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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from N/A to _______________
Commission File Number: 1-9566
FirstFed Financial Corp.
(Exact name of registrant as specified in its charter)
Delaware 95-4087449
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
401 Wilshire Boulevard
Santa Monica, California 90401-1490
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 319-6000
Securities registered pursuant to Section 12(b) of the Act:
Common Stock $0.01 par value
(Title of Class)
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 past 90 days.
Yes _X_ No ___
The approximate aggregate market value of the voting stock held by
non-affiliates of the Registrant as of February 12, 1999: $304,897,240.
The number of shares of Registrant's $0.01 par value common stock outstanding as
of February 12, 1999: 20,623,198.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Annual Meeting of Stockholders, April 21,
1999 (Parts III & IV).
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (sub-section 229.405 of this chapter) 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 the
Form 10-K or any amendment to this Form 10-K. [ ]
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FirstFed Financial Corp.
Index
Page
----
Part I Item 1. Business................................................................ 3
Item 2. Properties.............................................................. 23
Item 3. Legal Proceedings....................................................... 23
Item 4. Submission of Matters to a Vote of Security Holders..................... 23
Part II Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters..................................................... 23
Item 6. Selected Financial Data................................................. 24
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................... 25
Item 8. Financial Statements and Supplementary Data............................. 46
Notes to Consolidated Financial Statements.............................. 50
Independent Auditors' Report............................................ 81
Item 9. Changes In and Disagreements with Accountants on
Accounting and Financial Disclosure..................................... 82
Part III Item 10. Directors and Executive Officers of the Registrant...................... 82
Item 11. Executive Compensation.................................................. 82
Item 12. Security Ownership of Certain Beneficial Owners and
Management.............................................................. 82
Item 13. Certain Relationships and Related Transactions.......................... 82
Part IV Item 14. Exhibits, Consolidated Financial Statement
Schedules, and Reports on Form 8K....................................... 82
Signatures and Power of Attorney................................................................. 84
2
PART I
ITEM 1--BUSINESS
General Description
FirstFed Financial Corp., a Delaware corporation ["FFC," and collectively
with its sole and wholly-owned subsidiary, First Federal Bank of California (the
"Bank"), the "Company"], was incorporated on February 3, 1987. Since September
22, 1987, FFC has operated as a savings and loan holding company engaged
primarily in the business of owning the Bank. Because the Company does not
presently engage in any independent business operations, substantially all
earnings and performance figures herein reflect the operations of the Bank.
The Bank was organized in 1929 as a state-chartered savings and loan
association, and, in 1935, converted to a federal mutual charter. In February
1983 the Bank obtained a federal savings bank charter, and, in December 1983,
converted from mutual to stock ownership.
The principal business of the Bank is attracting savings and checking
deposits from the general public, and using such deposits, together with
borrowings and other funds, to make real estate, business and consumer loans.
At December 31, 1998, the Company had assets totaling $3.7 billion,
compared to $4.2 billion at December 31, 1997 and $4.1 billion at December 31,
1996. The Company recorded net earnings of $34.6 million for the year ended
December 31, 1998, net earnings of $23.1 million for the year ended December 31,
1997, and net earnings of $8.2 million for the year ended December 31, 1996.
The Bank derives its revenues principally from interest on loans and
investments, loan origination fees and servicing fees on loans sold. Its major
items of expense are interest on deposits and borrowings, and general and
administrative expense.
As of February 13, 1999, the Bank operated 24 retail savings branches, all
located in Southern California. Permission to operate all full-service branches
must be granted by the Office of Thrift Supervision ("OTS"). In addition to the
retail branches, the Bank has a retail call center which conducts transactions
with deposit customers by telephone, five retail loan offices, a wholesale loan
office and "LENDFFB," a loan origination group which operates primarily by
telephone.
The Bank's principal loan market is Southern California. To a limited
extent, LENDFFB solicits loans from areas outside of Southern California,
including certain areas in Northern California. Loans originated by the LENDFFB
unit are originated primarily for sale.
The Bank has three wholly-owned subsidiaries: Seaside Financial
Corporation, Oceanside Insurance Agency, Inc. and Santa Monica Capital Group,
all of which are California corporations. See "Subsidiaries." The Bank conducts
its loan origination business under the name "FirstFed Mortgage Services."
Current Operating Environment
The Company's operating results are significantly influenced by national
and regional economic conditions, monetary and fiscal policies of the federal
government, housing demand and affordability and general levels of interest
rates.
The Bank's primary market within Southern California is Los Angeles County.
The economic climate in Los Angeles County remains strong and has continued to
recover from the economic recession earlier this decade. According to the UCLA
Anderson Forecast for December, 1998 ("UCLA Forecast"), the greater Los Angeles
area is now leading the state in employment growth. The economic recovery is
being driven by strength in the durable goods manufacturing industry and the
construction industry, particularly commercial and industrial building.
According to the UCLA Forecast, consumer confidence remains high due to strong
growth in employment and increases in personal income.
3
The state's economic expansion has been adversely impacted by the Asian
international economic crisis. According to the UCLA Forecast, the state's
exports have decreased by 5% compared to the prior year due to reduced exports
to Asia. Further decreases in exports could affect job growth in the coming
years.
The real estate markets in the greater Los Angeles area have continued to
improve. According to the UCLA Forecast, home values in the Los Angeles County
area increased by 8% during 1998 compared to 1997 and are expected to increase
by 6% in 1999. Demand for housing by immigrants in the Los Angeles area has
helped to strengthen home sales in the region. Also, according to the UCLA
Forecast, non-residential construction increased 18% in 1998 compared to 1997
and is expected to increase by 9% in 1999. This accounts for the recent large
increase in construction employment in the area.
Consistent with the improved real estate climate in the greater Los Angeles
area, the Bank's non-performing assets declined to 0.84% of total assets at the
end of 1998 from 0.95% at the end of 1997 and 1.77% at the end of 1996.
The Bank continually monitors the sufficiency of the collateral supporting
its loan portfolio. The portfolio is evaluated on a number of factors including
property location, date of origination and the original loan-to-value ratio. The
Bank adjusts its general allowance for anticipated loan losses as a result of
these evaluations. The provision for loan losses was $7.2 million in 1998
compared to $20.5 million in 1997 and $35.2 million in 1996.
The ratio of general valuation allowance to the Bank's assets with loss
exposure (the Bank's loan portfolio plus real estate owned) was 2.26% at the end
of 1998 compared to 1.86% at the end of 1997 and 1.73% at the end of 1996. The
general valuation allowance at December 31, 1998 increased because the provision
for loan losses exceeded net charge-offs. See "Business - Loan Loss Experience
Summary."
The Bank also maintains separate valuation allowances for impaired loans
and loans sold with recourse. See "Business - Loan Loss Experience Summary" for
additional information regarding valuation allowances for these loans.
Current Interest Rate Environment. The Federal Reserve Board ("FRB")
decreased interest rates during 1998 and during 1996. The FRB did not make any
changes to interest rates during 1997. In a declining interest rate environment,
the Bank's interest rate spread typically increases (savings and borrowing costs
decrease immediately while the loan portfolio yield stays approximately the same
or decreases slowly.) The reverse is true during periods of increasing interest
rates. Changes in interest rates have a less severe impact on the Bank's loan
portfolio due to the interest rate adjustment features of its loans. However,
changes in interest rates for the Bank's loan portfolio have an inherent time
lag resulting from operational and regulatory constraints which do not allow the
Bank to pass through monthly changes in the primary index utilized for the
majority of its adjustable rate loan customers for a period of ninety days. Due
primarily to the decreasing interest rate environment during 1998, the Bank's
interest rate margin increased to 2.43% from 2.13% in 1997. See "Asset-Liability
Management" and "Components of Earnings - Net Interest Income" in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" for
additional information.
Competition. The Bank experiences strong competition in attracting and
retaining deposits and originating real estate loans. It competes for deposits
with many of the nation's largest savings institutions and commercial banks that
have significant operations in Southern California.
The Bank also competes for deposits with credit unions, thrift and loan
associations, money market mutual funds, issuers of corporate debt securities
and the government. In addition to the rates of interest offered to depositors,
the Bank's ability to attract and retain deposits depends upon the quality and
variety of services offered, the convenience of the Bank's locations and its
financial strength as perceived by depositors.
The Bank competes for real estate loans primarily with savings
institutions, commercial banks, mortgage banking companies and insurance
companies. The primary factors in competing for loans are interest rates, loan
fees, interest rate caps, interest rate adjustment provisions and the quality
and extent of service to borrowers and mortgage brokers.
4
Environmental Concerns. Under certain circumstances, such as if it actively
participates in the management or operation of a property securing its loans,
the Bank could have liability for any properties found to have pollutant or
toxic features. Environmental protection laws are strict and impose joint and
several liability on numerous parties. It is possible for the cost of cleanup of
environmental problems to exceed the value of the security property. The Bank
has adopted environmental underwriting requirements when considering loans
secured by properties which appear to have environmentally high risk
characteristics (e.g. commercial, industrial and construction of all types,
which may contain friable asbestos or lead paint hazards). These requirements
are intended to minimize the risk of environmental hazard liability. The Bank's
policies are also designed to avoid the potential for liability imposed on
lenders who assume the management of a property.
Business Concentration. The Bank has no single customer or group of
customers, either as depositors or borrowers, the loss of any one or more of
which would have a material adverse effect on the Bank's operations or earnings
prospects.
Yields Earned and Rates Paid. Net interest income, the major component of
core earnings for the Bank, depends primarily upon the difference between the
combined average yield earned on the loan and investment security portfolios and
the combined average interest rate paid on deposits and borrowings, as well as
the relative balances of interest-earning assets and interest-bearing
liabilities. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Overview and Components of Earnings - Net Interest
Income" for further analysis and discussion.
Lending Activities
General. The Bank's primary lending activity has been the origination of
loans for the purpose of enabling borrowers to purchase, refinance or construct
improvements on residential real property. The loan portfolio primarily consists
of loans made to homebuyers and homeowners on the security of single family
dwellings and multi-family dwellings. The loan portfolio also includes loans
secured by commercial and industrial properties.
For an analysis of loan portfolio composition and an analysis of the types
of loans originated, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Balance Sheet Analysis - Loan Portfolio
and Loan Composition."
Origination and Sale of Loans. The Bank employs loan officers on an
incentive compensation basis to obtain qualified applicants for loans. The Bank
also derives business from other sources such as mortgage brokers, borrower
referrals, direct telephone sales and clients from its retail banking branches.
Loan originations were $637.0 million in 1998, $481.3 million in 1997 and
$302.8 million in 1996. Loan origination volume improved in 1998 and 1997 due to
the increase in real estate activity in the Bank's market areas. Also, in 1998,
lower interest rates created an increase in loan refinance activity. Loan
originations by LENDFFB were $158.0 million in 1998 and $46.6 million in 1997.
Loans sold totaled $379.6 million in 1998, $52.4 million in 1997 and $24.1
million in 1996. For the year ended December 31, 1998, $382.4 million in loans
were originated for sale compared to $86.6 million in 1997 and $22.9 million
during 1996. Loans originated for sale totaled 60%, 18% and 8% of loan
originations during 1998, 1997 and 1996, respectively. The increase is due to
borrower preference for fixed rate loans, which were available at historically
low interest rates during 1998.
Loans held-for-sale at December 31, 1998, 1997 and 1996 were $16.5 million,
$40.4 million and $6.2 million, respectively, constituting 0.59%, 1.30% and
0.20%, respectively, of the Bank's total loans at such dates.
Loans originated for resale are recorded at the lower of cost or market.
The time from origination to sale may take up to three months due to
administrative requirements. During this time period the Bank will be exposed to
price adjustments as a result of fluctuations in market interest rates.
5
The Bank structures mortgage-backed securities with loans from its own loan
portfolio for use in collateralized borrowing arrangements. In exchange for the
improvement in credit risk when the mortgage-backed securities are formed,
guarantee fees are paid to the Federal Home Loan Mortgage Corporation ("FHLMC")
or the Federal National Mortgage Association ("FNMA"). No loans were converted
into mortgage-backed securities in 1998, 1997 or 1996. All loans underlying
mortgage-backed securities were originated by the Bank. Therefore,
mortgage-backed securities generally have the same experience with respect to
prepayment, repayment, delinquencies and other factors as the remainder of the
Bank's portfolio.
The portfolio of mortgage-backed securities was recorded at fair value as
of December 31, 1998, 1997 and 1996. Negative fair value adjustments of $413
thousand, $78 thousand and $4.1 million, net of taxes, were recorded in
stockholders' equity at December 31, 1998, 1997 and 1996, respectively.
The Bank serviced $424.9 million in loans for other investors as of
December 31, 1998. $203.0 million of these loans were sold under recourse
arrangements. The Bank has an additional $17.6 million in loans that were formed
into mortgage-backed securities with recourse features, but were still owned by
the Bank as of December 31, 1998. Due to regulatory requirements, the Bank
maintains capital for loans sold with recourse as if those loans had not been
sold. The Bank had been active in these types of transactions in the past, but
has not entered into any new recourse arrangements since 1989 when a change in
the capital regulations took effect. Loans sold with recourse are considered
along with the Bank's own loans in determining the adequacy of general loan
valuation allowances. The decrease in the principal balance of loans sold with
recourse to $203.0 million at the end of 1998 from $218.1 million at the end of
1997 and $230.8 million at the end of 1996 was due to loan amortization, payoffs
and foreclosures.
Interest Rates, Terms and Fees. The Bank makes adjustable mortgage loans
("AMLs") with 30 and 40 year terms and interest rates which adjust each month
based upon the Federal Home Loan Bank's Eleventh District Cost of Funds Index
("Index"). (See "Asset-Liability Management" in "Management's Discussion and
Analysis of Financial Condition and Results of Operations.") While the monthly
payment adjusts annually, the maximum annual change in the payment is limited to
7.5%. Any additional interest due as a result of a rising Index is added to the
principal balance of the loan ("negative amortization"). Payments are adjusted
every five years without regard to the 7.5% limitation to provide for full
amortization during the balance of the loan term. Although the interest rates
are adjusted monthly, these loans have maximum interest rates which can be
charged ranging from 400 to 750 basis points above their initial interest rate.
Generally, these loans may be assumed at any time during their term provided
that the person assuming the loan meets the Bank's credit standards and enters
into a separate written agreement with the Bank. Additionally, the new borrower
is required to pay assumption fees customarily charged for similar transactions.
The Bank offers two primary AML products based on the Index, the "AML IIC"
and the "AML IID." The initial interest rate on the AML IIC is below-market for
the first three months of the loan term. The AML IID has no below-market initial
interest rate but starts with a pay rate similar to the AML IIC. This results in
immediate negative amortization but allows the loan to earn at the fully indexed
interest rate immediately. The difference in negative amortization on these two
products is minor. The Bank also originates adjustable rate loans based on the
one year U.S. Treasury and LIBOR rates.
Under current portfolio loan programs, the Bank normally lends no more than
90% of a single family property's appraised value at the time of loan
origination. In addition, the Bank has special Community Reinvestment Act loan
programs in which it lends up to 95%.
The Bank generally requires that borrowers obtain private mortgage
insurance on loans in excess of 80% of the appraised property value. On certain
loans originated for the portfolio, the Bank charges premium rates and/or fees
in exchange for waiving the insurance requirement. Management believes that the
additional rates and fees charged on these loans compensate the Bank for the
additional risks associated with this type of loan. Subsequent to the
origination of a portfolio loan, the Bank may purchase private mortgage
insurance with its own funds. Under certain of these mortgage insurance
programs, the Bank acts as co-insurer and participates with the insurer in
absorbing any future loss. As of December 31, 1998 and 1997, loans which had
co-insurance totaled $206.5 million and $219.9 million, respectively. Loans over
80% loan-to-value, for which there was no private mortgage insurance, totaled
$265.0 million
6
at December 31, 1998 compared to $163.8 million at December 31, 1997 and $122.5
million at December 31, 1996.
Because AML loan-to-value ratios may increase above those established at
the time of loan origination due to negative amortization, the Bank rarely lends
in excess of 90% of the appraised value on AMLs. When the Bank does lend in
excess of 90% of the appraised value, additional fees and higher rates are
charged, and there is no below market initial interest rate. The amount of
negative amortization recorded by the Bank increases during periods of rising
interest rates. As of December 31, 1998, negative amortization on all loans
serviced by the Bank was immaterial.
Although regulations permit a maximum amortization period of 40 years for
real estate secured home loans and 30 years for other real estate loans, the
majority of the Bank's real estate loans provide for a maximum amortization term
of 30 years or less. Loans with 40-year terms constituted 4% and 11% of loan
originations during 1998 and 1997, respectively.
The following table shows the contractual remaining maturities of the
Bank's loans at December 31, 1998:
Loan Maturity Analysis
Maturity Period
----------------------------------------------------------------------------------------
>1 Year
Total 1 Year To 5 >5-10 >10-20 >20-30 >30
Balance or Less Years Years Years Years Years
---------- ---------- ---------- ---------- ---------- ---------- ----------
(Dollars In Thousands)
Interest rate sensitive loans:
AMLs ........................ $2,854,657 $ 73,254 $ 216,705 $ 373,668 $1,247,872 $ 864,220 $ 78,938
Fixed-rate loans:
1st mortgages .............. 30,683 3,781 6,591 6,463 6,600 7,248 --
2nd mortgages .............. 377 340 14 23 -- -- --
Consumer and other loans ... 6,807 825 3,183 601 2,198 -- --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total ....................... $2,892,524 $ 78,200 $ 226,493 $ 380,755 $1,256,670 $ 871,468 $ 78,938
========== ========== ========== ========== ========== ========== ==========
Non-accrual, Past Due, Impaired and Restructured Loans
The Bank establishes allowances for delinquent interest equal to the amount
of accrued interest on all loans 90 days or more past due or in foreclosure.
This practice effectively places such loans on non-accrual status for financial
reporting purposes.
The following is a summary of non-accrual loans for which delinquent
interest allowances had been established as of the end of each of the periods
indicated:
% of % of % of % of % of
1998 Total 1997 Total 1996 Total 1995 Total 1994 Total
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(Dollars In Thousands)
Non-accrual Loans:
Single family ............. $12,270 42% $16,799 49% $25,602 35% $25,991 26% $13,041 14%
Multi-family .............. 13,005 44 15,785 46 44,754 62 69,579 70 60,213 64
Commercial ................ 4,040 14 1,533 5 2,223 3 3,313 4 20,986 22
Other ..................... -- -- -- -- -- -- 220 -- 245 --
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total Non-accrual
Loans ................. $29,315 100% $34,117 100% $72,579 100% $99,103 100% $94,485 100%
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
The allowance for delinquent interest, based on loans past due more than 90
days or in foreclosure, totaled $1.9 million, $1.8 million, $4.2 million, $5.6
million and $5.2 million at December 31, 1998, 1997, 1996, 1995 and 1994,
respectively.
The Bank's modified loans result primarily from temporary modifications of
principal and interest payments. Under these arrangements, loan terms are
typically reduced to no less than a monthly interest payment required under the
note. If the borrower is unable to return to scheduled principal and interest
payments at the end of the modification period, foreclosure proceedings are
initiated or the modification period may be extended. As of December 31, 1998,
the Bank had modified loans totaling $11.0 million, net of loan loss allowances
of $3.3 million. This compares with $16.7 million, net of loan loss allowances
7
of $4.1 million as of December 31, 1997. No modified loans were 90 days or more
delinquent as of December 31, 1998 or December 31, 1997. Modified loans 90 days
or more delinquent as of December 31, 1996 were $472 thousand.
Statement of Financial Accounting Standards No. 114, "Accounting by
Creditors for Impairment of a Loan" ("SFAS No. 114"), requires the measurement
of impaired loans based on the present value of expected future cash flows
discounted at the loan's effective interest rate, or at the loan's observable
market price or at the fair value of its collateral. SFAS No. 114 does not apply
to large groups of homogeneous loans that are collectively reviewed for
impairment. For the Bank, loans collectively reviewed for impairment include all
single family loans less than $500 thousand and multi-family loans less than
$750 thousand.
Pursuant to SFAS No. 114, a loan is considered to be impaired when
management believes that it is probable that the Bank will be unable to collect
all amounts due under the contractual terms of the loan. Estimated impairment
losses are recorded as separate valuation allowances and may be subsequently
adjusted based upon changes in the measurement of impairment. Impaired loans,
which are disclosed net of valuation allowances, include non-accrual major loans
(single family loans with an outstanding principal amount greater than or equal
to $500 thousand and multi-family and commercial real estate loans with an
outstanding principal amount greater than or equal to $750 thousand), modified
loans, and major loans less than 90 days delinquent in which full payment of
principal and interest is not expected to be received.
Valuation allowances for impairment totaled $7.6 million, $9.8 million
$12.4 million as of December 31, 1998, 1997 and 1996, respectively. The
following is a summary of impaired loans, net of valuation allowances for
impairment, for the periods indicated:
December 31, December 31, December 31,
1998 1997 1996
------- ------- -------
(Dollars In Thousands)
Non-accrual loans .............. $ 5,934 $ 8,260 $20,052
Modified loans ................. 5,976 8,090 9,728
Other impaired loans ........... 5,613 9,335 7,854
------- ------- -------
$17,523 $25,685 $37,634
======= ======= =======
When a loan is considered impaired, the Bank measures impairment based on
the present value of expected future cash flows (over a period not to exceed 5
years) discounted at the loan's effective interest rate. However, if the loan is
"collateral-dependent" or a probable foreclosure, impairment is measured based
on the fair value of the collateral. When the measure of an impaired loan is
less than the recorded investment in the loan, the Bank records an impairment
allowance equal to the excess of the Bank's recorded investment in the loan over
its measured value. All impaired loans as of December 31, 1998 had valuation
allowances established. As of December 31, 1997 and December 31, 1996 impaired
loans totaling $2.5 million and $4.1 million, respectively, had no valuation
allowances established. The following summary details impaired loans measured
using the present value of expected future cash flows discounted at the
effective interest rate of the loan and impaired loans measured using the fair
value method for the periods indicated:
December 31, December 31, December 31,
1998 1997 1996
------- ------- -------
(Dollars In Thousands)
Present value method ........... $ 1,067 $ 1,067 $ 2,992
Fair value method .............. 16,456 24,618 34,642
------- ------- -------
Total impaired loans ........... $17,523 $25,685 $37,634
======= ======= =======
8
The present value of an impaired loan's expected future cash flows will
change from one reporting period to the next because of the passage of time and
also may change because of revised estimates in the amount or timing of those
cash flows. The Bank records the entire change in the present value of the
expected future cash flows as an impairment valuation allowance, which may
necessitate an increase in the provision for loan losses. Similarly, the fair
value of the collateral of an impaired collateral-dependent loan may change from
one reporting period to the next. The Bank also records a change in the measure
of these impaired loans as an impairment valuation allowance, which may
necessitate an adjustment to the provision for loan losses.
The following is an analysis of the activity in the Bank's valuation
allowance for impaired loans during the periods indicated (dollars in
thousands):
Balance at December 31, 1995 ...................... $ 26,101
Provision for loan losses ...................... 11,387
Net charge-offs ................................ (25,138)
--------
Balance at December 31, 1996 ...................... 12,350
Provision for loan losses ...................... 7,345
Net charge-offs ................................ (9,920)
--------
Balance at December 31, 1997 ...................... 9,775
Provision for loan losses ...................... 640
Net charge-offs ................................ (2,781)
--------
Balance at December 31, 1998 ...................... $ 7,634
========
Cash payments received from impaired loans are recorded in accordance with
the contractual terms of the loan. The principal portion of the payment is used
to reduce the principal balance of the loan, whereas the interest portion is
recognized as interest income.
The average recorded investment in impaired loans during 1998, 1997 and
1996 was $17.5 million, $24.5 million and $52.7 million, respectively. The
amount of interest income recognized from impaired loans during 1998, 1997 and
1996 was $1.3 million, $1.9 million and $2.7 million, respectively, under the
cash basis method of accounting. Interest income recognized under the accrual
basis method of accounting for 1998, 1997 and 1996 totaled $1.3 million, $1.9
million and $2.5 million, respectively.
The table below shows the Bank's net investment in non-accrual loans
determined to be impaired, by property type, as of the periods indicated:
December 31, December 31, December 31,
1998 1997 1996
------- ------- -------
(Dollars In Thousands)
Single family ........... $ -- $ 856 $ 2,002
Multi-family ............ 5,456 6,893 17,417
Commercial .............. 478 511 633
------- ------- -------
$ 5,934 $ 8,260 $20,052
======= ======= =======
Loan Loss Experience Summary. The Bank maintains a general valuation
allowance to absorb possible future losses that may be realized on its loan
portfolio. The allowance is reviewed and adjusted at least quarterly based upon
a number of factors, including asset classifications, economic trends, industry
experience, industry and geographic concentrations, estimated collateral values,
management's assessment of credit risk inherent in the portfolio, historical
loss experience and the Bank's underwriting practices.
9
The following is an analysis of the activity in the Bank's general loan
valuation allowance for the periods indicated:
Year Ended December 31,
----------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars In Thousands)
Beginning General Loan Valuation
Allowance ................................... $ 61,237 $ 54,900 $ 42,876 $ 55,353 $ 46,900
Provision for Loan Losses ..................... 6,560 13,155 23,768 6,958 53,175
Charge-Offs, Net of Recoveries:
Single Family ............................... (1,497) (5,633) (8,845) (6,040) (16,127)
Multi-Family ................................ 1,354 2,341 (2,448) (13,676) (19,800)
Commercial .................................. (32) 482 240 851 (664)
Non-Real Estate ............................. 16 226 9 (67) (180)
-------- -------- -------- -------- --------
Total Net Charge-Offs ....................... (159) (2,584) (11,044) (18,932) (36,771)
-------- -------- -------- -------- --------
Transfer to Liability Account for
Loans Sold with Recourse .............. -- (4,234) -- (503) (7,948)
Transfer to Real Estate General
Valuation Allowance ......................... -- -- (700) -- --
-------- -------- -------- -------- --------
Ending General Loan Valuation
Allowance ............................. $ 67,638 $ 61,237 $ 54,900 $ 42,876 $ 55,356
======== ======== ======== ======== ========
The Bank also maintains a valuation allowance for loans sold with recourse,
which is included in Other Liabilities in the Company's Statement of Financial
Condition. The activity in the general valuation allowance for loans sold with
recourse for 1998, 1997, 1996, 1995 and 1994 is presented below (dollars in
thousands):
Balance at December 31, 1994 ........................ $ 7,948
Provision for losses ................................ 2,123
Transfer from general valuation allowance ........... 503
Net charge-offs ..................................... (1,524)
--------
Balance at December 31, 1995 ........................ 9,050
Net charge-offs ..................................... (652)
--------
Balance at December 31, 1996 ........................ 8,398
Transfer from general valuation allowance ........... 4,234
Net recoveries ...................................... 397
--------
Balance at December 31, 1997 ........................ 13,029
Net charge-offs ..................................... (483)
--------
Balance at December 31, 1998 ........................ $ 12,546
========
In years prior to 1994, the valuation allowance for loans sold with
recourse was included in the general valuation allowance for loans. The balance
of such valuation allowance as of December 31, 1993 was $6.2 million.
The Bank's total general valuation allowance for loans (including general
valuation allowances for loans sold with recourse) was 2.51% of total assets
with loss exposure (including loans sold with recourse) at December 31, 1998,
2.12% at December 31, 1997 and 1.86% at December 31, 1996. Depending on the
economy and real estate markets in which the Bank operates, increases in the
general valuation allowance may be required in future periods. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank's general valuation allowance. These agencies may
require the Bank to establish additional general valuation allowances based on
their judgment of the information available at the time of their examination.
10
The following table details the general valuation allowance by loan type
for the periods indicated, including the general valuation allowance for loans
sold with recourse:
% of % of % of % of % of
1998 Total 1997 Total 1996 Total 1995 Total 1994 Total
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(Dollars In Thousands)
Real Estate Loans:
Single Family ....... $27,611 34% $21,583 29% $15,355 24% $ 8,887 17% $ 6,938 11%
Multi-Family ........ 47,264 59 45,029 61 44,078 70 35,278 68 50,018 79
Commercial .......... 5,247 7 6,658 9 3,587 6 7,529 15 6,170 10
Non-Real Estate Loans 62 -- 996 1 278 -- 232 -- 175 --
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total ............... $80,184 100% $74,266 100% $63,298 100% $51,926 100% $63,301 100%
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Net loan charge-offs, including net charge-offs from the general valuation
allowance, impaired allowance, and the general valuation allowance for loans
sold with recourse totaled $3.4 million, $12.1 million, $37.5 million, $39.7
million and $45.4 million for 1998, 1997, 1996, 1995 and 1994, respectively,
representing 0.09%, 0.39%, 1.21%, 1.28% and 1.58% of the average loan portfolio
for such periods. Charge-offs have improved due to the improvement in the
Southern California economy and real estate market.
Any increase in charge-offs would adversely impact the Company's future
loan loss provisions and earnings.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Asset Quality Ratios" for an analysis of the Bank's
general valuation allowances as a percentage of non-accrual loans, the total
loan portfolio and total loans with loss exposure.
Potential Problem Loans. The Bank also had $16.6 million, $41.6 million and
$44.0 million in potential problem real estate loans as of December 31, 1998,
December 31, 1997 and December 31, 1996, respectively. These are loans which do
not meet the criteria of impaired or non-performing loans but have displayed
some past or present weakness. If the weakness is not corrected, the loan could
eventually result in a loss to the Bank.
The Bank's Asset Classification Committee meets at least quarterly to
review and monitor the condition of the loan portfolio. Additionally, a special
workout group of the Bank's officers meets at least monthly to resolve
delinquent loan situations and to initiate actions enforcing the Bank's rights
in security properties pending foreclosure and liquidation.
Non-performing Assets. For a further discussion of non-performing assets,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Non-Performing Assets."
Generally, loans greater than 60 days delinquent are placed into
foreclosure and a valuation allowance is established, if necessary. The Bank
acquires title to the property in most foreclosure actions in which the loan is
not reinstated by the borrower. Once real estate is acquired in settlement of a
loan, the property is recorded at fair value less estimated costs to sell.
Following the acquisition of foreclosed real estate ("REO"), the Bank
evaluates the property and establishes a plan for marketing and disposing of the
property. After inspecting the property, the Bank determines whether the
property may be disposed of in its present condition or if repairs,
rehabilitation or improvements are necessary.
11
The following table provides information regarding the Bank's REO activity
for the periods indicated:
Real Estate Owned Activity
Year Ended December 31,
------------------------------------------
1998 1997 1996
-------- -------- --------
(Dollars In Thousands)
Beginning Balance ........... $ 10,218 $ 14,331 $ 19,701
Additions ................... 17,096 49,150 74,886
Sales ....................... (22,559) (53,263) (80,256)
-------- -------- --------
Ending Balance .............. $ 4,755 $ 10,218 $ 14,331
======== ======== ========
Other Interest-Earning Assets. The Bank owned no contractually delinquent
interest-earning assets other than loans as of December 31, 1998.
Investment Activities
Savings institutions are required by federal regulations to maintain a
minimum ratio of liquid assets which may be invested in certain government and
other specified securities. This level is adjusted from time to time in response
to prevailing economic conditions and as a means of controlling the amount of
available mortgage credit. At December 31, 1998, the regulatory liquidity
requirement was 4.00% and the Bank's liquidity percentage was 5.38%.
It is the Bank's policy to maintain liquidity investments at a modest level
and to use available cash to originate mortgages which normally command higher
yields. Therefore, interest income on investments generally represents less than
5% of total revenues.
The following table summarizes the total investment portfolio at historical
cost by type at the end of the periods indicated:
December 31,
--------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars In Thousands)
U.S. Treasury Securities .................. $ 300 $ 300 $ 301 $ 301 $ 4,205
U.S. Agency Securities .................... 28,156 48,142 49,989 46,561 36,565
Collateralized Mortgage
Obligations ("CMOs") ..................... 36,380 1,009 8,776 29,874 43,282
-------- -------- -------- -------- --------
64,836 49,451 59,066 76,736 84,052
Unrealized loss on
securities available-for-sale ............ (503) (541) (157) (552) --
-------- -------- -------- -------- --------
$ 64,333 $ 48,910 $ 58,909 $ 76,184 $ 84,052
======== ======== ======== ======== ========
Weighted average yield on
interest-earnings invest-
ments end of period ...................... 5.38% 5.17% 5.98% 5.15% 5.08%
======== ======== ======== ======== ========
12
The following is a summary of the maturities of investment securities at
historical value as of December 31, 1998:
Maturity
-----------------------------------------------------------------------------------------------
Total Historical
Within 1 Year 1-5 Years Value
-------------------- ------------------------ -----------------------------------------
Weighted Weighted Weighted Average
Average Average Average Maturity
Amount Yield Amount Yield Amount Yield Yrs/Mos
------- ------- ------- ------ ------- ------ -------
(Dollars In Thousands)
U.S. Treasury
Securities ................... $ -- --% $ 300 5.79% $ 300 5.79% 2/7
U.S. Agency Securities ........ -- -- 28,156 4.51 28,156 4.51 4/11
------- ------- -------
$ -- $28,456 4.52 $28,456 5.17 4/11
======= ======= =======
The Bank's CMOs all have expected maturities within five years.
Sources of Funds
General. The Bank's principal sources of funds are savings deposits,
advances from the Federal Home Loan Bank of San Francisco ("FHLBSF") and
securities sold under agreements to repurchase.
Deposits. The Bank obtains deposits through three different sources: 1) its
retail branch system, 2) phone solicitations by designated employees, and 3)
national brokerage firms.
Deposits acquired through telemarketing efforts are typically placed with
the Bank by professional money managers and represented 5%, 5% and 6% of total
deposits at December 31, 1998, 1997 and 1996, respectively. The level of
telemarketing deposits varies based on yields available to depositors on other
investment instruments and the depositors' perception of the Bank's
creditworthiness.
Deposits acquired through national brokerage firms represented 23%, 20% and
20% of total deposits at December 31, 1998, 1997 and 1996, respectively. Any
fees paid to deposit brokers are amortized over the term of the deposit. Based
on historical renewal percentages, management believes that these deposits are a
stable source of funds. Institutions meeting the regulatory capital standards
necessary to be deemed well-capitalized are not required to obtain a waiver from
the FDIC in order to accept brokered deposits. See "Management's Discussion and
Analysis - Capital Resources and Liquidity."
Deposits obtained through the retail branch system were $1.5 billion at
December 31, 1998, 1997 and 1995. Retail deposits comprised 72% of total
deposits at December 31, 1998, 75% of total deposits at December 31, 1997 and
74% at December 31, 1996. The level of deposits has remained stable over the
last three years due to increased competition for retail savings deposits in
Southern California. In order to increase fee income at the retail branches and
decrease interest costs, the Bank's retail deposit marketing efforts have been
concentrated on obtaining demand deposit accounts over the last several years.
The Bank operated 24 retail branches at the end of 1998.
The following table shows the average balances and average rates paid on
deposits by deposit type for the periods indicated:
During the Year Ended December 31,
------------------------------------------------------------------------------
1998 1997 1996
----------------------- ---------------------- ----------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
---------- -------- ---------- -------- ---------- --------
(Dollars In Thousands)
Passbook Accounts .............................. $ 84,711 2.04% $ 83,958 2.06% $ 94,858 2.02%
Money Market Deposit Accounts .................. 251,866 3.89 138,764 3.16 125,722 2.61
Interest-bearing Checking Accounts ............. 102,367 1.04 111,246 1.00 142,487 0.96
Fixed Term Certificate Accounts ................ 1,682,080 5.06 1,638,892 5.22 1,772,621 5.36
---------- ---------- ----------
$2,121,024 4.61% $1,972,860 4.70% $2,135,688 4.76%
========== ========== ==========
13
The following table shows the maturity distribution of jumbo certificates
of deposit ($100,000 and greater) as of December 31, 1998 (dollars in
thousands):
Maturing in:
1 month or less ................................ $ 82,648
Over 1 month to 3 months ....................... 93,045
Over 3 months to 6 months ...................... 76,723
Over 6 months to 12 months ..................... 67,170
Over 12 months ................................. 1,265
--------
Total ...................................... $320,851
========
Based on historical renewal percentages at maturity, management believes
that jumbo certificates of deposit are a stable source of funds. For additional
information with respect to deposits, see Note 8 of the Notes to Consolidated
Financial Statements.
The following tables set forth information regarding the amount of deposits
in the various types of savings programs offered by the Bank at the end of the
years indicated and the average balances and rates for those years:
December 31,
---------------------------------------------------------------------------------------
1998 1997 1996
------------------------- ------------------------- -------------------------
Amount % Amount % Amount %
---------- ---------- ---------- ---------- ---------- ----------
(Dollars In Thousands)
Variable rate non-term accounts:
Money market deposit accounts
(weighted average rate of 3.91%,
3.36% and 2.82%) ...................... $ 293,159 14% $ 156,221 8% $ 130,173 7%
Interest-bearing checking accounts
(weighted average rate of 1.06%
1.78% and 1.01%) ...................... 108,211 5 130,765 7 165,616 8
Passbook accounts (2.01%, 2.04%
and 2.04%) ............................ 84,132 4 86,547 4 94,718 5
Non-interest bearing checking
accounts .............................. 137,822 6 112,373 6 40,404 2
---------- ---------- ---------- ---------- ---------- ---------
623,324 29 485,906 25 430,911 22
---------- ---------- ---------- ---------- ---------- ---------
Fixed term rate certificate accounts:
Under six month term (weighted
average rate of 4.18%, 5.07%
and 5.11%) .......................... 62,642 3 120,637 6 160,430 8
Six month term (weighted average
rate of 5.14%, 6.00% and 5.69%) ....... 301,313 14 103,901 5 204,048 10
Nine month term (weighted average of
5.42%, 5.64% and 5.45%)................ 438,443 21 374,259 19 246,777 13
One year to 18 month term (weighted
average rate of 5.14%, 5.53% and
5.32%) ................................ 263,291 12 348,941 18 304,532 16
Two year or 30 month term (weighted
average rate of 5.28%, 5.23% and
5.32%) ............................... 23,015 1 30,689 2 40,498 2
Over 30 month term (weighted
average rate of 5.79%, 5.85%
and 6.27%) ........................... 103,030 5 125,971 7 202,724 10
Negotiable certificates of $100,000
and greater, 30 day to one year terms
(weighted average rate of 5.08%,
5.50% and 5.39%) ..................... 320,851 15 353,343 18 367,528 19
---------- ---------- ---------- ---------- ---------- ---------
1,512,585 71 1,457,741 75 1,526,537 78
---------- ---------- ---------- ---------- ---------- ---------
Total deposits (weighted average
rate of 4.36%, 4.66% and 4.67%) ....... $2,135,909 100% $1,943,647 100% $1,957,448 100%
========== ========== ========== ========== ========== =========
14
The cost of funds, operating margins and net earnings of the Bank
associated with brokered and telemarketing deposits are generally comparable to
the cost of funds, operating margins and net earnings of the Bank associated
with retail deposits, Federal Home Loan Bank ("FHLB") borrowings and securities
sold under agreements to repurchase. As the cost of each source of funds
fluctuates from time to time, the Bank seeks funds from the lowest cost source
until the relative costs change. As the costs of funds, operating margins and
net earnings of the Bank associated with each source of funds are generally
comparable, the Bank does not deem the impact of a change in incremental use of
any one of the specific sources of funds at a given time to be material.
Borrowings. The FHLB System functions as a source of credit to financial
institutions which are members of a regional Federal Home Loan Bank. The Bank
may apply for advances from the FHLBSF secured by the FHLBSF capital stock owned
by the Bank, certain of the Bank's mortgages and other assets (principally
obligations issued or guaranteed by the United States government or agencies
thereof). Advances can be requested for any sound business purpose which an
institution is authorized to pursue. Any institution not meeting the qualified
thrift lender test will be subject to restrictions on its ability to obtain
advances from the FHLBSF. See "Summary of Material Legislation and Regulation -
Qualified Thrift Lender Test." In granting advances, the FHLBSF also considers a
member's creditworthiness and other relevant factors.
Total advances from the FHLBSF were $714 million at December 31, 1998 at a
weighted average rate of 5.43%. This compares with advances of $1.3 billion at
December 31, 1997 and $1.2 billion at December 31, 1996 at weighted average
rates of 5.80% and 5.71%, respectively. The level of FHLB borrowings was
decreased during 1998 due to the availability of lower cost sources of funds and
increased cash flows from loan payoffs. The Bank has credit availability with
the FHLBSF which allows it to borrow up to 40% of the Bank's assets or
approximately $1.5 billion at December 31, 1998.
The Bank enters into sales of securities under agreements to repurchase
(reverse repurchase agreements) which require the repurchase of the same
securities. The agreements are treated as borrowings in the Company's
Consolidated Statements of Financial Condition. There are certain risks involved
with doing these types of transactions. In order to minimize these risks, the
Bank's policy is to enter into agreements only with well-known national
brokerage firms which meet their regulatory capital requirements. Borrowings
under reverse repurchase agreements totaled $471.2 million at December 31, 1998
at a weighted average rate of 5.37% and were secured by mortgage-backed
securities with principal balances totaling $490.4 million. Borrowings under
reverse repurchase agreements totaled $577.7 million at December 31, 1997 and
$646.5 million at December 31, 1996 at weighted average rates of 5.66% and
5.42%, respectively.
The Company has $50 million in 10-year senior unsecured notes ("Notes") due
in September of 2004. The Notes are interest only, with an interest rate of
11.75% and are due October 2004. The $47.8 million in net proceeds were
contributed to the Bank as capital. The Notes are governed by the terms of an
indenture dated September 28, 1994 (the "Indenture"). The Indenture contains
financial and operating covenants which, among other things, (i) limit the
incurrence of debt by the Company, (ii) limit the payment of dividends and the
making of certain other distributions by the Company and its subsidiaries,
including the Bank, (iii) limit the disposition of, and the existence of liens
on, the stock of the Company's subsidiaries, (iv) limit the existence of certain
liens on other property or assets of the Company and (v) limit the ability of
the Company to enter into certain transactions with affiliates. Management does
not believe that these covenants impair the Bank's activities in the ordinary
course of business. The amount of annual interest due on the Notes is $5.9
million. The Notes are callable beginning October 1, 1999 at a premium of
5.875%. The premium is reduced each year until October 1, 2002 when there is no
premium. The Company is solely dependent upon the Bank's ability to pay
dividends to provide funds for meeting the interest due on these Notes. See
"Summary of Material Legislation and Regulations" for a discussion of regulatory
restrictions on dividends and other capital distributions.
Borrowings from all sources totaled $1.2 billion, $1.9 billion and $1.9
billion at weighted average rates of 5.66%, 5.91% and 5.77% at December 31,
1998, 1997 and 1996, respectively. The Bank reduced its borrowings during 1998
due to increased cash flows from loan payoffs.
15
The Bank's portfolio of short term borrowings includes short-term variable
rate credit advances and FHLB advances due in less than one year from the
FHLBSF, securities sold under agreements to repurchase and other short term
borrowings. The following schedule summarizes short term borrowings for the last
three years:
Maximum
Month-End
Outstanding
End of Period Balance Average Period
------------------------- During the -------------------------
Outstanding Rate Period Outstanding Rate
----------- -------- ---------- ----------- --------
(Dollars In Thousands)
1998
Short term FHLB Advances ..................... $ 200,000 5.57% $1,035,000 $ 554,167 5.70%
Securities sold under agreements to repurchase 471,172 5.37 576,514 514,498 5.55
Other short term borrowings .................. -- -- 5,500 3,250 5.73
1997
Short term variable rate credit advances ..... $ -- --% $ -- $ 600 6.01%
Short term FHLB Advances ..................... 1,310,000 5.80 1,345,000 1,170,417 5.75
Securities sold under agreements to repurchase 577,670 5.66 634,976 607,479 5.60
Other short term borrowings .................. 4,000 5.85 26,500 15,703 5.63
1996
Short term variable rate credit advances ..... $ 32,000 7.33% $ 32,000 $ 87 7.33%
Short term FHLB Advances ..................... 980,000 5.69 1,140,000 896,250 5.74
Securities sold under agreements to repurchase 646,482 5.42 715,465 678,420 5.40
Other short term borrowings .................. 2,000 5.53 22,900 15,802 5.55
Other Sources
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Sources of Funds" for a discussion of other funding
sources.
Subsidiaries
The Bank has three wholly-owned subsidiaries: Seaside Financial Corporation
("Seaside"), Oceanside Insurance Agency, Inc. ("Oceanside"), and Santa Monica
Capital Group ("SMCG"), all of which are California corporations.
As of December 31, 1998, the Bank had invested an aggregate of $514
thousand (primarily equity) in Seaside, Oceanside and SMCG. Revenues and
operating results of these subsidiaries accounted for less than 1% of
consolidated revenues in 1998 and no material change is presently foreseen. For
the past several years, only Seaside and Oceanside have been active.
Real Estate Development Activities. Seaside has not been involved in any
real estate development activity for the last several years and there are no
plans for future real estate projects. Therefore, no gains or losses on real
estate development activities were recorded during 1998, 1997 or 1996.
Seaside continues to hold one condominium unit which is rented to the Bank
for use by its employees. In 1997, a condominium, rented to the Bank, was sold.
At December 31, 1998, Seaside's investment in the remaining unit totaled $36
thousand. There were no loans outstanding against the property at December 31,
1998. The unit is located in Southern California.
Trustee Activities. Seaside acts as trustee on the Bank's deeds of trust.
Trustee fees for this activity amounted to $274 thousand, $494 thousand and $695
thousand in 1998, 1997 and
16
1996, respectively. The decrease in trustee fees over the last three years is
consistent with the decrease in loan foreclosure activity.
Insurance Brokerage Activities. Oceanside engages in limited insurance
agent activities. Income to date from this source has been insignificant. In
1996, Oceanside began operating as a licensed life insurance agent for the
purpose of receiving commissions on the sale of fixed and variable rate
annuities and mutual funds conducted in the Bank's offices by a licensed third
party vendor. Independent Financial Securities, Inc. ("IFS"), a registered
broker-dealer, conducts its sales activities in the Bank's branch offices and
the Bank receives a percentage of the commissions on such sales through its
licensed insurance agency, Oceanside. During 1998, 1997 and 1996, Oceanside
received commission income of $263 thousand, $462 thousand and $428 thousand,
respectively, from the sale of non-insured investment products by IFS.
Employees
As of December 31, 1998, the Bank had a total of 475 full time equivalent
employees, including 118 part-time employees. No employees were represented by a
collective bargaining group. At present, the Company has no employees who are
not also employees of the Bank. The Bank provides its regular full-time
employees with a comprehensive benefits program that includes basic and major
medical insurance, long-term disability coverage, sick leave, a 401(k) plan and
a profit sharing employee stock ownership plan. The Bank considers its employee
relations to be excellent.
Summary of Material Legislation and Regulations
General. FFC, as a savings and loan holding company, is registered with,
and subject to regulation and examination by, the Office of Thrift Supervision
("OTS"). The Bank, which is a federally chartered savings bank and a member of
the FHLBSF, is subject to regulation and examination by the OTS with respect to
most of its business activities, including, among others, lending activities,
capital standards, general investment authority, deposit taking and borrowing
authority, mergers and other business combinations, establishment of branch
offices, and permitted subsidiary investments and activities. The Bank's
deposits are insured by the FDIC through the SAIF. As insurer, the FDIC is
authorized to conduct examinations of the Bank. The Bank is also subject to
Federal Reserve Board regulations concerning reserves required to be maintained
against deposits.
As a member of the FHLB System, the Bank is required to own capital stock
in its regional FHLB, the FHLBSF, in an amount at least equal to the greater of
1% of the aggregate principal amount of its unpaid residential mortgage loans,
home purchase contracts and similar obligations at the end of each year, or 5%
of its outstanding borrowings from the FHLBSF. The Bank was in compliance with
this requirement, with an investment of $72.7 million in FHLBSF stock at
December 31, 1998.
The FHLBSF serves as a source of liquidity for the member institutions
within its assigned region, the FHLB Eleventh District. It is funded primarily
from proceeds derived from the sale of consolidated obligations of the FHLB
System. It makes advances to members in accordance with policies and procedures
established by the Federal Housing Finance Board and the Board of Directors of
the FHLBSF. At December 31, 1998, the Bank's advances from the FHLBSF amounted
to $714.0 million, or 21% of the Company's total funding sources (deposits and
borrowings).
The FHLBs provide funds for the resolution of troubled savings institutions
and are required to contribute to affordable housing programs through direct
loans or interest subsidies on advances targeted for community investment and
low and moderate income housing projects. These contributions have adversely
affected the level of dividends that the FHLBs have paid to its members. These
contributions also could have an adverse effect on the value of FHLB stock in
the future. For the year ended December 31, 1998, dividends paid by the FHLBSF
to the Bank totaled approximately $4.2 million.
Savings and Loan Holding Company Regulations. The activities of savings and
loan holding companies are governed by the Home Owners' Loan Act, as amended.
Pursuant to that statute, the Company is subject to certain restrictions with
respect to its activities and investments.
17
A savings and loan holding company, like FFC, which controls only one
savings association, is exempt from restrictions on the conduct of unrelated
business activities that are applicable to savings and loan holding companies
that control more than one savings association. The restrictions on multiple
savings and loan holding companies are similar to the restrictions on the
conduct of unrelated business activities applicable to bank holding companies
under the Bank Holding Company Act. The Company would become subject to these
restrictions if it were to acquire control of another savings association or if
the Bank were to fail to meet its qualified thrift lender ("QTL") test. See
"Qualified Thrift Lender Test."
The OTS may impose restrictions when it has reasonable cause to believe
that the continuation of any particular activity by a savings and loan holding
company constitutes a serious risk to the financial safety, soundness or
stability of such holding company's savings institution. Specifically, the OTS
may, as necessary, (i) limit the payment of dividends by the savings
institution; (ii) limit transactions between the savings institution and its
holding company or its affiliates; and (iii) limit any activities of the savings
institution that create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings institution. Any such
limits will be issued in the form of a directive having the effect of a
cease-and-desist order.
Regulatory Capital Requirements. The capital regulations of the OTS (the
"Capital Regulations") require the Bank to maintain "tangible capital" of at
least 1.5% of adjusted total assets, "core capital" of at least 3% of adjusted
total assets, and a "risk-based capital" ratio of at least 8%. The OTS may
establish, on a case-by-case basis, individual minimum capital requirements for
a savings institution which vary from the requirements that would otherwise
apply under the Capital Regulations.
"Tangible capital" means stockholders' equity computed in accordance with
generally accepted accounting principles less any intangible assets, less
unrealized gains, plus unrealized losses on certain "available-for-sale"
securities, plus purchased mortgage servicing rights and purchased credit card
relationships, subject to certain limitations. "Core capital" is generally
defined the same as tangible capital except that certain qualifying intangible
assets may be included. The Bank has no such qualifying intangible assets as of
December 31, 1998. The "risk-based capital" ratio is defined as the ratio of
total capital to total assets after the assets have been risk-weighted in
accordance with certain percentages developed by the OTS and the other bank
regulatory agencies. Total capital for purposes of the risk-based capital
requirements consists of core capital and supplementary capital, less cash
pledged for credit support in certain loan sales. Supplementary capital
includes, among other things, a portion of the general loan valuation allowance.
The general loan valuation allowance may generally be included in supplementary
capital up to 1.25% of risk-weighted assets. At December 31, 1998, $26.5 million
of the Bank's $67.6 million in general valuation allowances was included in
supplementary capital. Supplementary capital may be used to satisfy an
institution's risk-based capital requirement in an amount not greater than its
core capital. The Bank is considered to be "well capitalized" for purposes of
these capital measures. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Capital Resources and Liquidity - Capital
Requirements."
A savings institution which fails to meet its capital standards must submit
a capital restoration plan to the OTS District Director which describes the
manner in which the institution proposes to increase its capital and the
activities in which it will engage, and requires that any increase in its assets
be met with a commensurate increase in tangible capital and risk-based capital.
The OTS also has the authority to issue a capital directive to a savings
institution that does not satisfy its minimum capital requirements. The capital
directive may also specify corrective actions to be taken.
Insurance of Accounts. The FDIC administers two separate deposit insurance
funds. The Bank Insurance Fund ("BIF") insures the deposits of commercial banks
and other institutions which were insured by the FDIC prior to the enactment of
the Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") . The Savings Association Insurance Fund ("SAIF") insures the
deposits of savings institutions which were insured by the Federal Savings and
Loan Insurance Corporation ("FSLIC") prior to the enactment of FIRREA. The FDIC
is authorized to increase deposit insurance premiums if it determines such
increases are appropriate to maintain the reserves of either the SAIF or the BIF
or to fund the administration of the FDIC. In addition, the FDIC is authorized
to levy emergency special assessments on BIF and SAIF members.
18
The FDIC has implemented a risk-based assessment system, under which an
institution's deposit insurance assessment is based on the probability that the
deposit insurance fund will incur a loss with respect to the institution, the
likely amount of any such loss, and the revenue needs of the deposit insurance
fund. Under the risk-based assessment system, a savings institution is
categorized into one of three capital categories: well capitalized, adequately
capitalized, and undercapitalized. A savings institution is also categorized
into one of three supervisory subgroup categories based on examinations by the
OTS.
The FDIC may terminate the deposit insurance of any insured depository if
the FDIC determines, after a hearing, that the institution 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 or order or
any condition imposed in writing by the FDIC. The FDIC may also suspend deposit
insurance temporarily during the hearing process if the institution has no
tangible capital (which may be calculated under certain conditions by including
goodwill). In addition, FDIC regulations provide that any insured institution
that falls below a 2% minimum leverage ratio will be subject to FDIC deposit
insurance termination proceedings unless it has submitted, and is in compliance
with, a capital plan with its primary federal regulator and the FDIC.
The OTS also imposes assessments and examination fees on savings
institutions. OTS assessments for the Bank were $599 thousand in 1998, $610
thousand in 1997 and $611 thousand in 1996.
The SAIF was recapitalized as part of the Economic Growth and Regulatory
Paperwork Reduction Act of 1996 (the "Economic Growth Act"). This legislation
included the Deposit Insurance Funds Act of 1996 (the "DIFA") which provided for
the recapitalization of the SAIF through a special assessment levied on all
institutions that have SAIF-insured deposits.
Liquidity. Federal regulations currently require a savings institution to
maintain a monthly average daily balance of liquid assets (including cash,
certain time deposits, bankers' acceptances and specified United States
government, state or federal agency obligations) equal to at least 4% of: (i)
the average daily balance of its net withdrawable accounts and short-term
borrowings during the preceding calendar quarter or (ii) the ending balance of
its net withdrawable accounts as of the end of the preceding calendar quarter.
This liquidity requirement may be changed from time to time by the OTS to any
amount within the range of 4% to 10% of such accounts and borrowings depending
upon economic conditions and the deposit flows of member institutions. On
November 24, 1997, the OTS reduced this liquidity requirement to 4% from 5%. The
OTS also gave institutions the option of using a quarterly average calculation
or an end of quarter calculation of the liquidity base and removed the
requirement of maintaining a monthly average balance of short-term liquid assets
equal to at least 1% of the average daily balance of its net withdrawable
accounts and short term borrowings. Monetary penalties may be imposed for
failure to meet these liquidity ratio requirements. The Bank's liquidity ratio
for the quarter ended December 31, 1998 was 5.38%, which exceeded the applicable
requirements.
Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires
each savings institution, as well as commercial banks and certain other lenders,
to identify the communities served by the institution's offices and to identify
the types of credit the institution is prepared to extend within those
communities. The CRA also requires the OTS to assess an institution's
performance in meeting the credit needs of its identified communities as part of
its examination of the institution, and to take such assessments into
consideration in reviewing applications with respect to branches, mergers and
other business combinations, including acquisitions by savings and loan holding
companies. An unsatisfactory CRA rating may be the basis for denying such an
application and community groups have successfully protested applications on CRA
grounds. In connection with its assessment of CRA performance, the OTS assigns
CRA ratings of "outstanding," "satisfactory," "needs to improve" or "substantial
noncompliance." The Bank was rated "satisfactory" in its last CRA examination,
which was conducted in 1998. New CRA regulations which were enacted in late 1995
took effect starting in 1996, for examinations in 1997 and thereafter. Under the
new regulations, institutions are evaluated based on: (i) performance in lending
in their assessment areas; (ii) the provision of deposit and other community
services in their assessment areas; and (iii) the investment in housing-related
and other qualified community investments. Under the new regulations, an
institution which is found to be deficient in its performance in meeting its
community's credit needs may be subject to enforcement actions, including cease
and desist orders and civil money penalties.
19
Restrictions on Dividends and Other Capital Distributions. Savings
association subsidiaries of holding companies generally are required to provide
not less than thirty days' advance notice to their OTS District Director of any
proposed declaration of a dividend on the association's stock.
Under OTS regulations, limitations are imposed on "capital distributions"
by savings institutions, including cash dividends, payments to repurchase or
otherwise acquire its shares, payments to stockholders of another institution in
a cash-out merger and other distributions charged against capital. The
regulations, which establish a three-tiered system of regulation, establish
"safe-harbor" amounts of capital distributions that institutions can make after
providing notice to the OTS, but without needing prior approval. Institutions
can distribute amounts in excess of the safe-harbor only with the prior approval
of the OTS.
Although the OTS has never prohibited the Bank from making a capital
distribution, the OTS nevertheless retains the authority to prohibit any capital
distribution otherwise authorized under the regulations if the OTS determines
that the capital distribution would constitute an unsafe or unsound practice.
The regulations also state that the capital distribution limitations apply to
direct and indirect distributions to affiliates, including those occurring in
connection with corporate reorganizations. Moreover, the Bank would not be
permitted to pay cash dividends if it were deemed to be an "undercapitalized"
institution for purposes of the "prompt corrective action" rules. At December
31, 1998, the Bank met the standards necessary to be deemed to be "well
capitalized" for purposes of the "prompt corrective action" rules.
Limits on Types of Loans and Investments. Federal savings institutions are
authorized, without quantitative limits, to make loans on the security of liens
upon residential real property and to invest in a variety of instruments such as
obligations of, or fully guaranteed as to principal and interest by, the United
States; stock or bonds of the FHLB; certain mortgages, obligations, or other
securities which have been sold by FHLMC or FNMA; and certain securities issued
by, or fully guaranteed as to principal and interest by, the Student Loan
Marketing Association and the Government National Mortgage Association. Certain
other types of loans or investments may be acquired subject to quantitative
limits: secured or unsecured loans for commercial, corporate, business, or
agricultural purposes, loans on the security of liens upon nonresidential real
property, investments in personal property, consumer loans and certain
securities such as commercial paper and corporate debt, and construction loans
without security.
Savings institutions are subject to the same loans-to-one borrower ("LTOB")
restrictions that are applicable to national banks, with limited provisions for
exceptions. In general, the national bank standard restricts loans to a single
borrower to no more than 15% of a bank's capital and surplus, plus an additional
10% if the loan is collateralized by certain readily marketable collateral. The
Bank's loans were within the LTOB limitations at December 31, 1998.
Savings institutions and their subsidiaries are prohibited from acquiring
or retaining any corporate debt security that, at the time of acquisition, is
not rated in one of the four highest rating categories by at least one
nationally recognized statistical rating organization. The Bank has no
impermissible equity investments in its investment portfolio.
Safety and Soundness Standards. OTS regulations contain "safety and
soundness" standards covering various aspects of the operations of savings
institutions. The guidelines relate to internal controls, information systems
and internal audit systems, loan documentation, credit underwriting, interest
rate exposure, asset growth, executive compensation, maximum ratios of
classified assets to capital, and minimum earnings sufficient to absorb losses
without impairing capital. If the OTS determines that a savings institution has
failed to meet the safety and soundness standards, it may require the
institution to submit to the OTS, and thereafter comply with, a compliance plan
acceptable to the OTS describing the steps the institution will take to attain
compliance with the applicable standard and the time within which those steps
will be taken.
Federal regulations contain a number of measures intended to promote early
identification of management problems at depository institutions and to ensure
that regulators intervene promptly to require corrective action by institutions.
The Bank's annual management report on the effectiveness of internal control
standards and compliance with certain designated laws will be made available in
March of 1999.
20
Prompt Corrective Action. The "prompt corrective action" regulations
require insured depository institutions to be classified into one of five
categories based primarily upon capital adequacy, ranging from "well
capitalized" to "critically undercapitalized." These regulations require,
subject to certain exceptions, the appropriate federal banking agency to take
"prompt corrective action" with respect to an institution which becomes
"undercapitalized" and to take additional actions if the institution becomes
"significantly undercapitalized" or "critically undercapitalized."
Only "well capitalized" institutions may obtain brokered deposits without a
waiver. An "adequately capitalized" institution can obtain brokered deposits
only if it receives a waiver from the FDIC. An "undercapitalized" institution
may not accept brokered deposits under any circumstances. The Bank met the
"well-capitalized" standards during 1998 and was eligible to accept brokered
deposits without a waiver.
Qualified Thrift Lender Test. In general, the QTL test requires that 65% of
an institution's portfolio assets be invested in "qualified thrift investments"
(primarily loans, securities and other investments related to housing), measured
on a monthly average basis for nine out of every 12 months on a rolling basis.
Any savings institution that fails to meet the QTL test must either convert to a
bank charter or become subject to national bank-type restrictions on branching,
business activities, and dividends, and its ability to obtain FHLB advances is
affected. The Bank met the QTL test at December 31, 1998, with 97% of its
portfolio assets comprised of "qualified thrift investments."
Transactions with Affiliates. Federal savings institutions are subject to
the provisions of Sections 23A and 23B of the Federal Reserve Act. Section 23A
restricts loans or extensions of credit to, or investments in, or certain other
transactions with, affiliates and as to the amount of advances to third parties
collateralized by the securities or obligations of affiliates. Section 23B
generally requires that transactions with affiliates must be on a
non-preferential basis. Federal savings institutions may not make any extension
of credit to an affiliate which is engaged in activities not permitted by bank
holding companies, and may not invest in securities issued by an affiliate
(except with respect to a subsidiary). The Company is an "affiliate" of the Bank
for the purposes of these provisions.
Transactions with Insiders. Federal savings institutions are subject to the
restrictions of Sections 22(g) and (h) of the Federal Reserve Act which, among
other things, restrict the amount of extensions of credit which may be made to
executive officers, directors, certain principal shareholders (collectively
"insiders"), and to their related interests. When lending to insiders, a savings
association must follow credit underwriting procedures that are not less
stringent than those applicable to comparable transactions with persons outside
the association. The amount that a savings association can lend in the aggregate
to insiders (and to their related interests) is limited to an amount equal to
the association's core capital and surplus. Insiders are also prohibited from
knowingly receiving (or knowingly permitting their related interests to receive)
any extensions of credit not authorized under these statutes.
Federal Reserve System. Federal Reserve Board regulations require savings
institutions to maintain non-interest bearing reserves against their transaction
accounts. The reserve for transaction accounts as of December 31, 1998 was 3% of
the first $43.1 million of such accounts and 10% (subject to adjustment by the
Federal Reserve Board between 8% and 14%) of the balance of such accounts. The
Bank is in compliance with these requirements.
Taxation. The Company, the Bank and its subsidiaries file a consolidated
federal income tax return on a calendar year basis using the accrual method. The
maximum marginal federal tax rate is currently 35%.
In August 1996, the Small Business Job Protection Act (the "Act") was
signed into law. One provision of the Act repealed the reserve method of
accounting for bad debts for savings institutions effective for taxable years
beginning after 1995. Therefore, the Bank used the specific charge-off method in
filing its 1996 and 1997 federal tax returns and will use this method in filing
its 1998 federal tax return.
The Bank may be required to recapture its "applicable excess reserves", if
its federal tax bad debt reserves are in excess of its base year reserve amount.
As of December 31, 1998, the Bank had no applicable excess reserves. The base
year reserves will be subject to recapture and the Bank could be
21
required to recognize a tax liability if: (1) the Bank fails to qualify as a
"bank" for federal income tax purposes; (2) certain distributions are made with
respect to the stock of the Bank; (3) the bad debt reserves are used for any
purpose other than to absorb bad debt losses; or (4) there is a change in
federal tax law. The enactment of this legislation has not and is not expected
to have a material impact on the Bank's operations or financial position.
For state tax purposes, the Bank is allowed an addition to its tax bad debt
reserves in an amount necessary to fill up to its tax reserve balance calculated
using the experience method.
To the extent that distributions by the Bank to the Company that are
permitted under federal regulations exceed the Bank's earnings and profits (as
computed for federal income tax purposes), such distributions would be treated
for tax purposes as being made out of the Bank's excess bad debt reserve and
would thereby constitute taxable income to the Bank in an amount equal to the
lesser of the Bank's excess bad debt reserve or the amount which, when reduced
by the amount of income tax attributable to the inclusion of such amount in
gross income, is equal to the amount of such distribution. At December 31, 1998,
the Bank's excess bad debt reserve was zero. At December 31, 1998, the Bank's
earnings and profits (as computed for federal income tax purposes) were
approximately $207.4 million.
At December 31, 1998, the Bank had $41.6 million in deferred tax assets. No
valuation allowance was established because management believes that it is more
likely than not that the deferred tax assets will be realized. Deferred tax
liabilities totaled $33.2 million at December 31, 1998.
The Bank is subject to an alternative minimum tax if such tax is larger
than the tax otherwise payable. Generally, alternative minimum taxable income is
a taxpayer's regular taxable income, increased by the taxpayer's tax preference
items for the year and adjusted by computing certain deductions in a special
manner which negates the acceleration of such deductions under the regular tax.
The adjusted income is then reduced by an exemption amount and is subject to tax
at a 20% rate. The excess of the addition to the bad debt reserve computed under
the percentage of taxable income method over the increase in the reserve
calculated on the basis of actual experience is an item of tax preference. No
alternative minimum taxes were applicable to the Bank for tax years 1998, 1997
or 1996.
California tax laws generally conform to federal tax laws. For California
franchise tax purposes, federal savings banks are taxed as "financial
corporations" at a rate 2% higher than that applicable to non-financial
corporations because of exemptions from certain state and local taxes. The tax
rates for 1998, 1997 and 1996 were 10.84%, 10.84% and 11.30%, respectively. The
Franchise Tax Board ("FTB") has not yet announced the rate for 1999.
During 1997, the Internal Revenue Service ("IRS") completed its examination
of the Company's consolidated federal income tax returns for tax years up to and
including 1992. The adjustments made by the IRS related to temporary differences
as to the recognition of certain taxable income and expense items. While the
Company had provided deferred taxes for federal and state purposes, the changes
in the period of recognition of certain income and expense items resulted in
interest due to the IRS and FTB. As a result, the Company paid $7.4 million in
interest to the IRS and FTB during 1997 and accrued an additional $210 thousand
in interest during the year. During 1998, the Company paid $598 thousand in
interest to the IRS and FTB and reversed $300 thousand. During 1996, the Company
recorded a net reversal of $5.1 million in accrued interest. The remaining $500
thousand remaining balance in accrued interest as of December 31, 1998 is for
interest due with amended returns which have not yet been filed.
22
ITEM 2--PROPERTIES
At December 31, 1998, the Bank owned the building and land for seven of its
branch offices, owned the building but leased the land for three additional
offices, and leased its remaining offices. Properties leased by the Bank include
its home and executive offices located in a 12-story office tower in downtown
Santa Monica and a general services and corporate operations office building in
Santa Monica. FFC does not lease or own properties. For information concerning
rental obligations, see Note 6 of the Notes to Consolidated Financial
Statements.
ITEM 3--LEGAL PROCEEDINGS
The Company is involved as a plaintiff or defendant in various legal
actions incident to its business, none of which are believed by management to be
material to the Company.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5--MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market Information. The Company's common stock is traded on the New
York Stock Exchange ("NYSE") under the symbol "FED." Included in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" is a
chart representing the range of high and low stock prices for the Company's
common stock for each quarterly period for the last five years.
(b) Holders. As of February 12, 1999, the Company had 20,623,198 shares of
its common stock outstanding, representing approximately 891 record
stockholders, which total does not include the number of stockholders whose
shares are held in street name.
(c) Dividends. As a publicly traded company, the Company has no history of
dividend payments on its common stock. However, the Company may in the future
adopt a policy of paying dividends, depending on its net earnings, financial
position and capital requirements, as well as regulatory restrictions, tax
consequences and the ability of the Company to obtain a dividend from the Bank
for payment to stockholders. OTS regulations limit amounts that the Bank can pay
as a dividend to the Company. No dividend may be paid if the Bank's net worth
falls below regulatory requirements. (See "Business - Summary of Material
Legislation and Regulations" for other regulatory restrictions on dividends.)
Within these regulations, the Board of Directors of the Bank declared and paid
$5.9 million in dividends during each of the years 1998, 1997 and 1996. These
dividends enabled the Company to service the $50 million in Notes due October
2004.
The ability of the Company to pay dividends is also restricted by the
covenants contained in its Indenture pertaining to $50 million in Notes due
October 2004. See "Business - Borrowings."
23
ITEM 6--SELECTED FINANCIAL DATA
Selected financial data for the Company is presented below:
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
FIVE YEAR CONSOLIDATED SUMMARY OF OPERATIONS
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(Dollars In Thousands, Except per Share Data)
For the Year Ended December 31:
Interest income ............................ $ 289,769 $ 299,220 $ 297,178 $ 301,735 $ 235,424
Interest expense ........................... 186,491 204,226 198,031 224,077 157,655
Net interest income ........................ 103,278 94,994 99,147 77,658 77,769
Provision for loan losses .................. 7,200 20,500 35,155 28,376 85,700
Other income ............................... 13,657 10,218 10,915 8,725 11,264
Non-interest expense ....................... 48,924 44,151 59,175 45,903 45,496
Earnings (loss) before
income taxes (benefit) .................... 60,811 40,561 15,732 12,104 (42,163)
Income taxes (benefit) ..................... 26,182 17,461 7,488 5,569 (17,699)
Net earnings (loss) ........................ 34,629 23,100 8,244 6,535 (24,464)
Basic earnings (loss) per share(1) ......... 1.63 1.09 0.39 0.31 (1.16)
Diluted earnings (loss)
per share(1) .............................. 1.60 1.07 0.39 0.31 (1.16)
End of Year:
Loans receivable, net ...................... 2,808,221 3,145,164 3,048,469 3,059,780 3,072,309
Mortgage-backed securities ................. 556,679 676,058 746,006 843,819 830,715
Investment securities ...................... 64,333 48,910 58,909 67,813 74,654
Total assets ............................... 3,677,128 4,160,115 4,143,852 4,139,737 4,157,414
Deposits ................................... 2,135,909 1,943,647 1,957,448 2,205,036 2,298,914
Borrowings ................................. 1,235,172 1,941,670 1,940,482 1,666,943 1,604,821
Liabilities ................................ 3,420,128 3,937,328 3,949,302 3,943,446 3,972,727
Stockholders' equity ....................... 257,000 222,787 194,550 196,291 184,687
Book value per share(1) .................... 12.16 10.52 9.24 9.25 8.71
Selected Ratios:
Return on average assets ................... 0.88% 0.56% 0.20% 0.16% (0.64)%
Return on average equity ................... 14.40% 11.25% 4.22% 3.47% (12.78)%
Ratio of non-performing
assets to total assets ................... 0.84% 0.95% 1.77% 2.33% 2.23%
Other Data:
Number of Bank full service
branches ................................. 24 24 25 25 25
(1) All per share amounts have been adjusted for the two-for-one stock split
declared June 25, 1998.
Also see summarized results of operations on a quarterly basis for 1998,
1997 and 1996 in Note 15 of the Notes to Consolidated Financial Statements.
24
ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
The Company's results of operations are primarily affected by its levels of
net interest income, provisions for loan losses, non-interest income,
non-interest expense and income taxes. The Company's results are strongly
influenced by the Southern California economy in which it operates.
Net earnings of $34.6 million or $1.60 per share were recorded in 1998,
compared to net earnings of $23.1 million or $1.07 per share in 1997 and $8.2
million or $0.39 per share in 1996. All per share amounts are presented on a
diluted basis and have been adjusted for the two for one stock split declared
June 25, 1998. The Company's results over the last three years have improved
primarily due to lower loan loss provisions and increased net interest income.
The Southern California economy continued to improve in 1998 from the economic
recession of the early 1990's. As a result, loan charge-offs declined to $3.4
million in 1998 compared to $12.1 million in 1997 and $37.5 million in 1996. In
addition, transfers to valuation allowances for impaired loans declined to $640
thousand in 1998 compared to $7.3 million in 1997 and $11.4 million in 1996.
Certain key financial ratios for the Company are presented below:
Average
Return on Return on Equity to
Average Average Average
Assets Equity Assets
------ ------ ------
1998 .............. .88% 14.40% 6.09%
1997 .............. .56 11.25 4.95
1996 .............. .20 4.22 4.61
1995 .............. .16 3.47 4.49
1994 .............. (.64) (12.78) 4.97
Core earnings reflect the Company's results from basic operations and were
$63.6 million in 1998, $60.6 million in 1997 and $60.5 million in 1996. Core
earnings are defined as net interest income before provision for loan losses
plus other income (excluding gain on sale of loans and securities) less
non-interest expense. Non-recurring items and provision for loan losses are
excluded from core earnings. Core earnings increased in 1998 compared to 1997
due to decreased levels of non-performing assets and lower interest rates.
Non-performing assets (primarily loans 90 days past due or in foreclosure
plus foreclosed real estate) decreased to $30.7 million or 0.84% of total assets
at December 31, 1998 compared to $40.1 million or 0.95% of total assets at
December 31, 1996 and $73.9 million or 1.77% of total assets at December 31,
1996. The decreasing trend in non-performing assets over the last two years is
due to lower balances of delinquent loans and foreclosed properties of all
collateral types.
The Company repurchased 100,800 shares of its common stock during 1998.
Total shares repurchased as of December 31, 1998 were 1,947,840 at an average
price of $6.86 per share. As of February 12, 1999, the Company repurchased an
additional 685,400 shares at an average price of $16.15. Total shares
repurchased as of February 12, 1999 were 2,633,240 at an average price of $9.27.
25
At December 31, 1998 the Bank's regulatory risk-based capital ratio was
15.43% and the tangible and core capital ratios were 7.98%. The Bank met the
regulatory capital standards to be deemed "well-capitalized" at December 31,
1998.
The Bank's deposits are insured by the SAIF up to a maximum of $100,000 for
each insured depositor. The Bank's FDIC insurance premiums decreased to $1.2
million in 1998 compared to $1.9 million in 1997 and $5.4 million in 1996. In
addition, the Bank paid a $15.0 million one time SAIF assessment during 1996.
The decrease in 1998 compared to 1997 was due to a drop in the Bank's assessment
rate to 6.3 basis points from 9.3 basis points due to an improvement in its
regulatory rating. The decrease in 1997 compared to 1996 was due to a drop in
the assessment rate to 9.3 basis points from 23 basis points after payment of
the special assessment.
Risks and Uncertainties
In the normal course of business, the Company encounters two significant
types of risk: economic risk and regulatory risk.
ECONOMIC RISK
There are two main components of economic risk: credit risk and market risk
(which includes interest rate risk.)
Credit Risk
Credit risk is the risk of default in the Company's loan portfolio that
results from a borrower's inability to make contractually required payments. See
"Loan Loss Provisions" and "Non-performing Assets."
The determination of the allowance for loan losses and the valuation of
real estate collateral is based on estimates that are susceptible to changes in
the economic environment and market conditions. Management believes that the
allowance for loan losses as of December 31, 1998 was adequate based on
information available at that time. A downward turn in the current economic
climate could increase the likelihood of losses due to credit risks. This could
create the need for additional loan loss provisions.
Market Risk
Market risk is the risk of loss from unfavorable changes in market prices
and interest rates. The Bank's market risk arises primarily from the interest
rate risk inherent in its lending and deposit taking activities.
See "Asset-Liability Management" for additional information relating to
market risk.
REGULATORY RISK
Regulatory risk is the risk that the regulators will reach different
conclusions than management regarding the financial position of the Company. The
OTS examines the Bank's financial results annually. The OTS reviews the
allowance for loan losses and may require the Bank to adjust the allowance based
on information available at the time of their examination.
26
OTHER RISKS
Year 2000 Issue
The Year 2000 issue arises because many computer systems identify dates
using only the last two digits of the year. These systems are unable to
distinguish between dates in the year 2000 and dates in the year 1900. If not
corrected, these systems could fail or provide incorrect information after
December 31, 1999 or when using dates after December 31, 1999. Any such failure
on the Bank's systems could have a material adverse impact on the Company and
its ability to process customer transactions or to provide customer service.
Over the course of the past two years, the Bank developed a process for
addressing the Year 2000 issue for the Bank's major computer systems and
applications. An internal committee was formed to address the issue and a formal
project plan was developed. The Company has identified and prioritized systems,
software and equipment with potential for being affected by the year 2000 issue.
All significant vendors have been contacted regarding their Year 2000 readiness.
In each case where the Bank is vulnerable to a third party's failure to remedy
its own year 2000 issues, the Bank has developed contingency plans to utilize
other vendors or alternative work flows if adequate response and verification is
not received from the vendor in a timely fashion.
The Bank's major computer applications are owned and operated by third
party vendors. Therefore, the Bank's challenge is to ensure that its vendors are
ready for the Year 2000 or have plans to become ready before the Year 2000.
Because the Bank had plans to convert its major data processing to new systems
during 1997 and 1998, requirements for Year 2000 compliance have been included
in all major systems contracts. Contractual arrangements with the Bank's major
data processing vendors provide for regular monitoring of the vendors' Year 2000
projects, substantial system compliance by the end of 1998 and testing and
verification in early 1999.
During 1988 and the first two months of 1999, the Bank completed testing
for substantially all of the significant data processing systems deemed to be
critical to the Bank. The remediation process is complete for these systems and
no material problems have arisen during the testing process. The Bank's process
of testing and verifying the year 2000 readiness of the systems provided by
third parties will continue through the middle of 1999, as system modifications
are made and further testing of interfaces and less critical systems continues.
Because of the third party nature of its major data processing
relationships, the Bank has not borne any programming costs of making its
systems Year 2000 ready. All of these costs will be borne by the vendors. The
Bank's major cost of becoming Year 2000 ready is related to staff and management
time spent planning, monitoring and testing the systems. Therefore, Year 2000
issues are expected to have an immaterial impact on the Company's results of
operations, liquidity and capital expenditures.
Inflation
Inflation substantially impacts the financial position and operations of
financial intermediaries, such as banks and savings institutions. These entities
primarily hold monetary assets and liabilities and, as such, can experience
significant purchasing power gains and losses over relatively short periods of
time. In addition, interest rate changes during inflationary periods change the
amounts and composition of assets and liabilities held by financial
intermediaries and could result in regulatory pressure for an additional equity
investment.
Pending Lawsuits
The Bank has been named as a defendant in various lawsuits, none of which
is expected to have a materially adverse effect on the Company.
27
COMPONENTS OF EARNINGS
Net Interest Income
Net interest income is the primary component of the Company's earnings. The
chief determinants of net interest income are the dollar amounts of
interest-earning assets and interest-bearing liabilities and the interest rates
earned or paid thereon. The greater the excess of average interest-earning
assets over average interest-bearing liabilities, the more beneficial the impact
on net interest income. The excess of average interest-earning assets over
average interest-bearing liabilities was $131.7 million in 1998, $109.9 million
in 1997 and $92.9 million in 1996. The increase over the last two years was due
to improved net earnings and a continued improvement in asset quality.
The Company's net interest income is also impacted by a three month time
lag before changes in the cost of funds can be passed along to monthly
adjustable rate loan customers. Savings and borrowing costs adjust to market
rates immediately while it takes several months for the loan yield to adjust.
This time lag decreases the Company's net interest income during periods of
rising interest rates. The reverse is true during periods of declining interest
rates. See "Asset-Liability Management" for further discussion.
The following table sets forth the components of interest-earning assets
and liabilities, the excess of interest-earning assets over interest-bearing
liabilities, the yields earned and rates paid and net interest income for the
periods indicated:
1998 1997 1996
---------- ---------- ----------
(Dollars In Thousands)
Average loans and mortgage-backed
securities (1) ...................... $3,638,628 $3,811,179 $3,806,979
Average investment securities ........ 148,871 160,224 165,710
---------- ---------- ----------
Average interest-earning assets ...... 3,787,499 3,971,403 3,972,689
---------- ---------- ----------
Average savings deposits ............. 2,121,024 1,972,860 2,135,688
Average borrowings ................... 1,534,820 1,888,662 1,744,091
---------- ---------- ----------
Average interest-bearing liabilities . 3,655,844 3,861,522 3,879,779
---------- ---------- ----------
Excess of interest-earning assets over
interest-bearing liabilities ........ $ 131,655 $ 109,881 $ 92,910
========== ========== ==========
Yields earned on average interest
earning assets ...................... 7.54% 7.40% 7.36%
Rates paid on average interest-
bearing liabilities ................. 5.11 5.27 5.25(3)
Net interest rate spread ............. 2.43 2.13 2.11
Effective net spread ................. 2.60 2.28 2.24
Total interest income (2) ............ $ 285,395 $ 293,931 $ 292,564
Total interest expense (2) ........... 186,890 203,434 203,633(3)
---------- ---------- ----------
Net interest income .................. $ 98,505 $ 90,497 $ 88,931
========== ========== ==========
(1) Non-accrual loans were included in the average dollar amount of loans
outstanding, but no income was recognized during the period that each such
loan was on non-accrual status.
(2) Dividends on FHLB stock and miscellaneous interest income and expense were
not considered in this analysis.
(3) Excludes the effect of the IRS accrued interest reversal.
The yield on earning assets increased slightly to 7.54% in 1998 from 7.40%
in 1997 due to a decline in non-performing assets and an 8 basis point increase
in the Index which determines the yield on over 93% of the Bank's loan
portfolio. The Bank's cost of funds decreased by 16 basis points in 1998
compared to 1997 due to lower market interest rates in 1998 compared to 1997.
28
The table below sets forth certain information regarding changes in the
interest income and interest expense of the Bank for the periods indicated. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in average balance multiplied by old rate) and (ii) changes in rates
(changes in rate multiplied by prior year average balance):
Year Ended Year Ended
December 31, 1998 December 31, 1997
Versus Versus
December 31, 1997 December 31, 1996
------------------------------------ ------------------------------------
Change Due To Change Due To
------------------------------------ ------------------------------------
Rate Volume Total Rate Volume Total
-------- -------- -------- -------- -------- --------
(Dollars In Thousands)
Interest Income:
Loans and mortgage-backed
Securities ............. $ 5,324 $(13,088) $ (7,764) $ 1,867 $ 312 $ 2,179
Investments ............. (168) (604) (772) (505) (307) (812)
-------- -------- -------- -------- -------- --------
Total interest income . 5,156 (13,692) (8,536) 1,362 5 1,367
-------- -------- -------- -------- -------- --------
Interest Expense:
Deposits ................ (1,892) 6,861 4,969 (1,137) (7,671) (8,808)
Borrowings (1) .......... (962) (20,551) (21,513) 141 8,468 8,609
-------- -------- -------- -------- -------- --------
Total interest expense (2,854) (13,690) (16,544) (996) 797 (199)
-------- -------- -------- -------- -------- --------
Change in net
interest income ...... $ 8,010 $ (2) $ 8,008 $ 2,358 $ (792) $ 1,566
======== ======== ======== ======== ======== ========
(1) Excludes the IRS interest reversal.
Note: Changes in rate/volume (change in rate multiplied by the change in average
volume) have been allocated to the change in rate or the change in volume based
upon the respective percentages of the combined totals. Dividends on Federal
Home Loan Bank stock and miscellaneous interest income and expense were not
considered in this analysis.
29
Interest Rate Spreads and Yield on Average Interest-Earning Assets
Year Ended December 31,
--------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------- ---------------- ------------------ ----------------- -----------------
During End of During End of During End of During End of During End of
Period Period Period Period Period Period Period Period Period Period
Weighted average yield
on loans and mortgage-
backed securities ........... 7.63% 7.48% 7.49% 7.48% 7.44% 7.47% 7.31% 7.63% 6.25% 6.50%
Weighted average yield
on investment portfolio(1) .. 5.29 5.14 5.40 6.06 5.71 5.98 5.56 5.15 5.00 5.08
Weighted average yield
on all interest-earning
assets ...................... 7.54 7.39 7.40 7.42 7.36 7.45 7.23 7.59 6.20 6.47
Weighted average rate
paid on deposits ............ 4.61 4.36 4.70 4.66 4.76 4.67 4.86 4.89 3.85 4.49
Weighted average rate
paid on borrowings and
FHLB advances ............... 5.81 5.66 5.86 5.91 5.85(4) 5.77 6.32 6.11 4.93 6.04
Weighted average rate
paid on all interest-
bearing liabilities ......... 5.11 4.84 5.27 5.28 5.25 5.22 5.51 5.41 4.27 5.12
Effective net spread(2) ...... 2.60 2.28 2.24 1.80 1.99
Interest rate spread(3) ...... 2.43 2.55 2.13 2.14 2.11 2.23 1.72 2.18 1.93 1.35
(1) Dividends on FHLB stock and miscellaneous interest income were not
considered in this analysis.
(2) Net interest income (the difference in the dollar amounts of interest
earned and paid) divided by average interest-earning assets.
(3) Weighted average yield on all interest-earning assets less weighted average
rate paid on all interest-bearing liabilities.
(4) Excludes effect of IRS accrued interest reversal.
Loss Provision
The Company recorded $7.2 million in loan loss provisions during 1998,
compared to $20.5 million recorded in 1997 and $35.2 million in 1996. The Bank
has a policy of providing for general valuation allowances, unallocated to any
specific loan, but available to offset any future loan losses. The allowance is
maintained at an amount that management believes adequate to cover estimable and
probable loan losses. The general valuation allowance, excluding the general
valuation allowance for loans sold with recourse, totaled $67.6 million and
$61.2 million at December 31, 1998 and December 31, 1997, respectively. The
increase in general valuation allowances from 1998 to 1997 is a result of a
decrease in loan charge-offs. In addition, the Bank recorded a $640 thousand
provision for losses on the impaired loan portfolio during 1998. Loan
charge-offs decreased from 0.32% of average loans outstanding in 1997 to 0.09%
of average loans outstanding in 1998. The Company also maintains valuation
allowances for impaired loans and loans sold with recourse. See "Allowances for
Loan Losses." Management performs regular risk assessments of the Bank's loan
portfolio to maintain appropriate general valuation allowances. Additional loan
loss provisions may also be required to the extent that charge-offs are recorded
against the valuation allowance for impaired loans, the general valuation
allowance, or the valuation allowance for loans sold with recourse. Loan
charge-offs decreased to $3.4 million in 1998 from $12.1 million in 1997 and
$37.5 million in 1996. Charge-offs result from declines in the value of the
underlying collateral of the non-performing loans.
Non-interest Income
Loan servicing and other fees were $4.2 million in 1998, $6.2 million in
1997 and $6.4 million in 1996. Loan servicing fees during 1998 were reduced by a
$1.4 million provision for impairment of the Bank's servicing asset.
Additionally, fees decreased in 1998 compared to 1997 due to decreased fees on
loans serviced for other lenders due to loan prepayments.
Gain (loss) on sale of loans increased to $4.1 million in 1998 compared to
$652 thousand in 1997, and $253 thousand in 1996. The increased gains from 1997
to 1998 and from 1996 to 1997 were due to cash gains and fees earned on the sale
of fixed rate loans which were available to the Bank's borrowers at historically
low rates. In 1998, 62% of single family loans originated were originated for
sale in the secondary market.
30
Real estate operations resulted in a net gain of $1.2 million in 1998
compared to gains of $20 thousand in 1997 and $1.2 million in 1996. Included in
the above amounts are provisions for losses on real estate totaling $572
thousand in 1998, $1.6 million in 1997 and $745 thousand in 1996. Gains from
real estate operations generally result from the recovery of excess valuation
allowances upon the sale of foreclosed properties. The Bank normally sells
foreclosed properties within a few months after acquisition.
Other operating income, which increased to $4.3 million in 1998 compared to
$3.3 million in 1997 and $3.0 million in 1996, consists primarily of fees earned
for services provided in the retail savings branches. The increase in 1998
compared to 1997 is due to the fact that item processing costs, which were
reported as an offset to service fee income in years prior to 1998, are included
in other operating expenses starting in 1998.
Non-interest Expense
The ratio of non-interest expense to average total assets for 1998 was
1.24% compared with 1.06% in 1997. The ratio for 1996 was 1.43%, including the
one-time SAIF special assessment. The increased ratio in 1998 compared to 1997
resulted from increased salaries and related benefits, and higher occupancy
costs.
Salary and benefit costs increased 14% in 1998 compared to 1997 due to
higher incentive costs, profit sharing costs and bonus expense. Incentive costs
were higher due to the Bank's increase in loan originations. Loan officers are
compensated based on loans originated. Salary and benefit costs increased 4% in
1997 compared to 1996 due to higher retirement and incentive costs.
Occupancy expense increased 23% in 1998 compared to 1997 due to mark to
market adjustments of $995 thousand on leased properties no longer occupied by
the Bank. Also, equipment costs increased in connection with the Bank's data
processing conversion during 1998. Occupancy expense increased 9% in 1997
compared to 1996 due primarily to the additional costs and depreciation expense
associated with the Bank's new loan origination system and call center.
Other operating expenses increased 16% in 1998 compared to 1997 due an
increase in costs associated with the data processing conversion and an increase
in uninsured losses related to the conversion. Item processing costs totaling
$1.3 million were included in data processing costs during 1998. In years prior
to 1998, item processing costs were offset against service fee income. Other
operating expense increased 21% in 1997 compared to 1996 due primarily to
increases in data processing and legal expenses.
Advertising expense decreased by 30% in 1998 compared to 1997 due to
advertising plans that were revised during 1998. Advertising expense increased
by 18% in 1997 compared to 1996 due to additional brand advertising and
increased advertising for LENDFFB.
Federal deposit insurance decreased in 1998 compared to 1997 due to lower
insurance rates based on an improvement in the Bank's regulatory rating. The
Bank's assessment rate dropped to 6.3 basis points in 1998 from 9.3 basis points
in 1997. Federal deposit insurance decreased in 1997 compared to 1996 due to a
drop in the deposit insurance rate from 26 basis points to 9.3 basis points as a
result of the Economic Growth Act and a decline in total deposits. Excluding the
$15.0 million special SAIF assessment, deposit insurance decreased in 1996
compared to 1995 due to a decline in deposits and a $268 thousand refund
received in the fourth quarter of 1996 as a result of an assessment rate
reduction.
31
The following table details the components of non-interest expense for the
periods indicated:
Non-Interest Expense
Year Ended December 31,
------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(Dollars In Thousands)
Salaries and Employee Benefits:
Salaries ................................ $16,643 $15,413 $15,749 $16,436 $16,887
Incentive compensation .................. 1,478 883 556 899 1,363
Payroll taxes ........................... 1,455 1,371 1,389 1,400 1,498
Employee benefit insurance .............. 1,069 1,048 1,137 1,180 1,225
Bonus compensation ...................... 1,335 1,100 1,000 1,001 300
Profit sharing .......................... 1,000 501 500 500 200
Pension ................................. -- -- 241 436 481
SERP .................................... 795 628 506 408 471
401(k) .................................. 235 392 -- -- --
Other salaries and benefits ............. 1,801 1,404 850 785 309
------- ------- ------- ------- -------
25,811 22,740 21,928 23,045 22,734
------- ------- ------- ------- -------
Occupancy:
Rent .................................... 5,105 4,351 4,270 4,250 4,246
Equipment ............................... 1,855 1,336 959 885 1,246
Maintenance costs ....................... 344 450 477 460 594
Other occupancy ......................... 1,189 741 583 663 600
------- ------- ------- ------- -------
8,493 6,878 6,289 6,258 6,686
------- ------- ------- ------- -------
Other Operating Expense:
Insurance ............................... 362 345 381 528 748
Goodwill ................................ 565 839 915 996 996
Data processing ......................... 3,359 2,539 945 1,012 1,094
Contributions ........................... 509 412 401 341 412
Professional services ................... 1,738 1,682 832 777 732
Supervisory exam ........................ 599 610 611 603 547
Other operating costs ................... 4,288 3,439 4,086 4,110 4,424
------- ------- ------- ------- -------
11,420 9,866 8,171 8,367 8,953
------- ------- ------- ------- -------
Federal Deposit Insurance:
Deposit insurance premiums .............. 1,241 1,872 5,418 6,400 5,151
SAIF special assessment ................. -- -- 15,007 -- --
------- ------- ------- ------- -------
1,241 1,872 20,425 6,400 5,151
------- ------- ------- ------- -------
Advertising ............................. 1,959 2,795 2,362 1,833 1,972
------- ------- ------- ------- -------
Total ................................. $48,924 $44,151 $59,175 $45,903 $45,496
======= ======= ======= ======= =======
Non-interest expense as
% of average assets .................... 1.24% 1.06% 1.43%(1) 1.10% 1.18%
======= ======= ======= ======= =======
(1) The ratio for 1996 includes the special SAIF assessment. Excluding the SAIF
assessment, the ratio would have been 1.06%.
32
BALANCE SHEET ANALYSIS
Consolidated assets at the end of 1998 were $3.7 billion, representing a
12% decrease from $4.2 billion at the end of 1997 and $4.1 billion at the end of
1996. Assets decreased during 1998 due to the prepayment of adjustable rate
mortgages and the borrowers' preference for fixed rate mortgages in the current
interest rate market.
Loan Portfolio
At the end of 1998, over 93% of the Bank's loans had adjustable interest
rates based on monthly changes in the Index. As part of its asset-liability
management strategy, the Bank has maintained the level of adjustable loans in
its portfolio at over 90% for several years. Management believes that the high
level of adjustable rate mortgages will help insulate the Bank from fluctuations
in interest rates, notwithstanding the several month time lag between a change
in its monthly cost of funds and a corresponding change in its loan yields. See
"Asset - Liability Management."
The Bank also originates loans with initial fixed interest rates with
periods ranging from 3 to 10 years. By policy, the Bank will either match the
fixed rate period of these loans with borrowings for the same term or will hold
an amount up to $120 million of unmatched fixed rate loans in its portfolio.
Management believes that the limited origination of fixed-rate loans will
enhance the Company's overall return on assets and improve loan originations in
this economy.
In 1998 and 1997, the Bank through its lending division, FirstFed Mortgage
Services, placed $21.3 million and $22.8 million, respectively in mortgages with
other lenders under fee arrangements, which amount is not included in loan
originations. In 1998, loans made on the security of single family properties
(one to four units) comprised 93% of the dollar amount of new loan originations.
Loans made on the security of multi-family properties (five or more units)
comprised 6% of new originations. Loans originated through the Bank's new
consumer lending and commercial lending units totaled $2.4 million and $1.7
million, respectively. No construction loans were originated in 1998. Adjustable
rate mortgages comprised 49% of new loan activity during 1998 compared to 85% in
1997.
The following table details loan originations by loan type for the periods
indicated:
Loan Originations by Type
Year Ended December 31,
------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars In Thousands)
Single Family (one to four units) $594,763 $430,223 $239,866 $237,508 $734,438
Multi-Family .................... 37,720 48,033 57,414 55,832 164,788
Commercial Real Estate .......... 383 2,551 5,568 4,881 9,858
Commercial Business Loans ....... 1,733 -- -- -- --
Other ........................... 2,428 444 -- 1,031 230
-------- -------- -------- -------- --------
Total ......................... $637,027 $481,251 $302,848 $299,252 $909,314
======== ======== ======== ======== ========
Loans originated upon the sale of the Bank's real estate owned were $10.0
million or 2% of total originations in 1998. $844 thousand of these loans were
originated based on the security of single family properties, $8.7 million were
originated based on the security of multi-family properties and $383 thousand
were based on the security of commercial properties.
From time-to-time, the Bank converts loans into mortgage-backed securities
for use in securitized borrowings (reverse repurchase agreements). No loans were
converted into mortgage-backed securities during 1998, 1997, or 1996.
Securitized loans have a lower risk weighting for regulatory risk-based capital
purposes. In exchange for the enhanced credit risk associated with
mortgage-backed securities, the Bank pays guarantee fees to FHLMC and/or FNMA.
33
The Bank's adjustable rate loan products often provide for first year
monthly payments that are lower than the fully-indexed interest and principal
due. Any interest not fully paid by such lower first year payments is added to
the principal balance of the loan. This causes negative amortization until
payments increase to cover interest and principal repayment shortfalls. Due to
negative amortization, loan-to-value ratios may increase above those calculated
at the inception of the loan.
To date, the Bank's foreclosure experience on loans with negative
amortization has been no different from that on the fully-amortizing portfolio.
The amount of negative amortization recorded by the Bank decreases in periods of
declining interest rates and increases during periods of increasing interest
rates. Due to the decreasing interest rate environment during 1998, the balance
of negative amortization on all loans serviced by the Bank was immaterial as of
December 31, 1998.
The Bank does not normally lend in excess of 90% of the appraised
collateral value on adjustable mortgage loans ("AMLs"). Where the Bank does lend
in excess of 90% of the appraised value, additional fees and rates are charged.
Mortgage insurance is required on loans in excess of 80% or premium rates and/or
fees are charged if the mortgage insurance requirement is waived. Subsequent to
the origination of a loan, the Bank may purchase private mortgage insurance with
its own funds. Loans originated under this program for which there is no private
mortgage insurance totaled $265.0 million at December 31, 1998 compared to
$163.8 million at December 31, 1997 and $122.5 million at December 31, 1996. See
"Business Interest Rates, Terms and Fees."
Loan Composition
Loans based on the security of single family properties (one to four units)
comprise the largest category of the Bank's loan portfolio (including
mortgage-backed securities). The loan portfolio also includes loans secured by
multi-family and commercial properties. At December 31, 1998, approximately 54%
of the loan and mortgage-backed securities portfolio consisted of first liens on
single family properties. First liens on multi-family properties comprised
approximately 39% of the portfolio, and first liens on commercial properties
represented approximately 7% of the portfolio.
Multi-family and commercial real estate loans are considered more
susceptible to market risk than single family loans and higher interest rates
and fees are charged to borrowers for these loans. Approximately 6% of loan
originations in 1998 were multi-family loans compared to 10% in 1997 and 9%
during 1996. Multi-family loans originated upon the sale of REO were 1%, 6% and
16% of total loan originations during 1998, 1997 and 1996, respectively.
The Bank has loss exposure on certain loans sold with recourse. These loans
are substantially all secured by multi-family properties. Loans sold with
recourse totaled $203.0 million as of December 31, 1998, $218.1 million as of
December 31, 1997 and $230.8 million as of December 31, 1996. Although no longer
owned by the Bank, these loans are evaluated for the purposes of computing
general valuation allowances and measuring risk exposure for regulatory capital.
Under the Bank's current policy, it no longer enters into loans sold with
recourse agreements.
34
The following table sets forth the composition of the Bank's portfolio of
loans and mortgage-backed securities for each of the last five years:
Loan Portfolio Composition
December 31,
------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(Dollars In Thousands)
REAL ESTATE LOANS:
First trust deed residential loans:
One to four units ........................... $1,565,105 $1,801,608 $1,621,497 $1,573,869 $1,542,969
Five or more units .......................... 1,127,228 1,217,577 1,277,634 1,344,866 1,357,251
---------- ---------- ---------- ---------- ----------
Residential loans ............................. 2,692,333 3,019,185 2,899,131 2,918,735 2,900,220
OTHER REAL ESTATE LOANS:
Commercial and industrial ................... 181,772 196,575 210,953 221,982 246,340
Second trust deeds .......................... 15,357 15,441 17,497 2,213 20,401
Other ....................................... -- 6,303 2,137 3,157 4,793
---------- ---------- ---------- ---------- ----------
Real estate loans ......................... 2,889,462 3,237,504 3,129,718 3,146,087 3,171,754
NON-REAL ESTATE LOANS:
Manufactured housing ........................ 893 1,154 1,480 1,938 2,439
Deposit accounts ............................ 1,002 1,644 1,042 1,104 1,301
Consumer .................................... 1,167 185 236 359 506
---------- ---------- ---------- ---------- ----------
Loans receivable .......................... 2,892,524 3,240,487 3,132,476 3,149,488 3,176,000
LESS:
General valuation allowance ................. 67,638 61,237 54,900 42,876 55,353
Valuation allowances -
impaired loans .............................. 7,634 9,775 12,350 26,101 23,887
Unrealized loan fees ........................ 9,031 24,311 16,757 20,731 24,451
---------- ---------- ---------- ---------- ----------
Net loans receivable ...................... 2,808,221 3,145,164 3,048,469 3,059,780 3,072,309
FHLMC AND FNMA MORT-
GAGE-BACKED SECURITIES:
Secured by single family
Dwellings ................................. 539,079 657,342 715,286 810,980 794,126
Secured by multi-family
Dwellings ................................. 17,600 18,716 20,189 24,468 27,191
---------- ---------- ---------- ---------- ----------
Mortgage-backed securities ................ 556,679 676,058 735,475 835,448 821,317
---------- ---------- ---------- ---------- ----------
TOTAL ................................... $3,364,900 $3,821,222 $3,783,944 $3,895,228 $3,893,626
========== ========== ========== ========== ==========
35
ASSET QUALITY
Asset Quality Ratios
The following table sets forth certain asset quality ratios of the Bank for
the periods indicated:
December 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
Non-performing Loans to Loans Receivable(1) ............. 90% .91% 1.89% 2.44% 2.39%
Non-performing Assets to Total Assets(2) ................ 84% .95% 1.77% 2.33% 2.23%
Loan Loss Allowances to Non-performing
Loans(3) .............................................. 242.09% 193.38% 94.27% 65.62% 78.27%
General Loss Allowances to Assets
with Loss Exposure(4) ................................. 2.26% 1.86% 1.73% 1.35% 1.73%
General Loss Allowances to Total Assets with
Loss Exposure(5) ...................................... 2.51% 2.12% 1.86% 1.52% 1.82%
(1) Non-performing loans are net of valuation allowances related to those
loans. Loans receivable exclude mortgage-backed securities and are before
deducting unrealized loan fees, general valuation allowances and valuation
allowances for impaired loans.
(2) Non-performing assets are net of valuation allowances related to those
assets.
(3) The Bank's loan loss allowances, including valuation allowances for
non-performing loans and general valuation allowances but excluding general
valuation allowances for loans sold by the Bank with full or limited
recourse. Non-performing loans are before deducting valuation allowances
related to those loans.
(4) The Bank's general valuation allowances, excluding general valuation
allowances for loans sold with full or limited recourse. The Bank's assets
with loss exposure include primarily loans and real estate owned, but
exclude mortgage-backed securities.
(5) The Bank's general valuation allowances, including general valuation
allowances for loans sold with full or limited recourse. Assets with loss
exposure include the Bank's loan portfolio plus loans sold with recourse,
but exclude mortgage-backed securities.
36
NON-PERFORMING ASSETS
Non-performing assets, as defined by the Bank, include loans delinquent
over 90 days or in foreclosure, real estate acquired in settlement of loans, and
other loans less than 90 days delinquent but for which collectibility is
questionable.
The table below details the amounts of non-performing assets by type of
collateral. Also shown is the ratio of non-performing assets to total assets.
Non-Performing Assets
December 31,
---------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------- ------------------- ------------------ ------------------ ------------------
$ % $ % $ % $ % $ %
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars In Thousands)
Real Estate Owned:
Single Family .......... $ 3,946 12.84% $ 5,806 14.66% $ 6,840 9.32% $ 7,252 7.50% $ 5,711 6.17%
Multi-Family ........... 1,309 4.26 4,034 10.19 7,339 10.00 9,827 10.17 10,647 11.50
Commercial ............. -- -- 826 2.09 673 .92 2,544 2.63 366 0.39
Less: General Valuation
Allowance ........... (500) (1.63) (500) (1.26) (521) (.71) -- -- -- --
Other .................. -- -- 52 .13 -- -- 78 0.08 -- --
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total Real Estate
Owned ................. 4,755 15.47 10,218 25.80 14,331 19.53 19,701 20.38 16,724 18.06
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Non-Performing Loans:
Single Family .......... 12,270 39.92 16,799 42.42 25,602 34.89 25,991 26.89 13,041 14.08
Multi-Family ........... 13,005 42.31 15,785 39.86 44,754 60.98 69,579 72.00 60,213 65.02
Commercial ............. 4,040 13.14 1,533 3.87 2,223 3.03 3,313 3.43 20,986 22.66
Other .................. -- -- -- -- -- -- 220 .23 245 0.26
Less Valuation
Allowances ............ (3,332) (10.84) (4,738) (11.97) (13,522) (18.43) (22,159) (22.93) (18,596) (20.08)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total Non-Performing
Loans ................. 25,983 84.53 29,379 74.20 59,057 80.47 76,944 79.62 75,889 81.94
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total .................. $ 30,738 100.00% $ 39,597 100.00% $ 73,388 100.00% $ 96,645 100.00% $ 92,613 100.00%
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Ratio of Non-Performing
Assets To Total Assets: .84% .95% 1.77% 2.33% 2.23%
======== ======== ======== ======== ========
The decrease in non-performing loans in 1998 and 1997 is due to reductions
in delinquent loans and non-performing loans due to improvement in the Southern
California real estate markets.
Single family non-performing loans are primarily due to factors such as
layoffs and decreased incomes. Multi-family and commercial non-performing loans
are attributable primarily to factors such as declines in occupancy rates and
decreased real estate values. The Bank actively monitors the status of all
non-performing loans. The increase in non-performing commercial real estate
loans is primarily attributable to a small number of loans which are current as
to payment but are in default of other loan terms.
Impaired loans totaled $17.5 million, $25.7 million and $37.6 million, net
of related allowances of $7.6 million, $9.8 million and $12.4 million as of
December 31, 1998, December 31, 1997 and 1996, respectively. See "Business -
Risk Elements" for a further discussion of impaired loans.
37
The Bank's modified loans result primarily from temporary modifications of
principal and interest payments. Under these arrangements, loan terms are
typically reduced to no less than a required monthly interest payment. Any loss
of revenues under the modified terms would be immaterial to the Bank. If the
borrower is unable to return to scheduled principal and interest payments at the
end of the modification period, foreclosure procedures are initiated, or, in
certain circumstances, the modification period is extended. As of December 31,
1998, the Bank had modified loans totaling $11.0 million, net of loan loss
allowances. This compares with $16.7 million and $19.0 million net of allowances
as of December 31, 1997 and December 31, 1996, respectively. Modified loans
included as impaired loan total $6.0 million, $8.1 million and $9.7 million, net
of valuation allowances, as of December 31, 1998, 1997 and 1996, respectively.
No modified loans were 90 days or more delinquent as of December 31, 1998 or
December 31, 1997. Modified loans 90 days or more delinquent as of December 31,
1996 were $472 thousand.
Allowances for Loan Losses
For an analysis of the changes in the loan loss allowances, see "Business -
Risk Elements." At December 31, 1998, the general valuation allowance was $67.6
million or 2.26% of the Bank's loans with loss exposure. This compares to 1.86%
at the end of 1997 and 1.73% at the end of 1996. In addition to the general
valuation allowance and the allowance for impaired loans mentioned above, the
Bank also maintains an allowance for loans sold with recourse. These allowances
amounted to 6.18%, 5.97% and 3.64% of loans sold with recourse at December 31,
1998, 1997 and 1996, respectively. Management considers the current level of
loss allowances adequate to cover the Bank's loss exposure at this time.
However, there can be no assurance that future additions to loan loss allowances
will not be required.
CAPITAL RESOURCES AND LIQUIDITY
Liquidity Requirements
Federal regulations currently require a savings institution to maintain a
monthly average daily balance of liquid assets (including cash, certain time
deposits, bankers' acceptances and specified United States government, state or
federal agency obligations) equal to at least 4% of: (i) the average daily
balance of its net withdrawable accounts and short-term borrowings during the
preceding calendar quarter or (ii) the ending balance of its net withdrawable
accounts as of the end of the preceding calendar quarter. The liquidity
requirement may be changed from time-to-time by the OTS to any amount within the
range of 4% to 10% of such accounts and borrowings depending upon economic
conditions and the deposit flows of member institutions. On November 24, 1997,
the OTS reduced this liquidity requirement to 4% from 5%. The OTS also gave
institutions the option of using a quarterly average calculation or an end of
quarter calculation of the liquidity base and removed the requirement of
maintaining a monthly average balance of short-term liquid assets equal to at
least 1% of the average daily balance of its net withdrawable accounts and short
term borrowings. Monetary penalties may be imposed for failure to meet these
liquidity ratio requirements. The Bank's liquidity ratio for the quarter ended
December 31, 1998 was 5.38%, which exceeded the applicable requirements.
38
External Sources of Funds
External sources of funds include savings deposits, loan sales, advances
from the FHLBSF and reverse repurchase agreements ("reverse repos"). For
purposes of funding asset growth, the source or sources of funds with the lowest
total cost for the desired term are generally selected. The incremental source
of funds used most often during 1998 was deposits obtained from national
brokerage firms.
Deposits obtained from national brokerage firms ("brokered deposits") are
considered a source of funds similar to a borrowing. In evaluating brokered
deposits as a source of funds, the cost of these deposits, including commission
fees, is compared to other funding sources. Brokered deposits were $494.2
million at December 31, 1998. This compares to $378.1 million at December 31,
1997 and $389.4 million at December 31, 1996.
Deposits at retail savings offices have remained steady at approximately
$1.5 billion for the last three years due to the availability of alternative
investments paying higher returns to customers and intense competition for
deposits by other financial institutions.
The Bank also solicits deposits through telemarketing efforts.
Telemarketing deposits are obtained by the Bank's employees via telephone, from
depositors outside of the Bank's normal service areas. Telemarketing deposits
increased by 16% to $115.6 million at the end of 1998. This compares with $99.8
million at the end of 1997 and $112.6 million at the end of 1996. The level of
telemarketing deposits varies based on the activity of investors, who are
typically professional money managers. The availability of telemarketing
deposits also varies based on the investors' perception of the Bank's
creditworthiness.
Reverse repurchase agreements are short term borrowings secured by
mortgage-backed securities. These borrowings decreased 18% to $471.2 million at
the end of 1998 from $577.7 million at the end of 1997 and $646.5 million at the
end of 1996. Borrowings under reverse repurchase agreements have decreased over
the last three years due to prepayments of the underlying collateral. The Bank
did not securitize any mortgage loans in 1998, 1997 or 1996.
FHLB advances decreased to $714.0 million at the end of 1998 compared to
$1.3 billion at the end of 1997 and $1.2 billion at the end of 1996. FHLB
Advances decreased during 1998 due to the availability of lower cost funds from
other sources and loan prepayments, which decreased the Bank's cash flow needs.
FHLB advances increased during 1997 and 1996 because these were often the lowest
cost source of funds available to the Bank.
Sales of loans were $379.6 million in 1998. This compares to $52.4 million
during 1997 and $24.1 million during 1996. Loan sales increased substantially in
1998 due to the high volume of fixed rate loans originated.
Internal Sources of Funds
Internal sources of funds include scheduled loan principal payments, loan
payoffs, and positive cash flows from operations. Principal payments were $658.0
million in 1998 compared to $289.1 million in 1997 and $199.3 million in 1996.
Principal payments include both amortization and prepayments and are a function
of real estate activity and the general level of interest rates. Prepayments
increased in 1998 due to refinancing activity into fixed rate loans which were
available to borrowers at favorable interest rates.
39
Capital Requirements
Current regulatory capital standards require that the Bank maintain
tangible capital of at least 1.5% of total assets, core capital of 3.0% of total
assets, and risk-based capital of 8.0% of total assets, risk-weighted. Among
other things, failure to comply with these capital standards will result in
restrictions on asset growth and necessitate the preparation of a capital plan,
subject to regulatory approval. Generally, any institution with a risk-based
capital ratio in excess of 10% and a core capital ratio greater than 5% is
considered well-capitalized for regulatory purposes. Institutions who maintain
this capital level can take in brokered deposits at their discretion, and if
they achieve a sufficient ranking on their regulatory examination, may be
assessed a lower deposit insurance rate.
Management presently intends to maintain its capital position at levels
above those required by regulators to ensure operating flexibility and growth
capacity for the Bank. The Bank's capital position is actively monitored by
management. The Bank met the regulatory capital standards to be deemed
"well-capitalized" for purposes of the various regulatory measures of capital
including the prompt corrective action regulations.
To be considered "well capitalized" for purposes of the prompt corrective
action requirements the Bank must maintain the capital ratios as set forth in
the table below:
December 31, 1998
--------------------
Amount %
-------- -----
(Dollars In Thousands)
Core capital requirement ................. $184,268 5.00%
Bank's core capital ...................... 294,223 7.98
-------- -----
Excess core capital .................... $109,955 2.98%
======== =====
Tier 1 risk-based capital requirement .... $124,722 6.00%
Bank's tier 1 risk-based capital ......... 294,223 14.15
-------- -----
Excess tier 1 risk-based capital ....... $169,501 8.15%
======== =====
Risk-based capital requirement ........... $207,871 10.00%
Bank's risk-based capital ................ 320,720 15.43
-------- -----
Excess risk-based capital .............. $112,849 5.43%
======== =====
40
ASSET-LIABILITY MANAGEMENT
The Bank's primary objective in managing interest rate risk is to minimize
the adverse impact of changes in interest rates on the Bank's net interest
income and capital, while, at the same time, adjusting the Bank's
asset-liability mix to achieve the most favorable impact on earnings.
The Bank's asset-liability management policy is designed to improve the
balance between the maturities and repricings of interest-earning assets and
interest-bearing liabilities in order to better insulate net earnings from
interest rate fluctuations. Under this program, the Bank emphasizes the funding
of monthly adjustable mortgages with short term savings and borrowings and
matching the maturities of these assets and liabilities. The Bank also match
funds a limited amount of fixed rate loans with initial fixed interest periods
ranging from 3 to 10 years.
The majority of the Bank's assets are monthly adjustable rate mortgages
with interest rates that fluctuate based on changes in the FHLBSF Eleventh
District Cost of Funds Index ("Index"). These mortgages constitute over 93% of
the loan portfolio at the end of 1998. Comparisons over the last several years
show that changes in the Bank's cost of funds generally correlates with changes
in the Index. The Bank does not use any futures, options or swaps in its
asset-liability strategy.
Assets and liabilities which are subject to repricing are considered rate
sensitive. The mis-match in the repricing of rate sensitive assets and
liabilities is referred to as a company's "GAP." The GAP is positive if
rate-sensitive assets exceed rate-sensitive liabilities. Generally, a positive
GAP benefits a company during periods of increasing interest rates. The reverse
is true during periods of decreasing interest rates. However, because the Index
lags changes in market interest rates by three months while the Bank's
short-term savings and borrowing costs adjust immediately, the Bank's net
interest income initially decreases during periods of rising interest rates and
increases during periods of declining interest rates.
In order to minimize the impact of rate fluctuations on earnings,
management's goal is to keep the one year GAP at less than 20% of total assets
(positive or negative). At December 31, 1998 the Company's one-year GAP was a
positive $478.0 million or 13.00% of total assets. This compares with positive
GAP ratios of 4.14% and 5.80% of total assets at December 31, 1997 and December
31, 1996, respectively.
The following chart shows the interest sensitivity of the Company's assets
and liabilities by repricing period at December 31, 1998 and the consolidated
GAP position as a percentage of total assets at that time:
41
INTEREST-SENSITIVITY GAP
Balances Balances Balances Balances
Repricing Repricing Repricing Repricing
Total Within Within Within After
Balance 0-3 Months 4-12 Months 1-5 Years 5 Years
----------- ----------- ----------- ----------- -----------
(Dollars In Thousands)
Interest-Earning Assets:
Repurchase Agreements .................. $ 71,000 $ 71,000 $ -- $ -- $ --
Investment Securities .................. 64,333 -- 27,636 304 36,393
Mortgage-backed Securities ............. 556,679 551,933 2,139 1,487 1,120
Loans Receivable ....................... 2,892,524 2,755,863 26,402 59,924 50,335
----------- ----------- ----------- ----------- -----------
Total Interest-Earning
Assets ........................... $ 3,584,536 $ 3,378,796 $ 56,177 $ 61,715 $ 87,848
=========== =========== =========== =========== ===========
Interest-Bearing Liabilities:
Demand Accounts ...................... $ 623,324 $ 623,324 $ -- $ -- $ --
Fixed Rate Term Certificate .......... 1,512,585 632,722 829,737 46,852 3,274
Borrowings:
FHLB Advances ...................... 714,000 375,000 25,000 279,000 35,000
Reverse Repurchase
Agreements .................... 471,172 191,403 279,769 -- --
Other Borrowings ................... 50,000 -- -- -- 50,000
----------- ----------- ----------- ----------- -----------
Total Interest-Bearing
Liabilities .................. $ 3,371,081 $ 1,822,449 $ 1,134,506 $ 325,852 $ 88,274
=========== =========== =========== =========== ===========
Interest-Sensitivity Gap .................. $ 213,455 $ 1,556,347 $(1,078,329) $ (264,137) $ (426)
=========== =========== =========== =========== ===========
Interest-Sensitivity Gap as a
Percentage of Total Assets ............. 42.33% (29.33)% (7.18)% (0.01)%
=========== =========== =========== ===========
Cumulative Interest-Sensitivity Gap ....... $ 1,556,347 $ 478,018 $ 213,881 $ 213,455
=========== =========== =========== ===========
Cumulative Interest-Sensitivity
Gap as a Percentage of Total
Assets ............................... 42.33% 13.00% 5.82% 5.80%
=========== =========== =========== ===========
42
Another measure of interest rate risk, required to be performed by OTS-regulated
institutions, is an analysis specified by OTS Thrift Bulletin TB-13a,
"Management of Interest Rate Risk, Investment Securities, and Derivatives
Activities". Under this regulation, which became effective December 1, 1998 and
replaced TB-13, institutions are required to establish limits on the sensitivity
of their net interest income and net portfolio value to changes in interest
rates. Such changes in interest rates are defined as instantaneous and sustained
movements in interest rates in 100 basis point increments. In addition, the Bank
monitors the impact of the same changes in interest rates on its interest
income. The following table shows the estimated impact of a parallel shift in
interest rates on the Bank's net interest income and net portfolio value at
December 31, 1998:
Percentage Change in
---------------------------------
Change in Interest Rates Net Interest Net Portfolio
(In Basis Points) Income(1) Value(2)
----------------- ------------ -------------
+300 ......................... (15)% (13)%
+200 ......................... (10)% (8)%
+100 ......................... (5)% (4)%
--100 ........................ 5% 1%
--200 ........................ 9% 2%
--300 ........................ 14% 7%
(1) The percentage change in this column represents the projected change in
net interest income for 12 months in a stable interest rate environment
versus the net interest income in the various rate scenarios.
(2) The percentage change in this column represents the projected change in
the net portfolio value of the Bank in a stable interest rate environment
versus the net portfolio value in the various rate scenarios. The OTS
defines net portfolio value as the present value of expected cash flows
from existing assets minus the present value of expected cash flows from
existing liabilities.
43
The following table shows the fair value and contract terms of the Bank's
interest-earning assets and interest-bearing liabilities as of December 31, 1998
categorized by type and expected maturity for each of the next five years and
thereafter:
Expected Maturity Date as of December 31,
-----------------------------------------------------------------------------------------------------
There- Total Fair
1999 2000 2001 2002 2003 after Balance Value
---------- --------- --------- -------- -------- ---------- ---------- ----------
Interest Earning Assets
Loans Receivable:
Adjustable Rate Loans:
Single family ............. $ 202,036 $ 177,150 $ 154,965 $135,492 $118,398 $ 742,326 $1,530,367 $1,575,173
Average interest rate ... 7.44% 7.43% 7.42% 7.42% 7.43% 7.42% 7.42%
Multi-family ............... 90,009 80,519 75,880 71,520 67,425 734,166 1,119,519 1,159,688
Average interest rate ... 7.23% 7.23% 7.23% 7.23% 7.23% 7.22% 7.22%
Commercial and Industrial . 15,930 13,994 13,216 12,483 11,696 111,465 178,784 188,145
Average interest rate ... 7.59% 7.61% 7.61% 7.61% 7.62% 7.65% 7.63%
Fixed Rate Loans:
Single family ............. 4,374 1,860 1,641 1,446 1,313 11,229 21,863 21,691
Average interest rate ... 8.03% 7.73% 7.69% 7.62% 7.56% 7.18% 7.49%
Multi-family ............... 955 886 836 787 713 3,080 7,257 7,680
Average interest rate ... 9.07% 9.09% 9.10% 9.10% 9.16% 8.84% 8.99%
Commercial and Industrial .. 409 387 310 130 90 614 1,940 1,968
Average interest rate ... 10.23% 10.24% 10.27% 9.55% 9.08% 8.68% 9.65%
Consumer loans ............. 1,260 359 -- -- -- -- 1,619 1,617
Average interest rate .. 12.08% 18.00% -- -- -- -- 13.39%
Other loans ................ 465 472 477 484 492 2,799 5,189 5,147
Average interest rate ... 1.16% 1.24% 1.33% 1.42% 1.51% 7.81% 4.83%
Non-performing loans ....... 25,986 -- -- -- -- -- 25,986 25,986
Mortgage-backed
Securities:
Adjustable ................ 55,705 55,879 71,346 60,569 51,350 257,401 552,250 551,393
Average interest rate ... 5.91% 5.91% 5.91% 5.91% 5.91% 5.91% 5.91%
Fixed ...................... 2,525 457 397 344 297 1,120 5,140 5,286
Average interest rate .. 6.79% 8.64% 8.64% 8.64% 8.63% 8.61% 7.72%
Investments Securities ..... 72,844 2,031 1,843 30,117 2,091 26,910 135,836 135,333
Average interest rate ... 5.02% 6.26% 6.34% 5.10% 6.34% 6.11% 5.31%
Total Interest-Earning
---------- --------- --------- -------- -------- ---------- ---------- ----------
Assets .................. $ 472,498 $ 333,994 $ 320,911 $313,372 $253,865 $1,891,110 $3,585,750 $3,679,107
========== ========= ========= ======== ======== ========== ========== ==========
Interest-Bearing Liabilities
Deposits:
Checking Accounts .......... $ 238,646 $ -- $ -- $ -- $ -- $ -- $ 238,646 $ 238,646
Average interest rate ... 0.51% -- -- -- -- -- 0.51%
Savings Accounts ........... 384,678 -- -- -- -- -- 384,678 384,678
Average interest rate ... 3.47% -- -- -- -- -- 3.47%
Certificate Accounts ....... 1,462,459 28,134 7,108 5,018 6,592 3,274 1,512,585 1,516,809
Average interest rate ... 5.10% 5.21% 5.17% 5.75% 5.56% 5.05% 5.11%
Borrowings:
FHLB Advances ............. 400,000 210,000 52,000 -- 17,000 35,000 714,000 719,447
Average interest rate ... 5.36% 5.57% 5.52% -- 5.34% 5.33% 5.43%
Reverse repurchase
agreements ............... 471,172 -- -- -- -- -- 471,172 472,412
Average interest rate ... 5.37% -- -- -- -- -- 5.37%
Senior Unsecured Notes ..... 50,000 -- -- -- -- -- 50,000 50,000
Average interest rate ... 11.75% -- -- -- -- -- 11.75%
Total Interest-Earning
---------- --------- --------- -------- -------- ---------- ---------- ----------
Liabilities ............. $3,006,955 $ 238,134 $ 59,108 $ 5,018 $ 23,592 $ 38,274 $3,371,081 $3,381,992
========== ========= ========= ======== ======== ========== ========== ==========
(1) Expected maturities are contractual maturities adjusted for prepayments of
principal. The Bank uses certain assumptions to estimate fair values and
expected maturities. For assets, expected maturities are based upon contractual
maturity, projected repayments and prepayments of principal. The prepayment
experience used is based on the Bank's historical experience. The Bank's average
CPR (Constant Prepayment Rate) is 9.2% for the single family portfolio and 5.5%
for its multi-family and commercial real estate portfolios. The Bank used
estimated deposit runoff based on available industry information.
44
STOCK PRICES
The common stock of FirstFed Financial Corp. is traded on the New York
Stock Exchange under the trading symbol "FED." The quarterly high and low
information presented below is based on information supplied by the New York
Stock Exchange.
The Company has never declared or paid a cash dividend. The Company's Board
of Directors declared a two-for-one stock split on June 25, 1998 to stockholders
of record on July 15, 1998. The additional shares were distributed on July 30,
1998.
The Company repurchased 100,800 shares of its common stock during 1998.
Total shares repurchased as of December 31, 1998 were 1,947,840 at an average
price of $6.86 per share. On October 21, 1998, the Board of Directors authorized
the repurchase of an additional 5% of the shares outstanding on that date. As of
February 12, 1999, the Company had repurchased an additional 685,400 shares at
an average price of $16.15 per share. Total shares repurchased as of February
12, 1999 were 2,633,240 at an average price of $9.27. Shares eligible for
repurchase as of February 12, 1999 were 544,035.
PRICE RANGE OF COMMON STOCK
First Quarter Second Quarter Third Quarter Fourth Quarter
--------------- --------------- --------------- ---------------
High Low High Low High Low High Low
----- ----- ----- ----- ----- ----- ----- -----
1998 ..... 21.19 15.94 26.41 20.41 26.94 14.75 18.56 14.13
1997 ..... 14.00 10.75 15.53 11.25 17.44 15.38 19.75 17.50
1996 ..... 7.94 6.19 8.75 7.75 9.88 8.38 12.13 9.75
1995 ..... 8.00 5.56 8.88 7.31 8.81 7.25 9.25 6.88
1994 ..... 8.50 6.69 8.63 6.69 8.25 6.88 7.63 5.13
(1) All amounts have been adjusted for the stock split declared June 25, 1998.
45
ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1998 AND 1997
(Dollars In Thousands, Except per Share Data)
1998 1997
----------- -----------
ASSETS
Cash and cash equivalents ........................ $ 126,280 $ 163,135
Investment securities, available-for-sale
(at fair value) (Note 2) ...................... 64,333 48,910
Mortgage-backed securities, available-for-sale
(at fair value) (Notes 3 and 10) ............... 556,679 676,058
Loans receivable, held-for-sale (market of
$16,602 and $40,800) (Notes 4 and 9) ........... 16,450 40,382
Loans receivable, net (Note 4) ................... 2,791,771 3,104,782
Accrued interest and dividends receivable ........ 23,476 26,990
Real estate (Note 5) ............................. 4,791 10,257
Office properties and equipment, net (Note 6) .... 11,819 9,868
Investment in Federal Home Loan Bank
(FHLB) stock, at cost (Notes 7 and 9) ......... 72,700 68,592
Other assets (Note 1) ............................ 8,829 11,141
----------- -----------
$ 3,677,128 $ 4,160,115
=========== ===========
LIABILITIES
Deposits (Note 8) ................................ $ 2,135,909 $ 1,943,647
FHLB advances and other borrowings (Notes 7 and 9) 764,000 1,364,000
Securities sold under agreements to repurchase
(Note 10) ...................................... 471,172 577,670
Accrued expenses and other liabilities ........... 49,047 52,011
----------- -----------
3,420,128 3,937,328
----------- -----------
COMMITMENTS AND CONTINGENT
LIABILITIES (Notes 4, 6 and 13)
STOCKHOLDERS' EQUITY (Notes 12 and 13)
Common stock, par value $.01 per share;
authorized 25,000,000 shares; issued 23,075,266
and 11,511,138 shares, outstanding
21,127,426 and 10,587,618 shares ............... 231 115
Additional paid-in capital ....................... 29,965 29,628
Retained earnings - substantially restricted ..... 241,694 207,065
Loan to employee stock ownership plan ............ (833) (1,744)
Treasury stock, at cost,
1,947,840 and 923,520 shares ................... (13,354) (11,885)
Accumulated other comprehensive loss,
net of taxes ................................... (703) (392)
----------- -----------
257,000 222,787
----------- -----------
$ 3,677,128 $ 4,160,115
=========== ===========
See accompanying notes to consolidated financial statements.
46
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE EARNINGS (LOSS)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Dollars In Thousands, Except per Share Data)
1998 1997 1996
------------ ------------ ------------
Interest income:
Interest on loans ...................................... $ 238,171 $ 237,835 $ 229,000
Interest on mortgage-backed securities ................. 39,462 48,652 54,825
Interest and dividends on investments .................. 12,136 12,733 13,353
------------ ------------ ------------
Total interest income ............................... 289,769 299,220 297,178
------------ ------------ ------------
Interest expense:
Interest on deposits (Note 8) ......................... 97,659 92,678 101,595
Interest on borrowings (Note 9) ....................... 88,832 111,548 96,436
------------ ------------ ------------
Total interest expense .............................. 186,491 204,226 198,031
------------ ------------ ------------
Net interest income ..................................... 103,278 94,994 99,147
Provision for loan losses (Note 4) ..................... 7,200 20,500 35,155
------------ ------------ ------------
Net interest income after provision for
loan losses ........................................... 96,078 74,494 63,992
------------ ------------ ------------
Other income:
Loan servicing and other fees ......................... 4,152 6,233 6,402
Gain on sale of loans ................................. 4,061 652 253
Real estate operations, net ........................... 1,182 20 1,246
Other operating income ................................ 4,262 3,313 3,014
------------ ------------ ------------
Total other income .................................. 13,657 10,218 10,915
------------ ------------ ------------
Non-interest expense:
Salaries and employee benefits (Note 13) .............. 25,811 22,740 21,928
Occupancy (Note 6) .................................... 8,493 6,878 6,289
Advertising ........................................... 1,959 2,795 2,362
Federal deposit insurance ............................. 1,241 1,872 5,418
SAIF special assessment ............................... -- -- 15,007
Other operating expense ............................... 11,420 9,866 8,171
------------ ------------ ------------
Total non-interest expense .......................... 48,924 44,151 59,175
------------ ------------ ------------
Earnings before income taxes ............................ 60,811 40,561 15,732
Income taxes (Note 11) ................................. 26,182 17,461 7,488
------------ ------------ ------------
Net earnings ............................................ $ 34,629 $ 23,100 $ 8,244
============ ============ ============
Other comprehensive earnings (loss)
Unrealized gain (loss) on mortgage-backed-
securities and securities
available-for-sale, net of taxes ...................... (311) 3,798 (8,766)
------------ ------------ ------------
Comprehensive earnings (loss) ........................... $ 34,318 $ 26,898 $ (522)
============ ============ ============
Earnings per share (Notes 12 and 15)(1)
Basic .............................................. $ 1.63 $ 1.09 $ 0.39
============ ============ ============
Diluted ............................................ $ 1.60 $ 1.07 $ 0.39
============ ============ ============
Weighted average shares outstanding (Notes 12 and 15) (1)
Basic .............................................. 21,181,859 21,139,544 21,103,530
============ ============ ============
Diluted ............................................ 21,589,377 21,494,016 21,272,472
============ ============ ============
(1) All per share amounts have been adjusted to reflect the two-for-one stock
split declared June 25, 1998.
See accompanying notes to consolidated financial statements.
47
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Dollars In Thousands)
Accumulated
Other
Comprehensive
Retained Earnings
Earnings (Loss)
(Sub- Loan to Net of
Additional stantially ESOP Taxes
Common Paid-In Restricted) (Notes 12 Treasury (Notes 3
Stock Capital (Note 12) and 13) Stock and 4) Total
-------- -------- -------- -------- -------- -------- --------
Balance, December 31, 1995 ........... $ 114 $ 28,212 $175,721 $ (2,500) $ (9,832) $ 4,576 $196,291
Exercise of employee stock options .. 1 465 -- -- -- -- 466
Net decrease in loan to employee stock
ownership plan ...................... -- -- -- 368 -- -- 368
Common stock repurchased
(127,000 shares) ................... -- -- -- -- (2,053) -- (2,053)
Unrealized loss on securities
available-for-sale, net of taxes .... -- -- -- -- -- (8,766) (8,766)
Net earnings 1996 .................... -- -- 8,244 -- -- -- 8,244
-------- -------- -------- -------- -------- -------- --------
Balance, December 31, 1996 ........... 115 28,677 183,965 (2,132) (11,885) (4,190) 194,550
Exercise of employee stock options ... -- 892 -- -- -- -- 892
Net decrease in loan to employee stock
ownership plan ...................... -- -- -- 388 -- -- 388
Unrealized gain on securities
available-for-sale, net of taxes .... -- -- -- -- -- 3,798 3,798
Benefit from stock option tax
adjustment ......................... -- 59 -- -- -- -- 59
Net earnings 1997 .................... -- -- 23,100 -- -- -- 23,100
-------- -------- -------- -------- -------- -------- --------
Balance, December 31, 1997 ........... 115 29,628 207,065 (1,744) (11,885) (392) 222,787
Exercise of employee stock options ... 1 452 -- -- -- -- 453
Net decrease in loan to employee stock
ownership plan ...................... -- -- -- 911 -- -- 911
Stock split in form of stock dividend
(Note 12) .......................... 115 (115) -- -- -- -- --
Unrealized loss on securities
available-for-sale, net of taxes .... -- -- -- -- -- (311) (311)
Common stock repurchased
(100,800) shares ................... -- -- -- -- (1,469) -- (1,469)
Net earnings 1998 .................... -- -- 34,629 -- -- -- 34,629
-------- -------- -------- -------- -------- -------- --------
Balance, December 31, 1998 ........... $ 231 $ 29,965 $241,694 $ (833) $(13,354) $ (703) $257,000
======== ======== ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
48
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Dollars In Thousands)
1998 1997 1996
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings ........................................ $ 34,629 $ 23,100 $ 8,244
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Gross change in loans held-for-sale ............... 23,932 (34,187) 1,182
Depreciation and amortization ..................... 1,546 1,775 1,722
Provision for losses on loans ..................... 7,200 20,500 35,155
Provision for losses on real estate owned ......... 572 1,639 745
Valuation adjustments on real estate sold ......... (6,591) 3,795 291
Amortization of fees and discounts ................ (1,549) (1,503) (2,210)
Decrease in deferred premium on sale of loans ..... 2,059 387 588
Change in deferred taxes .......................... (6,988) 2,919 (102)
Decrease in tax interest accrual .................. (881) (7,182) (5,135)
(Increase) decrease in interest and dividends
receivable ....................................... 3,514 (80) 1,710
Increase (decrease) in interest payable ........... 2,775 633 (8,685)
Increase in other assets .......................... (5,158) (1,237) (4,049)
Increase (decrease) in accrued expenses and
other liabilities ................................ 2,487 876 (3,947)
--------- --------- ---------
Total adjustments ............................... 22,918 (11,665) 17,265
--------- --------- ---------
Net cash provided by operating activities ....... 57,547 11,435 25,509
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Loans made to customers and principal collections
on loans ........................................... 288,360 (121,095) (84,424)
Loans repurchased under recourse arrangements ....... (1,765) (7,899) (14,806)
Proceeds from sales of real estate owned ............ 29,150 53,263 80,256
Proceeds from maturities and principal payments
of investment securities available-for-sale ........ 23,892 37,912 86,329
Principal reductions of mortgage-backed
securities available-for-sale ...................... 118,801 76,923 84,544
Purchases of investment securities
available-for-sale ................................. (39,061) (28,400) (79,405)
Purchases of FHLB stock ............................. -- (2,186) --
Other ............................................... 1,104 (1,288) 2,525
--------- --------- ---------
Net cash provided by investing activities ...... 420,481 7,230 75,019
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits ................. 192,262 (13,801) (247,588)
Net increase (decrease) in short term borrowings .... (706,498) 51,188 282,539
Repayment of long term borrowings ................... -- (50,000) (9,000)
Purchases of treasury stock ......................... (1,353) -- (2,053)
Other ............................................... 706 (5,319) 1,098
--------- --------- ---------
Net cash provided (used) by financing activities (514,883) (17,932) 24,996
--------- --------- ---------
Net increase in cash and cash
equivalents ........................................ (36,855) 733 125,524
Cash and cash equivalents at beginning of year ...... 163,135 162,402 36,878
--------- --------- ---------
Cash and cash equivalents at end of year ............ $ 126,280 $ 163,135 $ 162,402
========= ========= =========
See accompanying notes to consolidated financial statements.
49
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
The following is a summary of the significant accounting policies of
FirstFed Financial Corp. ("Company") and its wholly-owned subsidiary First
Federal Bank of California ("Bank").
The preparation of the Company's financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported operations of the Company for the periods presented.
Actual results may differ from those estimates calculated by management.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiary, the Bank. The Bank maintains 24 full-service savings
branches in Southern California. The Bank's primary business consists of
attracting retail deposits from the general public and originating loans secured
by mortgages on residential real estate. All significant inter-company balances
and transactions have been eliminated in consolidation. Certain items in the
1996 and 1997 consolidated financial statements have been reclassified to
conform to the 1998 presentation.
Statement of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include
cash, overnight investments and securities purchased under agreements to resell
with maturities within 90 days of the date of purchase.
Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments" ("SFAS No. 107"), requires the disclosure
of the fair value of financial instruments, whether or not recognized on the
statement of financial condition, for which it is practicable to estimate the
value. A significant portion of the Bank's assets and liabilities are financial
instruments as defined under SFAS No. 107. SFAS No. 107 requires that the Bank
disclose fair values for its financial instruments. Fair values, estimates and
assumptions are set forth in Note 16, Fair Value of Financial Instruments.
Risks Associated with Financial Instruments
The credit risk of a financial instrument is the possibility that a loss
may result from the failure of another party to perform in accordance with the
terms of the contract. The most significant credit risk associated with the
Bank's financial instruments is concentrated in its loans receivable.
Additionally, the Bank is subject to credit risk on certain loans sold with
recourse. The Bank has established a system for monitoring the level of credit
risk in its loan portfolio and for loans sold with recourse.
The market risk of a financial instrument is the possibility that future
changes in market prices may reduce the value of a financial instrument or
increase the contractual obligations of the Bank. The Bank's market risk is
concentrated in its portfolios of loans receivable and real estate acquired by
foreclosure. When a borrower fails to meet the contractual requirements of his
or her loan agreement, the Bank is subject to the market risk of the collateral
securing the loan. Likewise, the Bank is subject to the volatility of real
estate prices with respect to real estate acquired by
50
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
foreclosure. The Bank's securities available-for-sale are traded in active
markets. The value of these securities is susceptible to the fluctuations of the
market.
Interest Rate Risk
Financial instruments are subject to interest rate risk to the extent that
they report on a frequency, degree or basis that varies from market pricing. The
Bank is subject to interest rate risk to the degree that its interest-earning
assets reprice on a different frequency or schedule than its interest-bearing
liabilities. A majority of the Bank's loans receivable and mortgage-backed
securities reprice based on the Federal Home Loan Bank Eleventh District Cost of
Funds Index (the "Index"). The repricing of the Index tends to lag market
interest rates. The Bank closely monitors the pricing sensitivity of its
financial instruments.
Concentrations of Credit Risk
Concentrations of credit risk would exist for groups of borrowers when they
have similar economic characteristics that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic or other
conditions. The ability of the Bank's borrowers to repay their commitments is
contingent on several factors, including the economic condition in the
borrowers' geographic area and the individual financial condition of the
borrowers. The Company generally requires collateral or other security to
support borrower commitments on loans receivable . This collateral may take
several forms. Generally, on the Bank's mortgage loans, the collateral will be
the underlying mortgaged property. The Bank's lending activities are primarily
concentrated in Southern California. The Bank does not have significant exposure
to any individual customer.
Securities Purchased under Agreements to Resell
The Bank invests in securities purchased under agreements to resell
("repurchase agreements"). The Bank obtains collateral for these agreements,
which normally consists of U.S. treasury securities or mortgage-backed
securities guaranteed by agencies of the U.S. government. The collateral is held
in the custody of a trustee, who is not a party to the transaction. The duration
of these agreements is typically 1 to 30 days. The Bank deals only with
nationally recognized investment banking firms as the counterparties to these
agreements. The Bank's investment in repurchase agreements consisted solely of
securities purchased under agreements to resell identical securities.
Investments and Mortgage-Backed Securities
The Bank's investment in securities principally consists of U.S. Treasury
and agency securities and mortgage-backed securities. The Bank creates
mortgage-backed securities when it exchanges pools of its own loans for
mortgage-backed securities.
The Bank classifies its investment in securities as "held-to-maturity"
securities, "trading" securities and "available-for-sale" securities as
applicable.
51
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
The Bank classifies all of its investments and mortgage-backed securities
as "available-for-sale" based upon a determination that such securities may be
sold at a future date or that there may be foreseeable circumstances under which
the Bank would sell such securities.
Securities designated as available-for-sale are recorded at fair value.
Changes in the fair value of debt securities available-for-sale are included in
stockholders' equity as unrealized gains (losses) on securities
available-for-sale, net of taxes. Unrealized losses on available-for-sale
securities, reflecting a decline in value judged to be other than temporary, are
charged to earnings in the Consolidated Statements of Operations. Unrealized
gains or losses on available-for-sale securities are computed on a specific
identification basis.
The Bank did not hold any trading securities at December 31, 1998 or 1997.
Loans Held-for-Investment
The Bank's loan portfolio is primarily comprised of single family
residential loans (one to four units), and multi-family loans (five or more
units). Loans are generally recorded at the contractual amounts owed by
borrowers, less unearned interest and allowances for loan losses.
Loans Held-for-Sale
The Bank identifies loans that foreseeably may be sold prior to maturity
and classifies them as held-for-sale. These loans are carried at the lower of
amortized cost or fair value on an aggregate basis by type of asset. For loans,
fair value is calculated on an aggregate basis as determined by current market
investor yield requirements.
Impaired Loans
The Bank evaluates loans for impairment whenever the collectibility of
contractual principal and interest payments is questionable. A loan is impaired
when, based on current circumstances and events, a creditor will be unable to
collect all amounts contractually due under a loan agreement. Large groups of
smaller balance homogenous loans that are collectively evaluated for impairment
are not subject to the application of SFAS No. 114.
Cash payments received from impaired loans are recorded in accordance with
the contractual terms of the loan. The principal portion of the payment is used
to reduce the principal balance of the loan, whereas the interest portion is
recognized as interest income.
Allowances for Loan Losses
The Bank maintains a general valuation allowance for loan losses for the
inherent risk in the loan portfolio which has yet to be specifically identified.
The allowance is unallocated to any specific loan. The allowance is maintained
at an amount that management believes adequate to cover estimable and probable
loan losses based on a risk analysis of the current portfolio. Additionally,
management performs periodic reviews of the loan portfolio to identify potential
problems and to establish impairment allowances if losses are expected to be
incurred. Additions to the allowances are charged to earnings. The regulatory
agencies periodically review the
52
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
allowances for loan losses and may require the Bank to adjust the allowances
based on information available to them at the time of their examination.
General allowances are provided for all loans, regardless of any specific
allowances provided. The determination of the Bank's general allowance for loan
losses is based on estimates that are affected by changes in the regional or
national economy and market conditions. The Bank's management believes, based on
economic and market conditions, that the general allowance for loan losses is
adequate as of December 31, 1998 and 1997. Should there be an economic or market
downturn or if market interest rates increase significantly, the Bank could
experience a material increase in the level of loan defaults and charge-offs.
Loan Origination Fees and Costs
Loan origination fees and certain direct loan origination costs are
deferred and recognized over the lives of the related loans as an adjustment of
loan yields using the interest method. When a loan is repaid or sold, any
unamortized net deferred fee balance is credited to income.
Gain or Loss on Sale of Loans
The Bank primarily sells its mortgage loans on a servicing released basis
and recognizes cash gains or losses immediately in its Statement of Operations.
The Bank has previously sold mortgage loans and loan participations on a
servicing retained basis with yield rates to the buyer based upon the current
market rates which may differ from the contractual rate of the loans sold. Under
Statement of Financial Accounting Standards No. 125, servicing assets or
liabilities and other retained interests are required to be recorded as an
allocation of the carrying amount of the loans sold based on the estimated
relative fair values of the loans sold and any retained interests, less
liabilities incurred. Servicing assets are evaluated for impairment based on the
asset's fair value. The Bank estimates fair values by discounting servicing
assets cash flows using discount and prepayment rates that it believes market
participants would use. The Bank had no such activity in 1998, 1997 and 1996.
Servicing assets arising from the sale of loans are included in other
assets and were $2,685,000 and $4,744,000 at December 31, 1998 and 1997,
respectively. No additional servicing assets were recorded in 1998, 1997 and
1996.
Real Estate
The Bank's real estate acquired in settlement of loans ("REO") consists of
property acquired through foreclosure proceedings or by deed in lieu of
foreclosure. Generally, all loans greater than 60 days delinquent are placed
into foreclosure and, if necessary, a valuation allowance is established. The
Bank acquires title to the property in most foreclosure actions that are not
reinstated by the borrower. Once real estate is acquired in settlement of a
loan, the property is recorded as REO at fair market value, less estimated
selling costs. The REO's balance is adjusted for any subsequent declines in fair
value through a valuation allowance.
The recognition of gain on the sale of real estate is dependent on a number
of factors relating to the nature of the property, terms of sale, and any future
involvement of the Bank or its
53
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
subsidiaries in the property sold. If a real estate transaction does not meet
certain down payment, cash flow and loan amortization requirements, income is
deferred and recognized under an alternative method.
Depreciation and Amortization
Depreciation of office properties and equipment is provided by use of the
straight-line method over the estimated useful lives of the related assets.
Amortization of leasehold improvements is provided by use of the straight-line
method over the lesser of the life of the improvement or the term of the lease.
Income Taxes
The Company files a consolidated federal income tax return and a combined
California franchise tax report with the Bank and its subsidiaries. The Bank
accounts for income taxes using the asset and liability method. In the asset and
liability method, deferred tax assets and liabilities are established as of the
reporting date for the realizable cumulative temporary differences between the
financial reporting and tax return bases of the Bank's assets and liabilities.
The tax rates applied are the statutory rates expected to be in effect when the
temporary differences are realized or settled.
Earnings Per Share
The Company adopted Statement of Financial Accounting Standard No. 128,
Earnings Per Share ("SFAS No. 128") effective December 31, 1997. Under SFAS No.
128, the Company reports both basic and diluted net earnings per share. Basic
net earnings per share is determined by dividing net earnings by the average
number of shares of common stock outstanding, while diluted net earnings per
share is determined by dividing net earnings by the average number of shares of
common stock outstanding adjusted for the dilutive effect of common stock
equivalents. Net earnings per share for 1996 have been restated to conform with
the provisions of the pronouncement.
Comprehensive Income
In January of 1998, the Bank adopted SFAS No. 130, Reporting Comprehensive
Income. SFAS No. 130 establishes standards for reporting and presentation of
comprehensive income and its components in a full set of financial statements.
Comprehensive income consists of net income and net unrealized gains (losses) on
securities and is presented in the consolidated statements of operations and
comprehensive income (loss) and consolidated statements of stockholders' equity.
The Statement requires only additional disclosures in the consolidated
statements; it does not affect the Bank's financial position or results of
operations. Prior years financial statements have been reclassified to conform
to the requirements of SFAS No. 130.
Recent Accounting Pronouncements
In June of 1988, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging
54
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies (continued)
Activities" ("SFAS No. 133"), which establishes accounting and reporting
standards for derivative instruments and for hedging activities. It requires
recognition of all derivatives as either assets or liabilities in the statement
of financial condition and the measurement of those instruments at fair value.
Recognition of changes in fair value will be recognized into income or as a
component of other comprehensive income depending upon the type of the
derivative and its related hedge, if any. SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. Management has
not yet determined the impact of implementing this statement on its financial
condition or results of operations.
In October of 1998, the FASB issued Statement of Financial Accounting
Standards No. 134, "Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise"
("SFAS No. 134".) SFAS No 134 further requires that, after the securitization of
mortgage loans, an entity engaged in mortgage banking activities classify the
resulting mortgage-backed securities or other related interests based on its
ability and intent to sell or hold those investments. SFAS No. 134 conforms the
subsequent accounting for securities retained after the securitization of
mortgage loans by a mortgage banking enterprise with the subsequent accounting
for securities retained after the securitization of other types of assets by a
non-mortgage banking enterprise. SFAS is effective the first quarter beginning
after December 15, 1998. Management does not expect the implementation of this
statement to have a material affect on the Company's financial condition or
results of operations.
(2) Investment Securities
The amounts advanced under agreements to resell securities (repurchase
agreements) represent short-term investments. During the agreement period the
securities are maintained by the dealer under a written custodial agreement that
explicitly recognizes the Bank's interest in the securities. The Bank had
$71,000,000 and $115,000,000 in agreements to resell securities at December 31,
1998 and 1997, respectively which are classified as cash and cash equivalents in
the accompanying Statements of Financial Condition. Securities purchased under
agreements to resell averaged $101,637,000 and $91,195,000 during 1998 and 1997,
and the maximum amounts outstanding at any month end during 1998 and 1997 were
$147,000,000 and $154,000,000, respectively.
55
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2) Investment Securities (continued)
Investment securities, available-for-sale, are recorded at fair value and
summarized below for the periods indicated:
1998
-------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Value Gains Losses Value
-------- -------- -------- --------
(Dollars In Thousands)
United States Government
and federal agency
obligations ............ $ 28,456 $ 4 $ (521) $ 27,939
Collateralized
Mortgage Obligations ... 36,380 78 (64) 36,394
-------- -------- -------- --------
$ 64,836 $ 82 $ (585) $ 64,333
======== ======== ======== ========
1997
-------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Value Gains Losses Value
-------- -------- -------- --------
(Dollars In Thousands)
United States Government
and federal agency
obligations ............ $ 48,442 $ 1 $ (527) $ 47,916
Collateralized
Mortgage Obligations ... 1,009 -- (15) 994
-------- -------- -------- --------
$ 49,451 $ 1 $ (542) $ 48,910
======== ======== ======== ========
Related maturity data for investment securities, available-for-sale, is
summarized below for the period indicated:
1998
-------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Value Gains Losses Value
-------- -------- -------- --------
(Dollars In Thousands)
Maturing within 1 year ... $ -- $ -- $ -- $ --
Maturing after 5 years ... 28,456 4 (521) 27,939
-------- -------- -------- --------
$ 28,456 $ 4 $ (521) $ 27,939
======== ======== ======== ========
Collateralized Mortgage Obligations as of December 31, 1998 all have
expected maturities within five years. There were no sales of investment
securities during 1998, 1997 or 1996. Accrued interest on investments was
$693,000 and $940,000 at December 31, 1998 and 1997, respectively.
56
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) Mortgage-backed Securities
Mortgage-backed securities, available-for-sale, are due through the year
2035 and are summarized below for the periods indicated:
1998
-------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Value Gains Losses Value
-------- -------- -------- --------
(Dollars In Thousands)
FNMA ..................... $ 19,038 $ 85 $ -- $ 19,123
FHLMC .................... 538,352 40 (836) 537,556
-------- -------- -------- --------
Total .................... $557,390 $ 125 $ (836) $556,679
======== ======== ======== ========
1997
-------------------------------------------------
Gross Gross
Historical Unrealized Unrealized Fair
Value Gains Losses Value
-------- -------- -------- --------
(Dollars In Thousands)
FNMA ..................... $ 20,934 $ 71 $ (101) $ 20,904
FHLMC .................... 655,259 11 (116) 655,154
-------- -------- -------- --------
Total .................... $676,193 $ 82 $ (217) $676,058
======== ======== ======== ========
There were no mortgage-backed securities created with loans originated by
the Bank in 1998, 1997 or 1996. There were no sales of mortgage-backed
securities during 1998, 1997 or 1996.
Accrued interest receivable related to mortgage-backed securities
outstanding at December 31, 1998 and 1997 totaled $5,556,000 and $6,737,000,
respectively.
57
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) Loans Receivable
Loans receivable are summarized as follows:
1998 1997
---------- ----------
(Dollars In Thousands)
Real estate loans:
First trust deed residential loans:
One to four units ........................ $1,565,105 $1,801,608
Five or more units ....................... 1,127,228 1,217,577
---------- ----------
Residential loans ........................ 2,692,333 3,019,185
Other real estate loans:
Commercial and industrial ................ 181,772 196,575
Second trust deeds ....................... 15,357 15,441
Other .................................... -- 6,303
---------- ----------
Real estate loans ...................... 2,889,462 3,237,504
Non-real estate loans:
Manufactured housing ....................... 893 1,154
Deposit accounts ........................... 1,002 1,644
Consumer ................................... 1,167 185
---------- ----------
Loans receivable ....................... 2,892,524 3,240,487
Less:
General loan valuation allowance ........... 67,638 61,237
Valuation allowances for impaired loans .... 7,634 9,775
Unearned loan fees ......................... 9,031 24,311
---------- ----------
Subtotal ............................... 2,808,221 3,145,164
---------- ----------
Less:
Loans held-for-sale ........................ 16,450 40,382
---------- ----------
Loans receivable, net .................. $2,791,771 $3,104,782
========== ==========
Loans serviced for others totaled $424,908,000, $519,353,000 and
$572,275,000 at December 31, 1998, 1997 and 1996, respectively.
The Bank has loss exposure on certain loans sold with recourse. The dollar
amount of loans sold with recourse totaled $203,022,000 and $218,149,000 at
December 31, 1998 and 1997, respectively. The maximum potential recourse
liability totaled $37,267,000 and $39,926,000 at December 31, 1998 and December
31, 1997, respectively. The Bank's allowance for losses related to loans sold
with recourse, which is recorded as a liability, totaled $12,546,000 and
$13,029,000 at December 31, 1998 and 1997, respectively.
The Bank had outstanding commitments to fund $90,572,000 in real estate
loans at December 31,1998, 65% of which were adjustable rate mortgages with the
balance in fixed rate mortgages. The Bank had outstanding commitments to sell
real estate loans of $42,680,000 at December 31, 1998.
Accrued interest receivable related to loans outstanding at December 31,
1998 and 1997 totaled $18,052,000 and $20,119,000, respectively.
Loans delinquent greater than 90 days or in foreclosure were $29,315,000
and $34,117,000 at December 31, 1998 and 1997, respectively, and the related
allowances for delinquent interest were $1,896,000 and $1,819,000, respectively.
58
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4) Loans Receivable (continued)
Loans originated upon the sale of real estate totaled $9,966,000,
$31,649,000, and $54,227,000 during 1998, 1997 and 1996, respectively.
See Note 9 for loans which were pledged as security for borrowings.
The following is a summary of the activity in general loan valuation
allowances and impaired valuation allowances for the periods indicated:
General Impaired
Valuation Valuation
Allowance Allowance Total
--------- --------- -----
(Dollars In Thousands)
Balance at December 31, 1995 .................... $ 42,876 $ 26,101 $ 68,977
Provision for loan losses ....................... 23,768 11,387 35,155
Charge-offs ..................................... (16,114) (25,138) (41,252)
Recoveries ...................................... 5,070 -- 5,070
Transfer of general valuation allowance for loans
to real estate general valuation allowance .... (700) -- (700)
-------- -------- --------
Balance at December 31, 1996 .................... 54,900 12,350 67,250
Provision for loan losses ....................... 13,155 7,345 20,500
Charge-offs ..................................... (9,419) (10,064) (19,483)
Recoveries ...................................... 6,835 144 6,979
Transfer of general valuation allowance for loans
to recourse general valuation allowance ....... (4,234) -- (4,234)
-------- -------- --------
Balance at December 31, 1997 .................... 61,237 9,775 71,012
Provision for loan losses ....................... 6,560 640 7,200
Charge-offs ..................................... (3,208) (2,781) (5,989)
Recoveries ...................................... 3,049 -- 3,049
-------- -------- --------
Balance at December 31, 1998 .................... $ 67,638 $ 7,634 $ 75,272
======== ======== ========
Additionally the Bank maintains a general valuation allowance for loans
sold with recourse. This allowance is included in accrued expenses and other
liabilities in the Consolidated Statements of Financial Condition. The following
is a summary of the activity in the allowance for the periods indicated (dollars
in thousands):
Balance at December 31, 1995 ........................ $ 9,050
Charge-offs, net of recoveries ...................... (652)
--------
Balance at December 31, 1996 ........................ 8,398
Transfer from general valuation allowance ........... 4,234
Recoveries, net of charge-offs ...................... 397
--------
Balance at December 31, 1997 ........................ 13,029
Charge-offs, net of recoveries ...................... (483)
--------
Balance at December 31, 1998 ........................ $ 12,546
========
59
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) Loans Receivable (continued)
The following is a summary of impaired loans, net of valuation allowances
for impairment, for the periods indicated:
1998 1997
------- -------
(Dollars In Thousands)
Non-accrual loans .................. $ 5,934 $ 8,260
Modified loans ..................... 5,976 4,186
Other impaired loans ............... 5,613 13,239
------- -------
$17,523 $25,685
======= =======
Pursuant to SFAS No. 114, the Bank considers a loan to be impaired when
management believes that it is probable that the Bank will be unable to collect
all amounts due under the contractual terms of the loan. Estimated impairment
losses are included in the Bank's impairment allowances. At December 31, 1998,
the total recorded amount of loans for which impairment had been recognized in
accordance with SFAS No. 114 was $17,523,000 (after deducting $7,634,000 of
impairment allowances attributable to such loans). The Bank's impaired
non-accrual loans consist of single family loans with an outstanding principal
amount greater than or equal to $500,000 and multi-family loans with an
outstanding principal amount greater than or equal to $750,000.
Impaired loans for which there were no valuation allowances established are
included in the above summary and totaled $2,540,000 as of December 31, 1997.
There were no impaired loans without valuation allowances established as of
December 31, 1998.
The average recorded investment in impaired loans during the years ended
December 31, 1998, 1997 and 1996 was $17,546,000, $24,459,000 and $52,725,000
respectively. The amount of interest income recognized for impaired loans during
the years ended December 31, 1998, 1997 and 1996 was $1,289,000, $1,913,000, and
$2,656,000 respectively, under the cash basis method of accounting. Interest
income recognized under the accrual basis method of accounting for the years
ended December 31, 1998, 1997 and 1996 totaled $1,287,000, $1,900,000 and
$2,549,000, respectively. There were no commitments to lend additional funds to
borrowers whose loan terms have been modified.
(5) Real Estate
Real estate consists of the following:
1998 1997
-------- --------
(Dollars In Thousands)
Real estate acquired by
(or deed in lieu of) foreclosure ("REO") . $ 5,255 $ 10,718
Real estate general valuation allowance .. (500) (500)
-------- --------
4,755 10,218
Real estate held-for-investment .......... 36 39
-------- --------
Real estate, net ....................... $ 4,791 $ 10,257
======== ========
60
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Listed below is a summary of the activity in the general valuation
allowance for real estate owned for the periods indicated (dollars in
thousands):
Balance, December 31, 1995 ............................. $ --
Provision for losses on REO ............................ 745
Net transfers from loan general valuation allowance .... 700
Charge-offs ............................................ (924)
-------
Balance, December 31, 1996 ............................. 521
Provision for losses on REO ............................ 1,639
Charge-offs ............................................ (1,660)
-------
Balance at December 31, 1997 ........................... 500
Provision for losses on REO ............................ 572
Charge-offs ............................................ (572)
-------
Balance at December 31, 1998 ........................... $ 500
=======
The Bank acquired $16,934,000, $49,150,000 and $74,886,000 of real estate
in settlement of loans during 1998, 1997 and 1995, respectively.
61
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) Office Properties, Equipment and Lease Commitments
Office properties and equipment, at cost, less accumulated depreciation and
amortization, are summarized as follows:
1998 1997
------- -------
(Dollars In Thousands)
Land ......................................... $ 3,061 $ 3,061
Office buildings ............................. 4,594 4,519
Furniture, fixtures and equipment ............ 15,117 12,507
Leasehold improvements ....................... 8,671 8,720
Other ........................................ 44 44
------- -------
31,487 28,851
Less accumulated depreciation and amortization 19,668 18,983
------- -------
$11,819 $ 9,868
======= =======
The Bank is obligated under noncancelable operating leases for periods
ranging from five to thirty years. The leases are for certain of the Bank's
office facilities. Approximately half of the leases for office facilities
contain five and ten year renewal options. Minimum rental commitments at
December 31, 1999 under all noncancelable leases are as follows (dollars in
thousands):
1999 ......................................... $ 3,709
2000 ......................................... 3,491
2001 ......................................... 3,247
2002 ......................................... 3,147
2003 ......................................... 3,021
Thereafter ................................... 13,390
-------
$30,005
=======
Rent payments under these leases were $4,055,000, $4,325,000 and $4,270,000
for 1998, 1997 and 1996, respectively. Certain leases require the Bank to pay
property taxes and insurance. Additionally, certain leases have rent escalation
clauses based on specified indices.
(7) Federal Home Loan Bank Stock
The Bank's investment in FHLB stock at December 31, 1998 and 1997 was
$72,700,000 and $68,592,000, respectively. The FHLB provides a central credit
facility for member institutions. As a member of the FHLB system, the Bank is
required to own capital stock in the FHLBSF in an amount at least equal to the
greater of 1% of the aggregate principal amount of its unpaid home loans, home
purchase contracts and similar obligations at the end of each calendar year,
assuming for such purposes that at least 30% of its assets were home mortgage
loans, or 5% of its advances (borrowings) from the FHLBSF. The Bank was in
compliance with this requirement at December 31, 1998. The Bank's investment in
FHLB stock was pledged as collateral for advances from the FHLB at December 31,
1998 and 1997. The fair value of the Bank's FHLB stock approximates book value
due to the Bank's ability to redeem such stock with the FHLB at par value.
Accrued interest on FHLB stock totaled $1,071,000 and $1,013,000 as of December
31, 1998 and December 31, 1997, respectively.
62
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) Deposits
Deposit account balances are summarized as follows:
1998 1997
------------------------- -------------------------
Amount % Amount %
---------- ---------- ---------- ----------
(Dollars In Thousands)
Variable rate non-term accounts:
Money market deposit accounts (weighted
average rate of 3.91% and 3.36%) .......... $ 293,159 14% $ 156,221 8%
Interest-bearing checking accounts
(weighted average rate of 1.06% and
1.78%) .................................... 108,211 5 130,765 7
Passbook accounts (weighted average
rate of 2.01% and 2.04%) .................. 84,132 4 86,547 4
Non-interest bearing checking accounts ..... 137,822 6 112,373 6
---------- ---------- ---------- ----------
623,324 29 485,906 25
---------- ---------- ---------- ----------
Fixed-rate term certificate accounts:
Under six-month term (weighted average
rate of 4.18% and 5.07%) .................. 62,642 3 120,637 6
Six-month term (weighted average rate of
5.14% and 6.00%) .......................... 301,313 14 103,901 5
Nine-month term (weighted average rate of
5.42% and 5.64%) .......................... 438,443 21 374,259 19
One year to 18 month term (weighted
average rate of 5.14% and 5.53%) .......... 263,291 12 348,941 18
Two year or 30 month term (weighted
average rate of 5.28% and 5.23%) ......... 23,015 1 30,689 2
Over 30-month term (weighted average rate
of 5.79% and 5.85%) ...................... 103,030 5 125,971 7
Negotiable certificates of $100,000 and
greater, 30 day to one year terms (weighted
average rate of 5.08% and 5.50%) .......... 320,851 15 353,343 18
---------- ---------- ---------- ----------
1,512,585 71 1,457,741 75
---------- ---------- ---------- ----------
Total Deposits (weighted average rate of
4.36% and 4.66%) ........................ $2,135,909 100% $1,943,647 100%
========== ========== ========== ==========
63
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) Deposits (continued)
Certificates of deposit, placed through five major national brokerage
firms, totaled $494,224,000 and $378,501,000 at December 31, 1998 and 1997,
respectively.
Cash payments for interest on deposits (including interest credited)
totaled $93,793,000, $92,152,000 and $104,269,000 during 1998, 1997 and 1996,
respectively. Accrued interest on deposits at December 31, 1998 and 1997 totaled
$11,417,000 and $7,550,000, respectively, and is included in accrued expenses
and other liabilities in the accompanying Consolidated Statements of Financial
Condition.
The following table indicates the maturities and weighted average interest
rates of the Bank's deposits at December 31, 1998:
Non-Term There-
Accounts 1999 2000 2001 2002 After Total
-------- ---------- ------- ------- ------ ------- ----------
(Dollars In Thousands)
Deposits at
December 31, 1998....... $623,324 $1,462,460 $28,134 $ 7,108 $5,018 $ 9,865 $2,135,909
======== ========== ======= ======= ====== ======= ==========
Weighted average
interest rates ....... 2.30% 5.21% 5.21% 5.17% 5.75% 5.40% 4.36%
Interest expense on deposits is summarized as follows:
1998 1997 1996
-------- -------- ---------
(Dollars In Thousands)
Passbook accounts ................. $ 2,050 $ 1,750 $ 1,933
Money market deposits and
interest-bearing checking accounts 9,308 5,705 4,869
Certificate accounts .............. 86,301 85,223 94,793
-------- -------- --------
$ 97,659 $ 92,678 $101,595
======== ======== ========
64
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) Federal Home Loan Bank Advances and Other Borrowings
Federal Home Loan Bank (FHLB) advances and other borrowings consist of the
following:
1998 1997
---------- ----------
(Dollars In Thousands)
Advances from the FHLB of San Francisco with a
weighted average interest rate of 5.43% and 5.80%,
respectively, secured by FHLB stock and certain
real estate loans with unpaid principal balances of
approximately $1.7 billion at December 31, 1998,
advances mature through 2008 ....................... $ 714,000 $1,310,000
Unsecured term funds with a weighted average interest
rate of 5.85% for year 1997 ........................ -- 4,000
10 Year Senior Unsecured Notes with an interest
rate of 11.75%, due 2004 .......................... 50,000 50,000
---------- ----------
$ 764,000 $1,364,000
========== ==========
At December 31, 1998 and 1997, accrued interest payable on FHLB advances
and other borrowings totaled $2,050,000 and $1,690,000, respectively, which is
included in accrued expenses and other liabilities in the accompanying
Consolidated Statements of Financial Condition.
The Bank has a credit facility with the FHLB in the form of FHLB advances
and letters of credit which allow borrowings up to 40% of the Bank's assets, as
computed for regulatory purposes, or approximately $1,474,000,000 at December
31, 1998 with terms up to 30 years.
The Company's 10-year senior unsecured notes are governed by the terms of
an indenture dated September 28, 1994 (the "Indenture"). The Indenture contains
financial and operating covenants which, among other things, (i) limit the
incurrence of debt by the Company, (ii) limit the payment of dividends and the
making of certain other distributions by the Company and its subsidiaries,
including the Bank, (iii) limit the disposition of, and the existence of liens
on, the stock of the Company's subsidiaries, (iv) limit the existence of certain
liens on other property or assets of the Company and (v) limit the ability of
the Company to enter into certain transactions with affiliates. The notes are
callable each year, beginning October 1, 1999, at a premium of 5.875%. The
premium decreases annually until October 1, 2002, when there is no call premium.
65
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) Federal Home Loan Bank Advances and Other Borrowings (continued)
The following is a summary of borrowing maturities at December 31, 1998
(dollars in thousands):
1999 ....................................... $200,000
2000 ....................................... 210,000
2001 ....................................... 177,000
2003 ....................................... 92,000
2004 ....................................... 65,000
2005 ....................................... 10,000
2008 ....................................... 10,000
--------
$764,000
========
Cash payments for interest on borrowings (including reverse repurchase
agreements) totaled $101,757,000, $110,991,000 and $107,559,000 during 1998,
1997 and 1996, respectively.
Interest expense on borrowings is comprised of the following for the years
indicated:
Year Ended December 31,
--------------------------------------
1998 1997 1996
--------- --------- ---------
(Dollars In Thousands)
FHLB Advances ................. $ 53,116 $ 70,004 $ 57,427
Reverse Repurchase Agreements.. 29,915 34,335 37,345
10 Year Senior Unsecured Notes. 5,875 5,875 5,875
Other ......................... (74) 1,334 (4,211)
--------- --------- ---------
$ 88,832 $ 111,548 $ 96,436
========= ========= =========
Other interest expense in 1998 and 1996 includes the reversal of accrued
interest due to the IRS. See Note 11.
(10) Securities Sold Under Agreements to Repurchase
The Bank enters into sales of securities under agreements to repurchase
(reverse repurchase agreements) which require the repurchase of the same
securities. Reverse repurchase agreements are treated as financing arrangements,
and the obligation to repurchase securities sold is reflected as a borrowing in
the Consolidated Statements of Financial Condition. The mortgage-backed
securities underlying the agreements were delivered to the dealer who arranged
the transactions or its trustee.
At December 31, 1998, $471,172,000 in reverse repurchase agreements were
collateralized by mortgage-backed securities with principal balances totaling
$491,089,000 and fair values totaling $490,354,000. At December 31, 1997,
$577,670,000 in reverse repurchase agreements were collateralized by
mortgage-backed securities with principal balances totaling $603,544,000 and
fair values totaling $603,598,000.
The weighted average interest rates for borrowings under reverse repurchase
agreements were 5.37% and 5.66%, respectively, as of December 31, 1998 and
December 31, 1997.
66
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10) Securities Sold Under Agreements to Repurchase (continued)
Securities sold under agreements to repurchase averaged $514,498,000 and
$607,479,000 during 1998 and 1997, respectively, and the maximum amounts
outstanding at any month-end during 1998 and 1997 were $576,514,000 and
$634,976,000, respectively.
The following is a summary of maturities at December 31, 1998 (dollars in
thousands):
Up to 30 days .................................. $ 50,779
30 to 90 days .................................. 140,624
Over 90 to 182 days ............................ 279,769
--------
$471,172
========
Accrued interest on securities sold under agreements to repurchase which is
included in accrued expenses and other liabilities in the accompanying
Consolidated Statements of Financial Condition was $5,657,000 and $7,353,000 at
December 31, 1998 and 1997, respectively.
(11) Income Taxes
Income taxes (benefit) consist of the following:
1998 1997 1996
-------- -------- --------
(Dollars In Thousands)
Current:
Federal ......... $ 24,936 $ 14,311 $ 6,999
State ........... 8,234 231 591
-------- -------- --------
33,170 14,542 7,590
-------- -------- --------
Deferred:
Federal ......... (5,812) (1,502) (1,560)
State ........... (1,176) 4,421 1,458
-------- -------- --------
(6,988) 2,919 (102)
-------- -------- --------
Total:
Federal ......... 19,124 12,809 5,439
State ........... 7,058 4,652 2,049
-------- -------- --------
$ 26,182 $ 17,461 $ 7,488
======== ======== ========
A reconciliation of the statutory federal corporate income tax rate to the
Company's effective income tax rate follows:
1998 1997 1996
------ ------ ------
Statutory federal income tax rate ............ 35.0% 35.0% 35.0%
Increase (reductions) in taxes resulting from:
State franchise tax, net of federal income
tax benefit ............................... 7.5 7.4 8.5
Core deposit intangibles ................... 0.1 0.1 0.5
Provision for additional taxes due to audits -- -- 3.3
Other, net ................................. 0.5 0.5 0.3
------ ------ ------
Effective rate ........................... 43.1% 43.0% 47.6%
====== ====== ======
67
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(11) Income Taxes (continued)
Cash payments for income taxes totaled $31,762,000, $21,310,000 and
$6,754,000 during 1998, 1997 and 1996, respectively. The Company received cash
refunds totaling $48,000, $1,158,000 and $1,000,000 during 1998, 1997 and 1996,
respectively. No refunds were received during 1998.
Current income taxes receivable at December 31, 1998 and 1997 were $98,000
and $507,000, respectively.
Listed below are the significant components of the net deferred tax (asset)
and liability:
1998 1997
-------- --------
(Dollars In Thousands)
Components of the deferred tax asset:
Bad debts ...................................... $(32,819) $(29,952)
Pension expense ................................ (2,802) (2,281)
State taxes .................................... (3,484) (1,276)
IRS interest accrual ........................... (229) (633)
Tax effect of unrealized loss on
securities available-for-sale ................. (510) (284)
Other .......................................... (1,764) (1,427)
-------- --------
Total deferred tax asset ..................... (41,608) (35,853)
-------- --------
Components of the deferred tax liability:
Loan fees ...................................... 17,171 19,526
Loan sales ..................................... 1,178 2,083
FHLB stock dividends ........................... 14,294 12,386
Other .......................................... 559 3,712
-------- --------
Total deferred tax liability ................. 33,202 37,707
-------- --------
Net deferred tax liability (asset) ............... $ (8,406) $ 1,854
======== ========
Net state deferred tax liability (asset) ....... $ (9,399) $ 2,256
Net federal deferred tax liability (asset) ..... 993 (402)
-------- --------
Net deferred tax liability (asset) ............... $ (8,406) $ 1,854
======== ========
The Company provides for recognition and measurement of deductible
temporary differences to the extent that it is more likely than not that the
deferred tax asset will be realized. The Company did not have a valuation
allowance for the deferred tax asset at December 31, 1998 and 1997, as it is
more likely than not that the deferred tax asset will be realized through loss
carrybacks and the timing of future reversals of existing temporary differences.
During 1997, the Internal Revenue Service ("IRS") completed its examination
of the Company's consolidated federal income tax returns for tax years up to and
including 1992. The adjustments proposed by the IRS were primarily related to
temporary differences as to the recognition of certain taxable income and
expense items. While the Company had provided for deferred taxes for federal and
state purposes, the change in the period of recognition of certain income and
expense items resulted in interest due to the IRS and Franchise Tax Board
("FTB"). As a result, the Company paid $7,392,000 in interest to the IRS and FTB
and accrued an additional $210,000 in interest during 1997. During 1998, the
Company paid $598 thousand in interest to the IRS and FTB and reversed $300
thousand. During 1996, the Company recorded a
68
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(11) Income Taxes (continued)
$5,135,000 net reversal of accrued interest related to income taxes. The total
amount of accrued interest payable for amended returns, yet to be filed,
recorded as a liability in the Consolidated Statements of Financial Condition,
was $500,000 and $1,381,000 as of December 31, 1998 and December 31, 1997,
respectively.
As a result of legislation enacted during 1996, the Bank is required to use
the specific charge-off method of accounting for debts for all periods beginning
after 1995. Prior to this legislation, the Bank used the reserve method of
accounting for bad debts. The Consolidated Statements of Financial Condition at
December 31, 1998 and 1997 did not include a liability of $5,356,000 related to
the adjusted base year bad debt reserve. This reserve was created when the Bank
was on the reserve method.
(12) Stockholders' Equity and Earnings Per Share
The Company's stock charter authorizes 5,000,000 shares of serial preferred
stock. As of December 31, 1998 no preferred shares had been issued.
In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128, "Earnings per Share" ("SFAS No. 128"), which requires the disclosure of
two new earnings per share calculations, "basic earnings per share" and, if
applicable, "diluted earnings per share." Earnings per share for comparative
years have been restated for SFAS No. 128. Basic earnings per share is based on
the weighted average shares of common stock while diluted earnings per share
gives effect to all dilutive potential common shares that were outstanding
during part or all of the year. The Company's Board of Directors declared a
two-for-one stock split on June 25, 1998 to stockholders of record on July 15,
1998. The additional shares were distributed on July 30, 1998.
69
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(12) Stockholders' Equity and Earnings Per Share (continued)
A reconciliation of basic earnings per share with diluted earnings per
share follows (all per share amounts have been adjusted for the two-for-one
stock split declared June 25, 1998):
For the Year Ended December 31
----------------------------------------
1998
----------------------------------------
Net Earnings Shares Per-Share
Basic EPS
Income available to common stockholders $34,629,000 21,181,859 $1.63
=====
Effect of Dilutive Stock Options
Outstanding stock options .............. -- 407,518
----------- -----------
Diluted EPS
Income applicable to common stockholders
and assumed conversion ................ $34,629,000 21,589,377 $1.60
=========== =========== =====
For the Year Ended December 31
----------------------------------------
1997
----------------------------------------
Net Earnings Shares Per-Share
Basic EPS
Income available to common stockholders $23,100,000 21,139,544 $1.09
=====
Effect of Dilutive Stock Options
Outstanding stock options .............. -- 354,472
----------- -----------
Diluted EPS
Income applicable to common stockholders
and assumed conversion ................ $23,100,000 21,494,016 $1.07
=========== =========== =====
For the Year Ended December 31
----------------------------------------
1996
----------------------------------------
Net Earnings Shares Per-Share
Basic EPS
Income available to common stockholders $ 8,244,000 21,103,530 $0.39
=====
Effect of Dilutive Stock Options
Outstanding stock options .............. -- 168,942
----------- -----------
Diluted EPS
Income applicable to common stockholders
and assumed conversion ................ $ 8,244,000 21,272,472 $0.39
=========== =========== =====
Regulatory Capital
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory - and possibly additional discretionary - actions
by regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and
70
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(12) Stockholders' Equity and Earnings Per Share (continued)
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to risk
weighted assets (as defined). Management believes, as of December 31, 1998, that
the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 1998, the most recent notification from the OTS
indicated that the Bank was well capitalized under the regulatory framework for
prompt corrective action. There are no conditions or events since December 31,
1998 that management believes have changed the Bank's category.
The following table summarizes the Bank's regulatory capital and required
capital for the years indicated (dollars in thousands):
December 31, 1998
--------------------------------------------------------------
Tier 1
Tangible Core Risk-based Risk-based
Capital Capital Capital Capital
----------- ----------- ----------- -----------
Actual Capital:
Amount ............................... $ 294,223 $ 294,223 $ 294,223 $ 320,720
Ratio ................................ 7.98% 7.98% 14.15% 15.43%
FIRREA minimum required capital:
Amount ............................... $ 55,280 $ 110,561 -- $ 166,297
Ratio ................................ 1.50% 3.00% -- 8.00%
FIDICIA well capitalized required capital:
Amount ............................... -- $ 184,268 $ 124,722 $ 207,871
Ratio ................................ -- 5.00% 6.00% 10.00%
December 31, 1997
--------------------------------------------------------------
Tier 1
Tangible Core Risk-based Risk-based
Capital Capital Capital Capital
----------- ----------- ----------- -----------
Actual Capital:
Amount ............................... $ 261,099 $ 261,099 $ 261,099 $ 291,106
Ratio ................................ 6.28% 6.28% 11.02% 12.29%
FIRREA minimum required capital:
Amount ............................... $ 62,379 $ 124,757 -- $ 189,555
Ratio ................................ 1.50% 3.00% -- 8.00%
FIDICIA well capitalized required capital:
Amount ............................... -- $ 207,929 $ 142,166 $ 236,943
Ratio ................................ -- 5.00% 6.00% 10.00%
The payment of dividends is subject to certain federal income tax
consequences. Specifically, the Bank is capable of paying dividends to the
Company in any year without incurring tax liability only if such dividends do
not exceed both the tax basis current year earnings and profits and accumulated
tax earnings and profits as of the beginning of the year.
71
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12) Stockholders' Equity and Earnings Per Share (continued)
Thirty days' prior notice to the OTS of the intent to declare dividends is
required for the declaration of such dividends by the Bank. The OTS generally
allows a savings institution which meets its fully phased-in capital
requirements to distribute without OTS approval dividends up to 100% of the
institution's net earnings during a calendar year plus the amount that would
reduce the institution's "surplus capital ratio" (the excess over its fully
phased-in capital requirements) to one-half of its surplus capital ratio at the
beginning of the calendar year. However, the OTS has the authority to preclude
the declaration of any dividends or adopt more stringent amendments to its
capital regulations.
The Company may loan up to $6,000,000 to the Employee Stock Ownership Plan
("ESOP") under a line of credit loan. At December 31, 1998 and 1997, the loan to
the ESOP totaled $833,000 and $1,744,000, respectively. Interest on the
outstanding loan balance is due each December 31. Interest varies based on the
Bank's monthly cost of funds. The average rates paid during 1998 and 1997 were
5.11% and 5.27%, respectively.
On June 25, 1998, the Company adopted an Amended and Restated Shareholder
Rights Plan ("Rights Plan") which is designed to protect shareholders from
attempts to acquire control of the Company at an inadequate price. Under the
Rights Plan, the owner of each share of Company stock received a dividend of one
right ("Right") to purchase one one-thousandth of a share of a new series of
preferred stock for its estimated long term value of $200.00. In the event of
certain acquisitions of 15% or more of the voting stock or a tender offer for
15% or more of the voting stock of the Company, each holder of a Right who
exercises such Right will receive shares of the Company with a market value
equal to two times the exercise price of the Right. Also, in the event of
certain business combination transactions following the acquisition by a person
of 15% or more of the Company stock, each Rights holder will have the right to
receive upon exercise of the Right common stock of the surviving company in such
transaction having a market value of two times the exercise price of the Right.
The Company may redeem the Rights at any time prior to such acquisition or
tender offer should the Board of Directors deem redemption to be in its
stockholders' best interests. The Amended and Restated Shareholder Rights Plan
replaces the previous Shareholder Rights Plan which, by its terms, expired on
November 15, 1998.
(13) Employee Benefit Plans
Until August 31, 1996, the Bank maintained a pension plan ("Pension Plan")
covering substantially all employees who are employed on either a full time or a
part time basis. The benefits were based on an employee's years of credited
service, average annual salary and primary social security benefit, as defined
in the Pension Plan.
Effective August 31, 1996, the Pension Plan was discontinued and benefits
accrued to participants under the Pension Plan were distributed to participants
in accordance with their instructions during 1997. The Pension Plan's assets
exceeded its liabilities by $106,000, which reverted back to the Bank and are
included in the Company's 1997 Consolidated Statement of Operations.
Effective January 1, 1997, the Bank made available to its employees a
qualified defined contribution plan established under Section 401 (k) of the
Internal Revenue Code, as amended
72
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) Employee Benefit Plans (continued)
(the 401(k) Plan"). Participants are permitted to make contributions on a
pre-tax basis, a portion of which is matched by the Bank. The 401(k) Plan
expense was $235,000 and $392,000 for 1998 and 1997, respectively.
The Bank has a Supplementary Executive Retirement Plan ("SERP") which
covers any individual employed by the Bank as its Chief Executive Officer or
Chief Operating Officer. The pension expense for the SERP was $794,000, $628,000
and $506,000 in 1998, 1997 and 1996, respectively. The SERP is unfunded.
The discount rate and rate of increase in future compensation levels used
in determining the actuarial value of benefit obligations were 6.5% and 5.0%,
respectively, as of December 31, 1998. The discount rate and rate of increase in
future compensation levels used in determining the pension cost for the SERP was
5.0% as of December 31, 1998 and 1997. The plan had no assets at December 31,
1998.
The following table sets forth the funded status and amounts recognized in
the Company's Statements of Financial Condition for the SERP for the years
indicated:
1998 1997
------- -------
(Dollars In Thousands)
Actuarial present value of benefits obligations:
Accumulated benefits obligation .................... $ 4,052 $ 3,544
======= =======
Vested benefit obligation ......................... $ 4,569 $ 3,928
======= =======
Projected benefit obligation for service
rendered to date .................................... 6,472 5,548
------- -------
Shortage of plan assets over the projected
benefit obligation .................................. (6,472) (5,548)
Unrecognized net loss (gain) from past ex-
perience different from that assumed ................ 1,410 797
Prior service cost not yet recognized in
net periodic SERP cost .............................. 822 957
Unrecognized net (asset) obligation at transition .... 188 250
------- -------
Accrued SERP liability ............................... $(4,052) $(3,544)
======= =======
Net SERP cost for the year ended December
31, 1998 and 1997 included the following
components:
Service cost-benefits earned during the period ..... $ 219 $ 152
Interest cost on projected benefit obligation ...... 378 316
Net amortization ..................................... 197 160
------- -------
Net period SERP cost ................................. $ 794 $ 628
======= =======
73
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) Employee Benefit Plans (continued)
The Bank has a profit sharing plan (the "ESOP") for all salaried employees
and officers who have completed one year of continuous service. At December 31,
1998, the ESOP held 4.43% of outstanding stock of the Company. Profit sharing
expense for the years ended December 31, 1998, 1997 and 1996 was $1,000,000,
$501,000 and $500,000, respectively. The amount of the contribution made by the
Bank is determined each year by the Board of Directors, but is not to exceed 15%
of the participants' aggregated compensation. The Bank does not offer post
retirement benefits under this plan.
Stock Compensation Plans
At December 31, 1998, the Company had two stock-based compensation
programs, which are described below. The Company applies APB Opinion 25 and
related interpretations in accounting for its plans. Accordingly, no
compensation cost has been recognized for its stock compensation plans.
Stock Option Programs
The Company has an employee stock option program which is comprised of two
plans. One of these plans, the 1983 Stock Option and Stock Appreciation Rights
Plan (the "1983 Plan"), expired in 1993 but some grants issued under that plan
are still outstanding and exercisable. The 1983 Plan provided for the issuance
of up to 3,142,000 shares of common stock to employees of the Bank. Under the
1994 Stock Option and Stock Appreciation Rights Plan (the "1994 Plan"), the
Company may grant options to employees of the Bank for up to 3,000,000 shares of
common stock, subject to limitations set forth under the 1994 Plan. Under both
the 1983 Plan and the 1994 Plan, the exercise price of each option equals the
market value of the Company's stock on the date of the grant, and an option's
maximum term is 10 years. Options typically begin to vest on the second
anniversary date of the grant under both plans.
The Company also has a stock option plan for outside directors, the 1997
Non-employee Directors Stock Incentive Plan (the "Directors Stock Plan"). The
Directors Stock Plan provides for the issuance of up to 400,000 shares of common
stock to non-employee directors of the Company. The exercise price of each
option equals the market value of the Company's stock on the date of the grant,
and an option's maximum term is 10 years plus one month. Options typically vest
100% on the one year anniversary date of the grant.
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1998, 1997 and 1996, respectively: no dividend
yield in any year; expected volatility of 35%, 35% and 36%; risk free interest
rates of 4.7%, 6.5% and 5.8%; and expected average lives of 6, 6 and 10 years.
The weighted-average grant date fair value of options granted during the year
are $7.85, $5.15 and $4.25 for 1998, 1997 and 1996, respectively. The Company
has elected to recognize forfeitures in the year they occur.
74
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) Employee Benefit Plans (continued)
Had compensation cost for the Company's stock-option programs been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of Statement of Financial Standards No. 123,
"Accounting for Stock Based Compensation," the Company's net earnings and
earnings per share would have been reduced to the pro forma amounts indicated
below (all per share amounts have been adjusted for the two-for-one stock split
declared June 25, 1998):
1998 1997 1996
---- ---- ----
(Dollars in thousands except per share amounts)
Net earnings:
As reported ............. $ 34,629 $ 23,100 $ 8,244
Pro forma ............... $ 34,354 $ 22,910 $ 8,143
Earnings per share:
Basic:
As reported ............ $ 1.63 $ 1.09 $ 0.39
Pro forma .............. $ 1.62 $ 1.08 $ 0.39
Diluted:
As reported ............ $ 1.60 $ 1.07 $ 0.39
Pro forma .............. $ 1.59 $ 1.06 $ 0.38
Pro forma net earnings and earnings per share reflect only options granted
in 1998, 1997 and 1996. Therefore, the full impact of calculating compensation
cost for stock options under SFAS No. 123 is not reflected in the pro forma net
earnings per share amounts presented above because compensation cost is
reflected over the options' vesting period and compensation cost for options
granted prior to January 1, 1995 is not considered.
75
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) Employee Benefit Plans (continued)
Information with respect to stock options follows:
1998 1997 1996
-------- -------- --------
(In Shares)
Options Outstanding
(Weighted Average option prices)
Beginning of year ($7.85, $6.86 and $7.02) 707,914 639,062 694,844
Granted ($17.25, $10.88 and $7.14) ....... 168,790 226,700 68,266
Exercised ($8.55, $7.72 and $5.34) ....... (52,990) (115,538) (84,894)
Canceled ($8.99, $9.01 and $8.09) ........ (110,214) (42,310) (32,460)
Re-issued grants ($6.44) ................. -- -- 60,256
Cancellation of grants re-issued ($10.08) -- -- (66,950)
-------- -------- --------
End of Year ($9.84, $7.85 and $6.83) ..... 713,500 707,914 639,062
======== ======== ========
Shares exercisable at December 31
($5.69, $5.89 and $6.35) ............... 291,560 227,200 320,914
======== ======== ========
Restricted Stock Plan
The Company also has a restricted stock plan. Under the 1991 Restricted
Stock Plan (the "Restricted Stock Plan"), the Company may issue shares of
restricted stock to employees of the Company and its subsidiaries, including
officers and directors. A total of 1,000,000 shares have been reserved for
issuance under the Restricted Stock Plan. As of December 31, 1998 and 1997,
880,540 shares and 877,450 shares are available for grant. All per share amounts
have been adjusted for the two-for-one stock split declared June 25, 1998. The
shares consist of previously issued shares reacquired by the Company. The shares
typically vest in increments of 25% per year, beginning on the fourth
anniversary of the grant date. As shares vest, they are released to the
recipient, at which time the recipient will recognize ordinary income equal to
the fair market value of the restricted stock at the time the restrictions
lapse. In 1998, 1,000 shares were issued under this program. No shares were
issued in 1997 or 1996. Compensation costs related to shares granted under the
Restricted Stock Plan have been recorded in previous periods.
76
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(14) Parent Company Financial Information
The following condensed parent company financial information should be read
in conjunction with the other Notes to the Consolidated Financial Statements.
CONDENSED STATEMENTS OF FINANCIAL CONDITION
December 31, 1998
------------------------
1998 1997
-------- --------
(Dollars In Thousands)
Assets:
Cash ......................................... $ 12,466 $ 10,600
Other assets ................................. 1,333 1,567
Investment in subsidiary ..................... 294,819 262,572
-------- --------
$308,618 $274,739
======== ========
Liabilities and Stockholders' Equity:
Notes payable ................................ $ 50,000 $ 50,000
Other liabilities ............................ 1,618 1,952
Stockholders' equity ......................... 257,000 222,787
-------- --------
$308,618 $274,739
======== ========
Years Ended December 31,
--------------------------------------
1998 1997 1996
-------- -------- --------
CONDENSED STATEMENTS OF OPERATIONS AND (Dollars In Thousands)
COMPREHENSIVE EARNINGS
Dividends received from Bank ...... $ 5,875 $ 5,875 $ 5,875
Equity in undistributed net
earnings of subsidiary ........... 32,558 20,987 6,029
Other expense, net ................ (3,804) (3,762) (3,660)
-------- -------- --------
Net earnings ...................... $ 34,629 $ 23,100 $ 8,244
======== ======== ========
Years Ended December 31,
------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS 1998 1997 1996
-------- -------- --------
(Dollars In Thousands)
Net Cash Flows from Operating Activities:
Net earnings ..................................... $ 34,629 $ 23,100 $ 8,244
Adjustments to reconcile net earnings to
net cash provided by operating
activities:
Equity in undistributed net earnings of subsidiary (32,558) (20,987) (6,029)
Other ............................................ (129) 577 2,838
-------- -------- --------
Net cash provided by operating activities ........ 1,942 2,690 5,053
-------- -------- --------
Cash Flows from Investing Activities:
Decrease in ESOP loan ............................ 911 388 368
Purchase of treasury stock ...................... (1,469) -- (2,053)
-------- -------- --------
Net cash (used) provided by investing
Activities ...................................... (558) 388 (1,685)
-------- -------- --------
Cash Flows from Financing Activities:
Other .............................................. 482 952 465
-------- -------- --------
Net cash provided by financing activities ......... 482 952 465
-------- -------- --------
Net increase in cash .............................. 1,866 4,030 3,833
Cash at beginning of period ........................ 10,600 6,570 2,737
-------- -------- --------
Cash at end of period .............................. $ 12,466 $ 10,600 $ 6,570
======== ======== ========
77
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(15) Quarterly Results of Operations: (unaudited)
Summarized below are the Company's results of operations on a quarterly
basis for 1998, 1997 and 1996:
Basic Diluted
Provision Non- Net Earnings Earnings
Interest Interest For Loan Other Interest Earnings (Loss) (Loss)
Income Expense Losses Income Expense (Loss) Per Share Per Share
------ ------- ------ ------ ------- ------ --------- ---------
(Dollars In Thousands, Except Per Share Data)
First quarter
1998 ...................... $ 75,955 $ 49,504 $ 2,500 $ 2,255 $ 11,990 $ 8,143 $0.38 $0.37
1997 ...................... 73,685 49,653 6,000 2,902 11,911 5,168 0.25 0.24
1996 ...................... 76,097 52,952 9,000 3,273 11,466 3,368 0.16 0.16
Second quarter
1998 ...................... $ 73,587 $ 47,673 $ 2,100 $ 3,974 $ 12,684 $ 8,637 $0.41 $0.40
1997 ...................... 73,946 50,917 5,500 2,890 10,996 5,348 0.25 0.25
1996 ...................... 73,753 50,278 9,000 2,823 11,287 3,400 0.16 0.16
Third quarter
1998 ...................... $ 71,212 $ 46,402 $ 1,600 $ 3,868 $ 11,698 $ 8,830 $0.42 $0.41
1997 ...................... 75,551 51,862 5,000 2,564 10,784 5,971 0.28 0.28
1996 ...................... 73,540 50,280 8,700 2,143 25,561 (5,169) (0.25) (0.24)
Fourth quarter
1998 ...................... $ 69,015 $ 42,912 $ 1,000 $ 3,560 $ 12,552 $ 9,019 $0.43 $0.42
1997 ...................... 76,038 51,794 4,000 1,862 10,460 6,613 0.31 0.31
1996 ...................... 73,788 44,521 8,455 2,676 10,861 6,645 0.32 0.31
Total year
1998 ...................... $289,769 $186,491 $ 7,200 $ 13,657 $ 48,924 $ 34,629 $1.63 $1.60
1997 ...................... 299,220 204,226 20,500 10,218 44,151 23,100 1.09 1.07
1996 ...................... 297,178 198,031 35,155 10,915 59,175 8,244 0.39 0.39
(16) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures About
Fair Value of Financial Instruments" ("SFAS No. 107"), requires that the Company
disclose the estimated fair value for its financial instruments as of December
31, 1998 and 1997. The following table presents fair value information for
financial instruments for which a market exists. The fair values for these
financial instruments were estimated based upon prices published in financial
newspapers or quotations received from national securities dealers.
1998 1997
-------------------------- ---------------------------
Historical Historical
Value Fair Value Value Fair Value
---------- ---------- ---------- ----------
(Dollars In Thousands)
Mortgage-backed Securities ................. $557,390 $556,679 $676,193 $676,058
US Government Securities ................... 28,456 27,939 48,442 47,916
Collateralized Mortgage Obligations ........ 36,380 36,394 1,009 994
Loans Held-for-Sale ........................ 16,450 16,602 40,382 40,800
78
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(16) Fair Value of Financial Instruments (continued)
The following table presents fair value information for financial
instruments shown in the Company's Consolidated Statements of Financial
Condition for which there is no readily available market. The fair values for
these financial instruments were calculated by discounting expected cash flows.
Because these financial instruments have not been evaluated for possible sale
and because management does not intend to sell these financial instruments, the
Company does not know whether the fair values shown below represent values at
which the respective financial instruments could be sold.
1998 1997
-------------------------- --------------------------
Calculated Calculated
Carrying Fair Value Carrying Fair Value
Value Amount Value Amount
--------- --------- --------- ---------
(Dollars In Thousands)
Adjustable Loans:
Single Family ...................... $1,530,367 $1,575,173 $1,763,587 $1,818,629
Multi-Family ....................... 1,119,519 1,159,688 1,204,696 1,235,614
Commercial ........................ 178,784 188,145 201,558 211,752
Fixed Rate Loans:
Single Family ...................... 21,863 21,691 28,557 28,924
Multi-Family ....................... 7,257 7,680 6,969 7,394
Commercial ......................... 1,940 1,968 1,232 1,274
Other Real Estate Loans .............. 5,189 5,147 5,771 5,506
Consumer Loans........................ 1,619 1,617 2,099 2,097
Non-Performing Loans ................. 25,986 25,986 29,379 29,379
Fixed-Term Certificate Accounts ...... 1,512,585 1,516,809 1,457,741 1,458,317
Non-Term Deposit Accounts ............ 623,324 623,324 485,906 485,906
Borrowings ........................... 1,235,172 1,241,859 1,941,670 1,942,427
SFAS No. 107 specifies that fair values should be calculated based on the
value of one unit. The estimates do not necessarily reflect the price the
Company might receive if it were to sell the entire holding of a particular
financial instrument at one time.
Fair value estimates are based on the following methods and assumptions,
some of which are subjective in nature. Changes in assumptions could
significantly affect the estimates.
Cash and Cash Equivalents
The carrying amounts reported in the Consolidated Statements of Financial
Condition for this item approximate fair value.
Investment Securities and Mortgage-Backed Securities
Fair values are based on bid prices published in financial newspapers or
bid quotations received from national securities dealers.
79
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(16) Fair Value of Financial Instruments (continued)
Loans Receivable
The portfolio is segregated into those loans with adjustable rates of
interest and those with fixed rates of interest. Fair values are based on
discounting future cash flows by the current rate offered for such loans with
similar remaining maturities and credit risk. The amounts so determined for each
loan category are reduced by the Bank's allowance for loans losses which thereby
takes into consideration changes in credit risk. As of December 31, 1998, the
Bank had outstanding commitments to fund $90,572,000 in real estate loans which
were substantially at fair value.
Non-performing Assets
The carrying amounts reported in the Consolidated Statements of Financial
Condition for this item approximate fair value.
Deposits
The fair value of deposits with no stated term, such as regular passbook
accounts, money market accounts and checking accounts, is defined by SFAS No.
107 as the carrying amounts reported in the Consolidated Statements of Financial
Condition. The fair value of deposits with a stated maturity, such as
certificates of deposit, is based on discounting future cash flows by the
current rate offered for such deposits with similar remaining maturities.
Borrowings
For short term borrowings, fair value approximates carrying value. The fair
value of long term borrowings is based on their interest rate characteristics.
For variable rate borrowings, fair value is based on carrying values. For fixed
rate borrowings, fair value is based on discounting future contractual cash
flows by the current interest rate paid on such borrowings with similar
remaining maturities.
80
INDEPENDENT AUDITORS' REPORT
The Board of Directors
FirstFed Financial Corp.
We have audited the accompanying consolidated statements of financial
condition of FirstFed Financial Corp. and subsidiary ("Company") as of December
31, 1998 and 1997, and the related consolidated statements of operations and
comprehensive earnings (loss), stockholders' equity and cash flows for each of
the years in the three-year period ended December 31, 1998. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of FirstFed
Financial Corp. and subsidiary as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
KPMG LLP
Los Angeles, California
January 27, 1999
81
ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers appearing on pages 3
through 7 of the Proxy Statement for the Annual Meeting of Stockholders dated
April 21, 1999 is incorporated herein by reference.
ITEM 11--EXECUTIVE COMPENSATION
Information regarding executive compensation appearing on pages 8 through
14 of the Proxy Statement for the Annual Meeting of Stockholders dated April 21,
1999 is incorporated herein by reference.
ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and
management appearing on pages 2 and 3 of the Proxy Statement for the Annual
Meeting of Stockholders dated April 21, 1999 is incorporated herein by
reference.
ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
(a) Certain Relationships: None.
(b) Information regarding certain related transactions appearing on page
11 of the Proxy Statement for the Annual Meeting of Stockholders dated
April 21, 1999 is incorporated herein by reference.
PART IV
ITEM 14--EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8K
(a) 1. Consolidated Financial Statements
The consolidated financial statements included in this Report are listed
under Item 8.
2. Consolidated Financial Statement Schedules
Schedules have been omitted because they are not applicable or
the required information is presented in the consolidated
financial statements or notes thereto.
82
FIRSTFED FINANCIAL CORP. AND SUBSIDIARY
EXHIBIT
NUMBER
-------------
(1) Underwriting Agreement filed as Exhibit 1 to Amendment No. 2 to Form S-3
dated September 7, 1994 and incorporated by reference.
(3.1) Restated Certificate of Incorporation
(3.2) By-Laws filed as Exhibit (1)(a) to Form 8-A dated June 4,1987 and
incorporated by reference.
(4.1) Amended and Restated Rights Agreement dated as of June 25, 1998, filed
as Exhibit 4.1 to Form 8-A/A, dated June 25, 1998 and incorporated by
reference.
(4.2) Indenture filed as Exhibit 4 to Amendment No. 3 to Form S-3 dated
September 20, 1994 and incorporated by reference.
(10.1) Deferred Compensation Plan filed as Exhibit 10.3 to Form 10-K for the
fiscal year ended December 31, 1983 and incorporated by reference.
(10.2) Bonus Plan filed as Exhibit 10(iii)(A)(2) to Form 10 dated November 2,
1993 and incorporated by reference.
(10.3) Supplemental Executive Retirement Plan dated January 16, 1986 filed as
Exhibit 10.5 to Form 10-K for the fiscal year ended December 31, 1992
and incorporated by reference.
(10.4) Change of Control Agreement effective September 26, 1996 filed as
Exhibit 10.4 to Form 10-Q for the Quarter ended September 30, 1996 and
incorporated by reference.
(10.5) 1997 Non-employee Directors Stock Incentive Plan filed as Exhibit 1 to
Form S-8 dated August 12, 1997 and incorporated by reference.
(21) Registrant's sole subsidiary is First Federal Bank of California, a
federal savings bank.
(24) Power of Attorney (included at page 86).
This 1998 Annual Report on Form 10-K and the Proxy Statement for the Annual
Meeting of Stockholders dated April 21, 1999 have already been furnished to each
stockholder of record who is entitled to receive copies thereof. Copies of these
items will be furnished without charge upon request in writing by any
stockholder of record on March 5, 1999 and any beneficial owner of Company stock
on such date who has not previously received such material and who so represents
in good faith and in writing to:
Corporate Secretary
FirstFed Financial Corp.
401 Wilshire Boulevard
Santa Monica, California 90401
Other exhibits will be supplied to any such stockholder at a charge equal
to the Company's cost of copying, postage, and handling.
(b) Reports on Form 8-K
The Company filed a current report on Form 8-K dated October 22, 1998
which, among other things, announced a new stock repurchase program.
83
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRSTFED FINANCIAL CORP.,
a Delaware corporation
By: /s/ Babette E. Heimbuch
-----------------------------
Babette E. Heimbuch
President and
Chief Executive Officer
Date: February 25, 1999
84
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes Babette E.
Heimbuch and Douglas J. Goddard, and each of them or either of them, as
attorney-in-fact to sign on his or her behalf as an individual and in every
capacity stated below, and to file all amendments to the Registrant's Form 10-K,
and the Registrant hereby confers like authority to sign and file in its behalf.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on the 25th day of February, 1999.
SIGNATURE TITLE
/s/ Babette E. Heimbuch Chief Executive Officer (Principal
- -------------------------------------- Executive Officer)
Babette E. Heimbuch
/s/ Douglas J. Goddard Executive Vice President and
- -------------------------------------- Chief Financial Officer (Principal
Douglas J. Goddard Financial Officer)
/s/ Brenda J. Battey Senior Vice President and Controller
- -------------------------------------- (Principal Accounting Officer)
Brenda J. Battey
/s/ Christopher M. Harding Director
- --------------------------------------
Christopher M. Harding
/s/ James L. Hesburgh Director
- --------------------------------------
James L. Hesburgh
/s/ William S. Mortensen Chairman of the Board
- --------------------------------------
William S. Mortensen
/s/ William G. Ouchi Director
- --------------------------------------
William G. Ouchi
/s/ William P. Rutledge Director
- --------------------------------------
William P. Rutledge
/s/ Charles F. Smith Director
- --------------------------------------
Charles F. Smith
/s/ Steven L. Soboroff Director
- --------------------------------------
Steven L. Soboroff
/s/ John R. Woodhull Director
- --------------------------------------
John R. Woodhull
85