EXHIBIT 99.1
RISK FACTORS
Each of the factors set forth below could, directly or indirectly,
affect the Company's results of operations and financial condition. Capitalized
terms that are not defined herein shall have the meaning ascribed in the Annual
Report on Form 10-K of the Company to which this Exhibit relates.
CHANGING NATURE OF RISKS; NO ASSURANCES AS TO CONSISTENCY OF EARNINGS
CHANGING NATURE OF RISKS. The Company's corporate strategy emphasizes
the identification, development and management of specialized businesses which
the Company believes are not accurately evaluated and priced by the marketplace
due to market, economic and competitive conditions. This strategy can result in
the entry into or development of businesses and investment in assets which
produce substantial initial returns, which may be followed by an exit from any
of those businesses or the sale of those assets if, for example, results
decrease because markets become more efficient in the evaluation and pricing of
such businesses and assets. For example, in recent years, the Company's efforts
have focused on lending, the acquisition and resolution of discounted loans, and
investment in various types of mortgage- related securities. However, on October
26, 1998, the Company announced that it would refocus its resources on its core
competencies, namely the acquisition and management of servicing-intensive
assets and the development of exportable loan serving technology for the
mortgage and real estate industries. Given that this strategy involves the
potential of entering and exiting different businesses, past financial
performance may not be considered a reliable indicator of future performance and
historical trends may not be reliable indicators of anticipated results or
trends in future periods. In addition, there can be no assurance that the
Company will be able to accomplish its strategic objectives as a result of
changes in the nature of the Company?s operations over time or that such changes
will not have a material adverse effect from time to time or generally on the
Company's business, financial condition or results of operations.
INCONSISTENCY OF RESULTS AND NON-RECURRING ITEMS. In addition to
inconsistency in results caused by the entry or exit of businesses by the
Company, the consistency of the operating results of the Company has and may
continue to be significantly affected by inter-period variations in its current
operations, including in respect of (i) the amount of assets acquired,
particularly discounted loans; (ii) the amount of resolutions of discounted
loans, particularly large multi-family residential and commercial real estate
loans; (iii) the amount of multi-family residential and commercial real estate
loans which mature or are prepaid, particularly loans with terms pursuant to
which the Company participates in the profits of the underlying real estate; and
(iv) sales by the Company of loans and/or securities acquired from the Company's
securitization of loans. In addition, the Company's operating results have been
significantly affected by certain non-recurring items. For example, the Company
has earned significant non-interest income from gains on sales of
interest-earning assets and real estate owned. Gains on sales of
interest-earning assets and real estate owned generally are dependent on various
factors which are not within the control of the Company, including market and
economic conditions and accounting regulations. In addition, during 1998, the
Company took charges related to its portfolio of AAA-rated agency interest-only
("IO") strips, residual and subordinate securities available for sale,
curtailment of its domestic operations and investments in OAC and OPLP. There
can be no assurance that the level of gains on sales of interest-earning assets
and real estate owned reported by the Company in prior periods will be repeated
in future periods or that there will not be substantial inter-period variations
in the results from such activities or as a result of other non-recurring items.
RISKS RELATED TO NON-TRADITIONAL OPERATING ACTIVITIES
As discussed below, the Company is engaged in a variety of
businesses which generally involve more uncertainties and risks than
the single-family residential lending activities historically
emphasized by savings institutions. In addition, many of the Company's
business activities, including its lending activities, are conducted on
a nationwide basis, which reduces the risks associated with
concentration in any one particular market area but involves other
risks because, among other things, the Company may not be as familiar
with market conditions and other relevant factors as it would be in the
case of activities which are conducted in the market areas in which its
executive offices and branch office are located.
DISCOUNTED LOAN ACQUISITION AND RESOLUTION ACTIVITIES. The
Company's lending activities include the acquisition and resolution of
non-performing or underperforming single-family (one to four units)
residential loans, multi-family (over four units) residential loans and
commercial real estate loans which are purchased at a discount.
Non-performing and subperforming mortgage loans may presently be in
default or may have a greater than normal risk of future defaults and
delinquencies, as compared to newly-originated, high-quality loans of
comparable type, size and geographic concentration. Returns on an
investment of this type depend on the borrower's ability to make
required payments or, in the event of default, the ability of the
loan's servicer to foreclose and liquidate the mortgage loan. There can
be no assurance that the servicer can liquidate a defaulted mortgage
loan successfully or in a timely fashion.
1
The Company acquires discounted loans from governmental agencies,
which in the early years of the program consisted primarily of the
Federal Deposit Insurance Corporation (the "FDIC") and the Resolution
Trust Corporation, a federal agency formed to resolve failed savings
institutions which has since ceased operations, and in recent years has
consisted primarily of the U.S. Department of Housing and Urban
Development. In addition to governmental agencies, the Company acquires
discounted loans from various private sector sellers, such as banks,
savings institutions, mortgage companies and insurance companies.
Although the Company believes that a permanent market for the
acquisition of non-performing and underperforming mortgage loans at a
discount has emerged in recent years, there can be no assurance that
the Company will be able to acquire the desired amount and type of
discounted loans in future periods or that there will not be
significant inter-period variations in the amount of such acquisitions.
There also can be no assurance that the discount on the non-performing
and underperforming loans acquired by the Company will enable the
Company to resolve discounted loans in the future as profitably as in
prior periods. Adverse changes in national economic conditions or in
the economic conditions in regions in which the Company acquires pools
of loans could impair its ability to resolve successfully loans and
could have an adverse effect on the value of those loan pools. The
yield on the Company's discounted portfolio also is subject to
significant inter-period variations as a result of the timing of
resolutions of discounted loans, particularly multi-family residential
and commercial real estate loans and non-performing single-family
residential loans, interest on which is recognized on a cash basis, and
the mix of the overall portfolio between performing and non-performing
loans. In addition, the volume of discounted loans acquired by the
Company may vary over time, thereby affecting results of operations in
future periods as the quantity of loans resolved in any one time period
may be affected.
MULTI-FAMILY RESIDENTIAL, COMMERCIAL REAL ESTATE AND CONSTRUCTION
LENDING ACTIVITIES. The Company's lending activities currently include
(though to a lesser extent than in previous years) nationwide loans
secured by existing commercial real estate, particularly hotels and
office buildings, and existing multi-family residential real estate. In
addition, from time to time the Company originates loans for the
construction of multi-family residential real estate and land
acquisition and development loans (again, to a lesser extent than in
previous years). Multi-family residential real estate, commercial real
estate and construction lending generally are considered to involve a
higher degree of risk than single-family residential lending due to a
variety of factors, including generally larger loan balances, the
dependency on successful completion or operation of the project for
repayment, the difficulties in estimating construction costs and loan
terms which often require little or no amortization of the loan over
its term (typically five years) and, instead, provide for a balloon
payment at stated maturity. Furthermore, mezzanine loans, which are
subordinate to senior loans, and construction loans generally have
higher loan-to-value ratios than conventional loans. Although the
Company's borrowers generally have an equity investment of 10% to 15%
of total project costs, such equity may not be sufficient to protect
the Company's investment in these higher-yielding loans. There can be
no assurance that any multi-family residential, commercial real estate
and construction lending activities engaged in by the Company risks
also related to loans already made will not be adversely affected by
these and the other risks related to such activities.
SUB-PRIME FAMILY RESIDENTIAL LENDING ACTIVITIES. The Company's
lending activities also continue to include the origination or purchase
on a nationwide basis of single-family residential loans made to
borrowers who have significant equity in the properties which secure
the loans but who, because of prior credit problems, the absence of a
credit history or other factors, are unable or unwilling to qualify as
borrowers under federal agency guidelines. These loans are offered
pursuant to various programs, including programs which provide for
reduced or no documentation for verifying a borrower's income and
employment. Sub-prime loans present a higher level of risk of
delinquency or default than loans made to more creditworthy borrowers,
and may not be as saleable as loans which conform to the guidelines
established by various federal agencies. While the Company believes
that the business practices it employs enable it to reduce higher risks
inherent in these loans, no assurance can be given that such practices
will afford adequate protection against higher delinquencies,
foreclosures or losses than anticipated, and as a result, the Company's
financial condition or results of operation could be adversely
affected.
2
ENVIRONMENTAL RISKS OF LOAN ACQUISITION AND LENDING ACTIVITIES.
The Company evaluates the potential for significant environmental
problems prior to acquiring or originating a loan because there is a
risk for any mortgage loan, particularly a multifamily residential and
commercial real estate loan, that hazardous substances or other
environmentally restricted substances could be discovered on the
related real estate. Through foreclosure, the Company could become the
owner of the real estate that secured its loan and might be required to
remove such substances from the affected properties or to engage in
abatement procedures at its sole cost and expense. There can be no
assurance that the cost of such removal or abatement will not
substantially exceed the value of the affected properties or the loans
secured by such properties, that the Company would have adequate
remedies against the prior owners or other responsible parties or that
the Company would be able to resell the affected properties either
prior to or following completion of any such removal or abatement
procedures. If such environmental problems are discovered prior to
foreclosure, the Company generally will not foreclose on the related
loan; however, the value of such property as collateral will generally
be substantially reduced, and as a result, the Company may suffer a
loss upon collection of the loan.
INVESTMENTS IN LOW-INCOME HOUSING TAX CREDIT INTERESTS. The
Company invests in low-income housing tax credit interests (generally
limited partnerships) in order to obtain federal income tax credits
which are allocated pursuant to Section 42 of the Internal Revenue Code
of 1986, as amended (the "Code"). There are many uncertainties and
risks associated with an investment in low-income housing tax credit
interests, including the risks involved in the construction, lease-up
and operation of multi-family residential real estate, the investor's
ability to earn sufficient income to utilize the tax credits resulting
from such investments in accordance with the requirements of the Code
and the possibility of required recapture of previously-earned tax
credits. In addition, there are numerous tax risks associated with tax
credits resulting from potential changes to the Code.
INVESTMENTS IN MORTGAGE-RELATED SECURITIES. From time to time the
Company invests in a variety of mortgage-related securities, such as
senior, subordinate and residual interests in collateralized mortgage
obligations ("CMOs"), including CMOs which have qualified as Real
Estate Mortgage Investment Conduits. These investments include
so-called stripped mortgage-related securities, in which interest
coupons may be stripped from a mortgage security to create an
interest-only strip, where the investor receives all of the interest
cash flows and none of the principal, and a principal-only ("PO")
strip, where the investor receives all of the principal cash flows and
none of the interest. Some mortgage-related securities, such as IO
strips, PO strips and residual interests, exhibit considerably more
price volatility than mortgages or ordinary mortgage pass-through
securities, due in part to the uncertain cash flows that result from
changes in the prepayment rates of the underlying mortgages. Other
mortgage-related securities, such as subordinate interests, also
involve substantially more credit risk than the senior classes of the
mortgage-related securities to which such interests relate and
generally are not as liquid as such senior classes. The Company
generally acquires subordinate and residual interests primarily in
connection with the securitization of its loans, particularly
single-family residential loans to non-conforming borrowers and
discounted loans, and under circumstances in which it continues to
service the loans which back the related securities. The Company has
sought to offset the risk of changing interest rates on certain of its
mortgage-related securities by selling U.S. Treasury futures contracts
and through other hedging techniques, and believes that the resulting
interest-rate sensitivity profile compliments the Company's overall
exposure to changes in interest rates. See "--Economic Conditions"
below. Although generally intended to reduce the effects of changing
interest rates on the Company, investments in certain mortgage-related
securities and hedging transactions could cause the Company to
recognize losses depending on the terms of the instrument and the
interest rate environment.
RISK OF FUTURE ADJUSTMENTS TO ALLOWANCES FOR LOSSES
The Company believes that it has established adequate allowances
for losses for each of its loan portfolio and discounted loan portfolio
in accordance with generally accepted accounting principles. Future
additions to these allowances, in the form of provisions for losses on
loans and discounted loans, may be necessary, however, due to changes
in economic conditions, increases in loans and discounted loans and the
performance of the Company's loan and discounted loan portfolios.
3
In addition, the OTS, as part of its examination process, periodically
reviews the Company's allowances for losses and the carrying value of
its assets. As a result of OTS reviews, the Company in the past has
increased its allowances for losses on loans and discounted loans and
written down the carrying value of certain loans. There can be no
assurance that the Company will not determine, at the request of the
OTS or otherwise, to further increase its allowances for losses on
loans and discounted loans or adjust the carrying value of its real
estate owned or other assets. Increases in the Company's provisions for
losses on loans would adversely affect the Company's results of
operations.
RISKS RELATED TO REAL ESTATE OWNED
GENERAL. The Company's real estate owned consists almost entirely
of single-family residential real estate and multi-family residential
and commercial real estate acquired by foreclosure or deed-in-lieu
thereof on loans in the Company's discounted loan portfolio. Generally,
real estate owned properties are non-earning assets, although
multi-family residential and commercial real estate owned may provide
some operating income to the Company depending on the circumstances.
Such operating income may be affected by problems experienced by
lessees, which may weaken their financial condition and result in
failure to make rental payments when due. At any time, a lessee of the
Company's properties may seek the protection of bankruptcy laws, which
could result in rejection and termination of the lessee's lease and
thereby cause a reduction in cash flow available for distribution to
the Company. Moreover, the value of real estate can be significantly
affected by adverse changes in national or local economic conditions,
competition from other properties offering the same or similar
services, changes in interest rates and in the availability, cost and
terms of mortgage funds, acts of nature, including earthquakes,
hurricanes and other natural disasters, and other factors which are
beyond the control of the Company. These factors may require the
establishment of provisions for losses to ensure that real estate owned
properties are carried at the lower of cost or fair value, less
estimated costs to dispose of the properties, which may adversely
affect operations. Real estate owned also requires increased allocation
of resources and expense to the management and work out of the asset,
property taxes and compliance with respect to environmental laws and
the Americans with Disabilities Act of 1990, which can also adversely
affect operations. There can be no assurance that the amount of the
Company's real estate owned will not increase in the future as a result
of the Company's discounted loan acquisition and resolution activities
and the Company's single-family residential, multi-family residential,
commercial real estate and construction lending activities.
ENVIRONMENTAL RISKS. Operating costs and the value of real
property may be affected by the obligation to pay for the cost of
complying with existing environmental laws, ordinances and regulations,
as well as the cost of future legislation. Under various federal, state
and local environmental laws, ordinances and regulations, a current or
previous owner or operator of real property may be liable for the costs
of removal or remediation of hazardous or toxic substances on, under or
in such property. Such laws often impose liability whether or not the
owner or operator knew of, or was responsible for, the presence of such
hazardous or toxic substances. Therefore, an environmental liability
could have a material adverse effect on the underlying value of a real
property, and the revenue therefrom. Although the Company believes that
its pre-acquisition due diligence identified all material environmental
concerns which relate to its current investments in real estate and
accurately assessed the costs and liabilities to be concurred by it in
this regard, there can be no assurance that such investments will not
raise material unanticipated environmental concern or costs in the
future.
RISKS ASSOCIATED WITH ACQUISITIONS AND DIVESTITURES
Acquiring businesses and assets has been and may continue to be
an important focus of the Company's strategic efforts. Any acquisitions
could vary in size and may include those that are large relative to the
Company. There can be no assurance that suitable acquisition candidates
can be identified, that financing for such acquisitions would be
available on satisfactory terms, that the Company would be able to
accomplish its strategic objectives as a result of any such
acquisitions, that any business or assets acquired by the Company would
be integrated successfully or that integration of acquired businesses
would not divert management resources or otherwise have a material
adverse effect on the Company's business, financial condition or
results of operations. The Company is continually evaluating possible
acquisitions and engages in discussions with acquisition candidates
from time to time.
4
In addition, in the event that the Company chooses to divest any
business or sell any asset in the future, there can be no assurance
that a suitable purchaser could be identified, that the Company would
be able to accomplish its strategic objectives as a result of any such
sale, that any proposed asset or business sold by the Company would be
completed or that the separation of any such asset or business from the
Company would not diminish management resources or otherwise have a
material adverse effect on the Company's business, financial condition
or results of operations.
ABILITY TO MANAGE GROWTH
The Company has grown rapidly in the past and may continue to
grow rapidly in the future. If so, continued growth can be expected to
place a significant strain on the Company's management operations,
employees and resources. The Company's ability to support, manage and
control continued growth is dependent upon, among other things, its
ability to hire, train, supervise and manage its workforce and to
continue to develop the skills necessary for the Company to compete
successfully. There can be no assurance that the Company will be able
to manage effectively its expanding operations or achieve growth as
planned on a timely or profitable basis. If the Company is unable to
manage growth effectively, its business, results of operations or
financial condition could be materially adversely affected.
RISKS ASSOCIATED WITH PARTNERING
On July 28, 1998, the Company announced that it has engaged an
investment bank to identify potential business partners who can enable
the Company to expand its franchise both domestically and
internationally. Any transaction resulting therefrom could take on many
different forms, including a merger. No assurance can be given that the
Company will identify a business partner and transaction that will
satisfy its objectives or, if so identified, that such objectives will
be achieved.
INTERNATIONAL OPERATIONS
The Company conducts business in the United States and the United
Kingdom and may explore opportunities outside of these markets. The
Company's U.K. operations are subject to most of the same risks
associated with its U.S. operations, as well as additional risks, such
as unexpected changes in U.K. and European regulatory requirements,
difficulties in managing international operations, potentially adverse
tax consequences, enhanced accounting and control expenses and the
burden of complying with foreign laws. Changes in foreign currency
exchange rates may also affect the value of the Company's U.K. assets
and the gains realized from the sale of such assets. Although the
Company implements hedging strategies to limit the effects of currency
exchange rate fluctuations on the Company's results of operations,
currency hedging strategies, like those for interest rates, may not
perform their intended purpose. See "--Economic Conditions". There can
be no assurance that such factors will not have a material adverse
effect on the Company's business, results of operations or financial
condition. In addition, the Company's management has only limited
international experience outside of the U.S. and the U.K, which could
limit the Company's ability to capitalize on investment opportunities
that may arise elsewhere.
REGULATION AND REGULATORY CAPITAL REQUIREMENTS
Both the Company, as a savings and loan holding company, and the
Bank, as a federally-chartered savings institution, are subject to
significant governmental supervision and regulation, which is intended
primarily for the protection of depositors. Statutes and regulations
affecting the Company and the Bank may be changed at any time, and the
interpretation of these statutes and regulations by examining
authorities also is subject to change. There can be no assurance that
future changes in applicable statutes and regulations or in their
interpretation will not adversely affect the business of the Company.
The applicable regulatory authorities may, as a result of such
regulation and examination, impose regulatory sanctions upon the
Company or the Bank, as applicable, as well as various requirements or
restrictions which could adversely affect their business activities.
5
A substantial portion of the Bank's operations involves businesses that
are not traditionally conducted by savings institutions and, as a
result, there can be no assurance that future actions by applicable
regulatory authorities, or future changes in applicable statutes or
regulations, will not limit or otherwise adversely affect the Bank's
ability to engage in such activities.
Following an examination of the Bank in late 1996 and early 1997,
the staff of the Office of Thrift Supervision (the "OTS") expressed
concern about many of the Bank's non-traditional operations (which are
discussed under "--Risks Related to Non-Traditional Operating
Activities" above) and the adequacy of the Bank's capital in light of
the Bank's lending and investment strategies. As a result of such
examination, the Bank committed to the OTS to maintain, commencing on
June 30, 1997, regulatory capital ratios which significantly exceed the
requirements which are generally applicable to federally-chartered
savings institutions such as the Bank. Specifically, the Bank has
committed to the OTS to maintain a core capital (leverage) ratio and a
total risk-based capital ratio of at least 9% and 13%, respectively
(the requirements of general applicability are 3% and 8%,
respectively). At December 31, 1998, the Bank's core capital, Tier 1
risk-based capital and total risk-based capital ratios amounted to
9.07%, 11.71% and 17.26%, respectively. Based on discussions with the
OTS, the Bank believes that this commitment does not affect its status
as a "well-capitalized" institution, assuming the Bank's continued
compliance with the regulatory capital requirements that it committed
to maintain. Under applicable laws and regulations, an institution is
considered to be "well-capitalized" if it maintains a total risk-based
capital ratio of 10.0% or more, a Tier 1 risk-based capital ratio of
6.0% or more and a core capital (leverage) ratio of 5.0% or more and is
not subject to a written agreement, order or directive issued by an
appropriate agency to meet and maintain a specific capital level for
any capital measure.
There can be no assurance that in the future the OTS either will
agree to a decrease in the 9% core capital (leverage) ratio and the 13%
total risk-based capital ratio committed to be maintained by the Bank
or will not seek an increase in such requirements. Unless and until
these regulatory capital requirements are decreased, the Bank's ability
to leverage its capital through future growth in assets (including its
ability to continue growing at historical rates) will be adversely
affected, as will the Company's ability to receive dividends from the
Bank, which are a primary source of payments on outstanding
indebtedness and other expenses of the Company. Although the Company
and its non-banking subsidiaries will not be restricted in their growth
by these capital requirements, because they do not have access to the
Bank's funding sources, their profitability may be different from the
Bank's for particular types of businesses. In addition, there can be no
assurance that the Bank will continue to meet the regulatory capital
requirements that it has committed to maintain or that the OTS will not
formally impose such requirements pursuant to a written agreement,
order or directive, which would cause the Bank to cease to be a
"well-capitalized" institution under applicable laws and regulations.
In the event that the Bank ceased to be a "well-capitalized"
institution, the Bank would be prohibited from accepting, renewing or
rolling over its brokered and other wholesale deposits, which are its
principal source of funding, without the prior approval of the FDIC,
and the Bank could become subject to other regulatory restrictions on
its operations.
ECONOMIC CONDITIONS
GENERAL. The success of the Company is dependent to a certain
extent upon the general economic conditions in the geographic areas in
which it conducts substantial business activities. Adverse changes in
national economic conditions or in the economic conditions of regions
in which the Company conducts substantial business likely would impair
the ability of the Company to collect on outstanding loans or dispose
of real estate owned and would otherwise have an adverse effect on its
business, including the demand for new loans, the ability of customers
to repay loans and the value of both the collateral pledged to the
Company to secure its loans and its real estate owned. Moreover,
earthquakes and other natural disasters could have similar effects.
Although such disasters have not significantly adversely affected the
Company to date, the availability of insurance for such disasters in
California, in which the Company conducts substantial business
activities, is severely limited. Moreover, changes in building codes
and ordinances, environmental considerations and other factors also
might render infeasible the use of insurance proceeds to replace
damaged or destroyed property. Under such circumstances, the insurance
proceeds received by a borrower or the Company might not be adequate to
restore the Company's economic position with respect to the affected
collateral or real estate.
6
EFFECTS OF CHANGES IN INTEREST RATES. The Company's operating
results depend to a large extent on its net interest income, which is
the difference between the interest income earned on interest-earning
assets and the interest expense incurred in connection with its
interest-bearing liabilities. Changes in the general level of interest
rates can affect the Company's net interest income by affecting the
spread between the Company's return on interest-earning assets and the
Company's cost of interest-bearing liabilities, as well as, among other
things, the ability of the Company to originate loans; the value of the
Company's interest-earning assets and its ability to realize gains from
the sale of such assets; the average life of the Company's
interest-earning assets; the value of the Company's mortgage servicing
rights; and the Company's ability to obtain deposits in competition
with other available investment alternatives. Interest rates are highly
sensitive to many factors, including governmental monetary policies,
domestic and international economic and political conditions and other
factors beyond the control of the Company. Although management believes
that the maturities of the Company's assets are well balanced in
relation to its liabilities (which involves various estimates and
assumptions, including as to how changes in the general level of
interest rates will impact its assets and liabilities), there can be no
assurance that the profitability of the Company would not be adversely
affected during any period of changing interest rates.
POTENTIAL ADVERSE EFFECTS OF HEDGING STRATEGIES. The Company may
utilize a variety of financial instruments, including interest rate
swaps, caps, floors and other interest rate exchange contracts, in
order to limit the effects of interest rates on its operations. Among
the risks inherent with respect to the purchase and/or sale of such
derivative instruments are (i) interest rate risk, which consists of
the risks relating to fluctuating interest rates; (ii) basis risk,
which consists of the risk of loss associated with variations in the
spread between the asset yield and the funding and/or hedge costs;
(iii) credit or default risk, which consists of the risk of insolvency
or other inability of the counterparty to a particular transaction to
perform its obligations thereunder; (iv) prepayment risk, which
consists of reinvestment risk to the extent the Company is not able to
reinvest repayments, if any, at a yield which is comparable to the
yield being generated on the particular security; (v) liquidity risk,
which consists of the risk that the Company may not be able to sell a
particular security at a particular price; (vi) legal enforceability
risk, which consists of the risks related to the Company's ability to
enforce the terms of a particular instrument or to obtain or collect
upon a legal judgment in the United States in the event that the
counterparty to the transaction is a foreign entity or the underlying
collateral is located in a foreign jurisdiction; and (vii) volatility
risk, which consists of the risk that actual volatility (i.e., the
degree of uncertainty relating to the price of the underlying asset)
differs from the historical volatility or "implied" volatility of the
instrument.
RISKS RELATED TO RELIANCE ON BROKERED AND OTHER WHOLESALE DEPOSITS
The Company currently utilizes as its principal source of funds
certificates of deposit obtained through national investment banking
firms which obtain funds from their customers for deposit with the
Company ("brokered deposits") and, to a lesser extent, certificates of
deposit obtained from customers of regional and local investment
banking firms and direct solicitation efforts by the Company of
institutional investors and high net worth individuals. The Company
believes that the effective cost of brokered and other wholesale
deposits, as well as other non-branch dependent sources of funds, such
as securities sold under agreements to repurchase ("reverse repurchase
agreements") and advances from the Federal Home Loan Board ("FHLB") of
New York, generally is more attractive to the Company than deposits
obtained through branch offices after the general and administrative
costs associated with operating a branch office network are taken into
account. However, such funding sources, when compared to retail
deposits attracted through a branch network, are generally more
sensitive to changes in interest rates and volatility in the capital
markets and their availability and terms are more likely to be subject
to competitive pressures. In addition, such funding sources may be more
sensitive to significant changes in the financial condition of the
Company. There are also regulatory limitations on an insured
institution's ability to solicit and obtain brokered deposits in
certain circumstances, which currently are not applicable to the Bank
because of its status as a "well capitalized" institution under
applicable laws and regulations. See "--Regulation and Regulatory
Capital Requirements" above. As a result of the Company's reliance on
brokered and other wholesale deposits, significant changes in
prevailing interest rates, in the availability of alternative
investments for individual and institutional investors or in the
Company's financial condition, among other factors, could have a much
more significant effect on the Company's liquidity and results of
operations than might be the case with an institution that attracted a
greater portion of its funds from retail or core deposits obtained
through a branch network.
7
RISKS ASSOCIATED WITH CURRENT SOURCES OF LIQUIDITY AND ADDITIONAL
FINANCING FOR GROWTH
CURRENT SOURCES OF LIQUIDITY. The Company's primary sources of
funds for liquidity consist of deposits, FHLB advances, reverse
repurchase agreements, lines of credit and maturities and principal
payments on loans and securities and proceeds from sales thereof. An
additional significant source of asset liquidity stems from the
Company's ability to securitize assets such as discount loans and
sub-prime loans. The Company believes that its existing sources of
liquidity will be adequate to fund planned activities for the
foreseeable future, although there can be no assurances in this regard.
Moreover, the Company continues to evaluate other sources of liquidity,
such as lines of credit from unaffiliated parties, which will enhance
the Company's ability to increase its liquidity position. The inability
of the Company to maintain adequate sources of liquidity, including as
a result of the failure to extend or replace existing lines of credit
or as a result of the factors described under "--Risks Related to
Reliance on Brokered and Other Wholesale Deposits" above or "Risks of
Securitization" below, could have a material adverse effect on the
Company's business, financial condition or results of operations.
ADDITIONAL FINANCING FOR GROWTH. The Company's ability to enter
into certain business lines as opportunities emerge depends to a
significant degree on its ability to obtain additional indebtedness,
obtain additional equity capital or have access to other sources of
capital (e.g., through partnering, joint venturing or other economic or
contractual relationships). The Company has no commitments for
borrowings in addition to those under its current debt securities and
lines of credit, no commitments for future sales of equity capital and
no commitments to provide access to other sources of capital. There can
be no assurance that the Company will be successful in consummating
future financing transactions, if any, on terms satisfactory to the
Company, if at all. Factors which could affect the Company's access to
the capital markets or other economic or contractual relationships, or
the conditions under which the Company could obtain additional
financing, involve the perception in the capital markets and the
financial services industry of the Company's business, results of
operations, leverage, financial condition and business prospects. Each
of these factors is to a large extent subject to economic, financial
and competitive factors beyond the Company's control. In addition,
covenants under the Company's current debt securities and lines of
credit do, and future ones may, significantly restrict the Company's
ability to incur additional indebtedness, to issue Preferred Stock and
to enter into certain other contractual relationships.
RISKS ASSOCIATED WITH HOLDING COMPANY STRUCTURE
As a holding company, the ability of the Company to pay
dividends, to pay indebtedness and to conduct its financial operating
activities directly or in non-banking subsidiaries will depend
significantly on the receipt of dividends or other distributions from
the Bank, as well as any cash reserves and other liquid assets held by
the Company, any proceeds from securities offerings or other borrowings
and any dividends from non-banking subsidiaries of the Company. The
ability of the Bank to pay dividends or make other distributions to the
Company generally is dependent on the Bank's compliance with applicable
regulatory capital requirements and regulatory restrictions.
The Bank's ability to make capital distributions as a Tier 1
association pursuant to the OTS capital distribution regulation are
limited by the regulatory capital levels which it has committed to the
OTS it would maintain, commencing on June 30, 1997. As a result of an
agreement between the Bank and the OTS to dividend subordinate and
residual mortgage-related securities resulting from securitization
activities conducted by the Bank, which had an aggregate carrying value
of $13.9 million at December 31, 1998, the Bank may be limited in its
ability to pay cash dividends to the Company.
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In addition to the foregoing limitations, there are certain
contractual restrictions on the Bank's ability to pay dividends set
forth in the Indenture, dated as of June 12, 1995, between the Bank and
the Bank of New York, as trustee, relating to the Bank's issuance in
June 1995 of $100 million of 12% Subordinated Debentures due 2005, and
there are certain contractual restrictions on the ability of the
Company and the Bank to pay dividends set forth in the Indenture, dated
as of September 30, 1996, between the Company and Bank One, Columbus,
NA, as trustee, relating to the Company's issuance in September 1996 of
$125 million of 11.875% Notes due 2003, as well as in the Indenture,
dated as of August 12, 1997, between the Company and The Chase
Manhattan Bank, as trustee, relating to the Company's issuance in
August 1997 of $125 million of 10.875% Junior Subordinated Debentures
due 2027. In addition, 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, will be
subject to the prior claims of creditors of that subsidiary, except to
the extent that any claims of the Company as a creditor of such
subsidiary may be recognized as such.
RISKS OF SECURITIZATION
The Company has historically generated a significant amount of
revenues, earnings and cash flows from its pooling and selling through
securitizations of mortgages and other loans originated or purchased by
the Company. Adverse changes in the secondary market for such loans
could impair the Company's ability to originate or sell mortgages and
other loans on a favorable or timely basis. Accordingly, such
impairments could have an adverse effect upon the Company's business
and results of operations. Market and other considerations, including
rating agency requirements, could also affect the timing of such
transactions. Any delay in the sale of loans beyond the reporting
period in which such sale is anticipated to take place would delay any
expected gains and adversely affect the Company's reported earnings for
such reporting period. In addition, the Company retains some degree of
credit risk on substantially all loans sold. During the period of time
that loans are held pending sale, the Company is at risk for loan
delinquencies and defaults and the risk that the rapid increase in
interest rates would result in a decline in the value of loans to
potential purchasers. Following the sale of loans through a
securitization, the Company's direct risk with respect to loan
delinquency or default on such loan is limited to those circumstances
in which it is required to repurchase such loan due to a breach of a
representation or warranty in connection with the securitization.
COMPETITION
The businesses in which the Company is engaged generally are
highly competitive. The acquisition of discounted loans is particularly
competitive, as acquisitions of such loans are often based on
competitive bidding. The Company also encounters significant
competition in connection with its other lending activities, its
investment activities, its deposit-gathering activities and its
servicing activities. Many of the Company's competitors are
significantly larger than the Company and have access to greater
capital and other resources. In addition, many of the Company's
competitors are not subject to the same extensive federal regulation
that govern federally-insured institutions such as the Bank and their
holding companies. As a result, many of the Company's competitors have
advantages over the Company in conducting certain businesses and
providing certain services.
POTENTIAL CONFLICTS OF INTEREST INVOLVING OCWEN ASSET INVESTMENT CORP.
The Company will be subject to various potential conflicts of
interest arising from the relationship between Ocwen Asset Investment
Corp. ("OAC"), a real estate investment trust that specializes in
investments in real estate and real estate-related assets in which the
Company also may invest, directly or indirectly, through the Bank, and
the Company and Ocwen Capital Corporation ("OCC"), a wholly-owned
subsidiary of the Company that manages OAC. Historically, OAC has
invested primarily in (i) subordinate and residual interests in
commercial and residential mortgage-backed securities; (ii) distressed
commercial and multi-family residential real estate, including
properties acquired by a mortgage lender by foreclosure or by
deed-in-lieu thereof and underperforming or otherwise distressed real
property (collectively, "Distressed Real Estate"); and (iii)
single-family residential loans, multi-family residential loans and
commercial real estate loans, including in each case loans that are
current in accordance with their terms or are non-performing or
underperforming. The Company does not intend to invest in subordinate
classes of mortgage-related securities which are not created in
connection with its securitization activities or Distressed Real Estate
and, as a result, the Company, the Bank and OCC generally have agreed
to give OAC an exclusive right to purchase such subordinated classes of
mortgage-related securities and Distressed Real Estate. Both the
Company and OAC may engage in the acquisition and resolution of
mortgage loans, including non-performing and underperforming mortgage
loans, and from time to time each such entity also may invest in
various non-subordinated classes of mortgage-related securities. In
this regard, OCC, which, in addition to managing OAC, conducts the
large multi-family residential and commercial real estate lending
activities of the Company, has in the past acquired loans for OAC (in
order to enable OAC to leverage the proceeds from its initial public
offering ) rather than for the Company. As a result of the similarity
of the Company's and OAC's strategies to invest in certain assets,
there can be no assurance that investment opportunities which
previously would have been taken by the Company will not be allocated
to OAC. In addition, from time to time the Company may sell loans,
securities and real estate owned to OAC, which also would involve
potential conflicts of interest. Although the Company and OAC have
established certain policies and procedures in order to ensure that
sales and other transactions between the Company, the Bank and/or OCC,
on the one hand, and OAC, on the other hand (including, without
limitation, the base compensation to be paid to OCC by OAC for managing
its day-to-day operations), are conducted on an arms'-length basis on
substantially the same terms as would be present in transactions with
unaffiliated parties, there can be no assurance that such procedures
will be sufficient in all situations to solve potential conflicts of
interest.
IMPORTANCE OF THE CHIEF EXECUTIVE OFFICER
William C. Erbey, Chairman and Chief Executive Officer of the
Company, has had, and will continue to have, a significant role in the
development and management of the Company's business. The loss of his
services could have an adverse effect on the Company. The Company and
Mr. Erbey are not parties to an employment agreement, and the Company
currently does not maintain key man life insurance relating to Mr.
Erbey or any of its other officers.
CONTROL OF CURRENT STOCKHOLDERS
As of March 15, 1999, the Company's directors and executive
officers and their affiliates in the aggregate beneficially owned or
controlled 51.9% of the outstanding Common Stock of the Company,
including 32.0% owned or controlled by William C. Erbey, Chairman and
Chief Executive Officer of the Company, and 15.4% owned or controlled
by Barry N. Wish, currently a director and formerly the Chairman of the
Company. As a result, these shareholders, acting together, would be
able effectively to control virtually all matters requiring approval by
the shareholders of the Company, including amendment of the Company's
Articles of Incorporation, the approval of mergers or similar
transactions and the election of all directors.
SOFTWARE PRODUCT DEVELOPMENT; TECHNOLOGICAL CHANGE
The Company's wholly-owned subsidiary, Ocwen Technology Xchange,
Inc. ("OTX"), licenses the Company's mortgage loan servicing resolution
and work flow technology to third parties in the mortgage and real
estate industries. The products offered by OTX have resulted from the
enhancement of software products acquired through the Company's
purchases of Amos, Inc., a developer of mortgage loan servicing
software, and DTS Communication, Inc., a real estate technology
company, with the Company's own proprietary technology. While the
Company believes it has developed products attractive to the mortgage
and real estate industries, the computer software industry is subject
to rapid technological change, changing customer requirements, frequent
new product introductions and evolving industry standards that may
render existing products and services obsolete.
9
There can be no assurance that OTX will not experience future
difficulties that could delay or prevent the successful development,
introduction and marketing of its products, or that its products and
product enhancements will meet the requirements of the marketplace and
achieve market acceptance. If OTX is unable to develop and introduce
products of marketable quality in a timely manner in response to
changing market conditions or customer requirements, the Company's
business, operating results and financial condition could be adversely
affected.
DEPENDENCE ON PROPRIETARY INFORMATION
The Company's success is in part dependent upon its proprietary
information and technology. The Company relies on a combination of
copyright, trade secret and contract protection to establish and
protect its proprietary rights in its products and technology. The
Company generally enters into confidentiality agreements with its
management and technical staff and limits access to and distribution of
its proprietary information. There can be no assurance that the steps
taken by the Company in this regard will be adequate to deter
misappropriation of its proprietary rights or information or
independent third party development of substantially similar products
and technology. Although the Company believes that its products and
technology do not infringe any proprietary rights of others, the
growing use of copyrights and patents to protect proprietary rights has
increased the risk that third parties will increasingly assert claims
of infringement in the future.
YEAR 2000 DATE CONVERSION
The Company is in the process of establishing the readiness of
its computer systems and applications for the year 2000 with no effect
on customers or disruption to business operations. The Company has
established a project plan to achieve year 2000 readiness of its
mission critical and non-mission critical systems, including hardware
infrastructure and software applications. To date, the Company has
substantially completed the systems identification, evaluation,
remediation and validation phases of the project. The Company has
retained a business continuity expert to prepare contingency plans and
assist with the testing and validation of these plans. Until this phase
is completed, the Company will not know the full extent of the risks
associated with year 2000 readiness, including an analysis of the most
reasonably likely worst case year 2000 scenario. In addition, while the
Company expects its year 2000 conversion will be completed on a timely
basis and within the anticipated budget of approximately $2.0 million,
no assurance can be given in that regard or that third-party computer
systems and applications will not experience problems associated with
the recognition and processing of the year 2000 and beyond, any of
which could have a material adverse effect on the Company's business,
results of operations or financial condition.
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