10-Q 1 faco_10q-063002.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES AND EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES AND EXCHANGE ACT OF 1934 For the transition period from_________ to _________ COMMISSION FILE NUMBER 0-28706 ------- FIRST ALLIANCE CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 33-0721183 --------------------------------- --------------------------------------- (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER) INCORPORATION OR ORGANIZATION) 17305 VON KARMAN AVENUE, IRVINE, CALIFORNIA 92614 ----------------------------------------------------------- (Address of principal executive offices including ZIP Code) (949) 224-8500 ------------------------------ (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 and 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 --- --- APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities and Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes No X --- --- As of July 18, 2002, the registrant had outstanding, net of treasury shares, 17,864,788 shares of common stock (the "Common Stock."). ================================================================================ FIRST ALLIANCE CORPORATION INDEX PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Condensed Financial Statements Consolidated Statements of Net Assets Available for Liquidation (Unaudited) as of June 30, 2002 and December 31, 2001............ 1 Consolidated Statements of Change in Net Assets (Unaudited) for the quarter and six months ended June 30, 2002............... 2 Consolidated Statement of Change in Net Assets (Unaudited) for the Quarter and six months ended June 30, 2001............... 3 Notes to Consolidated Financial Statements (Unaudited)........... 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A")................................... 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 17 PART II. OTHER INFORMATION Item 1. Legal Proceedings................................................ 18 Item 2. Changes in Securities............................................ 20 Item 3. Defaults Upon Senior Securities.................................. 20 Item 4. Submission of Matters to a Vote of Security Holders.............. 20 Item 5. Other Information................................................ 20 Item 6. Exhibits and Reports on Form 8-K a. Exhibits ........................................... 21 Reports on Form 8-K ................................ 22 i PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED FINANCIAL STATEMENTS FIRST ALLIANCE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF NET ASSETS AVAILABLE FOR LIQUIDATION (DOLLARS IN THOUSANDS)

(1) See disclaimer of opinion under Risk Factors. See notes to condensed consolidated financial statements. 1 FIRST ALLIANCE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CHANGE IN NET ASSETS (DOLLARS IN THOUSANDS) (UNAUDITED)

See notes to condensed consolidated financial statements. 2 FIRST ALLIANCE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CHANGE IN NET ASSETS (DOLLARS IN THOUSANDS) (UNAUDITED)

See notes to condensed consolidated financial statements. 3 FIRST ALLIANCE CORPORATION NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS GENERAL The accompanying unaudited condensed consolidated financial statements, which include the accounts of First Alliance Corporation (FACO) and its subsidiaries (collectively the "Company"), have been prepared in accordance with the instructions to Form 10-Q and include all information and footnotes required for interim financial statement presentation. All adjustments (consisting only of various normal accruals) necessary to present fairly the Company's consolidated financial statements have been made. All significant intercompany transactions and balances have been eliminated and certain reclassifications have been made to prior periods' condensed consolidated financial statements to conform to the current period presentation. Such reclassifications had no effect on net income (loss). FINANCIAL STATEMENT PRESENTATION On March 23, 2000, First Alliance Corporation, along with several of its subsidiaries, filed voluntary petitions under Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Filing") in the United States Bankruptcy Court for the Central District of California. As of the date of the Company's voluntary bankruptcy petition, the United States Bankruptcy Court for the Central District of California assumed jurisdiction over the assets of the Company. As a debtor in possession, the Company remains in control of its assets and is authorized to operate its business, subject to the supervision of the Bankruptcy Court. The Company's filing is expected to facilitate the reorganization, marketing, sale and liquidation of the Company's remaining business and assets. The Company has laid off over 400 employees, ceased all loan origination and branch operations, and therefore, has no operating loan origination business. The affected offices were located in California, New York, New Jersey, Illinois, Arizona, Colorado, Maryland, Oregon, Utah and Washington. For financial statement presentation only, March 31, 2000 will be considered the effective date of the Bankruptcy Filing. However, the Company applied the liquidation basis accounting effective with the date of the Bankruptcy Filing. As a result of the Bankruptcy Filing and management's intention to market and sell the assets of the Company, the liquidation basis of accounting and financial statement presentation was adopted for periods subsequent to March 31, 2000. Accordingly, for financial information presented subsequent to March 31, 2000 the "Consolidated Statement of Financial Condition" has been replaced with the "Consolidated Statement of Net Assets Available for Liquidation," while the "Consolidated Statement of Operations" has been replaced with the "Consolidated Statement of Change in Net Assets." Prior to March 31, 2000, the Company reported a "Consolidated Statement of Financial Condition" and "Consolidated Statement of Operations" using the accounting principles applicable to going concern entities. Therefore, financial statements presented for the period prior to the Bankruptcy Filing are not comparable to the financial statements presented subsequent to the Bankruptcy Filing, which applies the liquidation basis of accounting. Liquidation basis accounting requires the Company to provide for all liabilities related to expenses, including general and administrative, to be incurred during the liquidation period using certain assumptions, including assumptions as to the timing of asset disposition. Therefore, the Company has recorded approximately $5.1 million in estimated liquidation cost accrual as of June 30, 2002. There is no assurance, however, that actual liquidation expenses will not exceed management's estimates. In the event that actual liquidation expenses exceed management's estimates, the Company's Consolidated Statement of Net Assets may be adversely affected. Liquidation basis accounting also requires assets to be valued at their estimated net realizable value and liabilities to be estimated at amounts to be paid in settlement of the entity's obligations. Estimated net realizable value represents management's best estimate as to liquidation value of the assets, net of selling expenses, and without consideration to the unknown impact that the Bankruptcy Filing or the outcome of any litigation or claims may have on the value of the assets. There can be no assurance, however, that the Company will be successful in selling the assets at the net realizable value which has been recorded in the Consolidated Statement of Net Assets Available for Liquidation. Obtaining proceeds of less than the value stated may have a material adverse effect on the Company's Consolidated Statement of Net Assets Available for Liquidation. During the three months ended June 30, 2002, the Company recorded no valuation adjustment to the cost basis of certain assets and liabilities. After the Bankruptcy Filing, various creditors, borrowers and governmental units 4 FIRST ALLIANCE CORPORATION NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS submitted proofs of claim against the Company. As of the filing of this report, the Company had received over $11 billion in claims and other unspecified amount claims from governmental units and others. The Company is currently in the process of reviewing over 2,800 claims. The review process consists of analyzing the validity, objectability and duplication of the claims. Based on the unfinished review process, the Company has established accruals and reserves for certain claims that, at this point, the Company has determined to be probably valid. As of June 30, 2002, the Company had provided for approximately $12.2 million for such claims. There is no assurance that this amount will be sufficient to satisfy the ultimate disposition of the claims once the final review is completed. In previous filings, the Company, based upon the advice of its outside bankruptcy counsel, had estimated that the overall reorganization/liquidation plan would take approximately 12 months. Accordingly, the Company, based upon the advice of its outside legal bankruptcy counsel, has re-estimated that the overall reorganization/liquidation plan may take approximately 6 months from June 30, 2002. The financial information provided herein, including the information under the heading Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations" (MD&A), is written with the presumption that the users of these interim consolidated financial statements have read, or have access to, the Company's most recent filings on Forms 8-K and Form 10-K which contains the latest available consolidated financial statements and notes thereto, as of and for the period ended December 31, 2001, together with the MD&A for such period. As described on page 7, the auditors' report on these financial statements did not express an opinion on the financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principals generally accepted in the U.S.A. have been condensed or omitted from this report. The changes in net assets for the period from December 31, 2001 to June 30, 2002 are not indicative of the changes to be expected for the full year. The Company's current sources of cash include interest income from residual interests, loans receivable and cash balances, limited servicing income from its remaining servicing business (approximately 275 loans), and proceeds from liquidation of assets. The Company's uses of cash include payments to creditors, payments of interest, repayment of its warehouse financing facilities, administrative expenses, and payment of income taxes. All such payments are on a post petition basis only or unless otherwise approved by the Bankruptcy Court. As a result of the Bankruptcy Filing, the closure of the Company's loan origination operations and the servicing rights portfolio sale, the Company has lost a significant source of cash flow. As of June 30, 2002, the Company had unrestricted cash and cash equivalents of $36.8 million. PREMISES The Company currently occupies approximately 4,000 square feet of its former headquarters at 17305 Von Karman Avenue, Irvine, California. This space is being subleased from an unrelated third party. The building is owned by MJB Associates, Inc., a California limited partnership ("MJB"). MJB is owned by Brian and Sarah Chisick, the majority stockholders of the Company. SALE OF REAL AND PERSONAL PROPERTY The Company has a fee simple ownership interest in the improved real property located at 17200 Jamboree Boulevard, Irvine, California and the personal property located on that premises. The real property is encumbered by a first-priority lien in the approximate amount of $3.4 million. On April 23, 2002, the Company entered into an agreement to sell the building to Standard Tool for the sum of $5.3 million. The District Court approved the sale by an order on July 11, 2002, and the transaction closed on July 16, 2002. 5 FIRST ALLIANCE CORPORATION NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS RECENT DEVELOPMENTS PROPOSED SETTLEMENT As of February 25, 2002, the Company and its subsidiaries, and the Federal Trade Commission ("FTC"), the Attorneys General of Arizona, California, Florida, Illinois, and Massachusetts, the New York State Banking Department, and the various Plaintiffs in the borrower related litigation reached a proposed Settlement ("Settlement") of most of the outstanding litigation. The terms of the Settlement are summarized below. The actual settlement documents are posted on the website of the FTC, and can be found at WWW.FTC.GOV/OPA/2002/03/FAMCO.HTM. The Settlement is conditioned on a number of events, including, without limitation, various approvals and Court orders. The Commissioners of the FTC approved the terms of the Settlement on March 15, 2002. In brief, the Settlement provides for a "Redress Fund" to be established under the control of the FTC. The FTC would then administer a claims process for the payment of borrower claims. The Redress Fund is to be comprised of the assets of the Company, less necessary amounts to pay: (1) present and future anticipated administrative expenses, (2) general unsecured creditors, in a percentage of their claims to be determined as part of the process of confirming a Bankruptcy Plan, and (3) present and future anticipated Professional and Employee claims in connection with the Settlement. Brian and Sarah Chisick have agreed to (i) contribute the sum of $20 million to the Company to be part of the Redress Fund, (ii) purchase the Company's Residual Interests for the amount of $25.1 million, the stated value of the residual interests on the Company's financial statements as of December 31, 2001, and (iii) be enjoined from engaging in any residential loan origination business, and have agreed to other restrictions. Certain insurers for the Company and others with whom it did business are contributing additional sums to the Redress Fund, and the terms of the Settlement shall be the basis for a liquidating Chapter 11 Plan (the "Amended Plan") and a Court approved settlement of the FTC, State, and various borrower class actions. As to the Company's shareholders, the Settlement proposes, in pertinent part, that the Company would cancel all issued and outstanding shares of the Company's common stock ("FACO Shares") two days after the effective date of the Amended Plan. After the effective date of the Settlement, a payment would be made from the Redress Fund to those persons who held FACO Shares on the effective date. FACO shareholders would be paid the lesser of $1.50 per share or the shareholder's purchase basis of such shares prior to cancellation, provided that the total amount of such payments to all shareholders does not exceed $3,250,000.00. Any FACO shares traded after February 25, 2002, would be presumed to have a purchase basis not to exceed $.09. If the total amount of such payments would exceed $3.25 million, the payment to each former shareholder of the Company would be reduced on an equal proportionate basis until the total payments do not exceed $3.25 million. Certain shareholders, including Brian and Sarah Chisick, would waive any payment for FACO shares they hold. Until the Court approves the proposed settlement, the Company continues to value its residual interests using the valuation formula described on page 13. Should the Court approve the proposed settlement, Brian and Sarah Chisick will purchase the residual interests, including all proceeds received and interest earned thereon since January 1, 2002, for the sum of $25.1 million. The effectiveness of the Settlement is conditioned on a number of events which have not occurred, including, but not limited to, the approval of the United States District Court for the Central District of California of the Settlement, the Amended Plan, and other matters. In addition, there can be no assurance that the Settlement or Amended Plan will be approved at all, or in the proposed form. 6 FIRST ALLIANCE CORPORATION NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS On April 22, 2002, the District Court held a preliminary approval hearing on the Proposed Settlement, and entered an Order preliminarily approving the Settlement, conditionally certifying the class actions for settlement purposes, and approving notice of the proposed Settlement. The Court also approved the Consent Decrees and withdrew the reference of the remainder of the bankruptcy cases from the Bankruptcy Court. A hearing is set on final approval on September 9, 2002. On May 7, 2002, the Company and its subsidiaries filed their First Amended Joint Plan of Liquidation and Disclosure Statement, which proposes liquidation in accordance with the terms of the Settlement Agreement. On June 11, 2002, the Court approved the adequacy of the Disclosure Statement, as amended, and the document packages will be sent to creditors prior to August 1, 2002. INTEREST RATE RISK MANAGEMENT Between the time of loan funding and loan sale or securitization, the Company has exposure to interest rate risk relating to its fixed rate loans. This is a result of the loans having an interest rate which is fixed based on the prevailing rates at the time of funding, whereas a fluctuation in rates may occur between that time and the time of loan sale. If market interest rates were to rise between the funding and loan sale, the fixed rate loans would, in turn, decrease in value. Owing to the minimal amount of fixed rate loans, this risk was considered negligible and was not hedged. RISK FACTORS DISCLAIMER OF OPINION ON FINANCIAL STATEMENTS With the filing of the Company's 10-K for December 31, 2001, the Company's current independent auditors, Hein + Associates LLP, included an explanatory paragraph, which provides that the Company has been named as a defendant in numerous lawsuits with aggregate claims in excess of $11 billion dollars, and that the Company has not been able to estimate the amounts expected to be paid to the claimants and the Company's other creditors, and because of the significance of such matters, such auditors were unable to express and did not express an opinion with respect to such financial statements. PLAN OF REORGANIZATION The Company's Bankruptcy Filing is expected to facilitate the reorganization/liquidation and sale of a significant portion of the Company's remaining business and assets and operation of those assets pending any such sale. As of the date of the Company's Bankruptcy Filing, the United States Bankruptcy Court for the Central District of California assumed jurisdiction and control over the assets of the Company. As a debtor in possession, the Company is authorized to operate its business, subject to the supervision of the Bankruptcy Court. No assurance can be given that the Company will remain a debtor-in-possession and that a trustee will not be appointed to operate the Company's business. In addition, although the Company has proposed a plan of reorganization/liquidation to the Bankruptcy Court, no assurance can be given that the Bankruptcy Court will confirm the Company's plan of reorganization/liquidation. It is management's intention to market for sale and operate pending such sale of all or a significant portion of the Company's remaining assets. Proceeds from the sale of assets that are security for the Company's obligations to its secured creditors will first be used to repay such secured creditors, which include the Company's warehouse financing facility and a note payable related to the financing of the Company's telemarketing facility in Irvine, California. The fact that the Company filed a voluntary bankruptcy petition may affect the Company's ability to maintain certain present business arrangements and may also affect the Company's ability to successfully negotiate future business arrangements. Among the relationships that may be materially affected by the 7 FIRST ALLIANCE CORPORATION NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Company's commencement of a bankruptcy case is the Company's relationship with its warehouse financing facility lender and the Company's relationships with other suppliers of goods and services vital to the Company's financing and business operations. There is no assurance that the Company will generate enough cash flow from its residual interest, investments, remaining servicing business and proceeds from asset sales to fund its existing operations or repay its debt obligations. In addition to cash flow from its remaining servicing business, interest on loans and investments, and proceeds from liquidation of assets, the Company derives a significant amount of cash flow from distribution of its residual interest. Among other factors, the amount of residual interest distribution may be affected by loan prepayments, delinquencies or losses. In the event of an increase in loan prepayments, delinquencies or losses, the Company's distribution from residual interest may be adversely affected. In addition, the outcome of pending litigation against the Company may also threaten to reduce or eliminate the level of residual interest distribution. Therefore, there can be no assurance that the Company will continue to receive the same level of cash flow from residual interest as it has in the past. EVENTS OF DEFAULT The Bankruptcy Filing may have triggered an event of default under various agreements entered into by the Company, though the Company contends that they are not, pursuant to, among other things, 11 USC ss.365(b)(2). Such agreements include the Company's pooling and servicing agreements. However, in conjunction with the sale of the servicing rights portfolio, and the "Consent Agreement" entered into with the trustees and bond insurers, the Company will have be deemed to have satisfied the events of default under the Company's pooling and servicing agreements subject to monetary holdback provisions contained in the agreement. The Bankruptcy Filing may have also created an event of default under the Company's warehouse financing facility, though the Company contends that it does not, pursuant to, among other things, 11 USC ss.365(b)(2). Notwithstanding the pendency of the bankruptcy case, the warehouse lender may be able to exercise its remedies under the agreement and require the Company to either repay the entire balance outstanding on the warehouse financing facility or force the Company to transfer ownership of the underlying loans held for sale, which are collateralizing the loan. FINANCIAL REPORTING As a result of the Bankruptcy Filing and management's intention to market and sell the assets of the Company, the financial statement presentation has been revised to the liquidation basis of accounting. Accordingly, the "Consolidated Statement of Financial Condition" has been replaced with the "Consolidated Statement of Net Assets Available for Liquidation," while the "Consolidated Statement of Operations" has been replaced with the "Consolidated Statement of Change in Net Assets." Liquidation basis accounting requires the Company to provide for all liabilities related to expenses, including general and administrative, to be incurred during the liquidation period. Therefore, the Company recorded and accrued an estimate of liquidation expenses to be incurred using certain assumptions, including assumptions as to the timing of asset disposition. There is no assurance, however, that actual liquidation expenses will not exceed management's estimates. In the event that actual liquidation expenses exceed management's estimates, the Company's Consolidated Statement of Net Assets may be adversely affected. Liquidation basis accounting also requires assets to be valued at their estimated net realizable value and liabilities to be estimated as amounts to be paid in settlement of the entity's obligation. Estimated net realizable value represents management's best estimate as to fair market value of the assets, net of selling expenses, and without consideration to the unknown impact that the Bankruptcy Filing or the outcome of any litigation or claims may have on the value of the assets. Therefore, the Company has recorded a valuation adjustment to the cost basis of certain assets and liabilities to approximate net realizable value. There can be no assurance, however, that the Company will be successful in selling the assets at the net realizable value which has been recorded in the Consolidated Statement of Net Assets Available for Liquidation. 8 FIRST ALLIANCE CORPORATION NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Obtaining proceeds of less than the value stated on the Company's Consolidated Statement of Net Assets Available for Liquidation may have a material adverse effect on the Company's Consolidated Statement of Net Assets Available for Liquidation. LITIGATION In addition to being a party to various legal proceedings and asserted claims arising out of the ordinary course of business, the Company has also been involved with several lawsuits which have targeted its lending practices (see Part II Item 1. "Legal Proceedings"). Any substantial judgment against the Company or settlements in connection therewith may materially diminish, if not eliminate, any distribution to shareholders. The Company is currently unable to assess the ultimate outcome with respect to such claims. SECURITIES RISKS RISK FACTORS REGARDING STOCK PRICE AND SETTLEMENT Stockholders may not receive the purchase price for their shares in connection with the Settlement. The Settlement proposes, in pertinent part, that the Company would cancel all issued and outstanding shares of the Company's common stock ("FACO Shares") upon the effective date of the Amended Plan. After the effective date of the Amended Plan, a payment would be made from the Redress Fund to those persons who held FACO Shares on the effective date. FACO shareholders would be paid the lesser of $1.50 per share or the shareholder's purchase basis of such shares prior to cancellation, provided that the total amount of such payments to all shareholders does not exceed $3,250,000.00. Any FACO shares traded after February 25, 2002, would be presumed to have a purchase basis not to exceed $0.09. If the total amount of such payments would exceed $3.25 million, the payment to each former shareholder of the Company would be reduced on an equal proportionate basis until the total payments do not exceed $3.25 million. Certain shareholders, including Brian and Sarah Chisick, would waive any payment for FACO shares they hold. In the event that stockholders purchase FACO shares for a purchase price in excess of $0.09 per share, and the Settlement was to be entered as part of a final Amended Plan, such stockholders would not be able to receive from the Redress Fund an amount in excess of $0.09 per share in connection with the cancellation of their FACO shares. Further, there can be no assurance that such stockholders would receive at least $0.09 per share in connection with the Settlement. The effectiveness of the Settlement is conditioned on a number of events which have not occurred, including, but not limited to, the approval of the United States District Court for the Central District of California of the Settlement, the Amended Plan, and other matters. In addition, there can be no assurance that the Settlement or Amended Plan will be approved at all, or in the proposed form. LIMITED PUBLIC MARKET FOR COMMON STOCK There is currently a limited public market for the Common Stock. Holders of the Company's Common Stock may, therefore, have difficulty selling their Common Stock, should they decide to do so. In addition, there can be no assurances that such markets will continue or that any shares of Common Stock, which may be purchased may be sold without incurring a loss. Any such market price of the Common Stock may not necessarily bear any relationship to the Company's book value, assets, past operating results, financial condition or any other established criteria of value, and may not be indicative of the market price for the Common Stock in the future. Further, the market price of the Common Stock may be volatile depending on a number of factors, including the status of the Company's Bankruptcy proceeding, business performance, industry dynamics, news announcements or changes in general economic conditions. (See also "Proposed Settlement.") 9 FIRST ALLIANCE CORPORATION NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS DISCLOSURE RELATING TO LOW-PRICED STOCKS The Company's Common Stock is currently listed for trading in the over-the-counter market on the NASD Electronic Bulletin Board which is generally considered to be a less efficient market than markets such as NASDAQ or other national exchanges, and which may cause difficulty in conducting trades. The Company's securities are also subject to the "penny stock rules" adopted pursuant to Section 15(g) of the Exchange Act. The penny stock rules apply to non-NASDAQ companies whose common stock trades at less than $5.00 per share or which have tangible net worth of less than $5,000,000 ($2,000,000 if the company has been operating for three or more years). Such rules require, among other things, that brokers who trade "penny stock" to persons other than "established customers" complete certain documentation, make suitability inquiries of investors and provide investors with certain information concerning trading in the security, including a risk disclosure document and quote information under certain circumstances. Many brokers have decided not to trade "penny stock" because of the requirements of the penny stock rules and, as a result, the number of broker-dealers willing to act as market makers in such securities is limited. In the event that the Company remains subject to the "penny stock rules" for any significant period, there may develop an adverse impact on the market, if any, for the Company's securities. Because the Company's securities are subject to the "penny stock rules," investors will find it more difficult to dispose of the securities of the Company. Further, for companies whose securities are traded in the Over-The-Counter Market, it is more difficult: (i) to obtain accurate quotations, (ii) to obtain coverage for significant news events because major wire services, such as the Dow Jones News Service, generally do not publish press releases about such companies, and (iii) for companies whose shares are traded in the Over-The-Counter Market to obtain needed capital (see "Proposed Settlement"). CONTROL BY PRINCIPAL STOCKHOLDERS Brian and Sarah Chisick, the Company's principal stockholders, and their affiliates control the voting power of approximately 80% of the outstanding Common stock. As a result of such Common Stock ownership, such persons will be in a position to exercise significant control with respect to the affairs of the Company and the election of directors, subject to the jurisdiction of the Bankruptcy Court. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The discussion in this item should be read in conjunction with the condensed financial statements and the notes thereto included in Item 1 of this report on Form 10-Q. The discussion in this item contains forward-looking statements relating to future events or financial results, such as statements indicating that "Company/management believes," "Company/management expects," "Company/management intends" that certain events may occur or certain trends may continue. All these forward-looking statements involve risks and uncertainties. Other forward-looking statements include statements about liquidity and capital needs and other statements about future matters. These statements, although they reflect the good faith judgment of management, should not be relied on too heavily, as they involve future events that might not occur. Management can only base such statements on facts and factors that it currently knows. Actual results could differ materially from those in these forward-looking statements as a result of various factors, including those set forth under "Risk Factors" included in other documents which the Company files with the Securities and Exchange Commission and elsewhere in this report on Form 10-Q. GENERAL OVERVIEW The Company was a financial services organization principally engaged in mortgage loan origination, purchases, sales and servicing. Loans originated by the Company primarily consisted of fixed and adjustable rate loans secured by first mortgages on single family residences. The Company originated loans from its retail branch network, Loan by Mail division and Coast Security Mortgage, a company which it purchased during 1999. The Company also purchased loans from qualified mortgage originators. The Company would then sell such loans to wholesale purchasers or securitize them in a trust. A significant portion of the Company's loan production was securitized with the Company retaining the right to service the loans. On March 23, 2000, FACO, along with several of its subsidiaries, filed voluntary petitions under Chapter 11 of the United States Bankruptcy Code. The Company's filing is expected to facilitate the reorganization/liquidation of the Company's remaining business and assets, and operation of those assets pending any such sale. The Company closed all of its loan origination operations, including its branches, and has laid off over 400 employees throughout the United States. The affected offices were located in California, New York, New Jersey, Illinois, Arizona, Colorado, Maryland, Oregon, Utah and Washington. As a result of the Bankruptcy Filing and management's intention to market and sell the assets of the Company, the liquidation basis of accounting and financial statement presentation was adopted for periods subsequent to March 31, 2000. Accordingly, for financial information presented subsequent to March 31, 2000, the "Consolidated Statement of Financial Condition" has been replaced with the "Consolidated Statement of Net Assets Available for Liquidation," while the "Consolidated Statement of Operations" has been replaced with the "Consolidated Statement of Change in Net Assets." Prior to March 31, 2000, the Company reported a "Consolidated Statement of Financial Condition" and "Consolidated Statement of Operations" using the accounting principles applicable to going concern entities. Therefore, financial statements presented for the period prior to the Bankruptcy Filing are not comparable to the financial statements presented subsequent to the Bankruptcy Filing, which applies the liquidation basis of accounting. Liquidation basis accounting requires the Company to provide for all liabilities related to expenses, including general and administrative, to be incurred during the liquidation period using certain assumptions, including assumptions as to the timing of asset disposition. Therefore, the Company has recorded approximately $5.1 million in estimated liquidation cost accrual as of June 30, 2002. There is no assurance, however, that actual liquidation expenses will not exceed management's estimates. In the event that actual liquidation expenses exceed management's estimates, the Company's Consolidated Statement of Net Assets may be adversely affected. Liquidation basis accounting also requires assets to be valued at their estimated net realizable value and liabilities to be estimated as amounts to be paid in settlement of the entity's obligation. Estimated net realizable value represents management's best estimate as to liquidation value of the assets, net of selling expenses, and without consideration to the unknown impact that the Bankruptcy Filing or the outcome of any litigation or claims may have on the value of the assets. There can be no assurance, however, that the Company will be successful in selling the assets at the net realizable value which has been recorded in the Consolidated Statement of Net Assets Available for Liquidation. Obtaining proceeds of less than the value stated may have a material adverse effect on the Company's Consolidated Statement of Net Assets Available for 11 Liquidation. During the three months ended June 30, 2002, the Company recorded no valuation adjustment to the cost basis of certain assets and liabilities. After the Bankruptcy Filing, various creditors, borrowers and governmental units submitted proofs of claim against the Company. As of the filing of this report, the Company had received over $11 billion in claims and other unspecified amount claims from governmental units and others. The Company is currently in the process of reviewing approximately over 2,800 claims. The review process consists of analyzing the validity, objectability and duplication of the claims. Based on the unfinished review process, the Company has established accruals and reserves for certain claims that, at this point, the Company has determined to be probably valid. As of June 30, 2002, the Company had provided for approximately $12.2 million for such claims. This liability is reflected on the Condensed Consolidated Statement of Net Assets Available for Liquidation as of June 30, 2002 as accrued contingent liabilities of $3.2 million, and includes $9.0 million of the $11.5 million of accounts payable and accrued liabilities. There is no assurance that this amount will be sufficient to satisfy the ultimate disposition of the claims once the final review is completed. These claims asserted against the Company may materially diminish, if not eliminate, any distribution to shareholders. In previous filings, the Company, based upon the advice of its outside bankruptcy counsel, had estimated that the overall reorganization/liquidation plan would take approximately 12 months. Recently, the United States District Court has issued Orders on appeals from rulings of the Bankruptcy Court and on Motions to Withdraw the Reference from the Bankruptcy Court by certain parties that indicate that the liquidation period may be substantially longer than previously estimated. Accordingly, the Company, based upon the advice of its outside bankruptcy counsel, has re-estimated that the overall reorganization/liquidation plan may take approximately 6 months from June 30, 2002. REVENUE The three primary components of the Company's revenues historically have been loan origination and sale, loan servicing and interest income. These revenue-generating sources have diminished significantly due to the Bankruptcy Filing and sale of assets of the Company. The Bankruptcy Filing resulted in the Company closing its loan origination and retail branch operations. In addition, in July 2000, the Company sold the majority of its servicing rights portfolio. The Company's current business operation has now been reduced to servicing approximately $25.4 million of its wholly-owned loans as of June 30, 2002. This asset is reflected on the Condensed Consolidated Statement of Net Assets Available for Liquidation as of June 30, 2002 at a $23.1 million value, allowing for $2.3 million of net deferred income over expenses. The Company's current sources of cash include interest income from residual interests, loans receivable and cash balances, limited servicing income from its remaining servicing business (approximately 275 loans), and proceeds from liquidation of assets. Other than proceeds from the sale of assets, the Company expects interest and limited servicing income to be its only source of revenue. Loan origination and sale revenue consisted of gain on sale of loans and the recognition of net origination fees. The Company's strategy of originating, as compared to purchasing, the majority of its loan volume resulted in the generation of a significant amount of loan origination fees. Revenue from loan origination fees has historically allowed the Company to generate positive operating cash flow. Origination fees for the Company's current wholly-owned loans are deferred and recognized into income as loans are paid off or sold. Loan servicing and other fee income represent management servicing fees and other ancillary fees, including prepayment penalties received from servicing loans and income generated from the Company's credit card operations. Mortgage servicing rights are amortized against loan servicing and other fee income over the period of estimated net future servicing fee income. Interest and other income is primarily comprised of three components: (i) interest on loans receivable, (ii) interest on residual interests, and (iii) interest from investments. SECURITIZATIONS As a fundamental part of its business and financing strategy, the Company securitized the majority of its loans. In a typical securitization, the Company sold loans to a special purpose entity, established for the limited purpose of buying the assets from the Company and transferring the assets to a trust. The trust issues interest-bearing securities, referred to as regular interest, which are collateralized by the underlying mortgages. The proceeds from the sale of the securities were used to purchase the assets from the Company. In addition to the cash proceeds received in connection with the securitization, the Company retained a residual interest in the trust. The Company has not securitized loans since the Bankruptcy Filing. 12 Gains on servicing retained sales of loans through securitization represent the difference between the net proceeds to the Company in the securitization and the allocated cost of loans securitized. In accordance with SFAS No. 125, the allocated cost of the loans securitized is determined by allocating their acquisition cost (for purchased loans) or net carrying value (for originated loans) between the loans securitized and the residual interests and the mortgage servicing rights retained by the Company based upon their relative fair values. As the holder of the residual interest, the Company is entitled to receive certain excess cash flows. These excess cash flows ("spread") are the difference between (a) principal and interest paid by borrowers and (b) the sum of (i) scheduled principal and interest paid to holders of the regular interests, (ii) trustee fees, (iii) third-party credit enhancement fees, (iv) servicing fees, and (v) loan losses. The Company begins receiving these excess cash flows after certain overcollateralization requirements, which are specific to each securitization and are used as a means of credit enhancement, have been met. The Company had utilized a cash flow modeling technique to arrive at the fair value of the residual interests. When the Company entered liquidation, it adjusted the valuation formula to use only discounted cash flows and return of overcollateral, and used the valuation of the Residual Interests as of March 31, 2000, as a starting point. This conservative adjustment was made to reflect the lack of a recognized market for these complex derivative interests, litigation risk, and other market conditions. In year 2000, there was not a significant difference between the valuation and the prior model. In year 2001 use of the prior model would have resulted in a higher valuation than use of the methodology adopted in 2000. Since the facts that led the Company to make the conservative adjustment in 2000 remain, the Company decided to make no upward adjustment to the valuation. In March 2002, the Company announced a proposed settlement of borrower litigation. The negotiated terms of the proposed settlement, if approved by the Court, will result in the sale of these assets for the $25.1 million value on the Company's financial statement as of December 31, 2001 to Brian and Sarah Chisick, related parties (see "Proposed Settlement"). Until the Court approves the proposed settlement, the Company continues to value these residual interests using the valuation formula described above. Should the Court approve the proposed settlement, the Chisicks will purchase the residual interests, including all proceeds received and interest earned thereon since January 1, 2002, for the sum of $25.1 million. RECENT DEVELOPMENTS PREMISES The Company currently occupies approximately 4,000 square feet of its former headquarters at 17305 Von Karman Avenue, Irvine, California. This space is being subleased from an unrelated third party. The building is owned by MJB Associates, Inc., a California limited partnership ("MJB"). MJB is owned by Brian and Sarah Chisick, the majority stockholders of the Company. SALE OF REAL AND PERSONAL PROPERTY The Company has a fee simple ownership interest in the improved real property located at 17200 Jamboree Boulevard, Irvine, California and the personal property located on that premises. The real property is encumbered by a first-priority lien in the approximate amount of $3.4 million. On April 23, 2002, the Company entered into an agreement to sell the building to Standard Tool for the sum of $5.3 million. The District Court approved the sale by an order on July 11, 2002, and the transaction closed on July 16, 2002. LOAN ORIGINATIONS, PURCHASES AND SALES There were no loan originations, purchases or sales during the six months ended June 30, 2002 and 2001. 13 RESULTS OF OPERATIONS (CHANGES IN NET ASSETS) As a result of the Bankruptcy Filing, the Company's intent to liquidate the remaining businesses and assets, and the adoption of liquidation based accounting, a discussion of material factors affecting the Company's changes in net assets (April 1, 2002 to June 30, 2002) is presented below, rather than a description of the Company's results of operations for the three months ended June 30, 2002. Please refer to the Company's June 30, 2001 Form 10-Q for a discussion of operating results for the second quarter of 2001. During the period of April 1, 2002 through June 30, 2002, the Company reported a $0.5 million increase in net assets available for liquidation. The Company generated operating revenues of $2.0 million, of which $1.6 million is attributable to interest from residual interest and loans receivable. The Company's operating expenses (excluding interest expense) during the period of April 1, 2002 through June 30, 2002 were less than $0.1 million. During such period, the Company reversed liquidation expenses which it contemplated in its liquidation accrual and also reported in the various expense line items of the Consolidated Statement of Change in Net Assets. The Company believes its estimates of liquidation expenses previously recorded are sufficient through the anticipated liquidation period. Therefore, no additional accrual was made during the three months ended June 30, 2002. Legal expenses accounted for $1.5 million of the Company's operating expenses, which are mainly related to the defense of the litigation cases and administrative bankruptcy proceedings. The net assets of the Company were also affected by a tax provision of $1.2 million. The tax provision is primarily based on the Company's limitations arising from the excess inclusion attributed to the Company's residual interest assets. Pursuant to recently enacted tax legislation, net operating losses ("NOL") generated in taxable years ending in 2001 and 2002 may be carried back up to five years (instead of the usual two years). If the effective date of the settlement occurs before the end of 2002 and the Company has an NOL for such year, such loss may be carried back and used to offset income in the Company's 1997 taxable year. This may result in a tax refund to the Company of as much as $10 million. No amounts have been recorded for this potential refund due to its uncertainty. The Company's net assets in liquidation were $44.9 million at June 30, 2002. 14 SERVICING The following tables provide data on loan delinquency, real estate owned (REO) and net losses for the Company's servicing portfolio:

FOR THE THREE MONTHS ENDED JUNE 30, ---------------------- 2002 2001 ----------- ---------- Average servicing portfolio (2)......................... $ 27,503 $ 51,789 (1) Includes REO of the Company as well as REO of the securitization trusts serviced by the Company; however, excludes private investor REO not serviced by the Company. (2) Average servicing portfolio balance equals the quarterly average of the servicing portfolio computed as the average of the balances at the beginning and end of each quarter. LIQUIDITY AND CAPITAL RESOURCES With the filing of the Company's 10-K for December 31, 2001, the Company's current independent auditors, Hein + Associates LLP, included an explanatory paragraph, which provides that the Company has been named as a defendant in numerous lawsuits with aggregate claims in excess of $11 billion dollars, and that the Company has not been able to estimate the amounts expected to be paid to the claimants and the Company's other creditors, and because of the significance of such matters, such auditors were unable to express and did not express an opinion with respect to such financial statements. The Company's current sources of cash include interest income from residual interests, loans receivable and cash balances, limited servicing income from its remaining servicing business (approximately 275 loans), and proceeds from liquidation of assets. The Company's uses of cash include payments to creditors, payments of interest, repayment of its warehouse financing facilities, administrative expenses, and payment of income taxes. All such payments are on a post petition basis only or unless otherwise approved by the Bankruptcy Court. As a result of the Bankruptcy Filing, the closure of the Company's loan origination operations and the servicing rights portfolio sale, the Company has lost a significant source of cash flow. As of June 30, 2002, the Company had unrestricted cash and cash equivalents of $36.8 million. Among other factors, the amount of residual interest distribution may be affected by loan prepayments, delinquencies or losses. In the event of an increase in loan prepayments, delinquencies or losses, the Company's distribution from residual interest may be adversely affected. In addition, the outcome of pending litigation against the Company may also threaten to reduce or eliminate the level of residual interest distribution. Therefore, there can be no assurance that the Company will continue to receive the same level of cash flow from residual interest as it has in the past. 15 In connection with the Bankruptcy Filing, it is management's intention to market for sale and operate pending such sale of all or a significant portion of the Company's remaining assets. Proceeds from the sale of assets that are security for the Company's obligations to its secured creditors will first be used to repay such secured creditors, which include the Company's warehouse financing facility and a note payable related to the financing of the Company's telemarketing facility in Irvine, California. This note has been satisfied with the sale of the real property on July 16, 2002. The Bankruptcy filing may have triggered an event of default under various agreements entered into by the Company, though the Company contends that they are not, pursuant to, among other things, 11 USC ss.365(b)(2). Such agreements include the Company's pooling and servicing agreements. However, in conjunction with the sale of the servicing rights portfolio, the Company entered into a "Consent Agreement" with the trustees and bond insurers, whereby the Company will be deemed to have satisfied the events of default under the Company's pooling and servicing agreements subject to monetary holdback provisions contained in the agreement. Included in the Company's restricted cash balance is approximately $3.1 million in monetary holdbacks related to this transaction. The Company's ability to recover any portion of the holdback is partially contingent on the outcome of the Company's liquidating plan of reorganization. The Bankruptcy Filing may have created an event of default under the Company's warehouse financing facility, though the Company contends that they are not, pursuant to, among other things, 11 USC ss.365(b)(2). Notwithstanding the pendency of the bankruptcy case, the warehouse lender may be able to exercise its remedies under the agreement and require the Company to repay the entire warehouse financing facility. This may force the Company to accelerate the sale of its loans, which secure the facility, at a price less favorable than might otherwise be obtained, thereby having a material adverse effect on the Company's Consolidated Statement of Net Assets Available for Liquidation. The Company has experienced a significant increase in legal expenses over the last two years, which have had a material adverse effect on the Company's results of operations and financial condition. Such legal expenses have related to legal settlement agreements, and an increase in attorneys' fees and reserves for ongoing legal matters. There is no assurance that legal expenses will be reduced in the future (see Part II, Item 1. Legal Proceedings). The Company believes that its current cash position coupled with cash generated from its existing operations will be sufficient to fund its operations through the anticipated liquidation period. 16 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Management, based upon the advice of its legal bankruptcy counsel, expects that the overall reorganization/liquidation process with respect to the remaining assets and liabilities of the Company to continue for approximately 6 months from June 30, 2002, subject to change depending on the outcome of certain litigation proceedings (see Part II, Item 1). No assurance, however, can be given that the Company will be able to completely liquidate its assets and settle its liabilities within the time expected. No other material changes with regard to market risk from the preceding fiscal year were noted. 17 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In June 2001, the Attorney General of the State of California filed an action on behalf of the State in the Los Angeles County Superior Court against the Company, one of its subsidiaries, the Chairman and Chief Executive Officer, and a former Vice President. The suit alleges violations of the California unfair business practices statute and certain federal laws. The Attorney General seeks restitution, damages, civil penalties, attorneys' fees and costs. This action was subsequently dismissed, and re-filed in the United States District Court with the FTC litigation (see below). This action is one of the subjects of the proposed Settlement (see "Proposed Settlement"). In October 2000, the Federal Trade Commission filed an action against the Company in the United States District Court for the Central District of California. The action alleges that the Company failed to substantiate advertising claims regarding cost savings to consumers of debt consolidation loans, misrepresented the terms of the loans to consumers, and violated Regulation Z regarding a consumer booklet. The action seeks injunctive relief and rescission or restitution on behalf of certain borrowers. The Bankruptcy Court enjoined prosecution of this action, but the U.S. District Court reversed the injunction, and withdrew the reference to the Bankruptcy Court of the FTC claim. That action is now proceeding in the District Court, and the Court set a trial date in April 2002. This action is one of the subjects of the proposed Settlement (see "Proposed Settlement"). In July 2000, the Florida Attorney General commenced an action in Broward County Circuit Court seeking injunctive relief, civil penalties, restitution, rescission and damages, and named a number of current and former officers, directors, and employees of the Company. The Bankruptcy Court enjoined prosecution of this action but the U.S. District Court reversed the injunction, and withdrew the reference to the Bankruptcy Court of the states' claims. Florida subsequently re-filed the action in the United States District Court with the FTC litigation (see above). This action is one of the subjects of the proposed Settlement (see "Proposed Settlement"). In May 2000, Jacqueline Bowser and Irene Huston filed a class action lawsuit against the Company. The complaint seeks damages and rescission based upon fraud and violation of the Truth-in-Lending Act and Home Ownership and Equity Protection Act. The complaint was filed as an adversary proceeding in the Company's consolidated bankruptcy case. In June 2000, Vincent Aiello and other borrowers filed a similar action in the Bankruptcy Court. On February 15, 2001, the Bankruptcy Court denied a motion for class certification in these actions and sustained the Company's objections to the class proofs of claim filed. An appeal of that order was filed, and the District Court reversed the holdings of the Bankruptcy Court, and certified a class action. The Company is appealing this ruling to the Ninth U.S. Circuit Court of Appeal. This action is one of the subjects of the proposed Settlement (see "Proposed Settlement"). In December 1998, the Attorney General of the State of Illinois filed an action on behalf of the State against the Company in the Cook County Circuit Court. The suit alleges violations of the Illinois Consumer Fraud Act, Deceptive Trade Practices Act and Illinois Interest Act. The Attorney General seeks injunctive relief, restitution, civil penalties, rescission, revocation of business licenses, attorneys' fees and costs. The Company's motion to dismiss the complaint was granted as to three of the four claims. The Company and the State were discussing settlement prior to the Bankruptcy Filing. The Bankruptcy Court enjoined prosecution of this action but the U.S. District Court reversed the injunction, and withdrew the reference to the Bankruptcy Court of Illinois' claim. An appeal filed by Illinois of the dismissal of most of its action is proceeding in the Illinois state courts. Illinois subsequently re-filed the action in the United States District Court with the FTC litigation (see above). This action is one of the subjects of the proposed Settlement (see "Proposed Settlement"). In December 1998, the American Association of Retired Persons ("AARP") filed an action against the Company and Brian Chisick, Chairman and Chief Executive Officer of the Company, and his wife, Sarah, in the Superior Court of California, in the County of Santa Clara. The suit alleges unfair, unlawful, fraudulent and deceptive business practices and conspiracy. The AARP is seeking injunctive relief, restitution, revocation of licenses, attorneys' fees and costs. The case was in the discovery stage, and the parties were discussing settlement prior to the Bankruptcy Filing. On March 16, 2001, the Bankruptcy Court sustained the Company's objections to the proofs of claim filed by AARP in their entirety. An appeal of that order was filed, and the District Court reversed the holdings of the Bankruptcy Court. The Company is appealing the ruling to the Ninth U.S. Circuit Court of Appeal. This action is one of the subjects of the proposed Settlement (see "Proposed Settlement"). In October 1998, the Attorney General of Massachusetts filed an action on behalf of the Commonwealth against the Company in the Superior Court of Massachusetts, in the County of Suffolk, alleging unfair and deceptive business practices and seeking an injunction against the Company from charging rates, 18 points and other terms which significantly deviate from industry-wide standards or which are otherwise unconscionable or unlawful. The remedies sought by the Attorney General include injunctive relief; restitution for all consumers; civil penalties; and the costs of investigating and prosecuting the action, including attorneys' fees. A preliminary injunction was granted, limiting the points the Company can charge to a total of five. In addition, the Company must advise the Attorney General before any foreclosure actions are filed in the Commonwealth. The Company filed a motion to vacate the injunction, which was denied without prejudice. The case was in the discovery stage prior to the Company's Bankruptcy Filing. The Bankruptcy Court enjoined prosecution of this action but the U.S. District Court reversed the injunction, and withdrew the reference to the Bankruptcy Court of the Commonwealth's claim. A motion for summary judgment was filed by the Commonwealth of Massachusetts in State Court, which the Company opposed, and the Court denied. This action is one of the subjects of the proposed Settlement (see "Proposed Settlement"). In June 1998, Leon Rasachack and Philip A. Ettedgui filed a class action suit on behalf of all purchasers of the Company's Common Stock between April 24, 1997 through May 15, 1998. The suit was filed in the Superior Court of California in the County of Orange against the Company, Brian Chisick, Sarah Chisick and Mark Mason. The complaint alleges that the Company conspired against those who purchased the stock during the stated class period by failing to disclose known material adverse conditions in making certain public statements about the Company's growth prospects. The state action was in the discovery stage prior to the Company's Bankruptcy Filing. This action is stayed as to the Company due to the Bankruptcy Filing, but since October 4, 2001, the action has been proceeding as to the individual defendants. In April 2001, the United States District Court granted motions of the FTC, the States of Arizona, California, Florida, Illinois, Massachusetts and New York, and the Official Borrowers' Committee (on behalf of the approximately 2,000 borrowers who filed proofs of claim in the Bankruptcy), to withdraw the reference to the Bankruptcy Court of the consideration of their claims. These claims will now be determined in the District Court, though some litigation may take place in the courts of the various states. On October 15, 2001, the District Court found that it had jurisdiction over claims against various third parties related to these actions, and indicated that the actions should proceed on a coordinated basis in the District Court. These actions are among the subjects of the proposed Settlement (see "Proposed Settlement"). Shortly after the Chapter 11 filing, the Company obtained an Order from the Bankruptcy Court staying certain pending actions as to current and former officers, directors and employees of the Company. That Order has been extended several times, most recently on July 2, 2001. The Company has not sought another extension of that Order, which has now expired on October 4, 2001. The Company is also a party to various legal proceedings arising out of the ordinary course of its business including a number of lawsuits alleging misleading lending practices, some of which were filed either as class actions or under private attorney general statutes. These claims are dealt with in the proposed Settlement (see "Proposed Settlement"). As a result of the Chapter 11 filing, most of these actions against the Company have been stayed pursuant to 11 USC ss.362(a). Various private parties and governmental units submitted proofs of claim against the Company. As of the filing of this report, the Company had received over $11 billion in claims and other unspecified amount claims from governmental units and others. These claims are dealt with in the proposed Settlement (see "Proposed Settlement"). PROPOSED SETTLEMENT As of February 25, 2002, the Company and its subsidiaries, and the Federal Trade Commission ("FTC"), the Attorneys General of Arizona, California, Florida, Illinois, and Massachusetts, the New York State Banking Department, and the various Plaintiffs in the borrower related litigation reached a proposed Settlement ("Settlement") of most of the outstanding litigation. The terms of the Settlement are summarized below. The actual settlement documents are posted on the website of the FTC, and can be found at WWW.FTC.GOV/OPA/2002/03/FAMCO.HTM. The Settlement is conditioned on a number of events, including, without limitation, various approvals and Court orders. The Commissioners of the FTC approved the terms of the Settlement on March 15, 2002. In brief, the Settlement provides for a "Redress Fund" to be established under the control of the FTC. The FTC would then administer a claims process for the payment of borrower claims. The Redress Fund is to be comprised of the assets of the Company, less necessary amounts to pay: (1) present and future anticipated administrative expenses, (2) general unsecured creditors, in a percentage of their claims to be determined as part of the process of confirming a Bankruptcy Plan, and (3) present and future anticipated Professional and Employee claims in connection with the Settlement. Brian and Sarah Chisick have agreed to (i) contribute the 19 sum of $20 million to the Company to be part of the Redress Fund, (ii) purchase the Company's Residual Interests for the amount of $25.1 million, the stated value of the residual interests on the Company's financial statements as of December 31, 2001, and (iii) be enjoined from engaging in any residential loan origination business, and have agreed to other restrictions. Certain insurers for the Company and others with whom it did business are contributing additional sums to the Redress Fund, and the terms of the Settlement shall be the basis for a liquidating Chapter 11 Plan (the "Amended Plan") and a Court approved settlement of the FTC, State, and various borrower class actions. As to the Company's shareholders, the Settlement proposes, in pertinent part, that the Company would cancel all issued and outstanding shares of the Company's common stock ("FACO Shares") two days after the effective date of the Amended Plan. After the effective date of the Settlement, a payment would be made from the Redress Fund to those persons who held FACO Shares on the effective date. FACO shareholders would be paid the lesser of $1.50 per share or the shareholder's purchase basis of such shares prior to cancellation, provided that the total amount of such payments to all shareholders does not exceed $3,250,000.00. Any FACO shares traded after February 25, 2002, would be presumed to have a purchase basis not to exceed $.09. If the total amount of such payments would exceed $3.25 million, the payment to each former shareholder of the Company would be reduced on an equal proportionate basis until the total payments do not exceed $3.25 million. Certain shareholders, including Brian and Sarah Chisick, would waive any payment for FACO shares they hold. Until the Court approves the proposed settlement, the Company continues to value its residual interests using the valuation formula described on page 12. Should the Court approve the proposed settlement, Brian and Sarah Chisick will purchase the residual interests, including all proceeds received and interest earned thereon since January 1, 2002, for the sum of $25.1 million. The effectiveness of the Settlement is conditioned on a number of events which have not occurred, including, but not limited to, the approval of the United States District Court for the Central District of California of the Settlement, the Amended Plan, and other matters. In addition, there can be no assurance that the Settlement or Amended Plan will be approved at all, or in the proposed form. On April 22, 2002, the District Court held a preliminary approval hearing on the Proposed Settlement, and entered an Order preliminarily approving the Settlement, conditionally certifying the class actions for settlement purposes, and approving notice of the proposed Settlement. The Court also approved the Consent Decrees and withdrew the reference of the remainder of the bankruptcy cases from the Bankruptcy Court. A hearing is set on final approval on September 9, 2002. On May 7, 2002, the Company and its subsidiaries filed their First Amended Joint Plan of Liquidation and Disclosure Statement, which proposes liquidation in accordance with the terms of the Settlement Agreement. On June 11, 2002, the Court approved the adequacy of the Disclosure Statement, as amended, and the document packages will be sent to creditors prior to August 1, 2002. ITEM 2. CHANGES IN SECURITIES Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable. 20 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits EXHIBIT NO. DESCRIPTION OF EXHIBIT --- ---------------------- 3.1 Amended Certificate of Incorporation of the Company (Incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1, Commission File No. 333-3633) 3.2 Bylaws of the Company (Incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-1, Commission File No. 333-3633) 4.1 1996 Stock Incentive Plan (Incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-1, Commission File No. 333-3633) 4.1.1 Form of Incentive Stock Option Agreement for use with 1996 Stock Incentive Plan (Incorporated by reference to Exhibit 4.1.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, Commission File No. 0-28706) 4.1.2 Form of Non-qualified Stock Option Agreement for use with 1996 Stock Incentive Plan (Incorporated by reference to Exhibit 4.1.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, Commission File No. 0-28706) 10.1 Warehouse Financing Facility dated October 29, 1993 (Incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-1, Commission File No. 333-3633) 10.2 Form of Pooling and Servicing Agreement (Incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-1, Commission File No. 333-3633) 10.3 Corporate Headquarters Lease (Incorporated by reference to Exhibit 10.3 to the Company's Registration Statement on Form S-1, Commission File No. 333-3633) 10.4 S Distribution Notes (Incorporated by reference to Exhibit 10.4 to the Company's Registration Statement on Form S-1, Commission File No. 333-3633) 10.5 Mason Employment Agreement (Incorporated by reference to Exhibit 10.5 to the Company's Registration Statement on Form S-1, Commission File No. 333-3633) 10.5.1 Mason Loan (Incorporated by reference to Exhibit 10.5.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1996, Commission File No. 0-28706) 10.6 Form of Directors' and Officers' Indemnity Agreement (Incorporated by reference to Exhibit 10.7 to the Company's Registration Statement on Form S-1, Commission File No. 333-3633) 10.7 Master Repurchase Agreement dated as of October 31, 1997 between Nationscapital Mortgage Corporation and the Company (Incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, Commission File No. 0-28706) 10.8 Master Repurchase Agreement dated as of October 31, 1997 between Coast Security Mortgage Inc. and the Company (Incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, Commission File No. 0-28706) 10.9 Chisick Employment Agreement (Incorporated by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-1, Commission File No. 333-3633) 10.10 Reimbursement Agreement (Incorporated by reference to Exhibit 10.11 to the Company's Registration Statement on Form S-1, Commission File No. 333-3633) 10.11 Warehouse Financing Facility dated September 5, 1996 (Incorporated by reference to Exhibit 10.12 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1996, Commission File No. 0-28706) 10.12 Interim Warehouse and Security Agreement dated as of February 15, 1997 between Nationscapital Mortgage Corporation and the Company (Incorporated by reference to Exhibit 10.12 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1997, Commission File No. 0-28706) 21 EXHIBIT NO. DESCRIPTION OF EXHIBIT --- ---------------------- 10.13 Interim Warehouse and Security Agreement dated as of February 15, 1997 between Coast Security Mortgage Inc. and the Company (Incorporated by reference to Exhibit 10.13 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1997, Commission File No. 0-28706) 10.14 Smith Loan (Incorporated by reference to Exhibit 10.14 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1997, Commission File No. 0-28706) 10.15 Building Purchase and Sale Agreement between Amresco Residential Mortgage Corporation and the Company (Incorporated by reference to Exhibit 10.15 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997, Commission File No. 0-28706) 10.16 (pound)25,000,000 Warehouse Credit Facility Agreement dated August 18, 1997 between Prudential Securities Credit Corporation and the Company (Incorporated by reference to Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997, Commission File No. 0-28706) 10.17 Master Repurchase Agreement dated as of October 27, 1997 between First Union National Bank and the Company (Incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, Commission File No. 0-28706) 10.18 Amendment to Warehouse Credit Facility Agreement dated August 18, 1997 between Prudential Securities Credit Corporation and the Company (Incorporated by reference to Exhibit 10.18 to the Company's Quarterly Report on Form 10-Q for the period ended March 30, 1998, Commission File No. 0-28706) 10.19 Master Repurchase Agreement dated as of December 30, 1998 between Lehman Commercial Paper Inc. and the Company (Incorporated by reference to Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998, Commission File No. 0-28706) 10.20 Deed of Trust Note dated as of February 19, 1999 between the Ohio National Life Insurance Company and the Company (Incorporated by reference to Exhibit 10.20 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1999, Commission File No. 0-28706) 10.21 Servicing Rights Purchase Agreement dated July 1, 2000 between Ocwen Federal Bank FSB and the Company (Incorporated by reference to Exhibit 10.21 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2000, Commission File No. 0-28706) 10.22 Consent Agreement dated July 14, 2000 between Wells Fargo Bank, Minnesota, National Association, The Chase Manhattan Bank, The Bank of New York, MBIA Insurance Corporation, Ocwen Federal Bank FSB, and the Company (Incorporated by reference to Exhibit 10.21 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2000, Commission File No. 0-28706) (a) Reports on Form 8-K: (1) A current report on Form 8-K was filed on May 17, 2002 by First Alliance Corporation. Under Item 5. "Other Events," First Alliance Corporation reported that it had filed its April Monthly Operating Reports as required to be filed with the Bankruptcy Court and Office of the United States Trustee. (2) A current report on Form 8-K was filed on June 14, 2002 by First Alliance Corporation. Under Item 5. "Other Events," First Alliance Corporation reported that it had filed its May Monthly Operating Reports as required to be filed with the Bankruptcy Court and Office of the United States Trustee. (3) A current report on Form 8-K was filed on July 12, 2002 by First Alliance Corporation. Under Item 5. "Other Events," First Alliance Corporation reported that it had filed its June Monthly Operating Reports as required to be filed with the Bankruptcy Court and Office of the United States Trustee. (4) A current report on Form 8-K was filed on August 15, 2002 by First Alliance Corporation. Under Item 5. "Other Events," First Alliance Corporation reported that it had filed its July Monthly Operating Reports as required to be filed with the Bankruptcy Court and Office of the United States Trustee. 22 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST ALLIANCE CORPORATION REGISTRANT Date: August 21, 2002 /S/ BRIAN CHISICK ------------------------ --------------------------------------- Brian Chisick Chairman and Chief Executive Officer Date: August 21, 2002 /S/ JOEL BLITZMAN ------------------------ --------------------------------------- Joel Blitzman Vice President and Controller Principal Financial Officer 23

FIRST ALLIANCE CORP /DE/ 10-Q