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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(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, 2000
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 33-13646
WESTCORP
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 51-0308535
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
23 PASTEUR, IRVINE, CALIFORNIA 92618-3816
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (949) 727-1002
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Common Stock, $1 par value New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
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 last 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 voting stock held by non-affiliates of the
registrant as of February 28, 2001:
COMMON STOCK, NO PAR VALUE -- $167,766,736
The number of shares outstanding of the issuer's class of common stock as of
February 28, 2001:
COMMON STOCK, NO PAR VALUE -- 31,959,172
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the Annual Meeting of
Shareholders to be held May 3, 2001 are incorporated by reference into Part III.
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WESTCORP AND SUBSIDIARIES
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 36
Item 3. Legal Proceedings........................................... 36
Item 4. Submission of Matters to a Vote of Security Holders......... 36
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 37
Item 6. Selected Financial Data..................................... 38
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of
Operations................................................ 40
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 63
Item 8. Financial Statements and Supplementary Data................. 66
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................. 66
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 67
Item 11. Executive Compensation...................................... 67
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 67
Item 13. Certain Relationships and Related Transactions.............. 67
PART IV
Item 14. Financial Statement Schedules, Exhibits and Reports on Form
8-K....................................................... 68
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PART I
ITEM 1. BUSINESS
GENERAL
We are a diversified financial services company that provides automobile
lending services through our second tier subsidiary, WFS Financial Inc, also
known as WFS, and retail and commercial banking services through our wholly
owned subsidiary, Western Financial Bank, also known as the Bank. The Bank
currently owns 82% of the capital stock of WFS.
AUTOMOBILE LENDING OPERATIONS
We are one of the nation's largest independent automobile finance companies
with 28 years of experience in the automobile finance industry. We originate,
service and securitize new and pre-owned automobile installment contracts which
are generated through our relationships with over 8,500 franchised and
independent automobile dealers in 42 states. We originated $4.2 billion of
automobile contracts during 2000 and serviced a portfolio of $6.8 billion of
automobile contracts at December 31, 2000.
We provide service to dealers through our nationwide network of business
development representatives. Our business development representatives provide
dealers with a single contact to whom they can sell most of their automobile
contracts. Unlike many of our competitors, we offer programs for both prime and
non-prime borrowers. Approximately 70% of our contract originations are with
borrowers who have strong credit histories, otherwise know as prime borrowers,
and approximately 30% of our contract originations are with borrowers who have
overcome past credit difficulties, otherwise known as non-prime borrowers.
We underwrite contracts through a credit approval process that is supported
and controlled by a centralized, automated front-end system. This system
incorporates proprietary credit scoring models and industry credit scoring
models and tools, which enhance our credit analysts' ability to tailor each
contract's pricing and structure to maximize risk-adjusted returns. Our
underwriters earn incentives based on the profitability rather than the volume
of the contracts that they purchase.
We structure our business to minimize operating costs while providing high
quality service to our dealers. Those aspects of our business that require a
local market presence are performed on a decentralized basis in our 44 offices.
All other operations are centralized.
We fund our purchases of automobile contracts, on an interim basis, with
deposits raised at the Bank which are insured by the Federal Deposit Insurance
Corporation, or the FDIC, and other borrowings raised by the Bank. For long-term
financing, we issue automobile contract asset-backed securities. Since 1985, we
have securitized over $20 billion of automobile contracts in 51 public offerings
of asset-backed securities, making us the fourth largest issuer of such
securities in the nation. We anticipate that we will continue to securitize
contracts in transactions recorded as secured financings. We believe that the
relationship maintained between WFS and the Bank provides us a competitive
advantage relative to other independent automobile finance companies by
providing a significant source of liquidity and by allowing us the ability to
enter the automobile contract asset-backed securities market on an opportunistic
basis.
The following table presents a summary of our automobile contracts
purchased:
FOR THE YEAR ENDED DECEMBER 31,
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2000 1999 1998
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
New vehicles...................................... $1,028,394 $ 796,339 $ 547,898
Pre-owned vehicles................................ 3,190,833 2,543,807 2,122,798
---------- ---------- ----------
Total volume................................. $4,219,227 $3,340,146 $2,670,696
========== ========== ==========
Prime contracts................................... $2,900,960 $2,313,573 $1,808,013
Non-prime contracts............................... 1,318,267 1,026,573 862,683
---------- ---------- ----------
Total volume................................. $4,219,227 $3,340,146 $2,670,696
========== ========== ==========
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To improve our long-term profitability, we restructured our automobile
lending operations in 1998. As a result, we incurred a net loss of $14.7 million
in 1998 due to higher credit losses and a $15.0 million charge related to the
restructuring. The higher credit losses were due to purchasing a higher
percentage of non-prime contracts during 1996 and 1997, as well as servicing
disruptions created by our restructuring. As part of this restructuring, we
closed 96 underperforming offices and reduced our number of employees, also
known as associates, by approximately 20%.
Since this restructuring, we have:
- realized record net income of $52.6 million in 1999 and $74.7 million in
2000, a 42% increase;
- increased operating cash flows from automobile lending operations from
$16.5 million in 1998, to $102 million in 1999 and to $140 million in
2000;
- increased automobile contract originations from $2.7 billion in 1998, to
$3.3 billion in 1999 and to $4.2 billion in 2000;
- improved the percentage of applications funded to applications received
from 13% in the first quarter of 1998 to 22% in the fourth quarter of
2000;
- lowered automobile lending operating expenses as a percentage of average
serviced contracts from 4.1% in 1998 to 3.1% in 2000; and
- reduced automobile net chargeoffs as a percentage of average serviced
contracts from 3.4% in 1998 to 1.9% in 2000.
BANK OPERATIONS
The Bank's primary focus is to generate diverse, low-cost funds to provide
the liquidity needed to fund automobile contracts while retaining its status as
a qualified thrift lender under applicable federal regulations. We have the
ability to raise significant amounts of liquidity by attracting both short-term
and long-term deposits from the general public, commercial enterprises and
institutions by offering a variety of accounts and rates. These funds are
generated through our retail and commercial banking divisions. We may also raise
funds by obtaining advances from the Federal Home Loan Bank, also known as the
FHLB, selling securities under agreements to repurchase and utilizing other
borrowings.
Our retail banking division serves the needs of individuals and small
businesses by offering a broad range of products, such as demand deposit
accounts, money market accounts, certificates of deposits and other investment
services through 25 retail branches located throughout California. Our
commercial banking division focuses on small and medium-sized businesses in
southern California, offering loans, lines of credit and trade finance services,
as well as account analysis, cash management and other commercial depository
services in order to attract low-cost commercial deposits. We also employ the
liquidity generated by the retail and commercial banking divisions by investing
in mortgage-backed securities, also known as MBS, to generate additional net
interest margin, manage interest rate risk, provide another source of liquidity
through repurchase agreements, support community reinvestment and housing
finance and meet regulatory requirements. See "Supervision and Regulation".
During 1998 and into 1999, we determined that our mortgage banking
activities no longer met our long-term profit goals and strategic objectives. As
a result, we closed our prime mortgage lending operations, sold $28.9 million in
mortgage servicing rights in the fourth quarter of 1998 and incurred a $3.0
million restructuring charge. During the third quarter of 1999, we completed the
sale of our sub-prime mortgage lending operations and sold the remaining $1.0
billion of mortgage servicing rights that we held. During the fourth quarter of
1999, we closed our mortgage loan servicing department and entered into an
agreement to sell the rights to service our remaining owned portfolio, thereby
completing our mortgage banking exit strategy. At December 31, 2000, we owned
$507 million in single-family and multi-family mortgage loans that were
originated through previous mortgage lending activities.
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The following table sets forth our loan origination, purchase and sale
activity over the past five years:
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Loans originated:
Consumer loans:
Automobile contracts............ $4,219,227 $3,340,146 $2,670,696 $2,285,279 $2,121,689
Other........................... 12,888 15,586 9,645 52,080 35,867
---------- ---------- ---------- ---------- ----------
Total consumer loans....... 4,232,115 3,355,732 2,680,341 2,337,359 2,157,556
Mortgage loans:
Existing property............... 17,382 263,019 2,725,415 2,306,251 1,240,652
Construction.................... 14,718 11,969 18,721 17,078 10,207
Equity.......................... 1,024 1,948 10,262 8,177 8,857
---------- ---------- ---------- ---------- ----------
Total mortgage loans....... 33,124 276,936 2,754,398 2,331,506 1,259,716
Commercial loans:.................. 266,342 237,316 124,259 71,399 8,632
---------- ---------- ---------- ---------- ----------
Total loans originated..... 4,531,581 3,869,984 5,558,998 4,740,264 3,425,904
Loans purchased:
Mortgage loans on existing
property........................ 488 412 450 6,166 213
---------- ---------- ---------- ---------- ----------
Total loans purchased...... 488 412 450 6,166 213
Loans sold:
Automobile contracts............... 660,000 2,500,000 1,885,000 2,190,000 2,090,000
Mortgage loans..................... 3,394 502,157 2,884,073 1,974,423 992,582
---------- ---------- ---------- ---------- ----------
Total loans sold........... 663,394 3,002,157 4,769,073 4,164,423 3,082,582
Principal reductions(1).............. 1,126,520 679,224 670,310 440,607 359,334
---------- ---------- ---------- ---------- ----------
Increase (decrease) in total loans... $2,742,155 $ 189,015 $ 120,065 $ 141,400 $ (15,799)
========== ========== ========== ========== ==========
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(1) Includes scheduled payments, prepayments and chargeoffs.
At December 31, 2000, our loan portfolio totaled $4.9 billion, of which 86%
were automobile contracts net of unearned interest, 10% were loans secured by
real property used primarily for residential purposes, 2% were commercial loans
and 2% were other consumer loans. Our loan portfolio totaled $2.2 billion at
December 31, 1999, of which 67% were automobile contracts net of unearned
interest, 28% were loans secured by real property used primarily for residential
purposes, 3% were commercial loans and 2% were other consumer loans. Consumer
loans serviced for the benefit of others totaled $2.6 billion at December 31,
2000 compared with $3.9 billion at December 31, 1999.
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The following table sets forth the composition of our loan portfolio by
type of loan, including loans held for sale, as of the dates indicated:
DECEMBER 31,
-------------------------------------------------------------------------------
2000 1999 1998 1997
-------------------- -------------------- -------------------- ----------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT
---------- ------- ---------- ------- ---------- ------- ----------
(DOLLARS IN THOUSANDS)
Consumer loans:
Automobile contracts... $4,307,267 87.5% $1,518,434 69.6% $ 923,952 46.4% $ 225,947
Other.................. 96,173 2.0 52,483 2.4 57,073 2.8 94,829
---------- ----- ---------- ----- ---------- ----- ----------
4,403,440 89.5 1,570,917 72.0 981,025 49.2 320,776
Less: unearned
interest............... 94,404 1.9 54,248 2.5 48,015 2.4 22,226
---------- ----- ---------- ----- ---------- ----- ----------
Total consumer
loans.............. 4,309,036 87.6 1,516,669 69.5 933,010 46.8 298,550
Mortgage loans:
Existing properties.... 498,963 10.1 589,286 27.0 993,645 49.9 1,529,776
Construction........... 14,784 0.3 23,190 1.1 18,345 0.9 15,835
---------- ----- ---------- ----- ---------- ----- ----------
513,747 10.4 612,476 28.1 1,011,990 50.8 1,545,611
Less: undisbursed loan
proceeds............... 6,316 0.1 14,174 0.7 5,057 0.4 8,657
---------- ----- ---------- ----- ---------- ----- ----------
Total mortgage
loans.............. 507,431 10.3 598,302 27.4 1,006,933 50.4 1,536,954
Commercial loans......... 107,586 2.1 66,927 3.1 52,940 2.8 37,314
---------- ----- ---------- ----- ---------- ----- ----------
Total loans.......... $4,924,053 100.0% $2,181,898 100.0% $1,992,883 100.0% $1,872,818
========== ===== ========== ===== ========== ===== ==========
DECEMBER 31,
------------------------------
1997 1996
------- --------------------
PERCENT AMOUNT PERCENT
------- ---------- -------
(DOLLARS IN THOUSANDS)
Consumer loans:
Automobile contracts... 12.1% $ 242,170 14.0%
Other.................. 5.0 82,568 4.7
----- ---------- -----
17.1 324,738 18.7
Less: unearned
interest............... 1.2 33,769 2.0
----- ---------- -----
Total consumer
loans.............. 15.9 290,969 16.7
Mortgage loans:
Existing properties.... 81.7 1,435,469 82.9
Construction........... 0.8 5,501 0.3
----- ---------- -----
82.5 1,440,970 83.2
Less: undisbursed loan
proceeds............... 0.4 8,201 0.4
----- ---------- -----
Total mortgage
loans.............. 82.1 1,432,769 82.8
Commercial loans......... 2.0 7,680 0.5
----- ---------- -----
Total loans.......... 100.0% $1,731,418 100.0%
===== ========== =====
The following table sets forth the composition of loans serviced for the
benefit of others:
DECEMBER 31,
-------------------------------------------------------------------------------
2000 1999 1998 1997
-------------------- -------------------- -------------------- ----------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT
---------- ------- ---------- ------- ---------- ------- ----------
(DOLLARS IN THOUSANDS)
Loans serviced for the
benefit of others:
Automobile contracts... $2,608,017 100.0% $3,890,685 97.0% $3,491,457 68.4% $3,459,272
Mortgage loans......... 120,832 3.0 1,612,103 31.6 4,917,712
---------- ----- ---------- ----- ---------- ----- ----------
Total loans serviced
for the benefit of
others............. $2,608,017 100.0% $4,011,517 100.0% $5,103,560 100.0% $8,376,984
========== ===== ========== ===== ========== ===== ==========
DECEMBER 31,
------------------------------
1997 1996
------- --------------------
PERCENT AMOUNT PERCENT
------- ---------- -------
(DOLLARS IN THOUSANDS)
Loans serviced for the
benefit of others:
Automobile contracts... 41.3% $2,812,637 38.8%
Mortgage loans......... 58.7 4,436,789 61.2
----- ---------- -----
Total loans serviced
for the benefit of
others............. 100.0% $7,249,426 100.0%
===== ========== =====
THE HISTORY OF WESTCORP
Western Thrift & Loan Association, a California-licensed thrift and loan
association, was founded in 1972. In 1973, we were formed as the holding company
for Western Thrift & Loan Association under the name Western Thrift Financial
Corporation. We later changed our name to Westcorp. In 1982, we acquired
Evergreen Savings and Loan Association, a California-licensed savings and loan
association, which became our wholly owned subsidiary. The activities of Western
Thrift & Loan Association and Evergreen Savings and Loan Association were merged
together in 1982, and Evergreen Savings and Loan Association's name was changed
ultimately to Western Financial Bank.
Western Thrift & Loan Association was involved in automobile finance
activities from its incorporation until its merger with Evergreen Savings and
Loan Association. At such time, the automobile finance activities of Western
Thrift & Loan Association were continued by the Bank. In 1988, Westcorp
Financial Services, Inc. was incorporated as a wholly owned consumer finance
subsidiary of the Bank to provide non-prime automobile finance services, a
market not serviced by the Bank's automobile finance division.
In 1995, the Bank transferred its automobile finance division to Westcorp
Financial Services, which changed its name to WFS Financial Inc. In connection
with that acquisition, the Bank transferred to WFS all assets relating to its
automobile finance division, including the contracts held on balance sheet and
all interests in the excess spread payable from outstanding securitization
transactions. The Bank also transferred all of the outstanding stock of WFS
Financial Auto Loans, Inc., also known as WFAL, and WFS Financial Auto Loans 2,
Inc., also known as WFAL2, the securitization entities of the Bank, thereby
making these companies subsidiaries of WFS. In 1995, WFS sold approximately 20%
of its shares in a public offering.
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On March 2, 2001, we filed a registration statement with the Securities and
Exchange Commission, also known as the SEC to provide our shareholders an
exclusive opportunity to purchase additional shares of stock through a rights
offering. The registration statement has not yet become effective. The number of
shares to be offered and the price per share has not yet been determined. Our
board of directors will make this determination immediately prior to the time at
which the registration statement becomes effective. We expect to raise
approximately $60.0 million in new capital from this transaction.
Ernest S. Rady, the Chairman of the board of directors of Westcorp, has
informed us that he will exercise his rights and that he expects to also
exercise his right to oversubscribe. Mr. Rady is the beneficial owner of
approximately 68% of our common stock.
On March 2, 2001, our 82% owned subsidiary, WFS, filed a registration
statement with the SEC to provide its shareholders an exclusive opportunity to
purchase additional shares of stock through a rights offering. The registration
statement for this offering has not yet become effective. The number of shares
to be offered and the price per share has not yet been determined. The board of
directors of WFS will make this determination immediately prior to the time at
which the registration statement becomes effective. The board of directors of
the Bank has informed us that they intend to exercise the Bank's basic
subscription right and expects to exercise its oversubscription right as part of
this offering. WFS expects that this transaction will provide it with
approximately $100 million in new capital.
The Bank and its subsidiaries are subject to examination and comprehensive
regulation by the Office of Thrift Supervision, also known as the OTS, and the
FDIC. It is further subject to certain regulations of the Board of Governors of
the Federal Reserve System, also known as the FRS, which governs reserves
required to be maintained against deposits and other matters. The Bank is also a
member of the FHLB of San Francisco, one of twelve regional banks for federally
insured savings and loan associations and banks comprising the FHLB System. The
FHLB System is under the supervision of the Federal Housing Finance Board. WFS
and certain other subsidiaries of the Bank are further regulated in part by
various departments or commissions of the states in which they do business.
Federal statutes and regulations primarily define the types of loans that the
Bank and its subsidiary may originate.
MARKET AND COMPETITION
We believe that the automobile finance industry is the second largest
consumer finance industry in the United States with over $700 billion of loan
and lease originations during 2000. The industry is generally segmented
according to the type of car sold (new versus pre-owned) and the credit
characteristics of the borrower (prime, non-prime or sub-prime). Based upon
industry data, we believe that during 2000, prime, non-prime and sub-prime loan
originations in the United States were $448 billion, $140 billion and $112
billion, respectively. The United States captive automobile finance companies,
General Motors Acceptance Corporation, Ford Motor Credit Company and Chrysler
Credit Corporation account for up to 30% of the automobile finance market. We
believe that the balance of the market is highly fragmented and that no other
market participant has greater than a 2% market share. Other market participants
include the other captive automobile finance companies of other manufacturers,
banks, credit unions, independent automobile finance companies and other
financial institutions.
Our dealer servicing and underwriting capabilities and systems enable us to
compete effectively in the automobile finance market. Our ability to compete
successfully depends largely upon our strong personal relationships with dealers
and their willingness to offer to us contracts that meet our underwriting
criteria. Our relationship is fostered by the promptness with which we process
and fund contracts, as well as the flexibility and scope of the programs we
offer. We purchase the full spectrum of prime and non-prime contracts secured by
both new and pre-owned vehicles.
The competition for contracts available within the prime and non-prime
credit quality contract spectrum is more intense when the rate of automobile
sales declines. Although we have experienced consistent growth for many years,
we can give no assurance that we will continue to do so. Several of our
competitors have greater financial resources than we have and may have a
significantly lower cost of funds. Many of our competitors also have
longstanding relationships with automobile dealers and may offer dealers or
their
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customers other forms of financing or services not provided by us. The finance
company that provides floor planning for the dealer's inventory is also
ordinarily one of the dealer's primary sources of financing for automobile
sales. We do not currently provide financing on dealers' inventories. We must
also compete with dealer interest rate subsidy programs offered by the captive
automobile finance companies. However, frequently those programs are limited to
certain models or to certain loan terms which may not be attractive to many new
automobile purchasers. Also, these programs are rarely offered on pre-owned
vehicles.
Competition in the retail banking business comes primarily from commercial
banks, credit unions, savings and loan associations, mutual funds, and corporate
and government securities markets. Many of the nation's largest savings and loan
associations and other depository institutions are headquartered or have
branches in California. We compete for deposits primarily on the basis of
interest rates paid and the quality of service provided to our customers. We do
not rely on any individual, group or entity for a material portion of our
deposits.
Competition in the commercial banking business comes primarily from other
commercial banks that maintain a presence in southern California. In general,
many commercial banks are more sizable institutions with larger lending
capacities and depository services. We have differentiated ourselves by
providing high quality service, local relationship management, prompt credit
decisions, and competitive rates on both loans and depository products.
OUR BUSINESS STRATEGY
Our business objective is to maximize long-term profitability by
efficiently purchasing and servicing prime and non-prime credit quality
automobile contracts that generate strong and consistent risk-adjusted returns.
We believe we will be able to achieve this objective by employing our business
strategies:
- produce measured growth in automobile contract originations;
- leverage technology to improve our business;
- effectively price automobile contracts relative to risk; and
- utilize the diverse funding sources of the Bank.
PRODUCE MEASURED GROWTH IN AUTOMOBILE CONTRACT ORIGINATIONS
Over the past five years, we have experienced a compounded annual growth
rate in automobile contract purchases of 23%. We provide a high degree of
personalized service to our dealership base by marketing, underwriting and
purchasing contracts on a local level. Our focus is to provide each dealer
superior service by providing a single source of contact to meet the dealer's
prime and non-prime financing needs. We believe that the level of our service
surpasses that of our competitors by making our business development
representatives available any time a dealer is open, making prompt credit
decisions, negotiating credit decisions within available programs by providing
structural alternatives and funding promptly.
Growth of originations is primarily through increased dealer penetration.
We intend to increase contract purchases from our current dealer base as well as
develop new dealer relationships. Prior to 1995, we originated contracts in
seven, primarily western states. Subsequently, we increased our geographic
penetration to 35 additional states. Although our presence is well established
throughout the country, we believe that we still have opportunities to build
market share, especially in those states which we entered since 1994. In
addition, we have improved our dealer education and delivery systems in order to
increase the ratio of contracts purchased to the number of applications received
from a dealer, thereby improving the efficiency of our dealer relationships. We
are also seeking to increase contract purchases through new dealer programs
targeting high volume, multiple location dealers. These programs focus on
creating relationships with dealers to achieve higher contract originations and
improving efficiencies. We also originate loans directly from consumers and
purchase loans from other finance companies on a limited basis. Additionally, we
continue to explore other distribution channels, including the Internet, and are
piloting different dealer-centric approaches to determine the most effective
Internet strategies.
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LEVERAGE TECHNOLOGY TO IMPROVE OUR BUSINESS
We are focused on leveraging technology to improve all aspects of our
business. Over the past three years, we have implemented technology and
streamlined operations to improve credit quality, enhance and manage growth and
improve operating efficiency. We plan to realize additional benefits with
ongoing investments in the future.
Our key technology systems include our:
- automated front-end origination system which calculates borrower ratios,
maintains lending parameters and approval limits, accepts electronic
applications and directs applications to the appropriate credit analyst,
all of which have reduced the cost of receiving, underwriting and funding
automobile contracts;
- custom designed proprietary scoring models that rank order the risk of
loss occurring on a particular automobile contract;
- behavioral delinquency management system which improves our ability to
queue accounts according to the level of risk, monitor collector
performance and track delinquent automobile accounts;
- centralized and upgraded borrower services department which includes
remittance processing, interactive voice response technology and direct
debit services;
- centralized imaging system that provides for the electronic retention and
retrieval of account records; and
- second generation data warehouse that provides analytical tools necessary
to evaluate performance of our portfolio by multiple dimensions.
We are currently developing a third generation credit scorecard to improve
loss severity analytics within our application and an on-line, Internet-based
credit application process to further enhance our growth.
EFFECTIVELY PRICE AUTOMOBILE CONTRACTS RELATIVE TO RISK
Quality underwriting and servicing are essential to effectively assess and
price for risk and to maximize risk-adjusted returns. We rely on a combination
of credit scoring models, system controlled underwriting policies and the
judgment of our trained credit analysts to make risk-based credit decisions. We
use credit scoring to differentiate applicants and to rank order credit risk in
terms of expected default probability. Based upon this statistical assessment of
credit risk, the underwriter is able to appropriately tailor contract pricing
and structure.
To achieve the return anticipated at origination, we have developed a
disciplined behavioral servicing process for the early identification and cure
of delinquent contracts and for loss mitigation. In addition, we provide credit
and profitability incentives to our associates to make decisions consistent with
our underwriting policies by offering bonuses based both on individual and
office-wide performance.
UTILIZE THE DIVERSE FUNDING SOURCES OF THE BANK
The Bank provides diverse, low-cost funds through its retail and commercial
banking divisions as well as its ability to obtain advances from the FHLB, sell
securities under agreements to repurchase and utilize other borrowing sources.
These significant and diverse sources of funds provide liquidity at a low cost
to fund our automobile contract purchases and allow us to opportunistically
enter the automobile contract asset-backed securities market.
OPERATIONS
AUTOMOBILE LENDING
Locations
We currently originate automobile contracts in 42 states through 44
offices. Each office manager is accountable for the performance of contracts
originated in that office throughout the life of the contracts,
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including acquisition, underwriting, funding and collection. We have two
regional production and servicing centers located in California and Texas with
functions including data entry and verification, records management, remittance
processing, customer service call centers and automated dialers. We maintain
three regional bankruptcy and remarketing centers and we have a centralized
asset recovery center located in California. Our corporate offices are located
in Irvine, California.
Business Development
The business development representatives' responsibilities include
improving our relationship with existing dealers and enrolling and educating new
dealers to increase the number of contracts originated. The business development
representatives target selected dealers within their territory based upon
volume, potential for business, financing needs of the dealers, and competitors
that are doing business with such dealers.
If we decide to do business with a new dealer, we perform a review process.
We then enter into a non-exclusive dealership agreement with the dealer. This
agreement contains certain representations regarding the contracts the dealer
will sell to us. Due to the non-exclusive nature of our relationship with
dealers, they retain discretion to determine whether to sell contracts to us or
another financial institution. The business development representative is
responsible for educating the finance managers about the types of contracts that
meet our underwriting standards. This education process ensures that we minimize
the number of applications we receive that are outside of our underwriting
guidelines, thereby increasing our efficiency and lowering our overall cost to
originate contracts.
After this relationship is established, the business development
representative continues to actively monitor the relationship with the objective
of maximizing the overall profitability of each dealer relationship within his
or her territory. This includes ensuring that a significant number of approved
applications received from each dealer are actually funded by us, ensuring that
the type of contracts received meets our underwriting standards, monitoring the
risk-based pricing of contracts acquired and reviewing the actual performance of
the contracts purchased. To the extent that a dealer does not meet minimum
conversion ratio or lending volume standards, the dealer may be precluded from
sending us applications in the future. During the past twelve months, our dealer
base has declined from approximately 8,700 to 8,500, primarily as a result of us
eliminating dealers that did not meet our standards. Our increase in volume is
the result of funding more contracts from dealers that meet our standards.
Business development managers within each regional business center provide
direct management oversight to each business development representative. In
addition, the director of sales and marketing provides oversight management to
ensure that all business development managers and representatives are following
overall corporate guidelines.
Underwriting and Purchasing of Contracts
The underwriting process begins when an application is faxed to our
centralized data entry center. Our data entry group enters the applicant
information into our front-end underwriting computer system. Once the
application has been entered, the computer system automatically obtains credit
bureau information on the applicant and calculates our proprietary credit score.
We use credit scoring to differentiate credit applicants and to rank order
credit risk in terms of expected default probabilities, which enables us to
tailor contract pricing and structure according to this statistical assessment
of credit risk. For example, a consumer with a lower score would indicate a
higher probability of default; therefore, we would structure and price the
transaction to compensate for this higher default risk. Multiple scorecards are
used to accommodate the full spectrum of contracts we purchase. In addition to a
credit score, the system highlights certain aspects of the credit application
which have historically impacted the credit worthiness of the borrowers.
Credit analysts are responsible for properly structuring and pricing deals
to meet our risk-based criteria. They review the information, structure and
price of an application and make a determination whether to approve, decline or
make a counteroffer to the dealer. Each credit analyst's lending levels and
approval authorities are established based on the individual's credit experience
and portfolio performance, credit
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manager audit results and quality control review results. Higher levels of
approvals are required for higher credit risk and are controlled by system
driven parameters and limits. System driven controls include limits on interest
rates, contract terms, contract advances, payment to income ratios, debt to
income ratios, collateral values and low side overrides.
Once adequate approval has been received, the computer system automatically
sends a fax back to the dealer with our credit decision, specifying approval,
denial or conditional approval based upon modification to the structure, such as
increase in down payment, reduction of term, or the addition of a co-signer. As
part of the approval process, the system or the credit analyst may require that
some of the information be verified, such as income, employment, residence or
credit history of the applicant. The system increases efficiency by
automatically denying approval in certain circumstances without additional
underwriting being performed. These automated notices are controlled by
parameters set by us consistent with our credit policy.
If the dealer accepts the terms of the approval, the dealer is required to
deliver the necessary documentation for each contract to the appropriate office.
The funding group audits such documents for completeness and consistency with
the application, providing final approval and funding of the contract. A direct
deposit is made or a check is prepared and is promptly sent to the dealer for
payment. The dealer's proceeds may include dealer participation for
consideration of the acquisition of the contract. The completed contract file is
then forwarded to the appropriate record center for imaging.
Under the direction of the Credit and Pricing Committee, the Chief Credit
Officer oversees credit risk management, sets underwriting policy, monitors
contract pricing, tracks compliance to underwriting policies and re-underwrites
select contracts. If re-underwriting statistics are unacceptable, all monthly
and quarterly incentives are forfeited by the office that originated the
contracts. Our internal quality control group reviews contracts on a statistical
sampling basis to ensure adherence to established lending guidelines and proper
documentation requirements. Credit managers within each regional business center
provide direct management oversight to each credit analyst. In addition, the
Chief Credit Officer provides oversight management to ensure that all credit
managers and analysts are following overall corporate guidelines.
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The following table sets forth information for automobile contracts
originated, contracts serviced and number of dealers in the states in which we
operate our business:
AUTOMOBILE CONTRACT PURCHASES
FOR THE TWELVE MONTHS ENDED
DECEMBER 31, AT DECEMBER 31, 2000
-------------------------------------- ----------------------------------------
STATE 2000 1999 1998 SERVICING PORTFOLIO NUMBER OF DEALERS
----- ---------- ---------- ---------- ------------------- -----------------
California........... $1,680,814 $1,375,877 $1,187,406 $2,862,894 2,169
Arizona.............. 277,217 196,935 155,439 424,319 286
Washington........... 186,078 166,760 135,271 297,738 380
Florida.............. 175,341 138,981 73,023 265,880 408
Ohio................. 165,860 103,615 70,183 247,326 547
Oregon............... 158,944 128,154 104,789 235,387 390
Texas................ 158,138 185,795 143,989 295,273 466
Colorado............. 130,247 111,486 80,800 201,197 231
North Carolina....... 106,664 84,543 59,454 167,394 237
Nevada............... 101,311 90,521 81,342 183,121 106
Virginia............. 97,997 61,094 39,592 143,272 256
South Carolina....... 91,246 57,315 32,782 128,589 160
Illinois............. 76,020 62,755 51,653 124,342 332
Georgia.............. 71,341 39,136 24,114 97,519 197
Tennessee............ 68,955 52,128 39,757 108,059 149
Missouri............. 64,372 46,456 28,958 100,437 197
Utah................. 63,531 45,767 24,394 87,771 182
Michigan............. 52,489 22,472 13,783 65,156 167
Alabama.............. 49,053 45,706 35,997 81,416 149
Idaho................ 48,639 36,649 34,961 78,011 146
Pennsylvania......... 39,317 28,831 37,508 69,539 177
Wisconsin............ 37,439 24,839 32,398 54,506 129
Maryland............. 36,431 26,279 13,556 58,112 103
Kentucky............. 34,658 23,603 16,793 50,145 106
Indiana.............. 26,759 23,951 17,829 46,273 133
New Jersey........... 26,552 17,690 6,844 40,175 81
Delaware............. 23,709 11,326 805 29,019 38
Kansas............... 22,683 12,736 14,166 34,208 70
Massachusetts........ 22,126 25,131 38,987 72
Mississippi.......... 17,434 14,901 13,503 31,932 36
West Virginia........ 16,763 7,241 9,750 21,956 54
Oklahoma............. 16,318 13,974 10,761 26,061 55
Connecticut.......... 13,638 15,799 1,448 22,539 55
Iowa................. 13,027 7,334 20,201 21,894 59
Minnesota............ 11,156 446 10,365 31
New Mexico........... 9,469 15,089 15,823 24,934 40
New Hampshire........ 7,157 4,125 4,837 10,427 28
Nebraska............. 5,427 683 1,303 5,802 25
Wyoming.............. 5,114 4,050 3,785 7,797 24
New York............. 5,097 395 158 5,199 54
Rhode Island......... 2,642 3,304 3,012 5,541 12
Maine................ 2,054 897 20,556 2,383 8
Hawaii............... 5,377 7,973 5,287
---------- ---------- ---------- ---------- -----
Total........... $4,219,227 $3,340,146 $2,670,696 $6,818,182 8,545
========== ========== ========== ========== =====
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Servicing of Contracts
We service all of the contracts we purchase, both those held by us and
those sold in securitization transactions. The servicing process includes the
routine collection and processing of payments, responding to borrower inquiries,
maintaining the security interest in the vehicle, maintaining physical damage
insurance coverage and repossessing and selling collateral when necessary.
During the second quarter of 2000, we implemented a new decision support system
which incorporates behavioral scoring models and allows us to continually seek
the most efficient and effective collection methods.
We use monthly billing statements to serve as a reminder to borrowers as
well as an early warning mechanism in the event a borrower has failed to notify
us of an address change. Payments received in the mail or through our offices
are processed by our remittance processing center. To expedite the collection
process, we accept payments from borrowers through automated payment programs
including PC banking, direct debits and third party payment processing services.
Our customer service center uses interactive voice response technology to answer
routine account questions and route calls to the appropriate service counselor.
Our fully integrated servicing, decision and collections system
automatically forwards accounts to our automated dialer or regional collection
centers based on the assessed risk of default or loss. Account assessment poses
several courses of action, including delaying collection activity based on the
likelihood of self curing, directing an account to the automated dialer for a
predetermined number of days before being forwarded to a regional collections
office, or directly forwarding to a collection specialist in the regional office
for accelerated collection efforts as early as seven days past due. This process
balances the efficiency of centralized collection efforts with the effectiveness
of decentralized personal collection efforts. Our systems track delinquencies
and chargeoffs, monitor the performance of our collection associates and assist
in delinquency forecasting. To assist in the collection process, we can access
original documents through our imaging system which stores all the documents
related to each contract. We limit deferments to a maximum of three over the
life of the contract and rarely rewrite contracts.
If satisfactory payment arrangements are not made, the automobile is
generally repossessed within 60 to 90 days of the date of delinquency, subject
to compliance with applicable law. We use independent contractors to perform
repossessions. The automobile remains in our custody generally for 15 days, or
longer if required by local law, to provide the obligor the opportunity to
redeem the contract. If after the redemption period the delinquency is not
cured, we write down the vehicle to fair value and reclassify the contract as a
repossessed asset. After the redemption period expires, we prepare the
automobile for sale. We sell substantially all repossessed automobiles through
wholesale automobile auctions, subject to applicable law. We do not provide the
financing on repossessions sold. We use regional remarketing departments to sell
our repossessed vehicles. Once the vehicles are sold, any remaining deficiency
balances are then charged off. At December 31, 2000, repossessed automobiles
outstanding managed by us was $6.2 million or 0.09% of the total serviced
portfolio, compared with $3.4 million or 0.06% of the total serviced portfolio
at December 31, 1999.
It is our policy to charge off an account when it becomes contractually
delinquent by 120 days, except for accounts that are in Chapter 13 bankruptcy,
even if we have not yet repossessed the vehicle. At the time that a contract is
charged off, all accrued interest is reversed. For those accounts that are in
Chapter 13 bankruptcy and contractually past due 120 days, all accrued interest
is reversed and income is recognized on a cash basis. Additionally, we mark down
such contracts to fair value and reclassify them as non-performing accounts.
After chargeoff, we collect deficiency balances through our centralized asset
recovery center. These efforts include contacting the borrower directly, seeking
a deficiency judgment through a small claims court, or instituting other
judicial action where necessary. In some cases, particularly where recovery is
believed to be less likely, the account may be assigned to a collection agency
for final resolution. We also monitor payment plans on those obligors who have
filed for bankruptcy.
RETAIL BANKING
Our retail banking operations are conducted through 25 branch offices
located throughout California. At December 31, 2000 and 1999, the total deposits
gathered by the retail banking division were $2.0 billion. Due
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to the limited number of branch offices, we have historically focused on
certificates of deposit accounts as the primary product offered by the retail
banking division.
Demand deposits and money market accounts obtained through our retail
banking operations totaled $460 million at December 31, 2000 compared with $477
million and $341 million at December 31, 1999 and 1998, respectively. At
December 31, 2000, demand deposits and money market accounts represented 23% of
our total retail deposits.
COMMERCIAL BANKING
We focus our commercial banking operations in the Orange, Los Angeles and
San Diego County metropolitan areas, operating through our Irvine headquarters
office. We target commercial clients with sales between $10 million and $100
million. We offer our commercial clients a full array of deposit and loan
products that are priced competitively and designed specifically for them. The
commercial banking division's strategy is to generate deposits in excess of the
loans it funds to provide another source of liquidity for the Bank. Deposit
products include money market, business checking and certificate of deposit
accounts delivered either through direct contact or through cash management
services. Loan products include term loans, lines of credit, asset-based loans,
construction and real estate loans. We also offer consumer deposit and money
market accounts as well as consumer loans and lines of credit to the company
owners, management and their associates. Loan products are generally priced on a
floating rate basis, based on the prime rate or London Interbank Offer Rate,
also known as LIBOR. Fixed rates are generally limited to a one-year term or
less.
Credit quality is managed by having each loan reviewed for approval by a
credit committee comprised of the Bank's President, Chairman of the Board, Board
members and our executives. In addition, account officers are directly assigned
to specific accounts to maintain close contact with the customer. Such contact
allows for greater opportunity to cross sell products, as well as for observing
and continually evaluating the customer for potential credit problems.
At December 31, 2000, the commercial banking division had generated $444
million in deposits compared with $216 million and $80 million at December 31,
1999 and 1998, respectively. Commercial loans outstanding totaled $108 million,
$66.9 million and $52.9 million at December 31, 2000, 1999 and 1998,
respectively.
MORTGAGE PORTFOLIOS
We have from time to time originated mortgage products that were held on
our balance sheet rather than selling such products into the secondary markets.
Other than mortgage loans originated on a limited basis through the commercial
banking division, we do not expect to add mortgage loans to our balance sheet.
CONSTRUCTION LOANS
On a limited basis, we originate construction loans primarily for single
family owner-occupied residences and commercial real estate. These include loans
for the acquisition and development of unimproved property to be used for
residential and commercial purposes. The construction loan portfolio generally
consists of loans with terms ranging from six to twelve months with fully
indexed adjustable interest rates that range between 8.12% and 10.50%. Advances
are generally made to cover actual construction costs and include a reserve for
paying the stated interest due on the loan.
TRANSACTIONS WITH RELATED PARTIES
In our opinion, the transactions described herein under the caption
"Transactions with Related Parties" have been on terms no less favorable to us
than could be obtained from unaffiliated parties, notwithstanding that the
transactions were not negotiated at arm's length. However, the transactions were
approved by our entire Board of Directors and the Boards of Directors of the
Bank and WFS, including their respective independent directors.
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INTERCOMPANY BORROWINGS
WFS has three separate borrowing arrangements with the Bank. The senior
note and the promissory note are long-term, unsecured debt, while the line of
credit is designed to provide short-term financing for the purchase of
contracts. These borrowings are the only source of liquidity for WFS outside of
the asset-backed securities market. These transactions eliminate upon
consolidation of WFS and the Bank.
WFS borrowed $125 million from the Bank under the terms of the senior note.
The senior note provides for principal payments of $25 million per year,
commencing on April 30, 1999 and continuing through its final maturity, April
30, 2003. Interest payments on the senior note are due quarterly, in arrears,
calculated at the rate of 7.25% per annum. WFS made paydowns of $32.7 million
and $66.1 million for the years ended December 31, 2000 and 1999, respectively,
without prepayment penalties. There was $11.2 million and $43.9 million
outstanding on the senior note at December 31, 2000 and 1999, respectively.
Interest expense totaled $1.5 million, $5.4 million and $9.0 million for the
years ended December 31, 2000, 1999 and 1998, respectively.
Additionally, WFS borrowed $135 million under the terms of the promissory
note from the Bank. The promissory note provides for principal payments of $67.5
million per year, commencing July 31, 2001 and continuing through its final
maturity, July 31, 2002. Interest payments on the promissory note are due
quarterly, in arrears, calculated at the rate of 9.42% per annum. Pursuant to
the terms of the promissory note, WFS may not incur any other indebtedness which
is senior to the obligations evidenced by the promissory note except for (i)
indebtedness under the senior note (ii) indebtedness collateralized or secured
under the line of credit and (iii) indebtedness for similar types of warehouse
lines of credit. There was $135 million outstanding on the promissory note at
December 31, 2000 and 1999. Interest expense totaled $12.7 million, $9.3 million
and $4.7 million for the years ended December 31, 2000, 1999 and 1998,
respectively.
WFS also has a line of credit extended by the Bank permitting it to draw up
to $1.8 billion as needed to be used in its operations. WFS does not pay a
commitment fee for the line of credit. The line of credit terminates on December
31, 2004, although the term may be extended by WFS for additional periods up to
60 months. When secured, the line of credit carries an interest rate equal to
one-month LIBOR plus 75 basis points. When unsecured, the line of credit carries
an interest rate equal to one-month LIBOR plus 125 basis points. The margins on
this line were increased from 62.5 basis points when secured and 112.5 basis
points when unsecured effective May 23, 2000. Interest on the amount outstanding
under the line of credit is paid monthly, in arrears, and is calculated on the
average amount outstanding that month. The Bank has the right under the line of
credit to refuse to permit additional amounts to be drawn on the line of credit
if, in the Bank's discretion, the amount sought to be drawn will not be used to
finance purchases of contracts or other working capital requirements. There was
$236 million and $551 million outstanding on the line of credit at December 31,
2000 and 1999, respectively. Interest expense totaled $38.4 million, $15.7
million and $11.1 million for the years ended December 31, 2000, 1999 and 1998,
respectively. The weighted average interest rate was 7.09%, 5.33% and 7.31% for
the years ended December 31, 2000, 1999 and 1998, respectively.
SHORT-TERM INVESTMENTS
WFS also invests its excess cash at the Bank under an investment agreement.
The Bank pays WFS an interest rate equal to the federal composite commercial
paper rate on this excess cash. The weighted average interest rate was 6.58%,
5.23% and 5.45% for the years ended December 31, 2000, 1999 and 1998. WFS held
no excess cash with the Bank under the investment agreement at December 31, 2000
and 1999. Interest income earned under this agreement totaled $1.2 million, $0.1
million and $0.5 million for the years ended December 31, 2000, 1999 and 1998,
respectively.
WFS REINVESTMENT CONTRACT
Through a series of agreements which WFS, the Bank, WFAL2, and other
parties have entered into, WFS has access to the cash flows of each of the
outstanding securitization transactions, including the cash held in each spread
account. WFS is permitted to use that cash as it determines, including in the
ordinary business activities of originating contracts.
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In each securitization transaction, the Bank and WFAL2 have entered into a
reinvestment contract that is deemed to be an eligible investment under the
relevant securitization agreements. The securitization agreements require,
provided certain conditions are met, that all cash flows of the relevant trust
and the associated spread accounts be invested in the applicable reinvestment
contract. A limited portion of the invested funds may be used by WFAL2 and the
balance may be used by the Bank. The Bank makes its portion available to WFS
pursuant to the terms of the WFS Reinvestment Contract. Under the WFS
Reinvestment Contract, WFS receives access to all of the cash available to the
Bank under each trust reinvestment contract and is obligated to repay to the
Bank an amount equal to the cash so used when needed by the Bank to meet its
obligations under the individual trust reinvestment contracts. With the portion
of the cash available to it under the individual trust reinvestment contracts,
WFAL2 purchases contracts from WFS pursuant to the terms of the sale and
servicing agreements.
In accordance with this agreement, the Bank and WFAL2 pledge property owned
by each for the benefit of the trustee of each trust and the surety. WFS pays
the Bank a fee equal to 12.5 basis points of the amount of collateral pledged by
the Bank as consideration for the pledge of collateral and for WFS' access to
cash under the WFS Reinvestment Contract. WFS paid the Bank $0.7 million, $0.6
million and $0.7 million for the years ended December 31, 2000, 1999 and 1998,
respectively, for this purpose. As WFAL2 directly utilizes the cash made
available to it to purchase contracts for its own account from WFS, no
additional consideration from WFS is required to support WFAL2's pledge of its
property under the agreement with Financial Security Assurance, also known as
FSA. While WFS is under no obligation to repurchase contracts from WFAL2, to the
extent WFAL2 needs to sell any such contracts to fund its repayment obligations
under the trust reinvestment contracts, it is anticipated that WFS would prefer
to purchase those contracts than for WFAL2 to sell those contracts to a third
party. The WFS Reinvestment Contract, by its terms, is to remain in effect so
long as any of the trust reinvestment contracts is an eligible investment for
its related securitization transaction. There was $832 million and $687 million
outstanding on the WFS Reinvestment Contract at December 31, 2000 and 1999,
respectively.
TAX SHARING AGREEMENT
We and our subsidiaries are parties to a tax sharing agreement with WFS,
the Bank and their subsidiaries, pursuant to which a consolidated federal tax
return is filed for all of the parties to the agreement. Under the agreement,
the tax due by the group is allocated to each member based upon the relative
percentage of each member's taxable income to that of all members. Each member
pays Westcorp its estimated share of that tax liability when otherwise due, but
in no event may the amount paid exceed the amount of tax that would have been
due if a member were to file a separate return. A similar process is used with
respect to state income taxes for those states which permit the filing of a
consolidated or combined return. Tax liabilities to states that require the
filing of separate tax returns for each company are paid by each company. The
term of the tax sharing agreement commenced on the first day of the consolidated
return year beginning January 1, 1994 and continues in effect until the parties
to the tax sharing agreement agree in writing to terminate it. See "Consolidated
Financial Statements -- Note 21 -- Income Taxes".
MANAGEMENT AGREEMENTS
We have entered into certain management agreements with WFS and the Bank
pursuant to which we pay an allocated portion of certain costs and expenses
incurred by the Bank and WFS. Such costs include the cost of services or
facilities of the Bank and WFS used by us or our subsidiaries, including our
principal office facilities and certain field offices, and overhead and
associate benefits pertaining to Bank and WFS associates who also provide
services to us or our subsidiaries. Amounts paid to WFS by the Bank relating to
these management agreements totaled $0.3 million, $0.7 million and $0.7 million
for the years ended December 31, 2000, 1999 and 1998, respectively. Amounts paid
by WFS to the Bank relating to these management agreements totaled $1.8 million,
$1.2 million and $4.8 million for the years ended December 31, 2000, 1999 and
1998, respectively. The management agreements may be terminated by any party
upon five days prior written notice without cause, or immediately in the event
of the other party's breach of any covenant,
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obligation, or duty contained in the applicable management agreement or for
violation of law, ordinance, statute, rule or regulation governing either party
to the applicable management agreement.
SUPERVISION AND REGULATION
GENERAL
In 1989, Congress adopted the Financial Institutions Reform, Recovery and
Enforcement Act, also known as FIRREA. Congress' adoption of FIRREA
substantially changed the laws under which we and the Bank operate. In 1991,
Congress enacted the Federal Deposit Insurance Corporation Improvement Act, also
known as FDICIA. FDICIA requires specified regulatory agencies to adopt
regulations which have broad application to insured financial institutions such
as the Bank. In 1994 and 1996, Congress adopted the Riegle Community Development
and Regulatory Improvement Act, also known as RCDA, and the Deposit Insurance
Fund Act, also known as the Fund Act. The adoptions of RCDA and the Fund Act
modified some of FDICIA's requirements. Finally, in 1999 the Gramm-Leach-Bliley
Act, also known as GLBA, was adopted. The GLBA substantially modernized federal
banking law.
Set forth below is a discussion of those provisions of the foregoing acts
and of pre-existing laws that have a material effect upon our business. To the
extent, however, that any of the following discussion describes statutory or
regulatory provisions, the exact language of the statute or regulatory provision
qualifies any such discussion. Furthermore, any future changes in the applicable
law or regulation or in the policies of various regulatory authorities may have
a material effect on our business. Accordingly, we cannot assure you that we
will not be affected by any such further changes.
WESTCORP
The Savings and Loan Holding Company Act
We, by virtue of our ownership of the Bank, are a savings and loan holding
company within the meaning of the Home Owners' Loan Act, as amended, also known
as HOLA, which was amended by FIRREA and most recently by the GLBA. Savings and
loan holding companies and their savings association subsidiaries, such as us
and the Bank, are extensively regulated by federal laws.
We are a savings and loan holding company registered with the OTS.
Therefore, we are subject to the OTS' regulations, examination and reporting
requirements. We are a "unitary" savings and loan holding company within the
meaning of regulations promulgated by the OTS. As a result, we are virtually
unrestricted in the types of business activities in which we may engage,
provided the Bank continues to meet the Qualified Thrift Lender test under HOLA.
We intend to remain a unitary savings and loan holding company. However, if we
acquire one or more insured institutions and operate them as separate
subsidiaries rather than merging them with the Bank, or if certain other
circumstances not currently applicable to us arise, we would be treated as a
"multiple" savings and loan holding company. As a "multiple" savings and loan
holding company, additional regulatory restrictions would be imposed on us. We
do not anticipate that those circumstances will arise unless we acquire one or
more insured institutions as a result of a supervisory acquisition and the
insured institution meets the Qualified Thrift Lender test.
HOLA prohibits a savings and loan holding company, without prior approval
of the OTS, from controlling any other savings association or savings and loan
holding company.
Additionally, FIRREA empowers the OTS to take substantive action when it
determines that there is reasonable cause to believe that the continuation by a
savings and loan holding company of any particular activity constitutes a
serious risk to the financial safety, soundness, or stability of that holding
company's subsidiary savings association. Thus, FIRREA confers on the OTS
oversight authority for all holding company affiliates, not just the Bank.
Specifically, the OTS may, as necessary:
- limit the payment of dividends by the Bank;
- limit transactions between the Bank, the holding company and the
subsidiaries or affiliates of either; and
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- limit any activities of the holding company that might create a serious
risk that the liabilities of the holding company and its affiliates may
be imposed on the Bank.
Any of these limits may be issued in the form of regulations or a directive
having the effect of a cease and desist order.
HOLA also limits the type of activities and investments in which the
savings association subsidiaries of a savings and loan holding company may
participate if the investment and/or activity involves an affiliate of that
savings association's subsidiary. In general, savings association subsidiaries
of a savings and loan holding company are subject to Sections 23A and 23B of the
Federal Reserve Act in the same manner and to the same extent as if the savings
association were a member bank of the Federal Reserve System, as well as
regulations adopted by the OTS. Section 23A of the Federal Reserve Act places
certain quantitative limitations on certain transactions between a bank and its
subsidiaries and an affiliate. The quantitative limitations are based upon a
percentage of the savings association's capital stock and surplus. Transactions
covered by Section 23A of the Federal Reserve Act, include transactions
involving:
- loans or extensions of credit to the affiliate;
- the purchase of or investment in securities issued by an affiliate;
- the purchase of certain assets from an affiliate;
- the acceptance of securities issued by an affiliate as security for a
loan or extension of credit to any person; or
- the issuance of a guarantee, acceptance or letter of credit on behalf of
an affiliate.
The definition of capital stock and surplus permits the Bank to include
subordinated debt that it issues in the calculation of capital stock and
surplus, as long as the debt qualifies for inclusion in Tier 2 capital.
In addition, Section 23B requires that transactions between a savings
association subsidiary or its subsidiary and an affiliate must meet certain
qualitative limitations. Section 23B requires that such transactions be on terms
that are at least as favorable to the bank or its subsidiary as are the terms of
the transactions with unaffiliated companies.
Section 11 of the HOLA, as amended by FIRREA, also specifically prohibits a
savings association subsidiary of the savings and loan holding company from:
- making a loan or extension of credit to an affiliate, unless that
affiliate is engaged only in activities permitted to bank holding
companies under Section 4(c) of the Bank Holding Company Act, or
- purchasing or investing in the securities of an affiliate, other than a
subsidiary of the savings association.
Under most circumstances, the above prohibitions include a purchase of
assets from an affiliate of the savings association subsidiary that is made
subject to the affiliate's agreement to repurchase the assets. The OTS
regulations exclude transactions between a savings association subsidiary and
its subsidiaries from the limitations of those sections. This exclusion is
consistent with the provisions of Sections 23A and 23B of the Federal Reserve
Act. However, the OTS regulations also define certain subsidiaries to be
affiliates of the savings association subsidiary. Therefore, such certain
subsidiaries are subject to the requirements of those sections of the OTS
regulation. At the present time, none of the Bank's subsidiaries are within the
definition of an affiliate for purposes of the OTS regulations.
FIRREA and FDICIA require that savings association subsidiaries comply with
the requirements of Federal Reserve Act Sections 22(g) and 22(h), and Regulation
O of the Federal Reserve System with respect to loans to executive officers,
directors and principal shareholders, in the same manner as member banks. The
RCDA permits loans secured by a first lien on an executive officer's residence
to be made without prior approval of the board of directors of the financial
institution. As a matter of policy, we do not make loans to executive officers,
directors or principal shareholders.
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The Gramm-Leach-Bliley Act
The GLBA permits insurance, banking and securities firms to be owned by a
single owner. GLBA also prohibits unitary savings and loan holding companies,
like us, from being acquired by commercial companies. We are permitted under
GLBA, however, to continue to engage in any business opportunities in which we
had a right to engage prior to the enactment of GLBA. In short, GLBA does not
have any effect on our business, and we do not expect that any of its provisions
will have an adverse effect on our operations or our financial condition.
However, because GLBA liberalizes the activities permitted to a bank
holding company from those closely related to banking to those which are
financial activities, entities which are well capitalized but previously could
not own banks can now acquire a bank and become a bank holding company. Thus,
GLBA creates the potential for well capitalized entities to enter into the
banking business. As any such entity could have become a unitary savings and
loan holding company prior to enactment of GLBA, we do not anticipate that this
change in the laws applicable to bank holding companies will have a significant
affect upon us or the Bank.
Under GLBA, savings associations have gained the same treatment long
applicable to banks and are now exempt from registering as an "investment
company" when using common or collective trust funds to offer trust and other
fiduciary services to their customers. GLBA expanded the exemption by amending
Section 2(a)(5)(A) of the Investment Company Act to include "depository
institutions" within the meaning of "bank." That term encompasses savings
associations insured by the FDIC. GLBA also amended Section 3(a)(2) of the
Securities Act of 1933 to exempt the interests in common or collective trust
funds from registration as securities.
GLBA also creates additional obligations on financial institutions, such as
the Bank and its subsidiaries, regarding the safeguarding of nonpublic personal
information of their customers and creates affirmative duties to advise
customers as to what the financial institutions do with their customers'
nonpublic personal information. Federal banking regulatory agencies implemented
these privacy guidelines in a recently issued regulation that provides detailed
instructions on safeguarding consumer financial information. We do not believe
that these privacy requirements will have a significant impact on the Bank or
any of its subsidiaries, because the Bank and its subsidiaries have historically
safeguarded the personal confidential information of their customers as required
by other federal statutes.
Other Matters
The OTS has recently proposed to require holding companies to notify the
OTS before engaging in certain debt transactions, in any transactions that
substantially reduce capital, in certain asset acquisitions and certain other
transactions on a case-by-case basis. The proposed notice is designed to prevent
activities that could have an adverse impact on the subsidiary savings
associations. We do not believe that these notice requirements will have a
significant impact on us, since we do not have a history of engaging in
activities that pose a material risk to the financial safety of our subsidiary
saving association.
The OTS has also recently proposed to codify its practice of requiring
additional capital and of case-by-case review of capital adequacy of savings and
loan holding companies. The proposed regulation identifies the key evaluating
factors -- debt, capital, cash flow and earnings and overall risk profile of the
holding company -- for determining if additional capital is necessary for a
holding company. Eventual codification of current OTS practice of a case-by-case
review is not expected to have an effect on us because we believe we are well
capitalized for the business in which we engage.
THE BANK
California Savings Association Law
As a federally chartered institution, the Bank's investments and
borrowings, loans, issuance of securities, payments of interest and dividends,
establishment of branch offices and all other aspects of its operations are
subject to the exclusive jurisdiction of the OTS. In other words, the OTS
jurisdiction preempts the jurisdiction
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of the California Financial Code or regulations of the California Commissioner
of Financial Institutions. The OTS adopted regulations preempting state laws
pertaining to the operations of federal savings associations and their operating
subsidiaries.
Federal Home Loan Bank System
The GLBA requires that the Bank, as a member of the FHLB System, fulfill
its minimum investment requirement in the FHLB System. The Bank is in compliance
with this requirement. The Federal Housing Finance Board, also known as the
Board, has recently proposed that either investment in capital stock of the FHLB
System or payment of an annual membership fee should satisfy the membership
investment requirement. The option of a membership fee might provide more
flexibility for the Bank and once the final regulation is issued, we will
consider that option.
Since the adoption of FIRREA, the requirements imposed by FIRREA on the
FHLB System have significantly reduced the dividends which the Bank has received
on its FHLB System stock. Each bank in the FHLB System is required to transfer a
percentage of its annual net earnings to the Affordable Housing Program, as
defined in FIRREA. This amount is a minimum of 10% of the annual net income of
each bank in the FHLB System.
Insurance of Accounts
The FDIC administers the Savings Association Insurance Fund, also known as
SAIF, which insures the deposits of savings associations that were insured by
the Federal Savings and Loan Insurance Corporation, also known as FSLIC, prior
to the enactment of FIRREA. Commencing in 1989, the deposits of the Bank became
insured through the SAIF to the maximum amount permitted by law, which is
currently $100,000.
During 2000, the Bank was required to pay insurance premiums of $1.2
million. FDICIA required the FDIC to implement a risk-based assessment system
under which a banking institution's premiums are based on the FDIC's
determination of the relative risk that the condition of the banking institution
poses to its insurance fund. In response, the FDIC adopted a final rule,
effective January 1, 1994. Under this rule, each insured banking institution is
classified as "well capitalized," "adequately capitalized" or
"undercapitalized." These three classifications use definitions substantially
the same as the definitions adopted with respect to the "prompt corrective
action" rules adopted by the regulatory agencies under FDICIA. See "Prompt
Corrective Regulatory Action." Within each of these three classifications, the
FDIC has created three risk categories into which an institution may be placed
based upon the supervisory evaluations of the institution's primary federal
financial institution regulatory agency and the FDIC. These three risk
categories consist of:
- those institutions deemed financially sound;
- those with demonstrated weakness that could result in significant
deterioration of the institution and risk of loss to the FDIC; and
- those which pose a substantial probability of loss to the FDIC.
Each of these nine assessment categories for SAIF insured banking
institutions, such as the Bank, is assigned an assessment rate. Under the
regulations, a banking institution may not disclose the risk-based assessment
category to which it has been assigned.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution:
- either has engaged or is engaging in unsafe or unsound practices;
- is in an unsafe or unsound condition to continue operations; or
- has violated any applicable law, regulation, order or any condition
imposed by an agreement with the FDIC.
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The FDIC also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is not aware of any existing circumstances that could
result in termination of the Bank's deposit insurance.
Liquidity Requirements
Under OTS regulations, the Bank must maintain an average daily balance of
liquid assets equal to at least 4% of the Bank's average daily balance of net
withdrawal accounts and borrowings payable on demand or in one year or less. The
balance of liquid assets includes cash, certain time deposits, bankers'
acceptances and specified United States government, state or federal agency
obligations and certain corporate debt obligations and commercial paper. If at
any time the Bank's liquid assets do not at least equal, on an average daily
basis for any quarter, the amount required by these regulations, the Bank would
be subject to various OTS enforcement procedures, including monetary penalties.
At December 31, 2000, the Bank's percentage was 10.23%. Thus, the Bank was in
compliance with these requirements. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Capital Resources and
Liquidity."
Brokered Deposits
In June 1992, the FDIC issued regulations under FDICIA that provide for
differential regulation relating to brokered deposits based on capital adequacy.
Institutions are divided into categories of "well capitalized," "adequately
capitalized" and "undercapitalized." Only "well capitalized" institutions may
continue to accept brokered deposits without restriction. The RCDA affirmatively
excludes well capitalized institutions from the definition of deposit brokers,
thereby eliminating the need for well capitalized institutions to register as
deposit brokers.
At December 31, 2000, the Bank met the capital requirements of a well
capitalized association as defined by the regulation. At that date, the Bank
held no brokered deposits.
Regulatory Capital Requirements
The HOLA, as amended by FIRREA, mandates that the OTS promulgate capital
regulations that include capital standards no less stringent than the capital
standards applicable to national banks. The Bank exceeded the current minimum
requirements for core capital, tangible capital and risk-weighted capital as of
December 31, 2000 as more fully described below.
The HOLA and the OTS regulations require savings associations to maintain
"core capital" in an amount not less than 3% of adjusted total assets. However,
effective April 1, 1999, all savings associations that do not have a Capital,
Asset Quality, Management, Earnings, Liquidity, Sensitivity toward market risk,
also known as CAMELS, rating system composite rating of 1 must maintain core
capital in an amount of not less than 4% of adjusted total assets. The OTS
capital regulations already permit the OTS to impose a higher individual minimum
capital requirement on a case-by-case basis. The Bank is not currently subject
to this requirement.
The Bank's core capital ratio at December 31, 2000 was 8.03%. Core capital
is defined in the OTS capital regulations as including, among other things:
- common shareholder's equity (including retained earnings);
- a certain portion of the association's qualifying supervisory goodwill;
- noncumulative perpetual preferred stock and related surplus; and
- capitalized servicing rights, also known as CSRs, and purchased credit
card relationships, also known as PCCRs meeting certain valuation
requirements.
All CSRs and PCCRs that are includable in capital are each subject to a 90%
fair value limitation. The maximum amount of CSRs and PCCRs which can be
included in core capital and tangible capital may not
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exceed, in the aggregate, an amount equal to 100% of the institutions core
capital, with nonmortgage servicing assets and PCCRs limited to 25% of core
capital. All other intangible assets, other than qualifying PCCRs, must be
deducted from core capital. At December 31, 2000, the Bank held no CSRs or
PCCRs.
A savings association must maintain "Tangible Capital" in an amount not
less than 1.5% of adjusted total assets. "Tangible Capital" means core capital
less any intangible assets, including supervisory goodwill, plus CSRs and PCCRs
to the extent includable in core capital as described above. At December 31,
2000, the Bank's tangible capital was 8.03%.
A savings institution's investments in, and extensions of credit to, a
subsidiary engaged in any activities not permissible for national banks, also
known as nonincludable subsidiaries, generally are deducted from the
institution's core capital and tangible capital in determining compliance with
capital standards. This deduction is not required for investments in and
extensions of credit to a subsidiary engaged solely in mortgage banking, to
certain subsidiaries which are themselves insured depository institutions or,
unless the FDIC determines otherwise in the interests of safety and soundness,
to a subsidiary which engages in these impermissible activities solely as agent
for its customers. Since July 1, 1996, the Bank has been required to deduct from
its core and tangible capital its entire investments in Western Consumer
Services, Inc., also known as WCS, both equity and extensions of credit, because
WCS is engaged in residential real estate activities not permitted to national
banks. At December 31, 2000, the amount excluded from the Bank's core and
tangible capital was $0.1 million.
As of December 31, 2000, the Bank's core capital was $534 million,
exceeding the Bank's regulatory requirement by $334 million. The Bank's tangible
capital at December 31, 2000 was $534 million, exceeding the applicable
regulatory requirement by $434 million.
The risk-based component of the capital standards requires that a savings
association have total capital equal to 8.0% of risk-weighted assets. The OTS
risk-based capital regulation provides that for assets sold as to which any
recourse liability is retained, including on balance sheet assets related to the
assets sold which are at risk, a savings association must hold capital as a part
of its risk-based capital requirement equal to the lesser of:
- the amount of that recourse liability; or
- the risk-weighted capital requirement for assets sold off balance sheet
as though the assets had not been sold.
In addition, in the former instance, when calculating the Bank's risk-based
capital ratio (a) the value of those on balance sheet assets which are subject
to recourse, to the extent of that recourse liability, also known as fully
capitalized assets, is deducted from the Bank's total capital and (b) neither
the risk-weighted value of the asset sold off balance sheet nor the amount of
the fully capitalized assets is included in the Bank's total risk-weighted
assets. The Bank's risk-based capital requirement at December 31, 2000 included
$261 million due to its recourse liability relating to trust financings,
including fully capitalized assets.
The Bank's total risk-weighted assets are determined by taking the sum of
the products obtained by multiplying each of the Bank's assets and certain off
balance sheet items by a designated risk-weight. Before an off balance sheet
item can be assigned a risk-weight, it must be converted to an on balance sheet
credit equivalent amount.
Four risk-weight categories exist for on balance sheet assets. The four
risk-weighted categories are:
- zero percent, which are generally cash and securities issued by or backed
by the full faith and credit of the United States;
- twenty percent, which are generally United States government-backed
mortgage securities;
- fifty percent, which are generally qualifying mortgage loans and
mortgage-backed securities not within lower categories; and
- one hundred percent, which are all other assets.
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Before a risk-weight category can be applied to a consolidated off balance
sheet item, the item must be converted into a credit-equivalent amount by
multiplying its face amount by whichever of four credit conversion factors is
appropriate. Consider the following:
- there is a one hundred percent conversion of direct credit substitutes
and net assets sold under an agreement to repurchase;
- a fifty percent conversion factor for transaction-related contingencies
and the unused portions of nonexempt loan commitments;
- a twenty percent conversion for trade-related contingencies, such as
commercial letters of credit; and
- a zero percent conversion for the unused portion of exempt loan
commitments and unused, unconditionally cancelable retail credit card
lines.
Interest rate contracts have special credit equivalent amounts equal to the
sum of their current credit exposure plus their potential credit exposure. The
risk-weight category to be applied to these amounts in determining the credit
risk component would depend on the obligor, but in no event would be higher than
fifty percent risk-weight. As of December 31, 2000, the Bank's total
risk-weighted assets equaled $6.4 billion.
In addition to regulations pertaining to risk-based capital for interest
rate risk, FDICIA also requires the adoption of risk-based capital regulations
regarding excessive exposure to concentration of credit risk and the risks
associated with nontraditional activities. The OTS individual minimum capital
regulations include these factors as additional grounds upon which the OTS could
impose these requirements. The regulations do not set specific standards, but
leave it to the discretion of the OTS to impose additional capital requirements
on a case-by-case basis. The RCDA requires the federal banking agencies to add
the size and activities of an institution to that list of factors which may
justify the need for additional risk-based capital. Under the RCDA the federal
banking agencies are not to cause undue reporting burdens in connection with
these regulations. The OTS has not yet proposed new regulations in response to
this law.
Total capital, as defined by OTS regulations, is core capital plus
supplementary capital, with supplementary capital not to exceed 100% of core
capital, less:
- direct equity investments not permissible to national banks, subject to a
phase-in schedule;
- reciprocal holdings of depository institution capital investments; and
- that portion of land loans and nonresidential construction loans in
excess of 80% loan-to-value ratio.
Supplementary capital is comprised of three elements:
- permanent capital instruments not included in core capital;
- maturing capital instruments; and
- general valuation loan and lease loss allowance.
The Bank currently has $42.5 million of its 8.5% Subordinated Capital
Debentures and $147 million of its 8.875% Subordinated Capital Debentures
outstanding, excluding discounts and issuance costs. Pursuant to the approval
from the OTS to treat those debentures as supplementary capital, the amount of
those debentures which may be included as supplementary capital may not exceed
one-third of the Bank's total capital. At December 31, 2000, the debentures then
outstanding represented 24.3% of the Bank's total capital. Consistent with the
OTS capital regulations, the amount of the 8.5% debentures which may be included
as supplementary capital decreases at the rate of 20% of the amount originally
outstanding per year, net of redemptions, commencing on July 1, 1998. The amount
of the 8.875% debentures which may be included as supplementary capital will
decrease at the rate of 20% of the amount originally outstanding per year, net
of redemptions, commencing on August 1, 2002. The Bank's total capital at
December 31, 2000 was $780 million and its risk-based capital ratio was 12.16%
As required by the provisions of FDICIA, the OTS has adopted an interest
rate risk component to its capital rules. The rule establishes a method for
determining an appropriate level of capital to be held by
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savings associations subject to the supervision of the OTS, such as the Bank,
against interest rate risk, also known as IRR. The rule generally provides that
if a savings association's IRR, calculated in accordance with the rule, exceeds
a specified percentage, the savings association must deduct from its total
capital an IRR component when calculating its compliance with the risk-based
capital requirement.
Specifically, the rule provides that a savings association's IRR is to be
determined by the decline in that savings association's Net Portfolio Value,
also known as NPV, or the value of the association's assets as determined in
accordance with the provisions of the rule, resulting from a 200 basis point
change in market interest rates, divided by the NPV prior to that change. If
that result is a decrease of greater than 2%, the association must deduct from
its total capital an amount equal to one-half of the decline in its NPV in
excess of 2% of its NPV prior to the interest rate change, also known as the IRR
component. The reduction of an association's total risk-based capital is
effective on the first day of the third quarter following the reporting date of
the information used to make the required calculations.
The rule also contains provisions which:
- reduce the IRR component if the association reduces its IRR by the end of
the quarter following the reporting date; and
- permit the OTS to waive or defer the IRR component on a showing that the
association has made meaningful steps to reduce or control its IRR.
The OTS has postponed the effective date as of which an IRR component will
be required to be deducted from a savings association's capital to permit the
OTS to review the interest rate risk regulations currently being promulgated by
the other federal banking agencies for their respective institutions. Even were
the rule currently being applied, the Bank would not be required to reduce its
total capital by an IRR component. The Bank does not anticipate being required
to do so during 2001.
Any savings association that fails any of the capital requirements is
subject to possible enforcement actions by the OTS or the FDIC. These actions
could include a capital directive, a cease and desist order, civil money
penalties, the establishment of restrictions on an association's operations and
the appointment of a conservator or receiver. The OTS' capital regulation
provides that these actions, through enforcement proceedings or otherwise, could
require one or more of a variety of corrective actions. The OTS must prohibit
asset growth by any institution that is in violation of the foregoing minimum
capital requirements, and must require any such institution to comply with a
capital directive issued by the OTS. See "Prompt Corrective Regulatory Action."
In summary, the Bank exceeded the current minimum requirements for core
capital, tangible capital and risk-weighted capital as of December 31, 2000.
Interagency Guidance Statement Regarding Asset-Backed Securitization
The OTS, in conjunction with the other federal banking regulatory agencies,
collectively known as the Agencies, issued a guidance statement regarding asset
securitization activities of banks and savings associations which applies to the
Bank and its subsidiary, WFS. The guidance states that reported values for
retained interest assets should be reasonable, conservative and supported by
objective and verifiable documentation. Furthermore, institutions engaged in
asset securitization activities should ensure that sufficient capital is held to
support the risks associated with those activities and that appropriate
management oversight and reporting is accomplished with respect to the
institution's asset securitization activities. The agencies noted that on a
case-by-case basis, additional capital may be required to be held by those
institutions whose asset securitization activities are not in compliance with
the guidance provisions, or the retained interests may be classified as loss and
not permitted to be included in calculating the institution's regulatory
capital. The Bank and WFS believe that WFS' valuation of its retained interest
assets and its securitization activities as an operating subsidiary of the Bank
are in compliance with the guidance provisions. Moreover, as WFS' recent
securitization activities have been primarily accounted for as secured
financings or involved a sale of contracts servicing released, WFS has
substantially reduced and does not anticipate creating in the future any
non-cash gain on sale residual interests, the valuation of which would be
subject to the guidance statement. The Bank
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and WFS believe that WFS' securitization activities to date, including the
creation, valuation and monitoring of our existing non-cash gain on sale
residual interests, have been conducted in full compliance with the guidance
statement.
The OTS, along with the other Agencies, has recently issued two proposals
to modify existing risk-based capital treatment of recourse obligations in asset
securitization activities of banking organizations. The first proposal provides
a single treatment for all types of recourse arrangements, including direct
credit substitutes and residual interests, regardless of the method used to
account for assets transferred with recourse. Such regulatory approach would
ensure that risk-based capital is held against the full amount of the
transferred assets that would be risk-weighted according to relative exposure to
credit risk. Determination of risk-weighted assets would also include all
securitization transactions that include early amortization provisions. The
Agencies' second proposal modifies risk-based capital treatment for residual
interests and restricts the amount of retained interest assets that may be
included in determining a bank's or savings association's regulatory capital.
Current capital standards do not require "dollar-for-dollar" capital protection
in case of residual interests that exceed the dollar amount of the full capital
charge on the assets transferred. The proposed modification would, however,
require that financial institutions hold "dollar-for-dollar" capital for the
organization's total contractual exposure to loss resulting from residual
interest assets retained by the financial institution. The rule would also limit
the amount of residual interests that can be included in Tier 1 capital by
including residual interests within the 25 percent of Tier 1 capital sublimit
already placed upon nonmortgage servicing assets and purchased credit card
relationships. Thus, the retained interests could be classified as loss and not
permitted to be included in calculating the institution's regulatory capital.
The Bank and numerous other financial institutions have submitted comments
to the proposed regulations, objecting primarily on the basis that the
regulations are unnecessary in light of the guidance statement and are
overbroad. The proposed retained interest regulation purports to be applicable
only to residual interests created upon a sale of financial assets. As such, the
proposal, even if adopted, should not apply to WFS or the Bank to the extent WFS
continues to account for its securitization transactions as secured financings.
At this time the Agencies have the proposals under consideration, and we cannot
predict when final regulations will be adopted or how the final regulations may
differ from those proposed. If the regulations are adopted as proposed, we
cannot determine the amount of additional capital the Bank may need to hold as
the amount of non-cash gain on sale residual interests we hold continue to
amortize as the underlying contracts are collected.
The OTS, along with the other Agencies, has adopted guidance pertaining to
sub-prime lending programs. Pursuant to the guidance, lending programs which
provide credit to borrowers whose credit histories reflect specified negative
characteristics, such as bankruptcies or payment delinquencies, are deemed to be
sub-prime lending programs. Pursuant to the guidance, examiners may require that
an institution with a sub-prime lending program hold additional capital,
typically one and one-half to three times the normal capital required for
similar loans made to borrowers who are not sub-prime borrowers, although
institutions whose sub-prime loans are well secured and well managed may not be
required to hold additional capital.
We cannot predict whether the regulations discussed above will be adopted
as proposed, whether any grandfather or phase-in features will be included in
the regulations as adopted or when the regulations, if adopted in any form, will
become effective. We also cannot predict whether the Bank will be required,
following its next examination, to hold additional capital with respect to those
contracts on its consolidated balance sheet as to which the borrowers are
sub-prime borrowers. To the extent that either the regulations, if adopted, or
the guidance, as implemented, require the Bank to raise and continue to maintain
higher levels of capital, our ability to originate, service and securitize new
and pre-owned automobile installment contracts, especially as to which the
borrower is a sub-prime borrower, may be adversely affected. Any changes to
regulations that would negatively impact the Bank may require us to curtail our
contract purchasing activities or change the relative percentage of types of
contracts we originate, either of which could have a material adverse effect on
our financial position, liquidity and results of operations.
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Prompt Corrective Regulatory Action
FDICIA requires each applicable agency and the FDIC to take prompt
corrective action to resolve the problems of insured depository institutions
that fall below certain capital ratios. This action must be accomplished at the
least possible long-term cost to the appropriate deposit insurance fund.
In connection with this action, each agency must promulgate regulations
defining the following five categories in which an insured depository
institution will be placed, based on the adequacy of its regulatory capital
level:
- well capitalized;
- adequately capitalized;
- undercapitalized;
- significantly undercapitalized; and
- critically undercapitalized.
The critically undercapitalized level cannot be set lower than 2% of total
assets or higher than 65% of the required minimum leverage capital level. In
addition to the various capital levels, FDICIA allows an institution's primary
federal regulatory agency to treat an institution as if it were in the next
lower category if that agency determines, after notice and an opportunity for
hearing, that the institution is in an unsafe or unsound condition, or that the
institution is engaged in an unsafe or unsound practice.
At each successive downward level of capital, institutions are subject to
more restrictions and regulators are given less flexibility in deciding how to
deal with the bank or thrift. For example, undercapitalized institutions will be
subject to asset growth restrictions and will be required to obtain prior
approval for acquisitions, branching and engaging in new lines of business. For
significantly undercapitalized institutions, the appropriate agency must:
- require the institution to sell shares in order to raise capital;
- restrict interest rates offered by the institution; and
- restrict transactions with affiliates.
However, in each case, if the agency determines that these actions would
not further the purposes of the prompt corrective action system, then the agency
need not take the action. In addition, for critically undercapitalized
institutions, the agency must require prior agency approval for any transaction
outside the ordinary course of business and the institution must be placed in
receivership or conservatorship, unless the appropriate agency and FDIC make
certain affirmative findings regarding the viability of the institution, which
must be reviewed every 90 days.
FDICIA prohibits any insured institution, regardless of its capitalization
category, from making capital distributions to anyone or paying management fees
to any persons having control of the institution if, after the transaction, the
institution would be undercapitalized. Any undercapitalized institution must
submit an acceptable capital restoration plan to the appropriate agency within
45 days of becoming undercapitalized.
A capital restoration plan will be acceptable only if each company having
control over an undercapitalized institution guarantees that the institution
will comply with the capital restoration plan until the institution has been
adequately capitalized on an average during each of four consecutive calendar
quarters and provides adequate assurances of performance. The aggregate
liability of the guarantee is limited to the lesser of either:
- an amount equal to 5% of the institution's total assets at the time the
institution became undercapitalized; or
- the amount which is necessary to bring the institution into compliance
with all capital standards applicable with respect to the institution as
of the time the institution fails to comply with its capital restoration
plan.
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The OTS, in conjunction with the other Agencies, adopted regulations
defining the five categories of capitalization and implementing a framework of
supervisory actions, including those described above, applicable to savings
associations in each category. The regulations provide that a savings
association will be deemed to be:
- "well capitalized" if it has a total risk-based capital ratio of 10% or
greater, a Tier 1, or core, risk-based capital ratio of 6% or greater, a
leverage ratio of 5% or greater and is not subject to any OTS order or
directive to meet and maintain a specific capital level for any capital
measure;
- "adequately capitalized" if it has a total risk-based capital ratio of 8%
or greater, has a Tier 1 risk-based capital ratio of 4% or greater and
has either:
- a leverage ratio of 4% or greater; or
- a leverage ratio of 3% or greater and is rated composite 1 under the
CAMELS rating system in the most recent examination of the institution;
- "undercapitalized" if it has a total risk-based capital ratio that is
less than 8%, has a Tier 1 risk-based capital ratio that is less than 4%,
has a leverage ratio that is less than 4% or, if rated composite 1 under
the CAMELS rating system in the most recent examination of the
institution, has a leverage ratio less than 3%;
- "significantly undercapitalized" if it has a total risk-based capital
ratio that is less than 6%, a Tier 1 risk-based capital ratio that is
less than 3% or a leverage ratio that is less than 3%; and
- "critically undercapitalized" if it has a ratio of tangible equity to
total assets that is equal to or less than 2%.
At December 31, 2000, the Bank met the capital requirements of a "well
capitalized" institution, as its total risk-based capital ratio was 12.16%, its
Tier 1 risk-based capital ratio was 8.32% and its leverage ratio was 8.03%.
Loans to One Borrower
Under the HOLA, as amended by FIRREA, the loans to one borrower limitations
for national banks apply to all savings associations in the same manner and to
the same extent as they do to national banks. Thus, savings associations
generally are not permitted to make loans to a single borrower in excess of 15%
to 25% of the savings associations' unimpaired capital and unimpaired surplus,
depending upon the type of loan and the collateral provided therefore.
In addition, further restrictions on a savings association's loans to one
borrower authority may be imposed by the OTS if necessary to protect the safety
and soundness of the savings association. At December 31, 2000, 15% of the
Bank's unimpaired capital and unimpaired surplus for loans to one borrower
purposes was $117 million. The largest amount outstanding at December 31, 2000
to one borrower and related entities was $14.0 million.
Equity Risk Investment Limitations
The Bank generally is not authorized to make equity investments other than
investments in subsidiaries. A savings association may not acquire a new
subsidiary or engage in a new activity through an existing subsidiary without
giving 30 days prior notice to the OTS and the FDIC. In addition, a savings
association must conduct the activities of the subsidiary in accordance with the
regulations and orders of the OTS. Under certain circumstances, the OTS also may
order a savings association to divest its interest in, terminate the activities
of, or take other corrective measures with respect to, an existing subsidiary.
The Bank's aggregate investment in service corporation subsidiaries was
$0.1 million and its equity investments in operating subsidiaries was $392
million as of December 31, 2000.
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Qualified Thrift Lender Test
A Qualified Thrift Lender, also known as QTL, test was enacted as a part of
FIRREA, and was modified by FDICIA and the Economic Growth and Regulatory
Paperwork Reduction Act, also known as EGRPRA. An association that fails to
become or remain a QTL must either:
- convert to a bank subject to the banking regulations; or
- be subject to severe restrictions, including being forbidden to invest in
or conduct any activity that is not permissible to both a savings
association and a national bank, and certain other restrictions on
branching, advances from its FHLB, and dividends.
For a three year period after an association fails to meet its QTL
requirements, the association is forbidden from retaining any investment or
continuing any activity not permitted for a national bank and must repay
promptly all FHLB advances. In addition, companies that control savings
associations that fail the QTL test must, within one year of the failure, become
a bank holding company subject to the Bank Holding Company Act.
Under the existing QTL requirements, a savings association's "qualified
thrift investments" must equal not less than 65% of the association's "portfolio
assets" measured on a monthly basis in nine of every twelve consecutive months.
Savings associations have the option of substituting compliance with the
Internal Revenue Code, also known as IRC, "domestic building and loan
association", also known as DBLA, test for compliance with the amended QTL
requirements. Qualified thrift investments include:
- all loans or mortgage-backed securities held by an association which are
secured or relate to domestic residential or manufactured housing;
- investments in educational, small business, credit card, and credit card