United States Securities and Exchange Commission Washington, DC 20549
FORM 10-Q
For the quarterly period ended March 31, 2001
Commission File Number 0-22193
LIFE FINANCIAL CORPORATION (Exact name of registrant as specified in its charter)
10540 MAGNOLIA AVENUE, RIVERSIDE, CALIFORNIA 92505
(909) 637 - 4000 (Registrant's telephone number, including area code)
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. (X) Yes ( ) No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 6,668,436 shares of common stock, par value $0.01 per share, were outstanding as of May 11, 2001.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES FORM 10-Q INDEX For the Quarter Ended March 31, 2001
Item 1. Financial Statements.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Dollars in thousands)
Accompanying notes are an integral part of these consolidated financial statements.
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LIFE FINANCIAL CORPORATIONS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except share data) (unaudited)
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LIFE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS (Dollars in thousands) (UNAUDITED)
Accompanying notes are an integral part of these consolidated financial statements
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LIFE FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (Dollars in thousands)
Accompanying notes are and integral part of these consolidated financial statements.
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LIFE FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 2001 (UNAUDITED)
Note 1—Basis of Presentation
The consolidated financial statements include the accounts of LIFE Financial Corporation (the "Company") and its subsidiaries, LIFE Bank (formerly Life Savings Bank, Federal Savings Bank), (the "Bank"), Life Financial Insurance Services, Inc. and Life Investment Holdings, Inc. All material intercompany accounts and transactions have been eliminated in consolidation.
In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the Company's financial position as of March 31, 2001 and December 31, 2000, and the results of its operations and its cash flows for the three months ended March 31, 2001 and 2000. Operating results for the three months ended March 31, 2001, are not necessarily indicative of the results that may be expected for any other interim period or the full year ending December 31, 2001.
Certain information and note disclosures normally included in financial statements prepared in accordance with Generally Accepted Accounting Principles ("GAAP") have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000.
Certain amounts reflected in the 2000 consolidated financial statements have been reclassified where practicable, to conform to the presentation for 2001.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. It requires that an entity recognize all derivatives as ether assets or liabilities in the balance sheet and measure those derivatives at fair value. The accounting for the gains or losses resulting from changes in the values of those derivatives depends on the use of the derivative and whether it qualifies for hedge accounting. In May 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of SFAS No. 133," that amends SFAS No. 133 and defers the effective date to fiscal years beginning after June 15, 2000. The adoption of SFAS No. 133 did not have a material impact on the Company's results of operations or financial position.
Note 2—Regulatory Matters
On September 25, 2000, the Company consented to the issuance of an Order to Cease and Desist (the "Order") by the Office of Thrift Supervision (the "OTS") which requires that the Company, among other things, to contribute $5.2 million to the capital of the Bank, not later than December 31, 2000, subject to extension by the OTS.
Also, on September 25, 2000, the Bank entered into a Supervisory Agreement with the OTS that requires that the Bank, among other things, to achieve a core capital of at least 6.0% and a total risk-based capital of at least 11.0% by March 31, 2001. In calculating these ratios, the Bank must risk weight all loans secured by owner-occupied 1 - 4 family residential property with a loan-to-value (LTV)
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ratio of 90% or greater unless the loan has appropriate credit support plus all subprime loans it holds at double the regularly prescribed risk weighting. In March 2001, the Company sold $29 million in subprime loans at a gain of approximately $132,000.
In March 2001, the OTS issued a Prompt Corrective Action Directive (the "PCA Directive") requiring the Bank, among other things, to raise sufficient capital through securities issuance to achieve the following capital levels by June 30, 2001: Total risk-based capital of 8.0%; Tier 1 risk-based capital of 4.0%; and Leverage ratio of 4.0%, or as an alternative, to recapitalize by merging or being acquired prior to September 30, 2001.
The additional $5.2 million capital contribution has not been raised, however, management of the Company has retained a financial advisor to assist in raising capital and has been actively pursuing investors or potential buyers of the Company. Management is continuing to focus on improving operating efficiency by reducing general and administrative expenses. Management is also evaluating the products and services offered through its branch network.
The Bank's capital amounts and ratios are presented in the following table:
The March 31, 2001 capital ratios are calculated using double risk weighting for high LTV residential and subprime loans in accordance with the Supervisory Agreement.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
The following presents management's discussion and analysis of the consolidated financial condition and operating results of the Company for the three months ended March 31, 2001 and 2000. The discussion should be read in conjunction with the Company's unaudited consolidated financial statements and the notes thereto appearing elsewhere in this report.
The statements contained herein that are not historical facts are forward-looking statements based on management's current expectations and beliefs concerning future developments and their potential effects on the Company. There can be no assurance that future developments affecting the Company will be the same as those anticipated by management. Actual results may differ from those projected in the forward-looking statements. These forward-looking statements involve risks and uncertainties. These include, but are not limited to, the following risks: (1) Changes in the performance of the financial markets, (2) Changes in the demand for and market acceptance of the Company's products and services, (3) Changes in general economic conditions including interest rates, presence of competitors with greater financial resources, and the impact of competitive projects and pricing, (4) the effect of the Company's policies, (5) the continued availability of adequate funding sources, (6) actual prepayment rates and credit losses as compared to prepayment rates and credit losses assumed by the Company for purposes of its valuation of mortgage derivative securities (the "participation contract"), (7) the effect of changes in market interest rates on the spread between the coupon rate and the pass through rate and on the discount rate assumed by the Company in its valuation of its participation contract, and (8) various legal, regulatory and litigation risks.
GENERAL
The Company, a Delaware corporation organized in 1997, is a savings and loan holding company that owns 100% of the capital stock of the Bank, the Company's principal operating subsidiary. The Company's primary business is community retail banking and real estate lending.
The Bank was founded in 1983 as a state chartered savings and loan and became a federally chartered stock savings bank in 1991. The Bank is a member of the Federal Home Loan Bank of San Francisco ("FHLB"), which is a member bank of the Federal Home Loan Bank System. The Bank's deposit accounts are insured up to the $100,000 maximum amount currently allowable under federal laws by the Savings Association Insurance Fund ("SAIF"), which is a separate insurance fund administered by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is subject to examination and regulation by the Office of Thrift Supervision ("OTS") and the FDIC. The Bank is further subject to regulations of the Board of Governors of the Federal Reserve System ("FRB") concerning reserves required to be maintained against deposits and certain other matters.
The Bank operates five full-service branches located in our market area of San Bernardino, Riverside, and Orange Counties, California. The Bank offers a variety of products and services for consumers and small businesses, which include checking, savings and money market accounts as well as
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certificates of deposit. The Bank originates and purchases conforming and jumbo prime credit quality real estate secured loans through a network of approved mortgage brokers within the state of California. Additionally, the Bank originates residential construction loans on a retail basis in Southern California. The Bank funds its lending activities primarily with retail deposits obtained through its branches and advances from the FHLB of San Francisco. Advances from the FHLB need to be approved by their credit committee and are limited to overnight borrowings.
The Company's principal sources of income are the net spread between interest earned and the interest costs associated with deposits and other borrowings used to finance its loans and investment portfolio and servicing fee income.
FINANCIAL CONDITION
Total assets of the Company were $354.7 million at March 31, 2001 compared to $414.4 million at December 31, 2000. The $59.7 million decrease in total assets from December 31, 2000 was primarily a result of a $48.4 million decrease in the loan portfolio. During the period ending March 31, 2001, the Company sold $29.0 million in loans resulting in a gain of approximately $132,000. Investments in mortgage-backed securities of $39.5 million were also sold at a gain of approximately $544,000. These decreases were partially offset by an increase of $34.1 million in other interest earning assets.
Investment Securities
A summary of the Company's securities as of March 31, 2001 and December 31, 2000 is as follows (dollars in thousands):
Loans
Loans totaled $268.3 million at March 31, 2001 compared to $316.7 million at December 31, 2000, or a decrease of $48.4 million. The decrease is primarily due to loans sold of $29 million resulting in a gain of approximately $132,000. Additionally, the Bank originated $5.2 million in loans during the three
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months ending March 31, 2001. Together with loan purchases of $5.0 million, total loan production for the three months ending March 31, 2001 was $10.2 million with principal repayments totaling $29.9 million.
For the three months ending March 31, 2000, the Bank originated $83.3 million in loans. The Bank's loan production total for the three months ending March 31, 2000 was $206.6 million and included $123.3 million of purchased loans. Loan sales totaled $205.9 million for the three months ending March 31, 2000.
The reduction in loan production is the result of ceasing the origination of loans for sale and of the Bank's stated intent to originate higher credit quality loans and to eliminate subprime originations.
A summary of the Company's loan originations and sales for the three months ended March 31, 2001 and 2000 are as follows (dollars in thousands):
Allowance for Loan Losses
For the three months ended March 31, 2001, the Company made a $419 thousand provision for loan losses compared to no provision during the three months ended March 31, 2000.
Allowance for loan losses totaled $4.8 million and $5.4 million at March 31, 2001 and December 31, 2000, respectively. The March 31, 2001 allowance for loan losses as a percent of total
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impaired loans was 20.29%, compared to 19.89% at December 31, 2000. Impaired loans, as a percent of gross loans was 8.39% at March 31, 2001, compared to 8.07% at December 31, 2000.
The Company's determination of the level of the allowance for loan losses and correspondingly, the provision for loan losses, rests upon various judgments and assumptions, including current economic conditions, loan portfolio composition, prior loan loss experience and industry trends. Given the composition of the Company's loan portfolio, the $4.8 million allowance for loan losses was considered adequate to cover losses inherent in the Company's loan portfolio at March 31, 2001. However, no assurance can be given that the Company will not, in any particular period, sustain loan losses that exceed the amount reserved, or that subsequent evaluation of the loan portfolio, in light of the prevailing factors, including economic conditions which may adversely affect the Company's or the Bank's service area or other circumstances, will not require significant increases in the loan loss allowance. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additional provisions to increase the allowance or take charge-offs in anticipation of future losses.
The table below summarizes the activity of the Company's allowance for loan losses for the three months ended March 31, 2001 and 2000 (in thousands):
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COMPOSITION OF IMPAIRED ASSETS
The table below summarizes the Company's composition of impaired assets as of the dates indicated:
Participation Contract
The Bank continues to carry the Participation Contract at $4.4 million, which was the value presented in the December 31, 2000 financial statement. The Bank does not believe there is an active market for this type of asset and has determined the estimated fair value utilizing a cash flow model which determines the present value of the estimated expected cash flows from this contract using a discount rate the Bank believes is commensurate with the risks involved. Additionally, the Bank is not accreting the discount, at this time, due to the significant uncertainty surrounding the asset.
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Mortgage Servicing Rights
The activity for the Company's mortgage servicing rights was as follows (dollars in thousands):
Liabilities and Stockholders' Equity
Total liabilities of the Company decreased from $400.5 million at December 31, 2000 to $341.0 million at March 31, 2001. The decrease was primarily from decreases in deposits and reduced borrowing requirements.
Total Bank deposits at March 31, 2001 was $316.6 million, compared to $345.1 million at December 31, 2000. The 8.26% decrease in deposits from December 31, 2000 is primarily due to decreases in certificates of deposit. The Bank's strategy continues to focus more heavily on increasing retail deposits through the growth of both local consumer and business accounts to reduce reliance on brokered deposits and other borrowings. Previously the Company utilized brokered deposits, but according to the OTS' Prompt Corrective Action guidelines for undercapitalized institutions, the Bank cannot renew existing brokered deposits. At March 31, 2001, the Bank had $35.6 million in brokered deposits remaining. By the end of May 2001, all brokered deposits will have matured and the accounts closed. The Bank has sufficient liquidity to manage the elimination of broker deposits.
Other borrowings as of March 1, 2001 was $20.0 million compared to $47.1 million at December 31, 2000. The $27.1 million decrease is due to reduced borrowing requirements with the decrease in loans.
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RESULTS OF OPERATIONS
Results for the quarter ended March 31, 2001 are compared to the quarter ended March 31, 2000 below.
Highlights for the three months ended March 31, 2001 and 2000:
The Company reported a net loss of $6,000 for the quarter ended March 31, 2001, or $0.00 loss per share, compared with net loss of $774,000, or $0.12 per share for the quarter ended March 31, 2000.
During the first quarter ended March 31, 2001, the Company sold all its investments in mortgage-backed securities at a gain of approximately $544,000, sold $5 million of servicing rights for a gain of approximately $170,000 and also sold $29 million in subprime loans at a gain of approximately $132,000. The decrease in noninterest expense is consistent with the reduction in the scale of operations and is a result of conscious efforts by management to gain efficiencies.
The loss of $774,000 for the quarter ended March 31, 2000 included a $506,500 mark-to-market adjustment related to the repurchase of first trust mortgages from loan sales completed in early 1999 and other charges related to the consolidation of the Bank's mortgage banking operations and corporate downsizing. Additionally, the loss included a $1.6 million loss on mortgage banking related to a loan sale yield enhancement derivative.
Net Interest Income:
The Company's net interest income before provision for credit losses decreased 46.3% to $2.2 million during the three months ended March 31, 2001, compared to $4.1 million for the three months ended March 31, 2000. The decline is primarily due to the decrease in loans outstanding and loan yield. Average loans for the three months ending March 31, 2001 decreased $159 million from the same prior year period. Additionally, the average loan yield was 72 basis points lower during the three months ended March 31, 2001 as compared to the same period in 2000.
For the three months ending March 31, 2001, the Company's net interest margin was 2.52% as compared to a net interest margin of 3.33% during the same period in 2000. The change in the Company's net interest margin was caused by the above mentioned loan yield decrease plus an increase in the cost of funds for interest bearing deposits of 45 basis points from the same prior year period. Average interest bearing deposits cost was 6.38% at March 31, 2001 and 5.93% for March 31, 2000.
The following table sets forth the Company's average balance sheets (unaudited), and the related weighted average yields and costs on average interest-earning assets and interest-bearing liabilities, for the three months period ended March 31, 2001 and 2000.
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The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are measured on a daily basis. The yields and costs include fees that are considered adjustments to yields.
Noninterest Income (loss)
Noninterest income was $2.1 million and $1.1 million for the three months ended March 31, 2001 and 2000, respectively. This increase in noninterest income is primarily due to the loss from mortgage banking on a loan sale yield enhancement derivative of $1.6 million incurred in the three months ended March 31, 2000. This was partially offset by reduced loan servicing and mortgage banking fee income in the three months ended March 31, 2001 due to the restructuring of the Company.
Noninterest Expense
Noninterest expense was $3.9 million for the three months ended March 31, 2001, which was $2.7 million lower than the same period in 2000. The 41.0% decrease is primarily a result of reduced compensation expense of $1.6 million related to reduction in personnel, and a $487 thousand decrease
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in premises and occupancy related to the closure of a branch in the last quarter of 2000 and the closure of its mortgage banking offices during 2000.
LIQUIDITY
The Company's primary sources of funds are principal and interest payments on loans and deposits. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition. However, the Company has continued to maintain the required minimum levels of liquid assets as defined by OTS regulations. This requirement, which may be varied at the direction of the OTS depending upon economic conditions and deposit flows, is based upon a percentage of deposits and short-term borrowings. The required ratio is currently 4%. The Bank's average liquidity ratios were 11.68% and 4.88% for the quarters ended March 31, 2001 and 2000, respectively. The Bank had $18.9 million in deposits maturing within one month as of March 31, 2001, which represents 6.53% of certificate accounts. The Bank anticipates that it will retain a portion of these accounts as well as raise new deposits to maintain sufficient liquidity.
The Company's cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities and financing activities. Cash flows (used in) provided by operating activities was ($4.2) million for the three months ended March 31, 2001, compared to $2.4 million for the three months ended March 31, 2000. Net cash provided by investing activities was $116.0 million and $13.7 million for the three months ended March 31, 2001 and 2000, respectively. Cash provided by investing activities during the three months ended March 31, 2001 was a result of the sale of investments in mortgage-backed securities of $39.8 million, sale of subprime loans of $29.3 million and the decrease in securities held under repurchase agreements of $25 million. Principal collections on loans of $28.1 million offset partially by the net increase in securities of $17.4 million were the primary components of cash provided by investing activities for the three months ended March 31, 2000. Net cash used in financing activities were $55.6 million and $28.3 million for the three months ended March 31, 2001 and 2000, respectively. This was primarily due to decreased deposit accounts and Federal Home Loan Bank advances.
The Company's most liquid assets are unrestricted cash and short-term investments. The levels of these assets are dependent on the Company's operating, lending and investing activities during any given period. At March 31, 2001, cash and short-term investments totaled $67.6 million. The Company has other sources of liquidity if a need for additional funds arises including the utilization of a line of credit at the Federal Home Loan Bank (FHLB) which is limited to overnight advances with new borrowings requiring FHLB credit committee approval. Advances outstanding as of March 31, 2001 consisted of $20.0 million at the FHLB.
CAPITAL RESOURCES
The OTS capital regulations require savings institutions to meet three minimum capital requirements: a 1.5% tangible capital ratio, a 3.0% leverage (core capital) ratio and an 8.0% risk-based capital ratio. The core capital requirement has been effectively increased to 4.0% because the prompt corrective action legislation provides that institutions with less than 4.0% core capital will be deemed "undercapitalized." In addition, the OTS, under the prompt corrective action regulation, can impose various constraints on institutions depending on their level of capitalization ranging from "well capitalized" to "critically undercapitalized."
Under the Supervisory Agreement, dated September 25, 2000, between the Bank and the OTS, the OTS is requiring the Bank to achieve a minimum individual core capital ratio of 6% and a minimum individual risked-based capital ratio of 11%. In calculating these ratios, the Bank is required to double risk weight all subprime loans and all loans secured by owner-occupied 1 - 4 family residential property
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with a loan-to-value (LTV) ratio of 90% or greater unless the loan has appropriate credit support. Appropriate credit support may include mortgage insurance, government guarantee, or readily marketable collateral that reduces the LTV ratio below 90%.
The following table reflects the Bank's capital ratios based on ending assets at March 31, 2001 and the related OTS requirements for adequately capitalized:
Dollars in Thousands
As of March 31, 2001, the Bank had outstanding commitments to originate or purchase mortgage loans of $5.4 million compared to $1.4 million as of December 31, 2000. Other than commitments to originate or purchase mortgage loans, there were no material changes to the Company's commitments or contingent liabilities as of March 31, 2001 compared to the period ended December 31, 2000 as discussed in the notes to the audited consolidated financial statements of LIFE Financial Corporation for the year ended December 31, 2000 included in the Company's Annual Report on Form 10K.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Management of Interest Rate Risk
The principal objective of the Company's interest rate risk management function is to evaluate the interest rate risk included in certain balance sheet accounts, determine the level of appropriate risk given the Company's business focus, operating environment, capital and liquidity requirements and performance objectives and manage the risk consistent with Board approved guidelines through the establishment of prudent asset concentration guidelines. Pursuant to the guidelines, management of the Company seeks to reduce the vulnerability of the Company's operations to changes in interest rates. Management of the Company monitors its interest rate risk as such risk relates to its operating strategies. The Company's Board of Directors reviews on a quarterly basis the Company's asset/liability position. The extent of movement in interest rates, higher or lower, is an uncertainty that could have a negative impact on the earnings of the Company.
Between the time the Company originates loans and purchase commitments are issued, the Company is exposed to both upward and downward movements in interest rates which may have a material adverse effect on the Company.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There have been no material developments in the legal proceedings as previously report in the Company's Annual Form 10-K.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Exhibits
Current Report on Form 8-K dated 01/03/01 and filed 01/04/01.Current Report on Form 8-K dated 03/06/01 and filed 03/07/01.Current Report on Form 8-K dated 03/22/01 and filed 03/23/01.Current Report on Form 8-K dated 03/27/01 and filed 03/28/01.Current Report on Form 8-K dated 04/12/01 and filed 04/13/01.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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