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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, 1997
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: (562) 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 September 18, 1997, on the Nasdaq National Market System
was approximately $89,006,000.
At September 18, 1997, 4,673,102 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 19, 1997 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........................................... 3
Delinquencies and Classification of Assets................... 10
Nonperforming Assets and Restructured Loans.................. 11
Impaired Loans............................................... 13
Allowances for Loan and Real Estate Losses................... 13
Investment Activities........................................ 16
Sources of Funds............................................. 18
Subsidiary Activities........................................ 20
Competition.................................................. 20
Personnel.................................................... 21
Federal Taxation............................................. 21
State and Local Taxation..................................... 22
Regulation and Supervision................................... 23
General..................................................... 23
Activities Restrictions..................................... 23
Deposit Insurance........................................... 24
FIRREA Capital Requirements................................. 25
Prompt Corrective Action Requirements....................... 27
Enforcement................................................. 27
Savings and Loan Holding Company Regulation................. 27
Classification of Assets.................................... 30
Community Reinvestment Act.................................. 31
Federal Home Loan Bank System............................... 31
Required Liquidity.......................................... 31
Federal Reserve System...................................... 32
Pending Legislation......................................... 32
ITEM 2. PROPERTIES................................................... 34
ITEM 3. LEGAL PROCEEDINGS............................................ 35
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......... 35
ITEM 4A. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........... 35
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.......................................... 36
ITEM 6. SELECTED FINANCIAL DATA...................................... 37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................... 39
General...................................................... 39
Problem Assets............................................... 39
Results of Operations........................................ 39
Financial Condition.......................................... 41
Capital Resources and Liquidity.............................. 42
Market Risk.................................................. 45
Asset/Liability Management................................... 47
Average Balance Sheet........................................ 50
Impact of Inflation and Changing Prices...................... 52
Impact of New Accounting Standards........................... 52
PAGE
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................. F-1
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE..................................... II-1
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........... II-1
ITEM 11. EXECUTIVE COMPENSATION....................................... II-1
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................... II-1
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............... II-1
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K.................................................. II-2
SIGNATURES................................................... II-5
This Annual Report on Form 10-K contains forward-looking statements,
including but not limited to statements regarding, among other items, (i) the
realization of the Company's business strategy, (ii) general economic
conditions and the condition of the real estate market in Southern California,
(iii) the adequacy of the Company's allowance for loan and real estate losses,
(iv) interest rate risk and (v) anticipated trends in the thrift industry.
Forward-looking statements are typically identified by the words "believes,"
"expects," "anticipates," "intends," "estimates" and similar expressions.
These forward-looking statements are subject to a number of risks and
uncertainties, many of which are beyond the Company's control. Actual results
could differ materially from those contemplated by these forward-looking
statements. There can be no assurance that the results and events contemplated
by the forward-looking information contained in this Annual Report on Form 10-
K will in fact transpire. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of their dates. The
Company undertakes no obligation to update or revise any forward-looking
statements.
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 (562) 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. The Company plans to open at least one new retail
banking branch during the 1998 fiscal year.
The Company is a savings and loan holding company and as such is subject to
examination and regulation by the Office of Thrift Supervision ("OTS"). The
deposits of the Association are insured by the Savings Association Insurance
Fund ("SAIF") of the Federal Deposit Insurance Corporation (the "FDIC"). The
Association is regulated by the Director of the OTS and the FDIC. The
Association is a member of the Federal Home Loan Bank ("FHLB") of San
Francisco, which is one of the twelve regional banks comprising the Federal
Home Loan Bank System. The Association is also subject to certain regulations
of the Board of Governors of the Federal Reserve System (the "Federal Reserve
Board") with respect to reserves required to be maintained against deposits
and certain other matters. See "--Regulation and Supervision--General."
The Company'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 Company also engages in the sale of insurance and
investment products on an agency basis. See "--Subsidiary Activities." The
Company 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
1
lesser extent, the Company invests in commercial real estate loans. At June
30, 1997, the Company's gross mortgage loan portfolio (including loans held
for sale) totaled approximately $659.7 million, of which approximately 45.47%
was secured by one-to-four residential properties, 45.77% was secured by
multifamily (five or more units) properties and 8.39% was secured by
commercial properties. See "--Lending Activities." At that same date,
approximately 84.94% of the one-to-four family, 95.17% of the multifamily and
92.29% of the commercial mortgage portfolios consisted of adjustable rate
mortgage ("ARM") loans.
In addition to originating loans to hold in portfolio, the Company also
originates loans for sale. The Company also purchases loans for investment and
for sale. Loan sales come from loans held in the Company's portfolio
designated as being held for sale or originated during the period and being so
designated. Historically, the Company has generally retained the servicing
rights on most loans sold, however, some loans are sold servicing released. In
addition, the Company 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 Company'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 Company's primary sources of funds are deposits, borrowings from the
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, 1997, the Company had deposits of approximately
$553.2 million, including approximately $78.3 million in time deposits of
$100,000 or more. At that date, the Company's borrowings included $157.7
million in FHLB advances. See "--Sources of Funds."
On April 24, 1997, the Board of Directors of the Company declared a 25%
common stock dividend paid on May 30, 1997, to shareholders of record on May
12, 1997. The dividend was intended as a distribution of retained earnings to
the Company's shareholders and to enhance both the marketability and liquidity
of the Company's stock. Total stockholders' equity was unchanged by the stock
dividend and all historical earnings per share data herein reflect the
increased number of shares of the Company's stock outstanding after the
dividend. At June 30, 1997, the Company had stockholders' equity of $70.2
million, representing 8.77% of total assets.
For the year ended June 30, 1997, the Company reported net earnings of $2.8
million, $0.61 per share. This compares to net earnings of $3.6 million, $0.74
per share and $2.3 million, $0.48 per share for the years ended June 30, 1996
and 1995, respectively. The reduction in fiscal 1997 earnings over fiscal 1996
was primarily due to the special assessment paid by the Association as part of
the recapitalization of the Savings Association Insurance Fund. During the
quarter ended September 30, 1996, the Association accrued $3.1 million in
expense for this special assessment and paid this amount during the second
quarter of fiscal 1997. Excluding the impact of the one-time special
assessment, net earnings for the fiscal year ended June 30, 1997, would have
been $4.6 million, $1.00 per share.
Total assets of the Company were $801.4 million at June 30, 1997, an
increase of $76.3 million during the fiscal year. The increase in assets was
primarily in residential loans with loans on multifamily properties increasing
$43.0 million and one-to-four loans decreasing $3.3 million, and with
investment securities and mortgage-backed securities increasing $33.6 million.
The asset growth was funded by an increase in deposits of $40.7 million and
borrowings of $22.1 million. At June 30, 1997, the Company had total deposits
of $553.2 million and total borrowings of $157.7 million.
The Southern California economy and real estate market in the Company's
primary lending area have shown improvement during the year, especially in
income property values. The Company's level of nonperforming assets declined
from June 30, 1996. The Company includes nonaccruing loans, troubled debt
restructured loans and real estate acquired through foreclosure ("REO") in
determining
2
its level of nonperforming assets. At June 30, 1997, the Company reported
$10.5 million in nonperforming assets in the Company's portfolio compared to
$13.1 million and $13.2 million at June 30, 1996 and 1995, respectively. The
Company recorded provisions for loan losses of $3.0 million for the year ended
June 30, 1997 compared to $2.1 million and $998,000 for the years ended June
30, 1996 and 1995, respectively. See "--Allowances for Loan and Real Estate
Losses" and "Management's Discussion and Analysis ("MD&A")--Results of
Operations."
LENDING ACTIVITIES
General. Since 1982, the Company has emphasized the origination of ARM loans
for retention in its portfolio. This practice has enabled the Company to
reduce its interest rate risk exposure by concentrating its loan portfolio in
assets with either shorter terms or more frequent repricing, or both. The
Company originates fixed rate loans in response to customer demand as well.
The type of loans the Company 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, the Company has
sold fixed rate loans in the secondary market to the Federal National Mortgage
Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC") and
others. During 1997, the Company retained certain fixed rate loans in its
portfolio.
Loan and Mortgage-Backed Securities Portfolio Composition. The Company'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, 1997, the Company had gross loans outstanding of $659.7 million, of which
$300.0 million, or 45.47%, were one-to-four family mortgage loans. At the same
date, multifamily mortgage loans totaled $302.0 million, or 45.77% of gross
loans. The remainder of the loan portfolio consists of $55.3 million of
commercial real estate loans, or 8.39% of gross loans, $1.4 million of land
loans, or 0.21% of gross loans, and other loans of $1.1 million, or 0.16% of
gross loans. Included in these amounts at June 30, 1997 were $623,000 of loans
held for sale, comprising 0.09% of gross loans. At that same date, 84.94% of
the Company's one-to-four family, 95.17% of its multifamily and 92.29% of its
commercial mortgage loans had adjustable interest rates.
The Company invests in MBS, including securities guaranteed by GNMA, FNMA
and FHLMC. To a limited extent the Company also invests in privately issued
MBS which typically have received a "AA" or "AAA" credit rating from at least
one nationally recognized rating service. The Company invests in both
adjustable rate and fixed rate MBS. In an effort to reduce the potential
interest rate risk inherent in fixed rate assets, the Company purchases fixed
rate MBS with a variety of coupon rates, maturities, and prices. Furthermore,
the assets are typically purchased with fixed rate FHLB advances of various
terms to maturity primarily ranging from 1 month to 5 years in order to
mitigate the Company's exposure to changes in interest rates. The adjustable
rate MBS portfolio typically have life caps that will prevent the MBS from
further upward adjustments in rate should interest rates rise above the cap
limit. Prior to purchase, management considers the Company's overall tolerance
to interest rate risk and invests accordingly. At June 30, 1997, the Company's
MBS portfolio totaled $74.1 million or 9.25% of total assets. MBS are
comprised of $48.1 million of agency securities, $4.6 million issued by other
financial institutions and $21.4 million in collateralized mortgage
obligations (CMO's). Of the $21.4 million in CMO's 97.20% or $20.8 million are
agency guaranteed. For all years presented, the CMO's represent non-equity
senior interests in mortgage pass-through certificates and were of investment
grade. At June 30, 1997, all MBS were classified as held to maturity.
The following table sets forth the composition of the Company's loan and MBS
portfolios in dollar amounts and percentages of the respective portfolio at
the dates indicated.
3
AT JUNE 30,
-------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------- -------------------- -------------------- -------------------- --------------------
PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL
-------- ---------- -------- ---------- -------- ---------- -------- ---------- -------- ----------
(DOLLARS IN THOUSANDS)
Loans:
Residential:
One-to-four
units.......... $299,979 45.47% $303,273 48.54% $288,664 51.85% $234,709 49.51% $201,617 46.25%
Multifamily..... 301,965 45.77 258,970 41.45 205,731 36.95 177,539 37.46 174,025 39.92
Commercial........ 55,331 8.39 60,822 9.74 60,709 10.91 60,617 12.79 58,975 13.53
Land.............. 1,352 0.21 1,038 0.17 1,046 0.19 691 0.15 720 0.17
Other............. 1,070 0.16 627 0.10 546 0.10 412 0.09 595 0.13
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Loans, gross.... 659,697 100.00% 624,730 100.00% 556,696 100.00% 473,968 100.00% 435,932 100.00%
====== ====== ====== ====== ======
Less:
Undisbursed loan
funds............ 441 378 187 183 215
Unamortized
discounts........ 2,404 2,864 2,815 1,999 2,385
Deferred loan
fees, net........ 3,493 3,093 2,442 2,184 2,014
Allowance for
loan losses...... 7,772 7,833 12,108 13,660 5,079
-------- -------- -------- -------- --------
Loans, net...... 645,587 610,562 539,144 455,942 426,239
Less:
Loans held for
sale:
One-to-four
units.......... 623 1,455 400 5,415 8,989
Multifamily..... -- 1,435 1,266 -- 3,683
-------- -------- -------- -------- --------
Net loans held
for investment. $644,964 $607,672 $537,478 $450,527 $413,567
======== ======== ======== ======== ========
Mortgage-backed
securities:
FNMA.............. $ 13,240 17.87% $ 11,129 26.70% $ 11,367 27.77% $ -- -- % $ -- -- %
FHLMC............. 1,298 1.75 1,697 4.07 2,117 5.17 119 0.80 192 1.40
GNMA.............. 33,577 45.32 7,885 18.92 -- -- -- -- -- --
Issued by other
financial
institutions..... 4,554 6.15 5,781 13.87 11,451 27.97 12,659 84.64 11,495 83.98
Collateralized
mortgage
obligations...... 21,423 28.91 15,185 36.44 16,004 39.09 2,178 14.56 2,001 14.62
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
74,092 100.00% 41,677 100.00% 40,939 100.00% 14,956 100.00% 13,688 100.00%
====== ====== ====== ====== ======
Plus (Less):
Unamortized
premium
(discount)....... 47 (502) (946) (247) (115)
-------- -------- -------- -------- --------
Mortgage-backed
securities,
net............ 74,139 41,175 39,993 14,709 13,573
Less:
Mortgage-backed
securities
available for
sale............. -- -- -- 5,997 6,660
-------- -------- -------- -------- --------
Net mortgage-
backed
securities held
to maturity.... 74,139 41,175 39,993 8,712 6,913
-------- -------- -------- -------- --------
Total net loans and
mortgage-backed
securities held
for investment or
to maturity....... $719,103 $648,847 $577,471 $459,239 $420,480
======== ======== ======== ======== ========
4
Loan Maturity. The following table shows the maturity of the Company's gross
loans and MBS at June 30, 1997. The table includes loans held for sale of
$623,000. The table does not include principal repayments. Principal
repayments on loans totaled $54.5 million, $48.0 million and $39.3 million for
the years ended June 30, 1997, 1996 and 1995, respectively. Principal
repayments on MBS totaled $7.3 million, $11.2 million, and $2.9 million for
the years ended June 30, 1997, 1996, and 1995, respectively.
AT JUNE 30, 1997
-------------------------------------------------------------------------
ONE- TOTAL MORTGAGE-
TO-FOUR MULTI- LOANS BACKED
FAMILY FAMILY COMMERCIAL LAND OTHER RECEIVABLE SECURITIES TOTAL
-------- -------- ---------- ------ ------ ---------- ---------- --------
(IN THOUSANDS)
Amounts due:
One year or less....... $ 578 $ 6,631 $ 3,358 $1,002 $ 310 $ 11,879 $ -- $ 11,879
-------- -------- ------- ------ ------ -------- ------- --------
After one year:
More than one year to
three years........... 1,257 4,812 2,045 -- 78 8,192 326 8,518
More than three years
to five years......... 10,448 10,179 7,085 291 1 28,004 -- 28,004
More than five years to
10 years.............. 11,796 37,493 11,627 -- 2 60,918 2,228 63,146
More than 10 years to
20 years.............. 42,150 214,427 29,910 -- 206 286,693 5,572 292,265
More than 20 years..... 233,750 28,423 1,306 59 473 264,011 65,966 329,977
-------- -------- ------- ------ ------ -------- ------- --------
Total due after one
year................. 299,401 295,334 51,973 350 760 647,818 74,092 721,910
-------- -------- ------- ------ ------ -------- ------- --------
Total amounts due..... $299,979 $301,965 $55,331 $1,352 $1,070 $659,697 $74,092 $733,789
======== ======== ======= ====== ====== ======== ======= ========
The following table sets forth at June 30, 1997, the dollar amount of all
loans due after June 30, 1998, and whether such loans have fixed or adjustable
interest rates.
AT JUNE 30, 1997
---------------------------
FIXED ADJUSTABLE TOTAL
------- ---------- --------
(IN THOUSANDS)
Real estate loans:
One-to-four family................................ $44,609 $254,792 $299,401
Multifamily....................................... 9,981 285,353 295,334
Commercial real estate............................ 2,020 49,953 51,973
Land.............................................. 350 -- 350
Other loans......................................... 726 34 760
------- -------- --------
Total loans....................................... $57,686 $590,132 $647,818
======= ======== ========
Origination, Purchase, Sale and Servicing of Loans. The Company's mortgage
lending activities are conducted primarily through its executive and branch
offices. The Company 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 Company purchases or participates in loans originated by
other institutions. The determination to purchase loans is based upon the
Company'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 Company's underwriting policies, which require consideration of
the financial condition of the borrower and the appraised value of the
property, among other factors. The Company has purchased loans from
independent parties in various transactions. During the year ended June 30,
1997, $12.5 million, or 9.82% of the Company's total new loans were purchased.
5
At origination or time of purchase, the Company 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 Company
generally retains the servicing rights on most loans sold, however, certain
loans are sold servicing released. The determination to sell a specific loan
or pool of loans is made based upon the Company'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 Company 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 Company 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 Company would remain obligated to fulfill its forward commitments. The
inability of the Company to originate or acquire loans to fulfill these
commitments may result in the Company being required to pay non-delivery fees.
In an increasing interest rate environment, the Company is subject to interest
rate risk in the event its commitments to make loans to borrowers exceeds its
commitments to sell loans. The Company does not intend to enter into forward
commitments on ARM loans.
The Company sells loans and participations in loans with yield rates to the
investors based upon current market rates. Gain or loss is recognized to the
extent that the selling prices differ from the carrying value of the loans
sold based on the estimated relative fair values of the assets sold and any
retained interests, less any liabilities incurred. The assets obtained on sale
are generally loan servicing assets. Liabilities incurred in a sale may
include recourse obligations or servicing liabilities. Historically, the
Company has not established servicing assets or liabilities, although the
Company has retained the servicing rights on loans sold, because management
has determined that the benefits from the contractually specified servicing
fees and other ancillary sources are offset by the cost the Company incurs in
servicing.
In addition to retaining the servicing rights for originated loans, the
Company may also purchase mortgage servicing rights related to mortgage loans
originated by other institutions. The Company's current loan policies provide
that the aggregate amount of purchased mortgage servicing shall not exceed 75%
of the total loans in the Company's portfolio that are serviced for others. At
June 30, 1997, the Company had no purchased mortgage servicing rights asset.
6
The following table sets forth activity in the Company's loan and MBS
portfolios for the periods indicated:
AT OR FOR THE YEAR ENDED
JUNE 30,
--------------------------
1997 1996 1995
-------- -------- --------
(IN THOUSANDS)
Gross loans:
Beginning balance................................. $624,730 $556,696 $473,968
Loans originated:
One-to-four family.............................. 32,092 51,383 60,915
Multifamily..................................... 79,541 70,841 39,177
Commercial...................................... 3,081 122 6,172
Land............................................ 292 -- --
-------- -------- --------
Total loans originated.......................... 115,006 122,346 106,264
Loans purchased................................. 12,521 27,789 24,792
Loans to facilitate the sale of REO............. 4,847 5,580 7,407
-------- -------- --------
Total.......................................... 132,374 155,715 138,463
Less:
Transfer to REO................................. 8,313 7,764 8,593
Principal repayments............................ 54,465 48,032 39,295
Sales of loans.................................. 33,870 27,662 10,321
Other, net...................................... 759 4,223 (2,474)
-------- -------- --------
Ending balance.................................... $659,697 $624,730 $556,696
======== ======== ========
Gross mortgage-backed securities:
Beginning balance................................. $ 41,677 $ 40,939 $ 14,956
Mortgage-backed securities purchased............ 40,228 13,766 28,102
Less:
Principal repayments............................ 7,305 11,157 2,906
Other, net...................................... 508 1,871 (787)
-------- -------- --------
Ending balance.................................... $ 74,092 $ 41,677 $ 40,939
======== ======== ========
One-to-Four Family Mortgage Lending. The Company 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 Company'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. Included in one-to-four family
loans are $12.5 million of adjustable rate home equity credit lines tied to
the Wall Street Prime index. These loans are generally secured by a first or
second trust deed, with maturities up to 25 years.
At June 30, 1997, the Company's gross loans outstanding were $659.7 million,
of which $300.0 million, or 45.47%, were one-to-four family mortgage loans. Of
the one-to-four family mortgage loans outstanding at that date, 15.06% were
fixed-rate loans, and 84.94% were ARM loans. The Company'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. In recent years, declines in the real estate
values in the Company's primary lending area have resulted in increases in the
loan-to-value ratio on some mortgage loans subsequent to origination.
Multifamily Lending. The Company originates multifamily mortgage loans
generally secured by 5-to-36 unit apartment buildings located in the Los
Angeles metropolitan area. In originating a
7
multifamily mortgage loan, the Company 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
operating income to debt service) and the ratio of the loan amount to
appraised value. Pursuant to the Company'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 Company also generally
requires a debt service coverage ratio of at least 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, 1997 was approximately $314,000, with the largest loan, as
discussed below, being $1.8 million. Declines in the real estate values in the
Company's primary lending area have resulted in an increase in the loan-to-
value ratio on some mortgage loans subsequent to origination.
When evaluating the qualifications of the borrower for a multifamily loan,
the Company considers the financial resources and income level of the
borrower, the borrower's experience in owning or managing similar property,
and the Company's lending experience with the borrower. The Company'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 Company generally reviews
the financial statements, employment and credit history of the borrower, as
well as other related documentation. The Company's largest multifamily loan at
June 30, 1997 had an outstanding loan balance of $3.6 million, of which the
Company 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 was classified as Substandard
at June 30, 1997 (for definition of Substandard, see "Delinquencies and
Classification of Assets--Classification of Assets" below). During the year
ended June 30, 1997, the Company originated $79.5 million of multifamily
loans. At June 30, 1997, the multifamily loan portfolio totaled $302.0 million
or 45.77% of gross loans. Of the $302.0 million in multifamily loans, 4.83%
were fixed-rate loans and 95.17% 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 prevailed in the Company's
primary lending market area in recent years tend to result in higher vacancy
and reduced rental rates and net operating incomes from multifamily
residential properties. Of the Company's $3.0 million of charge-offs in fiscal
1997, $2.2 million, or 73.33%, were for multifamily loans. See "--Allowances
for Loan and Real Estate Losses."
Commercial Real Estate Lending. The Company 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 parks located in the Association's primary
market area. At June 30, 1997, the commercial real estate loan portfolio
aggregated $55.3 million. Of the $55.3 million, 7.71% were fixed-rate loans
and 92.29% were ARM loans. The Company originated $3.1 million of commercial
real estate loans during the year ended June 30, 1997. The Company'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 Company's
underwriting standards and procedures are similar to those applicable to its
multifamily loans, wherein the Company considers the net operating income of
the property and the borrower's expertise, credit history and profitability.
The Company 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 Company's portfolio
8
is secured by a mobile home park located in El Monte, California and had an
outstanding principal balance at June 30, 1997 of $1.5 million and was not
classified.
Commercial real estate 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 prevailed in the Company's
primary lending market area in recent years tend to result in higher vacancy
and reduced rental rates and net operating incomes from commercial properties.
Of the Company's $3.0 million of charge-offs in fiscal 1997, $165,000, or
5.42%, were for commercial real estate loans. See "--Allowances for Loan and
Real Estate Losses."
Certain Loan Terms. The interest rates for the majority of the Company's ARM
loans in portfolio are indexed to the 11th District Cost of Funds Index
("COFI"). The Company currently offers a number of ARM loan programs with
interest rates tied to treasury based and COFI indices 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 Company'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 Company
over that which was originally lent. The Company currently has approximately
$384.4 million in mortgage loans that may be subject to negative amortization.
During the years ended June 30, 1997, 1996 and 1995, the negative amortization
associated with these loans totaled $618,000, $994,000 and $430,000,
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 Company, generally include due-on-sale
clauses which provide the Company with the contractual right to deem the loan
immediately due and payable in the event the borrower transfers ownership of
the property without the Company's consent. Due-on-sale clauses are an
important means of adjusting the rates on the Company's fixed rate multifamily
and commercial mortgage loan portfolios and the Company has generally
exercised its rights under these clauses.
Loan Approval Procedures and Authority. The Company's Board of Directors has
a standing Loan Committee. The Loan Committee is primarily responsible for
establishing the lending policies of the Company 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.
9
For all loans originated by the Company, 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 $150,000 are required,
which appraisals currently are performed by independent appraisers designated
and approved by the Company. The Company's Board annually approves the
independent appraisers used by the Company and approves the Company's
appraisal policy. The Company'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,
private mortgage insurance is required and the borrower will be required to
make payments to a mortgage impound account from which the Company 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 Company with respect to delinquencies vary depending
on the nature of the loan and period of delinquency.
The Company'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 Company'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 Company will attempt to obtain full payment or work out a
repayment schedule with the borrower to avoid foreclosure. See also "--
Nonperforming Assets and Restructured Loans."
At June 30, 1997, 1996 and 1995, delinquencies in the Company's loan
portfolio were as follows:
1997 1996 1995
--------------------------------- --------------------------------- ---------------------------------
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
family.......... 4 $ 442 25 $3,011 3 $ 246 12 $1,467 3 $ 144 9 $1,359
Multifamily...... 3 1,045 4 348 5 2,220 11 3,991 5 3,293 7 2,804
Commercial....... 5 3,648 3 1,054 1 1,087 7 3,155 2 1,111 4 2,757
Other loans...... -- -- -- -- -- -- 4 105 -- -- -- --
--- ------ --- ------ --- ------ --- ------ --- ------ --- ------
Total........... 12 $5,135 32 $4,413 9 $3,553 34 $8,718 10 $4,548 20 $6,920
=== ====== === ====== === ====== === ====== === ====== === ======
Delinquent loans
to total gross
loans........... 0.78% 0.67% 0.57% 1.40% 0.82% 1.24%
The loans in the above table have been considered in connection with the
Company's overall assessment of the adequacy of its allowance for loan losses.
However, there can be no assurance that the Company 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 Company's
Classification of Assets Policy require that the Company utilize an internal
asset classification system as a means of reporting problem and potential
problem assets. The Company has incorporated the OTS internal asset
classifications as a part of its credit monitoring system. The Company
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 "Doubtful" have all of the
10
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." See "--Regulation and Supervision--
Classification of Assets." The Company's Internal Asset Review Committee
monthly reviews and classifies the Company'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 Company at June 30, 1997.
AT JUNE 30, 1997
----------------------------
SUBSTANDARD DOUBTFUL TOTAL
----------- -------- -------
(IN THOUSANDS)
Real estate loans:
One-to-four family.............................. $ 6,865 $-- $ 6,865
Multifamily..................................... 8,289 -- 8,289
Commercial and Land............................. 3,419 -- 3,419
REO............................................... 1,720 -- 1,720
Investment in subsidiaries(1)..................... 119 -- 119
Securities........................................ 18 -- 18
------- ---- -------
Total Classified Assets........................... $20,430 $-- $20,430
======= ==== =======
- --------
(1) At June 30, 1997, the Company classified as Substandard 61% of the
Company's equity investment in subsidiaries. At such date, QCFC reported
total assets of $1.2 million. See "--Subsidiary Activities."
Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 114,
"Accounting by Creditors for Impairment of a Loan", the Company recognizes
impairment on troubled collateral dependent loans by creating a specific
valuation allowance. At June 30, 1997 and 1996, the specific valuation
allowance totaled $1.5 million and $2.2 million, respectively. The loans for
which a specific valuation allowance was established are in the process of
collection. At such time that these loans are deemed uncollectible the
specific valuation allowance is charged-off.
In addition to adversely classified assets, assets which do not currently
expose the Company 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, 1997, $10.0 million of assets were graded as Special Mention,
compared to $9.1 million at June 30, 1996.
These assets have been considered in connection with the Company's overall
assessment of the adequacy of its allowance for loan losses; however, there
can be no assurance that the Company 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."
NONPERFORMING ASSETS AND RESTRUCTURED LOANS
After 60 days, the Company ceases the accrual of interest on loans and any
previously accrued interest is reversed. In addition, the Company may
restructure a loan due to the debtor's financial difficulty and grant a
concession which the Company would not have otherwise considered. REO is
recorded at fair value less estimated costs of disposition.
11
The following table sets forth information regarding nonaccrual 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,
-------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Real estate loans:
One-to-four family.............. $ 3,226 $ 1,614 $ 1,269 $ 2,033 $ 2,960
Multifamily..................... 2,387 4,949 3,999 4,429 2,369
Commercial and land............. 2,926 3,781 2,510 3,359 713
Other:
Loans secured by savings
deposits....................... -- 105 -- 35 32
------- ------- ------- ------- -------
Total nonaccrual loans(1)....... 8,539 10,449 7,778 9,856 6,074
Troubled debt restructured loans.. 229 234 3,387 5,352 3,611
------- ------- ------- ------- -------
Total nonperforming loans....... 8,768 10,683 11,165 15,208 9,685
Real estate acquired through
foreclosure...................... 1,720 2,435 2,045 2,154 2,458
------- ------- ------- ------- -------
Total nonperforming assets...... $10,488 $13,118 $13,210 $17,362 $12,143
======= ======= ======= ======= =======
Ratios:
Net charge-offs to average
loans.......................... 0.47% 1.13% 0.75% 0.34% 0.03%
General Valuation Allowance
(GVA) on loans as a percentage
of total nonaccrual loans(1)... 72.81 54.72 99.00 87.13 70.27
GVA on loans as a percentage of
gross loans.................... 0.94 0.92 1.38 1.81 0.98
GVA on loans as a percentage of
total nonperforming loans(2)... 70.91 53.52 68.97 56.47 44.07
Total GVA as a percentage of
total nonperforming assets(3).. 60.95 44.92 59.61 50.13 35.93
Total nonaccrual loans as a
percentage of gross loans(1)... 1.29 1.67 1.40 2.08 1.39
Nonperforming loans as a
percentage of gross loans(2)... 1.33 1.71 2.01 3.21 2.22
Nonperforming assets as a
percentage of total assets(4).. 1.31 1.81 2.06 3.39 2.49
- --------
(1) Nonaccrual loans are net of specific allowances of $1.5 million, $2.2
million, $4.3 million, $5.1 million and $811,000 for the years ended June
30, 1997, 1996, 1995, 1994 and 1993, respectively.
(2) Nonperforming loans include nonaccrual and troubled debt restructured
loans. Gross loans include loans held for sale.
(3) Total GVA includes loan and REO general valuation allowances.
(4) Nonperforming assets include nonperforming loans and REO.
The gross amount of interest income on nonaccrual loans that would have been
recorded during the years ended June 30, 1997, 1996 and 1995 if the nonaccrual
loans had been current in accordance with their original terms was $782,000,
$1.1 million and $920,000, respectively. For the years ended June 30, 1997,
1996 and 1995, $469,000, $565,000 and $497,000, respectively, was actually
earned on nonaccrual loans and is included in interest income on loans in the
consolidated statements of operations for such years included in this report.
Interest income earned on nonaccrual loans is generally recorded utilizing the
cash-basis method of accounting. See "Financial Statements and Supplementary
Data."
12
IMPAIRED LOANS
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 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 Company measures
impairment based on the fair value of the loan's underlying collateral
property. Impaired loans exclude large groups of smaller balance homogeneous
loans that are collectively evaluated for impairment. For the Company, loans
collectively reviewed for impairment include all loans with principal balances
of less than $300,000.
Factors considered as part of the periodic loan review process to determine
whether a loan is impaired, as defined under SFAS 114, address both the amount
the Company believes is probable that it will collect and the timing of such
collection. As part of the Company's loan review process the Company will
consider such factors as the ability of the borrower to continue to meet the
debt service requirements, assessments of other sources of repayment, the fair
value of any collateral and the Company's prior history in dealing with the
particular type of loan involved. In evaluating whether a loan is considered
impaired, insignificant delays (less than twelve months) in the absence of
other facts and circumstances would not alone lead to the conclusion that a
loan was impaired.
At June 30, 1997 and 1996, the Company had a gross investment in impaired
loans of $8.0 million and $8.6 million, respectively. During the year ended
June 30, 1997 and 1996, the Company's average investment in impaired loans was
$8.2 million and $11.8 million, respectively, and for the years then ended,
interest income on such loans totaled $704,000 and $611,000, respectively.
Interest income on impaired loans which are performing is generally 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 $4.3 million and $6.4 million were not performing in accordance
with their contractual terms at June 30, 1997 and 1996, and have been included
in nonaccrual loans at that date.
The Company recognizes impairment on troubled collateral dependent loans by
creating a specific valuation allowance. The loans for which a specific
valuation allowance was established are in the process of collection. At such
time that these loans are deemed uncollectible, the specific valuation
allowance is charged-off.
Impaired loans at June 30, 1997, include $5.5 million of loans for which
specific valuation allowances of $1.2 million had been established and $2.5
million of loans for which no specific valuation allowance was considered
necessary. At June 30, 1996, the Company had $6.7 million of impaired loans
for which specific valuation allowances of $1.6 million had been established
and $1.9 million of such loans for which no specific valuation allowance was
considered necessary. All such provisions for losses and related recoveries
are recorded as part of the total allowance for loan losses.
ALLOWANCES FOR LOAN AND REAL ESTATE LOSSES
The Company's allowance for loan losses is comprised of specific valuation
allowances as well as a general valuation allowance (GVA). As discussed above,
specific valuation allowances are generally established to recognize
impairment on troubled collateral dependent loans. The GVA is maintained in an
amount that management believes will be adequate to absorb reasonably
anticipated losses that may be realized on existing loan-related assets and
off-balance sheet items.
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
13
maintained at an amount management considers adequate to cover estimated
losses in loans receivable which are deemed probable and estimable. 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
Company's underwriting policies and the regulatory environment. It is the
Company'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 Company's allowance for loan losses remained unchanged at $7.8 million,
or 1.18% of gross loans, at June 30, 1997 compared to $7.8 million, or 1.25%
of gross loans, at June 30, 1996. The allowance for loan losses at June 30,
1997 reflects management's evaluation of the risks inherent in its loan
portfolio in consideration of various factors, including trends in its
nonperforming assets, the regional economy and relevant real estate values.
The Company's ratio of nonperforming loans to gross loans decreased to 1.33%
at June 30, 1997 from 1.71% at June 30, 1996. The Company's ratio of
nonperforming assets to total assets decreased during this period to 1.31% at
June 30, 1997 from 1.81% at June 30, 1996. As of June 30, 1997, the Company's
total GVA to nonperforming assets, was 60.95% as compared to 44.92% at June
30, 1996.
The Company recorded a provision for loan losses of $3.0 million for the
year ended June 30, 1997, compared to $2.1 million, $998,000, $10.2 million
and $3.7 million for the years ended June 30, 1996, 1995, 1994 and 1993,
respectively. Management believes that the increases in the provisions for
1997 and 1996 were necessary to replenish the allowance for loan losses to
what management believes is an adequate level due to charge-offs taken during
these years. The decrease in the provision in 1995 as compared to 1994 was
primarily a result of the reduction in nonperforming assets during 1995. The
increase in the provision in 1994, reflected management's assessment of the
loan portfolio in consideration of various factors, including the trends in
the Company's nonperforming assets, continued declines in the Southern
California economy, the January 1994 Northridge earthquake and the regulatory
environment. The increase in charge-offs in 1994 through 1996 was primarily a
result of acquiring title to or resolve properties damaged in the January 1994
Northridge earthquake as well as continued declines in the Southern California
economy.
Although the Company believes that the allowance for loan losses at June 30,
1997 is adequate, there can be no assurance that the Company will not have to
establish additional loss provisions based upon future events. The Company
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 Company's valuation
allowance. These agencies may require the Company 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."
It is the policy of the Company 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 Company's portfolio, is to
establish an allowance for loan losses in accordance with the Company's asset
classification process, based on generally accepted accounting principles
("GAAP"). It has generally been the practice of the Company 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 Company to obtain an appraisal
on all REO upon acquisition by the Company.
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 Company 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.
14
The following table sets forth activity in the Company's total allowance for
loan losses and allowance for losses on REO.
AT OR FOR THE YEAR ENDED JUNE 30,
------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- ------
(IN THOUSANDS)
Accumulated through a charge to
earnings:
Balance at beginning of year.... $ 6,542 $10,614 $13,458 $ 4,833 $1,307
Provision for loan losses....... 3,001 2,103 998 10,200 3,657
Charge-offs:
One-to-four family............ (699) (968) (160) (57) --
Multifamily................... (2,182) (3,896) (3,252) (1,198) (131)
Commercial and land........... (165) (1,309) (428) (304) --
Non-mortgage.................. (1) (2) (2) (16) --
Recoveries...................... -- -- -- -- --
------- ------- ------- ------- ------
Subtotal charge-offs, net...... (3,047) (6,175) (3,842) (1,575) (131)
------- ------- ------- ------- ------
Balance at end of year.......... 6,496 6,542 10,614 13,458 4,833
Valuation allowance for portfolios
acquired:
Balance at beginning of year.... 1,291 1,494 202 246 286
Purchases....................... -- 294 1,308 -- --
Charge-offs:
Multifamily................... -- (471) -- -- --
Reductions credited............. (15) (26) (16) (44) (40)
------- ------- ------- ------- ------
Balance at end of year.......... 1,276 1,291 1,494 202 246
------- ------- ------- ------- ------
Total allowance for loan losses. $ 7,772 $ 7,833 $12,108 $13,660 $5,079
======= ======= ======= ======= ======
Allowance for REO losses:
Balance at beginning of year.... $ 175 $ 175 $ 115 $ 95 $ 81
Additions charged to operations. -- -- 60 20 14
------- ------- ------- ------- ------
Balance at end of year.......... $ 175 $ 175 $ 175 $ 115 $ 95
======= ======= ======= ======= ======
15
The following table sets forth the Company'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,
------------------------------------------------------------------------------------------
1997(1) 1996(1) 1995(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...... $1,709 21.99% 45.47% $1,306 16.67% 48.54% $ 1,338 11.05% 51.85%
Multifamily............. 3,318 42.69 45.77 4,744 60.56 41.45 6,499 53.68 36.95
Commercial.............. 1,085 13.96 8.39 1,288 16.44 9.74 2,475 20.44 10.91
Land.................... 210 2.70 0.21 199 2.54 0.17 344 2.84 0.19
Other................... -- -- 0.16 -- -- 0.10 -- -- 0.10
Unallocated............. 1,450 18.66 -- 296 3.79 -- 1,452 11.99 --
------ ------ ------ ------ ------ ------ ------- ------ ------
Total allowance
for loan losses....... $7,772 100.00% 100.00% $7,833 100.00% 100.00% $12,108 100.00% 100.00%
====== ====== ====== ====== ====== ====== ======= ====== ======
AT JUNE 30,
------------------------------------------------------------
1994(1) 1993(1)
------------------------------ -----------------------------
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...... $ 989 7.24% 49.51% $ 637 12.54% 46.25%
Multifamily............. 8,613 63.05 37.46 2,932 57.72 39.92
Commercial.............. 2,220 16.25 12.79 1,066 20.99 13.53
Land.................... 407 2.98 0.15 13 0.26 0.17
Other................... 2 0.02 0.09 -- -- 0.13
Unallocated............. 1,429 10.46 N/A 431 8.49 N/A
------- ------ ------ ------ ------ ------
Total allowance
for loan losses....... $13,660 100.00% 100.00% $5,079 100.00% 100.00%
======= ====== ====== ====== ====== ======
- --------
(1) In 1997, 1996, 1995, 1994 and 1993, total specific allowances amounted to
$1.6 million, $2.2 million, $4.3 million, $5.1 million and $811,000,
respectively.
The increase in the unallocated allowance at June 30, 1997 as compared to
June 30, 1996, is a result of a decrease in the allocated allowance required
on multifamily loans as a result of a decline in multifamily charge-offs and
nonaccrual multifamily loans during the year.
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
16
the Company's lending activities. Specifically, the Company's policy generally
limits investments to government and federal agency-backed securities and
other non-government guaranteed securities, 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, 1997, the Company had federal funds sold
and other short-term investments and investment securities in the aggregate
amount of $51.0 million with a fair value of $50.9 million.
The following table sets forth certain information regarding the amortized
cost 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,
-----------------------------------------------------
1997 1996 1995
----------------- ----------------- -----------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
--------- ------- --------- ------- --------- -------
(IN THOUSANDS)
Federal funds sold and
other short-term
investments............. $12,950 $12,950 $ 6,400 $ 6,400 $ 9,450 $ 9,450
======= ======= ======= ======= ======= =======
Investment securities:
Held to maturity:
U.S. Government and
Federal agency
obligations.......... $36,303 36,142 $37,048 $36,437 $23,509 $23,531
Municipal bonds....... 351 351 371 371 389 389
------- ------- ------- ------- ------- -------
Total held to
maturity........... 36,654 36,493 37,419 36,808 23,898 23,920
Available for sale:
Mutual funds.......... -- -- -- -- 150 150
Marketable Equity
Securities........... 1,200 1,432 -- -- -- --
------- ------- ------- ------- ------- -------
Total investment
securities......... $37,854 $37,925 $37,419 $36,808 $24,048 $24,070
======= ======= ======= ======= ======= =======
The table below sets forth certain information regarding the amortized cost,
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, 1997.
AT JUNE 30, 1997
----------------------------------------------------------------------------------------------------------------
MORE THAN ONE MORE THAN FIVE MORE THAN TEN
NO MATURITY ONE YEAR OR LESS YEAR TO FIVE YEARS YEARS TO TEN YEARS YEARS TOTAL
------------------ ------------------ ------------------ ------------------ ------------------ ----------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE
COST YIELD COST YIELD COST YIELD COST YIELD COST YIELD COST YIELD
--------- -------- --------- -------- --------- -------- --------- -------- --------- -------- -------- -------
(DOLLARS IN THOUSANDS)
Federal funds sold
and other short-
term investments. $ -- -- % $12,950 5.90% $ -- -- % $ -- -- % $ -- -- % $12,950 5.90%
====== === ======= ==== ======= ==== ====== ==== ====== ==== ======= ====
Investment
securities:
Held to maturity:
U.S. Government
and Federal
agency
obligations..... $ -- -- % $ 1,500 5.53% $25,811 6.55% $4,000 7.23% $4,992 7.42% $36,303 6.70%
Municipal bonds.. -- -- -- -- -- -- -- -- 351 7.00(1) 351 7.00
------ ------- ------- ------ ------ -------
Total held to
maturity....... -- -- 1,500 5.53 25,811 6.55 4,000 7.23 5,343 7.39 36,654 6.70
Available for
sale:
Equity
securities...... 1,200 N/A -- -- -- -- -- -- -- -- 1,200 N/A
------ ------- ------- ------ ------ -------
Total investment
securities..... $1,200 N/A $ 1,500 5.53% $25,811 6.55% $4,000 7.23% $5,343 7.39% $37,854 6.70%
====== ======= ======= ====== ====== =======
- -------
(1) This rate represents the coupon rate on the investment and has not been
computed on a tax equivalent basis.
17
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 Company's
funds for use in lending, investing and for other general purposes.
Deposits. The Company offers a variety of deposit accounts with a range of
interest rates and terms. The Company'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 Company's
deposits are obtained predominantly from the areas in which its branch offices
are located. The Company 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 Company's ability to attract and retain
deposits. Certificate of deposit accounts in excess of $100,000 are not
actively solicited by the Company nor does the Company use brokers to obtain
deposits. Management continually monitors the Company's certificate accounts
and historically the Company 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 Company for the
periods indicated.
FOR THE YEAR ENDED JUNE 30,
-------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
Deposits....................................... $ 651,616 $ 579,878 $ 556,933
Withdrawals.................................... (636,318) (572,111) (519,991)
--------- --------- ---------
Net deposits................................... 15,298 7,767 36,942
Interest credited on deposits.................. 25,371 23,592 20,256
--------- --------- ---------
Total increase in deposits................... $ 40,669 $ 31,359 $ 57,198
========= ========= =========
The following table presents the amount and weighted average rate of time
deposits equal to or greater than $100,000 at June 30, 1997:
FOR THE YEAR ENDED
JUNE 30, 1997
--------------------
MATURITY PERIOD WEIGHTED
AMOUNT AVERAGE RATE
- --------------- ------- ------------
(DOLLARS IN
THOUSANDS)
Three months or less....................................... $17,660 5.55%
Over three through six months.............................. 17,753 5.63
Over six through 12 months................................. 23,150 5.73
Over 12 months............................................. 19,728 6.07
-------
Total...................................................... $78,291 5.75
=======
18
The following table sets forth the distribution of the Company'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,
--------------------------------------------------------------------------------------
1997 1996 1995
---------------------------- ---------------------------- ----------------------------
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... $ 83,372 15.72% 4.20% $ 75,176 15.12% 3.99% $ 56,251 12.26% 3.19%
Passbook deposits....... 17,899 3.38 1.98 21,028 4.23 1.99 25,572 5.57 1.96
NOW and other demand
deposits............... 24,011 4.53 1.16 23,006 4.63 1.20 23,698 5.16 1.11
Non-interest bearing
deposits............... 7,718 1.46 -- 6,296 1.46 -- 7,032 1.53 --
-------- ------ -------- ------ -------- ------
Total.................. 133,000 25.09 126,766 25.49 112,553 24.52
-------- ------ -------- ------ -------- ------
Certificate accounts:
Three months or less.... 99,718 18.81 5.43 86,940 17.49 5.60 64,327 14.01 4.15
Over three through six
months................. 88,175 16.63 5.43 82,662 16.63 5.73 73,917 16.10 4.72
Over six through 12
months................. 110,972 20.93 5.61 121,386 24.40 5.77 98,100 21.37 5.16
Over one to three years. 68,637 12.94 5.76 43,524 8.75 5.89 70,879 15.44 6.07
Over three to five
years.................. 29,683 5.60 6.15 35,961 7.23 6.20 39,223 8.55 5.69
Over five years......... 6 -- 5.23 42 0.01 7.06 11 0.01 7.96
-------- ------ -------- ------ -------- ------
Total certificates..... 397,191 74.91 5.59 370,515 74.51 5.78 346,457 75.48 5.12
-------- ------ -------- ------ -------- ------
Total deposits......... $530,191 100.00% 4.97 $497,281 100.00% 5.05 $459,010 100.00% 4.43
======== ====== ======== ====== ======== ======
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
contractual maturity of the certificate accounts outstanding at June 30, 1997.
AT JUNE 30, CERTIFICATE AMOUNTS MATURING IN THE YEAR ENDING JUNE 30,
-------------------------- --------------------------------------------------------
2002 AND
1995 1996 1997 1998 1999 2000 2001 THEREAFTER TOTAL
-------- -------- -------- -------- ------- ------- ------- ---------- --------
(IN THOUSANDS)
Certificate accounts:
0 to 4.00%.............. $ 3,987 $ 720 $ 167 $ 167 $ 0 $ 0 $ 0 $ 0 $ 167
4.001 to 5.00%.......... 72,194 59,878 38,622 38,622 0 0 0 0 38,622
5.001 to 6.00%.......... 137,191 249,461 229,085 224,791 3,465 13 37 779 229,085
6.001 to 7.00%.......... 130,687 72,907 97,347 37,600 44,149 6,278 4,915 4,405 97,347
7.001 to 8.00%.......... 12,722 6,520 35,834 59 5,585 22,805 5,178 2,207 35,834
8.001 to 9.00%.......... 3,821 57 344 0 6 338 0 0 344
Over 9.001%............. 140 12 20 0 20 0 0 0 20
-------- -------- -------- -------- ------- ------- ------- ------ --------
Total.................. $360,742 $389,555 $401,419 $301,239 $53,225 $29,434 $10,130 $7,391 $401,419
======== ======== ======== ======== ======= ======= ======= ====== ========
Borrowings. From time to time the Company 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 Company and certain of the
Company'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 Company, for purposes other than meeting withdrawals, fluctuates from time
to time in accordance with the policies of the OTS and the FHLB. During 1997,
the Company 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, 1997, the Company had
$157.7 million in outstanding advances from the FHLB. During fiscal 1997, the
maximum amount of FHLB advances that the Company had outstanding at any month-
end
19
was $166.6 million. As anticipated by management, the Company's total
borrowing from the FHLB increased in fiscal 1997 comprising 100% of borrowings
compared to 99.78% and 73.66% in fiscal 1996 and 1995, respectively.
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,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
FHLB advances:
Average balance outstanding............. $148,312 $ 96,789 $46,029
Maximum amount outstanding at any month-
end during the period.................. $166,600 $135,300 $63,950
Balance outstanding at end of period.... $157,700 $135,300 $63,950
Weighted average interest rate during
the period............................. 5.77% 5.76% 5.64%
Weighted average interest rate at end of
period................................. 6.10% 5.87% 6.63%
Securities sold under agreements to
repurchase:
Average balance outstanding............. $ 72 $ 8,283 $11,342
Maximum amount outstanding at any month-
end during the period.................. $ 300 $ 17,146 $23,848
Balance outstanding at end of period.... $ -- $ 300 $22,873
Weighted average interest rate during
the period............................. 5.56% 5.92% 5.25%
Weighted average interest rate at end of
period................................. N/A 5.57% 6.08%
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. QCFC has a limited partner interest in the project,
with a carrying value of $65,000 at June 30, 1997. 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, 1997, and for the year then ended,
QCFC had $1.2 million in total assets and net income of $59,000.
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 Company's lending communities. The
subsidiary complements the Company'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. In fiscal 1997, this short-term note was paid off by
the City of Whittier.
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
20
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.
Under legislation adopted by Congress in 1994, bank holding companies based
in any state generally are allowed to acquire banks in California and banks
based in any state generally are allowed to acquire by merger banks based in
California. Under OTS regulations, federal savings associations have been
generally able to 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. The increased authority of
bank holding companies and banks to engage in interstate banking will allow
them to compete more effectively with savings associations.
PERSONNEL
As of June 30, 1997, the Association had 118 full-time employees and 47
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. Prior to 1996, savings institutions such as the
Association which meet certain definitional tests primarily relating to their
assets and the nature of their business ("qualifying thrifts") were permitted
to establish a reserve for bad debts and to make annual additions thereto,
which additions, within specified formula limits, were deducted in arriving at
their taxable income. The Association's deduction with respect to "qualifying
loans," generally loans secured by certain interests in real property, was
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 had 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%.
21
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 has changed 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, 1997 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. Since management intends to use the reserve only for the purpose for
which it was intended, a deferred tax liability of approximately $3.7 million
has not been recorded.
Distributions. To the extent that the Association makes "non-dividend
distributions" to stockholders that are considered to result in distributions
from the tax bad debt reserve for losses on qualifying real property, 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 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 amount of additional taxable income created from a distribution from the
tax bad debt reserve is an amount that when reduced by the tax attributable to
the income is equal to the amount of the distribution. The result is to tax
distributions from the tax bad debt reserve at approximately 51%. 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 Company'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 1994 through 1996 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
Company 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
22
by banks or financial corporations such as the Association); however, the
total tax rate currently applicable to the Company cannot exceed 11.30% for
the 1997 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 Company and its California
subsidiary file California state franchise tax returns on a combined basis.
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.
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. The
FDIC is no longer 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, 1997, approximately
92.45% of the Association's portfolio assets constituted qualified thrift
investments and the Association met the QTL test each month in fiscal 1997.
23
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
loans may not exceed 35% of the Association's total assets. At June 30, 1997,
the Association was in compliance with the above investment limitations.
Activities of Subsidiaries. A savings institution seeking to establish a new
subsidiary, acquire control of an existing company or conduct a new activity
through an existing subsidiary must provide 30 days prior notice to the FDIC
and OTS. A subsidiary of the Association may be able to engage in activities
that are not permissible for the Association directly, if the OTS determines
that such activities are reasonably related to the Association's business, but
the Association may be required to deduct its investment in such a subsidiary
from capital. The OTS has the power to require a savings institution to divest
any subsidiary or terminate any activity conducted by a subsidiary that the
OTS determines to be a serious threat to the financial safety, soundness or
stability of such savings institution or to be otherwise inconsistent with
sound banking practices.
Safety and Soundness Standards. The Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") required the OTS to prescribe for savings
associations minimum acceptable operational and managerial standards, and
standards for asset quality, earnings, and stock valuation. The standards
cover internal controls, loan documentation, credit underwriting, interest
rate exposure, asset growth, and employee compensation. Any institution that
fails to meet the OTS regulations promulgated under the safety and soundness
requirements must submit an acceptable plan for compliance or become subject
to the ability of the OTS, in its discretion, to impose operational
restrictions similar to those that would apply to a failure to meet minimum
capital requirements as discussed below.
Real Estate Lending Standards. The OTS and the other federal banking
agencies have adopted regulations which require institutions to adopt and at
least annually review written real estate lending policies. The lending
policies must include diversification standards, underwriting standards
(including loan-to-value limits), loan administration procedures, and
procedures for monitoring compliance with the policies. The policies must
reflect consideration of guidelines adopted by the banking agencies that
discuss certain loan-to-value and percentage of capital limits.
DEPOSIT INSURANCE
Deposit Insurance Premium Assessments. Pursuant to FDICIA, the FDIC has
established a risk-based system for setting deposit insurance assessments on
BIF and SAIF deposits. Under the risk-based assessment system, an
institution's insurance assessment will vary depending on the level of capital
the institution holds and the degree to which it is the subject of supervisory
concern to the FDIC. During most of calendar 1996, the assessment rate for
SAIF deposits varied from 0.23% of covered deposits for well-capitalized
institutions that were deemed to have no more than a few minor weaknesses, to
0.31% of covered deposits for less than adequately capitalized institutions
that posed substantial supervisory concern. The Association's assessment rate
was 0.23%. During this time, the lowest assessment rate for BIF deposits was
$2,000 per year for well-capitalized institutions that were
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deemed to have no more than a few minor weaknesses, to 0.27% of covered
deposits for less than adequately capitalized institutions that posed
substantial supervisory concern.
This premium structure provided institutions whose deposits were exclusively
or primarily BIF-insured (such as almost all commercial banks) certain
competitive advantages over institutions whose deposits were primarily SAIF-
insured. The BIF assessment rates were lower than the SAIF rates because the
BIF had reached its designated reserve ratio of 1.25% and the SAIF had not. In
addition, the SAIF was responsible for making interest payments on debt
incurred to provide funds to the ESLIC ("FICO Debt").
The Deposit Insurance Funds Act of 1996 ("DIFA") required institutions with
SAIF-insured deposits to pay a special assessment designed to increase the
SAIF's reserves to the required 1.25% of insured deposits. During the quarter
ended September 30, 1996, the Association accrued $3.1 million in expense for
this special assessment and paid this amount during the second quarter of
fiscal 1997. Because the reserves of both the SAIF and the BIF now equal or
exceed the required minimum amount and FICO Debt assessments are collected
separately from deposit insurance assessments, SAIF-insured and BIF-insured
deposits are assessed for deposit insurance according to the sa