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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark one)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the fiscal year ended December 31, 1999
Or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to ___________
Commission File Number 000-24051
UNITED PANAM FINANCIAL CORP.
(Exact name of Registrant as specified in its charter)
California 95-3211687
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1300 South El Camino Real
San Mateo, California 94402
(Address of principal executive offices) (Zip Code)
(650) 345-1800
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, No
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. Yes X 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 Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in PART III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the Common Stock held by non-affiliates of the
Registrant was approximately $7,230,000, based upon the closing sales price of
the Common Stock as reported on the Nasdaq National Market on March 13, 2000.
Shares of Common Stock held by each officer, director and holder of 5% or more
of the outstanding Common Stock have been excluded in that such persons may be
deemed to be affiliates. Such determination of affiliate status is not
necessarily a conclusive determination for other purposes.
The number of shares outstanding of the Registrant's Common Stock as of March
13, 2000 was 16,606,850 shares.
Documents Incorporated by Reference
Portions of the Registrant's Definitive Proxy Statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A in connection with
the 2000 Annual Meeting of Shareholders to be held June 20, 2000 are
incorporated by reference in PART III hereof. Such Proxy Statement will be
filed with the Securities and Exchange Commission not later than 120 days after
December 31, 1999.
UNITED PANAM FINANCIAL CORP.
1999 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
Item 1. Business 1
General 1
Automobile Finance 2
Insurance Premium Finance 6
Pan American Bank, FSB 12
Discontinued Operations - Mortgage Finance 12
Industry Segments 15
Competition 15
Employees 15
Supervision and Regulation 15
Taxation 24
Subsidiaries 25
Factors That May Affect Future Results of Operations 26
Item 2. Properties 29
Item 3. Legal Proceedings 29
Item 4. Submission of Matters to a Vote of Security Holders 29
PART II
Item 5. Market For Registrant's Common Equity and Related Shareholder Matters 30
Item 6. Selected Financial Data 31
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations 33
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 50
Item 8. Financial Statements and Supplementary Data 50
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosures 50
PART III
Item 10. Directors and Executive Officers of the Registrant 50
Item 11. Executive Compensation 50
Item 12. Security Ownership of Certain Beneficial Owners and Management 50
Item 13. Certain Relationships and Related Transactions 51
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 51
SIGNATURES 60
PART I
Certain statements in this Annual Report on Form 10-K, including statements
regarding United PanAm Financial Corp.'s (the "Company") strategies, plans,
objectives, expectations and intentions, may include forward-looking information
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These forward-
looking statements involve certain risks and uncertainties that could cause
actual results to differ materially from those expressed or implied in such
forward-looking statements. Such risks and uncertainties include, but are not
limited to, the following factors: limited operating history; loans made to
credit-impaired borrowers; need for additional sources of financing;
concentration of business in California; estimates involving discontinued
operations; valuation of residuals; interests in securitizations; reliance on
operational systems and controls and key employees; competitive pressure in the
banking industry; changes in the interest rate environment; rapid growth of the
Company's businesses; dependence on whole loan sale markets; general economic
conditions; and other risks, some of which may be identified from time to time
in the Company's filings with the Securities and Exchange Commission (the
"SEC"). See "Item 1. Business - Factors That May Affect Future Results of
Operations."
Item 1. Business
General
The Company was incorporated in California on April 19, 1998 for the
purpose of reincorporating its business in that state, through the merger of
United PanAm Financial Corp., a Delaware corporation (the "Predecessor"), into
the Company. Unless the context indicates otherwise, all references herein to
the "Company" include the Predecessor. The Company was originally organized as a
holding company for Pan American Financial, Inc., ("PAFI") and Pan American
Bank, FSB (the "Bank") to purchase certain assets and assume certain liabilities
of Pan American Federal Savings Bank from the Resolution Trust Corporation
("RTC") on April 29, 1994 pursuant to a whole purchase and assumption agreement.
The Company, PAFI and the Bank are considered to be minority owned. PAFI is a
wholly-owned subsidiary of the Company, and the Bank is a wholly-owned
subsidiary of PAFI. United PanAm Mortgage Corporation, a California corporation,
was organized in 1997 as a wholly-owned subsidiary of UPFC and is now inactive.
Effective, September 30, 1999, all of the outstanding common stock of United
PanAm Mortgage Corporation was contributed by the Company to the Bank, and,
accordingly, United PanAm Mortgage Corporation is now a wholly-owned subsidiary
of the Bank.
The Company is a diversified specialty finance company engaged primarily
in originating and acquiring for investment insurance premium finance contracts
and retail automobile installment sales contracts. The Company markets to
customers who generally cannot obtain financing from traditional lenders. These
customers usually pay higher loan origination fees and interest rates than those
charged by traditional lenders to gain access to consumer financing. The Company
has funded its operations to date principally through retail and wholesale
deposits, Federal Home Loan Bank ("FHLB") advances, warehouse lines of credit,
and whole loan sales or securitizations. All of the Company's revenues are
attributed to customers located in the United States.
The Company commenced operations in 1994 by purchasing from the RTC
certain assets and assuming certain liabilities of the Bank's predecessor, Pan
American Federal Savings Bank. The Bank is the largest Hispanic-controlled
savings association in California. The Company has used the Bank as a base for
expansion into its current specialty finance businesses. In 1995, the Company
commenced its insurance premium finance business through a joint venture with
BPN Corporation ("BPN") and in 1996 commenced its automobile finance business.
In December 1999, the Company decided to close its subprime mortgage
finance operations to focus on its auto lending and insurance premium finance
businesses. This business originated and sold or securitized subprime mortgage
loans secured primarily by first mortgages on single family residences. In
connection with
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the discontinuance of the mortgage finance division, all related operating
activity is treated as discontinued operations for financial statement reporting
purposes. See "Item 1. Business - Discontinued Operations - Mortgage Finance."
Automobile Finance
Business Overview
The Company entered the subprime automobile finance business in February
1996 through the establishment of United Auto Credit Corporation ("UACC") as a
subsidiary of the Bank. UACC purchases auto contracts primarily from dealers in
used automobiles, approximately 77% of which have been independent dealers and
23% of which have been franchisees of automobile manufacturers. The borrowers on
contracts purchased by UACC are classified as subprime because they typically
have limited credit histories or credit histories that preclude them from
obtaining loans through traditional sources. UACC maintains nine branch offices
located in California, three branch offices located in Florida, two branch
offices located in Washington and one each in Arizona, Colorado, Georgia, North
Carolina, Oregon and Utah. At December 31, 1999, UACC's portfolio contained
16,955 auto contracts in the aggregate gross amount of $128.1 million, including
unearned finance charges of $21.2 million.
Subprime Automobile Finance Industry
Automobile financing is one of the largest consumer finance markets in the
United States. In general, the automobile finance industry can be divided into
two principal segments: a prime credit market and a subprime credit market.
Traditional automobile finance companies, such as commercial banks, savings
institutions, thrift and loan companies, credit unions and captive finance
companies of automobile manufacturers, generally lend to the most creditworthy,
or so-called prime, borrowers. The subprime automobile credit market, in which
UACC operates, provides financing to borrowers who generally cannot obtain
financing from traditional lenders.
Historically, traditional lenders have not serviced the subprime market or
have done so only through programs that were not consistently available.
Independent companies specializing in subprime automobile financing and
subsidiaries of larger financial services companies have entered this segment of
the automobile finance market, but it remains highly fragmented, with no company
having a significant share of the market.
Business Strategy
UACC's business strategy includes controlled growth at the branch level,
with limited volume goals and the gradual addition of new branches. Each branch
is targeted to generate on average between $650,000 and $750,000 in gross
contracts per month within five months of opening. The Company believes that
UACC's strategy of controlled growth, disciplined underwriting, strong internal
audit procedures and focused servicing and collection efforts at the branch
level, will result in sustainable profitability and lower levels of delinquency
and loss than those experienced by many of its competitors, whose rapid growth
has resulted in portfolio quality problems.
The Company believes that the subprime automobile finance market is
inconsistently or poorly serviced by the consumer finance industry. As a
result, UACC's strategy is to differentiate itself by providing dealers with
consistent, same day decisions and up front verifications, which reduces the
percentage of rejected contracts submitted for purchase, and rapid funding of
approved contracts. The Company believes that UACC is also more flexible than
some of its competitors in financing older, higher mileage vehicles and
maintenance warranties.
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Operating Summary
The following table presents a summary of UACC's key operating and statistical
results for the years ended December 31, 1999 and 1998.
At or For the
Years Ended
December 31,
------------------------------------------------------
1999 1998
------------------------------------------------------
(Dollars in thousands, except portfolio and other data)
Operating Data
Gross contracts purchased $124,896 $86,098
Gross contracts outstanding 128,093 83,921
Unearned finance charges 21,181 17,371
Net contracts outstanding 106,912 66,550
Average purchase discount 8.79% 9.12%
APR to customers 21.47% 21.31%
Allowance for loan losses $ 7,915 $ 4,138
Loan Quality Data
Allowance for loan losses (% of net contracts) 7.40% 6.22%
Delinquencies (% of net contracts)
31-60 days 0.39% 0.44%
61-90 days 0.16% 0.16%
90+ days 0.08% 0.08%
Net charge-offs (% of average net contracts) 4.05% 4.56%
Repossessions (net) (% of net contracts) 0.47% 0.72%
Portfolio Data
Used vehicles 99.0% 99.0%
Vehicle age at time of contract (years) 6.0 6.2
Original contract term (months) 42.6 40.6
Gross amount financed to WSBB (1) 119% 117%
Net amount financed to WSBB (2) 108% 106%
Net amount financed per contract $ 8,019 $ 7,725
Down payment 19% 20%
Monthly payment $ 272 $ 270
Other Data
Number of branches 20 15
______________
(1) WSBB represents Kelly Wholesale Blue Book for used vehicles.
(2) Net amount financed equals the gross amount financed less unearned finance
charges or discounts.
Products and Pricing
UACC targets transactions which involve (i) a used automobile with an average
age of five to seven years and (ii) an average original contract term of 40 to
45 months.
The financial profile of the target transaction includes an amount financed
(before taxes, license, warranty and discount) equal to 95% to 100% of invoice
for new vehicles or current WSBB for used vehicles (after tax, license, warranty
and discount, the amount financed is targeted at 105% to 110%), a contract rate
and discount which yields 28.5%, an amount financed of $7,000 to $10,000 with a
down payment of 15% to 20% and a monthly payment from $225 to $325.
The target profile of a UACC borrower includes time on the job of three to
five years, time at current residence of three to five years, a ratio of total
debt to total income of 33% to 37% and a ratio of total monthly automobile
payments to total monthly income of 12% to 15%.
The application for an auto contract is taken by the dealer. UACC purchases
the auto contract from the dealer at a discount which increases the effective
yield on such contract. For the year ended December 31, 1999, the Company
allocated 90% of the discount to the allowance for loan losses, representing 9%
of the net
3
contract amount. Management periodically reviews the portion of the discount
allocated to the allowance for loan losses in light of the Company's operations.
Sales and Marketing
UACC markets its financing program to both independent used and franchised
automobile dealers. UACC's marketing approach emphasizes scheduled calling
programs, marketing materials and consistent follow-up. The Company uses
facsimile software programs to send marketing materials to established dealers
and potential dealers on a twice weekly basis in each branch market. UACC's
experienced local staff seeks to establish strong relationships with dealers in
their vicinity.
UACC solicits business from dealers through its branch managers who meet with
dealers and provide information about UACC's programs, train dealer personnel in
UACC's program requirements and assist dealers in identifying consumers who
qualify for UACC's programs. In order to both promote asset growth and achieve
required levels of credit quality, UACC compensates its branch managers on a
salary with a bonus that requires the achievement of delinquency, charge-off,
volume and return on average assets targets established for the branch, as well
as satisfactory audit results.
As of December 31, 1999, UACC directly marketed its programs to dealers
through its 20 branch offices in Arizona, California, Colorado, Florida,
Georgia, North Carolina, Oregon, Washington and Utah.
When a UACC branch decides to begin doing business with a dealer, a dealer
profile and investigation worksheet are completed. UACC and the dealer enter
into an agreement that provides UACC with recourse to the dealer in cases of
dealer fraud or a breach of the dealer's representations and warranties. When
UACC holds auto contracts aggregating $50,000 or more from a dealer, UACC
obtains a Experian Business Analysis Report for such dealer. Branch management
periodically monitors each dealer's overall performance and inventory to ensure
a satisfactory quality level, and regional managers regularly conduct audits of
the dealer's performance.
The following table sets forth certain data for auto contracts purchased by
UACC for the periods indicated.
For the Years Ended
--------------------------------
December 31, December 31,
1999 1998
--------------- -------------
(Dollars in thousands)
Gross amount of contracts $124,896 $86,098
Average original term of contracts (months) 42.6 40.6
At December 31, 1999, 68% of UACC's auto contracts were written by its
California branches, compared to 80% at December 31, 1998 and 95% at December
31, 1997. In addition to diversifying its geographic concentrations, UACC
maintains a broad dealer base to avoid dependence on a limited number of
dealers. At December 31, 1999, no dealer accounted for more than 1.5% of UACC's
portfolio and the ten dealers from which UACC purchased the most contracts
accounted for approximately 12% of its aggregate portfolio.
Underwriting Standards and Purchase of Contracts
Underwriting Standards and Purchase Criteria. Dealers submit credit
applications directly to UACC's branches. UACC uses credit bureau reports in
conjunction with information on the credit application to make a final credit
decision or a decision to request additional information. Only credit bureau
reports that have been obtained by UACC are acceptable.
UACC's credit policy places specific accountability for credit decisions
directly within the branches. The branch manager or assistant branch manager
reviews all credit applications. In general, no branch manager will have credit
approval authority for contracts greater than $15,000. Any transaction that
exceeds a
4
branch manager's approval limit must be approved by UACC's Regional Manager,
Operations Manager or President.
Verification. Upon approving or conditioning any application, all required
stipulations are presented to the dealer and must be satisfied before funding.
All dealers are required to provide UACC with written evidence of insurance in
force on a vehicle being financed when submitting the contract for purchase.
Prior to funding a contract, the branch must verify by telephone with the
insurance agent the customer's insurance coverage with UACC as loss payee. If
UACC receives notice of insurance cancellation or non-renewal, the branch will
notify the customer of his or her contractual obligation to maintain insurance
coverage at all times on the vehicle. However, UACC will not "force place"
insurance on an account if insurance lapses and, accordingly, UACC bears the
risk of an uninsured loss in these circumstances.
Post-Funding Quality Reviews. UACC's Regional Manager and Operations Manager
complete quality control reviews of the newly originated auto contracts. These
reviews focus on compliance with underwriting standards, the quality of the
credit decision and the completeness of auto contract documentation.
Additionally, UACC's Regional Manager and Operations Manager complete regular
branch audits that focus on compliance with UACC's policies and procedures and
the overall quality of branch operations and credit decisions.
Servicing and Collection
UACC services at the branch level all of the auto contracts it purchases.
Billing Process. UACC sends each borrower a coupon book. All payments are
directed to the customer's respective UACC branch. UACC also accepts payments
delivered to the branch by a customer in person.
Collection Process. UACC's collection policy calls for the following sequence
of actions to be taken with regard to all problem loans: call the borrower at
one day past due; immediate follow-up on all broken promises to pay; branch
management review of all accounts at ten days past due; and Regional Manager or
Operations Manager review of all accounts at 45 days past due.
UACC will consider extensions or modifications in working a collection
problem. All extensions and modifications require the approval of the branch
manager, and are monitored by the Regional Manager and Operations Manager.
Repossessions. It is UACC's policy to repossess the financed vehicle only
when payments are substantially in default, the customer demonstrates an
intention not to pay or the customer fails to comply with material provisions of
the contract. All repossessions require the prior approval of the branch
manager. In certain cases, the customer is able to pay the balance due or bring
the account current, thereby redeeming the vehicle.
When a vehicle is repossessed and sold at an automobile auction or through a
private sale, the sale proceeds are subtracted from the net outstanding balance
of the loan with any remaining amount recorded as a loss. UACC generally
pursues all customer deficiencies.
Allowance for Loan Losses. UACC's policy is to place on nonaccrual status
accounts delinquent in excess of 120 days on a contractual basis, and to reverse
all previously accrued but unpaid interest on such accounts. Accounts that have
had their collateral repossessed are placed on nonaccrual by the end of the
month in which they are repossessed regardless of delinquency status. Accounts
are not returned to accrual status until they are brought current.
UACC's policy is to charge-off accounts delinquent in excess of 120 days. The
remaining balance of accounts where the collateral has been repossessed and sold
is charged-off by the end of the month in which the collateral is sold and the
proceeds collected.
5
Loss reserves based on expected losses over the life of the contract are
established when each contract is purchased from the dealer. The reserve is
provided from the dealer discount that is taken on each transaction. Loss
reserve analyses are performed regularly to determine the adequacy of current
reserve levels. For the year ended December 31, 1999, the Company allocated 9%
of the net contract purchased to the allowance for loan losses. The loss
allowances recorded at the time of purchase represent an estimate of expected
losses for these loans. If actual experience exceeds estimates, an additional
provision for losses is established as a charge against earnings. Management
periodically reviews the portion of the discount allocated to the allowance for
loan losses in light of the Company's operations.
The following table reflects UACC's cumulative losses (i.e., net charge-offs
as a percent of original net contract balances) for each contract pool (defined
as the total dollar amount of net contracts purchased in a six-month period)
purchased since UACC's inception.
Number of Mar. 1996 Oct. 1996 Apr. 1997 Oct. 1997 Apr. 1998 Oct. 1998 Apr. 1999 Oct. 1999
Months - - - - - - - -
Outstanding Sept. 1996 Mar. 1997 Sept. 1997 Mar. 1998 Sept. 1998 Mar. 1999 Sept. 1999 Dec. 1999
---------- --------- ---------- --------- ---------- --------- ---------- ---------
1 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
3 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1%
5 0.0% 0.0% 0.1% 0.1% 0.1% 0.1% 0.2%
7 0.3% 0.4% 0.5% 0.5% 0.5% 0.3% 0.5%
9 1.0% 0.9% 1.1% 1.2% 1.1% 1.7% 1.1%
11 2.8% 2.1% 2.3% 2.1% 1.9% 1.3%
13 4.4% 3.1% 3.3% 2.9% 2.7% 1.8%
15 5.9% 4.1% 4.2% 3.7% 3.2% 2.6%
17 6.8% 4.8% 4.8% 4.2% 3.8%
19 7.7% 5.4% 5.3% 4.7% 4.4%
21 8.5% 5.8% 5.7% 5.2% 4.8%
23 8.7% 6.3% 6.4% 5.5%
25 9.1% 6.6% 6.8% 5.9%
27 9.2% 7.2% 7.2% 6.2%
29 9.3% 7.6% 7.4%
31 9.6% 7.9% 7.6%
33 9.9% 8.1% 7.9%
35 10.0% 8.3%
37 10.0% 8.3%
39 10.2% 8.6%
41 10.1%
43 10.1%
45 10.0%
Original Pool ($000) $4,885 $9,297 $15,575 $ 22,488 $30,271 $36,773 $42,115 $21,551
======= ======= ======== ========= ======== ======== ======== ========
Remaining Pool ($000) $ 258 $ 971 $ 2,988 $ 7,284 $14,087 $24,234 $36,546 $21,169
======= ======= ========= ======== ======== ======== ======== ========
(%) 5% 10% 19% 32% 49% 66% 87% 98%
======= ======= ========= ======== ======== ======== ======== ========
UACC purchased its first auto contracts in March 1996 and, accordingly, a
maximum of 45 months of loss history was available at December 31, 1999.
Insurance Premium Finance
Business Overview
In May 1995, the Company entered into a joint venture with BPN under the name
"ClassicPlan" (such business is referred to herein as "IPF"). Under this joint
venture, which commenced operations in September 1995, the Bank underwrites and
finances private passenger automobile and small business ("commercial")
insurance premiums in California and BPN markets this financing primarily to
independent insurance agents
6
that sell automobile or commercial insurance policies in California and,
thereafter, services such loans for the Bank.
IPF markets its automobile insurance financing to drivers who are classified
by insurance companies as non-standard or high risk for a variety of reasons,
including ages, driving record, a lapse in insurance coverage or ownership of
high performance automobiles. Insurance companies that underwrite insurance for
such drivers, including those participating in the assigned risk programs
established by California law, generally either do not offer financing of
insurance premiums or do not offer terms as flexible as those offered by IPF.
IPF markets its commercial insurance financing to small businesses for
property/casualty and specialty classes of insurance on an excess or surplus
lines basis, including commercial multi peril, other liability, commercial
automobile liability/comprehensive, fire and product liability.
Customers are directed to BPN through a non-exclusive network of insurance
brokers and agents who sell automobile or commercial insurance and offer
financing through programs like those offered by IPF. On a typical twelve-month
insurance policy, the borrower makes a cash down payment of 15% to 25% of the
premium (plus certain fees) and the balance is financed under a contract that
contains a payment period of shorter duration than the policy term. In the
event that the insured defaults on the loan, the Bank has the right to obtain
directly from the insurance company the unearned insurance premium held by the
insurance company, which can then be applied to the outstanding loan balance
(premiums are earned by the insurance company over the life of the insurance
policy). Each contract is designed to ensure that, at any point during the term
of the underlying policy, the unearned premium under the insurance policy
exceeds the unpaid principal amount due under the contract. Under the terms of
the contract, the insured grants IPF a power of attorney to cancel the policy in
the event the insured defaults under the contract. Upon cancellation, the
insurance company is required by California law to remit the unearned premium to
IPF which, in turn, offsets this amount against any amounts due from the
insured. IPF does not sell or have the risk of underwriting the underlying
insurance policy. IPF seeks to minimize its credit risk by perfecting a
security interest in the unearned premium, avoiding concentrations of policies
with insurance companies that are below certain industry ratings, and doing
automobile premium financing to date only in California which maintains an
insurance guaranty fund which protects consumers and insurance premium finance
companies against losses from failed insurance companies.
IPF seeks to minimize its credit risks in the financing of commercial
insurance policies by perfecting a security interest in the unearned premium,
obtaining premium verifications on loans over $5,000, avoiding concentrations of
policies with insurance companies that are below certain ratings and limiting
the amount of surplus lines business which is not covered by California's
guaranty fund. At December 31, 1999, IPF had less than 9% of its commercial
loan balances with surplus line insurance companies doing business on a non-
admitted basis in California.
In addition to insurance premiums, IPF will also finance broker fees (i.e.,
fees paid by the insured to the agent). If a policy cancels, the agent repays
any unearned broker fee financed by IPF. Broker fee financing represents
approximately 3% of total loans outstanding. At December 31, 1999,
approximately 60.8% of all broker fee financing was to a single insurance
agency. When IPF agrees to finance an agent's broker fees, a credit limit is
established for the agent. Agents are required to maintain deposits with the
Bank to mitigate IPF's possible losses on broker fees financed. To date, the
Bank has not charged-off a broker fee balance.
At December 31, 1999, the aggregate gross amount of insurance premium finance
contracts was $30.3 million with 70,726 contracts outstanding. Commercial loan
balances represented 24.5% of these loan balances at December 31, 1999. During
1999, IPF originated 108,218 insurance premium finance contracts of which 9,996
or 9.2% were commercial loan contracts. During January 1998, the Company with
BPN, purchased from Providian National Bank for $450,000 the right to solicit
new and renewal personal and commercial insurance premium finance business from
brokers who previously provided contracts to Commonwealth Premium Finance
("CPF"). The purchase price for the agreement was provided 60% by the Company
and 40% by BPN. The relationship between the Company and BPN continues to be
governed by the joint venture arrangement already in effect. See "Relationship
with BPN" below. The Company also acquired the
7
Commonwealth name and certain equipment and software. The agreement also
provides that Providian National Bank and the servicers of its insurance premium
finance business may not solicit or engage in the insurance premium finance
business in California for a period of three years from the date of the
agreement.
During November 1998, the Company and BPN, purchased from Norwest Financial
Coast, Inc. ("Coast") for $3.0 million the right to solicit new and renewal
personal and commercial insurance premium finance business from brokers who
previously provided contracts to Coast. The purchase price for the agreement
was provided 60% by the Company and 40% by BPN. The Company also acquired the
"Coast" name, and certain furniture, equipment and software. The agreement also
provides that Coast may not solicit or engage in the insurance premium finance
business in California and certain other states for five years from the date of
the agreement. Existing Coast customer receivables were not acquired.
Relationship with BPN
BPN is headquartered in Chino, California, and markets the Company's insurance
premium finance program under the trade name "ClassicPlan." The Company
believes that IPF is the largest provider of financing for consumer automobile
insurance premiums in California. On a more limited basis, IPF also finances
insurance premiums for businesses purchasing property, casualty and liability
insurance. At December 31, 1999, BPN had 40 employees.
BPN solicits insurance agents and brokers to submit their clients' financing
requests to the Bank. BPN is responsible for monitoring the agents' performance
and assisting with IPF's compliance with applicable consumer protection,
disclosure and insurance laws, and providing customer service, data processing
and collection services to IPF. The Bank pays fees to BPN for these services.
The amount of these fees is based on fixed charges, which include a loan service
fee per contract and cancellation fees charged by the Bank, and the earnings of
the loan portfolio, which include 50% of the interest earned on portfolio loans
after the Bank subtracts a specified floating portfolio interest rate and 50% of
late fees and returned check fees charged by the Bank. Additionally, BPN and
the Bank share equally certain collection and legal expenses which may occur
from time-to-time, all net loan losses experienced on the insurance premium loan
portfolio and all net losses up to $375,000 experienced on the broker fees loan
portfolio. BPN bears losses over $375,000 experienced on the broker fees loan
portfolio.
The shareholders of BPN have entered into certain guaranty agreements in favor
of the Bank whereby they agree to pay any sums owed to the Bank and not paid by
BPN. The total potential liability of the guarantors to the Bank is limited to
$2,000,000 plus any amounts by which BPN is obligated to indemnify the Bank.
Under these guaranties, all debts of BPN to the guarantors are subordinated to
the full payment of all obligations of BPN to the Bank.
The Company has entered into an option agreement with BPN and its shareholders
whereby the Company may purchase all of the issued and outstanding shares of BPN
(the "Shares Option") and all additional shares of any BPN affiliate which may
be organized outside of California (the "Affiliate Share Option"). The option
period expires March 31, 2005. The Company has agreed not to exercise the Share
Option prior to April 29, 1999 unless BPN or its shareholders have breached
their outstanding agreements with the Company. Until the date occurring 90 days
after delivery to the Company of a notice stating that BPN has had $30,000,000
or more in loans outstanding for the six months preceding delivery of such
notice, which notice cannot be delivered prior to October 29, 1999, the Company
may exercise the Share Option for $3,250,000 and must pay a $750,000 noncompete
payment to certain shareholders and key employees of BPN (the "Noncompete
Payment"). If the Share Option is exercised any time thereafter, the Noncompete
Payment will be made and the option exercise price shall be the greater of
$3,250,000 or four times BPN's pre-tax earnings for the twelve complete
consecutive calendar months immediately preceding the date of exercise less the
Noncompete Payment. The Affiliate Share Option may not be exercised
independently of the Share Option. The exercise price of the Affiliate Share
Option will equal the sum of four times BPN Affiliate's pre-tax earnings for the
twelve-month period prior to exercise.
8
In connection with the purchase of the rights to solicit new and renewal
business from Coast, the Bank made loans to two shareholders of BPN in the
aggregate amount of $1.2 million. The loans earn interest at a rate of 9.25%
per annum and are secured by the common stock of BPN. The loans provide for
principal and interest payments over a three-year period.
Automobile Insurance Premium Finance Industry
Insurance Finance. The private passenger automobile insurance industry in
the United States is estimated by A.M. Best Company ("A.M. Best"), a provider of
independent ratings on the financial strength and claims payment ability of
insurance companies, to have been a $109 billion market in annual premium volume
during 1996, with nonstandard automobile insurance comprising $23 billion of
this market. Although reliable data concerning the size and composition of the
personal lines premium finance market is not available, the Company believes
that the industry is highly fragmented with no independent insurance premium
finance company accounting for a significant share of the market. The Company
believes that the insurance premium finance industry in California is somewhat
more concentrated than elsewhere in the nation, with several long-established
competitors. In addition, insurance companies offering direct bill payment
programs and direct sales of insurance policies to the consumer are providing
significant competition to the Company.
California Insurance Laws. Under current law, automobiles in the state of
California cannot be registered without providing proof of insurance or posting
required bonds with the Department of Motor Vehicles.
In California, as in most states, insurance companies fall into two
categories, admitted or non-admitted. All insurance companies licensed to do
business in California are required to be members of the California Insurance
Guarantee Association ("CIGA"), and are classified as "admitted" companies.
CIGA was established to protect insurance policyholders in the event the company
that issued a policy fails financially, and to establish confidence in the
insurance industry. Should an insurance company fail, CIGA is empowered to
raise money by levying member companies. CIGA pays claims against insurance
companies, which protects both the customer and the premium financiers should an
admitted insurance company fail. In such event, CIGA will refund any unearned
premiums. This provides protection to companies, such as IPF, that provide
insurance premium financing. As a result, IPF's policy is to limit financing of
insurance policies issued by non-admitted carriers.
Because insurance companies will not voluntarily insure drivers whom they
consider to be excessively high risk, California has a program called the
California Automobile Assigned Risk Program ("CAARP"), to which all admitted
companies writing private passenger automobile insurance policies must belong.
This 45-year-old program is an insurance plan for high risk, accident-prone
drivers who are unable to purchase insurance coverage from regular insurance
carriers. CAARP policies are distributed to the admitted companies in
proportion to their share of California's private passenger automobile insurance
market. The companies participating in CAARP do not have any discretion in
choosing the customers they insure under the program. The customers are
arbitrarily assigned to them by CAARP. Although CAARP offers financing of its
policy premiums, its terms are not as competitive as the insurance premium
finance companies and, therefore, many CAARP policies are financed by others.
At December 31, 1999, approximately 13.8% of the insurance policies financed by
IPF were issued under CAARP.
Business Strategy
IPF's business strategy is to increase profitably the volume of contracts
originated and maintained in its portfolio. IPF intends to implement this
strategy by:
. Strengthening its relationships with insurance brokers and agents by
offering a variety of high-quality support services (e.g., computer
hardware and software and customer reports) and finance programs
designed to enable them to better serve their customers;
9
. Investing additional resources to ensure IPF's ability to continue to
provide technologically advanced and efficient contract origination and
servicing systems and support services;
. Continuing to expand its premium financing to other insurance lines of
business (e.g., commercial, property, casualty and liability insurance);
and
. Expanding the Company's operations into other states.
Operating Summary
The following table presents a summary of IPF's key operating and
statistical results for the years ended December 31, 1999 and 1998.
At or For the
Years Ended
December 31,
------------------------------------------------------
1999 1998
------------------------------------------------------
(Dollars in thousands, except portfolio averages)
Operating Data
Loan originations $107,212 $152,998
Loans outstanding at period end 30,334 44,709
Average gross yield (1) 22.32% 19.51%
Average net yield (2) 12.73% 13.90%
Allowance for loan losses $ 389 $ 349
Loan Quality Data
Allowance for loan losses (% of loans outstanding) 1.28% 0.78%
Net charge-offs (% of average loans outstanding) (3) 1.00% 0.78%
Delinquencies (% of loans outstanding) (4) 1.38% 1.79%
Portfolio Data
Average monthly loan originations (number of loans) 9,018 11,501
Average loan size at origination $ 991 $ 1,109
Commercial insurance policies (% of loans outstanding) 24.50% 13.14%
CAARP policies (% of loans outstanding) 13.79% 13.05%
Cancellation rate (% of premiums financed) 39.0% 42.1%
_______________
(1) Gross yield represents total rates and fees paid by the borrower.
(2) Net yield represents the yield to the Bank after interest and fee sharing
with BPN.
(3) Includes only the Bank's 50% share of charge-offs.
(4) This statistic measures delinquencies on canceled policy balances. Since
IPF seeks recovery of unearned premiums from the insurance companies, which
can take up to 90 days, loans are not considered delinquent until more than
90 days past due.
Products and Pricing
IPF generally charges from 16% to 23% annualized interest (depending on the
amount financed) and a $40 processing fee for each consumer contract, which the
Company believes is competitive in IPF's industry. In addition, contracts
provide for the payment by the insured of a delinquency charge and, if the
default results in cancellation of any insurance policy listed in the contract,
for the payment of a cancellation charge. Certain of these finance charges and
fees are shared with BPN. See "Relationship with BPN." The insured makes a
minimum 15% down payment on an annual policy and pays the remainder in a maximum
of ten monthly payments.
IPF designs its programs so that the unearned premium is equal to or
greater than the remaining principal amount due on the contract by requiring a
down payment and having a contract term shorter than the underlying policy term.
Sales and Marketing
IPF currently markets its insurance premium finance program through a
network of over 700 agents, primarily located in Los Angeles, Orange and San
Bernardino counties. Relationships with agents are established by BPN's
marketing representatives. The Company believes that IPF has been able to
attract and
10
maintain its relationship with agents by offering a higher level of service than
its competitors. IPF focuses on providing each agent with up-to-date information
on its customers' accounts, which allows the agent to service customers' needs
and minimize the number of policies that are canceled. Many of IPF's largest
agents have computer terminals provided by BPN in their offices, which allow on-
line access to customer information. Agents for IPF receive an average producer
fee ($20, equal to 50% of the aforementioned $40 processing fee per contract),
as collateral against early cancellations. IPF does not require return of this
$20 producer fee for early policy cancellation unless the policy pays off in the
first 30 days.
To minimize its exposure to reliance on a limited number of agents, the
Company has instituted portfolio guidelines generally limiting the dollar amount
of contracts originated by any agent to 15% of IPF's total portfolio. The
Company performs a quarterly analysis of all agents based on information
provided by BPN. At December 31, 1999, IPF had no agent that exceeded the 15%
portfolio parameter.
Underwriting Standards
IPF is a secured lender, and upon default, relies on its security interest
in the unearned premium held by the insurance company. IPF can, however, suffer
a loss on an insurance premium finance contract for four reasons: loss of all or
a portion of the unearned premium due to its failure to cancel the contract on a
timely basis; an insolvency of the insurance company holding the unearned
premium not otherwise covered by CIGA; inadequacy of the unearned premium to
cover charges in excess of unpaid principal amount; and cost of collection and
administration, including the time value of money, exceeding the unpaid
principal and other charges due under the contract. For the twelve months ended
December 31, 1999, IPF canceled for nonpayment contracts representing
approximately 39.0% of all premiums financed. Careful administration of
contracts is critical to protecting IPF against loss.
Credit applications are taken at the insurance agent's office. Given the
secondary source of repayment on unearned premiums due from the insurance
company on a canceled policy, and in most cases, access to CIGA, IPF does not
carry out a credit investigation of a borrower on loans under $25,000.
Servicing and Collection
The Company believes that an efficient and accurate servicing and
collection system is the most important management tool that an insurance
premium financing company can use to protect itself from losses as a result of
an insured's default on a contract. The insurance premium finance industry is
acutely time sensitive because insurance premiums are earned each day that an
insurance policy remains in effect, thus reducing, on a daily basis, the
collateral support provided by the unearned premium.
During July 1998, BPN purchased and installed a new computer system, a
Proliant 2500, manufactured by Compaq Computer Corporation. In addition, BPN
developed an Oracle-based management information system software which provides
complete online, real-time information processing services. The system also
provides direct electronic processing of many functions that were previously
paper intensive. This system satisfies IPF's current requirements for
application processing, payment processing and collections and monitoring and
reporting, and has significant capacity remaining. The Bank purchased a 50%
interest in the Oracle-based software developed by BPN for $175,000.
Billing Process. A customer's monthly payments are recorded in BPN's
computer system on the date of receipt. BPN's computer system is designed to
provide protection against principal loss by automatically canceling a policy no
later than 18 days after the customer's latest payment due date. If a payment is
not received on its due date, BPN's computer system automatically prints a
notice of intent to cancel and assesses a late fee which is mailed to the
insured and his or her insurance agent stating that payment must be received
within 18 days after the due date or IPF will cancel the insurance policy. If
payment is received within the 18 day period, BPN's computer system returns the
account to normal status.
Collections Process. If IPF does not receive payment within the statutory
period set forth in the notice of intent to cancel, BPN's computer system will
automatically generate a cancellation notice on the next
11
business day, instructing the insurance company to cancel the insured's
insurance policy and refund any unearned premium directly to IPF for processing.
Although California law requires the insurance company to refund unearned
premiums within 30 days of the cancellation date, most insurance companies pay
on more extended terms. After cancellation, IPF charges certain allowable fees
and continues to earn interest. Although the gross return premium may not fully
cover the fees and accrued interest owed to IPF by the insured, principal
generally is fully covered. Policies which are canceled in the first two months
generally have a greater risk of loss of fees.
IPF charges against income a general provision for possible losses on
finance receivables in such amounts as management deems appropriate. Case-by-
case direct write-offs, net of recoveries on finance receivables, are charged to
IPF's allowance for possible losses. This allowance amount is reviewed
periodically in light of economic conditions, the status of outstanding
contracts and other factors.
Insurance Company Failure. One of the principal risks involved in financing
insurance premiums is the possible insolvency of an insurance company. Another
risk is that an insurance company's financial circumstances cause it to delay
its refunds of unearned premiums. Either event can adversely affect the yield to
an insurance premium finance company on a contract. Despite the protection
afforded by CIGA, IPF also reviews the ratings assigned to the insurance
companies by A.M. Best or their financial statements. To minimize its exposure
to risks resulting from the insolvency of an insurance company, IPF limits the
number of policies financed that are issued by insurance companies rated "B" or
lower by A.M. Best.
Pan American Bank, FSB
Business Overview
The Bank is a federally chartered stock savings bank formed in 1994 to
purchase from the RTC certain assets and to assume certain liabilities of the
Bank's predecessor, Pan American Federal Savings Bank. It is the largest
Hispanic-controlled savings association in California, with five retail branch
offices in the state and $291.9 million in deposits at December 31, 1999. The
Bank has been the principal funding source to date for the Company's residential
mortgage, insurance premium and automobile finance businesses primarily through
its deposits, FHLB advances, warehouse lines of credit and whole loan sales. In
addition, the Bank holds a portfolio of primarily traditional residential
mortgage loans acquired from the RTC in 1994 and 1995 at a discount from the
unpaid principal balance of such loans, these loans aggregated $21.8 million
(before unearned discounts and premiums) at December 31, 1999. The Bank has
focused its branch marketing efforts on building a middle income customer base,
including efforts targeted at local Hispanic communities. The Bank has
bilingual employees in each of its branches, and key members of the Company's
and the Bank's Board of Directors and management are of Hispanic heritage and
are active in communities served by the Bank. In addition to operating its
retail banking business at four branches located in Northern California and one
in Southern California, the Bank provides, subject to appropriate cost sharing
arrangements, compliance, risk management, executive, financial, facilities and
human resources management to other business units of the Company. The business
of the Bank is subject to substantial government supervision and regulatory
requirement. See "Supervision and Regulation - Business Savings Bank
Regulation."
Discontinued Operations - Mortgage Finance
From 1996 to the end of 1999, one of the Company's primary lending
businesses was mortgage finance. The Company originated and sold or securitized
subprime mortgage loans secured primarily by first mortgages on single family
residences through United PanAm Mortgage, a division of the Bank (such business
is referred to as "UPAM").
The market for subprime mortgage lending deteriorated late in 1998 in
response to disruptions in the global capital markets, causing a severe
liquidity crisis in the mortgage securitization markets. As a result, the demand
for subprime mortgage loans was negatively affected and whole loan prices
dropped precipitously in the fourth quarter of 1998. During the first nine
months of 1998 the Company received an average price of
12
105% (of the principal amount of mortgages) for whole loan sales compared with
102.8% in the fourth quarter of 1998 and 103.2% for all of 1999.
To compensate for declining loan sale prices, the Company implemented a
number of actions including consolidating loan branches, reducing overhead costs
and improving loan quality. However, the mortgage finance division was unable to
achieve targeted profitability levels. Consequently, in December 1999, the
Company decided to discontinue this division in order to concentrate efforts on
its other businesses as well as to explore new finance businesses. Accordingly,
related operating activity for UPAM is reclassified and reported as discontinued
operations in the 1999 and the preceding years consolidated financial
statements. A loss on disposal for UPAM is also included in the 1999 financial
statements and provides for lease terminations, employment severance and
benefits, write-off of fixed assets and leasehold improvements and an accrual
for estimated future operating losses of UPAM.
During 1999, UPAM sold loans with servicing released to other mortgage
companies and investors through whole loan packages offered for bid several
times per month. During 1999, UPAM sold $552.2 million of loans through whole
loan sales at a weighted average sales price equal to 103.2% of the original
principal balance of the loans sold. Also, in 1999, UPAM completed two mortgage
loan securitizations totaling $458.0 million and recorded a weighted average
gain on these securitizations of 103.8% of the original principal balance of the
loans sold. In connection with these two securitizations, the Company recorded
residual interests of $22.3 million. These residual interests were not included
in the Company's discontinued mortgage finance operations.
Operating Summary
The following table presents a summary of UPAM's key operating results and
statistics for 1999 and 1998.
At of For the Years Ended
December 31,
-------------------------------------------------------
1999 1998
--------------------- --------------------
(Dollars in thousands)
Loan Origination Statistics
Loans originated $ 962,716 $1,189,741
Number of loans originated 8,833 11,934
Average principal balance per loan $ 109 $ 100
Weighted average interest rate
Fixed-rate loans 10.10% 10.35%
Adjustable-rate loans 9.86% 9.62%
Weighted average loan-to-value ratio 76% 76%
First mortgage loans 97% 96%
Fixed-rate loans 24% 29%
Owner occupied 89% 88%
Retail originations 18% 32%
California originations 35% 32%
Loans with prepayment penalties
Retail 94% 90%
Wholesale 84% 81%
Loan Sales Statistics
Loans sold or securitized $1,010,211 $1,084,701
Average whole loan sales price
(% of principal balance) 103.2% 104.8%
13
Loan Origination
During 1999, UPAM originated loans through its retail and wholesale
divisions. The retail division originated loans through the direct solicitation
of borrowers by mail and telemarketing and accounted for $173.4 million, or 18%
of UPAM's total loan production in 1999. The wholesale division originated loans
through independent loan brokers and accounted for $789.3 million, or 82%, of
UPAM's total loan production during the same period.
Loan Sales and Securitizations
Whole Loan Sales. During the twelve months ended December 31, 1999, UPAM
sold, for cash paid in full at closing, $552.2 million of mortgage loans
through whole loan sales at a weighted average sales price equal to 103.2% of
the original principal balance of the loans sold.
Whole loan sales were made on a non-recourse basis pursuant to a purchase
agreement containing customary representations and warranties by UPAM regarding
the underwriting criteria applied by UPAM in the origination process. In the
event of a breach of such representations and warranties, UPAM may be required
to repurchase or substitute loans. In addition, UPAM sometimes committed to
repurchase or substitute a loan if a payment default occurred within the first
month following the date the loan was funded, or if UPAM's appraisal was
significantly different than the purchaser's appraisal value, unless other
arrangements were made between UPAM and the purchaser. UPAM also was required
in some cases to repurchase or substitute a loan if the loan documentation was
alleged to contain fraudulent misrepresentations made by the borrower. During
1999, UPAM repurchased from investors $9.6 million of loans primarily as a
result of early payment defaults or property appraisal differences. If these
loans are non-performing, specific loss reserves have been recorded if the
outstanding principal balance is in excess of its estimated fair value.
Securitizations. UPAM completed its first securitization of mortgage loans
in December 1997, in the principal amount of $114.9 million. The Company sold
for cash, the residual interests from this securitization. No loan
securitizations were completed during 1998. UPAM completed two additional
securitizations in March and October of 1999 in the principal amount of
approximately $458.0 million. As part of the 1999 securitizations, the Company
recorded residual interests in securitizations of $22.3 million. The residual
interests consist of beneficial interests in the form of an interest-only strip
representing the subordinated right to receive cash flows from the pool of
securitized loans after payment of required amounts to the holders of the
securities and certain costs associated with the securitization. The Company
classifies its residual interests in securitizations as trading securities and
records them at fair market value with any unrealized gains or losses recorded
in the results of operations.
Valuations of the residual interests in securitizations at each reporting
period are based on discounted cash flows analyses. Cash flows are estimated as
the amount of the excess of the weighted average coupon on the loans sold over
the sum of the interest pass-through on the senior certificates, a servicing
fee, an estimate of annual future credit losses and prepayment assumptions and
other expenses associated with the securitization, discounted at an interest
rate which the Company believes is commensurate with the risks involved. The
Company uses prepayment and default assumptions that market participants would
use for similar instruments subject to prepayment, credit and interest rate
risks.
The assumptions used by the Company for valuing the residual interests
arising from its 1999 securitizations included prepayment assumptions of 5% for
the first year increasing to 30%-42% thereafter, an annual credit loss
assumption of 0.95% and a discount rate of 15%. The Company sold for cash, the
residual interests from its first securitization completed in 1997.
Loan Servicing and Delinquencies
UPAM sold most of its loans on a servicing released basis. All loans were
serviced and held by the Bank until sold. The Bank subcontracts with a third-
party sub-servicer to conduct its servicing operations, and monitors the sub-
servicers' activities to ensure that they comply with its guidelines. UPAM began
receiving
14
applications for mortgage loans under its regular lending programs in January
1996 and to date has sold many of its loans on a whole loan, servicing released
basis. Accordingly, UPAM does not have representative historical delinquency,
bankruptcy, foreclosure or default experience that may be referred to for
purposes of estimating future delinquency, loss and prepayment data with respect
to its loans.
In connection with discontinuing its subprime mortgage finance business,
the Company ceased originating loans in the first quarter of 2000. As part of
exiting this lending business, the Company expects to sell any remaining loans
on a whole loan servicing released basis as soon as practical. The costs
associated with these origination activities as well as an estimate of the
proceeds to be realized upon sale of the loans is included in the Company's loss
on disposal of discontinued operations.
Industry Segments
Information regarding industry segments is set forth in Footnote Number 21
to the Consolidated Financial Statements included in Item 8 to this Annual
Report on Form 10-K.
Competition
Each of the Company's businesses is highly competitive. Competition in the
Company's markets can take many forms, including convenience in obtaining a
loan, customer service, marketing and distribution channels, amount and terms of
the loan, loan origination fees and interest rates. Many of the Company's
competitors are substantially larger and have considerably greater financial,
technical and marketing resources than the Company. The Company competes in the
insurance premium finance business with other specialty finance companies,
independent insurance agents who offer premium finance services, captive premium
finance affiliates of insurance companies and direct bill plans established by
insurance companies. The Company competes in the subprime automobile finance
industry with commercial banks, the captive finance affiliates of automobile
manufacturers, savings associations and companies specializing in subprime
automobile finance, many of which have established relationships with automobile
dealerships and may offer dealerships or their customers other forms of
financing, including dealer floor plan financing and lending, which are not
offered by the Company. In attracting deposits, the Bank competes primarily
with other savings institutions, commercial banks, brokerage firms, mutual
funds, credit unions and other types of investment companies.
Fluctuations in interest rates and general and localized economic
conditions also may affect the competition the Company faces. Competitors with
lower costs of capital have a competitive advantage over the Company. During
periods of declining interest rates, competitors may solicit the Company's
customers to refinance their loans. In addition, during periods of economic
slowdown or recession, the Company's borrowers may face financial difficulties
and be more receptive to offers of the Company's competitors to refinance their
loans. As the Company seeks to expand into new geographic markets, it will face
additional competition from lenders already established in these markets.
Employees
At December 31, 1999, the Company had 607 full-time equivalent employees.
Included in this total are 395 full-time equivalent employees of the Company's
mortgage origination operations. Most of the mortgage origination employees
will be terminated during the first quarter of 2000 in connection with the
discontinuance of these operations. The Company believes its relations with its
employees are satisfactory.
Supervision and Regulation
Set forth below is a brief description of various laws and regulations
affecting the operations of the Company and its subsidiaries. The description
of laws and regulations contained herein does not purport to be complete and is
qualified in its entirety by reference to applicable laws and regulations. Any
change in applicable laws, regulations or regulatory policies may have a
material effect on the business, operations and prospects of the Company.
15
Holding Company Regulation
General. The Company is a unitary savings and loan holding company subject
to regulatory oversight by the Office of Thrift Supervision (the "OTS"). For
purposes of this discussion, the description of holding company regulation also
applies to PAFI, a direct subsidiary of the Company and the parent of the Bank.
As such, the Company is required to register and file reports with the OTS and
is subject to regulation and examination by the OTS. In addition, the OTS has
enforcement authority over the Company and its subsidiaries, which also permits
the OTS to restrict or prohibit activities that are determined to be a serious
risk to the subsidiary savings association.
Qualified Thrift Lender Test. As a unitary savings and loan holding
company, the Company generally is not subject to activity restrictions, provided
the Bank satisfies the Qualified Thrift Lender ("QTL") test or meets the
definition of domestic building and loan association pursuant to section 7701 of
the Internal Revenue Code of 1986, as amended (the "Code"). If the Company
acquires control of another savings association as a separate subsidiary, it
would become a multiple savings and loan holding company, and the activities of
the Company and any of its subsidiaries (other than the Bank or any other SAIF-
insured savings association) would become subject to restrictions applicable
to bank holding companies unless such other associations each also qualify as a
QTL or domestic building and loan association and were acquired in a supervisory
acquisition. See "- Business Savings Bank Regulation - Qualified Thrift Lender
Test."
Restrictions on Acquisitions. The Company must obtain approval from the
OTS before acquiring control of any other SAIF-insured association. Such
acquisitions are generally prohibited if they result in a multiple savings and
loan holding company controlling savings associations in more than one state.
However, such interstate acquisitions are permitted based on specific state
authorization or in a supervisory acquisition of a failing savings association.
Federal law generally provides that no "person," acting directly or
indirectly or through or in concert with one or more other persons, may acquire
"control," as that term is defined in OTS regulations, of a federally insured
savings association without giving at least 60 days written notice to the OTS
and providing the OTS an opportunity to disapprove the proposed acquisition. In
addition, no company may acquire control of such an institution without prior
OTS approval. These provisions also prohibit, among other things, any director
or officer of a savings and loan holding company, or any individual who owns or
controls more than 25% of the voting shares of a savings and loan holding
company, from acquiring control of any savings association not a subsidiary of
the savings and loan holding company, unless the acquisition is approved by the
OTS. For additional restrictions on the acquisition of a unitary thrift holding
company see "- Financial Services Modernization Legislation."
Financial Services Modernization Legislation. On November 12, 1999,
President Clinton signed into law the Gramm-Leach-Bliley Act of 1999 (the
"Financial Services Modernization Act"). The Financial Services Modernization
Act repeals the two affiliation provisions of the Glass-Steagall Act: Section
20, which restricted the affiliation of Federal Reserve Member Banks with firms
"engaged principally" in specified securities activities; and Section 32, which
restricts officer, director, or employee interlocks between a member bank and
any company or person "primarily engaged" in specified securities activities.
In addition, the Financial Services Modernization Act also contains provisions
that expressly preempt any state law restricting the establishment of financial
affiliations, primarily related to insurance. The general effect of the law is
to establish a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms, and other financial service
providers by revising and expanding the Bank Holding Company Act framework to
permit a holding company system to engage in a full range of financial
activities through a new entity known as a "Financial Holding Company."
"Financial activities" is broadly defined to include not only banking,
insurance, and securities activities, but also merchant banking and additional
activities that the Federal Reserve Board, in consultation with the Secretary of
the Treasury, determines to be financial in nature, incidental to such financial
activities, or complementary activities that do not pose a substantial risk to
the safety and soundness of depository institutions or the financial system
generally.
16
The Financial Services Modernization Act provides that no company may
acquire control of an insured savings association after May 4, 1999, unless that
company engages, and continues to engage, only in the financial activities
permissible for a Financial Holding Company, unless grandfathered as a unitary
savings and loan holding company. The Financial Institution Modernization Act
grandfathers any company that was a unitary savings and loan holding company on
May 4, 1999 (or becomes a unitary savings and loan holding company pursuant to
an application pending on that date). Such a company may continue to operate
under present law as long as the company continues to meet the two tests: it
can control only one savings institution, excluding supervisory acquisitions,
and each such institution must meet the QTL test. It further requires that a
grandfathered unitary savings and loan holding company must continue to control
at least one savings association, or a successor institution, that it controlled
on May 4, 1999.
The Financial Services Modernization Act also permits national banks to
engage in expanded activities through the formation of financial subsidiaries. A
national bank may have a subsidiary engaged in any activity authorized for
national banks directly or any financial activity, except for insurance
underwriting, insurance investments, real estate investment or development, or
merchant banking, which may only be conducted through a subsidiary of a
Financial Holding Company. Financial activities include all activities permitted
under new sections of the Bank Holding Company Act of 1956 ("BHCA") or permitted
by regulation.
The Company and the Bank do not believe that the Financial Services
Modernization Act will have a material adverse effect on the operations of the
Company and the Bank in the near-term. However, to the extent that the act
permits banks, securities firms, and insurance companies to affiliate, the
financial services industry may experience further consolidation. The Financial
Services Modernization Act is intended to grant to community banks certain
powers as a matter of right that larger institutions have accumulated on an ad
hoc basis and which unitary savings and loan holding companies already possess.
Nevertheless, this act may have the result of increasing the amount of
competition that the Company and the Bank face from larger institutions and
other types of companies offering financial products, many of which may have
substantially more financial resources than the Company and the Bank. In
addition, because the Company may only be acquired by other unitary savings and
loan holding companies or Financial Holding Companies, the legislation may have
an anti-takeover effect by limiting the number of potential acquirors or by
increasing the costs of an acquisition transaction by a bank holding company
that has not made the election to be a Financial Holding Company under the new
legislation.
Regulation of Mortgage Finance Operation
The consumer financing industry is a highly regulated industry. UPAM's
business is subject to extensive and complex rules and regulations of, and
examinations by, various federal, state and local government authorities. These
rules and regulations impose obligations and restrictions on UPAM's loan
origination, credit activities and secured transactions. In addition, these
rules limit the interest rates, finance charges and other fees UPAM may assess,
mandate extensive disclosure to UPAM's customers, prohibit discrimination and
impose multiple qualification and licensing obligations on UPAM. Failure to
comply with these requirements may result in, among other things, demands for
indemnification or mortgage loan repurchases, certain rights of rescission for
mortgage loans, class action lawsuits, administrative enforcement actions and
civil and criminal liability. Management of UPAM believes that UPAM is in
compliance with these rules and regulations in all material respects.
UPAM is subject to certain disclosure requirements under the Truth in
Lending Act ("TILA") and the Federal Reserve Board's Regulation Z promulgated
thereunder. TILA is designed to provide consumers with uniform, understandable
information with respect to the terms and conditions of loan and credit
transactions. TILA also guarantees consumers a three-day right to cancel certain
credit transactions, including loans of the type originated by UPAM. Such three-
day right to rescind may remain unexpired for up to three years if the lender
fails to provide the requisite disclosures to the consumer.
UPAM originates loans which are subject to the Home Ownership and Equity
Protection Act of 1994 (the "High Cost Mortgage Act"), which makes certain
amendments to TILA. The High Cost Mortgage Act
17
generally applies to consumer credit transactions secured by the consumer's
principal residence, in which the loan has either total points and fees upon
origination in excess of the greater of eight percent of the loan amount or $435
or an annual percentage rate of more than ten percentage points higher than
United States Treasury securities of comparable maturity ("Covered Loans"). The
High Cost Mortgage Act imposes additional disclosure requirements on lenders
originating Covered Loans. In addition, it prohibits lenders from, among other
things, originating Covered Loans that are underwritten solely on the basis of
the borrower's home equity without regard to the borrower's ability to repay the
loan and including prepayment fee clauses in Covered Loans to borrowers with a
debt-to-income ratio in excess of 50% or Covered Loans used to refinance
existing loans originated by the same lender. The High Cost Mortgage Act also
restricts, among other things, certain balloon payments and negative
amortization features. UPAM commenced originating Covered Loans during 1996.
UPAM is also required to comply with the Equal Credit Opportunity Act
("ECOA") and the Federal Reserve Board's Regulation B promulgated thereunder,
the Fair Credit Reporting Act ("FCRA"), the Real Estate Settlement Procedures
Act of 1974 ("RESPA") and the Home Mortgage Disclosure Act ("HMDA"). Regulation
B restricts creditors from requesting certain types of information from loan
applicants. FCRA requires lenders, among other things, to supply an applicant
with certain information if the lender denies the applicant credit. RESPA
requires lenders, among other things, to supply an applicant with certain
disclosures concerning settlement fees and changes and mortgage servicing
transfer practices. It also prohibits the payment or receipt of kickbacks or
referral fees in connection with the performance of settlement services. In
addition, beginning with loans originated in 1994, UPAM must file an annual
report with the Department of Housing and Urban Development pursuant to HMDA,
which requires the collection and reporting of statistical data concerning loan
transactions.
Regulation of Insurance Premium Finance Companies
The insurance premium finance industry is subject to state regulations. The
regulatory structure of each state places certain restrictions on the terms of
loans made to finance insurance premiums. These restrictions, among other
things, generally provide that the lender must provide certain cancellation
notices to the insured and the insurer in order to exercise an assigned right to
cancel an insurance policy in the event of a default under an insurance premium
finance agreement and to obtain in connection therewith a return from the
insurer of any unearned premiums that have been assigned by the insured to the
lender. Such state laws also require that certain disclosures be delivered by
the insurance agent or broker arranging for such credit to the insured regarding
the amount of compensation to be received by such agent or broker from the
lender.
Regulation of Subprime Automobile Lending
UACC's automobile lending activities are subject to various federal and
state consumer protection laws, including TILA, ECOA, FCRA, the Federal Fair
Debt Collection Practices Act, the Federal Trade Commission Act, the Federal
Reserve Board's Regulations B and Z, and state motor vehicle retail installment
sales acts. Retail installment sales acts and other similar laws regulate the
origination and collection of consumer receivables and impact UACC's business.
These laws, among other things, require UACC to obtain and maintain certain
licenses and qualifications, limit the finance charges, fees and other charges
on the contracts purchased, require UACC to provide specified disclosures to
consumers, limit the terms of the contracts, regulate the credit application and
evaluation process, regulate certain servicing and collection practices, and
regulate the repossession and sale of collateral. These laws impose specific
statutory liabilities upon creditors who fail to comply with their provisions
and may give rise to a defense to payment of the consumer's obligation. In
addition, certain of the laws make the assignee of a consumer installment
contract liable for the violations of the assignor.
Each dealer agreement contains representations and warranties by the dealer
that, as of the date of assignment, the dealer has compiled with all applicable
laws and regulations with respect to each contract. The dealer is obligated to
indemnify UACC for any breach of any of the representations and warranties and
to repurchase any non-conforming contracts. UACC generally verifies dealer
compliance with usury laws, but
18
does not audit a dealer's full compliance with applicable laws. There can be no
assurance that UACC will detect all dealer violations or that individual dealers
will have the financial ability and resources either to repurchase contracts or
indemnify UACC against losses. Accordingly, failure by dealers to comply with
applicable laws, or with their representations and warranties under the dealer
agreement, could have a material adverse affect on UACC.
UACC believes it is currently in compliance in all material respects with
applicable laws, but there can be no assurance that UACC will be able to
maintain such compliance. The failure to comply with such laws, or a
determination by a court that UACC's interpretation of any such law was
erroneous, could have a material adverse effect upon UACC. Furthermore, the
adoption of additional laws, changes in the interpretation and enforcement of
current laws or the expansion of UACC's business into jurisdictions that have
adopted more stringent regulatory requirements than those in which UACC
currently conducts business, could have a material adverse affect upon UACC.
If a borrower defaults on a contract, UACC, as the servicer of the
contract, is entitled to exercise the remedies of a secured party under the
Uniform Commercial Code as adopted in a particular state (the "UCC"), which
typically includes the right to repossession by self-help unless such means
would constitute a breach of the peace. The UCC and other state laws regulate
repossession and sales of collateral by requiring reasonable notice to the
borrower of the date, time and place of any public sale of collateral, the date
after which any private sale of the collateral may be held and the borrower's
right to redeem the financed vehicle prior to any such sale, and by providing
that any such sale must be conducted in a commercially reasonable manner.
Financed vehicles repossessed generally are resold by UACC through unaffiliated
wholesale automobile networks or auctions which are attended principally by used
automobile dealers.
Business Savings Bank Regulation
As a federally chartered, SAIF-insured savings association, the Bank is
subject to extensive regulation by the OTS and the Federal Deposit Insurance
Corporation ("FDIC"). Lending activities and other investments of the Bank must
comply with various statutory and regulatory requirements. The Bank is also
subject to certain reserve requirements promulgated by the Board of Governors of
the Federal Reserve System ("Federal Reserve Board").
The OTS, in conjunction with the FDIC, regularly examines the Bank and
prepares reports for the consideration of the Bank's Board of Directors on any
deficiencies found in the operations of the Bank. The relationship between the
Bank and depositors and borrowers is also regulated by federal and state laws,
especially in such matters as the ownership of savings accounts and the form and
content of mortgage documents utilized by the Bank.
The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition, in addition to obtaining regulatory
approvals prior to entering into certain transactions such as mergers with or
acquisitions of other financial institutions. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the SAIF and depositors.
The regulatory structure also gives the regulatory authorities extensive
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. Any change in such regulations, whether by the OTS, the FDIC, or the
Congress could have a material adverse impact on the Company, the Bank, and
their operations.
Insurance of Deposit Accounts. The Bank's deposit accounts are insured by
the SAIF, as administered by the FDIC, up to the maximum amount permitted by
law. Insurance of deposits may be terminated by the FDIC upon a finding that
the institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order, or condition imposed by the FDIC or the institution's
primary regulator.
19
The FDIC charges an annual assessment for the insurance of deposits based
on the risk a particular institution poses to its deposit insurance fund. Under
this system as of December 31, 1995, SAIF members paid within a range of 23
cents to 31 cents per $100 of domestic deposits, depending upon the
institution's risk classification. This risk classification is based on an
institution's capital group and supervisory subgroup assignment.
The FDIC charges an annual assessment for the insurance of deposits based
on the risk a particular institution poses to its deposit insurance fund. Under
this system as of December 31, 1999, SAIF members paid within a range of 0 cents
to 27 cents per $100 of domestic deposits, depending upon the institution's risk
classification. This risk classification is based on an institution's capital
group and supervisory subgroup assignment. In addition, pursuant to the
Economic Growth and Paperwork Reduction Act of 1996 (the "Paperwork Reduction
Act"), the Bank pays, in addition to its normal deposit insurance premium as a
member of the SAIF, an amount equal to approximately 6.4 basis points toward the
retirement of the Financing Corporation bonds ("Fico Bonds") issued in the 1980s
to assist in the recovery of the savings and loan industry. Members of the Bank
Insurance Fund ("BIF"), by contrast, pay, in addition to their normal deposit
insurance premium, approximately 1.3 basis points. Under the Paperwork Reduction
Act, the FDIC also is not permitted to establish SAIF assessment rates that are
lower than comparable BIF assessment rates. Effective January 1, 2000, the rate
paid to retire the Fico Bonds will be equal for members of the BIF and the SAIF.
The Paperwork Reduction Act also provided for the merging of the BIF and the
SAIF by January 1, 1999 provided there were no financial institutions still
chartered as savings associations at that time. Although legislation to
eliminate the savings association charter had been proposed, at January 1, 1999,
financial institutions such as the Bank were still chartered as savings
associations.
Regulatory Capital Requirements. OTS capital regulations require savings
associations to meet three capital standards: tangible capital equal to 1.5% of
total adjusted assets, leverage capital (core capital) equal to 3% of total
adjusted assets, and risk-based capital equal to 8.0% of total risk-based
assets. The Bank must meet each of these standards in order to be deemed in
compliance with OTS capital requirements. In addition, the OTS may require a
savings association to maintain capital above the minimum capital levels.
Under OTS regulations, a savings association with a greater than "normal"
level of interest rate exposure must deduct an interest rate risk ("IRR")
component in calculating its total capital for purposes of determining whether
it meets its risk-based capital requirement. Interest rate exposure is
measured, generally, as the decline in an institution's net portfolio value that
would result from a 200 basis point increase or decrease in market interest
rates (whichever would result in lower net portfolio value), divided by the
estimated economic value of the savings association's assets. The interest rate
risk component to be deducted from total capital is equal to one-half of the
difference between an institution's measured exposure and "normal" IRR exposure
(which is defined as 2%), multiplied by the estimated economic value of the
institution's assets. In August 1995, the OTS indefinitely delayed
implementation of its IRR regulation. Based on information voluntarily supplied
to the OTS, at December 31, 1999, the Bank would not have been required to
deduct an IRR component in calculating total risk-based capital had the IRR
component of the capital regulations been in effect.
These capital requirements are viewed as minimum standards by the OTS, and
most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: a savings
association has a high degree of exposure to interest rate risk, prepayment
risk, credit risk, concentration of credit risk, certain risks arising from
nontraditional activities, or similar risks or a high proportion of off-balance
sheet risk; a savings association is growing, either internally or through
acquisitions, at such a rate that supervisory problems are presented that are
not dealt with adequately by OTS regulations; and a savings association may be
adversely affected by activities or condition of its holding company,
affiliates, subsidiaries, or other persons, or
20
savings associations with which it has significant business relationships. The
Bank is not subject to any such individual minimum regulatory capital
requirement.
As shown below, the Bank's regulatory capital exceeded all minimum
regulatory capital requirements applicable to it as of December 31, 1999.
Percent of
Amount Adjusted Assets
---------------- ------------------
(Dollars in Thousands)
GAAP Capital............................ $47,931 10.60%
Tangible Capital: (1)
Regulatory requirement.................. $ 6,542 1.50%
Actual capital.......................... 46,234 10.60%
---------------- ----------------
Excess............................... $39,692 9.10%
================ ================
Leverage (Core) Capital: (1)
Regulatory requirement.................. $13,084 3.00%
Actual capital.......................... 46,234 10.60%
---------------- ----------------
Excess............................... $33,150 7.60%
================ ================
Risk-Based Capital: (2)
Regulatory requirement.................. $22,327 8.00%
Actual capital.......................... 28,581 10.24%
---------------- ----------------
Excess............................... $ 6,254 2.24%
================ ================
____________
(1) Regulatory capital reflects modifications from GAAP capital due to goodwill
and other intangible assets and a portion of deferred tax assets not
permitted to be included in regulatory capital.
(2) Based on risk-weighted assets of $279.1 million.
The Home Owners' Loan Act ("HOLA") permits savings associations not in
compliance with the OTS capital standards to seek an exemption from certain
penalties or sanctions for noncompliance. Such an exemption will be granted
only if certain strict requirements are met, and must be denied under certain
circumstances. If an exemption is granted by the OTS, the savings association
still may be subject to enforcement actions for other violations of law or
unsafe or unsound practices or conditions.
Prompt Corrective Action. The prompt corrective action regulation of the
OTS, requires certain mandatory actions and authorizes certain other
discretionary actions to be taken by the OTS against a savings association that
falls within certain undercapitalized capital categories specified in the
regulation.
The regulation establishes five categories of capital classification: "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," and "critically undercapitalized." Under the regulation, the
risk-based capital, leverage capital, and tangible capital ratios are used to
determine an institution's capital classification. At December 31, 1999, the
Bank met the capital requirements of a "well capitalized" institution under
applicable OTS regulations.
In general, the prompt corrective action regulation prohibits an insured
depository institution from declaring any dividends, making any other capital
distribution, or paying a management fee to a controlling person if, following
the distribution or payment, the institution would be within any of the three
undercapitalized categories. In addition, adequately capitalized institutions
may accept Brokered Deposits only with a waiver from the FDIC and are subject to
restrictions on the interest rates that can be paid on such deposits.
Undercapitalized institutions may not accept, renew, or roll-over Brokered
Deposits.
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may, if the institution is well capitalized,
reclassify it as adequately capitalized; if the institution is adequately
capitalized but not well capitalized, require it to comply with restrictions
applicable to undercapitalized institutions; and, if the institution is
21
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions.
Loans-to-One Borrower. Savings associations generally are subject to the
lending limits applicable to national banks. With certain limited exceptions,
the maximum amount that a savings association or a national bank may lend to any
borrower (including certain related entities of the borrower) at one time may
not exceed 15% of the unimpaired capital and surplus of the institution, plus an
additional 10% of unimpaired capital and surplus for loans fully secured by
readily marketable collateral. Savings associations are additionally authorized
to make loans to one borrower, for any purpose, in an amount not to exceed
$500,000 or, by order of the Director of OTS, in an amount not to exceed the
lesser of $30,000,000 or 30% of unimpaired capital and surplus to develop
residential housing, provided: the purchase price of each single-family dwelling
in the development does not exceed $500,000; the savings association is in
compliance with its fully phased-in capital requirements; the loans comply with
applicable loan-to-value requirements and the aggregate amount of loans made
under this authority does not exceed 150% of unimpaired capital and surplus. At
December 31, 1999, the Bank's loans-to-one-borrower limit was $6.9 million based
upon the 15% of unimpaired capital and surplus measurement.
Qualified Thrift Lender Test. Savings associations must meet a QTL test,
which test may be met either by maintaining a specified level of assets in
qualified thrift investments as specified in HOLA or by meeting the definition
of a "domestic building and loan association" in section 7701 of the Code. If
the Bank maintains an appropriate level of certain specified investments
(primarily residential mortgages and related investments, including certain
mortgage-related securities) and otherwise qualifies as a QTL or a domestic
building and loan association, it will continue to enjoy full borrowing
privileges from the Federal Home Loan Bank ("FHLB"). The required percentage of
investments under HOLA is 65% of assets while the Code requires investments of
60% of assets. An association must be in compliance with the QTL test or the
definition of domestic building and loan association on a monthly basis in nine
out of every 12 months. Associations that fail to meet the QTL test will
generally be prohibited from engaging in any activity not permitted for both a
national bank and a savings association. As of December 31, 1999, the Bank was
in compliance with its QTL requirement and met the definition of a domestic
building and loan association.
Affiliate Transactions. Transactions between a savings association and its
"affiliates" are subject to quantitative and qualitative restrictions under
Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings
association include, among other entities, the savings association's holding
company and companies that are under common control with the savings
association.
In general, Sections 23A and 23B and OTS regulations issued in connection
therewith limit the extent to which a savings association or its subsidiaries
may engage in certain "covered transactions" with affiliates to an amount equal
to 10% of the association's capital and surplus, in the case of covered
transactions with any one affiliate, and to an amount equal to 20% of such
capital and surplus, in the case of covered transactions with all affiliates.
In addition, a savings association and its subsidiaries may engage in covered
transactions and certain other transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with non-affiliated companies. A "covered transaction"
is defined to include a loan or extension of credit to an affiliate; a purchase
of investment securities issued by an affiliate; a purchase of assets from an
affiliate, with certain exceptions; the acceptance of securities issued by an
affiliate as collateral for a loan or extension of credit to any party; or the
issuance of a guarantee, acceptance, or letter of credit on behalf of an
affiliate.
In addition, under the OTS regulations, a savings association may not make
a loan or extension of credit to an affiliate unless the affiliate is engaged
only in activities permissible for bank holding companies; a savings association
may not purchase or invest in securities of an affiliate other than shares of a
subsidiary; a savings association and its subsidiaries may not purchase a low-
quality asset from an affiliate; and covered transactions and certain other
transactions between a savings association or its subsidiaries and an affiliate
must be on terms and conditions that are consistent with safe and sound banking
practices. With certain exceptions, each loan or extension of credit by a
savings association to an affiliate must be secured by collateral with a
22
market value ranging from 100% to 130% (depending on the type of collateral) of
the amount of the loan or extension of credit.
The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
such subsidiaries as affiliates. The regulation also requires savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail, and provides that certain classes of savings associations may
be required to give the OTS prior notice of affiliate transactions.
Capital Distribution Limitations. OTS regulations impose limitations upon
all capital distributions by savings associations, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The OTS recently adopted an amendment to these capital
distribution limitations. Under the new rule, a savings association in certain
circumstances may be required to file an application and await approval from the
OTS prior to making a capital distribution, may be required to file a notice 30
days prior to the capital distribution, or may be permitted to make the capital
distribution without notice or application to the OTS.
An application is required, if the savings association is not eligible for
expedited treatment of its other applications under OTS regulations; the total
amount of all of capital distributions (including the proposed capital
distribution) for the applicable calendar year exceeds net income for that year
to date plus retained net income for the preceding two years; the savings
association would not be at least adequately capitalized, under the prompt
corrective action regulations of the OTS following the distribution or the
savings association's proposed capital distribution would violate a prohibition
contained in any applicable statute, regulation, or agreement between the
savings association and the OTS (or the FDIC), or violate a condition imposed on
the savings association in an OTS-approved application or notice.
A notice of a capital distribution is required if a savings association is
not required to file an application, but: would not be well capitalized under
the prompt corrective action regulations of the OTS following the distribution;
the proposed capital distribution would reduce the amount of or retire any part
of your common or preferred stock or retire any part of debt instruments such as
notes or debentures included in capital (other than regular payments required
under a debt instrument approved by the OTS) or the savings association is a
subsidiary of a savings and loan holding company.
If neither the savings association nor the proposed capital distribution
meet any of the above listed criteria, no application or notice is required for
the savings association to make a capital distribution. The OTS may prohibit
the proposed capital distribution that would otherwise be permitted if the OTS
determines that the distribution would constitute an unsafe or unsound practice.
Activities of Subsidiaries. Federally chartered savings associations, such
as the Bank, are permitted to invest up to 2% of their assets in the capital
stock of, or secured or unsecured loans to, subsidiary service corporations,
with an additional investment of 1% of assets when such additional investment is
utilized primarily for community development purposes. Under the 2% limitation,
the Bank was permitted to invest up to approximately $8.7 million at December
31, 1999. A savings association seeking to establish a new subsidiary, acquire
control of an existing company or conduct a new activity through a subsidiary
must provide 30 days prior notice to the FDIC and the OTS and conduct any
activities of the subsidiary in accordance with regulations and orders of the
OTS. The OTS has the power to require a savings association to divest any
subsidiary or terminate any activity conducted by a subsidiary that the OTS
determines to pose a serious threat to the financial safety, soundness or
stability of the savings association or to be otherwise inconsistent with sound
banking practices.
Recent Legislation. Congress has been considering legislation in various
forms that would require federal thrifts, such as the Bank, to convert their
charters to national or state bank charters. The Treasury Department has been
studying the development of a common charter for federal savings associations
and commercial banks. Pursuant to the Paperwork Reduction Act, if the thrift
charter is eliminated after January 1, 1999, the Paperwork Reduction Act would
require the merger of the BIF and the SAIF into a single Deposit
23
Insurance Fund on that date. In the absence of appropriate "grandfather"
provisions, legislation eliminating the thrift charter could have a material
adverse effect on the Bank and the Company because, among other things, the
regulatory, capital, and accounting treatment for national and state banks and
savings associations differs in certain significant respects. The Bank cannot
determine whether, or in what form, such legislation may eventually be enacted
and there can be no assurance that any legislation that is enacted would contain
adequate grandfather rights for the Bank and the Company.
Community Reinvestment Act and the Fair Lending Laws. Savings associations
have a responsibility under the Community Reinvestment Act ("CRA") and related
regulations of the OTS to help meet the credit needs of their communities,
including low- and moderate-income neighborhoods. In addition, the ECOA and the
Fair Housing Act (together, the "Fair Lending Laws") prohibit lenders from
discriminating in their lending practices on the basis of characteristics
specified in those statutes. An institution's failure to comply with the
provisions of CRA could, at a minimum, result in regulatory restrictions on its
activities and the denial of certain applications, and failure to comply with
the Fair Lending Laws could result in enforcement actions by the OTS, as well as
other federal regulatory agencies and the Department of Justice.
Federal Home Loan Bank System. The Bank is a member of the FHLB system.
Among other benefits, each FHLB serves as a reserve or central bank for its
members within its assigned region. Each FHLB is financed primarily from the
sale of consolidated obligations of the FHLB system. Each FHLB makes available
to members loans (i.e., advances) in accordance with the policies and procedures
established by the Board of Directors of the individual FHLB.
As a member, the Bank is required to own capital stock in an FHLB in an
amount equal to the greater of: 1% of its aggregate outstanding principal amount
of its residential mortgage loans, home purchase contracts and similar
obligations at the beginning of each calendar year, 0.3% of total assets or 5%
of its FHLB advances (borrowings). At December 31, 1999, the Bank had $2.5
million in FHLB stock, which was in compliance with this requirement.
Liquidity Requirements. Under OTS regulations, a savings association is
required to maintain an average daily balance of liquid assets (including cash,
certain time deposits and savings accounts, bankers' acceptances, certain
government obligations, and certain other investments) in each calendar quarter
of not less than 4% of either its liquidity base (consisting of certain net
withdrawable accounts plus short-term borrowings) as of the end of the preceding
calendar quarter, or the average daily balance of its liquidity base during the
preceding quarter. This liquidity requirement may be changed from time to time
by the OTS to any amount between 4.0% to 10.0%, depending upon certain factors,
including economic conditions and savings flows of all savings associations.
The Bank maintains liquid assets in compliance with these regulations. Monetary
penalties may be imposed upon an institution for violations of liquidity
requirements.
Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain non-interest bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW, and Super NOW
checking accounts) and non-personal time deposits. The balances maintained to
meet the reserve requirements imposed by the Federal Reserve Board may be used
to satisfy the liquidity requirements that are imposed by the OTS. At December
31, 1999, the Bank was in compliance with these requirements.
Taxation
Federal
General. The Company and the Bank report their income on a consolidated
basis using the accrual method of accounting, and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the Bank'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
Bank or the Company. The Company has not been audited by the Internal Revenue
Service. For its 1999 taxable year, the Company is subject to a maximum federal
income tax rate of 34.0%.
24
Bad Debt Reserves. For fiscal years beginning prior to December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Code were permitted to use certain favorable provisions to
calculate their deductions from taxable income for annual additions to their bad
debt reserve. A reserve could be established for bad debts on qualifying real
property loans (generally secured by interests in real property improved or to
be improved) under the Percentage of Taxable Income Method or the Experience
Method. The reserve for non-qualifying loans was computed using the Experience
Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which was
enacted on August 20, 1996, requires savings institutions to recapture certain
portions of their accumulated bad debt reserves. The 1996 Act repeals the
reserve method of accounting for bad debts effective for tax years beginning
after 1995. Thrift institutions that would be treated as small banks are
allowed to utilize the Experience Method applicable to such institutions, while
thrift institutions that are treated as large banks (those generally exceeding
$500 million in assets) are required to use only the specific charge-off method.
To the extent the allowable bad debt reserve balance using the thrift's
historical computation method exceeds the allowable bad debt reserve method
under the newly enacted provisions, such excess is required to be recaptured
into income under the provisions of Code Section 481(a). Any Section 481(a)
adjustment required to be taken into income