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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, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from: _________________to ________________
Commission File No. 0-21341
OCWEN FINANCIAL CORPORATION
(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
------------------------ -----
(Address of principal executive office) (Zip Code)
(561) 682-8000
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE (NYSE)
(Title of each class) (Name of each exchange on
which registered)
Securities registered pursuant to Section 12 (g) of the Act: Not applicable.
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. [X]
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 March 9, 1999: $262,679,977
million (for purposes of this calculation affiliates include only directors and
executive officers of the registrant).
Number of shares of Common Stock, $.01 par value, outstanding as of March 9,
1999: 60,800,357 shares
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Annual Report to
Shareholders for fiscal year ended December 31, 1998 are incorporated by
reference into Part II, Items 5-8.
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OCWEN FINANCIAL CORPORATION
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business..........................................................4
General.........................................................4
Segments........................................................5
Discount Loan Acquisition and Resolution Activities.............7
Investment in Unconsolidated Entities..........................12
Lending Activities.............................................13
Loan Servicing Activities......................................19
Asset Quality..................................................20
Investment Activities..........................................26
Sources of Funds...............................................35
Computer Systems and Use of Technology.........................39
Economic Conditions............................................40
Competition....................................................40
Subsidiaries...................................................40
Employees......................................................41
Regulation.....................................................41
The Company....................................................42
The Bank.......................................................43
Federal Taxation...............................................47
State Taxation.................................................47
Item 2. Properties.......................................................48
Offices........................................................48
Item 3. Legal Proceedings................................................48
Item 4. Submission of Matters to a Vote of Security Holders..............48
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters..................................48
Item 6. Selected Consolidated Financial Data.............................48
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................48
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.......49
Item 8. Financial Statements.............................................49
2
OCWEN FINANCIAL CORPORATION
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
(CONTINUED)
PAGE
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure......................................49
PART III
Item 10. Directors and Executive Officers of Registrant....................49
Item 11. Executive Compensation............................................52
Item 12. Security Ownership of Certain Beneficial Owners and Management....55
Item 13. Certain Relationships and Related Transactions....................56
PART IV
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K.......................................57
Signatures........................................................59
FORWARD-LOOKING STATEMENTS
IN THE NORMAL COURSE OF BUSINESS, THE COMPANY, IN AN EFFORT TO HELP
KEEP ITS SHAREHOLDERS AND THE PUBLIC INFORMED ABOUT THE COMPANY'S OPERATIONS,
MAY FROM TIME TO TIME ISSUE OR MAKE CERTAIN STATEMENTS, EITHER IN WRITING OR
ORALLY, THAT ARE OR CONTAIN FORWARD-LOOKING STATEMENTS, AS THAT TERM IS DEFINED
IN THE U.S. FEDERAL SECURITIES LAWS. GENERALLY, THESE STATEMENTS RELATE TO
BUSINESS PLANS OR STRATEGIES, PROJECTED OR ANTICIPATED BENEFITS FROM
ACQUISITIONS MADE BY OR TO BE MADE BY THE COMPANY, PROJECTIONS INVOLVING
ANTICIPATED REVENUES, EARNINGS, PROFITABILITY OR OTHER ASPECTS OF OPERATING
RESULTS OR OTHER FUTURE DEVELOPMENTS IN THE AFFAIRS OF THE COMPANY OR THE
INDUSTRY IN WHICH IT CONDUCTS BUSINESS. THESE 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 "ANTICIPATE," "BELIEVE,"
"COMMITMENT," "CONSIDER," "CONTINUE," "COULD," "ENCOURAGE," "ESTIMATE,"
"EXPECT," "INTEND," "IN THE EVENT OF," "MAY," "PLAN," "PRESENT," "PROPOSE,"
"PROSPECT," "UPDATE," "WHETHER," "WILL," "WOULD," FUTURE OR CONDITIONAL VERB
TENSES, SIMILAR TERMS, VARIATIONS ON SUCH TERMS OR NEGATIVES OF SUCH TERMS.
ALTHOUGH THE COMPANY BELIEVES THE ANTICIPATED RESULTS OR OTHER EXPECTATIONS
REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE BASED ON REASONABLE
ASSUMPTIONS, IT CAN GIVE NO ASSURANCE THAT THOSE RESULTS OR EXPECTATIONS WILL BE
ATTAINED. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE INDICATED IN SUCH
STATEMENTS DUE TO RISKS, UNCERTAINTIES AND CHANGES WITH RESPECT TO A VARIETY OF
FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED BELOW. THE COMPANY DOES
NOT UNDERTAKE, AND SPECIFICALLY DISCLAIMS ANY OBLIGATION, TO RELEASE PUBLICLY
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 ("OCN" or 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 other
non-bank subsidiaries.
The Company is a Florida corporation which was organized in February
1988 in connection with its acquisition of the Bank. During the early 1990s, the
Company sought to take advantage of the general decline in asset quality of
financial institutions in many areas of the country and the large number of
failed savings institutions during this period by establishing its discounted
loan acquisition and resolution program. This program commenced with the
acquisition of discounted single-family residential loans for resolution in 1991
and was expanded to cover the acquisition and resolution of discounted
multi-family residential and commercial real estate loans in 1994.
During the early 1990s, the Company also acquired assets and
liabilities of three failed savings institutions and merged Berkeley Federal
Savings Bank ("Old Berkeley"), a troubled financial institution, into the Bank.
The Company subsequently sold substantially all of the assets and liabilities
acquired in connection with these acquisitions. 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 Bank'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.
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 a product line (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.
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(R)-based, have
client/server architecture and feature real-time processing, are designed to be
year 2000 compliant, feature a scalable database platform and have strong
workflow capabilities. On January 20, 1998, the Company acquired DTS
Communications, Inc. ("DTS"), a real estate technology company located in San
Diego, California. DTS has developed technology tools to automate real estate
transactions. DTS has been recognized by Microsoft Corporation for the
Microsoft(R) component-based architecture to facilitate electronic data
interchange. Both AMOS and DTS are wholly-owned subsidiaries of Ocwen Technology
Xchange, Inc. ("OTX").
OTX's principal products are REALTrans(SM) and OTX(TM) Mortgage
Software Suite. REALTrans(SM) is a web-based application that facilitates the
electronics purchase of real estate products and services via the Internet.
Products currently supported include title insurance, appraisals, escrow, field
services, inspections, warranty, broker price opinions, and real property data.
This application allows users remote access to send, receive, and track
information from any location. The user is able to track the status of orders,
and send and receive messages, as well as documents. In addition, the
REALTrans(SM) application includes several forms that can be completed online,
thereby facilitating the sending of actual data, not just images of documents,
REALTrans(SM) provides data integrity because all data are backed up and stored
at a secure off-site facility. The Company is making its advanced loan
resolution technology, the OTX(TM) Mortgage Software Suite, available to third
parties through the marketing of software licenses. OTX also provides consulting
services related to its software and Internet products.
The Company entered the United Kingdom ("UK") subprime residential
mortgage market in 1998 through the acquisition of 36.07% of the total
outstanding common stock of Norland Capital Group plc, doing business as
Kensington Mortgage Company ("Kensington"), on February 25, 1998. Kensington is
a leading originator of subprime residential mortgages in the U.K. On April 24,
1998, the Company, through its wholly-owned subsidiary Ocwen UK plc ("Ocwen
UK"), acquired substantially all of the assets, and certain liabilities, of the
U.K. operations of Cityscape Financial Corp. ("Cityscape UK"). As consummated,
the Company acquired Cityscape UK's mortgage loan portfolio and its residential
subprime mortgage loan origination and servicing businesses.
4
The Company's domestic subprime residential lending activities are
conducted primarily through Ocwen Financial Services, Inc. ("OFS"), a 97.8%
owned subsidiary. OFS acquired both the subprime 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.
On May 5, 1998, the Company, through its wholly-owned subsidiary,
Investor's Mortgage Insurance Holding Company ("IMI"), acquired 1,473,733
partnership units of Ocwen Partnership L.P. ("OPLP"), the operating subsidiary
partnerships of Ocwen Asset Investment Corp. ("OAC"). This purchase was in
addition to the 160,000 units owned at December 31, 1997, and the 175,000 units
acquired on February 17, 1998, for which the Company exchanged shares of OAC
stock, increasing the total number of units owned by IMI to 1,808,733 or 8.71%
of the total partnership units outstanding at December 31, 1998. OAC specializes
in the acquisition and management of real estate and mortgage assets and is
managed by Ocwen Capital Corporation ("OCC"), a wholly-owned subsidiary of OCN
formed in 1997. At December 31, 1998, the Company owned 1,540,000 or 8.12% of
the outstanding common stock of OAC.
SEGMENTS
The Company's primary business is the acquisition, servicing and
resolution of subperforming and nonperforming mortgage loans and the related
development of loan servicing technology and software for the mortgage and real
estate industries. Within its business, The Company's primary activities consist
of its single family residential and multi-family residential, small commercial
and large commercial discount loan acquisition and resolution activities,
servicing of residential and commercial mortgage loans for others, lending,
investments in a wide variety of mortgage-related securities and investments in
low-income housing tax credit interests.
Net Interest Net (Loss) Total
DECEMBER 31, 1998 Income Income Assets
----------- ----------- -----------
Discount loans: (Dollars in thousands)
Single family residential loans...................... $ 21,568 $ 14,394 $ 613,769
Large commercial real estate loans................... 35,220 28,103 591,612
Small commercial real estate loans................... 23,149 8,195 259,609
----------- ----------- -----------
79,937 50,692 1,464,990
----------- ----------- -----------
Mortgage loan servicing:
Domestic............................................. 6,604 8,066 56,302
Foreign (U.K.)....................................... 147 4,771 11,974
----------- ----------- -----------
6,751 12,837 68,276
----------- ----------- -----------
Investment in low-income housing tax credits............ (8,246) 9,119 220,234
Commercial real estate lending.......................... 16,066 13,588 74,439
OTX 5 (9,623) 21,659
Subprime single family residential lending:
Domestic............................................. 14,080 (20,524) 156,997
Foreign (U.K.)....................................... 11,898 7,475 286,224
----------- ----------- -----------
25,978 (13,049) 443,221
----------- ----------- -----------
Investment securities................................... (214) (59,186) 382,201
Equity investment in OAC................................ -- (8,701) 39,088
Other................................................... 2,524 3,123 593,971
----------- ----------- -----------
$ 122,801 $ (1,200) $ 3,308,079
=========== =========== ===========
5
Net Interest Net (Loss) Total
DECEMBER 31, 1997 Income Income Assets
---------- ---------- ----------
Discount loans: (Dollars in thousands)
Single family residential loans................ $ 24,870 $ 23,349 $ 844,146
Large commercial real estate loans............. 33,142 24,474 585,035
Small commercial real estate loans............. 19,257 5,349 308,543
---------- ---------- ----------
77,269 53,172 1,737,724
---------- ---------- ----------
Mortgage loan servicing:
Domestic....................................... 2,629 3,972 11,160
Foreign (U.K.)................................. -- -- --
---------- ---------- ----------
2,629 3,972 11,160
---------- ---------- ----------
Investment in low income housing tax credits..... (5,080) 9,087 168,748
Commercial real estate lending................... 25,794 12,405 230,682
OTX ............................................. (33) -- 5,116
Subprime single family residential lending:
Domestic....................................... 5,205 (2,166) 225,814
Foreign (U.K.)................................. -- -- --
---------- ---------- ----------
5,205 (2,166) 225,814
---------- ---------- ----------
Investment securities............................ 2,698 3,587 344,231
Equity investment in OAC......................... -- -- --
Other............................................ 7,760 (1,125) 345,690
------------- -------------- -------------
$ 116,242 $ 78,932 $ 3,069,165
============= ============= =============
6
Net Interest Net (Loss) Total
DECEMBER 31, 1996 Income Income Assets
---------- ---------- ----------
Discount loans: (Dollars in thousands)
Single family residential loans................ $ 12,122 $ 16,827 $ 650,261
Large commercial real estate loans............. 17,565 15,480 516,622
Small commercial real estate loans............. 14,851 1,398 283,466
---------- ---------- ----------
44,538 33,705 1,450,349
---------- ---------- ----------
Mortgage loan servicing:
Domestic....................................... 1,685 (2,558) 5,020
Foreign (U.K.)................................. -- -- --
---------- ---------- ----------
1,685 (2,558) 5,020
---------- ---------- ----------
Investment in low-income housing tax credits..... (4,962) 11,577 93,309
Commercial real estate lending................... 12,305 3,617 402,582
Subprime single family residential lending:
Domestic....................................... 4,486 3,131 128,878
Foreign (U.K.)................................. -- -- --
---------- ---------- ----------
4,486 3,131 128,878
---------- ---------- ----------
Investment securities............................ 8,632 987 342,801
Other............................................ 11,050 (317) 60,746
------------- ------------- -------------
$ 77,734 $ 50,142 $ 2,483,685
============= ============= =============
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 to 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. See "Business-Computer Systems and
Use of Technology."
COMPOSITION OF THE DISCOUNT LOAN PORTFOLIO. At December 31, 1998, the
Company's net discount loan portfolio amounted to $1.03 billion or 31% of the
Company's total assets. Substantially all of the Company's discount loan
portfolio is secured by first mortgage liens on real estate.
7
The following table sets forth the composition of the Company's
discount loan portfolio by type of loan at the dates indicated:
December 31,
----------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------- ------------
(Dollars in Thousands)
Single family residential loans $ 597,100 $ 900,817 $ 504,049 $ 376,501 $ 382,165
Multi-family residential loans 244,172 191,302 341,796 176,259 300,220
Commercial real estate loans(1) 449,010 701,035 465,801 388,566 102,138
Other loans................... 10,144 1,865 2,753 2,203 911
------------ ------------ ------------ ------------- ------------
Total discount loans........ 1,300,426 1,795,019 1,314,399 943,529 785,434
Unaccreted discount (2)....... (252,513) (337,350) (241,908) (273,758) (255,974)
Allowance for loan losses..... (21,402) (23,493) (11,538) -- --
------------ ------------ ------------ ------------ ------------
Discount loans, net........... $ 1,026,511 $ 1,434,176 $ 1,060,953 $ 669,771 $ 529,460
============ ============ ============ ============ ============
(1) The balance at December 31, 1998 consisted of $154.1 million of loans
secured by office buildings, $100.4 million of loans secured by hotels,
$21.2 million of loans secured by retail properties or shopping centers
and $173.3 million of loans secured by other properties. 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, 1998 consisted of $161.6 million on single
family residential loans, $20.8 million on multi family residential
loans, $69.8 million on commercial real estate loans and $0.3 million
on other loans respectively. 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, 1998, the five states with the
greatest concentration of properties securing the Company's discount loans were
California, New York, Illinois, Michigan and New Jersey, which had $211.5
million, $144.0 million, $111.2 million, $104.8 million and $84.4 million
principal amount of discount loans (before unaccreted discount), respectively.
The Company believes that the relatively dispersed geographic distribution of
its discount loan portfolio can reduce the risks associated with concentrating
such loans in limited 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 early years, 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, 1998, approximately
74% of the loans in the Company's discount loan portfolio had been acquired from
the private sector, as compared to 58% at December 31, 1997, 77% at December 31,
1996, and 90% at December 31, 1995.
Overall, the percentage of discount loans in the Company's discount
loan portfolio acquired from private sector sellers has decreased since 1995 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
8
$225.0 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
by the Bank and BlackRock Capital Finance L.P. ("BlackRock"). See "Investment in
Unconsolidated Entities - Investment in Joint Ventures."
Since 1996, the Company has acquired over $2.04 billion of single
family residential loans and $1.96 billion of distressed commercial and
multi-family residential loans from the private sector and government agencies,
making it the largest purchaser of such assets in the United States. In 1998,
the Company acquired $1.1 billion of unpaid principal balance of discount loans,
of which $0.6 billion were residential loans with the balance being commercial.
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 by the Company 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 reached 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 and other
resources which are necessary to conduct its 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 "Investment in Unconsolidated Entities - 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 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 information technology 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
9
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 risks, 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 72% of its residential discount loans before foreclosure, as compared to
a 23% industry average.
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.
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, 1998, 1997 and 1996, the Company
sold $696.1 million, $518.9 million and $230.2 million of discount loans,
respectively, which resulted in gains of $63.5 million, $60.4 million and $15.3
million, respectively, including net securitization gains of $48.1 million,
$53.1 million and $7.9, 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 following table sets forth certain information related to the
Company's securitization of discount loans during 1998, 1997 and 1996.
Loan Securitized
- - --------------------------------------------------------------------------- Book Value of
Types of Loans Principal No. of Loans Securities Retained(1) Net Gain
- - ---------------------------------- -------------- ------------- --------------------- -------------
1998: (Dollars in thousands)
Single family discount............ $ 498,798 7,638 $ 32,261 $ 48,085
============== ============= ================ =============
1997:
Single family discount............ $ 418,795 6,295 $ 20,635 $ 51,137
Small commercial discount......... 62,733 302 4,134 1,994
-------------- ------------- ---------------- -------------
$ 481,528 6,597 $ 24,769 $ 53,131
============== ============= ================ =============
1996:
Large commercial discount......... $ 164,417 25 $ 8,384 $ 7,929
============== ============= ================ =============
(1) Consists of subordinated and/or residual securities resulting from the
Company's securitization activities, which had a fair value of $71.5
million at December 31, 1998.
10
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,
--------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------------- -------------------- -------------------- -------------------- --------------------
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 ........... $ 1,795,019 12,980 $ 1,314,399 5,460 $ 943,529 4,543 $ 785,434 3,894 $ 433,516 5,160
Acquisitions(1) ...... 1,123,727 8,084 1,776,773 17,703 1,110,887 4,812 791,195 2,972 826,391 2,781
Resolutions and
repayments(2) ....... (539,353) (1,918) (484,869) (1,978) (371,228) (2,355) (300,161) (960) (265,292) (2,153)
Loans transferred to
real estate owned .. (382,904) (3,193) (292,412) (1,596) (138,543) (860) (281,344) (984) (171,300) (1,477)
Sales ................ (696,063) (7,853) (518,872) (6,609) (230,246) (680) (51,595) (379) (37,881) (417)
----------- -------- ----------- -------- ----------- -------- ----------- -------- ----------- --------
Balance at
end of period....... $ 1,300,426 8,100 $ 1,795,019 12,980 $ 1,314,399 5,460 $ 943,529 4,543 $ 785,434 3,894
=========== ======== =========== ======== =========== ======== =========== ======== =========== ========
(1) In 1998, acquisitions consisted of $613.2 million of single family
residential loans, $231.1 million multifamily residential loans, $264.7
million of commercial real estate loans and $14.7 million of consumer
loans. 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. 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.
(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
"Asset Quality - Real Estate Owned."
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,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(Dollars in Thousands)
Loan status:
Current ........................................ $ 579,449 $ 673,255 $ 579,597 $ 351,630 $ 113,794
Past due 31 days to 89 days .................... 39,601 22,786 22,161 86,838 57,023
Past due 90 days or more (1) ................... 624,328 1,070,925 563,077 385,112 413,506
Acquired and servicing not
yet transferred ............................... 57,048 28,053 149,564 119,949 201,111
----------- ----------- ----------- ----------- -----------
1,300,426 1,795,019 1,314,399 943,529 785,434
Unaccreted discount ............................ (252,513) (337,350) (241,908) (273,758) (255,974)
Allowance for loan losses ...................... (21,402) (23,493) (11,538) -- --
----------- ----------- ----------- ----------- -----------
$ 1,026,511 $ 1,434,176 $ 1,060,953 $ 669,771 $ 529,460
=========== =========== =========== =========== ===========
(1) Includes $110.1 million, $432.6 million and $57.0 million of loans with
forbearance agreements at December 31, 1998, 1997 and 1996,
respectively, and $522.0 billion, $638.3 million and $506.1 million of
loans without forbearance agreements at December 31, 1998, 1997 and
1996, respectively. Of the $110.1 million of loans with forbearance
agreements past due 90 days or more in accordance with original terms,
$77.9 million were current and $32.2 million were past due 31 to 89
days under the terms of the forbearance agreements.
11
ACCOUNTING FOR DISCOUNT LOANS. The acquisition cost for a pool of
discount loans is allocated to each individual loan within the pool based upon
relative fair value using 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.
INVESTMENT IN UNCONSOLIDATED ENTITIES
INVESTMENT IN OAC. At December 31, 1997, the Company, through IMI,
owned 1,715,000 shares or 9.04% of the outstanding common stock of OAC. Also at
December 31, 1997, the Company, through IMI, owned 160,000 units or 0.84% of the
partnership units of OPLP. On February 17, 1998, IMI exchanged 175,000 shares of
OAC stock for 175,000 OPLP units. On May 5, 1998, IMI acquired an additional
1,473,733 OPLP units. As a result of this activity, IMI's investment in OAC
stock declined to 1,540,000 shares or 8.12% at December 31, 1998, while its
investment in OPLP increased to 1,808,733 units or 8.71%. The Company began
accounting for these entities on the equity method effective May 5, 1998, upon
the increase in its combined ownership of OAC and OPLP to 16.83%. The Company's
investment in OAC stock amounted to $16.3 million at December 31, 1998. The
Company's investment in OAC stock at December 31, 1997, was designated as
available for sale and carried at a fair value of $35.2 million ($25.5 million
cost). The Company's investment in OPLP units amounted to $22.8 million at
December 31, 1998, as compared to $2.4 million at December 31, 1997. During
1998, the Company recorded equity in the losses of its investment in OAC and
OPLP of $4.0 million and $4.7 million, respectively.
INVESTMENT IN KENSINGTON. The Company's investment in unconsolidated
entities includes its 36.07% ownership interest in Kensington, which amounted to
$46.6 million at December 31, 1998, net of the excess of the purchase price over
the net investment. The excess of the purchase price over the net investment
amounted to $34.5 million ((pound)20.9million) at December 31, 1998, net of
accumulated amortization of $2.0 million ((pound)1.2 million), and is amortized
over a period of 15 years. During 1998, the Company recorded equity in earnings
of Kensington of $439,000, net of the $2.0 million of amortization of excess
cost over purchase price.
INVESTMENT IN JOINT VENTURES. From time to time, the Company and a
co-investor have acquired discount loans by means of a co-owned joint venture.
At December 31, 1998, the Company's $1.1 million investment in joint venture,
consisted of a 10% interest in BCFL, L.L.C. ("BCFL"), a limited liability
company which was formed by the Company and BlackRock in January 1997 to acquire
discount multi-family residential loans. On December 12, 1997, the LLC, a
limited liability company formed in March 1996 between the Company and
BlackRock, 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 recorded equity in earnings of the LLC of
$23.7 million and $38.3 million for 1997 and 1996, respectively.
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.
12
SECURITIZATION OF THE HUD LOANS BY THE LLC. 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 residuals 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
losses/equity in earnings of investment in unconsolidated entities.
ACCOUNTING FOR INVESTMENTS IN UNCONSOLIDATED ENTITIES. The Company's
investment in unconsolidated entities are 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.
LENDING ACTIVITIES
COMPOSITION OF LOAN PORTFOLIO. At December 31, 1998, the Company's net
loan portfolio amounted to $230.3 million or 7% 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.
The following table sets forth the composition of the Company's loan
portfolio by type of loan at the dates indicated.
December 31,
-------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(Dollars in Thousands)
Single family residential loans ...... $ 30,361 $ 46,226 $ 73,186 $ 75,928 $ 31,926
Multi-family residential loans (1) ... 75,599 71,382 67,842 49,047 1,800
Commercial real estate and land loans:
Hotels (2) (3) .................. 36,631 89,362 200,311 125,791 19,659
Office buildings (4) ............ 93,068 68,759 128,782 61,262 --
Land ............................ 2,266 2,858 2,332 24,904 1,315
Other ........................... 6,762 16,094 25,623 2,494 4,936
--------- --------- --------- --------- ---------
Total .......................... 138,727 177,073 357,048 214,451 25,910
Commercial non-mortgage .............. -- -- 2,614 -- --
Consumer ............................. 132 244 424 3,223 1,558
--------- --------- --------- --------- ---------
Total loans ..................... 244,819 294,925 501,114 342,649 61,194
Undisbursed loan proceeds ............ (7,099) (22,210) (89,840) (39,721) --
Unaccreted discount .................. (2,480) (2,721) (5,169) (5,376) (3,078)
Allowance for loan losses ............ (4,928) (3,695) (3,523) (1,947) (1,071)
--------- --------- --------- --------- ---------
Loans, net ...................... $ 230,312 $ 266,299 $ 402,582 $ 295,605 $ 57,045
========= ========= ========= ========= =========
(1) At December 31, 1998, 1997, 1996 and 1995, multi-family residential
loans included $22.3 million, $33.3 million and $36.6 million, and $7.7
million of construction loans, respectively.
(2) At December 31, 1998, 1997 and 1996, hotel loans included $6.9 million,
$25.3 million and $26.4 million of construction loans, respectively.
(3) During 1998 and 1997, payoffs of loans secured by hotels totaled $16.6
million and $80.5 million, respectively.
(4) During 1998 and 1997, payoffs of loans secured by office buildings
totaled $186.5 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, 1998, the five states in which the
largest amount of properties securing loans in the Company's loan portfolio were
New York, New Jersey, Florida, Texas and California, which had $52.3 million,
$29.8 million, $27.9 million, $12.2 million and $11.2 million of principal
amount of loans, respectively.
13
CONTRACTUAL PRINCIPAL REPAYMENTS. The following table sets forth
certain information at December 31, 1998 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 After Five
One Year Years
One Through Five Through Ten After Ten
Year or Less Years Years Years Total
------------- ------------ ------------ ------------ ------------
(Dollars in Thousands)
Single family residential loans....... $ 1,047 $ 794 $ 9,179 $ 19,341 $ 30,361
Multi-family residential loans........ 23,800 37,771 6,346 7,682 75,599
Commercial real estate and land loans. 35,517 96,183 7,027 -- 138,727
Consumer and other loans.............. 11 121 -- -- 132
------------ ------------ ------------ ------------ ------------
Total.............................. $ 60,375 $ 134,869 $ 22,552 $ 27,023 $ 244,819
============ ============ ============ ============ ============
Interest rate terms on amounts due:
Fixed.............................. $ 25,091 $ 17,488 $ 2,065 $ 12,485 $ 57,129
Adjustable......................... 35,284 117,381 20,487 14,538 187,690
------------ ------------ ------------ ------------ ------------
$ 60,375 $ 134,869 $ 22,552 $ 27,023 $ 244,819
============ ============ ============ ============ ============
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,
----------------------------------------------
1998 1997 1996
----------- ----------- -----------
(Dollars in Thousands)
Balance at beginning of period....................... $ 294,925 $ 501,114 $ 342,649
Originations:
Single family residential loans................... -- 1,987 10,681
Multi-family residential loans.................... 56,657 16,799 68,076
Commercial real estate loans...................... 116,452 69,948 199,017
Commercial non-mortgage and consumer loans........ -- 1,140 3,366
----------- ----------- -----------
Total loans originated......................... 173,109 89,874 281,140
----------- ----------- -----------
Purchases:
Single family residential loans................... -- 78 305
----------- ----------- -----------
Total loans purchased.......................... -- 78 305
----------- ----------- -----------
Sales ............................................... -- (2,346) --
Loans transferred from available for sale............ -- 13,782 45
Principal repayments................................. (222,668) (306,916) (121,818)
Transfer to real estate owned........................ (547) (661) (1,207)
------------ ----------- -----------
Net increase (decrease) in net loans................. (50,106) (206,189) 158,465
------------ ----------- -----------
Balance at end of period............................. $ 244,819 $ 294,925 $ 501,114
=========== =========== ===========
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, 1998, loans available for sale
amounted to $177.8 million or 5% of the Company's total assets.
14
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,
---------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(Dollars in Thousands)
Single family residential loans...... $ 177,578 $ 176,554 $ 111,980 $ 221,927 $ 16,825
Multi-family residential loans....... -- -- 13,657 28,694 83,845
Consumer loans....................... 269 487 729 1,169 1,623
----------- ----------- ----------- ----------- -----------
$ 177,847 $ 177,041 $ 126,366 $ 251,790 $ 102,293
=========== =========== =========== =========== ===========
At December 31, 1998, the five states or countries in which the largest
amount of properties securing the Company's loans available for sale were the
U.K., California, New Jersey, Florida and Illinois which had $87.6 million,
$21.0 million, $10.8 million, $10.6 million and $7.5 million of principal amount
of loans, respectively.
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 domestic 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." 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.
The principal sources of funds of OFS consist of lines of credit with
unaffiliated parties of (i) a $200.0 million secured of credit, of which $100.0
million was committed, (ii) a $50.0 million secured line of credit, all of which
was committed, (iii) a $200.0 million secured line of credit, of which $100.0
million ws committed (iv) a $100.0 million secure line of credit, none of which
was committed (v) a $20.0 million secured residual line of credit, none of which
was committed and are secured by the mortgage loans acquired with such lines and
(vi) a $30.0 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 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. See
"Sources of Funds - Borrowings".
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 loans to the appraised
value of the security property, each of the four principal classes of loans
identified by the Company includes 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.
15
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 Company further expanded its subprime single family residential
lending operations in 1998 by entering the United Kingdom through the
acquisition of a 36.07% interest in Kensington and, through Ocwen UK, the
acquisition of Cityscape UK's mortgage loan portfolio and its residential
subprime mortgage loan origination and servicing businesses.
Ocwen UK's sources of funding include a Loan Facility Agreement with
Greenwich International Ltd. ("Greenwich") under which Greenwich provided a
short-term facility to finance the acquisition of Cityscape UK's mortgage loan
portfolio (the "Term Loan") and to finance Ocwen UK's further originations and
purchase of subprime single family loans (the "Revolving Facility", and together
with the Term Loan, the "Greenwich Facility"). The Greenwich Facility is secured
by Ocwen UK's loans available for sale. The Revolving Facility, which matures in
April 1999, is set at a maximum of $166.0 million ((pound)100.0 million reduced
by the amount borrowed under the Term Loan), of which $87.1 million ((pound)52.5
million) was funded at December 31, 1998, to finance subprime single family loan
originations and bears interest at a rate of the one-month LIBOR plus 1.50%. At
December 31, 1998, $5.6 million ((pound)3.4 million) had been borrowed under the
Term Loan, which matured in January 1999. In addition, Ocwen UK has entered into
a secured warehouse line of credit with Barclays Bank plc (the "Barclays
Facility") to finance subprime single family loan originations. The Barclays
Facility, which matures in November 1999, and bears interest at a rate of the
one-month LIBOR plus 0.80%, is set at a maximum of $124.5 million ((pound)75.0
million), against which $24.6 million ((pound)14.8 million) had been borrowed at
December 31, 1998. The weighted average interest rate on these lines of credit
outstanding at December 31, 1998, was 7.35%.
The following table sets forth the activity in the Company's net loans
available for sale during the periods indicated:
Year Ended December 31,
------------------------------------------------------
1998 1997 1996
------------ ------------ --------------
(Dollars in Thousands)
Balance at beginning of period................... $ 177,041 $ 126,366 $ 251,790
Purchases:
Single family residential........................ 795,053 278,081 284,598
Multi-family residential......................... -- -- 10,456
------------ ------------ --------------
795,053 278,081 295,054
------------ ------------ --------------
Originations:
Single family residential........................ 959,105 316,101 9,447
Multi-family residential...................... -- -- --
------------ ------------ --------------
959,105 316,101 9,447
------------ ------------ --------------
Sales............................................ (1,658,773) (501,079) (395,999)
Increase in lower of cost or market reserve...... (4,064) (1,034) (2,455)
Loans transferred (to)/from loan portfolio....... -- (13,674) 45
Principal repayments, net of capitalized interest (82,728) (22,151) (27,845)
Transfer to real estate owned.................... (7,787) (5,569) (3,671)
------------- ------------ --------------
Net increase (decrease) in loans................. 806 50,675 (125,424)
------------ ------------ --------------
Balance at end of period......................... $ 177,847 $ 177,041 $ 126,366
============ ============ ==============
The Company purchased and originated a total of $1.75 billion of single
family residential loans to non-conforming borrowers during 1998 and $558.3
million of such loans during 1997. At December 31, 1998, the Company had $170.1
million of subprime single family residential loans, which had a weighted
average yield of 12.18%.
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, 1998. During 1998 the Company sold $2.9
million of subprime single family residential loans for gains of $53,000; during
1997 the Company sold $82.6 million of such loans for gains of $3.3 million; and
during 1996 the Company sold $161.5 million of subprime single family
residential loans for gains of $571,000. In addition, as presented in the table
below, loans were securitized and sold in public offerings underwritten by
unaffiliated investment banking firms during 1998, 1997 and 1996, generating
gains of $61.5 million, $18.8 million and $7.2 million, respectively, upon the
sale of the securities. The Company retained subordinate and residual securities
in connection with these transactions.
16
Loan Securitized
------------------------------------------ Book Value of
Types of Loans Principal No. of Loans Securities Retained(2) Net Gain
-------------- -------------- ------------- ---------------------- --------------
1998: (Dollars in thousands)
Single family subprime (1)........ $ 1,626,282 31,235 $ 139,594 $ 61,516
============== ============= ================ =============
1997:
Single family subprime............ $ 415,830 3,640 $ 25,334 $ 18,802
============== ============= ================ =============
1996:
Single family subprime............ $ 211,204 1,180 $ 18,236 $ 7,232
============== ============= ================ =============
(1) Includes 20,819 loans securitized by Ocwen UK with an unpaid principal
balance of $558.5 million ((pound)339.4 million) for a net gain of $25.6
million ((pound)15.4 million).
(2) Consists of subordinated and/or residual securities resulting from the
Company's securitization activities, which had a fair value of $177.5
million at December 31, 1998, including $87.3 million ((pound)52.6
million) related to securitizations by Ocwen UK.
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.
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, 1998, the
Company's loans secured by commercial real estate (and land) amounted to $138.7
million and consisted primarily of $36.6 million and $93.1 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, 1998, the Company's multi-family residential loan portfolio included $22.3
million of multi-family residential construction loans, of which $20.1 million
had been funded, and $53.3 million of acquisition and rehabilitation loans, of
which $51.3 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
17
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 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, 1998 and 1997, the Company's loan portfolio
included $12.3 million and $89.0 million of loans in which the Company
participates in the residual profits of the underlying real estate. 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. These eight loans were repaid in
full during 1998. The Bank (but not the Company) 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,
available funds 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
18
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.
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. Servicing fees, generally expressed as a percent of the unpaid
principal balance, are collected from the borrowers' payments. During any period
in which the borrower is not making payments, the Company is required under
certain servicing agreements to advance its own funds to meet contractual
principal and interest remittance requirements for certain investors, maintain
property taxes and insurance, and process foreclosures. The Company generally
recovers such advances from borrowers for reinstated and performing loans and
from investors for foreclosed loans.
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. The Bank is one of only seven
special servicers of commercial mortgage loans to have received a "Strong"
rating from Standard & Poor's. The Bank is recognized and/or designated by four
rating agencies (Standard & Poor's, Duff and Phelps, IBC Fitch Investors, and
Moody's) as a "Special Servicer" for residential mortgage loans and is the only
special servicer with this designation for all mortgage categories.
The Company developed the concept of residential special servicing in
1997 and, in 1998, began entering into special servicing arrangements wherein
the Company acted as a special servicer for third parties, typically as part of
a securitization. The Company services loans that become greater than 90 days
past due and receives incentive fees to the extent certain loss mitigation
parameters are achieved. Through December 31, 1998, the Company was designated
as a special servicer for securitized pools of mortgage loans totaling
approximately $9.1 billion in unpaid principal balance. Of this amount,
approximately $8.0 billion were residential loans, and the balance was
commercial.
19
The following tables set forth the number and amount of loans serviced
by the Company for others at the dates indicated:
DECEMBER 31, 1998:
Discount Loans Subprime Loans (1) 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....................... $1,015,988 16,840 $1,809,533 31,607 $ -- -- $ 2,825,521 48,447
Loans serviced for third parties. 1,573,285 20,835 5,327,441 83,085 866,219 1,091 7,766,945 105,011
---------- ------- ---------- -------- --------- ------ ----------- -------
$2,589,273 37,675 $7,136,974 114,692 $ 866,219 1,091 $10,592,466 153,458
========== ======= ========== ======== ========= ====== =========== =======
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
========== ========= ========= ========= ========= ======= ========== ========
(1) Includes 37,955 loans with an unpaid principal balance of $857.2
million ((pound)504.4 million) which were serviced by Ocwen UK at
December 31, 1998.
The Company generally does not purchase rights to service loans for
others, and as a result, capitalized mortgage servicing rights amounted to only
$7.1 million and $5.7 million at December 31, 1998 and 1997, respectively. In
connection with the securitization and sale of loans, the Company generally
retains the rights to service such loans for investors. On January 1, 1996, the
Company adopted Statement of Financial Accounting Standards ("SFAS") No. 122,
"Accounting for Mortgage Servicing Rights." SFAS No. 122 was superseded, for
transactions recorded after December 31, 1996, by SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
which the Company adopted on January 1, 1997. Both SFAS No. 122 and SFAS No. 125
require the recognition of a servicing asset or liability and other retained
interests as an allocation of the carrying amount of the assets sold between the
asset sold and the servicing obligation and other retained interests based on
the relative fair value of the assets sold to the interests retained. The
resulting mortgage servicing asset or liability is amortized in proportion to
and over the period of estimated net servicing income or loss. The Company
evaluates the mortgage servicing asset for impairment based on the fair value of
the servicing asset. The Company estimates fair values by discounting servicing
asset cash flows using discount and prepayment rates that it believes market
participants would use.
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 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.
20
The following table sets forth certain information relating to the
Company's nonperforming loans in its loan portfolio at the dates indicated:
December 31,
---------------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(Dollars in Thousands)
Nonperforming loans (1):
Single family residential loans......... $ 1,169 $ 1,575 $ 2,123 $ 2,923 $ 2,478
Multi-family residential loans(2)(3).... 7,392 7,583 106 731 152
Consumer and other loans................ 488 -- 55 202 29
--------- --------- --------- --------- ---------
Total................................ $ 9,049 $ 9,158 $ 2,284 $ 3,856 $ 2,659
========= ========= ========= ========= =========
Nonperforming loans as a percentage of:
Total loans (4)......................... 3.81% 3.36% 0.56% 1.27% 4.35%
Total assets............................ 0.27% 0.30% 0.09% 0.20% 0.21%
Allowance for loan losses as a percentage of:
Total loans(4)(5).................... 2.07% 1.35% 0.87% 0.65% 1.84%
Nonperforming loans.................. 54.46% 40.35% 154.25% 50.49% 40.28%
(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 non performing multi-family residential loans during 1997
was primarily attributable to a $7.4 million loan secured by 127-unit
condominium building located in New York, New York, which management
believes is well collateralized.
(3) Non performing multi-family residential loans at December 31, 1998 was
primarily attributable to three loans with an aggregate balance of $5.0
million, all of which management believes are well capitalized.
(4) Total loans is net of undisbursed loan proceeds.
(5) The decrease in the allowance for loan losses as a percentage of total
loans during 1995 was due to the significant increase in the loan
portfolio during 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,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
Nonperforming loans:
Single family loans.................. $ 39,415 $ 13,509 $ 14,409 $ 7,833 $ --
Consumer loans....................... 9 25 36 100 120
---------- ---------- ---------- ---------- ----------
$ 39,424 $ 13,534 $ 14,445 $ 7,933 $ 120
========== ========== ========== ========== ==========
Nonperforming loans a percentage of:
Total loans available for sale....... 22.17% 7.64% 11.43% 3.15% 0.12%
Total assets......................... 1.19% 0.44% 0.58% 0.58% 0.01%
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 $15.3 million, $12.3
million, $11.5 million, $4.6 million and $3.9 million at December 31, 1998,
1997, 1996 1995 and 1994, respectively.
21
The following table sets forth certain information relating to the
Company's real estate owned at the dates indicated.
December 31,
----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in Thousands)
Discount loan portfolio:
Single family residential $ 94,641 $ 76,409 $ 49,728 $ 75,144 $ 86,426
Multi-family residential 20,130 16,741 14,046 59,932 --
Commercial real estate 82,591 71,339 36,264 31,218 8,801
-------- -------- -------- -------- --------
Total ............ 197,362 164,489 100,038 166,294 95,227
Loan portfolio .......... 227 357 592 262 1,440
Loans available for sale 3,962 2,419 3,074 -- --
-------- -------- -------- -------- --------
Total ............ $201,551 $167,265 $103,704 $166,556 $ 96,667
======== ======== ======== ======== ========
The following table sets forth certain geographical information by type
of property at December 31, 1998 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)
Florida.................. $ 5,334 114 $ 54,187 12 $ 59,521 126
California............... 29,255 469 6,491 6 35,746 475
Maryland................. 8,078 141 14,942 3 23,020 144
Connecticut.............. 5,382 109 12,481 2 17,863 111
New York................. 6,938 157 955 3 7,893 160
Other(1)................. 43,843 945 13,665 38 57,508 983
-------- -------- --------- -------- --------- --------
Total................. $ 98,830 1,935 $ 102,721 64 $ 201,551 1,999
======== ======== ========= ======== ========= ========
(1) Consists of properties located in 43 other states, none of which
aggregated over $6.7 million in any one state.
The following table sets forth the activity in the real estate owned
during the periods indicated.
Year Ended December 31,
---------------------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
No. of No. of No of
Amount Properties Amount Properties Amount Properties
------ ---------- ------ ---------- ------ ----------
(Dollars in Thousands)
Balance at beginning of period... $ 167,265 1,505 $103,704 825 $ 166,556 1,070
Properties acquired through
foreclosure or deed-in-lieu
thereof....................... 280,522 3,278 205,621 1,656 102,098 918
Acquired in connection with
acquisitions of discount loans 19,949 303 38,486 545 2,529 12
Sales............................ (263,206) (3,087) (179,693) (1,521) (160,592) (1,175)
Change in allowance.............. (2,979) -- (853) -- (6,887) --
--------- --------- -------- --------- --------- ---------
Balance at end of period......... $ 201,551 1,999 $167,265 1,505 $ 103,704 825
========= ========= ======== ========= ========= =========
The following table sets forth the amount of time that the Company had
held its real estate owned at the dates indicated.
December 31,
1998 1997 1996
------------ ------------ ------------
(Dollars in Thousands)
One to two months................................. $ 38,444 $ 83,144 $ 17,695
Three to four months.............................. 79,264 28,912 15,291
Five to six months................................ 27,115 20,929 14,348
Seven to 12 months................................ 26,122 23,621 13,004
Over 12 months.................................... 30,606 10,659 43,366
------------ ------------ ------------
$ 201,551 $ 167,265 $ 103,704
============ ============ ============
22
The average period during which the Company held the $263.2 million,
$179.7 million and $160.6 million of real estate owned which was sold during the
years ended December 31, 1998, 1997 and 1996, respectively, was 6 months, 9
months and 11 months, respectively.
The following table sets forth the activity, in aggregate, in the
valuation allowances on real estate owned during the periods indicated.
Year Ended December 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in thousands)
Balance at beginning of year $ 12,346 $ 11,493 $ 4,606 $ 3,937 $ 2,455
Provisions for losses ...... 18,626 13,450 18,360 10,510 9,074
Charge-offs and sales ...... (15,647) (12,597) (11,473) (9,841) (7,592)
-------- -------- -------- -------- --------
Balance at end of year ..... $ 15,325 $ 12,346 $ 11,493 $ 4,606 $ 3,937
======== ======== ======== ======== ========
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, 1998, such loans amounted to $7.5 million and
consisted of $3.6 million of single family residential loans, $3.6 million of
multi-family residential loans and $262,000 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, 1998.
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 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
23
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, 1998 under the
above policy consisted of $49.8 million of assets classified as substandard and
$636,000 of assets classified as doubtful. In addition, at the same date, $80.5
million of assets were designated as special mention.
Substandard assets at December 31, 1998 under the above policy
consisted primarily of $5.6 million of loans and real estate owned related to
the Company's discount single family residential loan program, $22.9 million of
loans and real estate owned related to the Company's discount commercial real
estate loan program and $5.6 million of subprime single family residential
loans. Special mention assets at December 31, 1998 under the policy consisted
primarily of $26.9 million and $34.2 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.
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,
--------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------- -------------- -------------- -------------- --------------
Amount % Amount % Amount % Amount % Amount %
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in Thousands)
Loan portfolio:
Single family residential loans $ 215 4.4% $ 512 15.7% $ 520 14.6% $ 346 22.2% $ 615 52.2%
Multi-family residential loans 2,714 55.1 2,163 24.2 673 13.5 683 14.3 -- 2.9
Commercial real estate loans .. 1,999 40.5 1,009 60.0 2,299 71.3 875 62.6 218 42.3
Commercial non-mortgage loans . -- -- -- -- 11 0.5 -- -- -- --
Consumer loans ................ -- -- 11 0.1 20 0.1 43 0.9 238 2.6
------ ----- ------- ----- ------- ----- ------ ----- ------ -----
Total ....................... $4,928 100.0% $ 3,695 100.0% $ 3,523 100.0% $1,947 100.0% $1,071 100.0%
====== ===== ======= ===== ======= ===== ====== ===== ====== =====
Discount loan portfolio(1):
Single family residential loans $10,307 48.2% $15,017 50.2% $ 3,528 38.4% $ -- --% $ -- --%
Multi-family residential loans 2,457 11.5 2,616 10.7 3,124 26.0 -- -- -- --
Commercial real estate loans 8,607 40.2 5,860 39.0 4,886 35.4 -- -- -- --
Other loans............... 31 0.1 -- 0.1 -- 0.2 -- -- -- --
------ ----- ------- ----- ------- ------ ------ ----- ------ -----
Total................... $21,402 100.0% $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.
24
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,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in Thousands)
Balance at beginning of period...... $ 3,695 $ 3,523 $ 1,947 $ 1,071 $ 884
Provision for loan losses........... 891 325 1,872 1,121 --
Charge-offs:
Single family residential loans.. (212) (100) (261) (131) (302)
Multi-family residential loans... -- -- (7) -- --
Commercial real estate loans..... -- -- -- (40) --
Consumer loans................... (7) (53) (28) (92) (170)
-------- -------- -------- -------- --------
Total charge-offs.............. (219) (153) (296) (263) (472)
Recoveries:
Single family residential loans.. -- -- -- 3 410
Multi-family residential loans... -- -- -- -- --
Commercial real estate loans..... 561 -- -- 15 --
Consumer loans................... -- -- -- -- 249
-------- -------- -------- -------- --------
Total recoveries............... 561 -- -- 18 659
-------- -------- -------- -------- --------
Net (charge-offs) recoveries... 342 (153) (296) (245) 187
-------- -------- -------- -------- --------
Balance at end of period............ $ 4,928 $ 3,695 $ 3,523 $ 1,947 $ 1,071
======== ======== ======= ======== ========
Net charge-offs (recoveries) as a
percentage of average loan
portfolio, net................... 0.13% 0.04% 0.09% 0.19% (0.28)%
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,
----------------------------------
1998 1997 1996
-------- -------- --------
(Dollars in Thousands)
Balance at beginning of period ........... $ 23,493 $ 11,538 $ --
Provision for loan losses ................ 17,618 31,894 20,578
Charge-offs:
Single family residential loans ....... (14,574) (13,281) (7,009)
Multi-family residential loans ........ (2,648) (2,056) (704)
Commercial real estate loans .......... (2,888) (5,012) (1,503)
Other loans ........................... (20) -- --
-------- -------- --------
Total charge-offs .................. (20,130) (20,349) (9,216)
-------- -------- --------
Recoveries:
Single family residential loans ....... 421 410 176
Multi-family residential loans ........ -- -- --
Commercial real estate loans .......... -- -- --
Consumer loans ........................ -- -- --
-------- -------- --------
Total recoveries ................... 421 410 176
-------- -------- --------
Net (charge-offs) .................. (19,709) (19,939) (9,040)
-------- -------- --------
Balance at end of period ................. $ 21,402 $ 23,493 $ 11,538
======== ======== ========
Net charge-offs as a percentage of average
discount loan portfolio ............... 1.53% 1.55% 1.34%
25
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.
On July 27, 1998, the Company sold its entire portfolio of AAA-rated
agency IOs for $137.5 million, which represented book value. As a result of an
increase in prepayment speeds due to declining interest rates, the Company
recorded impairment charges of $86.1 million in 1998 prior to the sale ($77.6
million in the second quarter) resulting from the Company's decision to
discontinue this investment activity and write down the book value of the IOs.
The AAA-rated agency IOs consisted of IOs, which are classes of mortgage-related
securities that are entitled to payments of interest but no (or only nominal)
principal, and inverse IOs, which bear interest at a floating rate that varies
inversely with (and often at a multiple of) changes in a specified index.
At December 31, 1998, the fair value of the Company's investment in
subordinate and residual interests amounted to $249.1 million ($227.9 million
amortized cost) or 42% of total securities available for sale and supported
senior classes of securities having an outstanding principal balance of $3.84
billion. During 1998, the Company recorded $43.6 million of impairment charges
on its portfolio of subordinate and residual securities as a result of declines
in value that were deemed to be "other than temporary." Because of their
subordinate position, subordinated and residual classes of mortgage-related
securities provide protection to and involve more risk than the senior class.
Specifically, when cash flow is impaired, debt service goes first to the holders
of senior classes. In addition, incoming cash flows may be held in a reserve
fund to meet any future 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. Further, residual interests exhibit
considerably more price volatility than mortgages or ordinary mortgage
pass-through securities, due in part to the uncertain cash flows that result
from changes in the prepayment rates of the underlying mortgages. Lastly,
subordinate and residual interests involve substantially more credit risk than
the senior classes of the mortgage-related securities to which such interests
relate and generally are not as liquid as the senior classes.
The Company generally retains subordinate and residual securities,
which are certificated, related to its securitization of loans. Subordinate and
residual interests in mortgage-related securities provide credit support to the
more senior classes of the mortgage-related securities. Principal from the
underlying mortgage loans generally is allocated first to the senior classes,
with the most senior class having a priority right to the cash flow from the
mortgage loans until its payment requirements are satisfied. To the extent that
there are defaults and unrecoverable losses on the underlying mortgage loans,
resulting in reduced cash flows, the most subordinate security will be the first
to bear this loss. Because subordinate and residual interests generally have no
credit support, to the extent there are realized losses on the mortgage loans
26
comprising the mortgage collateral for such securities, the Company may not
recover the full amount or, indeed, any of its initial investment in such
subordinate and residual interests. The Company generally retains the most
subordinate classes of the securities from the securitization and therefore will
be the first to bear any credit losses.
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 include the anticipated prepayment speeds and the anticipated credit
losses related to the underlying mortgages. In order to determine the present
value of this estimated excess cash flow, the Company currently applies a
discount rate of 18% to the projected cash flows on the unrated classes of
securities. 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 and residual
securities retained. During 1998, the Company utilized proprietary prepayment
curves generated by the Company (reaching an approximate range of annualized
rates of 30% - 40%). In its estimates of annual loss rates, the Company utilizes
assumptions that it believes are reasonable. The Company estimates annual losses
of between 0.22% and 2.06% of the underlying loans.
Subordinate and residual interests are affected by the rate and timing
of payments of principal (including prepayments, repurchase, defaults and
liquidations) on the mortgage loans underlying a series of mortgage-related
securities. The rate of principal payments may vary significantly over time
depending on a variety of factors, such as the level of prevailing mortgage loan
interest rates and economic, demographic, tax, legal and other factors.
Prepayments on the mortgage loans underlying a series of mortgage-related
securities are generally allocated to the more senior classes of
mortgage-related securities. Although in the absence of defaults or interest
shortfalls all subordinates receive interest, amounts otherwise allocable to
residuals generally are used to make payments on more senior classes or to fund
a reserve account for the protection of senior classes until
overcollateralization or the balance in the reserve account reaches a specified
level. In periods of declining interest rates, rates of prepayments on mortgage
loans generally increase, and if the rate of prepayments is faster than
anticipated, then the yield on subordinates will be positively affected and the
yield on residuals will be negatively affected.
The credit risk of mortgage related securities is affected by the
nature of the underlying mortgage loans. In this regard, the risk of loss on
securities backed by commercial and multi-family loans and single family
residential loans made 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 under guidelines established by the FHLMC and the FNMA for
purchases of loans by such agencies, generally involve more risk than securities
backed by single family residential loans which conform to the requirements
established by FHLMC and FNMA for their purchase by such agencies.
The Company adjusts its securities portfolio to fair value at the end
of each month based upon the lower of dealer quotations or internal values,
subject to an internal review process. For those securities which do not have an
available market quotation, the Company will request market values and
underlying assumptions from the various securities dealers that underwrote, are
currently financing the securities, or have had prior experience with the type
of security to be valued. When quotations are obtained from two or more dealers,
the average dealer quote will be utilized.
The Company periodically assesses the carrying value of its subordinate
securities and 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 and
residual securities retained and servicing asset 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 and 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 recognized the disparity. Other factors may also result in a
write-down of the Company's subordinate securities and residual securities
retained in subsequent periods. Accelerated prepayment speeds were a significant
contributing factor to the $43.6 million of impairment charges recorded by the
Company in 1998 on its subordinate and residual securities.
27
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,
---------------------------------------------
1998 1997 1996
---------- ---------- ---------
Mortgage-related securities: (Dollars in Thousands)
Single family residential:
CMOs (AAA-rated)............................ $ 344,199 $ 160,451 $ 73,935
Interest only:
AAA-rated................................. -- 13,863 1,173
FHLMC..................................... -- 64,745 47,571
FNMA...................................... -- 59,715 49,380
GNMA...................................... -- 29,766 --
BB-rated subordinates....................... 8,517 2,515 --
B-rated subordinates........................ 6,344 -- --
Unrated subordinates ..................... 40,595 39,219 19,164
AAA-rated subprime residuals .............. 6,931 -- --
BBB-rated subprime residuals .............. 17,593 -- --
Unrated subprime residuals ................ 152,951 41,790 20,560
Futures contracts and swaps................. -- (94) (1,921)
---------- ---------- ---------
Total..................................... 577,130 411,970 209,862
---------- ---------- ---------
Multi-family residential and commercial:
Interest only:
AAA-rated................................. 71 3,058 83,590
BB-rated.................................. 2 189 --
Unrated................................... -- -- 3,799
B-rated subordinates........................ 8,813 8,512
Unrated..................................... -- -- 13,848
Unrated subordinates........................ 7,331 6,795 43,686
Futures contracts........................... -- -- (780)
---------- ---------- ---------
Total..................................... 16,217 18,554 144,143
---------- ---------- ---------
Marketable equity securities:
Common stocks............................... -- 46,272 --
---------- ---------- ---------
Total.................................. $ 593,347 $ 476,796 $ 354,005
========== ========== =========
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, 1998,
the Bank held mortgage-related securities with a fair value of $19.5 million
(amortized cost of $19.5 million) which were classified as "high-risk" mortgage
securities by the OTS.
28
The following tables detail the Company's securities available for sale
portfolio at December 31, 1998, and its estimates of expected yields on such
securities, taking into consideration expected prepayment and loss rates
together with other factors.
CLASS COLLATERAL BALANCE
ISSUE DESIGNATION RATING ------------------- PRODUCT TYPE AT
SECURITIZATION SECURITY DATE LETTER AGENCIES ISSUANCE 12/31/98 12/31/98
-------------- -------- ---- ------ -------- --------- -------- ---------------
SINGLE-FAMILY RESIDENTIAL (Dollars in Thousands)
Subordinates:
BCF 1996 R1............. B3 Oct-96 NR S&P, Moody's $ 505,513 $ 358,075 93% Fixed, 7% ARM
BCF 1997 R1............. B4 Mar-97 NR Moody's, Fitch 177,823 138,739 93% Fixed, 7% ARM
BCF 97 R2............... B4 Jun-97 Ba2, BB Moody's, Fitch 251,790 193,342 24% Fixed, 75% ARM
B5 B2,B
B6 NR
BCF 1997 R3............. B4 Dec-97 NR Moody's DCR 579,851 519,213 93% Fixed, 6% ARM
ORMBS 1998 R1........... B4 Mar-98 NR Moody's, DCR 565,411 546,176 94% Fixed, 6% ARM
ORMBS 1998 R2........... B4A Jun-98 Ba2 Moody's 123,917 115,320 39% Fixed, 61% ARM
B4F Ba2
B5A B2
B5F B2
B6F NR
B6A NR
ORMBS 1998 R3........... B4 Sep-98 BB Moody's, DCR 261,452 259,873 95% Fixed, 5% ARM
B5 B2,B
B6 NR
Subprime residuals:
SMBS 1996-3............. R Jun-96 NR S&P, Moody's 130,062 48,578 56% Fixed, 44% ARM
MLM1 1996-1............. R Sep-96 NR S&P, Moody's 81,142 33,469 30% Fixed, 70% ARM
MS 1997-1............... X1,X2 Jun-97 NR S&P, Moody's 104,846 66,732 22% Fixed, 78% ARM
1997 OFS(2)............. X Sep-97 NR S&P, Moody's 102,201 67,850 16% Fixed 84% ARM
1997 OFS(3)............. X Dec-97 NR S&P, Moody's 208,784 167,604 16% Fixed 84% ARM
1998 OFS(1)............. X Mar-98 NR Moody's, DCR 161,400 137,641 13% Fixed 87% ARM
1998 OFS(2)............. X Jun-98 NR S&P, Moody's 382,715 304,266 37% Fixed 63% ARM
1998 OFS(3)............. X Sep-98 NR S&P, DCR 261,649 253,156 27% Fixed 73% ARM
1998 OFS(4)............. X Dec-98 NR S&P, 262,055 262,055 37% Fixed 63% ARM
Moody's,Fitch
OML(1).................. R Jun-98 NR S&P, DCR 368,742 321,916 100% UK Subprime
OML(2).................. DAC-IO Nov-98 Aaa,AAA Moody's, Fitch 195,832 195,832 100% UK Subprime
S&R NR
B Baa2, BBB
MULTI-FAMILY AND COMMERCIAL
Subordinates:
CMAC 1996 C2............ G Dec-96 B Fitch 164,418 133,997 37% Retail, 19% Hotel,
H NR 16% Multi-family
XI,X2 AAA
BCF 97-C1............... F,G Oct-97 B Fitch 128,387 86,959 19% Multi-family, 18%
E-IO BB Hotel, 15% Industrial
X1,X2 AAA
29
WEIGHTED WEIGHTED TOTAL ACTUAL LIFE ACTUAL LIFE
AVERAGE COUPON AVERAGE DELINQUENCY TO DATE CPR TO DATE SUBORDINATION
AT: LTV AT: AT: AT: LOSSES AT: LEVEL YIELD TO MATURITY AT:
SECURITIZATION 12/31/98 12/31/98 12/31/98 12/31/98 12/31/98 AT 12/31/98 PURCHASE 12/31/98
- - -------------------------- --------------- -------- ----------- ----------- ----------- ------------- -------- ------------
SINGLE-FAMILY RESIDENTIAL (Dollars in Thousands)
Subordinates:
BCF 1996 R1 B3(5)....... 10.06% 101.05% 22.00% 12.47% $14,199 None 15.70% 14.73%
BCF 1997 R1 B4(5)....... 10.08 108.90 39.87 11.78 6,145 None 13.46 -0.04
BCF 97 R2 B4(5)......... 8.30 85.64 72.88 11.87 3,876 8.06 9.58 11.97
B5............ 4.94 10.74 15.97
B6............ None 15.98 5.35
BCF 1997 R3(5).......... 9.65 113.90 38.32 7.81 5,045 None 15.84 5.56
ORMBS 1998 R1(6)........ 8.98 117.19 30.83 4.45 1,945 None 20.50 8.96
ORMBS 1998 R3(6)........ 8.98 122.50 24.05 3.69 79 13.73 11.71 11.03
ORMBS 1998 R2 BA4(6).... 9.20 89.63 54.01 9.83 139 6.86 13.22 13.48
B4F....... 8.30 19.23 11.01
B5A....... 5.51 23.78 18.41
B5F....... 6.47 11.78 15.66
B5........ 10.16 16.54 8.82
B6A....... None 16.72 15.53
B6F....... None 19.50 22.33
ORMBS 1998 R3 B6(6)..... 8.98 122.50 24.05 3.69 79 None 18.00 1.58
Subprime residuals:
SMBS 1996-3(1).......... 11.24 70.00 19.93 31.74 1,896 10.14 15.52 3.94
MLM1 1996-1(2).......... 11.57 73.36 25.84 32.28 970 12.62 15.16 5.52
MS 1997-1 X1(3)......... 10.45 74.41 17.34 24.89 191 4.51 21.47 13.30
X2............ 20.38 8.60
OML 1(7)................ 14.08 64.00 22.05 22.36 24 Reserve Fund 20.72 29.98
- (pound) 7.0
million
OML 2 DAC IO(7)......... 13.79 65.80 30.95 n/a -- Reserve Fund 28.50 28.50
- (pound)2.5
million
B.......... 12.50 12.50
R.......... 36.50 36.50
S.......... 25.30 25.30
1997 OFS 2 X(4)......... 10.30 74.23 15.51 27.56 121 4.52 19.65 9.70
1997 OFS 3 X(4)......... 10.16 77.77 13.73 19.23 99 3.74 19.59 12.16
1998 OFS 1X(4).......... 10.34 77.14 12.74 18.73 148 2.23 18.00 12.13
1998 OFS 2 X(4)......... 10.82 73.51 8.94 36.43 -- 2.66 19.46 8.16
1998 OFS 3 X(4)......... 10.39 75.64 8.76 11.85 -- 1.09 18.00 13.52
1998 OFS 4 X(4)......... 10.57 76.01 -- -- -- -- 18.00 18.00
MULTI-FAMILY AND COMMERCIAL
Subordinates:
BCF 97-C1 F(5).......... 10.54 2.31 15.16 20.50 -- n/a 10.35 11.99
G............. 15.00 20.27
CMAC 1996 C2 G.......... 8.37 1.29 -- 8.07 -- n/a 11.11 14.60
18.46 31.13
H Interest-only:
CMAC 96 C2 X1 IO(8)..... 8.37 1.29 -- 8.07 -- n/a 54.86 39.01
X2 IO........ 25.94 3.67
BCF 97-C1 X1(3)......... 10.54 2.31 15.16 20.50 -- n/a 6.93 51.95
X2............ 8.53 35.63
E -IO......... 7.00 37.48
30
ISSUERS:
(1) Salomon Brothers Mortgage Securities VII
(2) Merrill Lynch Mortgage Investors, Inc.
(3) Morgan Stanley ABS Capital I, Inc.
(4) Ocwen Mortgage Loan Asset Backed Certificates
(5) BlackRock Capital Finance L.P.
(6) Ocwen Residential MBS Corporation
(7) Ocwen Mortgage Loans
(8) Commercial Mortgage Acceptance Corporation
n/a - not available
The following table sets forth the principal amount of mortgage loans
by the geographic location of the property securing the mortgages that underly
the Company's securities available for sale portfolio at December 31, 1998.
Description California Florida Texas New York Illinois Other (1) Total
----------- ---------- -------- --------- --------- --------- ----------- ----------
(Dollars In Thousands)
Single family residential .. $752,249 $254,751 $ 266,869 $ 226,727 $ 170,015 $ 1,794,782 $3,465,393
Multi-family and commercial 72,260 16,261 3,021 15,701 29,971 83,609 220,823
-------- -------- --------- --------- --------- ----------- ----------
Total ..................... $824,509 $271,012 $ 269,890 $ 242,428 $ 199,986 $ 1,878,391 $3,686,216
======== ======== ========= ========= ========= =========== ==========
Percentage (2) ............ % 22.4 % 7.4 % 7.3 % 6.6 % 5.4 % 50.9 % 100.0
======== ======== ========= ========= ========= =========== ==========
(1) No other individual state makes up more than 5% of the total. See
"Certain Transaction" under Item 13.
(2) Based on a percentage of the total unpaid principal balance of the
underlying loans.
31
The following table summarizes information relating to the Company's
mortgage-related securities available for sale at December 31, 1998.
ANTICIPATED ANTICIPATED
ORIGINAL UNLEVERAGED WEIGHTED
ANTICIPATED YIELD TO AVERAGE
AMORTIZED PERCENT YIELD TO MATURITY AT REMAINING
RATING/DESCRIPTION COST FAIR VALUE OWNED MATURITY 12/31/98(1) COUPON LIFE (2)
SINGLE-FAMILY RESIDENTIAL:
BB-rated subordinates......... $8,517 $8,517 84.27% 13.99% 11.29% 6.99% 6.08%
B-rated subordinates.......... 6,344 6,344 83.95 16.44 11.37 7.04 3.06
Unrated subordinates.......... 37,872 40,595 86.79 14.33 9.89 8.18 3.74
AAA-rated subprime securities. 6,178 6,931 100.00 28.50 28.50 10.90 1.70
BBB-rated subprime securities. 15,681 17,593 100.00 12.50 12.50 9.97 4.54
Unrated subprime residuals ... 141,526 152,951 100.00 24.35 30.78 -- 2.69
MULTI-FAMILY AND COMMERCIAL:
B-rated subordinates.......... 7,684 8,813 85.34 11.05 13.90 8.93 5.23
Unrated subordinates.......... 4,126 7,331 85.34 21.62 26.81 9.15 4.46
AAA-rated interest-only....... 71 71 85.41 4.87 (3.77) 2.02 1.23
BB-rated interest only........ -- 2 85.41 26.00 34.85 2.45 0.07
(1) Changes in the December 31, 1998 anticipated yield to maturity
from that originally anticipated are primarily the result of
changes in prepayment assumptions and to a lesser extent loss
assumptions.
(2) Equals the weighted average duration based off of December 31,
1998 book value.
The following table sets forth the property types of the Company's
commercial mortgage-backed securities at December 31, 1998, based upon the
principal amount.
Percentage
Property type Invested
------------- ----------
Retail........................ 26.3
Multi-family.................. 24.8%
Lodging....................... 18.7
Office........................ 13.1
Warehouse..................... 6.0
Mixed use..................... 6.2
Self storage.................. 1.1
Other......................... 3.8
--------
Total......................... 100.0%
========
The following is a glossary of terms included in the above tables.
ACTUAL DELINQUENCY - Represents the total unpaid principal balance of
loans more than 30 days delinquent at the indicated date as a percentage of the
unpaid principal balance of the collateral at such date.
ACTUAL LIFE-TO-DATE CPR - The Constant Prepayment Rate is used to
measure the average prepayment rate for the underlying mortgage pool(s) over the
period of time lapsed since the issuance of the securities through the date
indicated and is calculated as follows:
_ _
| ( 12 ) |
| ( ---------------- ) |
| ( months in period ) |
| ( 1 - Final Aggregate Balance actual ) |
| ( ---------------------------------- ) |
| ( Final Aggregate Balance scheduled ) |
Actual Life-to-Date CPR = 100 X | |
|_ _|.
ACTUAL LIFE-TO-DATE LOSSES - Represents cumulative losses expressed as
a percentage of the unpaid balance of the original collateral at the indicated
date.
32
CLASS DESIGNATION LETTER - Refers to the credit rating designated by
the rating agency for each securitization transaction. Classes designated "A"
have a superior claim on payment to those rated "B", which are superior to those
rated "C." Additionally, multiple letters have a superior claim to designations
with fewer letters. Thus, for example, "BBB" is superior to "BB," which in turn
is superior to "B." The lower class designations in any securitization will
receive interest payments subsequent to senior classes and will experience
losses prior to any senior class. The lowest potential class designation is not
rated ("NR") which, if included in a securitization, will always receive
interest last and experience losses first. IO securities receive the excess
interest remaining after the interest payments have been made on all senior
classes of bonds based on their respective principal balances. There is no
principal associated with IO securities and they are considered liquidated when
the particular class they are contractually tied to is paid down to zero.
Principal only ("PO") securities receive excess principal payments after the
principal has been made on all classes of bonds based on their respective
payment schedules. There is no interest associated with PO securities and they
are sold at a discount. The return on PO securities is earned through the
receipt of the payments and the collection of the discounted amount.
CLASS SIZE - Represents the percentage size of a particular class
relative to the total outstanding balance of all classes.
COLLATERAL BALANCE - Represents, in the case of residuals, the unpaid
principal balance of the collateral of the entire securities at the indicated
date and, in the case of subordinates, the outstanding principal balance of the
entire securitization at the indicated date.
ISSUE DATE - Represents the date on which the indicated securities were
issued.
OVER-COLLATERIZATION LEVEL - For residual interests in residential
mortgage-backed securities, over-collaterization ("OC") is the amount by which
the collateral balance exceeds the sum of the bond principal amounts. OC is
achieved by applying monthly a portion of the interest payments of the
underlying mortgages toward the reduction of the class certificate principal
amounts, causing them to amortize more rapidly than the aggregate loan balance.
The OC percentage, expressed as a percentage of the outstanding collateral
balance, represents the first tier of loss protection afforded to the
non-residual holders. The OC percentage also determines whether the
over-collaterization target has been satisfied as of a specific date, such that
cash flows to the residual holder are warranted. To the extent not consumed by
losses on more highly rated bonds, OC is remitted to the residual holders.
Reserve funds ("RF") are actual cash reserves expressed as a percentage of the
original collateral balance at issuance.
RATING - Represents the rating, if any, on the security or securities
by the indicated rating agencies.
SECURITIZATION - Series description.
SECURITY - Represents the name of the class associated with each
securitization held by the Company. This has no relationship to a formal rating
but is for identification purposes (although the names are usually in
alphabetical or numeric order from the highest rated to the lowest rated).
SUBORDINATION LEVEL - Represents the credit support for each
mortgage-backed security by indicating the percentage of outstanding bonds whose
right to receive payment is subordinate to the referenced security. The
subordinate classes must experience a complete loss before any additional losses
would affect the particular referenced security.
WEIGHTED AVERAGE DSCR - Represents debt service coverage ratio, which
is calculated by dividing cash flow available for debt service by debt service.
WEIGHTED AVERAGE LTV- Represents the ratio of the loan amount to the
value of the underlying collateral.
YIELD TO MATURITY - Yield to maturity represents a measure of the
average rate of return that is earned on a security if held to maturity.
INVESTMENT SECURITIES. Investment securities amounted to $10.8 million,
$10.8 million and $8.8 million at December 31, 1998, 1997 and 1996,
respectively, and consisted of the Company's required investment in FHLB stock.
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. Because the Company has the ability and the intent to hold these
securities to maturity they are considered non-marketable equity securities held
for investment and are stated at cost.
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.
33
Securities in this account are carried at fair 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, 1998 and 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, 1998, the Company's investment in low-income housing
tax credit interests amounted to $144.2 million or 4% of total assets, as
compared to $128.6 million or 4% of total assets at December 31, 1997, and $93.3
million or 4% of total assets at December 31, 1996. The Company's 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
$75.9 million in the aggregate at December 31, 1998, 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, 1998, the Company's investment in low-income housing tax
credit interests included $68.3 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, 1998, the Company had no commitments to make 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, 1998, the Company had $15.0
million of construction loans outstanding to low-income housing tax credit
partnerships and commitments to fund an additional $63.4 million of such loans.
Approximately $6.5 million of such funded construction loans at December 31,
1998 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
"Lending Activities".
The affordable housing projects owned by the low-income housing tax
credit partnerships in which the Company had invested at December 31, 1998 are
geographically located throughout the United States. At December 31, 1998, the
Company's largest investment in a low-income housing tax credit interest was a
$10.0 million investment in a partnership which owned a 170-unit qualifying
project located in Racine, Wisconsin.
At December 31, 1998, the Company had invested in or had commitments to
invest in 47 low-income housing tax credit partnerships, of which 33 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, 1998 will
provide approximately $299.4 million of tax credits.
During 1998, the Company sold its investment in five low-income housing
tax credit projects which had a carrying value of $28.9 million for gains of
$7.4 million. 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 $6.1 million.
34
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 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, lines
of credit, and maturities and payments of principal and interest on loans and
securities and proceeds from the sales and securitizations thereof 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 $1.48
billion or 68% of the Company's total deposits at December 31, 1998. 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, 1998, $242.2 million or 11% 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, 1998, $135.2 million or 6% of the Company's total
deposits consisted of deposits obtained by the Company from such efforts. The
Company's brokered deposits at December 31, 1998 were net of $9.6 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.
35
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, 1998, $976.7 million or 51% 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 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 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, 1998, the
deposits which were allocated to this office amounted to $66.0 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,
---------------------------------------------------------------------------------
1998 1997 1996
-------------------------- -------------------------- -------------------------
Amount Avg. Rate Amount Avg. Rate Amount Avg. Rate
----------- --------- ---------- --------- ---------- ---------
(Dollars in Thousands)
Non-interest bearing checking
accounts................. $ 233,427 --% $ 130,372 --% $ 96,563 --%
NOW and money market
checking accounts........ 33,272 3.40 27,624 4.73 22,208 2.99
Savings accounts............ 1,326 2.30 1,664 2.30 2,761 2.30
----------- ---------- ----------
268,025 159,660 121,532
----------- ---------- ----------
Certificates of deposit(1).. 1,916,548 1,834,899 1,809,098
Unamortized deferred fees... (9,557) (11,737) (10,888)
------------ ---------- ----------
Total certificates of deposit 1,906,991 5.78 1,823,162 6.00 1,798,210 5.80
----------- ---------- ----------
Total deposits......... $ 2,175,016 5.18 $1,982,822 5.95 $1,919,742 5.47
=========== ========== ==========
(1) At December 31, 1998, 1997 and 1996, certificates of deposit issued on an
uninsured basis amounted to $100.5 million, $133.7 million and $147.5
million, respectively. Of the $100.5 million of uninsured deposits at
December 31, 1998, $47.8 million were from political subdivisions in New
Jersey and secured or collateralized as required under state law.
36
The following table sets forth, by various interest rate categories, the
certificates of deposit in the Company at the dates indicated.
December 31,
--------------------------------------------------
1998 1997 1996
----------- ----------- -----------
(Dollars in Thousands)
2.99% or less.............................. $ 819 $ 841 $ 1,442
3.00-3.50%................................. -- -- 4
3.51-4.50.................................. 3,515 41 1,149
4.51-5.50.................................. 724,241 292,192 595,730
5.51-6.50.................................. 1,006,860 1,300,463 990,621
6.51-7.50.................................. 171,065 229,134 208,774
7.51-8.50.................................. 491 491 490
----------- ----------- -----------
$ 1,906,991 $ 1,823,162 $ 1,798,210
=========== =========== ===========
The following table sets forth the amount and maturities of the
certificates of deposit in the Company at December 31, 1998.
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............. $ 819 $ -- $ -- $ -- $ 819
3.00-3.50%................ -- -- -- -- --
3.51-4.50................. 3,030 352 133 -- 3,515
4.51-5.50................. 305,953 169,001 104,209 145,078 724,241
5.51-6.50................. 301,399 122,447 236,637 346,377 1,006,860
6.51-7.50................. 23,100 50,412 25,432 72,122 171,065
7.51-8.50................. 99 196 196 -- 491
------------ ------------ ------------ -------------- ------------
$ 634,400 $ 342,408 $ 366,607 $ 563,577 $ 1,906,991
============ ============ ============ -------------- ============
At December 31, 1998, the Company had $156.6 million of certificates of
deposit in amounts of $100,000 or more outstanding maturing as follows: $56.1
million within three months; $41.9 million over three months through six months;
$15.9 million over six months through 12 months; and $42.7 million thereafter.
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 to finance its subprime lending as follows: (i) a $200.0 million
secured line of credit, of which $100.0 million was committed, (ii) a $50.0
million secured line of credit, all of which was committed, (iii) a $200.0
million secured line of credit, of which $100.0 million was committed and (iv) a
$100.0 million secured line of credit, none of which was committed, and (v) a
$20.0 million secured residual line of credit, none of which was committed. The
lines of credit mature between March 1999 and July 2001 and bear interest at
rates that float in accordance with designated indices. The terms of the line of
credit agreements contain, among other provisions, requirements for maintaining
certain profitability, defined levels of net worth and debt-to-equity ratios.
For the period ended December 31, 1998, OFS obtained a lender's agreement
waiving compliance with the maintenance of a profitability covenant for one of
OFS' line of credit agreements, with which OFS failed to comply. The agreements
also require annual commitment fees to be paid based on the used and unused
portion of the facilities, as well as a facility fee based on the total
committed amount. Such commitment fees are capitalized and amortized on a
straight-line basis over a twelve-month period. An aggregate of $59.5 million
and $118.3 million was outstanding to OFS under these lines of credit at
December 31, 1998 and 1997, respectively.
37
In connection with the Company's acquisition of substantially all of
the assets of Cityscape UK, Ocwen UK has entered into a Loan Facility Agreement
with Greenwich which provided a short-term facility to finance the acquisition
of Cityscape UK's mortgage loan portfolio and to finance Ocwen UK's further
originations and purchase of subprime single family loans. The Greenwich
Facility is secured by Ocwen UK's loans available for sale. The Revolving
Facility, which matures in April 1999, is set at a maximum of $166.0 million
((pound)100.0 million reduced by the amount borrowed under the Term Loan) of
which $87.1 million ((pound)52.5 million) was funded at December 31, 1998, to
finance subprime single family loan originations and bears interest at a rate of
the one-month LIBOR plus 1.50%. At December 31, 1998, $5.6 million ((pound)3.4
million) had been borrowed under the Term Loan, which matured in January 1999.
In addition, Ocwen UK has entered into a secured warehouse line of credit with
Barclays Bank plc to finance subprime single family loan originations. The
Barclays Facility, which matures in November 1999 and bears interest at a rate
of the one-month LIBOR plus 0.80%, is set at a maximum of $124.5 million
((pound)75.0 million), against which $24.6 million ((pound)14.8 million) had
been borrowed at December 31, 1998.
The Company's borrowings also include notes, subordinated debentures
and other interest-bearing obligations. At December 31, 1998, this category of
borrowings consisted of $100.0 million of 12.000% Subordinated Debentures issued
by the Bank in June 1995 and due 2005 (the "Debentures") and $125.0 million of
11.875% Notes (the "Notes") issued by the Company through a public offering on
September 25, 1996 and due 2003.
The following table sets forth information relating to the Company's
borrowings and other interest-bearing obligations at the dates indicated.
December 31,
--------------------------------------------------------
1998 1997 1996
-------------- -------------- --------------
(Dollars in Thousands)
FHLB advances...................................... $ -- $ -- $ 399
Reverse repurchase agreements...................... 72,051 108,250 74,546
Obligations outstanding under lines of credit...... 179,285 118,304 --
Notes, debentures and other interest bearing
obligations:
Notes......................................... 125,000 125,000 125,000
Debentures.................................... 100,000 100,000 100,000
Hotel mortgages payable....................... -- -- 573
Short-term notes.............................. -- 1,975 --
-------------- -------------- --------------
225,000 226,975 225,573
-------------- -------------- --------------
$ 476,336 $ 453,529 $ 300,518
============== ============== ==============
38
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,
----------------------------------------------
1998 1997 1996
----------- ---------- ---------
(Dollars in Thousands)
FHLB ADVANCES:
Average amount outstanding during the period.... $ 2,201 $ 9,482 $ 71,221
Maximum month-end balance outstanding
During the period........................... $ -- $ 399 $ 81,399
Weighted average rate:
During the period............................ 5.45% 5.56% 5.69%
At end of period............................. --% --% 7.02%
OBLIGATIONS OUTSTANDING UNDER LINES OF CREDIT:
Average amount outstanding during the period.... $ 481,212 $ 84,272 $ --
Maximum month-end balance outstanding
during the period............................ $ 572,707 $ 267,095 $ --
Weighted average rate:
During the period............................ 7.19% 6.62% --%
At end of period............................. 6.9% 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 to increase 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 initiatives which further
automates the Company's communications with its third party service providers.
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 and SunUNIX 5500 file servers as its primary
hardware platform. The Company uses CISCO Routers, Cabletron Hubs and chassis
with fiber optic cabling throughout and between buildings. 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.
39
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.
RISK FACTORS
Information related to risk factors which could directly or indirectly,
affect the Company's results of operations and financial condition are included
in Exhibit 99.1 and are incorporated herein by reference.
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, 1998, the Company had loans with an unpaid balance aggregating
$243.7 million (including loans available for sale) secured by properties
located in California and $35.7 million of the Company's real estate owned was
located in California, which collectively represent 8.4% 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 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.
INVESTOR'S MORTGAGE INSURANCE HOLDING COMPANY. 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, 1998, IMI had a combined ownership of
16.83% of the outstanding common stock of OAC and OPLP units.
40
OCWEN FINANCIAL SERVICES, INC. OFS was formed by the Company under
Florida law in October 1996 for the purpose 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, 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, OCN purchased 2,705 additional
shares of common stock of OFS for $15.0 million, increasing its ownership
percentage from 80% to 93.7%. On March 31, 1998, OCN purchased 7,518 additional
shares of common stock in exchange for $40.0 million, further increasing its
ownership to 97.8%. The value of each share of stock was computed based on total
stockholders' equity at December 31, 1997 divided by the shares of stock
outstanding at that date.
OCWEN CAPITAL CORPORATION. OCC is a wholly-owned subsidiary of the
Company which was formed under Florida law to manage the day-to-day operations
of OAC, subject to supervision by OAC'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. OAC is a Virginia corporation which elected to be taxed as a REIT under
the Code. In May 1997, OAC 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 OAC common stock. The OAC
common stock is traded on the New York Stock Exchange under the symbol "OAC."
Pursuant to a management agreement between OCC and OAC, and subject to
supervision by OAC's Board of Directors, OCC formulates operating strategies for
OAC, arranges for the acquisition of assets by OAC, arranges for various types
of financing for OAC, monitors the performance of OAC's assets and provides
certain administrative and managerial services in connection with the operation
of OAC. 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 OAC, 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 OAC common stock
plus (b) gains (or minus losses) from debt restructuring and sales of property
per share of OAC common stock, exceeds (2) an amount equal to (a) the weighted
average of the initial public offering price per share of the OAC common stock
and the prices per share of any secondary offerings of OAC common stock by OAC
multiplied by (b) the ten-year U.S. Treasury rate plus 5% per annum, multiplied
by (B) the weighted average number of shares of OAC common stock outstanding.
The Board of Directors of OAC may adjust the base management fee in the future
if necessary to align the fee more closely with the actual costs of such
services. OCC also may be reimbursed for the costs of certain due diligence
tasks performed by it on behalf of OAC and will be reimbursed for the
out-of-pocket expenses incurred by it on behalf of OAC.
During 1997, 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 OAC (in order to enable OAC to
invest the proceeds from the initial public offering of OAC's common stock) and
not the Company.
OCWEN UK. In April 1998, the Company, through its wholly-owned
subsidiary Ocwen UK, acquired substantially all of the assets, and certain
liabilities of the U.K. operations of Cityscape Financial Corp., an originator
of subprime mortgages. As consummated, the Company acquired Cityscape UK's
mortgage loan portfolio and its residential subprime mortgage loan origination
and servicing businesses.
OCWEN TECHNOLOGY XCHANGE, INC. ("OTX"), a wholly-owned subsidiary of
the Company, is the Company's software solutions subsidiary which was formed in
May 1998 by combining the Company's Information Technology Group and two
previously acquired subsidiaries, AMOS and DTS. OTX designs advances software
solutions for mortgage and real estate transactions, including software systems
for managing the loan servicing cycle.
EMPLOYEES
At December 31, 1998 the Company had 1,462 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.
41
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 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 all 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.
42
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 1996, the Bank recorded a pre-tax charge of $7.1
million for this assessment. 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 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 $3.7
million at December 31, 1998. 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.
43
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.
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 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.
Effective April 1, 1999, the OTS minimum core capital ratio will
provide that only those institutions with a Uniform Financial Institution Rating
System ("UFIRS") rating of "1" will be subject to a 3% minimum core capital
ratio. All other institutions will be subject to a 4% minimum core capital
ratio. The 3% minimum core capital ratio currently applies to all federal
savings associations.
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 1
risk-based capital ratio of 6.0% or more, has a Tier 1 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 1 risk-based
capital ratio of 4.0% or more and a Tier 1 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 1 risk-based capital ratio that is
less than 4.0% or a Tier 1 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 1 risk-based
capital ratio that is less than 3.0% or a Tier 1 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, 1998,
the Bank was a "well capitalized" institution under the prompt corrective action
regulations of the OTS.
44
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. Under the QTL test provisions, a
savings institution must maintain at least 65% of its portfolio assets in
qualified thrift investments. In general, qualified thrift investments include
loans, securities and other investments that are related to housing, small
business and credit card lending, and to a more limited extent, consumer lending
and community service purposes. Portfolio assets are defined as an institution's
total assets less goodwill and other intangible assets, the institution's
business property and a limited amount of the institution's liquid assets. 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 1998, and its
qualified thrift investments comprised 68.47% of its portfolio assets at
December 31, 1998.
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 1 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 1 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, 1998, the Bank was a
Tier 1 association under the OTS capital distribution regulation.
The OTS recently published amendments to its capital distribution
regulation which become effective April 1, 1999. Under the revised regulation,
the Bank will be required to file either an application or a notice with the OTS
at least 30 days prior to making a capital distribution. The OTS may deny the
Bank's application or disapprove its notice if the OTS determines that (a) the
Bank will be "undercapitalized," "significantly undercapitalized" or "critically
under capitalized," as defined in the OTS capital regulations, following the
capital distribution, (b) the proposed capital distribution raises safety and
soundness concerns or (c) the proposed capital distribution violates a
prohibition contained in any statute, regulation or agreement between the Bank
and the OTS or a condition imposed on the Bank in an application or notice
approved by the OTS.
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 collateral. 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.
45
At December 31, 1998, the Bank's unimpaired capital and surplus
amounted to $345.8 million, resulting in a general loans-to-one borrower
limitation of $51.9 million under applicable laws and regulations. See "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 that is
well-capitalized, and any employee of any such 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 not subject to the 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) 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 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, 1998, 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, OAC 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.
46
COMMUNITY INVESTMENT AND CONSUMER PROTECTIONS 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 domestic 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 Federal consolidated tax return. Ocwen UK is a foreign entity
owned by the Company that is not included in the consolidated federal income tax
return but files its own tax return in the United Kingdom. Consolidated returns
have the effect of eliminating inter-company transactions, including dividends,
from the computation of taxable income.
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, 1998, the Company's gross
deferred tax assets included $5.3 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 1996. The statute of
limitations has run with respect to 1994 and all prior tax years. Thus, the
Federal income tax returns for the years 1995 through 1997 are open for
examination. Management of the Company does not anticipate any material
adjustments as a result of any examination, although there can be no assurances
in this regard.
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 10.84%, 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%. 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.
47
ITEM 2. PROPERTIES
The following table sets forth information relating to the Company's
facilities at December 31, 1998.
Net Book Value of
Leasehold
Improvements
Location Owned/Leased (Dollars in Thousands)
- - ----------------------------------------------- ------------ ----------------------
Executive offices:
1675 Palm Beach Lakes Blvd.
West Palm Beach, FL....................... Leased $ 6,066
Main office:
2400 Lemoine Ave
Fort Lee, NJ.............................. Leased $ 17
Foreign offices (Ocwen UK):
St. David's Court
Union Street
Wolverhampton, United Kingdom............. Leased $ --
Malvern House
Croxley Business Park
Watford, Hertfordshire
United Kingdom............................ Leased $ --
In addition to the above offices, OFS maintained 25 loan production
offices in 4 states of December 31, 1998. These offices are operated pursuant to
leases with up to three-year terms, each of which can be readily replaced on
commercially reasonable terms. Also, the Company is currently constructing a
national loan servicing center in Orlando, Florida which will have capacity for
900 loan servicing representatives per shift upon planned completion in the
summer of 1999.
ITEM 3. LEGAL PROCEEDINGS
The Company is currently not involved in any material litigation. To
the Company's knowledge, no material litigation is currently threatened against
the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
48
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 96 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 18 to 19 of the Annual Report to
Stockholders and is incorporated herein by reference.
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 21 to 43 of the Annual Report to Stockholders and is
incorporated herein by reference.
49
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this Item appears under the caption "Asset and
Liability Management" on pages 36 to 40, "Note 1: Summary of Significant
Accounting Policies" on pages 52 to 58 and "Note 21: Derivative Financial
Instruments" on pages 79 to 80 of the Annual Report to Stockholders and is
incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS
Information required by this Item appears on pages 45 to 95 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.
DIRECTORS
The following table sets forth certain information concerning the
directors of the Company.
Name Age (1) Director Since
----------------------------------------------------------- ------- --------------
William C. Erbey........................................... 49 1988
Hon. Thomas F. Lewis....................................... 74 1997
W.C. Martin................................................ 50 1996
Howard H. Simon............................................ 58 1996
Barry N. Wish.............................................. 57 1988
(1) As of March 15, 1999.
The principal occupation for the last five years of each director of
the Company, as well as some other information, is set for the below.
WILLIAM C. ERBEY. Mr. Erbey has served as the Chairman of the Board of
Directors of the Company since September 1996, as the Chief Executive Officer of
the Company since January 1988, as the Chief Investment Officer of the Company
since January 1992, and as the President of the Company from January 1988 to May
1988. Mr. Erbey has served as the Chairman of the Board of Directors of the Bank
since February 1988 and as the Chief Executive Officer of the Bank since June
1990. Mr. Erbey has served as the Chairman and Chief Executive Officer of OAC
since February 1997. He also serves as a director and officer of many
subsidiaries of the Company and OAC. From 1983 to 1995, Mr. Erbey served as a
Managing General Partner of The Oxford Financial Group ("Oxford"), a private
investment partnership that was the predecessor of the Company. From 1975 to
1983, Mr. Erbey served at General Electric Capital Corporation ("GECC") in
various capacities, most recently as the President and Chief Operating Officer
of General Electric Mortgage Insurance Corporation. Mr. Erbey also served as the
Program General Manager of GECC's Commercial Financial Services Department and
as the President of Acquisition Funding Corporation. He received a Bachelor of
Arts in Economics from Allegheny College and a Master's degree from the Harvard
Graduate School of Business Administration.
HON. THOMAS F. LEWIS. Mr. Lewis has served as a director of the Company
and of the Bank since May 1997. Mr. Lewis served as a United States Congressman,
representing the 12th District of Florida from 1983 to 1995. Mr. Lewis served in
the House and Senate of the Florida State Legislature at various times. Mr.
Lewis is a principal of Lewis Properties, Vice President of Marian V. Lewis Real
Estate and Investments and a director of T&M Ranch & Nursery.
50
He currently is Chairman of the Board of Directors of the U.S. Department of
Veterans Affairs and Research Foundation. He is also a member of the Economic
Council of Palm Beach County. Mr. Lewis formerly served as a United States
delegate to the North Atlantic Treaty Organization and as a member of the
Presidents Advisory Commission on Global Trade Policies. He attended the
University of Florida and holds an Associate's Degree from Palm Beach Junior
College, a Certificate in Engineering from the Massachusetts Institute of
Technology and honorary doctorates from the Florida Institute of Technology and
Nova University.
W.C. MARTIN. Mr. Martin has served as a director of the Company since
July 1996 and of the Bank since June 1996. Since 1982, Mr. Martin has been
associated with Holding Capital Group ("HCG") and has been engaged in the
acquisition and turnaround of business in a broad variety of industries. Since
March 1993, Mr. Martin also has served as President and Chief Executive Officer
of SV Microwave, a company he formed along with other HCG investors to acquire
the assets of the former Microwave Division of Solitron Devices, Inc. Prior to
1982, Mr. Martin was a Manager in Touche Ross & Company's Management Consulting
Division, and prior to that he held positions in financial management with
Chrysler Corporation. Mr. Martin received a Masters of Business Administration
from Notre Dame and a Bachelor of Science in Industrial Management from LaSalle
University.
HOWARD H. SIMON. Mr. Simon has served as a director of the Company
since July 1996 and of the Bank since 1987. Mr. Simon is the Managing Director
of Simon, Master & Sidlow, P.A., a certified public accounting firm which Mr.
Simon founded in 1978 and which is based in Wilmington, Delaware. Mr. Simon is a
past Chairman and current member of the Board of Directors of CPA Associates
International, Inc. Prior to 1978, Mr. Simon was a Partner of Touche Ross &
Company. Mr. Simon is a Certified Public Accountant in the State of Delaware and
a graduate of the University of Delaware.
BARRY N. WISH. Mr. Wish has served as Chairman, Emeritus of the Board
of Directors of the Company since September 1996, and he previously served as
Chairman of the Board of the Company from January 1988 to September 1996. Mr.
Wish has served as a director of the Bank since February 1988. From 1983 to
1995, he served as a Managing General Partner of Oxford, which he founded. From
1979 to 1983, he was a Managing General Partner of Walsh, Greenwood, Wish & Co.,
a member firm of the New York Stock Exchange. Prior to founding that firm, Mr.
Wish was a Vice President and shareholder of Kidder, Peabody & Co., Inc. He is a
graduate of Bowdoin College.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following table sets forth certain information with respect to each
person who currently serves as an executive officer of the Company but does not
serve on the Company's Board of Directors. Executive officers of the Company are
elected annually by the Board of Directors and generally serve at the discretion
of the Board. There are no arrangements or understandings between the Company
and any person pursuant to which such person was elected as an executive officer
of the Company. Other than William C. Erbey and John R. Erbey, who are brothers,
no director or executive officer is related to any other director or executive
officer of the Company or any of its subsidiaries by blood, marriage or
adoption.
Name Age(1) Position
------------------------------------ ----------- ---------------------------------------------------------------------------
John R. Barnes...................... 56 Senior Vice President
Joseph A. Dlutowski................. 34 Senior Vice President of the Bank and Chief Executive Officer of Ocwen UK
John R. Erbey....................... 58 Senior Managing Director, General Counsel and Secretary
Ronald M. Faris..................... 36 Executive Vice President
Christine A. Reich.................. 37 President
Mark S. Zeidman..................... 47 Senior Vice President and Chief Financial Officer
(1) As of March 15, 1999.
The background for the last five years of each executive officer of the
Company who is not a director, as well as certain other information, is set
forth below.
JOHN R. BARNES. Mr. Barnes has served as a Senior Vice President of the
Company and the Bank since May 1994 and served as a Vice President of the
Company and the Bank from October 1989 to May 1994. Mr. Barnes also has served
as Senior Vice President of OAC since February 1997 and serves as an officer of
many subsidiaries of the Company and OAC. Mr. Barnes was a Tax Partner in the
firm of Deloitte Haskins & Sells from 1986 to 1989 and in the firm of Arthur
Young & Co. from 1979 to 1986. Mr. Barnes was the Partner in Charge of the
Cleveland Office Tax Department of Arthur Young & Co. from 1979 to 1984. He is a
graduate of Ohio State University.
51
JOSEPH A. DLUTOWSKI. Mr. Dlutowski has served as Senior Vice President
of the Bank since March 1997 and as Chief Executive Officer of Ocwen UK since
April 1998. Mr. Dlutowski also served as Senior Vice President of the Company
from May 1997 to May 1998 and of OAC from February 1997 to May 1998. He joined
the Bank in October 1992 and served as a Vice President from May 1993 until
March 1997. From 1989 to 1991, Mr. Dlutowski was associated with the law firm of
Baker and Hostetler. He holds a Bachelor of Science degree from the Wharton
School of Business at the University of Pennsylvania and a Master of Business
and a Juris Doctor from the University of Pittsburgh.
JOHN R. ERBEY. Mr. Erbey has served as Senior Managing Director of the
Company since May 1998, as Secretary of the Company since June 1989, as a
Managing Director of the Company from January 1993 to May 1998, and as Senior
Vice President of the Company from June 1989 until January 1993. Mr. Erbey has
served as a director of the Bank since 1990, as a Senior Managing Director of
the Bank since May 1998, and as Secretary of the Bank since July 1989. Mr. Erbey
also has served as Senior Managing Director of OAC since May 1998 and as
Secretary of OAC since February 1997. He also serves as an officer and/or a
director of many subsidiaries of the Company and OAC. From 1971 to 1989, Mr.
Erbey was a member of the Law Department of Westinghouse Electric Corporation
and held various management positions, including Associate General Counsel and
Assistant Secretary from 1984 to 1989. Previously, he held the positions of
Assistant General Counsel of the Industries and International Group and
Assistant General Counsel of the Power Systems Group of Westinghouse. He is a
graduate of Allegheny College and Vanderbilt University School of Law.
RONALD M. FARIS. Mr. Faris has served as Executive Vice President of
the Company and the Bank since May 1998, as a Senior Vice President of the Bank
from May 1997 to May 1998, as Vice President and Chief Accounting Officer of the
Company from June 1995 to May 1998 and of the Bank from July 1994 to May 1997.
From March 1991 to July 1994 he served as Controller for a subsidiary of the
Company. From 1986 to 1991, Mr. Faris was a Vice President with Kidder, Peabody
& Co., Inc., and from 1984 to 1986 worked in the General Audit Department of
Price Waterhouse. He holds a Bachelor of Science from Pennsylvania State
University and is a Certified Public Accountant.
CHRISTINE A. REICH. Ms. Reich has served as President of the Company
since May 1998, as a Managing Director of the Company from June 1994 to May
1988, as Chief Financial Officer of the Company from January 1990 to May 1997,
as a Senior Vice President of the Company from January 1993 until June 1994 and
as a Vice President of the Company from January 1990 until January 1993. Ms.
Reich has served as a director of the Bank since June 1993 and as the President
of the Bank since May 1998. From 1987 to 1990, Ms. Reich served as an officer of
another subsidiary of the Company. Ms. Reich has served as the President and a
director of OAC since February 1997. Ms. Reich also serves as an officer and/or
a director of many subsidiaries of the Company and OAC. Prior to 1987, Ms. Reich
was employed by KPMG Peat Marwick LLP, most recently in the position of Manager.
She holds a Bachelor of Science in Accounting from the University of Southern
California.
MARK S. ZEIDMAN. Mr. Zeidman has served as Senior Vice President and
Chief Financial Officer of the Company and the Bank since May 1997. Mr. Zeidman
also has served as Senior Vice President and Chief Financial Officer of OAC
since June 1997 and serves as an officer of many subsidiaries of the Company and
OAC. From 1986 until May 1997, Mr. Zeidman was employed by Nomura Securities
International, Inc., most recently as Managing Director. Prior to 1986, he held
positions with Shearson Lehman Brothers and Coopers & Lybrand. Mr. Zeidman is a
Certified Public Accountant. He holds a Bachelor of Arts degree from the
University of Pennsylvania, a Master of International Affairs from Columbia
University and a Master of Business Administration from the Wharton School of
Business at the University of Pennsylvania.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's executive officers and directors, and persons who own
more than 10% of the Common Stock, to file reports of ownership and changes in
ownership with the Commission. Officers, directors and greater than 10%
shareholders are required by Commission regulations to furnish the Company with
copies of all Section 16(a) forms they file. Specific due dates for these
reports have been established by the Commission, and the Company is required to
report any failure to timely file such reports by those due dates during the
1998 fiscal year.
To the Company's knowledge, based solely upon review of the copies of
such reports furnished to the Company and written representations that no other
reports were required, all Section 16(a) filing requirements applicable to its
officers, directors and greater than 10% shareholders were complied with during
1998.
52
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table discloses compensation received by the Company's
chief executive officer and the four other most highly paid directors and
executive officers of the Company for the years indicated.
ANNUAL COMPENSATION LONG-TERM COMPENSATION
----------------------------------- --------------------------------------
AWARDS PAYOUTS
-------------------------- -------
NUMBER OF
SECURITIES ALL
RESTRICTED UNDERLYING OTHER
STOCK OPTIONS LTIP COMPEN-
NAME AND POSITION YEAR SALARY BONUS (1) AWARDS (#)(2) PAYOUTS SATION (4)
- - -------------------------------- ---- -------- ---------- ---------- ----------- ------- ----------
William C. Erbey................ 1998 $357,499 $ 197,438 -- 14,143(3) -- $10,000
Chairman of the Board and 1997 150,000 1,300,000 -- 235,756 -- 3,000
Chief Executive Officer 1996 150,000 650,000 -- 115,790 -- 3,000
Christine A. Reich.............. 1998 317,976 175,500 -- 12,572(3) -- 10,000
President 1997 150,000 850,000 -- 147,348 -- 3,000
1996 150,000 487,500 -- 163,158 -- 3,000
John R. Erbey................... 1998 298,214 329,063 -- 15,715(3) -- 10,000
Senior Managing Director 1997 150,000 925,000 -- 162,083 -- 3,000
and Secretary 1996 150,000 525,000 -- 178,948 -- 3,000
Ronald M. Faris................. 1998 218,916 219,933 -- 11,524(3) -- 10,000
Executive Vice President
Joseph A. Dlutowski............. 1998 297,916 223,988 -- 7,483(3) -- 10,000
Chief Executive Officer 1997 120,673 300,000 -- 39,293 -- 3,000
of Ocwen UK and Senior
Vice President of the Bank
(1) Consists of bonuses paid pursuant to the Company's 1998 Annual Incentive
Plan in the first quarter of the following year for services rendered in
the year indicated.
(2) Consists of options granted pursuant to the Company's 1991 Non-Qualified
Stock Option Plan, as amended (the "Stock Option Plan").
(3) Consists of grants made as of January 31, 1999 for services rendered in
1998.
(4) Consists of contributions by the Company pursuant to the Company's 401(k)
Savings Plan.
53
OPTION GRANTS FOR 1998
The following table provides information relating to option grants made
pursuant to the Company's 1991 Stock Option Plan in January 1999 to the
individuals named in the Summary Compensation Table for services rendered in
1998.
PERCENT OF
SECURITIES
NO. OF UNDERLYING
SECURITIES TOTAL POTENTIAL REALIZABLE VALUE AT ASSUMED
UNDERLYING OPTIONS RATES OF STOCK PRICE APPRECIATION
OPTION GRANTED TO EXERCISE FOR OPTION TERM (3)
GRANTED EMPLOYEES PRICE EXPIRATION -------------------------------------
NAME (#)(1) (2) (%) (2) ($/SH) DATE 0%($) 5%($) 10%($)
------------------------ ----------- ----------- -------- ---------- ------- -------- -------
William C. Erbey........ 14,143 7.8 12.3125 1/31/09 -- 109,573 277,592
Christine A. Reich...... 12,572 6.9 12.3125 1/31/09 -- 97,402 246,757
John R. Erbey........... 15,715 8.6 12.3125 1/31/09 -- 121,752 308,446
Ronald M. Faris......... 11,524 6.3 12.3125 1/31/09 -- 89,282 226,187
Joseph A. Dlutowski..... 7,483 4.1 12.3125 1/31/09 -- 57,975 146,873
(1) All options are to purchase shares of Common Stock, and one third vests
and becomes exercisable on each of January 31, 1999, 2000 and 2001.
(2) Indicated grants were made in January 1999 for services rendered in
1998. The percentage of securities underlying these options to the
total number of securities underlying all options granted to employees
of the Company is based on options to purchase a total of 181,945
shares of Common Stock granted to employees of the Company under the
Stock Option Plan as of January 31, 1999.
(3) Assumes future prices of shares of Common Stock of $12.3125, $20.06 and
$31.94 at compounded rates of return of 0%, 5% and 10%, respectively.
AGGREGATED OPTION EXERCISES IN 1998 AND YEAR-END OPTION VALUES
The following table provides information relating to option exercises
in 1998 by the individuals named in the Summary Compensation Table and the value
of each such individual's unexercised options at December 31, 1998.
NUMBER OF SECURITIES VALUE OF UNEXERCISED
NUMBER OF UNDERLYING UNEXERCISED OPTIONS AT IN-THE MONEY OPTIONS AT
SHARES DECEMBER 31, 1998 (1) DECEMBER 31, 1998 (2)
ACQUIRED VALUE --------------------------------- ---------------------------
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- - ---- ----------- -------- ----------- ------------- ----------- -------------
William C. Erbey..................... -- -- 467,336 14,143 $303,949 $ --
Christine A. Reich................... 163,158 2,528,949 147,348 12,572 -- --
John R. Erbey........................ -- -- 430,031 15,715 1,074,362 --
Ronald M. Faris...................... -- -- 60,345 11,524 27,631 --
Joseph A. Dlutowski.................. -- -- 20,870 7,483 80,874 --
(1) All options are to purchase shares of Common Stock and were granted
pursuant to the Stock Option Plan. Options listed as "exercisable"
consist of options granted in or prior to January 1998 which became
exercisable in or prior to January 1999. Options listed as
"unexercisable" consist of options granted in January 1999 which become
exercisable in January 2000.
(2) Based on the $12.3125 closing price of a share of Common Stock on the
New York Stock Exchange on December 31, 1998.
54
LONG-TERM INCENTIVE PLANS - AWARDS IN 1998
The following table provides information relating to basis points
awards made pursuant to the Company's Long-Term Incentive Plan (the "LTIP") to
the individuals named in the Summary Compensation Table.
ESTIMATED FUTURE PAYOUTS UNDER
NON-STOCK PRICE-BASED PLANS (1)
-------------------------------
NUMBER OF
BASIS POINTS
NAME AWARDED IN 1998 THRESHOLD TARGET
- - ---------------------------------- ---------------- --------- ------
William C. Erbey................. 15 $2,679,000 $3,855,000
John R. Erbey.................... 15 2,679,000 3,855,000
Christine A. Reich............... 15 2,679,000 3,855,000
Ronald M. Faris.................. 15 2,679,000 3,855,000
Joseph A. Dlutowski.............. 10 1,786,000 2,570,000
(1) Payout figures are for the entire five year performance period, which
runs from January 1, 1998 to December 31, 2002 (the "Performance
Period"). The maximum value of Basis Points that may be earned by any
LTIP participant for any Performance Period is $25 million.
The value of Basis Points awards under the LTIP (the "Basis Points
Awards") is tied to the Company's achievement of specified levels of return on
equity and growth in earnings per share during the Performance Period. The
threshold amount will be earned if average return on equity and average annual
growth in earnings per share are each five percentage points below their
respective target levels. The Basis Points Awards are subject to complete
forfeiture upon termination and partial forfeiture in any year certain personal
performance goals are not achieved. At the end of the Performance Period, the
Company will pay to the LTIP participants, as more fully described below, Basis
Points Awards in the form of shares of restricted stock based on the fair market
value of the Common Stock on the last day of the Performance Period. Ten percent
of the shares received shall vest on each of the first ten anniversaries of the
last day of the Performance Period. Upon vesting, the shares received shall be
automatically placed into a nonqualified irrevocable trust established by the
Company for the benefit of the recipient (the "Deferred Compensation Trust")
until such shares are payable. Upon the termination of employment with the
Company of an LTIP participant, all restrictions on the shares held in the
Deferred Compensation Trust shall lapse, and such shares of Common Stock shall
be payable in five equal annual installments.
COMPENSATION OF DIRECTORS
Pursuant to a Directors Stock Plan adopted by the Board of Directors
and shareholders of the Company in July 1996, the Company compensates directors
by delivering a total annual value of $10,000 payable in shares of Common Stock
(which may be prorated for a director serving less than a full one-year term, as
in the case of a director joining the Board of Directors after an annual meeting
of shareholders), subject to review and adjustment by the Board of Directors
from time to time. Such payment is made after the annual organizational meeting
of the Board of Directors which follows the annual meeting of shareholders of
the Company. An additional annual fee payable in shares of Common Stock, which
currently amounts to $2,000, subject to review and adjustment by the Board of
Directors from time to time, is paid to committee chairs after the annual
organizational meeting of the Board of Directors. During 1998, an aggregate of
2,235 shares of Common Stock was granted to the five directors of the Company
and the three committee chairs.
The number of shares issued pursuant to the Directors Stock Plan is
based on their "fair market value" on the date of grant. The term "fair market
value" is defined in the Directors Stock Plan to mean the average of the high
and low prices of the Common Stock as reported on the New York Stock Exchange on
the relevant date.
Shares issued pursuant to the Directors Stock Plan, other than the
committee fee shares, are subject to forfeiture during the 12 full calendar
months following election or appointment to the Board of Directors or a
committee thereof if the director does not attend an aggregate of at least 75%
of all meetings of the Board of Directors and committees thereof of which he is
a member during such period.
55
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Determinations regarding compensation of the Company's employees are
made by the Company's Nominating and Compensation Committee. Currently, the
members of the Nominating and Compensation committee are Directors Martin
(Chairman), Lewis, Simon and Wish.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding the
beneficial ownership of the Common Stock as of the date indicated by (i) each
director and executive officer of the Company, (ii) all directors and executive
officers of the Company as a group and (iii) all persons known by the Company to
own beneficially 5% or more of the outstanding Common Stock. The table is based
upon information supplied to the Company by directors, officers and principal
stockholders and filings under the Exchange Act.
SHARES BENEFICIALLY OWNED AS OF
MARCH 15, 1999
------------------------------------
NAME OF BENEFICIAL OWNER AMOUNT(1) PERCENT(1)
----------------------------------------------------- ------------ ----------
J.P. Morgan & Co. Incorporated....................... 4,276,200(2) 7.0%
60 Wall Street
New York, NY 10260
Directors and Executive Officers:
William C. Erbey................................. 19,617,505(3) 32.0
Hon. Thomas F. Lewis............................. 1,469(4) *
W.C. Martin...................................... 6,285(5) *
Howard H. Simon.................................. 2,885(6) *
Barry N. Wish.................................... 9,372,648(7) 15.4
Christine A. Reich............................... 587,650(8) *
John R. Erbey.................................... 2,190,491(9) 3.6
Ronald M. Faris.................................. 157,674(10) *
Joseph A. Dlutowski.............................. 84,123(11) *
All Directors and Executive Officers as a Group
(11 persons)..................................... 32,202,127(12) 51.9%
* Less than 1%.
(1) For purposes of this table, pursuant to rules promulgated under the
Exchange Act, an individual is considered to beneficially own any
shares of Common Stock if he or she directly or indirectly has or
shares: (i) voting power, which includes the power to vote or to direct
the voting of the shares, or (ii) investment power, which includes the
power to dispose or direct the disposition of the shares. Unless
otherwise indicated, (i) an individual has sole voting power and sole
investment power with respect to the indicated shares and (ii)
individual holdings amount to less than 1% of the outstanding shares of
Common Stock.
(2) Based on information contained in a Schedule 13G filed with the
Commission on February 23, 1999 by J.P. Morgan & Co. Incorporated, a
parent holding company whose subsidiaries include Morgan Guaranty Trust
Company of New York (a bank), J.P. Morgan Investment Management, Inc.
(an investment advisor) and J.P. Morgan Florida Federal Savings Bank
(an investment advisor). Includes 4,275,900 shares as to which sole
voting power is claimed and 3,439,600 shares as to which sole disposal
power is claimed.
(3) Includes 13,740,465 shares held by FF Plaza Partners, a Delaware
partnership of which the partners are William C. Erbey, his spouse, E.
Elaine Erbey, and Delaware Permanent Corporation, a corporation wholly
owned by William C. Erbey. Mr. and Mrs. William C. Erbey share voting
and dispositive power with respect to the shares owned by FF Plaza
Partners. Also includes 5,409,704 shares held by Erbey Holding
Corporation, a corporation wholly owned by William C. Erbey. Also
includes options to acquire 467,336 shares which were exercisable at or
within 60 days of March 15, 1999. Included in the shares held by FF
Plaza Partners are 2,885 shares held pursuant to the Directors Stock
Plan.
56
(4) Includes 400 shares held jointly with spouse. Also includes 1,069
shares held pursuant to the Directors Stock Plan.
(5) Includes 3,400 shares held by the Martin & Associates Management
Consultants, Inc. Defined Contribution Pension Plan & Trust. Also
includes 2,885 shares held pursuant to the Directors Stock Plan.
(6) Consists of shares held pursuant to the Directors Stock Plan.
(7) Includes 8,878,305 shares held by Wishco, Inc., a corporation
controlled by Barry N. Wish pursuant to his ownership of 93.0% of the
common stock thereof; 351,940 shares held by B.N.W. Partners, a
Delaware partnership of which the partners are Mr. Wish and B.N.W.,
Inc., a corporation wholly owned by Mr. Wish; and 140,000 shares held
by the Barry Wish Family Foundation, Inc., a charitable foundation of
which Mr. Wish is a director. Also includes 2,403 shares held pursuant
to the Directors Stock Plan.
(8) Includes 440,300 shares held by CPR Family Limited Partnership, a
Georgia limited partnership whose general partner is a corporation
wholly owned by Christine A. Reich and whose limited partners are
Christine A. Reich and her spouse. Also includes options to acquire
147,348 shares of Common Stock which were exercisable at or within 60
days of March 15, 1999.
(9) Includes 1,747,330 shares held by John R. Erbey Family Limited
Partnership, a Georgia limited partnership whose general partner is a
corporation wholly owned by John R. Erbey and whose limited partners
consist of John R. Erbey, his spouse and children. Also includes
options to acquire 430,031 shares of Common Stock which were
exercisable at or within 60 days of March 15, 1999.
(10) Includes 5,000 shares held jointly with spouse. Also includes options
to acquire 60,345 shares of Common Stock which were exercisable at or
within 60 days of March 15, 1999.
(11) Includes 23,960 shares held jointly with spouse. Also includes options
to acquire 60,163 shares of Common Stock which were exercisable at or
within 60 days of March 15, 1999.
(12) Includes options to acquire an aggregate of 1,209,427 shares of Common
Stock which were exercisable at or within 60 days of March 15, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
On January 20, 1998, the Company purchased indirectly from William C.
Erbey and Barry N. Wish, 159,156 shares and 159,155 shares of Common Stock,
respectively, which equaled the aggregate number of shares of Common Stock
issued by the Company on the same date in connection with its acquisition of
DTS. The per share price of the shares of Common Stock purchased from Messrs.
Erbey and Wish was $24.42, which was equal to the average per share price of the
Common Stock determined pursuant to the Agreement of Merger, dated as of January
7, 1998, among the Company, DTS and certain other parties for purposes of
determining the number of shares of Common Stock to be issued by the Company in
connection with the acquisition of DTS (which price was equal to the average of
the high and low per share sales price of the Common Stock on the New York Stock
Exchange during each of the 20 trading days ending three trading days prior to
consummation of the acquisition of DTS).
In September1998, Howard H. Simon repaid the remaining principal
balance outstanding on a residential mortgage loan with an interest rate of
8.5%. The lender was an institution that had been acquired by the Bank.
The highest principal balance of this loan during 1998 was $99,131.
In October 1998, the Company indirectly loaned $600,000 to John R.
Erbey and $250,000 to John R. Barnes in order to prevent them from having to
sell shares of Common Stock to meet or avoid margin calls. Each loan was: (i)
evidenced by a promissory note bearing interest at a rate of 9.5% per annum,
(ii) payable in two equal installments at 18 and 30 months from the date of
issuance, and (iii) secured by pledges of Common Stock. As of December 31, 1998,
John R. Erbey had prepaid approximately $86,860 on his note.
57
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 Amended and restated Bylaws
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 (2)
4.4 Amended and Restated Declaration of Trust of Ocwen Capital
Trust I (2)
4.5 Form of Capital Security of Ocwen Capital Trust I (3)
4.6 Form of Indenture between the Company and the Chase Manhattan
Bank, a Trustee (3)
4.7 Form of 10 7/8% Junior Subordinated Debentures due 2027 of the
Company (3)
4.8 Form of Guarantee of the Company relating to the Capital
Securities of Ocwen Capital Trust I (2)
4.9 Form of Indenture between the Company and The Bank of New York
as Trustee (4)
4.10 Form of Subordinated Debentures due 2005 (included in Exhibit
4.2) (4)
10.1 Ocwen Financial Corporation 1991 Non-Qualified Stock Option
Plan, as amended (5)
10.3 Ocwen Financial Corporation 1996 Stock Plan for Directors, as
amended (5)
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)
12.1 Ratio of Earnings to Fixed Charges
13.1 Annual Report to Stockholders for the year ended December 31,
1998
21.0 Subsidiaries (see "Business-General")
23.0 Consent of PricewaterhouseCoopers LLP
27.1 Financial Data Schedule - For the year ended December 31, 1998
99.1 Risk Factors
(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 identified exhibit filed in
connection with the Registrant's Registration Statement on Form S-1 (File
No. 333-28889), as amended, declared effective by the Commission on
August 6, 1997.
(3) Incorporated by reference to the similarly described exhibit included
with Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1997.
(4) 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.
(5) Incorporated by reference to the similarly described exhibit filed in
connection with the Registrant's Registration Statement on Form S-8, File
No. 333-44999, effective when filed with the Commission on January 28,
1998.
(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 78 in the Annual Report
to Stockholders and is incorporated herein by reference.
FINANCIAL STATEMENTS AND SCHEDULES. The following Consolidated Financial
Statements of Ocwen Financial Corporation and Report of PricewaterhouseCoopers
LLP, Independent Certified Public Accountants, are incorporated herein by
reference from pages 45 to 95 of the Company's Annual Report to Stockholders:
Report of Independent Certified Public Accountants
58
Consolidated Statements of Financial Condition at December 31, 1998 and
1997
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 1998
Consolidated Statements of Changes in Stockholders' Equity for each of
the three years in the period ended December 31, 1998
Consolidated Statements of Comprehensive Income for each of the three
years in the period ended December 31, 1998
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1998.
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, 1998.
(1) A Form 8-K was filed by the Company on October 28, 1998 which contained a
news release announcing the Company's financial results for the three and
nine months ended September 30, 1998.
59
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 and
Chief Executive Officer
(duly authorized representative)
Date: March 31, 1999
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 31,1999
- - ------------------------------------------------
William C. Erbey, Chairman of the Board and
Chief Executive Officer
(principal executive officer)
/s/ CHRISTINE A. REICH Date: March 31,1999
- - ------------------------------------------------
Christine A. Reich, President
/s/ BARRY N. WISH Date: March 31,1999
- - ------------------------------------------------
Barry N. Wish, Director
/s/ W.C. MARTIN Date: March 31,1999
- - ------------------------------------------------
W.C. Martin, Director
/s/ HOWARD H. SIMON Date: March 31,1999
- - ------------------------------------------------
Howard H. Simon, Director
/s/ HON. THOMAS F. LEWIS Date: March 31,1999
- - ------------------------------------------------
Hon. Thomas F. Lewis, Director
/s/ MARK S. ZEIDMAN Date: March 31,1999
- - ------------------------------------------------
Mark S. Zeidman, Senior Vice President and
Chief Financial Officer
(principal financial and accounting officer)
60
EXHIBIT 3.2
BYLAWS OF
OCWEN FINANCIAL CORPORATION
ARTICLE I
SHAREHOLDERS
SECTION 1.1 ANNUAL MEETING. Except as otherwise provided in Section 1.9
of these Bylaws, an annual meeting of shareholders of the Corporation for the
election of directors and for the transaction of any other proper business shall
be held each year on such date, at such hour on said date and at such place
within or without the State of Florida as may be fixed by the Board of
Directors.
SECTION 1.2 SPECIAL MEETINGS. A special meeting of shareholders of the
Corporation entitled to vote on any business to be considered at any such
meeting may be called by the Chairman of the Board or the President, and shall
be called by the Chairman of the Board, the President or the Secretary when
directed to do so by resolution of the Board of Directors or at the written
request of shareholders holding at least 10% of the Corporation's stock entitled
to vote at such meeting. Any such request shall state the purpose or purposes of
the proposed meeting.
SECTION 1.3 NOTICE OF MEETINGS. Whenever shareholders are required or
permitted to take any action at a meeting, unless notice is waived as provided
in Article VIII herein, a written notice of the meeting shall be given which
shall state the place, date and hour of the meeting, and, in the case of a
special meeting, the purpose or purposes for which the meeting is called.
Unless otherwise provided by law, and except as to any shareholder duly
waiving notice, the written notice of any meeting shall be given personally or
by mail, not less than ten nor more than sixty days before the date of the
meeting to each shareholder entitled to vote at such meeting. If mailed, notice
shall be deemed given when deposited in the United States mail, postage prepaid,
directed to the shareholder at his address as it appears on the records of the
Corporation.
When a meeting is adjourned to another date, time or place, notice need
not be given of the new date, time or place if the new date, time and place
thereof are announced at the meeting before the adjournment is taken. At the
adjourned meeting the Corporation may transact any business that might have been
transacted at the original meeting. If, however, the adjournment is for more
than one hundred twenty days, or if after the adjournment a new record date is
fixed for the adjourned meeting, a notice of the adjourned meeting shall be
given to each shareholder of record entitled to vote at the meeting.
SECTION 1.4 QUORUM. Except as otherwise provided by law, by the
Articles of Incorporation or by these Bylaws in respect of the vote required for
a specified action, at any meeting of shareholders the holders of a majority of
the shares of stock entitled to vote thereat, either present or represented by
proxy, shall constitute a quorum for the transaction of any business, but the
shareholders present, although less than a quorum, may adjourn the meeting to
another time or place and, except as provided in the last paragraph of Section
1.3 of these Bylaws, notice need not be given of the adjourned meeting.
SECTION 1.5 VOTING. Whenever directors are to be elected at a meeting,
they shall be elected by a plurality of the votes cast at the meeting by the
holders of stock entitled to vote. Whenever any corporate action, other than the
election of directors, is to be taken by vote of shareholders at a meeting, it
shall, except as otherwise required by law, by the Articles of Incorporation or
by these Bylaws, be approved if the votes cast by the holders of the shares
represented at the meeting and entitled to vote on the subject matter favoring
the action exceed the votes cast opposing the action.
Except as otherwise provided by law or by the Articles of
Incorporation, each holder of record of stock of the Corporation entitled to
vote on any matter at any meeting of shareholders shall be entitled to one vote
1
for each share of such stock standing in the name of such holder on the stock
ledger of the Corporation on the record date for the determination of the
shareholders entitled to vote at the meeting.
Upon the demand of any shareholder entitled to vote, the vote for
directors or the vote on any other matter at a meeting shall be by written
ballot, but otherwise the method of voting and the manner in which votes are
counted shall be discretionary with the presiding officer at the meeting.
SECTION 1.6 PRESIDING OFFICER AND SECRETARY. At every meeting of
shareholders the Chairman of the Board, or in his or her absence the Chief
Executive Officer, or in his or her absence the President, or in his or her
absence a Senior Managing Director or Managing Director, or, if none be present,
the appointee of the meeting, shall preside. The Secretary, or in his or her
absence an Assistant Secretary, or if none be present, the appointee of the
presiding officer of the meeting, shall act as secretary of the meeting.
SECTION 1.7 PROXIES. A shareholder entitled to vote at any meeting of
shareholders or any adjournment thereof may vote in person or by proxy executed
in writing and signed by the shareholder or the shareholder's attorney-in-fact.
The appointment of proxy will be effective when received by the Secretary or
other officer or agent authorized to tabulate votes. If a proxy designates two
or more persons to act as proxies, a majority of these persons present at the
meeting, or if only one is present, that one, shall have all of the powers
conferred by the instrument upon all the persons designated unless the
instrument otherwise provides. No proxy shall be valid more than eleven (11)
months after the date of its execution unless a longer term is expressly stated
in the proxy.
SECTION 1.8 LIST OF SHAREHOLDERS. The officer who has charge of the
stock ledger of the Corporation shall prepare and make, at least ten days before
every meeting of shareholders, a complete list of the shareholders entitled to
vote at the meeting, arranged in alphabetical order, and showing the address of
each shareholder and the number of shares registered in the name of each
shareholder. Such list shall be open to the examination of any shareholder, for
any purpose germane to the meeting, during ordinary business hours, for a period
of at least ten days prior to the meeting, at the Corporation's principal
office, at the office of the Corporation's transfer agent or registrar or at a
place within the city where the meeting is to be held, which place shall be
specified in the notice of the meeting, or, if not so specified, at the place
where the meeting is to be held. The list shall also be produced and kept at the
time and place of the meeting during the whole time thereof and may be inspected
by any shareholder who is present.
The stock ledger shall be the only evidence as to who are the
shareholders entitled to examine the stock ledger, the list required by this
Section or the books of the Corporation, or to vote in person or by proxy at any
meeting of shareholders.
SECTION 1.9 WRITTEN CONSENT OF SHAREHOLDERS IN LIEU OF MEETING. Except
as otherwise provided by law or by the Articles of Incorporation, any action
required or permitted by statute to be taken at any annual or special meeting of
shareholders of the Corporation may be taken without a meeting, without prior
notice and without a vote, if a consent in writing, setting forth the action so
taken, shall be dated and signed by the holders of outstanding stock having not
less than the minimum number of votes that would be necessary to authorize or
take such action at a meeting at which all shares entitled to vote thereon were
present and voted. Any such written consent may be given by one or any number of
substantially concurrent written instruments of substantially similar tenor
dated and signed by such shareholders, in person or by attorney or proxy duly
appointed in writing, and filed with the Secretary or an Assistant Secretary of
the Corporation. Within ten days after obtaining such authorization by written
consent, notice of the taking of the corporate action without a meeting by less
than unanimous written consent shall be given to those shareholders who have not
consented in writing or who are not entitled to vote on such action. The notice
shall fairly summarize the material features of the authorized action. If the
action creates dissenters' rights, the notice shall contain a clear statement of
the right of dissenting shareholders to be paid the fair value of their shares
upon compliance with and as provided for by the Florida Business Corporation
Act.
2
ARTICLE II
DIRECTORS
SECTION 2.1 NUMBER OF DIRECTORS. The Board of Directors shall consist
of not less than three directors and not more than seven directors, with the
exact number to be fixed by the Board of Directors. The number of directors may
be fixed at any time and from time to time by a resolution of the Board of
Directors passed by a majority of the whole Board of Directors or by a vote at a
meeting or by written consent of the holders of stock entitled to vote on the
election of directors, except that no decrease shall shorten the term of any
incumbent director unless such director is specifically removed pursuant to
Section 2.5 of these Bylaws at the time of such decrease.
SECTION 2.2 ELECTION AND TERM OF DIRECTORS. Directors shall be elected
annually, by election at the annual meeting of shareholders or by written
consent of the holders of stock entitled to vote thereon in lieu of such
meeting. If the annual election of directors is not held on the date designated
therefor, the directors shall cause such election to be held as soon thereafter
as convenient. Each director shall hold office from the time of his election and
qualification until his successor is elected and qualified or until his earlier
resignation or removal.
SECTION 2.3 VACANCIES AND NEWLY CREATED DIRECTORSHIPS. Vacancies and
newly created directorships resulting from any increase in the authorized number
of directors may be filled by election at a meeting of shareholders or by
written consent of the holders of stock entitled to vote thereon in lieu of a
meeting. Except as otherwise provided by law or by the Articles of
Incorporation, vacancies and such newly created directorships may also be filled
by a majority of the directors then in office, although less than a quorum, or
by a sole remaining director.
SECTION 2.4 RESIGNATION. Any director may resign at any time upon
written notice to the Board of Directors, the Chairman of the Board or the
Corporation. Any such resignation shall take effect at the time specified
therein or, if the time be not specified, upon receipt thereof, and the
acceptance of such resignation, unless required by the terms thereof, shall not
be necessary to make such resignation effective.
SECTION. 2.5 REMOVAL. Any or all of the directors may be removed at any
time, with or without cause, by vote of the holders of the shares of stock
entitled to vote on the election of directors, taken at a meeting or by written
consent, if the number of votes cast to remove such director or directors
exceeds the number of votes cast not to remove such director or directors.
SECTION 2.6 MEETINGS. Meetings of the Board of Directors, regular or
special, shall be held at the principal place of business of the Corporation or
at another place designated by the person or persons giving notice or otherwise
calling the meeting. Members of the Board of Directors, or of any committee
designated by the Board, may participate in a meeting of such Board or committee
by means of conference telephone or similar communications equipment by means of
which all persons participating in the meeting may simultaneously hear each
other, and participation in a meeting by such means shall constitute presence in
person at such meeting. The Board of Directors may fix dates, times and places
for regular meetings of the Board of Directors and no notice of such meetings
need be given. A special meeting of the Board of Directors shall be held
whenever called by the Chairman of the Board, if any, or by the President at
such date, time and place as shall be specified in the notice or waiver thereof.
Notice of each special meeting shall be given by the Secretary or by a person
calling the meeting to each director orally or in writing, and may be
communicated in person, by telegraph, teletype, telecopy or other form of
electronic communication not later than the day before the meeting or by mailing
the same, postage prepaid, not later than the second day before the meeting.
Notice of a meeting of the Board of Directors need not be given to a director
who signs a waiver of notice either before or after the meeting. Attendance of a
director at a meeting shall constitute a waiver of notice of that meeting and
waiver of all objections to the place of the meeting, the time of the meeting
and the manner in which it is called or convened, except when a director states,
at the beginning of the meeting or promptly upon arrival at the meeting,
objection to the transaction of business because the meeting is not lawfully
called or convened. Neither the business to be transacted at, nor the purpose
of, any regular or special meeting of the Board of Directors must be specified
in the notice or waiver of notice of such meeting.
3
SECTION 2.7 QUORUM AND VOTING. A majority of the total number of
directors shall constitute a quorum for the transaction of business, but, if
there be less than a quorum at any meeting of the Board of Directors, a majority
of the directors present may adjourn the meeting from time to time, and no
further notice thereof need be given other than announcement at the meeting
which shall be so adjourned. Except as otherwise provided by law, by the
Articles of Incorporation or by these Bylaws, the vote of a majority of the
directors present at a meeting at which a quorum is present shall be the act of
the Board of Directors.
SECTION 2.8 WRITTEN CONSENT OF DIRECTORS IN LIEU OF A MEETING. Any
action required or permitted to be taken at any meeting of the Board of
Directors or of any committee thereof may be taken without a meeting if all
members of the Board or of such committee, as the case may be, consent thereto
in writing, and the writing or writings are filed with the minutes of
proceedings of the Board or committee.
SECTION 2.9 COMPENSATION. Directors may receive compensation for
services to the Corporation in their capacities as directors or otherwise in
such manner and in such amounts as may be fixed from time to time by the Board
of Directors.
ARTICLE III
COMMITTEES OF THE BOARD OF DIRECTORS
SECTION 3.1 APPOINTMENT AND POWERS. The Board of Directors may from
time to time, by resolution passed by majority of the whole Board, designate one
or more committees, each committee to consist of two or more directors of the
Corporation. The Board of Directors may designate one or more directors as
alternate members of any committee, who may replace any absent or disqualified
member at any meeting of the committee. The resolution of the Board of Directors
may, in addition or alternatively, provide that in the absence or
disqualification of a member of a committee, the member or members thereof
present at any meeting and not disqualified from voting, whether or not he or
they constitute a quorum, may unanimously appoint another member of the Board of
Directors to act at the meeting in the place of any such absent or disqualified
member. Any such committee, to the extent provided in the resolution of the
Board of Directors, shall have and may exercise all the powers and authority of
the Board of Directors in the management of the business and affairs of the
Corporation, and may authorize the seal of the Corporation to be affixed to all
papers which may require it, except as otherwise provided by law. Any such
committee may adopt rules governing the method of calling and date, time and
place of holding its meetings. Unless otherwise provided by the Board of
Directors, a majority of any such committee shall constitute a quorum for the
transaction of business, and the vote of a majority of the members of such
committee present at a meeting at which a quorum is present shall be the act of
such committee. Each such committee shall keep a record of its acts and
proceedings and shall report thereon to the Board of Directors whenever
requested so to do. Any or all members of any such committee may be removed,
with or without cause, by resolution of the Board of Directors, passed by a
majority of the whole Board.
ARTICLE IV
OFFICERS, AGENTS AND EMPLOYEES
SECTION 4.1 APPOINTMENT AND TERM OF OFFICE. The officers of the
Corporation shall include a Chairman of the Board, a Chief Executive Officer, a
President, a Secretary and a Treasurer, and may include one or more Senior
Managing Directors, Managing Directors, Executive Vice Presidents, Senior Vice
Presidents and Vice Presidents. All such officers shall be appointed by the
Board of Directors or by a duly authorized committee thereof. Any number of such
offices may be held by the same person, but no officer shall execute,
acknowledge or verify any instrument in more than one capacity. Except as may be
prescribed otherwise by the Board of Directors or a committee thereof in a
particular case, all such officers shall hold their offices at the pleasure of
the Board of Directors for an unlimited term and need not be reappointed
annually or at any other periodic interval. The Board of Directors may appoint,
and may delegate power to appoint, such other officers (including Assistant
Secretaries and Assistant Treasurers) and agents as it may deem necessary or
proper, who shall hold their offices or positions for such terms, have such
authority and perform such duties as may from time to time be determined by or
pursuant to authorization of the Board of Directors.
4
SECTION 4.2 RESIGNATION AND REMOVAL. Any officer may resign at any time
upon written notice to the Secretary of the Corporation. Any officer, agent or
employee of the Corporation may be removed by the Board of Directors, or by a
duly authorized committee thereof, with or without cause at any time. The Board
of Directors or such a committee thereof may delegate such power of removal as
to officers, agents and employees not appointed by the Board of Directors or
such a committee.
SECTION 4.3 COMPENSATION AND BOND. The compensation of the officers of
the Corporation shall be fixed by the Board of Directors, but this power may be
delegated to any officer in respect of other officers under his control. The
Corporation may secure the fidelity of any or all of its officers, agents or
employees by bond or otherwise.
SECTION 4.4 CHAIRMAN OF THE BOARD. The Chairman of the Board shall
preside at all meetings of the Board of Directors and of the shareholders. The
Chairman of the Board shall have such other powers and perform such other duties
as are prescribed by these Bylaws and as usually pertain to such office and as
may be assigned to him or her at any time or from time to time by the Board of
Directors.
SECTION 4.5 CHIEF EXECUTIVE OFFICER; PRESIDENT. The Chairman of the
Board shall be the Chief Executive Officer of the Corporation, unless the Board
of Directors designates the President as Chief Executive Officer. The Chief
Executive Officer shall have the responsibility for carrying out the policies of
the Board of Directors, subject to the direction of the Board, and shall have
general supervision over the business and affairs of the Corporation. In the
absence of the Chairman of the Board, the President shall preside at meetings of
the Board of Directors and of the shareholders. The Chief Executive Officer or
President may employ and discharge employees and agents of the Corporation,
except as otherwise prescribed by the Board of Directors, and may delegate these
powers. The Chief Executive Officer or President may vote the stock or other
securities of any other domestic or foreign corporation of any type or kind
which may at any time be owned by the Corporation, may execute any shareholders'
or other consents in respect thereof and may in his or her discretion delegate
such powers by executing proxies, or otherwise, on behalf of the Corporation.
The Board of Directors by resolution from time to time may confer like powers
upon any other person or persons. The Chief Executive Officer and President
shall have such other powers and perform such other duties as are prescribed by
these Bylaws and as usually pertain to such office and as may be assigned to him
or her at any time or from time to time by the Board of Directors.
SECTION 4.6 MANAGING DIRECTORS. Each Senior Managing Director or
Managing Director shall have such powers and perform such duties as the Board of
Directors, the Chief Executive Officer or the President may from time to time
prescribe. In the absence or inability to act of the President, unless the Board
of Directors shall otherwise provide, the Senior Managing Director (or if none,
the Managing Director) who has served in that capacity for the longest time and
who shall be present and able to act, shall perform all the duties and may
exercise any of the powers of the President. The performance of any duty by a
Senior Managing Director or a Managing Director shall, in respect of any other
person dealing with the Corporation, be conclusive evidence of his or her power
to act.
SECTION 4.7 VICE PRESIDENTS. Each Executive Vice President, Senior Vice
President and Vice President shall have such powers and perform such duties as
the Board of Directors, the Chief Executive Officer or the President may from
time to time prescribe. The performance of any duty by an Executive Vice
President, Senior Vice President or Vice President shall, in respect of any
other person dealing with the Corporation, be conclusive evidence of his or her
power to act.
SECTION 4.8 TREASURER. The Treasurer shall have charge of all funds and
securities of the Corporation, shall endorse the same for deposit or collection
when necessary and deposit the same to the credit of the Corporation in such
banks or depositories as the Board of Directors may authorize. He may endorse
all commercial documents requiring endorsements for or on behalf of the
Corporation and may sign all receipts and vouchers for payments made to the
Corporation. He shall have all such further powers and duties as generally are
incident to the position of Treasurer or as may be assigned to him by the Board
of Directors, the Chief Executive Officer or the President.
SECTION 4.9 SECRETARY. The Secretary shall record all the proceedings
of the meetings of the shareholders and directors in a book to be kept for that
purpose and shall also record therein all action taken by written consent of the
shareholders or directors in lieu of a meeting. He or she shall attend to the
5
giving and serving of all notices of the Corporation. The Secretary shall have
custody of the seal of the Corporation and shall attest the same by his or her
signature whenever required. The Secretary shall have charge of the stock ledger
and such other books and papers as the Board of Directors may direct, but he or
she may delegate responsibility for maintaining the stock ledger to any transfer
agent appointed by the Board of Directors. He or she shall have all such further
powers and duties as generally are incident to the position of Secretary or as
may be assigned to him by the Board of Directors, the Chief Executive Officer or
the President
SECTION 4.10 ASSISTANT TREASURERS. In the absence or inability to act
of the Treasurer, any Assistant Treasurer may perform all the duties and
exercise all the powers of the Treasurer. The performance of any such duty
shall, in respect of any other person dealing with the Corporation, be
conclusive evidence of his or her power to act. An Assistant Treasurer shall
also perform such other duties as the Treasurer, the Board of Directors, the
Chief Executive Officer or the President may assign to him or her.
SECTION 4.11 ASSISTANT SECRETARIES. In the absence or inability to act
of the Secretary, any Assistant Secretary may perform all the duties and
exercise all the powers of the Secretary. The performance of any such duty
shall, in respect of any other person dealing with the Corporation, be
conclusive evidence of his or her power to act. An Assistant Secretary shall
also perform such other duties as the Secretary, the Board of Directors, the
Chief Executive Officer or the President may assign to him or her.
SECTION 4.12 DELEGATION OF DUTIES. In case of the absence of any
officer of the Corporation, or for any other reason that the Board of Directors
may deem sufficient, the Board of Directors may confer for the time being the
powers or duties, or any of them, of such officer upon any other officer or upon
any director.
SECTION 4.13 LOANS TO OFFICERS, DIRECTORS AND EMPLOYEES; GUARANTY OF
OBLIGATIONS OF OFFICERS, DIRECTORS AND EMPLOYEES. The Corporation may lend money
to, or guarantee any obligation of, or otherwise assist any officer, director or
employee of the Corporation or any subsidiary whenever, in the judgment of the
Board of Directors, such loan, guaranty or assistance may reasonably be expected
to benefit the Corporation. The loan, guaranty or other assistance may be with
or without interest and may be unsecured or secured in such manner as the Board
of Directors shall approve, including, without limitation, a pledge of shares of
stock of the Corporation.
ARTICLE V
INDEMNIFICATION
SECTION 5.1 INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND
AGENTS. Any person who was or is a party or is threatened to be made a party to
any threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (including any action or suit by or in
the right of the Corporation to procure a judgment in its favor) by reason of
the fact that he or she is or was a director, officer, employee or agent of the
Corporation, or is or was serving at the request of the Corporation as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, shall be indemnified by the Corporation, if,
as and to the extent authorized by applicable law, against expenses (including
attorneys' fees), judgments, liabilities, fines, costs and amounts paid in
settlement actually and reasonably incurred by him or her in connection with the
defense or settlement of such action, suit or proceeding. The indemnification
expressly provided by applicable law and by these Bylaws in a specific case
shall not be deemed exclusive of any other rights to which any person
indemnified may be entitled under any lawful agreement, vote of shareholders or
disinterested directors or otherwise, both as to action in his official capacity
and as to action in another capacity while holding such office, and shall
continue as to a person who has ceased to be a director, officer, employee or
agent and shall inure to the benefit of the heirs, executors and administrators
of such a person.
SECTION 5.2 INSURANCE. The Corporation may maintain insurance, at its
expense, to protect itself and its directors, officers, employees and agents
against expenses, judgments, liabilities, fines, costs and amounts paid in
settlement, whether or not the Corporation would have the legal power to
indemnify them directly against such liability.
6
SECTION 5.3 SAVINGS CLAUSE. If this Article or any portion of it is
invalidated on any ground by a court of competent jurisdiction, the Corporation
nevertheless shall indemnify each person described in Section 5.1 of this
Article to the fullest extent permitted by all portions of this Article that
shall not have been invalidated and to the fullest extent permitted by law.
ARTICLE VI
STOCK
SECTION 6.1 CERTIFICATES. The Board of Directors may authorize the
issuance of some or all of the Corporation's shares of stock of any or all
classes or series with or without certificates. Certificates for stock of the
Corporation shall be in such form as shall be approved by the Board of Directors
and shall be signed in the name of the Corporation by the Chairman of the Board,
the President, a Senior Managing Director or a Managing Director, and by the
Treasurer or an Assistant Treasurer, or the Secretary or an Assistant Secretary.
Such certificates may be sealed with the seal of the Corporation or a facsimile
thereof. Any or all of the signatures on a certificate may be a facsimile. In
case any officer, transfer agent or registrar who has signed or whose facsimile
signature has been placed upon a certificate shall have ceased to be such
officer, transfer agent or registrar before such certificate is issued, it may
be issued by the Corporation with the same effect as if he or she were such
officer, transfer agent or registrar at the date of issue.
SECTION 6.2 REGISTERED SHAREHOLDERS. No certificate shall be issued for
any share until the share is fully paid. The Corporation shall be entitled to
treat the holder of record of shares as the holder in fact and, except as
otherwise provided by law, shall not be bound to recognize any equitable or
other claim to or interest in the shares.
SECTION 6.3 TRANSFERS OF STOCK. Transfers of stock shall be made only
upon the books of the Corporation by the holder, in person or by duly authorized
attorney, and on the surrender of the certificate or certificates for such stock
properly endorsed. The Board of Directors shall have the power to make all such
rules and regulations, not inconsistent with applicable law, the Articles of
Incorporation or these Bylaws, as the Board of Directors may deem appropriate
concerning the issue, transfer and registration of certificates for stock of the
Corporation. The Board may appoint one or more transfer agents or registrars of
transfers, or both, and may require all stock certificates to bear the signature
of either or both.
SECTION 6.4 LOST, STOLEN OR DESTROYED CERTIFICATES. The Corporation may
issue a new stock certificate in the place of any certificate theretofore issued
by it, alleged to have been lost, stolen or destroyed, and the Corporation may
require the owner of the lost, stolen or destroyed certificate or his legal
representative to give the Corporation a bond sufficient to indemnify it against
any claim that may be made against it on account of the alleged loss, theft or
destruction of any such certificate or the issuance of any such new certificate.
The Board of Directors may require such owner to satisfy other reasonable
requirements.
SECTION 6.5 SHAREHOLDER RECORD DATE. In order that the Corporation may
determine the shareholders entitled to notice of or to vote at any meeting of
shareholders or any adjournment thereof, or to express consent to corporate
action in writing without a meeting, or entitled to receive payment of any
dividend or other distribution or allotment of any rights, or entitled to
exercise any rights in respect of any change, conversion or exchange of stock,
or for the purpose of any other lawful action, the Board of Directors may fix,
in advance, a record date, which shall not precede the date upon which the Board
of Directors adopts the resolution fixing such record date nor be more than
seventy days before the date of such meeting or other action requiring
shareholder determination. Only such shareholders as shall be shareholders of
record on the date so fixed shall be entitled to notice of, and to vote at, such
meeting and any adjournment thereof, or to give such consent, or to receive
payment of such dividend or other distribution, or to exercise such rights in
respect of any such change, conversion or exchange of stock, or to participate
in such action, as the case may be, notwithstanding any transfer of any stock on
the books of the Corporation after any record date so fixed.
If no record date is fixed by the Board of Directors, (i) the record
date for determining shareholders entitled to notice of or to vote at a meeting
of shareholders shall be at the close of business on the day next preceding the
date on which notice is given or, if notice is waived by all shareholders
entitled to vote at the meeting, at the close of business on the day next
preceding the day on which the meeting is held, (ii) the record date for
determining shareholders entitled to express consent to corporate action in
7
writing without a meeting, when no prior action by the Board of Directors is
necessary, shall be at the close of business on the day on which the first
written consent is expressed by the filing thereof with the Corporation as
provided in Section 1.10 of these Bylaws, and (iii) the record date for
determining shareholders for any other purpose shall be at the close of business
on the day on which the Board of Directors adopts the resolution relating
thereto.
A determination of shareholders of record entitled to notice of or to
vote at a meeting of shareholders shall apply to any adjournment of the meeting;
provided, however, that the Board of Directors may fix a new record date for the
adjourned meeting.
ARTICLE VII
SEAL
SECTION 7.1 SEAL. The seal of the Corporation shall be circular in form
and shall bear, in addition to any other emblem or device approved by the Board
of Directors, the name of the Corporation, the year of its incorporation and the
words "Corporate Seal" and "Florida". The seal may be used by causing it or a
facsimile thereof to be impressed or affixed or in any other manner reproduced.
ARTICLE VIII
WAIVER OF NOTICE
SECTION 8.1 WAIVER OF NOTICE. Whenever notice is required to be given
by statute or under any provision of the Articles of Incorporation or these
Bylaws, a written waiver thereof, signed by the person entitled to notice,
whether before or after the time stated therein, shall be deemed equivalent to
notice. In the case of a shareholder, such waiver of notice may be signed by
such shareholder's attorney or proxy duly appointed in writing. Attendance of a
person at a meeting shall constitute a waiver of notice of such meeting, except
when the person attends a meeting for the express purpose of objecting at the
beginning of the meeting to the transaction of any business because the meeting
is not lawfully called or convened. Neither the business to be transacted at,
nor the purpose of, any regular or special meeting of the shareholders,
directors or members of a committee of directors need be specified in any
written waiver of notice.
ARTICLE IX
CHECKS, NOTES, DRAFTS, ETC.
SECTION 9.1 CHECKS, NOTES, DRAFTS, ETC. Checks, notes, drafts,
acceptances, bills of exchange and other orders or obligations for the payment
of money shall be signed by such officer or officers or person or persons as the
Board of Directors or a duly authorized committee thereof may from time to time
designate.
ARTICLE X
AMENDMENT
SECTION 10.1 AMENDMENT. These Bylaws or any of them may be altered,
amended or repealed, and new Bylaws may be adopted, by the Board of Directors or
by the shareholders.
8
Ocwen Financial Corporation and Subsidiaries Exhibit 12.1
Computation of Earnings to Fixed Charges
(Dollars in Thousands)
Year Ended December 31,
------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Earnings:
(Loss) income from continuing operations
before income taxes (1) $ (32,805) $ 99,538 $ 61,301 $ 37,701 $ 81,577
Add:
Fixed charges (2) $ 202,003 $163,798 $116,680 $ 84,626 $ 63,549
--------- -------- -------- -------- --------
Earnings for computation purposes $ 169,198 $263,336 $177,981 $122,327 $145,126
Ratio of earnings to fixed charges:
Including interest on deposits (3) (4) 0.84 1.61 1.53 1.45 2.28
Excluding interest on deposits (3) (4) 0.62 3.39 3.68 3.95 5.40
- - ----------
(1) Earnings represents income from continuing operations excluding
undistributed income of $440 from a less than fifty percent owned entity.
(2) Fixed charges represent total interest expensed and capitalized, including
and excluding interest on deposits, amortization of capitalized debt
expenses, as well as the interest component of rental expense.
(3) The ratios of earnings to fixed charges were computed by dividing (x)
income from continuing operations before income taxes, extraordinary gains
and cumulative effect of a change in accounting principle excluding
undistributed income from a less than fifity percent owned entity plus
fixed charges by (y) fixed charges.
(4) Excluding after-tax impairment charges of $97.1 million ($152.8 million
pre-tax) the Company's ratio of earnings to fixed charges for the year
ended December 31, 1998 would have been 1.95 and 3.14 including and
excluding interest on deposits, respectively.
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following tables present selected consolidated financial data of
the Ocwen Financial Corporation and its subsidiaries ("OCN" 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, 1998, 1997, 1996, 1995 and
1994, have been derived from financial statements audited by
PricewaterhouseCoopers 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.
For the Year Ended December 31,
----------------------------------------------------- -----------
1998(1) 1997 1996 1995(2) 1994(2)
----------- ----------- ----------- ----------- -----------
(Dollars in thousands, except per share data)
OPERATIONS DATA:
Interest income....................................... $ 307,694 $ 272,531 $ 193,894 $ 137,275 $ 131,458
Interest expense...................................... 184,893 156,289 116,160 84,060 62,598
----------- ----------- ----------- ----------- -----------
Net interest income................................. 122,801 116,242 77,734 53,215 68,860
Provision for loan losses (3)......................... 18,509 32,218 22,450 1,082 --
----------- ----------- ----------- ----------- -----------
Net interest income after provision for loan losses. 104,292 84,024 55,284 52,133 68,860
----------- ----------- ----------- ----------- -----------
(Loss) gain on interest-earning assets, net........... (1,594) 82,212 21,682 6,916 5,727
Servicing fees and other charges...................... 59,180 25,962 4,682 2,870 4,786
Gain on sale of branch offices........................ -- -- -- 5,430 62,600
Income on real estate owned, net...................... 14,033 7,277 3,827 9,540 5,995
Other non-interest income............................. 39,696 8,498 7,112 6,385 2,467
----------- ----------- ----------- ----------- -----------
Total non-interest income........................... 111,315 123,949 37,303 31,141 81,575
----------- ----------- ----------- ----------- -----------
Compensation and employee benefits.................... 115,556 77,573 39,043 24,797 42,776
Other non-interest expense............................ 110,838 49,301 30,563 20,776 26,082
----------- ----------- ----------- ----------- -----------
Total non-interest expense.......................... 226,394 126,874 69,606 45,573 68,858
----------- ----------- ----------- ----------- -----------
Distributions on Capital Securities................... 13,594 5,249 -- -- --
Equity in (losses) earnings of investment in
unconsolidated entities (4)......................... (7,985) 23,688 38,320 -- --
Income tax benefit (expense).......................... 30,699 (21,309) (11,159) (4,562) (29,724)
Minority interest in net loss of consolidated subsidiary 467 703 -- -- --
----------- ----------- ----------- ----------- ------------
(Loss) income from continuing operations.............. (1,200) 78,932 50,142 33,139 51,853
Discontinued operations (5)........................... -- -- -- (7,672) (4,514)
----------- ----------- ----------- ------------ ------------
Net income............................................ $ (1,200) $ 78,932 $ 50,142 $ 25,467 $ 47,339
=========== =========== =========== =========== ===========
(Loss) income from continuing operations per share (5):
Basic............................................... $ (0.02) $ 1.40 $ 0.99 $ 0.64 $ 0.81
Diluted............................................. $ (0.02) $ 1.39 $ 0.94 $ 0.60 $ 0.76
Net (loss) income per share (6):
Basic............................................... $ (0.02) $ 1.40 $ 0.99 $ 0.49 $ 0.74
Diluted............................................. $ (0.02) $ 1.39 $ 0.94 $ 0.46 $ 0.70
18
At or For the Year Ended December 31,
---------------------------------------------------------------------------
1998 (1) 1997 1996 1995 (2) 1994 (2)
----------- ----------- ----------- ----------- -----------
(Dollars in thousands)
BALANCE SHEET DATA:
Total assets........................................ $ 3,308,079 $ 3,069,165 $ 2,483,685 $ 1,973,590 $ 1,226,403
Securities available for sale (7)................... 593,347 476,796 354,005 337,480 187,717
Loans available for sale (7) (8).................... 177,847 177,041 126,366 251,790 102,293
Investment securities, net.......................... 10,825 10,825 8,901 18,665 17,011
Mortgage-related securities held for investment, net -- -- -- -- 91,917
Loan portfolio, net (8)............................. 230,312 266,299 402,582 295,605 57,045
Discount loan portfolio (8)......................... 1,026,511 1,434,176 1,060,953 669,771 529,460
Investment in low-income housing tax credit interests 144,164 128,614 93,309 81,362 49,442
Real estate owned, net (9).......................... 201,551 167,265 103,704 166,556 96,667
Investment in unconsolidated entities............... 86,893 3,526 67,909 -- --
Excess of purchase price over
net assets acquired, net.......................... 12,706 15,560 -- -- --
Deposits............................................ 2,175,016 1,982,822 1,919,742 1,501,646 1,023,268
Borrowings and other interest-bearing obligations... 476,336 453,529 300,518 272,214 25,510
Capital Securities.................................. 125,000 125,000 -- -- --
Stockholders' equity (10)........................... 436,376 419,692 203,596 139,547 153,383
OTHER DATA:
Average assets (11)................................. $ 3,586,985 $ 2,835,514 $ 2,013,283 $ 1,521,368 $ 1,714,953
Average equity...................................... 427,512 290,030 161,332 121,291 119,500
Return on average assets (11) (12):
Income from continuing operations................ (0.03)% 2.78% 2.49% 2.18% 3.02%
Net income....................................... (0.03) 2.78 2.49 1.67 2.76
Return on average equity (12):
Income from continuing operations................ (0.28) 27.22 31.08 27.32 43.39
Net income....................................... (0.28) 27.22 31.08 21.00 39.61
Average equity to average assets.................... 11.92 10.23 8.01 7.97 6.97
Net interest spread................................. 3.98 4.81 5.46 5.25 4.86
Net interest margin................................. 4.32 4.91 4.84 4.54 4.75
Efficiency ratio (13)............................... 100.12 48.08 45.39 54.00 45.77
Nonperforming loans to total loans at end of
period (14)...................................... 3.81 3.36 0.56 1.27 4.35
Allowance for loan losses to total loans (14)....... 2.07 1.39 0.87 0.65 1.84
Bank regulatory capital ratios at end of period:
Tangible......................................... 9.07 10.66 9.33 6.52 11.28
Core (Leverage).................................. 9.07 10.66 9.33 6.52 11.28
Risk-based....................................... 17.26 14.83 12.85 11.80 14.74
Number of full-service offices at end of period..... 1 1 1 1 3
NOTES TO SELECTED CONSOLIDATED FINANCIAL INFORMATION
(1) Financial results for 1998 reflect pre-tax impairment charges of $152.8
million, of which $86.1 million related to the Company's portfolio of
AAA-rated agency interest-only securities ("IOs"), $43.6 million
related to residual and subordinate securities available for sale,
$13.0 million was for the anticipated curtailment of its domestic
operations, $8.2 million was for losses on its equity investments in
Ocwen Asset Investment Corp. ("OAC") and Ocwen Partnership L.P.
("OPLP"), and $1.9 million related to an impaired commercial real
estate investment. OAC specializes in the acquisition and management of
real estate and mortgage assets. OPLP is the operating partnership
subsidiary of OAC. Exclusive of these impairment charges and related
income taxes, net income for 1998 would have been $95.9 million.
(2) Financial data at December 31, 1995 and 1994, reflects the Company's
sale of two and 23 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 reflect the gains
19
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.
(3) The provision for loan losses in 1998, 1997 and 1996 consists primarily
of $17.6 million, $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) Results for 1998 related primarily to the Company's 16.83% combined
investment in OAC and OPLP, and its 36.07% investment in Norland
Capital Group plc, doing business as Kensington Mortgage Company
("Kensington"), a leading originator of non-conforming residential
mortgages in the United Kingdom ("U.K."). See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Results
of Operations-General." Results for 1997 and 1996 related to the
Company's investment in BCBF, L.L.C. (the "LLC"), a 50% owned joint
venture formed between the Company and BlackRock Capital Finance
("BlackRock") to acquire loans from the Department of Housing and Urban
Development ("HUD") in April 1996.
(5) In September 1995, the Company announced its decision to dispose of its
automated banking division, which was substantially complete at
December 31, 1995.
(6) 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 1 to the Consolidated Financial Statements.
(7) Securities available for sale are carried at fair market value. Loans
available for sale are carried at the lower of cost or fair 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 and is primarily attributable to the Company's
discount loan acquisition and resolution business.
(10) Reflects the Company's repurchase of 17,630,120 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 during 1997 and 1996.
(12) Exclusive of the after-tax impairment charges of $97.1 million recorded
in 1998, the return on average assets would have been 2.64%, and the
return on average equity would have been 22.16%. Exclusive of the $7.1
million one-time assessment to recapitalize the Savings Association
Insurance Fund (the "SAIF") in 1996 and of the gains from the sales of
branch offices in 1995 and 1994 and related income taxes, (i) return on
average assets on income from continuing operations would have been
2.54%, 2.00% and 1.40% during 1996, 1995 and 1994, respectively, and
(ii) return on average equity on income from continuing operations
would have been 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 unconsolidated entities.
Exclusive of the impairment charges of $152.8 million recorded in 1998,
the efficiency ratio would have been 58.05%. Exclusive of the SAIF
assessment in 1996 and gains from the sales of branch offices in 1995
and 1994, the efficiency ratio would have been 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.
20
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 a net loss of $1.2 million for 1998, as
compared to net income of $78.9 million for 1997 and $50.1 million for 1996.
Diluted loss per share was $0.02 for 1998, as compared with diluted earnings per
share of $1.39 for 1997 and $0.94 for 1996. The results for 1998 include pre-tax
impairment charges of $152.8 million, of which $86.1 million related to the
Company's securities portfolio of AAA-rated agency IOs, $43.6 million related to
residual and subordinate securities available for sale, $13.0 million was for
the anticipated curtailment of its domestic subprime operations, $8.2 million
was for combined losses on its equity investments in OAC and OPLP during the
fourth quarter, and $1.9 million related to an impaired commercial real estate
investment. Exclusive of these impairment charges, net income for 1998 would
have been $95.9 million, or $1.57 per diluted share.
The Company's operating results for 1998 have also been significantly affected
by the following transactions:
o 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(R)-based,
have client/server architecture and feature real-time processing, are
designed to be year 2000 compliant, feature a scalable database platform
and have strong workflow capabilities.
o 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. As a result, the Company
recorded equity in earnings of the LLC of $0 in 1998, as compared to $23.7
million and $38.3 million for 1997 and 1996, respectively. See "Results of
Operations N Equity in (Losses) Earnings of Investment in Unconsolidated
Entities."
o On January 20, 1998, the Company acquired DTS Communications, Inc. ("DTS"),
a real estate technology company located in San Diego, California. DTS has
developed technology tools to automate real estate transactions. DTS has
been recognized by Microsoft Corporation for the Microsoft(R)
component-based architecture to facilitate electronic data interchange.
Both AMOS and DTS are wholly-owned subsidiaries of Ocwen Technology
Xchange, Inc. ("OTX"), which incurred a net loss of $9.6 million in 1998.
o On February 25, 1998, the Company purchased 36.07% of the total outstanding
common stock of Kensington. Kensington is a leading originator of
non-conforming residential mortgages in the U.K. The Company recorded
equity in earnings of Kensington in 1998 of $439,000, net of goodwill
amortization of $2.0 million. See "Results of Operations N Equity in
(Losses) Earnings of Investment in Unconsolidated Entities."
o On April 24, 1998, the Company, through its wholly-owned subsidiary Ocwen
UK, acquired substantially all of the assets, and certain liabilities, of
the U.K. operations of Cityscape Financial Corp. ("Cityscape UK"). As
consummated, the Company acquired Cityscape UK's mortgage loan portfolio
and its residential subprime mortgage loan origination and servicing
businesses. The Company recorded net income of $12.3 million ($18.9 million
before income taxes) in 1998 from Ocwen UK's loan origination and servicing
businesses.
o On May 5, 1998, the Company, through its wholly-owned subsidiary Investor's
Mortgage Holding Company ("IMI"), acquired 1,473,733 partnership units of
OPLP for $24.5 million. This purchase was in addition to the 160,000 units
owned at December 31, 1997, and the 175,000 units acquired on February 17,
1998, increasing the total number of units owned by IMI to 1,808,733 or
8.71% of the total partnership units outstanding at December 31, 1998. OPLP
is the operating partnership subsidiary of OAC, which is managed by Ocwen
Capital Corporation ("OCC"), a wholly-owned subsidiary of OCN. At December
31, 1998, the Company owned 1,540,000 or 8.12% of the outstanding common
stock of OAC. Combined equity in the losses of the Company's investments in
OPLP and OAC amounted to $8.7 million in 1998, of which $8.2 million was
21
incurred during the fourth quarter. See "Results of Operations Equity in
(Losses) Earnings of Investment in Unconsolidated Entities."
See Note 2 to the Consolidated Financial Statements for additional information
regarding these transactions.
SEGMENT PROFITABILITY. The following table presents the contribution by business
segment to the Company's net (loss) income for the years indicated.
1998 1997 1996
----------- ----------- -----------
Discount loans: (Dollars in thousands)
Single family residential loans......................... $ 14,394 $ 23,349 $ 16,827
Large commercial real estate loans...................... 28,103 24,474 15,480
Small commercial real estate loans...................... 8,195 5,349 1,398
----------- ----------- -----------
50,692 53,172 33,705
----------- ----------- -----------
Mortgage loan servicing:
Domestic................................................ 8,066 3,972 (2,558)
Foreign (U.K.).......................................... 4,771 -- --
----------- ----------- -----------
12,837 3,972 (2,558)
----------- ----------- -----------
Investment in low-income housing tax credits............ 9,119 9,087 11,577
Commercial real estate lending.......................... 13,588 12,405 3,617
OTX..................................................... (9,623) -- --
Subprime single family residential lending:
Domestic................................................ (20,524) (2,166) 3,131
Foreign (U.K.).......................................... 7,475 -- --
----------- ----------- -----------
(13,049) (2,166) 3,131
----------- ----------- -----------
Investment securities................................... (59,186) 3,587 987
Equity investment in OAC................................ (8,701) -- --
Other................................................... 3,123 (1,125) (317)
----------- ----------- -----------
$ (1,200) $ 78,932 $ 50,142
=========== =========== ===========
o Single Family Residential Discount Loans. Included in 1998 is an
impairment charge of approximately $12.2 million on residential
subordinate securities and gains of $48.1 million earned on the
securitization of loans with an aggregate unpaid principal balance of
$498.8 million. Securitization gains during 1997 and 1996 were $51.1
million and $0, respectively. See "Results of Operations Non-Interest
Income."
o Large Commercial Discount Real Estate Loans. Net income for 1998
reflects a gain of $4.7 million earned on the sale of loans. Net income
for 1997 includes $3.5 million of gains from sales of loans, as
compared to a $7.9 million gain earned in 1996 in connection with the
securitization of 25 loans with an unpaid principal balance of $164.4
million. See "Results of Operations Non-Interest Income."
o Small Commercial Discount Real Estate Loans. Gains from the sale of
loans amounted to $7.6 million, $2.7 million (of which $2.0 million
were securitization gains), and $0 during 1998, 1997 and 1996,
respectively. See "Results of Operations Non-Interest Income."
o Investment in Low-Income Housing Tax Credits. Net income for 1998
includes $7.4 million of gains associated with the sale of tax credit
interests. This compares to gains of $6.1 million and $4.9 million in
1997 and 1996, respectively. Low-income housing tax credits and
benefits amounted to $17.7 million, $14.9 million and $9.3 million for
1998, 1997 and 1996, respectively. Net operating losses from tax credit
properties in service amounted to $6.9 million, $4.9 million and
$636,000
22
during 1998, 1997 and 1996, respectively. See "Changes in Financial
Condition Investment in Low-Income Housing Tax Credit Interests."
o Commercial Real Estate Lending. Net income for 1998 includes $12.4
million of additional interest received on the payoff of nine loans
with an unpaid principal balance of $107.2 million. The increase in net
income during 1997 as compared to 1996 is primarily attributed to $12.3
million of additional interest received on the repayment of loans.
o Subprime Single Family Residential Lending. The net loss in 1998 from
the domestic lending operations includes a $31.0 million impairment
charge on subprime residual securities available for sale, $13.0
million of goodwill write-offs and other charges recorded in connection
with the anticipated curtailment of the domestic subprime operations
and gains of $35.9 million on the securitization of loans with an
unpaid principal balance of $1.07 billion. The Company's domestic
subprime lending operations are conducted primarily through Ocwen
Financial Services, Inc. ("OFS"), which was formed in 1997. The $13.0
million of curtailment charges consisted of $10.1 million of goodwill
write-offs, $1.5 million of compensation to former owners and employees
and $1.4 million related to lease terminations and fixed asset
write-offs. During 1997, gains of $18.8 million were recorded in
connection with the securitization of loans with an unpaid principal
balance of $415.8 million. During 1998, Ocwen UK recorded gains of
$25.6 million ((pound)15.4 million) in connection with the
securitization of loans with an unpaid principal balance of $558.5
million ((pound)339.4 million).
o Mortgage Loan Servicing. Servicing fees amounted to $45.6 million,
$22.1 million and $2.4 million during 1998, 1997 and 1996,
respectively. The increases in servicing fees reflects an increase in
loans serviced for others from $1.92 billion at December 31, 1996, to
$5.51 billion at December 31, 1997, and $10.59 billion at December 31,
1998. The unpaid principal balance of loans serviced for others
averaged $8.06 billion, $3.11 billion and $887.9 million during 1998,
1997 and 1996, respectively. The increase in net income for 1998 was
partially offset by the increase in expenses associated with
establishing a nationwide customer service and collection facility in
Orlando, Florida. At December 31, 1998, the Company serviced 153,458
loans, as compared to 70,308 and 30,163 at December 31, 1997 and 1996,
respectively.
o OTX. The 1998 operating loss of $9.6 million was partially offset by
$2.4 million of capitalized software costs in 1998.
o Investment Securities. The $59.2 million loss in 1998 includes the
$86.1 million of pre-tax impairment charges ($54.9 million net of tax)
related to the Company's securities portfolio of AAA-rated agency IOs.
These charges were recorded prior to the sale of the IOs on July 27,
1998. The Company has discontinued this investment activity. See
"Changes in Financial Condition Securities Available for Sale."
o Equity Investment in OAC. The $8.7 million loss for 1998 represents the
combined equity in the losses of the Company's investments in OAC and
its operating partnership subsidiary, OPLP. As a result of the
Company's increased combined ownership of OAC and OPLP during 1998, the
Company began accounting for these investments on the equity method.
The losses incurred by OAC and OPLP relate primarily to impairment
losses on subordinate and residual mortgage-backed securities. See
"Changes in Financial Condition Investment in Unconsolidated Entities."
See Note 27 to the Consolidated Financial Statements for additional disclosures
related to the Company's operating segments.
NET INTEREST INCOME: 1998 VERSUS 1997 AND 1997 VERSUS 1996. 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.
23
Year Ended December 31,
1998 1997 1996
----------------------------- ----------------------------- -----------------------------
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
---------- --------- ------ ---------- --------- ------ ---------- --------- ------
(Dollars in thousands)
AVERAGE ASSETS:
Federal funds sold and repurchase
agreements....................... $ 149,441 $ 7,930 5.31% $ 163,671 $ 8,975 5.48% $ 84,997 $ 4,681 5.51%
Securities held for trading........ -- -- -- 3,295 248 7.53 21,291 1,216 5.71
Securities available for sale (1).. 590,367 40,705 6.90 299,558 29,851 9.97 284,433 26,932 9.47
Loans available for sale (2)....... 520,859 56,791 10.90 171,837 18,368 10.69 175,078 17,092 9.76
Investment securities and other.... 32,122 2,812 8.75 36,905 2,739 7.42 36,264 3,990 11.00
Loan portfolio (2)................. 266,519 38,609 14.49 410,863 54,701 13.31 328,378 36,818 11.21
Discount loan portfolio............ 1,285,383 160,847 12.51 1,283,020 157,649 12.29 675,345 103,165 15.28
---------- --------- ---------- --------- ---------- ---------
Total interest earning assets... 2,844,691 307,694 10.82 2,369,149 272,531 11.50 1,605,786 193,894 12.07
--------- --------- ---------
Non-interest earning cash.......... 23,739 14,843 6,372
Allowance for loan losses.......... (25,655) (22,001) (11,250)
Low-income ........................
Housing tax credit interests....... 130,391 96,096 83,110
Investment in joint ventures....... 82,779 34,777 46,193
Real estate owned, net............. 178,223 131,007 137,250
Investment in real estate.......... 36,922 44,722 --
Other assets....................... 315,895 166,921 145,822
---------- ---------- ----------
Total assets.................... $3,586,985 $2,835,514 $2,013,283
========== ========== ==========
AVERAGE LIABILITIES AND
STOCKHOLDERS' EQUITY:
Interest-bearing demand deposits... $ 39,934 1,434 3.59% $ 31,719 1,220 3.85% $ 33,167 620 1.87%
Savings deposits................... 1,652 38 2.30 2,121 49 2.31 3,394 78 2.30
Certificates of deposit............ 1,844,977 115,112 6.24 1,964,351 120,801 6.15 1,481,197 93,075 6.28
---------- --------- ---------- --------- ---------- ---------
Total interest-bearing deposits. 1,886,563 116,584 6.18 1,998,191 122,070 6.11 1,517,758 93,773 6.18
Securities sold under agreements to 5.62
repurchase...................... 104,980 6,514 6.20 16,717 1,000 5.98 19,581 1,101
Advances from the Federal Home Loan
Bank............................. 2,201 120 5.45 9,482 527 5.56 71,221 4,053 5.69
Obligation outstanding under lines
of credit........................ 481,212 34,587 7.19 84,272 5,578 6.62 -- -- --
Subordinated debentures............ 227,858 27,088 11.89 228,233 27,114 11.88 148,282 17,233 11.62
---------- --------- ---------- --------- ---------- ---------
Total interest-bearing liabilities 2,702,814 184,893 6.84 2,336,895 156,289 6.69 1,756,842 116,160 6.61
--------- --------- ---------
Non-interest bearing deposits...... 19,483 23,224 10,938
Escrow deposits.................... 165,111 78,986 41,306
Capital securities................. 125,000 48,387 $ --
Other liabilities.................. 147,065 57,992 42,865
---------- ---------- ----------
Total liabilities............... 3,159,473 2,545,484 1,851,951
Stockholders' equity............... 427,512 290,030 161,332
---------- ---------- ----------
Total liabilities and
stockholders' equity.......... $3,586,985 $2,835,514 $2,013,283
========== ========== ==========
Net interest income................ $ 122,801 $ 116,242 $ 77,734
========= ========= =========
Net interest spread................ 3.98% 4.81% 5.46%
==== ==== ====
Net interest margin................ 4.32% 4.91% 4.84%
==== ==== ====
Ratio of interest-earning assets...
to interest-bearing liabilities.. 105% 101% 91%
========== ========== ==========
(1) Excludes effect of unrealized gains or losses on securities available
for sale.
(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.
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.
24
Year Ended December 31,
----------------------------------------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
----------------------------------------- ------------------------------------------
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 ........................... $ (283) $ (762) $ (1,045) $ (20) $ 4,314 $ 4,294
Securities available for sale .......... (11,348) 22,202 10,854 1,449 1,470 2,919
Securities held for trading ............ (124) (124) (248) 297 (1,265) (968)
Loans available for sale ............... 375 38,048 38,423 1,597 (321) 1,276
Loan portfolio ......................... 4,479 (20,571) (16,092) 7,642 10,241 17,883
Discount loan portfolio ................ 2,907 291 3,198 (23,426) 77,910 54,484
Investment securities and other ........ 455 (382) 73 (1,320) 69 (1,251)
----------- ----------- ----------- ----------- ----------- -----------
Total interest-earning assets ..... (3,539) 38,702 35,163 (13,781) 92,418 78,637
----------- ----------- ----------- ----------- ----------- -----------
INTEREST-BEARING LIABILITIES:
Interest-bearing demand deposits ....... (85) 299 214 628 (28) 600
Savings deposits ....................... -- (11) (11) -- (29) (29)
Certificates of deposit ................ 1,738 (7,427) (5,689) (2,026) 29,752 27,726
----------- ----------- ----------- ----------- ----------- -----------
Total interest-bearing deposits ... 1,653 (7,139) (5,486) (1,398) 29,695 28,297
Securities sold under agreements to
repurchase ........................... 39 5,475 5,514 67 (168) (101)
Advances from the Federal Home Loan Bank (10) (397) (407) (92) (3,434) (3,526)
Obligations outstanding under lines of
credit ............................... 519 28,490 29,009 -- 5,578 5,578
Notes, debentures and other
interest-bearing obligations ......... 19 (45) (26) 391 9,490 9,881
----------- ----------- ----------- ----------- ----------- -----------
Total interest-bearing liabilities 2,220 26,384 28,604 (1,032) 41,161 40,129
----------- ----------- ----------- ----------- ----------- -----------
Increase (decrease) in net interest income $ (5,759) $ 12,318 $ 6,559 $ (12,749) $ 51,257 $ 38,508
=========== =========== =========== =========== =========== ===========
1998 VERSUS 1997:
The Company's net interest income before provision for loan losses of $122.8
million increased $6.6 million or 6% during 1998 as compared to the prior year.
The increase was due to an increase in average interest-earning assets, offset
by an increase in average interest-bearing liabilities and a decline in the net
interest spread. Average interest-earning assets increased by $475.5 million or
20% during 1998 and yielded $38.7 million of interest income, while average
interest-bearing liabilities increased $365.9 million or 16% and contributed
$26.4 million of interest expense. The net impact of these volume changes
resulted in an increase of $12.3 million to net interest income. The increase in
average interest-earning assets was primarily due to a $349.0 million increase
in the average balance of loans available for sale and a $290.8 million increase
in securities available for sale, offset by a $144.3 million decrease in the
average balance of the loan portfolio. The increase in average interest-bearing
liabilities was primarily due to a $396.9 million increase in the average
balance of obligations outstanding under lines of credit. The net interest
spread decreased 83 basis points during 1998 as a result of a 68-basis-point
decline in the weighted average rate on interest-earning assets and a
15-basis-point increase in the weighted average rate on interest-bearing
liabilities. The net impact of these rate changes resulted in a $5.7 million
decrease in net interest income.
Interest income on loans available for sale increased $38.4 million or 209%
during 1998 as compared to 1997 primarily as a result of a $349.0 million or
203% increase in the average balance and a 21-basis-point increase in the
weighted average yield earned. The increase in the average balance was due to
significant growth in the Company's domestic purchases and originations, as well
as those of Ocwen UK, which accounted for the U.S. dollar equivalent of $147.1
million of the increase in the average balance. The Company anticipates a
significant curtailment of its domestic subprime lending operations in 1999.
Interest income on securities available for sale increased $10.9 million or 36%
during 1998 as compared to 1997 primarily as a result of a $290.8 million or 97%
increase in the average balance, offset by a 307 basis-point decline in the
weighted average yield earned. The increase in the average balance, as well as
the decline in the weighted average yield, are due in large part to the
Company's increased investment in collateralized mortgage obligations ("CMOs").
The average balance of CMOs held for sale during 1998 amounted to $405.0
million, or 69% of the average balance of securities available for sale, as
compared to $182.3 million, or 61% of the average balance of securities
available for sale, during 1997. Because CMOs have less cash flow variability,
their average lives and yields to maturity are more stable and, therefore, CMOs
are priced to yield less than a less stable class of mortgage-related securities
such as IOs. See "Changes in Financial Condition Securities Available for Sale."
Interest income on the loan portfolio decreased by $16.1 million or 29% in 1998
versus 1997 primarily due to a $144.3 million or 35% decrease in the average
balance of the loan portfolio which was offset in part by a 118-basis-point
increase in the weighted average yield earned. The significant yield earned
during 1998, as well as the decrease in the average balance, were primarily due
25
to $12.4 million of additional interest received in connection with the
repayment of nine commercial real estate (secured primarily by hotel properties)
and multi-family residential loans having an unpaid principal balance of $107.2
million.
Interest expense on obligations outstanding under lines of credit increased
$29.0 million or 520% during 1998 as compared to 1997 due to a $396.9 million or
471% increase in the average balance and a 57-basis-point increase in the
weighted average interest rate. The increase in the average balance is primarily
due to the Company's use of lines of credit at OFS and Ocwen UK to fund the
growth in subprime single family residential loans. Ocwen UK accounted for the
US dollar equivalent of $130.5 million of the increase in the average balance.
See "Changes in Financial Condition Obligations Outstanding Under Lines of
Credit."
Interest expense on securities sold under agreements to repurchase increased by
$5.5 million or 551% during 1998 primarily as a result of an $88.3 million or
528% increase in the average balance. From time to time, the Company utilizes
such collateralized borrowings as an additional source of liquidity depending on
the cost and availability of alternative sources of funding.
Interest expense on deposits decreased $5.5 million or 4% during 1998 primarily
due to a $111.6 million or 6% net decrease in the average balance of
interest-bearing deposits. Certificates of deposits accounted for $119.4 million
of the $111.6 million net decrease in the average balance of interest-bearing
deposits.
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. The increase was due to an increase in average interest-earning assets,
offset by an increase in average interest-bearing liabilities and a decline in
the net interest spread. Average interest-earning assets increased by $763.4
million or 48% during 1998 and yielded $92.4 million of interest income, while
average interest-bearing liabilities increased $580.1 million or 33% and
contributed $41.2 million of interest expense. The net impact of these volume
changes resulted in an increase of $51.2 million to net interest income. The
increase in average interest-earning assets was primarily due to a $607.7
million increase in the average balance of discount loans and an $82.5 million
increase in loan portfolio. The increase in average interest-bearing liabilities
was primarily due to a $483.2 million increase in the average balance of
certificates of deposit, an $84.3 million increase in the average balance of
obligations outstanding under lines of credit and an $80.0 million increase in
notes, debentures and other interest-bearing obligations. The net interest
spread decreased 65 basis points during 1998 as a result of a 57-basis-point
decline in the weighted average rate on interest-earning assets and an
8-basis-point increase in the weighted average rate on interest-bearing
liabilities. The net impact of these rate changes resulted in a $12.7 million
decrease in net interest income.
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 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 multi-family 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
as compared to 1996 primarily due to $12.3 million of additional interest
received in connection with the repayment of 10 loans secured by hotel and
office properties and, to a lesser extent, net 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.
26
Interest expense on deposits increased $28.3 million or 30% during 1997 as
compared to 1996, and reflected 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 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.
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.
The following table presents the provisions for loan losses by the discount loan
and loan portfolios for the years indicated.
1998 1997 1996
----------- ----------- -----------
(Dollars in thousands)
Provisions for loan losses:
Discount loan.................................... $ 17,618 $ 31,894 $ 20,578
Loan portfolio................................... 891 324 1,872
----------- ----------- -----------
$ 18,509 $ 32,218 $ 22,450
=========== =========== ===========
The $14.3 million decrease in the provision for losses on the discount loan
portfolio in 1998 as compared to 1997 was primarily due to a $407.7 million or
28% decrease in the balance of the discount loan portfolio. See "Changes in
Financial Condition Discount Loan Portfolio, Net." The $11.3 million increase in
the provision for losses on the discount loan portfolio in 1997 occurred
primarily as a result of a $373.2 million or 35% increase in the balance of the
discount loan portfolio and higher charge-offs. Net charge-offs on the discount
loan portfolio amounted to $20.1 million, $20.3 million and $9.2 million during
1998, 1997 and 1996, respectively. The Company establishes provisions for losses
on discount loans as 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. At December 31, 1998 and 1997, the Company had allowances for
losses on its discount loan portfolio of $21.4 million and $23.5 million,
respectively, which amounted to 2.0% and 1.6% of the respective balances.
Charge-offs on the loan portfolio amounted to $219,000, $153,000 and $296,000
during 1998, 1997 and 1996, respectively. At December 31, 1998 and 1997, the
Company maintained allowances for losses on its loan portfolio of $4.9 million
and $3.7 million, respectively, which amounted to 2.1% and 1.4% of the
respective balances.
Although management utilizes its best judgment in providing for possible loan
losses, there can be no assurance that the Company will not increase or decrease
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 decreased $12.6 million or 10% during
1998 and increased $86.6 million or 232% during 1997.
27
The following table sets forth the principal components of the Company's
non-interest income during the years indicated.
1998 1997 1996
------------ ------------ ------------
(Dollars in thousands)
Servicing fees and other charges................ $ 59,180 $ $25,962 $ $4,682
(Loss) gain on interest-earning assets, net..... (1,594) 82,212 21,682
Gain on real estate owned, net.................. 14,033 7,277 3,827
Other income.................................... 39,696 8,498 7,112
------------ ------------ ------------
Total........................................... $ 111,315 $ 123,949 $ 37,303
============ ============ ============
Servicing fees and other charges increased during 1998 and 1997 primarily as a
result of increases in loan servicing and related fees as a result of the
Company's increase in loans serviced for others. During 1998, 1997 and 1996, the
average unpaid principal balance of loans serviced for others amounted to $8.06
billion, $3.11 billion and $887.9 million, respectively. The increases in loans
serviced for others during 1998 and 1997 were primarily related to subprime
loans and resulted from servicing retained in connection with the
securitizations of loans, the acquisition of servicing rights and the
acquisition of Cityscape UK's servicing business by Ocwen UK in 1998.
The following table sets forth the Company's loans serviced for others at the
dates indicated.
DECEMBER 31, 1998:
Discount Loans Subprime Loans (1) 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....................... $1,015,988 16,840 $1,809,533 31,607 $ -- -- $ 2,825,521 48,447
Loans serviced for third parties. 1,573,285 20,835 5,327,441 83,085 866,219 1,091 7,766,945 105,011
---------- ------- ---------- -------- --------- ------ ----------- -------
$2,589,273 37,675 $7,136,974 114,692 $ 866,219 1,091 $10,592,466 153,458
========== ======= ========== ======== ========= ====== =========== =======
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
========== ========= ========= ========= ========= ======= ========== ========
(1) Includes 37,955 loans with an unpaid principal balance of $857.2
million ((pound)504.4 million) which were serviced by Ocwen UK at
December 31, 1998.
Net losses on interest-earning assets in 1998 were primarily comprised of $129.7
million of impairment charges on securities available for sale, including $86.1
million on the portfolio of AAA-rated agency IOs which were sold in the third
quarter, offset by $112.1 million of gains recognized in connection with the
securitization of single family subprime loans and discount loans, as presented
in the table below, $7.6 million of gains from the sales of small commercial
discount loans and $4.7 million of gains from the sales of large commercial
discount loans.
Net gains on 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 OAC,
$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.
28
Net gains on 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 large commercial discount 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 commercial discount
loans.
The following table sets forth the Company's net gains recognized in connection
with the securitization of loans during 1998, 1997 and 1996.
Loan Securitized
- - ------------------------------------------------------------------------ Book Value of
Types of Loans Principal No. of Loans Securities Retained(2) Net Gain
- - ---------------------------------- ---------------- ------------- ---------------------- -------------
1998: (Dollars in thousands)
Single family discount............ $ 498,798 7,638 $ 32,261 $ 48,085
Single family subprime (1)........ 1,626,282 31,235 139,594 61,516
-------------- ------------- ---------------- -------------
$ 2,125,080 38,873 $ 171,855 $ 109,601
============== ============= ================ =============
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
============== ============= ================ =============
(1) Includes 20,819 loans securitized by Ocwen UK with an unpaid principal
balance of $558.5 million ((pound)339.4 million) for a net gain of
$25.6 million ((pound)15.4 million).
(2) Consists of subordinated and/or residual securities resulting from the
Company's securitization activities, which had a fair value of $249.0
million at December 31, 1998, including $87.3 million ((pound)52.6
million) related to securitizations by Ocwen UK.
Gains on 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
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.
Year Ended December 31,
--------------------------------------------------
1998 1997 1996
--------------- -------------- --------------
(Dollars in thousands)
Gains on sales............................................ $ 43,839 $ 30,651 $ 22,835
Provision for losses in fair value........................ (18,626) (13,450) (18,360)
Carrying costs, net....................................... (11,180) (9,924) (648)
--------------- -------------- --------------
Income on real estate owned, net.......................... $ 14,033 $ 7,277 $ 3,827
============== ============== ==============
The increases in gains on sales during 1998 and 1997 reflect increases in the
number of properties sold from 1,175 during 1996, to 1,521 and 3,087 during 1997
and 1998, respectively. At December 31, 1998, 1997 and 1996, the Company owned
1,999, 1,505 and 825 properties, respectively, the majority of which were
related to the discount loan portfolio. For additional information relating to
the Company's real estate owned, see "Changes in Financial Condition Real Estate
Owned."
29
Other income of $39.7 million for 1998 included $10.4 million of gains on sales
of investments in real estate (see "Changes in Financial Condition Investment in
Real Estate"), $10.0 million of brokerage commissions earned in connection with
Ocwen UK loan originations, $7.4 million of gains recognized in connection with
the sale of investments in low-income housing tax credit projects (see "Changes
in Financial Condition Investments in Low Income Housing Tax Credit Interests"),
and $5.9 million of management fees earned from OAC. Other income of $8.5
million for 1997 was primarily comprised of $6.1 million of gains recognized in
connection with the sale of investments in low-income housing tax credit
projects and $1.8 million of management fees earned from OAC. Other income of
$7.1 million for 1996 was primarily comprised of $4.9 million of gains
recognized in connection with the sale of investments in low-income housing tax
credit projects.
NON-INTEREST EXPENSE. Non-interest expense increased $99.5 million or 78% during
1998 and $57.2 million or 82% during 1997. The increase in non-interest expense
during 1998 and 1997 is largely due to recent acquisitions, new business lines
and growth in existing business lines. Non-interest expense for 1998 included
$41.3 million and $11.3 million related to Ocwen UK and OTX, respectively.
The following table sets forth the principal components of the Company's
non-interest expense during the years indicated.
1998 1997 1996
----------- ----------- -----------
(Dollars in thousands)
Compensation and employee benefits.............................. $ 115,556 $ 77,573 $ 39,043
Occupancy and equipment......................................... 34,878 17,657 8,921
Net operating loss (income) on investment in real estate and
certain low-income housing tax credit interests.............. 6,753 4,792 (425)
Amortization of excess of purchase price over
net assets acquired
(Goodwill)................................................... 11,614 557 --
Loan expenses................................................... 25,193 7,014 4,111
Other operating expenses........................................ 32,400 19,281 17,956
----------- ----------- -----------
Total........................................................ $ 226,394 $ 126,874 $ 69,606
=========== =========== ===========
The increases in compensation and employee benefits in 1998 and 1997 reflect an
increase in the average number of employees from 398 during 1996 to 872 during
1997 to 1,512 during 1998. Compensation and employee benefit expense for 1998
includes $12.4 million and $7.4 million related to Ocwen UK and OTX,
respectively.
Occupancy and equipment expense increased $17.2 million in 1998, of which $5.6
million related to Ocwen UK, primarily as a result of a $5.8 million increase in
data processing costs, a $4.7 million increase in general office expenses and a
$3.5 million increase in rent expense. 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 expenses, a $3.1 million increase in data processing costs and
a $1.3 million increase in rent expense.
The increase in net operating losses on investments in real estate and certain
low-income housing tax credits during 1998 and 1997 is primarily the result of
net operating losses and deprecation expense on low-income housing tax credit
projects placed in service, primarily during 1997. The associated tax credits on
such projects are reported as a reduction of income tax expense. See "Income Tax
Benefit (Expense)."
Of the $11.1 million increase in the amortization of goodwill during 1998, $10.3
million related to OFS, including the $10.1 million write-off of the remaining
unamortized balance which was deemed impaired by the Company.
Loan expenses of $15.2 million incurred by Ocwen UK account for the majority of
the total increase in loan expenses in 1998 of $18.2 million.
Primarily due to a $9.7 million increase in professional fees and a $4.5 million
increase in marketing costs, other operating expenses increased $13.1 million in
1998, of which $8.1 million and $3.0 million related to Ocwen UK and OTX,
respectively. Exclusive of the non-recurring expense of $7.1 million in 1996
related to the Federal Deposit Insurance Corporation's ("FDIC") assessment to
recapitalize the Savings Association Insurance Fund ("SAIF"), other operating
expenses increased by $8.5 million in 1997, primarily as a result of a $2.7
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. See Note 26 to the Consolidated Financial
Statements for a disclosure of the components of other operating expenses.
30
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. The Company recorded $13.6 million and
$5.2 million of distributions to holders of the Capital Securities during 1998
and 1997, respectively. See Note 19 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 (LOSSES) EARNINGS OF INVESTMENTS IN UNCONSOLIDATED ENTITIES. Equity in
earnings of investment in unconsolidated entities for 1997 and 1996 included the
Company's 50% joint venture investment in the LLC. All of the assets of the LLC
were distributed at the end of 1997, and therefore the Company recorded no
income from this investment in 1998. The Company's $23.7 million of earnings
from the LLC during 1997 consisted primarily of $4.5 million of interest income
on discount loans, $14.0 million of gains on the sale of discount loans,
including the securitizations of HUD loans in March and December of 1997, and
the recapture of $5.1 million of valuation allowances established in 1996 by the
Company on its equity investment in the LLC. The Company's equity in earnings of
LLC amounted to $38.3 million in 1996 and consisted primarily of $10.1 million
of net interest income on discount loans, $35.6 million of gains on sales of
discount loans, offset by a $7.6 million provision for losses on the equity
investment in the LLC. The Company has recognized 50% of the loan servicing fees
not eliminated in consolidation in servicing fees and other charges. See
"Changes in Financial Condition Investment in Unconsolidated Entities."
During 1998, the Company recorded equity in the losses of its investments in OAC
and OPLP of $4.0 million and $4.7 million, respectively. The Company owned,
through IMI, 1,540,000 or 8.12% of the outstanding common stock of OAC at
December 31, 1998. The Company also owned, through IMI, 1,808,733 or 8.71% of
the total partnership units of OPLP outstanding at December 31, 1998. The
Company began accounting for its investments in OAC and OPLP on the equity
method effective May 5, 1998, upon the acquisition of 1,473,733 OPLP units,
which increased its combined ownership in OAC and OPLP to 16.83%. Equity in the
losses of OAC and OPLP reflect the period from May 5, 1998, through December 31,
1998, and relate primarily to losses incurred by those entities in connection
with impairment charges recorded on subordinate and residual mortgage-backed
securities. See "Changes in Financial Condition Investment in Unconsolidated
Entities."
During 1998, the Company recorded equity in earnings of Kensington of $439,000,
net of $2.0 million of goodwill amortization. At December 31, 1998, the Company
owned 36.07% of the total outstanding common stock of Kensington, a leading
originator of non-conforming residential mortgages in the U.K. See "Changes in
Financial Condition Investment in Unconsolidated Entities."
Income Tax Benefit (Expense). Income tax benefit (expense) on the Company's net
(loss) income amounted to $30.7 million, $(21.3) million and $(11.2) million
during 1998, 1997 and 1996, respectively. The Company's effective tax rate was
(94.8)%, 21.4% and 18.2% during 1998, 1997 and 1996, respectively. The Company's
effective tax rates in 1998, 1997 and 1996 reflect tax credits resulting from
the Company's investment in low-income housing tax credit interests of $17.7
million, $14.9 million and $9.3 million during 1998, 1997 and 1996,
respectively. Exclusive of the above amounts, the Company's effective tax rate
amounted to 31.0%, 36.4% and 33.4% during 1998, 1997 and 1996, respectively. See
"Changes in Financial Condition Investments in Low Income Housing Tax Credit
Interests."
31
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)
---------------------------- ------------------------
1998 1997 Dollars Percent
----------- ----------- ----------- -------
(Dollars in thousands)
ASSETS:
Total assets.............................................. $ 3,308,079 $ 3,069,165 $ 238,914 8%
Securities available for sale............................. 593,347 476,796 116,551 24
Loans available for sale.................................. 177,847 177,041 806 --
Loan portfolio, net....................................... 230,312 266,299 (35,987) (14)
Discount loan portfolio, net.............................. 1,026,511 1,434,176 (407,665) (28)
Investment in low-income housing tax credit interests..... 144,164 128,614 15,550 12
Investment in unconsolidated entities..................... 86,893 3,526 83,367 2,364
Real estate owned, net.................................... 201,551 167,265 34,286 20
Investment in real estate................................. 36,860 76,340 (39,480) (52)
Deferred tax asset........................................ 66,975 45,148 21,827 48
LIABILITIES:
Total liabilities......................................... 2,746,111 2,523,430 222,681 9
Deposits.................................................. 2,175,016 1,982,822 192,194 10
Securities sold under agreements to repurchase............ 72,051 108,250 (36,199) (33)
Notes, debentures and other interest-bearing obligations.. 225,000 226,975 (1,975) (1)
Obligations outstanding under lines of credit............. 179,285 118,304 60,981 52
Capital Securities........................................ 125,000 125,000 -- --
Stockholders' equity...................................... 436,376 419,692 16,684 4
SECURITIES AVAILABLE FOR SALE. At December 31, 1998, securities available for
sale amounted to $593.3 million or 18% of total assets, as compared to $476.8
million or 16% at December 31, 1997. Securities available for sale are carried
at fair value with unrealized gains or losses reported as a separate component
of stockholders' equity net of deferred taxes. Unrealized losses on securities
that reflect a decline in value which is other than temporary are charged to
earnings. At December 31, 1998, securities available for sale included an
aggregate of $21.7 million of unrealized gains ($22.0 million of gross gains and
$335,000 of gross losses), as compared to $11.8 million of unrealized losses
($32.5 million of gross losses and $20.7 million of gross gains) at December 31,
1997.
32
The following table sets forth the carrying value (which represents fair value)
of the Company's securities available for sale at the dates indicated.
December 31, Increase (Decrease)
------------------------------ --------------------------
MORTGAGE-RELATED SECURITIES: 1998 1997 Dollars Percent
------------ ------------ ------------ -------
Single family residential:
CMOs (AAA-rated)........................ $ 344,199 $ 160,451 $ 183,748 115%
Interest-only:
FHLMC................................ -- 64,745 (64,745) (100)
FNMA................................. -- 59,715 (59,715) (100)
GNMA................................. -- 29,766 (29,766) (100)
AAA-rated............................ -- 13,863 (13,863) (100)
BB-rated subordinates..................... 8,517 2,515 6,002 239
B-rated subordinates...................... 6,344 -- 6,344 100
Unrated subordinates...................... 40,595 39,219 1,376 4
AAA-rated subprime residuals.............. 6,931 -- 6,931 100
BBB-rated subprime residuals.............. 17,593 -- 17,593 100
Unrated subprime residuals................ 152,951 41,790 111,161 266
Swap contracts............................ -- (94) 94 100
------------ ------------ ------------
577,130 411,970 165,160 40
------------ ------------ ------------
MULTI-FAMILY RESIDENTIAL AND COMMERCIAL:
Interest-only:
AAA-rated............................ 71 3,059 (2,988) (98)
BB-rated............................. 2 189 (187) (99)
Subordinates:
B-rated.............................. 8,813 8,511 302 4
Unrated.............................. 7,331 6,795 536 8
------------ ------------ ------------
16,217 18,554 (2,337) (13)
------------ ------------ ------------
MARKETABLE EQUITY SECURITIES:
Common stocks........................... -- 46,272 (46,272) (100)
------------ ------------ ------------
Total................................... $ 593,347 $ 476,796 $ 116,551 24
============ ============ ============
The Company's securities available for sale increased by $116.6 million or 24%
during 1998 due primarily to $735.6 million of purchases, $171.9 million of
subordinates and residual securities acquired in connection with the Company's
securitizations of loans which was offset by $270.0 million of sales, $360.0
million of maturities and principal repayments, $56.5 million of net premium
amortization and $129.7 million of impairment charges, including $86.1 million
on AAA-rated agency IOs and $43.6 million on certain subordinate and residual
securities.
On July 27, 1998, the Company sold its entire portfolio of AAA-rated agency IOs
for $137.5 million, which represented book value. As a result of an increase in
prepayment speeds due to declining interest rates, the Company recorded
impairment charges of $86.1 million in 1998 prior to the sale ($77.6 million in
the second quarter) resulting from the Company's decision to discontinue this
investment activity and write down the book value of the IOs. The AAA-rated
agency IOs consisted of IOs, which are classes of mortgage-related securities
that are entitled to payments of interest but no (or only nominal) principal,
and inverse IOs, which bear interest at a floating rate that varies inversely
with (and often at a multiple of) changes in a specified index.
Common stocks at December 31, 1997, were comprised primarily of the Company's
investment in OAC. At December 31, 1997, the Company, through IMI, owned
1,715,000 shares or 9.04% of the outstanding common stock of OAC, having a
market value of $35.2 million ($25.5 million book value). On May 5, 1998, IMI
purchased an additional 1,473,733 units of OAC's operating partnership
subsidiary, OPLP, increasing its combined ownership of OAC and OPLP to 16.83%.
As a result of this increase in ownership, the Company began accounting for its
investments in OAC and OPLP under the equity method. See "Investment in
Unconsolidated Entities." The Company's other common stock investment, which had
a market value of $11.1 million ($13.0 million book value) at December 31, 1997,
was sold during 1998 for a loss of $293,000.
At December 31, 1998, the fair value of the Company's investment in subordinate
and residual interests amounted to $249.1 million ($227.9 million amortized
cost) or 42% of total securities available for sale and supported senior classes
of securities having an outstanding principal balance of $3.84 billion. During
1998, the Company recorded $43.6 million of impairment charges on its portfolio
of subordinate and residual securities as a result of declines in value that
were deemed to be "other than temporary."
33
Because of their subordinate position, subordinated and residual classes of
mortgage-related securities provide protection to and involve more risk than the
senior class. Specifically, when cash flow is impaired, debt service goes first
to the holders of senior classes. In addition, incoming cash flows may be held
in a reserve fund to meet any future 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. Further, residual interests exhibit
considerably more price volatility than mortgages or ordinary mortgage
pass-through securities, due in part to the uncertain cash flows that result
from changes in the prepayment rates of the underlying mortgages. Lastly,
subordinate and residual interests involve substantially more credit risk than
the senior classes of the mortgage-related securities to which such interests
relate and generally are not as liquid as the senior classes. The weighted
average prospective yield to maturity on subordinate securities and subprime
residual securities was 0.04% and 13.66%, respectively, at December 31, 1998.
The Company generally retains subordinate and residual securities, which are
certificated, related to its securitization of loans. Subordinate and residual
interests in mortgage-related securities provide credit support to the more
senior classes of the mortgage-related securities. Principal from the underlying
mortgage loans generally is allocated first to the senior classes, with the most
senior class having a priority right to the cash flow from the mortgage loans
until its payment requirements are satisfied. To the extent that there are
defaults and unrecoverable losses on the underlying mortgage loans, resulting in
reduced cash flows, the most subordinate security will be the first to bear this
loss. Because subordinate and residual interests generally have no credit
support, to the extent there are realized losses on the mortgage loans
comprising the mortgage collateral for such securities, the Company may not
recover the full amount or, indeed, any of its initial investment in such
subordinate and residual interests. The Company generally retains the most
subordinate classes of the securities from the securitization and therefore will
be the first to bear any credit losses.
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 include the anticipated prepayment speeds and the anticipated credit
losses related to the underlying mortgages. In order to determine the present
value of this estimated excess cash flow, the Company currently applies a
discount rate of 18% to the projected cash flows on the unrated classes of
securities. 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 and residual
securities retained. During 1998, the Company utilized proprietary prepayment
curves generated by the Company (reaching an approximate range of annualized
rates of 30% - 40%). In its estimates of annual loss rates, the Company utilizes
assumptions that it believes are reasonable. The Company estimates annual losses
of between 0.22% and 2.06% of the underlying loans.
Subordinate and residual interests are affected by the rate and timing of
payments of principal (including prepayments, repurchase, defaults and
liquidations) on the mortgage loans underlying a series of mortgage-related
securities. The rate of principal payments may vary significantly over time
depending on a variety of factors, such as the level of prevailing mortgage loan
interest rates and economic, demographic, tax, legal and other factors.
Prepayments on the mortgage loans underlying a series of mortgage-related
securities are generally allocated to the more senior classes of
mortgage-related securities. Although in the absence of defaults or interest
shortfalls all subordinates receive interest, amounts otherwise allocable to
residuals generally are used to make payments on more senior classes or to fund
a reserve account for the protection of senior classes until
overcollateralization or the balance in the reserve account reaches a specified
level. In periods of declining interest rates, rates of prepayments on mortgage
loans generally increase, and if the rate of prepayments is faster than
anticipated, then the yield on subordinates will be positively affected and the
yield on residuals will be negatively affected.
The credit risk of mortgage related securities is affected by the nature of the
underlying mortgage loans. In this regard, the risk of loss on securities backed
by commercial and multi-family loans and single family residential loans made 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 under
guidelines established by the Federal Home Loan Mortgage Corporation ("FHLMC")
and the Federal National Mortgage Association ("FNMA") for purchases of loans by
such agencies, generally involve more risk than securities backed by single
family residential loans which conform to the requirements established by FHLMC
and FNMA for their purchase by such agencies.
The Company adjusts its securities portfolio to market value at the end of each
month based upon the lower of dealer quotations or internal values, subject to
an internal review process. For those securities which do not have an available
market quotation, the Company will request market values and underlying
assumptions from the various securities dealers that underwrote, are currently
financing the securities, or have had prior experience with the type of security
to be valued. When quotations are obtained from two or more dealers, the average
dealer quote will be utilized.
34
The Company periodically assesses the carrying value of its subordinate
securities and 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 and
residual securities retained and servicing asset 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 and 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 recognized the disparity. Other factors may also result in a
write-down of the Company's subordinate securities and residual securities
retained in subsequent periods. Accelerated prepayment speeds were a significant
contributing factor to the $43.6 million of impairment charges recorded by the
Company in 1998 on its subordinate and residual securities. See Note 1 to the
Consolidated Financial Statements.
It is intended that any securities retained by the Bank resulting from the
securitization of assets held by it directly will be distributed to the Company
as a dividend, subject to the Bank's ability to declare such dividends under
applicable limitations. Four securities with an aggregate value of $60.8 million
were distributed to the Company from the Bank in the form of dividends during
1998. At December 31, 1998, the Bank held two subordinate securities with a fair
value and amortized cost of $13.9 million.
LOANS AVAILABLE FOR SALE. Loans available for sale, which are comprised
primarily of subprime single family residential loans, increased by $806,000
during 1998. The increase in 1998 occurred primarily as a result of purchases
and originations of $1.75 billion of single family residential subprime loans,
offset in part by sales of $1.66 billion and principal repayments of $82.7
million of such loans. Purchases and originations during 1998 include $292.8
million purchased from the U.S. operations of Cityscape Financial Corp. and
$675.6 million purchased and originated by Ocwen UK. Of the single family loans
sold during 1998, $1.63 billion or 98% were due to the Company's securitization
of such loans, including $558.5 million related to securitizations by Ocwen UK.
Of the $177.8 million loans available for sale at December 31, 1998, $85.0
million related to Ocwen UK.
At December 31, 1998, nonperforming loans available for sale amounted to $39.4
million or 22.2% of total loans available for sale, as compared to $13.5 million
or 7.6% at December 31, 1997. Nonperforming loans available for sale consist
primarily of subprime single family residential loans, reflecting the higher
risks associated with such loans. During 1998, 1997 and 1996, respectively, the
Company recorded $5.4 million, $1.4 million and $2.5 million of reductions in
the carrying value of these loans to record them at the lower of cost or fair
market value. The reductions in carrying value recorded during 1998 reflect the
significant increase in volume, including the acquisition of Ocwen UK. Ocwen UK
accounted for $1.9 million of such reductions in carrying value. See Note 6 to
the Consolidated Financial Statements.
LOAN PORTFOLIO, NET. The Company's net loan portfolio decreased by $36.0 million
or 14% during 1998 primarily as a result of $227.7 million of principal
repayments, offset by $188.7 million of originations. The Company earned $12.4
million of additional fees during 1998 in connection with the payoff of $107.2
million of commercial real estate loans, secured primarily by hotel properties,
and multi-family residential loans.
Nonperforming loans amounted to $9.0 million or 3.8% of total loans at December
31, 1998, as compared to $9.2 million or 3.4% of total loans at December 31,
1997. At December 31, 1998 and 1997, nonperforming loans consisted primarily of
multi-family residential loans. The Company's allowance for loan losses amounted
to 54.5% and 40.4% of nonperforming loans at December 31, 1998 and 1997,
respectively. See Note 7 to the Consolidated Financial Statements.
DISCOUNT LOAN PORTFOLIO, NET. The discount loan portfolio decreased $407.7
million or 28% during 1998. During 1998, sales of loans with an unpaid principal
balance of $696.1 million, resolutions and repayments of $539.4 million and
transfers to real estate owned of $382.9 million more than offset acquisitions
having an unpaid principal balance of $1.12 billion. Of the discount loans sold
during 1998, $498.8 million resulted from the Company's securitization of
performing single family discount loans. See Note 8 to the Consolidated
Financial Statements.
At December 31, 1998, discount loans which were performing in accordance with
original or modified terms amounted to $781.8 million or 60% of the gross
discount loan portfolio, as compared to $1.01 billion or 56% at December 31,
1997. The Company's allowance for losses on its discount loan portfolio amounted
to $21.4 million, or 2.0% of the loan balance, at December 31, 1998, as compared
to $23.5 million, or 1.6% of the loan balance, at December 31, 1997.
35
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, 1998, the
Company had $144.2 million of investments in low-income housing tax credit
interests, as compared to $128.6 million at December 31, 1997. During 1998, the
Company sold its investment in five low-income housing tax credit projects which
had a carrying value of $28.9 million for gains of $7.4 million.
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 $56.3 million and $47.2 million at December 31, 1998 and 1997,
respectively, 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 $19.6
million and $31.4 million at December 31, 1998 and 1997, respectively, 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
$68.3 million and $50.0 million at December 31, 1998 and 1997, respectively, and
are presented on a consolidated basis. See Note 13 to the Consolidated Financial
Statements.
INVESTMENT IN UNCONSOLIDATED ENTITIES. At December 31, 1997, the Company,
through IMI, owned 1,715,000 shares or 9.04% of the outstanding common stock of
OAC. Also at December 31, 1997, the Company, through IMI, owned 160,000 units or
0.84% of the partnership units of OPLP, the operating partnership subsidiary of
OAC. On February 17, 1998, IMI exchanged 175,000 shares of OAC stock for 175,000
OPLP units. On May 5, 1998, IMI acquired an additional 1,473,733 OPLP units. As
a result of this activity, IMI's investment in OAC stock declined to 1,540,000
shares or 8.12% at December 31, 1998, while its investment in OPLP increased to
1,808,733 units or 8.71%. The Company began accounting for these entities on the
equity method effective May 5, 1998, upon the increase in its combined ownership
of OAC and OPLP to 16.83%. An adjustment to reduce retained earnings in the
amount of $979,000 (net of income taxes of $526,000) was recorded to reflect the
cumulative effect of the conversion to the equity method of accounting. The
Company's investment in OAC stock amounted to $16.3 million at December 31,
1998. The Company's investment in OAC stock at December 31, 1997, was designated
as available for sale and carried at a fair value of $35.2 million ($25.5
million cost). The Company's investment in OPLP units amounted to $22.8 million
at December 31, 1998, as compared to $2.4 million at December 31, 1997. During
1998, the Company recorded equity in the losses of its investment in OAC and
OPLP of $4.0 million and $4.7 million, respectively. See Note 9 to the
Consolidated Financial Statements.
On February 25, 1998, the Company purchased 36.07% of the total outstanding
common stock of Kensington for $45.9 million ((pound)27.8 million). The
Company's investment in Kensington amounted to $46.6 million at December 31,
1998, net of the excess of the purchase price over the net investment. The
excess of the purchase price over the net investment amounted to $34.5 million
((pound)20.9 million) at December 31, 1998, net of accumulated amortization of
$2.0 million ((pound)1.2 million), and is amortized over a period of 15 years.
During 1998, the Company recorded equity in earnings of Kensington of $439,000,
net of the $2.0 million of amortization of excess cost over purchase price. See
Note 9 to the Consolidated Financial Statements.
From time to time, the Company and a co-investor have acquired 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. On
December 12, 1997, the LLC, a limited liability company formed in March 1996
between the Company and BlackRock 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 recorded equity in
earnings of the LLC of $23.7 million and $38.3 million for 1997 and 1996,
respectively. See Note 9 to the Consolidated Financial Statements.
REAL ESTATE OWNED, NET. Real estate owned, net, increased by $34.3 million or
21% during 1998 due primarily to $292.3 million of foreclosures and acquisitions
in connection with the acquisition of discount loans, offset by $263.2 million
of sales. Real estate owned 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 $197.4 million or 98% of total real
estate owned at December 31, 1998, and consisted of $94.6 million, $20.1 million
and $82.6 million of properties attributable to single family residential loans,
multi-family residential loans and commercial real estate loans, respectively.
The Company actively manages its real estate owned. During 1998, the Company
sold 3,087 properties with a carrying value of $263.2 million, as compared to
the sale of 1,521 properties with a carrying value of $179.7 million during 1997
and 1,175 properties with a carrying value of $160.6 million during 1996. These
sales resulted in gains, net of the provision for loss, of $25.2 million, $17.2
million and $4.5 million during 1998, 1997 and 1996, respectively, which are
included in determining the Company's income (loss) on real estate owned. The
average holding period for real estate owned which was sold during 1998, 1997
and 1996, was six months, nine months and 11 months, respectively. See Note 10
to the Consolidated Financial Statements.
36
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 contributed substantial equity to the project. As such, the
Company accounted for these loans under the equity method of accounting as
though it had made an investment in a real estate limited partnership. The
Company's investment in such loans, which amounted to $64.3 million at December
31, 1997, has been reduced to $0 at December 31, 1998, as a result of loan
payoffs during 1998.
The Company's investments in real estate also included $32.9 million and $6.4
million at December 31, 1998 and 1997, respectively, of property (land and
buildings) held for lease.
The Company also has invested, indirectly through a 31% partnership interest, in
The Westin Hotel located in Columbus, Ohio. The Company's investment in such
property amounted to $1.3 million at December 31, 1998, as compared to $1.4
million at December 31, 1997. See Note 11 to the Consolidated Financial
Statements.
DEFERRED TAX ASSET. At December 31, 1998, the deferred tax asset, net of
deferred tax liabilities, amounted to $67.0 million, an increase of $21.9
million from the $45.1 million deferred tax asset at December 31, 1997. At
December 31, 1998, the gross deferred tax asset amounted to $80.0 million and
consisted primarily of $5.3 million related to tax residuals, $6.2 million of
gains on loan foreclosures, $3.8 million mark-to-market and reserves on real
estate owned properties, $7.9 million of loan loss reserves, $16.3 million of
reserves on securities available for sale, $3.5 million of goodwill reserves,
$3.9 million of accrued profit sharing expense, $12.6 million of deferred
interest expense on the discount loan portfolio, $7.1 million partnership losses
and low-income housing tax credits, $2.7 million contingent interest income on
equity participations and $5.0 million reserves on investments. The gross
deferred tax liability amounted to $6.6 million and consisted primarily of $4.7
million of deferred interest income on the discount loan portfolio. Additional
deferred tax liabilities consisted of $7.9 million mark-to-market on securities
available for sale. At December 31, 1997, the gross deferred tax asset amounted
to $42.9 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. Additional deferred tax assets consisted of $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.
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, 1998. 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, 1998, 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 22 to the Consolidated Financial Statements.
DEPOSITS. Deposits increased $192.2 million or 10% during 1998 primarily as a
result of a $116.6 million increase in escrow deposits, primarily related to
loans serviced for others, and an $83.8 million increase in certificates of
deposit. Brokered deposits obtained through national investment banking firms
which solicit deposits from their customers, amounted to $1.49 billion at
December 31, 1998, as compared to $1.35 billion at December 31, 1997. 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 $377.4 million at December 31, 1998, as
compared to $430.1 million at December 31, 1997. See Note 15 to the Consolidated
Financial Statements.
NOTES, DEBENTURES AND OTHER INTEREST-BEARING OBLIGATIONS. Notes, debentures and
other interest-bearing obligations of $225.0 million at December 31, 1998,
decreased $2.0 million during 1998 and consists 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 18 to the Consolidated Financial
Statements.
37
OBLIGATIONS OUTSTANDING UNDER LINES OF CREDIT. Obligations outstanding under
lines of credit increased $61.0 million during 1998 to $179.3 million at
December 31, 1998, and included $59.5 million of borrowings at OFS and $117.3
million of borrowings under new lines of credit established at Ocwen UK during
1998. These lines of credit fund the acquisition and origination of subprime
single family residential loans at OFS and Ocwen UK and generally have a
one-year term with interest rates that float in accordance with a designated
prime rate. During that one-year period, the Company would anticipate
securitizing the underlying loans (or refinancing any remaining loans) and then
repaying the corresponding lines of credit. See Note 17 to the Consolidated
Financial Statements.
COMPANY OBLIGATED, MANDATORILY REDEEMABLE SECURITIES OF SUBSIDIARY TRUST
HOLDINGS 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.
For the years ended December 31, 1998 and 1997, the Company recorded $13.6
million and $5.2 million, respectively, of distributions to holders of the
Capital Securities, of which $5.7 million was accrued and unpaid at December 31,
1998. See Note 19 to the Consolidated Financial Statements.
STOCKHOLDERS' EQUITY. Stockholders' equity increased $16.7 million or 4% during
1998. The increase in stockholder's equity during 1998 was primarily due to a
$19.1 million increase in unrealized gains on securities available for sale,
offset by a $1.7 million foreign currency translation loss related to the
Company's investments in Ocwen UK and Kensington, and a $1.2 million net loss
for the year.
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 and foreign currency
exchange rate movements. In general, management's strategy is to match asset and
liability balances within maturity categories and to manage foreign currency
rate exposure related to its investments in non-U.S. dollar functional currency
operations in order to limit the Company's exposure to earnings variations and
variations in the value of assets and liabilities as interest rates and foreign
currency exchange rates change over time. The Company's asset and liability
management strategy is formulated and monitored by the Asset/Liability
Committee, which is composed of directors and officers of the Company, in
accordance with policies approved by the Board of Directors of the Company. The
Asset/Liability Committee meets to review, among other things, the sensitivity
of the Company's assets and liabilities to interest rate changes and foreign
currency exchange 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 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 and foreign currency exchange rate risk. These techniques
include interest rate exchange or "swap" agreements, Eurodollar and U.S.
Treasury interest rate futures contracts, foreign currency futures contracts and
foreign currency swap agreements.
INTEREST RATE RISK MANAGEMENT. Under interest rate swap agreements, 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, 1998, the Company
had no interest rate exchange agreements outstanding. 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 decreasing the Company's net interest income by $115,000, $198,000 and
$58,000 during 1998, 1997 and 1996, respectively. See Note 21 to the
Consolidated Financial Statements.
38
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, 1998, the
Company had no U.S. Treasury futures contracts outstanding. At December 31,
1997, the Company had entered into U.S. Treasury futures (short) contracts with
an aggregate notional amount of $194.5 million. The Company had no outstanding
Eurodollar futures contracts at December 31, 1998 or 1997. Futures contracts had
the effect of (decreasing) increasing the Company's net interest income by
$(49,000), $2.0 million, and $(729,000) during 1998, 1997 and 1996,
respectively. In addition, futures contracts had the effect of decreasing the
Company's non-interest income by $5.8 million, $4.8 million and $4.1 million
during 1998, 1997 and 1996, respectively. See Note 21 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, 1998. 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) 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 (v) escrow deposits and other non-interest bearing checking accounts, which
amounted to $233.4 million at December 31, 1998, 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 were
used or actual experience differs from the historical experience on which the
assumptions are based.
39
December 31, 1998
-----------------------------------------------------------------------
More Than
Within Three Four to One Year to Three Years
Months Twelve Months Three Years and Over Total
------------ ------------- ----------- ----------- ----------
(Dollars in thousands)
RATE-SENSITIVE ASSETS:
Interest-earning deposits.................... $ 49,374 $ -- $ -- $ -- $ 49,374
Federal funds sold........................... 275,000 -- -- -- 275,000
Securities available for sale................ 134,291 198,047 118,180 142,829 593,347
Loans available for sale (1)................. 4,049 81,436 19,453 72,909 177,847
Investment securities, net................... -- -- -- 10,825 10,825
Loan portfolio, net (1)...................... 46,279 60,063 87,544 36,426 230,312
Discount loan portfolio, net................. 119,727 328,160 320,932 257,692 1,026,511
---------- ---------- ---------- ---------- ----------
Total rate-sensitive assets................. 628,720 667,706 546,109 520,681 2,363,216
---------- ---------- ---------- ---------- ----------
RATE-SENSITIVE LIABILITIES:
NOW and money market checking deposits....... 10,124 3,507 6,958 12,683 33,272
Savings deposits............................. 75 202 399 650 1,326
Certificates of deposit...................... 329,189 647,743 659,524 270,535 1,906,991
---------- ---------- ---------- ---------- ---------
Total interest-bearing deposits.............. 339,388 651,452 666,881 283,868 1,941,589
Securities sold under agreements to repurchase 72,051 -- -- -- 72,051
Obligations outstanding under lines of credit 179,285 -- -- -- 179,285
Notes and debentures......................... -- -- -- 225,000 225,000
---------- ---------- ---------- ---------- ----------
Total rate-sensitive liabilities............ 590,724 651,452 666,881 508,868 2,417,925
---------- ---------- ---------- ---------- ---------
Interest rate sensitivity gap before
off-balance sheet financial instruments...... 37,996 16,254 (120,772) 11,813 (54,709)
Futures contracts.............................. -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Interest rate sensitivity gap.................. $ 37,996 $ 16,254 $ (120,772) $ 11,813 $ (54,709)
========== ========== ========== ========== ==========
Cumulative interest rate sensitivity gap....... $ 37,996 $ 54,250 $ (66,522) $ (54,709)
========== ========== ========== ==========
Cumulative interest rate sensitivity gap as a
percentage of total rate-sensitive assets.... 1.61% 2.30% (2.81)% (2.32)%
(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. The
OTS has established specific minimum guidelines for thrift institutions to
observe in the area of interest rate risk as described in Thrift Bulletin No.
13a, "Management of Interest Rate Risk, Investment Securities, and Derivative
Activities" ("TB 13a"). Under TB 13a, institutions are required to establish and
demonstrate quarterly compliance with board-approved limits on interest rate
risk that are defined in terms of net portfolio value ("NPV"), which is defined
as the net present value of an institution's existing assets, liabilities and
off-balance sheet instruments. These limits specify the minimum net portfolio
value ratio ("NPV Ratio") allowable under current interest rates and
hypothetical interest rate scenarios. An institution's NPV Ratio for a given
interest rate scenario is calculated by dividing the NPV that would result in
that scenario by the present value of the institution's assets in that same
scenario. The hypothetical scenarios are represented by immediate, permanent,
parallel movements in the term structure of interest rates of plus and minus
100, 200 and 300 basis points from the actual term structure observed at quarter
end. The current NPV Ratio for each of the seven rate scenarios and the
corresponding limits approved by the Board of Directors of the Bank, is as
follows at December 31, 1998:
40
Rate Shock Board Limits Current
(in basis points) (minimum NPV Ratios) NPV Ratios
----------------- -------------------- ----------
+300 5.00% 14.90%
+200 6.00% 15.73%
+100 7.00% 16.43%
0 8.00% 16.95%
-100 7.00% 17.49%
-200 6.00% 18.00%
-300 5.00% 18.45%
The Asset/Liability Committee also regularly reviews interest rate risk by
forecasting the impact of alternative interest rate environments on net interest
income and NPV and evaluating such impacts against the maximum potential changes
in net interest income and NPV that is authorized by the Board of Directors of
the Bank. The following table quantifies the potential changes in net interest
income and net portfolio value should interest rates go up or down (shocked) 300
basis points, assuming the yield curves of the rate shocks will be parallel to
each other. The cash flows associated with the loan portfolios and securities
available for sale are calculated based on prepayment and default rates that
vary by asset. Projected losses, as well as prepayments, are generated based
upon the actual experience with the subject pool, as well as similar, more
seasoned pools. To the extent available, loan characteristics such as
loan-to-value ratio, interest rate, credit history, prepayment penalty terms and
product types are used to produce the projected loss and prepayment assumptions
that are included in the cash flow projections of the securities. When interest
rates are shocked, these projected loss and prepayment assumptions are further
adjusted. For example, under current market conditions, a 100-basis-point
decline in the market interest rate is estimated to result in a 200-basis-point
increase in the prepayment rate of a typical subprime residential loan. Most
commercial and multi-family loans are not subject to prepayments as a result of
prepayment penalties and contractual terms which prohibit prepayments during
specified periods. However, for those commercial and multi-family loans where
prepayments are not currently precluded by contract, declines in interest rates
are associated with steep increases in prepayment speeds in computing cash
flows. A risk premium is then calculated for each asset, which, when added to
the interest rate being modeled, results in a matrix of discount rates that are
applied to the cash flows computed by the model. The base interest rate scenario
assumes interest rates at December 31, 1998. Actual results could differ
significantly from those estimated in the table.
Estimated Changes in
Change in Interest Rates -----------------------------
(Rate Shock in basis points) Net Interest NPV
---------------------------- ------------ --------
+300 12.2% (17.3)%
+200 8.1 % (10.7)%
+100 4.1 % (4.9)%
0 -- --
-100 (4.1)% 5.1%
-200 (8.1)% 10.2%
-300 (12.2)% 15.0%
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 NPV 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, 1998. Market-rate-sensitive instruments
are generally defined as on and off balance sheet derivatives and other
financial instruments.
41
Expected Maturity Date At December 31, 1998
---------------------------------------------------------------------------------------
Total Fair
1999 2000 2001 2002 2003 Thereafter Balance Value
---------- --------- --------- -------- -------- ---------- ---------- ----------
(Dollars in thousands)
Rate-Sensitive Assets:
Interest-earning deposits............ $ 49,374 $ -- $ -- $ -- $ -- $ -- $ 49,374 $ 49,374
Average interest rate ............. 4.49% -- -- -- -- -- 4.49%
Federal funds sold................... 275,000 -- -- -- -- -- 275,000 275,000
Average interest rate ............. 3.57% -- -- -- -- -- 3.57%
Securities available for sale........ 332,338 85,666 32,514 20,246 22,233 100,350 593,347 593,347
Average interest rate ............. 6.52% 10.26% 16.96% 17.58% 17.79% 17.06% 10.21%
Loans available for sale(2).......... 85,485 13,771 5,683 4,656 3,558 64,694 177,847 177,847
Average interest rate ............. 8.94% 8.95% 8.97% 8.99% 9.01% 9.05% 8.98%
Investment securities, net........... -- -- -- -- -- 10,825 10,825 10,825
Average interest rate ............. -- -- -- -- -- -- --
Loan portfolio, net(2)............... 106,341 56,613 30,931 7,577 4,397 24,453 230,312 232,242
Average interest rate ............. 9.87% 9.61% 9.35% 9.11% 8.97% 8.79% 9.58%
Discount loan portfolio, net......... 447,887 228,740 92,192 62,637 49,582 145,473 1,026,511 1,046,945
Average interest rate ............. 8.46% 8.40% 8.42% 8.46% 8.49% 8.62% 8.46%
---------- --------- --------- -------- -------- -------- ---------- ----------
Total rate-sensitive assets...... $1,296,425 $ 384,790 $ 161,320 $ 95,116 $ 79,770 $345,795 $2,363,216 $2,385,580
========== ========= ========= ======== ======== ======== ========== ==========
Rate-Sensitive Liabilities:
NOW and money market checking deposits $ 13,631 $ 3,860 $ 3,098 $ 2,487 $ 1,997 $ 8,199 $ 33,272 $ 32,901
Average interest rate ............. 3.50% 3.39% 3.38% 3.37% 3.35% 3.28% 3.40%
Savings deposits..................... 277 222 177 142 114 394 1,326 1,259
Average interest rate ............. 2.30% 2.30% 2.30% 2.30% 2.30% 2.30% 2.30%
Certificates of deposit.............. 976,932 366,658 292,866 197,447 48,873 24,215 1,906,991 1,950,955
Average interest rate ............. 5.64% 5.83% 5.92% 6.12% 5.51% 5.86% 5.78%
---------- --------- --------- -------- -------- -------- ---------- ----------
Total interest-bearing deposits.. 990,840 370,740 296,141 200,076 50,984 32,808 1,941,589 1,985,115
Securities sold under agreements to
repurchase......................... 72,051 -- -- -- -- -- 72,051 72,051
Average interest rate 7.77% -- -- -- -- -- 7.77%
Obligations outstanding under lines
of credit.......................... 179,285 -- -- -- -- -- 179,285 179,285
Average interest rate ............. 6.85% -- -- -- -- -- 6.85%
Notes and debentures................. -- -- -- -- 125,000 100,000 225,000 205,750
Average interest rate ............. -- -- -- -- 11.88% 12.00% 11.93%
---------- --------- --------- -------- -------- -------- ---------- ----------
Total rate-sensitive liabilities. $1,242,176 $ 370,740 $ 296,141 $200,076 $175,984 $132,808 $2,417,925 $2,442,201
========== ========= ========= ======== ======== ======== ========== ==========
(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 13.3% and 11.79% 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, loan portfolio and loans available for sale reduces the risks that
would otherwise result from concentrating such loans in limited geographic
areas. See Note 6, Note 7 and Note 8 to the Consolidated Financial Statements.
Foreign Currency Exchange Rate Risk Management. The Company uses foreign
currency derivatives to hedge its equity investment in Ocwen UK and Kensington
("net investment hedges"). The Company's exposure to foreign currency exchange
rates exists with the British Pound versus the U.S. dollar. It is the Company's
policy to periodically adjust the amount of foreign currency derivative
contracts it has entered into in response to changes in its recorded equity
investment in these foreign entities.
On February 25, 1998, the Company entered into a foreign currency swap with a
AAA-rated counterparty to hedge its equity investment in Kensington. Under the
terms of the agreement, the Company will swap (pound)27.5 million for $43.5
million in five years based on the exchange rate on the date the contract became
effective. On August 6, 1998, the Company also sold short foreign currency
futures contracts to further hedge its foreign currency exposure related to its
equity investment in Kensington. Under the terms of the currency futures, the
Company has the right to receive $1.5 million and pay (pound)938,000.
During 1998, the Company sold short foreign currency futures to hedge its
foreign currency exposure related to its equity investment in Ocwen UK. Under
the terms of the currency futures, the Company has the right to receive $43.8
million and pay (pound)26.6 million. The value of the currency futures is based
on quoted market prices.
42
The Company's net investment hedges and related foreign currency equity
investments and net exposures as of December 31, 1998, were as follows. There
were no net investment hedges at December 31, 1997:
Equity Investment Net Hedges Net Exposure
----------------- ------------- -------------
Ocwen UK.................. $53.8 million $43.8 million $10.0 million
Kensington................ $46.6 million $45.1 million $ 1.5 million
The net exposures are subject to gain or loss if foreign currency exchange rates
fluctuate. See Note 21 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 and for
other general business purposes. The primary sources of funds for liquidity
consist of deposits, FHLB advances, reverse repurchase agreements, lines of
credit and maturities and payments of principal and interest on loans and
securities and proceeds from sales and securitizations thereof. Consistent with
the Company's disclosure in its Form 10-Q for the quarter ended September 30,
1998, the Company is continuing its efforts to increase its liquidity position.
Sources of liquidity include certificates of deposit obtained primarily from
wholesale sources. At December 31, 1998, the Company had $1.92 billion of
certificates of deposit, including $1.86 billion of brokered certificates of
deposit obtained through national, regional and local 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, 1999 and 2000,
and thereafter amounted to $982.9 million, $381.4 million and $542.7 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, 1998, the Company
was eligible to borrow up to an aggregate of $641.0 million from the FHLB of New
York (subject to the availability of acceptable collateral) and had $31.8
million of single family residential loans and $5.6 million of multi-family
residential loans which could be pledged as security for such advances. At the
same date, the Company had contractual relationships with 12 brokerage firms and
the FHLB of New York pursuant to which it could obtain funds from reverse
repurchase agreements. Additionally, at December 31, 1998, the Company had
unrestricted cash and cash equivalents of $424.8 million, $344.2 million of
short duration CMOs and $100.2 million of subordinate and residual mortgages
which could be used to secure additional borrowings. At present, the Company has
no outstanding FHLB advances.
The liquidity of the Company includes lines of credit obtained by OFS to finance
its subprime lending as follows: (i) a $200.0 million secured line of credit, of
which $100.0 million was committed, (ii) a $50.0 million secured line of credit,
all of which was committed, (iii) a $200.0 million secured line of credit, of
which $100.0 million was committed, (iv) a $100.0 million secured line of
credit, none of which was committed, and (v) a $20.0 million secured residual
line of credit, none of which was committed. The lines of credit mature between
March 1999 and July 2001 and bear interest at rates that float in accordance
with designated indices. The terms of the line of credit agreements contain,
among other provisions, requirements for maintaining certain profitability,
defined levels of net worth and debt-to-equity ratios. For the period ended
December 31, 1998, OFS obtained a lender's agreement waiving compliance with the
maintenance of a profitability covenant for one of OFS' line of credit
agreements, with which OFS failed to comply. The agreements also require annual
commitment fees to be paid based on the used and unused portion of the
facilities, as well as a facility fee based on the total committed amount. Such
commitment fees are capitalized and amortized on a straight-line basis over a
twelve-month period. An aggregate of $59.5 million was outstanding to OFS under
these lines of credit at December 31, 1998. 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, 1998.
43
In connection with the Company's acquisition of substantially all of the assets
of Cityscape UK, Ocwen UK, has entered into a Loan Facility Agreement with
Greenwich International Ltd. ("Greenwich") under which Greenwich provided a
short-term facility to finance the acquisition of Cityscape UK's mortgage loan
portfolio (the "Term Loan") and to finance Ocwen UK's further originations and
purchase of subprime single family loans (the "Revolving Facility" and together
with the Term Loan, the "Greenwich Facility"). The Greenwich Facility is secured
by Ocwen UK's loans available for sale. The Revolving Facility, which matures in
April 1999, is set at a maximum of $166.0 million ((pound)100.0 million reduced
by the amount borrowed under the Term Loan) of which $87.1 million ((pound)52.5
million) was funded at December 31, 1998, to finance subprime single family loan
originations and bears interest at a rate of the one-month LIBOR plus 1.50%. At
December 31, 1998, $5.6 million ((pound)3.4 million) had been borrowed under the
Term Loan, which matured in January 1999. In addition, Ocwen UK has entered into
a secured warehouse line of credit with Barclays Bank plc (the "Barclays
Facility") to finance subprime single family loan originations. The Barclays
Facility, which matures in November 1999 and bears interest at a rate of the
one-month LIBOR plus 0.80%, is set at a maximum of $124.5 million ((pound)75.0
million), against which $24.6 million ((pound)14.8 million) had been borrowed at
December 31, 1998.
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 $398.7 million, $90.2 million and
$63.0 million of cash flows during 1998, 1997 and 1996, respectively. 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 $314.0 million,
$471.1 million and $519.9 million during 1998, 1997 and 1996, 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. Cash flows from investing activities were primarily utilized
to purchase and originate discount loans and loans held for investment and to
purchase securities available for sale.
The Company's financing activities provided cash flows of $208.7 million, $479.5
million and $454.5 million during 1998, 1997 and 1996, respectively. Cash flows
from financing activities were primarily related to changes in the Company's
deposits, issuance of obligations outstanding under lines of credit, issuance of
common stock and the Capital Securities in 1997, issuance of the Notes in 1996
and advances from FHLB. Cash flows used by financing activities were primarily
utilized to repay advances from the FHLB, reverse repurchase agreements and
obligations outstanding under lines of credit.
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 8.34%, 5.6%, 8.8% and 12.9% during
the years ended December 31, 1998, 1997, 1996 and 1995, respectively, and
amounted to 10.78% at December 31, 1998.
The Bank's ability to make capital distributions pursuant to the OTS capital
distribution regulations is limited by the regulatory capital levels which it
has committed to the OTS it would maintain, commencing on June 30, 1997. As a
result of a verbal agreement between the Bank and the OTS to dividend
subordinate and residual mortgage-related securities resulting from
securitization activities conducted by the Bank, which had an aggregate fair
value of $13.9 million at December 31, 1998, the Bank may be limited in its
ability to pay cash dividends to the Company. The Bank recently received
approval from the OTS to pay a $30.0 million cash dividend to OCN, which the
Bank paid to OCN on November 16, 1998. Future cash dividends depend on future
operating results of the Bank. See "Regulatory Capital and Other Requirements."
44
At December 31, 1998, the Company had $133.5 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 required and that substantially all of such unfunded
commitments will be funded during 1998. See Note 28 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 and foreign currency exchange
rate. See "Asset and Liability Management" above and Note 21 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.
Following an examination in late 1996 and early 1997, 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 25 to the Consolidated Financial
Statements. The Bank's core capital, Tier 1 risk-based capital and total
risk-based capital ratios at December 31, 1998, were 9.07%, 11.71% and 17.26%,
respectively, placing the Bank in the "well-capitalized" category as defined by
federal regulations. 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 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 is in the process of establishing the readiness of its computer
systems and applications for the year 2000 with no effect on customers or
disruption to business operations. The Company has established a project plan to
achieve year 2000 readiness of its mission critical and non-mission critical
systems, including hardware infrastructure and software applications. The
project plan has a budget of approximately $2.0 million and is divided into six
phases: identification, evaluation, remediation, validation, risk assessment and
contingency planning. The addition of risk assessment and contingency planning
efforts to the overall project plan accounts for the difference between the $2.0
million budgeted as of December 31, 1998, and the estimate of $1.5 million for
achieving year 2000 compliance included in the Company's 10-Q for the quarter
ended June 30, 1998.
As of December 31, 1998, the Company had expended approximately 66% of budgeted
man-hours and incurred costs of approximately $1.1 million, which included
approximately $115,000 for year 2000 testing tools, additional hardware and
outside consulting assistance, while the remainder consisted of labor and
overhead expense from within the Company. To date, the Company has substantially
completed the systems identification, evaluation, remediation and validation
phases of the project, at a cost that was approximately 27% below budget.
45
In its systems evaluation and validation efforts, the Company has employed
automated testing tools that are designed to meet guidelines established by the
Federal Financial Institution Examination Council (FFIEC) as required by the
OTS. All new application development will include significant year 2000
readiness validation prior to implementation, followed by such end-to-end
testing as necessary. During 1999, the Company plans to focus on any remaining
validation tasks, including end-to-end testing with third parties. During the
second and third quarters of 1999, the Company plans to participate in the
Mortgage Banker Association Year 2000 Inter-System Readiness Test with other
mortgage industry leaders as a means of coordinating critical end-to-end
validation.
As part of the identification and evaluation phases of the project, the Company
documented critical operating functions within each business unit, as well as
strategic third-party and vendor relationships. These efforts also are serving
as the basis of the Company's year 2000 risk assessment and contingency planning
efforts. The Company has retained a business continuity expert to prepare
contingency plans and assist with the testing and validation of these plans.
Until the risk assessment phase is completed, the Company will not know the full
extent of the risks associated with year 2000 readiness, including an analysis
of the most reasonably likely worst case year 2000 scenario. The Company expects
to complete its year 2000 risk assessment and contingency planning efforts
during the first half of 1999.
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 (THE
"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 ACT OF 1934, AS
AMENDED. THESE 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(S) OR BY THE USE OF FORWARD-LOOKING TERMINOLOGY
SUCH AS "ANTICIPATE," "BELIEVE," "COMMITMENT," "CONSIDER," "CONTINUE," "COULD,"
"ENCOURAGE," "ESTIMATE," "EXPECT," "FORESEE," "INTEND," "IN THE EVENT OF,"
"MAY," "PLAN," "PRESENT," "PROPOSE," "PROSPECT," "UPDATE," "WHETHER," "WILL,"
"WOULD," FUTURE OR CONDITIONAL VERB TENSES, SIMILAR TERMS, VARIATIONS ON SUCH
TERMS OR NEGATIVES OF SUCH TERMS. ALTHOUGH THE COMPANY BELIEVES THE ANTICIPATED
RESULTS OR OTHER EXPECTATIONS REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE
BASED ON REASONABLE ASSUMPTIONS, IT CAN GIVE NO ASSURANCE THAT THOSE RESULTS OR
EXPECTATIONS WILL BE ATTAINED. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
INDICATED IN SUCH STATEMENTS DUE TO RISKS, UNCERTAINTIES AND CHANGES WITH
RESPECT TO A VARIETY OF FACTORS, INCLUDING, BUT NOT LIMITED TO, INTERNATIONAL,
NATIONAL, REGIONAL OR LOCAL ECONOMIC ENVIRONMENTS (PARTICULARLY IN THE MARKET
AREAS WHERE THE COMPANY OPERATES), GOVERNMENT FISCAL AND MONETARY POLICIES
(PARTICULARLY IN THE MARKET AREAS WHERE THE COMPANY OPERATES), PREVAILING
INTEREST OR CURRENCY EXCHANGE RATES, EFFECTIVENESS OF INTEREST RATE, CURRENCY
AND OTHER HEDGING STRATEGIES, LAWS AND REGULATIONS AFFECTING FINANCIAL
INSTITUTIONS, REAL ESTATE INVESTMENT TRUSTS, INVESTMENT COMPANIES AND REAL
ESTATE (INCLUDING REGULATORY FEES, CAPITAL REQUIREMENTS, INCOME AND PROPERTY
TAXATION, ACCESS FOR DISABLED PERSONS AND ENVIRONMENTAL COMPLIANCE), UNCERTAINTY
OF FOREIGN LAWS, COMPETITIVE PRODUCTS, PRICING AND CONDITIONS (INCLUDING FROM
COMPETITORS THAT HAVE SIGNIFICANTLY GREATER RESOURCES THAN THE COMPANY), CREDIT,
PREPAYMENT, BASIS, DEFAULT, SUBORDINATION AND ASSET/LIABILITY RISKS, LOAN
SERVICING EFFECTIVENESS, ABILITY TO IDENTIFY ACQUISITIONS AND INVESTMENT
OPPORTUNITIES MEETING THE COMPANY'S INVESTMENT STRATEGY, COURSE OF NEGOTIATIONS
AND ABILITY TO REACH AGREEMENT WITH RESPECT TO MATERIAL TERMS OF ANY PARTICULAR
TRANSACTION, SATISFACTORY DUE DILIGENCE RESULTS, SATISFACTION OR FULFILLMENT OF
AGREED UPON TERMS AND CONDITIONS OF CLOSING OR PERFORMANCE, TIMING OF
TRANSACTION CLOSINGS, RECENT EFFORTS TO REFOCUS ON CORE BUSINESSES AND INCREASE
LIQUIDITY, DISPOSITIONS AND WINDING DOWN OF DISCONTINUED BUSINESSES,
ACQUISITIONS AND INTEGRATION OF ACQUIRED BUSINESSES, SOFTWARE INTEGRATION,
DEVELOPMENT AND LICENSING, AVAILABILITY OF AND COSTS ASSOCIATED WITH OBTAINING
ADEQUATE AND TIMELY SOURCES OF LIQUIDITY, DEPENDENCE ON EXISTING SOURCES OF
FUNDING, ABILITY TO REPAY OR REFINANCE INDEBTEDNESS (AT MATURITY OR UPON
ACCELERATION), TO MEET COLLATERAL CALLS BY LENDERS (UPON RE-VALUATION OF THE
UNDERLYING ASSETS OR OTHERWISE), TO GENERATE REVENUES SUFFICIENT TO MEET DEBT
SERVICE PAYMENTS AND OTHER OPERATING EXPENSES AND TO SECURITIZE WHOLE LOANS,
TAXABLE INCOME EXCEEDING CASH FLOW, AVAILABILITY OF DISCOUNT LOANS FOR PURCHASE,
SIZE OF, NATURE OF AND YIELDS AVAILABLE WITH RESPECT TO THE SECONDARY MARKET FOR
MORTGAGE LOANS AND FINANCIAL, SECURITIES AND SECURITIZATION MARKETS IN GENERAL,
ALLOWANCES FOR LOAN LOSSES, CHANGES IN REAL ESTATE CONDITIONS (INCLUDING
LIQUIDITY, VALUATION, REVENUES, RENTAL RATES, OCCUPANCY LEVELS AND COMPETING
PROPERTIES), ADEQUACY OF INSURANCE COVERAGE IN THE EVENT OF A LOSS, KNOWN OR
UNKNOWN ENVIRONMENTAL CONDITIONS, YEAR 2000 COMPLIANCE, OTHER FACTORS GENERALLY
UNDERSTOOD TO AFFECT THE REAL ESTATE ACQUISITION, MORTGAGE AND LEASING MARKETS,
SECURITIES INVESTMENTS AND RAPID GROWTH COMPANIES, AND OTHER RISKS DETAILED FROM
TIME TO TIME IN THE COMPANY'S REPORTS AND FILINGS WITH THE COMMISSION, INCLUDING
ITS REGISTRATION STATEMENTS ON FORMS S-1 AND S-3 AND PERIODIC REPORTS ON FORMS
10-Q, 8-K AND 10-K. GIVEN THESE UNCERTAINTIES, READERS ARE CAUTIONED NOT TO
PLACE UNDUE RELIANCE ON SUCH STATEMENTS. THE COMPANY DOES NOT UNDERTAKE, AND
SPECIFICALLY DISCLAIMS ANY OBLIGATION, TO PUBLICLY RELEASE THE RESULT OF ANY
REVISIONS THAT 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. PLEASE REFER TO EXHIBIT 99.1, RISK FACTORS, INCLUDED
WITH THE FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998, AND FILED WITH THE
COMMISSION, FOR A DESCRIPTION OF MATERIAL RISKS FACED BY THE COMPANY AND ITS
SECURITIES HOLDERS.
46
REPORT OF MANAGEMENT
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.
PricewaterhouseCoopers 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
PricewaterhouseCoopers 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
PricewaterhouseCoopers 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 and Chief Executive Officer Senior Vice President and
Chief Financial Officer
================================================================================
OCWEN FINANCIAL CORPORATION
47
PRICEWATERHOUSECOOPERS
PRICEWATERHOUSECOOPERS
One East Broward Boulevard
Suite 1700
Fort Lauderdale, FL 33301
Telephone (954) 463-6280
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 comprehensive income,
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, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the CompanyOs
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 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 audits provide a reasonable basis for the opinion expressed
above.
/s/ PRICEWATERHOUSECOOPERS LLP
- - ------------------------------
PRICEWATERHOUSECOOPERS LLP
Fort Lauderdale, Florida
January 29, 1999
48
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands, Except Share Data)
December 31,1998 December 31,1997
---------------- ----------------
ASSETS:
Cash and amounts due from depository institutions........................... $ 120,805 $ 11,832
Interest earning deposits................................................... 49,374 140,001
Federal funds sold.......................................................... 275,000 --
Securities available for sale, at fair value................................ 593,347 476,796
Loans available for sale, at lower of cost or market........................ 177,847 177,041
Investment in capital stock of Federal Home Loan Bank, at cost.............. 10,825 10,825
Loan portfolio, net......................................................... 230,312 266,299
Discount loan portfolio, net................................................ 1,026,511 1,434,176
Investments in low-income housing tax credit interests...................... 144,164 128,614
Investments in unconsolidated entities...................................... 86,893 3,526
Real estate owned, net...................................................... 201,551 167,265
Investment in real estate................................................... 36,860 76,340
Premises and equipment, net................................................. 33,823 21,542
Income taxes receivable..................................................... 34,333 --
Deferred tax asset.......................................................... 66,975 45,148
Excess of purchase price over net assets acquired, net...................... 12,706 15,560
Principal, interest and dividends receivable................................ 18,993 17,280
Escrow advances on loans.................................................... 88,277 47,888
Other assets................................................................ 99,483 29,032
-------------- --------------
$ 3,308,079 $ 3,069,165
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits.................................................................. $ 2,175,016 $ 1,982,822
Securities sold under agreements to repurchase............................ 72,051 108,250
Obligations outstanding under lines of credit............................. 179,285 118,304
Notes, debentures and other interest bearing obligations.................. 225,000 226,975
Accrued interest payable.................................................. 33,706 32,238
Income taxes payable...................................................... -- 3,132
Accrued expenses, payables and other liabilities.......................... 61,053 51,709
-------------- --------------
Total liabilities......................................................... 2,746,111 2,523,430
-------------- --------------
Company-obligated, mandatorily redeemable securities of subsidiary trust
holding solely junior subordinated debentures of the Company............ 125,000 125,000
Minority interest......................................................... 592 1,043
COMMITMENTS AND CONTINGENCIES (NOTE 28)
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; 60,800,357 and
60,565,835 shares issued and outstanding at December 31, 1998,
and December 31, 1997, respectively................................... 608 606
Additional paid-in capital................................................ 166,234 164,751
Retained earnings......................................................... 257,170 259,349
Accumulated other comprehensive income, net of taxes:
Unrealized gain (loss) on securities available for sale................... 14,057 (5,014)
Net unrealized foreign currency translation loss.......................... (1,693) --
-------------- --------------
Total stockholders' equity................................................ 436,376 419,692
-------------- --------------
$ 3,308,079 $ 3,069,165
============== ==============
The accompanying notes are an integral part of these consolidated financial statements.
49
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Share Data)
For the years ended December 31,
--------------------------------------------
1998 1997 1996
------------ ------------ ------------
Interest income:
Federal funds sold and repurchase agreements .................................. $ 7,930 $ 8,975 $ 4,681
Securities available for sale ................................................. 40,705 29,851 26,932
Securities held for trading ................................................... -- 248 1,216
Loans available for sale ...................................................... 56,791 18,368 17,092
Loans ......................................................................... 38,609 54,701 36,818
Discount loans ................................................................ 160,847 157,649 103,165
Investment securities and other ............................................... 2,812 2,739 3,990
------------ ------------ ------------
307,694 272,531 193,894
------------ ------------ ------------
Interest expense:
Deposits ...................................................................... 116,584 122,070 93,773
Securities sold under agreements to repurchase ................................ 6,514 1,000 1,101
Advances from the Federal Home Loan Bank ...................................... 120 527 4,053
Obligations outstanding under lines of credit ................................. 34,587 5,578 --
Notes, debentures and other interest bearing obligations ...................... 27,088 27,114 17,233
------------ ------------ ------------
184,893 156,289 116,160
------------ ------------ ------------
Net interest income before provision for loan losses .......................... 122,801 116,242 77,734
Provision for loan losses ..................................................... 18,509 32,218 22,450
------------ ------------ ------------
Net interest income after provision for loan losses ........................... 104,292 84,024 55,284
------------ ------------ ------------
Non-interest income:
Servicing fees and other charges .............................................. 59,180 25,962 4,682
(Loss) gain on interest earning assets, net ................................... (1,594) 82,212 21,682
Gain on real estate owned, net ................................................ 14,033 7,277 3,827
Other income .................................................................. 39,696 8,498 7,112
------------ ------------ ------------
111,315 123,949 37,303
------------ ------------ ------------
Non-interest expense:
Compensation and employee benefits ............................................ 115,556 77,573 39,043
Occupancy and equipment ....................................................... 34,878 17,657 8,921
Net operating loss (income) on investments in real estate and certain low-income
housing tax credit interests ................................................ 6,753 4,792 (425)
Amortization and write-off of excess of purchase price over net assets acquired 11,614 557 --
Loan expenses ................................................................. 25,193 7,014 4,111
Other operating expenses ...................................................... 32,400 19,281 17,956
------------ ------------ ------------
226,394 126,874 69,606
------------ ------------ ------------
Distributions on Company-obligated, mandatory redeemable securities of
subsidiary trust holding solely junior subordinated debentures ................ 13,594 5,249 --
Equity in (losses) earnings of investments in unconsolidated entities ........... (7,985) 23,688 38,320
------------ ------------ ------------
(Loss) income before income taxes ............................................. (32,366) 99,538 61,301
Income tax benefit (expense) .................................................... 30,699 (21,309) (11,159)
Minority interest in net loss of consolidated subsidiary ........................ 467 703 --
------------ ------------ ------------
Net (loss) income ............................................................... $ (1,200) $ 78,932 $ 50,142
============ ============ ============
(Loss) earnings per share:
Basic ......................................................................... $ (0.02) $ 1.40 $ 0.99
Diluted ....................................................................... $ (0.02) $ 1.39 $ 0.94
Weighted average common shares outstanding:
Basic ......................................................................... 60,736,950 56,185,956 50,556,572
Diluted ....................................................................... 60,736,950 56,836,484 53,378,882
The accompanying notes are an integral part of these consolidated financial statements.
50
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in Thousands)
For the years ended December 31,
-------------------------------------------
1998 1997 1996
---------- ----------- ----------
Net (loss) income..................................................... $ (1,200) $ 78,932 $ 50,142
Other comprehensive income, net of taxes:
Unrealized gain (loss) on securities available for sale............. 1,493 (8,500) 4,901
Unrealized foreign currency translation loss ....................... (1,693) -- --
Less: Reclassification adjustment for losses included in net income. 17,578 -- --
---------- ----------- ----------
Other comprehensive income.......................................... 17,378 (8,500) 4,901
---------- ------------ ----------
Comprehensive income.................................................. $ 16,178 $ 70,432 $ 55,043
========== =========== ==========
Disclosure of reclassification adjustment:
Unrealized holding losses arising during the year on securities sold $ (37,390)
Add: Adjustment for losses included in net loss..................... 54,968
----------
Net reclassification adjustment for losses recognized in other
comprehensive income in prior years................................. $ 17,578
==========
The accompanying notes are an integral part of these consolidated financial statements.
51
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(Dollars in Thousands)
Notes
Accumulated receivable
other on exercise
Common Stock Additional Comprehensive of common
---------------------- paid-in Retained income stock
Shares Amount capital earnings net of taxes options Total
----------- ------- ---------- --------- ------------- ----------- ---------
Balances at December 31, 1995 ........ $47,624,540 $ 476 $ 10,211 $ 130,275 $ (1,415) $ -- $ 139,547
Net income ........................... -- -- -- 50,142 -- -- 50,142
Issuance of common stock ............. 6,140 -- 23 -- -- -- 23
Repurchase of common stock options ... -- -- (177) -- -- -- (177)
Exercise of common stock options ..... 5,857,660 59 12,933 -- -- -- 12,992
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
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
Net loss ............................. -- -- -- (1,200) -- -- (1,200)
Conversion of investment in an
unconsolidated entity to the
equity method .................... -- -- -- (979) -- -- (979)
Repurchase of common stock ........... (318,311) (3) (7,769) -- -- -- (7,772)
Issuance of common stock ............. 320,550 3 7,825 -- -- -- 7,828
Repurchase of common stock options ... -- -- (6,502) -- -- -- (6,502)
Exercise of common stock options ..... 232,283 2 7,929 -- -- -- 7,931
Other comprehensive income, net of
taxes: ........................... -- -- -- -- -- -- --
Change in unrealized gain (loss) on
securities available for sale .... -- -- -- -- 19,071 -- 19,071
Net unrealized foreign currency
translation loss ................. -- -- -- -- (1,693) -- (1,693)
----------- ------- --------- --------- -------- ------- ---------
Balances at December 31, 1998 ........ $60,800,357 $ 608 $ 166,234 $ 257,170 $ 12,364 $ -- $ 436,376
=========== ======= ========= ========= ======== ======= =========
The accompanying notes are an integral part of these consolidated financial statements.
52
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
For the years ended December 31,
---------------------------------------
1998 1997 1996
----------- ----------- ---------
Cash flows from operating activities:
Net (loss) income .............................................................. $ (1,200) $ 78,932 $ 50,142
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Net cash provided (used) by trading activities ............................... 109,601 132,600 (60,881)
Proceeds from sales of loans available for sale .............................. 1,659,368 519,163 397,606
Purchases of loans available for sale ........................................ (370,865) (278,081) (295,054)
Origination of loans available for sale ...................................... (959,105) (316,101) (9,447)
Principal payments received on loans available for sale ...................... 82,728 22,240 26,689
Premium amortization (discount accretion), net ............................... 56,487 63,506 11,640
Depreciation and amortization ................................................ 26,229 10,865 7,646
Provision for loan losses .................................................... 18,509 32,218 22,450
Provision for real estate owned, net ......................................... 18,627 13,450 18,360
Loss (gain) on interest-earning assets, net .................................. 1,594 (82,212) (21,682)
Loss on sales of premises and equipment ...................................... 47 1 97
Gain on sale of low-income housing tax credit interests ...................... (7,316) (6,298) (4,861)
Gain on real estate owned, net ............................................... (43,839) (30,651) (22,835)
Gain on sale of real estate held for investment .............................. (10,383) -- --
Equity in losses (earnings) of unconsolidated entities, net .................. 7,985 (23,688) (38,320)
Increase in principal, interest and dividends receivable ..................... (1,713) (459) (2,277)
(Increase) decrease in income taxes receivable ............................... (37,465) 18,247 (14,110)
(Increase) decrease in deferred tax asset .................................... (21,827) (39,288) 16,403
Increase in escrow advances .................................................. (40,389) (20,479) (6,255)
Increase in other assets ..................................................... (84,137) (27,916) (12,037)
Increase (decrease) in accrued expenses, interest payable and other
liabilities ................................................................ (4,257) 24,118 (226)
----------- ----------- ---------
Net cash provided (used) by operating activities ............................... 398,679 90,167 63,048
----------- ----------- ---------
Cash flows from investing activities:
Proceeds from sales of securities available for sale ......................... 269,828 202,670 175,857
Purchases of securities available for sale ................................... (914,232) (415,822) (233,858)
Maturities of and principal payments received on securities available for
sale ....................................................................... 359,525 46,084 28,756
Maturities of and principal payments received on securities held for
investment ................................................................. -- -- 10,006
Purchase of securities held for investment ................................... -- (42,166) (276)
Acquisition of subsidiaries .................................................. (426,096) (11,635) --
Purchase of low-income housing tax credit interests .......................... (49,063) (54,573) (34,240)
Proceeds from sales of low-income housing tax credit interests ............... 37,918 22,026 24,667
Proceeds from sales of discount loans ........................................ 626,423 500,151 190,616
Proceeds from sale of real estate held for investment ........................ 47,644 14,905 --
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 ................................................................. (188,716) (138,884) (237,525)
Purchase of discount loans ................................................... (938,859) (1,464,611) (925,850)
(Increase) decrease in investment in unconsolidated entities ................. (70,190) 90,541 (29,589)
Principal payments received on loans held for investment ..................... 227,349 291,998 119,923
Principal payments received on discount loans ................................ 446,566 382,781 244,205
Purchase of and capital improvements to real estate held for investment ...... -- (39,844) (29,946)
Proceeds from sale of real estate owned ...................................... 301,485 196,180 169,084
Purchase of real estate owned in connection with discount loan purchase ...... (19,949) (38,486) (1,628)
Additions to premises and equipment .......................................... (23,680) (13,745) (5,243)
Other, net ................................................................... -- -- 227
----------- ----------- ---------
Net cash (used) provided by investing activities ............................... (314,047) (470,046) (519,931)
----------- ----------- ---------
The accompanying notes are an integral part of these consolidated financial statements.
53
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
For the years ended December 31,
-------------------------------------
1998 1997 1996
----------- --------- ---------
Cash flows from financing activities:
Increase in deposits ....................................................... 192,194 63,080 414,728
Increase (decrease) in securities sold under agreements to repurchase ...... (36,199) 33,704 (10,215)
Proceeds from issuance of notes, debentures and other interest-bearing
obligations, net of repayment ........................................... -- 1,402 125,000
Proceeds from issuance of obligations under lines of credit ................ 60,981 118,304 --
Payments of obligations assumed in connection with acquisition of subsidiary -- (3,000) --
Payment of debt issuance costs ............................................. -- -- (5,252)
Payments on advances from Federal Home Loan Bank ........................... -- (399) (146,000)
Payments on notes and mortgages payable .................................... (1,975) -- (8,798)
Repayments (originations) of loans made to executive officers, net ......... -- 3,832 (3,832)
Exercise of common stock options ........................................... 7,931 3,037 12,993
Advances from the Federal Home Loan Bank ................................... -- -- 76,000
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 .................................... 56 142,003 --
Repurchase of common stock options ......................................... (6,502) (3,208) (177)
Repurchase of common stock ................................................. (7,772) -- --
Other ...................................................................... -- -- 23
----------- --------- ---------
Net cash provided by financing activities .................................... 208,714 479,493 454,470
----------- --------- ---------
Net increase (decrease) in cash and cash equivalents ....................... 293,346 99,614 (2,413)
Cash and cash equivalents at beginning of period ........................... 151,833 52,219 54,632
----------- --------- ---------
Cash and cash equivalents at end of period ................................. $ 445,179 $ 151,833 $ 52,219
=========== ========= =========
Reconciliation of cash and cash equivalents at end of period:
Cash and amounts due from depository institutions .......................... $ 120,805 $ 11,832 $ 6,878
Interest-earning deposits .................................................. 49,374 140,001 13,341
Federal funds sold and repurchase agreements ............................... 275,000 -- 32,000
----------- --------- ---------
$ 445,179 $ 151,833 $ 52,219
=========== ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest ................................................................... $ 183,424 $ 148,895 $ 115,051
Income taxes ............................................................... $ 36,754 $ 28,228 $ 4,725
Supplemental schedule of non-cash investing and financing activities:
Real estate owned acquired through foreclosure ............................. $ 280,522 $ 205,621 $ 102,140
Exchange of discount loans and loans available for sale for securities ..... $ 2,125,080 $ 897,358 $ 375,621
Transfer of securities for sale to investment in unconsolidated entities ... $ 35,158 $ -- $ --
Acquisition of businesses:
Fair value of assets acquired .............................................. $ 449,420 $ 15,052 $ --
Liabilities assumed ........................................................ 15,069 3,399 --
Less stock issued .......................................................... (7,772) -- --
----------- --------- ---------
Cash paid .................................................................. 426,579 11,653 --
Less cash acquired ......................................................... (483) (18) --
----------- --------- ---------
Net cash paid for assets acquired .......................................... $ 426,096 $ 11,635 $ --
=========== ========= =========
The accompanying notes are an integral part of these consolidated financial statements.
54
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
Ocwen Financial Corporation ("OCN" or the "Company") is a specialty financial
services company whose primary business activities consist of single family,
small commercial and large commercial discount loan acquisition and resolution
commercial real estate lending activities, subprime single family residential
lending mortgage loans serviced for others, investments in a wide variety of
mortgage-related securities and investments in low-income housing tax credit
interests. The Company's consolidated financial statements include the accounts
of OCN 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"), Investors Mortgage Insurance Holding Company
("IMI"), Ocwen UK plc ("Ocwen UK") and Ocwen Technology Xchange, Inc. ("OTX").
The Company also owns 97.8% of Ocwen Financial Services, Inc. ("OFS"), with the
remaining 2.2% owned by owners (and their spouses) of Admiral Home Loan
("Admiral") and is reported in the consolidated financial statements as a
minority interest. All significant intercompany transactions and balances have
been eliminated in consolidation.
The consolidated financial statements of the Company's foreign subsidiary, Ocwen
UK, and its equity investee, Norland Capital Group plc, doing business as
Kensington Mortgage Company ("Kensington"), have been prepared in accordance
with accounting principles generally accepted in the United Kingdom ("U.K.
GAAP"). U.K. GAAP varies in certain significant respects from generally accepted
accounting principles in the United States ("U.S. GAAP"). The principal
adjustment made to conform to U.S. GAAP was to recognize a gain on sale of
interest-earning assets in connection with the securitization of single family
subprime residential mortgage loans and record the residual security retained at
fair value.
The Bank is a federally chartered savings bank regulated by the Office of Thrift
Supervision ("OTS").
RECLASSIFICATION
Certain amounts included in the 1997 and 1996 consolidated financial statements
have been reclassified in order to conform to the 1998 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.
SHORT-TERM HIGHLY LIQUID INVESTMENTS
The Company's short-term highly liquid investments generally consist of federal
funds sold and assets purchased under agreements to resell. The Company invests
in these assets to maximize its return on liquid funds. At December 31, 1998,
such investments amounted to $275,000 of federal funds sold which had an
overnight maturity. The Company had no such short-term highly liquid investments
at December 31, 1997. The average investment in federal funds sold and assets
purchased under agreements to resell amounted to $149,441, $163,671 and $84,997
during 1998, 1997 and 1996, respectively.
The Bank is required by the Federal Reserve System to maintain
non-interest-earning cash reserves against certain of its transaction accounts
and time deposit accounts. Such reserves totaled $5,557 and $895 at December 31,
1998 and 1997, respectively.
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 fair
value with the unrealized gains or losses included in gains on sales of
interest-earning assets, net.
55
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
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 fair value with the net unrealized gains or
losses reported as a separate component of accumulated comprehensive income in
stockholders' equity. 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.
On a quarterly basis the Company evaluates each individual security in its
available for sale portfolio to determine whether a decline in value below
amortized cost has occurred which is other than temporary. In making this
assessment, the Company considers several factors, including but not limited to
the following:
(1) Determining whether the present value of estimated future cash flows
discounted at a risk-free rate (the rate on monetary assets of a
comparable duration which are essentially risk free, such as the
three-month Treasury bill rate) is less than the amortized cost basis
of the instrument;
(2) Examining whether the duration of the decline in market value has
exceeded six consecutive months; and
(3) Identifying and understanding the reasons for significant declines in
value (i.e., greater than 20%).
For each security where the Company concludes that all or a portion of the
decrease in value is other than temporary, such amount is charged to earnings,
thereby establishing a new cost basis for the security.
Investments in marketable equity securities not accounted for under the equity
method are designated as available for sale and are carried at fair value based
on quoted market prices. Net unrealized gains or losses are reported as a
separate component of accumulated comprehensive income in stockholders' equity.
Unrealized losses on securities that reflect a decline in value which is other
than temporary, if any, are charged to earnings.
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. Unrealized losses are
recorded as a reduction in earnings and are included under the caption "(Loss)
gain on interest-earning assets" in the consolidated statements of operations.
Loan origination fees and certain direct loan origination costs are deferred and
included in the carrying 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 loans are computed
on a specific identification basis.
Loans held for investment are stated at amortized cost, less an allowance for
loan losses, discount, deferred loan fees and undisbursed loan funds. To qualify
for this treatment, the Company must have both the ability and the intent to
hold such loans to maturity. 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.
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.
Loans are returned to accrual status only when the loan is reinstated and
ultimate collectibility is no longer in doubt. In addition, the amortization of
deferred loan fees is suspended when a loan is placed on nonaccrual status.
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
56
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
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 real estate owned
("REO") or charged off, any related valuation allowance is removed from 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. 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 for 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 which 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.
The Company periodically evaluates loans in the discount loan portfolio for
impairment. Individually identified impaired loans are measured based on either
the present value of payments expected to be received (using a discount rate
equating the Company's estimate of expected future cash flows to the acquisition
price), observable market prices, or the estimated fair value of the collateral
(for loans that are solely dependent on the collateral for repayment). If the
recorded investment in the impaired loan exceeds the measure of estimated fair
value, a valuation allowance is established as a component of the allowance for
loan losses.
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.
57
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
VALUATION ALLOWANCES ON DISCOUNT LOANS AND REAL ESTATE OWNED
The Company records 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. The Company records losses and
charge-offs on discount loans against the allowance for loan losses.
MORTGAGE SERVICING RIGHTS
In connection with the securitization and sale of loans, the Company generally
retains the rights to service such loans for investors. On January 1, 1996, the
Company adopted Statement of Financial Accounting Standards ("SFAS") No. 122,
"Accounting for Mortgage Servicing Rights." SFAS No. 122 was superseded, for
transactions recorded after December 31, 1996, by SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
which the Company adopted on January 1, 1997. Both SFAS No. 122 and SFAS No. 125
require the recognition of a servicing asset or liability and other retained
interests as an allocation of the carrying amount of the assets sold between the
asset sold and the servicing obligation and other retained interests based on
the relative fair value of the assets sold to the interests retained. The
resulting mortgage servicing asset or liability is amortized in proportion to
and over the period of estimated net servicing income or loss. The Company
evaluates the mortgage servicing asset for impairment based on the fair value of
the servicing asset. The Company estimates fair values by discounting servicing
asset cash flows using discount and prepayment rates that it believes market
participants would use.
The Company receives fees from investors for servicing mortgage loans. Servicing
fees, generally expressed as a percent of the unpaid principal balance, are
collected from the borrowers' payments. During any period in which the borrower
is not making payments, the Company is required under certain servicing
agreements to advance its own funds to meet contractual principal and interest
remittance requirements for certain investors, maintain property taxes and
insurance, and process foreclosures. The Company generally recovers such
advances from borrowers for reinstated and performing loans and from investors
for foreclosed loans.
INVESTMENT IN REAL ESTATE
Investment in real estate is recorded at cost less accumulated depreciation
(which is less than the net realizable value of the property) and relates
primarily to properties held for lease. The Company reviews its investment in
real estate for impairment whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable.
Depreciation is computed on a straight-line basis over the estimated useful
lives of the assets as follows:
Buildings and improvements......... 40 years
Land improvements ................. 20 years
Furniture, fixtures and equipment.. 5-10 years
Expenditures for repairs and maintenance are charged to operations as incurred.
Significant improvements are capitalized. The leases are classified as operating
leases in accordance with SFAS No. 13 "Accounting for Leases." Fees and costs
incurred in the successful negotiation of leases are deferred and amortized on a
straight-line basis over the terms of the respective leases. Rental income is
reported on a straight-line basis over the terms of the respective leases.
In conjunction with its multi-family and commercial lending business activity,
the Company made certain acquisition, development and construction loans in
which the Company participated in the residual profits of the underlying real
estate and the borrower had not contributed substantial equity to the project.
As such, the Company accounted for these loans under the equity method of
accounting as though it has made an investment in a real estate limited
partnership. All such loans were repaid during 1998 and no new loans were
originated.
58
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
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 which a subsidiary acts as the general partner,
are consolidated and included in the Company's consolidated financial
statements. 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, not to exceed 15 years. 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 expected cash flows 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. The results of operations of acquired companies are included
in the consolidated statements of operations beginning with the acquisition
date.
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 three to 10 years.
CAPITALIZED SOFTWARE COSTS
The Company's policy is to capitalize certain costs attributable to developing,
modifying and enhancing its software revenue products in accordance with SFAS
No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed." Costs incurred up to the establishment of technological
feasibility are expensed as research and development expenses. Once the products
are made available for general release to customers, capitalized costs are
amortized using the straight-line method over the estimated economic lives of
the individual products. The unamortized costs by product are reduced to an
amount not to exceed the future net realizable value by product at each
financial statement date.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses derivative financial instruments for the purpose of reducing
its exposure to adverse fluctuations in interest and foreign currency exchange
rates. While these hedging instruments are subject to fluctuations in value,
such fluctuations are generally offset by the change in value of the underlying
exposures being hedged. The Company does not hold any derivative financial
instruments for trading purposes. To qualify for hedge accounting, the asset or
liability to be hedged must be specifically identified and expose the Company to
interest rate or currency risk, and must eliminate or substantially reduce the
risk of loss from the asset or liability being hedged. If the derivative
financial instrument fails or ceases to qualify for hedge accounting, it is
accounted for at fair value with changes in fair value recorded in earnings in
the consolidated statements of operations.
The Company enters into foreign currency futures contracts and foreign currency
swap agreements to hedge its equity investments in Ocwen UK and Kensington. It
is the Company's policy to periodically adjust the amount of foreign currency
derivative contracts it has entered into in response to changes in its recorded
equity investment in these foreign entities. The unamortized discount related to
foreign currency swaps and the values of financial hedge instruments are
included as a component of comprehensive income in stockholders' equity.
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
59
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS 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 measured at fair
value.
FOREIGN CURRENCY TRANSLATION
The Company has determined that the functional currency of Ocwen UK and the
Company's equity investment in Kensington is the British Pound. In accordance
with SFAS No. 52, "Foreign Currency Translation," assets and liabilities
denominated in a foreign currency are translated into U.S. dollars at the
current rate of exchange existing at the statement of financial condition date
and revenues and expenses are translated at average monthly rates. The resulting
translation adjustments are included as a component of accumulated comprehensive
income in stockholders' equity.
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 UNCONSOLIDATED ENTITIES
The Company's investments in unconsolidated entities are 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.
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. Common stock equivalents would be excluded from the diluted calculation
if a net loss was incurred for the period as they would be antidilutive.
COMPREHENSIVE INCOME
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. Accumulated other comprehensive
income is presented net of income taxes and is comprised of unrealized gains and
losses on securities available for sale, and unrealized foreign currency
translation gains and losses.
60
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
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: credit risk, market risk and concentration of credit risk. Credit risk is
the risk of default on the Company's loan portfolios that results from a
borrowers' inability or unwillingness to make contractually required payments.
Market risk includes interest rate risk, foreign currency exchange rate risk,
and equity price risk. The Company is exposed 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. The Company is
exposed to foreign currency exchange rate risk in connection with its investment
in non-U.S. dollar functional currency operations and to the extent its foreign
exchange positions remain unhedged. The Company is exposed to equity price risk
as a result of its investments in the equity securities of other entities.
Market risk also reflects the risk of declines in the valuation of loans held
for sale and securities available for sale, and in the value of the collateral
underlying loans and the value of real estate held by the Company. Concentration
of credit risk refers to the risk that, if the Company extends a significant
portion of its total outstanding credit to borrowers in a specific geographical
area or industry or on the security of a specific form of collateral, the
Company may experience disproportionately high levels of default and losses if
those borrowers, or the value of such type of collateral, is adversely affected
by economic or other factors that are particularly applicable to such borrowers
or collateral.
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.
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.
CURRENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 128, "Earnings per Share." SFAS No. 128 simplifies the standards found in
Accounting Principles Board Opinion ("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 have 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 did not have an impact on the
Company's financial position or results of operation upon adoption.
61
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
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 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 did not have an effect on the
Company's financial position or results of operations upon adoption.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative and hedging activities and supersedes and
amends a number of existing standards. SFAS No. 133 requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial condition. The gain or loss recognition is determined on the intended
use and resulting designation of the financial instruments as follows:
o Gains or losses on derivative instruments not designated as hedging
instruments are recognized in the period of change in fair value.
o Gains or losses on derivative instruments designated as hedging the
exposure to changes in the fair value of a recognized asset, liability or
firm commitment are recognized in earnings in the period of the fair value
change, together with the offsetting fair value loss or gain on the hedged
item.
o Gains or losses on derivative instruments designated as hedging exposure to
variable cash flows arising from a forecasted transaction are initially
reported, to the extent the fair value change is offset by the change in
the forecasted cash flows, as a component of other comprehensive income.
The portion of the change in fair value in excess of the offsetting change
in forecasted cash flows is reported in earnings in the period of the
change.
o Gains or losses on derivative instruments designated as foreign currency
hedges of net investments in foreign operations are reported in other
comprehensive income as part of the foreign currency translation
adjustment.
SFAS No. 133 precludes the use of nonderivative financial instruments as hedging
instruments, except that nonderivative financial instruments denominated in a
foreign currency may be designated as a hedge of the foreign currency exposure
of an unrecognized firm commitment denominated in a foreign currency or a net
investment in a foreign operation.
Under SFAS No. 133, an entity that elects to apply hedge accounting is required
to establish at the inception of the hedge the method it will use for assessing
the effectiveness of the hedging derivative and the measurement approach for
determining the ineffective aspect of the hedge. Those methods must be
consistent with the entity's approach to managing risk.
SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Initial application of SFAS No. 133 should be as of the
beginning of an entity's fiscal quarter; on that date, hedging relationships
must be designated anew and documented pursuant to the provisions of SFAS No.
133. Earlier application of SFAS No. 133 is encouraged but is permitted only as
of the beginning of any fiscal quarter that begins after issuance of SFAS No.
133. The Company has not yet adopted SFAS No. 133 nor has it determined the
impact on the results of operations, financial position or cash flows as a
result of implementing SFAS No. 133.
In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise" as an amendment of SFAS No. 65, "Accounting for
Certain Mortgage Banking Activities." SFAS No. 65 establishes accounting and
reporting standards for certain activities of mortgage banking enterprises and
other enterprises that conduct operations that are substantially similar to the
primary operations of a mortgage banking enterprise. SFAS No. 65, as amended by
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," requires that after the
securitization of a mortgage loan held for sale, an entity engaged in mortgage
banking activities classifies the resulting mortgage-backed security as a
trading security. SFAS No. 134 further amends SFAS No. 65 to require that after
the securitization of mortgage loans held for sale, an entity engaged in
mortgage banking activities classifies the resulting mortgage-backed securities
62
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
or other retained interests based on its ability and intent to sell or hold
those investments. SFAS No. 134 conforms the subsequent accounting for
securities retained after the securitization of mortgage loans by a mortgage
banking enterprise with the subsequent accounting for securities retained after
the securitization of other types of assets by a nonmortgage banking enterprise.
SFAS No. 134 is effective for the first fiscal quarter beginning after December
15, 1998. Early application is encouraged and is permitted as of October 1998.
The Company adopted SFAS No. 134 effective October 31, 1998, which did not have
a material impact on the Company's financial position or results of operations
upon adoption.
NOTE 2: ACQUISITION AND DISPOSITION TRANSACTIONS
On May 5, 1998, the Company, through IMI, acquired 1,473,733 partnership units
of Ocwen Partnership L.P. ("OPLP") for $24,508. This purchase was in addition to
the 160,000 units owned at December 31, 1997, and the 175,000 units acquired on
February 17, 1998, for which the Company exchanged shares of Ocwen Asset
Investment Corp. ("OAC") stock, increasing the total number of units owned by
IMI to 1,808,733 or 8.71% of the total partnership units outstanding at December
31, 1998. OPLP is the operating partnership subsidiary of OAC. OAC specializes
in the acquisition and management of real estate and mortgage assets and is
managed by Ocwen Capital Corporation ("OCC"), a wholly-owned subsidiary of OCN.
At December 31, 1998, the Company also owned 1,540,000 or 8.12% of the
outstanding common stock of OAC. Combined equity in the losses of the Company's
investments in OPLP and OAC amounted to $8,701 in 1998.
On April 24, 1998, the Company, through its wholly-owned subsidiary Ocwen UK,
acquired substantially all of the assets, and certain liabilities, of the United
Kingdom ("UK") operations of Cityscape Financial Corp. ("Cityscape UK"). The
acquisition was accounted for as a purchase. The Company acquired Cityscape UK's
mortgage loan portfolio and its residential subprime mortgage loan origination
and servicing businesses for $421,326 ((pound)249,571) and assumed $12,393
((pound)7,341) of Cityscape UK's liabilities. The excess of net assets acquired
over the purchase price (negative goodwill) related to this transaction was
applied to reduce non-current assets, primarily fixed assets.
On February 25, 1998, the Company purchased 36.07% of the total outstanding
common stock of Kensington for $45,858 ((pound)27,837). This investment is
accounted for under the equity method. The acquisition was accounted for as a
purchase. The excess of the purchase price over the net investment, which
amounted to $34,492 ((pound)20,933) net of accumulated amortization of $2,029
((pound)1,192) at December 31, 1998, is being amortized on a straight-line basis
over a period of 15 years and is included under the caption "Investment in
unconsolidated entities" in the consolidated statements of financial condition.
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 $13,025 in cash, common stock of the Company and repayment of certain
indebtedness. The acquisition was accounted for as a purchase. DTS has developed
technology tools to automate real estate transactions. 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. The excess of purchase price over net assets acquired related to
this transaction, which amounted to $7,584 net of accumulated amortization of
$505 at December 31, 1998, is being amortized on a straight-line basis over a
period of 15 years. DTS is a wholly-owned subsidiary of OTX.
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, was deemed impaired and therefore written off during 1998.
On November 6, 1997, the Company acquired AMOS, Inc. ("AMOS"), a
Connecticut-based company engaged primarily in the development of mortgage loan
servicing software. The acquisition was accounted for as a purchase. AMOS'
products are Microsoft(R) Windows(R)-based, have client/server architecture and
feature real-time processing, are designed to be year 2000 compliant, feature a
scalable database platform and have strong workflow capabilities. The aggregate
purchase price was $9,718, including $4,815 which is contingent on AMOS meeting
certain software development performance criteria. The excess of purchase price
over net assets acquired related to this transaction, which amounted to $5,122
net of accumulated amortization of $389 at December 31, 1998, is being amortized
on a straight-line basis over a period of 15 years. AMOS is a wholly-owned
subsidiary of OTX.
63
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
On December 12, 1997, BCBF, L.L.C., (the "LLC"), a limited liability company
formed in March 1996 between the Company and BlackRock Capital Finance L.P.
("BlackRock") 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.
NOTE 3: 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, 1998 and 1997, 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.
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.
SECURITIES AVAILABLE FOR SALE
The Company adjusts its securities portfolio to fair value at the end of each
month based upon the lower of dealer quotations or internal values, subject to
an internal review process. For those securities which do not have an available
market quotation, the Company will request market values and underlying
assumptions from the various securities dealers that underwrote, are currently
financing the securities, or have had prior experience with the type of security
to be valued. When quotations are obtained from two or more dealers, the average
dealer quote is utilized.
LOANS AND DISCOUNT LOANS
The fair value of performing loans is estimated based upon quoted market prices
for similar whole loan pools. The fair value of nonperforming loans is based on
estimated cash flows discounted using a rate commensurate with the risk
associated with the estimated cash flows. 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.
64
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
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, including securities sold under agreements to repurchase and
obligations outstanding under lines of credit, approximate carrying value.
DERIVATIVE FINANCIAL INSTRUMENTS
The fair value of an interest rate swap is the estimated amount that the Company
would receive or pay to terminate the swap at the reporting date taking into
account interest rates and the creditworthiness 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. The fair value of a
currency swap is calculated as the notional amount of the swap multiplied by the
difference between the spot rate at the date of inception and the spot rate at
the financial statement date.
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, 1998 December 31, 1997
----------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ---------- ---------- ----------
FINANCIAL ASSETS:
Cash and cash equivalents ...................... $ 445,179 $ 445,179 $ 151,833 $ 151,833
Securities available for sale .................. 593,347 593,347 476,796 476,796
Loans available for sale ....................... 177,847 177,847 177,041 184,884
Investment securities .......................... 10,825 10,825 10,825 10,825
Loan portfolio, net ............................ 230,312 232,242 266,299 281,850
Discount loan portfolio, net ................... 1,026,511 1,046,945 1,434,176 1,657,222
Investments in low-income housing tax credit
interests .................................... 144,164 158,521 128,614 151,130
Real estate owned, net ......................... 201,551 245,471 167,265 212,443
FINANCIAL LIABILITIES:
Deposits ....................................... 2,175,016 2,218,542 1,982,822 2,024,857
Securities sold under agreements to repurchase.. 72,051 72,051 108,250 108,250
Obligations outstanding under lines of credit .. 179,285 179,285 118,304 118,304
Notes, debentures and other interest-bearing
Obligations .................................. 225,000 205,750 226,975 255,538
Capital securities ............................. 125,000 97,500 125,000 135,313
OTHER:
Loan commitments ............................... 133,489 133,489 182,095 182,095
NOTE 4: SECURITIES HELD FOR TRADING
The Company traded assets totaling $2,250,831, $1,023,965 and $373,723 in
aggregate sales proceeds during the years ended December 31, 1998, 1997 and
1996, respectively, primarily in connection with the Company's securitizations
of loans, resulting in realized net gains of $109,601, $72,214 and $14,645 for
the years ended December 31, 1998, 1997 and 1996, respectively. The Company held
no securities for trading at December 31, 1998 or 1997.
NOTE 5: SECURITIES 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, 1998
Mortgage-related securities
Single family residential:
AAA-rated collateralized mortgage obligations. $ 343,686 $ 552 $ (39) $ 344,199
BB-rated subordinates......................... 8,517 -- -- 8,517
B-rated subordinates.......................... 6,344 -- -- 6,344
Unrated subordinates.......................... 37,872 2,723 -- 40,595
AAA-rated subprime residuals (1).............. 6,178 753 -- 6,931
BBB-rated subprime residuals (1).............. 15,681 1,912 -- 17,593
Unrated subprime residuals (1)................ 141,526 11,425 -- 152,951
----------- ----------- ----------- -----------
559,804 17,365 (39) 577,130
----------- ----------- ----------- -----------
Multi-family and commercial:
B-rated subordinates.......................... 7,684 1,290 (161) 8,813
Unrated subordinates.......................... 4,126 3,340 (135) 7,331
AAA-rated interest-only....................... 71 -- -- 71
BB-rated interest-only........................ -- 2 -- 2
----------- ----------- ----------- -----------
11,881 4,632 (296) 16,217
----------- ----------- ----------- -----------
$ 571,685 $ 21,997 $ (335) $ 593,347
=========== =========== =========== ===========
(1) Includes subprime residuals with a total fair value of $87,334
((pound)51,274) and amortized cost of $73,615 ((pound)44,354) relating
to Ocwen UK.
One security in the available for sale portfolio, with a fair value of $9,929 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).
The amortized cost of mortgage-related securities at December 31, 1998, was net
of unaccreted (discounts) and unamortized premiums of $(65,546).
A profile of the maturities of securities available for sale at December 31,
1998, follows. Mortgage-backed securities are included based on their
weighted-average maturities, reflecting anticipated future prepayments based on
consensus of dealers in the market.
65
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
Amortized Cost Fair Value
---------------- ----------------
Due within one year..................... $ 328,551 $ 332,338
Due after 1 through 5 years............. 151,625 160,659
Due after 5 through 10 years............ 55,780 61,615
Due after 10 years...................... 35,729 38,735
---------------- ----------------
$ 571,685 $ 593,347
================ ================
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Values
------------ ------------ ------------ ------------
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
BB-rated subordinates.......................... 2,496 19 -- 2,515
Unrated subordinates........................... 34,041 5,922 (744) 39,219
Unrated subprime residuals..................... 42,977 552 (1,739) 41,790
Swaps.......................................... -- -- (94) (94)
------------ ------------ ------------ ------------
434,211 7,755 (29,996) 411,970
------------ ------------ ------------ ------------
Multi-family and commercial:
B-rated subordinates........................... 7,585 927 -- 8,512
Unrated subordinates........................... 6,106 1,325 (636) 6,795
AAA-rated interest-only........................ 2,002 1,056 -- 3,058
BB-rated interest-only......................... 165 24 -- 189
------------ ------------ ------------ ------------
15,858 3,332 (636) 18,554
------------ ------------ ------------ ------------
Marketable equity securities:
Common stocks..................................... 38,545 9,638 (1,911) 46,272
------------ ------------ ------------ ------------
$ 488,614 $ 20,725 $ (32,543) $ 476,796
============ ============ ============ ============
Common stocks at December 31, 1997, were comprised primarily of the Company's
investment in OAC. At December 31, 1997, the Company, through IMI, owned
1,715,000 shares or 9.04% of the outstanding common stock of OAC. On May 5,
1998, IMI purchased an additional 1,473,733 units of OPLP, OAC's operating
partnership subsidiary, increasing its combined ownership of OAC and OPLP to
16.83%. As a result of this increase in ownership, the Company began accounting
for its investments in OAC and OPLP under the equity method. See Note 9. The
Company's other common stock investment at December 31, 1997, was sold during
1998.
A profile of the maturities of mortgage-related securities at December 31, 1997,
follows. Mortgage-backed securities are included based on their weighted-average
maturities, reflecting anticipated future prepayments based on 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
============== ==============
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:
66
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
Securities 1998 1997 1996
------------------- ----------- ----------- -----------
Gross realized gains ............ $ 9,082 $ 9,637 $ 4,323
Gross realized losses ........... (957) (3,591) (3,757)
----------- ----------- -----------
Net realized gains (losses) (1).. $ 8,125 $ 6,046 $ 566
=========== =========== ===========
Proceeds on sales ............... $ 269,828 $ 202,670 $ 175,857
=========== =========== ===========
Net premium amortization ........ $ 56,487 $ 66,285 $ 20,247
=========== =========== ===========
(1) Excludes impairment charges of $129,714 incurred during 1998 related to
AAA-rated agency interest-only securities, subordinates and subprime
residual securities.
NOTE 6: LOANS AVAILABLE FOR SALE
The following table sets forth the composition of the Company's loans available
for sale by type of loan at the December 31:
Carrying Value
---------------------------
1998 1997
------------ ------------
Loan type:
Single family residential ............ $ 177,578 $ 176,554
Consumer ............................. 269 487
------------ ------------
Total loans available for sale......
$ 177,847 $ 177,041
============ ============
The loans available for sale portfolio is secured by mortgages on property
located throughout the United States and the United Kingdom. The following table
sets forth the five states or countries in which the largest amount of
properties securing the Company's loans available for sale were located at
December 31, 1998:
Single family
Residential Consumer Total
-------------- ------------- ------------
U.K. (1)..................... $ 87,644 $ -- $ 87,644
California................... 20,960 -- 20,960
New Jersey................... 10,806 -- 10,806
Florida...................... 10,635 108 10,743
Illinois..................... 7,455 -- 7,455
Other (2).................... 40,078 161 40,239
------------ ------------ ------------
Total........................ $ 177,578 $ 269 $ 177,847
============ ============ ============
(1) Represents loans originated by Ocwen UK with a carrying value
of(pound)52,808.
(2) Consists of properties located in 40 other states, none of which
aggregated over $6,180 in any one state.
The following table presents a summary of the Company's nonperforming loans
(loans which were past due 90 days or more) in the loans available for sale
portfolio at December 31:
Nonperforming loans: 1998 1997
-------------- --------------
Single family........................... $ 39,415 $ 13,509
Consumer................................ 9 25
-------------- --------------
$ 39,424 $ 13,534
============== ==============
Nonperforming loans as a percentage of:
Total loans available for sale.......... 22.17% 7.64%
Total assets............................ 1.19% 0.44%
NOTE 7: LOAN PORTFOLIO
The Company's loan portfolio consisted of the following at December 31:
Carrying Value
--------------------------
1998 1994
--------- ---------
Loan type:
Single family residential .................... $ 30,361 $ 46,226
Multi-family residential:
Permanent ................................ 53,311 38,105
Construction ............................. 22,288 33,277
--------- ---------
Total multi-family residential ........... 75,599 71,382
--------- ---------
Commercial real estate:
Hotel:
Permanent ................................ 29,735 64,040
Construction ............................. 6,896 25,322
Office ..................................... 93,068 68,759
Land ....................................... 2,266 2,858
Other ...................................... 6,762 16,094
--------- ---------
Total commercial real estate ............ 138,727 177,073
--------- ---------
Consumer ..................................... 132 244
--------- ---------
Total loans ............................. 244,819 294,925
Undisbursed loan funds ....................... (7,099) (22,210)
Unaccreted discount .......................... (2,480) (2,721)
Allowance for loan losses .................... (4,928) (3,695)
--------- ---------
Loans, net .............................. $ 230,312 $ 266,299
========= =========
At December 31, 1998, the Company had $3,582 of single family residential loans
and $3,645 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, 1998 and 1997, was $12,297 and
$88,954, respectively, of loans in which the Company participated in the
residual profits of the underlying real estate. The Company records any residual
profits as part of interest income when received.
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:
1998 1997 1996
-------------- -------------- --------------
Nonperforming loans:
Single family residential......................... $ 1,169 $ 1,575 $ 2,123
Multi-family residential........................... 7,392 7,583 106
Commercial real estate and other................... 488 -- 55
-------------- -------------- --------------
$ 9,049 $ 9,158 $ 2,284
============== ============== ==============
Allowance for loan losses:
Balance, beginning of year......................... $ 3,695 $ 3,523 $ 1,947
Provision for loan losses.......................... 891 325 1,872
Charge-offs........................................ (219) (153) (296)
Recoveries......................................... 561 -- --
-------------- -------------- --------------
Balance, end of year............................... $ 4,928 $ 3,695 $ 3,523
============== ============== ==============
Significant ratios:................................
Nonperforming loans as a percentage of: Loans 3.81% 3.36% 0.56%
Total assets....................................... 0.27% 0.30% 0.09%
Allowance for loan losses as a percentage of Loans 2.07% 1.35% 0.87%
Nonperforming loans................................ 54.46% 40.35% 154.25%
67
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
If non-accrual loans had been current in accordance with their original terms,
interest income for the years ended December 31, 1998, 1997 and 1996, would have
been greater by approximately $284, $515 and $214, respectively. No interest has
been accrued on loans greater than 89 days past due.
At and for the years ended December 31, 1998 and 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 secured by mortgages on property 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, 1998.
Single Family Multi-family Commercial
Residential Residential Real Estate Consumer Total
------------- ------------- ------------ ------------ ------------
New York................... $ 1,554 $ 23,042 $ 27,663 $ 55 $ 52,314
New Jersey................. 19,679 6,875 3,219 14 29,787
Florida.................... 177 -- 27,686 -- 27,863
Texas...................... 1,710 7,372 3,122 -- 12,204
California................. 268 6,358 4,523 -- 11,149
Other...................... 6,973 31,952 72,514 63 111,502
------------ ------------ ------------ ------------ ------------
Total................... $ 30,361 $ 75,599 $ 138,727 $ 132 $ 244,819
============ ============ ============ ============ ============
NOTE 8: 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
----------------------------
1998 1997
------------ ------------
Loan type:
Single family residential...................... $ 597,100 $ 900,817
Multi-family residential....................... 244,172 191,302
Commercial real estate......................... 449,010 701,035
Other.......................................... 10,144 1,865
------------ ------------
Total discount loans........................ 1,300,426 1,795,019
Unaccreted discount............................ (252,513) (337,350)
Allowance for loan losses...................... (21,402) (23,493)
------------ ------------
Discount loans, net......................... $ 1,026,511 $ 1,434,176
============ ============
68
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
The following table sets forth the payment status at December 31 of the loans in
the Company's gross discount loan portfolio:
December 31, 1998 December 31, 1997
--------------------------- -----------------------
Principal % of Principal % of
Amount Loans Amount Loans
------------- --------- ----------- --------
Loans without Forbearance Agreements:
Current....................................... $ 578,269 44.47% $ 670,115 37.33%
Past due 31 to 89 days........................ 35,555 2.73 21,098 1.18
Past due 90 days or more...................... 509,838 39.21 638,319 35.56
Acquired and servicing not yet transferred.... 57,048 4.39 28,053 1.56
------------- --------- ----------- --------
Subtotal.................................... 1,180,710 90.80 1,357,585 75.63
------------- --------- ----------- --------
Loans with Forbearance Agreements:
Current....................................... 1,180 0.09 3,140 0.18
Past due 31 to 89 days........................ 4,046 0.31 1,688 0.09
Past due 90 days or more (1)(2)............... 114,490 8.80 432,606 24.10
------------- --------- ----------- --------
Subtotal.................................... 119,716 9.20 437,434 24.37
------------- --------- ----------- --------
Total............................................ $ 1,300,426 100.00% $ 1,795,019 100.00%
============= ========== =========== ========
(1) Includes $110,072 of loans which were less than 90 days past due under
the terms of the forbearance agreements at December 31, 1998, of which
$77,893 were current and $32,179 were past due 31 to 89 days.
(2) Includes $316,347 of loans which were less than 90 days past due under
the terms of the forbearance agreements at December 31, 1997, of which
$184,526 were current and $131,821 were past due 31 to 89 days.
A summary of income on discount loans is as follows for the years ended December
31:
1998 1997 1996
----------- ----------- -----------
Interest income:
Realized............................. $ 160,847 $ 157,649 $ 97,174
Accreted and unrealized.............. -- -- 5,991
----------- ----------- -----------
$ 160,847 $ 157,649 $ 103,165
=========== =========== ===========
Gains on sales:
Realized gains on sales.............. $ 12,609 $ 4,215 $ 7,393
=========== =========== ===========
Proceeds on sales.................... $ 626,423 $ 500,151 $ 190,616
=========== =========== ===========
Proceeds and gains on sales of discount loans exclude non-cash proceeds related
to the exchange of discount loans for securities in connection with the
Company's securitization activities (see Note 4).
The following table sets forth the activity in the Company's gross discount loan
portfolio during the years ended December 31:
1998 1997 1996
----------- ----------- -----------
Principal balance at beginning of year..... $ 1,795,019 $ 1,314,399 $ 943,529
Acquisitions............................... 1,123,727 1,776,773 1,110,887
Resolutions and repayments................. (539,353) (484,869) (371,228)
Loans transferred to real estate owned..... (382,904) (292,412) (138,543)
Sales...................................... (696,063) (518,872) (230,246)
----------- ----------- -----------
Principal balance at end of year........... $ 1,300,426 $ 1,795,019 $ 1,314,399
=========== =========== ===========
The discount loan portfolio is secured by mortgages on property 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, 1998:
69
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
Commercial
Single Family Multi-Family Real Estate
Residential Residential and Other Total
----------- ----------- ----------- -----------
California..................... $ 87,850 $ 26,391 $ 97,395 $ 211,636
New York....................... 71,076 8,506 64,381 143,963
Illinois....................... 25,310 74,186 11,662 111,158
Michigan....................... 8,527 65,808 30,513 104,848
New Jersey..................... 71,233 2,903 10,270 84,406
Other.......................... 333,104 66,378 244,933 644,415
----------- ----------- ----------- -----------
Total....................... $ 597,100 $ 244,172 $ 459,154 $ 1,300,426
=========== =========== =========== ===========
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:
1998 1997 1996
----------- ----------- -----------
ALLOWANCE FOR LOAN LOSSES:
Balance at beginning of year.............................. $ 23,493 $ 11,538 $ --
Provision for loan losses................................. 17,618 31,894 20,578
Charge-offs............................................... (20,130) (20,349) (9,216)
Recoveries................................................ 421 410 176
----------- ----------- -----------
Balance at end of year.................................... $ 21,402 $ 23,493 $ 11,538
=========== =========== ===========
SIGNIFICANT RATIOS:
Allowances for loan losses as a percentage of
discount loan portfolio, net of discount.................. 2.04% 1.61% 1.08%
Net charge-offs as a percentage of average discount loans. 1.53% 1.55% 1.34%
NOTE 9: INVESTMENT IN UNCONSOLIDATED ENTITIES
At December 31, 1997, the Company, through IMI, owned 1,715,000 shares or 9.04%
of the outstanding common stock of OAC. Also at December 31, 1997, the Company,
through IMI, owned 160,000 units or 0.84% of the partnership units of OPLP, the
operating partnership subsidiary of OAC. On February 17, 1998, IMI exchanged
175,000 shares of OAC stock for 175,000 OPLP units. On May 5, 1998, IMI acquired
an additional 1,473,733 OPLP units. As a result of this activity, IMI's
investment in OAC stock declined to 1,540,000 shares or 8.12% at December 31,
1998, while its investment in OPLP increased to 1,808,733 units or 8.71%. The
Company began accounting for these entities under the equity method effective
May 5, 1998 upon the increase in the combined ownership of OAC and OPLP to
16.83%. An adjustment to reduce retained earnings in the amount of $979 (net of
income taxes of $526) was recorded upon conversion to the equity method to
reflect the cumulative effect of the accounting change. The Company's investment
in OAC stock amounted to $16,268 at December 31, 1998. The Company's investment
in OAC stock at December 31, 1997, was designated as available for sale and
carried at a fair value of $35,158 ($25,519 cost). The Company's investment in
OPLP units amounted to $22,820 at December 31, 1998, as compared to $2,381 at
December 31, 1997. During 1998, the Company recorded equity in the losses of its
investment in OAC and OPLP of $4,007 and $4,694, respectively. At December 31,
1998, the Company's investment in OAC stock was pledged as collateral on
obligations outstanding under a line of credit.
The Company's investment in unconsolidated entities at December 31, 1998,
includes 36.07% of the total outstanding common stock of Kensington, a leading
originator of non-conforming residential mortgages in the U.K., purchased on
February 25, 1998, for $45,858 ((pound)27,837). The Company's investment in
Kensington amounted to $46,586 at December 31, 1998, net of the excess of the
purchase price over the net investment. The excess of the purchase price over
the net investment amounted to $34,492 ((pound)20,933) at December 31, 1998, net
of accumulated amortization of $2,029 ((pound)1,192), and is amortized over a
period of 15 years. During 1998, the Company recorded equity in earnings of
Kensington of $439, net of the $2,029 amortization of excess cost over purchase
price.
70
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
On December 12, 1997, the LLC distributed all of its assets. 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, includes 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 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.
Set forth below are the statements of operations of the LLC for the periods
indicated.
BCBF, L.L.C.
STATEMENTS OF OPERATIONS
For the Period March
For the March 13, 1996
Year Ended 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
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's investment in unconsolidated entities also includes a joint
venture investment in BCFL, L.L.C. ("BCFL"), a limited liability corporation
formed in January 1997 between the Company and BlackRock. The Company owns a 10%
interest in BCFL which was formed to acquire multi-family loans. At December 31,
1998 and 1997, the Company's investment amounted to $1,133 and $1,056,
respectively. Equity in earnings of BCFL amounted to $277 during 1998.
NOTE 10: REAL ESTATE OWNED
Real estate owned, net of allowance for losses, is held for sale and were
provided from the following portfolios at December 31:
71
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
1998 1997
----------- -----------
Discount loan portfolio:
Single family residential........................ $ 94,641 $ 76,409
Multi-family residential......................... 20,130 16,741
Commercial real estate........................... 82,591 71,339
----------- -----------
Total discount loan portfolio.................... 197,362 164,489
Loan portfolio................................... 227 357
Loans available for sale......................... 3,962 2,419
----------- -----------
$ 201,551 $ 167,265
=========== ===========
The following schedule presents the activity, in aggregate, in the valuation
allowances on real estate owned for the years ended December 31:
1998 1997 1996
----------- ----------- -----------
Balance at beginning of year..................... $ 12,346 $ 11,493 $ 4,606
Provision for losses............................. 18,626 13,450 18,360
Charge-offs and sales............................ (15,647) (12,597) (11,473)
----------- ----------- -----------
Balance at end of year........................... $ 15,325 $ 12,346 $ 11,493
=========== =========== ===========
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:
1998 1997 1996
----------- ----------- -----------
Gains on sales................................... $ 43,839 $ 30,651 $ 22,835
Provision for losses............................. (18,626) (13,450) (18,360)
Carrying costs, net.............................. (11,180) (9,924) (648)
----------- ----------- -----------
$ 14,033 $ 7,277 $ 3,827
=========== =========== ===========
NOTE 11: INVESTMENT IN REAL ESTATE
The Company's investment in real estate consisted of the following at December
31:
1998 1997
----------- -----------
Loans accounted for as investments in real estate:
Multi-family residential...................... $ -- $ 61,967
Nonresidential................................ -- 2,369
----------- -----------
$ -- $ 64,336
----------- -----------
Properties held for lease:
Land and land improvements, (net of accumulated
Depreciation of $3 and $0, respectively).... 5,170 3,477
Building, (net of accumulated depreciation
of $115 and $0, respectively)............... 26,011 2,156
Other (net of accumulated amortization of
$170 and $0, respectively).................. 1,701 814
----------- -----------
32,882 6,447
----------- -----------
Other investments in real estate:
Land.......................................... -- 3,921
Nonresidential................................ 3,978 1,636
----------- -----------
3,978 5,557
----------- -----------
$ 36,860 $ 76,340
=========== ===========
72
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
NOTE 12: MORTGAGE SERVICING
The Company services for other investors mortgage loans which it does not own.
The total amount of such loans serviced for others was $10,592,467 and
$5,509,819 at December 31, 1998 and 1997, respectively. Servicing fee income on
such loans amounted to $45,559, $22,056 and $2,414 for the years ended December
31, 1998, 1997 and 1996, respectively.
The unamortized balance of mortgage servicing rights, which are included in
other assets, is as follows at December 31:
1998 1997
----------- -----------
Unamortized balance............................. $ 8,690 $ 7,369
Valuation allowance............................. (1,630) (1,630)
----------- -----------
$ 7,060 $ 5,739
=========== ===========
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:
1998 1997
-------- --------
Investments solely as a limited partner made prior to May 18, 1995 ........... $ 19,607 $ 31,418
Investments solely as a limited partner made on or after May 18, 1995 ........ 56,299 47,153
Investments both as a limited and, through subsidiaries, as a general partner. 68,258 50,043
-------- --------
$144,164 $128,614
======== ========
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, 1998, the Company's largest single investment
was $9,965, which related to 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 $4,650, $6,846 and $8,144 for the years ended December
31, 1998, 1997 and 1996, respectively. Had these investments been accounted for
under the equity method, net income would have been reduced by $1,113, $665 and
$2,194 for the years ended December 31, 1998, 1997 and 1996, respectively. For
limited partnership investments made after May 18, 1995, and for investments as
a limited and, through subsidiaries, as a general partner, the Company
recognized tax credits of $13,017, $8,035 and $1,186 for the years ended
December 31, 1998, 1997 and 1996, respectively, and recorded a loss of $6,905,
$4,935 and $636 from operations on the underlying real estate after depreciation
for the years ended December 31, 1998, 1997 and 1996, respectively.
Included in other income for the years ended December 31, 1998, 1997 and 1996,
are gains of $7,366, $6,053 and $4,861, respectively, on the sales of certain
investments in low-income housing tax credit interests which had carrying values
of $28,887, $15,728 and $19,806, respectively, at time of sale.
NOTE 14: PREMISES AND EQUIPMENT
Premises and equipment at December 31 are summarized as follows:
1998 1997
----------- -----------
Land and land improvements......................... $ 4,782 $ 773
Leasehold improvements............................. 9,062 7,664
Office and computer equipment...................... 44,828 28,675
Construction in progress........................... 951 --
Less accumulated depreciation and amortization..... (25,800) (15,570)
----------- -----------
$ 33,823 $ 21,542
=========== ===========
Occupancy and equipment expenses include depreciation expense of $11,703, $6,821
and $4,547 for 1998, 1997 and 1996, respectively. Construction in progress
represents the construction costs incurred in connection with the nationwide
customer service and collection facility currently under construction in
Orlando, Florida.
73
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
NOTE 15: DEPOSITS
The Company's deposits consist of the following at December 31:
1998 1997
------------------------------------ ---------------------------------------
Weighted Percent Weighted Percent
Average Book of Total Average Book of Total
Rate Value Deposits Rate Value Deposits
-------- ----------- ---------- --------- ----------- ------------
Non-interest-bearing deposits...... --% $ 233,427 10.7% --% $ 130,372 6.6%
NOW and money market checking 3.40 33,272 1.5 4.73 27,624 1.4
accounts........................
Savings accounts................... 2.30 1,326 0.1 2.30 1,664 0.1
------ -----------
268,025 12.3 159,660 8.1
------ -----------
Certificates of deposit............ 1,916,548 1,834,899
Unamortized deferred fees.......... (9,557) (11,737)
----------- -----------
5.78 1,906,991 87.7 6.00 1,823,162 91.9
----------- ------ -----------
Total deposits..................... 5.18 $ 2,175,016 100.0% 5.95 $ 1,982,822 100.0%
=========== ====== =========== ======
At December 31, 1998 and 1997, certificates of deposit, exclusive of unamortized
deferred fees, include $1,856,902 and $1,777,586, 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, 1998 and 1997, $100,463 and $133,738,
respectively, of certificates of deposit were issued on an uninsured basis. Of
the $100,463 of uninsured deposits at December 31, 1998, $47,858 were from
political subdivisions in New Jersey and are secured or collateralized as
required under state law. Non-interest bearing deposits include $213,116 and
$96,518 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, 1998 and 1997, respectively.
The contractual maturity of the Company's certificates of deposit at December
31, 1998, follows:
CONTRACTUAL REMAINING MATURITY:
Within one year.......................................... $ 976,808
Within two years......................................... 366,607
Within three years....................................... 292,871
Within four years........................................ 197,493
Within five years........................................ 48,879
Thereafter............................................... 24,333
---------------
$ 1,906,991
===============
The amortization of the deferred fees of $6,353, $6,619 and $5,384 for the years
ended December 31, 1998, 1997 and 1996, 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:
1998 1997 1996
----------- ----------- -----------
NOW accounts and money market checking......... $ 1,434 $ 1,220 $ 620
Savings ....................................... 38 49 78
Certificates of deposit........................ 115,112 120,801 93,075
----------- ----------- -----------
$ 116,584 $ 122,070 $ 93,773
=========== =========== ===========
Accrued interest payable on deposits amounted to $22,687 and $21,967 at December
31, 1998 and 1997, respectively.
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
74
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
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.
December 31,
----------------------------------------------
1998 1997 1996
----------- ----------- -----------
OTHER INFORMATION CONCERNING SECURITIES
SOLD UNDER AGREEMENTS TO REPURCHASE:
Balance at end of year (1)...................... $ 72,051 $ 108,250 $ 74,546
Accrued interest payable at end of year......... $ 214 $ 306 $ 12
Weighted average interest rate at end of year... 7.95% 6.06% 5.46%
Average balance during the year................. $ 104,980 $ 16,717 $ 19,581
Weighted average interest rate during the year.. 6.20% 5.98% 5.62%
Maximum month-end balance....................... $ 314,515 $ 108,250 $ 84,321
(1) At December 31, 1998, $29,011 ((pound)17,480) related to Ocwen UK.
Securities sold under agreements to repurchase at December 31, 1998, were
contractually due between January 1999 and December 2030. Mortgage-related
securities with an amortized cost of $137,705 and a fair value of $148,839 were
posted as collateral for securities sold under agreements to repurchase at
December 31, 1998. Interest expense incurred on securities sold under agreements
to repurchase amounted to $6,514, $1,000 and $1,101 during 1998, 1997 and 1996
respectively.
NOTE 17: OBLIGATIONS OUTSTANDING UNDER LINES OF CREDIT
The Company through its subsidiaries has obtained secured lines of credit
arrangements from various unaffiliated financial institutions primarily to fund
its growth in subprime single family residential loans, both domestically and in
the U.K.
At December 31, 1998, the Company, through its subsidiary OFS, had short-term
secured lines of credit with unaffiliated financial institutions as follows: (i)
a $200,000 secured line of credit, of which $100,000 was committed, (ii) a
$50,000 secured line of credit, all of which was committed, (iii) a $200,000
secured line of credit, of which $100,000 was committed, (iv) a $100,000 secured
line of credit, none of which was committed, and (v) a $20,000 secured residual
line of credit, none of which was committed. The lines of credit mature between
March 1999 and July 2001 and bear interest at rates that float in accordance
with designated indices. The terms of the line of credit agreements contain,
among other provisions, requirements for maintaining certain profitability,
defined levels of net worth and debt-to-equity ratios. At December 31, 1998, OFS
failed to comply with the maintenance of profitability covenant for one of its
credit lines. OFS obtained the lender's agreement waiving the requirement of
this covenant for the period ended December 31, 1998. The agreements also
require a facility fee based on the total committed amount. Such commitment fees
are capitalized and amortized on a straight-line basis over a twelve-month
period. In addition, one agreement requires a non-usage fee, which is expensed
as incurred, based on the unused portion of the committed amount. At December
31, 1998 and 1997, obligations outstanding under these lines of credit totaled
$59,492 and $118,304, respectively. The weighted average interest rate on these
lines of credit outstanding at December 31, 1998 and 1997, was 6.26% and 6.32%,
respectively.
Additionally, the Company's foreign subsidiary, Ocwen UK, has entered into a
Loan Facility Agreement with Greenwich International Ltd. ("Greenwich") under
which Greenwich provided a short-term facility to finance the acquisition of
Cityscape UK's mortgage loan portfolio (the "Term Loan") and to finance Ocwen
UK's further originations and purchase of subprime single family loans (the
"Revolving Facility, and together with the Term Loan, the "Greenwich Facility").
The Greenwich Facility is secured by Ocwen UK's loans available for sale. The
Revolving Facility which matures in April 1999, is set at a maximum of $166,000
((pound)100,000 reduced by the amount borrowed under the Term Loan) of which
$87,100 ((pound)52,504) was funded at December 31, 1998, to finance subprime
single family loan originations and bears interest at a rate of the one-month
LIBOR plus 1.50%. At December 31, 1998, $5,600 ((pound)3,381) had been borrowed
under the Term Loan, which matured in January 1999. In addition, Ocwen UK has
entered into a secured warehouse line of credit with Barclays Bank plc (the
"Barclays Facility") to finance subprime single family loan originations. The
Barclays Facility, which matures in November 1999, and bears interest at a rate
of the one-month LIBOR plus 0.80%, is set at a maximum of $124,500
((pound)75,000), against which $24,600 ((pound)14,800) had been borrowed at
December 31, 1998. The weighted average interest rate on these lines of credit
outstanding at December 31, 1998, was 7.35%.
75
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
The lines are used to fund mortgage loan originations and are generally advanced
at a rate of 80% to 98% of the principal balance of the mortgage loan. Interest
expense on obligations outstanding under lines of credits amounted to $34,587,
$5,578 and $0 during 1998, 1997 and 1996, respectively.
NOTE 18: NOTES, DEBENTURES AND OTHER INTEREST-BEARING OBLIGATIONS
Notes, debentures and other interest-bearing obligations mature as follows:
December 31,
-----------------------------
1998 1997
----------- -----------
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
----------- -----------
$ 225,000 $ 226,975
=========== ===========
The $100,000 of 12% Subordinated Debentures due 2005 (the "Debentures") were
issued by the Bank 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 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 $1,894 and $2,319, at December 31, 1998 and 1997,
respectively, and is included in other assets. Accrued interest payable on the
Debentures amounted to $500 at December 31, 1998 and 1997, 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 semiannually 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'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%
76
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
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.
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 semiannual interest payment dates. The Company
maintains an investment in cash and cash equivalents, or $14,844 at December 31,
1998 and 1997, 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 $3,838 and $4,647 at December 31, 1998 and 1997, respectively, and
is included in other assets. Accrued interest payable on the Notes amounted to
$3,711 at December 31, 1998 and 1997, and is included in accrued expenses,
payables and other liabilities.
NOTE 19: CAPITAL SECURITIES
In August 1997, Ocwen Capital Trust ("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 are entitled to receive cumulative cash
distributions accruing from the date of original issuance and payable
semiannually 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 $5,664 and $5,249 at
December 31, 1998 and 1997, respectively, 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 semiannual 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 semiannually.
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)
77
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
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 semiannual 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 $4,187 and $4,262 at December 31, 1998 and 1997, respectively, and
is included in other assets.
NOTE 20: BASIC AND DILUTED EARNINGS PER SHARE
Under SFAS No. 128, 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, excludes common stock equivalents and 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, including
the dilutive potential common shares related to outstanding stock options. In
computing diluted net loss per share for 1998, the conversion of common stock
equivalents was not assumed as the effect would be antidilutive.
The following is a reconciliation of the calculation of basic EPS to diluted
EPS.
1998 1997 1996
----------- ----------- -----------
Net (loss) income ....................... $ (1,200) $ 78,932 $ 50,142
=========== =========== ===========
Basic EPS:
Weighed average shares of common stock... 60,736,950 56,185,956 50,556,572
=========== =========== ===========
Basic EPS .......................... $ (0.02) $ 1.40 $ 0.99
=========== =========== ===========
Diluted EPS:
Weighed average shares of common stock... 60,736,950 56,185,956 50,556,572
Effect of dilutive securities:
Stock options ...................... -- 650,528 2,822,310
----------- ----------- -----------
60,736,950 56,836,484 53,378,882
=========== =========== ===========
Diluted EPS ........................ $ (0.02) $ 1.39 $ 0.94
=========== =========== ===========
78
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
NOTE 21: DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses derivative financial instruments for the purpose of reducing
its exposure to adverse fluctuations in interest and foreign currency exchange
rates. While these hedging instruments are subject to fluctuations in value,
such fluctuations are generally offset by the change in value of the underlying
exposures being hedged.
INTEREST RATE MANAGEMENT
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. In
addition, the notional amount of the swap outstanding is amortized (i.e.,
reduced) monthly based on estimated prepayment rates. At December 31, 1998, the
Company had no swaps outstanding.
The terms of the outstanding swap at December 31, 1997, are as follows:
Notional LIBOR Floating Rate
Maturity Amount Index Fixed Rate at End of Year Fair Value
-------- ------ ----- ---------- -------------- ----------
1998 $36,860 1-Month 6.18% 5.69% $(94)
The interest expense or benefit of the swaps had the effect of decreasing net
interest income by $115, $198 and $58 for the years ended December 31, 1998,
1997 and 1996, 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. At December
31, 1998, the Company had no interest rate futures contracts outstanding.
Terms and other information on interest rate futures contracts sold short at
December 31, 1997, were as follows:
Notional
Maturity Principal Fair Value
-------- --------- ----------
U.S. Treasury futures............. 1998 $194,500 $1,996
The fair value of the interest rate swaps and interest rate futures contacts
represent the estimated amount that the Company would receive or pay to
terminate these agreements taking into account current interest rates. Market
quotes are available for these agreements. The fair values are recorded in the
Consolidated Statements of Financial Condition offsetting the items being
hedged. The following table summarizes the Company's use of interest rate risk
management instruments.
79
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
Notional Amount
----------------------------------------------
Short Short
Eurodollar U.S. Treasury
Swaps Futures Futures
----------- ------------- -----------
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
Purchases................................................. -- -- 440,500
Maturities................................................ (36,860) -- --
Terminations.............................................. -- -- (635,000)
----------- ----------- -----------
BALANCE, DECEMBER 31, 1998................................ $ -- $ -- $ --
=========== =========== ===========
U.S. Treasury Bills with a fair value of $2,055 were pledged by the Company as
security for the obligations under these swaps and interest rate futures
contracts at December 31, 1997.
FOREIGN CURRENCY MANAGEMENT
The Company enters into foreign currency derivatives to hedge its equity
investments in Ocwen UK and Kensington. It is the Company's policy to
periodically adjust the amount of foreign currency derivative contracts it has
entered into in response to changes in its recorded equity investment in these
foreign entities.
The Company has determined that the local currency of its foreign subsidiary,
Ocwen UK and its equity investment in Kensington, is the functional currency. In
accordance with SFAS No. 52, "Foreign Currency Translation," assets and
liabilities denominated in a foreign currency are translated into U.S. dollars
at the current rate of exchange existing at the statement of financial condition
date and revenues and expenses are translated at average monthly rates.
On April 22, 1998, the Company sold short foreign currency futures contracts
("currency futures") to hedge its foreign currency exposure related to its
equity investment in Ocwen UK. Periodically, the Company adjusts the amount of
currency futures contracts it has entered into in response to changes in its
equity investment in Ocwen UK. Under the terms of the currency futures at
December 31, 1998, the Company has the right to receive $43,828 and pay
(pound)26,563. The fair value of the currency futures is based on quoted market
prices.
On February 25, 1998, the Company entered into a foreign currency swap agreement
("currency swap") with a AAA-rated counterparty to hedge its equity investment
in Kensington. Under the terms of the currency swap, the Company will swap
(pound)27,500 for $43,546 in five years based on the exchange rate on the date
the contract became effective. The discount on the currency swap, representing
the difference between the contracted forward rate and the spot rate at the date
of inception, is amortized over the life of the currency swap on a straight-line
basis. The value of the currency swap is calculated as the notional amount of
the currency swap multiplied by the difference between the spot rate at the date
of inception and the spot rate at the financial statement date. In addition, the
Company sold short foreign currency futures contracts to further hedge its
foreign currency exposure related to its equity investment in Kensington. Under
the terms of the currency futures, the Company has the right to receive $1,547
and pay (pound)938. The fair value of the currency futures is based on quoted
market prices.
The resulting translation adjustments, the unamortized discount on the currency
swap and the values of the hedging financial instruments are reported as
translation adjustments and included as a component of stockholders' equity.
80
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
The following table sets forth the terms and values of these financial
instruments at December 31, 1998. No such financial instruments were held at
December 31, 1997:
Notional Amount
-------------------------- Contract Unamortized
Maturity Pay Receive Rate Discount Fair Value
-------- ------------- ------- -------- ----------- ----------
Currency swap...................... 2003 (pound)27,500 $ 43,546 1.5835 $ 1,562 $ (2,096)
British Pound currency futures..... 1999 (pound)938 $ 1,547 1.6500 n/a $ (6)
1999 (pound)26,563 $ 43,828 1.6500 n/a $ (181)
Because interest rate futures and foreign currency 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 interest and currency swaps and controls this risk
through credit monitoring procedures. The notional principal amount does not
represent the Company's exposure to credit loss.
On January 1, 1999, 11 of the 15 member countries of the European Union
converted to a common currency (the "Euro"). Since such time transactions have
been conducted using either the Euro or the countries' existing currencies.
Although the United Kingdom is a member of the European Union, it is not one of
the participating countries in the Euro conversion, and the Company currently
does not have transactions or operations in any of the participating countries.
As a result, the Euro conversion had no effect on the Company's financial
condition or results of operations.
NOTE 22: INCOME TAXES
Total income tax expense (benefit) was allocated as follows:
Years Ended December 31,
----------------------------------
1998 1997 1996
--------- --------- ---------
Income (loss) from continuing operations........................................... $ (30,699) $ 21,309 $ 11,159
Benefit of tax deduction in excess of amounts recognized for financial reporting
purposes related to employee stock options reflected in stockholders' equity.... (2,398) (1,965) (2,987)
Benefit of tax deduction in excess of amounts recognized for financial reporting
purposes related to director restricted stock reflected in stockholders' equity. (13) -- --
--------- --------- ---------
$ (33,110) $ 19,344 $ 8,172
========= ========= =========
The components of income tax expense (benefit) attributable to income from
continuing operations were as follows:
Years Ended December 31,
----------------------------------------------
CURRENT: 1998 1997 1996
----------- ----------- -----------
Federal................................. $ (11,668) $ 42,482 $ (6,844)
Foreign................................. 5,995 -- --
State................................... 4,608 3,579 (576)
----------- ----------- -----------
(1,065) 46,061 (7,420)
----------- ----------- -----------
DEFERRED:
Federal................................. (27,443) (23,085) 16,616
State................................... (2,191) (1,667) 1,963
----------- ----------- -----------
(29,634) (24,752) 18,579
----------- ----------- -----------
Total................................... $ (30,699) $ 21,309 $ 11,159
=========== =========== ===========
Income tax expense differs from the amounts computed by applying the U.S.
Federal corporate income tax rate of 35% as follows:
81
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
Years Ended December 31,
--------------------------------
1998 1997 1996
-------- -------- --------
Expected income tax expense at statutory rate .... $(11,328) $ 34,838 $ 21,455
Differences between expected and actual tax: ..... -- -- --
Excess of cost over net assets acquired ....... 19 (30) (76)
adjustments
Tax effect of utilization of net operating loss (3,003) (906) (1,782)
State tax (after Federal tax benefit) ......... 1,571 1,243 901
Low-income housing tax credits ................ (17,666) (14,881) (9,330)
Adjustments resulting from IRS audit .......... -- 921 --
Other ......................................... (292) 124 (9)
-------- -------- --------
Actual income tax (benefit) expense ......... $(30,699) $ 21,309 $ 11,159
======== ======== ========
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 $42,400 of applicable
excess reserves. As of December 31, 1996, the Bank had fully provided for the
tax related to this recapture.
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, 1998 and
1997, the amount of those reserves was approximately $5,700. This reserve could
be recognized in the future under the conditions described in the preceding
paragraph.
82
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
The net deferred tax assets were comprised of the following:
December 31,
-------------------
1998 1997
-------- -------
DEFERRED TAX ASSETS:
Tax residuals and deferred income on tax residuals.. $ 5,328 $ 3,497
State taxes ........................................ 2,511 2,203
Application of purchase accounting ................. 127 655
Accrued profit sharing ............................. 3,861 3,234
Accrued other liabilities .......................... 773 2,495
Deferred interest expense on discount loan portfolio 12,554 7,685
Mark-to-market and reserves on REO properties ...... 3,828 3,187
Gain on loan foreclosure ........................... 6,246 5,635
Bad debt and loan loss reserves .................... 7,857 9,770
Reserves and impairments on securities held for sale 16,308 4,007
Mortgage servicing right impairment and amortization 787 --
Goodwill impairment and amortization ............... 3,521 --
Contingent interest income on equity participation.. 2,673 --
Reserves and impairment on investments ............. 4,978 --
Partnership losses and low-income housing tax credit 7,113 --
Other .............................................. 1,542 495
-------- -------
80,007 42,863
-------- -------
DEFERRED TAX LIABILITIES:
Net U.S. tax on undistributed foreign income .......... 784 --
Deferred interest income on discount loan portfolio ... 4,698 2,254
Partnership losses and low income housing tax credit .. -- 1,386
Other ................................................. 1,094 763
-------- -------
6,576 4,403
-------- -------
73,431 38,460
-------- -------
Mark-to-market on certain mortgage-backed and related
securities available for sale ......................... (7,894) 6,688
Foreign currency translation adjustments .............. 912 --
Prior period adjustment on investments ................ 526 --
-------- -------
66,975 45,148
-------- -------
Deferred tax asset valuation allowance ................ -- --
-------- -------
Net deferred tax assets ............................... $ 66,975 $45,148
======== =======
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, 1998, 1997 and 1996, the Company had approximately $0,
$0 and $10,228, respectively, of net operating loss carryforwards for tax
purposes.
International Hotel Group ("IHG"), a wholly-owned subsidiary of IMI, and IHG's
subsidiaries had at December 31, 1998, approximately $1,079 of Separate Return
Limitation Year ("SRLY") net operating loss carryforwards. The SRLY net
operating loss carryforward can only offset IHG and its subsidiaries' future
taxable income. The $1,079 operating loss carryforward will expire, if unused,
in the year 2008.
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, 1998. 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.
83
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
A valuation allowance was not required as of December 31, 1998 and 1997, 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 23: EMPLOYEE BENEFIT AND COMPENSATION PLANS
The Company maintains a defined contribution plan to provide postretirement
benefits to eligible employees. The Company also adopted a number of
compensation plans for certain employees. These plans were designed to
facilitate a pay-for-performance policy, further align the interests of officers
and key employees with the interests of the Company's shareholders and assist in
the attraction and retention of employees vital to the Company's long-term
success. These plans are summarized below.
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. The Company's contributions to the 401(k) plan in the years ended
December 31, 1998, 1997 and 1996, were $611, $368 and $258, respectively.
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.
ANNUAL INCENTIVE PLAN
In May 1998, the Company's shareholders approved the 1998 Annual Incentive Plan
(the "AIP") to replace the Company's former annual incentive plan. Participation
in the AIP is limited to officers and other key employees of the Company and
designated subsidiaries that are selected by the AIP Committee. Performance
targets are established based on the achievement of specified levels of
increases in net earnings, return in equity, average net equity used or growth
in assets, as well as individual participant performance targets. Awards under
the AIP are based on achieving the performance targets and are paid in cash or a
combination of cash and non-qualified stock options to purchase OCN's common
stock. Such non-qualified stock options are granted pursuant to the Ocwen
Financial Corporation Non-Qualified Stock Option Plan.
Stock options awarded to key employees under the AIP (both the 1998 plan and
former plan) to purchase shares of OCN common stock are summarized as follows.
Options Exercise Options Forfeited or Options
Granted Price Exercised Repurchased Vested
--------- ---------- --------- ----------- --------
1995........................... 594,760 $ 2.880 223,919 281,841 89,000
1995........................... 14,220 .472 5,057 4,083 5,080
1996........................... 1,147,370 11.000 174,573 281,743 691,054
1997........................... 1,083,794 20.350 -- 145,678 938,116
1998........................... 80,000 20.350 -- 40,000 40,000
1998........................... 181,945 12.313 -- -- --
Stock options awarded under the AIP prior to 1998 have a one-year vesting
period. Stock options awarded under the AIP in 1998 vest ratably over a
three-year period. The difference, if any, 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 $0, $5,514 and $2,725 for the years
ended December 31, 1998, 1997 and 1996, respectively, related to options
granted.
84
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
LONG-TERM INCENTIVE PLAN
In May 1998 the Company's shareholders approved the Long-Term Incentive Plan
(the "LIP"). Participation in the LIP is limited to officers and other key
employees of the Company and designated subsidiaries that are selected by the
LIP Administrator. The LIP provides for the grant of Basis Points to
participants. In connection with this grant, the LIP Administrator has
established three five-year performance cycles as well as Company and individual
participant performance targets for such periods. At the end of each performance
cycle, the Company will determine the value of the Basis Points held by each
participant based on the extent to which the related performance targets are
achieved, and will pay each participant their respective value in restricted
common stock of the Company. The number of shares received will be determined
based on the fair market value, as defined, of the common stock on the last day
of the performance cycle. The restricted stock issued to participants will vest
over a ten-year period and, upon vesting, certificates representing the shares
will be held by the Company in a nonqualified irrevocable trust established by
the Company for the benefit of the participant and will be issued to
participants in 20% increments in each year over a five-year pay-out period.
While the shares are held by the Company the participant will have all the
rights of a shareholder, including the right to vote except that (i) the
participant will not be entitled to receive a certificate representing the
shares and (ii) the shares may not be transferred, sold, assigned, pledged or
otherwise encumbered. Any cash dividends paid on common stock will be reinvested
to purchase additional shares of common stock, subject to the same restrictions
that apply to restricted stock. Compensation expense of $2,369 was recorded in
1998 for future distributions under the Plan.
PRO FORMA EFFECT OF SFAS NO. 123
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 Ended December 31,
-------------------------------------------
1998 1997 1996
-------- -------- --------
Net (loss) income, as reported............................ $ (1,200) $ 78,932 $ 50,142
Pro forma net (loss) income............................... $ (2,638) $ 72,668 $ 47,777
Earnings per share, as reported:
Basic.................................................. $ (0.02) $ 1.40 $ 0.99
Diluted................................................ $ (0.02) $ 1.39 $ 0.94
Pro forma earnings per share:
Basic.................................................. $ (0.04) $ 1.29 $ 0.95
Diluted................................................ $ (0.04) $ 1.28 $ 0.90
The fair value of the option grants were estimated using the Black-Scholes
option-pricing model with the following assumptions:
Year Ended December 31,
--------------------------
1998 1997
-------- --------
Expected dividend yield................................... 0.00% 0.00%
Expected stock price volatility........................... 57.00% 48.00%
Risk-free interest rate................................... 4.54% 5.71%
Expected life of options.................................. 5 years 5 years
NOTE 24: STOCKHOLDERS' EQUITY
On July 12, 1996, shareholders 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.
85
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
During September 1996, 5,857,660 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, were
repaid during 1997.
On September 25, 1996, certain shareholders of Ocwen completed an initial public
offering of 4,600,000 shares of Ocwen common stock. At that time, the Company's
common stock began trading on the NASDAQ National Market System under the symbol
"OCWN." 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 6,900,000 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 shareholders and retired 17,630,120
shares of common stock for the aggregate price of $41,997.
NOTE 25: 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, 1998, the minimum regulatory capital requirements
were:
Tangible and core capital of 1.50 percent and 3.00 percent of total
adjusted assets, respectively, consisting principally of stockholders' equity,
but excluding most intangible assets, such as goodwill and any net unrealized
gains or losses on debt securities available for sale.
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 8.00 percent of the value of
risk-weighted assets.
At December 31, 1998 and 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, 1998, that
management believes have changed the institution's category.
86
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
The following tables summarize the Bank's actual and required regulatory capital
at December 31, 1998 and 1997.
To Be Well Agreed Upon
Capitalized Capital
Minimum For Capital For Prompt Corrective Requirements
December 31, 1998 Actual Adequacy Purposes Action Provisions Actual
- - -------------------------------------- ----------------- ------------------ ------------------ ----------
Ratio Amount Ratio Amount Ratio Amount Percentage
----- --------- ----- --------- ----- --------- ----------
Stockholders' equity, and ratio to
total assets....................... 9.30% $ 241,419
Net unrealized (gain) loss on certain
available for sale securities...... (303)
Non includable subsidiary.......... (6,030)
Excess mortgage servicing rights and
deferred tax assets................ (411)
---------
Tangible capital, and ratio to adjusted
total assets....................... 9.07% $ 234,675 1.50% $ 38,821
========= =========
Tier 1 (core) capital, and ratio to
adjusted total assets............ 9.07% $ 234,675 3.00% $ 77,641 5.00% $ 129,402 9.00%
========= ========= =========
Tier 1 capital, and ratio to
risk-weighted assets............... 11.71% $ 234,675 6.00% $ 120,027
========= =========
Allowance for loan and lease losses... 25,047
Subordinated debentures............... 100,000
---------
Tier 2 Capital........................ 125,047
---------
Low-level recourse reduction.......... (13,897)
---------
Total risk-based capital, and ratio to
risk-weighted assets............... 17.26% $ 345,825 8.00% $ 160,295 10.00% $ 200,368 13.00%
========== ========= =========
Total regulatory assets............... $2,594,792
==========
Adjusted total assets................. $2,588,048
==========
Risk-weighted assets.................. $2,003,684
==========
Agreed Upon
To Be Well Agreed Upon
Capitalized Capital
Minimum For Capital For Prompt Corrective Requirements
December 31, 1997 Actual Adequacy Purposes Action Provisions Actual
- - -------------------------------------- ----------------- ------------------ ------------------ ----------
Ratio Amount Ratio Amount Ratio Amount Percentage
----- --------- ----- --------- ----- --------- ----------
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
==========
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.
87
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
The OTS recently published amendments to its capital distribution regulation
which becomes effective April 1, 1999. Under the revised regulation, the Bank
will be required to file either an application or a notice with the OTS at least
30 days prior to making a capital distribution. The OTS may deny the Bank's
application or disapprove its notice if the OTS determines that (a) the Bank
will be "undercapitalized," "significantly undercapitalized" or "critically
under capitalized," as defined in the OTS capital regulations, following the
capital distribution, (b) the proposed capital distribution raises safety and
soundness concerns or (c) the proposed capital distribution violates a
prohibition contained in any statute, regulation or agreement between the Bank
and the OTS or a condition imposed on the Bank in an application or notice
approved by the OTS.
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
18).
Following an examination by the OTS in late 1996 and early 1997, 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 above). 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.
88
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
NOTE 26: OTHER OPERATING EXPENSES
Years Ended December 31,
---------------------------
1998 1997 1996
------- ------- -------
Professional fees ...................... $14,647 $ 4,989 $ 2,293
Marketing .............................. 5,246 774 701
Travel, lodging, meals and entertainment 4,573 2,636 1,522
FDIC insurance ......................... 1,867 1,593 3,098
Amortization of offering costs ......... 1,381 1,302 622
Conferences and seminars ............... 1,117 666 295
Investment and treasury services ....... 914 458 438
Corporate insurance .................... 608 611 441
Deposit related expenses ............... 420 255 91
OTS assessment ......................... 400 375 293
Due diligence costs .................... 315 1,977 564
Other .................................. 912 3,645 458
SAIF recapitalization assessment (1) ... -- -- 7,140
------- ------- -------
$32,400 $19,281 $17,956
======= ======= =======
(1) Represents 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 27: BUSINESS SEGMENT REPORTING
The Company adopted SFAS No. 131 which requires public enterprises to report
financial and descriptive information about its reportable operating segments.
Operating segments are defined as components of an enterprise that (a) engages
in business activities from which it may earn revenues and incur expenses, (b)
whose operating results are regularly reviewed by the enterprise's chief
operating decision maker to make decisions about resources to be allocated to
the segment and assess its performance, and (c) for which discrete financial
information is available. An operating segment may engage in business activities
for which it has yet to earn revenues. The Company conducts a variety of
business activities within the following segments.
Net Interest Non-Interest Non-Interest Net (Loss) Total
Income Income Expense Income Assets
--------- --------- --------- ----------- ----------
December 31, 1998 Discount loans:
Single family residential loans ............ $ 21,568 $ 35,667 $ 17,339 $ 14,394 $ 613,769
Large commercial real estate loans ......... 35,220 31,254 13,723 28,103 591,612
Small commercial real estate loans ......... 23,149 7,643 9,634 8,195 259,609
--------- --------- --------- ----------- ----------
79,937 74,564 40,696 50,692 1,464,990
--------- --------- --------- ----------- ----------
Mortgage loan servicing:
Domestic ................................... 6,604 46,732 39,945 8,066 56,302
Foreign (U.K.) ............................. 147 12,989 6,222 4,771 11,974
--------- --------- --------- ----------- ----------
6,751 59,721 46,167 12,837 68,276
--------- --------- --------- ----------- ----------
Investment in low-income housing tax credits (8,246) 8,286 11,498 9,119 220,234
Commercial real estate lending ............. 16,066 8,542 2,624 13,588 74,439
OTX ........................................ 5 1,711 11,335 (9,623) 21,659
Subprime single family residential lending:
Domestic ................................... 14,080 5,807 52,514 (20,524) 156,997
Foreign (U.K.) ............................. 11,898 35,609 35,550 7,475 286,224
--------- --------- --------- ----------- ----------
25,978 41,416 88,064 (13,049) 443,221
--------- --------- --------- ----------- ----------
Investment securities ...................... (214) (85,031) 5,143 (59,186) 382,201
Equity investment in OAC ................... -- (8,701) -- (8,701) 39,088
Other ...................................... 7,493 7,790 17,557 (4,764) 593,971
--------- --------- --------- ----------- ----------
127,770 108,298 223,084 (9,087) 3,308,079
Unallocated amounts ........................ (4,969) 3,017 3,310 7,887 --
--------- --------- --------- ----------- ----------
$ 122,801 $ 111,315 $ 226,394 $ (1,200) $3,308,079
========= ========= ========= =========== ==========
89
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
Net Interest Non-Interest Non-Interest Net (Loss) Total
Income Income Expense Income Assets
--------- --------- --------- ----------- ----------
December 31, 1997
Discount loans:
Single family residential loans ............ $ 24,870 $ 45,195 $ 17,695 $ 23,349 $ 844,146
Large commercial real estate loans ......... 33,142 18,505 12,940 24,474 585,035
Small commercial real estate loans ......... 19,257 1,966 8,555 5,349 308,543
--------- --------- --------- ----------- ----------
77,269 65,666 39,190 53,172 1,737,724
--------- --------- --------- ----------- ----------
Mortgage loan servicing:
Domestic ................................... 2,629 25,934 29,215 3,972 11,160
Foreign (U.K.) ............................. -- -- -- -- --
--------- --------- --------- ----------- ----------
2,629 25,934 29,215 3,972 11,160
--------- --------- --------- ----------- ----------
Investment in low income housing tax credits (5,080) 6,121 10,052 9,087 168,748
Commercial real estate lending ............. 25,794 (191) 6,520 12,405 230,682
OTX ........................................ (33) (2) 419 -- 5,116
Subprime single family residential lending:
Domestic ................................... 5,205 18,475 28,875 (2,166) 225,814
Foreign (U.K.) ............................. -- -- -- -- --
--------- --------- --------- ----------- ----------
5,205 18,475 28,875 (2,166) 225,814
--------- --------- --------- ----------- ----------
Investment securities ...................... 2,698 5,227 3,784 3,587 344,231
Equity investment in OAC ................... -- -- -- -- --
Other ...................................... 7,960 2,737 9,241 944 345,690
--------- --------- --------- ----------- ----------
116,442 123,967 127,296 81,001 3,069,165
Unallocated amounts ........................ (200) (18) (422) (2,069) --
--------- --------- --------- ----------- ----------
$ 116,242 $ 123,949 $ 126,874 $ 78,932 $3,069,165
========= ========= ========= =========== ==========
Net Interest Non-Interest Non-Interest Net (Loss) Total
Income Income Expense Income Assets
--------- --------- --------- ----------- ----------
December 31, 1996
Discount loans:
Single family residential loans ............ $ 12,122 $ (3,865) $ 10,163 $ 16,827 $ 650,261
Large commercial real estate loans ......... 17,565 24,117 11,376 15,480 516,622
Small commercial real estate loans ......... 14,851 (5) 7,525 1,398 283,466
--------- --------- --------- ----------- ----------
44,538 20,247 29,064 33,705 1,450,349
--------- --------- --------- ----------- ----------
Mortgage loan servicing:
Domestic ................................... 1,685 7,498 13,308 (2,558) 5,020
Foreign (U.K.) ............................. -- -- -- -- --
--------- --------- --------- ----------- ----------
1,685 7,498 13,308 (2,558) 5,020
--------- --------- --------- ----------- ----------
Investment in low-income housing tax credits (4,962) 4,572 4,280 11,577 93,309
Commercial real estate lending ............. 12,305 118 5,458 3,617 402,582
Subprime single family residential lending:
Domestic ................................... 4,486 6,504 5,346 3,131 128,878
Foreign (U.K.) ............................. -- -- -- -- --
--------- --------- --------- ----------- ----------
4,486 6,504 5,346 3,131 128,878
--------- --------- --------- ----------- ----------
Investment securities ...................... 8,632 (1,777) 5,084 987 342,801
Other ...................................... 11,030 (34) 7,553 2,591 60,746
--------- --------- --------- ----------- ----------
77,714 37,128 70,093 53,050 2,483,685
Unallocated amounts ........................ 20 175 (487) (2,908) --
--------- --------- --------- ----------- ----------
$ 77,734 $ 37,303 $ 69,606 $ 50,142 $2,483,685
========= ========= ========= =========== ==========
90
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
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 $17,667, $14,881, and $9,330 are
included as credits against income tax expense for the years ended December 31,
1998, 1997 and 1996, respectively. Commercial and real estate lending includes
the Company's origination of multi-family and commercial real estate loans held
for investment. Subprime single residential family lending includes the
Company's acquisition and origination of single family residential loans to
non-conforming borrowers, which are recorded as available for sale. 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 subprime residuals and
subordinate interests related to the Company's securitization activities which
have been included in the related business activity. Other consists primarily of
individually insignificant business activities, including the Company's
historical loan portfolio of conventional single family residential loans, small
commercial loan originations, unsecured collections, and the operations of OCC.
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.
Income taxes are allocated to each business segment based on the Company's
estimated effective tax rate, exclusive of low-income housing tax credit
interests. As such, the resulting amounts represent estimates of the
contribution of each business activity to the Company. Unallocated amounts
represent amounts not allocated to the operating segments, and are primarily
comprised of distributions on the Capital Securities, transfer pricing
mismatches, unallocated income taxes, and other general corporate expenses.
91
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
NOTE 28: COMMITMENTS AND CONTINGENCIES
Certain premises are leased under various noncancellable operating leases with
terms expiring at various times through 2007, exclusive of renewal option
periods. The annual aggregate minimum rental commitments under these leases are
summarized as follows:
1999...................................................... $ 8,993
2000...................................................... 9,240
2001...................................................... 8,653
2002...................................................... 8,485
2003...................................................... 8,264
Thereafter................................................ 32,812
-----------
Minimum lease payments (1)................................ $ 76,447
===========
(1) Includes $50,875 ((pound)30,642) which relates to Ocwen UK.
Rent expense for the years ended December 31, 1998, 1997 and 1996 was $6,410,
$2,877 and $1,563, respectively.
At December 31, 1998, the Company was committed to purchase $17,619 of
commercial discount loans. The Company also had commitments to originate (i)
$22,455 of loans secured by multi-family residential buildings, (ii) $2,484 of
mortgage loans secured by office buildings, (iii) $370 of loans secured by hotel
properties and (iv) $90,561 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 $1,913 on single family
residential loans sold to the Federal Home Loan Mortgage Corporation. The
Company, through its investment in subordinated securities and subprime
residuals, which had a carrying value of $230,157 at December 31, 1998, supports
senior classes of securities.
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.
NOTE 29: PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed Statements of Financial Condition
December 31,
-------------------------
1998 1997
----------- -----------
Assets:
Cash and cash equivalents................................. $ 32,516 $ 62,586
Securities available for sale, at market value............ -- 116,943
Investment securities, net................................ -- 11,115
Investment in bank subsidiary............................. 232,336 272,401
Investments in non-bank subsidiaries...................... 314,215 120,059
Investment in unconsolidated entity....................... 46,586 --
Loan portfolio, net....................................... 2,484 7,285
Discount loan portfolio, net.............................. 6,876 48,413
Investment in real estate................................. -- 10,675
Income taxes receivable................................... 35,321 13,739
Deferred tax asset........................................ 19,780 6,636
Other assets.............................................. 4,945 11,063
----------- -----------
$ 695,059 $ 680,915
Liabilities and Stockholders' Equity:
Notes payable............................................. $ 250,000 $ 250,000
Securities sold under agreements to repurchase............ 3,075
Other liabilities......................................... 21,031 15,008
----------- -----------
Total liabilities......................................... 271,031 268,083
Stockholders' equity...................................... 424,028 412,832
----------- -----------
$ 695,059 $ 680,915
=========== ===========
92
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
Condensed Statements of Operations
Years Ended December 31,
-----------------------------------
1998 1997 1996
--------- --------- ---------
Interest income .................................... $ 12,402 $ 10,019 $ 1,645
Interest expense ................................... (33,178) (20,367) (6,656)
Non-interest income ................................ -- -- 266
Non-interest expense ............................... (44,174) (3,942) (1,131)
--------- --------- ---------
Loss before income taxes ........................... (64,950) (14,290) (5,876)
Income tax benefit ................................. 42,942 5,083 2,925
--------- --------- ---------
Loss before equity in net income of subsidiaries ... (22,008) (9,207) (2,951)
Equity in net income of bank subsidiary ............ 55,747 88,598 48,486
Equity in net (loss) income of non-bank subsidiaries (34,939) (459) 4,607
--------- --------- ---------
Net (loss) income .................................. $ (1,200) $ 78,932 $ 50,142
========= ========= =========
Condensed Statements of Cash Flows
For the Years Ended December 31,
-----------------------------------
1998 1997 1996
--------- --------- ---------
Cash flows from operating activities:
Net (loss) income ........................................... $ (1,200) $ 78,932 $ 50,142
Adjustments to reconcile net income to net cash
provided (used) in operating activities:
Equity in income of bank subsidiary ......................... (56,124) (88,598) (49,186)
Equity in loss (income) of non-bank subsidiaries ............ 38,107 459 (1,657)
Equity in income of unconsolidated entity, net .............. (439) -- --
Premium amortization, net ................................... 18,383 11,467 --
Provision for loan losses ................................... 162 -- --
Loss on interest-earning assets ............................. 44,998 -- --
Gain on sale of real estate held for investment ............. (2,389) -- --
Increase in deferred tax assets ............................. (13,144) (6,830) --
(Increase) decrease in other assets ......................... (3,333) (5,662) 4,067
Increase in income taxes receivable ......................... (21,582) (3,736) (10,003)
Increase (decrease) in accrued expenses, payables and other
liabilities ............................................... 6,023 9,970 (3,286)
--------- --------- ---------
Net cash provided (used) by operating activities ............ 9,462 (3,998) (9,923)
--------- --------- ---------
Cash flows from investing activities:
Purchase of securities available for sale ................... (34,755) (146,643) (13,125)
Maturities of and principal payments received on securities
available for sale ........................................ 8 579 63
Net distributions from (investments in) bank subsidiary ..... 96,189 37,291 (49,707)
Net (investments in) distributions from non-bank subsidiaries (201,059) (86,599) 5,410
Investment in unconsolidated entity ......................... (45,886) -- --
Proceeds from sales of securities available for sale ........ 70,080 15,574 --
Purchase of securities held for investment .................. -- (11,115) --
Proceeds from sales of securities held for investment ....... 13,025 -- --
Purchase of discount loans .................................. (2,557) (48,413) --
Proceeds from sales of loans held for investment ............ 53,949 5,080 --
Proceeds from real estate held for investment ............... 13,064 -- --
Purchase of real estate held for investment ................. -- (995) (9,680)
Purchase of loans held for investment ....................... -- -- (11,845)
--------- --------- ---------
Net cash used by investing activities ....................... (37,942) (235,241) (78,884)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of notes and debentures .............. -- 120,738 125,000
Payment of debt issuance costs .............................. -- -- (5,252)
Repayment of notes payable .................................. -- -- (8,628)
(Decrease) increase in securities sold under agreements to
repurchase ................................................ (3,075) 3,075 --
Repayments (originations) of loans to
executive officers, net ................................... -- 3,832 (3,832)
Exercise of common stock options ............................ 7,931 3,037 12,993
Issuance of shares of communion stock ....................... 7,828 142,003 --
Repurchase of common stock options .......................... (6,502) (3,208) (177)
Repurchase of common stock .................................. (7,772) -- --
Other ....................................................... -- -- 23
--------- --------- ---------
Net cash (used) provided by financing activities ............ (1,590) 269,477 120,127
--------- --------- ---------
Net (decrease) increase in cash and cash equivalents ........ (30,070) 30,238 31,320
Cash and cash equivalents at beginning of year .............. 62,586 32,348 1,028
--------- --------- ---------
Cash and cash equivalents at end of year .................... $ 32,516 $ 62,586 $ 32,348
========= ========= =========
93
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS AND BRITISH POUNDS IN THOUSANDS, EXCEPT SHARE DATA)
NOTE 30: QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Quarters Ended
----------------------------------------------------------------
December 31, September 30, June 30, March 31,
----------- ----------- ----------- -----------
1998 1998 1998 1998
----------- ----------- ----------- -----------
Interest income........................................... $ 66,237 $ 88,542 $ 90,891 $ 62,024
Interest expense.......................................... (43,602) (47,859) (52,576) (40,856)
Provision for loan losses................................. (4,775) (1,806) (9,675) (2,253)
----------- ----------- ----------- -----------
Net interest income after provision
for loan losses......................................... 17,860 38,877 28,640 18,915
Non-interest income....................................... 28,742 54,942 (13,750) 41,381
Non-interest expense...................................... (70,618) (65,516) (56,249) (34,011)
Distributions on Capital Securities....................... (3,399) (3,398) (3,398) (3,399)
Equity in (losses) earnings of investments in
unconsolidated entities................................. (11,443) 2,915 513 30
----------- ----------- ----------- -----------
(Loss) income before income taxes......................... (38,858) 27,820 (44,244) 22,916
Income taxes (expense) benefit............................ 27,811 (2,922) 6,383 (573)
Minority interest in net loss (earnings) of
consolidated subsidiary................................. 469 33 (68) 33
----------- ----------- ----------- -----------
Net (loss) income......................................... $ (10,578) $ 24,931 $ (37,929) $ 22,376
=========== =========== =========== ===========
Earnings per share:
Basic..................................................... $ (0.17) $ 0.41 $ (0.62) $ 0.37
=========== =========== =========== ===========
Diluted................................................... $ (0.17) $ 0.41 $ (0.62) $ 0.36
=========== =========== =========== ===========
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....................................... 43,770 25,431 33,397 21,351
Non-interest expense...................................... (41,770) (31,219) (31,188) (22,697)
Distributions on Capital Securities....................... (3,399) (1,850) -- --
Equity in earnings of investment in
unconsolidated entities................................ 7,468 547 1,301 14,372
----------- ----------- ----------- -----------
Income before income taxes................................ 29,013 26,203 23,675 20,647
Income taxes (expense) benefit............................ (6,398) (6,179) (5,126) (3,606)
Minority interest in net loss of
consolidated subsidiary................................ 319 141 243 --
----------- ----------- ----------- -----------
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
=========== =========== =========== ===========
94
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
1998:
First quarter.................................... $ 30.7500 $ 22.2500
Second quarter................................... 28.3750 22.3125
Third quarter.................................... 27.8750 8.5000
Fourth quarter................................... 16.1875 5.6875
At the close of business on March 9, 1999, the Company's common stock price was
$8.8125.
The Company does not currently pay cash dividends on 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 18, 19 and 25 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 March 9, 1999, 60,800,357 shares of Company common stock were outstanding and
held by approximately 1,310 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.
95
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 on January 27, 1998 (Registration No. 333-44999),
Registration Statement on Form S-8 filed on August 25, 1998 (Registration No.
333-62217) and Registration Statement on Form S-3 filed on November 5, 1998
(Registration No. 333-64915) of Ocwen Financial Corporation of our report dated
January 29, 1999 appearing on page 45 of the 1998 Annual Report of Shareholders
which is incorporated in this Annual Report on Form 10-K.
/s/ PRICEWATERHOUSECOOPERS LLP
- - ----------------------------------------------
PRICEWATERHOUSECOOPERS LLP
Ft. Lauderdale, Florida
March 31, 1999
EXHIBIT 99.1
RISK FACTORS
Each of the factors set forth below could, directly or indirectly,
affect the Company's results of operations and financial condition. Capitalized
terms that are not defined herein shall have the meaning ascribed in the Annual
Report on Form 10-K of the Company to which this Exhibit relates.
CHANGING NATURE OF RISKS; NO ASSURANCES AS TO CONSISTENCY OF EARNINGS
CHANGING NATURE OF RISKS. The Company's corporate strategy emphasizes
the identification, development and management of specialized businesses which
the Company believes are not accurately evaluated and priced by the marketplace
due to market, economic and competitive conditions. This strategy can result in
the entry into or development of businesses and investment in assets which
produce substantial initial returns, which may be followed by an exit from any
of those businesses or the sale of those assets if, for example, results
decrease because markets become more efficient in the evaluation and pricing of
such businesses and assets. For example, in recent years, the Company's efforts
have focused on lending, the acquisition and resolution of discounted loans, and
investment in various types of mortgage- related securities. However, on October
26, 1998, the Company announced that it would refocus its resources on its core
competencies, namely the acquisition and management of servicing-intensive
assets and the development of exportable loan serving technology for the
mortgage and real estate industries. Given that this strategy involves the
potential of entering and exiting different businesses, past financial
performance may not be considered a reliable indicator of future performance and
historical trends may not be reliable indicators of anticipated results or
trends in future periods. In addition, there can be no assurance that the
Company will be able to accomplish its strategic objectives as a result of
changes in the nature of the Company?s operations over time or that such changes
will not have a material adverse effect from time to time or generally on the
Company's business, financial condition or results of operations.
INCONSISTENCY OF RESULTS AND NON-RECURRING ITEMS. In addition to
inconsistency in results caused by the entry or exit of businesses by the
Company, the consistency of the operating results of the Company has and may
continue to be significantly affected by inter-period variations in its current
operations, including in respect of (i) the amount of assets acquired,
particularly discounted loans; (ii) the amount of resolutions of discounted
loans, particularly large multi-family residential and commercial real estate
loans; (iii) the amount of multi-family residential and commercial real estate
loans which mature or are prepaid, particularly loans with terms pursuant to
which the Company participates in the profits of the underlying real estate; and
(iv) sales by the Company of loans and/or securities acquired from the Company's
securitization of loans. In addition, the Company's operating results have been
significantly affected by certain non-recurring items. For example, the Company
has earned significant non-interest income from gains on sales of
interest-earning assets and real estate owned. Gains on sales of
interest-earning assets and real estate owned generally are dependent on various
factors which are not within the control of the Company, including market and
economic conditions and accounting regulations. In addition, during 1998, the
Company took charges related to its portfolio of AAA-rated agency interest-only
("IO") strips, residual and subordinate securities available for sale,
curtailment of its domestic operations and investments in OAC and OPLP. There
can be no assurance that the level of gains on sales of interest-earning assets
and real estate owned reported by the Company in prior periods will be repeated
in future periods or that there will not be substantial inter-period variations
in the results from such activities or as a result of other non-recurring items.
RISKS RELATED TO NON-TRADITIONAL OPERATING ACTIVITIES
As discussed below, the Company is engaged in a variety of
businesses which generally involve more uncertainties and risks than
the single-family residential lending activities historically
emphasized by savings institutions. In addition, many of the Company's
business activities, including its lending activities, are conducted on
a nationwide basis, which reduces the risks associated with
concentration in any one particular market area but involves other
risks because, among other things, the Company may not be as familiar
with market conditions and other relevant factors as it would be in the
case of activities which are conducted in the market areas in which its
executive offices and branch office are located.
DISCOUNTED LOAN ACQUISITION AND RESOLUTION ACTIVITIES. The
Company's lending activities include the acquisition and resolution of
non-performing or underperforming single-family (one to four units)
residential loans, multi-family (over four units) residential loans and
commercial real estate loans which are purchased at a discount.
Non-performing and subperforming mortgage loans may presently be in
default or may have a greater than normal risk of future defaults and
delinquencies, as compared to newly-originated, high-quality loans of
comparable type, size and geographic concentration. Returns on an
investment of this type depend on the borrower's ability to make
required payments or, in the event of default, the ability of the
loan's servicer to foreclose and liquidate the mortgage loan. There can
be no assurance that the servicer can liquidate a defaulted mortgage
loan successfully or in a timely fashion.
1
The Company acquires discounted loans from governmental agencies,
which in the early years of the program consisted primarily of the
Federal Deposit Insurance Corporation (the "FDIC") and the Resolution
Trust Corporation, a federal agency formed to resolve failed savings
institutions which has since ceased operations, and in recent years has
consisted primarily of the U.S. Department of Housing and Urban
Development. In addition to governmental agencies, the Company acquires
discounted loans from various private sector sellers, such as banks,
savings institutions, mortgage companies and insurance companies.
Although the Company believes that a permanent market for the
acquisition of non-performing and underperforming mortgage loans at a
discount has emerged in recent years, there can be no assurance that
the Company will be able to acquire the desired amount and type of
discounted loans in future periods or that there will not be
significant inter-period variations in the amount of such acquisitions.
There also can be no assurance that the discount on the non-performing
and underperforming loans acquired by the Company will enable the
Company to resolve discounted loans in the future as profitably as in
prior periods. Adverse changes in national economic conditions or in
the economic conditions in regions in which the Company acquires pools
of loans could impair its ability to resolve successfully loans and
could have an adverse effect on the value of those loan pools. The
yield on the Company's discounted portfolio also is subject to
significant inter-period variations as a result of the timing of
resolutions of discounted loans, particularly multi-family residential
and commercial real estate loans and non-performing single-family
residential loans, interest on which is recognized on a cash basis, and
the mix of the overall portfolio between performing and non-performing
loans. In addition, the volume of discounted loans acquired by the
Company may vary over time, thereby affecting results of operations in
future periods as the quantity of loans resolved in any one time period
may be affected.
MULTI-FAMILY RESIDENTIAL, COMMERCIAL REAL ESTATE AND CONSTRUCTION
LENDING ACTIVITIES. The Company's lending activities currently include
(though to a lesser extent than in previous years) nationwide loans
secured by existing commercial real estate, particularly hotels and
office buildings, and existing multi-family residential real estate. In
addition, from time to time the Company originates loans for the
construction of multi-family residential real estate and land
acquisition and development loans (again, to a lesser extent than in
previous years). Multi-family residential real estate, commercial real
estate and construction lending generally are considered to involve a
higher degree of risk than single-family residential lending due to a
variety of factors, including generally larger loan balances, the
dependency on successful completion or operation of the project for
repayment, the difficulties in estimating construction costs and loan
terms which often require little or no amortization of the loan over
its term (typically five years) and, instead, provide for a balloon
payment at stated maturity. Furthermore, mezzanine loans, which are
subordinate to senior loans, and construction loans generally have
higher loan-to-value ratios than conventional loans. Although the
Company's borrowers generally have an equity investment of 10% to 15%
of total project costs, such equity may not be sufficient to protect
the Company's investment in these higher-yielding loans. There can be
no assurance that any multi-family residential, commercial real estate
and construction lending activities engaged in by the Company risks
also related to loans already made will not be adversely affected by
these and the other risks related to such activities.
SUB-PRIME FAMILY RESIDENTIAL LENDING ACTIVITIES. The Company's
lending activities also continue to include the origination or purchase
on a nationwide basis of single-family residential loans made to
borrowers who have significant equity in the properties which secure
the loans but who, because of prior credit problems, the absence of a
credit history or other factors, are unable or unwilling to qualify as
borrowers under federal agency guidelines. These loans are offered
pursuant to various programs, including programs which provide for
reduced or no documentation for verifying a borrower's income and
employment. Sub-prime loans present a higher level of risk of
delinquency or default than loans made to more creditworthy borrowers,
and may not be as saleable as loans which conform to the guidelines
established by various federal agencies. While the Company believes
that the business practices it employs enable it to reduce higher risks
inherent in these loans, no assurance can be given that such practices
will afford adequate protection against higher delinquencies,
foreclosures or losses than anticipated, and as a result, the Company's
financial condition or results of operation could be adversely
affected.
2
ENVIRONMENTAL RISKS OF LOAN ACQUISITION AND LENDING ACTIVITIES.
The Company evaluates the potential for significant environmental
problems prior to acquiring or originating a loan because there is a
risk for any mortgage loan, particularly a multifamily residential and
commercial real estate loan, that hazardous substances or other
environmentally restricted substances could be discovered on the
related real estate. Through foreclosure, the Company could become the
owner of the real estate that secured its loan and might be required to
remove such substances from the affected properties or to engage in
abatement procedures at its sole cost and expense. There can be no
assurance that the cost of such removal or abatement will not
substantially exceed the value of the affected properties or the loans
secured by such properties, that the Company would have adequate
remedies against the prior owners or other responsible parties or that
the Company would be able to resell the affected properties either
prior to or following completion of any such removal or abatement
procedures. If such environmental problems are discovered prior to
foreclosure, the Company generally will not foreclose on the related
loan; however, the value of such property as collateral will generally
be substantially reduced, and as a result, the Company may suffer a
loss upon collection of the loan.
INVESTMENTS IN LOW-INCOME HOUSING TAX CREDIT INTERESTS. The
Company invests in low-income housing tax credit interests (generally
limited partnerships) in order to obtain federal income tax credits
which are allocated pursuant to Section 42 of the Internal Revenue Code
of 1986, as amended (the "Code"). There are many uncertainties and
risks associated with an investment in low-income housing tax credit
interests, including the risks involved in the construction, lease-up
and operation of multi-family residential real estate, the investor's
ability to earn sufficient income to utilize the tax credits resulting
from such investments in accordance with the requirements of the Code
and the possibility of required recapture of previously-earned tax
credits. In addition, there are numerous tax risks associated with tax
credits resulting from potential changes to the Code.
INVESTMENTS IN MORTGAGE-RELATED SECURITIES. From time to time the
Company invests in a variety of mortgage-related securities, such as
senior, subordinate and residual interests in collateralized mortgage
obligations ("CMOs"), including CMOs which have qualified as Real
Estate Mortgage Investment Conduits. These investments include
so-called stripped mortgage-related securities, in which interest
coupons may be stripped from a mortgage security to create an
interest-only strip, where the investor receives all of the interest
cash flows and none of the principal, and a principal-only ("PO")
strip, where the investor receives all of the principal cash flows and
none of the interest. Some mortgage-related securities, such as IO
strips, PO strips and residual interests, exhibit considerably more
price volatility than mortgages or ordinary mortgage pass-through
securities, due in part to the uncertain cash flows that result from
changes in the prepayment rates of the underlying mortgages. Other
mortgage-related securities, such as subordinate interests, also
involve substantially more credit risk than the senior classes of the
mortgage-related securities to which such interests relate and
generally are not as liquid as such senior classes. The Company
generally acquires subordinate and residual interests primarily in
connection with the securitization of its loans, particularly
single-family residential loans to non-conforming borrowers and
discounted loans, and under circumstances in which it continues to
service the loans which back the related securities. The Company has
sought to offset the risk of changing interest rates on certain of its
mortgage-related securities by selling U.S. Treasury futures contracts
and through other hedging techniques, and believes that the resulting
interest-rate sensitivity profile compliments the Company's overall
exposure to changes in interest rates. See "--Economic Conditions"
below. Although generally intended to reduce the effects of changing
interest rates on the Company, investments in certain mortgage-related
securities and hedging transactions could cause the Company to
recognize losses depending on the terms of the instrument and the
interest rate environment.
RISK OF FUTURE ADJUSTMENTS TO ALLOWANCES FOR LOSSES
The Company believes that it has established adequate allowances
for losses for each of its loan portfolio and discounted loan portfolio
in accordance with generally accepted accounting principles. Future
additions to these allowances, in the form of provisions for losses on
loans and discounted loans, may be necessary, however, due to changes
in economic conditions, increases in loans and discounted loans and the
performance of the Company's loan and discounted loan portfolios.
3
In addition, the OTS, as part of its examination process, periodically
reviews the Company's allowances for losses and the carrying value of
its assets. As a result of OTS reviews, the Company in the past has
increased its allowances for losses on loans and discounted loans and
written down the carrying value of certain loans. There can be no
assurance that the Company will not determine, at the request of the
OTS or otherwise, to further increase its allowances for losses on
loans and discounted loans or adjust the carrying value of its real
estate owned or other assets. Increases in the Company's provisions for
losses on loans would adversely affect the Company's results of
operations.
RISKS RELATED TO REAL ESTATE OWNED
GENERAL. The Company's real estate owned consists almost entirely
of single-family residential real estate and multi-family residential
and commercial real estate acquired by foreclosure or deed-in-lieu
thereof on loans in the Company's discounted loan portfolio. Generally,
real estate owned properties are non-earning assets, although
multi-family residential and commercial real estate owned may provide
some operating income to the Company depending on the circumstances.
Such operating income may be affected by problems experienced by
lessees, which may weaken their financial condition and result in
failure to make rental payments when due. At any time, a lessee of the
Company's properties may seek the protection of bankruptcy laws, which
could result in rejection and termination of the lessee's lease and
thereby cause a reduction in cash flow available for distribution to
the Company. Moreover, the value of real estate can be significantly
affected by adverse changes in national or local economic conditions,
competition from other properties offering the same or similar
services, changes in interest rates and in the availability, cost and
terms of mortgage funds, acts of nature, including earthquakes,
hurricanes and other natural disasters, and other factors which are
beyond the control of the Company. These factors may require the
establishment of provisions for losses to ensure that real estate owned
properties are carried at the lower of cost or fair value, less
estimated costs to dispose of the properties, which may adversely
affect operations. Real estate owned also requires increased allocation
of resources and expense to the management and work out of the asset,
property taxes and compliance with respect to environmental laws and
the Americans with Disabilities Act of 1990, which can also adversely
affect operations. There can be no assurance that the amount of the
Company's real estate owned will not increase in the future as a result
of the Company's discounted loan acquisition and resolution activities
and the Company's single-family residential, multi-family residential,
commercial real estate and construction lending activities.
ENVIRONMENTAL RISKS. Operating costs and the value of real
property may be affected by the obligation to pay for the cost of
complying with existing environmental laws, ordinances and regulations,
as well as the cost of future legislation. Under various federal, state
and local environmental laws, ordinances and regulations, a current or
previous owner or operator of real property may be liable for the costs
of removal or remediation of hazardous or toxic substances on, under or
in such property. Such laws often impose liability whether or not the
owner or operator knew of, or was responsible for, the presence of such
hazardous or toxic substances. Therefore, an environmental liability
could have a material adverse effect on the underlying value of a real
property, and the revenue therefrom. Although the Company believes that
its pre-acquisition due diligence identified all material environmental
concerns which relate to its current investments in real estate and
accurately assessed the costs and liabilities to be concurred by it in
this regard, there can be no assurance that such investments will not
raise material unanticipated environmental concern or costs in the
future.
RISKS ASSOCIATED WITH ACQUISITIONS AND DIVESTITURES
Acquiring businesses and assets has been and may continue to be
an important focus of the Company's strategic efforts. Any acquisitions
could vary in size and may include those that are large relative to the
Company. There can be no assurance that suitable acquisition candidates
can be identified, that financing for such acquisitions would be
available on satisfactory terms, that the Company would be able to
accomplish its strategic objectives as a result of any such
acquisitions, that any business or assets acquired by the Company would
be integrated successfully or that integration of acquired businesses
would not divert management resources or otherwise have a material
adverse effect on the Company's business, financial condition or
results of operations. The Company is continually evaluating possible
acquisitions and engages in discussions with acquisition candidates
from time to time.
4
In addition, in the event that the Company chooses to divest any
business or sell any asset in the future, there can be no assurance
that a suitable purchaser could be identified, that the Company would
be able to accomplish its strategic objectives as a result of any such
sale, that any proposed asset or business sold by the Company would be
completed or that the separation of any such asset or business from the
Company would not diminish management resources or otherwise have a
material adverse effect on the Company's business, financial condition
or results of operations.
ABILITY TO MANAGE GROWTH
The Company has grown rapidly in the past and may continue to
grow rapidly in the future. If so, continued growth can be expected to
place a significant strain on the Company's management operations,
employees and resources. The Company's ability to support, manage and
control continued growth is dependent upon, among other things, its
ability to hire, train, supervise and manage its workforce and to
continue to develop the skills necessary for the Company to compete
successfully. There can be no assurance that the Company will be able
to manage effectively its expanding operations or achieve growth as
planned on a timely or profitable basis. If the Company is unable to
manage growth effectively, its business, results of operations or
financial condition could be materially adversely affected.
RISKS ASSOCIATED WITH PARTNERING
On July 28, 1998, the Company announced that it has engaged an
investment bank to identify potential business partners who can enable
the Company to expand its franchise both domestically and
internationally. Any transaction resulting therefrom could take on many
different forms, including a merger. No assurance can be given that the
Company will identify a business partner and transaction that will
satisfy its objectives or, if so identified, that such objectives will
be achieved.
INTERNATIONAL OPERATIONS
The Company conducts business in the United States and the United
Kingdom and may explore opportunities outside of these markets. The
Company's U.K. operations are subject to most of the same risks
associated with its U.S. operations, as well as additional risks, such
as unexpected changes in U.K. and European regulatory requirements,
difficulties in managing international operations, potentially adverse
tax consequences, enhanced accounting and control expenses and the
burden of complying with foreign laws. Changes in foreign currency
exchange rates may also affect the value of the Company's U.K. assets
and the gains realized from the sale of such assets. Although the
Company implements hedging strategies to limit the effects of currency
exchange rate fluctuations on the Company's results of operations,
currency hedging strategies, like those for interest rates, may not
perform their intended purpose. See "--Economic Conditions". There can
be no assurance that such factors will not have a material adverse
effect on the Company's business, results of operations or financial
condition. In addition, the Company's management has only limited
international experience outside of the U.S. and the U.K, which could
limit the Company's ability to capitalize on investment opportunities
that may arise elsewhere.
REGULATION AND REGULATORY CAPITAL REQUIREMENTS
Both the Company, as a savings and loan holding company, and the
Bank, as a federally-chartered savings institution, are subject to
significant governmental supervision and regulation, which is intended
primarily for the protection of depositors. Statutes and regulations
affecting the Company and the Bank may be changed at any time, and the
interpretation of these statutes and regulations by examining
authorities also is subject to change. There can be no assurance that
future changes in applicable statutes and regulations or in their
interpretation will not adversely affect the business of the Company.
The applicable regulatory authorities may, as a result of such
regulation and examination, impose regulatory sanctions upon the
Company or the Bank, as applicable, as well as various requirements or
restrictions which could adversely affect their business activities.
5
A substantial portion of the Bank's operations involves businesses that
are not traditionally conducted by savings institutions and, as a
result, there can be no assurance that future actions by applicable
regulatory authorities, or future changes in applicable statutes or
regulations, will not limit or otherwise adversely affect the Bank's
ability to engage in such activities.
Following an examination of the Bank in late 1996 and early 1997,
the staff of the Office of Thrift Supervision (the "OTS") expressed
concern about many of the Bank's non-traditional operations (which are
discussed under "--Risks Related to Non-Traditional Operating
Activities" above) and the adequacy of the Bank's capital in light of
the Bank's lending and investment strategies. As a result of such
examination, the Bank committed to the OTS to maintain, commencing on
June 30, 1997, regulatory capital ratios which significantly exceed the
requirements which are generally applicable to federally-chartered
savings institutions such as the Bank. Specifically, the Bank has
committed to the OTS to maintain a core capital (leverage) ratio and a
total risk-based capital ratio of at least 9% and 13%, respectively
(the requirements of general applicability are 3% and 8%,
respectively). At December 31, 1998, the Bank's core capital, Tier 1
risk-based capital and total risk-based capital ratios amounted to
9.07%, 11.71% and 17.26%, respectively. Based on discussions with the
OTS, the Bank believes that this commitment does not affect its status
as a "well-capitalized" institution, assuming the Bank's continued
compliance with the regulatory capital requirements that it committed
to maintain. Under applicable laws and regulations, an institution is
considered to be "well-capitalized" if it maintains a total risk-based
capital ratio of 10.0% or more, a Tier 1 risk-based capital ratio of
6.0% or more and a core capital (leverage) ratio of 5.0% or more and is
not subject to a written agreement, order or directive issued by an
appropriate agency to meet and maintain a specific capital level for
any capital measure.
There can be no assurance that in the future the OTS either will
agree to a decrease in the 9% core capital (leverage) ratio and the 13%
total risk-based capital ratio committed to be maintained by the Bank
or will not seek an increase in such requirements. Unless and until
these regulatory capital requirements are decreased, the Bank's ability
to leverage its capital through future growth in assets (including its
ability to continue growing at historical rates) will be adversely
affected, as will the Company's ability to receive dividends from the
Bank, which are a primary source of payments on outstanding
indebtedness and other expenses of the Company. Although the Company
and its non-banking subsidiaries will not be restricted in their growth
by these capital requirements, because they do not have access to the
Bank's funding sources, their profitability may be different from the
Bank's for particular types of businesses. In addition, there can be no
assurance that the Bank will continue to meet the regulatory capital
requirements that it has committed to maintain or that the OTS will not
formally impose such requirements pursuant to a written agreement,
order or directive, which would cause the Bank to cease to be a
"well-capitalized" institution under applicable laws and regulations.
In the event that the Bank ceased to be a "well-capitalized"
institution, the Bank would be prohibited from accepting, renewing or
rolling over its brokered and other wholesale deposits, which are its
principal source of funding, without the prior approval of the FDIC,
and the Bank could become subject to other regulatory restrictions on
its operations.
ECONOMIC CONDITIONS
GENERAL. The success of the Company is dependent to a certain
extent upon the general economic conditions in the geographic areas in
which it conducts substantial business activities. Adverse changes in
national economic conditions or in the economic conditions of regions
in which the Company conducts substantial business likely would impair
the ability of the Company to collect on outstanding loans or dispose
of real estate owned and would otherwise have an adverse effect on its
business, including the demand for new loans, the ability of customers
to repay loans and the value of both the collateral pledged to the
Company to secure its loans and its real estate owned. Moreover,
earthquakes and other natural disasters could have similar effects.
Although such disasters have not significantly adversely affected the
Company to date, the availability of insurance for such disasters in
California, in which the Company conducts substantial business
activities, is severely limited. Moreover, changes in building codes
and ordinances, environmental considerations and other factors also
might render infeasible the use of insurance proceeds to replace
damaged or destroyed property. Under such circumstances, the insurance
proceeds received by a borrower or the Company might not be adequate to
restore the Company's economic position with respect to the affected
collateral or real estate.
6
EFFECTS OF CHANGES IN INTEREST RATES. The Company's operating
results depend to a large extent on its net interest income, which is
the difference between the interest income earned on interest-earning
assets and the interest expense incurred in connection with its
interest-bearing liabilities. Changes in the general level of interest
rates can affect the Company's net interest income by affecting the
spread between the Company's return on interest-earning assets and the
Company's cost of interest-bearing liabilities, as well as, among other
things, the ability of the Company to originate loans; the value of the
Company's interest-earning assets and its ability to realize gains from
the sale of such assets; the average life of the Company's
interest-earning assets; the value of the Company's mortgage servicing
rights; and the Company's ability to obtain deposits in competition
with other available investment alternatives. Interest rates are highly
sensitive to many factors, including governmental monetary policies,
domestic and international economic and political conditions and other
factors beyond the control of the Company. Although management believes
that the maturities of the Company's assets are well balanced in
relation to its liabilities (which involves various estimates and
assumptions, including as to how changes in the general level of
interest rates will impact its assets and liabilities), there can be no
assurance that the profitability of the Company would not be adversely
affected during any period of changing interest rates.
POTENTIAL ADVERSE EFFECTS OF HEDGING STRATEGIES. The Company may
utilize a variety of financial instruments, including interest rate
swaps, caps, floors and other interest rate exchange contracts, in
order to limit the effects of interest rates on its operations. Among
the risks inherent with respect to the purchase and/or sale of such
derivative instruments are (i) interest rate risk, which consists of
the risks relating to fluctuating interest rates; (ii) basis risk,
which consists of the risk of loss associated with variations in the
spread between the asset yield and the funding and/or hedge costs;
(iii) credit or default risk, which consists of the risk of insolvency
or other inability of the counterparty to a particular transaction to
perform its obligations thereunder; (iv) prepayment risk, which
consists of reinvestment risk to the extent the Company is not able to
reinvest repayments, if any, at a yield which is comparable to the
yield being generated on the particular security; (v) liquidity risk,
which consists of the risk that the Company may not be able to sell a
particular security at a particular price; (vi) legal enforceability
risk, which consists of the risks related to the Company's ability to
enforce the terms of a particular instrument or to obtain or collect
upon a legal judgment in the United States in the event that the
counterparty to the transaction is a foreign entity or the underlying
collateral is located in a foreign jurisdiction; and (vii) volatility
risk, which consists of the risk that actual volatility (i.e., the
degree of uncertainty relating to the price of the underlying asset)
differs from the historical volatility or "implied" volatility of the
instrument.
RISKS RELATED TO RELIANCE ON BROKERED AND OTHER WHOLESALE DEPOSITS
The Company currently utilizes as its principal source of funds
certificates of deposit obtained through national investment banking
firms which obtain funds from their customers for deposit with the
Company ("brokered deposits") and, to a lesser extent, certificates of
deposit obtained from customers of regional and local investment
banking firms and direct solicitation efforts by the Company of
institutional investors and high net worth individuals. The Company
believes that the effective cost of brokered and other wholesale
deposits, as well as other non-branch dependent sources of funds, such
as securities sold under agreements to repurchase ("reverse repurchase
agreements") and advances from the Federal Home Loan Board ("FHLB") of
New York, generally is more attractive to the Company than deposits
obtained through branch offices after the general and administrative
costs associated with operating a branch office network are taken into
account. However, such funding sources, when compared to retail
deposits attracted through a branch network, are generally more
sensitive to changes in interest rates and volatility in the capital
markets and their availability and terms are more likely to be subject
to competitive pressures. In addition, such funding sources may be more
sensitive to significant changes in the financial condition of the
Company. There are also regulatory limitations on an insured
institution's ability to solicit and obtain brokered deposits in
certain circumstances, which currently are not applicable to the Bank
because of its status as a "well capitalized" institution under
applicable laws and regulations. See "--Regulation and Regulatory
Capital Requirements" above. As a result of the Company's reliance on
brokered and other wholesale deposits, significant changes in
prevailing interest rates, in the availability of alternative
investments for individual and institutional investors or in the
Company's financial condition, among other factors, could have a much
more significant effect on the Company's liquidity and results of
operations than might be the case with an institution that attracted a
greater portion of its funds from retail or core deposits obtained
through a branch network.
7
RISKS ASSOCIATED WITH CURRENT SOURCES OF LIQUIDITY AND ADDITIONAL
FINANCING FOR GROWTH
CURRENT SOURCES OF LIQUIDITY. The Company's primary sources of
funds for liquidity consist of deposits, FHLB advances, reverse
repurchase agreements, lines of credit and maturities and principal
payments on loans and securities and proceeds from sales thereof. An
additional significant source of asset liquidity stems from the
Company's ability to securitize assets such as discount loans and
sub-prime loans. The Company believes that its existing sources of
liquidity will be adequate to fund planned activities for the
foreseeable future, although there can be no assurances in this regard.
Moreover, the Company continues to evaluate other sources of liquidity,
such as lines of credit from unaffiliated parties, which will enhance
the Company's ability to increase its liquidity position. The inability
of the Company to maintain adequate sources of liquidity, including as
a result of the failure to extend or replace existing lines of credit
or as a result of the factors described under "--Risks Related to
Reliance on Brokered and Other Wholesale Deposits" above or "Risks of
Securitization" below, could have a material adverse effect on the
Company's business, financial condition or results of operations.
ADDITIONAL FINANCING FOR GROWTH. The Company's ability to enter
into certain business lines as opportunities emerge depends to a
significant degree on its ability to obtain additional indebtedness,
obtain additional equity capital or have access to other sources of
capital (e.g., through partnering, joint venturing or other economic or
contractual relationships). The Company has no commitments for
borrowings in addition to those under its current debt securities and
lines of credit, no commitments for future sales of equity capital and
no commitments to provide access to other sources of capital. There can
be no assurance that the Company will be successful in consummating
future financing transactions, if any, on terms satisfactory to the
Company, if at all. Factors which could affect the Company's access to
the capital markets or other economic or contractual relationships, or
the conditions under which the Company could obtain additional
financing, involve the perception in the capital markets and the
financial services industry of the Company's business, results of
operations, leverage, financial condition and business prospects. Each
of these factors is to a large extent subject to economic, financial
and competitive factors beyond the Company's control. In addition,
covenants under the Company's current debt securities and lines of
credit do, and future ones may, significantly restrict the Company's
ability to incur additional indebtedness, to issue Preferred Stock and
to enter into certain other contractual relationships.
RISKS ASSOCIATED WITH HOLDING COMPANY STRUCTURE
As a holding company, the ability of the Company to pay
dividends, to pay indebtedness and to conduct its financial operating
activities directly or in non-banking subsidiaries will depend
significantly on the receipt of dividends or other distributions from
the Bank, as well as any cash reserves and other liquid assets held by
the Company, any proceeds from securities offerings or other borrowings
and any dividends from non-banking subsidiaries of the Company. The
ability of the Bank to pay dividends or make other distributions to the
Company generally is dependent on the Bank's compliance with applicable
regulatory capital requirements and regulatory restrictions.
The Bank's ability to make capital distributions as a Tier 1
association pursuant to the OTS capital distribution regulation are
limited by the regulatory capital levels which it has committed to the
OTS it would maintain, commencing on June 30, 1997. As a result of an
agreement between the Bank and the OTS to dividend subordinate and
residual mortgage-related securities resulting from securitization
activities conducted by the Bank, which had an aggregate carrying value
of $13.9 million at December 31, 1998, the Bank may be limited in its
ability to pay cash dividends to the Company.
8
In addition to the foregoing limitations, there are certain
contractual restrictions on the Bank's ability to pay dividends set
forth in the Indenture, dated as of June 12, 1995, between the Bank and
the Bank of New York, as trustee, relating to the Bank's issuance in
June 1995 of $100 million of 12% Subordinated Debentures due 2005, and
there are certain contractual restrictions on the ability of the
Company and the Bank to pay dividends set forth in the Indenture, dated
as of September 30, 1996, between the Company and Bank One, Columbus,
NA, as trustee, relating to the Company's issuance in September 1996 of
$125 million of 11.875% Notes due 2003, as well as in the Indenture,
dated as of August 12, 1997, between the Company and The Chase
Manhattan Bank, as trustee, relating to the Company's issuance in
August 1997 of $125 million of 10.875% Junior Subordinated Debentures
due 2027. In addition, the right of the Company to participate in any
distribution of assets of any subsidiary, including the Bank, upon such
subsidiary's liquidation or reorganization or otherwise, will be
subject to the prior claims of creditors of that subsidiary, except to
the extent that any claims of the Company as a creditor of such
subsidiary may be recognized as such.
RISKS OF SECURITIZATION
The Company has historically generated a significant amount of
revenues, earnings and cash flows from its pooling and selling through
securitizations of mortgages and other loans originated or purchased by
the Company. Adverse changes in the secondary market for such loans
could impair the Company's ability to originate or sell mortgages and
other loans on a favorable or timely basis. Accordingly, such
impairments could have an adverse effect upon the Company's business
and results of operations. Market and other considerations, including
rating agency requirements, could also affect the timing of such
transactions. Any delay in the sale of loans beyond the reporting
period in which such sale is anticipated to take place would delay any
expected gains and adversely affect the Company's reported earnings for
such reporting period. In addition, the Company retains some degree of
credit risk on substantially all loans sold. During the period of time
that loans are held pending sale, the Company is at risk for loan
delinquencies and defaults and the risk that the rapid increase in
interest rates would result in a decline in the value of loans to
potential purchasers. Following the sale of loans through a
securitization, the Company's direct risk with respect to loan
delinquency or default on such loan is limited to those circumstances
in which it is required to repurchase such loan due to a breach of a
representation or warranty in connection with the securitization.
COMPETITION
The businesses in which the Company is engaged generally are
highly competitive. The acquisition of discounted loans is particularly
competitive, as acquisitions of such loans are often based on
competitive bidding. The Company also encounters significant
competition in connection with its other lending activities, its
investment activities, its deposit-gathering activities and its
servicing activities. Many of the Company's competitors are
significantly larger than the Company and have access to greater
capital and other resources. In addition, many of the Company's
competitors are not subject to the same extensive federal regulation
that govern federally-insured institutions such as the Bank and their
holding companies. As a result, many of the Company's competitors have
advantages over the Company in conducting certain businesses and
providing certain services.
POTENTIAL CONFLICTS OF INTEREST INVOLVING OCWEN ASSET INVESTMENT CORP.
The Company will be subject to various potential conflicts of
interest arising from the relationship between Ocwen Asset Investment
Corp. ("OAC"), a real estate investment trust that specializes in
investments in real estate and real estate-related assets in which the
Company also may invest, directly or indirectly, through the Bank, and
the Company and Ocwen Capital Corporation ("OCC"), a wholly-owned
subsidiary of the Company that manages OAC. Historically, OAC has
invested primarily in (i) subordinate and residual interests in
commercial and residential mortgage-backed securities; (ii) distressed
commercial and multi-family residential real estate, including
properties acquired by a mortgage lender by foreclosure or by
deed-in-lieu thereof and underperforming or otherwise distressed real
property (collectively, "Distressed Real Estate"); and (iii)
single-family residential loans, multi-family residential loans and
commercial real estate loans, including in each case loans that are
current in accordance with their terms or are non-performing or
underperforming. The Company does not intend to invest in subordinate
classes of mortgage-related securities which are not created in
connection with its securitization activities or Distressed Real Estate
and, as a result, the Company, the Bank and OCC generally have agreed
to give OAC an exclusive right to purchase such subordinated classes of
mortgage-related securities and Distressed Real Estate. Both the
Company and OAC may engage in the acquisition and resolution of
mortgage loans, including non-performing and underperforming mortgage
loans, and from time to time each such entity also may invest in
various non-subordinated classes of mortgage-related securities. In
this regard, OCC, which, in addition to managing OAC, conducts the
large multi-family residential and commercial real estate lending
activities of the Company, has in the past acquired loans for OAC (in
order to enable OAC to leverage the proceeds from its initial public
offering ) rather than for the Company. As a result of the similarity
of the Company's and OAC's strategies to invest in certain assets,
there can be no assurance that investment opportunities which
previously would have been taken by the Company will not be allocated
to OAC. In addition, from time to time the Company may sell loans,
securities and real estate owned to OAC, which also would involve
potential conflicts of interest. Although the Company and OAC have
established certain policies and procedures in order to ensure that
sales and other transactions between the Company, the Bank and/or OCC,
on the one hand, and OAC, on the other hand (including, without
limitation, the base compensation to be paid to OCC by OAC for managing
its day-to-day operations), are conducted on an arms'-length basis on
substantially the same terms as would be present in transactions with
unaffiliated parties, there can be no assurance that such procedures
will be sufficient in all situations to solve potential conflicts of
interest.
IMPORTANCE OF THE CHIEF EXECUTIVE OFFICER
William C. Erbey, Chairman and Chief Executive Officer of the
Company, has had, and will continue to have, a significant role in the
development and management of the Company's business. The loss of his
services could have an adverse effect on the Company. The Company and
Mr. Erbey are not parties to an employment agreement, and the Company
currently does not maintain key man life insurance relating to Mr.
Erbey or any of its other officers.
CONTROL OF CURRENT STOCKHOLDERS
As of March 15, 1999, the Company's directors and executive
officers and their affiliates in the aggregate beneficially owned or
controlled 51.9% of the outstanding Common Stock of the Company,
including 32.0% owned or controlled by William C. Erbey, Chairman and
Chief Executive Officer of the Company, and 15.4% owned or controlled
by Barry N. Wish, currently a director and formerly the Chairman of the
Company. As a result, these shareholders, acting together, would be
able effectively to control virtually all matters requiring approval by
the shareholders of the Company, including amendment of the Company's
Articles of Incorporation, the approval of mergers or similar
transactions and the election of all directors.
SOFTWARE PRODUCT DEVELOPMENT; TECHNOLOGICAL CHANGE
The Company's wholly-owned subsidiary, Ocwen Technology Xchange,
Inc. ("OTX"), licenses the Company's mortgage loan servicing resolution
and work flow technology to third parties in the mortgage and real
estate industries. The products offered by OTX have resulted from the
enhancement of software products acquired through the Company's
purchases of Amos, Inc., a developer of mortgage loan servicing
software, and DTS Communication, Inc., a real estate technology
company, with the Company's own proprietary technology. While the
Company believes it has developed products attractive to the mortgage
and real estate industries, the computer software industry is subject
to rapid technological change, changing customer requirements, frequent
new product introductions and evolving industry standards that may
render existing products and services obsolete.
9
There can be no assurance that OTX will not experience future
difficulties that could delay or prevent the successful development,
introduction and marketing of its products, or that its products and
product enhancements will meet the requirements of the marketplace and
achieve market acceptance. If OTX is unable to develop and introduce
products of marketable quality in a timely manner in response to
changing market conditions or customer requirements, the Company's
business, operating results and financial condition could be adversely
affected.
DEPENDENCE ON PROPRIETARY INFORMATION
The Company's success is in part dependent upon its proprietary
information and technology. The Company relies on a combination of
copyright, trade secret and contract protection to establish and
protect its proprietary rights in its products and technology. The
Company generally enters into confidentiality agreements with its
management and technical staff and limits access to and distribution of
its proprietary information. There can be no assurance that the steps
taken by the Company in this regard will be adequate to deter
misappropriation of its proprietary rights or information or
independent third party development of substantially similar products
and technology. Although the Company believes that its products and
technology do not infringe any proprietary rights of others, the
growing use of copyrights and patents to protect proprietary rights has
increased the risk that third parties will increasingly assert claims
of infringement in the future.
YEAR 2000 DATE CONVERSION
The Company is in the process of establishing the readiness of
its computer systems and applications for the year 2000 with no effect
on customers or disruption to business operations. The Company has
established a project plan to achieve year 2000 readiness of its
mission critical and non-mission critical systems, including hardware
infrastructure and software applications. To date, the Company has
substantially completed the systems identification, evaluation,
remediation and validation phases of the project. The Company has
retained a business continuity expert to prepare contingency plans and
assist with the testing and validation of these plans. Until this phase
is completed, the Company will not know the full extent of the risks
associated with year 2000 readiness, including an analysis of the most
reasonably likely worst case year 2000 scenario. In addition, while the
Company expects its year 2000 conversion will be completed on a timely
basis and within the anticipated budget of approximately $2.0 million,
no assurance can be given in that regard or that third-party computer
systems and applications will not experience problems associated with
the recognition and processing of the year 2000 and beyond, any of
which could have a material adverse effect on the Company's business,
results of operations or financial condition.
10
9
0000873860
OCWEN FINANCIAL CORPORATION
1,000
USD
12-MOS
DEC-31-1998
JAN-01-1998
DEC-31-1998
1
120,805
49,374
275,000
0
593,347
10,825
10,825
1,434,670
26,330
3,308,079
2,175,016
251,336
94,759
225,000
0
0
608
435,768
3,308,079
256,247
43,517
7,930
307,694
116,584
184,893
122,801
18,509
(121,589)
239,933
(32,366)
(32,366)
0
0
(1,200)
(.02)
(.02)
10.82
672,801
0
0
0
27,188
20,350
421
26,330
26,330
0
0
Tag 9-03(7) includes Loans Available for Sale of $177,847, Loan Portfolio
of $230,312, and Discount Loan Portfoio of $1,026,511.
Tag 9-03(7)(2) includes Allowance for Loan Losses on Loan Portfolio of
$4,928 and on the Discount Loan Portfolio of $21,402.
Tag 9-03(13) includes Securities sold under agreements to repurchase of
$72,051 and Obligations outstanding under lines of credit of $179,285.
Tag 9-04(1) includes Interest Income on Loans Available for Sale of
$56,791, Loan Portfolio of $38,609, and Discount Loans of $160,847.
Tag 9-04(13)(h) includes Gains on sale of securities of $8,125 and an
impairment loss on AAA-rated agency IO's of $129,714.
Tag 9-04(14) includes Non-Interest expense of $226,394 and Distributions on
Company obligated, Mandatorily Redeemable Securities of Subsidiary Trust
Holding Solely Junior Subordinated Debentures of the Company of $13,594.
