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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1994
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-7850
SOUTHWEST GAS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 88-0085720
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
5241 SPRING MOUNTAIN ROAD
POST OFFICE BOX 98510 89193-8510
LAS VEGAS, NEVADA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (702) 876-7237
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF SUCH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Common Stock, $1 par value New York Stock Exchange, Inc.
Pacific Stock Exchange, Inc.
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
9% DEBENTURES, SERIES A, DUE 2011 9 3/8% DEBENTURES, SERIES D, DUE 2017
9% DEBENTURES, SERIES B, DUE 2011 10% DEBENTURES, SERIES E, DUE 2013
8 3/4% DEBENTURES, SERIES C, DUE 2011 9 3/4% DEBENTURES, SERIES F, DUE 2002
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NONAFFILIATES OF THE
REGISTRANT:
$321,428,580 at March 3, 1995
THE NUMBER OF SHARES OUTSTANDING OF COMMON STOCK:
Common Stock, $1 Par Value 21,428,572 shares as of March 3, 1995
DOCUMENTS INCORPORATED BY REFERENCE
DESCRIPTION PART INTO WHICH INCORPORATED
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Proxy Statement dated March 1995 III
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TABLE OF CONTENTS
PART I
PAGE
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ITEM 1. BUSINESS.................................................................. 1
Natural Gas Operations.................................................... 1
General Description..................................................... 1
Properties.............................................................. 2
Rates and Regulation.................................................... 4
Competition............................................................. 4
Demand for Natural Gas.................................................. 5
Natural Gas Supply...................................................... 5
Environmental Matters................................................... 6
Employees............................................................... 6
Financial Services Activities............................................. 7
General Description..................................................... 7
Lending Activities...................................................... 7
Asset Quality........................................................... 11
Real Estate Development Activities...................................... 14
Investment Activities................................................... 14
Deposit Activities...................................................... 16
Borrowings.............................................................. 17
Employees............................................................... 18
Competition............................................................. 18
Properties.............................................................. 18
Regulation.............................................................. 18
Holding Company Matters................................................... 24
ITEM 2. PROPERTIES................................................................ 25
ITEM 3. LEGAL PROCEEDINGS......................................................... 25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................... 25
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS................................................................... 25
ITEM 6. SELECTED FINANCIAL DATA................................................... 26
Consolidated Selected Financial Statistics................................ 26
Segment Data.............................................................. 27
Natural Gas Operations.................................................. 27
Financial Services...................................................... 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS................................................................ 29
Consolidated Capital Resources and Liquidity.............................. 29
Results of Consolidated Operations........................................ 30
Recently Issued Accounting Pronouncements................................. 30
Natural Gas Operations Segment............................................ 31
Capital Resources and Liquidity......................................... 31
Results of Natural Gas Operations....................................... 32
Rates and Regulatory Proceedings........................................ 35
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PAGE
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Financial Services Segment................................................ 36
Financial and Regulatory Capital........................................ 36
Capital Resources and Liquidity......................................... 36
Risk Management......................................................... 38
Results of Financial Services Operations................................ 44
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................... 50
Consolidated Statements of Financial Position............................. 50
Consolidated Statements of Income......................................... 51
Consolidated Statements of Cash Flows..................................... 52
Consolidated Statements of Stockholders' Equity........................... 53
Notes to Consolidated Financial Statements................................ 54
Note 1 -- Summary of Significant Accounting Policies................... 54
Note 2 -- Summarized Financial Statement Data.......................... 58
Note 3 -- Debt Securities.............................................. 64
Note 4 -- Loans Receivable............................................. 66
Note 5 -- Allowances and Reserves...................................... 68
Note 6 -- Property, Plant, and Equipment............................... 69
Note 7 -- Deposits..................................................... 70
Note 8 -- Cash Equivalents and Securities Sold Under Repurchase
Agreements................................................... 71
Note 9 -- Commitments and Contingencies................................ 72
Note 10 -- Short-term Debt.............................................. 72
Note 11 -- Long-term Debt............................................... 73
Note 12 -- Preferred and Preference Stocks.............................. 75
Note 13 -- Employee Postretirement Benefits............................. 76
Note 14 -- Income Taxes................................................. 79
Note 15 -- Segment Information.......................................... 82
Note 16 -- Quarterly Financial Data (Unaudited)......................... 83
Note 17 -- Interest Rate Risk Management................................ 84
Report of Independent Public Accountants.................................. 88
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...................... 89
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........................ 89
ITEM 11. EXECUTIVE COMPENSATION.................................................... 90
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............ 90
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................ 90
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K........... 90
List of Exhibits.......................................................... 91
SIGNATURES.......................................................................... 94
GLOSSARY OF TERMS................................................................... 96
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PART I
ITEM 1. BUSINESS
The registrant, Southwest Gas Corporation (the Company), is incorporated
under the laws of the State of California effective March 1931, and is comprised
of two segments: natural gas operations and financial services. The natural gas
operations segment (gas segment) includes natural gas transmission and
distribution operations in Arizona, Nevada and California. The financial
services segment consists of PriMerit Bank (the Bank), a wholly owned
subsidiary, which operates principally in the thrift industry. See Selected
Financial Data for financial information related to each business segment.
The executive offices of the Company are located at 5241 Spring Mountain
Road, P.O. Box 98510, Las Vegas, Nevada 89193-8510, telephone number (702)
876-7237.
NATURAL GAS OPERATIONS
GENERAL DESCRIPTION
The Company is subject to regulation by the Arizona Corporation Commission
(ACC), the Public Service Commission of Nevada (PSCN) and the California Public
Utilities Commission (CPUC). These commissions regulate public utility rates,
practices, facilities and service territories in their respective states. The
service areas certificated to the Company by the respective regulatory
commissions having jurisdiction over it are exclusive. They remain exclusive
unless the Company defaults on its obligations to provide adequate service and
another utility can be found that is willing and able to supply the service. The
CPUC also regulates the issuance of all securities by the Company, with the
exception of short-term borrowings. Certain of the Company's accounting
practices, transmission facilities and rates are subject to regulation by the
Federal Energy Regulatory Commission (FERC).
The Company purchases, transports and distributes natural gas to
approximately 980,000 residential, commercial and industrial customers in
geographically diverse portions of Arizona, Nevada and California. There were
48,000 customers added to the system during 1994. See Natural Gas Operations
Segment - Capital Resources and Liquidity of Management's Discussion and
Analysis (MD&A) for discussion of capital requirements to meet the Company's
expected future growth.
The table below lists the Company's percentage of operating margin
(operating revenues less net cost of gas) by major customer class for the years
indicated:
ELECTRIC
GENERATION,
FOR THE RESIDENTIAL AND LARGE COMMERCIAL, RESALE AND
YEAR ENDED SMALL COMMERCIAL INDUSTRIAL AND OTHER TRANSPORTATION
---------- ---------------- -------------------- ---------------
December 31, 1994................ 79% 7% 14%
December 31, 1993................ 79% 7% 14%
December 31, 1992................ 80% 8% 12%
The volume of sales and transportation activity for electric utility
generating plants varies greatly according to demand for electricity and the
availability of alternative energy sources; however, it is not material in
relation to the Company's earnings. In addition, the Company is not dependent on
any one or a few customers to the extent that the loss of any one or several
would have a significant adverse impact on the Company.
Transportation of customer-secured gas to end-users on the Company's system
continues to have a significant impact on the Company's throughput, accounting
for 51 percent of total system throughput in 1994. Although the volumes were
significant, these customers provide a much smaller proportionate share of the
Company's operating margin as indicated in the table above. In 1994, customers
who utilized this service transported 915 million therms.
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The demand for natural gas is seasonal, and it is management's opinion that
comparisons of earnings for interim periods do not reliably reflect overall
trends and changes in the Company's operations. Also, earnings for interim
periods can be significantly affected by the timing of general rate relief.
PROPERTIES
The plant investment of the Company consists primarily of transmission and
distribution mains, compressor stations, peak shaving/storage plants, service
lines, meters and regulators which comprise the pipeline systems and facilities
located in and around the communities served. The Company also includes other
properties such as land, buildings, furnishings, work equipment and vehicles in
plant investment. The Company's northern Nevada and northern California
properties are referred to as the northern system; the Arizona, southern Nevada
and southern California properties are referred to as the southern system.
Several properties are leased by the Company, including a Liquefied Natural Gas
(LNG) storage plant on its northern Nevada system and a portion of the corporate
headquarters office complex located in Las Vegas, Nevada. See Note 6 of the
Notes to Consolidated Financial Statements for additional discussion regarding
these leases. Total gas plant, exclusive of leased property, at December 31,
1994, was $1.5 billion, including construction work in progress. It is the
opinion of management that the properties of the Company are suitable and
adequate for its purposes.
Substantially all of the Company's gas mains and service lines are
constructed across property owned by others under right-of-way grants obtained
from the record owners thereof, on the streets and grounds of municipalities
under authority conferred by franchises or otherwise, or on public highways or
public lands under authority of various federal and state statutes. None of the
Company's numerous county and municipal franchises are exclusive, and some are
of limited duration. These franchises are renewed regularly as they expire, and
the Company anticipates no serious difficulties in obtaining future renewals.
With respect to the right-of-way grants, the Company has had continuous and
uninterrupted possession and use of all such rights-of-way, and the associated
gas mains and service lines, commencing with the initial stages of the
construction of such facilities. Permits have been obtained from public
authorities in certain instances to cross, or to lay facilities along, roads and
highways. These permits typically are revocable at the election of the grantor,
and the Company occasionally must relocate its facilities when requested to do
so by the grantor. Permits have also been obtained from railroad companies to
cross over or under railroad lands or rights-of-way, which in some instances
require annual or other periodic payments and are revocable at the grantors'
elections.
The Company operates two major pipeline transmission systems: (i) a system
owned by Paiute Pipeline Company (Paiute), a wholly owned subsidiary of the
Company, extending from the Idaho-Nevada border to the Reno, Sparks and Carson
City areas and communities in the Lake Tahoe area in both California and Nevada
and other communities in northern and western Nevada; and (ii) a system
extending from the Colorado River at the southern tip of Nevada to the Las Vegas
distribution area.
The Company also owns a 35,000 acre site in northern Arizona which was
acquired for the purpose of constructing an underground natural gas storage
facility, known as the Pataya Gas Storage Project (Pataya), to serve its
southern system. Based upon current studies and the continued restructuring of
the utility industry, the Company believes that it will need an underground
natural gas storage facility, such as Pataya, in the future to meet the needs of
its customers on the southern system. In addition to the gas storage facility,
the Company is considering other opportunities for other portions of the site,
such as the partial sale of its water rights. Other potential uses for the land
include sites for solar generating facilities, cogeneration facilities and
various other business ventures. Project costs of $11.1 million have been
capitalized through December 1994 and include land acquisition and related
development costs.
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The map below shows the locations of the Company's major facilities and
major transmission lines, and principal communities to which the Company
supplies gas either as a wholesaler or distributor. The map also shows major
supplier transmission lines that are interconnected with the Company's systems.
[MAP]
[DESCRIPTION: Map of Arizona, Nevada, and southern California indicating the
location of the Company's service areas. Service areas in Arizona include most
of the central and southern areas of the state including Phoenix, Tucson, Yuma
and surrounding communities. Service areas in northern Nevada include Carson
City, Yerington, Fallon, Lovelock, Winnemucca and Elko. Service areas in
southern Nevada include the Las Vegas valley (including Henderson and Boulder
City), and Laughlin. Service areas in southern California include Barstow, Big
Bear, Needles and Victorville. Service areas in northern California include the
north shore of Lake Tahoe. Companies providing gas transportation services for
the Company are indicated by showing the location of their pipelines. Major
transporters include El Paso Natural Gas Company, Northwest Pipeline Corporation
and Southern California Gas Company. The location of Paiute Pipeline Company's
transmission pipeline (extending from the Idaho/Nevada border to the Reno/Tahoe
area) and the Company's pipeline (extending from Laughlin/Bullhead City to the
Las Vegas valley) are indicated. The LNG facility is located near Lovelock,
Nevada. The liquefied petroleum gas facility is located near Reno, Nevada.]
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RATES AND REGULATION
Rates that the Company is authorized to charge its distribution system
customers are determined by the ACC, CPUC and PSCN in general rate cases and are
derived using rate base, cost of service and cost of capital experienced in a
historical test year, as adjusted in Arizona and Nevada, and projected for a
future test year in California. The FERC regulates the northern Nevada
transmission and LNG storage facilities of Paiute and the rates it charges for
transportation of gas directly to certain end-users and to various local
distribution companies (LDCs). The LDCs transporting on Paiute's system are:
Sierra Pacific Power Company (Reno and Sparks, Nevada), Washington Water Power
Company (South Lake Tahoe, California) and Southwest Gas Corporation (North Lake
Tahoe, California and various locations throughout northern Nevada).
Rates charged to customers vary according to customer class and are fixed
at levels allowing for the recovery of all prudently incurred costs, including a
return on rate base sufficient to pay interest on debt, preferred dividends, and
a reasonable return on common equity. The Company's rate base consists generally
of the original cost of utility plant in service, plus certain other assets such
as working capital and inventories, less accumulated depreciation on utility
plant in service, net deferred income tax liabilities, and certain other
deductions. The Company's rate schedules in all of its service areas contain
purchased gas adjustment (PGA) clauses which permit the Company to adjust its
rates as the cost of purchased gas changes. Generally, the Company's tariffs
provide for annual adjustment dates for changes in purchased gas costs. However,
the Company may request to adjust its rates more often than once each year, if
conditions warrant. These changes have no significant impact on the Company's
profit margin.
The table below lists the docketed rate filings initiated and/or completed
within each ratemaking area in 1994 and the first quarter of 1995:
MONTH
MONTH FINAL RATES
RATEMAKING AREA TYPE OF FILING FILED EFFECTIVE
--------------- -------------- ----- -----------
Arizona:
Southern......................... General rate case October 1993 July 1994
California:
Northern & Southern.............. General rate case January 1994 January 1995
Northern & Southern.............. Attrition November 1993 January 1994
Nevada:
Northern & Southern.............. General rate case March 1993 November 1993(1)
FERC:
Paiute........................... General rate case October 1992 April 1993(2)
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(1) See Natural Gas Operations Segment - Rates and Regulatory Proceedings of
MD&A for a discussion on the final order by the PSCN of certain rate case
issues.
(2) Interim rates reflecting the increased revenues became effective in April
1993. The rates were subject to refund until a final order was issued in
January 1995.
See Natural Gas Operations Segment -- Rates and Regulatory Proceedings of
MD&A for a discussion of the financial impact of recent general rate cases.
COMPETITION
Electric utilities are the Company's principal competitors for the
residential and small commercial markets throughout the Company's service areas.
Competition for space heating, general household and small commercial energy
needs generally occurs at the initial installation phase when the customer
typically makes the decision as to which type of equipment to install and
operate. The customer will generally continue to use the chosen energy source
for the life of the equipment due to its relatively high replacement cost. As a
result of
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its success in these markets, the Company has experienced consistent growth
among the residential and small commercial customer classes.
Unlike residential and small commercial customers, certain large
commercial, industrial and electric generation customers have the capability to
switch to alternative energy sources. Rates for these customers are set at
levels competitive with alternative energy sources such as fuel oils and coal.
The Company has been able to maintain the maximum allowable prices for most of
its alternate fuel capable customers. As a result, management does not
anticipate any material adverse impact on its operating margin. The Company
maintains no backlog on its orders for gas service.
The Company continues to compete with interstate transmission pipeline
companies, such as El Paso Natural Gas Company (El Paso), Kern River Gas
Transmission Company (Kern River), and the proposed Tuscarora pipeline, to
provide service to end-users. End-use customers located in close proximity to
these interstate pipelines pose a potential bypass threat and, therefore,
require the Company to monitor closely each customer's situation and provide
competitive service in order to retain the customer. The Company has experienced
no significant financial impact to date from the threat of bypass. However,
industry restructuring as a result of the capacity release provisions of FERC
Order No. 636, whereby shippers can release available pipeline capacity on a
temporary or permanent basis, could increase the viability of end-use customer
bypass directly to interstate pipeline companies.
DEMAND FOR NATURAL GAS
Deliveries of natural gas by the Company are made under a priority system
established by each regulatory commission having jurisdiction over the Company.
The priority system is intended to ensure that the gas requirements of
higher-priority customers, primarily residential customers and nonresidential
customers who use 50,000 cubic feet of gas per day or less, are fully satisfied
on a daily basis before lower-priority customers, primarily electric utility and
large industrial customers able to use alternative fuels, are provided any
quantity of gas or capacity.
Demand for natural gas is greatly affected by temperature. On cold days,
use of gas by residential and commercial customers may be as much as eight times
greater than on warm days because of increased use of gas for space heating. To
fully satisfy this increased high-priority demand, gas is withdrawn from
storage, or peaking supplies are purchased from suppliers. If necessary, service
to interruptible lower-priority customers may also be curtailed to provide the
needed delivery system capacity.
NATURAL GAS SUPPLY
The Company believes that natural gas supplies will remain plentiful and
readily available. The Company primarily obtains its gas supplies for its
southern system from producing regions in New Mexico (San Juan basin), Texas
(Permian basin) and Oklahoma (Anadarko basin). For its northern system, the
Company primarily obtains gas from Rocky Mountain producing areas and from
Canada. The Company arranges for transportation of gas to its Arizona, Nevada
and California service territories through the pipeline systems of El Paso, Kern
River, Northwest Pipeline Corporation and Southern California Gas Company
(SoCal). The Company continually monitors supply availability on both short-term
and long-term bases to ensure the continued reliability of service to its
customers.
The Company's primary objective with respect to gas supply is to ensure
that adequate, as well as economical, supplies of natural gas are available from
reliable sources. The Company acquires its gas from a wide variety of sources,
including suppliers on the spot market and those who provide firm supplies over
short-term and longer-term durations. Balancing firm supply assurances against
the associated costs dictate a continually changing natural gas purchasing mix
within the Company's supply portfolio. The Company believes its portfolio
provides security as well as the operating flexibility needed to meet changing
market conditions. During 1994, the Company acquired gas supplies from nearly 60
suppliers.
The purchase of natural gas at the wellhead is not regulated. During 1991,
price ceilings on wells drilled after July 1989 were abolished and the remaining
price ceilings on existing wells were abolished in
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January 1993. The elimination of price ceilings has had no direct impact on the
Company because natural gas is selling well below the previous regulatory
ceilings, and supplies are adequate. The last few years have generally
demonstrated seasonal volatility in the price of natural gas, with higher prices
in the heating season and lower prices during the summer or off-peak consumption
period.
Natural Gas Industry Changes. In 1992, FERC Order No. 636 required
open-access interstate pipelines to significantly restructure their services
prior to the 1993/94 winter heating season. Interstate pipelines discontinued
their traditional role of gas supplier and began offering unbundled common
carrier services, such as transportation, storage, and capacity release.
Additionally, pipelines were required to implement a new method of rate design
and to provide the information necessary for natural gas buyers and sellers to
arrange transportation service on a more flexible basis. As a result of the new
method of rate design, the Company is experiencing higher costs, which are
currently being recovered through its PGA provisions.
Because of these and other utility industry changes, the Company continues
to evaluate natural gas storage as an option to enable the Company to take
advantage of seasonal price differentials and to otherwise protect the Company
from the uncertainties associated with spot market purchases and the Company's
need to obtain natural gas from a variety of sources to meet the growing demand
of its customers.
In order to increase its options concerning gas supplies, the Company
signed an agreement with SoCal in November 1992 to use a portion of SoCal's
underground storage facilities. The agreement had many significant precedent
conditions, all of which needed to be satisfied before the agreement could be
implemented. Many of these conditions have not been satisfied and management now
believes it is doubtful that all of the issues can be satisfactorily resolved.
The Company continues to research and review other options concerning gas
supplies, including other gas storage possibilities.
ENVIRONMENTAL MATTERS
Federal, state and local laws and regulations governing the discharge of
materials into the environment have had little direct impact upon either the
Company or its subsidiaries. Environmental efforts, with respect to matters such
as protection of endangered species and archeological finds, have resulted in
the Company spending a greater amount of time in obtaining pipeline
rights-of-way and sites for other facilities. However, increased environmental
legislation and regulation are also perceived to be beneficial to the natural
gas industry. Because natural gas is one of the most environmentally safe fuels
currently available, its use will allow energy users to comply with stricter
environmental standards. For example, management is of the opinion that
legislation, such as the Clean Air Act Amendments of 1990 and the Energy Policy
Act of 1992, has a positive effect on natural gas demand, including provisions
encouraging the use of natural gas vehicles, cogeneration and independent power
production.
EMPLOYEES
At December 31, 1994, the natural gas operations segment had 2,359 regular
full-time employees. The Company believes it has a good relationship with its
employees. No employees are represented by a union.
Reference is hereby made to Item 10 in Part III of this report on Form 10-K
for information relative to the executive officers of the Company.
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FINANCIAL SERVICES ACTIVITIES
GENERAL DESCRIPTION
The Bank is a federally chartered stock savings bank conducting business
through branch offices in Nevada. The Bank was organized in 1955 as Nevada
Savings and Loan Association which, in 1988, changed its name to PriMerit Bank
and its charter from a state chartered stock savings and loan association to a
federally chartered stock savings bank. Deposit accounts are insured to the
maximum extent permitted by law by the Federal Deposit Insurance Corporation
(FDIC) through the Savings Association Insurance Fund (SAIF). The Bank is
regulated by the Office of Thrift Supervision (OTS) and the FDIC, and is a
member of the Federal Home Loan Bank (FHLB) system.
The Bank's principal business is to attract deposits from the general
public and make loans secured by real estate and other collateral to enable
borrowers to purchase, refinance, construct or improve such property. Revenues
are derived from interest on real estate loans and debt securities and, to a
lesser extent, from interest on nonmortgage loans, gains on sales of loans and
debt securities, and fees received in connection with loans and deposits. The
Bank's major expense is the interest it pays on savings deposits and borrowings.
Since December 31, 1990, total assets have declined from $2.7 billion to
$1.8 billion at December 31, 1994 as management restructured the balance sheet
to more effectively operate under the guidelines of the Financial Institutions
Reform, Recovery and Enforcement Act (FIRREA). The decrease is also part of a
long-term Strategic Business Plan "right size-right structure" strategy to
optimize the Bank's size and earnings potential under the strict capital
requirements of FIRREA.
The rising interest rate environment during 1994 has slowed prepayments
within the loan and debt security portfolios, and has put pressure on the cost
of funds. Net interest margin increased in 1994 despite this environment, in
large part due to the ability to lag increases in rates paid on deposits versus
increases in the wholesale market.
The following table sets forth certain ratios for the Bank for each of the
periods stated:
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------
1994 1993 1992 1991 1990
---- ---- ---- ----- ----
Return on average assets (net income divided by
average total assets)......................... 0.4% 0.3% (0.5)% (1.2)% 0.4%
Return on average equity (net income divided by
average stockholder's equity)................. 4.4% 4.0% (6.0)% (17.2)% 5.8%
Equity-to-assets ratio (average stockholder's
equity divided by average total assets)....... 10.1% 8.2% 7.5 % 6.7 % 6.1%
LENDING ACTIVITIES
The Bank's loan portfolio totaled $938 million at December 31, 1994,
representing 52 percent of total assets at that date. The loan portfolio
consists principally of intermediate-term and long-term real estate loans and,
to a lesser extent, secured and unsecured commercial loans, and consumer loans
including: home improvement, recreational vehicle, mobile home, marine and auto
loans. The contractual maturity of loans secured by single-family dwellings has
historically been 30 years, although in recent years the Bank has made a number
of loans with maturities of 23 years or less. In January 1994, the Bank sold its
credit card portfolio and entered into an agent bank relationship with the
purchaser to issue credit cards to the Bank's customers. The Bank recognized a
gain of $1.7 million ($1.1 million net of charge-offs).
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The following table sets forth the composition of the loan portfolio by
type of loan at the dates indicated (thousands of dollars):
DECEMBER 31,
------------------------------------------------------
1994 1993 1992 1991 1990
-------- -------- -------- -------- ----------
Loans collateralized by real estate:
Conventional single-family residential... $490,157 $436,853 $395,976 $497,448 $ 624,414
FHA and VA insured single-family
residential........................... 35,429 25,051 24,670 35,563 25,221
Commercial mortgage...................... 178,076 192,046 198,235 212,518 195,118
Construction and land (1)................ 90,992 82,638 91,344 120,776 174,068
-------- -------- -------- -------- ----------
794,654 736,588 710,225 866,305 1,018,821
Commercial secured......................... 40,349 25,443 30,137 26,736 24,469
Commercial unsecured....................... 2,317 354 384 3,966 6,339
Consumer installment....................... 119,460 93,431 42,444 53,537 87,475
Consumer unsecured......................... 6,570 19,309 18,371 16,568 13,445
Equity and property improvement loans...... 26,054 21,061 16,712 14,287 11,012
Deposit accounts........................... 2,659 2,944 4,248 5,122 5,589
-------- -------- -------- -------- ----------
992,063 899,130 822,521 986,521 1,167,150
-------- -------- -------- -------- ----------
Undisbursed proceeds....................... (41,702) (48,251) (44,937) (44,544) (64,465)
Allowance for estimated credit losses...... (17,659) (16,251) (17,228) (12,061) (3,646)
Premiums (discounts)....................... 5,969 3,270 (125) (1,294) (1,285)
Deferred fees.............................. (4,999) (4,782) (4,406) (6,678) (6,232)
Accrued interest........................... 4,479 4,214 4,586 6,358 8,619
-------- -------- -------- -------- ----------
(53,912) (61,800) (62,110) (58,219) (67,009)
-------- -------- -------- -------- ----------
Loans receivable........................... $938,151 $837,330 $760,411 $928,302 $1,100,141
======== ======== ======== ======== ==========
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(1) The Bank's portfolio of construction and land loans is generally due in one
year or less.
Loan Origination and Credit Risk
One of the Bank's primary businesses is to make and acquire loans secured
by real estate and other collateral to enable borrowers to purchase, refinance,
construct and improve such property. These activities entail potential credit
losses, the size of which depends on a variety of economic factors affecting
borrowers and the real estate collateral. While the Bank has adopted
underwriting guidelines and credit review procedures to minimize credit losses,
some losses will inevitably occur. Therefore, periodic reviews are made of the
assets in an attempt to identify and deal appropriately with potential credit
losses.
The Bank originates both fixed- and adjustable-rate loans in the
single-family residential, commercial mortgage, and consumer home equity
portfolios. The Bank's adjustable-rate loans in these portfolios are based on
various indices, including the prime rate, the one-year constant maturity
Treasury, six-month London Interbank Offering Rate (LIBOR), and to a lesser
extent the 11th District cost of funds. Other consumer loans are generally
fixed-rate, while construction and non-real estate commercial loans are
generally adjustable-rate prime-based loans.
The Bank currently originates single-family residential (SFR)
adjustable-rate mortgages (ARM) which generally have an initial interest rate
below the current market rate and adjust to the applicable index plus a defined
spread, subject to caps, after the first year. The Bank's ARM generally provide
that the maximum rate that can be charged cannot exceed the initial rate by more
than six percentage points. The annual interest rate adjustment on the Bank's
ARM loans is generally limited to two percentage points.
Many of the other adjustable-rate loans contain limitations as to both the
amount and the interest rate change at each repricing date (periodic caps) and
the maximum rates the loan can be repriced over the life of
8
12
the loan (lifetime caps). At December 31, 1994, periodic caps in the adjustable
loan portfolio ranged from 25 to 800 basis points. Lifetime caps ranged from
9.75 to 22 percent.
See Financial Services Segment -- Risk Management -- Interest Rate Risk
Management of MD&A for the static gap table which includes the maturity and
repricing sensitivity of the Bank's loan portfolio.
The Bank's loan policies and underwriting standards are the primary means
used to reduce credit risk exposure. The loan approval process is intended to
assess both: (i) the borrower's ability to repay the loan by determining whether
the borrower meets the established underwriting criteria; and (ii) the adequacy
of the proposed collateral by determining whether the appraised value of (and,
if applicable, the cash flow from) the collateral property is sufficient for the
proposed loan. Under OTS regulations, management is held responsible for
developing, implementing and maintaining prudent appraisal policies.
The Bank reviews adherence to approved lending policies and procedures,
including proper approvals, timely completion of quarterly asset reviews, early
identification of problem loans, reviewing the quality of underwriting and
appraisals, tracking trends in asset quality and evaluating the adequacy of the
allowance for credit losses. To further control its credit risk, the Bank
monitors and manages its credit exposure in portfolio concentrations. Portfolio
concentrations, including collateral types, industry groups, geographic
locations, and loan types are assessed and the exposure is managed through the
establishment of limitations of aggregate exposures.
The Bank maintains a comprehensive risk-rating system used in determining
classified assets and allowances for estimated credit losses. The system
involves an ongoing review of all assets containing an element of credit risk
including loans, real estate and investment securities. The review process
assigns a risk rating to each asset reviewed based upon various credit criteria.
If the review indicates that it is probable that some portion of an asset will
result in a loss, the asset is written down to its expected recovery value. An
allocated general valuation allowance is established for each asset reviewed
which has been assigned a risk classification. The allowance is determined,
subject to certain minimum percentages, based upon probability of default (in
the case of loans), estimated ranges of recovery, and probability of each
estimate of recovery value. An allowance for estimated credit losses on
classified assets not subject to a detailed review is established by multiplying
a percentage by the aggregate balances of the assets outstanding in each risk
category. The percentages assigned increase based on the degree of risk and
reflect management's estimate of potential future losses from assets in a
specific risk category. With respect to loans not subject to specific reviews,
principally single-family residential and consumer loans, the allowance is
established based upon historical loss experience. Additionally, an unallocated
allowance is established to reflect economic and other conditions that may
negatively affect the portfolio in the aggregate.
As part of the regular asset review process, management reviews factors
relating to the possibility and magnitude of prospective loan and real estate
losses, including historical loss experience, prevailing market conditions and
classified asset levels. The Bank is required to classify assets and establish
prudent valuation allowances in accordance with OTS regulations.
Each loan portfolio contains unique credit risks for which the Bank has
developed policies and procedures to manage as follows:
Single-Family Residential Lending. SFR mortgage loans comprise 56 percent
of the loan portfolio at December 31, 1994 compared to 55 percent at December
31, 1993. This portfolio represents the largest lending component and is the
component which contains the least credit risk.
It is the general policy of the Bank not to make SFR loans which have a
loan-to-value ratio in excess of 80 percent unless insured by private mortgage
insurance, Federal Housing Authority (FHA) insurance, or guaranteed by the
Veterans Administration (VA). Single-family loans are generally underwritten to
underwriting guidelines established by FHA, VA, Federal Home Loan Mortgage
Corporation (FHLMC), Federal National Mortgage Association (FNMA) or preapproved
private investors. On its SFR ARM offered with initial below market rates, the
Bank qualifies the applicants using the fully indexed rate.
9
13
The Bank requires title insurance on all loans secured by liens on real
property. The Bank also requires fire and other hazard insurance be maintained
in amounts at least equal to the replacement cost of improvements on all
properties securing its loans. Earthquake insurance, however, is not required.
Consumer Lending. Consumer loans include installment loans secured by
recreational vehicles, boats, autos and mobile homes, home equity loans, and
loans secured by deposit accounts. Approximately 96 percent of the consumer loan
portfolio is collateralized at December 31, 1994. The credit risk of the
consumer loan portfolio is managed through both the origination function and the
collection process. All consumer loan origination and collection efforts, except
those secured by deposits, are performed at a central location in order to
provide greater control in the process and a more uniform application of credit
standards.
The Bank originates a majority of its installment loans through automobile,
recreational vehicle and marine vehicle dealers. These loans are subject to
underwriting by Bank personnel. Additionally, credit reviews of the dealers are
performed on a periodic basis. The Bank pays dealers a fee for these loans based
upon the excess of the contractual interest rate of the loan over the Bank's
stated rate schedule.
The Bank utilizes a credit scoring model to assist in the analysis of loan
applications and credit reports. Additionally, as a follow up to the application
process, a review of selected originations is performed to monitor adherence to
credit standards.
Commercial and Construction. The commercial and construction portfolios
consist of amortizing mortgage loans on multi-family residential and
nonresidential real estate, construction and development loans secured by real
estate, and commercial loans secured by collateral other than real estate.
Residential tract construction loans are generally underwritten with a
discounted loan-to-value ratio of less than 85 percent, while commercial income
property loans are generally underwritten with a ratio less than 75 percent.
Construction loans involve risks different from completed project lending
because loan funds are advanced upon the security of the project under
construction, and if the loan goes into default, additional funds may have to be
advanced to complete the project before it can be sold. Moreover, construction
projects are subject to uncertainties inherent in estimating construction costs,
potential delays in construction time, market demand and the accuracy of the
estimate of value upon completion.
The Bank manages its risk in these portfolios through its credit
evaluation, approval and monitoring processes. In addition to obtaining
appraisals on real estate collateral-based loans, a review of actual and
forecasted financial statements and cash flow analyses is performed. After such
loans are funded, they are monitored by obtaining and analyzing current
financial and cash flow information on a periodic basis.
To further control its credit risk in this portfolio, the Bank monitors and
manages credit exposure on portfolio concentrations. The Bank regularly monitors
portfolio concentrations by collateral types, industry groups, loan types, and
individual and related borrowers. Such concentrations are assessed and exposures
managed through establishment of limitations of aggregate exposures. The Bank no
longer originates new construction and commercial loans in California and
Arizona. At December 31, 1994, 48 percent or $19.5 million of the Bank's
outstanding commercial secured loan portfolio consisted of loans to borrowers in
the gaming industry, with additional unfunded commitments of $11.5 million.
These loans are generally secured by real estate and equipment. The Bank's
portfolio of loans, collateralized by real estate, consists principally of real
estate located in Nevada, California and Arizona. Collectibility is, therefore,
somewhat dependent on the economies and real estate values of these areas and
industries. Construction loans and commercial real estate loans (including
multi-family) generally have higher default rates than single-family residential
loans. See Financial Services Segment -- Risk Management -- Credit Risk
Management of MD&A for a table that sets forth the amounts of classified assets
by type of loan.
Origination, Purchase and Sale of Loans
The Bank originates the majority of its loans within the state of Nevada;
however, under current laws and regulations, the Bank may also originate and
purchase loans or purchase participating interests in loans without regard to
the location of the secured property. During 1994, the Bank originated $466
million in new loans, virtually all of which were secured by property located in
Nevada. In the first quarter of 1994, the Bank
10
14
purchased $41.9 million of single-family residential whole loans. During 1993,
the Bank originated $500 million in new loans, of which 90 percent were secured
by property located in Nevada, 8 percent were secured by property located in
Arizona, and 2 percent were secured by property in California. As of December
31, 1994, 82 percent of the loan portfolio was secured by property located in
Nevada, 12 percent secured by property located in California and 6 percent
secured by property located in Arizona. The Bank originates real estate and
commercial loans principally through its in-house personnel.
Secondary Marketing Activity
The Bank has been involved in secondary mortgage market transactions
through the sale of whole loans. In accordance with the Bank's Accounting
Policy, fixed-rate residential loans with maturities greater than 25 years have
been designated as held for sale. At December 31, 1994, $2.1 million of
residential loans are designated as held for sale. See Note 4 of the Notes to
Consolidated Financial Statements for additional discussion relating to such
loans.
Under its loan participation and whole loan sale agreements, the Bank may
continue to service the loans and collect payments on the loans as they become
due. The amount of loans serviced for others was $415 million at December 31,
1994, compared to $477 million at year-end 1993, including $68 million and $93
million, respectively, of loans serviced for mortgage-backed securities (MBS)
originated and owned by the Bank. The Bank pays the participating lender, under
the terms of the participation agreement, a yield on the participant's portion
of the loan, which is usually less than the interest agreed to be paid by the
borrower. The difference is retained by the Bank as servicing income.
In connection with mortgage loan sales, the Bank makes representations and
warranties customary in the industry relating to, among other things, compliance
with laws, regulations and program standards and accuracy of information. In the
event of a breach of these representations and warranties, or under certain
limited circumstances, regardless of whether there has been such a breach, the
Bank may be required to repurchase such mortgage loans. Typically, any
documentation defects with respect to these mortgage loans that caused them to
be repurchased, are corrected and the mortgage loans are resold. Certain
repurchased mortgage loans may remain in the Bank's loan portfolio and, in some
cases, repurchased mortgage loans are foreclosed and the acquired real estate
sold.
Loan Fees
The Bank receives loan origination fees for originating loans and
commitment fees for making commitments to originate construction, income
property and multi-family residential loans. It also receives loan fees and
charges related to existing loans, including prepayment charges, late charges
and assumption fees. The amount of loan origination fees, commitment fees and
discounts received varies with loan volumes, loan types, purchase commitments
made, and competitive and economic conditions. Loan origination and commitment
fees, offset by certain direct loan origination costs, are being deferred and
recognized over the contractual life of such loans as yield adjustments.
ASSET QUALITY
Nonperforming Assets. Nonperforming assets may be comprised of nonaccrual
assets, restructured loans and real estate acquired through foreclosure.
Nonaccrual assets are those on which management believes the timely collection
of interest is doubtful. Assets are transferred to nonaccrual status when
payments of interest or principal are 90 days past due or if, in management's
opinion, the accrual of interest should be ceased sooner. There are no assets on
accrual status which are over 90 days delinquent or past maturity.
Nonaccrual assets are restored to accrual status when, in the opinion of
management, the financial condition of the borrower and/or debt service capacity
of the security property has improved to the extent that collectibility of
interest and principal appears assured and interest payments sufficient to bring
the asset current are received.
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15
Restructured loans represent loans for which the borrower is complying with
the terms of a loan modified as to rate, maturity, or payment amount.
The following table summarizes nonperforming assets as of the dates
indicated (thousands of dollars):
DECEMBER 31,
-------------------------------------------------------
1994 1993 1992 1991 1990
------- ------- ------- ------- -------
Nonaccrual loans past due 90 days or
more:
Mortgage loans:
Construction and land............... $ 576 $ 1,233 $ 8,514 $ 8,904 $ 6,599
Permanent single-family
residences........................ 5,517 6,636 4,667 7,737 4,467
Other mortgage loans................ 5,696 6,728 3,736 10,388 9,405
------- ------- ------- ------- -------
11,789 14,597 16,917 27,029 20,471
Nonmortgage loans...................... 904 184 2,164 87 331
Restructured loans....................... 16,768 2,842 1,190 1,229 1,385
------- ------- ------- ------- -------
Total nonperforming loans...... 29,461 17,623 20,271 28,345 22,187
Real estate acquired through
foreclosure............................ 7,631 9,707 24,488 14,875 10,363
------- ------- ------- ------- -------
Total nonperforming assets..... $37,092 $27,330 $44,759 $43,220 $32,550
======= ======= ======= ======= =======
Allowance for estimated credit losses.... $17,659 $16,251 $17,228 $12,061 $ 3,646
======= ======= ======= ======= =======
Allowance for estimated credit losses as
a percentage of nonperforming loans.... 59.94% 92.21% 84.99% 42.55% 16.43%
======= ======= ======= ======= =======
Allowance for estimated credit losses as
a percentage of nonperforming assets... 47.61% 59.46% 38.49% 27.91% 11.20%
======= ======= ======= ======= =======
The increase in restructured loans in 1994 is a result of the
classification of $13.9 million of single-family residential loan modifications
made for borrowers with earthquake-related damage in California. Federal
agencies encouraged financial institutions to modify loan terms for certain
borrowers who were affected by the earthquake which occurred in January 1994.
The terms of these modifications were generally three- to six-month payment
extensions with no negative credit reporting regarding the borrower. These loans
were on a nonaccrual basis during the extension period. Current interpretation
by the OTS concerning the modifications made requires the loans to be classified
as "troubled debt restructured" until they mature, are paid off, or are sold.
The Bank reviewed the earthquake-related loans and classified $3.1 million as
special mention and $677,000 as substandard and considered all of the loans in
the overall general valuation analysis. The remainder of the earthquake-related
loans are not classified and are deemed to have adequate reserves as they carry
no more risk than any other SFR loan.
At December 31, 1994, all nonaccrual loans and real estate acquired through
foreclosure are classified substandard. Additionally, $2.3 million of the
restructured loans are classified substandard.
The amount of interest income that would have been recorded on the
nonaccrual and restructured assets if they had been current under their original
terms was $2.1 million for 1994. Actual interest income recognized on these
assets was $970,000, resulting in $1.1 million of interest income foregone for
the year. See further discussion below in Provision and Allowance for Credit
Losses.
Classified Assets. OTS regulations require the Bank to classify certain
assets and establish prudent valuation allowances. Classified assets fall in one
of three categories --"substandard," "doubtful," and "loss." In addition, the
Bank can designate an asset as "special mention."
Assets classified as "substandard" are inadequately protected by the
current net worth or paying capacity of the obligor or the collateral pledged,
if any. Assets which are designated as "special mention" possess weaknesses or
deficiencies deserving close attention, but do not currently warrant
classification as "substandard." See Financial Services Segment -- Risk
Management -- Credit Risk Management of MD&A for the amounts of the Bank's
classified assets and ratio of classified assets to total assets, net of
charge-offs.
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Provision and Allowance for Credit Losses. The provision for credit losses
is dependent upon management's evaluation as to the amount needed to maintain
the allowance for losses at a level considered appropriate to the perceived risk
of future losses. A number of factors are weighed by management in determining
the adequacy of the allowance, including internal analyses of portfolio quality
measures and trends, specific economic and market conditions affecting valuation
of the security properties and certain other factors. In addition, the OTS
considers the adequacy of the allowance for credit losses and the net carrying
value of real estate owned in connection with periodic examinations of the Bank.
The OTS has the ability to require the Bank to recognize additions to the
allowance or reductions in the net carrying value of real estate owned based on
their judgement at the time of such examinations. In connection with the 1993
examination by the OTS, no additional reserves were required to be recorded by
the Bank. The OTS commenced their 1994 examination of the Bank in February 1995.
Activity in the allowances for credit losses on loans and real estate is
summarized as follows (thousands of dollars):
REAL REAL
ESTATE ESTATE
CONSTRUCTION NON- ACQUIRED HELD FOR
MORTGAGE & LAND MORTGAGE TOTAL THROUGH SALE OR
LOANS LOANS LOANS LOANS FORECLOSURE DEVELOPMENT TOTAL RATIO*
-------- ------------ -------- ------- ----------- ----------- -------- ------
Balance at 12/31/89............ $ 2,235 $ 900 $ 1,249 $ 4,384 $ 3,175 $ 2,275 $ 9,834
Provisions for estimated
losses....................... 1,201 399 1,669 3,269 2,500 2,000 7,769
Charge-offs, net of
recoveries................... (657) -- (1,166) (1,823) (3,233) (117) (5,173) 0.43%
Transfers...................... (1,645) -- (539) (2,184) 1,645 -- (539)
------- ------- ------- ------- ------- -------- --------
Balance at 12/31/90............ 1,134 1,299 1,213 3,646 4,087 4,158 11,891
Provisions for estimated
losses....................... 5,835 2,643 3,580 12,058 1,686 49,010 62,754
Charge-offs, net of
recoveries................... (394) (1,121) (1,545) (3,060) (6,595) (49,529) (59,184) 5.85%
Transfers...................... (583) -- -- (583) 822 -- 239
------- ------- ------- ------- ------- -------- --------
Balance at 12/31/91............ 5,992 2,821 3,248 12,061 -- 3,639 15,700
Provisions for estimated
losses....................... 1,903 6,460 5,766 14,129 -- 18,309 32,438
Charge-offs, net of
recoveries................... (515) (3,765) (4,682) (8,962) -- (20,485) (29,447) 3.29%
------- ------- ------- ------- ------- -------- --------
Balance at 12/31/92............ 7,380 5,516 4,332 17,228 -- 1,463 18,691
Provisions for estimated
losses....................... 4,634 172 1,406 6,212 -- 1,010 7,222
Charge-offs, net of
recoveries................... (3,191) (2,248) (1,750) (7,189) -- (1,538) (8,727) 1.07%
------- ------- ------- ------- ------- -------- --------
Balance at 12/31/93............ 8,823 3,440 3,988 16,251 -- 935 17,186
Provisions for estimated
losses....................... 2,954 71 4,205 7,230 -- 163 7,393
Charge-offs, net of
recoveries................... (1,786) (1,297) (2,739) (5,822) -- (622) (6,444) 0.72%
------- ------- ------- ------- ------- -------- --------
Balance at 12/31/94............ $ 9,991 $ 2,214 $ 5,454 $17,659 $ -- $ 476 $ 18,135
======= ======= ======= ======= ======= ======== ========
- ---------------
* Ratio = Net charge-offs to average loans and real estate outstanding
Included in net charge-offs are $1.7 million, $1.4 million, $1.9 million,
$2.6 million and $2.6 million of recoveries from 1990 through 1994,
respectively.
The real estate write-downs for 1992 were primarily the result of a
decrease in the net realizable value and slower sales activity of five
California single-family real estate development projects. The largest of these
involved write-downs of $9.3 million as a result of an appraisal reflecting the
continuing market decline in the California market and difficulty in obtaining
third party construction financing.
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Allocation of Allowance for Credit Losses. The following is a breakdown of
allocated loan loss allowance amounts by major categories. However, in
management's opinion, the allowance must be viewed in its entirety.
DECEMBER 31,
-----------------------------------------------------------------------------------------------------------
1994 1993 1992 1991 1990
------------------- ------------------- ------------------- ------------------- -------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
OF OF OF OF OF
LOANS LOANS LOANS LOANS LOANS
TO TO TO TO TO
ALLOWANCE TOTAL ALLOWANCE TOTAL ALLOWANCE TOTAL ALLOWANCE TOTAL ALLOWANCE TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
--------- ------- --------- ------- --------- ------- --------- ------- --------- -------
(THOUSANDS OF DOLLARS)
LOANS BY TYPE
Real estate....... $ 9,991 73.6 $ 8,823 76.9 $ 7,380 81.2 $ 5,992 82.4 $1,134 84.4
Construction and
land............ 2,214 5.1 3,440 4.0 5,516 4.3 2,821 4.8 1,299 4.9
Nonmortgage....... 5,454 21.3 3,988 19.1 4,332 14.5 3,248 12.8 1,213 10.7
------- ----- ------- ----- ------- ----- ------- ----- ------ -----
Total........... $17,659 100.0 $16,251 100.0 $17,228 100.0 $12,061 100.0 $3,646 100.0
======= ===== ======= ===== ======= ===== ======= ===== ====== =====
REAL ESTATE DEVELOPMENT ACTIVITIES
The Bank's investment in real estate held for development, net of allowance
for estimated losses, excluding real estate acquired through foreclosure,
decreased from $28.1 million at December 31, 1991 to $771,000 at December 31,
1994. The Bank's pretax loss from real estate operations was $612,000 in 1994,
$910,000 in 1993, and $15.3 million in 1992.
The Bank and its subsidiaries have ceased making investments in new real
estate development activities as a result of legislative and regulatory actions
which have placed certain restrictions on the Bank's ability to invest in real
estate. See Regulation -- General herein for additional discussion. The Bank and
its subsidiaries are continuing the sale and wind down of remaining real estate
investments.
INVESTMENT ACTIVITIES
Federal regulations require thrifts to maintain certain levels of liquidity
and to invest in various types of liquid assets. The Bank invests in a variety
of securities, including commercial paper, certificates of deposit, U.S.
government and U.S. agency obligations, short-term corporate debt, municipal
bonds, repurchase agreements and federal funds. The Bank also invests in longer
term investments such as MBS and collateralized mortgage obligations (CMO) to
supplement its loan production and to provide liquidity to meet unforeseen cash
outlays. Income from cash equivalents and debt securities provides a significant
source of revenue for the Bank, constituting 43 percent, 41 percent and 32
percent of total revenues for each of the years ended December 31, 1992, 1993
and 1994, respectively.
The Bank's activities in derivatives are limited to investments in CMO,
interest rate swaps, and forward sale commitments. CMO are discussed in the
following tables. Interest rate swaps and forward sale commitments are discussed
in Note 17 of the Notes to Consolidated Financial Statements, and in Risk
Management -- Interest Rate Risk Management of MD&A.
In order to mitigate the interest rate risk (IRR) and credit risk exposure
in the debt security portfolio, the Bank has established guidelines within its
Investment Portfolio Policy for maximum duration, credit quality, concentration
limits per issuer, and counterparty capital requirements. The Investment
Portfolio Policy also sets forth the types of permissible investment securities
and unsuitable investment activities.
Additionally, the debt security portfolio is subject to the Asset
Classification Policy of the Bank based on credit risk as determined by private
rating firms, such as Standard and Poor's Corporation and Moody's Investors
Services.
On December 31, 1993, the Bank adopted Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." In conjunction with adoption, the Bank designated the vast majority
of its debt security portfolio as available for sale. At December 31, 1993
14
18
and 1994, no securities were designated as "trading securities." See Note 2 of
the Notes to Consolidated Financial Statements for further discussion.
The following tables present the composition of the debt security
portfolios as of the dates indicated. See Financial Services Segment -- Capital
Resources and Liquidity of MD&A and Note 3 of the Notes to Consolidated
Financial Statements for further discussion of the portfolios:
DECEMBER 31,
-----------------------------------
1994 1993 1992
-------- ------- ----------
(THOUSANDS OF DOLLARS)
DEBT SECURITIES HELD TO MATURITY
GNMA -- MBS................................................ $ -- $ -- $ 12,222
FHLMC -- MBS............................................... -- -- 629,225
FNMA -- MBS................................................ -- -- 217,391
CMO........................................................ -- -- 37,722
Corporate issue MBS........................................ 60,922 69,660 229,303
Money market instruments................................... -- -- 100
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies................ 40,958 -- 15,996
Medium-term notes.......................................... -- -- 17,018
-------- ------- ----------
Total............................................ $101,880 $69,660 $1,158,977
======== ======= ==========
DECEMBER 31,
---------------------------------
1994 1993 1992
-------- -------- -------
(THOUSANDS OF DOLLARS)
DEBT SECURITIES AVAILABLE FOR SALE
GNMA -- MBS................................................. $ 6,397 $ 9,672 $ 6,780
FHLMC -- MBS................................................ 300,896 379,786 --
FNMA -- MBS................................................. 109,108 119,657 --
CMO......................................................... 88,380 47,249 --
Corporate issue MBS......................................... 19,517 24,106 --
Money market instruments.................................... -- 10,036 --
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies................. 5,102 5,220 --
-------- -------- -------
Total............................................. $529,400 $595,726 $ 6,780
======== ======== =======
The following schedule of the expected maturity of debt securities held to
maturity is based upon dealer prepayment expectations and historical prepayment
activity (thousands of dollars):
EXPECTED/CONTRACTUAL MATURITY
------------------------------------------------------------------------------------
AFTER AFTER AFTER
ONE YEAR FIVE YEARS TEN YEARS
BUT BUT BUT
WITHIN WITHIN WITHIN WITHIN AFTER TOTAL
ONE FIVE TEN TWENTY TWENTY AMORTIZED
DECEMBER 31, 1994 YEAR YEARS YEARS YEARS YEARS COST YIELD
- ----------------- ------- -------- ---------- --------- ------ --------- -----
Corporate issue MBS... $15,593 $31,603 $8,883 $4,574 $269 $ 60,922 7.25%
U.S. Treasury
securities and
obligations of U.S.
Government
corporations and
agencies............ 20,822 20,136 -- -- -- 40,958 8.01%
------- ------- ------ ------ ---- -------- ----
Total....... $36,415 $51,739 $8,883 $4,574 $269 $101,880 7.55%
======= ======= ====== ====== ==== ======== ====
Yield................. 7.62% 7.58% 7.40% 6.69% 6.46% 7.55%
======= ======= ====== ====== ==== ========
15
19
The expected maturities of MBS and CMO are based upon dealer prepayment
expectations and historical prepayment activity. The following schedule reflects
the expected maturities of MBS and CMO and the contractual maturity of all other
debt securities available for sale (thousands of dollars):
EXPECTED/CONTRACTUAL MATURITY
-----------------------------------------------------------------------------------
AFTER AFTER AFTER
ONE YEAR FIVE YEARS TEN YEARS
BUT BUT BUT TOTAL
WITHIN WITHIN WITHIN WITHIN AFTER ESTIMATED
ONE FIVE TEN TWENTY TWENTY FAIR
DECEMBER 31, 1994 YEAR YEARS YEARS YEARS YEARS VALUE YEAR(1)
- ---------------------- -------- -------- ---------- --------- ------- --------- -------
GNMA -- MBS........... $ 1,595 $ 4,091 $ 711 $ -- $ -- $ 6,397 8.29%
FHLMC -- MBS.......... 57,237 167,998 37,894 29,991 7,776 300,896 6.64%
FNMA -- MBS........... 15,879 49,915 20,241 20,030 3,043 109,108 7.11%
CMO................... 48,692 38,236 819 606 27 88,380 5.92%
Corporate issue MBS... 3,295 11,283 4,056 778 105 19,517 7.24%
U.S. Treasury
securities
and obligations of
U.S. Government
corporations and
agencies............ 5,102 -- -- -- -- 5,102 5.83%
-------- -------- ---------- --------- ------- --------- ----
Total....... $131,800 $271,523 $ 63,721 $51,405 $10,951 $ 529,400 6.65%
======== ======== ======== ======= ======= ======== ====
Yield(1).............. 6.43% 6.67% 6.84% 6.83% 6.78% 6.65%
======== ======== ======== ======= ======= ========
- ---------------
(1) The yields are completed based on amortized cost.
DEPOSIT ACTIVITIES
Deposit accounts are the Bank's primary source of funds constituting 75
percent of the Bank's total liabilities at December 31, 1994. The Bank solicits
both short-term and long-term deposits in the form of transaction related and
certificate of deposit accounts.
The Bank's average retail deposit base has remained steady during the past
three years, despite the effect of the sale of Arizona-based deposit liabilities
(Arizona sale) in 1993. See Note 2 of the Notes to Consolidated Financial
Statements for further discussion of the Arizona sale. Average retail deposits,
as a percentage of average interest-bearing liabilities, were 80 percent in
1994, compared to 79 percent in 1993 and 83 percent in 1992. The Bank has
emphasized retail deposits over wholesale funding sources in an effort to reduce
the volatility of its cost of funds. Additionally, the Bank has emphasized
growth in transaction based accounts versus term accounts in order to reduce its
overall cost of funds.
The Bank's deposits increased $32 million during 1994. Due to the rising
interest rate environment, many customers moved their transaction deposits into
higher-yielding certificate of deposit accounts. The growth in retail deposits
has been achieved through marketing programs, increased emphasis on customer
service and strong population growth in southern Nevada.
At December 31, 1994, the Bank maintained over $291 million in collateral,
at market value, which could be borrowed against or sold to offset any run-offs
which could occur in retail deposits in a declining or low interest rate
environment. The Bank considers this level of excess collateral to be adequate
and considers the likelihood of substantial run-offs occurring to be remote.
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The average balances in and average rates paid on deposit accounts for the
years indicated are summarized as follows (thousands of dollars):
1994 1993 1992
------------------- -------------------- ---------------------
BALANCE YIELD BALANCE YIELD BALANCE YIELD
---------- ----- ---------- ----- ----------- -----
Noninterest-bearing demand
deposits...................... $ 66,339 -- $ 77,144 -- $ 74,245 --
Interest-bearing demand
deposits...................... 325,885 2.68 % 329,785 2.60 % 279,793 3.19 %
Savings deposits................ 84,584 2.52 % 83,935 2.81 % 71,548 2.49 %
Certificates of deposit......... 751,572 4.42 % 952,764 4.90 % 1,263,298 5.96 %
---------- ----- ---------- ---- ---------- ----
$1,228,380 3.59 % $1,443,628 3.99 % $1,688,884 5.09 %
========== ==== ========== ==== ========== ====
See Note 7 of the Notes to Consolidated Financial Statements for further
discussion.
Certificates of deposit include approximately $169 million, $152 million,
and $223 million in time certificates of deposits in amounts of $100,000 or more
at December 31, 1994, 1993, and 1992, respectively. The following table
represents time certificates of deposits, none of which are brokered, in amounts
of $100,000 or more by time remaining until maturity as of December 31, 1994
(thousands of dollars):
LESS THAN 3 MONTHS - 6 MONTHS - GREATER THAN
3 MONTHS 6 MONTHS 1 YEAR 1 YEAR
- --------- ---------- ---------- ------------
$52,452 $ 27,055 $ 37,597 $ 51,854
======= ======== ======== ==========
BORROWINGS
Sources of funds other than deposits have included advances from the FHLB,
reverse repurchase agreements and other borrowings.
FHLB Advances. As a member of the FHLB system, the Bank may obtain advances
from the FHLB pursuant to various credit programs offered from time to time. The
Bank borrows these funds from the FHLB principally on the security of certain of
its mortgage loans. See Regulation -- Federal Home Loan Bank System herein for
additional discussion. Such advances are made on a limited basis to supplement
the Bank's supply of lendable funds, to meet deposit withdrawal requirements and
to lengthen the maturities of its borrowings. See Note 11 of the Notes to
Consolidated Financial Statements for additional discussion.
Securities Sold Under Repurchase Agreements. The Bank sells securities
under agreements to repurchase (reverse repurchase agreements). Reverse
repurchase agreements involve the Bank's sale of debt securities to a
broker/dealer with a simultaneous agreement to repurchase the same debt
securities on a specified date at a specified price. The initial price paid to
the Bank under reverse repurchase agreements is less than the fair market value
of the debt securities sold, and the Bank may be required to pledge additional
collateral if the fair market value of the debt securities sold declines below
the price paid to the Bank for these debt securities. See Note 8 of the Notes to
Consolidated Financial Statements for additional discussion of the terms and
description of the reverse repurchase agreements.
Reverse repurchase agreements are summarized as follows (thousands of
dollars):
1994 1993 1992
-------- -------- --------
Balance at year end........................... $281,935 $259,041 $376,859
Accrued interest payable at year end.......... 3,335 3,871 3,717
Daily average amount outstanding during
year........................................ 222,620 305,123 204,222
Maximum amount outstanding at any month end... 281,935 367,859 376,859
Weighted-average interest rate during the
year........................................ 4.95% 4.30% 5.98%
Weighted-average interest rate on year-end
balances.................................... 6.37% 4.31% 4.54%
At December 31, 1994, the balance of reverse repurchase agreements included
$19.7 million in long-term fixed-rate flexible reverse repurchase agreements
with a weighted average interest rate of 8.70 percent.
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EMPLOYEES
At December 31, 1994 the Bank had 586 full-time equivalent employees. No
employees are represented by any union or collective bargaining group and the
Bank considers its relations with its employees to be good.
COMPETITION
The Bank experiences substantial competition in attracting and retaining
deposit accounts and in making mortgage and other loans. The primary factors in
competing for deposit accounts are interest rates paid on deposits, the range of
financial services offered, the quality of service, convenience of office
locations and the financial strength of an institution. Direct competition for
deposit accounts comes from savings and loan associations, commercial banks,
money market mutual funds, credit unions and insurance companies. During 1993,
the Bank experienced deposit outflows from certificate of deposit accounts as
customers sought higher yielding alternative investments in a low interest rate
environment. The Bank has sought to retain relationships with these customers by
establishing an agreement with a third party broker to offer uninsured
investment alternatives in the Bank's branches. With the rising interest rate
environment and the mediocre and poor performance of many stock and bond mutual
funds in 1994, many investors have returned to certificates of deposits as a
safe investment vehicle.
The primary factors in competing for loans are interest rates, loan
origination fees, quality of service and the range of lending services offered.
Competition for origination of first mortgage loans normally comes from savings
and loan associations, mortgage banking firms, commercial banks, insurance
companies, real estate investment trusts and other lending institutions.
PROPERTIES
The Bank occupies facilities at 25 locations in Nevada, of which 12 are
owned. The Bank leases the remaining facilities. The Bank may add branches in
the future in order to achieve the deposit goals set forth in the Bank's
Strategic Plan. The Bank intends to build three new branches in metropolitan Las
Vegas and one in Reno. During 1994, specific strategic areas were identified:
Northwest Las Vegas, Green Valley, the Lakes and Reno. The Lakes site is
currently under construction. See Note 6 of the Notes to Consolidated Financial
Statements for a schedule of net future minimum rental payments that have
initial or remaining noncancelable lease terms in excess of one year as of
December 31, 1994.
REGULATION
General
In August 1989, FIRREA was enacted into law. FIRREA had and will continue
to have a significant impact on the thrift industry including, among other
things, imposing significantly higher capital requirements and providing funding
for the liquidation of insolvent thrifts. In December 1991, the Federal Deposit
Insurance Corporation Improvement Act of 1991 (FDICIA) was enacted into law.
This legislation included changes in the qualified thrift lender test, deposit
insurance assessments and capital standards.
Regulatory Infrastructure. The Bank's principal supervisory agency is the
OTS, an agency reporting to the U.S. Treasury Department. The OTS is responsible
for the examination and regulation of all thrifts and for the organization,
incorporation, examination and regulation of federally chartered thrifts.
The FDIC is the Bank's secondary regulator and is the administrator of the
SAIF which generally insures the deposits of thrifts.
Deposit Insurance Premiums. Deposit accounts are insured to the maximum
extent permitted by law by the FDIC through the SAIF. During 1993, the FDIC
implemented a risk-based deposit insurance premium assessment. Under the
regulation, annual deposit insurance premiums ranging from 23 to 31 basis points
(bp) are imposed on institutions based upon the institution's level of capital
and a supervisory risk assessment. In February 1995, the FDIC proposed a
significant reduction in the premiums banks pay to the Bank Insurance Fund
(BIF). The amended rate schedule will be changed from the current range of 23 bp
to 31 bp to a
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proposed range of 4 bp to 31 bp; thereby substantially reducing the premiums
that well-capitalized, low risk-rated institutions will pay. However, the FDIC
is proposing to retain the current SAIF premium schedule until the SAIF is
recapitalized.
Capital Standards. Effective December 1989, the OTS issued the minimum
regulatory capital regulations (capital regulations) required by FIRREA.
The capital regulations require that all thrifts meet three separate
capital standards as follows:
1. A tangible capital requirement equal to at least 1.5 percent of
adjusted total assets (as defined).
2. A core capital requirement equal to at least three percent of
adjusted total assets (as defined).
3. A risk-based capital requirement equal to at least eight percent of
risk-weighted assets (as defined).
The OTS may establish, on a case by case basis, individual minimum capital
requirements for a thrift institution which may vary from the requirements which
would otherwise be applicable under the capital regulations. The OTS has not
established such minimum capital requirements for the Bank.
A thrift institution which fails to meet one or more of the applicable
capital requirements is subject to various regulatory limitations and sanctions,
including a prohibition on growth and the issuance of a capital directive by the
OTS requiring the following: an increase in capital, a reduction of rates paid
on savings accounts, cessation of or limitations on deposit taking and lending,
limitations on operational expenditures, an increase in liquidity, and such
other actions as are deemed necessary or appropriate by the OTS. In addition, a
conservator or receiver may be appointed under certain circumstances.
FDICIA requires federal banking regulators to take prompt corrective action
if an institution fails to satisfy minimum capital requirements. Under FDICIA,
capital requirements include a leverage limit, a risk-based capital requirement,
and any other measure of capital deemed appropriate by the federal banking
regulators for measuring the capital adequacy of an insured depository
institution. All institutions, regardless of their capital levels, are
restricted from making any capital distribution or paying management fees which
are not in capital requirement compliance or if such payment would cause the
institution to fail to satisfy minimum levels for any of its capital
requirements.
Insured institutions are divided into five capital categories -- (1) well
capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly
undercapitalized, and (5) critically undercapitalized. The categories are
defined as follows:
RISK-BASED CORE CAPITAL TO CORE
CATEGORY CAPITAL RATIO RISK-BASED ASSETS CAPITAL RATIO
- --------------------------------------------- ------------- ----------------- -------------
Well capitalized............................. >=10% >=6% >=5%
Adequately capitalized....................... >=8%<10% >=4%<6% >=4%<5%
Undercapitalized............................. >=6%<8% >=3%<4% >=3%<4%
Significantly undercapitalized............... <6% <3% <3%
- ---------------
Critically undercapitalized if tangible equity to total assets ratio 2%
Institutions must meet all three capital ratios in order to qualify for a
given category. At December 31, 1994, the Bank was classified as "well
capitalized." At December 31, 1994, under fully phased-in capital rules
applicable to the Bank at July 1, 1996, the Bank would have exceeded the
"adequately capitalized" fully phased-in total risk-based, tier 1 risk-based,
and tier 1 leverage ratios by $46.7 million, $72.8 million, and $38.7 million,
respectively. See Financial Services Segment -- Financial and Regulatory Capital
of MD&A for further discussion.
In January 1993, the OTS issued a Thrift Bulletin limiting the amount of
deferred tax assets that can be used to meet capital requirements. Under the
bulletin, for purposes of calculating regulatory capital, net deferred tax
assets are limited to the amount which could be theoretically realized from
carryback potential
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plus the lesser of the tax on one year's projected earnings or ten percent of
core capital. Transitional provisions apply to deferred tax assets existing at
December 31, 1992 which are not subject to the limitation. At December 31, 1994
the Bank's net deferred tax asset is less than this limitation. Management does
not anticipate this regulation will impact the Bank's compliance with capital
standards in the foreseeable future.
In November 1994, the OTS announced its decision to reverse immediately its
1993 interim policy requiring associations to include unrealized gains and
losses, net of income taxes, on available-for-sale (AFS) debt securities in
regulatory capital. Under the revised OTS policy, associations exclude any
unrealized gains and losses, net of income taxes, on a prospective basis, on AFS
debt securities reported as a separate component of equity capital pursuant to
SFAS No. 115.
The capital regulations specify that only the following elements may be
included in tangible capital: stockholder's equity, noncumulative perpetual
preferred stock, retained earnings and minority interests in the equity accounts
of fully consolidated subsidiaries. Further, goodwill and investments in and
loans to subsidiaries engaged in activities not permitted by national banks must
be deducted from assets and capital. See Regulation -- General -- Separate
Capitalization of Nonpermissible Activities herein for additional discussion.
In calculating adjusted total assets under the capital regulations, certain
adjustments are made to give effect to the exclusion of certain assets from
tangible capital and to appropriately account for the investments in and assets
of both includable and nonincludable activities.
Core capital under the current regulations may include only tangible
capital, plus certain intangible assets up to a limit of 25 percent of core
capital, provided such assets are: (i) separable from the thrift's assets; (ii)
valued at an established market value through an identifiable stream of cash
flows with a high degree of certainty that the asset will hold this market value
notwithstanding the prospects of the thrift and (iii) salable in a market that
is liquid. In addition, prior to January 1, 1995, certain qualifying
"supervisory" goodwill was includable as core capital. At December 31, 1994,
$6.6 million of supervisory goodwill is includable in core capital. Under the
regulation, on January 1, 1995, none of the Bank's supervisory goodwill is
includable in core capital.
Regarding the risk-based capital requirement, under the capital
regulations, assets are assigned to one of four "risk-weighted" categories (zero
percent, 20 percent, 50 percent or 100 percent) based upon the degree of
perceived risk associated with the asset. The total amount of a thrift's
risk-weighted assets is determined by multiplying the amount of each of its
assets by the risk weight assigned to it, and totaling the resulting amounts.
The capital regulation also establishes the concept of "total capital" for
the risk-based capital requirement. As defined, total capital consists of core
capital and supplementary capital. Supplementary capital includes: (i) permanent
capital instruments such as cumulative perpetual preferred stock, perpetual
subordinated debt and mandatory convertible subordinated debt (capital notes),
(ii) maturing capital instruments such as subordinated debt, intermediate-term
preferred stock, mandatory convertible subordinated debt (commitment notes) and
mandatory redeemable preferred stock, subject to an amortization schedule and
(iii) general valuation loan and lease loss allowances up to 1.25 percent of
risk-weighted assets.
The OTS issued a regulation which added a component to an institution's
risk-based capital calculation in 1994. The regulation requires a reduction of
an institution's risk-based capital by 50 percent of the decline in the
institution's net portfolio value (NPV) exceeding two percent of assets under a
hypothetical 200 basis point increase or decrease in market interest rates.
Based on the OTS's measurement of the Bank's September 30, 1994 and December 31,
1994 IRR, the Bank may be required to reduce its risk-based capital by
approximately $1.5 million on June 30, 1995 and $1.9 million on September 30,
1995, in the absence of corrective action to reduce the Bank's IRR exposure or
significant change in market interest rates in the interim. As of December 31,
1994, the Bank has sufficient risk-based capital to allow it to continue to be
classified as "well capitalized" under FDICIA capital requirements after such
reduction for IRR exposure. Management is currently reviewing possible
strategies for reducing the Bank's IRR exposure.
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See Note 2 of the Notes to Consolidated Financial Statements for the
calculation of the Bank's regulatory capital and related excesses as of December
31, 1994 and 1993.
Separate Capitalization of Nonpermissible Activities. For purposes of
determining a thrift's capital under all three capital requirements, its entire
investment in and loans to any subsidiary engaged in an activity not permissible
for a national bank must be deducted from the capital of the thrift. The capital
regulations provide for a transition period with respect to this provision.
During the transition period, a thrift is permitted to include in its
calculation the applicable percentage (as provided below) of the lesser of the
thrift's investments in and loans to such subsidiaries on: (i) April 12, 1989 or
(ii) the date on which the thrift's capital is being determined, unless the FDIC
determines with respect to any particular thrift that a lesser percentage should
be applied in the interest of safety and soundness.
In July 1992, legislation was enacted which delayed the increased
transitional deduction from capital for real estate investments, and allowed
thrifts to apply to the OTS for use of a delayed schedule. The Bank applied for
and received approval for use of the delayed phase-out schedule. The Bank had
$1.6 million in investments in and loans to nonpermissible activities at
December 31, 1994. These investments, which fall under this section of FIRREA,
will be deductible from capital by 60 percent from July 1, 1995 to June 30, 1996
and thereafter, totally deductible. Included in this amount are investments in
real estate, land loans and certain foreclosed real estate.
Lending Activities. FIRREA limits the amount of commercial real estate
loans that a federally chartered thrift may make to four times its capital (as
defined). Based on core capital of $117 million at December 31, 1994, the Bank's
commercial real estate lending limit was $468 million. At December 31, 1994, the
Bank had $178 million invested in commercial real estate loans; therefore, this
limitation should not unduly restrict the Bank's ability to engage in commercial
real estate loans.
FIRREA conformed thrifts' loans-to-one-borrower limitations to those
applicable to national banks. After December 31, 1991 thrifts generally are not
permitted to make loans to a single borrower in excess of 15 percent to 25
percent of the thrift's unimpaired capital and unimpaired surplus (depending
upon whether the loan is collateralized and the type of collateral), except that
a thrift may make loans to one borrower in excess of such limits under one of
the following circumstances: (i) for any purpose, in any amount not to exceed
$500,000 and (ii) to develop domestic residential housing units, in an amount
not to exceed the lesser of $30 million, or 30 percent, of the thrift's
unimpaired capital and unimpaired surplus, provided the thrift meets fully
phased-in capital requirements and certain other conditions are satisfied. The
Bank was in compliance with the loans-to-one-borrower limitation of $17.1
million at December 31, 1994. This limitation is not expected to materially
affect the operations of the Bank.
In December 1992, the OTS issued a regulation (Real Estate Lending
Standards) as mandated by FDICIA, which became effective in March 1993. The
regulation requires insured depository institutions to adopt and maintain
comprehensive written real estate lending policies which include: prudent
underwriting standards; loan administration procedures; portfolio
diversification standards; and documentation, approval and reporting
requirements. The policies must be reviewed and approved annually to ensure
appropriateness for current market conditions. The regulation also provides
supervisory loan-to-value limits for various types of real estate based loans.
Loans may be originated in excess of these limitations up to a maximum of 100
percent of total regulatory capital. The regulation has not made a material
impact on the Bank's lending operations.
In August 1993, the OTS issued revised guidance for the classification of
assets and a new policy on the classification of collateral-dependent loans
(where proceeds from repayment can be expected to come only from the operation
and sale of the collateral). With limited exceptions, effective September 1993,
for troubled collateral-dependent loans where it is probable that the lender
will be unable to collect all amounts due, an institution must classify as
"loss" any excess of the recorded investment in the loan over its "value," and
classify the remainder as "substandard." The "value" of a loan is either the
present value of the expected future cash flows, the loan's observable market
price or the fair value of the collateral. The policy did not materially impact
the Bank.
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The federal agencies regulating financial institutions issued a joint
policy statement in December 1993 providing quantitative guidance and
qualitative factors to consider in determining the appropriate level of general
valuation allowances that institutions should maintain against various asset
portfolios. The policy statement also requires institutions to maintain
effective asset review systems and to document the institution's process for
evaluating and determining the level of its general valuation allowance.
Management believes the Bank's current policies and procedures regarding general
valuation allowances and asset review procedures are consistent with the policy
statement.
FDICIA amended the Qualified Thrift Lender (QTL) test prescribed by FIRREA
by reducing the qualified percentage to 65 percent and adding certain
investments as qualifying investments. A savings institution must meet the
percentage in at least 9 of every 12 months. At December 31, 1994, the Bank's
QTL ratio was approximately 80 percent. A thrift that fails to meet the QTL test
must either become a commercial bank or be subject to a series of restrictions.
Safety and Soundness Standards. Pursuant to statutory requirements, the OTS
issued a proposed rule in November 1993, that prescribes certain "safety and
soundness standards." The standards are intended to enable the OTS to address
problems at savings associations before the problems cause significant
deterioration in the financial condition of the association. The proposed
regulation provides operational and managerial standards for internal controls
and information systems, loan documentation, internal audit systems, credit
underwriting, interest rate exposure, asset growth, and compensation, fees and
benefits. The proposed regulation also requires a savings association to
maintain a ratio of classified assets to total capital and ineligible allowances
that is no greater than 1.0. A minimum earnings standard is also included in the
proposed regulation requiring earnings sufficient to absorb losses without
impairing capital. Earnings would be sufficient under the proposed regulation if
the institution meets applicable capital requirements and would remain in
capital compliance if its net income or loss over the last four quarters of
earnings continued over the next four quarters of earnings. An institution that
fails to meet any of the standards must submit a compliance plan. Failure to
submit an acceptable compliance plan or to implement the plan could result in an
OTS order or other enforcement action against the association. The Bank's level
of adversely classified assets is less than its total capital plus ineligible
allowances at December 31, 1994 as defined under the proposed rule. This
proposed rule has not been issued as final as of March 1995.
Federal Home Loan Bank System
The FHLB system consists of 12 regional FHLB banks, which provide a central
credit facility primarily for member institutions. The Bank, as a member of the
FHLB of San Francisco, is required to own capital stock in that institution in
an amount at least equal to: one percent of the aggregate outstanding balance at
the beginning of the year of its outstanding residential mortgage loans, home
purchase contracts and similar obligations; 0.3 percent of total assets; or five
percent of its advances from the FHLB, whichever is greater. The Bank is in
compliance with this requirement, with an investment in FHLB stock at December
31, 1994 of $17.3 million.
Liquidity
The Bank is required to maintain an average daily balance of liquid assets
equal to at least five percent of its liquidity base (as defined in the
Regulation) during the preceding calendar month. The Bank is also required to
maintain an average daily balance of short-term liquid assets equal to at least
one percent of its liquidity base. The Bank has complied with these regulatory
requirements. For the month of December 1994, the Bank's liquidity ratios were
13.4 percent and 8.3 percent, respectively. See Financial Services Segment --
Capital Resources and Liquidity of MD&A for additional discussion.
Investments
A Federal Financial Institutions Examinations Council Supervisory Policy
Statement on Securities Activities (Policy Statement): (1) addresses the
selection of securities dealers, (2) requires depository institutions to
establish prudent policies and strategies for securities transactions, (3)
defines securities trading or sales practices that are viewed by the agencies as
being unsuitable when conducted in an investment
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portfolio, (4) indicates characteristics of loans held for sale or trading, and
(5) establishes a framework for identifying when certain mortgage derivative
products are high-risk mortgage securities which must be held either in a
trading or held for sale account. Management believes that items (1) through (4)
have not unduly restricted the operating strategies of the Bank. Item (5) has
not affected the Bank's treatment of its $1 million investment in CMO residuals
since the Policy Statement includes a grandfathering provision whereby any
mortgage derivative owned prior to the date of adoption by the OTS is exempt
from the tests. However, the Bank will have to apply the specified tests to any
mortgage derivative product, including CMO, Real Estate Mortgage Investment
Conduits (REMIC), CMO and REMIC residuals and stripped MBS purchases in the
future.
Insurance of Deposits
The Bank's deposits are insured by the FDIC through the SAIF up to the
maximum amount permitted by law, currently $100,000 per insured depositor. The
SAIF requires quarterly insurance premium payments in 1995 instead of
semi-annual payments as in prior years. See Regulation -- General -- Deposit
Insurance Premiums herein for additional discussion of insurance premiums to be
paid by SAIF members.
Insurance of deposits may be terminated by the FDIC, after notice and
hearing, upon a finding by the FDIC that a thrift has engaged in unsafe or
unsound practices, or is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, rule, order or
condition imposed by the OTS and FDIC. Management of the Bank is not aware of
any practice, condition, or violation that might lead to termination of its
deposit insurance.
Community Reinvestment Act
The Community Reinvestment Act of 1977 (CRA) and regulations promulgated
under the act encourage savings associations to help meet the credit needs of
the communities they do business in, particularly the credit needs of low and
moderate income neighborhoods. The OTS periodically evaluates the Bank's
performance under CRA. This evaluation is taken into account in determining
whether to grant approval for new branches, relocations, mergers, acquisitions
and dispositions. The Bank received a "satisfactory" evaluation in its most
recent examination.
Federal Reserve System
The Board of Governors of the Federal Reserve System (the Federal Reserve)
has adopted regulations that require depository institutions to maintain
noninterest earning reserves against their transaction accounts (primarily
negotiable order of withdrawal (NOW), demand deposit accounts, and Super NOW
accounts) and nonpersonal money market deposit accounts. These regulations
generally require that reserves of three percent be maintained against aggregate
transaction accounts in an institution, up to $49.8 million, and an initial
reserve of ten percent be maintained against that portion of total transaction
accounts in excess of such amount. In addition, an initial reserve of three
percent must be maintained on nonpersonal money market deposit accounts (which
include borrowings with maturities of less than four years). These accounts and
percentages are subject to adjustment by the Federal Reserve. The balances
maintained to meet the reserve requirements imposed by the Federal Reserve may
be used to satisfy liquidity requirements which may be imposed by the OTS. At
December 31, 1994, the Bank was required to maintain approximately $1.6 million
in noninterest earning reserves and was in compliance with this requirement.
As a creditor and financial institution, the Bank is subject to various
additional regulations promulgated by the Federal Reserve, including, without
limitation, Regulation B (Equal Credit Opportunity Act), Regulation E
(Electronic Funds Transfer Act), Regulation F (Interbank Liabilities),
Regulation Z (Truth-in-Lending Act), Regulation CC (Expedited Funds Availability
Act), Regulation O (Insider Lending) and Regulation DD (Truth-in-Savings Act).
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HOLDING COMPANY MATTERS
The Bank is a wholly owned subsidiary of the Company. As a unitary savings
bank holding company, the Company is subject to certain OTS regulation,
examination, supervision and reporting requirements. The Bank is generally
prohibited from engaging in certain transactions with the Company and is subject
to certain OTS restrictions on the payment of dividends to the Company.
In 1990, the OTS issued a regulation governing limitations of capital
distributions, including dividends. Under the regulation, a tiered system keyed
to capital is imposed on capital distributions. Insured thrifts fall under one
of three tiers.
1. Tier 1 includes those thrifts with net capital exceeding fully
phased-in requirements and with Capital, Assets, Management, Earnings
and Liquidity (CAMEL) ratings of 1 or 2. (The CAMEL system was
established by the FDIC and adopted by the OTS to comprehensively and
uniformly grade all thrifts with regard to financial condition,
compliance with laws and regulations, and overall operating soundness.)
2. Tier 2 includes those thrifts having net capital above their regulatory
capital requirement, but below the fully phased-in requirement.
3. Tier 3 includes those thrifts with net capital below the current
regulatory requirement.
Under the regulation, insured thrifts are permitted to make dividend
payments as follows:
1. Tier 1 thrifts are permitted to make (without application but with
notification) capital distributions of half their surplus capital (as
defined) at the beginning of a calendar year plus 100 percent of their
earnings to date for the year.
2. Tier 2 thrifts can make (without application but with notification)
capital distributions ranging from 25 to 75 percent of their net income
over the most recent four quarter period, depending upon their level of
capital in relation to the fully phased-in requirements.
3. Tier 3 thrifts are prohibited from making any capital distributions
without prior supervisory approval.
Based upon these regulations, the Bank is currently restricted to paying no
more than 75 percent of its net income over the last four quarters in dividends
to its parent. The Bank did not pay any cash dividends during the past three
years.
In December 1994, the OTS proposed an amendment to the capital
distributions regulation to conform to the FDICIA prompt corrective action
system. Under the proposal, a savings association that is not held by a savings
and loan holding company and that has a CAMEL rating of "1" or "2" need not
notify the OTS before making a capital distribution. Other institutions that
remain adequately capitalized after making a capital distribution would be
required to provide notice to the OTS. Troubled and undercapitalized
institutions must file and receive approval from the OTS prior to making capital
distributions. This proposed regulation will have no material impact on the
Bank.
Generally transactions between a savings and loan association and its
affiliates are required to be on terms as favorable to the association as
comparable transactions with nonaffiliates. In addition, certain of these
transactions are restricted to a percentage of the association's capital.
Affiliates of the Bank include the Company. In addition, a savings and loan
association may not lend to any affiliate engaged in activities not permissible
for a bank holding company or acquire the securities of such affiliates. It is
not permissible for bank holding companies to operate a gas utility. Therefore,
loans by the Bank to the Company and purchases of the Company's securities by
the Bank are prohibited.
The Company, at the time that it acquired the Bank, agreed to assist the
Bank in maintaining levels of net worth required by the regulations in effect at
the time or as they were thereafter in effect so long as it controlled the Bank.
The enforceability of a net worth maintenance agreement of this type is
uncertain. However, under current regulations, a holding company that has
executed a capital maintenance obligation of this type may not divest control of
a thrift if the thrift has a capital deficiency, unless the holding company
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either provides the OTS with an agreement to infuse sufficient capital into the
thrift to remedy the deficiency or the deficiency is satisfied.
The Company is prohibited from issuing any bond, note, lien, guarantee or
indebtedness of any kind pledging its utility assets or credit for or on behalf
of a subsidiary which is not engaged in or does not support the business of the
regulated public utility. As a result, there are limitations on the Company's
ability to assist the Bank in maintaining levels of capital required by
applicable regulations.
The Company also stipulated in connection with the acquisition of the Bank
that dividends paid by the Bank to the Company would not exceed 50 percent of
the Bank's cumulative net income after the date of acquisition, without approval
of the regulators. In addition, the Company agreed that the Bank would not at
any time declare a dividend that would reduce the Bank's regulatory net worth
below minimum regulatory requirements in effect at the time of the acquisition
or thereafter. Since the acquisition, the Bank's cumulative net income is $37.1
million, resulting in maximum dividends payable of $18.6 million as of December
31, 1994. Since the acquisition, the Bank has paid the Company $1.8 million in
capital distributions, net of $20 million of capital contributions received from
the Company.
ITEM 2. PROPERTIES
The information appearing in Part I, Item 1, pages 2 and 18 in this report
is incorporated herein by reference.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The principal market in which the common stock of the Company is traded is
the New York Stock Exchange. At March 3, 1995, there were 20,730 holders of
record of common stock. The market price of the common stock was $15.00 as of
March 3, 1995. Prices shown are those as quoted by the Dow Jones News Retrieval
Service.
COMMON STOCK PRICE AND DIVIDEND INFORMATION
DIVIDENDS
1994 1993 PAID
--------------- --------------- -------------
HIGH LOW HIGH LOW 1994 1993
------ ------ ------ ------ ----- -----
Fiscal Quarter
First...................................... $19.38 $15.75 $17.88 $13.38 $.195 $.175
Second..................................... 18.63 15.00 18.50 16.75 .195 .175
Third...................................... 18.25 17.50 17.38 16.13 .205 .195
Fourth..................................... 17.63 13.75 18.50 15.50 .205 .195
----- -----
$.800 $.740
===== =====
See Holding Company Matters and Note 2 of the Notes to Consolidated
Financial Statements for a discussion of limitations on the Bank's ability to
make capital distributions to the Company.
25
29
ITEM 6. SELECTED FINANCIAL DATA
CONSOLIDATED SELECTED FINANCIAL STATISTICS
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1994 1993 1992 1991 1990
---------- ---------- ---------- ---------- ----------
Operating revenues.................. $ 728,169 $ 689,841 $ 718,483 $ 794,791 $ 867,671
Operating expenses.................. 625,415 602,263 642,635 765,688 761,244
---------- ---------- ---------- ---------- ----------
Operating income.................... 102,754 87,578 75,848 29,103 106,427
Other income and (expenses)......... (1,396) (14,252) (599) 1,824 1,808
Net interest and amortization of
debt discount and expenses........ (57,335) (49,706) (43,115) (44,461) (45,441)
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes... 44,023 23,620 32,134 (13,534) 62,794
Income taxes........................ 17,722 11,259 14,473 641 25,623
---------- ---------- ---------- ---------- ----------
Net income (loss) before cumulative
effect of accounting change....... 26,301 12,361 17,661 (14,175) 37,171
Cumulative effect of change in
method of accounting.............. -- 3,045 -- -- --
---------- ---------- ---------- ---------- ----------
Net income (loss)................... $ 26,301 $ 15,406 $ 17,661 $ (14,175) $ 37,171
========== ========== ========== ========== ==========
Net income (loss) applicable to
common stock...................... $ 25,791 $ 14,665 $ 16,610 $ (15,500) $ 35,576
========== ========== ========== ========== ==========
Contribution to consolidated
net income (loss)
Gas operations.................... $ 23,524 $ 13,751 $ 32,214 $ 18,291 $ 30,981
Financial services................ 2,777 1,655 (14,553) (32,466) 6,190
---------- ---------- ---------- ---------- ----------
$ 26,301 $ 15,406 $ 17,661 $ (14,175) $ 37,171
========== ========== ========== ========== ==========
Total assets at year end............ $3,089,993 $2,943,949 $3,341,528 $3,462,974 $3,764,260
========== ========== ========== ========== ==========
Construction expenditures........... $ 144,642 $ 115,424 $ 105,595 $ 81,063 $ 104,419
========== ========== ========== ========== ==========
Cash flow, net
From operating activities......... $ 112,933 $ 89,491 $ 86,441 $ 112,958 $ 73,985
From investing activities......... (245,670) 343,823 36,045 219,715 (33,502)
From financing activities......... 141,393 (444,613) (102,560) (290,353) (29,948)
---------- ---------- ---------- ---------- ----------
Net change in cash.................. $ 8,656 $ (11,299) $ 19,926 $ 42,320 $ 10,535
========== ========== ========== ========== ==========
Capitalization at year end
Common equity..................... $ 339,089 $ 343,878 $ 329,444 $ 327,149 $ 353,254
Preferred and preference stocks... 4,000 8,058 15,316 22,574 29,832
Long-term debt.................... 790,798 692,865 654,523 674,330 842,572
---------- ---------- ---------- ---------- ----------
$1,133,887 $1,044,801 $ 999,283 $1,024,053 $1,225,658
========== ========== ========== ========== ==========
Common stock data
Return on average common equity... 7.6% 4.4% 5.1% (4.6)% 10.3%
Earnings (loss) per share......... $ 1.22 $ 0.71 $ 0.81 $ (0.76) $ 1.81
Dividends paid per share.......... $ 0.80 $ 0.74 $ 0.70 $ 1.05 $ 1.40
Payout ratio...................... 66% 104% 86% N/A 77%
Book value per share at year
end............................ $ 15.93 $ 16.38 $ 15.99 $ 15.88 $ 17.63
Market value per share at year
end............................ $ 14.13 $ 16.00 $ 13.75 $ 10.63 $ 13.13
Market value per share to book
value per share................ 89% 98% 86% 67% 74%
Common shares outstanding at
year end (000)................. 21,282 20,997 20,598 20,598 20,036
Number of common shareholders at
year end....................... 20,765 21,851 22,943 24,396 24,510
26
30
SEGMENT DATA
NATURAL GAS OPERATIONS
(THOUSANDS OF DOLLARS)
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
1994 1993 1992 1991 1990
---------- ---------- ---------- ---------- ----------
Sales........................ $ 560,207 $ 503,789 $ 506,937 $ 493,647 $ 503,961
Transportation............... 39,061 34,361 27,190 21,201 15,008
Other........................ 285 955 263 50,162 69,973
---------- ---------- ---------- ---------- ----------
Total revenue................ 599,553 539,105 534,390 565,010 588,942
Net cost of gas purchased.... 249,922 212,290 214,293 276,954 294,597
---------- ---------- ---------- ---------- ----------
Operating margin............. 349,631 326,815 320,097 288,056 294,345
Expenses
Operations and
maintenance............. 178,310 169,921 159,954 154,370 144,809
Depreciation and
amortization............ 57,284 55,088 52,277 47,140 43,979
Other...................... 25,347 24,124 22,291 20,289 19,246
---------- ---------- ---------- ---------- ----------
Operating income............. $ 88,690 $ 77,682 $ 85,575 $ 66,257 $ 86,311
========== ========== ========== ========== ==========
Contribution to consolidated
net income................. $ 23,524 $ 13,751 $ 32,214 $ 18,291 $ 30,981
========== ========== ========== ========== ==========
Total assets at year end..... $1,277,727 $1,194,679 $1,103,794 $1,106,917 $1,051,698
========== ========== ========== ========== ==========
Net gas plant at year end.... $1,035,916 $ 954,488 $ 906,420 $ 854,254 $ 806,960
========== ========== ========== ========== ==========
Construction expenditures.... $ 141,390 $ 113,903 $ 102,517 $ 76,871 $ 99,634
========== ========== ========== ========== ==========
Cash flow, net
From operating
activities.............. $ 87,364 $ 50,628 $ 81,457 $ 93,925 $ 55,188
From investing
activities.............. (141,547) (116,246) (103,065) (96,588) (91,527)
From financing
activities.............. 58,132 67,297 (7,792) 27,351 39,363
---------- ---------- ---------- ---------- ----------
Net change in cash........... $ 3,949 $ 1,679 $ (29,400) $ 24,688 $ 3,024
========== ========== ========== ========== ==========
Total throughput (thousands
of therms)
Sales...................... 881,868 850,557 825,521 885,255 908,836
Transportation............. 914,791 725,023 651,141 509,478 459,303
---------- ---------- ---------- ---------- ----------
Total throughput........... 1,796,659 1,575,580 1,476,662 1,394,733 1,368,139
========== ========== ========== ========== ==========
Weighted average cost of gas
purchased ($/therm)........ $ 0.30 $ 0.29 $ 0.26 $ 0.26 $ 0.26
Customers at year end........ 980,000 932,000 897,000 870,000 828,000
Employees at year end........ 2,359 2,318 2,285 2,243 2,217
Degree days -- actual........ 2,427 2,470 2,261 2,470 2,448
Degree days -- ten year
average.................... 2,387 2,401 2,375 2,419 2,356
27
31
SEGMENT DATA
FINANCIAL SERVICES
(THOUSANDS OF DOLLARS)
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
1994 1993 1992 1991 1990
---------- ---------- ---------- ---------- ----------
Interest income.............. $ 118,434 $ 132,325 $ 165,678 $ 213,991 $ 255,907
Interest expense............. 59,790 75,076 111,917 158,788 208,236
---------- ---------- ---------- ---------- ----------
Net interest income.......... 58,644 57,249 53,761 55,203 47,671
Provision for credit
losses..................... (7,230) (6,212) (14,129) (12,058) (3,269)
---------- ---------- ---------- ---------- ----------
Net interest income after
credit loss provision...... 51,414 51,037 39,632 43,145 44,402
Net income (loss) from real
estate operations.......... (612) (910) (15,286) (50,477) 5,676
Loan fees.................... 1,165 1,025 2,280 3,428 3,164
Other income, net............ 9,466 11,024 13,112 12,143 9,482
General and administrative
expenses................... (43,508) (48,296) (45,309) (41,237) (38,452)
Amortization of cost in
excess of net assets
acquired................... (3,861) (3,984) (4,156) (4,156) (4,156)
---------- ---------- ---------- ---------- ----------
Operating income (loss)...... $ 14,064 $ 9,896 $ (9,727) $ (37,154) $ 20,116
========== ========== ========== ========== ==========
Contribution to consolidated
net income (loss).......... $ 2,777 $ 1,655 $ (14,553) $ (32,466) $ 6,190
========== ========== ========== ========== ==========
Total assets at year end..... $1,816,321 $1,751,419 $2,237,734 $2,356,057 $2,712,562
========== ========== ========== ========== ==========
Interest-earning assets at
year end................... $1,675,368 $1,582,720 $2,022,121 $2,152,494 $2,450,629
========== ========== ========== ========== ==========
Interest-bearing liabilities
at year end................ $1,629,419 $1,546,158 $2,058,663 $2,164,402 $2,494,111
========== ========== ========== ========== ==========
Cash flow, net
From operating
activities.............. $ 25,569 $ 38,863 $ 4,984 $ 19,033 $ 18,797
From investing
activities.............. (104,123) 460,069 139,110 316,303 58,025
From financing
activities.............. 83,261 (511,910) (94,768) (317,704) (69,311)
---------- ---------- ---------- ---------- ----------
Net change in cash........... $ 4,707 $ (12,978) $ 49,326 $ 17,632 $ 7,511
========== ========== ========== ========== ==========
Average yield on loans....... 8.58% 9.25% 10.14% 10.95% 11.06%
Average yield on debt
securities................. 6.20 5.93 7.15 8.74 9.05
Average yield on cash
equivalents................ 4.31 3.09 3.54 5.60 4.81
Average earning asset
yield...................... 7.45 7.28 8.32 9.56 10.02
Average cost of deposits..... 3.59 3.99 5.09 6.77 7.74
Average cost of borrowings... 5.00 4.69 6.95 7.35 8.71
Average cost of funds (net of
capitalized and transferred
interest and cost of
hedging activities)........ 3.90 4.14 5.58 7.03 7.89
Interest rate spread......... 3.55 3.14 2.74 2.53 2.13
Net yield on interest-earning
assets..................... 3.69 3.15 2.70 2.47 1.87
28
32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company is comprised of two business segments; natural gas operations
and financial services. The gas segment purchases, transports and distributes
natural gas to residential, commercial, and industrial customers in
geographically diverse portions of Arizona, Nevada, and California. The
financial services segment (the Bank) is engaged in retail and commercial
banking. The Bank's principal business is to attract deposits from the general
public and make consumer and commercial loans secured by real estate and other
collateral. During 1994, the gas segment contributed $23.5 million and the
financial services segment contributed $2.8 million towards consolidated net
income of $26.3 million.
CONSOLIDATED CAPITAL RESOURCES AND LIQUIDITY
The capital requirements and resources of the Company generally are
determined independently for the natural gas operations and financial services
segments. Each business segment is generally responsible for securing its own
financing sources.
Liquidity refers to the ability of an enterprise to generate adequate
amounts of cash to meet its cash requirements. General factors that could affect
consolidated capital resources and liquidity significantly in future years
include inflation, growth in the economy and changes in income tax laws. In
addition, other factors specific to the two operating segments of the Company
include: the level of natural gas prices, interest rates, and changes in the
ratemaking policies of regulatory commissions for the gas segment; and new
banking regulations, interest rate sensitivity, credit risk, and competition for
the financial services segment.
Inflation, as measured by the Consumer Price Index for all urban consumers
averaged 2.7 percent in 1994, 2.7 percent in 1993 and 2.9 percent in 1992. See
separate discussions of each business segment for impact of inflation on
operations.
In May 1994, the Company's Board of Directors (the Board) declared a
quarterly common stock dividend of 20.5 cents per share payable September 1,
1994, a 1 cent, or five percent, increase from the previous level. The increase
was established in accordance with the Company's dividend policy which states
that the Company will pay common stock dividends at a prudent level that is
within the normal dividend payout range for its respective businesses, and that
the dividend will be established at a level considered sustainable in order to
minimize business risk and maintain a strong capital structure throughout all
economic cycles.
The Board continues to review the Company's investment in the Bank with an
emphasis on the Bank's capital position relative to its capital requirements.
The Company presently does not anticipate having to contribute additional
capital to the Bank.
The Bank's capital position has continued to improve. Accordingly, it now
has the ability to pay cash dividends to the Company, subject to regulatory
limitations. During 1994, the Company did not receive any dividends from the
Bank. The Bank's Board of Directors (the BOD) will determine the amount of
dividends, if any, the Bank will pay to the Company in 1995.
Consolidated cash and cash equivalents increased $8.7 million during 1994,
the result of increased cash flow from the gas segment of $4 million and from
the financial services segment of $4.7 million. The increase from the gas
segment is mainly attributable to the proceeds from the issuance of notes
payable, offset by increased construction expenditures. The increase from the
financial services segment is primarily due to deposit inflows.
In November 1994, Moody's Investors Service, Inc. upgraded the Company's
unsecured debt rating from Ba1 to Baa3. In February 1995, Standard and Poor's
Ratings Group reaffirmed the unsecured long-term debt rating at BBB- (triple B
minus). Duff and Phelps Credit Rating Company's unsecured debt rating remained
unchanged at BB+ (double B plus).
See Capital Resources and Liquidity for separate discussions of each
business segment.
29
33
RESULTS OF CONSOLIDATED OPERATIONS
CONTRIBUTION TO
CONSOLIDATED NET INCOME
YEAR ENDED DECEMBER 31,
-------------------------------
(THOUSANDS OF DOLLARS)
1994 1993 1992
------- ------- -------
Natural gas operations segment................................ $23,524 $13,751 $32,214
Financial services segment.................................... 2,777 (1,390) (14,553)
Financial services segment cumulative effect of accounting
change...................................................... -- 3,045 --
------- ------- -------
Consolidated net income....................................... $26,301 $15,406 $17,661
======= ======= =======
1994 vs. 1993
Consolidated net income increased $10.9 million compared to consolidated
net income from the same period a year ago. The increase resulted from a $9.8
million increase in net income contributed by the gas segment, and a $1.1
million improvement in net income contributed by the financial services segment.
See separate discussions of each business segment for an analysis of these
changes.
Earnings per share increased 51 cents to $1.22 per share in 1994. Dividends
paid increased 6 cents to 80 cents per share, the result of the Board's two
decisions to increase quarterly dividends. Average shares outstanding increased
by 349,000 shares.
1993 vs. 1992
Consolidated net income decreased $2.3 million compared to consolidated net
income from the prior year. The decrease resulted from an $18.5 million decrease
in net income contributed by the gas segment, offset by a $16.2 million
improvement in net income contributed by the financial services segment ($13.2
million before cumulative effect of accounting change). See separate discussions
of each business segment for an analysis of these changes.
In January 1993, the Company adopted SFAS No. 109, "Accounting for Income
Taxes," and applied the provisions prospectively. The cumulative effect of this
change in method of accounting was an increase in net income of $3 million. See
Note 14 of the Notes to Consolidated Financial Statements for additional
discussion.
Earnings per share decreased 10 cents to 71 cents per share in 1993.
Dividends paid increased 4 cents to 74 cents per share, the result of the
Board's decision to increase the quarterly dividend in May 1993. Average shares
outstanding increased by 131,000 shares.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In May 1993, the Financial Accounting Standards Board (FASB) issued SFAS
No. 114, "Accounting by Creditors for Impairment of a Loan." This statement is
applicable to all creditors and to all loans, uncollateralized as well as
collateralized, except for large groups of smaller-balance homogeneous loans
that are collectively evaluated for impairment, loans that are measured at fair
value or at lower of cost or fair value, leases, and debt securities as defined
in SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." SFAS No. 114 requires that an impaired loan be measured at the
present value of expected future cash flows by discounting those cash flows at
the loan's effective interest rate or, in the case of a collateral dependent
loan such as a mortgage loan, at the fair value of the collateral. A loan is
considered impaired when, based on current information and events, it is
probable that a creditor will be unable to collect all amounts due according to
the contractual terms of the loan agreement. The statement amends SFAS No. 15,
"Accounting by Debtors and Creditors for Troubled Debt Restructurings," to
require a creditor to account for a troubled debt restructuring involving a
modification of terms at fair value as of the date of the restructuring. The
statement also amends SFAS No. 5, "Accounting for Contingencies," to clarify
that a creditor should evaluate the collectibility of both contractual interest
and principal of a receivable when
30
34
assessing the need for a loss accrual. The provisions of the statement apply to
financial statements issued for fiscal years beginning after December 15, 1994,
with earlier application permitted. Retroactive restatement of previously issued
annual financial statements is not permitted. In October 1994, the FASB issued
SFAS No. 118, "Accounting by Creditors for Impairment of a Loan -- Income
Recognition and Disclosures." The Statement amends SFAS No. 114 to allow a
creditor to use existing methods for recognizing interest income on impaired
loans. The statement is effective for financial statements issued for fiscal
years beginning after December 15, 1994. The Company will adopt these statements
on January 1, 1995 and does not anticipate a material impact on results of
operations as a result of implementation.
In October 1994, the FASB also issued SFAS No. 119, "Disclosure about
Derivative Financial Instruments and Fair Value of Financial Instruments." The
statement was adopted by the Company as of December 31, 1994. See Note 17 of the
Notes to Consolidated Financial Statements for additional discussion.
NATURAL GAS OPERATIONS SEGMENT
The Company is engaged in the business of purchasing, transporting, and
distributing natural gas in portions of Arizona, Nevada and California. Its
service areas are geographically as well as economically diverse. The Company is
the largest distributor in Arizona, selling and transporting gas in most of
southern, central and northwestern Arizona. The Company is also the largest
distributor and transporter of natural gas in Nevada. The Company also
distributes and transports gas in portions of California, including the Lake
Tahoe area and high desert and mountain areas in San Bernardino County.
As of December 31, 1994, the Company had approximately 980,000 residential,
commercial, industrial and other customers, of which 583,000 customers were
located in Arizona, 292,000 in Nevada and 105,000 in California. Residential and
commercial customers represented over 99 percent of the Company's customer base.
During 1994, the Company added 48,000 customers, a five percent increase, of
which 20,000 customers were added in Arizona, 26,000 in Nevada, and 2,000 in
California. These additions are largely attributable to continued population
growth in the Company's service areas. Customer growth over the past three years
averaged four percent annually. Based on current commitments from builders, the
Company expects to add approximately 60,000 customers by the end of 1995. During
1994, 57 percent of operating margin was earned in Arizona, 32 percent in
Nevada, and 11 percent in California. This pattern is consistent with prior
years and is expected to continue.
The Company's total gas plant in service increased from $1.2 billion to
$1.4 billion, or at an annual rate of seven percent, during the three-year
period ended December 31, 1994, reflecting continued customer growth within the
Company's service territories.
CAPITAL RESOURCES AND LIQUIDITY
The growth of the gas segment during the last several years has required
capital resources in excess of the amount of cash flow generated from operating
activities (net of dividends paid). During 1994, the gas segment's capital
expenditures were $141 million. Cash flow from operating activities (net of
dividends) provided $70 million, or approximately 50 percent, of the required
capital resources pertaining to these construction expenditures. The remainder
was provided from net external financing activities. The Company received no
dividends from the Bank during 1994 and is not dependent upon such dividends to
meet the gas segment's cash requirements.
The Company currently estimates that construction expenditures for its gas
segment during 1995 through 1997 will be approximately $410 million, and debt
maturities and repayments, and other cash requirements are expected to
approximate $15 million. In January 1995, term loan facilities totaling $165
million were refinanced with a new $200 million term loan facility which does
not mature until 1998. See Note 11 of Notes to Consolidated Financial Statements
for further discussion. It is currently estimated that cash flow from operating
activities (net of dividends) will generate approximately one-half of the gas
segment's total financing requirements during 1995 through 1997. A portion of
the remaining financing requirements will be provided by $83 million of funds
held in trust from the 1993 Clark County, Nevada, Series A issue and 1993
31
35
City of Big Bear Lake, California, Series A issue industrial development revenue
bonds (IDRB). The remaining cash requirements are expected to be provided by
external financing sources. The timing, types, and amounts of these additional
external financings will be dependent on a number of factors, including
conditions in the capital markets, timing and amounts of rate relief, and growth
factors in the Company's service areas. These external financings may include
the issuance of both debt and equity securities, bank and other short-term
borrowings, and other forms of financing.
In September 1994, the Company filed a shelf registration statement with
the Securities and Exchange Commission. The shelf registration allows the
Company to offer from time to time, in one or more series, its unsecured debt
securities, shares of preferred stock, $50 par value, and shares of its common
stock, $1 par value. These securities will have a maximum aggregate offering
price of $300 million and will be offered on terms to be determined at the time
of the sale.
The gas segment's costs of natural gas, labor and construction are the
categories most significantly impacted by inflation. Changes to the Company's
cost of gas are generally recovered through PGA mechanisms and do not
significantly impact net earnings. Labor is a component of the cost of service,
and construction costs are the primary component of rate base. In order to
recover increased costs, and earn a fair return on rate base, general rate cases
are filed by the Company, when deemed necessary, for review and approval by its
regulatory authorities. Regulatory lag, that is, the time between the date
increased costs are incurred and the time such increases are recovered through
the ratemaking process, can impact earnings. See Rates and Regulatory
Proceedings for discussion of recent rate case proceedings.
RESULTS OF NATURAL GAS OPERATIONS
1994 1993 1992
-------- -------- --------
(THOUSANDS OF DOLLARS)
Gas operating revenues..................................... $599,553 $539,105 $534,390
Net cost of gas............................................ 249,922 212,290 214,293
-------- -------- --------
Operating margin......................................... 349,631 326,815 320,097
Operations and maintenance expense......................... 178,310 169,921 159,954
Depreciation and amortization.............................. 57,284 55,088 52,277
Taxes other than income taxes.............................. 25,347 24,124 22,291
-------- -------- --------
Operating income......................................... 88,690 77,682 85,575
Other income (expense), net................................ (1,396) (14,252) (599)
-------- -------- --------
Income before interest and income taxes.................. 87,294 63,430 84,976
Net interest deductions.................................... 57,335 49,706 43,115
Income tax expense......................................... 11,331 4,914 14,382
-------- -------- --------
Net income before allocation to the Bank................. 18,628 8,810 27,479
Carrying costs allocated to the Bank, net of tax........... 4,896 4,941 4,735
-------- -------- --------
Contribution to consolidated net income.................. $ 23,524 $ 13,751 $ 32,214
======== ======== ========
1994 vs. 1993
Contribution to consolidated net income was $23.5 million, an increase of
$9.8 million from 1993, the result of increased operating margin, partially
offset by increased operations and maintenance expenses, depreciation expense
and general taxes. The recognition of the Arizona pipe replacement program
disallowances during 1993 also contributed to the change.
Operating margin increased $22.8 million, or seven percent, during 1994
compared to 1993. This increase was primarily due to annualized rate relief
totaling $9.5 million in the Arizona, southern California, and federal rate
jurisdictions. The balance of the increase in margin is attributed to customer
growth and weather. Increased demand for natural gas, through the addition of
48,000 customers, directly benefitted margin. Differences in heating demand
between periods also positively impacted the change in margin, since weather
more closely approximated normal in 1994 compared to 1993's warmer than normal
conditions.
32
36
Operations and maintenance expenses increased $8.4 million, or five
percent, reflecting a general increase in labor costs, increased costs of
materials and contractor services related to maintenance and other operating
expenses. These increases are attributable to the incremental costs of providing
service to the Company's steadily growing customer base.
Depreciation expense and taxes other than income taxes increased $3.4
million, or four percent, primarily due to an increase in average gas plant in
service of $80 million, or six percent. This is attributable to capital
expenditures for the upgrade of existing operating facilities and the expansion
of the system to accommodate customer growth.
Other expenses for 1993 include the Arizona pipe replacement program
disallowances. See Arizona Pipe Replacement Program Disallowances herein for
additional information.
Net interest deductions increased $7.6 million, or 15 percent, in 1994.
Average debt outstanding during 1994 increased 13 percent compared to 1993, and
consisted of a $38 million increase in average long-term debt, net of funds held
in trust, and a $41 million increase in average short-term debt. The increase in
debt is attributed primarily to borrowings for construction expenditures and
operating activities as well as the drawdown of the IDRB funds previously held
in trust. Higher interest rates on the variable-rate term loan facilities and
short-term debt accounted for $2.7 million of the increase in net interest
deductions.
Carrying costs allocated to the Bank consist primarily of costs associated
with the Company's investment in the Bank (principally interest) net of taxes.
1993 vs. 1992
Contribution to consolidated net income was $13.7 million, a decrease of
$18.5 million from 1992, the result of increased operations and maintenance
expenses, depreciation expense and general taxes partially offset by increased
operating margin. An increase in net interest deductions and the recognition of
the Arizona pipe replacement program disallowances also contributed to the
decrease in net income.
Operating margin during 1993 increased $6.7 million, or two percent,
compared to 1992. This increase was primarily due to increased transportation
volumes, and continued customer growth in all of the Company's service areas,
combined with annualized rate relief of $1.4 million effective January 1993 in
its southern California jurisdiction, rate relief in its FERC jurisdiction
(subject to refund) effective April 1993, and $6.5 million in its central
Arizona jurisdiction effective September 1993. Weather also had a significant
impact on margin.
Operating margin from weather-sensitive customers increased $1.3 million
due to the rate relief in Arizona and California, and the addition of 35,000
customers system-wide during the 12-month period. However, differences in
heating demand between periods negatively impacted operating margin from these
customers largely offsetting the favorable occurrences.
Operating margin from other customers, primarily transportation, increased
$5.4 million. Transportation volumes increased by 11 percent over 1992 as
cogeneration and electric generation customers increased throughput.
Operations and maintenance expenses increased $10 million, or six percent,
reflecting a general increase in labor costs, increased costs of materials and
contractor services related to maintenance and other operating expenses. These
increases are attributable to the incremental costs of providing service to the
Company's steadily growing customer base.
Depreciation expense and other operating expenses (primarily property
taxes) increased $4.6 million, or six percent. During 1993, average gas plant in
service increased $105 million, or nine percent. This is attributable to capital
expenditures for the continued upgrade of existing operating facilities and the
expansion of the system to accommodate substantial customer growth, including
the capacity expansion project on Paiute's pipeline system.
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37
Net interest deductions increased $6.6 million, or 15 percent, in 1993.
Higher average outstanding long-term debt balances with associated higher
average interest rates are the primary reasons for the increased interest
expense. The increase in the average long-term debt balance is attributable to
the net impact of the issuances of $100 million in Series F Debentures and $130
million in tax-exempt IDRB during the second half of 1992. The Company used $80
million from the sale of the fixed-rate Series F Debentures to retire existing
variable-rate indebtedness, which included $40 million of short-term borrowings.
The remaining $20 million was used for general corporate purposes, including the
planned expansion and replacement of utility plant. The Company used $80 million
from the sale of the fixed-rate IDRB to retire existing variable-rate IDRB. The
remaining $50 million was used to finance qualifying construction expenditures
in the Company's Southern Nevada Division. The Company replaced the
variable-rate long-term debt instruments with fixed-rate debt instruments in
order to take advantage of the low interest rate environment. While interest
costs have increased in the short term, the Company believes that it will
achieve overall interest costs savings in the long term.
Arizona Pipe Replacement Program Disallowances. In August 1990, the ACC
issued its opinion and order (Decision No. 57075) on the Company's 1989 general
rate increase requests applicable to the Company's Central and Southern Arizona
Divisions. Among other things, the order stated that $16.7 million of the total
capital expenditures incurred as part of the Company's Central Arizona Division
pipe replacement program were disallowed for ratemaking purposes and all costs
incurred as part of the Company's Southern Arizona Division pipe replacement
program were excluded from the rate case and rate consideration was deferred to
the Company's next general rate application, which was filed in November 1990.
In October 1990, the Company filed a Complaint in the Superior Court of the
State of Arizona, against the ACC, to seek a judgement modifying or setting
aside this decision. In February 1991, the Company filed a Motion for Summary
Judgement in the Superior Court to seek a judgement summarily determining that
Decision No. 57075 of the ACC is unreasonable and unlawful and, in accordance
with that determination, modifying or setting aside Decision No. 57075 and
allowing the Company to establish and collect reasonable, temporary rates under
bond, pending the establishment of reasonable and lawful rates by the
Commission. In June 1991, the Court affirmed the ACC's rate order without
explanation or opinion. In August 1991, the Company appealed to the Arizona
Court of Appeals from the Superior Court's judgement. In April 1993, Division
Two of the Arizona Court of Appeals issued a Memorandum Decision affirming the
ACC's opinion and order. Based on this decision, the Company filed a Motion for
Reconsideration in the Court of Appeals in May 1993. The Motion for
Reconsideration was denied and the Company, in July 1993, filed a Petition for
Review with the Arizona Supreme Court. In February 1994, immediately following
the denial of the Petition for Review by the Arizona Supreme Court, the Court of
Appeals issued its Mandate ordering the Company to comply with its April 1993
Memorandum Decision.
As a result of the Arizona Court of Appeals Division Two Mandate, the
Company wrote off in December 1993 $15.9 million in gross plant related to the
central and southern Arizona pipe replacement program disallowances. The impact
of these disallowances, net of accumulated depreciation, tax benefits and other
related items, was a noncash reduction to 1993 net income of $9.3 million, or
$0.44 per share.
In addition, as part of the southern Arizona settlement (see Rates and
Regulatory Proceedings -- Arizona below for further information), the Company
agreed to write off $3.2 million of gross plant in service related to southern
Arizona pipe replacement programs in addition to the $1.3 million disallowance
previously written off in December 1993. The settlement also established a
disallowance formula to be used in future rate cases for expenditures related to
defective materials and/or installation. Cumulatively, the Company has written
off $19.1 million in gross plant related to both central and southern Arizona
pipe replacement programs. The impact of these disallowances, net of accumulated
depreciation, tax benefits and other related items, was a noncash reduction to
net income of $9.6 million, or $0.45 per share, $9.3 million of which was
recognized in December 1993. The Company believes this settlement effectively
resolves all financial issues associated with currently challenged Arizona pipe
replacement programs, that it has adequately provided for future disallowances
and does not anticipate further material effects on results of operations as a
result of gross plant disallowances related to these pipe replacement programs.
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38
RATES AND REGULATORY PROCEEDINGS
California
Effective January 1994, the Company received approval of an attrition
allowance to increase annual margin by $1.5 million for its southern and
northern California rate jurisdictions. Pursuant to the CPUC rate case
processing plan, the Company filed a general rate application in January 1994 to
increase annual margin by $1.1 million for its southern and northern California
rate jurisdictions effective January 1995. In December 1994, the CPUC approved a
settlement agreement effective January 1995 authorizing a $1.1 million increase
in margin. The settlement, which is in effect through 1998, suspends the supply
adjustment mechanism (SAM) previously utilized in California. SAM is a mechanism
by which actual margin is adjusted to the margin authorized in the Company's
current tariff. The Company is now able to retain excess margin generated from
additional volumes sold, but is also at risk for reductions in margin resulting
from lower than projected sales volumes. In addition, the settlement suspends
required annual attrition filings for southern California, but retains attrition
adjustments in northern California for certain safety-related improvements.
Nevada
In March 1993, the Company filed general rate cases with the PSCN seeking
approval to increase revenues by $9.4 million, or eight percent, annually for
its southern Nevada rate jurisdiction and $3.3 million, or nine percent,
annually for its northern Nevada rate jurisdiction. The Company's last general
rate cases were September 1987 for southern Nevada and December 1988 for
northern Nevada. Since that time, general rate cases had not been necessary in
these jurisdictions primarily because of ongoing customer growth and Company
initiated cost containment measures. The Company was seeking recovery of
increased operating costs in these ratemaking areas and the restructuring of its
tariffs and rates to reflect current changes within the natural gas industry.
The PSCN issued its rate order in October 1993 and ordered the Company to reduce
general rates by $648,000 in southern Nevada and authorized a $799,000 increase
in northern Nevada. The primary reasons for the difference between the Company's
requested annual revenue increases and the amounts authorized by the PSCN
included lower authorized returns on rate base and lower authorized depreciation
expenses. The Company filed a motion for reconsideration and rehearing on
several issues following the issuance of the rate order. In January 1994, the
PSCN granted the rehearing of certain rate case issues. In December 1994, the
PSCN modified its previous decision and authorized the Company to increase rates
in Nevada by approximately $250,000.
Arizona
In October 1993, the Company filed a rate application with the ACC seeking
approval to increase annual revenues by $10 million, or 9.3 percent, for its
southern Arizona jurisdiction. The Company sought to recover increased operating
costs and obtain a return on construction expenditures, and had proposed tariff
restructurings which would be consistent with the tariff modifications
authorized by the ACC in its August 1993 central Arizona decision. In July 1994,
the ACC approved a settlement agreement of the southern Arizona general rate
case. The agreement was reached through negotiations between the Company, the
ACC staff, and the Residential Utility Consumer Office. The agreement specifies
a $4.3 million, or 3.9 percent, rate increase which became effective July 1994.
The Company also agreed not to file another general rate request for its
southern Arizona jurisdiction before November 1996.
FERC
In October 1992, Paiute filed a general rate case with the FERC requesting
approval to increase revenues by $6.8 million annually. Paiute sought recovery
of increased costs associated with its capacity expansion project that was
placed into service in February 1993. Interim rates reflecting the increased
revenues became effective in April 1993, which were subject to refund until a
final order was issued. In January 1995, the FERC approved a settlement
authorizing a $4.3 million increase in revenue. Refunds of approximately $5
million, including interest, were made to customers in March 1995. These refunds
were fully reserved as of December 31, 1994.
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39
FINANCIAL SERVICES SEGMENT
The Bank recorded net income of $7.7 million for the year ended December
31, 1994 compared to net income of $6.6 million and a net loss of $9.8 million
for the years ended December 31, 1993 and 1992, respectively. The Bank's 1994
net income is comprised of $11.3 million from core banking operations compared
to $7.9 million in 1993. The growth in the 1994 income was attributable to an
increased net interest margin along with increased operational efficiency.
FINANCIAL AND REGULATORY CAPITAL
At December 31, 1994, stockholder's equity totaled $166 million.
Stockholder's equity decreased $10.6 million compared to December 31, 1993, as a
result of the decline in unrealized gains, after tax, on debt securities
available for sale partially offset by net income of $7.7 million. The Bank has
not paid any cash dividends to the Company since 1989. The Bank may pay cash
dividends to the Company of 50 percent of cumulative net income. Cash dividends
in excess of this amount require regulatory approval. In addition, under OTS
regulations, the Bank is restricted to paying no more than 75 percent of its net
income over the preceding four quarters to the Company.
During 1994, the Bank's regulatory capital levels and ratios decreased
under each of the three fully phased-in FDICIA capital standards. OTS
regulations effective in 1993 included unrealized gains, net of tax, on debt
securities in regulatory capital for all three capital measures. In 1994, the
OTS and other federal banking regulators issued regulations excluding this
component from regulatory capital. Other factors contributing to the change in
regulatory capital levels include a decrease in the amount of includable
goodwill and real estate investments.
As discussed in Note 2 of the Notes to Consolidated Financial Statements,
as of December 31, 1994 and 1993, the Bank exceeded all three fully phased-in
minimum capital requirements under the regulatory capital regulations issued
under FDICIA.
During 1993, the Bank achieved "well capitalized" status through a
combination of increased capital from net income and unrealized gains from debt
securities, and the reduction of assets and goodwill through the Arizona sale.
It is management's intent to maintain and improve the level of capital through
earnings and the stabilization of the asset base. The Bank maintained its "well
capitalized" status throughout 1994.
The Bank is subject to an OTS regulation requiring institutions with IRR
exposure classified as "above normal" to reduce their risk-based capital by 50
percent of the amount by which the IRR exposure exceeds a specified "normal"
threshold. Based on the OTS's measurement of the Bank's September 30, 1994 and
December 31, 1994 IRR, the Bank may be required to reduce its risk-based capital
by approximately $1.5 million on June 30, 1995 and $1.9 million on September 30,
1995, in the absence of corrective action to reduce the Bank's IRR exposure or a
significant change in market interest rates in the interim. As of December 31,
1994, the Bank has sufficient risk-based capital to allow it to continue to be
classified as "well capitalized" under FDICIA capital requirements after such a
reduction for IRR exposure. Management is currently reviewing possible
strategies for reducing the Bank's IRR exposure to a "normal" level or below.
Under SFAS No. 115, unrealized gains and losses, net of tax, on securities
available for sale are recorded as an adjustment to stockholder's equity. Under
OTS regulations in 1993, this component of equity was included as regulatory
capital under all three capital measures. In 1994, OTS and other federal banking
regulators issued regulations excluding this component from regulatory capital.
Approximately $8.8 million of unrealized gain was includable in capital for
1993, whereas in 1994 no such gain (or loss) was included.
CAPITAL RESOURCES AND LIQUIDITY
Liquidity is defined as the Bank's ability to have sufficient cash reserves
on hand and unencumbered assets, which can be sold or utilized as collateral for
borrowings at a reasonable cost, or with minimal losses. The Bank's debt
security portfolio provides the Bank with adequate levels of liquidity so that
the Bank is able to meet any unforeseeable cash outlays and regulatory liquidity
requirements.
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Potential liquidity demands may include funding loan commitments, deposit
withdrawals, and other funding needs. In order to achieve sufficient liquidity
for the Bank without taking a large liquid or illiquid position and avoiding
funding concentrations, the Bank has taken the following actions: 1) maintaining
lines of credit with authorized brokers/dealers; 2) managing the debt security
portfolio to ensure that maturities meet liquidity needs; 3) limiting investment
or lending activities at certain times and 4) establishing maximum borrowing
limits for meeting liquidity needs.
The OTS has issued regulations regarding liquidity requirements which state
that the Bank is required to maintain an average daily balance of liquid assets
equal to at least five percent of its liquidity base (as defined in the OTS
Regulations) during the preceding calendar month. The Bank is also required to
maintain an average daily balance of short-term liquid assets equal to at least
one percent of its liquidity base as defined in the regulations. Throughout
1994, the Bank exceeded both regulatory liquidity requirements. For the month of
December the Bank's liquidity ratios were 13.4 percent and 8.3 percent,
respectively. The Bank's liquidity ratio is substantially higher than the
regulatory requirement due to the Bank's increasing level of transaction
accounts. The regulatory requirement is aimed at a more traditional savings
institution which has a higher level of certificate of deposit accounts versus
transaction accounts.
Borrowings, in the form of reverse repurchase agreements, increased from
$259 million at December 31, 1993 to $282 million at December 31, 1994. During
1994, the Bank repaid $29.4 million in long-term fixed-rate borrowings while
increasing short-term borrowings by $52.3 million.
The Bank has adequate levels of liquidity and unencumbered assets to meet
its day-to-day operational needs and to meet the regulatory requirements for
liquidity. The daily operational liquidity needs of the Bank in 1994 were
primarily met through $603 million of repayments on loans and debt securities,
$28.4 million of borrowings from the FHLB, $46.1 million of loan sales, and
$32.1 million in deposit growth.
The Bank's borrowing capacity is a function of the availability of its
readily marketable, unencumbered assets and the Bank's financial condition.
Secured borrowings may be obtained from the FHLB in the form of advances and
from authorized broker/dealers in the form of reverse repurchase agreements. At
December 31, 1994, the Bank maintained in excess of $319 million of unencumbered
assets, with a market value of $311 million, which could be borrowed against, or
sold, to increase liquidity levels.
The primary management objective of the investment portfolio is to invest
the excess funds of the Bank. This includes ensuring that the Bank maintains
adequate levels of liquidity so it is able to meet any unforeseeable cash
outlays. This task is accomplished by active investment in securities that
provide the greatest return, for a given price and credit risk, in order to
maximize the total return to the Bank.
The secondary management objective of the investment portfolio is to serve
as the Bank's primary short-term tool to manage the IRR exposure of the
institution. The Bank's asset/liability management objective generally requires
a trade-off between achieving the highest profitability in terms of net interest
income, while maintaining acceptable levels of IRR. To accomplish these
objectives, management can change the composition of the investment portfolio
allowing management to quickly adjust the IRR exposure of the Bank, and take
advantage of interest rate changes in the markets. The tables in Note 3 of the
Notes to Consolidated Financial Statements depict the amortized cost, estimated
fair values, contractual maturity, and yields of the debt security portfolios.
As of December 31, 1994, the Bank's debt security portfolio was composed of
securities with a fair value of $629 million (amortized cost of $646 million)
with a yield of 6.79 percent compared to a debt security portfolio with a fair
value of $664 million (amortized cost of $652 million) yielding 6.17 percent at
December 31, 1993.
During 1994, the debt security portfolio balance declined by $34 million.
Purchases of debt securities and poolings of loans into debt securities
approximated the total of sales, maturities, and prepayments during 1994. The
decline in the portfolio is primarily the result of a $28 million decline in the
unrealized gain in debt securities available for sale. Debt securities available
for sale included a $13.5 million unrealized gain at December 31, 1993, which
declined to a $14.5 million unrealized loss at December 31, 1994 as a result of
increases in interest rates during the period.
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The Bank's assets and liabilities consist primarily of monetary assets
(cash, cash equivalents, debt securities and loans receivable) and liabilities
(savings deposits and borrowings) which are, or will be converted into a fixed
amount of dollars in the ordinary course of business regardless of changes in
prices. Monetary assets lose purchasing power due to inflation, but this is
offset by gains in the purchasing power of liabilities, as these obligations are
repaid with inflated dollars.
The level and movement of interest rates is of much greater significance.
Inflation is but one factor that can cause interest rate volatility and changes
in interest levels. The results of operations of the Bank are dependent upon its
ability to manage such movements. See Risk Management -- Interest Rate Risk
Management herein for additional discussion.
RISK MANAGEMENT
The financial services industry has certain risks. In order to be
successful and profitable, in an increasingly volatile and competitive
marketplace, the Bank must accept some forms of risk and manage these risks in a
safe and sound manner. Generally, transactions that the Bank enters into require
the Bank to accept some measure of credit risk and IRR, and utilize equity
capital. The Bank has established certain guidelines in order to manage the
Bank's assets and liabilities. These guidelines will help ensure that the risks
taken and consumption of capital are optimized to achieve maximum profitability,
while minimizing risks to equity and the federal deposit insurance fund. See
Note 17 of Notes to Consolidated Financial Statements for further discussion of
Interest Rate Risk Management.
Interest Rate Risk (IRR) Management
The Bank has established certain guidelines to manage the exposure of the
Bank's net interest income, net income, and net portfolio value (NPV) to
interest rate fluctuations. NPV represents a theoretical estimate of the market
value of the Bank's stockholder's equity, calculated as the net present value of
expected cash flows from financial assets and liabilities, plus the book values
of all nonfinancial assets and liabilities. The guidelines establish acceptable
activities and instruments to manage IRR and include limits on overall IRR
exposure, methods of accountability and specific reports to be provided by
management for periodic review.
The Bank maintains an IRR simulation model which enables management to
measure the Bank's IRR exposure using various assumptions and interest rate
scenarios, and to incorporate alternative strategies for the reduction of IRR
exposure. The Bank measures its IRR using several methods to provide a
comprehensive view of its IRR from various perspectives. These methods include
projection of current NPV and future periods' net interest income after rapid
and sustained interest rate movements, static analysis of repricing and maturity
mismatches, or gaps, between assets and liabilities, and analysis of the size
and sources of basis risk.
Static gap analysis measures the difference between financial assets and
financial liabilities scheduled and expected to mature or reprice within a
specified time period. The gap is positive when repricing and maturing assets
exceed repricing and maturing liabilities, where as the gap is negative when
repricing and maturing liabilities exceed repricing and maturing assets. A
positive or negative cumulative gap indicates in a general way how the Bank's
net interest income should respond to interest rate fluctuations. A positive
cumulative gap for a period generally means that rising interest rates would be
reflected sooner in financial assets than in financial liabilities, thereby
increasing net interest income over that period. A negative cumulative gap for a
period would produce an increase in net interest income over that period if
interest rates declined.
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At December 31, 1994, the Bank had financial assets of $1.7 billion with a
weighted average yield of 7.26 percent, and financial liabilities of $1.6
billion with a weighted average rate of 4.10 percent. The Bank's cumulative
one-year static gap was a negative $145 million, or eight percent of financial
assets. The Bank's financial assets and financial liabilities are presented
according to their frequency of repricing, and scheduled or expected maturities
in the following table (thousands of dollars):
STATIC GAP AS OF DECEMBER 31, 1994
REPRICING SENSITIVITY AT
DECEMBER 31, 1994
----------------------------------
PERCENT OF TOTAL YIELD/ WITHIN 1 - 5 OVER 5
TOTAL BALANCE RATE 1 YEAR YEARS YEARS
---------- ---------- ------ ---------- -------- --------
FINANCIAL ASSETS
Cash and cash equivalents(1).... 7.2% $ 123,922 4.29% $ 123,922 $ -- $ --
Debt securities available for
sale(2) ...................... 30.7 529,400 6.65 405,276 114,108 10,016
Debt securities held to
maturity(2)................... 5.9 101,880 7.55 69,273 29,722 2,885
Loans receivable:
Loans receivable held for
sale....................... 0.1 2,114 8.20 2,114 -- --
Adjustable-rate real estate(3)
Construction and land...... 2.8 47,971 10.23 46,492 1,045 434
Other real estate.......... 13.9 238,897 6.56 238,131 766 --
Fixed-rate real estate(4)..... 26.9 464,028 8.06 55,497 192,847 215,684
Consumer, commercial and all
other(4)................... 11.5 197,351 9.17 103,699 77,496 16,156
FHLB stock(5)................... 1.0 17,277 3.50 17,277 -- --
----- ---------- ----- ---------- -------- --------
Total financial assets.......... 100.0% 1,722,840 7.26% 1,061,681 415,984 245,175
===== =====
---------- -------- --------
Nonfinancial assets............. 93,481
----------
Total assets.................. $1,816,321
==========
FINANCIAL LIABILITIES
Deposits:
Interest-bearing demand and
money market deposits(6)... 19.3% $ 313,949 3.11% 313,949 -- --
Certificates of deposit(1).... 47.7 777,830 4.81 523,438 229,037 25,355
Savings deposits(6)........... 4.8 78,876 2.56 78,876 -- --
Noninterest-bearing demand
deposits(7)................ 4.3 69,294 -- 26,671 7,687 34,936
Borrowings:
Advances from FHLB(1)......... 6.1 99,400 4.70 50,000 46,000 3,400
Securities sold under
agreements to
repurchase(8).............. 17.3 281,935 4.31 277,996 3,939 --
Other(10).................. 0.5 8,135 8.91 8,135 -- --
----- ---------- ----- ---------- -------- --------
Total financial liabilities..... 100.0% 1,629,419 4.10% 1,279,065 286,663 63,691
===== =====
---------- -------- --------
Impact of hedging-fixed(9)...... -- 72,450 (45,400) (27,050)
---------- -------- --------
Nonfinancial liabilities........ 20,514
Stockholder's equity.......... 166,388
----------
Total liabilities and
stockholder's equity..... $1,816,321
==========
Maturity gap.................... $ (144,934) $ 83,921 $154,434
========== ======== ========
Cumulative gap.................. $ (144,934) $(61,013) $ 93,421
========== ======== ========
Cumulative gap as a percent of
financial assets.............. (8.4)% (3.5)% 5.4%
========== ======== ========
- ---------------
Note: Loans receivable exclude allowance for credit losses, discount reserves,
deferred loan fees, loans in process, and accrued interest on loans.
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STATIC GAP ASSUMPTIONS AS OF DECEMBER 31, 1994
(1) Based on the contractual maturity or term to next repricing of the
instrument(s).
(2) Maturity sensitivity is based upon characteristics of underlying loans.
Portions represented by adjustable-rate certificates are included in the
"Within 1 Year" category, as underlying loans are subject to interest rate
adjustment at least semiannually or annually. Portions represented by
fixed-rate loans are based on contractual maturity, and projected
repayments and prepayments of principal.
(3) Adjustable-rate loans are included in each respective category depending on
the term to next repricing and projected repayments and prepayments of
principal.
(4) Maturity sensitivity is based upon contractual maturity, and projected
repayments and prepayments of principal.
(5) FHLB stock has no contractual maturity. The Bank receives quarterly
dividends on all shares owned and the balance is therefore included in the
"Within 1 Year" category. The amount of such dividends is not fixed, and
varies quarterly.
(6) Interest-bearing demand, money market deposits, and savings deposits may be
subject to daily interest rate adjustment and withdrawal on demand, and are
therefore included in the "Within 1 Year" category.
(7) Noninterest-bearing demand deposits have no contractual maturity, and are
included in each repricing category based on the Bank's historical
attrition of such accounts.
(8) Floating-rate reverse repurchase agreements are included in the "Within 1
Year" category. Principal repayments of flexible reverse repurchase
agreements are based on the projected timing of construction or funding of
the underlying project.
(9) Hedging consisted of fixed rate interest rate swaps as of December 31,
1994.
(10) Based on expected maturity.
While the static gap analysis is a useful asset/liability management tool,
it does not fully assess IRR. Static gap analysis does not address the effects
of customer options (such as early withdrawal of time deposits, withdrawal of
deposits with no stated maturity, and mortgagors' options to prepay loans) and
Bank strategies (such as delaying increases in interest rates paid on certain
interest-bearing demand and money market deposit accounts) on the Bank's net
interest income, net income, and NPV. In addition, the static gap analysis
assumes no changes in the spread relationships between market rates on
interest-sensitive financial instruments (basis risk), or in yield curve
relationships. Therefore, a static gap analysis is only one tool with which to
analyze IRR, and must be reviewed in conjunction with other asset/liability
management reports.
Credit Risk Management
Management has also established certain guidelines and criteria in order to
manage the credit risk of the Bank's debt security portfolios, including
concentration limits, credit rating and geographic distribution requirements.
The following table presents the credit quality of the debt security portfolios:
AT DECEMBER 31, 1994 AT DECEMBER 31, 1993
RATING: PERCENTAGE OF PORTFOLIO PERCENTAGE OF PORTFOLIO
------------------------------------- ------------------------ ------------------------
AAA.................................. 91.2% 87.6%
AA................................... 2.7 5.9
A.................................... 1.0 1.8
BBB.................................. 1.3 0.2
Other................................ 3.8 4.5
----- -----
Total................................ 100.0% 100.0%
===== =====
The other category primarily includes the Bank's investment in the
privately issued MBS classified as substandard, as further explained in this
section.
OTS regulations require the Bank to classify certain assets into one of
three categories -- "substandard," "doubtful" and "loss." An asset which does
not currently warrant classification as substandard but which
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44
possesses weaknesses or deficiencies deserving close attention is considered a
criticized asset and is designated as "special mention." The Bank designated
$32.2 million of its assets as "special mention" at December 31, 1994.
The following table sets forth the amounts of the Bank's classified assets
and ratio of classified assets to total assets, net of specific reserves and
charge-offs, as of the dates indicated (thousands of dollars):
DECEMBER 31,
--------------------------------------------------------
1994 1993 1992 1991 1990
------- ------- ------- -------- -------
Substandard assets:
Loans................................. $29,591 $37,886 $55,727 $ 66,839 $25,965
Foreclosed real estate (net).......... 7,631 9,707 24,488 14,875 10,363
Loans to facilitate................... -- -- 80 760 357
Real estate held for investment....... 1,191 2,166 1,616 24,587 3,111
Investment............................ 21,972 29,509 -- -- 17,857
Doubtful assets......................... -- -- -- -- --
Loss assets............................. -- -- -- -- --
------- ------- ------- -------- -------
Total................................... $60,385 $79,268 $81,911 $107,061 $57,653
======= ======= ======= ======== =======
Ratio of classified assets to total
assets................................ 3.32% 4.53% 3.66% 4.54% 2.13%
======= ======= ======= ======== =======
The Bank's "substandard" assets decreased from $79 million at December 31,
1993 to $60 million at December 31, 1994, primarily as a result of upgrade of
loans to special mention, payoffs of real estate loans, repayments on the
classified investment security, and disposition of foreclosed real estate.
Assets classified as "substandard" are inadequately protected by the current net
worth or paying capacity of the obligor or the collateral pledged, if any.
Foreclosed real estate decreased $2.1 million during 1994, principally as a
result of partial sales on insubstance foreclosures of $1.8 million and other
sales and write-downs. It is the Bank's practice to charge off all assets which
it considers to be "loss." As a result, none of the Bank's assets, net of
charge-offs, were classified as "loss" at December 31, 1994.
The investment classified as substandard represents a privately issued MBS
collateralized by apartments, office buildings, town homes, shopping centers and
day care centers located in various states along the southeastern seaboard which
is supported by a credit enhancement feature. The single A credit rating of this
security was withdrawn by the rating agency in January 1993, due to the
delinquency of a large number of the loans underlying the security. Because of
the limited number of owners of the security, no quoted market value is
available on the MBS. Therefore, the Bank's management performed a credit review
of the loans underlying the MBS to determine the appropriate fair value of the
security. Based on such reviews, the Bank determined that only a portion of the
underlying loans met the criteria for substandard classification. However, the
entire investment security is classified as substandard because the OTS does not
have a policy for the "split rating" of a security.
The current level of the Bank's classified assets reflects significant
improvement from the prior two years. Aggressive management of the resolution of
these assets along with some stabilization within the economy contributed to the
success in reducing the classified asset portfolio. Although progress has been
positive, the Bank is unable to predict at this time what level, if any, of
these assets may subsequently be charged off or may result in actual losses. The
rising interest rate environment could have an adverse impact on both the level
of classified assets and the level of charge-offs on interest rate sensitive
assets.
As a result of the Bank's internal review process, the general allowance
for estimated credit losses increased to $17.7 million at December 31, 1994,
from $16.3 million at December 31, 1993. During 1994, the Bank established
provisions for estimated credit losses totaling $7.4 million, of which $7.2
million related to the Bank's loan, foreclosed real estate, and debt security
portfolio and $200,000 was related to its real estate investment portfolio. In
1993, the Bank established provisions for estimated credit losses totaling $7.2
million, of which $1 million related to the Bank's real estate investment
portfolio and $6.2 million related to its loan, foreclosed real estate
portfolio, and debt security portfolio.
41
45
The Bank's loan portfolio is concentrated primarily in Nevada, California
and Arizona. The following table summarizes the geographic concentrations of the
Bank's loan portfolios at December 31, 1994 (thousands of dollars):
LOANS BY REGION
COMMERCIAL CONSTRUCTION
RESIDENTIAL MORTGAGE CONSUMER AND LAND COMMERCIAL TOTAL
----------- ---------- -------- ------------ ---------- --------
Nevada.......................... $384,757 $159,955 $139,370 $45,974 $43,329 $773,385
California...................... 105,347 2,107 1,286 172 -- 108,912
Arizona......................... 35,281 4,592 15,285 -- 110 55,268
Other........................... 349 -- 237 -- -- 586
-------- -------- -------- ------- ------- --------
Total........................... $525,734 $166,654 $156,178 $46,146 $43,439 $938,151
======== ======== ======== ======= ======= ========
At December 31, 1994, 48 percent or $19.5 million of the Bank's outstanding
commercial secured loan portfolio consisted of loans to borrowers in the gaming
industry, with additional unfunded commitments of $11.5 million. These loans are
generally secured by real estate and equipment. The Bank's portfolio of loans,
collateralized by real estate, consists principally of real estate located in
Nevada, California and Arizona. Collectibility is, therefore, somewhat dependent
on the economies and real estate values of these areas and industries.
The following table sets forth by geographic location the amount of
classified assets at December 31, 1994 (thousands of dollars):
CLASSIFIED ASSETS BY GEOGRAPHIC LOCATION
CONSTRUCTION NON- INVESTMENTS
MORTGAGE AND LAND MORTGAGE FORECLOSED IN
LOANS LOANS LOANS REAL ESTATE REAL ESTATE TOTAL
-------- ------------ -------- ------------ ------------ -------
Nevada............................ $22,469 $ 8 $1,297 $2,086 $ 330 $26,190
California........................ 4,330 607 -- 5,248 -- 10,185
Arizona........................... 880 -- -- 297 861 2,038
Other............................. 21,972 -- -- -- -- 21,972
------- ---- ------ ------ ------ -------
Total............................. $49,651 $615 $1,297 $7,631 $1,191 $60,385
======= ==== ====== ====== ====== =======
The mortgage loans of $22 million in other states represents the classified
MBS collateralized by loans in states along the southeastern seaboard.
Classified construction and land loans include committed but undisbursed loan
amounts.
The following table sets forth by type of collateral, the amount of
classified assets at December 31, 1994 (thousands of dollars):
CLASSIFIED ASSETS BY TYPE OF LOAN
FORECLOSED INVESTMENTS DEBT
LOANS REAL ESTATE IN REAL ESTATE SECURITY
------- ------------ -------------- --------
Single-family residential........................ $ 6,882 $1,549 $ -- $ --
Commercial and multi-family mortgage............. 20,797 3,257 861 21,972
Construction/land................................ 615 2,722 330 --
Consumer......................................... 1,297 103 -- --
Other............................................ -- -- -- --
------- ------ ------ -------
Total............................................ $29,591 $7,631 $1,191 $21,972
======= ====== ====== =======
The largest substandard loan at December 31, 1994 was an $8.2 million
multi-family real estate loan in Nevada. In addition, the Bank had three other
substandard loans at December 31, 1994 in excess of $1 million: two hotel loans
and one multi-family loan, all located in Nevada.
42
46
The largest parcel of foreclosed real estate owned by the Bank at December
31, 1994, was a $1.4 million land parcel located in California. The Bank also
owns two parcels of foreclosed real estate at December 31, 1994 with book values
in excess of $1 million: one apartment complex located in Nevada and a
single-family construction property located in California.
Substandard real estate held for investment includes an $860,000 Arizona
branch facility not included as part of the Arizona sale. This branch facility
was formerly included in premises and equipment. See Note 2 of the Notes to
Consolidated Financial Statements for further discussion.
The following table presents the Bank's net charge-off experience for loans
receivable and real estate acquired through foreclosure by loan type (thousands
of dollars):
NET CHARGE-OFFS
----------------------------
1994 1993 1992
------ ------ ------
Single-family residential................................ $ 827 $ 916 $ 422
Commercial and multi-family mortgage..................... 959 2,275 93
Construction/land........................................ 1,297 2,248 3,765
Nonmortgage.............................................. 2,739 1,750 4,682
------ ------ ------
Net charge-offs................................ $5,822 $7,189 $8,962
====== ====== ======
The $959,000 of commercial mortgage charge-offs for the year ended December
31, 1994 were comprised principally of two apartment complex properties totaling
$765,000, both located in Nevada. Construction and land losses in 1994 consisted
primarily of two California loans totaling $747,000 and one land parcel in
Nevada for $145,000. Nonmortgage loan charge-offs were principally comprised of
$1.4 million of losses in installment loans, $558,000 of credit card
charge-offs, and $432,000 in charge-offs from the merchant services portfolio in
1994. SFR charge-offs for 1994 and 1993 consist primarily of California-based
loans and real estate acquired through foreclosure.
43
47
RESULTS OF FINANCIAL SERVICES OPERATIONS
The Bank's net income depends in large part on the difference, or interest
rate spread, between the yield it earns from its loan and debt security
portfolios and the rates it pays on deposits and borrowings.
The following table reflects, for the periods indicated, the components of
net interest income of the Bank, setting forth average assets, liabilities and
equity; interest income on interest-earning assets and interest expense on
interest-bearing liabilities; average yields on interest-earning assets and
interest-bearing liabilities; and net interest income (thousands of dollars):
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------------
1994 1993 1992
------------------------------- ------------------------------- -------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD BALANCE INTEREST YIELD BALANCE INTEREST YIELD
---------- -------- ------- ---------- -------- ------- ---------- -------- -------
Assets
Interest-earning assets
Cash equivalents........ $ 56,380 $ 2,432 4.31% $ 42,787 $ 1,321 3.09% $ 38,107 $ 1,349 3.54%
Debt securities held to
maturity.............. 73,520 4,919 6.69 425,141 26,909 6.33 1,065,593 75,955 7.13
Debt securities
available for sale.... 556,781 34,165 6.14 542,264 30,395 5.61 12,029 1,043 8.67
Loans receivable........ 886,702 76,080 8.58 790,082 73,106 9.25 858,360 87,038 10.14
FHLB stock.............. 16,916 838 4.95 16,475 594 3.61 17,392 293 1.68
---------- -------- ---- ---------- -------- ---- ---------- -------- -----
Total interest-earning
assets.................. 1,590,299 118,434 7.45 1,816,749 132,325 7.28 1,991,481 165,678 8.32
-------- ---- -------- ---- -------- -----
Noninterest-earning assets
Real estate held for
sale or development... 10,785 26,132 36,947
Premises and equipment,
net................... 22,236 28,807 32,846
Other assets............ 39,502 56,443 57,107
Excess of cost over net
assets acquired....... 67,632 73,972 81,620
---------- ---------- ----------
Total assets.............. $1,730,454 $2,002,103 $2,200,001
========== ========== ==========
Liabilities and
Stockholder's Equity
Interest-bearing
liabilities
Deposits................ $1,229,515 44,116 3.59 $1,443,628 57,643 3.99 $1,688,884 85,974 5.09
Securities sold under
agreements to
repurchase............ 222,620 11,024 4.95 305,123 13,132 4.30 204,222 12,213 5.98
Advances from FHLB...... 73,510 3,543 4.82 38,897 2,147 5.52 40,639 3,389 8.34
Bonds payable........... -- -- -- -- -- -- 29,102 3,015 10.36
Notes payable........... 8,203 635 7.74 14,229 1,170 8.22 19,448 1,623 8.35
Unsecured senior
notes................. -- -- -- 13,777 1,021 7.41 25,000 1,881 7.52
---------- -------- ---- ---------- -------- ---- ---------- -------- -----
Total interest-bearing
liabilities............. 1,533,848 59,318 3.87 1,815,654 75,113 4.14 2,007,295 108,095 5.39
Cost of hedging
activities.............. 485 .03 24 -- 4,794 .24
-------- ---- -------- ---- -------- -----
Cost of funds............. 59,803 3.90 75,137 4.14 112,889 5.63
-------- ---- -------- ---- -------- -----
Noninterest-bearing
liabilities and
stockholder's equity
Other liabilities and
accrued expenses...... 21,625 22,914 28,558
---------- ---------- ----------
Total liabilities......... 1,555,473 1,838,568 2,035,853
Total stockholder's
equity.................. 174,981 163,535 164,148
---------- ---------- ----------
Total liabilities and
equity.................. $1,730,454 $2,002,103 $2,200,001
========== ========== ==========
Capitalized and
transferred interest.... 13 -- 61 -- 972 .05
-------- ---- -------- ---- -------- -----
Net interest income....... $ 58,644 3.55% $ 57,249 3.14% $ 53,761 2.74%
======== ==== ======== ==== ======== =====
Net yield on
interest-earning
assets.................. 3.69% 3.15% 2.70%
==== ==== =====
- ---------------
Note: Loans receivable include accrued interest and loans on nonaccrual, and are
net of undisbursed funds, valuation allowances, discounts and deferred
loan fees.
44
48
The following table shows, for the periods indicated, the effects of the
two primary determinants of the Bank's net interest income: interest rate spread
and the relative amounts of interest-sensitive assets and liabilities. The table
also shows the extent to which changes in interest rates and changes in the
volumes of interest sensitive assets and liabilities have affected the Bank's
interest income and expense for the periods indicated. Changes from period to
period are attributed to: (i) changes in rate (change in weighted average
interest rate multiplied by prior period average portfolio balance); (ii)
changes in volume (change in average portfolio balance multiplied by prior
period rate); and (iii) net or combined changes in rate and volume. Any changes
attributable to both rate and volume that cannot be segregated have been
allocated proportionately between the two factors.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1994 COMPARED TO 1993 1993 COMPARED TO 1992
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO CHANGES IN DUE TO CHANGES IN
----------------------------- ------------------------------
VOLUME RATE NET VOLUME RATE NET
-------- ------- -------- -------- -------- --------
(THOUSANDS OF DOLLARS)
INTEREST INCOME ON:
Cash equivalents.................... $ 496 $ 615 $ 1,111 $ 623 $ (651) $ (28)
Debt securities held to maturity.... (23,620) 1,630 (21,990) (41,340) (7,706) (49,046)
Debt securities available for
sale.............................. 831 2,939 3,770 29,589 (237) 29,352
Loans receivable.................... 7,336 (4,362) 2,974 (6,635) (7,297) (13,932)
Dividends on FHLB stock............. 16 228 244 (15) 316 301
-------- ------- -------- -------- -------- --------
Total interest income.......... (14,941) 1,050 (13,891) (17,778) (15,575) (33,353)
-------- ------- -------- -------- -------- --------
INTEREST EXPENSE ON:
Deposits............................ (8,035) (5,492) (13,527) (11,402) (16,929) (28,331)
Securities sold under agreements to
repurchase........................ (4,755) 2,647 (2,108) 2,124 (1,205) 919
Advances from FHLB.................. 1,628 (232) 1,396 (140) (1,102) (1,242)
Bonds payable....................... -- -- -- (1,508) (1,507) (3,015)
Notes payable....................... (470) (65) (535) (430) (23) (453)
Unsecured senior notes.............. (1,021) -- (1,021) (832) (28) (860)
-------- ------- -------- -------- -------- --------
Total interest expense......... (12,653) (3,142) (15,795) (12,188) (20,794) (32,982)
Cost (benefit) of hedging
activity.......................... 730 (269) 461 (3,364) (1,406) (4,770)
-------- ------- -------- -------- -------- --------
Cost of funds....................... (11,923) (3,411) (15,334) (15,552) (22,200) (37,752)
Capitalized and transferred
interest.......................... (12) (36) (48) (502) (409) (911)
-------- ------- -------- -------- -------- --------
Net interest income............ $ (3,030) $ 4,425 $ 1,395 $ (2,728) $ 6,216 $ 3,488
======== ======= ======== ======== ======== ========
1994 vs. 1993
The Bank recorded net income of $7.7 million for the year ended December
31, 1994, compared to net income of $6.6 million for the year ended December 31,
1993. The increase in net income was principally due to an improved net interest
margin, along with increased operational efficiency.
The lower interest-earning asset base is the result of the Bank's strategy
of reducing its total asset size. The increase in the average yield on
interest-earning assets is the result of the repricing of interest sensitive
loans and debt securities, repayment of lower yielding loans and debt
securities, and the replacement of such loans and debt securities with higher
yielding originations and purchases.
The following summarizes the significant effects of these factors:
(i) Interest on cash equivalents increased due to the higher yield which
was a result of the higher interest rates, and increased volume
during the year.
(ii) Debt securities, in total, decreased principally as a result of the
sale of $334 million to fund the transfer of the Arizona-based
deposit liabilities in 1993 (Arizona sale) and paydowns within the
45
49
portfolio, offset partially by purchases of $296 million. The
decrease in average balance of debt securities also resulted in a
decrease of the interest on debt securities. As the Arizona sale did
not occur until the last half of 1993, the average balance of the
debt securities was higher in 1993. The increase in the yield was
due to sales of lower coupon securities in 1993 and to the purchase
of higher yielding debt securities in 1994.
(iii) The average loans receivable portfolio increased principally due to
a decrease in loan payoffs from 1994 compared to 1993, partially
offset by decreased loan originations. Total loan originations for
1994 were $466 million compared to originations of $500 million for
1993. The decline in loan originations for 1994 was due to the
rising interest rate environment and the corresponding decline in
refinance activity. The rise in interest rates also slowed down the
prepayments within the Bank's mortgage loan portfolio. The average
yield on loans declined as a result of lower interest rates on newly
funded adjustable-rate mortgage loans.
(iv) Dividends on FHLB stock increased as a result of a higher declared
dividend rate in 1994.
(v) The average balance for deposits decreased as a result of the
Arizona sale of $321 million in 1993. The average balance of
deposits was higher in 1993 because the sale occurred in the last
half of the year. The decrease in the cost of savings was due to the
lower interest rate environment.
(vi) The decrease in interest on securities sold under agreements to
repurchase was due to net repayments of borrowings during the year,
partially offset by an increase in the cost.
(vii) The increase in the average balance for FHLB advances was due to the
new borrowings during the year, partially offset by repayment of
advances. The decrease in the cost of these advances was due to
lower interest rates on the new borrowings versus the higher rates
on these advances paid off.
(viii) Interest on notes payable declined primarily as a result of the
repayment of $10.4 million in the third quarter of 1993.
(ix) Interest on unsecured senior notes declined as a result of the
pay-off of the $25 million balance in the third quarter of 1993.
The Bank's cost of hedging activities increased principally as a result of
the Bank entering into interest rate swaps of $72.5 million (notional amount) in
1994 compared to $7.5 million (notional amount) of interest rate swaps in 1993.
See Note 17 of the Notes to Consolidated Financial Statements for further
discussion.
Provisions for estimated credit losses increased in 1994 versus 1993 as a
result of management's evaluation of the adequacy of the allowances for
estimated credit losses. See Risk Management -- Credit Risk Management herein
and Note 5 of the Notes to Consolidated Financial Statements for further
discussion.
The net gain on sale of loans decreased $1.5 million from $1.7 million in
1993 to $247,000 in 1994, due to a decrease in the amount of loans sold from $78
million in 1993 to $46 million in 1994. Net gains on the sale of debt securities
decreased from a net gain of $8 million in 1993 to a net gain of $34,000 in
1994, primarily due to the sale in 1993 of $361 million in debt securities, of
which $334 million were sold to fund the sale of the Arizona-based deposit
liabilities. In January 1994, the Bank sold its credit card portfolio and
recognized a gain of $1.7 million ($1.1 million net of charge-offs). Other
income decreased principally due to a legal settlement of $1.2 million received
in 1993, while legal fees of $810,000 were incurred in 1994 associated with a
Las Vegas apartment complex which the Bank built.
General and administrative expenses decreased $4.8 million, or 10 percent,
in 1994. This decrease was due to the general and administrative expenses
associated with the Arizona operations which were incurred in 1993 until the
sale in the third quarter of that year, which were not incurred in 1994 along
with increases in efficiency and focus on cost reduction.
The Bank's effective tax rate was 45.4 percent in 1994 primarily as a
result of goodwill amortization.
46
50
1993 vs. 1992
The Bank recorded net income of $6.6 million for the year ended December
31, 1993 compared to a net loss of $9.8 million for the year ended December 31,
1992. The increase in net income was principally due to the decrease in
provisions for estimated credit losses, the gain recorded on the sale of debt
securities in connection with the Arizona sale, the cumulative effect of change
in method for accounting for income taxes and an improved net interest margin,
offset partially by the write-off of goodwill as the result of the Arizona sale
as described in Note 2 of the Notes to Consolidated Financial Statements.
The lower interest-earning asset base is the result of the Bank's strategy
of reducing its total asset size. The decline in the average yield on
interest-earning assets is the result of the repricing of interest sensitive
loans and debt securities, repayment of higher yielding loans and debt
securities and the replacement of such loans and debt securities with lower
yielding originations and purchases.
The following summarizes the significant effects of these factors:
(i) Interest on cash equivalents decreased due to the lower yield
which was a result of the lower interest rates during the year.
(ii) Interest on debt securities, in total, decreased principally as
a result of $294 million of payoffs and principal amortization in
the portfolio and the third quarter effect of the sale of $334
million to fund the transfer of the Arizona-based deposit
liabilities, offset partially by $113 million in debt security
purchases. The decrease in debt securities held to maturity was
the result of the reclassification of the majority of the
portfolio to debt securities available for sale category during
the second quarter. This resulted in the increase in debt
securities available for sale offset partially by the sale of $334
million to fund the sale of the Arizona-based deposit liabilities.
The decrease in yield was due to sales of higher coupon securities
in 1992 and 1993 and to repricing of adjustable-rate debt
securities, repayments, and purchase of lower yielding debt
securities.
(iii) The average loans receivable portfolio decreased principally
due to payoffs exceeding originations of loans held for
investment. The average yield on loans declined as a result of
lower interest rates on newly funded loans, repricing of
adjustable loans, and payoffs of higher yielding loans.
(iv) Dividends on FHLB stock increased as a result of a higher
declared dividend rate in 1993.
(v) The average balance for deposits decreased as a result of the
Arizona sale of $321 million. The decrease in the cost of savings
was due to the Arizona sale, the lower interest rates, and the
disintermediation of certificates of deposit accounts to
transaction accounts.
(vi) The increase in interest on securities sold under agreements to
repurchase was due to new borrowings during the first part of
1993, partially offset by a decrease in the cost.
(vii) The decrease in the average balance for FHLB advances was due
to the repayment of advances in the early part of 1993 somewhat
offset by new borrowings later in the year. The decrease in the
cost of these advances was due to lower interest rates on the new
borrowings versus the higher rates on these advances which paid
off.
(viii) The decrease in interest on bonds payable was the result of the
payoff of mortgage-backed bonds during the second quarter of 1992.
The bonds were called on June 30, 1992.
(ix) Interest on notes payable declined as a result of the repayment
of $10.4 million in the third quarter of 1993.
(x) Interest on unsecured senior notes declined as a result of the
pay-off of the $25 million balance in the third quarter of 1993.
The Bank's cost of hedging activities decreased principally as a result of
the cancellation of $300 million (notional amount) of interest rate swaps
outstanding during the second and third quarters of 1992 and only $7.5 million
(notional amount) of interest rate swaps were entered into in late 1993.
47
51
Provisions for estimated credit losses decreased in 1993 versus 1992 as a
result of management's evaluation of the adequacy of the allowances for
estimated credit losses. See Risk Management -- Credit Risk Management herein
and Note 5 of the Notes to Consolidated Financial Statements for further
discussion.
The net gain on sale of loans decreased $2.9 million from $4.6 million in
1992 to $1.7 million in 1993 due to a decrease in the amount of loans sold from
$240 million in 1992 to $78 million in 1993. The gain on sale of mortgage loan
servicing decreased $1.9 million in 1993, as there were no sales of mortgage
loan servicing in 1993. Net gains on the sale of debt securities, including the
interest rate swap loss, increased from a net loss of $809,000 in 1992 to a net
gain of $8 million in 1993, primarily due to the sale of $361 million in debt
securities, of which $334 million were sold to fund the sale of the
Arizona-based deposit liabilities. The net loss on the termination of the
interest rate swaps in 1992 was $14.1 million. No similar activity occurred in
1993. The net loss on the termination of the interest rate swaps was related to
the cancellation of $300 million (notional amount) of interest rate swaps which
hedged loans and debt securities sold during 1992 as part of the balance sheet
restructuring. Loan related fees decreased $1.3 million due to the decrease in
loan servicing volume. Deposit fees increased $984,000 due to an increase in the
fee structure. Other income increased principally due to a legal settlement
received of $1.2 million.
General and administrative expenses increased $3 million, or seven percent,
in 1993. This increase was due to the reinstatement of employee merit increases
and incentive awards during 1993, a scheduled rent increase on office space, and
increased professional services fees from legal efforts related to California
real estate development projects.
The Bank's effective tax rate was 64.1 percent in 1993 primarily as a
result of goodwill amortization and goodwill write-offs not deductible for tax
purposes.
48
52
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49
53
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(THOUSANDS OF DOLLARS)
ASSETS
DECEMBER 31,
------------------------
1994 1993
---------- ----------
Cash and cash equivalents (Note 8).................................. $ 129,998 $ 121,342
Debt securities available for sale (Notes 3 and 8).................. 529,400 595,726
Debt securities held to maturity (fair value of $99,403 and $68,738)
(Note 3).......................................................... 101,880 69,660
Loans receivable, net of allowance for estimated credit losses of
$17,659 and $16,251 (Notes 4 and 5)............................... 936,037 817,279
Loans receivable held for sale (fair value of $2,135 and $22,019)
(Note 4).......................................................... 2,114 20,051
Receivables, less reserves for uncollectibles of $1,553 and $1,683
(Note 5).......................................................... 105,438 98,265
Gas utility property, net of accumulated depreciation of $433,429
and $399,155 (Note 6)............................................. 1,035,916 954,488
Other property, net of accumulated depreciation of $28,175 and
$25,229........................................................... 35,605 36,495
Excess of cost over net assets acquired............................. 65,640 69,501
Other assets........................................................ 147,965 161,142
---------- ----------
Total assets.............................................. $3,089,993 $2,943,949
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (Note 7)................................................... $1,239,949 $1,207,852
Securities sold under agreements to repurchase (Note 8)............. 281,935 259,041
Deferred income taxes and tax credits, net (Note 14)................ 133,531 151,558
Accounts payable and other accrued liabilities...................... 208,691 194,697
Short-term debt (Note 10)........................................... 92,000 86,000
Long-term debt, including current maturities (Note 11).............. 790,798 692,865
---------- ----------
Total liabilities......................................... 2,746,904 2,592,013
---------- ----------
Commitments and contingencies (Note 9)
Preferred and preference stocks, including current maturities (Note
12)............................................................... 4,000 8,058
---------- ----------
Stockholders' equity:
Common stock --
Authorized -- 30,000,000 shares
Issued and outstanding -- 21,281,717 shares and 20,997,319
shares........................................................ 22,912 22,627
Additional paid-in capital........................................ 278,898 274,410
Capital stock expense............................................. (5,681) (5,685)
Unrealized gain (loss), net of tax, on debt securities available
for sale (Note 3).............................................. (9,467) 8,761
Retained earnings................................................. 52,427 43,765
---------- ----------
Total stockholders' equity................................ 339,089 343,878
---------- ----------
Total liabilities and stockholders' equity................ $3,089,993 $2,943,949
========== ==========
The accompanying notes are an integral part of these statements.
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54
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
----------------------------------
1994 1993 1992
-------- -------- --------
Operating revenues:
Gas operating revenues................................... $599,553 $539,105 $534,390
Financial services interest income....................... 118,434 132,325 165,678
Other.................................................... 10,182 18,411 18,415
-------- -------- --------
Total (Notes 15 and 16).......................... 728,169 689,841 718,483
-------- -------- --------
Operating expenses:
Net cost of gas purchased................................ 249,922 212,290 214,293
Financial services interest expense, net................. 59,790 75,076 111,917
Operating expense (Note 13).............................. 169,893 165,150 155,654
Maintenance expense...................................... 30,198 28,337 26,842
Provision for estimated credit losses (Note 5)........... 7,393 7,222 32,438
Depreciation, depletion and amortization (Note 15)....... 65,063 63,583 60,668
Taxes other than income taxes............................ 25,751 24,760 22,940
Other.................................................... 17,405 25,845 17,883
-------- -------- --------
Total............................................ 625,415 602,263 642,635
-------- -------- --------
Operating income (Notes 15 and 16)......................... 102,754 87,578 75,848
-------- -------- --------
Other income and (expenses):
Other income............................................. 1,823 1,549 5,336
Interest and amortization of debt discount and expense... (57,335) (49,706) (43,115)
Other expenses........................................... (3,219) (15,801) (5,935)
-------- -------- --------
Total............................................ (58,731) (63,958) (43,714)
-------- -------- --------
Income before income taxes................................. 44,023 23,620 32,134
Income taxes (Note 14)..................................... 17,722 11,259 14,473
-------- -------- --------
Net income before cumulative effect of accounting change... 26,301 12,361 17,661
Cumulative effect of change in method of accounting (Note
14)...................................................... -- 3,045 --
-------- -------- --------
Net income (Note 16)....................................... 26,301 15,406 17,661
Preferred/preference stock dividend requirements (Note
12)...................................................... 510 741 1,051
-------- -------- --------
Net income applicable to common stock (Note 16)............ $ 25,791 $ 14,665 $ 16,610
======== ======== ========
Earnings per share before cumulative effect of accounting
change................................................... $ 1.22 $ 0.56 $ 0.81
Earnings per share from cumulative effect of change in
method of accounting..................................... -- 0.15 --
-------- -------- --------
Earnings per share of common stock (Note 16)............... $ 1.22 $ 0.71 $ 0.81
======== ======== ========
Average number of common shares outstanding................ 21,078 20,729 20,598
======== ======== ========
The accompanying notes are an integral part of these statements.
51
55
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
YEAR ENDED DECEMBER 31,
-------------------------------------
1994 1993 1992
--------- ----------- -----------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income............................................. $ 26,301 $ 15,406 $ 17,661
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation, depletion and amortization.......... 65,063 63,583 60,668
Provision for estimated losses.................... 7,393 7,222 32,438
Deferred income taxes............................. (8,212) 27,201 (16,256)
Unrecovered purchased gas costs................... 9,014 (33,571) 24,353
Net gain on sales of loans........................ (1,936) (1,751) (6,563)
Net gain on sales of debt securities.............. (34) (7,973) (13,278)
Loss on sale of Arizona assets and services....... -- 6,262 --
Cumulative effect of change in method of
accounting for income taxes.................... -- (3,045) --
Other............................................. 15,344 16,157 (12,582)
--------- ----------- -----------
Net cash provided by operating activities...... 112,933 89,491 86,441
--------- ----------- -----------
CASH FLOW FROM INVESTING ACTIVITIES:
Construction expenditures.............................. (144,642) (115,424) (105,595)
Loan originations, net of repayments................... (155,024) (186,609) (190,511)
Sales of loans and loan servicing rights............... 46,090 78,353 240,605
Purchases of debt securities........................... (296,349) (113,078) (545,706)
Proceeds from sales of debt securities................. 5,074 360,853 274,802
Proceeds from maturities and repayments of debt
securities.......................................... 291,747 293,788 348,603
Proceeds from sale of real estate held for sale or
development......................................... 4,294 1,926 11,003
Proceeds from sale of real estate acquired through
foreclosure......................................... 4,048 22,916 18,030
Additions to real estate held for development.......... (1,140) (3,211) (4,246)
Termination of interest rate swaps..................... -- -- (14,087)
Proceeds from sale of Arizona assets and services...... -- 6,718 --
Other.................................................. 232 (2,409) 3,147
--------- ----------- -----------
Net cash provided by (used in) investing
activities................................... (245,670) 343,823 36,045
--------- ----------- -----------
CASH FLOW FROM FINANCING ACTIVITIES:
Issuance of common stock............................... 4,773 6,790 --
Reacquisition of preferred stock....................... (4,058) (7,258) (7,258)
Dividends paid......................................... (17,411) (16,139) (15,497)
Issuance of long-term debt............................. 104,900 86,909 211,943
Retirement of long-term debt........................... (6,967) (48,567) (231,750)
Issuance (repayment) of short-term debt................ 6,000 66,000 (60,000)
Net change in deposit accounts......................... 32,097 (92,815) (111,446)
Sale and assumption of Arizona deposit liabilities..... -- (320,902) --
Proceeds from repos/other borrowings................... 281,333 1,499,893 1,448,546
Repayment of repos/other borrowings.................... (258,439) (1,617,711) (1,336,220)
Other.................................................. (835) (813) (878)
--------- ----------- -----------
Net cash provided by (used in) financing
activities................................... 141,393 (444,613) (102,560)
--------- ----------- -----------
Net change in cash and cash equivalents........ 8,656 (11,299) 19,926
Cash and cash equivalents at beginning of period....... 121,342 132,641 112,715
--------- ----------- -----------
Cash and cash equivalents at end of period............. $ 129,998 $ 121,342 $ 132,641
========= =========== ===========
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest, net of amounts capitalized................ $ 69,688 $ 66,885 $ 73,513
Income taxes, net of refunds........................ 2,132 10,982 13,293
The accompanying notes are an integral part of these statements.
52
56
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
COMMON STOCK ADDITIONAL CAPITAL
---------------- PAID-IN STOCK UNREALIZED RETAINED
SHARES AMOUNT CAPITAL EXPENSE GAIN (LOSS) EARNINGS TOTAL
------ ------- ---------- ------- ----------- -------- --------
DECEMBER 31, 1991........... 20,598 $22,228 $267,917 $(5,685) $ -- $ 42,689 $327,149
Common stock issuances...... 64 64
Net income.................. 17,661 17,661
Dividends declared
Preferred: $9.50 per
share.................. (589) (589)
Second preference: $3.00
per share.............. (422) (422)
Common: $0.70 per share... (14,419) (14,419)
------ ------- -------- ------- -------- -------- --------
DECEMBER 31, 1992........... 20,598 22,228 267,981 (5,685) -- 44,920 329,444
Common stock issuances...... 399 399 6,429 6,828
Net income.................. 15,406 15,406
Dividends declared
Preferred: $9.50 per
share.................. (513) (513)
Second preference: $3.00
per share.............. (228) (228)
Common: $0.76 per share... (15,820) (15,820)
Unrealized gain............. 8,761 8,761
------ ------- -------- ------- -------- -------- --------
DECEMBER 31, 1993........... 20,997 22,627 274,410 (5,685) 8,761 43,765 343,878
Common stock issuances...... 285 285 4,488 4,773
Net income.................. 26,301 26,301
Dividends declared
Preferred: $9.50 per
share.................. (437) (437)
Second preference: $3.00
per share.............. (73) (73)
Common: $0.81 per share... (17,125) (17,125)
Unrealized loss............. (18,228) (18,228)
Redemption of second
preference stock.......... 4 (4) --
------ ------- -------- ------- -------- -------- --------
DECEMBER 31, 1994........... 21,282 $22,912 $278,898 $(5,681) $ (9,467) $ 52,427 $339,089
====== ======= ======== ======= ========= ======== ========
The accompanying notes are an integral part of these statements.
53
57
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General
Basis of Presentation -- The Company follows generally accepted accounting
principles (GAAP) in all of its businesses. Accounting for the Company's gas
utility operations conforms with GAAP as applied to regulated companies and as
prescribed by federal agencies and the commissions of the various states in
which the utility operates.
Consolidation -- The accompanying financial statements are presented on a
consolidated basis and include the accounts of the Company, including the Bank.
Intercompany balances and transactions have been eliminated.
Cash Flows -- For purposes of reporting consolidated cash flows, cash and
cash equivalents include cash on hand, amounts due from banks, federal funds
sold and other financial instruments with a maturity of three months or less.
Excess of Cost Over Net Assets Acquired -- The Company amortizes excess of
cost over net assets acquired on a straight-line basis over 25 years.
Income Taxes -- Effective January 1993, the Company adopted SFAS No. 109,
"Accounting for Income Taxes," which required a change from the deferred method
of accounting for income taxes to the asset and liability method of accounting
for income taxes. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and
liabilities of a change in tax rates is recognized in the period that includes
the enactment date.
For years prior to 1993, deferred income taxes were recognized for income
and expense items that were reported in different years for financial reporting
purposes and income tax purposes using the tax rate applicable for the year of
the calculation. Under the deferred method, deferred taxes were not adjusted for
subsequent changes in tax rates.
Investment tax credits (ITC) related to gas utility operations are deferred
and amortized over the life of related fixed assets.
Earnings Per Common Share -- Earnings per common share are calculated based
on the weighted average number of shares outstanding during the period.
Reclassifications -- Certain reclassifications have been made to prior
years' amounts to conform to the current year presentation.
Gas Utility
Gas Utility Property, Net -- Gas utility property, net includes gas plant
at original cost, less the accumulated provision for depreciation and
amortization, plus the unamortized balance of acquisition adjustments. Original
cost includes contracted services, material, payroll and related costs such as
taxes and benefits, general and administrative expenses, and an allowance for
funds used during construction less contributions in aid of construction.
Depreciation and Amortization -- Depreciation is computed on the
straight-line remaining life method at composite rates considered sufficient to
amortize costs over estimated service lives. Acquisition adjustments are
amortized as ordered by regulatory bodies at the date of acquisition, which
periods approximate the
54
58
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
remaining estimated life of the acquired properties. Costs related to refunding
utility debt and debt issuance expenses are deferred and amortized over the
weighted average lives of the new issues.
Deferred Gas Costs -- The Company is authorized by the various regulatory
authorities having jurisdiction to adjust its billing rates for changes in the
cost of gas purchased. The difference between the current cost of gas purchased
and the cost of gas recovered in billed rates is deferred. Generally, these
deferred amounts are recovered or refunded within one year.
Utility Revenues -- Gas revenues are accrued from the date the customer was
last billed to the end of the accounting period. In California, through 1994,
the Company was authorized to adjust gas revenues to reflect changes in
operating margins from authorized levels related to all customer classes. This
mechanism was discontinued effective January 1995.
Capitalization of Interest -- The Company capitalized $653,000, $381,000
and $934,000 of interest expense and a portion of the cost of equity funds
related to natural gas utility operations for each of the years ended December
31, 1994, 1993 and 1992. The cost of equity funds used to finance the
construction of utility plant is reported net within the consolidated statements
of income as a reduction of interest charges. Utility plant construction costs,
including cost of equity funds, are recovered in authorized rates through
depreciation when completed projects are placed into operation.
Financial Services
Debt Securities -- On December 31, 1993, the Bank adopted SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." The
statement requires classification of investments in debt and equity securities
into one of three categories: held to maturity, available for sale, or trading.
At the time of purchase, the Bank designates a security into one of these three
categories.
Debt securities classified as held to maturity are those which the Bank has
the positive intent and ability to hold to maturity. These securities are
carried at cost adjusted for the amortization of the related premiums or
accretion of the related discounts into interest income using methods
approximating the level-yield method or a method based on principal repayments
over the actual lives of the underlying loans. The Bank has the ability and it
is its policy to hold the debt securities so designated until maturity. The
Bank's current accounting policy is that no security with a remaining maturity
greater than 25 years may be designated as held to maturity.
Securities classified as available for sale are those which the Bank
intends to hold for an indefinite period and which may be sold in response to
changes in market interest rates, changes in the security's prepayment risk, the
Bank's need for liquidity, changes in the availability and yield of alternative
investments, and other asset/liability management needs. Securities classified
as available for sale are stated at fair value in the Consolidated Statements of
Financial Position. Changes in fair value are reported net of tax as a separate
component of stockholders' equity, but are not included in net income. Realized
gains or losses are recorded into income when sold.
Trading securities are those which are bought and held principally for the
purpose of selling in the near term. Trading securities include MBS held for
sale in conjunction with mortgage banking activities. Trading securities are
measured at fair value with changes in fair value included in earnings. At
December 31, 1994 and 1993, no securities were designated as "trading
securities."
Loans Receivable -- Real estate loans are recorded at cost, net of the
undisbursed loan funds, loan discounts, unearned interest, deferred loan fees
and provisions for estimated losses. Interest on loans receivable is credited to
income when earned. Generally, if a loan becomes 90 days contractually
delinquent, the accrual
55
59
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
of interest is ceased and all previously accrued, but uncollected, interest
income is reversed. Interest income on loans placed on nonaccrual status is
generally recognized on a cash basis.
Fees are charged for originating and in some cases, for committing to
originate loans. Loan origination and commitment fees, offset by certain direct
origination costs, are deferred, and the net amounts amortized as an adjustment
of the related loans' yields over the contractual lives thereof. Unamortized
fees are recognized as income upon the sale or payoff of the loan.
Unearned interest, premiums and discounts on consumer installment, equity
and property improvement loans are amortized to income over the expected lives
of the loans using a method which approximates the level-yield method.
Mortgage Banking Activities -- The Bank's accounting policy is to designate
all fixed-rate interest-sensitive assets with maturities greater than or equal
to 25 years (which possess normal qualifying characteristics required for sale)
as held for sale or available for sale, along with single-family residential
loans originated for specific sales commitments. Fixed-rate interest-sensitive
assets with maturities less than 25 years, and all adjustable-rate
interest-sensitive assets continue to be held for investment unless designated
as held for sale at time of origination.
Loans held for sale are carried at the lower of amortized cost or fair
value as determined by outstanding investor commitments or, in the absence of
such commitments, current investor yield requirements calculated on an aggregate
basis. Valuation adjustments are charged against gain (loss) on sale of loans.
Gains and losses on loan and MBS sales are determined using the specific
identification method. Gains and losses are recognized to the extent that sales
proceeds exceed or are less than the carrying value of the loans and MBS. Loans
sold with servicing retained include a normal servicing fee to be earned by the
Bank as income over the life of the loan. Loans held for sale may be securitized
into MBS and designated as trading securities and recorded at fair value.
Real Estate Acquired Through Foreclosure -- Real estate acquired through
foreclosure is stated at the lower of cost or fair value less cost to sell.
Included in real estate acquired through foreclosure is $2.9 million and $5.5
million of loans foreclosed in-substance at December 31, 1994 and 1993,
respectively. Write downs to fair value, disposition gains and losses, and
operating income and costs are charged to the allowance for estimated credit
losses.
Loans foreclosed in-substance consist of loans accounted for as foreclosed
property even though actual foreclosure has not occurred. Although the
collateral underlying these loans has not been repossessed, the borrower has
little or no equity in the collateral at its current estimated fair value.
Proceeds for repayment are expected to come only from the operation or sale of
the collateral, and it is doubtful the borrower will rebuild equity in the
collateral or repay the loan by other means in the foreseeable future. The
amounts ultimately recovered from loans foreclosed in-substance could differ
from the amounts used in arriving at the net carrying value of the assets
because of future market factors beyond management's control or changes in
strategy for recovering the investment.
Allowance for Estimated Credit Losses -- On a routine basis, management
evaluates the adequacy of the allowances for estimated losses on loans,
investments and real estate, and establishes additions to the allowances through
provisions to expense. The Bank utilizes a comprehensive internal asset review
system and general valuation allowance methodology. General valuation allowances
are established for each of the loan, investment and real estate portfolios for
unforeseen losses. A number of factors are taken into account in determining the
adequacy of the level of allowances including management's review of the extent
of existing risks in the portfolios, prevailing and anticipated economic
conditions, actual loss experience, delinquencies, regular reviews of the
quality of the loan and real estate portfolios and examinations by regulatory
authorities.
56
60
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Charge-offs are recorded on particular assets when it is determined that
the fair or net realizable value of an asset is below the carrying value. When a
loan is foreclosed, the asset is written down to fair value based on a current
appraisal of the subject property.
While management uses currently available information to evaluate the
adequacy of allowances and estimate identified losses for charge off, ultimate
losses may vary from current estimates. Adjustments to estimates are charged to
earnings in the period in which they become known.
Interest Rate Exchange Agreements -- The Bank uses interest rate swaps and
interest rate collars to hedge its exposure to interest rate risk. These
instruments are used only to hedge asset and liability portfolios and are not
used for speculative purposes. Premiums, discounts and fees associated with
these interest rate exchange agreements are amortized to expense on a
straight-line basis over the lives of the agreements. The net interest received
or paid is included in interest expense as a cost of hedging. Gains or losses
resulting from the cancellation of agreements hedging assets and liabilities
which remain outstanding are deferred and amortized over the remaining contract
lives. Gains or losses are recognized in the current period if the hedged asset
or liability is retired.
57
61
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA
Summarized consolidated financial statement data for the Bank is as
follows. Certain reclassifications have been made to conform presentations for
prior years with the current year's presentation:
CONSOLIDATED STATEMENTS OF INCOME
(THOUSANDS OF DOLLARS)
YEAR ENDED DECEMBER 31,
----------------------------------
1994 1993 1992
-------- -------- --------
Interest income.................................... $118,434 $132,325 $165,678
Interest expense................................... 59,790 75,076 111,917
-------- -------- --------
Net interest income...................... 58,644 57,249 53,761
Provision for estimated credit losses.............. (7,230) (6,212) (14,129)
-------- -------- --------
Net interest income after provision for
credit losses.......................... 51,414 51,037 39,632
-------- -------- --------
Net loss from real estate operations............... (612) (910) (15,286)
-------- -------- --------
Gain on sale of loans.............................. 598 1,835 5,676
Loss on sale of loans.............................. (351) (84) (1,043)
Gain on sale of debt securities.................... 56 8,317 13,649
Loss on sale of debt securities.................... (22) (344) (371)
Gain (loss) on secondary marketing hedging
activities....................................... 389 (968) --
Gain on sale of mortgage loan servicing............ -- -- 1,930
Loss on cancellation of interest rate swaps........ -- -- (14,087)
Loss on sale -- Arizona branches................... -- (6,262) --
Gain on sale of credit cards....................... 1,689 -- --
Loan related fees.................................. 1,165 1,025 2,280
Deposit related fees............................... 6,788 6,397 5,413
Other income....................................... 319 2,133 1,945
-------- -------- --------
Total noninterest income................. 10,631 12,049 15,392
-------- -------- --------
General and administrative expenses................ 43,508 48,296 45,309
Amortization of cost in excess of net assets
acquired......................................... 3,861 3,984 4,156
-------- -------- --------
Total noninterest expense................ 47,369 52,280 49,465
-------- -------- --------
Income (loss) before income taxes.................. 14,064 9,896 (9,727)
Income tax expense................................. 6,391 6,345 91
-------- -------- --------
Net income (loss) before cumulative effect of
accounting change................................ 7,673 3,551 (9,818)
Cumulative effect of change in method of
accounting....................................... -- 3,045 --
-------- -------- --------
Net income (loss)........................ $ 7,673 $ 6,596 $ (9,818)
======== ======== ========
Contribution to consolidated net
income(1).............................. $ 2,777 $ 1,655 $(14,553)
======== ======== ========
- ---------------
(1) Includes after-tax allocation of costs from parent.
58
62
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(THOUSANDS OF DOLLARS)
DECEMBER 31,
-------------------------------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
1994 1994 1993 1993
---------- ---------- ---------- ----------
ASSETS
Cash and due from banks................. $ 35,262 $ 35,262 $ 55,712 $ 55,712
Cash equivalents........................ 88,660 88,660 63,503 63,503
Debt securities available for sale...... 529,400 529,400 595,726 595,726
Debt securities held to maturity........ 101,880 99,403 69,660 68,738
Loans receivable held for sale.......... 2,114 2,135 20,051 22,305
Loans receivable, net of allowance for
estimated credit losses of $17,659 and
$16,251............................... 936,037 897,723 817,279 841,127
Real estate acquired through
foreclosure........................... 7,631 * 9,707 *
Real estate held for sale or
development, net of allowance for
estimated losses of $476 and $935..... 771 * 4,088 *
FHLB stock, at cost..................... 17,277 17,277 16,501 16,501
Other assets............................ 31,649 * 29,691 *
Excess of cost over net assets
acquired.............................. 65,640 * 69,501 *
---------- ----------
$1,816,321 $1,751,419
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
Deposits................................ $1,239,949 $1,229,893 $1,207,852 $1,217,225
Securities sold under agreements to
repurchase............................ 281,935 282,155 259,041 261,625
Advances from FHLB...................... 99,400 97,565 71,000 71,281
Notes payable........................... 8,135 8,174 8,265 8,647
Other liabilities....................... 20,514 * 28,318 *
---------- ----------
1,649,933 1,574,476
Stockholder's equity.................... 166,388 * 176,943 *
---------- ----------
$1,816,321 $1,751,419
========== ==========
- ---------------
* These items are not comprised of financial instruments subject to fair value
disclosure under SFAS No. 107. See SFAS No. 107 discussion herein.
59
63
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)
DECEMBER 31,
--------------------------------------------
1994 1993
-------------------- --------------------
FAIR FAIR
COMMITMENT VALUE COMMITMENT VALUE
---------- ------ ---------- ------
(THOUSANDS OF DOLLARS)
OFF-BALANCE SHEET ITEMS
Outstanding commitments to originate
loans..................................... $ 46,387 $ (420) $ 47,903 $ 53
Commercial and other letters of credit...... 707 6 1,169 12
Interest rate swaps......................... 72,450 2,986 7,500 169
Loan servicing rights....................... 415,097 4,958 476,835 4,451
Outstanding firm commitments to sell loans
and MBS................................... 2,544 (2) 25,905 21
Outstanding master commitments to sell
loans..................................... 116,097 (14) 217,393 (11)
Outstanding commitments to purchase loans
and MBS................................... -- -- 51,500 3
Outstanding commitments to builders......... 10,543 (33) -- --
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires that the Bank disclose estimated fair values for its financial
instruments.
The fair value estimates were made at a discrete point in time based on
relevant market information and other information about the financial
instruments. Because no active market exists for a significant portion of the
Bank's financial instruments, fair value estimates were based on judgements
regarding current economic conditions, risk characteristics of various financial
instruments, prepayment assumptions, future expected loss experience and other
factors. These estimates are subjective in nature and involve uncertainties and
matters of significant judgement and therefore cannot be determined with
precision. Changes in assumptions could significantly affect the estimates.
In addition, the fair value estimates were based on existing on-balance
sheet and off-balance sheet financial instruments without attempting to estimate
the value of existing and anticipated future customer relationships and the
value of assets and liabilities that were not considered financial instruments.
Significant assets and liabilities that were not considered financial assets or
liabilities include the Bank's retail branch network, deferred tax assets and
liabilities, furniture, fixtures and equipment, and goodwill.
Additionally, the Bank intends to hold a significant portion of its assets
and liabilities to their stated maturities. Therefore, the Bank does not intend
to realize any significant differences between carrying value and fair value
through sale or other disposition. No attempt should be made to adjust equity to
reflect the fair value disclosures.
60
64
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)
Methods and assumptions used to determine estimated fair values are set
forth below for the Bank's financial instruments as of December 31, 1994 and
1993.
ASSETS METHODS AND ASSUMPTIONS USED TO ESTIMATE FAIR VALUE
- ----------------------------------- --------------------------------------------------------
Cash, due from banks and cash Carrying value was used as the estimate of fair value
equivalents based upon the short-term nature of the instruments.
Debt securities available for sale, Fair value was estimated using quoted market prices and
debt securities held to maturity dealer quotes, with the exception of privately issued
and loans receivable held for debt securities and CMO residuals. Privately issued debt
sale securities were valued based on the estimated fair value
of the underlying loans. CMO residuals were valued using
the discounted estimated future cash flows from these
investments.
Loans receivable, net Fair values were estimated for portfolios of loans with
similar financial characteristics. Loans were segregated
by type, such as commercial, commercial real estate,
residential mortgage, credit card and other consumer.
Each loan category was further segregated into fixed and
adjustable-rate interest terms. Fair value for
single-family residential loans was estimated by
discounting the estimated future cash flows from these
instruments using quoted market rates and dealer
prepayment assumptions. Fair value for commercial
mortgage, construction, land and other commercial loans
was derived by discounting the estimated future cash
flows from these instruments using the rates at which
loans with similar maturity and underwriting
characteristics would be made on December 31, 1994 or
1993, as applicable. Fair value for consumer loans was
estimated using dealer quotes for securities backed by
similar collateral. The book value for the allowance for
estimated credit losses was used as the fair value
estimate for credit losses within the entire loan
portfolio.
FHLB stock Carrying value was used as the estimate for fair value
since it represents the price at which the FHLB will
redeem the stock.
LIABILITIES
- -----------------------------------
Deposits The fair value of demand deposits, savings deposits and
money market deposits was estimated to be the book value
reported in the financial statements since it represents
the amount payable on demand. The fair value of fixed
maturity deposits was estimated using the rates
currently offered by the Bank for deposits with similar
remaining maturities. The fair value of deposits does
not include an estimate of the long-term relationship
value of the Bank's deposit customers or the benefit
that results from the low cost funding provided by
deposit liabilities compared to the cost of borrowing
funds in the market.
Securities sold under agreements to Fair value was estimated by discounting the future cash
repurchase and notes payable flows using market and dealer quoted rates for debt with
the same remaining maturities and characteristics.
Advances from FHLB Fair value was estimated using the quoted cost to prepay
the advance.
61
65
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)
OFF-BALANCE SHEET ITEMS METHODS AND ASSUMPTIONS USED TO ESTIMATE FAIR VALUE
- ----------------------------------- --------------------------------------------------------
Commitments to originate loans and The fair value of commitments was estimated by
builder commitments calculating a theoretical gain or loss on the sale of a
funded loan considering the difference between current
levels of interest rates and the committed loan rates.
Letters of credit The fair value of letters of credit was based on fees
currently charged for similar agreements.
Interest rate swaps The fair value of interest rate swaps was determined by
various dealer quotes.
Loan servicing rights The fair value for loan servicing rights was estimated
based upon market and dealer quotes for the incremental
price paid for a loan sold servicing released, adjusted
for the age of the portfolio.
Outstanding firm and master The fair value of these commitments are estimated based
commitments to purchase and sell on the market and dealer quotes to terminate or fill the
loans and MBS commitments.
REGULATORY CAPITAL
The Bank is subject to various capital adequacy requirements under a
uniform framework by federal banking agencies. Specific capital guidelines
require the Bank to maintain minimum amounts and ratios as set forth below.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
required the federal banking agencies to adopt regulations implementing a system
of progressive constraints as capital levels decline at banks and savings
institutions. Federal banking agencies have enacted uniform "prompt corrective
action" rules which classify banks and savings institutions into one of five
categories based upon capital adequacy, ranging from "well capitalized" to
"critically undercapitalized." Banks become subject to prompt corrective action
when their ratios fall below "adequately capitalized" status. A reconciliation
of stockholder's equity, as shown in the accompanying Consolidated Statements of
Financial Position, to the FDICIA capital standards and the Bank's resulting
ratios are set forth in the table below (thousands of dollars):
DECEMBER 31, 1994 DECEMBER 31, 1993
------------------------------------ ------------------------------------
TOTAL TIER 1 TIER 1 TOTAL TIER 1 TIER 1
RISK-BASED RISK-BASED LEVERAGE RISK-BASED RISK-BASED LEVERAGE
---------- ---------- ---------- ---------- ---------- ----------
Stockholder's equity....................... $166,388 $166,388 $ 166,388 $176,943 $176,943 $ 176,943
Capital adjustments:
Nonsupervisory goodwill.................. (40,376) (40,376) (40,376) (42,464) (42,464) (42,464)
Supervisory goodwill..................... (18,661) (18,661) (18,661) (14,422) (14,422) (14,422)
Real estate investments.................. (1,325) (194) (194) (478) -- --
Unrealized loss, net of tax, on debt
securities available for sale.......... 9,467 9,467 9,467 -- -- --
General loan loss reserves............... 11,512 -- -- 11,008 -- --
-------- -------- ---------- -------- -------- ----------
Regulatory capital......................... $127,005 $116,624 $ 116,624 $130,587 $120,057 $ 120,057
======== ======== ========== ======== ======== ==========
Regulatory capital ratio................... 13.88% 12.75% 6.62% 14.92% 13.71% 7.14%
Adequately capitalized required ratio...... 8.00 4.00 4.00 8.00 4.00 4.00
-------- -------- ---------- -------- -------- ----------
Excess..................................... 5.88% 8.75% 2.62% 6.92% 9.71% 3.14%
======== ======== ========== ======== ======== ==========
Asset base................................. $914,812 $914,812 $1,760,801 $875,387 $875,387 $1,681,952
======== ======== ========== ======== ======== ==========
As of December 31, 1994 and 1993, PriMerit Bank exceeded the adequately
capitalized ratios and was categorized as "well capitalized."
62
66
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)
The regulatory capital standards contain certain phase-in requirements
concerning the amount of supervisory goodwill which is includable in tier 1 and
risk-based capital as well as the amount of real estate investments which are
required to be deducted from capital under all three standards. On January 1,
1995, all supervisory goodwill must be deducted from regulatory capital. Based
upon this limitation, the Bank's risk-based and tier 1 capital levels declined
by $6.6 million on January 1, 1995.
The decline in the Bank's capital ratios over prior year-end is principally
the result of the change in the allowable supervisory goodwill and the inclusion
of $8.8 million of unrealized gain, net of tax, on debt securities available for
sale in regulatory capital for 1993; partially offset by year-to-date net income
of $7.7 million. At December 31, 1994, under fully phased-in capital rules
applicable at July 1, 1996, the Bank would have exceeded the "adequately
capitalized" fully phased-in, total risk-based, tier 1 risk-based, and tier 1
leverage ratios by $46.7 million, $72.8 million and $38.7 million, respectively.
The Bank is subject to an OTS regulation requiring institutions with IRR
exposure classified as "above normal" to reduce their risk-based capital by 50
percent of the amount by which the IRR exposure exceeds a specified "normal"
threshold. The normal IRR threshold is defined as a two percent decline of an
institution's net portfolio value as a percentage of its market value of assets
after a hypothetical 200 basis point immediate and sustained increase or
decrease in market interest rates. The reduction of an institution's risk-based
capital resulting from its exceeding the IRR threshold becomes effective at the
end of the third calendar quarter after the measurement date, unless the
institution's IRR exposure returns to a "normal" level or below in the interim.
Based on the OTS's measurement of the Bank's September 30, 1994 and
December 31, 1994 IRR, the Bank may be required to reduce its risk-based capital
by approximately $1.5 million on June 30, 1995 and $1.9 million on September 30,
1995, in the absence of corrective action to reduce the Bank's IRR exposure or a
significant change in market interest rates in the interim. As of December 31,
1994, the Bank has sufficient risk-based capital to allow it to continue to be
classified as "well capitalized" under FDICIA capital requirements after such a
reduction for IRR exposure. Management is currently reviewing possible
strategies for reducing the Bank's IRR exposure to a "normal" level or below.
OTHER REGULATORY MATTERS
In conjunction with the acquisition of the Bank in 1986, the Company agreed
that as long as it controls the Bank, adequate capital as required by applicable
regulations, will be maintained at the Bank and if required, the Company will
infuse additional capital into the Bank to assure compliance with such
requirements. The Company presently does not anticipate having to contribute
additional capital to the Bank.
The Company also stipulated in connection with the acquisition of the Bank
that dividends paid by the Bank to the Company would not exceed 50 percent of
the Bank's cumulative net income after the date of acquisition without approval
of the regulators. Since the acquisition, the Bank's cumulative net income is
$37.1 million, resulting in maximum dividends payable of $18.6 million as of
December 31, 1994. Since the acquisition, the Bank has paid the Company $1.8
million in capital distributions, net of $20 million in capital contributions
received from the Company in 1991 and 1992.
Capital distributions, including dividends, are also governed by an OTS
regulation which limits distributions by applying a tiered system based on
capital levels. Under the regulation, the Bank is restricted to paying no more
than 75 percent of its net income over the preceding four quarters to the
Company. The Bank did not pay any dividends to the Company during the last three
years.
63
67
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)
SALE OF ARIZONA BRANCH OPERATIONS
In May 1993, the Bank signed a Definitive Agreement with World Savings and
Loan Association (World) of Oakland, California, whereby World agreed to acquire
the Bank's Arizona branch operations, including all related deposit liabilities
of approximately $321 million. The transaction was approved by the appropriate
regulatory authorities and closed in August 1993. During 1993, the Bank recorded
a $6.3 million loss, which included a write-off of $5.9 million in goodwill
(excess of cost over net assets acquired) and $367,000 of other related net
costs. The Bank sold $334 million of MBS to effect the sale of the Bank's
Arizona-based deposit liabilities to World and to maintain the Bank's interest
rate risk position. The sale of the securities resulted in a gain of $7.4
million ($4.9 million after tax) included in gain on sale of debt securities in
the Consolidated Statements of Income. The final disposition resulted in an
after-tax loss of approximately $1 million.
NOTE 3 -- DEBT SECURITIES
Debt securities held to maturity are stated at amortized cost. The yields
on these securities are computed based upon amortized cost. The amortized cost,
estimated fair values and yields of debt securities held to maturity are as
follows (thousands of dollars):
TOTAL TOTAL ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 1994 COST GAINS LOSSES VALUE YIELD
----------------- --------- ---------- ---------- --------- -----
Corporate issue MBS...................... $ 60,922 $50 $2,292 $58,680 7.25%
U.S. Treasury securities and
obligations of U.S. Government
corporations and agencies.............. 40,958 -- 235 40,723 8.01%
-------- --- ------ ------- ----
Total.......................... $101,880 $50 $2,527 $99,403 7.55%
======== === ====== ======= ====
DECEMBER 31, 1993
-----------------
Corporate issue MBS...................... $69,660 $403 $1,325 $68,738 6.85%
======= ==== ====== ======= ====
The following schedule of the expected maturity of debt securities held to
maturity is based upon dealer prepayment expectations and historical prepayment
activity (thousands of dollars):
EXPECTED/CONTRACTUAL MATURITY
----------------------------------------------------------------
AFTER AFTER AFTER
ONE YEAR FIVE YEARS TEN YEARS
BUT BUT BUT
WITHIN WITHIN WITHIN WITHIN AFTER TOTAL
ONE FIVE TEN TWENTY TWENTY AMORTIZED
DECEMBER 31, 1994 YEAR YEARS YEARS YEARS YEARS COST
----------------- ------- -------- ---------- --------- ------ ---------
Corporate issue MBS............. $15,593 $31,603 $8,883 $4,574 $269 $ 60,922
U.S. Treasury securities and
obligations of U.S. Government
corporations and agencies..... 20,822 20,136 -- -- -- 40,958
------- ------- ------ ------ ---- --------
Total................. $36,415 $51,739 $8,883 $4,574 $269 $101,880
======= ======= ====== ====== ==== ========
64
68
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 -- DEBT SECURITIES -- (CONTINUED)
Debt securities available for sale are stated at fair value. The yields on
these securities are computed based upon amortized cost. The amortized cost,
estimated fair values and yields of debt securities available for sale are as
follows (thousands of dollars):
TOTAL TOTAL ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 1994 COST GAINS LOSSES VALUE YIELD
----------------- --------- ---------- ---------- --------- -----
GNMA - MBS...................... $ 6,564 $ 70 $ 237 $ 6,397 8.29%
FHLMC - MBS..................... 307,082 745 6,931 300,896 6.64%
FNMA - MBS...................... 112,892 154 3,938 109,108 7.11%
CMO............................. 92,097 928 4,645 88,380 5.92%
Corporate issue MBS............. 20,225 11 719 19,517 7.24%
U.S. Treasury securities and
obligations of U.S. Government
corporations and agencies..... 5,105 -- 3 5,102 5.83%
-------- ------- ------- -------- ----
Total................. $543,965 $ 1,908 $16,473 $529,400 6.65%
======== ======= ======= ======== ====
DECEMBER 31, 1993
-----------------
GNMA - MBS...................... $ 9,081 $ 591 $ -- $ 9,672 8.41%
FHLMC - MBS..................... 368,436 11,518 168 379,786 6.12%
FNMA - MBS...................... 119,208 1,144 695 119,657 6.60%
CMO............................. 45,733 1,516 -- 47,249 4.82%
Corporate issue MBS............. 24,644 159 697 24,106 5.81%
Money market instruments........ 10,036 -- -- 10,036 3.37%
U.S. Treasury securities and
obligations of U.S. Government
corporations and agencies..... 5,110 110 -- 5,220 5.93%
-------- -------- ------ -------- ----
Total................. $582,248 $15,038 $1,560 $595,726 6.09%
======== ======= ====== ======== ====
The following schedule reflects the expected maturity of MBS and CMO and
the contractual maturity of all other debt securities available for sale. The
expected maturity of MBS and CMO are based upon dealer prepayment expectations
and historical prepayment activity (thousands of dollars):
EXPECTED/CONTRACTUAL MATURITY
------------------------------------------------------------------
AFTER AFTER AFTER
ONE YEAR FIVE YEARS TEN YEARS
BUT BUT BUT
WITHIN WITHIN WITHIN WITHIN AFTER TOTAL
ONE FIVE TEN TWENTY TWENTY AMORTIZED
DECEMBER 31, 1994 YEAR YEARS YEARS YEARS YEARS COST
----------------- -------- -------- ---------- --------- ------- ---------
GNMA - MBS.................. $ 1,595 $ 4,091 $ 711 $ -- $ -- $ 6,397
FHLMC - MBS................. 57,237 167,998 37,894 29,991 7,776 300,896
FNMA - MBS.................. 15,879 49,915 20,241 20,030 3,043 109,108
CMO......................... 48,692 38,236 819 606 27 88,380
Corporate issue MBS......... 3,295 11,283 4,056 778 105 19,517
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies.............. 5,102 -- -- -- -- 5,102
-------- -------- ------- ------- ------- --------
Total............. $131,800 $271,523 $63,721 $51,405 $10,951 $529,400
======== ======== ======= ======= ======= ========
65
69
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 -- LOANS RECEIVABLE
Loans receivable held for investment, recorded at amortized cost, are
summarized as follows (thousands of dollars):
DECEMBER 31,
---------------------
1994 1993
-------- --------
Loans collateralized by real estate:
Conventional single-family residential....................... $489,649 $431,854
FHA and VA insured single-family residential................. 33,823 21,491
Commercial mortgage.......................................... 178,076 192,046
Construction and land........................................ 90,992 82,638
-------- --------
792,540 728,029
Commercial secured (other than real estate).................... 40,349 25,443
Commercial unsecured........................................... 2,317 354
Consumer installment........................................... 119,460 93,431
Consumer unsecured............................................. 6,570 7,817
Equity and property improvement loans.......................... 26,054 21,061
Deposit accounts............................................... 2,659 2,944
-------- --------
989,949 879,079
-------- --------
Undisbursed proceeds........................................... (41,702) (48,251)
Allowance for estimated credit losses.......................... (17,659) (16,251)
Premiums....................................................... 5,969 3,270
Deferred fees.................................................. (4,999) (4,782)
Accrued interest............................................... 4,479 4,214
-------- --------
(53,912) (61,800)
-------- --------
Loans receivable held for investment........................... $936,037 $817,279
======== ========
Loans receivable held for sale, recorded at lower of aggregate cost or
market, are summarized as follows (thousands of dollars):
DECEMBER 31,
-------------------
1994 1993
------ -------
Loans collateralized by single-family residential real estate:
Conventional................................................... $ 508 $ 4,999
FHA and VA insured............................................. 1,606 3,560
------ -------
2,114 8,559
Credit cards..................................................... -- 11,492
------ -------
Loans receivable held for sale................................... $2,114 $20,051
====== =======
66
70
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 -- LOANS RECEIVABLE -- (CONTINUED)
Additional loan information (thousands of dollars):
DECEMBER 31,
---------------------
1994 1993
-------- --------
Average portfolio yield at end of year................. 8.11% 8.12%
Principal balance of loans serviced for others
(including $67,871 and $92,658 of loans serviced for
MBS owned by the Bank)............................... $415,097 $476,835
Adjustable-rate real estate loans...................... 286,868 233,133
Outstanding commitments to originate loans............. 46,387 47,903
Unused lines of credit................................. 57,180 79,472
Standby letters of credit.............................. 707 1,004
Outstanding commitments to builders.................... 10,543 --
Outstanding commitments to originate loans represent agreements to
originate real estate secured loans to customers at specified rates of interest.
Commitments generally expire in 30 to 60 days and may require payment of a fee.
Some of the commitments are expected to expire without being drawn upon,
therefore the total commitments do not necessarily represent future cash
requirements.
The Bank has designated portions of its portfolio of residential real
estate loans and credit card accounts as held for sale. These loans are carried
at the lower of aggregate cost, market or sales commitment price. In January
1994, the Bank sold its credit card portfolio held for sale and recognized a
gain of approximately $1.7 million ($1.1 million net of charge-offs).
At December 31, 1994, 48 percent, or $19.5 million, of the Bank's
outstanding commercial secured loan portfolio consisted of loans to borrowers in
the gaming industry, with additional unfunded commitments of $11.5 million.
These loans are generally secured by real estate, machinery and equipment. The
Bank's portfolio of loans, collateralized by real estate, consists principally
of real estate located in Nevada, California, and Arizona. Collectibility is,
therefore, somewhat dependent on the economies and real estate values of these
areas and industries.
The Bank's loan approval process is intended to assess both: (i) the
borrower's ability to repay the loan by determining whether the borrower meets
the Bank's established underwriting criteria, and (ii) the adequacy of the
proposed security by determining whether the appraised value of the security
property is sufficient for the proposed loan.
It is the general policy of the Bank not to make single-family residential
loans when the loan-to-value ratio exceeds 80 percent unless the loans are
insured by private mortgage insurance, FHA insurance or VA guarantee.
Residential tract construction loans are generally underwritten with the
discounted loan-to-value ratio less than 85 percent, while commercial/income
property loans are generally underwritten with a ratio of less than 75 percent.
Management considers the above mentioned factors when evaluating the
adequacy of the allowance for estimated credit losses.
Many of the Bank's adjustable-rate loans contain limitations as to both the
amount the interest rate can change at each repricing date (periodic caps) and
the maximum rates the loan can be repriced to over the life of the loan
(lifetime caps). At December 31, 1994, periodic caps in the adjustable loan
portfolio ranged from 25 to 800 basis points. Lifetime caps ranged from 9.75 to
22 percent.
67
71
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5 -- ALLOWANCES AND RESERVES
Activity in the allowances for losses on loans and real estate held for
sale or development is summarized as follows (thousands of dollars):
REAL
ESTATE
CONSTRUCTION NON- HELD FOR
MORTGAGE AND LAND MORTGAGE TOTAL SALE OR
LOANS LOANS LOANS LOANS DEVELOPMENT TOTAL
-------- ------------ -------- -------- ----------- --------
Balance at 12/31/91...................... $ 5,992 $ 2,821 $ 3,248 $12,061 $ 3,639 $ 15,700
Provisions for estimated losses........ 1,903 6,460 5,766 14,129 18,309 32,438
Charge-offs, net of recovery........... (515) (3,765) (4,682) (8,962) (20,485) (29,447)
------ ------- ------- ------- -------- -------
Balance at 12/31/92...................... 7,380 5,516 4,332 17,228 1,463 18,691
Provisions for estimated losses........ 4,634 172 1,406 6,212 1,010 7,222
Charge-offs, net of recovery........... (3,191) (2,248) (1,750) (7,189) (1,538) (8,727)
------- ------- ------- ------- -------- --------
Balance at 12/31/93...................... 8,823 3,440 3,988 16,251 935 17,186
Provisions for estimated losses........ 2,954 71 4,205 7,230 163 7,393
Charge-offs, net of recovery........... (1,786) (1,297) (2,739) (5,822) (622) (6,444)
------- ------- ------- ------- -------- --------
Balance at 12/31/94...................... $ 9,991 $ 2,214 $ 5,454 $17,659 $ 476 $ 18,135
======= ======= ======= ======= ======== ========
The Bank establishes allowances for estimated credit losses by portfolio
through charges to expense. On a regular basis, management reviews the level of
loss allowances which have been provided against the portfolios. Adjustments are
made thereto in light of the level of problem loans and current economic
conditions. Included in net charge-offs are $1.9 million, $2.6 million and $2.6
million of recoveries for 1992, 1993, and 1994, respectively. Write-downs to
fair value, disposition gains and losses, and operating income and costs
affiliated with real estate acquired through foreclosure are charged to the
allowance for estimated credit losses.
The Company's business activity with respect to gas utility operations is
conducted with customers located within the three state region of Arizona,
Nevada and California. Any credit risk the Company is exposed to related to
utility operations is minimized by the taking of security deposits. Provisions
for uncollectible accounts are recorded monthly and are recovered from customers
through billed rates. Activity in the reserve for uncollectibles is summarized
as follows (thousands of dollars):
RESERVE FOR
UNCOLLECTIBLES
--------------
Balance, December 31, 1991.............................. $ 1,373
Additions charged to income........................... 1,667
Accounts written off, less recoveries................. (1,533)
-------
Balance, December 31, 1992.............................. 1,507
Additions charged to income........................... 1,460
Accounts written off, less recoveries................. (1,284)
-------
Balance, December 31, 1993.............................. 1,683
Additions charged to income........................... 1,445
Accounts written off, less recoveries................. (1,575)
-------
Balance, December 31, 1994.............................. $ 1,553
=======
68
72
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 -- PROPERTY, PLANT AND EQUIPMENT
Gas utility property as of December 31, 1994 and 1993 was as follows
(thousands of dollars):
DECEMBER 31,
-------------------------
1994 1993
---------- ----------
Plant in Service:
Production, gathering and storage................. $ 14,252 $ 13,960
Transmission...................................... 140,281 139,262
Distribution...................................... 1,077,425 989,021
General........................................... 164,018 150,482
Other............................................. 32,756 33,000
---------- ----------
1,428,732 1,325,725
Less: accumulated depreciation...................... (433,429) (399,155)
Construction work in progress....................... 33,675 20,758
Acquisition adjustment, net......................... 6,729 7,160
Gas plant held for future use....................... 209 --
---------- ----------
Net gas utility property.................. $1,035,916 $ 954,488
========== ==========
Depreciation expense on gas utility property was $56.5 million, $54 million
and $51.3 million during the years ended December 31, 1994, 1993 and 1992,
respectively.
Leases and Rentals. The Company leases a portion of its corporate
headquarters office complex in Las Vegas and the LNG facilities on its northern
Nevada system. The leases provide for initial terms which expire in 1997 and
2003, respectively, with optional renewal terms available at the expiration
dates. The rental payments are $3.1 million annually, and $7.7 million in the
aggregate over the remaining initial term for the Las Vegas facility, and $6.7
million annually and $56.6 million in the aggregate for the LNG facilities.
Rentals included in operating expenses with respect to these leases
amounted to $9.8 million in each of the three years in the period ended December
31, 1994. Both of these leases are accounted for as operating leases and are
treated as such for regulatory purposes. Other operating leases of the Company
are immaterial individually and in the aggregate.
The Bank leases certain of its facilities under noncancelable operating
lease agreements. The more significant of these leases expire between 1995 and
2029 and provide for renewals subject to certain escalation clauses. Net rental
expense for the Bank was $2.7 million in 1994, $3.1 million in 1993 and $3
million in 1992.
The following is a schedule of net future minimum rental payments for the
Bank under various operating lease agreements that have initial or remaining
noncancelable lease terms in excess of one year as of December 31, 1994
(thousands of dollars):
TOTAL TOTAL NET
MINIMUM MINIMUM MINIMUM
LEASE SUBLEASE LEASE
PAYMENTS RECEIPTS PAYMENTS
-------- -------- --------
Year Ending December 31:
1995.............................................. $ 5,026 $ 2,664 $ 2,362
1996.............................................. 4,988 2,580 2,408
1997.............................................. 4,950 2,213 2,737
1998.............................................. 4,602 1,926 2,676
1999.............................................. 3,969 1,613 2,356
Thereafter........................................ 46,608 2,275 44,333
------- ------- -------
$70,143 $13,271 $56,872
======= ======= =======
69
73
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7 -- DEPOSITS
Deposits are summarized as follows (thousands of dollars):
DECEMBER 31,
-------------------------
1994 1993
---------- ----------
Interest-bearing demand and money market deposits... $ 313,949 $ 324,011
Noninterest-bearing demand deposits................. 69,294 64,797
Savings deposits.................................... 78,876 86,781
---------- ----------
Total transaction accounts................ 462,119 475,589
---------- ----------
Certificates of deposit:
<$100,000........................................ 608,872 580,018
>=$100,000........................................ 168,958 152,245
---------- ----------
Total certificates of deposit............. 777,830 732,263
---------- ----------
$1,239,949 $1,207,852
========== ==========
Average annual interest rate at year-end............ 3.97% 3.56%
========== ==========
The above balance includes $5.8 million deposited by the State of Nevada
that is collateralized by real estate loans and debt securities with a fair
value of approximately $8.5 million at December 31, 1994. There were no brokered
deposits at December 31, 1994 or December 31, 1993.
Interest expense on deposits for the years ended December 31, is summarized
as follows (thousands of dollars):
1994 1993 1992
------- ------- -------
Interest-bearing demand and money market
deposits.................................... $ 8,740 $ 8,578 $ 8,915
Savings deposits.............................. 2,135 2,364 1,779
Certificates of deposit....................... 33,241 46,701 75,280
------- ------- -------
Total deposit interest expense...... $44,116 $57,643 $85,974
======= ======= =======
Certificates of deposit maturity schedule (thousands of dollars):
CERTIFICATES MATURING ON OR PRIOR TO DECEMBER 31,
----------------------------------------------------------------------
INTEREST RATE CATEGORY 1995 1996 1997 1998 1999 THEREAFTER
---------------------- -------- ------- ------- ------- ------- ----------
2.99% and lower............... $ 3,793 $ 88 $ 14 $ 13 $ 8 $ 9
3.00% to 3.99%................ 298,360 7,253 93 -- -- 27
4.00% to 4.99%................ 171,177 23,046 9,141 2,140 5 --
5.00% to 5.99%................ 14,679 22,828 16,086 19,897 10,182 13,498
6.00% to 6.99%................ 909 2,698 39,614 360 19,641 11,484
7.00% to 7.99%................ 2,398 34,484 5,756 14 15,163 203
8.00% to 8.99%................ 32,069 79 -- -- -- 136
9.00% and over................ 53 -- 33 399 -- --
-------- ------- ------- ------- ------- -------
$523,438 $90,476 $70,737 $22,823 $44,999 $25,357
======== ======= ======= ======= ======= =======
70
74
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8 -- CASH EQUIVALENTS AND SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
Cash Equivalents
Cash equivalents are stated at cost, which approximates fair value, and
include the following (thousands of dollars):
DECEMBER 31,
-------------------
1994 1993
------- -------
Securities purchased under resale agreements............. $77,657 $55,102
Federal funds sold....................................... 11,003 8,401
------- -------
$88,660 $63,503
======= =======
Securities purchased under resale agreements at December 31, 1994 and at
December 31, 1993 matured within 11 days and 24 days, respectively, and called
for delivery of the same securities. The collateral for these agreements
consisted of debt securities which at December 31, 1994 and 1993 were held on
the Bank's behalf by its safekeeping agents and safekeeping agents for various
broker/dealers. The securities purchased under resale agreements represented 47
percent of the Bank's stockholder's equity at December 31, 1994 and 31 percent
at December 31, 1993.
The average amount of securities purchased under resale agreements
outstanding during the years ended December 31, 1994 and 1993 were $36.2 million
and $26.6 million, respectively. The maximum amount of resale agreements
outstanding at any month end was $77.7 million during 1994 and $60 million
during 1993.
Securities Sold Under Repurchase Agreements
The Bank sells securities under agreements to repurchase (reverse
repurchase agreements). Reverse repurchase agreements are treated as borrowings
and are reflected as liabilities in the accompanying Consolidated Statements of
Financial Position. Reverse repurchase agreements are summarized as follows
(thousands of dollars):
DECEMBER 31,
---------------------
1994 1993
-------- --------
Balance at year end.................................... $281,935 $259,041
Accrued interest payable at year end................... 3,335 3,871
Daily average amount outstanding during year........... 222,620 305,123
Maximum amount outstanding at any month end............ 281,935 367,859
Weighted average interest rate during the year......... 4.95% 4.30%
Weighted average interest rate on year-end balances.... 6.37% 4.31%
All agreements are collateralized by MBS and U.S. Treasury notes and
require the Bank to repurchase identical securities as those which were sold.
The MBS collateralizing the agreements are reflected as assets with a carrying
value of $17 million in excess of borrowing amount and a weighted average
maturity of 1.35 years. Agreements were transacted with the following dealers:
Morgan Stanley & Co., Inc.; Lehman Brothers; and Bear Stearns. Reverse
repurchase agreements are collateralized as follows (thousands of dollars):
DECEMBER 31,
-----------------------------------------------
1994 1993
--------------------- ---------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- -------- -------- --------
MBS............................. $258,477 $258,477 $280,928 $280,928
U.S. Treasury notes............. 40,428 40,191 -- --
-------- -------- -------- --------
$298,905 $298,668 $280,928 $280,928
======== ======== ======== ========
71
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SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8 -- CASH EQUIVALENTS AND SECURITIES SOLD UNDER REPURCHASE
AGREEMENTS -- (CONTINUED)
At December 31, 1994, borrowings of $144 million were in accordance with a
long-term agreement executed with Morgan Stanley & Co., Incorporated (primary
dealer). The agreement, which allows for a maximum borrowing of $300 million
with no minimum, matures in July 1997. The interest rate on the borrowings is
adjusted monthly based upon a spread over or under the one month London
Interbank Offering Rate (LIBOR), dependent upon the underlying collateral.
The Bank is also party to two separate flexible reverse repurchase
agreements (flex repos) totaling $19.7 million at December 31, 1994. A flex repo
represents a long-term fixed-rate contract to borrow funds through the primary
dealer, collateralized by MBS with a flexible repayment schedule. The principal
balance of the Bank's flex repo agreements will decline over the stated maturity
period based upon the counterparty's need for the funds.
Principal payments on flex repos at December 31, 1994 are projected as
follows (thousands of dollars):
FLEX FLEX
PROJECTED REPAYMENT REPO-1 REPO-2
------------------- --------- ---------
12 months............................................ $ 500 $ 15,222
24 months............................................ 3,939 --
--------- ---------
$ 4,439 $ 15,222
======== =========
Maturity date........................................ July 1996 June 1995
Interest rate........................................ 8.86% 8.65%
======== =========
Actual principal payments may differ from those shown above due to the
actual timing of the funding being faster or slower than originally projected.
NOTE 9 -- COMMITMENTS AND CONTINGENCIES
Legal Proceedings. The Company has been named as defendant in various legal
proceedings. The ultimate dispositions of these proceedings are not presently
determinable; however, it is the opinion of management that no litigation to
which the Company is subject will have a material adverse impact on its
financial position or results of operations.
NOTE 10 -- SHORT-TERM DEBT
The Company has an agreement with several banks for committed credit lines
which aggregate $150 million at December 31, 1994. The agreement provides for
the payment of interest at competitive market rates. The lines of credit also
require the payment of a facility fee based on the long-term debt rating of the
Company. The committed credit lines have no compensating balance requirements
and expire in July 1995. Short-term borrowings at December 31, 1994 and 1993
were $92 million and $86 million, respectively. The weighted average interest
rates on these borrowings were 6.36 percent and 3.80 percent.
72
76
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11 -- LONG-TERM DEBT
DECEMBER 31,
-----------------------------------------
1994 1994 1993 1993
CARRYING MARKET CARRYING MARKET
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
(THOUSANDS OF DOLLARS)
Southwest Gas Corporation
Debentures--
9% Series A, due 2011.................... $ 27,557 $ 26,386 $ 27,688 $ 28,795
9% Series B, due 2011.................... 31,913 30,557 31,944 33,222
8 3/4% Series C, due 2011................ 19,261 18,587 19,699 20,487
9 3/8% Series D, due 2017................ 120,000 118,650 120,000 126,826
10% Series E, due 2013................... 23,079 23,541 23,127 24,283
9 3/4% Series F, due 2002................ 100,000 102,897 100,000 116,596
Unamortized discount..................... (6,723) -- (7,220) --
-------- -------- -------- --------
315,087 320,618 315,238 350,209
-------- -------- -------- --------
Term loan facilities and other debt......... 200,000 165,000
-------- --------
Industrial development revenue bonds--
Variable rate bonds
Series due 2028........................ 50,000 50,000 50,000 50,000
Less funds held in trust............... (38,510) -- (44,055) --
-------- --------
11,490 5,945
-------- --------
Fixed-rate bonds
7.30% 1992 Series A, due 2027.......... 30,000 30,338 30,000 33,450
7.50% 1992 Series B, due 2032.......... 100,000 102,550 100,000 112,000
6.50% 1993 Series A, due 2033.......... 75,000 71,807 75,000 79,500
Unamortized discount................... (3,865) -- (3,969) --
Less funds held in trust............... (44,449) -- (73,614) --
-------- --------
156,686 127,417
-------- --------
683,263 613,600
-------- --------
PriMerit Bank
Advances from FHLB....................... 99,400 97,565 71,000 71,281
Notes payable............................ 8,135 8,174 8,265 8,647
-------- --------
107,535 79,265
-------- --------
$790,798 $692,865
======== ========
The Company had two term loan facilities totaling $165 million as of
December 31, 1994. The first term loan facility was a Restated and Amended
Credit Agreement (Credit Agreement) dated April 1990 in the amount of $125
million. During 1994 and 1993, the average cost of this facility was 4.99
percent and 3.89 percent, respectively. The second term loan was a $40 million
Bridge Term Loan Facility (Bridge Loan) which was used to refinance the $40
million Amended and Restated Domestic Credit Agreement in August 1994. During
1994, the average interest rate for the Bridge Loan and the Amended and Restated
Domestic Credit Agreement was 5.26 percent.
In January 1995, the Company closed a new $200 million term-loan facility
with a group of banks. This new facility was utilized to refinance the existing
$125 million Credit Agreement and the $40 million Bridge Loan which were to
mature in April 1995. In addition to refinancing $165 million of term loans, $35
million of
73
77
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11 -- LONG-TERM DEBT -- (CONTINUED)
short-term notes payable were refinanced with the proceeds from this new
facility, and are classified as long-term debt at December 31, 1994. The $200
million facility provides for a revolving period through January 1998 at which
time any amounts borrowed under the agreement become payable on demand. Direct
borrowing options provide for the payment of interest at either the prime rate,
LIBOR, or certificate of deposit rate plus a margin based on the Company's
credit rating. In addition to direct borrowing options, a letter of credit is
available to provide credit support for the issuance of commercial paper.
In December 1993, the Company borrowed $75 million in Clark County, Nevada,
tax-exempt IDRB. The IDRB have an annual coupon rate of 6.50 percent, are
noncallable for 10 years and have a final maturity in December 2033. The
proceeds from the sale of the IDRB will be used to finance certain additions and
improvements to the Company's natural gas distribution and transmission system
in Clark County, Nevada.
In December 1993, the City of Big Bear Lake, California sold $50 million of
tax-exempt IDRB which are secured as to the payment of principal and interest by
the Company. The net proceeds from these sales were placed with a trustee and
will be drawn down as required to finance certain additions and improvements to
the Company's natural gas distribution and transmission system in San Bernardino
County, California. The interest rate on the bonds is established on a weekly
basis and averaged 3.85 percent during 1994 and 3.53 percent for December 1993.
At the option of the Company, the interest period can be converted from a weekly
rate to a daily term or variable term rate.
The fair value of the term loan facilities approximates carrying value.
Market values for debentures and fixed-rate bonds of the Company, excluding the
Bank, were determined based on dealer quotes using trading records for December
31, 1994 and 1993, as applicable, and other secondary sources which are
customarily consulted for data of this kind. The carrying value of the IDRB
Series due 2028 was used as the estimate of fair value based upon the variable
interest rate of the bonds.
Requirements to retire long-term debt, excluding those of the Bank, at
December 31, 1994 for the next five years are expected to be $5 million, $5
million, $5 million, $211 million and $11 million, respectively.
Principal payments on Bank borrowings at December 31, 1994 are due as
follows (thousands of dollars):
ADVANCES
FROM NOTES
MATURITY INTEREST RATE FHLB PAYABLE
-------- ------------- -------- -------
12 months................................ 4.30% - 8.20% $50,000 $ 140
24 months................................ 4.40% - 8.50% 10,000 7,995
36 months................................ 8.23% 6,000 --
48 months................................ 5.01% 5,000 --
60 months................................ 8.23% 25,000 --
84 months................................ 7.52% 3,400 --
------- ------
$99,400 $8,135
======= ======
Coupon interest rates on Bank borrowings are as follows:
DECEMBER 31,
-------------------------------
1994 1993
------------- -------------
Advances from FHLB........................... 4.30% - 8.23% 4.30% - 8.23%
Notes payable................................ 8.20% - 8.50% 8.00% - 8.50%
The effective rate of the advances from the FHLB at December 31, 1994 was
5.68 percent.
74
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SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11 -- LONG-TERM DEBT -- (CONTINUED)
In 1994, the FHLB established a Financing Availability for the Bank which
is currently 25 percent of the Bank's assets with terms up to 360 months. All
borrowings from the FHLB must be collateralized by mortgages or securities. The
Bank also has the capability of borrowing up to $5 million in federal funds from
Bank of America. At December 31, 1994 and 1993, there were no outstanding draws
from this line of credit which expires in August 1995.
Bank borrowings are collateralized as follows (thousands of dollars):
DECEMBER 31,
----------------------------------------------
1994 1993
--------------------- --------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- -------- -------- -------
MBS...................................... $ 13,971 $ 13,971 $ 14,797 $14,797
Real estate loans........................ 140,000 99,400 98,860 71,000
-------- -------- -------- -------
$153,971 $113,371 $113,657 $85,797
======== ======== ======== =======
NOTE 12 -- PREFERRED AND PREFERENCE STOCKS
CUMULATIVE
PREFERRED SECOND PREFERENCE STOCK
STOCK ---------------------------
9.5% FIRST SECOND THIRD
SERIES SERIES SERIES SERIES
---------- ------- ------- -------
NUMBER OF SHARES (In thousands):
Balance, December 31, 1991.................... 64 20 44 98
Redemptions................................... (8) (10) (22) (33)
------ ------- ------- -------
Balance, December 31, 1992.................... 56 10 22 65
Redemptions................................... (8) (10) (22) (33)
------ ------- ------- -------
Balance, December 31, 1993.................... 48 -- -- 32
Redemptions................................... (8) -- -- (32)
------ ------- ------- -------
Balance, December 31, 1994.................... 40 -- -- --
====== ======= ======= =======
AMOUNT (In thousands):
Balance, December 31, 1991.................... $6,400 $ 2,000 $ 4,400 $ 9,774
Redemptions................................... (800) (1,000) (2,200) (3,258)
------ ------- ------- -------
Balance, December 31, 1992.................... 5,600 1,000 2,200 6,516
Redemptions................................... (800) (1,000) (2,200) (3,258)
------ ------- ------- -------
Balance, December 31, 1993.................... 4,800 -- -- 3,258
Redemptions................................... (800) -- -- (3,258)
------ ------- ------- -------
Balance, December 31, 1994.................... $4,000 $ -- $ -- $ --
====== ======= ======= =======
The Company is authorized to issue up to 500,000 shares each of its
Cumulative Preferred and Second Preference Stock, respectively. The Company is
required to redeem 8,000 shares, or $800,000 annually, through 1999, of the $100
Cumulative Preferred Stock, 9.5 Percent Series. All outstanding Cumulative
Preferred shares are redeemable at the option of the Company at any time upon 30
days notice at par plus accrued dividends and a percentage premium equal to the
dividend rate in the first year commencing December 1979, and declining ratably
each year thereafter to par value in 1999.
The estimated fair value of the Company's Cumulative Preferred Stock at
December 31, 1994 and 1993 was $4 million and $5 million, respectively. These
figures were based on a yield-to-maturity of 9.05 percent
75
79
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12 -- PREFERRED AND PREFERENCE STOCKS -- (CONTINUED)
and 8.14 percent, respectively, and a required redemption of 8,000 shares per
year. Since this issue is not traded, yield-to-maturity was estimated based on
the weighted average yield-to-maturity of the Company's outstanding debentures,
adjusted for historical spreads between Moody's Baa rated utility debt and Baa
utility preferred stock issues.
During 1994, the Company redeemed, as required, the remaining shares of its
Second Preference Stock, Third Series. The dividend rate on Second Preference
Stock was cumulative and varied from 3 to 16 percent, based on a formula tied to
operating results with respect to the gas distribution system purchased from
Arizona Public Service Company. During each of the last three years, the
dividend rate was three percent.
The Articles of Incorporation provide that in the event of involuntary
liquidation, before distributions may be made to holders of any other class of
stock, holders of the Cumulative Preferred Stock are entitled to payment at par
value, together with any accumulated and unpaid dividends.
NOTE 13 -- EMPLOYEE POSTRETIREMENT BENEFITS
The Company has a qualified retirement plan covering the employees of its
natural gas operations segment. The plan is noncontributory with defined
benefits, and covers substantially all employees. It is the Company's policy to
fund the plan at not less than the minimum required contribution nor more than
the tax deductible limit. Plan assets are held in a master trust whose
investments consist of common stock, corporate bonds, government obligations,
real estate, an insurance company contract and cash or cash equivalents.
The plan covering the natural gas operations provides that an employee may
earn benefits for a period of up to 30 years and will be vested after 5 years of
service. Retirement plan costs were $7.8 million, $6.6 million, and $6.1 million
for each of the three years ended December 31, 1994, 1993 and 1992,
respectively.
The following table sets forth, for the gas segment, the plan's funded
status and amounts recognized on the Company's consolidated statements of
financial position and statements of income. The Bank has a separate retirement
plan whose cost and liability are not significant.
DECEMBER 31,
-----------------------
1994 1993
--------- ---------
(THOUSANDS OF DOLLARS)
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including vested
benefits of $(86,800) and $(90,267),
respectively....................................... $ (93,225) $ (98,926)
========= =========
Projected benefit obligation for service rendered to
date............................................... $(136,157) $(141,694)
Market value of plan assets.......................... 130,497 126,433
--------- ---------
Projected benefit obligation in excess of assets..... (5,660) (15,261)
Unrecognized net transition obligation being
amortized through 2004............................. 7,489 8,326
Unrecognized net loss (gain)......................... (2,010) 6,389
Unrecognized prior service cost...................... 523 903
--------- ---------
Prepaid retirement plan asset included in the
Consolidated Statements of Financial Position...... $ 342 $ 357
========= =========
Assumptions used to develop pension obligations were:
Discount rate...................................... 8.25% 7.25%
Long-term rate of return on assets................. 8.75% 8.75%
Rate of increase in compensation levels............ 5.50% 4.75%
76
80
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13 -- EMPLOYEE POSTRETIREMENT BENEFITS -- (CONTINUED)
YEAR ENDED DECEMBER 31,
--------------------------------
1994 1993 1992
-------- ------- -------
(THOUSANDS OF DOLLARS)
Net retirement plan costs include the
following components:
Service cost............................... $ 7,805 $ 6,339 $ 5,111
Interest cost.............................. 10,164 9,213 8,585
Actual return on plan assets............... 254 (8,853) (6,406)
Net amortization and deferrals............. (10,440) (67) (1,174)
-------- ------- -------
Net periodic retirement plan cost............ $ 7,783 $ 6,632 $ 6,116
======== ======= =======
In addition to the basic retirement plans, the Company has separate
unfunded supplemental retirement plans for its natural gas operations and
financial services segments, which are limited to certain officers. The gas
segment's plan is noncontributory with defined benefits. Senior officers who
retire with ten years or more of service with the Company are eligible to
receive benefits. Other officers who retire with 20 years or more of service
with the Company are eligible to receive benefits. Plan costs were $2 million,
$1.5 million and $1.5 million for each of the three years ended December 31,
1994, 1993 and 1992, respectively. The accumulated benefit obligation of the
plan was $13.3 million, including vested benefits of $12.4 million, at December
31, 1994. The cost and liability of the financial services supplemental
retirement plan are not significant. The Company also has an unfunded retirement
plan for directors not covered by the employee retirement plan. The cost and
liability for this plan are not significant.
The Company has a deferred compensation plan for all officers and members
of the Board. The plan provides the opportunity to defer from a minimum of
$2,000 up to 50 percent of annual compensation. The Company matches one-half of
amounts deferred up to six percent of an officer's annual salary. Payments of
compensation deferred, plus interest, commence upon the participant's retirement
in equal monthly installments over 10, 15 or 20 years, as determined by the
Company. Deferred compensation earns interest at a rate determined each January.
The interest rate represents 150 percent of Moody's Seasoned Corporate Bond
Index.
The Employees' Investment Plan (401k) provides for purchases of the
Company's common stock or certain other investments by eligible gas segment
employees through deductions of up to 16 percent of base compensation, subject
to IRS limitations. The Company matches one-half of amounts deferred up to six
percent of an employee's annual compensation. The cost of the plan was $2.6
million, $1.9 million and $1.7 million for each of the three years ended
December 31, 1994, 1993 and 1992, respectively. The Bank has a separate 401k
plan which provides for purchases of certain securities by eligible employees
through deductions of up to 15 percent of base compensation, subject to IRS
limitations. The Bank matches 100 percent of amounts deferred up to six percent
of employee base compensation. The cost of this plan is not significant.
At December 31, 1994, 464,050 common shares were reserved for issuance
under provisions of the Employee Investment Plan and the Company's Dividend
Reinvestment and Stock Purchase Plan.
The Company provides postretirement benefits other than pensions (PBOP) to
its qualified gas segment retirees for health care, dental and life insurance.
The Bank does not provide PBOP to its retirees. In December 1990, the FASB
issued SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions." The statement requires the Company to account for PBOP on an
accrual basis rather than reporting these benefits on a pay-as-you-go basis. The
Company adopted SFAS No. 106 in January 1993. The PSCN, CPUC and FERC have
approved the use of SFAS No. 106 for ratemaking purposes, subject to certain
77
81
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13 -- EMPLOYEE POSTRETIREMENT BENEFITS -- (CONTINUED)
conditions, including funding. The Company did not receive approval to recover
PBOP costs on an accrual basis in its Arizona rate jurisdictions, but was
authorized to continue to recover the pay-as-you-go costs for ratemaking
purposes. The Company began funding the non-Arizona portion of the PBOP
liability in 1994. Plan assets are combined with the pension plan assets in the
master trust.
The following table sets forth, for the gas segment, the PBOP funded status
and amounts recognized on the Company's consolidated statements of financial
position and statements of income.
YEAR ENDED
DECEMBER 31,
-----------------------------
1994 1993
-------- --------
(THOUSANDS OF DOLLARS)
Accumulated postretirement benefit
obligation (APBO)
Retirees............................. $(13,348) $(14,035)
Fully eligible actives............... (1,639) (1,649)
Other active participants............ (4,524) (5,164)
-------- --------
Total........................ (19,511) (20,848)
Market value of plan assets............ 697 --
-------- --------
APBO in excess of plan assets.......... (18,814) (20,848)
Unrecognized transition obligation..... 15,605 16,472
Unrecognized prior service cost........ -- --
Unrecognized loss...................... 175 2,659
-------- --------
Accrued postretirement benefit
liability............................ $ (3,034) $ (1,717)
======== ========
Assumptions used to develop
postretirement benefit obligations
were:
Discount rate........................ 8.25% 7.25%
Medical inflation.................... 10% graded to 5% 11% graded to 5%
Salary increases..................... 5.50% 4.75%
Net periodic postretirement benefit
costs include the following
components:
Service cost......................... $ 473 $ 346
Interest cost........................ 1,472 1,394
Actual return on plan assets......... -- --
Net amortization and deferrals....... 911 867
-------- --------
Net periodic postretirement benefit
cost................................. $ 2,856 $ 2,607
======== ========
The Company makes fixed contributions, based on age and years of service,
to retiree spending accounts for the medical and dental costs of employees who
retire after 1988. The Company pays up to 100 percent of the medical coverage
costs for employees who retired prior to 1989. The medical inflation assumption
in the table above applies to the benefit obligations for pre-1989 retirees
only. This inflation assumption was estimated at ten percent in 1995 and
decreases one percent per year until 1997 and one-half of one percent per year
until 2003, at which time the annual increase is projected to be five percent. A
one percent increase in these assumptions would change the accumulated
postretirement benefit obligation by approximately $1 million and $1.1 million
for the years ended December 31, 1994 and 1993, respectively. The 1995 and 1994
annual benefit cost would increase $90,000 and $160,000, respectively.
78
82
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14 -- INCOME TAXES
The Company adopted SFAS No. 109, "Accounting for Income Taxes," in January
1993. That statement requires the use of the asset and liability approach for
financial reporting of income taxes. As permitted under SFAS No. 109, the prior
year's (1992) financial statements were not restated. The cumulative effect of
this change in accounting method was an increase in net income of $3 million,
which was reported in the year of adoption.
Income tax expense (benefit) consists of the following (thousands of
dollars):
YEAR ENDED DECEMBER 31,
-------------------------------
1994 1993 1992
------- ------- -------
Current:
Federal............................................. $19,100 $ (402) $13,879
State............................................... 2,110 700 1,982
------- ------- -------
21,210 298 15,861
------- ------- -------
Deferred:
Federal............................................. (3,444) 10,128 (1,350)
State............................................... (44) 833 (38)
------- ------- -------
(3,488) 10,961 (1,388)
------- ------- -------
Total income tax expense.................... $17,722 $11,259 $14,473
======= ======= =======
Deferred income tax expense (benefit) consists of the following significant
components (thousands of dollars):
YEAR ENDED DECEMBER 31,
-------------------------------
1994 1993 1992
------- ------- -------
Deferred federal and state:
Real estate/loan loss provisions.................... $ 345 $11,912 $(5,667)
Property-related items.............................. 2,021 552 393
Energy cost adjustments............................. (5,531) 3,804 (132)
Loan fees and discounted interest................... 976 425 (1,030)
Unearned revenues................................... -- (865) --
Self insurance...................................... 1,161 (691) 444
CMO................................................. 473 827 (544)
Customer refunds.................................... -- -- 5,275
All other deferred.................................. (2,057) (4,154) 706
------- ------- -------
Total deferred federal and state............ (2,612) 11,810 (555)
------- ------- -------
Deferred investment tax credit, net................... (876) (849) (833)
------- ------- -------
Total deferred income tax expense
(benefit)................................. $(3,488) $10,961 $(1,388)
======= ======= =======
79
83
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14 -- INCOME TAXES -- (CONTINUED)
The consolidated effective income tax rate for the period ended December
31, 1994 and the two prior periods differs from the federal statutory income tax
rate. The sources of these differences and the effect of each are summarized as
follows:
YEAR ENDED DECEMBER 31,
--------------------------
1994 1993 1992
---- ---- ----
Federal statutory income tax rate.......................... 35.0% 35.0% 34.0%
Net state tax liability.................................. 2.7 3.9 5.8
Property-related items................................... 1.8 4.8 4.0
Bad debt deduction....................................... -- -- (7.7)
Purchase accounting adjustments.......................... -- -- (0.3)
Goodwill amortization.................................... 3.1 14.6 4.4
Provision for estimated loan loss........................ -- -- 14.9
Tax credits.............................................. (2.0) (3.6) (2.7)
Tax exempt interest...................................... -- (0.7) (0.3)
Effect of Internal Revenue Service examination........... -- (4.8) --
All other differences.................................... (0.3) (1.5) (7.1)
---- ---- ----
Consolidated effective income tax rate..................... 40.3% 47.7% 45.0%
==== ==== ====
Deferred tax assets and liabilities consist of the following (thousands of
dollars):
DECEMBER 31,
---------------------
1994 1993
-------- --------
Deferred tax assets:
Deferred income taxes for future amortization of
ITC............................................... $ 13,784 $ 14,312
Allowance for estimated loan losses.................. 6,198 5,785
Real estate held for sale............................ 5,267 4,865
Employee benefits.................................... 2,813 3,699
Securities available for sale........................ 5,098 --
Other................................................ 8,561 5,974
Valuation allowance.................................. -- --
-------- --------
41,721 34,635
-------- --------
Deferred tax liabilities:
Property-related items, including accelerated
depreciation...................................... 96,089 90,652
Property-related items previously flowed-through..... 28,775 31,083
Unamortized ITC...................................... 20,741 22,992
Regulatory balancing accounts........................ 9,048 20,218
Securities available for sale........................ -- 4,717
Loan fees............................................ 5,188 2,933
Debt-related costs................................... 4,941 4,396
Other................................................ 10,470 9,202
-------- --------
175,252 186,193
-------- --------
Net deferred tax liabilities........................... $133,531 $151,558
======== ========
80
84
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14 -- INCOME TAXES -- (CONTINUED)
Prior to 1981, federal income tax expense for the gas segment was reduced
to reflect additional depreciation and other deductions claimed for income tax
purposes (flow-through method). Subsequently, deferred taxes have been provided
for all differences between book and taxable income (normalization method) in
all jurisdictions. The various utility regulatory authorities have consistently
allowed the recovery of previously flowed-through income tax benefits on
property related items by means of increased federal income tax expense in
determining cost of service for ratemaking purposes. Pursuant to SFAS No. 109, a
deferred tax liability and corresponding regulatory asset of approximately $28.8
million are included in the financial statements at December 31, 1994 to reflect
the expected recovery of income tax benefits previously flowed-through.
For regulatory and financial reporting purposes, the Company has deferred
recognition of investment tax credits (ITC) by amortizing the benefit over the
depreciable lives of the related properties. Pursuant to SFAS No. 109, a
deferred tax asset and corresponding regulatory liability of approximately $13.8
million are included in the financial statements at December 31, 1994 to reflect
the Company's expected reduction to future income tax expense that will result
from the amortization of ITC through utility rates.
Under the Internal Revenue Code, the Bank is allowed a special bad debt
deduction (unrelated to the amount of losses charged to earnings) based on a
percentage of taxable income (currently eight percent). Under SFAS No. 109, no
deferred taxes are provided on bad debt reserves arising prior to December 31,
1987, unless it becomes apparent that these differences will reverse in the
foreseeable future. At December 31, 1994, the portion of tax bad debt reserves
not expected to reverse is $14.3 million, which results in a retained earnings
benefit of $5 million, recognized in years prior to 1988.
81
85
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15 -- SEGMENT INFORMATION
The financial information pertaining to the Company's gas and financial
services segments for each of the three years in the period ended December 31,
1994, is as follows (thousands of dollars):
1994
----------------------------------------
GAS FINANCIAL
OPERATIONS SERVICES TOTAL
---------- ---------- ----------
Revenues....................................... $ 599,553 $ 128,616 $ 728,169
Operating expenses excluding income taxes...... 510,863 114,552 625,415
---------- ---------- ----------
Operating income............................... $ 88,690 $ 14,064 $ 102,754
========== ========== ==========
Depreciation, depletion and amortization....... $ 57,284 $ 7,779 $ 65,063
========== ========== ==========
Construction expenditures...................... $ 141,390 $ 3,252 $ 144,642
========== ========== ==========
Identifiable assets............................ $1,277,727 $1,816,321 $3,094,048*
========== ========== ==========
1993
----------------------------------------
GAS FINANCIAL
OPERATIONS SERVICES TOTAL
---------- ---------- ----------
Revenues....................................... $ 539,105 $ 150,736 $ 689,841
Operating expenses excluding income taxes...... 461,423 140,840 602,263
---------- ---------- ----------
Operating income............................... $ 77,682 $ 9,896 $ 87,578
========== ========== ==========
Depreciation, depletion and amortization....... $ 55,088 $ 8,495 $ 63,583
========== ========== ==========
Construction expenditures...................... $ 113,903 $ 1,521 $ 115,424
========== ========== ==========
Identifiable assets............................ $1,194,679 $1,751,419 $2,946,098*
========== ========== ==========
1992
----------------------------------------
GAS FINANCIAL
OPERATIONS SERVICES TOTAL
---------- ---------- ----------
Revenues....................................... $ 534,390 $ 184,093 $ 718,483
Operating expenses excluding income taxes...... 448,815 193,820 642,635
---------- ---------- ----------
Operating income (loss)........................ $ 85,575 $ (9,727) $ 75,848
========== ========== ==========
Depreciation, depletion and amortization....... $ 52,277 $ 8,391 $ 60,668
========== ========== ==========
Construction expenditures...................... $ 102,517 $ 3,078 $ 105,595
========== ========== ==========
Identifiable assets............................ $1,103,794 $2,237,734 $3,341,528
========== ========== ==========
- ---------------
* Combined assets of the business segments do not equal consolidated assets as
certain reclassifications were made during consolidation.
82
86
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
CONSOLIDATED QUARTERLY FINANCIAL DATA
QUARTER ENDED:
------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- -------- ------------ -----------
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
1994
Operating revenues........................ $239,155 $140,177 $124,295 $224,542
Operating income (loss)................... 51,454 (327) (4,699) 56,326
Net income (loss)......................... 22,710 (9,781) (11,165) 24,537
Net income (loss) applicable to common
stock................................... 22,571 (9,919) (11,303) 24,442
Earnings (loss) per common share*......... 1.07 (.47) (.54) 1.15
1993
Operating revenues........................ $220,561 $137,971 $126,244 $205,065
Operating income (loss)................... 35,937 (5,401) (257) 57,299
Net income (loss) before cumulative effect
of accounting change.................... 14,081 (13,072) (7,344) 18,696
Net income (loss)......................... 17,126 (13,072) (7,344) 18,696
Net income (loss) applicable to common
stock................................... 16,920 (13,275) (7,538) 18,558
Earnings (loss) per share before
cumulative effect of accounting
change.................................. .67 (.64) (.37) .90
Earnings (loss) per common share*......... .82 (.64) (.37) .90
1992
Operating revenues........................ $240,646 $144,291 $125,229 $208,317
Operating income (loss)................... 36,868 (5,107) (5,628) 49,715
Net income (loss)......................... 14,808 (10,447) (11,395) 24,695
Net income (loss) applicable to common
stock................................... 14,535 (10,718) (11,656) 24,449
Earnings (loss) per common share*......... .71 (.52) (.57) 1.19
- ---------------
* The sum of quarterly earnings (loss) per average common share may not equal
the annual earnings (loss) per share due to the ongoing change in the weighted
average number of common shares outstanding.
The demand for natural gas is seasonal, and it is management's opinion that
comparisons of earnings for the interim periods do not reliably reflect overall
trends and changes in the Company's operations. Also, the timing of general rate
relief can have a significant impact on earnings for interim periods. See MD&A
for additional discussion of the Company's operating results.
83
87
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
BANK QUARTERLY FINANCIAL DATA
QUARTER ENDED:
-----------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
(THOUSANDS OF DOLLARS)
1994
Interest income............................. $28,045 $29,124 $29,894 $31,371
Interest expense............................ 14,049 14,200 14,867 16,674
Provision for estimated losses.............. 1,848 1,908 1,498 2,139
Net income.................................. 2,189 2,176 1,977 1,331
1993
Interest income............................. $35,997 $34,976 $31,881 $29,471
Interest expense............................ 22,240 20,906 17,267 14,663
Provision for estimated losses.............. 1,361 1,397 2,782 1,682
Net income (loss) before cumulative effect
of accounting change...................... 609 (4,717) 5,341 2,318
Net income (loss)........................... 3,654 (4,717) 5,341 2,318
1992
Interest income............................. $47,552 $44,910 $37,818 $35,398
Interest expense............................ 33,041 30,933 25,315 22,628
Provision for estimated losses.............. 14,277 8,625 5,240 4,296
Net income (loss)........................... (4,897) (3,890) (1,557) 526
NOTE 17 -- INTEREST RATE RISK MANAGEMENT
The Bank is exposed to interest rate risk (IRR) resulting from (a) timing
differences in the maturity and/or repricing of the Bank's assets, liabilities,
and off-balance sheet contracts; (b) the exercise of options embedded in the
Bank's financial instruments and accounts, such as prepayments of loans before
scheduled maturity, caps on the amounts of interest rate movement permitted for
adjustable-rate loans, and withdrawals of funds on deposit with and without
stated terms to maturity; and (c) differences in the behavior of lending and
funding rates, referred to as basis risk. The role of the Bank's asset/liability
management function is to prevent the erosion of the Bank's earnings and equity
capital due to interest rate fluctuations. Changes in the Bank's IRR exposure
affect the current market values of the Bank's loan, debt securities, deposit
and borrowing portfolios, as well as the Bank's future earnings. The level of
IRR exposure can also adversely affect the Bank's regulatory capital.
The Bank's Board of Directors (BOD) has established certain guidelines to
manage the exposure of the Bank's net interest income, net income, and net
portfolio value (NPV) to interest rate fluctuations. NPV represents a
theoretical estimate of the market value of the Bank's stockholder's equity,
calculated as the net present value of expected cash flows from financial assets
and liabilities, plus the book values of all non-financial assets and
liabilities. The guidelines include limits on overall IRR exposure, methods of
accountability and specific reports to be provided to the BOD by management for
periodic review, and established acceptable activities and instruments to manage
IRR.
The Bank maintains an IRR simulation model which enables the Bank to
measure IRR exposure using various assumptions and interest rate scenarios, and
to incorporate alternative strategies for the reduction of IRR exposure. The
Bank measures its IRR using several methods to provide a comprehensive view of
its IRR from various perspectives. These methods include projection of current
NPV and future periods' net interest
84
88
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 17 -- INTEREST RATE RISK MANAGEMENT -- (CONTINUED)
income after rapid and sustained interest rate movements, static analysis of
repricing and maturity mismatches, or gaps, between assets and liabilities, and
analysis of the size and sources of basis risk.
Using the Bank's IRR simulation model, the following table presents
management's estimate of the Bank's NPV after a hypothetical, instantaneous 200
basis points (bp) change in the market interest rates at December 31, 1994 and
1993 (thousands of dollars):
CHANGE IN ESTIMATED NPV ESTIMATED NPV
INTEREST RATES DECEMBER 31, 1994 DECEMBER 31, 1993
- -------------- ----------------- -----------------
+200 bp $ 102,192 $ 113,128
0 $ 143,020 $ 132,827
-200 bp $ 155,585 $ 123,742
As shown above, the Bank's estimated NPV increased from December 31, 1993
to December 31, 1994 by $10.2 million and $31.8 million under assumed changes in
market interest rates of zero bp and -200 bp, respectively. Over the same
period, however, the Bank's estimated NPV declined by $10.9 million under an
assumed change in market rates of +200 bp.
During 1994, market interest rates generally increased. Although the Bank's
estimated NPV had been expected to decline in a rising rate environment in IRR
simulations run as of December 31, 1993, the opposite actually occurred as a
result of actions taken by management. During 1994, the intangible value of the
Bank's core deposits increased as the Bank was able to lag increases in the
interest rates it pays on such deposits relative to increases in market interest
rates. During 1994, management also acted to acquire long-term deposits and
borrowings at historically low interest rates, and implemented several
off-balance sheet hedges to effectively convert certain fixed-rate loans to
adjustable-rate loans. These actions had a net effect of outweighing other
declines in the estimated market values of the Bank's assets, resulting in a net
increase in the Bank's estimated NPV as of December 31, 1994. These actions also
benefited the Bank's net interest margin and resulted in an increase in the net
yield of the Bank's interest-earning assets from 3.15 percent in 1993 to 3.69
percent in 1994.
Management also measures the Bank's IRR using static gap analysis to
further identify sources of IRR and its potential impact on net interest income.
Static gap analysis measures the difference between financial assets and
financial liabilities scheduled and expected to mature or reprice within a
specified time period. The gap for that period is positive when repricing and
maturing assets exceed repricing and maturing liabilities. The gap for that
period is negative when repricing and maturing liabilities exceed repricing and
maturing assets. A positive or negative cumulative gap indicates in a general
way how the Bank's net interest income should respond to interest rate
fluctuations. A positive cumulative gap for a period generally means that rising
interest rates would be reflected sooner in financial assets than in financial
costing liabilities, thereby increasing net interest income over that period. A
negative cumulative gap for a period would produce an increase in net interest
income over that period if interest rates declined.
At December 31, 1994 and 1993, the Bank's cumulative one-year static gap
was $(145) million and $(39.4) million, respectively, or negative eight percent
and negative two percent of financial assets.
The financial instruments approved by the BOD to manage the Bank's IRR
exposure in its balance sheet include the Bank's debt security portfolio,
interest rate swaps, interest rate caps, interest rate collars, interest rate
futures, and put and call options. These financial instruments provide effective
methods of reducing the impact of changes in interest rates on the market values
of and earnings provided by the Bank's assets and liabilities. The Bank also
actively manages its retail and wholesale funding sources to minimize its cost
of funds and provide stable funding sources for its loan and investment
portfolios. Management's use of particular financial instruments is based on a
complete analysis of current IRR exposure and the projected effect of any
85
89
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 17 -- INTEREST RATE RISK MANAGEMENT -- (CONTINUED)
proposed strategy. In addition, to manage the IRR exposure associated with the
Bank's held for sale loan portfolio, the Bank utilizes forward sale commitments.
At December 31, 1994 and 1993, the Bank utilized interest rate swap
agreements as a hedge to convert permanent fixed-rate loans into adjustable-rate
loans. The agreements require the Bank to make fixed-rate payments and in turn,
the Bank receives floating interest payments based on the six month LIBOR.
The following table presents the notional amount of interest rate swaps
outstanding, unrealized gains and losses of the swaps, the weighted average
interest rates payable and receivable, and the remaining term (thousands of
dollars).
DECEMBER 31, 1994
FIXED RATE VARIABLE RATE NOTIONAL UNREALIZED UNREALIZED
MATURITY PAID RECEIVED AMOUNT GAIN LOSS
-------- ---------- ------------- -------- ---------- ----------
1 - 3 Years................ 6.70% 5.56% $21,400 $ 652 $
3 - 5 Years................ 7.22 5.66 26,150 833 --
5 - 10 Years............... 6.88 5.76 24,900 1,506 (5)
---- ---- ------- ------ ----
6.95% 5.66% $72,450 $2,991 $ (5)
==== ==== ======= ====== ====
DECEMBER 31, 1993
FIXED RATE VARIABLE RATE NOTIONAL UNREALIZED UNREALIZED
MATURITY PAID RECEIVED AMOUNT GAIN LOSS
-------- ---------- ------------- -------- ---------- ----------
5 - 10 Years............... 5.45% 3.55% $7,500 $ 169 $ --
==== ==== ======= ====== ====
The notional amount of interest rate swaps do not represent amounts
exchanged by the parties and, thus, are not a measure of the Bank's exposure
through its use of derivatives. The amounts exchanged are determined by
reference to the notional amounts and the interest rates.
The Bank is exposed to credit-related losses in the event of nonperformance
by counterparties to financial instruments but does not expect any
counterparties to fail to meet their obligations. The Bank deals only with
highly rated broker/dealers. The current credit exposure of derivatives is
represented by the fair value of contracts with a positive fair value
(unrealized gain) at the reporting date.
During 1992, in conjunction with the restructuring of the Bank's balance
sheet and the sale of long-term fixed-rate assets, $300 million (notional
amount) of interest rate swaps hedging such assets were canceled at a cost of
$14.1 million, which is included as an expense in the accompanying Consolidated
Statements of Income. In addition, $35 million (notional amount) of interest
rate swaps matured during 1992. No interest rate swaps matured or were
terminated during 1993 and 1994. The interest rate swap agreements at December
31, 1994 are collateralized with MBS with a fair value of $2.7 million. The net
expense on interest rate swaps of $485,000, $24,000 and $4.8 million in 1994,
1993 and 1992, respectively, are included in interest expense as a cost of
hedging activities in the accompanying Consolidated Statements of Income.
The Bank is also exposed to IRR through the issuance of fixed-rate loan
commitments and builder loan commitments. Fixed-rate loan commitments represent
firm commitments to originate loans secured by real estate to specific borrowers
at a specified rate of interest. Builder commitments represent agreements to
home builders for the Bank to provide loans secured by real estate to
unspecified qualified customers of the builder at interest rates not to exceed
specified levels. Fixed-rate loan commitments generally expire in 30 to 60 days
and builder commitments generally expire within 6 to 12 months. The Bank
generally receives a fee for both of these types of commitments. Many of the
commitments are expected to expire without fully being drawn upon and therefore,
the total commitments do not necessarily represent future cash requirements.
86
90
SOUTHWEST GAS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 17 -- INTEREST RATE RISK MANAGEMENT -- (CONTINUED)
The Bank hedges IRR on fixed-rate loan commitments expected to be sold in
the secondary market and the inventory of loans held for sale through a
combination of commitments from permanent investors, optional delivery
commitments, and mandatory forward contracts. Outstanding firm commitments to
sell loans represent agreements to sell loans to a third party at a specified
price on a specified date. These commitments are used to hedge loans for sale
and to hedge outstanding commitments to originate loans. Outstanding master
commitments to sell loans represent agreements to sell a stated volume of loans
to a third party within a specified period of time without regard to price.
Master commitments are entered in order to ensure availability of a buyer for
loans meeting specified underwriting criteria and to maximize the sales price at
the time a firm commitment is executed. Related hedging gains and losses are
recognized at the time gains and losses are recognized on the related loans. See
Note 2 for commitments outstanding and their estimated fair value.
87
91
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders,
Southwest Gas Corporation:
We have audited the accompanying consolidated statements of financial
position of Southwest Gas Corporation (a California corporation, hereinafter
referred to as the Company) and subsidiaries as of December 31, 1994 and 1993,
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1994. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Company and its
subsidiaries as of December 31, 1994 and 1993, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1994 in conformity with generally accepted accounting principles.
As discussed in notes 1, 13 and 14 of the notes to consolidated financial
statements, and as required by generally accepted accounting principles, the
Company changed its methods of accounting for investments in certain debt and
equity securities, postretirement benefits other than pensions and income taxes
in 1993.
ARTHUR ANDERSEN LLP
Las Vegas, Nevada
February 8, 1995
88
92
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Identification of Directors. Information with respect to Directors is
set forth under the heading "Election of Directors" in the Company's
definitive Proxy Statement dated March 1995, which by this reference is
incorporated herein.
(b) Identification of Executive Officers. The name, age, position and
period position held during the last five years for each of the
Executive Officers of the Company are as follows:
PERIOD
POSITION
NAME AGE POSITION HELD
---- --- -------- --------
Michael O. Maffie 47 President and Chief Executive Officer 1993-Present
President and Chief Operating Officer 1990-1993
Dan J. Cheever 39 President and Chief Executive Officer/PriMerit Bank 1992-Present
President and Chief Operating Officer/PriMerit Bank 1991-1992
Executive Vice President and Chief Financial
Officer/PriMerit Bank 1990-1991
George C. Biehl 47 Senior Vice President and Chief Financial Officer 1990-Present
James F. Lowman 48 Senior Vice President/Central Arizona Division 1990-Present
Dudley J. Sondeno 42 Senior Vice President/Staff Operations 1993-Present
Vice President/Engineering and Operations Support 1990-1993
L. Keith Stewart 54 Senior Vice President/Operations 1993-Present
Senior Vice President/Southern Arizona Division 1992-1993
Senior Vice President/Nevada-California Region 1990-1992
Thomas J. Trimble 63 Senior Vice President, General Counsel and
Corporate Secretary 1990-Present
(c) Identification of Certain Significant Employees.
None.
(d) Family Relationships. None of the Company's Directors or Executive
Officers are related to any other either by blood, marriage or
adoption.
(e) Business Experience. Information with respect to Directors is set forth
under the heading "Election of Directors" in the Company's definitive
Proxy Statement dated March 1995, which by this reference is
incorporated herein. All Executive Officers have held responsible
positions with the Company for at least five years as described in (b)
above.
(f) Involvement in Certain Legal Proceedings.
None.
(g) Item 405 Review. Section 16(a) of the Securities Exchange Act of 1934
requires the Company's officers and directors, and persons who own more
than ten percent of a registered class of the Company's equity
securities, to file reports of ownership and changes in ownership with
the Securities and Exchange Commission (SEC) and the New York Stock
Exchange. Officers, directors and beneficial owners of more than ten
percent of any class of equity securities are required by SEC
regulation to furnish the Company with copies of all Section 16(a)
forms they file.
The Company has adopted procedures to assist its directors and
executive officers in complying with Section 16(a) of the Securities
and Exchange Act of 1934, which includes assisting in the preparation
of forms for filing. For 1994, all the required reports were filed
timely. In addition, amended Form 5s for 1992 and 1993 were filed for
Lloyd T. Dyer to reflect dividend reinvestment plan holdings that,
through an oversight, were omitted from the original Form 5 filings.
89
93
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation is set forth under the
heading "Executive Compensation and Benefits" in the Company's definitive Proxy
Statement dated March 1995, which by this reference is incorporated herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) Not applicable.
(b) Information with respect to security ownership of management is set
forth under the heading "Securities Ownership by Nominees and Executive
Officers" in the Company's definitive Proxy Statement dated March 1995,
which by this reference is incorporated herein.
(c) Not applicable.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to certain relationships and related transactions
is set forth under the heading "Certain Relationships and Related Transactions"
in the Company's definitive Proxy Statement dated March 1995, which by this
reference is incorporated herein.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report on Form 10-K:
(1) The following are included in Part II, Item 8 of this form:
PAGES
-----
Consolidated statements of financial position............................. 50
Consolidated statements of income......................................... 51
Consolidated statements of cash flows..................................... 52
Consolidated statements of stockholders' equity........................... 53
Notes to consolidated financial statements................................ 54
Report of independent public accountants.................................. 88
(2) None
(3) See list of exhibits.
(b) Reports on Form 8-K
The Company filed a Form 8-K, dated February 9, 1995, reporting summary
financial information for the year ended December 31, 1994.
(c) See Exhibits.
90
94
LIST OF EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
2.01 Not applicable.
3.01(3) Restated Articles of Incorporation, as amended.
3.02(12) Amended Bylaws of Southwest Gas Corporation.
4.01(1) Certificate of Determination establishing Cumulative Preferred Stock, 9.5%
Dividend Series, effective December 11, 1979.
4.02(4) Indenture between the Company and Bank of America National Trust and Savings
Association, as successor by merger to Security Pacific National Bank as
Trustee, dated August 1, 1986, with respect to the Company's 9% Series A and
Series B and 8 3/4% Series C Debentures.
4.03(5) First Supplemental Indenture of the Company to Bank of America National
Trust and Savings Association, as successor by merger to Security Pacific
National Bank as Trustee, dated as of October 1, 1986, supplementing and
amending the Indenture dated as of August 1, 1986, with respect to the
Company's 9% Debentures, Series A, due 2011.
4.04(5) Second Supplemental Indenture of the Company to Bank of America National
Trust and Savings Association, as successor by merger to Security Pacific
National Bank as Trustee, dated as of November 1, 1986, supplementing and
amending the Indenture dated as of August 1, 1986, with respect to the
Company's 9% Debentures, Series B, due 2011.
4.05(6) Third Supplemental Indenture of the Company to Bank of America National
Trust and Savings Association, as successor by merger to Security Pacific
National Bank as Trustee, dated as of December 1, 1986, supplementing and
amending the Indenture dated as of August 1, 1986, with respect to the
Company's 8 3/4% Debentures, Series C, due 2011.
4.06(6) Fourth Supplemental Indenture of the Company to Bank of America National
Trust and Savings Association, as successor by merger to Security Pacific
National Bank as Trustee, dated as of February 1, 1987, supplementing and
amending the Indenture dated as of August 1, 1986, with respect to the
Company's 10% Debentures, Series D, due 2017.
4.07(7) Fifth Supplemental Indenture of the Company to Bank of America National
Trust and Savings Association, as successor by merger to Security Pacific
National Bank as Trustee, dated as of August 1, 1988, supplementing and
amending the Indenture dated as of August 1, 1986, with respect to the
Company's 9 3/8% Debentures, Series E, due 2013.
4.08(8) Sixth Supplemental Indenture of the Company to Bank of America National
Trust and Savings Association, as successor by merger to Security Pacific
National Bank as Trustee, dated as of June 16, 1992, supplementing and
amending the Indenture dated as of August 1, 1986, with respect to the
Company's 9 3/4% Debentures, Series F, due 2002.
4.09(9) Indenture between Clark County, Nevada, and Bank of America Nevada as
Trustee, dated September 1, 1992, with respect to the issuance of
$130,000,000 Industrial Development Revenue Bonds (Southwest Gas
Corporation), $30,000,000 1992 Series A and $100,000,000 1992 Series B.
4.10(11) Indenture between Clark County, Nevada, and Harris Trust and Savings Bank as
Trustee, dated December 1, 1993, with respect to the issuance of $75,000,000
Industrial Development Revenue Bonds (Southwest Gas Corporation), 1993
Series A, due 2033.
4.11(11) Indenture between City of Big Bear Lake, California, and Harris Trust and
Savings Bank as Trustee, dated December 1, 1993, with respect to the
issuance of $50,000,000 Industrial Development Revenue Bonds (Southwest Gas
Corporation Project), 1993 Series A, due 2028.
4.12(13) Form of Deposit Agreement.
4.13(13) Form of Depositary Receipt (attached as Exhibit A to Deposit Agreement
included as Exhibit 4.12 hereto).
4.14(13) Form of Indenture relating to the Debt Securities.
91
95
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
4.15 The Company hereby agrees to furnish to the SEC, upon request, a copy of any
instruments defining the rights of holders of long-term debt issued by
Southwest Gas Corporation or its subsidiaries.
9.01 Not applicable.
10.01(2) Participation Agreement among the Company and General Electric Credit
Corporation, Prudential Insurance Company of America, Aetna Life Insurance
Company, Merrill Lynch Interfunding, Bank of America through purchase of
Valley Bank of Nevada, Bankers Trust Company and First Interstate Bank of
Nevada, dated as of July 1, 1982.
10.02(2) Lease and Agreement between the Company and Spring Mountain Road Associates,
dated as of June 15, 1982 and amended as of July 1, 1982.
10.03(11) Financing Agreement between the Company and Clark County, Nevada, dated
September 1, 1992.
10.04(11) Financing Agreement between the Company and Clark County, Nevada, dated as
of December 1, 1993.
10.05(11) Project Agreement between the Company and City of Big Bear Lake, California,
dated as of December 1, 1993.
10.06(12) Southwest Gas Corporation Executive Deferral Plan, amended and restated May
10, 1994.
10.07(10) Southwest Gas Corporation Directors Deferral Plan, as amended October 29,
1992.
10.08(11) Southwest Gas Corporation Board of Directors Retirement Plan, amended and
restated effective October 1, 1993.
10.09(12) Southwest Gas Corporation Management Incentive Plan, amended and restated
May 10, 1994.
10.10(12) Southwest Gas Corporation Supplemental Retirement Plan, amended and restated
as of May 10, 1994.
10.11(11) Agreements between PriMerit Bank and World Savings and Loan Association
regarding sale of Arizona assets and assumption of related liabilities.
10.12 Management Contract with PriMerit Bank officer.
10.13 $200 million Credit Agreement between the Company, Union Bank of
Switzerland, et al., dated as of January 27, 1995.
11.01 Not applicable.
12.01 Not applicable.
13.01 Not applicable.
16.01 Not applicable.
18.01 Not applicable.
21.01 List of subsidiaries of Southwest Gas Corporation.
22.01 Not applicable.
23.01 Consent of Arthur Andersen LLP, Independent Public Accountants.
24.01 Not applicable.
27.01 Financial Data Schedule (filed electronically only).
28.01 Not applicable.
99.01 PriMerit Bank 1994 Financial Statement Package.
- ---------------
(1) Incorporated herein by reference to the Company's Registration Statement on
Form S-16, No. 2-68833.
(2) Incorporated herein by reference to the Company's report on Form 10-K for
the year ended December 31, 1982.
(3) Incorporated herein by reference to the Company's Registration Statement on
Form S-2, No. 2-92938.
(4) Incorporated herein by reference to the Company's Registration Statement on
Form S-3, No. 33-7931.
92
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(5) Incorporated herein by reference to the Company's report on Form 10-K for
the year ended December 31, 1986.
(6) Incorporated herein by reference to the Company's report on Form 10-Q for
the quarter ended March 31, 1987.
(7) Incorporated herein by reference to the Company's report on Form 8-K dated
August 23, 1988.
(8) Incorporated herein by reference to the Company's report on Form 10-Q for
the quarter ended June 30, 1992.
(9) Incorporated herein by reference to the Company's report on Form 10-Q for
the quarter ended September 30, 1992.
(10) Incorporated herein by reference to the Company's report on Form 10-K for
the year ended December 31, 1992.
(11) Incorporated herein by reference to the Company's report on Form 10-K for
the year ended December 31, 1993.
(12) Incorporated herein by reference to the Company's report on Form 10-Q for
the quarter ended June 30, 1994.
(13) Incorporated herein by reference to the Company's Registration Statement on
Form S-3, No. 33-55621.
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97
SIGNATURES
Pursuant to the requirements of Section 15(d) 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.
SOUTHWEST GAS CORPORATION
By MICHAEL O. MAFFIE
----------------------------------
Michael O. Maffie, President
(Chief Executive Officer)
Date: March 6, 1995
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
GEORGE C. BIEHL Senior Vice President March 6, 1995
----------------------------- (Chief Financial Officer)
(George C. Biehl)
EDWARD A. JANOV Controller March 6, 1995
----------------------------- (Chief Accounting Officer)
(Edward A. Janov)
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98
SIGNATURES
Pursuant to the requirements of Section 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
RALPH C. BATASTINI Director March 6, 1995
-------------------------------
(Ralph C. Batastini)
MANUEL J. CORTEZ Director March 6, 1995
-------------------------------
(Manuel J. Cortez)
LLOYD T. DYER Director March 6, 1995
-------------------------------
(Lloyd T. Dyer)
KENNY C. GUINN Chairman of the Board
------------------------------- of Directors March 6, 1995
(Kenny C. Guinn)
THOMAS Y. HARTLEY Director March 6, 1995
-------------------------------
(Thomas Y. Hartley)
MICHAEL B. JAGER Director March 6, 1995
-------------------------------
(Michael B. Jager)
------------------------------- Director
(Leonard R. Judd)
JAMES R. LINCICOME Director March 6, 1995
-------------------------------
(James R. Lincicome)
MICHAEL O. MAFFIE President and Director
------------------------------- (Chief Executive Officer) March 6, 1995
(Michael O. Maffie)
CAROLYN M. SPARKS Director March 6, 1995
-------------------------------
(Carolyn M. Sparks)
ROBERT S. SUNDT Director March 6, 1995
-------------------------------
(Robert S. Sundt)
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99
GLOSSARY OF TERMS
401k -- The Employees' Investment Plan
ACC -- Arizona Corporation Commission
AFS -- Available-For-Sale
ARM -- Adjustable-Rate Mortgages
the Bank -- PriMerit Bank
the Board -- Southwest Gas Corporation Board of Directors
BOD -- The Bank's Board of Directors
CAMEL -- Capital, Assets, Management, Earnings and Liquidity
CMO -- Collateralized Mortgage Obligations
the Company -- Southwest Gas Corporation
CPUC -- California Public Utilities Commission
CRA -- Community Reinvestment Act of 1977
Credit Agreement -- Restated and Amended Credit Agreement
El Paso -- El Paso Natural Gas Company
FASB -- Financial Accounting Standards Board
FDIC -- Federal Deposit Insurance Corporation
FDICIA -- Federal Deposit Insurance Corporation Improvement Act of 1991
FERC -- Federal Energy Regulatory Commission
FHA -- Federal Housing Authority
FHLB -- Federal Home Loan Bank
FHLMC -- Federal Home Loan Mortgage Corporation
FIRREA -- Financial Institutions Reform, Recovery and Enforcement Act
flex repos -- Flexible Reverse Repurchase Agreements
FNMA -- Federal National Mortgage Association
GAAP -- Generally Accepted Accounting Principles
gas segment -- Natural Gas Operations Segment
GNMA -- Government National Mortgage Association
IDRB -- Industrial Development Revenue Bonds
IRR -- Interest Rate Risk
ITC -- Investment Tax Credit
Kern River -- Kern River Gas Transmission Company
LDC -- Local Distribution Company
LIBOR -- London Interbank Offering Rate
LNG -- Liquefied Natural Gas
MBS -- Mortgage-Backed Securities
MD&A -- Management's Discussion and Analysis
NOW -- Negotiable Order of Withdrawal
NPV -- Net Portfolio Value
OTS -- Office of Thrift Supervision
Paiute -- Paiute Pipeline Company
Pataya -- Pataya Gas Storage Project
PBOP -- Postretirement Benefits Other Than Pensions
PGA -- Purchased Gas Adjustment
PSCN -- Public Service Commission of Nevada
REMIC -- Real Estate Mortgage Investment Conduits
SAIF -- Savings Association Insurance Fund
SAM -- Supply Adjustment Mechanism
SEC -- Securities and Exchange Commission
SFAS -- Statement of Financial Accounting Standards
SFR -- Single-Family Residential
SoCal -- Southern California Gas Company
VA -- Veterans Administration
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