Item 1. Business
General
PacificAmerica Money Center, Inc. (the "Company") is a mortgage banking company primarily engaged, through its subsidiaries, in the business of originating and selling home equity mortgage loans secured by single family residences. The Company has, since its formation in 1981, specialized in home equity loans for borrowers whose credit histories or other factors limit their access to credit from traditional mortgage lenders. The Company currently originates fixed and adjustable rate residential mortgage loans to borrowers of all credit grades. Borrowers generally obtain loans from the Company for the purpose of financing a purchase of the related property, refinancing an existing mortgage loan on more favorable terms, consolidating debt or obtaining cash proceeds for personal use by the borrowers.
In the third quarter of 1998, a chain reaction of events occurred which caused significant and sudden changes in the subprime lending industry, and significantly and adversely affected the Company's business for the third and fourth quarters of 1998. These events began with the Asia economic crisis and the substantial losses incurred by several large U.S. hedge funds. These losses led to a general stock market decline in September 1998 as institutional investors decreased their holdings of a variety of securities in favor of U.S. Treasury securities, along with a sharp drop in buyers for the subordinated interests in mortgage securitization pools. Since mortgage prices are based on comparable maturity Treasuries, yields on mortgages plummeted to lows not seen in decades, causing an increase in prepayments on existing mortgage loans. Simultaneously, the lack of buyers for subordinated interests in mortgage securitization pools caused a reduction in the number of securitization pools completed in the third quarter of 1998. As a result of both the reduced value of existing securitization pools caused by increased prepayments and the inability to complete new securitizations, Wall Street investment banks, one of the primary sources of funding to subprime lenders, made margin calls on loans to subprime lenders and reduced warehouse loan funding availability. This caused a number of asset-backed and mortgage-backed securitization sponsors in September 1998, particularly subprime lenders, to experience significant liquidity shortages due to their reduced ability to obtain financing on loans and interest-only strips receivable. In order to relieve the liquidity shortages, a number of subprime lenders announced that they would begin selling their loans on a cash basis, creating an increase in supply of mortgage loans being sold for cash. These factors led to an oversupply of loans for sale in the secondary loan market, which has continued into the fourth quarter of 1998.
As a result of these significant adverse changes in the subprime lending industry, the Company experienced a sudden loss of ready purchasers for its loans, as well as a substantial reduction in loan sale prices, beginning in the third quarter of 1998. Loan sale prices available to the Company in the secondary loan market were reduced from approximately 105% to 106% of par value, the price at which the Company sold loans in September 1998, to 101% to 102% of par value. The Company, along with many other subprime lenders, found it necessary to substantially reduce its loan origination volume and its loan origination costs, which it did by discontinuing its wholesale loan division effective as of October 28, 1998. The Company notes that several other large subprime lenders took similar actions to close or reduce their wholesale loan production units as a result of the reduction in loan sale prices. Over the first nine months of 1998, the wholesale loan division had produced approximately 75% of the Company's lending volume, and the retail loan division had produced the remaining approximately 25% of the lending volume. The closure of the
wholesale loan division therefore had the effect of reducing by approximately 75% the total loans the Company expected to originate during the fourth quarter of 1998.
Since October 27, 1998, the Company has continued originating loans exclusively through its retail loan division, where origination costs, net of fees, are approximately 23% lower than origination costs of wholesale loan origination. The retail division is able to offset costs of loan origination against loan fees charged to borrowers, which are retained by the Company upon sale of loans, and may be taken into income immediately upon sale of loans. In order to further reduce operating costs, between November 1, 1998 and March 18, 1999, the retail division has closed 7 of its 47 offices which were in operation at October 27, 1998, and the Company now has 40 retail offices operating in 21 states and the District of Columbia.
Loan sale prices have partially recovered since the third quarter, as the Company's February and March loan sales have been at prices ranging from 102.5% to 103.5%. In addition, the Company has experienced an increase in the number of potential purchasers for its loans, and has sold loans to six different third party purchasers during the first quarter of 1999. However, neither prices nor demand levels have stabilized as of March 31, 1999. The Company has operated at a loss for the first three months of 1999, primarily because it has been unable to sell a sufficient amount of loans at currently available prices to cover its operating expenses.
Management believes that the Company may return to profitable operations at current loan sale price levels, provided that it increases the monthly volume of loans originated by approximately $2 million and the monthly volume of loans sold by approximately $5 million from levels reached in the first three months of 1999. The Company is devoting all of its efforts towards these goals. In addition, the Company is continuing to seek strategic partners and strategic opportunities to improve its financial condition and its operations. During the second and third quarters of 1998, the Company held discussions with several potential purchasers of the Company, but the severe adverse conditions affecting the subprime lending industry in the third quarter caused the potential purchasers to terminate discussions with the Company. As conditions in the industry improve, the Company believes that more strategic opportunities will become available, although there can be no assurance that the Company will be able to complete a transaction with a strategic partner.
The Company sells substantially all of its loans on a servicing released basis, so that the purchasers of the loans acquire all servicing rights. The Company is named as master servicer on three securitization pools which the Company securitized in 1997 and 1998, but the actual servicing is performed by a subservicer. The Company retains a small servicing department to service its loans held for sale and a small amount of loans held for investment.
The Company's principal operating subsidiary is Pacific Thrift and Loan Company, a California corporation ("Pacific Thrift") and a California licensed thrift and loan formed in 1988. Pacific Thrift originates loans for sale, services the Company's loans held for sale and investment, and issues deposits insured by the Federal Deposit Insurance Corporation (the "FDIC"). Pacific Thrift is subject to regulation by both the FDIC and the California Department of Financial Institutions (the "DFI"). In the fourth quarter of 1998, the FDIC and the DFI issued regulatory orders requiring Pacific Thrift to limit its lending volume to an amount which could readily be sold, to cease securitization of loans and to raise additional capital, among other things. (See "--Supervision and Regulation -- Regulatory Orders.")
The Company also conducts business through PacificAmerica Money Centers, Inc. ("PAMC"), a Delaware corporation which currently originates loans under appropriate state licenses in four states in which Pacific Thrift cannot operate under state laws.
Until December 31, 1996, the Company also engaged in the trust deed foreclosure services business through three subsidiaries: Consolidated Reconveyance Company ("CRC"), Lenders Posting and Publishing Company ("LPPC") and Consolidated Reconveyance Corporation ("CRCWA"). The Company sold substantially all of the assets of CRC and LPPC and all of the stock of CRCWA as part of the Company's strategy to concentrate all of its financial and human resources on its primary business of residential lending for securitization.
The Company's main offices are located at 21031 Ventura Boulevard, Woodland Hills, California 91364. Its telephone number is (818) 992-8999.
1997 Stock Split Effected by Means of a Stock Dividend
On August 13, 1997, the Company paid a one-for-one stock dividend to all stockholders of record on July 31, 1997, having the effect of a two-for-one stock split. All share and per share data reported herein reflects the one-for-one stock dividend.
1996 Corporate Restructuring
The Company commenced its operations in 1981 as a California limited partnership under the name Presidential Mortgage Company (the "Partnership"). On June 27, 1996, the Company and the Partnership completed a restructuring plan (the "Restructuring"), pursuant to which all of the assets and liabilities of the Partnership were transferred to the Company in exchange for shares of Common Stock of the Company. As a result of the Restructuring, 1,206,468 shares of Common Stock were issued to partners of the Partnership for their interests in the Partnership and $2,855,600 was paid by the Company to partners electing a "cash out option." As part of the Restructuring, the Company also sold warrants to the general partner of the Partnership (the "General Partner Warrants"), each exercisable until December 27, 1997, for one share of Common Stock at an exercise price of $7.50 per share. Concurrently with the solicitation of consent of the partners for the Restructuring, the Company made a rights offering to the partners of the Partnership and certain other related persons of the Partnership (the "Rights Offering"), pursuant to which a total of 649,256 shares were subscribed for and issued at $5.00 per share and 129,850 warrants ("Subscriber Warrants") were issued to the subscribers, each exercisable until June 27, 1998, for one share of Common Stock at an exercise price of $6.25 per share. Concurrently with the Restructuring, the Company completed a public offering of an additional 1,756,420 shares of Common Stock at $5.00 per share (the "Public Offering").
Revised Business Strategy
Because of the sudden and severe changes in the secondary loan market which occurred in the third and fourth quarters of 1998 and the continued instability of the market through the first quarter of 1999, the Company has been required to substantially alter its business strategy from that followed prior to October 1998. The Company believes that borrower demand for subprime residential loans remains strong, and that the secondary loan market will eventually stabilize at prices higher than were generally available in the first quarter of 1999. During the current period of uncertainty, however, it is necessary to reduce expenses to the greatest extent possible without sacrificing loan quality or the franchise value of the existing retail operations. The Company has succeeded in reducing expenses over 48%, by closing five wholesale loan offices and 15 retail loan offices and reducing the number of its employees from 599 at September 30, 1998 to 215 at March 31, 1999. The Company now seeks to maximize its loan origination volume using its remaining 40 loan offices, through more focused direct mailing and telemarketing and renewed emphasis on self-generated loan originations through its existing loan representatives. In addition, the Company seeks to increase its revenues by increasing fee income on loans originated for sale.
The Company believes that the value of its operations is enhanced because of its ability to operate through Pacific Thrift. As an FDIC insured financial institution, Pacific Thrift can generate funds for lending activity by issuing FDIC-insured deposits and take advantage of favorable federal laws in the states in which it operates. However, because of the adverse changes in the secondary loan market, the Company has been unable to meet the capital requirements of the FDIC for "adequately capitalized" institutions, and is required to raise additional capital under the terms of a Cease and Desist Order issued by the FDIC on December 14, 1998 (the "1998 Order"). (See Item 1. Business -- Supervision and Regulation -- Regulatory Actions.) Under the terms of the 1998 Order, the Company has agreed to raise approximately $20 million, which is the amount of additional capital necessary for Pacific Thrift to become "well capitalized" by June 30, 1999. The Company is currently seeking to raise the additional capital necessary to meet the requirements of the Order, but there can be no assurance that the Company will be successful in raising additional capital. The 1998 Order also limits Pacific Thrift's lending volume to an amount which may readily be sold and prohibits securitization of loans, among other things.
The Company is also continuing to work with its financial adviser, Friedman, Billings, Ramsey & Co., Inc., to assist it in locating strategic partners or other opportunities. The Company intends to actively pursue strategic opportunities in 1999. There can be no assurance that any transactions will be completed by the Company either as a result of its engagement of Friedman, Billings, Ramsey & Co., Inc. or any other efforts to raise additional capital or enter into agreements with strategic partners.
Mortgage Loan Production
General
The Company has specialized in residential mortgage loans to borrowers underserved by traditional financial institutions since its formation in 1981. Until the Company began selling loans for securitization in late 1993, the Company generally originated loans to hold and service in its own loan portfolio. From 1994 through 1996, the Company steadily increased the volume of loans originated for sale and securitization and decreased the volume of loans originated for portfolio investment. In 1996, the Company determined to discontinue the origination of portfolio loans and concentrate all of its resources on increasing the volume of loans originated for sale and securitization. In the third quarter of 1998, the Company substantially discontinued loan securitization, and a majority of its loans have been sold for cash only since that time.
The Company historically originated the substantial majority of its loans through independent loan brokers. In 1996, the Company began developing a retail division, which had expanded to 47 offices by October 1998. Since closing of the wholesale division in October 1998, substantially all loans have been originated through the retail division. The retail division has averaged total loan originations of approximately $25 million per month since November 1, 1998. The following table sets forth the combined loan originations by category and purchases, sales and repayments for the past two years:
At or At or At or For the for the for the Year Ended Year Ended Year Ended December 31, December 31, December 31, 1998 1997 1996 ----------- ----------- ----------- (Dollars in Thousands)
Beginning Balance $ 55,909 $ 51,662 $ 56,485 Loans Originated for Sale . Wholesale ............ 662,006 584,527 292,116 Retail ............... 273,084 183,699 43,355 Junior loans .............. 21,651 -0- -0-
Portfolio Loans originated -0- -0- 37,987 Loans purchased ........... -0- -0- -0- ----------- ----------- ----------- Total (1).................. 1,012,650 819,888 429,943 Less: Principal repayments ............. (2,326) (1,053) (12,388) Sales of loans originated for sale (917,318) (742,776) (337,563) Sales of portfolio loans ......... (8,530) (17,063) (26,176) Transfers of REO net of reserves . (904) (2,936) (3,945) Other net changes(2) ............. (1,314) (151) 1,791 ----------- ----------- ----------- Total loans(1) ............ $ 82,258 $ 55,909 $ 51,662 =========== =========== ===========
(1) Includes loans held for sale.
(2) Other net changes includes changes in allowance for loan losses, deferred loan fees, loans in process and unamortized premiums and discounts.
Geographic Diversity
Prior to 1994, the Company conducted lending operations exclusively in California. For the last four years, the Company has steadily expanded operations throughout the United States. At March 15, 1998, the Company operated 40 retail loan offices in 21 states and the District of Columbia, including 6 in California; 8 in the western states of Colorado, Nevada, Arizona, Utah, Washington and Minnesota; 12 in the mid-Atlantic states of Pennsylvania, Maryland, Virginia,
Delaware, New Jersey and the District of Columbia; 3 in the northeastern states of New York, Connecticut and New Hampshire; and 11 in the mid-western states of Ohio, Michigan, Wisconsin, Kentucky, Illinois and Indiana.
Underwriting
The following is a description of the current underwriting guidelines customarily employed by the Company with respect to the origination of home equity mortgage loans. The Company's underwriting guidelines may change from time to time as management of the Company deems appropriate.
The Company views its underwriting process as one that begins with the marketing of its products and includes each function involved in the lending activity through the ultimate loan funding. As an integral part of this process, the Company trains its telemarketing representatives, account executives, account managers, loan processors, and underwriters to evaluate each loan request relative to the Company's underwriting guidelines and overall lending philosophy. Such philosophy is to evaluate the merits of each loan application on a case-by-case basis in accordance with the Company's underwriting guidelines. On occasion, such an evaluation leads the Company to approve a loan application that does not completely meet the guidelines. Conversely, the Company occasionally rejects a loan application that does meet the guidelines.
The Company believes that its underwriting guidelines (which are revised from time to time) are consistent with those generally used by lenders in the business of making subprime mortgage loans. The underwriting process is intended to assess both the prospective borrower's ability to repay and the adequacy of the real property as collateral for the loan. The Company's guidelines require an analysis of the value of and equity in the collateral, the property type, the payment history of the borrower and the borrower's ability to repay debt.
As presented in the following table, the Company's guidelines permit the origination of mortgage loans with multi-tiered credit characteristics tailored to individual credit profiles.
Charge-offs, Collections and Judgments. Collections, Charge-offs and Judgments under $500 are not to be considered. All judgments that appear as a lien of record against the subject property must be paid through the loan. The date of the original occurrence of the collection is to be used in all credit.
- -------------------- (1) Loan cannot be upgraded to receive maximum LTV. (2) Will allow 5% increase in D/R (not to exceed 60%) for a corresponding 5% reduction in LTV. (3) Max LTV is 90%. (4) Not available for "fixed" income borrowers or wage earners with less than "B" final grade. * For 2nd homes & vacation properties reduce maximum LTV by 5%. Maximum CLTV for second mortgages may not exceed 85%.
The final grade for a loan is determined by blending the mortgage credit grade and the consumer credit grade using a credit blending table. In addition, a final grade of B or C (as determined by the credit blending table) is eligible for a one credit class upgrade through the Company's upgrade matrix. The upgrade matrix takes into account such compensating factors as property condition, length of employment and length of property ownership.
The Company's guidelines permit the origination of fixed or adjustable rate loans that generally amortize over a period not to exceed 30 years. In addition to adjustable rate loans with interest rates that adjust on a quarterly basis throughout the term of the loans, the Company offers loans with fixed rates for the first two or three years, which automatically convert to adjustable rates after the initial fixed rate period. These loans are generally referred to as 2/28 or 3/27 loans. Loan amounts generally range from a minimum of $20,000 to a maximum of $350,000 unless a higher amount is specifically approved by senior management of the Company. The average loan size of loans originated during 1998 was approximately $98,000.
The collateral securing the loans may be either owner-occupied or non-owner-occupied one-to-four family dwellings, which includes condominiums, townhouses, manufactured housing, and occasionally second and vacation homes. Substantially all of the loans secured by first mortgages are limited to a maximum loan-to-value ratio of 90%, and substantially all of the loans secured by second mortgages are limited to a combined maximum loan-to-value ratio of 85%.
In order to determine the loan-to-value ratio, all home equity loans require at least one recent written appraisal on a current Federal National Mortgage Association ("FNMA") or Federal Home Loan Mortgage Corporation ("FHLMC") form with certain supporting information (e.g., location maps, legal descriptions, sale and listing histories, floor plans, and photographs) from a state licensed appraiser. Properties with higher appraised values ($650,000 in California and Hawaii, $500,000 elsewhere) require a second appraisal. All appraisals are required to contain at least three recently closed sales of comparable properties located near the subject property. The Company's appraisal review department reviews each appraisal for reasonableness, completeness, conformity with the Company's guidelines and acceptable property condition. If the internal review department believes there is insufficient information or data to perform the review internally, the appraisal is outsourced to an independent review appraisal company. The Company intends to continually monitor the quality of both its internal and external appraisal reviews with follow-up additional reviews on a percentage of loan appraisals. The Company's underwriting guidelines require that any major deferred maintenance on any property securing a loan be cured either by the applicant prior to loan closing or the amount to cure will be withheld from the proceeds of the loan until such deferred maintenance is completed.
A credit report combining information from two separate independent credit reporting agencies is required reflecting the applicant's complete credit history. If the report is obtained more than 60 days prior to the loan closing, the Company will obtain an updated credit report to determine whether or not the reported information has changed in a materially negative way, in which case such loan will be reunderwritten.
The Company's underwriting guidelines provide for the origination of loans under three general income documentation programs: (i) full documentation, (ii) alternate documentation, and (iii) stated income. Under the full documentation program the Company obtains one of the following: (i) Verification of Employment signed by the employer and the most recent paycheck stub showing year to date income; (ii) IRS Form W-2 for the most recent two-year period and the most recent paycheck stub showing year-to-date income; (iii) individual tax returns for the most recent two years and the most recent paycheck stub showing year-to-date income; or (iv) personal bank statements for the most recent 24-month period and the most recent paycheck stub showing year-to-date income. For each of the above, the Company obtains telephone verification of employment. If the applicant is self-employed, the two most recent years' applicable tax returns (Form 1040, 1120, 1120S or 1065) are required. Under the alternative documentation program, applicants are required to submit six months of personal bank statements, a recent paycheck stub showing year-to-date income and the Company obtains telephone verification of employment. For self-employed borrowers, proof that the business has been in existence for at least one year is required. Under the stated income program, income is taken from the application as stated by the applicant and employment or business is verified telephonically.
Exceptions to the Company's underwriting guidelines can only be approved by senior underwriters, managers or higher level of senior management. Where exceptions are made on loan-to-value or debt-to-income ratios, such exceptions are generally limited to no more than 2%.
The Company's guidelines require title insurance coverage issued by an approved title insurance company on each mortgage loan. The Company and its assignees are named as the insured. Title insurance policies guarantee the lien position of the loan and protect the insured against loss if the title or lien position is not as indicated.
The following table sets forth selected information relating to loan originations for sale and securitization during the three years ended December 31, 1998 (portfolio loans which are not originated for sale and "piggyback loans" which are held for sale are not included):
Quality Control
The Company's quality control program monitors and improves the overall quality of loan production. Sample loan files are reviewed on a regular basis to assure the accuracy of all credit information, the compliance with appraisal standards, the compliance with employment and income verification requirements and the accuracy of legal documents. Any inaccuracies or inadequacies are corrected, and the internal audit department reports its findings to senior management of the Company on a quarterly basis.
Loan Sales and Securitizations
Since 1995, the Company has originated mortgage loans primarily for sale and securitization. Prior to the fourth quarter of 1996, the Company sold substantially all of its loans for a cash premium, with no continuing interest in the loans after sale. In the fourth quarter of 1996, the Company began retaining an interest-only strip receivable in the securitization trusts to which its loans were sold, under agreements with Aames Capital Corporation ("Aames") and Advanta Mortgage Conduit Services, Inc. ("Advanta"). In the fourth quarter of 1997 and the first and second quarters of 1998, the Company sponsored three of its own securitizations through Merrill Lynch, Pierce, Fenner & Smith ("Merrill"). In the third quarter of 1998, the Company determined to resume selling loans for cash only. In the later half of 1998, the Company has sold all loans for cash except for approximately $60 million of loans which were securitized under the Company's existing agreement with Advanta in October and November 1998. In the aggregate, the Company securitized $551 million of loans and sold $366 million of loans for cash in 1998, compared to $727 million of loans securitized and $16.0 million sold for cash in 1997.Gain on sale of loans was $32.8 million, $81.7 million and $29.2 million for 1998, 1997 and 1996.
As of March 31, 1999, the Company held interest-only strips receivable in thirteen securitization trusts (the "Securitization Trusts"), including one formed by Aames in the fourth quarter of 1996, nine formed by Advanta in 1997, 1998 and the first quarter of 1999 and three sponsored by the Company (the "PAMM Trusts") in 1997 and 1998. Securities issued by each Securitization Trust are credit enhanced either through an insurance policy issued by a monoline
insurer or through over-collateralization. The securities issued to investors in each of the Securitization Trusts were rated "AAA" by Standard & Poor's Ratings Group and "AAA" by Moody's Investor Service, Inc. Each of the Aames and Advanta Securitization Trusts holds loans sold by the Company as well as loans originated or purchased by Aames or Advanta. However, the Company's interest-only strip receivable in each of these Securitization Trusts is dependent primarily upon the performance of the loans originated by the Company and held by each of these Securitization Trust. All loans sold for cash or securitization have been sold on a nonrecourse basis, except for the obligation to repurchase any loan which does not meet certain customary representations and warranties, and the obligation to repurchase loans adversely affected by any breach of general representations and warranties. The Company is named as master servicer for loans held by the PAMM Trusts, and Advanta has been appointed Sub-Servicer. Advanta provides substantially all servicing related to the loans in the PAMM Trusts. Aames and Advanta are the servicers of the loans in the Securitization Trusts each of them has sponsored.
To the extent that the Company or one of its subsidiaries originates loans for sale, it bears an interest rate risk between the loan approval date and the date that each loan is sold. However, loans are generally sold on a monthly basis, which reduces the risk of interest rate fluctuations. Loans which are held for sale during the period prior to sale are accounted for at the lower of cost or market value of such loans.
In 1998 and 1997 the Company adjusted the fair value of interest-only strips receivable down by $38,300,000 and $2,306,000 (see Note 6 to Financial Statements included under Item 14 of Part IV).
Loan Portfolio
Until Pacific Thrift began originating loans for sale in 1994, both the Partnership and Pacific Thrift originated loans primarily for their own loan portfolios, and generally held and serviced those loans until payoff or refinancing. In 1995, the Company stopped all portfolio lending. The Company does currently originate small second trust deed loans made to facilitate marketing of loans originated for sale (referred to as "piggy-back loans"). While a majority of these loans are sold in bulk loan sales, a portion of these loans are held and serviced by the Company. As of December 31, 1998, the aggregate balance of all portfolio loans held by the Company was approximately $9.4 million, net of loan loss reserves. All portfolio loans are secured primarily by one-to-four family residential, multi-family residential and commercial real property. The characteristics of the Company's remaining loan portfolio at December 31, 1998, are described below.
Geographic Concentration. At December 31, 1998, the Company's loan portfolio included loans geographically distributed, based on principal loan balances, approximately 81% in Southern California (south of San Luis Obispo), 13% in Northern California and the remaining 6% in other states, primarily Washington and Oregon. The Company's portfolio loan policy limits the total dollar amount of loans and total number of loans made in each zip code area to no more than 5% of its total outstanding loans.
Collateral. At each of the dates set forth below, the gross loan portfolio of the Company (net of reserves for loan losses) was collateralized by the following types of real property:
PORTFOLIO COLLATERAL
Loan Origination and Underwriting. Each portfolio loan made by the Company, other than "piggyback" loans as described below, was analyzed at origination based on the loan applicant's credit history and repayment ability, using the Company's then existing underwriting guidelines. Portfolio loans generally required credit histories from independent credit reporting companies, proof of income and independent appraisal reports of the value of the mortgaged property.
Piggyback loans meet the same credit and documentation requirements as the companion senior loans originated for sale, except that loan-to-value ratios are usually 5% higher than the loan-to-value ratios allowed by the purchaser of the senior loans. To compensate for the higher loan-to-value ratios, the Company provides higher general reserves for piggyback loans. From time to time, the Company sells piggyback loans to third party purchasers. During 1998, the Company sold $28 million of piggyback loans at 79.4% of par value. During 1997, the Company sold $5.7 million of piggyback loans at par value. During 1996, the Company sold $5.5 million of piggyback loans, of which $3.8 million were sold for a discount of approximately 1% of par value and $1.7 million were sold at par value. As of December 31, 1998, the Company held 604 piggyback loans, with an aggregate principal balance of $4.3 million.
Maturities and Rate Sensitivities of Loan Portfolio. The following table sets forth the contractual maturities of the loan portfolio at December 31, 1998.
PORTFOLIO LOAN MATURITIES
The following table sets forth, as of December 31, 1998, the dollar amounts of loans receivable (not including loans held for sale) that are contractually due after December 31, 1999 and whether such loans have fixed or adjustable interest rates:
PORTFOLIO LOANS
Due after December 31, 1999 ------------------------------------ Fixed Adjustable Total ------------------------------------ (In thousands) One- to four-family ............... $1,292 $2,272 $3,564 Multi-family ...................... -- 1,769 1,769 Commercial ........................ 884 2,739 3,623 Home improvement .................. 812 -0- 812 ------ ------ ------ Total loans receivable ............... $2,988 $6,780 $9,768 ====== ====== ======
The Company generally rewrites a portfolio loan at maturity if the borrower makes a new loan application. In cases where the loan-to-value ratio has declined on an existing loan and no longer meets the applicable loan-to-value guidelines, the Company will generally rewrite the loan.
A substantial portion of the Company's loan portfolio is repriced, pays off or matures approximately every year. Of the 28% of all loans bearing fixed rates at December 31, 1998, 1% were due in one year or less. Based upon these facts, over 72% of the loan portfolio at December 31, 1998, consisted of either variable rate loans or fixed rate loans which mature within one year. Management therefore expects that within one year, approximately 72% of the loan portfolio will be paid off or reprice at the rate in effect on the existing loan at the time the loan is repriced or the then applicable rate for new or refinanced loans.
The initial interest rate on variable rate portfolio loans is set as of the date of origination of each loan based upon the then prevailing reference rate established by Bank of America. The rate may increase by not less than .125% in any three-month period, but may not increase by more than five (10 in some cases) percentage points in the aggregate. Such increases (or decreases, as the case may be) occur at three-month intervals as the result of changes in the Bank of America reference rate. Although the interest rate may decrease, it cannot decrease below the original interest rate set for each loan.
Classified Assets and Loan Losses
The Company's general policy is to discontinue accrual of interest and make a provision for anticipated loss on a loan when: (i) it is two or more payments contractually past due and the current estimated loan-to-value ratio is 80% or more; or (ii) the loan exhibits the characteristics of an in-substance foreclosure, generally including any loan as to which the borrower does not have the ability, willingness or motivation to repay the loan. The current estimated loan-to-value ratios of substantially all delinquent loans are determined by new independent appraisal or broker price opinions, unless an independent appraisal was obtained no more than twelve months prior to the monthly review of each delinquent loan. When a loan is reclassified from accrual to nonaccrual status, all previously accrued interest is reversed. Interest income on nonaccrual loans is subsequently recognized when the loan resumes payment or becomes contractually current as appropriate. Loans which are deemed fully or partially uncollectible by management are generally fully reserved or charged off for the amount that exceeds the estimated net realizable value (net of selling costs) of the underlying real estate collateral. Gains on the sale of real estate acquired in settlement of loans ("REO") are not recognized until the close of escrow.
Unless an extension, modification or rewritten loan is obtained, or a bankruptcy is filed, the Company's policy is to commence procedures for a non-judicial trustee's sale within 30 to 60 days of a payment delinquency on a loan under the power of sale provisions of the trust deed securing such loan, as regulated by applicable law. A delinquent loan will only be rewritten or extended if it can be determined that the borrower has the ability to repay the loan on the modified terms. The initiation of foreclosure proceedings against a borrower does not suggest that the recovery of the loan is dependent solely on the underlying collateral. In fact, many borrowers bring payments current or undertake other remedies so that a foreclosure sale is not required.
The determination of the adequacy of the allowance for loan losses is based on a variety of factors, including loan classifications and underlying loan collateral values, and the level of nonaccrual loans. Therefore, changes in the amount of nonaccrual loans will not necessarily result in increases in the allowance for loan losses. The ratio of nonaccrual portfolio loans
past due 90 days or more to total portfolio loans was 21.83% at December 31, 1998, 4.96% at December 31, 1997, and 3.81% at December 31, 1996. The ratio of the allowance for loan losses to nonaccrual loans past due 90 days or more was 37.68% at December 31, 1998, 130.14% at December 31, 1997 and 176.76% at December 31, 1996.
The following table sets forth the number and remaining balances of all loans in the Company's loan portfolio (net of specific reserves for loan losses) that were more than 30 days delinquent at December 31, 1998, 1997 and 1996.
PORTFOLIO LOAN Delinquencies
Nonaccrual and Restructured Loans. The following table sets forth the aggregate amount of loans at December 31, 1998, 1997 and 1996 which were (i) accounted for on a nonaccrual basis; (ii) accruing loans which are contractually past due 90 days or more as to principal and interest payments; and (iii) troubled debt restructurings, which are defined in SFAS 15 as loans modified to reduce interest rates below market rates, to reduce amounts due at maturity, to reduce accrued interest or to loan additional funds.
PORTFOLIO LOAN Non Accruals and Restructurings
The following table sets forth information concerning interest accruals and interest on nonaccrual loans past due 90 days as of December 31, 1998, 1997 and 1996.
PORTFOLIO LOAN INTEREST Due on Delinquent Loans
Upon request of a borrower, the Company generally grants one to two month extensions of payments during the term of a loan. In 1998, one loan with a principal balance of approximately $60,000 was extended for a term not exceeding six months, and two loans with an aggregate principal balance of approximately $300,000 were modified. There were no delinquent loans rewritten. The Company applies the same documentation standards on a rewritten loan as on an original loan, and makes these accommodations only if it can be determined that the borrower has the ability to repay the loan on the modified terms. In general, this determination is made based upon a review of the borrower's current income, current debt to income ratio, or anticipated sale of the collateral.
At December 31, 1998, the Company held REO (net of specific reserves) of approximately $200,000. In accordance with the policy for recognizing losses upon acquisition of REO, the Company charges off or posts specific reserves for those portions of the loans with respect to which REO has been acquired to the extent of the difference between the loan amount and the estimated fair value of the REO. Included in REO at December 31, 1998 were two commercial properties with an aggregate net book value of approximately $200,000. For the year ended December 31, 1998, total expenses on operation, including valuation allowances, and losses on sale of REO were $0.3 million and gains on sale of REO and REO income were $0.2 million, for a total expense of $0.1 million. There can be no assurance that net losses on the sale of REO will not be experienced in the future.
Allowance for Loan Losses. The following is a summary of the changes in the consolidated allowance for loan losses of the Company for each of the years ended December 31, 1998, 1997 and 1996:
PORTFOLIO LOANS Reserve for Loan Losses
At or for the Years Ended December 31, ---------------------------------------- 1998 1997 1996 (In thousands) ---------------------------------------- Balance at beginning of period........ $1,438 $ 2,464 $ 4,229 Provision for loan losses............. 1,314 3,087 1,151 Transferred to loans held for sale.... -0- (1,902) -0- Chargeoffs............................ (1,888) (2,211) (3,187) Recoveries............................ -0- -0- 271 -------- --------- --------- Balance at end of period.............. $ 864 $ 1,438 $ 2,464 ======== ======== ========
Pacific Thrift uses an asset classification system pursuant to which every delinquent loan and every performing loan which exhibits certain risk characteristics is graded monthly, and a general reserve percentage is assigned to each classification
level. Management of the Company also reviews every delinquent loan on a monthly basis and reviews the current estimated fair market value of the property securing that loan. To the extent that the amount of the delinquent loan exceeds the estimated fair market value of the property, an additional reserve provision is made for that loan.
Pacific Thrift's current policy is to maintain an allowance for loan losses equal to the amount determined necessary based upon Pacific Thrift's asset classification policy, which is written to conform with generally accepted accounting principles and FDIC requirements. PacificAmerica Money Center's current policy is to maintain an allowance for loan losses determined in accordance with generally accepted accounting principles.
Management utilizes its best judgment in providing for possible loan losses and establishing the allowance for loan losses. However, the allowance is an estimate which is inherently uncertain and depends on the outcome of future events. In addition, regulatory agencies, as an integral part of their examination process, periodically review Pacific Thrift's allowance for loan losses. Such agencies could require Pacific Thrift, just as any other FDIC-insured institution, to post additions to the allowance based upon their judgment of the information available to them at the time of their examination.
Implicit in lending activities is the fact that losses will be experienced and that the amount of such losses will vary from time to time, depending upon the risk characteristics of the portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense. The conclusion that a loan may become uncollectible, in whole or in part, is a matter of judgment.
Investment Activities
Pacific Thrift maintains an investment portfolio which is used primarily for liquidity purposes and secondarily for investment income. Pacific Thrift's policy is to invest cash in short-term U.S. government securities or federal funds sold due in less than 30 days. Overnight federal funds sold are limited to no more than 100% of total capital at any single financial institution that is either adequately or well capitalized. If the financial institution is neither adequately nor well capitalized, the limit is $100,000. As of December 31, 1998, Pacific Thrift held $38 million in federal funds sold due in an overnight federal reserve account and approximately $3.6 million in deposits with a bank.
Sources of Funds Deposits
Pacific Thrift's major source of funds is FDIC-insured deposits, including passbook savings accounts, money market accounts and investment certificates (similar to certificates of deposit). Pacific Thrift attracts customers for its deposits by offering rates that are slightly higher than rates offered by large commercial banks and savings and loans. Pacific Thrift had no brokered deposits as of December 31, 1998. Management believes its deposits are a stable and reliable funding source. At December 31, 1998, Pacific Thrift had outstanding 3,373 deposit accounts of approximately $162 million.
The following table sets forth the average balances and average rates paid on each category of Pacific Thrift's deposits for the three years ended December 31, 1998.
Deposit Analysis
The following schedule sets forth the time remaining until maturity for all certificates at December 31, 1998, 1997 and 1996.
Deposit Maturities
Other Borrowings
The Company has in the past utilized lines of credit and warehouse financing to finance its lending operations. In 1996 and the first part of 1997, the Company completed the final pay off of a bank credit line which in 1990 reached a peak borrowing of $82 million. In October 1997, the Company began using warehouse financing provided by Merrill Lynch pending securitization of loans by the Company through Merrill Lynch. This warehouse financing was paid off by December 31, 1998, and the Company is not currently using warehouse financing.
The Company has also obtained advances from Aames, Advanta and Merrill Lynch on the interest-only strips receivable held by the Company in each of the Securitization Trusts, as further described below.
The Company obtained an advance from Aames secured by the Company's interest in the Aames 1996- D Trust. The advance is repaid from cash flow on the Company's interest-only strips receivable. As of December 31, 1998, the Company owed a balance of approximately $1.9 million on the advance from Aames, which bears interest at 12.5% per annum. The loan is due in December 1999. The Company currently anticipates that a portion of the advance will be repaid with cash flow from the Aames 1996-D Trust by the maturity date of the advance, but that additional cash flow anticipated in 2000 will be necessary to fully repay the advance. No arrangements have yet been made with Aames for extension of the maturity date. (See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Certain Accounting Considerations.").
Until the advance is fully repaid, the Company will not be entitled to receive cash flow for its interest in the Aames 1996-D Trust.
The Company obtained advances from Advanta on each of the nine Advanta Trusts. All of these advances are non-recourse, and are payable solely from cash flow on the Company's interests in each of the Advanta Trusts. Cash flow is applied to repay advances from Advanta in accordance with the terms of an amortization schedule of between 36 and 48 months, as applicable to each Advanta Trust. As of December 31, 1998, the Company owed an aggregate balance of approximately $30 million (excluding accrued interest of $2.5 million), on the advances from Advanta, which bear interest at rates of between LIBOR plus 1% and LIBOR plus 2% per annum. Any advance which has not been fully repaid after 48 months from cash flow on the applicable Advanta Trust may be paid from cash flow from any other Advanta Trust.
The Company obtained warehouse financing for loans sold to the PAMM Trusts in 1997 and 1998 under a Master Repurchase Agreement with affiliates of Merrill Lynch. The full remaining balance owed by the Company under this agreement was repaid as of December 31, 1998. Because of the reduction of its lending activities in the third quarter of 1998, the Company currently has no need for warehouse loan financing.
The Company obtained advances from Merrill Lynch on each of the three PAMM Trusts under the terms of a Master Assignment Agreement with an affiliate of Merrill Lynch. The advances are secured by the Company's interest-only strips in the PAMM Trusts. At December 31, 1998, the Company owed a principal amount of $18.4 million under this agreement, bearing interest at a weighted average rate of approximately 7.5% (LIBOR plus 2.5% as of that date). Under the terms of the Master Assignment Agreement, each advance is due in one year unless extended pursuant to the mutual agreement of the Company and Merrill Lynch. In addition, the Company is required to make mandatory prepayments under the Master Assignment Agreement in the event that the interest-only strips assigned to Merrill Lynch experience a decline in value from the levels established at the time of the advance. Merrill Lynch requested the Company to make a payment of $2 million in October 1998 on the total amount owed under the Master Assignment Agreement. The initial advance of $4.8 million under the agreement matured in December 1998, $6.1 million matured in March 1999, and $7.5 million is scheduled to mature in June 1999. The Company notified Merrill Lynch in November 1998 that it would be unable to make principal or interest payments as they became due, and proposed a debt repayment schedule, with payments derived from anticipated cash flow on the Company's interest-only strips receivable in the PAMM Trusts. This plan was based on anticipated cash flows beginning in January 1999 and continuing without interruption. Merrill Lynch advised the Company in December 1998 that it did not at that time intend to exercise any of its rights other than to require that cash flow payments on the PAMM Trust interest-only strips receivable be made directly to Merrill Lynch. Merrill Lynch further indicated at that time a general willingness to discuss a repayment plan; however, in March 1999, the Company and Merrill Lynch were advised that cash flow payments would be suspended on the one PAMM Trust which had begun distributions of cash flow, because loan delinquencies had exceeded certain trigger levels provided for in the indenture agreement for that PAMM Trust. Until the loan delinquency levels on that PAMM Trust are reduced, all distributions that would otherwise be made on the interest-only strip receivable will be deposited into the reserve account for that PAMM Trust. As a result, no cash flow is currently being paid to Merrill Lynch. The Company and Merrill Lynch are currently reviewing possible actions to reduce the delinquency level on the PAMM 1997-1 Trust which would allow a resumption of cash flow distributions to Merrill Lynch. Until Merrill Lynch and the Company have some assurance as to the level of cash flow that can be expected over the near term, it is doubtful that a mutually acceptable payment plan can be agreed to between the parties. The Company has not received any further indication from Merrill Lynch of its intended course of action with respect to the debt owed, but there can be no assurance that Merrill Lynch will not exercise one or more of its rights, including a sale of the interest-only strips in the PAMM Trusts, unless an agreement can be reached on a repayment plan and distributions of cash flow on the interest-only strips in the PAMM Trusts are resumed as a source of payment to Merrill Lynch.
In October 1998, while the Company was engaged in acquisition discussions with Fremont General Corporation ("Fremont"), the Company received a $3.0 million loan from Fremont. The proceeds of the loan were used to repay Merrill Lynch $2.0 million under the Master Assignment Agreement and $1.0 million to pay operating and other expenses of the Company. The loan was originally due and payable six months after
termination of merger discussions with Fremont, but Fremont has extended the loan maturity until January 8, 2000. The loan is secured by a pledge of 100% of the stock of Pacific Thrift.
Competition
The Company faces significant competition for the origination and selling of home equity mortgage loans from consumer finance companies, mortgage banking companies and other subprime lenders. Many of these companies are substantially larger and have considerably greater financial, technical and marketing resources than the Company. In addition, many other financial services organizations have formed national loan origination networks offering loan products that are substantially similar to the Company's loan programs. Factors influencing consumer decisions to choose one lender over another include convenience, customer service, marketing and distribution channels, amount and term of the loan, loan origination fees and interest rates. Increases in competition may result in lower rates charged to borrowers, which could lower gain on future loan sales and securitizations. Fluctuations interest rates and general economic conditions may also affect competition in the consumer finance industry. During periods of rising rates, competitors that have locked in low borrowing costs may have a competitive advantage. During periods of declining rates, competitors may solicit the Company's customers to refinance their loans.
The Company also faces competition in connection with the sale of its loans in the secondary loan market. Prior to the third quarter of 1998, the Company had not experienced difficulty in selling its loans, but recent market changes has reduced the number of loan purchasers, as well as a reduction in the prices offered for loans sold. Many of the companies selling loans are substantially larger and have greater financial resources than the Company. The Company believes that its record of loan quality is a positive factor in attracting purchasers of its loans. However, the adverse conditions currently affecting the Company, including regulatory actions and the status of its loan with Merrill Lynch, have had an adverse effect on the Company's ability to sell loans to some purchasers.
Pacific Thrift faces competition for depositors' funds from other thrift and loans, banks, savings and loans and credit unions. Pacific Thrift does not offer checking accounts, travelers' checks or safe deposit boxes and thus has a competitive disadvantage to commercial banks and savings associations in attracting depositors seeking these services. Pacific Thrift's lower costs, however, enable it to compensate for the lack of a full array of services by offering slightly higher interest rates for deposits than most large banks and savings and loans, which are not, however, higher than prevailing rates at other small savings and loan associations and thrift and loans.
Employees
During 1998, the Company and its subsidiaries reached a peak of 640 full-time employees, including 261 commission-based loan representatives. As a result of the closure of the wholesale loan division in October 1998 and additional layoffs, as of December 31, 1998 the Company and its subsidiaries had 234 full-time employees, including 83 commission-based loan representatives.
Supervision and Regulation
Financial and lending institutions are extensively regulated under both federal and state law. Set forth below is a summary description of the principal laws which relate to the regulation of Pacific Thrift and PAMC. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.
Consumer Protection Laws
Pacific Thrift and PAMC are subject to numerous federal and state consumer protection laws, including the Federal Truth-In-Lending Act, the Federal Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Federal Fair Debt Collection Practices Act and the Federal Reserve Board's Regulations B and Z. These laws and regulations, among other things, limit certain finance charges, fees and other charges on loans, require
certain disclosures be made to borrowers and loan applicants, regulate the credit application and evaluation process and regulate certain servicing and collection practices. These laws and regulations impose specific liability upon lenders who fail to comply with their provisions, and may give rise to defense to payment of a borrower's obligation in the event of a failure to comply with certain applicable laws. Pacific Thrift and PAMC believe they are currently in compliance in all material respects with all applicable laws, but there can be no assurance that they or any other financial institution will be able to maintain such compliance. The failure to comply with such laws, or a determination by a court that their interpretation of law was erroneous, could have a material adverse effect on Pacific Thrift or PAMC.
State Law
PAMC
PAMC is currently a licensed lender in 11 states, and currently operates in four states. The lending laws of some states have certain interest and fee limitations, disclosure and loan document requirements and penalties for failure to meet these requirements. PAMC reviews the applicable lending laws of each state prior to commencement of business in the state and regularly monitors changes in the lending laws of all states in which it conducts business.
Pacific Thrift
Pacific Thrift is subject to regulation, supervision and examination under its California thrift and loan license by the Department of Financial Institutions ("DFI") which regulates all banks, savings and loans, thrift and loans, and credit unions chartered by the State of California. The California Industrial Loan Law and the rules and regulations of the DFI regulate interest rates, fees, collateral requirements, payment terms and maturities of the various types of loans that are permitted to be made by California-licensed thrift and loan companies. The majority of these limitations, however, apply to loans under $10,000.
A thrift and loan generally may not make any loan to, or hold an obligation of, any of its directors, officers or any shareholder holding 10% or more of its shares, or any director or officer or any shareholder holding 10% or more of the shares of its holding company or affiliates, except in specified cases and subject to regulation by the DFI. A thrift and loan may not make any loan to, or hold an obligation of, any of its shareholders or any shareholder or its holding company or affiliates. There are currently no outstanding loans made by Pacific Thrift to any officers or directors of the Company or any of its affiliates. Any person who wishes to acquire 10% or more of the capital stock of a California thrift and loan company or 10% or more of the voting capital stock or other securities giving control over management of its parent company must obtain the prior written approval of the DFI.
A thrift and loan is subject to certain leverage limitations which are not generally applicable to commercial banks or savings and loan associations. In particular, thrift and loans may not have outstanding at any time investment certificates that exceed 20 times paid-up and unimpaired capital and surplus. Under California law, thrift and loans that desire to increase their leverage must meet specified minimum standards for liquidity reserves in cash, loan loss reserves, minimum capital stock levels and minimum unimpaired paid-in surplus levels. As approved by the DFI, Pacific Thrift can currently operate with a ratio of deposits to unimpaired capital and unimpaired surplus of up to 15:1. At December 31, 1998, Pacific Thrift's deposit ratio was 12.7:1.
Thrift and loan companies are not permitted to borrow, except by the sale of investment or thrift certificates, in an amount exceeding 300% of tangible net worth, surplus and undivided profits, without the DFI's prior consent. All sums borrowed in excess of 150% of tangible net worth, surplus and undivided profits must be unsecured borrowings or, if secured, approved in advance by the DFI, and be included as investment or thrift certificates for purposes of computing the maximum amount of certificates a thrift and loan may issue. However, collateralized Federal Home Loan Bank advances are excluded for this test of secured borrowings and are not specifically limited by California law. Pacific Thrift had no borrowed funds (other than deposits) at December 31, 1998.
Under California law, thrift and loan companies are generally limited to investments, other than loans, that are legal investments for commercial banks. A thrift and loan company may acquire real property only in satisfaction of debts previously contracted, pursuant to certain foreclosure transactions or as may be necessary for the transaction of its business, in which case such investment, combined with all investments in personal property, is limited to one-third of a thrift and loan's paid-in capital stock and surplus not available for dividends.
Although investment authority and other activities that may be engaged in by Pacific Thrift generally are prescribed under the California Industrial Loan Law, certain provisions of Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") may limit Pacific Thrift's ability to engage in certain activities that otherwise are authorized under the California Industrial Loan Law.
Federal Law
Pacific Thrift's deposits are insured by the FDIC to the full extent permissible by law. As an insurer of deposits, the FDIC issues regulations, conducts examinations, requires the filing of reports and generally supervises the operations of institutions for which it provides deposit insurance. Among the numerous applicable regulations are those issued under the Community Reinvestment Act of 1977 ("CRA") to encourage insured state nonmember banks, such as Pacific Thrift, to meet the credit needs of local communities, including low and moderate income neighborhoods, consistent with safety and soundness, and a rating system to measure performance. Inadequacies of performance may result in regulatory action by the FDIC. Pacific Thrift received a satisfactory rating with respect to its CRA compliance in its most recent FDIC compliance examination completed in November 1995.
Pacific Thrift is subject to the rules and regulations of the FDIC to the same extent as all other state banks that are not members of the Federal Reserve System. The approval of the FDIC is required prior to any merger, consolidation or change in control, or the establishment or relocation of any branch office of Pacific Thrift. This supervision and regulation is intended primarily for the protection of the deposit insurance funds.
Under provisions of FDICIA and regulations issued by the FDIC, additional limitations have been imposed with respect to depository institutions' authority to accept, renew or rollover brokered deposits. Pacific Thrift does not have any brokered deposits as of the date hereof.
Pacific Thrift is subject to certain capital adequacy guidelines issued by the FDIC. See "Federal Law --Capital Adequacy Guidelines" under this heading.
Regulatory Actions
On April 1, 1996, Pacific Thrift entered into a Memorandum of Understanding ("MOU") with the FDIC and DOC. The 1996 MOU provided that Pacific Thrift was required to (i) maintain Tier I capital of not less than 8% of total assets (ii) maintain an adequate reserve for loan losses (iii) eliminate assets classified "loss" as of September 30, 1995, reduce assets classified "substandard" as of September 30, 1995 to not more than $4,000,000 within 180 days, and reduce all assets classified substandard, doubtful and loss to no more than 50% of capital and reserves by September 30, 1996; (iv) obtain FDIC approval before opening additional offices; (v) develop strategies to stabilize net interest margin on portfolio loans and develop procedures to implement those strategies; and (vi) furnish written quarterly progress reports.
On March 9, 1998, the 1996 MOU was replaced with a new MOU (the "1998 MOU") between Pacific Thrift and the FDIC. The 1998 MOU required Pacific Thrift: (i) continue to maintain Tier 1 capital of not less than 8.0% of total assets; (ii) by July 7, 1998, have and thereafter maintain risk-based capital of not less than 10.0% of total assets; (iii) maintain a fully funded loan loss reserve; (iv) by March 19, 1998, eliminate assets classified "loss" as of June 30, 1997, and by September 5, 1998, reduce assets classified "substandard" to $4 million; (v) by June 7, 1998, reduce and thereafter maintain the amount of interest-only strip receivables, net of tax liabilities, to no more than 100% of total capital; (vi) by June 7, 1998, obtain an independent valuation of interest-only strip receivables, and
thereafter obtain an annual independent valuation of such receivables until they represent no more than 50% of Tier 1 capital; (vii) by June 7, 1998, and thereafter quarterly, perform valuations and cash flow analyses on the interest-only strip receivables; (viii) by May 8, 1998, eliminate and/or correct certain transactions between the Company and Pacific Thrift and develop, adopt, and implement a written policy governing the relationship between the Company & Pacific Thrift (ix) by June 7, 1998, revise, adopt and implement a written asset/liability management policy to include risk tolerance levels for income and annual independent audits of Pacific Thrift's interest rate risk process; (x) pay no cash dividends without prior written FDIC approval; (xi) pay no executive or director bonuses without prior written FDIC approval; (xii) by June 7, 1998, submit a strategic plan covering the period 1998 through 2000 reflecting restricted growth of the interest-only strip receivable; and (xiii) by May 15, 1998, and thereafter at the end of each quarter, furnish written progress reports.
On November 6, 1998, Pacific Thrift entered into a stipulation and consent to an order issued by the California Department of Financial Institutions (the "DFI"), under which Pacific Thrift agreed: (i) that it will not issue loan commitments without having a clearly identified and reasonably assured source of funds, such as deposits, loan sale commitments or other financing, with which to fund its loans; (ii) that it will not make any shareholder distributions except with the prior written approval of the DFI; and (iii) that it will discontinue selling loans under conduit loan sale arrangements through its parent company. The DFI Order is currently in effect, and management believes that Pacific Thrift is currently in compliance with all of the terms of the DFI order.
On November 23, 1998, the Federal Deposit Insurance Corporation ("FDIC") issued a prompt corrective action directive against Pacific Thrift (the "PCA Directive"). The PCA Directive required that: (i) Pacific Thrift sell enough voting shares or obligations on or before December 31, 1998 to be adequately capitalized after the sale; (ii) that Pacific Thrift accept an offer to be acquired by a depository institution holding company or to combine with another insured depository institution if notified in writing by the FDIC that one or more grounds exist for appointing a conservator or receiver for Pacific Thrift; (iii) that Pacific Thrift restrict the interest rates that it pays on deposits to the prevailing rates of interest on deposits of comparable amounts and maturities; (iv) that Pacific Thrift comply with Section 23A of the Federal Reserve Act as if subsection (d) (1) of that section did not apply; (v) that Pacific Thrift not commit to fund any loan until such time as Pacific Thrift or its parent has in place a formal written committed loan production warehousing line of credit; (vi) that Pacific Thrift not permit its average total assets, or its average total deposits, during any calendar month to exceed its average total assets, or its average total deposits, during the preceding calendar month; (vii) that Pacific Thrift shall not establish or operate any branch without FDIC approval or any loan production office without prior approval of the DFI; (viii) that Pacific Thrift not make any distributions to its parent or any affiliate or pay any bonuses or increase the compensation of any director or officer of Pacific Thrift. Certain provisions of the PCA Directive are not consistent with the 1998 Order (as described below), but the FDIC has advised that it does not intend to seek enforcement of the PCA Directive as long as the provisions of the 1998 Order are complied with.
On December 14, 1998, Pacific Thrift entered into a stipulation and consent to an order issued by the FDIC (the "1998 Order") which replaced the 1998 MOU. Under the 1998 Order, Pacific Thrift has agreed: (i) to have and retain qualified management to operate its regulated business; (ii) to achieve, by January 31, 1999, and thereafter maintain, Tier 1 capital equal to or in excess of 8.0 percent of its total assets, and to achieve, by June 30, 1999, and thereafter maintain, Tier 1 risk-based capital of no less than 6.0 percent and total risk-based capital of no less than 10.0 percent; (iii) to maintain an adequate allowance for loan losses; (iv) to take the following steps with regard to its interest-only strips receivables: (a) by June 30, 1999, reduce the amount of the receivable as a percentage of total capital to no more than 100%; (b) not acquire or book any additional interest-only strips receivable without the consent of the FDIC; and (c) obtain quarterly and annual independent valuations of the existing interest-only strips receivable; (v) to prepare and submit a written two-year business/strategic plan; (vi) to discontinue selling loans under conduit loan sale arrangements through its parent company and, by February 27, 1999, to develop a plan for Pacific Thrift to directly achieve all of the benefits of prior intercompany conduit loan sales; (vii) by February 27, 1999, to develop a revised written asset/liability management policy specifically addressing interest rate risks associated with the mortgage banking business; (viii) not to pay cash dividends or distributions without the prior written consent of the FDIC; (ix) not to enter into any executive compensation and/or bonus agreements without prior approval of the FDIC; (x) to develop and
implement a written policy for all intercompany transactions with affiliates; (xi) to furnish a description of the Order to its shareholder; and (xii) to furnish written quarterly progress reports detailing actions taken to comply with the Order. The 1998 Order is currently in effect, and Pacific Thrift is taking action to comply with the terms of the Order by the dates specified.
On March 1, 1999, Pacific Thrift entered into a stipulation and consent to an order issued by the FDIC related to Year 2000 readiness (the "Year 2000 Order"). Under the Year 2000 Order, Pacific Thrift has agreed: (i) to designate an executive officer as the institution's Year 2000 Officer, who shall have authority to engage the services of a consultant who possesses the experience and qualifications necessary to achieve Year 2000 readiness and prepare the institution for contingencies that may arise relating to the Year 2000; (ii) by March 26, 1999, develop and adopt a plan for achieving Year 2000 readiness; (iii) by April 15, 1999, develop and implement a remediation contingency plan setting forth the institution's alternative plans to assure continuity of operations in the event the institution must retain Year 2000 ready replacement mission-critical systems, suppliers, hardware or software from other alternate sources; (iv) by June 30, 1999, develop a business resumption contingency plan setting forth the institution's plans to mitigate risks associated with the failure of its systems at critical dates; (v) by no later than June 30, 1999, have in place mission-critical systems that are Year 2000 ready, including a written determination by the institution that the mission-critical systems have been tested successfully; (vi) for as long as the order is in effect, acquire or contract for the use of electronic information systems, hardware, operating systems, and applications software only if such hardware, systems, and software have been successfully tested for Year 2000 readiness prior to use by the institution; (vii) by April 10, 1999, perform due diligence reviews to determine whether the Year 2000 readiness procedures of its service providers and software vendors, and the time frames for implementation of those procedures, are adequate and by March 31, 1999, implement an internal testing or verification process, and complete such testing by June 30, 1999; (viii) by March 21, 1999, amend the institution's internal and external audit policies to require periodic audits of the institution's Year 2000 Plan and its implementation; (ix) provide monthly status reports to the Board of Directors and the FDIC detailing the institution's progress in implementing the Year 2000 Plan.
Restrictions on Transfers of Funds to Affiliates by Pacific Thrift
There are statutory and regulatory limitations on the amount of dividends which may be paid to the Company by Pacific Thrift. Under California law, a thrift and loan is not permitted to declare dividends on its capital stock unless it has at least $750,000 of unimpaired capital plus additional capital of $50,000 for each branch office maintained. In addition, no distribution of dividends is permitted unless: (i) such distribution would not exceed a thrift's retained earnings; or, (ii) in the alternative, after giving effect to the distribution, (a) the sum of a thrift's assets (net of goodwill, capitalized research and development expenses and deferred charges) would be not less than 125% of its liabilities (net of deferred taxes, income and other credits), or (b) current assets would be not less than current liabilities (except that if a thrift's average earnings before taxes for the last two years had been less than average interest expenses, current assets must not be less than 125% of current liabilities).
In addition, a thrift and loan is prohibited from paying dividends from that portion of capital which its board of directors has declared restricted for dividend payment purposes. The amount of restricted capital maintained by a thrift and loan provides the basis of establishing the maximum amount that a thrift may lend to a single borrower and determines the amount of capital that may be counted by the thrift for purposes of calculating the thrift to capital ratio. Pacific Thrift has, in the past, restricted as much capital as necessary to support its level of assets. The board of directors of Pacific Thrift may unrestrict all or any portion of its equity in the future for dividends to the Company, provided that Pacific Thrift remains adequately capitalized.
The FDIC also has authority to prohibit thrift and loans from engaging in what, in the FDIC's opinion, constitutes an unsafe or unsound practice in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the FDIC could assert that the payment of dividends or other payments might, under some circumstances, be such an unsafe or unsound practice. Further, the FDIC has established guidelines with respect to the maintenance of appropriate levels of capital by banks under their jurisdiction. Compliance with the standards set forth in such guidelines and the restrictions that are or may be
imposed under the prompt corrective action provisions of the FDICIA could limit the amount of dividends which Pacific Thrift may pay to the Company. See "Capital Standards" under this heading for a discussion of these additional restrictions on capital distributions.
Thrift and loans are subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, the Company or other affiliates, the purchase of or investments in stock or other securities thereof, the taking of such securities as collateral for loans and the purchase of assets of the Company or other affiliates. Such restrictions prevent the Company and other affiliates from borrowing from Pacific Thrift unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by Pacific Thrift to or in the Company or to or in any other affiliate is limited to 10% of Pacific Thrift's capital and surplus (as defined by federal regulations) and such secured loans and investments are limited, in the aggregate, to 20% of Pacific Thrift's capital and surplus (as defined by federal regulations). In addition, any transaction with an affiliate of Pacific Thrift must be on terms and under circumstances that are substantially the same as a comparable transaction with a non-affiliate. Additional restrictions on transactions with affiliates may be imposed on thrift and loans, under the prompt corrective action provisions of FDICIA.
Capital Standards
The Federal Reserve Board and the FDIC have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a depository institution's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans.
A depository institution's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which includes off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists primarily of common stock, retained earnings, noncumulative perpetual preferred stock (cumulative perpetual preferred stock for bank holding companies) and minority interests in certain subsidiaries, less most intangible assets. Tier 2 capital may consist of a limited amount of the allowance for possible loan and lease losses, cumulative preferred stock, long term preferred stock, eligible term subordinated debt and certain other instruments with some characteristics of equity. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%.
In addition to the risk-based guidelines, federal banking regulators require depository institutions to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a depository institution rated in the highest of the five categories used by regulators to rate depository institutions, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all depository institutions not rated in the highest category, the minimum leverage ratio must be at least 100 to 200 basis points above the 3% minimum, or 4% to 5%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios.
In January 1995, the federal banking agencies issued a final rule relating to capital standards and the risks arising from the concentration of credit and nontraditional activities. Institutions which have significant amounts of their assets concentrated in high risk loans or nontraditional banking activities and who fail to adequately manage these risks, will be required to set aside capital in excess of the regulatory minimums. The federal banking agencies have not imposed any quantitative assessment for determining when these risks are significant, but have identified these issues as important factors they will review in assessing an individual bank's capital adequacy.
The federal banking agencies interagency policy statement on the allowance for loan and lease losses establishes certain benchmark ratios of loan loss reserves to classified assets. The benchmark set forth by such policy statement is the sum of (a) assets classified loss; (b) 50% of assets classified doubtful; (c) 15% of assets classified substandard; and (d) estimated credit losses on other assets over the upcoming 12 months.
Federally supervised banks and savings associations are currently required to report deferred tax assets in accordance with SFAS No. 109. The federal banking agencies limit the amount of deferred tax assets that are allowable in computing an institution's regulatory capital. Deferred tax assets that can be realized for taxes paid in prior carryback years and from future reversals of existing taxable temporary differences are generally not limited. Deferred tax assets that can only be realized through future taxable earnings are limited for regulatory capital purposes to the lesser of (i) the amount that can be realized within one year of the quarter-end report date, or (ii) 10% of Tier 1 Capital. The amount of any deferred tax in excess of this limit would be excluded from Tier 1 Capital and total assets and regulatory capital calculations. Management believes that Pacific Thrift is in compliance with these requirements.
The following table presents the capital ratios for Pacific Thrift, as of December 31, 1998, compared to the regulatory capital requirements for adequately capitalized and well capitalized institutions.
December 31, 1998 --------------------------------------- Well Actual Adequately Capitalized Ratio Capitalized Requirement ----- ----------- ----------- Leverage ratio................ 6.9% 4.0% 5.0%(1) Tier 1 risk-based ratio....... 3.2% 4.0% 6.0% Total risk-based ratio........ 3.6% 8.0% 10.0%(1)
(1) Pursuant to the 1998 Order, Pacific Thrift is required to maintain a minimum 8.0% leverage ratio and by June 30, 1999, to reach and thereafter maintain a 10.0% total risk-based capital ratio.
Prompt Corrective Action and Other Enforcement Mechanisms
Federal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The law required each federal banking agency to promulgate regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.
In September 1992, the federal banking agencies issued uniform final regulations implementing the prompt corrective action provisions of federal law. An insured depository institution generally will be classified in the following categories based on capital measures indicated below:
"Well capitalized" "Adequately capitalized" ------------------ ------------------------ Total risk-based capital of 10%; Total risk-based capital of 8%; Tier 1 risk-based capital of 6%; and Tier 1 risk-based capital of 4%; and Leverage ratio of 5%. Leverage ratio of 4% (3% if the institution receives the highest rating from its primary regulator)
"Undercapitalized" "Significantly undercapitalized" ------------------ -------------------------------- Total risk-based capital less Total risk-based capital less than 8%; than 6%; Tier 1 risk-based capital less Tier 1 risk-based capital less than 4%; or than 3%; Leverage ratio less than 4% (3% if or Leverage ratio less than 3%. the institution receives the highest rating from its primary regulator)
"Critically undercapitalized" ----------------------------- Tangible equity to total assets less than 2%.
An institution that, based upon its capital levels, is classified as "well capitalized," "adequately capitalized" or "undercapitalized" may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat an institution as "critically undercapitalized" unless its leverage capital ratio actually warrants such treatment.
The law prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. If an insured depository institution is undercapitalized, it will be closely monitored by the appropriate federal banking agency, subject to asset growth restrictions and required to obtain prior regulatory approval for acquisitions, branching and engaging in new lines of business. Any undercapitalized depository institution must submit an acceptable capital restoration plan to the appropriate federal banking agency 45 days after becoming undercapitalized. The appropriate federal banking agency cannot accept a capital plan unless, among other things, it determines that the plan (i) specifies the steps the institution will take to become adequately capitalized, (ii) is based on realistic assumptions and (iii) is likely to succeed in restoring the depository institution's capital. In addition, each company controlling an undercapitalized depository institution must guarantee that the institution will comply with the capital plan until the depository institution has been adequately capitalized on an average basis during each of four consecutive calendar quarters and must otherwise provide adequate assurances of performance. The aggregate liability of such guarantee is limited to the lesser of (a) an amount equal to 5% of the depository institution's total assets at the time the institution became undercapitalized or (b) the amount which is necessary to bring the institution into compliance with all capital standards applicable to such institution as of the time the institution fails to comply with its capital restoration plan. Finally, the appropriate federal banking agency may impose any of the additional restrictions or sanctions that it may impose on significantly undercapitalized institutions if it determines that such action will further the purpose of the prompt correction action provisions.
An insured depository institution that is significantly undercapitalized, or is undercapitalized and fails to submit, or in a material respect to implement, an acceptable capital restoration plan, is subject to additional restrictions and sanctions. These include, among other things: (i) a forced sale of voting shares to raise capital or, if grounds exist for appointment of a receiver or conservator, a forced merger; (ii) restrictions on transactions with affiliates; (iii) further limitations on interest rates paid on deposits; (iv) further restrictions on growth or required shrinkage; (v) modification or termination of specified activities; (vi) replacement of directors and/or senior executive officers; (vii) prohibitions on the receipt of deposits from correspondent institutions; (viii) restrictions on capital distributions by the holding companies of such institutions; (ix) required divestiture of subsidiaries by the institution; or (x) other restrictions as determined by the appropriate federal banking agency. Although the appropriate federal banking agency has discretion to determine which of the foregoing restrictions or sanctions it will seek to impose, it is required to force a sale of voting shares or merger, impose restrictions on affiliate transactions and impose restrictions on rates paid on deposits unless it determines that such actions would not further the purpose of the prompt corrective action provisions. In addition, without the prior written approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to its senior executive officers or provide compensation to any of them at a rate that exceeds such officer's average rate of base compensation during the 12 calendar months preceding the month in which the institution became undercapitalized.
Further restrictions and sanctions are required to be imposed on insured depository institutions that are critically undercapitalized. For example, a critically undercapitalized institution generally would be prohibited from engaging in any material transaction other than in the ordinary course of business without prior regulatory approval and could not, with certain exceptions, make any payment of principal or interest on its subordinated debt beginning 60 days after becoming critically undercapitalized. Most importantly, however, except under limited circumstances, the appropriate federal banking agency, not later than 90 days after an insured depository
institution becomes critically undercapitalized, is required to appoint a conservator or receiver for the institution. The board of directors of an insured depository institution would not be liable to the institution's shareholders or creditors for consenting in good faith to the appointment of a receiver or conservator or to an acquisition or merger as required by the regulator.
In addition to measures taken under the prompt corrective action provisions, commercial depository institutions may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease and desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.
Safety and Soundness Standards
In July 1995, the federal banking agencies adopted final guidelines establishing standards for safety and soundness, as required by FDICIA. The guidelines set forth operational and managerial standards relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. Guidelines for asset quality and earnings standards will be adopted in the future. The guidelines establish the safety and soundness standards that the agencies will use to identify and address problems at insured depository institutions before capital becomes impaired. If an institution fails to comply with a safety and soundness standard, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan or to implement an accepted plan may result in enforcement action.
The regulations of the federal banking agencies prescribe uniform guidelines for real estate lending. The regulations require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit secured by real estate. The policies must address loan portfolio management, underwriting standards and loan to value limits that do not exceed the supervisory limits prescribed by the regulations.
Appraisals for "real estate related financial transactions" must be conducted by either state certified or state licensed appraisers for transactions in excess of certain amounts. State certified appraisers are required for all transactions with a transaction value of $1,000,000 or more; for all nonresidential transactions valued at $250,000 or more; and for "complex" 1-4 family residential properties of $250,000 or more. A state licensed appraiser is required for all other appraisals. However, appraisals performed in connection with "federally related transactions" must now comply with the agencies' appraisal standards. Federally related transactions include the sale, lease, purchase, investment in, or exchange of, real property or interests in real property, the financing or refinancing of real property, and the use of real property or interests in real property as security for a loan or investment, including mortgage-backed securities.
Premiums for Deposit Insurance
Pacific Thrift's deposit accounts are insured by the FDIC generally up to a maximum of $100,000 per separately insured depositor, and Pacific Thrift, like all FDIC-insured institutions, is subject to FDIC deposit insurance assessments. Pursuant to FDICIA, the FDIC adopted a risk-based system for determining deposit insurance assessments under which all insured institutions were placed into one of nine categories and assessed annual insurance premiums, ranging from $2,000 to 0.27% of insured deposits, based upon their level of capital and supervisory evaluation. Because the FDIC sets the assessment rates based upon the level of assets in the insurance fund, premium rates rise and fall as the number and size of bank failures increases and decreases, respectively. Under the system, institutions are assigned to one of three capital groups which is based solely on the level of an institution's capital - "well capitalized," "adequately capitalized" and "undercapitalized" - which
are defined in the same manner as the regulations establishing the prompt corrective action system under Section 38 of FDIA, as discussed in "-- Capital Standards." These three groups are then divided into three subgroups which reflect varying levels of supervisory concern, from those which are considered to be of minimal supervisory concern to those which are considered to be of substantial supervisory concern.
Community Reinvestment Act and Fair Lending Developments
Pacific Thrift, just as all other federally regulated banking institutions, is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act ("CRA") activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of their local communities, including low and moderate income neighborhoods. In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities. The FDIC rated Pacific Thrift "satisfactory" in complying with its CRA obligations as of the most recent examination date of November 1995.
Potential Enforcement Actions
Insured depository institutions, such as Pacific Thrift, and their institution-affiliated parties, which include the Company, may be subject to potential enforcement actions by the FDIC and the DFI for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by either agency or any written agreement with either agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits and with respect to Pacific Thrift and the Company, could also include the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the imposition of restrictions and sanctions under the prompt corrective action provisions of FDICIA.
Item 2.
Item 2. Properties
The Company's corporate headquarters are located at 21031 Ventura Boulevard, Woodland Hills, California 91364, where the Company leases approximately 20,000 square feet of office space. The lease expires on July 31, 2003. The Company also leases approximately 22,000 square feet of office space in Walnut Creek, California, where its Wholesale Division was headquartered, under leases which expire between July 1998 and November 2000, with the largest lease, for 14,000 square feet, expiring November 14, 2000. In addition, the Company leases approximately 28,000 square feet of office space in Irvine, California, where the Company's Retail Loan operations are headquartered, under a lease which expires on January 31, 2004. The Company also leases offices for its 40 current and 11 former retail branch offices which are located in 24 states. The average size of these retail branch offices is approximately 750 square feet, with an annual average base rent of approximately $16,800, generally with terms of 18 months or less. The Company has subleased approximately 12,500 square feet of office space in its Walnut Creek facility and is seeking to sublease an additional 9,500 square feet of the Walnut Creek facility, approximately 14,000 square feet of the Irvine facility and the 11 offices that it has closed since October 1998 as a result of the closing of the Wholesale Lending division and additional cost reduction actions. The Company believes its existing facilities are sufficient to support its current and planned levels of operations.
Item 3.
Item 3. Legal Proceedings
Except as described below, the Company is not currently a party to any litigation other than legal proceedings related to collection actions on loans receivable. The Company and its subsidiaries are regularly involved in collection actions incidental to the lending business. Some of these actions seek unspecified damages or substantial monetary damages in the form of punitive damages. The ultimate outcome of such litigation cannot presently be determined. Management, after review and consultation with counsel, and based upon historical experience with prior actions, has determined that it is unlikely that the outcome of any proceedings currently
pending against the Company would have a material adverse impact on the Company's business, financial condition, results of operations or cash flows.
On March 12, 1999, Pacific Thrift and Loan was served with a lawsuit filed by Aames Financial Corporation in Los Angeles Superior Court concerning loans sold to Aames on a whole loan basis between December 1993 and September 1996. The complaint alleges very generally, and without specific reference to any particular loans, that the loans sold by Pacific Thrift did not meet various representations and warranties made by Pacific Thrift at the time the loans were sold. The complaint further alleges that Aames has lost more than $15 million as a result of the failure of these unspecified loans to meet unspecified representations and warranties. As of the date of this report, Pacific Thrift has not filed a response to the complaint or conducted any discovery regarding the allegations made in the complaint.
Management believes that there is no basis for any of the allegations for several reasons. First, in spite of the provisions of the loan sale agreements which allow Aames to demand that Pacific Thrift repurchase loans which did not meet representations and warranties, Aames has previously requested that Pacific Thrift repurchase only $1.1 million of loans in five years, which is less than one-half of 1% of the total amount of loans sold to Aames. Second, Aames has never previously identified to Pacific Thrift any problem loans other than those few loans Aames has previously requested be repurchased. Third, substantially all of the loans sold to Aames were written to Aames' own underwriting guidelines specifically for sale to Aames. Fourth, Aames reviewed in detail and approved every loan file for every loan originated for sale to Aames prior to loan funding. Fifth, Pacific Thrift had an independent review appraiser, selected from a list of appraisers approved by Aames, review every appraisal for every loan originated for sale to Aames. For these reasons, management of Pacific Thrift has no reason to believe that there is any merit to the complaint.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of stockholders during the fourth quarter of 1998.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
From June 1996 until February 26, 1999, the Company's Common Stock traded under the symbol PAMM on the Nasdaq National Market. The Common Stock was delisted from the Nasdaq National Market on February 26, 1999 because the trading price of the Common Stock was less than $1 per share and the market value of public float was less than $5 million. The Common Stock is currently traded on the OTC Bulletin Board. The following table sets forth the range of high and low sale prices. All share prices have been adjusted to reflect the two-for-one stock split in the form of a stock dividend effected on August 13, 1997.
High Low ---- ---
---- Third Quarter $ 11.125 $ 6.500
Fourth Quarter 16.000 10.875
---- First Quarter 17.000 14.000
Second Quarter 16.375 12.000
Third Quarter 27.250 15.500
Fourth Quarter 29.500 15.000
---- First Quarter 26.000 16.000
Second Quarter 23.000 14.500
Third Quarter 14.875 3.500
Fourth Quarter 7.500 0.4375
On March 31, 1999, the closing sale price for the Common Stock reported on the OTC Bulletin Board was $0.50 per share.
As of March 22, 1999, there were approximately 2,150 shareholders of the Common Stock, including beneficial holders whose shares are held of record by brokerage firms and clearing agencies.
Dividend Policy
The Company has never paid a cash dividend on its Common Stock. The Company's ability to pay dividends is subject to restrictions set forth in the Delaware General Corporation Law. The Delaware General Corporation Law provides that a Delaware corporation may pay dividends either (i) out of the corporation's surplus (as defined in Delaware law), or (ii) if there is no surplus, out of the corporation's net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. However, pursuant to Section 2115 of the California General Corporation Law, under certain circumstances, certain provisions of the California General Corporation Law may be applied to foreign corporations qualified to do business in California, which may reduce the amount of dividends payable by the Company.
Since the Company derives a substantial amount of its revenues from Pacific Thrift, a California corporation, California law and FDIC regulations with respect to dividends have a substantial effect on the Company's ability to pay dividends. Under California law, a corporation is prohibited from paying dividends unless (i) the retained earnings of the corporation immediately prior to the distribution exceed the amount of the distribution; (ii) the assets of the corporation exceed 1-1/4 times its liabilities; or (iii) the current assets of the corporation exceed its current liabilities, but if the average pretax net earnings of the corporation before interest expense for the two years preceding the distribution was less than the average interest expense of the corporation for those years, the current assets of the corporation must exceed 1-1/4 times its current liabilities.
Item 6.
Item 6. Selected Consolidated Financial Data
Selected Consolidated Financial and Other Data
The following tables present selected consolidated financial and other data of the Company (or the Partnership for periods prior to June 27, 1996) as of and for each of the years in the five years ended December 31, 1998. The information below should be read in conjunction with, and is qualified in its entirety by, the more detailed information included elsewhere in this Report, including the Consolidated Financial Statements of the Company and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.
(1) Earnings per common share for the years ended December 31, 1996 and 1995 assumes the Restructuring (Note 1) took place at the beginning of the period and the Company was taxed for federal and state income tax purposes as a taxable corporation at a 42% effective tax rate. (2) Net of allowances for loan loss and deferred loan fees and costs, including loans held for sale. (3) Net interest margin represents net interest income divided by total average earning assets. (4) Efficiency ratio represents noninterest expense divided by noninterest income and net interest income.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the preceding Selected Financial Data and the Company's Financial Statements and the Notes thereto and the other financial data included elsewhere in this Report. The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements which always involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth below under the heading "Forward Looking Statements."
General
On June 27, 1996, the Company completed the Restructuring with the Partnership, which was accounted for as a change in legal organization but not in the enterprise of the Partnership. Therefore, the financial statements of the Company give effect to the Restructuring as a recapitalization of the Partnership into the Corporation. References to the Company in this Report refer to the financial condition and results of operations of the Partnership on a consolidated basis for all periods prior to June 27, 1996.
The Company, through its subsidiaries Pacific Thrift and PAMC, is engaged in the business of originating, purchasing and selling mortgage loans secured primarily by one-to-four family residences. The Company's primary source of revenue is the recognition of gains upon sale of loans. Most loans sold by the Company until the fourth quarter of 1996 were sold for a cash premium received on the date of sale. Between the fourth quarter of 1996 and the fourth quarter of 1998, the Company sold its loans for securitization under agreements providing that it would retain an interest-only strip receivable in each securitization pool in which the Company's loans were sold. The Company recognized gain from the sale of these loans as the present value of the interest-only strips receivable. See "Certain Accounting Considerations," below. Since December 1998, the Company has sold all of its loans on a cash-only, whole loan sale basis. The Company currently intends to continue selling loans for cash only.
Until the sale of the assets of CRC and LPPC and the stock of CRCWA as of December 31, 1996, the Company operated two business segments: the subprime residential mortgage lending business and the trust deed foreclosure services business. See Note 15 in the Notes to Consolidated Financial Statements. The Company's primary business has always been subprime residential mortgage lending, and in November 1996, the Company sold CRC, LPPC and CRCWA in order to devote all of its financial and human resources to its primary lending business. Since January 1, 1997, the Company has operated only its mortgage lending business.
Certain Accounting Considerations
Between the fourth quarter of 1996 and the fourth quarter of 1998, the Company sold loans for consideration consisting partly of interest-only strips receivable in securitization trusts. Interest-only strips receivable are recorded at their estimated fair value at the time of sale, based on the present value of the expected future cash flows. The Company estimates future cash flows from interest-only strips receivable utilizing assumptions that it believes are consistent with those that would be utilized by an unaffiliated third party purchaser. There is no active market for the sale of interest-only strips receivable, however, and there can be no assurance that the interest-only strips receivable could be sold to a third party purchaser for the fair value determined by the Company. In 1998 and 1997 the Company wrote down the fair value of interest-only strips receivable by $38,300,000 and $2,306,000 (see Note 6 to Financial Statements included under item 14 of Part IV).
The fair value of the Company's interest-only strips receivable is determined by using estimated discounted future cash flows taking into consideration current and estimated future prepayment rates and default experience. Future cash flows are computed as the excess of the weighted average coupon on the loans sold over the sum of: (1) the coupon on the senior interests, (2) the contracted servicing fee, (3) expected losses to be incurred on the portfolio of loans sold over the lives of the loans, (4) overcollateralization and (5) fees payable to the trustee, the loan servicer or subservicer and the monoline insurer. The present value calculation uses prepayment and default assumptions that market participants would be expected to use for similar financial instruments that are subject to prepayment, credit and interest rate risk. The cash flows expected to be received by the Company are then discounted at an interest rate that the Company believes an unaffiliated third-party purchaser would require as a rate of return on such a financial instrument. The carrying amount is considered to be a reasonable estimate of fair value. To the extent that actual future excess cash flows are different from
estimated excess cash flows, the fair value of the Company's interest-only strips receivable is adjusted quarterly with corresponding adjustments made to operations in that period.
In September 1998, the Company made a $19.2 million (net of tax benefit of $14.4 million) adjustment to the valuation of its interest-only strips receivable, reflecting the adoption of more conservative prepayment assumptions and a higher discount rate. The adjustment of the valuation in the interest-only strips receivable in part, due to the delay in the sale of the Company's loans during the third quarter 1998 was primarily due, to a chain reaction of events which caused significant and sudden changes in the securitization market late in the quarter. See "Item 1 -- Business".
During the third quarter of 1998, there was a moderate change in the performance of the Company's securitization pools, affecting primarily the Company's three oldest pools formed during the last quarter of 1996 and the first two quarters of 1997. That fact, coupled with the current unsettled nature of the securitization markets in general, led the Company to determine that it was necessary to adopt more conservative prepayment assumptions and a more conservative discount rate in the valuation of its interest-only strips receivable to reflect the higher risks perceived by the market for these types of assets. At the end of the third quarter of 1998, the Company increased its discount rate from 11% to 15% which it believes to be consistent with others in the industry.
The fair value of the Company's interest-only strips receivable is calculated using the "cash out" method of estimating future cash flows from the various mortgage trusts. The "cash out" method assumes that the cash flows deposited in the overcollateralization reserve for each securitization trust are not available until they are actually distributed to the Company.
In March 1999, the Company obtained an independent valuation and report of the interest-only strips receivable as of December 31, 1998, which determined fair values of the interest-only strips receivable using the discounted cash flow method of valuation. The fair value of the interest-only strips receivable reflected on the Statement of Financial Condition at December 31, 1998 is consistent with the results of that report. The following table compares the actual constant prepayment rates ("CPRs") through December 31, 1998 of each of the Company's Securitization Trusts with the model CPRs used to value interest-only strips recievable in those pools. Model CPRs are generally ramped up over a specified numeber of months after formation of each Securization Trust, and the later Trusts have not reached their full ramped-up CPR rate assumptions. The model CPRs astrisked below are the fully-ramped CPR rates for those pools which are currently in the ramp-up phase. CPR amounts are based on the models from the independent valuation.
COMPARISON OF ACTUAL CONSTANT PREPAYMENT RATES WITH MODEL CONSTANT PREPAYMENT RATES
Pool Securitization Actual Life- Model Description Date To-Date CPRs CPR - ------------- -------------- ------------- ------ AAMES 96-4 NOV 96 31.0% 29%
ADVANTA 97-1 FEB 97 25.6% 29%
ADVANTA 97-2 MAY 97 23.7% 30%
ADVANTA 97-3 AUG 97 22.8% 30%
ADVANTA 97-4 NOV 97 22.2% 29%
ADVANTA 98-1 MARCH 98 18.1% 29%
ADVANTA 98-2 JUNE 98 11.7% 29%*
ADVANTA 98-3 SEPT 98 10.2% 29%*
ADVANTA 98-4 NOV 98 N/A 29%*
ADVANTA 99-1 MARCH 99 N/A 29%*
PAMM 97-1 DEC 97 18.0% 29%*
PAMM 98-1 MARCH 98 15.3% 29%*
PAMM 98-2 JUNE 98 7.3% 29%*
* RAMPS TO THESE CPRs
The following table compares the actual annualized loan losses through December 31, 1998 for each of the Company's Securitization Trusts with the annual loss rate assumption used by the Company to value its interest-only strips receivable in those pools.
COMPARISON OF ACTUAL ANNUALIZED LOSSES WITH ANNUAL LOAN LOSS RESERVES
Actual Annual Pool Securitization Annualized Loan Loss Description Date Losses Reserve - ----------- -------------- ---------- --------- Aames 96-4 Nov 96 1.15% 1.00%
Advanta 97-1 Feb 97 0.40% 1.00%
Advanta 97-2 May 97 0.20% 1.00%
Advanta 97-3 Aug 97 0.13% 1.00%
Advanta 97-4 Nov 97 0.09% 1.00%
Advanta 98-1 March 98 0.00% 1.00%
Advanta 98-2 June 98 0.00% 1.00%
Advanta 98-3 Sept 98 0.00% 1.00%
Advanta 98-4 Nov 98 0.00% 1.00%
Advanta 99-1 March 99 n/a 1.00%
PAMM 97-1 Dec 97 0.05% 1.00%
PAMM 98-1 March 98 0.02% 1.00%
PAMM 98-2 June 98 0.00% 0.50%
It is possible that the assumptions used to determine fair value of the Company's interest-only strips receivable could change in the future, due to changes required by future accounting pronouncements, the general economy, adverse changes in the securitization market, and actual prepayment and default experience which vary from the assumed rates, which would require adjustments in the reported fair value of the interest-only strip receivable. As a result the actual cash flows received by the Company could differ significantly from the modeled cash flows using current assumptions. The estimated fair value of the Company's interest-only strips receivable are reviewed quarterly with required adjustments, if necessary, made to earnings in that period. The Company intends to obtain a quarterly third party valuation of its interest-only strips receivable as further assurance regarding the Company's valuation methodology.
The interest-only strips receivable held by the Company are accounted for under SFAS 115 "Accounting for Investments in Certain Debt and Equity Marketable Securities." As an interest-only strip receivable is subject to significant prepayment risk, and therefore has an undetermined maturity date, it cannot be classified as held to maturity. The Company has chosen to classify its interest-only strips receivable as trading securities. Based on this classification, the Company is required to mark these securities to estimated fair value with the accompanying increases or decreases in fair value being recorded as a component of gain on sale of loans. The determination of fair value is based on the previously mentioned valuation methodology, and the Company assesses fair value quarterly.
As the gain recognized in the year of sale discounts anticipated cash flows to determine the present value of the interest-only strips receivable, if the prepayment and loss rate assumptions prove to be accurate (which cannot be predicted with certainty), the cash flow actually received over the lives of the loans would exceed the gain on sale recognized at the time the loans were sold. Any additional unrealized gain on sale of loans would be recognized over the life of the loans securitized.
There can be no assurance that future performance of the above identified Securitization Trusts will be consistent relative to the Company's assumptions.
Financial Condition
At December 31, 1998 compared with December 31, 1997.
Total consolidated assets of the Company increased $22.3 million (9.8%) to $250.2 million at December 31, 1998 from $227.9 million at December 31, 1997. The increase resulted primarily from the increase in interest-only strips receivable and loans held for sale, partially offset by decreases in cash and cash equivalents, loans receivable and REO. Interest-only strips receivable, after a $34 million valuation writedown in fair value during 1998, increased $22.2 million (23.55%), to $116.6 million at December 31, 1998, from $94.4 million at December 31, 1997, reflecting securitization transactions done primarily in the first half of 1998. The valuation adjustment reflects the adoption of a more conservative prepayment assumption and a higher discount rate. See "Business -- Lending Activities - Loan Sales and Securitizations." Loans held for sale increased $37.5 million (106.4%), to $72.8 million at December 31, 1998, from $35.3 million at December 31, 1997. Cash and cash equivalents decreased $24.1 million (36.6%) to $41.8 million at December 31, 1998, from $65.9 million at December 31, 1997, due primarily to the increase in loans held for sale. Loans receivable decreased $11.2 million (54.2%) to $9.4 million from $20.6 million, due to the Company's decision to continue to sell portfolio loans throughout 1998. REO decreased $1.8 million (89.2%) to $0.2 million at December 31, 1997, from $2.0 million at December 31, 1997, due to the reduction in the Company's loan portfolio and sales of REO held during 1998.
Total liabilities increased $45.4 million (25.37%) to $224.9 million at December 31, 1998, from $179.5 million at December 31, 1997. The increase resulted from an increase in total thrift certificates payable and notes payable, partially offset by a decrease in the net deferred income tax liability. Total thrift certificates payable increased $29.8 million (22.5%), to $162.3 million from $132.5 million, reflecting increased issuance of thrift certificates to fund Pacific Thrift's lending operations. Notes payable increased $24.8 million (87.6%) to $53.1 million at December 31, 1998 from $28.3 million at December 31, 1997, reflecting advances received by the Company on interest-only strips receivable under arrangements with Advanta and Merrill Lynch, and a $3.0 million loan from Fremont Financial Corporation. (See "BUSINESS -- Lending Activities - Loan Sales and Securitizations. and "-- Other Borrowings.") The net deferred income tax liability decreased by $10.9 million to $1.2 million at December 31, 1998, from $12.1 million at December 31, 1997, primarily from the deferred income tax effect of the $34 million interest-only strips receivable valuation writedown.
Total stockholders' equity decreased $23.1 million, to $25.3 million at December 31, 1998, from $48.4 million at December 31, 1997, due to the consolidated net loss of $24.5 million in 1998 partially offset by the issuance of additional common stock of $1.4 million.
At December 31, 1997 compared with December 31, 1996
Total consolidated assets of the Company increased $117.7 million (106.8%) to $227.9 million at December 31, 1997 from $110.2 million at December 31, 1996. The increase resulted primarily from the increase in interest-only strips receivable, cash and cash equivalents and loans held for sale, partially offset by decreases in receivable for mortgage loans shipped, loans receivable, and REO. Interest-only strips receivable increased $82.7 million (706.8%), to $94.4 million
at December 31, 1997, from $11.7 million at December 31, 1996, reflecting a substantially higher volume of loans sold for securitization in 1997 and a full year of securitization transactions in which the Company retained residual interests. See "Business -- Lending Activities - Loan Sales and Securitizations." Cash and cash equivalents increased $57.5 million (668.6%) to $66.1 million at December 31, 1997, from $8.6 million at December 31, 1996, due to timing of payments for loan sales in December of each year. Loans held for sale increased $17.2 million (95.0%), to $35.3 million at December 31, 1997, from $18.1 million at December 31, 1996. A receivable for mortgage loan sales of $24.3 million was held at December 31, 1996 for a pool of loans sold to Advanta, which was paid in January 1997; no similar item was held at the end of 1997. Loans receivable decreased $12.9 million (38.5%) to 20.6 million from $33.5 million, due to the Company's strategic decision to cease portfolio lending in 1996 and sell portfolio loans to raise additional funds for its mortgage banking business. REO decreased $2.3 million (53.5%) to $2.0 million at December 31, 1997, from $4.3 million at December 31, 1996, due to the reduction in the Company's loan portfolio and sales of REO held during 1997.
Total liabilities increased $91.2 million (103.3%) to $179.5 million at December 31, 1997, from $88.3 million at December 31, 1996. The increase resulted from an increase in total thrift certificates payable, notes payable and deferred income tax liability. Total thrift certificates payable increased $51.5 million (63.6%), to $132.5 million from $81.0 million, reflecting increased issuance of thrift certificates to fund Pacific Thrift's lending operations. Notes payable increased $25.0 million (757.6%) to $28.3 million at December 31, 1997 from $3.3 million at December 31, 1996, reflecting advances received by the Company on interest-only strips receivable under arrangements with Advanta and Merrill Lynch. See "BUSINESS -- Lending Activities - Loan Sales and Securitizations." The deferred income tax liability increased by $12.1 million to $12.1 million at December 31, 1997, from $0 million at December 31, 1996, reflecting the deferral of the gains on sale. Accounts payable and accrued expenses increased $3.9 million (177.3%), to $6.1 million from $2.2 million, due primarily to the accrual of executive bonuses of $2.5 million, the Supplemental Employee Retirement Plan accrual of $.6 million and accrued interest on the residual financing note payable of $.7 million.
Total stockholders' equity increased $26.4 million, to $48.4 million at December 31, 1997, from $22.0 million at December 31, 1996, due to consolidated net income of $17.1 million in 1997 and net proceeds from exercise of General Partner and Subscriber Warrants of $9.3 million.
Results of Operations
Year Ended December 31, 1998 compared with Year Ended December 31, 1997
General
The Company reported a consolidated net loss of $24.5 million for 1998, a decrease of $41.6 million (243.3%) from net income of $17.1 million in 1997. The decrease from net income in 1997 to a net loss in 1998 is due primarily to a substantial decrease in gain on sale of loans in 1998, resulting from a $34 million writedown in interest-only strips receivable in the third quarter of 1998.
Interest Income and Expense
Net interest income before provision for loan losses decreased $3.8 million (73.1%), to $1.4 million for 1998 from $5.2 million for 1997. Total interest income increased $4.6 million (38.0%), to $16.7 million for 1998 from $12.1 million for 1997. Interest expense increased $8.3 million (120.3%), to $15.2 million for 1998 from $6.9 for 1997, due to increases in total outstanding thrift certificates and notes payable.
Provision for Loan Losses
The provision for loan losses decreased $1.8 million (57.4%), to $1.3 million for 1998 from $3.1 million for 1997. The decrease in the provision reflected the decrease in loans receivable.
The calculation of the adequacy of the allowance for loan losses is based on a variety of factors, including loan classifications and underlying loan collateral values, and is not directly proportional to the level of nonperforming loans. See "BUSINESS -- Classified Assets and Loan Losses."
Noninterest Income and Expense
Total noninterest income decreased $48.3 million (58.8%), to $33.8 million for 1998 from $82.1 million for 1997, reflecting a decrease in gain on sale of loans. Gain on sale of loans decreased $48.9 million (59.9%) to $32.8 million for 1998 from $81.7 million for 1997 due to a substantial write down in the interest-only strips receivable at the end of the third quarter of 1998. Total noninterest expense increased $14.8 million (27.1%) to $69.4 million for 1998 from $54.6 million for 1997. Salary and related benefits increased $4.7 million (15.9%) to $34.2 million in 1998 from $29.5 million in 1997, and general and administrative expenses increased $5.3 million (23.7%), to $27.7 million in 1998 from $22.4 million in 1997, because of expanded mortgage banking activities in the first three quarters of 1998. In the fourth quarter of 1998, the Company also incurred a restructuring charge of $3.5 million due to the closure of the wholesale loan division resulting in a workforce reduction of approxmately 300 employees and the impairment of certain long-lived assets. Occupancy expense increased $1.2 million (70.6%) to $2.9 million in 1998 from $1.7 million in 1997 due to increase in the number of wholesale and retail offices opened in 1998.
Income Taxes (Benefit)
Income tax benefit from continuing operations was $11.0 million for 1998, compared to a tax expense of $12.5 million for 1997, as a result of the $65 million decrease in income before income taxes, to a loss of $35.5 million for 1998 from income of $29.5 million for 1997.
Year Ended December 31, 1997 compared to Year ended December 31, 1996
General
The Company reported net income of $17.1 million for 1997, an increase of $12.9 million (307.1%) from $4.2 million in 1996, compared with a net loss of $1.7 million for 1995. The increase in net income is due primarily to a substantial increase in gain on sale of loans in 1997, resulting from a substantial increase in loan originations in 1997.
Interest Income and Expense
Net interest income before provision for loan losses decreased $1.3 million (20.0%), to $5.2 million for 1997 from $6.5 million for 1996. Total interest income increased $.2 million (1.7%), to $11.7 million for 1997 from $11.5 million for 1996. Interest expense increased $1.5 million (30.0%), to $6.5 million for 1997 from $5.0 for 1996, due to increases in total outstanding thrift certificates and notes payable.
Provision for Loan Losses
The provision for loan losses increased $1.9 million (158.3%), to $3.1 million for 1997 from $1.2 million for 1996. The increase in the provision was made to reflect an increase in the reserve for $8.4 million of piggyback loans reclassified as held for sale in December 1997 and sold in January 1998 at a discount of approximately 24%. As this discount was fully reserved at December 31, 1997, the effect was that the sale resulted in a nominal gain.
The calculation of the adequacy of the allowance for loan losses is based on a variety of factors, including loan classifications and underlying loan collateral values, and is not directly proportional to the level of nonperforming loans. See "BUSINESS -- Classified Assets and Loan Losses."
Noninterest Income and Expense
Total noninterest income increased $52.1 million (173.7%), to $82.1 million for 1997 from $30.0 million for 1996, reflecting an increase in gain on sale of loans. Gain on sale of loans increased $52.5 million (179.8%) to $81.7 million for 1997 from $29.2 million for 1996. Total noninterest expense increased $25.7 million (88.9%) to $54.6 million for 1997 from $28.9 million for 1996, due to expansion of the Company's mortgage banking business, which required the addition of more employees and office space. Salary and related benefits increased $14.9 million (102.1%) to $29.5 million in 1997 from $14.6 million in 1996, and general and administrative expenses increased $12.1 million (100.8%), to $24.1 million in 1997 from $12.0 million in 1996, because of expanded mortgage banking activities.
Income Taxes (Benefit)
Income tax expense from continuing operations was $12.5 million for 1997, compared to $1.7 million for 1996, as a result of the $23.1 million increase in income before income taxes, to $29.6 million for 1997 from $6.5 million for 1996.
Net Interest Income Analysis
The following table sets forth certain information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon. Average balances are calculated on a quarterly basis and nonaccrual loans have been included in interest-earning assets for the computations. Fee income on loans included in interest income and in the calculation of average yields was 0, $.2 million and $.3 million for the years ended December 31, 1998, 1997 and 1996, respectively.
Yields and Rates on Interest-earning Assets and Interest-bearing Liabilities
Interest income and interest expense can fluctuate widely based on changes in the level of interest rates in the economy. Pacific Thrift attempts to minimize the effect of interest rate fluctuations on net interest margins by matching as nearly as possible interest sensitive assets and interest sensitive liabilities. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Asset/Liability Management."
Net interest income can also be affected by a change in the composition of assets and liabilities, such as when higher yielding loans replace lower yielding loans. Net interest income is affected by changes in volume and changes in rates. Volume changes are caused by differences in the level of earning assets and interest-bearing liabilities. Rate changes result from differences in yields earned on assets and rates paid on liabilities.
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities due to changes in volume and interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume; (i.e., changes in volume multiplied by new rate) and (ii) changes in rate (i.e. changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume which cannot be segregated, have been allocated proportionately to changes due to volume and changes due to rate.
Liquidity and Capital Resources
The Company's primary operating cash requirements include the funding or payment of: (i) loan originations; (ii) fees and expenses incurred in connection with loan sales; (iii) income taxes; (iv) capital expenditures; and (v) other operating and administrative expenses. The Company generates cash flow from loan sales, and loans sold for
securitization, advances on interest-only strips receivable, deposits issued by Pacific Thrift used to fund its lending operations, whole loan sales, principal payments and interest income on portfolio loans, and sale of REO.
The Company obtained advances on interest-only strips receivable from Aames and Advanta as part of the securitization transactions with those entities, which are payable from the cash flow payments made on the interest-only strips receivable. The Company has also obtained advances on interest-only strips receivable in the PAMM Trusts under a Master Assignment Agreement. The Company is currently in default under the Master Assignment Agreement. In addition, the Company obtained a $3.0 million loan from Fremont Financial Corporation in April 1998, secured by all of the stock of Pacific Thrift, the maturity date of which has been extended to January 8, 2000. (See "Item 1. Business --Other Borrowings.")
Certificates of deposit which are scheduled to mature in one year or less from December 31, 1998 totaled $127.9 million. Based upon historical experience, management believes that a significant portion of such deposits will be renewed to the extent deemed desirable by management. In general, depositors have historically tended to renew deposits when the rates paid on such deposits remain competitive with rates offered by comparable financial institutions. From time to time in the past, management of Pacific Thrift intentionally took steps to reduce deposit renewals in order to reduce the total amount of deposits. These steps included reducing the interest rates offered on maturing deposits, declining to renew certain large deposits and redeeming certificates of deposit.
Pacific Thrift maintains minimum levels of liquid assets as required under the liquidity policy adopted by the board of directors of Pacific Thrift. The relationship between short-term liquid assets and total deposits at December 31, 1998 was 70.1%, which exceeded the 10% minimum established by the Board. At December 31, 1997 and 1996, the liquidity ratio was 68.0% and 49.8%, respectively.
The Company incurred a net loss of $24,488,000 during the year ended December 31, 1998 and has an accumulated deficit of $3,231,000 at December 31, 1998. Management believes these losses were reflective of the rapid change in marketplace demand for the purchase of sub-prime paper by the secondary market during the latter half of 1998. At December 31, 1998, the Company is in default of the repayment terms of its obligations related to its interest-only strips receivable (Note 8c to the financial statements included under item 14 for Part IV). In addition, Pacific Thrift was not "adequately capitalized" at the end of 1998 or by March 22, 1999 and became subject to certain regulatory mandates and sanctions (Note 13 to the financial statements included under item 14 for Part IV). Pacific Thrift also has additional regulatory mandates imposed relating to its Year 2000 readiness and the related Bank information systems (Notes 13 and 15 to the financial statements included under item 14 for Part IV). Failure to implement the regulatory mandates would expose Pacific Thrift to various regulatory actions, including the risk of regulatory takeover.
The Company's independent certified public accountants have included an explanatory paragraph in their report which indicates that these matters raise substantial doubt about the ability of the Company to continue as a going concern. Management's plans regarding these matters are as follows:
Management has taken and continues to take steps to return the Company to profitability and improve its financial condition, including such actions as the closure of Pacific Thrift's wholesale operations (Note 2Q to the financial statements included under item 14 for Part IV), an emphasis on originating residential real estate loans for sale under whole loan sale agreements for a cash premium through its retail division, a reduction in portfolio lending until targeted capital ratios are achieved, and reducing overhead expenses. Pacific Thrift has hired a consultant and submitted a revised Year 2000 plan to the regulators and believes it will be able to meet the guidelines of the order regarding Year 2000 (Note 13 to the financial statements included under item 14 for Part IV).
Management expects that Pacific Thrift will be profitable in 1999 and will comply to the greatest extent possible with the regulatory mandates. Management has submitted a Capital Restoration Plan (the Plan) which was approved by the FDIC. In addition to a revised business plan, the Plan includes restructuring debt to provide capital contributions to Pacific Thrift and raising capital through private or public offerings of debt or equity securities. Management is negotiating a restructuring of its obligations in default relating to its interest-only strips receivable. There is no assurance that management's plans can be achieved. The financial statements do not include any provisions or adjustments that might result from the outcome of these uncertainties.
Pacific Thrift is subject to certain leverage and risk-based capital adequacy standards applicable to FDIC-insured institutions. At December 31, 1998, Pacific Thrift was classified by the FDIC as "significantly undercapitalized." Pacific Thrift has filed a capital plan which has been approved by the FDIC, under the terms of which Pacific Thrift or the Company will seek to raise approximately $20 million in new capital, the amount necessary for Pacific Thrift to meet the capital requirements of the 1998 Order. See "SUPERVISION AND REGULATION -- Federal Law -- Capital Adequacy Guidelines."
The Company used $91.9 million net cash in operating activities in 1998, compared to $46.5 million in 1997 and $22.9 million in 1996, reflecting the funding of loans for securitization in 1998 and 1997. The increase in cash used in operating activities in 1998 reflects primarily the net loss of $24.5 million, nets increase in interest-only strips receivable of $22.9 million and an increase of loan originations over loan sales of $39.4 million. The Company used net cash from investing activities of $11.8 million in 1998, reflecting primarily sales of $8.5 million in portfolio loans and $2.7 million in sales of REO. The Company realized net cash from investing activities of $17.2 million in 1997, reflecting primarily a sale of $17.1 million in portfolio loans in 1997. The Company used net cash from investing activities of $1.8 million in 1996, primarily due to an increase in loan receivables in 1996 before the Company determined to discontinue portfolio lending. The Company realized $56.0 million net cash from financing activities in 1998 reflecting a net increase of $29.8 million in thrift certificates and a $25.4 million net increase in notes payable. The Company realized $85.9 million net cash from financing activities in 1997, reflecting a net increase of $51.6 million in thrift certificates, $26.2 million in advances on interest-only strips and $9.3 million from the issuance of common stock upon exercise of General Partner and Subscriber Warrants and stock options. The Company realized $22.8 million net cash from financing activities in 1996, reflecting primarily a net increase of $20.8 million in thrift certificates, and $10.8 million in proceeds from the Public Offering and Rights Offering.
At December 31, 1998 the Company had deferred tax liabilities of $1.2 million, primarily related to the interest-only strips receivable. Over the next few years, the Company expects to generate future taxable income from the interest-only strips receivable. Management believes that it is more likely than not that such future taxable income will be sufficient for realization of the deferred tax assets.
Asset/Liability Management
The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's "interest rate sensitivity gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated, based upon certain assumptions, to mature or reprice within a specific time period and the amount of interest-bearing liabilities anticipated, based upon certain assumptions, to mature or reprice within that same time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would generally tend to adversely affect net interest income while a positive gap would generally tend to result in an increase in net interest income. During a period of declining interest rates, a negative gap would generally tend to result in increased net interest income while a positive gap would generally tend to adversely affect net interest income. At December 31, 1998, total interest-bearing liabilities maturing or repricing during each period exceeded total interest-earning assets maturing or repricing in the same periods by $37.3 million, representing a negative cumulative interest rate sensitivity gap ratio of 30%. However, because interest rates for different asset and liability products offered by depository institutions respond differently to changes in the interest rate environment, the gap is only a general indicator of interest rate sensitivity.
Pacific Thrift actively monitors its interest rate risk. The Board of Directors of Pacific Thrift reviews its interest rate risk position no less than quarterly.
To the extent consistent with its interest rate spread objectives, Pacific Thrift attempts to reduce its interest rate risk and has taken a number of steps to match its interest sensitive assets and liabilities to minimize the potential negative impact of changing interest rates. Pacific Thrift has focused on making adjustable rate loans, virtually all of which adjust quarterly, and focuses its investment activity on short-term obligations of banks and U.S. government securities.
The following table sets forth the interest rate sensitivity of Pacific Thrift's assets and liabilities at December 31, 1998 on the basis of certain assumptions. Except as stated below, the amounts of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of the repricing timing or contractual term of the asset or liability. Pacific Thrift has assumed that its savings accounts (passbook accounts and money market accounts), which totaled $29.7 million at December 31, 1998 reprice immediately. Certificates of deposit are included in the table below at their dates of maturity.
Certain shortcomings are inherent in the method of analysis presented in the following table. For example, interest rate floors on some adjustable rate loans can have the effect of increasing the net interest income as interest rates decline or, conversely, limiting increases in net interest income as interest rates rise. Also, loan prepayments and early withdrawal of certificates of deposit could cause the interest sensitivities to vary from what appears in the table. Finally, the ability of many borrowers to service their adjustable rate debt may be adversely affected by an interest rate increase.
INTEREST RATE SENSITIVITY GAP AS OF DECEMBER 31, 1998 (Dollars in Thousands)
(1) Includes loans sold by each month end, for which cash has not yet been received.
(2) The interest rate sensitivity gap ratio represents total interest-earning assets divided by total interest-bearing liabilities.
(3) The cumulative interest rate sensitivity gap ratio represents the cumulative interest rate sensitivity gap divided by total interest-earning assets.
Impact of Inflation and Changing Prices
The financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations of the Company and its subsidiaries. Like most mortgage companies and industrial loan companies, nearly all the assets and liabilities of the Company and Pacific Thrift are monetary. As a result, interest rates have a greater impact on the Company's consolidated 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.
Effect of New Accounting Pronouncements
In February 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 132 ("SFAS No. 132"), Employers' Disclosures about Pensions and other Post-retirement Benefits, which stan dardizes the disclosure requirements for pension and other post-retirement benefits. The adoption of SFAS No. 132 did not materially impact the Company's current disclosures.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 ("SFAS No. 133"), Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 requires
companies to recognize all derivative contracts as either assets or liabilities in the balance sheet and to measure them at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge, the objective of which is to match the timing of gain or loss recognition on the hedging derivative with the recognition of (i) the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk or (ii) the earnings effect of the hedged forecasted transaction. For a derivative not designated as a hedging instrument, the gain or loss is recognized as income in the period of change. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Based on its current and planned future activities relative to derivative instruments, the Company believes that the adoption of SFAS No. 133 on January 1, 2000 will not have a significant effect on its financial statements.
In October 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 134 ("SFAS No. 134"), Accounting for Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. This statement effectively changes the way mortgage banking firms account for certain securities and other interests they retain after securitizing mortgage loans that were held for sale. The adoption of SFAS No. 134 is not expected to have a material impact on the Company's financial position.
In February 1999 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 135 ("SFAS No. 135"), Rescission of Financial Accounting Standards Board No. 75 ("SFAS No. 75") and Technical Corrections. SFAS No. 135 rescinds SFAS No. 75 and amends Statement of Financial Accounting Standards Board No. 35. SFAS No. 135 also amends other existing authoritative literature to make various technical corrections, clarify meanings, or describe applicability under changed conditions. SFAS No. 135 is effective for financial statements issued for fiscal years ending after February 15, 1999. The Company believes that the adoption of SFAS No. 135 will not have a significant effect on its financial statements.
Year 2000 Compliance Information
Pacific Thrift has prepared a Year 2000 Project Plan which will be used for all computer-related systems of the Company as a whole. The Plan provides for four phases of implementation: assessment, renovation, testing and contingency planning. The Company has completed the assessment phase of the Plan, including an analysis of mission critical and non-mission critical systems. The renovation phase of the Company's software systems has also been substantially completed. The Company's core operating systems have all been upgraded to vendor provided Year 2000 compliant versions and are running on Year 2000 compliant hardware. The testing phase of the Year 2000 Project Plan has been partially completed, with the completion of tests of the most critical systems, including the deposit system, the loan servicing system, the loan processing system and the general ledger system as of March 31, 1999. The remaining mission critical systems should be tested and validated by April 30, 1999. The contingency planning phase will consist of the creation and validation of a business resumption contingency plan to address all actions to be taken in the event that any aspect of the Company's mission critical systems fails to operate properly on or after January 1, 2000. The contingency planning phase should be completed by June 30, 1999.
An independent audit report of the Year 2000 project is expected to be completed by April 22, 1999 and the Company expects to be Year 2000 compliant by June 30, 1999.
The Company has budgeted a total of $50,000 to complete its Year 2000 Project Plan, and does not anticipate that total expenses necessary to become Year 2000 compliant will be material.
On March 1, 1999, Pacific Thrift entered into a stipulation and consent to an order issued by the FDIC related to Year 2000 readiness (the "Year 2000 Order"), the terms of which are described under the heading Item 1. Business - --Supervision and Regulation -- Regulatory Actions. The Company believes that Pacific Thrift has taken actions required
to be in compliance with the Year 2000 Order as of this date, but the FDIC has not verified such compliance as of this date.
Seasonality
The Company's results of operations have not been materially affected by seasonality.
Risk Factors
The discussion in this Report contains certain forward-looking statements relating to anticipated financial performance, business prospects and business plans. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that actual future results could differ materially from those described in the forward-looking statements as a result of a variety of factors, including those specifically discussed below. The Company cautions the reader, however, that these lists of risk factors may not be exhaustive. The Company undertakes no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect any future events or circumstances.
The Company incurred a net loss of $24,488,000 during the year ended December 31, 1998 and has an accumulated deficit of $3,231,000 at December 31, 1998. Management believes these losses were reflective of the rapid change in marketplace demand for the purchase of sub-prime paper by the secondary market during the latter half of 1998. At December 31, 1998, the Company is in default of the repayment terms of its obligations related to its interest-only strips receivable (Note 8c to the financial statements included under item 14 for Part IV). In addition, Pacific Thrift was not "adequately capitalized" at the end of 1998 or by March 22, 1999 and became subject to certain regulatory mandates and sanctions (Note 13 to the financial statements included under item 14 for Part IV). Pacific Thrift also has additional regulatory mandates imposed relating to its Year 2000 readiness and the related Bank information systems (Notes 13 and 15 to the financial statements included under item 14 for Part IV). Failure to implement the regulatory mandates would expose Pacific Thrift to various regulatory actions, including the risk of regulatory takeover.
The Company's independent certified public accountants have included an explanatory paragraph in their report which indicates that these matters raise substantial doubt about the ability of the Company to continue as a going concern. Management's plans regarding these matters are as follows:
Management has taken and continues to take steps to return the Company to profitability and improve its financial condition, including such actions as the closure of Pacific Thrift's wholesale operations (Note 2Q to the financial statements included under item 14 for Part IV), an emphasis on originating residential real estate loans for sale under whole loan sale agreements for a cash premium through its retail division, a reduction in portfolio lending until targeted capital ratios are achieved, and reducing overhead expenses. Pacific Thrift has hired a consultant and submitted a revised Year 2000 plan to the regulators and believes it will be able to meet the guidelines of the order regarding Year 2000 (Note 13 to the financial statements included under item 14 for Part IV).
Management expects that Pacific Thrift will be profitable in 1999 and will comply to the greatest extent possible with the regulatory mandates. Management has submitted a Capital Restoration Plan (the Plan) which was approved by the FDIC. In addition to a revised business plan, the Plan includes restructuring debt to provide capital contributions to Pacific Thrift and raising capital through private or public offerings of debt or equity securities. Management is negotiating a restructuring of its obligations in default relating to its interest-only strips receivable. There is no assurance that management's plans can be achieved. The financial statements do not include any provisions or adjustments that might result from the outcome of these uncertainties.
Reliance on Secondary Loan Market. The Company relies upon its ability to originate loans for immediate resale in the secondary loan market. The Company does not have the resources to hold a significant amount of loans, and must therefore be able to sell existing loans in order to have the capacity to originate new loans. The secondary loan market experienced substantial adverse changes in the third and fourth quarters of 1998, the effects of which have continued into 1999. As a result of these events, the Company believes that there are fewer loan purchasers in the secondary loan market, that these purchasers are buying fewer loans, and that this has reduced the prices which buyers are willing to pay for loans. Although there has been some improvement in the secondary loan market in the first quarter of 1999, as evidenced by some increase in loan sale prices and sales of loans by Pacific Thrift to several new loan purchasers, there can be no assurance that either general market factors or specific factors related to Pacific Thrift will not reduce Pacific Thrift's ability to sell loans in the future. Any further deterioration in the secondary loan market could have a substantial negative impact upon the Company.
Need for Additional Capital at Pacific Thrift. The terms of the 1998 Order issued by the FDIC require Pacific Thrift to raise sufficient additional capital to become "well capitalized" as defined by FDIC regulations by June 30, 1999. Pacific Thrift currently estimates that this would require it to raise approximately $20 million in additional capital. There can be no assurance that Pacific Thrift or the Company will have the ability to raise sufficient capital to meet the terms of the 1998 Order, particularly in light of the current adverse conditions in the secondary loan market and the Company's current financial condition.
Risk of Additional Regulatory Action. Pacific Thrift is currently subject to regulatory orders issued by the FDIC and the DFI concerning the raising of additional capital, the limitation of lending activities, the restriction on asset growth and new offices, and the reduction of interest-only strips receivable as a percentage of capital, among other provisions. Pacific Thrift is also subject to a regulatory order issued by the FDIC concerning actions required to be taken to become Year 2000 compliant. (See Item 1. Business -- Supervision and Regulation -- Regulatory Action.) There can be no assurance that Pacific Thrift will have the ability to meet all of the requirements of the existing regulatory orders, or that additional regulatory orders will not be issued further restricting Pacific Thrift's business. If Pacific Thrift is unable to comply with the terms of the orders, the FDIC and the DFI have authority to take a number of enforcement actions, including appointing a receiver for Pacific Thrift, withdrawing FDIC insurance, requiring a sale of Pacific Thrift, or imposing civil money penalties. There can be no assurance of what action, if any, the FDIC and/or the DFI would deem appropriate in the event that Pacific Thrift were unable to meet the terms of the existing orders or any new regulatory orders.
Risk of Inability to Repay Existing Indebtedness to Merrill Lynch and Fremont. The Company is currently in default on an $18.4 million loan made by Merrill Lynch under a Master Assignment Agreement. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Sources of Funds -- Other Borrowings." The Company had anticipated that cash flow from the PAMM Trusts would be used to repay this loan,
but cash flow payments have been interrupted due to the delinquency level of one of the PAMM Trusts. Although Merrill Lynch indicated in December 1998 that it did not intend to take any action other than to direct that all cash flow payments be paid directly to it, because of the interruption in cash flow payments, the Company is uncertain whether Merrill Lynch will take further action to collect the loan, including a sale of the interest-only strips receivable held by the Company in the PAMM Trusts. In the event of such a sale, the Company may not receive the full carrying value of those assets, which could result in a substantial loss to the Company. It is also uncertain at this time whether the Company will have the ability to repay a $3.0 million loan owed to Fremont which matures on January 8, 2000. The Fremont loan is secured by a pledge of 100% of the stock of Pacific Thrift, and Fremont would have the right to sell the stock if the Company cannot repay the loan to Fremont upon its maturity.
Risks of Holding Interest-Only Strips Receivable. The Company has a significant investment in interest-only strips receivable from loans sold in 1996 through 1998. While a market does exist for these assets, it is not the type of market that results in active bid/ask levels, but is a negotiated market in which interests trade based upon the availability and exchange of information regarding the asset as well as the purchaser's knowledge of similar assets. The adverse events in the subprime lending industry which occurred in the third and fourth quarters of 1998 have also had a negative impact on the market for interest-only strips receivable. This has reduced the Company's ability to obtain financing using these receivables as collateral, which could be used as additional capital at Pacific Thrift or to refinance the Merrill Lynch indebtedness. In addition, if the Company were to attempt to sell all or a part of these receivables, there can be no assurance that a purchaser of the receivables would be willing to pay the amount which the Company estimates to be their present value, based upon a discounted cash flow analysis. In addition, as the Company continues to hold the receivables, it is also subject to the risk of valuation adjustments based upon performance of the loans in each Securitization Trust, particularly with respect to voluntary and involuntary prepayments. Actual prepayment and loss rates on each Securitization Trust are affected by a variety of factors which cannot be predicted with certainty. Therefore, there is a risk that the value of interest-only strips receivable will require adjustment to reflect future events. See "Certain Accounting Considerations" above for a detailed discussion of the various factors which impact valuation of interest-only strips receivable.
Delinquencies and Losses in Securitization Trusts; Negative Impact on Cash Flow. Each of the Securitization Trusts in which the Company holds an interest contains specified limits on delinquencies and losses that may be incurred in each Trust. If, at any measuring date, the delinquencies or losses with respect to any Securitization Trust were to exceed the limits applicable to such Trust, provisions of the agreements require increased overcollateralization reserve levels, thereby deferring the Company's receipt of cash flow by diverting cash flow from the Company to the reserve. When and if delinquency levels fall back to acceptable levels, the Company has a right to receive the cash flow which has been deposited in the reserve in accordance with the terms of the Securitization Trust documents. Higher delinquency levels leading to higher loss and involuntary prepayment levels than those estimated by the Company in its valuation models also adversely influence the Company's anticipated cash flow from and the valuation of the interest-only strips receivable.
Risks of Contracted Servicing. The Company contracts with third parties to service all of its loans sold for securitization. Aames services all loans in the Aames Trust and Advanta services all loans in the Advanta Trusts and subservicers all loans in the PAMM Trusts. The Company is subject to risks associated with inadequate or untimely service rendered by these loan servicers with respect to the cash flow it expects to receive on its interest-only strips receivable. In addition, as master servicer of the PAMM Trusts, the Company is also liable for any failure to provide adequate servicing by Advanta, which is the subservicer for the PAMM Trusts. Many of the Company's borrowers require notices and reminders to keep their loans current and to prevent delinquencies and foreclosures. Any failure by a servicer to provide adequate or timely service could result in higher delinquency rates and foreclosure losses on loan pools, which could have an adverse impact on the value of the Company's interest-only strip receivables in those pools.
Risk of Changes in Interest Rate Environment. A substantial sustained increase in long-term interest rates could, among other things, decrease the demand for consumer credit and thereby adversely affect the ability of the Company to originate loans. Conversely, a significant decline in long-term interest rates could cause an increase in loan prepayments on loans in the Securitization Trusts, thereby reducing the cash flow to the Company from its interest-only strips receivable. In addition, changes in interest rates affect Pacific Thrift's interests costs on deposits.
Changes in Economic Conditions. The risks associated with the Company's business become more acute in any economic slowdown or recession, particularly when accompanied by declining real estate values. Any material decline in real estate values reduces the ability of borrowers to use home equity to support borrowings and increases the risk of loss on outstanding loans. A sustained period of increased delinquencies and losses or increased costs could adversely affect the Company's ability to securitize or sell loans in the secondary market and/or decrease the profitability of the Company's loan securitization business.
Year 2000 Risks. The Company believes that it will achieve Year 2000 compliance in advance of January 1, 2000, and that its major service providers will also achieve compliance. However, there can be no assurance that an unforeseen problem will not develop which could cause losses to the Company and disruption to its operations. (See "Year 2000 Compliance Information".)
Government Regulation. The Company's lending operations are subject to extensive regulation, supervision and licensing by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on its lending business. The Company's consumer lending activities are subject to 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, as amended, the Federal Real Estate Settlement Procedures Act and Regulation X, the Home Mortgage Disclosure Act, the Federal Debt Collection Practices Act and the National Housing Act of 1934, as well as other federal and state statutes and regulations affecting the Company's activities. The Company is also subject to the rules and regulations of, and examinations by, state regulatory authorities with respect to its lending business. Pacific Thrift is subject to additional extensive governmental supervision, regulation and control by the FDIC and the California DFI, as well as various other agencies of the states in which it conducts its lending business. (See "Item 1. BUSINESS -- Supervision and Regulation.")
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company carries interest-sensitive assets on its balance sheet that are financed by interest-sensitive liabilities. Since the interval for re-pricing of the assets and liabilities is not matched, the Company is subject to interest-rate risk. A sudden, sustained increase or decrease in interest rates would impact the Company's net interest income, as well as the fair value of its residual interests in securitizations and interest-only strips.
The following table illustrates the timing of the re-pricing of the Company's interest-sensitive assets and liabilities as of December 31, 1998. Management has made certain assumptions in determining the timing of repricing of such assets and liabilities. One of the more significant assumptions is that all of the Company's loans receivable held for sale will be sold in the first six months of 1999. In addition, the timing of re-pricing or maturity of the Company's residual interests in securitizations is based on certain prepayment and loss assumptions (See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations" for further details).
Significant assumptions are as follows:
Loans Receivable: all variable rate loans are when they reprice and all fixed rate loans are when they mature. Loans Held For Sale are assumed to be sold within six months. Interest-Only Strips Receivable are included based on the present values of the modeled cash flows. Certificates of Deposit are included based on when they mature. Notes Payable related to the Interest-Only Strips Receivable are included based on the present values of the modeled cash flows. Other notes payable are based on scheduled maturity.
See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Net Interest Income Analysis" and "-Certain Accounting Considerations." [GET ADDITIONAL INFORMATION FROM BDO]
Item 8.
Item 8. Financial Statements and Supplementary Data
See Item 14(a) 1-2.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Directors
Mr. Joel R. Schultz, age 62, is Chairman of the Board, President and Chief Executive Officer of the Company and was Chief Managing Officer of Presidential Mortgage Company, a California limited partnership, which was the Company's predecessor. Since 1989, Mr. Schultz has been the Chairman of the Board and Chief Executive Officer of Pacific Thrift. He also served as President of Pacific Thrift from 1988 to November 1993. He also is President and Chief Executive Officer of PAMC. Mr. Schultz is an attorney admitted to practice in California, a certified public accountant, and a California licensed real estate broker.
Mr. James C. Neuhauser, age 40, has been a non-employee director of the Company since June 1996 and a non-employee director of Pacific Thrift and Loan Company, a wholly owned subsidiary of the Company ("Pacific Thrift"), since August 1996. Since March 1993, he has been employed with Friedman, Billings, Ramsey & Company, Inc., an investment banking firm headquartered in Arlington, Virginia, where he is currently a Managing Director. He was
formerly employed with Trident Financial Corporation from 1986 to 1993, where he last held the position of Senior Vice President. Mr. Neuhauser is a Chartered Financial Analyst.
Mr. Paul D. Weiser, age 62, has been a non-employee director of the Company and PAMC since June 1996 and a non-employee director of Pacific Thrift since August 1996. Since 1968, he has been employed with Dataproducts Corporation, a manufacturer and seller of computer printers and related products, currently as its Senior Vice President, Secretary and General Counsel. Mr. Weiser is an attorney admitted to practice in California and former chairman of the Securities and Exchange Commission's Advisory Committee on Shareholder Communications.
Mr. Alan J. Siebler, age 68, was appointed as a director of the Company on April 21, 1997. Mr. Siebler is also a non-employee director of Pacific Thrift, on which Board he has served since June 1992. He was a Human Resource Manager of the Van Nuys, California Plant of General Motors Corporation from August 1956 until September 1992. Mr. Siebler also served as Chairman of the California Joint Apprenticeship State Advisory Committee for Single Plant Industry from 1986 to 1989; and Member of the Committee for Industrial Training Curriculum of Pierce College.
The terms of Joel R. Schultz and Paul D. Weiser will expire at the 1999 annual meeting of stockholders, or when their successors are elected and qualified. The term of Alan J. Siebler will expire at the 2000 annual meeting of stockholders, or when his successor is elected and qualified. The term of James C. Neuhauser will expire at the 2001 annual meeting of stockholders, or when his successor is elected and qualified. Mr. Richard D. Young resigned from the Board on January 11, 1999, and the Board reduced the number of directors from five to four on February 24, 1999. The Board of Directors may fill interim vacancies of directors. Each officer is elected by and serves at the discretion of, the Board of Directors, subject to the terms of any employment agreement.
Executive Officers
The following table sets forth certain information concerning the Company's executive officers.
Item 11.
Item 11. Executive Compensation
Executive Compensation
Summary of Cash and Certain Other Compensation. The Company is a successor to the Partnership. On June 27, 1996, the Company and the Partnership completed the Restructuring, as a result of which all of the assets and liabilities of the Partnership were transferred to the Company. Prior to the Restructuring, the executive officers of the Company received compensation from the Partnership, Presidential Management Company, the general partner of the Partnership (the "General Partner") and/or Pacific Thrift, under various arrangements with those entities. The following table sets forth certain summary information concerning compensation paid or accrued by the Company, the Partnership, the General Partner and Pacific Thrift to or on behalf of the Chief Executive Officer and each of the Named Executives for the fiscal years ended December 31, 1998, 1997, and 1996:
Actual Annual Compensation
- -----------------------
(1) The amounts specified above include automobile allowances and directors' fees, but do not include life insurance or medical insurance premiums for benefits in excess of group benefits provided to employees, the aggregate amount of which do not exceed the lesser of either $50,000 or 10% of the total annual salary and bonus reported for each of the above named executives in each reported year.
(2) All options shown in this column are exercisable at a price equal to the fair market value of the options on the date of grant.
(3) Salary amounts for 1996 include payments prior to the effective date of the Restructuring for providing legal services in connection with loan accounts prior to June 27, 1996. Bonus amount for 1997 includes the value of 10,007 shares of Common Stock paid by the Company in lieu of a portion of the cash bonus earned under an employment agreement based on the fair market value of the shares on the date paid. See "--Employment Agreements." Bonus amounts for each of 1996 and 1997 include amounts earned for the year reported but paid in the following year.
(4) Mr. Richard Young resigned his positions with the Company and all of its subsidiaries on January 11, 1999. Bonus amount for 1997 includes the value of 22,766 shares of Common Stock paid by the Company in lieu of a portion of the cash bonus earned under an employment agreement, based on the fair market value of the shares on the date paid, plus a $174,102 promissory note payable in two semi-annual installments six months and one year after issuance, bearing interest at the Bank of America prime rate. See "--Employment Agreements." Bonus amounts for each of 1996 and 1997 include amounts earned for the year reported but paid in the following year. Bonus amount for 1996 consists of a bonus of $107,000 paid in 1996 for the period prior to the Restructuring, a special discretionary bonus of $25,000 paid after
the Restructuring and a bonus of $222,750 accrued for in 1996 under an employment agreement entered into effective as of the closing date of the Restructuring Date and paid in 1997.
(5) Mr. Landini resigned his position with Pacific Thrift on October 27, 1998. His salary included a severance payment of $200,000, representing six months salary. Bonus amount for 1997 consisted of a bonus of $637,008 accrued for 1997, of which 75% was paid in January 1998 and 25% is due to be paid in January 2000 under his employment agreement. Bonus amount for 1996 consists of a bonus of $182,112 accrued for 1996, of which 75% was paid in January 1997 and 25% is due to be paid in January 1999 under his employment agreement, and a special discretionary bonus of $25,000 paid after the Restructuring. See "-- Employment Agreements."
Options
Option Grants During 1998. The Named Executives of the Company received grants of Incentive Stock Options during the year ended December 31, 1998 for the following amounts of shares of Common Stock.
Option Exercises in 1998 and Current Option Values..
The following table provides certain information concerning options exercised in 1998 and unexercised options held as of December 31, 1998, by the executive officers who held options at the end of 1998:
Aggregate Option Exercises in 1998 Fiscal Year and Fiscal Year End Values
(1) Value of unexercised "in-the-money" options is the difference between the market price of the Common Stock at December 31, 1998 ($0.4375 per share) and the exercise price of the option, multiplied by the number of shares subject to the option.
Employment Agreements
The Company entered into employment agreements with Joel R. Schultz, Richard D. Young, Norman A. Markiewicz and Richard B. Fremed, effective as of June 27, 1996, the closing date of the Restructuring (the "Closing Date"). In addition, Pacific Thrift entered into an employment agreement with Frank P. Landini which became effective as of January 1, 1996. On January 1, 1997, the Company entered an employment agreement with Charles J. Siegel. On April 9, 1999, the Pacific Thrift entered into a new employment agreement with Michael A. Iachelli, subject to approval of the FDIC.
The employment agreements of Mr. Schultz and Mr. Young were superseded with new employment agreements dated as of January 1, 1998, which were approved by the stockholders at the 1998 annual meeting of stockholders. Mr. Young resigned his positions with the Company and its subsidiaries effective January 11, 1999. The Company and Mr. Young have executed a Separation Agreement, and Pacific Thrift and Mr. Young have executed a six-month Consulting Agreement, both of which agreements are subject to approval of the FDIC, which approval has not been obtained as of the date of this report.
The new employment agreements with Mr. Schultz is for an initial term of three years, beginning effective January 1, 1998 and expiring on December 31, 2000. The agreement is subject to automatic extension for successive one year terms unless, at least six months prior to the end of the term, either the Company or the executive gives notice of intent not to renew.
Under the new agreement, Mr. Schultz receives an annual base salary of $425,000 per year, adjusted annually to reflect any increases in the consumer price index. In addition, Mr. Schultz is entitled to receive an annual bonus if the Company earns net after-tax profits for any calendar year during the term of the agreement. Mr. Schultz did not earn an annual bonus for the year ended December 31, 1998 due to the net after-tax loss reported by the Company. The amount of any annual bonus that may be earned in any future year under the agreement would be equal to 2-1/2% of the annual net pre-tax profits of the Company (before deduction of bonuses paid to Mr. Schultz referred to as "annual bonuses") if the Company earns annual net after-tax profits (after payment of annual bonuses) equal to a minimum annual return on equity in excess of 10%, or 5% of the annual net pre-tax profits of the Company if the Company earns annual net after-tax profits equal to a minimum annual return on equity in excess of 20%. Return on equity is determined as net after-tax profits as a percentage of stockholder equity at January 1 of each year. The annual bonuses are payable in quarterly installments during the year earned, determined by annualizing the quarterly net pre-tax profits, net after-tax
profits and return on equity for each of the first three quarters of the year, with a final determination of the total annual bonus following release of the Company's audited consolidated financial statements for the year.
Each installment of any annual bonus is paid 50% in cash and 50% in Common Stock. The Common Stock portion of the annual bonus will be held in escrow by the Company unless and until either of the following forfeiture conditions are met: (a) pre-tax net income for the year following the bonus year must be at least 12.5% higher than the bonus year (i.e., for any 1999 bonus, 2000 pre-tax net income must exceed 1999 pre-tax net income by 12.5%); or (b) return on equity (after payment of annual bonuses) must be at least 25% for the year following the bonus year (i.e., for the 1999 bonus, 2000 return on equity must be at least 25%). (The forfeiture conditions are only applicable for the year 2000 bonus year if the executive is employed under an employment contract through the end of the year 2001.) The amount of Common Stock issued in payment of quarterly installments of the annual bonus is determined as the highest of (x) the closing price on the last trading day of the applicable quarter; (y) the average closing price for the 10 trading days prior to the end of the applicable quarter; or (z) $10 per share. The Company will use its best efforts to register with the Securities and Exchange Commission for resale by the executive the Common Stock issued in payment of the annual bonus.
Any amount paid as a quarterly installment of the annual bonus is subject to repayment if the Company determines that the amount paid was in excess of the amount of the annual bonus earned for the year. To the extent that the total quarterly annual bonus payments exceed the total annual bonus determined at the end of the year, the excess will be repaid first from the Common Stock issued to the executive during the year, using the average weighted price per share of the Common Stock issued in payment of the annual bonus during the year, and then in cash or, at the executive's option, in shares of Common Stock previously purchased by him. For 1998, Mr. Schultz received a quarterly bonus installment of $133,950 in the first quarter of 1998, which Mr. Schultz intends to repay with the return of 6,159 shares of Common Stock previously purchased by him, at $21.75 per share, which was the average weighted price per share of Common Stock issued in payment of the bonus installments during 1998 as provided for in Mr. Schultz's employment agreement.
Mr. Schultz is also entitled to receive a special cash bonus equal to 1% of the annual pre-tax net income of the Company calculated before payment of the special bonus but after payment of the annual bonuses, if the following conditions are met: (a) comparing the special bonus year with the prior year, the pre-tax net income for the special bonus year is at least 25% higher than the prior year or the return on equity for the special bonus year is at least 25%; and (b) comparing the special bonus year with the following year, the pre-tax net income for the year following the special bonus year is at least 25% higher than the special bonus year or the return on equity for the year following the special bonus year is at least 25%. (For the year 2000 special bonus, the performance conditions for the year 2001 are only applicable if the executive is employed under an employment contract through the end of the year 2001.)
Mr. Schultz also received a stock option for 100,000 shares upon approval by the stockholders of the new employment agreement, at an exercise price equal to $17.75 per share, which was 100% of the fair market value of the Common Stock on the date of grant. The option is exercisable at any time beginning six months after grant for a term of 10 years.
Mr. Schultz is also entitled to participate in benefit plans maintained by the Company for its executive officers, including insurance, pension, stock option plans and stock purchase plans, and to receive perquisite benefits including an automobile allowance and expense allowance. In addition, Mr. Schultz is entitled to receive the insurance benefits made available to all executives of the Company.
Upon a termination of the employment agreement as a result of the death or disability of the executive, he or his personal representative is entitled to receive any unpaid annual and special bonuses for any prior year and through the last full quarter prior to termination, including cash and Common Stock, free of any forfeiture or other conditions otherwise applicable to such bonuses, plus a lump sum payment equal to the sum of the full annual bonus and special bonus earned in the prior year, plus payments of the base salary and all benefits for one year. If, at the end of the year of such a termination, it is determined that the annual bonus that would have been earned in the year of termination is higher than the annual bonus for the prior year, the executive or his personal representative is entitled to an additional payment equal to the difference between the annual bonus that would have been earned and the annual bonus amount paid upon termination.
The Company may terminate Mr. Schultz' employment agreement "for cause," which is defined to include: (i) theft or embezzlement; (ii) fraud or other acts of dishonesty in the conduct of the Company's business; (iii) conviction or plea of nolo contendere to any felony or crime of moral turpitude; (iv) any action willfully and knowingly taken which is injurious to the Company's business or reputation. Upon a termination for cause, the Company is only obligated to pay the amount of base salary and annual bonus earned through the date of termination. Any Common Stock held in escrow upon termination for cause will be released to the executive if and when the conditions are met in accordance with the terms of his employment agreement. In addition, the Company is obligated to pay any special bonus to the executive for each year that he was employed, to the extent the performance targets are met in accordance with the terms of the employment agreement.
If Mr. Schultz terminates his employment agreement for any reason other than a "corporate change" (as defined below), he is entitled to his base salary through the date of termination and his annual bonus earned through the end of the last full quarter prior to termination. Any Common Stock held in escrow upon such a termination by Mr. Schultz will be released to the executive if and when the conditions are met in accordance with the terms of his employment agreement. In addition, the Company is obligated to pay any special bonus for each year that Mr. Schultz was employed, to the extent the performance targets are met in accordance with the terms of his employment agreement.
If the Company terminates the employment agreement of Mr. Schultz without cause, he is entitled to benefits for one year, plus a lump sum payment equal to one year's base salary and the annual bonus earned for the prior year. Mr. Schultz is also entitled to any special bonus for the year prior to termination if the performance targets were met for the year prior to termination, plus the cash value of all vacation, holiday and sick days which have accrued and would have accrued for one year following termination. If, at the end of the year of termination, it is determined that the annual or special bonus that would have been earned by Mr. Schultz in the year of termination is higher than the annual or special bonus for the prior year, Mr. Schultz is entitled to an additional payment equal to the difference between the annual and/or special bonus that would have been earned and the annual and special bonus amounts paid upon termination. In addition, all Common Stock then held in escrow for Mr. Schultz is required to be released immediately.
If, at any time within one year of a "corporate change" (as defined below), the Company or Mr. Schultz terminates his employment for any reason other than "for cause," Mr. Schultz is entitled to receive full benefits for 18 months after termination and the cash value of all vacation, holiday and sick days which would have accrued for 18 months following termination. In addition, Mr. Schultz is also entitled to receive any earned and unpaid installments of his annual bonus through the last full quarter of his employment, and an additional lump sum equal to the sum of two times his annual base salary, two times his annual bonus earned in the prior year, the special bonus amount earned for the year prior to termination, plus an additional "in lieu of special bonus" amount equal to 1% of the annualized pre-tax net income for the year of termination. If, at the end of the year of termination, it is determined that two times the annual bonus or the special bonus that would have been earned in the year of termination is higher than the two times the annual bonus or the special bonus amount paid upon termination, Mr. Schultz is entitled to an additional payment equal to the difference between two times the annual bonus and the special bonus actually paid and two time the amount that would have been earned in the year of termination, in addition to a payment equal to the difference between the "in lieu of special bonus" amount paid and the amount that would have been paid as a special bonus in the year of termination. In addition, all Common Stock then held in escrow for Mr. Schultz is required to be released.
The employment agreement with Mr. Siegel provides for a term of two years, which is automatically extended for additional one year terms thereafter unless either party gives at least six months written notice of its or his intention not to renew the agreement. The Company has given notice to Mr. Siegel that it does not intend to renew his contract after its expiration date of December 31, 1999 at which time, Mr. Siegel will become an "at-will" employee. Mr. Siegel's annual salary was $160,000 per year until May 1997, when it was increased to $175,000 per year, as adjusted annually for increases in the cost of living index. Mr. Siegel is also eligible to participate in the employee cash bonus pool of the Company. Upon certain events constituting a change of control (a Corporate Change," as further defined below), Mr. Siegel is entitled to receive two times his annual salary and three times his last annual bonus.
The employment agreements with Mr. Markiewicz and Mr. Fremed provide for a term of one year, which is automatically extended for additional one year terms thereafter unless either party gives at least six months written notice of its or his intention not to renew the agreement. The Company has notified Mr. Markiewicz and Mr. Fremed that their employment agreements will not be renewed after expiration on June 26, 1999 at which time Mr. Markiewicz and Mr. Fremed will become "at-will" employees. Mr. Markiewicz' annual salary is
$135,000 per year, and Mr. Fremed's annual salary is $125,000 per year, in each case as adjusted annually for increases in the cost of living index, and Mr. Markiewicz and Mr. Fremed are also eligible to participate in the employee cash bonus pool of the Company. Upon a Corporate Change, Mr. Markiewicz and Mr. Fremed are each entitled to receive one-half his annual salary.
As described above, the employment agreements of Messrs. Schultz, Siegel, Markiewicz and Fremed contain special termination provisions upon a Corporate Change. Corporate Change is defined in each of the employment agreements to include any one (or more) of the following events: (i) any person, including a group as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), becomes the beneficial owner of shares of the Company with respect to which twenty percent (20%) or more of the total number of votes for the election of the Board may be cast; (ii) as a result of, or in connection with, any cash tender offer, exchange offer, merger or other business combination, sale of assets, or contested election for the Board of Directors, or combination of the foregoing, persons who were directors of the Company just prior to such event(s) shall cease to constitute a majority of the Board; (iii) a transaction in which the Company will cease to be an independent publicly owned corporation that is required to file quarterly and annual reports under the Exchange Act, or a sale or other disposition of all or substantially all the assets of the Company (including but not limited to the assets or stock of Company's subsidiaries that results in all or substantially all of the assets or stock of Company on a consolidated basis being sold); (iv) a tender offer or exchange offer is made for shares of the Company's Common Stock (other than one made by the Company) and shares of Common Stock are acquired thereunder; (v) the stockholders of the Company cause a change in the majority of the members of the Board of Directors within a twelve (12) month period; provided, however, that the election of one or more new directors shall not be deemed to be a change in the membership of the Board of Directors if the nomination of the newly elected directors was approved by the vote of three-fourths of the directors then still in office who were directors at the beginning of such twelve (12) month period; (vi) with respect to Joel Schultz only, a change in his duties or a reduction in compensation; or (vii) with respect to Mr. Siegel only, a change in the Chief Executive Officer and Senior Executive Vice President of the Company.
The Company retains the right to terminate any of the employment agreements in the event of an employee's physical or mental disability which renders him unable to perform under the agreement for any period of one hundred and twenty (120) consecutive days or for an aggregate period of one hundred and twenty (120) or more days during any twelve (12) month period. In the event of termination due to disability, an employee would be entitled to receive as disability compensation a lump sum payment equal to the annual bonus earned by employee during the fiscal year preceding the year of termination, one year's annual salary, payable not less frequently than monthly and continuation of certain benefits for the greater of one year or the remainder of the term under the agreement. In the event of death, an employee's personal representative is entitled to receive as a death benefit, in addition to any other payments which he may be entitled to receive under any of the Company's benefit plans, payment of one year's salary, payable not less frequently than monthly.
From January 1, 1996 until October 28, 1998, the date of closing of the wholesale loan division, Mr. Frank Landini was employed under written employment agreements with Pacific Thrift. Upon his termination in October 1998, Pacific Thrift paid Mr. Landini a termination payment of $200,000. The original employment agreement of Mr. Landini with Pacific Thrift was for a term of two years, with automatic extensions for additional one year terms thereafter unless either party gave at least six (6) months written notice of its or his intention not to renew the agreement. Mr. Landini received an annual base salary of $150,000, as adjusted annually for increases in the cost of living index. Mr. Landini also received an annual bonus equal to the sum of (a) 1.5% of the pre-tax net profits of the Pacific Thrift Wholesale Division up to $10 million; (b) 1.875% of the pre-tax profits between $10 and $20 million; and (c) 2.25% of all pre-tax profits in excess of $20 million, less the amount of Mr. Landini's salary. For purposes of the bonus calculation, Mr. Landini's salary was deducted from the calculation of pre-tax net profits.
In April 1998, Mr. Landini entered a new employment agreement with Pacific Thrift under which he was to receive an annual base salary of $400,000. Also in April 1998, Mr. Landini entered into a bonus agreement with the Company, under which the Company agreed to assume responsibility for payment of Mr. Landini's annual bonus, in accordance with the same formula and payment terms provided in Mr. Landini's prior agreement with Pacific Thrift.
Mr. Landini's original agreement provided for him to receive up to $100,000 of his bonus earned in 1996 plus one-half of any bonus earned in 1996 in excess of $200,000 in January 1997, with any remaining bonus amount earned
in 1996 to be paid 36 months later. For years after 1996, one-half of Mr. Landini's bonus was to be paid the following January, and the remaining half paid 36 months later. Pursuant to an amendment to his agreement dated as of January 1, 1997, 75% of the bonus earned in 1996 was paid in January 1997, and 75% of the bonus payable for future years is payable in the following January, with the remainder of each year's bonus payable three years thereafter. In every case, the deferred bonus amount was subject to forfeiture if Mr. Landini voluntarily terminated his employment or Pacific Thrift terminated his employment "for cause." As a result of Mr. Landini's termination in connection with the closing of the wholesale loan division in October 1998, the Company has calculated that it and its affiliates owed Mr. Landini a total of $200,000 for severance pay and benefits and $523,284 for deferred bonuses earned in 1996 and 1997, of which $200,000 in severance has been paid to date. No arrangements have been made with Mr. Landini regarding the amounts owed to him and the Company has informed Mr. Landini that it does not expect to pay these amounts for the foreseeable future.
Effective January 11, 1999, Mr. Richard D. Young Senior Executive Vice President of the Company and President and Chief Operating Officer of Pacific Thrift was no longer employed by the Company. The Company entered into a Separation Agreement with Mr. Young dated as of March 9, 1999, and Pacific Thrift entered into a Consulting Agreement with Mr. Young, also dated as of March 9, 1999. The Separation Agreement provides for Mr. Young to receive payments from the Company under a note for $475,000, payable over two years beginning January 1, 2002. The Consulting Agreement provides for Mr. Young to provide consulting services for a period of six months, for a consulting fee of $10,000 per month. The Separation Agreement and the Consulting Agreement are subject to the approval of the FDIC, which was applied for on March 11, 1999, but has not yet been granted.
On April 9, 1999, Pacific Thrift entered into a new employment agreement with Mr. Michael A. Iachelli, subject to approval of the FDIC. Under the agreement, Mr. Iachelli has been appointed as President and Chief Executive Officer of Pacific Thrift for a term of one year, with automatic renewal for successive one year terms unless either party notifies the other of nonrenewal 60 days before expiration of the current term. The agreement provides for Mr. Iachelli to receive an annual salary of $200,000, plus an annual bonus similar in form and structure to that of Mr. Schultz, as it may be modified from time to time, but excluding from the determination of net pre-tax and net after-tax income the effect of any changes in valuation of existing interest-only strips receivable held by Pacific Thrift. In addition, Mr. Iachelli receives a car allowance and standard executive benefits. Mr. Iachelli has further been granted stock options exercisable for 100,000 shares of Common Stock of the Company at $.4375 per share, the closing price of the Common Stock on April 9, 1999, vested 25% annually. In addition, Mr. Iachelli has received a grant of nonqualified stock options exercisable for 25,000 shares of Common Stock of the Company at $2.00 per share, vested 100% in one from the date of his commencement of employment. Mr. Iachelli has further received the right, exercisable within 30 days from the date of commencement of his employment, to purchase up to 100,000 shares of Common Stock of the Company at fair market value as of the date of purchase. The other terms of Mr. Iachelli's employment are similar to Mr. Schultz' employment agreement, except that, upon a change in control of the Company, Mr. Iachelli is entitled to receive a payment equal to one year of his base salary, plus full vesting of all unvested options.
Plans and Arrangements
Employees of the Company, including executive officers, are entitled to participate in various benefit plans established by the Company and approved by the Board of Directors and the Partnership, as the sole stockholder of the Company, prior to the Restructuring.
1995 Stock Option Plan
The 1995 PacificAmerica Money Center, Inc. Stock Option Plan (the "1995 Plan") is designed to promote and advance the interests of the Company and its stockholders by: (i) enabling the Company to attract, retain and reward managerial and other key employees and non-employee directors; and (ii) strengthening the mutuality of interests between participants and the stockholders of the Company in its long term growth, profitability and financial success by offering stock options. The 1995 Plan empowers the Company to award or grant options from time to time until December 31, 2003, when the 1995 Plan expires except with respect to options then outstanding, to officers, directors, key employees and consultants of the Company and its subsidiaries, Incentive and Non-Qualified Stock Options ("Options") authorized by the Executive Compensation Committee of the Board of Directors, which administers the 1995 Plan.
Shares Subject to 1995 Plan. As approved by the stockholders at the annual meeting of stockholders in June 1998, the adjusted maximum number of shares of Common Stock in respect of which Options may be granted under the Plan (the "Plan Maximum") is 800,000 with an increase of two percent (2%) of the total issued and outstanding shares of the Common Stock on the first day of each subsequent calendar year, up to a maximum of 1,000,000 shares, commencing January 1, 1997. As of February 28, 1999 902,977 options were issuable under the 1995 Plan, and options for 403,049 shares had been granted under the 1995 Plan, leaving options for 499,928 shares available for future issuance.
For the purpose of computing the total number of shares of Common Stock available for Options under the 1995 Plan, the above limitations are reduced by the number of shares of Common Stock subject to issuance upon exercise or settlement of Options, determined at the date of the grant of such Options. However, if any Options are forfeited, terminated, settled in cash or exchanged for other Options or expire unexercised, the shares of Common Stock previously subject to such Options are again available for further Option grants. The shares of Common Stock which may be issued to participants in the 1995 Plan may be either authorized and unissued Common Stock or issued Common Stock reacquired by the Company. No fractional shares may be issued under the 1995 Plan.
The maximum number of shares of Common Stock issuable upon exercise of Options granted or which may be subject to Options, as applied to the 1995 Plan and its several components, is subject to appropriate equitable adjustment in the event of a reorganization, stock split, stock dividend, combination of shares, merger, consolidation or other recapitalization of the Company. The number of shares subject to outstanding options and issuable under the 1995 Plan was adjusted to reflect the one-for-one stock dividend paid on August 13, 1997, which had the effect of a two-for-one stock split.
Administration. The 1995 Plan is administered by the Executive Compensation Committee of the Board of Directors (the "Committee"). The 1995 Plan provides that the Committee must consist of at least two directors of the Company who are "non-employee directors" within the meaning of Rule 16b-3(b)(3)(i) of the Exchange Act promulgated by the Securities and Exchange Commission (the "Commission"). The Committee has the sole authority to construe and interpret the 1995 Plan, to make rules and procedures relating to the implementation of the 1995 Plan, to select participants, to establish the terms and conditions of Options and to grant Options, with broad authority to delegate its responsibilities to others, except with respect to the selection for participation of, and the granting of Options to, persons subject to Sections 16(a) and 16(b) of the Exchange Act. Members of the Committee are not eligible to receive discretionary Options under the 1995 Plan.
Eligibility Conditions. All officers and key employees of the Company and its subsidiaries, are eligible to receive Options under the 1995 Plan. Non-employee directors and consultants are only eligible to receive Non-Qualified Stock Options under the 1995 Plan. Except for Non-Qualified Stock Options granted to non-employee directors, the selection of recipients of, and the nature and size of, Options granted under the 1995 Plan is wholly within the discretion of the Committee. The 1995 Plan is subject to specific formula provisions relating to the grant of options to non-employee directors, the exercisability of Incentive Stock Options and the total shares available for option grants. In addition, there is a 50,000 share limit on the number of shares of Common Stock in respect of which any type of Options may be granted to any person in each calendar year.
Transferability. No Option granted under the 1995 Plan, and no right or interest therein, is assignable or transferable by a participant except by will or the laws of descent and distribution.
Term, Amendment and Termination. The 1995 Plan currently provides for termination on December 31, 2003, except with respect to Options then outstanding. The Board of Directors may amend or terminate the 1995 Plan at any time, except that: (i) to the extent restricted by Rule 16b-3 promulgated under the Exchange Act, as amended and in effect from time to time (or any successor rule), the Board of Directors may not, without approval of the stockholders of the Company, make any amendment that would: (a) increase the total number of shares available for issuance (except as permitted by the 1995 Plan to reflect changes in capital structure); (b) materially change the eligibility requirements; or (c) materially increase the benefits accruing to participants under the 1995 Plan; and (ii) the provisions of the 1995 Plan governing the award of options to non-employee directors may not be amended more than once every six months other than to comport with changes to the Internal Revenue Code of 1986, as amended (the "Code"), the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), or the regulations promulgated thereunder.
Change of Control. The 1995 Plan provides that the exercisability of outstanding Options shall be accelerated upon any of the following events: (i) any person, including a group as defined in Section 13(d)(3) of the Exchange Act, becomes the beneficial owner of shares of the Company with respect to which twenty percent (20%) or more of the total number of votes for the election of the Board of Directors may be cast; (ii) as a result of, or in connection with, any cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election for the Board, or combination of the foregoing, persons who were directors of the Company just prior to such event(s) shall cease to constitute a majority of the Board of Directors; (iii) a transaction in which the Company will cease to be an independent publicly owned corporation that is required to file quarterly and annual reports under the Exchange Act, or a sale or other disposition of all or substantially all the assets of the Company (including but not limited to the assets or stock of the Company's subsidiaries that results in all or substantially all of the assets or stock of Company on a consolidated basis being sold); (iv) a tender offer or exchange offer is made for shares of the Company's Common Stock (other than one made by the Company) and shares of Common Stock are acquired thereunder; or (v) the stockholders of the Company cause a change in the majority of the members of the Board of Directors within a twelve (12) month period; provided, however, that the election of one or more new directors shall not be deemed to be a change in the membership of the Board of Directors if the nomination of the newly elected directors was approved by the vote of three-fourths of the directors then still in office who were directors at the beginning of such twelve (12) month period (collectively, a "Change of Control").
Incentive Stock Options. Options designated as Incentive Stock Options, within the meaning of Section 422 of the Code, in respect of up to the Plan Maximum may be granted under the 1995 Plan. The number of shares of Common Stock in respect of which Incentive Stock Options are first exercisable by any optionee during any calendar year shall not have a fair market value (determined at the date of grant) in excess of $100,000 (or such other limit as may be imposed by the Code). To the extent the fair market value of the shares for which options are designated as Incentive Stock Options that are first exercisable by any optionee during any calendar year exceed $100,000, the excess amount shall be treated as Non-Qualified Stock Options. Incentive Stock Options shall be exercisable for such period or periods, not in excess of ten years after the date of grant, as shall be determined by the Committee.
Grant of Incentive Stock Options. As of February 28, 1999, the Board of Directors of the Company has granted Incentive Stock Options to acquire a total of 499,921 shares of Common Stock to certain key employees, including the executive officers, of the Company, at exercise prices ranging from $0.50 to $28.75 per share. For employees who were employed by the Partnership for five (5) years or more, options become exercisable 20% after the first six (6) months following the grant, and an additional 20% on the first, second, third and fourth-year anniversary dates of the grant thereafter. For employees who were employed by the Partnership for less than five (5) years, options become exercisable 25% on each of the first, second, third and fourth-year anniversary dates of the grant.
Non-Qualified Stock Options. Non-Qualified Stock Options may be granted for such number of shares of Common Stock and will be exercisable for such period or periods as the Committee shall determine, up to a maximum term of ten years.
Options to Non-Employee Directors. The 1995 Plan also provides for the grant of Options to non-employee directors of the Company or any of its subsidiaries, without any action on the part of the Board of Directors or the Committee, only upon the terms and conditions set forth in the 1995 Plan. The 1995 Plan was amended in June 1997 to provide that non-employee directors of the Company and its subsidiaries would be entitled to receive an initial grant of 1,000 shares of Common Stock and an annual grant of 1,000 shares of Common Stock after each twelve (12) month period of continuous service as a director. On April 22, 1998 the Board of Directors amended the 1995 Plan to clarify that, as a result of the August 13, 1997 stock dividend which had the effect of a two-for-one stock split, the amount of each initial and annual grant of options to non-employee directors of the Company and its subsidiaries would be increased to 2,000 shares of Common Stock. Each Option becomes exercisable as to 50% of the shares of Common Stock subject to the Option on the first anniversary date of the grant and 50% on the second anniversary date of the grant, and expires ten (10) years from the date the Option is granted. The exercise price of all Options granted non-employee directors must be equal to 100% of the fair market value of the Common Stock subject to the Option on the date on which such Options are granted. Each Option is subject to the other provisions of the 1995 Plan.
As of February 28, 1999, the non-employee directors of the Company have been granted Non-Qualified Options to acquire 18,000 shares of Common Stock, at exercise prices ranging from $5 to $16 per share.
Option Exercise Prices. The exercise price of an Incentive Stock Option must be at least 100% of the fair market value of the Common Stock on the date of grant. Except for Options to non-employee directors, Non-Qualified Stock Options may be issued at such option exercise price as the Committee shall determine, but not less than par value per share. The fair market value of all Options is determined as the closing price of the Common Stock on the date the Option is granted.
Exercise of Options. Options are exercisable for a maximum term of 10 years, but may not be exercised after three months following a termination of employment, or after one year following disability or death of an optionee. Options are exercisable only upon the payment in full of the applicable Option exercise price in cash or, if approved by the Committee, in shares of the Common Stock (at the fair market value thereof at exercise date) or by concurrent sale of the shares under the Option with instructions to the selling broker to deliver the proceeds of sale, up to the exercise price, to the Company. No Incentive or Non-Qualified Stock Option may be exercised within six months following the date of grant.
Retirement Plan
The Company has a 401(k) Plan (the "401(k) Plan") which Plan allows employees to invest contributions in Common Stock of the Company.
All employees (including officers) of the Company and its subsidiaries are eligible to participate in the Retirement Plan and future employees will be eligible following the completion of 1,000 hours of service and their first year of employment. Subject to certain limitations, participants in the 401(k) Plan may make contributions from 2% to 15% of their pretax compensation, up to a maximum of $9,500 per year (in 1997), subject to certain limitations and annual adjust ments for inflation. The Company may, in its discretion, make a matching contribution equal to a percentage of compensation contributed by each participant, not to exceed 6% of compensation. The 401(k) Plan is designed to qualify under Section 401(k) of the Internal Revenue Code and therefore contributions by the Company and the participants are deductible by the Company and not includable in the income of the participants for federal income tax purposes. Participants will always be fully vested in all of their individual contributions to the 401(k) Plan (and in earnings on such contributions). Participants will be fully vested in employer contributions (and earnings on such contributions) to the 401(k) Plan, regardless of years of service, upon the attainment of normal retirement age (age 65), such participant's death or permanent and total disability while employed by the Company or the termination or complete discontinuance of the 401(k) Plan. If a participant terminates employment with the Company for any reason other than retirement, then such participant's interest in employer contributions to the 401(k) Plan shall vest 20% after one year of service, and 20% for each year of service thereafter, so they will be vested 100% after five or more years of service. An employee's service with the Partnership, the General Partner and former affiliates is counted for purposes of vesting under the 401(k) Plan.
Stock Purchase Plan
The 1995 Employee Stock Purchase Plan (the "Stock Purchase Plan") provides for eligible employees of the Company and its subsidiaries to participate in the ownership of the Company by acquiring the right to purchase shares of the Company's Common Stock. As approved by the stockholders at the 1998 annual meeting of stockholders the Stock Purchase Plan covers a total of 230,000 shares of Common Stock. Shares of Common Stock may be purchased by the Stock Purchase Plan in the open market or issued by the Company from authorized and unissued treasury stock. The purpose of the Stock Purchase Plan is to promote the interests of the Company by providing a method whereby employees of the Company may participate in the ownership of the Company by acquiring an interest in the Company's growth and productivity.
The Options. The Stock Purchase Plan provides that, during each specified period ("Option Period"), the Company may grant options to participants to purchase, at the termination of that Option Period, shares of Common Stock under the Stock Purchase Plan. The Option Periods coincide with the Company's calendar year. The price at which each share covered by an option under the Stock Purchase Plan may be purchased is 100% of the fair market value of a share of Common Stock on the first day of the applicable Option Period.
Unless terminated, options granted at the commencement of an Option Period are exercised automatically on the last day of that Option Period. An option terminates upon a voluntary withdrawal from participation in the Stock
Purchase Plan by a participant, which may be effected any time prior to the last day of the Option Period by completing a notice of termination form. An option also terminates automatically if the participant holding the option ceases to be employed by the Company or a subsidiary of the Company for any reason (including death, disability or retirement) prior to the last day of the Option Period.
An option may not be sold, pledged, assigned, hypothecated, transferred or disposed of in any manner other than by will or by the laws of descent or distribution, and may be exercised, during the lifetime of the optionee, only by such optionee. Optionees do not have rights as stockholders of the Company with respect to option shares until they exercise their options.
Eligibility and Participation. All full-time employees of the Company and its subsidiaries who have been employed continuously for at least 30 days and who work more than 20 hours per week are eligible to participate in the Stock Purchase Plan at their election. However, no employee may be granted an option if such employee would immediately thereafter own, directly or indirectly, 5% or more of the combined voting power of all classes of stock of the Company, as determined pursuant to Section 424(d) of the Code.
Eligible employees may enroll as participants in the Stock Purchase Plan by executing a form provided by the Company prior to the commencement of each Option Period on which they may designate the stated maximum set forth on the form, to: (i) the portion of their compensation, in any amount up to the stated maximum set forth on the form, to be deducted semi-monthly, and accumulated for the purchase of shares of Common Stock; and/or (ii) the amount of funds, if any, which they will deposit at the beginning of the Option Period for the purchase of shares of Common Stock. Once chosen, the semi-monthly contribution for that Option Period cannot be decreased or increased without terminating the option. The aggregate maximum dollar amount which may be designated by a participant to be applied to the purchase of shares under the Stock Purchase Plan may not exceed the lesser of 15% of base compensation or $25,000 per year.
Administration and Amendment. The Stock Purchase Plan is administered by the Executive Compensation Committee of the Board of Directors. That committee is empowered to interpret and construe any provision of the Stock Purchase Plan and to adopt such rules and regulations for administering the Stock Purchase Plan as it deems necessary.
The Board of Directors of the Company may at any time, insofar as is permitted by law, alter, amend, suspend or discontinue the Stock Purchase Plan with respect to any shares not already subject to options; provided, however, that without the approval of the stockholders of the Company, no modification or amendment may increase the number of shares subject to the Stock Purchase Plan, extend the term of the Stock Purchase Plan, alter the option price formula, otherwise materially increase the benefits accruing to participants, materially modify the requirements as to eligibility for participation or amend the Stock Purchase Plan in any manner that will cause it to fail to meet the requirements of an "Employee Stock Purchase Plan" as defined in Section 423 of the Code.
Supplemental Executive Retirement Plan
The PacificAmerica Money Center, Inc. Supplemental Executive Retirement Plan (the "Supplemental Plan"), an unfunded retirement plan, is designed to provide additional employer paid benefits to certain long-term executive officers of the Company and its predecessors. Participants' years of service with the Partnership and its affiliates prior to the completion of the Restructuring carry forward for vesting and benefit accrual purposes. The Supplemental Plan covers the following four employees: Joel R. Schultz, Richard B. Fremed, Norman A. Markiewicz and Charles J. Siegel. Future participants, if any, will be determined by the Board of Directors. Administration of the Supplemental Plan is the responsibility of the Executive Compensation and Stock Option Committee of the Board of Directors.
Under the Supplemental Plan, a participant's 65th birthday is deemed his or her normal retirement date ("Normal Retirement Date"). The yearly benefit that a participant will receive at his or her Normal Retirement Date will be 1-2/3% of his or her average compensation (whether paid by the General Partner, the Partnership or the Company) for his or her highest 3 consecutive years, multiplied by the actual number of his or her years of service. However, in no event will any years of service in excess of 30 be taken into account. The participant's benefits are reduced by his estimated Social Security benefit and by his estimated Section 401(k) Plan benefit. Effective January 1, 1997, the maximum annual retirement benefit payable under the Supplemental Plan (determined after application of the reductions for a participant's estimated Social Security and 401(k) benefits) is limited to $400,000 for Joel R. Schultz and $100,000 for all other
participants. Beginning in 1998, the benefit cap amounts described above are subject to cost-of-living adjustments during the period of a participant's employment, up to a maximum of 5% per year, but only if the increase in the applicable cost-of-living index exceeds 5% for any plan year. The estimated 401(k) benefit is determined as a straight life annuity that is the actuarial equivalent of the sum of the elective deferral and company matching contributions made to the 401(k) Plan, based on the assumption that the maximum elective deferrals and company match are contributed to the 401(k) Plan on behalf of the participant each year and the participant's account yields an assumed earnings rate. Benefits are payable monthly upon the participant's retirement.
A participant is entitled to elect early retirement before his or her Normal Retirement Date, and still receive retirement benefits, at any time after: (i) he or she has completed fifteen (15) years of service; and (ii) the sum of his or her age and years of service equals or exceeds seventy (70) ("Early Retirement Date"). The dollar amount of a participant's early retirement benefit equals the normal retirement benefit reduced 1/4% for each month prior to his or her 65th birthday.
If a participant dies while employed by the Company at any time when he or she is eligible for early or normal retirement, his or her surviving spouse will receive the survivor portion of a benefit determined as if the participant had retired on the day before his or her death, and had elected to receive his or her benefit in the form of a 50% joint and survivor annuity.
Participants' benefits will become fully vested upon the attainment of their Early Retirement Date or Normal Retirement Date; however, participants will forfeit all of their benefits in the event they either: (i) are terminated for cause; or (ii) engage in competition with the Company, either before or after retirement, without express written consent of the Company.
Special rules apply following a Change of Control of the Company. If a participant terminates his employment within five (5) years following a Change of Control:
(a) the participant will be entitled to receive a benefit even if he or she voluntarily terminates employment prior to eligibility for retirement, provided it is for "good reason," which includes, among other circumstances, reduction in the participant's annual base salary, the failure to pay, within seven (7) days of the due date, any portion of the participant's compensation and the Company's failure to effectively continue any material compensation plan in which the participant participated immediately before the Change of Control;
(b) the participant will be credited with an additional five (5) years of service and entitled to receive a lump sum distribution of the present value of his or her accrued benefit; and
(c) the participant's benefit can be forfeited because he or she is terminated "for cause" only: (i) if the termination is because of the willful and continued failure by the participant to substantially perform his or her duties with the Company after a written demand for substantial performance is delivered to the participant by the Board of Directors; or (ii) by the participant's theft or embezzlement from the Company, fraud or other acts of dishonesty in the conduct of the Company's business, conviction or plea of nolo contendere to any felony or any crime involving moral turpitude, or willful and knowing action which is materially injurious to the business or reputation of the Company.
A participant also has the right to receive a lump sum benefit under the Supplemental Plan in the event of a voluntary termination of employment within one year following a Change of Control, based on his actual years of service.
The Board of Directors of the Company may amend or terminate the Supplemental Plan at any time, provided that such amendment or termination may not cancel or reduce the amount of a participant's previously accrued benefits without the consent of that participant. The termination of the Supplemental Plan will not result in immediate vesting of accrued benefits.
The following table shows the estimated annual retirement benefits, before any applicable offset for estimated Social Security benefits or estimated 401(k) benefits under the 401(k) Plan and before application of the benefit cap. Such benefits would be payable to participants in the Supplemental Plan on their Normal Retirement Date on a straight life
annuity basis. Offsets for social security and 401(k) contributions made under the 401(k) Plan may be substantial for certain participants.
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(1) Estimated annual retirement benefits, before any applicable offset for estimated Social Security benefits or estimated 401(k) benefits under the 401(k) Plan and before application of the benefit cap. Effective January 1, 1997, the maximum annual retirement benefit payable under the Supplemental Plan (determined after application of the reductions for a participant's estimated Social Security and 401(k) benefits) is limited to $400,000 for Joel R. Schultz and $100,000 all other participants - $100,000.
As of December 31, 1998, all of the Named Executives were participating in the Supplemental Plan. The average salary of the Named Executives for purposes of the Supplemental Plan does not differ substantially from that set forth in the Actual Annual Compensation table, except for the inclusion of amounts realized upon exercise or sale of shares of Common Stock received upon exercise of stock options, and except for Joel R. Schultz, whose average annual eligible compensation currently is $600,769, which is the average of his annual compensation for the years 1989, 1990 and 1991. Credited years of service in the Retirement Plan by the executives participating in the Retirement Plan are as follows: Joel R. Schultz, 24 years of service; Charles J. Siegel, five years of service; Norman A. Markiewicz, 24 years of service and Richard B. Fremed, 20 years of service. It is estimated that Mr. Schultz will reach the maximum $400,000 in annual retirement benefit payable if his average annual eligible compensation exceeds $960,000 and he has 25 or more years of service.
JOINT REPORT OF THE EXECUTIVE COMPENSATION COMMITTEE AND THE EMPLOYEE COMPENSATION COMMITTEE
The Company's Executive Compensation Committee ("Executive Compensation Committee") and Employee Compensation Committee ("Employee Compensation Committee") make this joint report on executive compensation pursuant to Item 402 of Regulation S-K. Notwithstanding anything to the contrary set forth in any of the Company's previous filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, that might incorporate future filings, including this Report, in whole or in part, this report and the performance graph which follows this report shall not be incorporated by reference into any such filings, and such information shall be entitled to the benefits provided in Item 402(a)(9) of Regulation S-K.
Compensation Committee Interlocks and Insider Participation
During the fiscal year ended December 31, 1998, the Executive Compensation Committee determined the salary and the performance-based bonuses of the Company's executive officers under written employment contracts and appropriate awards under the 1995 Stock Option Plan for all officers and employees of the Company and administered the Company's 401(k) Plan. None of the members of the Executive Compensation Committee is now, and none of the members of the Executive Compensation Committee or its predecessor the Executive Compensation and Stock Option Committee was, at any time during 1997, an officer or employee of the Company.
The Employee Compensation Committee, consisting of Joel R. Schultz and Richard D. Young, determined the salary and bonus structure for all employees who are not employed under written contracts and the annual bonuses of Messrs. Markiewicz, Fremed and Siegel.
Executive Officer Compensation Policy and Philosophy
The Company's compensation program for executive officers consists primarily of three key elements: a base salary, a performance-based annual cash bonus and periodic grants of stock options. The Company believes that its compensation policies are designed to attract, retain and reward executive officers who contribute to the Company's success, to provide economic incentives for executive officers to achieve the Company's business objectives by linking the executive officers' compensation to the performance of the Company, to strengthen the relationship between executive pay and stockholder value and to reward individual performance. Thus, compensation for such executive officers involves a high proportion of pay which is at risk: the variable annual cash bonus (which permits individual performance to be recognized on an annual basis, and which is based, in significant part, on an evaluation of the contribution made by the officer to the Company's overall performance) and stock options (which directly relate a significant portion of the executive officer's long-term remuneration to stock price appreciation realized by the Company's stockholders).
Components of Compensation
Base Salary. Executive officer salaries are established in relation to a range of salaries for comparable positions in the subprime residential lending industry. For the purpose of establishing base salary levels prior to the Restructuring, the Company compared itself to a self-selected group of subprime lenders of small to medium market capitalization, which included approximately five companies in the comparison group. When the new employment agreements with Mr. Schultz and Mr. Young were negotiated in 1998, increases in the base salary of each of them were in part established with reference to the performance of the Company at that time, and in part based upon certain other changes in those employment agreements to provide for half of each bonus payment to be made in Common Stock rather than in cash.
The Company seeks to pay salaries to executive officers that are commensurate with the qualifications, duties and responsibilities of each officer and that are competitive in the marketplace. In making its annual salary recommendations, the Executive Compensation Committee and the Employee Compensation Committee review the Company's financial position and performance, the contribution of the individual executive officers during the prior fiscal year in helping to meet the Company's financial and business objectives as well as the executive officers' performance of their individual responsibilities.
Annual Cash Bonus. Executive officer cash bonuses are used to provide executive officers with financial incentives to meet annual performance targets of the Company. The performance goals of Messrs. Schultz and Young were established in their employment agreements as specified returns on stockholder equity. The performance goals of Mr. Landini are established as a percentage of the profits of the wholesale division of Pacific Thrift. The performance targets and bonus recommendations for executives other than Messrs. Schultz, Young and Landini are established by the Employee Compensation Committee. The Employee Compensation Committee develops a Company-wide bonus pool following the end of each fiscal year. The size of the bonus pool is based upon a subjective assessment of overall Company and individual business unit performance as compared to both budgeted and prior fiscal year performance and the extent to which the Company achieved its overall financial goals of growth in earnings and return on stockholders' equity. Once the overall size of the bonus pool has been approved, the Employee Compensation Committee makes
discretionary, individual bonus recommendations for eligible employees based upon an evaluation of their individual performance and contribution to the Company's overall performance
Stock Options. The Board believes that equity ownership by executive officers provides incentive to build stockholder value and align the interests of executive officers with the interests of stockholders. Upon hiring executive officers, the Executive Compensation Committee of the Board will typically recommend stock option grants to the officers under the 1995 Plan, subject to applicable vesting periods. Thereafter, the Executive Compensation Committee will con sider awarding additional grants, usually on an annual basis, under the 1995 Plan. The Executive Compensation Committee believes that these additional annual grants will provide incentives for executive officers to remain with the Company. Options will be granted at the then current market price of the Company's Common Stock and, consequently, will have value only if the price of the Company's Common Stock increases over the exercise price. The size of the initial grant will usually be determined based upon prior grants to executive officers. In determining the size of the periodic grants the Executive Compensation Committee will consider prior option grants to the executive officer, the executive's performance during the current fiscal year and his or her expected contributions during the succeeding fiscal year.
Other Employee Benefit Plans. The Company has certain broad-based employee benefit plans in which all employees, including executive officers, are permitted to participate on the same terms and conditions relating to eligibility and subject to the same limitations on amounts that may be contributed. The Company also makes matching contributions for all participants in the Company's 401(k) Plan.
Compensation of the Principal Executive Officers
Mr. Schultz's 1998 Compensation. The terms of Mr. Schultz' employment agreement, which was approved by the stockholders at the 1998 annual stockholders meeting, provide for a base salary of $400,000 per annum and a bonus determined as a specified percentage of the net pre-tax profits of the Company if the after-tax net income of the Company results in a specified return on equity. Since the Company did not report after-tax net income for 1998, Mr. Schultz earned no bonus for 1998. See "EXECUTIVE COMPENSATION AND OTHER MATTERS - -- Employment Agreements."
Compensation of other Executive Officers and Employees. The terms of the 1998 compensation of all of the Company's executive officers were determined based on their employment agreements. See "EXECUTIVE COMPENSATION AND OTHER MATTERS -- Executive Compensation -- Employment Agreements." The annual bonuses of Mr. Young and Mr. Landini were determined under specific performance-based formulas provided in their employment agreements, both of which have been terminated. Since neither the Company nor the wholesale loan division reported any after-tax net income for 1998, neither Mr. Young nor Mr. Landini earned a bonus for 1998. See "EXECUTIVE COMPENSATION AND OTHER MATTERS -- Employment Agreements." Messrs. Siegel, Markiewicz and Fremed also received no annual bonuses based upon the Company's performance in 1998.
Respectfully submitted,
Executive Compensation Committee
Paul D. Weiser James C. Neuhauser Alan J. Siebler
Employee Compensation Committee
Joel R. Schultz
STOCKHOLDER RETURN PERFORMANCE PRESENTATION
The graph below compares the cumulative total stockholder return on the Company's Common Stock with the cumulative total return on the Nasdaq Stock Market US Index for the period commencing on June 25, 1996 (the date trading of the Company's Common Stock commenced on the Nasdaq National Market) and ending on December 31, 1998. The data set forth below assumes the value of an investment in the Company's Common Stock and the Index was $100 on June 25, 1996.
Comparison of Total Return* Since the Initial Public Offering of PacificAmerica Money Center, Inc. Among PacificAmerica Money Center, Inc., The Nasdaq Stock Market-US Index and the Nasdaq Financial Stocks Index
[THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIALS.]
NASDAQ NASDAQ Stock Financial Date PAMM Market Stocks
6/25/96 100 100 100 6/28/96 108 101 101 9/30/96 176 105 109 12/31/96 232 110 121 3/31/97 240 104 126 6/30/97 256 123 147 9/30/97 408 144 172 12/31/97 292 135 185 3/31/98 340 158 196 6/30/98 246 162 191 9/30/98 121 147 159 12/31/98 8 190 179
*In calculating cumulative total stockholder return, reinvestment of dividends, if any, was assumed.
Item 12.
Item 12. Security Ownership Of Certain Beneficial Owners and Management
The following tables sets forth the ownership of Common Stock as of March 31, 1999 by (i) those persons known by the Company to hold at least 5% of the total outstanding Common Stock of the Company; (ii) the four directors of the Company, (iii) the Chief Executive Officer and the other four most highly compensated executive officers of the Company for the fiscal year ended December 31, 1998 (the "Named Executives"), and (iv) all executive officers and directors of the Company, as a group. The table includes that portion of stock options granted to the Named Executives which are exercisable within the next 60 days, as described herein under the heading "EXECUTIVE COMPENSATION AND OTHER MATTERS - -- Plans and Arrangements -- Stock Option Plan."
Common Stock Percent Name and Address of Beneficially of Beneficial Owner Owned(1) Class ---------------- -------- -----
Joel R. Schultz(2) 110,805 2.1% 21031 Ventura Boulevard Woodland Hills, CA 91364
Richard D. Young (3) 44,049 * 5500 Wembly Ave. Oak Park, CA 91377
Charles J. Siegel(4) 38,493 * 21031 Ventura Boulevard Woodland Hills, CA 91364
Frank P. Landini(5) 30,436 * 500 Ygnacio Valley Road Walnut Creek, CA 94596
Norman A. Markiewicz(6) 66,045 1.3% 21031 Ventura Boulevard Woodland Hills, CA 91364
James C. Neuhauser(7) 27,889 * 21031 Ventura Boulevard Woodland Hills, CA 91364
Paul D. Weiser(8) 44,947 * 21031 Ventura Boulevard Woodland Hills, CA 91364
Alan J. Siebler(9) 6,600 * 21031 Ventura Boulevard Woodland Hills, CA 91364
All Directors and Executive Officers, as a group 385,602 7.4% (10 persons)(10)
- ---------- * Less than 1%.
(1) Except as otherwise noted and except as required by applicable community property laws, each person has sole voting and disposition powers with respect to the shares.
(2) Includes an aggregate of 10,007 shares of Common Stock held by Joel R. Schultz, Toby Schultz, his spouse, and The Schultz Living Trust, of which Joel R. Schultz and Toby Schultz are the co-trustees, and currently exercisable options for 100,798 shares.
(3) Includes 44,049 shares of Common Stock and no stock options.
(4) Includes 19,993 shares of Common Stock and currently exercisable options for 18,500 shares.
(5) Includes 30,436 shares of Common Stock and no stock options.
(6) Includes 55,245 shares of Common Stock and currently exercisable options for 10,800 shares.
(7) Includes 24,889 shares of Common Stock and currently exercisable options for 3,000 shares.
(8) Includes 41,947 shares of Common Stock and currently exercisable options for 3,000 shares.
(9) Includes 4,600 shares of Common Stock and currently exercisable options for 2,000 shares.
(10) Includes 244,504 shares of Common Stock and currently exercisable options for 141,098 shares.
The Company knows of no contractual arrangements which may at a subsequent date result in a change in control of the Company.
Item 13.
Item 13. Certain Relationships and Related Transactions
In 1998, the Company engaged Friedman, Billings, Ramsey & Co., Inc. ("FBR"), an investment banking firm, to act as the Company's exclusive financial adviser in connection with an analysis of the Company's strategic opportunities. James C. Neuhauser, a director of the Company, is also a Managing Director of FBR. In the event that the Company engages in a purchase or sale of assets or stock with another company, or completes a financing transaction, the Company has agreed to pay commissions to FBR pursuant to either a specified formula or to be negotiated in connection with the transaction. If a transaction is completed, the amount of compensation payable to FBR is expected to exceed $60,000, but the amount cannot be determined until the details of any such transaction are known.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) List of Financial Statements
Financial Statements required to be filed hereunder start on page
(a)(2) List of Financial Statement Schedules
None.
(a)(3) List of Exhibits
The exhibits required to be filed hereunder are indexed on page S-1 hereof.
(b) The Company filed no Reports on Form 8-K for the quarter ended December 31, 1998.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on April 15, 1999.
PACIFICAMERICA MONEY CENTER, INC.
By: /S/ JOEL R. SCHULTZ ---------------------------------------- Joel R. Schultz, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Registration Statement has been signed below by the following persons on behalf of the Company in the capacities and on the dates indicated.
Signature Capacity Date - --------- -------- ----
/S/ JOEL R. SCHULTZ Director, Chief Executive Officer April 15, 1999 - ------------------------- and Chairman of the Board Joel R. Schultz
/S/ CHARLES J. SIEGEL Chief Financial and Accounting April 15, 1999 - ------------------------- Officer Charles J. Siegel
/S/ JAMES C. NEUHAUSER Director April 15, 1999 - ------------------------- James C. Neuhauser
/S/ PAUL D. WEISER Director April 15, 1999 - ------------------------- Paul D. Weiser
/S/ ALAN J. SIEBLER Director April 15, 1999 - ------------------------- Alan Siebler
PacificAmerica Money Center, Inc. and Subsidiaries
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Consolidated Financial Statements Years Ended December 31, 1998, 1997 and 1996
PacificAmerica Money Center, Inc. and Subsidiaries
Contents
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PacificAmerica Money Center, Inc. and Subsidiaries
Report of Independent Certified Public Accountants
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Changes in Stockholders' Equity/Partners' Capital for the years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements for the years ended December 31, 1998, 1997 and 1996
Supplemental Material
Schedule I - Consolidated Schedule - Financial Position - December 31, 1998 Schedule II - Consolidating Schedule - Operations - year ended December 31, 1998 Schedule III - Consolidating Schedule - Financial Position - December 31, 1997 Schedule IV - Consolidating Schedule - Operations - year ended December 31, 1997 Schedule V - Consolidating Schedule - Operations - year ended December 31, 1996
Report of Independent Certified Public Accountants
To the Stockholders PacificAmerica Money Center, Inc.
We have audited the accompanying consolidated balance sheets of PacificAmerica Money Center, Inc. and subsidiaries (collectively, the Company) as of December 31, 1998 and 1997 and the related consolidated statements of operations, changes in stockholders' equity/partners' capital, and cash flows for each of the three years in the period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits 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 audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PacificAmerica Money Center, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years ended December 31, 1998, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1, the Company incurred a net loss of $24,488,000 during the year ended December 31, 1998 and has an accumulated deficit of $3,231,000 at December 31, 1998. At December 31, 1998, the Company is in default of the repayment terms of its obligations related to its interest-only strips receivable (Note 9(b)). At December 31, 1998, the Company's major subsidiary, Pacific Thrift & Loan Company ("Pacific Thrift"), did not meet the minimum capital requirements to be considered "adequately capitalized" by the Federal Deposit Insurance Corporation (FDIC). As a result of its capital designation, Pacific Thrift was required to submit a capital restoration plan to the FDIC. In addition, Pacific Thrift consented to a comprehensive Order to Cease and Desist (the 1998 Order) issued by the FDIC. The 1998 Order requires that Pacific Thrift take various actions, which included increasing its leverage capital ratio to 8% by January 31, 1999. As of April 9, 1999 Pacific Thrift did not meet the capital requirements specified in the 1998 Order. Failure to implement the capital restoration plan and meet the capital requirements of the 1998 Order expose Pacific Thrift to various regulatory actions, including the risk of regulatory takeover. Pacific Thrift entered into an additional Order to Cease and Desist (the 1999 Order) which relates to Banking information systems. These matters raise substantial doubt about the ability of the Company to continue as a going concern. Management's plans regarding these matters are discussed in Note 1. The accompanying financial statements do not include any provisions or adjustments which might result from the outcome of the uncertainties discussed above.
Our audit was made for the purpose of forming an opinion on the consolidated financial statements taken as a whole. The consolidating information in Schedules I, II, III, IV and V is presented for the purpose of additional analysis of the consolidated financial statements rather than to present the financial position and results of operations of the individual companies. The consolidating information in Schedules I, II, III, IV and V has been subjected to the auditing procedures applied to the audit of the consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the consolidated financial statements taken as a whole.
BDO Seidman, LLP
Los Angeles, CA April 9, 1999
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December 31, 1998 1997 - --------------------------------------------------------------------------------
Assets
Cash and cash equivalents (Note 2C) $ 41,811,000 $ 65,927,000
Restricted cash (Note 2D) 582,000 163,000
Receivables 132,000 1,532,000
Accrued interest receivable 1,315,000 1,274,000
Refundable income taxes -- 222,000
Receivables from related parties (Note 11) 215,000 83,000
Note receivable -- 1,015,000
Loans held for sale, (Notes 2E and 3) 72,814,000 35,280,000
Loans receivable (Notes 2F, 2G and 3) 9,444,000 20,629,000
Other real estate (Notes 2M and 5) 219,000 2,028,000
Interest-only strips receivable (Notes 2H, 2I, 2J, 6 and 9) 116,628,000 94,424,000
Property and equipment (Notes 2N and 7) 4,421,000 3,596,000
Other assets 2,633,000 1,693,000 - --------------------------------------------------------------------------------
$250,214,000 $227,866,000 ================================================================================
PacificAmerica Money Center, Inc. and Subsidiaries
Consolidated Balance Sheets
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See accompanying notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Consolidated Statements of Operations
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PacificAmerica Money Center, Inc. and Subsidiaries
Consolidated Statements of Operations
================================================================================
See accompanying notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity/Partners' Capital
================================================================================
See accompanying notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
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PacificAmerica Money Center, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
================================================================================
PacificAmerica Money Center, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
================================================================================
See accompanying notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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1. General Organization
On June 27, 1996, PacificAmerica Money Center, Inc. (the "Corporation" or "Company"), a Delaware Corporation formed in 1994 as a wholly owned subsidiary of Presidential Mortgage Company, a California limited partnership (the "Partnership") completed a Restructuring Plan dated May 1, 1996 (the "Restructuring"), whereby all of the assets and liabilities of the Partnership were transferred to the Corporation in exchange for common stock of the Corporation (the "Common Stock"). The Common Stock was distributed to the partners of the Partnership, pro rata in accordance with their capital accounts in the Partnership. In accordance with the terms of the Restructuring Plan, the consent of a majority of limited partners to the Restructuring Plan was solicited pursuant to a Proxy Statement/Prospectus dated May 14, 1996, and the consent of approximately 75% of all limited partners was obtained by June 17, 1996, the expiration of the solicitation period. Every limited partner was given the right to elect to receive cash in lieu of shares of the Corporation (the "Cash Out Option"), in an amount equal to $5.00 per share times the number of shares that would have been received by that partner based on their capital account in the Partnership. Pursuant to the Restructuring Plan, 1,206,468 shares of Common Stock were issued to partners of the Partnership (other than partners accepting the cash out option) for their interests in the Partnership and $2,855,600 was paid by the Corporation to partners electing the Cash Out Option.
Also pursuant to the terms of the Restructuring Plan, Presidential Management Company, the general partner of the Partnership (the "General Partner") purchased 1,126,666 warrants ("General Partner Warrants") for a purchase price of $385,000. The General Partner Warrants were each exercisable for one share of Common Stock at a purchase price of $7.50 per share from June 27, 1996 until December 27, 1997. The General Partner Warrants were nontransferable, except to and between partners of the General Partner.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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1. General Organization (Continued) (Continued) Concurrently with the solicitation of consent pursuant to the Proxy Statement/Prospectus dated May 16, 1996, all partners of the Partnership, together with all partners of the General Partner, and all officers, directors, proposed directors and employees of the Partnership, all of its subsidiaries and the Corporation, were given the right to purchase additional shares of Common Stock (the "Rights Offering") at a purchase price of $5 per share. A total of 649,256 shares were subscribed for and issued in the Rights Offering. For every ten shares subscribed for in the Rights Offering, a subscriber also received one warrant ("Subscriber Warrants"). A total of 129,850 Subscriber Warrants were issued in connection with the Rights Offering, each exercisable from June 27, 1996 until June 27, 1998, for one share of Common Stock at a purchase price of $6.25 per share.
Pursuant to a Prospectus dated June 24, 1996, the Corporation also conducted a public offering of additional shares of Common Stock at $5.00 per share (the "Public Offering"). A total of 1,756,420 shares were issued in the Public Offering, including 220,098 shares in connection with the exercise of an over-allotment option by the underwriter of the Public Offering.
The Corporation issued a total of 3,612,144 shares of Common Stock in connection with the Restructuring Plan, the Rights Offering and the Public Offering. The shares of Common Stock were listed for trading on the Nasdaq National Market under the symbol "PAMM." Trading in the stock commenced on June 25, 1996. The Common Stock was delisted from the Nasdaq National Market on February 26, 1999 because the trading price of the Common Stock was less than $1 per share and the market value of public float was less than $5 million. The Common Stock is currently traded on the OTC Bulletin Board.
Concurrently with the closing of the Restructuring, the Rights Offering and the Public Offering on June 27, 1996, the Partnership filed certificates of dissolution and liquidation with the California Secretary of State.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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1. General Organization (Continued) (Continued) The Restructuring has been accounted for as a change in legal organization but not in the enterprise of the Partnership. Therefore, the financial statements of the Corporation give effect to the Restructuring as a recapitalization of the Partnership into the Corporation. References to the Corporation in the financial statements refer to the financial condition and results of operations of the Partnership on a consolidated basis for all periods prior to June 27, 1996.
In 1988, the Partnership formed Pacific Thrift and Loan Company, a California corporation ("Pacific Thrift"), as a wholly owned subsidiary, to engage in the business of origination, purchase and sale of real estate secured loans under a California thrift and loan license. Pacific Thrift also issues deposits insured by the Federal Deposit Insurance Corporation ("FDIC"), and is therefore subject to regulation by both the FDIC and the California Department of Financial Institutions. The Company has been primarily engaged in mortgage banking activities and as such originates and sells mortgage loans to investors in the secondary markets. In December 1997, the Company began to securitize loans into asset-backed securities. The Company's ability to continue to originate loans is dependent, in part, upon its ability to sell loans in the secondary market in order to generate cash proceeds for new origination. The value of and market for the Company's loans are dependent upon a number of factors, including general economic conditions, interest rates and governmental regulations. Adverse changes in such factors may affect the Company's ability to sell loans for acceptable prices within reasonable periods of time. A prolonged reduction in the size of the secondary market demand for loans of these types originated by the Company could adversely affect the Company's ability to operate profitably in the future.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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1. General Organization (Continued) (Continued) Pacific Thrift specializes in home equity loans for borrowers whose credit histories and/or other factors limit their ability to qualify for financing from conventional sources. Such loans are generally referred to in the lending industry as "sub-prime" or "B"/"C" credit loans. Borrowers generally obtain loans from Pacific Thrift to finance the purchase of property, refinance an existing mortgage on more favorable terms, consolidate debt or obtain cash proceeds for their personal use.
In October 1998, due to a reduction in demand for the purchase of loans by the secondary market, Pacific Thrift closed its wholesale division which management felt was no longer profitable (Note 2V). Approximately 75% of the current loan production came from this division.
Pacific Thrift continues to operate its retail division because the net loan origination costs are lower for retail production and Pacific Thrift believes it can generate profits through the retail division at loan sale premiums currently available in the secondary market. Pacific Thrift's retail division originates loans directly with borrowers using primarily telemarketing and direct mail. The largest volume of home equity loan originations were in California, New York, New Jersey, Washington and Florida. The Company issues thrift certificates to investors that are redeemable upon maturity at the option of the investors, although penalties for early withdrawal may be assessed. The California Industrial Loan Law maintains provisions governing the types of loans that may be made, the amount of thrift certificates that may be issued, and the amount of funds that may be borrowed.
PacificAmerica Money Centers, Inc. ("PAMC") (formerly PacificAmerica Lending), was formed in 1996 for the purpose of engaging in the lending business under a California finance lender's license and other state licenses where management deems it appropriate. Immediately after the restructuring the Company contributed net assets of $2,920,000 to PAMC at book value. As of the date hereof, PAMC has not engaged in significant loan production, but it may become more active in the future, depending upon business requirements.
The Company formed a wholly-owned subsidiary, PacificAmerica Securities, Inc. (PSI), which is a special purpose entity. Its purpose is to acquire loans from the Company and use them as collateral under a warehousing agreement with an outside third party.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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1. General Organization (Continued) (Continued) The Partnership also owned substantially all of the interests in three subsidiaries engaged in the trust deed foreclosure services and posting and publishing businesses, Consolidated Reconveyance Company ("CRC"), a California limited partnership, Lenders Posting and Publishing Company ("LPPC"), a California limited partnership, and Consolidated Reconveyance Corporation ("CRCWA"), a Washington corporation. The Corporation acquired all of the Partnership's interests in these entities in connection with the Restructuring. Effective December 31, 1996, all of the assets and liabilities of CRC and LPPC and all of the stock of CRCWA were sold (Note 16). This is part of the Company's strategy to concentrate all of its financial and human resources on its primary business of residential lending for sale and securitization.
The Partnership's general partner, Presidential Management Company, was a California limited partnership. Presidential Management Company's general partner, Presidential Services Corporation, was a California corporation owned by Joel R. Schultz, John A. DeRosa and Constance DeRosa.
The Partnership's limited partners consisted of approximately 2,500 individuals and entities in classes A, B, C, D, and E. The differences between the various classes primarily related to the different offering dates and unit prices as well as profit priorities and percentages. In addition, certain partners elected to reinvest their distributions in Distribution Reinvestment Plan (DRP) Units.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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1. General Operating Results and Capital Restoration Plan (Continued) The Company incurred a net loss of $24,488,000 during the year ended December 31, 1998 and has an accumulated deficit of $3,231,000 at December 31, 1998. Management believes these losses were reflective of the rapid change in marketplace demand for the purchase of sub-prime paper by the secondary market during the latter half of 1998. In 1998 the fair value of the interest-only strips receivable were adjusted down by $38,300,000 (Notes 2H and 6). It is possible that future adjustments may be required. At December 31, 1998, the Company is in default of the repayment terms of its obligations related to its interest-only strips receivable (Note 9b). In addition, Pacific Thrift was not "adequately capitalized" at the end of 1998 or by March 22, 1999 and became subject to certain regulatory mandates and sanctions (Note 13). Pacific Thrift also has additional regulatory mandates imposed relating to its Year 2000 readiness and the related Bank information systems (Notes 13 and 15). Failure to implement the regulatory mandates would expose Pacific Thrift to various regulatory actions, including the risk of regulatory takeover.
These matters raise substantial doubt about the ability of the Company to continue as a going concern. Management's plans regarding these matters are as follows:
Management has taken and continues to take steps to return the Company to profitability and improve its financial condition, including such actions as the closure of Pacific Thrift's wholesale operations (Note 2V), an emphasis on originating residential real estate loans for sale under whole loan sale agreements for a cash premium through its retail division, a reduction in portfolio lending until targeted capital ratios are achieved, and reducing overhead expenses. Pacific Thrift has hired a consultant and submitted a revised Year 2000 plan to the regulators and believes it will be able to meet the guidelines of the order regarding Year 2000 (Note 13).
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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1. General Operating Results and Capital Restoration Plan (Continued) (Continued)
Management expects that Pacific Thrift will be profitable in 1999 and will comply to the greatest extent possible with the regulatory mandates. Management has submitted a Capital Restoration Plan (the Plan) which was approved by the FDIC. In addition to a revised business plan, the Plan includes restructuring debt to provide capital contributions to Pacific Thrift and raising capital through private or public offerings of debt or equity securities. Management is negotiating a restructuring of its obligations in default relating to its interest-only strips receivable. (Note 9) There is no assurance that management's plans can be achieved. These financial statements do not include any provisions or adjustments that might result from the outcome of these uncertainties.
2. Summary of A. Consolidation Significant Accounting The consolidated financial statements include the Policies accounts of the Corporation, Pacific Thrift, PAMC, CRC, LPPC, CRC Washington and PSI. All significant intercompany balances and transactions have been eliminated. Consolidating information is presented in Schedules I, II, III, IV and V. On December 31, 1996 CRC, LPPC and CRC Washington were sold (Note 16).
B. Earnings Per Share
On July 10, 1997, the Board of Directors of the Company declared a stock dividend accounted for as a one-for-one stock split to all stockholders of record as of July 31, 1997. The stock dividend was paid on August 13, 1997. These financial statements reflect the effect of the stock dividend on current and prior period's earnings per share and shares outstanding.
On December 31, 1997 the Company adopted Statement of Financial Accounting Standards No. 128 (SFAS No. 128), "Earnings Per Share", which established new standards for calculating and disclosing earnings per share. All prior period earnings per share data have been restated to conform to the provisions of SFAS No. 128.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of B. Earnings Per Share (Continued) Significant Accounting Basic earnings per share is computed by dividing Policies net earnings by the weighted average number of (Continued) shares of Common Stock outstanding during each year. Diluted earnings per share is computed by dividing net earnings by the weighted average number of shares of Common Stock and potential Common Stock outstanding during each year. All share and per-share amounts have been restated to reflect the stock dividend accounted for as a one-for-one stock split, in August 1997. The following table presents the earnings per share data as required by SFAS No. 128.
Pro Historical Forma --------------------------- ---------- Year ended December 31, 1998 1997 1996 - --------------------------------------------------------------------------------
Income (numerator) Income/(loss) before income taxes (benefit) $(35,478,000) $29,563,000 $6,471,000
Income taxes (benefit) (10,990,000) 12,468,000 2,718,000 - --------------------------------------------------------------------------------
Income (loss) from continuing operations $(24,448,000) $17,095,000 $3,753,000 ================================================================================
Shares (denominator) Weighted average common shares outstanding for basic earnings per share 5,078,325 4,093,274 2,449,454 Effect of dilutive common shares: Subscriber warrants 0 68,025 41,681 General partner warrants -- 471,287 317,666 Options 0 281,816 146,877 - --------------------------------------------------------------------------------
Diluted common shares 5,078,325 4,914,402 2,955,678 ================================================================================
Basic earnings (loss) per common share from continuing operations $ (4.82) $ 4.18 $ 1.53 - --------------------------------------------------------------------------------
Diluted earnings (loss) per common share from continuing operations $ (4.82) $ 3.48 $ 1.27 ================================================================================
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of B. Earnings Per Share (Continued) Significant Accounting Options to purchase 456,362 shares of common stock Policies at a range of price from $0.50 to $28.75 per share (Continued) were outstanding at December 31, 1998 but were not included in the computation of earnings per share because the options' exercise price was greater than the average market price of the common stock.
Options to purchase 11,424 shares of common stock at a range of price from $23.00 to $28.75 per share were outstanding at December 31, 1997 but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common stock.
Earnings per common share for the years ended December 31, 1996 assumes the restructuring (Note 1) took place at the beginning of the period and the Company was taxed for federal and state income tax purposes as a taxable corporation at a 42% effective tax rate.
Earnings per share related to discontinued operations and net income for 1996 includes additional pro forma income tax expense of $126,000 related to the tax effect of the income from the discontinued operations.
C. Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with an initial maturity of three months or less to be cash equivalents. Cash and cash equivalents at December 31, 1998 includes $38,000,000 on deposit with the Federal Reserve and $3,811,000 on deposit with a major well capitalized bank which is in excess of the federally insured limit of $100,000. Cash and cash equivalents at December 31, 1997 includes $50,000,000 on deposit with the Federal Reserve and $15,270,000 on deposit with a major well capitalized bank in an account which is in excess of the federally insured limit of $100,000.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of D. Restricted Cash Significant Accounting Cash received in connection with certain loan sale Policies transactions are held in a trust account for the (Continued) beneficiary and is classified as restricted cash on the Company's balance sheet. This amount represents the monthly timing difference between when cash is received and when it is remitted.
E. Loans Held for Sale
The Company has designated certain of its loans receivable as being held for sale. Loans held for sale are recorded at the lower of cost or market value. Any unrealized losses are recorded as a reduction in income. Gains or losses on disposition are based on the net proceeds and the adjusted carrying amount of the assets sold, using the specific identification method.
F. Loans Receivable
Loans receivable are stated at the principal amount outstanding, less unamortized deferred fees and costs and the allowance for loan losses (ALLL). Loans receivable are primarily secured by first and second trust deeds.
Interest income is accrued as earned and is based on the principal balance outstanding. The Company's policy is to cease accruing interest on loans that are more than two monthly payments past due and for which there appears to be insufficient collateral to support collectibility. In many cases, interest, late fees, and other charges continue to accrue until the time management deems that such amounts are not collectible. When a loan is placed on a nonaccrual status, the Company records allowances for all accrued but uncollected interest income.
Nonrefundable loan fees and direct costs associated with the origination of loans are deferred and are offset against outstanding loan balances. These net deferred fees and costs are recognized in interest income over the loan term as an adjustment to the yield, using a method that approximates the effective interest (level yield) method, or included in income when the loan is sold.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of G. Allowance for Loan Losses Significant Accounting Loan losses are charged to the ALLL and recoveries Policies are credited to the ALLL. The provision for loan (Continued) losses charged to expense and added to the ALLL is based upon management's judgment and evaluation of the known and inherent risks in the loan portfolio. Management's judgment takes into consideration such factors as changes in the nature and volume of the portfolio, continuing review of delinquent loans, current economic conditions, risk characteristics of the various categories of loans, and other pertinent factors that may affect the borrower's ability to repay. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions.
The Company follows 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). A loan is considered to be impaired when it is probable that the Company will be unable to collect all principal and interest amounts according to the contractual terms of the loan agreement. The ALLL related to loans identified as impaired is primarily based on the excess of the loan's current outstanding principal balance over the estimated fair market value of the related collateral. For a loan that is not collateral-dependent, the allowance is recorded at the amount by which the outstanding principal balance exceeds the current best estimate of the future cash flows on the loan discounted at the loan's effective interest rate.
For impaired loans that are on non-accrual status, cash payments received are generally applied to reduce the outstanding principal balance. However, all or a portion of a cash payment received on a non-accrual loan may be recognized as interest income to the extent allowed by the loan contract, assuming management expects to fully collect the remaining principal balance of the loan.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of G. Allowance for Loan Losses (Continued) Significant Accounting A restructuring of a debt is considered a troubled Policies debt restructuring when the Company, for economic (Continued) or legal reasons related to the borrower's financial difficulties, grants a concession to the borrower that it would not otherwise grant. Troubled debt restructuring may include changing repayment terms, reducing the stated interest rate and reducing the amounts of principal and/or interest due or significantly extending the maturity date. The restructuring of a loan is intended to recover as much of the Company's investment as possible and to achieve the highest yield possible.
H. Loan Sales Revenue Recognition
Gain or loss on the sale of mortgage loans to investors is recognized at the date the loans are sold to the investors, and all title and rights to such loans are legally conveyed to the investors pursuant to existing sales agreements and the Company has surrendered control of such financial assets. Loans are generally sold on a servicing-released basis.
Gain on sale of loans represents the difference between the gross proceeds (including premiums) from the sale, net of related transaction costs, and the allocated carrying amount of the loans sold. The allocated carrying amount is determined by allocating the carrying amount of loan between the portion sold and any retained residual interests (interest-only strips receivable), based on their relative fair values at the date of transfer. In addition, gain on sale includes non-refundable fees on loans sold.
Gain on sale of loans includes the recognition of an unrealized gain, which represents the initial difference between the allocated carrying amount and the fair value of the interest-only strips at the date of sale.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of H. Loan Sales Revenue Recognition (Continued) Significant Accounting The fair value of the interest-only strips Policies receivable is determined by computing the present (Continued) value of the excess interest income to be received by the Company over the coupon interest to the investor after giving effect to prepayment assumptions, allowance for potential credit losses, and other transaction costs on loans sold. The interest-only strips receivable, which is classified as a trading security, is carried at fair value and is analyzed quarterly by the Company. Adjustments to the fair value are recognized as unrealized gains or losses and are included as part of gain on sale of loans. Adjustments of $38.3 million and $2.3 million were recorded as a reduction of the interest-only strips receivable fair value in 1998 and 1997.
Fair value of the interest-only strips receivable is based on management's judgments regarding expected future cash flows taking into account estimated loan prepayment speeds, estimated default rates and an appropriate discount rate given the risk characteristics associated with the instrument. It is possible that these judgments and estimates could change in the near term due to competitive pressures, the overall economy, adverse changes in the securitization market, and actual prepayment and default experience rates. The amounts the Company will ultimately realize could differ significantly and could require an adjustment to the fair value of this asset in the near term.
The premium earned from whole loans originated and subsequently sold at par plus an upfront premium, with no further rights to any further yield, is included under gain on sale of loans in the Statements of Operations.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of I. Mortgage Servicing Rights Significant Accounting In 1996, the Company adopted SFAS No. 122, Policies "Accounting for Mortgage Servicing Rights, an (Continued) amendment of FASB Statement No. 65." SFAS No. 122 requires the Corporation to capitalize mortgage servicing rights on originated mortgage loans when the loans are originated to be sold or securitized and servicing is retained. When a mortgage loan is originated to be sold with servicing retained, the total cost of the loan is allocated to the mortgage servicing right and the loan based on their relative fair values. Under SFAS No. 122, capitalized servicing rights are assessed for impairment based on the fair value of those rights. In addition, capitalized mortgage servicing rights must be stratified based on one or more predominant risk characteristics of the underlying loans and impairment is recognized through a valuation allowance for each impaired stratum.
The effect of the adoption of SFAS No. 122 was not material to the Company, primarily because the Company sells substantially all of its loans on a servicing released basis.
J. Transfers and Servicing of Financial Assets and Extinguishment of Liabilities
On January 1, 1997, the Company adopted Statement of Financial Accounting Standard No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities: (SFAS 125). This statement provides guidance for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS 125 supersedes SFAS 76, 77 and 122, while amending both SFAS 65 and 115. The statement was to be applied prospectively and earlier implementation was not permitted. The adoption of SFAS 125 did not have a material effect on the Company's results of operations.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of J. Transfers and Servicing of Financial Assets and Significant Extinguishment of Liabilities (Continued) Accounting Policies A transfer of financial assets in which control is (Continued) surrendered is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in the exchange. Liabilities and derivatives incurred or obtained by the transfer of financial assets are required to be measured at fair value, if practicable. Also, servicing assets and other retained interests in the transferred assets must be measured by allocating the previous carrying value between the asset sold and the interest retained, if any, based on their relative fair values at the date of transfer. For each servicing contract in existence before January 1, 1997, previously recognized servicing rights and excess servicing receivables that did not exceed contractually specified servicing fees were required to be combined, net of any previously recognized servicing obligations under that contract, as a servicing asset or liability. Previously recognized servicing receivables that exceed contractually specified servicing fees (formerly known as excess yield receivable) are required to be reclassified as interest-only strip receivables and the allowance for credit losses on loans sold reclassified as a reduction of these receivables.
SFAS 125 also requires an assessment of interest-only strips, loans, other receivables and retained interests in securitizations. If these assets can be contractually prepaid or otherwise settled such that the holder would not recover substantially all of its recorded investment, the assets will be measured like available-for-sale securities or trading securities under SFAS 115. This assessment is required for financial assets held on or acquired after January 1, 1997.
K. Impairment of Long-Lived Assets
In 1996, the Company adopted SFAS No. 121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," which addresses accounting for impairment of long-lived assets, including certain identifiable intangibles, and goodwill related to those assets. SFAS No. 121 requires that assets to be held and used be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The initial adoption of SFAS No. 121 did not have a material impact on the Company's financial condition or results of operations.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of L. Advertising Costs Significant Accounting The Company generally charges to expense the Policies production costs of advertising the first time the (Continued) advertising takes place, except for direct-response advertising, which is capitalized and amortized over the expected period of future benefits. Direct-response advertising includes mailing campaigns relating to retail loan solicitations which are mailed over a period of twelve weeks. Capitalized direct-response advertising included in prepaid expenses and other assets was $577,818 and $167,012 at December 31, 1998 and 1997. Advertising expense was $7,714,000, $4,653,000 and $689,000 for the years ended December 31, 1998, 1997 and 1996.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of M. Other Real Estate Significant Accounting Other real estate is comprised of formally Policies foreclosed property. These assets are recorded at (Continued) the lower of the net investment in the loan or the fair value of the property. At the time of foreclosure, any excess of the net investment in the loan over its fair value is charged to the allowance for loan losses. Selling costs and any subsequent declines in value are charged to operations, and a valuation allowance is established.
N. Property and Equipment
Property and equipment is stated at cost, less accumulated depreciation. Depreciation of property and equipment is based on the asset's estimated useful life, ranging from two to eight years, and is computed using the straight-line method. Expenditures that improve or extend the service lives of assets are capitalized. Repairs and maintenance are charged to expense as incurred.
O. Goodwill
Goodwill represented the excess of the total purchase price (consisting of the initial consideration and subsequent consideration) of CRC and LPPC over the fair value of purchased net assets. Goodwill was amortized using the straight-line method over approximately 20 years. The Company sold CRC and LPPC in 1996 and wrote off the remaining goodwill, which is included in loss from discontinued operations in the Consolidated Statement of Operations (Note 16).
P. Income Taxes
The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for tax consequences of temporary differences by applying enacted statutory tax rates to differences between the financial statement carrying amount and the tax basis of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of P. Income Taxes (Continued) Significant Accounting All tax benefits are recorded and then reduced by Policies a valuation allowance when management believes (Continued) there is a greater likelihood, the benefit will not be realized than there is of the asset being realized.
Partnerships are generally not subject to income taxes, accordingly, the Partnership income or loss was reported in the individual partners' tax returns. However, Pacific Thrift, the Partnership's wholly owned corporate subsidiary, has always been subject to federal income and state franchise taxes. Since completion of the restructuring (Note 1) the Company is also subject to federal and state income taxes.
Q. Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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.
R. Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments (SFAS 107), requires that the Company disclose estimated fair values for its financial instruments. Fair value estimates, methods, and assumptions are set forth below for the Company's financial instruments. SFAS No. 107 defines fair value as the amount which the instrument could be exchanged for in a current transaction between willing parties, other than in a forced sale or liquidation. Where possible, the Company has utilized quoted market prices to estimate fair value. Since quoted market prices were not available for a significant portion of the financial instruments, the fair values were approximated using discounted cash flow techniques.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of R. Fair Value of Financial Instruments (Continued) Significant Accounting Fair value estimates are made at a specific point Policies in time, based on judgments regarding future (Continued) expected loss experience, current economic conditions, risk conditions, risk characteristics of various financial instruments and other factors. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates in the near term.
Fair value estimates were based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.
The following presents the carrying value and estimated fair value of the various classes of financial instruments held by the Company. This information is presented solely for compliance with SFAS No. 107 and is subject to change over time based on a variety of factors.
December 31, 1998 ---------------------------------- Carrying Estimated Value Fair Value ----------------------------------------------------------------------- Assets Cash and cash equivalents $ 41,811,000 $ 41,811,000
Loans receivable 10,504,000 10,288,000 Allowance for loan losses (1,060,000) (1,046,000) -----------------------------------------------------------------------
Total loans 9,444,000 9,242,000 -----------------------------------------------------------------------
Loans held for sale 72,814,000 74,998,000 Interest-only strips receivable 116,628,000 116,628,000
Liabilities Installment certificates 29,692,000 29,692,000 Fully-paid certificates 132,618,000 132,328,000 Notes payable 52,958,000 52,958,000
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of R. Fair Value of Financial Instruments (Continued) Significant Accounting Policies (Continued) December 31, 1997 ---------------------------------- Carrying Estimated Value Fair Value ----------------------------------------------------------------------- Assets Cash and cash equivalents $ 65,927,000 $ 65,927,000
Loans receivable 22,067,000 21,981,000 Allowance for loan losses (1,438,000) (1,438,000) -----------------------------------------------------------------------
Total loans 20,629,000 20,543,000 -----------------------------------------------------------------------
Loans held for sale 35,280,000 37,154,000 Interest-only strips receivable 94,424,000 94,424,000
Liabilities Fully-paid certificates 113,731,000 113,449,000 Installment certificates 18,793,000 18,793,000 Notes payable 28,318,000 28,318,000
Cash, Short Term-Investments, Trade Receivables, and Trade Payables
The carrying amount approximates fair value because of the short maturity of these instruments.
Loans
Fair values were estimated for portfolios of loans with similar financial characteristics. Loans were segregated by type such as commercial real estate and residential mortgage. Each loan category was further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of R. Fair Value of Financial Instruments (Continued) Significant Accounting Loans (Continued) Policies (Continued) The fair value for performing fixed rate commercial real estate loans was estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. The fair values for performing commercial real estate loans indexed to a market-lending rate with normal credit risk were assumed to approximate their carrying value. For residential mortgage loans, fair value was estimated by using quoted market prices for loans with similar credit and interest rate risk characteristics.
Fair value for significant nonperforming loans was based on recent external appraisals or broker price opinions adjusted for anticipated credit loss risk, estimated time for resolution, valuation of the underlying collateral and other related resolution costs. If appraisals or recent broker price opinions are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information.
Loans Held for Sale
The fair values were estimated by using current institutional purchaser yield requirements.
Interest-only Strips Receivable
The fair value was determined by using estimated discounted future cash flows taking into consideration current and estimated future prepayment rates and default experience. The carrying amount is considered to be a reasonable estimate of fair value.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of R. Fair Value of Financial Instruments (Continued) Significant Accounting Thrift Certificates Payable Policies (Continued) Under SFAS 107, the fair value of deposits with no stated maturity, such as savings and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
December 31, 1998 ------------------------------ Carrying Estimated Value Fair Value ---------------------------------------------------------------------- Installment certificates $ 29,692,000 $ 29,692,000 ====================================================================== Fully-paid certificates: Maturing in six months or less $ 55,412,000 $ 55,297,000 Maturing between six months and one year 72,465,000 72,246,000 Maturing between one and three years 4,741,000 4,785,000 ---------------------------------------------------------------------- Total fully-paid certificates $132,618,000 $132,328,000 ======================================================================
December 31, 1997 ------------------------------ Carrying Estimated Value Fair Value ---------------------------------------------------------------------- Installment certificates $ 18,793,000 $ 18,793,000 ======================================================================
Fully-paid certificates: Maturing in six months or less $ 53,637,000 $ 53,518,000 Maturing between six months and one year 59,999,000 59,836,000 Maturing between one and three years 95,000 95,000 ---------------------------------------------------------------------- Total fully-paid certificates $113,731,000 $113,449,000 ======================================================================
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of R. Fair Value of Financial Instruments (Continued) Significant Accounting Thrift Certificates Payable (Continued) Policies (Continued) The remaining assets and liabilities of the Company are not considered financial instruments and have not been valued differently than is customary under historical cost accounting. Since assets and liabilities that are not financial instruments are excluded, the difference between total financial assets and financial liabilities does not, nor is it intended to, represent the market value of the Company. Furthermore, the estimated fair value information may not be comparable between financial institutions due to the wide range of valuation techniques permitted, and assumptions necessitated, in the absence of an available trading market.
Notes Payable
Due to the adjustable rate characteristics of the notes payable, the fair value approximates the carrying value.
The remaining assets and liabilities of the Company are not considered financial instruments and have not been valued differently than is customary under historical cost accounting. Since assets and liabilities that are not financial instruments are excluded, the difference between total financial assets and financial liabilities does not, nor is it intended to, represent the market value of the Company. Furthermore, the estimated fair value information may not be comparable between financial institutions due to the wide range of valuation techniques permitted, and assumptions necessitated, in the absence of an available trading market.
S. Stock-Based Compensation
In 1996, the Company adopted for footnote disclosure purposes only, SFAS No. 123, "Accounting for Stock-Based Compensation," which requires that companies measure the cost of stock-based employee compensation at the grant date based on the value of the award and recognize this cost over the service period. The value of the stock-based award is determined using the intrinsic value method whereby compensation cost is the excess of the quoted market prices of the stock at grant date or other measurement date over the amount an employee must pay to acquire the stock.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of T. Recently Issued Accounting Pronouncements Significant Accounting Reporting Comprehensive Income Policies (Continued) In June 1997, FASB issued SFAS 130, "Reporting Comprehensive Income" (SFAS 130"). SFAS 130 established disclosure standards for reporting comprehensive income in a full set of general purpose financial statements. SFAS 130 is effective for fiscal years beginning after December 15, 1997. The Company had no comprehensive income (loss) during the year ended December 31, 1998 and as a result comprehensive loss is the same as the net loss for the year ended December 31, 1998.
Segment Reporting
In June 1997, the FASB issued Statement of financial Accounting Standard No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS 131). This statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. This statement supersedes FASB Statement No. 14 "Financial Reporting for a Business Enterprise", but retains the requirement to report information about major customers. It amends FASB Statement No. 94 "Consolidation of All Majority-Owned Subsidiaries" to remove the special disclosure requirements for previously unconsolidated subsidiaries. This statement does not apply to nonpublic business enterprises or to not-for-profit organizations.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of T. Recently Issued Accounting Pronouncements Significant (Continued) Accounting Policies Segment Reporting (Continued) (Continued) SFAS 131 is effective for financial statements for periods beginning after December 15, 1997. In the initial year of application, comparative information for earlier years is to be restated. This statement need not be applied to interim financial statements in the initial year of application, but comparative information for interim periods in the initial year of application is to be reported in financial statements for interim periods in the second year of application. The adoption of this statement did not have a material effect on the Company's financial statements.
The Company, through the branch network of its subsidiary, Pacific Thrift and Loan, provides a broad range of mortgage products. While the Company's chief decision makers monitor the revenue streams through wholesale and retail loan originations, operations are managed and financial performance is evaluated on a Company wide basis. Accordingly, all of the Company's operations are considered by management to be aggregated in one reportable operating segment.
Pensions and Other Postretirement Benefits
In February 1998, the Financial Accounting Standards Board issued SFAS No. 132, Employers' Disclosures about Pensions and other Postretirement Benefits ("SFAS No. 132"), an amendment of FASB statements No. 87, 88, and 106. SFAS No. 132 revises employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans. This statement is effective for fiscal years beginning after December 15, 1997. Restatement of disclosures for earlier periods provided for comparative purposes is required. The impact of the adoption of this statement is disclosure related and the adoption did not have a material impact on the financial condition, results of operations and cash flows.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of T. Recently Issued Accounting Pronouncements Significant (Continued) Accounting Policies Derivative Instruments and Hedging Activities (Continued) In June 1998, the Financial Accounting Standards Board issued SFAS 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") which requires companies to recognize all derivatives contracts as either assets or liabilities in the balance sheet and to measure them at fair value. The provisions of this statement are effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company has not determined the effect, if any, adoption of the new standard will have on its financial condition, results of operations and cash flows.
Mortgage Backed Securities
In October 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise", which effectively changes the way mortgage banking firms account for certain securities and other interests they retain after securitizing mortgage loans that were held for sale. The adoption of SFAS 134 had no impact on the Company's financial position.
Technical Corrections
In February 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 135 ("SFAS No. 135"), Rescission of Financial Accounting Standards Board no. 75 ("SFAS No. 75") and Technical Corrections. SFAS No. 135 rescinds SFAS No. 75 and amends Statement of Financial Accounting Standards Board No. 35 also amends other existing authoritative literature to make various technical corrections, clarify meanings, or describe applicability under changed conditions. SFAS No. 135 is effective for financial statements issued for fiscal years ending after February 15, 1999. The Company believes that the adoption of SFAS No. 135 will not have a significant effect on its financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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2. Summary of U. Reclassifications Significant Accounting Certain reclassifications of balances from prior Policies years have been made to conform to the current (Continued) year's reporting format.
V. Restructuring Charge
In the third quarter of 1998, the Company recorded a restructuring charge, including related asset impairment, of approximately $3.5 million. The restructuring initiatives involve the Company's closure of its wholesale loan origination activity resulting in workforce reductions of approximately 300 employees and the impairment of certain long-lived assets.
Details of the restructuring charge included on the statement of operations are as follows:
Utilized Balance at Original ------------------ December 31, (In 000's) Accrual Cash Noncash 1998 -------------------------------------------------------------------------- Impairment of long-lived assets $1,067 $ -- $1,067 $ --
Employees severance and termination benefits 1,951 1,128 -- 823
Other 518 74 -- 444 -------------------------------------------------------------------------- $3,536 $1,202 $1,067 $1,267 ==========================================================================
The tangible assets to be disposed of have been written down to their estimated fair value, less cost of disposal. All intangible asset carrying values associated with the wholesale operation have been eliminated. Management is negotiating sublease arrangements on existing office lease commitments and the restructuring accrual related to these leases has been recorded taking this into account. Considerable management judgment is necessary to estimate fair value, accordingly, actual results could vary significantly from such estimates. As part of the restructuring initiative, approximately 300 employees have separated from the Company as of December 31, 1998. The restructuring actions were substantially complete by late 1998.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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3. Loans Held Loans held for sale comprised of real estate For Sale loans.
The Company intends to sell the $72,814,000 of loans held for sale at December 31, 1998 under whole loan sale agreements. The Company has sold approximately $46.3 million of these loans for cash premiums ranging from 1.1% to 3.5% through April 9, 1999.
The Company entered into transactions with two customers which accounted for more than 10% of total whole loan sales for the year ended December 31, 1998. Approximately 62.0% and 20.2% of whole loans sold to these two customers resulted in whole loan gains on sales of approximately 89.7% and 10%, of the total gross gains related to whole loan sales. During the year ended December 31, 1997, the Company did not have transactions with any single customer which accounted for more than 10% of the Company's total whole loan sales.
During 1998 and 1997 the Company sold approximately $366 million and approximately $15.7 million of loans under whole loan sale agreements and received cash premiums of approximately $10.2 million and $460,000.
During 1996, the Company sold loans primarily to two purchasers on a whole loan basis. On October 31, 1996, the Company entered into a new agreement with one of the Purchasers (Purchaser). For all loans sold after September 30, 1996, the Company receives par value; interest payments less a servicing fee and warehousing fee from the date of sale until the loans are securitized; certain premium and/or advance payments upon securitization; and an interest-only strip on the loans sold. On December 16, 1996, the Company entered into a similar agreement with a Second Purchaser of loans effective for all loans sold after November 30, 1996.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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3. Loans Held During 1998, 1997 and 1996, the Company sold an For Sale aggregate of $221 million, $643 million and $338 (Continued) million of pre-approved securitizable loans to the Purchasers.
In 1998 and 1997, the Company securitized $330 million and $100 million of loans into Asset-Backed Securities (ABS), which are secured primarily by fixed and adjustable rate one-to four-family, first lien home equity loans, and were issued by the Company pursuant to an indenture between the Company and Bankers Trust Company of California, N.A., the Indenture Trustee.
4. Loans Receivable Loans Receivable and Allowance for Loan Loans receivable at December 31, 1998 and 1997 are Losses summarized as follows:
December 31, 1998 1997 -------------------------------------------------------------------------- Real estate loans $ 22,542,000 $ 43,474,000 Participations sold (12,038,000) (21,183,000) -------------------------------------------------------------------------- Total real estate loans - net $ 10,504,000 $ 22,291,000 ========================================================================== Loans receivable held for investment $ 10,504,000 $ 22,291,000 Net deferred loan fees and costs (196,000) (224,000) Allowance for loan losses (864,000) (1,438,000) -------------------------------------------------------------------------- $ 9,444,000 $ 20,629,000 ==========================================================================
The components of the loan portfolio at December 31, 1998 and 1997 were as follows:
December 31, 1998 1997 -------------------------------------------------------------------------- One-to-four family residential $ 4,038,000 $ 6,028,000 Five-or-more family residential 1,769,000 6,172,000 Home improvement 827,000 1,090,000 Commercial 3,870,000 9,001,000 -------------------------------------------------------------------------- $ 10,504,000 $ 22,291,000 ==========================================================================
During 1998 and 1997, the Company sold, without recourse, approximately $8,530,000 and $17,063,000 of portfolio mortgage loans.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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4. Loans Receivable Allowance for Loan Losses and Allowance for Loan Changes in the allowance for loan losses for the Losses (Continued) years ended December 31, 1998, 1997 and 1996 are as follows:
Years ended December 31, 1998 1997 1996 - --------------------------------------------------------------------------------
Balance at beginning $ 1,438,000 $ 2,464,000 $ 4,229,000 Provision charged to expense 1,314,000 3,087,000 1,151,000 Transferred to loans held for sale -- (1,902,000) -- Loan charge-offs, net of recoveries (1,888,000) (2,211,000) (2,916,000) - -------------------------------------------------------------------------------- Balance at end $ 864,000 $ 1,438,000 $ 2,464,000 ================================================================================
At December 31, 1998 and 1997, loans with more than two monthly payments past due and on nonaccrual status totaled $836,000 and $1,395,000. If interest on these loans had been accrued, interest income would have increased by approximately $98,000 and $175,000 in 1998 and 1997. At December 31, 1998 and 1997, loans with more than two monthly payments past due and on accrual status totaled $696,000 and $1,962,000. Interest income recognized on these loans totaled approximately $26,000 and $402,000 in 1998 and 1997.
The following information relates to the Company's impaired loans which includes troubled debt restructuring that meet the definition of impaired loans as of and for the years ended December 31, 1998 and 1997:
December 31, 1998 1997 ------------------------------------------------------------------------- Impaired loans with a specific allowance $ 993,000 $ 852,000 Impaired loans with no specific allowance 959,000 813,000 -------------------------------------------------------------------------
Total impaired loans $1,952,000 $1,665,000
Total allowance related to impaired loans $ 288,000 $ 337,000 Average balance of impaired loans for the period $1,728,000 $2,191,000 Interest income on impaired loans for the period recorded on a cash basis $ 97,000 $ 104,000 =========================================================================
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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5. Other Real Estate Other real estate consisted of the following at December 31, 1998 and 1997:
December 31, 1998 1997 ----------------------------------------------------------------------------- Foreclosed real estate $ 734,000 $ 3,132,000 Allowance for losses on other real estate (515,000) (1,104,000) ----------------------------------------------------------------------------- $ 219,000 $ 2,028,000 =============================================================================
Changes in the allowance for losses on other real estate for the years ended December 31, 1998, 1997 and 1996 are as follows:
Years ended December 31, 1998 1997 1996 - -------------------------------------------------------------------------------- Balances at beginning $ 1,104,000 $ 2,285,000 $ 2,434,000 Provision for losses 165,000 26,000 337,000 Net charge offs (754,000) (1,207,000) (486,000) - -------------------------------------------------------------------------------- Balance at end $ 515,000 $ 1,104,000 $ 2,285,000 ================================================================================
Operations of other real estate for the years ended December 31, 1998, 1997 and 1996 consisted of the following:
Years ended December 31, 1998 1997 1996 - -------------------------------------------------------------------------------- Provision for losses $ 165,000 $ 26,000 $ 337,000 Net gain on sales (170,000) (181,000) (224,000) Other expenses 129,000 599,000 568,000 - -------------------------------------------------------------------------------- $ 124,000 $ 444,000 $ 681,000 ================================================================================
Upon foreclosure of a junior lien, the Company takes title to the real estate, subject to existing senior liens. These mortgage notes payable totaled $-0- and $-0- at December 31, 1998 and 1997.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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6. Interest-Only Strips Interest-only strips receivable consist of assets Receivables generated from loan sales and securitization as follows:
December 31, 1998 1997 -------------------------------------------------------------------- Interest-only strip, certificated $ 44,351,000 $13,417,000 Interest-only strip, non-certificated 72,277,000 81,007,000 -------------------------------------------------------------------- $116,628,000 $94,424,000 ====================================================================
Net unrealized holding loss included in gain on sale of loans on the statement of operations was $38,300,000 and $2,306,000 for the years ended December 31, 1998 and 1997, and accordingly was recorded as a reduction of the interest-only strips receivable in these same years.
The interest-only strips receivable are recorded as a result of the Company's sale and securitization of real estate loans. The interest-only strips receivables classified as a trading security and reported at fair value, with unrealized gains and losses included in earnings. The Company estimates and values its future cash flows on interest-only strips receivable by utilizing assumptions that it believes are consistent with those that would be utilized by an unaffiliated third party purchaser. To the Company's knowledge, there is no active market for the sale of the interest-only strips receivable. The amounts the Company will ultimately realize could differ significantly and could require an adjustment in the near term to the fair value of this asset.
In December 1998, the FASB issued, in question and answer format, "A Guide to Implementation of Statement 125 on Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, Questions and Answers, Second Edition" (the "Special Report"). The Special Report indicates that two methods have arisen in practice for accounting for credit enhancements relating to securitization. These methods are the cash-in method and the cash-out method. The cash-in method treats credit enhancements (pledged loans or cash) as belonging to the Company. As such, these assets are recorded at their face value as of the time they are received by the trust. The cash-out method treats credit enhancements as assets owned by the related securitization trust. As such, these assets are treated as part of the interest-only strips and are recorded at a discounted value for the period between when collected by the trust and released to the Company. The Special Report indicates that if no true market exists for credit enhancement assets, the cash-out method should be used to measure the fair value of credit enhancements. The Company uses the cash-out method, which is consistent with prior periods.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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6. Interest-Only Strips The fair value of the interest-only strips Receivables receivable is determined by computing the present (Continued) value of the excess cash flows based on the weighted average coupon on the loans sold over the sum of: (1) the coupon on the senior interests, (2) the contracted servicing fee, (3) expected losses to be incurred on the portfolio of loans sold over the lives of the loans, (4) overcollateralization and (5) fees payable to the trustee and the monoline insurer. The present value calculation uses prepayment and default assumptions that market participants would be expected to use for similar financial instruments that are subject to prepayment, credit and interest rate risk.
The cash flows expected to be received by the Company are then discounted at an interest rate that the Company believes an unaffiliated third-party purchaser would require as a rate of return on such a financial instrument. To the extent that actual future excess cash flows are different from estimated excess cash flows, the fair value of the Company's interest-only strips will be adjusted quarterly with corresponding adjustments made to earnings in that period.
The Company builds overcollateralization from the excess cash flows. The current amount of such overcollateralization built through cash flows is part of the interest-only strips receivable.
In March 1999 the Company obtained an independent valuation report of interest-only strips receivable and recorded a writedown of $794,000 at December 31, 1998. During 1998 the aggregate writedown was $38,300,000. At December 31, 1997, the Company adjusted the fair value of its interest-only strip receivable downward by approximately $2.3 million. In March 1998, the Company obtained an independent valuation report of the interest-only strips receivable, as of December 31, 1997, which, using the "cash out" method of modeling cash flows, determined fair values of the interest-only strips receivable.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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6. Interest-Only Strips The fair values at December 31, 1998 can be Receivables calculated with constant prepayment rate (Continued) assumptions ranging from 22.5% to 37.8%; a range of .50% to 1% annual loss rate after an initial six month ramp up period; and an 15% discount rate on estimated cash flows from each of its pools.
The fair values at December 31, 1997 can be calculated with constant prepayment rate assumptions ranging from 26% to 36%; a .50% annual loss rate after an initial six month ramp-up period; and an 11% discount rate on estimated cash flows from each of its pools.
It is possible that these assumptions could change in the near future, due to changes required by future accounting pronouncements, the general economy, adverse changes in the securitization market, and actual prepayment and default experience which vary from the assumed rates, which would require adjustments in the reported fair value of the interest-only strips receivable. As a result the actual cash flows received by the Company could differ significantly from the modeled cash flows using current assumptions. The estimated fair value of the Company's interest-only strips receivable is reviewed quarterly with required adjustments, if necessary, made to earnings (loss) in that period.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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7. Property and Property and equipment consisted of the following Equipment at December 31, 1998 and 1997:
December 31, 1998 1997 ------------------------------------------------------------- Computer and office equipment $ 3,006,000 $ 3,738,000 Furniture and fixtures 3,069,000 1,235,000 Leasehold improvements 783,000 676,000 ------------------------------------------------------------- 6,858,000 5,649,000 Accumulated depreciation and amortization (2,437,000) (2,053,000) ------------------------------------------------------------- $ 4,421,000 $ 3,596,000 =============================================================
In 1998 the Company wrote off certain impaired assets after it closed down its wholesale division (Note 2V).
At December 31, 1998 the Company subleases certain assets with a net book value of $80,000 under a sublease arrangement which expires on October 31, 1999. The lease arrangement provides monthly rental income of $4,500.
8. Thrift Certificates Thrift certificates are fully paid certificates Payable and installment certificates. The approximate weighted average interest rate of fully-paid and installment certificate accounts at December 31, 1998 was 5.65% and 5.05% and at December 31, 1997 was 6.11% and 5.01%. The interest payable on the thrift certificates totaled $508,000, $370,000 and $185,000 at December 31, 1998, 1997 and 1996.
At December 31, 1998 and 1997, fully-paid thrift certificates consisted of the following:
December 31, 1998 1997 --------------------------------------------------------------------------- Certificates equal or greater than $100,000 $ 498,000 $ 4,180,000
Certificates less than $100,000 132,120,000 109,551,000 --------------------------------------------------------------------------- $132,618,000 $113,731,000 ===========================================================================
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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8. Thrift Certificates At December 31, 1998, scheduled maturities of Payable (Continued) fully-paid thrift certificates were as follows:
December 31, 1998 ---------------------------------- Less than 3 months $ 19,560,000 3 to 6 months 35,852,000 6 to 12 months 72,465,000 1 to 5 years 4,741,000 ---------------------------------- $132,618,000 ==================================
9. Notes Payable Notes payable consisted of the following at December 31, 1998 and 1997:
December 31, 1998 1997 --------------------------------------------------------------- Third party (a) $ 3,000,000 $ -- Interest-only strips advances (b) 49,958,000 28,318,000 --------------------------------------------------------------- $52,958,000 $28,318,000 ===============================================================
(a) The loan interest rate is 3-month LIBOR plus 5.0%, which was 10.07% at December 31, 1998. The stock of the Company's subsidiary, Pacific Thrift and Loan, is pledged as security for this loan. This loan was due in April 1999. However, in February 1999, the due date was extended by the third party to January 2000.
(b) The interest-only strip advances are from the Purchasers (Note 3) secured by the Company's interest-only strips receivable. Advances ranging from 3.00% to 4.75% of the par value of loans sold are made by the Purchasers when the loans are securitized. The advances are reduced by any monthly payments to be made against the interest-only strips receivable until the advances are fully repaid. The advances bear an annual interest rate ranging from LIBOR plus 1.00% to LIBOR plus 2.0%.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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9. Notes Payable In connection with the advances received under a (Continued) Master Assignment Agreement, dated as of December 18, 1997, with Merrill Lynch Mortgage Capital, Inc., each advance is due one year from the date of the advance, and the Company is required to make mandatory prepayments under the Master Assignment Agreement in the event that the residual interests assigned to Merrill Lynch experience a decline in value from the levels established at the time of the advance. At December 31, 1998, the Company is in default of the repayment terms of the Master Assignment Agreement on $18.4 million of advances collateralized by $44.4 million of interest only strips receivable.
In connection with the advances received under the Corporate Finance Agreement, dated as of January 27, 1997 with Advanta Mortgage Corp. USA, such advances are due 38 to 46 months after the advance is made. The advances are cross collateralized. At December 31, 1998 $29.6 million of outstanding advances are collateralized by $68.5 million of interest-only strips receivable.
10. Income Taxes The Partnership was not subject to income taxes. However, the Partnership was still required to file partnership returns in order to report its income or loss in total as well as the distributable share of income or loss of each of the partners. These partnership returns, as all tax returns, are potentially subject to examination by the taxing authorities.
Subsequent to the restructuring (Note 1) the Corporation became subject to federal income and California franchise taxes. Pacific Thrift, the major operating subsidiary, was always subject to income taxes because it has been a taxable corporation from its inception. Significant components of the provision for income taxes (benefits) from continuing operations included in the consolidated statements of operations are as follows:
December 31, 1998 1997 1996 ====================================================== Current $ 55,000 $ 26,000 $ 727,000 Deferred (11,045,000) 12,442,000 931,000 ------------------------------------------------------ $(10,990,000) $12,468,000 $1,658,000 ======================================================
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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10. Income Taxes The tax effects of temporary differences that give (Continued) rise to the deferred tax assets and liabilities at December 31, 1998 and 1997 are as follows:
December 31, 1998 1997 --------------------------------------------------------------------------- Deferred tax assets Net operating loss carryforward $ 25,402,000 $ 18,321,000 Accrued expenses 1,197,000 848,000 Loans held for sale 817,000 -- Reserves 703,000 1,157,000 Capital loss carryforward 402,000 402,000 State tax deduction 19,000 2,050,000 Alternate minimum tax credit carryforward -- 196,000 Other 100,000 63,000 ---------------------------------------------------------------------------
Total gross deferred tax assets 28,640,000 23,037,000 ---------------------------------------------------------------------------
Valuation allowance (2,036,000) (402,000) ---------------------------------------------------------------------------
Deferred tax liabilities Interest-only strip receivable (27,332,000) (33,628,000) Depreciation (299,000) (198,000) Loan loss reserve (91,000) --
Loans held for sale -- (726,000) Deferred loan costs (67,000) (230,000) ---------------------------------------------------------------------------
Total deferred tax liabilities (27,789,000) (34,782,000) ---------------------------------------------------------------------------
Total deferred tax asset (liability), net $ (1,185,000) $(12,147,000) ===========================================================================
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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10. Income Taxes Included in the deferred tax asset at December 31, (Continued) 1998 and 1997 is a capital loss carryforward of $402,000 which is fully reserved (Note 16). In 1998, the Company established an additional valuation reserve of $1,546,000 on net operating loss carryforwards because management believes it is more likely than not that the full amount will not be utilized before they expire.
At December 31, 1998, the Company has net operating loss carryforwards for federal income tax purposes of approximately $71 million that are available to offset future federal taxable income. These federal net operating losses expire in the years 2010 through 2013. Net operating loss carryforwards for State franchise tax purposes are approximately $34 million. These State carryforwards expire in the years 2001 and 2013. Should there occur a 50% ownership change of the Company as defined under Section 382 of the Internal Revenue Code of 1986, the Company's ability to use the net operating losses would be restricted to a prescribed annual amount.
The following summarizes the difference between the 1998, 1997 and 1996 provision for income taxes (benefit) from continuing operations and the federal statutory tax rate:
1998 1997 1996 ------------------------------------------------------------- Federal statutory tax rate 34% 35% 34% Valuation allowance (8)% -- (19) Loss of benefit of former partnership losses -- -- 11 State taxes net of federal benefit 5 7 -- ------------------------------------------------------------- Effective tax rate (benefit) 31% 42% 26% =============================================================
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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11. Related Parties The Partnership had various related party and Affiliates transactions with the following entities:
o Presidential Management Company - Prior to the restructuring (Note 1) the former general partner received specified fees for services performed and reimbursements of certain expenses. Under the Partnership Agreement, the general partner received a base fee of up to 35% of the loan origination fees paid by borrowers to the Partnership or Pacific Thrift. The general partner also received a loan servicing fee of 3/8 of 1% per annum on loans with terms over three years.
Amounts charged by the former general partner for services performed and overhead-related expenses for the year ended December 31, 1996 was as follows:
Years ended December 31, 1996 ------------------------------------------------ Base fee $834,000 Loan servicing fee 125,000 ------------------------------------------------ Total fees $959,000 ================================================ Salaries and overhead reimbursements $100,000 ================================================
o In connection with an amendment to the loan agreement with a bank lender, in 1992 the general partner loaned the Partnership $600,000 in subordinated debt, with interest at the prime rate and only repayable upon consent by the lender or at such time as the Partnership repaid all of its outstanding indebtedness to the lender. The general partner was repaid in 1996.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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11. Related Parties o Presidential Management Company (Continued) and Affiliates (Continued) During 1996, Pacific Thrift paid and allocated certain salaries and overhead for the Partnership, Corporation, PAMC, CRC, LPPC and the general partner totaling $159,000, $753,000, $212,000, $6,000 and $174,000 and was reimbursed on a monthly basis.
o Other - Prior to the Restructuring, a managing officer of the Partnership and stockholder provided legal services in connection with the loan accounts of the Partnership and Pacific Thrift, for which he received $100 from the fees paid by each borrower for legal services related to each loan origination. Total fees of $212,000 were paid by the Partnership to the managing officer for the years ended December 31, 1996.
A partner with a law firm that provides legal services to the Company is a stockholder of the Company and formerly a partner of the Partnership. Total fees for the services provided to the Company by the law firm were approximately $994,000, $785,000 and $424,000 for the years ended December 31, 1998, 1997 and 1996.
Receivables from related parties consisted of the following at December 31, 1998 and 1997:
December 31, 1998 1997 ---------------------------------------- Due from officer $134,000 $ -- Employee advances 81,000 83,000 ---------------------------------------- $215,000 $83,000 ========================================
The above receivable of $134,000 at December 31, 1998 is due from the Chief Executive Officer relating to overpayment of bonus for 1998.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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11. Related Parties o Other (Continued) and Affiliates (Continued) Loans to employees at rates ranging from 6.5% to 8.25% totaled approximately $151,000 and $88,000 at December 31, 1998 and 1997.
Thrift certificates purchased by members of management totaled approximately and $160,000 and $34,000 at December 31, 1998 and 1997, on terms slightly more favorable than the terms for unrelated parties. Interest expense on these certificates totaled approximately $1,000 and $2,000 for the years ended December 31, 1998 and 1997.
At December 31, 1998, the Company has an unsecured note payable to the former president of Pacific Thrift & Loan. The underlying interst rate is prime and the loan was due on March 27, 1999. This was incorporated as part of a negotiated severance agreement (Note 17 "Other Subsequent Events").
12. Commitments and At December 31, 1998 the Company had committed to Contingencies but not yet funded approximately $622,000 of real estate loans.
The Company conducts its operations from leased facilities under non-cancelable operating leased. Rental expenses were approximately $2,947,000, $1,725,000 and $1,129,000 for the years ended December 31, 1998, 1997 and 1996 . At December 31, 1998, the approximate minimum rental commitments under all noncancelable operating leases are as follows:
Year Amount --------------------------------- 1999 $2,618,000 2000 2,173,000 2001 1,587,000 2002 1,235,000 2003 and thereafter 872,000 --------------------------------- $8,485,000 =================================
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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12. Commitments and On November 1, 1998 the Company entered into a Contingencies subleasing arrangement which expires on November (Continued) 1, 1999. The sublease provides for monthly rental income of $26,395. The lease has an option to extend all or a portion of the sublease for an additional year.
At December 31, 1998 and 1997, the Company was servicing Title I loans for others totaling approximately $4,433,000 and $6,352,000. In addition, the Company had filed claims with the Federal Housing Administration that depleted the insurance on these loans during 1994.
The Corporation entered into employment agreements with five of its officers effective as of the closing date of the Restructuring on June 27, 1996 (Note 1). One employment agreement with the President of CRC, LPPC and CRCWA was terminated effective December 31, 1996 upon the sale of those subsidiaries (Note 15). On January 1, 1997, the Corporation entered into an employment agreement with its Chief Financial Officer. In January 1999 the Company ended its relationship with the President and Chief Executive Officer of Pacific Thrift. In April 1999 a new President and Chief Executive Officer of Pacific Thrift was appointed (see Note 17- "Other Subsequent Events").
The agreements provide for initial terms ranging from one to three years and all extend automatically for additional one-year terms thereafter unless either party gives at least six months written notice of their intentions not to renew. The agreements provide for annual salaries adjusted annually to the cost of living index. The agreements also provide for two of the officers to receive annual bonuses based on a calculation of net pre-tax profits subject to a minimum return on equity. In addition, one of the officers is also entitled to received a special cash bonus equal to 1% of the annual pre-tax net income of the Company calculated before payment of the special bonus but after payment of the annual bonuses, under certain conditions.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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12. Commitments and Litigation Contingencies (Continued) On March 9, 1999 the Company was served with a lawsuit with allegations related to the sale of pools of loans between 1993 and 1995. The lawsuit is for an amount in excess of $15 million plus costs and unspecified punitive damages. Management believes that there is no basis for any of the allegations for several reasons. First, in spite of the provisions of the loan sale agreements which allow the party to demand that the Company repurchase loans which did not meet representations and warranties, the party has requested that the Company repurchase less than 0.5% of the total amount of loans sold to the party over the approximately three year period that the loans were sold. Second, the party has never previously identified to the Company any problem loans other than those few loans the party has previously requested be repurchased. Third, the Company believes substantially all of the loans sold to the party were written to the party's own underwriting guidelines specifically for sale to the party. Fourth, the party reviewed in detail and approved every loan file for every loan originated for sale to them prior to loan funding. Fifth, the Company had an independent review appraiser approved by the party, review every appraisal for every loan originated for sale to them. For these reasons, management of the Company has no reason to believe that there is any merit to the complaint and is unable to determine the likelihood of an unfavorable outcome and range of possible loss, if any.
The Company and Pacific Thrift and PacificAmerica Money Centers are involved in certain lawsuits and there are claims pending against these entities which management considers incidental to normal operations. The legal responsibility and financial impact with respect to such litigation and claims cannot presently be determined. However, management considers that any ultimate liability, which would likely arise from these lawsuits and claims, would not materially affect the financial position, results of operations or cash flows of the Company.
See Note 17 for Regulatory Matters and Capital Adequacy.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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13. Retirement The Company implemented a retirement savings plan Plans (defined contribution plan) in 1994. All full-time employees who have completed six months of service and reached age 21 are eligible to participate in the plan. Contributions are made from employee-elected salary deferrals. The Company matches the first 6% of employee contributions to the plan at the rate of $.50 on the dollar. During the years ended December 31, 1998, 1997 and 1996, the Company's contributions to the plan totaled $-0-, $231,000 and $241,000.
The Company implemented an employee severance plan in 1994. Regular full-time and part-time (as defined) employees receive severance benefits based on their period of employment (Note 2V).
The PacificAmerica Money Center, Inc. Supplemental Executive Retirement Plan, effective from June 27, 1996 forward, is an unfunded plan to provide benefits to certain long-term executives officers of the Company. The yearly benefit that a participant will receive at normal retirement (as defined) is based on a formula which takes into account his highest average annual compensation for three consecutive years multiplied by the actual number of years of service (as defined), not to exceed 30 years. Benefits are reduced by participants' estimated social security and 401(k) benefits.
Net period pension cost for 1998, 1997, and 1996 includes the following components:
The net pension liability at December 31, 1998 and 1997 was $1,314,000 and $760,000.
Actuarial assumptions are a weighted average discount rate of 7% and a salary progression rate of 3%.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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14. Stockholders' The Company has a 1995 Stock Option Plan and a Equity/Partners' 1995 Stock Purchase Plan pursuant to which options Capital, Stock to purchase shares of the Company's common stock Options and may be granted to employees. The plans provide Warrants that the option price shall not be less than the fair market value of the shares on the date of grant. Under the 1995 Stock Option Plan, the maximum number of shares of Common Stock in respect of which Options may be granted under the Plan (the "Plan Maximum") is 500,000 with an increase of two percent (2%) of the total issued and outstanding shares of the Common Stock on the first day of each subsequent calendar year, up to a maximum 660,000 shares, commencing January 1, 1997. Under the 1995 Stock Purchase Plan a total of 100,000 options may be issued. Options vest ratably over four or five year periods as provided for in each employee's option agreement. At December 31, 1996, there were 466,800 shares reserved for options to be granted under the plans. The following summarizes stock option transactions:
Weighted Average Price Shares Per Share ----------------------------------------------------------- Outstanding at June 27, 1996 -- -- Granted 480,000 $ 5.51 Exercised -- -- Cancelled (13,200) 5.42 ----------------------------------------------------------- Outstanding at December 31, 1996 466,800 5.52 Granted 119,300 17.55 Exercised (87,838) 5.18 Cancelled (25,880) 8.27 ----------------------------------------------------------- Outstanding at December 31, 1997 472,382 8.45 Granted 143,200 9.65 Exercised (72,205) 5.11 Cancelled (87,015) 10.67 ----------------------------------------------------------- Outstanding at December 31, 1998 456,362 $10.96 ===========================================================
At December 31, 1996 the Corporation had 1,106,754 general partner warrants outstanding each exercisable for one share of common stock at any time until December 27, 1997 at an exercise price of $7.50 per share. During the year ended December 31, 1997, 1,105,078 general partner warrants were exercised. As of December 31, 1997, all unexercised general partner warrants were cancelled.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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14. Stockholders' At December 31, 1998 and 1997 the Corporation had Equity/Partners' zero and 52,052 subscriber warrants outstanding Capital, Stock each exercisable for one share of common stock at Options and any time until June 27, 1998 at an exercise price Warrants of $6.25 per share. During the years ended (Continued) December 31, 1998 and 1997, 50,236 and 75,730 subscriber warrants were exercised.
Information relating to stock options is summarized by exercise price as follows
December 31, 1998 - -------------------------------------------------------------------------------- Outstanding ------------------------------------ Exercisable Weighted Average ----------------------- Exercise Price -------------------------- Weighted Per Share Shares Life (Year) Exercise Price Shares Exercise Price - -------------------------------------------------------------------------------- $0.50 to $0.50 100 10.0 $ 0.50 -- $ -- $0.53 to $5.00 214,912 7.5 $ 4.94 69,712 $ 5.00 $6.25 to $14.50 68,650 8.0 $11.32 21,182 $ 9.92 $14.63 to $17.50 35,500 8.7 $15.51 12,025 $15.40 $17.75 to $17.75 100,000 9.5 $17.75 100,000 $17.75 $18.00 to $25.50 36,600 8.7 $22.39 2,675 $23.47 $25.75 to $25.75 200 8.8 $25.75 50 $25.75 $26.75 to $26.75 100 8.8 $26.75 25 $26.75 $27.00 to $27.00 125 8.8 $27.00 50 $27.00 $28.75 to $28.75 175 8.8 $28.75 100 $28.75 - -------------------------------------------------------------------------------- $0.50 to $28.75 456,362 8.2 $10.96 205,819 $12.57 ================================================================================
All stock options issued to employees have an exercise price not less than the fair market value of the Company's common stock on the date of grant, and in accordance with accounting for such options utilizing the intrinsic value method there is no related compensation expense recorded in the Company's financial statements. Had compensation cost for stock-based compensation been determined based on the fair value at the grant dates consistent with the method of SFAS 123, the Company's net income (loss) from continuing operations and earnings (loss) per share from continuing operations for the year ended December 31, 1998 and 1997 would have been reduced to the pro forma amounts presented below:
1998 1997 ------------------------------------------------------- Net income As reported $(24,488,000) $17,095,000 Pro forma (26,547,000) 16,794,000
Earnings per share As reported Basic $ (4.82) $ 4.18 Diluted (4.82) 3.48
Pro forma Basic $ (5.23) 4.10 Diluted (5.23) 3.42
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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14. Stockholders' The fair value of option grants is estimated on Equity/Partners' the date of grants utilizing the Black-Scholes Capital, Stock option-pricing model with the following weighted Options and average assumptions for grants in 1998 and 1997, Warrants expected life of options of 8 years for both (Continued) years, expected volatility of 161% and 50%, risk-free interest rates of 5.50% and 5.74%, and a 0% dividend yield for both years. The weighted average fair value at date of grant for options granted during 1998 and 1997 approximated $16.65 and $9.56 per option.
15. Quarterly Results The unaudited quarterly results of operations for of Operations 1998 and 1997 are as follows (in $000's): (Unaudited)
Mar. 31, June 30, Sept. 30, Dec. 31, 1998 1998 1998 1998 - --------------------------------------------------------------------------------
Interest income $ 3,222 $ 3,562 $ 5,108 $ 4,768 Interest expense 2,116 3,134 3,696 6,268 - --------------------------------------------------------------------------------
Net interest income 1,106 428 1,412 (1,500) Provision for loan losses 1,413 1,840 (531) (1,408) Noninterest income 22,805 28,307* (23,058)** 5,734 Noninterest expense 17,140 18,510 18,175 15,573 Income tax benefit (expense) (2,250) (3,563) 16,896 (93) - --------------------------------------------------------------------------------
Net income (loss) $ 3,108 $ 4,822 $(22,394) $(10,024) ================================================================================
Net income per share: Basic $ .62 $ .95 $ (4.35) $ (1.95) Diluted .58 .90 (4.35) (1.95)
Quarter Ended ------------------------------------------------ Mar. 31, June 30, Sept. 30, Dec. 31, 1997 1997 1997 1997 - --------------------------------------------------------------------------------
Interest income $ 2,742 $ 2,761 $ 3,241 $ 2,986 Interest expense 1,073 1,100 2,000 2,367 - --------------------------------------------------------------------------------
Net interest income 1,669 1,661 1,241 619 Provision for loan losses 309 738 225 1,815 Noninterest income 13,425 18,308 22,605 27,717*** Noninterest expense 9,561 12,331 14,093 18,610 Income tax benefit (expense) (2,195) (2,897) (4,002) (3,374) - --------------------------------------------------------------------------------
Net income $ 3,029 $ 4,003 $ 5,526 $ 4,537 ================================================================================
Net income per share: Basic $ .80 $ 1.06 $ 1.36 $ .96 Diluted .64 .86 1.10 .86
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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15. Quarterly Results * At June 30, 1998, the Company recorded a of Operations prefunding receivable of $52,268,000 for (Unaudited) loans which were pre-sold as part of the June (Continued) 1998 securitization which resulted in a $22,635,000 gain on sale of loans. The prefunding receivable was subsequently collected in full in August 1998.
** During the quarter ended September 30, 1998 the company recorded a $33,500,000 net unrealized holding loss which is included in gain on sale of loans.
*** In the quarter ended December 31, 1997 as a result of a change in estimate the interest-only strip receivable was adjusted. The Company also completed its first direct securitization offering in the fourth quarter.
16. Discontinued Effective December 31, 1996, the Company's trustee Operations and foreclosure services were discontinued when the assets and liabilities of CRC and LPPC and all of the stock of CRCWA were sold. Accordingly, the operations have been reclassified to present the trustee and foreclosure services as discontinued operations in the Statement of Operations. The Company recorded a fourth quarter 1996 pre-tax and after-tax charge of $1,038,000 for disposition of this segment which comprises a $926,000 loss on the measurement date plus a loss from discontinued operations from the measurement date until the disposal date. The tax benefit of approximately $402,000 from the loss on disposition was fully reserved for as such loss is capital in nature and the Company is unable to quantify the portion of such capital loss benefit which may be ultimately realizable.
Net assets disposed of were $2,674,000 against proceeds of $1,748,000 resulting in a loss of approximately $926,000. The $1,748,000 was included in accounts receivable at December 31, 1996 and $450,000 was received by early February 1997. The remaining $1,298,000 represented a secured promissory note and was fully repaid in February 1998.
Prior to sale of these subsidiaries, the Company operated principally in two industries, real estate secured lending (including the origination and sale of loans) and trustee and foreclosure services.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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17. Regulatory Matters Cease and Desist Order by the Federal Deposit and Capital Insurance Corporation and California Department Adequacy and of Corporations Subsequent Events On April 1, 1996, Pacific Thrift entered into a Memorandum of Understanding (MOU) with the FDIC and DOC. The 1996 MOU provided that Pacific Thrift was required to: (i) maintain Tier 1 capital of not less than 8.0% of total assets; (ii) maintain an adequate reserve for loan losses; (iii) eliminate assets classified "loss" as of September 30, 1995, reduce assets classified "substandard" as of September 30, 1995 to not more than $4.0 million within 180 days and reduce all users classified substandard, doubtful and loss to no more than 50% of capital and reserves by September 30, 1996: (iv) obtain FDIC approval before opening additional offices; (v) develop strategies to stabilize net interest margin on portfolio loans and develop procedures to implement those strategies; and (vi) furnish written quarterly progress reports.
On March 9, 1998, the 1996 MOU was replaced with a new MOU (the "1998 MOU") between Pacific Thrift and the FDIC. The 1998 MOU required Pacific Thrift to: (i) maintain Tier 1 capital of not less than 8.0% of total assets; (ii) by July 7, 1998, have, and thereafter maintain, risk-based capital of not less than 10.0% of total assets; (iii) maintain a fully funded loan loss reserve; (iv) by March 19, 1998, eliminate assets classified "loss" as of June 30, 1997, and by September 5, 1998, reduce assets classified "substandard" to $4 million; (v) by June 7, 1998, reduce and thereafter maintain the amount of interest-only strip receivables, net of tax liabilities, to no more than 100% of total capital; (vi) by June 7, 1998, obtain an independent valuation of interest-only strips receivable, and thereafter obtain an annual independent valuation of such receivables until they represent no more than 50% of Tier 1 capital; (vii) by June 7, 1998, and thereafter quarterly, perform valuations and cash flow analyses on the interest-only strips receivable; (viii) by May 8, 1998, eliminate and/or correct certain transactions between the Company and Pacific Thrift and develop, adopt and implement a written policy governing the relationship between the Company and Pacific Thrift; (ix) by June 7, 1998, revise, adopt and implement a written asset/liability management policy to include risk tolerance levels for income and annual independent audits of Pacific Thrift's interest rate risk process; (x) pay no cash dividends without prior written FDIC approval; (xi) pay no executive or director bonuses without prior written FDIC approval; (xii) by June 7, 1998, submit a strategic plan covering the period 1998 through 2000 reflecting restricted growth of interest-only strips receivable; and (xiii) by May 15, 1998, and thereafter at the end of each quarter, furnish written progress reports.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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17. Regulatory Matters Cease and Desist Order by the Federal Deposit and Capital Insurance Corpora-tion and California Department Adequacy and of Corporations (Continued) Subsequent Events (continued) On November 6, 1998, Pacific Thrift entered into a stipulation and consent to an order issued by the California Department of Financial Institutions (the "DFI), which assumed jurisdiction over Pacific Thrift from the DOC in July 1998, under which Pacific Thrift agreed: (i) that it will not issue loan commitments without having a clearly identified and reasonably assured source of funds, such as deposits, loan sale commitments or other source of funds, such as deposits, loan sale commitments or other financing, with which to fund its loans; (ii) that it will not make any shareholder distributions except with the prior written approval of the DFI; and (iii) that it will discontinue selling loans under conduit loan sale arrangements. The DFI Order is currently in effect, and management believes that Pacific Thrift will be able to comply with all of the terms of the DFI order.
On December 14, 1998, Pacific Thrift entered into a stipulation and consent to an Order to Cease and Desist issued by the FDIC (the "1998 Order") which replaced the 1998 MOU. Under the 1998 Order, Pacific Thrift has agreed: (i) to have and retain qualified management to operate its regulated business; (ii) to achieve, by January 31, 1999, and thereafter maintain, Tier 1 capital equal to or in excess of 8.0 percent of its total assets, and to achieve, by June 30, 1999, and thereafter maintain, Tier 1 risk-based capital of no less than 6.0 percent and total risk-based capital of no less than 10.0 percent; (iii) to maintain an adequate allowance for loan losses; (iv) to take the following steps with regard to its interest-only strips receivables: (a) by June 30, 1999, reduce the amount of the receivable as a percentage of total capital to no more than 100%; (b) not acquire or book any additional interest-only strips receivable; and (c) obtain quarterly and annual independent valuations of the existing interest-only strips receivable; (v) to prepare and submit a written two-year business/strategic plan; (vi) by February 27, 1999 eliminate and/or correct violations of Sections 23A and B of the Federal Reserve Act and Sections 18025, 18448 and 18455(b) of the California Financial Code relating to certain transactions between the Company and its subsidiary; (vii) by February 27, 1999, to develop a revised written asset/liability management policy specifically addressing interest rate risks associated with the mortgage banking business; (viii) not to pay cash dividends or distributions without the prior written consent of the FDIC;
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
================================================================================
17. Regulatory Matters Cease and Desist Order by the Federal Deposit and Capital Insurance Corpora-tion and California Department Adequacy and of Corporations Subsequent Events (continued) (ix) not to enter into any executive compensation and/or bonus agreements without prior approval of the FDIC; (x) to develop and implement a written policy for all intercompany transactions with affiliates; (xi) to furnish a description of the Order to its shareholder; and (xii) to furnish written quarterly progress reports detailing actions taken to comply with the Order. The 1998 Order is currently in effect, and Pacific Thrift has taken certain actions to comply with the terms of the Order including no longer selling loans under a conduit loan sale agreement.
In March 1999, Pacific Thrift entered into an additional stipulation and consent to an Order to Cease and Desist (the 1999 order) issued by the FDIC under which Pacific agreed to: (i) operate with a Board of Directors which provides adequate supervision and direction with respect to the electronic information systems and other automated systems (Bank Information Systems); (ii) take appropriate measures to ensure that the Bank Information Systems are Year 2000 compliant and in March 1999, designate an executive officer as the Year 2000 Officer; (iii) authorize the Year 2000 Officer to appoint additional personnel to assist in complying with the provisions in this order relating to Year 2000 readiness; (iv) as long as this order remains in effect, notify the Regional Director of the FDIC's Regional Office ("Regional Director") in writing of any vacancy in the Year 2000 position or change in the person filling the position; (v) within 15 days from the effective date of the order, develop and adopt a plan for achieving Year 2000 readiness ("Year 2000 Plan"); (vi) the Year 2000 Plan to be reviewed and approved by Pacific Thrift's Board of Directors prior to adoption, and submit a copy of the plan to the Regional Director; (vii) by April 15, 1999, develop and implement a Remediation Contingency Plan which includes alternate external third party suppliers or ready replacement computer hardware or software from alternate sources; (viii) by June 30, 1999, develop a Business Resumption Contingency Plan; (ix) by no later than June 30, 1999, have in place mission-critical systems that are Year 2000 ready; (x) for so long as the order is in effect, acquire or contract for the use of electronic information systems hardware, operating systems, and applications software only if this hardware, systems, and software have been successfully tested for Year 2000 readiness; (xi) by April 1999, perform due diligence reviews to
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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17. Regulatory Matters Cease and Desist Order by the Federal Deposit and Capital Insurance Corporation and California Department Adequacy and of Corporations Subsequent Events (continued) determine whether the Year 2000 readiness procedures of its service providers and software vendors, and the time frames for implementation of those procedures, are adequate; (xii) by March 31, 1999, implement an internal testing or verification process; (xiii) in March 1999, amend its internal and external audit policies to require periodic audits of the Year 2000 Plan and its implementation; (xiv) provide monthly status reports to Pacific Thrift's Board of Directors.
Noncompliance with the terms of the 1998 Order or 1999 Order could result in various regulatory actions, including the assessment of civil money penalties, termination of deposit insurance, and placing Pacific Thrift in conservatorship or receivership. Management expects that Pacific Thrift will continue to work toward substantial compliance with the 1998 Order and the 1999 Order, however there is no assurance Pacific Thrift will be able to fully comply with these Orders. These financial statements do not include any provisions or adjustments that might result from the outcome of these uncertainties.
Capital Adequacy
Pacific Thrift is subject to various regulatory capital requirements administered by the FDIC. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary - actions by the FDIC that, if undertaken, could have a direct material effect on the Company's financial statements. The regulations require Pacific Thrift to meet specific capital adequacy guidelines that involve quantitative measures of Pacific Thrift's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Pacific Thrift's capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. At December 31, 1998, Pacific Thrift did not meet the minimum capital requirements to be considered "adequately capitalized" by the FDIC.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
================================================================================
17. Regulatory Matters Capital Adequacy (Continued) and Capital Adequacy and Quantitative measures established by regulation to Subsequent Events ensure capital adequacy require Pacific Thrift to (continued) maintain minimum amounts and ratios of Tier 1 capital (as defined in the regulations) to average assets (as defined), and Tier 1 capital (as defined) to risk-weighted assets (as defined) and total capital (as defined) to risk weighted assets (as defined). To be considered adequately capitalized as defined under the Prompt Corrective Action (PCA) provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991, Pacific Thrift must maintain the minimum Tier 1 leverage, Tier 1 risk-based, and total risk-based ratios.
According to the following capital ratios, Pacific Thrift is categorized as "Significantly Undercapitalized" at December 31, 1998 and "Undercapitalized" at December 31, 1997 according to the prompt corrective action provisions of Part 325 of Federal Deposit Insurance Corporation Rules and Regulations.
(Dollar Amounts in Thousands) ---------------------------------------- For Required Capital Actual Adequacy Purposes ----------------- ------------------- Amount Ratio Amount Ratio ----------------------------------------------------------------------------
As of December 31, 1998
Total capital (to risk weighted assets) $14,149 3.6% $31,403 8.0% Tier 1 capital (to risk weighted assets) $12,773 3.2% $15,701 4.0% Tier 1 capital (to average $12,733 6.9% $ 7,403 4.0% assets)
As of December 31, 1997
Total capital (to risk weighted assets) $21,697 8.1% $21,479 8.0% Tier 1 capital (to risk weighted assets) $18,925 7.1% $10,740 4.0% Tier 1 capital (to average $18,967 12.8% $ 5,907 4.0% assets) ============================================================================
As of April 9, 1999 Pacific Thrift has not met the capital requirements specified in the 1998 order.
Other Subsequent Events
In January 1999, the employment of its Senior Executive Vice President who also served as President and Chief Operating Officer of Pacific Thrift was terminated. The Company entered into a negotiated separation agreement with the officer dated as of March 9, 1999 which provided for the officer to receive an unsecured note for $475,000 payable over two years beginning January 1, 2002. Pacific Thrift entered into a consulting agreement with the former officer dated March 9, 1999 which provides for a consulting fee of $10,000 per month for six months. Both agreements are subject to approval of the FDIC which has not yet been received.
On April 9, 1999, Pacific Thrift entered into an employment agreement with its new President and Chief Executive Officer. The agreement provides for a term of one year, with automatic renewal successive one year terms unless either party notifies the other of nonrenewal 60 days before expiration of the current term. This agreement is subject to approval of the FDIC.
PacificAmerica Money Center, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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18. Business The Company's loans held for sale and loans Concentrations and receivable consist of mortgage loans to borrowers, Off Balance Sheet primarily secured by first or second trust deeds Risk on California real estate. The loans are collateralized by the borrowers equity in single-family residential and other types of real estate. Loans are expected to be repaid either by cash from the borrower at maturity or by borrower refinancing. The Company would incur a loss in the amount of the loan balance plus accrued interest to the extent of any collateral deficiency.
The Company has a significant concentration in interest-only strips receivable which are dependant on performance of the underlying mortgages held by the securitization trust.
During 1998, the Company's loan origination and purchase volume was concentrated in California, Washington, New York, New Jersey and Florida. Upon securitization, an estimate of credit loss is computed based on the estimated default rate.
The Company currently contracts for the servicing of all loans it originates, purchases and holds for sale with Advanta. This arrangement allows the Company to increase the volume of loans it originates and purchases without incurring the overhead investment in servicing operations. As with any external service provider, the Company is subject to risks associated with inadequate or untimely services. The Company regularly reviews the delinquency of its servicing portfolio.
Many of the Company's borrowers require notices and reminders to keep their loans current and to prevent delinquencies and foreclosures. A substantial increase in the Company's delinquency rate or foreclosure rate could adversely affect its ability to profitably access the capital markets for its financing needs. Although the Company periodically reviews the cost associated with establishing servicing operations to service the loans it originates and purchases, it has no plans to establish and perform servicing operations at this time.
PacificAmerica Money Center, Inc. and Subsidiaries
Schedule I Consolidating Schedule - Financial Position December 31, 1998
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See report of independent certified public accountants and notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Schedule I Consolidating Schedule - Financial Position December 31, 1998
================================================================================
See report of independent certified public accountants and notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Schedule II Consolidating Schedule - Operations Year Ended December 31, 1998
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See report of independent certified public accountants and notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Schedule II Consolidating Schedule - Operations Year Ended December 31, 1998 (Continued)
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See report of independent certified public accountants and notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Schedule III Consolidating Schedule - Financial Position December 31, 1997
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See report of independent certified public accountants and notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Schedule III Consolidating Schedule - Financial Position December 31, 1997
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See report of independent certified public accountants and notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Schedule IV Consolidating Schedule - Operations Year Ended December 31, 1997
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See report of independent certified public accountants and notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Schedule IV Consolidating Schedule - Operations Year Ended December 31, 1997 (Continued)
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See report of independent certified public accountants and notes to consolidated financial statements.
PacificAmerica Money Center, Inc. and Subsidiaries
Schedule V Consolidating Schedule - Operations Year Ended December 31, 1996
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PacificAmerica Money Center, Inc. and Subsidiaries
Schedule V Consolidating Schedule - Operations Year Ended December 31, 1996 (Continued)
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See report of independent certified public accountants and notes to consolidated financial statements.
Index of Exhibits
Exhibit Number Description
3.1 Certificate of Incorporation of the Company, incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-4, as filed with the Securities and Exchange Commission on December 22, 1995, as amended and declared effective on May 14, 1996 (the "Registration Statement").
3.2 Bylaws of the Company, incorporated by reference to the Exhibit 3.2 of the Registration Statement.
4.1 Specimen Common Stock Certificate, incorporated by reference to Exhibit 4.1 of the Registration Statement.
10.1 Employment Agreement by and between the Company and Joel R. Schultz, dated as of January 1, 1998 and approved by the stockholders at the Annual Meeting held June 12, 1998.
10.2 Employment Agreement by and between the Company and Norman A. Markiewicz, incorporated by reference to Exhibit 10.4 of the Registration Statement.
10.3 Employment Agreement by and between the Company and Richard B. Fremed, incorporated by reference to Exhibit 10.5 of the Registration Statement.
10.4 Employment Agreement by and between the Company and Charles J. Siegel, incorporated by reference to Exhibit 10.7 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996 ("1996 10-K").
10.5 Form of Indemnification Agreement by and between the Company and each of its directors and executive officers, incorporated by reference to Exhibit 10.7 of the Registration Statement.
10.6 Stock Option Plan of the Company, dated January 1, 1996, incorporated by reference to Exhibit 10.8 of the Registration Statement.
10.7 Stock Purchase Plan of the Company, dated January 1, 1996, incorporated by reference to Exhibit 10.9 of the Registration Statement.
10.8 Supplemental Executive Retirement Plan of the Company, dated January 1, 1996, incorporated by reference to Exhibit 10.10 of the Registration Statement.
10.9 Master Loan Purchase Agreement dated as of October 31, 1996, by and between the Company and Aames Capital Corporation, incorporated by reference to Exhibit 10.1 of the Company's Report on Form 10-Q for the quarter ended September 30, 1996.
10.10 First and Second Amendments to Master Loan Purchase Agreement by and between the Company and Aames Capital Corporation, incorporated by reference to Exhibit 10.13 to 1996 10-K.
10.11 Amended and Restated Corporate Finance Agreement, dated as of January 27, 1997, by and among the Company, Advanta Mortgage Conduit Services, Inc. and Advanta Mortgage Corp. USA, incorporated by reference to Exhibit 10.14 of the 1996 10-K.
10.12 Asset and Stock Purchase and Sale and Assumption of Liabilities Agreement, Secured Promissory Note and Security Agreement, all dated as of December 15, 1996, among the Company, Consolidated Reconveyance Company, Lenders Posting and Publishing Company, Consolidated Reconveyance Corporation, Consolidated Reconveyance Company, LLC and Lenders Posting and Publishing Company, LLC, incorporated by reference to Exhibit 10.1 of the Company's Report on Form 8-K for December 31, 1996.
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10.13 Home Equity Loan Purchase Agreement, dated as of December 11, 1997, by and among the Company, Merrill Lynch Mortgage Investors, Inc., as depositor, PacificAmerica Home Equity Loan Trust Series 1997-1, as issuer, and Bankers Trust Company of California, N.A., as indenture trustee, incorporated by reference to Exhibit 10.1 of the Company's Report on Form 8-K for December 18, 1997 (the "December 1997 8-K").
10.14 Master Assignment Agreement, dated as of December 18, 1997, by and between the Company and Merrill Lynch Mortgage Capital, Inc., incorporated by reference to Exhibit 10.2 of the December 1997 8-K.
10.15 Master Repurchase Agreement, dated as of October 31, 1997, by and between the Company, on the one hand, and Merrill Lynch Mortgage Capital, Inc. and Merrill Lynch Credit Corporation on the other, which Agreement includes, without limitation, the Supplemental Terms and Conditions attached to and incorporated into the Master Repurchase Agreement, incorporated by reference to Exhibit 10.3 of the December 1997 8-K.
10.16 Home Equity Loan Purchase Agreement, dated as of March 19, 1998, by and among the Company, Merrill Lynch Mortgage Investors, Inc. ("Depositor"), PacificAmerica Home Equity Loan Trust Series 1998-1, as issuer (the "Trust"), and Bankers Trust Company of California, N.A. ("Indenture Trustee"), incorporated by reference to Exhibit 10.1 of the Company's Report on Form 8-K for March 25, 1998 (the "March 1998 8-K").
10.17 Indenture, dated as of March 1, 1998, between the Trust and the Indenture Trustee, incorporated by reference to Exhibit 10.2 of the March 1998 8-K. .
10.18 Amended and Restated Trust Agreement, dated as of March 1, 1998, between the Depositor and Wilmington Trust Company ("Owner Trustee"), incorporated by reference to Exhibit 10.3 of the March 1998 8-K.
10.19 Servicing Agreement dated March 1, 1998 by and among the Company, the Indenture Trustee and the Trust, incorporated by reference to Exhibit 10.3 of the March 1998 8-K.
10.20 Home Equity Loan Purchase Agreement, dated as of June 22, 1998, by and among the Company, Merrill Lynch Mortgage Investors, Inc. ("Depositor"), PacificAmerica Home Equity Loan Trust Series 1998-2F, as issuer (the "Trust"), and Bankers Trust Company of California, N.A. ("Indenture Trustee"), incorporated by reference to Exhibit 10.1 of the Company's Report on Form 8-K for June 25, 1998 (the "June 1998 8-K").
10.21 Indenture, dated as of June 1, 1998, between the Trust and the Indenture Trustee.
10.22 Amended and Restated Trust Agreement, dated as of June 1, 1998, between the Depositor and Wilmington Trust Company ("Owner Trustee"), incorporated by reference to Exhibit 10.2 of the June 1998 8-K.
10.23 Servicing Agreement dated June 1, 1998, by and among the Company, the Indenture Trustee and the Trust, incorporated by reference to Exhibit 10.3 of the June 1998 8-K.
10.24 Secured Promissory Note dated September 17, 1998 of the Company payable to Fremont Financial Corporation, incorporated by reference to Exhibit 10.1 of the Company's Report on Form 8-K for September 17, 1998 (the "September 1998 8-K").
10.25 Stock Pledge Agreement between the Company and Fremont Financial Corporation, incorporated by reference to Exhibit 10.2 of the September 1998 8-K.
21.1 Subsidiaries of the Company, incorporated by reference to Exhibit 21.1 of the Company's 1997 10-K.
27 Financial Data Schedule
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