercisable.
A change in control is defined in the Option Plans generally to occur when a
person or group of persons acting in concert acquires beneficial ownership of
20% or more of any class of equity security of the Company or the Bank or in
the event of a tender or exchange offer, merger or other form of business
combination, sale of all or substantially all of the assets of the Company or
the Bank or contested election of directors which resulted in the replacement
of a majority of the Board of Directors by persons not nominated by the
directors in office prior to the contested election.
The following table lists all grants of options and stock appreciation
rights ("SARs") under the Option Plan to the Named Executive Officers for
fiscal 1996 and contains certain information about the potential value of
those options based upon certain assumptions as to the appreciation of the
Company's stock over the life of the option.
OPTIONS GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
--------------------------------------------------- VALUE AT ASSUMED
NUMBER OF ANNUAL RATES OF
SECURITIES % OF TOTAL STOCK PRICE
UNDERLYING OPTION/SARS APPRECIATION FOR
OPTIONS/ GRANTED TO EXERCISE OR OPTIONS(1)
SARS GRANTED EMPLOYEES IN BASE PRICE EXPIRATION ---------------------
NAME (#)(2)(3)(4)(5) FISCAL YEAR PER SHARE DATE(6) 5% 10%
---- --------------- ------------ ----------- ---------- --------- -----------
Daniel L. Perl.......... 192,960 60.00% $3.33 11/21/06 $404,811 $1,021,605
Joseph R.L. Passerino... 12,540 3.90 3.33 11/21/06 26,308 66,396
- --------
(1) The amounts represent certain assumed rates of appreciation. Actual gains,
if any, on stock option exercises and Common Stock holdings are dependent
on the future performance of the Common Stock and overall stock market
conditions. There can be no assurance that the amounts reflected in this
table will be realized.
(2) Options granted pursuant to the Bank Option Plan become exercisable in
equal installments at an annual rate of 33.3% beginning November 21, 1999,
unless otherwise accelerated.
(3) The purchase price may be paid in cash or in Common Stock.
(4) Under limited circumstances, such as death or disability of an employee,
the employee (or his beneficiary) may request that the Company, in
exchange for the employee's surrender of an option, pay to the employee
(or beneficiary), the amount by which the fair market value of the Common
Stock exceeds the exercise price of the option on the date of the
employee's termination of employment. It is within the Company's
discretion to accept or reject such a request.
(5) To the extent possible, options will be treated as incentive options.
(6) The option term is ten years.
109
The following table provides certain information with respect to the number
of shares of Common Stock represented by outstanding options held by the Named
Executive Officers as of December 31, 1996. Also reported are the values for
"in-the-money" options which represent the positive spread between the
exercise price of any such existing stock options and the year end price of
the Common Stock. No stock appreciation rights were granted to the Named
Executive Officers during the year ended December 31, 1996.
FISCAL YEAR-END OPTION/SAR VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTION/SARS AT
FISCAL YEAR END(#) FISCAL YEAR END($)
---------------------------- ----------------------------
NAME EXERCISABLE/UNEXERCISABLE(1) EXERCISABLE/UNEXERCISABLE(2)
---- ---------------------------- ----------------------------
Daniel L. Perl.......... 0/192,960 0/0
Joseph R.L. Passerino... 0/12,540 0/0
- --------
(1) The options in this table have an exercise price of $3.33 and become
exercisable at an annual rate of 33.3% beginning November 21, 1999. The
options will expire ten years from the date of grant.
(2) Based on market value of the underlying stock at January 21, 1997, minus
the exercise price. The bid and ask prices for the Bank's common stock on
January 21, 1997 was $3.00 and $3.67 per share, respectively. Therefore,
using the average of the bid and ask prices, there is no positive spread
between the exercise price of the options and the price of the common
stock of the Bank.
TRANSACTIONS WITH CERTAIN RELATED PERSONS
The Financial Institutions Reform, Recovery, and Enforcement Act of 1989
("FIRREA") requires that all loans or extensions of credit to executive
officers and directors must be made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with the general public and must not involve more than the normal
risk of repayment or present other unfavorable features. In addition, loans
made to a director or executive officer in excess of the greater of $25,000 or
5% of the Bank's capital and surplus (up to a maximum of $500,000) must be
approved in advance by a majority of the disinterested members of the Board of
Directors.
The Bank's current policy provides that all loans made by the Bank to its
directors and officers are made in the ordinary course of business, are made
on substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with other persons
and do not involve more than the normal risk of collectibility or present
other unfavorable features. During 1996, the law firm of Keller and Keller
provided legal representation to the Bank for which it was paid approximately
$2,300 for legal fees and related services. Until his retirement in 1996, Mr.
Edgar C. Keller, a director of the Bank was a partner with Keller and Keller.
In addition, the Bank purchased four policies of insurance from Caldwell &
Moreland Insurance Brokers, Inc. for approximately $45,000 which yielded
commissions of approximately $5,600. Richard C. Caldwell is a director of the
Bank and the Company and a partner of Caldwell & Moreland Insurance Brokers,
Inc.
110
SECURITY OWNERSHIP OF MANAGEMENT AND OTHER BENEFICIAL OWNERS
The following table sets forth, as of September 30, 1997, certain
information as to those persons who were known by management to be beneficial
owners of more than 5% of the Company's outstanding shares of Common Stock,
each director, each Named Executive Officer and the shares of Common Stock
beneficially owned by all directors and executive officers of the Company as a
group.
PERCENTAGE
NUMBER OF BENEFICIALLY
NAME OF BENEFICIAL OWNER POSITION(S) WITH THE COMPANY SHARES(1) OWNED
- ------------------------ ---------------------------- --------- ------------
Richard C. Caldwell........... Director 185,798(2) 2.8%
John D. Goddard............... Director 171,926(3) 2.6
Ronald G. Skipper............. Chairman of the Board 165,000(4) 2.5
Milton E. Johnson............. Director 114,526(5) 1.7
Daniel L. Perl................ Director, President and Chief
Executive Officer 92,422(6) 1.4
Edgar C. Keller............... Director 33,461 0.5
Joseph R.L. Passerino......... Senior Vice President 5,301 0.1
L. Bruce Mills, Jr............ Executive Vice President,
Secretary and Treasurer 1,198 --
Wellington Management Company, 872,900 13.3
LLP(7)........................
75 State Street
Boston, MA 02109
Financial Stocks Inc. (8)..... 473,500 7.2
507 Carew Tower
Cincinnati, Ohio 45208
All Executive Officers and Di-
rectors
as a Group (9 persons)....... 769,632(9)(10) 11.8
- --------
(1) The number of shares of Common Stock outstanding and the number owned by
the individuals or entities listed does not include any shares issuable
pursuant to outstanding options, none of which may be exercised until
November 21, 1999.
(2) 141,298 shares are held through a qualified employee benefit plan in which
Mr. Caldwell is a participant.
(3) Of these shares, 78,128 are held by Mr. Goddard and his wife as joint
tenants and 93,798 are held in the John D. Goddard Corporation Profit
Sharing Plan and Trust.
(4) Of these shares 154,836 are held in the Ronald Skipper Pension Sharing
Plan and 1,596 are held in custodial accounts for minors.
(5) Of these shares, 14,004 are held by Mr. Johnson and his wife as joint
tenants, 83,646 are held in an IRA account for Mr. Johnson and his wife,
9,414 are held in custodial accounts for minors, 4,614 are held in joint
tenancy with other family members and 924 are owned of record by another
family member.
(6) Of these shares, 40,006 are held in joint tenancy with Mr. Perl's wife and
52,416 are held in the Navieve Financial Corp. Profit Sharing Trust.
(7) As disclosed on a Schedule 13G filed on October 2, 1997.
(8) As disclosed on a Schedule 13D Amendment No. 1 filed on September 9, 1997.
Financial Stocks, Inc. is general partner of Financial Stocks Limited
Partnership and the discretionary investment advisor of Rising Stars
Offshore Fund. Of the 473,500 shares, 449,827 shares are owned of record
by Financial Stocks Limited Partnership and 23,675 shares are owned by
Rising Stars Offshore Fund.
(9) Does not include 46,122 shares of Common Stock held by Mrs. Nora L.
Vineyard who is currently serving as a consultant to the Bank.
(10) Does not include 24,480 shares held by Louis E. Yeager who retired from
the Bank's Board of Directors on May 21, 1997.
111
THE TRUST
The Trust is a statutory business trust created under Delaware law pursuant
to (i) a declaration of trust, dated as of December 2, 1997, executed by the
Company, as Sponsor, the Initial Trustee, the Delaware Trustee and the
Property Trustee named therein (the "Initial Declaration"), and (ii) the
filing of a certificate of trust with the Secretary of State of the State of
Delaware on December 2, 1997. The Initial Declaration will be replaced by the
Declaration. The Trust exists for the exclusive purposes of (i) issuing and
selling the Trust Securities, which represent undivided beneficial interests
in the assets of the Trust, (ii) investing the gross proceeds from the sale of
the Trust Securities in the Junior Subordinated Debentures and (iii) engaging
in only those other activities necessary, advisable or incidental thereto.
Accordingly, the Junior Subordinated Debentures will be the sole assets of the
Trust and payments under the Junior Subordinated Debentures will be the sole
revenues of the Trust. All of the Common Securities will be owned directly by
the Company. The Common Securities will rank pari passu, and payments will be
made thereon pro rata, with the Capital Securities, except that upon the
occurrence and during the continuance of an Event of Default (as defined
herein), the rights of the Company as holder of the Common Securities to
payments in respect of distributions and payments upon liquidation, redemption
or otherwise will be subordinated and rank junior to the rights of the holders
of the Capital Securities. See "Description of Capital Securities--
Subordination of Common Securities." The Company will acquire Common
Securities in a Liquidation Amount equal to approximately, but not less than,
3% of the total capital of the Trust. The Trust has a term of 31 years, but
may dissolve earlier as provided in the Declaration. The Trust's business and
affairs will be conducted by the Issuer Trustees and the Administrators,
appointed by the Company as the direct holder of the Common Securities. The
Issuer Trustees will be State Street, as the Property Trustee, and Delaware
Trust as the Delaware Trustee. State Street, as Property Trustee, will act as
sole indenture trustee under the Declaration. State Street also will act as
trustee under the Guarantee and the Indenture. See "Description of the
Guarantee" and "Description of Junior Convertible Subordinated Debentures."
The holder of the Common Securities or, if an Event of Default under the
Declaration has occurred and is continuing, the holders of a majority in
Liquidation Amount of the Capital Securities, will be entitled to appoint,
remove or replace the Property Trustee and/or the Delaware Trustee. In no
event will the holders of the Capital Securities have the right to vote to
appoint, remove or replace the Administrators; such voting rights will be
vested exclusively in the holder of the Common Securities. The duties and
obligations of each Issuer Trustee and the Administrators are governed by the
Declaration. The Company will pay directly all fees, expenses, debts and
obligations (other than the Trust Securities) related to the Trust and the
offering of the Capital Securities, including all ongoing costs, expenses and
liabilities of the Trust. The principal executive office of the Trust is LIFE
Financial Capital Trust, c/o LIFE Financial Corporation, 10540 North Magnolia
Avenue, Unit B, Riverside, California 92505, Attention: Chief Executive
Officer. Under the Declaration, all parties to the Declaration will agree, and
the holders of the Capital Securities upon purchase of their Capital
Securities will be deemed to have agreed, for United States income tax
purposes, to treat the Trust as a grantor trust, the Junior Subordinated
Debentures as indebtedness of the Company and the Capital Securities as
evidence of indirect beneficial ownership in the Junior Subordinated
Debentures.
DESCRIPTION OF CAPITAL SECURITIES
The Capital Securities will represent preferred undivided beneficial
interests in the assets of the Trust and the holders thereof will be entitled
to a preference over the Common Securities in certain circumstances with
respect to Distributions and amounts payable on redemption of the Trust
Securities or liquidation of the Trust. See "--Subordination of Common
Securities" below. The Declaration will be qualified as an indenture under the
Trust Indenture Act of 1939, as amended (the "Trust Indenture Act"). The
following description does not purport to be complete and is subject to, and
is qualified in its entirety by reference to, the Declaration and the Trust
Indenture Act. Certain capitalized terms used herein are defined in the
Declaration.
GENERAL
The Capital Securities will be limited to $ aggregate Liquidation Amount
at any one time outstanding. The Capital Securities will rank pari passu, and
payments will be made thereon pro rata, with the
112
Common Securities except as described under "--Subordination of Common
Securities" below. Legal title to the Junior Subordinated Debentures will be
held by the Property Trustee in trust for the benefit of the holders of the
Capital Securities and the Common Securities. The Guarantee will not guarantee
payment of Distributions or amounts payable on redemption of the Capital
Securities or liquidation of the Trust when the Trust does not have funds on
hand legally available for such payments. See "Description of the Guarantee."
DISTRIBUTIONS
Distributions on the Capital Securities will be cumulative, will accumulate
from the Issue Date and will be payable quarterly in arrears on March 15, June
15, September 15, and December 15 of each year, commencing March 15, 1998, at
the annual rate of % of the Liquidation Amount to the holders of the Capital
Securities on the relevant record dates. The record dates will be the
fifteenth day of the month in which the relevant Distribution Date (as defined
herein) falls (each, a "Distribution Record Date"). The amount of
Distributions payable for any period will be computed on the basis of a 360-
day year of twelve 30-day months and, for any period of less than a full
calendar month, the number of days elapsed in such month. In the event that
any date on which Distributions are payable on the Capital Securities is not a
Business Day (as defined herein), payment of the Distributions payable on such
date will be made on the next succeeding day that is a Business Day (and
without any interest or other payment in respect to any such delay), with the
same force and effect as if made on the date such payment was originally
payable (each date on which Distributions are payable in accordance with the
foregoing, a "Distribution Date"). A "Business Day"" shall mean any day other
than a Saturday or a Sunday, or a day on which banking institutions in
California are authorized or required by law or executive order to close.
So long as no Debenture Event of Default shall have occurred and be
continuing, the Company will have the right under the Indenture to elect to
defer the payment of interest on the Junior Subordinated Debentures at any
time and from time to time for a period not exceeding 20 consecutive quarters
with respect to each Extension Period, provided that no Extension Period will
end on a day other than an interest payment date for the Junior Subordinated
Debentures or extend beyond the Stated Maturity Date. Upon any such election,
quarterly Distributions on the Capital Securities will be deferred by the
Trust during such Extension Period. Distributions to which holders of the
Capital Securities are entitled during any such Extension Period will
accumulate additional Distributions thereon at the rate per annum of %
thereof, compounded quarterly from the relevant Distribution Date, to the
extent permitted by applicable law. The term "Distributions," as used herein,
shall include any such additional Distributions.
During any such Extension Period, the Company may extend such Extension
Period, provided that such extension does not cause such Extension Period to
exceed 20 consecutive quarters or to extend beyond the Stated Maturity Date.
Upon the termination of any such Extension Period and the payment of all
amounts then due, and subject to the foregoing limitations, the Company may
elect to begin a new Extension Period. The Company must give the Property
Trustee, the Administrators and the Debenture Trustee notice of its election
of any Extension Period or any extension thereof at least five Business Days
prior to the earlier of (i) the date the Distributions on the Capital
Securities would have been payable except for the election to begin or extend
such Extension Period and (ii) the date the Administrators are required to
give notice to any securities exchange or to holders of the Capital Securities
of the Distribution Record Date or the date such Distributions are payable,
but in any event not less than five Business Days prior to such record date.
There is no limitation on the number of times that the Company may elect to
begin an Extension Period. See "Description of Junior Convertible Subordinated
Debentures--Option to Extend Interest Payment Date" and "Certain Federal
Income Tax Considerations--Interest, Original Issue Discount, Premium and
Market Discount."
During any such Extension Period, the Company may not (i) declare or pay any
dividends or distributions on, or redeem, purchase, acquire, or make a
liquidation payment with respect to, any of the Company's capital stock or
(ii) make any payment of principal of or premium, if any, or interest on or
repay, repurchase or redeem any debt securities of the Company (including
Other Debentures) that rank pari passu with or junior in right of
113
payment to the Junior Subordinated Debentures or (iii) make any guarantee
payments with respect to any guarantee by the Company of any securities of any
subsidiary of the Company (including guarantees issued with respect to capital
securities to Other Trusts ("Other Guarantees")) if such guarantee ranks pari
passu with or junior in right of payment to the Junior Subordinated
Debentures, other than (a) dividends or distributions in shares of, or
options, warrants or rights to subscribe for or purchase shares of, Common
Stock or preferred stock of the Company, (b) any declaration of a dividend in
connection with the implementation of a stockholders' rights plan, or the
issuance of stock under any such plan in the future, or the redemption or
repurchase of any such rights pursuant thereto, (c) payments under the
Guarantee, (d) as a direct result of, and only to the extent required in order
to avoid the issuance of fractional shares of capital stock following, a
reclassification of the Company's capital stock or the exchange or conversion
of one class, or series of the Company's capital stock for another class or
series of the Company's capital stock, (e) the purchase of fractional
interests in shares of the Company's capital stock pursuant to the conversion
or exchange provisions of such capital stock or the security being converted
or exchanged, and (f) purchases of Common Stock related to the issuance of
Common Stock or rights under any of the Company's benefit plans for its
directors, officers or employees.
The Company believes that, as a result of its inability to pay any dividends
or distributions on, or redeem, purchase, acquire or make a liquidation
payment with respect to, its Common Stock during an Extension Period and the
additional restrictions imposed upon it to the extent described under
"Description of Junior Convertible Subordinated Debentures--Option to Extend
Interest Payment Date," the likelihood of its exercising its right to defer
payments of interest is remote and it has no such current intention. However,
the Company reserves the right in the future to exercise its option to defer
payments of interest on the Junior Subordinated Debentures. See "Risk Factors
Related to the Capital Securities--Option to Extend Interest Payment Period;
Tax Considerations."
The revenue of the Trust available for distribution to holders of the
Capital Securities will be limited to payments under the Junior Subordinated
Debentures in which the Trust will invest the proceeds from the issuance and
sale of the Trust Securities. See "Description of Junior Convertible
Subordinated Debentures--General." If the Company does not make interest
payments on the Junior Subordinated Debentures, the Property Trustee will not
have funds available to pay Distributions on the Capital Securities. The
payment of Distributions (if and only to the extent the Trust has funds on
hand legally available for the payment of such Distributions) will be
guaranteed by the Company on a limited basis as set forth herein under
"Description of the Guarantee."
CONVERSION RIGHTS
General. Capital Securities will be convertible at any time prior to the
earlier of (i) 5:00 p.m. (New York time) on the Business Day immediately
preceding the date of repayment of such Capital Securities, whether at
maturity or upon redemption, and (ii) 5:00 p.m. (New York time) on the
Conversion Termination Date (if any), at the option of the holders thereof and
in the manner described below, into shares of Common Stock at a conversion
rate of shares of Common Stock for each Capital Security (equivalent to a
conversion price of $ per share of Common Stock), subject to adjustment as
described below under "--Conversion Price Adjustments." The Trust will
covenant in the Declaration not to convert Junior Subordinated Debentures held
by it except pursuant to a conversion request delivered to the Property
Trustee, as initial conversion agent (the "Conversion Agent"), by a holder of
Capital Securities.
A holder of Capital Securities wishing to exercise its conversion right will
be required to deliver an irrevocable conversion request, to the Conversion
Agent which will exchange such Capital Security for an equivalent amount of
the Junior Subordinated Debentures (based on an exchange ratio of $
principal amount of Junior Subordinated Debentures for each $ Liquidation
Amount of Capital Securities) on behalf of such holder and immediately convert
such Junior Subordinated Debentures into Common Stock. Holders may obtain
copies of the required form of the conversion request from the Conversion
Agent. So long as a book-entry system for the Capital Securities is in effect,
however, procedures for converting book-entry Capital Securities into shares
of Common Stock will differ, as described under "--Form, Denomination, Book-
Entry Procedures and Transfer."
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Holders of Capital Securities at 5:00 p.m. (New York time) on a Distribution
Record Date will be entitled to receive the Distribution payable on such
Capital Securities on the corresponding Distribution Date notwithstanding the
conversion of such Capital Securities following such Distribution Record Date
but on or prior to such Distribution Date. Except as provided in the
immediately preceding sentence, neither the Trust nor the Company will make,
or be required to make, any payment, allowance or adjustment for accumulated
and unpaid Distributions, whether or not in arrears, on converted Capital
Securities; provided, however, that if notice of redemption of Capital
Securities is mailed or otherwise given to holders of Capital Securities or
the Trust issues a press release announcing a Conversion Termination Date,
then, if any holder of Capital Securities converts any Capital Securities into
Common Stock on any date on or after the date on which such notice of
redemption is mailed or otherwise given or the date of such press release, as
the case may be, and if such date of conversion falls on any day from and
including the first day of an Extension Period and on or prior to the
Distribution Date upon which such Extension Period ends, such converting
holder shall be entitled to receive either (i) if the date of such conversion
falls after a Distribution Record Date and on or prior to the next succeeding
Distribution Date, all accrued and unpaid Distributions on such Capital
Securities (including interest thereon, if any, to the extent permitted by
applicable law) to such Distribution Date or (ii) if the date of such
conversion does not fall on a date described in clause (i) above, all accrued
and unpaid Distributions on such Capital Securities (including interest
thereon, if any, to the extent permitted by applicable law) to the most recent
Distribution Date prior to the date of such conversion, which Distributions
shall, in either such case, be paid to such converting holder unless the date
of conversion of such Capital Securities is on or prior to the Distribution
Date upon which such Extension Period ends and after the Distribution Record
Date for such Distribution Date, in which case such Distributions shall be
paid to the person who was the holder of such Capital Securities (or one or
more predecessor Capital Securities) at 5:00 p.m. New York time on such
Distribution Record Date. The Company will make no payment or allowance for
distributions on the shares of Common Stock issued upon such conversion,
except to the extent that such shares of Common Stock are held of record on
the record date for any such distributions. Each conversion will be deemed to
have been effected immediately prior to 5:00 p.m. (Pacific time) on the day on
which the related conversion request was received by the Conversion Agent.
No fractional shares of Common Stock will be issued as a result of
conversion, but in lieu thereof such fractional interest will be paid by the
Company in cash based on the Closing Price of the Common Stock on the date
such Capital Securities are converted.
Conversion Price Adjustments--General. The Conversion Price is subject to
adjustment in certain events, including (a) the issuance after the Issue Date
of shares of Common Stock as a dividend or a distribution with respect to
Common Stock, (b) subdivisions, combinations and reclassification of Common
Stock effected after the Issue Date, (c) the issuance to all holders of Common
Stock after the Issue Date of rights or warrants entitling them (for a period
not exceeding 45 days) to subscribe for or purchase shares of Common Stock at
less than the then Current Market Price (as defined below) of the Common
Stock, (d) the distribution to all holders of Common Stock after the Issue
Date of evidences of indebtedness, capital stock, cash or assets (including
securities, but excluding those rights, warrants, dividends and distributions
referred to above and dividends and distributions paid exclusively in cash),
(e) the payment of dividends (and other distributions) on Common Stock after
the Issue Date paid exclusively in cash, excluding cash dividends if the
annualized per share amount thereof does not exceed 15% of the Current Market
Price of Common Stock as of the trading day immediately preceding the date of
declaration of such dividend, and (f) payment to holders of Common Stock after
the Issue Date in respect of a tender or exchange offer (other than an odd-lot
offer) by the Company for Common Stock at a price in excess of % of the then
Current Market Price of Common Stock as of the trading day next succeeding the
last date tenders or exchanges may be made pursuant to such tender or exchange
offer.
"Current Market Price" means, in general, the average of the daily Closing
Prices (as defined below) for the five consecutive trading days selected by
the Company commencing not more than 20 trading days before, and ending not
later than, the earlier of the day in question or, if applicable, the day
before the "ex" date (as defined) with respect to the issuance or distribution
in question.
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The Company from time to time may reduce the conversion price of the Junior
Subordinated Debentures (and thus the Conversion Price of the Capital
Securities) by any amount selected by the Company for any period of at least
20 days, in which case the Company shall give at least 15 days' notice of such
reduction. The Company may, at its option, make such reductions in the
Conversion Price, in addition to those set forth above, as the Company deems
advisable to avoid or diminish any income tax to holders of Common Stock
resulting from any dividend or distribution of stock (or rights to acquire
stock) or from any event treated as such for income tax purposes. See "Certain
Federal Income Tax Considerations--Adjustment of Conversion Price."
No adjustment of the Conversion Price will be made upon the issuance of any
shares of Common Stock pursuant to any present or future plan providing for
the issuance of any shares of Common Stock or options or rights pursuant to
any employee benefit plan or program, or pursuant to any option, warrant,
right or any exercisable, exchangeable or convertible security outstanding as
of the date on which the Junior Subordinated Debentures are first issued. No
adjustment of the Conversion Price will be made upon the issuance of rights
under any shareholder rights plan. No adjustment in the Conversion Price will
be required unless adjustment would require a change of at least one percent
(1%) in the price then in effect; provided, however, that any adjustment that
would not be required to be made shall be carried forward and taken into
account in any subsequent adjustment. If any action would require adjustment
of the Conversion Price pursuant to more than one of the provisions described
above, only one adjustment shall be made with respect to that action and such
adjustment shall be the amount of adjustment that has the highest absolute
value to the holder of the Capital Securities.
Conversion Price Adjustment--Merger, Consolidation or Sale of Assets of the
Company. In the event that the Company shall be a party to any transaction,
including, without limitation, and with certain exceptions, (a) a
recapitalization or reclassification of the Common Stock, (b) consolidation of
the Company with, or merger of the Company into, any other person, or any
merger of another person into the Company, (c) any sale, transfer or lease of
all or substantially all of the assets of the Company or (d) any compulsory
share exchange pursuant to which the Common Stock is converted into the right
to receive other securities, cash or other property (each of the foregoing
being referred to as a "Transaction"), then the holders of Capital Securities
then outstanding will have the right to convert the Capital Securities into
the kind and amount of securities, cash or other property receivable upon the
consummation of such Transaction by a holder of the number of shares of Common
Stock issuable upon conversion of such Capital Securities immediately prior to
such Transaction.
In the case of a Transaction, each Capital Security would become convertible
into the securities, cash or property receivable by a holder of the number of
shares of the Common Stock into which such Capital Security was convertible
immediately prior to such Transaction. This change could substantially lessen
or eliminate the value of the conversion privilege associated with the Capital
Securities in the future. For example, if the Company were acquired in a cash
merger, each Capital Security would become convertible solely into cash and
would no longer be convertible into securities which value would vary
depending on the future prospects of the Company and other factors.
Conversion Price adjustments or omissions in making such adjustments may,
under certain circumstances, be deemed to be distributions that could be
taxable as dividends to holders of Capital Securities or to the holders of
Common Stock. See "Certain Federal Income Tax Considerations--Adjustment of
Conversion Price."
Termination of Conversion Rights. In addition to the rights of the Company
to redeem the Capital Securities under the circumstances described in this
Prospectus, the Company also will have the right to terminate the
convertibility of the Capital Securities into Common Stock as described in
this paragraph. On and after , and provided the Trust is current in the
payment of Distributions on the Capital Securities (except to the extent that
the payment of Distributions may have been duly deferred as the result of an
Extension Period), the Company may, at its option, terminate the right to
convert the Junior Subordinated Debentures into Common Stock, in which case
the right to convert the Capital Securities into Common Stock will likewise
terminate. The Company may exercise this option only if for at least 20
trading days within any period of 30
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consecutive trading days ending on or after , , including the last
trading day of such period, the Closing Price of the Common Stock exceeds %
of the then applicable Conversion Price of the Capital Securities. To exercise
this conversion termination option, the Company must cause the Trust to issue
a press release for publication on the Dow Jones News Service or on a
comparable news service announcing the Conversion Termination Date prior to
the opening of business on the second trading day after a period in which the
condition in the preceding sentence has been met, but in no event may such
press release be issued prior to , . The press release shall announce
the Conversion Termination Date and provide the Conversion Price and the
Closing Price of the Capital Securities and the Common Stock, in each case as
of the close of business on the trading day next preceding the date of the
press release.
Notice of the termination of conversion rights will be given by first-class
mail to the holders of the Capital Securities not more than four Business Days
after the Trust issues the press release. The Conversion Termination Date will
be a Business Day selected by the Company not less than 30 nor more than 60
days after the date on which the Trust issues the press release announcing its
intention to terminate conversion rights of Capital Security holders. In the
event that the Company exercises its conversion termination option, conversion
rights will expire at 5:00 p.m. (New York time) on the Conversion Termination
Date. In the event the Company has not exercised its conversion termination
option and the Capital Securities are otherwise called for redemption, the
Capital Securities will be convertible at any time prior to 5:00 p.m. (New
York time) on the Business Day immediately preceding the date of such
redemption.
"Closing Price" of any security on any day means the last reported sale
price, regular way, on such day or, if no sale takes place on such day, the
average of the reported closing bid and asked prices on such day, regular way,
in either case as reported on the NYSE Composite Tape, or, if such security is
not listed or admitted to trading on the NYSE, on the principal national
securities exchange on which such security is listed or admitted to trading,
or if such security is not listed or admitted to trading on a national
securities exchange, on the National Market System of the National Association
of Securities Dealers, Inc. or, if such security is not quoted or admitted to
trading on such quotation system, on the principal quotation system on which
such security is listed or admitted to trading or quoted, or, if not listed or
admitted to trading or quoted on any national securities exchange or quotation
system, the average of the closing bid and asked prices of such security in
the over-the-counter market on the day in question as reported by the National
Quotation Bureau Incorporated, or a similar generally accepted reporting
service, or, if not so available in such manner, as furnished by any NYSE
member firm selected from time to time by the Board of Directors of the
Company for that purpose or, if not so available in such manner, as otherwise
determined in good faith by the Board of Directors of the Company.
REDEMPTION
Upon the repayment on the Stated Maturity Date or prepayment prior to the
Stated Maturity Date of the Junior Subordinated Debentures, the proceeds from
such repayment or prepayment shall be applied by the Property Trustee to
redeem a Like Amount (as defined below) of the Trust Securities, upon not less
than 30 nor more than 60 days' notice of a date of redemption (the "Redemption
Date") at the applicable Redemption Price, which shall be equal to (i) in the
case of the repayment of the Junior Subordinated Debentures on the Stated
Maturity Date, the Maturity Redemption Price (equal to the principal of and
accrued and unpaid interest on the Junior Subordinated Debentures), (ii) in
the case of the optional prepayment of the Junior Subordinated Debentures upon
the occurrence and continuation of a Special Event, the Special Event
Redemption Price (equal to the Special Event Prepayment Price in respect of
the Junior Subordinated Debentures) and (iii) in the case of the optional
prepayment of the Junior Subordinated Debentures other than as contemplated in
clause (ii) above, the Optional Redemption Price (equal to the Optional
Prepayment Price in respect of the Junior Subordinated Debentures). See
"Description of Junior Convertible Subordinated Debentures--Optional
Prepayment" and "--Special Event Prepayment."
"Like Amount" means (i) with respect to a redemption of the Trust
Securities, Trust Securities having a Liquidation Amount equal to the
principal amount of Junior Subordinated Debentures to be paid in accordance
117
with their terms and (ii) with respect to a distribution of Junior
Subordinated Debentures upon the liquidation of the Trust, Junior Subordinated
Debentures having a principal amount equal to the Liquidation Amount of the
Trust Securities of the holder to whom such Junior Subordinated Debentures are
distributed.
The Company will have the option to prepay the Junior Subordinated
Debentures, (i) in whole or in part, on or after the Initial Optional
Prepayment Date, at the applicable Optional Prepayment Price and (ii) in whole
but not in part, at any time, upon the occurrence of a Special Event, at the
Special Event Prepayment Price.
LIQUIDATION OF THE TRUST AND DISTRIBUTION OF JUNIOR SUBORDINATED DEBENTURES
The Company will have the right at any time to dissolve the Trust and cause
the Junior Subordinated Debentures to be distributed to the holders of the
Trust Securities in liquidation of the Trust, subject to satisfaction of
liabilities to creditors of the Trust as provided by applicable law. Such
right is subject to the receipt by the Company of any required regulatory
approval and to the Company having received an opinion of counsel to the
effect that such distribution will not be a taxable event to holders of
Capital Securities. Under the terms of the Indenture, the Company must use its
best efforts to have the Junior Subordinated Debentures listed on Nasdaq or on
an exchange at the time that they are distributed to the holders of the Trust
Securities. It is not anticipated that an application to have the Junior
Subordinated Debentures approved for listing will be made unless a liquidation
of the Trust occurs, and there is no assurance that the debentures would be
approved for listing upon such application. See "Risk Factors Related to the
Capital Securities--Absence of Public Market and Transfer Restrictions."
The Trust shall automatically dissolve upon the first to occur of: (i)
certain events of bankruptcy, dissolution or liquidation of the Company or the
Trust, (ii) the distribution of a Like Amount of the Junior Subordinated
Debentures to the holders of the Trust Securities, if the Company, as holder
of the Common Securities, has given written direction to the Property Trustee
to dissolve the Trust (which direction is optional and, except as described
above, wholly within the discretion of the Company, as holder of the Common
Securities), (iii) redemption of all of the Trust Securities as described
under "--Redemption" above, (iv) expiration of the term of the Trust and (v)
the entry of an order for the dissolution of the Trust by a court of competent
jurisdiction.
If a dissolution occurs as described in clause (i), (ii), (iv), or (v) of
the preceding paragraph, the Trust will be liquidated by the Administrators as
expeditiously as practicable by distributing, after satisfaction of or
provision for liabilities to creditors of the Trust as provided by applicable
law, to the holders of the Trust Securities a Like Amount of the Junior
Subordinated Debentures, in which event such holders will be entitled to
receive out of the assets of the Trust legally available for distribution to
holders, after satisfaction of or provision for liabilities to creditors of
the Trust as provided by applicable law, an amount equal to the aggregate of
the Liquidation Amount plus accumulated and unpaid Distributions thereon to
the date of payment (such amount being the "Liquidation Distribution"). If the
Liquidation Distribution can be paid only in part because the Trust has
insufficient assets on hand legally available to pay in full the aggregate
Liquidation Distribution, then the amounts payable directly by the Trust on
the Capital Securities and the Common Securities shall be paid on a pro rata
basis, except that if a Debenture Event of Default has occurred and is
continuing, the Capital Securities shall have a priority over the Common
Securities. See "--Subordination of Common Securities" below.
After the liquidation date is fixed for any distribution of Junior
Subordinated Debentures to holders of the Trust Securities, (i) the Trust
Securities will no longer be deemed to be outstanding, (ii) each registered
global certificate, if any, representing Trust Securities and held by DTC or
its nominee will receive a registered global certificate or certificates
representing the Junior Subordinated Debentures to be delivered upon such
distribution, and (iii) any certificates representing Trust Securities not
held by DTC or its nominee will be deemed to represent Junior Subordinated
Debentures having a principal amount equal to the Liquidation Amount of such
Trust Securities, and bearing accrued and unpaid interest in an amount equal
to the accumulated and unpaid Distributions on such Trust Securities until
such certificates are presented to the Administrators or their agent for
cancellation, whereupon the Company will issue to such holder, and the
Debenture Trustee will authenticate, a certificate representing such Junior
Subordinated Debentures.
There can be no assurance as to the market prices for the Capital Securities
or, if a dissolution and liquidation of the Trust were to occur, for the
Junior Subordinated Debentures that may be distributed in
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exchange for the Trust Securities. Accordingly, the Capital Securities that an
investor may purchase, or the Junior Subordinated Debentures that the investor
may receive on dissolution and liquidation of the Trust, may trade at a
discount to the price that the investor paid to purchase the Capital
Securities.
REDEMPTION PROCEDURES
If applicable, Trust Securities shall be redeemed at the applicable
Redemption Price with the proceeds from the contemporaneous repayment or
prepayment of the Junior Subordinated Debentures. Any redemption of Trust
Securities shall be made and the applicable Redemption Price shall be payable
on the Redemption Date only to the extent that the Trust has funds legally
available for the payment of such applicable Redemption Price. See also "--
Subordination of Common Securities" below.
If the Trust gives a notice of redemption in respect of the Capital
Securities, then, by 12:00 noon (New York City time) on the Redemption Date,
to the extent funds are legally available, with respect to the Capital
Securities held by DTC or its nominees, the Property Trustee will pay or cause
the Paying Agent (as defined herein) to pay the Redemption Price to DTC. See
"--Form, Denomination, Book-Entry Procedures and Transfer" below.
Distributions payable on or prior to the Redemption Date shall be payable to
the holders of such Capital Securities on the relevant Distribution Record
Dates for the related Distribution Dates. If notice of redemption shall have
been given and funds deposited with the Property Trustee to pay the Redemption
Price for the Capital Securities called for redemption, then all rights of the
holders of such Capital Securities will cease, except the right of the holders
of such Capital Securities to receive the applicable Redemption Price (without
interest on such Redemption Price) or to convert the holder's Capital
Securities into Common Stock as described under "--Conversion Rights" above
and such Capital Securities will cease to be outstanding. In the event that
any Redemption Date is not a Business Day, then the applicable Redemption
Price payable on such date will be paid on the next succeeding day that is a
Business Day (and without any interest or other payment in respect of any such
delay). In the event that payment of the applicable Redemption Price is
improperly withheld or refused and not paid either by the Trust or by the
Company pursuant to the Guarantee as described under "Description of the
Guarantee," (i) Distributions on Capital Securities called for redemption will
accumulate on the Redemption Price at the then applicable rate, from the
Redemption Date originally established by the Trust to the date such
applicable Redemption Price is actually paid, and (ii) the actual payment date
will be the Redemption Date for purposes of calculating the applicable
Redemption Price.
Subject to applicable law (including, without limitation, United States
federal securities law and the regulations of the OTS), the Company or its
subsidiaries may at any time and from time to time purchase outstanding
Capital Securities by tender, in the open market or by private agreement.
Notice of any redemption will be mailed at least 30 days but not more than
60 days prior to the Redemption Date to each holder of Trust Securities at its
registered address. Unless the Company defaults in payment of the applicable
Prepayment Price on, or in the repayment of, the Junior Subordinated
Debentures, on and after the Redemption Date Distributions will cease to
accrue on the Trust Securities called for redemption.
SUBORDINATION OF COMMON SECURITIES
Payment of Distributions on, and the Redemption Price of, the Capital
Securities and the Common Securities, as applicable, shall be made pro rata
based on the Liquidation Amount of the Capital Securities and Common
Securities; provided, however, that if on any Distribution Date or Redemption
Date a Debenture Event of Default shall have occurred and be continuing, no
payment of any Distribution on, or applicable Redemption Price of, any of the
Common Securities, and no other payment on account of the redemption,
liquidation or other acquisition of the Common Securities, shall be made
unless payment in full in cash of all accumulated and unpaid Distributions on
all of the outstanding Capital Securities for all Distribution periods
terminating on or prior thereto or, in the case of Capital Securities called
for redemption on a Redemption Date on or prior thereto, the full amount of
the Redemption Price therefor, shall have been made or provided for, and all
funds available to the Property Trustee shall first be applied to the payment
in full in cash of all Distributions on, or Redemption Price of, the Capital
Securities then due and payable.
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In the case of any Event of Default, the Company as holder of the Common
Securities will be deemed to have waived any right to act with respect to such
Event of Default until the effect of such Event of Default shall have been
cured, waived or otherwise eliminated. Until any such Event of Default has
been so cured, waived or otherwise eliminated, the Property Trustee shall act
solely on behalf of the holders of the Capital Securities and not on behalf of
the Company as holder of the Common Securities, and only the holders of the
Capital Securities will have the right to direct the Property Trustee to act
on their behalf.
EVENTS OF DEFAULT; NOTICE
The occurrence of a Debenture Event of Default (see "Description of Junior
Convertible Subordinated Debentures--Debenture Events of Default") constitutes
an "Event of Default" under the Declaration.
Within 10 business days after the occurrence of any Event of Default
actually known to the Company, the Company shall transmit notice of such Event
of Default to the holders of the Capital Securities, the Administrators and
the Property Trustee, unless such Event of Default shall have been cured or
waived. The Company, as Sponsor, and the Administrators are required to file
annually with the Property Trustee a certificate as to whether or not they are
in compliance with all the conditions and covenants applicable to them under
the Declaration.
If a Debenture Event of Default has occurred and is continuing, the Capital
Securities shall have a preference over the Common Securities as described
under "--Liquidation of the Trust and Distribution of Junior Subordinated
Debentures" and "--Subordination of Common Securities" above.
REMOVAL OF ISSUER TRUSTEES AND ADMINISTRATORS
Unless a Debenture Event of Default shall have occurred and be continuing,
any Issuer Trustee or Administrator may be removed at any time by the holder
of the Common Securities. If a Debenture Event of Default has occurred and is
continuing, the Property Trustee and the Delaware Trustee may be removed at
such time by the holders of a majority in Liquidation Amount of the
outstanding Capital Securities. In no event will the holders of the Capital
Securities have the right to vote to appoint, remove or replace the
Administrators, which voting rights are vested exclusively in the Company as
the holder of the Common Securities. No resignation or removal of an Issuer
Trustee or Administrator and no appointment of a successor trustee or
administrator shall be effective until the acceptance of appointment by the
successor trustee or administrator in accordance with the provisions of the
Declaration.
MERGER OR CONSOLIDATION OF ISSUER TRUSTEES AND ADMINISTRATORS
Any entity into which the Property Trustee, the Delaware Trustee or any
Administrator that is not a natural person may be merged or converted or with
which it may be consolidated, or any entity resulting from any merger,
conversion or consolidation to which such Issuer Trustee or Administrator
shall be a party, or any entity succeeding to all or substantially all the
corporate trust business of such Issuer Trustee or Administrator, shall be the
successor of such Issuer Trustee or Administrator under the Declaration,
provided such entity shall be otherwise qualified and eligible.
MERGERS, CONVERSIONS, CONSOLIDATIONS, AMALGAMATION OR REPLACEMENTS OF THE
TRUST
The Trust may not merge or convert with or into, consolidate, amalgamate, or
be replaced by, or convey, transfer or lease its properties and assets as an
entirety or substantially as an entirety to any corporation or other Person,
except as described below or as otherwise described in " -- Liquidation of the
Trust and Distribution of Junior Subordinated Debentures." The Trust may, at
the request of the Company, as holder of the Common Securities, but without
the consent of the holders of the Capital Securities, merge or convert with or
into, consolidate, amalgamate, or be replaced by or convey, transfer or lease
its properties and assets as an entirety or substantially as an entirety to a
trust organized as such under the laws of any State; provided, that (i) such
successor entity either (a) expressly assumes all of the obligations of the
Trust with respect to the Capital
120
Securities or (b) substitutes for the Capital Securities other securities
having substantially the same terms as the Capital Securities (the "Successor
Securities") so long as the Successor Securities rank the same as the Capital
Securities rank in priority with respect to distributions and payments upon
liquidation, redemption and otherwise, (ii) the Company expressly appoints a
trustee of such successor entity possessing the same powers and duties as the
Property Trustee with respect to the Junior Subordinated Debentures, (iii) the
Successor Securities are listed, or any Successor Securities will be listed
upon notification of issuance, on any national securities exchange or other
organization on which the Capital Securities are then listed or quoted, if
any, (iv) such merger, conversion, consolidation, amalgamation, replacement,
conveyance, transfer or lease does not cause the Capital Securities (including
any Successor Securities) to be downgraded by any nationally recognized
statistical rating organization, (v) such merger, conversion, consolidation,
amalgamation, replacement, conveyance, transfer or lease does not adversely
affect the rights, preferences and privileges of the holders of the Capital
Securities (including any Successor Securities) in any material respect (other
than any dilution of such holders' interests in the new entity), (vi) such
successor entity has a purpose substantially identical to that of the Trust,
(vii) prior to such merger, conversion, consolidation, amalgamation,
replacement, conveyance, transfer or lease, the Company has received an
opinion from independent counsel to the Trust experienced in such matters to
the effect that (a) such merger, conversion, consolidation, amalgamation,
replacement, conveyance, transfer or lease does not adversely affect the
rights, preferences and privileges of the holders of the Capital Securities
(including any Successor Securities) in any material respect (other than any
dilution of such holders' interests in the new entity), and (b) following such
merger, conversion, consolidation, amalgamation, replacement, conveyance,
transfer or lease, neither the Trust nor such successor entity will be
required to register as an investment company under the Investment Company Act
of 1940, as amended (the "Investment Company Act"), and (viii) the Company or
any permitted successor or assignee owns all of the common securities of such
successor entity and guarantees the obligations of such successor entity under
the Successor Securities at least to the extent provided by the Guarantee.
Notwithstanding the foregoing, the Trust shall not, except with the consent of
holders of 100% in Liquidation Amount of the Trust Securities, consolidate,
amalgamate, merge or convert with or into, or be replaced by or convey,
transfer or lease its properties and assets as an entirety or substantially as
an entirety to any other entity or permit any other entity to consolidate,
amalgamate, merge or convert with or into, or replace it if such
consolidation, amalgamation, merger, conversion, replacement, conveyance,
transfer or lease would cause the Trust or the successor entity not to be
classified as a grantor trust for United States federal income tax purposes.
VOTING RIGHTS; AMENDMENT OF THE DECLARATION
Except as provided below and under "--Mergers, Conversions, Consolidations,
Amalgamations or Replacements of the Trust" above and "Description of the
Guarantee--Amendments and Assignment" and as otherwise required by law and the
Declaration, the holders of the Capital Securities will have no voting rights.
The Declaration may be amended from time to time by the Company, the
Property Trustee and the Administrators, without the consent of the holders of
the Trust Securities (i) to cure any ambiguity, correct or supplement any
provisions in the Declaration that may be inconsistent with any other
provision, or to make any other provisions with respect to matters or
questions arising under the Declaration, which shall not be inconsistent with
the other provisions of the Declaration, or (ii) to modify, eliminate or add
to any provisions of the Declaration to such extent as shall be necessary to
ensure that the Trust will be classified for United States federal income tax
purposes as a grantor trust at all times that any Trust Securities are
outstanding or to ensure that the Trust will not be required to register as an
"investment company" under the Investment Company Act; provided, however, that
in the case of clause (i), such action shall not adversely affect in any
material respect the interests of the holders of the Trust Securities. Any
amendments of the Declaration pursuant to the foregoing shall become effective
when notice thereof is given to the holders of the Trust Securities. The
Declaration may be amended by the Issuer Trustees, the Administrators and the
Company (i) with the consent of holders representing a majority (based upon
Liquidation Amount) of the outstanding Trust Securities, and (ii) upon receipt
by the Issuer Trustees and the Administrators of an opinion of counsel to the
effect that such amendment or the exercise of any power granted to the Issuer
Trustees or Administrators in accordance with such amendment will not affect
the Trust's status as a grantor trust for United States federal income tax
purposes or the Trust's
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exemption from status as an "investment company" under the Investment Company
Act, provided that, without the consent of each holder of Trust Securities,
the Declaration may not be amended to (i) change the amount or timing of any
Distribution or other payment on the Trust Securities or otherwise adversely
affect the amount of any Distribution or other payment required to be made in
respect of the Trust Securities as of a specified date or (ii) restrict the
right of a holder of Trust Securities to institute suit for the enforcement of
any such payment on or after such date.
So long as any Junior Subordinated Debentures are held by the Property
Trustee, the Issuer Trustees shall not (i) direct the time, method and place
of conducting any proceeding for any remedy available to the Debenture
Trustee, or executing any trust or power conferred on the Debenture Trustee
with respect to the Junior Subordinated Debentures, (ii) waive certain past
defaults under the Indenture, (iii) exercise any right to rescind or annul a
declaration of acceleration of the maturity of the principal of the Junior
Subordinated Debentures or (iv) consent to any amendment, modification or
termination of the Indenture or the Junior Subordinated Debentures, where such
consent shall be required, without, in each case, obtaining the prior approval
of the holders of a majority in Liquidation Amount of all outstanding Capital
Securities; provided, however, that where a consent under the Indenture would
require the consent of each holder of Junior Subordinated Debentures affected
thereby, no such consent shall be given by the Property Trustee without the
prior approval of each holder of the Capital Securities. The Issuer Trustees
shall not revoke any action previously authorized or approved by a vote of the
holders of the Capital Securities except by subsequent vote of such holders.
The Property Trustee shall notify each holder of Capital Securities of any
notice of default with respect to the Junior Subordinated Debentures. In
addition to obtaining the foregoing approvals of such holders of the Capital
Securities, prior to taking any of the foregoing actions, the Issuer Trustees
shall obtain an opinion of counsel experienced in such matters to the effect
that such action will not affect the Trust's status as a grantor trust for
United States federal income tax purposes.
Any required approval of holders of Capital Securities may be given at a
meeting of such holders convened for such purpose or pursuant to written
consent. The Property Trustee will cause a notice of any meeting at which
holders of Capital Securities are entitled to vote, or of any matter upon
which action by written consent of such holders is to be taken, to be given to
each holder of record of Capital Securities in the manner set forth in the
Declaration.
No vote or consent of the holders of Capital Securities will be required for
the Trust to redeem and cancel the Capital Securities in accordance with the
Declaration.
Notwithstanding that holders of the Capital Securities are entitled to vote
or consent under any of the circumstances described above, any of the Capital
Securities that are owned by the Company or any affiliate of the Company
shall, for purposes of such vote or consent, be treated as if they were not
outstanding.
FORM, DENOMINATION, BOOK-ENTRY PROCEDURES AND TRANSFER
The Capital Securities to be issued in the Offering may be transferred or
exchanged in the manner and at the offices described below.
The Capital Securities to be issued in the Offering initially will be
represented by one or more Capital Securities in registered, global form
(collectively, the "Global Capital Securities"). The Global Capital Securities
will be deposited upon issuance with the Property Trustee as custodian for
DTC, in New York, New York, and registered in the name of DTC or its nominee,
in each case for credit to an account of a direct or indirect participant in
DTC, as described below.
Except as set forth below, the Global Capital Securities may be transferred,
in whole and not in part, only to another nominee of DTC or to a successor of
DTC or its nominee. Beneficial interests in the Global Capital Securities may
not be exchanged for Certificated Capital Securities except in the limited
circumstances described under "--Exchange of Book-Entry Capital Securities for
Certificated Capital Securities" below. In addition, transfer of beneficial
interests in the Global Capital Securities will be subject to the applicable
rules and procedures of DTC and its direct or indirect participants, which may
change from time to time.
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DEPOSITARY PROCEDURES
DTC has advised the Trust and the Company that DTC is a limited-purpose
trust company created to hold securities for its participating organizations
(collectively, the "Participants") and to facilitate the clearance and
settlement of transactions in those securities between Participants through
electronic book-entry changes in accounts of its Participants. The
Participants include securities brokers and dealers, banks, trust companies,
clearing corporations and certain other organizations. Access to DTC's system
is also available to other entities such as banks, brokers, dealers and trust
companies that clear through or maintain a custodial relationship with a
Participant, either directly or indirectly (collectively, the "Indirect
Participants"). Persons who are not Participants may beneficially own
securities held by or on behalf of DTC only through the Participants or the
Indirect Participants. The ownership interest and transfer of ownership
interest of each actual purchaser of each security held by or on behalf of DTC
are recorded on the records of the Participants and Indirect Participants.
DTC has also advised the Trust and the Company that, pursuant to procedures
established by it, (i) upon deposit of the Global Capital Securities, DTC will
credit the accounts of Participants on behalf of purchasers of the Capital
Securities with portions of the Liquidation Amount of the Global Capital
Securities and (ii) ownership of such interests in the Global Capital
Securities will be shown on, and the transfer of ownership thereof will be
effected only through, records maintained by DTC (with respect to the
Participants) or by the Participants and the Indirect Participants (with
respect to other owners of beneficial interests in the Global Capital
Securities).
Investors in the Global Capital Securities may hold their interests therein
directly through DTC if they are Participants in such system, or indirectly
through organizations which are Participants in such system. All interests in
a Global Capital Security may be subject to the procedures and requirements of
DTC. The laws of some states require that certain persons take physical
delivery in certificated form of securities that they own. Consequently, the
ability to transfer beneficial interests in a Global Capital Security to such
persons will be limited to that extent. Because DTC can act only on behalf of
Participants, which in turn act on behalf of Indirect Participants and certain
banks, the ability of a person having beneficial interests in a Global Capital
Security to pledge such interests to persons or entities that do not
participate in the DTC system, or otherwise take actions in respect of such
interests, may be affected by the lack of a physical certificate evidencing
such interests. For certain other restrictions on the transferability of the
Capital Securities, see "--Exchange of Book-Entry Capital Securities for
Certificated Capital Securities."
Except as described below, owners of interests in the Global Capital
Securities will not have Capital Securities registered in their name, will not
receive physical delivery of Certificated Capital Securities and will not be
considered the registered owners or holders thereof under the Declaration for
any purpose.
Payments in respect of the Global Capital Security registered in the name of
DTC or its nominee will be payable by the Property Trustee to DTC in its
capacity as the registered holder under the Declaration. Under the terms of
the Declaration, the Property Trustee will treat the persons in whose names
the Capital Securities, including the Global Capital Securities, are
registered as the owners thereof for the purpose of receiving such payments
and for any and all other purposes whatsoever. Consequently, neither the
Property Trustee nor any agent thereof has or will have any responsibility or
liability for (i) any aspect of DTC's records or any Participant's or Indirect
Participant's records relating to or payments made on account of beneficial
ownership interests in the Global Capital Securities, or for maintaining,
supervising or reviewing any of DTC's records or any Participant's or Indirect
Participant's records relating to the beneficial ownership interests in the
Global Capital Securities or (ii) any other matter relating to the actions and
practices of DTC or any of its Participants or Indirect Participants. DTC has
advised the Trust and the Company that its current practice, upon receipt of
any payment in respect of securities such as the Capital Securities, is to
credit the accounts of the relevant Participants with the payment on the
payment date, in amounts proportionate to their respective holdings in
Liquidation Amount of beneficial interests in the relevant security as shown
on the records of DTC unless DTC has reason to believe it will not receive
payment on such payment date. Payments by the Participants and the Indirect
Participants to the beneficial owners of Capital Securities will be governed
by standing instructions and customary practices and will be the
responsibility of the Participants or the Indirect Participants and will not
be
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the responsibility of DTC, the Property Trustee, the Trust or the Company.
Neither the Trust nor the Company or the Property Trustee will be liable for
any delay by DTC or any of its Participants in identifying the beneficial
owners of the Capital Securities, and the Trust or the Company and the
Property Trustee may conclusively rely on and will be protected in relying on
instructions from DTC or its nominee for all purposes.
Beneficial owners of Capital Securities who desire to convert their Capital
Securities into Common Stock should contact their brokers or other
Participants or Indirect Participants to obtain information on procedures,
including proper forms and cut-off times, for submitting such requests. See
"--Conversion Rights."
DTC has advised the Trust and the Company that it will take any action
permitted to be taken by a holder of Capital Securities only at the direction
of one or more Participants to whose account with DTC interests in the Global
Capital Securities are credited and only in respect of such portion of the
Liquidation Amount of the Capital Securities as to which such Participant or
Participants has or have given such direction. However, if there is an Event
of Default under the Declaration, DTC reserves the right to exchange the
Global Capital Securities for Certificated Capital Securities and to
distribute such Capital Securities to its Participants.
The information in this section concerning DTC and book-entry systems has
been obtained from sources that the Trust and the Company believe to be
reliable, but neither the Trust nor the Company takes responsibility for the
accuracy thereof.
EXCHANGE OF BOOK-ENTRY CAPITAL SECURITIES FOR CERTIFICATED CAPITAL SECURITIES
A Global Capital Security is exchangeable for Certificated Capital
Securities if (i) DTC (x) notifies the Company that it is unwilling or unable
to continue as depositary for the Global Capital Security and the Company
thereupon fails to appoint a successor depositary within 90 days or (y) has
ceased to be a clearing agency registered under the Exchange Act and the
Company thereupon fails to appoint a successor depositary within 90 days, (ii)
the Company in its sole discretion elects to cause the issuance of the Capital
Securities in certificated form or (iii) there shall have occurred and be
continuing an Event of Default or any event which after notice or lapse of
time or both would be an Event of Default under the Declaration. In addition,
beneficial interests in a Global Capital Security may be exchanged for
Certificated Capital Securities upon request but only upon at least 20 days
prior written notice given to the Property Trustee by or on behalf of DTC in
accordance with customary procedures. In all cases, Certificated Capital
Securities delivered in exchange for any Global Capital Security or beneficial
interests therein will be registered in the names, and issued in any approved
denominations, requested by or on behalf of DTC (in accordance with its
customary procedures).
PAYMENT AND PAYING AGENCY
Payments in respect of the Capital Securities held in global form shall be
made to DTC, which shall credit the relevant accounts at DTC on the applicable
Distribution Dates or, in respect of the Capital Securities that are not held
by DTC, such payments shall be made by check mailed to the address of the
holder entitled thereto as such address shall appear on the register. The
paying agent (the "Paying Agent") shall initially be the Property Trustee and
any co-paying agent chosen by the Property Trustee and acceptable to the
Company, as holder of the Common Securities. The Paying Agent shall be
permitted to resign as Paying Agent upon 30 days written notice to the
Property Trustee and the Company. In the event that the Property Trustee shall
no longer be the Paying Agent, the Company, as holder of the Common
Securities, shall appoint a successor (which shall be a bank or trust company)
to act as Paying Agent.
REGISTRAR, TRANSFER AGENT AND CONVERSION AGENT
The Property Trustee will act as registrar, transfer agent and Conversion
Agent for the Capital Securities.
Registration of transfers of the Capital Securities will be effected without
charge by or on behalf of the Trust but upon payment of any tax or other
governmental charges that may be imposed in connection with any
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transfer or exchange. The Trust will not be required to register or cause to
be registered the transfer of any Capital Securities (i) during the period
starting 15 days before the mailing of a notice of redemption and ending on
the date of such mailing and (ii) after they have been called for redemption.
INFORMATION CONCERNING THE PROPERTY TRUSTEE
The Property Trustee is under no obligation to exercise any of the powers
vested in it by the Declaration at the request of any holder of Trust
Securities unless it is offered reasonable indemnity against the costs,
expenses and liabilities that might be incurred thereby. If no Event of
Default has occurred and is continuing and the Property Trustee is required to
decide between alternative causes of action, construe ambiguous provisions in
the Declaration or is unsure of the application of any provision of the
Declaration, and the matter is not one on which holders of the Capital
Securities or the Common Securities are entitled under the Declaration to
vote, then the Property Trustee shall take such action as is directed by the
Company and, if not so directed, shall take such action as it deems advisable
and in the best interests of the holders of the Trust Securities and will have
no liability except for its own bad faith, negligence or willful misconduct.
MISCELLANEOUS
The Administrators are authorized and directed to conduct the affairs of and
to operate the Trust in such a way that the Trust will not be deemed to be an
"investment company" required to be registered under the Investment Company
Act, so that the Trust will be classified for United States federal income tax
purposes as a grantor trust and so that the Junior Subordinated Debentures
will be treated as indebtedness of the Company for United States federal
income tax purposes. In this connection, the Company and the Administrators
are authorized to take any action, not inconsistent with applicable law, the
certificate of trust of the Trust or the Declaration, that the Company and the
Administrators determine in their discretion to be necessary or desirable for
such purposes, as long as such action does not materially adversely affect the
interests of the holders of the Trust Securities.
Holders of the Trust Securities have no preemptive or similar rights.
The Trust may not borrow money, issue debt, execute mortgages or pledge any
of its assets.
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DESCRIPTION OF JUNIOR CONVERTIBLE SUBORDINATED DEBENTURES
The Junior Subordinated Debentures are to be issued under an Indenture (the
"Indenture"), between the Company and State Street, as trustee (the "Debenture
Trustee"). The Indenture will be qualified under the Trust Indenture Act. This
summary of certain terms and provisions of the Junior Subordinated Debentures
and the Indenture does not purport to be complete and, where reference is made
to particular provisions of the Indenture, such provisions, including the
definitions of certain terms, some of which are not otherwise defined herein,
are qualified in their entirety by reference to all of the provisions of the
Indenture and the Trust Indenture Act.
GENERAL
Concurrently with the issuance of the Capital Securities, the Trust will
invest the proceeds thereof, together with the consideration paid by the
Company for the Common Securities, in Junior Subordinated Debentures issued by
the Company. The Junior Subordinated Debentures will bear interest at the
annual rate of % of the principal amount thereof, payable quarterly in
arrears on March 15, June 15, September 15, and December 15 of each year
(each, an "Interest Payment Date"), commencing March 15, 1998, to the person
in whose name each Junior Subordinated Debenture is registered, subject to
certain exceptions, at the close of business on the fifteenth day of the month
in which the relevant Interest Payment Date falls (each, a "Payment Record
Date"). It is anticipated that, until the liquidation, if any, of the Trust,
each Junior Subordinated Debenture will be held in the name of the Property
Trustee in trust for the benefit of the holders of Trust Securities. The
amount of interest payable for any period will be computed on the basis of a
360-day year of twelve 30-day months and, for any period of less than a full
calendar month, the number of days elapsed in such month. In the event that
any date on which interest is payable on the Junior Subordinated Debentures is
not a Business Day, then payment of the interest payable on such date will be
made on the next succeeding day that is a Business Day (and without any
interest or other payment in respect of any such delay), with the same force
and effect as if made on the date such payment was originally payable. Accrued
interest that is not paid on the applicable Interest Payment Date will bear
additional interest on the amount thereof (to the extent permitted by law) at
the rate per annum of % thereof, compounded quarterly. The term "interest,"
as used herein, shall include quarterly interest payments, interest on
quarterly interest payments not paid on the applicable Interest Payment Date
and Additional Sums (as defined herein), as applicable. The Junior
Subordinated Debentures will mature on , 2027 (the "Stated Maturity
Date").
The Junior Subordinated Debentures will rank pari passu with all Other
Debentures and will be unsecured and subordinate and rank junior in right of
payment to the extent and in the manner set forth in the Indenture to all
Senior Indebtedness of the Company. See "--Subordination" below. Because the
Company is a holding company, the right of the Company to participate in any
distribution of assets of any subsidiary upon such subsidiary's liquidation or
reorganization or otherwise (and thus the ability of holders of the Capital
Securities to benefit indirectly from such distribution) is subject to the
prior claims of creditors of that subsidiary (including depositors in the case
of the Bank), except to the extent that the Company may itself be recognized
as a creditor of that subsidiary. At September 30, 1997, the subsidiaries of
the Company had total liabilities (excluding liabilities owed to the Company)
of approximately $242.6 million, including deposits, in the case of the Bank.
Accordingly, the Capital Securities will be effectively subordinated to all
existing and future liabilities of the Company's subsidiaries, and holders of
Capital Securities should look only to the assets of the Company for payments
on the Capital Securities. The Indenture does not limit the incurrence or
issuance of other secured or unsecured debt of the Company, including Senior
Indebtedness, whether under any other indenture that the Company may enter
into in the future or otherwise, and does not limit the incurrence or issuance
of secured or unsecured debt by the Company's subsidiaries. See "--
Subordination" below.
In addition, as the Company is a holding company, a majority of the
operating assets of the Company are owned by the Company's subsidiaries. The
Company may rely on dividends from such subsidiaries to meet its obligations
for payment of principal and interest on its outstanding debt obligations, if
any, and corporate expenses. To the extent that the Company becomes dependent
on the Bank for such payments, the Bank will be
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subject to certain restrictions imposed by federal law on any extensions of
credit to, and certain other transactions with, the Company and certain other
affiliates, and on investments in stock or other securities thereof. Such
restrictions prevent the Company and such other affiliates from borrowing from
the Bank unless the loans are secured by various types of collateral. Further,
such secured loans, other transactions and investments by the Bank are generally
limited in amount as to the Company and as to each of such other affiliates to
10% of the Bank's capital and surplus and as to the Company and all of such
other affiliates to an aggregate of 20% of the Bank's capital and surplus. In
addition, payment of dividends to the Company by the Bank is subject to ongoing
review by banking regulators and is subject to various statutory limitations and
in certain circumstances requires prior approval by banking regulatory
authorities. Under current OTS regulations, at October 1, 1997 the Bank could
have declared dividends to the Company of approximately $ million, of
which approximately $ million has been subsequently declared and paid to
the Company. Federal regulatory agencies also have the authority to limit
further the Bank's payment of dividends based on other factors, such as the
maintenance of adequate capital for the Bank, which could reduce the amount of
dividends otherwise payable.
FORM, REGISTRATION AND TRANSFER
If the Junior Subordinated Debentures are distributed to the holders of the
Capital Securities issued in the Public Offering, the Junior Subordinated
Debentures may be represented by one or more global certificates registered in
the name of Cede & Co. as the nominee of DTC. The depositary arrangements for
such Junior Subordinated Debentures are expected to be substantially similar
to those in effect for the Capital Securities issued in the Offering. For a
description of DTC and the terms of the depositary arrangements relating to
payments, transfers, voting rights, redemptions and other notices and other
matters, see "Description of Capital Securities--Form, Denomination, Book-
Entry Procedures and Transfer."
PAYMENT AND PAYING AGENTS
Payment of principal of and premium, if any, and any interest on Junior
Subordinated Debentures will be made at the office of the Debenture Trustee in
Boston, Massachusetts or at the office of such Paying Agent or Paying Agents
as the Company may designate from time to time, except that at the option of
the Company payment of any interest may be made (i) by check mailed to the
address of the Person entitled thereto as such address shall appear in the
register for Junior Subordinated Debentures or (ii) by transfer to an account
maintained by the Person entitled thereto as specified in such register,
provided that proper transfer instructions have been received by the relevant
Record Date. Payment of any interest on any Junior Subordinated Debenture will
be made to the Person in whose name such Junior Subordinated Debenture is
registered at the close of business on the Payment Record Date for such
interest, except in the case of defaulted interest. The Company may at any
time designate additional Paying Agents or rescind the designation of any
Paying Agent; however, the Company will at all times be required to maintain a
Paying Agent in each place of payment for the Junior Subordinated Debentures.
Any monies deposited with the Debenture Trustee or any Paying Agent, or then
held by the Company in trust, for the payment of the principal of and premium,
if any, or interest on any Junior Subordinated Debenture and remaining
unclaimed for two years after such principal and premium, if any, or interest
has become due and payable shall, at the request of the Company, be repaid to
the Company and the holder of such Junior Subordinated Debenture shall
thereafter look, as a general unsecured creditor, only to the Company for
payment thereof.
OPTION TO EXTEND INTEREST PAYMENT DATE
So long as no Debenture Event of Default has occurred and is continuing, the
Company will have the right under the Indenture at any time during the term of
the Junior Subordinated Debentures to defer the payment of interest at any
time or from time to time for a period not exceeding 20 consecutive quarters
with respect to each Extension Period, provided that no Extension Period will
end on a day other than an Interest Payment Date for the Junior Subordinated
Debentures or extend beyond the Stated Maturity Date. At the end of an
Extension Period, the Company must pay all interest then accrued and unpaid
(together with interest thereon accrued at the
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annual rate of %, compounded quarterly, to the extent permitted by
applicable law). During an Extension Period, interest will continue to accrue
and, if the Junior Subordinated Debentures have been distributed to holders of
the Trust Securities, holders of Junior Subordinated Debentures (or holders of
the Trust Securities while Trust Securities are outstanding) will be required
to accrue OID in respect of the stated interest on the Capital Securities for
United States federal income tax purposes prior to the receipt of cash
attributable to such income. See "Certain Federal Income Tax Considerations--
Interest, Original Issue Discount, Premium and Market Discount."
During any such Extension Period, the Company may not (i) declare or pay any
dividends or distributions on, or redeem, purchase, acquire, or make a
liquidation payment with respect to, any of the Company's capital stock, (ii)
make any payment of principal, interest or premium, if any, on or repay,
repurchase or redeem any debt securities of the Company (including any Other
Debentures) that rank pari passu with or junior in right of payment to the
Junior Subordinated Debentures or (iii) make any guarantee payments with
respect to any guarantee by the Company of any securities of any subsidiary of
the Company (including Other Guarantees) if such guarantee ranks pari passu
with or junior in right of payment to the Junior Subordinated Debentures,
other than (a) dividends or distributions in shares of or options, warrants or
rights to subscribe for or purchase shares of, Common Stock or preferred stock
of the Company, (b) any declaration of a dividend in connection with the
implementation of a stockholders' rights plan, or the issuance of stock under
any such plan in the future, or the redemption or repurchase of any such
rights pursuant thereto, (c) payments under the Guarantee, (d) as a direct
result of, and only to the extent required in order to avoid the issuance of
fractional shares of capital stock following, a reclassification of the
Company's capital stock or the exchange or conversion of one class or series
of the Company's capital stock for another class or series of the Company's
capital stock, (e) the purchase of fractional interests in shares of the
Company's capital stock pursuant to the conversion or exchange provisions of
such capital stock or the security being converted or exchanged, and (f)
purchases of Common Stock related to the issuance of Common Stock or rights
under any of the Company's benefit plans for its directors, officers or
employees.
Prior to the termination of any such Extension Period, the Company may
further extend such Extension Period, provided that such extension does not
cause such Extension Period to exceed 20 consecutive quarters or to extend
beyond the Stated Maturity Date. Upon the termination of any such Extension
Period and the payment of all amounts then due on any Interest Payment Date,
the Company may elect to begin a new Extension Period, subject to the above
requirements. No interest shall be due and payable during an Extension Period,
except at the end thereof. The Company must give the Property Trustee, the
Administrators and the Debenture Trustee notice of its election of any
Extension Period (or an extension thereof) at least five Business Days prior
to the earlier of (i) the date the Distributions on the Trust Securities would
have been payable except for the election to begin or extend such Extension
Period or (ii) the date the Administrators are required to give notice to any
securities exchange or to holders of Capital Securities of the Distribution
Record Date or the date such Distributions are payable, but in any event not
less than five Business Days prior to such record date. The Debenture Trustee
shall give notice of the Company's election to begin or extend a new Extension
Period to the holders of the Capital Securities. There is no limitation on the
number of times that the Company may elect to begin an Extension Period.
OPTIONAL PREPAYMENT
The Junior Subordinated Debentures will be prepayable, in whole or in part,
at the option of the Company at any time on or after , , at a
prepayment price (the "Optional Prepayment Price") equal to the percentage of
the outstanding principal amount of the Junior Subordinated Debentures
specified below, plus, in each case, accrued interest thereon to the date of
prepayment:
On or after , : 100.000%
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SPECIAL EVENT PREPAYMENT
If a Special Event shall occur and be continuing, the Company may, at any
time prior to or after the Initial Optional Prepayment Date, within 90 days
after the occurrence of the Special Event, at its option, prepay the Junior
Subordinated Debentures in whole, but not in part, at a prepayment price (the
"Special Event Prepayment Price") equal to 100% of the principal amount of
such Junior Subordinated Debentures plus accrued and unpaid interest thereon
to the date of prepayment.
A "Special Event" means a Tax Event, a Regulatory Capital Event or an
Investment Company Event, as the case may be.
A "Tax Event" means (a) the receipt by the Company and the Trust of an
opinion of Muldoon, Murphy & Faucette or any other nationally recognized tax
counsel experienced in such matters, to the effect that as a result of (i) any
amendment to, clarification of, or change (including any announced prospective
change) in, the laws or any regulations thereunder of the United States or any
political subdivision or taxing authority thereof or therein, (ii) any
amendment to, clarification of, or change in, an interpretation or application
of any such laws or regulations by any legislative body, court, governmental
agency or regulatory authority (including the enactment of any legislation and
the publication of any judicial decision or regulatory determination or the
publication of an explanation of legislation by the staff of the Joint
Committee on Taxation), (iii) any interpretation or pronouncement that
provides for a position with respect to such laws or regulations that differs
from the theretofore generally accepted position or (iv) any judicial
decision, administrative pronouncement, ruling, regulatory procedure, notice,
announcement (including any notice or announcement of intent to adopt
procedures or regulations) or any other actions taken by any governmental
agency or regulatory authority, which amendment or change is enacted,
promulgated, issued or announced or which interpretation or pronouncement is
issued or announced or which action is taken, in each case, on or after the
Issue Date, there is more than an insubstantial risk that (x) the Trust is or
within 90 days will be subject to United States federal income tax with
respect to income received or accrued on the Junior Subordinated Debentures,
(y) interest payable by the Company on the Junior Subordinated Debentures is
not or within 90 days will not be deductible by the Company, in whole or in
part, for United States federal income tax purposes, or (z) the Trust is or
within 90 days will be subject to more than a de minimis amount of other
taxes, duties or other governmental charges, or (b) a proposed audit
adjustment by a taxing authority which, if sustained, would result in any of
the events described in clauses (x), (y) or (z) above (without regard to the
90-day period referred to therein).
A "Regulatory Capital Event" means the receipt by the Company and the Trust
of an opinion of Muldoon, Murphy & Faucette or any other independent bank
regulatory counsel experienced in such matters, to the effect that, as a
result of (a) any amendment to, or change (including any announced prospective
change) in, the laws (or any regulations thereunder) of the United States or
any rules, guidelines or policies of the OTS, the Board of Governors of the
Federal Reserve System (the "Federal Reserve") or any other federal bank
regulatory agency or (b) any official administrative pronouncement or judicial
decision interpreting or applying such laws or regulations, which amendment or
change is effective or such pronouncement or decision is announced on or after
the Issue Date, (i) the Company is or within 90 days will be subject to
capital adequacy requirements and such requirements do not or will not permit
the Capital Securities to constitute Tier 1 capital (or its then-equivalent),
provided that limitations on inclusion of the Capital Securities in Tier 1
capital that are no more stringent than Federal Reserve capital guidelines in
effect as of the date of this Prospectus shall not constitute a Regulatory
Capital Event or (ii) the amount of net proceeds received from the sale of the
Capital Securities and contributed by the Company to the Bank does not or
within 90 days will not constitute Tier 1 (core) capital (or its then-
equivalent).
An "Investment Company Event" means the receipt by the Company and the Trust
of an opinion of Muldoon, Murphy & Faucette or any other nationally recognized
counsel experienced in such matters, to the effect that (a) as a result of any
amendment to, or change (including any announced prospective change) in, the
laws or any regulations thereunder of the United States or any political
subdivision or authority thereof or therein or (b) any official administrative
pronouncement or judicial decision interpreting or applying such laws or
regulations, which amendment or change is effective or such pronouncement or
decision is announced on or after
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the Issue Date, there is more than an insubstantial risk that the Trust is or
within 90 days will be considered an "investment company" that is required to
be registered under the Investment Company Act.
"Additional Sums" means such additional amounts as may be necessary in order
that the amount of Distributions then due and payable by the Trust on the
outstanding Capital Securities and Common Securities shall not be reduced as a
result of any additional taxes, duties or other governmental charges to which
the Trust has become subject as a result of a Tax Event.
Notice of any prepayment will be mailed at least 30 days but not more than
60 days before the prepayment date to each holder of Junior Subordinated
Debentures to be prepaid at its registered address. Unless the Company
defaults in payment of the prepayment price, on and after the prepayment date
interest ceases to accrue on such Junior Subordinated Debentures called for
prepayment.
If the Trust is required to pay any additional taxes, duties or other
governmental charges as a result of a Tax Event, the Company will pay as
additional amounts on the Junior Subordinated Debentures the Additional Sums.
CERTAIN COVENANTS OF THE COMPANY
If (1) a Debenture Event of Default occurs (other than solely a default as
described in paragraph (iii) under "--Debenture Events of Default" below), (2)
there shall have occurred any event of which the Company has actual knowledge
that (a) with the giving of notice or the lapse of time, or both, would be, a
Debenture Event of Default (other than solely a default as described in
paragraph (iii) under "--Debenture Events of Default") and (b) in respect of
which the Company shall not have taken reasonable steps to cure, (3) the
Company shall be in default with respect to its payment of any obligations
under the Guarantee or (4) the Company shall have given notice of its election
of an Extension Period, or any extension thereof, as provided in the Indenture
and shall not have rescinded such notice, and such Extension Period, or any
extension thereof, shall have commenced, then the Company will not (i) declare
or pay any dividends or distributions on, or redeem, purchase, acquire, or
make a liquidation payment with respect to, any of the Company's capital stock
or (ii) make any payment of principal, interest or premium, if any, on or
repay or repurchase or redeem any debt securities of the Company (including
Other Debentures) that rank pari passu with or junior in right of payment to
the Junior Subordinated Debentures or (iii) make any guarantee payments with
respect to any guarantee by the Company of any securities of any subsidiary of
the Company (including Other Guarantees) if such guarantee ranks pari passu or
junior in right of payment to the Junior Subordinated Debentures, other than
(a) dividends or distributions in shares of, or options, warrants or rights to
subscribe for or purchase shares of, Common Stock or preferred stock of the
Company, (b) any declaration of a dividend in connection with the
implementation of a stockholders' rights plan, or the issuance of stock under
any such plan in the future, or the redemption or repurchase of any such
rights pursuant thereto, (c) payments under the Guarantee, (d) as a direct
result of, and only to the extent required in order to avoid the issuance of
fractional shares of capital stock following, a reclassification of the
Company's capital stock or the exchange or conversion of one class or series
of the Company's capital stock for another class or series of the Company's
capital stock, (e) the purchase of fractional interests in shares of the
Company's capital stock pursuant to the conversion or exchange provisions of
such capital stock or the security being converted or exchanged, and (f)
purchases of Common Stock related to the issuance of Common Stock or rights
under any of the Company's benefit plans for its directors, officers or
employees.
The Company will also covenant to (i) maintain 100% ownership of the Common
Securities; provided, however, that any permitted successor of the Company
under the Indenture may succeed to the Company's ownership of the Common
Securities, (ii) use its reasonable efforts to cause the Trust (a) to remain a
statutory business trust, except in connection with the distribution of Junior
Subordinated Debentures to the holders of Trust Securities in liquidation of
the Trust, the redemption of all of the Trust Securities of the Trust, or
certain mergers, consolidations or amalgamations, each as permitted by the
Declaration of the Trust, and (b) to continue not to be classified as an
association taxable as a corporation or a partnership for United States
federal income
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tax purposes and (iii) use its reasonable efforts to cause each holder of
Trust Securities to be treated as owning an undivided beneficial interest in
the Junior Subordinated Debentures.
DEBENTURE EVENTS OF DEFAULT
The Indenture provides that any one or more of the following described
events with respect to the Junior Subordinated Debentures constitutes a
"Debenture Event of Default" (whatever the reason for such Debenture Event of
Default and whether it shall be voluntary or involuntary or be effected by
operation of law or pursuant to any judgment, decree or order of any court or
any order, rule or regulation of any administrative or governmental body):
(i) failure for 30 days to pay any interest on the Junior Subordinated
Debentures or any Other Debentures, when due (subject to the deferral of
any due date in the case of an Extension Period); or
(ii) failure to pay any principal or premium, if any, on the Junior
Subordinated Debentures or any Other Debentures when due whether at
maturity, upon redemption, by declaration of acceleration of maturity or
otherwise; or
(iii) failure to observe or perform in any material respect certain other
covenants contained in the Indenture for 90 days after written notice to
the Company from the Debenture Trustee or the holders of at least 25% in
aggregate outstanding principal amount of Junior Subordinated Debentures;
or
(iv) certain events in bankruptcy, insolvency or reorganization of the
Company.
The holders of a majority in aggregate outstanding principal amount of the
Junior Subordinated Debentures have the right to direct the time, method and
place of conducting any proceeding for any remedy available to the Debenture
Trustee. The Debenture Trustee or the holders of not less than 25% in
aggregate outstanding principal amount of the Junior Subordinated Debentures
may declare the principal due and payable immediately upon a Debenture Event
of Default. The holders of a majority in aggregate outstanding principal
amount of the Junior Subordinated Debentures may annul such declaration and
waive the default if the default (other than the nonpayment of the principal
of the Junior Subordinated Debentures which has become due solely by such
acceleration) has been cured and a sum sufficient to pay all matured
installments of interest and principal due otherwise than by acceleration has
been deposited with the Debenture Trustee.
The holders of a majority in aggregate outstanding principal amount of the
Junior Subordinated Debentures affected thereby may, on behalf of the holders
of all the Junior Subordinated Debentures, waive any past default except a
default in the payment of principal of or premium, if any, or interest on, the
Junior Subordinated Debentures (unless such default has been cured and a sum
sufficient to pay all matured installments of interest and premium, if any,
and principal due otherwise than by acceleration has been deposited with the
Debenture Trustee) or a default in respect of a covenant or provision which
under the Indenture cannot be modified or amended without the consent of the
holder of each outstanding Junior Subordinated Debenture.
The Indenture requires the annual filing by the Company with the Debenture
Trustee of a certificate as to the absence of certain defaults under the
Indenture.
The Indenture provides that the Debenture Trustee may withhold notice of a
Debenture Event of Default from the holders of the Junior Subordinated
Debentures (except a Debenture Event of Default in payment of principal of, or
of interest or premium on, the Junior Subordinated Debentures) if the
Debenture Trustee considers it in the interest of such holders to do so.
CONVERSION OF THE JUNIOR SUBORDINATED DEBENTURES
Junior Subordinated Debentures will be convertible at any time prior to the
earlier of (i) 5:00 p.m. (Eastern time) on the Business Day immediately
preceding the date of repayment of such Junior Subordinated Debentures,
whether at maturity or upon prepayment, and (ii) 5:00 p.m. (Eastern time) on
the Conversion Termination Date
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(if any), into Common Stock at the option of the holders of the Junior
Subordinated Debentures at the Conversion Price referred to on the cover page
of this Prospectus, subject to the Conversion Price adjustments described
under "Description of Capital Securities--Conversion Rights." The Trust will
covenant not to convert Junior Subordinated Debentures held by it except
pursuant to a conversion request delivered to the Conversion Agent by a holder
of Capital Securities. Upon surrender of a Capital Security to the Conversion
Agent for conversion, the Trust will distribute $ principal amount of
the Junior Subordinated Debentures to the Conversion Agent on behalf of the
holder of the Capital Security so converted, whereupon the Conversion Agent
will convert such Junior Subordinated Debentures into Common Stock on behalf
of such holder. The Company's delivery to the holders of the Junior
Subordinated Debentures (through the Conversion Agent) of the fixed number of
shares of Common Stock into which the Junior Subordinated Debentures are
convertible (together with the cash payment, if any, in lieu of fractional
shares) will be deemed to satisfy the Company's obligation to pay the
principal amount of the Junior Subordinated Debentures so converted, and the
accrued and unpaid interest thereon attributable to the period from the last
date to which interest has been paid or duly provided for; provided, however,
that if any Junior Subordinated Debenture is converted after a Payment Record
Date, the interest payable on the related Interest Payment Date with respect
to such Junior Subordinated Debenture shall be paid to the Trust (which will
distribute such interest to the holder of such Junior Subordinated Debentures
on the Payment Record Date) or other holder of such Junior Subordinated
Debenture on the Payment Record Date, as the case may be, despite such
conversion; provided, further, that if notice of prepayment of Junior
Subordinated Debentures is mailed or otherwise given to holders of Junior
Subordinated Debentures or the Trust issues a press release announcing a
Conversion Termination Date, then, if any holder of Junior Subordinated
Debentures converts any Junior Subordinated Debentures into Common Stock on
any date on or after the date on which such notice of prepayment is mailed or
otherwise given or the date of such press release, as the case may be, and if
such date of conversion falls on any day from and including the first day of
an Extension Period and on or prior to the Interest Payment Date on which such
Extension Period ends, such converting holder shall be entitled to receive
either (i) if the date of such conversion falls after a Payment Record Date
and on or prior to the next succeeding Interest Payment Date, all accrued and
unpaid interest on such Junior Subordinated Debentures to such Interest
Payment Date or (ii) if the date of such conversion does not fall on a date
described in clause (i) above, all accrued and unpaid interest on such Junior
Subordinated Debentures to the most recent Interest Payment Date prior to the
date of such conversion, which interest shall, in either such case, be paid to
such converting holder, unless the date of conversion of such Junior
Subordinated Debentures is on or prior to the Interest Payment Date upon which
such Extension Period ends and after the Payment Record Date for such Interest
Payment Date, in which case such interest shall be paid to the person who was
the holder of such Junior Subordinated Debentures (or one or more predecessor
Junior Subordinated Debentures) at 5:00 p.m. (Eastern time) on such Payment
Record Date, which amount shall be simultaneously distributed to the holders
of the Capital Securities so that any holder of Capital Securities who
delivers such Capital Securities for conversion (or who held such converted
Capital Securities at 5:00 p.m. (Eastern time) on the Payment Record Date for
the Interest Payment Date upon which such Extension Period ends, as the case
may be) under the circumstances and during the periods described above will be
entitled to receive accumulated and unpaid Distributions in a corresponding
amount. See "Description of Capital Securities--Conversion Rights" and "--
Redemption."
On and after , , the Company may, at its option, terminate the
conversion rights of holders of the Junior Subordinated Debentures if (i) the
Company is then current in the payment of interest on the Junior Subordinated
Debentures (except to the extent that the payment of interest has been duly
deferred as the result of an Extension Period) and (ii) for at least 20
trading days within any period of 30 consecutive trading days ending on or
after , , including the last trading day of such period, the Closing
Price of the Common Stock shall have exceeded % of the then applicable
Conversion Price of the Junior Subordinated Debentures. In order to exercise
this conversion termination option, the Company must cause the Trust to issue
(or, if the Junior Subordinated Debentures shall have been distributed to
holders of the Capital Securities following a Special Event, the Company must
issue) a press release for publication on the Dow Jones News Service or on a
comparable news service announcing the Conversion Termination Date prior to
the opening of business on the second trading day after a period in which the
condition in the preceding sentence has been met, but in no event prior to
, . The press release shall announce the Conversion
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Termination Date and provide the Conversion Price and the Closing Price of the
Capital Securities and the Common Stock, in each case as of the close of
business on the trading day next preceding the date of the press release. The
Company is also required to give notice by first-class mail to holders of the
Junior Subordinated Debentures in the manner provided for holders of Capital
Securities under "Description of Capital Securities--Conversion Rights--
Termination of Conversion Rights." The Conversion Termination Date will be a
Business Day selected by the Company which is not less than 30 nor more than
60 calendar days after the date on which such press release is issued. In the
event that the Company exercises its conversion termination option, conversion
rights will expire at 5:00 p.m. (Eastern time) on the Conversion Termination
Date. In the event that the Company has not exercised its conversion
termination option and the Junior Subordinated Debentures are otherwise called
for prepayment, the Junior Subordinated Debentures will be convertible at any
time prior to 5:00 p.m. (Pacific time) on the Business Day immediately
preceding the date of such prepayment and in any other case at any time prior
to 5:00 p.m. (Eastern time) on the Business Day immediately preceding the
Stated Maturity Date of the Junior Subordinated Debentures.
ENFORCEMENT OF CERTAIN RIGHTS BY HOLDERS OF CAPITAL SECURITIES
If a Debenture Event of Default shall have occurred and be continuing and
shall be attributable to the failure of the Company to pay interest or
premium, if any, on or principal of the Junior Subordinated Debentures on the
due date, a holder of Capital Securities may institute a Direct Action. A
holder of Capital Securities may, to the fullest extent permitted by law, also
institute an action to enforce the rights of the Property Trustee if the
Property Trustee fails to enforce its rights as the holder of the Junior
Subordinated Debentures. The Company may not amend the Indenture to remove the
foregoing right to bring a Direct Action without the prior written consent of
the holders of all of the Capital Securities. Notwithstanding any payments
made to a holder of Capital Securities by the Company in connection with a
Direct Action, the Company shall remain obligated to pay the principal of or
premium, if any, or interest on, the Junior Subordinated Debentures, and the
Company shall be subrogated to the rights of the holder of such Capital
Securities with respect to payments on the Capital Securities to the extent of
any payments made by the Company to such holder in any Direct Action.
The holders of the Capital Securities will not be able to exercise directly
any remedies, other than those set forth in the preceding paragraph, available
to the holders of the Junior Subordinated Debentures. See "Description of
Capital Securities--Events of Default; Notice."
CONSOLIDATION, MERGER, SALE OF ASSETS AND OTHER TRANSACTIONS
The Indenture provides that the Company shall not consolidate with or merge
into any other Person or convey, transfer or lease its properties and assets
as an entirety or substantially as an entirety to any Person, and no Person
shall consolidate with or merge into the Company or convey, transfer or lease
its properties and assets as an entirety or substantially as an entirety to
the Company, unless: (i) in case the Company consolidates with or merges into
another Person or conveys or transfers its properties and assets substantially
as an entirety to any Person, the successor Person is organized under the laws
of the United States or any State or the District of Columbia, and such
successor Person expressly assumes the Company's obligations on the Junior
Subordinated Debentures, (ii) immediately after giving effect thereto, no
Debenture Event of Default, and no event which, after notice or lapse of time
or both, would become a Debenture Event of Default, shall have occurred and be
continuing, and (iii) certain other conditions as prescribed in the Indenture
are met.
The general provisions of the Indenture do not afford holders of the Junior
Subordinated Debentures protection in the event of a highly leveraged or other
transaction involving the Company that may adversely affect holders of the
Junior Subordinated Debentures.
MODIFICATION OF THE INDENTURE
From time to time the Company and the Debenture Trustee may, without the
consent of the holders of Junior Subordinated Debentures, amend, waive or
supplement the Indenture for specified purposes, including, among
133
other things, curing ambiguities, defects or inconsistencies; provided that,
in any such case, such action does not materially adversely affect the
interest of the holders of Junior Subordinated Debentures. The Indenture
contains provisions permitting the Company and the Debenture Trustee, with the
consent of the holders of a majority in principal amount of the Junior
Subordinated Debentures, to modify the Indenture in a manner affecting the
rights of the holders of Junior Subordinated Debentures; provided that no such
modification may, without the consent of the holders of each outstanding
Junior Subordinated Debenture so affected, (i) change the Stated Maturity
Date, or reduce the principal amount of the Junior Subordinated Debentures or
reduce the rate or extend the time of payment of interest thereon or (ii)
reduce the percentage of principal amount of Junior Subordinated Debentures
the holders of which are required to consent to any such modification of the
Indenture.
SATISFACTION AND DISCHARGE
The Indenture provides that when, among other things, all Junior
Subordinated Debentures not previously delivered to the Debenture Trustee for
cancellation (i) have become due and payable or (ii) will become due and
payable at maturity within one year, and the Company deposits or causes to be
deposited with the Debenture Trustee funds, in trust, for the purpose and in
an amount sufficient to pay and discharge the entire indebtedness on the
Junior Subordinated Debentures not previously delivered to the Debenture
Trustee for cancellation, for the principal and premium, if any, and interest
to the date of the deposit or to the Stated Maturity Date, as the case may be,
then the Indenture will cease to be of further effect (except as to the
Company's obligations to pay all other sums due pursuant to the Indenture and
to provide the officers' certificates and opinions of counsel described
therein), and the Company will be deemed to have satisfied and discharged the
Indenture.
SUBORDINATION
In the Indenture, the Company has agreed that any Junior Subordinated
Debentures issued thereunder will be subordinate and junior in right of
payment to all Senior Indebtedness to the extent provided in the Indenture.
Upon any payment or distribution of assets to creditors upon any liquidation,
dissolution, winding up, reorganization, assignment for the benefit of
creditors, marshaling of assets or any bankruptcy, insolvency, debt
restructuring or similar proceedings in connection with any insolvency or
bankruptcy proceeding of the Company, the holders of Senior Indebtedness will
first be entitled to receive payment in full of all Allocable Amounts (as
defined below) in respect of such Senior Indebtedness before the holders of
Junior Subordinated Debentures will be entitled to receive or retain any
payment in respect thereof.
In the event of the acceleration of the maturity of Junior Subordinated
Debentures, the holders of all Senior Indebtedness outstanding at the time of
such acceleration will first be entitled to receive payment in full of all
Allocable Amounts due in respect of such Senior Indebtedness before the
holders of Junior Subordinated Debentures will be entitled to receive or
retain any payment in respect of the Junior Subordinated Debentures.
No payments on account of principal or premium, if any, or interest, if any,
in respect of the Junior Subordinated Debentures may be made if there shall
have occurred and be continuing a default in any payment with respect to
Senior Indebtedness, or an event of default with respect to any Senior
Indebtedness resulting in the acceleration of the maturity thereof, or if any
judicial proceeding shall be pending with respect to any such default.
"Allocable Amounts," when used with respect to any Senior Indebtedness,
means all amounts due or to become due on such Senior Indebtedness less, if
applicable, any amount which would have been paid to, and retained by, the
holders of such Senior Indebtedness (whether as a result of the receipt of
payments by the holders of such Senior Indebtedness from the Company or any
other obligor thereon or from any holders of, or trustee in respect of, other
indebtedness that is subordinate and junior in right of payment to such Senior
Indebtedness pursuant to any provision of such indebtedness for the payment
over of amounts received on account of such indebtedness to the holders of
such Senior Indebtedness or otherwise) but for the fact that such Senior
Indebtedness is subordinate or junior in right of payment to (or subject to a
requirement that amounts received on such Senior Indebtedness be paid over to
obligees on) trade accounts payable or accrued liabilities arising in the
ordinary course of business.
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"Indebtedness" means (i) any obligation of, or any obligation guaranteed by,
the Company for the repayment of borrowed money, whether or not evidenced by
bonds, debentures, notes or other written instruments and any deferred
obligation for the payment of the purchase price of property or assets
acquired other than in the ordinary course of business and (ii) all
indebtedness of the Company for claims in respect of derivative products such
as interest and foreign exchange rate contracts, commodity contracts and
similar arrangements, whether outstanding on the date of execution of the
Indenture or thereafter created, assumed or incurred. For purposes of this
definition "claim" has the meaning assigned in Section 101(5) of the
Bankruptcy Code of 1978, as amended and in effect on the date of the execution
of the Indenture.
"Indebtedness Ranking on a Parity with the Junior Subordinated Debentures"
means Indebtedness, whether outstanding on the date of execution of the
Indenture or thereafter created, assumed or incurred, which specifically by
its terms ranks equally with and not prior to the Junior Subordinated
Debentures in the right of payment upon the happening of the dissolution or
winding-up or liquidation or reorganization of the Company. The securing of
any Indebtedness, otherwise constituting Indebtedness Ranking on a Parity with
the Junior Subordinated Debentures, shall not be deemed to prevent such
Indebtedness from constituting Indebtedness Ranking on a Parity with the
Junior Subordinated Debentures.
"Indebtedness Ranking Junior to the Junior Subordinated Debentures" means
any Indebtedness, whether outstanding on the date of execution of the
Indenture or thereafter created, assumed or incurred, which specifically by
its terms ranks junior to and not equally with or prior to the Junior
Subordinated Debentures (and any other Indebtedness Ranking on a Parity with
the Junior Subordinated Debentures) in right of payment upon the happening of
the dissolution or winding-up or liquidation or reorganization of the Company.
The securing of any Indebtedness, otherwise constituting Indebtedness Ranking
Junior to the Junior Subordinated Debentures, shall not be deemed to prevent
such Indebtedness from constituting Indebtedness Ranking Junior to the Junior
Subordinated Debentures.
"Senior Indebtedness" means all Indebtedness, whether outstanding on the
date of execution of the Indenture or thereafter created, assumed or incurred,
except Indebtedness Ranking on a Parity with the Junior Subordinated
Debentures or Indebtedness Ranking Junior to the Junior Subordinated
Debentures, and any deferrals, renewals or extensions of such Senior
Indebtedness.
The Indenture places no limitation on the amount of additional Senior
Indebtedness that may be incurred by the Company in the future. The Company
expects from time to time to incur additional indebtedness constituting Senior
Indebtedness.
GOVERNING LAW
The Indenture and the Junior Subordinated Debentures will be governed by and
construed in accordance with the laws of the State of Delaware.
INFORMATION CONCERNING THE DEBENTURE TRUSTEE
The Debenture Trustee shall have and be subject to all the duties and
responsibilities specified with respect to an indenture trustee under the
Trust Indenture Act. Subject to such provisions, the Debenture Trustee is
under no obligation to exercise any of the powers vested in it by the
Indenture at the request of any holder of Junior Subordinated Debentures,
unless offered reasonable indemnity by such holder against the costs, expenses
and liabilities which might be incurred thereby. The Debenture Trustee is not
required to expend or risk its own funds or otherwise incur personal financial
liability in the performance of its duties.
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DESCRIPTION OF THE GUARANTEE
The Guarantee will be executed and delivered by the Company concurrently
with the issuance by the Trust of the Capital Securities for the benefit of
the holders from time to time of the Capital Securities. State Street will act
as indenture trustee ("Guarantee Trustee") under the Guarantee. The Guarantee
will be qualified under the Trust Indenture Act. This summary of certain
provisions of the Guarantee does not purport to be complete and is subject to,
and qualified in its entirety by reference to, all of the provisions of the
Guarantee, including the definitions therein of certain terms, and the Trust
Indenture Act. The Guarantee Trustee will hold the Guarantee for the benefit
of the holders of the Capital Securities.
GENERAL
The Company will irrevocably agree to pay in full on a subordinated basis,
to the extent set forth herein, the Guarantee Payments (as defined below) to
the holders of the Capital Securities, as and when due, regardless of any
defense, right of set-off or counterclaim that the Trust may have or assert
other than the defense of payment. The following payments with respect to the
Capital Securities, to the extent not paid by or on behalf of the Trust (the
"Guarantee Payments"), will be subject to the Guarantee: (i) any accumulated
and unpaid Distributions required to be paid on Capital Securities, to the
extent the Trust has funds on hand legally available therefor, (ii) the
Redemption Price with respect to any Capital Securities called for redemption,
to the extent that the Trust has funds on hand legally available therefor, or
(iii) upon a voluntary or involuntary dissolution and liquidation of the Trust
(unless the Junior Subordinated Debentures are distributed to holders of the
Capital Securities), the lesser of (a) the Liquidation Distribution and (b)
the amount of assets of the Trust remaining available for distribution to
holders of Capital Securities. The Company's obligation to make a Guarantee
Payment may be satisfied by direct payment of the required amounts by the
Company to the holders of the Capital Securities or by causing the Trust to
pay such amounts to such holders.
The Guarantee will rank subordinate and junior in right of payment to all
Senior Indebtedness to the extent provided therein. See "--Status" below.
Because the Company is a holding company, the right of the Company to
participate in any distribution of assets of any subsidiary, including the
Bank, upon such subsidiary's liquidation or reorganization or otherwise (and
thus the ability of holders of the Capital Securities to benefit indirectly
from such distribution) is subject to the prior claims of creditors of such
subsidiary, except to the extent the Company may itself be recognized as a
creditor of such subsidiary. Accordingly, the Company's obligations under the
Guarantee effectively will be subordinated to all existing and future
liabilities of its subsidiaries, including the Bank, and claimants should look
only to the assets of the Company for payments thereunder. See "Description of
Junior Convertible Subordinated Debentures--General." The Guarantee does not
limit the incurrence or issuance of other secured or unsecured debt of the
Company, including Senior Indebtedness, whether under the Indenture, any other
indenture that the Company may enter into in the future or otherwise, and does
not limit the incurrence or issuance of secured or unsecured debt by the
Company's subsidiaries.
The Company will, through the Guarantee, the Declaration, the Junior
Subordinated Debentures and the Indenture, taken together, fully, irrevocably
and unconditionally guarantee all of the Trust's obligations under the Capital
Securities. No single document standing alone or operating in conjunction with
fewer than all of the other documents constitutes such guarantee. It is only
the combined operation of these documents that has the effect of providing a
full, irrevocable and unconditional guarantee of the Trust's obligations under
the Capital Securities. See "Relationship Among the Capital Securities, the
Junior Subordinated Debentures and the Guarantee."
STATUS
The Guarantee will constitute an unsecured obligation of the Company and
will rank subordinate and junior in right of payment to all Senior
Indebtedness in the same manner as the Junior Subordinated Debentures.
The Guarantee will rank pari passu with the Junior Subordinated Debentures
and with all other guarantees (if any) issued by the Company after the Issue
Date with respect to capital securities (if any) issued by Other
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Trusts. The Guarantee will constitute a guarantee of payment and not of
collection (i.e., the guaranteed party may institute a legal proceeding
directly against the Company to enforce its rights under the Guarantee without
first instituting a legal proceeding against any other person or entity). The
Guarantee will be held for the benefit of the holders of the Capital
Securities. The Guarantee will not be discharged except by payment of the
Guarantee Payments in full to the extent not paid by the Trust or upon
distribution to the holders of the Capital Securities of the Junior
Subordinated Debentures. The Guarantee does not place a limitation on the
amount of additional Senior Indebtedness that may be incurred by the Company
in the future. The Company expects from time to time to incur additional
indebtedness constituting Senior Indebtedness.
EVENTS OF DEFAULT
An event of default under the Guarantee will occur upon the failure of the
Company to perform any of its payment or other obligations thereunder. The
holders of a majority in Liquidation Amount of the Capital Securities will
have the right to direct the time, method and place of conducting any
proceeding for any remedy available to the Guarantee Trustee in respect of the
Guarantee or to direct the exercise of any trust or power conferred upon the
Guarantee Trustee under the Guarantee.
Any holder of the Capital Securities may institute a legal proceeding
directly against the Company to enforce its rights under the Guarantee without
first instituting a legal proceeding against the Trust, the Guarantee Trustee
or any other person or entity.
The Company, as guarantor, will be required to file annually with the
Guarantee Trustee a certificate as to whether or not the Company is in
compliance with all the conditions and covenants applicable to it under the
Guarantee.
CERTAIN COVENANTS OF THE COMPANY
The Guarantee will provide that, so long as any Capital Securities remain
outstanding, if there shall have occurred any event that would constitute an
event of default under the Guarantee or the Declaration (other than solely a
default as described in paragraph (iii) under "Description of Junior
Convertible Subordinated Debentures--Debenture Events of Default"), then the
Company will not (i) declare or pay any dividends or distributions on, or
redeem, purchase, acquire, or make a liquidation payment with respect to, any
of the Company's capital stock, (ii) make any payment of principal, interest
or premium, if any, on or repay, repurchase or redeem any debt securities of
the Company (including any Other Debentures) that rank pari passu with or
junior in right of payment to the Junior Subordinated Debentures or (iii) make
any guarantee payments with respect to any guarantee by the Company of any
securities of any subsidiary of the Company (including Other Guarantees) if
such guarantee ranks pari passu with or junior in right of payment to the
Junior Subordinated Debentures, other than (a) dividends or distributions in
shares of or options, warrants or rights to subscribe for or purchase shares
of, Common Stock or preferred stock of the Company, (b) any declaration of a
dividend in connection with the implementation of a stockholders' rights plan,
or the issuance of stock under any such plan in the future, or the redemption
or repurchase of any such rights pursuant thereto, (c) payments under the
Guarantee, (d) as a direct result of, and only to the extent required in order
to avoid the issuance of fractional shares of capital stock following, a
reclassification of the Company's capital stock or the exchange or conversion
of one class or series of the Company's capital stock for another class or
series of the Company's capital stock, (e) the purchase of fractional
interests in shares of the Company's capital stock pursuant to the conversion
or exchange provisions of such capital stock or the security being converted
or exchanged, and (f) purchases of Common Stock related to the issuance of
Common Stock or rights under any of the Company's benefit plans for its
directors, officers or employees.
AMENDMENTS AND ASSIGNMENT
Except with respect to any changes that do not materially adversely affect
the rights of holders of the Capital Securities (in which case no vote will be
required), the Guarantee may not be amended without the prior approval of the
holders of a majority of the Liquidation Amount of such outstanding Capital
Securities. The manner of
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obtaining any such approval will be as set forth under "Description of Capital
Securities--Voting Rights; Amendment of the Declaration." All guarantees and
agreements contained in the Guarantee Agreement shall bind the successors,
assigns, receivers, trustees and representatives of the Company and shall
inure to the benefit of the holders of the Capital Securities then
outstanding.
TERMINATION
The Guarantee will terminate and be of no further force and effect upon full
payment of the applicable Redemption Price of the Capital Securities, upon
full payment of the Liquidation Amount payable upon liquidation of the Trust
or upon distribution of the Junior Subordinated Debentures to the holders of
the Capital Securities. The Guarantee will continue to be effective or will be
reinstated, as the case may be, if at any time any holder of the Capital
Securities must restore payment of any sums paid under the Capital Securities
or the Guarantee.
INFORMATION CONCERNING THE GUARANTEE TRUSTEE
The Guarantee Trustee is under no obligation to exercise any of the powers
vested in it by the Guarantee at the request of any holder of Capital
Securities, unless offered reasonable indemnity against the costs, expenses
and liabilities which might be incurred thereby. The Guarantee Trustee is not
required to expend or risk its own funds or otherwise incur personal financial
liability in the performance of its duties if it reasonably believes that
repayment or adequate indemnity is not reasonably assured to it.
GOVERNING LAW
The Guarantee will be governed by, and construed in accordance with, the
laws of the State of Delaware.
RELATIONSHIP AMONG THE CAPITAL SECURITIES, THE JUNIOR
SUBORDINATED DEBENTURES AND THE GUARANTEE
FULL AND UNCONDITIONAL GUARANTEE
Payments of Distributions and other amounts due on the Capital Securities
(to the extent the Trust has funds on hand legally available for the payment
of such Distributions) will be irrevocably guaranteed by the Company as and to
the extent set forth under "Description of the Guarantee." Taken together, the
Company's obligations under the Junior Subordinated Debentures, the Indenture,
the Declaration and the Guarantee will provide, in the aggregate, a full,
irrevocable and unconditional guarantee, on a subordinated basis, of payments
of Distributions and other amounts due on the Capital Securities. No single
document standing alone or operating in conjunction with fewer than all of the
other documents constitutes such guarantee. It is only the combined operation
of these documents that has the effect of providing a full, irrevocable and
unconditional guarantee, on a subordinated basis, of the Trust's obligations
under the Capital Securities. If and to the extent that the Company does not
make the required payments on the Junior Subordinated Debentures, the Trust
will not have sufficient funds to make the related payments, including
Distributions, on the Capital Securities. The Guarantee will not cover any
such payment when the Trust does not have sufficient funds on hand legally
available therefor. In such event, the remedy of a holder of Capital
Securities is to institute a Direct Action. The obligations of the Company
under the Guarantee will be subordinate and junior in right of payment to all
Senior Indebtedness.
SUFFICIENCY OF PAYMENTS
As long as payments of interest and other payments are made when due on the
Junior Subordinated Debentures, such payments will be sufficient to cover
Distributions and other payments due on the Capital Securities, primarily
because: (i) the aggregate principal amount or Prepayment Price of the Junior
Subordinated Debentures will be equal to the sum of the Liquidation Amount or
Redemption Price, as applicable, of the Capital
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Securities and Common Securities; (ii) the interest rate and interest and
other payment dates on the Junior Subordinated Debentures will match the
Distribution rate and Distribution and other payment dates for the Trust
Securities; (iii) the Company shall pay for all and any costs, expenses and
liabilities of the Trust except the Trust's obligations to holders of Trust
Securities under such Trust Securities; and (iv) the Declaration will provide
that the Trust is not authorized to engage in any activity that is not
consistent with the limited purposes thereof.
ENFORCEMENT OF RIGHTS OF HOLDERS OF CAPITAL SECURITIES
A holder of any Capital Security may institute a legal proceeding directly
against the Company to enforce its rights under the Guarantee without first
instituting a legal proceeding against the Guarantee Trustee, the Trust or any
other person or entity.
A default or event of default under any Senior Indebtedness would not
constitute a default or Event of Default under the Declaration. However, in
the event of payment defaults under, or acceleration of, Senior Indebtedness,
the subordination provisions of the Indenture will provide that no payments
may be made in respect of the Junior Subordinated Debentures until such Senior
Indebtedness has been paid in full or any payment default thereunder has been
cured or waived. Failure to make required payments on Junior Subordinated
Debentures would constitute an Event of Default under the Declaration.
LIMITED PURPOSE OF THE TRUST
The Capital Securities will represent preferred beneficial interests in the
Trust, and the Trust exists for the sole purpose of issuing and selling the
Trust Securities, using the proceeds from the sale of the Trust Securities to
acquire the Junior Subordinated Debentures and engaging in only those other
activities necessary, advisable or incidental thereto.
RIGHTS UPON DISSOLUTION
Unless the Junior Subordinated Debentures are distributed to holders of the
Trust Securities, upon any voluntary or involuntary dissolution and
liquidation of the Trust, after satisfaction of liabilities to creditors of
the Trust as required by applicable law, the holders of the Trust Securities
will be entitled to receive, out of assets held by the Trust, the Liquidation
Distribution in cash. See "Description of Capital Securities--Liquidation of
the Trust and Distribution of Junior Subordinated Debentures." Upon any
voluntary or involuntary liquidation or bankruptcy of the Company, the
Property Trustee, as holder of the Junior Subordinated Debentures, would be a
subordinated creditor of the Company, subordinated in right of payment to all
Senior Indebtedness as set forth in the Indenture, but entitled to receive
payment in full of principal (and premium, if any) and interest, before any
stockholders of the Company receive payments or distributions. Since the
Company will be the guarantor under the Guarantee and will agree to pay for
all costs, expenses and liabilities of the Trust (other than the Trust's
obligations to the holders of its Trust Securities), the positions of a holder
of Capital Securities and a holder of Junior Subordinated Debentures relative
to other creditors and to stockholders of the Company in the event of
liquidation or bankruptcy of the Company are expected to be substantially the
same.
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DESCRIPTION OF CAPITAL STOCK OF THE COMPANY
GENERAL
The Company is authorized to issue 25,000,000 shares of Common Stock having
a par value of $.01 per share and 5,000,000 shares of preferred stock having a
par value of $.01 per share (the "Preferred Stock"). The Company issued
3,211,716 shares of Common Stock and no shares of Preferred Stock in the
Reorganization and 3,335,000 shares of Common Stock in the IPO. Except as
discussed below, each share of the Company's Common Stock has the same
relative rights as, and is identical in all respects with, each other share of
Common Stock.
The Common Stock of the Company represents non-withdrawable capital, will
not be an account of an insurable type, and will not be insured by the FDIC or
any governmental agency.
COMMON STOCK
Dividends. The Company can pay dividends out of statutory surplus or from
certain net profits if, as and when declared by its Board of Directors. The
payment of dividends by the Company is subject to limitations which are
imposed by law and applicable regulation. See "Dividend Policy" and
"Regulation." The holders of Common Stock of the Company will be entitled to
receive and share equally in such dividends as may be declared by the Board of
Directors of the Company out of funds legally available therefor. If the
Company issues Preferred Stock, the holders thereof may have a priority over
the holders of the Common Stock with respect to dividends.
Voting Rights. The holders of Common Stock of the Company possess exclusive
voting rights in the Company. They elect the Company's Board of Directors and
act on such other matters as are required to be presented to them under
Delaware law or the Company's Certificate of Incorporation or as are otherwise
presented to them by the Board of Directors. Except as discussed in
"Restrictions on Acquisition of the Company," each holder of Common Stock is
entitled to one vote per share and does not have any right to cumulate votes
in the election of directors. If the Company issues Preferred Stock, holders
of the Preferred Stock may also possess voting rights. Certain matters require
an 80% shareholder vote. See "Comparison of Stockholder Rights and Certain
Antitakeover Considerations."
As a federal savings bank, corporate powers and control of the Bank are
vested in its Board of Directors, who elect the officers of the Bank and who
fill any vacancies on the Board of Directors. Voting rights are vested
exclusively in the owner of the shares of capital stock of the Bank, which is
the Company, and voted at the direction of the Company's Board of Directors.
Consequently, the holders of the Common Stock do not have direct control of
the Bank.
Liquidation. In the event of any liquidation, dissolution or winding up of
the Bank, the Company, as holder of the Bank's capital stock, would be
entitled to receive, after payment or provision for payment of all debts and
liabilities of the Bank (including all deposit accounts and accrued interest
thereon) all assets of the Bank available for distribution. In the event of
liquidation, dissolution or winding up of the Company, the holders of its
Common Stock would be entitled to receive, after payment or provision for
payment of all its debts and liabilities, all of the assets of the Company
available for distribution. If Preferred Stock is issued, the holders thereof
may have a priority over the holders of the Common Stock in the event of
liquidation or dissolution.
Preemptive Rights. Holders of the Common Stock of the Company are not
entitled to preemptive rights with respect to any shares which may be issued.
The Common Stock is not subject to redemption.
PREFERRED STOCK
None of the shares of the Company's authorized Preferred Stock have been
issued. Such stock may be issued with such preferences and designations as the
Board of Directors may from time to time determine. The
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Board of Directors can, without stockholder approval, issue preferred stock
with voting, dividend, liquidation and conversion rights which could dilute
the voting strength of the holders of the Common Stock and may assist
management in impeding an unfriendly takeover or attempted change in control.
CERTAIN ANTI-TAKEOVER PROVISIONS
Certain provisions in the Company's Certificate of Incorporation and Bylaws
and in its management remuneration programs, together with provisions of
Delaware corporate law, may have anti-takeover effects. Regulatory
restrictions also may make it difficult for persons or companies to acquire
control of the Company. However, the Company may be subject to Section 2115 of
the California General Corporation Law. This may have the effect of
superseding certain provisions of the Company's Certificate of Incorporation
and Bylaws that could have anti-takeover effects, particularly those
provisions providing for a staggered board of directors, eliminating
cumulative voting, electing and removing directors, calling of special
meetings and approval of certain corporate transactions. In addition,
California law is more restrictive than Delaware law as to the payment of
dividends. However, if its securities remain listed on the National Market
System of the Nasdaq Stock Market and there are at least 800 stockholders, or
if more than 50% of the Company's stockholders have addresses outside
California, the Company will be exempt from the provisions of Section 2115.
RESTRICTIONS IN THE COMPANY'S CERTIFICATE OF INCORPORATION AND BYLAWS
A number of provisions of the Company's Certificate of Incorporation and
Bylaws deal with matters of corporate governance and certain rights of
stockholders. The following discussion is a general summary of the provisions
of the Company's Certificate of Incorporation and Bylaws which might be deemed
to have a potential "anti-takeover" effect. These provisions may have the
effect of discouraging a future takeover attempt which is not approved by the
Board of Directors but which individual Company stockholders may deem to be in
their best interests or in which stockholders may receive a substantial
premium for their shares over then current market prices. As a result,
stockholders who might desire to participate in such a transaction may not
have an opportunity to do so. Such provisions will also render the removal of
the current Board of Directors or management of the Company more difficult.
The following description of certain of the provisions of the
Certificate of Incorporation and Bylaws of the Company is necessarily general
and reference should be made in each case to such Certificate of Incorporation
and Bylaws, which are incorporated herein by reference. See "Additional
Information" as to how to obtain a copy of these documents.
Limitation on Voting Rights. The Certificate of Incorporation of the Company
provides that in no event shall any record owner of any outstanding Common
Stock which is beneficially owned, directly or indirectly, by a person who
beneficially owns in excess of 10% of the then outstanding shares of Common
Stock (the "Limit") be entitled or permitted to any vote in respect of the
shares held in excess of the Limit. Beneficial ownership is determined
pursuant to Rule 13d-3 of the General Rules and Regulations promulgated
pursuant to the Exchange Act, and includes shares beneficially owned by such
person or any of his affiliates (as defined in the Certificate of
Incorporation), shares which such person or his affiliates have the right to
acquire upon the exercise of conversion rights or options and shares as to
which such person and his affiliates have or share investment or voting power,
but shall not include shares beneficially owned by employee benefit plans or
directors, officers and employees of the Bank or Company or shares that are
subject to a revocable proxy and that are not otherwise beneficially owned, or
deemed by the Company to be beneficially owned, by such person and his
affiliates. The Certificate of Incorporation also contains provisions
authorizing the Board of Directors to construe and apply the Limit and to
demand that any person reasonably believed to beneficially own Common Stock in
excess of the Limit (or hold of record Common Stock beneficially owned in
excess of the Limit) to provide the Company with certain information. No
assurance can be given that a court applying Delaware law would enforce such
provisions of the Certificate of Incorporation. The Certificate of
Incorporation of the Company further provides that this provision limiting
voting rights may only be amended upon the vote of 80% of the outstanding
shares of voting stock (after giving effect to the limitation on voting
rights).
141
Board of Directors. The Board of Directors of the Company is divided into
three classes, each of which shall contain approximately one-third of the
whole number of members of the Board. Each class shall serve a staggered term,
with approximately one-third of the total number of directors being elected
each year. The Company's Certificate of Incorporation and Bylaws provide that
the size of the Board shall be determined by a majority of the directors. The
Certificate of Incorporation and the Bylaws provide that any vacancy occurring
in the Board, including a vacancy created by an increase in the number of
directors or resulting from death, resignation, retirement, disqualification,
removal from office or other cause, may be filled for the remainder of the
unexpired term exclusively by a majority vote of the directors then in office.
The classified Board is intended to provide for continuity of the Board of
Directors and to make it more difficult and time consuming for a stockholder
group to fully use its voting power to gain control of the Board of Directors
without the consent of the incumbent Board of Directors of the Company. The
Certificate of Incorporation of the Company provides that a director may be
removed from the Board of Directors prior to the expiration of his term only
for cause, upon the vote of 80% of the outstanding shares of voting stock.
In the absence of these provisions, the vote of the holders of a majority of
the shares could remove the entire Board, with or without cause, and replace
it with persons of such holders' choice.
Cumulative Voting, Special Meetings and Action by Written Consent. The
Certificate of Incorporation does not provide for cumulative voting for any
purpose. Moreover, special meetings of stockholders of the Company may be
called only by the Board of Directors of the Company. The Certificate of
Incorporation also provides that any action required or permitted to be taken
by the stockholders of the Company may be taken only at an annual or special
meeting and prohibits stockholder action by written consent in lieu of a
meeting.
Authorized Shares. The Certificate of Incorporation authorizes the issuance
of 25,000,000 shares of Common Stock and 5,000,000 shares of Preferred Stock.
The shares of Common Stock and Preferred Stock were authorized in an amount
greater than that issued in the Reorganization and the IPO to provide the
Company's Board of Directors with as much flexibility as possible to effect,
among other transactions, financings, acquisitions, stock dividends, stock
splits and employee stock options. However, these additional authorized
shares may also be used by the Board of Directors consistent with its
fiduciary duty to deter future attempts to gain control of the Company. The
Board of Directors also has sole authority to determine the terms of any one
or more series of Preferred Stock, including voting rights, conversion rates,
and liquidation preferences. As a result of the ability to fix voting rights
for a series of Preferred Stock, the Board has the power, to the extent
consistent with its fiduciary duty, to issue a series of Preferred Stock to
persons friendly to management in order to attempt to block a post-tender
offer merger or other transaction by which a third party seeks control, and
thereby assist management to retain its position. The Company's Board of
Directors currently has no plans for the issuance of additional shares, other
than the issuance of additional shares as established in connection with the
exercise of conversion rights by holders of Capital Securities, see
"Description of Capital Securities--Conversion Rights," and upon exercise of
stock options to be issued pursuant to the terms of the Option Plans.
Stockholder Vote Required to Approve Business Combinations with Principal
Stockholders. The Certificate of Incorporation requires the approval of the
holders of 80% of the Company's outstanding shares of voting stock to approve
certain "Business Combinations," as defined therein, and related transactions.
Under Delaware law, absent this provision, Business Combinations, including
mergers, consolidations and sales of all or substantially all of the assets of
a corporation must, subject to certain exceptions, be approved by the vote of
the holders of only a majority of the outstanding shares of Common Stock of
the Company and any other affected class of stock. Under the Certificate of
Incorporation, 80% approval of stockholders is required in connection with any
transaction involving an Interested Stockholder (as defined below) except (i)
in cases where the proposed transaction has been approved in advance by a
majority of those members of the Company's Board of Directors who are
unaffiliated with the Interested Stockholder and were directors prior to the
time when the Interested Stockholder became an Interested Stockholder or (ii)
if the proposed transaction meets certain conditions set forth therein which
are designed to afford the stockholders a fair price in consideration for
their shares in which case, if a stockholder vote is required, approval of
only a majority of the outstanding shares of voting stock would be sufficient.
The term "Interested Stockholder" is defined to include any individual,
corporation, partnership or
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other entity (other than the Company or its subsidiary) which owns
beneficially or controls, directly or indirectly, 10% or more of the
outstanding shares of voting stock of the Company. This provision of the
Certificate of Incorporation applies to any "Business Combination," which is
defined to include: (i) any merger or consolidation of the Company or any of
its subsidiaries with or into any Interested Stockholder or Affiliate (as
defined in the Certificate of Incorporation) of an Interested Stockholder;
(ii) any sale, lease, exchange, mortgage, transfer, or other disposition to or
with any Interested Stockholder or Affiliate of 25% or more of the assets of
the Company or combined assets of the Company and its subsidiary; (iii) the
issuance or transfer to any Interested Stockholder or its Affiliate by the
Company (or any subsidiary) of any securities of the Company in exchange for
any assets, cash or securities the value of which equals or exceeds 25% of the
fair market value of the Common Stock of the Company; (iv) the adoption of any
plan for the liquidation or dissolution of the Company proposed by or on
behalf of any Interested Stockholder or Affiliate thereof; and (v) any
reclassification of securities, recapitalization, merger or consolidation of
the Company which has the effect of increasing the proportionate share of
Common Stock or any class of equity or convertible securities of the Company
owned directly or indirectly by an Interested Stockholder or Affiliate
thereof.
Evaluation of Offers. The Certificate of Incorporation of the Company
further provides that the Board of Directors of the Company, when evaluating
any offer of another "Person" (as defined therein) to: (i) make a tender or
exchange offer for any equity security of the Company; (ii) merge or
consolidate the Company with another corporation or entity; or (iii) purchase
or otherwise acquire all or substantially all of the properties and assets of
the Company, may, in connection with the exercise of its judgment in
determining what is in the best interest of the Company, the Bank and the
stockholders of the Company, give due consideration to all relevant factors,
including, without limitation, the social and economic effects of acceptance
of such offer on the Company's customers and the Bank's present and future
account holders, borrowers and employees; on the communities in which the
Company and the Bank operate or are located; and on the ability of the Company
to fulfill its corporate objectives as a savings and loan holding company and
on the ability of the Bank to fulfill the objectives of a federally chartered
stock savings association under applicable statutes and regulations. No
assurance can be given that a court applying Delaware law would enforce the
foregoing provision of the Certificate of Incorporation. By having these
standards in the Certificate of Incorporation of the Company, the Board of
Directors may be in a stronger position to oppose such a transaction if the
Board concludes that the transaction would not be in the best interest of the
Company, even if the price offered is significantly greater than the then market
price of any equity security of the Company.
Amendment of Certificate of Incorporation and Bylaws. Amendments to the
Company's Certificate of Incorporation must be approved by a majority vote of
its Board of Directors and also by a majority of the outstanding shares of its
voting stock; provided, however, that an affirmative vote of at least 80% of
the outstanding voting stock entitled to vote (after giving effect to the
provision limiting voting rights) is required to amend or repeal certain
provisions of the Certificate of Incorporation, including the provision
limiting voting rights, the provisions relating to approval of certain
business combinations, calling special meetings, the number and classification
of directors, director and officer indemnification by the Company and
amendment of the Company's Bylaws and Certificate of Incorporation. The
Company's Bylaws may be amended by its Board of Directors, or by a vote of 80%
of the total votes eligible to be voted at a duly constituted meeting of
stockholders.
Certain Bylaw Provisions. The Bylaws of the Company also require a
stockholder who intends to nominate a candidate for election to the Board of
Directors, or to raise new business at a stockholder meeting to give at least
90 days advance notice to the Secretary of the Company. The notice provision
requires a stockholder who desires to raise new business to provide certain
information to the Company concerning the nature of the new business, the
stockholder and the stockholder's interest in the business matter. Similarly,
a stockholder wishing to nominate any person for election as a director must
provide the Company with certain information concerning the nominee and the
proposing stockholder.
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ANTI-TAKEOVER EFFECTS OF THE COMPANY'S CERTIFICATE OF INCORPORATION AND BYLAWS
AND MANAGEMENT REMUNERATION
The provisions described above are intended to reduce the Company's
vulnerability to takeover attempts and certain other transactions which have
not been negotiated with and approved by members of its Board of Directors.
The provisions of the employment agreement with Mr. Perl and the Stock Option
Plans may also discourage takeover attempts by increasing the costs to be
incurred by the Bank and the Company in the event of a takeover. See "The
Board of Directors and Management of the Bank--Employment Agreements" and "--
Stock Option Plans."
The Company's Board of Directors believes that the provisions of the
Certificate of Incorporation, Bylaws and management remuneration plans are in
the best interest of the Company and its stockholders. An unsolicited non-
negotiated proposal can seriously disrupt the business and management of a
corporation and cause it great expense. Accordingly, the Board of Directors
believes it is in the best interests of the Company and its stockholders to
encourage potential acquirors to negotiate directly with management and that
these provisions will encourage such negotiations and discourage non-
negotiated takeover attempts. It is also the Board of Directors' view that
these provisions should not discourage persons from proposing a merger or
other transaction at a price that reflects the true value of the Company and
that otherwise is in the best interest of all stockholders.
DELAWARE CORPORATE LAW
The State of Delaware has a statute designed to provide Delaware
corporations with additional protection against hostile takeovers. The
takeover statute, which is codified in Section 203 of the Delaware General
Corporate Law ("Section 203"), is intended to discourage certain takeover
practices by impeding the ability of a hostile acquiror to engage in certain
transactions with the target company.
In general, Section 203 provides that a "Person" (as defined therein) who
owns 15% or more of the outstanding voting stock of a Delaware corporation (an
"Interested Stockholder") may not consummate a merger or other business
combination transaction with such corporation at any time during the three-
year period following the date such "Person" became an Interested Stockholder.
The term "business combination" is defined broadly to cover a wide range of
corporate transactions including mergers, sales of assets, issuances of stock,
transactions with subsidiaries and the receipt of disproportionate financial
benefits.
The statute exempts the following transactions from the requirements of
Section 203: (i) any business combination if, prior to the date a person
became an Interested Stockholder, the Board of Directors approved either the
business combination or the transaction which resulted in the stockholder
becoming an Interested Stockholder; (ii) any business combination involving a
person who acquired at least 85% of the outstanding voting stock in the
transaction in which he became an Interested Stockholder, with the number of
shares outstanding calculated without regard to those shares owned by the
corporation's directors who are also officers and by certain employee stock
plans; (iii) any business combination with an Interested Stockholder that is
approved by the Board of Directors and by a two-thirds vote of the outstanding
voting stock not owned by the Interested Stockholder; and (iv) certain
business combinations that are proposed after the corporation had received
other acquisition proposals and which are approved or not opposed by a
majority of certain continuing members of the Board of Directors. A
corporation may exempt itself from the requirements of the statute by
adopting an amendment to its Certificate of Incorporation or Bylaws electing
not to be governed by Section 203. At the present time, the Board of Directors
does not intend to propose any such amendment.
REGULATORY RESTRICTIONS ON ACQUISITIONS OF THE COMPANY
Any proposal to acquire 10% or more of any class of equity security of the
Company generally would be subject to approval by the OTS under the Change in
Bank Control Act. The OTS requires all persons seeking control of a savings
institution, and, therefore, indirectly its holding company, to obtain
regulatory approval prior to offering to obtain control. Federal law generally
provides that no "person," acting directly or indirectly or
144
through or in concert with one or more other persons, may acquire directly or
indirectly "control," as that term is defined in OTS regulations, of a
federally-insured savings institution without giving at least 60 days' written
notice to the OTS and providing the OTS an opportunity to disapprove the
proposed acquisition. Such acquisitions of control may be disapproved if it is
determined, among other things, that: (i) the acquisition would substantially
lessen competition; (ii) the financial condition of the acquiring person might
jeopardize the financial stability of the savings institution or prejudice the
interests of its depositors; or (iii) the competency, experience or integrity
of the acquiring person or the proposed management personnel indicates that it
would not be in the interest of the depositors or the public to permit the
acquisition of control by such person. Persons holding revocable or
irrevocable proxies may be deemed to be beneficial owners of such securities
under OTS regulations and therefore prohibited from voting all or the portion
of such proxies in excess of the 10% aggregate beneficial ownership limit.
Such regulatory restrictions may prevent or inhibit proxy contests for control
of the Company or the Bank which have not received prior regulatory approval.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of certain of the principal United States federal
income tax consequences of the purchase, ownership and disposition of the
Capital Securities to a holder that is a citizen or resident of the United
States, a corporation, partnership or other entity created or organized under
the laws of the United States or any state thereof or the District of Columbia
or an estate or trust the income of which is subject to United States federal
income taxation regardless of source or a trust with respect to which a court
within the United States is able to exercise primary supervision over its
administration and one or more United States fiduciaries have the authority to
control all of its substantial decisions (a "U.S. Holder"). This summary does
not address the United States federal income tax consequences to persons other
than U.S. Holders who purchase Capital Securities upon their initial issuance.
This summary is based on the United States federal income tax laws,
regulations and rulings and decisions now in effect, all of which are subject
to change, possibly on a retroactive basis. This summary does not address the
tax consequences applicable to investors that may be subject to special tax
rules such as banks, thrifts, real estate investment trusts, regulated
investment companies, insurance companies, dealers in securities or
currencies, tax-exempt investors or persons that will hold the Capital
Securities as a position in a "straddle," as part of a "synthetic security" or
"hedge," "conversion transaction" or other integrated investment or as other
than a capital asset. This summary also does not address the tax consequences
to persons that have a functional currency other than the U.S. dollar or the
tax consequences to shareholders, partners or beneficiaries of a holder of
Capital Securities. Further, it does not include any description of any
alternative minimum tax consequences or the tax laws of any state or local
government or of any foreign government that may be applicable to the Capital
Securities.
PROSPECTIVE INVESTORS ARE ADVISED TO CONSULT WITH THEIR OWN TAX ADVISORS IN
LIGHT OF THEIR OWN PARTICULAR CIRCUMSTANCES AS TO THE FEDERAL TAX CONSEQUENCES
OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF CAPITAL SECURITIES, AS WELL AS
THE EFFECT OF ANY STATE, LOCAL OR FOREIGN TAX LAWS.
The Company intends to take the position that, under current law, the Junior
Subordinated Debentures constitute indebtedness for federal income tax
purposes and, by acceptance of a Capital Security, each holder covenants to
treat the Junior Subordinated Debentures as indebtedness and the Capital
Securities as evidence of an indirect beneficial interest in the Junior
Subordinated Debentures. No assurances can be given, however, that such
position of the Company will not be challenged by the Internal Revenue Service
(the "Service") or, if challenged, that such challenge will not be successful.
The remainder of this discussion assumes that the Junior Subordinated
Debentures are classified as indebtedness for federal income tax purposes.
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CLASSIFICATION OF THE TRUST
Upon the issuance of the Capital Securities, Muldoon, Murphy & Faucette will
issue its opinion (the "Tax Opinion") to the effect that, under then current
law and assuming full compliance with the terms of the Declaration (and
certain other documents), and based on certain facts and assumptions contained
in such opinion, the Trust will be classified, for United States federal
income tax purposes, as a grantor trust and not as an association taxable as a
corporation. As a result, each holder of Capital Securities will be treated as
owning an undivided beneficial interest in the Junior Subordinated Debentures
and each holder will be required to include in its gross income the items of
income realized with respect to its allocable share of those Junior
Subordinated Debentures. Investors should be aware that the Tax Opinion does
not address any other issue and is not binding on the Service or the courts.
INTEREST, ORIGINAL ISSUE DISCOUNT, PREMIUM AND MARKET DISCOUNT
Final Treasury Regulations issued on June 16, 1996 generally provide that
stated interest on a debt instrument is not "qualified stated interest" and,
therefore, will give rise to OID unless such interest is unconditionally
payable in cash or in property (other than debt instruments of the issuer) at
least annually at a single fixed rate. Interest is considered to be
unconditionally payable only if reasonable legal remedies exist to compel
timely payment or the debt instrument otherwise provides terms and conditions
that make the likelihood of late payment (other than late payment that occurs
within a reasonable grace period) or non-payment a "remote contingency."
The Company has the right, at any time and from time to time during the term
of the Junior Subordinated Debentures, to defer payments of interest by
extending the interest payment period for a period not exceeding
20 consecutive quarters, provided that no Extension Period may extend beyond
the Stated Maturity of the Junior Subordinated Debentures. During any
Extension Period, the Company may not (i) declare or pay any dividends or
distributions on, or redeem, purchase, acquire, or make a liquidation payment
with respect to, any of the Company's capital stock, (ii) make any payment of
principal, interest or premium, if any, on or repay, repurchase or redeem any
debt securities of the Company (including any Other Debentures) that rank pari
passu with or junior in right of payment to the Junior Subordinated Debentures
or (iii) make any guarantee payments with respect to any guarantee by the
Company of any securities of any subsidiary of the Company (including Other
Guarantees) if such guarantee ranks pari passu with or junior in right of
payment to the Junior Subordinated Debentures, other than (a) dividends or
distributions in shares of or options, warrants or rights to subscribe for or
purchase shares of, Common Stock or preferred stock of the Company, (b) any
declaration of a dividend in connection with the implementation of a
stockholders' rights plan, or the issuance of stock under any such plan in the
future, or the redemption or repurchase of any such rights pursuant thereto,
(c) payments under the Guarantee, (d) as a direct result of, and only to the
extent required in order to avoid the issuance of fractional shares of capital
stock following, a reclassification of the Company's capital stock or the
exchange or conversion of one class or series of the Company's capital stock
for another class or series of the Company's capital stock, (e) the purchase
of fractional interests in shares of the Company's capital stock pursuant to
the conversion or exchange provisions of such capital stock or the security
being converted or exchanged, and (f) purchases of Common Stock related to the
issuance of Common Stock or rights under any of the Company's benefit plans
for its directors, officers or employees. See "Description of Junior
Convertible Subordinated Debentures--Option to Extend Interest Payment Date."
The Company believes that the adverse impact that the imposition of such
restrictions would have on the Company and the value of its equity securities
makes the likelihood of its exercising its right to defer payments of interest
on the Junior Subordinated Debentures remote. Accordingly, the Company
believes, and this discussion assumes, that the stated interest on the
Subordinated Debentures should be considered unconditionally payable and that
the Junior Subordinated Debentures should not be considered to have been
issued with OID. If so, stated interest paid or payable prior to the exercise,
if any, by the Company, of its right to defer interest payments, will be
taxable to a holder as ordinary interest income, generally at the time it is
received or accrued, in accordance with such holder's regular method of
accounting for federal income tax purposes. There can be no assurance that the
Service will agree with the Company's position.
146
Moreover, if, notwithstanding the foregoing, the Company does exercise its
right to defer payments of interest thereon, the Junior Subordinated
Debentures will be considered to be retired and reissued for their adjusted
issue price at such time, and the Junior Subordinated Debentures thereafter
will be considered to have been issued with OID. In such case, all the
interest payments thereafter payable will be treated as OID. If the payments
were treated as OID (either because the Company exercises the right to defer
interest payments or because the likelihood of exercise of such right was not
remote at the time of issuance), holders must include that discount in income
on an economic accrual basis before the receipt of cash attributable to the
interest, regardless of their method of tax accounting, and any holders who
dispose of Capital Securities prior to the Distribution Record Date for
payment of Distributions thereon following such Extension Period will include
OID in gross income but will not receive any cash related thereto from the
Trust. The amount of OID that accrues in any quarterly period will
approximately equal the amount of the interest that accrues in that period at
the stated interest rate. In the event that the interest payment period is
extended, holders will accrue OID approximately equal to the amount of the
interest payment due at the end of the extended interest payment period on an
economic accrual basis over the length of the extended interest period.
Holders of Capital Securities will not be entitled to a dividends-received
deduction with respect to any income earned on the Capital Securities.
Holders of Capital Securities other than a holder who purchased the Capital
Securities upon original issuance may be considered to have acquired their
undivided interests in the Junior Subordinated Debentures with market discount
or acquisition premium, as such phrases are defined for United States federal
income tax purposes. Such holders are advised to consult their tax advisors as
to the income tax consequences of the acquisition, ownership and disposition
of Capital Securities.
RECEIPT OF JUNIOR SUBORDINATED DEBENTURES UPON LIQUIDATION OF THE TRUST
As described under "Description of Capital Securities--Liquidation of the
Trust and Distribution of Junior Subordinated Debentures," Junior Subordinated
Debentures may be distributed to holders in exchange for the Capital
Securities and in liquidation of the Trust. Under current law, such a
distribution would be treated as a non-taxable event to each holder and each
holder's aggregate tax basis in the Junior Subordinated Debentures would be
equal to such holder's aggregate tax basis in its Capital Securities. A
holder's holding period in the Junior Subordinated Debentures so received in
liquidation of the Trust would include the period for which the Capital
Securities were held by such holder. If, however, the liquidation of the Trust
were to occur because the Trust is subject to United States federal income tax
with respect to income accrued or received on the Junior Subordinated
Debentures, the distribution of Junior Subordinated Debentures to the holders
of Capital Securities by the Trust would be a taxable event to the Trust and a
holder of Capital Securities would recognize gain or loss as if such holder
had exchanged its Capital Securities for the Junior Subordinated Debentures it
received upon the liquidation of the Trust. A holder will be taxable on OID
(if any) in respect of Junior Subordinated Debentures received from the Trust
in the manner described above under "--Interest, Original Issue Discount,
Premium and Market Discount."
SALE OR REDEMPTION OF CAPITAL SECURITIES
A holder that sells Capital Securities (including a redemption for cash)
will recognize gain or loss equal to the difference between the amount
realized on the sale (other than amounts attributable to accrued but unpaid
interest which has not yet been included in income, which will be treated as
ordinary income) and its adjusted tax basis in the securities sold or
redeemed. A holder's adjusted tax basis in the Capital Securities generally
will be its initial purchase price increased by OID (if any) previously
includible in such holder's gross income to the date of disposition (and the
accrual of market discount, if any, if an election to accrue market discount
in income currently is made) and decreased by payments received on the Capital
Securities (other than payments of qualified stated interest). Except to the
extent noted above and subject to the market discount rules of the Internal
Revenue Code of 1986, as amended (the "Code"), any such gain or loss generally
will be short-term, mid-term or long-term capital gain or loss depending on
the length of time the Capital Securities were held.
147
The Capital Securities may trade at a price that does not fully reflect the
value of accrued but unpaid interest with respect to the underlying Junior
Subordinated Debentures. A holder who uses the accrual method of accounting
(and a cash method holder, during and after an Extension Period or if the
Junior Subordinated Debentures are deemed to have been issued with OID) and
who disposes of its Capital Securities between Distribution Record Dates will
be required to include accrued but unpaid interest (or OID) on the Junior
Subordinated Debentures through the date of disposition in income as ordinary
income, and to add such amount to its adjusted tax basis in its Capital
Securities disposed of. To the extent the selling price (which may not fully
reflect the value of accrued but unpaid interest or OID) is less than such
holder's adjusted tax basis, a holder will recognize a capital loss. Subject
to certain limited exceptions, capital losses cannot be applied to offset
ordinary income for United States federal income tax purposes.
CONVERSION OF CAPITAL SECURITIES
A holder of Capital Securities generally will not recognize income, gain or
loss upon the conversion, through the Conversion Agent, of its Capital
Securities into Common Stock. A holder will, however, recognize gain upon the
receipt of cash in lieu of a fractional share of Common Stock equal to the
amount of cash received less the holder's tax basis in such fractional share.
A holder's tax basis in the Common Stock received upon exchange and conversion
will generally be equal to the holder's tax basis in the Capital Securities
delivered to the Conversion Agent for exchange less that basis allocated to
any fractional share for which cash is received, and a holder's holding period
in the Common Stock received upon exchange and conversion will generally begin
on the date the holder acquired the Capital Securities delivered to the
Conversion Agent for exchange.
ADJUSTMENT OF CONVERSION PRICE
Treasury Regulations promulgated under Section 305 of the Code would treat
holders of Capital Securities as having received a constructive distribution
from the Company in the event the Conversion Price of the Junior Subordinated
Debentures were adjusted if (i) as a result of such adjustment, the
proportionate interest (measured by the quantum of Common Stock into or for
which the Junior Subordinated Debentures are convertible or exchangeable) of
the holders of the Capital Securities in the assets or earnings and profits of
the Company were increased, and (ii) the adjustment was not made pursuant to a
bona fide, reasonable antidilution formula. An adjustment in the Conversion
Price would not be considered made pursuant to such a formula if the
adjustment was made to compensate for certain taxable distributions with
respect to the Common Stock. Thus, under certain circumstances, a reduction in
the Conversion Price for the holders may result in deemed dividend income to
holders to the extent of the current or accumulated earnings and profits of
the Company. Holders of the Capital Securities would be required to include
their allocable share of such deemed dividend income in gross income but would
not receive any cash related thereto.
BACKUP WITHHOLDING TAX AND INFORMATION REPORTING
Subject to the qualifications discussed below, income on the Capital
Securities will be reported to holders on Forms 1099, which forms are expected
to be mailed to holders of Capital Securities by January 31 following each
calendar year.
The Trust will be obligated to report annually to the holders of record of
the Capital Securities, the interest (or OID) related to the Junior
Subordinated Debentures for that year. The Trust currently intends to report
such information on Form 1099 prior to January 31 following each calendar year
even though the Trust is not legally required to report to record holders
until April 15 following each calendar year. Under current law, holders of
Capital Securities who hold as nominees for beneficial holders will not have
any obligation to report information regarding the beneficial holders to the
Trust. The Trust, moreover, will not have any obligation to report to
beneficial holders who are not also record holders.
148
Payments made on, and proceeds from the sale of, the Capital Securities may
be subject to a "backup" withholding tax of 31% unless the holder complies
with certain identification requirements. Any withheld amounts will be allowed
as a credit against the holder's federal income tax liability, provided the
required information is provided to the Service.
THE UNITED STATES FEDERAL INCOME TAX DISCUSSION SET FORTH ABOVE IS INCLUDED
FOR GENERAL INFORMATION ONLY AND MAY NOT BE APPLICABLE DEPENDING UPON A
HOLDER'S PARTICULAR SITUATION. HOLDERS SHOULD CONSULT THEIR TAX ADVISORS WITH
RESPECT TO THE TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND
DISPOSITION OF THE CAPITAL SECURITIES, INCLUDING THE TAX CONSEQUENCES UNDER
THE ALTERNATIVE MINIMUM TAX AND THE STATE, LOCAL, FOREIGN AND OTHER TAX LAWS
AND THE POSSIBLE EFFECTS OF CHANGES IN UNITED STATES FEDERAL OR OTHER TAX
LAWS.
ERISA CONSIDERATIONS
If an employee benefit plan within the meaning of Section 3(3) of the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"),
individual retirement account or other plan within the meaning of Section 4975
of the Code, or persons which are treated as using assets of such employee
benefit plans, accounts or plans (collectively, "Plans") acquires Capital
Securities, the assets of the Trust may be treated as assets of the investing
Plans for purposes of the fiduciary requirements of ERISA and the prohibited
transaction provisions of ERISA or Section 4975 of the Code. The Department of
Labor has issued final regulations (the "Labor Regulations") as to what
constitutes assets of an employee benefit plan under ERISA. The Labor
Regulations provide that, as a general rule, when a plan acquires an equity
interest in an entity and such interest does not represent a publicly offered
security nor a security issued by an investment company registered under the
Investment Advisors Act of 1940, the plan's assets include both the equity
interest and an undivided interest in each of the underlying assets of the
entity, unless the entity is an operating company or equity participation in
the entity by benefit plan investors is not "significant." For purposes of the
Labor Regulations, the Trust will not be an investment company nor an
operating company and there is no assurance that the Capital Securities will
constitute "publicly offered securities" or that benefit plan investor
participation in the equity of the Trust will be insignificant.
Pursuant to the exception in the Labor Regulations for insignificant equity
participation by benefit plan investors, the assets of the Trust would not
constitute plan assets of investing Plans at any time if, immediately after
the most recent acquisition of any equity interest in the Trust, less than 25%
of the value of each class of equity interest in the Trust were held by Plans
and other "benefit plan investors," which term includes governmental, church
and foreign plans not subject to ERISA and entities deemed to hold assets of
such plans. No assurance can be given that the value of Capital Securities
held by benefit plan investors will be less than 25% of the total value of
such securities at the completion of the Offering or thereafter and no
monitoring or other measures will be taken to assure satisfaction of the
conditions to this exception. It is also possible that the Capital Securities
may qualify for the exemption available to "publicly offered securities," if
in addition to being offered pursuant to an effective registration statement,
they are registered under the Securities Exchange Act of 1934, are "widely
held" at the close of the Offering and are "freely transferable." Under the
Labor Regulations, a class of securities is "widely held" only if it is a
class of securities held by 100 or more investors independent of the issuer
and each other. Although it is possible that the Capital Securities will be
"widely held," no measures will be taken to assure that they will be "widely
held." Thus, no assurances can be given that the Capital Securities will
qualify for the "publicly offered securities" exemption.
It is unlikely that the Company, the obligor of the Junior Subordinated
Debentures and the Guarantee, would be a party in interest or disqualified
person with respect to a Plan before a Plan's acquisition of Capital
Securities. However, if the assets of the Trust were considered "plan assets"
of Plans holding Capital Securities for purposes of ERISA and Section 4975 of
the Code, service providers with respect to the assets of the Trust may
149
become parties in interest or disqualified persons (as defined in ERISA and
Section 4975 of the Code, respectively) with respect to investing Plans, and
any discretionary authority exercised with respect to the Junior Subordinated
Debentures by such persons could be deemed to constitute or give rise to a
prohibited transaction under ERISA or the Code. In order to minimize the risk
of such prohibited transactions, each investing Plan, by purchasing the
Capital Securities, will be deemed to have directed the Trust to invest in the
Junior Subordinated Debentures, to enter into the Guarantee and to have
appointed the Issuer Trustees.
A fiduciary with respect to a Plan subject to ERISA (excluding individual
retirement accounts) not sponsored by an employer for its employees should
consider whether the purchase of Capital Securities could result in a
delegation of fiduciary authority to the Property Trustee, and, if so, whether
such a delegation of authority is permissible under the Plan's governing
instrument or any investment management agreement with the Plan. In making
such determination, a Plan fiduciary should note that the Property Trustee is
a U.S. bank qualified to be an investment manager (within the meaning of
section 3(38) of ERISA) to which such delegation of authority generally would
be permissible under ERISA. Further, prior to an Event of Default with respect
to the Junior Subordinated Debentures, the Property Trustee will have only
limited custodial and ministerial authority with respect to Trust assets. In
addition, unless an exemption applies, the Junior Subordinated Debentures and
the Guarantee would constitute a prohibited extension of credit between the
Company and Plans holding Capital Securities, if the Company were considered a
party in interest or disqualified person.
Any purchaser proposing to acquire Capital Securities with assets of any
Plan should consult with counsel, particularly regarding the application of
the fiduciary and prohibited transaction provisions. Each fiduciary with
respect to a Plan who is responsible for the acquisition of Capital Securities
by such Plan shall be deemed to have represented and warranted for the benefit
of the Company, the Issuer Trustees and the Guarantee Trustee that the
acquisition and holding of Capital Securities by such Plan does not result in
or give rise to a non-exempt prohibited transaction by reason of the
application of the following class exemptions issued by the Department of
Labor: Prohibited Transaction Class Exemption ("PTCE") 84-14 (an exemption for
certain transactions determined by an independent qualified professional asset
manager), PTCE 90-1 (an exemption for certain transactions involving insurance
company pooled separate accounts), PTCE 91-38 (an exemption for certain
transactions involving bank collective investment funds), PTCE 95-60 (an
exemption for transactions involving certain insurance company general
accounts) or PTCE 96-23 (an exception for certain transactions determined by
an in-house asset manager) or another exemption for which the fiduciary
provides a satisfactory opinion of counsel or other evidence of its
availability.
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UNDERWRITING
Subject to the terms and conditions set forth in an underwriting agreement
(the "Underwriting Agreement"), the Trust has agreed to sell to the
Underwriter, and the Underwriter has agreed to purchase of the Capital
Securities at the initial public offering price set forth on the cover page of
the Prospectus. In the Underwriting Agreement, the Underwriter has agreed,
subject to the terms and conditions set forth therein, to purchase all the
Capital Securities offered hereby if any of the Capital Securities are
purchased.
The Company has been advised by the Underwriter that it proposes initially
to offer the Capital Securities to the public at the initial public offering
price set forth on the cover page of this Prospectus, and to certain dealers
at such price less a concession not in excess of $ per Capital Security.
The Underwriter may allow, and such dealers may reallow, a discount not in
excess of $ per Capital Security on sales to certain other dealers.
After the initial public offering, the public offering price, concession and
discount may be changed.
The Trust and the Company have granted the Underwriter an option,
exercisable not later than 30 days after the date of this Prospectus, to
purchase up to an aggregate of additional Capital Securities at the
initial public offering price set forth on the cover page of this Prospectus.
The Underwriter may exercise such option, in part or in full, only to cover
over-allotments, if any, made in connection with the sale of the Capital
Securities offered hereby. If purchased, the Underwriter will offer such
additional Capital Securities on the same terms as the Capital Securities
are being offered. To the extent that the Underwriter exercises such option,
the Underwriter will be obligated, subject to certain conditions, to purchase
the number of Capital Securities covered by such exercise and the Trust will
be obligated to sell such Capital Securities to the Underwriter.
In view of the fact that the proceeds of the sale of the Capital Securities
will be used to purchase the Junior Convertible Subordinated Debentures of the
Company, the Purchase Agreement provides that the Company will pay as
compensation ("Underwriter's Compensation") to the Underwriter, for the
Underwriter's arranging the investment therein of such proceeds, an amount in
same day funds of $ per Capital Security (or $ in the aggregate,
or $ in the aggregate if the Underwriter's over-allotment option is
exercised in full) for the account of the Underwriter.
The Trust and the Company have agreed that they will not, for a period of 90
days after the date of the Prospectus, except with the prior written consent
of the Underwriter directly or indirectly sell, offer to sell, grant any
option for the sale of, or otherwise dispose of, (a) any trust certificates or
other securities of the Trust (other than the Capital Securities offered
hereby and the Common Securities issued to the Company), (b) any preferred
stock or any other security of the Company that is substantially similar to
the Capital Securities, (c) any shares of any class of common stock of the
Company (other than (i) shares of Common Stock issuable upon conversion of the
Capital Securities or pursuant to the exercise of options or warrants
outstanding on the date of this Prospectus, and (ii) the grant of stock
options or other stock-based awards (and the exercise thereof) to directors,
officers and employees of the Company or any of its subsidiaries) or (d) any
debt securities of the Company that are substantially similar to the Junior
Convertible Subordinated Debentures (other than the Junior Convertible
Subordinated Debentures issued to the Trust).
The Company has applied to have the Capital Securities approved for
quotation on the Nasdaq, subject to official notice of issuance, under the
symbol "LFCOP." Prior to this offering, there has been no public market for
the Capital Securities.
The Company and the Trust have agreed to indemnify the Underwriter against,
or contribute to payments that the Underwriter may be required to make in
respect of, certain liabilities, including liabilities under the Securities
Act of 1933, as amended.
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EXPERTS
The consolidated financial statements of LIFE Financial Corporation as of
December 31, 1996 and for the year then ended included in this Prospectus,
have been audited by Deloitte & Touche LLP, independent auditors, as stated in
their report appearing herein (which report expresses an unqualified opinion
and includes an explanatory paragraph referring to the adoption of Statement
of Financial Accounting Standards No. 122), and are included in reliance upon
the report of such firm given upon their authority as experts in accounting
and auditing.
The financial statements of LIFE Financial Corporation as of December 31,
1995 and for the year ended December 31, 1995 included in this Prospectus have
been audited by Grant Thornton LLP, independent auditors, as stated in their
report appearing herein, and are included in reliance upon such report given
the authority of such firm as experts in accounting and auditing.
The financial statements of LIFE Financial Corporation for the year ended
December 31, 1994 included in this Prospectus, have been audited by Price
Waterhouse LLP, independent accountants, as stated in their report appearing
herein, and are included in reliance upon such report given upon the authority
of such firm as experts in accounting and auditing.
LEGAL MATTERS
Certain matters of Delaware law relating to the validity of the Capital
Securities will be passed upon on behalf of the Company and the Trust by
Prickett, Jones, Elliott, Kristol & Schree, special Delaware counsel to the
Company and the Trust. The validity under Delaware law of the Junior
Subordinated Debentures and the Guarantee will be passed upon for the Company
and the Trust by Muldoon, Murphy & Faucette, Washington, D.C. Certain legal
matters will be passed upon for the Underwriter by Brobeck, Phleger & Harrison
LLP, Newport Beach, California.
ADDITIONAL INFORMATION
The Company has filed with the SEC a registration statement under the
Securities Act with respect to the securities offered hereby. As permitted by
the rules and regulations of the SEC, this Prospectus does not contain all the
information set forth in the registration statement. This Prospectus contains
a description of the material terms and features of all material contracts,
reports or exhibits to the registration statement required to be described;
however, the statements contained in this Prospectus as to the contents of any
contract or other document filed as an exhibit to the registration statement
are, of necessity, brief descriptions thereof and are not necessarily
complete; each such statement is qualified by reference to such contract or
document. Such information and all exhibits to the Registration Statement can
be examined without charge at the public reference facilities of the SEC
located at 450 Fifth Street, N.W., Washington, D.C. 20549; and at the Pacific
Regional Office of the Commission at 5670 Wilshire Blvd., 11th Floor, Los
Angeles, California 90036-3648, and copies of such material can be obtained
from the SEC at prescribed rates. In addition, the SEC maintains a website
(http://www.sec.gov) that contains reports, proxy and information statements
and other information regarding registrants that file electronically with the
SEC, including the Company.
The Company is subject to the informational requirements of the Exchange
Act, and in accordance therewith files reports, proxy statements and other
information with the Commission. Reports, proxy statements and other
information concerning the Company can be inspected and copied or accessed as
described above.
No separate financial statements of the Trust have been included herein.
Neither the Company nor the Trust consider that such financial statements
would be material to holders of the Capital Securities because (i) all of the
voting securities of the Trust will be owned, directly or indirectly, by the
Company, a reporting company under the Exchange Act, (ii) the Trust has no
independent operations but exists for the sole purpose of issuing securities
representing undivided beneficial interests in the assets of the Trust and
investing the proceeds thereof
152
in Junior Subordinated Debentures issued by the Company, and (iii) the
Company's obligations described herein to provide certain indemnities in
respect of, and be responsible for, certain costs, expenses, debts and
liabilities of the Trust under the Indenture and any supplemental indenture
thereto and pursuant to the Declaration of the Trust, the Guarantee issued
with respect to the Capital Securities issued by the Trust, the Junior
Subordinated Debentures purchased by the Trust and the related Indenture,
taken together, constitute a full and unconditional guarantee of payments due
on the Capital Securities. See "Description of Junior Convertible Subordinated
Debentures" and "Description of the Guarantee." In addition, the Company does
not expect that the Trust will file reports, proxy statements and other
information under the Exchange Act with the Commission.
153
LIFE FINANCIAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants for the year ended December 31, 1994.... F-1
Independent Auditors' Report as of and for the year ended December 31,
1995..................................................................... F-2
Independent Auditors' Report as of and for the year ended December 31,
1996..................................................................... F-3
Consolidated Statements of Financial Condition as of September 30, 1997
(unaudited) and December 31, 1996 and 1995............................... F-4
Consolidated Statements of Operations for the nine months ended September
30, 1997 and 1996 (unaudited) and for each of the three years in the
period ended December 31, 1996........................................... F-5
Consolidated Statements of Stockholders' Equity for the nine months ended
September 30, 1997 (unaudited) and for each of the three years in the
period ended December 31, 1996........................................... F-6
Consolidated Statements of Cash Flows for the nine months ended September
30, 1997 and 1996 (unaudited) and for each of the three years in the
period ended December 31, 1996........................................... F-7
Notes to Consolidated Financial Statements................................ F-8
All schedules are omitted because they are not required or applicable, or
the required information is shown in the financial statements or notes
thereto.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
LIFE Financial Corporation
In our opinion, the accompanying statements of operations, of cash flows and
of stockholders' equity present fairly, in all material respects the results
of operations and cash flows of LIFE Financial Corporation (the Company) for
the year ended December 31, 1994, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statements presentation. We believe that
our audit provides a reasonable basis for the opinion expressed above. We have
not audited the financial statements of LIFE Financial Corporation for any
period subsequent to December 31, 1994.
/s/ PRICE WATERHOUSE LLP
PRICE WATERHOUSE LLP
Los Angeles, California
January 31, 1995, except for the "Basis of Presentation and Description of
Business" and "Earnings Per Share" paragraphs in Note 1 which are as of June
30, 1997.
F-1
INDEPENDENT AUDITORS' REPORT
Board of Directors
LIFE Financial Corporation
We have audited the accompanying statement of financial condition of LIFE
Financial Corporation (formerly Life Savings Bank, Federal Savings Bank) as of
December 31, 1995, and the related statements of operations, stockholders'
equity and cash flows for the year then ended. These financial statements are
the responsibility of the Bank's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the 1995 financial statements referred to above present
fairly, in all material respects, the financial position of LIFE Financial
Corporation as of December 31, 1995, and the results of its operations and its
cash flows for the year then ended in conformity with generally accepted
accounting principles.
As discussed in Note 1 to the financial statements, in 1995 the Bank changed
its method of accounting for mortgage servicing rights to conform with
Statement of Financial Accounting Standards No. 122.
/s/ Grant Thornton LLP
Grant Thornton LLP
Irvine, California
February 8, 1996 (except for the "Earnings Per Share" paragraph of Note 1, as
to which the date is June 30, 1997)
F-2
INDEPENDENT AUDITORS' REPORT
Board of Directors
LIFE Financial Corporation
We have audited the accompanying consolidated statement of financial condition
of LIFE Financial Corporation and subsidiary (the Company) as of December 31,
1996, and the related consolidated statements of operations, stockholders'
equity and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, such 1996 consolidated financial statements present fairly, in
all material respects, the financial position of LIFE Financial Corporation
and subsidiary as of December 31, 1996, and the results of their operations
and their cash flows for the year then ended in conformity with generally
accepted accounting principles.
As discussed in Note 1 to the financial statements, in 1995, the Company
changed its method of accounting for mortgage servicing rights to conform with
Statement of Financial Accounting Standards No. 122, Accounting for Mortgage
Servicing Rights.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Costa Mesa, California
February 7, 1997 (March 14, 1997 as to Note 16)
F-3
LIFE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
DECEMBER 31,
SEPTEMBER 30, -----------------
1997 1996 1995
------------- -------- -------
(UNAUDITED)
ASSETS
Cash and cash equivalents..................... $ 12,872 $ 13,265 $ 3,932
Restricted cash............................... 10,856 1,636
Securities held to maturity, estimated fair
value of $7,029 (1997) (unaudited), $7,981
(1996) and $1,985 (1995)..................... 7,015 8,023 1,985
Residual assets, at fair value................ 24,533 5,700
Loans held for sale........................... 191,555 31,018 21,688
Loans held for investment, net of allowance
for estimated loan losses of $1,859 (1997)
(unaudited), $1,625 (1996) and $1,177
(1995)....................................... 32,133 36,895 41,693
Mortgage servicing rights..................... 5,713 2,645 683
Accrued interest receivable................... 1,714 537 507
Foreclosed real estate, net................... 975 561 827
Premises and equipment, net................... 3,770 1,579 976
Federal Home Loan Bank stock.................. 1,050 814 715
Deferred income taxes......................... 131 397 138
Other assets.................................. 1,785 940 992
-------- -------- -------
TOTAL ASSETS.............................. $294,102 $104,010 $74,136
======== ======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposit accounts............................ $159,840 $ 85,711 $67,535
Other borrowings............................ 61,523 3,278
Subordinated debentures..................... 10,000
Accounts payable and other liabilities...... 13,262 5,748 2,333
-------- -------- -------
Total liabilities......................... 244,625 94,737 69,868
COMMITMENTS AND CONTINGENCIES (NOTE 11)
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 5,000,000
shares authorized; no shares outstanding...
Common stock, $.01 par value; 25,000,000
shares authorized; 6,546,716 (1997)
(unaudited), 3,211,716 (1996) and 933,108
(1995) shares issued and outstanding....... 65 32 9
Additional paid-in capital.................. 41,834 9,358 3,393
Retained earnings (deficit), partially
restricted................................. 7,578 (117) 866
-------- -------- -------
Total stockholders' equity................ 49,477 9,273 4,268
-------- -------- -------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY................................... $294,102 $104,010 $74,136
======== ======== =======
See notes to consolidated financial statements.
F-4
LIFE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------- -----------------------------
1997 1996 1996 1995 1994
--------- --------- --------- --------- ---------
(UNAUDITED)
INTEREST INCOME:
Loans.................... $ 10,001 $ 4,674 $ 6,542 $ 5,433 $ 4,530
Securities held to
maturity................ 334 55 56 159 138
Other interest-earning
assets.................. 1,817 193 331 233 156
--------- --------- --------- --------- ---------
Total interest income.. 12,152 4,922 6,929 5,825 4,824
--------- --------- --------- --------- ---------
INTEREST EXPENSE:
Deposit accounts......... 5,440 2,507 3,514 3,192 2,534
Federal Home Loan Bank
advances and other
borrowings.............. 888 192 252 256 187
Subordinated debentures.. 773
--------- --------- --------- --------- ---------
Total interest
expense............... 7,101 2,699 3,766 3,448 2,721
--------- --------- --------- --------- ---------
NET INTEREST INCOME BEFORE
PROVISION FOR ESTIMATED
LOAN LOSSES............... 5,051 2,223 3,163 2,377 2,103
PROVISION FOR ESTIMATED
LOAN LOSSES............... 900 359 963 1,194 1,306
--------- --------- --------- --------- ---------
NET INTEREST INCOME AFTER
PROVISION FOR ESTIMATED
LOAN LOSSES............... 4,151 1,864 2,200 1,183 797
NONINTEREST INCOME:
Loan servicing and other
fees.................... 413 321 496 231 164
Service charges on
deposit accounts........ 94 93 128 111 84
Net gains from mortgage
financing operations.... 17,413 3,759 8,352 3,575 1,428
Other income............. 265 91 136 103 12
--------- --------- --------- --------- ---------
Total noninterest
income................ 18,185 4,264 9,112 4,020 1,688
NONINTEREST EXPENSE:
Compensation and
benefits................ 5,534 3,206 5,233 2,544 1,575
Premises and occupancy... 805 538 746 471 418
Data processing.......... 524 281 390 208 167
Net loss on foreclosed
real estate............. 94 171 158 53 280
FDIC insurance premiums.. 69 136 174 184 186
SAIF special assessment.. 448 448
Marketing................ 195 119 189 65 55
Telephone................ 439 159 246 143 128
Professional services.... 243 137 218 92 86
Other expense............ 1,247 623 879 629 561
--------- --------- --------- --------- ---------
Total noninterest
expense............... 9,150 5,818 8,681 4,389 3,456
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME
TAX PROVISION (BENEFIT)... 13,186 310 2,631 814 (971)
INCOME TAX PROVISION
(BENEFIT)................. 5,491 142 1,126 294 (300)
--------- --------- --------- --------- ---------
NET INCOME (LOSS).......... $ 7,695 $ 168 $ 1,505 $ 520 $ (671)
========= ========= ========= ========= =========
EARNINGS (LOSS) PER SHARE.. $ 1.70 $ 0.08 $ 0.63 $ 0.28 $ (0.36)
========= ========= ========= ========= =========
WEIGHTED AVERAGE SHARES
OUTSTANDING............... 4,522,251 2,090,466 2,370,779 1,866,216 1,866,216
========= ========= ========= ========= =========
See notes to consolidated financial statements.
F-5
LIFE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
COMMON STOCK ADDITIONAL RETAINED TOTAL
---------------- PAID-IN EARNINGS STOCKHOLDERS'
SHARES AMOUNT CAPITAL (DEFICIT) EQUITY
--------- ------ ---------- --------- -------------
BALANCE, January 1, 1994.. 933,108 $ 9 $ 3,393 $ 1,017 $ 4,419
Net loss.................. (671) (671)
--------- --- ------- ------- -------
BALANCE, December 31,
1994..................... 933,108 9 3,393 346 3,748
Net income................ 520 520
--------- --- ------- ------- -------
BALANCE, December 31,
1995..................... 933,108 9 3,393 866 4,268
Stock split effected in
the form of a dividend... 933,108 9 2,479 (2,488)
Net proceeds from issuance
of common stock.......... 1,345,500 14 3,486 3,500
Net income................ 1,505 1,505
--------- --- ------- ------- -------
BALANCE, December 31,
1996..................... 3,211,716 32 9,358 (117) 9,273
Unaudited:
Net proceeds from issu-
ance of common stock... 3,335,000 33 32,476 32,509
Net income.............. 7,695 7,695
--------- --- ------- ------- -------
BALANCE, September 30,
1997 (unaudited)......... 6,546,716 $65 $41,834 $ 7,578 $49,477
========= === ======= ======= =======
See notes to consolidated financial statements.
F-6
LIFE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------- ------------------------------
1997 1996 1996 1995 1994
-------- --------- --------- --------- --------
(UNAUDITED)
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income (loss)........ $ 7,695 $ 168 $ 1,505 $ 520 $ (671)
Adjustments to reconcile
net income (loss) to net
cash used in operating
activities:
Depreciation and
amortization........... 388 215 301 166 179
Provision for estimated
loan losses............ 900 359 963 1,194 1,306
Accretion of deferred
fees................... (7) (8) (41) (11) (20)
Provision for estimated
losses on foreclosed
real estate............ 62 167 145 104 187
Gain on sale of
foreclosed real estate,
net.................... (43) (21) (41) (137) (39)
Gain on sale and
securitization of loans
held for sale.......... (16,811) (3,759) (7,868) (3,549) (1,014)
Gain on bulk sale of
mortgage servicing
rights................. (26) (414)
Unrealized gain on
residual asset......... (602) (484)
Net accretion of
residual asset......... (1,056) (29)
Change in valuation
allowance on mortgage
servicing rights....... 247 (12) (12) 13
Amortization of mortgage
servicing rights....... 694 177 320 268 20
Purchase and origination
of loans held for sale,
net of loan fees....... (450,128) (151,234) (227,156) (135,552) (72,613)
Proceeds from sales and
securitization of loans
held for sale.......... 277,567 143,026 212,226 130,086 66,408
Increase in restricted
cash................... (9,477) (1,636)
(Increase) decrease in
accrued interest
receivable............. (1,177) 26 (30) (76) (2)
Deferred income taxes... (266) (259) (81) 51
Decrease (increase) in
income taxes
receivable............. (117) 479 (64)
Increase in accounts
payable and other
liabilities............ 7,514 803 3,415 1,618 86
Federal Home Loan Bank
stock dividend......... (41) (43) (34) (30) (20)
Decrease (increase) in
other assets........... 13 (81) 52 (315) (271)
-------- --------- --------- --------- --------
Net cash used in
operating activities.. (184,528) (10,334) (18,663) (5,329) (6,891)
CASH FLOWS FROM INVESTING
ACTIVITIES:
Net decrease in loans.... 7,246 9,690 8,578 6,428 8,133
Proceeds from sale of
foreclosed real estate.. 776 1,118 1,471 1,097 1,424
Purchase of securities
held to maturity........ (2,000) (8,013) (8,969) (991)
Proceeds from maturities
of securities held to
maturity................ 3,000 1,975 1,975 9,241 2,042
Purchase of mortgage
servicing rights........ (706) (128)
Proceeds from bulk sales
of servicing rights..... 632 522
Additions to premises and
equipment, net.......... (2,541) (236) (904) (523) (33)
Purchase of Federal Home
Loan Bank stock......... (195) (44) (65) (82) (8)
Cash received on residual
assets.................. 3,322
-------- --------- --------- --------- --------
Net cash provided by
investing activities.. 9,608 12,503 3,042 7,118 10,961
CASH FLOWS FROM FINANCING
ACTIVITIES:
Net increase (decrease)
in deposit accounts..... 74,129 5,791 18,176 1,846 (6,319)
Increase (decrease) in
Federal Home Loan Bank
advances................ 6,900 (1,250) 50
Net proceeds from other
borrowings.............. 51,345 3,278
Net proceeds from
issuance of common
stock................... 32,509 3,500 3,500
Net proceeds from
issuance of subordinated
debentures.............. 9,644
-------- --------- --------- --------- --------
Net cash provided by
(used in) financing
activities............ 174,527 9,291 24,954 596 (6,269)
-------- --------- --------- --------- --------
NET (DECREASE) INCREASE
IN CASH AND CASH
EQUIVALENTS............. (393) 11,460 9,333 2,385 (2,199)
CASH AND CASH
EQUIVALENTS, beginning
of period............... 13,265 3,932 3,932 1,547 3,746
-------- --------- --------- --------- --------
CASH AND CASH
EQUIVALENTS, end of
period.................. $ 12,872 $ 15,392 $ 13,265 $ 3,932 $ 1,547
======== ========= ========= ========= ========
SUPPLEMENTAL CASH FLOW
DISCLOSURES:
Interest paid............ $ 5,300 $ 2,513 $ 3,773 $ 3,418 $ 2,729
======== ========= ========= ========= ========
Income taxes paid
(refunded).............. $ 3,524 $ 172 $ 267 $ 191 $ (290)
======== ========= ========= ========= ========
NONCASH INVESTING
ACTIVITIES DURING THE
PERIOD:
Transfers from loans held
for sale to loans held
for investment.......... $ -- $ -- $ 856 $ -- $ --
======== ========= ========= ========= ========
Transfers from loans held
for investment to loans
held for sale........... $ -- $ -- $ -- $ -- $ 10,090
======== ========= ========= ========= ========
Transfers from loans to
foreclosed real estate.. $ 1,496 $ 1,983 $ 2,070 $ 1,983 $ 1,871
======== ========= ========= ========= ========
Loans to facilitate sales
of foreclosed real
estate.................. $ 287 $ 553 $ 761 $ 647 $ 1,516
======== ========= ========= ========= ========
NONCASH FINANCING
ACTIVITIES DURING THE
PERIOD--
Stock dividends paid.... $ -- $ 2,488 $ 2,488 $ -- $ --
======== ========= ========= ========= ========
See notes to consolidated financial statements.
F-7
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
AND THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Insofar as these financial statements and notes relate to information at
September 30, 1997 and for the nine month periods ended September 30, 1997 and
1996, they are unaudited. In the opinion of management, such unaudited
financial statements and notes thereto reflect all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of
financial position, results of operations and cash flows for such periods. The
financial position at September 30, 1997 and results of operations for the
nine months then ended are not necessarily indicative of the financial
position that may be expected at December 31, 1997 or results of operations
that may be expected for the year ending December 31, 1997.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Description of Business--The consolidated
financial statements include the accounts of LIFE Financial Corporation (Life)
and its wholly-owned subsidiary, Life Bank (formerly Life Savings Bank,
Federal Savings Bank) (the Bank) (collectively, the Company). All significant
intercompany accounts and transactions have been eliminated in consolidation.
Life is a savings and loan holding company incorporated in the State of
Delaware that was initially organized for the purpose of acquiring all of the
capital stock of the Bank through the holding company reorganization (the
"Reorganization") of the Bank, which was consummated on June 27, 1997.
Pursuant to the Reorganization, Life issued 3,211,716 shares of common stock
in exchange for the 1,070,572 shares of the Bank's outstanding common stock
and accordingly the Bank became a wholly-owned subsidiary of Life. Such
business combination was accounted for at historical cost in a manner similar
to a pooling of interests. On June 30, 1997 the Company completed its sale of
2,900,000 additional shares of its common stock through an initial public
offering. On July 2, 1997, the Company issued 435,000 shares of common stock
to the public through the exercise of the underwriter's overallotment option,
bringing the total shares outstanding to 6,546,716. The consolidated financial
condition and results of operations of the Company for periods prior to the
date of the Reorganization consist of those of the Bank.
The Company originates, purchases, sells and services nonconventional
mortgage loans principally secured by first and second mortgages on one- to
four-family residences. The Company focuses on loans for the purchase or
refinance of residential real property by borrowers who, because of prior
credit problems or the absence of a credit history, are considered "subprime
borrowers." The Company also originates debt consolidation loans for up to
125% of the loan to value ratio of such loans for borrowers whose credit
history qualifies for loans under federal agency programs. The Company
purchases and originates mortgage loans and other real estate secured loans
through a network of approved correspondents and mortgage brokers on a
nationwide basis, as well as through the Company's retail lending division.
Except for a limited number of loans specifically originated for retention in
the Company's portfolio as loans held for investment, since 1994, loans
originated or purchased are generally originated for sale in the secondary
mortgage market or in asset securitizations. The Company generally retains the
majority of the servicing rights to the loans sold or securitized and may sell
servicing rights at a later date depending on market opportunities. In
addition, the Company purchases and originates for resale in the secondary
market, smaller commercial real estate and multi-family loans. The Company
funds substantially all of the loans which it purchases or originates through
deposits from customers concentrated in the communities surrounding its home
office in San Bernardino County, internally generated funds, advances from the
Federal Home Loan Bank and other borrowings.
The Company has recently begun to focus efforts on the origination of multi-
family and commercial real estate as well as consumer-oriented loans secured
by real estate, primarily home equity lines of credit and second
F-8
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
AND THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
trust deeds. Specifically, the Company has targeted borrowers seeking loans
secured by multi-family properties or properties used for commercial business
purposes such as small office buildings or light industrial or retail
facilities. Such loans are generally originated for sale.
Securities Held to Maturity--Investments in debt securities that management
has the positive intent and ability to hold to maturity are reported at cost,
adjusted for premiums and discounts that are recognized in interest income
using the interest method over the period to maturity.
Loans--The Company's real estate loan portfolio consists of long-term loans
secured by first and second trust deeds on single-family residences.
The Company primarily originates mortgage loans for sale in the secondary
market. At origination or purchase, mortgage loans are designated as held for
sale or held for investment. Loans held for sale are carried at the lower of
cost or estimated market value determined on an aggregate basis by outstanding
investor commitments or current investor requirements and include related loan
origination costs and fees, as well as premiums or discounts for purchased
loans. Net unrealized losses, if any, are recognized in a valuation allowance
by charges to operations. Any transfers of loans held for sale to the
investment portfolio are recorded at the lower of cost or estimated market
value on the transfer date. At September 30, 1997 and December 31, 1996,
respectively, the principal balance of loans held for sale consist of
$149,800,000 and $25,414,000 in single family residential mortgage loans,
$15,963,000 and $2,628,000 in multi-family residential mortgage loans,
$14,193,000 and $2,412,000 in commercial mortgage loans and $6,682,000 and $0
in other loans. At December 31, 1995, all loans held for sale are single
family residential mortgage loans.
Loans held for investment are carried at amortized cost and net of deferred
loan origination fees and costs and allowance for estimated loan losses. Net
deferred loan origination fees and costs on loans are amortized or accreted
using the interest method over the expected lives of the loans. Amortization
of deferred loan fees is discontinued for nonperforming loans. Loans held for
investment are not adjusted to the lower of cost or estimated market value
because it is management's intention, and the Company has the ability to, hold
these loans to maturity.
Interest on loans is credited to income as earned. Interest receivable is
accrued only if deemed collectible. Generally, allowances are established for
uncollected interest on loans on which payments are more than 90 days past
due.
On January 1, 1995, the Company adopted Statement of Financial Accounting
Standards (SFAS) No.114, Accounting by Creditors for Impairment of a Loan, as
amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan--
Income Recognition and Disclosures. SFAS No. 114 generally requires all
creditors to account for impaired loans, except those loans that are accounted
for at fair value or at the lower of cost or fair value, at the present value
of the expected future cash flows discounted at the loan's effective interest
rate or, as a practical expedient, at the loan's observable market price or
the fair value of the collateral if the loan is collateral dependent. SFAS No.
114 indicated that a creditor should evaluate the collectibility of both
contractual interest and contractual principal when assessing the need for a
loss accrual. The adoption of these statements did not have a material impact
on the results of operations or the financial position of the Company, taken
as a whole.
The Company considers a loan impaired when it is probable that the Company
will be unable to collect all contractual principal and interest payments
under the terms of the original loan agreement. Loans are evaluated
F-9
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
AND THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
for impairment as part of the Company's normal internal asset review process.
However, in determining when a loan is impaired, management also considers the
loan documentation, current loan to value ratios, and the borrower's current
financial position. Included as impaired loans are all loans delinquent 90
days or more and all loans that have a specific loss allowance applied to
adjust the loan to fair value. The accrual of interest on impaired loans is
discontinued after a 90-day delinquent period or when, in management's
opinion, the borrower may be unable to meet payments as they become due. When
the interest accrual is discontinued, all unpaid accrued interest is reverse.
Interest income is subsequently recognized only to the extent cash payments
are received. Where impairment is considered other than temporary, a charge-
off is recorded; where impairment is considered temporary, an allowance is
established. Impaired loans which are performing under the contractual terms
are reported as performing loans, and cash payments are allocated to principal
and interest in accordance with the terms of the loans. The Company uses the
fair value of collateral method for measuring impaired loans. The Company
applies such measurement provision to all loans in its portfolio except for
one-to-four-family residential mortgage loans and unsecured consumer loans,
which are collectively evaluated for impairment.
Allowances for Estimated Loan and Real Estate Losses--It is the policy of
the Company to maintain allowances for estimated loan and real estate losses
at levels deemed appropriate by management to provide for known or inherent
risks in the portfolio. Specific loss allowances are established for loans
that are deemed impaired if the fair value of the loan or the collateral is
estimated to be less than the gross carrying value of the loan. In estimating
losses, management considers the estimated sales price, cost of refurbishment,
payment of delinquent taxes, cost of holding the property (if an extended
period is anticipated) and cost of disposal. Additionally, general valuation
allowances for loan and real estate losses have been established. Management's
determination of the adequacy of the loan and real estate loss allowances is
based on an evaluation of the composition of the portfolio, actual loss
experience, current and prospective economic conditions, industry trends and
other relevant factors, such as the recent adverse economic conditions
experienced (including declining real estate values) in the area in which the
Company's lending and real estate activities are based, which may affect the
borrower's ability to pay and the value of the underlying collateral. In
addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses.
Such agencies may require the Bank to recognize additions to the allowance
based on judgments different from those of management.
Although management uses the best information available to make these
estimates, future adjustments to the allowances may be necessary due to
economic, operating, regulatory and other conditions that may be beyond the
Company's control.
Mortgage Financing Operations--The Company sells and securitizes the
majority of loans held for sale with servicing retained. Under the servicing
agreements, the investor is paid its share of the principal collections
together with interest at an agreed-upon rate, which generally differs from
the loans' contractual interest rate. Such differences result in a "loan
servicing spread."
Effective July 1, 1995, the Company adopted SFAS No. 122, Accounting for
Mortgage Servicing Rights, which amended SFAS No. 65, Accounting for Certain
Mortgage Banking Activities. SFAS No. 122 requires an institution that
purchases or originates mortgage loans and sells or securitizes those loans
with servicing rights retained to allocate the total cost of the mortgage
loans to the mortgage servicing rights and the loans (without the mortgage
servicing rights) based on their relative fair values. The impact of adopting
SFAS No. 122 was an increase in pretax income of $594,000, net income of
$438,000 and earnings per share of $.23 for the year ended December 31, 1995.
F-10
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
AND THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
In addition, SFAS No. 122 requires that all capitalized mortgage servicing
rights (MSRs) be evaluated for impairment based on the fair value of those
rights. The Company's periodic evaluation is performed on a disaggregated
basis whereby MSRs are stratified based upon type of interest rate (variable
or fixed), loan type and original loan term. Impairment is recognized in a
valuation allowance for each pool in the period of impairment. The Company
determines fair value based on the present value of estimated net future cash
flows related to servicing income. In estimating fair values at December 31,
1996, the Company utilized a weighted average prepayment assumption of 23% and
a weighted average discount rate of 16.5%. The cost allocated to servicing
rights is amortized in proportion to and over the period of estimated net
future servicing fee income.
Prior to adoption of SFAS No. 122, the Company used the methodology set
forth in Emerging Issues Task Force No. 88-11, Allocation of Recorded
Investment When a Loan or Part of a Loan is Sold, in accounting for loan
sales.
Gains on bulk sales of mortgage loan servicing rights are recognized when
title and all risks and rewards have irrevocably passed to the buyer and there
are no significant unresolved contingencies.
Residual Assets--During the nine months ended September 30, 1997 and the
year ended December 31, 1996, the Company completed the securitization and
sale of approximately $204,000,000 and $51,900,000, respectively, in loans
held for sale in the form of mortgage pass-through certificates and recognized
gains of approximately $17,000,000 and $4,300,000, respectively. These
certificates are held in a trust independent of the Company. The Company will
act as servicer for the trust and receive a stated servicing fee. The Company
has also retained a beneficial interest in the form of an interest-only strip
which represents the subordinated right to receive cash flows from the pool of
securitized loans after payment of the required amounts to the holders of the
securities and the costs associated with the securitization. This interest-
only strip receivable is classified as a trading security and recorded at fair
value with any unrealized gains or losses recorded in the results of
operations in the period of the change in fair value. For the nine months
ended September 30, 1997 and the year ended December 31, 1996, a net
unrealized gain of $602,000 and $484,000, respectively, resulting from changes
in fair value is included in results of operations.
Valuations at origination and at each reporting period are based on
discounted cash flow analyses. The cash flows are estimated as the excess of
the weighted average coupon on each pool of loans sold over the sum of the
pass-through interest rate, a servicing fee, a trustee fee, an insurance fee
and an estimate of annual future credit losses related to the prepayment,
default, loss, and interest rate assumptions that market participants would
use for similar financial instruments subject to prepayment, credit and
interest rate risk and are discounted using an interest rate that a purchaser
unrelated to the seller of such a financial instrument would demand. At
origination, the Company utilized a prepayment assumption ranging from 12.0%
to 25.0%, an estimated loss factor assumption ranging from 0.5% to 2.0% and a
weighted average discount rate of 13.5% to value the residual assets. The
valuation includes consideration of characteristics of the loans including
loan type and size, interest rate, origination date, term and geographic
location. The Company also uses other available information such as externally
prepared reports on prepayment rates, collateral value, economic forecasts and
historical default and prepayment rates of the portfolio under review. To the
Company's knowledge, there is no active market for the sale of residual
assets. The range of values attributable to the factors used in determining
fair value is broad. Accordingly, the Company's estimate of fair value is
subjective.
In connection with certain securitization transactions, the Company
initially deposited cash with a trustee and will subsequently deposit a
portion of the servicing spread collected on the related loans. Such amounts
serve as credit enhancement for the related trust. The amount set aside is
available for distribution to investors in the
F-11
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
AND THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
event of certain shortfalls in amounts due to investors. These amounts are
subject to increase up to a reserve level as specified in the related
securitization documents. Cash amounts on deposit are invested in certain
instruments as permitted by the related securitization documents. To the
extent amounts on deposit exceed specified levels, distributions are made to
the Company; and, at the termination of the related trust, any remaining
amounts on deposit are distributed to the Company. The amount on deposit at
September 30, 1997 and December 31, 1996 is classified as restricted cash in
the accompanying consolidated statement of financial condition.
Foreclosed Real Estate--Real estate properties acquired through or in lieu
of loan foreclosure are initially recorded at the lower of fair value or the
balance of the loan at the date of foreclosure through a charge to the
allowance for estimated loan losses. After foreclosure, valuations are
periodically performed by management and an allowance for losses is
established by a charge to operations if the carrying value of a property
exceeds its fair value less estimated cost to sell. Revenue and expenses from
operations and changes in the valuation allowance are included in net gain
(loss) on foreclosed real estate in the statement of operations.
Premises and Equipment--Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization are
computed using both the straight-line and accelerated methods over the
estimated useful lives of the assets, which range from 31 years for buildings,
15 years for leasehold improvements, 7 years for furniture, fixtures and
equipment, and 3 years for computer equipment.
Income Taxes--The Company accounts for income taxes under SFAS No. 109,
Accounting for Income Taxes. SFAS No. 109 requires the recognition of deferred
tax assets and liabilities for the expected future tax consequences of events
that have been recognized in the Company's financial statements or tax
returns. In estimating future tax consequences, all expected future events
other than enactments of changes in the tax law or rates are considered. If
necessary, a valuation allowance is established based on management's
determination of the likelihood of realization of deferred tax assets.
Derivative Financial Instruments--The Company has entered into various
interest rate exchange agreements (swaps) to manage exposure to changes in
interest rates. Net interest income (expense) on the swaps resulting from the
differential between exchanging floating and fixed rate interest payments is
recorded using the accrual method. No interest rate exchange agreements were
outstanding as of September 30, 1997 and December 31, 1996 and 1995 (Note 13).
In the ordinary course of business, the Company has entered into other off-
balance sheet financial instruments consisting of commitments to extend
credit. Such financial instruments are recorded in the financial statements
when they are funded or related fees are incurred or received.
Earnings Per Share--Earnings per share is based on the weighted average
number of shares of common stock and common stock equivalents outstanding
adjusted retroactively to reflect the three for one stock exchange effected
pursuant to the Reorganization and the stock split effected in the form of a
dividend during 1996. The 1995 and 1994 per share amounts and weighted average
shares outstanding included in the accompanying consolidated financial
statements have been restated to reflect the Reorganization and stock split.
Presentation of Cash Flows--For purposes of reporting cash flows, cash and
cash equivalents include cash and federal funds sold. Generally, federal funds
are sold for one-day periods. At September 30, 1997 and December 31, 1996 and
1995, federal funds sold approximated $2,900,000, $10,350,000 and $1,600,000,
respectively.
F-12
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
AND THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Use of Estimates--In preparing the Company's financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements, and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Stock-Based Compensation--In 1995, the Financial Accounting Standards Board
(FASB) issued SFAS No. 123, Accounting for Stock-Based Compensation, which
encourages companies to account for stock compensation awards based on their
fair value at the date the awards are granted. SFAS No. 123 does not require
the application of the fair value method and allows for the continuance of
current accounting methods, which require accounting for stock compensation
awards based on their instrinsic value as of the grant date. However, SFAS No.
123 requires pro forma disclosure of net income and, if presented, earnings
per share, as if the fair value based method of accounting defined in this
Statement had been applied. The accounting and disclosure requirements of this
Statement are effective for financial statements for fiscal years beginning
after December 15, 1995. The Company did not adopt the accounting method in
SFAS No. 123 with respect to its stock option plans and accounts for such
plans in accordance with Accounting Principles Board Opinion No. 25.
Recent Accounting Developments--In June 1996, the FASB issued SFAS No. 125,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities, which was amended by SFAS No. 127. This statement provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities based on consistent application of a
financial-components approach that focuses on control. It distinguishes
transfers of financial assets that are sales from transfers that are secured
borrowings. Under the financial-components approach, after a transfer of
financial assets, an entity recognizes all financial and servicing assets it
controls and liabilities it has incurred and derecognizes financial assets it
no longer controls and liabilities that have been extinguished. The financial-
components approach focuses on the assets and liabilities that exist after the
transfer. Many of these assets and liabilities are components of financial
assets that existed prior to the transfer. If a transfer does not meet the
criteria for a sale, the transfer is accounted for as a secured borrowing with
pledge of collateral. The statement is effective for transfers and servicing
of financial assets and extinguishments of liabilities occurring after
December 31, 1996. SFAS No. 125 superceded SFAS No. 122. Retroactive
application of this statement is not permitted. Implementation of SFAS No. 125
did not have a material impact on the Company's results of operations or
financial condition.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share" which
is effective for financial statements issued for periods ending after December
15, 1997. It replaces the presentation of primary earnings per share with a
presentation of basic earnings per share. It also requires the presentation of
diluted earnings per share for entities with complex capital structures.
Diluted earnings per share takes into account the potential dilution that
could occur if securities or other contracts to issue common stock, such as
options, were exercised or converted into common stock. The Company does not
believe that SFAS No. 128 will have a material impact on its financial
statements.
In June 1997, FASB issued SFAS No. 130 "Reporting Comprehensive Income"
which is effective for annual and interim periods ending after December 15,
1997. This statement requires that all items that are required to be
recognized under accounting standards as comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. Management is in the process of determining the impact,
if any, this statement will have on the Company.
In June 1997, FASB issued SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information" which is effective for annual and interim
periods ending after December 15, 1997. This statement
F-13
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
AND THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
establishes standards for the method by which public entities report
information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about product and services,
geographical areas, and major customers. Management is in the process of
determining the impact, if any, this statement will have on the Company.
Reclassifications--Certain reclassifications have been made to the 1995 and
1994 financial statements to conform to the 1996 presentation.
2. REGULATORY CAPITAL REQUIREMENTS AND OTHER REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions
by regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors. Management believes, as of September 30, 1997
and December 31, 1996, that the Bank meets all capital adequacy requirements
to which it is subject.
Qualitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to
average assets (as defined).
As of September 30, 1997 and December 31, 1996, respectively, management
believes that the Bank is considered as well capitalized and adequately
capitalized under the regulatory framework for prompt corrective action. As of
December 31, 1995, the most recent notification from the Office of Thrift
Supervision (OTS) categorized the Bank as well-capitalized under the
regulatory framework for prompt corrective action. To be categorized as well-
capitalized or adequately capitalized, the Bank must maintain minimum total
risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the
table. There are no conditions or events since September 30, 1997 that
management believes have changed the Bank's category.
F-14
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The Bank's actual capital amounts and ratios are also presented in the
table:
TO BE ADEQUATELY TO BE WELL
CAPITALIZED UNDER CAPITALIZED UNDER
PROMPT CORRECTIVE PROMPT CORRECTIVE
ACTUAL ACTION PROVISIONS: ACTION PROVISIONS:
------------- ------------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ---------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
AS OF SEPTEMBER 1997
(UNAUDITED):
Total capital (to risk-
weighted assets)....... $27,918 13.49% $16,556 8.00% $ 20,695 10.00%
Tier 1 capital (to risk-
weighted assets)....... 16,286 7.87% 8,278 4.00% 12,417 6.00%
Tier 1 capital (to
average assets)........ 16,286 6.19% 10,528 4.00% 13,161 5.00%
TO BE ADEQUATELY TO BE WELL
CAPITALIZED UNDER CAPITALIZED UNDER
PROMPT CORRECTIVE PROMPT CORRECTIVE
ACTUAL ACTION PROVISIONS: ACTION PROVISIONS:
------------- ------------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ---------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
AS OF DECEMBER 31, 1996:
Total capital (to risk-
weighted assets)....... $10,446 9.43% $ 8,865 8.0% $ 11,081 10.0%
Tier 1 capital (to risk-
weighted assets)....... 9,273 8.37% 4,432 4.0% 6,649 6.0%
Tier 1 capital (to
average assets)........ 9,273 8.90% 4,169 4.0% 5,211 5.0%
TO BE ADEQUATELY TO BE WELL
CAPITALIZED UNDER CAPITALIZED UNDER
PROMPT CORRECTIVE PROMPT CORRECTIVE
ACTUAL ACTION PROVISIONS: ACTION PROVISIONS:
------------- ------------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ---------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
AS OF DECEMBER 31, 1995:
Total capital (to risk-
weighted assets)....... $ 4,871 10.17% $ 3,832 8.0% $ 4,789 10.0%
Tier 1 capital (to risk-
weighted assets)....... 4,268 8.91% 1,916 4.0% 2,874 6.0%
Tier 1 capital (to
average assets)........ 4,268 5.69% 3,003 4.0% 3,753 5.0%
The Bank has been required by the OTS since the Bank's examination completed
August 9, 1996 to compute its regulatory capital ratios based upon the higher
of (1) the average of total assets based on month-end results or (2) total
assets as of the quarter-end.
Under the framework, the Bank's capital levels at December 31, 1996 did not
allow the Bank to accept additional brokered deposits without prior approval
from the regulators. The Bank had approximately $2,200,000 of brokered
deposits at December 31, 1996. This is not expected to materially impact the
Bank as it has other sources of funds. The Bank's capital levels at September
30, 1997 allow the Bank to accept brokered deposits without prior approval
from the regulators.
In accordance with the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 (FIRREA), the OTS established regulations requiring
the Bank to maintain (i) tangible capital equal to 1.5% of adjusted total
assets, (ii) core capital equal to 3% of adjusted total assets, and (iii)
risk-based capital equal to 8% of risk-weighted assets.
F-15
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The following table summarizes the OTS regulatory capital requirements under
FIRREA for the Bank at September 30, 1997 (unaudited) and December 31, 1996.
As indicated in the table, the Bank's capital levels exceed all three of the
currently applicable minimum capital requirements.
SEPTEMBER 30, 1997 (UNAUDITED)
---------------------------------------------
TOTAL RISK-
TANGIBLE CAPITAL CORE CAPITAL BASED CAPITAL
---------------- ------------ -------------
AMOUNT % AMOUNT % AMOUNT %
-------- ------ ------- ---- ------- -----
(DOLLARS IN THOUSANDS)
Balance at end of period:
Equity per Bank financial
statements................... $ 16,286 $16,286 $16,286
Adjustments for regulatory
capital purposes:
Qualifying subordinated
debentures.................. 10,000
General valuation allowance.. 1,632
--------- ------ ------- ---- ------- -----
Regulatory capital.............. 16,286 6.19% 16,286 6.19% 27,918 13.49%
Minimum capital requirement..... 3,948 1.50 7,896 3.00 16,556 8.00
--------- ------ ------- ---- ------- -----
Excess regulatory capital....... $12,338 4.69% $ 8,390 3.19% $11,362 5.49%
========= ====== ======= ==== ======= =====
DECEMBER 31, 1996
------------------------------------------------
TOTAL RISK-
TANGIBLE CAPITAL CORE CAPITAL BASED CAPITAL
----------------- ------------- --------------
AMOUNT % AMOUNT % AMOUNT %
--------- ------- ------- ----- ------- ------
(DOLLARS IN THOUSANDS)
Balance at end of year:
Equity per Bank financial
statements................ $ 9,273 $ 9,273 $ 9,273
Adjustments for regulatory
capital purposes--general
valuation allowance....... 1,173
--------- ------- ------- ----- -------- -----
Regulatory capital........... 9,273 8.90% 9,273 8.90% 10,446 9.43%
Minimum capital requirement.. 1,563 1.50 3,127 3.00 8,865 8.00
--------- ------- ------- ----- -------- -----
Excess regulatory capital.... $ 7,710 7.40% $ 6,146 5.90% $ 1,581 1.43%
========= ======= ======= ===== ======== =====
The OTS issued regulations which set forth the methodology for calculating
an interest rate risk component that is being incorporated into the OTS
regulatory capital rules. Under the new regulations, only savings institutions
with above normal interest rate risk exposure are required to maintain
additional capital. This additional capital would increase the amount of a
savings institution's otherwise required risk-based capital requirement. The
final rule became effective January 1, 1994, and implementation will not begin
until the Bank has been notified by the OTS.
Management believes that, under current regulations, the Bank will continue
to meet its minimum capital requirements in the foreseeable future. However,
events beyond the control of the Bank, such as changing interest rates or a
further downturn in the economy in areas where the Bank has most of its loans,
could adversely affect future earnings and, consequently, the ability of the
Bank to meet its future minimum capital requirements.
At periodic intervals, both the OTS and the FDIC routinely examine the
Bank's financial statements as part of their legally prescribed oversight of
the savings and loan industry. Based on these examinations, the regulators can
direct that the Bank's financial statements be adjusted in accordance with
their findings.
F-16
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The OTS concluded an examination of the Bank in June 1996. Examination
results have been reflected in the financial statements presented herein.
Future examinations by the OTS or FDIC could include a review of certain
transactions or other amounts reported in the 1997 and 1996 financial
statements. Adjustments, if any, cannot presently be determined.
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 (the Funds Act), which, among other things, imposes a
special one-time assessment on Savings Association Insurance Fund (SAIF)
member institutions, including the Bank, to recapitalize the SAIF. As required
by the Funds Act, the FDIC imposed a special assessment of 65.7 basis points
on SAIF-assessable deposits held as of March 31, 1995, payable November 27,
1996. The special assessment was recognized as an expense in the third quarter
of 1996 and is tax deductible. The Bank took a pretax charge of $448,000 as a
result of the SAIF special assessment.
The Funds Act also spreads the obligations for payment of the Financing
Corporation (FICO) bonds across all SAIF and Bank Insurance Fund (BIF)
members. Beginning on January 1, 1997, BIF deposits will be assessed for FICO
payments at a rate of 20% of the rate assessed on SAIF deposits. Based on
current estimates by the FDIC, BIF deposits will be assessed a FICO payment of
1.3 basis points, while SAIF deposits will pay an estimated 6.5 basis points
on the FICO bonds. Full pro rata sharing of the FICO payments between BIF and
SAIF members will occur on the earlier of January 1, 2000 or the date the BIF
and SAIF are merged. The Funds Act specifies that the BIF and SAIF will be
merged on January 1, 1999 provided no savings associations remain as of that
time.
As a result of the Funds Act, the FDIC recently proposed to lower SAIF
assessments to 0 to 27 basis points effective January 1, 1997, a range
comparable to that of BIF members. However, SAIF members will continue to make
the higher FICO payments described above. Management cannot predict the level
of FDIC insurance assessments on an ongoing basis, whether the savings
association charter will be eliminated or whether the BIF and SAIF will
eventually be merged.
F-17
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
3. SECURITIES HELD TO MATURITY
The amortized cost and estimated fair value of securities held to maturity
are summarized as follows (in thousands):
SEPTEMBER 30, 1997
---------------------------------------
GROSS UNREALIZED
AMORTIZED ----------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ------- -------- ----------
(UNAUDITED)
U.S. Treasury and other agency
securities....................... $7,006 $14 $ -- $7,020
Mortgage-backed securities........ 9 9
------ ------- -------- ------
$7,015 $ 14 $ -- $7,029
====== ======= ======== ======
DECEMBER 31, 1996
-----------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------ ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- -------- -------- ----------
U.S. Treasury and other agency
securities..................... $8,013 $ -- $(42) $7,971
Mortgage-backed securities...... 10 10
------ -------- -------- ------
$8,023 $ -- $(42) $7,981
====== ======== ======== ======
DECEMBER 31, 1995
----------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------ ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- -------- -------- ----------
U.S. Treasury and other agency
securities...................... $1,974 $ -- $ -- $1,974
Mortgage-backed securities....... 11 11
------ -------- -------- ------
$1,985 $ -- $ -- $1,985
====== ======== ======== ======
The maturity distribution of securities held to maturity is as follows (in
thousands):
SEPTEMBER 30, 1997
-------------------
ESTIMATED
AMORTIZED FAIR
COST VALUE
--------- ---------
(UNAUDITED)
Due in one year or less.................................. $4,008 $4,010
Due from one to five years............................... 2,998 3,010
Mortgage-backed securities............................... 9 9
------ ------
$7,015 $7,029
====== ======
DECEMBER 31, 1996
-------------------
ESTIMATED
AMORTIZED FAIR
COST VALUE
--------- ---------
Due in one year or less.................................. $5,000 $4,976
Due from one to five years............................... 3,013 2,995
Mortgage-backed securities............................... 10 10
------ ------
$8,023 $7,981
====== ======
F-18
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The weighted average yield on securities held to maturity was 5.93%, 5.47%
and 5.41% at September 30, 1997 and December 31, 1996 and 1995, respectively.
4. LOANS HELD FOR INVESTMENT
Loans held for investment consisted of the following (in thousands):
DECEMBER 31,
SEPTEMBER 30, ----------------
1997 1996 1995
------------- ------- -------
(UNAUDITED)
Mortgage loans:
Residential:
One- to four-family......................... $25,586 $28,861 $32,517
Multi-family................................ 453 2,124 2,412
Commercial and land.......................... 7,673 7,247 7,615
------- ------- -------
33,712 38,232 42,544
Other loans:
Loans secured by deposit accounts............ 128 177 186
Unsecured commercial loans................... 64 67 70
Unsecured consumer loans..................... 123 65 63
------- ------- -------
315 309 319
------- ------- -------
34,027 38,541 42,863
Less:
Deferred loan origination fees (costs)....... 35 21 (7)
Allowance for estimated loan losses.......... 1,859 1,625 1,177
------- ------- -------
1,894 1,646 1,170
------- ------- -------
$32,133 $36,895 $41,693
======= ======= =======
Weighted average interest rate at end of
period....................................... 9.33% 8.06% 8.91%
======= ======= =======
The Company grants residential and commercial loans held for investment to
customers located primarily in Southern California. Consequently, a borrower's
ability to repay may be impacted by economic factors in the region.
At September 30, 1997 and December 31, 1996, included in loans held for
investment and loans held for sale are adjustable rate loans with principal
balances of $122,681,000 and $58,648,000, respectively. Adjustable rate loans
are indexed primarily to COFI.
F-19
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The following summarizes activity in the allowance for estimated loan losses
(in thousands):
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------ -------------------------
1997 1996 1996 1995 1994
-------- -------- ------- ------- -------
(UNAUDITED)
Balance, beginning of period... $ 1,625 $ 1,177 $ 1,177 $ 832 $ 436
Provision for estimated loan
losses........................ 900 359 963 1,194 1,306
Recoveries..................... 7 124 219 65 3
Charge offs.................... (673) (632) (734) (914) (913)
-------- -------- ------- ------- -------
Balance, end of period......... $ 1,859 $ 1,028 $ 1,625 $ 1,177 $ 832
======== ======== ======= ======= =======
The Company had nonaccrual loans at September 30, 1997 and December 31,
1996, 1995 and 1994 of $3,073,000, $2,416,000, $1,397,000 and $1,889,000,
respectively. If nonaccrual loans had been performing in accordance with their
original terms, the Company would have recorded interest income of
$10,273,000, $4,774,000, $6,692,000, $5,500,000 and $4,637,000, respectively,
instead of interest income actually recognized of $10,001,000, $4,674,000,
$6,542,000, $5,433,000, and $4,530,000, respectively, for the nine months
ended September 30, 1997 and 1996 and for the years ended December 31, 1996,
1995 and 1994.
At September 30, 1997 and December 31, 1996 and 1995, the Company had
impaired loans totaling $3,467,000, $2,878,000 and $1,397,000, respectively,
with specific reserves of $227,000, $452,000 and $382,000, respectively.
During the nine months ended September 30, 1997 and 1996 and the years ended
December 31, 1996 and 1995, the average recorded investment in impaired loans
was $2,756,000, $2,227,000, $2,300,000 and $1,980,000, respectively. Total
cash collected on impaired loans during the nine months ended September 30,
1997 and 1996 and the years ended December 31, 1996 and 1995 was $1,172,000,
$863,000, $1,339,000 and $1,079,000, respectively, of which $1,127,000,
$838,000, $1,249,000 and $960,000, respectively, was credited to principal.
Interest income of $45,000, $25,000, $90,000 and $119,000 on impaired loans
was recognized for cash payments received in the nine months ended September
30, 1997 and 1996 and the years ended December 31, 1996 and 1995,
respectively.
At September 30, 1997 and December 31, 1996 and 1995, troubled debt
restructured loans amounted to $131,000. There were no troubled debt
restructurings effected during the nine months ended September 30, 1997 and
the year ended December 31, 1996.
The Company is not committed to lend additional funds to debtors whose loans
have been modified.
The Bank is subject to numerous lending-related regulations. Under FIRREA,
the Bank may not make real estate loans to one borrower in excess of 15% of
its unimpaired capital and surplus except for loans not to exceed $500,000.
This 15% limitation results in a dollar limitation of approximately $2,700,000
and $1,567,000 at September 30, 1997 and December 31, 1996, respectively.
During 1996, the Company originated a loan for $154,500 to an executive
officer. Immediately subsequent to origination, the loan was sold servicing
released.
5. MORTGAGE FINANCING OPERATIONS
Loans serviced for others at September 30, 1997 and December 31, 1996, 1995
and 1994 totaled $334,114,000, $168,963,000, $189,451,000 and $48,204,000,
respectively.
F-20
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
In connection with mortgage servicing activities, the Company held funds in
trust for others totaling approximately $4,780,000, $957,000, and $934,000 at
September 30, 1997 and December 31, 1996 and 1995, respectively. At September
30, 1997 and December 31, 1996 and 1995, $933,000, $266,000 and $19,000,
respectively, of these funds are included in deposit accounts of the Bank
(subject to FDIC insurance limits).
For the nine months ended September 30, 1997 and the year ended December 31,
1996, 23.6% and 34.0%, respectively, of the properties securing loans funded
by the Company were located in California, 5.9% and 11.9%, respectively, were
located in Utah, 2.3% and 7.6%, respectively, were located in Colorado, 4.8%
and 6.8% were located in Florida, 5.8% and 3.2%, respectively, were located in
Virginia, 5.4% and 3.9%, respectively, were located in Maryland, and the
remainder were dispersed throughout the country. At September 30, 1997 and
December 31, 1996, 33% and 40%, respectively, of the loan servicing portfolio
was collateralized by real estate properties located in California. No other
state accounted for more than 10%.
Although the Company sells without recourse substantially all of the
mortgage loans it originates or purchases, the Company retains some degree of
risk on substantially all of the loans it sells. In addition, during the
period of time that the loans are held for sale, the Company is subject to
various business risks associated with the lending business, including
borrower default, foreclosure and the risk that a rapid increase in interest
rates would result in a decline of the value of loans held for sale to
potential purchasers.
In connection with its securitizations, the Company is required to
repurchase or substitute loans in the event of a breach of a representation or
warranty made by the Company. While the Company may have recourse to the
sellers of loans it purchased, there can be no assurance of the seller's
abilities to honor their respective obligations to the Company. Likewise, in
connection with its whole loan sales, the Company enters agreements which
generally require the Company to repurchase or substitute loans in the event
of a breach of a representation or warranty made by the Company to the loan
purchaser, any misrepresentation during the mortgage loan origination process
or, in some cases, upon any fraud or early default on such mortgage loans. The
remedies available to a purchaser of mortgage loans from the Company are
generally broader than those available to the Company against the sellers of
such loans, and if a loan purchaser enforces its remedies against the Company,
the Company may not be able to enforce whatever remedies the Company may have
against such sellers. If the loans were originated directly by the Company,
the Company will be solely responsible for any breaches of representations or
warranties.
In addition, borrowers, loan purchasers, monoline insurance carriers and
trustees in the Company's securitizations may make claims against the Company
arising from alleged breaches of fiduciary obligations, misrepresentations,
errors and omissions of employees, officers and agents of the Company,
including appraisers, incomplete documentation and failure by the Company to
comply with various laws and regulations applicable to its business. Any
claims asserted in the future may result in liabilities or legal expenses that
could have a material adverse effect on the Company's results of operations,
financial condition and business prospects.
F-21
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The following is a summary of activity in mortgage servicing rights (in
thousands):
NINE MONTHS ENDED YEAR ENDED DECEMBER
SEPTEMBER 30, 31,
------------------ -----------------------
1997 1996 1996 1995 1994
-------- -------- ------- ------ ------
(UNAUDITED)
Balance, beginning of period..... $ 2,645 $ 683 $ 683 $ -- $ --
Additions through originations... 4,009 1,528 2,270 864
Additions through purchase of
servicing rights................ 706 128
Amortization..................... (694) (177) (320) (268) (20)
Sales............................ (606) (108)
Change in valuation allowance.... (247) 12 12 (13)
-------- -------- ------- ------ ------
Balance, end of period........... $ 5,713 $ 2,046 $ 2,645 $ 683 $ --
======== ======== ======= ====== ======
The following is a summary of activity in the valuation allowance for
mortgage servicing rights (in thousands):
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
------------- -------------------------
1997 1996 1996 1995 1994
------ ------ -------- ----------------
(UNAUDITED)
Balance, beginning of period......... $ 1 $ 13 $ 13 $ -- $ --
Additions (reductions) charged
(credited) to operations............ 247 (12) (12) 13
Direct write-downs...................
------ ------ ------- ------- --------
Balance, end of period............... $ 248 $ 1 $ 1 $ 13 $ --
====== ====== ======= ======= ========
Net gains from mortgage financing operations consisted of the following (in
thousands):
NINE MONTHS ENDED YEAR ENDED DECEMBER
SEPTEMBER 30, 31,
------------------ --------------------
1997 1996 1996 1995 1994
--------- -------- ------ ------ ------
(UNAUDITED)
Gains on sale and securitization of
loans held for sale.................. $ 16,811 $ 3,759 $7,868 $3,549 $1,014
Net unrealized gain on residual
assets............................... 602 484
Gains on bulk sale of mortgage
servicing rights..................... 26 414
--------- -------- ------ ------ ------
$ 17,413 $ 3,759 $8,352 $3,575 $1,428
========= ======== ====== ====== ======
6. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following (in thousands):
DECEMBER 31,
SEPTEMBER 30, ----------------
1997 1996 1995
------------- ------- -------
(UNAUDITED)
Premises.................................. $ 569 $ 569 $ --
Leasehold improvements.................... 1,821 530 614
Furniture, fixtures and equipment......... 2,994 1,787 1,430
------- ------- -------
5,384 2,886 2,044
Less accumulated depreciation and
amortization............................. (1,614) (1,307) (1,068)
------- ------- -------
$ 3,770 $ 1,579 $ 976
======= ======= =======
F-22
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The adoption of SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of, did not have a material
impact on the results of operations or the financial condition of the Company.
7. FORECLOSED REAL ESTATE
Activity in the allowance for estimated real estate losses is as follows (in
thousands):
NINE MONTHS
ENDED
SEPTEMBER YEAR ENDED
30, DECEMBER 31,
------------- ------------------
1997 1996 1996 1995 1994
----- ------ ----- ---- -----
(UNAUDITED)
Balance, beginning of
period................. $ 65 $ 44 $ 44 $ 29 $ 94
Provision for estimated
real estate losses..... 62 167 145 104 187
Recoveries.............. 2
Charge offs............. (52) (102) (126) (89) (252)
----- ------ ----- ---- -----
Balance, end of period.. $ 75 $ 109 $ 65 $ 44 $ 29
===== ====== ===== ==== =====
Net loss on foreclosed real estate is summarized as follows (in thousands):
NINE MONTHS
ENDED
SEPTEMBER YEAR ENDED
30, DECEMBER 31,
------------ -----------------
1997 1996 1996 1995 1994
----- ----- ---- ----- ----
Net gain on sales of foreclosed real estate... $ (43) $ (21) $(41) $(137) $(39)
Other expenses, net........................... 75 25 54 86 132
Provision for estimated real estate losses.... 62 167 145 104 187
----- ----- ---- ----- ----
Net loss on foreclosed real estate............ $ 94 $ 171 $158 $ 53 $280
===== ===== ==== ===== ====
8. DEPOSIT ACCOUNTS
Deposit accounts are summarized as follows (in thousands):
DECEMBER 31,
-------------------------------------------
SEPTEMBER 30, 1997 1996 1995
---------------------- --------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
INTEREST RATE AMOUNT INTEREST RATE AMOUNT INTEREST RATE AMOUNT
------------- -------- ------------- ------- ------------- -------
(UNAUDITED)
Checking accounts....... 2.46% $ 11,197 2.22% $ 8,947 1.37% $ 6,735
Passbook accounts....... 2.10 3,968 2.10 4,117 2.10 4,842
Money market accounts... 2.99 3,794 2.99 3,217 2.76 4,156
Certificate accounts:
Under $100,000........ 5.93 96,391 5.66 49,437 5.70 39,989
$100,000 and over..... 5.99 44,490 5.63 19,993 5.80 11,813
-------- ------- -------
5.54% $159,840 5.02% $85,711 4.84% $67,535
======== ======= =======
F-23
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The aggregate annual maturities of certificate accounts are approximately as
follows (in thousands):
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
Within one year................................... $134,281 $59,438
One to two years.................................. 3,819 6,197
Two to three years................................ 1,290 1,700
Three to four years............................... 451 925
Four to five years................................ 544 613
Thereafter........................................ 496 557
-------- -------
$140,881 $69,430
======== =======
Interest expense is summarized as follows (in thousands):
NINE MONTHS
ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------- -----------------------
1997 1996 1996 1995 1994
------ ------ ------- ------- -------
(UNAUDITED)
Checking accounts.................. $ 201 $ 73 $ 112 $ 92 $ 95
Passbook accounts.................. 63 71 92 127 157
Money market accounts.............. 67 90 118 144 163
Certificate accounts............... 5,109 2,273 3,192 2,829 2,119
------ ------ ------- ------- -------
$5,440 $2,507 $ 3,514 $ 3,192 $2,534
====== ====== ======= ======= =======
9. ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWINGS
As of September 30, 1997 and December 31, 1996, the Company had an available
line of credit with the Federal Home Loan Bank of San Francisco (FHLB) of
$19,027,000 and $17,346,000, respectively, which is contingent upon continued
compliance with the Advances and Security Agreement and other eligibility
requirements established by the FHLB. Advances and/or the line of credit are
collateralized by pledges of certain real estate loans and securities with an
aggregate principal balance of $24,300,000, $20,474,000 and $24,426,000 at
September 30, 1997 and December 31, 1996 and 1995, respectively.
At September 30, 1997, outstanding FHLB advances totalled $6,900,000. There
were no FHLB advances outstanding at December 31, 1996 and 1995.
F-24
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The following summarizes activities in advances from the FHLB (dollars in
thousands):
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------ --------------------------
1997 1996 1996 1995 1994
-------- -------- -------- ------- -------
(UNAUDITED)
Average balance
outstanding............... $ 9,230 $ 3,885 $ 4,259 $ 3,112 $ 1,863
Maximum amount outstanding
at any month-end during
the period................ 19,950 13,900 13,900 7,600 7,000
Balance outstanding at end
of period................. 6,900 -- -- -- 1,250
Weighted average interest
rate during the period.... 5.69% 5.92% 5.93% 6.55% 4.87%
At December 31, 1996, the Company had a borrowing of $3,278,000 with an
interest rate of 8.43% from a financial institution. The borrowing was
collateralized by certain real estate loans with an aggregate principal
balance of $3,278,000. The borrowing was repaid on January 17, 1997.
As of September 30, 1997, the Company has two warehousing lines of credit
available to it from national investment banking firms. The first line allows
the Company to draw up to $50 million and expires on May 1, 1998. The second
line allows the Company to draw up to $200 million and expires August 20,
1998. An aggregate of $54,623,000 was drawn on these lines as of September 30,
1997 at a weighted average interest rate of 6.92%. Both lines of credit bear
interest at a variable rate based on LIBOR. Outstanding borrowings under both
lines of credit are collateralized by loans held for sale. These lines of
credit contain certain affirmative, negative and financial covenants, with
which the Company was in compliance at September 30, 1997.
The following summarizes activities in the lines of credit (dollars in
thousands):
NINE MONTHS ENDED
SEPTEMBER 30, 1997
------------------
(UNAUDITED)
Average balance outstanding............................. $ 9,757
Maximum amount outstanding at any month-end during
period................................................. 54,623
Balance outstanding at end of period.................... 54,623
Weighted average interest rate during the period........ 6.24%
F-25
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
10. INCOME TAXES
Income taxes are summarized as follows (in thousands):
NINE MONTHS YEAR ENDED DECEMBER
ENDED SEPTEMBER 30, 31,
------------------- ----------------------
1997 1996 1996 1995 1994
---------- ---------------- ------ ------
(UNAUDITED)
Current provision (benefit):
Federal...................... $ 4,365 $ 120 $ 1,073 $ 374 $ (352)
State........................ 1,392 22 312 1 1
---------- -------- ------- ----- ------
5,757 142 1,385 375 (351)
---------- -------- ------- ----- ------
Deferred (benefit) provision:
Federal...................... (229) (235) (81) 10
State........................ (37) (24) 41
---------- -------- ------- ----- ------
(266) (259) (81) 51
---------- -------- ------- ----- ------
Total income tax provision
(benefit).................. $ 5,491 $ 142 $ 1,126 $ 294 $ (300)
========== ======== ======= ===== ======
A reconciliation from the statutory federal income tax rate to the Bank's
effective income tax rate is as follows:
NINE MONTHS YEAR ENDED DECEMBER
ENDED SEPTEMBER 30, 31,
------------------- -----------------------
1997 1996 1996 1995 1994
--------- --------- ------ ------ -------
(UNAUDITED)
Statutory federal income
tax rate.................. 35.0% 35.0% 35.0% 35.0% (35.0)%
State taxes, net of federal
income tax benefit........ 7.0 7.0 7.2 3.1
Other...................... (0.4) 3.8 0.6 1.1 1.0
--------- --------- ------ ------ -------
41.6% 45.8% 42.8% 36.1% (30.9)%
========= ========= ====== ====== =======
F-26
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Deferred tax assets (liabilities) were comprised of the following (in
thousands):
DECEMBER 31,
SEPTEMBER 30, --------------
1997 1996 1995
------------- ------ ------
(UNAUDITED)
Deferred tax assets:
Allowance for loan losses..................... $ 613 $ 479 $ 258
Capital loss carryforward..................... 63 63 63
Loans held for sale........................... 1,005 115 201
Other......................................... 201 301 23
------- ------ ------
1,882 958 545
------- ------ ------
Deferred tax liabilities:
Depreciation.................................. (61) (61) (82)
Purchased servicing rights.................... (89) (14)
Originated servicing rights................... (446) (358) (179)
Gain on sale of loans......................... (999)
Federal Home Loan Bank dividends.............. (120) (106) (85)
------- ------ ------
(1,715) (525) (360)
------- ------ ------
167 433 185
Less valuation allowance....................... (36) (36) (47)
------- ------ ------
Net deferred tax asset......................... $ 131 $ 397 $ 138
======= ====== ======
Gross deferred tax assets are expected to be realized during 1997 through
2001.
At December 31, 1996, the Company has approximately $555,000 of net capital
loss carryforwards available to offset future capital gains for state tax
purposes. If not utilized, the losses would expire in 1998. A valuation
allowance has been placed against the portion of this capital loss
carryforward for which realization is not more likely than not.
The Bank's financial statement equity includes tax bad debt deductions for
which no provision for federal income taxes has been made. If distributions to
shareholders are made in excess of current or accumulated earnings and profits
or if stock of the Bank is partially redeemed, this tax bad debt reserve,
which approximates $330,000 at December 31, 1996, will be recaptured into
income at the then prevailing federal income tax rate. The related
unrecognized deferred tax liability is approximately $116,000. It is not
contemplated that the Bank will make any disqualifying distributions that
would result in the recapture of these reserves.
11. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF RISK
The Company is involved in various legal proceedings associated with normal
operations. In the opinion of management, based on the advice of legal
counsel, such litigation and claims are expected to be resolved without
material effect on the financial position of the Company.
F-27
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The Company leases a portion of its facilities from nonaffiliates under
operating leases expiring at various dates through 2002. The following
schedule shows the minimum annual lease payments, excluding property taxes and
other operating expenses, due under these agreements (in thousands) at
December 31, 1996:
1997................................................................. $215
1998................................................................. 185
1999................................................................. 179
2000................................................................. 116
2001................................................................. 82
Thereafter...........................................................
----
$777
====
Rental expense under all operating leases totaled $266,000, $173,000,
$232,000, $124,000, and $118,000 for the nine months ended September 30, 1997
and 1996, and for the years ended December 31, 1996, 1995 and 1994,
respectively.
The Company has negotiated an employment agreement with its chief executive
officer. This agreement provides for the payment of a base salary, a bonus
based upon performance of the Company and the payment of severance benefits
upon termination.
Lending Activities--Loans to subprime borrowers present a higher level of
risk of default than conforming loans because of the increased potential for
default by borrowers who may have had previous credit problems or who do not
have any credit history. Loans to subprime borrowers also involve additional
liquidity risks, as these loans generally have a more limited secondary market
than conventional loans. The actual rates of delinquencies, foreclosures and
losses on loans to subprime borrowers could be higher under adverse economic
conditions than those currently experienced in the mortgage lending industry
in general. While the Company believes that the underwriting procedures and
appraisal processes it employs enable it to somewhat mitigate the higher risks
inherent in loans made to these borrowers, no assurance can be given that such
procedures or processes will afford adequate protection against such risks.
The debt consolidation loans the Company originates for agency qualified
borrowers are primarily home equity lines of credit and second deeds of trust
generally up to 125% of the appraised value of the real estate underlying the
loans. In the event of a default on such a loan by a borrower, there generally
would be insufficient collateral to pay off the balance of such loan and the
Company, as holder of a second position on the property, would likely lose a
substantial portion, if not all, of its investment. While the Company believes
that the underwriting procedures it employs enable it to somewhat mitigate the
higher risks inherent in such loans, no assurance can be given that such
procedures will afford adequate protection against such risks. Approximately
65% of the loans included in the securitization transaction completed in 1996
consisted of this type of loan.
The Company has been actively involved in the origination, purchase and sale
to institutional investors of real estate secured loans and, more recently, in
asset securitizations. Generally, the profitability of such mortgage financing
operations depends on maintaining a sufficient volume of loans for sale and
the availability of purchasers. Changes in the level of interest rates and
economic factors affect the amount of loans originated or available for
purchase by the Company, and thus the amount of gains on sale of loans and
servicing fee income. Changes in the purchasing policies of institutional
investors or increases in defaults after funding could substantially reduce
the amount of loans sold to such investors or sold through asset
securitizations. Any such changes could have a material adverse effect on the
Company's results of operations and financial condition.
F-28
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The Company's ability to originate, purchase and sell loans through its
mortgage financing operations is also significantly impacted by changes in
interest rates. Increases in interest rates may also reduce the amount of loan
and commitment fees received by the Company. A significant decline in interest
rates could also decrease the size of the Company's servicing portfolio and
the related servicing income by increasing the level of prepayments. The
Company does not currently utilize any specific hedging instruments to
minimize exposure to fluctuations in the market price of loans and interest
rates with regard to loans held for sale in the secondary mortgage market.
Therefore, between the time the Company originates the loans or purchase
commitments are issued or asset securitizations are completed, the Company is
exposed to downward movements in the market price of such loans due to upward
movements in interest rates.
The Company depends largely on mortgage brokers and correspondents for its
purchases and originations of new loans. The Company's competitors also seek
to establish relationships with the Company's mortgage brokers and
correspondents. The Company's future results may become increasingly exposed
to fluctuations in the volume and cost of its wholesale loans resulting from
competition from other purchasers of such loans.
Availability of Funding Sources--The Company funds substantially all of the
loans which it originates or purchases through deposits, internally generated
funds, FHLB advances or other borrowings. The Company competes for deposits
primarily on the basis of rates, and, as a consequence, the Company could
experience difficulties in attracting deposits to fund its operations if the
Company does not continue to offer deposit rates at levels that are
competitive with other financial institutions. The Company also uses the
proceeds generated by the Company in selling loans in the secondary market or
pools of loans in asset securitizations to fund subsequent originations or
purchases. On an ongoing basis, the Company explores opportunities to access
credit lines as an additional source of funds. To the extent that the Company
is not able to maintain its currently available funding sources or to access
new funding sources, it would have to curtail its loan production activities
or sell loans earlier than is optimal. Any such event would have a material
adverse effect on the Company's results of operations and financial condition.
Dependence on Securitizations--During the nine months ended September 30,
1997 and in December 1996, the Company completed various loan securitization
transactions. The Company derived a significant portion of its income by
recognizing such gains on sale of loans. The Company's ability to complete
securitizations is affected by several factors, including conditions in the
securities markets generally and in the asset-backed securities markets
specifically, the credit quality of the Company's loan portfolio and the
Company's ability to obtain credit enhancements. Although the Company obtained
credit enhancements in its securitizations which facilitated an investment
grade rating for the securitization interests, there can be no assurance that
the Company will be able to obtain future credit enhancements on acceptable
terms or that future securitizations will be similarly rated. Any substantial
reduction in the ability of the Company to complete asset securitizations
could have a material adverse effect on the Company's results of operations
and financial condition.
12. BENEFIT PLANS
401(k) Plan--The Company maintains an Employee Savings Plan (the Plan) which
qualifies under section 401(k) of the Internal Revenue Code. Under the Plan,
employees may contribute from 1% to 15% of their compensation. The Company
will match, at its discretion, 25% of the amount contributed by the employee
up to a maximum of 8% of the employee's salary. The amount of contributions
made to the Plan by the Company were not material for the years ended December
31, 1996, 1995 and 1994.
F-29
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Cash Bonus Plan--The Company adopted a cash bonus plan (the Bonus Plan)
effective February 1996. All employees except for commissioned employees and
employees with employment contracts are eligible to participate. Approximately
$100,000 was accrued pursuant to the Bonus Plan at December 31, 1996. For
1997, the Bonus Plan will pay bonuses in the aggregate of 15% of the after tax
profits of the Company in excess of a 15% return on average equity, as defined
in the Bonus Plan.
Stock Option Plans--On November 21, 1996, the Board of Directors of the Bank
adopted the Life Bank 1996 Stock Option Plan (the Bank Option Plan). The Bank
Option Plan authorizes the granting of options equal to 321,600 shares of
common stock for issuance to executives, key employees, officers and
directors. The Bank Option Plan will be in effect for a period of ten years
from the adoption by the Board of Directors. Options granted under the Bank
Option Plan will be made at an exercise price equal to the fair market value
on the date of grant. Awards granted to officers and employees may include
incentive stock options, nonstatutory stock options and limited rights which
are exercisable only upon change in control of the Bank. Awards granted to
nonemployee directors are nonstatutory options. All 1996 options were granted
at an exercise price of $3.33 per share. Stock options will become vested and
exercisable in the manner specified by the Bank. The options granted by the
Bank will vest at a rate of 33.3% per year, beginning on November 21, 1999. No
options were exercisable at December 31, 1996. Options for 18,360 shares were
exercisable as of September 30, 1997.
The following is a summary of activity in the Bank Option Plan during 1996:
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
------- ----------------
Options granted.................................. 321,540 $3.33
======= =====
Options outstanding at December 31, 1996......... 321,540 $3.33
======= =====
There was no activity in the Bank Option Plan during the nine months ended
September 30, 1997.
All options granted have a remaining contractual life of 10 years.
The estimated fair value of the options granted during 1996 was $1.66 per
share. The Company applies Accounting Principles Board Opinion No. 25 and
related interpretations in accounting for its Bank Option Plan. No
compensation cost has been recognized for its Bank Option Plan. Had
compensation cost for the Bank Option Plan been determined based on the fair
value at the grant date for awards under the plan consistent with the method
of SFAS No. 123, Accounting for Stock-Based Compensation, the Company's net
income and earnings per share for the year ended December 31, 1996 would have
been reduced to the pro forma amounts indicated below:
Net income to common stockholders:
As reported............................................... $1,505,000
Pro forma................................................. $1,489,000
Net income per common share:
As reported............................................... $.63
Pro forma................................................. $.63
The fair value of options granted under the Bank Option Plan during 1996 was
estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted average assumptions used: no dividend yield, no
volatility, risk-free interest rate of 7% and expected lives of 10 years.
F-30
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The Board of Directors of the Company has adopted the Life Financial Corp
1997 Stock Option Plan (the "Company Option Plan"), which became effective
upon the completion of the public offering (the Bank Option Plan and the
Company Option Plan will sometimes hereinafter be referred to as the "Option
Plans"). The Board of Directors of the Company has reserved shares equal to
10% of the issued and outstanding shares of the Company giving effect to the
Reorganization and the public offering, including Company options that were
exchanged for Bank options pursuant to the Bank Option Plan for issuance under
the Option Plans. Stock options with respect to shares of the Bank's Common
Stock granted under the Bank Option Plan and outstanding prior to completion
of the Reorganization automatically became options to purchase three shares of
the Company's Common Stock upon identical terms and conditions. The Company
assumed all of the Bank's obligations with respect to the Bank Option Plan.
After the Reorganization, the Option Plans became available to directors,
officers and employees of the Company and to directors, officers and employees
of its direct or indirect subsidiaries, including the Bank, as selected
pursuant to the Option Plans and all references to the Bank's Common Stock
under the Bank Option Plan are now deemed references to the Company's Common
Stock. As of September 30, 1997, 190,500 shares of the Company Option Plan
were outstanding at weighted average exercise price of $11.14 per share. The
options granted by the Company will vest at a rate of 33.3% per year,
beginning on June 30, 2000. No options were exercisable at September 30, 1997.
13. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit in the form
of originating loans or providing funds under existing lines of credit. These
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the accompanying statement of
financial condition.
During 1988 the Company entered into agreements to pay fixed-rate interest
payments in exchange for the receipt of variable market-indexed interest
payments (interest rate swaps). The notional principal amount of interest rate
swaps outstanding at December 31, 1994 was $2,000,000, all of which matured in
1995. The weighted average fixed payment rate on such swap was 9.23%. At
December 31, 1994, the weighted average variable market-indexed interest rate
was 5.75%, which is based on LIBOR. The intent of these agreements was to
match the maturities of certain liabilities and convert variable rate
liabilities into fixed rate. The notional amount of interest rate swaps does
not represent exposure to credit loss. No new interest rate swap transactions
were entered into during the nine months ended September 30, 1997 and the
years ended December 31, 1996 and 1995.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual or notional amount of those instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates and may require payment of a
fee. Since many commitments are expected to expire, the total commitment
amounts do not necessarily represent future cash requirements. The Company
evaluates each customer's credit worthiness on a case-by-case basis. The
Company's commitments to extend credit at September 30, 1997 and December 31,
1996 and 1995 totaled $37,942,000, $9,217,000 and $9,933,000, respectively.
F-31
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The Company regularly enters into commitments to sell certain dollar amounts
of loans to third parties under specific, negotiated terms. The terms include
the minimum maturity of the loans, yield to purchaser, servicing spread to the
Company, and the maximum principal amount of the individual loans.
The Company typically satisfies these commitments from its current
production of loans. These commitments have fixed expiration dates and may
require a fee. At September 30, 1997 and December 31, 1996 and 1995, the
Company had outstanding commitments to sell loans of $21,290,000, $3,072,000
and $250,000, respectively.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
Disclosures About Fair Value of Financial Instruments. The estimated fair
value amounts have been determined by the Company using available market
information and appropriate valuation methodologies. However, considerable
judgment is necessarily required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
SEPTEMBER 30, 1997
-------------------
CARRYING ESTIMATED
AMOUNT FAIR VALUE
-------- ----------
(IN THOUSANDS)
(UNAUDITED)
Assets:
Cash and cash equivalents............................... $ 12,872 $ 12,872
Restricted cash......................................... 10,856 10,856
Securities held to maturity............................. 7,015 7,029
Residual assets......................................... 24,533 24,533
Loans held for sale..................................... 191,555 195,614
Loans held for investment, net.......................... 32,133 31,968
Mortgage servicing rights............................... 5,713 6,305
FHLB stock.............................................. 1,050 1,050
Liabilities:
Deposit accounts........................................ 159,840 159,905
Other borrowings........................................ 61,523 61,523
Subordinated debentures................................. 10,000 10,000
F-32
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
DECEMBER 31, 1996
-------------------
CARRYING ESTIMATED
AMOUNT FAIR VALUE
-------- ----------
(IN THOUSANDS)
Assets:
Cash and cash equivalents............................... $13,265 $13,265
Restricted cash......................................... 1,636 1,636
Securities held to maturity............................. 8,023 7,981
Residual asset.......................................... 5,700 5,700
Loans held for sale..................................... 31,018 31,288
Loans held for investment, net.......................... 36,895 37,475
Mortgage servicing rights............................... 2,645 2,984
FHLB stock.............................................. 814 814
Liabilities:
Deposit accounts........................................ 85,711 86,278
Other borrowings........................................ 3,278 3,278
DECEMBER 31, 1995
-------------------
CARRYING ESTIMATED
AMOUNT FAIR VALUE
-------- ----------
(IN THOUSANDS)
Assets:
Cash and cash equivalents............................... $ 3,932 $ 3,932
Securities held to maturity............................. 1,985 1,985
Loans held for sale..................................... 21,688 22,125
Loans held for investment, net.......................... 41,693 41,902
Mortgage servicing rights............................... 683 784
FHLB stock.............................................. 715 715
Liabilities:
Deposit accounts........................................ 67,535 67,688
The Company utilized the following methods and assumptions to estimate the
fair value of each class of financial instruments for which it is practicable
to estimate that value:
Cash and Cash Equivalents--The carrying amount approximates fair value.
Restricted Cash--The carrying amount approximates fair value.
Securities Held to Maturity--Fair values are based on quoted market prices.
Loans Held for Sale--Fair values are based on quoted market prices or
dealer quotes.
Loans Held for Investment--The fair value of gross loans receivable has
been estimated using the present value of cash flow method, discounted
using the current rate at which similar loans would be made to borrowers
with similar credit ratings and for the same maturities, and giving
consideration to estimated prepayment risk and credit loss factors.
Residual Assets and Mortgage Servicing Rights--Fair values are estimated
using discounted cash flows based on current market values.
F-33
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
FHLB Stock--The fair value is based on its redemption value.
Deposit Accounts--The fair value of checking, passbook and money market
accounts is the amount payable on demand at the reporting date. The fair
value of certificate accounts is estimated using the rates currently
offered for deposits of similar remaining maturities.
Subordinated Debentures and Other Borrowings--The carrying amount
approximates fair value as the interest rate currently approximates market.
Financial Instruments with Off-Balance Sheet Risk--No fair value is
ascribed to the Company's outstanding commitments to fund loans since
commitment fees are not significant and predominantly all such commitments
are variable-rate loan commitments. There were no significant unrealized
gains and losses on commitments to sell loans.
The fair value estimates presented herein are based on pertinent information
available to management as of September 30, 1997 and December 31, 1996 and
1995. Although management is not aware of any factors that would significantly
affect the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these financial statements since that
date; and, therefore, current estimates of fair value may differ significantly
from the amounts presented herein.
15. SEGMENT INFORMATION
The Company's operations within the financial services industry principally
focus on banking and mortgage financing activities. Information about these
segments as of or for the years ended December 31, 1996 and 1995 are as
follows (dollars in thousands):
DECEMBER 31, 1996
---------------------------
MORTGAGE
BANKING FINANCING TOTAL
------- --------- --------
Revenue for the year............................ $ 3,898 $12,143 $ 16,041
Pre-tax operating income (loss) for the year.... (2,325) 4,956 2,631
Assets employed at year-end..................... 59,943 44,067 104,010
Depreciation and amortization for the year...... 120 501 621
Capital expenditures for the year............... 276 628 904
DECEMBER 31, 1995
---------------------------
MORTGAGE
BANKING FINANCING TOTAL
------- --------- --------
Revenue for the year............................ $ 4,207 $ 5,638 $ 9,845
Pre-tax operating income (loss) for the year.... (1,128) 1,942 814
Assets employed at year-end..................... 49,201 24,935 74,136
Depreciation and amortization for the year...... 92 342 434
Capital expenditures for the year............... 56 467 523
F-34
LIFE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
16. SUBORDINATED DEBENTURES
On March 14, 1997, the Bank issued subordinated debentures (Debentures) in
the aggregate principal amount of $10 million through a private placement and
pursuant to a Debenture Purchase Agreement. The Debentures will mature on
March 15, 2004 and bear interest at the rate of 13.5% per annum, payable semi-
annually. The Debentures qualify as supplementary capital under regulations of
the OTS which capital may be used to satisfy the risk-based capital
requirements in an amount up to 100% of the Bank's core capital. The
Debentures are direct, unconditional obligations of the Bank ranking with all
other existing and future unsecured and subordinated indebtedness of the Bank.
They are subordinated on liquidation, as to principal and interest, and
premium, if any, to all claims against the Bank having the same priority as
savings account holders or any higher priority.
The Debentures are redeemable at the option of the Bank, in whole or in
part, at any time after September 15, 1998, at the aggregate principal amount
thereof, plus accrued and unpaid interest, if any. The Bank may substitute
Life in its place as obligor on the Debentures (the Substitution). If such
Substitution occurs, holders of the Debentures will have the option at
September 15, 1998 or at such later time as the Substitution occurs to require
Life to purchase all or part of the holder's outstanding Debentures at a price
equal to 100% of the principal amount repurchased plus accrued interest
through the repurchase date. If the Substitution occurs, upon a change in
control of Life, holders of the Debentures will have the option to require
Life to purchase all or part of the holder's outstanding Debentures at a price
equal to 101% of the principal amount repurchased plus accrued interest
through the repurchase date.
F-35
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN AS CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFERING MADE HEREBY, AND, IF GIVEN OR MADE,
SUCH OTHER INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY LIFE FINANCIAL CAPITAL TRUST, LIFE FINANCIAL CORPORATION,
OR KEEFE, BRUYETTE & WOODS, INC. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED
HEREBY TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION
IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS
NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH
OFFER OR SOLICITATION IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY
IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF LIFE FINANCIAL
CAPITAL TRUST OR LIFE FINANCIAL CORPORATION SINCE ANY OF THE DATES AS OF WHICH
INFORMATION IS FURNISHED HEREIN OR SINCE THE DATE HEREOF.
-----------
TABLE OF CONTENTS
PAGE
----
Prospectus Summary....................................................... 1
Risk Factors Related to the Capital Securities........................... 15
Risk Factors Related to the Company...................................... 20
Use of Proceeds.......................................................... 28
Price Range of Common Stock and Dividends................................ 28
Ratios of Earnings to Fixed Charges...................................... 29
Accounting Treatment..................................................... 29
Capitalization........................................................... 30
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 31
Business................................................................. 49
Federal and State Taxation............................................... 90
Regulation............................................................... 92
The Board of Directors and Management of the Company..................... 100
The Board of Directors and Management of the Bank ....................... 102
The Trust................................................................ 112
Description of Capital Securities........................................ 112
Description of Junior Convertible Subordinated Debentures................ 126
Description of the Guarantee............................................. 136
Relationship Among the Capital Securities, the Junior Subordinated
Debentures and the Guarantee............................................ 138
Description of Capital Stock of the Company.............................. 140
Certain Federal Income Tax Considerations................................ 145
ERISA Considerations..................................................... 149
Underwriting............................................................. 151
Experts.................................................................. 152
Legal Matters............................................................ 152
Additional Information................................................... 152
Financial Statements..................................................... F-1
-----------
UNTIL , OR 25 DAYS AFTER COMMENCEMENT OF THE OFFERING, IF ANY,
WHICHEVER IS LATER, ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED
SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED
TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
[LOGO OF LIFE FINANCIAL CORPORATION]
LIFE FINANCIAL CAPITAL TRUST
% CONVERTIBLE TRUST PREFERRED SECURITIES
GUARANTEED, TO THE EXTENT SET FORTH HEREIN, BY
LIFE FINANCIAL CORPORATION
-----------
PROSPECTUS
-----------
KEEFE, BRUYETTE & WOODS, INC.
DECEMBER , 1997
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the approximate costs and expenses payable in
connection with the securities being registered other than the underwriting
discounts and commissions.
SEC registration fee............................................. $ 7,375
NASD filing fee.................................................. 3,000
Nasdaq Listing Fee............................................... 5,000
Legal fees and expenses.......................................... 75,000
Blue Sky fees and expenses....................................... 5,000
Accounting fees and expenses..................................... 60,000
Trustees' fees and expenses...................................... 27,000
Printing, postage and mailing.................................... 70,000
Miscellaneous.................................................... 7,625
--------
TOTAL............................................................ $265,000
========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
In accordance with the General Corporation Law of the State of Delaware
(being Chapter 1 of Title 8 of the Delaware Code), Articles 10 and 11 of the
Registrant's Certificate of Incorporation provide as follows:
TENTH:
A. Each person who was or is made a party or is threatened to be made a
party to or is otherwise involved in any action, suit or proceeding, whether
civil, criminal, administrative or investigative (hereinafter a "proceeding"),
by reason of the fact that he or she is or was a Director or an Officer of the
Corporation or is or was serving at the request of the Corporation as a
Director, Officer, employee or agent of another corporation or of a
partnership, joint venture, trust or other enterprise, including service with
respect to an employee benefit plan (hereinafter an "indemnitee"), whether the
basis of such proceeding is alleged action in an official capacity as a
Director, Officer, employee or agent or in any other capacity while serving as
a Director, Officer, employee or agent, shall be indemnified and held harmless
by the Corporation to the fullest extent authorized by the Delaware General
Corporation Law, as the same exists or may hereafter be amended (but, in the
case of any such amendment, only to the extent that such amendment permits the
Corporation to provide broader indemnification rights than such law permitted
the Corporation to provide prior to such amendment), against all expense,
liability and loss (including attorneys' fees, judgments, fines, ERISA excise
taxes or penalties and amounts paid in settlement) reasonably incurred or
suffered by such indemnitee in connection therewith; provided, however, that,
except as provided in Section C hereof with respect to proceedings to enforce
rights to indemnification, the Corporation shall indemnify any such indemnitee
in connection with a proceeding (or part thereof) initiated by such indemnitee
only if such proceeding (or part thereof) was authorized by the Board of
Directors of the Corporation.
B. The right to indemnification conferred in Section A of this Article TENTH
shall include the right to be paid by the Corporation the expenses incurred in
defending any such proceeding in advance of its final disposition (hereinafter
an "advancement of expenses"); provided, however, that, if the Delaware
General Corporation Law requires, an advancement of expenses incurred by an
indemnitee in his or her capacity as a Director or Officer (and not in any
other capacity in which service was or is rendered by such indemnitee,
including, without limitation, services to an employee benefit plan) shall be
made only upon delivery to the Corporation of an undertaking (hereinafter an
"undertaking"), by or on behalf of such indemnitee, to repay all amounts so
advanced if it shall ultimately be determined by final judicial decision from
which there is no further
II-1
right to appeal (hereinafter a "final adjudication") that such indemnitee is
not entitled to be indemnified for such expenses under this Section or
otherwise. The rights to indemnification and to the advancement of expenses
conferred in Sections A and B of this Article TENTH shall be contract rights
and such rights shall continue as to an indemnitee who has ceased to be a
Director, Officer, employee or agent and shall inure to the benefit of the
indemnitee's heirs, executors and administrators.
C. If a claim under Section A or B of this Article TENTH is not paid in full
by the Corporation within sixty days after a written claim has been received
by the Corporation, except in the case of a claim for an advancement of
expenses, in which case the applicable period shall be twenty days, the
indemnitee may at any time thereafter bring suit against the Corporation to
recover the unpaid amount of the claim. If successful in whole or in part in
any such suit, or in a suit brought by the Corporation to recover an
advancement of expenses pursuant to the terms of an undertaking, the
indemnitee shall be entitled to be paid also the expenses of prosecuting or
defending such suit. In (i) any suit brought by the indemnitee to enforce a
right to indemnification hereunder (but not in a suit brought by the
indemnitee to enforce a right to an advancement of expenses) it shall be a
defense that, and (ii) in any suit by the Corporation to recover an
advancement of expenses pursuant to the terms of an undertaking the
Corporation shall be entitled to recover such expenses upon a final
adjudication that, the indemnitee has not met any applicable standard for
indemnification set forth in the Delaware General Corporation Law. Neither the
failure of the Corporation (including its Board of Directors, independent
legal counsel, or its stockholders) to have made a determination prior to the
commencement of such suit that indemnification of the indemnitee is proper in
the circumstances because the indemnitee has met the applicable standard of
conduct set forth in the Delaware General Corporation Law, nor an actual
determination by the Corporation (including its Board of Directors,
independent legal counsel, or its stockholders) that the indemnitee has not
met such applicable standard of conduct, shall create a presumption that the
indemnitee has not met the applicable standard of conduct or, in the case of
such a suit brought by the indemnitee, be a defense to such suit. In any suit
brought by the indemnitee to enforce a right to indemnification or to an
advancement of expenses hereunder, or by the Corporation to recover an
advancement of expenses pursuant to the terms of an undertaking, the burden of
proving that the indemnitee is not entitled to be indemnified, or to such
advancement of expenses, under this Article TENTH or otherwise shall be on the
Corporation.
D. The rights to indemnification and to the advancement of expenses
conferred in this Article TENTH shall not be exclusive of any other right
which any person may have or hereafter acquire under any statute, the
Corporation's Certificate of Incorporation, Bylaws, agreement, vote of
stockholders or Disinterested Directors or otherwise.
E. The Corporation may maintain insurance, at its expense, to protect itself
and any Director, Officer, employee or agent of the Corporation or subsidiary
or Affiliate or another corporation, partnership, joint venture, trust or
other enterprise against any expense, liability or loss, whether or not the
Corporation would have the power to indemnify such person against such
expense, liability or loss under the Delaware General Corporation Law.
F. The Corporation may, to the extent authorized from time to time by the
Board of Directors, grant rights to indemnification and to the advancement of
expenses to any employee or agent of the Corporation to the fullest extent of
the provisions of this Article TENTH with respect to the indemnification and
advancement of expenses of Directors and Officers of the Corporation.
ELEVENTH:
A Director of this Corporation shall not be personally liable to the
Corporation or its stockholders for monetary damages for breach of fiduciary
duty as a Director, except for liability (i) for any breach of the Director's
duty of loyalty to the Corporation or its stockholders, (ii) for acts or
omissions not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) under Section 174 of the Delaware General
Corporation Law, or (iv) for any transaction from which the Director derived
an improper personal benefit. If the Delaware General Corporation Law is
amended to authorize corporate action further eliminating
II-2
or limiting the personal liability of Directors, then the liability of a
Director of the Corporation shall be eliminated or limited to the fullest
extent permitted by the Delaware General Corporation Law, as so amended.
Any repeal or modification of the foregoing paragraph by the stockholders of
the Corporation shall not adversely affect any right or protection of a
Director of the Corporation existing at the time of such repeal or
modification.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
None.
II-3
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The exhibits and financial statement schedules filed as a part of this
Registration Statement are as follows:
(a) List of Exhibits (filed herewith unless otherwise noted)
1.1 Form of Underwriting Agreement
3.1 Certificate of Incorporation of LIFE Financial Corporation*
3.2 Bylaws of LIFE Financial Corporation*
4.0 Certificate of Trust of LIFE Financial Capital Trust (the "Trust"), dated
December 2, 1997
4.1 Form of Amended and Restated Declaration of the Trust, among the Company,
as sponsor, the Administrators party thereto, Delaware Trust Capital
Management, as Delaware Trustee, State Street Bank and Trust Company as
Property Trustee and the holders from time to time of undivided
interests in the assets of the Trust
4.2 Form of Indenture, between the Company and State Street Bank and Trust
Company, as Trustee
4.3 Form of Capital Security Certificate (included in the Declaration filed
as Exhibit 4.1 to this Registration Statement)
4.4 Form of Junior Subordinated Debenture (included in the Indenture filed as
Exhibit 4.2 to this Registration Statement)
4.5 Form of Capital Securities Guarantee Agreement, between the Company and
State Street Bank and Trust Company, as Guarantee Trustee
5.0 Opinion of Prickett, Jones, Elliott, Kristol & Schree as to the validity
of the Capital Securities+
5.1 Opinion of Muldoon, Murphy & Faucette as to the validity of the Junior
Subordinated Debentures, the Guarantee to be issued by the Company and
the Common Stock issuable upon conversion of the Capital Securities
8.0 Opinion of Muldoon, Murphy & Faucette regarding Federal income tax
matters+
23.1 Consent of Grant Thornton LLP
23.2 Consent of Price Waterhouse LLP
23.3 Consent of Deloitte & Touche LLP
23.4 Consent of Muldoon, Murphy & Faucette
23.5 Consent of Prickett, Jones, Elliott, Kristol & Schree+
24.1 Powers of Attorney (included on signature page)
25.1 Form T-1 Statement of Eligibility of State Street Bank and Trust Company
to act as trustee under the Declaration
25.2 Form T-1 Statement of Eligibility of State Street Bank and Trust Company
to act as trustee under the Indenture
25.3 Form T-1 Statement of Eligibility of State Street Bank and Trust Company
to act as trustee under the Guarantee
27.1 Financial Data Schedule
- --------
* Incorporated herein by reference from the Company's Registration Statement
on Form S-4 (filed initially as Form S-1), filed on January 27, 1997, as
amended (SEC File No. 333-20497).
+ To be filed by amendment
(B) FINANCIAL STATEMENT SCHEDULES
All schedules have been omitted as not applicable or not required under the
rules of Regulation S-X.
II-4
ITEM 17. UNDERTAKINGS.
The undersigned registrant hereby undertakes:
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the
registrant in the successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with
the securities being registered, the registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Act and will be governed by
the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time be deemed to
be the initial bona fide offering thereof.
II-5
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Riverside, State of
California, on December 4, 1997.
LIFE FINANCIAL CORPORATION
By: /s/ Daniel L. Perl
---------------------------------
Daniel L. Perl
President, Chief Executive
Officer and Director
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Daniel L. Perl and L. Bruce Mills, Jr., and
each of them, with full power to act without the other, such person's true and
lawful attorney-in-fact and agent, with full power of substitution and
resubstitution, for such person and in such person's name, place and stead, in
any and all capacities, to sign any or all amendments to this Registration
Statement, and to file the same, with all exhibits thereto and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or either of them, or
their or such person's substitute or substitutes, may lawfully do or cause to
be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Daniel L. Perl President, Chief Executive December 4, 1997
____________________________________ Officer and Director
Daniel L. Perl (principal executive
officer)
/s/ L. Bruce Mills, Jr. Executive Vice President, December 4, 1997
____________________________________ Chief Financial Officer,
L. Bruce Mills, Jr. Treasurer and Secretary
(principal financial and
accounting officer)
/s/ Ronald G. Skipper Chairman of the Board December 4, 1997
____________________________________
Ronald G. Skipper
/s/ Richard C. Caldwell Director December 4, 1997
____________________________________
Richard C. Caldwell
II-6
SIGNATURE TITLE DATE
--------- ----- ----
/s/ John D. Goddard Director December 4, 1997
____________________________________
John D. Goddard
/s/ Milton E. Johnson Director December 4, 1997
____________________________________
Milton E. Johnson
/s/ Robert K. Riley Director December 4, 1997
____________________________________
Robert K. Riley
II-7
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Riverside, State of
California, on December 4, 1997.
LIFE FINANCIAL CORPORATION
By: LIFE Financial Corporation, as
Sponsor
By: /s/ Daniel L. Perl
----------------------------------
Daniel L. Perl
President and Chief Executive
Officer
II-8
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
1.1 Form of Underwriting Agreement
3.1 Certificate of Incorporation of LIFE Financial Corporation*
3.2 Bylaws of LIFE Financial Corporation*
4.0 Certificate of Trust of LIFE Financial Capital Trust (the "Trust"),
dated December 2, 1997
4.1 Form of Amended and Restated Declaration of the Trust, among the
Company, as sponsor, the Administrators party thereto, Delaware Trust
Capital Management, Inc., as Delaware Trustee, State Street Bank and
Trust Company as Property Trustee and the holders from time to time of
undivided interests in the assets of the Trust
4.2 Form of Indenture, between the Company and State Street Bank and Trust
Company, as Trustee
4.3 Form of Capital Security Certificate (included in the Declaration
filed as Exhibit 4.1 to this Registration Statement)
4.4 Form of Junior Subordinated Debenture (included in the Indenture filed
as Exhibit 4.2 to this Registration Statement)
4.5 Form of Capital Securities Guarantee Agreement, between the Company
and State Street Bank and Trust Company, as Guarantee Trustee
5.0 Opinion of Prickett, Jones, Elliott, Kristol & Schree as to the
validity of the Capital Securities+
5.1 Opinion of Muldoon, Murphy & Faucette as to the validity of the Junior
Subordinated Debentures, the Guarantee to be issued by the Company and
the Common Stock issuable upon conversion of the Capital Securities
8.0 Opinion of Muldoon, Murphy & Faucette regarding Federal income tax
matters+
23.1 Consent of Grant Thornton LLP
23.2 Consent of Price Waterhouse LLP
23.3 Consent of Deloitte & Touche LLP
23.4 Consent of Muldoon, Murphy & Faucette
23.5 Consent of Prickett, Jones, Elliott, Kristol & Schree+
24.1 Powers of Attorney (included on signature page)
25.1 Form T-1 Statement of Eligibility of State Street Bank and Trust
Company to act as trustee under the Declaration
25.2 Form T-1 Statement of Eligibility of State Street Bank and Trust
Company to act as trustee under the Indenture
25.3 Form T-1 Statement of Eligibility of State Street Bank and Trust
Company to act as trustee under the Guarantee
27.1 Financial Data Schedule
- --------
* Incorporated herein by reference from the Company's Registration Statement
on Form S-4 (filed initially as Form S-1), filed on January 27, 1997, as
amended (SEC File. No. 333-20497).
+ To be filed by amendment.