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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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 ____________ TO ____________ .
COMMISSION FILE NUMBER 33-13646
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WESTCORP
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 51-0308535
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
23 PASTEUR, IRVINE, CALIFORNIA 92618-3816
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE: (714) 727-1000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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COMMON STOCK $1 PAR VALUE NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports, and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 28,1999:
COMMON STOCK, $1.00 PAR VALUE -- $201,327,555
The number of shares outstanding of the issuer's class of common stock as of
February 28,1999:
COMMON STOCK, $1.00 PAR VALUE -- 26,475,090
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the 1998 Annual Meeting of
Shareholders to be held April 27, 1999 are incorporated by reference into Part
III.
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WESTCORP AND SUBSIDIARIES
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 33
Item 3. Legal Proceedings........................................... 33
Item 4. Submission of Matters to a Vote of Security Holders......... 33
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 34
Item 6. Selected Financial Data..................................... 35
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 37
Item 7A. Quantitative and Qualitative Disclosure about Market Risk... 64
Item 8. Financial Statements and Supplementary Data................. 65
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................. 66
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 66
Item 11. Executive Compensation...................................... 66
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 66
Item 13. Certain Relationships and Related Transactions.............. 66
PART IV
Item 14. Financial Statement Schedules, Exhibits and Reports on Form
8-K....................................................... 66
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PART I
ITEM 1. BUSINESS
GENERAL
Westcorp (the "Company"), a California corporation, is a diversified
financial services holding company providing automobile lending through WFS
Financial Inc. ("WFS") and community banking and mortgage banking through
Western Financial Bank (the "Bank"). The Company owns all the capital stock of
the Bank, its principal subsidiary. The Bank owns 87% of the capital stock of
WFS. See "Subsidiaries."
In 1982, the Company acquired Evergreen Savings and Loan Association
("Evergreen"), a California-licensed savings and loan association, which became
a wholly-owned subsidiary of the Company. Evergreen's name was later changed to
Western Financial Savings Bank. In 1992, Western Financial Savings Bank
converted to a federal charter and the name was ultimately changed to Western
Financial Bank.
The Bank is subject to examination and comprehensive regulation by the
Office of Thrift Supervision ("OTS") and the Federal Deposit Insurance
Corporation ("FDIC"). It is further subject to certain regulations of the Board
of Governors of the Federal Reserve System ("FRS") which governs reserves
required to be maintained against deposits and other matters. The Bank is also a
member of the Federal Home Loan Bank of San Francisco ("FHLB"), one of twelve
regional banks for federally insured savings and loan associations and banks
comprising the FHLB System. The FHLB System is under the supervision of the
Federal Housing Finance Board. WFS and certain other subsidiaries of the Bank
are further regulated, in part, by various departments or commissions of the
states in which they do business. The types of loans which the Company may
originate are primarily defined by federal statutes and regulations.
The Company's strategy has been to focus on and expand its three principal
lines of business -- automobile lending, community banking, and mortgage
banking.
Since 1973, WFS and its predecessors, has been in the business of
purchasing fixed rate consumer auto loans ("contracts") from its network of new
and used car dealers ("dealers"). WFS then securitizes the majority of these
contracts through underwritten public sales of AAA/Aaa rated asset backed
securities and retains the rights to service them. As of February 28, 1999, WFS
purchased contracts in California and 41 other states. Over the past five years,
WFS has increased its volume of contracts purchased from $1.2 billion in 1994 to
$2.7 billion in 1998, representing an 18% compounded annual growth rate. WFS
serviced a total of $4.4 billion, $3.7 billion and $3.0 billion of contracts at
December 31, 1998, 1997 and 1996, respectively.
Based upon published data, the auto finance industry exceeded $500 billion
in 1998, and is the second largest consumer finance market in the United States.
The Company's contract purchase and securitization activities have made it one
of the largest sellers, in aggregate dollar amount, of auto receivable backed
securities in the United States after the captive auto finance companies,
Chrysler Credit Corporation ("Chrysler Credit"), General Motors Acceptance
Corporation ("GMAC") and Ford Motor Credit Company ("Ford Credit"). Aside from
these and other captive auto finance companies, the balance of the auto finance
industry is highly fragmented among banks, credit unions, savings associations
and independent auto finance companies.
WFS competes in both the prime and non-prime segments of the auto finance
industry. During 1998, WFS purchased approximately 69% of its contracts from
franchised new car dealers, 30% from independent used car dealers and originated
1% directly from consumers. During that same period, contracts for new and used
autos represented 21% and 79%, respectively, of the Company's volume of
contracts purchased. References herein to "purchase" and "contracts" refer to
both the purchase of contracts by WFS from new and used car dealers and the
origination of auto loans directly from consumers by WFS.
The Company continues its expansion of its community banking operations
which includes a commercial banking division and a retail banking division. The
commercial banking division commenced operation in 1996.
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The Company's strategy is to target small and medium-sized businesses in
southern California, offering loans, lines of credit and trade finance services,
as well as account analysis, cash management and other commercial depository
services. In its retail banking operations, the Company serves the needs of
individuals and small businesses by establishing "relationship banking" and
offers a broad range of products, such as demand deposits, money market
accounts, certificates of deposits and other investment services. The Company
continues to look for ways to improve or expand its delivery channels of such
products including its 25 retail banking locations, automated teller machines
("ATMs") and the Internet.
Given the declining interest rates experienced in 1998 and the accelerating
rate of changes in the mortgage banking industry, the Company determined to
shift the focus of its mortgage banking division from prime and non-agency
originations to the sub-prime mortgage market. During 1999, the Company will
focus primarily on originating sub-prime mortgages nationwide through its
wholesale broker network. In turn, these loans will generally be packaged and
sold on a whole loan, servicing released basis in the secondary market. This
shift in strategy led to the sale of substantially all of the mortgage loan
servicing rights portfolio and the consolidation of the Company's prime lending
offices. See "Improve Operating Efficiencies -- Mortgage Banking".
The following table sets forth the loan origination, purchase and sale
activity of the Company for the periods indicated.
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Loans originated:
Consumer loans
Automobile(1)................... $2,670,696 $2,285,279 $2,121,689 $1,527,649 $1,177,031
Other........................... 9,645 52,080 35,867 28,647 14,529
---------- ---------- ---------- ---------- ----------
Total consumer loans............ 2,680,341 2,337,359 2,157,556 1,556,296 1,191,560
Mortgage loans:
Existing property............... 2,725,415 2,306,251 1,240,652 481,441 621,416
Construction.................... 18,721 17,078 10,207 5,697 18,853
Equity.......................... 10,262 8,177 8,857 4,136 35,692
---------- ---------- ---------- ---------- ----------
Total mortgage loans............ 2,754,398 2,331,506 1,259,716 491,274 675,961
Commercial......................... 124,259 71,399 8,632
---------- ---------- ---------- ---------- ----------
Total loans originated............... 5,558,998 4,740,264 3,425,904 2,047,570 1,867,521
Loans purchased:
Mortgage loans on existing
property........................ 450 6,166 213 252 45,373
---------- ---------- ---------- ---------- ----------
Total loans purchased................ 450 6,166 213 252 45,373
Loans sold or securitized:
Automobile loans................... 1,885,000 2,190,000 2,090,000 1,480,000 842,000
Mortgage loans..................... 2,884,073 1,974,423 992,582 304,242 541,923
---------- ---------- ---------- ---------- ----------
Total loans sold or securitized...... 4,769,073 4,164,423 3,082,582 1,784,242 1,383,923
Principal reductions(2).............. 670,252 440,714 359,334 273,244 334,627
---------- ---------- ---------- ---------- ----------
Increase (decrease) in total loans... $ 120,123 $ 141,293 $ (15,799) $ (9,664) $ 194,344
========== ========== ========== ========== ==========
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(1) Includes automobile loans purchased from automobile dealers.
(2) Includes scheduled payments, prepayments and chargeoffs.
At December 31, 1998, the Company's loan portfolio totalled $2.0 billion,
of which 44% were automobile loans net of unearned discounts, 51% were loans
secured by real property used primarily for residential purposes, 3% were
commercial loans and 2% were other consumer loans. The Company's loan portfolio
totalled $1.9 billion at December 31, 1997, of which 13% were automobile loans,
82% were loans secured by real property used primarily for residential purposes,
2% were commercial loans and 3% were other consumer
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loans. Consumer loans serviced for the benefit of others remained constant at
$3.5 billion at December 31, 1998 and 1997. Mortgage loans serviced for the
benefit of others declined to $1.6 billion at December 31, 1998 compared with
$4.9 billion at December 31, 1997 as a result of the Company selling the
majority of its servicing rights as part of the Company's strategy to shift
towards originating sub-prime mortgage products that would be sold on a whole
loans, servicing released basis.
The following table sets forth the composition of the Company's loan
portfolio by type of loan, including loans held for sale, as of the dates
indicated.
DECEMBER 31,
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1998 1997 1996 1995
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AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT
---------- ------- ---------- ------- ---------- ------- ----------
(DOLLARS IN THOUSANDS)
Consumer loans:
Automobile........................... $ 923,662 46.3% $ 253,455 13.5% $ 267,716 15.5% $ 320,870
Other................................ 45,529 2.3 62,870 3.4 56,553 3.3 26,597
---------- ----- ---------- ----- ---------- ----- ----------
969,191 48.6 316,325 16.9 324,269 18.8 347,467
Less: unearned discounts.............. 48,015 2.4 22,225 1.2 33,768 2.0 4,440
---------- ----- ---------- ----- ---------- ----- ----------
Total consumer loans........... 921,176 46.2 294,100 15.7 290,501 16.8 343,027
Mortgage loans:
Loans on existing property........... 994,404 49.9 1,529,764 81.7 1,435,750 82.9 1,406,552
Construction loans................... 18,950 0.9 15,835 0.9 5,501 0.3 8,469
---------- ----- ---------- ----- ---------- ----- ----------
Total mortgage loans........... 1,013,354 50.8 1,545,599 82.6 1,441,251 83.2 1,415,021
Less: undisbursed loan proceeds....... 6,417 0.3 8,657 0.5 8,201 0.5 10,831
---------- ----- ---------- ----- ---------- ----- ----------
Total mortgage loans........... 1,006,937 50.5 1,536,942 82.1 1,433,050 82.7 1,404,190
---------- ----- ---------- ----- ---------- ----- ----------
Commercial loans...................... 64,720 3.3 41,668 2.2 7,867 0.5
---------- ----- ---------- ----- ---------- ----- ----------
Total loans.................... $1,992,833 100.0% $1,872,710 100.0% $1,731,418 100.0% $1,747,217
========== ===== ========== ===== ========== ===== ==========
Loan serviced for the benefit of
others:
Consumer loans..................... $3,491,457 68.4% $3,459,272 41.3% $2,812,637 38.8% $1,894,944
Mortgage loans..................... 1,612,103 31.6 4,917,712 58.7 4,436,789 61.2 3,688,730
---------- ----- ---------- ----- ---------- ----- ----------
Total loans serviced for the
benefit of others............. $5,103,560 100.0% $8,376,984 100.0% $7,249,426 100.0% $5,583,674
========== ===== ========== ===== ========== ===== ==========
DECEMBER 31,
------------------------------
1995 1994
------- --------------------
PERCENT AMOUNT PERCENT
------- ---------- -------
(DOLLARS IN THOUSANDS)
Consumer loans:
Automobile........................... 18.4% $ 508,719 29.0%
Other................................ 1.5 14,837 0.8
----- ---------- -----
19.9 523,556 29.8
Less: unearned discounts.............. 0.3 82,762 4.7
----- ---------- -----
Total consumer loans........... 19.6 440,794 25.1
Mortgage loans:
Loans on existing property........... 80.5 1,307,744 74.4
Construction loans................... 0.5 19,813 1.2
----- ---------- -----
Total mortgage loans........... 81.0 1,327,557 75.6
Less: undisbursed loan proceeds....... 0.6 11,470 0.7
----- ---------- -----
Total mortgage loans........... 80.4 1,316,087 74.9
----- ---------- -----
Commercial loans......................
----- ---------- -----
Total loans.................... 100.0% $1,756,881 100.0%
===== ========== =====
Loan serviced for the benefit of
others:
Consumer loans..................... 33.9% $1,208,674 42.2%
Mortgage loans..................... 66.1 1,656,811 57.8
----- ---------- -----
Total loans serviced for the
benefit of others............. 100.0% $2,865,485 100.0%
===== ========== =====
AUTOMOBILE OPERATIONS
AUTOMOBILE LENDING
WFS purchases contracts across the full spectrum of prime and non-prime
credit quality contracts and offers competitive rates commensurate with the risk
inherent in its obligor's ability to make payments under their contracts. During
1997 and 1998, WFS tightened its underwriting standards on the lowest tier of
its non-prime contract purchases based upon WFS' credit performance experience.
As a result, WFS purchased a higher percentage of prime contracts in 1998. This
shift in product mix is providing WFS with higher returns based upon loss
expectations.
The following table below presents a summary of the Company's automobile
lending production volumes.
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
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(DOLLARS IN THOUSANDS)
New vehicles................................... $ 547,898 $ 417,075 $ 441,529
Used vehicles.................................. 2,122,798 1,868,204 1,680,160
---------- ---------- ----------
Total volume......................... $2,670,696 $2,285,279 $2,121,689
========== ========== ==========
Prime contracts................................ $1,808,013 $1,245,027 $1,129,314
Non-prime contracts............................ 862,683 1,040,252 992,375
---------- ---------- ----------
Total volume......................... $2,670,696 $2,285,279 $2,121,689
========== ========== ==========
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BUSINESS STRATEGIES
WFS pursues its business objective of maximizing earnings through the
profitable purchase, securitization and servicing of contracts using four
strategies: (i) provide a consistent source of prime and non-prime financing to
its nationwide network of dealers, (ii) maintain solid asset quality, (iii)
maximize liquidity through relationship with parent and securitizations
transactions, and (iv) improve operating efficiencies.
Prime and Non-Prime Financing
WFS has provided a consistent source of auto financing since 1973 and is
dedicated to continuing to provide a consistent source of prime and non-prime
financing to its network of over 11,300 dealers. While other lenders have
retreated from time to time, WFS has consistently and continuously expanded its
operations in the auto finance market. WFS' focus is to provide each dealer
maximum service by providing a single source of contact to meet the dealer's
prime and non-prime financing needs. Substantially all contracts are purchased
without recourse to the dealer. WFS pays an upfront dealer participation to the
originating dealer for each contract purchased.
Maintain Solid Asset Quality
Consistent and Expeditious Underwriting -- The Company relies on a
combination of multiple credit scoring models, system controlled underwriting
policies and the judgment of its trained credit analysts to make risk based
credit decisions. In order to make timely credit decisions, WFS personnel are
trained to obtain, examine and verify all relevant underwriting information
quickly utilizing the Company's automated credit application processing system.
The Company's credit analysts are closely monitored by management through trend
analysis, risk management reporting, and internal quality control professionals
to insure adherence to the Company's underwriting guidelines. Credit analyst
lending levels and approval authorities are established based on the
individual's credit experience, portfolio performance, Credit Manager audit
results and quality control review results. The goal in underwriting contracts
is to correctly determine whether an applicant has the ability and intent to
perform on his or her obligations under the contract, thereby maximizing returns
while optimizing credit quality.
Collection Activities -- WFS services all of the contracts it purchases,
both those held by the Company and those sold in securitization transactions.
The servicing process includes the routine collection and allocation of payments
to WFS or to the appropriate securitization transaction into which the contract
has been sold.
WFS has developed procedures for the early identification and cure of
delinquent contracts. During the early stages of delinquency, WFS utilizes an
automated telephone dialing system to aid in the servicing and collection
process. If the early collection efforts do not result in a satisfactory
resolution of the delinquent account, then the account is forwarded to the
appropriate regional collection specialist.
If satisfactory payment arrangements are not made, the automobile is
generally repossessed within 60 to 90 days of the date of delinquency, subject
to compliance with applicable law. WFS uses independent contractors to perform
repossessions. The automobile remains in the custody of WFS for 15 days (or
longer if required by local law) to provide the obligor the opportunity to
redeem the contract. If after the redemption period the delinquency is not
cured, WFS writes down the vehicle to fair value and reclassifies the contract
as a repossessed asset. After the redemption period expires, WFS prepares the
automobile for sale. WFS sells substantially all repossessed automobiles through
wholesale auto auctions, subject to applicable law. WFS does not provide the
financing on repossessions sold. WFS uses regional remarketing departments to
sell its repossessed vehicles. Once the vehicle is sold, any remaining
deficiency balances are then charged off. At December 31, 1998, the total amount
of repossessed autos managed by WFS was $7.8 million or 0.18% of the total
serviced portfolio compared with $9.7 million or 0.26% of the total serviced
portfolio at December 31, 1997.
After chargeoff, WFS will seek to collect deficient balances through its
centralized asset recovery center ("ARC"). The ARC will first attempt to collect
directly from the obligor with its in-house collection staff. If
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efforts are not successful, the ARC will seek a deficiency judgment through a
small claims court procedure, where available, or an attorney employed by WFS
takes more formal judicial action against customers with deficiency balances in
excess of that which may be brought in a small claims court proceeding. In some
cases, particularly when the likelihood of recovery is believed to be less
likely, the account is assigned to a collection agency for final resolution. The
ARC will attempt to obtain vehicles that could not be found for repossession by
skip tracing to locate the vehicle. WFS also monitors payment plans on those
obligors who have filed for bankruptcy. If the obligor is not following the
payment plan stipulated by the courts in a Chapter 13 bankruptcy, WFS will seek
a judgment for dismissal or discharge from the bankruptcy court, or will seek an
order permitting it to repossess the vehicle.
Maximize Liquidity Through Relationship with Parent and Securitization
Transactions
As a subsidiary of a federally chartered savings bank, WFS may utilize the
Bank's liquidity sources through the use of intercompany financing arrangements.
WFS believes that this relationship provides it a competitive advantage relative
to other independent auto finance companies that must enter into financing
arrangements with outside financial institutions. WFS also utilizes both
securitization and hedging strategies to leverage its capital efficiently and
substantially reduce its interest rate risk, while also limiting its credit loss
exposure on contracts sold. See "Hedging and Securitization". During the third
quarter of 1998 when adverse conditions existed in the secondary markets, WFS
was able to increase its borrowing with its parent and delay its securitization
transaction until market conditions improved. WFS expects to continue to utilize
both its funding sources with its parent company and securitization as
conditions warrant.
Improve Operating Efficiencies -- Auto
In 1998, the Company completed a restructuring plan initially announced on
February 10, 1998. The plan had four objectives: to reduce operating costs, to
increase contract production volume, to strengthen credit quality and to improve
the quality of personnel. The plan was achieved in two phases. Phase I of the
plan, completed in the first quarter of 1998, consisted of the restructuring of
operations in the Western United States. Phase II of the plan, completed in the
third quarter of 1998 and patterned after Phase I, consisted of the
restructuring of operations in the Central and Eastern United States.
As a result of the restructuring, a total of 400 positions, or 19% of the
Company's workforce, were eliminated and 96 offices were closed. The Company now
purchases contracts through 21 regional business centers ("RBCs") and 26
satellite offices, each offering the full spectrum of prime and non-prime
products. The total pre-tax restructuring charge in 1998 for the completed plan
was $15.0 million. Restructuring related costs included $1.8 million for
employee severance and $13.2 million for lease termination fees and the write
off of disposed assets. The restructuring charge was substantially utilized
during 1998. Operating costs as a percent of serviced contracts has declined
from 5.4% in 1997 to 3.8% in 1998, resulting in a decrease in operating costs of
$65 million on an annual run rate basis.
Through the restructuring, WFS increased its contract production volume to
$2.7 billion compared with $2.3 billion in 1997. Prior to the restructuring, the
Company purchased contracts in 143 offices, each serving either the prime or
non-prime market. As part of the restructuring, the Company closed poorly
performing offices and combined its prime and non-prime marketing into a single,
unified marketing effort. By combining the marketing of the two products under a
single marketing force, WFS is able to more fully leverage its existing dealer
relationships across the full spectrum of credit.
Each of the 47 offices underwrites contracts by employing separate credit
analysts that specialize in either reviewing prime or non-prime contracts. The
underwriting process is further enhanced by credit policies and contract
approval authorities controlled by the front-end contract production system and
through the use of the Company's proprietary scorecard which was implemented in
the fourth quarter of 1998. See "Maintain Solid Asset Quality -- Consistent and
Expeditious Underwriting."
As part of the restructuring, early delinquency collection efforts were
centralized at two national servicing centers that employ automated queuing and
dialing techniques to contact customers. When these efforts are
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unsuccessful, the collection process is transferred to the RBCs where loan
service counselors undertake more extensive collection efforts up to and
including repossession. The Company plans to further improve its collection
efforts by implementing a new collection system, including risk-based
collections, in 1999.
During 1998, the Company also established a more effective management
structure. Each RBC is managed by a RBC manager who directs and is responsible
for the performance of the region. Four functional managers who oversee
marketing, credit, collections and operations report directly to the RBC
manager. This organization is designed to provide overall coordination of the
activities within the RBC with appropriate focus and specialization in each of
these four critical business areas. Each of these critical functions also has a
national director who provides expertise, training and policy development,
management and enforcement. This matrix structure has been effective in
providing greater oversight, compliance and focus for each aspect of the
organization and has helped standardize operating practices by identifying best
practices and employing these practices throughout the organization.
HEDGING AND SECURITIZATION
The Company employs a hedging and securitization strategy to leverage its
capital efficiently, lock in interest rate spreads and materially reduce its
interest rate risk while also limiting its credit loss exposure on automobile
loans sold. Securitization enables the Company to sell automobile loans on a
regular basis while continuing to receive servicing fees and to use the proceeds
from such sales to purchase additional automobile loans.
Between December 1985 and December 1998, the Company sold, in 43
transactions, approximately $11.9 billion of automobile loans in publicly
underwritten securitization transactions. The Company also sold $1.0 billion of
automobile loans in February of 1999. The first issue was rated AA by Standard &
Poor's Rating Service, a division of McGraw-Hill, Inc. ("S&P") and Aa by Moody's
Investor Service, Inc. ("Moody's") and all 43 issues since that time were rated
AAA by S&P and Aaa by Moody's, their highest rating categories, as a result of
the structure of the transactions and the quality of the automobile loans
securitized or the credit enhancement provided by FSA. In all of its
securitization transactions, the Company continues to service the automobile
loans sold. Each transaction is independent of all others, with no cross-
collateralization or cross-default provisions applicable. Each securitization
transaction and each class of security with a maturity date prior to the date
hereof has been paid in full on or before its contracted final maturity date and
no recourse has been made to FSA on any transaction.
In 1996, the Company began to securitize its automobile loans using an
owner trust structure, issuing both collateralized notes and pass-through
certificates. Securitizations using the owner trust structure are also treated
as sales without recourse thereby removing the automobile loans sold from the
balance sheet of the Company. The Company retains the servicing of the
automobile loans sold to the owner trust and receives excess interest from the
automobile loans sold. The owner trust structure enables the Company to maximize
the residual return from a securitization transaction by matching the yield paid
to the investor to the yield curve existing at the time the securitization
transaction is consummated. The Company securitized $1.9 billion and $2.2
billion of automobile loans using this structure during 1998 and 1997,
respectively.
The Company derives multiple benefits from the securitization of automobile
loans, including a stable source of low cost funding, reduction of interest rate
for sold automobile loans, enhanced return on assets and regulatory compliance.
Low Cost of Funds -- Other than the first transaction, all of the
securitization transactions completed by WFS to date hereof have been rated
in the highest credit categories by both S&P and Moody's. Accordingly, WFS
has been able to sell these securities at attractive yields relative to its
cost of alternative funding sources at the time of pricing.
Reduction of Interest Rate Risk -- Since these transactions are
structured as asset sales, interest rate risk is largely transferred to the
third party buyers of the related asset backed securities. The interest
rate and maturity of the pool of contracts have durations that are matched
with the securities, thereby locking-in the excess spread of the automobile
loans securitized.
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Enhanced Return on Assets -- These securitizations reduce the level of
average assets on balance sheet while providing WFS with ongoing retained
interest income and contractual servicing fee income.
Regulatory Compliance -- As a Federal savings bank, the Bank may not
have more than 35% of its consolidated assets invested in consumer loans,
including automobile loans purchased from Dealers. Automobile loans
securitized are not included in the calculation of consolidated assets.
WFS REINVESTMENT CONTRACT
Pursuant to a series of agreements to which WFS, the Bank and WFS Financial
Auto Loans 2, Inc. ("WFAL2"), among others, are parties, WFS is able to access
the cash flows of each of the outstanding securitization transactions and the
cash held in the spread account for each of those transactions. WFS is permitted
to use that cash without restriction, including in its ordinary business
activities of originating contracts.
In each securitization transaction, the Bank and WFAL2 have entered into a
reinvestment contract, which is deemed to be an eligible investment under the
relevant securitization agreements. The securitization agreements require,
provided certain conditions are met, that all cash flows of the relevant trust
and the associated spread accounts be invested in the applicable reinvestment
contract. A limited portion of the invested funds may be used by WFAL2 and the
balance may be used by the Bank. The Bank makes its portion available to WFS
pursuant to the terms of the WFS Reinvestment Contract ("RIC"). Under the RIC,
WFS receives access to all of the cash available to the Bank under each trust
reinvestment contract and is obligated to repay to the Bank an amount equal to
the cash so used when needed by the Bank to meet its obligations under the
individual trust reinvestment contracts. With the portion of the cash available
to it under the individual trust reinvestment contracts, WFAL2 purchases
contracts from WFS pursuant to the terms of Sale and Servicing Agreements.
Pursuant to an agreement with Financial Security Assurance ("FSA"), the
issuer of financial guaranty insurance policies for each securitization
transaction, the trust reinvestment contracts may be eligible investments
provided the Bank and WFAL2 pledge adequate collateral to secure their
respective obligations under the reinvestment contracts. In accordance with this
agreement, the Bank and WFAL2 pledge property owned by each for the benefit of
the trustee of each trust and FSA. WFS pays the Bank a fee equal to 12.5 basis
points of the amount of collateral pledged by the Bank as consideration for the
pledge of collateral by the Bank and for WFS' access to cash under the RIC.
During 1998, WFS paid the Bank $0.7 million for this purpose. As WFAL2 directly
utilizes the cash made available to it to purchase contracts for its own account
from WFS, no additional consideration from WFS is required to support WFAL2's
pledge of its property under the agreement with FSA. While WFS is under no
obligation to repurchase contracts from WFAL2 to the extent WFAL2 needs to sell
any such contracts to fund its repayment obligations under the trust
reinvestment contracts, it is anticipated that WFS would prefer to purchase
those contracts than for WFAL2 to sell those contracts to a third party. The
RIC, by its terms, is to remain in effect so long as any of the trust
reinvestment contracts is an eligible investment for its related securitization
transaction. During 1998 the average amount outstanding under the RIC was $585
million and the average amount of contracts purchased by WFAL2 from WFS was $119
million. At December 31, 1998, the amount outstanding under the RIC was $364
million and the amount of contracts held by WFAL2 purchased from WFS was $355
million.
BANK OPERATIONS
COMMUNITY BANKING
COMMERCIAL BANKING
The Company continues to focus its commercial banking operations in the
Orange, Los Angeles and San Diego County metropolitan areas, operating through
the Irvine headquarters office. The Company targets companies with sales of $10
million to $100 million offering loans, lines of credit and financing of trade
receivables and cross-sells products to the target companies' owners and
management as well as their employees. In addition, the Company offers private
banking services to individuals. In general, the commercial banking business
focuses on the southern California region, allowing the Company to differentiate
itself from
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its competition by providing high quality services, local relationship
management and fast turnaround time on loan decisions through experienced
employees.
The Company offers its commercial customers a full array of deposit and
loan products which are priced competitively and designed specifically for the
customer. Deposit products include money market deposits, business checking and
certificates of deposits delivered either through direct contact or cash
management products. Loan products include lines of credit, term loans, asset
based loans and credit lines, real estate related loans and trade finance
services, as well as consumer loans and lines of credit made available to
company owners, management and employees. Deposit products are generally priced
on a floating rate basis, based on the prime rate or LIBOR rate. Fixed rates are
generally limited to a one year term or less.
The Company manages credit quality by having each loan reviewed for
approval by a credit committee comprised of the Bank's President, Chairman of
the Board and other Board members. In addition, account officers are directly
assigned to specific accounts to maintain close contact with the customer. Such
contact allows for greater opportunity to cross-sell products, as well as for
observing and continually evaluating the customer for potential credit problems.
At December 31, 1998, the Company had $154 million of outstanding
commercial commitments to commercial banking customers for various commercial
loan products of which $94.2 million were outstanding.
RETAIL BANKING
The Company's retail banking operations are conducted through 25 retail
banking offices located in California. Historically, the Company has focused on
certificates of deposit as the primary source of funding for its lending
operations. The Company continues with its strategy to lower its overall cost of
funds by becoming the primary bank for its customers and attracting funds
through demand deposit and money market accounts. Additionally, the Company also
provides these customers with various loan and investment products.
The target market for these products is comprised of four categories: (i)
existing certificates of deposit and savings customers; (ii) automobile loan
customers generated through WFS; (iii) mortgage customers; and (iv) potential
consumer and small business customers.
The Company will continue to pursue its target market and simultaneously
expand into other areas. Core deposit growth represents the retail banking
division's top priority. The Company added small business deposit accounts and
business money market accounts to its line of product offerings. The Company
targets these products to small and middle market businesses generally with
annual gross sales under $10 million and is aggressively pursuing a personal
banking relationship with the principals and employees of such businesses.
Success in increasing core deposits is expected to continue to reduce the
Company's overall cost of funds. Since the introduction of demand deposit
accounts in the second quarter of 1996, core deposit balances (demand deposit,
money market and savings accounts) increased to $411 million at December 31,
1998 compared with $244 million at December 31, 1997. This amount represents
less than 19% of the Company's total deposits, and provides a significant
opportunity to materially increase the core to total deposit ratio.
At December 31, 1998, the Company's deposits in checking accounts, savings
accounts, certificates of deposits and money market accounts totaled $2.2
billion.
MORTGAGE BANKING
MORTGAGE PRODUCTS
As of February 28, 1999, the Company's mortgage products were marketed and
distributed through 3 Regional Operations Centers ("ROCs"). The Company's
primary focus is on sub-prime loans that are marketed to borrowers who would not
normally qualify under conventional FNMA and FHLMC guidelines, primarily due to
past credit problems, debt coverage ratios in excess of traditional limits or an
inability to sufficiently document income. During 1998, the Company originated
$159 million of sub-prime loans, compared with $174 million during 1997. The
Company expects to increase its originations of sub-prime loans
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during 1999. Sub-prime loans generally are sold within 60 days of origination to
investors, with the servicing rights released.
Sub-prime are originated by account executives primarily through
relationships with loan brokers. The Company undertakes a significant review of
each broker before accepting any loan applications. This analysis includes
reviewing the broker's license and financial statements, performing a search for
criminal offenses, and contacting references. In addition, the broker must sign
a broker agreement which contain significant representations and warranties for
which a broker may be held liable.
Sub-prime include 15 and 30 year fixed rate loans and Adjustable Rate
Mortgagees ("ARMs") tied to the LIBOR index. The principal amount of loans is
capped at $500,000. Sub-prime interest rates that are higher than rates for
conventional conforming financing, with spreads ranging from 250 to 400 basis
points over typical conventional conforming loans. At December 31, 1998, the
weighted average interest rate for sub-prime loans secured by a first deed of
trust was 10.15%. The Company also collects discount and/or origination points
on each sub-prime loan as well as miscellaneous loan fees.
In order to ensure credit quality and salability, tiered approval
authorities have been established within each ROC for underwriters. In addition,
prior to funding, each appraisal is reviewed by an in-house appraiser or an
outside appraiser approved by the Company to assure collateral requirements are
being met. Post funding audits are performed on a monthly basis to ensure that
the loans meet investor's and the Company's criteria.
During 1998, the Company also originated prime and non-agency loans through
a nationwide wholesale broker network. Prime and non-agency loans for 1998
totaled $2.6 billion compared with $2.1 billion during 1997. These loans were
generally sold on servicing retained basis, without recourse, thereby removing
the mortgage loans from the Company's balance sheet. During 1998, the Company
sold $2.8 billion of prime and non-agency loans compared with $1.7 billion in
1997. The decision to focus on originating a greater percentage of sub-prime
mortgage products was based upon the wider margins and higher fee revenues
generated by such a product. The Company believes that focusing on such products
is a more effective use of its capital.
MORTGAGE LOAN SERVICING
As a result of the Company's decision to shift away from originating prime
mortgage products that were sold primarily on a servicing retained basis to
originating sub-prime mortgage products that were sold on a whole loan,
servicing released basis, the Company decided to sell substantially all of its
mortgage servicing rights. At December 31, 1998, the Company serviced for the
benefit of others $1.6 billion in mortgage loans compared with $4.9 billion at
December 31, 1997. The Company will continue to service mortgage loans that it
holds on its balance sheet. At December 31, 1998 the Company held $1.0 billion
in mortgage loans on its balance sheet compared with $1.5 billion at December
31, 1997.
IMPROVE OPERATING EFFICIENCIES -- MORTGAGE BANKING
During the fourth quarter of 1998 the Company incurred a $3.0 million
restructuring charge relating to the consolidation of its 14 mortgage banking
offices into 3 Regional Operating Centers and the elimination of 200 positions,
or 55% of the work force in the mortgage banking area. This restructuring is the
result of the Company's decision to focus on primarily sub-prime mortgage
products rather than prime and non-agency loans. Restructuring related costs
included $0.6 million for employee severance and $2.4 million for lease
termination fees and the writeoff of disposed assets. The restructuring program
is designed to save up to $19 million annually in expenses.
MORTGAGE PORTFOLIOS
The Company has from time to time originated mortgage products that it has
held on its balance sheet rather than selling such products into the secondary
markets. Other than mortgage loans originated through the Commercial Banking
Division on a limited basis and sub-prime loans held during the warehousing
period, the Company does not currently add newly originated mortgage loans to
its balance sheet. However, the
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Company continues to evaluate all mortgage products that it originates to
determine whether the yield associated with the mortgage product warrants the
risks associated with retaining such products on the balance sheet.
The Company's total mortgage loan portfolio (including those held for sale)
consisted of the following:
DECEMBER 31,
-------------------------------------------
1998 1997
-------------------- -------------------
AMOUNT % AMOUNT %
---------- ------ ---------- -----
(DOLLARS IN THOUSANDS)
Single family residential loans:
First trust deeds....................... $ 618,670 61.4% $1,062,208 69.1%
Second trust deeds...................... 27,051 2.7 48,393 3.1
---------- ------ ---------- -----
645,721 64.1 1,110,601 72.2
Multifamily residential loans............. 331,652 32.9 410,139 26.7
Construction loans........................ 18,950 1.9 15,835 1.0
Other..................................... 17,031 1.7 9,024 0.6
---------- ------ ---------- -----
1,013,354 100.6 1,545,599 100.5
Less: undisbursed loan proceeds........... 6,417 0.6 8,657 0.5
---------- ------ ---------- -----
Total mortgage loans................. $1,006,937 $100.0% $1,536,942 100.0%
========== ====== ========== =====
SINGLE FAMILY RESIDENTIAL LOANS
The Company's single family (1 - 4 units) portfolio consists of fixed rate
loans, ARMs without negative amortization and ARMs with potential negative
amortization. By diversifying its loan portfolio among three types of loan
products, the Company has reduced its overall interest rate risk exposure and
increased its flexibility in asset/liability management. The following table
sets forth information on the amount of fixed rate mortgage loans and ARMs, net
of undisbursed loan proceeds, in the Company's portfolio.
DECEMBER 31,
------------------------------------------
1998 1997
------------------- -------------------
AMOUNT % AMOUNT %
---------- ----- ---------- -----
(DOLLARS IN THOUSANDS)
Fixed rate loans........................... $ 280,589 27.9% $ 417,991 27.2%
Adjustable rate loans:
Negative amortization.................... 514,819 51.1 707,431 46.0
Without negative amortization............ 211,529 21.0 411,520 26.8
---------- ----- ---------- -----
Total mortgage loans............. $1,006,937 100.0% $1,536,942 100.0%
========== ===== ========== =====
Both ARMs and fixed rate first trust deed loans are secured by single
family residences. These loans generally have not exceeded $400,000 in original
principal amount. ARMs were designed with limits on the amount the interest rate
may change in a given period and with maximum lifetime interest rates, or caps,
to stimulate greater customer acceptance while maintaining the desired interest
rate flexibility. The interest rates on ARMs generally can increase or decrease
no more than 3% to 6% over the life of the loan. All ARMs are assumable by
qualified buyers at the interest rate then in effect on the loan, in some cases
with the payment of an assumption fee, but the maximum upward or downward
interest rate adjustment over the life of the assumed loan is reset at the time
of assumption. On ARMs without negative amortization, the maximum change in
interest rate per period may be limited to 2% or less on certain loan programs.
On ARMs with negative amortization, the amount of any interest due in excess of
the monthly payment is capitalized by adding it to the principal balance of the
loan resulting in an increased principal balance. The monthly payment on ARMs
with negative amortization is adjusted annually, subject to a 7.5% maximum
increase. At the end of each five-year interval throughout the life of the loan
(or sooner if the outstanding loan amount reaches a dollar figure specified by
the terms of the loan, generally no greater than 125% of the original loan
amount), adjustments are made regardless of the 7.5% cap to fully amortize the
loan over the remaining term. At December 31, 1998, the total amount of negative
amortizing ARMs totaled $515 million.
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The Company requires title insurance which insures the priority of its
liens on loans made that are secured by real property, and may require
additional title endorsements to standard policies as necessary to protect its
security in the property encumbered. Fire and extended coverage must be
maintained in amounts at least equal to the replacement costs of structures and
improvements on all properties serving as security for its loans. If the
borrower fails to obtain or maintain the required insurance, the Company has the
right to obtain, and add the premium for, such insurance to the principal
balance of the loan. The Company also requires flood insurance on properties
that are within areas defined as having a special flood hazard.
MULTIFAMILY RESIDENTIAL LOANS
Since 1991, the Company has not focused on originating multifamily
residential loans. Multifamily loans made subsequent to 1991 were to refinance
or restructure loans currently in the portfolio, to facilitate loans for the
disposition of real estate owned or to fund Community Reinvestment Act ("CRA")
loans. See "Supervision and Regulation -- The Company -- Community Reinvestment
Act" for further discussion.
During 1998, the Company originated $15.3 million in multifamily
residential loans, of which $13.5 million or 88% were originated by the
Commercial Banking Division. During 1997, the Company originated $15.5 million
in multifamily residential loans, of which $5.6 million, or 36 % was for sales
of REO, $6.0 million, or 39% was for the funding of CRA loans, and the remainder
was related to loans that were refinanced or restructured.
CONSTRUCTION LOANS
On a limited basis, the Company has originated construction loans primarily
for single family owner-occupied residences and commercial real estate. These
include loans for the acquisition and development of unimproved property to be
used for residential and commercial purposes. The construction loan portfolio
generally consists of loans with terms ranging from 12 to 18 months with fully
indexed adjustable interest rates that range between 7.50% and 8.75%. Advances
are generally made to cover actual construction costs and include a reserve for
paying the stated interest due on the loan.
SUBSIDIARIES
WESTERN FINANCIAL BANK
The Bank is a federally chartered and federally insured savings bank. The
Bank provides diversified financial services through its community banking
operations which includes a commercial banking division and a retail banking
division. The commercial banking division targets small and medium-sized
businesses in southern California, offering loans, lines of credit and trade
finance services, as well as account analysis, cash management and other
commercial depository services. The retail banking division offers a broad range
of products, such as demand deposits, money market accounts, certificates of
deposits and other investment services Substantially all of the Company's
operations are conducted through the Bank and its subsidiaries. The Bank's
subsidiaries are WFS (which in turn owns all of the stock of WFS Financial Auto
Loans, Inc. ("WFAL"), WFAL2 and WFSII), Westfin Insurance Agency ("WFIA"),
Western Reconveyance Company, Inc. ("RECON"), Western Consumer Services, Inc.
("WCS"), Westhrift Life Insurance Company ("Westhrift") and The Hammond Company,
The Mortgage Bankers ("THCMB"). Each of these entities are further described
below.
WFS FINANCIAL INC
WFS is in the business of financing automobile loans purchased from new and
used car dealers. WFS operates in 42 states as of February 28, 1999. Each of its
offices are licensed to the extent required by law to conduct business in each
respective state. WFS was created in 1995 by the combination of the Bank's
automobile lending operations and the Bank's subsidiaries, Westcorp Financial
Services, Inc., WFAL and WFAL2. The Bank owns an 87% interest in WFS. The
remaining interest is traded on the National Association of Securities Dealers
Automated Quotation System ("NASDAQ") under the ticker symbol
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"WFSI." During 1998, WFS originated $2.7 billion of automobile loans. The loans
which WFS originates are generally sold in securitized offerings by its
subsidiaries WFAL. See "Automobile Operations."
WFS FINANCIAL AUTO LOANS, INC.
WFAL is a wholly owned, limited purpose subsidiary of WFS. WFAL was
organized primarily for the purpose of purchasing automobile loans from WFS and
securitizing those loans in the asset-backed securities market. A total of three
securitization transactions totaling $1.9 billion were completed during 1998,
with another $1.0 billion securitization transaction completed in February 1999.
WFS FINANCIAL AUTO LOANS 2, INC.
WFAL2 is a wholly owned, limited purpose subsidiary of WFS. WFAL2 purchases
automobile loans originated by WFS, to be used as collateral for its
reinvestment contract activities (See "WFS Reinvestment Contract").
WFS INVESTMENTS, INC
WFSII is a wholly owned, limited purpose subsidiary of WFS. WFSII was
incorporated for the purpose of purchasing ownership interests in owner trusts
in connection with securitization transactions. WFSII is limited by its Articles
of Incorporation from engaging in any business activities not incidental or
necessary to its stated purpose.
WESTFIN INSURANCE AGENCY
WFIA is a California based insurance agency which acts as an agent for
independent insurers in providing property and casualty insurance coverage on
collateral, primarily automobiles, securing loans made by the Company,
collateral protection insurance and other noncredit related life and disability
programs. WFIA's revenues consist of commissions received on policies sold to
customers.
WESTERN RECONVEYANCE COMPANY, INC.
RECON is a California corporation which acts primarily as the trustee under
trust deed loans made by the Company and is not a significant source of revenues
or expenses.
WESTERN CONSUMER SERVICES, INC.
WCS conducts real estate development activities through two California
limited liability companies ("LLC"). The purpose of the LLCs is to acquire,
develop and ultimately sell single family residences. The Company's interest
includes a participating share of the profits realized upon the sale of each
unit. WCS also owns two branch locations of the Company. These properties cannot
be treated as branch premises for regulatory purposes since the Bank does not
occupy at least 25% of the premises, consistent with OTS guidelines. The Bank is
required to hold risk-based capital against its investment in WCS.
WESTHRIFT LIFE INSURANCE COMPANY
Westhrift, an Arizona corporation, is engaged in the business of reinsuring
credit life and credit disability insurance offered to borrowers of the Company
and underwritten by an independent insurer. The credit life insurance policies
provide for full payment to the Company of the insured's financial obligation in
the event of the insured's death. The credit disability insurance policies
provide for payment to the Company of an insured's financial obligation during a
period of disability resulting from illness or physical injury. Westhrift has a
Certificate of Authority from the California Insurance Commissioner authorizing
it to conduct insurance business in California. At December 31, 1998, credit
life and disability insurance in force was $4.7 million.
For Arizona statutory purposes, Westhrift is required to maintain reserves
for losses on credit life and credit disability policies. Westhrift's aggregate
reserves for credit life and credit disability policies at December 31, 1998
were $0.3 million. The aggregate reserves are computed in accordance with
commonly
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accepted actuarial standards consistently applied, and are based on actuarial
assumptions which are in accordance with or stronger than those called for in
policy provisions. The policies reinsured are underwritten by the independent
insurer for no more than the amount that the insured owes to the Company, not to
exceed $25 thousand per loan. Westhrift also maintains a $0.5 million deposit
account in accordance with California statutory deposit requirements. Westhrift
does not engage in any business except with respect to customers of the Company.
THE HAMMOND COMPANY, THE MORTGAGE BANKERS
An 80% interest in The Hammond Company ("THC") and its subsidiaries was
acquired by the Company on December 21, 1995. On June 19, 1996, the Company
acquired the remaining 20% of THC. On August 13, 1996, THC was merged into its
subsidiary The Hammond Company, The Mortgage Bankers ("THCMB"). In late 1996,
the Bank combined all of THCMB, except for its Veterans Administration ("VA")
and California Housing Finance Authority ("CHFA") mortgage lending, with the
Company's Mortgage Banking Division, as the retail mortgage arm of the Company.
THCMB is not a significant source of revenues or expenses.
WESTCORP INVESTMENTS, INC.
Westcorp Investments, Inc. ("WII") is a limited-purpose, wholly owned
subsidiary of the Company. WII was incorporated in California on February 9,
1996 for the purpose of purchasing an ownership interest in an owner trust
created for a WFS automobile loan securitization transaction. WII is limited by
its Articles of Incorporation from engaging in any business activities not
incidental or necessary to its stated purpose.
WESTFIN SECURITIES CORPORATION
WestFin Securities Corporation ("WestFin"), formerly known as Western
Financial Investments, Inc. ("WFI"), began operations in 1994 as a licensed
broker-dealer selling mutual funds and variable annuities to the general public.
Western Financial Investments, Inc. changed its name to WestFin Securities
Corporation in July 1997 and was currently made a direct subsidiary of the
Company. Prior to this change, WFI was a subsidiary of the Bank. Effective
January 1, 1999 WFI was again made a subsidiary of the Bank.
WESTRAN SERVICES CORP.
Westran Services Corp. ("Westran") is a California corporation which
provides travel related services for the Company and its subsidiaries. It is not
a significant source of revenues or expenses for the Company.
TRANSACTIONS WITH RELATED PARTIES
WFS leases office space for its Encino, California office and Walnut Creek,
California office from Insurance Company of the West ("ICW"), an affiliate of
Mr. Rady, Chairman of WFS, the Bank and Westcorp. The basic annual rent is
adjusted annually and includes a portion of direct operating expenses. The
Encino lease arrangement expires in 2001. The Company paid $297,541 in rent to
ICW in 1998.
The Kearny Mesa Business Center is landlord to WFS' office in San Diego.
Kearny Mesa Business Center is an affiliate of Mr. Rady. The total amount paid
in 1998 pursuant to this lease, which expires in 2001, was $53,057.
The Carmel Country Plaza is landlord to a WFS Satellite office in San
Diego. Carmel Country is an affiliate of Mr. Rady. The total amount paid in 1998
pursuant to this lease, which expires in 2001, was $118,417.
WCS is landlord to WFS' office in Walnut Creek. WCS is an affiliate of Mr.
Rady. The total amount paid in 1998 pursuant to this lease, which expires in
2002, was $74,580.
The Company leased space to ICW in Sacramento, California for which it
received rent of $69,939 in 1998.
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COMPETITION
The Company faces strong competition in both its lending and deposit
gathering activities. The Company believes it can differentiate itself from its
competition based on product pricing, the high degree of quality and
professionalism in the services it provides and through long-standing
relationships with borrowers, real estate brokers, automobile dealers and retail
deposit customers.
The auto finance business is highly competitive. Strong competition in the
purchase of contracts is provided by Chrysler Credit, GMAC, Ford Credit and
other captive auto finance companies, commercial banks, other consumer finance
companies and credit unions. WFS competes for the purchase of such loans on the
basis of price and the level of service provided to its dealers.
Competition in originating mortgage loans comes primarily from other
savings and loan associations, commercial banks and mortgage bankers. The
Company competes for mortgage loans principally on the basis of the interest
rates and loan fees it charges, the types of loans it originates and the quality
of services it provides borrowers and real estate brokers.
The greatest competition for deposits comes from other savings and loan
associations, money market funds, commercial banks, credit unions, thrift and
loan associations, corporate and government securities and mutual funds. Many of
the nation's largest savings and loan associations and other depository
institutions are headquartered or have branches in the areas where the Company
primarily conducts its business. The Company competes for deposits primarily on
the basis of interest rates paid and quality of service provided to its
customers. The Company does not rely on any individual, group or entity for a
material portion of its deposits.
Competition in the commercial banking business comes primarily from other
commercial banks with a presence in the same geographic area. In general, many
commercial banks are more sizable institutions with larger lending capacity and
a lower cost of funds than the Company. The Company has differentiated itself
through outstanding relationship management as well as on its ability to provide
quick credit decisions, competitive interest rates and competitive pricing on
loans, deposits and other services.
TAXATION
FEDERAL INCOME TAXES
The Company and its subsidiaries file a calendar year consolidated federal
income tax return. All entities included on the consolidated financial
statements are included in the consolidated tax return.
The Bank is a savings and loan association for federal tax purposes. Prior
to 1996, savings and loan associations satisfying certain conditions were
permitted under the Internal Revenue Code ("IRC") to establish reserves for bad
debts and to make annual additions to these reserves which qualified as
deductions from income. However, in 1996 new legislation was enacted which
eliminated the reserve method of accounting for bad debts for tax purposes for
savings and loan associations. The repeal of the reserve method is effective for
tax years beginning after December 31, 1995. Savings and loan associations are
now subject to the same tax laws regarding bad debt reserves as banks. A bank
which qualifies as a "small bank" may still be allowed to use the reserve method
of accounting for bad debts, but may only calculate its addition to the reserve
using the experience method, not the percentage of taxable income method. A bank
which qualifies as a "large bank" is not allowed to use the reserve method and
is only allowed amounts which are specifically charged off to be taken as a tax
deduction. The Bank is considered a "large bank" for federal income tax purposes
and, therefore, is required to use the specific charge off method for deducting
bad debts for federal income tax purposes.
The tax reserves for bad debts which were added after 1987 and which still
exist as of the date of this change, are required to be recaptured into income
ratably over a period of six years starting with the first taxable year after
1995. However, savings and loan associations which meet the "residential loan
requirement" will be allowed to defer the recapture of their reserves for up to
two years. In order to meet the residential loan requirement, the principal
amount of residential loans made by a savings and loan association must equal or
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exceed the average principal amount of the residential loans made by the savings
and loan association during the six most recent tax years beginning before 1996.
The tax reserves related to pre-1988 additions to the reserves, are not required
to be recaptured into income as a result of this legislation. The balance of the
Bank's post-1987 reserve as of December 31, 1998, which will be required to be
recaptured into income is $17 million. The Bank met the residential loan
requirement for 1997 and, thus, has postponed recapture of its post-1987
reserves for that year. The Bank was required to recapture approximately $2.8
million into taxable income for 1998 and each of the next five years.
Prior to the legislation discussed above, the Bank, if it met certain
criteria, was permitted to compute its addition to the bad debt reserve on loans
using one of the following two methods: (i) the percentage of taxable income
method; or (ii) the experience method. The Bank has used whichever method has
provided the maximum tax deduction in the past. A savings and loan association
which utilized the percentage of taxable income method is subject to recapture
taxes on such reserves if it makes certain distributions to its stockholders.
Dividends may be paid without the imposition of any tax on the Bank if the
amounts paid as dividends do not exceed the Bank's current or accumulated
earnings and profits as calculated for federal income tax purposes. Dividends
paid in excess of current and accumulated earnings and profits, stock
redemption's and other distributions with respect to stock, are deemed to be
made from the bad debt reserve for qualifying real property loans, to the extent
that this reserve exceeds the amount that could have accumulated under the
experience method. The amount of tax that would be payable upon any distribution
which is treated as having been made from the bad debt reserve for qualifying
real property loans are also deemed to have been paid from the reserve to the
extent thereof.
Management does not contemplate making distributions that will create
taxable income, but assuming a 35% tax rate, distributions to stockholders which
are treated as having been made from the bad debt reserve for qualifying real
property loans could result in a federal recapture tax which is approximately
equal to one-half of the amount of such distributions. Despite the new laws
regarding tax bad debt reserves, to the extent that the Bank has not recaptured
its reserves into income as discussed above, and makes distributions deemed to
have been made from their remaining reserves, the Bank would still be subject to
the recapture tax discussed above.
The Company will be subject to the alternative minimum tax if such tax is
larger than the regular federal 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 federal tax. This amount is then reduced by an exemption
amount and is subject to tax at a 20% rate. In the past, the Company has not
generally paid alternative minimum tax and does not expect that they will in the
current year.
Currently the Company and its subsidiaries are under examination by the
Internal Revenue Service for the tax years ended December 31, 1993 through 1996.
Management does not anticipate any significant changes based upon these
examinations.
CALIFORNIA FRANCHISE TAX AND OTHER STATE PROVISIONS
At the end of 1998, the Company and subsidiaries had a tax presence in
approximately 36 states. However, the majority of the activity of the group and
the resulting income should be taxed as California source income, with minor
amounts apportioned or allocated outside California.
The California franchise tax applicable to the Bank is higher than the rate
of tax applicable to non-financial corporations because it includes an amount
"in lieu" of local personal property and business license taxes paid by
non-financial corporations, but not generally paid by financial corporations
such as the Bank. For taxable years ending after December 31, 1995, the tax rate
for a financial corporation is equal to the tax rate on a regular corporation
plus 2%, or 11.3%. For income years beginning after January 1, 1997, the
California regular corporate tax rate was reduced to 8.84% resulting in a tax
rate of 10.84% for the Bank.
Under California law, a savings and loan association may determine its bad
debt deduction using one of two methods. The first method allows a deduction for
debts which become wholly or partially worthless during
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the tax year (i.e., the specific charge off method). The second method allows a
reasonable addition to a reserve to be deducted. A reasonable addition can be
calculated using an experience ratio, or may be determined by management to be
greater than the experience ratio, but not greater than the amount deducted for
regulatory and financial statement purposes, and not greater than 1% of
outstanding loans at year end. The Bank generally determines its California bad
debt deduction using an experience ratio. California has not yet conformed to
the federal repeal of the reserve method of accounting for bad debts for a
savings and loan association, but may do so in the future.
The Company and its subsidiaries compute their taxable income for
California purposes an a unitary basis, or as if they were one business unit,
and file one combined California franchise tax return (excluding Westhrift). The
California returns of the Company and subsidiaries for the tax years 1990
through 1993 were examined by the Franchise Tax Board. A minor assessment has
been paid as a result of that examination, and a claim for refund based upon a
Research and Experimentation credit is still pending. All other issues for those
years have been settled.
SUPERVISION AND REGULATION
GENERAL
The adoption of Financial Institutions Reform, Recovery and Enforcement Act
of 1989 ("FIRREA") substantially restructured the regulatory framework in which
the Company and the Bank operate. In December 1991, the Federal Deposit
Insurance Corporation Improvement Act ("FDICIA") was enacted. FDICIA requires
specified regulatory agencies to adopt regulations having broad application to
insured financial institutions such as the Bank. In 1994, the Riegle Community
Development and Regulatory Improvement Act of 1994 ("RCDA") was adopted, which
modified several of the requirements initiated by FDICIA. In addition, the
Deposit Insurance Fund Act (the "Fund Act"), enacted in 1996 has further
modified certain of these requirements.
Set forth below is a discussion of the statutory and regulatory framework
for the Company and the Bank as affected by FIRREA, FDICIA, RCDA and the Fund
Act and the regulations promulgated thereunder. However, to the extent that the
following information describes statutory or regulatory provisions, it is
qualified in its entirety by reference to the particular statutory and
regulatory provisions. Any change in the applicable law or regulation or in the
policies of various regulatory authorities may have a material effect on the
business and prospects of the Company and the Bank. In that regard, a bill
denominated H.R. 10 has been introduced in the current Congress. As was the case
with a similarly denominated bill pending in the last Congress but not enacted,
it seeks to limit the benefits available to unitary savings and loan holding
companies as described below to those entities which held that status as of
March 4, 1999. While the benefits are grandfathered for previously existing
unitary savings and loan holding companies, those benefits would not be
transferable upon acquisition by an entity which was not itself a unitary
savings and loan association holding company. Whether H.R. 10 will be adopted
and if so whether the provisions in it affecting unitary savings and loan
holding companies will be in the final bill is uncertain. Accordingly, no
assurance can be given that the Company will not be affected by that bill.
WESTCORP
The Savings and Loan Holding Company Act
Westcorp, by virtue of its ownership of the Bank, is a savings and loan
holding company within the meaning of the Home Owners' Loan Act ("HOLA"), as
amended by FIRREA. Savings and loan holding companies and their savings
association subsidiaries are extensively regulated under federal laws.
As a savings and loan holding company registered with the OTS, the Company
is subject to its regulations, examination and reporting requirements. The
Company is a "unitary" savings and loan holding company within the meaning of
regulations promulgated by the OTS, and as a result the Company is virtually
unrestricted in the types of business activities in which it may engage,
provided the Bank continues to meet the Qualified Thrift Lender test under HOLA.
Although the Company intends to remain a unitary savings and loan holding
company, if it acquires one or more insured institutions and operates them as
separate
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subsidiaries rather than merging them with the Bank, or if certain other
circumstances not currently applicable to the Company arise, the Company would
be treated as a "multiple" savings and loan holding company and could cause
additional regulatory restrictions to be imposed on the Company. The Company
does not anticipate that those circumstances will arise unless such institutions
are acquired pursuant to a supervisory acquisition and the insured subsidiaries
meet the Qualified Thrift Lender test.
HOLA prohibits a savings and loan holding company, without prior approval
of the OTS, from controlling any other savings association or savings and loan
holding company.
Additionally, FIRREA empowers the OTS to take substantive action when it
determines that there is reasonable cause to believe that the continuation by a
savings and loan holding company of any particular activity constitutes a
serious risk to the financial safety, soundness, or stability of that holding
company's subsidiary savings association. Thus, FIRREA confers on the OTS
oversight authority for all holding company affiliates, not just the Bank.
Specifically, the OTS may, as necessary: (i) limit the payment of dividends by
the Bank; (ii) limit transactions between the Bank, the holding company and the
subsidiaries or affiliates of either; and (iii) limit any activities of the
holding company that might create a serious risk that the liabilities of the
holding company and its affiliates may be imposed on the Bank. Any such limits
may be issued in the form of regulations, or a directive having the effect of a
cease and desist order.
Savings association subsidiaries of a savings and loan holding company are
limited by HOLA in the type of activities and investments in which they may
participate if the investment and/or activity involves an affiliate. In general,
savings association subsidiaries of a savings and loan holding company are
subject to Sections 23A and 23B of the Federal Reserve Act ("FRA") in the same
manner and to the same extent as if the savings association were a member bank
of the Federal Reserve System, as well as being subject to similar regulations
adopted by the OTS. Section 23A of the FRA puts certain quantitative
limitations, based upon a percentage of the savings association's capital stock
and surplus, on certain transactions between a bank or its subsidiary and an
affiliate, including transactions involving (i) loans or extensions of credit to
the affiliate; (ii) the purchase of or investment in securities issued by an
affiliate; (iii) the purchase of certain assets from an affiliate; (iv) the
acceptance of securities issued by an affiliate as security for a loan or
extension of credit to any person; or (v) the issuance of a guarantee,
acceptance or letter of credit on behalf of an affiliate. The Board of Governors
of the Federal Reserve System (the "Board") has revised the definition of
capital stock and surplus for purposes of Section 23A to conform that definition
to that used by the Board in calculating the limits in Regulation O for insider
lending and by the Office of the Comptroller of the Currency ("OCC") in
calculating the limit on loans by a national bank to a single borrower. The
revised definition will permit subordinated debt issued by the bank that
qualifies for inclusion in Tier 2 capital to be included in the calculation of
capital stock and surplus.
In addition, under Section 23B, transactions between a bank or its
subsidiary and an affiliate must meet certain qualitative limitations. Such
transactions must be on terms at least as favorable to the bank or its
subsidiary as transactions with unaffiliated companies.
Section 11 of the HOLA, as amended by FIRREA, also specifically prohibits a
savings association subsidiary of the savings and loan holding company from
making a loan or extension of credit to an affiliate (which also includes under
most circumstances, a purchase of assets from an affiliate that is subject to
the affiliate's agreement to repurchase the assets) unless that affiliate is
engaged only in activities permitted to bank holding companies under Section
4(c) of the Bank Holding Company Act or from purchasing or investing in the
securities of any affiliate (other than a subsidiary of the savings
association). The OTS regulations, consistent with the provisions of Sections
23A and 23B, exclude transactions between a savings association and its
subsidiaries from the limitations of those sections, but those regulations also
define certain subsidiaries to be affiliates and subject to the requirements of
those sections. At the present time, none of the Bank's subsidiaries are within
the definition of an affiliate for purposes of those regulations.
Amendments made by FIRREA and FDICIA require that savings associations
comply with the requirements of FRA Sections 22(g) and 22(h), and FRS Regulation
O promulgated thereunder, in the same manner as member banks, with respect to
loans to executive officers, directors and principal shareholders. The RCDA
permits loans secured by a first lien on an executive officer's residence to be
made without prior
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approval of the board of directors of the financial institution. As a matter of
policy, the Company does not make loans to executive officers, directors or
principal shareholders.
THE BANK
California Savings Association Law
As a federally chartered institution, the Bank's investments and
borrowings, loans, issuance of securities, payments of interest and dividends,
establishment of branch offices and all other aspects of its operations are
subject to the exclusive jurisdiction of the OTS, to the exclusion of the
California Financial Code or regulations of the California Commissioner of
Financial Institutions. The OTS has adopted regulations to the effect that State
laws pertaining to the operations of federal savings associations and their
operating subsidiaries are preempted.
Federal Home Loan Bank System
The Bank, as a member of the FHLB, is required to own capital stock in the
FHLB in an amount at least equal to the greater of 1% of the aggregate
outstanding balance of its loans secured by residential real property or 5% of
the sum of advances outstanding plus committed FHLB commercial paper lines. The
Bank is in compliance with this requirement.
Since the adoption of FIRREA, the dividends which the Bank has received on
its FHLB stock have been significantly reduced as a result of requirements
imposed by FIRREA on the FHLB System. Each bank in the FHLB System is required
to transfer a percentage of its annual net earnings to the Affordable Housing
Program, as defined in FIRREA. This amount is a minimum of 10% of the annual net
income of each bank in the FHLB system.
Insurance of Accounts
The FDIC administers two separate deposit insurance funds for financial
institutions: (i) the Savings Association Insurance Fund ("SAIF"), which insures
the deposits of associations that were insured by the Federal Savings and Loan
Insurance Corporation ("FSLIC") prior to the enactment of FIRREA, and (ii) the
Bank Insurance Fund ("BIF"), which insures the deposits of institutions that
were insured by the FDIC prior to FIRREA. Commencing in 1989, the deposits of
the Bank became insured through the SAIF to the maximum amount permitted by law
(currently $100,000).
During 1998 the Bank was required to pay insurance premiums of $1.2
million. FDICIA required the FDIC to implement a risk-based assessment system
under which an institution's premiums are based on the FDIC's determination of
the relative risk the condition of such institution poses to its insurance fund.
In response, the FDIC adopted a final rule, effective January 1, 1994. Under
this rule, each insured institution is classified as "well capitalized,"
"adequately capitalized" or "undercapitalized," using definitions substantially
the same as those adopted with respect to the "prompt corrective action" rules
adopted by the regulatory agencies under FDICIA. See "Prompt Corrective
Regulatory Action." Within each of these classifications, the FDIC has created
three risk categories into which an institution may be placed, based upon the
supervisory evaluations of the institution's primary federal financial
institution regulatory agency and the FDIC. These three categories consist of
those institutions deemed financially sound, those with demonstrated weakness
that could result in significant deterioration of the institution and risk of
loss to the FDIC, and those which pose a substantial probability of loss to the
FDIC. Each of these nine assessment categories for SAIF insured institutions
such as the Bank is assigned an assessment rate. Under the regulations, an
institution is precluded from disclosing the risk-based assessment category to
which it has been assigned.
Pursuant to the provisions of FIRREA, the FDIC adopted a significant
reduction in the insurance premiums to be paid by those financial institutions,
primarily commercial banks, whose deposits are insured under the BIF. For BIF
insured institutions, the assessment rate ranged from 0 to 27 basis points per
annum of the institution's deposit assessment base, with a minimum premium of
$2,000 per year, while for SAIF insured institutions it ranged from 23 to 31
basis points per annum. The Fund Act provides for elimination of the
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differential in premiums. In addition, the Fund Act authorized a one-time
special assessment of 65.7 basis points of SAIF-assessable deposits as of March
31, 1995, to be paid by SAIF insured institutions to recapitalize the SAIF. On
November 27, 1996, the FDIC collected from the Bank a special assessment of
$11.6 million. As a result of the special assessment required by the Fund Act,
the SAIF was capitalized at the target Designated Reserve Ratio ("DRR") of 1.25%
of estimated insured deposits on October 1, 1996. Therefore, the FDIC lowered
the rates on assessments paid to the SAIF, while simultaneously widening the
spread between the lowest and highest rates, to avoid collecting more than
needed to maintain the DRR, and to improve the effectiveness of the risk-based
system. Effective October 1, 1996, for all SAIF insured institutions other than
SAIF-member savings associations, the assessment rate ranged from 0 to 27 basis
points per annum. On January 1, 1997, the adjusted rates became effective for
all institutions including the Bank.
FIRREA established a five year moratorium on conversions from the SAIF to
the BIF. The Resolution Trust Corporation Completion Act ("RTCCA"), enacted on
December 17, 1993, extended this moratorium until the date on which the SAIF
first meets the reserve ratio designed for it. The Fund Act provides that the
moratorium will now terminate on the earlier of January 1, 2000 or when the bank
and savings association charters are united and the BIF and SAIF are merged.
There are several exceptions to this moratorium. Most importantly, a SAIF member
may convert to a bank charter if the resulting bank remains a SAIF member during
the term of the moratorium. Additionally, conversions to a bank charter can take
place during the moratorium if: (i) it affects only an "insubstantial" portion
of an institution's total deposits and is approved by the FDIC; (ii) it results
from the acquisition of a troubled institution that is in default or in danger
of default and is approved by the FDIC; or (iii) it results from a merger or
consolidation of a bank and a savings association and is approved by the FDIC or
the OCC, as well as by the FRS.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it 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, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which could result in
termination of the Bank's deposit insurance.
Liquidity Requirements
Under OTS regulations, the Bank is required to maintain an average daily
balance of liquid assets (cash, certain time deposits, bankers' acceptances and
specified United States government, state or federal agency obligations and
certain corporate debt obligations and commercial paper) equal to at least 4% of
its average daily balance of net withdrawal accounts and borrowings payable on
demand or in one year or less. If at any time the Bank's liquid assets do not at
least equal (on an average daily basis for any quarter) the amount required by
these regulations, the Bank would be subject to various OTS enforcement
procedures, including monetary penalties. At December 31, 1998, the Bank's
percentage was 9.0%. Thus, the Bank was in compliance with these requirements.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Capital Resources and Liquidity."
Brokered Deposits
In June 1992, the FDIC issued regulations under FDICIA that provide for
differential regulation relating to brokered deposits based on capital adequacy.
Institutions are divided into categories of "well capitalized," "adequately
capitalized" and "undercapitalized." Only "well capitalized" institutions may
continue to accept brokered deposits without restriction. The RCDA affirmatively
excludes well capitalized institutions from the definition of deposit brokers,
thereby eliminating the need for well capitalized institutions to register as
deposit brokers.
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At December 31, 1998, the Bank met the capital requirements of a well
capitalized association as defined by the regulation. At that date, the Bank
held $75.5 million of brokered deposits.
Regulatory Capital Requirements
The HOLA, as amended by FIRREA, mandates that the OTS promulgate capital
regulations which provide capital standards no less stringent than the capital
standards applicable to national banks.
The HOLA and the OTS regulation require savings associations to maintain
"core capital" in an amount not less than 3% of adjusted total assets. Core
capital is defined in the OTS capital regulations as including, among other
things, (i) common shareholder's equity (including retained earnings); (ii) a
certain portion of the association's qualifying supervisory goodwill; (iii)
noncumulative perpetual preferred stock and related surplus; and (iv)
capitalized servicing rights ("CSR") and purchased credit card relationships
("PCCRs") meeting certain valuation requirements. All CSRs and PCCRs that are
includable in capital are each subject to a 90% fair value limitation. The
maximum amount of CSRs and PCCRs which can be included in core capital and
tangible capital may not exceed, in the aggregate, an amount equal to 100% of
the institutions core capital, with nonmortgage servicing assets and PCCRs
limited to 25% of core capital. All other intangible assets (other than
qualifying PCCRs) must be deducted from core capital. At December 31, 1998, the
Bank had $8.7 million of CSRs, but held no PCCRs. Of the CSRs held by the Bank,
$877 thousand are in excess of the amount which may be included within the
Bank's core capital.
The regulations of the OCC, the principal national bank regulator, require
a minimum core capital requirement of 3% of adjusted total assets for national
banks with a composite 1 rating (the highest rating available) under the
Capital, Asset Quality, Management, Earnings, Liquidity, Sensitivity toward
market risk ("CAMELS") rating system for national banks and substantially higher
core capital requirements for lower rated national banks. Most national banks
are required to maintain core capital of 4% to 5% under this regulation.
Effective April 1, 1999, only savings associations rated composite CAMELS 1 will
be permitted to operate at the regulatory minimum core capital ratio of 3%. For
all other savings associations, the minimum core capital ratio will be 4%. In
determining the amount of additional core capital any savings institution will
be required to maintain, the OTS will assess both the quality of risk management
systems and the level of overall risk in each individual savings association
through the supervisory process on a case-by-case basis. The OTS has not yet
issued a final rule. The OTS capital regulations already permit the OTS to
impose a higher individual minimum capital requirement on a case-by-case basis.
The Bank is not currently subject to any such requirement. The Bank's core
capital ratio at December 31, 1998 was 9.02%.
A savings association must maintain "Tangible Capital" in an amount not
less than 1.5% of adjusted total assets. "Tangible Capital" means core capital
less any intangible assets (including supervisory goodwill), plus CSRs and PCCRs
to the extent includable in core capital as described above. At December 31,
1998, the Bank's tangible capital was 9.02%.
A savings institution's investments in, and extensions of credit to, a
subsidiary engaged in any activities not permissible for national banks
("nonincludable subsidiaries") generally are deducted from the institution's
core capital and tangible capital in determining compliance with capital
standards. This deduction is not required for investments in, and extensions of
credit to, a subsidiary engaged solely in mortgage banking, to certain
subsidiaries which are themselves insured depository institutions or, unless the
FDIC determines otherwise in the interests of safety and soundness, to a
subsidiary which engages in such impermissible activities solely as agent for
its customers. Since July 1, 1996, the Bank has been required to deduct from its
core and tangible capital its entire investments in WCS (both equity and
extensions of credit), as WCS is engaged in residential real estate activities
not permitted by national banks. At December 31, 1998, the amount excluded from
the Bank's core and tangible capital was $4.8 million.
As of December 31, 1998, the Bank's core capital was $345 million,
exceeding the Bank's regulatory requirement by $230 million. The Bank's tangible
capital at December 31, 1998 was $345 million, exceeding the applicable
regulatory requirement by $288 million.
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The risk-based component of the capital standards requires that an
association have total capital equal to 8.0% of risk-weighted assets. The OTS
risk-based capital regulation provides that for assets sold as to which any
recourse liability is retained (including on balance sheet assets related to the
assets sold which are at risk) a savings association must hold capital as a part
of its risk-based capital requirement equal to the lesser of (i) the amount of
that recourse liability or (ii) the risk-weighted capital requirement for assets
sold off-balance sheet as though the assets had not been sold. In addition, in
the former instance, when calculating the Bank's risk-based capital ratio (a)
the value of those on balance sheet assets which are subject to recourse, to the
extent of that recourse liability ("fully capitalized assets"), is deducted from
the Bank's total capital and (b) neither the risk-weighted value of the asset
sold off-balance sheet nor the amount of the fully capitalized assets is
included in the Bank's total risk-weighted assets. The Bank's risk-based capital
requirement at December 31, 1998 included $349 million due to its recourse
liability relating to grantor and owner trust financings, including fully
capitalized assets.
The RCDA requires the federal banking agencies, including the OTS, to
review their risk-based capital recourse rules, and to adopt new rules for
assets sold with low levels of recourse to ensure that the risk-based capital
held for such assets does not exceed the contractual maximum recourse liability
retained by the institution upon the sale of those assets. The federal banking
agencies, including the OTS have adopted such regulations. As the existing OTS
low level recourse regulations were already consistent with those called for by
the RCDA, the OTS regulations discussed in the preceding paragraph were not
modified. Accordingly, these regulations will not affect the Bank.
Also in response to the RCDA, the federal banking agencies, including the
OTS, have adopted regulations pertaining to the amount of risk-based capital
which must be held upon the sale, with recourse, of qualifying small business
loans. Under these regulations, a well capitalized institution, such as the
Bank, upon the sale of loans which meet the criteria for loans to small
business, as defined by the Small Business Administration, needs to maintain
capital only against the amount of recourse retained, provided a reserve is
established, under GAAP, for that recourse liability. In addition, the maximum
amount of recourse retained under this regulation may not exceed 15% of the
Bank's total capital. The effect of this regulation is to substantially reduce
the amount of risk-based capital which must be maintained upon the sale of
qualifying small business loans.
The Bank's total risk-weighted assets are determined by taking the sum of
the products obtained by multiplying each of the Bank's assets and certain
off-balance sheet items by a designated risk-weight. Before an off-balance sheet
item can be assigned a risk-weight, it must be converted to an on balance sheet
credit equivalent amount.
Four risk-weight categories exist for on balance sheet assets. The four
risk-weighted categories are zero percent (generally cash and securities issued
by or backed by the full faith and credit of the United States), twenty percent
(generally US government backed mortgage securities), fifty percent (generally
qualifying mortgage loans and mortgage backed securities not within lower
categories) and one hundred percent (all other assets).
Before a risk-weight category can be applied to a consolidated off-balance
sheet item, such item must be converted into a credit-equivalent amount by
multiplying its face amount by whichever of four credit conversion factors is
appropriate. There is a one hundred percent conversion of direct credit
substitutes, and net assets sold under an agreement to repurchase; a fifty
percent conversion factor for transaction-related contingencies and the unused
portions of nonexempt loan commitments; a twenty percent conversion for
trade-related contingencies, such as commercial letters of credit; and a zero
percent conversion for the unused portion of exempt loan commitments and unused,
unconditionally cancelable retail credit card lines. Interest rate contracts
have special credit equivalent amounts equal to the sum of their current credit
exposure plus their potential credit exposure. The risk-weight category to be
applied to such amounts in determining the credit risk component would depend on
the obligor, but in no event would be higher than fifty percent risk-weight. As
of December 31, 1998, the Bank's total risk-weighted assets equaled $5.4
billion.
In addition to regulations pertaining to risk-based capital for interest
rate risk, FDICIA also requires the adoption of risk-based capital regulations
regarding excessive exposure to concentration of credit risk and the
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risks associated with nontraditional activities. The OTS individual minimum
capital regulations include these factors as additional grounds upon which the
OTS could impose such requirements. The regulations do not set specific
standards, but leave it to the discretion of the OTS to impose additional
capital requirements on a case by case basis. The RCDA requires the federal
banking agencies to add the size and activities of an institution to that list
of factors which may justify the need for additional risk-based capital. Under
the RCDA the federal banking agencies are not to cause undue reporting burdens
in connection with such regulations. The OTS has not yet proposed new
regulations in response to this law.
Total capital, as defined by OTS regulations, is core capital plus
supplementary capital (supplementary capital cannot exceed 100% of core capital)
less direct equity investments not permissible to national banks (subject to a
phase-in schedule), reciprocal holdings of depository institution capital
investments, and that portion of land loans and nonresidential construction
loans in excess of 80% loan-to-value ratio. Supplementary capital is comprised
of three elements: (i) permanent capital instruments not included in core
capital; (ii) maturing capital instruments; and (iii) general valuation loan and
lease loss allowance.
The Bank currently has $94.5 million (excluding discount and issuance
costs) of its 8.5% Subordinated Capital Debentures and $150 million of its
8.875% Subordinated Capital Debentures (excluding discounts and issuance costs)
outstanding. Pursuant to the approval from the OTS to treat those debentures as
supplementary capital, prior to January 1, 1999 the amount of those debentures
which may be included as supplementary capital may not exceed 40% of the Bank's
total capital. Effective January 1, 1999 the inclusion reverts back to one-third
of the Bank's total capital. At December 31, 1998, the debentures then
outstanding represented 39.7% of the Bank's total capital. Consistent with the
OTS capital regulations, the amount of the 8.5% debentures which may be included
as supplementary capital will decrease at the rate of 20% of the amount
originally outstanding per year (net of redemptions), commencing on July 1, 1998
and the amount of the 8.875% debentures which may be included as supplementary
capital will decrease at the rate of 20% of the amount originally outstanding
per year (net of redemptions), commencing on August 1, 2002.
The OTS regulations also permits the Bank to include as supplementary
capital up to 45% of the pre-tax net unrealized holding gains on certain
available-for-sale equity securities. The Bank's total capital at December 31,
1998 was $605 million and its risk-based capital ratio was 11.23%.
As required by the provisions of FDICIA, the OTS has adopted an interest
rate risk component to its capital rules. The new rule establishes a method for
determining an appropriate level of capital to be held by savings associations
subject to the supervision of the OTS, such as the Bank, against interest rate
risk ("IRR"). The new rule generally provides that if a savings association's
IRR, calculated in accordance with the rule, exceeds a specified percentage, the
savings association must deduct from its total capital an IRR component when
calculating its compliance with the risk-based capital requirement.
Specifically, the rule provides that a savings association's IRR is to be
determined by the decline in that association's Net Portfolio Value ("NPV")
(i.e., the value of the association's assets as determined in accordance with
the provisions of the rule) resulting from a 200 basis point change in market
interest rates (increase or decrease, whichever results in a lower NPV) divided
by the NPV prior to that change. If that result is a decrease of greater than
2%, the association must deduct from its total capital an amount equal to
one-half of the decline in its NPV in excess of 2% of its NPV prior to the
interest rate change (the "IRR component"). The reduction of an association's
total risk-based capital is effective on the first day of the third quarter
following the reporting date of the information used to make the required
calculations. The rule also contains provisions (i) reducing the IRR component
if the association reduces its IRR by the end of the quarter following the
reporting date and (ii) permitting the OTS to waive or defer the IRR component
on a showing that the association has made meaningful steps to reduce or control
its interest rate risk. The OTS has postponed the effective date as of which an
IRR component will be required to be deducted from a savings association's
capital to permit the OTS to review the interest rate risk regulations currently
being promulgated by the other federal banking agencies for their respective
institutions. Even were the rule currently being applied, the Bank would not be
required to reduce its total capital by an IRR component, and does not
anticipate being required to do so during 1999.
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Any savings association that fails any of the capital requirements is
subject to possible enforcement actions by the OTS or the FDIC. Such actions
could include a capital directive, a cease and desist order, civil money
penalties, the establishment of restrictions on an association's operations and
the appointment of a conservator or receiver. The OTS's capital regulation
provides that such actions, through enforcement proceedings or otherwise, could
require one or more of a variety of corrective actions. The OTS must prohibit
asset growth by any institution that is in violation of the foregoing minimum
capital requirements, and must require any such institution to comply with a
capital directive issued by the OTS. See "Prompt Corrective Regulatory Action."
In summary, the Bank exceeded the current minimum requirements for core
capital, tangible capital and risk-weighted capital as of December 31, 1998.
Prompt Corrective Regulatory Action
FDICIA requires each applicable agency and the FDIC to take prompt
corrective action to resolve the problems of insured depository institutions
that fall below certain capital ratios. Such action must be accomplished at the
least possible long-term cost to the appropriate deposit insurance fund.
In connection with such action, each agency must promulgate regulations
defining the following five categories in which an insured depository
institution will be placed, based on the adequacy of its regulatory capital
level: well-capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized. The critically
undercapitalized level cannot be set lower than 2% of total assets or higher
than 65% of the required minimum leverage capital level. In addition to the
various capital levels, FDICIA allows an institution's primary federal
regulatory agency to treat an institution as if it were in the next lower
category if that agency (i) determines (after notice and an opportunity for
hearing) that the institution is in an unsafe or unsound condition or (ii) deems
the institution to be engaged in an unsafe or unsound practice.
At each successive downward level of capital, institutions are subject to
more restrictions and regulators are given less flexibility in deciding how to
deal with the bank or thrift. For example, undercapitalized institutions will be
subject to asset growth restrictions and will be required to obtain prior
approval for acquisitions, branching and engaging in new lines of business. For
significantly undercapitalized institutions, the appropriate agency must require
the institution to sell shares in order to raise capital, must restrict interest
rates offered by the institution, and must restrict transactions with affiliates
unless, in each case, the agency determines that such actions would not further
the purposes of the prompt corrective action system. In addition, for critically
undercapitalized institutions, the agency must require prior agency approval for
any transaction outside the ordinary course of business, and the institution
must be placed in receivership or conservatorship unless the appropriate agency
and FDIC make certain affirmative findings regarding the viability of the
institution (which findings must be reviewed every 90 days).
FDICIA prohibits any insured institution (regardless of its capitalization
category) from making capital distributions to anyone or paying management fees
to any persons having control of the institution if, after such transaction, the
institution would be undercapitalized. Any undercapitalized institution must
submit an acceptable capital restoration plan to the appropriate agency within
45 days of becoming undercapitalized.
A capital restoration plan will be acceptable only if each company having
control over an undercapitalized institution guarantees that the institution
will comply with the capital restoration plan until the institution has been
adequately capitalized on an average during each of four consecutive calendar
quarters and provides adequate assurances of performance. The aggregate
liability of such guarantee is limited to the lesser of (i) an amount equal to
5% of the institution's total assets at the time the institution became
undercapitalized or (ii) the amount which is necessary to bring the institution
into compliance with all capital standards applicable with respect to such
institution as of the time the institution fails to comply with its capital
restoration plan.
The OTS, in conjunction with the other federal financial institution
regulatory agencies, adopted regulations defining the five categories of
capitalization and implementing a framework of supervisory actions,
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including those described above, applicable to savings institutions in each
category. The regulations provide that a savings association will be deemed to
be (i) "well capitalized" if it has a total risk-based capital ratio of 10% or
greater, a Tier 1 (i.e., core) risk-based capital ratio of 6% or greater, a
leverage ratio of 5% or greater and is not subject to any OTS order or directive
to meet and maintain a specific capital level for any capital measure; (ii)
"adequately capitalized" if it has a total risk-based capital ratio of 8% or
greater; has a Tier 1 risk-based capital ratio of 4% or greater and has either
(a) a leverage ratio of 4% or greater or (b) a leverage ratio of 3% or greater
and is rated composite 1 under the CAMELS rating system in the most recent
examination of the institution; (iii) "undercapitalized" if it has a total
risk-based capital ratio that is less than 8%, has a Tier 1 risk-based capital
ratio that is less than 4%, has a leverage ratio that is less than 4% or, if
rated composite 1 under the CAMELS rating system in the most recent examination
of the institution, has a leverage ratio that is less than 3%; (iv)
"significantly undercapitalized" if it has a total risk-based capital ratio that
is less than 6%, a Tier 1 risk-based capital ratio that is less than 3% or a
leverage ratio that is less than 3%; and (v) "critically undercapitalized" if it
has a ratio of tangible equity to total assets that is equal to or less than 2%.
At December 31, 1998, the Bank met the capital requirements of a "well
capitalized" institution, as its total risk-based capital ratio was 11.23%, its
Tier 1 risk-based capital ratio was 6.42% and its leverage ratio was 9.02%.
Loans to One Borrower
Under the HOLA as amended by FIRREA, the loans to one borrower limitations
for national banks apply to all savings associations in the same manner and to
the same extent as they do to national banks. Thus, savings associations
generally are not permitted to make loans to a single borrower in excess of 15%
to 25% of the savings associations' unimpaired capital and unimpaired surplus
(depending upon the type of loan and the collateral provided therefore), except
that a savings association may make loans to one borrower in excess of such
limits under one of the following circumstances: (i) for any purpose, in any
amount not to exceed $500,000; (ii) to develop domestic residential housing
units, in an amount not to exceed the lesser of $30.0 million or 30% of the
savings association's unimpaired capital and unimpaired surplus, provided that
the association receives the written approval of the OTS to do so (which
approval the Bank has not sought) and certain other conditions are satisfied; or
(iii) to finance the sale of real property which it owns as a result of
foreclosure, providing that no new funds are advanced. In addition, further
restrictions on a savings association's loans to one borrower authority may be
imposed by the OTS if necessary to protect the safety and soundness of the
savings association. At December 31, 1998, 15% of the Bank's unimpaired capital
and unimpaired surplus for loans to one borrower purposes was $90.2 million. The
largest amount outstanding at December 31, 1998 to one borrower (and related
entities) was $13.5 million.
Equity Risk Investment Limitations
The Bank generally is not authorized to make equity investments other than
investments in subsidiaries. A savings association may not acquire a new
subsidiary or engage in a new activity through an existing subsidiary without
giving 30 days prior notice to the OTS and the FDIC, and must conduct the
activities of the subsidiary in accordance with the regulations and orders of
the OTS. Under certain circumstances, the OTS also may order a savings
association to divest its interest in, terminate the activities of, or take
other corrective measures with respect to, an existing subsidiary.
The Bank's aggregate investment in service corporation subsidiaries was
$(0.5) million and its equity investments in operating subsidiaries was $263
million as of December 31, 1998.
Qualified Thrift Lender Test
A Qualified Thrift Lender ("QTL") test was enacted as a part of FIRREA, and
was modified by FDICIA and the Economic Growth and Regulatory Paperwork
Reduction Act ("EGRPRA"). An association that fails to become or remain a QTL
must either (i) convert to a bank subject to the banking regulations or (ii) be
subject to severe restrictions, including being forbidden to invest in or
conduct any activity that is not permissible to both a savings association and a
national bank, and certain other restrictions on branching, advances from its
Federal Home Loan Bank, and dividends. For a three year period after an
association fails to
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meet its QTL requirements, the association is forbidden from retaining any
investment or continuing any activity not permitted for a national bank and must
repay promptly all FHLB advances. In addition, companies that control savings
associations that fail the QTL test must, within one year of such failure,
become a bank holding company subject to the Bank Holding Company Act.
Under the existing QTL requirements, a savings association's "qualified
thrift investments" must equal not less than 65% of the association's "portfolio
assets" measured on a monthly basis, in 9 of every 12 consecutive months.
Savings associations have the option of substituting compliance with the IRC
"domestic building and loan association" ("DBLA") test for compliance with the
amended QTL requirements. Qualified thrift investments include: (i) all loans or
mortgage-backed securities held by an association which are secured or relate to
domestic residential or manufactured housing; (ii) investments in educational,
small business, credit card, and credit card account loans; and (iii) FHLB stock
and certain obligations of the FDIC and related entities. Certain other
investments are included as qualified thrift investments, but are limited to 20%
of an association's portfolio assets, including (i) 50% of residential mortgage
loans sold by an association within 90 days of their origination, (ii)
investments in subsidiaries which derive at least 80% of their revenue from
domestic residential or manufactured housing, (iii) subject to certain
limitations, 200% of investments relating to "starter homes" or housing and
community facilities in "credit-needy areas," (iv) consumer loans in the
aggregate of not more than 20% of portfolio assets, and (v) FHLMC and FNMA
stock. Portfolio assets are total assets less goodwill and other intangible
assets, the value of the association's facilities and the association's liquid
assets maintained to meet its liquidity requirements (but not over 20% of its
total assets).
At December 31, 1998 the Bank's percentage of qualified thrift investments
to portfolio assets was 78%. The Company anticipates that the Bank will continue
to remain a QTL.
Dividend Regulations
The OTS has adopted regulations limiting the amount of capital
distributions a savings association may make. The regulation divides savings
associations into three tiers; those which meet all of the fully phased-in
capital requirements of the OTS both before and after the proposed distribution
(Tier 1 Associations), those which meet all of the current capital requirements
both before and after the proposed distribution (Tier 2 Associations), and those
which fail to meet one or more of the current capital requirements (Tier 3
Associations). A Tier 1 Association may make capital distributions in an amount
equal to the greater of (i) 100% of its net income for the current calendar year
to the date of capital distribution, plus the amount that would reduce by
one-half its "surplus capital ratio" (the amount by which the association's
total capital-to-risk-weighted assets ratio exceeds its fully phased-in
requirement of 8%) at the beginning of the current calendar year (i.e., at the
end of the preceding calendar year), or (ii) 75% of its net income over the most
recent four-quarter period preceding the quarter in which the capital
distribution is to be made. A Tier 2 Association may make capital distributions
of up to 75% of its net income over the past four-quarter period. A Tier 3
Association may not make any capital distribution without the prior
authorization of the OTS. Although Tier 1 and Tier 2 Associations do not need to
obtain prior approval to make a capital distribution which complies with the
requirements of the OTS regulation, the savings association must file a notice
with the OTS at least 30 days in advance of the date on which the distribution
is to be made. The OTS has the authority, under the regulation, to preclude a
savings association from making capital distributions, notwithstanding its
qualification to do so on the above tests, if the OTS determines that the
savings association is in need of more than normal supervision, or if the
proposed distribution will constitute an unsafe or unsound practice given the
condition of the savings association. In addition, a Tier 1 Association deemed
to be in need of more than normal supervision by the OTS may be downgraded to a
Tier 2 or Tier 3 Association as a result of such determination. A savings
association may also apply to the OTS for approval to make a capital
distribution even though it does not meet the above tests, or for an amount
which exceeds the amount permitted by the express terms of the regulation. In
January of 1999, the OTS adopted a new rule which becomes effective on April 1,
1999, which will allow institutions that are not subsidiaries of a savings and
loan holding company to qualify for a capital distribution without a notice or
application to OTS, if they meet certain conditions, including retaining their
well capitalized designation following the distribution and having
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CAMELS and compliance ratings of 1 or 2. Other institutions either have to
notify OTS or obtain the agency's approval, depending on the condition of the
institution and the amount and nature of the capital distribution, but following
the effective date of the rule they may file a schedule of proposed capital
distributions for a year at a time, rather than filing separate notices. As a
subsidiary of a savings and loan holding company, the Bank will continue to be
required to file a notice or application.
In addition, another OTS regulation pertaining to holding companies
requires that the OTS be given a 30 day advance notice before a savings
association subsidiary pays a dividend to its holding company. The notice
described above can also constitute the notice for this purpose, if so
designated.
The Bank is a Tier 1 Association. As of the date hereof, under the
limitations of the OTS capital distributions regulation, the Bank may pay
dividends up to the greater of 100% of its net income since January 1, 1998 plus
50% of its surplus capital or 75% of its net income over the four-quarter period
ending December 31, 1998. However, the Bank is also subject to certain
limitations on the payment of dividends by the terms of the indenture for its
8.5% and 8.875% Debentures, which limitations are more severe than the OTS
capital distribution regulations. Under the most restrictive of those
limitations, the greatest capital distribution which the Bank could currently
make is $73.9 million. During 1998, the Company made an additional investment in
the Bank of $15.0 million which increased the availability of a capital
distribution. In 1997, the available capital distribution was $85.6 million. The
Company received dividends from the Bank during 1998 in the aggregate amount of
$14.0 million.
Community Reinvestment Act
CRA was passed by Congress in 1977 as a means to encourage each financial
institution to help meet the credit needs of the communities it served,
including low- to moderate-income neighborhoods. Depository institutions were
required to:
- Delineate their community by describing their primary lending area;
- List the types of credit available;
- Maintain a CRA statement and lobby poster (CRA Notice); and
- Complete an annual review of the CRA statement by the Board of Directors.
In 1989, additional regulations were passed which amended or expanded the
CRA requirements improving public awareness of the activities of financial
institutions and making it possible to better quantify the performance of
individual banks. These changes included:
- The power of regulatory institutions to deny branch applications on CRA
grounds;
- Increased compliance requirements including documenting affirmative steps
to develop and maintain an effective CRA program; and
- FIRREA which required the regulators to prepare a written CRA evaluation,
which after July 1, 1990, must be made public within 30 business days
after the institution receives its final examination report, including a
public rating of the financial institution's CRA performance.
The CRA regulation was changed again effective July 1, 1995, when the
regulatory agencies consisting of the OCC, the Board, FDIC and OTS passed a
joint final rule. This amended regulation established a uniform framework and
criteria by which the agencies could assess an institution's record of helping
to meet the credit needs of its community, including low- and moderate-income
neighborhoods, consistent with safe and sound operations, and provided for
consideration of the agencies assessment when reviewing certain applications.
Commonly referred to as the New CRA, the regulation establishes certain
performance standards under which the Company is to be examined. Periodically,
the OTS will review the Company's performance and publish a "Community
Reinvestment Act Performance Evaluation". The revised examination procedures
provide for an evaluation under the lending, investment and service tests.
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As required by the new CRA regulation, the Company has identified eleven
Primary Metropolitan Statistical Areas ("PMSA's") and Metropolitan Statistical
Areas ("MSA's") in the state of California as its assessment area(s). These
geographic markets contain the Company's retail banking offices and are
representative of where the Company accepts deposits from its customer base. The
revised examination procedures will focus on performance rather than process.
The Bank received a "satisfactory" rating in its most recent CRA evaluation. The
new system will evaluate the degree to which the institution is providing (i)
loans, (ii) branches and other services, and (iii) investments to low and
moderate income areas. Under the new regulation, the Company could seek to be
assessed on its CRA performance under a strategic plan prepared by the
association and approved by the OTS. This would take the place of the three
tests mentioned above. The new regulation also emphasized the importance of an
institution's CRA performance in the corporate application process, and seeks to
make the regulation more enforceable.
The Company has elected to be audited under the Lending Test, Investment
Test and Service Test and does not believe that its performance under the new
CRA regulation will differ materially from its performance under the previously
existing CRA regulations. Following the scheduled audit the Company will receive
an updated performance evaluation which will be made public in each branch
office.
Classification of Assets
The OTS has adopted a classification system for problem assets of insured
institutions. Problem assets are classified as "special mention," "substandard,"
"doubtful" or "loss," depending on the presence of certain characteristics. An
asset will be considered "special mention" when assets do not currently expose a
savings association to a sufficient degree of risk to warrant classification but
possess credit deficiencies or potential weaknesses deserving management's close
attention; an asset is "substandard" if it is inadequately protected by the
current capital and paying capacity of the obligor or by the collateral pledged,
if any. Assets classified as "doubtful" have all of the weaknesses inherent in
those classified "substandard," with the added characteristic that the
weaknesses make "collection or liquidation in full," on the basis of currently
existing facts, conditions and values, "highly questionable and improbable."
Assets classified as "loss" are those considered "uncollectible" and of such
little value that their continuance as assets without the establishment of a
specific loss reserve is not warranted. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Asset
Quality -- Allowance for Loan Losses."
Insured institutions are required to classify their own assets and to
establish general valuation allowances (reserves) where appropriate. Assets
classified as substandard or doubtful may be reviewed by the OTS examiner and
valuation allowances may be required to be increased subject to review by the
OTS Regional Director. For the portion of assets classified as loss, the OTS
permits 100% of the amount classified to be charged off or the establishment of
a specific valuation allowance.
The OTS has revised its asset classification scheme. The OTS removed the
specific description of assets classified as "substandard," "doubtful" and
"loss" from the regulatory text, and is now providing such descriptions in
guidance, as is the practice of the federal banking regulatory agencies. As of
December 31, 1998, the Bank had established allowances for loan and real estate
losses of $38.4 million.
Insurance Operations
The insurance subsidiaries of the Bank are subject to regulation and
supervision in the jurisdictions in which they do business. The method and
extent of such regulation varies, but the insurance laws of most states
establish agencies with broad regulatory and supervisory powers. These powers
relate primarily to the establishment of solvency standards which must be met
and maintained, the licensing of insurers and their agents, the nature and
amount of investments, approval of policy forms and rates, and the form and
content of required financial statements. The Bank, through its insurance
subsidiaries, is also subject to various state laws and regulations covering
extraordinary dividends, transactions with insurance subsidiaries and other
matters. The Bank is in compliance with these state laws and regulations.
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Investment Powers
Pursuant to the Interagency Guidelines for Real Estate Lending Policies,
the Bank is required to have lending policies consistent with the guidelines,
including as to loan portfolio management considerations, underwriting standards
and loan administration. In particular, the regulation establishes supervisory
LTV limits for real property secured loans. Each insured institution is to set
its own policy with respect to LTV, but those LTV limits are not to exceed the
LTV limits of the guidelines, except as specifically permitted by the
guidelines. Generally, the LTV limits are as follows: for raw land, 65%; for
land development, 75%; for construction of 1 to 4 family residential housing,
85%, and 80% for other construction loans; and for improved property, 85%. Loans
secured by owner occupied 1 to 4 family residences are not subject to a
supervisory LTV limit, except that any such loan with a LTV ratio of greater
than 90% at origination requires either private mortgage insurance or other
readily marketable collateral.
The Bank's LTV standards are consistent with these supervisory limitations.
In addition, the OTS and the other federal banking agencies have adopted uniform
real estate appraisal guidelines which require the board of directors of
financial institutions to adopt appraisal and evaluation programs which will
cover the selection of appraisers, monitoring their activities, require needed
independence from the real estate transaction at issue, establish criteria for
reports, formats and the use thereof.
The EGRPRA expanded the small business and agricultural lending authority
of federal associations. Federal associations can make total loans secured by
business or agricultural real estate in amounts up to 400% of capital, and can
make additional secured and unsecured loans to businesses and farms in total
amounts up to 20% of total assets, provided that amounts in excess of 10% of
assets may only be used for "small business loans." The OTS also no longer
aggregates commercial loans made by a savings association's service corporation
with commercial loans made by the savings association itself for purposes of the
statutory 10% of assets limitation.
In addition, the EGRPRA amended section 5 of the HOLA to conform and
clarify that federal savings associations may engage in credit card lending
without a percentage of assets investment limitation, as OTS has maintained. The
EGRPRA also amended HOLA section 5 to permit federal associations to make
education loans without investment restriction, as opposed to the previous limit
of 5% of total assets.
Pass-Through Investments
A federal savings association may invest in entities, such as limited
partnerships and mutual funds, that hold only assets, and engage only in
activities, permissible for federal savings associations. A savings association
does not have to give advance notice to the OTS if the pass-through investment
satisfies the following: (1) the savings association does not invest more than
15% of its total capital in one company; (2) the book value of the association's
aggregate pass-through investment does not exceed 50% of its total capital after
making the investment; (3) its investment would not give it direct or indirect
control of the company; (4) its liability is limited to the amount of its
investment; and (5) the company falls into one of the following categories: (i)
a limited partnership; (ii) an open-end mutual fund; (iii) a closed-end
investment trust; (iv) a limited liability company; or (v) an entity which is
invested in primarily to use the company's services (e.g. data processing). A
savings association must provide 30 day's advance written notice to OTS before
making any pass-through investment that does not meet these standards. Loans
that a savings association makes to an entity in which it has made a
pass-through equity investment will be subject to the loans to one borrower rule
in the same manner as loans by a savings association to any third party. A
thrift's investment in its operating subsidiaries is not subject to these
restrictions. The Bank does not currently have any pass-through investments.
Accounting Requirements
The OTS has a statement of policy which provides guidance regarding the
proper classification of, and accounting for, securities held for investment,
sale and trading. Securities held for investment, sale or trading may be
differentiated based upon an institution's desire to earn an interest yield
(held for investment), to realize a holding gain from assets held for indefinite
periods of time (held for sale), or to earn a dealer's spread
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between the bid and asked prices (held for trading). Critical to the proper
classification of accounting for securities as investments is the intent and
ability of an institution to hold the securities until maturity. A positive
intent to hold to maturity, not just a current lack of intent to dispose, is
necessary for securities acquired to be considered to be held for investment
purposes. Securities held for investment purposes may be accounted for at
amortized cost while securities held for sale are to be accounted for at the
lower of cost or market and securities held for trading are to be accounted for
at market. The Bank believes that its investment activities have been and will
continue to be conducted in accordance with the requirements of OTS policies and
generally accepted accounting principles.
In June 1998 the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). This statement provides
guidance for the way public enterprises report information about derivatives and
hedging in annual financial statements and in interim financial reports. The
derivatives and hedging disclosure is required for financial statements for
fiscal years beginning after June 15, 1999. The Statement will require the
Company to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through income.
If the derivative is a hedge, depending on the nature of the hedge, changes in
fair value of derivatives will either be offset against the change in fair value
of the hedged assets, liabilities, or firm commitments through earnings or
recognized in earnings. The ineffective portion of a derivative's change in fair
value will be immediately recognized in earnings. The Company is in the process
of evaluating the effect of SFAS 133, if any, will be on the earnings and
financial position of the Company.
Annual Examinations
FDICIA significantly reduces regulatory discretion by mandating the
appropriate federal financial institution regulatory agency to conduct a full
scope, on-site examination of each insured depository institution every twelve
months. The Bank's last annual examination ended in April, 1998.
FDIC Back-Up Enforcement Authority
The FDIC has the statutory authority under FDICIA to direct an insured
institution's principal regulator to take enforcement action, and to take that
action itself if the principal regulator fails to act timely, or in an emergency
situation.
Financial Reporting
FDICIA requires insured institutions to submit independently audited annual
reports to the FDIC and the other appropriate regulated agencies. These publicly
available reports must include: (i) annual financial statements prepared in
accordance with generally accepted accounting principles and such other
disclosure requirements as required by the FDIC or the appropriate agencies;
(ii) a report, signed by the chief executive officer and the chief financial
officer or chief accounting officer of the institution which contains
statements, attested to by independent auditors, about the adequacy of internal
controls and procedures for financial reporting. Insured institutions such as
the Bank are required to monitor these activities through an independent audit
committee.
FDICIA also directs the FDIC to develop with other appropriate agencies a
method for insured depository institutions to provide supplemental disclosure of
the estimated fair market value of assets and liabilities, to the extent
feasible and practicable, in any balance sheet, financial statement, report of
condition or any other report of any insured depository institution.
Standards for Safety and Soundness
FDICIA, as amended by the RCDA, requires the federal banking regulatory
agencies to prescribe, by regulation or guidelines, standards for all insured
depository institutions and depository institution holding companies relating
to: (i) internal controls, information systems and audit systems; (ii) loan
documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v)
asset growth; and (vi) compensation, fees and
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benefits. In addition, the federal banking regulatory agencies are required to
prescribe standards relating to asset quality, earnings and stock valuation as
they determine to be appropriate.
The OTS, in conjunction with the federal banking regulatory agencies, has
adopted a final regulation and Interagency Guidelines Prescribing Standards for
Safety and Soundness to meet the amended FDICIA requirements. In general, the
guidelines are designed to identify emerging safety and soundness problems and
ensure that such action is taken to address those concerns before they pose a
risk to the deposit insurance fund. The guidelines call for each insured
institution to have policies, procedures and systems appropriate to its size and
the nature of its assets and liabilities which address the specific criteria
identified in the guidelines for each of the six items identified above. The
guidelines do not set any specific numerical targets or minimum requirements.
In the event the OTS determines that a savings association has failed to
satisfy the safety and soundness standards called for by the guidelines, the OTS
may, upon requisite notice, require such association to submit a compliance plan
that sets forth the steps it will take and the time frame required to correct
the deficiency. If the association fails to comply with the OTS request, the OTS
may then issue a notice of intent to issue an order (or in an appropriate case
an immediate order, subject to appeal by the association) requiring that
association to correct a safety and soundness deficiency or to take or refrain
from other actions.
Year 2000 Standards for Safety and Soundness
The OTS issued interim guidelines establishing Year 2000 safety and
soundness standards for insured depository institutions. The development and
implementation of a written due diligence process to monitor and evaluate Year
2000 efforts by third-party service providers and software vendors is a critical
component of an institution's initial assessment period. The guidelines also
require each insured depository institution to develop and adopt a written
project plan that addresses each phase of the planning process. Insured
depository institutions are expected to perform adequate testing of admission
critical systems. The guidelines require an insured depository institution to
design contingency plans appropriate for the institutions technological systems
and operating structure that describe how the institution will mitigate the
risks associated with the failure of systems (the business resumption
contingency plan) and as applicable the failure to complete renovation testing
or implementation emission critical system.
The guidelines require insured depository institutions to implement a due
diligence process that identifies customers posing material Year 2000 risk,
evaluate the Year 2000 preparedness, assess the Year 2000 risk and implement the
appropriate risk controls. Finally, the guidelines require that the Board of
Directors and management must be involved in all stages of the institutions
efforts to achieve the Year 2000 readiness. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Year 2000".
OTS Prohibitions
The OTS prohibits directors, officers, and natural persons having the power
to control the management or policies of savings associations from receiving,
directly, or indirectly, any commission, fee or other compensation in connection
with the procurement of any loan by the savings association or a subsidiary of
the savings association. This regulation does not apply to holding companies and
holding company affiliates of savings associations. Therefore, this regulation
does not apply to the Company, but does apply to the Bank.
Furthermore, the OTS prohibits directors, officers, employees, persons
having the power to control management or policies of savings associations, and
other persons who perform fiduciary duties for savings associations, from
advancing their own personal or business interests, or those of others with whom
they have a personal business relationship, at the expense of the institutions
they serve. Generally, a person will not be deemed to be advancing his, her or
its interests at the expense of the institution if the transaction complies with
sections 23A and 23B of the FRA, Regulation O, or the OTS' safe harbor
provision. Likewise, the rule does not prohibit an executive officer, director
or principal shareholder from receiving a loan from the association which they
serve under certain circumstances.
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The OTS also prohibits directors or officers of savings associations,
persons having the power to control the management or policies of savings
associations and other persons who owe a fiduciary duty to savings associations
from taking advantage of corporate opportunities belonging to their savings
association or its subsidiaries. A corporate opportunity will be deemed to
belong to the savings association if: (i) it is within the corporate powers of
the savings association or its subsidiary; and (ii) the opportunity is of
present or potential practical advantage to the savings association, directly or
through its subsidiary. The OTS will deem a person not to have taken advantage
of a corporate opportunity belonging to the savings association if a
disinterested and independent majority of the savings association's board of
directors, after receiving a full and fair presentation of the matter, rejected
the opportunity as a matter of sound business judgment.
WFS
WFS is an operating subsidiary of the Bank. WFS purchases automobile loans
from new and used car dealers and makes installment loans to individual
consumers, secured, in both instances, by automobiles and light duty trucks. WFS
purchased automobile loans in 42 states at February 28, 1999. While WFS has
historically been licensed in each state in which it operates, WFS is now
relying upon the preemption of such state licensing laws afforded by OTS
regulations. To the extent WFS relies on preemption it is no longer subject to
audit and examination by the applicable state agencies for these states, but
remains subject to examination and supervision by the OTS and the FDIC. WFS
engages local counsel familiar with the applicable consumer finance and auto
finance, licensing and titling laws and regulations of general application of
each of the states in which it has offices and from which it purchases
automobile loans to the extent it purchases automobile loans from states in
which it has no office. WFS will continue to do so as to each of the states in
which WFS intends to purchase automobile loans.
Numerous federal and state consumer protection laws and regulations not
preempted by OTS regulations impose requirements applicable to the automobile
loans purchased and serviced by WFS. Among these enactment's are the federal
Truth-in-Lending Act, the Federal Trade Commission Act, the Fair Credit Billing
Act, the Fair Credit Reporting Act, the Equal Credit Opportunity Act, the Fair
Debt Collection Practices Act and the California Rees-Levering Act and similar
retail installment sales laws and similar laws of other states in which WFS
originates automobile loans.
Most of the states in which WFS is originating automobile loans have
statutes or regulations pertaining to the repossession and sale process WFS must
follow when seeking to recover on a defaulted automobile loan. Generally, WFS
must follow those requirements with precision to ensure its ability to maximize
its recovery on a defaulted automobile loan. In addition, some states, such as
Texas and Washington, have consumer protection laws which limit the assets WFS
may reach in order to recover on any deficiency following repossession and sale
of the vehicle which secures a defaulted automobile loans.
As an operating subsidiary of the Bank, WFS is precluded by regulations of
the OTS from engaging in any business activity which the Bank could not itself
undertake. All of its current business activities are permitted activities for
the Bank. Also, as an operating subsidiary of the Bank, the Bank is required to
retain ownership of at least a majority of the voting stock of WFS. WFS may not
engage in any new business activity nor may it acquire a business from a third
party, even if such business activities are permitted to the Bank and thereby to
WFS, until the Bank has first given notice thereof to the FDIC and to the OTS.
EMPLOYEES
At December 31, 1998, the Company had 2,191 full-time and 102 part-time
employees. None of these employees is represented by a collective bargaining
unit or union and the Company and its subsidiaries believe they have good
relations with their respective personnel.
32
34
FORWARD-LOOKING STATEMENTS
Included in the preceding section of this Annual Report on Form 10-K are
several "forward-looking statements." Forward-looking statements are those which
use words such as "believe," "expect," "anticipate," "intend," "plan," "may,"
"will," "should," "estimate," "continue" or other comparable expressions. These
words indicate future events and trends. Forward-looking statements are our
current views with respect to future events and financial performance. These
forward-looking statements are subject to many risks and uncertainties which
could cause actual results to differ significantly from historical results or
from those anticipated by us. The most significant risks and uncertainties we
face are
(1) the level of chargeoffs, as an increase in the level of chargeoffs will
decrease our earnings;
(2) our ability to originate new loans in a sufficient amount to reach our
needs, as a decrease in the amount of loans we originate will decrease
our earnings;
(3) a decrease in the difference between the average interest rate we
receive on the loans we originate and the rate of interest we must pay
to fund our cost of originating those loans as a decrease will reduce
our earnings;
(4) the continued availability of sources of funding for our operations, as
a reduction in the availability of funding will reduce our ability to
originate loans;
(5) maintaining the level of operating costs; as an increase in those costs
will reduce our net earnings; and
(6) the Year 2000 issues; as a disruption of our collection efforts as a
result of Year 2000 problems or an increase in our costs to correct
Year 2000 issues will reduce earnings.
There are other risks and uncertainties we face, including the effect of
changes in general economic conditions and the effect of new laws, regulations
and court decisions. You are cautioned not to place undue reliance on our
forward-looking statements. We undertake no obligation to publicly update or
revise any forward-looking statements, whether as a result of new information,
future events or otherwise.
ITEM 2. PROPERTIES
At December 31, 1998, the Company owned 20 properties in California and one
property in Texas and leased 126 properties at various locations in other
states.
The executive offices are located at 23 Pasteur Road, Irvine, California.
The remaining owned and leased properties are used as branch offices, finance
company offices, regional business centers, and mortgage banking offices. At
December 31, 1998, the net book value of property and leasehold improvements was
approximately $57.8 million. The Company leases space at seven locations from
companies controlled by a major shareholder. For further information see
"Transactions with Related Parties."
ITEM 3. LEGAL PROCEEDINGS
The Company is involved as a party to certain legal proceedings incidental
to its business. Management believes that the outcome of such proceedings will
not have a material effect upon the Company's financial condition, results of
operations and cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
33
35
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE BY QUARTER
The common stock of the Company has been publicly traded since 1986 and is
currently traded on the New York Stock Exchange ("NYSE"), identified by the
symbol, WES. The following table illustrates the high and low prices by quarter
in 1998 and 1996, as reported by NYSE, which prices are believed to represent
actual transactions:
1998 1997
---------------- ----------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First Quarter.......................... $20.31 $15.63 $22.88 $14.50
Second Quarter......................... 16.88 11.50 19.00 13.25
Third Quarter.......................... 15.75 8.63 22.88 17.94
Fourth Quarter......................... 9.19 5.81 23.50 15.63
There were approximately 1,600 shareholders of Westcorp common stock at
December 31, 1998. The number of shareholders was determined by the number of
record holders, including the number of individual participants, in security
position listings.
DIVIDENDS
The Company paid cash dividends of $0.25, $0.40 and $0.39 per share for the
years ended December 31, 1998, 1997 and 1996, respectively. The Company declared
a stock dividend of 5% in 1996. The 1997 and 1996 dividends and earning per
share and share amounts have been retroactively adjusted to give effect to the
1996 5% stock dividend. On January 12, 1999, the Company declared a quarterly
cash dividend of $0.05 per share for shareholders of record as of January 22,
1999 and paid that dividend on February 8, 1999.
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36
ITEM 6. SELECTED FINANCIAL DATA
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED SUMMARY OF
OPERATIONS
Interest income................. $ 272,142 $ 270,532 $ 242,388 $ 222,093 $ 143,639
Interest expense................ 161,331 161,070 139,194 139,279 88,766
----------- ----------- ----------- ----------- -----------
Net interest income........... 110,811 109,462 103,194 82,814 54,873
Provision for loan losses....... 18,960 12,851 13,571 11,470 13,033
----------- ----------- ----------- ----------- -----------
Net interest income after
provision for loan
losses..................... 91,851 96,611 89,623 71,344 41,840
Noninterest income.............. 133,438 222,853 187,964 107,951 88,263
Noninterest expense(1).......... 253,532 246,269 210,346 117,724 97,464
----------- ----------- ----------- ----------- -----------
Income (loss) before income
taxes......................... (28,243) 73,195 67,241 61,571 32,639
Income taxes (benefit).......... (11,330) 31,287 28,095 25,235 13,819
----------- ----------- ----------- ----------- -----------
Income (loss) before minority
interest...................... (16,913) 41,908 39,146 36,336 18,820
Minority interest in earnings
(loss) of subsidiaries........ (2,216) 5,120 7,349 2,908
----------- ----------- ----------- ----------- -----------
Net income (loss)............... $ (14,697) $ 36,788 $ 31,797 $ 33,428 $ 18,820
=========== =========== =========== =========== ===========
OTHER SELECTED FINANCIAL DATA
Book value per share(2)......... $ 12.43 $ 13.27 $ 12.23 $ 11.54 $ 8.32
----------- ----------- ----------- ----------- -----------
Weighted average number of
shares and common share
equivalents -- diluted........ 26,305,117 26,351,144 26,199,537 25,917,018 25,531,182
Net income (loss) per share --
diluted(2).................... $ (0.56) $ 1.40 $ 1.21 $ 1.29 $ 0.74
=========== =========== =========== =========== ===========
Dividends per share(2).......... $ 0.25 $ 0.40 $ 0.39 $ 0.34 $ 0.27
Dividend payout ratio........... N/A 28.6% 32.2% 26.4% 36.5%
- ---------------
(1) Includes $18.0 million in restructuring charges in 1998.
(2) Reflects 5% stock dividends in 1994, 1995, and 1996.
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37
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
CONSOLIDATED SUMMARY FINANCIAL
CONDITION
Assets:
Cash and other assets.......... $ 704,907 $ 665,891 $ 514,955 $ 331,604 $ 229,547
Loans:
Consumer(1)................. 921,176 294,100 290,501 343,027 440,794
Mortgage(2)................. 1,006,937 1,536,942 1,433,050 1,404,190 1,316,087
Commercial(2)............... 64,720 41,668 7,867
Mortgage-backed securities..... 980,044 941,448 849,548 852,552 470,669
Investments and time
deposits.................... 125,730 248,815 239,124 291,564 285,192
---------- ---------- ---------- ---------- ----------
Total assets........... $3,803,514 $3,728,865 $3,335,045 $3,222,937 $2,742,289
========== ========== ========== ========== ==========
Liabilities:
Deposits....................... $2,178,735 $2,000,896 $1,873,942 $1,753,475 $1,632,782
FHLB advances and other
borrowings.................. 440,924 563,922 569,357 655,100 545,652
Amounts held on behalf
of trustee.................. 528,092 488,653 393,449 341,693 216,204
Other liabilities.............. 65,005 57,910 47,058 48,605 31,488
---------- ---------- ---------- ---------- ----------
Total liabilities...... $3,212,756 $3,111,381 $2,883,806 $2,798,873 $2,426,126
========== ========== ========== ========== ==========
Subordinated debt.............. $ 239,856 $ 239,195 $ 104,917 $ 104,360 $ 103,851
Minority interest in equity of
subsidiaries................ 21,857 29,538 28,392 21,965
Shareholders' equity........... 329,045 348,751 317,930 297,739 212,312
---------- ---------- ---------- ---------- ----------
Total liabilities and
shareholders'
equity............... $3,803,514 $3,728,865 $3,335,045 $3,222,937 $2,742,289
========== ========== ========== ========== ==========
OTHER SELECTED FINANCIAL DATA
Average assets................... $3,642,960 $3,787,480 $3,233,713 $2,837,292 $2,162,141
Return on average assets......... (0.39)% 1.01% 0.98% 1.18% 0.87%
Average shareholders' equity..... $ 329,250 $ 329,250 $ 308,305 $ 213,311 $ 208,178
Return on average shareholders'
equity......................... (4.46)% 11.17% 10.31% 13.51% 9.04%
Equity-to-assets ratio........... 8.65% 9.35% 9.53% 9.24% 7.74%
Originations:
Consumer loans................. $2,680,341 $2,337,359 $2,157,556 $1,556,296 $1,191,560
Mortgage loans................. 2,754,398 2,331,506 1,259,716 491,274 675,961
Commercial loans............... 124,259 71,399 8,632
---------- ---------- ---------- ---------- ----------
Total originations..... $5,558,998 $4,740,264 $3,425,904 $2,047,570 $1,867,521
========== ========== ========== ========== ==========
Interest rate spread............. 2.88% 2.66% 2.86% 2.44% 2.18%
- ---------------
(1) Net of unearned discounts.
(2) Net of undisbursed loan proceeds.
36
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSES OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Consolidated Financial Statements and notes thereto and other information
included or incorporated by reference herein.
RESULTS OF OPERATIONS
OVERVIEW
The Company's primary sources of revenue are net interest income and
noninterest income. Net interest income is the difference between the income
earned on interest earning assets and the interest paid on interest bearing
liabilities. The primary components of noninterest income include gain on sale
of automobile and mortgage loans, retained interest income on sold automobile
loans, contractually specified servicing fees for the servicing of loans for the
benefit of others, and other servicing related fees earned by servicing loans
including late charges and other miscellaneous servicing fee income. Other
components of noninterest income include gains and losses from the sale of
investment and mortgage-backed securities, insurance income, fees related to the
sales of investment products such as mutual funds and annuities and other fee
income for deposits and various other products.
Other significant factors that can affect the Company's results of
operations include the levels of automobile, commercial and mortgage
originations, the timing of sales of such products, the level of asset quality
of products originated, and the operating efficiency of the company.
NET INTEREST INCOME
Net interest income is affected by the difference between yields earned by
the Company on its interest earning assets and the rates paid on its interest
bearing liabilities (interest rate spread), and the relative amounts of the
Company's interest earning assets and interest bearing liabilities. Net interest
income totaled $111 million in 1998 compared to $109 million and $103 million in
1997 and 1996, respectively. The increase in net interest income for the year
ended December 31, 1998 compared to 1997 and 1996 was due primarily to the
increase in automobile loans held on balance sheet.
As the Company sells or securitizes its on-balance sheet loans, revenue
previously recognized as net interest income will, upon sale or securitization,
be recognized as noninterest income. Noninterest income from automobile loans is
recorded as a component of automobile lending income and servicing income from
single family residential loans is recorded as a component of mortgage banking
income.
37
39
The following table presents information relative to the average balances
and interest rates of the Company for the periods indicated.
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------ ------------------------------ ------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- -------- ------ ---------- -------- ------ ---------- -------- ------
(DOLLARS IN THOUSANDS)
Interest earning assets:
Other investments............ $ 172,694 $ 9,252 5.36% $ 133,416 $ 7,612 5.71% $ 107,866 $ 5,969 5.53%
Investment securities........ 103,026 6,070 5.89 132,197 7,376 5.58 138,184 7,620 5.51
Mortgage-backed securities... 981,772 65,039 6.62 936,026 68,055 7.27 786,925 57,471 7.30
Total loans:
Consumer loans............. 581,911 90,560 15.56 415,226 65,985 15.89 409,255 65,542 16.01
Mortgage loans(1).......... 1,266,628 96,491 7.62 1,552,392 119,859 7.72 1,366,509 105,682 7.73
Commercial................. 54,439 4,730 8.69 19,090 1,645 8.62 1,093 104 9.50
---------- -------- ----- ---------- -------- ----- ---------- -------- -----
Total interest earning
assets....................... 3,160,470 272,142 8.61 3,188,347 270,532 8.49 2,809,832 242,388 8.63
Noninterest earning assets:
Amounts due from trusts...... 316,419 233,241 140,067
Retained interests in
securitized assets......... 167,640 141,008 84,949
Capitalized servicing
rights..................... 36,704 33,591 26,922
Premises and equipment and
real estate owned.......... 93,496 97,371 87,159
Other assets................. 59,511 131,331 125,941
Less: allowance for loan
losses..................... 35,112 37,409 41,157
---------- ---------- ----------
Total.................. $3,799,128 $3,787,480 $3,233,713
========== ========== ==========
Interest bearing liabilities:
Deposits..................... $2,086,972 109,005 5.22 $1,945,520 107,078 5.50 $1,761,319 99,091 5.63
Securities sold under
agreements to repurchase... 321,367 18,639 5.80 308,573 17,376 5.63 299,211 15,491 5.18
FHLB advances and other
borrowings................. 171,464 12,233 7.13 339,110 21,809 6.43 245,908 15,397 6.26
Subordinated debentures...... 239,584 21,454 8.95 166,924 14,807 8.87 104,619 9,215 8.81
---------- -------- ----- ---------- -------- ----- ---------- -------- -----
Total interest bearing
liabilities.................. 2,819,387 161,331 5.72 2,760,127 161,070 5.84 2,411,057 139,194 5.77
Noninterest bearing
liabilities:
Amounts held on behalf of
trustee.................... 389,276 318,621 178,754
Other liabilities............ 254,958 379,482 335,597
Shareholders' equity........... 335,507 329,250 308,305
---------- ---------- ----------
Total.................. $3,799,128 $3,787,480 $3,233,713
========== -------- ----- ========== -------- ----- ========== -------- -----
Net interest income and
interest rate
spread............... $110,811 2.89% $109,462 2.65% $103,194 2.86%
======== ===== ======== ===== ======== =====
Net yield on average
interest earning
assets............... 3.51% 3.43% 3.67%
===== ===== =====
- ---------------
(1) For the purposes of these computations, nonaccruing loans are included in
the average loan amounts outstanding.
The total interest rate spread increased 24 basis points for 1998, compared
with 1997 due to a increase of 12 basis points in the yield on interest earning
assets while the cost of funds decreased by 11 basis points.
The increase in income on interest earning assets for 1998, compared with
1997 was due primarily to a higher percentage of automobile loans held on the
balance sheet.
The decline in the cost of funds is primarily the result of the 28 basis
point decrease in the cost of deposits. This decline was affected by a 17 basis
point increase in securities sold under agreements to repurchase, a 70 basis
point increase in the rate paid on FHLB advances and other borrowings, and a 8
basis point increase in the rate paid on subordinated debentures.
38
40
The following table sets forth the changes in net interest income
attributable to (i) changes in volume (change in average portfolio volume
multiplied by prior period average rate), (ii) changes in rates (change in
weighted average interest rate multiplied by prior period average portfolio
balance), and (iii) the combined effect of changes in rates and volume (change
in weighted average interest rate multiplied by change in average portfolio
balance).
RATE/ RATE/
VOLUME RATE VOLUME TOTAL VOLUME RATE VOLUME TOTAL
-------- ------- ------- -------- ------- ------- ------ -------
(DOLLARS IN THOUSANDS)
Interest income:
Other investments.......................... $ 2,242 $ (466) $ (136) $ 1,640 $ 1,412 $ 194 $ 37 $ 1,643
Investment securities...................... (1,627) 409 (88) (1,306) (329) 96 (11) (244)
Mortgage-backed securities................. 3,325 (6,084) (257) (3,016) 10,884 (236) (64) 10,584
Total loans:
Consumer loans........................... 26,486 (1,370) (541) 24,575 955 (491) (21) 443
Mortgage loans........................... (22,060) (1,552) 244 (23,386) 14,368 (136) (55) 14,177
Commercial loans......................... 3,047 13 25 3,085 1,709 (9) (159) 1,541
-------- ------- ------- -------- ------- ------- ----- -------
Total interest earning assets........ $ 11,413 $(9,050) $ (753) 1,610 $28,999 $ (582) $(273) 28,144
======== ======= ======= ======= ======= =====
Interest expense:
Deposits................................... $ 7,779 $(5,447) $ (405) 1,927 $10,370 $(2,290) $ (93) 7,987
Securities sold under agreements to
repurchase............................... 720 523 20 1,263 484 1,346 55 1,885
FHLB advances.............................. (10,779) 2,372 (1,169) (9,576) 5,834 418 160 6,412
Subordinated debentures.................... 6,444 134 69 6,647 5,489 63 40 5,592
-------- ------- ------- -------- ------- ------- ----- -------
Total interest bearing liabilities $ 4,164 $(2,418) $(1,485) 261 $22,177 $ (463) $ 162 21,876
======== ======= ======= -------- ======= ======= ===== -------
Net change in net interest income.... $ 1,349 $ 6,268
======== =======
PROVISION FOR LOAN LOSSES
The Company maintains an allowance for loan losses to cover anticipated
losses on the loans held on the balance sheet. The allowance for loan losses is
increased by charging the provision for loan losses and decreased by actual
losses on the loans held on balance sheet or as a result of the reduction of
loans held on the balance sheet through loan sales. When the Company sells
automobile loans in a securitization transaction, it reduce its allowance for
loan losses and factors potential losses into its gain on sale calculation. The
Company believes that the allowance for loan losses is currently adequate to
absorb potential losses in its owned loan portfolio. See "Note 1 -- Summary of
Significant Accounting Policies" to the Company's Consolidated Financial
Statements.
During 1998, the provision for loan losses totaled $19.0 million compared
with $12.9 million and $13.6 million in 1997 and 1996, respectively. The
increase in provision for loan losses in 1998 was due primarily to an increased
amount of automobile loans held on the balance sheet. See "Asset Quality."
NONINTEREST INCOME
Automobile Lending Income
The Company originates and sells automobile loans with servicing rights
retained in the asset-backed market. The Company purchased $2.7 billion of
automobile loans in 1998 compared to $2.3 billion in 1997. Noninterest income
from automobile lending includes gains from the sale of loans, loan servicing
income net of amortization of Retained Interest in Securitized Assets (" RISA"),
and other related income such as document fees and late charges. For the year
ended December 31, 1998, automobile lending generated income of $99 million
compared to $176 million and $153 million for the years ended December 31, 1997
and 1996, respectively.
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41
Automobile lending is summarized as follows:
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
------- -------- --------
(DOLLARS IN THOUSANDS)
Gains on sale of automobile loans........... $25,622 $ 39,945 $ 42,121
Loan servicing and retained interest
income.................................... 39,141 100,647 79,623
Other fee income............................ 34,384 35,600 31,355
------- -------- --------
$99,147 $176,192 $153,099
======= ======== ========
The Company recorded gain on sale of contracts of $25.6 million, $39.9
million and $42.1 million in 1998, 1997 and 1996, respectively. Gain on sale of
contracts declined compared to prior periods due to not executing a
securitization transaction in the third quarter of 1998, and as a result of
changes in the gross interest rate spread of contracts securitized, the amount
of dealer participation paid, changes in credit loss assumptions and the effect
of hedging activities. Gross interest rate spread is affected by product mix,
general market conditions and overall market interest rates. The risk inherent
in interest rate fluctuation are reduced through hedging activities. See
"Business -- Hedging and Securitizations."
Loan servicing and retained interest income decreased to $39.1 million for
the year ended December 31, 1998 compared to $101 million and $79.6 million for
1997 and 1996, respectively. Loan servicing income decreased primarily due to
(1) higher amortization of retained interest in securitized assets as a result
of higher credit losses; (2) lower retained interest income as a result of not
executing a securitization transaction in the third quarter; and (3) increased
levels of bankruptcies. The Company serviced automobile loans both owned and
those sold and serviced for the benefit of others, of $4.4 billion, $3.8 billion
and $3.1 billion at December 31, 1998, 1997 and 1996, respectively.
Other fee income, consisting primarily of documentation fees, late charges
and deferment fees, decreased to $34.4 million during 1998 compared to $35.6
million and $31.4 million in 1997 and 1996, respectively, representing a
decrease and an increase of 3% and 14%, respectively.
Mortgage Banking Income
During 1998, the Company originated $2.8 billion of prime and sub-prime
mortgage loans compared to $2.3 billion in 1997. Income from mortgage banking
includes gains on the sale of loans, loan servicing income net of amortization
of capitalized servicing, and other income which primarily consists of late
charges.
Total mortgage banking income decreased to $14.2 million compared to $24.5
million and $18.5 million for the years ended December 31, 1998, 1997 and 1996,
respectively.
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
(DOLLARS IN THOUSANDS)
Net gains from sale of mortgage loans......... $14,769 $18,945 $10,564
Loan servicing income (loss).................. (2,949) 3,284 5,988
Other......................................... 2,410 2,311 1,963
------- ------- -------
$14,230 $24,540 $18,515
======= ======= =======
Gains on sales of mortgage loans for 1998 totaled $14.8 million compared to
$18.9 million and $10.6 million for the years ended December 31, 1997 and 1996,
respectively. The decline in the gain on sale for the year ended December 31,
1998 was the result of lower pricing on products sold.
Net loan servicing loss totaled $2.9 million for the year ended December
31, 1998 compared to net loan servicing income of $3.3 million and $6.0 million
for the years ended December 31, 1998, 1997 and 1996, respectively. The decrease
in servicing income was the result of higher prepayment experience on loans
serviced for the benefit of others as interest rates declined.
40
42
As a result of the Company's decision to shift from originating prime
mortgage products that were sold primarily on a servicing retained basis to
originating sub-prime mortgage products that were to be sold on a whole loan,
servicing released basis, the Company decided to sell substantially all of its
mortgage servicing rights. At December 31, 1998, the Company serviced for the
benefit of others $1.6 billion in mortgage loans compared with $4.9 billion at
December 31, 1997.
Other Noninterest Income
Other noninterest income consists primarily of investment and
mortgage-backed securities gains and losses and insurance income. The Company
had investment and mortgage-backed securities gains of $7.6 million for the year
ended December 31, 1998 compared with gains of $8.0 million in 1997 and a losses
of $1.6 million in 1996. The gain on sale recorded in 1998 was the result of the
sale of $366 million of mortgage-backed securities compared with the sale of
$394 million during 1997. Insurance income, which totaled $5.7 million, $6.5
million and $12.9 million for the years ended December 31, 1998, 1997 and 1996,
includes premiums and commissions earned on insurance and insurance-related
products, including credit life and collateral protection insurance. Sales of
mutual funds and annuities totaled $2.0 million in 1998 and $1.8 million in 1997
NONINTEREST EXPENSES
Noninterest expenses, excluding $18.0 million in restructuring charges,
declined $10.7 million, or 4.4% to $236 million for the year ended, December 31,
1998 compared with $246 million for all of 1997. Salaries and employee benefits
declined $3.1 million, or 2.2% to $135 million during 1998 compared with $138
million during 1997. Occupancy costs decreased $3.6 million, or 20% to $14.5
million for the year ended December 31, 1998 compared with $18.1 million the
same period a year earlier. Data processing declined $3.5 million, or 20% to
14.5 million for all of 1998 compared with $17.9 million for 1997. The decline
in noninterest expense is the result of the completion of the Company's
restructuring programs in the automobile lending and mortgage banking areas
during 1998.
Restructuring
In 1998, the WFS completed a restructuring plan initially announced on
February 10, 1998. The plan had four objectives: to reduce operating costs, to
increase contract production volume, to strengthen credit quality and to improve
the quality of personnel. The plan was achieved in two phases. Phase I of the
plan, completed in the first quarter of 1998, consisted of the restructuring of
operations in the Western United States. Phase II of the plan, completed in the
third quarter of 1998 and patterned after Phase I, consisted of the
restructuring of operations in the Central and Eastern United States.
As a result of the restructuring, a total of 400 positions, or 19% of WFS's
workforce, were eliminated and 96 offices were closed. WFS now purchases
contracts through 21 regional business centers ("RBCs") and 26 satellite
offices, each offering the full spectrum of prime and non-prime products. The
total pre-tax restructuring charge in 1998 for the completed plan was $15.0
million. Restructuring related costs included $1.8 million for employee
severance and $13.2 million for lease termination fees and the write off of
disposed assets. The restructuring charge was substantially utilized during
1998. Operating costs as a percent of serviced contracts has declined from 5.4%
in 1997 to 3.8% in 1998, resulting in a decrease in operating costs of $65
million on an annual run rate basis.
Through the restructuring, WFS increased its contract production volume to
$2.7 billion compared with $2.3 billion in 1997. Prior to the restructuring, WFS
purchased contracts in 143 offices, each serving either the prime or non-prime
market. As part of the restructuring, the Company closed poorly performing
offices and combined its prime and non-prime marketing into a single, unified
marketing effort. By combining the marketing of the two products under a single
marketing force, WFS is able to more fully leverage its existing dealer
relationships across the full spectrum of credit.
Each of the 47 offices underwrites contracts by employing separate credit
analysts that specialize in either reviewing prime or non-prime paper. The
underwriting process is further enhanced by credit policies and
41
43
contract approval authorities controlled by the front-end contract production
system and through the use of the Company's proprietary scorecard which was
implemented in the fourth quarter of 1998. See "Business -- Maintain Solid Asset
Quality -- Consistent and Expeditious Underwriting."
As part of the restructuring, early delinquency collection efforts were
centralized at two national servicing centers that employ automated queuing and
dialing techniques to contact customers. When these efforts are unsuccessful,
the collection process is transferred to the RBCs where loan service counselors
undertake more extensive collection efforts up to and including repossession.
The Company plans to further improve its collection efforts by implementing a
new collection system, including risk-based collections, in 1999.
During 1998, the Company also established a more effective management
structure. Each RBC is managed by a RBC manager who directs and is responsible
for the performance of the region. Four functional managers who oversee
marketing, credit, collections and operations report directly to the RBC
manager. This organization is designed to provide overall coordination of the
activities within the RBC with appropriate focus and specialization in each of
these four critical business areas. Each of these critical functions also has a
national director who provides expertise, training and policy development,
management and enforcement. This matrix structure has been effective in
providing greater oversight, compliance and focus for each aspect of the
organization and has helped standardize operating practices by identifying best
practices and employing these practices throughout the organization.
During the fourth quarter of 1998, the Company incurred a $3.0 million
restructuring charge relating to the consolidation of its 14 mortgage banking
offices into 3 Regional Operating Centers and the elimination of 200 positions,
or 55% of the work force in the mortgage banking area. This restructuring is the
result of the Company's decision to focus on primarily sub-prime mortgage
products rather than prime and non-agency originations. Restructuring related
costs included $0.6 million for the employee severance and $2.4 million for
lease termination fees and the writeoff of disposed assets. The restructuring
program is designed to save up to $19 million annually in expenses
INCOME TAXES
The Company's effective tax benefit was 40% for the year ended December 31,
1998 compared with an effective tax rate of 43% and 42% for the years ended
December 31, 1997 and 1996, respectively.
FINANCIAL CONDITION
OVERVIEW
During 1998, the Company's strategy has been to focus on and expand its
three principal lines of business -- automobile lending, community banking, and
mortgage banking. The Company originated $2.7 billion of automobile loans in
1998 compared with $2.3 billion during 1997. The 17% increase in automobile loan
originations is the result of the successful implementation of a full spectrum
single point of contact marketing approach initiated as part of the Company's
restructuring program. Automobile loans securitized totaled $1.9 billion for all
of 1998 compared with $2.2 billion during 1997. The decline in securitizations
was the result of the Company's decision not to execute a securitization
transaction in the third quarter during adverse market conditions.
During 1998, commercial loans originated increased $52.8 million or 74% to
$124 million compared with $71.4 million during 1997 as the Company continues to
expand this line of business. Since the introduction of demand deposit accounts
in the Retail Banking Division, core deposit balances (demand deposit, money
market and savings accounts) have increased to $411 million at December 31, 1998
compared with $244 million at December 31, 1997. This amount represents less
than 19% of the Company's total deposits, and provides a significant opportunity
to materially increase the core to total deposit ratio.
Mortgage loan production during 1998 increased to $2.8 billion compared
with $2.3 billion during 1997. The Company securitized $2.9 billion of its
mortgage loan origination during 1998 compared with $2.0 billion during 1997.
Based upon current market pricing of prime and non-agency mortgage products, the
Company decided to shift its focus to the sub-prime mortgage market. The
decision to focus on more sub-prime
42
44
mortgage products was based upon the wider margins and higher fee revenues
generated by such loans. The Company believes that focusing on sub-prime
mortgage loans is a more effective use of its capital. Sub-prime mortgage
products will be sold on a whole loan, servicing released basis. This shift in
strategy led to the sale of substantially all of the mortgage loan servicing
portfolio and the closure of the Company's prime lending offices.
At December 31, 1998, nonperforming assets totaled $16.3 million compared
to $26.1 million at December 31, 1997. Nonperforming assets represented less
than 1% of total assets in 1998 and 1997. At December 31, 1998, loans past due
60 days or more as a percentage of total loans in the Company's consumer and
real estate loan portfolios were 0.8% and 0.9%, respectively, compared to 1.1%
and 0.9% at December 31, 1997.
The Company currently exceeds all regulatory capital requirements. At
December 31, 1998, the Bank's FDICIA regulatory capital ratios for Tier 1 and
risk-based capital were 6.42% and 11.24% respectively. The Bank's FIRREA
regulatory capital ratios for tangible, core and risk-based capital were 9.02%,
9.02% and 11.24%, respectively.
INVESTMENT SECURITIES
The Company's investment securities portfolio consists primarily of United
States Agency and Treasury securities and is classified as available for sale.
Accordingly, the portfolio is reported at fair value with unrealized gains and
losses being reflected as a separate component of shareholders' equity. This
portfolio is maintained primarily for liquidity purposes in accordance with
regulatory requirements. The Company also holds FHLB stock, which is carried at
cost, as required by its affiliation with the FHLB System. All of the Company's
investment securities held to maturity were reclassified to available for sale
in 1997. In 1997, the Company held other investments which include investment
securities. At December 31, 1998, the weighted average interest rate of the
Company's investment securities portfolio was 4.85% for securities with
maturities of up to one year, 5.70% for securities with maturities greater than
one year up to five years, and 5.01% for securities with maturities greater than
five years up to ten years. The following table summarizes the Company's
investment securities at the dates indicated.
DECEMBER 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Interest bearing deposits with other
financial institutions............ $ 515 $ 15,510 $ 510 $ 689 $ 563
Other short-term investments........ 22,864 84,136 62,798 126,227 145,391
Investment securities:
U.S. Treasury securities and
obligations of other U.S.
Government
agencies and corporations --
available for sale............. 75,592 121,714 140,806 130,052 111,677
U.S. Treasury securities and
obligations of other U.S.
Government
agencies and corporations --
held to maturity............... 1,504 1,506
Obligations of states and
political subdivisions......... 1,572 1,532 1,513 3,441 3,062
FHLB stock........................ 24,555 25,762 31,967 29,624 24,474
Corporate bonds -- below
investment grade...............
Other............................. 632 163 25 25 25
-------- -------- -------- -------- --------
$125,730 $248,817 $239,123 $291,564 $285,192
======== ======== ======== ======== ========
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45
The following table sets forth the stated maturities of the Company's
investment securities at December 31, 1998.
UP TO ONE YEAR TO FIVE YEARS TO TEN YEARS NO STATED
ONE YEAR FIVE YEARS TEN YEARS OR MORE MATURITY
-------- ----------- ------------- --------- ---------
(DOLLARS IN THOUSANDS)
Interest bearing deposits with other
financial institutions............ $ 515
Other short-term investments........ 22,864
Investment securities:
U.S. Treasury securities and
obligations of other U.S.
Government agencies and
corporations................... 24,306 $51,286
Obligations of states and
political subdivisions......... 134 $1,438
FHLB stock........................ $24,555
Other............................. 25 607
------- ------- ------ ---- -------
$47,710 $51,420 $1,438 $25,162
======= ======= ====== ==== =======
Weighted average interest rate...... 4.85% 5.70% 5.01% 0.00% 5.27%
MORTGAGE-BACKED SECURITIES
The Company invests in mortgage-backed securities ("MBS") to generate net
interest income, to manage its mix of assets and liabilities and to invest in
certain low-income housing programs designed to provide affordable access to the
housing market. In 1997, the Company reclassified all of the portfolio as
available for sale and accounts for it at fair value with unrealized gains or
losses being reported as a separate component of shareholders' equity. The
following table summarizes the Company's MBS portfolio by issuer.
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Available for sale securities:
GNMA certificates.................................... $859,627 $786,942
FNMA participation certificates...................... 113,842 143,451
FHLMC participation certificates..................... 3,658 8,125
Other................................................ 2,917 2,930
-------- --------
$980,044 $941,448
======== ========
The carrying value of the MBS available for sale is equal to its estimated
market value of $980 million and has a weighted average interest rate of 6.62%
at December 31, 1998. The Company's MBS portfolio had maturities of ten years or
greater at December 31, 1998, although payments are generally received monthly
throughout the life of these securities.
LOAN PORTFOLIOS
Mortgage Loan Portfolios
The Company has from time to time originated mortgage products that it has
held on its balance sheet rather than selling such products into the secondary
markets. Other than mortgage loans originated through the Commercial Banking
Division on a limited basis and sub-prime loans held prior to sale, the Company
does not currently add newly mortgage loans to its balance sheet. However, the
Company continues to evaluates all mortgage products that it originates to
determine whether the yield associated with the mortgage product warrants the
risks associated with retaining such products on the balance sheet.
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46
The Company's total mortgage loan portfolio (including those held for sale)
consisted of the following:
DECEMBER 31,
------------------------------------------
1998 1997
------------------- -------------------
AMOUNT % AMOUNT %
---------- ----- ---------- -----
(DOLLARS IN THOUSANDS)
Single family residential loans:
First trust deeds........................ $ 618,670 61.4% $1,062,208 69.1%
Second trust deeds....................... 27,051 2.7 48,393 3.1
---------- ----- ---------- -----
645,721 64.1 1,110,601 72.2
Multifamily residential loans.............. 331,652 32.9 410,139 26.7
Construction loans......................... 18,950 1.9 15,835 1.0
Other...................................... 17,031 1.7 9,024 0.6
---------- ----- ---------- -----
1,013,354 100.6 1,545,599 100.5
Less: undisbursed loan proceeds............ 6,417 0.6 8,657 0.5
---------- ----- ---------- -----
Total mortgage loans.................. $1,006,937 100.0% $1,536,942 100.0%
========== ===== ========== =====
Consumer Loan Portfolios
The composition of the consumer loan portfolio (including those held for
sale) consisted of the following:
DECEMBER 31,
--------------------------------------
1998 1997
----------------- -----------------
AMOUNT % AMOUNT %
-------- ----- -------- -----
(DOLLARS IN THOUSANDS)
Automobile loans.............................. $923,662 95.3% $253,455 80.1%
Other......................................... 45,529 4.7 62,870 19.9
-------- ----- -------- -----
$969,191 100.0% $316,325 100.0%
======== ===== ======== =====
The balance of automobile loans held on the balance sheet is largely
dependent upon the timing of the originations and securitizations of contracts.
The Company completed securitization transactions of $1.9 billion during 1998,
down from $2.2 billion in 1997 as a result of the Company's decision not to
execute a securitization transaction in the third quarter, during a time when
asset-backed transactions were adversely affected by wider spreads, thereby
leaving a greater amount of loans held on the balance sheet. The Company
completed a $1.0 billion securitization in February, 1999. WFS plans to continue
to securitize contracts on a regular basis when favorable market conditions
exist. The Company believes, however, that it holds a competitive advantage
relative to other independent auto finance companies because of its ability to
utilize the Bank's liquidity sources during unfavorable market conditions in the
asset-backed securities market.
Commercial Loan Portfolio
The Company had outstanding commercial loan commitments of $154 million at
December 31, 1998 compared with $54.7 million at December 31, 1997. During 1998,
the Company originated $124 million of commercial loans compared with $71.4
million during 1997. Though the Company continues to focus on expanding its
commercial banking operations, it is not a significant source of revenues for
the Company for the year ended December 31, 1998.
ASSET QUALITY
Overview
Nonperforming assets, loan delinquency and loan losses are considered key
measures of asset quality by the Company. Asset quality, in turn, affects the
determination of the allowance for loan losses. In addition to nonperforming
assets and loan delinquency levels, valuation allowances for estimated losses on
loans and real estate are also determined by taking into consideration general
economic conditions in the markets the Company serves, historical loss
experience, individual loan reviews and the level of assets relative to
reserves.
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Automobile Loan Quality
Consistent and Expeditious Underwriting -- The Company relies on a
combination of multiple credit scoring models, system controlled underwriting
policies and the judgment of its trained credit analysts to make risk based
credit decisions. In order to make timely credit decisions, WFS personnel are
trained to obtain, examine and verify all relevant underwriting information
quickly utilizing the Company's automated credit application processing system.
The Company's credit analysts are closely monitored by management through trend
analysis, risk management reporting, and internal quality control professionals
to insure adherence to the Company's underwriting guidelines. Credit analyst
lending levels and approval authorities are established based on the
individual's credit experience, portfolio performance, Credit Manager audit
results and quality control review results. The goal in underwriting contracts
is to correctly determine whether an applicant has the ability and intent to
perform on his or her obligations under the contract, thereby maximizing returns
while optimizing credit quality.
Collection Activities -- WFS services all of the contracts it purchases,
both those held by the Company and those sold in securitization transactions.
The servicing process includes the routine collection and allocation of payments
to WFS or to the appropriate securitization transaction into which the contract
has been sold.
WFS has developed procedures for the early identification and cure of
delinquent contracts. During the early stages of delinquency, WFS utilizes an
automated telephone dialing system ("autodialer") to aid in the servicing and
collection process.. If the early collection efforts do not result in a
satisfactory resolution of the delinquent account, then the account is forwarded
to the appropriate regional collection specialist.
If satisfactory payment arrangements are not made, the automobile is
generally repossessed within 60 to 90 days of the date of delinquency, subject
to compliance with applicable law. WFS uses independent contractors to perform
repossessions. The automobile remains in the custody of WFS for 15 days (or
longer if required by local law) to provide the obligor the opportunity to
redeem the contract. If after the redemption period the delinquency is not
cured, WFS writes down the vehicle to fair value and reclassifies the contract
as a repossessed asset. After the redemption period expires, WFS prepares the
automobile for sale. WFS sells substantially all repossessed automobiles through
wholesale auto auctions at the best price possible, subject to applicable law.
WFS does not provide the financing on repossessions sold. WFS uses regional
remarketing departments to sell its repossessed vehicles. The remarketing
departments are responsible for transportation of the vehicle to wholesale
auction houses, reconditioning and repairs when necessary and tracking vehicles
until they are sold. Once the vehicle is sold, any remaining deficiency balances
are then charged off. At December 31, 1998, the total amount of repossessed
autos managed by WFS was $7.8 million or 0.18% of the total serviced portfolio
compared with $9.7 million or 0.26% of the total serviced portfolio at December
31, 1997.
After chargeoff, WFS will seek to collect deficient balances through its
centralized asset recovery center ("ARC"). The ARC will first attempt to collect
directly from the obligor with its in-house collection staff. If efforts are not
successful, the ARC will seek a deficiency judgment through a small claims court
procedure, where available, or an attorney employed by WFS takes more formal
judicial action against customers with deficiency balances in excess of that
which may be brought in a small claims court proceeding. In some cases,
particularly when the likelihood of recovery is believed to be remote, the
account is assigned to a collection agency for final resolution. The ARC will
attempt to obtain vehicles that could not be found for repossession by skip
tracing to locate the vehicle. The ARC also monitors payment plans on those
obligors who have filed for bankruptcy. If the obligor is not following the
payment plan stipulated by the courts in a Chapter 13 bankruptcy the ARC will
seek a judgment for dismissal or discharge from the bankruptcy court, or will
seek an order permitting it to repossess the vehicle.
The following tables reflect the delinquency, repossession and loss
experience that WFS has achieved as a result of its collection efforts. It is
the Company's policy to charge off all contracts once they become 120 days past
due, including those that are not in compliance with the court ordered
bankruptcy plan and whether or not the automobile has been repossessed or sold
by that date. WFS continues to accrue interest on a contract until it is charged
off. At the time a contract is charged off, all accrued but unpaid interest
which has been
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previously included as income is reversed by charging the allowance for credit
losses. No assurance can be given that the future performance of the contracts
purchased by the Company will be similar to the delinquency, repossession and
loss rates disclosed in the following tables.
The following table sets forth information with respect to the delinquency
of the Company's portfolio of automobile loans serviced.
DECEMBER 31,
---------------------------------------------------------------------------
1998 1997 1996
----------------------- ----------------------- -----------------------
NUMBER OF NUMBER OF NUMBER OF
AUTOMOBILE AUTOMOBILE AUTOMOBILE
LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT
---------- ---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Automobile loans
serviced(1)................ 464,257 $4,367,099 408,958 $3,680,817 341,486 $3,046,585
======= ========== ======= ========== ======= ==========
Period of delinquency(2)
31 - 59 days............... 13,885 $ 112,208 6,605 $ 54,450 4,511 $ 38,173
60 - 89 days............... 3,966 32,100 2,161 18,652 1,305 11,470
90 days or more............ 1,768 14,441 918 7,762 567 5,144
------- ---------- ------- ---------- ------- ----------
Total automobile loans
delinquent................. 19,619 $ 158,749 9,684 $ 80,864 6,383 $ 54,787
======= ========== ======= ========== ======= ==========
Delinquencies for automobile
loans as a percentage of
number and amount of
automobile loans
outstanding................ 4.23% 3.64% 2.37% 2.20% 1.87% 1.80%
======= ========== ======= ========== ======= ==========
- ---------------
(1) Includes delinquency information relating to automobile loans which are
owned by the Company which have been sold and securitized but are serviced
by the Company.
(2) The period of delinquency is based on the number of days payments are
contractually past due.
The following table sets forth information with respect to the delinquency
of the Company's portfolio of automobile loans owned. Due to the timing of
securitizations, owned delinquency statistics may, from time to time, experience
wide fluctuations as a result of the amount of newly originated contracts
pending securitization.
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
-------------------- -------------------- --------------------
NUMBER NUMBER NUMBER
OF OF OF
CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
--------- -------- --------- -------- --------- --------
(DOLLARS IN THOUSANDS)
Contracts owned...................... 76,474 $875,642 21,562 $231,228 22,208 $233,947
======= ======== ====== ======== ====== ========
Period of delinquency(1)
31-59 days......................... 7,579 $ 12,743 3,587 $ 3,053 2,376 $ 3,285
60-89 days......................... 2,442 3,622 1,313 1,595 820 1,488
90 days or more.................... 1,129 1,868 557 587 350 617
------- -------- ------ -------- ------ --------
Total contracts
delinquent............... 11,150 $ 18,233 5,457 $ 5,235 3,546 $ 5,390
======= ======== ====== ======== ====== ========
Delinquencies as a percentage of
number and amount of contracts
outstanding........................ 14.58% 2.08% 26.31% 2.26% 5.25% 2.30%
- ---------------
(1) The period of delinquency is based on the number of days payments are
contractually past due.
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The following table sets forth information with respect to repossessions in
the Company's portfolio of serviced contracts.
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
---------------------- ---------------------- ----------------------
NUMBER OF NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
--------- ---------- --------- ---------- --------- ----------
(DOLLARS IN THOUSANDS)
Servicing portfolio(1)........ 464,257 $4,367,099 408,958 $3,680,817 341,486 $3,046,585
======= ========== ======= ========== ======= ==========
Repossessed autos............. 1,232 $ 7,790 1,554 $ 9,672 1,133 $ 6,135
======= ========== ======= ========== ======= ==========
Repossessed autos as a
percentage of number and
amount of contracts
outstanding................. 0.27% 0.18% 0.38% 0.26% 0.33% 0.20%
- ---------------
(1) Includes delinquency information relating to contracts which are owned by
WFS and contracts which have been sold and securitized but are serviced by
the Company.
The following table sets forth information with respect to actual loss
experience of the Company's portfolio of automobile loans serviced and includes
automobile loan loss information relating to automobile loans which are owned by
the Company and automobile loans which have been sold and securitized but are
serviced by the Company.
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Portfolio
Automobile loans serviced at end of period
(net of unearned add-on interest)(1)...... $4,637,099 $3,680,817 $3,046,585
========== ========== ==========
Average during period (net of unearned add-on
interest)(1).............................. $4,006,185 $3,383,570 $2,627,622
========== ========== ==========
Gross chargeoffs of automobile loans during
period.................................... $ 173,422 $ 136,773 $ 86,464
Recoveries of automobile loans charged off in
current and prior periods................. 36,230 34,634 25,946
---------- ---------- ----------
Net chargeoffs............................... $ 137,192 $ 102,139 $ 60,518
========== ========== ==========
Net chargeoffs as a percent of average
automobile loans outstanding during
period.................................... 3.42% 3.02% 2.30%
========== ========== ==========
- ---------------
(1) Includes loan loss information for loans which are owned by the company and
loans sold and securitized that were originated and serviced by the Company.
Delinquency and loss experience was impacted by the disruption in
collection efforts during the current year restructurings. (See "Improve
Operating Efficiencies"), the shift to greater non-prime paper during 1996 and
1997 and higher levels of bankruptcies.
Real Estate Loan Quality
The Company has established procedures to assist in the effective
identification, measurement and rehabilitation of delinquent and other problem
loans. An integral part of this process is the Internal Asset Review Department
("IAR"). IAR performs an independent review function to measure risk with the
Company's asset portfolio. IAR reviews and classifies assets as Pass, Special
Mention, Substandard, Doubtful or Loss. Substandard assets have one or more
defined weaknesses and are characterized by the distinct possibility that the
Company may sustain some loss unless the deficiencies are corrected. Doubtful
assets have a higher possibility of loss than substandard assets. Special
mention assets are assets not falling in the foregoing categories, but which
have apparent weaknesses or potential weaknesses deserving management's close
attention.
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50
The following table sets forth the delinquency percentages relative to the
dollar amounts of the Company's total mortgage portfolio, including loans held
for sale, for the past five years.
DECEMBER 31,
------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Period of Delinquency:
Two payments (31 - 59 days)................... 0.71% 0.55% 0.34% 0.57% 0.56%
Three payments (60 - 89 days)................. 0.21 0.10 0.14 0.40 0.09
Four or more payments (90 days or more)....... 0.71 0.80 1.03 0.89 1.11
The following table of mortgage delinquencies over 60 days by loan type
highlights the fact that real estate loan related delinquencies have stabilized
over the past three years.
DECEMBER 31,
--------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
AMOUNT AMOUNT AMOUNT
PAST DUE PAST DUE PAST DUE
OVER % OF OVER % OF OVER % OF
60 DAYS CATEGORY 60 DAYS CATEGORY 60 DAYS CATEGORY
-------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Single family........... $7,588 1.19% $12,993 1.17% $15,266 1.55%
Multifamily............. 669 0.30 938 0.22 1,756 0.38
Construction............ 964 6.92 220 2.79
------ ---- ------- ---- ------- ----
$9,221 0.91% $14,151 0.90% $17,022 1.17%
====== ==== ======= ==== ======= ====
Nonperforming Assets
The Company's total nonperforming assets ("NPAs") decreased $9.8 million to
$17.1 million at December 31, 1998 compared to $26.1 million at December 31,
1997 and $33.0 million at December 31, 1996. NPAs as a percentage of total
assets decreased by 0.3% for 1998 compared to 1997. At December 31, 1998, NPAs
represented 0.4% of total assets. NPAs represented 0.7% and 1.0% of total assets
at December 31, 1997 and 1996, respectively. Real estate markets have become
stronger throughout California and have been relatively stable throughout the
United States.
NPAs consist of nonperforming loans ("NPLs") and REO. REO is carried at
lower of cost or fair value less estimated disposition costs. NPLs are defined
as all nonaccrual loans, which include mortgage loans 90 days or more past due
and impaired loans where full collection of principal and interest is not
reasonably assured. When a loan is designated as nonaccrual, all previously
accrued but unpaid interest is reversed. At December 31, 1998, 1997 and 1996,
interest on nonperforming loans excluded from interest income was $0.4 million,
$0.8 million, and $1.0 million, respectively.
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect all amounts
due according to the contractual terms of the loan agreement. The Company
measures impairment based on, among other factors, the fair value of the loan's
collateral. Changes in the fair value of loans are recorded through the
allowance for loan losses. At December 31, 1998 and 1997, impaired loans were
$4.0 million and $4.8 million, respectively.
The following table classifies NPLs into significant categories:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Loans placed on nonaccrual....................... $ 8,181 $14,979
Impaired loans................................... 4,046 4,806
------- -------
$12,227 $19,785
======= =======
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51
Single family loans accounted for 47% of total NPAs at December 31, 1998
while multifamily loans accounted for 40%, although no single loan or series of
such loans predominate. The decrease in total NPAs is the result of improving
asset quality and stabilization of market values. The following tables show the
roll forward and migration of NPLs and REO since December 31, 1996:
SINGLE
FAMILY MULTIFAMILY MULTIFAMILY
TOTAL 1 - 4 UNITS 5 - 36 UNITS 37+ UNITS CONSTRUCTION
-------- ----------- ------------ ----------- ------------
(DOLLARS IN THOUSANDS)
NONPERFORMING LOANS
Balance December 31, 1996........ $ 20,939 $ 13,639 $ 3,327 $ 3,973
New nonperforming loans........ 24,674 19,878 3,062 1,180 $ 554
REO............................ (16,605) (11,739) (3,685) (1,181)
Cures and payoffs.............. (7,941) (6,464) (1,346) (106) (25)
Chargeoffs..................... (1,230) (1,060) (170)
Transfers...................... (52) (945) 893
-------- -------- ------- ------- ------
Balance December 31, 1997........ $ 19,785 $ 13,309 $ 2,251 $ 3,866 $ 359
New nonperforming loans........ 17,476 11,310 2,871 3,295
REO............................ (12,403) (9,882) (1,648) (873)
Cures and payoffs.............. (11,587) (8,749) (2,392) (111) (335)
Chargeoffs..................... (1,044) (199) (845)
-------- -------- ------- ------- ------
Balance December 31, 1998........ $ 12,227 $ 5,789 $ 1,082 $ 3,755 $1,601
======== ======== ======= ======= ======
REAL ESTATE ACQUIRED THROUGH
FORECLOSURE
Balance December 31, 1996........ $ 12,063 $ 9,178 $ 2,515 $ 370
New REO........................ 27,021 15,113 10,622 $ 1,181 105
Sales.......................... (26,489) (17,906) (7,317) (1,181) (85)
Writedowns..................... (5,475) (1,237) (4,127) (111)
-------- -------- ------- ------- ------
Balance December 31, 1997........ 7,120 5,148 1,693 279
New REO........................ 14,851 11,858 2,394 599
Sales.......................... (17,673) (13,232) (3,719) (722)
Writedowns..................... 563 (27) 746 (156)
-------- -------- ------- ------- ------
Balance December 31, 1998........ $ 4,861 $ 3,747 $ 1,114 $ 0
======== ======== ======= ======= ======
Allowance For Loan Losses
The Company's allowance for loan losses was $37.7 million at December 31,
1998 compared to $33.8 million at December 31, 1997 and $40.2 million at
December 31, 1996. The allowance for loan losses and related provisions are
determined by considering loan volumes, loan sales, prepayments, loss trends,
levels of NPLs and management's analysis of market conditions, individual loan
reviews, levels of assets to reserves and other relevant factors. The allowance
for loan losses is reduced by net chargeoffs and increased by the provision for
loan losses. For the year ended December 31, 1998, the provision for loan losses
totaled $19.0 million compared to $12.9 million and $13.6 million for the years
ended December 31, 1997 and 1996, respectively. Net chargeoffs for the years
ended December 31, 1998, 1997 and 1996 were $15.1 million, $18.4 million and
$14.1 million, respectively.
The Company believes that the allowance for loan losses is currently
adequate to absorb inherent losses in the portfolio. While the Company's
portfolio consists primarily of single family loans, no single loan, borrower or
series of such loans comprise a significant portion of the total portfolio. The
provision and allowance for loan losses are indicative of loan volumes, loss
trends and management's analysis of market conditions.
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The following table sets forth the activity in the allowance for loan
losses.
AT OR FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Balance at beginning of period..................... $ 33,834 $ 40,211 $ 39,260
Chargeoffs:
Mortgage loans................................... (4,761) (6,850) (5,678)
Consumer loans................................... (14,944) (15,956) (15,580)
-------- -------- --------
(19,705) (22,806) (21,258)
Recoveries:
Mortgage loans................................... 427 66 2,010
Consumer loans................................... 4,144 4,303 5,158
-------- -------- --------
4,571 4,369 7,168
-------- -------- --------
Net chargeoffs..................................... (15,134) (18,437) (14,090)
Transfers from the allowance for real estate losses
Business acquisition adjustments(1).............. (791) 1,470
Provision for loan losses.......................... 18,960 12,851 13,571
-------- -------- --------
Balance at end of period........................... $ 37,660 $ 33,834 $ 40,211
======== ======== ========
Ratio of net chargeoffs during the period to
average loans outstanding during the period...... 0.79% 0.93% 0.79%
- ---------------
(1) Adjustments related to the acquisition of The Hammond Company and its
subsidiaries were $791 thousand and $1.47 million at December 31, 1997 and
1996 respectively. There were no adjustments at December 31, 1998.
The allowance for loan loss by loan category was as follows:
DECEMBER 31,
------------------------------------------------------------------
1998 1997
------------------------------- -------------------------------
LOANS IN EACH LOANS IN EACH
CATEGORY AS A % OF CATEGORY AS A % OF
ALLOWANCE TOTAL LOANS ALLOWANCE TOTAL LOANS
--------- ------------------ --------- ------------------
(DOLLARS IN THOUSANDS)
Consumer...................... $13,971 45.6% $ 6,787 15.5%
Single family residential..... 5,881 33.4 8,952 60.4
Multifamily residential....... 15,467 17.7 16,111 21.9
Commercial.................... 2,341 3.3 1,984 2.2
------- ----- ------- -----
$37,660 100.0% $33,834 100.0%
======= ===== ======= =====
The allowance for real estate losses remained constant at $0.8 million at
December 31, 1998 and December 31, 1997. The allowance for real estate losses is
charged with writedowns of foreclosed assets or changes in estimated fair value
occurring subsequent to foreclosure. No later than at the time of foreclosure,
individual properties are written down to estimated fair value and the allowance
for loan losses is charged. Management believes that the allowance for real
estate losses is currently adequate to absorb potential losses in the foreclosed
portfolio.
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The following table presents summarized data relative to the allowances for
loan and real estate losses.
DECEMBER 31,
------------------------
1998 1997
---------- ----------
(DOLLARS IN THOUSANDS)
Total loans(1).............................................. $1,992,833 $1,872,710
Allowance for loan losses................................... 37,660 33,834
Allowance for real estate losses............................ 784 784
Loans past due 60 days or more.............................. 17,364 17,312
Nonperforming loans......................................... 12,227 19,785
Nonperforming assets(2)..................................... 16,304 26,905
Allowance for loan losses as a percent of:
Total loans(2)............................................ 1.9% 1.8%
Loans past due 60 days or more............................ 230.1 195.4
Nonperforming loans....................................... 308.0 171.0
Total allowance for loan losses and REO losses as a percent
of nonperforming assets................................... 235.8 128.7
Nonperforming loans as a percent of total loans............. 0.6 1.1
Nonperforming assets as a percent of total assets........... 0.4 0.7
- ---------------
(1) Loans net of unearned discounts and undisbursed loan proceeds.
(2) Nonperforming loans and real estate owned.
AMOUNTS DUE FROM TRUST
The excess cash flow generated by contracts sold to trusts is deposited
into spread accounts by the trustee under the terms of the securitization
transactions. In addition, at the time a securitization transaction closes, WFS
advances additional monies to WFAL to initially fund these spread accounts. WFS
establishes a liability associated with its use of the spread account funds
which is reduced as such funds reach predetermined funding levels. WFS is
released from obligation after the spread account reaches a predetermined
funding level. Amounts due from trusts represents amounts due to WFS that are
still under obligation to be held in the spread accounts. The amounts due from
trusts at December 31, 1998 was $333 million compared with $295 million at
December 31, 1997. The increase is a result of the increase in the total
contracts securitized and outstanding.
SECURITIZED ASSETS AND CAPITALIZED SERVICING RIGHTS
Statement of Financial Accounting Standards ("SFAS") No. 125 requires that,
following a transfer of financial assets, an entity must recognize the assets it
controls and the liabilities it has incurred, and derecognize assets for which
control has been surrendered and liabilities that have been extinguished. SFAS
125 defines two separate financial assets retained at the time of securitization
or sale, RISA which represents the excess spread created from securitization or
sale, and CSR which represents the benefit derived from retaining the rights to
service loans securitized or sold. The Company did not recognize any CSR as of
December 31, 1998 or 1997 with respect to securitized automobile loans. Previous
accounting guidance did not separately distinguish these rights.
Retained Interest in Securitized Assets
Retained Interest in Securitized Assets ("RISA") capitalized upon
securitization of automobile loans represents the present value of the estimated
future earnings to be received by the Company from the excess spread created in
securitization transactions. Excess spread is calculated by taking the
difference between the coupon rate of the automobile loans sold and the interest
rate paid to the investors less contractually specified servicing and guarantor
fees.
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Prepayment and credit loss assumptions are utilized to project future
earnings and are based upon historical experience. Credit losses are estimated
using a cumulative loss rate estimated by management to reduce the likelihood of
asset impairment. All assumptions used are evaluated each quarter and adjusted,
if appropriate, to reflect actual performance of the automobile loans.
Future earnings are discounted at a rate management believes to be
representative of market at the time of securitization. The balance of the RISA
is amortized against actual excess spread income earned on a monthly basis over
the expected repayment life of the underlying automobile loans. RISAs are
classified in a manner similar to available for sale securities, and as such are
marked to market each quarter. Market value changes are calculated by
discounting the excess spread using a current market discount rate. Any changes
in the market value of the RISA is reported as a separate component of
shareholders' equity as an unrealized gain or loss, net of applicable taxes.
Two methods have arisen in practice to determine the fair value of future
retained interest earnings, the cash-in method and the cash-out method. The
Securities and Exchange Commission ("SEC") has set forth specific guidance that
the cash-out method is the only appropriate method to be used in determining the
fair value of such assets as defined by the SFAS No. 125. The cash-out method
discounts future retained interest earnings from the period in which the
transferor expects to receive the cash, thereby taking into consideration the
period of time that the cash is received from obligors but restricted from
distribution to the transferor. WFS has historically and will continue to use
the cash-out method in measuring such assets.
The following table presents the activity of the RISA:
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
--------- -------- --------
(DOLLARS IN THOUSANDS)
Beginning balance................................. $ 181,177 $121,597 $ 78,045
Additions......................................... 91,914 112,230 104,071
Amortization...................................... (103,610) (53,421) (60,519)
Change in unrealized gains on RISA................ 1,749 771
--------- -------- --------
Ending balance.................................... $ 171,230 $181,177 $121,597
========= ======== ========
At the time of a securitization, the Company utilizes prepayment speed, net
credit loss and discount rate assumptions to initially compute the value of the
RISA. These assumptions may change periodically based on actual performance or
other factors. During 1998, the Company utilized prepayment rates of 1.6% ABS in
computing RISA. Cumulative net credit loss assumptions utilized for 1998
securitizations ranged from 6% to 7%. The Company used a discount rate of 425
basis points over the two-year Treasury rate at the time of securitization in
discounting future earnings.
The following table presents the estimated future undiscounted retained
interest earnings to be received from securitizations. Estimated future
undiscounted RISA earnings are calculated by taking the difference between the
coupon rate of the automobile loans sold and the certificate rate paid to the
investors, less the contractually specified servicing fee and guarantor fees,
after giving effect to estimated prepayments and assuming no losses. To arrive
at the RISA, this amount is reduced by the off-balance sheet allowance
established for potential future losses and by discounting to present value.
DECEMBER 31,
------------------------
1998 1997
---------- ----------
(DOLLARS IN THOUSANDS)
Estimated net undiscounted RISA earnings............ $ 361,209 $ 438,190
Off-balance sheet allowance for losses.............. (170,664) (236,796)
Discount to present value........................... (19,315) (20,217)
---------- ----------
Retained interests in securitized assets............ $ 171,230 $ 181,177
========== ==========
Outstanding balance of automobile loans sold through
securitizations................................... $3,491,452 $3,449,590
Off-balance sheet allowance for losses as a percent
of automobile loans sold through securitization... 4.89% 6.86%
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CUMULATIVE STATIC POOL LOSS CURVES
AT DECEMBER 31, 1998
PERIOD 1995-1 1995-2 1995-3 1995-4 1995-5 1996-A 1996-B 1996-C 1996-D
- --------------------------------------------------------------------------------------------------------------
1 0.00% 0.03% 0.00% 0.00% 0.01% 0.00% 0.01% 0.00% 0.02%
2 0.10% 0.15% 0.09% 0.06% 0.09% 0.06% 0.09% 0.09% 0.10%
3 0.26% 0.23% 0.20% 0.16% 0.16% 0.17% 0.20% 0.22% 0.24%
4 0.43% 0.43% 0.36% 0.31% 0.32% 0.29% 0.35% 0.52% 0.44%
5 0.68% 0.58% 0.58% 0.52% 0.48% 0.48% 0.61% 0.74% 0.71%
6 0.79% 0.77% 0.80% 0.70% 0.62% 0.63% 0.88% 0.98% 0.93%
7 0.96% 0.95% 1.04% 0.86% 0.78% 0.81% 1.14% 1.27% 1.16%
8 1.10% 1.09% 1.27% 1.02% 0.98% 1.08% 1.42% 1.52% 1.43%
9 1.32% 1.28% 1.46% 1.13% 1.16% 1.35% 1.67% 1.77% 1.72%
10 1.49% 1.49% 1.62% 1.26% 1.32% 1.63% 1.91% 1.98% 2.03%
11 1.68% 1.64% 1.79% 1.41% 1.54% 1.87% 2.18% 2.21% 2.34%
12 1.86% 1.81% 1.92% 1.52% 2.01% 2.06% 2.38% 2.49% 2.62%
13 2.05% 1.94% 2.01% 1.66% 2.03% 2.28% 2.58% 2.73% 2.97%
14 2.20% 2.09% 2.17% 1.86% 2.25% 2.47% 2.79% 2.99% 3.27%
15 2.38% 2.16% 2.26% 2.07% 2.41% 2.63% 2.95% 3.21% 3.53%
16 2.51% 2.24% 2.42% 2.26% 2.59% 2.79% 3.14% 3.47% 3.79%
17 2.67% 2.36% 2.57% 2.47% 2.77% 2.97% 3.38% 3.70% 4.02%
18 2.79% 2.46% 2.86% 2.59% 2.88% 3.12% 3.55% 3.94% 4.19%
19 2.90% 2.55% 3.08% 2.72% 3.00% 3.31% 3.80% 4.18% 4.43%
20 2.98% 2.69% 3.23% 2.88% 3.12% 3.49% 3.98% 4.36% 4.65%
21 3.08% 2.83% 3.38% 2.95% 3.24% 3.63% 4.14% 4.53% 4.80%
22 3.21% 2.96% 3.49% 3.04% 3.39% 3.80% 4.31% 4.67% 5.07%
23 3.27% 3.06% 3.59% 3.13% 3.53% 3.95% 4.46% 4.84% 5.27%
24 3.41% 3.17% 3.68% 3.22% 3.64% 4.10% 4.58% 5.01% 5.47%
25 3.53% 3.24% 3.74% 3.30% 3.72% 4.22% 4.74% 5.17% 5.65%
26 3.59% 3.28% 3.81% 3.37% 3.83% 4.33% 4.87% 5.34% 5.80%
27 3.68% 3.33% 3.88% 3.47% 3.95% 4.41% 4.98% 5.50%
28 3.72% 3.42% 3.97% 3.50% 4.08% 4.51% 5.11% 5.67%
29 3.77% 3.46% 4.01% 3.58% 4.16% 4.60% 5.21%
30 3.82% 3.49% 4.06% 3.65% 4.25% 4.70% 5.31%
31 3.87% 3.52% 4.07% 3.75% 4.31% 4.79% 5.42%
32 3.91% 3.56% 4.14% 3.80% 4.35% 4.85%
33 3.95% 3.55% 4.20% 3.83% 4.40% 4.91%
34 3.99% 3.60% 4.26% 3.87% 4.46% 4.99%
35 4.02% 3.62% 4.31% 3.91% 4.54%
36 4.00% 3.67% 4.34% 3.94% 4.58%
37 4.05% 3.70% 4.38% 3.96% 4.61%
38 4.06% 3.73% 4.40% 3.99%
39 4.10% 3.74% 4.41% 4.01%
40 4.14% 3.76% 4.44% 4.04%
41 4.15% 3.77% 4.48%
42 4.16% 3.80% 4.49%
43 4.16% 3.80% 4.51%
44 4.16% 3.82%
45 4.16% 3.84%
46 4.16%
47 4.16%
48 4.15%
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CUMULATIVE STATIC POOL LOSS CURVES
AT DECEMBER 31, 1998
PERIOD 1997-A 1997-B 1997-C 1997-D 1998-A 1998-B 1998-C
------ ------ ------ ------ ------ ------ ------ ------
1 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
2 0.08% 0.07% 0.06% 0.05% 0.04% 0.02% 0.04%
3 0.20% 0.18% 0.15% 0.14% 0.11% 0.08%
4 0.36% 0.33% 0.29% 0.31% 0.25% 0.18%
5 0.62% 0.56% 0.46% 0.56% 0.44% 0.38%
6 0.85% 0.77% 0.67% 0.75% 0.66% 0.59%
7 1.12% 1.10% 0.93% 0.99% 0.95% 0.83%
8 1.45% 1.40% 1.16% 1.24% 1.23%
9 1.70% 1.70% 1.37% 1.47% 1.50%
10 2.02% 2.00% 1.66% 1.75% 1.79%
11 2.32% 2.22% 1.94% 2.06%
12 2.61% 2.43% 2.16% 2.35%
13 2.92% 2.66% 2.40% 2.63%
14 3.14% 2.91% 2.65%
15 3.30% 3.15% 2.90%
16 3.55% 3.56% 3.15%
17 3.77% 3.77% 3.36%
18 3.94% 3.97%
19 4.21% 4.20%
20 4.40% 4.39%
21 4.59%
22 4.81%
23 5.00%
The Company believes that the off balance sheet allowance for losses is
currently adequate to absorb potential losses in the sold portfolio.
Capitalized Servicing Rights
Capitalized servicing rights consisted of the following:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Purchased mortgage servicing rights...................... $ 6,360 $14,695
Originated mortgage servicing rights..................... 6,136 26,161
Impairment allowance for mortgage servicing rights....... (3,723) (3,439)
------- -------
$ 8,773 $37,417
======= =======
CSR assets represent an allocation of the cost basis of loans sold between
the CSR and the loans based upon their relative fair value at the date the loans
are originated or purchased. The fair value of CSR is calculated by estimating
future servicing revenues, including servicing fees, late charges, other
ancillary income, and float benefit, less the actual cost to service loans.
For the year ended December 31, 1998, the Company capitalized servicing
rights totalling $18.7 million compared to $23.9 million in 1997. The mortgage
servicing rights are included in capitalized servicing rights and the
amortization is a component of mortgage banking income in noninterest income.
The Company's mortgage banking results were directly impacted by a declining
interest rate environment that caused higher prepayments, which, in turn,
accelerated the amortization of the Company's capitalized servicing rights. The
55
57
Company sold $31.9 million of its CSR in 1998. The sale represented 67% of the
Company's portfolio serviced for the benefit of others.
The remaining CSR asset was revalued to fair market value at December 31,
1998. The fair value of the CSRs was $8.8 million and $42.8 million at December
31, 1998 and December 31, 1997, respectively. Fair value was determined based on
the present value of estimated future earnings. Significant assumptions were
based upon prepayment, default, servicing cost and discount rate. For the
purpose of estimated fair value, CSRs are stratified on the basis of loan type,
loan coupon and loan term.
CSR are evaluated for impairment based on the excess of the carrying amount
of the CSR over their fair value on a disaggregated basis.
Amortization of capitalized servicing rights are reflected as a component
of mortgage banking income in noninterest income. Amortization expense for the
year ended December 31, 1998 was $15.5 million, compared to $9.5 million for the
year ended December 31, 1997.
CAPITAL RESOURCES AND LIQUIDITY
OVERVIEW
The Company requires substantial capital resources to support its business.
The primary cash requirements related to operating activities include (i)
amounts needed to purchase loans or investment securities, (ii) amounts paid to
brokers and dealers, (iii) securitization costs including spread account
advances, and (iv) P&I advances to trusts. WFS also uses significant amounts of
cash for operating expenditures. Sources available to the Company include (i)
retail and commercial deposits, (ii) loan sales or securitizations, (iii)
collection of principal and interest from loans and investment securities, (iv)
other borrowing sources. These sources provide the Company the liquidity needed
to fund its operations.
Although Westcorp does not have publicly rated debt, its subsidiary,
Western Financial Bank receives long term deposit and subordinated debt ratings.
In November 1998, Moody's Investor Services, Inc. downgraded long term deposit
to Ba3 from Ba2, issuer to B1 from Ba3 and subordinated debt to B2 from B1
ratings. This downgrade could result in higher future financing costs for the
Company.
PRINCIPAL USES OF CASH
Acquisition of Loans or Investment Securities
The most significant cash flow requirement for the Company is the
acquisition of loans or investment securities. During 1998, total loan
originations for the Company was $5.6 billion compared with $4.7 billion in the
previous year. The Company purchased $665 million of investment securities
during all of 1998 compared with $612 for the same period in 1997.
OTS regulations require the Company, as a savings association, to maintain
a specified level of liquid assets such as cash and short-term U.S. government
and other qualifying securities. Such liquid assets must not be less than 4.0%
for December 1998 and 5.0% for December 1997 of the Company's average daily
balance of net withdrawable deposit accounts and borrowings payable in one year
or less. At December 31, 1998 and 1997, such ratios were 9.0% and 9.1%,
respectively.
As a member of the FHLB, the Bank is required to maintain a specified ratio
of cash, short-term United States government and other qualifying securities to
net withdrawable accounts and borrowings payable in a year or less. The required
liquidity ratio is currently 4%. The Bank has maintained liquidity in excess of
the required amount in 1998.
Amounts Paid to Brokers and Dealers
The Company's mortgage and automobile loan operations are not retail based.
The Company acquires automobile loans through its relationships with franchised
new and independent used car dealers. The Company pays an up-front dealer
participation to the originating dealer for most automobile loans purchased.
Participation paid by the Company to dealers during 1998 was $76.7 million
compared with $68.0 million in
56
58
1997. The Company acquires its mortgage loans primarily through relationships
with real estate brokers and agents that assists property buyers, homebuilders
and thrifts. During 1998, the Company paid $0.7 million in broker fees compared
with $0.6 million a year earlier.
Advances to Fund Spread Account
The Company is required to maintain spread accounts related to automobile
securitizations. At the time of securitization transaction closes, the Company
is required to advance monies to initially fund spread accounts. The Company
funds these spread accounts by foregoing receipt of excess cash flow until these
accounts exceed predetermined levels. The amounts due from trusts at December
31, 1998, including initial advances not yet returned, was $333 million compared
with $295 million at December 31, 1997 (see "Business -- Automobile
Operations -- WFS Reinvestment Contract").
Advances Due to Servicer
As the servicer of automobile loans sold in securitizations, the Company
periodically makes advances to the securitization trusts to provide for
temporary delays in the receipt of required payments by borrowers in accordance
with servicing agreements. The Company receives reimbursement of these advances
through payments from the obligor on the automobile loan or from the trustee at
the time a contract liquidates.
PRINCIPAL SOURCES OF CASH
The Company employs various financing vehicles to fund its operations,
including deposits, securitizations, commercial paper, advances from the FHLB,
repurchase agreements, subordinated debentures and other borrowings. The sources
used vary depending on such factors as rates paid, maturities, and the impact on
capital.
Deposits
The Company attracts both short-term and long-term deposits from the
general public, commercial enterprises and institutions by offering a variety of
accounts and rates. The Company offers regular passbook accounts, various money
market accounts, demand deposit accounts, fixed interest rate certificates with
varying maturities and individual retirement accounts. In 1998, the retail
banking division continued its strategy to lower overall cost of funds. This
strategy involved becoming the primary bank for its customers by providing
checking accounts, money market accounts, ATMs, debit cards, overdraft
protection and alternative investments (primarily mutual funds and annuities).
The Company's deposits are obtained primarily from the areas surrounding its
banking offices in California.
The following table sets forth the amount of the Company's deposits by type
at the dates indicated.
DECEMBER 31,
--------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
No minimum term:
Demand deposit accounts............ $ 38,511 $ 14,179 $ 28,734
Passbook accounts.................. 15,412 21,883 42,482 $ 65,293 $ 104,085
Money market deposit accounts...... 320,160 126,956 438 602 801
Noninterest bearing deposits....... 75,240 94,910 40,418
Certificate accounts:
Certificates (30 days to five
years).......................... 1,461,539 1,488,352 1,481,847 1,462,649 1,335,805
IRA................................ 192,473 214,640 231,535 224,931 192,091
Brokered deposits.................... 75,400 39,976 48,489
---------- ---------- ---------- ---------- ----------
$2,178,735 $2,000,896 $1,873,943 $1,753,475 $1,632,782
========== ========== ========== ========== ==========
57
59
The variety of deposits offered by the Company has allowed it to remain
competitive in obtaining funds and to respond with flexibility to changes in
customer demand and competitive pressures. Generally, the Company, as other
financial institutions, has become more subject to short-term fluctuations in
deposit flows as customers have become more interest rate conscious. The ability
of the Company to attract and maintain deposits and control its cost of funds
has been, and will continue to be, significantly affected by money market
conditions.
The Company's average certificate accounts outstanding are summarized
below.
DECEMBER 31,
------------------------
1998 1997
---------- ----------
(DOLLARS IN THOUSANDS)
Average certificate accounts outstanding.... $1,745,179 $1,782,967
Average interest rate paid.................. 5.6% 5.8%
Deposit accounts, subject to certain FDIC attribution rules, are insured by
the FDIC up to $100,000 per customer. The Company's maturities of certificate
accounts greater than or equal to $100,000 are as follows:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Three months or less........................... $ 3,214 $163,336
Over three months through six months........... 18,328 65,135
Over six months through one year............... 313,117 128,081
Over one year through three years.............. 85,396 49,546
Over three years............................... 20,831 9,471
-------- --------
$440,886 $415,569
======== ========
Securitizations
The primary source of funds used by the Company for automobile loans is the
sale of such products through asset-backed securities in the secondary markets.
The Company has regularly securitized automobile loans through underwritten
public sales of securities since 1985. Although the underlying interest costs
associated with the securitizations fluctuate, they are primarily market driven
and not necessarily related to the operations of the Company. The Company
expects to continue to utilize securitization transactions as part of its
liquidity strategy when the appropriate market conditions exist. During 1998,
the Company securitized $1.9 billion of automobile loans compared with $2.2
billion for all of 1997.
The primary source of funds used by the Company for mortgage loans is the
sale of such products. Historically, the Company has been active in the
secondary market, it has sold FHA and VA loans, as well as other conforming and
non-conforming loans to FNMA, FHLMC, and other established conduits. As part of
the Company's focus of originating sub-prime mortgage, the Company will continue
to sell all its originations on a whole-loan, servicing released basis. During
1998, the Company sold $2.9 billion of mortgage loans through the secondary
markets compared with $2.0 during 1997.
Borrowings and Other Sources of Funds
The Company's other sources of funds include issuing commercial paper and
obtaining advances from the FHLB, selling securities under agreements to
repurchase and other borrowings as well as loan repayments and cash generated
from operations. The Company selects from among these funding alternatives based
on the timing and duration of its cash needs, as well as the costs, maturities
and other requirements of each funding source.
The FHLB system functions in a reserve capacity for savings institutions.
As a member, the Company is required to own capital stock in the FHLB and is
authorized to apply for advances from the FHLB on security of such stock and on
certain residential mortgage loans. The Bank has been pre-approved for advances
up to
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25% of its assets, based on remaining availability under credit facilities
established by the Bank with the FHLB, with 24 hours notice. Such borrowings may
be made pursuant to several different programs offered from time to time by the
FHLB. Additional funds are available subject to additional collateral and other
requirements. Each credit program has its own interest rate, which may be fixed
or variable, and range of maturities. The FHLB prescribes the acceptable uses to
which advances pursuant to each program may be put, as well as limitations on
the sizes of advances and repayment provisions.
At December 31, 1998, the Company did not have commercial paper
outstanding. At December 31, 1997, the Company had $171 million of commercial
paper outstanding. The maximum amount of commercial paper outstanding at any
month-end was $388 million and $399 million during 1998 and 1997, respectively.
The average amount of commercial paper outstanding and the weighted average
interest rate during 1998 and 1997 was $175 million and 5.7%; and $178 million
and 5.7%, respectively.
Savings associations such as the Bank also have authority to borrow from
the Federal Reserve System ("FRS") "discount window." FRS regulations require
these institutions to exhaust all reasonable alternative sources of funds,
including FHLB sources, before borrowing from the FRS. Federal regulations have
been promulgated which connect CRA performance with access to long term advances
from FHLB to member institutions. The Bank received a "satisfactory" rating in
its most recent CRA evaluation.
Subordinated Capital Debentures
In 1993 and 1997, the Company, through the Bank, issued $125 million of
8.5% and $150 million of 8.875% Subordinated Capital Debentures due 2003 and
2007, respectively, of which $240 million is currently outstanding. In addition
to being a funding source, the Bank is permitted to include these Debentures in
supplementary capital for purposes of determining compliance with risk-based
capital requirements. See "Business -- Supervision and Regulation -- Regulatory
Capital Requirements."
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CAPITAL REQUIREMENTS
The Bank is a federally chartered savings bank. As such, it is subject to
certain minimum capital requirements imposed by FIRREA and FDICIA. FDICIA
separates all financial institutions into one of five capital categories: "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," and "critically undercapitalized." In order to be considered
"well capitalized," an institution must have a total risk-based capital ratio of
10% or greater, a Tier 1 (i.e., core) risk-based capital ratio of 6% or greater,
a leverage ratio of 5% or greater and not be subject to any OTS order. The Bank
currently meets all of the requirements of a "well capitalized" institution. The
following table summarizes the Company's actual capital and required capital as
of December 31, 1998 and 1997:
TIER 1
TANGIBLE CORE RISK-BASED RISK-BASED
CAPITAL CAPITAL CAPITAL CAPITAL
-------- ------------ ---------- ----------
(DOLLARS IN THOUSANDS)
DECEMBER 31, 1998
Actual Capital:
Amount.............................. $345,427 $345,427 $345,427 $604,552
Capital ratio....................... 9.02% 9.02% 6.42% 11.23%
FIRREA minimum required capital:
Amount.............................. $ 57,464 $114,929 N/A $430,112
Capital ratio....................... 1.50% 3.00% N/A 8.00%
Excess.............................. $287,963 $230,498 N/A $174,440
FDICIA well capitalized required
capital:
Amount.............................. N/A $191,548 $322,584 $537,640
Capital ratio....................... N/A 5.00% 6.00% 10.00%
Excess.............................. N/A $153,879 $ 22,843 $ 66,912
DECEMBER 31, 1997
Actual Capital:
Amount.............................. $355,650 $355,650 $352,123 $639,937
Capital ratio....................... 9.48% 9.48% 6.74% 12.24%
FIRREA minimum required capital:
Amount.............................. $ 56,249 $112,498 N/A $418,115
Capital ratio....................... 1.50% 3.00% N/A 8.00%
Excess.............................. $299,401 $243,152 N/A $221,822
FDICIA well capitalized required
capital:
Amount.............................. N/A $188,574 $313,587 $522,644
Capital ratio....................... N/A 5.00% 6.00% 10.00%
Excess.............................. N/A $167,076 $ 38,536 $117,293
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The following table reconciles the Bank's capital in accordance with GAAP
to the Bank's tangible, core and risk-based capital:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Bank shareholder's equity-GAAP basis........................ $332,951 $345,426
Adjustment: Unrealized gains under SFAS 115................. (3,693) (5,858)
Less: non-permissible activities(1)....................... (4,811) (10,222)
Add: minority interest in equity of subsidiaries.......... 21,857 29,538
Less: disallowed capitalized servicing rights............. (877) (3,234)
-------- --------
Total tangible and core capital................... 345,427 355,650
Adjustments for risk-based capital:
Subordinated debentures(2)................................ 224,844 256,311
General loan valuation allowance(3)....................... 34,281 31,503
Less: fully capitalized assets............................ (3,527)
-------- --------
Risk-based capital........................................ $604,552 $639,937
======== ========
- ---------------
(1) Does not include minority interest in joint venture subsidiaries.
(2) Excludes capitalized discounts and issue costs.
(3) Limited to 1.25% of risk-weighted asset.
EFFECT OF INFLATION AND CHANGING PRICES
Unlike many industrial companies, substantially all of the assets and
liabilities of the Company are monetary in nature. As a result, interest rates
have a more significant effect on the Company's performance than the general
level of inflation. See "Item 7A Quantitative and Qualitative Disclosures about
Market Risk."
YEAR 2000
During 1997, the Company began a formal risk evaluation of potential Year
2000 issues. The Year 2000 issue arose because many existing computer programs
use only the last two digits to refer to a year. Therefore, these computer
programs do not properly recognize a year that begins with "20" instead of the
familiar "19". If not corrected, many computer applications could fail and
create erroneous results. The outcome of the risk evaluation was the formation
of a Year 2000 Committee that consists of officers and employees of the Company.
In addition, there is a committee that consists of directors that provide
oversight and direction to the Year 2000 Committee. The purpose of the Year 2000
Committee is to assess all risks, analyze current systems, coordinate upgrades
and replacements, and report current and projected status of all known Year 2000
compliance issues.
The Bank, a federally chartered savings bank, is subject to supervision and
regulation by the OTS. As such, the Bank's compliance to Year 2000 issues are
subject to the examination by the OTS.
The Company has initiated a five-phase program to address the issues
related to the Year 2000 and the impact on the Company's information and
non-information technology systems. In addition, as part of the program the
Company is in contact with its principal vendors to assess whether their Year
2000 issues, if any, will affect the Company.
The Company, in phase one, identified Year 2000 issues and created a plan.
In phase two, the Company took inventory of the systems and programs affected by
the Year 2000 issues. Currently, the Company is in the third, fourth and fifth
phases of its Year 2000 plan. The third phase was completed in January 1999.
Phase four, in which the Company tests for Year 2000 compliance, is anticipated
to be completed by March 31, 1999. The final phase implements the tested Year
2000 compliant system. The final phase has begun and is now estimated to be
completed by June 30, 1999.
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Currently, the Company is in the third and fourth phases of its Year 2000
plan. In these phases, the Company ensures that the systems have been fixed and
tested. It is expected that the third and fourth phases be completed by March
1999. The final phase implements the tested Year 2000 compliant systems. For
some applications, this phase has begun. The Company expects to have all
applications implemented by June 30, 1999.
The Company's replacement or remedied costs for Year 2000 compliance issues
expense is estimated approximately $1.8 million, which the Company will expense
as incurred. This estimated cost consists primarily of software upgrades that
include new features which are combined with Year 2000 corrections. The
Company's inception to date Year 2000 cost is approximately $1.1 million.
Due to the uncertainty and lack of current disclosure by the electrical
utility industry regarding the progress toward becoming Year 2000 compliant, the
Company estimates that the worst case Year 2000 scenario would be a possible
discontinuance of electrical power. In the event of an electrical power failure,
the Company has the capability to run its information systems at the corporate
location on diesel powered generators. There is no guarantee, however, that all
issues will be foreseen and corrected, or that no material disruption of our
business will occur.
CURRENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued "SFAS No. 130, Reporting Comprehensive
Income". This statement is effective with the year-end 1998 financial
statements; however, a total for comprehensive income is required in the
financial statements of interim periods beginning with the first quarter of
1998. Reclassification of financial statements for earlier periods provided for
comparative purposes is required. This Statement establishes standards for
reporting and displaying comprehensive income and its components in the
financial statements. It requires that a company classify items of other
comprehensive income, as defined by accounting standards, by their nature (e.g.,
unrealized gains or losses on securities available for sale and retained
interests in securitized assets) in a financial statement with the same
prominence as other financial statements, but does not require a specific format
for that statement. The accumulated balance of comprehensive income is to be
displayed separately from retained earnings and additional paid-in capital in
the equity section of the consolidated statements of financial condition.
In June 1998, the FASB issued "SFAS No. 131, Disclosure about Segments of
an Enterprise and Related Information." This Statement provides guidance for the
way public enterprises report information about operating segments in annual
financial statements and requires selected information about operating segments
in annual financial statements and in interim financial reports. It also
requires certain related disclosures about products and services, geographic
areas and major customers. The segment and other information disclosures are
required for the year ended December 31, 1998. In the initial year of
application, comparative information for earlier years is to be restated.
In June 1998 the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS
133"). This statement provides guidance for the way public enterprises report
information about derivatives and hedging in annual financial statements and in
interim financial reports. The derivatives and hedging disclosure is required
for financial statements for fiscal years beginning after June 15, 1999. The
Statement will require the Company to recognize all derivatives on the balance
sheet at fair value. Derivatives that are not hedges must by adjusted to fair
value through income. If the derivative is a hedge, depending on the nature of
the hedge, changes in fair value of derivatives will either be offset against
the change in fair value of the hedged assets, liabilities, or firm commitments
through earnings or recognized in earnings. The ineffective portion of a
derivative's change in fair value will be immediately recognized in earnings.
The Company is in the process of evaluating what the effect of SFAS 133, if any,
will have on the earnings and financial position of the Company.
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FORWARD-LOOKING STATEMENTS
Included in the preceding section of this Annual Report on Form 10-K are
several "forward-looking statements." Forward-looking statements are those which
use words such as "believe," "expect," "anticipate," "intend," "plan," "may,"
"will," "should," "estimate," "continue" or other comparable expressions. These
words indicate future events and trends. Forward-looking statements are our
current views with respect to future events and financial performance. These
forward-looking statements are subject to many risks and uncertainties which
could cause actual results to differ significantly from historical results or
from those anticipated by us. The most significant risks and uncertainties we
face are
(1) the level of chargeoffs, as an increase in the level of chargeoffs
will decrease our earnings;
(2) our ability to originate new loans in a sufficient amount to reach
our needs, as a decrease in the amount of loans we originate will decrease
our earnings;
(3) a decrease in the difference between the average interest rate we
receive on the loans we originate and the rate of interest we must pay to
fund our cost of originating those loans; as a decrease will reduce our
earnings;
(4) the continued availability of sources of funding for our
operations, as a reduction in the availability of funding will reduce our
ability to originate loans;
(5) maintaining the level of operating costs; as an increase in those
costs will reduce our net earnings; and
(6) the Year 2000 issues; as a disruption of our collection efforts as
a result of Year 2000 problems or an increase in our costs to correct Year
2000 issues will reduce earnings.
There are other risks and uncertainties we face, including the effect of
changes in general economic conditions and the effect of new laws, regulations
and court decisions. You are cautioned not to place undue reliance on our
forward-looking statements. We undertake no obligation to publicly update or
revise any forward-looking statements, whether as a result of new information,
future events or otherwise.
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65
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Credit risk and interest rate risk are the primary risks facing the
Company. The Company relies upon loan review and an adequate loan loss reserve
in order to address credit risk. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Asset Quality."
The Company's Asset/Liability committee is responsible for the management
of interest rate risk. This committee closely monitors interest rate risk and
recommends policy for managing this risk. The primary measurement tool for
evaluating this risk is the use of interest rate shock analysis. This analysis
simulates the effects of an instantaneous and sustained change in interest rates
(in increments of 100 basis points) on the Company's assets and liabilities and
measures the resulting increase or decrease to the net present value ("NPV") of
the Company's assets and liabilities. Another important measurement of the
Company's interest rate risk is its "GAP." GAP is defined as the difference
between the amount of interest sensitive assets that reprice versus the amount
of interest-sensitive liabilities that also reprice within a defined period of
time. For the Company, more interest rate sensitive liabilities than assets are
repricing in the shorter maturity buckets and more interest rate sensitive
assets then liabilities are repricing in the longer maturity buckets. In
general, an increase in interest rates would more adversely affect the Company's
NPV than would a decrease in interest rates improve the Company's NPV. As of
December 31, 1998, a 200 basis point increase in interest rates would decrease
the Company's NPV by 11% whereas a 200 basis point decline in interest rates
would increase NPV by 2%. It should be noted that shock analysis is objective
but not entirely realistic in that it assumes an instantaneous and isolated set
of events. The following table summarizes the maturity GAP position of the
Company at December 31, 1998.
INTEREST RATE SENSITIVITY ANALYSIS AT DECEMBER 31, 1998
-------------------------------------------------------------------------
WITHIN 3 MONTHS 1 YEAR TO 3 YEARS TO AFTER 5
3 MONTHS TO 1 YEAR 3 YEARS 5 YEARS YEARS TOTAL
---------- ---------- --------- ---------- --------- ----------
(DOLLARS IN THOUSANDS)
Interest earning assets:
Investment securities................ $ 611 $ 25,239 $ 40,342 $ 10,217 $ 1,387 $ 77,796
Other investments.................... 23,179 200 23,379
Mortgage-backed securities........... 63,727 281,772 279,313 151,882 203,350 980,044
Consumer loans(1).................... 69,030 234,928 403,375 203,723 10,120 921,176
Mortgage loans:
Adjustable rate(2)................. 561,737 152,078 713,815
Fixed rate(2)...................... 10,206 40,536 78,979 51,045 99,823 280,589
Construction(2)...................... 12,533 12,533
Commercial(2)........................ 61,558 240 703 1,926 293 64,720
---------- ---------- --------- --------- --------- ----------
Total interest earning assets........ 802,581 734,993 802,712 418,793 314,973 3,074,052
Interest bearing liabilities:
Deposits:
Passbook/statement accounts(3)..... 2,916 7,888 4,608 15,412
Money market deposit accounts(3)... 30,211 115,606 212,855 358,672
Certificate accounts(4)............ 553,729 1,034,182 100,614 40,886 1,729,411
FHLB advances(4)..................... 151,513 60 176 6,700 2,404 160,853
Securities sold under agreements to
repurchase(4)...................... 265,644 265,644
Subordinated debentures(4)........... 92,714 147,142 239,856
Other borrowings(4).................. 14,427 14,427
---------- ---------- --------- --------- --------- ----------
Total interest bearing
liabilities............... 1,018,440 1,157,736 318,253 140,300 149,546 2,784,275
---------- ---------- --------- --------- --------- ----------
Excess interest earning assets
(liabilities)...................... (215,859) (422,743) 484,459 278,493 165,427 289,777
Effect of hedging activities......... 590,000 (100,000) (100,000) (165,000) (225,000)
---------- ---------- --------- --------- --------- ----------
Hedged excess (deficit).............. $ 374,141 $ (522,743) $ 384,459 $ 113,493 $ (59,573) $ 289,777
========== ========== ========= ========= ========= ==========
Cumulative excess (deficit).......... $ 374,141 $ (148,602) $ 235,857 $ 349,350 $ 289,777 $ 289,777
========== ========== ========= ========= ========= ==========
Cumulative difference as a percentage
of total interest earning assets... 12.17% (4.83)% 7.67% 11.36% 9.43% 9.43%
- ---------------
(1) Based on contractual maturities adjusted by the Company's historical
prepayment rate.
(2) Based on interest rate repricing adjusted for projected prepayments.
(3) Based on assumptions established by the OTS.
(4) Based on contractual maturity.
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66
The Company utilizes a variety of means in order to manage interest rate
risk including originating adjustable rate loans, securitizing loans with
liabilities that have similar repricing and maturity characteristics, matching
fixed rate loans held in the portfolio with FHLB advances and selling fixed rate
loans. The Company hedges its MBS portfolio with interest rate caps and swaps.
Also, as an originator of fixed rate mortgage loans, the Company enters into MBS
forward agreements in order to limit the risk of a change in interest rates
related to its pipeline of mortgage loans. Similarly, the Company utilizes
two-year Treasury securities forward agreements in order to limit interest rate
risk related to automobile loans prior to their inclusion in securitization
transactions.
The following table provides information about the Company's derivative
financial instruments and other financial instruments used that are sensitive to
changes in interest rates. For loans, securities and liabilities with
contractual maturities, the table presents principal cash flows and related
weighted average interest rates by contractual maturities as well as the
Company's historical experience of the impact of interest rate fluctuations on
the prepayment of real estate loans, automobile loans and mortgage-backed
securities. For core deposits (e.g., Passbooks, Money Market and interest
bearing-demand deposits) that have no contractual maturity, the table presents
principal cash flows and, as applicable, related weighted average interest rates
based on the Company's historical experience, management's judgment and
statistical analysis, as applicable, concerning their most likely withdrawal
behaviors.
For interest rate swaps and interest rate caps, the table presents notional
amounts and, as applicable, weighted average interest rates by contractual
maturity date. Notional amounts are used to calculate the contractual payments
to be exchanged under the contracts.
THERE-
1999 2000 2001 2002 2003 AFTER TOTAL FAIR VALUE
---------- -------- -------- -------- -------- -------- ---------- ----------
(DOLLARS IN THOUSANDS)
RATE SENSITIVE ASSETS:
Fixed interest rate
loans.................... $ 366,093 $276,280 $204,247 $154,364 $100,983 $109,635 $1,211,602 $1,325,371
Average interest rate.... 13.19% 13.54% 13.52% 13.42% 12.77% 8.14% 12.86%
Variable interest rate
loans.................... $ 259,512 $152,898 $110,876 $ 82,723 $ 63,845 $111,378 $ 781,232 $ 781,388
Average interest rate.... 7.83% 7.64% 7.65% 7.65% 7.65% 7.66% 7.71%
Fixed interest rate
securities............... $ 249,513 $157,229 $137,674 $ 87,912 $ 56,813 $157,189 $ 846,330 $ 854,116
Average interest rate.... 6.80% 7.14% 6.91% 7.18% 7.25% 7.20% 7.02%
Variable interest rate
securities............... $ 34,939 $ 31,977 $ 29,253 $ 24,723 $ 20,071 $ 93,926 $ 234,889 $ 237,238
Average interest rate.... 6.22% 6.14% 6.01% 5.96% 5.97% 6.04% 6.06%
RATE SENSITIVE LIABILITIES:
Passbook deposits.......... $ 10,804 $ 3,676 $ 932 $ 15,412 $ 15,242
Average interest rate.... 2.17% 2.17% 2.17% 2.17%
Money market and interest
bearing demand
deposits................. $ 145,817 $121,294 $ 91,561 $ 358,672 $ 354,727
Average interest rate.... 4.54% 4.45% 4.33% 4.45%
Certificates of deposits... $1,587,910 $ 90,162 $ 10,453 $ 37,198 $ 3,688 $1,729,411 $1,732,870
Average interest rate.... 5.35% 5.68% 5.26% 6.01% 5.13% 5.38%
Fixed interest rate
borrowings............... $ 417,217 $ 85 $ 91 $ 4,797 $ 91,760 $152,403 $ 666,353 $ 621,707
Average interest rate.... 5.55% 7.25% 7.25% 8.17% 8.50% 8.84% 6.74%
Variable interest rate
borrowings............... $ 5,218 $ 9,209 $ 14,427 $ 14,427
Average interest rate.... 7.28% 7.44% 7.38%
RATE SENSITIVITY DERIVATIVE
FINANCIAL INSTRUMENTS:
Forward agreements in net
receivable positions..... $ 4,389
Pay variable interest rate
swaps.................... $ (1,280)
Average pay rate......... 5.90% 5.90% 5.90% 5.90% 5.90%
Average receive rate..... 5.22% 5.22% 5.22% 5.22% 5.22%
Interest rate caps
purchased................ 1,081 1,081 934 686 563 809 5,154 5,154
Average strike rate...... 8.00% 6.00% 6.50% 6.63% 6.50% 6.57%
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements begin on page F-1 of this
report.
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
Certain information required by Part III is omitted from this report, as
the Company will file a definitive proxy statement (the "Proxy Statement")
within 120 days after the end of its fiscal year pursuant to Regulation 14A of
the Securities Exchange Act of 1934 for its Annual Meeting of Stockholders to be
held April 30, 1998 and the information included therein is incorporated herein
by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors appears under the caption "Election of
Directors" in the Proxy Statement and is incorporated herein by reference.
Information regarding executive officers appears under the caption "Executive
Officers Who Are Not Directors" in the Proxy Statement and is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation appears under the caption
"Compensation of Executive Officers" in the Proxy Statement and 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 appears under the caption "Security Ownership of Management Directors
and Nominees" in the Proxy Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions
appears under the caption "Certain Transactions Between Management and the
Company or its Subsidiaries" in the Proxy Statement and is incorporated herein
by reference.
PART IV
ITEM 14. FINANCIAL STATEMENT SCHEDULES, EXHIBITS, AND REPORTS ON FORM 8-K
(a) List of documents filed as part of this report:
(1) FINANCIAL STATEMENTS
The following consolidated financial statements and report of
independent auditors of the Company and subsidiaries are included in
this Report commencing on page F-1.
Report of Independent Auditors.
Consolidated Statements of Financial Condition at December 31, 1998 and
1997.
Consolidated Statements of Operations for the years ended December 31,
1998, 1997, and 1996.
Consolidated Statements of Changes in Shareholders' Equity for the years
ended December 31, 1998, 1997, and 1996.
Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997, and 1996.
Notes to Consolidated Financial Statements.
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(2) FINANCIAL STATEMENT SCHEDULES
Schedules to the consolidated financial statements are omitted because
the required information is inapplicable or the information is presented
in the Company's consolidated financial statements or related notes.
(3) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 Certificate of Incorporation(a)
3.2 Bylaws(a)
4.1 Indenture dated as of June 17, 1993 issued by Western
Financial Bank, formerly Western Financial Savings Bank,
F.S.B., with respect to $125,000,000 in aggregate principal
amount of 8.5% Subordinated Capital Debentures due 2003(b)
4.2 Indenture dated as of June 25, 1998 issued by Western
Financial Bank, formerly Western Financial Savings Bank,
F.S.B., with respect to $150,000,000 in aggregate principal
amount of 8.875% Subordinated Capital Debentures due 2007(c)
10.1 Westcorp Incentive Stock Option Plan(d)
10.2 Westcorp Employee Stock Ownership and Salary Savings Plan(a)
10.3 Westcorp 1991 Stock Option Plan(e)
10.4 WFS Financial Inc ("WFS") 1996 Incentive Stock Option
Plan(f)
10.5 Westcorp Employee Stock Ownership and Salary Saving Plan(g)
10.6 Employment Agreements(h)(i)(j)(k)
21.1 Subsidiaries of Westcorp
23.1 Consent of Independent Auditors
27 Financial Data Schedule
- ---------------
(a) Exhibits previously filed with Westcorp Registration Statement on Form S-4
(File No. 33-34286), filed April 11, 1990, incorporated herein by reference
under Exhibit Numbers indicated.
(b) Exhibit previously filed with, Western Financial Bank, formerly Western
Financial Savings Bank, F.S.B., Offering Circular with the OTS, dated June
17, 1993 (will be provided to the SEC upon request).
(c) Exhibit previously filed with Western Financial Bank, formerly Western
Financial Bank, F.S.B., Offering Circular with the OTS, dated July 25, 1998
(will be provided to the SEC upon request).
(d) Exhibit previously filed with Westcorp Registration Statement on Form S-1
(File No. 33-04295), filed May 2, 1986, incorporated herein by reference
under Exhibit Number indicated.
(e) Exhibit previously filed with Westcorp Registration Statement on Form S-8
(File No. 33-43898), filed December 11, 1991, incorporated herein by
reference under the Exhibit Number indicated.
(f) Exhibit previously filed with WFS Registration Statement on Form S-8 (File
No. 33-07485), filed July 3, 1996, incorporated herein by reference under
the Exhibit Number indicated. Amendment No. 1 dated as of November 13, 1998
filed with the WFS Registration Statement on Form S-8 (File No. 333-040121,
incorporated herein by reference under Exhibit Number indicated.
(g) Exhibit previously filed with Westcorp Registration Statement on Form S-8
(File No. 333-11039) and the related Form 11K (File No. 001-09910), filed
August 29, 1996 and June 28, 1996, respectively, incorporated herein by
reference under the Exhibit Number indicated.
(h) Employment Agreement, in letter form, dated January 11, 1996 between the
registrant and Donald H. Kasle (will be provided to the SEC upon request).
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69
(i) Employment Agreement, in letter form, dated March 11, 1998 between the
registrant and Andrea R. Kosovych (will be provided to the SEC upon
request).
(j) Employment Agreement, in letter form, dated February 28, 1998 between WFS
and Joy Schaefer (will be provided to the SEC and/or the OTS upon request).
(k) Employment Agreement, in letter form, dated February 28, 1998 between WFS
and Lee A. Whatcott (will be provided to the SEC and/or the OTS upon
request).
(b) REPORT ON FORM 8-K
None.
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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.
WESTCORP
Dated: March 16, 1999 By: /s/ ERNEST S. RADY
------------------------------------
Ernest S. Rady,
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following on behalf of the registrant in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ ERNEST S. RADY Chairman of the Board, and March 23, 1999
- ----------------------------------------------------- Chief Executive Officer
Ernest S. Rady
Director March , 1999
- -----------------------------------------------------
Judith M. Bardwick
/s/ ROBERT T. BARNUM Director March 23, 1999
- -----------------------------------------------------
Robert T. Barnum
/s/ STANLEY E. FOSTER Director March 23, 1999
- -----------------------------------------------------
Stanley E. Foster
Director March , 1999
- -----------------------------------------------------
Roy Henderson
/s/ HOWARD C. REESE Director March 23, 1999
- -----------------------------------------------------
Howard C. Reese
/s/ CHARLES R. SCRIBNER Director March 23, 1999
- -----------------------------------------------------
Charles E. Scribner
/s/ LEE A. WHATCOTT Senior Vice President March 23, 1999
- ----------------------------------------------------- (Principal Financial and
Lee A. Whatcott Accounting Officer) and Chief
Financial Officer
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
WESTCORP AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORT OF INDEPENDENT AUDITORS
PAGE
----
REPORT OF INDEPENDENT AUDITORS.............................. F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Statements of Financial Condition at December
31, 1998 and 1997......................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996.......................... F-4
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1998, 1997 and 1996...... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.......................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
72
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Westcorp
We have audited the accompanying consolidated statements of financial
condition of Westcorp and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, changes in shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1998. These consolidated financial statements are the responsibility of
Westcorp'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 financial statements referred to above present fairly
in all material respects, the consolidated financial position of Westcorp and
subsidiaries at December 31, 1998 and 1997 and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Los Angeles, California
January 25, 1999
F-2
73
WESTCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31,
------------------------
1998 1997
---------- ----------
(DOLLARS IN THOUSANDS)
ASSETS
Cash...................................................... $ 114,375 $ 71,484
Interest bearing deposits with other financial
institutions........................................... 515 15,510
Other short-term investments.............................. 22,864 84,136
---------- ----------
Cash and due from banks................................ 137,754 171,130
Investment securities available for sale.................. 77,796 123,409
Mortgage-backed securities available for sale............. 980,044 941,448
Loans receivable, net of allowance for loan losses of
$37,660 and $33,834, respectively...................... 798,094 1,126,322
Loans held for sale....................................... 1,157,079 712,554
Amounts due from trusts................................... 332,732 295,123
Retained interest in securitized assets................... 171,230 181,177
Premises and equipment, net............................... 86,417 89,791
Other assets.............................................. 62,368 87,911
---------- ----------
$3,803,514 $3,728,865
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits.................................................. $2,178,735 $2,000,896
Securities sold under agreements to repurchase............ 265,644 287,071
Federal Home Loan Bank advances........................... 160,853 84,971
Amounts held on behalf of trustee......................... 528,092 488,653
Short term borrowings..................................... 14,427 191,880
Other liabilities......................................... 65,005 57,910
---------- ----------
3,212,756 3,111,381
SUBORDINATED DEBENTURES..................................... 239,856 239,195
MINORITY INTEREST IN EQUITY OF SUBSIDIARIES................. 21,857 29,538
SHAREHOLDERS' EQUITY
Common stock, par value $1.00 per share; authorized
45,000,000 shares; issued and outstanding 26,474,814
shares in 1998 and 26,278,593 in 1997.................. 26,475 26,279
Paid-in capital........................................... 188,739 185,187
Retained earnings......................................... 110,138 131,427
Accumulated other comprehensive income, net of tax.......... 3,693 5,858
---------- ----------
329,045 348,751
---------- ----------
$3,803,514 $3,728,865
========== ==========
See accompanying notes to consolidated financial statement.
F-3
74
WESTCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996
-------------- -------------- --------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Interest income:
Loans, including fees............................. $ 191,781 $ 187,489 $ 171,328
Mortgage-backed securities........................ 65,039 68,055 57,471
Investment securities............................. 6,070 7,376 7,620
Other............................................. 9,252 7,612 5,969
----------- ----------- -----------
TOTAL INTEREST INCOME..................... 272,142 270,532 242,388
Interest expense:
Deposits.......................................... 109,005 107,078 99,091
Federal Home Loan Bank advances and other
borrowings..................................... 33,687 36,616 24,612
Securities sold under agreements to repurchase.... 18,639 17,376 15,491
----------- ----------- -----------
TOTAL INTEREST EXPENSE.................... 161,331 161,070 139,194
----------- ----------- -----------
NET INTEREST INCOME................................. 110,811 109,462 103,194
Provision for loan losses........................... 18,960 12,851 13,571
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES.................................... 91,851 96,611 89,623
Noninterest income:
Automobile lending................................ 99,147 176,192 153,099
Mortgage banking.................................. 14,230 24,540 18,515
Investment and mortgage-backed securities gains
(losses)....................................... 7,602 8,026 (1,620)
Insurance income.................................. 5,713 6,454 12,905
Miscellaneous..................................... 6,746 7,641 5,065
----------- ----------- -----------
TOTAL NONINTEREST INCOME.................. 133,438 222,853 187,964
Noninterest expenses:
Salaries and employee benefits.................... 134,666 137,741 110,494
Credit and collections............................ 22,277 15,703 10,040
Occupancy......................................... 14,531 18,091 13,353
Insurance......................................... 1,907 1,760 16,382
Data processing................................... 14,376 17,894 10,949
Telephone......................................... 9,787 9,585 6,450
Restructuring charges............................. 18,000
Miscellaneous..................................... 37,988 45,495 42,678
----------- ----------- -----------
TOTAL NONINTEREST EXPENSES................ 253,532 246,269 210,346
----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES................... (28,243) 73,195 67,241
Income taxes (benefit).............................. (11,330) 31,287 28,095
----------- ----------- -----------
INCOME (LOSS) BEFORE MINORITY INTEREST.............. (16,913) 41,908 39,146
Minority interest in earnings (losses) of
subsidiaries...................................... (2,216) 5,120 7,349
----------- ----------- -----------
NET INCOME (LOSS)......................... $ (14,697) $ 36,788 $ 31,797
=========== =========== ===========
NET INCOME (LOSS) PER COMMON SHARE:
Basic............................................. $ (0.56) $ 1.41 $ 1.23
Diluted........................................... (0.56) 1.40 1.21
Weighted average common shares outstanding:
Basic............................................. 26,305,117 26,165,678 25,910,548
Diluted........................................... 26,305,117 26,351,144 26,199,537
See accompanying notes to consolidated financial statements.
F-4
75
WESTCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
ACCUMULATED
OTHER
COMPREHENSIVE
PAID-IN RETAINED INCOME NET
SHARES PAR VALUE CAPITAL EARNINGS OF TAX TOTAL
---------- --------- -------- -------- ------------- --------
(DOLLARS IN THOUSANDS)
BALANCE JANUARY 1, 1996.................. 24,563,419 $24,563 $167,039 $105,951 $ 186 $297,739
Net income............................. 31,797 31,797
Accumulated other comprehensive income,
net of tax(1).......................
Gross unrealized gain............... 898 898
--------
Comprehensive income................ 32,695
Stock options exercised................ 134,017 134 923 1,057
Stock dividend......................... 1,233,742 1,234 21,285 (22,519) --
ESOP contribution...................... 65,440 66 1,115 1,181
Cash dividends......................... (10,121) (10,121)
Purchase of subsidiary stock........... (4,620) (4,620)
---------- ------- -------- -------- ------ --------
BALANCE DECEMBER 31, 1996................ 25,996,618 $25,997 $185,742 $105,108 $1,084 $317,931
Net income............................. 36,788 36,788
Accumulated other comprehensive income,
net of tax(1).......................
Gross unrealized gain............... 4,893 4,893
Reclassification adjustment for
gains included in net income...... (119) (119)
--------
Comprehensive income................... 41,562
Stock options exercised................ 116,605 117 940 1,057
ESOP contribution...................... 165,370 165 2,728 2,893
Cash dividends......................... (10,469) (10,469)
Purchase of subsidiary stock........... (4,223) (4,223)
---------- ------- -------- -------- ------ --------
BALANCE DECEMBER 31, 1997................ 26,278,593 $26,279 $185,187 $131,427 $5,858 $348,751
Net loss............................... (14,697) (14,697)
Accumulated other comprehensive income,
net of tax(1).......................
Gross unrealized gain............... 2,021 2,021
Reclassification adjustment for
gains included in net income...... (4,186) (4,186)
--------
Comprehensive loss..................... (16,862)
Stock options exercised................ 118,905 119 891 1,010
ESOP contribution...................... 77,316 77 1,135 1,212
Cash dividends......................... (6,592) (6,592)
Purchase of subsidiary stock........... 1,526 1,526
---------- ------- -------- -------- ------ --------
BALANCE DECEMBER 31, 1998................ 26,474,814 $26,475 $188,739 $110,138 $3,693 $329,045
========== ======= ======== ======== ====== ========
- ---------------
(1) Includes securities available for sale and retained interest in securitized
assets. The pre-tax decrease in unrealized gains on securities available for
sale was $3.9 million at December 31, 1998 compared to pre-tax increases of
$8.4 million and $1.6 million at December 31, 1997 and 1996, respectively.
See accompanying notes to consolidated financial statements.
F-5
76
WESTCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
OPERATING ACTIVITIES
Net income (loss)........................................... $ (14,697) $ 36,788 $ 31,797
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Provision for loan losses................................. 18,960 12,851 13,571
Depreciation and amortization............................. 31,629 26,649 17,102
Amortization of retained interest in securitized assets... 103,610 53,421 60,519
Loss on the disposal of assets............................ 12,754
Gain on sale of loans and other assets.................... (50,239) (72,111) (53,180)
Stock Contribution to Employee Stock Ownership and Salary
Savings Plans........................................... 1,181
Minority interest in (loss) income of consolidated
subsidiaries............................................ (2,216) 5,120 7,349
Distributions received from joint ventures................ 1,401
(Increase) decrease in assets:
Origination of loans.................................... (5,558,998) (4,740,264) (3,425,904)
Proceeds from sale of loans............................. 4,769,073 4,164,423 3,082,582
Other changes in loans.................................. 679,644 457,652 377,448
Proceeds from sale of capitalized servicing rights...... 31,909 5,563 3,084
Other changes in capitalized servicing rights........... (18,720) (23,882) (18,589)
Disposition of real estate owned........................ 20,049 25,886 22,617
Other assets............................................ (4,866) 23,588 3,085
Increase (decrease) in other liabilities.................... 2,803 9,771 (2,470)
----------- ----------- -----------
NET CASH PROVIDED (USED IN) BY OPERATING ACTIVITIES......... 22,096 (14,545) 120,192
INVESTING ACTIVITIES
Investment securities held to maturity:
Purchases................................................. (1,667)
Investment securities available for sale:
Purchases................................................. (44,581) (29,976) (42,809)
Proceeds from sale........................................ 10,460 1,915
Proceeds from maturities.................................. 81,538 53,000 33,000
Mortgage-backed securities held to maturity:
Purchases................................................. (934) (1,336)
Payments received on mortgage-backed securities........... 47,502 72,959
Mortgage-backed securities available for sale:
Purchases................................................. (620,328) (581,753) (299,683)
Proceeds from sale........................................ 365,990 393,599 197,531
Payments received on mortgage-backed securities........... 212,823 62,126 31,852
Additions to premises and equipment......................... (23,281) (22,585) (22,156)
Purchases of FHLB stock..................................... (8,554) (18,817) (4,114)
Proceeds of FHLB stock...................................... 9,761 25,022 1,771
Increase in amounts due from trusts......................... (37,609) (103,654) (81,238)
----------- ----------- -----------
NET CASH USED IN INVESTING ACTIVITIES....................... (53,781) (176,470) (113,975)
FINANCING ACTIVITIES
Increase in deposits........................................ 177,839 126,954 120,467
Increase in retained interest in securitized assets......... (91,914) (112,230) (104,071)
Increase in securities sold under agreements to
repurchase................................................ (21,427) (341) (66,612)
(Decrease) increase in FHLB advances, net................... 75,882 (141,029) 34,000
Increase (decrease) in short-term borrowings................ (177,453) 135,935 (53,130)
Increase in amounts held on behalf of trustee............... 39,438 95,204 51,757
Increase in subordinated debentures......................... 133,505
Proceeds from issuance of common stock...................... 1,010 1,057 1,057
Purchase of subsidiary common stock......................... 1,526 (4,223) (4,620)
Cash dividends.............................................. (6,592) (10,469) (10,121)
----------- ----------- -----------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES......... (1,691) 224,363 (31,273)
----------- ----------- -----------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS............ (33,376) 33,348 (25,056)
Cash and equivalents at beginning of period................. 171,130 137,782 162,838
=========== =========== ===========
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 137,754 $ 171,130 $ 137,782
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest.................................................. $ 160,630 $ 156,852 $ 138,400
Income taxes.............................................. 1,832 5,738 18,322
SUPPLEMENTAL DISCLOSURES OF NONCASH TRANSACTIONS:
Acquisition of real estate acquired through foreclosure..... $ 15,414 $ 20,953 $ 26,889
Unrealized gains (loss) on securities available for sale and
retained interests in securitized assets, net of tax...... (2,165) 4,774 898
Investment securities and mortgage-backed securities held to
maturity transferred to available for sale................ 395,411
See accompanying notes to consolidated financial statements.
F-6
77
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The accompanying consolidated financial statements
include the accounts of Westcorp ("the Company"), its wholly-owned subsidiaries,
Westran Services Corp., Westcorp Investments, Inc., WestFin Securities
Corporation and Western Financial Bank, and the Bank's subsidiaries including
WFS Financial Inc ("WFS") of which the Bank owns 87%. All significant
intercompany accounts and transactions have been eliminated upon consolidation.
Certain prior year amounts have been reclassified to conform with the current
year's presentation.
Use of Estimates: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Nature of Operations: The Company is a financial services holding company
which specializes in automobile lending, commercial banking, retail banking,
mortgage banking, and other related services.
Cash and Cash Equivalents: Cash and cash equivalents include cash,
interest-bearing deposits with other financial institutions and other short-term
investments which have no material restrictions as to withdrawal or usage.
Investment Securities and Mortgage-Backed Securities Available for
Sale: Investments and mortgage-backed securities intended to be held for an
indefinite period of time but which may be sold in response to events reasonably
expected in the foreseeable future are classified as available for sale and
carried at fair value. Unrealized holding gains and losses on such investments
are recorded as a separate component of shareholders' equity, net of income
taxes. Any decline in the fair value of the investments which is deemed to be
other than temporary is charged against current earnings. The method used in
determining the cost of investments sold is specific identification.
The Company has entered into or committed to interest rate caps, swaps and
forward agreements as hedges against market value changes in designated portions
of its mortgage-backed securities and loans held for sale portfolios and to
manage interest rate risk exposure on its available for sale securities. These
financial instruments are also recorded at fair value and are included in the
basis of the designated available for sale securities and loans held for sale.
The interest rate differential to be paid or received is accrued and included as
part of interest income, thereby adjusting the overall yield on securities or
loans for which management is attempting to reduce its exposure to interest rate
risk. Recognition of unrealized gains and losses on these contracts are deferred
and amortized into interest income over the shorter of the remaining life of the
derivative instrument or the expected life of the associated asset. When the
related mortgage-backed securities or loans are sold, settled or terminated, the
deferred gains or losses from these contracts are recognized in the Consolidated
Statements of Operations as a component of automobile lending income, mortgage
banking income and investment and mortgage-backed securities gains and losses.
Allowance for Loan Losses: The allowance for loan losses for loans
receivables is maintained at a level believed adequate by management to absorb
inherent losses in the loan portfolios. Management's determination of the
adequacy of the allowance is based on an evaluation of the portfolio, past loan
loss experience, current economic conditions, volume, growth and composition of
the loan portfolio, and other relevant factors. The allowance is increased by
provisions for loan losses charged against income.
Loans Held for Sale: Loans held for sale are stated at the lower of
aggregate amortized cost or market. The carrying amount of the specific loan
pools sold is used to compute gains or losses. Market value is based on
prevailing market quotes for real estate loans and discounted cash flow
calculations for consumer loans.
Sales of Loans and Securitized Assets and Capitalized Servicing
Rights: Certain mortgage and consumer loans are originated and sold to investors
with servicing rights retained by the Company. The Company does
F-7
78
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
not retain any direct recourse with respect to the automobile loans securitized.
As part of the automobile loan sale, the trustee reimburses the Company for
borrowing costs incurred between the cut-off of the loans and the closing date
of the sale.
Gain on sale of automobile loans represents the present value of the
estimated future earnings to be received from the excess spread created in the
securitization transactions less prepaid dealer commission, issuance costs, and
the effect of hedging activities. These retained interest in securitized assets
("RISA") are capitalized and amortized over the expected repayment life of the
underlying automobile loans. The Company evaluates quarterly the carrying value
of its RISA in light of the actual repayment experience of the underlying
automobile loans and makes adjustments to reduce the carrying value, if
appropriate. The Company utilizes the cash-out method in determining the
valuation of the RISA. Servicing income and amortization of RISA are included in
automobile lending income in noninterest income in the Consolidated Statements
of Operations.
Gain on sale of mortgage loans represents the difference between the
allocated cost basis loans sold and proceeds from sale, which includes the
carrying value of capitalized servicing rights ("CSR") created as a result of
the sale. The carrying value of the CSR assets represent an allocation of the
cost basis of loans sold between the CSR and the loans based upon their relative
fair value at the date the loans are originated or purchased. The fair value of
CSR is calculated by estimating future servicing revenues, including servicing
fees, late charges, other ancillary income, and float benefit, less the actual
cost to service loans. The amortization of the CSR is a component of mortgage
banking income in noninterest income over the period of, and in proportion to,
the expected repayment term of the underlying loans. CSR is evaluated for
impairment based on the excess of the carrying amount of the CSR over their fair
value. See Note 5 for additional disclosure related to the RISA and CSR.
Nonaccrual Loans: Nonaccrual loans are loans on which accrual of interest
has been suspended. Interest is suspended on all real estate loans when, in
management's judgement, the interest will not be collectible in the normal
course of business or when the loan is 90 days or more past due or full
collection of principal is not assured. When a loan is placed on nonaccrual,
interest accrued is reversed against interest income. Interest income is
suspended on all loans, except consumer loans. On these loans, interest
continues to accrue until the loan is charged off, which occurs automatically
after the loan is past due 120 days, whereupon all accrued interest is reversed.
Premises and Equipment: Premises and equipment are recorded at cost and are
depreciated over their estimated useful lives principally using the
straight-line method for financial reporting and accelerated methods for tax
purposes. Leasehold improvements are amortized over the lives of the respective
leases or the service lives of the improvements, whichever is shorter.
Real Estate Owned: Real estate acquired through foreclosure is recorded at
the lower of cost or fair value less estimated costs to sell. Costs of holding
this real estate, and related gains and losses on disposition, are credited or
charged to real estate operations as incurred. These values are periodically
reviewed and write-downs are recorded, if appropriate.
Real estate owned is carried net of an allowance for potential losses which
is maintained at a level believed by management to be adequate to absorb any
potential losses in the portfolio. Management's determination of the adequacy of
the allowance is based on an evaluation of the past loss experience, current
economic conditions, selling costs and other relevant factors.
Interest Income and Fee Income: Interest income on real estate and certain
consumer loans is earned using the effective yield method and classified on the
balance sheets as part of other assets to the extent not collected. Certain
consumer loans use the sum of the months digits method, which approximates the
interest method.
F-8
79
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The Company defers loan origination and commitment fees and certain loan
origination costs. The net amount is amortized as an adjustment to the related
loan's yield over the contractual life of the related loans. Commitment fees
based on a percentage of a customer's unused line of credit are recognized over
the commitment period. Fees for other services are recorded as income when
earned.
Insurance Commissions: Commissions on insurance policies sold are
recognized as income over the life of the policies.
Insurance Premiums: Premiums for life and accident/health insurance
policies are recognized as income over the term of the insurance contract.
Income Taxes: The Company files consolidated federal and state tax returns
with all of its subsidiaries except for Westhrift, which files a separate state
tax returns.
Current Accounting Pronouncements: In June 1997, the FASB issued "SFAS No.
130, Reporting Comprehensive Income". This statement is effective with the
year-end 1998 financial statements; however, a total for comprehensive income is
required in the financial statements of interim periods beginning with the first
quarter of 1998. Reclassification of financial statements for earlier periods
provided for comparative purposes is required. This Statement establishes
standards for reporting and displaying comprehensive income and its components
in the financial statements. It requires that a company classify items of other
comprehensive income, as defined by accounting standards, by their nature (e.g.,
unrealized gains or losses on securities available for sale and retained
interests in securitized assets) in a financial statement with the same
prominence as other financial statements, but does not require a specific format
for that statement. The accumulated balance of comprehensive income is to be
displayed separately from retained earnings and additional paid-in capital in
the equity section of the consolidated statements of financial condition.
In June 1997, the FASB issued "SFAS No. 131, Disclosure about Segments of
an Enterprise and Related Information." This Statement provides guidance for the
way public enterprises report information about operating segments in annual
financial statements and requires selected information about operating segments
in annual financial statements and in interim financial reports. It also
requires certain related disclosures about products and services, geographic
areas and major customers. The segment and other information disclosures are
required for the year ended December 31, 1998. In the initial year of
application, comparative information for earlier years is to be restated.
In June 1998, the FASB issued SFAS 133 "Accounting for Derivative
Instruments and Hedging Activities." This statement provides guidance for the
way public enterprises report information about derivatives and hedging in
annual financial statements and in interim financial reports. The derivatives
and hedging disclosure is required for financial statements for fiscal years
beginning after June 15, 1999. The Statement will require the Company to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the derivative
is a hedge, depending on the nature of the hedge, changes in fair value of
derivatives will either be offset against the change in fair value of the hedged
assets, liabilities, or firm commitments through earnings or recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings. The Company is in the process of evaluating
the effect of Statement 133, if any, will have on the earnings and financial
position of the Company.
F-9
80
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
NOTE 2 -- INVESTMENT SECURITIES AVAILABLE FOR SALE
Investment securities available for sale consisted of the following:
DECEMBER 31, 1998
----------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
--------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
U.S. Treasury securities and obligations of
other U.S. Government agencies and
corporations............................. $ 74,307 $1,285 $ 75,592
Obligations of states and political
subdivisions............................. 1,510 62 1,572
Other...................................... 632 632
-------- ------ ---- --------
$ 76,449 $1,347 $ 77,796
======== ====== ==== ========
DECEMBER 31, 1997
----------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
--------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
U.S. Treasury securities and obligations of
other U.S. Government agencies and
corporations............................. $121,716 $ 418 $420 $121,714
Obligations of states and political
subdivisions............................. 1,511 21 1,532
Other...................................... 163 163
-------- ------ ---- --------
$123,390 $ 439 $420 $123,409
======== ====== ==== ========
At December 31, 1998, the stated maturities of the Company's investment
securities available for sale were as follows:
ONE YEAR TO FIVE YEARS
UP TO ONE YEAR FIVE YEARS TO TEN YEARS
------------------- ------------------- ------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
--------- ------- --------- ------- --------- ------
(DOLLARS IN THOUSANDS)
U.S. Treasury securities and obligations
of other U.S. Government agencies and
corporations.......................... $24,252 $24,305 $50,055 $51,287
Obligations of states and political
subdivisions.......................... 130 134 $1,380 $1,438
Other................................... 632 632
------- ------- ------- ------- ------ ------
$24,884 $24,937 $50,185 $51,421 $1,380 $1,438
======= ======= ======= ======= ====== ======
Proceeds from the sale of investment securities available for sale totalled
approximately $10.5 million in 1998. The Company had gross realized gains of $21
thousand and $139 thousand in 1998 and 1997, respectively, and had no gross
realized losses in 1998 and 1997.
F-10
81
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
NOTE 3 -- MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE
Mortgage-backed securities available for sale consisted of the following:
DECEMBER 31, 1998
----------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
GNMA certificates.......................... $858,682 $ 6,261 $5,316 $859,627
FNMA participation certificates............ 112,351 1,511 20 113,842
FHLMC participation certificates........... 3,600 58 3,658
Other...................................... 2,917 2,917
-------- ------- ------ --------
$977,550 $ 7,830 $5,336 $980,044
======== ======= ====== ========
DECEMBER 31, 1997
----------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
GNMA certificates.......................... $778,302 $12,710 $4,070 $786,942
FNMA participation certificates............ 142,572 972 93 143,451
FHLMC participation certificates........... 8,188 42 105 8,125
Other...................................... 2,912 54 36 2,930
-------- ------- ------ --------
$931,974 $13,778 $4,304 $941,448
======== ======= ====== ========
Proceeds from the sale of mortgage-backed securities available for sale
totalled approximately $366 million and $394 million in 1998 and 1997
respectively. The Company had gross realized gains of $8.3 million and $8.5
million in 1998 and 1997, respectively, and gross realized losses of $875
thousand and $487 thousand in 1998 and 1997, respectively.
The Company's mortgage-backed securities available for sale all had
maturities at December 31, 1998 and 1997, of ten years or more, although
payments are generally received monthly throughout the life of these securities.
The Company has issued certain mortgage-backed securities that include
recourse provisions. Subject to certain limitations, the Company is required,
for the life of the loans, to repurchase the buyer's interest in individual
loans on which foreclosure proceedings have been completed. Securities with
recourse issued by the Company had a total outstanding balance of $146 million
and $159 million at December 31, 1998 and 1997, respectively.
The Company has provided for possible losses that may occur as a result of
its recourse obligations. The maximum remaining exposure under these recourse
provisions at December 31, 1998 and 1997 was $128 million and $88.7 million,
respectively. The Company has pledged $11.1 million and $13.6 million of
mortgage-backed securities as collateral under these recourse provisions at
December 31, 1998 and 1997, respectively.
F-11
82
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
NOTE 4 -- NET LOANS RECEIVABLE
Net loans receivable consisted of the following:
DECEMBER 31,
------------------------
1998 1997
---------- ----------
DOLLARS IN THOUSANDS)
Real Estate:
Mortgage.................................................. $ 994,404 $1,529,764
Construction.............................................. 18,950 15,835
---------- ----------
1,013,354 1,545,599
Less: undisbursed loan proceeds............................. (6,417) (8,657)
---------- ----------
1,006,937 1,536,942
Consumer:
Automobile loans.......................................... 923,662 253,455
Other..................................................... 45,529 62,870
Unearned discounts........................................ (48,015) (22,225)
---------- ----------
921,176 294,100
Commercial.................................................. 64,720 41,668
---------- ----------
1,992,833 1,872,710
Allowance for loan losses................................... (37,660) (33,834)
---------- ----------
1,955,173 1,838,876
Less: loans held for sale
Mortgage.................................................. 309,013 529,026
Consumer.................................................. 848,066 183,528
---------- ----------
1,157,079 712,554
---------- ----------
$ 798,094 $1,126,322
========== ==========
Loans serviced by the Company for the benefit of others totalled
approximately $5.1 billion and $8.4 billion at December 31, 1998 and 1997,
respectively. These amounts are not included in the Consolidated Statements of
Financial Condition.
Changes in the allowance for loan losses were as follows:
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
(DOLLARS IN THOUSANDS)
Balance at beginning of year....................... $ 33,834 $ 40,211 $ 39,260
Provision for loan losses.......................... 18,960 12,851 13,571
Chargeoffs......................................... (19,705) (22,806) (21,258)
Recoveries......................................... 4,571 4,369 7,168
Transfers from the allowance for real estate losses
Business acquisition adjustment.................... (791) 1,470
-------- -------- --------
Balance at end of year............................. $ 37,660 $ 33,834 $ 40,211
======== ======== ========
NOTE 5 -- SECURITIZED ASSETS AND CAPITALIZED SERVICING RIGHTS
Statement of Financial Accounting Standards ("SFAS") No. 125 requires that,
following a transfer of financial assets, an entity must recognize the assets it
controls and the liabilities it has incurred, and
F-12
83
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
derecognizes assets for which control has been surrendered and liabilities that
have been extinguished. SFAS 125 defines two separate financial assets retained
at the time of securitization or sale, RISA which represents the excess spread
created from securitization or sale, and CSR which represents the benefit
derived from retaining the rights to service loans securitized or sold. The
Company did not recognize any CSR as of December 31, 1998 or 1997 with respect
to securitized automobile loans. Previous accounting guidance did not separately
distinguish these rights.
Retained Interest in Securitized Assets
Retained Interest in Securitized Assets ("RISA") capitalized upon
securitization of automobile loans represents the present value of the estimated
future earnings to be received by the Company from the excess spread created in
securitization transactions. Excess spread is calculated by taking the
difference between the coupon rate of the automobile loans sold and the interest
rate paid to the investors less contractually specified servicing and guarantor
fees.
Prepayment and credit loss assumptions are utilized to project future
earnings and are based upon historical experience. Credit losses are estimated
using a cumulative loss rate estimated by management to reduce the likelihood of
asset impairment. All assumptions used are evaluated each quarter and adjusted,
if appropriate, to reflect actual performance of the automobile loans.
Future earnings are discounted at a rate management believes to be
representative of market at the time of securitization. The balance of the RISA
is amortized against actual excess spread income earned on a monthly basis over
the expected repayment life of the underlying automobile loans. RISAs are
classified in a manner similar to available for sale securities, and as such are
marked to market each quarter. Market value changes are calculated by
discounting the excess spread using a current market discount rate. Any changes
in the market value of the RISA is reported as a separate component of
shareholders' equity as an unrealized gain or loss, net of applicable taxes.
Two methods have arisen in practice to determine the fair value of future
retained interest earnings, the cash-in method and the cash-out method. The
Securities and Exchange Commission ("SEC") has set forth specific guidance that
the cash-out method is the only appropriate method to be used in determining the
fair value of such assets as defined by the Financial Accounting Standards Board
Statement No. 125. The cash-out method discounts future retained interest
earnings from the period in which the transferor expects to receive the cash,
thereby taking into consideration the period of time that the cash is received
from obligors but restricted from distribution to the transferor. WFS has
historically and will continue to use the cash-out method in measuring such
assets.
The following table presents the activity of the RISA:
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
--------- -------- --------
(DOLLARS IN THOUSANDS)
Beginning balance................................. $ 181,177 $121,597 $ 78,045
Additions......................................... 91,914 112,230 104,071
Amortization...................................... (103,610) (53,421) (60,519)
Change in unrealized gains on RISA................ 1,749 771
--------- -------- --------
Ending balance.................................... $ 171,230 $181,177 $121,597
========= ======== ========
At the time of a securitization, the Company utilizes prepayment speed, net
credit loss and discount rate assumptions to initially compute the value of the
RISA. These assumptions may change periodically based on actual performance or
other factors. During 1998, the Company utilized prepayment rates of 1.6% ABS in
F-13
84
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
computing RISA. Cumulative net credit loss assumptions utilized for 1998
securitizations ranged from 6% to 7%. The Company used a discount rate of 425
basis points over the two-year Treasury rate at the time of securitization in
discounting future earnings.
The following table presents the estimated future undiscounted retained
interest earnings to be received from securitizations. Estimated future
undiscounted RISA earnings are calculated by taking the difference between the
coupon rate of the automobile loans sold and the certificate rate paid to the
investors, less the contractually specified servicing fee and guarantor fees,
after giving effect to estimated prepayments and assuming no losses. To arrive
at the RISA, this amount is reduced by the off-balance sheet allowance
established for potential future losses and by discounting to present value.
DECEMBER 31,
------------------------
1998 1997
---------- ----------
(DOLLARS IN THOUSANDS)
Estimated net undiscounted RISA earnings............ $ 361,209 $ 438,190
Off-balance sheet allowance for losses.............. (170,664) (236,796)
Discount to present value........................... (19,315) (20,217)
---------- ----------
Retained interests in securitized assets............ $ 171,230 $ 181,177
========== ==========
Outstanding balance of automobile loans sold through
securitizations................................... $3,491,452 $3,449,590
Off-balance sheet allowance for losses as a percent
of automobile loans sold through securitization... 4.89% 6.86%
The Company believes that the off balance sheet allowance for losses is
currently adequate to absorb potential losses in the sold portfolio.
Capitalized Servicing Rights
Capitalized servicing rights consisted of the following:
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Purchased mortgage servicing rights...................... $ 6,360 $14,695
Originated mortgage servicing rights..................... 6,136 26,161
Impairment allowance for mortgage servicing rights....... (3,723) (3,439)
------- -------
$ 8,773 $37,417
======= =======
CSR assets represent an allocation of the cost basis of loans sold between
the CSR and the loans based upon their relative fair value at the date the loans
are originated or purchased. The fair value of CSR is calculated by estimating
future servicing revenues, including servicing fees, late charges, other
ancillary income, and float benefit, less the actual cost to service loans.
At December 31, 1998, the Company capitalized servicing rights totalled
$18.7 million with $23.9 million in 1997. The mortgage servicing rights are
included in capitalized servicing rights and the amortization is a component of
mortgage banking income in noninterest income. The Company's mortgage banking
results were directly impacted by a declining interest rate environment that
caused higher prepayments, which, in turn, accelerated the amortization of the
Company's capitalized servicing rights. The Company sold $31.9 million of its
CSR in 1998. The sale represented 67% of the Company's portfolio serviced for
the benefit of others.
F-14
85
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The remaining CSR asset was revalued to fair market value at December 31,
1998. The fair value of the CSRs was $8.8 million and $42.8 million at December
31, 1998 and December 31, 1997, respectively. Fair value was determined based on
the present value of estimated future earnings. Significant assumptions were
based upon prepayment, default, servicing cost and discount rate. For the
purpose of estimated fair value, CSRs are stratified on the basis of loan type,
loan coupon and loan term.
CSR are evaluated for impairment based on the excess of the carrying amount
of the CSR over their fair value.
Amortization of capitalized servicing rights are reflected as a component
of mortgage banking income in noninterest income. Amortization expense for the
year ended December 31, 1998 was $15.5 million, compared with $9.5 million for
the year ended December 31, 1997.
NOTE 6 -- PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Land........................................................ $23,516 $24,496
Construction in progress.................................... 8,211 7,507
Buildings and improvements.................................. 52,324 48,599
Furniture and equipment..................................... 31,689 46,290
Automobiles and airplanes................................... 6,994 6,916
------- -------
122,734 133,808
Less: accumulated depreciation.............................. 36,317 44,017
------- -------
$86,417 $89,791
======= =======
NOTE 7 -- NONPERFORMING ASSETS
Nonperforming loans consisted of the following:
DECEMBER 31,
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Unimpaired loans placed on nonaccrual....................... $ 8,181 $14,979
Impaired loans.............................................. 4,046 4,806
======= =======
$12,227 $19,785
======= =======
Interest forgone on nonaccrual loans was $0.4 million, $0.8 million and
$1.0 million for the years ended December 31, 1998, 1997 and 1996, respectively.
The following table presents a breakdown of impaired loans and the
impairment allowance related to impaired loans:
DECEMBER 31,
----------------
1998 1997
------ ------
(DOLLARS IN
THOUSANDS)
Recorded investment with allowance.......................... $5,321 $6,343
Less: impairment allowance.................................. 1,275 1,537
------ ------
$4,046 $4,806
====== ======
F-15
86
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
For the years ended December 31, 1998 and 1997, average impaired loans were
$3.7 million and $5.7 million, respectively. For the years ended December 31,
1998 and 1997, Westcorp recognized $1.8 million and $1.5 million, respectively,
of interest income on impaired loans, all of which was recognized on a cash
basis.
Real estate owned consisted of the following:
DECEMBER 31,
----------------------
1998 1997
-------- --------
(DOLLARS IN THOUSANDS)
Real estate acquired through foreclosure................. $4,861 $7,120
Less: allowance for losses............................... 784 784
------ ------
$4,077 $6,336
====== ======
There were no changes in the allowance for REO losses for the years ended
December 31, 1998, 1997 and 1996, respectively
Changes in the allowance for real estate losses were as follows:
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------
1998 1997 1996
----- ----- -----
(DOLLARS IN THOUSANDS)
Balance at beginning of year.......................... $784 $784 $784
Provision for real estate losses......................
Transfers to the allowance for loan losses............
---- ---- ----
Balance at end of year................................ $784 $784 $784
==== ==== ====
NOTE 8 -- ACCRUED INTEREST RECEIVABLE
Accrued interest receivable consisted of the following:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Interest on loans receivable............................. $11,962 $10,887
Interest on securities................................... 6,762 7,236
Interest on other........................................ 8 24
======= =======
$18,732 $18,147
======= =======
Accrued interest receivable at December 31, 1998 and 1997 are included in
other assets in the Consolidated Statements of Financial Condition.
F-16
87
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
NOTE 9 -- DEPOSITS
Deposits consisted of the following at December 31:
WEIGHTED
AVERAGE RATE
FOR THE YEAR
ENDED
1998 1998 1997
------------ ---------- ----------
(DOLLARS IN THOUSANDS)
Demand deposit accounts................ 0.7% $ 38,511 $ 14,179
Passbook accounts...................... 2.3 15,412 21,883
Money market deposit accounts.......... 4.7 320,160 126,956
Certificate accounts................... 5.7 1,654,012 1,702,992
Brokered certificate accounts.......... 5.3 75,400 39,976
Noninterest bearing deposits........... 75,240 94,910
---------- ----------
$2,178,735 $2,000,896
========== ==========
The aggregate amount of deposits in denominations greater than or equal to
$100,000 at December 31, 1998 and 1997 was $443 million and $418 million,
respectively.
Scheduled maturities of certificate accounts at December 31, 1998 were
follows:
WEIGHTED
AVERAGE RATE AMOUNT
------------ -----------
(DOLLARS IN
THOUSANDS)
Six months or less................................ 5.5% $ 863,906
More than six months through one year............. 5.2 641,773
More than one year through three years............ 5.7 107,427
More than three years through ten years........... 5.9 40,906
----------
$1,654,012
==========
Interest expense on deposits consisted of the following:
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
-------- -------- -------
(DOLLARS IN THOUSANDS)
Demand deposit accounts..................... $ 858 $ 399 $ 335
Passbook accounts........................... 404 746 1,414
Money market deposit accounts............... 9,259 2,181 14
Certificate accounts........................ 93,283 101,085 97,180
Brokered certificate accounts............... 5,201 2,667 148
-------- -------- -------
$109,005 $107,078 $99,091
======== ======== =======
Accrued interest payable on deposits at December 31, 1998 and 1997 was $2.2
million and $95 thousand, respectively, which is included in other liabilities
in the Consolidated Statements of Financial Condition.
F-17
88
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The following table summarizes certificate accounts by interest rate within
maturity categories at December 31:
1998
-----------------------------------------------------------------------------
1999 2000 2001 2002 2003 THEREAFTER TOTAL
---------- -------- ------- ------- ------- ---------- ----------
(DOLLARS IN THOUSANDS)
0% - 3.99%........ $ 5,092 $ 52 $ 72 $19 $ 5,235
4.00% - 5.99%........ 1,411,285 63,860 11,311 $11,599 $ 4,044 1,502,099
6.00% - 7.99%........ 89,300 31,972 161 25,187 58 146,678
---------- -------- ------- ------- ------- --- ----------
$1,505,677 $ 95,884 $11,544 $36,786 $ 4,102 $19 $1,654,012
========== ======== ======= ======= ======= === ==========
1997
-----------------------------------------------------------------------------
1998 1999 2000 2001 2002 THEREAFTER TOTAL
---------- -------- ------- ------- ------- ---------- ----------
(DOLLARS IN THOUSANDS)
0% - 3.99%........ $ 1,034 $ 21 $ 1,055
4.00% - 5.99%........ 1,115,388 156,868 $20,702 $ 400 $12,272 1,305,630
6.00% - 7.99%........ 286,063 51,404 32,540 155 26,112 $ 7 396,281
8.00% - 9.99%........ 26 26
---------- -------- ------- ------- ------- --- ----------
$1,402,511 $208,293 $53,242 $ 555 $38,384 $ 7 $1,702,992
========== ======== ======= ======= ======= === ==========
NOTE 10 -- SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase are summarized as follows:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Balance at end of period............................... $265,644 $287,071
Balance at end of period, including accrued interest... 266,238 287,714
Estimated fair value at end of period.................. 247,846 293,323
Average amount outstanding during the period........... 321,367 308,573
Maximum amount outstanding at any given month-end
during the period.................................... 532,519 417,688
Weighted average interest rate during the period....... 5.8% 5.6%
Weighted average interest rate at end of period........ 5.4% 5.9%
Mortgage-backed securities available for sale sold under reverse repurchase
agreements were delivered to dealers who arranged the transactions. The dealers
may have sold, loaned, or otherwise disposed of such securities to other parties
in the normal course of their operations, and have agreed to resell to the
Company substantially identical securities at the maturities of the agreements.
The agreements at December 31, 1998 mature within 30 days. The agreements at
December 31, 1997 mature with terms between 30 to 90 days. Average amounts are
computed based upon daily ending balances.
NOTE 11 -- SHORT-TERM BORROWINGS
The Company has a letter of credit supporting the Company's commercial
paper facility with the Federal Home Loan Bank ("FHLB"). It is collateralized by
eligible real estate loans and mortgage backed securities described in Note 12,
Federal Home Loan Bank advances, with an approved letter of credit of up to $400
million in 1998 and 1997, and a weighted average interest rate of 5.2% at
December 31, 1998. The maximum amount of commercial paper outstanding at any
month-end during 1998 and 1997 was $388 million
F-18
89
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
and $399 million, respectively and the average amount of commercial paper
outstanding during 1998 and 1997 was $175 million and $178 million respectively,
with a weighted average interest rate of 5.7% at December 31, 1998 and 1997. The
Company's commercial paper generally matures within 30 days from the issuance
date. There was no amount of commercial paper outstanding at December 31, 1998.
The Company has two lines of credit with a bank which has a maximum
availability of $25 million and a line of credit with a maximum availability of
$15 million at December 31, 1998 and 1997, respectively. The lines of credit
have an interest rate tied to the FHLB Reference Rate.
The components of short-term borrowings are as follows:
DECEMBER 31,
-----------------------
1998 1997
--------- ----------
(DOLLARS IN THOUSANDS)
Commercial paper, net of discount (1997, $536
thousand)............................................. $ $170,973
Lines of credit......................................... 5,218 17,518
Other................................................... 9,209 3,389
------- --------
$14,427 $191,880
======= ========
NOTE 12 -- FEDERAL HOME LOAN BANK ADVANCES
Advances from the FHLB are collateralized with eligible real estate loans
and mortgage-backed securities. The FHLB letter of credit disclosed in Note
11 -- Short-Term Borrowings is also pledged with the same collateral. The FHLB
advances and the FHLB letter of credit are collateralized with mortgage loans
totalling $471 million and $642 million at December 31, 1998 and 1997,
respectively, and mortgage-backed securities totalling $219 million and $67.0
million at December 31, 1998 and 1997, respectively.
Information as to interest rates and maturities on the advances from the
FHLB are as follows:
1998 1997
------------ ------------
(DOLLARS IN THOUSANDS)
Range of interest rates......................... 5.3% - 18.2% 6.0% - 8.2%
Weighted average interest rate.................. 5.5% 6.3%
Year due:
1998.......................................... $70,000
1999.......................................... $151,500 6,500
2000..........................................
2001..........................................
2002.......................................... 6,500 6,500
Thereafter.................................... 2,853 1,971
============ ============
$160,853 $84,971
============ ============
The Company had a credit availability of approximately $531 million with
the FHLB at December 31, 1998.
NOTE 13 -- SUBORDINATED DEBENTURES
Subordinated capital debentures of the Company ("subordinated debentures")
totalled $240 million at December 31, 1998 and $239 million at December 31,
1997, net of discount and issuance costs (1998, $4.7 million; 1997, $5.3
million). The subordinated debentures are unsecured and consist of two issuances
with outstanding balances of $94.5 million with an interest rate of 8.5% due in
2003 and $146 million with an interest rate of 8.875% due in 2007. They are
redeemable, in whole or in part, at the option of the Company,
F-19
90
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
on or after July 1, 2000 and August 1, 2004, respectively, both at 100% of the
principal amount being redeemed plus accrued interest as of the date of
redemption. For regulatory purposes, the subordinated debentures are included as
part of the Bank's supplementary capital, subject to certain limitations.
NOTE 14 -- COMMITMENTS AND CONTINGENCIES
Future minimum payments under noncancellable operating leases on premises
and equipment with terms of one year or more were as follows at December 31:
1998
----------------------
(DOLLARS IN THOUSANDS)
1999...................................... $ 5,368
2000...................................... 4,576
2001...................................... 3,135
2002...................................... 1,443
2003...................................... 824
Thereafter................................ 858
-------
$16,204
=======
These agreements include, in certain cases, various renewal options and
contingent rental agreements. Rental expense amounted to $6.1 million, $7.8
million and $5.5 million in 1998, 1997 and 1996, respectively.
The Company's commercial, mortgage loan commitments and mortgage loans sold
with recourse were as follows:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Commercial letter of credit and unused lines of credit
provided.................................................. $ 21,159 $ 68,214
======== ========
Commitments to fund mortgage loans
Fixed rate loans.......................................... $276,144 $202,674
Variable rate loans....................................... 22,724 43,643
-------- --------
$298,868 $246,317
======== ========
Commitments to sell mortgage loans.......................... $336,362 $537,621
======== ========
Mortgage loans sold with recourse........................... $ 94,334 $131,359
======== ========
The Company has pledged certain assets relative to amounts held on behalf
of trustees as follows:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
FNMA participation certificates............................. $ 82,460 $105,790
FHLMC participation certificates
GNMA certificates........................................... 203,695 397,214
Automobile loans............................................ 357,805
Residential second mortgages................................ 44,748
Multifamily first mortgages................................. 48,910 70,714
-------- --------
$692,870 $618,466
======== ========
F-20
91
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The Company is also involved as a party to certain legal proceedings
incidental to its business. Management of the Company believes that the outcome
of such proceedings will not have a material effect upon its business or
financial condition, results of operations or cash flows.
NOTE 15 -- EARNINGS PER SHARE
SFAS No. 128, "Earnings Per Share", was issued by the Financial Accounting
Standards Board ("FASB") in February, 1997 and adopted on December 31, 1998.
Under the provisions of SFAS No. 128, primary and fully diluted earnings per
share were replaced with basic and diluted earnings per share in an effort to
simplify the computation of these measures and align them more closely with the
methodology used internationally. Basic earnings per share is calculated by
dividing net income available to common stockholders by the weighted average
number of common share outstanding and does not include the impact of any
potentially dilutive common stock equivalents. The diluted earnings per share
calculation method is similar to the previously required fully diluted earnings
per share method and is arrived at by dividing the weighted average number of
shares outstanding, adjusted for the dilutive effect of outstanding stock
options. For purposes of comparability, all prior period earnings per share data
has been restated.
The following table sets forth the computation of basic and diluted
earnings (loss) per share:
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996
-------------- -------------- --------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
BASIC
Net income (loss)........................... $ (14,697) $ 36,788 $ 31,797
=========== =========== ===========
Average common shares outstanding........... 26,305,117 26,165,678 25,910,548
=========== =========== ===========
Net income (loss) per common
share -- basic............................ $ (0.56) $ 1.41 $ 1.23
=========== =========== ===========
DILUTED
Net income (loss) $ (14,697) $ 36,788 $ 31,797
=========== =========== ===========
Average common shares outstanding........... 26,305,117 26,165,678 25,910,548
Stock option adjustment..................... 185,466 288,989
----------- ----------- -----------
Average common shares outstanding........... 26,305,117 26,351,144 26,199,537
=========== =========== ===========
Net income (loss) per common
share -- diluted.......................... $ (0.56) $ 1.40 $ 1.21
=========== =========== ===========
Options to purchase 331,620 shares of common stock ranging from $12.60 to
$18.69 per share, respectively, were outstanding during 1998 but were not
included in the computation of diluted earnings per share because the Company
experienced a loss from operations. Options to purchase 257,500 and 2,000 shares
of common stock at December 31, 1997 and 1996 , respectively, were not included
in the computation of diluted earnings per share because the options' exercise
price was greater than the average market price of the common share, and
therefore, the effect would be antidilutive. The weighted average exercise price
for the options outstanding at December 31, 1998 and 1997 and 1996 was $11.73,
$18.72 and $22.75, respectively.
NOTE 16 -- STOCK OPTIONS
In 1991, the Company reserved 3,150,000 shares of common stock for future
issuance to certain employees under an incentive stock option plan ("the Plan").
At December 31, 1998, there were 1,804,511 shares available for future grants.
The options may be exercised, within five to seven years after the date of
grant. Additionally, the weighted average life of the options at December 31,
1998 was 2.8 years and the exercise price of the options outstanding at December
31, 1998 ranged from $7.37 to $18.69 per share.
F-21
92
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
At December 31, 1998, there were no exercisable stock options under the
plan. In October, 1998 the Company canceled 405,250 of existing options as part
of a voluntary stock option exchange program. All option holders taking part in
this program traded in their existing options and were issued a proportionately
smaller number of new options based upon a reduced exercise price. Stock option
activity is summarized as follows:
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
-------- ----------------
Outstanding at January 1, 1996.................... 568,828 $ 8.26
Issued.......................................... 470,958 17.30
Exercised....................................... (139,711) 8.71
Cancelled....................................... (5,869) 10.95
-------- ------
Outstanding at December 31, 1996.................. 894,206 13.10
Issued.......................................... 348,000 18.09
Exercised....................................... (116,605) 11.86
Cancelled....................................... (142,444) 15.32
-------- ------
Outstanding at December 31, 1997.................. 983,157 15.07
Issued.......................................... 355,221 12.37
Exercised....................................... (118,905) 8.52
Cancelled....................................... (728,609) 17.09
-------- ------
Outstanding at December 31, 1998.................. 490,864 $11.73
======== ======
Effective January 1, 1996 the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation". SFAS No. 123 provides for companies to recognize
compensation expense associated with stock-based compensation plans over the
anticipated service period based on the fair value of the award on the date of
grant. However, SFAS No. 123 allows companies to continue to measure
compensation costs prescribed by Accounting Principles Board Opinion ("APB") No.
25, "Accounting for Stock Issued to Employees." Companies electing to continue
accounting for stock-based compensation plans under APB No. 25 must make pro
forma disclosures of net income and earnings per share as if SFAS No. 123 has
been adopted if the fair value of the options has material impact on earnings.
The Company has continued to account for stock-based compensation plans under
APB No. 25.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's and WFS' stock options have characteristics
significantly different from those traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing model does not necessarily provide a reliable
single measure of the fair value of its employee stock options.
The Company's fair value of options granted in 1998, 1997 and 1996 was
estimated at the date of grant using a Black-Scholes option pricing model with
the following assumptions:
1998 1997 1996
------------ ------- -------
Risk-free interest rate..................... 4.7% 5.7% 6.2%
Volatility factor........................... 0.54 0.41 0.30
Expected option life........................ 5 to 7 years 5 years 5 years
The Company's weighted average fair value of options granted during 1998,
1997, and 1996 was $5.87, $2.39 and $1.49, respectively.
F-22
93
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
NOTE 17 -- REGULATORY CAPITAL
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") and the regulations promulgated thereunder established certain
minimum levels of regulatory capital for savings institutions supervised by the
Office of Thrift Supervision ("OTS"). The Bank must follow specific capital
guidelines stipulated by the OTS which involve quantitative measures of the
Bank's assets, liabilities and certain off-balance sheet items as calculated
under regulatory accounting practices. An institution that fails to comply with
its regulatory capital requirements must obtain OTS approval of a capital plan
and can be subject to a capital directive and certain restrictions on its
operations which could have a direct material effect on the Bank's financial
statements.
At December 31, 1998 and 1997 , the Bank's most recent notification from
the OTS categorized the Bank as "well capitalized" under the prompt corrective
action ("PCA") regulations adopted by the OTS pursuant to the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"). To be categorized as
"well capitalized," the Bank must maintain minimum capital ratios as set forth
in the table below. The Bank's capital is subject to review by federal
regulators for the components, amounts, risk weighting classifications and other
factors. 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 actual capital and required
capital as of December 31, 1998 and 1997:
TIER 1
TANGIBLE RISK-BASED RISK-BASED
CAPITAL CORE CAPITAL CAPITAL CAPITAL
-------- ------------ ---------- ----------
(DOLLARS IN THOUSANDS)
DECEMBER 31, 1998
Actual Capital:
Amount...................................... $345,427 $345,427 $345,427 $604,552
Capital ratio............................... 9.02% 9.02% 6.42% 11.23%
FIRREA minimum required capital:
Amount...................................... $ 57,464 $114,929 N/A $430,112
Capital ratio............................... 1.50% 3.00% N/A 8.00%
Excess...................................... $287,963 $230,498 N/A $174,440
FDICIA well capitalized required capital:
Amount...................................... N/A $191,548 $322,584 $537,640
Capital ratio............................... N/A 5.00% 6.00% 10.00%
Excess...................................... N/A $153,879 $ 22,843 $ 66,912
DECEMBER 31, 1997
Actual Capital:
Amount...................................... $355,650 $355,650 $352,123 $639,937
Capital ratio............................... 9.48% 9.48% 6.74% 12.24%
FIRREA minimum required capital:
Amount...................................... $ 56,249 $112,498 N/A $418,115
Capital ratio............................... 1.50% 3.00% N/A 8.00%
Excess...................................... $299,401 $243,152 N/A $221,822
FDICIA well capitalized required capital:
Amount...................................... N/A $188,574 $313,587 $522,644
Capital ratio............................... N/A 5.00% 6.00% 10.00%
Excess...................................... N/A $167,076 $ 38,536 $117,293
F-23
94
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The following table reconciles the Bank's capital in accordance with
generally accepted accounting principles ("GAAP") to the Bank's tangible, core
and risk-based capital:
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Bank shareholder's equity -- GAAP basis..................... $332,951 $345,426
Adjustment: Unrealized gains under SFAS 115................. (3,693) (5,858)
Less: Non-permissible activities at required
phase-in(1)............................................ (4,811) (10,222)
Add: Minority interest in equity of subsidiaries.......... 21,857 29,538
Less: Disallowed capitalized servicing rights............. (877) (3,234)
-------- --------
Total tangible and core capital............................. 345,427 355,650
Adjustments for risk-based capital:
Subordinated debentures(1)................................ 224,844 256,311
General loan valuation allowance(2)....................... 34,281 31,503
Less: Fully capitalized assets............................ (3,527)
-------- --------
Risk-based capital........................................ $604,552 $639,937
======== ========
- ---------------
(1) Does not include minority interest in joint venture subsidiaries.
(2) Excludes capitalized discounts and issue costs.
(3) Limited to 1.25% of risk-weighted assets.
NOTE 18 -- DIVIDENDS
The Company paid cash dividends of $0.25 , $0.40 and $0.39 per share for
the years ended December 31, 1998, 1997 and 1996, respectively. The Company
declared a stock dividend of 5% in 1996. The 1996 dividends and earnings per
share and share amounts have been retroactively adjusted to give effect of the
1996 5% stock dividends. On January 12, 1999, the Company declared a quarterly
cash dividend of $0.05 per share for shareholders of record as of January 22,
1999, and paid on February 8, 1999.
NOTE 19 -- EMPLOYEE STOCK OWNERSHIP AND SALARY SAVINGS PLAN
The Company has an Employee Stock Ownership and Salary Savings Plan ("the
Plan"), which covers essentially all full-time employees who have completed one
year of service. Contributions to the Plan are discretionary and determined by
the Board of Directors within limits set forth under the Employment Retirement
Income Security Act of 1974. Contributions to the Plan are fully expensed in the
year to which the contribution applies.
The Company's contribution to the Plan amounted to $0.8 million, $2.4
million and $3.4 million in 1998, 1997 and 1996, respectively.
NOTE 20 -- RESTRUCTURING
In 1998, the Company completed the restructuring plan initially announced
on February 10, 1998. The goal of the plan was to consolidate offices and
eliminate redundant staff positions on a national level. The plan was achieved
in two phases. Phase I of the plan, completed in the first quarter of 1998,
consisted of the restructuring of operations in the Western United States. Phase
II of the plan, completed in the third quarter of 1998 and patterned after Phase
I, consisted of the restructuring of operations in the Central and Eastern
United States. As a result of these two restructurings, a total of 400 positions
of its automobile lending operations, or 19% of the Company's workforce were
eliminated and 96 offices were closed. The total pre-tax
F-24
95
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
restructuring charge in 1998 for the completed plan was $15.0 million.
Restructuring related costs included $1.8 million for employee severance and
$13.2 million for lease termination fees and write off of a disposition of
assets. The restructuring charge was substantially utilized in 1998.
Through the restructuring, WFS merged prime and non-prime office locations
with close geographic proximity and closed poorly performing offices. The
remaining offices now offer its dealer base the full spectrum of prime and
non-prime products through a single sales and marketing force. However, WFS
employs separate credit analysts that specialize in either reviewing prime or
non-prime paper. These analysts provide more consistent underwriting practices
through the use of a proprietary scorecard with its system-enforced credit
requirements which was also implemented during the year.
During the fourth quarter of 1998 the Company incurred a $3.0 million
restructuring charge relating to the consolidation of its 14 mortgage banking
offices into 3 Regional Operating Centers and the elimination of 200 positions,
or 55% of the work force in the mortgage banking area. This restructuring is the
result of the Company's decision to focus on primarily sub prime mortgage
products rather than prime and non-agency originations. Restructuring related
costs included $0.6 million for the employee severance and $2.4 million for
lease termination fees and the writeoff of disposed assets. The restructuring
charge was substantially utilized in 1998.
NOTE 21 -- INCOME TAXES
Income tax expense consisted of the following for the years ended:
1998 1997 1996
-------- ------- -------
(DOLLARS IN THOUSANDS)
Current:
Federal.................................... $ 8,523 $ 1,562 $ 4,169
State...................................... 3,196 349 1,362
-------- ------- -------
11,719 1,911 5,531
Deferred:
Federal.................................... (16,875) 21,617 17,394
State...................................... (6,174) 7,759 5,170
-------- ------- -------
(23,049) 29,376 22,564
-------- ------- -------
$(11,330) $31,287 $28,095
======== ======= =======
A reconciliation of total tax provisions and the amounts computed by
applying the statutory federal income tax rate of 35% to income before taxes is
as follows for the year ended December 31:
DECEMBER 31,
------------------------------
1998 1997 1996
-------- ------- -------
(DOLLARS IN THOUSANDS)
Tax at statutory rate........................ $ (9,885) $25,618 $23,534
State tax (net of Federal tax benefit)....... (1,936) 5,270 4,246
Other........................................ 491 399 315
-------- ------- -------
$(11,330) $31,287 $28,095
======== ======= =======
Deferred taxes reflect the net tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Amounts previously reported as
current and deferred income tax expense have been restated. Such changes to the
components of the expense occur because all tax alternatives available to the
Company are not known for a number of months subsequent to year-end.
F-25
96
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
Significant components of the Company's deferred tax assets and liabilities
are as follows:
DEFERRED TAX POSITION
ASSETS/(LIABILITIES)
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Deferred tax assets:
Loan loss reserves................................... $ 9,758 $ 6,936
State tax deferred benefit........................... 2,835 3,939
Deferred compensation accrual........................ 3,306 3,211
Tax basis difference -- marketable securities........ (55) 1,295
Other, net........................................... 6,986 4,110
-------- --------
22,830 19,491
Deferred tax liabilities:
Loan fee income deferred for tax purposes............ (2,034) (4,335)
FHLB dividends....................................... (5,244) (4,608)
Accelerated depreciation for tax purposes............ 3,632 (565)
Loan costs........................................... (2,227) (1,638)
SFAS 115 deferred taxes.............................. (2,710) (4,404)
Asset securitization income recognized for book
purposes.......................................... (28,940) (28,662)
Capitalized mortgage service rights.................. (1,115) (7,941)
Other, net........................................... (3,893) (3,414)
-------- --------
(42,531) (55,567)
======== ========
$(19,701) $(36,076)
======== ========
F-26
97
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
NOTE 22 -- BUSINESS SEGMENT DATA
In addition to its principal operations in banking, the Company conducts a
significant amount of automobile lending as presented below:
1998 1997 1996
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Revenues:
Automobile lending
Net interest income............................... $ 64,978 $ 52,657 $ 53,533
Total other income................................ 101,548 177,152 153,487
---------- ---------- ----------
Total automobile lending..................... $ 166,526 $ 229,809 $ 207,020
========== ========== ==========
Banking operations
Net interest income............................... $ 49,435 $ 58,701 $ 52,084
Total other income................................ 24,037 36,760 16,552
---------- ---------- ----------
Total banking operations..................... $ 73,472 $ 95,461 $ 68,636
========== ========== ==========
Other operations
Net interest income............................... $ (3,602) $ (1,896) $ (2,423)
Total other income................................ 7,853 8,941 17,925
---------- ---------- ----------
Total other operations....................... 4,251 7,045 15,502
---------- ---------- ----------
Consolidated total revenues.......................... $ 244,249 $ 332,315 $ 291,158
========== ========== ==========
Depreciation
Automobile lending................................... $ 8,066 $ 9,730 $ 740
Banking operations................................... 381 348 335
Other operations..................................... 4,053 4,040 8,984
---------- ---------- ----------
Total Depreciation................................... $ 12,500 $ 14,118 $ 10,059
========== ========== ==========
Segment profit or loss
Automobile lending................................... $ (28,662) $ 54,143 $ 66,420
Banking operations................................... 3,345 22,325 102
Other operations..................................... (2,926) (3,273) 719
---------- ---------- ----------
Consolidated operating income (loss)................. $ (28,243) $ 73,195 $ 67,241
========== ========== ==========
Segment assets
Automobile lending................................... $1,444,340 $ 878,160 $ 675,572
Banking operations................................... 2,219,870 2,558,630 2,436,822
Other operations..................................... 139,304 292,075 222,651
---------- ---------- ----------
Consolidated total assets............................ $3,803,514 $3,728,865 $3,335,045
========== ========== ==========
The Company has two reportable segments: automobile lending and banking
operations. The automobile lending segment involves the purchase, origination,
sale and servicing of automobile contracts. The banking operations segment
includes activities associated with commercial banking, mortgage banking, retail
banking and other ancillary services. Segments below the quantitative thresholds
are attributable to two operating segments of the Company. Those segments
include a life insurance business and a broker-dealer of securities business.
The revenues for each segment are generated through lending and related
activities from unaffiliated customers. The Company derives a majority of its
revenues from interest. In addition, management primarily relies on net interest
revenue, not gross revenue and expense amounts, in managing the segments.
Therefore,
F-27
98
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
as permitted by SFAS 131 "Disclosure About Segments of an Enterprise and Related
Information", the accounting policies of the segments are the same as those
described in the summary of significant accounting policies. The Company
evaluates performance based on profit or loss from operations before income
taxes.
The Company's reportable segments are strategic business units that offer
different products and services. They are managed separately because each
business requires specific industry expertise in management and each business
requires different marketing strategies.
NOTE 23 -- FINANCIAL INSTRUMENT AGREEMENTS
The Company uses interest rate swaps, purchased options, forward
agreements, floors and caps to minimize its exposure to interest rate risk. The
fair value of these agreements may vary substantially with changes in interest
rates. At December 31, the Company's portfolio of such agreements consisted of
the following:
1998
----------------------
NOTIONAL CREDIT
AMOUNT EXPOSURE
---------- --------
(DOLLARS IN THOUSANDS)
Interest rate swaps................................... $ 50,000 $ 354
Interest rate caps.................................... 540,000 5,154
Forward agreements.................................... 775,000
---------- ------
$1,365,000 $5,508
========== ======
1997
----------------------
NOTIONAL CREDIT
AMOUNT EXPOSURE
---------- --------
(DOLLARS IN THOUSANDS)
Interest rate swaps................................... $ 50,000 $ 802
Interest rate caps.................................... 365,000 6,087
Forward agreements.................................... 607,621
---------- ------
$1,022,621 $6,889
========== ======
Notional amounts do not represent amounts exchanged by parties and, thus,
are not a measure of the Company's exposure to loss through its use of these
agreements. The amounts exchanged are determined by reference to the notional
amounts and the other terms of the agreements.
The Company's interest rate swaps consist of agreements with other parties
to exchange, at specified intervals, the difference between fixed rate and
floating rate interest amounts calculated by reference to an agreed notional
amount and a specified index. The Company pays a fixed interest rate and
receives a floating interest rate on all of its interest rate swaps. At December
31, 1998 and 1997, the terms of the Company's interest rate swaps were to pay a
weighted average fixed rate of 5.9% in each year, and to receive a weighted
average variable rate of 5.2% and 5.9%, respectively, maturing in 2002 with
collateral requirement of 0.7% to 1.6%. Variable interest rates may change in
the future.
The Company purchases interest rate caps to effectively remove lifetime
interest rate caps on mortgage-backed securities, to hedge interest rate
fluctuations on assets available for sale and to limit the erosion of net
interest income resulting from increases in interest rates. The interest rate
cap agreements have strike rates from 6.0% to 8.0% with expiration dates ranging
from 1999 to 2004 as of December 31, 1998 and 6.0% to 7.5% with expiration dates
ranging from 2001 to 2004 as of December 31, 1997.
F-28
99
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The Company's hedging strategy for its loan production includes the use of
forward agreements. The Company enters into these agreements in numbers and
amounts which generally correspond to the principal amount of the sale and/or
securitization transactions. The market value of these forward agreements
responds inversely to the market value changes of the underlying loans. Because
of this inverse relationship, the Company can effectively lock in its gross
interest rate spread at the time of the hedge transaction. Gains and losses
relative to these agreements are deferred and recognized in full at the time of
loan sale and/or securitization as an adjustment to the gain or loss on the sale
of loans. The Company uses only highly rated counterparties and further reduces
its risk by avoiding any material concentration with a single counterparty.
Credit exposure is limited to those agreements with a positive fair value and
only to the extent of fair value that has been recognized in the Consolidated
Statement of Condition. At December 31, 1998, the Company held forward
agreements with a notional amount outstanding of $775 million.
The current credit exposure under these agreements is limited to the fair
value of the agreements with a positive fair value at the reporting date. Master
netting agreements are arranged or collateral is obtained through physical
delivery of, or rights to, securities to minimize the Company's exposure to
credit losses in the event of nonperformance by counterparties to financial
instruments. The Company also minimizes its counterparty risk by entering into
agreements only with highly rated counterparties.
NOTE 24 -- FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair Values of Financial Instruments: Fair value information about
financial instruments, whether or not recognized in the balance sheet, for which
it is practicable to estimate that value, are reported using quoted market
prices. In cases where quoted market prices are not available, fair values are
based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and in many cases, could not be realized in immediate settlement of the
instrument. Fair values for certain financial instruments and all non-financial
instruments are not required to be disclosed. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents and other short-term investments: The carrying
amounts reported in the balance sheet for cash and short-term instruments
approximate those assets' fair values.
Investment securities and mortgage-backed securities: Fair values for
investment securities are based on quoted market prices, where available. If
quoted market prices are not available, fair values are based on quoted market
prices of comparable instruments.
Loans receivable (including held for sale): The fair values for loans are
estimated using discounted cash flow analyses, using interest rates currently
being offered for loans with similar terms to borrowers of similar credit
quality.
Retained interest in securitized assets: The fair value of retained
interest in securitized assets is based on discounted cash flow calculations.
Capitalized servicing rights: The fair values are estimated using
discounted cash flows based on a current market interest rate. These cash flows
generally include servicing fees, float income from payments and escrow
accounts, servicing costs, foreclosure costs and interest expense for funds
advanced.
Interest rate swaps: Interest rate swaps are carried at fair value as
hedges of available for sale securities. The fair value is determined by
obtaining market quotes from brokers.
F-29
100
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
Interest rate options, floors and caps: The carrying amount comprises the
unamortized premiums paid for the contracts. The fair value is estimated by
obtaining market quotes from brokers.
Forward agreements: The carrying amount comprises the amount of the gain or
loss deferred on expired agreements. The fair value is estimated by obtaining
market quotes from brokers.
Loan Commitments (including fixed and variable): The fair values of the
loan commitments are based on quoted market prices of similar loans sold in the
secondary market.
Deposits: The fair values disclosed for demand deposit accounts, passbook
accounts, certificate accounts, brokered certificate accounts and certain types
of money market accounts are, by definition, equal to the amount payable on
demand at the reporting date (i.e., their carrying amounts). Fair values for
fixed-rate certificates of deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on certificates
of deposit to a schedule of aggregated expected monthly maturities on time
deposits.
Securities sold under agreements to repurchase: The fair value is estimated
by using discounted cash flow analyses, based on the Company's current
incremental borrowing rates for similar types of borrowing arrangements.
Short-term borrowings: The carrying amounts of the commercial paper and the
lines of credit with a bank approximate their fair values.
Federal Home Loan Bank advances: The fair value is estimated by using
discounted cash flow analyses, based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
Amounts held on behalf of trustee: The carrying amounts reported in the
balance sheet approximate fair value.
Subordinated debentures: The fair values of the subordinated debentures are
estimated using discounted cash flow analyses, based on the current incremental
borrowing rates for similar types of borrowing arrangements.
F-30
101
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The estimated fair values of the Company's financial instruments are as
follows:
DECEMBER 31,
-------------------------------------------------
1998 1997
----------------------- -----------------------
CARRYING FAIR CARRYING FAIR
AMOUNTS VALUE AMOUNTS VALUE
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Financial assets:
Cash and cash equivalents.................. $ 114,890 $ 114,890 $ 86,994 $ 86,994
Other short-term investments............... 22,864 22,864 84,136 84,136
Investment securities and mortgage-backed
securities.............................. 1,052,332 1,052,332 1,057,968 1,057,968
Loans receivable (including held for
sale)................................... 1,992,833 2,106,759 1,872,710 1,920,419
Retained interests in securitized assets... 171,230 171,230 181,177 181,177
Capitalized servicing rights............... 8,773 8,773 37,417 42,768
Financial instrument agreements held for
purposes other than trading:
Interest rate swaps........................ 354 354 802 802
Interest rate options, floors and caps..... 5,154 5,154 6,087 6,087
Forward agreements......................... 4,389 (55)
Fixed rate loan commitments................ 25,930 1,190
Variable rate loan commitments............. 5 113
Financial liabilities:
Deposits................................... $2,178,735 $2,177,251 $2,000,896 $1,986,353
Securities sold under agreements to
repurchase.............................. 265,644 247,846 287,071 293,323
Short-term borrowings...................... 14,427 14,427 191,880 196,121
Federal Home Loan Bank advances............ 160,853 150,076 84,971 86,849
Amounts held on behalf of trustee.......... 528,092 528,092 488,653 488,653
Subordinated debentures.................... 239,856 223,786 239,195 244,481
NOTE 25 -- WESTCORP (PARENT COMPANY ONLY) FINANCIAL INFORMATION
STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS)
Assets
Cash...................................................... $ 842 $ 3,433
Investment in subsidiaries................................ 333,364 347,834
Other..................................................... 4,704 17,334
-------- --------
$338,910 $368,601
======== ========
Liabilities and shareholders' equity
Other liabilities......................................... $ 9,865 $ 19,850
-------- --------
9,865 19,850
Shareholders' equity........................................ 329,045 348,751
-------- --------
$338,910 $368,601
======== ========
F-31
102
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- -------- --------
(DOLLARS IN THOUSANDS)
Income
Interest income (expense)................................. $ (70) $(1,473) $ 20
Dividends from subsidiaries............................... 14,000 46,366 5,000
Other..................................................... 9 (1)
-------- ------- -------
13,930 44,902 5,019
Noninterest expenses........................................ 1,337 1,156 1,816
-------- ------- -------
Income before income taxes and equity in net income of
subsidiaries.............................................. 12,593 43,746 3,203
Income tax expense (benefit)................................ (541) (1,099) (669)
-------- ------- -------
Income before equity in net income of subsidiaries.......... 13,134 44,845 3,872
Equity in undistributed net income (loss) of subsidiaries... (27,831) (8,057) 27,925
-------- ------- -------
NET INCOME (LOSS)........................................... $(14,697) $36,788 $31,797
======== ======= =======
STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
(DOLLARS IN THOUSANDS)
OPERATING ACTIVITIES
Net income (loss).......................................... $(14,697) $ 36,788 $ 31,797
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................ 12 343 6,262
Contribution to employee stock option plan............... 1,181
Equity in undistributed net income of subsidiaries....... 29,897 8,057 (27,925)
Other, net............................................... (3,261) (2,415) 10,106
-------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES.................. 11,951 42,773 21,421
INVESTMENT ACTIVITIES
Infusion of capital to subsidiary.......................... (15,120) (15,000) (60,400)
Net increase investment in subsidiaries.................... 7,522
Sales (purchases) of investment securities available for
sale..................................................... 12,434 (12,434)
Addition to premises and equipment......................... 698 (9,021)
-------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES...................... (2,686) (19,214) (69,421)
FINANCING ACTIVITIES
(Decrease) increase in short-term borrowings............... (7,800) (15,382) 25,000
Purchase of subsidiary stock............................... 1,526 (4,487)
Dividends paid............................................. (6,592) (10,469) (10,121)
Proceeds from issuance of common stock..................... 1,010 1,057 1,057
-------- -------- --------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES........ (11,856) (29,281) 15,936
-------- -------- --------
DECREASE IN CASH........................................... (2,591) (5,722) (32,064)
Cash and cash equivalents at beginning of year............. 3,433 9,155 41,219
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR................... $ 842 $ 3,433 $ 9,155
======== ======== ========
F-32
103
WESTCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
NOTE 26 -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations for
the years ended December 31, 1998 and 1997. Certain quarterly amounts have been
adjusted to conform with the year-end presentation.
FOR THE THREE MONTHS ENDED
------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- -------- ------------ -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1998
Interest income................................ $ 65,046 $ 64,501 $ 69,515 $ 73,080
Interest expense............................... 40,155 39,015 40,592 41,569
-------- -------- -------- --------
Net interest income.......................... 24,891 25,486 28,923 31,511
Provision for loan losses...................... (6,388) (2,402) (2,347) (7,823)
Noninterest expense.......................... (43,260) (21,855) (33,595) (21,384)
-------- -------- -------- --------
Income (loss) before income taxes............ (24,757) 1,229 (7,019) 2,304
Income taxes (benefit)......................... (10,392) 550 (2,816) 1,328
-------- -------- -------- --------
Income (loss) before minority interest......... (14,365) 679 (4,203) 976
Minority interest in earnings of
subsidiaries................................. (2,162) 61 (329) 214
======== ======== ======== ========
Net income................................... $(12,203) $ 618 $ (3,874) $ 762
======== ======== ======== ========
Net income (loss) per common share -- basic.... $ (0.46) $ 0.02 $ (0.15) $ 0.03
======== ======== ======== ========
Net income (loss) per common share --diluted... $ (0.46) $ 0.02 $ (0.15) $ 0.03
======== ======== ======== ========
1997
Interest income................................ $ 62,530 $ 68,558 $ 71,300 $ 68,144
Interest expense............................... 36,481 40,033 42,176 42,380
-------- -------- -------- --------
Net interest income.......................... 26,049 28,525 29,124 25,764
Provision for loan losses...................... (4,371) (2,602) (2,223) (3,655)
Noninterest expense............................ (5,457) (5,718) (9,584) (2,657)
-------- -------- -------- --------
Income (loss) before income taxes............ 16,221 20,205 17,317 19,452
Income taxes................................... 6,814 8,573 7,268 8,632
-------- -------- -------- --------
Income before minority interest................ 9,407 11,632 10,049 10,820
Minority interest in earnings of
subsidiaries................................. 1,511 1,747 1,121 741
======== ======== ======== ========
Net income (loss)............................ $ 7,896 $ 9,885 $ 8,928 $ 10,079
======== ======== ======== ========
Net income per common share -- diluted......... $ 0.30 $ 0.38 $ 0.34 $ 0.38
======== ======== ======== ========
F-33
104
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 Certificate of Incorporation(a)
3.2 Bylaws(a)
4.1 Indenture dated as of June 17, 1993 issued by Western
Financial Bank, formerly Western Financial Savings Bank,
F.S.B., with respect to $125,000,000 in aggregate principal
amount of 8.50% Subordinated Capital Debentures due 2003(b)
4.2 Indenture dated as of June 25, 1997 issued by Western
Financial Bank, formerly Western Financial Savings Bank,
F.S.B., with respect to $150,000,000 is aggregate principal
amount of 8.875% Subordinated Capital Debentures due 2007(c)
10.1 Westcorp Incentive Stock Option Plan(d)
10.2 Westcorp Employee Stock Ownership and Salary Savings Plan(a)
10.3 Westcorp 1991 Incentive Stock Option Plan(e)
10.4 WFS Financial Inc ("WFS") 1996 Incentive Stock Option
Plan(f)
10.5 Westcorp Employee Stock Ownership and Salary Savings Plan(g)
10.6 Employment Agreement(h)(i)(j)(k)
21.1 Subsidiaries of Westcorp
23.1 Consent of Independent Auditors
27 Financial Data Schedule
- ---------------
(a) Exhibits previously filed with Westcorp Registration Statement on Form S-4
(File No. 33-34286), filed April 11, 1990, incorporated herein by reference
under Exhibit Numbers indicated.
(b) Exhibit previously filed with, Western Financial Bank, formerly Western
Financial Savings Bank, F.S.B., Offering Circular with the OTS, dated June
17, 1993 (will be provided to the SEC upon request).
(c) Exhibit previously filed with Western Financial Bank, formerly Western
Financial Bank, F.S.B., Offering Circular with the OTS, dated July 25, 1997
(will be provided to the SEC upon request).
(d) Exhibit previously filed with Westcorp Registration Statement on Form S-1
(File No. 33-04295), filed May 2, 1986, incorporated herein by reference
under Exhibit Number indicated.
(e) Exhibit previously filed with Westcorp Registration Statement on Form S-8
(File No. 33-43898), filed December 11, 1991, incorporated herein by
reference under the Exhibit Number indicated.
(f) Exhibit previously filed with WFS Registration Statement on Form S-8 (File
No. 33-07485), filed July 3, 1996, incorporated herein by reference under
the Exhibit Number indicated. Amendment No. 1 dated as of November 13, 1997
filed with the WFS Registration Statement on Form S-8 (File No. 333-040121,
incorporated herein by reference under Exhibit Number indicated.
(g) Exhibit previously filed with Westcorp Registration Statement on Form S-8
(File No. 333-11039) and the related Form 11K (File No. 001-09910), filed
August 29, 1996 and June 28, 1996, respectively, incorporated herein by
reference under the Exhibit Number indicated.
(h) Employment Agreement, in letter form, dated January 11, 1996 between the
registrant and Donald H. Kasle (will be provided to the SEC upon request).
(i) Employment Agreement, in letter form, dated March 11, 1997 between the
registrant and Andrey R. Kosovych (will be provided to the SEC upon
request).
(j) Employment Agreement, in letter form, dated February 28, 1998 between WFS
and Joy Schaefer (will be provided to the SEC and/or the OTS upon request).
(k) Employment Agreement, in letter form, dated February 28, 1998 between WFS
and Lee A. Whatcott (will be provided to the SEC and /or the OTS upon
request).