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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 June 30, 1996
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 0-22528
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QUAKER CITY BANCORP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4444221
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
7021 GREENLEAF AVENUE 90602
WHITTIER, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 907-2200
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
[X] Yes [_] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the average bid and asked price of its Common Stock,
$.01 par value, on August 31, 1996, on the Nasdaq National Market System was
approximately $48,117,000.
At September 19, 1996, 3,800,600 shares of the Registrant's Common Stock
were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement to be filed with the Securities
and Exchange Commission in connection with the Annual Meeting of Stockholders
to be held November 13, 1996 are incorporated by reference in Part III hereof.
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TABLE OF CONTENTS
PAGE
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PART I
ITEM 1. BUSINESS..................................................... 1
General...................................................... 1
Lending Activities........................................... 5
Delinquencies and Classification of Assets................... 12
Non-Performing Assets and Restructured Loans................. 13
Allowances for Loan and Real Estate Losses................... 15
Investment Activities........................................ 17
Sources of Funds............................................. 19
Subsidiary Activities........................................ 21
Competition.................................................. 22
Personnel.................................................... 22
Federal Taxation............................................. 22
State and Local Taxation..................................... 24
Regulation and Supervision................................... 25
General..................................................... 25
Activities Restrictions..................................... 25
Deposit Insurance........................................... 26
FIRREA Capital Requirements................................. 28
Prompt Corrective Action Requirements....................... 30
Savings and Loan Holding Company Regulation................. 30
Classification of Assets.................................... 33
Community Reinvestment Act.................................. 34
Federal Home Loan Bank System............................... 34
Required Liquidity.......................................... 34
Federal Reserve System...................................... 35
ITEM 2. PROPERTIES................................................... 36
ITEM 3. LEGAL PROCEEDINGS............................................ 37
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......... 37
ITEM 4A. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........... 37
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.......................................... 38
ITEM 6. SELECTED FINANCIAL DATA...................................... 39
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................... 41
General...................................................... 41
Problem Assets............................................... 41
Results of Operations........................................ 41
Financial Condition.......................................... 43
Capital Resources and Liquidity.............................. 44
Asset/Liability Management................................... 46
Net Interest Income.......................................... 49
Average Balance Sheet........................................ 49
Impact of Inflation and Changing Prices...................... 51
Impact of New Accounting Standards........................... 52
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................. 53
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE..................................... 88
PAGE
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 88
ITEM 11. EXECUTIVE COMPENSATION........................................ 88
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................... 88
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 88
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K................................................... 89
SIGNATURES.................................................... 92
PART I
ITEM 1. BUSINESS
GENERAL
Quaker City Bancorp, Inc. (the "Company"), incorporated in Delaware, is
primarily engaged in the savings and loan business through its wholly owned
subsidiary Quaker City Federal Savings and Loan Association (the
"Association"). The Company was organized on September 13, 1993 for the
purpose of acquiring all of the capital stock of the Association issued in the
conversion of the Association from mutual to stock form effective December 30,
1993. The Association was originally founded in 1920 as the Mutual Building
and Loan Association of Whittier, and in 1938 became a federally chartered
mutual savings and loan association. The Company's principal business is
serving as the holding company for the Association. Historical information
presented throughout this report at and for periods ended prior to the
Company's commencement of operations on December 30, 1993 is that of the
Association. The executive offices of the Company are located at 7021
Greenleaf Avenue, Whittier, California 90602, telephone number (310) 907-2200.
The Association operates eight retail full service branches in the Southern
California communities of Whittier (2), La Habra (2), Brea, Fullerton, La
Mirada and Hacienda Heights. At June 30, 1996, the Association also operated
two loan origination centers located in the Southern California communities of
Hacienda Heights and Palm Desert.
The Association's principal business has been and continues to be attracting
retail deposits from the general public in the area surrounding its offices
and investing those deposits, together with funds generated from operations
and borrowings. Through its wholly owned subsidiary, Quaker City Financial
Corporation ("QCFC"), the Association also engages in the sale of insurance
and investment products on an agency basis. See "--Subsidiary Activities." The
Association originates predominantly one-to-four family loans and multifamily
loans within its primary market area and emphasizes multifamily lending in low
and moderate income communities, specifically in the Los Angeles metropolitan
area. To a lesser extent, the Association invests in commercial real estate
loans. At June 30, 1996, the Association's mortgage loan portfolio (including
loans held for sale) aggregated approximately $624.7 million, of which
approximately 48.54% was secured by one-to-four residential properties, 41.45%
was secured by multifamily (five or more units) properties and 9.74% was
secured by commercial properties. See "--Lending Activities." At that same
date, approximately 85.48% of the one-to-four family, 94.03% of the
multifamily and 89.50% of the commercial mortgage portfolios consisted of
adjustable rate loans.
In addition to originating loans to hold in portfolio, the Association also
originates loans for sale. The Association also purchases loans for investment
and for sale. Loan sales come from loans held in the Association's portfolio
designated as being held for sale or originated during the period and being so
designated. Historically, the Association has generally retained the servicing
rights of loans sold, but it may not necessarily do so in the future. In
addition, the Association invests in securities issued by the U.S. Government
and agencies thereof, mortgage-backed securities ("MBS") and other permitted
investments under applicable federal laws and regulations. The Association's
revenues are derived principally from interest on its mortgage loans, and to a
lesser extent, mortgage loan servicing activities, and interest and dividends
on its investment securities and MBS.
The Association's primary sources of funds are deposits, borrowings from the
Federal Home Loan Bank ("FHLB") of San Francisco ("FHLB advances"), securities
sold under agreements to repurchase, principal and interest payments on loans
and proceeds from the sale of loans. At June 30, 1996, the Association had
deposits of approximately $512.5 million, including approximately $66.1
million in time deposits of $100,000 or more. At that date, the Association's
borrowings included $135.3 million in
1
FHLB advances and $300,000 in securities sold under agreements to repurchase.
See "--Sources of Funds."
The Association's deposit accounts are insured by the Federal Deposits
Insurance Corporation (the "FDIC") through the Savings Association Insurance
Fund (the "SAIF"). A number of proposals for recapitalizing the SAIF have been
under discussion by various affected parties, relevant governmental agencies
and members of Congress during 1995 and 1996. The Company is not able to
predict whether or in what form any of the proposals that have been discussed
will be adopted. However, a significant special assessment to recapitalize the
SAIF or a significant increase in regularly assessed insurance premiums would
have an initial adverse effect on the operating expenses and results of the
Association and the Company and would reduce the Association's regulatory
capital. Over the long-term, however, a recapitalization of the SAIF could be
expected to reduce the Association's annual deposit insurance costs. See
"Business--Regulation and Supervision--Deposit Insurance--Insurance Premium
Assessments."
The Company and the Association are subject to the examination, supervision
and reporting requirements of the Office of Thrift Supervision (the "OTS"),
their primary federal banking regulator. The Association is also subject to
examination and supervision by the FDIC. See "--Regulation and Supervision--
General."
Based upon its regulatory capital levels the Association is classified as
"well-capitalized" for purposes of regulations promulgated by the OTS.
For the year ended June 30, 1996, the Company reported net earnings of $3.6
million. This compares to a net earnings of $2.3 million for the year ended
June 30, 1995 and a net loss of $2.3 million for the year ended June 30, 1994.
At June 30, 1996, the Company had total consolidated assets of $725.1 million,
total deposits of $512.5 million and stockholders' equity of $67.9 million,
representing 9.37% of total assets.
The 54% improvement in fiscal 1996 earnings over last year was primarily due
to improvement of the net interest margin and a 13% increase in total assets
during the year. The net interest margin increased to 3.24% for the year
ending June 30, 1996 compared to 3.07% for the previous year. The increase in
the net interest margin is a result of adjustable rate loans, previously
originated at a lower introductory rate, repricing upward during the year, as
well as an increase in originations of higher yielding multifamily loans. In
addition, the Company's cost of funds, which is also a component of the net
interest margin, declined during the period.
Total assets of the Company were $725.1 million at June 30, 1996, an
increase of $83.9 million during the fiscal year. The increase in assets was
primarily in residential lending with loans on multifamily properties
increasing $53.2 million, single family loans increasing $14.6 million, and
with investment securities and mortgage backed securities increasing $14.6
million. The asset growth was funded by an increase in deposits of $31.4
million and borrowings of $48.8 million.
The Southern California economy and real estate markets in the Association's
primary lending area remained weak during 1996; however, the Association's
level of non-performing assets declined from June 30, 1995. The Association
includes nonaccruing loans, troubled debt restructured loans and real estate
acquired through foreclosure ("REO") in determining its level of non-
performing assets. At June 30, 1996 the Company reported $14.9 million in non-
performing assets in the Association's portfolio compared to $16.9 million and
$22.2 million at June 30, 1995 and 1994, respectively. The Association
recorded provisions for loan losses of $2.1 million for the year ended
June 30, 1996 compared to $998,000 and $10.2 million for the years ended June
30, 1995 and 1994, respectively. Management believes that the increase in the
provision for 1996 was necessary in order to replenish the allowance for loan
losses to a level that management believes to be adequate following increased
charge-offs during 1996 compared to 1995. See "--Allowances for Loan and Real
Estate Losses" and "MD&A--Results of Operations."
2
The following tables set forth certain financial and operating information
with respect to the Company.
AT OR FOR THE YEAR ENDED JUNE 30,
------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
SELECTED FINANCIAL DATA:
Total assets........... $725,085 $641,173 $512,102 $487,020 $489,698
Total liabilities...... 657,159 574,732 447,464 445,186 450,090
Stockholders' equity... 67,926 66,441 64,638 41,834 39,608
SELECTED OPERATING DATA:
Interest income........ $ 52,646 $ 41,042 $ 35,286 $ 40,660 $ 38,410
Interest expense....... 31,151 23,503 17,456 20,483 21,723
-------- -------- -------- -------- --------
Net interest income
before provision for
loan losses......... 21,495 17,539 17,830 20,177 16,687
Provision for loan
losses................ 2,103 998 10,200 3,657 304
-------- -------- -------- -------- --------
Net interest income
after provision for
loan losses......... 19,392 16,541 7,630 16,520 16,383
Total other income..... 2,489 2,080 2,856 2,034 1,595
Total other expense.... 15,739 15,033 14,430 14,934 10,889
-------- -------- -------- -------- --------
Earnings (loss) before
income taxes.......... 6,142 3,588 (3,944) 3,620 7,089
Income taxes (benefit). 2,573 1,267 (1,613) 1,394 3,055
-------- -------- -------- -------- --------
Net earnings (loss).... $ 3,569 $ 2,321 $ (2,331) $ 2,226 $ 4,034
======== ======== ======== ======== ========
Net earnings (loss) per
share................. $ 0.92(1) $ 0.60(1) $ (0.66)(2) N/A N/A
======== ======== ======== ======== ========
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(1) Earnings per share in 1996 and 1995 were calculated based on weighted
average shares outstanding of 3,871,290 and 3,850,176, respectively.
(2) Earnings per share data was calculated based on the Company's net loss of
$2,745,000 for the period December 30, 1993 through June 30, 1994 and
4,140,000 shares of common stock of the Company outstanding; the Company
completed its initial public stock offering and commenced operations on
December 30, 1993.
3
AT OR FOR THE YEAR ENDED JUNE 30,
-----------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
SELECTED FINANCIAL RATIOS AND OTHER
DATA:
PERFORMANCE RATIOS:
Return on average assets.......... 0.53% 0.39% (0.46)% 0.45% 0.97%
Return on average equity.......... 5.25 3.53 (4.13) 5.38 10.85
Average equity to average assets.. 10.04 11.18 11.24 8.32 8.99
Equity to total assets............ 9.37 10.36 12.62 8.59 8.09
Interest rate spread during the
period(1)........................ 2.68 2.56 3.20 3.67 3.67
Net interest margin(2)............ 3.24 3.07 3.66 4.06 4.18
Average interest-earning assets to
average
interest-bearing liabilities..... 111.47 112.31 113.02 109.17 109.45
General and administrative expense
to average
assets........................... 2.18 2.39 2.59 2.56 2.60
Other expense to average assets... 2.32 2.55 2.87 3.00 2.63
Dividend pay-out ratio............ -- -- -- N/A N/A
REGULATORY CAPITAL RATIOS:
Tangible capital.................. 7.67 8.11 9.88 8.25 7.84
Core capital...................... 7.67 8.11 9.88 8.25 7.84
Risk-based capital................ 12.74 14.07 16.09 14.24 13.02
ASSET QUALITY RATIOS:
Non-performing loans as a percent-
age of total
loans(3)......................... 2.00 2.67 4.22 2.41(5) 0.52
Non-performing assets as a per-
centage of total
assets(4)........................ 2.06 2.64 4.33 2.65(5) 0.70
Allowance for loan losses as a
percentage of
total loans...................... 1.25 2.17 2.88 1.17 0.36
Allowance for loan losses as a
percentage of
non-performing loans............. 62.64 81.51 68.30 48.39 68.78
Allowance for losses as a percent-
age of total
non-performing assets(6)......... 53.60 72.68 62.18 39.94 48.71
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(1) The interest rate spread represents the difference between the weighted-
average rate on interest-earning assets and the weighted-average rate on
interest-bearing liabilities.
(2) The net interest margin represents net interest income as a percentage of
average interest-earning assets.
(3) Non-performing loans consist of non-accrual and troubled debt restructured
loans. Total loans include loans held for sale.
(4) Non-performing assets consist of non-performing loans and REO.
(5) The non-accrual loan policy was changed in October, 1992 from ninety to
sixty days.
(6) Allowance for losses includes valuation allowances on loans and REO.
4
LENDING ACTIVITIES
General. Since 1982 the Association has emphasized the origination of
adjustable rate mortgage ("ARM") loans for retention in its portfolio. This
practice has enabled the Association to reduce its interest-rate risk exposure
by concentrating its loan portfolio in assets with either shorter terms, more
frequent repricing, or both. The Association originates fixed-rate loans in
response to customer demand as well. The type of loans the Association
originates is dependent upon the relative customer demand for fixed-rate or
ARM loans, which in turn is affected by the current and expected level of
interest rates. Historically, fixed-rate loans have been sold in the secondary
market to the Federal National Mortgage Association ("FNMA"), Federal Home
Loan Mortgage Corporation ("FHLMC") and others. During 1996 the Association
retained certain fixed rate loans in its portfolio. It is anticipated that the
Association may continue this policy in the immediate future.
During the fiscal year ended June 30, 1996, the Association originated loans
with an outstanding balance of $5.7 million under an agreement with the City
of Los Angeles in which the Association will guarantee up to $10 million of
multifamily housing revenue bonds primarily for the acquisition and renovation
of earthquake-stricken properties. In conjunction with this guarantee, a
standby letter of credit was issued by the Federal Home Loan Bank. During the
fiscal year ended June 30, 1996, the Association entered into an agreement
with the City of Los Angeles to guarantee up to an additional $5 million of
multifamily housing revenue bonds. At June 30, 1996, no loans were originated
under this agreement. In conjunction with this guarantee a standby letter of
credit was issued by the Federal Home Loan Bank.
Loan and Mortgage-Backed Securities Portfolio Composition. The Association's
loan portfolio consists primarily of conventional first mortgage loans secured
by one-to-four family and multifamily (five or more units) residences. At June
30, 1996, the Association had total loans outstanding of $624.7 million, of
which $303.3 million, or 48.54%, were one-to-four family mortgage loans. At
the same date, multifamily mortgage loans totaled $259.0 million, or 41.45% of
total loans. The remainder of the portfolio consists of $60.8 million of
commercial real estate loans, or 9.74% of total loans, $1.0 million of land
loans, or 0.17% of total loans, and other loans of $627,000, or 0.10% of total
loans. Included in these amounts at June 30, 1996 were $2.9 million of loans
held for sale, comprising 0.46% of total loans. At that same date, 85.48% of
the Association's one-to-four family, 94.03% of its multifamily and 89.50% of
its commercial mortgage loans had adjustable interest rates.
The Company has also invested in MBS. At June 30, 1996, MBS totaled $41.2
million, or 5.68% of total assets. At June 30, 1996, all MBS were classified
as held to maturity.
The following table sets forth the composition of the Company's loan and
mortgage-backed securities portfolios in dollar amounts and percentages of the
respective portfolio at the dates indicated.
5
AT JUNE 30,
---------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------------ ------------------ ------------------ ------------------ -----------------
PERCENT
PERCENT PERCENT PERCENT PERCENT OF
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT TOTAL
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------
(DOLLARS IN THOUSANDS)
Loans:
Residential:
One-to-four units.... $303,273 48.54% $288,664 51.85% $234,709 49.51% $201,617 46.25% $230,783 52.01%
Multifamily.......... 258,970 41.45 205,731 36.95 177,539 37.46 174,025 39.92 148,882 33.55
Commercial............. 60,822 9.74 60,709 10.91 60,617 12.79 58,975 13.53 62,939 14.18
Construction........... -- -- -- -- -- -- -- -- 660 0.15
Land................... 1,038 0.17 1,046 0.19 691 0.15 720 0.17 -- --
Other................... 627 0.10 546 0.10 412 0.09 595 0.13 480 0.11
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
624,730 100.00% 556,696 100.00% 473,968 100.00% 435,932 100.00% 443,744 100.00%
====== ====== ====== ====== ======
Less:
Undisbursed loan
funds................. 378 187 183 215 225
Unamortized discounts.. 2,864 2,815 1,999 2,385 3,067
Deferred loan fees,
net................... 3,093 2,442 2,184 2,014 1,910
Allowance for loan
losses................ 7,833 12,108 13,660 5,079 1,593
-------- -------- -------- -------- --------
Loans, net........... 610,562 539,144 455,942 426,239 436,949
Less:
Loans held for sale:
One-to-four units.... 1,455 400 5,415 8,989 6,079
Multifamily.......... 1,435 1,266 -- 3,683 19,097
-------- -------- -------- -------- --------
Net loans held for
investment.......... $607,672 $537,478 $450,527 $413,567 $411,773
======== ======== ======== ======== ========
Mortgage-backed
securities:
FNMA................... $ 11,129 26.70% $ 11,367 27.77% $ -- -- % $ -- -- % $ 40 0.28%
FHLMC.................. 1,697 4.07 2,117 5.17 119 0.80 192 1.40 435 3.06
GNMA................... 7,885 18.92 -- -- -- -- -- -- -- --
Issued by other
financial
institutions.......... 5,781 13.87 11,451 27.97 12,659 84.64 11,495 83.98 13,464 94.75
Collateralized
mortgage obligations.. 15,185 36.44 16,004 39.09 2,178 14.56 2,001 14.62 271 1.91
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
41,677 100.00% 40,939 100.00% 14,956 100.00% 13,688 100.00% 14,210 100.00%
====== ====== ====== ====== ======
Plus (Less):
Unamortized premium
(discount)............ (502) (946) (247) (115) (185)
-------- -------- -------- -------- --------
Mortgage-backed
securities, net..... 41,175 39,993 14,709 13,573 14,025
Less:
Mortgage-backed
securities available
for sale.............. -- -- 5,997 6,660 --
-------- -------- -------- -------- --------
Net mortgage-backed
securities held to
maturity............ $ 41,175 $ 39,993 $ 8,712 $ 6,913 $ 14,025
-------- -------- -------- -------- --------
Total net loans and
mortgage-backed
securities held for
investment............. $648,847 $577,471 $459,239 $420,480 $425,798
======== ======== ======== ======== ========
6
Loan Maturity. The following table shows the maturity of the Company's gross
loans and MBS at June 30, 1996. The table includes loans held for sale of $2.9
million. The table does not include principal repayments. Principal repayments
on loans totaled $48.0 million, $39.3 million and $64.1 million for the years
ended June 30, 1996, 1995 and 1994. Principal repayments on mortgage-backed
securities totaled $11.2 million, $2.9 million and $3.1 million for the years
ended June 30, 1996, 1995 and 1994.
AT JUNE 30, 1996
------------------------------------------------------------------------
TOTALS
---------------------
ONE- MORTGAGE-
TO-FOUR MULTI- LOANS BACKED
FAMILY FAMILY COMMERCIAL LAND OTHER RECEIVABLE SECURITIES TOTAL
-------- -------- ---------- ------ ----- ---------- ---------- --------
(IN THOUSANDS)
Amounts due:
One year or less....... $ 236 $ 1,805 $ 4,042 $ 645 $357 $ 7,085 $ -- $ 7,085
-------- -------- ------- ------ ---- -------- ------- --------
After one year:
More than one year to
three years........... 1,277 7,272 3,532 -- 36 12,117 1,131 13,248
More than three years
to five years......... 12,032 2,233 4,804 334 21 19,424 -- 19,424
More than five years to
10 years.............. 11,527 34,134 18,030 -- 2 63,693 3,267 66,960
More than 10 years to
20 years.............. 31,170 174,840 27,865 -- 206 234,081 81 234,162
More than 20 years..... 247,031 38,686 2,549 59 5 288,330 37,198 325,528
-------- -------- ------- ------ ---- -------- ------- --------
Total due after one
year................. 303,037 257,165 56,780 393 270 617,645 41,677 659,322
-------- -------- ------- ------ ---- -------- ------- --------
Total amounts due..... $303,273 $258,970 $60,822 $1,038 $627 $624,730 $41,677 $666,407
======== ======== ======= ====== ==== ======== ======= ========
The following table sets forth at June 30, 1996, the dollar amount of all
loans due after June 30, 1997, and whether such loans have fixed or adjustable
interest rates.
AT JUNE 30, 1996
---------------------------
FIXED ADJUSTABLE TOTAL
------- ---------- --------
(IN THOUSANDS)
Real estate loans:
One-to-four family................................ $43,787 $259,250 $303,037
Multifamily....................................... 13,658 243,507 257,165
Commercial real estate............................ 5,542 51,238 56,780
Land.............................................. 393 -- 393
Other loans......................................... 256 14 270
------- -------- --------
Total loans....................................... $63,636 $554,009 $617,645
======= ======== ========
Origination, Purchase, Sale and Servicing of Loans. The Association's
mortgage lending activities are conducted primarily through its executive
offices and two loan origination centers. The Association originates both
fixed-rate and ARM loans. Its ability to originate ARM loans as opposed to
fixed-rate loans is dependent upon the relative customer demand, which is
affected by the current and expected future level of interest rates.
Additionally, the Association purchases or participates in loans originated
by other institutions. The determination to purchase loans is based upon the
Association's investment needs and market opportunities. All loan types may be
purchased. The determination to purchase specific loans or pools of loans is
subject to the Association's underwriting policies, which require
consideration of the financial condition of the borrower and the appraised
value of the property, among other factors. Since
7
1990, the Association has purchased loans from independent parties in various
transactions, a substantial portion of which was purchased as part of certain
branch acquisitions. During the year ended June 30, 1996, $27.8 million, or
18.51% of the Association's total loan originations and purchases, were
purchased.
At origination or time of purchase, the Association designates loans as held
for investment or held for sale. Historically, loans held for sale have been
sold in the secondary market to FNMA, FHLMC and other investors. The
Association has generally retained the servicing rights of loans sold, but it
may not necessarily do so in the future. The determination to sell a specific
loan or pool of loans is made based upon the Association's investment needs,
growth objectives and market opportunities.
In an attempt to further minimize interest-rate risk associated with fixed-
rate loans designated as held for sale, the Association may enter into
commitments with FNMA and other investors (known as forward commitments) to
sell loans at a future date at a specified price. The Association will then
simultaneously process and close the loans, thereby attempting to protect the
price of loans in process from interest-rate fluctuations that may occur from
application to sale. There is risk involved in this forward commitment
activity. In a declining interest-rate environment, borrowers may choose not
to close loans but the Association would remain obligated to fulfill its
forward commitments. The inability of the Association to originate or acquire
loans to fulfill these commitments may result in the Association being
required to pay non-delivery fees. In an increasing interest-rate environment,
the Association is subject to interest-rate risk in the event its commitments
to make loans to borrowers exceeds its commitments to sell loans. The
Association does not intend to enter into forward commitments on ARM loans.
The Association recognizes at the time of sale, the cash gain or loss on the
sale of the loans based on the difference between the net cash proceeds
received and the carrying value of the loans sold. In addition, excess
servicing, which is the present value of any difference between the interest
rate charged to the borrower and the interest rate paid to the purchaser after
deducting a normal servicing fee, is recognizable as an adjustment to the cash
gain or loss. The excess servicing gain or loss is dependent on prepayment
estimates and discount rate assumptions. Historically, such excess servicing
gains or losses have not been material to the Association. At June 30, 1996,
the Association had no excess servicing asset.
In addition to retaining the servicing rights for originated loans, the
Association may also purchase mortgage servicing rights related to mortgage
loans originated by other institutions. The Association's loan policies
provide that the aggregate amount of purchased mortgage servicing shall not
exceed 75% of the total loans in the Association's portfolio that are serviced
for others. At June 30, 1996, the Association had no purchased mortgage
servicing rights asset.
8
The following table sets forth activity in the Company's loan and mortgage-
backed securities portfolios for the periods indicated:
AT OR FOR THE YEAR ENDED
JUNE 30,
---------------------------
1996 1995 1994
-------- -------- --------
(IN THOUSANDS)
Gross loans:
Beginning balance................................ $556,696 $473,968 $435,932
Loans originated:
One-to-four family............................. 51,383 60,915 127,251
Multifamily.................................... 70,841 39,177 22,612
Commercial..................................... 122 6,172 5,085
Land........................................... -- -- --
-------- -------- --------
Total loans originated......................... 122,346 106,264 154,948
Loans purchased................................ 27,789 24,792 4,773
Loans to facilitate the sale of REO............ 5,580 7,407 3,170
-------- -------- --------
Total......................................... 155,715 138,463 162,891
Less:
Transfer to REO................................ 7,764 8,593 4,174
Principal repayments........................... 48,032 39,295 64,063
Sales of loans................................. 27,662 10,321 54,869
Other, net..................................... 4,223 (2,474) 1,749
-------- -------- --------
Ending balance................................... $624,730 $556,696 $473,968
======== ======== ========
Gross mortgage-backed securities:
Beginning balance................................ $ 40,939 $ 14,956 $ 13,688
Mortgage-backed securities, purchased.......... 13,766 28,102 4,298
Less:
Principal repayments........................... 11,157 2,906 3,134
Other, net..................................... 1,871 (787) (104)
-------- -------- --------
Ending balance................................... $ 41,677 $ 40,939 $ 14,956
======== ======== ========
One-to-Four Family Mortgage Lending. The Association offers both fixed-rate
mortgage loans and ARM loans secured by one-to-four family residences,
including, to a lesser extent, condominium units, located in the Association's
primary market area, with maturities up to 30 years. Substantially all of such
loans are secured by property located in Southern California. Loan
originations are generally obtained from existing or past customers, members
of the local communities and loan brokers. In addition, the Association offers
fixed-rate personal loans to customers with a first trust deed loan on one-to-
four family units in a minimum amount of $1,000 and a maximum amount of
$25,000. The borrower must meet the Association's underwriting criteria at the
time the loan is made. The Association takes a security interest in the
borrower's first trust deed loan.
At June 30, 1996, the Association's total loans outstanding were $624.7
million, of which $303.3 million, or 48.54%, were one-to-four family mortgage
loans. Of the one-to-four family mortgage loans outstanding at that date,
14.52% were fixed-rate loans, and 85.48% were ARM loans. The Association's
policy is to originate one-to-four family mortgage loans in amounts generally
up to 80% of the lower of the appraised value or the selling price of the
property securing the loan and up to 95% of the appraised value or selling
price if private mortgage insurance is obtained. Subsequent declines in the
real estate values in the Association's primary lending area have resulted in
increases in the loan-to-value ratio on some mortgage loans.
Multifamily Lending. The Association originates multifamily mortgage loans
generally secured by 5-to-36 unit apartment buildings located in the Los
Angeles metropolitan area. In originating a
9
multifamily mortgage loan, the Association considers the qualifications of the
borrower as well as the underlying security. Some of the foremost factors to
be considered are the net operating income of the mortgaged premises before
debt service and depreciation, the debt service ratio (the ratio of net
earnings to debt service) and the ratio of loan amount to appraised value.
Pursuant to the Association's underwriting policies, a multifamily ARM loan
generally may only be made in an amount up to 80% of the appraised value of
the underlying property. The Association also generally requires a debt
service coverage ratio of 110%. Properties securing a loan are appraised by an
independent appraiser and title insurance is required on all loans. The
average outstanding loan balance on multifamily mortgage loans at June 30,
1996 was approximately $207,000, with the largest loan, as discussed below,
being $1.8 million. Subsequent declines in the real estate values in the
Association's primary lending area have resulted in an increase in the loan-
to-value ratio on some mortgage loans.
When evaluating the qualifications of the borrower for a multifamily loan,
the Association considers the financial resources and income level of the
borrower, the borrower's experience in owning or managing similar property,
and the Association's lending experience with the borrower. The Association's
underwriting policies require that the borrower be able to demonstrate strong
management skills and the ability to maintain the property with current rental
income. The borrower should also present evidence of the ability to repay the
mortgage and a history of making mortgage payments on a timely basis. In
assessing the creditworthiness of the borrower, the Association generally
reviews the financial statements, employment and credit history of the
borrower, as well as other related documentation. The Association's largest
multifamily loan at June 30, 1996 had an outstanding loan balance of $3.6
million, of which the Association owns $1.8 million and has participated the
remaining balance to another financial institution, and is secured by a
residential hotel located in the Los Angeles metropolitan area. This loan is
classified as Substandard by the Association (for definition of Substandard,
see "Delinquencies and Classification of Assets--Classification of Assets"
below). During the year ended June 30, 1996, the Association originated
$70.8 million of multifamily loans. At June 30, 1996, the multifamily loan
portfolio totaled $259.0 million or 41.45% of total loans. Of the $259.0
million in multifamily loans, 5.97% were fixed-rate loans and 94.03% were ARM
loans.
Multifamily loans are generally considered to involve a higher degree of
credit risk and to be more vulnerable to deteriorating economic conditions
than one-to-four family residential mortgage loans. These loans typically
involve higher loan principal amounts and the repayment of such loans
generally depend on the income produced by the operation or sale of the
property being sufficient to cover operating expenses and debt service.
Recessionary economic conditions of the type that have prevailed in the
Company's primary lending market area tend to result in higher vacancy and
reduced rental rates and net operating incomes from multifamily residential
properties. Of the Association's $6.2 million of charge-offs in fiscal 1996,
$4.4 million, or 70.71%, were for multifamily loans. See "Business--Allowances
for Loan and Real Estate Losses."
Commercial Real Estate Lending. The Association originates commercial real
estate loans that are generally secured by properties used for business
purposes such as small office buildings or a combination of residential and
retail facilities and mobile home park loans located in the Association's
primary market area. At June 30, 1996, the commercial real estate loan
portfolio aggregated $60.8 million. Of the $60.8 million, 10.50% were fixed-
rate loans and 89.50% were ARM loans. The Association originated $122,000 of
commercial real estate loans during the year ended June 30, 1996. The
Association's underwriting procedures provide that commercial real estate
loans generally may be made in amounts up to 70% of the appraised value of the
property. These loans may be made with terms up to 30 years for ARM loans. The
Association's underwriting standards and procedures are similar to those
applicable to its multifamily loans, wherein the Association considers the net
operating income of the property and the borrower's expertise, credit history
and profitability. The Association has generally required that the properties
securing commercial real estate loans have debt service coverage ratios of at
least 110%. The largest commercial real estate loan in the Association's
portfolio
10
is secured by a shopping center located in Orange, California and had an
outstanding principal balance at June 30, 1996 of $2.0 million and was not
classified.
Construction and Land Lending. Since April 1991, the Association has not
originated loans to contractors and individuals for the acquisition and
development of property; however, it may do so in the future. The
Association's construction loans primarily have been made to finance the
construction of one-to-four family properties and multifamily real estate
properties. The Association's policies provide that construction loans
generally may be made in amounts up to 85% of the appraised value of the
property for construction of one-to-four family construction loans and up to
80% of the appraised value for multifamily construction loans. The Association
typically requires an independent appraisal of the property. The Association
generally requires personal guarantees and a permanent loan commitment if the
Association will not be making the permanent loan. Loan proceeds are disbursed
in increments as construction progresses and as inspections warrant. Land
loans are determined on an individual basis, but generally they do not exceed
50% of the actual cost or current appraised value of the property, whichever
is less. Since June 1993, the Association has not originated land loans;
however, it may do so in the future. At June 30, 1996, the largest land loan
in the Association portfolio is secured by property in La Habra with a loan
balance of $1.0 million. This loan is classified as Substandard by the
Association. The Association had no construction loans outstanding as of
June 30, 1996.
Certain Loan Terms. The interest rates for the majority of the Association's
ARM loans are indexed to the 11th District Cost of Funds Index ("COFI"). The
Association currently offers a number of ARM loan programs with interest rates
which adjust monthly, semi-annually or annually, some of which have payment
caps. Because of payment caps and the different times at which interest rate
adjustments and payment adjustments are made, in periods of rising interest
rates monthly payments may not be sufficient to pay the interest accruing on
some of the Association's ARM loans. The amount of any shortfall ("negative
amortization") is added to the principal balance of the loan to be repaid
through future monthly payments, which could cause increases in the amount of
principal owed to the Association over that which was originally lent. The
Association currently has approximately $336.0 million in mortgage loans that
may be subject to negative amortization. During the years ended June 30, 1996,
1995 and 1994, the negative amortization associated with these loans totaled
$994,000, $430,000 and $46,000, respectively. Significant negative
amortization can increase the associated risk of default on loans,
particularly for loans originated with relatively high loan-to-value ratios.
Based on historical experience, management does not believe that the loss
experience on the loans that are subject to negative amortization is
materially different from the loss experience on the balance of its portfolio.
Mortgage loans originated by the Association, with the exception of one-to-
four family mortgage loans, generally include due-on-sale clauses which
provide the Association with the contractual right to deem the loan
immediately due and payable in the event the borrower transfers ownership of
the property without the Association's consent. Due-on-sale clauses are an
important means of adjusting the rates on the Association's fixed-rate
multifamily and commercial mortgage loan portfolios and the Association has
generally exercised its rights under these clauses.
Loan Approval Procedures and Authority. The Association's Board of Directors
has a standing Loan Committee. The Loan Committee is primarily responsible for
establishing the lending policies of the Association and reviewing properties
offered as security. The Board of Directors has authorized the following
persons to approve loans up to the amounts indicated: mortgage loans in
amounts of $750,000 and below may be approved by the Loan Division Manager or
his designate; mortgage loans in excess of $750,000 and up to $1.5 million
require the approval of the President or any member of the Loan Committee; and
mortgage loans in excess of $1.5 million requires the approval of at least two
members of the Loan Committee.
11
For all loans originated by the Association, upon receipt of a completed
loan application from a prospective borrower, a credit report is ordered and
certain other information is verified by an independent credit agency and, if
necessary, additional financial information is required. Appraisals of the
real estate intended to secure proposed loans over $100,000 are required,
which appraisals currently are performed by independent appraisers designated
and approved by the Association. The Association's Board annually approves the
independent appraisers used by the Association and approves the Association's
appraisal policy. The Association's policy is to obtain title and hazard
insurance on all real estate loans. If the original loan amount exceeds 80% of
the underlying property's value on a sale or refinance of a first trust deed
loan or private mortgage insurance is required, the borrower will be required
to make payments to a mortgage impound account from which the Association
makes disbursements for property taxes and mortgage insurance.
DELINQUENCIES AND CLASSIFICATION OF ASSETS
Delinquent Loans. Management performs a monthly review of all delinquent
loans and reports to the Company's Board of Directors regarding the same. The
procedures taken by the Association with respect to delinquencies vary
depending on the nature of the loan and period of delinquency.
The Association's policies generally provide that delinquent mortgage loans
be reviewed and that a written late charge notice be mailed no later than the
11th or 16th day of delinquency for mortgage loans with 10 day or 15 day grace
periods, respectively. The Association's policies provide that telephone
contact will be attempted to ascertain the reasons for delinquency and the
prospects of repayment. When contact is made with the borrower at any time
prior to foreclosure, the Association will attempt to obtain full payment or
work out a repayment schedule with the borrower to avoid foreclosure. See also
"--Non-Performing Assets and Restructured Loans."
At June 30, 1996, 1995 and 1994, delinquencies in the Association's loan
portfolio were as follows:
1996 1995 1994
--------------------------------- --------------------------------- ---------------------------------
60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE
---------------- ---------------- ---------------- ---------------- ---------------- ----------------
NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL
OF BALANCE OF BALANCE OF BALANCE OF BALANCE OF BALANCE OF BALANCE
LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS
------ --------- ------ --------- ------ --------- ------ --------- ------ --------- ------ ---------
(DOLLARS IN THOUSANDS)
One-to-four fami-
ly.............. 3 $ 246 12 $1,467 3 $ 144 9 $1,359 3 $ 406 14 $ 1,666
Multifamily...... 5 2,220 11 3,991 5 3,293 7 2,804 3 1,222 20 6,858
Commercial....... 1 1,087 7 3,155 2 1,111 4 2,757 1 456 9 4,006
Other loans...... -- -- 4 105 -- -- -- -- -- -- 10 35
--- ------ --- ------ --- ------ --- ------ --- ------ --- -------
Total........... 9 $3,553 34 $8,718 10 $4,548 20 $6,920 7 $2,084 53 $12,565
=== ====== === ====== === ====== === ====== === ====== === =======
Delinquent loans
to total gross
loans........... 0.57% 1.40% 0.82% 1.24% 0.44% 2.65%
The loans in the above table have been considered in connection with the
Association's overall assessment of the adequacy of its allowance for loan
losses. However, there can be no assurance that the Association will not have
to establish additional loss provisions for these loans in the future. See "--
Allowances for Loan and Real Estate Losses" and "MD&A--Problem Assets."
Classification of Assets. Federal regulations and the Association's
Classification of Assets Policy require that the Association utilize an
internal asset classification system as a means of reporting problem and
potential problem assets. The Association has incorporated the OTS internal
asset classifications as a part of its credit monitoring system. The
Association currently classifies problem and potential problem assets as
"Substandard," "Doubtful" or "Loss" assets. An asset is considered
"Substandard" if it is inadequately protected by the current net worth and
paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the insured institution will sustain "some loss" if the deficiencies are
not corrected. Assets classified as
12
"Doubtful" have all of the weaknesses inherent in those classified
"Substandard" with the added characteristic that the weaknesses present make
"collection or liquidation in full", on the basis of currently existing facts,
conditions, and values, "highly questionable and improbable." Assets
classified as "Loss" are those considered "uncollectible" and of such little
value that their continuance as assets without the establishment of a specific
loss reserve is not warranted. See "--Regulation and Supervision--
Classification of Assets." The Association's Internal Asset Review Committee
monthly reviews and classifies the Association's assets and reports the
results of its review to the Company's Board of Directors.
The following table sets forth information with respect to the classified
assets of the Association at June 30, 1996.
AT JUNE 30, 1996
-----------------------------------
SUBSTANDARD DOUBTFUL LOSS TOTAL
----------- -------- ------ -------
(IN THOUSANDS)
Real estate loans:
One-to-four family....................... $ 5,723 $-- $ 99 $ 5,822
Multifamily.............................. 13,749 -- 1,624 15,373
Commercial............................... 3,483 -- 461 3,944
Construction/Land........................ 995 -- -- 995
REO........................................ 2,435 -- -- 2,435
Investment in subsidiaries(1).............. 144 -- -- 144
------- ---- ------ -------
Total Classified Assets.................... $26,529 $-- $2,184 $28,713
======= ==== ====== =======
- --------
(1) At June 30, 1996, the Company classified as Substandard 61% of the
Association's equity investment in subsidiaries. At such date, QCFC
reported total assets of $1.2 million. See "--Subsidiary Activities."
In addition to adversely classified assets, assets which do not currently
expose the Association to sufficient risk to warrant adverse classification
but possess weaknesses are designated "Special Mention." According to OTS
guidelines, Special Mention assets are not adversely classified and do not
expose an institution to sufficient risk to warrant adverse classification. At
June 30, 1996, $9.1 million of assets were graded as Special Mention, compared
to $11.6 million at June 30, 1995.
These assets have been considered in connection with the Association's
overall assessment of the adequacy of its allowance for loan losses; however,
there can be no assurance that the Association will not establish additional
loss provisions for these assets in the future. See "--Allowances for Loan and
Real Estate Losses" and "MD&A--Problem Assets."
NON-PERFORMING ASSETS AND RESTRUCTURED LOANS
Prior to October 1992, it was the Association's general policy to continue
to accrue interest on all loans up to 90 days past due. As of October 1992,
the Association's non-accrual policy was changed from 90 to 60 days
delinquent. After 60 days, the Association ceases the accrual of interest on
loans and any previously accrued interest is reversed. In addition, the
Association may restructure a loan due to the debtor's financial difficulty
and grant a concession which the Association would not have otherwise
considered. REO is recorded at fair value less estimated costs of disposition.
Effective July 1, 1995, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment
of a Loan." SFAS No. 114 was subsequently amended by SFAS No. 118, "Accounting
by Creditors for Impairment of a Loan--Income Recognition and Disclosure." A
loan is considered impaired when based on current circumstances and events, it
is probable that a creditor will be unable to collect all amounts due
according to the contractual terms of
13
the loan agreement. Creditors are required to measure impairment of a loan
based on any one of the following: (i) the present value of expected future
cash flows from the loan discounted at the loan's effective interest rate,
(ii) an observable market price or (iii) the fair value of the loan's
underlying collateral. The adoption of SFAS 114 and 118 did not result in
additional charge-offs, provisions for loan losses or changes in previously
reported earnings, primarily because of the Company's historical practice of
measuring loan impairment based upon the fair value of the loan's underlying
collateral property, which is an acceptable methodology under the provisions
contained in SFAS 114 and 118.
At June 30, 1996, the Company had a gross investment in impaired loans of
$8.6 million, including $6.7 million for which allowance of $1.6 million had
been recorded and $1.9 million for which no allowance was required. During the
year ended June 30, 1996, the Company's average investment in impaired loans
was $11.8 million and income recorded on impaired loans totaled $611,000,
substantially all of which was recorded utilizing the cash-basis method of
accounting. Payments received on impaired loans which are performing under
their contractual terms are allocated to principal and interest in accordance
with the terms of the loans. Impaired loans totaling to $6.4 million were not
performing in accordance with their contractual terms at June 30, 1996, and
have been included in non-accrual loans at that date.
The following table sets forth information regarding non-accrual loans,
troubled debt restructured loans and REO. There were no accruing loans past
due 60 days or more for any of the periods presented below.
AT JUNE 30,
------------------------------------------
1996 1995 1994 1993 1992
------- ------- ------- ------- ------
(DOLLARS IN THOUSANDS)
Real estate loans:
One-to-four family............... $ 1,713 $ 1,503 $ 2,072 $ 2,983 $ 355
Multifamily...................... 6,211 6,097 8,080 3,107 1,652
Commercial....................... 4,242 3,868 4,462 763 309
Other:
Loans secured by savings
deposits....................... 105 -- 35 32 --
------- ------- ------- ------- ------
Total non-accrual loans......... 12,271 11,468 14,649 6,885 2,316
Troubled debt restructured loans... 234 3,387 5,352 3,611 --
------- ------- ------- ------- ------
Total non-performing loans...... 12,505 14,855 20,001 10,496 2,316
Real estate acquired through
foreclosure....................... 2,435 2,045 2,154 2,458 1,121
------- ------- ------- ------- ------
Total non-performing assets..... $14,940 $16,900 $22,155 $12,954 $3,437
======= ======= ======= ======= ======
Ratios:
Net charge-offs to average loans. 1.13% 0.75% 0.34% 0.03% 0.00%
Allowance for loan losses as a
percentage of total non-accrual
loans........................... 63.83 105.58 93.25 73.77 68.78
Allowance for loan losses as a
percentage of total loans....... 1.25 2.17 2.88 1.17 0.36
Allowance for loan losses as a
percentage of total non-
performing loans................ 62.64 81.51 68.30 48.39 68.78
Allowance for losses as a
percentage of total non-
performing assets(1)............ 53.60 72.68 62.18 39.94 48.71
Total non-accrual loans as a
percentage of total loans....... 1.96 2.06 3.09 1.58 0.52
Non-performing loans as a
percentage of total loans....... 2.00 2.67 4.22 2.41 0.52
Non-performing assets as a
percentage of total assets...... 2.06 2.64 4.33 2.65 0.70
- --------
(1) Allowance for losses includes valuation allowances on loans and real
estate owned.
14
The gross amount of interest income on non-accrual loans that would have
been recorded during the years ended June 30, 1996, 1995 and 1994 if the non-
accrual loans had been current in accordance with their original terms was
$1.1 million, $920,000 and $1.1 million, respectively. For the years ended
June 30, 1996, 1995 and 1994, $565,000, $497,000 and $614,000, respectively,
was actually earned on non-accrual loans and is included in interest income on
loans in the consolidated statements of operations for such years included in
this report. See "Financial Statements and Supplementary Data."
The Association has reached agreements with certain borrowers that provide
for the restructuring of existing loans secured by income-producing
properties. Restructurings are generally in the form of interest-rate
adjustments, extensions of maturities or deferred payments of principal or
interest. At June 30, 1996, the Association had one $234,000 troubled debt
restructured loan which was modified prior to the implementation of SFAS 114
and which was performing in accordance with the modified terms. The Company
accounts for such loans under the provisions of SFAS No. 15 "Accounting by
Debtors and Creditors for Troubled Debt Restructuring," as permitted under
SFAS 114. See "Financial Statements and Supplementary Data."
ALLOWANCES FOR LOAN AND REAL ESTATE LOSSES
The allowance for loan losses is established through a provision for loan
losses based on management's evaluation of the risks inherent in its loan
portfolio. The allowance for loan losses is maintained at an amount management
considers adequate to cover estimated losses in loans receivable which are
deemed probable and estimable in accordance with Statement of Financial
Accounting Standards No. 5, "Accounting for Contingencies." The allowance is
based upon a number of factors, including asset classifications, economic
trends, industry experience and trends, industry and geographic
concentrations, estimated collateral values, management's assessment of the
credit risk inherent in the portfolio, historical loan loss experience, the
Association's underwriting policies and the regulatory environment. It is the
Association's general policy to obtain appraisals on the underlying property
for loans 90 days or more past due and over $500,000. If the loan amount is
under $500,000, appraisals are obtained at the time of foreclosure.
The Association's allowance for loan losses decreased to $7.8 million, or
1.25% of total loans, at June 30, 1996 from $12.1 million, or 2.17% of total
loans, at June 30, 1995. The decrease in the allowance for loan losses during
the period ended June 30, 1996 reflects management's evaluation of the risks
inherent in its loan portfolio in consideration of various factors, including
trends in its non-performing assets, the regional economy and relevant real
estate values. The Association's ratio of non-performing loans to total loans
decreased to 2.00% at June 30, 1996 from 2.67% at June 30, 1995. The
Association's ratio of non-performing assets to total assets decreased during
this period to 2.06% at June 30, 1996 from 2.64% at June 30, 1995. As of June
30, 1996, the Association's allowance for losses to non-performing assets,
including loans 60 days past due, was 53.60% as compared to 72.68% at June 30,
1995.
The Association recorded a provision for loan losses of $2.1 million for the
year ended June 30, 1996 compared to $998,000 and $10.2 million for the years
ended June 30, 1995 and 1994, respectively. Management believes that the
increase in the provision for 1996 was necessary to replenish the allowance
for loan losses to what management believes is an adequate level following
increased charge-offs during 1996 compared to 1995. Although the Association
believes that the allowance for loan losses at June 30, 1996 is adequate,
there can be no assurance that the Association will not have to establish
additional loss provisions based upon future events. The Association will
continue to monitor and modify its allowances for loan losses as conditions
dictate. In addition, the OTS and the FDIC, as an integral part of their
examination process, periodically review the Association's valuation
allowance. These agencies may require the Association to establish additional
allowances, based on their judgments of the information available at the time
of the examination. See "Regulation and Supervision--Classification of
Assets."
15
It is the policy of the Association to "charge-off" consumer loans when it
is determined that they are no longer collectible. The policy for loans
secured by real estate, which comprise the bulk of the Association's
portfolio, is to establish an allowance for loan losses in accordance with the
Association's asset classification process, based on generally accepted
accounting principles ("GAAP"). It has generally been the practice of the
Association to "charge-off" losses after acquiring title to a property
securing the loan. Prior to acquiring title to REO, losses are recognized
through the establishment of valuation allowances. It is the policy of the
Association to obtain an appraisal on all REO upon acquisition by the
Association.
REO is initially recorded at fair value at the date of acquisition, less
estimated costs of disposition. Thereafter, if there is a further
deterioration in value, the Association writes down the REO directly for the
diminution in value. Real estate held for investment is carried at the lower
of cost or net realizable value. All costs of anticipated disposition are
considered in the determination of net realizable value. See "MD&A--Impact of
New Accounting Standards."
Included in loans purchased are $4.6 million of participation loan interests
sold by the Association in prior years that were repurchased during the fourth
quarter of fiscal 1995. Prior to the repurchase the Association owned from 20%
to 50% of the individual loans. The remaining interests were repurchased at a
discount amounting to $1.9 million of which $1.3 million was allocated to the
allowance for loan losses.
The following table sets forth activity in the Association's allowance for
loan losses and allowance for losses on REO.
AT OR FOR THE YEAR ENDED JUNE 30,
-----------------------------------------
1996 1995 1994 1993 1992
------- ------- ------- ------ ------
(IN THOUSANDS)
Accumulated through a charge to
earnings:
Balance at beginning of year..... $10,614 $13,458 $ 4,833 $1,307 $1,003
Provision for loan losses........ 2,103 998 10,200 3,657 304
Charge-offs(1)................... (6,175) (3,842) (1,575) (131) --
Recoveries....................... -- -- -- -- --
------- ------- ------- ------ ------
Subtotal charge-offs, (net)..... (6,175) (3,842) (1,575) (131) --
------- ------- ------- ------ ------
Balance at end of year........... 6,542 10,614 13,458 4,833 1,307
Valuation allowance for portfolios
acquired:
Balance at beginning of year..... 1,494 202 246 286 167
Purchases........................ 294 1,308 -- -- 201
Charge-offs(1)................... (471) -- -- -- --
Reductions credited.............. (26) (16) (44) (40) (82)
------- ------- ------- ------ ------
Balance at end of year........... 1,291 1,494 202 246 286
------- ------- ------- ------ ------
Total allowance for loan losses.. $ 7,833 $12,108 $13,660 $5,079 $1,593
======= ======= ======= ====== ======
Allowance for REO losses:
Balance at beginning of year..... $ 175 $ 115 $ 95 $ 81 $ --
Additions charged to operations.. -- 60 20 14 81
------- ------- ------- ------ ------
Balance at end of year........... $ 175 $ 175 $ 115 $ 95 $ 81
======= ======= ======= ====== ======
- --------
(1) Charge-offs by loan type for the year ended June 30, 1996 were $968,000,
$4,367,000, $795,000, $514,000 and $2,000 for one-to-four family,
multifamily, commercial real estate, land and non-mortgage loans,
respectively.
16
The following table sets forth the Association's allowance for loan losses
to total loans and the percentage of loans to total loans in each of the
categories listed.
AT JUNE 30,
-------------------------------------------------------------------------------------------
1996(1) 1995(1) 1994(1)
----------------------------- ------------------------------ ------------------------------
PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE
OF OF LOANS OF OF LOANS OF OF LOANS
ALLOWANCE IN EACH ALLOWANCE IN EACH ALLOWANCE IN EACH
TO TOTAL CATEGORY TO TO TOTAL CATEGORY TO TO TOTAL CATEGORY TO
AMOUNT ALLOWANCE TOTAL LOANS AMOUNT ALLOWANCE TOTAL LOANS AMOUNT ALLOWANCE TOTAL LOANS
------ ---------- ----------- ------- ---------- ----------- ------- ---------- -----------
(DOLLARS IN THOUSANDS)
One-to-four family...... $1,306 16.67% 48.54% $ 1,338 11.05% 51.85% $ 989 7.24% 49.51%
Multifamily............. 4,744 60.56 41.45 6,499 53.68 36.95 8,613 63.05 37.46
Commercial.............. 1,288 16.44 9.73 2,475 20.44 10.91 2,220 16.25 12.79
Land.................... 199 2.54 0.16 344 2.84 0.19 407 2.98 0.15
Other................... -- -- 0.12 -- -- 0.10 2 0.02 0.09
Unallocated............. 296 3.79 -- 1,452 11.99 -- 1,429 10.46 N/A
------ ------ ------ ------- ------ ------ ------- ------ ------
Total allowance
for loan losses....... $7,833 100.00% 100.00% $12,108 100.00% 100.00% $13,660 100.00% 100.00%
====== ====== ====== ======= ====== ====== ======= ====== ======
AT JUNE 30,
-----------------------------------------------------------
1993 1992
----------------------------- -----------------------------
PERCENTAGE PERCENTAGE
PERCENTAGE OF LOANS PERCENTAGE OF LOANS
OF IN EACH OF IN EACH
ALLOWANCE CATEGORY ALLOWANCE CATEGORY
TO TOTAL TO TO TOTAL TO
AMOUNT ALLOWANCE TOTAL LOANS AMOUNT ALLOWANCE TOTAL LOANS
------ ---------- ----------- ------ ---------- -----------
(DOLLARS IN THOUSANDS)
One-to-four family...... $ 637 12.54% 46.25% $ 252 15.82% 52.01%
Multifamily............. 2,932 57.72 39.92 504 31.64 33.55
Commercial.............. 1,066 20.99 13.53 629 39.48 14.18
Land.................... 13 0.26 0.17 10 0.63 0.15
Other................... -- -- 0.13 -- -- 0.11
Unallocated............. 431 8.49 N/A 198 12.43 N/A
------ ------ ------ ------ ------ ------
Total allowance
for loan losses....... $5,079 100.00% 100.00% $1,593 100.00% 100.00%
====== ====== ====== ====== ====== ======
- --------
(1) In 1996, 1995 and 1994, total specific allowances amounted to $2.2
million, $4.3 million and $5.1 million, respectively.
INVESTMENT ACTIVITIES
Federally chartered savings institutions such as the Association have the
authority to invest in various types of liquid assets, including United States
Treasury obligations, securities of various federal agencies, certain
certificates of deposit of insured banks and savings institutions, certain
bankers' acceptances, repurchase agreements and federal funds. Subject to
various restrictions, federally chartered savings institutions may also invest
their assets in commercial paper, investment grade corporate debt securities
and mutual funds whose assets conform to the investments that a federally
chartered savings institution is otherwise authorized to make directly.
Additionally, a federally chartered savings institution such as the
Association must maintain minimum levels of investments that qualify as liquid
assets under OTS regulations. See "--Regulation and Supervision--Required
Liquidity." The Association currently manages liquid assets at the minimum
level required under OTS requirements in an effort to maximize overall yield
on its investment portfolio.
The investment policy of the Company attempts to provide and maintain
liquidity, generate a favorable return on investments without incurring undue
interest-rate and credit risk, and complement the Association's lending
activities. Specifically, the Company's policy generally limits investments to
government and federal agency-backed securities and other non-government
guaranteed securities,
17
including corporate debt obligations, that are investment-grade. The Company's
policy authorizes investment in marketable equity securities meeting the
Company's guidelines. The policy requires that all investment purchases be
ratified by the Board of Directors of the Company. At June 30, 1996, the
Company had federal funds sold and other short-term investments and investment
securities in the aggregate amount of $43.8 million with a market value of
$43.2 million.
The following table sets forth certain information regarding the carrying
and fair values of the Company's federal funds sold and other short-term
investments and investment securities portfolio at the dates indicated:
AT JUNE 30,
--------------------------------------------------
1996 1995 1994
---------------- ---------------- ----------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE VALUE VALUE
-------- ------- -------- ------- -------- -------
(IN THOUSANDS)
Federal funds sold and other
short-term investments..... $ 6,400 $ 6,400 $ 9,450 $ 9,450 $ 2,400 $ 2,400
======= ======= ======= ======= ======= =======
Investment securities:
Held to maturity:
U.S. Government and
Federal agency
obligations............. $37,048 $36,437 $23,509 $23,531 $18,533 $18,244
Municipal bonds.......... 371 371 389 389 410 410
------- ------- ------- ------- ------- -------
Total held to maturity. 37,419 36,808 23,898 23,920 18,943 18,634
Available for sale:
Mutual funds............. -- -- 150 150 470 470
------- ------- ------- ------- ------- -------
Total investment
securities............ $37,419 $36,808 $24,048 $24,070 $19,413 $19,104
======= ======= ======= ======= ======= =======
The table below sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of the Company's federal
funds sold and other short-term investments and investment securities as of
June 30, 1996.
AT JUNE 30, 1996
-----------------------------------------------------------------------------------------------------
MORE THAN ONE MORE THAN FIVE MORE THAN TEN
ONE YEAR OR LESS YEAR TO FIVE YEARS YEARS TO TEN YEARS YEARS TOTAL
----------------- --------------------- --------------------- ----------------- -----------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
-------- -------- ---------- --------- ---------- --------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Federal funds sold and
other short-term
investments........... $6,400 4.62% $ -- -- % $ -- -- % $ -- -- % $ 6,400 4.62%
====== ==== ========== ======= ========== ======== ====== ==== ======= ====
Investment securities:
Held to maturity:
U.S. Government and
Federal agency
obligations.......... $ 395 6.33% $ 28,026 6.52% $ 3,635 6.96% $4,992 7.42% $37,048 6.68%
Municipal bonds....... -- -- -- -- -- -- 371 7.00(1) 371 7.00
------ ---------- ---------- ------ -------
Total investment
securities.......... $ 395 6.33% $28,026 6.52% $ 3,635 6.96% $5,363 7.39% $37,419 6.68%
====== ========== ========== ====== =======
- -------
(1) This rate represents the coupon rate on the investment and has not been
computed on a tax equivalent basis.
18
SOURCES OF FUNDS
General. Deposits, FHLB advances, securities sold under agreements to
repurchase, loan repayments and prepayments, proceeds from sales of loans, and
cash flows generated from operations are the primary sources of the
Association's funds for use in lending, investing and for other general
purposes.
Deposits. The Association offers a variety of deposit accounts with a range
of interest rates and terms. The Association's deposits consist of passbook
savings, checking accounts and certificates of deposit. The flow of deposits
is influenced significantly by general economic conditions, changes in money
market rates, prevailing interest rates and competition. The Association's
deposits are obtained predominantly from the areas in which its branch offices
are located. The Association relies primarily on customer service and long-
standing relationships with customers to attract and retain these deposits;
however, market interest rates and rates offered by competing financial
institutions significantly affect the Association's ability to attract and
retain deposits. Certificate of deposit accounts in excess of $100,000 are not
actively solicited by the Association nor does the Association use brokers to
obtain deposits. Management continually monitors the Association's certificate
accounts and historically the Association has retained a large portion of such
accounts upon maturity. See "MD&A--Capital Resources and Liquidity--Sources of
Funds and Liquidity."
The following table presents the deposit activity of the Association for the
periods indicated.
FOR THE YEAR ENDED JUNE 30,
-------------------------------
1996 1995 1994
--------- --------- ---------
(IN THOUSANDS)
Deposits...................................... $ 579,878 $ 556,933 $ 543,496
Withdrawals................................... (572,111) (519,991) (572,768)
--------- --------- ---------
Net deposits (withdrawals).................... 7,767 36,942 (29,272)
Interest credited on deposits................. 23,592 20,256 16,892
--------- --------- ---------
Total increase (decrease) in deposits....... $ 31,359 $ 57,198 $ (12,380)
========= ========= =========
The following table presents the amount and weighted average rate of time
deposits equal to or greater than $100,000 at June 30, 1996:
FOR THE YEAR ENDED
JUNE 30, 1996
--------------------
MATURITY PERIOD WEIGHTED
AMOUNT AVERAGE RATE
- --------------- ------- ------------
(DOLLARS IN
THOUSANDS)
Three months or less....................................... $19,053 5.81%
Over three through six months.............................. 18,088 5.60
Over six through 12 months................................. 17,607 5.52
Over 12 months............................................. 11,374 6.11
-------
Total...................................................... $66,122 5.72%
=======
19
The following table sets forth the distribution of the Association's deposit
accounts for the periods indicated and the weighted average interest rates on
each category of deposits presented.
FOR THE YEAR ENDED JUNE 30,
--------------------------------------------------------------------------------------
1996 1995 1994
---------------------------- ---------------------------- ----------------------------
PERCENTAGE PERCENTAGE PERCENTAGE
OF TOTAL WEIGHTED OF TOTAL WEIGHTED OF TOTAL WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE
-------- ---------- -------- -------- ---------- -------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
Money market deposits... $ 75,176 15.12% 3.99% $ 56,251 12.26% 3.19% $ 44,505 10.47% 2.33%
Passbook deposits....... 21,028 4.23 1.99 25,572 5.57 1.96 33,545 7.89 2.22
NOW and other demand
deposits............... 23,006 4.63 1.20 23,698 5.16 1.11 25,871 6.08 1.25
Non-interest bearing
deposits............... 6,296 1.46 -- 7,032 1.53 -- 7,259 1.71 --
-------- ------ -------- ------ -------- ------
Total.................. 126,766 25.49 112,553 24.52 111,180 26.15
-------- ------ -------- ------ -------- ------
Certificate accounts:
Three months or less.... 86,940 17.49 5.60 64,327 14.01 4.15 80,341 18.90 4.26
Over three through six
months................. 82,662 16.63 5.73 73,917 16.10 4.72 65,898 15.50 4.18
Over six through 12
months................. 121,386 24.40 5.77 98,100 21.37 5.16 64,994 15.29 4.44
Over one to three years. 43,524 8.75 5.89 70,879 15.44 6.07 67,612 15.91 5.38
Over three to five
years.................. 35,961 7.23 6.20 39,223 8.55 5.69 34,922 8.22 5.90
Over five to ten years.. 42 0.01 7.06 11 0.01 7.96 116 0.03 9.01
-------- ------ -------- ------ -------- ------
Total certificates..... 370,515 74.51 346,457 75.48 313,883 73.85
-------- ------ -------- ------ -------- ------
Total deposits......... $497,281 100.00% $459,010 100.00% $425,063 100.00%
======== ====== ======== ====== ======== ======
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at June 30, 1996.
CERTIFICATE AMOUNTS
AT JUNE 30, MATURING IN THE YEAR ENDING JUNE 30,
-------------------------- ----------------------------------------------------
2001 AND
1994 1995 1996 1997 1998 1999 2000 THEREAFTER TOTAL
-------- -------- -------- -------- ------- ------- ------- ---------- --------
(IN THOUSANDS)
Certificate accounts:
0 to 4.00%.............. $132,048 $ 3,987 $ 720 $ 720 $ -- $ -- $ -- $ -- $ 720
4.001 to 5.00%.......... 104,025 72,194 59,878 56,387 95 3,390 -- 6 59,878
5.001 to 6.00%.......... 34,801 137,191 249,461 216,869 15,153 7,350 5,284 4,805 249,461
6.001 to 7.00%.......... 23,414 130,687 72,907 42,656 5,217 3,087 20,280 1,667 72,907
7.001 to 8.00%.......... 13,480 12,722 6,520 5,982 27 6 355 150 6,520
8.001 to 9.00%.......... 5,958 3,821 57 6 32 19 -- -- 57
Over 9.001%............. 191 140 12 12 -- -- -- -- 12
-------- -------- -------- -------- ------- ------- ------- ------ --------
Total.................. $313,917 $360,742 $389,555 $322,632 $20,524 $13,852 $25,919 $6,628 $389,555
======== ======== ======== ======== ======= ======= ======= ====== ========
Borrowings. From time to time the Association has obtained advances from the
FHLB and may do so in the future as an alternative to retail deposit funds.
FHLB advances may also be used to acquire certain other assets as may be
deemed appropriate for investment purposes. These advances are collateralized
by the capital stock of the FHLB held by the Association and certain of the
Association's mortgage loans. See "--Regulation and Supervision--Federal Home
Loan Bank System." Such advances are made pursuant to several different credit
programs, each of which has its own interest rate and range of maturities. The
maximum amount that the FHLB will advance to member institutions, including
the Association, for purposes other than meeting withdrawals, fluctuates from
time to time in accordance with the policies of the OTS and the FHLB. During
1996, the Association periodically borrowed advances to provide needed
liquidity and to supplement retail deposit gathering activity. See "MD&A--
Capital Resources and Liquidity--Sources of Funds and Liquidity." At June 30,
1996, the Association had $135.3 million in outstanding advances from the
FHLB. During fiscal 1996, the maximum amount of FHLB advances that the
Association had outstanding at any month-end was $135.3 million. As
anticipated by management, the Association's total borrowing from the FHLB
increased in fiscal 1996 comprising 99.78% of borrowings compared to 73.66%
and 64.94% in fiscal 1995 and 1994, respectively.
20
During 1996, the Company borrowed from a registered broker-dealer and FHLB
in transactions known as repurchase agreements. In these transactions, the
Company pledges securities as collateral to the broker and receives cash in
return. These transactions have terms to maturity of generally 30 days or
less. At termination, the securities are returned to the Company and the
Company repays the cash borrowed with interest. At June 30, 1996, the Company
had $300,000 in such transactions. Such transactions are reported as
securities sold under agreements to repurchase.
The following table sets forth certain information regarding the Company's
borrowed funds at or for the periods ended on the dates indicated:
AT OR FOR THE YEAR ENDED JUNE 30,
------------------------------------
1996 1995 1994
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
FHLB advances:
Average balance outstanding.............. $ 96,789 $ 46,029 $ 12,583
Maximum amount outstanding at any month-
end during the period................... $ 135,300 $ 63,950 $ 29,000
Balance outstanding at end of period..... $ 135,300 $ 63,950 $ 13,000
Weighted average interest rate during the
period.................................. 5.76% 5.64% 4.50%
Weighted average interest rate at end of
period.................................. 5.87% 6.63% 5.82%
Securities sold under agreements to
repurchase:
Average balance outstanding.............. $ 8,283 $ 11,342 $ 293
Maximum amount outstanding at any month-
end during the period................... $ 17,146 $ 23,848 $ 7,019
Balance outstanding at end of period..... $ 300 $ 22,873 $ 7,019
Weighted average interest rate during the
period.................................. 5.92% 5.25% 4.10%
Weighted average interest rate at end of
period.................................. 5.57% 6.08% 4.51%
SUBSIDIARY ACTIVITIES
QCFC, a wholly owned subsidiary of the Association, is currently engaged, on
an agency basis, in the sale of casualty insurance, mutual funds and annuity
products primarily to the Association's customers and members of the local
community and as a trustee of the Association's deeds of trust. In the past,
QCFC has been involved in real estate development projects. Currently, the
only real estate development project in which QCFC has an investment is an
apartment building in Pasadena, California. The apartment building is managed
by the general partner. The Association has a limited partner interest in the
project, with a carrying value of $158,000 at June 30, 1996. It is anticipated
that the building will be sold as market conditions permit. The Association
does not currently intend to engage in any future real estate development
projects through QCFC or otherwise. As of June 30, 1996, and for the year then
ended, QCFC had $1.2 million in total assets and net income of $82,000.
The Company incorporated Quaker City Neighborhood Development, Inc.
("QCND"), a wholly owned community development subsidiary, during the first
quarter of fiscal 1994. The purpose of QCND is to engage in community lending
and development activities including affordable housing loans to low-and
moderate-income individuals in the Association's lending communities. The
subsidiary complements the Association's community reinvestment activities and
its "Outstanding" Community Reinvestment Act rating. The Company funded
operations for the subsidiary on June 30, 1994 in the amount of $2.4 million.
QCND, in turn, invested those funds in a short-term note to the city of
Whittier for the purpose of facilitating community development projects
consistent with the goals of the subsidiary.
21
COMPETITION
Savings associations face strong competition both in attracting deposits and
making real estate loans. The Company's most direct competition for deposits
has historically come from other savings associations and from commercial
banks located in its principal market areas of Los Angeles and Orange Counties
in California, including many large financial institutions which have greater
financial and marketing resources available to them. In addition, particularly
during times of high interest rates, the Company has faced significant
competition for investors' funds from short-term money market securities and
other corporate and government securities and mutual funds which invest in
such securities. Periods of low interest rates have made the attraction and
retention of deposits difficult as savers seek higher rates of return in
alternative investments. The ability of the Company to attract and retain
savings deposits depends on its ability to generally provide a rate of return,
liquidity and risk comparable to that offered by competing investment
opportunities. Furthermore, management considers the Company's reputation for
financial strength and quality service provided through its contiguous
branching network to local customers to be a major competitive advantage in
attracting and retaining savings deposits.
The Company experiences strong competition for real estate loans principally
from other savings associations, commercial banks and mortgage banking
companies. It competes for loans principally through the interest rates and
loan fees it charges and the efficiency and quality of services it provides
borrowers. Management considers the Company's focus in multifamily and low-
to-moderate income lending in the Los Angeles area to be a competitive
advantage also. Competition may increase as a result of the continuing
reduction in restrictions on the interstate operations of financial
institutions.
Competition may increase as a result of recent legislation which, beginning
in September 1995, will generally allow bank holding companies based in any
state to acquire banks in California, and beginning in September 1997 will
generally allow banks based in any state to acquire by merger banks based in
California. In addition, under existing regulations, federal savings
associations may generally branch nationwide as long as the association's
assets attributable to each state outside of its home state in which it
operates branches are predominantly housing-related assets. Additionally,
provisions of the Federal Deposit Insurance Corporation Improvement Act of
1991 further removed barriers to mergers and acquisitions among savings
associations and banks, allowing savings associations and banks to merge with
each other.
PERSONNEL
As of June 30, 1996, the Association had 122 full-time employees and 53
part-time employees. The employees are not represented by a collective
bargaining unit and the Association considers its relationship with its
employees to be good.
FEDERAL TAXATION
General. The Company reports its income for tax purposes on a calendar year
basis using the accrual method of accounting and will be subject to federal
income taxation in the same manner as other corporations with some exceptions,
including particularly the Association's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary
and does not purport to be a comprehensive description of the tax rules
applicable to the Company.
Tax Bad Debt Reserve. Savings institutions such as the Association which
meet certain definitional tests primarily relating to their assets and the
nature of their business ("qualifying thrifts") are permitted to establish a
reserve for bad debts and to make annual additions thereto, which additions
may, within specified formula limits, be deducted in arriving at their taxable
income. The Association's deduction with respect to "qualifying loans,"
generally loans secured by certain interests
22
in real property, may be computed using the Association's actual loss
experience, or 8% of the Association's taxable income. Use of the percentage
of taxable income method of calculating its deductible addition to its loss
reserve has the effect of reducing the maximum marginal rate of federal tax on
the Association's income to 31.28%, exclusive of any minimum or environmental
tax, as compared to the general maximum corporate federal income tax rate of
34% that would be applicable to the Association for tax year 1994. The
Association's deduction with respect to non-qualifying loans must be computed
under the experience method which essentially allows a deduction for actual
charge-offs. Historically, the Association has reviewed each year the most
favorable way to calculate the deduction attributable to an addition to the
tax bad debt reserve.
The amount of the addition to the reserve for losses on qualifying real
property loans under the percentage of taxable income method cannot exceed the
amount necessary to increase the balance of the reserve for losses on
qualifying real property loans at the close of the taxable year to 6% of the
balance of the qualifying real property loans outstanding at the end of the
taxable year. At June 30, 1996, the Association's total tax bad debt reserve
is approximately $10.9 million, which is less than 6% of its qualifying real
property loans outstanding. Also, if the qualifying thrift uses the percentage
of taxable income method, then the qualifying thrift's aggregate addition to
its reserve for losses on qualifying real property loans cannot, when added to
the addition to the reserve for losses on non-qualifying loans, exceed the
amount by which (i) 12% of the amount that the total deposits or withdrawable
accounts of depositors of the qualifying thrift at the close of the taxable
year exceeded (ii) the sum of the qualifying thrift's surplus, undivided
profits and reserves at the beginning of such year. At June 30, 1996, 12% of
the Association's deposits and withdrawable accounts, less its surplus,
undivided profits and reserves, exceeds the balance of its reserve for losses
on qualifying real property loans.
Pursuant to certain provisions appended to the Small Business Job Protection
Act signed into law in August 1996 (the "Act"), the above-described bad debt
deduction rules available to thrifts such as the Association have been
repealed. Under the Act, the Association is required to change its method of
accounting for bad debts from the reserve method formerly permitted under
section 593 of the Internal Revenue Code of 1986, as amended (the "Code") to
the "specific charge-off" method. Under the specific charge-off method, which
is governed by section 166 of the Code and the regulations thereunder, tax
deductions may be taken for bad debts only if loans become wholly or partially
worthless. Although the Act generally requires that qualifying thrifts
recapture (i.e., include in taxable income) over a six-year period a portion
of their existing bad debt reserves equal to their "applicable excess
reserves," the Association does not have applicable excess reserves subject to
recapture. However, the Association's tax bad debt reserve balance of
approximately $10.9 million (as of June 30, 1996) will, in future years, be
subject to recapture in whole or in part upon the occurrence of certain
events, such as a distribution to stockholders in excess of the Association's
current and accumulated earnings and profits, a redemption of shares, or upon
a partial or complete liquidation of the Association. The Association does not
intend to make distributions to stockholders that would result in recapture of
any portion of its bad debt reserve.
Distributions. To the extent that (i) the Association's tax bad debt reserve
for losses on qualifying real property loans exceeds the amount that would
have been allowed under an experience method and (ii) the Association makes
"non-dividend distributions" to stockholders that are considered to result in
distributions from the excess tax bad debt reserve or the reserve for losses
on loans ("Excess Distributions"), then an amount based on the amount
distributed will be included in the Association's taxable income. Non-dividend
distributions include distributions in excess of the Association's current and
accumulated earnings and profits, distributions in redemption of stock and
distributions in partial or complete liquidation. However, dividends paid out
of the Association's current or accumulated earnings and profits, as
calculated for federal income tax purposes, will not be considered to result
in a distribution from the Association's tax bad debt reserves. Thus, any
dividends to the Company that
23
would reduce amounts appropriated to the Association's tax bad debt reserves
and deducted for federal income tax purposes may create a tax liability for
the Association. The tax treatment of non-dividend distributions under the Act
is the same as under existing law, except that recapture of reserves for
qualifying real property loans is required without regard to the portion which
would have been allowed under the experience method.
The amount of additional taxable income created from an Excess Distribution
is an amount that when reduced by the tax attributable to the income is equal
to the amount of the distribution. If certain portions of the Association's
accumulated tax bad debt reserve amounting to $10.9 million are used for any
purpose other than to absorb qualified tax bad debt loans, such as for the
payment of dividends or other distributions with respect to the Association's
capital stock (including distributions upon redemption or liquidation),
approximately one and one-half times the amount so used would be includable in
gross income for federal income tax purposes, assuming a 34% corporate income
tax rate (exclusive of state taxes). See "--Regulation and Supervision--
Savings and Loan Holding Company Regulation--Payment of Dividends and Other
Capital Distributions by Association" and "Market for the Registrant's Common
Equity and Related Stockholder Matters" for limits on the payment of dividends
of the Association. The Association does not intend to pay dividends that
would result in a recapture of any portion of its tax bad debt reserve.
The date of the Association's last complete Internal Revenue Service (IRS)
tax audit was December, 1985. There is a three-year statute of limitations for
federal tax filings. Tax years 1993 through 1995 are considered open tax years
for IRS audit purposes.
Dividends Received Deduction and Other Matters. The Company may exclude from
its income 100% of dividends received from the Association as a member of the
same affiliated group of corporations. The corporate dividends received
deduction is generally 70% in the case of dividends received from unaffiliated
corporations with which the Company and the Association will not file a
consolidated tax return, except that if the Company and the Association own
more than 20% of the stock of a corporation distributing a dividend 80% of any
dividends received may be deducted.
STATE AND LOCAL TAXATION
State of California. The California franchise tax rate applicable to the
Association equals the franchise tax rate applicable to corporations generally
plus an "in lieu" rate approximately equal to personal property taxes and
business license taxes paid by such corporations (but not generally paid by
banks or financial corporations such as the Association); however, the total
tax rate currently applicable to the Association cannot exceed 11.30% for the
1996 calendar year. Under California regulations, bad debt deductions are
available in computing California franchise taxes using a three or six year
weighted average loss experience method. The Association and its California
subsidiary file California state franchise tax returns on a combined basis.
Assuming that the holding Association form of organization is utilized, the
Association, as a savings and loan holding Association commercially domiciled
in California, will generally be treated as a financial corporation and
subject to the general corporate tax rate plus the "in lieu" rate as discussed
previously for the Association.
The Company is currently under examination by the California Franchise Tax
Board for tax years ending December 1990-1993. No adjustments have been
proposed at this time.
Delaware Taxation. As a Delaware holding Company not earning income in
Delaware, the Company is exempted from Delaware Corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
24
REGULATION AND SUPERVISION
GENERAL
The Association is a federally chartered savings association, a member of
the FHLB of San Francisco, and is subject to regulation by the OTS and the
FDIC. The Association's deposits are insured by the FDIC through the SAIF. As
a result of its ownership of the Association, the Company is a savings and
loan holding company subject to regulation by the OTS. As described in more
detail below, statutes and regulations applicable to the Association govern
such matters as the investments and activities in which the Association can
engage; the amount of capital the Association must hold; mergers and changes
of control; establishment and closing of branch offices; and dividends payable
by the Association. Statutes and regulations applicable to the Company govern
such matters as changes of control of the Company and transactions between the
Association and the Company.
The Company and the Association are subject to the examination, supervision
and reporting requirements of the OTS, their primary federal regulator,
including a requirement for the Association of at least one full scope, on-
site examination every year. The Director of the OTS is authorized to impose
assessments on the Association to fund OTS operations, including the cost of
examinations. The Association is also subject to examination, when deemed
necessary, and supervision by the FDIC, and the FDIC has "back-up" authority
to take enforcement action against the Association if the OTS fails to take
such action after a recommendation by the FDIC. The FDIC may impose
assessments on the Association to cover the cost of FDIC examinations.
Beginning in 1996, the FDIC will no longer be able to conduct separate
examinations of the Association except in exigent circumstances. In addition,
the Association is subject to regulation by the Board of Governors of the
Federal Reserve System ("FRB") with respect to certain aspects of its
business. The descriptions set forth below and elsewhere in this document of
the statutes and regulations that are applicable to the Company do not purport
to be a complete description of such statutes and regulations and their
effects on the Company, or to identify every statute and regulations that may
apply to the Company.
ACTIVITIES RESTRICTIONS
Qualified Thrift Lender Test. The qualified thrift lender ("QTL") test
requires that, in at least nine out of every twelve months, at least 65% of a
savings bank's "portfolio assets" must be invested in a limited list of
"qualified thrift investments," primarily investments related to housing
loans. If the Association fails to satisfy the QTL test and does not requalify
as a QTL within one year, the Company must register and be regulated as a bank
holding company, and the Association must either convert to a commercial bank
charter or become subject to restrictions on branching, business activities
and dividends as if it were a national bank. At June 30, 1996, approximately
91.73% of the Association's portfolio assets constituted qualified thrift
investments and the Association met the QTL test each month in fiscal 1996.
Investment and Loan Limits. In general, federal savings institutions such as
the Association may not invest directly in equity securities, debt securities
that are not rated investment grade, or real estate, other than real estate
used for the institution's offices and related facilities. Indirect equity
investment in real estate through a subsidiary is permissible, but subject to
limitations based on the amount of the institution's assets, and the
institution's investment in such a subsidiary must be deducted from regulatory
capital in full or (for certain subsidiaries owned by the institution prior
toApril 12, 1989) phased out of capital by no later than July 1, 1996.
Loans by a savings institution to a single borrower are generally limited to
15% of the institution's "unimpaired capital and unimpaired surplus," which is
similar but not identical to total capital. Aggregate loans by the Association
that are secured by nonresidential real property are generally limited to 400%
of the institution's total capital. Commercial loans not secured by real
property may not exceed 10% of the Association's total assets, and consumer
lo