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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