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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from: to
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Commission File No. 0-21341
OCWEN FINANCIAL CORPORATION
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(Exact name of Registrant as specified in its charter)
FLORIDA 65-0039856
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
THE FORUM, SUITE 1000
1675 PALM BEACH LAKES BOULEVARD
WEST PALM BEACH, FLORIDA 33401
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(Address of principal executive office) (Zip Code)
(561) 681-8000
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: Not applicable.
Securities registered pursuant to Section 12 (g) of the Act:
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE (NYSE)
(Title of each class) (Name of each exchange on which registered)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Aggregate market value of the Common Stock, $.01 par value, held by
nonaffiliates of the registrant, computed by reference to the closing price as
reported on the NYSE as of the close of business on February 27, 1998:
$902,378,460 (for purposes of this calculation affiliates include only directors
and executive officers of the Company).
Number of shares of Common Stock, $.01 par value, outstanding as of February 27,
1998: 60,708,520 shares
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the definitive Proxy Statement
for the Annual Meeting of Shareholders to be held on May 13, 1998 are
incorporated by reference into Part III, Items 10-13. Portions of the Annual
Report to Shareholders are incorporated by reference into Part II, Items 5-8.
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1
OCWEN FINANCIAL CORPORATION
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PAGE
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PART I
Item 1. Business................................................................................ 4
General............................................................................... 4
Recent Transactions................................................................... 5
Discount Loan Acquisition and Resolution Activities................................... 6
Investment in Joint Ventures.......................................................... 11
Lending Activities ................................................................... 11
Loan Servicing Activities............................................................. 18
Asset Quality......................................................................... 18
Investment Activities................................................................. 24
Sources of Funds...................................................................... 30
Computer Systems and Use of Technology................................................ 33
Economic Conditions................................................................... 34
Competition........................................................................... 35
Subsidiaries.......................................................................... 35
Employees............................................................................. 36
Regulation............................................................................ 36
The Company........................................................................... 36
The Bank.............................................................................. 37
Federal Taxation...................................................................... 41
State Taxation........................................................................ 43
Item 2. Properties.............................................................................. 43
Offices............................................................................... 43
Item 3. Legal Proceedings....................................................................... 43
Item 4. Submission of Matters to a Vote of Security Holders..................................... 43
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters............... 43
Item 6. Selected Consolidated Financial Data.................................................... 43
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations... 44
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.............................. 44
Item 8. Financial Statements.................................................................... 44
2
OCWEN FINANCIAL CORPORATION
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
(CONTINUED)
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PAGE
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Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................................... 44
PART III
Item 10. Directors and Executive Officers of Registrant.......................................... 44
Item 11. Executive Compensation.................................................................. 44
Item 12. Security Ownership of Certain Beneficial Owners and Management.......................... 44
Item 13. Certain Relationships and Related Transactions.......................................... 44
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................ 45
Signatures.............................................................................. 47
FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS CONTAINED HEREIN ARE NOT, AND CERTAIN STATEMENTS
CONTAINED IN FUTURE FILINGS BY THE COMPANY WITH THE SECURITIES AND EXCHANGE
COMMISSION, IN THE COMPANY'S PRESS RELEASES OR IN THE COMPANY'S OTHER PUBLIC OR
SHAREHOLDER COMMUNICATIONS, MAY NOT BE BASED ON HISTORICAL FACTS AND ARE
"FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934,
AS AMENDED. FORWARD-LOOKING STATEMENTS WHICH ARE BASED ON VARIOUS ASSUMPTIONS
(SOME OF WHICH ARE BEYOND THE COMPANY'S CONTROL), MAY BE IDENTIFIED BY REFERENCE
TO A FUTURE PERIOD OR PERIODS, OR BY THE USE OF FORWARD-LOOKING TERMINOLOGY,
SUCH AS "MAY," "WILL," "COULD," "BELIEVE," "EXPECT," "ANTICIPATE," "CONTINUE,"
"INTENDS," "PLANS," "PRESENTS," OR SIMILAR TERMS OR VARIATION ON THOSE TERMS, OR
BY THE USE OF THE NEGATIVE OF SUCH TERMINOLOGY. ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE SET FORTH IN FORWARD-LOOKING STATEMENTS DUE TO A VARIETY
OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE RELATED TO THE ECONOMIC
ENVIRONMENT, PARTICULARLY IN THE MARKET AREAS IN WHICH THE COMPANY OPERATES,
COMPETITIVE PRODUCTS AND PRICING, THE GROWTH OR DECLINE OF, AND THE AVAILABILITY
OF PRODUCT TO PURCHASE IN, THE DISCOUNT LOAN INDUSTRY FISCAL AND MONETARY
POLICIES OF THE U.S. OR U.K. GOVERNMENTS, CHANGES IN GOVERNMENT REGULATIONS
AFFECTING FINANCIAL INSTITUTIONS AND REAL ESTATE INVESTMENT TRUSTS, INCLUDING
REGULATORY FEES, CAPITAL REQUIREMENTS AND TAXATION, CHANGES IN PREVAILING
INTEREST AND CURRENCY EXCHANGE RATES, ACQUISITIONS AND THE INTEGRATION OF
ACQUIRED BUSINESSES, SOFTWARE INTEGRATION, DEVELOPMENT AND LICENSING, CREDIT
INTEREST RATE AND OPERATIONAL RISK MANAGEMENT, ASSET/LIABILITY MANAGEMENT, THE
FINANCIAL AND SECURITIES MARKETS AND THE AVAILABILITY OF AND COSTS ASSOCIATED
WITH SOURCES OF LIQUIDITY. THE COMPANY DOES NOT UNDERTAKE, AND SPECIFICALLY
DISCLAIMS ANY OBLIGATION, TO PUBLICLY RELEASE THE RESULTS OF ANY REVISIONS WHICH
MAY BE MADE TO ANY FORWARD-LOOKING STATEMENTS TO REFLECT THE OCCURRENCE OF
ANTICIPATED OR UNANTICIPATED EVENTS OR CIRCUMSTANCES AFTER THE DATE OF SUCH
STATEMENTS.
3
PART I
ITEM 1. BUSINESS
GENERAL
Ocwen Financial Corporation (the "Company") is a specialty financial
services company which conducts business primarily through Ocwen Federal Bank
FSB (the "Bank"), a federally-chartered savings bank and a wholly-owned
subsidiary of the Company, and, to a lesser extent, through Ocwen Financial
Services, Inc. ("OFS"), 93.7% owned subsidiary of the Company which acquired
both the subprime single family residential lending operations previously
conducted by the Bank and substantially all of the assets of Admiral Home Loan
("Admiral"), the Company's primary correspondent mortgage banking firm for
subprime single family residential loans, in a transaction which closed on May
1, 1997. The Company, directly and through its non-bank subsidiaries, also
conducts certain lending and investment activities.
The Company considers itself to be involved in the single business
segment of providing financial services and conducts a variety of business
activities within this segment. The Company's primary business activities
currently consist of its subprime single family, small commercial and large
commercial discount loan acquisition and resolution activities, commercial real
estate lending activities, single family residential lending activities,
mortgage loans for others, investments in a wide variety of mortgage-related
securities and investments in low-income housing tax credit interests. In
addition, the Company previously operated an automated banking division, the
operations of which were discontinued in September 1995. The following table
presents the contribution by business activity to the Company's net income for
the years indicated.
Year Ended December 31,
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1997 1996 1995
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(Dollars in Thousands)
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Amount % Amount % Amount %
-------- -------- -------- -------- -------- --------
Discount Loans:
Single family residential loans ........ $ 22,384 28% $ 12,580 25% $ 4,778 19%
Large commercial real estate loans ..... 23,476 30 16,179 32 9,824 39
Small commercial real estate loans ..... 5,194 7 3,687 7 4,395 17
Investment in low-income housing tax
credits ................................ 9,353 12 7,269 14 3,538 14
Commercial real estate lending ........... 11,802 15 3,785 8 3,041 12
Subprime single family residential
lending ................................. (1,526) (2) 4,115 8 364 1
Mortgage loan servicing .................. 3,780 5 2,559 5 175 1
Investment securities .................... 5,615 7 2,226 4 2,454 10
Other .................................... (1,146) (2) (2,258) (3) (3,102) (13)
-------- ----- -------- ----- -------- -----
$ 78,932 100% $ 50,142 100% $ 25,467 100%
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The Company's strategy focuses on what it believes to be the current
trend toward the growth in the sale or outsourcing of servicing of nonperforming
and underperforming loans by financial institutions and government agencies,
particularly in the event that credit quality for some product lines (such as
subprime mortgage loans) deteriorates. The Company's strategy also focuses on
leveraging its technology infrastructure and core expertise to expand its
activities into related business lines both for itself and on a fee basis for
others. For example, the Company has acquired two software companies and formed
a new corporation, Ocwen Asset Investment Corp. ("OAIC"), a Virginia corporation
which elected to be taxed as a real estate investment trust ("REIT") for federal
income tax purposes and which is managed by Ocwen Capital Corporation ("OCC"), a
newly-formed, wholly-owned subsidiary of the Company.
In May 1997, OAIC successfully completed an initial public offering of
its common stock, which resulted in net proceeds of $283.8 million for its
shares, inclusive of the amount contributed by Investors Mortgage Insurance
Holding Company ("IMI"), a wholly-owned subsidiary of the Company. At December
31, 1997, IMI owned approximately 9.0% of the outstanding common stock of OAIC
and had options to purchase an additional 10% of OAIC's common stock (one
4
quarter of which vest annually over the next four years beginning in May 1998.
Also at December 31, 1997, IMI owned 160,000 or 0.837% of the outstanding
limited partnership units of Ocwen Partnership, L.P. ("OPLP"), the operating
partnership formed to undertake the business of OAIC.
On November 6, 1997, the Company acquired Amos, Inc. ("Amos"), a
Connecticut based company engaged primarily in the development of mortgage loan
servicing software. Amos' products are Microsoft(R) Windows based, client/server
architecture and feature real-time processing, year 2000 compliance, a scaleable
database platform and strong workflow capabilities. The aggregate purchase price
was $9.7 million, including $4.9 million which is contingent on Amos meeting
certain software development performance criteria.
On January 20, 1998, the Company acquired DTS Communications, Inc.
("DTS"), a real estate technology company located in San Diego, California, for
a purchase price of $13.0 million in cash, common stock of the Company and
repayment of certain indebtedness. DTS has developed technology tools to
automate real estate transactions over the Internet. DTS has been recognized by
Microsoft Corporation for the Microsoft(R) component-based architecture to
facilitate electronic data interchange. The common stock of the Company issued
in the acquisition was acquired from affiliates of the Company at the same price
per share as was used to calculate the number of shares issued in the
acquisition. DTS was recently honored as the recipient of this year's Inman
Innovator Award for "Software Applications that help the Real Estate Industry be
more efficient and speed up the Real Estate Transaction Process."
The Company plans to enhance both the Amos and DTS products by
combining features from its proprietary software systems for loan default
management and loss mitigation. Eventually, it is the Company's intention to
make its advanced loan resolution technology available to third parties in the
mortgage industry through the marketing of software licenses.
The Company is a registered savings and loan holding company subject to
regulation by the Office of Thrift Supervision (the "OTS"). The Bank is subject
to regulation by the OTS, as its chartering authority, and by the Federal
Deposit Insurance Corporation ("FDIC"), as a result of its membership in the
Savings Association Insurance Fund ("SAIF") which insures the Company's deposits
up to the maximum extent permitted by law. The Bank is also subject to certain
regulation by the Board of Governors of the Federal Reserve System ("Federal
Reserve Board") and currently is a member of the Federal Home Loan Bank ("FHLB")
of New York, one of the 12 regional banks which comprise the FHLB System.
RECENT TRANSACTIONS
On January 20, 1998, the Company acquired DTS (as discussed above).
On March 6, 1998, the Company acquired an approximately 35% interest in
Norland Capital Group PLC, which trades as Kensington Mortgage Company
("Kensington"), for (POUND STERLING) 27.5 million, or approximately US$45.4
million. Kensington Mortgage is a leading originator of non-conforming
residential mortgages in the UK, with over (POUND STERLING) 400 million of total
loans outstanding to over 8,000 borrowers as of December 1997. Founded in
October of 1995, Kensington has become a major provider of residential home
loans to UK borrowers who are unable to qualify for loans from traditional
sources, such as building societies and banks. Kensington has the distinction of
being the only non-conforming originator on the UK Council of Mortgage Lenders,
the trade association for the UK mortgage lending industry, whose 122 members
collectively account for 98% of the residential mortgage lending in the UK. This
council represents the UK's mortgage lenders, including banks, building
societies and other residential mortgage lenders, to the government, Parliament,
the media and other audiences.
On January 28, 1998, the Company, OAIC and Aames Financial Corporation
("Aames") announced that they had entered into a nonbinding letter of intent
pursuant to which they are negotiating for OAIC to acquire subordinated residual
interests with respect to mortgage loans originated or acquired by Aames through
the first quarter of 1998 and for the Company to assume responsibility for the
special servicing of nonperforming loans underlying such residuals. As the
result of these negotiations, on March 19, 1998, OAIC announced that it had
executed a definitive agreement with a Wall Street firm concerning the
acquisition of a subordinate interest-only security for approximately $14.3
million plus closing costs. Pursuant to related agreements, the Bank will be the
special servicer with respect to the underlying loans.
On February 17, 1998, OAIC repurchased from IMI 175,000 shares of
OAIC's common stock for an aggregate of approximately $3.1 million, reducing
IMI's ownership in OAIC to 8.12%. These shares were immediately resold to
5
certain officers and directors of the Company and OAIC. As part of this
transaction, IMI acquired 175,000 units from OPLP for approximately $3.1
million, increasing IMI's ownership in OPLP to 1.736%.
On March 31, 1998, the Company announced that it had entered into
definitive agreements for the acquisition of substantially all of the assets,
and certain liabilities, of the United Kingdom operations of Cityscape Financial
Corp. (Nasdaq SmallCap Market: CTYSC). The acquisition includes the purchase of
Cityscape's UK whole loan portfolio, securitized loan residuals, and loan
origination and servicing businesses for a price of approximately (POUND
STERLING) 285 million, subject to adjustment as of closing based on an agreed
upon formula (currently estimated to result in an upward or downward adjustment
of approximately (POUND STERLING) 5 million). Closing, which is anticipated to
occur in April, 1998, is subject to satisfaction of a number of conditions,
including obtaining rating agency consents and various substitutions in
connection with the transfer of the securitized residuals and related servicing
rights (which will require the consents of the trustees of the several
securitizations). As a result, there can be no assurance that the transaction
will be consummated.
DISCOUNT LOAN ACQUISITION AND RESOLUTION ACTIVITIES
The Company believes that, under appropriate circumstances, the
acquisition of nonperforming and underperforming mortgage loans at discounts
offers significant opportunities to the Company. Discount loans generally have
collateral coverage which is sufficiently in excess of the purchase price of the
loan, such that successful resolutions can produce total returns which are in
excess of an equivalent investment in performing mortgage loans.
The Company began its discount loan operations in 1991 and initially
focused on the acquisition of single family residential loans. In 1994 the
Company expanded this business to include the acquisition and resolution of
discount multi-family residential and commercial real estate loans (together,
unless the context otherwise requires, "commercial real estate loans"). Prior to
entering the discount loan business, management of the Company had substantial
loan resolution experience through former subsidiaries of the Company which had
been engaged in the business of providing private mortgage insurance for
residential loans. This experience assisted the Company in developing the
procedures, facilities and systems which are necessary to appropriately evaluate
and acquire discount loans and to resolve such loans in a timely and profitable
manner. Management of the Company believes that the resources utilized by the
Company in connection with the acquisition, servicing and resolution of discount
real estate loans, which include proprietary technology and software, allow the
Company to effectively manage an extremely data-intensive business and that, as
discussed below, these resources have applications in other areas.
COMPOSITION OF THE DISCOUNT LOAN PORTFOLIO. At December 31, 1997, the
Company's net discount loan portfolio amounted to $1.43 billion or 47% of the
Company's total assets. Substantially all of the Company's discount loan
portfolio is secured by first mortgage liens on real estate.
The following table sets forth the composition of the Company's
discount loan portfolio by type of loan at the dates indicated:
December 31,
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1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
(Dollars in Thousands)
Single family residential
loans ..................... $ 900,817 $ 504,049 $ 376,501 $ 382,165 $ 430,355
Multi-family residential
loans ..................... 191,302 341,796 176,259 300,220 --
Commercial real estate loans 701,035 (1) 465,801 (1) 388,566 102,138 1,845
Other loans ................ 1,865 2,753 2,203 911 1,316
----------- ----------- ----------- ----------- -----------
Total discount loans ..... 1,795,019 1,314,399 943,529 785,434 433,516
Unaccreted discount ........ (337,350)(2) (241,908)(2) (273,758) (255,974) (129,882)
Allowance for loan losses .. (23,493) (11,538) -- -- --
----------- ----------- ----------- ----------- -----------
Discount loans, net ........ $ 1,434,176 $ 1,060,953 $ 669,771 $ 529,460 $ 303,634
=========== =========== =========== =========== ===========
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(1) The balance at December 31, 1997 consisted of $363.7 million of loans
secured by office buildings, $98.9 million of loans secured by hotels,
$106.8 million of loans secured by retail properties or shopping centers
and $131.6 million of loans secured by other properties. The balance at
December 31, 1996 consisted of $202.1 million of loans secured by office
buildings, $46.0 million of loans secured by hotels, $138.6 million of
loans secured by retail properties or shopping centers and $79.1 million
of loans secured by other properties.
(2) The balance at December 31, 1997 consisted of $170.7 million on single
family residential loans, $46.0 million on multi-family residential loans,
$120.5 million on commercial real estate loans and $0.2 million on other
loans, respectively. The balance at December 31, 1996 consisted of $92.2
million on single family residential loans, $71.8 million on multi-family
residential loans, $77.6 million on commercial real estate loans and $0.3
million on other loans, respectively.
The properties which secure the Company's discount loans are located
throughout the United States. At December 31, 1997, the five states with the
greatest concentration of properties securing the Company's discount loans were
California, New Jersey, New York, Connecticut and Pennsylvania, which had $311.1
million, $220.9 million, $201.5 million, $103.7 million and $95.5 million
principal amount of discount loans (before unaccreted discount), respectively.
6
The Company believes that the relatively geographic distribution of its discount
loan portfolio can reduce the risks associated with concentrating such loans in
very limited more geographic areas, and that, due to its expertise, technology
and software, and procedures, the geographic distribution of its discount loan
portfolio does not place significantly greater burdens on the Company's ability
to resolve such loans.
Discount loans may have net book values up to the Bank's loan-to-one
borrower limitation. See "Business Regulation-The Bank-Loan-to-One Borrower."
ACQUISITION OF DISCOUNT LOANS. In the early years of the program, the
Company acquired discount loans from the FDIC and the Resolution Trust
Corporation ("RTC") primarily in auctions of pools of loans acquired by them
from the large number of financial institutions which failed during the late
1980s and early 1990s. Although the RTC no longer is in existence and the
banking and thrift industries have recovered from the problems experienced in
the late 1980s and early 1990s, governmental agencies, particularly the
Department of Housing and Urban Development ("HUD"), continue to be potential
sources of discount loans. The Company obtains a substantial amount of discount
loans from various private sector sellers, such as banks, savings institutions,
mortgage companies, subprime lenders and insurance companies. At December 31,
1997, approximately 58% of the loans in the Company's discount loan portfolio
had been acquired from the private sector.
The percentage of discount loans in the Company's discount loan
portfolio acquired from private sector sellers has decreased in recent periods
as a result of the Company's acquisition of a substantial amount of discount
loans from HUD. During the year ended December 31, 1997, the Company and a
co-investor were the successful bidder to purchase from HUD 24,773 single family
residential loans with an aggregate unpaid principal balance of $1.55 billion
and a purchase price of $1.34 billion. The Company acquired $771.6 million of
these loans and the right to service all of such loans. In 1996, the Company and
a co-investor were the successful bidder to purchase from HUD 4,591 single
family residential loans with an aggregate unpaid principal balance of $258.1
million and a purchase price of $204.0 million. The Company acquired $112.2
million of these loans and the right to service all of such loans. In 1996, the
Company also acquired from HUD discount multi-family residential loans with an
unpaid principal balance of $225 million. The foregoing acquisitions were in
addition to the acquisition of $741.2 million gross principal amount of single
family residential loans from HUD by BCBF, LLC (the "LLC"), a limited liability
company formed in March 1996 between the Bank and BlackRock Capital Finance L.P.
("BlackRock"). See "Business-Investment in Joint Ventures."
Primarily as a result of acquisitions from HUD, during 1996 and 1997
the Company (including its pro rata interest in the LLC) was the second largest
acquiror in the United States (behind Goldman Sachs' Whitehall Street Real
Estate Fund) of distressed real estate assets worldwide and the largest acquiror
in the U.S. of portfolios of such assets, according to statistics published by
REAL ESTATE ALERT.
HUD loans are acquired by HUD pursuant to various assignment programs
of the Federal Housing Administration ("FHA"). Under programs of the FHA, a
lending institution may assign an FHA-insured loan to HUD because of an economic
hardship on the part of the borrower which precludes the borrower from making
the scheduled principal and interest payment on the loan. FHA-insured loans also
are automatically assigned to HUD upon the 20th anniversary of the mortgage
loan. In most cases, loans assigned to HUD after this 20-year period are
performing under the original terms of the loan. Once a loan is assigned to HUD,
the FHA insurance has been paid and the loan is no longer insured. As a result,
none of the HUD loans are insured by the FHA.
A majority of the $771.6 million of loans acquired from HUD during the
year ended December 31, 1997 are subject to forbearance agreements after the
servicing transfer date. During the forbearance period, borrowers are required
to make a monthly payment which is based on their ability to pay and which may
be less than the contractual monthly payment. Once the forbearance period is
over, the borrower is required to make at least the contractual payment
regardless of ability to pay. Virtually all of the foregoing loans acquired from
HUD will reach the end of the forbearance period by the end of 1998. Prior
purchases of loans from HUD by the Company (and the LLC) primarily included
loans that were beyond the forbearance period.
Discount real estate loans generally are acquired in pools, although
discount commercial real estate loans may be acquired individually. These pools
generally are acquired in auctions or competitive bid circumstances in which the
Company faces substantial competition. Although many of the Company's
competitors have access to greater capital and have other advantages, the
Company believes that it has a competitive advantage relative to many of its
competitors as a result of its experience in managing and resolving discount
loans, its large investment in the computer systems, technology
7
and other resources which are necessary to conduct this business, its national
reputation and the strategic relationships and contacts which it has developed
in connection with these activities.
The Company generally acquires discount loans solely for its own
portfolio. From time to time, however, the Company and one or more co-investors
may submit a joint bid to acquire a pool of discount loans in order to enhance
the prospects of submitting a successful bid. If successful, the Company and the
co-investors generally allocate ownership of the acquired loans in an agreed
upon manner, although in certain instances the Company and the co-investor may
continue to have a joint interest in the acquired loans. In addition, from time
to time the Company and a co-investor may acquire discount loans through a joint
venture. See "Business-Investment in Joint Ventures."
Prior to making an offer to purchase a portfolio of discount loans, the
Company conducts an extensive investigation and evaluation of the loans in the
portfolio. Evaluations of potential discount loans are conducted primarily by
the Company's employees who specialize in the analysis of nonperforming loans,
often with further specialization based on geographic or collateral specific
factors. The Company's employees regularly use third parties, such as brokers,
who are familiar with a property's type and location, to assist them in
conducting an evaluation of the value of a collateral property, and depending on
the circumstances, particularly in the case of commercial real estate loans, may
use subcontractors, such as local counsel and engineering and environmental
experts, to assist in the evaluation and verification of information and the
gathering of other information not previously made available by a potential
seller.
The Company determines the amount to be offered by it to acquire
potential discount loans by using a proprietary modeling system and loan
information database which focuses on the anticipated recovery amount and the
timing and cost of the resolution of the loans. The amount offered by the
Company generally is at a discount from both the stated value of the loan and
the value of the underlying collateral which the Company estimates is sufficient
to generate an acceptable return on its investment.
RESOLUTION OF DISCOUNT LOANS. After a discount loan is acquired, the
Company utilizes its computer software systems to resolve the loan as
expeditiously as possible in accordance with specified procedures. The various
resolution alternatives generally include the following: (i) the borrower brings
the loan current in accordance with original or modified terms, (ii) the
borrower repays the loan or a negotiated amount of the loan, (iii) the borrower
agrees to deed the property to the Company in lieu of foreclosure, in which case
it is classified as real estate owned and held for sale by the Company, or (iv)
the Company forecloses on the loan and the property is acquired at the
foreclosure sale either by a third party or by the Company, in which case it is
classified as real estate owned and held for sale by the Company. In addition,
in the case of single family residential loans, assistance is provided to
borrowers in the form of forbearance agreements under which the borrower either
makes a monthly payment less than or equal to the original monthly payment or
makes a monthly payment more than the contractual monthly payment to make up for
arrearages.
In appropriate cases, the Company works with borrowers to resolve the
loan in advance of foreclosure. One method is through forbearance agreements,
which generally allow the borrower to pay the contractual monthly payment plus a
portion of the arrearage each month, and other means. Although this strategy may
result in an initial reduction in the yield on a discounted loan, the Company
believes that it is advantageous because it (i) generally results in a higher
resolution value than foreclosure; (ii) reduces the amount of real estate owned
acquired by foreclosure or by deed-in-lieu thereof and related costs and
expenses; (iii) enhances the ability of the Company to sell the loan in the
secondary market, either on a whole loan basis or through securitizations (in
which case the Company may continue to earn fee income from servicing such
loans); and (iv) permits the borrower to retain ownership of the home and, thus,
enhances relations between the Company and the borrower. As a result of the
Company's current loan resolution strategy of emphasizing forbearance agreements
and other resolutions in advance of foreclosure, the Company has been able to
resolve 71% of its discount loans before foreclosure.
The general goal of the Company's asset resolution process is to
maximize, in a timely manner, cash recovery on each loan in the discount loan
portfolio. The Company generally anticipates a longer period (approximately 12
to 30 months) to resolve discount commercial real estate loans than discount
single family residential loans because of their complexity and the wide variety
of issues that may occur in connection with the resolution of such loans.
The Credit Committee of the Board of Directors of the Bank actively
monitors the asset resolution process to identify discount loans which have
exceeded their expected foreclosure period and real estate owned which has been
held longer than anticipated. Plans of action are developed for each of these
assets to remedy the cause for delay and are reviewed by the Credit Committee.
8
SALE OF DISCOUNT LOANS. From time to time the Company sells performing
discount loans either on a whole loan basis or indirectly through the
securitization of such loans and sale of the mortgage-related securities backed
by them. During the years ended December 31, 1997, 1996 and 1995, respectively,
the Company sold $518.9 million, $230.2 million and $51.6 million of discount
loans, respectively, which resulted in gains of $60.4 million, $15.3 million and
$6.0 million, respectively, including net securitization gains of $53.1 million,
$7.9 million and $0, respectively. Also during 1997, the LLC, as part of larger
transactions involving the Company and an affiliate of Black Rock, completed the
securitizations of 1,730 discount single family residential loans acquired from
HUD in 1996 and 1995, with an unpaid principal balance of $78.4 million and past
due interest of $22.5 million, which resulted in the Company recognizing
indirect gains of $14.0 million as a result of the Company's pro rata interest
in the LLC. The Company continues to service the loans for a fee and has
retained interests in the related subordinate class of securities. For
information concerning the foregoing securitizations and retained securities,
see "Business-Investment Activities."
ACTIVITY IN THE DISCOUNT LOAN PORTFOLIO. The following table sets forth
the activity in the Company's gross discount loan portfolio during the periods
indicated:
Year Ended December 31,
------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------- ------------------- ------------------ ------------------ ------------------
No. of No. of No. of No. of No. of
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
---------- ------ ---------- ----- --------- ----- --------- ------ --------- ------
(Dollars in Thousands)
Balance at beginning
of period........... $1,314,399 5,460 $ 943,529 4,543 $ 785,434 3,894 $ 433,516 5,160 $ 310,464 5,358
Acquisitions(1)...... 1,776,773 17,703 1,110,887 4,812 791,195 2,972 826,391 2,781 294,359 2,412
Resolutions and
repayments(2)....... (484,869) (1,978) (371,228) (2,355) (300,161) (960) (265,292) (2,153) (116,890) (1,430)
Loans transferred to
real estate owned... (292,412) (1,596) (138,543) (860) (281,344) (984) (171,300) (1,477) (26,887) (602)
Sales................ (518,872) (6,609) (230,246) (680) (51,595) (379) (37,881) (417) (27,530) (578)
---------- ------ ---------- ----- --------- ----- --------- ------ --------- ------
Balance at end of
period.............. $1,795,019 12,980 $1,314,399 5,460 $ 943,529 4,543 $ 785,434 3,894 $ 433,516 5,160
========== ====== ========== ===== ========= ===== ========= ====== ========= ======
- ---------------------
(1) In 1997, acquisitions consisted of $1.06 billion of single family
residential loans, $57.7 million of multi-family residential loans and
$657.0 million of commercial real estate loans. In 1996, acquisitions
consisted of $365.4 million of single family residential loans, $310.4
million of multi-family residential loans, $433.5 million of commercial
real estate loans and $1.5 million of other loans. The 1996 data does not
include the Company's pro rata share of the $741.2 million of discount
loans acquired by the LLC (see Business Investment in Joint Ventures). In
1995, acquisitions consisted of $272.8 million of single family residential
loans, $141.2 million of multi-family residential loans, $374.9 million of
commercial real estate loans and $2.3 million of other loans. In 1994,
acquisitions consisted of $395.8 million of single family residential
loans, $315.5 million of multi-family residential loans and $115.1 million
of commercial real estate loans. In 1993, substantially all of the
acquisitions were of single family residential loans.
(2) Resolutions and repayments consists of loans which were resolved in a
manner which resulted in partial or full repayment of the loan to the
Company, as well as principal payments on loans which have been brought
current in accordance with their original or modified terms (whether
pursuant to forbearance agreements or otherwise) or on other loans which
have not been resolved.
For information relating to the activity in the Company's real estate
owned which is attributable to the Company's discount loan acquisitions, see
"Business-Asset Quality - Real Estate Owned."
9
PAYMENT STATUS OF DISCOUNT LOANS. The following table sets forth
certain information relating to the payment status of loans in the Company's
discount loan portfolio at the dates indicated.
December 31,
-----------------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ---------- ---------- ----------
(Dollars in Thousands)
Loan status:
Current....................... $ 673,256 $ 579,597 $ 351,630 $ 113,794 $ 23,629
Past due 31 days to 89 days... 22,786 22,161 86,838 57,023 15,175
Past due 90 days or more (1).. 1,070,924 563,077 385,112 413,506 254,413
Acquired and servicing not
yet transferred.............. 28,053 149,564 119,949 201,111 140,299
----------- ----------- ---------- ---------- ----------
1,795,019 1,314,399 943,529 785,434 433,516
Unaccreted discount........... (337,350) (241,908) (273,758) (255,974) (129,882)
Allowance for loan losses..... (23,493) (11,538) -- -- --
----------- ----------- ---------- ---------- ----------
$ 1,434,176 $ 1,060,953 $ 669,771 $ 529,460 $ 303,634
=========== =========== ========== ========== ==========
- ----------------
(1) Includes $432.6 million and $57.0 million of loans with forbearance
agreements at December 31, 1997 and 1996, respectively, and $638.3 million
and $506.1 million of loans without forbearance agreements at December 31,
1997 and 1996, respectively. Of the $432.6 million of loans with
forbearance agreements past due 90 days or more in accordance with
original terms, $184.5 million were current and $131.8 million were past
due 31 to 89 days under the terms of the forbearance agreements.
ACCOUNTING FOR DISCOUNT LOANS. The acquisition cost for a pool of
discount loans is allocated to each individual loan within the pool based upon
the Company's pricing methodology. Prior to January 1, 1997, the discount
associated with all single family residential loans was recognized as a yield
adjustment and was accreted into interest income using the interest method
applied on a loan-by-loan basis once foreclosure proceedings were initiated, to
the extent the timing and amount of cash flows could be reasonably determined.
Effective January 1, 1997, the Company ceased accretion of discount on its
nonperforming single family residential loans. The discount which is associated
with a single family residential loan and certain multi-family residential and
commercial real estate loans which are current or subsequently brought current
by the borrower in accordance with the loan terms is accreted into the Company's
interest income as a yield adjustment using the interest method over the
contractual maturity of the loan. For all other loans interest is earned as cash
is received.
Gains on the repayment and discharge of loans are recorded in interest
income on discount loans. Upon receipt of title to property securing a discount
loan, the loans are transferred to real estate owned.
Beginning in 1996, adjustments to reduce the carrying value of discount
loans to the fair value of the property securing the loan are charged against
the allowance for loan losses on the discount loan portfolio. Prior to 1996,
such adjustments were charged against interest income on discount loans.
OTHER DISCOUNT LOAN ACTIVITIES. The Company believes that the
procedures, facilities and systems which it has developed in connection with the
acquisition and resolution of discount loans may be applied in other businesses.
The Company commenced a program in 1995 to utilize this experience by financing
the acquisition of discount loans by other institutions. During 1997 and 1996,
the Company originated $0 million and $25.8 million, respectively, of portfolio
finance loans, which had an aggregate balance of $17.7 million at December 31,
1997. Portfolio finance loans generally have two-year terms, floating interest
rates which adjust in accordance with a designated reference rate and a
loan-to-value ratio which does not exceed the lesser of 90% of the purchase
price or the estimated value of the collateral as determined by the Company, and
may include terms which provide the Company with a participation interest in the
profits from the resolution of the discount loan collateral. Portfolio finance
loans are included in the Company's non-discount loan portfolio under the
category of loan which is represented by the properties which secure the
discount loans that collateralize the Company's portfolio finance loans. See
"Business - Lending Activities."
The Company's discount loan acquisitions and resolution activities and
related securitization activities also have contributed significantly to
increases in the Company's loan servicing activities. See "Business-Loan
Servicing Activities."
10
INVESTMENT IN JOINT VENTURES
At December 31, 1997, the Company's investment in joint ventures
consisted solely of its investment in BCFL, L.L.C. ("BCFL"), a limited liability
company formed in January 1997 between the Company and BlackRock to acquire
multi-family loans. At December 31, 1996, the Company's investment in joint
ventures consisted of its 50% investment in the LLC. On December 12, 1997, the
LLC distributed all of its assets to the Company and its other 50% investor,
BlackRock. Simultaneous to the distribution, the Company acquired BlackRock's
portion of the distributed assets.
ACQUISITION OF HUD LOANS BY THE LLC. In April 1996, the LLC purchased
16,196 single family residential loans offered by HUD at an auction. Many of the
loans, which had an aggregate unpaid principal balance of $741.2 million at the
date of acquisition, were not performing in accordance with their original terms
or an applicable forbearance agreement. The aggregate purchase price paid to HUD
amounted to $626.4 million. All of the HUD loans acquired by the LLC were
secured by first mortgage liens on single family residences.
In connection with the acquisition, the Company entered into an
agreement with the LLC to service the HUD loans in accordance with its loan
servicing and loan default resolution procedures. In return for such servicing,
the Company received specific fees which were payable on a monthly basis. The
Company did not pay any additional amount to acquire these servicing rights and,
as a result, the acquisition of the right to service the HUD loans held by the
LLC did not result in the Company's recording capitalized mortgage servicing
rights for financial reporting purposes.
SECURITIZATION OF THE HUD LOANS. During 1997, the LLC, as part of
larger transactions involving the Company and an affiliate of BlackRock,
completed securitizations of 1,730 HUD loans held by it with an unpaid principal
balance of $78.4 million, past due interest of $22.5 million and a net book
value of $60.6 million; and during 1996, the LLC completed a securitization of
9,825 HUD loans with an aggregate unpaid principal balance of $419.4 million,
past due interest of $86.1 million and a net book value of $394.2 million. The
LLC recognized gains of $14.0 million and $69.8 million (including a gain of
$12.9 million on the sale in 1996 of $79.4 million of securities to the Company)
from the sale of the senior classes in the REMICs formed for purposes of these
transactions in the years ended December 31, 1997 and 1996, respectively, of
which $7.0 million and $34.9 million, respectively, were allocable to the
Company as a result of its pro rata interest in the LLC and included in equity
in earnings of joint venture.
ACCOUNTING FOR INVESTMENT IN JOINT VENTURES. The Company's investment
in the LLC was accounted for under the equity method of accounting. Under the
equity method of accounting, an investment in the shares or other interests of
an investee is initially recorded at the cost of the shares or interests
acquired and thereafter is periodically increased (decreased) by the investor's
proportionate share of the earnings (losses) of the investee and decreased by
all dividends received by the investor from the investee. The Company's
investment in the LLC amounted to $0 and $67.9 million at December 31, 1997 and
1996, respectively. Because the LLC was a pass-through entity for federal income
tax purposes, provisions for income taxes were established by each of the
Company and its co-investor, and not the LLC. The Company recognized $23.7
million and $38.3 million of pre-tax income from its investment in the LLC for
the years ended December 31, 1997 and 1996, respectively.
LENDING ACTIVITIES
COMPOSITION OF LOAN PORTFOLIO. At December 31, 1997, the Company's net
loan portfolio amounted to $266.3 million or 9% of the Company's total assets.
Loans held for investment in the Company's loan portfolio are carried at
amortized cost, less an allowance for loan losses, because the Company has the
ability and presently intends to hold them to maturity.
11
The following table sets forth the composition of the Company's loan
portfolio by type of loan at the dates indicated.
December 31,
----------------------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(Dollars in Thousands)
Single family residential loans.. $ 46,226 $ 73,186 $ 75,928 $ 31,926 $ 30,385
Multi-family residential loans... 71,382(1) 67,842(1) 49,047(1) 1,800 39,352
Commercial real estate and land
loans:
Hotels (3) .................... 89,362(2) 200,311(2) 125,791 19,659 14,237
Office buildings (3) .......... 68,759 128,782 61,262 -- --
Land .......................... 2,858 2,332 24,904 1,315 4,448
Other ......................... 16,094 25,623 2,494 4,936 4,059
--------- --------- --------- --------- ---------
Total ....................... 177,073 357,048 214,451 25,910 22,744
Commercial non-mortgage ......... -- 2,614 -- -- --
Consumer ........................ 244 424 3,223 1,558 3,639
--------- --------- --------- --------- ---------
Total loans ................. 294,925 501,114 342,649 61,194 96,120
Undisbursed loan proceeds ....... (22,210) (89,840) (39,721) -- --
Unaccreted discount ............. (2,721) (5,169) (5,376) (3,078) (6,948)
Allowance for loan losses ....... (3,695) (3,523) (1,947) (1,071) (884)
--------- --------- --------- --------- ---------
Loans, net ................ $ 266,299 $ 402,582 $ 295,605 $ 57,045 $ 88,288
========= ========= ========= ========= =========
- ------------------
(1) At December 31, 1997, 1996 and 1995, multi-family residential loans
included $33.3 million, $36.6 million, and $7.7 million of construction
loans, respectively.
(2) At December 31, 1997 and 1996, hotel loans included $25.3 million and
$26.4 million of construction loans, respectively.
(3) During 1997, payoffs of commercial real estate loans secured by hotels and
office buildings totaled $80.5 million and $107.3 million, respectively.
The Company's lending activities are conducted on a nationwide basis
and, as a result, the properties which secure its loan portfolio are located
throughout the United States. At December 31, 1997, the five states in which the
largest amount of properties securing loans in the Company's loan portfolio were
New York, New Jersey, California, Maryland and Illinois, which had $58.8
million, $35.4 million, $27.7 million, $26.1 million and $21.2 million of
principal amount of loans, respectively. As noted above, the Company believes
that the relatively geographic distribution of its loan portfolio can reduce the
risks associated with concentrating such loans in more limited geographic areas.
12
CONTRACTUAL PRINCIPAL REPAYMENTS. The following table sets forth
certain information at December 31, 1997 regarding the dollar amount of loans
maturing in the Company's loan portfolio based on scheduled contractual
amortization, as well as the dollar amount of loans which have fixed or
adjustable interest rates. Demand loans, loans having no stated schedule of
repayments and no stated maturity and overdrafts are reported as due in one year
or less. Loan balances have not been reduced for (i) undisbursed loan proceeds,
unearned discounts and the allowance for loan losses or (ii) nonperforming
loans.
Maturing in
----------------------------------------------------------------------
After One Year After Five Years
One Through Five Through After Ten
Year or Less Years Ten Years Years
------------ ------------ ------------ ------------
(Dollars in Thousands)
Single family residential loans....... $ 4,999 $ 1,789 $ 8,094 $ 31,344
Multi-family residential loans........ 24,454 29,227 3,979 13,722
Commercial real estate and land loans. 18,646 150,108 4,233 4,085
Consumer and other loans.............. 21 224 -- --
------------ ------------ ------------ ------------
Total.............................. $ 48,120 $ 181,348 $ 16,306 $ 49,151
============ ============ ============ ============
Interest rate terms on amounts due:
Fixed.............................. $ 10,974 $ 166,001 $ 16,132 $ 27,951
Adjustable......................... 37,146 15,347 174 21,200
------------ ------------ ------------ ------------
$ 48,120 $ 181,348 $ 16,306 $ 49,151
============ ============ ============ ============
Scheduled contractual principal repayments may not reflect the actual
maturities of loans because of prepayments and, in the case of conventional
mortgage loans, due-on-sale clauses. The average life of mortgage loans,
particularly fixed-rate loans, tends to increase when current mortgage loan
rates are substantially higher than rates on existing mortgage loans and,
conversely, decrease when rates on existing mortgages are substantially higher
than current mortgage loan rates.
ACTIVITY IN THE LOAN PORTFOLIO. The following table sets forth the
activity in the Company's loan portfolio during the periods indicated.
Year Ended December 31,
----------------------------------------------
1997 1996 1995
----------- ----------- -----------
(Dollars in Thousands)
Balance at beginning of period....................... $ 501,114 $ 342,649 $ 61,194
Originations:
Single family residential loans................... 1,987 10,681 14,776
Multi-family residential loans.................... 16,799 68,076 48,664
Commercial real estate loans...................... 69,948 199,017 212,630
Commercial non-mortgage and consumer loans........ 1,140 3,366 207
----------- ----------- -----------
Total loans originated......................... 89,874 281,140 276,277
----------- ----------- -----------
Purchases:
Single family residential loans................... 78 305 29,833
Commercial real estate loans...................... -- -- 2,245
Consumer loans.................................... -- -- 1,966
----------- ----------- -----------
Total loans purchased.......................... 78 305 34,044
----------- ----------- -----------
Sales ............................................... (2,346) -- --
Loans transferred from available for sale............ 13,782 45 4,353
Principal repayments................................. (306,916) (121,818) (33,168)
Transfer to real estate owned........................ (661) (1,207) (51)
----------- ----------- -----------
Net increase (decrease) in net loans................. (206,189) 158,465 281,455
----------- ----------- -----------
Balance at end of period............................. $ 294,925 $ 501,114 $ 342,649
=========== =========== ===========
13
LOANS AVAILABLE FOR SALE. In addition to loans acquired for investment,
the Company also originates and purchases loans which it presently does not
intend to hold to maturity. Such loans are designated as loans available for
sale upon origination or purchase and generally are carried at the lower of cost
or aggregate market value. At December 31, 1997, loans available for sale
amounted to $177.0 million or 6% of the Company's total assets.
The following table sets forth the composition of the Company's loans
available for sale by type of loan at the dates indicated.
December 31
--------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
(Dollars in thousands)
Single family residential loans...... $ 176,554 $ 111,980 $ 221,927 $ 16,825 $ 30,217
Multi-family residential loans....... -- 13,657 28,694 83,845 44,919
Consumer loans....................... 487 729 1,169 1,623 25,930
----------- ----------- ----------- ----------- -----------
177,041 $ 126,366 $ 251,790 $ 102,293 $ 101,066
=========== =========== =========== =========== ===========
Although the Company's loans available for sale are secured by
properties located nationwide, currently a substantial majority of such loans
are subprime single family residential loans originated primarily in the western
states, particularly California, primarily as the result of Admiral having been
located there prior to the acquisition of substantially all of its assets by
OFS. As a result, $35.2 million or 20% of the Company's loans available for sale
at December 31, 1997 were secured by properties located in California, primarily
as the result of Admiral having been located there prior to the acquisition of
substantially all of its assets by OFS.
SINGLE FAMILY RESIDENTIAL LOANS. Since late 1994, the Company's lending
activities have included the origination and purchase of single family
residential loans to borrowers who because of prior credit problems, the absence
of a credit history or other factors are unable or unwilling to qualify as
borrowers for a single family residential loan under guidelines of the Federal
National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage
Corporation ("FHLMC") ("conforming loans") and who have substantial equity in
the properties which secure the loans. Loans to non-conforming borrowers are
perceived by the Company as being advantageous because they generally have
higher interest rates and origination and servicing fees and generally lower
loan-to-value ratios than conforming loans and because the Company's expertise
in the servicing and resolution of nonperforming loans can be utilized in
underwriting such loans, as well as to address loans acquired pursuant to this
program which become nonperforming after acquisition.
Through 1996, the Company acquired subprime single family residential
loans primarily through a correspondent relationship with Admiral and, to a
lesser extent, correspondent relationships with three other financial services
companies. Correspondent institutions originate loans based on guidelines
provided by the Company and promptly sell the loans to the Company on a
servicing-released basis.
In order to solidify and expand its sources of subprime single family
residential loans, the Company, through OFS, acquired substantially all of the
assets of Admiral in a transaction which closed on May 1, 1997. See
"Business-Subsidiaries." At the time of acquisition, Admiral engaged in subprime
lending on a retail and wholesale basis through eleven loan production offices
located in California and independent mortgage brokers and correspondent lending
institutions located in California and eleven other states. In connection with
the Company's acquisition of assets from Admiral, the Bank transferred its
retail and wholesale subprime single family residential lending operations to
OFS, which included, among other things, transferring its rights under contracts
with brokers and correspondent lending institutions and its rights and
obligations under leases to six loan production offices recently opened by it,
which are located in California, Illinois, Massachusetts, Oregon and Utah. OFS
currently conducts its business on a retail and wholesale basis through 27 loan
production offices located in seven states and plans to open an additional five
such offices in 1998.
OFS' principal sources of funds consist of (i) four lines of credit
with unaffiliated parties which aggregate $650 million and are secured by the
mortgage loans acquired with such lines and (ii) a $30 million unsecured,
subordinated credit facility provided by the Company to OFS at the time of the
acquisition of substantially all of the assets of Admiral. The Company has
adopted policies that set forth the specific lending requirements of the Company
as they relate to the processing, underwriting, property appraisal, closing,
funding and delivery of subprime loans. These policies include program
descriptions which set forth four classes of loans, designated A, B, C and D.
Class A loans generally relate to borrowers who have no or limited adverse
incidents in their credit histories, whereas Class B, C and D loans relate to
14
increasing degrees of adverse incidents in the borrower's credit histories.
Factors which are considered in evaluating a borrower in this regard are the
presence or absence of a credit history, prior delinquencies in the payment of
mortgage and consumer credit and personal bankruptcies.
The terms of the loan products offered by the Company directly or
through its correspondents emphasize real estate loans which generally are
underwritten with significant reliance on a borrower's level of equity in the
property securing the loan, which may be an owner-occupied or, depending on the
class of loan and its terms, a non-owner occupied property. Although the
Company's guidelines require information in order to enable the Company to
evaluate a borrower's ability to repay a loan by relating the borrower's income,
assets and liabilities to the proposed indebtedness, because of the significant
reliance on the ratio of the principal amount of the loan to the appraised value
of the security property, each of the four principal classes of loans identified
by the Company include products which permit reduced documentation for verifying
a borrower's income and employment. Loans which permit reduced documentation
generally require documentation of employment and income for the most recent
six-month period, as opposed to the two-year period required in the case of full
documentation loans. Although the Company reserves the right to verify a
borrower's income, assets and liabilities and employment history, other than as
set forth above, it generally does not verify such information through other
sources.
The Company's strategy is to offer a broad range of products to its
borrowers and its origination sources. Loans may have principal amounts which
conform to the guidelines set by FHLMC or FNMA for conforming loans or principal
amounts which significantly exceed these amounts (so called "jumbo loans").
Loans may have fixed or adjustable interest rates and terms ranging up to 30
years.
The following table sets forth the activity in the Company's net loans
available for sale during the periods indicated:
Year Ended December 31,
------------------------------------------------------
1997 1996 1995
------------ -------------- --------------
(Dollars in Thousands)
Balance at beginning of period................. $ 126,366 $ 251,790 $ 102,293
Purchases:
Single family residential.................... 278,081 284,598 230,077
Multi-family residential..................... -- 10,456 10,056
------------ -------------- --------------
278,081 295,054 240,133
------------ -------------- --------------
Originations:
Single family residential.................... 316,101 9,447 360
Multi-family residential..................... -- -- 24,810
------------ -------------- --------------
316,101 9,447 25,170
------------ -------------- --------------
Sales.......................................... (501,079) (395,999) (100,104)
Increase in lower of cost or market reserve.... (1,034) (2,455) (118)
Loans transferred (to)/from loan portfolio..... (13,674) 45 (4,353)
Principal repayments, net of capitalized
interest..................................... (22,151) (27,845) (11,231)
Transfer to real estate owned.................. (5,569) (3,671) --
------------ -------------- --------------
Net increase (decrease) in loans............. 50,675 (125,424) 149,497
------------ -------------- --------------
Balance at end of period....................... $ 177,041 $ 126,366 $ 251,790
============ ============== ==============
The Company purchased and originated a total of $588.3 million of
single family residential loans to non-conforming borrowers during 1997 and
$294.0 million of such loans during 1996. At December 31, 1997, the Company had
$167.0 million of subprime single family residential loans, which had a weighted
average yield of 10.41%.
The Company generally intends to sell or securitize its subprime single
family residential loans, and as a result, all of such loans were classified as
available for sale at December 31, 1997. During 1997, the Company sold $82.6
million of subprime single family residential loans for gains of $3.3 million;
during 1996 the Company sold $161.5 million of such
15
loans for gains of $571,000; and during 1995 the Company sold $25.3 million of
subprime single family residential loans for gains of $188,000. An additional
$415.8 million and $211.2 million of loans were securitized and sold in public
offerings underwritten by unaffiliated investment banking firms during 1997 and
1996, respectively, generating gains of $18.8 million and $7.2 million,
respectively, upon the sale of the securities. The Company retained subordinate
and REMIC residual securities in connection with these transactions. Such
securities had an aggregate carrying value of $41.8 million at December 31,
1997. See "Business-Investment Activities."
Although subprime loans generally have higher levels of default than
conforming loans, the Company believes that the borrower's equity in the
security property and its expertise in the area of resolution of nonperforming
loans will continue to make its subprime borrower loan program a successful one
notwithstanding such defaults and any resulting losses. There can be no
assurance that this will be the case, however.
In addition to the Company's subprime single family residential loan
programs, from time to time the Company purchases pools of single family
residential loans for investment purposes. During 1995, the Company purchased
$29.8 million of loans which were primarily secured by properties located in the
area surrounding the Bank's physical facility in northern New Jersey.
MULTI-FAMILY RESIDENTIAL AND COMMERCIAL REAL ESTATE LOANS. The
Company's lending activities include the acquisition of loans secured by
commercial real estate, particularly loans secured by hotels and office
buildings, which the Company began originating in late 1994 and late 1995,
respectively. Commercial real estate loans currently are made to finance the
purchase and refinance of commercial properties, the refurbishment of distressed
properties and, recently, the construction of hotels. At December 31, 1997, the
Company's loans secured by commercial real estate (and land) amounted to $177.1
million and consisted primarily of $89.4 million and $68.8 million of loans
secured by hotels and office buildings, respectively.
From time to time, the Company originates loans for the construction of
multi-family residences, as well as bridge loans to finance the acquisition and
rehabilitation of distressed multi-family residential properties. At December
31, 1997, the Company's multi-family residential loan portfolio included $33.3
million of multi-family residential construction loans, of which $21.1 million
had been funded, and $38.1 million of acquisition and rehabilitation loans, of
which $34.8 million had been funded.
From time to time the Company also originates loans secured by existing
multi-family residences. Although the Company has deemphasized this type of
lending in recent periods, it previously was active in the origination and
securitization of such loans. During 1995, 1994 and 1993, the Company
securitized multi-family residential loans acquired by it with an aggregate
principal amount of $83.9 million, $346.6 million and $67.1 million,
respectively. The Company subsequently sold all of the securities backed by
these loans.
The multi-family residential and commercial real estate loans acquired
by the Company in recent periods generally have principal amounts between $3.0
million and the Bank's loan-to-one-borrower limitation (see "Regulation-The
Bank-Loans-to-One-Borrower") and are secured by properties which in management's
view have good prospects for appreciation in value during the loan term. In
addition, the Company currently is implementing a program to originate
multi-family residential and commercial real estate loans with smaller principal
amounts (generally up to $3.0 million) and which may be secured by a wide
variety of such properties.
The Company's large multi-family residential and commercial real estate
loans generally have fixed interest rates, terms of two to five years and
payment schedules which are based on amortization over 15 to 25 year periods.
The maximum loan-to-value ratio generally does not exceed 80% of the stabilized
value of the property and 88% of the total costs of the property in the case of
construction, refurbishment or rehabilitation loans.
Multi-family residential and commercial real estate loans are secured
by a first priority lien on the real property, all improvements thereon and, in
the case of hotel loans, all fixtures and equipment used in connection
therewith, as well as a first priority assignment of all revenue and gross
receipts generated in connection with the property. The liability of a borrower
on multi-family residential and commercial real estate loans generally is
limited to the borrower's interest in the property, except with respect to
certain specified circumstances.
In addition to stated interest, the large multi-family residential and
commercial real estate loans originated by the Company commonly include
provisions pursuant to which the borrower agrees to pay the Company as
additional interest
16
on the loan an amount based on specified percentages (generally between 10-38%)
of the net cash flow from the property during the term of the loan and/or the
net proceeds from the sale or refinancing of the property upon maturity of the
loan. Participating interests also may be obtained in the form of additional
fees which must be paid by the borrower in connection with a prepayment of the
loan, generally after an initial lock-out period during which prepayments are
prohibited. The fees which could be payable by a borrower during specified
periods of the loan consist either of fixed exit fees or yield maintenance
payments, which are required to be paid over a specified number of years after
the prepayment and are intended to increase the yield to the Company on the
proceeds from the loan payoff to a level which is comparable to the yield on the
prepaid loan. At December 31, 1997, the Company's loan portfolio included $101.1
million of funded and unfunded loans in which the Company participates in the
residual profits of the underlying real estate, of which $89.0 million had been
funded. The Company generally accounts for loans in which it participates in
residual profits as loans and not as investments in real estate; however,
because of concerns raised by the staff of the OTS in this regard, in December
1996 and during 1997 the Bank sold to the Company subordinated, participating
interests in a total of eleven acquisition, development and construction loans,
which interests had an aggregate principal balance of $18.0 million. On a
consolidated basis, eight of these loans, which amounted to $64.3 million at
December 31, 1997, were carried by the Company as investments in real estate.
The Bank (but not the Company) has agreed with the OTS to cease origination of
mortgage loans with profit participation features in the underlying real estate,
with the exception of existing commitments.
Construction loans generally have terms of three to four years and
interest rates which float on a monthly basis in accordance with designated
reference rates. Payments during the term of the loan may be made to the Company
monthly on an interest-only basis. The loan amount may include an interest
reserve which is maintained by the Company and utilized to pay interest on the
loan during a portion of its term.
Construction loans are secured by a first priority lien on the real
property, all improvements thereon and all fixtures and equipment used in
connection therewith, as well as a first priority assignment of all revenues and
gross receipts generated in connection with the property. Construction loans are
made without pre-leasing requirements or any requirement of a commitment by
another lender to "take-out" the construction loan by making a permanent loan
secured by the property upon completion of construction. Disbursements on a
construction loan are subject to a retainage percentage of 10% and are made only
after evidence that available funds have been utilized by the borrower and are
sufficient to pay for all construction costs through the date of the
construction advance and funds remain in the construction budget and from
sources other than the loan to complete construction of the project.
The Company generally requires the general contractor selected by the
borrower, which along with the general construction contract is subject to the
Company's review and approval, to provide payment and performance bonds issued
by a surety approved by the Company in an amount at least equal to the costs
which are estimated to be necessary to complete construction of the project in
accordance with the construction contract. Moreover, the Company generally
conducts site inspections of projects under construction at least bi-monthly and
of completed projects at least semi-annually.
Multi-family residential, commercial real estate and construction
lending generally are considered to involve a higher degree of risk than single
family residential lending because such loans involve larger loan balances to a
single borrower or group of related borrowers. In addition, the payment
experience on multi-family residential and commercial real estate loans
typically is dependent on the successful operation of the project, and thus such
loans may be adversely affected to a greater extent by adverse conditions in the
real estate markets or in the economy generally. Risk of loss on a construction
loan is dependent largely upon the accuracy of the initial estimate of the
property's value at completion of construction or development and the estimated
cost (including interest) of construction, as well as the availability of
permanent take-out financing. During the construction phase, a number of factors
could result in delays and cost overruns. If the estimate of value proves to be
inaccurate, the Company may be confronted, at or prior to the maturity of the
loan, with a project which, when completed, has a value which is insufficient to
ensure full repayment. In addition to the foregoing, multi-family residential
and commercial real estate loans which are not fully amortizing over their
maturity and which have a balloon payment due at their stated maturity, as is
generally the case with the Company's multi-family residential and commercial
real estate loans, involve a greater degree of risk than fully amortizing loans
because the ability of a borrower to make a balloon payment typically will
depend on its ability either to timely refinance the loan or to timely sell the
security property. The ability of a borrower to accomplish these results will be
affected by a number of factors, including the level of available mortgage rates
at the time of sale or refinancing, the financial condition and operating
history of the borrower and the property which secures the loan, tax laws,
prevailing economic conditions and the availability of financing for
multi-family residential and commercial real estate generally.
17
LOAN SERVICING ACTIVITIES
During 1996, the Company developed a program to provide loan servicing
and various other asset management and resolution services to third party owners
of nonperforming assets, underperforming assets and subprime assets such as
Class B, C and D single family residential mortgage loans. Servicing contracts
entered into by the Company provide for the payment to the Company of specified
fees and in some cases may include terms which allow the Company to participate
in the profits resulting from the successful resolution of the assets being
serviced.
The Bank has been approved as a loan servicer by HUD, FHLMC and FNMA.
The Bank is rated a Tier 1 servicer and as a preferred servicer for high-risk
mortgages by FHLMC, the highest rating categories, and also is rated as a
"strong" special servicer for commercial mortgage loans by Standard & Poor's,
which also is the highest rating category. In addition, the Bank is the only
servicer rated as a special servicer for residential mortgage loans.
The following tables set forth the number and amount of loans serviced
by the Company for others at the dates indicated:
December 31, 1997
-----------------------------------------------------------------------------------------------------
Discount Loans Subprime Loans Other Loans Total
----------------------- ----------------------- ----------------------- -----------------------
No. of No. of No. of No. of
Amount Loans Amount Loans Amount Loans Amount Loans
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
Loans securitized and sold
with recourse ............ $ 624,591 11,148 $ 555,914 4,976 $ -- -- $1,180,505 16,124
Loans serviced for third
parties .................. 1,682,764 23,181 2,352,352 29,911 294,198 1,092 4,329,314 54,184
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
$2,307,355 34,329 $2,908,266 34,887 $ 294,198 1,092 $5,509,819 70,308
========== ========== ========== ========== ========== ========== ========== ==========
December 31, 1996
-----------------------------------------------------------------------------------------------------
Discount Loans Subprime Loans Other Loans Total
----------------------- ----------------------- ----------------------- -----------------------
No. of No. of No. of No. of
Amount Loans Amount Loans Amount Loans Amount Loans
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
Loans securitized and sold
with recourse ............ $ 204,586 4,796 $ 202,766 1,879 $ -- -- $ 407,352 6,675
Loans serviced for third
parties .................. 1,209,535 22,511 6,784 60 294,427 917 1,510,746 23,488
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
$1,414,121 27,307 $ 209,550 1,939 $ 294,427 917 $1,918,098 30,163
========== ========== ========== ========== ========== ========== ========== ==========
The increases in the number and amount of loans serviced by the Company
for others in recent periods were primarily attributable to the Company's
acquisition of rights to service discount loans acquired from HUD by BlackRock,
directly and indirectly through the LLC, and servicing rights resulting from the
securitization of both loans acquired from HUD by the Company and BlackRock,
directly and indirectly through the LLC, and subprime single family residential
loans held by the Company.
The Company generally does not purchase rights to service loans for
others and, as a result, capitalized mortgage servicing rights amount to only
$5.7 million and $2.4 million at December 31, 1997 and 1996, respectively. In
accordance with Statement of Financial Accounting Standards ("SFAS") No. 122
"Accounting for Mortgage Servicing Rights," the Company amortizes mortgage
servicing rights over the estimated weighted average life of the loans and
periodically evaluates its mortgage servicing rights for impairment based on the
fair value of those rights, which is recognized through a valuation allowance.
ASSET QUALITY
The Company, like all financial institutions, is exposed to certain
credit risks related to the value of the collateral that secures its loans and
the ability of borrowers to repay their loans. Management of the Company closely
monitors the Company's loan and investment portfolios and the Company's real
estate owned for potential problems and reports to the Board of Directors at
regularly scheduled meetings.
NONPERFORMING LOANS. It is the Company's policy to establish an
allowance for uncollectible interest on loans in its loan portfolio and loans
available for sale which are past due 90 days or more and to place such loans on
non-accrual
18
status. As a result, the Company currently does not have any loans which are
accruing interest but are past due 90 days or more. Loans also may be placed on
non-accrual status when, in the judgment of management, the probability of
collection of interest is deemed to be insufficient to warrant further accrual.
When a loan is placed on non-accrual status, previously accrued but unpaid
interest is reversed by a charge to interest income.
The following table sets forth certain information relating to the
Company's nonperforming loans in its loan portfolio at the dates indicated:
December 31,
--------------------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(Dollars in Thousands)
Nonperforming loans (1):
Single family residential loans......... $ 1,575 $ 2,123 $ 2,923 $ 2,478 $ 2,347
Multi-family residential loans.......... 7,583(2) 106 731 152 664
Consumer and other loans................ -- 55 202 29 556
--------- --------- --------- --------- ---------
Total................................. $ 9,158 $ 2,284 $ 3,856 $ 2,659 $ 3,567
========= ========= ========= ========= =========
Nonperforming loans as a percentage of:
Total loans (3)......................... 3.36% 0.56% 1.27% 4.35% 3.71%
Total assets............................ 0.30% 0.09% 0.20% 0.21% 0.27%
Allowance for loan losses as
a percentage of:
Total loans(3)........................ 1.37% 0.87% 0.65%(4) 1.84% 0.99%
Nonperforming loans................... 40.35% 154.24% 50.49% 40.28% 24.78%
- -------------------
(1) The Company did not have any nonperforming loans in its loan portfolio
which were deemed troubled debt restructurings at the dates indicated.
(2) The increase in nonperforming multi-family residential loans during 1997
was primarily attributable to a $7.4 million loan secured by a 127-unit
condominium building located in New York, New York, which management
believes is well collateralized.
(3) Total loans is net of undisbursed loan proceeds.
(4) The decrease in the allowance for loan losses as a percentage of total
loans from 1994 was due to the significant increase in the loan portfolio
in 1995 as a result of the purchase of single family residential loans and
the origination of multi-family residential and commercial real estate
loans.
The following table presents a summary of the Company's nonperforming
loans in the loans available for sale portfolio at the dates indicated:
December 31,
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
Nonperforming loans:
Single family loans.................. $ 13,509 $ 14,409 $ 7,833 $ -- $ --
Consumer loans....................... 25 36 100 120 884
---------- ---------- ---------- ---------- ----------
$ 13,534 $ 14,445 7,933 $ 120 $ 884
========== ========== ========== ========== ==========
Nonperforming loans a percentage of:
Total loans available for sale 7.64% 11.43% 3.2% .12% .87%
Total assets .44% .58% .58% .01% .06%
19
For information relating to the payment status of loans in the
Company's discount loan portfolio, see "Business-Discount Loan Acquisition and
Resolution Activities."
REAL ESTATE OWNED. Properties acquired through foreclosure or by
deed-in-lieu thereof are valued at the lower of amortized cost or fair value.
Properties included in the Company's real estate owned portfolio are
periodically re-evaluated to determine that they are being carried at the lower
of cost or fair value less estimated costs to sell. Holding and maintenance
costs related to properties are recorded as expenses in the period incurred.
Deficiencies resulting from valuation adjustments to real estate owned
subsequent to acquisition are recognized as a valuation allowance. Subsequent
increases related to the valuation of real estate owned are reflected as a
reduction in the valuation allowance, but not below zero. Increases and
decreases in the valuation allowance are charged or credited to income,
respectively. Accumulated valuation allowances amounted to $12.3 million at
December 31, 1997 as compared to $11.5 million at December 31, 1996.
The following table sets forth certain information relating to the
Company's real estate owned at the dates indicated.
December 31,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(Dollars in Thousands)
Discount loan portfolio:
Single family residential......................... $ 76,409 $ 49,728 $ 75,144 $ 86,426 $ 33,369
Multi-family residential ......................... 16,741 14,046 59,932 -- --
Commercial real estate ........................... 71,339 36,264 31,218 8,801 --
-------- -------- -------- -------- --------
Total ....................................... 164,489 100,038 166,294 95,227 33,369
Loan portfolio ...................................... 357 592 262 1,440 128
Loans available for sale............................. 2,419 3,074 -- -- --
-------- -------- -------- -------- --------
Total ....................................... $167,265 $103,704 $166,556 $ 96,667 $ 33,497
======== ======== ======== ======== ========
The following table sets forth certain geographical information by type
of property at December 31, 1997 related to the Company's real estate owned.
Multi-family Residential
Single Family Residential and Commercial Total
------------------------- ------------------------- ------------------------
No. of No. of No. of
Amount Properties Amount Properties Amount Properties
-------- ---------- -------- ---------- --------- ----------
(Dollars in Thousands)
California............... $ 24,717 314 $ 28,703 41 $ 53,420 355
Florida.................. 3,080 53 14,181 20 17,261 73
Connecticut.............. 3,945 63 13,075 11 17,020 74
New York................. 11,099 216 2,101 13 13,201 229
New Jersey............... 7,536 105 3,555 12 11,091 117
Other.................... 28,451(1) 604 26,822(2) 53 55,272 657
-------- -------- -------- -------- --------- --------
Total................... $ 78,828 1,355 $ 88,437 150 $ 167,265 1,505
======== ======== ======== ======== ========= ========
- -------------------
(1) Consists of properties located in 40 other states, none of which
aggregated over $5.6 million in any one state.
(2) Consists of properties located in 20 other states, none of which
aggregated over $7.5 million in any one state.
20
The following table sets forth the activity in the real estate owned
during the periods indicated.
Year Ended December 31,
---------------------------------------------------------------------------
1997 1996 1995
------------------------ ------------------------- -----------------------
No. of No. of No of
Amount Properties Amount Properties Amount Properties
--------- ---------- --------- ---------- --------- ----------
(Dollars in Thousands)
Balance at beginning of period.... $ 103,704 825 $ 166,556 1,070 $ 96,667 1,018
Properties acquired through
foreclosure or deed-in-lieu
thereof ........................ 205,621 1,656 102,098 918 185,174 970
Acquired in connection with
acquisitions of discount loans.. 38,486 545 2,529 12 24,617 311
Sales ............................ (179,693) (1,521) (160,592) (1,175) (139,233) (1,229)
Change in allowance .............. (853) -- (6,887) -- (669) --
--------- --------- --------- --------- --------- ---------
Balance at end of period ......... $ 167,265 1,505 $ 103,704 825 $ 166,556 1,070
========= ========= ========= ========= ========= =========
The following table sets forth the amount of time that the Company had
held its real estate owned at the dates indicated.
December 31,
----------------------------------------------------
1997 1996 1995
------------ ------------ ------------
(Dollars in Thousands)
One to two months................................. $ 83,144 $ 17,695 $ 25,398
Three to four months.............................. 28,912 15,291 22,672
Five to six months................................ 20,929 14,348 25,742
Seven to 12 months................................ 23,621 13,004 76,782
Over 12 months.................................... 10,659 43,366 15,962
------------ ------------ ------------
$ 167,265 $ 103,704 $ 166,556
============ ============ ============
The average period during which the Company held the $179.7 million,
$160.6 million and $139.2 million of real estate owned which was sold during the
years ended December 31, 1997, 1996 and 1995, respectively, was 9 months, 11
months and 8 months, respectively.
Although the Company evaluates the potential for significant
environmental problems prior to acquiring or originating a loan, there is a risk
for any mortgage loan, particularly a multi-family residential and commercial
real estate loan, that hazardous substances or other environmentally restricted
substances could be discovered on the related real estate. In such event, the
Company might be required to remove such substances from the affected properties
or to engage in abatement procedures at its sole cost and expense. There can be
no assurance that the cost of such removal or abatement will not substantially
exceed the value of the affected properties or the loans secured by such
properties, that the Company would have adequate remedies against the prior
owners or other responsible parties or that the Company would be able to resell
the affected properties either prior to or following completion of any such
removal or abatement procedures. If such environmental problems are discovered
prior to foreclosure, the Company generally will not foreclose on the related
loan; however, the value of such property as collateral will generally be
substantially reduced, and as a result, the Company may suffer a loss upon
collection of the loan.
From time to time, the Company makes loans to finance the sale of real
estate owned. At December 31, 1997, such loans amounted to $8.4 million and
consisted of $4.4 million of single family residential loans, $3.7 million of
multi-family residential loans and $339,000 of commercial loans. All of the
Company's loans to finance the sale of real estate owned were performing in
accordance with their terms at December 31, 1997.
CLASSIFIED ASSETS. OTS regulations require that each insured savings
association classify its assets on a regular basis. In addition, in connection
with examinations of insured associations, OTS examiners have authority to
identify problem assets and, if appropriate, require them to be classified.
There are three classifications for problem assets: "substandard," "doubtful"
and "loss." Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility
21
of loss. An asset classified as a loss is considered uncollectible and of such
little value that continuance as an asset of the institution is not warranted.
Another category designated "special mention" also must be established and
maintained for assets which do not currently expose an insured institution to a
sufficient degree of risk to warrant classification as substandard, doubtful or
loss but do possess credit deficiencies or potential weaknesses deserving
management's close attention. Assets classified as substandard or doubtful
require the institution to establish general allowances for loan losses. If an
asset or portion thereof is classified as a loss, the insured institution must
either establish specific allowances for loan losses in the amount of 100% of
the portion of the asset classified as a loss or charge off such amount. In this
regard, the Company establishes required reserves and charges off loss assets as
soon as administratively practicable. General loss allowances established to
cover possible losses related to assets classified substandard or doubtful may
be included in determining an institution's regulatory capital, while specific
valuation allowances for loan losses do not qualify as regulatory capital.
In 1996, based upon discussions with the OTS and as a result of an OTS
bulletin issued on December 13, 1996 entitled "Guidance on the Classification
and Regulatory Reporting of Certain Delinquent Loans and Other Credit Impaired
Assets," the Company has classified all discount loans that are 90 or more days
contractually past due, not otherwise classified, as special mention and all
real estate owned, not otherwise classified, as special mention. The Company
also modified its policy for classifying nonperforming discount loans and real
estate owned related to its discount loan portfolio ("nonperforming discount
assets") to take into account both the holding period of such assets from the
date of acquisition and the ratio of book value to market value of such assets.
All nonperforming discount assets which are held 15 months or more after the
date of acquisition are classified substandard; nonperforming discount assets
held 12 months to less than 15 months from the date of acquisition are
classified as substandard if a ratio of book value to market value is 80% or
more; and nonperforming discount assets held less than 12 months from the date
of acquisition are classified as substandard if they have a ratio of book value
to market value of more than 85%. In addition, nonperforming discount assets
which are performing for a period of time subsequent to acquisition by the
Company are classified as substandard at the time such loans become
nonperforming. The Company also modified its classified assets policy to
classify all real estate owned which is not cash flowing and which has been held
for more than 15 months and three years as substandard and doubtful,
respectively. The Company's past experience indicates that classified discount
assets do not necessarily correlate to probability or severity of loss.
Excluding assets which have been classified loss and fully reserved by
the Company, the Company's classified assets at December 31, 1997 under the
above policy consisted of $404.1 million of assets classified as substandard and
$577,000 of assets classified as doubtful. In addition, at the same date, $616.1
million of assets were designated as special mention.
Substandard assets at December 31, 1997 under the above policy
consisted primarily of $242.4 million of loans and real estate owned related to
the Company's discount single family residential loan program, $150.5 million of
loans and real estate owned related to the Company's discount commercial real
estate loan program and $9.7 million of subprime single family residential
loans. Special mention assets at December 31, 1997 under the policy consisted
primarily of $559.3 million and $56.8 million of loans and real estate owned
related to the Company's discount single family residential and discount
commercial real estate loan programs, respectively.
ALLOWANCES FOR LOSSES. The Company maintains an allowance for loan
losses for each of its loan and discount loan portfolios at a level which
management considers adequate to provide for potential losses in each portfolio
based upon an evaluation of known and inherent risks in such portfolios.
22
The following table sets forth the breakdown of the allowance for loan
losses on the Company's loan portfolio and discount loan portfolio by loan
category and the percentage of loans in each category to total loans in the
respective portfolios at the dates indicated:
December 31,
--------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
--------------- --------------- --------------- -------------- ---------------
Amount % Amount % Amount % Amount % Amount %
------- ------ ------- ----- ------ ------ ------ ----- ------ -----
(Dollars in Thousands)
Loan portfolio:
Single family residential
loans..................... $ 512 15.7% $ 520 14.6% $ 346 22.2% $ 615 52.2% $ 174 31.6%
Multi-family residential
loans..................... 2,163 24.2 673 13.5 683 14.3 -- 2.9 333 40.9
Commercial real estate
loans..................... 1,009 60.0 2,299 71.3 875 62.6 218 42.3 218 23.7
Commercial non-mortgage
loans..................... -- -- 11 0.5 -- -- -- -- -- --
Consumer loans.............. 11 0.1 20 0.1 43 0.9 238 2.6 159 3.8
------- ------ ------- ----- ------ ------ ------ ----- ------ -----
Total..................... $ 3,695 100.0% $ 3,523 100.0% $1,947 100.0% $1,071 100.0% $ 884 100.0%
======= ====== ======= ===== ====== ====== ====== ===== ====== =====
Discount loan
portfolio(1):
Single family residential
loans..................... $15,017 50.2% $ 3,528 38.4% $ -- --% $ -- --% $ -- --%
Multi-family residential
loans..................... 2,616 10.7 3,124 26.0 -- -- -- -- -- --
Commercial real estate
loans..................... 5,860 39.0 4,886 35.4 -- -- -- -- -- --
Other loans................. -- 0.1 -- 0.2 -- -- -- -- -- --
------- ------ ------- ----- ------ ------ ------ ----- ------ -----
Total................... $23,493 100.0% $11,538 100.0% $ -- --% $ -- --% $ -- --%
======= ====== ======= ===== ====== ====== ====== ===== ====== =====
- -------------------
(1) The Company did not maintain an allowance for loan losses on its discount
loan portfolio prior to 1996.
The allocation of the allowance to each category is not necessarily
indicative of future losses and does not restrict the use of the allowance to
absorb losses in any other category.
The following table sets forth an analysis of activity in the allowance
for loan losses relating to the Company's loan portfolio during the periods
indicated:
Year Ended December 31,
--------------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(Dollars in Thousands)
Balance at beginning of period.... $ 3,523 $ 1,947 $ 1,071 $ 884 $ 752
Provision for loan losses......... 325 1,872 1,121 -- --
Charge-offs:
Single family residential loans (100) (261) (131) (302) (150)
Multi-family residential loans.. -- (7) -- -- (170)
Commercial real estate loans.... -- -- (40) -- --
Consumer loans.................. (53) (28) (92) (170) (16)
-------- -------- -------- -------- --------
Total charge-offs.............. (153) (296) (263) (472) (336)
Recoveries:
Single family residential loans -- -- 3 410 346
Multi-family residential loans.. -- -- -- -- --
Commercial real estate loans.... -- -- 15 -- --
Consumer loans.................. -- -- -- 249 122
-------- -------- -------- -------- --------
Total recoveries............... -- -- 18 659 468
-------- -------- -------- -------- --------
Net (charge-offs) recoveries... (153) (296) (245) 187 132
-------- -------- -------- -------- --------
Balance at end of period.......... $ 3,695 $ 3,523 $ 1,947 $ 1,071 $ 884
======== ======== ======== ======== ========
Net charge-offs (recoveries) as a
percentage of average loan
portfolio, net.................. 0.04% 0.09% 0.19% (0.28)% (0.10)%
23
The following table sets forth an analysis of activity in the allowance
for loan losses relating to the Company's discount loan portfolio during the
periods indicated:
Year Ended December 31,
-----------------------
1997 1996
-------- ----------
(Dollars in Thousands)
Balance at beginning of period .................... $ 11,538 $ --
Provision for loan losses ......................... 31,894 20,578
Charge-offs:
Single family residential loans ................. (13,281) (7,009)
Multi-family residential loans .................. (2,056) (704)
Commercial real estate loans .................... (5,012) (1,503)
Other loans ..................................... -- --
-------- ----------
Total charge-offs ............................ (20,349) (9,216)
-------- ----------
Recoveries:
Single family residential loans ................. 410 176
Multi-family residential loans .................. -- --
Commercial real estate loans .................... -- --
Consumer loans .................................. -- --
-------- ----------
Total recoveries ............................. 410 176
-------- ----------
Net (charge-offs) ............................ (19,939) (9,040)
-------- ----------
Balance at end of period .......................... $ 23,493 $ 11,538
======== ==========
Net charge-offs as a percentage of average
discount loan portfolio ........................ 1.55% 1.34%
INVESTMENT ACTIVITIES
GENERAL. The investment activities of the Company currently include
investments in mortgage-related securities, investment securities and low-income
housing tax credit interests. The investment policy of the Company, which is
established by the Investment Committee and approved by the Board of Directors,
is designed primarily to provide a portfolio of diversified instruments while
seeking to optimize net interest income within acceptable limits of interest
rate risk, credit risk and liquidity.
MORTGAGE-BACKED AND RELATED SECURITIES. From time to time, the Company
invests in mortgage-backed and mortgage-related securities. Although
mortgage-backed and mortgage-related securities generally yield less than the
loans that back such securities because of costs associated with their payment
guarantees or credit enhancements, such securities are more liquid than
individual loans and may be used to collateralize borrowings of the Company.
Other mortgage-backed and mortgage-related securities indirectly bear the risks
of the underlying loans, such as prepayment risk (interest-only securities) and
credit risk (subordinated interests), and are generally less liquid than
individual loans.
Mortgage-related securities include senior and subordinate regular
interests and residual interests in collateralized mortgage obligations
("CMOs"), including CMOs which have qualified as REMICs. The regular interests
in some CMOs are like traditional debt instruments because they have stated
principal amounts and traditionally defined interest-rate terms. Purchasers of
certain other interests in REMICs are entitled to the excess, if any, of the
issuer's cash inflows, including reinvestment earnings, over the cash outflows
for debt service and administrative expenses. These interests may include
instruments designated as residual interests, which represent an equity
ownership interest in the underlying collateral, subject to the first lien of
the investors in the other classes of the REMIC.
A senior-subordinated structure often is used with CMOs to provide
credit enhancement for securities which are backed by collateral which is not
guaranteed by FNMA, FHLMC or the Government National Mortgage Association
("GNMA"). These structures divide mortgage pools into two risk classes: a senior
class and one or more subordinated classes. The subordinated classes provide
protection to the senior class. When cash flow is impaired, debt service goes
first to the holders of senior classes. In addition, incoming cash flows also
may be held in a reserve fund to meet any future shortfalls of cash flow to
holders of senior classes. The holders of subordinated classes may not receive
any principal repayments until the holders of senior classes have been paid and,
when appropriate, until a specified level of funds has been contributed to the
reserve fund.
24
Interest-only and principal-only securities are so-called stripped
mortgage-related securities, in which interest coupons may be stripped from a
mortgage-related security to create an interest-only ("IO") strip, where the
investor receives all of the interest cash flows and none of the principal, and
a principal-only ("PO") strip, where the investor receives all of the principal
cash flows and none of the interest. Inverse floating rate interest-only
("Inverse IO") securities also have coupons which are stripped from a
mortgage-related security. However, Inverse IOs have coupons whose interest
rates change inversely with, and often as a multiple of, a specialized index
such as the one-month London Interbank Offered Rate ("LIBOR").
The following table sets forth the fair value of the Company's
mortgage-backed and related securities available for sale at the dates
indicated.
December 31,
---------------------------------------------
1997 1996 1995
---------- ---------- ----------
(Dollars in Thousands)
Mortgage-related securities:
Single family residential:
CMOs (AAA-rated)............................ $ 160,451 $ 73,935 $ 138,831
Interest only:
AAA-rated................................. 13,863 1,173 --
FHLMC..................................... 64,745 47,571 2,182
FNMA...................................... 59,715 49,380 9,592
GNMA...................................... 29,766 -- --
Principal only.............................. -- -- 8,218
Subordinates................................ 67,830 19,164 27,310
PAC securities ............................. -- -- 574
REMIC residuals............................. 15,693 20,560 472
Futures contracts and swaps................. (94) (1,921) (1,598)
---------- ---------- ----------
Total..................................... 411,969 209,862 185,581
---------- ---------- ----------
Multi-family residential and commercial:
Interest only:
AAA-rated................................. 1,030 83,590 103,932
FNMA...................................... -- -- 5,261
Non-investment grade...................... 3,477 3,799 --
Subordinates................................ 14,048 57,534 42,954
Futures contracts........................... -- (780) (248)
---------- ---------- ----------
Total..................................... 18,555 144,143 151,899
---------- ---------- ----------
Total.................................. $ 430,524 $ 354,005 $ 337,480
========== ========== ==========
At December 31, 1997, the carrying value of the Company's investment in
IO strips amounted to $172.6 million. The Company invests in IO strips and PO
strips from time to time based on its capital position, interest rate risk
profile and the market for such securities. IO strips and PO strips exhibit
considerably more price volatility than mortgages or ordinary mortgage
pass-through securities, due in part to the uncertain cash flows that result
from changes in the prepayment rates of the underlying mortgages. In the case of
IO strips in particular, increased prepayments of the underlying mortgages as a
result of a decrease in market interest rates or other factors can result in a
loss of all or part of the purchase price of such security, although IO strips
relating to mortgage-related securities backed by multi-family residential and
commercial real estate loans (which amounted to $4.5 million of the $172.6
million of IO strips owned by the Company at December 31, 1997) generally have
provisions which prohibit and/or provide economic disincentives to prepayments
for specified periods. The Company generally attempts to offset the interest
rate risk associated with a particular IO strip or PO strip by purchasing other
securities. At December 31, 1997, all of the Company's IO strips were either
issued by FHLMC, FNMA or GNMA or rated AAA by national rating agencies, with the
exception of IO securities with an aggregate carrying value of $3.5 million,
which were rated investment grade below this level.
The Company generally retains subordinate securities, subordinate IOs
and REMIC residual securities, which are certificated, related to its
securitization of loans. Subordinate securities, subordinate IOs and REMIC
residual
25
securities retained represent the present value of the right to the excess cash
flows generated by the securitized loans that represent the difference between
(a) principal and interest at the stated rate paid by borrowers and (b) the sum
of (i) principal and pass-through interest paid to third-party investors, (ii)
trustee fees, (iii) third-party credit enhancement fees (if applicable), (iv)
stipulated servicing fees and (v) estimated loan portfolio losses. The Company's
right to receive this excess cash flow may begin after certain reserve
requirements have been met, which are specific to each securitization and may be
used as a means of credit enhancement. The Company determines the present value
of anticipated cash flows at the time each securitization transaction closes,
utilizing valuation assumptions appropriate for each particular transaction.
The significant valuation assumptions are related to the anticipated
average lives of the loans sold, the anticipated prepayment speeds and the
anticipated credit losses related thereto. In order to determine the present
value of this excess cash flow, the Company currently applies a discount rate of
between 18% and 28% to the projected cash flows.
The annual prepayment rate of the securitized loans is a function of
full and partial prepayments and defaults. The Company makes assumptions as to
the prepayment rates of the underlying loans, which the Company believes are
reasonable, in estimating fair values of the subordinate securities, subordinate
IOs and REMIC residual securities retained. During fiscal 1997, the Company
utilized proprietary prepayment curves generated by the Company (reaching an
approximate maximum annual rate of 28%).
In its estimates of annual loss rates, the Company utilizes assumptions
that it believes are reasonable. The Company estimates annual losses of between
0.25% and 1.20% of the underlying loans.
The Company classifies its subordinate securities, subordinate IOs and
REMIC residual securities retained as available for sale securities in
accordance with SFAS No. 115. Securities available for sale are carried at fair
value with the net unrealized gains or losses reported as a separate component
of stockholders' equity, net of tax. The determination of fair value is based on
the previously mentioned valuation basis and on broker valuation estimates. The
subordinate securities, subordinate IOs and REMIC residual securities retained
are amortized based on the interest method.
The Company retains the right to service loans it originates or
purchases and then subsequently securitizes. Fees for servicing loans are based
on a stipulated percentage which is equal to between 0.50% and 0.60% of the
unpaid principal balance of the underlying loans. The Company recognizes a
servicing asset as part of its gain on securitized loan sales.
The Company periodically assesses the carrying value of its subordinate
securities, subordinate IOs and REMIC residual securities retained as well as
the servicing assets for impairment. There can be no assurance that the
Company's estimates used to determine the gain on securitized loan sales,
subordinate securities, subordinate IOs and REMIC residual securities retained
and servicing assets valuations will remain appropriate for the life of each
securitization. If actual loan prepayments or defaults exceed the Company's
estimates, the carrying value of the Company's subordinate securities,
subordinate IOs and REMIC residual securities retained and/or servicing assets
may be decreased or the Company may increase its allowance for possible credit
losses on loans sold through a charge against earnings during the period
management recognizes the disparity. Other factors may also result in a
writedown of the Company's subordinate securities, subordinate IOs and REMIC
residual securities retained in subsequent periods. As of December 31, 1997 the
Company determined that no such impairment existed.
At December 31, 1997, the carrying value of the Company's investment in
subordinate classes of mortgage-related securities amounted to $81.9 million,
and included $62.8 million of subordinated classes of mortgage-related
securities acquired in connection with the securitization activities of the
Company and $19.1 million acquired from the LLC in 1996 in connection with its
securitization of HUD loans. During 1997, the Company acquired $50.1 million of
subordinate classes of mortgage-related securities, all of which were acquired
in connection with the Company's securitizations of loans. For additional
information see "Business - Discount Loan Acquisition and Resolution Activities
- - Activity in the Discount Loan Portfolio" and "Business - Lending
Activities-Single Family Residential Loans." At December 31, 1997, the Company's
subordinate securities supported senior classes of securities having an
outstanding principal balance of $1.77 billion. Because of their subordinate
position, subordinate classes of mortgage-related securities involve more risk
than the other classes.
26
During 1996, the Company retained residual securities in REMICs which
were formed in connection with the securitization and sale of $211.2 million of
subprime single family residential loans in two underwritten public offerings as
partial payment for the loans sold by it. These REMIC residual securities had a
carrying value of $15.7 million at December 31, 1997 and supported senior
classes of securities having an outstanding principal balance of $135.6 million,
which provide credit support similar to the senior-subordinated structure. Cash
flows supporting the REMIC residuals are generated by the amount by which the
interest collected on the underlying mortgage loans exceeds the interest due on
the senior securities. See "Business - Lending Activities - Single family
Residential Loans."
The Company generally does not intend to purchase subordinate classes
of mortgage-related securities created by unaffiliated parties. The Company may
retain subordinated classes resulting from the securitization of assets held by
it directly or indirectly through the Bank and investments in joint ventures,
although it is intended that any such securities held by the Bank will be
distributed to the Company as a dividend subject to its ability to declare such
dividends under applicable limitations.
Under a regulatory bulletin issued by the OTS, a federally-chartered
savings institution such as the Bank generally may invest in "high risk"
mortgage securities only to reduce its overall interest rate risk and after it
has adopted various policies and procedures, although under specified
circumstances such securities also may be acquired for trading purposes. A "high
risk" mortgage security for this purpose generally is any mortgage-related
security which meets one of three tests which are intended to measure the
average life or price volatility of the security in relation to a benchmark
fixed rate, 30-year mortgage-backed pass-through security. At December 31, 1997,
the Bank held mortgage-related securities with a carrying value of $141.1
million (amortized cost of $137.0 million) which were classified as "high-risk"
mortgage securities by the OTS.
The expected actual maturity of a mortgage-backed and related security
is shorter than its stated maturity due to prepayments of the underlying
mortgages. Prepayments that are faster than anticipated may shorten the life of
the security and adversely affect its yield to maturity. The yield is based upon
the interest income and the amortization of any premium or accretion of any
discount related to the mortgage-backed and related security. Prepayments on
mortgage-backed and related securities have the effect of accelerating the
amortization of premiums and accretion of discounts, which decrease and increase
interest income, respectively. Although prepayments of underlying mortgages
depend on many factors, including the type of mortgages, the coupon rate, the
age of mortgages, the geographical location of the underlying real estate
collateralizing the mortgages and general levels of market interest rates, the
difference between the interest rates on the underlying mortgages and the
prevailing mortgage interest rates generally is the most significant determinant
of the rate of prepayments. During periods of falling mortgage interest rates,
if the coupon rate of the underlying mortgages exceeds the prevailing market
interest rates offered for mortgage loans, refinancing generally increases and
accelerates the prepayment of the underlying mortgages and the related security.
Similarly, during periods of increasing interest rates, refinancing generally
decreases, thus lengthening the estimated maturity of mortgage loans.
INVESTMENT SECURITIES. At December 31, 1997, investment securities
consisted primarily of the Company's investment in OAIC and a required
investment in FHLB stock and investments in other common stocks. Non-marketable
equity securities held for investment are stated at cost because the Company has
the ability and the intent to hold them to maturity. Marketable equity
securities are designated as available for sale and are carried at market value
based on quoted market prices. Net unrealized gains or losses are reported as a
separate component of stockholders' equity. Unrealized losses on securities that
reflect a decline in value which is other than temporary, if any, are charged to
earnings.
27
The following table sets forth the Company's investment securities at
the dates indicated.
December 31,
---------------------------------------------------
1997 1996 1995
------------ ------------ ------------
(Dollars in Thousands)
Marketable equity securities:
Other common stocks (1)............... $ 46,272 $ -- $ --
Non-marketable equity securities:
U.S. Government securities............ -- -- 10,036
FHLB stock(2)......................... 10,825 8,798 8,520
Limited partnership interests (3)..... 2,470 103 109
------------ ------------ ------------
Total............................... $ 59,567 $ 8,901 $ 18,665
============ ============ ============
- -------------------
(1) Balance at December 31, 1997 consisted primarily of 1,715,000 shares of
stock of OAIC.
(2) As a member of the FHLB of New York, the Bank is required to purchase and
maintain stock in the FHLB of New York in an amount equal to at least 1%
of its aggregate unpaid residential mortgage loans, home purchase
contracts and similar obligations at the beginning of each year or 5% of
borrowings, whichever is greater.
(3) Balance at December 31, 1997 consisted primarily of 160,000 limited
partnership units of OPLP.
TRADING SECURITIES. When securities are purchased with the intent to
resell in the near term, they are classified as trading securities and reported
on the Company's consolidated statement of financial condition as a separately
identified trading account. Securities in this account are carried at current
market value. All trading securities are marked-to-market, and any increase or
decrease in unrealized appreciation or depreciation is included in the Company's
consolidated statements of operations.
Under guidelines approved by the Board of Directors of the Company, the
Company is authorized to hold a wide variety of securities as trading
securities, including U.S. Government and agency securities and mortgage-backed
and mortgage-related securities. The Company also is authorized by such
guidelines to use various hedging techniques in connection with its trading
activities, as well as to effect short sales of securities, pursuant to which
the Company sells securities which are to be acquired by it at a future date.
Under current guidelines, the amount of securities held by the Company in a
trading account may not exceed on a gross basis the greater of $200 million or
15% of the Company's total assets, and the total net amount of securities
(taking into account any related hedge or buy/sell agreement relating to similar
securities) may not exceed the greater of $150 million or 10% of total assets.
The Company's securities held for trading at December 31, 1996 amounted
to $75.6 million and represented one AAA-rated CMO which was sold in January
1997. The Company held no securities for trading at December 31, 1997.
INVESTMENTS IN LOW-INCOME HOUSING TAX CREDIT INTERESTS. The Company
invests in low-income housing tax credit interests primarily through limited
partnerships for the purpose of obtaining Federal income tax credits pursuant to
Section 42 of the Code, which provides a tax credit to investors in qualified
low-income rental housing that is constructed, rehabilitated or acquired after
December 31, 1986. To be eligible for housing tax credits, a property generally
must first be allocated an amount of tax credits by the tax credit allocating
agency, which in most cases also serves as the housing finance agency, of the
state in which the property is located. If the property is to be constructed or
rehabilitated, it must be completed and placed in service within a specified
time, generally within two years after the year in which the tax credit
allocation is received. A specified portion of the apartment units in a
qualifying project may be rented only to qualified tenants for a period of 15
years, or a portion of any previously claimed tax credits will be subject to
recapture, as discussed below.
At December 31, 1997, the Company's investment in low-income housing
tax credit interests amounted to $128.6 million or 4% of total assets, as
compared to $93.3 million or 4% of total assets at December 31, 1996. The
Company's
28
investments in low-income housing tax credit interests are made by the Company
indirectly through subsidiaries of the Company, which may be a general partner
and/or a limited partner in the partnership.
In accordance with a 1995 pronouncement of the Emerging Issues Task
Force, the Company's accounting for investments in low-income housing tax credit
partnerships in which it acts solely as a limited partner, which amounted to
$78.6 million in the aggregate at December 31, 1997, depends on whether the
investment was made on or after May 18, 1995.
Low-income housing tax credit partnerships in which the Company,
through a subsidiary, acts as a general partner, are presented on a consolidated
basis. At December 31, 1997, the Company's investment in low-income housing tax
credit interests included $50.0 million of assets related to low-income housing
tax credit partnerships in which a subsidiary of the Company acts as a general
partner. At December 31, 1997, the Company had commitments to make $2.1 million
of additional investments in such partnerships.
The Company also makes loans to low-income housing tax credit
partnerships in which it has invested to construct the affordable housing
project owned by the partnerships. At December 31, 1997, the Company had $37.6
million of construction loans outstanding to low-income housing tax credit
partnerships and commitments to fund an additional $9.9 million of such loans.
Approximately $7.3 million of such funded construction loans at December 31,
1997 were made to partnerships in which subsidiaries of the Company acted as the
general partner and thus were consolidated with the Company for financial
reporting purposes. The risks associated with these construction loans generally
are the same as those made by the Company to unaffiliated third parties. See
"Business-Lending Activities".
The affordable housing projects owned by the low-income housing tax
credit partnerships in which the Company had invested at December 31, 1997 are
geographically located throughout the United States. At December 31, 1997, the
Company's largest funded investment in a low-income housing tax credit interest
was a $9.7 million investment in a partnership which owned a 170-unit qualifying
project located in Racine, Wisconsin, and the Company's largest unfunded
investment in such a partnership was a $9.0 million commitment to fund equity
and debt investments in a partnership which will construct a 96-unit qualifying
project in Knoxville, Tennessee, of which $1.3 million of equity and $849,000 of
debt was funded as of such date.
At December 31, 1997, the Company had invested in or had commitments to
invest in 43 low-income housing tax credit partnerships, of which 31 had been
allocated tax credits. The Company estimates that the investment in low-income
housing tax credit interests in which it had invested at December 31, 1997 will
provide approximately $217.3 million of tax credits.
During 1997, the Company sold an investment in a low-income housing tax
credit interest which had a carrying value of $15.7 million for a gain of $6.3
million. During 1996, the Company sold $19.8 million of its investments in
low-income housing tax credit interests for a gain of $4.9 million. Depending on
available prices, its ability to utilize tax credits and other factors, the
Company may seek to sell other of its low-income housing tax credit interests in
the future.
The ownership of low-income housing tax credit interests produces two
types of tax benefits. The primary tax benefit flows from the low-income housing
tax credits under the Code which are generated by the ownership and operation of
the real property in the manner required to obtain such tax credits. These
credits may be used to offset Federal income tax on a dollar for dollar basis
but may not offset the alternative minimum tax; tax credits thus may reduce the
overall Federal income tax to an effective rate of 20%. In addition, the
operation of the rental properties produces losses for financial statement and
tax purposes in the early years and sometimes throughout the anticipated
ownership period. These tax losses may be used to offset taxable income from
other operations and thereby reduce income tax which would otherwise be paid on
such taxable income.
Tax credits may be claimed over a ten-year period on a straight-line
basis once the underlying multi-family residential properties are placed in
service. Tax credits claimed reduce the tax payments computed based upon taxable
income to not less than the alternative minimum tax computed for that year or
any year not more than three years before or 15 years after the year the tax
credit is earned. The taxpayer Relief Act of 1997 changed the tax credit
carryback period from 3 years to 1 year and the carry forward period from 15
years to 20 years for credits that become available for use in years beginning
after December 31, 1997. Tax credits are realized even if units in the project
do not continue to be occupied once the units in the project have been initially
rented to a qualifying tenant, and tax credits are not dependent on a project's
operating income or appreciation. Tax credits can be claimed over a ten-year
period and generally can be lost or
29
recaptured only if non-qualifying tenants are placed in units, ownership of the
project is transferred or the project is destroyed and not rebuilt during a
15-year compliance period for the project. The Company has established specific
investment criteria for investment in multi-family residential projects which
have been allocated tax credits, which require, among other things, a third
party developer of the project and/or the seller of the interest therein to
provide a guarantee against loss or recapture of tax credits and to maintain
appropriate insurance to fund rebuilding in case of destruction of the project.
Notwithstanding the Company's efforts, there can be no assurance that the
multi-family residential projects owned by the low-income housing tax credit
partnerships in which it has invested will satisfy applicable criteria during
the 15-year compliance period and that there will not be loss or recapture of
the tax credits associated therewith.
Investments made pursuant to the affordable housing tax credit program
of the Code are subject to numerous risks resulting from changes in the Code.
For example, the Balanced Budget Act of 1995, which was vetoed by the President
of the United States in December 1995 for reasons which were unrelated to the
tax credit program, generally would have established a sunset date for the
affordable housing tax credit program of the Code for housing placed in service
after December 31, 1997 and would have required a favorable vote by Congress to
extend the credit program. Although this change would not have impacted the
Company's existing investments, other potential changes in the Code, which have
been discussed from time to time, could reduce the benefits associated with the
Company's existing investments in low-income housing tax credit interests,
including the replacement of the current graduated income taxation provisions in
the Code with a "flat tax" based system and increases in the alternative minimum
tax, which cannot be reduced by tax credits. Management of the Company is unable
to predict whether any of the foregoing or other changes to the Code will be
subject to future legislation and, if so, what the contents of such legislation
will be and its effects, if any, on the Company.
SOURCES OF FUNDS
GENERAL. Deposits, FHLB advances, reverse repurchase agreements,
securities financings, maturities, resolutions and principal repayments on
securities and loans and proceeds from the sale of securities, loans and real
estate owned held for sale currently are the principal sources of funds for use
in the Company's investment and lending activities and for other general
business purposes. Management of the Company closely monitors rates and terms of
competing sources of funds on a regular basis and generally utilizes the sources
which are the most cost effective.
DEPOSITS. The primary source of deposits for the Company currently is
brokered certificates of deposit obtained primarily through national investment
banking firms which, pursuant to agreements with the Company, solicit funds from
their customers for deposit with the Company ("brokered deposits"). Such
deposits obtained through national investment banking firms amounted to $1.34
billion or 68% of the Company's total deposits at December 31, 1997. In
addition, during 1995, the Company commenced a program to obtain certificates of
deposit from customers of regional and local investment banking firms which are
made aware of the Company's products by the Company's direct solicitation and
marketing efforts. At December 31, 1997, $251.9 million or 13% of the Company's
deposits were obtained in this manner through over 140 regional and local
investment banking firms. The Company also solicits certificates of deposit from
institutional investors and high net worth individuals identified by the
Company. At December 31, 1997, $177.9 million or 9% of the Company's total
deposits consisted of deposits obtained by the Company from such efforts.
The Company's brokered deposits at December 31, 1997 were net of $11.7
million of unamortized deferred fees. The amortization of deferred fees is
computed using the interest method and is included in interest expense on
certificates of deposit.
The Company believes that the effective cost of brokered and other
wholesale deposits is more attractive to the Company than deposits obtained on a
retail basis from branch offices after the general and administrative expense
associated with the maintenance of branch offices is taken into account.
Moreover, brokered and other wholesale deposits generally give the Company more
flexibility than retail sources of funds in structuring the maturities of its
deposits and in matching liabilities with comparably maturing assets. At
December 31, 1997, $840.5 million or 46% of the Company's certificates of
deposits were scheduled to mature within one year.
Although management of the Company believes that brokered and other
wholesale deposits are advantageous in certain respects, such funding sources,
when compared to retail deposits attracted through a branch network, are
generally more sensitive to changes in interest rates and volatility in the
capital markets and are more likely to be compared by the investor to competing
investments. In addition, such funding sources may be more sensitive to
significant changes in the financial condition of the Company. There are also
various regulatory limitations on the ability of all but well-capitalized
insured financial institutions to obtain brokered deposits. See "Regulation The
Bank - Brokered Deposits." These
30
limitations currently are not applicable to the Company because the Bank is a
well-capitalized financial institution under applicable laws and regulations.
See "Regulation - The Bank -Regulatory Capital Requirements." There can be no
assurances, however, that the Company will not become subject to such
limitations in the future.
As a result of the Company's reliance on brokered and other wholesale
deposits, significant changes in the prevailing interest rate environment, in
the availability of alternative investments for individual and institutional
investors or in the Company's financial condition, among other factors, could
affect the Company's liquidity and results of operations much more significantly
than might be the case with an institution that obtained a greater portion of
its funds from retail or core deposits attracted through a branch network.
In addition to brokered and other wholesale deposits, the Company
obtains deposits from its office located in Bergen County, New Jersey. These
deposits include non-interest bearing checking accounts, NOW and money market
checking accounts, savings accounts and certificates of deposit and are obtained
through advertising, walk-ins and other traditional means. At December 31, 1997,
the deposits which were allocated to this office amounted to $60.7 million or 3%
of the Company's deposits.
The following table sets forth information related to the Company's
deposits at the dates indicated.
December 31,
-------------------------------------------------------------------------------
1997 1996 1995
----------------------- ------------------------ ------------------------
Amount Avg. Rate Amount Avg. Rate Amount Avg. Rate
---------- --------- ---------- --------- ---------- ----------
(Dollars in Thousands)
Non-interest bearing
checking accounts.......... $ 130,372 --% $ 96,563 --% $ 48,482 --%
NOW and money market
checking accounts.......... 27,624 4.73 22,208 2.99 17,147 3.37
Savings accounts.............. 1,664 2.30 2,761 2.30 3,471 2.30
---------- ---------- ----------
159,660 121,532 69,100
---------- ---------- ----------
Certificates of deposit(1).... 1,834,899 1,809,098 1,440,240
Unamortized deferred fees..... (11,737) (10,888) (7,694)
---------- ---------- ----------
Total certificates of deposit. 1,823,162 6.00 1,798,210 5.80 1,432,546 5.68
---------- ---------- ----------
Total deposits........... $1,982,822 5.95 $1,919,742 5.47 $1,501,646 5.46
========== ========== ==========
- -------------------
(1) At December 31, 1997, 1996 and 1995, certificates of deposit issued on an
uninsured basis amounted to $133.7 million, $147.5 million and $80.0
million, respectively. Of the $133.7 million of uninsured deposits at
December 31, 1997, $98.1 million were from political subdivisions in New
Jersey and secured or collateralized as required under state law.
The following table sets forth, by various interest rate categories,
the certificates of deposit in the Company at the dates indicated.
December 31,
--------------------------------------------------
1997 1996 1995
----------- ----------- -----------
(Dollars in Thousands)
2.99% or less.............................. $ 841 $ 1,442 $ 222
3.00-3.50%................................. -- 4 39
3.51-4.50.................................. 41 1,149 42,751
4.51-5.50.................................. 292,192 595,730 454,653
5.51-6.50.................................. 1,300,463 990,621 660,745
6.51-7.50.................................. 229,134 208,774 273,655
7.51-8.50.................................. 491 490 481
----------- ----------- -----------
$ 1,823,162 $ 1,798,210 $ 1,432,546
=========== =========== ===========
31
The following table sets forth the amount and maturities of the
certificates of deposit in the Company at December 31, 1997.
Over Six
Months and One Year
Six Months Less than Through Two Over Two
and Less One Year Years Years Total
------------ ------------ ------------ ------------ ------------
(Dollars in Thousands)
2.99% or less............. $ 813 $ -- $ 28 $ -- $ 841
3.00-3.50%................ -- -- -- -- --
3.51-4.50................. 24 -- 11 6 41
4.51-5.50................. 172,733 32,710 42,758 43,991 292,192
5.51-6.50................. 288,206 287,208 260,386 464,663 1,300,463
6.51-7.50................. 28,568 30,201 73,151 97,214 229,134
7.51-8.50................. -- -- 295 196 491
------------ ------------ ------------ ------------ ------------
$ 490,344 $ 350,119 $ 376,629 $ 606,070 $ 1,823,162
============ ============ ============ ============ ============
At December 31, 1997, the Company had $194.5 million of certificates of
deposit in amounts of $100,000 or more outstanding maturing as follows: $97.7
million within three months; $28.4 million over three months through six months;
$19.4 million over six months through 12 months; and $49.0 million thereafter.
For additional information related to the Company's deposits, see Note
15 to the Consolidated Financial Statements included in Item 8 hereof.
BORROWINGS. Through the Bank, the Company obtains advances from the
FHLB of New York upon the security of certain of its residential first mortgage
loans, mortgage-backed and mortgage-related securities and other assets,
including FHLB stock, provided certain standards related to the creditworthiness
of the Bank have been met. FHLB advances are available to member financial
institutions such as the Bank for investment and lending activities and other
general business purposes. FHLB advances are made pursuant to several different
credit programs, each of which has its own interest rate, which may be fixed or
adjustable, and range of maturities.
The Company also obtains funds pursuant to securities sold under
reverse repurchase agreements. Under these agreements, the Company sells
securities (generally mortgage-backed and mortgage-related securities) under an
agreement to repurchase such securities at a specified price at a later date.
Reverse repurchase agreements have short-term maturities (typically 90 days or
less) and are deemed to be financing transactions. All securities underlying
reverse repurchase agreements are reflected as assets in the Company's
consolidated financial statements and are held in safekeeping by broker-dealers.
Beginning in 1997, borrowings of the Company include lines of credit
obtained by OFS, as follows: (i) a $200.0 million secured line of credit from
Morgan Stanley Mortgage Capital Inc., (ii) a $50.0 million secured line of
credit from Texas Commerce Bank National Association, (iii) a $200.0 million
secured line of credit from Merrill Lynch and (iv) a $200.0 million secured line
of credit from Lehman Commercial Paper, Inc. An aggregate of $118.3 million was
outstanding to OFS under these lines of credit at December 31, 1997, which have
interest rates which float in accordance with a designated prime rate.
The Company's borrowings also include notes, subordinated debentures
and other interest-bearing obligations. At December 31, 1997, this category of
borrowings consisted primarily of $100.0 million of 12% Subordinated Debentures
issued by the Bank in June 1995 and due 2005 (the "Debentures") and $125.0
million of 11.875% Notes due 2003 (the "Notes") issued by the Company through a
public offering on September 25, 1996 and due 2003. Historically, from time to
time, the Company privately has raised funds by issuing short-term notes to
certain executives and stockholders of the Company. Such notes were repaid
during 1996 and amounted to $8.6 million at December 31, 1995.
32
The following table sets forth information relating to the Company's
borrowings and other interest-bearing obligations at the dates indicated.
December 31,
------------------------------
1997 1996 1995
-------- -------- --------
(Dollars in Thousands)
FHLB advances ............................... $ -- $ 399 $ 70,399
Reverse repurchase agreements ............... 108,250 74,546 84,761
Obligations outstanding under lines of
credit ..................................... 118,304 -- --
Notes, debentures and other interest
bearing obligations:
Notes .................................... 125,000 125,000 --
Debentures ............................... 100,000 100,000 100,000
Hotel mortgages payable .................. -- 573 8,427
Short-term notes ......................... 1,975 -- 8,627
-------- -------- --------
226,975 225,573 117,054
-------- -------- --------
$453,529 $300,518 $272,214
======== ======== ========
The following table sets forth certain information relating to the
Company's short term borrowings having average balances during any of the
reported periods of greater than 30% of stockholders' equity at the end of the
reported period.
At or for the Year Ended December 31,
-----------------------------------------------
1997 1996 1995
---------- --------- ----------
(Dollars in Thousands)
FHLB ADVANCES:
Average amount outstanding during the period.... $ 9,482 $ 71,221 $ 14,866
Maximum month-end balance outstanding
during the period.............................. $ 399 $ 81,399 $ 100,399
Weighted average rate:
During the period.............................. 5.46% 5.69% 7.57%
At end of period............................... --% 7.02% 5.84%
OBLIGATIONS OUTSTANDING UNDER LINES OF CREDIT:
Average amount outstanding during the period.... $ 84,272 $ -- $ --
Maximum month-end balance outstanding
during the period.............................. $ 267,095 $ -- $ --
Weighted average rate:
During the period.............................. 6.62% --% --%
At end of period............................... 6.32% --% --%
COMPUTER SYSTEMS AND USE OF TECHNOLOGY
The Company believes that its use of information technology has been a
key factor in achieving success in the acquisition, management and resolution of
discount loans and believes that this technology also has applicability to other
aspects of its business which involve servicing intensive assets, including
subprime residential mortgage lending, servicing of nonperforming or
underperforming loans for third parties and asset management services.
In addition to its standard industry software applications which have
been customized to meet the Company's requirements, the Company has internally
developed fully integrated proprietary applications designed to provide decision
support, automation of decision execution, tracking and exception reporting
associated with the management of nonperforming and underperforming loans. The
Company also has deployed: a predictive dialing solution which permits the
Company to direct the calls made by its collectors and increases the
productivity of the department; an interactive voice response system which
provides automated account information to customers; a document imaging system
which permits immediate access to pertinent loan documents; and a data warehouse
which permits corporate data to be shared on a centralized basis for decision
support. The Company is also implementing electronic commerce which further
automates the Company's communications with its third party service providers.
33
The Company's proprietary systems result in a number of benefits
including consistency of service to customers, reduced training periods for
employees, resolution decisions which evaluate on an automated basis the optimal
means to maximize the net resolution proceeds (which may include a variety of
resolution alternatives including placing the borrowers on forbearance plans,
pursuing a pre-approved sale of the property, or completing foreclosure
proceedings), the ability to effect foreclosure as quickly as possible within
state-specific foreclosure timelines and the management of third party service
providers to ensure quality of service. The federal mortgage agencies and
credit-rating agencies have established a variety of measurements for approved
servicers, against which the Company compares favorably. See "Business-Loan
Servicing Activities."
Through its document imaging system, the Company is able to produce
complete foreclosure packages within minutes. The Company believes that the
industry standard generally is to prepare a complete foreclosure package within
sixty days. Delays in the time to resolution result in increased third party
costs, opportunity costs and direct servicing expenses. As a result, the Company
has designed its systems and procedures to move a loan through the foreclosure
process in a timely manner.
The Company has invested in a sophisticated computer infrastructure to
support its software applications. The Company uses an IBM RISC AS400 and
NetFrame and COMPAQ Proliant file servers as its primary hardware platform. The
Company uses CISCO Routers, Cabletron Hubs and chassis with fiber optic cabling
throughout and between buildings so as to achieve the highest performance. The
Company also has deployed a DAVOX predicative dialer which currently has
capacity for 120 seats. The Company's document imaging system currently stores 6
million images. The Company's systems have significant capacity for expansion
and upgrade.
The Company protects its proprietary information by developing,
maintaining and enforcing a comprehensive set of information security policies;
by having each employee execute an intellectual property agreement with the
Company, which among other things, prohibits disclosure of confidential
information and provides for the assignment of developments; by affixing a
copyright symbol to copies of any of the Company's proprietary information to
which a third party has access; by emblazoning the start-up screen of any of the
Company's proprietary software with the Company's logo and a copyright symbol;
by having third-party contract employees and consultants execute a contract with
the Company which contains, among other things, confidentiality and assignment
provisions; and by otherwise limiting third-party access to the Company's
proprietary information.
ECONOMIC CONDITIONS
GENERAL. The success of the Company is dependent to a certain extent
upon the general economic conditions in the geographic areas in which it
conducts substantial business activities. Adverse changes in national economic
conditions or in the economic conditions of regions in which the Company
conducts substantial business likely would impair the ability of the Company to
collect on outstanding loans or dispose of real estate owned and would otherwise
have an adverse effect on its business, including the demand for new loans, the
ability of customers to repay loans and the value of both the collateral pledged
to the Company to secure its loans and its real estate owned. Moreover,
earthquakes and other natural disasters could have similar effects. Although
such disasters have not significantly adversely affected the Company to date,
the availability of insurance for such disasters in California, in which the
Company conducts substantial business activities, is severely limited. At
December 31, 1997, the Company had loans with an unpaid balance aggregating
$375.1 million (including loans available for sale) secured by properties
located in California and $48.3 million of the Company's real estate owned was
located in California, which collectively represent 13.8% of the Company's total
assets at such date.
EFFECTS OF CHANGES IN INTEREST RATES. The Company's operating results
depend to a large extent on its net interest income, which is the difference
between the interest income earned on interest-earning assets and the interest
expense incurred in connection with its interest-bearing liabilities. Changes in
the general level of interest rates can affect the Company's net interest income
by affecting the spread between the Company's interest-earning assets and
interest-bearing liabilities, as well as, among other things, the ability of the
Company to originate loans; the value of the Company's interest-earning assets
and its ability to realize gains from the sale of such assets; the average life
of the Company's interest-earning assets; the value of the Company's mortgage
servicing rights; and the Company's ability to obtain deposits in competition
with other available investment alternatives. Interest rates are highly
sensitive to many factors, including governmental monetary policies, domestic
and international economic and political conditions and other factors beyond the
control of the Company. The Company actively monitors its assets and liabilities
and employs a hedging strategy which seeks to limit the effects of changes in
interest rates on its operations. Although management believes that the
maturities of the Company's assets currently are well balanced in relation to
its liabilities (based on various estimates as to how changes
34
in the general level of interest rates will impact its assets and liabilities),
there can be no assurance that the profitability of the Company would not be
adversely affected during any period of changes in interest rates.
COMPETITION
The businesses in which the Company is engaged generally are highly
competitive. The acquisition of discount loans is particularly competitive, as
acquisitions of such loans are often based on competitive bidding. The Company
also encounters significant competition in connection with its other lending
activities, its investment and in its deposit-gathering activities. Many of the
Company's competitors are significantly larger than the Company and have access
to greater capital and other resources. In addition, many of the Company's
competitors are not subject to the same extensive federal regulations that
govern federally-insured institutions such as the Bank and their holding
companies. As a result, many of the Company's competitors have advantages over
the Company in conducting certain businesses and providing certain services.
SUBSIDIARIES
Set forth below is a brief description of the operations of the
Company's significant non-banking subsidiaries.
IMI. Through subsidiaries, IMI owns an interest in the Westin Hotel in
Columbus, Ohio, residential units in cooperative buildings which are acquired in
connection with the foreclosure on loans held by the Bank or by deed-in-lieu
thereof, as well as other real estate related ventures. During 1997, IMI sold a
69% partnership interest in the Westin Hotel for a small gain. At December 31,
1997, IMI also owned 9% of the outstanding common stock of OAIC.
OFS. OFS was formed by the Company under Florida law in October 1996
for the purposes of purchasing substantially all of the assets of Admiral, the
Company's primary correspondent mortgage banking firm for subprime single family
residential loans, and assuming all of the Bank's subprime single family
residential lending operations. Under the terms of the acquisition, a
transaction which closed on May 1, 1997, the Company agreed to pay Admiral $6.8
million and to transfer to Admiral 20% of the voting stock of OFS. In addition,
OFS assumed specified liabilities of Admiral in connection with this
transaction, including a $3.0 million unsecured loan which was made by the Bank
to Admiral at the time OFS entered into the asset acquisition agreement with
Admiral, which loan was repaid with the proceeds from a $30.0 million unsecured,
subordinated credit facility provided by the Company to OFS at the time of the
closing of such acquisition. On December 3, 1997, Ocwen purchased 2,705
additional shares of common stock of OFS for $15.0 million, increasing its
ownership percentage from 80% to 93.7%.
See "Business- Lending Activities-Single Family Residential Loans."
OCC. OCC is a wholly-owned subsidiary of the Company which was formed
under Florida law to manage the day-to-day operations of OAIC, subject to
supervision by OAIC's Board of Directors. The directors and executive officers
of OCC consist solely of William C. Erbey, Chairman, President and Chief
Executive Officer, and other executive officers of the Company. OAIC is a
Virginia corporation which elected to be taxed as a REIT under the Code. In May
1997, OAIC conducted an initial public offering of 17,250,000 shares of its
common stock, which resulted in net proceeds of $238.8 million, inclusive of the
$27.9 million contributed by the Company for an additional 1,875,000 shares, or
9.8% of the outstanding shares of OAIC common stock. The OAIC common stock is
traded on the Nasdaq National Market under the symbol "OAIC."
Pursuant to a management agreement between OCC and OAIC, and subject to
supervision by OAIC's Board of Directors, OCC formulates operating strategies
for OAIC, arranges for the acquisition of assets by OAIC, arranges for various
types of financing for OAIC, monitors the performance of OAIC's assets and
provides certain administrative and managerial services in connection with the
operation of OAIC. For performing these services, OCC receives (i) a base
management fee in an amount equal to 1% of total assets per annum, calculated
and paid quarterly based upon the average invested assets, as defined, by OAIC,
which is intended to cover OCC's cost of providing management services to the
Company, and (ii) a quarterly incentive fee in an amount equal to the product of
(A) 25% of the dollar amount by which (1)(a) funds from operations, as defined,
per share of OAIC common stock plus (b) gains (or minus losses) from debt
restructuring and sales of property per share of OAIC common stock, exceeds (2)
an amount equal to (a) the weighted average of the initial public offering price
per share of the OAIC common stock and the prices per share of any secondary
offerings of OAIC common stock by OAIC multiplied by (b) the ten-year U.S.
Treasury rate plus 5% per annum, multiplied by (B) the weighted average number
of shares of OAIC common stock outstanding. The Board of Directors of OAIC may
adjust the base management fee in the future if necessary to align the fee more
closely with the actual costs of
35
such services. OCC also may be reimbursed for the costs of certain due diligence
tasks performed by it on behalf of OAIC and will be reimbursed for the
out-of-pocket expenses incurred by it on behalf of OAIC.
Recently, the Company transferred the lending operations associated
with its large multi-family residential and commercial real estate loans to OCC.
To date, OCC has emphasized originating loans for OAIC (in order to enable OAIC
to invest the proceeds from the initial public offering of OAIC's common stock)
and not the Company.
EMPLOYEES
At December 31, 1997 the Company had 990 full time employees. The
employees are not represented by a collective bargaining agreement. Management
considers the Company's employee relations to be satisfactory.
REGULATION
Financial institutions and their holding companies are extensively
regulated under federal and state laws. As a result, the business, financial
condition and prospects of the Company can be materially affected not only by
management decisions and general economic conditions, but also by applicable
statutes and regulations and other regulatory pronouncements and policies
promulgated by regulatory agencies with jurisdiction over the Company and the
Bank, such as the OTS and the FDIC. The effect of such statutes, regulations and
other pronouncements and policies can be significant, cannot be predicted with a
high degree of certainty and can change over time. Moreover, such statutes,
regulations and other pronouncements and policies are intended to protect
depositors and the insurance funds administered by the FDIC and not stockholders
or holders of indebtedness which are not insured by the FDIC.
The enforcement powers available to Federal banking regulators are
substantial and include, among other things, the ability to assess civil
monetary penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution-affiliated
parties, as defined. In general, these enforcement actions must be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with regulatory authorities.
The following discussion and other references to and descriptions of the
regulation of financial institutions contained herein constitute brief summaries
thereof as currently in effect. This discussion is not intended to constitute,
and does not purport to be, a complete statement of all legal restrictions and
requirements applicable to the Company and the Bank and all such descriptions
are qualified in their entirety by reference to applicable statutes, regulations
and other regulatory pronouncements.
THE COMPANY
GENERAL. The Company is a registered savings and loan holding company
under the Home Owner's Loan Act (the "HOLA"). As such, the Company is subject to
regulation, supervision and examination by the OTS.
ACTIVITIES RESTRICTION. There are generally no restrictions on the
activities of a savings and loan holding company, such as the Company, which
holds only one subsidiary savings institution. However, if the Director of the
OTS determines that there is reasonable cause to believe that the continuation
by a savings and loan holding company of an activity constitutes a serious risk
to the financial safety, soundness or stability of its subsidiary savings
institution, the Director may impose such restrictions as are deemed necessary
to address such risk, including limiting: (i) payment of dividends by the
savings institution; (ii) transactions between the savings institution and its
affiliates; and (iii) any activities of the savings institution that might
create a serious risk that the liabilities of the holding company and its
affiliates may be imposed on the savings institution. Notwithstanding the above
rules as to permissible business activities of unitary savings and loan holding
companies, if the savings institution subsidiary of such a holding company fails
to meet the qualified thrift lender ("QTL") test set forth in OTS regulations,
then such unitary holding company shall become subject to the activities and
restrictions applicable to multiple savings and loan holding companies and,
unless the savings institution requalifies as a QTL within one year thereafter,
shall register as, and become subject to the restriction applicable to, a bank
holding company. See "The Bank-Qualified Thrift Lender Test."
If the Company were to acquire control of another savings institution
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisition and where each subsidiary
36
savings institution meets the QTL test, as set forth below, the activities of
the Company and any of its subsidiaries (other than the Bank or other subsidiary
savings institutions) would thereafter be subject to further restrictions. Among
other things, no multiple savings and loan holding company or subsidiary thereof
which is not a savings institution generally shall commence or continue for a
limited period of time after becoming a multiple savings and loan holding
company or subsidiary thereof any business activity, other than: (i) furnishing
or performing management services for a subsidiary savings institution; (ii)
conducting an insurance agency or escrow business; (iii) holding, managing, or
liquidating assets owned by or acquired from a subsidiary savings institution;
(iv) holding or managing properties used or occupied by a subsidiary savings
institution; (v) acting as trustee under deeds of trust; (vi) those activities
authorized by regulation as of March 5, 1987 to be engaged in by multiple
savings and loan holding companies; or (vii) unless the Director of the OTS by
regulation prohibits or limits such activities for savings and loan holding
companies, those activities authorized by the Federal Reserve Board as
permissible for bank holding companies. Those activities described in clause
(vii) above also must be approved by the Director of the OTS prior to being
engaged in by a multiple savings and loan holding company.
RESTRICTIONS ON ACQUISITIONS. Except under limited circumstances,
savings and loan holding companies are prohibited from acquiring, without prior
approval of the Director of the OTS: (i) control of any other savings
institution or savings and loan holding company or substantially of the assets
thereof; or (ii) more than 5% of the voting shares of a savings institution or
holding company thereof which is not a subsidiary. Except with the prior
approval of the Director of the OTS, no director or officer of a savings and
loan holding company, or person owning or controlling by proxy or otherwise more
than 25% of such company's stock, may acquire control of any savings
institution, other than a subsidiary savings institution, or of any other
savings and loan holding company.
The Director of the OTS may approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state only if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office located in the state of the institution to be acquired as of March
5, 1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act ("FDIA"); or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered savings institutions located in the state where the
acquiring entity is located (or by a holding company that controls such
state-chartered savings institutions).
RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES. Transactions between the
Company or any of its non-bank subsidiaries and the Bank are subject to various
restrictions, which are described below under "The Bank-Affiliate Transactions."
THE BANK
GENERAL. The Bank is a federally-chartered savings bank organized under
the HOLA. As such, the Bank is subject to regulation, supervision and
examination by the OTS. The deposit accounts of the Bank are insured up to
applicable limits by the SAIF administered by the FDIC and, as a result, the
Bank also is subject to regulation, supervision and examination by the FDIC.
The business and affairs of the Bank are regulated in a variety of
ways. Regulations apply to, among other things, insurance of deposit accounts,
capital ratios, payment of dividends, liquidity requirements, the nature and
amount of the investments that the Bank may make, transactions with affiliates,
community and consumer lending laws, internal policies and controls, reporting
by and examination of the Bank and changes in control of the Bank.
INSURANCE OF ACCOUNTS. Pursuant to legislation enacted in September
1996, a fee was required to be paid by all SAIF-insured institutions at the rate
of $0.657 per $100 of deposits held by such institutions at March 31, 1995. The
money collected recapitalized the SAIF reserve to the level of 1.25% of insured
deposits as required by law. In September 1996, the Bank recorded a pre-tax
accrual of $7.1 million for this assessment, which was subsequently paid in
November 1996. The recapitalization of the SAIF has resulted in lower deposit
insurance premiums for most SAIF-insured financial institutions, including the
Bank.
Insured institutions also are required to share in the payment of
interest on the bonds issued by a specially created government entity ("FICO"),
the proceeds of which were applied toward resolution of the thrift industry
crisis in the 1980s. Beginning on January 1, 1997, in addition to the insurance
premiums paid by SAIF-insured institutions to maintain the SAIF reserve at its
required level pursuant to the current risk classification system, SAIF-insured
institutions pay deposit
37
insurance premiums at the annual rate of 6.4 basis points of their insured
deposits and BIF-insured institutions will pay deposit insurance premiums at the
annual rate of 1.3 basis points of their insured deposits towards the payment of
interest on the FICO bonds.
Under the current risk classification system, institutions are assigned
to one of three capital groups which are 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 the FDIA,
as discussed below. These three groups are then divided into three subgroups,
which are based on supervisory evaluations by the institution's primary federal
regulator, resulting in nine assessment classifications. Assessment rates
currently range from 0 basis points for well capitalized, healthy institutions
to 27 basis points for undercapitalized institutions with substantial
supervisory concerns.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of the Bank's deposit insurance.
REGULATORY CAPITAL REQUIREMENTS. Federally-insured savings associations
are subject to three capital requirements of general applicability: a tangible
capital requirement, a core or leverage capital requirement and a risk-based
capital requirement. All savings associations currently are required to maintain
tangible capital of at least 1.5% of adjusted total assets (as defined in the
regulations), core capital equal to 3% of adjusted total assets and total
capital (a combination of core and supplementary capital) equal to 8% of
risk-weighted assets (as defined in the regulations). For purposes of the
regulation, tangible capital is core capital less all intangibles other than
qualifying purchased mortgage servicing rights, of which the Bank had $4.9
million at December 31, 1997. Core capital includes common stockholders' equity,
non-cumulative perpetual preferred stock and related surplus, minority interests
in the equity accounts of fully consolidated subsidiaries and certain
nonwithdrawable accounts and pledged deposits. Core capital generally is reduced
by the amount of a savings association's intangible assets, other than
qualifying mortgage servicing rights.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital included does not exceed the savings association's core capital.
Supplementary capital consists of certain capital instruments that do not
qualify as core capital, including subordinated debt (such as the Bank's
Debentures) which meets specified requirements, and general valuation loan and
lease loss allowances up to a maximum of 1.25% of risk-weighted assets. In
determining the required amount of risk-based capital, total assets, including
certain off-balance sheet items, are multiplied by a risk weight based on the
risks inherent in the type of assets. The risk weights assigned by the OTS for
principal categories of assets currently range from 0% to 100%, depending on the
type of asset.
OTS policy imposes a limitation on the amount of net deferred tax
assets under SFAS No. 109 that may be included in regulatory capital. (Net
deferred tax assets represent deferred tax assets, reduced by any valuation
allowances, in excess of deferred tax liabilities.) Application of the limit
depends on the possible sources of taxable income available to an institution to
realize deferred tax assets. Deferred tax assets that can be realized from the
following generally are not limited: taxes paid in prior carryback years and
future reversals of existing taxable temporary differences. To the extent that
the realization of deferred tax assets depends on an institution's future
taxable income (exclusive of reversing temporary differences and carryforwards),
or its tax-planning strategies, such deferred tax assets are limited for
regulatory capital purposes to the lesser of the amount that can be realized
within one year of the quarter-end report date or 10% of core capital. The
Bank's regulatory capital at December 31, 1997, has been reduced by $536,000 of
disallowed deferred tax assets in excess of the OTS limit.
In August 1993, the OTS adopted a final rule incorporating an
interest-rate risk component into the risk-based capital regulation. Under the
rule, an institution with a greater than "normal" level of interest rate risk
will be subject to a deduction of its interest rate risk component from total
capital for purposes of determining whether it has met the risk-based capital
requirement. As a result, such an institution will be required to maintain
additional capital in order to comply with the risk-based capital requirement.
Although the final rule was originally scheduled to be effective as of January
1994, the
38
OTS has indicated that it will delay invoking its interest rate risk rule until
appeal procedures are implemented and evaluated. The OTS has not yet established
an effective date for the capital deduction. Management of the Company does not
believe that the adoption of an interest rate risk component to the risk-based
capital requirement will adversely affect the Bank if it becomes effective in
its current form.
In April 1991, the OTS proposed to modify the 3% of adjusted total
assets core capital requirement in the same manner as was done by the
Comptroller of the Currency for national banks. Under the OTS proposal, only
savings associations rated composite 1 under the CAMEL rating system will be
permitted to operate at the regulatory minimum core capital ratio of 3%. For all
other savings associations, the minimum core capital ratio will be 3% plus at
least an additional 100 to 200 basis points, which will increase the core
capital ratio requirement from 4% to 5% of adjusted total assets or more. In
determining the amount of additional capital, the OTS will assess both the
quality of risk management systems and the level of overall risk in each
individual savings association through the supervisory process on a case-by-case
basis.
PROMPT CORRECTIVE ACTION. Federal law provides the Federal banking
regulators with broad power to take "prompt corrective action" to resolve the
problems of undercapitalized institutions. The extent of the regulators' powers
depends on whether the institution in question is "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized"
or "critically undercapitalized." Under regulations adopted by the Federal
banking regulators, an institution shall be deemed to be: (i) "well capitalized"
if it has a total risk-based capital ratio of 10.0% or more, has a Tier I
risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of
5.0% or more and is not subject to specified requirements to meet and maintain a
specific capital level for any capital measure; (ii) "adequately capitalized" if
it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based
capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or
more (3.0% under certain circumstances) and does not meet the definition of
"well capitalized," (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is
less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0%
under certain circumstances), (iv) "significantly undercapitalized" if it has a
total risk-based capital ratio that is less than 6.0%, a Tier I risk-based
capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is
less than 3.0%, and (v) "critically undercapitalized" if it has a ratio of
tangible equity to adjusted total assets that is equal to or less than 2.0%. The
regulations also permit the appropriate Federal banking regulator to downgrade
an institution to the next lower category (provided that a significantly
undercapitalized institution may not be downgraded to critically
undercapitalized) if the regulator; determines: (i) after notice and opportunity
for hearing or response, that the institution is in an unsafe or unsound
condition or (ii) that the institution has received (and not corrected) a
less-than-satisfactory rating for any of the categories of asset quality,
management, earnings or liquidity in its most recent exam. At December 31, 1997,
the Bank was a "well capitalized" institution under the prompt corrective action
regulations of the OTS.
Depending upon the capital category to which an institution is
assigned, the regulators' corrective powers, many of which are mandatory in
certain circumstances, include: prohibition on capital distributions;
prohibition on payment of management fees to controlling persons; requiring the
submission of a capital restoration plan; placing limits on asset growth;
limiting acquisitions, branching or new lines of business; requiring the
institution to issue additional capital stock (including additional voting
stock) or to be acquired; restricting transactions with affiliates; restricting
the interest rates that the institution may pay on deposits; ordering a new
election of directors of the institution; requiring that senior executive
officers or directors be dismissed; prohibiting the institution from accepting
deposits from correspondent banks; requiring the institution to divest certain
subsidiaries; prohibiting the payment of principal or interest on subordinated
debt; and, ultimately, appointing a receiver for the institution.
QUALIFIED THRIFT LENDER TEST. All savings associations are required to
meet the QTL test set forth in the HOLA and regulations of the OTS thereunder to
avoid certain restrictions on their operations. A savings association that does
not meet the QTL test set forth in the HOLA and implementing regulations must
either convert to a bank charter or comply with the following restrictions on
its operations: (i) the association may not engage in any new activity or make
any new investment, directly or indirectly, unless such activity or investment
is permissible for a national bank; (ii) the branching powers of the association
shall be restricted to those of a national bank; (iii) the association shall not
be eligible to obtain any advances from its FHLB; and (iv) payment of dividends
by the association shall be subject to the rules regarding payment of dividends
by a national bank. Upon the expiration of three years from the date the
association ceases to be a QTL, it must cease any activity and not retain any
investment not permissible for a national bank and immediately repay any
outstanding FHLB advances (subject to safety and soundness considerations). The
Bank met the QTL test throughout 1997.
39
RESTRICTIONS ON CAPITAL DISTRIBUTIONS. The OTS has promulgated a
regulation governing capital distributions by savings associations, which
include cash dividends, stock redemptions or repurchases, cash-out mergers,
interest payments on certain convertible debt and other transactions charged to
the capital account of a savings association as a capital distribution.
Generally, the regulation creates three tiers of associations based on
regulatory capital, with the top two tiers providing a safe harbor for specified
levels of capital distributions from associations so long as such associations
notify the OTS and receive no objection to the distribution from the OTS.
Associations that do not qualify for the safe harbor provided for the top two
tiers of associations are required to obtain prior OTS approval before making
any capital distributions.
Tier I associations may make the highest amount of capital
distributions, and are defined as savings associations that, before and after
the proposed distribution, meet or exceed their fully phased-in regulatory
capital requirements. Tier I associations may make capital distributions during
any calendar year equal to the greater of: (i) 100% of net income for the
calendar year-to-date plus 50% of its "surplus capital ratio" at the beginning
of the calendar year; and (ii) 75% of its net income over the most recent
four-quarter period. The "surplus capital ratio" is defined to mean the
percentage by which the association's ratio of total capital to assets exceeds
the ratio of its fully phased-in capital requirement to assets, and "fully
phased-in capital requirement" is defined to mean an association's capital
requirement under the statutory and regulatory standards applicable on December
31, 1994, as modified to reflect any applicable individual minimum capital
requirement imposed upon the association. At December 31, 1997, the Bank was a
Tier I association under the OTS capital distribution regulation.
In December 1994, the OTS published a notice of proposed rulemaking to
amend its capital distribution regulation. Under the proposal, the three tiered
approach contained in existing regulations would be replaced and institutions
would be permitted to make capital distributions that would not result in their
capital being reduced below the level required to remain "adequately
capitalized," as defined above under "Prompt Corrective Action."
LOAN-TO-ONE BORROWER. Under applicable laws and regulations, the amount
of loans and extensions of credit which may be extended by a savings institution
such as the Bank to any one borrower, including related entities, generally may
not exceed the greater of $500,000 or 15% of the unimpaired capital and
unimpaired surplus of the institution. Loans in an amount equal to an additional
10% of unimpaired capital and unimpaired surplus also may be made to a borrower
if the loans are fully secured by readily marketable securities. An
institution's "unimpaired capital and unimpaired surplus" includes, among other
things, the amount of its core capital and supplementary capital included in its
total capital under OTS regulations.
At December 31, 1997, the Bank's unimpaired capital and surplus
amounted to $405.1 million, resulting in a general loans-to-one borrower
limitation of $60.8 million under applicable laws and regulations. See
"Business-Discount Loan Acquisition and Resolution Activities-Composition of the
Discount Loan Portfolio" and "Lending Activities-Composition of Loan Portfolio."
BROKERED DEPOSITS. Under applicable laws and regulations, an insured
depository institution may be restricted in obtaining, directly or indirectly,
funds by or through any "deposit broker," as defined, for deposit into one or
more deposit accounts at the institution. The term "deposit broker" generally
includes any person engaged in the business of placing deposits, or facilitating
the placement of deposits, of third parties with insured depository institutions
or the business of placing deposits with insured depository institutions for the
purpose of selling interests in those deposits to third parties. In addition,
the term "deposit broker" includes any insured depository institution, and any
employee of any insured depository institution, which engages, directly or
indirectly, in the solicitation of deposits by offering rates of interest (with
respect to such deposits) which are significantly higher than the prevailing
rates of interest on deposits offered by other insured depository institutions
having the same type of charter in such depository institution's normal market
area. As a result of the definition of "deposit broker," all of the Bank's
brokered deposits, as well as possibly its deposits obtained through customers
of regional and local investment banking firms and the deposits obtained from
the Bank's direct solicitation efforts of institutional investors and high net
worth individuals, are potentially subject to the restrictions described below.
Under FDIC regulations, well-capitalized institutions are subject to the
no-brokered deposit limitations, while adequately- capitalized institutions are
able to accept, renew or roll over brokered deposits only: (i) with a waiver
from the FDIC; and (ii) subject to the limitation that they do not pay an
effective yield on any such deposit which exceeds by more than (a) 75 basis
points, the effective yield paid on deposits of comparable size and maturity in
such institution's normal market area for deposits accepted in its normal market
area or (b) by 120% for retail deposits and 130% for wholesale deposits,
respectively, of the current yield on comparable maturity U.S. Treasury
obligations for deposits accepted outside the institution's normal market area.
Undercapitalized institutions are not permitted to accept brokered deposits and
may not
40
solicit deposits by offering an effective yield that exceeds by more than 75
basis points, the prevailing effective yields on insured deposits of comparable
maturity in the institution's normal market area or in the market area in which
such deposits are being solicited. At December 31, 1997, the Bank was a
well-capitalized institution which was not subject to restrictions on brokered
deposits. See "Business - Sources of Funds - Deposits."
LIQUIDITY REQUIREMENTS. All savings associations are required to
maintain an average daily balance of liquid assets, which include specified
short-term assets and certain long-term assets, equal to a certain percentage of
the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. In November 1997, the OTS amended its
liquidity regulations to, among other things, provide that a savings association
shall maintain liquid assets of not less than 4% of the amount of its liquidity
base at the end of the preceding calendar quarter as well as to provide that
each savings association must maintain sufficient liquidity to ensure its safe
and sound operation. Prior to November 1997, the required liquid asset ratio was
5%. Historically, the Bank has operated in compliance with these requirements.
AFFILIATE TRANSACTIONS. Under federal law and regulation, transactions
between a savings association and its affiliates are subject to quantitative and
qualitative restrictions. Affiliates of a savings association include, among
other entities, companies that control, are controlled by or are under common
control with the savings association. As a result, the Company, OAIC and the
Company's non-bank subsidiaries are affiliates of the Bank.
Savings associations are restricted in their ability to engage in
"covered transactions" with their affiliates. In addition, covered transactions
between a savings association and an affiliate, as well as certain other
transactions with or benefiting an affiliate, must be on terms and conditions at
least as favorable to the savings association as those prevailing at the time
for comparable transactions with non-affiliated companies. Savings associations
are required to make and retain detailed records of transactions with
affiliates.
Notwithstanding the foregoing, a savings association is not permitted
to make a loan or extension of credit to any affiliate unless the affiliate is
engaged only in activities the Federal Reserve Board has determined to be
permissible for bank holding companies. Savings associations also are prohibited
from purchasing or investing in securities issued by an affiliate, other than
shares of a subsidiary.
Savings associations are also subject to various limitations and
reporting requirements on loans to insiders. These limitations require, among
other things, that all loans or extensions of credit to insiders (generally
executive officers, directors or 10% stockholders of the institution) or their
"related interests" be made on substantially the same terms (including interest
rates and collateral) as, and follow credit underwriting procedures that are not
less stringent than, those prevailing for comparable transactions with the
general public and not involve more than the normal risk of repayment or present
other unfavorable features.
COMMUNITY INVESTMENT AND CONSUMER PROTECTION LAWS. In connection with
its lending activities, the Bank is subject to a variety of federal laws
designed to protect borrowers and promote lending to various sectors of the
economy and population. Included among these are the Federal Home Mortgage
Disclosure Act, Real Estate Settlement Procedures Act, Truth-in-Lending Act,
Equal Credit Opportunity Act, Fair Credit Reporting Act and the Community
Reinvestment Act.
SAFETY AND SOUNDNESS. Other regulations include: (i) real estate
lending standards for insured institutions, which provide guidelines concerning
loan-to-value ratios for various types of real estate loans; (ii) risk-based
capital rules to account for interest rate risk, concentration of credit risk
and the risks posed by "non-traditional activities;" (iii) rules requiring
depository institutions to develop and implement internal procedures to evaluate
and control credit and settlement exposure to their correspondent banks; and
(iv) rules addressing various "safety and soundness" issues, including
operations and managerial standards, standards for asset quality, earnings and
stock valuations, and compensation standards for the officers, directors,
employees and principal stockholders of the insured institution.
FEDERAL TAXATION
GENERAL. The Company and all of its subsidiaries currently file, and
expect to continue to file, a consolidated Federal income tax return based on a
calendar year. Prior to October 1, 1996, IMI and its subsidiaries filed a
separate
41
Federal consolidated tax return. Consolidated returns have the effect of
eliminating inter-company transactions, including dividends, from the
computation of taxable income.
For taxable years beginning prior to January 1, 1996, a savings
institution, such as the Bank, that met certain definitional tests relating to
the composition of its assets and the sources of its income (a "qualifying
savings institution") was permitted to establish reserves for bad debts and to
claim annual tax deductions for additions to such reserves. A qualifying savings
institution was permitted to make annual additions to such reserves based on the
institution's loss experience. Alternatively, a qualifying savings institution
could elect, on an annual basis, to use the "percentage of taxable income"
method to compute its addition to its bad debt reserve on qualifying real
property loans (generally, loans secured by an interest in improved real
estate). The percentage of taxable income method permitted the institution to
deduct a specified percentage of its taxable income before such deduction,
regardless of the institution's actual bad debt experience, subject to certain
limitations. From 1988 to 1995, the Bank has claimed bad debt deductions under
the percentage of taxable income method because that method produced a greater
deduction than did the experience method.
On August 20, 1996, President Clinton signed the Small Business Job
Protection Act ("the Act") into law. One provision of the Act repealed the
reserve method of accounting for bad debts for savings institutions effective
for taxable years beginning after 1995 and provided for recapture of a portion
of the reserves existing at the close of the last taxable year beginning before
January 1, 1996. For its tax years beginning on or after January 1, 1996, the
Bank is required to account for its bad debts under the specific charge-off
method. Under this method, deductions may be claimed only as and to the extent
that loans become wholly or partially worthless.
ALTERNATIVE MINIMUM TAX. In addition to the regular corporate income
tax, corporations, including qualifying savings institutions, are subject to an
alternative minimum tax. The 20% tax is computed on Alternative Minimum Taxable
Income ("AMTI") and applies if it exceeds the regular tax liability. AMTI is
equal to regular taxable income with certain adjustments. For taxable years
beginning after 1989, AMTI includes an adjustment for 75% of the excess of
"adjusted current earnings" over regular taxable income. Net operating loss
carrybacks and carryforwards are permitted to offset only 90% of AMTI.
Alternative minimum tax paid can be credited against regular tax due in later
years.
TAX RESIDUALS. From time to time, the Company acquires REMIC residuals
or retains residual securities in REMICs which were formed by the Company in
connection with the securitization and sale of loans. Although a tax residual
may have little or no future economic cash flows from the REMIC from which it
has been issued, the tax residual does bear the income tax liability or benefit
resulting from the difference between the interest rate paid on the securities
by the REMIC and the interest rate received on the mortgage loans held by the
REMIC. This generally results in taxable income for the Company in the first
several years of the REMIC and equal amounts of tax deductions thereafter. The
Company receives cash payments in connection with the acquisition of tax
residuals to compensate the Company for the time value of money associated with
the tax payments related to these securities and the costs of modeling,
recording, monitoring and reporting the securities. The Company defers all fees
received and recognizes such fees in interest income on a level yield basis over
the expected life of the deferred tax asset related to tax residuals. The
Company also adjusts the recognition in interest income of fees deferred based
upon the changes in the actual prepayment rates of the underlying mortgages held
by the REMIC and periodic reassessments of the expected life of the deferred tax
asset related to tax residuals. At December 31, 1997, the Company's gross
deferred tax assets included $3.5 million which was attributable to the
Company's tax residuals and related deferred income.
INVESTMENTS IN LOW-INCOME HOUSING TAX CREDIT INTERESTS. For a
discussion of the tax effects of investments in low-income housing tax credit
interests, see "Business-Investment Activities-Investment in Low-Income Housing
Tax Credit Interests."
EXAMINATIONS. The most recent examination by the IRS of the Company's
Federal income tax return was of the tax return filed for 1993. The statute of
limitations has run out with respect to 1993 and all prior tax years. Thus, the
Federal income tax returns for the years 1994 through 1997 are open for
examination. The Internal Revenue Service currently is completing an examination
of the Company's Federal income tax return for 1994; management of the Company
does not anticipate any material adjustments as a result of this examination,
although there can be no assurances in this regard. No state return of the
Company has been examined, and no notification has been received by the Company
that any state intends to examine any of the Company's tax returns.
42
STATE TAXATION
The Company's income is subject to tax by the States of Florida and
California, which have statutory tax rates of 5.5% and 11.3%, respectively, and
is determined based on certain apportionment factors. The Company is taxed in
New Jersey on income, net of expenses, earned in New Jersey at a statutory rate
of 3.0%.
ITEM 2. PROPERTIES
At December 31, 1997, the Company conducted business from its executive
and administrative offices located in West Palm Beach, Florida and a
full-service banking office located in northern New Jersey.
The following table sets forth information relating to the Company's
executive and main offices at December 31, 1997.
Net Book Value of Property or
Leasehold
Location Owned/Leased Improvements
(Dollars in Thousands)
- ------------------------------------------------- ---------------------- -----------------------------------
Executive Offices:
1675 Palm Beach Lakes Blvd.
West Palm Beach, FL....................... Leased $ 6,021
Main Office:
2400 Lemoine Ave
Fort Lee, NJ.............................. Leased $ --
In addition to the above offices, OFS maintains 27 loan production
offices in 7 states, including 18 offices in California. These offices are
operated pursuant to leases with up to three-year terms, each of which can be
readily replaced on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Information required by this Item appears under the caption
"Shareholder Information" on page 71 of the Annual Report to Stockholders and is
incorporated herein by reference.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION
Information required by this Item appears under the caption "Selected
Consolidated Financial Information" on pages 1 to 2 of the Annual Report to
Stockholders and is incorporated herein by reference.
43
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Information required by this Item appears under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pages 4 to 20 of the Annual Report to Stockholders and is
incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this Item appears under the caption "Asset and
Liability Management" on pages 15 to 17 of the Annual Report to Stockholders and
is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS
Information required by this Item appears on pages 22 to 70 in the
Annual Report to Stockholders and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained in the Company's 1998 Proxy Statement under
the captions "Election of Directors -- Nominees for Director," "Executive
Officers Who Are Not Directors," and "Security Ownership of Certain Beneficial
Owners -- Section 16(a) Beneficial Ownership Reporting Compliance" is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information contained in the Company's 1998 Proxy Statement under
the captions "Executive Compensation," other than under the sub-caption "Report
of the Nominating and Compensation Committee," and "Board of Directors
Compensation" is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained in the Company's 1998 Proxy Statement under
the caption "Security Ownership of Certain Beneficial Owners -- Beneficial
Ownership of Common Stock" is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained in the Company's 1998 Proxy Statement under
the caption "Certain Relationships and Related Transactions" is incorporated
herein by reference.
44
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
EXHIBITS
3.1 Amended and Restated Articles of Incorporation (1)
3.2 Bylaws (1)
4.0 Form of Certificate of Common Stock (1)
4.1 Form of Indenture between the Company and Bank One, Columbus,
NA as Trustee (1)
4.2 Form of Note due 2003 (included in Exhibit 4.1) (1)
4.3 Certificate of Trust of Ocwen Capital Trust I (3)
4.4 Amended and Restated Declaration of Trust of Ocwen Capital
Trust I (3)
4.5 Form of Capital Security of Ocwen Capital Trust I (4)
4.6 Form of Indenture relating to 10 7/8% Junior Subordinated
Debentures due 2027 of the Company (3)
4.7 Form of 10 7/8% Junior Subordinated Debentures due 2027 of the
Company (4)
4.8 Form of Guarantee of the Company relating to the Capital
Securities of Ocwen Capital Trust I (3)
4.9 Form of Indenture between the Company and The Bank of New York
as Trustee
4.10 Form of Subordinated Debentures due 2005 (included in Exhibit
4.2) (5)
10.1 Ocwen Financial Corporation 1991 Non-Qualified Stock Option
Plan, as amended (1)
10.2 Annual Incentive Plan (1)
10.3 Ocwen Financial Corporation 1996 Stock Plan for Directors, as
amended (2)
10.4 Ocwen Financial Corporation 1998 Annual Incentive Plan (6)
10.5 Ocwen Financial Corporation Long-Term Incentive Plan (6)
11.1 Computation of earnings per share (7)
13.1 Annual Report to Stockholders for the year ended December 31,
1997
21.0 Subsidiaries (see "Business-General")
23.0 Consent of Price Waterhouse LLP
27.1 Financial Data Schedule - For the year ended December 31, 1997
27.2 Amended Financial Data Schedule - For the year ended December
31, 1996
27.3 Amended Financial Data Schedule - For the period ended
September 30, 1996
27.4 Amended Financial Data Schedule - For the period ended March
31, 1997
27.5 Amended Financial Data Schedule - For the period ended June
30, 1997
27.6 Amended Financial Data Schedule - For the period ended
September 30, 1997
99.0 BCBF, L.L.C. December 31, 1997 audited financial statements
- -------------------
(1) Incorporated by reference to the similarly described exhibit filed in
connection with the Registrant's Registration Statement on Form S-1, File
No. 333-5153, declared effective by the commission on September 25, 1996.
(2) Incorporated by reference to the similarly described exhibit included with
the Registrants Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996.
(3) Incorporated by reference to the similarly identified exhibit filed in
connection with the Company's Registration Statement on Form S-1 (File No.
333-28889), as amended, declared effective by the Commission on August 6,
1997.
(4) Incorporated by reference to similarly described exhibit included with
Registrant's Quarterly Report on Form 10-Q for the quarter ended September
30, 1997.
(5) Incorporated by reference to the similarly described exhibit filed in
connection with Amendment No. 2 to Offering Circular on Form OC (on Form
S-1) filed on June 7, 1995.
(6) Incorporated by reference to the similarly described exhibit to the
Company's Definitive Proxy Statement with respect to the Company's 1998
Annual Meeting as filed with the Commission on March 31, 1998.
(7) Computation of earnings per share appears on page 55 in the Annual Report
to Stockholders and is incorporated herein by reference.
The Company's management contracts or compensatory plans or arrangements
consist of Exhibits No. 10.1, 10.2, 10.3, 10.4 and 10.5.
45
FINANCIAL STATEMENTS AND SCHEDULES. The following Consolidated
Financial Statements of Ocwen Financial Corporation and Report of Price
Waterhouse LLP, Independent Certified Public Accountants are incorporated by
reference to pages 22 to 70 of the Company's Annual Report to Stockholders:
Report of Independent Certified Public Accountants
Consolidated Statements of Financial Condition at December 31,
1997 and 1996
Consolidated Statements of Operations for each of the three years
in the period ended December 31, 1997
Consolidated Statements of Changes in Stockholders' Equity for
each of the three years in the period ended December 31, 1997
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 1997
Notes to Consolidated Financial Statements
Financial statement schedules have been omitted because they are not
applicable or the required information is shown in the Consolidated Financial
Statements or notes thereto.
REPORTS ON FORM 8-K FILED DURING THE QUARTER ENDED DECEMBER 31, 1997.
(1) A Form 8-K was filed by the Company on October 30, 1997 which contained
a news release announcing the Company's financial results for the three
and nine months ended September 30, 1997.
(2) A Form 8-K/A was filed by the Company on November 21, 1997 which
contained the news release announcing the Company's financial results
for the three and nine months ended September 30, 1997 dated October
27, 1997 and originally filed on October 30, 1997, amended for changes
to reflect the final financial information as determined in connection
with the filing by the Company of its Form 10-Q for the quarter ended
September 30, 1997, including the retroactive adjustment for the
2-for-1 stock split approved by the Board of Directors on October 29,
1997.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
OCWEN FINANCIAL CORPORATION
By: /s/ William C. Erbey
------------------------------------------------
William C. Erbey
Chairman of the Board, President and
Chief Executive Officer
(duly authorized representative)
Date: March 31, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
/s/ William C. Erbey Date: March 31, 1998
- ------------------------------------------------------
William C. Erbey, Chairman of the Board,
Chief Executive Officer and President
(principal executive officer)
/s/ Barry N. Wish Date: March 31, 1998
- -------------------------------------------------------
Barry N. Wish, Director
/s/ W.C. Martin Date: March 31, 1998
- -------------------------------------------------------
W.C. Martin, Director
/s/ Howard H. Simon Date: March 31, 1998
- -------------------------------------------------------
Howard H. Simon, Director
/s/ Hon. Thomas F. Lewis Date: March 31, 1998
- -------------------------------------------------------
Hon. Thomas F. Lewis, Director
/s/ Mark S. Zeidman Date: March 31, 1998
- -------------------------------------------------------
Mark S. Zeidman, Chief Financial Officer
(principal financial and accounting officer)
47
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following tables present selected consolidated financial data of the
Ocwen Financial Corporation and its subsidiaries ("Ocwen" or the "Company") at
the dates and for the periods indicated. The historical operations and balance
sheet data at and for the years ended December 31, 1997, 1996, 1995, 1994 and
1993 have been derived from financial statements audited by Price Waterhouse
LLP, independent certified public accountants. The selected consolidated
financial data should be read in conjunction with, and is qualified in its
entirety by reference to, the information in the Consolidated Financial
Statements and related notes set forth elsewhere herein.
Year Ended December 31,
---------------------------------------------------------------
1997 1996 1995(1) 1994(1) 1993(2)
--------- --------- --------- --------- --------
(Dollars in Thousands, Except per share data)
Operations Data:
Interest income.......................................... $ 272,531 $ 193,894 $ 137,275 $131,458 $ 78,923
Interest expense......................................... 156,289 116,160 84,060 62,598 35,306
--------- --------- --------- -------- --------
Net interest income................................. 116,242 77,734 53,215 68,860 43,617
Provision for loan losses (3)............................ 32,218 22,450 1,082 -- --
--------- --------- --------- -------- --------
Net interest income after provision for loan losses. 84,024 55,284 52,133 68,860 43,617
--------- --------- --------- -------- --------
Gains on sales of interest earning assets, net........... 82,212 21,682 6,916 5,727 8,386
Servicing fees and other charges......................... 25,881 4,682 2,870 4,786 3,738
Gain on sale of branch offices........................... -- -- 5,430 62,600 --
Income (loss) on real estate owned, net.................. 7,277 3,827 9,540 5,995 (1,158)
Fees on financing transactions (4)....................... -- -- -- -- 15,340
Other non-interest income................................ 8,498 7,112 6,385 2,467 9,566
--------- --------- --------- -------- --------
Total non-interest income........................... 123,868 37,303 31,141 81,575 35,872
--------- --------- --------- -------- --------
Non-interest expense..................................... 126,793 69,606 45,573 68,858 41,859
Distributions on capital securities...................... 5,249 -- -- -- --
Equity in earnings of investment in joint venture (5).... 23,688 38,320 -- -- --
Income taxes............................................. (21,309) (11,159) (4,562) (29,724) (10,325)
Minority interest in net loss of consolidated subsidiary. 703 -- -- -- --
--------- --------- --------- -------- --------
Income from continuing operations........................ 78,932 50,142 33,139 51,853 27,305
Discontinued operations (6).............................. -- -- (7,672) (4,514) (2,270)
Extraordinary gains...................................... -- -- -- -- 1,538
Cumulative effect of a change in accounting principle.... -- -- -- -- (1,341)
--------- --------- --------- -------- --------
Net income.......................................... $ 78,932 $ 50,142 $ 25,467 $ 47,339 $ 25,232
========= ========= ========= ======== ========
Income from continuing operations per share (16):
Basic............................................... $ 1.40 $ 0.99 $ 0.64 $ 0.81 $ 0.42
Diluted............................................. $ 1.39 $ 0.94 $ 0.60 $ 0.76 $ 0.40
Net income per share (16):
Basic............................................... $ 1.40 $ 0.99 $ 0.49 $ 0.74 $ 0.38
Diluted $ 1.39 $ 0.94 $ 0.46 $ 0.70 $ 0.37
1
December 31,
------------------------------------------------------------------
1997 1996 1995(1) 1994(1) 1993(2)
---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
Balance Sheet Data:
Total assets ............................................ $3,069,165 $2,483,685 $1,973,590 $1,226,403 $1,396,677
Securities available for sale (7) ....................... 430,524 354,005 337,480 187,717 527,183
Loans available for sale (7)(8) ......................... 177,041 126,366 251,790 102,293 101,066
Investment securities, net .............................. 59,567 8,901 18,665 17,011 32,568
Mortgage-related securities held for investment, net .... -- -- -- 91,917 121,550
Loan portfolio, net (8) ................................. 266,299 402,582 295,605 57,045 88,288
Discount loan portfolio (8) ............................. 1,434,176 1,060,953 669,771 529,460 303,634
Investment in low-income housing tax credit interests ... 128,614 93,309 81,362 49,442 16,203
Real estate owned, net (9) .............................. 167,265 103,704 166,556 96,667 33,497
Investment in joint ventures (15) ....................... 1,056 67,909 -- -- --
Excess of purchase price over net assets acquired, net .. 15,560 -- -- -- 10,467
Deposits ................................................ 1,982,822 1,919,742 1,501,646 1,023,268 871,879
Borrowings and other interest-bearing obligations ....... 453,529 300,518 272,214 25,510 373,792
Capital securities ...................................... 125,000 -- -- -- --
Stockholders' equity (10) ............................... 419,692 203,596 139,547 153,383 111,831
Other Data:
Average assets (11) ..................................... $2,835,514 $2,013,283 $1,521,368 $1,714,953 $1,152,655
Average equity .......................................... 290,030 161,332 121,291 119,500 97,895
Return on average assets (11)(12):
Income from continuing operations ..................... 2.78% 2.35% 2.18% 3.02% 2.37%
Net income ............................................ 2.78 2.35 1.67 2.76 2.19
Return on average equity (12):
Income from continuing operations ..................... 27.22 31.08 27.32 43.39 27.89
Net income ............................................ 27.22 31.08 21.00 39.61 25.77
Average equity to average assets ........................ 10.23 8.01 7.97 6.97 8.49
Net interest spread ..................................... 4.81 5.46 5.25 4.86 4.05
Net interest margin ..................................... 4.91 4.84 4.54 4.75 4.30
Efficiency ratio (13) ................................... 48.06 45.38 54.00 45.77 52.66
Nonperforming loans to loans at end of period (14)....... 3.39 0.56 1.27 4.35 3.71
Allowance for loan losses to loans at end of period (14). 1.37 0.87 0.65 1.84 0.99
Bank regulatory capital ratios at end of period:
Tangible .............................................. 10.66 9.33 6.52 11.28 5.25
Core (Leverage) ....................................... 10.66 9.33 6.52 11.28 6.00
Risk-based ............................................ 14.83 12.85 11.80 14.74 13.31
Number of full-service offices at end of period ......... 1 1 1 3 28
2
NOTES TO SELECTED CONSOLIDATED FINANCIAL INFORMATION
(1) Financial data at December 31, 1995 and 1994 reflects the Company's sale
of two and twenty-three branch offices, respectively, which resulted in
the transfer of deposits of $111.7 million and $909.3 million,
respectively, and resulted in a gain on sale of $5.4 million and $62.6
million during 1995 and 1994, respectively. Operations data for 1995 and
1994 reflects the gains from these transactions. Exclusive of these gains
and related income taxes and profit sharing expense, the Company's income
from continuing operations would have been $30.3 million and $24.0
million during 1995 and 1994, respectively. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Results
of Operations."
(2) Balance sheet data at December 31, 1993 reflects the merger of Berkeley
Federal Savings Company ("Old Berkeley") into the Bank on June 3, 1993,
and operations data for the year ended December 31, 1993 reflects the
operations of Old Berkeley from the date of merger. This transaction was
accounted for using the purchase method of accounting.
(3) The provision for loan losses in 1997 and 1996 consists primarily of
$31.9 million and $20.6 million, respectively, related to the Company's
discount loan portfolio. Beginning in the first quarter of 1996, the
Company began recording general valuation allowances on discount loans.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Results of Operations-Provision for Loan Losses."
(4) Represents a portion of the amounts paid to the Company in connection
with the Company's acquisition of certain mortgage-related securities
which generate taxable income in the first several years of the
instrument's life and tax losses of an equal amount thereafter, but have
minimal or no cash flows. Commencing in 1994, such amounts are deferred
and recognized in interest income on a level yield basis over the
expected life of that portion of the deferred tax asset which relates to
tax residuals.
(5) Relates to the Company's investment in BCBF, L.L.C. (the "LLC"), a 50%
owned joint venture formed between the Bank and BlackRock Capital Finance
("BlackRock") to acquire loans from the Department of Housing and Urban
Development ("HUD") in April 1996.
(6) In September 1995, the Company announced its decision to dispose of its
automated banking division, which was substantially complete at December
31, 1995. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Results of Operations -
Discontinued Operations" and Note 3 to the Consolidated Financial
Statements.
(7) Securities available for sale are carried at market value. Loans
available for sale are carried at the lower of cost or market value.
(8) The discount loan portfolio consists of mortgage loans purchased at a
discount to the unpaid debt, most of which were nonperforming or
subperforming at the date of acquisition. The loan portfolio and loans
available for sale consist of other loans which were originated or
purchased by the Company for investment or for potential sale,
respectively. Data related to discount loans does not include discount
loans held by the LLC.
(9) Real estate owned consists of properties acquired by foreclosure or by
deed-in-lieu thereof on loans and is primarily attributable to the
Company's discount loan acquisition and resolution business.
(10) Reflects the Company's repurchase of 8,815,060 shares of its common stock
during 1995 for an aggregate of $42.0 million.
(11) Includes the Company's pro rata share of the average assets held by the
LLC.
(12) Exclusive of a one-time assessment to recapitalize the Savings
Association Insurance Fund (the "SAIF") in 1996 and of gains from the
sales of branch offices in 1995 and 1994 and related income taxes and
profit sharing expense, (i) return on average assets on income from
continuing operations amounted to 2.54% and 2.00% and 1.40% during 1996,
1995 and 1994, respectively, and (ii) return on average equity on income
from continuing operations amounted to 33.35%, 25.02% and 20.06% during
1996, 1995 and 1994, respectively.
(13) The efficiency ratio represents non-interest expense divided by the sum
of net interest income before provision for loan losses, non-interest
income and equity in earnings of investment in joint venture. Exclusive
of the SAIF assessment in 1996 and gains from the sales of branch offices
in 1995 and 1994 and related profit sharing expense, the efficiency ratio
amounted to 41.33%, 56.34% and 64.14% during 1996, 1995 and 1994,
respectively.
(14) Nonperforming loans and total loans do not include loans in the Company's
discount loan portfolio or loans available for sale.
(15) Relates to the Company's investment in BCFL, L.L.C. ("BCFL"), a limited
liability corporation in which the Company has a 10% interest which was
formed in January 1997 with BlackRock to acquire multi-family residential
loans from HUD, at December 31, 1997 and the LLC at December 31, 1996. At
December 31, 1996, the net discount loans, which were available for sale,
held by the LLC amounted to $110.7 million. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Changes in
Financial Condition - Investment in Joint Ventures."
(16) All per share amounts have been adjusted retroactively to reflect the
10-for-1 stock split in 1996 and the 2-for-1 stock split in 1997. In
addition, all per share amounts have been adjusted for the adoption of
Statement of Financial Accounting Standards No. 128, "Earnings per
share." See Note 23 to the Consolidated Financial Statements.
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion of the Company's consolidated financial condition,
results of operations and capital resources and liquidity should be read in
conjunction with Selected Consolidated Financial Data and the Consolidated
Financial Statements and related notes included elsewhere herein.
Results of Operations
GENERAL. The Company recorded net income of $78.9 million for 1997,
compared with $50.1 million for 1996 and $25.5 million for 1995. Diluted
earnings per share were $1.39 for 1997, as compared with $0.94 for 1996 and
$0.46 for 1995.
The Company has emphasized discount loan acquisition and resolution
activities and a variety of other mortgage lending activities, which generally
reflect the Company's focus on business lines which offer the potential for
greater returns without increased risk of loss. As a result of the Company's
business strategy, the average balance of the Company's discount loan portfolio
(which does not include the Company's pro rata share of discount loans held by
LLC), loan portfolio and loans available for sale have increased as follows:
Year Ended December 31,
---------------------------------------------------------------------------------
1997 1996 1995
----------------------- ------------------------- ------------------------
% of % of % of
Average Average Average Average Average Average
Balance Assets Balance Assets Balance Assets
---------- ----------- ---------- ----------- ----------- -----------
(Dollars in Thousands)
Discount loan portfolio................... $1,283,020 45% $ 675,345 34% $ 483,204 32%
Loan portfolio............................ 410,863 15 328,378 16 130,901 9
Loans available for sale.................. 171,837 6 175,078 9 167,011 11
---------- --- ---------- --- ---------- ---
$1,865,720 66% $1,178,801 59% $ 781,116 52%
========== === ========== === ========== ===
This growth in the Company's lending activities, particularly its discount
loan activities, has substantially contributed to the Company's profitability in
recent periods. In this regard, the Company estimates that its discount loan
acquisition and resolution activities, which includes the single family, large
commercial and small commercial business lines, accounted for approximately 65%,
64% and 75% of its net income during the years ended December 31, 1997, 1996 and
1995, respectively.
The Company's discount loan activities also include investments in joint
ventures to acquire discount loans, which to date have consisted primarily of
the Company's 50% interest in the LLC. Equity in earnings of investment in joint
ventures amounted to $23.7 million and $38.3 million during the years ended
December 31, 1997 and 1996, respectively, and were primarily comprised of $14.0
million and $35.6 million of gains related to the securitization of discount
single family residential loans acquired from HUD, respectively. See "Changes In
Financial Condition -- Investment in Joint Ventures."
The Company currently anticipates that the available current and future
supply of discount loans is sufficient to support the Company's operational
needs, but this is not a certainty and could change as a result of a variety of
factors which bear on market availability.
The Company's lending activities and increasing use of securitizations have
resulted in gains on the sale of interest-earning assets becoming a significant
part of the Company's operating results. Gains from the sale of interest-earning
assets amounted to $82.2 million, $21.7 and $7.0 million during the years ended
December 31, 1997, 1996 and 1995, respectively. A significant component of these
gains in 1997 and 1996 (approximately $71.9 million and $15.2 million,
respectively) were gains from the securitization of discount loans and subprime
single family residential loans.
The Company's operating results in 1995 were significantly affected by the
effects of the sale of branch offices at the end of 1995 and 1994, which
resulted in $5.4 million and $62.6 million of gains before profit sharing
expense and income taxes during these respective periods. As a result of these
sales, the Company's average assets decreased during 1995 and the Company's
principal source of deposits shifted to brokered and other wholesale deposits.
The Company's operating results during 1995 were also affected by losses from
discontinued operations of its automated banking division and related
activities, which, net of the applicable tax effect, amounted to $7.7 million.
NET INTEREST INCOME. The operations of the Company are substantially
dependent on its net interest income, which is the difference between the
interest income received from its interest-earning assets and the interest
expense paid on its interest-bearing liabilities. Net interest income is
determined by an institution's net interest spread (i.e., the difference between
the yield earned on its interest-earning assets and the rates paid on its
interest-bearing liabilities), the relative amount of interest-earning assets
and interest-bearing liabilities and the degree of mismatch in the maturity and
repricing characteristics of its interest-earning assets and interest-bearing
liabilities.
The following table sets forth, for the periods indicated, information
regarding the total amount of income from interest-earning assets and the
resultant average yields, the interest expense associated with interest-bearing
liabilities, expressed in dollars and rates, and the net interest spread and net
interest margin. Information is based on average daily balances during the
indicated periods.
4
Year Ended December 31,
--------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------- ----------------------------- ----------------------------
Average Average Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate Balance Interest Yield/Rate
---------- --------- ---------- -------- -------- ---------- -------- --------- ----------
(Dollars in Thousands)
Average Assets:
Federal funds sold and
repurchase agreements.............. $ 163,671 $ 8,959 5.47% $ 84,997 $ 4,681 5.51% $ 55,256 $ 3,502 6.34%
Securities held for trading........... 3,295 248 7.53 21,291 1,216 5.71 -- -- --
Securities available for sale(1)...... 299,558 28,545 9.53 284,433 26,932 9.47 211,559 18,391 8.69
Loans available for sale(2)........... 171,837 18,368 10.69 175,078 17,092 9.76 167,011 15,608 9.35
Investment securities and other(3).... 36,905 4,061 11.00 36,264 3,990 11.00 46,440 4,033 8.68
Mortgage-related securities
held for investment................ -- -- -- -- -- -- 77,257 4,313 5.58
Loan portfolio (1).................... 410,863 54,701 13.31 328,378 36,818 11.21 130,901 15,430 11.79
Discount loan portfolio .............. 1,283,020 157,649 12.29 675,345 103,165 15.28 483,204 75,998 15.73
---------- --------- ---------- --------- ---------- ---------
Total interest earning assets,
interest income.................. 2,369,149 272,531 11.50 1,605,786 193,894 12.07 1,171,628 137,275 11.72
--------- --------- ---------
Non-interest earning cash............. 14,843 6,372 17,715
Allowance for loan losses............. (22,001) (11,250) (1,180)
Investment in low-income
housing tax credit interests ...... 96,096 83,110 63,925
Investment in joint ventures.......... 34,777 46,193 --
Real estate owned..................... 131,007 137,250 144,348
Other assets.......................... 211,643 145,822 124,932
---------- ----------- ----------
Total assets....................... $2,835,514 $ 2,013,283 $1,521,368
========== =========== ==========
Average Liabilities and
Stockholders' Equity:
Interest-bearing demand deposits...... $ 31,719 1,220 3.85 $ 33,167 620 1.87 $ 31,373 1,031 3.29
Savings deposits...................... 2,121 49 2.31 3,394 78 2.30 20,370 451 2.21
Certificates of deposit............... 1,964,351 120,801 6.15 1,481,197 93,075 6.28 1,119,836 70,371 6.28
---------- --------- ----------- --------- ---------- ---------
Total interest-bearing deposits....... 1,998,191 122,070 6.11 1,517,758 93,773 6.18 1,171,579 71,853 6.13
Securities sold under agreements
to repurchase...................... 16,717 1,000 5.98 19,581 1,101 5.62 16,754 951 5.68
Securities sold but not yet purchased. -- -- -- -- -- -- 17,149 1,142 6.66
Advances from the Federal Home
Loan Bank ......................... 9,482 518 5.46 71,221 4,053 5.69 14,866 1,126 7.57
Obligations outstanding under lines
of credit ......................... 84,272 5,578 6.62 -- -- -- -- -- --
Notes, debentures and other
interest bearing obligations....... 228,233 27,123 11.88 148,282 17,233 11.62 78,718 8,988 11.42
---------- --------- ----------- --------- ---------- ---------
Total interest-bearing liabilities,
interest expense................. 2,336,895 156,289 6.69 1,756,842 116,160 6.61 1,299,066 84,060 6.47
--------- --------- ---------
Non-interest bearing deposits......... 23,224 10,938 19,960
Escrow deposits....................... 78,986 41,306 4,073
Other liabilities .................... 106,379 42,865 76,978
---------- ----------- ----------
Total liabilities.................. 2,545,484 1,851,951 1,400,077
Stockholders' equity ................. 290,030 161,332 121,291
---------- ----------- ----------
Total liabilities and
stockholders' equity ............ $2,835,514 $ 2,013,283 $1,521,368
========== =========== ==========
Net interest income................... $ 116,242 $ 77,734 $ 53,215
========= ========= ========
Net interest spread................... 4.81% 5.46% 5.25%
======= ========= ========
Net interest margin................... 4.91% 4.84% 4.54%
======= ========= ========
Ratio of interest-earning assets
to interest-bearing liabilities ... 101% 91% 90%
========== ============ ==========
- -------------------
(1) Excludes effect of unrealized gains or losses on securities available for
sale, net of taxes.
(2) The average balances of loans available for sale and the loan portfolio
include nonperforming loans, interest on which is recognized on a cash
basis.
(3) Interest income from investment securities and other includes interest
income attributable to that portion of the Company's deferred tax asset
which relates to tax residuals. See Note 21 to the Consolidated Financial
Statements. If the average balance of the deferred tax asset related to
tax residuals was included in the average balance of investment securities
and other, the weighted average yield would have been 10.88%, 7.34% and
5.93% during 1997, 1996 and 1995, respectively.
5
The following table describes the extent to which changes in interest rates
and changes in volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and expense during the
periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (change in volume multiplied by prior rate), (ii) changes
in rate (change in rate multiplied by prior volume) and (iii) total change in
rate and volume. Changes attributable to both volume and rate have been
allocated proportionately to the change due to volume and the change due to
rate.
Year Ended December 31,
--------------------------------------------------------------------
1997 vs. 1996 1996 vs. 1995
-------------------------------- --------------------------------
Increase (Decrease) Due To Increase (Decrease) Due To
-------------------------------- --------------------------------
Rate Volume Total Rate Volume Total
-------- -------- -------- -------- -------- --------
(Dollars in Thousands)
Interest-Earning Assets:
Federal funds sold and
repurchase agreements .................... $ (29) $ 4,307 $ 4,278 $ (507) $ 1,686 $ 1,179
Securities available for sale ............... 173 1,440 1,613 1,757 6,784 8,541
Securities held for trading ................. 297 (1,265) (968) 608 608 1,216
Loans available for sale .................... 1,597 (321) 1,276 713 771 1,484
Mortgage-related securities held
for investment ........................... -- -- -- -- (4,313) (4,313)
Loan portfolio .............................. 7,642 10,241 17,883 (788) 22,176 21,388
Discount loan portfolio ..................... (23,426) 77,910 54,484 (2,235) 29,402 27,167
Investment securities and other ............. -- 71 71 947 (990) (43)
-------- -------- -------- -------- -------- --------
Total interest-earning assets ............ (13,746) 92,383 78,637 495 56,124 56,619
-------- -------- -------- -------- -------- --------
Interest-Bearing Liabilities:
Interest-bearing demand deposits ............ 628 (28) 600 (467) 56 (411)
Savings deposits ............................ -- (29) (29) 17 (390) (373)
Certificates of deposit ..................... (2,026) 29,752 27,726 (3) 22,707 22,704
-------- -------- -------- -------- -------- --------
Total interest-bearing deposits .......... (1,398) 29,695 28,297 (453) 22,373 21,920
Securities sold under agreements
to repurchase ............................ 67 (168) (101) (9) 159 150
Securities sold but not yet purchased ....... -- -- -- -- (1,142) (1,142)
Advances from the Federal Home Loan Bank .... (156) (3,379) (3,535) (345) 3,272 2,927
Obligations outstanding under lines of credit -- 5,578 5,578 -- -- --
Notes, debentures and other interest
bearing obligations ...................... 397 9,493 9,890 163 8,082 8,245
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities ....... (1,090) 41,219 40,129 (644) 32,744 32,100
-------- -------- -------- -------- -------- --------
Increase (decrease) in net interest income .. $(12,656) $ 51,164 $ 38,508 $ 1,139 $ 23,380 $ 24,519
======== ======== ======== ======== ======== ========
1997 VERSUS 1996
The Company's net interest income before provision for loan losses of
$116.2 million increased $38.5 million or 50% during 1997 as compared to the
prior year. This increase resulted from a $78.6 million or 41% increase in
interest income due to a $763.4 million or 48% increase in average
interest-earning assets during 1997, offset in part by a 57 basis point decrease
in the weighted average yield earned. The increase in interest income was offset
in part by a $40.1 million or 35% increase in interest expense due to a $580.1
million or 33% increase in the Company's average interest-bearing liabilities.
Interest income on the discount loan portfolio increased by $54.5 million
or 53% in 1997 versus 1996 as a result of a $607.7 million or 90% increase in
the average balance of the discount loan portfolio, which was offset in part by
a 299 basis point decrease in the weighted average yield earned. The decline in
the yield during 1997, as compared to 1996, is primarily attributable to an
increase in the average balance of single family discount loans as a result of
acquisitions from HUD and the Company's decision to cease accretion of discount
on nonperforming single family residential discount loans effective January 1,
1997. Discount accretion on nonperforming single family discount loans amounted
to $4.6 million or 69 basis points in yield during 1996. The Company believes
that the yield earned on its single family residential discount loan portfolio
in 1997 remained below
6
the yield earned in the prior year also due to its current strategy of
attempting to work with borrowers to either (i) bring their loans current, (ii)
modify the terms of their loans, (iii) enter into forbearance agreements that
require the borrower to make monthly payments greater than or equal to scheduled
payment amounts or (iv) refinance the loans with the Company. This resolution
strategy results in lower initial yields as compared to borrowers paying off
their loans in full or in part and, to the extent the loans are ultimately sold,
will result in a significant portion of the earnings being reflected in gains on
sales of interest earning assets. In addition, the majority of the single family
HUD loans acquired by the Company in February and September 1997 are currently
under a HUD forbearance plan whereby the borrower makes payments based upon
ability to pay for a specific period of time, which generally results in a lower
effective yield than the contract rate. Once this period is over the borrower
must make at least its contractual mortgage payment or the Company can pursue
foreclosure or other actions. The yield on the overall discount loan portfolio
is also likely to continue to fluctuate from year to year as a result of the
timing of resolutions, particularly the resolution of large multifamily
residential and commercial real estate loans, and the mix of the overall
portfolio between paying and nonpaying loans.
Interest income on the loan portfolio increased by $17.9 million or 49% in
1997 from 1996 primarily due to $12.3 million of additional interest received in
connection with the payoff of ten loans secured by hotel and office properties
and, to a lesser extent, an increase in the average balance of the loan
portfolio for 1997 of $82.5 million or 25% over that of 1996.
Interest income on federal funds sold and repurchase agreements increased
$4.3 million or 91% during 1997 as compared to 1996 primarily as a result of a
$78.7 million or 93% increase in the average balance.
Interest expense on deposits increased $28.3 million or 30% during 1997 as
compared to 1996, and reflects the Company's continued use of certificates of
deposit to fund its asset growth. The average amount of the Company's
certificates of deposits increased from $1.48 billion during 1996 to $1.96
billion during 1997.
Interest expense on notes, debentures and other interest-bearing
obligations increased by $9.9 million or 57% during 1997 as compared to 1996
primarily due to the issuance of $125.0 million of 11.875% Notes (the "Notes")
in September 1996.
Also contributing to the increase in interest expense during 1997 is the
interest expense on lines of credit established at Ocwen Financial Services,
Inc. ("OFS") (see "Changes in Financial Condition - Obligations Outstanding
Under Lines of Credit"), which amounted to $5.6 million during 1997, as compared
to $0 during 1996 and 1995. OFS, a recently formed, 93.7% owned subsidiary of
the Company, acquired substantially all of the assets of Admiral Home Loan
("Admiral"), the Company's primary correspondent mortgage banking firm for
subprime single family loans.
1996 VERSUS 1995
The Company's net interest income before provision for loan losses
increased by $24.5 million or 46.1% during 1996, as compared to the prior year.
This increase resulted from a $56.6 million or 41% increase in interest income
due to a $434.2 million or 37% increase in average interest-earning assets and,
to a lesser extent, a 35 basis point increase in the weighted average yield on
such assets. The increase in interest income was offset in part by a $32.1
million or 38% increase in interest expense due to a $457.8 million or 35%
increase in average interest-bearing liabilities, primarily certificates of
deposit, Federal Home Loan Bank ("FHLB") advances, notes and debentures, and to
a lesser extent, a 14 basis point increase in the weighted average rate paid on
interest-bearing liabilities. The Company's net interest margin increased to
4.84% in 1996 from 4.54% in 1995.
The increase in interest income during 1996, as compared to the prior year,
reflects substantial increases in the average balances of the discount loan
portfolio, loan portfolio and securities available for sale. Beginning in 1996,
adjustments to reduce the carrying value of discount loans to the fair value of
the property securing the loan are charged against the allowance for loan losses
on the discount loan portfolio. Prior to 1996, such adjustments were charged
against interest income on discount loans. Had charge-offs on discount loans
been included as a reduction of interest income in 1996, the weighted average
yield on the discount loan portfolio would have been 13.9%.
The average balance of the Company's interest-bearing liabilities increased
substantially during 1996, as compared to the prior year, as a result of a
$361.4 million or 32% increase in the average balance of certificates of
deposit, a $56.4 million or 379% increase in the average balance of FHLB
advances and a $69.6 million or 88% increase in the average balance of notes and
debentures, which reflect the Company's reliance on brokered and other wholesale
certificates of deposit and advances from the FHLB as a source of funds, the
Company's issuance of the Notes in September 1996 and the Bank's issuance of 12%
Subordinated Debentures (the "Debentures") in June 1995, respectively.
PROVISIONS FOR LOAN LOSSES. Provisions for losses on loans are charged to
operations to maintain an allowance for losses on both the loan portfolio and
the discount loan portfolio at a level which management considers adequate based
upon an evaluation of known and inherent risks in such loan portfolios.
Management's periodic evaluation is based on an analysis of both the discount
loan portfolio and the loan portfolio, historical loss experience, current
economic conditions and other relevant factors.
Provisions for loan losses amounted to $32.2 million, $22.5 million and
$1.1 million during the years ended December 31, 1997, 1996 and 1995,
respectively. The increase in provisions for loan losses in 1997 was largely due
to an $11.3 million increase in the provision for losses on the discount loan
portfolio, which occurred primarily as a result of a $607.7 million or 90%
increase in the average balance of the discount loan portfolio during 1997 as
compared to 1996. The increase in provisions for losses in 1996 was primarily
attributable to a change in methodology for valuing discount loans, which was
adopted by the Company effective January 1, 1996. Pursuant to this change in
methodology, the Company establishes provisions for losses on discount loans as
7
necessary to maintain an allowance for losses at a level which management
believes reflects the inherent losses which may have occurred but have not yet
been specifically identified, and records all charge-offs on the discount loan
portfolio, net of recoveries, against the allowance for losses on discount
loans. Prior to 1996, provisions for losses on loans were not established in
connection with the discount loan portfolio because adjustments to reduce the
carrying value of discount loans to the lower of amortized cost or the fair
market value of the properties securing the loans discounted at the effective
interest rate, which amounted to $5.0 million in 1995, were recorded in interest
income on discount loans. Provisions for losses on the discount loan portfolio
amounted to $31.9 million and $20.6 million during 1997 and 1996, respectively,
and net charge-offs on the discount loan portfolio amounted to $20.3 million and
$9.2 million during the same respective years.
Provisions for losses on the loan portfolio amounted to $325,000, $1.9
million and $1.1 million during the years ended December 31, 1997, 1996 and
1995, respectively. Net charge-offs on the loan portfolio amounted to $153,000,
$296,000 and $245,000 during the years ended December 31, 1997, 1996 and 1995,
respectively.
Although management utilizes its best judgment in providing for possible
loan losses, there can be no assurance that the Company will not increase its
provisions for possible loan losses in subsequent periods. Changing economic and
business conditions, fluctuations in local markets for real estate, future
changes in nonperforming asset trends, material upward movements in market
interest rates or other factors could affect the Company's future provisions for
loan losses. In addition, the Office of Thrift Supervision ("OTS"), as an
integral part of its examination process, periodically reviews the adequacy of
the Company's allowance for losses on loans and discount loans and as a result,
may require the Company to recognize changes to such allowances for losses based
on its judgment about information available to it at the time of examination.
NON-INTEREST INCOME. Non-interest income increased $86.6 million or 232% in
1997 as compared to 1996. Exclusive of the $5.4 million gain from the sale of
branch offices in 1995, non-interest income increased by $11.5 million or 45% in
1996. The increase in non-interest income during 1997 was primarily attributable
to gains from the sale of interest-earning assets and servicing fees and other
charges. The increase in non-interest income during 1996 was primarily due to
gains from the sale of interest-earning assets.
The following table sets forth the principal components of the Company's
non-interest income during the years indicated.
Year Ended December 31,
-------------------------------------
1997 1996 1995
--------- --------- ---------
(Dollars in Thousands)
--------- --------- ---------
Servicing fees and other charges.............................. $ 25,881 $ 4,682 $ 2,870
Gains on sales of interest-earning assets, net................ 82,212 21,682 6,916
Income on real estate owned, net.............................. 7,277 3,827 9,540
Other income.................................................. 8,498 7,112 6,385
--------- --------- ---------
Subtotal.................................................... 123,868 37,303 25,711
Gain from sale of branch offices.............................. -- -- 5,430
--------- --------- ---------
Total....................................................... $ 123,868 $ 37,303 $ 31,141
========= ========= =========
Servicing fees and other charges increased in 1997 and 1996 primarily as a
result of increases in loan servicing and related fees as a result of the
Company's increase in loans (primarily subprime and nonperforming) serviced for
others. During 1997 and 1996, the average unpaid principal balance of loans
serviced for others amounted to $3.11 billion and $887.9 million, respectively.
The following table sets forth the Company's loans serviced for others at
December 31, 1997 and 1996.
December 31, 1997
----------------------------------------------------------------------------------------
Discount Loans Subprime Loans Other Loans Total
------------------- -------------------- --------------------- -------------------
No. of No. of No. of No. of
Amount Loans Amount Loans Amount Loans Amount Loans
---------- -------- ---------- ------- ---------- -------- ---------- -------
(Dollars in Thousands)
Loans securitized and sold with recourse.. $ 624,591 11,148 $ 555,914 4,976 $ -- -- $1,180,505 16,124
Loans serviced for third parties ......... 1,682,764 23,181 2,352,352 29,911 294,198 1,092 4,329,314 54,184
---------- -------- ---------- ------- ---------- -------- ---------- --------
$2,307,355 34,329 $2,908,266 34,887 $ 294,198 1,092 $5,509,819 70,308
========== ======== ========== ======= ========== ======== ========== ========
December 31, 1996
----------------------------------------------------------------------------------------
Discount Loans Subprime Loans Other Loans Total
------------------- -------------------- --------------------- -------------------
No. of No. of No. of No. of
Amount Loans Amount Loans Amount Loans Amount Loans
---------- -------- ---------- ------- ---------- -------- ---------- --------
(Dollars in Thousands)
Loans securitized and sold with recourse.. $ 204,586 4,796 $ 202,766 1,879 $ -- -- $ 407,352 6,675
Loans serviced for third parties ......... 1,209,535 22,511 6,784 60 294,427 917 1,510,746 23,488
---------- -------- ---------- ------- ---------- -------- ---------- --------
$1,414,121 27,307 $ 209,550 1,939 $ 294,427 917 $1,918,098 30,163
========== ======== ========== ======= ========== ======== ========== ========
8
Net gains on sales of interest-earning assets in 1997 were primarily
comprised of $71.9 million of net gains recognized in connection with the
securitization of single family subprime loans, single family discount loans and
small commercial discount loans, as presented in the table below. Additionally,
the Company recorded a $2.6 million gain on the sale of mortgage-related
securities to OAIC, $2.7 million of gains from the sales of single family
subprime loans and $3.5 million of gains from sales of certain large commercial
loans in the Company's discount loan portfolio.
Net gains on sales of interest-earning assets in 1996 were primarily
comprised of a $5.4 million gain from the sale of 256 single family loans in the
Company's discount loan portfolio which had been brought current in accordance
with their terms, a $4.5 million gain from the sale of discount commercial real
estate loans and, as presented in the table below, $15.2 million of net gains in
connection with the securitization of single family subprime loans and large
discount commercial real estate loans.
Net gains on sales of interest-earning assets in 1995 were primarily
comprised of a $6.0 million gain from the sale of loans in the Company's
discount loan portfolio which had been brought current in accordance with their
terms and, as presented in the table below, a $1.6 million gain in connection
with the securitization of multi-family residential loans.
The following table sets forth the Company's net gains recognized in
connection with the securitization of loans during 1997, 1996 and 1995.
Loans Securitized
- ------------------------------------------------------------------------------------
Book Value of
Type of Loans Principal No. of Loans Securities Retained (1) Net Gain
- -------------------------------------------- --------------- -------------- ----------------------- --------------
1997:
Single family discount...................... $ 418,795 6,295 $ 20,635 $ 51,137
Single family subprime...................... 415,830 3,640 25,334 18,802
Small commercial discount................... 62,733 302 4,134 1,994
---------- -------- ---------- ---------
$ 897,358 10,237 $ 50,103 $ 71,933
========== ======== ========== =========
1996:
Large commercial discount................... $ 164,417 25 $ 8,384 $ 7,929
Single family subprime...................... 211,204 1,180 18,236 7,232
---------- -------- ---------- ---------
$ 375,621 1,205 $ 26,620 $ 15,161
---------- -------- ---------- ---------
1995:
Multi-family................................ $ 83,875 25 $ -- $ 1,606
========== ======== ========== =========
- -------------------
(1) Consists of subordinated and/or residual securities resulting from the
Company's securitization activities, which had a carrying value of $78.5
million at December 31, 1997.
Gains on sale of interest-earning assets (as well as other assets, such as
real estate owned, as discussed below) generally are dependent on various
factors which are not necessarily within the control of the Company, including
market and economic conditions. As a result, there can be no assurance that the
gains on sale of interest-earning assets (and other assets) reported by the
Company in prior periods will be reported in future periods or that there will
not be substantial inter-period variations in the results from such activities.
The following table sets forth the results of the Company's real estate
owned (which does not include investments in real estate, as discussed below)
during the years indicated, which were primarily related to the discount loan
portfolio.
Year Ended December 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(Dollars in Thousands)
Gains on sales ...................... $ 30,651 $ 22,835 $ 19,006
Provision for losses in fair value... (13,450) (18,360) (10,510)
Rental income (carrying costs), net.. (9,924) (648) 1,044
-------- -------- --------
Income on real estate owned, net..... $ 7,277 $ 3,827 $ 9,540
======== ======== ========
For additional information relating to the Company's real estate owned, see
"Changes in Financial Condition - Real Estate Owned."
Other income for 1997 and 1996 included gains in the amount of $6.3 million
and $4.9 million, respectively, realized in connection with the sale of certain
of the Company's investments in low-income housing tax credit projects. See
"Changes in Financial Condition - Investments in Low-Income Housing Tax Credit
Interests." Other income for 1995 includes a $4.7 million gain realized on the
sale of one of the two hotels owned by the Company. A 69% partnership interest
in the second hotel was sold in 1997 for a minimal gain. See "Changes in
Financial Condition - Investment in Real Estate."
The Company realized a $5.4 million gain from the sale of two branch
offices and $111.7 million of related deposits at the end of 1995 and a $62.6
million gain from the sale of twenty-three branch offices and $909.3 million of
related deposits at the end of
9
1994. The Company sold these branch offices and the related deposit liabilities
because of the premiums which could be obtained for such deposits under existing
market and economic conditions and because the Company believed that it could
replace these deposits with other sources of funds, such as brokered and other
wholesale deposits, FHLB advances and reverse repurchase agreements, which
management generally believes have an effective cost to the Company which is
more attractive than the deposits obtained from branch offices after the general
and administrative expense associated with such offices is taken into account.
NON-INTEREST EXPENSE. Non-interest expense increased $57.2 million or 82%
during 1997 and $24.0 million or 53% during 1996. The increase in non-interest
expense in 1997 was primarily attributable to an increase of 474 in the average
number of employees which resulted in a $38.5 million or 99% increase in
compensation and employee benefits, an $8.7 million or 98% increase in occupancy
and equipment expense and an $11.8 million or 79% increase in other operating
expenses. The increase in non-interest expense in 1996 was primarily related to
a $14.2 million or 57% increase in employee compensation and benefits and the
SAIF assessment of $7.1 million.
The following table sets forth the principal components of the Company's
non-interest expense during the periods indicated.
Year Ended December 31,
-------------------------------
1997 1996 1995
-------- -------- --------
(Dollars in Thousands)
Compensation and employee benefits ............ $ 77,573 $ 39,043 $ 24,797
Occupancy and equipment ....................... 17,657 8,921 8,360
Net operating loss (income) on investment
in real estate and certain low-income housing
tax credit interests ........................ 4,792 (425) 337
SAIF assessment ............................... -- 7,140 --
Other operating expenses ...................... 26,771 14,927 12,079
-------- -------- --------
Total ....................................... $126,793 $ 69,606 $ 45,573
======== ======== ========
The increases in compensation and employee benefits in 1997 and 1996
reflect an increase in the average number of employees from 344 during 1995 to
398 during 1996 to 872 during 1997. In addition, profit sharing expense
increased by $8.6 million and $8.4 million during 1997 and 1996, respectively.
The increase in occupancy and equipment expense of $8.7 million in 1997 was
primarily related to a $3.4 million increase in general office and equipment
expenses, a $3.1 million increase in data processing costs and a $1.3 million
increase in rent expense, all largely attributable to the increase in leased
loan and production office space and to the increase in the number of full-time
employees discussed above.
Other operating expenses increased by $11.8 million in 1997, primarily as a
result of a $2.9 million increase in loan related expenses (primarily as a
result of the Company's increased investment in loans), a $2.6 million increase
in professional fees, a $1.4 million increase in due diligence costs, a $1.4
million reserve established on a receivable and $1.1 million of certain other
one-time charges offset in part by a $1.5 million decline in FDIC insurance
premiums (primarily due to a reduction in assessment rates as a result of the
recapitalization of the SAIF in 1996). See Note 25 to the Consolidated Financial
Statements for a disclosure of the components of other operating expenses.
DISTRIBUTIONS ON COMPANY-OBLIGATED, MANDATORILY REDEEMABLE SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES OF THE COMPANY.
In August 1997, Ocwen Capital Trust I ("OCT"), a wholly-owned subsidiary of the
Company, issued $125.0 million of 10 7/8% Capital Securities. Cash distributions
on the Capital Securities accrue from the date of original issuance and are
payable semi-annually in arrears on February 1 and August 1 of each year,
commencing on February 1, 1998, at an annual rate of 10 7/8% of the liquidation
amount of $1,000 per Capital Security. Through December 31, 1997, the Company
has accrued $5.2 million of distributions payable to holders of the Capital
Securities. See Note 18 to the Consolidated Financial Statements and "Changes in
Financial Condition - Company-Obligated, Mandatorily Redeemable Securities of
Subsidiary Trust Holding Solely Junior Subordinated Debentures of the Company."
EQUITY IN EARNINGS OF INVESTMENT IN JOINT VENTURE. Equity in earnings of
investment in joint venture relates to the LLC. The Company's $23.7 million of
earnings from the LLC during 1997 consisted of 50% of the net income of the LLC
before deduction of the Company's 50% share of loan servicing fees, which are
paid 100% to the Company, and the recapture of $5.1 million of valuation
allowances established in 1996 by the Company on its equity investment in the
LLC as a result of the resolution and securitization of loans. The Company's 50%
pro rata share of the LLC's income during 1997 consisted primarily of $4.5
million of interest income on discount loans and $14.0 million of gains on the
sale of discount loans, including the securitizations of HUD loans in March and
December of 1997. All of the assets of the LLC were distributed at the end of
1997.
The Company's equity in earnings of LLC amounted to $38.3 million in 1996
and included 50% of the net income of the LLC before deduction of the Company's
50% share of loan servicing fees, which are paid 100% to the Company, 50% of the
gain on sale of loan servicing rights which the Company acquired from the LLC,
$7.6 million in provision for losses on the equity investment in the LLC and a
$460,000 gain on sale of future contracts used to hedge the loans securitized.
The Company's 50% pro rata share of the LLC's income in 1996 consisted primarily
of $10.1 million of net interest income on discount loans and $35.6 million of
gains on sales of discount loans. The Company has recognized 50% of the loan
servicing fees not eliminated in consolidation in
10
servicing fees and other charges. See "Changes in Financial Condition -
Investment in Joint Ventures" and Note 2 to the Consolidated Financial
Statements.
INCOME TAX EXPENSE. Income tax expense on the Company's income from
continuing operations amounted to $21.3 million, $11.2 million and $4.6 million
during 1997, 1996 and 1995, respectively. The Company's effective tax rate
amounted to 21.4%, 18.2% and 12.1% during 1997, 1996 and 1995, respectively. The
Company's low effective tax rates in 1997, 1996 and 1995 were primarily
attributable to the tax credits resulting from the Company's investment in
low-income housing tax credit interests, which amounted to $14.9 million, $9.3
million and $7.7 million during 1997, 1996 and 1995, respectively. Exclusive of
the above amounts, the Company's effective tax rate amounted to 36.4%, 33.4% and
32.6% during 1997, 1996 and 1995, respectively. See "Changes in Financial
Condition - Investments in Low Income Housing Tax Credit Interests."
DISCONTINUED OPERATIONS. In September 1995, the Company announced its
decision to dispose of its automated banking division, which generally
emphasized the installation of automated teller machines and automated banking
centers in a wide variety of locations which were not associated with branch
offices of the Company, as well as the development and installation of an
automated multi-application card system for the distribution of financial
products and services to members of a college or university population. As a
result of this decision, an after-tax loss on disposal of $3.2 million was
recorded, which consisted of a net loss of $2.0 million on the sale of assets
and a loss of $1.2 million incurred from related operations until the sale and
disposition, which was substantially completed at December 31, 1995. Losses from
the operations of the discontinued division prior to discontinuance, net of tax,
amounted to $4.5 million during 1995. See Note 3 to the Consolidated Financial
Statements.
11
CHANGES IN FINANCIAL CONDITION
The following table sets forth information relating to certain of the
Company's assets and liabilities at the dates indicated.
December 31, Increase (Decrease)
------------------------------- ----------------------------
1997 1996 Dollars Percent
----------- ----------- ---------- -----------
(Dollars in Thousands)
ASSETS:
Securities held for trading.................... $ -- $ 75,606 $ (75,606) (100)%
Securities available for sale.................. 430,524 354,005 76,519 22
Loans available for sale....................... 177,041 126,366 50,675 40
Loan portfolio, net............................ 266,299 402,582 (136,283) (34)
Discount loan portfolio, net................... 1,434,176 1,060,953 373,223 35
Investment in low-income housing
tax credit interests......................... 128,614 93,309 35,305 38
Investment in joint ventures................... 1,056 67,909 (66,853) (98)
Real estate owned, net......................... 167,265 103,704 63,561 61
Investment in real estate...................... 65,972 41,033 24,939 61
Deferred tax asset............................. 45,148 5,860 39,288 670
Total assets................................... 3,069,165 2,483,685 585,480 24
LIABILITIES:
Deposits....................................... 1,982,822 1,919,742 63,080 3
Securities sold under agreements
to repurchase................................ 108,250 74,546 33,704 45
Notes, debentures and other.................... 226,975 225,573 1,402 1
Obligations outstanding under lines of credit.. 118,304 -- 118,304 --
Capital securities............................. 125,000 -- 125,000 --
Total liabilities.............................. 2,523,430 2,280,089 243,341 11
Stockholders' equity........................... 419,692 203,596 216,096 106
SECURITIES HELD FOR TRADING. The Company held $75.6 million in single
family collateralized mortgage obligations ("CMO") for trading at December 31,
1996. This security, which was sold in January 1997, was acquired from the LLC
in connection with the LLC's securitization of a portion of the HUD Loans. See
"Investment in Joint Ventures" and Note 2 to the Consolidated Financial
Statements.
SECURITIES AVAILABLE FOR SALE. Securities available for sale increased by
$76.5 million or 22% during 1997 primarily as a result of the purchase of $196.2
million of interest only securities ("IO"), $175.4 million of CMOs and the
acquisition of $50.1 million of subordinate securities. All of the subordinate
securities were acquired in connection with the Company's securitization of
loans. These acquisitions were offset in part by the repayment of $43.2 million
of CMOs, the sale of $122.0 million, $44.2 million and $37.2 million of IOs,
CMOs and multi-family subordinates, respectively, $59.2 million of net premium
amortization on IOs and a $25.0 million increase in net unrealized losses. See
Note 6 to the Consolidated Financial Statements.
LOANS AVAILABLE FOR SALE. Loans available for sale, which are comprised
primarily of subprime single family residential loans, increased by $50.7
million or 40% during 1997. The increase in 1997 occurred primarily as a result
of purchases and originations of $594.2 million of single family residential
loans, offset in part by sales of $501.1 million and principal repayments of
$22.2 million of such loans. Of the single family loans sold during 1997, $415.8
million were due to the Company's securitization of such loans.
At December 31, 1997, nonperforming loans available for sale amounted to
$13.5 million or 7.6% of total loans available for sale, as compared to $14.4
million or 11.4% at December 31, 1996. Nonperforming loans available for sale
consist primarily of subprime single family residential loans, reflecting the
higher risks associated with such loans. During 1997 and 1996, respectively, the
Company recorded a $2.1 million and $1.6 million reduction in the carrying value
of these loans to record them at the lower of cost or fair market value.
LOAN PORTFOLIO, NET. The Company's net loan portfolio decreased by $136.3
million or 34% during 1997 primarily as a result of significant payoffs of
commercial real estate loans secured by hotel and office buildings. From
December 31, 1996 to December 31, 1997, commercial real estate and land loans
decreased by $180.0 million, including a $110.9 million and a $60.0 million
decrease in loans secured by hotels and office buildings, respectively.
Nonperforming loans amounted to $9.2 million or 3.4% of total loans at
December 31, 1997, as compared to $2.3 million or 0.6% of total loans at
December 31, 1996. At December 31, 1997, nonperforming loans consisted primarily
of $7.6 million of multi-family residential loans. The Company's allowance for
loan losses amounted to 40.4% and 154.2% of nonperforming loans at December 31,
1997 and 1996, respectively. See Note 8 to the Consolidated Financial
Statements.
12
DISCOUNT LOAN PORTFOLIO, NET. The discount loan portfolio increased $373.2
million or 35% during 1997. During 1997, discount loan acquisitions having an
unpaid principal balance of $1.78 billion, which included $771.6 million of
single family residential loans acquired from HUD, more than offset $484.9
million of resolutions and repayments, $292.4 million of transfers to real
estate owned and $518.9 million of sales. Of the discount loans sold during
1997, $416.5 million were due to the Company's securitization of performing
discount loans. See Note 9 to the Consolidated Financial Statements.
At December 31, 1997, discount loans which were performing in accordance
with original or modified terms amounted to $1.01 billion or 56.4% of the gross
discount loan portfolio, as compared to $579.6 million or 44.1% at December 31,
1996. The Company's allowance for losses on its discount loan portfolio amounted
to $23.5 million or 1.6% at December 31, 1997, as compared to $11.5 million or
1.1% at December 31, 1996. The Company did not maintain an allowance for losses
on its discount loan portfolio prior to 1996.
INVESTMENTS IN LOW-INCOME HOUSING TAX CREDIT INTERESTS. In 1993, the
Company commenced a program to invest in multi-family residential projects which
have been allocated low-income housing tax credits under Section 42 of the
Internal Revenue Code by a state tax credit allocating agency. At December 31,
1997, the Company had $128.6 million of investments in low-income housing tax
credit interests, as compared to $93.3 million at December 31, 1996.
Investments by the Company in low-income housing tax credit interests made
on or after May 18, 1995 in which the Company invests solely as a limited
partner, which amounted to $47.2 million at December 31, 1997, are accounted for
using the equity method in accordance with the consensus of the Emerging Issues
Task Force through Issue Number 94-1. Limited partnership investments made prior
to May 18, 1995, which amounted to $31.4 million at December 31, 1997, are
accounted for under the effective yield method as a reduction of income tax
expense. Low-income housing tax credit partnerships in which the Company invests
as both a limited and, through a subsidiary, a general partner, amounted to
$50.0 million at December 31, 1997 and are presented on a consolidated basis.
See Note 13 to the Consolidated Financial Statements.
INVESTMENT IN JOINT VENTURES. From time to time the Company and a
co-investor acquire discount loans by means of a co-owned joint venture. At
December 31, 1997, the Company's $1.1 million investment in joint venture, net
consisted of a 10% interest in BCFL, a limited liability company which was
formed by the Company and BlackRock in January 1997 to acquire discount
multi-family residential loans from HUD. In December 1997, the LLC distributed
its assets to the Company and its other 50% investor, BlackRock. Simultaneous
with the distribution, the Company acquired BlackRock's portion of the
distributed assets. See Note 2 to the Consolidated Financial Statements.
REAL ESTATE OWNED, NET. Real estate owned, net, consists almost entirely of
properties acquired by foreclosure or deed-in-lieu thereof on loans in the
Company's discount loan portfolio. Such properties amounted to $164.5 million or
98.3% of total real estate owned at December 31, 1997 and consisted of $76.4
million, $16.7 million and $71.3 million of properties attributable to single
family residential loans, multi-family residential loans and commercial real
estate loans, respectively. Real estate owned increased by $63.6 million or 61%
during 1997 as a result of increases in single family and multi-family real
estate owned attributable to the discount loan portfolio.
The Company actively manages its real estate owned. During 1997, the
Company sold 1,521 properties with a carrying value of $179.7 million as
compared to the sale of 1,175 properties with a carrying value of $160.6 million
during 1996 and 1,229 properties with a carrying value of $139.2 million during
1995. These sales resulted in gains, net of the provision for loss, of $17.2
million, $4.5 million and $8.5 million during 1997, 1996 and 1995, respectively,
which are included in determining the Company's income (loss) on real estate
owned. See Note 10 to the Consolidated Financial Statements.
INVESTMENT IN REAL ESTATE. In conjunction with its multi-family residential
and commercial real estate lending business activities, the Company has made
certain acquisition, development and construction loans in which the Company
participates in the expected residual profits of the underlying real estate and
the borrower has not made an equity contribution substantial to the overall
project. As such, the Company accounts for these loans under the equity method
of accounting as though it has made an investment in a real estate limited
partnership. The Company's investment in such loans amounted to $62.0 million at
December 31, 1997, as compared to $24.9 million at December 31, 1996.
The Company also has invested, indirectly, in The Westin Hotel (the
"Westin") located in Columbus, Ohio. The Company's investment in such property
decreased to $1.4 million at December 31, 1997 from $16.1 million at December
31, 1996 primarily as a result of the Company's sale of a 69% partnership
interest in the Westin on July 15, 1997 for a minimal gain.
DEFERRED TAX ASSET. At December 31, 1997, the deferred tax asset, net of
deferred tax liabilities, amounted to $45.1 million, an increase of $39.2
million from the $5.9 million deferred tax asset at December 31, 1996. At
December 31, 1997, the gross deferred tax asset amounted to $49.5 million and
consisted primarily of $3.5 million related to tax residuals, $5.6 million of
gains on loan foreclosures, $3.2 million mark-to-market and reserves on real
estate owned properties, $9.8 million of loan loss reserves, $4.0 million of
reserves on securities available for sale, $2.0 million of contingency reserves,
$3.2 million of accrued profit sharing expense, $7.7 million of deferred
interest expense on the discount loan portfolio and $6.7 million mark-to-market
on securities available for sale. The gross deferred tax liability amounted to
$4.4 million and consisted primarily of $2.3 million of deferred interest income
on the discount loan portfolio. At December 31, 1996, the gross tax asset
amounted to $15.1 million, and consisted primarily of $3.7 million related to
tax residuals, $3.5 million of mark-to-market and reserves on real estate owned
and $3.9 million of deferred interest expense on the discount loan portfolio and
the gross deferred tax liability amounted to $9.2
13
million and consisted primarily of $4.6 million of deferred interest income on
the discount loan portfolio and $2.1 million of mark-to-market on certain
securities available for sale.
As a result of the Company's earnings history, current tax position and
taxable income projections, management believes that the Company will generate
sufficient taxable income in future years to realize the deferred tax asset
which existed at December 31, 1997. In evaluating the expectation of sufficient
future taxable income, management considered future reversals of temporary
differences and available tax planning strategies that could be implemented, if
required. A valuation allowance was not required at December 31, 1997 because it
was management's assessment that, based on available information, it is more
likely than not that all of the deferred tax asset will be realized. A valuation
allowance will be established in the future to the extent of a change in
management's assessment of the amount of the net deferred tax asset that is
expected to be realized. See Note 21 to the Consolidated Financial Statements.
DEPOSITS. Deposits increased $63.1 million or 3% during 1997 primarily as a
result of brokered deposits obtained through national investment banking firms
which solicit deposits from their customers, which amounted to $1.34 billion at
December 31, 1997, as compared to $1.22 billion at December 31, 1996. Deposits
obtained as a result of the Company's direct solicitation and marketing efforts
to regional and local investment banking firms and institutional investors and
high net worth individuals amounted to $429.8 million at December 31, 1997 as
compared to $540.6 million at December 31, 1996. See Note 15 to the Consolidated
Financial Statements.
NOTES, DEBENTURES AND OTHER INTEREST-BEARING OBLIGATIONS. Notes, debentures
and other interest-bearing obligations of $227.0 million at December 31, 1997
increased $1.4 million during 1997 and consist primarily of the $125.0 million
of 11.875% Notes issued by the Company in 1996 and the $100.0 million of 12%
Debentures issued by the Bank in 1995. See Note 17 to the Consolidated Financial
Statements.
OBLIGATIONS OUTSTANDING UNDER LINES OF CREDIT. Obligations outstanding
under lines of credit amounted to $118.3 million at December 31, 1997 and
represent borrowings under new lines of credit established at OFS during 1997.
These lines of credit have a one-year term with interest rates that float in
accordance with a designated prime rate (see "Liquidity, Commitments and
Off-Balance Sheet Risks").
COMPANY-OBLIGATED, MANDATORILY REDEEMABLE SECURITIES OF SUBSIDIARY TRUST
HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES OF THE COMPANY. In August 1997,
OCT, a wholly owned subsidiary of Ocwen, issued $125.0 million of 10 7/8%
Capital Securities. Proceeds from issuance of the Capital Securities were
invested in 10 7/8% Junior Subordinated Debentures issued by Ocwen. The Junior
Subordinated Debentures, which represent the sole assets of the Trust, will
mature on August 1, 2027. Intercompany transactions between OCT and the Company,
including the Junior Subordinated Debentures, are eliminated in the consolidated
financial statements of the Company.
Through December 31, 1997, the Company had accrued $5.2 million of
distributions payable to holders of the Capital Securities. See Note 18 to the
Consolidated Financial Statements.
STOCKHOLDERS' EQUITY. Stockholders' equity increased $216.1 million or 106%
during 1997. The increase in stockholder's equity during 1997 was primarily due
to $78.9 million of net income and $142.0 million of net proceeds in connection
with the sale of 3,450,000 shares of common stock, offset in part by an $8.5
million decrease in unrealized gain on equity securities and securities
available for sale. The $64.0 million increase in stockholders' equity during
1996 was primarily due to $50.1 million of net income earned during 1996, a $4.9
million increase in unrealized gain on securities available for sale and a $13.0
million increase in common stock and additional paid-in capital in connection
with the issuance of 2,928,830 shares of common stock as a result of the
exercise of vested stock options by certain of the Company's and the Bank's
current and former officers and directors. These increases more than offset the
loans made to certain of such officers and directors to fund their exercise of
the stock options, which had an unpaid principal balance of $0 and $3.8 million
at December 31, 1997 and 1996, respectively.
14
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and magnitude
of the repricing of assets and liabilities. It is the objective of the Company
to attempt to control risks associated with interest rate movements. In general,
management's strategy is to match asset and liability balances within maturity
categories to limit the Company's exposure to earnings variations and variations
in the value of assets and liabilities as interest rates change over time. The
Company's asset and liability management strategy is formulated and monitored by
the Asset/Liability Committee, which is comprised of directors and officers of
the Bank, in accordance with policies approved by the Board of Directors of the
Bank. The Asset/Liability Committee meets regularly to review, among other
things, the sensitivity of the Company's assets and liabilities to interest rate
changes, the book and market values of assets and liabilities, unrealized gains
and losses, including those attributable to hedging transactions, purchase and
sale activity, and maturities of investments and borrowings. The Asset/Liability
Committee also approves and establishes pricing and funding decisions with
respect to the Company's overall asset and liability composition.
The Asset/Liability Committee is authorized to utilize a wide variety of
off-balance sheet financial techniques to assist it in the management of
interest rate risk. These techniques include interest rate exchange agreements,
pursuant to which the parties exchange the difference between fixed-rate and
floating-rate interest payments on a specified principal amount (referred to as
the "notional amount") for a specified period, without the exchange of the
underlying principal amount. Interest rate exchange agreements are utilized by
the Company to protect against the decrease in value of a fixed-rate asset or
the increase in borrowing cost from a short-term, fixed-rate liability, such as
reverse repurchase agreements, in an increasing interest rate environment. At
December 31, 1997, the Company had entered into interest rate exchange
agreements with an aggregate notional amount of $36.9 million. Interest rate
exchange agreements had the effect of increasing (decreasing) the Company's net
interest income by $(198,000), $(58,000) and $358,000 during 1997, 1996 and
1995, respectively. See Note 20 to the Consolidated Financial Statements.
The Company also enters into interest rate futures contracts, which are
commitments to either purchase or sell designated financial instruments at a
future date for a specified price and may be settled in cash or through
delivery. Eurodollar futures contracts have been sold by the Company to hedge
the repricing or maturity risk of certain short duration mortgage-related
securities, and U.S. Treasury futures contracts have been sold by the Company to
offset declines in the market value of its fixed-rate loans and certain
fixed-rate mortgage-backed and related securities available for sale in the
event of an increasing interest rate environment. At December 31, 1997 the
Company had no outstanding Eurodollar futures contracts. At December 31, 1996,
the Company had entered into Eurodollar futures (short) contracts with an
aggregate notional amount of $405.0 million. At December 31, 1997 and 1996, the
Company had entered into U.S. Treasury futures (short) contracts with an
aggregate notional amount of $194.5 million and $165.1 million, respectively.
Futures contracts had the effect of increasing (decreasing) the Company's net
interest income by $2.0 million, $(729,000) and $(619,000) during 1997, 1996 and
1995, respectively. In addition, futures contracts had the effect of decreasing
the Company's non-interest income by $4.8 million, $4.1 million and $3.3 million
during the years ended December 31, 1997, 1996 and 1995, respectively. See Note
20 to the Consolidated Financial Statements.
The Asset/Liability Committee's methods for evaluating interest rate risk
include an analysis of the Company's interest rate sensitivity "gap," which is
defined as the difference between interest-earning assets and interest-bearing
liabilities maturing or repricing within a given 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 interest-rate
sensitive assets. During a period of rising interest rates, a negative gap would
tend to adversely affect net interest income, while a positive gap would tend to
result in an increase in net interest income. During a period of falling
interest rates, a negative gap would tend to result in an increase in net
interest income, while a positive gap would tend to affect net interest income
adversely. Because different types of assets and liabilities with the same or
similar maturities may react differently to changes in overall market rates or
conditions, changes in interest rates may affect net interest income positively
or negatively even if an institution were perfectly matched in each maturity
category.
The following table sets forth the estimated maturity or repricing of the
Company's interest-earning assets and interest-bearing liabilities at December
31, 1997. The amounts of assets and liabilities shown within a particular period
were determined in accordance with the contractual terms of the assets and
liabilities, except (i) adjustable-rate loans, performing discount loans,
securities and FHLB advances are included in the period in which they are first
scheduled to adjust and not in the period in which they mature, (ii) fixed-rate,
mortgage-related securities reflect estimated prepayments, which were estimated
based on analyses of broker estimates, the results of a prepayment model
utilized by the Company and empirical data, (iii) nonperforming discount loans
reflect the estimated timing of resolutions which result in repayment to the
Company, (iv) fixed-rate loans reflect scheduled contractual amortization, with
no estimated prepayments, (v) NOW and money market checking deposits and savings
deposits, which do not have contractual maturities, reflect estimated levels of
attrition, which are based on detailed studies of each such category of deposit
by the Company, and (vi) escrow deposits and other non-interest bearing checking
accounts, which amounted to $130.4 million at December 31, 1997, are excluded.
Management believes that these assumptions approximate actual experience and
considers them reasonable; however, the interest rate sensitivity of the
Company's assets and liabilities in the table could vary substantially if
different assumptions are used or actual experience differs from the historical
experience on which the assumptions are based.
15
December 31, 1997
------------------------------------------------------------------
Four to More than
Within Three Twelve One Year to Three Years
Months Months Three Years and Over Total
------------ ---------- ----------- ---------- ----------
(Dollars in Thousands)
Rate-Sensitive Assets:
Interest-earning cash .................................. $ 140,001 $ -- $ -- $ -- $ 140,001
Securities available for sale .......................... 42,763 150,736 130,694 106,331 430,524
Loans available for sale(1) ............................ 19,045 64,904 83,406 9,686 177,041
Investment securities, net ............................. -- -- -- 59,567 59,567
Loan portfolio, net(1) ................................. 113,372 31,298 39,922 81,707 266,299
Discount loan portfolio, net ........................... 199,115 373,111 349,201 512,749 1,434,176
---------- ---------- ---------- ---------- ----------
Total rate-sensitive assets ............................ 514,296 620,049 603,223 770,040 2,507,608
---------- ---------- ---------- ---------- ----------
Rate-Sensitive Liabilities:
NOW and money market checking deposits ................. 7,277 3,072 6,101 11,174 27,624
Savings deposits ....................................... 84 227 448 905 1,664
Certificates of deposit ................................ 277,966 562,498 610,872 371,826 1,823,162
---------- ---------- ---------- ---------- ----------
Total interest-bearing deposits ...................... 285,327 565,797 617,421 383,905 1,852,450
Securities sold under agreement to repurchase .......... 108,250 -- -- -- 108,250
Obligations outstanding under lines of credit .......... 118,304 -- -- -- 118,304
Notes, debentures and other interest bearing obligations 1,975 -- -- 225,000 226,975
---------- ---------- ---------- ---------- ----------
Total rate-sensitive liabilities ..................... 513,856 565,797 617,421 608,905 2,305,979
---------- ---------- ---------- ---------- ----------
Interest rate sensitivity gap before off-
balance sheet financial instruments .................. 440 54,252 (14,198) 161,135 201,629
Futures contracts and interest rate swap ............... 189,274 (14,487) (30,827) (143,960) --
---------- ---------- ---------- ---------- ----------
Interest rate sensitivity gap ............................. $ 189,714 $ 39,765 $ (45,025) $ 17,175 $ 201,629
========== ========== ========== ========== ==========
Cumulative interest rate sensitivity gap .................. $ 189,714 $ 229,479 $ 184,454 $ 201,629
========== ========== ========== ==========
Cumulative interest rate sensitivity gap as a
percentage of total rate-sensitive assets............. 7.57% 9.15% 7.36% 8.04%
========== ========== ========== ==========
(1) Balances have not been reduced for nonperforming loans.
Although the interest rate sensitivity gap analysis is a useful measurement
and contributes toward effective asset and liability management, it is difficult
to predict the effect of changing interest rates based solely on that measure.
As a result, the Asset/Liability Committee also regularly reviews interest rate
risk by forecasting the impact of alternative interest rate environments on net
interest income and market value of portfolio equity ("MVPE"), which is defined
as the net present value of an institution's existing assets, liabilities and
off-balance sheet instruments, and evaluating such impacts against the maximum
potential changes in net interest income and MVPE that is authorized by the
Board of Directors of the Bank.
The following table sets forth at December 31, 1997 the estimated
percentage change in the Company's net interest income over a four-quarter
period and MVPE based upon the indicated changes in interest rates, assuming an
instantaneous and sustained uniform change in interest rates at all maturities.
Estimated Changes in
Change -----------------------------------------------------------
(in Interest Rates) Net Interest Income MVPE
---------------------------- ---------------------------- ----------------------------
+400 (10.5)% (11.4)%
+300 (5.1) (5.3)
+200 7.6 0.3
+100 4.3 3.3
0 -- --
-100 (18.7) (12.2)
-200 (35.5) (15.2)
-300 (33.9) (13.9)
-400 (33.8) (12.3)
The negative estimated changes in MVPE for -100 to -400 and for +300 and
+400 changes in interest rates as well as in net interest income for +300 and
+400 changes in interest rates are attributable to the Company's sensitivity to
changes in interest rates. Such sensitivity stems from the Company's investments
in IO-stripped and inverse IO-stripped mortgage-backed securities (together "IO
strips"). IO strips exhibit considerably more price volatility than mortgage or
ordinary mortgage pass-through securities, due in part to the uncertain cash
flows that result from changes in the prepayment rates of the underlying
mortgages. In the case of IO strips, increased prepayments of the underlying
mortgages as a result of a decrease in market interest rates or other factors
can result in a loss of all or part of the purchase price of such security.
16
Management of the Company believes that the assumptions used by it to
evaluate the vulnerability of the Company's operations to changes in interest
rates approximate actual experience and considers them reasonable; however, the
interest rate sensitivity of the Company's assets and liabilities and the
estimated effects of changes in interest rates on the Company's net interest
income and MVPE could vary substantially if different assumptions are used or
actual experience differs from the historical experience on which they are
based.
The following table shows the Company's financial instruments that are
sensitive to changes in interest rates, categorized by expected maturity, and
the instruments' fair values at December 31, 1997. Market-rate-sensitive
instruments are generally defined as on and off balance sheet derivatives and
other financial instruments.
Expected Maturity Date At December 31, 1997 (1)
---------------------------------------------------------------------------------------------
Total Fair
1998 1999 2000 2001 2002 Thereafter Balance Value
---------- -------- -------- ---------- --------- ---------- ---------- ----------
(Dollars in Thousands)
Rate-Sensitive Assets:
Interest-earning cash............. $ 140,001 $ -- $ -- $ -- $ -- $ -- $ 140,001 $ 140,001
Average interest rate .......... 4.46% -- -- -- -- -- 4.46%
Securities available for sale .... 195,526 93,302 36,275 23,049 14,999 67,373 430,524 430,524
Average interest rate .......... 8.58% 10.10% 13.84% 13.56% 13.97% 14.66% 10.76%
Loans available for sale(2) ...... 77,994 37,376 14,443 10,952 8,648 27,628 177,041 184,884
Average interest rate .......... 9.37% 9.20% 9.48% 9.50% 9.47% 9.40% 9.36%
Investment securities, net ....... -- -- -- -- -- 59,567 59,567 59,567
Average interest rate .......... -- -- -- -- -- -- --% --
Loan portfolio, net(2) ........... 111,323 30,348 41,540 63,914 4,865 14,309 266,299 281,850
Average interest rate .......... 9.10% 9.07% 9.04% 9.01% 8.99% 8.97% 9.06% --
Discount loan portfolio, net ..... 457,624 262,918 122,206 63,511 45,038 482,879 1,434,176 1,657,222
Average interest rate .......... 8.71% 8.79% 8.83% 8.86% 8.85% 8.81% 8.78% --
---------- -------- -------- ---------- --------- ---------- ---------- ----------
Total rate-sensitive assets ...... $ 982,468 $423,944 $214,464 $ 161,426 $ 73,550 $ 651,756 $2,507,608 $2,754,048
========== ======== ======== ========== ========= ========== ========== ==========
Rate-Sensitive Liabilities:
NOW and money market checking
deposits ....................... $ 10,349 $ 3,384 $ 2,717 $ 2,183 $ 1,754 $ 7,237 $ 27,624 $ 72,233
Average interest rate .......... 3.45% 3.33% 3.32% 3.31% 3.30% 3.21% 3.34%
Savings deposits ................. 311 249 199 159 128 618 1,664 1,589
Average interest rate .......... 2.30% 2.30% 2.30% 2.30% 2.30% 2.30% 2.30% --
Certificates of deposit .......... 840,463 376,607 234,265 225,497 145,995 335 1,823,162 1,865,196
Average interest rate .......... 5.82% 6.11% 6.10% 6.11% 6.39% 6.53% 6.00% --
---------- -------- -------- ---------- --------- ---------- ---------- ----------
Total interest-bearing deposits... 851,123 380,240 237,181 227,839 147,877 8,190 1,852,450 1,939,018
Securities sold under agreement
to repurchase .................. 108,250 -- -- -- -- -- 108,250 108,250
Average interest rate .......... 5.93% -- -- -- -- -- 5.93% --
Obligations outstanding under
lines of credit .............. 118,304 -- -- -- -- -- 118,304 118,304
Average interest rate .......... 6.59% -- -- -- -- -- 6.59% --
Notes, debentures and other ...... 1,975 -- -- -- -- 225,000 226,975 255,538
Average interest rate .......... 7.06% -- -- -- -- 11.93% 11.89% --
---------- -------- -------- ---------- --------- ---------- ----------- ----------
Total rate-sensitive liabilities.. $1,079,652 $380,240 $237,181 $ 227,839 $ 147,877 $ 233,190 $ 2,305,979 $2,421,110
========== ======== ======== ========== ========= ========== =========== ==========
- -------------------
(1) Expected maturities are contractual maturities adjusted for prepayments of
principal. The Company uses certain assumptions to estimate fair values and
expected maturities. For assets, expected maturities are based upon
contractual maturity, projected repayments and prepayments of principal.
The prepayment experience reflected herein is based on the Company's
historical experience. The Company's average Constant Prepayment Rate
("CPR") is 12.6% and 16.7% on its fixed-rate and adjustable-rate
portfolios, respectively, for interest-earning assets (excluding investment
securities, which do not have prepayment features). The actual maturities
of these instruments could vary substantially if future prepayments differ
from the Company's historical experience.
(2) Balances have not been reduced for nonperforming loans.
The Company believes that the broad geographic distribution of its discount
loan portfolio and loan portfolio reduces the risks associated with
concentrating such loans in limited geographic areas. See Note 8 and Note 9 to
the Consolidated Financial Statements.
Liquidity, Commitments and Off-Balance Sheet Risks
Liquidity is a measurement of the Company's ability to meet potential cash
requirements, including ongoing commitments to fund deposit withdrawals, repay
borrowings, fund investment, loan acquisition and lending activities, make
corporate acquisitions and fund other general business purposes. The primary
sources of funds for liquidity currently consist of deposits, FHLB advances,
reverse repurchase agreements, lines of credit and maturities and principal
payments on loans and securities and proceeds from sales thereof. Another
significant source of asset liquidity is the ability to securitize assets such
as discount loans and subprime
17
loans, as well as the direct sale of such loans.
Sources of liquidity include certificates of deposit obtained primarily
from wholesale sources. At December 31, 1997, the Company had $1.82 billion of
certificates of deposit, including $1.34 billion of brokered certificates of
deposit obtained through national investment banking firms, all of which are
non-cancelable. At the same date, scheduled maturities of certificates of
deposit during the 12 months ending December 31, 1998 and 1999 and thereafter
amounted to $840.5 million, $376.6 million and $606.1 million, respectively.
Brokered and other wholesale deposits generally are more responsive to changes
in interest rates than core deposits and, thus, are more likely to be withdrawn
from the Company upon maturity as changes in interest rates and other factors
are perceived by investors to make other investments more attractive. Management
of the Company believes that it can adjust the rates paid on certificates of
deposit to retain deposits in changing interest rate environments and that
brokered and other wholesale deposits can be both a relatively cost-effective
and stable source of funds. There can be no assurance that this will continue to
be the case in the future, however.
Sources of borrowings include FHLB advances, which are required to be
secured by single family and/or multi-family residential loans or other
acceptable collateral, and reverse repurchase agreements. At December 31, 1997,
the Company had no FHLB advances outstanding, was eligible to borrow up to an
aggregate of $647.9 million from the FHLB of New York (subject to availability
of acceptable collateral) and had $68.2 million of single family residential
loans, approximately $9.0 million of multi-family residential loans and $26.1
million of loans secured by hotel properties which could be pledged as security
for such advances. At the same date, the Company had contractual relationships
with six brokerage firms and the FHLB of New York pursuant to which it could
obtain funds from reverse repurchase agreements and had $326.2 million of
unencumbered mortgage-related securities which could be used to secure such
borrowings. At present, the Company has no outstanding FHLB advances due to the
availability of other less costly sources of funding, a circumstance which the
Company evaluates on a regular basis.
The liquidity of the Company includes lines of credit obtained by OFS
subsequent to its assumption of the subprime lending activities of the Bank and
acquisition of substantially all of the assets of Admiral, as follows: (i) a
$200.0 million secured line of credit from Morgan Stanley Mortgage Capital Inc.,
of which $100 million was committed, (ii) a $50.0 million secured line of credit
from Texas Commerce Bank National Association, (iii) a $200 million secured line
of credit from Merrill Lynch, of which $100 million was committed, and (iv) a
$200 million secured line of credit from Lehman Commercial Paper, Inc., of which
$100 million was committed. An aggregate of $118.3 million was outstanding to
OFS under these lines of credit at December 31, 1997, which have interest rates
which float in accordance with a designated prime rate. In addition, the Company
has provided a $30.0 million unsecured, subordinated credit facility to OFS, of
which $30.0 million was outstanding at December 31, 1997. At present OFS intends
to continue to seek appropriate leverage with respect to its underlying
business, and thus, will seek additional lines of credit as its assets warrant.
The Company believes that its existing sources of liquidity, including
internally generated funds, will be adequate to fund planned activities for the
foreseeable future, although there can be no assurances in this regard.
Moreover, the Company continues to evaluate other sources of liquidity, such as
lines of credit from unaffiliated parties, which will enhance the management of
its liquidity and the costs thereof.
The Company's operating activities provided cash flows of $114.3 million
and of $101.4 million during 1997 and 1996, respectively, and used cash flows of
$189.4 million during 1995. During the foregoing years, cash resources were
provided primarily by net income and proceeds from sales of loans available for
sale, and cash resources were used primarily to purchase and originate loans
available for sale.
The Company's investing activities used cash flows totaling $493.7 million,
$558.3 million and $474.5 million during 1997, 1996 and 1995, respectively.
During the foregoing years, cash flows from investing activities were provided
primarily by principal payments on discount loans and loans held for investment,
maturities of and principal payments received on securities available for sale
and proceeds from sales of discount loans, securities available for sale and
real estate owned, and cash flows from investing activities were primarily
utilized to purchase and originate discount loans and loans held for investment
and purchase securities available for sale.
The Company's financing activities provided cash flows of $479.5 million,
$454.5 million and of $681.8 million during 1997, 1996 and 1995, respectively.
Cash flows from financing activities were primarily related to changes in the
Company's deposits, issuance of common stock and the Capital Securities in 1997,
issuance of the Notes in 1996, issuance of the Debentures in 1995 and advances
from FHLB. Cash flows used by financing activities were primarily utilized to
repay advances from the FHLB and reverse repurchase agreements and include the
transfer of deposits in connection with the sale of branch offices in 1995.
The Bank is required under applicable federal regulations to maintain
specified levels of "liquid" investments in qualifying types of U.S. government,
federal agency and other investments having maturities of five years or less.
Current OTS regulations require that a savings association maintain liquid
assets of not less than 4% of its average daily balance of net withdrawable
deposit accounts and borrowings payable in one year or less. Monetary penalties
may be imposed for failure to meet applicable liquidity requirements. The Bank's
liquidity, as measured for regulatory purposes, averaged, 5.6%, 8.8% and 12.9%
during the years ended December 31, 1997, 1996 and 1995, respectively, and
amounted to 5.0% at December 31, 1997.
At December 31, 1997, the Company had $182.1 million of unfunded
commitments related to the purchase and origination of loans. Management of the
Company believes that the Company has adequate resources to fund all such
unfunded commitments to the extent
18
required and that substantially all of such unfunded commitments will be funded
during 1998. See Note 27 to the Consolidated Financial Statements. In addition,
management of the Company believes it has adequate resources to fund its
anticipated employee and facility expansion needs.
In addition to commitments to extend credit, the Company is party to
various off-balance sheet financial instruments in the normal course of the
Company's business in order to manage its interest rate risk. See "Asset and
Liability Management" above and Note 27 to the Consolidated Financial
Statements.
The Company conducts business with a variety of financial institutions and
other companies in the normal course of business, including counterparties to
its off-balance sheet financial instruments. The Company is subject to potential
financial loss if the counterparty is unable to complete an agreed upon
transaction. The Company seeks to limit counterparty risk through financial
analysis, dollar limits and other monitoring procedures.
Regulatory Capital and Other Requirements
Federally-insured institutions such as the Bank are required to maintain
minimum levels of regulatory capital. These standards generally must be as
stringent as the comparable capital requirements imposed on national banks. In
addition to regulatory capital requirements of general applicability, a
federally-chartered savings association such as the Bank may be required to meet
individual minimum capital requirements established by the OTS on a case-by-case
basis upon a determination that a savings association's capital is or may become
inadequate in view of its circumstances.
In connection with an examination of the Bank in late 1996 and early 1997,
the staff of the OTS expressed concern about many of the Bank's non-traditional
operations, which generally are deemed by the OTS to involve higher risk,
certain of the Bank's accounting policies and the adequacy of the Bank's capital
in light of the Bank's lending and investment strategies. The activities which
were of concern to the OTS included the Bank's subprime single family
residential lending activities, the Bank's origination of acquisition,
development and construction loans with terms which provide for shared
participation in the results of the underlying real estate, the Bank's discount
loan activities, which involve significantly higher investment in nonperforming
and classified assets than the majority of the savings and loan industry, and
the Bank's investment in subordinated classes of mortgage-related securities
issued in connection with the Bank's asset securitization activities and
otherwise.
Following the above-referenced examination, the Bank committed to the OTS
to maintain a core capital (leverage) ratio and a total risk-based capital ratio
of at least 9% and 13%, respectively. The Bank continues to be in compliance
with this commitment as well as the regulatory capital requirements of general
applicability, as indicated in Note 24 to the Consolidated Financial Statements.
Based on discussions with the OTS, the Bank believes that this commitment does
not affect its status as a "well-capitalized" institution, assuming the Bank's
continued compliance with the regulatory capital requirements required to be
maintained by it pursuant to such commitment.
Although the Bank has expressed disagreement with the level of risk
perceived by the OTS in its business, the Bank has taken various other actions
to address OTS concerns with respect to its risk profile, including the
following: (i) the sale to the Company in 1996 of subordinated, participating
interests in a total of eleven acquisition, development and construction loans,
which interests had an aggregate principal balance of $16.9 million; (ii) the
cessation of originating mortgage loans with profit participation features in
the underlying real estate, with the exception of existing commitments, which
consisted of commitments for nine loans with an aggregate principal amount of
$79.2 million at December 31, 1997; (iii) the transfer of its subprime single
family residential lending operations and its large multi-family residential and
commercial real estate lending operations to OFS and OCC, respectively; (iv) an
agreement (a) to discontinue the purchase of subordinate classes of
mortgage-related securities created by unaffiliated parties, (b) to sell the
five such securities held by it at March 31, 1997 (aggregate book value of $32.0
million), which was completed by a sale to OAIC on May 19, 1997 (at a gain of
$2.6 million to the Company), and (c) subject to the requirements of the OTS
capital distribution regulation, to dividend to the Company all subordinate
mortgage-related securities acquired by the Bank in connection with its
securitization activities, including two subordinate securities with an
aggregate book value of $19.5 million which were dividended to the Company in
June 1997 and one subordinate security and one residual security with an
aggregate book value of $14.4 million which were dividended to the Company in
November 1997; (v) the establishment as of December 31, 1996 of requested write
downs of cost basis, which amounted to $7.2 million, against loans and
securities resulting from its investment in loans acquired from HUD; (vi) an
agreement to employ a senior officer to head its Credit Management Department
and to take other steps to improve the effectiveness of its independent asset
review function; and (vii) an agreement to provide the OTS with certain reports
on a regular basis. In addition to the foregoing, and based on discussions with
the OTS, the Company modified certain of its accounting policies in a manner
which will result in more conservative recognition of income. Specifically, the
Company (i) ceased accreting into interest income discount on nonperforming
residential loans, effective January 1, 1997; (ii) discontinued the
capitalization of period expenses to real estate owned, effective January 1,
1997; and (iii) an agreement to classify as doubtful for regulatory purposes all
real estate owned which are not generating cash flow and which has been held for
more than three years. If the new policy on accretion of discount on
nonperforming residential loans had been applied in 1996 and 1995, the Company's
income from continuing operations before income taxes, as adjusted for related
profit sharing expense, would have decreased by approximately $1.4 million and
$1.1 million, respectively. If the new policy on capitalization of period
expenses on real estate owned had been adopted in 1996 and 1995, the Company's
income from continuing operations before income taxes, as adjusted for related
profit sharing expense, would have increased by approximately $610,000 in 1996
and would have decreased by approximately $2.3 million in 1995. In light of the
foregoing, the Company does not believe that the above-referenced accounting
changes had a material effect on the Company's financial condition or results of
operations.
19
Although the above individual regulatory capital requirements have been
agreed to by the OTS, there can be no assurance that in the future the OTS will
agree to a decrease in such requirements or will not seek to increase such
requirements or will not impose these or other individual regulatory capital
requirements in a manner which affects the Bank's status as a "well-capitalized"
institution under applicable laws and regulations.
Recent Accounting Developments
For information relating to the effects on the Company of the adoption of
recent accounting standards, see Note 1 to the Consolidated Financial
Statements.
Year 2000 Date Conversion
The Company has begun to coordinate the identification, evaluation, and
implementation of changes to computer systems and applications necessary to
achieve a year 2000 date conversion with no effect on customers or disruption to
business operations. These actions are necessary to ensure that the systems and
applications will recognize and process the year 2000 and beyond. Major areas of
potential business impact have been identified and dimensioned, and initial
conversion efforts are underway. The Company also is communicating with
customers, financial institutions and others with which it does business to
identify and coordinate year 2000 conversion issues. The Company expects its
year 2000 conversion will be completed on a timely basis. The cost of achieving
year 2000 compliance, which will be largely incurred through 1998, is estimated
to range from $300,000 to $600,000, and will be charged to expense as incurred.
Forward-Looking Statements
CERTAIN STATEMENTS CONTAINED IN THIS ANNUAL REPORT ARE NOT, AND CERTAIN
STATEMENTS CONTAINED IN FUTURE FILINGS BY THE COMPANY WITH THE SECURITIES AND
EXCHANGE COMMISSION, IN THE COMPANY'S PRESS RELEASES OR IN THE COMPANY'S OTHER
PUBLIC OR SHAREHOLDER COMMUNICATIONS, MAY NOT BE BASED ON HISTORICAL FACTS AND
ARE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE
SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE
ACT OF 1934, AS AMENDED. FORWARD-LOOKING STATEMENTS WHICH ARE BASED ON VARIOUS
ASSUMPTIONS (SOME OF WHICH ARE BEYOND THE COMPANY'S CONTROL), MAY BE IDENTIFIED
BY REFERENCE TO A FUTURE PERIOD OR PERIODS, OR BY THE USE OF FORWARD-LOOKING
TERMINOLOGY, SUCH AS "MAY," "WILL," "COULD," "BELIEVE," "EXPECT," "ANTICIPATE,"
"CONTINUE," "INTENDS," "PLANS," "PRESENTS," OR SIMILAR TERMS OR VARIATION ON
THOSE TERMS, OR BY THE USE OF THE NEGATIVE OF SUCH TERMINOLOGY. ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE SET FORTH IN FORWARD-LOOKING STATEMENTS DUE
TO A VARIETY OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE RELATED TO THE
ECONOMIC ENVIRONMENT, PARTICULARLY IN THE MARKET AREAS IN WHICH THE COMPANY
OPERATES, COMPETITIVE PRODUCTS AND PRICING, THE GROWTH OR DECLINE OF, AND THE
AVAILABILITY OF PRODUCT TO PURCHASE IN, THE DISCOUNT LOAN INDUSTRY FISCAL AND
MONETARY POLICIES OF THE U.S. OR U.K. GOVERNMENTS, CHANGES IN GOVERNMENT
REGULATIONS AFFECTING FINANCIAL INSTITUTIONS AND REAL ESTATE INVESTMENT TRUSTS,
INCLUDING REGULATORY FEES, CAPITAL REQUIREMENTS AND TAXATION, CHANGES IN
PREVAILING INTEREST AND CURRENCY EXCHANGE RATES, ACQUISITIONS AND THE
INTEGRATION OF ACQUIRED BUSINESSES, SOFTWARE INTEGRATION, DEVELOPMENT AND
LICENSING, CREDIT INTEREST RATE AND OPERATIONAL RISK MANAGEMENT, ASSET/LIABILITY
MANAGEMENT, THE FINANCIAL AND SECURITIES MARKETS AND THE AVAILABILITY OF AND
COSTS ASSOCIATED WITH SOURCES OF LIQUIDITY. THE COMPANY DOES NOT UNDERTAKE, AND
SPECIFICALLY DISCLAIMS ANY OBLIGATION, TO PUBLICLY RELEASE THE RESULTS OF ANY
REVISIONS WHICH MAY BE MADE TO ANY FORWARD-LOOKING STATEMENTS TO REFLECT THE
OCCURRENCE OF ANTICIPATED OR UNANTICIPATED EVENTS OR CIRCUMSTANCES AFTER THE
DATE OF SUCH STATEMENTS.
20
REPORT OF MANAGEMENT
OCWEN
[LOGO]
The management of Ocwen is responsible for the preparation and fair
presentation of the financial statements and other financial
information contained in this annual report. The accompanying
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles applied on a consistent basis
and include amounts based on management's best estimates and judgments.
Nonfinancial information included in this annual report has also been
prepared by management and is consistent with the consolidated
financial statements. In the opinion of management, the consolidated
financial statements fairly reflect the Company's financial position,
results of operations and cash flows.
To assure that financial information is reliable and assets are
safeguarded, management has established and maintains an effective
system of internal accounting controls and procedures that provide
reasonable assurance as to the integrity and reliability of the
financial statements, the protection of assets against loss from
unauthorized use or disposition and the prevention and detection of
errors and irregularities on a timely basis.
Price Waterhouse LLP conducts its audit of the consolidated financial
statements in accordance with generally accepted auditing standards.
Such standards include the evaluation of internal accounting controls
to establish a basis for developing the scope of its examination of the
consolidated financial statements. In addition to the use of
independent certified public accountants, the Company maintains a
professional staff of internal auditors who conduct financial,
procedural and special audits. To ensure their independence, both Price
Waterhouse LLP and the internal auditors have direct access to the
Audit Committee of the Board of Directors.
The Audit Committee, which consists solely of independent directors of
the Company, makes recommendations to the Board of Directors concerning
the appointment of the independent certified public accountants and
meets with Price Waterhouse LLP and the internal auditors to discuss
the results of their audits, the Company's internal accounting controls
and financial reporting matters.
/s/ WILLIAM C. ERBEY /s/ MARK S. ZEIDMAN
------------------------------ -----------------------
William C. Erbey Mark S. Zeidman
Chairman, Chief Executive Officer Senior Vice President and
and President Chief Financial Officer
================================================================================
OCWEN FINANCIAL CORPORATION
21
One East Broward Boulevard Telephone 954 463 6280
Suite 1700
Fort Lauderdale, FL 33301
PRICE WATERHOUSE LLP [LOGO]
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of Ocwen Financial Corporation
In our opinion, the accompanying consolidated statements of financial condition
and the related consolidated statements of operations, of changes in
stockholders' equity and of cash flows present fairly, in all material respects,
the financial position of Ocwen Financial Corporation (the "Company") and its
subsidiaries at December 31, 1997 and 1996 and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatements. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PRICE WATERHOUSE LLP
---------------------------
PRICE WATERHOUSE LLP
Fort Lauderdale, Florida
January 27, 1998
22
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITIONS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
December 31,
--------------------------
1997 1996
----------- -----------
Assets
Cash and amounts due from depository institutions ............................... $ 12,243 $ 6,878
Interest earning deposits ....................................................... 140,001 13,341
Federal funds sold and repurchase agreements .................................... -- 32,000
Securities held for trading ..................................................... -- 75,606
Securities available for sale, at market value .................................. 430,524 354,005
Loans available for sale, at lower of cost or market ............................ 177,041 126,366
Investment securities, net ...................................................... 59,567 8,901
Loan portfolio, net ............................................................. 266,299 402,582
Discount loan portfolio, net .................................................... 1,434,176 1,060,953
Investments in low-income housing tax credit interests .......................... 128,614 93,309
Investment in joint ventures .................................................... 1,056 67,909
Real estate owned, net .......................................................... 167,265 103,704
Investment in real estate ....................................................... 65,972 41,033
Premises and equipment, net ..................................................... 21,542 14,619
Income taxes receivable ......................................................... -- 15,115
Deferred tax asset .............................................................. 45,148 5,860
Excess of purchase price over net assets acquired, net .......................... 15,560 --
Principal, interest and dividends receivable .................................... 17,284 16,821
Escrow advances on loans ........................................................ 47,888 27,409
Other assets .................................................................... 38,985 17,274
----------- -----------
$ 3,069,165 $ 2,483,685
=========== ===========
Liabilities and Stockholders' Equity
Liabilities:
Deposits ..................................................................... $ 1,982,822 $ 1,919,742
Advances from the Federal Home Loan Bank ..................................... -- 399
Securities sold under agreements to repurchase ............................... 108,250 74,546
Obligations outstanding under lines of credit ................................ 118,304 --
Notes, debentures and other interest bearing obligations ..................... 226,975 225,573
Accrued interest payable ..................................................... 32,238 24,843
Income taxes payable ......................................................... 3,132 --
Accrued expenses, payables and other liabilities ............................. 51,709 34,986
----------- -----------
Total liabilities .......................................................... 2,523,430 2,280,089
----------- -----------
Company-obligated, mandatorily redeemable securities of subsidiary
trust holding solely junior subordinated debentures of the Company ........... 125,000 --
Minority interest ............................................................... 1,043 --
Commitments and Contingencies (Note 27)
Stockholders' Equity:
Preferred stock, $.01 par value; 20,000,000 shares authorized;
0 shares issued and outstanding ............................................ -- --
Common stock, $.01 par value; 200,000,000 shares authorized;
60,565,835 and 53,488,340 shares issued and outstanding at
December 31, 1997 and 1996, respectively ................................... 606 535
Additional paid-in capital ................................................... 164,751 22,990
Retained earnings ............................................................ 259,349 180,417
Unrealized (loss) gain on securities available for sale and equity securities,
net of taxes ............................................................... (5,014) 3,486
Notes receivable on exercise of common stock options ......................... -- (3,832)
----------- -----------
Total stockholders' equity ................................................. 419,692 203,596
----------- -----------
$ 3,069,165 $ 2,483,685
=========== ===========
THE ACCOMPANYING NOTES ARE INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
23
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITIONS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
For the years ended December 31,
--------------------------------------------
1997 1996 1995
----------- ------------ -----------
Interest income:
Federal funds sold and repurchase agreements............................. $ 8,959 $ 4,681 $ 3,502
Securities available for sale............................................ 28,545 26,932 18,391
Securities held for trading.............................................. 248 1,216 --
Loans available for sale................................................. 18,368 17,092 15,608
Mortgage-related securities held for investment.......................... -- -- 4,313
Loans.................................................................... 54,701 36,818 15,430
Discount loans........................................................... 157,649 103,165 75,998
Investment securities and other.......................................... 4,061 3,990 4,033
----------- ------------ -----------
272,531 193,894 137,275
----------- ------------ -----------
Interest expense:
Deposits................................................................. 122,070 93,773 71,853
Securities sold under agreements to repurchase........................... 1,000 1,101 951
Securities sold but not yet purchased.................................... -- -- 1,142
Advances from the Federal Home Loan Bank................................. 518 4,053 1,126
Obligations outstanding under lines of credit............................ 5,578 -- --
Notes, debentures and other interest bearing obligations................. 27,123 17,233 8,988
----------- ------------ -----------
156,289 116,160 84,060
----------- ------------ -----------
Net interest income before provision for loan losses..................... 116,242 77,734 53,215
Provision for loan losses................................................... 32,218 22,450 1,082
----------- ------------ -----------
Net interest income after provision for loan losses...................... 84,024 55,284 52,133
----------- ------------ -----------
Non-interest income:
Servicing fees and other charges......................................... 25,881 4,682 2,870
Gains on sales of interest earning assets, net........................... 82,212 21,682 6,916
Gains from sale of branch offices........................................ -- -- 5,430
Gain on real estate owned, net........................................... 7,277 3,827 9,540
Gain on sale of real estate held for investment.......................... -- -- 4,658
Other income............................................................. 8,498 7,112 1,727
----------- ------------ -----------
123,868 37,303 31,141
----------- ------------ -----------
Non-interest expense:
Compensation and employee benefits....................................... 77,573 39,043 24,797
Occupancy and equipment.................................................. 17,657 8,921 8,360
Net operating loss (income) on investments in real estate and certain
low-income housing tax credit interests................................ 4,792 (425) 337
Savings Association Insurance Fund recapitalization assessment........... -- 7,140 --
Other operating expenses................................................. 26,771 14,927 12,079
----------- ------------ -----------
126,793 69,606 45,573
----------- ------------ -----------
Distributions on Company-obligated, mandatorily redeemable
securities of subsidiary trust holding solely junior subordinated
debentures of the Company................................................ 5,249 -- --
Equity in earnings of investment in joint venture........................... 23,688 38,320 --
----------- ------------ -----------
Income from continuing operations before income taxes.................... 99,538 61,301 37,701
Income tax expense.......................................................... (21,309) (11,159) (4,562)
Minority interest in net loss of consolidated subsidiary.................... 703 -- --
----------- ------------ -----------
Income from continuing operations........................................ 78,932 50,142 33,139
Discontinued operations:
Loss from operations of discontinued divisions to September 30, 1995
net of tax benefits of $2,321 for 1995................................. -- -- (4,468)
Loss on disposal of divisions, net of tax benefit of $1,776.............. -- -- (3,204)
----------- ------------ -----------
Net income ............................................................ $ 78,932 $ 50,142 $ 25,467
=========== ============ ===========
Basic earnings per share:
Income from continuing operations........................................ $ 1.40 $ 0.99 $ 0.64
Discontinued operations, net of tax benefit.............................. -- -- (0.15)
----------- ------------ -----------
Net income............................................................. $ 1.40 $ 0.99 $ 0.49
=========== ============ ===========
Diluted earnings per share:
Income from continuing operations........................................ $ 1.39 $ 0.94 $ 0.60
Discontinued operations, net of tax benefit.............................. -- -- (0.14)
----------- ------------ -----------
Net income............................................................. $ 1.39 $ 0.94 $ 0.46
=========== ============ ===========
Weighted average common shares outstanding:
Basic.................................................................... 56,185,956 50,556,572 51,712,415
=========== ============ ===========
Diluted.................................................................. 56,836,484 53,378,882 55,538,160
=========== ============ ===========
THE ACCOMPANYING NOTES ARE INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
24
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Dollars in Thousands, except share data)
Unrealized Notes
gain (loss) receivable
on securities on exercise
Additional available of common
Common Stock paid-in Retained for sale, stock
Shares Amount capital earnings net of taxes options Total
------ ------ ------- -------- ------------ ------- -----
Balances at December 31, 1994........................ 64,389,420 $ 644 $ 13,330 $ 142,230 $ (2,821) $ -- $ 153,383
Net Income........................................... -- -- -- 25,467 -- -- 25,467
Repurchase of common stock options................... -- -- (132) -- -- -- (132)
Exercise of common stock options..................... 865,240 8 1,412 -- -- -- 1,420
Repurchase of common stock ..........................(17,630,120) (176) (4,399) (37,422) -- -- (41,997)
Change in unrealized gain (loss) on securities,
net of taxes ..................................... -- -- -- -- 1,406 -- 1,406
----------- -------- --------- --------- --------- ------- --------
Balances at December 31, 1995........................ 47,624,540 476 10,211 130,275 (1,415) -- 139,547
Net Income........................................... -- -- -- 50,142 -- -- 50,142
Repurchase of common stock options................... -- -- (177) -- -- -- (177)
Exercise of common stock options..................... 5,857,660 59 12,933 -- -- -- 12,992
Issuance of common stock............................. 6,140 -- 23 -- -- -- 23
Notes receivable on exercise of common stock options,
net of repayments................................. -- -- -- -- -- (3,832) (3,832)
Change in unrealized gain (loss) on securities,
net of taxes ..................................... -- -- -- -- 4,901 -- 4,901
----------- -------- --------- --------- --------- ------- --------
Balances at December 31, 1996........................ 53,488,340 535 22,990 180,417 3,486 (3,832) 203,596
Net income........................................... -- -- -- 78,932 -- -- 78,932
Issuance of common stock............................. 6,906,198 69 141,934 -- -- -- 142,003
Repurchase of common stock options................... -- -- (3,208) -- -- -- (3,208)
Exercise of common stock options..................... 171,297 2 3,035 -- -- -- 3,037
Repayment of notes receivable on exercise of
common stock options, net of advances............. -- -- -- -- -- 3,832 3,832
Change in unrealized gain (loss) on securities,
net of taxes ..................................... -- -- -- -- (8,500) -- (8,500)
----------- -------- --------- --------- --------- ------- --------
Balances at December 31, 1997........................ 60,565,835 $ 606 $ 164,751 $ 259,349 $ (5,014) $ -- $419,692
=========== ======== ========= ========= ========= ======= ========
THE ACCOMPANYING NOTES ARE INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
25
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in Thousands)
For the years ended December 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
Cash flows from operating activities:
Net income .............................................................. $ 78,932 $ 50,142 $ 25,467
Adjustments to reconcile net income to net cash
provided by operating activities:
Net cash provided from trading activities ............................... 132,600 (60,881) 2,949
Proceeds from sales of loans available for sale ......................... 519,163 397,606 100,104
Purchases of loans available for sale ................................... (278,081) (295,054) (271,210)
Origination of loans available for sale ................................. (316,101) (9,447) (2,829)
Principal payments received on loans available for sale ................. 22,240 26,689 10,103
Premium amortization (discount accretion), net .......................... 63,506 11,640 (2,401)
Depreciation and amortization ........................................... 10,865 7,646 3,755
Provision for loan losses ............................................... 32,218 22,450 1,082
Gains on sales of interest earning assets, net .......................... (82,212) (21,682) (6,955)
Loss on sales of premises and equipment ................................. -- 97 3,002
Gain on sale of low-income housing tax credit interests ................. (6,298) (4,861) --
Gain on sale of real estate owned, net .................................. (17,201) (4,475) (8,496)
Gain on sales of branch offices ......................................... -- -- (5,430)
Gain on sale of real estate held for investment ......................... -- -- (4,658)
Decrease (increase) in principal, interest and dividends receivable ..... (463) (2,277) (6,484)
Decrease (increase) in income taxes receivable .......................... 18,247 (14,110) (11,030)
(Increase) decrease in deferred tax asset ............................... (39,288) 16,403 (1,568)
(Increase) decrease in escrow advances .................................. (20,479) (6,255) 914
Increase in other assets ................................................ (27,501) (12,037) (14,064)
Increase (decrease) in accrued expenses, interest payable
and other liabilities ................................................. 24,118 (226) (1,677)
----------- ----------- -----------
Net cash provided (used) by operating activities ........................... 114,265 101,368 (189,426)
----------- ----------- -----------
Cash flows used by investing activities:
Proceeds from sales of securities available for sale .................... 202,670 175,857 836,247
Purchases of securities available for sale .............................. (415,822) (233,858) (934,179)
Maturities of and principal payments received on securities
available for sale .................................................... 46,084 28,756 21,639
Maturities of and principal payments received on securities
held for investment ................................................... -- 10,006 17,545
Purchase of investment securities ....................................... (42,166) (276) --
Acquisition of subsidiaries ............................................. (11,635) -- --
Purchase of low-income housing tax credit interests ..................... (54,573) (34,240) (29,280)
Proceeds from sales of low-income housing tax credit interests .......... 22,026 24,667 --
Proceeds from sales of discount loans ................................... 500,151 190,616 38,942
Proceeds from sale of real estate held for investment ................... 14,905 -- 25,193
Proceeds from sales of loans held for investment ........................ 2,384 14,883 --
Purchase and originations of loans held for investment,
net of undisbursed loan funds ......................................... (138,884) (237,525) (270,600)
Purchase of discount loans .............................................. (1,464,611) (925,850) (547,987)
Decrease (increase) in investment in joint ventures ..................... 66,853 (67,909) --
Principal payments received on loans held for investment ................ 291,998 119,923 36,859
Principal payments received on discount loans ........................... 382,781 244,205 214,626
Purchase of and capital improvements to real estate held for investment.. (39,844) (29,946) --
Proceeds from sales of real estate owned ................................ 196,180 169,084 148,225
Purchase of real estate owned in connection with discount loan purchases (38,486) (1,628) (24,617)
Additions to premises and equipment ..................................... (13,744) (5,243) (12,207)
Other, net .............................................................. -- 227 5,067
----------- ----------- -----------
Net cash used by investing activities ...................................... (493,733) (558,251) (474,527)
----------- ----------- -----------
(Continued on next page)
THE ACCOMPANYING NOTES ARE INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
26
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in Thousands)
For the years ended December 31,
-----------------------------------
1997 1996 1995
--------- --------- ---------
Cash flows from financing activities:
Increase in deposits ................................................. 63,080 414,728 585,335
Increase (decrease) in securities sold under agreements to repurchase 33,704 (10,215) 84,761
Proceeds from issuance of notes, debentures and other interest bearing
obligations, net of repayments ..................................... 1,402 125,000 107,615
Proceeds from issuance of obligations under lines of credit .......... 118,304 -- --
Repayment of obligations assumed in connection with acquisition of
subsidiary ......................................................... (3,000) -- --
Payment of debt issuance costs ....................................... -- (5,252) (3,301)
Payments on advances from Federal Home Loan Bank ..................... (399) (146,000) (105,000)
Payments and repurchase of notes and mortgages payable ............... -- (8,798) (10,672)
Repayments (originations) of loans made to executive officers, net ... 3,832 (3,832) --
Exercise of common stock options ..................................... 3,037 12,993 1,420
Advances from the Federal Home Loan Bank ............................. -- 76,000 170,000
Proceeds from issuance of Capital Trust Securities ................... 125,000 -- --
Payment of Capital Trust Securities issuance costs ................... (4,262) -- --
Issuance of shares of common stock, net .............................. 142,003 -- --
Sales of deposits .................................................... -- -- (111,686)
Premium received on sales of deposits ................................ -- -- 5,492
Repurchase of common stock options and common stock .................. (3,208) (177) (42,129)
Other ................................................................ -- 23 --
--------- --------- ---------
Net cash provided by financing activities ............................... 479,493 454,470 681,835
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents .................... 100,025 (2,413) 17,882
Cash and cash equivalents at beginning of period ........................ 52,219 54,632 36,750
--------- --------- ---------
Cash and cash equivalents at end of period .............................. $ 152,244 $ 52,219 $ 54,632
========= ========= =========
Reconciliation of cash and cash equivalents at end of period:
Cash and amounts due from depository institutions .................... $ 12,243 $ 6,878 $ 4,200
Interest earning deposits ............................................ 140,001 13,341 50,432
Federal funds sold and repurchase agreements ......................... -- 32,000 --
--------- --------- ---------
$ 152,244 $ 52,219 $ 54,632
========= ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest ............................................................. $ 148,895 $ 115,015 $ 72,626
========= ========= =========
Income taxes ......................................................... $ 28,228 $ 4,725 $ 12,858
========= ========= =========
Supplemental schedule of non-cash investing and financing activities:
Exchange of discount loans and loans available for sale for securities $ 897,358 $ 375,621 $ 83,875
========= ========= =========
Real estate owned acquired through foreclosure ....................... $ 205,621 $ 102,140 $ 185,001
========= ========= =========
Transfer of mortgage-related securities from held for investment
to available for sale .............................................. $ -- $ -- $ 73,706
========= ========= =========
THE ACCOMPANYING NOTES ARE INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
27
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
Ocwen Financial Corporation ("Ocwen" or the "Company") is a financial
services holding company engaged primarily in the acquisition, servicing and
resolution of nonperforming and underperforming mortgage loans ("discount
loans"), multi-family residential and commercial real estate lending activities,
subprime single family residential lending activities and various investment
activities including mortgage related securities and, low-income housing tax
credit interests. The Company's consolidated financial statements include the
accounts of Ocwen and its subsidiaries. The Company owns directly and indirectly
all of the outstanding common and preferred stock of its primary subsidiaries,
Ocwen Federal Bank FSB (the "Bank") and, Investors Mortgage Insurance Holding
Company ("IMI"). Ocwen also owns 93.7% of Ocwen Financial Services ("OFS"), with
the remaining 6.3% owned by Admiral Home Loan ("Admiral") and reported in the
consolidated financial statements as a minority interest. All significant
intercompany transactions and balances have been eliminated in consolidation.
The Bank is a federally chartered savings bank regulated by the Office of
Thrift Supervision ("OTS"). IMI's primary subsidiaries are engaged in hotel
operations and other real estate related ventures. OFS is engaged in subprime
single family residential lending activities.
Reclassification
Certain amounts included in the 1996 and 1995 consolidated financial
statements have been reclassified in order to conform to the 1997 presentation.
Consolidated Statements of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, interest bearing and non-interest bearing deposits and all highly
liquid debt instruments purchased with an original maturity of three months or
less. Cash flows associated with items intended as hedges of identifiable
transactions or events are classified in the same category as the cash flows
from the items being hedged.
Trading Activities
From time to time, the Company purchases investment and mortgage-backed and
related securities into its trading account. In addition, securities acquired
and sold shortly thereafter resulting from the securitization of loans available
for sale are accounted for as the sale of loans and the purchase and sale of
trading securities. Securities held for trading purposes are carried at market
value with the unrealized gains or losses included in gains on sales of interest
earning assets, net.
Securities Available for Sale
Certain mortgage-related securities are designated as assets available for
sale because the Company does not intend to hold them to maturity. Securities
available for sale are carried at market value with the net unrealized gains or
losses reported as a separate component of stockholders' equity. Unrealized
losses on securities that reflect a decline in value which is other than
temporary, if any, are charged to earnings. At disposition, the realized net
gain or loss is included in earnings on a specific identification basis. The
amortization of premiums and accretion of discounts are computed using the
interest method after considering actual and estimated prepayment rates, if
applicable. Actual prepayment experience is periodically reviewed and effective
yields are recalculated when differences arise between prepayments originally
anticipated and amounts actually received plus anticipated future prepayments.
During December 1995, in conjunction with a transition provision provided
by the Financial Accounting Standards Board pertaining to the classification of
securities in accordance with Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities", the Company transferred all of its mortgage-related securities held
for investment, with a book value of $75,194 and a market value of $73,706 to
securities available for sale.
Investment Securities
Non-marketable equity securities held for investment are stated at cost
because the Company has the ability and the intent to hold them to maturity.
Investments in marketable equity securities are designated as available for
sale and are carried at market value based on quoted market prices. Net
unrealized gains or losses are reported as a separate component of stockholders'
equity. Unrealized losses on securities that reflect a decline in value which is
other than temporary, if any, are charged to earnings.
28
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
Loan Available for Sale and Held for Investment
Loans originated or purchased by the Company which the Company presently
does not intend to hold to maturity are designated as loans available for sale
upon origination or purchase and are stated at the lower of cost, after
considering deferred loan fees and costs, or aggregate market value. Upon the
sale of a loan, any unamortized deferred loan fees, net of costs, are included
in the gain or loss on sale of interest earning assets. Gains and losses on
disposal of such assets are computed on a specific identification basis.
Loans held for investment are stated at amortized cost, less an allowance
for loan losses, because the Company has the ability and the intent to hold them
to maturity.
Interest income is accrued as it is earned. Loans are placed on non-accrual
status after being delinquent greater than 89 days, or earlier if the borrower
is deemed by management to be unable to continue performance. When a loan is
placed on non-accrual status, interest accrued but not received is reversed.
While a loan is on non-accrual status, interest is recognized only as cash is
received. Loans are returned to accrual status only when the loan is reinstated
and ultimate collectibility of future interest is no longer in doubt.
Loan origination fees and certain direct loan origination costs are
deferred and recognized over the lives of the related loans as a yield
adjustment and included in interest income using the interest method applied on
a loan-by-loan basis.
Allowance for Estimated Loan Losses on Loan Portfolio
The allowance for estimated loan losses is maintained at a level that
management, based upon an evaluation of known and inherent risks in the
portfolio, considers adequate to provide for potential losses. Specific
valuation allowances are established for impaired loans in the amount by which
the carrying value, before allowance for estimated losses, exceeds the fair
value of collateral less costs to dispose on an individual loan basis, except
for single family residential mortgage loans and consumer loans which are
generally evaluated for impairment as homogeneous pools of loans. The Company
considers a loan to be impaired when, based upon current information and events,
it believes that it is probable that the Company will be unable to collect all
amounts due according to the contractual terms of the loan agreement on a timely
basis. The Company measures these impaired loans at the fair value of the loans'
underlying collateral less estimated disposal costs. Impaired loans may be left
on accrual status during the period the Company is pursuing repayment of the
loan. These loans are placed on non-accrual status at such time that the loans
either: (i) become 90 days delinquent; or (ii) the Company determines the
borrower is incapable of, or has ceased efforts toward, curing the cause of the
impairment. Impairment losses are recognized through an increase in the
allowance for loan losses and a corresponding charge to the provision for loan
losses. When an impaired loan is either sold, transferred to REO or charged off,
any related valuation allowance is credited to the allowance for loan losses.
Charge-offs occur when loans, or a portion thereof, are considered uncollectible
and of such little value that their continuance as bankable assets is not
warranted. General valuation allowances are also established for the inherent
risks in the loan portfolio which have occurred but have yet to be specifically
identified. Management's periodic evaluation of the allowance for estimated loan
losses is based upon an analysis of the portfolio, historical loss experience,
economic conditions and trends, collateral values and other relevant factors.
Future adjustments to the allowance may be necessary if economic conditions and
trends, collateral values and other relevant factors differ substantially from
the assumptions used in making the evaluation.
Discount Loan Portfolio
Certain mortgage loans, for which the borrower is not current as to
principal and interest payments or which there is a reason to believe the
borrower will be unable to continue to make its scheduled principal and interest
payments, are acquired at a discount. The Company accounts for its initial
investment in a pool of loans based upon the pricing methodologies used to bid
on the pool. The acquisition cost is allocated to each loan within the pool when
the bid price was determined based upon an analysis of the expected future cash
flows of each individual loan. The acquisition cost is accounted for in the
aggregate when the bid price was determined using assumptions concerning the
expected future cash flows from groups of loans within the pool. Prior to
January 1, 1997, the discount associated with all single family residential
loans was recognized as a yield adjustment and accreted into interest income
using the interest method applied on a loan-by-loan basis once foreclosure
proceedings are initiated, to the extent the timing and amount of cash flows
could be reasonably determined. Effective January 1, 1997, the Company ceased
accretion of discount on its nonperforming discount single family residential
loans. For those single family residential mortgage loans which are brought
current by the borrower and certain multi-family and commercial real estate
loans which are current and the Company believes will remain current, the
remaining unamortized discount is accreted into interest income as a yield
adjustment using the interest method over the contractual maturity of the loan.
For all other loans, interest is reported as cash is received. Gains on the
repayment and discharging of loans are reported as interest income. In
situations where the collateral is foreclosed upon, the loans are transferred to
real estate owned upon receipt of title to the property and accretion of the
related discount is discontinued.
29
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
Real Estate Owned
Properties acquired through foreclosure are valued at the lower of the
adjusted cost basis of the loan or fair value less estimated costs of disposal
of the property at the date of foreclosure. Properties held are periodically
re-evaluated to determine that they are being carried at the lower of cost or
fair value less estimated costs to dispose. Sales proceeds and related costs are
recognized with passage of title to the buyer and, in cases where the Company
finances the sale, receipt of sufficient down payment. Rental income related to
properties is reported as income as earned. Holding and maintenance costs
related to properties are reported as period costs as incurred. No depreciation
expense related to properties has been recorded. Decreases in market value of
foreclosed real estate subsequent to foreclosure are recognized as a valuation
allowance on a property specific basis. Subsequent increases in market value of
the foreclosed real estate are reflected as reductions in the valuation
allowance, but not below zero. Such changes in the valuation allowance are
charged or credited to income.
Valuation Allowances on Discount Loans and Real Estate Owned
Beginning in the first quarter of 1996, the Company began recording general
valuation allowances on discount loans and real estate owned to reflect the
inherent losses which have occurred but have yet to be specifically identified.
Management has established the valuation allowances based upon historical loss
experience, economic conditions and trends, collateral values and other relevant
factors. Previously, the Company recorded specific valuation allowances on real
estate owned. Also beginning in 1996, the Company began recording losses and
charge-offs on discount loans against the allowance for loan losses. Previously,
these amounts were deducted from interest income.
Investment in Real Estate
In conjunction with its multi-family and commercial lending business
activity, the Company has made certain acquisition, development and construction
loans in which the Company participates in the residual profits of the
underlying real estate and the borrower has not made an equity contribution
substantial to the overall project. As such, the Company accounts for these
loans under the equity method of accounting as though it has made an investment
in a real estate limited partnership.
The Company also has invested indirectly, through its IMI subsidiaries, in
certain hotel properties and other real estate related ventures.
Investments in Low-income Housing Tax Credit Interests
Low-income housing tax credit partnerships own multi-family residential
properties which have been allocated tax credits under the Internal Revenue
Code. The obligations of the partnership to sustain qualifying status of the
properties covers a 15-year period; however, tax credits accrue over a 10-year
period on a straight-line basis. Investments by the Company in low-income
housing tax credit partnerships made on or after May 18, 1995 in which the
Company invests solely as a limited partner, are accounted for using the equity
method in accordance with the consensus of the Emerging Issues Task Force
through issue number 94-1. For the Company's limited partnership investments
made prior to this date, the Company records its receipt of income tax credits
and other tax benefits on a level yield basis over the 15-year obligation period
and reports the tax credits and tax benefits net of amortization of its
investment in the limited partnership as a reduction of income tax expense.
Low-income housing tax credit partnerships in which the Company has invested as
a limited partner, and through a subsidiary acts as the general partner, are
presented on a consolidated basis. For all investments in low-income housing tax
credit partnerships made after May 18, 1995, the Company capitalizes interest
expense and certain direct costs incurred during the pre-operating period.
Excess of Cost Over Net Assets Acquired
The excess of purchase price over net assets of acquired businesses is
stated at cost and is amortized on a straight-line basis over the estimated
future periods to be benefited. The carrying value of cost in excess of net
assets acquired is reviewed for impairment whenever events or changes in
circumstances indicate that it may not be recoverable. If such an event
occurred, the Company would prepare projections of future results of operations
for the remaining amortization period. If such projections indicated that the
cost in excess of net assets acquired would not be recoverable, the Company's
carrying value of such asset would be reduced by the estimated excess of such
value over projected income. No such impairment existed at December 31, 1997.
Premises and Equipment
Premises and equipment are carried at cost and, except for land, are
depreciated over their estimated useful lives on the straight-line method. The
estimated useful lives of the related assets range from 3 to 10 years.
Interest Rate Risk Management Activities
The Company manages its exposure to interest rate movements by seeking to
match asset and liability balances within maturity categories, both directly and
through the use of derivative financial instruments. These derivative
instruments include interest rate swaps ("swaps") and interest rate futures
30
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
contracts that are designated and effective as hedges, as well as swaps that are
designated and effective in modifying the interest rate and/or maturity
characteristics of specified assets or liabilities.
The net interest received or paid on swaps is reflected as interest income
or expense of the related hedged position. Gains and losses resulting from the
termination of swaps are recognized over the shorter of the remaining contract
lives of the swaps or the lives of the related hedged positions or, if the
hedged positions are sold, are recognized in the current period as gains on
sales of interest earning assets, net. Gains and losses on futures contracts are
deferred and amortized over the terms of the related assets or liabilities and
reflected as interest income or expense of the related hedged positions. If the
hedged positions are sold, any unamortized deferred gains or losses on futures
contracts are recognized in the current period as gains on sales of interest
earning assets, net. Interest rate contracts are carried at fair value.
Income Taxes
The Company files consolidated Federal income tax returns with its
subsidiaries. Consolidated income tax is allocated among the subsidiaries
participating in the consolidated returns as if each subsidiary of the Company,
which has one or more subsidiaries, filed its own consolidated return.
The Company accounts for income taxes using the asset and liability method
which requires the recognition of deferred tax liabilities and assets for the
expected future tax consequences of temporary differences between the carrying
amounts and the tax basis of assets and liabilities. Additionally, deferred
taxes are adjusted for subsequent tax rate changes.
Investment in Joint Ventures
In March 1996, the Company and BlackRock Capital Finance L.P. ("BlackRock")
formed BCBF, L.L.C. (the "LLC"), a limited liability corporation, to acquire
loans from the U.S. Department of Housing and Urban Development ("HUD"). The
Company and BlackRock each owned 50% of the LLC. In December 1997, the LLC
distributed all of its assets to the Company and BlackRock. Simultaneous to the
distribution, the Company acquired BlackRock's portion of the distributed
assets. In January 1997, BCFL, L.L.C. ("BCFL"), a limited liability company, was
formed by the Company and BlackRock to acquire discount multi-family residential
loans from HUD.
The Company's investment in the LLC is accounted for under the equity
method of accounting. Under the equity method of accounting, an investment in
the shares or other interests of an investee is initially recorded at the cost
of the shares or interests acquired and thereafter is periodically increased
(decreased) by the investor's proportionate share of the earnings (losses) of
the investee and decreased by all dividends received by the investor from the
investee. The Company's investment in BCFL is accounted for under the cost
method.
The Company services all loans on behalf of the LLC for a fee, and all
intercompany transactions between the Company and the LLC are eliminated for
financial reporting purposes to the extent of the Company's ownership in the
LLC.
Basic and Diluted Earnings Per Share
Basic earnings per share is calculated based upon the weighted average
number of shares of common stock outstanding during the year. Diluted earnings
per share is calculated based upon the weighted average number of shares of
common stock outstanding and all dilutive potential common shares outstanding
during the year. The computation of diluted earnings per share includes the
impact of the exercise of the outstanding options to purchase common stock and
assumes that the proceeds from such issuance are used to repurchase common
shares at fair value.
Risks and Uncertainties
In the normal course of business, the Company encounters two significant
types of risk: economic and regulatory. There are three main components of
economic risk: interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different speeds, or different bases, than its
interest-earning assets. Credit risk is the risk of default on the Company's
loan portfolio that results from a borrowers' inability or unwillingness to make
contractually required payments. Market risk reflects changes in the value of
loans held for sale, securities available for sale and purchased mortgage
servicing rights due to changes in interest rates or other market factors,
including the rate of prepayments of principal and the value of the collateral
underlying loans and the valuation of real estate held by the Company.
The Bank is subject to the regulations of various government agencies.
These regulations can and do change significantly from period to period. The
Bank also undergoes periodic examinations by the regulatory agencies, which may
subject it to further changes with respect to asset valuations, amounts of
required loss allowances and operating restrictions resulting from the
regulators' judgments based on information available to them at the time of
their examination.
31
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
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. Material
estimates that are particularly susceptible to significant change in the near or
medium term relate to the determination of the allowance for losses on loans and
discount loans.
Recent Accounting Standards
On January 1, 1996, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation," which requires that the fair value of employee
stock-based compensation plans be recorded as a component of compensation
expense in the statement of operations as of the date of grant of awards related
to such plans or that the impact of such fair value on net income and earnings
per share be disclosed on a pro forma basis in a footnote to financial
statements for awards granted after December 15, 1994, if the accounting for
such awards continues to be in accordance with Accounting Principles Board
Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees". The Company
has elected to continue such accounting under the provisions of APB No. 25 and
has disclosed the pro forma information as required in Note 23.
On January 1, 1997, the Company adopted SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
SFAS No. 125 (i) sets forth the criteria for (a) determining when to recognize
financial and servicing assets and liabilities; and (b) accounting for transfers
of financial assets as sales or borrowings; and (ii) requires (a) liabilities
and derivatives related to a transfer of financial assets to be recorded at fair
value; (b) servicing assets and retained interests in transferred assets
carrying amounts be determined by allocating carrying amounts based on fair
value; (c) amortization of servicing assets and liabilities be in proportion to
net servicing income; (d) impairment measurement based on fair value; and (e)
pledged financial assets to be classified as collateral. SFAS No. 125 provides
implementation guidance for assessing isolation of transferred assets and for
accounting for transfers of partial interests, servicing of financial assets,
securitizations, transfers of sales-type and direct financing lease receivables,
securities lending transactions, repurchase agreements including "dollar rolls",
"wash sales", loan syndications and participations, risk participations in
banker's acceptances, factoring arrangements, transfers of receivables with
recourse and extinguishments of liabilities. In December 1996, the FASB issued
SFAS No. 127, "Deferral of the Effective Date of FASB Statement No. 125", which
delayed implementation of certain provisions of SFAS No. 125.
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share." SFAS
No. 128 simplifies the standards found in APB No. 15 for computing earnings per
share ("EPS") and makes them comparable to international standards. Under SFAS
No. 128, the Company is required to present both basic and diluted EPS on the
face of its statements of operations. Basic EPS, which replaces primary EPS
required by APB No. 15 for entities with complex capital structures, excludes
common stock equivalents and is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS gives effect to all dilutive potential common shares that
were outstanding during the period. SFAS No. 128 is effective for financial
statements for both interim and annual periods ending after December 15, 1997
with earlier application not permitted. The Company adopted SFAS No. 128
effective December 31, 1997. All prior period EPS data has been restated.
In February 1997, the FASB also issued SFAS No. 129, "Disclosure of
Financial Information About Capital Structure". SFAS No. 129 supersedes capital
structure disclosure requirements found in previous accounting pronouncements
and consolidates them into one statement for ease of retrieval and greater
visibility for non-public entities. These disclosures are required for financial
statements for periods ending after December 15, 1997. As SFAS No. 129 makes no
changes to previous accounting pronouncements as those pronouncements applied to
the Company, the adoption of SFAS No. 129 had no impact on the Company's results
of operations and financial condition.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 requires the inclusion of comprehensive income, either in
a separate statement for comprehensive income, or as part of a combined
statement of income and comprehensive income in a full-set of general-purpose
financial statements. Comprehensive income is defined as the change in equity of
a business enterprise during a period from transactions and other events and
circumstances, excluding those resulting from investments by and distributions
to owners. SFAS No. 130 requires that comprehensive income be presented
beginning with net income, adding the elements of comprehensive income not
included in the determination of net income, to arrive at comprehensive income.
SFAS No. 130 also requires that an enterprise display the accumulated balance of
other comprehensive income separately from retained earnings and additional
paid-in capital in the equity section of the statement of financial position.
SFAS No. 130 is effective for the Company's fiscal year beginning January 1,
1998. SFAS No. 130 requires the presentation of information already contained in
the Company's financial statements and therefore is not expected to have an
impact on the Company's financial position or results of operation.
In June 1997, the FASB also issued SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information." SFAS No. 131 establishes
standards for the reporting of information about operating segments by public
business enterprises in their
32
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
annual and interim financial reports issued to shareholders. SFAS No. 131
requires that a public business enterprise report financial and descriptive
information, including profit or loss, certain specific revenue and expense
items, and segment assets, about its reportable operating segments. Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision-maker in deciding how to allocate resources and in assessing
performance. SFAS No. 131 is effective for financial statements for periods
beginning after December 15, 1997. SFAS No. 131 is a disclosure requirement and
therefore is not expected to have an effect on the Company's financial position
or results of operations.
33
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 2 ACQUISITION AND DISPOSITION TRANSACTIONS
During 1997, the Company consolidated its subprime single family lending
operations within OFS in connection with its acquisition of substantially all of
the assets of Admiral in a transaction which closed on May 1, 1997. The excess
of purchase price over net assets acquired related to this transaction, which
amounted to $10,826, net of accumulated amortization of $504 at December 31,
1997, is amortized on a straight-line basis over a period of 15 years.
On November 6, 1997, the Company acquired AMOS, Inc., a Connecticut based
company engaged primarily in the development of mortgage loan servicing
software. AMOS' products are Microsoft(R) Windows(R) based, client/server
architecture and feature real-time processing, year 2000 compliance, a scaleable
database platform and strong workflow capabilities. The aggregate purchase price
was $9.7 million, including $4.9 million which is contingent on AMOS, Inc.
meeting certain software development performance criteria. The excess of
purchase price over net assets acquired related to this transaction, which
amounted to $4,735, net of accumulated amortization of $53 at December 31, 1997,
is amortized on a straight-line basis over a period of 15 years.
The Company's investment in joint ventures include investments in BCFL and
the LLC. The Company owns a 10% interest in BCFL and a 50% interest in the LLC.
BCFL was formed to acquire multifamily loans. At December 31, 1997, the
Company's 10% investment, which is accounted for under the cost method, amounted
to $1,056.
On December 12, 1997, the LLC distributed all of its assets to the Company
and its other 50% investor, BlackRock. Simultaneously, the Company acquired
BlackRock's portion of the distributed assets. The Company's 50% investment in
the LLC amounts to $0 and $67,909, net of a valuation allowance of $0 and
$5,114, at December 31, 1997 and 1996, respectively.
The Company's equity in earnings of the LLC of $23,688 and $38,320 for the
years ended December 31, 1997 and 1996, respectively, include 50% of the net
income of the LLC before deduction of the Company's 50% share of loan servicing
fees which are paid 100% to the Company. Equity in earnings for 1997 also
includes the recapture of $5,114 of valuation allowances established in 1996 by
the Company on its equity investment in the joint venture as a result of the
resolution and securitization of loans. Equity in earnings for 1996 includes a
provision for losses on the Company's equity investment in the joint venture of
$7,614. The Company has recognized 50% of the loan servicing fees not eliminated
in consolidation in servicing fees and other charges. Because the LLC is a
pass-through entity for federal income tax purposes, provisions for income taxes
were established by each of the Company and its co-investor, and not the LLC.
Set forth below are the statements of financial condition of the LLC at the
dates indicated, and statements of operations for the periods indicated.
BCBF, L.L.C.
STATEMENTS OF FINANCIAL CONDITION
December 31,
---------------------
1997 1996
--------- ---------
(Dollars in Thousands)
--------- ---------
Assets:
Cash ....................................................... $ -- $ 10
Loans held for sale, at lower of cost or market value ...... -- 110,702
Real estate owned, net of valuation allowance of $0 and $511
at December 31, 1997 and 1996, respectively .............. -- 25,595
Other assets ............................................... -- 10,526
-------- --------
$ -- $146,833
======== ========
Liabilities and Owners' Equity
Liabilities:
Accrued expenses, payables and other liabilities ......... $ -- $ 787
-------- --------
Total liabilities ........................................ -- 787
-------- --------
Owners' Equity:
Ocwen Federal Bank FSB ................................... -- 73,023
BlackRock Capital Finance L.P. ........................... -- 73,023
-------- --------
Total owners' equity ..................................... -- $146,046
-------- --------
$ -- $146,833
======== ========
34
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
BCBF, L.L.C.
STATEMENTS OF OPERATIONS
For the Period For the Period
January 1, 1997 March 13, 1996
Through Through
December 31, December 31,
1997 1996
-------------- --------------
Interest income ............................... $ 8,928 $ 38,647
Interest expense .............................. -- 18,503
.............................................. -------- --------
Net interest income ......................... 8,928 20,144
.............................................. -------- --------
Non-interest income:
Gain on sale of loans held for sale ......... 27,994 71,156
Gain on sale of loan servicing rights........ -- 1,048
Loss on real estate owned, net .............. (93) (130)
Loan fees ................................... 23 50
-------- --------
27,924 72,124
Operating expenses:
Loan servicing fees ......................... 1,850 5,743
Other loan expenses ......................... 13 273
-------- --------
1,863 6,016
-------- --------
Net income .................................... $ 34,989 $ 86,252
======== ========
In October 1996, the LLC securitized 9,825 loans with an unpaid principal
balance of $419,382, past due interest of $86,131 and a net book value of
$394,234. Proceeds from sales of the related securities by the LLC amounted to
$466,806. In March 1997, as part of a larger transaction involving the Company
and an affiliate of BlackRock, the LLC securitized 1,196 loans with an unpaid
principal balance of $51,714, past due interest of $14,209 and a net book value
of $40,454. Proceeds from the sale of the related securities amounted to
$58,866. In December 1997, as part of a larger transaction involving the Company
and BlackRock, the LLC securitized 534 loans with an unpaid principal balance of
$26,644, past due interest of $8,303 and a net book value of $20,139. Proceeds
from the sale of the related securities amounted to $30,178. The Company
continues to service the securitized loans and is paid a servicing fee.
35
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 3 DISCONTINUED OPERATIONS
In September 1995, the Company announced its decision to dispose of its
automated banking division and related activities. As a result of this decision,
a loss of $3,204, net of tax benefit of $1,776 was recorded consisting of a net
loss of $1,954 on the sale of assets and a loss of $1,250 incurred from related
operations until the sales and dispositions, both of which were substantially
complete at December 31, 1995. Losses from operations of the discontinued
division, net of tax, amounted to $4,468 for the nine months ended September 30,
1995. Gross revenues from the automated banking division and related activities
for the year ended December 31, 1995 amounted to $1,822.
36
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 4 FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the Company's assets, liabilities and off-balance
sheet instruments and commitments are considered financial instruments. For the
majority of the Company's financial instruments, principally loans and deposits,
fair values are not readily available since there are no available trading
markets as characterized by current exchanges between willing parties.
Accordingly, fair values can only be derived or estimated using various
valuation techniques, such as computing the present value of estimated future
cash flows using discount rates commensurate with the risks involved. However,
the determination of estimated future cash flows is inherently subjective and
imprecise. In addition, for those financial instruments with option-related
features, prepayment assumptions are incorporated into the valuation techniques.
It should be noted that minor changes in assumptions or estimation methodologies
can have a material effect on these derived or estimated fair values.
The fair values reflected below are indicative of the interest rate
environments as of December 31, 1997 and 1996 and do not take into consideration
the effects of interest rate fluctuations. In different interest rate
environments, fair value results can differ significantly, especially for
certain fixed-rate financial instruments and non-accrual assets. In addition,
the fair values presented do not attempt to estimate the value of the Company's
fee generating businesses and anticipated future business activities. In other
words, they do not represent the Company's value as a going concern.
Furthermore, the differences between the carrying amounts and the fair values
presented may not be realized because, except as indicated, the Company
generally intends to hold these financial instruments to maturity and realize
their recorded values.
Reasonable comparability of fair values among financial institutions is
difficult due to the wide range of permitted valuation techniques and numerous
estimates that must be made in the absence of secondary market prices. This lack
of objective pricing standards introduces a degree of subjectivity to these
derived or estimated fair values. Therefore, while disclosure of estimated fair
values of financial instruments is required, readers are cautioned in using this
data for purposes of evaluating the financial condition of the Company.
The methodologies used and key assumptions made to estimate fair value, the
estimated fair values determined and recorded carrying values follow:
Cash and Cash Equivalents
Cash and cash equivalents have been valued at their carrying amounts as
these are reasonable estimates of fair value given the relatively short period
of time between origination of the instruments and their expected realization.
Investments and Mortgage-Backed and Related Securities
For investments and mortgage-backed and related securities, fair value
equals quoted price, if available. For securities for which a quoted market
price is not available, fair value is estimated using quoted market prices for
similar instruments.
Loans and Discount Loans
The fair value of performing whole loans is estimated based upon quoted
market prices for similar whole loan pools. The fair value of the discount loan
portfolio is estimated based upon current market yields at which recent pools of
similar mortgages have traded taking into consideration the timing and amount of
expected cash flows.
Low-Income Housing Tax Credit Interests
The fair value of the investments in low-income housing tax credit
interests is estimated by discounting the future tax benefits expected to be
realized from these investments using discount rates at which similar
investments were being made on or about the respective financial statement
dates.
Deposits
The fair value of demand deposits, savings accounts and money market
deposits is the amount payable on demand at the reporting date. The fair value
of fixed-maturity certificates of deposit is estimated by discounting the
required cash payments at the market rates offered for deposits with similar
maturities on or about the respective financial statement dates.
Borrowings
The fair value of the Company's notes and debentures and capital securities
are based upon quoted market prices. The fair value of the Company's other
borrowings is estimated based upon the discount value of the future cash flows
expected to be paid on such borrowings using estimated market discount rates
that reflect the borrowings of others with similar terms and maturities.
37
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
Risk Management Instruments
The fair value of interest rate swap agreements is the estimated amount
that the Company would receive or pay to terminate the swap agreements at the
reporting date taking into account interest rates and the credit worthiness of
the swap counterparties on or about the respective financial statement dates.
Market quotes are used to estimate the fair value of interest rate futures
contracts.
Loan Commitments
The fair value of loan commitments is estimated considering the difference
between interest rates on or about the respective financial statement dates and
the committed rates.
Real Estate Owned
Real estate, although not a financial instrument, is an integral part of
the Company's business. The fair value of real estate is estimated based upon
appraisals, broker price opinions and other standard industry valuation methods,
less anticipated selling costs.
The carrying amounts and the estimated fair values of the Company's
financial instruments and real estate owned are as follows:
December 31, 1997 December 31, 1996
------------------------------------- -------------------------------------
Carrying Amount Fair Value Carrying Amount Fair Value
----------------- ---------------- ----------------- -----------------
FINANCIAL ASSETS:
Cash and cash equivalents................ $ 152,244 $ 152,244 $ 52,219 $ 52,219
Securities held for trading.............. -- -- 75,606 75,606
Securities available for sale............ 430,524 430,524 354,005 354,005
Loans available for sale................. 177,041 184,884 126,366 128,784
Investment securities.................... 59,567 59,567 8,901 8,901
Loan portfolio, net...................... 266,299 281,850 402,582 410,934
Discount loan portfolio, net............. 1,434,176 1,657,222 1,060,953 1,140,686
Investments in low-income housing tax
credit interests....................... 128,614 151,130 93,309 113,850
Real estate owned, net................... 167,265 212,443 103,704 130,221
FINANCIAL LIABILITIES:
Deposits................................. 1,982,822 2,024,857 1,919,742 1,934,717
Advances from the Federal Home Loan Bank -- -- 399 399
Securities sold under agreements
to repurchase.......................... 108,250 108,250 74,546 74,546
Obligations outstanding under lines of credit 118,304 118,304 -- --
Notes, debentures and other interest
bearing obligations.................... 226,975 255,538 225,573 246,511
Capital securities........................ 125,000 135,313 -- --
OTHER:
Loan commitments......................... 225,569 225,569 194,128 194,128
38
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 5 SECURITIES HELD FOR TRADING
The Company held no securities for trading at December 31, 1997. The book
and fair values and gross unrealized gains and losses for the Company's
securities held for trading at December 31, 1996 were as follows:
Gross Gross
Book Unrealized Unrealized Fair
Value Gains Losses Value
---------- ------------ ------------ ------------
Collateralized mortgage obligations......... $ 75,526 $ -- $ (140) $ 75,386
Futures contracts........................... -- 220 -- 220
---------- ------------ ------------ ------------
$ 75,526 $ 220 $ (140) $ 75,606
========== ============ ============ ============
The Company traded assets totaling $1,023,965, $373,723 and $93,942 in
aggregate sales proceeds during the years ended December 31, 1997, 1996 and
1995, respectively, primarily in connection with the Company's securitizations
of loans, resulting in realized net gains of $72,214, $14,645 and $2,949 for the
years ended December 31, 1997, 1996 and 1995, respectively. Unrealized gains on
securities held for trading and included in gains on sales of interest earning
assets amounted to $0, $80 and $0, respectively, in 1997, 1996 and 1995.
39
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 6 SECURITIES AND LOANS AVAILABLE FOR SALE
The amortized cost, fair value and gross unrealized gains and losses on the
Company's securities and loans available for sale are as follows at the periods
ended:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ----------- ----------- ---------
DECEMBER 31, 1997:
Mortgage-related securities:
Single family residential:
AAA-rated collateralized mortgage
obligations.......................... $ 160,347 $ 195 $ (91) $ 160,451
FHLMC interest only.................... 73,214 219 (8,688) 64,745
FNMA interest only..................... 71,215 829 (12,329) 59,715
GNMA interest only..................... 35,221 -- (5,455) 29,766
AAA-rated interest only................ 14,700 19 (856) 13,863
Subordinates........................... 62,247 6,587 (1,004) 67,830
REMIC residuals........................ 17,267 -- (1,574) 15,693
Swaps.................................. -- -- (94) (94)
---------- -------- ---------- ---------
434,211 7,849 (30,091) 411,969
---------- -------- ---------- ---------
Multi-family and commercial:
AAA-rated interest only................ 1,008 229 (207) 1,030
Non-investment grade interest only..... 2,743 734 -- 3,477
Subordinates........................... 12,107 2,047 (106) 14,048
---------- -------- ---------- ---------
15,858 3,010 (313) 18,555
---------- -------- ---------- ---------
$ 450,069 $ 10,859 $ (30,404) $ 430,524
========== ======== ========== =========
Loans:
Single family residential.............. $ 176,554 $ 7,843 $ -- $ 184,397
Consumer loans......................... 487 -- -- 487
---------- -------- ---------- ---------
$ 177,041 $ 7,843 $ -- $ 184,884
========== ======== ========== =========
40
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ----------- ---------
DECEMBER 31, 1996:
Mortgage-related securities:
Single- family residential:
AAA-rated collateralized mortgage
obligations.......................... $ 74,224 $ 227 $ (516) $ 73,935
FHLMC interest only.................... 46,735 963 (127) 47,571
FNMA interest only..................... 48,573 1,315 (508) 49,380
AAA-rated interest only................ 1,166 27 (20) 1,173
Subordinates........................... 15,550 3,614 -- 19,164
REMIC residuals........................ 19,211 1,349 -- 20,560
Futures contracts...................... -- 19 (1,940) (1,921)
---------- --------- ---------- ---------
205,459 7,514 (3,111) 209,862
---------- --------- ---------- ---------
Multi-family and commercial:
AAA-rated interest only................ 82,996 1,353 (759) 83,590
Non-investment grade interest only..... 3,620 205 (26) 3,799
Subordinates........................... 56,500 1,856 (822) 57,534
Futures contracts...................... -- -- (780) (780)
---------- --------- ---------- ---------
143,116 3,414 (2,387) 144,143
---------- --------- ---------- ---------
$ 348,575 $ 10,928 $ (5,498) $ 354,005
========== ========= ========== =========
Loans:
Single family residential................ 111,980 $ 2,948 $ (970) $ 113,958
Multi-family residential................. 13,657 305 13,962
Consumer loans........................... 729 143 (8) 864
---------- --------- ---------- ---------
$ 126,366 $ 3,396 $ (978) $ 128,784
========== ========= ========== =========
A profile of the maturities of securities available for sale at December
31, 1997 follows. Mortgage-backed securities are included based on their
weighted-average maturities, reflecting anticipated future prepayments based on
a consensus of dealers in the market.
Amortized Cost Fair Value
-------------- -----------
Due within one year........................................... $ 120,839 $ 120,700
Due after 1 through 5 years................................... 246,204 223,873
Due after 5 through 10 years.................................. 79,322 81,655
Due after 10 years............................................ 3,704 4,296
----------- -----------
$ 450,069 $ 430,524
=========== ===========
41
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
Gross realized gains and losses, proceeds on sales, premiums amortized
against and discounts accreted to income were as follows during the periods
ended December 31:
1997 1996 1995
--------- --------- ---------
Securities:
Gross realized gains.......................................... $ 9,637 $ 4,323 $ 1,266
Gross realized losses......................................... (3,591) (3,757) (2,079)
--------- --------- ---------
Net realized gains (losses)................................... $ 6,046 $ 566 $ (813)
========= ========= =========
Proceeds on sales............................................. $ 202,670 $ 175,857 $ 836,247
========= ========= =========
Premiums amortized against interest income.................... $ 73,019 $ 23,508 $ 5,188
Discounts accreted to interest income......................... $ (6,734) (3,261) (3,135)
--------- --------- ---------
Net premium amortization...................................... $ 66,285 $ 20,247 $ 2,053
========= ========= =========
Loans:
Gross realized gains.......................................... $ 4,069 $ 2,150 $ 1,817
Gross realized losses......................................... (1,662) (3,152) --
--------- --------- ---------
Net realized gains (losses)................................... $ 2,407 $ (1,002) $ 1,817
========= ========= =========
Proceeds on sales............................................. $ 519,163 $ 397,606 $ 100,104
========= ========= =========
One security in the available for sale portfolio, with a market value of
$12,334, is pledged as collateral to the State of New Jersey in connection with
the Bank's sales of certificates of deposit over $100 to New Jersey
municipalities. Additionally, certain mortgage-related securities are pledged as
collateral for securities sold under agreements to repurchase (see Note 16).
42
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 7 INVESTMENT SECURITIES
The book and fair values and gross unrealized gains and losses on the
Company's investment securities are as follows at December 31:
Gross Gross
Book Unrealized Unrealized Fair
Value Gains Losses Value
---------- ---------- ---------- ---------
1997:
Marketable Equity Securities:
Other common stocks...................... $ 38,545 $ 9,638 $ (1,911) $ 46,272
Non-marketable Equity Securities:
Federal Home Loan Bank stock............. 10,825 -- -- 10,825
Limited partnership interests............ 2,470 -- -- 2,470
---------- -------- ---------- ---------
$ 51,840 $ 9,638 $ (1,911) $ 59,567
========== ======== ========== =========
1996:
Non-marketable Equity Securities:
Federal Home Loan Bank stock............. $ 8,798 $ -- $ -- $ 8,798
Limited partnership interests............ 103 -- -- 103
---------- -------- ---------- ---------
$ 8,901 $ -- $ -- $ 8,901
========== ======== ========== =========
Included in interest income on investment securities and other for the
periods ended December 31, 1997, 1996 and 1995 are $1,603, $1,767 and $1,388,
respectively, of deferred fees accreted on tax residuals (see Note 21).
As a member of the FHLB system, the Bank is required to maintain an
investment in the capital stock of the FHLB in an amount at least equal to the
greater of 1% of residential mortgage assets, 5% of outstanding borrowings
(advances) from the FHLB, or 0.3% of total assets. FHLB capital stock is
generally pledged to secure FHLB advances.
The Company's investment in other common stocks at December 31, 1997 is
primarily comprised of 1,715,000 shares of stock in OAIC with a book value and
fair value of $25,519 and $35,158, respectively.
Dividends earned on FHLB stock and other common stocks amounted to $2,000,
$567 and $505 during 1997, 1996 and 1995, respectively.
43
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 8 LOAN PORTFOLIO
The Company's loan portfolio consisted of the following at December 31:
1997 1996
----------- -----------
Carrying value:
Single family residential................................... $ 46,226 $ 73,186
Multi-family residential:
Permanent................................................. 38,105 31,252
Construction.............................................. 33,277 36,590
----------- -----------
Total multi-family residential............................ 71,382 67,842
----------- -----------
Commercial real estate:
Hotel:
Permanent............................................... 64,040 173,947
Construction............................................ 25,322 26,364
Office ................................................... 68,759 128,782
Land ..................................................... 2,858 2,332
Other .................................................... 16,094 25,623
----------- -----------
Total commercial real estate............................ 177,073 357,048
----------- -----------
Commercial non-mortgage....................................... -- 2,614
----------- -----------
Consumer ..................................................... 244 424
----------- -----------
Total loans............................................. 294,925 501,114
Undisbursed loan funds.......................................... (22,210) (89,840)
Unaccreted discount........................................... (2,721) (5,169)
Allowance for loan losses..................................... (3,695) (3,523)
----------- -----------
Loans, net.............................................. $ 266,299 $ 402,582
=========== ===========
At December 31, 1997 the Company had $4,382 of single family residential
loans and $3,686 of multi-family residential loans outstanding, at market
interest rates and terms, which were issued to facilitate the sale of the
Company's real estate owned and real estate held for development.
Included in the loan portfolio at December 31, 1997 and 1996 are $101,126
and $315,871 respectively, of loans in which the Company participates in the
residual profits of the underlying real estate, of which $88,954 and $233,749,
respectively, have been funded. The Company records any residual profits as part
of interest income when received.
44
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
The following table presents a summary of the Company's nonperforming
loans, allowance for loan losses and significant ratios at and for the years
ended December 31:
1997 1996 1995
--------- --------- ---------
Nonperforming loans:
Single family residential..................................... $ 1,575 $ 2,123 $ 2,923
Multi-family.................................................. 7,583 106 731
Consumer...................................................... -- 55 202
--------- --------- ---------
$ 9,158 $ 2,284 $ 3,856
--------- --------- ---------
Allowance for loan losses:
Balance at beginning of year.................................. $ 3,523 $ 1,947 $ 1,071
Provision for loan losses..................................... 325 1,872 1,121
Charge-offs................................................... (153) (296) (263)
Recoveries.................................................... -- -- 18
--------- --------- ---------
Balance at end of year........................................ $ 3,695 $ 3,523 $ 1,947
========= ========= =========
Significant ratios:
Nonperforming loans as a percentage of:
Loans......................................................... 3.36% 0.56% 1.27%
Total assets.................................................. 0.30% 0.09% 0.20%
Allowance for loan losses as a percentage of:
Loans......................................................... 1.39% 0.87% 0.65%
Nonperforming loans........................................... 40.35% 154.24% 50.49%
Net charge-offs (recoveries) as a percentage of average loans. 0.04% 0.09% 0.19%
If non-accrual loans had been current in accordance with their original
terms, interest income for the years ended December 31, 1997, 1996 and 1995
would have been approximately $515, $214 and $322 higher, respectively. No
interest has been accrued on loans greater than 89 days past due.
At December 31, 1997, the Company had no investment in impaired loans as
defined in accordance with SFAS No. 114, and as amended by SFAS No. 118.
The loan portfolio is geographically located throughout the United States.
The following table sets forth the five states in which the largest amount of
properties securing the Company's loans were located at December 31, 1997.
Singe Family Multi-family Commercial
Residential Residential Real Estate Consumer Total
----------- ----------- ----------- ----------- -----------
New York............................................ $ 3,871 $ 31,835 $ 23,068 $ -- $ 58,774
New Jersey.......................................... 27,433 5,448 2,544 9 35,434
California.......................................... 2,771 4,763 20,213 -- 27,747
Maryland............................................ 140 -- 26,008 -- 26,148
Illinois............................................ 56 -- 21,098 -- 21,154
Other............................................... 11,955 29,336 84,142 235 125,668
----------- ----------- ----------- ----------- -----------
Total............................................... $ 46,226 $ 71,382 $ 177,073 $ 244 $ 294,925
=========== =========== =========== =========== ===========
45
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 9 DISCOUNT LOAN PORTFOLIO
The Company has acquired, through private sales and auctions, mortgage
loans at a discount because the borrowers are either not current as to principal
and interest payments or there is doubt as to the borrowers' ability to pay in
full the contractual principal and interest. The Company estimates the amounts
it will realize through foreclosure, collection efforts or other resolution of
each loan and the length of time required to complete the collection process in
determining the amounts it will bid to acquire such loans.
The resolution alternatives applied to the discount loan portfolio are (i)
the borrower brings the loan current in accordance with original or modified
terms; (ii) the borrower repays the loan or a negotiated amount; (iii) the
borrower agrees to a deed-in-lieu of foreclosure, in which case it is classified
as real estate owned and held for sale by the Company and (iv) the Company
forecloses on the loan and the property is either acquired at the foreclosure
sale by a third-party or by the Company, in which case it is classified as real
estate owned and held for sale. The Company periodically reviews the discount
loan portfolio performance to ensure that nonperforming loans are carried at the
lower of amortized cost or net realizable value of the underlying collateral and
the remaining unaccreted discount is adjusted accordingly. Upon receipt of title
to the property, the loans are transferred to real estate owned.
The Company's discount loan portfolio consists of the following at December
31:
Carrying Value
-------------------------------
1997 1996
----------- -----------
Loan type:
Single family residential................................... $ 900,817 $ 504,049
Multi-family residential.................................... 191,302 341,796
Commercial real estate...................................... 701,035 465,801
Other....................................................... 1,865 2,753
----------- -----------
Total discount loans...................................... 1,795,019 1,314,399
Unaccreted discount......................................... (337,350) (241,908)
Allowance for loan losses................................... (23,493) (11,538)
----------- -----------
Discount loans, net......................................... $ 1,434,176 $ 1,060,953
----------- -----------
The following table sets forth the payment status at December 31 of the
loans in the Company's gross discount loan portfolio:
December 31, 1997 December 31, 1996
------------------------------ ------------------------------
Principal Percentage Principal Percentage
Amount of Loans Amount of Loans
----------- ----------- ----------- -----------
Loans without Forbearance Agreements:
Current..................................... $ 670,115 37.33% $ 572,043 43.52%
Past due 31 to 89 days...................... 21,098 1.18 19,458 1.48
Past due 90 days or more.................... 638,319 35.56 506,113 38.51
Acquired and servicing not yet transferred.. 28,053 1.56 149,564 11.38
----------- -------- ----------- ---------
Subtotal.................................... 1,357,585 75.63 1,247,178 94.89
----------- -------- ----------- ---------
Loans with Forbearance Agreements:
Current..................................... 3,140 0.18 7,554 0.57
Past due 31 to 89 days...................... 1,688 0.09 2,703 0.21
Past due 90 days or more.................... 432,606(1) 24.10 56,964 4.33
----------- -------- ----------- ---------
Subtotal.................................... 437,434 24.37 67,221 5.11
----------- -------- ----------- ---------
Total....................................... $ 1,795,019 100.00% $ 1,314,399 100.00 %
=========== ======== =========== =========
- -------------------
(1) Includes $316.3 million of loans which were less than 90 days past due
under the terms of the forbearance agreements at December 31, 1997, of
which $184.5 million were current and $131.8 million were past due 31 to 89
days.
46
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
A summary of income on discount loans is as follows for the years ended
December 31:
1997 1996 1995
--------- --------- ---------
Interest Income:
Realized.................................................... $ 157,649 $ 97,174 $ 70,807
Accreted and unrealized..................................... -- 5,991 5,191
--------- --------- ---------
$ 157,649 $ 103,165 $ 75,998
========= ========= =========
Gains on Sales:
Realized gains on sales..................................... $ 4,215 $ 7,393 $ 6,008
========= ========= =========
Proceeds on sales........................................... $ 500,151 $ 190,616 $ 38,942
========= ========= =========
Proceeds on sales of discount loans during 1997 and 1996 include non-cash
proceeds related to the exchange of discount loans for securities in connection
with the Company's securitization activities (see Note 5).
The following table sets forth the activity in the Company's gross discount
loan portfolio during the years ended December 31:
1997 1996 1995
------------ ----------- ----------
Principal balance at beginning of year........................ $ 1,314,399 $ 943,529 $ 785,434
Acquisitions.................................................. 1,776,773 1,110,887 791,195
Resolutions and repayments.................................... (484,869) (371,228) (300,161)
Loans transferred to real estate owned........................ (292,412) (138,543) (281,344)
Sales......................................................... (518,872) (230,246) (51,595)
------------ ----------- ----------
Principal balance at end of year ............................. $ 1,795,019 $ 1,314,399 $ 943,529
============ =========== ==========
The discount loan portfolio is geographically located throughout the United
States. The following table sets forth the five states in which the largest
amount of properties securing the Company's discount loans were located at
December 31, 1997:
Commercial
Single family Multi-family Real Estate
Residential Residential and Other Total
------------- ------------ ----------- -----------
California............................. $ 160,042 $ 59,473 $ 91,627 $ 311,142
New Jersey............................. 80,442 3,430 137,026 220,898
New York............................... 98,248 9,527 93,677 201,452
Connecticut............................ 54,802 21,856 27,074 103,732
Pennsylvania........................... 39,616 52,599 3,329 95,544
Other.................................. 467,667 44,417 350,167 862,251
---------- --------- ----------- -----------
Total.................................. $ 900,817 $ 191,302 $ 702,900 $ 1,795,019
========== ========= =========== ===========
The following schedule presents a summary of the Company's allowance for
loan losses and significant ratios for its discount loans at and for the years
ended December 31:
1997 1996 1995
--------- --------- ---------
Allowance for loan losses:
Balance at beginning of year.................................. $ 11,538 $ -- $ --
Provision for loan losses..................................... 31,894 20,578 --
Charge-offs................................................... (20,349) (9,216) --
Recoveries.................................................... 410 176 --
--------- --------- ---------
Balance at end of year........................................ $ 23,493 $ 11,538 $ --
========= ========= =========
Significant ratios:
Allowances for loan losses as a percentage of
discount loan portfolio, net.................................... 1.64% 1.09% --%
Net charge-offs (recoveries) as a percentage of average discount loans 1.55% 1.34% --%
47
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 10 REAL ESTATE OWNED
Real estate owned, net of allowance for losses, is held for sale and
consists of the following at December 31:
1997 1996
----------- -----------
Discount loan portfolio:
Single family residential................................... $ 76,409 $ 49,728
Multi-family residential.................................... 16,741 14,046
Commercial real estate...................................... 71,339 36,264
----------- -----------
Total discount loan portfolio............................. 164,489 100,038
Loan portfolio................................................ 357 592
Loans available for sale...................................... 2,419 3,074
----------- -----------
$ 167,265 $ 103,704
=========== ===========
The following schedule presents the activity, in aggregate, in the
valuation allowances on real estate owned for the years ended December 31:
1997 1996 1995
--------- --------- ---------
Balance at beginning of year.................................. $ 11,493 $ 4,606 $ 3,937
Provision for losses.......................................... 13,450 18,360 10,510
Charge-offs and sales......................................... (12,597) (11,473) (9,841)
--------- --------- ---------
Balance at end of year........................................ $ 12,346 $ 11,493 $ 4,606
========= ========= =========
The following table sets forth the results of the Company's investment in
real estate owned, which were primarily related to the discount loan portfolio,
during the years ended December 31:
1997 1996 1995
--------- --------- ---------
Gains on sales................................................ $ 30,651 $ 22,835 $ 19,006
Provision for losses.......................................... (13,450) (18,360) (10,510)
(Carrying costs) rental income, net........................... (9,924) (648) 1,044
--------- --------- ---------
$ 7,277 $ 3,827 $ 9,540
========= ========= =========
NOTE 11 INVESTMENT IN REAL ESTATE
December 31,
-------------------------------
1997 1996
----------- -----------
Loans accounted for as investments in real estate:
Multi-family residential.................................... $ 61,967 $ 24,946
Nonresidential.............................................. 2,369 --
Hotels........................................................ 1,426 16,087
Other......................................................... 210 --
----------- -----------
$ 65,972 $ 41,033
=========== ===========
During 1997, the Company sold a 69% partnership interest in the one hotel
it owned and operated.
48
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 12 MORTGAGE SERVICING RIGHTS
The Company services for other investors mortgage loans which it does not
own. The total amount of such loans serviced for others was $5,509,819 and
$1,918,098 at December 31, 1997 and 1996, respectively. Servicing fee income on
such loans amounted to $22,056, $2,414 and $493 for the years ended December 31,
1997, 1996 and 1995, respectively.
The unamortized balance of mortgage servicing rights, which are included in
other assets, is as follows at December 31:
1997 1996
----------- -----------
Unamortized balance................. $ 7,369 $ 4,048
Valuation allowance................. (1,630) (1,630)
----------- -----------
$ 5,739 $ 2,418
=========== ===========
Periodically, the Company evaluates the recoverability of mortgage
servicing rights based on the projected value of future net servicing income.
Future prepayment rates are estimated based on current interest rates and
various portfolio characteristics, including loan type, interest rate, and
market prepayment estimates. If the estimated recovery is lower than the current
amount of mortgage servicing rights, a reduction to mortgage servicing rights is
recorded through an increase in the valuation allowance. Valuation allowances
were established through charges to servicing fees and other charges during 1996
primarily as a result of higher than projected prepayment rates.
NOTE 13 INVESTMENTS IN LOW INCOME HOUSING TAX CREDIT INTERESTS
The carrying value of the Company's investments in low-income housing tax
credit interests are as follows at December 31:
1997 1996
----------- -----------
Investments solely as a limited partner made
prior to May 18, 1995....................................... $ 31,418 $ 55,595
Investments solely as a limited partner made on or after
May 18, 1995................................................ 47,153 12,887
Investments as both a limited and, through subsidiaries,
general partner............................................. 50,043 24,827
----------- -----------
$ 128,614 $ 93,309
=========== ===========
The qualified affordable housing projects underlying the Company's
investments in low-income housing tax credit interests are geographically
located throughout the United States. At December 31, 1997, the Company's
largest single investment was $9,693 which is in a project located in Racine,
Wisconsin.
Income on the Company's limited partnership investments made prior to May
18, 1995, is recorded under the level yield method as a reduction of income tax
expense, and amounted to $6,846, $8,144 and $7,709 for the years ended December
31, 1997, 1996 and 1995, respectively. Had these investments been accounted for
under the equity method, net income would have been reduced by $2,779, $2,223
and $2,798 for the years ended December 31, 1997, 1996 and 1995, respectively.
For limited partnership investments made after May 18, 1995, and for investments
as a limited and, through subsidiaries, general partner, the Company recognized
tax credits of $8,035 and $1,186 for the years ended December 31, 1997 and 1996,
respectively, and recorded a loss of $4,935 and $636 from operations of the
underlying real estate after depreciation for the years ended December 31, 1997
and 1996, respectively.
Other liabilities include $0 and $9,105 at December 31, 1997 and 1996,
respectively, representing contractual obligations to fund certain limited
partnerships which invest in low-income housing tax credit interests.
Included in other income for the years ended December 31, 1997 and 1996 are
gains of $6,298 and $4,861, respectively, on the sales of certain investments in
low-income housing tax credit interests which had carrying values of $15,728 and
$19,806, respectively, at time of sale.
NOTE 14 PREMISES AND EQUIPMENT
December 31,
-------------------------------
1997 1996
----------- -----------
Land ......................................................... $ 773 $ 485
Leasehold improvements........................................ 7,664 5,999
Office and computer equipment................................. 28,675 15,950
Less accumulated depreciation and amortization................ (15,570) (7,815)
----------- -----------
$ 21,542 $ 14,619
=========== ===========
49
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 15 DEPOSITS
The Company's deposits consist of the following at December 31:
1997 1996
--------------------------------- --------------------------------
Weighted Book Weighted Book
Average Rate Value Average Rate Value
------------- ----------- ------------ -----------
Non-interest bearing deposits............ --% $ 130,372 --% $ 96,563
NOW and money market
checking accounts...................... 4.73 27,624 2.99 22,208
Savings accounts......................... 2.30 1,664 2.30 2,761
----------- -----------
159,660 121,532
----------- -----------
Certificates of deposit.................. 1,834,899 1,809,098
Unamortized deferred fees................ (11,737) (10,888)
----------- -----------
6.00 1,823,162 5.80 1,798,210
----------- -----------
Total deposits........................... 5.95 $ 1,982,822 5.47 $ 1,919,742
=========== ===========
At December 31, 1997 and 1996, certificates of deposit include $1,607,043
and $1,572,081, respectively, of deposits originated through national, regional
and local investment banking firms which solicit deposits from their customers,
all of which are non-cancelable. Additionally, at December 31, 1997 and 1996,
$133,738 and $147,488, respectively, of certificates of deposit were issued on
an uninsured basis. Of the $133,738 of uninsured deposits at December 31, 1997,
$98,069 were from political subdivisions in New Jersey and secured or
collateralized as required under state law. Non-interest bearing deposits
include $96,518 and $82,885 of advance payments by borrowers for taxes,
insurance and principal and interest collected but not yet remitted in
accordance with loan servicing agreements at December 31, 1997 and 1996,
respectively.
The contractual maturity of the Company's certificates of deposit at
December 31, 1997 follows:
CONTRACTUAL REMAINING MATURITY:
Within one year.................................... $ 840,463
Within two years................................... 376,628
Within three years................................. 234,244
Within four years.................................. 225,479
Within five years.................................. 146,013
Thereafter......................................... 335
-------------
$ 1,823,162
=============
The amortization of the deferred fees of $6,619, $5,384 and $4,729 for the years
ended December 31, 1997, 1996 and 1995, respectively, is computed using the
interest method and is included in interest expense on certificates of deposit.
The interest expense by type of deposit account is as follows for the years
ended December 31:
1997 1996 1995
--------- --------- ---------
NOW accounts and money market checking........................ $ 1,220 $ 620 $ 1,031
Savings ...................................................... 49 78 451
Certificates of deposit....................................... 120,801 93,075 70,371
--------- --------- ---------
$ 122,070 $ 93,773 $ 71,853
========= ========= =========
Accrued interest payable on deposits amounted to $21,967 and $18,249 at
December 31, 1997 and 1996, respectively.
50
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 16 SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Company periodically enters into sales of securities under agreements
to repurchase the same securities (reverse repurchase agreements). Fixed coupon
reverse repurchase agreements with maturities of three months or less are
treated as financings, and the obligations to repurchase securities sold are
reflected as a liability in the accompanying consolidated statements of
financial condition. All securities underlying reverse repurchase agreements are
reflected as assets in the accompanying consolidated statements of financial
condition and are held in safekeeping by broker/dealers.
Year Ended December 31,
-----------------------------------
1997 1996 1995
-------- -------- --------
Other information concerning securities sold
under agreements to repurchase:
Balance at end of year ............................. $108,250 $ 74,546 $ 84,761
Accrued interest payable at end of year ............ $ 306 $ 12 $ 153
Weighted average interest rate at end of year ...... 6.06% 5.46% 5.70%
Average balance during the year .................... $ 16,717 $ 19,581 $ 16,754
Weighted average interest rate during the year ..... 5.98% 5.62% 5.68%
Maximum month-end balance .......................... $108,250 $ 84,321 $ 84,761
Mortgage-related securities at amortized cost of $121,371 and a market
value of $120,168 were posted as collateral for securities sold under agreements
to repurchase at December 31, 1997.
51
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 17 NOTES, DEBENTURES AND OTHER INTEREST BEARING OBLIGATIONS
Notes, debentures and other interest bearing obligations mature as follows:
December 31,
-------------------------------
1997 1996
----------- ----------
1998:
7.063% note due January 31.................................... 1,975 --
2003:
11.875% notes due October 1................................... 125,000 125,000
2005:
12% subordinated debentures due June 15....................... 100,000 100,000
2014:
0 - 8.5% mortgage loan due December 1......................... -- 573
----------- -----------
$ 226,975 $ 225,573
=========== ===========
On June 12, 1995, the Bank issued $100,000 of 12% Subordinated Debentures
due 2005 (the "Debentures") with interest payable semiannually on June 15 and
December 15. The Debentures are unsecured general obligations of the Bank and
are subordinated in right of payment to all existing and future senior debt.
The Debentures may not be redeemed prior to June 15, 2000, except as
described below. On or after such date, the Debentures may be redeemed at any
time at the option of the Bank, in whole or in part, together with accrued and
unpaid interest, if any, on not less than 30 nor more than 60 days notice at the
following redemption prices (expressed as a percentage of the principal amount),
if redeemed during the twelve month period beginning June 15 of the years
indicated below:
Year Redemption Price
-------------------------------- ---------------------------------
2000 105.333%
2001 104.000%
2002 102.667%
2003 101.333%
2004 and thereafter 100.000%
In addition, the Bank may redeem, at its option, up to $35,000 principal
amount of the Debentures at any time prior to June 15, 1998 with the net cash
proceeds received by the Bank from one or more public equity offerings at a
purchase price of 112.000% of the principal amount thereof, plus accrued and
unpaid interest.
In connection with the issuance of the Debentures, the Bank incurred
certain costs which have been capitalized and are being amortized on a
straight-line basis over the expected life of the Debentures. The unamortized
balance of these issuance costs amounted to $2,319 and $2,745, at December 31,
1997 and 1996, respectively, and is included in other assets. Accrued interest
payable on the Debentures amounted to $500 at December 31, 1997 and 1996, and is
included in accrued expenses, payables and other liabilities.
On September 25, 1996, the Company completed the public offering of
$125,000 aggregate principal of 11.875% Notes due October 1, 2003 ("the Notes")
with interest payable semi-annually on April 1 and October 1. The Notes are
unsecured general obligations of the Company and are subordinated in right of
payment to the claims of creditors of the Company and the Company's
subsidiaries.
The Notes may not be redeemed prior to October 1, 2001 except as described
below. On or after such date, the Notes may be redeemed at any time at the
option of the Company, in whole or in part, at the following redemption prices
(expressed as a percentage of the principal amount) plus accrued and unpaid
interest, if redeemed during the twelve-month period beginning October 1 of the
years indicated below:
Year Redemption Price
-------------------------------- ----------------------------------
2001 105.938%
2002 102.969%
In addition, the Company may redeem, at its option, up to 35% of the
original aggregate principal amount of the Notes at any time and from time to
time until October 1, 1999 with the net cash proceeds received by the Company
from one or more public or private equity offerings at a redemption price of
111.875% of the principal amount thereof, plus accrued and unpaid interest.
52
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
The indenture governing the Notes requires the Company to maintain, at all
times when the Notes are not rated in an investment grade category by one or
more nationally recognized statistical rating organizations, unencumbered liquid
assets with a value equal to 100% of the required interest payments due on the
Notes on the next two succeeding semi-annual interest payment dates. The Company
maintained a $15,000 investment in cash and cash equivalents at December 31,
1997 and 1996 that is restricted for purposes of meeting this liquidity
requirement. The indenture further provides that the Company shall not sell,
transfer or otherwise dispose of shares of common stock of the Bank or permit
the Bank to issue, sell or otherwise dispose of shares of its common stock
unless in either case the Bank remains a wholly-owned subsidiary of the Company.
Proceeds from the offering of the Notes amounted to approximately $120,156
(net of underwriting discount). On September 30, 1996, the Company contributed
$50,000 of such proceeds to the Bank to support future growth. The remainder of
the proceeds retained by the Company have been available for general corporate
purposes, with the exception of the liquidity maintenance requirement described
above.
In connection with the issuance of the Notes, the Company incurred certain
costs which have been capitalized and are being amortized on a straight-line
basis over the life of the Notes. The unamortized balance of these issuance
costs amounted to $4,647 and $5,252 at December 31, 1997 and 1996, respectively,
and is included in other assets. Accrued interest payable on the Notes amounted
to $3,711 and $3,752 at December 31, 1997 and 1996, respectively, and is
included in accrued expenses, payables and other liabilities.
53
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 18 CAPITAL SECURITIES
In August 1997, OCT, issued $125.0 million of 10 7/8% Capital Securities
(the "Capital Securities"). Proceeds from issuance of the Capital Securities
were invested in 10 7/8% Junior Subordinated Debentures issued by Ocwen. The
Junior Subordinated Debentures, which represent the sole assets of OCT, will
mature on August 1, 2027.
Holders of the Capital Securities will be entitled to receive cumulative
cash distributions accruing from the date of original issuance and payable
semi-annually in arrears on February 1 and August 1 of each year, commencing on
February 1, 1998, at an annual rate of 10 7/8% of the liquidation amount of
$1,000 per Capital Security. Payment of distributions out of moneys held by OCT,
and payments on liquidation of OCT or the redemption of Capital Securities, are
guaranteed by the Company to the extent OCT has funds available. If the Company
does not make principal or interest payments on the Junior Subordinated
Debentures, OCT will not have sufficient funds to make distributions on the
Capital Securities, in which event the guarantee shall not apply to such
distributions until OCT has sufficient funds available therefor. Accumulated
distributions payable on the Capital Securities amounted to $5,249 at December
31, 1997 and is included in accrued interest payable.
The Company has the right to defer payment of interest on the Junior
Subordinated Debentures at any time or from time to time for a period not
exceeding 10 consecutive semi-annual periods with respect to each deferral
period, provided that no extension period may extend beyond the stated maturity
of the Junior Subordinated Debentures. Upon the termination of any such
extension period and the payment of all amounts then due on any interest payment
date, the Company may elect to begin a new extension period. Accordingly, there
could be multiple extension periods of varying lengths throughout the term of
the Junior Subordinated Debentures. If interest payments on the Junior
Subordinated Debentures are deferred, distributions on the Capital Securities
will also be deferred and the Company may not, and may not permit any subsidiary
of the Company to, (i) declare or pay any dividends or distributions on, or
redeem, purchase, acquire, or make a liquidation payment with respect to, the
Company's capital stock or (ii) make any payment of principal, interest or
premium, if any, on or repay, repurchase or redeem any debt securities that rank
pari passu with or junior to the Junior Subordinated Debentures. During an
extension period, interest on the Junior Subordinated Debentures will continue
to accrue at the rate of 10 7/8% per annum, compounded semi-annually.
The Junior Subordinated Debentures are redeemable prior to maturity at the
option of the Company, subject to the receipt of any necessary prior regulatory
approval, (i) in whole or in part on or after August 1, 2007 at a redemption
price equal to 105.438% of the principal amount thereof on August 1, 2007
declining ratably on each August 1 thereafter to 100% on or after August 1,
2017, plus accrued interest thereon, or (ii) at any time, in whole (but not in
part), upon the occurrence and continuation of a special event (defined as a tax
event, regulatory capital event or an investment company event) at a redemption
price equal to the greater of (a) 100% of the principal amount thereof or (b)
the sum of the present values of the principal amount and premium payable with
respect to an optional redemption of such Junior Subordinated Debentures on
August 1, 2007, together with scheduled payments of interest from the prepayment
date to August 1, 2007, discounted to the prepayment date on a semi-annual basis
at the adjusted Treasury rate plus accrued interest thereon to the date of
prepayment. The Capital Securities are subject to mandatory redemption, in whole
or in part, upon repayment of the Junior Subordinated Debentures at maturity or
their earlier redemption, in an amount equal to the amount of the related Junior
Subordinated Debentures maturing or being redeemed and at a redemption price
equal to the redemption price of the Junior Subordinated Debentures, plus
accumulated and unpaid distributions thereon to the date of redemption.
For financial reporting purposes, OCT is treated as a subsidiary of the
Company and, accordingly, the accounts of OCT are included in the consolidated
financial statements of the Company. Intercompany transactions between OCT and
the Company, including the Junior Subordinated Debentures, are eliminated in the
consolidated financial statements of the Company. The Capital Securities are
presented as a separate caption between liabilities and stockholders' equity in
the consolidated statement of financial condition of the Company as
"Company-obligated, mandatorily redeemable securities of subsidiary trust
holding solely junior subordinated debentures of the Company". Distributions on
the Capital Securities are recorded as a separate caption immediately following
non-interest expense in the consolidated statement of operations of the Company.
The Company intends to continue this method of accounting going forward.
In connection with the issuance of the Capital Securities, the Company
incurred certain costs which have been capitalized and are being amortized over
the term of the Capital Securities. The unamortized balance of these issuance
costs amounted to $4,262 at December 31, 1997 and is included in other assets.
54
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 19 BASIC AND DILUTED EARNINGS PER SHARE
The Company is required to present both basic and diluted EPS on the face
of its statement of operations. Basic EPS, which replaced primary EPS required
by APB 15, is calculated by dividing net income by the weighted average number
of common shares outstanding during the year. Diluted EPS is calculated by
dividing net income by the weighted average number of common shares outstanding
and the dilutive potential common shares related to outstanding stock options.
The following is a reconciliation of the calculation of basic EPS to diluted
EPS.
1997 1996 1995
---------- ---------- ----------
Net income............................................................. $ 78,932 $ 50,142 $ 25,467
========== ========== ==========
Basic EPS:
Weighted average shares of common stock................................ 56,185,956 50,556,572 51,712,415
========== ========== ==========
Basic EPS........................................................... $ 1.40 $ 0.99 $ 0.49
========== ========== ==========
Diluted EPS:
Weighted average shares of common stock................................ 56,185,956 50,556,572 51,712,415
Effect of dilutive securities:
Stock options 650,528 2,822,310 3,825,745
---------- ---------- ----------
56,836,484 53,378,882 55,538,160
========== ========== ==========
Diluted EPS......................................................... $ 1.39 $ 0.94 $ 0.46
========== ========== ==========
55
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 20 INTEREST RATE RISK MANAGEMENT INSTRUMENTS
In managing its interest rate risk, the Company on occasion enters into
swaps. Under swaps, the Company agrees with other parties to exchange, at
specified intervals, the difference between fixed-rate and floating-rate
interest amounts calculated by reference to an agreed notional amount. The terms
of the swaps provide for the Company to receive a floating rate of interest
based on the London Interbank Offered Rate ("LIBOR") and to pay fixed interest
rates. The notional amount of the swap outstanding at December 31, 1997 is
amortized (i.e., reduced) monthly based on estimated prepayment rates. The terms
of the outstanding swap, at December 31, 1997 and 1996 are as follows:
Notional Floating Rate
Maturity Amount LIBOR Index Fixed Rate at End of Year Fair Value
------------------ ------------ --------------- ------------- --------------- -------------
December 31, 1997 $ 36,860 1-Month 6.18% 5.69% $ (94)
December 31, 1996 $ 45,720 1-Month 6.18% 5.67% $ (103)
The 1-month LIBOR was 5.72% on December 31, 1997. The interest expense or
benefit of the swaps had the effect of increasing (decreasing) net interest
income by $(198), $(58) and $358 for the years ended December 31, 1997, 1996 and
1995, respectively.
The Company also enters into short sales of Eurodollar and U.S. Treasury
interest rate futures contracts as part of its overall interest rate risk
management activity. Interest rate futures contracts are commitments to either
purchase or sell designated financial instruments at a future date for a
specified price and may be settled in cash or through delivery. The Eurodollar
futures contracts have been sold by the Company to hedge the maturity risk of
certain short duration mortgage-related securities. U.S. Treasury futures have
been sold by the Company to hedge the risk of a reduction in the market value of
fixed rate mortgage loans and certain fixed rate mortgage-backed and related
securities available for sale in a rising interest rate environment.
Terms and other information on interest rate futures contracts sold short
are as follows:
Notional Fair
Maturity Principal Value
----------- ----------- ---------
December 31, 1997:
U.S. Treasury futures............................................... 1998 $ 194,500 $ 1,996
December 31, 1996:
Eurodollar futures.................................................. 1997 $ 365,000 $ (558)
1998 40,000 (87)
U.S. Treasury futures............................................... 1997 165,100 498
The following table summarizes the Company's use of interest rate risk
management instruments.
Notional Amount
-------------------------------------
Short Short
Eurodollar U.S. Treasury
Swaps Futures Futures
--------- ---------- ----------
Balance, December 31, 1995............................................. $ -- $ 412,000 $ 11,100
Purchases........................................................... 47,350 564,000 3,362,400
Maturities.......................................................... (1,630) -- --
Terminations........................................................ -- (571,000) (3,208,400)
--------- --------- ----------
Balance, December 31, 1996............................................. 45,720 405,000 165,100
Purchases........................................................... -- -- 966,400
Maturities.......................................................... (8,860) -- --
Terminations........................................................ -- (405,000) (937,000)
--------- --------- ----------
Balance, December 31, 1997............................................. $ 36,860 $ -- $ 194,500
========= ========= ==========
Because interest rate futures contracts are exchange traded, holders of
these instruments look to the exchange for performance under these contracts and
not the entity holding the offsetting futures contract, thereby minimizing the
risk of nonperformance under these contracts. The Company is exposed to credit
loss in the event of nonperformance by the counterparty to the swap and controls
this risk through credit monitoring procedures. The notional principal amount
does not represent the Company's exposure to credit loss.
U.S. Treasury Bills with a carrying value of $2,055 and $3,138 and a fair
value of $2,055 and $3,138 were pledged by the Company as security for the
obligations under these swaps and interest rate futures contracts at December
31, 1997 and 1996, respectively.
56
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 21 INCOME TAXES
Total income tax expense (benefit) was allocated as follows:
Years Ended December 31,
-------------------------------------
1997 1996 1995
--------- --------- ---------
Income from continuing operations................................... $ 21,309 $ 11,159 $ 4,562
Discontinued operations............................................. -- -- (4,097)
Benefit of tax deduction in excess of amounts recognized for
financial reporting purposes related to employee stock options
reflected in stockholders' equity................................. (1,965) (2,987) (375)
--------- --------- ---------
$ 19,344 $ 8,172 $ 90
========= ========= =========
The components of income tax expense (benefit) attributable to income from
continuing operations were as follows:
Years Ended December 31,
-------------------------------------
1997 1996 1995
--------- --------- ---------
Current:
Federal..................................................... $ 42,482 $ (6,844) $ 1,673
State....................................................... 3,579 (576) 5,011
--------- --------- ---------
46,061 (7,420) 6,684
--------- --------- ---------
Deferred:
Federal..................................................... (23,085) 16,616 1,762
State....................................................... (1,667) 1,963 (3,884)
--------- --------- ---------
(24,752) 18,579 (2,122)
--------- --------- ---------
Total..................................................... $ 21,309 $ 11,159 $ 4,562
========= ========= =========
Income tax expense differs from the amounts computed by applying the U.S.
Federal corporate income tax rate of 35% as follows:
Years Ended December 31,
-------------------------------------
1997 1996 1995
--------- --------- ---------
Expected income tax expense at statutory rate.......................... $ 34,838 $ 21,455 $ 13,196
Differences between expected and actual tax:
Excess of cost over net assets acquired adjustments.................... (30) (76) (76)
Tax effect of utilization of net operating loss........................ (906) (1,782) (1,380)
State tax (after Federal tax benefit).................................. 1,243 901 733
Low-income housing tax credits......................................... (14,881) (9,330) (7,709)
Adjustments resulting from IRS audit................................... 921 -- --
Other.................................................................. 124 (9) (202)
--------- --------- ---------
Actual income tax expense........................................... $ 21,309 $ 11,159 $ 4,562
========= ========= =========
For taxable years beginning prior to January 1, 1996, a savings institution
that met certain definitional tests relating to the composition of its assets
and the sources of its income (a "qualifying savings institution") was permitted
to establish reserves for bad debts and make annual additions thereto under the
experience method. Alternatively, a qualifying savings institution could elect,
on an annual basis, to use the percentage of taxable income method to compute
its allowable addition to its bad debt reserve on qualifying real property loans
(generally loans secured by an interest in improved real estate). The applicable
percentage was 8% for tax periods after 1987. The Bank utilized the percentage
of taxable income method for these years.
On August 20, 1996, President Clinton signed the Small Business Job
Protection Act (the "Act") into law. One provision of the Act repealed the
reserve method of accounting for bad debts for savings institutions effective
for taxable years beginning after 1995. The Bank, therefore, was required to use
the specific charge-off method on its 1996 and subsequent federal income tax
returns. The Bank will be required to recapture its "applicable excess
reserves", which are its federal tax bad debt reserves in excess of the base
year reserve amount described in the following paragraph. The Bank will include
one-sixth of its applicable excess reserves in taxable income in each year from
1996 through 2001. As of December 31, 1995, the Bank had approximately $42.4
million of applicable excess reserves. As of December 31, 1996, the Bank had
fully provided for the tax related to this recapture.
57
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
The base year reserves will continue to be subject to recapture and the
Bank could be required to recognize a tax liability if: (1) the Bank fails to
qualify as a "bank" for federal income tax purposes, (2) certain distributions
are made with respect to the stock of the Bank, (3) the bad debt reserves are
used for any purpose other than to absorb bad debt losses, or (4) there is a
change in federal tax law. The enactment of this legislation is expected to have
no material impact on the Bank's or the Company's operations or financial
position.
In accordance with SFAS No. 109 "Accounting for Income Taxes," a deferred
tax liability has not been recognized for the tax bad debt base year reserves of
the Bank. The base year reserves are generally the balance of reserves as of
December 31, 1987 reduced proportionately for reductions in the Bank's loan
portfolio between that date and December 31, 1995. At December 31, 1997 and
1996, the amount of those reserves was approximately $5.7 million. This reserve
could be recognized in the future under the conditions described in the
preceding paragraph.
The net deferred tax asset was comprised of the following:
December 31,
-------------------------------
1997 1996
----------- -----------
Deferred Tax Assets:
Tax residuals and deferred income on tax residuals.................. $ 3,497 $ 3,712
State taxes......................................................... 2,203 552
Application of purchase accounting.................................. 655 1,503
Accrued profit sharing.............................................. 3,234 1,422
Accrued other liabilities........................................... 2,495 420
Deferred interest expense on discount loan portfolio................ 7,685 3,989
Mark-to-market and reserves on REO properties....................... 3,187 3,513
Gain on loan foreclosure............................................ 5,635 --
Bad debt and loan loss reserves..................................... 9,770 --
Reserves on securities held for sale................................ 4,007 --
Other............................................................... 495 --
----------- -----------
42,863 15,111
----------- -----------
Deferred Tax Liabilities:
Bad debt and loan loss reserves..................................... -- 810
Deferred interest income on discount loan portfolio................. 2,254 4,632
Partnership losses.................................................. 1,386 1,205
Other............................................................... 763 500
----------- -----------
4,403 7,147
----------- -----------
38,460 7,964
Mark-to-market on certain mortgage-backed and
related securities available for sale............................. 6,688 (2,104)
----------- -----------
45,148 5,860
----------- -----------
Deferred tax asset valuation allowance.............................. -- --
----------- -----------
Net deferred tax assets............................................. $ 45,148 $ 5,860
=========== ===========
Deferred tax assets, net of deferred fees, include tax residuals which
result from the ownership of Real Estate Mortgage Investment Conduits ("REMIC").
While a tax residual is anticipated to have little or no future cash flows from
the REMIC from which it has been issued, the tax residual does bear the income
tax liability and benefit resulting from the annual differences between the
interest paid on the debt instruments issued by the REMIC and the interest
received on the mortgage loans held by the REMIC. Typically this difference
generates taxable income to the Company in the first several years of the REMIC
and equal amounts of tax losses thereafter, thus resulting in the deferred tax
asset. As a result of the manner in which REMIC residual interests are treated
for tax purposes, at December 31, 1997, 1996 and 1995, the Company had
approximately $0, $10,228 and $55,000, respectively, of net operating loss
carryforwards for tax purposes.
IMI, a wholly owned subsidiary of the Company, had at December 31, 1997
approximately $9,680 of Separate Return Limitation Year ("SRLY") net operating
loss carryforward. These SRLY net operating loss carryforwards can only offset
IMI future taxable income. Net operating loss carryforward of $8,044 and $1,636
will expire, if unused, in years 2005 and 2007, respectively. In addition,
International Hotel Group ("IHG"), a wholly owned subsidiary of IMI, and IHG's
subsidiaries had at December 31, 1997 approximately $828 of SRLY net operating
loss carryforwards. The SRLY net operating loss carryforward can only offset IHG
and its subsidiaries' future taxable income. The $828 operating loss
carryforward will expire, if unused, in the year 2008.
58
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
As a result of the Company's earnings history, current tax position and
taxable income projections, the Company believes that it will generate
sufficient taxable income in future years to realize the net deferred tax asset
position as of December 31, 1997. In evaluating the expectation of sufficient
future taxable income, the Company considered future reversals of temporary
differences and available tax planning strategies that could be implemented, if
required.
A valuation allowance was not required as of December 31, 1997 and 1996 as
it was the Company's assessment that, based on available information, it is more
likely than not that all of the deferred tax asset will be realized. A valuation
allowance will be established in the future to the extent of a change in the
Company's assessment of the amount of the net deferred tax asset that is
expected to be realized.
NOTE 22 RETIREMENT PLAN
The Company maintains a defined contribution 401(k) plan. The Company
matches 50% of each employee's contributions, limited to 2% of the employee's
compensation.
In connection with its acquisition of Berkeley Federal Savings Bank in June
1993, the Bank assumed the obligations under a noncontributory defined benefit
pension plan (the "Plan") covering substantially all employees upon their
eligibility under the terms of the Plan. The Plan was frozen for the plan year
ended December 31, 1993 and has been fully funded.
The Company's combined contributions to 401(k) plan in the years ended
December 31, 1997, 1996 and 1995 were $368, $258 and $248, respectively.
59
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 23 STOCKHOLDERS' EQUITY
On July 12, 1996 stockholders of the Company approved an amendment to the
Company's articles of incorporation to increase the authorized number of common
shares from 20,000,000 to 200,000,000 shares, to increase the authorized number
of preferred shares from 250,000 to 20,000,000 shares and to decrease the par
value of the authorized preferred shares from $1.00 to $0.01 per share. On July
30, 1996, the Company's Board of Directors declared a 10-for-1 stock split for
each share of common stock then outstanding in the form of a stock dividend
which was paid to holders of record on July 31, 1996. On October 29, 1997, the
Company's Board of Directors approved a 2-for-1 stock split of its issued and
outstanding common stock. The stock split was effected through the distribution
of authorized but unissued shares of its common stock on November 20, 1997, to
holders of record of its common stock at the close of business on November 12,
1997. All references in the consolidated financial statements to the number of
shares and per share amounts have been adjusted retroactively for the
recapitalization and the stock splits.
During September 1996, 2,928,830 shares of common stock were issued in
connection with the exercise of vested stock options by certain of the Company's
and the Bank's current and former officers and directors. The Company loaned
$6,654 to certain of such officers to fund their exercise of the stock options.
Such notes, which are presented as a reduction of shareholders' equity, had an
unpaid principal balance of $0 and $3,832 at December 31, 1997 and 1996,
respectively, bear interest at 10.5% per annum, are payable in two equal
installments on March 1, 1998 and March 1, 1999 and are secured by the related
shares of common stock. These notes were repaid during 1997.
On September 25, 1996, certain stockholders of Ocwen completed an
initial public offering of 2,300,000 shares of Ocwen common stock. At that time,
the Company's common stock began trading on the NASDAQ National Market System
under the symbol "OCWEN". Prior to this offering, there had been no public
trading market for the common stock. The Company did not receive any of the
proceeds from this common stock offering.
On August 12, 1997, the Company completed a secondary stock offering to the
public of 3,450,000 shares which resulted in net proceeds of $141,898. Effective
August 1, 1997, shares of the Company's common stock began trading on the New
York Stock Exchange ("NYSE") under the symbol "OCN". Upon effectiveness of the
NYSE listing, the Company delisted its common stock from NASDAQ.
During 1995, the Company repurchased from stockholders and retired
8,815,060 shares of common stock for the aggregate price of $41,997.
In December 1991, as part of its annual incentive compensation plan, the
Company adopted a Non-Qualified Stock Option Plan (the "Stock Plan"). The Stock
Plan provides for the issuance of stock options to key employees to purchase
shares of common stock at prices less than the fair market value of the stock at
the date of grant.
Options Exercise Options Forfeited or Options
Granted Price Exercised Repurchased Vested
---------- ---------- ------------- --------------- ----------
1995:................ 594,760 $ 2.880 194,232 231,148 169,380
1995:................ 14,220 0.472 -- -- 14,220
1996:................ 1,147,370 11.000 -- 63,158 1,084,212
1997:................ 1,083,794 20.350 -- -- --
The difference between the fair market value of the stock at the date of
grant and the exercise price is treated as compensation expense. Included in
compensation expense is $5,514, $2,725, and $65 for the years ended December 31,
1997, 1996 and 1995, respectively, related to options granted.
60
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
The Company adopted SFAS No. 123 during 1996. In accordance with the
provisions of SFAS No. 123, the Company has retained its current accounting
method for its stock-based employee compensation plans under the provisions of
APB 25. However, entities continuing to apply APB 25 are required to disclose
pro forma net income and earnings per share as if the fair value method of
accounting for stock-based employee compensation plans as prescribed by SFAS No.
123 had been utilized. The following is a summary of the Company's pro forma
information:
Years ending December 31,
----------------------------
1997 1996
-------- --------
Net income (as reported)...................................... $ 78,932 $ 50,142
Pro forma net income.......................................... $ 72,668 $ 47,777
Earnings per share (as reported): ............................
Basic....................................................... $ 1.40 $ 0.99
Diluted..................................................... $ 1.39 $ 0.94
Pro forma earnings per share: ................................
Basic....................................................... $ 1.29 $ 0.95
Diluted..................................................... $ 1.28 $ 0.90
The fair value of the option grants were estimated using the Black-Scholes
option-pricing model with the following assumptions:
Years ending December 31,
---------------------------
1997 1996
------- -------
Expected dividend yield....................................... 0.00% 0.00%
Expected stock price volatility............................... 48.00% 21.00%
Risk-free interest rate....................................... 5.71% 6.20%
Expected life of options...................................... 5 years 5 years
61
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 24 REGULATORY REQUIREMENTS
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") and the regulations promulgated thereunder established certain
minimum levels of regulatory capital for savings institutions subject to OTS
supervision. The Bank must follow specific capital guidelines stipulated by the
OTS which involve quantitative measures of the Bank's assets, liabilities and
certain off-balance sheet items. An institution that fails to comply with its
regulatory capital requirements must obtain OTS approval of a capital plan and
can be subject to a capital directive and certain restrictions on its
operations. At December 31, 1997, the minimum regulatory capital requirements
were:
o Tangible and core capital of 1.5 percent and 3 percent of total adjusted
assets, respectively, consisting principally of stockholders' equity, but
excluding most intangible assets, such as goodwill and any net unrealized
holding gains or losses on debt securities available for sale.
o Risk-based capital consisting of core capital plus certain subordinated
debt and other capital instruments and, subject to certain limitations,
general valuation allowances on loans receivable, equal to 8 percent of the
value of risk-weighted assets.
o At December 31, 1997, the Bank was "well capitalized" under the prompt
corrective action ("PCA") regulations adopted by the OTS pursuant to the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA").
To be categorized as "well capitalized", the Bank must maintain minimum
core capital, Tier 1 risk-based capital and risk-based capital ratios as
set forth in the table below. The Bank's capital amounts and classification
are subject to review by federal regulators about components,
risk-weightings and other factors. There are no conditions or events since
December 31, 1997 that management believes have changed the institution's
category.
The following tables summarize the Bank's actual and required regulatory
capital at December 31, 1997 and 1996.
DECEMBER 31, 1997
To Be
Well Capitalized Agreed Upon
Minimum For Capital For Prompt Corrective Capital
Actual Adequacy Purposes Action Provisions Requirements
------------------ -------------------- ------------------- -------
Ratio Amount Ratio Amount Ratio Amount Ratio
------ ----------- ------ ---------- -------- --------- -------
Stockholders' equity, and ratio to total assets. 10.62% 276,277
Net unrealized loss on certain available for
sale securities ................................... 2,378
Excess mortgage servicing rights and deferred tax
assets ............................................ (1,029)
-----------
Tangible capital, and ratio to adjusted total
assets. ........................................... 10.66% $ 277,626 1.50% $ 39,060
=========== =========
Tier 1 (core) capital, and ratio to adjusted total
assets ............................................ 10.66% $ 277,626 3.00% $ 78,120 5.00% $ 130,200 9.00%
=========== ========= =========
Tier 1 capital, and ratio to risk-weighted assets.... 10.17% $ 277,626 6.00% $ 163,837
=========== =========
Allowance for loan and lease losses.................. 27,436
Subordinated debentures.............................. 100,000
-----------
Tier 2 Capital....................................... 127,436
-----------
Total risk-based capital, and ratio to risk-weighted
assets ............................................ 14.83% $ 405,062 8.00% $ 218,449 10.00% $ 273,062 13.00%
=========== ========= =========
Total regulatory assets.............................. $ 2,602,642
===========
Adjusted total assets................................ $ 2,603,991
===========
Risk-weighted assets................................. $ 2,730,616
===========
62
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
DECEMBER 31, 1996
To Be Well Capitalized
Minimum For Capital For Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------ ------------------- -----------------------
Ratio Amount Ratio Amount Ratio Amount
------ ----------- ------- ---------- ---------- ----------
Stockholders' equity, and ratio to total assets...... 9.49% $ 228,153
Net unrealized gain on certain available for sale
securities ........................................ (3,526)
Excess mortgage servicing rights..................... (242)
Tangible capital, and ratio to adjusted total assets. 9.33% $ 224,385 1.50% $ 36,057
=========== ==========
Tier 1 (core) capital, and ratio to adjusted total
assets ............................................ 9.33% $ 224,385 3.00% $ 72,114 5.00% $ 120,190
=========== ========== ==========
Tier 1 capital, and ratio to risk-weighted assets.... 8.47% $ 224,385 6.00% $ 159,011
=========== ==========
Allowance for loan and lease losses.................. 16,057
Subordinated debentures.............................. 100,000
-----------
Tier 2 Capital....................................... 116,057
-----------
Total risk-based capital, and ratio to risk-weighted
assets ............................................ 12.85% $ 340,442 8.00% $ 212,014 10.00% $ 265,018
=========== ========== ==========
Total regulatory assets.............................. $ 2,405,188
===========
Adjusted total assets................................ $ 2,403,790
===========
Risk-weighted assets................................. $ 2,650,175
===========
The OTS has promulgated a regulation governing capital distributions. The
Bank is considered to be a Tier 1 association under this regulation because it
met or exceeded its fully phased-in capital requirements at December 31, 1996. A
Tier 1 association that before and after a proposed capital distribution meets
or exceeds its fully phased-in capital requirements may make capital
distributions during any calendar year equal to the greater of (i) 100% of net
income for the calendar year to date plus 50% of its "surplus capital ratio" at
the beginning of the year or (ii) 75% of its net income over the most recent
four-quarter period. In order to make these capital distributions, the Bank must
submit written notice to the OTS 30 days in advance of making the distribution.
In addition to these OTS regulations governing capital distributions, the
indenture governing the Bank's debentures limits the declaration or payment of
dividends and the purchase or redemption of common or preferred stock in the
aggregate to the sum of 50% of consolidated net income and 100% of all capital
contributions and proceeds from the issuance or sale (other than to a
subsidiary) of common stock, since the date the Debentures were issued (see Note
17).
In connection with an examination of the Bank in late 1996 and early 1997,
the staff of the OTS expressed concern about many of the Bank's non-traditional
operations, which generally are deemed by the OTS to involve higher risk,
certain of the Bank's accounting policies and the adequacy of the Bank's capital
in light of the Bank's lending and investment strategies. The activities which
were of concern to the OTS included the Bank's subprime single family
residential lending activities, the Bank's origination of acquisition,
development and construction loans with terms which provide for shared
participation in the results of the underlying real estate, the Bank's discount
loan activities, which involve significantly higher investment in nonperforming
and classified assets than the majority of the savings and loan industry, and
the Bank's investment in subordinated classes of mortgage-related securities
issued in connection with the Bank's asset securitization activities and
otherwise.
Although the Bank has expressed disagreement with the level of risk
perceived by the OTS in its business, the Bank has taken various other actions
to address OTS concerns with respect to its risk profile, including the
following: (i) the sale to the Company in 1996 of subordinated, participating
interests in a total of eleven acquisition, development and construction loans,
which interests had an aggregate principal balance of $16,949; (ii) the
cessation of originating mortgage loans with profit participation features in
the underlying real estate, with the exception of existing commitments, which
consisted of commitments for nine loans with an aggregate principal amount of
$79,197 at December 31, 1997; (iii) the transfer of its subprime single family
residential lending operations and its large multi-family residential and
commercial real estate lending operations to OFS and OCC, respectively; (iv) an
agreement (a) to discontinue the purchase of subordinate classes of
mortgage-related securities created by unaffiliated parties, (b) to sell the
five such securities held by it at March 31, 1997 (aggregate book value of $32.0
million), which was completed by a sale to OAIC on May 19, 1997 (at a gain of
$2.6 million to the Company), and (c) subject to the requirements of the OTS
capital distribution regulation, to dividend to the Company all subordinate
mortgage-related securities acquired by the Bank in connection with its
securitization activities, including two subordinate securities with an
aggregate book value of $19.5 million which were dividend to the Company in June
1997 and one subordinate security and one residual security with an aggregate
book value of $14.4 million which were dividended to the Company in November
1997; (v) the establishment as of December 31, 1996 of requested write downs of
cost basis, which amounted to $7.2 million, against loans and securities
resulting from its investment in loans acquired from HUD; (vi) an agreement to
employ a senior officer to head its Credit Management Department and to take
other steps to improve the effectiveness of
63
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
its independent asset review function; and (vii) an agreement to provide the OTS
with certain reports on a regular basis. In addition to the foregoing, and based
on discussions with the OTS, the Company modified certain of its accounting
policies in a manner which will result in more conservative recognition of
income. Specifically, the Company (i) ceased accreting into interest income
discount on nonperforming residential loans, effective January 1, 1997; (ii)
discontinued the capitalization of period expenses to real estate owned,
effective January 1, 1997; and (iii) agreed to classify as doubtful for
regulatory purposes all real estate owned which are not generating cash flow and
which have been held for more than three years. If the new policy on accretion
of discount on nonperforming residential loans had been applied in 1996 and
1995, the Company's income from continuing operations before income taxes, as
adjusted for related profit sharing expense, would have decreased by
approximately $1.4 million and $1.1 million, respectively. If the new policy on
capitalization of period expenses on real estate owned had been adopted in 1996
and 1995, the Company's income from continuing operations before income taxes,
as adjusted for related profit sharing expense, would have increased by
approximately $610,000 in 1996 and would have decreased by approximately $2.3
million during 1995. In light of the foregoing, the Company does not believe
that the above-referenced accounting changes had a material effect on the
Company's financial condition or results of operations.
In connection with the foregoing actions, the Bank also committed to the
OTS to maintain a core capital ratio and a total risk-based capital ratio of at
least 9% and 13%, respectively, effective June 30, 1997. Although these
individual regulatory capital requirements have been agreed to by the OTS, there
can be no assurance that in the future the OTS will agree to a decrease in such
requirements or will not seek to increase such requirements or will not impose
these or other individual regulatory capital requirements in a manner which
affects the Bank's status as a "well-capitalized" institution under applicable
laws and regulations.
64
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 25 OTHER EXPENSES
Years Ended December 31,
-------------------------------------
1997 1996 1995
--------- --------- ---------
OTHER OPERATING EXPENSES:
Loan related expenses ........................................ $ 7,014 $ 4,111 $ 2,383
Professional fees............................................. 4,909 2,293 1,884
Travel, lodging, meals and entertainment...................... 2,636 1,522 1,151
Due diligence costs........................................... 1,977 564 784
FDIC insurance................................................ 1,593 3,098 2,212
Amortization of offering costs................................ 1,302 622 234
Marketing..................................................... 774 701 968
Conferences and seminars...................................... 666 295 173
Corporate insurance........................................... 611 441 410
Investment and treasury services.............................. 458 438 387
OTS assessment................................................ 375 293 257
Deposit related expenses...................................... 255 91 304
Other......................................................... 4,201 458 932
--------- --------- ---------
$ 26,771 $ 14,927 $ 12,079
========= ========= =========
Included in the 1996 results of operations is a non-recurring expense of
$7,140 related to the Federal Deposit Corporation's ("FDIC") assessment to
recapitalize the Savings Association Insurance Fund ("SAIF") as a result of
federal legislation passed into law on September 30, 1996.
NOTE 26 BUSINESS LINE REPORTING
The Company considers itself to be involved in the single business segment
of providing financial services and conducts a variety of business activities
within this segment. Such activities are as follows:
Net Interest Non-Interest Net Income Total
Income Income (1) (Loss) Assets
----------- ----------- ----------- -----------
DECEMBER 31, 1997:
Discount Loans:
Single family residential loans ......... $ (8,293) $ 68,829 $ 22,384 $ 844,164
Large Commercial ........................ 33,684 20,299 23,476 582,877
Small Commercial ........................ 15,749 1,949 5,194 288,029
Investment in low-income housing tax credits (4,311) 6,053 9,353 128,614
Commercial lending ......................... 29,152 (1,634) 11,802 253,496
Subprime single family lending ............. 7,170 17,533 (1,526) 225,813
Mortgage loan servicing .................... 3,128 26,966 3,780 13,411
Investment securities ...................... 12,814 6,902 5,615 642,335
Other ...................................... (5,069) 659 (1,146) 90,426
----------- ----------- ----------- -----------
$ 84,024 $ 147,556 $ 78,932 $ 3,069,165
=========== =========== =========== ===========
DECEMBER 31, 1996:
Discount Loans:
Single family residential loans ......... $ 3,787 $ 34,095 $ 12,580 $ 650,261
Large Commercial ........................ 14,046 21,745 16,179 516,622
Small Commercial ........................ 11,993 (189) 3,687 283,466
Investment in low-income housing tax credits (3,857) 4,470 7,269 93,309
Commercial lending ......................... 14,843 (389) 3,785 402,582
Subprime single family lending ............. 4,787 6,423 4,115 128,878
Mortgage loan servicing .................... 1,697 7,495 2,559 5,020
Investment securities ...................... 15,783 (2,244) 2,226 342,801
Other ...................................... (7,795) 4,217 (2,258) 60,746
----------- ----------- ----------- -----------
$ 55,284 $ 75,623 $ 50,142 $ 2,483,685
=========== =========== =========== ===========
65
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
DECEMBER 31, 1995:
Discount Loans:
Single family residential loans................ $ 14,889 $ 2,507 $ 4,778 $ 360,742
Large Commercial............................... 12,986 12,953 9,824 376,823
Small Commercial............................... 8,864 2,436 4,395 173,114
Investment in low-income housing tax credits...... (3,549) 1,923 3,538 81,362
Commercial lending................................ 5,839 362 3,041 256,166
Subprime single family lending.................... 2,333 (291) 364 224,722
Mortgage loan servicing........................... 192 2,717 175 2,263
Investment securities............................. 9,377 4,708 2,454 410,777
Other............................................. 1,202 3,826 (3,102) 87,621
---------- ----------- ---------- -----------
$ 52,133 $ 31,141 $ 25,467 $ 1,973,590
========== =========== ========== ===========
- -------------------
(1) Non-interest income includes $23,688 and $38,320 of equity in earnings of
investment in joint venture for the years ended December 31, 1997 and 1996,
respectively.
The Company's discount loan activities include asset acquisition, servicing
and resolution of single family residential, large commercial and small
commercial loans and the related real estate owned. Investment in low-income
housing tax credits includes the Company's investments, primarily through
limited partnerships, in qualified low-income rental housing for the purpose of
obtaining Federal income tax credits pursuant to Section 42 of the Code.
Low-income housing tax credits and benefits of $14,881, $9,330 and $7,709 are
included as credits against income tax expense for the years ended December 31,
1997, 1996 and 1995, respectively. Commercial lending includes the Company's
origination of multi-family and commercial real estate loans held for investment
and the origination and purchase of multi-family residential loans available for
sale. Subprime single family lending includes the Company's acquisition and
origination of single family residential loans to non-conforming borrowers,
which began in late 1994 and which are recorded as available for sale, and the
Company's historical loan portfolio of single family residential loans held for
investment. Mortgage loan servicing includes the Company's fee-for-services
business of providing loan servicing, including asset management and resolution
services, to third-party owners of nonperforming, underperforming and subprime
assets. Investment securities includes the results of the securities portfolio,
whether available for sale, trading or investment, other than REMIC residuals
and subordinate interests related to the Company's securitization activities
which have been included in the related business activity.
Interest income and expense have been allocated to each business segment
for the investment of funds raised or funding of investments made at an interest
rate based upon the Treasury swap yield curve taking into consideration the
actual duration of such liabilities or assets. Allocations of non-interest
expense generated by corporate support services were made to each business
segment based upon management's estimate of time and effort spent in the
respective activity. As such, the resulting net income amounts represent
estimates of the contribution of each business activity to the Company.
66
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 27 COMMITMENTS AND CONTINGENCIES
Certain premises are leased under various noncancellable operating leases
with terms expiring at various times through 2006, exclusive of renewal option
periods. The annual aggregate minimum rental commitments under these leases are
summarized as follows:
1998..................................................... $ 3,833
1999..................................................... 3,687
2000..................................................... 2,954
2001..................................................... 2,598
2002..................................................... 2,508
2003-2006................................................ 5,974
----------
Minimum lease payments................................... $ 21,554
==========
Rent expense for the years ended December 31, 1997, 1996 and 1995 was
$2,877, $1,563 and $1,601, respectively, which are net of sublease rentals of
$0, $0 and $68, respectively.
At December 31, 1997 the Company was committed to purchase $9,848 of
commercial discount loans. The Company also had commitments to originate (i)
$29,956 of loans secured by multi-family residential buildings, (ii) $16,798 of
mortgage loans secured by office buildings, (iii) $5,125 of loans secured by
hotel properties and (iv) $120,368 of loans secured by single family residential
buildings. In connection with its 1993 acquisition of Berkeley Federal Savings
Bank, the Company has a recourse obligation of $2,720 on single family
residential loans sold to the Federal Home Loan Mortgage Corporation ("FHLMC").
The Company, through its investment in subordinated securities and REMIC
residuals, which had a carrying value of $97,571 at December 31, 1997, supports
senior classes of securities having an outstanding principal balance of
$1,905,171.
At December 31, 1996 the Company was committed to lend up to $5,744 under
outstanding unused lines of credit. The Company also had commitments to
originate (i) $105,490 of loans secured by multi-family residential buildings
(ii) $19,849 of loans secured by office buildings, (iii) $55,949 of loans
secured by hotel properties and (iv) $12,840 of loans secured by land. In
connection with its acquisition of Berkeley Federal Savings Bank, the Company
had a recourse obligation of $3,486 on single family residential loans sold to
the Federal Home Loan Mortgage Corporation. The Company, through its investment
in subordinated securities which had a carrying value of $76,699 at December 31,
1996, supports senior classes of securities having an outstanding principal
balance of $1,453,573.
The Company is subject to various pending legal proceedings. Management is
of the opinion that the resolution of these claims will not have a material
effect on the consolidated financial statements.
67
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 28 PARENT COMPANY ONLY FINANCIAL INFORMATION
CONDENSED STATEMENTS OF FINANCIAL CONDITION:
December 31,
-------------------
1997 1996
-------- --------
ASSETS
Cash and cash equivalents .................... $ 62,586 $ 32,348
Securities available for sale, at market value 116,943 13,062
Investment securities, net ................... 11,115 --
Investment in bank subsidiary ................ 272,401 221,094
Investments in non-bank subsidiaries ......... 120,059 29,657
Loan portfolio, net .......................... 7,285 12,365
Discount loan portfolio, net ................. 48,413 --
Investment in real estate .................... 10,675 9,680
Income taxes receivable ...................... 13,739 10,003
Deferred tax asset ........................... 6,636 --
Other assets ................................. 11,063 5,618
-------- --------
$680,915 $333,827
======== ========
LIABILITIES
Notes payable ................................ $250,000 $125,000
Securities sold under agreements to repurchase 3,075 --
Deferred tax liability ....................... -- 194
Other liabilities ............................ 15,008 5,037
-------- --------
Total liabilities ....................... 268,083 130,231
Stockholders' Equity
Total stockholders' equity ................... 412,832 203,596
-------- --------
$680,915 $333,827
======== ========
CONDENSED STATEMENTS OF OPERATIONS:
Years Ended December 31,
--------------------------------
1997 1996 1995
-------- -------- --------
Interest income ......................................... $ 10,019 $ 1,645 $ 401
Non-interest income ..................................... -- 266 8
-------- -------- --------
10,019 1,911 409
Interest expense ........................................ (20,367) (4,406) (654)
Non-interest expense .................................... (3,942) (1,131) (277)
Loss before income taxes ................................ (14,290) (3,626) (522)
Income tax benefit ...................................... 5,083 2,925 1,533
-------- -------- --------
(Loss) income before equity in net income of subsidiaries (9,207) (701) 1,011
Equity in net income of bank subsidiary ................. 88,598 49,186 24,773
Equity in net (loss) income of non-bank subsidiaries .... (459) 1,657 (317)
-------- -------- --------
Net income .............................................. $ 78,932 $ 50,142 $ 25,467
======== ======== ========
68
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
CONDENSED STATEMENTS OF CASH FLOWS:
For The Years Ended December 31,
-----------------------------------
1997 1996 1995
--------- --------- ---------
Cash flows from operating activities:
Net income .................................................. $ 78,932 $ 50,142 $ 25,467
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Equity in income of bank subsidiary ....................... (88,598) (49,186) (24,773)
Equity in (income) loss of non-bank subsidiaries .......... 459 (1,657) 317
Premium amortization, net ................................. 11,467 -- --
Increase in deferred tax assets ........................... (6,830) -- --
(Increase) decrease in other assets ....................... (5,662) 4,067 (2,254)
Increase in income taxes receivable ....................... (3,736) (10,003) --
Increase (decrease) in accrued expenses,
payables and other liabilities ......................... 9,970 (3,286) 5,209
--------- --------- ---------
Net cash provided (used) by operating activities ............ (3,998) (9,923) 3,966
--------- --------- ---------
Cash flows from investing activities:
Purchase of securities available for sale ................... (146,643) (13,125) --
Maturities of and principal payments received
on securities available for sale .......................... 579 63 --
Net distributions from (investments in) bank subsidiary ..... 37,291 (49,707) 39,216
Net (investments in) distributions from non-bank subsidiaries (86,599) 5,410 (10,450)
Proceeds from sales of securities available for sale ........ 15,574 -- --
Purchase of securities held for investment .................. (11,115) -- --
Purchase of discount loans .................................. (48,413) -- --
Proceeds from sales of loans held for investment ............ 5,080 -- --
Purchase of real estate held for investment ................. (995) (9,680) --
Purchase of loans held for investment ....................... -- (11,845) (520)
--------- --------- ---------
Net cash provided (used) by investing activities ............... (235,241) (78,884) 28,246
--------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of notes and debentures .............. 120,738 125,000 7,615
Payment of debt issuance costs .............................. -- (5,252) --
Repayment of notes payable .................................. -- (8,628) --
Increase in securities sold under agreements to repurchase .. 3,075 -- --
Repayments (originations) of loans to executive officers, net 3,832 (3,832) --
Exercise of common stock options ............................ 3,037 12,993 1,420
Issuance of shares of common stock .......................... 142,003 -- --
Repurchase of common stock options and common stock ......... (3,208) (177) (42,129)
Other ....................................................... -- 23 --
--------- --------- ---------
Net cash provided (used) by financing activities ............... 269,477 120,127 (33,094)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ........... 30,238 31,320 (882)
Cash and cash equivalents at beginning of year ................. 32,348 1,028 1,910
--------- --------- ---------
Cash and cash equivalents at end of year ....................... $ 62,586 $ 32,348 $ 1,028
========= ========= =========
69
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 and 1995
(Dollars in Thousands, except share data)
NOTE 29 QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Quarters Ended
-----------------------------------------------------------
December 31, September 30, June 30, March 31,
1997 1997 1997 1997
------------ ------------- -------- ---------
Interest income ................................... $ 73,736 $ 77,326 $ 66,942 $ 54,527
Interest expense .................................. (40,313) (39,944) (38,868) (37,164)
Provision for loan losses ......................... (10,479) (4,088) (7,909) (9,742)
-------- -------- -------- --------
Net interest income after provision
for loan losses ................................ 22,944 33,294 20,165 7,621
Non-interest income ............................... 43,798 25,431 33,289 21,351
Non-interest expense .............................. (41,798) (31,219) (31,080) (22,697)
Distributions on Company-obligated
mandatorily redeemable securities of
subsidiary trust holding solely junior
subordinated debentures of the Company ......... (3,399) (1,850) -- --
Equity in earnings of investment in
joint venture .................................. 7,468 546 1,301 14,372
-------- -------- -------- --------
Income before income taxes ........................ 29,013 26,202 23,675 20,647
Income taxes (expense) benefit .................... (6,398) (6,179) (5,126) (3,606)
Minority interest in net loss of
consolidated subsidiary ........................ 319 142 243 --
-------- -------- -------- --------
Net income ........................................ $ 22,934 $ 20,165 $ 18,792 $ 17,041
======== ======== ======== ========
Earnings per share:
Basic .......................................... $ 0.38 $ 0.35 $ 0.35 $ 0.32
Diluted ........................................ $ 0.37 $ 0.35 $ 0.35 $ 0.31
Quarters Ended
-----------------------------------------------------------
December 31, September 30, June 30, March 31,
1996 1996 1996 1996
------------ ------------- -------- ---------
Interest income ................................... $ 50,292 $ 44,145 $ 51,501 $ 47,956
Interest expense .................................. (33,907) (27,217) (26,904) (28,132)
Provision for loan losses ......................... (3,611) (4,469) (4,963) (9,407)
-------- -------- -------- --------
Net interest income after provision for
loan losses .................................... 12,774 12,459 19,634 10,417
Non-interest income ............................... 10,795 15,146 8,069 3,292
Non-interest expense .............................. (22,520) (21,531) (13,871) (11,683)
Equity in earnings of investment in
joint venture .................................. 33,103 4,139 1,078 0
-------- -------- -------- --------
Income before income taxes ........................ 34,152 10,213 14,910 2,026
Income taxes (expense) benefit .................... (9,092) (157) (2,913) 1,003
-------- -------- -------- --------
Net income ........................................ $ 25,060 $ 10,056 $ 11,997 $ 3,029
-------- -------- -------- --------
Earnings per share:
Basic .......................................... $ 0.47 $ 0.19 $ 0.25 $ 0.06
Diluted ........................................ $ 0.46 $ 0.19 $ 0.23 $ 0.06
70
SHAREHOLDER INFORMATION
Price Range of the Company's Common Stock
The Company's common stock was traded on The NASDAQ Stock Market's National
Market ("NASDAQ") from September 25, 1996 until July 31, 1997 under the symbol
"OCWN" and has been traded on the New York Stock Exchange ("NYSE") since August
1, 1997 under the symbol "OCN." There was no established market for the common
stock prior to September 25, 1996. The following table sets forth for the
indicated periods the high and low bid prices (for the period through July 31,
1997) and high and low sales prices (for the period beginning August 1, 1997)
for the common stock, as traded on such market and exchange. The share price
information below has been retroactively adjusted to reflect the 2-for-1 stock
split effective November 20, 1997 to stockholders of record on November 12,
1997.
High Low
--------------- ---------------
1996
Third quarter (from September 25)........... $ 10.5000 $ 9.5000
Fourth quarter.............................. 15.2500 10.1250
1997
First quarter............................... $ 17.3750 $ 12.6250
Second quarter.............................. 16.4375 12.7500
Third quarter............................... 22.6250 15.7500
Fourth quarter.............................. 28.8125 21.0000
At the close of business on February 27, 1998, the Company's common stock
price was $30.00.
The Company does not currently pay cash dividends on the common stock and
has no current plans to do so in the future. In the future, the timing and
amount of dividends, if any, will be determined by the Board of Directors of the
Company and will depend, among other factors, upon the Company's earnings,
financial condition, cash requirements, the capital requirements of the Bank and
other subsidiaries and investment opportunities at the time any such payment is
considered. In addition, the indentures relating to the Notes and the Junior
Subordinated Debentures contain certain limitations on the payment of dividends
by the Company.
As a holding company, the payment of any dividends by the Company will be
significantly dependent on dividends and other payments received by the Company
from its subsidiaries, including the Bank. For a description of limitations on
the ability of the Company to pay dividends on the common stock and on the
ability of the Bank to pay dividends on its capital stock to the Company, see
Notes 17, 18 and 24 to the Consolidated Financial Statements. The Company has
not paid any cash dividends on its common stock in recent years.
Number of Holders of Common Stock
At February 27, 1998, 60,708,520 shares of Company common stock were
outstanding and held by approximately 1,431 holders of record. Such number of
stockholders does not reflect the number of individuals or institutional
investors holding stock in nominee name through banks, brokerage firms and
others.
71
CORPORATE INFORMATION
Corporate Headquarters
Ocwen Financial Corporation
The Forum, Suite 1000
1675 Palm Beach Lakes Blvd.
West Palm Beach, Florida 33401
(561) 681-8000
Annual Meeting
The Annual Meeting of Ocwen Shareholders will be held on May 13, 1998.
1675 Palm Beach Lakes Blvd.
West Palm Beach, Florida 33401
Investor Relations
All investor inquiries may be directed to or copies of Ocwen Form 10-K may be
obtained from:
Investor Relations
Ocwen Financial Corporation
The Forum, Suite 1003
1675 Palm Beach Lakes Blvd.
West Palm Beach, Florida 33401
(561) 681-8400
Listing
The common stock of Ocwen Financial Corporation is listed on the NYSE. Its
symbol is "OCN".
Registrar and Transfer Agent
Transfer Agent for Stock
The Bank of New York
Shareholder Relations Department 11E
P.O. Box 11258
Church Street Station
New York, NY 10286
(800) 524-4458
Send certificates for transfer and address change notices to:
The Bank of New York
Receive and Deliver Department 11W
P.O. Box 11002
Church Street Station
New York, NY 10286
72
NOTES:
73
NOTES:
74
NOTES:
75
NOTES:
76
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (Registration No. 333-44999) of Ocwen Financial
Corporation of our report dated January 27, 1998 relating to the consolidated
balance sheets of Ocwen Financial Corporation and subsidiaries as of December
31, 1997 and 1996 and the related consolidated statements of earnings, cash
flows and shareholders' equity and financial data schedule for each of the years
in the three year period ended December 31, 1997, which report is included as
Exhibit 13.1 and Exhibits 27.1 through 27.2 (financial data schedules) of Ocwen
Financial Corporation's Annual Report on Form 10-K. We further consent to the
incorporation by reference in the Registration Statement on Form S-8
(Registration No. 333-44999) of our report dated January 27, 1998 relating to
the statement of financial condition of BCBF, L.L.C. as of December 31, 1997 and
1996 and the statements of operations, changes in owners' equity and cash flow
for each of the periods March 13, 1996 through December 31, 1996 and January 1,
1997 through December 31, 1997, which report is included as Exhibit 99.0 of
Ocwen Financial Corporation's Annual Report on form 10-K.
/s/ PRICE WATERHOUSE LLP
- ----------------------------------------------
PRICE WATERHOUSE LLP
Fort Lauderdale, Florida
January 27, 1998
EXHIBIT 99.0
BCBF, L.L.C.
FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Partners of BCBF, L.L.C.
In our opinion, the accompanying statements of financial condition and the
related statements of operations, of changes in owners' equity and of cash flows
present fairly, in all material respects, the financial position of BCBF, L.L.C.
(the "Company") at December 31, 1997 and 1996, and the results of its operations
and its cash flows for the year ended December 31, 1997 and for the period from
March 13, 1996 through December 31, 1996, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
/s/ Price Waterhouse LLP
- ------------------------
Price Waterhouse LLP
Fort Lauderdale, Florida
January 27, 1998
1
BCBF, L.L.C.
STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
December 31,
-------------------
1997 1996
-------- --------
Assets:
Cash ................................................ $ -- $ 10
Loans held for sale, at lower of cost or
market value ...................................... -- 110,702
Real estate owned, net .............................. -- 25,595
Other assets ........................................ -- 10,526
-------- --------
$ -- $146,833
======== ========
Liabilities and Owners' Equity:
Liabilities:
Accrued expenses, payables and other liabilities... $ -- $ 787
-------- --------
Total liabilities ............................... -- 787
-------- --------
Owner's Equity:
Ocwen Federal Bank FSB ............................ -- 73,023
BlackRock Capital Finance L.P. .................... -- 73,023
-------- --------
Total owners' equity ............................ -- 146,046
-------- --------
$ -- $146,833
======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
2
BCBF, L.L.C.
STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
For the Period For the Period
January 1, 1997 March 13, 1996
Through Through
December 31, 1997 December 31, 1996
----------------- -----------------
Interest income................................... $ 8,928 $ 38,647
Interest expense.................................. -- (18,503)
----------- -----------
Net interest income............................ 8,928 20,144
----------- -----------
Non-interest income:
Gain on sale of loans held for sale............ 27,994 71,156
Gain on sale of loan servicing rights.......... -- 1,048
Loss on real estate owned, net................. (93) (130)
Loan fees...................................... 23 50
----------- -----------
27,924 72,124
----------- -----------
Non-interest expense:
Loan servicing fees............................ 1,850 5,743
Other loan expenses............................ 13 273
----------- -----------
1,863 6,016
----------- -----------
Net income................................... $ 34,989 $ 86,252
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
3
BCBF, L.L.C.
STATEMENTS OF CHANGES IN OWNERS' EQUITY
FOR THE PERIOD JANUARY 1, 1997 THROUGH DECEMBER 31, 1997
AND THE PERIOD MARCH 13, 1996 THROUGH DECEMBER 31, 1996
(DOLLARS IN THOUSANDS)
Ocwen BlackRock
Federal Capital
Bank FSB Finance L.P. Total
--------- ----------- ---------
Contributions of capital............................................. $ 66,204 $ 66,204 $ 132,408
Net income........................................................... 43,126 43,126 86,252
Distributions of cash................................................ (16,534) (16,534) (33,068)
Distributions of securities.......................................... (19,773) (19,773) (39,546)
--------- --------- ---------
Balances at December 31, 1996........................................ 73,023 73,023 146,046
Net income........................................................... 17,494 17,495 34,989
Distribution of securities........................................... (1,989) (1,989) (3,978)
Distributions of cash................................................ (77,576) (77,577) (155,153)
Liquidating distribution............................................. (10,952) (10,952) (21,904)
--------- --------- ---------
Balances at December 31, 1997........................................ $ -- $ -- $ --
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
4
BCBF, L.L.C.
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
For the Period For the Period
January 1, 1997 March 13, 1996
Through Through
December 31, 1997 December 31, 1996
----------------- -----------------
Cash flows from operating activities:
Net income ............................................. $ 34,989 $ 86,252
Adjustments to reconcile net income to net cash provided
by (used) in operating activities:
Provision for losses on real estate owned ............ 1,110 636
Gain on sale of loans held for sale .................. (27,994) (71,156)
Gain on sale of real estate owned .................... (6,619) (775)
Gain on sale of loan servicing rights ................ -- (1,048)
Purchase of loans held for sale ...................... -- (626,400)
Proceeds from sale of loans held for sale, net ....... 89,044 466,806
Principal repayments on loans held for sale .......... 3,478 42,210
Proceeds from sale of real estate owned .............. 57,359 4,364
Proceeds from sale of loan servicing rights .......... -- 1,048
Decrease (increase) in other assets .................. 4,563 (2,054)
(Decrease) increase in accrued expenses, payables
and other liabilities ............................... (787) 787
--------- ---------
Net cash provided (used) in operating activities .......... 155,143 (99,330)
--------- ---------
Cash flows from financing activities:
Proceeds from note payable ............................ -- 473,042
Repayment of note payable ............................. -- (473,042)
Proceeds from capital contributions ................... -- 132,408
Distributions of capital .............................. (155,153) (33,068)
--------- ---------
Net cash (used) provided by financing activities .......... (155,153) 99,340
--------- ---------
Net (decrease) increase in cash and cash equivalents ...... (10) 10
Cash and cash equivalents at beginning of period .......... 10 --
--------- ---------
Cash and cash equivalents at end of period ................ $ -- $ 10
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest .............................................. $ -- $ (18,503)
========= =========
Supplemental schedule of non-cash activities:
Exchange of loans for mortgage-backed securities ....... $ 60,593 $ 394,234
========= =========
Real estate owned acquired through foreclosure ......... $ 37,059 $ 29,820
========= =========
Distribution of securities to Partners ................. $ (3,978) $ (39,546)
========= =========
Liquidating distribution of non-cash assets to Partners $ (21,904) $ --
========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
5
BCBF, L.L.C.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(DOLLARS IN THOUSANDS)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
BCBF, L.L.C. (the "LLC") is a limited liability company formed on March
13, 1996 between Ocwen Federal Bank FSB ("Ocwen") and BlackRock Capital Finance
L.P. ("BlackRock"), or collectively, the "Partners". The Partners each have a
50% interest in the LLC and share equally in net income or loss.
On March 22, 1996, the LLC was notified by the Department of Housing
and Urban Development ("HUD") that it was the successful bidder to purchase
16,196 single-family residential loans offered by HUD at an auction (the "HUD
Loans"). On April 10, 1996 the LLC consummated the acquisition of the HUD Loans,
which had an aggregate unpaid principal balance of $741,176 for a purchase price
of $626,400. The purchase was financed by $117,647 in equity contributions,
$35,711 of proceeds from the LLC's concurrent sale of 1,631 HUD Loans and the
proceeds from a $473,042 note payable from an unaffiliated party. No significant
activity occurred prior to April 10, 1996.
On December 12, 1997, the LLC distributed all of its assets to Ocwen
and BlackRock. No significant activity occurred subsequent to this date.
STATEMENT OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, interest and non-interest bearing deposits and all highly liquid
debt instruments purchased with an original maturity of three months or less.
HUD LOANS HELD FOR SALE
The HUD Loans purchased by the LLC were designated as held for sale
because it was the LLC's intent to securitize and sell the majority of these
loans. Loans held for sale are carried at the lower of aggregate cost or market
value. Market value is determined based upon current market yields at which
recent pools of similar mortgages have been traded. There was no allowance for
market value losses on loans held for sale at December 31, 1996.
All of the HUD Loans were secured by first mortgage liens on
single-family residences. The HUD Loans were acquired by HUD pursuant to various
assignment programs of the Federal Housing Authority ("FHA"). Under programs of
the FHA, a lending institution may assign an FHA-insured loan to HUD because of
an economic hardship on the part of the borrower which precludes the borrower
from making the scheduled principal and interest payments on the loan.
FHA-insured loans are also automatically assigned to HUD upon the 20th
anniversary of the mortgage loan. In most cases, loans assigned to HUD after
this 20 year period are performing under the original terms of the loan. Once a
loan is assigned to HUD, the FHA insurance has been paid and the loan is no
longer insured. As a result, none of the HUD Loans were insured by the FHA.
The HUD Loans were purchased by the LLC at a substantial discount to
the unpaid principal balance of the loans as many of the HUD Loans were not
performing in accordance with the original terms of the loans or an applicable
forbearance agreement. The cost of acquiring the pool of loans was allocated to
each individual loan within the pool based on the LLC's pricing methodology.
Loans are considered performing if they are less than 90 days past due based on
the original terms of the mortgage loan. Interest
6
BCBF, L.L.C.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(DOLLARS IN THOUSANDS)
income on performing loans is recognized on the accrual method. Interest income
on all other loans is recognized on a cash basis due to the uncertainty of
collection. Gains and losses on the repayment and the discharging of loans are
also reported as part of interest income. In situations where the collateral is
foreclosed upon, the loans are transferred to real estate owned upon receipt of
title to the property.
REAL ESTATE OWNED
Properties acquired through foreclosure or deed-in-lieu of foreclosure
were valued at the lower of the adjusted basis of the loan or fair value less
estimated costs of disposal of the property at the date of foreclosure.
Properties held are periodically re-evaluated to determine that they are being
carried at the lower of cost or fair value less estimated costs to dispose. All
of the LLC's real estate owned was held for sale. Gains and losses on the sale
of REO are recognized with the passage of title and all risks of ownership to
the buyer. Rental income related to properties is reported as income as earned.
Holding and maintenance costs related to properties are reported as period costs
as incurred. No depreciation expense related to foreclosed real estate held for
sale is recorded. Decreases in market value of foreclosed real estate subsequent
to foreclosure are recognized as a valuation allowance on a property specific
basis. Subsequent increases in market value of the foreclosed real estate are
reflected as reductions in the valuation allowance, but not below zero. Such
changes in the valuation allowance are charged or credited to income. Additional
valuation allowances are also established for the inherent risks in the real
estate owned portfolio which have yet to be specifically identified.
INCOME TAXES
Because the LLC is a pass-through entity for federal income tax
purposes, provisions for income taxes are established by each of the Partners
and not the LLC.
USE OF ESTIMATES
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 the
reported amount of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
NOTE 2 ADOPTION OF RECENTLY ISSUED ACCOUNTING STANDARDS
On January 1, 1997, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities." SFAS No. 125 (i) sets
forth the criteria for (a) determining when to recognize financial and servicing
assets and liabilities; and (b) accounting for transfers of financial assets as
sales or borrowings; and (ii) requires (a) liabilities and derivatives related
to a transfer of financial assets to be recorded at fair value; (b) servicing
assets and retained interests in transferred assets carrying amounts be
determined by allocating carrying amounts based on fair value; (c) amortization
of servicing assets and liabilities be in proportion to net servicing income;
(d) impairment measurement based on fair value; and (e) pledged financial assets
to be classified as collateral. SFAS No. 125 provides implementation guidance
for assessing isolation of transferred assets and for accounting for transfers
of partial interests, servicing of financial assets, securitizations, transfers
of sales-type and direct financing lease receivables, securities lending
transactions, repurchase agreements including "dollar rolls", "wash sales", loan
syndications and participations, risk participations in banker's acceptances,
factoring arrangements, transfers of receivables with recourse and
extinguishments of liabilities. In December 1996, the FASB issued SFAS No. 127,
"Deferral of the Effective Date of FASB Statement No. 125", which delayed
implementation of certain provisions of SFAS No. 125.
7
BCBF, L.L.C.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(DOLLARS IN THOUSANDS)
NOTE 3 FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the LLC's assets at December 31, 1996 were
considered financial instruments. The LLC had no assets or liabilities at
December 31, 1997. For loans held for sale, fair values are not readily
available since there are no available trading markets as characterized by
current exchanges between willing parties. Accordingly, fair values can only be
derived or estimated using various valuation techniques, such as computing the
present value of the estimated cash flows using discount rates commensurate with
the risks involved. However, the determination of estimated future cash flows is
inherently subjective and imprecise.
The fair values reflected below are indicative of the interest rate
environments as of December 31, 1996 and do not take into consideration the
effects of interest rate fluctuations. In different interest rate environments,
fair value results can differ significantly, especially for certain fixed-rate
financial instruments and non-accrual assets. In addition, the fair values
presented do not attempt to estimate the value of the LLC's future business
activities. In other words, they do not represent the LLC's value as a going
concern. Furthermore, the differences between the carrying amounts and the fair
values presented may not be realized.
Reasonable comparability of fair values among financial institutions is
difficult due to the wide range of permitted valuation techniques and numerous
estimates that must be made in the absence of secondary market prices. This lack
of objective pricing standards introduces a degree of subjectivity to these
derived or estimated values. Therefore, while disclosure of estimated fair
values of financial instruments is required, readers are cautioned in using this
data for purposes of evaluating the financial condition of the LLC.
The methodologies used and key assumptions made to estimate fair value,
the estimated fair values determined and recorded carrying values follow:
CASH AND CASH EQUIVALENTS
Cash and cash equivalents have been valued at their carrying amounts as
these are reasonable estimates of fair value given the relatively short period
of time between origination of the instruments and their expected realization.
LOANS HELD FOR SALE
The HUD Loans, which were designated held for sale, have been valued at
their carrying amount which approximates fair value given that the assumptions
used to value such loans at their date of purchase have remained relatively
constant.
REAL ESTATE OWNED
Real estate owned, although not a financial instrument, is an integral
part of the LLC's loan business. The fair value of real estate owned was
estimated based upon appraisals, broker price opinions and other standard
industry valuation methods, less anticipated selling costs.
8
BCBF, L.L.C.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(DOLLARS IN THOUSANDS)
As mentioned above, on December 12, 1997, the LLC distributed all of
its assets to Ocwen and BlackRock. The carrying amounts and the estimated fair
values of the LLC's financial instruments and real estate owned at December 31,
1996 were as follows:
CARRYING AMOUNT FAIR VALUE
--------------- ----------
FINANCIAL ASSETS:
Cash and cash equivalents.............. $ 10 $ 10
Loans held for sale.................... 110,702 110,702
Real estate owned, net................. 25,595 31,738
NOTE 4 HUD LOAN PORTFOLIO
The LLC acquired the HUD Loans through an auction at a discount with
the intent of securitizing and selling the majority of the loans. Because many
of the mortgage loan borrowers were either not current as to principal and
interest payments or there was doubt as to their ability to pay in full the
contractual principal and interest, the LLC estimated the amounts expected to be
realized through foreclosure, collection efforts or other resolution of each HUD
loan and the length of time required to complete the collection process in
determining the amount it bid to acquire the HUD Loans.
At December 31, 1997, the LLC had no loans outstanding, having
previously distributed all assets to its Partners. At December 31, 1996 the
LLC's HUD Loan portfolio, which was designated held for sale, consisted of the
following:
Unpaid principal balance................................... $ 159,405
Discount................................................... (48,703)
------------
$ 110,702
============
The following table sets forth information relating to the payment
status of the HUD Loans at December 31, 1996:
% of HUD
Amount Loans
---------- ---------
Loans without Forbearance Agreements:
Past due less than 31 days....................... $ 6,709 4.21%
Past due 31 to 90 days........................... 3,011 1.89
Past due 90 days or more......................... 84,509 53.02
---------- -----
94,229 59.12
---------- -----
Loans with Forbearance Agreements:
Past due less than 31 days....................... 4,867 3.05
Past due 31 to 90 days........................... 5,168 3.24
Past due 90 days or more......................... 55,141 34.59
---------- -----
65,176 40.88
---------- -----
Total......................................... $ 159,405 100.00%
========== ======
9
BCBF, L.L.C.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(DOLLARS IN THOUSANDS)
Forbearance agreements are agreements entered into by HUD or the LLC
with the borrower for the repayment of delinquent payments over a period and for
forbearance from foreclosure during the term for such agreement. HUD forbearance
agreements are generally twelve months in duration and the borrower may be
granted up to a maximum of three consecutive twelve month plans. Under the terms
of the contract governing the sale of the HUD Loans, the LLC and Ocwen, as the
servicer of the loans, are obligated to comply with the terms of the HUD
forbearance agreements, which may be written or oral in nature, until the term
of the forbearance agreement expires or there is a default under the forbearance
agreement.
The HUD loans at December 31, 1996 were geographically located
throughout the United States and Puerto Rico. The following table sets forth the
five states in which the largest amount of properties securing the LLC's
discounted loans were located at December 31, 1996:
Texas................................................. $ 30,382
California............................................ 26,596
Connecticut........................................... 11,729
Maryland.............................................. 9,487
Colorado.............................................. 9,018
Other ................................................ 72,193
--------------
Total................................................ $ 159,405
==============
NOTE 5 MORTGAGE LOAN SALES AND SECURITIZATION OF MORTGAGE LOANS
In March 1997, as part of a larger transaction involving Ocwen and an
affiliate of BlackRock, the LLC securitized 1,196 loans with an unpaid principal
balance of $51,714, past due interest of $14,209 and a net book value of
$40,454. Net proceeds from the sale of the related securities amounted to
$58,866. In December 1997, as part of a larger transaction involving Ocwen and
BlackRock, the LLC securitized 534 loans with an unpaid principal balance of
$26,644, past due interest of $8,303 and a net book value of $20,139. Net
proceeds from the sale of the related securities amounted to $30,178.
In April 1996, the LLC sold 1,631 loans with an unpaid principal
balance of $61,885 and a net book value of $34,388 for $35,711 resulting in a
gain on sale of loans of $1,323.
In October 1996, the LLC securitized 9,825 loans with an unpaid
principal balance of $419,382 and a net book value of $394,234. Certain of the
mortgage related securities created from the securitization were sold in October
1996 for $431,095, resulting in a gain of $69,833 which includes a gain of
$12,863 on the sale of $79,411 of securities directly to Ocwen. Certain other
mortgage related securities created from the securitization were distributed to
the Partners at their allocated book values which amounted to $39,546.
NOTE 6 REAL ESTATE OWNED
Real estate owned, net of valuation allowances, is held for sale. At
December 31, 1997, the LLC held no real estate owned, having previously
distributed all assets to its Partners. At December 31, 1996, the LLC's real
estate owned portfolio, acquired through foreclosure or deed-in-lieu of
foreclosure, consisted of the following:
Single-family residential................................ $ 26,106
Valuation allowance...................................... (511)
--------------
Real estate owned, net................................ $ 25,595
==============
10
BCBF, L.L.C.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(DOLLARS IN THOUSANDS)
The following schedule presents the activity in the valuation allowance
on real estate owned for the indicated periods:
For the Period For the Period
January 1, 1997 March 13, 1996
Through through
December 31, 1997 December 31, 1996
----------------- -----------------
Balance, beginning of period............................... $ 511 $ --
Provision for losses....................................... 1,110 636
Charge-offs and sales...................................... (1,621) (125)
------------- -------------
Balance, end of period.................................... $ -- $ 511
============= =============
Real estate owned is geographically located throughout the United
States and Puerto Rico. The following table sets forth the five states with the
largest amount of properties owned by the LLC at December 31, 1996:
Texas $ 7,782
California................................................. 6,992
Maryland................................................... 2,692
Virginia................................................... 1,318
Georgia.................................................... 1,274
Other ..................................................... 5,537
-------------
Total.................................................... $ 25,595
=============
The following table sets forth the results of the LLC's investment in
real estate owned during the following periods:
For the Period For the Period
January 1, 1997 March 13, 1996
Through through
December 31, 1997 December 31, 1996
----------------- -----------------
DESCRIPTION:
Gains on sales........................................ $ 6,619 $ 775
Provision for losses.................................. (1,110) (636)
Carrying costs, net of rental income.................. (5,602) (269)
---------- ----------
Loss on real estate owned, net....................... $ (93) $ (130)
========== ==========
NOTE 7 NOTE PAYABLE ACQUISITION DEBT
In April 1996, the LLC financed the acquisition of the HUD Loans with
the proceeds from a $473,042 note payable from an unaffiliated party. Interest
on the note payable was payable monthly and accrued at a rate equal to LIBOR
plus 2.25%. The note payable, which was scheduled to mature in January 1997, was
secured by a first position lien on the HUD Loans purchased. The cash proceeds
from the sale of securities resulting from the securitization of the 9,825 HUD
Loans in October, 1996 and additional capital contributions by the Partners were
used to fully repay the note payable in 1996.
11
BCBF, L.L.C.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(DOLLARS IN THOUSANDS)
NOTE 8 RELATED PARTY TRANSACTIONS
In connection with the LLC's acquisition of the HUD Loans, Ocwen
entered into an agreement with the LLC to service the HUD Loans in accordance
with its loan servicing and loan default resolution procedures. In return for
such servicing, Ocwen received specified fees which were payable on a monthly
basis. For the year ended December 31, 1997 and for the period from March 13,
1996 to December 31, 1996, Ocwen earned $1,850 and $5,743 in such servicing
fees, respectively.
As the servicer for the HUD Loans, Ocwen was responsible for the
collection of the payments due from borrowers and the payment of certain costs
incurred in connection with the operation and maintenance of real estate owned
properties. A cash settlement was made monthly between Ocwen and the LLC for the
net of such collections and payments. At December 31, 1996, $5,447 was due from
Ocwen and is included in other assets. Such amount was paid by Ocwen to the LLC
in January, 1997.
In connection with the 1996 securitization transactions (see Note 5),
the LLC sold $79,411 of securities to Ocwen for a gain of $12,863. Additionally,
also in 1996, the LLC sold certain rights to service the securitized loans to
Ocwen for $1,048.
NOTE 9 DISTRIBUTION OF ASSETS
On December 12, 1997, in accordance with the decision of the Partners,
the assets of the LLC were distributed as follows:
Ocwen BlackRock Total
------------ ------------ ------------
Cash......................................... $ 5 $ 5 $ 10
Loans held for sale at book value............ 4,501 4,501 9,002
Real estate owned at book value.............. 5,402 5,402 10,804
Amount due from loan servicer................ 295 295 590
Escrow advances.............................. 537 537 1,074
Other advances............................... 212 212 424
------------ ------------ ------------
$ 10,952 $ 10,952 $ 21,904
============ ============ ============
12
9
0000873860
Ocwen Financial Corp.
1,000
USD
YEAR
DEC-31-1997
JAN-01-1997
DEC-01-1997
1
12,243
140,001
0
0
430,524
59,567
59,567
1,877,516
27,188
3,069,165
1,982,822
226,554
87,709
226,975
0
0
606
419,086
3,069,165
230,718
32,854
8,959
272,531
122,070
156,289
116,242
32,218
77,979
132,042
99,538
99,538
0
0
78,932
1.40
1.39
11.50
880,357
0
0
0
15,061
20,501
410
27,188
27,188
0
0
Tag 18 includes Loans Available for Sale of $177,041 Loan Portfolio of
$266,299 and Discount Loan Portfolio of $1,434,176.
Tag 19 includes allowance for loan losses on loan portfolio of $3,695 and
on discount loan portfolio of $23,493.
Tag 30 includes Interest Income on Loans Available for Sale of $18,368.
Loans of $54,701 and Discount Loans of $157,649.
Tag 39 includes Non-interest expense of $126,793 and Distributions on
Company-Obligated, Mandatorily Reedemable Securities of Subsidiary Trust
Holding Solely Junior Subordinated Debentures of the Company of $5,249.
9
0000873860
Ocwen Financial Corp.
1,000
USD
YEAR
DEC-31-1996
JAN-01-1996
DEC-31-1996
1
6,878
13,341
32,000
75,606
354,005
8,901
0
1,589,901
15,061
2,483,685
1,919,742
74,945
59,829
225,573
0
0
535
203,061
2,483,685
157,075
32,138
4,681
193,894
93,773
116,160
77,734
22,450
15,291
69,578
61,301
61,301
0
0
50,142
0.99
0.94
12.075
517,774
45,635
100,343
0
1,947
9,512
176
15,061
15,061
0
0
Tag 18 includes loans available for sale of $126,366 loan portfolio of
$402,582 and discount loan portfolio of $1,060,953.
Tag 19 includes allowances for loan losses on loan portfolio of $3,523 and
on discount loan portfolio of $11,538.
Tag 30 includes interest income on loans available for sale of $17,092,
Loans of $36,818, and discount loans of $103,165.
Tag 45 EPS-Primary has been restated in accordance with SFAS No. 128,
"Earnings per Share" and for the 2-for-1 stock split approved by the
Company's Board of Directors on October 29, 1997.
Tag 46 EPS-Diluted has been restated in accordance with SFAS No. 128,
"Earnings per Share" and for the 2-for-1 stock split approved by the
Company's Board of Directors on October 29, 1997.
9
0000873860
Ocwen Financial Corp.
1,000
USD
9-MOS
DEC-31-1996
JAN-01-1996
SEP-30-1996
1
7,278
17,173
185,000
0
235,305
8,902
0
1,347,983
16,200
2,200,772
1,650,323
0
137,113
240,669
0
0
534
172,133
2,200,772
116,755
23,007
3,840
143,602
68,234
82,253
61,349
18,839
17,580
47,038
27,149
25,082
0
0
25,082
0.50
0.48
12.259
332,352
50,264
110,348
0
2,271
5,875
94
16,200
16,200
0
0
Tag 18 includes Loans Available for sale of $70,248 Loan Portfolio of
$369,651 and Discounted Loan Portfolio of $906,084.
Tag 19 includes Allowance for Loan Losses on Loans Available for Sale of
$1,196 on Loan Portfolio of $3,400 and on Discounted Loan Portfolio of
$11,604.
Tag 45 EPS-Primary has been restated in accordance with SFAS No. 128,
"Earnings per Share" and for the 2-for-1 stock split approved by the
Company's Board of Directors on October 29, 1997.
Tag 46 EPS-Diluted has been restated in accordance with SFAS No. 128,
"Earnings per Share" and for the 2-for-1 stock split approved by the
Company's Board of Directors on October 29, 1997.
9
0000873860
Ocwen Financial Corp.
1,000
USD
3-MOS
DEC-31-1997
JAN-01-1997
MAR-31-1997
1
8,966
8,802
99,000
0
348,066
11,201
0
1,791,715
21,642
2,649,471
2,106,829
39,623
52,290
225,573
0
0
536
224,620
2,649,471
43,767
9,102
1,658
54,527
29,894
37,164
17,363
9,742
10,563
22,697
20,647
20,647
0
0
17,041
0.32
0.31
10.062
811,376
0
0
0
15,061
3,209
47
21,642
21,642
0
0
Tag 18 includes loans available for sale of $88,511 loan portfolio of
$422,232 and discount loan portfolio of $1,280,972.
Tag 19 includes allowance for loan losses on portfolio of $4,834 and on
discount loan portfolio of $16,808.
Tag 45 EPS-Primary has been restated in accordance with SFAS No. 128,
"Earnings per Share" and for the 2-for-1 stock split approved by the
Company's Board of Directors on October 29, 1997.
Tag 46 EPS-Diluted has been restated in accordance with SFAS No. 128,
"Earnings per Share" and for the 2-for-1 stock split approved by the
Company's Board of Directors on October 29, 1997.
9
0000873860
Ocwen Financial Corp.
1,000
USD
6-MOS
DEC-31-1997
JAN-01-1997
JUN-30-1997
1
6,911
29,992
189,844
0
263,412
38,821
0
1,832,410
24,825
2,786,879
2,198,603
0
55,927
286,972
0
0
536
243,328
2,786,879
102,660
16,356
2,453
121,469
61,264
76,032
45,437
17,651
29,593
53,777
44,323
44,323
0
0
35,833
0.67
0.66
10.79
847,655
0
0
0
15,061
7,982
95
24,825
24,825
0
0
Tag 18 includes loans available for sale of $103,627 loan portfolio of
$433,663 and discount loan portfolio of $1,295,120.
Tag 19 includes allowance for loan losses of loan portfolio of $4,974 and
on discount loan portfolio of $19,851.
Tag 45 EPS-Primary has been restated in accordance with SFAS No. 128,
"Earnings per Share" and for the 2-for-1 stock split approved by the
Company's Board of Directors on October 29, 1997.
Tag 46 EPS-Diluted has been restated in accordance with SFAS No. 128,
"Earnings per Share" and for the 2-for-1 stock split approved by the
Company's Board of Directors on October 29, 1997.
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
9
