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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1993
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _________to __________
COMMISSION FILE NUMBER 1-8625
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CITADEL HOLDING CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-3885184
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
600 NORTH BRAND BOULEVARD 91203
GLENDALE, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 956-7100
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------ ---------------
COMMON STOCK, $.01 PAR VALUE PER SHARE AMERICAN 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. [X]
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant, as of March 15, 1994 was $20,034,000.
The number of shares of common stock, par value $.01 per share, of Registrant
outstanding as of March 15, 1994 was 6,595,624 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's 1994 Proxy Statement, which will be filed with the
Securities and Exchange Commission in connection with the Company's 1994 Annual
Meeting of Stockholders, are incorporated by reference in Part III hereof.
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CITADEL HOLDING CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1993
PAGE
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PART I
Item 1. Business........................................................ 1
General....................................................... 1
Recent Developments........................................... 3
Retail Financial Services Group............................... 7
Mortgage Banking Group Operations............................. 8
Credit Administration......................................... 17
Credit Loss Experience........................................ 24
Foreclosure Policies.......................................... 27
Real Estate Acquired in Settlement of Loans................... 27
Investment Activities......................................... 30
Sources of Funds.............................................. 32
Interest Rate Risk Management................................. 36
Competition................................................... 39
Employees..................................................... 40
Taxation...................................................... 40
Regulation and Supervision.................................... 41
Item 2. Properties...................................................... 55
Item 3. Legal Proceedings............................................... 55
Item 4. Submission of Matters to a Vote of Security Holders............. 55
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters........................................................ 56
Item 6. Selected Financial Data......................................... 57
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A").................................. 58
Net Earnings.................................................... 58
Net Interest Income............................................. 59
Noninterest Income.............................................. 62
Operating Expense............................................... 64
Efficiency Ratio................................................ 65
Capital Resources and Liquidity................................. 66
Asset Quality................................................... 73
Impact of Inflation............................................. 83
Interest Rate Risk Management................................... 84
Other Factors Affecting Earnings ............................... 87
Item 8. Financial Statements and Supplementary Data..................... F-1
Item 9. Change in and Disagreements with Accountants on Accounting and
Financial Disclosure........................................... II-1
i
PART III
Item 10. Directors and Executive Officers of the Registrant.............. II-1
Item 11. Executive Compensation.......................................... II-1
Item 12. Security Ownership of Certain Beneficial Owners and Management.. II-1
Item 13. Certain Relationships and Related Transactions.................. II-1
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K...................................................... II-1
Signatures..................................................... II-4
ii
PART I
ITEM 1. BUSINESS
CITADEL HOLDING CORPORATION
GENERAL
Citadel Holding Corporation ("Citadel"), incorporated in Delaware in 1983,
is a financial services holding company engaged primarily in the savings bank
business through its wholly owned subsidiary, Fidelity Federal Bank, a Federal
Savings Bank ("Fidelity" or the "Bank"). Citadel is also engaged in the
securities brokerage business through its wholly owned subsidiary, Gateway
Investment Services, Inc. ("Gateway"). Citadel currently has no significant
business or operations other than serving as the holding company for Fidelity
and Gateway. Citadel is actively pursuing a significant internal restructuring
plan described below in "Recent Developments." Unless otherwise indicated,
references to the "Company" include Citadel, Fidelity, and all subsidiaries of
Fidelity and Citadel. The principal executive offices of Citadel and Fidelity
are located at 600 North Brand Boulevard, Glendale, California 91203,
telephone number (818) 956-7100.
Fidelity operates through 42 branches, all of which are located in Southern
California, principally in Los Angeles and Orange counties. At December 31,
1993, Fidelity's mortgage loan portfolio (including loans held for sale)
aggregated approximately $3.8 billion, of which approximately 71% was secured
by residential properties containing 2 or more apartment units, 21% was
secured by single family residences and 8% was secured by commercial property.
At that same date, 96% of Fidelity's loans consisted of adjustable rate
mortgages.
Fidelity funds its portfolio lending operations principally with deposits.
At December 31, 1993, Fidelity had deposits of approximately $2.8 billion,
exclusive of $593 million in certificates of deposit of $100,000 or more.
Other borrowings on that date included $326.4 million in Federal Home Loan
Bank ("FHLB") Advances, $100.0 million in mortgage-backed borrowings, $304.0
million in commercial paper backed by a letter of credit issued by the FHLB of
San Francisco and $60.0 million in subordinated debt that qualifies as
supplementary Tier 2 regulatory capital.
Fidelity's deposit accounts are insured by the Federal Deposit Insurance
Corporation (the "FDIC") through the Savings Association Insurance Fund (the
"SAIF"). Citadel and Fidelity are subject to the examination, supervision and
reporting requirements of the Office of Thrift Supervision (the "OTS"), their
primary federal banking regulator. Fidelity is also subject to examination and
supervision by the FDIC. See "Regulation and Supervision."
Gateway became a National Association of Securities Dealers, Inc. ("NASD")
registered broker/dealer in October 1993. Through Gateway, the Company
currently provides customers of the Bank with investment products including a
number of mutual funds, annuities and unit investment trusts. Fidelity is
implementing a new business strategy that integrates traditional banking
functions (mortgage originations and deposit services) with the sale of
investment services and products by Gateway. See "Retail Financial Services
Group."
The Southern California economy and real estate markets further declined
during 1993, adversely affecting the Bank's loan and real estate portfolios.
The Company reported a net loss of $67.2 million for the year ended
December 31, 1993, as compared to net earnings of $2.0 million and $2.7
million for the years ended December 31, 1992 and 1991, respectively. Pre-tax
loss for the Company increased by $99.8 million from a loss of $3.8 million in
1992 to a loss of $103.6 million in 1993. Operating expenses increased $27.4
million in 1993 to $105.3 million from $77.9 million in 1992. The increase in
1993 expenses was attributable in part to increased staffing levels required
to manage rising problem assets, strengthen internal asset review, handle
increased financial services offered at the retail branch network and expand
originations and sales of residential mortgages in the mortgage banking
network. The increase in expenses is also attributable to certain nonrecurring
charges incurred in connection with the Company's valuation of its intangible
assets and further development of the internal reorganization and
restructuring plan discussed below, including the write-off of $8.8 million of
goodwill and $5.2 million in core deposit intangibles, and an increase of $5.9
million in professional fees, of which approximately $3.3 million was
attributable to analysis and development of the Company's restructuring plan
and to the related asset valuation process.
At December 31, 1993, the Bank had nonperforming assets ("NPAs") totaling
$235.6 million and a general valuation allowance ("GVA") totaling $80.0
million. NPAs include nonaccruing loans, in-substance foreclosed real estate
("ISF") and real estate acquired in settlement of loans by foreclosure or
otherwise, but do not include troubled debt restructurings ("TDRs") unless the
TDRs would otherwise fall into nonaccruing loans or ISF. At year-end 1993, the
Bank's GVA equaled 2.03% of total loans and real estate owned (including ISF,
"REO") and 32.8% of NPAs.
1
The following table sets forth selected financial and other data for the
Company at or for the periods indicated:
AT OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------
1993 1992 1991 1990 1989
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(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
BALANCE SHEET DATA:
Total assets........... $4,390 $4,698 $5,127 $5,698 $4,981
Total loans, net....... 3,713 3,992 4,551 5,085 4,437
Deposits............... 3,369 3,458 3,885 3,967 3,317
FHLB Advances.......... 326 581 325 755 725
Other borrowings....... 408 327 546 594 622
Subordinated notes..... 60 60 60 60 --
Stockholders'
equity(2)............. 187 223 221 218 195
Stockholders' equity
per share(2).......... 28.41 67.68 67.06 66.25 59.20
Common shares
outstanding(1)(2)...... 6,595,624 3,297,812 3,297,812 3,297,812 3,295,562
OPERATING DATA:
Net interest income.... $ 101 $ 131 $ 142 $ 115 $ 76
Net earnings (loss).... (67) 2 3 23 8
Net earnings (loss) per
share................. (11.56) .62 .81 7.07 2.47
Average common and
common equivalent
shares outstand-
ing(1)(2)............. 5,809,570 3,297,812 3,297,812 3,298,140 3,296,919
SELECTED OPERATING
RATIOS:
Return on average
assets................ (1.47)% 0.04% 0.05% 0.44% 0.17%
Return on average
equity................ (28.92)% 0.91% 1.20% 11.21% 4.24%
Average equity divided
by average assets..... 5.07% 4.66% 4.01% 3.94% 3.97%
Ending equity divided
by ending assets...... 4.27% 4.75% 4.31% 3.84% 3.92%
Operating expenses to
average assets........ 2.30% 1.61% 1.43% 1.26% 1.33%
Efficiency ratio(3).... 77.55% 53.16% 51.18% 55.35% 74.31%
ASSET QUALITY DATA--
FIDELITY:
NPAs(4)................ $ 236 $ 234 $ 125 $ 48 $ 21
NPAs to total assets... 5.37% 4.99% 2.43% 0.85% 0.42%
Nonaccruing loans...... $ 93 $ 112 $ 69 $ 30 $ 12
Nonaccruing loans to
total loans........... 2.52% 2.83% 1.53% 0.61% 0.27%
GVA.................... $ 80 $ 76 $ 52 $ 17 $ 8
GVA to NPAs(5)......... 32.79% 30.49% 41.99% 34.14% 38.38%
GVA to loans and REO
(including ISF)(6).... 2.03% 1.82% 1.13% 0.32% 0.18%
Loan GVA to nonaccruing
loans and ISF......... 58.75% 38.15% 55.44% 56.67% 66.67%
OTHER DATA:
Number of:
Real estate loan
accounts (in
thousands)........... 16 18 21 28 27
Deposit accounts (in
thousands)........... 241 233 238 234 203
Retail branch
offices(7)........... 42 43 43 44 34
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(1) Net of treasury shares, where applicable.
(2) 1993 data includes 3,297,812 shares issued in March 1993 in connection with
a stock rights offering which produced net proceeds to the Company of $31.4
million.
(3) The efficiency ratio is computed by dividing total operating expense by net
interest income and noninterest income, excluding nonrecurring items,
provisions for estimated loan and real estate losses, direct costs of real
estate operations and gains/losses on the sale of securities.
2
(4) NPAs include nonaccruing loans, foreclosed real estate and ISF (net of REO
GVA), but do not include TDRs, unless they fall into one of the foregoing
categories.
(5) NPAs in this ratio are calculated prior to the reduction for REO GVA.
(6) Loans and REO in the ratio are calculated prior to the reduction for loan
and REO GVA, but are net of specific reserves.
(7) All retail branch offices are located in Southern California.
For additional information, see Item 6. "Selected Financial Data," Item 7.
"MD&A" and Item 8. "Financial Statements and Supplementary Data."
RECENT DEVELOPMENTS
Internal Reorganization and Restructuring
In mid-1992, the Company commenced a series of steps to internally reorganize
in order to strengthen the Bank's internal operations and meet the needs of its
customer base. First, a new Chief Executive Officer and certain additional
senior management personnel were hired to strengthen key areas of future
potential growth, such as mortgage banking, residential loan originations,
credit administration and retail financial services. The Company broadened the
product line of loans originated by the Bank and increased its emphasis on
mortgage banking, in particular developing its loan pipeline hedging
capability. It also reorganized the retail branch system to integrate the
provision of traditional banking services with the provision through Gateway of
a broader range of nontraditional financial services and uninsured investment
products. Additionally, Fidelity upgraded its systems management capabilities
by converting to new computer systems in its retail banking and loan
administration operations and by adding state-of-the-art software capability to
the asset/liability management function. Fidelity also enhanced its real estate
management operations by adding experienced real estate professionals to that
department.
In October 1992, the Company hired outside financial advisors to identify and
assess strategic alternatives for the Company to pursue with a view to
maximizing value for stockholders. In mid-1993, as an outgrowth of the
reorganization effort, management evaluated the strategic alternatives
available to it and subsequently determined that the proposed restructuring
plan described below had the greatest potential to maximize stockholder value
in the foreseeable future.
The Company is actively pursuing a restructuring plan that would include both
the transfer to a newly-formed Citadel subsidiary or division of certain
problem assets of the Bank and a sale of the Bank and Gateway (the
"Restructuring"; discussions of the sale of the Bank in the context of the
Restructuring include the sale of Gateway). The Company is currently seeking
another financial institution (a "strategic buyer") or a new core set of equity
investors for the Bank. Any such sale of the Bank will be subject to the
approval of Citadel's Board of Directors (the "Board") and stockholders as well
as the OTS. Following the proposed sale of the Bank, Citadel would become a
real estate company and focus on the servicing and enhancement of its loan and
real estate portfolio.
The Restructuring calls for the Bank's disposition of substantially all of
its problem assets, together with a small amount of its performing assets, so
as to improve the attractiveness of the Bank to potential acquisition or
investment candidates. Most of the Bank's problem assets would be transferred
to the new Citadel real estate subsidiary or division using securitized debt
financing. These assets would consist of commercial and large multifamily loans
and real estate owned properties with a current net book value of approximately
$401 million. The impact of the January 1994 Northridge Earthquake on the
assets to be transferred is not expected to alter significantly the value of
such assets. The Restructuring also calls for the Bank's disposition of a
smaller group of problem assets, consisting primarily of smaller multifamily
loans with a current net book value of approximately $81 million, in a bulk
sale to a third-party purchaser or Citadel.
While the Board will fully explore the market values of this Restructuring
before making any final decisions, the Board views this approach as having the
greatest potential to maximize stockholder value in the foreseeable future. In
formulating the proposed Restructuring, the Company believes that the value of
3
Fidelity to a purchaser or investor would be heavily, and perhaps excessively,
discounted due to its problem assets. Thus, it was determined that the Bank's
attractiveness to an acquisition or investment candidate would be enhanced if
the Bank disposed of these problem assets. However, management also believes
that these assets, if managed outside the environment of a federally regulated
institution, may present the potential for Citadel stockholders to realize
future values that would not be reflected in the bulk sale price of those
assets to a third party today. Accordingly, the Restructuring was designed to
retain in a Citadel subsidiary or division approximately $401 million of
primarily problem assets after a sale of the Bank. Management believes that an
asset disposition is critical to a successful major recapitalization program
for Fidelity. Citadel has commenced efforts to raise the financing necessary
to consummate its problem asset purchase from Fidelity.
Because of the significant conditions to and uncertainty in accomplishing a
successful Restructuring, the Company expects that the losses associated with
the Restructuring would only be incurred upon the sale of the Bank, at which
time the effects of the losses on capital should be offset by either a new
infusion of capital from investors, who would purchase ownership of the Bank,
or a merger with another financial institution.
The following discussion focuses on certain financial consequences of the
Restructuring and is not indicative of the loss content of the Bank's assets
in the absence of the Restructuring or other bulk asset dispositions.
To consummate the bulk transfers of assets to a Citadel subsidiary or
division and obtain debt financing in the capital markets for the larger
transfer, Fidelity would be required to write down these assets to their bulk
sale values. These losses would be offset in part by the reduction in the
Bank's GVA (reflecting the healthier remaining asset pool) and possible tax
benefits. If the restructuring were to be consummated in mid-1994,
management's latest estimate is that the Bank's core capital, after giving
effect to the writedowns on the asset transfers, tax benefits associated
therewith, use of relevant reserves and extraordinary charges relating to the
Restructuring, but before giving effect to any new capital infusion into the
Bank by the acquiror or new investors, would be approximately $102 million.
This estimate will be subject to ongoing adjustment in view of changing
variables such as future earnings or losses, changes in the composition and
size of the problem assets and other factors.
The Bank does not intend to implement the above-described bulk problem asset
dispositions, or to incur the consequent losses, in the absence of an
acquisition of the Bank by another financial institution or financial
investors who are able to infuse additional core capital into the Bank. Any
such acquisition will also require the approval of Citadel's Board and
stockholders, as well as the OTS, which will condition its approval in part on
the adequacy of the capital of the Bank after the Restructuring.
No assurances can be given that the proposed Restructuring can be
successfully implemented.
On March 4, 1994, The Chase Manhattan Bank, N.A. ("Chase"), one of four
lenders under Fidelity's $60 million subordinated loan agreement of 1990 (the
"Subordinated Loan Agreement"), sued Fidelity, Citadel and Citadel's Chairman
of the Board, alleging, among other things, that the transfer of assets
pursuant to the Restructuring would constitute a breach of the Subordinated
Loan Agreement, and seeking to enjoin the Restructuring and to recover damages
in unspecified amounts. In addition, the lawsuit alleges that past responses
of Citadel and Fidelity to requests by Chase for information regarding the
Restructuring violate certain provisions of the Subordinated Loan Agreement
and that such alleged violations, with the passage of time, have become
current defaults under the Subordinated Loan Agreement. While the other three
lenders under the Subordinated Loan Agreement hold $25 million of the
subordinated notes (the "Notes"), none of them has joined Chase in this
lawsuit. The Company is evaluating the lawsuit and, based on its current
assessment, the Company does not believe that the allegations have merit. See
Item 7. "MD&A--Capital Resources and Liquidity" for additional considerations
relating to the Subordinated Loan Agreement.
OTS Examinations
In January 1994, Citadel and the Bank received reports of the various
regular examinations conducted by the OTS in 1993. As a result of the findings
of the OTS in its safety and soundness examination of the Bank, Fidelity will
be subject to higher examination assessments and is subject to additional
regulatory restrictions
4
including, but not limited to, (a) a prohibition, absent prior OTS approval,
on increases in total assets during any quarter in excess of an amount equal
to net interest credited on deposit liabilities during the quarter; (b) a
requirement that the Bank submit to the OTS for prior review and approval the
names of proposed new directors and executive officers and proposed employment
contracts with any director or senior officer; (c) a requirement that the Bank
submit to the OTS for prior review and approval any third-party contract
outside the normal course of business; and (d) the OTS would have the ability,
in its discretion, to require 30 days' prior notice of all transactions
between Fidelity and its affiliates (including Citadel and Gateway).
The OTS also expressed concern in a number of specific areas principally
relating to asset quality, asset review administration and the resulting
negative impact on capital levels and earnings, as well as management
effectiveness in certain areas. Management believes that the proposed
Restructuring, if accomplished, would be responsive to most of the OTS'
concerns.
Capital and Liquidity
Despite the negative impact of losses and provisions to GVA on the Bank's
earnings and thus its capital, at December 31, 1993 and to date, the Bank was
and is classified as "adequately capitalized" for purposes of the prompt
corrective action regulations promulgated by the OTS. An institution is
"adequately capitalized" if its ratio of core capital to adjusted total assets
("core capital ratio") is at least 4.0%, its ratio of core capital to risk-
weighted assets is at least 4.0% and its ratio of total capital to risk-
weighted assets is at least 8.0%. At December 31, 1993, Fidelity's ratios were
4.15%, 6.27% and 9.32%, respectively. See "Regulation and Supervision--FDICIA
Prompt Corrective Action Requirements" and Item 7. "MD&A--Capital Resources
and Liquidity." However, Citadel supplemented the Bank's capital in 1993 with
two capital infusions totaling $28.0 million, without which the Bank would
have had to significantly reduce its assets or at December 31, 1993 the Bank
would not have met the 4% core capital requirement of the "adequately
capitalized" category, and thus the Bank would have been classified as
"undercapitalized" for purposes of the OTS' prompt corrective action
regulations. See "Regulation and Supervision--FDICIA Prompt Corrective Action
Requirements".
Citadel, with only $2.3 million in liquid assets at December 31, 1993, and
ongoing expenses in connection with the contemplated Restructuring, is not in
a position to make further capital contributions to the Bank, nor does Citadel
have ready access to additional funds under current circumstances. See Item 7.
"MD&A--Capital Resources and Liquidity." Management anticipates that the Bank
will incur losses in the first and second quarters of 1994. The losses will,
in the absence of a new capital infusion or a reduction in the Bank's total
assets, reduce the Bank's core capital ratio to less than 4%. In an effort to
maintain the Bank's core capital ratio above 4% at March 31, 1994 by
downsizing its balance sheet, the Bank has entered into an agreement to sell
approximately $160 million of single family and multifamily (2 to 4 units)
performing loans in the first quarter of 1994. Additionally, in order to
maintain the Bank's capital above the regulatory minimums necessary to
continue to be designated "adequately capitalized" while the Restructuring is
pursued, management continues to explore possibilities for increasing the
Bank's capital, either through the issuance of new equity or the sale of
assets. Management may also consider further downsizings in the Bank's balance
sheet through additional loan sales, although such dispositions of income-
producing assets would reduce the Bank's future income. Downsizing options
will be limited due to the relative illiquidity of the commercial and
multifamily loan portfolio.
Because of Fidelity's current capital levels, dividends and distributions
from Fidelity will not be available to Citadel for the foreseeable future.
Thus, Citadel's current cash balances, together with future dividends from
Gateway, are the only sources of cash to Citadel. Gateway's ability to pay
dividends to Citadel may be restricted by certain regulatory net capital
rules. See "Regulation and Supervision--Gateway." Management believes that
Citadel's cash resources will only be sufficient to meet Citadel expenditures
through mid-1994. If the Restructuring is not completed at such time, Citadel
will be required to raise additional cash to fund its expenditures, and no
assurances can be given that Citadel will be able to raise any such funds.
The defaults alleged by Chase under the Subordinated Loan Agreement and
possible resulting cross defaults under other debt instruments could also
adversely affect the liquidity of the Company. See Item 7. "MD&A--Capital
Resources and Liquidity."
5
Impact of Not Accomplishing the Restructuring
If the Restructuring is not accomplished, the Bank will be required to take
other actions to maintain its capital ratios, including the further downsizing
of the Bank and the raising of additional equity. If such actions are not
successful, the Bank would likely become "undercapitalized" for purposes of the
prompt corrective action regulations of the OTS. The consequences of becoming
undercapitalized would include, but would not be limited to, (a) the obligation
of Fidelity to file a capital restoration plan that is accompanied by an
acceptable Citadel guarantee; (b) restrictions on asset growth, branch
acquisitions and new activities; (c) a prohibition on dividends and capital
distributions by Fidelity (subject to certain limited exceptions); and (d)
increased monitoring by the OTS. An acceptable capital restoration plan
guarantee would require Citadel to demonstrate appropriate assurances of its
ability to perform on the guarantee. Given Citadel's current capital resources
and liquidity position, no assurance can be given that such a Citadel guarantee
would be found acceptable by the OTS. Failure to provide an acceptable capital
restoration plan could result in additional OTS sanctions typically reserved
for "significantly undercapitalized" institutions. These discretionary
sanctions include, but are not limited to, (a) OTS authority to require the
recapitalization, merger or sale of the Bank; (b) divestiture of subsidiaries
of the Bank or a holding company divestiture of the Bank; (c) more stringent
asset growth restrictions than applicable to "undercapitalized" institutions;
and(d) management changes, including election of new directors, and dismissal
of directors or senior officers who have held office for more than 180 days,
among other things.
If the Restructuring is not successful and if the Bank has no viable problem
asset disposition alternative, the Bank anticipates that it may be required to
increase its GVA to higher levels that cannot currently be determined. Further,
should the Restructuring not be accomplished and the Bank's financial condition
continue to deteriorate, the future viability of the Bank and Citadel may be
significantly threatened unless the Company is able to raise substantial
additional capital.
Northridge Earthquake
The Northridge Earthquake of January 17, 1994, and subsequent aftershocks
will adversely affect the Bank's loan and real estate portfolios. The Bank's
portfolio includes loans and REO with a net book value of approximately $937
million secured by or comprised of 1,414 multifamily (5 units or more), 15
commercial, and 2,313 single family and multifamily (2 to 4 units) collateral
properties in the primary earthquake areas. After the earthquake, the Bank's
appraisers surveyed all the multifamily (5 units or more) and commercial
properties located in these areas which secured the Bank's loans or constitute
REO of the Bank. The Bank also made selected inspections at more remote
locations where damage has been reported. In total, approximately 1,450
properties have been inspected. Of such inspected properties, 231 properties,
representing loans and REO with a net book value of $140 million, have been
identified as having sustained more than "cosmetic" damage. Of such 231
properties, 204 properties related to the Bank's loans and REO with a net book
value of $124 million were identified as having "possible serious damage" and
an additional 27 properties with a net book value of $16 million were
identified as "actually or potentially condemned". The Bank commissioned
structural and building engineers or building inspectors to estimate the cost
of repairs to properties in these two categories. The cost of repairs has been
preliminarily estimated to be $5.7 million and $11.1 million, respectively. Of
this total $16.8 million, approximately $6.0 million of seismic damage exceeds
the net book value of the related loans and REO. Accordingly, the Bank
currently would not expect its losses due to the earthquake to exceed $10.8
million with respect to its commercial and multifamily loans and REO. The Bank
expects the actual losses payable by the Bank to be lower because many repair
costs may be borne by the borrowers, who in addition to their own funds, may
have access to government assistance and/or earthquake insurance proceeds. As
part of its normal internal asset review process, the Bank will adjust its
reserves as its losses become quantifiable.
In addition to the multifamily and commercial assets referenced above, the
Bank has identified 2,313 single family and multifamily (2 to 4 units) assets
in the affected areas. 173 borrowers with unpaid principal balances totaling
$29.4 million called in to report damages through February 8, 1994. The Bank
has commenced inspection of these properties and continues to assess damages
and potential earnings and loss impact with respect to these properties.
6
The earthquake will also have some adverse affect on loan originations and
the sale of financial services in the retail branch network in the near term.
RETAIL FINANCIAL SERVICES GROUP
Fidelity operates 42 branches in Los Angeles, Orange, San Bernardino,
Riverside and Ventura counties. In 1993, Fidelity reorganized internally to
provide at each of its branch locations, either directly or through Gateway, a
broad array of mortgage products, financial services and investment products to
current and potential customers.
Fidelity's deposits are highly concentrated in Los Angeles and Orange
counties. Each of Fidelity's branches generally has between $40 million and
$100 million in deposits. Seventeen of the branches are in the $40 million to
$59 million range.
Total deposits at Fidelity have decreased since December 1991. Management
believes that depositors have reacted to current low interest rates by placing
short-term fixed income investments into mutual funds and other uninsured
product alternatives.
Management believes that, given the highly competitive nature of the Bank's
historical business and the regulatory constraints it faces in competing with
unregulated companies, the Bank must expand from its historical business focus
and adopt a broader product line business strategy. Specifically, management
believes that the Bank's existing customers provide a ready market for the sale
of nontraditional financial services and investment products. This belief
prompted the implementation of a new business strategy for the retail financial
services group that integrated its traditional functions (mortgage origination,
deposit services, checking, savings, etc.) with the sale of investment services
and products by Gateway. Management's objective is to build a "relationship
bank" that works with clients to determine their financial needs and offers a
broad array of more customized products and services.
Through this new strategy of targeting retail and mortgage customers and
offering a variety of new investment products and services, Fidelity and
Gateway hope to attract more of the Bank customers' deposits, investment
accounts and mortgage business. Management believes that this new strategy has
been successful, as evidenced by the increase of 22% in total checking accounts
at December 31, 1993 over the level a year earlier. As a result of this
strategy, fee income should become a growing portion, and net interest income a
declining portion, of the Company's total income.
Gateway currently sells a combination of investment products including mutual
funds, annuities and unit investment trusts. Gateway offers mutual funds of a
number of well-known sponsors. The fixed and variable annuities that are
offered are issued by insurance companies all of which maintain a rating of A+
or better by A.M. Best. These product offerings are continually under review
and change from time to time depending on market demand, management's judgment
and product availability.
During 1993, Fidelity reorganized the personnel structure of its branches to
further its strategy of integrating investment services with its traditional
deposit activities. Most branches are now individual profit centers reporting
to a branch business manager who has responsibility for determining the sales
focus and resource allocation within the branch area. On average, branch
staffing consists of eight individuals who are divided into administrative
personnel and sales personnel, with a branch operations manager and a financial
sales manager reporting to the business manager. The sales group merges the
responsibilities of the broker/dealer specialists and the traditional deposit
products personnel into the role of a "relationship banker", responsible for
selling all deposit and nondeposit product offerings. Relationship bankers will
eventually be located at each branch.
In connection with its strategy of integrating investment services with its
traditional deposit activities, Fidelity conducts its activities in compliance
with the February 1994 interagency guidance of the federal bank and thrift
regulators on retail sales of uninsured, nondeposit investment products by
federally insured financial institutions. In order to minimize customer
confusion, Fidelity endeavors to ensure that customers are fully informed that
such investment products are not insured, are not deposits of or guaranteed by
the Bank and involve investment risk, including the potential loss of
principal.
7
Also during 1993, Fidelity and Gateway retrained sales personnel as
"relationship bankers." The training program lasted four to eight weeks and
covered professional topics from accounting to sales management. The focus of
this program was to educate the managers about product offerings,
identification of customer needs and profitable operation of a business unit.
Appropriate personnel are licensed to sell securities and insurance products.
This retail strategy is being reinforced through revised incentive and
performance measurements based in part on customer satisfaction levels. Such
measurements were implemented during 1993.
To support this new marketing effort, Fidelity is upgrading its computer and
reporting systems for tracking customer profiles and investment activities,
for monitoring demographic data for marketing purposes, and for updating new
financial products being offered. Fidelity is also employing customer surveys,
focus groups and private interviews to determine actual and potential customer
needs and desires and thereby to tailor its financial services and investment
products.
Management also intends to offer a wider range of loan types than the Bank
currently originates. While continuing to offer adjustable rate mortgages and
to maintain an expertise in originating and servicing multifamily mortgages,
the Bank plans to increase its mortgage banking capabilities and to originate
mortgages that, while not appropriate for inclusion in the Bank's portfolio in
significant quantities, are attractive to borrowers and to the secondary
market.
MORTGAGE BANKING GROUP OPERATIONS
The Bank conducts its residential real estate lending activities through its
Mortgage Banking Group. Operating as a Fidelity division, the Mortgage Banking
Group is responsible for originating single family and multifamily residential
real estate loans for retention in the Company's loan portfolio or sale to
secondary market investors and conduits. After receiving completed loan
applications, the Bank reviews applicant credit history, obtains verification
of employment and other pertinent financial information, confirms property
value through appraisal and completes a transaction evaluation and loan
underwriting. Approved loans are then submitted to the Bank's loan funding
staff. Payment processing, collection and related loan functions are performed
by the Bank's servicing employees. The extent of Fidelity's direct
responsibility for applicant information collection and verification may
depend on whether business is sourced entirely through its own employees
(retail origination) or third parties (as in wholesale or correspondent
business).
The Mortgage Banking Group has adopted an operating strategy more similiar
to that of a mortgage bank than a thrift or savings and loan institution. In
the second quarter of 1993, the Bank adopted a requirement that substantially
all loan originations meet secondary market standards, to enable the Bank to
sell or securitize more loans and thereby enhance its financial liquidity and
operating flexibility. The Bank also enhanced its single family loan program
features and gave borrowers more competitive interest rate lock-in options for
its fixed-rate loan product offerings. The associated increase in the
Company's interest rate risk was addressed through modifications of its
secondary market capabilities and operations.
From 1986 to mid-1992, the Bank had emphasized the origination and retention
of loans secured by multifamily property (2 or more units). From mid-1992 to
present, emphasis has been redirected toward originating single family
residential loans. At December 31, 1993, 71% of Fidelity's loan portfolio was
secured by residential properties containing two or more apartment units, 21%
by single family residential properties and 8% by other properties. OTS
capital regulations established generally lower risk-based capital
requirements for loans secured by single family and multifamily properties
with 36 or fewer units, than for commercial and consumer loans. See
"Regulation and Supervision--FIRREA Capital Requirements."
In the first quarter of 1993, the Bank completed a reorganization of its
real estate lending operations. The loan origination function was separated
into two divisions: a Residential Production Division, focused on increasing
the volume of single family mortgages and two to four unit loan products; and
a Major Loan Production Division, responsible for the Bank's five or more unit
residential lending. The Bank also
8
consolidated all "retail" mortgage application processing and underwriting in
one business unit located in its administration center. All single family loan
production personnel were relocated from regional lending offices and assigned
to key branch locations, furthering the integration of mortgage products into
the Bank's retail financial services delivery system. These actions resulted
in the closure of two of the Bank's four existing regional lending offices as
well as the refocus of the remaining regional offices solely on five unit or
over loan originations. The Bank also started a new business effort designed
to increase single family and two to four unit origination from third party
loan brokers. A number of staff additions were made in 1993 to implement this
operational plan. Fidelity's overall goal is to reposition itself in the
residential lending business as a secondary market, mortgage banking-oriented
loan originator.
In retail loan origination, the Bank's employees have direct control over
verification of necessary applicant income, deposit and credit information as
well as other important elements of the application process. This is in
contrast to third party mortgage origination or wholesale business, where
approved loan brokers assemble key application material and verifications and
submit these completed information packages to the Bank for underwriting,
approval and funding. Wholesale mortgage origination offers the opportunity
for increased loan funding volume at lower fixed operational expense than
would be possible through retail mortgage origination. However, since a
greater portion of the application processing and information verification is
performed by the third-party loan brokers, wholesale business poses greater
credit risk than retail loan originations. The Bank has addressed this
potential credit quality issue through qualification standards for approval of
new loan broker accounts as well as underwriting practices and quality control
procedures.
In addition to the structural reorganization of its multifamily loan
origination function discussed above, the Bank took severe measures in 1993 to
reposition its multifamily lending business orientation and to revise its
multifamily lending criteria. From January to April 1993, the Bank sharply
curtailed new multifamily loan generation by limiting new transactions to
purchase money funding or the refinancing of existing loans and reassigning
key major loan production staff to internal multifamily loan due diligence and
property inspection teams. Significantly reduced multifamily business
origination and lower funding levels resulted from these actions.
Over the January to April interval, the Company reevaluated its multifamily
loan approval guidelines and operational practices, resulting in new
underwriting procedures and more conservative qualifying standards. When
multifamily business origination was resumed in May, the Major Loan Production
Division instituted a new multifamily property scoring system that establishes
a numerical score and corresponding letter grade for each multifamily loan
request. The score and grade then determine qualifying loan-to-value ratios
and debt service coverage requirements, with higher-graded properties eligible
for more favorable underwriting guidelines. Transaction review procedures were
also modified so that multifamily transactions now require, at a minimum, two
loan officer signatures for final loan approval. The Bank believes these
operational enhancements and evaluation measures provide adequate business
credit quality and are appropriate due to current adverse multifamily property
operating economics and market values in the geographic areas where the Bank's
loan portfolio is concentrated. While the Bank is aware that certain of its
underwriting guidelines and standards may be more conservative than other
local market competitors, and thus may decrease new business volume, the Bank
believes that the multifamily origination effort remains competitive and
increases the Bank's ability to securitize the multifamily loan product.
Until the third quarter of 1993, almost all loans funded were generated
through employee loan personnel and outside loan agents. Outside loan agents
are independent real estate brokers who are compensated on a commission basis
upon funding of their loans. Beginning in the third quarter of 1993, however,
Fidelity's single family origination volume increasingly came from third party
loan brokers, reflecting the Bank's conscious decision to develop and expand
this residential mortgage origination channel as discussed above. In July
1993, the Bank opened and staffed two loan origination offices devoted
exclusively to processing single family and two to four unit residential loan
applications from third party loan brokers or "wholesale" mortgage business. A
third wholesale office became fully operational in October. The Bank plans to
open additional wholesale operations in 1994, including one or more offices in
Northern California.
9
Fidelity made significant enhancements in its internal computer systems and
reporting capabilities in 1993. In October, the Bank converted its loan
servicing operation to a new computer system which is expected to result in
systems expense reduction in 1994. The Bank also installed a new automated loan
application processing and tracking computer system which will further its
mortgage banking and secondary marketing capabilities.
Multifamily Residential Loans
The Company offers adjustable rate mortgage ("ARM") loans secured by
apartment buildings with 2 or more units with a maximum amortized loan term of
30 years, with some loans having balloon payments due in 15 years. A majority
of Fidelity's ARM loans adjust with the FHLB Eleventh District Cost of Funds
Index ("COFI"), with a monthly interest rate adjustment commencing after an
initial introduction period of up to six months. Since the borrower's monthly
payment amount adjusts only annually, if COFI increases, these loans can
negatively amortize if the monthly payment is not sufficient to pay in full the
additional interest accruing on the loan. Although multifamily loans in the
Company's loan portfolio contain a due-on-sale clause, by their terms they are
generally transferable to a purchaser of the property if the purchaser meets
the Company's credit standards.
Multifamily real estate lending entails certain risks different from those
posed by single family residential lending. Multifamily and commercial real
estate loans typically involve larger loan balances concentrated with single
borrowers or groups of related borrowers. In addition, the payment experience
on loans secured by multifamily and commercial real estate is typically
dependent on the successful operation of the related real estate project and
thus may be subject, to a greater extent, to adverse conditions in the real
estate market or in the economy in general than are loans secured by single
family properties. Multifamily ARM loans may have greater vulnerability to
default than fixed rate loans during times of increasing interest rates due to
the potential for increase in the amount of a borrower's payment obligations,
while the borrower's income from the property may not increase. See "ARM
Loans."
The Company is concerned about the elevated delinquency rates and loan
restructuring requests being experienced in certain parts of its multifamily
portfolio. Among other things, with respect to its multifamily loan portfolio,
the Company is also concerned about: (a) increasing vacancy rates which
diminish the ability of the property to service the underlying loan; (b)
decreasing apartment rental rates; (c) the potentially greater willingness of
investors to abandon such properties or seek bankruptcy protection,
particularly where such properties are experiencing negative cash flow and the
loans are not cross-collateralized by other performing properties; (d) the
substantial decreases in the market value of multifamily properties experienced
in recent periods (resulting, in many cases, in appraised or resale values less
than the outstanding loan balances) and the general illiquidity of such
properties at the current time in Southern California; (e) the comparative
illiquidity of multifamily residential mortgages, given the limited secondary
market for such mortgages; and (f) potential losses resulting from the January
1994 Northridge Earthquake.
On March 18, 1994, the OTS published a final regulation effective on that
date that permits a loan secured by multifamily residential property,
regardless of the number of units, to be risk-weighted at 50% for purposes of
the risk-based capital standards if the loan meets specified criteria relating
to term of the loan, timely payments of interest and principal, loan-to-value
ratio and ratio of net operating income to debt service requirements. Under the
prior rule, loans secured by multifamily residential properties with more than
36 units were required to be risk-weighted at 100%.
As of December 31, 1993, Fidelity held $406.3 million in loans secured by
multifamily residential properties with 37 or more units and therefore risk-
weighted at 100%, some of which qualify for 50% risk-weighting under the
criteria of the new regulation. Thus, Fidelity's risk-based capital ratio could
increase. However, the additional criteria of the new rule could cause some of
Fidelity's existing loans secured by 5 to 36 unit residential properties to
increase in risk-weighting from 50% to 100%. See "Regulation and Supervision--
FIRREA Capital Requirements." The ultimate impact on Fidelity of the new
regulation has not been determined.
10
Single Family Residential Loans
The Bank offers single family residential mortgage loans with fixed interest
rates having maximum amortization loan terms of up to 30 years. Some single
family loan programs have maturities of only 15 years or balloon payments due
in 5 or 7 years. Due to the interest rate risk presented by the holding of
fixed rate loans combined with variable cost sources of funding, the Bank sells
substantially all originations of fixed rate residential 1 to 4 unit loans to
secondary market investors. While this reduces the interest rate exposure from
a portfolio investor standpoint, there remains the risk associated with adverse
movements in interest rates from the date of loan application to approval,
investor settlement and final delivery. In the second quarter of 1993, Fidelity
modified and augmented internal policies to provide for greater management
control of loan pipeline interest rate risk exposure. During the same quarter,
the Bank also entered into a consulting arrangement with a nationally
recognized organization for daily pipeline valuation services, hedging
strategies and trading execution. This agreement provided Fidelity with state-
of-the-art computer-based valuation methodology for application tracking and
securities commitments necessary for mortgage pipeline hedging management until
these capabilities were developed internally. In October 1993, the Bank reduced
the consulting arrangement to an advisory service, with hedging management
being performed internally. The Bank will assess on a regular basis the
continuation of this pipeline tracking and valuation advisory service
arrangement over in-house alternatives. Management anticipates that secondary
market practices and pipeline interest rate risk management techniques will
continue to be enhanced in 1994 to provide higher quality data transmission and
more efficient product pricing and delivery to secondary market investors.
The Bank also offers ARM loans secured by owner and non-owner occupied single
family residences with a maximum amortized loan term of 30 years. ARM loans
adjust with the one-year U.S. Treasury index or COFI with a monthly interest
rate adjustment commencing after an initial introduction period of up to six
months. Since the borrower's payment amount adjusts annually for the loans
indexed to COFI, if COFI increases these loans can negatively amortize if the
monthly payment is not sufficient to pay in full the additional interest
accruing on the loan. Although single family ARM loans in the Bank's loan
portfolio contain a due-on-sale clause, by their terms they are transferable to
a purchaser of the property if the purchaser meets the Bank's credit standards.
See "ARM Loans" for further discussion of the Bank's asset/liability strategy.
Home Equity Loans
The Bank offers home equity credit lines. The maximum term of the credit
lines offered is 15 years. All of the credit lines provide for variable
interest rates based on a prime rate. These loans are generally underwritten
using a maximum loan-to-value ratio of between 70% and 75%. The total of
undrawn credit lines plus outstanding balances at December 31, 1993, 1992 and
1991 was $108 million, $129 million and $138 million, respectively.
The decline in undrawn credit lines plus outstanding balances was due to a
slowdown in new credit facility growth over the 1992 to 1993 period. New home
equity credit lines originated during 1993, 1992 and 1991 totaled approximately
$13.6 million, $26.9 million and $42.5 million, respectively. In 1993, new home
equity credit line originations declined 49% from 1992 levels as a function,
the Bank believes, of borrowers accessing equity in their homes through
refinancings of their mortgage loans, as well as lower homeowner equity, as
single family housing appraisals fell from higher values of prior years. In
addition, in May 1993, management implemented a new $300 home equity
application fee which also contributed to the home equity volume reduction from
1992 levels.
11
Portfolio statistics
All presentations of the Company's total loan portfolio include loans
receivable and loans held for sale unless stated otherwise.
The following table sets forth the composition of the Company's total loans
receivable by type of security at the dates indicated:
DECEMBER 31,
--------------------------------------------------------------------------------------------------
1993 1992 1991 1990 1989
------------------ ------------------ ------------------ ------------------ ------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
OF OF OF OF OF
LOANS BY TYPE OF TOTAL TOTAL TOTAL TOTAL TOTAL
SECURITY AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
- ---------------- ---------- ------- ---------- ------- ---------- ------- ---------- ------- ---------- -------
(DOLLARS IN THOUSANDS)
Residential loans:
Single family......... $ 792,054 20.80% $ 857,631 21.08% $1,083,652 23.46% $1,671,332 32.53% $1,705,569 38.00%
Multifamily:
2 to 4 units........ 505,219 13.26 526,826 12.96 566,452 12.27 583,474 11.36 462,972 10.32
5 to 36 units....... 1,795,374 47.14 1,880,589 46.23 1,991,089 43.11 1,847,215 35.96 1,317,346 29.35
37 units and over... 406,330 10.67 444,576 10.93 572,285 12.39 600,288 11.68 543,403 12.11
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Total multifamily.. 2,706,923 71.07 2,851,991 70.12 3,129,826 67.77 3,030,977 59.00 2,323,721 51.78
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Total residential
loans............ 3,498,977 91.87 3,709,622 91.20 4,213,478 91.23 4,702,309 91.53 4,029,290 89.78
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Other real estate
loans:
Commercial and
industrial......... 295,761 7.76 343,270 8.44 385,960 8.36 417,299 8.12 440,951 9.83
Land and land
improvements....... 4,828 0.13 6,445 0.16 10,926 0.24 9,123 0.18 7,210 0.16
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Total other real
estate loans......... 300,589 7.89 349,715 8.60 396,886 8.60 426,422 8.30 448,161 9.99
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Gross mortgage loans... 3,799,566 99.76 4,059,337 99.80 4,610,364 99.83 5,128,731 99.83 4,477,451 99.77
Loans secured by
savings accounts and
other non-real estate
loans................. 8,998 0.24 8,278 0.20 7,815 0.17 8,748 0.17 10,343 0.23
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Gross loans receivable. 3,808,564 100.00% 4,067,615 100.00% 4,618,179 100.00% 5,137,479 100.00% 4,487,794 100.00%
---------- ====== ---------- ====== ---------- ====== ---------- ====== ---------- ======
Less:
Undisbursed loan
funds................ -- 301 2,706 24,992 38,073
Unearned discounts.... 210 104 120 101 1,280
Deferred loan fees.... 11,139 11,152 12,131 10,621 3,906
Allowance for esti-
mated losses......... 83,832 64,277 52,374 16,552 7,336
---------- ---------- ---------- ---------- ----------
95,181 75,834 67,331 52,266 50,595
---------- ---------- ---------- ---------- ----------
Total loans
receivable........... $3,713,383 $3,991,781 $4,550,848 $5,085,213 $4,437,199
========== ========== ========== ========== ==========
The following table sets forth the composition of the Company's loans held for
sale, which are included in the table above, by type of security at the dates
indicated:
DECEMBER 31,
--------------------------------------------------------------------------------------------------
1993 1992 1991 1990 1989
------------------ ------------------ ------------------ ------------------ ------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
LOANS BY TYPE OF OF OF OF OF OF
SECURITY AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
- ---------------- ---------- ------- ---------- ------- ---------- ------- ---------- ------- ---------- -------
(DOLLARS IN THOUSANDS)
Residential loans:
Single family......... $239,371 65.10% $25,043 94.57% $37,497 100.00% $199,500 100.00% -- --
Multifamily 2 to 4
units................ 128,317 34.90 1,439 5.43 -- -- -- -- -- --
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Total loans held
for sale......... $367,688 100.00% $26,482 100.00% $37,497 100.00% $199,500 100.00% -- --
========== ====== ========== ====== ========== ====== ========== ====== ========== ======
12
The following table presents the Company's gross mortgage loans by type and
location as of December 31, 1993:
COMMERCIAL AND
MULTIFAMILY INDUSTRIAL
---------------------------- ----------------
SINGLE 2 TO 4 5 TO 36 37 UNITS HOME HOTEL/ OTHER
FAMILY UNITS UNITS AND OVER EQUITY(1) MOTEL C & I TOTAL
-------- -------- ---------- -------- --------- ------- -------- ----------
(DOLLARS IN THOUSANDS)
California:
Southern California
Counties:
Los Angeles......... $379,688 $178,016 $1,328,497 $281,714 $39,018 $20,740 $120,639 $2,348,312
Orange.............. 137,398 199,942 185,262 50,657 12,893 26,742 58,309 671,203
San Diego........... 24,235 18,251 93,927 16,220 210 1,409 8,158 162,410
San Bernardino...... 18,050 31,471 43,194 24,173 1,476 -- 4,639 123,003
Riverside........... 24,590 17,287 29,187 10,832 978 -- 18,793 101,667
Ventura............. 24,144 8,693 30,398 2,546 921 2,593 1,211 70,506
Other............... 25,668 12,949 25,508 7,573 87 2,655 5,297 79,737
-------- -------- ---------- -------- ------- ------- -------- ----------
633,773 466,609 1,735,973 393,715 55,583 54,139 217,046 3,556,838
Northern California
Counties:
Santa Clara......... 56,769 25,506 39,612 147 530 -- 2,252 124,816
Other............... 45,289 11,818 19,789 5,197 233 2,251 16,170 100,747
-------- -------- ---------- -------- ------- ------- -------- ----------
Total California.. 735,831 503,933 1,795,374 399,059 56,346 56,390 235,468 3,782,401
-------- -------- ---------- -------- ------- ------- -------- ----------
Hawaii.................. 255 -- -- -- -- -- -- 255
Arizona................. 73 -- -- 1,554 -- -- 4,708 6,335
Washington.............. 325 -- -- 2,282 -- -- 543 3,150
Oregon.................. -- -- -- 3,435 -- -- 254 3,689
Maryland................ -- -- -- -- -- 2,713 -- 2,713
Colorado................ 21 -- -- -- -- 513 -- 534
Texas................... 410 -- -- -- -- -- -- 410
New York................ 59 -- -- -- -- -- -- 59
Nevada.................. 20 -- -- -- -- -- -- 20
-------- -------- ---------- -------- ------- ------- -------- ----------
Total out-of-state 1,163 -- -- 7,271 -- 3,226 5,505 17,165
-------- -------- ---------- -------- ------- ------- -------- ----------
Gross mortgage loans.... $736,994 $503,933 $1,795,374 $406,330 $56,346 $59,616 $240,973 $3,799,566
======== ======== ========== ======== ======= ======= ======== ==========
- --------
(1) Includes home equity loans of $55,060 and $1,286 on single family and
multifamily (2 to 4 units) properties, respectively. Therefore, including
the home equity loans, loans on single family and multifamily (2 to 4
units) properties total $792,054 and $505,219, respectively.
13
The following table sets forth the types of loans by repricing attribute,
held by the Company at the dates indicated:
DECEMBER 31,
--------------------------------------------------------------------------------------------------
1993 1992 1991 1990 1989
------------------ ------------------ ------------------ ------------------ ------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
OF OF OF OF OF
TOTAL TOTAL TOTAL TOTAL TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
---------- ------- ---------- ------- ---------- ------- ---------- ------- ---------- -------
(DOLLARS IN THOUSANDS)
Adjustable rate loans... $3,649,714 95.83% $3,924,093 96.47% $4,447,838 96.31% $4,551,857 88.60% $4,069,508 90.68%
Fixed rate loans........ 158,850 4.17 143,522 3.53 170,341 3.69 585,622 11.40 418,286 9.32
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Gross loans receivable. 3,808,564 100.00% 4,067,615 100.00% 4,618,179 100.00% 5,137,479 100.00% 4,487,794 100.00%
====== ====== ====== ====== ======
Less:
Undisbursed loan funds. -- 301 2,706 24,992 38,073
Unearned discounts 210 104 120 101 1,280
Deferred loan fees..... 11,139 11,152 12,131 10,621 3,906
Allowance for estimated
losses................ 83,832 64,277 52,374 16,552 7,336
---------- ---------- ---------- ---------- ----------
95,181 75,834 67,331 52,266 50,595
---------- ---------- ---------- ---------- ----------
Loans receivable, net.. $3,713,383 $3,991,781 $4,550,848 $5,085,213 $4,437,199
========== ========== ========== ========== ==========
The following table sets forth by contractual maturity and interest rate, the
Company's fixed rate and adjustable rate real estate loan portfolio at December
31, 1993. The table does not consider the prepayment experience of the loan
portfolio when scheduling the maturities of loans. See Item 7. "MD&A--Interest
Rate Risk Management."
DECEMBER 31, 1993
-------------------------------------------------------------------------------------
SUBTOTAL
MATURITIES MATURES IN
TOTAL GREATER -----------------------------------------------------
LOANS MATURES THAN ONE 1997- 1999- 2004- AFTER
RECEIVABLE IN 1994 YEAR 1995 1996 1998 2003 2008 2008
----------- -------- ---------- ------- ------- -------- -------- -------- ----------
(DOLLARS IN THOUSANDS)
Adjustable rate loans:
Under 5.00%................. $ 22,572 $ -- $ 22,572 $ -- $ -- $ -- $ 90 $ 560 $ 21,922
5.00%-- 6.99%................. 3,086,684 -- 3,086,684 1,404 486 11,585 187,424 505,770 2,380,015
7.00%-- 8.99%................. 385,295 7,380 377,915 4,897 5,184 9,506 67,539 162,752 128,037
9.00%-- 10.99%................ 146,214 21,333 124,881 3,435 186 300 82,744 22,870 15,346
11.00%-- 12.99%................ 8,413 970 7,443 5,212 -- -- -- 587 1,644
Over 13.00%................ 536 -- 536 -- -- -- 536 -- --
----------- -------- ---------- ------- ------- -------- -------- -------- ----------
Total adjustable rate loans.... 3,649,714 29,683 3,620,031 14,948 5,856 21,391 338,333 692,539 2,546,964
----------- ======== ========== ======= ======= ======== ======== ======== ==========
Fixed rate loans:
Under 5.00%................. $ 240 $ -- $ 240 $ 240 $ -- $ -- $ -- $ -- $ --
5.00%-- 6.99%................. 32,844 7,989 24,855 96 203 5,549 791 5,500 12,716
7.00%-- 8.99%................. 56,323 1 56,322 781 695 3,060 9,951 8,177 33,658
9.00%-- 10.99%................ 52,881 39 52,842 249 1,006 2,767 2,641 27,901 18,278
11.00%-- 12.99%................ 11,198 4,653 6,545 862 717 -- 115 418 4,433
Over 13.00%................ 5,364 3,016 2,348 -- -- 502 33 120 1,693
----------- -------- ---------- ------- ------- -------- -------- -------- ----------
Total fixed rate loans......... $ 158,850 $ 15,698 $ 143,152 $ 2,228 $ 2,621 $ 11,878 $ 13,531 $ 42,116 $ 70,778
----------- ======== ========== ======= ======= ======== ======== ======== ==========
Less:
Undisbursed loan funds.......... --
Unearned discounts.............. 210
Deferred loan fees.............. 11,139
Allowance for estimated losses.. 83,832
-----------
95,181
-----------
Loans receivable, net.......... $ 3,713,383
===========
14
The following table details the activity in the Company's loan portfolio for
the periods indicated:
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1993 1992 1991 1990 1989
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Principal balance at
beginning of period.... $3,991,781 $4,550,848 $5,085,213 $4,437,199 $4,058,886
Real estate loans
originated:
Conventional:
Single family......... 271,316 261,563 186,320 248,849 248,932
Multifamily:
2 to 4 units......... 42,931 29,931 63,146 179,515 121,648
5 to 36 units........ 89,935 121,940 239,165 640,621 288,549
37 units and over.... 12,887 19,588 15,785 104,864 115,376
---------- ---------- ---------- ---------- ----------
Total multifamily... 145,753 171,459 318,096 925,000 525,573
Commercial and indus-
trial................. 1,335 993 1,910 16,390 70,659
Construction........... -- -- -- 21,091 52,415
---------- ---------- ---------- ---------- ----------
Total real estate
loans originated(1).. 418,404 434,015 506,326 1,211,330 897,579
---------- ---------- ---------- ---------- ----------
Real estate loans
purchased:
Single family.......... -- -- -- 195,157 555
Multifamily:
2 to 4 units.......... -- -- -- -- --
5 to 36 units......... 3,741 241 -- 500 --
37 units and over..... -- 1,434 1,080 473 --
---------- ---------- ---------- ---------- ----------
Total multifamily.... 3,741 1,675 1,080 973 --
Commercial and
industrial............ 210 -- 1,859 62 --
Construction........... -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Total real estate
loans purchased...... 3,951 1,675 2,939 196,192 555
---------- ---------- ---------- ---------- ----------
Total real estate
loans funded........ 422,355 435,690 509,265 1,407,522 898,134
---------- ---------- ---------- ---------- ----------
Payments and refinances. (575,348) (674,261) (517,880) (507,942) (484,738)
Increase (decrease) in
non real estate loans.. 720 463 (928) (465) 855
(Increase) decrease in
reserves for loan loss-
es..................... (19,555) (11,903) (35,822) (9,216) (4,791)
Other increases (de-
crease) in total loans,
net.................... 8,433 9,656 29,486 9,146 (19,114)
Loans sold or
securitized:
Whole loans(2)......... (115,003) (318,712) (486,413) (239,260) (1,824)
Participations......... -- -- (32,073) (11,771) (10,209)
---------- ---------- ---------- ---------- ----------
Total loans sold or
securitized.......... (115,003) (318,712) (518,486) (251,031) (12,033)
---------- ---------- ---------- ---------- ----------
Net increase (decrease)
in loans receivable.... (278,398) (559,067) (534,365) 648,014 378,313
---------- ---------- ---------- ---------- ----------
Principal balance at end
of period.............. $3,713,383 $3,991,781 $4,550,848 $5,085,213 $4,437,199
========== ========== ========== ========== ==========
Loans serviced for
others................. $ 888,362 $ 982,698 $ 925,368 $ 676,101 $ 505,297
- -------
(1) Includes loans originated to finance sales of REO of $51.6 million, $11.2
million and $1.6 million, for the years ended December 31, 1993, 1992 and
1991, respectively. In 1990 and 1989 loans originated to finance sales of
REO were insignificant.
(2) Net of repurchases.
15
Declines in total real estate loans originated in 1993 and 1992 were due
primarily to the curtailment of multifamily origination during the
reorganization of the Mortgage Banking Group and the imposition of more
stringent multifamily loan underwriting criteria. Declines in loan
originations in 1991 were due primarily to the Company's decision to reduce
assets to strengthen its capital ratios.
Sale of Loans
Over the past several years, the Company has sold most of its current
production of fixed rate single family residential loans in the secondary
mortgage market and has retained its ARM production. Loan sales totaled
approximately $138.4 million, $204.4 million and $282.7 million for the years
ended December 31, 1993, 1992 and 1991, respectively. In addition, sales of
mortgage-backed securities totaled $522.1 million, $0 and $273.1 million,
respectively, in the three years. Fidelity is an approved originator and
servicer for the Federal National Mortgage Association (the "FNMA"), the
Federal Home Loan Mortgage Corporation (the "FHLMC"), the Federal Housing
Administration (the "FHA") and the Veterans Administration (the "VA"). As
Fidelity's single family lending volumes increase, sales of loans in the
secondary mortgage market will increase.
In the beginning of 1993, Fidelity concentrated on selling all fixed rate
loans it originated into the secondary market to maximize liquidity and reduce
interest rate risk. During 1993, the Company approved a policy of more active
management of its loans and investment portfolio with a view toward
disposition of securities with unfavorable risk/return profiles and to allow
more asset/liability management and asset size flexibility to facilitate
further downsizing of the Bank. To this end, the Company designated $321
million of certain adjustable rate mortgage loans meeting specific criteria as
held for sale as of December 31, 1993.
In connection with loan sales, Fidelity is required to make representations
and warranties with respect to the loans and their underwriting criteria.
These representations and warranties create a contingent liability to
repurchase the loans to the extent they are subsequently found to be untrue.
ARM Loans
To assist in reducing the sensitivity of its earnings to interest rate
fluctuations, Fidelity has emphasized the origination of ARMs for its
portfolio. ARMs help to improve the matching of interest rate repricing
between Fidelity's asset and liability portfolios. ARMs reduce the interest
rate risk inherent in a portfolio of long-term mortgages by repricing each
individual asset at regular intervals over the life of the asset. The initial
period before the first adjustment varies between one month and five years.
ARM loans represented 52% of all loans funded in 1993 and 96% of the total
loan portfolio at December 31, 1993. Fidelity's ARMs generally bear an
interest rate which periodically adjusts at a stated margin (the "contractual
spread") above COFI, which is the index which most closely matches Fidelity's
liability base. The risk of different asset and liability repricing can be
reduced by diversifying the ARM portfolio. Other ARMs originated are generally
indexed to U.S. Treasury indices, which more closely match the repricing speed
of deposits, but are more volatile than a COFI index.
ARMs may have greater vulnerability to default than fixed rate loans during
times of increasing interest rates due to the potential for substantial
increase in the amount of a borrower's payments or, to the extent payments do
not increase, erosion of a borrower's equity in the underlying property. Risks
of default are reduced by caps on both the maximum interest that can be
charged and the amount by which a borrower's payments can be periodically
increased. However, during periods of significant interest rate increases,
interest rate caps can adversely affect interest rate margins and payment caps
can increase borrower exposure to negative amortization, unless the loan
contains a prohibition on negative amortization. When the borrower's payment
is not sufficient to cover the computed interest amount, negative amortization
occurs and the difference then increases the principal balance of the loan.
Fidelity uses a combination of interest rate caps and payment caps to reduce
risk of default, and to date, negative amortization has not adversely affected
16
Fidelity's default ratios. At December 31, 1993, the total negative
amortization included in the loan portfolio was $0.7 million compared to $3.7
million at December 31, 1992.
During periods of declining interest rates, ARMs with high interest rate caps
relative to market are vulnerable to prepayment as borrowers refinance into
ARMs with lower caps or into fixed rate loans. Fidelity has also attempted to
minimize the risk of default associated with all ARMs by using the COFI (a
relatively stable index) for adjustment, thereby limiting interest rate
volatility over short periods, and utilizing loan-to-value ratios generally not
in excess of 80% unless private mortgage insurance is obtained. During periods
of declining interest rates, ARMs with negative amortization potential will
experience accelerated amortization, thereby offsetting, in whole or in part,
previously incurred negative amortization, if any, or reducing the principal
balance ahead of the original schedule.
Most of Fidelity's ARMs provide for a lifetime interest rate cap (currently
ranging from 1.875% to 6.250% above the initial rate). A limited number of
Fidelity's ARMs also provide for an annual interest rate cap. In addition, for
competitive reasons, ARMs are often offered at an initial reduced interest rate
(the "introductory rate") for a period of time (one, three, or six months).
Fidelity's ARMs are underwritten for credit purposes based on the pro forma
payment which would be required at the fully-indexed rate or at the time of the
first interest rate adjustment, depending on the type of property.
Fidelity currently offers primarily three types of ARMs. One type has a
lifetime interest rate cap and payment cap on the amount by which monthly
payments can increase from one annual or semiannual payment adjustment to the
next; another type provides for a lifetime interest rate cap but includes
payment adjustments concurrent with interest rate adjustments without a cap on
the payment increase; and the last type provides for an initial five-year fixed
rate of interest after which it reverts to the type of ARM first described
above.
CREDIT ADMINISTRATION
Appraisal and Underwriting Standards
All properties taken as collateral are appraised utilizing either an outside
appraiser or a Fidelity staff appraiser. Fidelity requires that loans secured
by real estate be approved at various levels of management, depending upon the
size of the loan. Until 1991, Fidelity had a low delinquency rate on all of its
single family and multifamily loans as well as its commercial properties
located in California. However, with worsening economic conditions and declines
in the real estate values in Southern California, delinquency rates have been
steadily increasing. Fidelity has reassessed its underwriting practices and, in
light of current conditions, has taken steps to increase qualifying ratios
including debt service coverage minimums and loan-to-value maximums.
During the underwriting process for single family loans, Fidelity obtains
information regarding the applicant's income, financial condition, employment
and credit history to determine the applicant's ability to service the debt
obligations. Fidelity underwrites loans pursuant to internal underwriting
criteria as well as to the requirements of the secondary market for such loans
or special investor needs. Increasing third party generation of single family
loans will require Fidelity to maintain strict underwriting and quality control
standards.
Fidelity's underwriting standards for multifamily and commercial real estate
lending require the underwriter to review an applicant's experience in owning
and operating such type of income-producing property to determine if the
applicant is qualified to manage such property. At the time of origination,
Fidelity reviews the borrower's financial resources, credit history and income-
producing capacity, verifies employment, reviews an appraisal of the security
property, analyzes the anticipated occupancy, operating expenses and cash flow
of income-producing properties, and performs other underwriting procedures. In
accordance with its underwriting guidelines Fidelity generally requires a
minimum debt coverage ratio (net
17
operating income divided by debt service payment) of from 112% to 130%,
depending on the rated quality of the property, whether the loan involves the
arms-length market sale of the property or is a refinancing and if it is a
refinancing whether there is "cash out" or "no cash out." The debt service
coverage ratio is calculated on actual occupancy figures typically utilizing a
10% vacancy factor and using a payment which is the greater of a fully indexed
rate, start rate or (typically higher) qualifying rate. The Bank also limits
its loans to a maximum of 50% to 75% of the appraised value of the property,
again depending on the rated quality of the property and other circumstances
outlined above with respect to debt service coverage.
Loan Portfolio Risk Elements
Fidelity's loan portfolio risk elements and credit loss experience may be
more clearly understood when the following sections are read in conjunction
with Item 7. "MD&A--Asset Quality."
Fidelity originates loans with the expectation that borrowers will honor
their repayment obligations. In an attempt to reduce credit risk, Fidelity
maintained the underwriting criteria described above. As is the case with other
lenders, however, some of Fidelity's borrowers have or will become unable or
unwilling to pay interest or principal when due. The reasons for such defaults
include, without limitation, (a) adverse conditions in the regional or national
economy; (b) unemployment; (c) an oversupply of apartments for lease; (d) an
increase in vacancies; (e) a decline in real estate values; (f) declines in
rents; and (g) loss of equity. If the borrower is unable to meet his obligation
but is willing to make an additional financial commitment to the property
securing the loan, Fidelity may restructure the loan to more closely match the
reduced cash flow and value of the collateral. In other circumstances, Fidelity
commences proceedings to foreclose upon the property securing the loan. Such
proceedings may be delayed by litigation or bankruptcy initiated by the
borrower. Fidelity's risk of loss relates both to the frequency of such
defaults and to the severity of loss, namely, the excess, if any, of the
outstanding principal balance of the loan plus accrued interest over the amount
realized upon ultimate disposition of the collateral. In rare instances,
Fidelity may be able to recover all or some of the loss it incurs from other
assets of the borrower. Fidelity also is exposed to loss if the value of the
collateral declines between the time of foreclosure and the time of resale.
Fidelity is also exposed to loss to the extent that it is required to invest
significant funds to foreclose on and sell its collateral, which may include
rehabilitating dilapidated or distressed collateral.
Loan Monitoring
Fidelity has established a monitoring system for its loan portfolio to
attempt to identify potential problem loans. Loans that are currently
performing but have met certain criteria requiring further scrutiny are placed
on a "watch list". These criteria include, but are not limited to, a large
outstanding balance, collateral performing in an inadequate manner, origination
for the purpose of facilitating the sale of real estate owned by Fidelity, and
other high risk characteristics identified through the internal asset review
process that warrant further analysis. Fidelity's relationship management group
actively gathers updated operating information on large multifamily loans.
18
The following table details Fidelity's net loans which are 30 to 89 days
delinquent at the dates indicated:
DECEMBER 31,
--------------------------------------
1993 1992 1991 1990 1989
------- ------- ------- ------ -------
(DOLLARS IN THOUSANDS)
Loans 60 to 89 days contractually
delinquent:
Single family....................... $ 2,497 $ 3,665 $ 3,370 $ 824 $ 1,532
Multifamily:
2 to 4 units....................... 1,707 1,180 1,841 -- 1
5 to 36 units...................... 12,770 9,241 7,811 -- --
37 units and over.................. 5,035 1,223 -- -- --
------- ------- ------- ------ -------
Total multifamily................ 19,512 11,644 9,652 -- 1
Commercial and industrial............. 1,723 -- 7,869 3,612 719
------- ------- ------- ------ -------
Total................................ $23,732 $15,309 $20,891 $4,436 $ 2,252
======= ======= ======= ====== =======
Loans 30 to 59 days contractually
delinquent:
Single family....................... $ 7,480 $ 7,939 $ 6,627 $3,063 $ 2,556
Multifamily:
2 to 4 units....................... 3,599 1,432 416 94 190
5 to 36 units...................... 16,948 15,927 6,515 1,587 415
37 units and over.................. 4,114 5,623 19,453 -- 2,783
------- ------- ------- ------ -------
Total multifamily................ 24,661 22,982 26,384 1,681 3,388
Commercial and industrial............. 2,048 1,807 3,040 139 4,409
------- ------- ------- ------ -------
Total................................ $34,189 $32,728 $36,051 $4,883 $10,353
======= ======= ======= ====== =======
The following table presents net delinquent loans at December 31, 1993,
including those detailed above (30 to 89 days delinquent) as well as those 90
days or more delinquent:
COMMERCIAL AND
MULTIFAMILY INDUSTRIAL
------------------------ --------------------
SINGLE 2 TO 4 5 TO 36 37 UNITS
FAMILY UNITS UNITS AND OVER CONSTRUCTION OTHER TOTAL
------- ------- ------- -------- ------------ ------- --------
(DOLLARS IN THOUSANDS)
California:
Southern California
Counties:
Los Angeles.......... $14,011 $ 5,224 $49,876 $11,442 $1,483 $ 6,079 $ 88,115
Orange............... 3,576 4,559 5,115 -- -- 1,495 14,745
San Bernardino....... 419 8,301 2,335 -- -- -- 11,055
Riverside............ 754 940 1,896 -- -- -- 3,590
San Diego............ 814 1,248 3,114 3,473 -- -- 8,649
Ventura.............. 628 225 546 -- -- -- 1,399
Other................ 717 238 -- -- -- 682 1,637
------- ------- ------- ------- ------ ------- --------
20,919 20,735 62,882 14,915 1,483 8,256 129,190
------- ------- ------- ------- ------ ------- --------
Northern California
Counties:
Santa Clara.......... 807 224 1,309 -- -- 651 2,991
Sacramento........... -- -- -- -- -- 4,416 4,416
Other................ 906 -- 273 -- -- -- 1,179
------- ------- ------- ------- ------ ------- --------
1,713 224 1,582 -- -- 5,067 8,586
------- ------- ------- ------- ------ ------- --------
Total California.... 22,632 20,959 64,464 14,915 1,483 13,323 137,776
------- ------- ------- ------- ------ ------- --------
Arizona................. 5 -- -- -- -- -- 5
------- ------- ------- ------- ------ ------- --------
$22,637 $20,959 $64,464 $14,915 $1,483 $13,323 $137,781
======= ======= ======= ======= ====== ======= ========
19
Nonaccrual Loans
The Bank generally places a loan on nonaccrual status whenever the payment of
interest is 90 or more days delinquent, or earlier if a loan exhibits
materially deficient characteristics. At December 31, 1993, $13.6 million of
loans were less than 90 days delinquent but had been placed on nonaccrual
status. Loans on nonaccrual status are resolved by the borrower bringing the
loan current, by the Company and the borrower agreeing to modify the terms of
the loan or by foreclosure upon the collateral securing the loan. See
"Restructured Loans" and "Foreclosure Policies."
The following table presents Fidelity's net nonaccrual loans by type of
collateral at the dates indicated:
DECEMBER 31,
----------------------------------------
1993 1992 1991 1990 1989
------- -------- ------- ------- -------
(DOLLARS IN THOUSANDS)
PROPERTY TYPE
- -------------
Single family......................... $12,661 $ 14,064 $ 8,100 $ 3,631 $ 1,543
Multifamily:
2 to 4 units......................... 15,652 6,372 1,256 628 1,000
5 to 36 units........................ 34,745 37,501 12,620 376 218
37 units and over.................... 18,112 35,357 26,123 19,629 2,325
------- -------- ------- ------- -------
Total multifamily................... 68,509 79,230 39,999 20,633 3,543
Commercial and industrial............. 12,305 18,747 20,883 5,897 7,001
------- -------- ------- ------- -------
Total nonaccrual loans(1)........... $93,475 $112,041 $68,982 $30,161 $12,087
======= ======== ======= ======= =======
- --------
(1) Includes loans over 90 days contractually delinquent and other nonaccrual
loans.
It is the Company's policy to reserve all earned but unpaid interest on loans
placed on nonaccrual status. The reduction in income related to nonaccrual
loans upon which interest was not paid was $8.7 million, $13.6 million, and
$7.6 million in 1993, 1992 and 1991, respectively.
The following table presents net nonaccrual loans by property type and
location at December 31, 1993:
COMMERCIAL
MULTIFAMILY AND INDUSTRIAL
----------------------- --------------------
37
UNITS
SINGLE 2 TO 4 5 TO 36 AND
FAMILY UNITS UNITS OVER CONSTRUCTION OTHER TOTAL
------- ------- ------- ------- ------------ ------- -------
(DOLLARS IN THOUSANDS)
California:
Southern California
Counties:
Los Angeles........... $ 7,654 $ 3,780 $28,594 $18,112 $1,344 $ 4,909 $64,393
Orange................ 1,694 2,253 2,015 -- -- 303 6,265
San Bernardino........ 83 7,766 1,284 -- -- -- 9,133
Riverside............. 362 766 687 -- -- -- 1,815
San Diego............. 606 638 1,346 -- -- -- 2,590
Ventura............... 398 225 546 -- -- -- 1,169
Other................. 706 -- -- -- -- 682 1,388
------- ------- ------- ------- ------ ------- -------
11,503 15,428 34,472 18,112 1,344 5,894 86,753
------- ------- ------- ------- ------ ------- -------
Northern California
Counties:
Santa Clara........... 807 224 -- -- -- 651 1,682
Sacramento............ -- -- -- -- -- 4,416 4,416
Other................. 346 -- 273 -- -- -- 619
------- ------- ------- ------- ------ ------- -------
1,153 224 273 -- -- 5,067 6,717
------- ------- ------- ------- ------ ------- -------
Total California.... 12,656 15,652 34,745 18,112 1,344 10,961 93,470
Arizona................. 5 -- -- -- -- -- 5
------- ------- ------- ------- ------ ------- -------
Total nonaccrual loans. $12,661 $15,652 $34,745 $18,112 $1,344 $10,961 $93,475
======= ======= ======= ======= ====== ======= =======
20
Restructured Loans
The Bank has modified the terms of a number of its loans. In some cases, the
modifications have taken the form of "early recasts" in which the amortizing
payments are revised (or recalculated) earlier than scheduled to reflect
current lower interest rates. In other cases, the Bank has agreed to accept
interest only payments for a limited time at current interest rates. In still
other cases, the Bank has reduced the loan balance in exchange for a paydown of
the loan or otherwise modified loans at terms that are less favorable to the
Bank than the current market. These loans have interest rates that may be less
than current market rates or may contain other concessions. Modified loans are
categorized as TDRs by the Bank when the modification contains concessions to
the borrower that the Bank would not otherwise consider except for the
borrower's poor financial condition.
The following table presents TDRs by property type at December 31, 1993 and
1992:
DECEMBER 31,
---------------
1993 1992
------- -------
PROPERTY TYPE (DOLLARS IN
- ------------- THOUSANDS)
Single family.................................................. $ 633 $ 3,160
Multifamily:
2 to 4 units.................................................. 3,171 4,065
5 to 36 units................................................. 13,648 20,404
37 units and over............................................. 11,090 54,108
------- -------
Total multifamily............................................ 27,909 78,577
Commercial and industrial...................................... -- 5,567
Land........................................................... 171 --
------- -------
Total TDRs................................................... $28,713 $87,304
======= =======
Of the total $87.3 million of TDRs at December 31, 1992, during 1993, the
terms of the modification expired on $39.8 million which are performing in
accordance with their original terms (of which $19.6 million are classified as
Substandard, $6.2 million are categorized as Special Mention and $14.0 million
are Pass assets), $20.4 million became nonperforming loans, $9.8 million
defaulted and were foreclosed, $3.5 million became ISF, $0.5 million was paid,
and $13.3 million continued to be categorized as TDRs at December 31, 1993.
The following table presents TDRs at December 31, 1993, by property type and
location:
MULTIFAMILY
-----------------------
SINGLE 2-4 5-36 37 UNITS
FAMILY UNITS UNITS AND OVER LAND TOTAL
------ ------ ------- -------- ---- -------
(DOLLARS IN THOUSANDS)
California:
Southern California Counties:
Los Angeles....................... $633 $1,222 $ 7,122 $ 1,872 $ 95 $10,944
Orange............................ -- 323 3,573 3,997 -- 7,893
San Bernardino.................... -- 177 2,337 1,786 76 4,376
Riverside......................... -- 1,098 616 -- -- 1,714
Other............................. -- 351 -- -- -- 351
---- ------ ------- ------- ---- -------
Total California................... 633 3,171 13,648 7,655 171 25,278
Oregon.............................. -- -- -- 3,435 -- 3,435
---- ------ ------- ------- ---- -------
Total TDRs......................... $633 $3,171 $13,648 $11,090 $171 $28,713
==== ====== ======= ======= ==== =======
21
The following table presents the loan balances of the TDRs at the dates
indicated by the type of modification:
DECEMBER 31,
-------------------------------------------
1993 1992
--------------------- ---------------------
PERCENT OF PERCENT OF
AMOUNT RESTRUCTURINGS AMOUNT RESTRUCTURINGs
------ -------------- ------ --------------
(DOLLARS IN MILLIONS)
LOANS MODIFIED BY:
- ------------------
Early recast of scheduled
payments................ $12.0 41.9% $29.3 33.6%
Interest only payments... 8.6 29.8 28.0 32.1
Deferral of one or more
payments................ 1.3 4.5 21.4 24.5
Fixed rate reduced to
market.................. 3.4 12.0 4.4 5.0
Extension of maturity
date.................... 0.1 0.3 3.8 4.4
Reduction in rate to
below market............ -- -- 0.4 0.4
Principal forgiveness(1). 3.3 11.5 -- --
----- ----- ----- -----
Total TDRs.............. $28.7 100.0% $87.3 100.0%
===== ===== ===== =====
- --------
(1) $1.0 million in actual principal forgiveness in 1993 on $3.3 million of
outstanding loans.
During 1993, interest income of $8.3 million was recorded on TDRs, $0.1
million less than would have been recorded had the loans performed according
to their original terms. In 1992, the amounts were $10.0 million and $0.3
million, respectively. During 1991, $0.7 million of interest income was
recorded on TDRs, which consisted of one loan of $6.9 million at year-end
1991. The modification of this loan did not result in any reduction of
interest income in 1991. The Bank did not have any TDRs at December 31, 1990
or 1989.
Please refer to Item 7. "MD&A--Asset Quality" for further information on
nonperforming assets during 1993 and 1992.
Internal Asset Classifications
The OTS has promulgated a regulation and issued other regulatory guidance
requiring savings institutions to utilize an internal asset classification
system as a means of reporting problem and potential problem assets for
regulatory supervision purposes. The Bank has incorporated the OTS' internal
asset classifications as a part of its credit monitoring system. The Bank
currently designates its assets as Pass, Special Mention, Substandard,
Doubtful, or Loss. A brief description of these categories follows:
A Pass asset is considered of sufficient quality to preclude designation
as Special Mention or an adverse classification. Pass assets generally are
protected by the current net worth and paying capacity of the obligor or by
the value of the asset or underlying collateral.
An asset designated as Special Mention does not currently expose an
institution to a sufficient degree of risk to warrant an adverse
classification. However, it does possess credit deficiencies or potential
weaknesses deserving management's close attention. If uncorrected, such
weaknesses or deficiencies may expose an institution to an increased risk
of loss in the future.
An asset classified as Substandard is inadequately protected by the
current net worth and paying capacity of the obligor or of the collateral
pledged, if any. Assets so classified have a well-defined weakness or
weaknesses. They are characterized by the distinct possibility that the
insured institution will sustain some loss if the deficiencies are not
corrected.
Assets classified as Doubtful have all the weaknesses inherent in those
classified as Substandard. In addition, these weaknesses make collection or
liquidation in full, on the basis of currently existing facts,
22
conditions and values, highly questionable or improbable. The Bank views
the Doubtful classification as a temporary category. The Bank will
generally classify assets as Doubtful when inadequate data is available or
when such uncertainty exists as to preclude a Substandard classification.
Therefore, the Bank will normally tend to have a minimal amount of assets
classified in this category.
Assets classified as Loss are considered uncollectible and of such little
value that their continuance as assets without establishment of a specific
reserve is not warranted. A Loss classification does not mean that an asset
has absolutely no recovery or salvage value; rather it means that it is not
practical or desirable to defer establishing a specific allowance for a
basically worthless asset even though partial recovery may be effected in
the future. The Bank will generally classify as Loss the portion of assets
identified as exceeding the asset's fair market value and a specific
reserve is established for such excess.
A "classified asset" is one that has been designated a Substandard, Doubtful
or Loss. Classified assets do not include Special Mention or Pass assets. All
of the foregoing standards require the application of considerable subjective
judgments by the Bank.
The following table summarizes Fidelity's net classified assets at the dates
indicated:
DECEMBER 31,
--------------------------------------------------
1993 1992 1991 1990 1989
--------- --------- --------- -------- -------
(DOLLARS IN THOUSANDS)
Nonperforming assets:
Nonaccrual loans.......... $ 93,475 $ 112,041 $ 68,982 $ 30,161 $12,087
REO(1).................... 142,146 122,364 55,743 18,307 8,625
--------- --------- --------- -------- -------
Total nonperforming as-
sets.................... 235,621 234,405 124,725 48,468 20,712
Performing loans with in-
creased risk:
Single family............. 5,749 6,808 6,963 2,930 3,833
Multifamily:
2 to 4 units............. 7,616 3,648 3,390 -- --
5 to 36 units............ 56,485 38,589 22,757 990 --
Over 37 units............ 51,965 49,566 36,405 11,207 2,751
--------- --------- --------- -------- -------
Total multifamily....... 116,066 91,803 62,552 12,197 2,751
Commercial and industrial. 3,905 9,831 19,584 16,773 6,640
--------- --------- --------- -------- -------
Total performing loans
with increased risk...... 125,720 108,442 89,099 31,900 13,224
--------- --------- --------- -------- -------
Other classified assets:
Real estate held for in-
vestment, net............ 11,161 10,891 14,516 14,367 14,911
Investment in subsidiar-
ies...................... -- -- -- 247 508
Other assets.............. -- -- 63 91 660
--------- --------- --------- -------- -------
Total classified assets.. $ 372,502 $ 353,738 $ 228,403 $ 95,073 $50,015
========= ========= ========= ======== =======
Nonperforming assets to
total assets.............. 5.37% 4.99% 2.43% 0.85% 0.42%
==== ==== ==== ==== ====
Classified assets to total 8.49% 7.53% 4.46% 1.67% 1.00%
assets.................... ==== ==== ==== ==== ====
- --------
(1) For presentation purposes, NPAs include REO net of REO GVA.
23
The following tables present the quarterly data for 1993 and 1992 of
Fidelity's net classified assets:
MARCH 31, 1993 JUNE 30, 1993 SEPTEMBER 30, 1993 DECEMBER 31, 1993
-------------- ------------- ------------------ -----------------
(DOLLARS IN THOUSANDS)
Nonperforming assets:
Nonaccruing loans...... $126,349 $ 96,419 $ 88,412 $ 93,475
REO.................... 145,349 157,466 151,574 142,146
-------- -------- -------- --------
Total nonperforming
assets............... 271,698 253,885 239,986 235,621
-------- -------- -------- --------
Performing loans with
increased risk......... 117,478 95,975 103,769 125,720
Other classified assets:
Real estate held for
investment............ 10,803 10,702 11,371 11,161
Other assets........... -- -- -- --
-------- -------- -------- --------
Total classified
assets............... $399,979 $360,562 $355,126 $372,502
======== ======== ======== ========
Nonperforming assets
to total assets...... 5.72% 5.61% 5.40% 5.37%
======== ======== ======== ========
Classified assets to
total assets......... 8.43% 7.97% 7.99% 8.49%
======== ======== ======== ========
MARCH 31, 1992 JUNE 30, 1992 SEPTEMBER 30, 1992 DECEMBER 31, 1992
-------------- ------------- ------------------ -----------------
(DOLLARS IN THOUSANDS)
Nonperforming assets:
Nonaccruing loans...... $116,774 $108,264 $118,832 $112,041
REO.................... 60,814 81,547 117,421 122,364
-------- -------- -------- --------
Total nonperforming
assets............... 177,588 189,811 236,253 234,405
-------- -------- -------- --------
Performing loans with
increased risk......... 58,127 73,380 133,218 108,442
Other classified assets:
Real estate held for
investment............ 12,428 12,341 12,253 10,891
Other assets........... -- -- -- --
-------- -------- -------- --------
Total classified
assets............... $248,143 $275,532 $381,724 $353,738
======== ======== ======== ========
Nonperforming assets
to total assets...... 3.53% 3.94% 4.93% 4.99%
======== ======== ======== ========
Classified assets to
total assets......... 4.93% 5.71% 7.96% 7.53%
======== ======== ======== ========
Loans meeting certain criteria are accounted for as ISFs. These
substantially foreclosed assets are recorded at the lower of the loan's book
value or at the estimated fair value of the collateral at the date the loan
was determined to be in-substance foreclosed. These assets are reported as
"real estate owned" as if they were formally foreclosed real estate. The
estimated fair value is based on the net amount that the Bank could reasonably
expect to receive for the asset in a current sale between a willing buyer and
a willing seller, that is, other than in a forced or liquidation sale.
Inherent in the estimated fair value of these properties are assumptions about
the length of time the Bank may have to hold the property before disposition.
The holding costs through the expected date of sale and estimated disposition
costs are considered in the valuations.
CREDIT LOSS EXPERIENCE
Credit losses are inherent in the business of originating and retaining real
estate loans. As previously discussed, the Bank, in an effort to identify and
mitigate the risk of credit losses in a timely manner, performs periodic
reviews of any asset that has been identified as having potential excess
credit risk. The Bank maintains specific departments with responsibility for
resolving problem loans and selling real estate acquired through foreclosure
to facilitate this process. Valuation allowances for estimated potential
future losses are established on a specific and general basis for loans and
real estate owned. Specific reserves for individual
24
assets are determined by the excess of the recorded investment over the fair
market value of the collateral or property when it is probable that the asset
has been impaired. General valuation allowances are provided for losses
inherent in the loan and real estate portfolios which have yet to be
specifically identified. The GVA is based upon a number of factors, including
historical loss experience, composition of the loan and real estate portfolios,
loan delinquency experience patterns, loan classifications, prevailing and
forecasted economic conditions and management's judgment. A more detailed
discussion of the Bank's policies for determining valuation allowances is
presented in Item 7. "MD&A--Asset Quality" and in Note 6 to the consolidated
financial statements. See also "Real Estate Acquired in Settlement of Loans."
The following table sets forth Fidelity's GVA and specific reserves by loan
or real estate portfolio as of December 31, 1993:
LOANS REO TOTAL
------- ------- --------
(DOLLARS IN THOUSANDS)
GVA.................................................... $71,578 $ 8,442 $ 80,020
Specific reserves...................................... 12,254 9,273 21,527
------- ------- --------
$83,832 $17,715 $101,547
======= ======= ========
The following summarizes Fidelity's GVA to total loans and real estate owned
and GVA to NPAs for the period indicated:
YEAR ENDED DECEMBER 31,
---------------------------------
1993 1992 1991 1990 1989
----- ----- ----- ----- -----
GVA to total loans and REO (including
ISFs)(1)................................... 2.03% 1.82% 1.13% 0.32% 0.18%
===== ===== ===== ===== =====
GVA to NPAs (2)............................. 32.79% 30.49% 41.99% 34.14% 38.38%
===== ===== ===== ===== =====
- --------
(1) Loans and REO in this ratio are calculated prior to the reduction for loan
and REO GVA, but are net of specific reserves.
(2) NPAs in this ratio are calculated prior to the reduction for REO GVA.
The following summarizes the activity in Fidelity's allowance for estimated
loan losses for the periods indicated:
YEAR ENDED DECEMBER 31,
----------------------------------------------
1993 1992 1991 1990 1989
-------- -------- -------- ------- -------
(DOLLARS IN THOUSANDS)
Balance at beginning of period. $ 64,277 $ 52,374 $ 16,552 $ 7,336 $ 2,545
Provision for estimated loan
losses....................... 65,100 51,180 49,843 11,039 8,359
Transfer to real estate GVA... -- (12,400) -- -- --
Charge-offs................... (50,504) (27,350) (17,005) (1,841) (3,680)
Recoveries and other.......... 4,959 473 2,984 18 112
-------- -------- -------- ------- -------
Balance at end of period....... $ 83,832 $ 64,277 $ 52,374 $16,552 $ 7,336
======== ======== ======== ======= =======
Charge-offs to average loans 1.28% 0.61% 0.36% 0.04% 0.09%
outstanding................... ==== ==== ==== ==== ====
25
The following table presents loan and REO charge-offs by property type and
year of loan origination for the year ended December 31, 1993:
YEAR OF ORIGINATION
----------------------------------------------
TOTAL 1992 1991 1990 1989 1988 1979 TO 1987
----- ---- ---- ----- ----- ----- ------------
(DOLLARS IN MILLIONS)
PROPERTY TYPE:
Single family................... $ 3.5 $ -- $0.3 $ 2.1 $ 0.8 $ 0.3 $ --
Multifamily:
2 to 4 units................... 5.0 -- 0.1 3.6 0.8 0.4 0.1
5 to 36 units.................. 44.0 0.1 6.0 21.7 7.4 4.5 4.3
37 units and over.............. 21.8 -- 0.8 9.1 0.9 5.0 6.0
----- ---- ---- ----- ----- ----- -----
Total multifamily............. 70.8 0.1 6.9 34.4 9.1 9.9 10.4
Commercial and industrial....... 5.1 -- -- -- 0.5 1.1 3.5
----- ---- ---- ----- ----- ----- -----
Total charge-offs............. $79.4 $0.1 $7.2 $36.5 $10.4 $11.3 $13.9
===== ==== ==== ===== ===== ===== =====
The following table presents loan and REO charge-offs by property type and
year of loan origination for the year ended December 31, 1992:
YEAR OF ORIGINATION
-------------------------------------------
TOTAL 1991 1990 1989 1988 1977 TO 1987
----- ---- ----- ---- ---- ------------
(DOLLARS IN MILLIONS)
PROPERTY TYPE:
Single Family...................... $ 1.7 $0.2 $ 1.1 $0.3 $ -- $ 0.1
Multifamily:
2 to 4 units...................... 2.2 -- 1.9 0.3 --
5 to 36 units..................... 12.4 0.2 7.7 2.1 0.3 2.1
37 units and over................. 13.2 0.7 1.6 3.5 4.0 3.4
----- ---- ----- ---- ---- -----
Total multifamily................ 27.8 0.9 11.2 5.9 4.3 5.5
Commercial and industrial.......... 11.7 -- 0.7 -- 0.7 10.3
----- ---- ----- ---- ---- -----
Total charge-offs................ $41.2 $1.1 $13.0 $6.2 $5.0 $15.9
===== ==== ===== ==== ==== =====
The following table presents Fidelity's real estate loan portfolio (including
loans held for sale) as of December 31, 1993 by year of origination and type of
security:
YEAR OF ORIGINATION
----------------------------------------------------------------
1987 AND
TOTAL 1993 1992 1991 1990 1989 1988 PRIOR
---------- -------- -------- -------- -------- -------- -------- ----------
(DOLLARS IN THOUSANDS)
Property type:
Single family.......... $ 792,054 $118,802 $ 54,035 $ 40,417 $105,854 $ 73,466 $149,435 $ 250,045
Multifamily:
2 to 4 units......... 505,219 36,822 23,892 50,069 139,430 77,837 100,182 76,987
5 to 36 units........ 1,795,374 92,798 118,176 205,279 479,998 216,091 273,376 409,656
37 units and over.... 406,330 12,861 15,753 8,049 59,566 75,111 62,990 172,000
---------- -------- -------- -------- -------- -------- -------- ----------
Total multifamily.. 2,706,923 142,481 157,821 263,397 678,994 369,039 436,548 658,643
Commercial and
industrial............ 300,589 1,332 815 1,821 11,532 53,936 65,239 165,914
---------- -------- -------- -------- -------- -------- -------- ----------
Total mortgage
loans receivable.. $3,799,566 $262,615 $212,671 $305,635 $796,380 $496,441 $651,222 $1,074,602
========== ======== ======== ======== ======== ======== ======== ==========
Loans by year of
origination to total... 100.0% 6.9% 5.6% 8.0% 21.0% 13.1% 17.1% 28.3%
========== ======== ======== ======== ======== ======== ======== ==========
26
During the years 1990, 1989 and 1988, Fidelity originated loans at peak
levels totaling $1,211.3 million, $897.6 million and $1,467.1 million,
respectively. During 1993, the Bank reserved and/or charged off amounts
corresponding to these peak origination years totaling $36.5 million, $10.4
million and $11.3 million, respectively. These losses were due primarily to the
decline of the California economy and real estate market. Multifamily (5 or
more units) and commercial loans accounted for a substantial percentage of such
losses, and as a result, the Bank has reduced recent loan origination
activities in these areas. However, continued downward pressure on the economy
and real estate market could lead to additional losses in these portfolios.
The high level of provisions for loss and charge-offs during 1993, 1992 and
1991 is primarily due to a depressed market for real estate in Southern
California. If recent economic trends do not abate, it is likely that
additional charge-offs and reserves will be required and if future declines in
the Southern California economy and real estate market are substantial, it is
likely that the future corresponding charge-offs and reserves will also be
significant.
FORECLOSURE POLICIES
The Bank typically initiates foreclosure proceedings between 30 and 90 days
after a borrower defaults on a loan. The proceedings take at least four months
before the collateral for the loan can be sold at "foreclosure" auction, and
this period can be extended under certain circumstances, such as, if the
borrower files bankruptcy or if the Bank enters into negotiations with the
borrower to restructure the loan. In California, foreclosure proceedings almost
always take the form of a nonjudicial foreclosure, upon the completion of which
the lender is left without recourse against the borrower for any deficiency or
shortfall from the difference between the value of the collateral and the
amount of the loan, and in most cases the Bank ends up with title to the
property. In some cases, while the foreclosure proceedings are under way, the
borrower requests forbearance from collection efforts, more time to cure the
default, or a restructuring of the loan. The Bank agrees to such a request if
it determines that the loan, as modified, is likely to result in a greater
ultimate recovery than taking title to the property. Among the factors the Bank
considers in granting the borrower a concession is the extent to which the
borrower pays down the loan, furnishes more collateral or makes a further
investment in the property by way of repairs or refurbishment, and demonstrates
an awareness and ability to manage the property according to a reasonable
operating plan.
REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS
Real estate acquired in settlement of loans results when property
collateralizing a loan is foreclosed upon or otherwise acquired in satisfaction
of the loan and the Bank takes title to the property. This property owned by
the Bank is included in REO. The Bank experiences foreclosures as part of the
normal process of conducting its primary business activity, real estate
lending. Certain loans are also included in REO when they exhibit
characteristics more closely associated with the risk of real estate ownership
than with loans. These loans are designated in-substance foreclosures if they
meet the following criteria: (a) the borrower currently has little or no equity
at fair market value in the underlying collateral; (b) the only source of
repayment is the property securing the loan; and (c) the borrower has abandoned
the property or will not be able to rebuild equity in the foreseeable future.
Collateral that has been categorized as ISF is reported in the same manner as
property that is owned by the Bank. ISFs and property owned by the Bank differ
in one key respect: the Bank can only sell or dispose of property it owns. As
with any loan, it must complete foreclosure of an ISF before it can sell the
underlying collateral.
As a result of the adoption of SFAS No. 114, beginning January 1, 1994, loans
that meet the criteria for ISF designation will no longer be reported as REO,
although they will continue to be valued based on the fair value of the
collateral and will generally continue to be included in NPAs.
27
The following table presents Fidelity's net REO, including ISF, by property
type at the dates indicated:
DECEMBER 31,
------------------------------------------
1993 1992 1991 1990 1989
-------- -------- ------- ------- ------
(DOLLARS IN THOUSANDS)
Property Type:
Single family...................... $ 6,942 $ 7,014 $ 3,032 $ 1,202 $1,276
Multifamily:
2 to 4 units...................... 10,345 4,129 695 -- --
5 to 36 units..................... 41,177 32,535 8,674 253 253
37 units and over................. 47,565 40,924 15,040 1,518 1,606
-------- -------- ------- ------- ------
Total Multifamily................ 99,087 77,588 24,409 1,771 1,859
Commercial and industrial.......... 44,559 51,381 28,302 15,334 5,490
REO GVA............................ (8,442) (13,619) -- -- --
-------- -------- ------- ------- ------
Total REO(1)...................... $142,146 $122,364 $55,743 $18,307 $8,625
======== ======== ======= ======= ======
Total ISFs included above.......... $ 28,362 $ 47,324 $25,490 $ -- $ --
======== ======== ======= ======= ======
- --------
(1) Foreclosed real estate is shown net of first trust deed loans to others,
where applicable.
28
The following table presents the Bank's real estate acquired in settlement of
loans (ISF is excluded) by location and property type at December 31, 1993:
MULTIFAMILY COMMERCIAL AND INDUSTRIAL
------------------------ -----------------------------
SINGLE 2 TO 4 5 TO 36 37 UNITS HOTEL/ OFFICE
FAMILY UNITS UNITS AND OVER MOTEL BUILDING CONSTRUCTION OTHER TOTAL
------ ------- ------- -------- ------- -------- ------------ ------ --------
(DOLLARS IN THOUSANDS)
California:
Southern California
Counties:
Los Angeles.......... $3,703 $ 5,895 $19,621 $21,638 $ 6,585 $1,603 $2,351 $2,200 $ 63,596
Orange............... 502 1,410 4,677 5,484 -- 5,490 -- 222 17,785
San Bernardino....... -- 1,228 2,308 13,837 -- -- -- 600 17,973
Riverside............ 326 1,069 2,794 -- -- -- -- 826 5,015
San Diego............ 830 211 250 1,249 1,885 -- -- -- 4,425
Ventura.............. 606 -- -- -- -- 363 -- -- 969
Other................ -- 532 -- -- -- -- -- -- 532
------ ------- ------- ------- ------- ------ ------ ------ --------
5,967 10,345 29,650 42,208 8,470 7,456 2,351 3,848 110,295
------ ------- ------- ------- ------- ------ ------ ------ --------
Northern California
Counties:
Santa Clara.......... 209 -- -- -- -- 2,498 -- -- 2,707
Other................ 54 -- -- -- -- -- -- -- 54
------ ------- ------- ------- ------- ------ ------ ------ --------
263 -- -- -- -- 2,498 -- -- 2,761
------ ------- ------- ------- ------- ------ ------ ------ --------
Total California....... 6,230 10,345 29,650 42,208 8,470 9,954 2,351 3,848 113,056
------ ------- ------- ------- ------- ------ ------ ------ --------
Hawaii.................. 712 -- -- -- -- -- -- -- 712
Florida................. -- -- -- -- 7,823 -- -- -- 7,823
Washington.............. -- -- -- -- -- -- -- 635 635
------ ------- ------- ------- ------- ------ ------ ------ --------
Total out-of-state.... 712 -- -- -- 7,823 -- -- 635 9,170
------ ------- ------- ------- ------- ------ ------ ------ --------
Total REO............... $6,942 $10,345 $29,650 $42,208 $16,293 $9,954 $2,351 $4,483 $122,226
====== ======= ======= ======= ======= ====== ====== ====== ========
The following table presents the Bank's ISF by location and property type at
December 31, 1993:
MULTIFAMILY COMMERCIAL AND INDUSTRIAL
------------------------ -----------------------------
SINGLE 2 TO 4 5 TO 36 37 UNITS HOTEL/ OFFICE
FAMILY UNITS UNITS AND OVER MOTEL BUILDING CONSTRUCTION OTHER TOTAL
------ ------- ------- -------- ------- -------- ------------ ------ --------
(DOLLARS IN THOUSANDS)
California:
Southern California
Counties:
Los Angeles.......... $ -- $ -- $ 9,078 $ 5,357 $ -- $ -- $ -- $ 133 $ 14,568
Orange............... -- -- 2,155 -- -- -- -- -- 2,155
San Diego............ -- -- 294 -- -- -- -- -- 294
San Bernardino....... -- -- -- -- -- -- -- 509 509
------ ------- ------- ------- ------- ------ ------ ------ --------
Total California....... -- -- 11,527 5,357 -- -- -- 642 17,526
------ ------- ------- ------- ------- ------ ------ ------ --------
Hawaii.................. -- -- -- -- 10,388 -- -- -- 10,388
Pennsylvania............ -- -- -- -- 448 -- -- -- 448
------ ------- ------- ------- ------- ------ ------ ------ --------
Total out-of-state.... -- -- -- -- 10,836 -- -- -- 10,836
------ ------- ------- ------- ------- ------ ------ ------ --------
Total ISFs.............. $ -- $ -- $11,527 $ 5,357 $10,836 $ -- $ -- $ 642 $ 28,362
====== ======= ======= ======= ======= ====== ====== ====== ========
In the current market, the Bank rarely sells REO for a price equal to or
greater than the loan balance, and the losses suffered are impacted by the
market factors discussed elsewhere in this report. REO is recorded at
acquisition at the lower of the recorded investment in the subject loan or the
fair market value of the assets received. The fair market value of the assets
received is based upon a current appraisal adjusted for estimated carrying,
rehabilitation and selling costs. Income-producing properties acquired by the
Bank through foreclosure are managed by third party contract managers, under
the supervision of Bank personnel. During 1993 and 1992, the Bank's policy has
been generally to proceed promptly to market the properties acquired through
foreclosure, and the Bank often makes financing terms available to buyers of
such properties.
29
Generally, the Bank experiences higher losses on sale of REO properties for all
cash, as opposed to financing the sale, although when it finances the sale, the
Bank incurs the risk that the loan may not be repaid in full. During 1993, the
Bank sold 210 REO properties for net sales proceeds of $83.5 million, with a
gross book and net book value totaling $138.5 million and $89.8 million,
respectively. This compares to 43 properties sold in 1992 for net sales
proceeds of $25.6 million, with a gross book and net book value of $34.9
million and $27.6 million, respectively. The Bank made 107 loans in connection
with the sale of REO for the year ended December 31, 1993 for a total of
$51.6 million. Of these, $10.9 million contained terms favorable to the
borrower that were not available for the purchase of non-REO property. The
comparable data for 1992 were 15 loans for $11.2 million, of which $10.7
million were made with favorable terms.
The following table shows real estate sold by property type during the years
indicated:
1993 1992
-------------------------- --------------------------
NO. OF NET BOOK VALUE NO. OF NET BOOK VALUE
PROPERTIES AT DATE OF SALE PROPERTIES AT DATE OF SALE
---------- --------------- ---------- ---------------
(DOLLARS IN THOUSANDS)
Single family............ 61 $12,932 20 $ 3,546
Multifamily:
2 to 4 units........... 21 4,248 6 529
5 to 36 units.......... 109 53,496 9 6,386
37 units and over...... 14 17,919 4 11,773
--- ------- --- -------
Total multifamily..... 144 75,663 19 18,688
Commercial & industrial.. 5 1,227 4 5,401
--- ------- --- -------
210 $89,822 43 $27,635
=== ======= === =======
Direct costs of foreclosed real estate operations totaled $18.8 million, $3.6
million and $1.1 million for the years ended December 31, 1993, 1992 and 1991
respectively. The large increase in 1993 over 1992 is due primarily to an
increase in the number of properties foreclosed in 1993 over 1992. During 1993,
the Bank foreclosed on 282 properties with a gross book value of $204.7 million
compared to 139 properties with a gross book value of $112.9 million, during
1992. The average number of REOs held during 1993 was 205 compared to 117
during 1992. Property tax expense on foreclosed property for the year ended
1993 was $5.1 million (at the time of foreclosure, a typical property was
delinquent for three property tax payments). Due to the deterioration in the
real estate market in Southern California, property tax assessments are
generally higher than the appraised value of REO properties at the time of
foreclosure. The Bank's policy is to appeal all property tax valuations on REO
property at the time of acquisition.
INVESTMENT ACTIVITIES
As a matter of prudent business practice, Fidelity maintains assets that are
easily liquidated or otherwise saleable to meet unexpected funding
requirements.
Fidelity also is required by federal regulations to maintain a minimum level
of liquid assets which may be invested in certain government and other
specified securities. See "Regulation and Supervision--Required Liquidity."
Investment decisions are made within guidelines approved by Fidelity's Board of
Directors. Such investments are managed in an effort to produce a yield
consistent with maintaining safety of principal and compliance with applicable
regulations.
30
The Company's securities portfolio consisted of the following at the dates
indicated:
DECEMBER 31,
-----------------------------------------------------
1993 1992 1991
----------------- ----------------- -----------------
WEIGHTED WEIGHTED WEIGHTED
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
-------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Federal funds sold....... $ 60,000 3.00% $ -- --% $ -- --%
-------- -------- --------
Investment securities:
Held for sale:
U.S. Government and
agency obligations... 87,385 4.59 -- -- -- --
Other investments..... 4,874 5.07 -- -- -- --
-------- -------- --------
92,259 4.65 -- -- -- --
-------- -------- --------
Held for investment:
U.S. Government
obligations.......... -- -- 24,950 8.54 32,916 8.55
Commercial paper...... -- -- 29,986 3.92 980 5.15
Other investments..... -- -- 12,401 4.65 -- --
-------- -------- --------
-- -- 67,337 5.77 33,896 8.45
-------- -------- --------
Total investment
securities.......... 92,259 4.65 67,337 5.77 33,896 8.45
-------- -------- --------
Mortgage-backed
securities:
Held for sale:
FHLMC................. 34,184 5.13 -- -- -- --
FNMA.................. 14,853 4.67 -- -- -- --
Participation
Certificates......... 38,223 5.87 -- -- -- --
CMO................... 3,848 4.39 -- -- -- --
-------- -------- --------
91,108 5.33 -- -- -- --
-------- -------- --------
Held for investment:
FHLMC................. -- -- 102,476 5.89 15,733 8.63
GNMA.................. -- -- 14,466 8.24 16,941 8.17
FNMA.................. -- -- 113,442 6.54 -- --
-------- -------- --------
-- -- 230,384 6.36 32,674 8.39
-------- -------- --------
Total mortgage-backed
securities.......... 91,108 5.33 230,384 6.36 32,674 8.39
-------- -------- --------
FHLB and FRB stock....... 52,151 3.20 50,574 1.47 49,245 6.16
-------- -------- --------
$295,518 4.27% $348,295 5.54% $115,815 7.46%
======== ======== ========
31
The following table summarizes the maturity and weighted average yield of the
Company's investment securities at December 31, 1993:
MATURES IN
--------------------------------------------------------------------
1999 THROUGH 2003 AND
TOTAL 1994 1995 THROUGH 1998 2003 THEREAFTER
----------------- ----------------- ----------------- --------------- ----------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
-------- -------- -------- -------- -------- -------- ------ -------- ------- --------
(DOLLARS IN THOUSANDS)
Federal funds sold...... $ 60,000 3.00% $ 60,000 3.00% $ -- --% $ -- --% $ -- --%
Investment securities
held for sale:
U.S. Government and
agency obligations.... 87,385 4.59 145 3.52 87,240 4.59 -- -- -- --
Other investments...... 4,874 5.07 1,156 3.91 3,446 5.91 272 6.19 -- --
-------- -------- -------- ---- -------
Total investment
securities............ 92,259 4.65 1,301 3.87 90,686 4.65 272 6.19 -- --
Mortgage-backed
securities held for
sale................... 91,108 5.33 -- -- 48,832 5.05 -- -- 42,276 5.66
FHLB and FRB Stock...... 52,151 3.20 52,151 3.20 -- -- -- -- -- --
-------- -------- -------- ---- -------
$295,518 4.27% $113,452 3.10% $139,518 4.79% $272 6.19% $42,276 5.66%
======== ======== ======== ==== =======
Interest income from the investment portfolio contributed 6.5%, 3.9% and 4.3%
of the Company's total revenue not including the impact of real estate loss
provisions and direct costs of real estate operations, for the years ended
December 31, 1993, 1992 and 1991, respectively.
SOURCES OF FUNDS
The Company derives funds from deposits, FHLB Advances, securities sold under
agreements to repurchase, and other short-term and long-term borrowings. In
addition, funds are generated from loan payments and payoffs as well as from
the sale of loans and investments.
Deposits
The largest source of funds for the Company is deposits. Customer deposits
are insured by the FDIC up to $100,000 per account. The Company has several
types of deposit accounts designed to attract both short-term and long-term
deposits. The following table sets forth the weighted average interest rates
paid by the Company and the amounts of deposits held by the Company at the
dates indicated:
WEIGHTED AVERAGE
RATES AT DECEMBER 31, DECEMBER 31,
--------------------- --------------------------------
1993 1992 1991 1993 1992 1991
------- ------- ------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Checking--no minimum
term:
NOW.................... 1.0% 1.6% 3.0% $ 263,192 $ 257,575 $ 204,454
Money market checking.. 1.8 1.8 3.8 50,840 49,289 62,837
Noninterest bearing.... -- -- -- 52,936 31,632 14,091
Savings--no minimum
term:
Passbook............... 2.0 2.5 4.0 82,168 74,738 58,817
Money market savings... 2.4 2.8 4.6 280,474 427,978 414,482
Certificate accounts:
Original term:
Less than 3 months.... 2.8 3.0 5.1 118,697 108,399 99,525
3 months to 5 months.. 3.4 3.2 5.3 601,419 230,396 282,741
6 months to 11 months. 3.3 3.4 6.1 740,741 1,009,970 1,691,551
12 months to 23
months............... 4.2 4.7 6.4 601,382 614,581 621,625
24 months to 59
months............... 5.3 6.6 7.2 228,194 325,764 287,752
60 months and over.... 6.9 7.1 7.7 348,600 327,596 146,832
---------- ---------- ----------
3.6% 4.0% 5.9% $3,368,643 $3,457,918 $3,884,707
========== ========== ==========
32
The following table provides additional deposit information by remaining
maturity at December 31, 1993:
REMAINING MATURITY
-----------------------------------------------------------------------------------------
OVER OVER OVER OVER
3 MONTHS 6 MONTHS 12 MONTHS 24 MONTHS
INDETERMINATE 3 MONTHS BUT WITHIN BUT WITHIN BUT WITHIN BUT WITHIN OVER
MATURITY OR LESS 6 MONTHS 12 MONTHS 24 MONTHS 36 MONTHS 36 MONTHS TOTAL
------------- ---------- ---------- ---------- ---------- ---------- --------- ----------
(DOLLARS IN THOUSANDS)
Passbook, 2.00% and
2.50% at December 31,
1993 and 1992.......... $ 82,168 $ -- $ -- $ -- $ -- $ -- $ -- $ 82,168
Checking and money
market checking, 0.96%
and 1.48% at December
31, 1993 and 1992...... 366,968 -- -- -- -- -- -- 366,968
Money market passbook,
2.37% and 2.79% at
December 31, 1993 and
1992................... 280,474 -- -- -- -- -- -- 280,474
Certificate Accounts:
Under 3.00%............ -- 290,813 127,298 121 65 8 21 418,326
3.01--4.00%............ -- 623,389 556,413 123,412 23,050 185 -- 1,326,449
4.01--5.00%............ -- 87,639 74,716 48,148 171,365 10,049 3,212 395,129
5.01--6.00%............ -- 53,840 36,897 4,833 9,870 232 32,038 137,710
6.01--7.00%............ -- 739 8,518 11,587 1,103 34,955 168,133 225,035
7.01--8.00%............ -- 1,018 4,900 21,764 3,979 45,709 12,910 90,280
Over 8.01%............. -- 4,549 8,053 8,827 11,359 473 12,843 46,104
-------- ---------- -------- -------- -------- ------- -------- ----------
Total deposits....... $729,610 $1,061,987 $816,795 $218,692 $220,791 $91,611 $229,157 $3,368,643
======== ========== ======== ======== ======== ======= ======== ==========
Certificates of deposits of $100,000 or more accounted for $592.7 million and
represented 17.6% of all deposits at December 31, 1993; $549.5 million or 15.9%
of all deposits at December 31, 1992 and $628.5 million or 16.2% of all
deposits at December 31, 1991. Fidelity intends to continue to use such
certificates of deposit as a source of funds to manage its liquidity. However,
a significant increase is not currently expected.
The following table summarizes certificates of deposit of $100,000 or more by
remaining maturity and weighted average rate at December 31, 1993:
PERCENT OF WEIGHTED
REMAINING TERM TO MATURITY AMOUNT TOTAL DEPOSITS AVERAGE RATE
-------------------------- -------- -------------- ------------
(IN MONTHS) (DOLLARS IN THOUSANDS)
Three or less....................... $242,949 7.2% 3.56%
Over three to six................... 155,795 4.6 3.82
Over six to twelve.................. 75,677 2.3 4.56
Over twelve......................... 118,307 3.5 5.92
-------- ----
$592,728 17.6% 4.23%
======== ====
33
The distribution of certificate accounts by date of maturity is an important
indicator of the relative stability of a major source of lendable funds. Longer
term certificate accounts generally provide greater stability as a source of
lendable funds, but currently entail greater interest costs than passbook
accounts. The following table summarizes certificate accounts by maturity, as a
percentage of total deposits and weighted average rate at December 31, 1993:
CERTIFICATE ACCOUNTS PERCENT OF WEIGHTED
MATURING IN QUARTER ENDING AMOUNT TOTAL DEPOSITS AVERAGE RATE
-------------------------- ---------------------- -------------- ------------
(DOLLARS IN THOUSANDS)
March 31, 1994........... $1,061,987 31.5% 3.55%
June 30, 1994............ 816,795 24.2 3.71
September 30, 1994....... 119,672 3.6 4.50
December 31, 1994........ 99,020 2.9 4.51
March 31, 1995........... 79,247 2.4 4.38
June 30, 1995............ 67,399 2.0 4.56
September 30, 1995....... 40,687 1.2 4.95
December 31, 1995........ 33,458 1.0 4.67
March 31, 1996........... 5,349 0.2 6.16
June 30, 1996............ 21,394 0.6 6.84
September 30, 1996....... 36,075 1.1 6.98
December 31, 1996........ 28,793 0.9 6.65
After December 31, 1996.. 229,157 6.8 6.60
---------- ----
$2,639,033 78.4% 4.14%
========== ====
The Bank also utilizes brokered deposits as a short-term means of funding.
These deposits are obtained or placed by or through a deposit broker and are
subject to certain regulatory limitations. Should the Bank become
undercapitalized, it would be prohibited from accepting, renewing or rolling
over deposits obtained through a deposit broker. See "Regulation and
Supervision--FDICIA Prompt Corrective Action Requirements." The following table
summarizes the Bank's outstanding balance of brokered deposits at the dates
indicated:
PERCENT
OF TOTAL
DECEMBER 31, AMOUNT DEPOSITS
------------ ------------ ------------
(DOLLARS IN THOUSANDS)
1993............................................ $92,196 2.74%
1992............................................ $12,850 0.37%
1991............................................ -- --
Borrowings
The Company utilizes borrowings from the FHLB System ("FHLB Advances") as a
source of funds for operations. The FHLB System functions as a source of credit
to savings institutions which are members of a Federal Home Loan Bank. See
"Regulation and Supervision--Federal Home Loan Bank System." Fidelity may apply
for advances from the FHLB secured by the capital stock of the FHLB owned by
Fidelity and certain of Fidelity's mortgages and other assets (principally
obligations issued or guaranteed by the United States Government or agencies
thereof). Advances can be requested for any business purpose in which Fidelity
is authorized to engage, except that advances with a term greater than 5 years
can be granted only for the purpose of providing funds for residential housing
finance. In granting advances, the FHLB considers a member's creditworthiness
and other relevant factors. FHLB Advances to Fidelity totaled $326.4 million,
$581.4 million, and $325.0 million at December 31, 1993, 1992 and 1991,
respectively. The decreased use of FHLB Advances in 1993 as a source of funds
results primarily from the use of commercial paper, which is less costly, as an
alternate source of funds. Fidelity's available FHLB line of credit is based
primarily on a portion of Fidelity's residential loan portfolio pledged for
such purpose, up to a maximum 25% of total assets.
34
At December 31, 1993, Fidelity's remaining available line of credit was $297.7
million, after deducting outstanding advances and a $304.0 million backup
letter of credit for outstanding commercial paper, as described below.
The Company also utilizes the capital markets to obtain funds for its lending
operations. This source has been used for long-term borrowings in the past and
can be utilized in the future. Details on borrowings on the Company's books for
all or part of 1993 are as follows:
. Mortgage-backed medium-term notes, Series A, with a fixed interest rate
of 8 7/8%. These notes had a balance of $100 million, matured and were
paid off on May 15, 1993.
. Commercial mortgage-backed bonds, with a fixed interest rate of 9 3/4%.
These bonds had a balance of $62 million, matured and were paid off on
September 15, 1993.
. 8 1/2% Mortgage-backed medium-term notes, Series A, due April 15, 1997
(the "1997 MTNs"). At December 31, 1993, the 1997 MTNs had a balance of
$100 million. The 1997 MTNs are secured by mortgage loans and U.S.
Treasury notes with a combined principal balance of $255.7 million at
December 31, 1993.
During 1992, the Bank started issuing commercial paper, backed by a $400
million letter of credit from the FHLB of San Francisco to ensure a high
quality investment grade rating. The letter of credit commitment varies with
the level of commercial paper outstanding, and the FHLB line of credit for
advances described above increases or decreases accordingly. Commercial paper
outstanding totaled $304 million and $65 million at December 31, 1993 and 1992,
respectively. All commercial paper outstanding at December 31, 1993 matures
within 120 days with an average interest rate of 3.38%.
From time to time, Fidelity enters into reverse repurchase agreements by
which it sells securities with an agreement to repurchase the same securities
at a specific future date (overnight to 30 days). Fidelity deals only with
dealers perceived by management to be financially strong and who are recognized
as primary dealers in U.S. Treasury securities by the Federal Reserve Board.
Reverse repurchase agreements outstanding totaled $3.8 million at December 31,
1993.
In May 1990, Fidelity issued the Notes which were approved by the OTS as
additional regulatory risk-based capital. The Notes were issued to
institutional investors in the amount of $60 million, with interest payable
semiannually at 11.68% per annum and are repayable in five equal annual
installments commencing May 15, 1996. See "Recent Developments--Internal
Reorganization and Restructuring," Item 3. "Legal Proceedings and Item 7.
"MD&A--Capital Resources and Liquidity" for a description of certain litigation
relating to the Notes and certain circumstances that may result in the Notes
and outstanding FHLB Advances being declared due and payable and/or the
unavailability of funds under the Bank's commercial paper program and the FHLB
credit line.
35
The following table sets forth certain information as to the Company's FHLB
Advances, other borrowings and subordinated notes at the dates indicated:
DECEMBER 31,
----------------------------
1993 1992 1991
-------- -------- --------
(DOLLARS IN THOUSANDS)
FHLB Advances:
Fixed rate advances........ $110,000 $ 40,000 $ 20,000
Floating rate advances..... 216,400 541,400 305,000
-------- -------- --------
326,400 581,400 325,000
-------- -------- --------
Borrowings:
Mortgage-backed
notes/bonds:
Fixed rate bonds.......... -- 62,000 62,000
Fixed rate notes.......... 100,000 200,000 200,000
Floating rate bonds....... -- -- 65,950
Floating rate notes....... -- -- 200,000
-------- -------- --------
100,000 262,000 527,950
Commercial paper........... 304,000 65,000 --
Securities sold under
agreements to repurchase.. 3,830 -- --
Other...................... -- -- 3,200
-------- -------- --------
407,830 327,000 531,150
Related party loan......... -- -- 15,000
Subordinated notes......... 60,000 60,000 60,000
-------- -------- --------
Total borrowings........ $794,230 $968,400 $931,150
======== ======== ========
Weighted average interest 5.12% 5.91% 7.47%
rate on all borrowings..... ==== ==== ====
For more information on the Company's borrowings see Notes 9 and 10 to the
consolidated financial statements.
Loan Repayments and Loan Sales
Another important source of funds for the Company is the repayment of loans
it has made and sales of loans. Receipts from loan repayments (scheduled and
unscheduled) and sales of loans, net of repurchases, were approximately $690
million, $878 million, and $926 million for the years ended December 31, 1993,
1992 and 1991, respectively. See "Mortgage Banking Group Operations."
INTEREST RATE RISK MANAGEMENT
Net interest income is the difference between interest earned on the
Company's loans and investment securities and interest paid on its deposits and
borrowings. Net interest income is affected by the interest rate spread, which
is the difference between the rates earned on its interest-earning assets and
rates paid on its interest-bearing liabilities, as well as the relative amounts
of its interest-earning assets and interest-bearing liabilities. When interest-
earning assets exceed interest-bearing liabilities, any positive interest rate
spread will generate net interest income. The Company's average interest rate
margin for the years ended December 31, 1993, 1992 and 1991 was 2.28%, 2.67%
and 2.54%, respectively. Excluding the writedown of core deposit intangibles of
$5.2 million, the average interest rate margin for the year ended December 31,
1993 would have been 2.39%. See Item 7. "MD&A" and Note 7 to the consolidated
financial statements.
The objective of interest rate risk management is to manage interest rate
risk in a prudent manner to maximize the net income of the Bank. Banks and
savings institutions are subject to interest rate risk when assets and
liabilities mature or reprice at different times (duration risk), against
different indices (basis risk)
36
or for different terms (yield curve risk). The decision to control or accept
interest rate risk can only be made with an understanding of the probability of
various scenarios occurring. Having liabilities that reprice more quickly than
assets is beneficial when interest rates fall, but may be detrimental when
interest rates rise.
Since 1985, the Company has shifted its portfolio toward adjustable rate
mortgage loans that reprice more closely with its interest-bearing liabilities.
ARM loans comprised 96% of the total loan portfolio at December 31, 1993, 1992
and 1991. The percentage of monthly adjustable ARMs to total loans was 74.7% at
December 31, 1993 compared to 74.4% and 71.6% at December 31, 1992 and 1991,
respectively. Interest sensitive assets provide the Company with a degree of
long-term protection from rising interest rates. At December 31, 1993,
approximately 96% of Fidelity's total loan portfolio consisted of loans which
mature or reprice within one year, compared with approximately 95% at December
31, 1992 and approximately 97% at December 31, 1991. Fidelity has in recent
periods benefited from the fact that decreases in the interest rates accruing
on Fidelity's ARMs lagged the decreases in interest rates accruing on its
deposits, primarily due to the lagging effects of the COFI, the index to which
most of Fidelity's ARMs reprice. Fidelity benefited in 1992 and 1991 from the
fact that decreases in its asset yield lagged decreases in its liability cost.
During 1993, short and intermediate term rates to which most of Fidelity's
liabilities reprice, remained essentially constant. As COFI continued to
decline, the Company's interest rate spread narrowed. If market rates fall, the
Company's spread will initially improve. If market rates increase, the
Company's spread will deteriorate initially until a catch up in lag in the COFI
index. See "ARM Loans."
The Company took steps in 1993 to reduce the impact of its declining spread.
These steps include the decision not to replace expired interest rate cap
agreements, and the decision to enter into interest rate swap contracts. The
Company continues to monitor and control its interest rate risk exposure within
approved guidelines and in such a way as to avoid the need to hold extra
capital because of interest rate risk.
See Item 7. "MD&A--Interest Rate Risk Management" for a table of projected
maturities and repricing details of major financial asset and liability
categories of the Company as of December 31, 1993, for further information
regarding the Company's off-balance sheet hedging activities and a discussion
of interest rate risk capital requirements.
37
The following table presents, for the periods indicated, the Company's total
dollar amount of interest income from average interest-earning assets and the
resultant yields, as well as the interest expense on average interest-bearing
liabilities and the resultant costs, expressed both in dollars and rates. The
table also sets forth the net interest income and the net earnings balance for
the periods indicated. Average balances are computed using an average of the
daily balances during the year. Certain reclassifications have been made to
prior periods to conform to the 1993 presentation.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------
1993 1992 1991
--------------------------- --------------------------- ---------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- -------- ------- ---------- -------- ------- ---------- -------- -------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans and mortgage-
backed securities(1).. $4,136,044 $280,763 6.79% $4,421,798 $361,191 8.17% $5,034,392 $503,021 9.99%
Investment securities
and cash equivalents.. 170,504 7,189 4.22 197,873 8,791 4.44 221,117 14,032 6.35
Investment in FHLB
stock................. 51,210 1,640 3.20 50,219 740 1.47 49,891 3,071 6.16
---------- -------- ---------- -------- ---------- --------
Total interest-earning
assets................ 4,357,758 289,592 6.65 4,669,890 370,722 7.94 5,305,400 520,124 9.80
-------- -------- --------
Noninterest-earning
assets................. 220,725 182,291 232,333
---------- ---------- ----------
Total assets........... $4,578,483 $4,852,181 $5,537,733
========== ========== ==========
Interest-earning
liabilities:
Deposits:
Demand deposits....... $ 303,206 4,781 1.58 $ 282,572 6,959 2.46 $ 259,464 12,195 4.70
Savings deposits...... 451,590 19,215 4.26 497,070 24,911 5.01 430,163 30,106 7.00
Time deposits......... 2,499,076 107,622 4.31 2,853,393 143,154 5.02 3,330,847 236,316 7.09
---------- -------- ---------- -------- ---------- --------
Total deposits......... 3,253,872 131,618 4.04 3,633,035 175,024 4.82 4,020,474 278,617 6.93
Borrowings............. 1,049,291 56,773 5.41 916,836 64,917 7.04 1,188,759 99,400 8.36
---------- -------- ---------- -------- ---------- --------
Total interest-bearing
liabilities........... 4,303,163 188,391 4.37 4,549,871 239,941 5.27 5,209,233 378,017 7.26
-------- -------- --------
Noninterest-bearing
liabilities............ 43,078 76,342 106,166
Stockholders' equity.... 232,242 225,968 222,334
---------- ---------- ----------
Total liabilities and
stockholders' equity.. $4,578,483 $4,852,181 $5,537,733
========== ========== ==========
Net interest income;
Interest rate spread... $101,201 2.28%(4) $130,781 2.67% $142,107 2.54%
======== ======== ========
Net earning balance(2);
Net yield on interest-
earning assets(3)...... $ 54,595 2.33%(4) $ 120,019 2.81% $ 96,167 2.68%
========== ========== ==========
- -------
(1) Nonaccrual loans are included in the average balance column, however, only
collected interest on such loans is included in the interest column.
(2) The "net earning balance" equals the difference between the average balance
of interest-earning assets and the average balance of interest-bearing
liabilities.
(3) The net yield on interest-earning assets during the period equals (a) the
difference between the interest income on interest-earning assets and
interest expense on interest-bearing liabilities, divided by (b) average
interest-earning assets for the period.
(4) Excluding the writedown of core deposit intangibles of $5.2 million, the
interest rate spread and the net yield on interest-earning assets for the
year ended December 31, 1993, would have been 2.39% and 2.44%,
respectively.
38
The following table presents the dollar amount of changes in interest income
and expense for each major component of interest-earning assets and interest-
bearing liabilities and the amount of change attributable to changes in average
balances and average rates for the periods indicated. The net change
attributable to changes in both volume and rate, which cannot be segregated,
has been allocated proportionately to the change due to volume and the change
due to rate. Interest-bearing asset and liability balances in the calculations
are computed using the average of the daily balances during the periods.
Certain reclassifications have been made to prior periods to conform to the
1993 presentation.
YEAR ENDED DECEMBER 31,
1992
YEAR ENDED DECEMBER 31, 1993 COMPARED TO DECEMBER 31,
COMPARED TO DECEMBER 31, 1992 1991
FAVORABLE (UNFAVORABLE) FAVORABLE (UNFAVORABLE)
------------------------------- -----------------------------
VOLUME RATE NET VOLUME RATE NET
-------------------- --------- -------- -------- ---------
(DOLLARS IN THOUSANDS)
Interest income on loans
and mortgage-backed
securities............. $ (22,256) $ (58,172) $ (80,428) $(56,795) $(85,035) $(141,830)
Interest income on
investment securities
and cash equivalent.... (1,180) (422) (1,602) (1,357) (3,884) (5,241)
Investment in FHLB
stock.................. 15 885 900 20 (2,351) (2,331)
--------- --------- --------- -------- -------- ---------
Total interest income
on interest-earning
assets................ (23,421) (57,709) (81,130) (58,132) (91,270) (149,402)
Interest expense on
deposits:
Demand deposits........ (442) 2,479 2,037 (469) 5,479 5,010
Savings deposits....... 1,983 3,716 5,699 (2,768) 8,064 5,296
Time deposits.......... 15,477 20,193 35,670 28,142 65,145 93,287
--------- --------- --------- -------- -------- ---------
Total interest expense
on deposits........... 17,018 26,388 43,406 24,905 78,688 103,593
Interest expense on
borrowings............. (8,355) 16,499 8,144 20,401 14,082 34,483
--------- --------- --------- -------- -------- ---------
Total interest on
interest-bearing
liabilities........... 8,663 42,887 51,550 45,306 92,770 138,076
--------- --------- --------- -------- -------- ---------
Increase (decrease) in
net interest income.... $ (14,758) $ (14,822) $ (29,580) $(12,826) $ 1,500 $ (11,326)
========= ========= ========= ======== ======== =========
COMPETITION
The Company believes that the traditional role of thrift institutions, such
as Fidelity, as the nation's primary housing lenders has diminished, and that
thrift institutions are subject to increasing competition from commercial
banks, mortgage bankers and others for both depositor funds and lending
opportunities. In addition, with assets of approximately $4.4 billion, the
Company faces competition from a number of substantially larger institutions.
The ability of thrift institutions, such as Fidelity, to compete by
diversifying into lending activities other than real estate lending (and
residential real estate lending in particular) and by offering investments
other than deposit-like investments is limited by law and by these
institutions' relative lack of experience in such other activities. However,
the Company believes these nontraditional activities and the related fee income
is vital for future success. See "Retail Financial Services Group."
The Company faces intense competition in attracting savings deposits and in
making real estate loans as many of the nation's largest depository and other
financial institutions are headquartered or have a significant number of
branches in the areas where Fidelity conducts its business. Competition for
depositors' funds comes principally from other savings institutions, commercial
banks, money market mutual funds, credit unions, other thrift institutions,
corporate and government debt securities, insurance companies, pension funds
and money market mutual funds offered through investment banking firms. The
principal basis of competition for deposits is the interest rate paid, the
perceived credit risk and the quality and types of services offered. In
39
addition to offering competitive rates and terms, the Company attracts
deposits through advertising, readily accessible office locations and the
quality of its customer service.
EMPLOYEES
At January 31, 1994, the Company had 1,007 active employees (this includes
both full-time and part-time employees with full-time equivalents of 940),
none of whom were represented by a collective bargaining group. Management
believes that it maintains good relations with its employees. Employees are
provided with retirement, 401(k) and other benefits, including life, medical,
dental, vision insurance and short and long-term disability insurance.
However, the Company is exploring various alternatives to the existing plans
to reduce the total cost, which may include reducing future benefits accruing
to employees.
Employees severely affected by the January 1994 Northridge Earthquake were
provided with access to additional time off, salary advances, favorable short-
term loans and alternate living arrangements. The total cost of these programs
is not expected to be material.
TAXATION
The Company files a consolidated federal income tax return on a calendar
year basis. For federal income tax purposes, the maximum rate of tax
applicable to savings institutions is currently 35% for taxable income over
$10 million.
Savings institutions are generally subject to federal taxation in the same
manner as other types of corporations. However, under applicable provisions of
the Internal Revenue Code, savings institutions that meet certain definitional
and other tests ("qualifying institutions") can, unlike most other
corporations, use the reserve (versus specific charge-off) method to compute
their deduction for bad debt losses.
Under the reserve method, qualifying associations are generally allowed to
use either of two alternative computations. Under the "percentage of taxable
income method" computation, qualifying institutions can claim a bad debt
deduction computed as a percentage of taxable income before such deduction.
Alternatively, a qualifying association may elect to utilize its own bad debt
loss experience to compute its annual addition to its bad debt reserves (the
"experience method").
Prior to the enactment of the Tax Reform Act of 1986 ("1986 Act"), many
qualifying institutions, including the Bank, used the percentage of taxable
income method which generally resulted in a lower effective federal income tax
rate than that applicable to other types of corporations. However, the 1986
Act reduced the maximum percent that could be deducted under the percentage of
taxable income method from 40% to 8% for tax years beginning after December
31, 1986; thus many qualifying institutions, including the Bank, began to use
the experience method beginning in 1987. The amount by which a qualifying
institution's total bad debt reserves exceed the amount computed under the
experience method ("excess tax bad debt reserves") may be subject to recapture
tax as noted below.
On December 31, 1993, the bad debt reserves of the Bank for federal income
tax purposes included $14.0 million representing excess tax bad debt reserves.
If, in the future, amounts appropriated to these excess tax bad debt reserves
are used for the payment of dividends or other distributions by the Bank
(including distributions in dissolution, liquidation or redemption of stock),
an amount equal to the distribution plus the tax attributable thereto, but not
exceeding the aggregate amount of excess tax bad debt reserves, will generally
be included in the Bank's taxable income and be subject to tax. In addition,
if in the future the Bank fails to meet the definitional or other tests of a
qualifying association, the entire tax bad debt reserves of $52.5 million will
have to be recaptured and included in taxable income. It is not contemplated
that the accumulated reserves will be used in a manner that will create such
liabilities.
The Company's tax returns have been audited by the Internal Revenue Service
through December 31, 1987 and by the California Franchise Tax Board through
December 31, 1985. The tax returns filed for 1986,
40
1987 and 1988 are currently under audit by the California Franchise Tax Board.
The tax returns for years ended 1988 and 1989 are currently in the appeals
process with the Internal Revenue Service. In addition, the Internal Revenue
Service is currently auditing the tax returns filed for 1990 and 1991. For
additional information regarding the federal income and California franchise
taxes payable by the Company, see Note 12 to the consolidated financial
statements.
For California franchise tax purposes, savings institutions are taxed as
"financial corporations" at a higher rate than that applicable to nonfinancial
corporations because of exemptions from certain state and local taxes. The
California franchise tax rate applicable to financial corporations is
approximately 11%.
REGULATION AND SUPERVISION
General
Citadel is a savings and loan holding company subject to regulation by the
OTS. Fidelity is a federally-chartered savings bank, a member of the Federal
Home Loan Bank of San Francisco, and is subject to regulation by the OTS and
the FDIC. Fidelity's deposits are insured by the FDIC through the Savings
Association Insurance Fund ("SAIF"). As described in more detail below,
statutes and regulations applicable to Citadel govern such matters as changes
of control of Citadel and transactions between Fidelity and Citadel. Statutes
and regulations applicable to Fidelity govern such matters as the amount of
capital Fidelity must hold; dividends, mergers and changes of control;
establishment and closing of branch offices; and the investments and
activities in which Fidelity can engage.
Citadel and Fidelity are subject to the examination, supervision and
reporting requirements of the OTS, their primary federal regulator, including
a requirement for Fidelity of at least one full scope, on-site examination
every year. The Director of the OTS is authorized to impose assessments on
Fidelity to fund OTS operations, including the cost of examinations. Fidelity
is also subject to examination and supervision by the FDIC, and the FDIC has
"back-up" authority to take enforcement action against Fidelity if the OTS
fails to take such action after a recommendation by the FDIC. The FDIC may
impose assessments on Fidelity to cover the cost of FDIC examinations. In
addition, Fidelity is subject to regulation by the Board of Governors of the
Federal Reserve System ("FRB") with respect to certain aspects of its
business.
FIRREA Capital Requirements
The OTS's capital regulations, as required by the Financial Institutions
Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), include three
separate minimum capital requirements for the savings institution industry--a
"tangible capital requirement," a "leverage limit" and a "risk-based capital
requirement." These capital standards must be no less stringent than the
capital standards applicable to national banks. The OTS also has the
authority, after giving the affected institution notice and an opportunity to
respond, to establish individual minimum capital requirements ("IMCR") for a
savings institution which are higher than the industry minimum requirements,
upon a determination that an IMCR is necessary or appropriate in light of the
institution's particular circumstances, such as if the institution is expected
to have losses resulting in capital inadequacy, has a high degree of exposure
to credit risk, or has a high amount of nonperforming loans. The OTS has
proposed a regulation that would add to the list of circumstances in which an
IMCR may be appropriate for a savings association the following: a high degree
of exposure to concentration of credit risk or risks arising from
nontraditional activities, or failure to adequately monitor and control the
risks presented by concentration of credit and nontraditional activities.
The industry minimum capital requirements are as follows:
Tangible capital of at least 1.5% of adjusted total assets. Tangible capital
is composed of (1) an institution's common stock, perpetual noncumulative
preferred stock, and related earnings, and (2) the amount, if any, of equity
investment by others in the institution's subsidiaries, after deducting (a)
intangible assets other than purchased mortgage servicing rights, and (b) the
institution's investments in and extensions
41
of credit to subsidiaries engaged as principal in activities not permissible
for national banks, net of any reserves established against such investments,
subject to a phase-out ending July 1, 1996 rather than a deduction for the
amount of investments made or committed to be made prior to April 12, 1989. In
general, adjusted total assets equal the institution's consolidated total
assets, minus any assets that are deducted in calculating capital.
Core capital of at least 3% of adjusted total assets (the "leverage limit").
Core capital consists of tangible capital plus (1) goodwill resulting from pre-
April 12, 1989 acquisitions of troubled savings institutions, subject to a
phase-out ending December 31, 1994; and (2) certain marketable intangible
assets, such as core deposit premium (the premium paid for acquisition of
deposits from other institutions). Deferred tax assets whose realization
depends on the institution's future taxable income (exclusive of income
attributable to reversing taxable temporary differences and carry forwards) or
on the institution's tax-planning strategies must be deducted from core capital
to the extent that such assets exceed the lesser of (1) 10% of core capital, or
(2) the amount of such assets that can be realized within one year, unless such
assets were reportable as of December 31, 1992, in which case no deduction is
required.
The OTS has recently adopted a regulation effective March 4, 1994 with
respect to the inclusion of intangible assets in regulatory capital. Under this
regulation, purchased mortgage servicing rights will generally be includible in
tangible and core capital, and purchase credit card relationships will
generally be includible in core capital, as long as they do not exceed 50% of
core capital in the aggregate, with a separate sublimit of 25% for purchased
credit card relationships. All other intangible assets, including, core deposit
premium, will generally have to be deducted. Core deposit intangible in
existence on March 4, 1994, however, may continue to be included in core
capital to the extent permitted by the OTS, as long as the premium is valued in
accordance with GAAP, supported by credible assumptions, and its amortization
is adjusted at least annually. At December 31, 1993, Fidelity included $2.1
million of core deposit premium in core capital. Fidelity anticipates that such
$2.1 million in core deposit premium will continue to be includible in core
capital after March 4, 1994.
Total capital of at least 8% of risk-weighted assets (the "risk-based capital
requirement"). Total capital includes both core capital and "supplementary"
capital items deemed less permanent than core capital, such as subordinated
debt and general loan loss allowances (subject to certain limits), but equity
investments (with the exception of investments in subsidiaries and investments
permissible for national banks) and portions of certain high-risk land loans
and nonresidential construction loans must be deducted from total capital,
subject to a phase-out rather than a deduction until July 1, 1994. At least
half of total capital must consist of core capital.
Risk-weighted assets are determined by multiplying each category of an
institution's assets, including off balance sheet asset equivalents, by an
assigned risk weight based on the credit risk associated with those assets, and
adding the resulting sums. The four risk weight categories range from zero
percent for cash and government securities to 100% for assets (including past-
due loans and real estate owned) that do not qualify for preferential risk-
weighting.
Effective September 30, 1994, institutions that are deemed to have above-
normal exposure to interest-rate risk, based on their assets and liabilities as
of the end of the third quarter prior to the measuring date, will be required
to deduct from their total capital an amount equal to 50% of the excess risk.
If this requirement had been in effect at December 31, 1993, based on its
assets and liabilities as of March 31, 1993, Fidelity would not have been
deemed to have above-normal exposure to interest-rate risk.
On March 18, 1994, the OTS published a final regulation effective on that
date that permits a loan secured by multifamily residential property,
regardless of the number of units, to be risk-weighted at 50% for purposes of
the risk-based capital standards if the loan meets specified criteria relating
to the term of the loan, timely payments of interest and principal, loan-to-
value ratio and ratio of net operating income to debt service requirements.
Under the prior regulation, only loans secured by multifamily residential
properties consisting of 5 to 36 units were eligible for risk-weighting at 50%,
and then only if such loans had a
loan-to-value ratio at origination of not more than 80% and the collateral
property had an average annual
42
occupancy rate of at least 80% for a year or more. Based upon the results of
Fidelity's annual survey, management believes that at December 31, 1993, at
which time the prior rule was still in effect, approximately 85% of Fidelity's
portfolio of loans secured by multifamily residences with 5 to 36 units
qualified for 50% risk-weighting.
Any loans that qualified for risk-weighting under the prior regulation as of
March 18, 1994 will be "grandfathered" and will continue to be risk-weighted at
50% as long as they continue to meet the criteria of the prior regulation. Thus
occupancy rates, which recently have been decreasing generally, will continue
to affect the risk-weighting of such grandfathered multifamily loans unless
such loans qualify for 50% risk-weighting under the criteria of the new rule,
which criteria do not include an occupancy requirement.
Under the prior rule, loans secured by multifamily residential properties
with more than 36 units were required to be risk-weighted at 100% even if they
met the loan-to-value and occupancy criteria applicable to loans secured by 5
to 36 unit properties. As of December 31, 1993, Fidelity held $406.3 million in
loans secured by multifamily residential properties with 37 or more units, some
of which qualify under the criteria of the new regulation for 50% risk-
weighting. Therefore, Fidelity's risk-based capital ratio could increase.
However, some of Fidelity's existing loans secured by 5 to 36 unit residential
properties could increase in risk-weighting from 50% to 100% if they fail to
qualify for grandfathering and if they do not meet the additional criteria of
the new rule, which would have a negative effect on Fidelity's risk-based
capital ratio. The ultimate impact on Fidelity of the new regulation has not
been determined.
Fidelity exceeded all three of the industry minimum capital requirements at
December 31, 1993, with a tangible capital ratio of 4.10%, a core capital ratio
of 4.15%, and a risk-based capital ratio of 9.32%. A discussion of Fidelity's
compliance with the industry minimum requirements appears in Item 7. "MD&A--
Capital Resources and Liquidity." Savings institutions that do not meet the
industry minimum capital requirements are subject to a number of sanctions
similar to but less restrictive than the sanctions under the FDICIA Prompt
Corrective Action system described below, and to a requirement that the OTS be
notified of any changes in Fidelity's directors or senior executive officers.
FDICIA Prompt Corrective Action Requirements
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
required the OTS to implement a system requiring regulatory sanctions against
institutions that are not adequately capitalized, with the sanctions growing
more severe the lower the institution's capital. The OTS was required to and
has established specific capital ratios for five separate capital categories:
"well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized," and "critically undercapitalized."
Under the OTS regulations implementing FDICIA, an institution is treated as
well capitalized if its ratio of total capital to risk-weighted assets is at
least 10.0%, its ratio of core capital to risk-weighted assets is at least
6.0%, its ratio of core capital to adjusted total assets is at least 5.0%, and
it is not subject to any order or directive by the OTS to meet a specific
capital level. An institution will be adequately capitalized if its ratio of
total capital to risk-weighted assets is at least 8.0%, its ratio of core
capital to risk-weighted assets is at least 4.0%, and its ratio of core capital
to adjusted total assets (leverage ratio) is at least 4.0% (3.0% if the
institution receives the highest rating on the MACRO financial institutions
rating system). The OTS has stated that it intends to lower the leverage ratio
requirement to 3.0% for all savings institutions after September 30, 1994, when
the interest rate risk component of its capital regulations goes into effect.
The OTS' reduction of the leverage ratio requirement may depend on obtaining
agreement of the other federal banking agencies to such a reduction, and no
assurances can be given that the reduction will occur.
An institution whose capital does not meet the amounts required in order to
be adequately capitalized will be treated as undercapitalized. If an
undercapitalized institution's capital ratios are less than 6.0%, 3.0%, or 3.0%
respectively, it will be treated as significantly undercapitalized. Finally, an
institution will be treated as critically undercapitalized if its ratio of
"tangible equity" (core capital plus cumulative preferred stock
43
minus intangible assets other than supervisory goodwill and purchased mortgage
servicing rights) to adjusted total assets is equal to or less than 2.0%.
At December 31, 1993 and to date, the Bank was and is classified as
adequately capitalized. However, Citadel supplemented the Bank's capital in
1993 with two capital infusions totaling $28 million, without which the Bank
would have had to significantly reduce its assets or the Bank's core capital
ratio at December 31, 1993 would have fallen below 4% and the Bank would have
been classified as undercapitalized. Management anticipates that the Bank will
incur losses in the first and second quarters of 1994. These losses will, in
the absence of a new capital infusion or a further reduction in the Bank's
total assets, reduce the Bank's core capital ratio to less than 4% at June 30,
1994 and thereby render it undercapitalized. See "Recent Developments--Capital
and Liquidity." Fidelity's capital category under the prompt corrective action
system may not be an accurate representation of Fidelity's overall financial
condition or prospects. A discussion of Fidelity's compliance with the industry
minimum capital requirements and the standards of the prompt corrective action
capital categories appears in Item 7. "MD&A--Capital Resources and Liquidity."
An institution's capital category is based on its capital levels as of the
most recent of the following dates: (1) the date the institution's most recent
quarterly Thrift Financial Report ("TFR") was required to be filed with the
OTS; (2) the date the institution received from the OTS its most recent final
report of examination; or (3) the date the institution received written notice
from the OTS of the institution's capital category. If subsequent to the most
recent TFR or report of examination a material event has occurred that would
cause the institution to be placed in a lower capital category, the institution
must provide written notice to the OTS within 15 days, and the OTS shall
determine whether to change the association's capital category.
Mandatory Sanctions Tied to Prompt Corrective Action Capital Categories
Capital Restoration Plan. An institution that is undercapitalized must submit
a capital restoration plan to the OTS within 45 days after becoming
undercapitalized. The capital restoration plan must specify the steps the
institution will take to become adequately capitalized, the levels of capital
the institution will attain while the plan is in effect, the types and levels
of activities the institution will conduct, and such other information as the
OTS may require. The OTS must act on the capital restoration plan
expeditiously, and generally not later than 60 days after the plan is
submitted.
The OTS may approve a capital restoration plan only if the OTS determines
that the plan is likely to succeed in restoring the institution's capital and
will not appreciably increase the risks to which the institution is exposed. In
addition, the OTS may approve a capital restoration plan only if the
institution's performance under the plan is guaranteed by every company that
controls the institution, up to the lesser of (a) 5% of the institution's total
assets at the time the institution became undercapitalized, or (b) the amount
necessary to bring the institution into compliance with all capital standards
as of the time the institution fails to comply with its capital restoration
plan. Such guarantee must remain in effect until the institution has been
adequately capitalized for four consecutive quarters, and the controlling
company or companies must provide the OTS with appropriate assurances of their
ability to perform the guarantee. If the controlling company guarantee is not
acceptable, the OTS may treat the "undercapitalized" institution as
"significantly undercapitalized." There are additional restrictions which are
applicable to "significantly undercapitalized" institutions which are described
below.
Limits on Expansion. An institution that is undercapitalized, even if its
capital restoration plan has been approved, may not acquire an interest in any
company, open a new branch office, or engage in a new line of business unless
the OTS determines that such action would further the implementation of the
institution's capital plan or the FDIC approves the action. An undercapitalized
institution also may not increase its average total assets during any quarter
except in accordance with an approved capital restoration plan.
Capital Distributions. With one exception, an undercapitalized savings
institution generally may not pay any dividends or make other capital
distributions. Under the exception, the OTS may permit, after consultation with
the FDIC, repurchases or redemptions of the institution's shares that are made
in
44
connection with the issuance of additional shares to improve the institution's
financial condition. Undercapitalized institutions also may not pay management
fees to any company or individual that controls the institution. Similarly, an
adequately capitalized institution may not make a capital distribution or pay
a management fee to a controlling person if such payment would cause the
institution to become undercapitalized.
Brokered Deposits and Benefit Plan Deposits. An undercapitalized savings
institution cannot accept, renew, or rollover deposits obtained through a
deposit broker, and may not solicit deposits by offering interest rates that
are more than 75 basis points higher than market rates. Savings institutions
that are adequately capitalized but not well capitalized must obtain a waiver
from the FDIC in order to accept, renew, or rollover brokered deposits, and
even if a waiver is granted may not solicit deposits, through a broker or
otherwise, by offering interest rates that exceed market rates by more than 75
basis points.
Institutions that are ineligible to accept brokered deposits can only offer
FDIC insurance coverage for employee benefit plan deposits up to $100,000 per
plan, rather than $100,000 per plan participant, unless, at the time such
deposits are accepted, the institution meets all applicable capital standards
and certifies to the benefit plan depositor that its deposits are eligible for
coverage on a per-participant basis.
Restrictions on Significantly and Critically Undercapitalized Institutions.
In addition to the above mandatory restrictions which apply to all
undercapitalized savings institutions, institutions that are significantly
undercapitalized may not without the OTS's prior approval (a) pay a bonus to
any senior executive officer, or (b) increase any senior executive officer's
compensation over the average rate of compensation (excluding bonuses, options
and profit-sharing) during the 12 months preceding the month in which the
institution became undercapitalized. The same restriction applies to
undercapitalized institutions that fail to submit or implement an acceptable
capital restoration plan.
If a savings institution is critically undercapitalized, the institution is
also prohibited from making payments of principal or interest on subordinated
debt beginning sixty days after the institution becomes critically
undercapitalized, unless the FDIC permits such payments or the subordinated
debt was outstanding on July 15, 1991 and has not subsequently been extended
or renegotiated. In addition, the institution cannot without prior FDIC
approval enter into any material transaction outside the ordinary course of
business. Critically undercapitalized savings institutions must be placed in
receivership or conservatorship within 90 days of becoming critically
undercapitalized unless the OTS, with the concurrence of the FDIC, determines
that some other action would better resolve the problems of the institution at
the least possible long-term loss to the insurance fund, and documents the
reasons for its determination. A determination by the OTS not to place a
critically undercapitalized institution in conservatorship or receivership
must be reviewed every 90 days. If the institution remains critically
undercapitalized on average during the calendar quarter beginning 270 days
after it became critically undercapitalized, the findings which the OTS must
make regarding the viability of the institution in order to avoid the
appointment of a conservator or receiver become more stringent.
Discretionary Sanctions Tied to Prompt Corrective Action Capital Categories
Operating Restrictions. With respect to an undercapitalized institution, the
OTS will, if it deems such actions necessary to resolve the institution's
problems at the least possible loss to the insurance fund, have the explicit
authority to: (a) order the institution to recapitalize by selling shares of
capital stock or other securities; (b) order the institution to agree to be
acquired by another depository institution holding company or combine with
another depository institution; (c) restrict transactions with affiliates; (d)
restrict the interest rates paid by the institution on new deposits to the
prevailing rates of interest in the region where the institution is located;
(e) require reduction of the institution's assets; (f) restrict any activities
that the OTS determines pose excessive risk to the institution; (g) order a
new election of directors; (h) order the institution to dismiss any director
or senior executive officer who held office for more than 180 days before the
institution became undercapitalized, subject to the director's or officer's
right to obtain administrative review of the dismissal; (i) order the
institution to employ qualified senior executive officers subject to the OTS's
approval;
45
(j) prohibit the acceptance of deposits from correspondent depository
institutions; (k) require the institution to divest any subsidiary or the
institution's holding company to divest the institution or any other
subsidiary; or (l) take any other action that the OTS determines will better
resolve the institution's problems at the least possible loss to the deposit
insurance fund.
If an institution is significantly undercapitalized, or if it is
undercapitalized and its capital restoration plan is not approved or
implemented within the required time periods, the OTS must take one or more of
the above actions, and must take the actions described in clauses (a) or (b),
(c) and (d) above unless it finds that such actions would not resolve the
institution's problems at the least possible loss to the deposit insurance
fund. The OTS also may prohibit the institution from making payments on any
outstanding subordinated debt or entering into material transactions outside
the ordinary course of business without the OTS's prior approval.
The OTS' determination to order one or more of the above discretionary
actions will be evidenced by a written directive to the institution, and the
OTS will generally issue a directive only after giving the institution prior
notice and an opportunity to respond. The period for response shall be at
least 14 days unless the OTS determines that a shorter period is appropriate
based on the circumstances. The OTS, however, may issue a directive without
providing any prior notice if the OTS determines that such action is necessary
to resolve the institution's problems at the least possible loss to the
deposit insurance fund. In such a case, the directive will be effective
immediately, but the institution may appeal the directive to the OTS within 14
days.
Receivership or Conservatorship. In addition to the mandatory appointment of
a conservator or receiver for critically undercapitalized institutions,
described above, the OTS or FDIC may appoint a receiver or conservator for an
institution if the institution is undercapitalized and (a) has no reasonable
prospect of becoming adequately capitalized, (b) fails to submit a capital
restoration plan within the required time period, or (c) materially fails to
implement its capital restoration plan. FDICIA provides that directors of an
FDIC-insured depository institution will have no liability to the
institution's stockholders or creditors if they consent in good faith to the
appointment of a conservator or receiver or to an FDIC-assisted sale of the
institution.
Down-grading to Lower Capital Category. The OTS can apply to an institution
in a particular capital category the sanctions that apply to the next lower
capital category, if the OTS determines, after providing the institution
notice and opportunity for a hearing, that (a) the institution is in an unsafe
or unsound condition, or (b) the institution received, in its most recent
report of examination, a less-than-satisfactory rating for asset quality,
management, earnings or liquidity, and the deficiency has not been corrected.
The OTS cannot, however, use this authority to require an adequately
capitalized institution to file a capital restoration plan, or to subject a
significantly undercapitalized institution to the sanctions applicable to
critically undercapitalized institutions.
Expanded Regulatory Authority Under FDICIA
In addition to the prompt corrective action provisions discussed above based
on an institution's regulatory capital ratios, FDICIA contains several
measures intended to promote early identification of management problems at
depository institutions and to ensure that regulators intervene promptly to
require corrective action by institutions with inadequate operational and
managerial standards.
Safety and Soundness Standards. FDICIA requires the OTS to prescribe minimum
acceptable operational and managerial standards, and standards for asset
quality, earnings, and valuation of publicly traded shares, for savings
institutions and their holding companies. Such standards were to be effective
no later than December 1, 1993, but have not yet been finalized. The
operational standards must cover internal controls, loan documentation, credit
underwriting, interest rate exposure, asset growth, and employee compensation.
The asset quality and earnings standards must specify a maximum ratio of
classified assets to capital, minimum earnings sufficient to absorb losses,
and minimum ratio of market value to book value for publicly traded shares.
46
Any institution or holding company that fails to meet the standards must
submit a plan for corrective action within 30 days. If a savings institution
fails to submit or implement an acceptable plan, the OTS must order it to
correct the safety and soundness deficiency, and may restrict its rate of
asset growth, prohibit asset growth entirely, require the institution to
increase its ratio of tangible equity to assets, restrict the interest rate
paid on deposits to the prevailing rates of interest on deposits of comparable
amounts and maturities, or require the institution to take any other action
that the OTS determines will better carry out the purpose of prompt corrective
action. Imposition of these sanctions is within the discretion of the OTS in
most cases but is mandatory if the savings institution commenced operations or
experienced a change in control during the 24 months preceding the
institution's failure to meet the safety and soundness standards, or underwent
extraordinary growth during the preceding 18 months.
The OTS and the other federal banking agencies have jointly published a
proposed regulation prescribing the required safety and soundness standards.
Among other things, the proposed regulation would set out asset quality
standards which specify that the ratio of a depository institution's
classified assets to the sum of(a) its total capital and (b) any allowances
for loan losses not included in total capital should not exceed 100%. Minimum
earnings standards would require that institutions be able to demonstrate pro
forma compliance with capital requirements if net earnings or losses over the
preceding four quarters continue over the next four quarters. If the proposed
safety and soundness standards had been in effect at December 31, 1993,
Fidelity would not have been in compliance with the minimum earnings standard
or the maximum ratio of classified assets to capital standard and would have
been required to submit a plan for corrective action.
Under the proposed regulation, the safety and soundness standards would
apply primarily at the savings institution level, and savings and loan holding
companies such as Citadel would only be required (a) to ensure that their
transactions with a subsidiary savings institution are not detrimental to the
institution, (b) to avoid creating a serious risk that the holding company's
liabilities would be imposed on the institution, (c) not to take any action
that would impede the institution's compliance with the safety and soundness
standards, and (d) if the subsidiary institution is required to submit a plan
for corrective action, to take any corporate actions necessary to enable the
subsidiary to take the actions required by the plan.
Expanded Requirements Relating to Internal Controls. Each depository
institution with assets above a specified threshold (which the FDIC has set at
$500 million and which therefore includes Fidelity) must prepare an annual
report, signed by the chief executive officer and chief financial officer, on
the effectiveness of the institution's internal control structures and
procedures for financial reporting, and on the institution's compliance with
laws and regulations relating to safety and soundness. The institution's
independent public accountant must attest to, and report separately on,
management's assertions in the annual report. The report and the attestation,
along with financial statements and such other disclosure requirements as the
FDIC and the OTS may prescribe, must be submitted to the FDIC and OTS and will
be available to the public.
Every institution with assets above the $500 million threshold must also
have an audit committee of its Board of Directors made up entirely of
directors who are independent of the management of the institution. Fidelity
is in compliance with this requirement. Audit committees of "large"
institutions (defined by the FDIC as an institution with more than $3 billion
in assets, which includes Fidelity) must include members with banking or
financial management expertise, may not include members who are large
customers of the institution, and must have access to independent counsel.
Activities Restrictions Not Related to Capital Compliance
Qualified Thrift Lender Test. The qualified thrift lender ("QTL") test
requires that, in at least nine out of every twelve months, at least 65% of a
savings bank's "portfolio assets" must be invested in a limited list of
qualified thrift investments, primarily investments related to housing loans.
If Fidelity fails to satisfy the QTL test and does not requalify as a QTL
within one year, Citadel must register and be regulated as a bank holding
company, and Fidelity must either convert to a commercial bank charter or
become subject to restrictions on branching, business activities and dividends
as if it were a national bank.
47
Portfolio assets consist of tangible assets minus (a) assets used to satisfy
liquidity requirements, and(b) property used by the institution to conduct its
business. Assets that may be counted as qualified thrift investments without
limit include residential mortgage and construction loans; home improvement and
repair loans; mortgage-backed securities; home equity loans; Federal Savings
and Loan Insurance Corporation ("FSLIC"), FDIC, Resolution Funding Corporation
and Resolution Trust Corporation obligations; and FHLB stock.
Assets includable subject to an aggregate maximum of 20% of portfolio assets
include Federal National Mortgage Association and Federal Home Loan Mortgage
Corporation stock; investments in residential housing-oriented subsidiaries;
consumer and education loans up to a maximum of 10% of portfolio assets; 200%
of loans for development of low-income housing; 200% of certain community
development loans; loans to construct, purchase or maintain churches, schools,
nursing homes and hospitals; and 50% of any residential mortgage loans
originated by the institution and sold during the month for which the QTL
calculation is made, if such loans were sold within 90 days of origination. At
December 31, 1993, 89.8% of Fidelity's portfolio assets constituted qualified
thrift investments.
Investments and Loans. In general, federal savings institutions such as
Fidelity may not invest directly in equity securities, noninvestment grade debt
securities, or real estate, other than real estate used for the institution's
offices and related facilities. Indirect equity investment in real estate
through a subsidiary is permissible, but subject to limitations based on the
amount of the institution's assets, and the institution's investment in such a
subsidiary must be deducted from regulatory capital in full or (for certain
subsidiaries owned by the institution prior to April 12, 1989) phased out of
capital by no later than July 1, 1996.
Loans by a savings institution to a single borrower are generally limited to
15% of the institution's "unimpaired capital and unimpaired surplus," which is
similar but not identical to total capital. At December 31, 1993, the largest
Fidelity borrower had a total outstanding balance of $31.5 million or 10.1% of
unimpaired capital and unimpaired surplus. Aggregate loans secured by
nonresidential real property are generally limited to 400% of the institution's
total capital. Commercial loans may not exceed 10% of Fidelity's total assets,
and consumer loans may not exceed 35% of Fidelity's total assets. At December
31, 1993, Fidelity was in compliance with the above investment limits.
Activities of Subsidiaries. A savings institution seeking to establish a new
subsidiary, acquire control of an existing company or conduct a new activity
through an existing subsidiary must provide 30 days prior notice to the FDIC
and OTS. A subsidiary of Fidelity may be able to engage in activities that are
not permissible for Fidelity directly, if the OTS determines that such
activities are reasonably related to Fidelity's business, but Fidelity may be
required to deduct its investment in such a subsidiary from capital. The OTS
has the power to require a savings institution to divest any subsidiary or
terminate any activity conducted by a subsidiary that the OTS determines to be
a serious threat to the financial safety, soundness or stability of such
savings institution or to be otherwise inconsistent with sound banking
practices.
Real Estate Lending Standards. The OTS and the other federal banking agencies
have adopted regulations, effective March 19, 1993, which require institutions
to adopt and at least annually review written real estate lending policies. The
lending policies must include diversification standards, underwriting standards
(including loan-to-value limits), loan administration procedures, and
procedures for monitoring compliance with the policies. The policies must
reflect consideration of guidelines adopted by the banking agencies. Among the
guidelines adopted by the agencies are maximum loan-to-value ratios for land
loans (65%); development loans (75%); construction loans (80%-85%); loans on
owner-occupied 1 to 4 family property, including home equity loans (no limit,
but loans at or above 90% require private mortgage insurance); and loans on
other improved property (85%).
The guidelines permit institutions to make loans in excess of the supervisory
loan-to-value limits if such loans are supported by other credit factors, but
the aggregate of such nonconforming loans should not exceed the institution's
risk-based capital, and the aggregate of nonconforming loans secured by real
estate other than 1 to 4 family property should not exceed 30% of risk-based
capital. Fidelity believes that its current lending policies and practices are
consistent with the guidelines.
48
Additional Regulatory Restrictions. As a result of its findings in a recent
examination of Fidelity, the OTS has taken action that will result in
Fidelity's being subjected to higher examination assessments and subjects
Fidelity to additional regulatory restrictions including, but not limited to
(a) a requirement that Fidelity submit to the OTS for prior approval any
changes in its board of directors or senior executive officers and any proposed
employment contracts with a director or senior officer; (b) a prohibition,
absent prior OTS approval, on increases in Fidelity's total assets during any
quarter in excess of an amount equal to the net interest credited on deposit
liabilities during the quarter; (c) a requirement that Fidelity submit to the
OTS for prior review and approval any third party contracts outside the normal
course of business; and (d) the OTS would have the ability, in its discretion,
to require 30 days' prior notice of all transactions between Fidelity and its
affiliates (including Citadel and Gateway). See "Recent Developments--OTS
Examinations."
Deposit Insurance
General. Fidelity's deposits are insured by the FDIC to a maximum of $100,000
for each insured depositor. Under FIRREA, the FDIC administers two separate
deposit insurance funds: the Bank Insurance Fund (the "BIF") which insures the
deposits of institutions that were insured by the FDIC prior to FIRREA, and the
SAIF which maintains a fund to insure the deposits of institutions, such as
Fidelity, that were insured by the FSLIC prior to FIRREA.
Insurance Premium Assessments. The Federal Deposit Insurance Corporation
Improvement Act of 1991 directed the FDIC to establish by January 1, 1994, a
risk-based system for setting deposit insurance assessments. The FDIC has
implemented such a system, under which an institution's insurance assessments
will vary depending on the level of capital the institution holds and the
degree to which it is the subject of supervisory concern to the FDIC. Under the
FDIC's system, the assessment rate for both BIF deposits and SAIF deposits
varies from 0.23% of covered deposits for well-capitalized institutions that
are deemed to have no more than a few minor weaknesses, to 0.31% of covered
deposits for less than adequately capitalized institutions that pose
substantial supervisory concern. The FDIC in the future may determine to change
the assessment rates, or the parity of BIF and SAIF rates, based on the
condition of the BIF and the SAIF.
Under current law, the SAIF has three major obligations: beginning in 1995,
to fund losses associated with the failure of institutions with SAIF-insured
deposits; to increase its reserves to 1.25% of insured deposits over a
reasonable period of time; and to make interest payments on debt incurred to
provide funds to the former Federal Savings and Loan Insurance Corporation
("FICO debt"). The reserves of the SAIF are currently lower than the reserves
of the BIF, and the BIF does not have an obligation to pay interest on FICO
debt. Recent legislation authorizes the United States Treasury to provide up to
$8 billion to the SAIF, but use of such funds would require additional
Congressional action, and the funds could be used only to cover SAIF losses and
only under limited circumstances. Therefore, in the future premiums assessed on
deposits insured by the SAIF may be higher than premiums on deposits insured by
the BIF. Such a premium structure could provide institutions whose deposits are
exclusively or primarily BIF-insured (such as almost all commercial banks)
certain competitive advantages over institutions whose deposits are SAIF-
insured (such as Fidelity) in the pricing of loans and deposits and in lower
operating costs. Such a competitive disadvantage could have an adverse effect
on Fidelity's results of operations.
Termination of Deposit Insurance. The FDIC may initiate a proceeding to
terminate an institution's deposit insurance if, among other things, the
institution is in an unsafe or unsound condition to continue operations. It is
the policy of the FDIC to deem an insured institution to be in an unsafe or
unsound condition if its ratio of Tier 1 capital to total assets is less than
2%. Tier 1 capital is similar to core capital but includes certain investments
in and extensions of credit to subsidiaries engaged in activities not permitted
for national banks.
Conversion of Deposit Insurance. Generally, savings institutions may not
convert from SAIF membership to BIF membership until SAIF has increased its
reserves to 1.25% of insured deposits. However, a savings institution may
convert to a bank charter, if the resulting bank remains a SAIF member, and may
merge
49
with a BIF member institution as long as deposits attributable to the savings
institution remain subject to assessment by the SAIF. Institutions that
convert from SAIF to BIF membership, either under an exception during the
moratorium or after expiration of the moratorium, must pay exit fees to SAIF
and entrance fees to BIF.
Savings and Loan Holding Company Regulation
Affiliate and Insider Transactions. The ability of Citadel and its non-
depository subsidiaries to deal with Fidelity is limited by the affiliate
transaction rules, including Sections 23A and 23B of the Federal Reserve Act
which also govern BIF-insured banks. With very limited exceptions, these rules
require that all transactions between Fidelity and an affiliate must be on
arms' length terms. The term "affiliate" covers any company that controls or
is under common control with Fidelity, but does not include individuals and
generally does not include Fidelity's subsidiaries.
Under Section 23A and section 11 of the Home Owners' Loan Act, specific
restrictions apply to transactions in which Fidelity provides funding to its
affiliates: Fidelity may not purchase the securities of an affiliate, make a
loan to any affiliate that is engaged in activities not permissible for a bank
holding company, or acquire from an affiliate any asset that has been
classified, a nonaccrual loan, a restructured loan, or a loan that is more
than 30 days past due. As to affiliates engaged in bank holding company-
permissible activities, the aggregate of (a) loans, guarantees, and letters of
credit provided by the savings bank for the benefit of any one affiliate, and
(b) purchases of assets by the savings bank from the affiliate, may not exceed
10% of the savings bank's capital stock and surplus (20% for the aggregate of
permissible transactions with all affiliates). All loans to affiliates must be
secured by collateral equal to at least 100% of the amount of the loan (130%
if the collateral consists of equity securities, leases or real property).
In addition, OTS regulations on affiliate transactions require, among other
things, that savings institutions retain records of their affiliate
transactions that reflect such transactions in reasonable detail. If a savings
institution has been the subject of a change of control application or notice
within the preceding two-year period, does not meet its minimum capital
requirements, has entered into a supervisory agreement, is subject to a formal
enforcement proceeding, or is determined by the OTS to be the subject of
supervisory concern, the institution may be required to provide the OTS with
30 days' prior notice of any affiliate transaction.
Loans by Fidelity to its directors, executive officers, and 10% stockholders
of Fidelity, Citadel, or Citadel's subsidiaries (collectively, "insiders"), or
to a corporation or partnership that is at least 10% owned by an insider (a
"related interest") are subject to limits separate from the affiliate
transaction rules. However, a company (such as Citadel) that controls a
savings institution is excluded from the coverage of the insider lending rules
even if it owns 10% or more of the stock of the institution, and is subject
only to the affiliate transaction rules. All loans to insiders and their
related interests must be underwritten and made on non-preferential terms;
loans in excess of $500,000 must be approved in advance by Fidelity's Board of
Directors; and Fidelity's total of such loans may not exceed 100% of
Fidelity's capital. Loans by Fidelity to its executive officers are subject to
additional limits which are even more stringent. Fidelity has adopted a policy
which requires prior approval of its Board of Directors for any loans to
insiders or their related interests.
Payment of Dividends and Other Capital Distributions. The payment of
dividends, stock repurchases, and other capital distributions by Fidelity to
Citadel is subject to regulation by the OTS. Currently, 30 days prior notice
to the OTS of any capital distribution is required. The OTS has promulgated a
regulation that measures a savings institution's ability to make a capital
distribution according to the institution's capital position. The rule
establishes "safe-harbor" amounts of capital distributions that institutions
can make after providing notice to the OTS, but without needing prior
approval. Institutions can distribute amounts in excess of the safe harbor
only with the prior approval of the OTS.
For institutions ("Tier 1 institutions") that meet their fully phased-in
capital requirements (the requirements that will apply when the phase-out of
supervisory goodwill and investments in certain subsidiaries from capital is
complete), the safe harbor amount is the greater of (a) 75% of net income for
the prior four quarters, or (b) the sum of (1) the current year's net income
and (2) the amount that would reduce
50
the excess of the institution's total capital to risk-weighted assets ratio
over 8% to one-half of such excess at the beginning of the year in which the
dividend is paid. For institutions that meet their current minimum capital
requirements but do not meet their fully phased-in requirements ("Tier 2
institutions"), the safe harbor distribution is 75% of net income for the prior
four quarters. As a function of the prompt corrective action provisions
discussed above and the OTS regulation regarding capital distributions, savings
institutions that do not meet their current minimum capital requirements ("Tier
3 institutions") may not make any capital distributions, with the exception of
repurchases or redemptions of the institution's shares permitted by the OTS,
after consultation with the FDIC, that are made in connection with the issuance
of additional shares and that will improve the institution's financial
condition.
The OTS retains the authority to prohibit any capital distribution otherwise
authorized under the regulation if the OTS determines that the distribution
would constitute an unsafe or unsound practice. The OTS also may reclassify a
Tier 1 institution as a Tier 2 or Tier 3 institution by notifying the
institution that it is in need of more than normal supervision. While Fidelity
was a Tier 1 institution at December 31, 1993, the OTS has taken action that
could cause Fidelity to be reclassified as a Tier 2 or Tier 3 institution.
Further, while Fidelity is currently classified as adequately capitalized for
purposes of the prompt corrective action system, an adequately capitalized
institution may not make a capital distribution if such payment would cause the
institution to become undercapitalized. Because of Fidelity's current capital
levels, dividends and distributions from Fidelity will not be available to
Citadel for the foreseeable future.
On December 31, 1993, the bad debt reserves of the Bank for federal income
tax purposes included $14.0 million representing excess tax bad debt reserves.
If, in the future, amounts appropriated to these excess tax bad debt reserves
are used for the payment of dividends or other distributions by the Bank
(including distributions in dissolution, liquidation or redemption of stock),
an amount equal to the distribution plus the tax attributable thereto, but not
exceeding the aggregate amount of excess tax bad debt reserves, will generally
be included in the Bank's taxable income and be subject to tax. In addition, if
in the future the Bank fails to meet the definitional or other tests of a
qualifying association, the entire tax bad debt reserves of $52.5 million will
have to be recaptured and included in taxable income. It is not contemplated
that the accumulated reserves will be used in a manner that will create such
liabilities.
Enforcement. Whenever the OTS has reasonable cause to believe that the
continuation by a savings and loan holding company of any activity or of
ownership or control of any non FDIC-insured subsidiary constitutes a serious
risk to the financial safety, soundness, or stability of a savings and loan
holding company's subsidiary savings institution and is inconsistent with the
sound operation of the savings institution, the OTS may order the holding
company, after notice and opportunity for a hearing, to terminate such
activities or to divest such noninsured subsidiary. FIRREA also empowers the
OTS, in such a situation, to issue a directive without any notice or
opportunity for a hearing, which directive may (a) limit the payment of
dividends by the savings institution, (b) limit transactions between the
savings institution and its holding company or its affiliates, and (c) limit
any activity of the association that creates a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings institution.
In addition, FIRREA includes savings and loan holding companies within the
category of person designated as "institution-affiliated parties." An
institution-affiliated party may be subject to significant penalties and/or
loss of voting rights in the event such party took any action for or toward
causing, bringing about, participating in, counseling, or aiding and abetting a
violation of law or unsafe or unsound practice by a savings institution.
Limits on Change of Control. Subject to certain limited exceptions, control
of Fidelity or Citadel may only be obtained with the approval (or in the case
of an acquisition of control by an individual, the nondisapproval) of the OTS,
after a public comment and application review process. Under OTS regulations
defining "control," a rebuttable presumption of control arises if an acquiring
party acquires more than 10% of any class of voting stock of Fidelity or
Citadel (or more than 25% of any class of stock, whether voting or
51
non-voting) and is subject to any "control factors" as defined in the
regulation. Control is conclusively deemed to exist if an acquirer holds more
than 25% of any class of voting stock of Fidelity or Citadel, or has the power
to control in any manner the election of a majority of directors.
Any company acquiring control of Fidelity or Citadel becomes a savings and
loan holding company, must register and file periodic reports with the OTS, and
is subject to OTS examination. With limited exceptions, a savings and loan
holding company may not directly or indirectly acquire more than 5% of the
voting stock of another savings and loan holding company or savings institution
without prior OTS approval.
Notification of New Officers and Directors. A savings and loan holding
company that has undergone a change in control in the preceding two years, is
subject to a supervisory agreement with the OTS, or is deemed to be in
"troubled condition" by the OTS, must give the OTS 30 days' notice of any
change to its Board of Directors or its senior executive officers. The OTS must
disapprove such change if the competence, experience or integrity of the
affected individual indicates that it would not be in the best interests of the
public to permit the appointment. The OTS has taken action as a result of which
Fidelity is deemed to be in "troubled condition" for this purpose.
Classification of Assets
Savings institutions are required to classify their assets on a regular
basis, to establish appropriate allowances for losses and report the results of
such classification quarterly to the OTS. A savings institution is also
required to set aside adequate valuation allowances to the extent that an
affiliate possesses assets posing a risk to the institution, and to establish
liabilities for off-balance sheet items, such as letters of credit, when loss
becomes probable and estimable. The OTS has the authority to review the
institution's classification of its assets and to determine whether and to what
extent (a) additional assets must be classified, and (b) the institution's
valuation allowances must be increased. See Item 7. "MD&A--Asset Quality."
Troubled assets are classified into one of three categories as follows:
SUBSTANDARD ASSETS. Prudent general valuation allowances are required to
be established for such assets.
DOUBTFUL ASSETS. Prudent GVAs are required to be established for such
assets.
LOSS ASSETS. 100% of the amount classified as loss must be charged off,
or a specific allowance of 100% of the amount classified as loss must be
established.
GVAs for loan and lease losses are included within regulatory capital for
certain purposes and up to certain limits, while specific allowances and other
general allowances are not included at all.
The OTS and the other federal banking agencies have adopted a statement of
policy regarding the appropriate levels of GVA for loan and lease losses that
institutions should maintain. Under the policy statement, examiners will
generally accept management's evaluation of adequacy of GVAs for loans and
lease losses if the institution has maintained effective systems and controls
for identifying and addressing asset quality problems, analyzed in a reasonable
manner all significant factors that affect the collectability of the portfolio,
and established an acceptable process for evaluating the adequacy of GVAs.
However, the policy statement also provides that OTS examiners will review
management's analysis more closely if GVAs for loan and lease losses do not
equal at least the sum of (a) 15% of assets classified as substandard, (b) 50%
of assets classified as doubtful, and (c) for the portfolio of unclassified
loans and leases, an estimate of credit losses over the upcoming twelve months
based on the institution's average rate of net charge-offs over the previous
two or three years on similar loans, adjusted for current trends and
conditions. The GVA policy statement has had no material impact on Fidelity's
results of operations or financial condition.
52
Community Reinvestment Act
The Community Reinvestment Act ("CRA") requires each savings institution, as
well as other lenders, to identify the communities served by the institution's
offices and to identify the types of credit the institution is prepared to
extend within such communities. The CRA also requires the OTS to assess the
performance of the institution in meeting the credit needs of its community and
to take such assessment into consideration in reviewing applications for
mergers, acquisitions, and other transactions. An unsatisfactory CRA rating may
be the basis for denying such an application.
In connection with its assessment of CRA performance, the OTS assigns a
rating of "outstanding," "satisfactory," "needs to improve," or "substantial
noncompliance." Based on an examination conducted during 1993, Fidelity was
rated satisfactory. The OTS and the other federal banking agencies have jointly
proposed amendments to their CRA regulations that would replace the current
assessment system, which is based on the adequacy of the processes an
institution has established to comply with the CRA, with a new system based on
the institution's performance in making loans and investments and maintaining
branches in low- and moderate-income areas.
Federal Home Loan Bank System
The Federal Home Loan Banks provide a credit facility for member
institutions. As a member of the FHLB of San Francisco, Fidelity is required to
own capital stock in the FHLB of San Francisco in an amount at least equal to
the greater of 1% of the aggregate principal amount of its unpaid home loans,
home purchase contracts and similar obligations at the end of each calendar
year, assuming for such purposes that at least 30% of its assets were home
mortgage loans, or 5% of its advances from the FHLB of San Francisco. At
December 31, 1993, Fidelity was in compliance with this requirement with an
investment in the stock of the FHLB of San Francisco of $52.0 million. Long-
term FHLB advances may be obtained only for the purpose of providing funds for
residential housing finance and all FHLB advances must be secured by specific
types of collateral.
Required Liquidity
OTS regulations require savings institutions to maintain, for each calendar
month, an average daily balance of liquid assets (including cash, certain time
deposits, bankers' acceptances, specified United States government, state and
federal agency obligations, and balances maintained in satisfaction of the FRB
reserve requirements described below) equal to at least 5% of the average daily
balance of its net withdrawable accounts plus short-term borrowings during the
preceding calendar month. The OTS may change this liquidity requirement from
time to time to an amount within a range of 4% to 10% of such accounts and
borrowings depending upon economic conditions and the deposit flows of member
institutions, and may exclude from the definition of liquid assets any item
other than cash and the balances maintained in satisfaction of FRB reserve
requirements. Fidelity's average regulatory liquidity ratio for the month of
December 1993 was 8.79%, and accordingly Fidelity was in compliance with the
liquidity requirement. Monetary penalties may be imposed for failure to meet
liquidity ratio requirements.
OTS regulations also require each member institution to maintain, for each
calendar month, an average daily balance of short-term liquid assets (generally
those having maturities of 12 months or less) equal to at least 1% of the
average daily balance of its net withdrawable accounts plus short-term
borrowings during the preceding calendar month. The average short-term
liquidity ratio of Fidelity for the month of December 1993 was 5.70%.
Federal Reserve System
The FRB requires savings institutions to maintain noninterest-earning
reserves against certain of their transaction accounts (primarily deposit
accounts that may be accessed by writing unlimited checks) and non-personal
time deposits. For the calculation period including December 31, 1993, Fidelity
was required to maintain $28.6 million in noninterest-earning reserves and was
in compliance with this requirement. The balances maintained to meet the
reserve requirements imposed by the FRB may be used to satisfy Fidelity's
liquidity requirements discussed above.
53
As a creditor and a financial institution, Fidelity is subject to certain
regulations promulgated by the FRB, including, without limitation, Regulation B
(Equal Credit Opportunity Act), Regulation D (Reserves), Regulation E
(Electronic Funds Transfers Act), Regulation F (limits on exposure to any one
correspondent depository institution), Regulation Z (Truth in Lending Act),
Regulation CC (Expedited Funds Availability Act), and Regulation DD (Truth in
Savings Act). As creditors of loans secured by real property and as owners of
real property, financial institutions, including Fidelity, may be subject to
potential liability under various statute and regulations applicable to
property owners, generally including statutes and regulations relating to the
environmental condition of the property.
Gateway
Gateway became an NASD-registered broker/dealer in October 1993 and offers
securities products, such as mutual funds and variable annuities, to customers
of the Bank. All securities transactions are executed and cleared by another
broker/dealer. Gateway does not maintain security accounts for customers or
perform custodial functions relating to customer securities.
The securities business is subject to regulation by the Securities and
Exchange Commission ("SEC"), the NASD and other federal and state agencies.
Regulatory violations can result in the revocation of broker/dealer licenses,
the imposition of censures or fines and the suspension or expulsion from the
securities business of a firm, its officers or employees. With the enactment of
the Insider Trading and Securities Fraud Enforcement Act of 1988, the SEC and
the securities exchanges have intensified their regulation of broker/dealers,
emphasizing in particular the need for supervision and control by
broker/dealers of their own employees.
As a broker/dealer registered with the NASD, Gateway is subject to the SEC's
uniform net capital rules, designed to measure the general financial condition
and liquidity of a broker/dealer. These rules require Gateway to maintain
minimum net capital of $100,000 as of January 1, 1994 and do not permit
Gateway's aggregate indebtedness to exceed eight times its net capital during
its first twelve months of operations. At December 31, 1993, Gateway's net
capital and required net capital were $579,929 and $52,000, respectively, and
its ratio of aggregate indebtedness to net capital was .72 to 1. Under certain
circumstances, these rules limit the ability of Citadel to make withdrawals of
capital from Gateway. In addition, Gateway is required to file monthly reports
with the NASD and quarterly and annual reports with the NASD and SEC containing
detailed financial information with respect to its broker/dealer operations.
54
ITEM 2. PROPERTIES
The executive offices of Citadel and Fidelity are located at 600 N. Brand
Boulevard, Glendale, California 91203. This facility contains approximately
90,000 square feet of office space including a branch banking facility of
approximately 12,000 square feet. Fidelity also owns an approximately 130,000
square feet facility located at 4565 Colorado Boulevard, Los Angeles,
California 90039, which houses most of the administrative operations of Citadel
and Fidelity. Present local zoning entitlements will allow for the construction
of an additional approximately 300,000 square feet of office space plus parking
on this 7.75-acre parcel. The potential for increasing the amount of office
space at this Los Angeles site would satisfy Fidelity's anticipated facilities
requirements for future years.
The aggregate net book value of all owned administrative facilities was
approximately $26.0 million as of December 31, 1993. On December 31, 1993,
Fidelity owned 16 of its branch and/or loan office facilities having an
aggregate net book value of approximately $9.4 million, and leased the
remaining 26 of its branch and/or loan office facilities under leases with
terms (including optional extension periods) expiring from 1994 through 2050.
The aggregate annual rent under those leases as of December 31, 1993 was
approximately$2.6 million and the aggregate net book value of Fidelity's
leasehold improvements associated with those leased premises was approximately
$1.9 million. At December 31, 1993, Fidelity owned furniture, fixtures and
equipment, related to both owned and leased facilities, having a net book value
of approximately$11.7 million.
As a result of the January 1994 Northridge Earthquake, physical damage was
sustained at some of the Bank administrative and branch office facilities
located in the Los Angeles area, however, only one Bank-owned building in the
San Fernando Valley region of Los Angeles sustained major damage. It is
estimated that necessary repairs to all affected facilities, net of anticipated
insurance reimbursement, shall not exceed $0.5 million.
All owned office facilities are located in Southern California.
ITEM 3. LEGAL PROCEEDINGS
The Company has lawsuits pending against it in the ordinary course of
business. As of December 31, 1993, the Company's management and its counsel
believe that none of the pending lawsuits or claims taken separately or
together will have a materially adverse impact on the financial condition or
business of the Company.
On March 4, 1994, Chase, one of four lenders under Fidelity's $60 million
Subordinated Loan Agreement, sued Fidelity, Citadel and Citadel's Chairman of
the Board alleging, among other things, that the transfer of assets pursuant to
the Restructuring would constitute a breach of the Subordinated Loan Agreement,
and seeking to enjoin the Restructuring and to recover damages in unspecified
amounts. In addition, the lawsuit alleges that past responses of Citadel and
Fidelity to requests by Chase for information regarding the Restructuring
violate certain provisions of the Subordinated Loan Agreement and that such
alleged violations, with the passage of time, have become current defaults
under the Subordinated Loan Agreement. While the other three lenders under the
Subordinated Loan Agreement hold $25 million of the subordinated debt, none of
them has joined Chase in this lawsuit. The Company is evaluating the lawsuit
and, based on its current assessment, the Company does not believe that the
allegations have merit. See Item 7. "MD&A"--Capital Resources and Liquidity"
for additional considerations relating to the Subordinated Loan Agreement.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 1993.
55
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's common stock is listed and quoted on the American Stock
Exchange ("AMEX"). The following table sets forth the high and low closing bid
prices of the common stock of the Company as reported by AMEX for each of the
following quarters:
HIGH LOW
---- ----
1994:
First quarter through March 15, 1994(1)................. $12 1/4 $ 4 1/4
1993:
Fourth quarter.......................................... 19 1/2 9 3/8
Third quarter........................................... 18 5/8 14 1/4
Second quarter.......................................... 21 7/8 12 5/8
First quarter(2)........................................ 23 7/8 16
1992:
Fourth quarter.......................................... 20 7/8 13 7/8
Third quarter........................................... 25 5/8 13
Second quarter.......................................... 29 1/2 23 1/2
First quarter........................................... 32 7/8 14 5/8
1991:
Fourth quarter.......................................... 28 8 7/8
Third quarter........................................... 37 1/8 28 5/8
Second quarter.......................................... 34 1/8 28 1/2
First quarter........................................... 34 1/4 17 1/4
- --------
(1) The closing price of the Company's common stock on March 15, 1994 was $4.25
per share.
(2) The closing price of the Company's common stock on March 29, 1993 was
$22.13 per share. This price reflects the sale of 3,297,812 newly issued
shares of common stock on March 29, 1993 for $10 per share.
HOLDERS OF RECORD
The number of holders of record of the Company's common stock at February 28,
1994 was 259.
DIVIDENDS
While Citadel has never declared a dividend and has no current plan to
declare a dividend, it is Citadel's policy to review this matter on an ongoing
basis.
Regulatory restrictions applicable to Fidelity and certain provisions of the
Company's Subordinated Loan Agreement currently limit the ability of the
Company to declare or pay dividends. These limitations include: (a) a statutory
prohibition on Fidelity making capital distributions that would cause it to
become undercapitalized for purposes of the prompt corrective action system and
other potentially applicable restrictions under OTS regulations; (b)
limitations in the Subordinated Loan Agreement as to the aggregate amount
declared and paid as a proportion of the Company's consolidated net earnings
and (c) the absence of any default by the Company in its obligations as
specified in the Subordinated Loan Agreement. See Item 1. "Business--Regulation
and Supervision--Savings and Loan Holding Company Regulation--Payment of
Dividends and Other Capital Distributions." See also Item 3. "Legal
Proceedings" and Item 7. "MD&A--Capital Resources and Liquidity" for additional
information regarding the Subordinated Loan Agreement.
At December 31, 1993, Fidelity had accumulated earnings and profits for
federal income tax purposes. Any dividend paid by Fidelity in excess of current
or accumulated earnings and profits for federal income tax purposes would be
treated as made out of the tax bad debt reserve and will increase income for
federal income tax purposes. Currently Fidelity's accumulated earnings and
profits for federal income tax purposes is of such an amount that it would be
highly unlikely that any dividend, if such dividend were payable by Fidelity,
would be treated as made out of the tax bad debt reserve. See Item 1.
"Business--Taxation."
56
ITEM 6. SELECTED FINANCIAL DATA
FIVE-YEAR SELECTED FINANCIAL DATA
The tables below set forth certain historical financial data regarding the
Company. This information is derived in part from, and should be read in
conjunction with, the consolidated financial statements of the Company. None of
the data in the tables have been adjusted for effects of the Citadel rights
offering in March 1993.
AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
1993 1992 1991 1990 1989
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
INCOME STATEMENT
SUMMARY:
Interest income........ $ 289,592 $ 370,722 $ 520,124 $ 525,906 $ 471,469
Interest expense....... 188,391 239,941 378,017 411,256 395,241
---------- ---------- ---------- ---------- ----------
Net interest income... 101,201 130,781 142,107 114,650 76,228
Provision for estimated
loan losses........... 65,100 51,180 49,843 11,039 8,359
---------- ---------- ---------- ---------- ----------
Net interest income
after provision for
estimated loan
losses............... 36,101 79,601 92,264 103,611 67,869
Gains (losses) on sales
of loans, net......... 194 1,117 2,118 (1,408) 1
Gains (losses) on sales
of mortgage-backed
securities, net....... 1,342 -- 8,993 (165) --
Gains (losses) on sales
of investment
securities............ (54) -- 1 32 (234)
Other income (expense). (35,870) (6,602) (5,616) 5,510 9,846
Operating expense...... 105,341 77,911 79,446 66,527 64,411
---------- ---------- ---------- ---------- ----------
Earnings (loss) before
income taxes.......... (103,628) (3,795) 18,314 41,053 13,071
Income tax expense
(benefit)............. (36,467) (5,841) 15,651 17,734 4,931
---------- ---------- ---------- ---------- ----------
Net earnings (loss).... $ (67,161) $ 2,046 $ 2,663 $ 23,319 $ 8,140
========== ========== ========== ========== ==========
Net earnings (loss) per
share................. $ (11.56) $ 0.62 $ 0.81 $ 7.07 $ 2.47
========== ========== ========== ========== ==========
Average common and
common equivalent
shares outstand-
ing(1)(2)............. 5,809,570 3,297,812 3,297,812 3,298,140 3,296,919
BALANCE SHEET DATA:
Total assets........... $4,389,519 $4,698,326 $5,126,525 $5,697,664 $4,980,593
Cash and investments... 238,220 177,599 289,150 309,814 312,785
Total loans, net....... 3,713,383 3,991,781 4,550,848 5,085,213 4,437,199
Deposits............... 3,368,643 3,457,918 3,884,707 3,967,488 3,317,044
Borrowings............. 734,230 908,400 871,150 1,349,166 1,347,219
Subordinated notes..... 60,000 60,000 60,000 60,000 --
Stockholders' equity... 187,403 223,186 221,140 218,477 195,084
Stockholders' equity
per share............. 28.41 67.68 67.06 66.25 59.20
Common shares outstand-
ing(1)(2)............. 6,595,624 3,297,812 3,297,812 3,297,812 3,295,562
OTHER DATA:
Real estate loans
funded................ $ 422,355 $ 435,690 $ 509,265 $1,407,522 $ 898,134
Average interest rate
on new loans.......... 6.75% 7.77% 9.07% 9.31% 9.44%
Loans sold............. $ 137,870 $ 204,435 $ 282,728 $ 158,691 $ 12,033
Nonperforming assets to
total assets.......... 5.37% 4.99% 2.43% .85% .42%
Number of deposit
accounts.............. 241,093 233,037 238,187 233,546 203,015
Interest rate margin at
the end of the
period................ 2.19%(3) 2.68% 3.20% 2.33% 2.16%
Interest rate margin
for the period........ 2.28%(3) 2.67% 2.54% 2.11% 1.49%
Retail branch
offices(4)............ 42 43 43 44 34
- -------
(1) Net of treasury shares, where applicable.
(2) 1993 data includes 3,297,812 shares issued in March 1993 in connection with
a stock rights offering, which produced net proceeds to the Company of
$31.4 million.
(3) Excluding the writedown of core deposit intangibles of $5.2 million,
interest rate margins at and for the year ended December 31, 1993, would
have been 2.32% and 2.39%, respectively.
(4) All retail branch offices are located in Southern California.
57
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
NET EARNINGS
Citadel Holding Corporation ("Citadel") reported a net loss of $67.2
million, or $11.56 per share (average outstanding shares of 5,809,570) in 1993
compared to net earnings of $2.0 million, or $0.62 per share (average
outstanding shares of 3,297,812) in 1992 and $2.7 million, or $0.81 per share
(average outstanding shares of 3,297,812) in 1991. Unless otherwise indicated,
references to the "Company" include Citadel, Fidelity Federal Bank, a Federal
Savings Bank ("Fidelity" or the "Bank") and all subsidiaries of Fidelity and
Citadel.
The following table summarizes these results:
YEAR ENDED DECEMBER 31,
-----------------------------------
1993 1992 1991
---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
Earnings (loss) before income taxes....... $ (103,628) $ (3,795) $ 18,314
Net earnings (loss)....................... $ (67,161) $ 2,046 $ 2,663
Net earnings (loss) per share............. $ (11.56) $ 0.62 $ 0.81
Average common and common equivalent
shares outstanding(1).................... 5,809,570 3,297,812 3,297,812
Return on average equity.................. (28.92)% 0.91% 1.20%
Return on average assets.................. (1.47)% 0.04% 0.05%
- --------
(1) 1993 data includes 3,297,812 shares issued in March 1993 in connection
with a stock rights offering.
The components of the changes in earnings/loss before income taxes are shown
below:
FAVORABLE (UNFAVORABLE) VARIANCE
------------------------------------
1993 VS 1992 1992 VS 1991
---------------- ----------------
(DOLLARS IN THOUSANDS)
Net interest income.................... $(29,580) $(11,326)
Provision for loan losses.............. (13,920) (1,337)
---------------- ----------------
Net interest income after loan loss
provision............................ (43,500) (12,663)
Fee income and other income............ (3,609) 9,652
Provision for real estate losses....... (12,380) (9,258)
Direct costs of real estate operations,
net................................... (14,202) (2,381)
Gains on sales of securities........... 1,288 (8,994)
---------------- ----------------
Noninterest income.................... (28,903) (10,981)
Operating expense...................... (27,430) 1,535
---------------- ----------------
Earnings/loss before income taxes...... (99,833) (22,109)
Income tax expense/benefit............. 30,626 21,492
---------------- ----------------
Net earnings/loss...................... $(69,207) $ (617)
================ ================
The $99.8 million change in earnings/loss before income taxes between 1992
and 1993 is primarily due to (a) decreased net interest income of $29.6
million, (b) increased operating expense of $27.4 million, (c) a $26.3 million
increase in the provision for loan and real estate losses, (d) a $14.2 million
increase in direct costs related to real estate operations, and (e) decreased
fee income and other income of $3.6 million. This was partially offset by a
$1.3 million increase in gains on sales of securities. The $27.4 million
increase in expenses from 1992 to 1993 was attributable in part to increased
staffing levels required to manage rising problem assets,
58
strengthen internal asset review, handle increased financial services offered
at the retail branch network and expand originations and sales of residential
mortgages in the mortgage banking network. The increase is also attributable
to certain nonrecurring charges incurred in connection with the Company's
valuation of its intangible assets and further development of the internal
reorganization and restructuring plan discussed below, including the write-off
$8.8 million of goodwill and $5.2 million in core deposit intangibles, and an
increase of $5.6 million in professional fees, of which approximately $3.3
million was attributable to analysis and development of the Company's
restructuring plan and related asset valuation process.
In 1993, Fidelity reassessed the valuation of its intangible assets. Based
upon the results of a branch profitability analysis and an analysis of the
recoverability of its core deposit intangible assets, Fidelity wrote down the
carrying value of its core deposit intangible assets in the amount of $5.2
million (which writedown is included in interest expense). In addition, an
analysis was performed of the recoverability of the goodwill related to the
acquisition of Mariners Savings and Loan ("Mariners") in 1978. These analyses
indicated that the net expected future earnings from the branches or assets
acquired did not support the carrying value of the goodwill. As a result,
Fidelity wrote down the remaining $8.8 million balance of goodwill related to
the Mariners acquisition (which writedown is included in operating expense).
The $22.1 million change in earnings/loss before income taxes between 1991
and 1992 was mainly due to (a) an $11.3 million decrease in net interest
income, (b) an increase in the provision for loan and real estate operations
of $10.6 million, (c) a $9.0 million decrease in gains on sales of securities,
and (d) a $2.4 million increase in direct costs related to real estate
operations. These were partially offset by increased fee income and other
income of $9.7 million and decreased operating expenses of $1.5 million.
The following table summarizes certain regulatory capital and asset quality
information for Fidelity as of the dates indicated:
DECEMBER 31,
----------------------------
1993 1992 1991
-------- -------- --------
(DOLLARS IN THOUSANDS)
Core Capital(1)................................... $182,100 $203,400 $205,300
Core Capital Ratio(1)............................. 4.15% 4.35% 4.02%
NPAs to Total Assets.............................. 5.37% 4.99% 2.43%
Nonaccruing Loans to NPAs......................... 39.67% 47.80% 55.31%
REO (including ISF) to NPAs....................... 60.33% 52.20% 44.69%
GVA............................................... $ 80,020 $ 75,621 $ 52,374
GVA to Loans and REO (including ISF).............. 2.03% 1.82% 1.13%
GVA to NPAs....................................... 32.79% 30.49% 41.99%
- --------
(1) 1993 capital includes capital contributions from Citadel of $28.0 million.
See "Capital Requirements."
See "Asset Quality" for more information.
NET INTEREST INCOME
Net interest income is the difference between interest income earned on
interest-earning assets and interest expense paid on interest-bearing
liabilities. Stated differently, the level of net interest income is the sum
of (a) the interest rate margin (the difference between the yield earned on
the interest-earning assets and the rate paid on the interest-bearing
liabilities) multiplied by the amount of interest-earning assets; plus (b) the
excess balance of interest-earning assets over interest-bearing liabilities
multiplied by the rate paid on interest-bearing liabilities. Therefore, the
higher the yield on interest-earning assets relative to the rate paid on
interest-bearing liabilities, the higher the net interest income. Conversely,
the lower the yield on interest-earning assets relative to the rate paid on
interest-bearing liabilities, the lower the net interest income. Similarly,
the smaller the level of interest-earning assets relative to the level of
interest-bearing liabilities, the smaller the net interest income. As a
result, net interest income between two periods will decline if the interest
rate margin declines, the excess
59
of interest-earning assets over interest-bearing liabilities declines,
interest-earning accounts decline and the rate paid on interest-bearing
liabilities increases. The converse also holds true.
In a period of increased loan defaults, interest-earning assets tend to
decline faster than interest-bearing liabilities, which in turn tends to
depress net interest income. As a result, a higher interest rate margin would
be needed to maintain a constant level of net interest income. In a period of
declining interest rates, prepayments on mortgages tend to increase and as a
result, the level of interest earning-assets will decline if the volume of new
loan originations held in the portfolio does not increase to offset the
increased level of prepayments. The decline in net interest income is
partially offset by the decline in the rate paid on interest-bearing
liabilities.
The change in net interest income is a result of: (a) the change in
interest-earning assets multiplied by the current interest rate margin, plus
(b) the change in the interest rate margin multiplied by prior interest-
earning assets, plus (c) the change in the rate paid on interest-bearing
liabilities multiplied by the current excess balance of interest-earning
assets over interest-bearing liabilities, plus (d) the change in the excess
balance of interest-earning assets over interest-bearing liabilities
multiplied by the prior rate paid on interest-bearing liabilities.
In addition, net interest income is affected by the level of nonperforming
loans. The Bank generally places loans on nonaccrual status whenever the
payment of interest is 90 or more days delinquent or when the Bank believes
they exhibit materially deficient characteristics. The reduction in income
related to these nonaccruing loans was approximately $8.7 million in 1993
compared to $13.6 million in 1992 and $7.6 million in 1991.
As previously discussed, net interest income was also reduced by a $5.2
million writedown of core deposit intangibles ("CDI") in 1993. The remaining
net unamortized balance of core deposit intangibles at December 31, 1993 was
$2.1 million which is being amortized over the average remaining life of the
deposits acquired, generally 1 to 3 years.
Net interest income for 1993 of $101.2 million decreased by $29.6 million or
22.6% from $130.8 million for 1992. This decrease resulted from the combined
impacts of (a) a 6.7% decrease in average interest-earning assets, reducing
net interest income by $14.7 million, and (b) a 48 basis point decrease in the
effective yield on interest-earning assets, decreasing net interest income by
$14.9 million, caused in part by the impact of the CDI write-off discussed
above.
Net interest income for 1992 of $130.8 million decreased by $11.3 million or
8.0% from $142.1 million for 1991. This $11.3 million decrease resulted from
the offsetting impacts of (a) a 12.0% decrease in average interest-earning
assets, reducing net interest income by $12.8 million, and (b) a 13 basis
point increase in the effective yield on interest-earning assets, increasing
net interest income by $1.5 million.
60
The following table displays the components of the Company's interest rate
margin at the end of, and for each period, as well as the effective yield for
each period:
AT OR FOR THE YEAR ENDED
DECEMBER 31,
-------------------------------
1993 1992 1991
-------- -------- --------
Rate at the end of the period:
Weighted average yield on combined loans and
investments................................. 6.37% 7.21% 9.41%
Weighted average cost of funds............... 4.18 4.53 6.21
-------- -------- --------
Interest rate margin at the end of the
period..................................... 2.19%(1) 2.68% 3.20%
======== ======== ========
Rate for the period:
Weighted average yield on combined loans and
investments................................. 6.65% 7.94% 9.80%
Weighted average cost of funds............... 4.37 5.27 7.26
-------- -------- --------
Interest rate margin for the period......... 2.28%(1) 2.67% 2.54%
======== ======== ========
Effective yield for the period.............. 2.33%(1) 2.81% 2.68%
======== ======== ========
- --------
(1) Excluding the writedown of core deposit intangibles of $5.2 million, the
interest rate margins at and for the year ended December 31, 1993 and the
effective yield on interest-earning assets for the year ended December 31,
1993, would have been 2.32%, 2.39% and 2.44%, respectively.
The reduction in the interest rate margin in 1993 from 1992 can be attributed
to the lagging relationship between the repricing of assets and liabilities as
market interest rates stabilize. The average rate paid on interest-bearing
liabilities adjusts to market rates faster than the average rate earned on
interest-earning assets. This difference in the speed of adjustment to changes
in market interest rates is primarily due to the nature of the Federal Home
Loan Bank ("FHLB") of San Francisco Eleventh District Cost of Funds Index (the
"COFI") to which most of the Bank's loans are tied, the contractual repricing
terms of the loans held in the portfolio, the advance notification requirements
to borrowers for any rate change, the time lag in the availability of the
actual index, as well as the amount of the lifetime interest rate caps. As a
result of these factors, changes in the yield on COFI-based loans lag changes
in market interest rates.
The interest rate margin of the Company increases in a period of steady
decline in interest rates, since the yield on interest-bearing assets drops
more slowly than the rates paid on interest-bearing liabilities. Conversely, as
market interest rates stabilize and then increase, the interest rate margin of
the Company will shrink, other conditions being equal. This factor, together
with the timing of asset repricing and the increase in nonperforming assets,
resulted in a reduction of 132 basis points in the yield on loans in 1993 from
1992 average levels, while the decrease in market interest rates resulted in a
reduction in the cost of funds of only 90 basis points for the comparable
period. The Federal Reserve Board ("FRB") increased the federal funds rate by
0.25% in February 1994 and another 0.25% in March 1994, which may be indicative
of future reductions to the Company's interest rate margin.
The increase in the Company's interest margin for 1992 compared to 1991 was
primarily caused by the continued downward trend in market interest rates
during 1992 which resulted in a decrease in the cost of funds of 199 basis
points. The effect of the reduced cost of funds on the interest margin was
partially offset by a decrease of 179 basis points in the yield on loans from
1991 due to declines in the COFI.
Since 1990, the Company has continued its strategy to more closely match the
repricing periods of its interest-bearing liability and interest-earning asset
portfolios by concentrating on the origination and retention of ARM loans. In
1993, 1992 and 1991, the Bank retained substantially all of the ARM loans it
originated. The percentage of monthly adjustable ARMs outstanding to the total
ARM portfolio was 78%, 77% and 74% at December 31, 1993, 1992 and 1991,
respectively, while the percentage of semiannual adjustable ARMs was 19% at
December 31, 1993 compared to 21% in 1992 and 24% in 1991. This trend of
increasing the monthly adjustable ARM portfolio in relation to the decreasing
semiannual adjustable ARM portfolio will reduce, but not eliminate, the risk
created by the mismatch of the assets' repricing index and the
61
liabilities' repricing indices. However, certain ARMs meeting specific
criteria have been identified as held for sale and transferred to the held for
sale portfolio as part of the asset/liability strategy and the possible need
to increase regulatory capital in the future. See "Interest Rate Risk
Management" for further discussion.
NONINTEREST INCOME
Noninterest income has three major components: (a) gains and losses on the
sale of loans and fee income associated with other on-going operations, such
as fees earned on the sale of securities and annuities, loan origination fees
and service charges on deposit accounts, (b) income/expenses associated with
owned real estate, which includes both the provision for real estate losses as
well as income/expenses experienced by the Bank related to the operations of
its owned real estate properties (e.g., maintenance expenses, capital
expenditures and payment of current and delinquent property taxes), and (c)
gains and losses on the sale of investment securities and mortgage-backed
securities. The last two items can fluctuate widely, and could therefore mask
the underlying fee generating performance of the Company on an ongoing basis.
Noninterest income declined from a loss of $5.5 million in 1992 to a loss of
$34.4 million in 1993.
The following table details the noninterest income/expense:
YEAR ENDED DECEMBER 31,
------------------------
1993 1992 VARIANCE
----------- ----------- --------
(DOLLARS IN THOUSANDS)
Loan and other fee income.................. $ 5,389 $ 7,885 $ (2,496)
Gains on sales of loans, net............... 194 1,117 (923)
Fee income from investment products........ 4,313 3,368 945
Fee income from deposits and other income.. 3,271 4,406 (1,135)
----------- ----------- --------
13,167 16,776 (3,609)
----------- ----------- --------
Provision for estimated real estate losses. (30,200) (17,820) (12,380)
Direct costs of real estate operations,
net....................................... (18,643) (4,441) (14,202)
----------- ----------- --------
(48,843) (22,261) (26,582)
----------- ----------- --------
Gains on sales of mortgage-backed securi-
ties, net................................. 1,342 -- 1,342
Gains (losses) on sales of investment secu-
rities, net............................... (54) -- (54)
----------- ----------- --------
1,288 -- 1,288
----------- ----------- --------
$ (34,388) $ (5,485) $(28,903)
=========== =========== ========
Noninterest income from ongoing operations decreased by $3.6 million, to
$13.2 million during 1993 from $16.8 million during 1992 partly due to the
Company's retooling and refocusing efforts during 1993 (see "Operating
Expense"). An increase in fee income from investment products of $0.9 million
to $4.3 million was offset by decreases in loan and other fees, gains on sales
of loans and fee income from deposits.
Foreclosure activities increased markedly from December 31, 1992 to December
31, 1993, resulting in an increase in real estate owned ("REO") both in terms
of numbers of properties and total dollars. REO consists of real estate
acquired in settlement of loans and in-substance foreclosures ("ISFs").
62
The following table summarizes certain components of Fidelity's real estate
operations:
1993 1992
COMPARED TO COMPARED TO
1992 1991
----------- -----------
(DOLLARS IN THOUSANDS)
Increase in:
Provision for estimated real estate losses............. $ 12,380 $ 9,258
Direct costs of real estate operations, net............ 14,202 2,381
-------- --------
$ 26,582 $ 11,639
======== ========
The following table provides detail on the net book value and number of
properties owned at the given dates:
(DOLLARS IN THOUSANDS)
Owned real estate, net book value:
December 31, 1993...................................... $153,307
December 31, 1992...................................... 133,255 $133,255
December 31, 1991...................................... 70,259
-------- --------
Increase.............................................. $ 20,052 $ 62,996
======== ========
Number of real estate properties owned:
December 31, 1993...................................... 240
December 31, 1992...................................... 170 170
December 31, 1991...................................... 63
-------- --------
Increase.............................................. 70 107
======== ========
The Bank has a policy of providing general valuation allowances for both
estimated loan and real estate losses, in addition to valuation allowances on
specific loans and REO, in response to the continuing deterioration of the
quality of the Bank's loan and REO portfolio. Provisions for real estate
losses increased by $12.4 million in the year ended December 31, 1993 as
compared to the same period in 1992, and provisions for loan losses increased
by $13.9 million over the same period. See "Asset Quality" for further detail.
Noninterest income decreased by $11.7 million in 1992 compared to 1991. This
decrease was due to the combined effects of (a) an increase in net expense
from real estate operations of $11.6 million, inclusive of provisions for
estimated real estate losses, (b) a decrease in gains on sales of mortgage-
backed securities of $9.0 million as there were no such sales in 1992, and (c)
a decrease in other expense of $7.0 million due to the accrual for contingent
liabilities of $6.0 million in 1991 with a $1.0 million reduction in such
accrual in 1992.
63
OPERATING EXPENSE
Operating expense increased to $105.3 million in 1993 from $77.9 million in
1992 and $79.4 million in 1991. The following table details the operating
expenses for 1993 and 1992:
YEAR ENDED DECEMBER 31, FAVORABLE
------------------------- (UNFAVORABLE)
1993 1992 VARIANCE
------------ ----------- -------------
(DOLLARS IN THOUSANDS)
Personnel and benefits................ $ 48,822 $ 39,305 $ (9,517)
Occupancy............................. 13,202 12,705 (497)
FDIC insurance........................ 8,628 8,391 (237)
Professional services................. 11,970 6,119 (5,851)
Office-related expenses............... 6,785 5,031 (1,754)
Marketing............................. 3,080 2,548 (532)
Amortization of intangibles........... 9,246 596 (8,650)
Other general and administrative...... 5,650 5,991 341
------------ ----------- --------
Total before capitalized costs....... 107,383 80,686 (26,697)
Capitalized costs..................... (2,042) (2,775) (733)
------------ ----------- --------
Total operating expenses............. $ 105,341 $ 77,911 $(27,430)
============ =========== ========
Efficiency ratio(1)................... 77.55% 53.16%
============ ===========
Ratio of operating expenses to average
assets(2)............................ 2.30% 1.61%
============ ===========
- --------
(1) The efficiency ratio is computed by dividing total operating expense by net
interest income and noninterest income, excluding nonrecurring items,
provisions for estimated loan and real estate losses, direct costs of real
estate operations and gains/losses on the sale of securities.
(2) The operating expense ratio is computed by dividing total operating expense
by average total assets.
A substantial portion of the increase from 1992 to 1993, as detailed below,
was due to the re-engineering of certain functions of the Bank, including the
related training and personnel costs. The associated improved operating results
are expected to be realized in later years.
The increases in personnel and benefits are mainly due to increased staffing
levels during 1993 (with average full-time equivalent employees ("FTEs") of
882) over 1992 (with average FTEs of 828). The increased staffing levels are
due to (a) increased staffing required to manage the rising problem asset
portfolio and to strengthen the internal asset review function, (b) increased
staffing levels in the retail branch network to support the 1993 strategies of
customer orientation and retail financial services focus, and (c) increased
staffing levels in the mortgage banking network to expand the origination and
sale of residential mortgages. These increases were partially offset by the
reduction of data processing personnel in connection with the outsourcing of
substantially all of the information systems functions in May 1993. The Bank
has aggressively increased the staff of its real estate asset management
department by 27 FTEs during 1993, which handles foreclosures, loan
restructurings and REO sales. The Bank continues to increase the staff of its
internal asset review department, which continuously monitors asset quality and
adequacy of loss reserves.
The staffing level in the retail network increased due to improved ability to
fill open positions and an increased emphasis on providing investment products
to customers. The staffing level in the mortgage banking network also increased
due to the increased emphasis on meeting a broader range of customer real
estate borrowing requirements. The general rise in office-related expenses is
due to the higher staffing levels.
In addition to staffing increases, the Bank incurred higher personnel and
benefits costs related to (a) training costs associated with the data systems
conversions and reorganization of the retail financial services group, (b) the
adoption in 1993 of a new accounting pronouncement related to retiree health
and life insurance benefits (as discussed below), (c) increased costs of
employee insurance benefit and retirement plans,
64
and (d) increased travel costs associated with data systems conversion training
and the exploration of strategic alternatives and restructuring of the Company.
Effective January 1, 1993, the Bank adopted SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions" for its unfunded
postretirement health care and life insurance program. This statement requires
the cost of postretirement benefits to be accrued during the service lives of
employees. The Bank's previous practice was to expense these costs on a cash
basis. The net periodic postretirement benefit cost for 1993 totaled $0.6
million.
However, in an effort to reduce operating expense, the Bank is exploring
various alternatives to all the existing benefit plans, which may include
reducing future benefits accruing to employees.
The Bank's Federal Deposit Insurance Corporation ("FDIC") insurance premium
is based upon three factors: (a) the volume of deposits, (b) the rate at which
the FDIC assesses the deposits, and (c) any other adjustments or credits the
FDIC may allow. The increase in the FDIC insurance expense in 1993, from the
level of expense in 1992, was primarily due to an increase in the rate the FDIC
assessed to deposits in 1993, which was partially offset by a credit received
from the FDIC for the final distribution of the secondary reserve and from the
reduced level of deposits.
Professional services increased in 1993 over 1992 primarily due to financial
advisory fees associated with (a) costs of approximately $3.3 million incurred
in reviewing the Company's strategic objectives and developing a restructuring
plan and in the related asset valuation process and (b) higher outside data
services costs of approximately $2.9 million relative to the outsourcing of the
primary information systems functions in May 1993, which costs were partially
offset by some savings in compensation expense of approximately $1.0 million.
As previously discussed, amortization of intangibles included an $8.8 million
writedown of goodwill in 1993.
Operating expense decreased by $1.5 million in 1992 from the level in 1991.
This decrease was caused principally due to (a) $0.3 million decrease in FDIC
insurance expense due to average deposit shrinkage during the assessment
period, (b) a $0.7 million decrease in professional services due to reduction
in consulting expense, (c) a $0.4 million decrease in other operating expense
due to reductions in marketing expense and level of amortization of intangible
assets, and (d) a $0.6 million increase in capitalized costs due to an increase
in the number of loan originations (although the total dollar amount of loan
originations decreased in 1992 over 1991). These decreases were partially
offset by a $0.9 million increase in personnel and benefits primarily due to
increases in personnel, severance and pension costs.
The increase in operating expenses combined with the decrease in the total
average asset size of the Company (from $5.5 billion at December 31, 1991 to
$4.9 billion at December 31, 1992 and to $4.6 billion at December 31, 1993),
resulted in an increase in the operating expense ratio from 1.43% in 1991 to
1.61% in 1992 and 2.30% in 1993. The operating expense ratio would have been
2.04% for 1993 without the nonrecurring expenses directly related to the
Company's restructuring and the $8.8 million writedown of goodwill. Due to the
sensitivity of the operating expense ratio to changes in the size of the
balance sheet, management also looks at trends in the efficiency ratio to
assess the changing relationship between operating expenses and income
generated.
EFFICIENCY RATIO
The efficiency ratio measures the amount of cost expended by the Company to
generate a given level of revenues in the normal course of business. It is
computed by dividing total operating expense by net interest income and
noninterest income, excluding nonrecurring items, provisions for estimated loan
and real estate losses, costs of real estate operations on specific properties
and gains/losses on the sale of securities. This computation reflects a change
from the method of computation used in previous periods in that the impact of
65
real estate operations on specific properties is now excluded from the
computation. The lower the efficiency ratio, the lower the amount of resources
being expended by the Company to generate a given level of revenues. As a
result, an increase in the efficiency ratio indicates that the Company is
expending more resources to generate revenues and the Company is thus becoming
less efficient in the use of its resources. A decrease in the efficiency ratio
indicates the opposite (i.e. an improvement). Changes in the efficiency ratio
are due to three factors: (a) changes in net interest income, (b) changes in
noninterest income, and (c) changes in operating expenses. A decline in net
interest income and/or noninterest income and/or a rise in operating expenses
will have an unfavorable impact on the ratio (i.e. will increase the ratio) and
the converse holds true. The Company's efficiency ratio worsened by 24.39
percentage points between the year ended December 31, 1992 and 1993 due to
unfavorable variances in all three components. Asset quality problems adversely
affected two of the components of the efficiency ratio; reduced net interest
income via an increase in nonperforming loans and mounting foreclosure
activities, which resulted in a decrease in interest-bearing assets and lower
asset yield; and higher operating expenses associated with the increased
staffing level described above. Additionally, the increased staffing levels in
the retail financial services network and mortgage banking network adversely
impacted the efficiency ratio. These increases should result in increased
expense in the short-term, but increased income in the long-term.
In spite of lower operating expenses in 1992 compared to 1991 levels, the
Company's efficiency ratio worsened by approximately 1.98 percentage points
from 51.18% in 1991 to 53.16% in 1992, as a result of lower interest income due
to increases in nonperforming assets and a smaller balance sheet, partially
offset by increased noninterest income.
An analysis of the change in the efficiency ratios during 1993 and 1992 is
shown below:
YEAR ENDED YEAR ENDED
DECEMBER 31, 1993 DECEMBER 31, 1992
COMPARED TO COMPARED TO
DECEMBER 31, 1992 DECEMBER 31, 1991
----------------- -----------------
Change in efficiency ratio caused by:
Decreased net interest income.............. 15.87% 3.89%
Decreased (increased) noninterest income... 1.25 (0.91)
Increased (decreased) operating expense.... 7.27 (1.00)
----- -----
Unfavorable variance...................... 24.39% 1.98%
===== =====
Continued deterioration in the asset quality of the Bank, and/or stable or
higher short-term interest rates in the future (if they occur) would have an
adverse effect on net interest income and noninterest income, which would in
turn lead to an increase (or worsening) in the efficiency ratio, assuming
expenses remain constant.
CAPITAL RESOURCES AND LIQUIDITY
Regulatory Capital Requirements
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") and implementing capital regulations require Fidelity to maintain:
(1) Tangible Capital of at least 1.5% of Adjusted Total Assets (as defined in
the regulations); (2) Core Capital of at least 3% of Adjusted Total Assets (as
defined in the regulations); and (3) Total Risk-based Capital equal to 8.0% of
Total Risk-weighted Assets (as defined in the regulations). See Item 1.
"Business--Regulation and Supervision--FIRREA Capital Requirements."
The following table summarizes the regulatory capital requirements for
Fidelity at December 31, 1993, but does not reflect the required future phasing
out of certain assets, including investments in, and loans to, subsidiaries
which may presently be engaged in activities not permitted for national banks
and, for risk-based capital, real estate held for investment (the impact of
which the Bank believes to be immaterial). As indicated in the table,
Fidelity's capital levels exceed all three of the currently applicable minimum
capital requirements. Fidelity's capital as shown below includes $28.0 million
of capital contributions from Citadel during 1993. Fidelity's capital levels
also exceeded all of the then applicable minimum capital requirements at
December 31, 1992 and 1991.
66
DECEMBER 31, 1993
---------------------------------------------------
CURRENT RISK-
TANGIBLE CAPITAL CORE CAPITAL BASED CAPITAL
----------------- --------------- ---------------
BALANCE % BALANCE % BALANCE %
----------- ----- ---------- ---- ---------- ----
(DOLLARS IN THOUSANDS)
Regulatory capital......... $ 180,000 4.10% $ 182,100 4.15% $ 270,600 9.32%
Required minimum........... 65,800 1.50 131,700 3.00 232,300 8.00
----------- ----- ---------- ---- ---------- ----
Excess capital............. $ 114,200 2.60% $ 50,400 1.15% $ 38,300 1.32%
=========== ===== ========== ==== ========== ====
Adjusted Assets(1)......... $4,386,300 $4,388,400 $2,903,600
=========== ========== ==========
- --------
(1) The term "adjusted assets" refers to the term "adjusted total assets" as
defined in 12 C.F.R. section 567.1(a) for purposes of tangible and core
capital requirements, and for purposes of risk-based capital requirements,
refers to the term "risk-weighted assets" as defined in 12 C.F.R. section
567.1(bb).
At December 31, 1993, Fidelity met the fully phased-in capital requirements
for all three measurements based upon regulations currently in effect. However,
because of the regulatory advantages available to benefit well-capitalized
institutions, the Bank continues to have as its objective to increase its core
capital to at least 5%. At December 31, 1993, based on then current asset
levels, Fidelity would have been required to increase its core capital by
approximately $37.3 million to reach the 5% core capital level.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
requires the OTS and the federal bank regulatory agencies to revise their risk-
based capital standards to ensure that those standards take adequate account of
interest rate risk, concentration of credit risk, and risks of nontraditional
activities. The OTS added an interest rate risk capital component to its risk-
based capital requirement. This component is effective September 30, 1994,
based on the December 31, 1993 balance sheet. This capital component will
require institutions deemed to have above normal risk to hold additional
capital equal to 50% of the excess risk. As of December 31, 1993, the Bank's
internal risk measurement system showed a risk level less than half of the OTS
limit. The most recently available OTS report (September 30, 1993) shows an
even lower risk. Therefore, if the requirement had been in effect on December
31, 1993, using the year-end balance sheet, there would have been no interest
rate risk component required to be added to Fidelity's risk-based capital
requirement.
In addition, FDICIA required the OTS to implement a system requiring
regulatory sanctions against institutions that are not adequately capitalized,
with the sanctions growing more severe, the lower the institution's capital.
Under FDICIA, the OTS issued regulations establishing specific capital ratios
for five separate capital categories. The five categories of ratios are:
TOTAL
CAPITAL TO
CORE CAPITAL TO CORE CAPITAL TO RISK-
ADJUSTED TOTAL ASSETS RISK-WEIGHTED WEIGHTED
(LEVERAGE) RATIO ASSETS RATIO ASSETS RATIO
--------------------- --------------- ------------
Well Capitalized............ 5% or above 6% or above 10% or above
Adequately capitalized...... 4% or above 4% or above 8% or above
Undercapitalized............ Under 4% Under 4% Under 8%
Significantly
undercapitalized........... Under 3% Under 3% Under 6%
Critically undercapitalized. Ratio of tangible equity to adjusted total assets
of 2% or less
67
The following table summarizes the capital ratios of the adequately
capitalized category and Fidelity's regulatory capital at December 31, 1993 as
compared to such ratios. As indicated in the table, Fidelity's capital levels
exceeded the three minimum capital ratios of the adequately capitalized
category.
CORE CAPITAL TO TOTAL CAPITAL TO
CORE CAPITAL TO RISK- RISK-
ADJUSTED TOTAL ASSETS WEIGHTED ASSETS WEIGHTED ASSETS
--------------------- --------------- -----------------
BALANCE % BALANCE % BALANCE %
------------- ------- ---------- ---- ----------- -----
(DOLLARS IN THOUSANDS)
Regulatory capital...... $ 182,100 4.15% $ 182,100 6.27% $ 270,600 9.32%
Adequately capitalized
requirement............ 175,500 4.00 116,100 4.00 232,300 8.00
---------- ----- ---------- ---- ---------- -----
Excess capital.......... $ 6,600 0.15% $ 66,000 2.27% $ 38,300 1.32%
========== ===== ========== ==== ========== =====
Adjusted Assets(1)...... $4,388,400 $2,903,600 $2,903,600
========== ========== ==========
- --------
(1) The term "adjusted assets" refers to the term "adjusted total assets" as
defined in 12 C.F.R. section 567.1(a) for purposes of core capital
requirements, and for purposes of risk-based capital requirements, refers
to the term "risk-weighted assets" as defined in 12 C.F.R. section
567.1(bb).
Although the Bank was deemed adequately capitalized at December 31, 1993, at
such date, absent the $28 million in capital contributed to the Bank by Citadel
during the year, the Bank would have had to significantly reduce its assets or
the Bank would not have met the 4% core capital to adjusted total assets
requirement of the adequately capitalized category and thus would have been
classified as undercapitalized for purposes of the OTS' prompt corrective
action regulations.
Citadel, with only $2.3 million in liquid assets at December 31, 1993 and
ongoing expenses in connection with the contemplated Restructuring of the
Company defined below, is not in a position to make further capital
contributions to the Bank, nor does Citadel have ready access to additional
funds under current circumstances. Management anticipates that the Bank will
incur losses in the first and second quarters of 1994 that will, in the absence
of a new capital infusion or a reduction in the Bank's total assets, reduce the
Bank's core capital ratio to less than 4%. In an effort to maintain the Bank's
core capital ratio above 4% at March 31, 1994 by downsizing its balance sheet,
the Bank has entered into an agreement to sell approximately $160 million of
single family and multifamily (2 to 4 units) performing loans in the first
quarter of 1994. Additionally, in order to maintain the Bank's capital above
the regulatory minimums necessary to continue to be designated "adequately
capitalized" while the Restructuring is pursued, management continues to
explore possibilities for increasing the Bank's capital, either through the
issuance of new equity or the sale of assets. Management may also consider
further downsizings in the Bank's balance sheet through additional loan sales,
although such dispositions of income-producing assets would reduce the Bank's
future income.
If the Restructuring of the Company discussed below is not accomplished, the
Bank will be required to take other actions to maintain its capital ratios,
including further downsizing the Bank and raising of additional equity. If such
actions are not successful, the Bank would likely become "undercapitalized" for
purposes of the prompt corrective action regulations of the OTS. The
consequences of becoming undercapitalized would include, but would not be
limited to, (a) the obligation of Fidelity to file a capital restoration plan
that is accompanied by an acceptable Citadel guarantee; (b) restrictions on
asset growth, branch acquisitions and new activities; (c) a prohibition on
dividends and capital distributions by Fidelity (subject to certain
exceptions); and (d) increased monitoring by the OTS. An acceptable capital
restoration plan guarantee would require Citadel to demonstrate appropriate
assurances of its ability to perform on the guarantee. Given Citadel's current
capital resources and liquidity position, no assurance can be given that such a
Citadel guarantee would be found acceptable by the OTS. Failure to provide an
acceptable capital restoration plan could result in additional OTS sanctions
typically reserved for "significantly undercapitalized" institutions. These
discretionary sanctions include, but are not limited to, (a) OTS authority to
require the recapitalization, merger or sale of the Bank; (b) divestiture of
subsidiaries of the Bank or a
68
holding company divestiture of the Bank; (c) more stringent asset growth
restrictions than applicable to "undercapitalized" institutions; and (d)
management changes, including election of new directors, and dismissal of
directors or senior officers who have held office for more than 180 days, among
other things.
Economic trends in Southern California continue to adversely affect both the
delinquencies being experienced by thrifts such as Fidelity and the ability of
such institutions to recoup principal and accrued interest by realization upon
underlying collateral. No assurances can be given that such trends will not
continue in future periods creating increasing downward pressure on the capital
and earnings of thrift institutions.
The OTS has the ability to fix specific capital-required levels for Fidelity
higher than those set forth above. Fidelity is under continuing regulatory
pressure to raise capital ratios.
The Company is actively pursuing a restructuring plan that would include both
the transfer to a newly-formed Citadel subsidiary or division of certain
problem assets of the Bank and a sale of the Bank and Gateway (the
"Restructuring"; discussions of the sale of the Bank in the context of the
Restructuring include the sale of Gateway). The Company is currently seeking a
strategic buyer or a new core set of equity investors for the Bank. Any such
sale of the Bank will be subject to the approval of Citadel's Board of
Directors (the "Board") and stockholders, as well as the OTS. Following the
proposed sale of the Bank, Citadel would become a real estate company and focus
on the servicing and enhancement of its loan and real estate portfolio.
The Restructuring calls for the Bank's disposition of substantially all of
its problem assets, together with a small amount of performing assets, so as to
improve the attractiveness of the Bank to potential acquisition or investment
candidates. Most of the Bank's problem assets would be transferred to the new
Citadel real estate subsidiary or division using securitized debt financing.
These assets would consist of commercial and large multifamily loans and real
estate owned properties with a current net book value of approximately $401
million. The impact of the January 1994 Northridge Earthquake on the assets to
be transferred is not expected to alter significantly the value of such assets.
The Restructuring plan also calls for the Bank's disposition of a smaller group
of problem assets, consisting primarily of smaller multifamily loans with a
current net book value of approximately $81 million, in a bulk sale to a third-
party purchaser or Citadel.
While the Board will fully explore the market values of this Restructuring
before making any final decisions, the Board views this approach as having the
greatest potential to maximize stockholder values in the foreseeable future. In
formulating the proposed Restructuring, the Company believes that the value of
Fidelity to a purchaser or investor would be heavily, and perhaps excessively,
discounted due to its problem assets. Thus, it was determined that the Bank's
attractiveness to an acquisition or investment candidate would be enhanced if
the Bank disposed of these problem assets. However, management also believes
that these assets, if managed outside the environment of a federally regulated
institution, present the potential for Citadel stockholders to realize future
value that would not be reflected in the bulk sale price of those assets to a
third party today. Accordingly, the Restructuring was designed to retain in a
Citadel subsidiary or division approximately $401 million of primarily problem
assets after a sale of the Bank. Management believes that an asset disposition
is critical to a successful major recapitalization program for Fidelity.
Citadel has commenced efforts to raise the financing necessary to consummate
its problem asset purchase from Fidelity.
Because of the significant conditions to and uncertainty in accomplishing a
successful Restructuring, the Company expects that the losses associated with
the Restructuring would only be incurred upon the sale of the Bank, at which
time the effects of the losses on capital should be offset by either a new
infusion of capital from investors, who would purchase ownership of the Bank,
or a merger with another financial institution.
The following discussion focuses on certain financial consequences of the
Restructuring and is not indicative of the loss content of the Bank's assets in
the absence of the restructuring or other bulk asset dispositions.
To consummate the bulk transfers of assets to a Citadel subsidiary or
division and obtain debt financing in the capital markets for the larger
transfer, Fidelity would be required to write down these assets to their bulk
sale values. These losses would be offset in part by the reduction in the
Bank's GVA (reflecting the
69
healthier remaining asset pool) and possible tax benefits. If the
Restructuring were to be consummated in mid-1994, management's latest estimate
is that the Bank's core capital, after giving effect to the writedowns on the
asset transfers, tax benefits associated therewith, use of relevant reserves
and extraordinary charges relating to the Restructuring, but before giving
effect to any new capital infusion into the Bank by the acquiror or new
investors, would be approximately $102 million. This estimate will be subject
to ongoing adjustment in view of changing variables such as future earnings or
losses, changes in the composition and size of the problem assets and other
factors.
The Bank does not intend to implement the above-described bulk problem asset
dispositions, or to incur the consequent losses, in the absence of an
acquisition of the Bank by another financial institution or financial
investors who are able to infuse additional core capital into the Bank. Any
such acquisition will also require the approval of Citadel's Board and
stockholders, as well as the OTS, which will condition its approval in part on
the adequacy of the capital of the Bank after the Restructuring.
No assurances can be given that the proposed Restructuring can be
successfully implemented.
Sources of Funds and Liquidity
The Bank's primary sources of operating funds are deposits, borrowings, loan
payments and prepayments, loan sales and earnings.
Deposit activity is an important factor in Fidelity's cash flow position. At
December 31, 1993, Fidelity had deposits of $3.4 billion, down from $3.5
billion at December 31, 1992 and $3.9 billion at December 31, 1991. This
reduction has been, in part, the natural result of the Company's determination
to reduce total assets and, in part, the result of the need on the part of its
depositors to withdraw funds to meet current living expenses and/or increase
yields through other investments.
As a part of its strategy of preserving and enhancing the value of its
customer franchise, Fidelity has increasingly focused its efforts on
attracting and retaining a greater number of profitable, low-cost transaction
accounts, such as checking, passbook and money market accounts. In the year
ended December 31, 1993, Fidelity increased the number of checking accounts to
94,100 from 77,400 at year-end 1992 and 65,400 at year-end 1991. Similarly,
the number of passbook accounts increased from 19,700 at year-end 1991 to
24,300 at year-end 1992 and 28,100 at year-end 1993. The number of money
market savings accounts declined from 21,600 at year-end 1991 to 18,800 at
year-end 1992 and 15,200 at year-end 1993, primarily due to decreasing
interest rates during those periods.
The Bank has also restructured its branch network with an emphasis on
providing retail financial services to its customers. In order to capture the
funds moving out of traditional bank products into higher yield investments,
sales of investment products have been integrated into the retail network, and
new positions and compensation systems have been developed and implemented. In
1993, the Company, through Gateway, sold investment and annuities products to
customers of the Bank totaling $96.4 million, compared with total sales of
$79.9 million in 1992 and $57.8 million in 1991.
During 1993, the total balance of certificates of deposit increased by $22.3
million to $2.6 billion, while the total balance of retail transaction
accounts (checking, passbook and money market savings) and other lower-cost
accounts decreased by $111.6 million to $729.6 million. These reductions in
total balance have been influenced by lower rates of interest offered on
retail accounts, causing depositors to seek increased yields through other
investments. On December 31, 1993, certificates of deposit over $100,000
represented approximately 18% of total deposits compared to 16% at December
31, 1992 and 16% at December 31, 1991. Broker-originated deposits totaling
$92.2 million, $12.9 million and $0 were included in certificates of deposit
at the comparable periods.
FHLB Advances are another major source of funds. At December 31, 1993, 1992
and 1991, the outstanding balances were $326.4 million, $581.4 million and
$325.0 million, respectively. The decreased use of FHLB Advances in 1993 as a
source of funds results primarily from the use of commercial paper, which is
less costly, as an alternative source of funds.
70
In an ongoing effort to diversify its funding source, the Bank started
issuing commercial paper during the third quarter of 1992. The commercial
paper is backed by a letter of credit from the FHLB to ensure a high quality
investment grade rating. Fidelity's obligation to reimburse the FHLB for any
amounts paid under the letter of credit is secured by a pledge of mortgage
loans by Fidelity to the FHLB. At December 31, 1993, $239.0 million of net
funds were provided by the issuance of commercial paper, compared to $65.0
million at December 31, 1992.
The Bank also enters into reverse repurchase agreements ("repos") whereby
the Bank sells securities under agreements to repurchase the securities at a
specific price and date. The Bank deals only with dealers judged by management
to be financially strong or who are recognized as primary dealers in U.S.
Treasury securities by the FRB. In 1993, $3.8 million of net funds were
provided by repo activity.
Loan principal payments including prepayments, were a major source of funds
in 1993, providing$290.0 million, compared to $469.0 million in 1992, and
$408.0 million in 1991. It is anticipated that loan payments and prepayments
will continue to be a major source of funds in the future.
Another source of operating funds is the proceeds from the sale of loans
which totaled $138.4 million in 1993, compared to $204.4 million in 1992 and
$282.7 million in 1991. Sales of loans are dependent upon various factors,
including interest rate movements, investor demand for loan products, deposit
flows, the availability and attractiveness of other sources of funds, loan
demand by borrowers, desired asset size and evolving capital and liquidity
requirements. In 1993, the Bank designated $321 million of adjustable rate
mortgage loans as held for sale to enhance asset/liability management and
liquidity. Due to the volatility and unpredictability of these factors, the
volume of Fidelity's sales of loans has fluctuated significantly and
therefore, an accurate estimate of future sales cannot be made at this time.
The sale of investment and mortgage-backed securities ("MBS") also provides
operating funds to the Bank. During 1993, the Bank changed its investment
strategy and as a result moved its entire portfolio of its investment and
mortgage-backed securities securities from the investment portfolio to the
held for sale portfolio. Sales of investment securities totaled $351.8 million
for the year ended December 31, 1993, compared to no such sales in 1992 and
$1.5 million in 1991. Sales of MBS totaled $522.1 million in 1993 compared to
no such sales during 1992 and to $273.0 million in sales during 1991.
Sales of loans and securities from the held for investment portfolio would
be caused by unusual events. The level of future sales, if any, is difficult
to predict. During 1993, the Bank approved a policy of more active management
of its investment portfolio with a view toward disposition of securities and
loans with unfavorable risk/return profiles. This policy may result in loans
being reclassified from held for investment to held for sale. Any subsequent
sale of such loans would not generally be expected to result in any material
gain or loss. The higher level of sales of loans and mortgage-backed
securities in 1993 was from the Bank's held for sale portfolio and the result
of efforts to reduce its asset size for capital planning purposes.
At December 31, 1993 and 1992, the Bank had $367.7 million and $26.5
million, respectively, of loans in its held for sale portfolio.
Fidelity's sources of cash are utilized in funding loans and investments,
for payment of its debt obligations and in maintaining a liquidity ratio in
compliance with regulatory requirements. Fidelity's total loans funded
(excluding Fidelity's refinances) in the year ended December 31, 1993 were
$383 million versus $386 million in the corresponding 1992 period. The Bank
had commitments outstanding to originate $37.9 million in loans at market
interest rates at December 31, 1993 compared to $37.5 million at December 31,
1992. In addition, the Bank had a total of $155.8 million at December 31, 1993
and $138.1 million at December 31, 1992 of unfunded loans in its pipeline.
The overall decline in the loan pipeline resulted from: (a) a decision by
the Bank to limit multifamily loan originations in accordance with the Bank's
more rigorous view of multifamily loans as, in fact, business loans which
require considerably more scrutiny and continuous monitoring, (b) the
restructuring associated
71
with the development and implementation of the Bank's strategy in building a
mortage banking division geared toward single family residential loan
originations, (c) the development of independent originators for multifamily
originations, and (d) a reduction in market demand for products Fidelity
desired for its portfolio.
Fidelity also had $52.1 million in the unused balance of home equity credit
lines at December 31, 1993, compared to $66.2 million at December 31, 1992 and
$66.3 million at December 31, 1991. The decline in unused balances of home
equity credit lines was due to a slowdown in new credit facility growth over
the 1992 to 1993 period. New home equity credit lines totaled approximately
$13.6 million, $26.9 million and $42.5 million for the years 1993, 1992 and
1991, respectively. The 49% decline in 1993 new home equity lines reflected
significant levels of first trust deed refinancings as well as lower homeowner
equity as single family housing appraisals fell from higher values of prior
years. In May 1993, management implemented a new $300 home equity application
fee which also contributed to a home equity volume reduction over the third and
fourth quarters of 1992.
The OTS regulations require the maintenance of an average regulatory
liquidity ratio of at least 5% of deposits and short-term borrowings.
Fidelity's monthly average regulatory liquidity ratio was 8.8% and 5.3% for
December 1993 and 1992, respectively. Fidelity's year-end liquidity ratios were
6.1% in 1993 and 5.7% in 1992. Both Fidelity's short-term and long-term cash
flow forecasts indicate an adequate liquidity margin to meet foreseeable
operational demands.
Fidelity maintains other sources of liquidity to draw upon if unforeseen
circumstances should occur such as changes in regulatory liquidity, capital
requirements, sudden deposit outflows or pending tax legislation. At December
31, 1993, these sources of liquidity included: (a) presently available line of
credit from the FHLB of $201.7 million (assuming all of the $400 million
capacity of commercial paper is used); (b) unused commercial paper facility of
$96 million; (c) unpledged securities in the amount of $106.1 million available
to be placed in reverse repurchase agreements or sold; and (d) unpledged loans
of $1.4 billion, of which some portion would be available to collateralize
additional FHLB or private borrowings or which may be securitized. In 1993,
Fidelity received two capital contributions totaling $28.0 million from
Citadel. See "Citadel" below for further discussion.
Citadel has limited cash assets and no material potential cash-producing
operations or assets other than its investment in Fidelity and in Gateway
Investment Services, Inc., its securities brokerage subsidiary ("Gateway"). In
March 1993, Citadel issued 3,297,812 shares of common stock through a rights
offering to stockholders and received net proceeds of approximately $31.4
million. Of this amount, Citadel contributed $18.0 million in March 1993 and
$10.0 million in December 1993 to the capital of Fidelity and retained the
balance for liquidity and working capital purposes. Gateway paid a dividend of
$1.0 million to Citadel in December 1993. Citadel had $2.3 million in cash and
cash equivalents at December 31, 1993. Because of Fidelity's current capital
levels, dividends and distributions from Fidelity will not be available to
Citadel for the foreseeable future. Thus, Citadel's current cash balances,
together with future dividends from Gateway, are the only sources of cash to
Citadel. Gateway's ability to pay dividends may be restricted by certain
regulatory net capital rules. See Item 1. "Business--Regulation and
Supervision--Gateway." Management believes that Citadel's cash resources will
only be sufficient to meet Citadel expenditures through mid-1994. If the
Restructuring is not completed at such time, Citadel will be required to raise
additional cash to fund its expenditures, and no assurances can be given that
Citadel will be able to raise any such funds.
The Bank entered into a Subordinated Loan Agreement dated as of May 15, 1990
(the "Subordinated Loan Agreement") pursuant to which $60 million in
subordinated notes (the "Notes") are outstanding, which Notes are guaranteed by
Citadel. The Subordinated Loan Agreement, among other covenants, contains a
provision requiring Fidelity to maintain a consolidated tangible net worth at
least equal to the greater of (a) $170 million plus 50% of consolidated net
earnings since January 1, 1990, or (b) 3.25% of consolidated assets. As stated
above, management anticipates that additional losses are likely to be incurred
during 1994 and that, as a result, consolidated tangible net worth may be
reduced to less than $170 million during the first quarter of 1994. However,
management's projections for 1994 indicate that the Bank's consolidated
tangible net worth will remain above the net worth requirement under the
foregoing clause (a) through the first quarter of the year, assuming the
formula in clause (a) permits a reduction of the $170 million test if a
72
consolidated net loss has been sustained since January 1, 1990. Under this
interpretation, the amount of consolidated tangible net worth necessary to meet
the requirement of clause (a) would be $153.9 million at December 31, 1993 and
would be further reduced by 50% of all losses during 1994. The amount of
consolidated tangible net worth necessary to meet the requirement of clause (b)
was less than $153.9 million at December 31, 1993. As of December 31, 1993, the
Bank's consolidated tangible net worth amounted to $180.2 million. Management's
projections for the balance of 1994 indicate that the Bank's consolidated
tangible net worth will remain above the net worth requirement under the test
of either clause (a) (assuming it is interpreted as described above) or clause
(b) only if the Restructuring is accomplished or other capital-raising efforts
are successful.
The holders of the Notes could take the position that the amount under clause
(a) may not be reduced by losses to less than $170 million. Under that
position, Fidelity would be in violation of the covenant as soon as
consolidated tangible net worth were reduced to less than $170 million.
Management believes that such position is not correct; however, there can be no
assurance that such position would not prevail if the issue were ever tested in
court. If the above covenant were violated, the holders of 66 2/3% in aggregate
principal amount of the Notes would be entitled to declare the entire amount of
the Notes immediately due and payable. However, if such acceleration would
result in the Bank's failure to meet applicable regulatory capital
requirements, the holders would be prohibited from accelerating the Notes
without the prior approval of the OTS. If the Bank failed to make such payment,
Citadel would be required to make such payment under its guarantee of the
Notes. Management anticipates that Citadel's funds would be insufficient to
make such payment, unless additional funds were raised.
The holders of the Notes have power of approval over certain matters,
including certain asset sales, and may require a repurchase of the Notes upon a
"Significant Event." Management believes that neither the approval of the
holders nor a Significant Event repurchase offer would be required for
consummation of the proposed Restructuring if an acquiror of the Bank has
outstanding, immediately prior to the closing of the Restructuring, unsecured
debt with a credit rating of BBB or better by Standard & Poor's Corporation or
Baa2 or better by Moody's Investors Service, Inc. and various financial tests
are satisfied after giving effect to the Restructuring. However, should the
Restructuring be found to trigger the Significant Event repurchase requirement,
Fidelity could be required to pay the principal balance of the Notes of $60
million plus accrued interest and a premium of approximately $12.8 million
(calculated as of December 31, 1993). Also, if the consent of the holders
should be required under any of the covenants of the Subordinated Loan
Agreement but not be obtained, an event of default would occur under the
Subordinated Loan Agreement (subject to grace or cure periods in the case of
certain covenants) if the Restructuring is completed.
On March 4, 1994, Chase Manhattan Bank, N.A. ("Chase"), one of four lenders
under the Subordinated Loan Agreement, sued Fidelity, Citadel and Citadel's
Chairman of the Board, alleging, among other things, that the transfer of
assets pursuant to the Restructuring would constitute a breach of the
Subordinated Loan Agreement, including the tangible net worth and various other
financial tests contained therein, and seeking to enjoin the Restructuring and
to recover damages in unspecified amounts. In addition, the lawsuit alleges
that past responses of Citadel and Fidelity to requests by Chase for
information regarding the Restructuring violate certain provisions of the
Subordinated Loan Agreement and that such alleged violations, with the passage
of time, have become current defaults under the Subordinated Loan Agreement.
While the other three lenders under the Subordinated Loan Agreement hold $25
million of the Notes, none of them has joined Chase in this lawsuit. The
Company is evaluating the lawsuit and, based on its current assessment, the
Company does not believe that the allegations have merit.
Any violation of the tangible net worth covenant or the occurrence of any
other event of default under the Subordinated Loan Agreement would also result
in a cross default under Fidelity's debt agreements with the FHLB (whether or
not the Notes are accelerated) and entitle the FHLB to declare all amounts
outstanding to become immediately due and payable. Also, the FHLB may elect not
to make further Advances to the Bank and may prevent the Bank from issuing
further commercial paper under its existing facility.
73
ASSET QUALITY
The Bank continues to be principally involved in the Southern California
single family and multifamily (2 units or more) residential lending businesses.
At December 31, 1993, 20.8% of Fidelity's total loan portfolio (including loans
held for sale) consisted of California single family residences while another
71.2% consisted of California multifamily dwellings. At December 31, 1992,
21.1% of Fidelity's loan portfolio consisted of California single family
residences and 70.2% consisted of California multifamily dwellings. Current
Southern California economic conditions have adversely impacted the credit risk
profile of the Bank's loan portfolio.
The Company's performance continues to be adversely affected by increased
foreclosure activities of the Bank reflecting the continued weakness of the
Southern California economy and a depressed real estate market. Nonperforming
assets increased slightly to $235.6 million at December 31, 1993 from $234.4
million at December 31, 1992. Classified assets increased from $353.7 million
in 1992 to $372.5 million at December 31, 1993. Troubled debt restructuring
declined by $58.6 million in 1993 to $28.7 million as of December 31, 1993
compared to $87.3 million at December 31, 1992. Asset quality details of
Fidelity are as follows:
DECEMBER 31,
------------------
1993 1992
-------- --------
(DOLLARS IN
THOUSANDS)
Nonperforming Assets ("NPAs"):
Nonaccruing loans.......................................... $ 93,475 $112,041
ISF........................................................ 28,362 47,324
Foreclosed real estate..................................... 122,226 88,659
REO GVA.................................................... (8,442) (13,619)
-------- --------
Total NPAs................................................ $235,621 $234,405
======== ========
Nonaccruing loans to total assets......................... 2.13% 2.38%
======== ========
NPAs to total assets...................................... 5.37% 4.99%
======== ========
NPAs and Troubled Debt Restructuring ("TDR"):
NPAs....................................................... $235,621 $234,405
Classified TDRs............................................ 23,650 44,308
Nonclassified TDRs......................................... 5,062 42,996
-------- --------
Total NPAs and TDRs....................................... $264,333 $321,709
======== ========
TDRs to total assets...................................... 0.65% 1.86%
======== ========
NPAs and TDRs to total assets.............................. 6.03% 6.85%
======== ========
Classified Assets:
NPAs....................................................... $235,621 $234,405
Performing loans with increased risk....................... 125,720 108,442
Real estate held for investment............................ 11,161 10,891
-------- --------
Total classified assets................................... 372,502 353,738
Criticized assets (Special Mention assets).................. 199,826 146,411
-------- --------
Total classified and criticized assets.................... $572,328 $500,149
======== ========
Classified assets to total assets.......................... 8.49% 7.53%
======== ========
Classified and criticized assets to total assets........... 13.05% 10.65%
======== ========
Nonperforming Asset Ratios:
REO (including ISF) to NPAs................................ 60.33% 52.20%
Foreclosed real estate to NPAs............................. 48.29% 32.01%
Nonaccruing loans to NPAs.................................. 39.67% 47.80%
ISF to NPAs................................................ 12.04% 20.19%
74
There was a marked shift in the composition of NPAs in 1993. Foreclosed real
estate increased from 32.0% of NPAs at December 31, 1992 to 48.3% at December
31, 1993 while nonaccruing loans and in-substance foreclosures declined from
68.0% to 51.7% in the same time period. This shift may be an indicator that the
problem assets are working their way through the system toward eventual
resolution. However, as stated previously, the Southern California economy
remains weak and no assurance can be made that problem assets will not increase
in the future.
Loans are categorized as ISF based upon meeting all of the following three
criteria: (a) the borrower currently has little or no equity at fair market
value in the underlying collateral, (b) the only source of repayment is the
property securing the loan, and (c) the borrower has abandoned the property or
will not be able to rebuild equity in the foreseeable future. The Bank
generally places a loan on nonaccrual status whenever the payment of interest
is 90 or more days delinquent, or earlier if a loan exhibits materially
deficient characteristics.
In May 1993, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for
Impairment of a Loan." This statement prescribes the recognition criteria for
loan impairment and the measurement methods for certain impaired loans and
loans whose terms are modified in TDRs. SFAS No. 114 defines a loan as impaired
when it is probable that a creditor will be unable to collect all principal and
interest amounts due according to the contracted terms of the loan agreement.
This statement also clarified the existing accounting for ISFs by stating that
a collateral dependent real estate loan would be reported as REO only if the
lender had taken possession of the collateral.
Additionally, in June 1993, the Office of the Comptroller of the Currency,
Federal Deposit Insurance Corporation, Federal Reserve Board and Office of
Thrift Supervision issued a joint statement providing interagency guidance on
the reporting of ISFs. This joint statement clarified that losses must be
recognized on real estate loans that meet the existing ISF criteria based on
fair value of the collateral, but such loans need not be reported as REO unless
possession of the underlying collateral has been obtained. The Company intends
to adopt SFAS No. 114 as of January 1, 1994. As the Bank already measures
impairment based on the fair value of the collateral, the estimated impact of
such application will consist of a reclassification of ISFs on the statement of
financial condition from REO to loans. This reclassification will also result
in an increase in nonaccrual loans. As NPAs consist of nonaccrual loans plus
REO, this shift from ISF to nonaccrual loans will not affect the level of NPAs.
At December 31, 1993 and 1992, the amount of ISFs totaled $28.4 million, and
$47.3 million, respectively. This shift would not have had a material impact on
the results of operations had this standard been in effect at December 31,
1993.
The Bank has modified the terms of certain loans that resulted in those loans
being defined as TDRs according to SFAS No. 15, "Accounting by Debtors and
Creditors for Troubled Debt Restructurings". TDRs represent loans that are
current as to payment of principal and interest, but have had their terms
renegotiated to a more favorable position for the borrower due to an inability
to meet the original terms of the note. Troubled debt restructurings decreased
by $58.6 million during 1993 as a number of borrowers were either able to
return to the original payment terms at the expiration of the modification
period or the loans migrated to nonperforming loans or REO. The average loan
balance of loans being modified has also declined, further reducing TDRs.
Classified assets consist of NPAs and all other assets classified for
internal and regulatory purposes, including other assets that are currently
performing, but exhibit deficiencies that indicate the distinct possibility
that the Bank will sustain some loss if the deficiencies are not corrected
("performing loans with increased risk"). Classified assets are assigned to one
of the following three categories in the order of increasing credit risk: (a)
Substandard - an asset with well-defined weaknesses characterized by a distinct
possibility that some loss will be sustained if the weaknesses are not
corrected, (b) Doubtful - an asset which has all the weaknesses of a
Substandard asset with the added characteristic that the weaknesses make
collection or liquidation in full, on the basis of currently existing facts,
conditions and values, highly
75
questionable and improbable, and (c) Loss - an asset, or portion thereof,
considered uncollectible and of such little value that a loss classification is
warranted; the amount identified as loss can be charged off or a specific
reserve established for the amount considered uncollectible. As of December 31,
1993, classified assets were $372.5 million (8.49% of total assets), increasing
from $353.7 million (7.53% of total assets) at December 31, 1992 and $228.4
million (4.46% of total assets) as of December 31, 1991. The increase in
classified assets in 1993 consisted primarily of a sharp increase in performing
loans with increased risk.
The increase in classified assets in 1992 primarily consisted of the increase
in NPAs of $109.7 million and the increase of performing loans with increased
risk of $19.3 million (primarily attributed to 25 multifamily residential loans
in Southern California and two commercial and industrial complexes in Southern
California).
In addition to classifying assets, the Bank also designates certain assets as
Special Mention which are considered criticized assets but not classified as
they do not currently expose the Bank to a sufficient degree of risk to warrant
an adverse classification. However, they do possess credit deficiencies or
potential weaknesses deserving management's close attention. If uncorrected,
such weaknesses or deficiencies may expose an institution to an increased risk
of loss in the future.
Criticized assets consist of loans on 1 to 4 unit properties which are 60 to
89 days delinquent and on other multifamily properties (5 units and over) which
are 30 to 89 days delinquent, assets in bankruptcy less than 60 days
delinquent, and all other assets otherwise criticized for internal or
regulatory purposes. Total criticized assets increased by $53.4 million during
1993 due to an increase in delinquent loans and loans having delinquent
property taxes and as the result of increased internal review.
Total loan delinquencies decreased by $3.8 million during 1993. This decrease
was due primarily to the migration of loans delinquent 90 days and over to REO.
76
The following table illustrates the trend of delinquencies of the respective
loan portfolios:
NET LOAN DELINQUENCIES TO NET REAL ESTATE LOAN PORTFOLIO
DECEMBER 31,
-------------------
1993 1992
-------- ---------
(DOLLARS IN
THOUSANDS)
Delinquencies by number of days:
30 to 59 days............................................. 0.92% 0.82%
60 to 89 days............................................. 0.64 0.39
90 days and over.......................................... 2.15 2.36
-------- ---------
Loan delinquencies to net loan portfolio.................. 3.71% 3.57%
======== =========
Delinquencies by property type:
Single family:
30 to 59 days............................................ $ 7,480 $ 7,939
60 to 89 days............................................ 2,497 3,665
90 days and over......................................... 12,661 14,064
-------- ---------
22,638 25,668
-------- ---------
Percent to respective loan portfolio...................... 2.85% 3.00%
Multifamily (2 to 4 units):
30 to 59 days............................................ 3,599 1,432
60 to 89 days............................................ 1,707 1,180
90 days and over......................................... 15,652 6,372
-------- ---------
20,958 8,984
-------- ---------
Percent to respective loan portfolio...................... 4.16% 1.70%
Multifamily (5 to 36 units):
30 to 59 days............................................ 16,948 15,927
60 to 89 days............................................ 12,770 9,241
90 days and over......................................... 34,746 33,627
-------- ---------
64,464 58,795
-------- ---------
Percent to respective loan portfolio...................... 3.60% 3.13%
Multifamily (37 units and over):
30 to 59 days............................................ 4,114 5,623
60 to 89 days............................................ 5,035 1,223
90 days and over......................................... 4,358 23,691
-------- ---------
13,507 30,537
-------- ---------
Percent to respective loan portfolio...................... 3.35% 6.89%
Commercial & Industrial:
30 to 59 days............................................ 2,048 1,807
60 to 89 days............................................ 1,723 --
90 days and over......................................... 12,443 15,772
-------- ---------
16,214 17,579
-------- ---------
Percent to respective loan portfolio...................... 5.45% 5.05%
Total loan delinquencies, net............................. $137,781 $ 141,563
======== =========
California has been hit particularly hard by the current recession and
Southern California has experienced the brunt of the economic downturn in the
state. While the rest of the nation is experiencing a modest economic recovery,
the Southern California economy remains sluggish with higher unemployment than
elsewhere in the country and real estate values that continue to deteriorate.
There can be no assurances
77
that these economic conditions will improve in the near future. Consequently,
rents and real estate values may continue to decline which may affect future
delinquency and foreclosure levels and may adversely impact the Bank's asset
quality, earnings performance and capital.
The Bank recorded additions to its allowances for estimated loan losses and
real estate losses totaling $95.3 million during 1993 compared to $69.0 million
in 1992. The total allowances for such losses consist of the sum of the GVA for
both loans and real estate and all specific loss reserves for assets classified
as "Loss." These provisions have been made in response to continuing
deterioration of the Bank's loan portfolio. In the opinion of the Bank, this
deterioration is caused by the decline in apartment occupancy levels and of
rents available to apartment owners in Southern California; downward revisions
in projections as to inflation and rental income growth; the increased returns
currently being required by purchasers of multifamily income-producing
properties; announced cutbacks in public sector spending; the general
illiquidity in the Southern California market for multifamily income-producing
properties; and the continuing high level of unemployment in and migration of
skilled and white collar labor from Southern California. The Bank's combined
GVA for loan and real estate losses at December 31, 1993 was $80.0 million or
2.03% of total loans and real estate up from $75.6 million or 1.82% at December
31, 1992 and $52.4 million or 1.13% at December 31, 1991.
The following table summarizes Fidelity's reserves, writedowns and certain
coverage ratios at the dates indicated:
DECEMBER 31,
------------------------
1993 1992
----------- -----------
(DOLLARS IN THOUSANDS)
Loans:
GVA................................................. $ 71,578 $ 60,802
Specific reserves................................... 12,254 3,475
----------- -----------
Total allowance for estimated losses............... $ 83,832 $ 64,277
=========== ===========
Writedowns(1)....................................... $ 4,251 $ 5,574
=========== ===========
Total allowance and loan writedowns to gross loans.. 2.32% 1.72%
Loan GVA to loans and ISF........................... 1.88% 1.49%
Loan GVA to nonaccruing loans and ISF............... 58.75% 38.15%
Nonperforming loans to total loans.................. 2.52% 2.83%
Owned Real Estate (including ISF and real estate held
for investment):
REO GVA............................................. $ 8,442 $ 13,619
GVA on real estate held for investment.............. -- 1,200
Specific reserves................................... 9,273 1,631
----------- -----------
Total allowance for estimated losses............... $ 17,715 $ 16,450
=========== ===========
Writedowns(1)....................................... $ 90,901 $ 79,041
=========== ===========
Total REO allowance and REO writedowns to gross REO. 37.41% 34.97%
REO GVA to REO (excluding ISF)(2)................... 6.91% 15.36%
Total Loans and REO:
GVA................................................. $ 80,020 $ 75,621
Specific reserves................................... 21,527 5,106
----------- -----------
Total allowance for estimated losses............... $ 101,547 $ 80,727
=========== ===========
Writedowns(1)....................................... $ 95,152 $ 84,615
=========== ===========
Total allowance and writedowns to gross loans and
REO (including ISF)................................ 4.87% 3.88%
Total GVA to loans and REO (including ISF)(2)....... 2.03% 1.82%
Total GVA to NPAs(2)................................ 32.79% 30.49%
- --------
(1) Writedowns include cumulative charge-offs taken on outstanding loans and
REO as of the date indicated.
(2) Loans, REO and NPAs in these ratios are calculated prior to the reduction
for loan and REO GVA, but are net of specific reserves.
78
During current market conditions, the Bank rarely sells REO for a price equal
to or greater than the loan balance, and the losses suffered are impacted by
the market factors discussed elsewhere in this report. REO is recorded at
acquisition at the lower of the recorded investment in the subject loan or the
fair market value of the assets received. The fair market value of the assets
received is based upon a current appraisal adjusted for estimated carrying,
rehabilitation and selling costs. The Bank's policy has been generally to
proceed promptly to market the properties acquired through foreclosure, and the
Bank often makes financing terms available to buyers of such properties.
Generally, the Bank experiences higher losses on sales of REO properties for
all cash, as opposed to financing the sale. However, by financing the sale, the
Bank incurs the risk that the loan may not be repaid. During 1993, the Bank
sold 210 REO properties for net sales proceeds of $83.5 million, with a gross
book and net book value totaling $138.5 million and $89.8 million,
respectively. This compares to 43 properties sold in 1992 for net sales
proceeds of $25.6 million, with a gross book and net book value of $34.9
million and $27.6 million, respectively. The loss on sale of REO (i.e., the
shortfall between the net proceeds and net book value) is charged to the REO
GVA upon sale.
The Company is pursuing its Restructuring plan, including the possible
transfer of a significant portion of certain Fidelity assets (including
substantially all of its problem assets). As a result of such plan the Bank is
not currently marketing the assets expected to be transferred in the
Restructuring transaction, and thus a slowdown from the rate at which REO
properties were disposed in 1993 can be expected in the first half of 1994.
During 1993, 1992 and 1991, the Bank charged off a total of $79.4 million,
$41.2 million and $25.6 million, respectively, on loans and on real estate
owned. The following table indicates the charge-offs and recoveries by property
type for the respective years:
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1993 1992 1991
---------------- ---------------- ----------------
NUMBER OF NUMBER OF NUMBER OF
PROPERTIES TOTAL PROPERTIES TOTAL PROPERTIES TOTAL
---------- ----- ---------- ----- ---------- -----
(DOLLARS IN MILLIONS)
Charge-offs:
Properties in California:
Multifamily (2 units and
over).................... 311 $70.8 92 $27.8 12 $ 4.6
Commercial................ 11 3.9 11 9.6 3 0.3
Single family residences.. 64 3.5 36 1.7 4 0.1
Single family development
projects................. -- -- -- -- 2 5.5
Hotels.................... 1 0.9 -- -- 3 2.9
Out-of-state properties:
Commercial................ 2 0.3 2 2.1 2 3.8
Hotels.................... -- -- -- -- 2 7.4
Multifamily (2 units and
over).................... -- -- -- -- 3 1.0
--- ----- --- ----- --- -----
Total charge-offs.......... 389 79.4 141 41.2 31 25.6
=== === ===
Recoveries.................. 129 5.0 13 0.5 11 3.0
=== ----- === ----- === -----
Net charge-offs........... $74.4 $40.7 $22.6
===== ===== =====
79
The following table presents loan and REO charge-offs by property type and
year of loan origination for the year ended December 31, 1993:
YEAR OF ORIGINATION
-----------------------------------------------
TOTAL 1992 1991 1990 1989 1988 1979 TO 1987
----- ---- ---- ------ ----- ----- ------------
(DOLLARS IN MILLIONS)
PROPERTY TYPE:
Single Family.................. $ 3.5 $ -- $0.3 $ 2.1 $ 0.8 $ 0.3 $ --
Multifamily:
2 to 4 units.................. 5.0 -- 0.1 3.6 0.8 0.4 0.1
5 to 36 units................. 44.0 0.1 6.0 21.7 7.4 4.5 4.3
37 units and over............. 21.8 -- 0.8 9.1 0.9 5.0 6.0
----- ---- ---- ------ ----- ----- -----
Total multifamily............ 70.8 0.1 6.9 34.4 9.1 9.9 10.4
Commercial and industrial...... 5.1 -- -- -- 0.5 1.1 3.5
Total charge-offs............ $79.4 $0.1 $7.2 $36.5. $10.4 $11.3 $13.9
===== ==== ==== ====== ===== ===== =====
The following table presents loan and REO charge-offs by property type and
year of loan origination for the year ended December 31, 1992:
YEAR OF ORIGINATION
-------------------------------------------
TOTAL 1991 1990 1989 1988 1977 TO 1987
----- ---- ----- ---- ---- ------------
(DOLLARS IN MILLIONS)
PROPERTY TYPE:
Single Family...................... $ 1.7 $0.2 $ 1.1 $0.3 $ -- $ 0.1
Multifamily:
2 to 4 units...................... 2.2 -- 1.9 0.3 --
5 to 36 units..................... 12.4 0.2 7.7 2.1 0.3 2.1
37 units and over................. 13.2 0.7 1.6 3.5 4.0 3.4
----- ---- ----- ---- ---- -----
Total multifamily................ 27.8 0.9 11.2 5.9 4.3 5.5
Commercial and industrial.......... 11.7 -- 0.7 -- 0.7 10.3
----- ---- ----- ---- ---- -----
Total charge-offs................ $41.2 $1.1 $13.0 $6.2 $5.0 $15.9
===== ==== ===== ==== ==== =====
The following table presents Fidelity's real estate loan portfolio (including
loans held for sale) as of December 31, 1993 by year of origination and type of
security:
YEAR OF ORIGINATION
----------------------------------------------------------------
1987 AND
TOTAL 1993 1992 1991 1990 1989 1988 PRIOR
---------- -------- -------- -------- -------- -------- -------- ----------
(DOLLARS IN THOUSANDS)
Property type:
Single family.......... $ 792,054 $118,802 $ 54,035 $ 40,417 $105,854 $ 73,466 $149,435 $ 250,045
Multifamily:
2 to 4 units......... 505,219 36,822 23,892 50,069 139,430 77,837 100,182 76,987
5 to 36 units........ 1,795,374 92,798 118,176 205,279 479,998 216,091 273,376 409,656
37 units and over.... 406,330 12,861 15,753 8,049 59,566 75,111 62,990 172,000
---------- -------- -------- -------- -------- -------- -------- ----------
Total multifamily.. 2,706,923 142,481 157,821 263,397 678,994 369,039 436,548 658,643
Commercial and
industrial............ 300,589 1,332 815 1,821 11,532 53,936 65,239 165,914
---------- -------- -------- -------- -------- -------- -------- ----------
Total mortgage
loans receivable.. $3,799,566 $262,615 $212,671 $305,635 $796,380 $496,441 $651,222 $1,074,602
========== ======== ======== ======== ======== ======== ======== ==========
Loans by year of
origination to total... 100.0% 6.9% 5.6% 8.0% 21.0% 13.1% 17.1% 28.3%
========== ======== ======== ======== ======== ======== ======== ==========
80
During the years 1990, 1989 and 1988, Fidelity originated loans at peak
levels totaling $1,211.3 million, $897.6 million and $1,467.1 million,
respectively. During 1993, the Bank reserved and/or charged off amounts
corresponding to these peak origination years totaling $36.5 million, $10.4
million and $11.3 million, respectively. These losses were due primarily to the
decline of the California economy and real estate market. Multifamily (5 or
more units) and commercial loans accounted for a substantial percentage of such
losses, and as a result, the Bank has reduced recent loan origination
activities in these areas. However, continued downward pressure on the economy
and real estate market could lead to additional losses in these portfolios.
The ongoing uncertainty in the Southern California economy, the weak real
estate market and the level of the Bank's nonperforming assets continue to be
significant concerns to the Company. The Bank increased the staff of the Real
Estate Asset Management ("REAM") Group in 1993 from 13 to 40 in order to handle
the increased number of foreclosed properties and the increased volume of loan
workout requests. In 1993, the REAM Group sold 210 properties, generating net
sales proceeds of $83.5 million and restructured109 loans with an aggregate
gross book value of $89.1 million. These increased loan workout activities are
expected to continue in 1994, due primarily to the January 1994 Northridge
Earthquake, property tax delinquencies and the continued soft real estate
market. The REAM Group will shift its focus to bulk sales transactions in 1994
and concentrate its efforts on the "hands on" management of its real estate
assets. All of these factors may require additional loss provisions, as the
Bank performs its quarterly reviews of the adequacy of its allowance for
estimated losses on loans and real estate, based upon the then current economic
environment.
If economic conditions in Southern California do not improve and delinquent
loans continue at current levels, it is likely that Fidelity will need to
establish further reserves in 1994. If the trend continues, no assurances can
be given that potentially significant additional reserves will not be needed in
future periods.
As of December 31, 1993, Fidelity's 15 largest borrowers accounted for $226.7
million of gross loans. A number of these borrowing relationships also include
Fidelity's largest loans. Details of these relationships follow:
NUMBER TOTAL LARGEST
OF AMOUNT OF SINGLE
BORROWER LOANS LOANS LOAN
-------- ------ --------- -------
1 46(1) $ 31,486(2) $9,934
2 9 27,340(2) 11,122
3 3 23,880 15,081
4 3 20,714(2) 13,912
5 55 16,159 6,570
6 1 13,929 13,929
7 3 13,810 13,682
8 2 11,355 5,845
9 3 11,057 6,826
10 1 10,253 10,253
11 9 10,229(2) 3,484
12 1 10,056 10,056
13 1 9,276 9,276
14 3 8,765(2) 7,550
15 5 8,404 3,101
--------
$226,713
========
- --------
(1) Includes 9 loans totaling $8.0 million that were considered as ISF as of
December 31, 1993.
(2) Amounts are shown net of participations.
81
Fidelity's 10 largest loans aggregated $114.8 million at December 31, 1993,
of which $21.1 million was classified as Substandard and $37.9 million was
listed as Special Mention. As of December 31, 1993, 3 of Fidelity's 5 largest
borrowers and 4 of Fidelity's 15 largest borrowers had loans either considered
nonperforming or performing with increased risk.
At December 31, 1993, Fidelity had approximately $31.5 million total loans
outstanding (including 9 loans designated as ISF) to its largest borrower on 46
loans secured by multifamily apartment dwellings located in the San Gabriel
Valley and eastern Los Angeles areas. Of the total loans, $24.1 million were
classified as Substandard, including the 9 loans considered ISF. Fidelity began
discussions with the borrower regarding modifications in mid-1993. In January
1994, Fidelity completed the restructure of $3.3 million of loans and is
continuing the modification process with the remaining loans.
During 1992, Fidelity's second largest borrower was in default on eight of
that borrower's nine loans. Six of the eight defaulted loans were restructured
in 1992 allowing the borrower to make interest only payments through the end of
1992. The remaining two loans in default were modified in February 1993 to
include interest only payments through June 1993. These two loans were
classified as Substandard and identified as TDRs. As of December 31, 1993,
seven of the loans totaling $24.6 million were 29 days delinquent and one
totaling $2.1 million was 59 days delinquent. At December 31, 1993, 5 loans
totaling $17.2 million were classified as Substandard. Fidelity has entered
into a forebearance agreement with the borrower whereby Fidelity agreed not to
instigate foreclosure proceedings against the borrower's eight properties
securing the loans until February 28, 1994, in exchange for $150,000. Fidelity
is currently pursuing a workout arrangement with the borrower. However, the
January 1994 Northridge Earthquake has further complicated the situation, as
several of the borrower's properties are located in the most severely damaged
areas. In January 1994, an additional 3 loans totaling $9.5 million were moved
to the Substandard classified loans, for a total of 8 loans and $26.7 million.
It is the Bank's practice to review the adequacy of its GVA on loans and real
estate owned on a quarterly basis. The Bank uses two methodologies in
determining the adequacy of its GVA. These are delinquency migration and
classification methods. The delinquency migration method attempts to capture
the potential future losses as of a particular date associated with a given
portfolio of loans, based on the Bank's own historical experience over a given
period of time, in a 4-step process: first, estimate the percentage of a given
portfolio of performing loans which will become newly delinquent; second,
evaluate the probability that new delinquent loans will become REO; third,
calculate the historical loss ratio on REO and other problem loans; and fourth,
derive the resulting potential losses for the portfolio of performing loans by
multiplying the corresponding potential amount of REO with the reserve factor.
The likelihood that new delinquent loans will become REO is estimated
historically by tracing the percentage of the balances of a given set of new
delinquent loans that have migrated toward an increasingly worse credit status:
i.e., the percentage of the balances of 30 to 59 days delinquent loans that
have become 60 to 89 days delinquent; then the percentage of the balances of
these loans that have become at least 90 days delinquent; and the percentage of
the balances of these loans which have become REO. To ensure that the
historically derived percentages are calculated on a consistent basis, only
those loans that have become newly delinquent are traced through the different
stages of delinquencies all the way to REO.
The total projected loss associated with a given portfolio of performing and
nonperforming loans and REO is calculated by summing the losses corresponding
to each credit status category at a given point in time. The result is
sensitive to a number of factors, including the historical period over which
the estimates are derived; the growth pattern of the portfolio, the composition
of the portfolio and the stability of the underwriting criteria over the period
covered.
The Bank has derived migration statistics over past periods and updates them
quarterly to take into account the most recent trends. The Bank has applied the
results of such methodology with respect to the December 31, 1993 financial
statements and the Bank updates its analysis quarterly. The Bank has observed
82
an increasing delinquency trend as a percentage of the net real estate loan
portfolio and during 1993, as property values deteriorated, the resulting
historical loss ratios increased. Continuation of these trends may increase the
historical loss ratios in 1994.
The second methodology for determining the adequacy of GVA is the
classification method. During 1993, the Bank utilized this approach to analyze
classifications including Pass, Special Mention, Substandard, Doubtful and
Loss. A reserve factor is applied to each aggregate classification level by
asset collateral type in an effort to estimate the loss content in the
portfolio. The Company's actual loss experience with Pass and Special Mention
assets is 0.0% while the actual loss experience on Substandard assets is 23.5%.
Again, the Company has observed an increase of classified loans at all levels
which will inevitably lead to increased estimates of loss exposure under this
method. See Item 1. "Business--Regulation and Supervision--Classification of
Assets."
Each quarter, the Bank calculates a range of loss using both methodologies.
Once a range is established, the Company applies judgment and a knowledge of
particular credits, trends in the market, and other factors to estimate the GVA
amount. As of December 31, 1993, the Bank's GVA was approximately $80.0
million.
Once a GVA is estimated, the Bank applies three separate stress tests to the
portfolio to analyze the ability of the Bank to maintain adequate capital
levels under different economic scenarios. This process is considered
appropriate given the weak economy and the unstable market in which the Bank
operates. The scenarios range from mild change (continuation of current rates
of loss migration and expected percentage loss estimates) to severe change (the
worst experience in the 1980s in Texas and Arizona). The Bank's peak loan
balance was reached in late 1990 and early 1991. The stress tests assume the
losses in the peak portfolio will be experienced for the most part over a five-
year cycle and that three years of this cycle has lapsed. The peak portfolio
performance is stressed with a variety of projected levels of NPA, REO, and
loss on sale of REO. Projected losses are first absorbed by current levels of
GVA, then by forecasted Company earnings over the remaining three years of the
assumed cycle. Tangible capital ratios are then calculated for each of the
economic scenarios. At December 31, 1993, these studies showed the Company
could maintain capital in excess of the 1.5% minimum required level of tangible
capital under the capital regulations and the 2.0% level of tangible equity to
total assets required to avoid being "critically undercapitalized," as defined
by the OTS regulations implementing the FDICIA prompt corrective action
requirements. See "Capital Resources and Liquidity" and Item 1. "Business--
Regulation and Supervision--FDICIA Prompt Corrective Action Requirements." The
foregoing exercise is only a test, based on assumptions that can change at any
time. There can be no assurance that the Bank would be allowed to operate
independently if its tangible capital began to approach the minimum required
levels.
If the OTS disagrees with management's assessment of the adequacy of such
reserves, it can effectively require Fidelity to increase its reserves to
levels satisfactory to the OTS. The Bank increased its GVA for losses on loans
and real estate to approximately $80.0 million at year-end 1993 from its third
quarter 1993 level of approximately $71.0 million in part to address OTS
concerns regarding the Bank's asset quality. If the Restructuring is not
successful and the Bank has no viable problem asset disposition alternative,
the Bank anticipates that it may be required to increase its GVA to higher
levels that cannot currently be determined.
Approximately 71.1% of Fidelity's loan portfolio consisted of loans secured
by multifamily properties at December 31, 1993. Although, in the view of the
Bank, this portfolio is less sensitive to the effects of the recession than
those of institutions which have emphasized commercial and/or construction
lending, it is likely to be more sensitive than the portfolios of institutions
which have placed greater emphasis on single family residential lending.
IMPACT OF INFLATION
The Company's assets and liabilities are primarily monetary in nature and are
affected most directly by changes in interest rates rather than other elements
of the Consumer Price Index. As a result, increases in the prices of goods and
services do not have a significant impact on the Company's results of
operations.
83
INTEREST RATE RISK MANAGEMENT
Prevailing economic conditions, particularly changes in market interest
rates, as well as governmental policies and regulations concerning, among other
things, monetary and fiscal affairs, significantly affect interest rates and a
savings institution's net interest income. Fidelity actively manages its assets
and liabilities in an effort to mitigate its exposure to interest rate risk,
but it cannot eliminate this exposure entirely without unduly affecting its
profitability. As is the case with many thrift institutions, Fidelity's
deposits historically have matured or repriced more rapidly than its loans and
other investments, and consequently, increases in market interest rates have
tended to reduce Fidelity's net interest income, while decreases in market
interest rates have tended to increase its net interest income.
Fidelity's interest rate risk ("IRR") management plan is aimed at maximizing
net interest income while controlling interest rate risk exposure in terms of
market value of portfolio equity, consistent with the objectives and limits set
by the Board of Directors and applicable regulations. Financial institutions,
by their funds intermediation function, gather deposits which have a different
duration than the loans that they originate, i.e., interest rate risk exposure
is an inherent characteristic of the banking business. The IRR management plan
is designed to maintain interest rate exposure within target limits.
Elimination of interest rate risk is usually not cost effective; while excess
exposure could result in additional capital requirements.
There are two ways by which Fidelity maintains its exposure profile within
satisfactory limits: first, by explicitly changing the composition of its
balance sheet; second, by the use of financial instruments, often in the form
of off-balance sheet derivative products. The extent to which Fidelity elects
to use either or both of these methods will depend on the observed preferences
of its customers, time horizon of its objectives (short-term versus long-term
objectives), conditions in the financial markets (especially volatility of
interest rates and steepness of the yield curves), its operating
characteristics and the associated cost/benefit tradeoffs.
In accordance with the Company's IRR management plan, the Company continues
to monitor its interest rate risk position and to maintain its sensitivity to
rate changes within desired limits. The balance sheet strategies consist of
reducing basis risk by adding market index loans to the asset portfolio and
decreasing liability sensitivity by encouraging growth of its transactions
account base. The Bank provides products to meet its customers' needs. The Bank
uses derivative products and changes its asset mix to maintain its desired risk
profile in response to changing customers' preference.
The Company continues to naturally reduce its IRR exposure by originating ARM
loans for its portfolio. Since 1985, the Company has consistently moved toward
building a portfolio consisting predominantly of interest rate sensitive loans.
ARM loans comprised 96% of the portfolio of total loans at December 31, 1993,
1992 and 1991. The percentage of monthly adjustable ARMs to total loans was 75%
at December 31, 1993, 74% at December 31, 1992, and 72% at December 31, 1991.
Interest sensitive assets provide the Company with long-term protection from
rising interest rates.
The Bank is also emphasizing the growth of its transaction account base to
reduce its overall cost of funds. The ratio of retail transaction accounts,
money market savings and passbook accounts to total deposits decreased to 21.6%
at December 31, 1993 from 24.3% at December 31, 1992 and increased from 19.4%
at December 31, 1991.
At December 31, 1993, the Company had synthetic hedges with a total notional
principal amount of $250 million. These were composed of interest rate swap
contracts with an average receive rate of 4.84% and a current pay rate of
3.43%. These contracts support the Bank's total risk management by lengthening
certain short-term assets and shortening certain long-term liabilities.
In 1993, the Bank had also sold options to enter into swap contracts with a
notional principal amount of $200 million. These options give the buyers the
right to cancel the swap agreements at a specified future date and if not
cancelled, provide the Bank with additional synthetic hedges. During the life
of the agreement, the Bank receives a fixed interest rate and pays a floating
interest rate tied to LIBOR. At December 31, 1993, the average fixed receive
rate was 5.00% and the average pay rate was 3.34%. The swap options were held
as
84
trading positions during the option period and were carried at market value
with gains and losses recorded. In January 1994, the options to cancel were not
exercised and the average fixed receive rate adjusted to 4.70%. The swaps have
remaining maturities of less than four years.
In 1990, the Company purchased interest rate caps to protect against rising
rates. In 1993, the final $400 million of interest rate caps matured and were
not renewed. During 1992 and the first 6 months of 1993, the average maturity
of the Company's liabilities lengthened, due primarily to customer preference
for longer term CDs. To maintain its target risk position, the Company entered
interest rate swap contracts to synthetically shorten the maturity of these
liabilities.
The Company's maturity and repricing mismatch ("Gap") between interest rate
sensitive assets and liabilities due within one year was a negative 3.38% and a
positive 6.12% of total assets at December 31, 1993 and 1992, respectively. A
positive gap indicates an excess of maturing or repricing assets over such
liabilities while a negative gap indicates an excess of maturing or repricing
liabilities over such assets. However, Gap is not a particularly helpful
measure of IRR exposure, because of four major deficiencies: (a) Gap assumes
that both assets and liabilities react immediately to market rate changes
although loans usually reprice to an index that is approximately two months old
and therefore cannot immediately react to current rates; (b) Gap assumes that
all instruments react fully to market rates, whereas loans tied to COFI or
other lagging indices can take many months to fully adjust to market rate
changes; (c) Gap assumes that there will be no change in repricing behavior
caused by a change in interest rates and, in reality, prepayment speed,
amortization schedules and early withdrawal are all impacted by changes in
rate; and (d) finally, Gap does not consider periodic rate caps and floors.
Consequently, the Company does not use Gap as an IRR measurement and management
tool. Instead, it uses a scenario-based approach which measures bankwide risk
and a probabilistic approach for specific products. The Bank regularly analyzes
scenarios that contemplate low, expected and high inflation. The Bank also
complies with OTS requirements for interest rate shock scenarios (immediate
permanent change in interest rates of various levels). For product and option
valuation, the Bank employs a Monte Carlo simulation model (one that assumes
random variation in interest rates) to measure and evaluate risk and return
trade-offs.
The Company's IRR management plan is reviewed on a continuing basis. As
previously discussed, the Bank's interest rate risk is less than half of the
OTS limit. See "Capital Resources and Liquidity." Even at this lower risk
level, due to the lag effect that COFI has on Fidelity's loan portfolio the
decline in short-term rates from 1990 to early 1993 contributed significantly
to the Company's net interest margin. Recent stable rates have eroded this
margin, and an increase in rates could produce an initial reduction in net
interest income. Management intends to continue to manage its IRR exposure
through introducing products tied to indices that reprice without a timing lag
and by using hedging techniques.
85
The following table of projected maturities and repricings details major
financial asset and liability categories of the Company as of December 31,
1993. Projected maturities are based on contractual maturities as adjusted for
estimates of prepayments and normal historical amortization. (Prepayment
estimates are based on recent portfolio experience of approximately 15%
Constant Prepayment Rate ("CPR") on all residential 1 to 4 unit loans and 10%
on all other loans.) While the estimated prepayment rates utilized are based on
the best information available to the Company, there can be no assurance that
the projected rates used in developing this table will coincide with the actual
results.
MATURITY AND RATE SENSITIVITY ANALYSIS
AS OF DECEMBER 31, 1993 MATURITY OR REPRICING
------------------------------------------------------------------
0-3 4-12 1-5 6-10 OVER 10
MONTHS MONTHS YEARS YEARS YEARS TOTAL
---------- ---------- -------- -------- ------- ----------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Cash and cash equiva-
lents................. $ 62,690 $ -- $ -- $ -- $ -- $ 62,690
Investment securi-
ties(1)(2)............ -- 54,587 97,094 1,143 -- 152,824
Mortgage-backed
securities(1)......... 39,669 8,885 42,059 -- -- 90,613
Loans receivable:
ARMs and other
adjustables(3)....... 2,877,329 492,028 257,768 22,472 117 3,649,714
Fixed rate loans...... 54,701 348 8,219 4,616 81,968 149,852
Consumer and other
loans................ 5,332 2,408 1,258 -- -- 8,998
---------- ---------- -------- -------- ------- ----------
Gross loans receiv-
able................ 2,937,362 494,784 267,245 27,088 82,085 3,808,564
---------- ---------- -------- -------- ------- ----------
Total............... 3,039,721 558,256 406,398 28,231 82,085 $4,114,691
---------- ---------- -------- -------- ------- ==========
INTEREST-BEARING LIABIL-
ITIES:
Deposits:
Checking and savings
accounts............. 396,201 -- -- -- -- $ 396,201
Money market accounts. 280,474 -- -- -- -- 280,474
Fixed maturity depos-
its:
Retail customers..... 961,634 964,895 530,056 330 -- 2,456,915
Wholesale customers.. 100,353 70,592 11,173 -- -- 182,118
---------- ---------- -------- -------- ------- ----------
1,738,662 1,035,487 541,229 330 -- 3,315,708
---------- ---------- -------- -------- ------- ----------
Borrowings:
FHLB Advances(3)...... 216,400 -- 90,000 20,000 -- 326,400
Other................. 307,830 -- 100,000 60,000 -- 467,830
---------- ---------- -------- -------- ------- ----------
524,230 -- 190,000 80,000 -- 794,230
---------- ---------- -------- -------- ------- ----------
Total............... 2,262,892 1,035,487 731,229 80,330 -- $4,109,938
==========
IMPACT OF HEDGING(5).... (400,000) (50,000) 450,000 -- --
---------- ---------- -------- -------- -------
MATURITY GAP............ $ 376,829 $ (527,231) $125,169 $(52,099) $82,085
========== ========== ======== ======== =======
GAP TO TOTAL ASSETS..... 8.46% (11.84)% 2.81% (1.17)% 1.84%
========== ========== ======== ======== =======
CUMULATIVE GAP TO TOTAL
ASSETS................. 8.46% (3.38)% (0.57)% (1.74)% 0.10%
========== ========== ======== ======== =======
- -------
(1) Maturities shown are based on the contractual maturity of the instrument.
(2) Includes investments in FHLB and FRB stock and cash equivalents.
(3) ARMs and variable rate FHLB Advances are in the "within 0-3 months"
categories as they are subject to interest rate adjustments.
(4) These liabilities are subject to daily adjustments and are therefore
included in the "within one year" category.
(5) Fidelity had synthetic hedges with a total notional principal amount of
$450 million at December 31, 1993. These off-balance sheet instruments
support the Bank's total risk management by enhancing yield and altering
its exposure to interest rate risk.
86
OTHER FACTORS AFFECTING EARNINGS
Growing Emphasis on Fee Income Generation
Management believes that, given the highly competitive nature of the Bank's
historical business and the regulatory constraints it faces in competing with
unregulated companies, the Bank must expand from its historical business focus
and adopt a broader product line business strategy. Specifically, management
believes that the Bank's existing customers provide a ready market for the
sale of nontraditional financial services and investment products. This belief
prompted the implementation of a new business strategy for the retail
financial services group that integrated its traditional functions (mortgage
origination, deposit services, checking, savings, etc.) with the sale of
investment services and products by Gateway. Management's objective is to
build a "relationship bank" that works with clients to determine their
financial needs and offers a broad array of more customized products and
services.
Through this new strategy of targeting retail and mortgage customers and
offering a variety of new investment products and services, Fidelity and
Gateway hope to attract more of the Bank customers' deposits, investment
accounts and mortgage business. Management believes that this new strategy has
been successful, as evidenced by the increase of 22% in total checking
accounts at December 31, 1993 over the level a year earlier. As a result of
this strategy, fee income should become a growing portion, and net interest
income a declining portion, of the Company's total income.
Management also intends to offer a wider range of loan types than the Bank
currently originates. While continuing to offer adjustable rate mortgages and
to maintain an expertise in originating and servicing multifamily mortgages,
the Bank plans to increase its mortgage banking capabilities and to originate
mortgages that, while not appropriate for inclusion in the Bank's portfolio in
significant quantities, are attractive to borrowers and to the secondary
market.
Northridge Earthquake
The Northridge Earthquake of January 17, 1994, and subsequent aftershocks
will adversely affect the Bank's loan and real estate portfolios. The Bank's
portfolio includes loans and REO with a net book value of approximately $937
million secured by or comprised of 1,414 multifamily (5 units or more), 15
commercial, and 2,313 single family and multifamily (2 to 4 units) collateral
properties in the primary earthquake areas. After the earthquake, the Bank's
appraisers surveyed all the multifamily (5 units or more) and commercial
properties located in these areas which secured the Bank's loans or constitute
REO of the Bank. The Bank also made selected inspections at more remote
locations where damage has been reported. In total, approximately 1,450
properties have been inspected. Of such inspected properties, 231 properties,
representing loans and REO with a net book value of $140 million, have been
identified as having sustained more than "cosmetic" damage. Of such 231
properties, 204 properties related to the Bank's loans and REO with a net book
value of $124 million were identified as having "possible serious damage" and
an additional 27 properties with a net book value of $16 million were
identified as "actually or potentially condemned". The Bank commissioned
structural and building engineers or building inspectors to estimate the cost
of repairs to properties in these two categories. The cost of repairs has been
preliminarily estimated to be $5.7 million and $11.1 million, respectively. Of
this total $16.8 million, approximately $6.0 million of seismic damage exceeds
the net book value of the related loans and REO. Accordingly, the Bank
currently would not expect its losses due to the earthquake to exceed $10.8
million with respect to its commercial and multifamily loans and REO. The Bank
expects the actual losses payable by the Bank to be lower because many repair
costs may be borne by the borrowers, who in addition to their own funds, may
have access to government assistance and/or earthquake insurance proceeds. As
part of its normal internal asset review process, the Bank will adjust its
reserves as its losses become quantifiable.
In addition to the multifamily and commercial assets referenced above, the
Bank has identified 2,313 single family and multifamily (2 to 4 units) assets
in the affected areas. 173 borrowers with unpaid principal balances totaling
$29.4 million called in to report damages through February 8, 1994. The Bank
has commenced inspection of these properties and continues to assess damages
and potential earnings and loss impact with respect to these properties.
The earthquake will also have some adverse affect on loan originations and
the sale of financial services in the retail branch network in the near term.
87
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Citadel Holding Corporation
Glendale, California
We have audited the accompanying consolidated statements of financial
condition of Citadel Holding Corporation and subsidiaries (the "Company") as of
December 31, 1993 and 1992, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1993. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these 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 principle 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Citadel Holding Corporation and
subsidiaries at December 31, 1993 and 1992 and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1993 in conformity with generally accepted accounting principles.
As discussed in Note 17 to the consolidated financial statements, on March 4,
1994, one of four lenders to Fidelity Federal Bank, F.S.B. (the "Bank") under
its $60 million Subordinated Loan Agreement of 1990 filed a lawsuit against the
Bank and Citadel Holding Corporation ("Citadel") alleging a breach of the loan
agreement and other allegations, and is seeking to enjoin a restructuring plan
(described in footnote 14) and to recover damages in unspecified amounts. The
impact of this lawsuit on the capital position of the Bank, cross default
provisions under the Bank's other debt agreements and the guarantee by Citadel
is uncertain. Accordingly, no adjustments that may result from the ultimate
resolution of this uncertainty have been made in the accompanying financial
statements.
As discussed in Notes 14 and 16 to the financial statements, the Bank, the
primary subsidiary of Citadel, is subject to numerous regulatory requirements,
including, among others: (i) minimum capital to be considered "adequately
capitalized" under the Prompt Corrective Action provisions of the Federal
Deposit Insurance Corporation Improvement Act ("FDICIA") as implemented by the
Office of Thrift Supervision ("OTS"), and (ii) minimum capital requirements of
the OTS. Although the Bank met these capital requirements at December 31, 1993,
the Bank's ability to meet the prescribed capital requirements in the future is
uncertain. Failure on the part of the Bank to meet these capital requirements
may subject the Bank to significant regulatory sanctions. Management's
immediate plans to address these capital requirements are described in Note 14.
The financial statement impact, if any, that might result from the failure of
the Bank to comply with the capital requirements prescribed by the OTS cannot
presently be determined. Accordingly, no adjustments that may result from the
ultimate resolution of the uncertainty have been made in the accompanying
financial statements.
Deloitte & Touche
February 4, 1994, except for Note 17,
as to which the date is March 4, 1994
Los Angeles, California
F-1
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
---------------------
1993 1992
---------- ----------
ASSETS:
Cash, federal funds sold and other cash equivalents
(Note 2)............................................... $ 145,961 $ 110,262
Investment securities held for sale (market value of
$92,512) (Notes 2 and 10).............................. 92,259 --
Investment securities, at amortized cost (market value
of $69,041) (Notes 2 and 10)........................... -- 67,337
Mortgage-backed securities held for sale (market value
of $91,298) (Note 3)................................... 91,108 --
Mortgage-backed securities, at amortized cost (market
value of $230,561) (Notes 3 and 10).................... -- 230,384
Loans held for sale, at lower of cost or market
(Note 4)............................................... 367,688 26,482
Loans receivable, net of allowances of $83,832 and
$64,277 at December 31, 1993 and 1992, respectively
(Notes 4, 6, 8, 9 and 10).............................. 3,345,695 3,965,299
Interest receivable (Notes 2, 3 and 4).................. 23,052 27,132
Investment in FHLB and FRB stock (Note 9)............... 52,151 50,574
Owned real estate (Notes 5 and 6)....................... 153,607 133,255
Premises and equipment, net............................. 49,247 46,585
Intangible assets, net (Note 7)......................... 2,098 20,556
Deferred tax assets (Note 12)........................... 1,247 3,182
Other assets (Note 12).................................. 65,406 17,278
---------- ----------
$4,389,519 $4,698,326
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Deposits (Note 8)...................................... $3,368,643 $3,457,918
FHLB Advances (Note 9)................................. 326,400 581,400
Commercial paper (Note 10)............................. 304,000 65,000
Mortgage-backed notes and bonds (Note 10).............. 100,000 262,000
Other borrowings (Note 10)............................. 3,830 --
Deferred tax liabilities (Note 12)..................... 14,564 2,008
Other liabilities (Notes 11 and 12).................... 24,679 46,814
Subordinated notes (Note 10)........................... 60,000 60,000
---------- ----------
4,202,116 4,475,140
---------- ----------
Commitments and contingencies (Note 13)
Stockholders' equity (Note 14):
Serial preferred stock, par value $.01 per share;
authorized, 5,000,000 shares; no shares outstanding.. -- --
Common stock, par value of $.01 per share; authorized
10,000,000 shares; issued and outstanding, 6,595,624
shares and 3,297,812 shares at December 31, 1993 and
1992, respectively.................................... 66 33
Paid-in capital......................................... 60,052 28,707
Retained earnings (Note 12)............................. 127,285 194,446
---------- ----------
187,403 223,186
---------- ----------
$4,389,519 $4,698,326
========== ==========
See notes to consolidated financial statements.
F-2
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
----------------------------------
1993 1992 1991
---------- ---------- ----------
Interest Income:
Loans..................................... $ 269,712 $ 355,560 $ 497,005
Mortgage-backed securities................ 11,051 5,631 6,016
Investment securities and other........... 8,829 9,531 17,103
---------- ---------- ----------
Total interest income.................... 289,592 370,722 520,124
---------- ---------- ----------
Interest Expense:
Deposits.................................. 131,618 175,024 278,617
FHLB Advances............................. 17,077 20,877 43,024
Other borrowings.......................... 32,323 36,667 49,003
Subordinated notes........................ 7,373 7,373 7,373
---------- ---------- ----------
Total interest expense................... 188,391 239,941 378,017
---------- ---------- ----------
Net Interest Income........................ 101,201 130,781 142,107
Provision for estimated loan losses
(Notes 4 and 6)......................... 65,100 51,180 49,843
---------- ---------- ----------
Net Interest Income after Provision for
Estimated Loan Losses ................... 36,101 79,601 92,264
---------- ---------- ----------
Noninterest Income (Expense):
Loan and other fee income................. 5,389 7,885 5,869
Gains on sales of loans, net.............. 194 1,117 2,118
Fee income from investment products....... 4,313 3,368 2,487
Fee income on deposits and other income
(expense)................................ 3,271 4,406 (3,350)
---------- ---------- ----------
13,167 16,776 7,124
---------- ---------- ----------
Provision for estimated real estate losses
(Notes 5 and 6).......................... (30,200) (17,820) (8,562)
Direct costs of real estate operations,
net (Note 5)............................. (18,643) (4,441) (2,060)
---------- ---------- ----------
(48,843) (22,261) (10,622)
---------- ---------- ----------
Gains on sales of mortgage-backed
securities, net (Note 3)................ 1,342 -- 8,993
Gains (losses) on sales of investment
securities, net (Note 2)................ (54) -- 1
---------- ---------- ----------
1,288 -- 8,994
---------- ---------- ----------
Total noninterest income (expense)....... (34,388) (5,485) 5,496
---------- ---------- ----------
Operating Expense:
Personnel and benefits.................... 46,873 36,656 36,293
Occupancy................................. 13,202 12,705 12,692
FDIC insurance............................ 8,628 8,391 8,680
Professional services..................... 11,970 6,119 6,786
Office-related expenses................... 6,785 5,031 5,565
Marketing................................. 3,080 2,548 3,130
Amortization of intangibles (Note 7)...... 9,246 596 840
Other general and administrative.......... 5,557 5,865 5,460
---------- ---------- ----------
Total operating expense.................. 105,341 77,911 79,446
---------- ---------- ----------
Earnings (Loss) before Income Taxes........ (103,628) (3,795) 18,314
Income tax expense (benefit) (Note 12).... (36,467) (5,841) 15,651
---------- ---------- ----------
Net Earnings (Loss)........................ $ (67,161) $ 2,046 $ 2,663
========== ========== ==========
Net Earnings (Loss) Per Share.............. $ (11.56) $ 0.62 $ 0.81
========== ========== ==========
Weighted Average Common and Common
Equivalent Shares Outstanding............ 5,809,570 3,297,812 3,297,812
========== ========== ==========
See notes to consolidated financial statements.
F-3
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
THREE YEARS ENDED DECEMBER 31, 1993
-----------------------------------------------------------
COMMON STOCK
---------------- TOTAL
NUMBER PAR PAID-IN RETAINED TREASURY STOCKHOLDERS'
OF SHARES VALUE CAPITAL EARNINGS STOCK EQUITY
--------- ----- ------- -------- -------- -------------
Balance, January 1,
1991................... 3,477,512 $35 $34,784 $189,737 $(6,079) $218,477
Net earnings for 1991.. -- -- -- 2,663 -- 2,663
--------- --- ------- -------- ------- --------
Balance, December 31,
1991................... 3,477,512 35 34,784 192,400 (6,079) 221,140
Retirement of treasury
stock................. (179,700) (2) (6,077) -- 6,079 --
Net earnings for 1992.. -- -- -- 2,046 -- 2,046
--------- --- ------- -------- ------- --------
Balance, December 31,
1992................... 3,297,812 33 28,707 194,446 -- 223,186
Proceeds of rights
offering.............. 3,297,812 33 31,345 -- -- 31,378
Net loss for 1993...... -- -- -- (67,161) -- (67,161)
--------- --- ------- -------- ------- --------
Balance, December 31,
1993................... 6,595,624 $66 $60,052 $127,285 $ -- $187,403
========= === ======= ======== ======= ========
See notes to consolidated financial statements.
F-4
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------
1993 1992 1991
--------- ----------- -----------
CASH FLOWS--OPERATING ACTIVITIES:
Net earnings (loss)...................... $ (67,161) $ 2,046 $ 2,663
Reconciliation of net earnings (loss) to
net operating cash flows:
Provisions for estimated losses.......... 95,300 69,079 58,597
Gains on sales of loans and securities... (1,482) (1,117) (11,112)
Capitalized loan origination costs....... (2,187) (3,001) (2,450)
Amortization of deferred loan items, net. (1,163) (604) (1,057)
Purchases of investment securities held
for trading............................. (248,272) -- --
Proceeds from sales of investment
securities held for trading............. 248,248 -- --
Purchases of investment securities held
for sale................................ (420,956) -- --
Maturities of investment securities held
for sale................................ 260,838 -- --
Proceeds from sales of investment
securities held for sale................ 76,687 -- --
Investment securities held for sale lower
of cost or market writedown............. 2,074 -- --
Purchases of mortgage-backed securities
("MBS") held for trading................ (51,248) -- --
Proceeds from sales of MBS held for
trading................................. 51,277 -- --
Purchases of MBS held for sale........... (395,561) -- --
Principal repayment of MBS held for sale. 58,865 -- --
Proceeds from sales of MBS held for sale. 463,704 -- --
Originations of loans held for sale...... (162,868) (176,220) (354,365)
Proceeds from sales of loans held for
sale.................................... 138,399 204,435 282,728
FHLB stock dividend...................... (1,640) (790) (3,070)
Depreciation and amortization............ 23,092 9,344 10,079
Interest receivable net decrease......... 4,080 9,974 7,849
Other assets (increase) decrease......... (49,414) 3,934 11,770
Deferred income tax expense (benefit).... 14,491 (19,966) (13,276)
Interest payable increase (decrease)..... (5,103) (5,954) (2,431)
Other liabilities and deferred income,
net increase (decrease)................. (16,350) (19,283) 4,366
Other, net............................... 72 257 (3,426)
--------- ----------- -----------
Operating cash flows, net............... 13,722 72,134 (13,135)
--------- ----------- -----------
CASH FLOWS--INVESTING ACTIVITIES:
Purchases of investment securities....... (200,055) (170,539) (187,592)
Maturities of investment securities...... 226,617 137,237 280,165
Proceeds from sales of investment
securities.............................. 26,908 -- 1,547
Purchases of MBS held for investment..... -- (92,502) --
Principal repayments of MBS held for
investment.............................. 9,565 8,588 9,724
Proceeds from sales of MBS held for
investment.............................. 7,114 -- 273,098
Purchases of loans....................... (3,951) (1,675) (2,939)
Loans receivable, net decrease........... 149,909 274,181 286,120
Real estate investment dispositions, net. 3,050 -- --
Proceeds from sales of real estate....... 41,608 24,329 6,237
Premises and equipment additions, net.... (6,946) (2,460) (5,318)
Other, net............................... 225 (4,746) (107)
--------- ----------- -----------
Investing cash flows, net................ 254,044 172,413 660,935
--------- ----------- -----------
F-5
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------
1993 1992 1991
--------- ---------- ----------
CASH FLOWS--FINANCING ACTIVITIES:
Demand deposits and passbook savings, net
increase (decrease)....................... (111,601) 86,531 370,014
Certificate accounts, net increase
(decrease)................................ 22,326 (513,320) (452,795)
Proceeds from FHLB Advances................ 250,000 1,273,400 860,000
Repayments of FHLB Advances................ (505,000) (1,017,000) (1,290,000)
Proceeds from (repayments of) related party
loan...................................... -- (15,000) 15,000
Short-term borrowings, net increase
(decrease)................................ 242,830 61,800 (27,390)
Repayments of long-term borrowings......... (162,000) (265,950) (35,626)
Proceeds from stock rights offering........ 31,378 -- --
--------- ---------- ----------
Financing cash flows, net.................. (232,067) (389,539) (560,797)
--------- ---------- ----------
Net increase (decrease) in cash and cash
equivalents.............................. 35,699 (144,992) 87,003
Cash and cash equivalents at beginning of
period.................................... 110,262 255,254 168,251
--------- ---------- ----------
Cash and cash equivalents at end of
period................................... $ 145,961 $ 110,262 $ 255,254
========= ========== ==========
CASH FLOWS--SUPPLEMENTAL INFORMATION:
Cash paid (received) during the period for:
Interest on deposits, advances and other
borrowings............................... $ 180,861 $ 236,953 $ 369,366
Income taxes.............................. (679) 21,697 30,105
Noncash transactions:
Additions to real estate acquired through
foreclosure.............................. 193,641 121,192 49,951
Loans originated to finance sale of real
estate acquired through foreclosure...... 51,607 11,243 1,604
Transfers from loan and investment
portfolio to held for sale:
Loans receivable......................... 325,222 -- --
Investment securities.................... 14,264 -- --
Mortgage-backed securities............... 214,310 -- --
Mortgage loans exchanged for mortgage-
backed securities....................... -- 114,277 235,758
Retirement of treasury stock............. -- 6,079 --
See notes to consolidated financial statements.
F-6
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Citadel Holding
Corporation ("Citadel") and subsidiaries. Citadel is the holding company of
Fidelity Federal Bank, a Federal Savings Bank ("Fidelity" or the "Bank") and
Gateway Investment Services, Inc. ("Gateway"). Unless otherwise indicated,
references to the "Company" include Citadel, Fidelity, Gateway, and all
subsidiaries of Fidelity and Citadel. All significant intercompany transactions
and balances have been eliminated. Certain reclassifications have been made to
prior years' consolidated financial statements to conform to the 1993
presentation.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash
on hand, amounts due from banks and federal funds sold. Generally, federal
funds are sold for one-day periods. Fidelity is required by the Federal Reserve
System to maintain noninterest-earning cash reserves against certain of its
transaction accounts. At December 31, 1993, the required reserves totaled $28.6
million including vault cash.
Investment Securities and Mortgage-backed Securities
U.S. Government and agency obligations, commercial paper, mortgage-backed
securities and other corporate debt securities identified as held for
investment are recorded at cost, with any discount or premium recognized over
the life of the related security by using a methodology which approximates the
interest method. The Bank's portfolio of mortgage-backed securities consists of
pools of mortgage loans exchanged for mortgage-backed securities and those
purchased. Securities held for investment are those securities which the
Company has the intent and ability to hold until maturity, and are carried on
an amortized cost basis. Securities to be held for indefinite periods of time,
including securities that management intends to use as part of its
asset/liability strategy, or that may be sold in response to changes in
interest rates, changes in prepayment risk, the need to increase regulatory
capital or other similar factors, are classified as held for sale and are
carried at the lower of cost or market value. Any gains or losses incurred on
sales of securities are calculated based upon the specific identification
method. Any investment securities held for trading are carried at market value.
Loans
Interest on loans is credited to income as earned and is accrued only if
deemed collectible. Accrued interest is fully reserved on loans over 90 days
contractually delinquent and on other loans which have developed inherent
problems prior to being 90 days delinquent. Discounts and premiums on loans are
included with loans receivable and are credited or charged to operations over
the estimated life of the related loans using the interest method. The Bank
charges fees for originating loans. Loan origination fees, net of direct costs
of originating the loan are recognized as an adjustment of the loan yield over
the life of the loan by the interest method, which results in a constant rate
of return. When a loan is sold, net loan, origination fees and direct costs are
recognized in operations. Other loan fees and charges representing service
costs for the prepayment of loans, for delinquent payments or for miscellaneous
loan services are recognized when collected. Loan commitment fees received are
deferred to the extent they exceed direct underwriting costs.
The Bank has designated certain of its loans receivable as being held for
sale. In determining the level of loans held for sale, the Bank considers
whether loans (a) would be sold as part of its asset/liability strategy, or (b)
may be sold in response to changes in interest rates, changes in prepayment
risk, the need to increase regulatory capital or other similar factors. Such
loans are classified as held for sale and are carried at the lower of cost or
market value.
F-7
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
The Bank's current policy is to designate substantially all originations of
fixed rate residential 1 to 4 unit loans as being held for sale as part of the
asset/liability strategy. In further compliance with the Bank's policy, $321
million of adjustable FHLB Eleventh District Cost of Funds Index ("COFI") loans
were transferred from held for investment to held for sale in December 1993 as
part of the Bank's asset/liability strategy and the possible need to increase
regulatory capital in the future. Loans held for sale are valued at the lower
of aggregate cost or market value as determined by outstanding commitments from
investors or, in the absence of such commitments, the current investor yield
requirements calculated on an aggregate loan basis. The market value
calculation includes consideration of commitments and related fees. Adjustments
to the lower of cost or market are charged to current operations and are
included in net gains/losses on loan sales in the statement of operations.
Fidelity has sold loans which have generated gains on sale, a stream of loan
servicing revenue and cash for lending or liquidity. Sales of loans are
dependent upon various factors, including interest rate movements, investor
demand for loan products, deposit flows, the availability and attractiveness of
other sources of funds, loan demand by borrowers and liquidity and capital
requirements. Due to the volatility and unpredictability of these factors, the
volume of Fidelity's sales of loans has fluctuated. All loans sold during 1993
and 1992 were from the held for sale portfolio. Fidelity has the intent and
ability to hold all of its loans, other than those designated as held for sale,
until maturity.
Owned Real Estate
Real estate held for sale acquired in settlement of loans generally results
when property collateralizing a loan is foreclosed upon or otherwise acquired
by the Bank in satisfaction of the loan. Real estate acquired through
foreclosure is recorded at the lower of fair value or the recorded investment
in the loan satisfied at the date of foreclosure. Fair value is based on the
amount that the Company could reasonably expect to receive for the asset in a
current sale between a willing buyer and a willing seller, that is, other than
in a forced or liquidation sale. Inherent in the computation of estimated fair
value are assumptions about the length of time the Company may have to hold the
property before disposition. The holding costs through the expected date of
sale and estimated disposition costs are included in the valuations. Real
estate held for investment or development is carried at the lower of cost or
fair value. Adjustments to the carrying value of the assets are made through
valuation allowances and charge-offs, through a charge to operations. Net cash
receipts on real estate owned or on those loans designated as in-substance
foreclosures and net cash payments are recorded in real estate operations on
specific properties.
Loans meeting certain criteria are accounted for as "in-substance
foreclosures." These substantially foreclosed assets are recorded at the lower
of the loan's carrying amount or at the estimated fair value of the collateral
at the date the loan was determined to be in-substance foreclosed. These assets
are reported as "real estate owned" in addition to formally foreclosed real
estate.
Statement of Position ("SOP") 92-3, "Accounting for Foreclosed Assets," was
issued by the Accounting Standards Division of the American Institute of
Certified Public Accountants in April 1992 and became effective for the
Company's December 31, 1992 financial statements. SOP 92-3 presumes that
foreclosed assets are held for sale and not for the production of income. It
requires the Company to carry foreclosed assets held for sale, after
foreclosure, at the lower of (a) fair value minus estimated costs to sell or
(b) cost. The impact of implementing SOP 92-3 was immaterial to the Company's
financial position, due to the Company's policy of carrying foreclosed assets
at fair value, net of disposition costs.
F-8
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Allowances for Estimated Losses on Loans and Real Estate
The Company has established valuation allowances for estimated losses on
specific loans and real estate ("specific reserves") and for the inherent risk
in the loan and real estate portfolios which has yet to be specifically
identified ("general valuation allowances" or "GVA"). The internal asset review
department reviews the quality and recoverability of the Company's assets on a
quarterly basis in order to establish adequate specific reserves and general
valuation allowances. The Bank utilizes the delinquency migration and the
classification methods in determining the adequacy of its GVA. The delinquency
migration method attempts to capture the potential future losses as of a
particular date associated with a given portfolio of loans, based on the Bank's
own historical migration experience over a given period of time. Under the
classification method, a reserve factor is applied to each aggregate
classification level by asset collateral type in an effort to estimate the loss
content in the portfolio. The Bank calculates a range of loss by applying both
methodologies and then applies judgment and knowledge of particular credits,
economic trends, industry experience and other relevant factors to estimate the
GVA amount. Additions to the allowances, in the form of provisions, are
reflected in current operations. Charge-offs to the allowances are made when
the loss is determined to be significant and permanent.
Depreciation and Amortization
Depreciation and amortization are computed principally on the straight-line
method over the estimated useful lives of the assets. Leasehold improvements
are amortized over the lives of the respective leases or the useful lives of
the improvements, whichever is shorter.
Earnings per Share
Earnings per share are based on weighted average common shares outstanding,
net of treasury stock in 1992 and 1991, of 5,809,570 in 1993 and 3,297,812 in
1992 and 1991.
Intangible Assets
In 1993, the Company reassessed the valuation of its intangible assets which
resulted in a writedown of $14.0 million. See Note 7 for further information.
Until 1993, the excess of cost over the fair value of net assets acquired
(goodwill) in connection with the acquisition of Mariners Savings and Loan in
1978, was included in intangible assets in the statements of financial
condition and was being amortized to operations over forty years.
The cost of core deposits purchased from various financial institutions is
amortized over the average life of the deposits acquired, generally five to ten
years.
Income Taxes
The Company files a consolidated federal income tax return with its
subsidiaries and a combined California franchise tax return.
Beginning in 1991, income taxes have been determined pursuant to Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
Prior to 1991, income taxes were determined pursuant to SFAS No. 96. The impact
of adopting SFAS No. 109 was not material in relation to SFAS No. 96.
F-9
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Financial Instruments
In the normal course of business, the Company enters into off-balance sheet
instruments to enhance yields and to alter its exposure to interest rate risk.
These financial instruments include interest rate swaps and swap option
agreements and puts and calls. The differences to be paid or received on swaps
are included in interest expense as payments are made or received. The swap
options are held as trading positions during the option period and are carried
at market value and gains and losses are reflected in operations.
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosure of fair value information about financial instruments,
whether or not recognized in the statement of financial condition, for which it
is practicable to estimate that value. Financial instruments are defined as
cash, evidence of an ownership in an entity, or a contract that conveys or
imposes on an entity the contractual right or obligation to either receive or
deliver cash or another financial instrument.
Much of the information used to determine fair value is highly subjective.
When applicable, readily available market information has been utilized.
However, for a significant portion of the Bank's financial instruments, active
markets do not exist. Therefore, considerable judgment was required in
estimating fair value for certain items. The subjective factors include, among
other things, the estimated timing and amount of cash flows, risk
characteristics, credit quality and interest rates, all of which are subject to
change. Since the fair value is estimated as of December 31, 1993, the amounts
that will actually be realized or paid at settlement or maturity of the
instruments could be significantly different. SFAS No. 107 excludes certain
financial instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Company.
The following methods and assumptions were used in estimating fair value
disclosures for financial instruments which are contained in the notes to the
consolidated financial statements that describe each financial instrument.
Cash and cash equivalents: The book value amounts reported in the statement
of financial condition for cash and cash equivalents approximate the fair value
of such assets, because of the short maturity of such investments.
Investment securities and mortgage-backed securities: Estimated fair values
for investment and mortgage-backed securities are based on quoted market
prices, where available. If quoted market prices are not available, estimated
fair values are based on quoted market prices of comparable instruments.
Loans: The estimated fair values of real estate loans held for sale are based
on quoted market prices. The estimated fair values of loans receivable are
based on quoted market prices, when available, or an option adjusted cash flow
valuation ("OACFV"). The OACFV includes forward interest rate simulations and
the credit quality of performing and nonperforming loans. Such valuations may
not be indicative of the value derived upon a sale of all or part of the
portfolio. The book value of accrued interest approximates its fair value.
Investment in FHLB stock: The book value reported in the statement of
financial condition for the investment in FHLB stock approximates fair value as
the stock may be sold back to the Federal Home Loan Bank at face value to the
extent that it exceeds the amount of FHLB stock which Fidelity is required to
hold.
F-10
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Deposits: The fair value of demand deposits, savings accounts and certain
money market deposits is the amount payable on demand. The fair value of fixed
rate certificates of deposits is estimated by using an OACFV analysis.
Borrowings (including FHLB Advances, other borrowings and subordinated
notes): The estimated fair value is based on an OACFV model.
Off-balance sheet instruments: The estimated fair value for the Bank's off-
balance sheet instruments are based on quoted market prices, when available, or
an OACFV analysis.
Recent Accounting Pronouncements
In May 1993, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 114, "Accounting by Creditors for Impairment of a Loan." This statement
prescribes the recognition criteria for loan impairment and the measurement
methods for certain impaired loans and loans whose terms are modified in
troubled debt restructurings ("TDRs"). SFAS No. 114 states that a loan is
impaired when it is probable that a creditor will be unable to collect all
principal and interest amounts due according to the contracted terms of the
loan agreement. A creditor is required to measure impairment by discounting
expected future cash flows at the loan's effective interest rate, or by
reference to an observable market price, or by determining the fair value of
the collateral for a collateral dependent asset. The statement also clarified
the existing accounting for in-substance foreclosures ("ISFs") by stating that
a collateral dependent real estate loan would be reported as real estate owned
("REO") only if the lender had taken possession of the collateral. The
statement is effective for financial statements issued for fiscal years
beginning after December 15, 1994. Earlier application is encouraged.
Additionally, in June 1993, the Office of the Comptroller of the Currency,
Federal Deposit Insurance Corporation, Federal Reserve Board and Office of
Thrift Supervision issued a Joint Statement providing interagency guidance on
the reporting of ISFs. This Joint Statement lent support to SFAS No. 114,
further clarifying that losses must be recognized on real estate loans that
meet the existing ISF criteria based on fair value of the collateral, but such
loans need not be reported as REO unless possession of the underlying
collateral has been obtained.
Management will implement SFAS No. 114 beginning in 1994. The Company already
measures impairment based on the fair value of the collateral, therefore, the
estimated impact of application will consist of a reclassification of ISFs on
the statement of financial condition from REO to loans. At December 31, 1993,
the amount of ISFs totaled $28.4 million.
In May 1993, the FASB also issued SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." This statement addresses the
accounting and reporting for investments in equity securities that have readily
determinable fair values and for all investments in debt securities. Those
investments are to be classified in three categories and accounted for as
follows: (a) debt securities for which the enterprise has the positive intent
and ability to hold to maturity are classified as held to maturity securities
and reported at amortized cost; (b) debt and equity securities that are bought
and held principally for the purpose of selling in the near term are classified
as trading securities and reported at fair value, with unrealized gains and
losses included in earnings; and (c) debt and equity securities not classified
as either held to maturity securities or trading securities are classified as
available for sale securities and reported at fair value, with unrealized gains
and losses excluded from earnings and reported, net of tax effect, in a
separate component of stockholders'
F-11
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
equity. SFAS No. 115 does not apply to unsecuritized loans. However, after
mortgage loans are converted to mortgage-backed securities, they are subject to
its provisions.
SFAS No. 115 is effective for fiscal years beginning after December 15, 1993.
It is to be initially applied as of the beginning of a company's fiscal year
and cannot be applied retroactively to prior years' financial statements.
However, a company may elect to initially apply this statement as of the end of
1993. The Company has not elected to apply this statement in 1993. However, the
impact of the adoption of SFAS No. 115 as of December 31, 1993, would not have
had a material effect on stockholders' equity.
NOTE 2--CASH EQUIVALENTS AND INVESTMENT SECURITIES
Federal funds sold are included in cash and cash equivalents. The Company had
$60.0 million of federal funds sold at December 31,1993 and no outstanding
federal funds sold at December 31, 1992.
Investment securities held for trading
Investment securities held for trading during 1993 consisted of U.S.Treasury
securities purchased with the intent to be subsequently sold to provide net
securities gains. Proceeds from sales of investment securities held for trading
during 1993 were $248.3 million. Gross gains of $332,000 and gross losses of
$345,000 were realized from those sales and are reported in the statement of
operations as a component of gains/losses on sales of investment securities.
There were no investment securities held for trading activities during 1992
and 1991 and the Company had no outstanding investment securities held for
trading at year-end 1993 or 1992.
Investment securities held for sale
The following table summarizes the investment securities held for sale at
December 31, 1993:
BOOK UNREALIZED UNREALIZED MARKET
VALUE GAINS LOSSES VALUE
------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
U.S. Government and agency
obligations....................... $87,385 $ 256 $ (3) $ 87,638
Other investments.................. 4,874 -- -- 4,874
------- ----- ---- --------
$92,259 $ 256 $ (3) $ 92,512
======= ===== ==== ========
Weighted average yield............ 4.65%
=======
Other investments represent U.S. Treasury securities, carried at the lower of
cost or market value, which have been pledged and placed in trust to provide a
credit enhancement to a FNMA securitization of loans in September 1992 of
$114.3 million.
The Company had no outstanding investment securities held for sale at
December 31, 1992 or 1991.
During the year ended December 31, 1993, the Company had gross gains of
$110,000 and gross losses of $23,000 on the sale of investment securities held
for sale. The Company also recorded a loss of $2.1 million at December 31, 1993
to adjust the book value of investment securities held for sale to the lower of
cost or market. During the years ended December 31, 1992 and 1991, the Company
had no gross gains or losses on the sale of investment securities held for
sale.
F-12
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 2--CASH EQUIVALENTS AND INVESTMENT SECURITIES--(CONTINUED)
The following maturity table shows the book value and market value of
investment securities held for sale at December 31, 1993:
BOOK MARKET
YEAR OF MATURITY VALUE VALUE
---------------- ----------- -----------
(DOLLARS IN THOUSANDS)
1994................................................. $ 1,301 $ 1,301
1995 through 1998.................................... 90,686 90,939
1999 through 2003.................................... 272 272
----------- -----------
$92,259 $92,512
=========== ===========
Investment securities held for investment
Proceeds from sales of securities held for investment during 1993, 1992 and
1991 were $26.9 million, $0 and $1.5 million, respectively. The following gross
gains and gross losses were realized from those sales and are reported in the
statements of operations for the indicated periods, as a component of
gains/losses on sales of investment securities, net:
GROSS
-----------------------
YEAR ENDED DECEMBER 31, SALES GAINS (LOSSES)
----------------------- ------- ------ --------
(DOLLARS IN THOUSANDS)
1993.................................... $26,908 $1,946 --
1992.................................... -- -- --
1991.................................... 1,547 1 --
During 1993, the Company changed its investment strategy and as a result,
moved its entire portfolio of investment securities from the investment
portfolio to the held for sale portfolio. The Company had no outstanding
investment securities held for investment at December 31, 1993.
The following table summarizes the investment securities held for investment
at December 31, 1992:
BOOK UNREALIZED UNREALIZED MARKET
VALUE GAINS LOSSES VALUE
------- ---------- ---------- -------
(DOLLARS IN THOUSANDS)
U.S. Government
obligations..... $24,950 $1,908 $ -- $26,858
Commercial paper. 29,986 14 -- 30,000
Other
investments..... 12,401 -- (218) 12,183
------- ------ ----- -------
$67,337 $1,922 $(218) $69,041
======= ====== ===== =======
Weighted average
yield.......... 5.77%
=======
Other investments represents U.S. Treasury securities which have been pledged
and placed in trust to provide a credit enhancement to a FNMA securitization of
loans in September 1992 of $114.3 million.
At December 31, 1993 and 1992, the Company had accrued interest receivable of
$0.7 million and $0.8 million, respectively, on investment securities held for
sale and investment, which is included in interest receivable in the
accompanying statements of financial condition.
F-13
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 3--MORTGAGE-BACKED SECURITIES
Mortgage-backed securities held for trading
The Company had no outstanding mortgage-backed securities held for trading at
December 31, 1993 and 1992. Proceeds from sales of mortgage-backed securities
held for trading during 1993 totaled $51.3 million. Gross gains of $54,000 were
realized from those sales and are reported in the statement of operations as a
component of gains/losses on sales of mortgage-backed securities, net. There
were no comparable activities for mortgage-backed securities held for trading
during 1992 and 1991.
Mortgage-backed securities held for sale
Summarized below are mortgage-backed securities held for sale at December 31,
1993:
BOOK UNREALIZED UNREALIZED MARKET
VALUE GAINS LOSSES VALUE
------- ---------- ---------- -------
(DOLLARS IN THOUSANDS)
FHLMC............................. $34,184 $ 3 $(217) $33,970
FNMA.............................. 14,853 -- (33) 14,820
Participation Certificates........ 38,223 454 -- 38,677
CMO............................... 3,848 -- (17) 3,831
------- ---- ----- -------
$91,108 $457 $(267) $91,298
======= ==== ===== =======
Weighted average yield............ 5.33%
=======
The Company had no outstanding mortgage-backed securities held for sale at
December 31, 1992.
During the year ended December 31, 1993, the Company had gross gains of $4.9
million and gross losses of $5.1 million on the sale of mortgage-backed
securities held for sale compared to no gross gains or losses for the years
ended December 31, 1992 and 1991.
Mortgage-backed securities held for investment
During 1993, the Company changed its investment strategy and as a result,
moved its entire portfolio of mortgage-backed securities from the investment
portfolio to the held for sale portfolio. The Company had no outstanding
mortgage-backed securities held for investment at December 31, 1993.
During the year ended December 31, 1993, the Company had gross gains of $1.5
million and gross losses of $1,000 on the sale of mortgage-backed securities
held for investment compared to no gross gains or losses for the year ended
December 31, 1992 and gross gains of $9.3 million and gross losses of $.3
million for the year ended December 31, 1991.
Summarized below are mortgage-backed securities held for investment at
December 31, 1992:
BOOK UNREALIZED UNREALIZED MARKET
VALUE GAINS LOSSES VALUE
-------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
FHLMC............................ $102,476 $ 410 $(1,397) $101,489
GNMA............................. 14,466 889 -- 15,355
FNMA............................. 113,442 275 -- 113,717
-------- ------ ------- --------
$230,384 $1,574 $(1,397) $230,561
======== ====== ======= ========
Weighted average yield........... 6.36%
========
F-14
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 3--MORTGAGE-BACKED SECURITIES--(CONTINUED)
At December 31, 1993 and 1992, the Company had accrued interest receivable on
mortgage-backed securities held for sale and investment of $0.5 million and
$1.5 million, respectively, which is included in interest receivable in the
accompanying statements of financial condition.
NOTE 4--LOANS RECEIVABLE AND LOANS HELD FOR SALE
Total loans include loans receivable and loans held for sale and are
summarized as follows:
DECEMBER 31,
-----------------------
1993 1992
----------- -----------
(DOLLARS IN THOUSANDS)
Real Estate loans:
Single family................................... $ 792,054 $ 857,631
Multifamily:
2 to 4 units................................... 505,219 526,826
5 to 36 units.................................. 1,795,374 1,880,589
37 units and over.............................. 406,330 444,576
Commercial and industrial....................... 295,761 343,270
Land............................................ 4,828 6,445
----------- -----------
Total real estate loans........................ 3,799,566 4,059,337
Other............................................ 8,998 8,278
----------- -----------
3,808,564 4,067,615
----------- -----------
Less:
Undisbursed loan funds.......................... -- 301
Unearned discounts.............................. 210 104
Deferred loan fees.............................. 11,139 11,152
Allowance for estimated losses (Note 6)......... 83,832 64,277
----------- -----------
95,181 75,834
----------- -----------
$ 3,713,383 $ 3,991,781
=========== ===========
Included above are $56.3 million and $63.3 million of amounts drawn under home
equity lines of credit at December 31, 1993 and 1992, respectively. The
remaining, unused balance of approved home equity credit lines was $52.1 million
and $66.2 million at the respective dates.
Also included above are loans held for sale, consisting of the following at
the dates indicated:
DECEMBER 31,
-----------------------
1993 1992
----------- -----------
(DOLLARS IN THOUSANDS)
Residential loans:
Single family................................... $ 239,371 $ 25,043
Multifamily 2 to 4 units........................ 128,317 1,439
----------- -----------
Total loans held for sale...................... $ 367,688 $ 26,482
=========== ===========
Fidelity's portfolio of mortgage loans serviced for others amounted to $888.4
million at December 31, 1993 and $982.7 million at December 31, 1992.
F-15
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 4--LOANS RECEIVABLE AND LOANS HELD FOR SALE--(CONTINUED)
Fidelity's loan portfolio includes multifamily, commercial and industrial
loans of $2.9 billion which depend on operating income to provide debt service
coverage. Therefore, these loans generally have a greater risk of default than
single family residential loans and, accordingly, earn a higher rate of
interest to compensate in part for the risk. Approximately 99% of these loans
are secured by property within the state of California. The continued weakening
in the California real estate market does not make the market compare as
favorably to other sections of the country as it has in the past.
The Company has modified a number of its loans. In some cases, the
modifications have taken the form of "early recasts" in which the amortizing
payments are revised (or recalculated) earlier than scheduled to reflect
current lower interest rates. In other cases, the Company has agreed to accept
interest only payments for a limited time at current interest rates. In still
other cases, the Company has modified loans at terms that are less favorable to
the Company than the current market. These loans have interest rates that may
be less than current market rates or may contain other concessions. Due to the
fact that these modifications resulted from formal requests from borrowers
claiming economic distress and due to increased risk of borrower inability to
perform according to contractual terms, these modified loans have been
categorized by the Company as "TDRs". At December 31, 1993 and 1992,
outstanding TDRs totaled $28.7 million and $87.3 million, respectively.
For the year ended December 31, 1993, interest income of $8.3 million was
recorded on TDRs, $0.1 million less than would have been recorded had the loans
performed according to their original terms. During 1992, $10.0 million of
interest income was recorded on TDRs, $0.3 million less than would have been
recorded had the loans performed according to their original terms.
It is the Company's policy to reserve all earned but unpaid interest on loans
over 90 days contractually delinquent and other loans the Company believes
exhibit materially deficient characteristics. The total of these loans was
$93.5 million, $112.0 million, and $69.0 million at December 31, 1993, 1992 and
1991, respectively. The reduction in income related to these loans upon which
interest was not paid was $8.7 million,$13.6 million and $7.6 million for the
corresponding periods.
The estimated fair value of loans receivable (not including loans held for
sale) as of December 31, 1993, was $3.4 billion, which includes $93.5 million
of nonperforming loans (See Note 1 discussion of SFAS No. 107).
At December 31, 1993, loans held for sale consisted of $321 million of
adjustable rate loans and $47 million of fixed rate loans on 1 to 4 unit
properties. The estimated fair value of loans held for sale as of December 31,
1993, was $368.8 million (see Note 1 discussion of SFAS No. 107).
NOTE 5--OWNED REAL ESTATE
Owned real estate consists of the following:
DECEMBER 31,
------------------
1993 1992
-------- --------
(DOLLARS IN
THOUSANDS)
Real estate held for investment or development........... $ 11,161 $ 15,411
Real estate acquired through foreclosure................. 131,799 90,290
In-substance foreclosed real estate...................... 28,362 44,004
Allowance for estimated losses........................... (17,715) (16,450)
-------- --------
$153,607 $133,255
======== ========
F-16
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 5--OWNED REAL ESTATE--(CONTINUED)
The following summarizes the results of real estate operations:
DECEMBER 31,
----------------------------
1993 1992 1991
-------- -------- --------
(DOLLARS IN THOUSANDS)
Income (loss) from:
Real estate acquired for investment or
development................................. $ 110 $ (841) $ (934)
Real estate acquired through foreclosure..... (18,753) (3,600) (1,126)
Provision for estimated losses............... (30,200) (17,820) (8,562)
-------- -------- --------
$(48,843) $(22,261) $(10,622)
======== ======== ========
NOTE 6--ALLOWANCE FOR ESTIMATED LOAN AND REAL ESTATE LOSSES
The following summarizes the activity in the Company's allowance for
estimated loan and real estate losses:
OWNED
LOANS REAL ESTATE TOTAL
-------- ----------- --------
(DOLLARS IN THOUSANDS)
Balance at January 1, 1991................... $ 16,552 $ -- $ 16,552
Provision for losses........................ 49,843 8,562 58,405
Charge-offs................................. (17,005) (8,562) (25,567)
Recoveries.................................. 2,984 -- 2,984
-------- -------- --------
Balance at December 31, 1991................. 52,374 -- 52,374
Provision for losses........................ 51,180 17,820 69,000
Transfer of general valuation allowance..... (12,400) 12,400 --
Charge-offs................................. (27,350) (13,826) (41,176)
Recoveries.................................. 473 56 529
-------- -------- --------
Balance at December 31, 1992................. 64,277 16,450 80,727
Provision for losses........................ 65,100 30,200 95,300
Charge-offs................................. (50,504) (28,940) (79,444)
Recoveries.................................. 4,959 5 4,964
-------- -------- --------
Balance at December 31, 1993................. $ 83,832 $ 17,715 $101,547
======== ======== ========
Current Southern California economic conditions have adversely affected the
credit risk profile and performance of the Company's loan portfolio. In light
of the concentration of the Company's loan portfolio in loans secured by
Southern California multifamily residential properties, there is particular
concern about the potential for further declines in the Southern California
economy, increasing vacancy rates, declining rents, declining debt coverage
ratios, declining market values for multifamily residential properties, and
the possibility that investors may abandon properties or seek bankruptcy
protection with respect to properties experiencing negative cash flow,
particularly where such properties are not cross-collateralized by other
performing assets.
Fidelity's percentage of nonperforming assets to total assets increased to
5.37% at December 31, 1993 from 4.99% at December 1992 and 2.43% at December
31, 1991.
NOTE 7--INTANGIBLE ASSETS
In 1993, Fidelity reassessed the valuation of its intangible assets. Based
upon the results of a branch profitability analysis and an analysis of the
recoverability of its core deposit intangible assets, Fidelity wrote
F-17
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 7--INTANGIBLE ASSETS--(CONTINUED)
down the carrying value of its core deposit intangible assets in an amount of
$5.2 million (which writedown is included in interest expense). The net
unamortized balance of core deposit intangibles was $2.1 million at December
31, 1993 and is being amortized over the remaining average life of the deposits
acquired, generally one to three years.
In addition, an analysis was performed of the recoverability of the goodwill
related to the acquisition of Mariners Savings and Loan ("Mariners") in 1978.
This analysis indicated that the expected future net earnings from the branches
or assets acquired did not support the carrying value of the goodwill. As a
result, Fidelity wrote down the remaining $8.8 million balance of goodwill
related to the Mariners acquisition (which writedown is included in operating
expense).
The amortization and writedown of core deposit intangibles, resulting from
purchases of deposits, and goodwill acquired in the acquisitions of other
financial institutions for each of the three years in the period ended
December 31, 1993, are summarized as follows:
1993 1992 1991
------- ------ ------
(DOLLARS IN
THOUSANDS)
Amortization of core deposit intangibles............... $ 4,020 $4,199 $4,296
Writedown of core deposit intangibles.................. 5,192 -- --
Amortization of goodwill............................... 470 596 840
Writedown of goodwill.................................. 8,776 -- --
------- ------ ------
Net decrease in income before income taxes............. $18,458 $4,795 $5,136
======= ====== ======
F-18
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 8--DEPOSITS
Deposits consist of the following:
DECEMBER 31,
------------------------------------
1993 1992
----------------- -----------------
TYPE OF ACCOUNT, WEIGHTED AVERAGE INTEREST
RATE AMOUNT % AMOUNT %
- ------------------------------------------ ---------- ----- ---------- -----
(DOLLARS IN THOUSANDS)
Passbook, 2.00% at December 31, 1993 and
2.50% at December 31, 1992............... $ 82,168 2.4% $ 74,738 2.2%
Checking and money market checking, 0.96%
at December 31, 1993 and 1.48% at December
31, 1992................................. 366,968 10.9 338,496 9.7
Money market passbook, 2.37% at December
31, 1993 and 2.79% at December 31, 1992.. 280,474 8.3 427,978 12.4
---------- ----- ---------- -----
729,610 21.6 841,212 24.3
---------- ----- ---------- -----
Certificates with rates of:
Under 3.00%.............................. 418,326 12.4 290,646 8.4
3.01-4.00%.............................. 1,326,449 39.4 1,127,109 32.7
4.01-5.00%.............................. 395,129 11.7 375,034 10.8
5.01-6.00%.............................. 137,710 4.1 236,627 6.8
6.01-7.00%.............................. 225,035 6.7 381,334 11.0
7.01-8.00%.............................. 90,280 2.7 147,037 4.3
Over 8.00%............................... 46,104 1.4 58,919 1.7
---------- ----- ---------- -----
2,639,033 78.4 2,616,706 75.7
---------- ----- ---------- -----
$3,368,643 100.0% $3,457,918 100.0%
========== ===== ========== =====
Weighted average interest rate............ 3.59% 4.00%
========== ==========
Fidelity had noninterest-bearing checking accounts of $52.9 million and $31.6
million at December 31, 1993 and 1992, respectively.
At December 31, 1993, certificate accounts were scheduled to mature as
follows:
YEAR OF MATURITY AMOUNT
---------------- ----------------------
(DOLLARS IN THOUSANDS)
1994................................................ $2,097,475
1995................................................ 220,791
1996................................................ 91,610
1997................................................ 203,317
1998................................................ 25,488
After 1999.......................................... 352
----------
$2,639,033
==========
At December 31, 1993, loans totaling $98.3 million were pledged as collateral
for $5.9 million of public funds on deposit with the Bank and potential future
deposits.
F-19
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 8--DEPOSITS--(CONTINUED)
Certificates of deposits of $100,000 or more accounted for $593 million and
represented 18% of all deposits at December 31, 1993, $550 million or 16% of
all deposits at December 31, 1992 and $629 million or 16% of all deposits at
December 31, 1991.
The Bank also utilizes brokered deposits as a short-term means of funding.
These deposits are obtained or placed by or through a deposit broker and are
subject to certain regulatory limitations. The following table summarizes the
Bank's outstanding balance of brokered deposits at the dates indicated:
PERCENT OF
DECEMBER 31, AMOUNT TOTAL DEPOSITS
------------ ------- --------------
(DOLLARS IN THOUSANDS)
1993...................... $92,196 2.74%
1992...................... $12,850 0.37%
The carrying amounts and the estimated fair values of deposits consisted of
the following at December 31, 1993 (see Note 1 discussion of SFAS No. 107):
BOOK VALUE FAIR VALUE
---------- ----------
(DOLLARS IN
THOUSANDS)
Passbook, checking and money market accounts.......... $ 729,610 $ 729,600
Certificates of deposit............................... 2,639,033 2,684,100
---------- ----------
Total deposits...................................... $3,368,643 $3,413,700
========== ==========
SFAS No. 107 defines the fair value of demand deposits as the stated amount
of passbook, checking and certain money market accounts. Although SFAS No. 107
specifically prohibits including a deposit-based intangible element as part of
the fair value disclosure for deposit liabilities, it does allow supplemental
disclosure, which is unaudited. The core deposit intangible is the excess of
the fair value of demand deposits over recorded amounts and represents the
benefit of retaining these deposits for an expected period of time. Fair value
is based on a discounted cash flow analysis using the Bank's alternative
funding costs for similar maturities and assumed retention rates for each type
of deposit. The core deposit intangible is estimated to be $63.0 million at
December 31, 1993, and is not included in the above fair values or recorded as
an asset in the statement of financial condition.
F-20
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 9--FEDERAL HOME LOAN BANK ADVANCES
FHLB Advances are summarized as follows:
DECEMBER 31,
---------------------
1993 1992
-------- -----------
(DOLLARS IN
THOUSANDS)
Balance at year-end...................................... $326,400 $ 581,400
Average amount outstanding during the year............... $394,591 $ 393,344
Maximum amount outstanding at any month-end.............. $496,400 $ 581,400
Weighted average interest rate during the year........... 4.33% 5.27%
Weighted average interest rate at year-end............... 4.52% 4.25%
Secured by:
FHLB Stock.............................................. $ 51,951 $ 50,559
Loans receivable (1).................................... 900,776 1,661,950
-------- -----------
$952,727 $ 1,712,509
======== ===========
- --------
(1) Includes pledged loans available for use under the letter of credit
securing commercial paper (available unused balance was $96 million at
December 31, 1993). See Note 10.
The maturities and weighted average interest rates on FHLB Advances are
summarized as follows:
DECEMBER 31,
---------------------------------------------------
1993 1992
------------------------- -------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
YEAR OF MATURITY AMOUNT INTEREST RATE AMOUNT INTEREST RATE
- ---------------- -------- ---------------- -------- ----------------
(DOLLARS IN THOUSANDS)
1993........................ $ -- --% $325,000 3.64%
1994........................ 3,700 3.32 3,700 4.10
1996........................ 60,000 4.88 -- --
1997........................ 232,700 4.02 232,700 4.73
1998........................ 10,000 6.30 -- --
2000........................ 20,000 8.61 20,000 8.61
-------- --------
$326,400 4.52% $581,400 4.25%
======== ========
The estimated fair value of FHLB Advances at December 31, 1993, was $328
million (see Note 1 discussion of SFAS No. 107).
F-21
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 10--OTHER BORROWINGS AND SUBORDINATED NOTES
Other borrowings consist of the following:
DECEMBER 31,
YEAR OF -----------------
MATURITY 1993 1992
-------- -------- --------
(DOLLARS IN
THOUSANDS)
Short-term borrowings:
8 7/8% Mortgage-backed medium term notes ("1993
MTNs")............................................ 1993 $ -- $100,000
9 3/4% Commercial mortgage-backed bonds ("CMBBs").. 1993 -- 62,000
Commercial paper................................... 1993 -- 65,000
Commercial paper................................... 1994 304,000 --
Securities sold under agreement to repurchase...... 1994 3,830 --
-------- --------
307,830 227,000
Long-term borrowings:
8 1/2% Mortgage-backed medium-term notes ("1997
MTNs")............................................ 1997 100,000 100,000
-------- --------
$407,830 $327,000
======== ========
The mortgage-backed bonds and notes are summarized as follows:
DECEMBER 31,
------------------
1993 1992
-------- --------
(DOLLARS IN
THOUSANDS)
Mortgage-backed medium term notes:
1993 MTNs, matured May 15, 1993:
Balance at year-end...................................... -- $100,000
Interest rate at year-end................................ -- 8.88%
1997 MTNs, due April 15, 1997:
Balance at year-end...................................... $100,000 $100,000
Interest rate at year-end................................ 8.50% 8.50%
1993 and 1997 MTNs are secured by:
Joint pool of mortgage loans and mortgage-backed
securities, at cost..................................... -- $414,573
Joint pool of mortgage loans and U.S. Treasury notes, at
cost.................................................... $255,720 --
CMBBs, matured September 15, 1993:
Balance at year-end....................................... -- $ 62,000
Secured by mortgage loans and U.S. Treasury notes, at
cost..................................................... -- $208,923
Interest rate at year-end................................. -- 9.32%
F-22
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 10--OTHER BORROWINGS AND SUBORDINATED NOTES--(CONTINUED)
Borrowings other than the mortgage-backed bonds and notes are summarized as
follows:
DECEMBER 31,
------------------
1993 1992
-------- --------
(DOLLARS IN
THOUSANDS)
Commercial paper:
Balance at year-end........................................ $304,000 $ 65,000
Average amount outstanding during the year................. $274,620 $ 21,165
Maximum amount outstanding at any month-end................ $342,090 $ 94,400
Weighted average interest rate during the year............. 3.44% 4.05%
Weighted average interest rate at year-end................. 3.38% 3.57%
Secured by Letter of Credit from FHLB...................... $400,000 $400,000
Securities sold under agreement to repurchase:
Balance at year-end........................................ $ 3,830 --
Average amount outstanding during the year................. $138,701 $ 19,542
Maximum amount outstanding at any month-end................ $289,885 $111,633
Weighted average interest rate during the year............. 3.23% 3.32%
Weighted average interest rate at year-end................. 3.40% --
Secured by mortgage-backed securities, at cost............. $ 4,000 --
Other borrowings:
Balance at year-end........................................ -- --
Average amount outstanding during the year................. -- $ 1,085
Maximum amount outstanding at any month-end................ -- $ 3,193
Weighted average interest rate during the year............. -- 9.54%
Weighted average interest rate at year-end................. -- --
The Bank entered into a Subordinated Loan Agreement dated as of May 15, 1990
(the "Subordinated Loan Agreement") pursuant to which $60 million in
subordinated notes (the "Notes") are outstanding, which Notes are guaranteed by
Citadel. The Notes were approved by the OTS as additional regulatory capital.
The Notes were issued to institutional investors in the amount of $60.0
million, interest payable semiannually at 11.68% per annum, and are repayable
in five equal annual installments commencing May 15, 1996.
The Subordinated Loan Agreement, among other covenants, contains a provision
requiring Fidelity to maintain a consolidated tangible net worth at least equal
to the greater of (a) $170 million plus 50% of consolidated net earnings since
January 1, 1990, or (b) 3.25% of consolidated assets. Management anticipates
that additional losses are likely to be incurred during 1994 and that, as a
result, consolidated tangible net worth may be reduced to less than $170
million sometime during the first quarter of 1994. However, management's
projections for 1994 indicate that the Bank's consolidated tangible net worth
will remain above the net worth requirement under the foregoing clause (a)
through the end of the year, assuming the formula in clause (a) permits a
reduction of the $170 million test if a consolidated net loss has been
sustained since January 1, 1990. Under this interpretation, the required
consolidated tangible net worth under clause (a) would be $153.9 million at
December 31, 1993 and would be further reduced by 50% of all losses during
1994. As of December 31, 1993, the Bank's consolidated tangible net worth
amounted to $180.2 million.
F-23
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 10--OTHER BORROWINGS AND SUBORDINATED NOTES--(CONTINUED)
On the other hand, the holders of the Notes could take the position that the
amount under clause (a) may not be reduced by losses to less than $170
million. Under that position, Fidelity would be in violation of the covenant
as soon as consolidated tangible net worth were reduced to less than $170
million. Management believes that such position is not correct; however, there
can be no assurance that such position would not prevail if the issue were
ever tested in court. If the above covenant were violated, the holders of 66
2/3% in aggregate principal amount of the Notes would be entitled to declare
the entire amount of the Notes immediately due and payable. However, if such
acceleration would result in the Bank's failure to meet applicable regulatory
capital requirements, the holders would be prohibited from accelerating the
Notes without the prior approval of the OTS. If the Bank failed to make such
payment, Citadel would be required to make such payment under its guarantee of
the Notes. Management anticipates that Citadel's funds would be insufficient
to make such payment, unless additional funds were raised.
The holders of the Notes have power of approval over certain matters,
including certain asset sales, and may require a repurchase of the Notes upon
a "Significant Event." Management believes that neither the approval of the
holders nor a Significant Event repurchase offer would be required for
consummation of the proposed Restructuring (See Note 14.) if an acquiror of
the Bank has outstanding, immediately prior to the closing of the
Restructuring, unsecured debt with a credit rating of BBB or better by
Standard & Poor's Corporation or Baa2 or better by Moody's Investors Service,
Inc. and various financial tests are satisfied after giving effect to the
Restructuring. However, should the Restructuring be found to trigger the
Significant Event repurchase requirement, Fidelity could be required to pay
the principal balance of the Notes of $60 million plus accrued interest and a
premium of approximately $12.8 million (calculated as of December 31, 1993).
Also, if the consent of the holders should be required under any of the
covenants of the Subordinated Loan Agreement but not be obtained, an event of
default would occur under the Subordinated Loan Agreement (subject to grace or
cure periods in the case of certain covenants) if the Restructuring is
completed.
On March 4, 1994, The Chase Manhattan Bank, N.A. ("Chase"), one of four
lenders under the Subordinated Loan Agreement, sued Fidelity, Citadel and
Citadel's Chairman of the Board, alleging, among other things, that the
transfer of assets pursuant to the Restructuring would constitute a breach of
the Subordinated Loan Agreement, including the tangible net worth and other
various financial tests contained therein, and seeking to enjoin the
Restructuring and to recover damages in unspecified amounts. In addition, the
lawsuit alleges that past responses of Citadel and Fidelity to requests by
Chase for information regarding the Restructuring violate certain provisions
of the Subordinated Loan Agreement and that such alleged violations, with the
passage of time, have become current defaults under the Subordinated Loan
Agreement. While the other three lenders under the Subordinated Loan Agreement
hold $25 million of the Notes, none of them has joined Chase in this lawsuit.
The Company is evaluating the lawsuit and, based on its current assessment,
the Company does not believe that the allegations have merit.
Any violation of the tangible net worth covenant or the occurrence of any
other event of default under the Subordinated Loan Agreement would also result
in a cross default under Fidelity's debt agreements with the FHLB (whether or
not the Notes are accelerated) and entitle the FHLB to declare all amounts
outstanding to become immediately due and payable. Also, the FHLB may elect
not to make further Advances to the Bank and may prevent the Bank from issuing
further commercial paper under its existing facility.
During 1992 and 1991, the Company paid $0.4 million and $0.7 million,
respectively, in interest to Craig Corporation (an 8.9% stockholder of the
Company and thus a related party) on a $15 million borrowing from that entity.
The loan was paid off in June 1992.
The weighted average interest rate on other borrowings and subordinated
notes was 5.54% and 8.39% at December 31, 1993 and 1992, respectively.
F-24
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 10--OTHER BORROWINGS AND SUBORDINATED NOTES--(CONTINUED)
The carrying and estimated fair values of other borrowings and subordinated
notes consisted of the following at December 31, 1993 (see Note 1 discussion of
SFAS No. 107):
BOOK VALUE FAIR VALUE
---------- ----------
(DOLLARS IN
THOUSANDS)
Commercial paper....................................... $304,000 $304,000
1997 MTNs.............................................. 100,000 110,600
Subordinated notes..................................... 60,000 60,300
Securities sold under agreement to repurchase.......... 3,830 3,800
-------- --------
$467,830 $478,700
======== ========
NOTE 11--EMPLOYEE BENEFIT PLANS
Postretirement Benefits
The Company provides certain health and life insurance postretirement
benefits for all eligible retired employees. Eligibility for the plan is met
when the participant reaches age 55 and has 10 years of continuous service.
Effective January 1, 1993, the Company adopted SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions" for its unfunded
postretirement health care and life insurance program. This statement requires
the cost of postretirement benefits to be accrued during the service lives of
employees. The Company's previous practice was to expense these costs on a cash
basis.
As of December 31, 1992, the Company's accumulated postretirement benefit
obligation ("APBO") was approximately $3.1 million. Upon adoption of the
statement, the Company could make the election to immediately recognize the
liability or to amortize the amount to expense over 20 years. The Company has
elected to amortize this transition obligation over 20 years. Net periodic
postretirement benefit costs for 1993 included the following components:
AMOUNT
----------------------
(DOLLARS IN THOUSANDS)
Service cost (benefits attributed to service during
the period)........................................ $187.1
Interest cost on accumulated postretirement benefit
obligation......................................... 250.2
Amortization of transition obligation............... 156.4
------
Net periodic postretirement benefit cost............ $593.7
======
F-25
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 11--EMPLOYEE BENEFIT PLANS--(CONTINUED)
The following table sets forth the postretirement benefit liability at
December 31, 1993:
Accumulated postretirement benefit obligation:
AMOUNT
----------------------
(DOLLARS IN THOUSANDS)
Retirees............................................. $1,616.7
Employees presently eligible to retire............... 1,115.9
Employees not yet eligible to retire................. 974.7
--------
Total APBO.......................................... 3,707.3
Unrecognized transition obligation................... (2,971.2)
Unrecognized cumulative loss......................... (237.4)
--------
Net postretirement benefit liability recognized in
the statement of financial condition................ $ 498.7
========
The APBO as of December 31, 1993, was determined using a 7.25% weighted
average discount rate. The health care cost trend rates were assumed to be
9.5% at December 31, 1993, gradually declining to 5.25% after ten years and
remaining at that level thereafter. The health care cost trend rate assumption
has a significant effect on the amount reported. For example, a 1% increase in
the health care trend rate in each year, would increase the accumulated
postretirement benefit obligation by $0.6 million (or 17.2%) at December 31,
1993 and the net periodic cost by $0.1 million (or 14.6%) for the year.
Retirement Income Plan
The Company has a retirement income plan covering substantially all
employees. The defined benefit plan provides for payment of retirement
benefits commencing normally at age 65 in a monthly annuity, however, the
option of a single cash payment is available. An employee becomes vested upon
five years of service. Benefits payable under the plan are generally
determined on the basis of the employee's length of service and average
earnings. Annual contributions to the plans are sufficient to satisfy legal
funding requirements.
401(k) Plan
The Company has a 401(k) defined contribution plan available to all
employees who have been with the Company for one year and have reached the age
of 21. Employees may generally contribute up to 15% of their salary each year,
and the Company matches 50% up to the first 6% contributed by the employee.
F-26
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 12--INCOME TAXES
Income tax expense/benefit was comprised of the following:
YEAR ENDED DECEMBER 31,
----------------------------
1993 1992 1991
-------- -------- --------
(DOLLARS IN THOUSANDS)
Current income tax expense (benefit):
Federal.......................................... $(51,033) $ 12,429 $ 21,562
State............................................ 75 1,696 7,365
-------- -------- --------
(50,958) 14,125 28,927
-------- -------- --------
Deferred income tax expense (benefit):
Federal.......................................... 17,746 (15,503) (8,383)
State............................................ (3,255) (4,463) (4,893)
-------- -------- --------
14,491 (19,966) (13,276)
-------- -------- --------
$(36,467) $ (5,841) $ 15,651
======== ======== ========
Income tax liability/receivable was comprised of the following:
DECEMBER 31,
------------------------
1993 1992
----------- -----------
(DOLLARS IN THOUSANDS)
Current income tax liability (receivable):
Federal............................................... $ (43,603) $ 6,242
State................................................. (1,767) (1,332)
----------- ----------
(45,370) 4,910
----------- ----------
Deferred income tax liability (receivable):
Federal............................................... 14,564 (3,182)
State................................................. (8,555) 2,008
Valuation Allowance--State............................ 7,308 --
----------- ----------
13,317 (1,174)
----------- ----------
$ (32,053) $ 3,736
=========== ==========
F-27
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 12--INCOME TAXES--(CONTINUED)
The components of the net deferred tax liability/asset are as follows:
DECEMBER 31,
-----------------
1993 1992
-------- -------
(DOLLARS IN
THOUSANDS)
FEDERAL:
Deferred tax liabilities:
Loan fees and interest...................................... $ 12,995 $13,906
FHLB stock dividends........................................ 12,066 11,515
California franchise tax.................................... 2,691 --
Other....................................................... 7,480 5,229
-------- -------
Gross deferred tax liabilities............................... 35,232 30,650
-------- -------
Deferred tax assets:
California franchise tax.................................... -- 1,633
Bad debt and loan loss deduction............................ 11,369 25,997
REO operating income........................................ 2,926 --
Other....................................................... 6,373 6,202
-------- -------
Gross deferred tax assets.................................... 20,668 33,832
Valuation allowance.......................................... -- --
-------- -------
Deferred tax assets, net of allowance........................ 20,668 33,832
-------- -------
Net deferred tax liability (asset)........................... $ 14,564 $(3,182)
======== =======
STATE:
Deferred tax liabilities:
Loan fees and interest...................................... $ 4,245 $ 4,502
FHLB stock dividends........................................ 3,942 3,728
Other....................................................... 2,514 1,371
-------- -------
Gross deferred tax liabilities............................... 10,701 9,601
Deferred tax assets:
Bad debt and loan loss deduction............................ 16,187 5,391
Other....................................................... 3,069 2,202
-------- -------
Gross deferred tax assets.................................... 19,256 7,593
Valuation allowance.......................................... (7,308) --
-------- -------
Deferred tax assets, net of allowance........................ 11,948 7,593
-------- -------
Net deferred tax liability (asset)........................... $ (1,247) $ 2,008
======== =======
No valuation allowance under SFAS No. 109 was required for federal purposes.
Federal deferred tax assets would be fully realized as an offset against
reversing temporary differences which create net future tax liabilities, and/or
through loss carrybacks. Therefore, even if no future income was expected,
federal deferred tax assets would still be fully realized. However, a valuation
allowance under SFAS No. 109 was required for state purposes, as certain state
deferred tax assets would not be realized as an offset against reversing
temporary differences which create net future state tax liabilities.
F-28
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 12--INCOME TAXES--(CONTINUED)
A reconciliation from the statutory income tax expense/benefit to the
consolidated effective income tax expense/benefit follows:
YEAR ENDED DECEMBER 31,
--------------------------
1993 1992 1991
-------- ------- -------
(DOLLARS IN THOUSANDS)
Expected federal income tax expense (benefit)... $(35,234) $(1,290) $ 6,227
Increases (reductions) in taxes resulting from:
Franchise tax expense (benefit), net of
federal income tax............................ (4,398) (234) 1,631
Bad debt and loan loss deduction............... -- -- 3,300
Goodwill....................................... 3,108 124 124
Redetermination of tax......................... -- (4,130) 4,373
Other, net..................................... 57 (311) (4)
-------- ------- -------
Income tax expense (benefit).................... $(36,467) $(5,841) $15,651
======== ======= =======
The Company's tax returns have been audited by the Internal Revenue Service
through December 31, 1987 and by the California Franchise Tax Board through
December 31, 1985. The tax returns filed for 1986, 1987 and 1988 are currently
under audit by the California Franchise Tax Board. The tax returns filed for
1988 and 1989 are currently in the appeals process with the Internal Revenue
Service. In addition, the Internal Revenue Service is currently auditing the
tax returns filed for 1990 and 1991. Although the Company's management believes
its federal income tax returns properly reflect the Company's tax liability,
the Internal Revenue Service might assess additional taxes related to, among
other things, certain disputed industry issues affecting the industry as a
whole. If additional taxes are assessed, the Company intends to utilize all
statutorily allowable remedies to achieve a favorable outcome for years under
examination.
Savings institutions are allowed a bad debt deduction for federal income tax
purposes based on either 8% of taxable income or the savings institution's
actual loss experience. Fidelity's bad debt deductions for the years presented
were based on actual loss experience.
Under the provisions of SFAS No. 109 (paragraphs 31 and 32), a deferred tax
liability has not been provided for tax bad debt and loan loss reserves which
arose in tax years prior to December 31, 1987. The Company had $52.5 million of
such reserves at December 31, 1993, for which $18.4 million of taxes have not
been provided. If these reserves are used for any purpose other than to absorb
bad debt losses, federal taxes would have to be provided at the then current
income tax rate. It is not contemplated that the accumulated reserves will be
used in a manner that will create such liabilities.
NOTE 13--COMMITMENTS AND CONTINGENCIES
The Company and certain of its subsidiaries had a number of lawsuits and
claims pending at December 31, 1993. The Company's management and its counsel
believe that none of the lawsuits or claims pending will have a materially
adverse impact on the financial condition or business of the Company.
See Note 17--Subsequent Events.
F-29
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 13--COMMITMENTS AND CONTINGENCIES--(CONTINUED)
Fidelity enters into agreements to extend credit to customers on an ongoing
basis. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Most commitments are expected to be
drawn upon, and therefore the total commitment amounts generally represent
future cash requirements. At December 31, 1993, the Bank had commitments to
fund loans of $37.9 million at market interest rates on the dates such
commitments are to be funded.
At December 31, 1993, the Bank was a party to interest rate swap agreements
in which the Bank receives a fixed interest rate and pays a floating interest
rate on a total notional principal amount of $250 million. These agreements
have remaining maturities of less than four years and an estimated fair value
of $2.0 million (See Note 1 discussion of SFAS No. 107).
As of December 31, 1993, the Bank had sold several interest rate swap option
agreements with a total notional amount of $200 million. The agreements give
the right to the buyer to cancel the swap agreement at a specified future date.
The Bank receives a fixed interest rate and pays a floating interest rate tied
to LIBOR over the life of the agreement for the option and swap. At December
31, 1993, the average fixed receive rate was 5.00% and the average pay rate was
3.34%. The swap options are held as trading positions during the option period
and are carried at market value and gains and losses are recorded in
operations. The estimated fair value of these positions at December 31, 1993
was a loss of approximately $1.7 million. In January 1994, the options to
cancel were not exercised and the average fixed receive rate adjusted to 4.70%.
The swaps have remaining maturities of less than four years.
As of December 31, 1993, the Bank had several open put and call positions for
mortgage loans expiring in January 1994. These positions were minor and no
losses were incurred.
As of December 31, 1993, the Bank had certain loans with a gross principal
balance of $127.3 million, of which $106.3 million had been sold in the form of
mortgage pass-through certificates, over various periods of time, to four
investor financial institutions leaving a balance of $21.0 million retained by
the Bank. These mortgage pass-through certificates provide a credit enhancement
to the investor financial institutions in the form of the Bank's subordination
of its retained percentage interest to that of the investor financial
institutions. In this regard, the aggregate of $106.3 million held by the
investor financial institutions are deemed Senior Mortgage Pass-Through
Certificates and the $21.0 million held by the Bank are subordinated to the
Senior Mortgage Pass-Through Certificates in the event of borrower default.
Full recovery of the $21.0 million is subject to this contingent liability due
to its subordination. In 1993, the Bank repurchased one of the Senior Mortgage
Pass-Through Certificates with a face value of $38.3 million, from one of the
investor institutions. It is included in the mortgage-backed securities held
for sale portfolio at December 31, 1993. The other Senior Mortgage Pass-Through
Certificates totaling $68.0 million are owned by other investor institutions.
During 1992, the Bank effected the securitization by FNMA of $114.3 million
of multifamily mortgages wherein $114.3 million in whole loans were swapped for
Triple A rated mortgage-backed securities through FNMA's Alternative Credit
Enhancement Structure ("ACES") program. These mortgage-backed securities were
sold in December 1993 and the current outstanding balance as of December 31,
1993 of $102.0 million is serviced by the Bank.
As part of a credit enhancement to absorb losses relating to the ACES
transaction, the Bank has pledged and placed in a trust account, as of December
31, 1993, $13.3 million, comprised of (a) $2.7 million in cash and (b) $10.6
million in book value U.S. Treasury securities. The Bank shall absorb losses,
if any, which may
F-30
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 13--COMMITMENTS AND CONTINGENCIES--(CONTINUED)
be incurred on the securitized multifamily loans and FNMA is responsible for
losses, if any, in excess of the $13.3 million. The securities have been
included in other investments held for sale and in response to this
classification, an adjustment has been recorded for lower of cost or market in
addition to any credit losses. Total reserves equal $8.4 million as of December
31, 1993.
The Company conducts portions of its operations from leased facilities. All
of the Company's leases are operating leases. At December 31, 1993, aggregate
minimum rental commitments on operating leases with noncancelable terms in
excess of one year were as follows:
YEAR OF MATURITY AMOUNT
---------------- ----------------------
(DOLLARS IN THOUSANDS)
1994.......................... $ 3,218
1995.......................... 2,751
1996.......................... 2,759
1997.......................... 2,830
1998.......................... 2,709
Thereafter.................... 10,842
-------
$25,109
=======
Operating expense includes rent expense of $3.0 million in 1993, $2.8 million
in 1992, and $2.7 million in 1991.
NOTE 14--STOCKHOLDERS' EQUITY
Fidelity's Regulatory Capital
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") required
the OTS to implement a system requiring regulatory sanctions action against
institutions that are not adequately capitalized, with the sanctions growing
more severe, the lower the institution's capital. Under FDICIA, the OTS issued
regulations establishing specific capital ratios for five separate capital
categories. The five categories of ratios are:
TOTAL
CAPITAL TO
CORE CAPITAL TO CORE CAPITAL TO RISK-
ADJUSTED TOTAL ASSETS RISK-WEIGHTED WEIGHTED
(LEVERAGE) RATIO ASSETS RATIO ASSETS RATIO
--------------------- --------------- ------------
Well capitalized............ 5% or above 6% or above 10% or above
Adequately capitalized...... 4% or above 4% or above 8% or above
Undercapitalized............ Under 4% Under 4% Under 8%
Significantly
undercapitalized........... Under 3% Under 3% Under 6%
Critically undercapitalized. Ratio of tangible equity to adjusted total assets
of 2% or less
F-31
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 14--STOCKHOLDERS' EQUITY--(CONTINUED)
The following table summarizes the capital ratios of the adequately
capitalized category and Fidelity's regulatory capital at December 31, 1993 as
compared to such ratios. As indicated in the table, Fidelity's capital levels
exceeded the three minimum capital ratios of the adequately capitalized
category.
CORE CAPITAL
CORE CAPITAL TO TO RISK- TOTAL CAPITAL
ADJUSTED TOTAL WEIGHTED TO RISK-
ASSETS ASSETS WEIGHTED ASSETS
--------------- --------------- ---------------
BALANCE % BALANCE % BALANCE %
---------- ---- ---------- ---- ---------- ----
(DOLLARS IN THOUSANDS)
Regulatory capital........ $ 182,100 4.15% $ 182,100 6.27% $ 270,600 9.32%
Adequately capitalized
requirement.............. 175,500 4.00 116,100 4.00 232,300 8.00
---------- ---- ---------- ---- ---------- ----
Excess capital............ $ 6,600 0.15% $ 66,000 2.27% $ 38,300 1.32%
========== ==== ========== ==== ========== ====
Adjusted Assets(1)........ $4,388,400 $2,903,600 $2,903,600
========== ========== ==========
- --------
(1) The term "adjusted assets" refers to the term "adjusted total assets" as
defined in 12 C.F.R. section 567.1(a) for purposes of core capital
requirements, and for purposes of risk-based capital requirements, refers
to the term "risk-weighted assets" as defined in 12 C.F.R. section
567.1(bb).
Although the Bank was deemed adequately capitalized at December 31, 1993, at
such date, absent the $28 million in capital contributed to the Bank by Citadel
during the year (see "Other Equity Transactions" below), the Bank would not
have met the 4% core capital to adjusted total assets requirement of the
adequately capitalized category and thus would have been classified as
undercapitalized for purposes of the OTS' prompt corrective action regulations.
The OTS' capital regulations, as required by the Financial Institutions
Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), include three separate
minimum capital requirements for the savings institution industry--a "tangible
capital requirement," a "leverage limit" and a "risk-based capital
requirement." These capital standards must be no less stringent than the
capital standards applicable to national banks. The OTS also has the authority,
after giving the affected institution notice and an opportunity to respond, to
establish individual minimum capital requirements ("IMCR") for a savings
institution which are higher than the industry minimum requirements, upon a
determination that an IMCR is necessary or appropriate in light of the
institution's particular circumstances, such as if the institution is expected
to have losses resulting in capital inadequacy, has a high degree of exposure
to credit risk, or has a high amount of nonperforming loans. The OTS has
proposed a regulation that would add to the list of circumstances in which an
IMCR may be appropriate for a savings association the following: a high degree
of exposure to concentration of credit risk or risks arising from
nontraditional activities, or failure to adequately monitor and control the
risks presented by concentration of credit and nontraditional activities.
F-32
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 14--STOCKHOLDERS' EQUITY--(CONTINUED)
The following table summarizes the regulatory capital requirements for
Fidelity under FIRREA at December 31, 1993, but does not reflect the required
future phasing out of certain assets, including investments in, and loans to,
subsidiaries which may presently be engaged in activities not permitted for
national banks and, for risk-based capital, real estate held for investment
(the impact of which the Bank believes to be immaterial), nor does the table
reflect the impact of certain proposed regulations. As indicated in the table,
Fidelity's capital levels exceed all three of the currently applicable minimum
capital requirements.
DECEMBER 31, 1993
----------------------------------------------------
CURRENT
TANGIBLE RISK-BASED
CAPITAL CORE CAPITAL CAPITAL
---------------- ---------------- ----------------
BALANCE % BALANCE % BALANCE %
---------- ---- ---------- ---- ---------- ----
(DOLLARS IN THOUSANDS)
Stockholder's Equity(1).. $ 182,300 $ 182,300 $ 182,300
Adjustments:
Intangible assets....... (2,100) -- --
Nonincludable
subsidiaries........... (200) (200) (200)
General valuation
allowances............. -- -- 36,700
Qualifying subordinated
notes.................. -- -- 59,200
Equity investments...... -- -- (7,400)
---------- ---------- ----------
Regulatory capital(2).... 180,000 4.10% 182,100 4.15% 270,600 9.32%
Required minimum......... 65,800 1.50 131,700 3.00 232,300 8.00
---------- ---- ---------- ---- ---------- ----
Excess capital........... $ 114,200 2.60% $ 50,400 1.15% $ 38,300 1.32%
========== ==== ========== ==== ========== ====
Adjusted assets(3)....... $4,386,300 $4,388,400 $2,903,600
========== ========== ==========
- --------
(1) Fidelity's total stockholder's equity, calculated in accordance with
generally accepted accounting principles, was 4.16% of its total assets at
December 31, 1993.
(2) At periodic intervals, both the OTS and the FDIC routinely examine the bank
as part of their legally prescribed oversight of the industry. Based on
their examinations, the regulators can direct that the Bank's financial
statements be adjusted in accordance with their findings.
(3) The term "adjusted assets" refers to the term "adjusted total assets" as
defined in 12 C.F.R. section 567.1(a) for purposes of tangible and core
capital requirements, and for purposes of risk-based capital requirements,
refers to the term "risk-weighted assets" as defined in 12 C.F.R. section
567.1(bb).
The Company is actively pursuing a restructuring plan that would include both
the transfer to a newly-formed Citadel subsidiary or division of certain
problem assets of the Bank and a sale of the Bank and Gateway (the
"Restructuring"; discussions of the sale of the Bank in the context of the
Restructuring include the sale of Gateway). The Company is currently seeking a
strategic buyer or a new core set of equity investors for the Bank. Any such
sale of the Bank will be subject to the approval of Citadel's Board of
Directors (the "Board") and stockholders as well as the OTS. Following the
proposed sale of the Bank, Citadel would become a real estate company and focus
on the servicing and enhancement of its loan and real estate portfolio. The
Restructuring calls for the Bank's disposition of substantially all of its
problem assets, together with a small amount of its performing assets, so as to
improve the attractiveness of the Bank to potential acquisition or investment
candidates. Most the Bank's problem assets would be transferred to the new
Citadel real estate subsidiary or division using securitized debt financing.
F-33
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 14--STOCKHOLDERS' EQUITY--(CONTINUED)
The Bank does not intend to implement the above-described bulk problem asset
dispositions in the absence of an acquisition of the Bank by another financial
institution or financial investors who are able to infuse additional core
capital into the Bank. Any such acquisition will also require the approval of
Citadel's Board and stockholders, as well as the OTS, which will condition its
approval in part on the adequacy of the capital of the Bank after the
Restructuring.
OTS Examinations
In January 1994, Citadel and the Bank received reports of the various
regular examinations conducted by the OTS in 1993. As a result of the findings
of the OTS in its safety and soundness examination of the Bank, Fidelity will
be subject to higher examination assessments and is subject to additional
regulatory restrictions including, but not limited to, (a) a prohibition,
absent prior OTS approval, on increases in total assets during any quarter in
excess of an amount equal to net interest credited on deposit liabilities
during the quarter; (b) a requirement that the Bank submit to the OTS for
prior review and approval the names of proposed new directors and executive
officers and proposed employment contracts with any director or senior
officer; (c) a requirement that the Bank submit to the OTS for prior review
and approval any third-party contract outside the normal course of business;
and (d) the OTS would have the ability, in its discretion, to require 30 days'
prior notice of all transactions between Fidelity and its affiliates
(including Citadel and Gateway).
The OTS also expressed concern in a number of specific areas principally
relating to asset quality and the resulting negative impact on capital levels
and earnings, as well as management effectiveness in certain areas. Management
believes that the proposed Restructuring of the Company discussed above, if
accomplished, will be responsive to most of the OTS' concerns.
Other Equity Transactions
In March 1993, the Company completed a rights offering in which
approximately $31.4 million of capital, net of expenses, was raised. Of that
amount, $18.0 million was contributed to the capital of Fidelity in the first
quarter of 1993 and an additional $10.0 million was contributed in the fourth
quarter of 1993. Also, in the fourth quarter of 1993, Gateway paid a $1.0
million dividend to Citadel.
In the third quarter of 1992, the Company retired its treasury stock of
179,700 shares. The carrying value of the stock of $6.1 million reduced the
common stock and paid-in capital accounts as reflected in the statement of
financial condition. The retirement of treasury stock did not affect the
Bank's regulatory capital.
The Bank paid a cash dividend of $1.0 million in the third quarter of 1992
to Citadel and during the fourth quarter of 1992, Fidelity paid a dividend in
kind to Citadel consisting of its equity ownership of its securities brokerage
subsidiary, Gateway. These dividends reduced Fidelity's capital by $2.1
million and had an immaterial effect on the Bank's tangible, core and risk-
based capital.
Stock Option Plans
Citadel has two qualified stock option plans under which options to purchase
shares of Citadel's common stock may be granted. Under the Key Employee Stock
Option Program (the "1982 Stock Option Plan"), all options available for grant
have been granted. Under the 1987 Stock Option and Stock Appreciation Rights
Plan (the "1987 Stock Option Plan"), options to purchase up to 175,000 shares
may be granted through April 22, 1997 and at December 31, 1993, there were
140,450 shares still available to grant. Options granted under both plans may
not have an exercise price less than the fair market value of the common stock
on the date of the grant, are exercisable in whole or in part, and expire no
later than the tenth anniversary of the date of grant.
F-34
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 14--STOCKHOLDERS' EQUITY--(CONTINUED)
A summary of the 1982 Stock Option Plan and the 1987 Stock Option Plan
activity follows:
1982 1987
STOCK OPTION STOCK OPTION
PLAN PLAN
---------------- ----------------
NUMBER AVERAGE NUMBER AVERAGE
OF OPTION OF OPTION
OPTIONS PRICE OPTIONS PRICE
------- ------- ------- -------
Balance, January 1, 1991................... 4,825 $58.00 30,100 $40.66
Expired................................... -- -- (3,800) 32.78
------ -------
Balance, December 31, 1991................. 4,825 58.00 26,300 41.80
Expired................................... (4,825) 58.00 (20,750) 44.21
------ -------
Balance, December 31, 1992................. -- -- 5,550 32.78
Granted................................... -- -- 20,000 21.90
------ -------
Balance, December 31, 1993................. -- -- 25,550 $24.26
====== =======
At December 31, 1993, all of the options outstanding under the 1987 Stock
Option Plan were fully exercisable.
NOTE 15--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER YEAR
-------- ------- ------- ------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
1993:
Interest income................. $ 78,187 $73,679 $69,187 $68,539 $289,592
Interest expense................ 49,397 46,748 43,767 48,479 188,391
Provision for estimated loan
losses......................... 7,500 14,500 19,500 23,600 65,100
Provision for estimated real
estate losses.................. 1,000 16,000 4,000 9,200 30,200
Gains (losses) on sales of
loans, net..................... 395 225 (34) (392) 194
Gains (losses) on sales of
mortgage-backed securities,
net............................ -- 1,543 917 (1,118) 1,342
Gains (losses) on sales of
investment securities, net..... -- 1,946 17 (2,017) (54)
Net earnings (loss)............. 135 (15,245) (14,725) (37,326) (67,161)
Net earnings (loss) per share... .04 (2.31) (2.23) (5.66) (11.56)
Market prices of common stock:
High........................... 23 7/8 21 7/8 18 5/8 19 1/2 23 7/8
Low............................ 16 12 5/8 14 1/4 9 3/8 9 3/8
1992:
Interest income................. $104,918 $96,838 $86,743 $82,223 $370,722
Interest expense................ 69,757 61,203 56,337 52,644 239,941
Provision for estimated loan
losses......................... 6,970 7,656 32,660 3,894 51,180
Provision for estimated real
estate losses.................. 2,030 2,344 6,340 7,106 17,820
Gains on sales of loans, net.... 353 284 403 77 1,117
Net earnings (loss)............. 6,055 4,472 (14,870) 6,389 2,046
Net earnings (loss) per share... 1.84 1.35 (4.51) 1.94 .62
Market prices of common stock:
High........................... 32 7/8 29 1/2 25 5/8 20 7/8 32 7/8
Low............................ 14 5/8 23 1/2 13 13 7/8 13
F-35
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 15--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)--(CONTINUED)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER YEAR
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
1991:(1)
Interest income................. $136,808 $133,934 $128,080 $121,302 $520,124
Interest expense................ 105,268 98,494 89,865 84,390 378,017
Provision for estimated loan
losses......................... 3,924 5,417 36,502 4,000 49,843
Provision for estimated real es-
tate losses.................... 2,076 583 3,903 2,000 8,562
Gains on sales of loans, net.... -- 114 256 1,748 2,118
Gains on sales of mortgage-
backed securities, net......... -- 1,008 -- 7,985 8,993
Gains on sales of investment se-
curities, net.................. -- 1 -- -- 1
Net earnings (loss)............. 4,421 7,093 (21,129) 12,278 2,663
Net earnings (loss) per share... 1.34 2.15 (6.41) 3.73 .81
Market prices of common stock:
High........................... 34 1/4 34 1/8 37 1/8 28 37 1/8
Low............................ 17 1/4 28 1/2 28 5/8 8 7/8 8 7/8
- --------
(1) The 1991 third quarter earnings originally reported had been reduced by
$11,593,000 due to the temporary Staff Accounting Bulletin ("SAB") No. 91
limitation of tax benefits on loan loss reserves. The restated third
quarter amounts reflect earnings which were increased by $11,593,000 in tax
benefits which were allowable under SFAS No. 109 and SFAS No. 96. No other
amounts were required to be restated. See Notes 1 and 12 to the
consolidated financial statements. The effect of the change on the third
quarter of 1991 is as follows:
QUARTER ENDED
SEPTEMBER 30, 1991
---------------------------
NET LOSS
NET LOSS PER SHARE
------------- ------------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNT)
As originally reported with SAB No. 91
limitation.................................... $ (32,722) $ (9.92)
Effect of reversal of SAB No. 91 limitation.... 11,593 3.51
------------- -----------
As restated.................................... $ (21,129) $ (6.41)
============= ===========
F-36
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 16--PARENT COMPANY CONDENSED FINANCIAL INFORMATION
This information should be read in conjunction with the other notes to the
consolidated financial statements.
CITADEL HOLDING CORPORATION
STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31,
-----------------
1993 1992
-------- --------
(DOLLARS IN
THOUSANDS)
ASSETS:
Cash........................................................ $ 2,284 $ 710
Investment in subsidiaries.................................. 182,966 221,427
Other assets................................................ 2,767 2,931
-------- --------
$188,017 $225,068
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Income tax liability....................................... $ 15 $ 590
Other liabilities.......................................... 599 1,292
-------- --------
614 1,882
Total stockholders' equity.................................. 187,403 223,186
-------- --------
$188,017 $225,068
======== ========
F-37
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 16--PARENT COMPANY CONDENSED FINANCIAL INFORMATION--(CONTINUED)
CITADEL HOLDING CORPORATION
STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
-------------------------
1993 1992 1991
--------- ------ --------
(DOLLARS IN THOUSANDS)
INCOME:
Dividends from subsidiaries......................... $ 1,000 $2,075 $ --
Subordinated notes interest income.................. -- 538 1,800
Other income........................................ 324 55 230
--------- ------ --------
1,324 2,668 2,030
EXPENSES:
Interest expense.................................... -- -- 752
Related party loan interest expense................. -- 408 709
Provision for estimated real estate losses.......... -- -- 1,025
Other expense....................................... 2,986 2,402 3,630
--------- ------ --------
2,986 2,810 6,116
--------- ------ --------
Earnings (loss) before income tax benefit............ (1,662) (142) (4,086)
Income tax benefit................................... (961) (845) (1,595)
--------- ------ --------
Net earnings (loss) before equity in undistributed
net earnings of subsidiaries........................ (701) 703 (2,491)
Equity in undistributed net earnings (loss) of
subsidiaries........................................ (66,460) 1,343 5,154
--------- ------ --------
Net earnings (loss).................................. $(67,161) $2,046 $ 2,663
========= ====== ========
F-38
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 16--PARENT COMPANY CONDENSED FINANCIAL INFORMATION--(CONTINUED)
CITADEL HOLDING CORPORATION
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
----------------------------
1993 1992 1991
-------- -------- --------
(DOLLARS IN THOUSANDS)
CASH FLOWS--OPERATING ACTIVITIES:
Net earnings (loss)............................. $(67,161) $ 2,046 $ 2,663
Reconciliation of net earnings (loss) to net
operating cash flows:
Provision for estimated losses................. -- 33 1,025
Losses on sales of securities.................. 16 -- --
Purchases of investment securities held for
sale.......................................... (35,001) -- --
Maturities of investment securities held for
sale.......................................... 21,844 -- --
Sale of investment securities held for sale.... 13,239 -- --
Interest receivable decrease................... -- 471 7
Other assets increase (decrease)............... 164 (1,032) (204)
Equity in net (earnings) loss of subsidiaries.. 65,460 (3,418) (5,154)
Deferred income taxes increase (decrease)...... 36 (816) 312
Interest payable (decrease).................... -- -- (4)
Other liabilities and deferred income increase
(decrease).................................... (1,303) 116 1,514
Other, net..................................... (98) -- (445)
-------- -------- --------
Operating cash flows, net..................... (2,804) (2,600) (286)
-------- -------- --------
CASH FLOWS--INVESTING ACTIVITIES:
Retirement of subordinated notes................ -- 15,000 --
Other, net...................................... -- 1,059 (1,891)
-------- -------- --------
Investing cash flows, net..................... -- 16,059 (1,891)
-------- -------- --------
CASH FLOWS--FINANCING ACTIVITIES:
Short-term borrowings decrease.................. -- -- (15,000)
Proceeds from (repayment of) related party loan. -- (15,000) 15,000
Proceeds from stock rights offering............. 31,378 -- --
Capital contributions to Fidelity............... (28,000) -- --
Dividends from subsidiaries..................... 1,000 1,000 --
-------- -------- --------
Financing cash flows, net...................... 4,378 (14,000) --
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents.................................. 1,574 (541) (2,177)
Cash and cash equivalents at beginning of
period........................................ 710 1,251 3,428
-------- -------- --------
Cash and cash equivalent at end of period...... $ 2,284 $ 710 $ 1,251
======== ======== ========
CASH FLOWS--SUPPLEMENTAL INFORMATION:
Cash paid during the period for:
Interest expense on borrowings................. $ -- $ 408 $ 1,465
Income taxes................................... 75 96 52
Dividend of Gateway from Fidelity............... -- 1,075 --
F-39
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 16--PARENT COMPANY CONDENSED FINANCIAL INFORMATION--(CONTINUED)
Citadel's Liquidity
Citadel has limited cash assets and no material cash producing operations or
assets other than its investment in Fidelity and in Gateway.
Because of Fidelity's current capital levels, dividends and distributions
from Fidelity will not be available to Citadel for the foreseeable future.
Thus, Citadel's current cash balances, together with potential future dividends
from Gateway, are the only sources of cash to Citadel. Management believes that
these cash resources will only be sufficient to meet Citadel expenditures
through mid-1994. Unless the Restructuring (see Note 14) is consummated at that
time, Citadel will be required to obtain additional cash to fund its
expenditures, and no assurances can be given that Citadel will be able to
obtain such funds.
NOTE 17--SUBSEQUENT EVENTS
Northridge Earthquake
In January 1994, the greater Los Angeles area was seriously affected by a
major earthquake and attendant aftershocks, centered in the San Fernando
Valley. Because the Bank's main operations are located near the most seriously
affected areas, and a substantial number of its customers are located in the
most seriously affected areas, management has initiated, but not completed,
efforts to evaluate the effect of the earthquake on the Bank's operations and
customers.
The Bank's portfolio includes loans and REO with a net book value of
approximately $937 million secured by or comprised of 1,414 multifamily (5
units or more), 15 commercial, and 2,313 single family and multifamily (2 to 4
units) collateral properties in the primary earthquake areas. After the
earthquake, the Bank's appraisers surveyed all of Fidelity's multifamily and
commercial properties located in these areas and identified 231 properties,
representing loans and REO with a net book value of $140 million, with more
than "cosmetic" damage. Of such 231 properties, 204 properties related to the
Bank's loans and REO with a net book value of $124 million were identified as
having "possible serious damage" and an additional 27 properties with a net
book value of $16 million were identified as "actually or potentially
condemned". The Bank commissioned structural and building engineers or building
inspectors to estimate the cost of repairs to properties in these two
categories. The cost of repairs has been preliminarily estimated to be $5.7
million and $11.1 million, respectively. Of this total $16.8 million,
approximately $6.0 million of seismic damage exceeds the principal balance on
the collateral properties' respective loans. Accordingly, the Bank currently
would not expect its losses due to the earthquake to exceed $10.8 million with
respect to its commercial and multifamily properties. The Bank expects the
actual losses payable by the Bank to be lower because many repair costs may be
borne by the borrowers, who in addition to their own funds, may have access to
government assistance and/or earthquake insurance proceeds. As part of its
normal internal asset review process, the Bank will adjust its reserves as its
losses become quantifiable.
In addition to the multifamily and commercial assets referenced above, the
Bank has identified 2,313 single family and multifamily (2 to 4 units) assets
in the affected areas. 173 borrowers with unpaid principal balances totaling
$29.4 million called in to report damages through February 8, 1994. The Bank
has commenced inspection of these properties and continues to assess damages
and potential earnings and loss impact with respect to these properties.
The earthquake will also have some adverse affect on loan originations and
the sale of financial services in the retail branch network in the near term.
In addition, physical damage was sustained at some of
F-40
CITADEL HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE YEARS ENDED DECEMBER 31, 1993
NOTE 17--SUBSEQUENT EVENTS--(CONTINUED)
the Bank administrative and branch office facilities located in the Los Angeles
area, however, only one Bank-owned building in the San Fernando Valley region
of Los Angeles sustained major damage. It is estimated that necessary repairs
to all affected facilities, net of anticipated insurance reimbursement, shall
not exceed $0.5 million. Other potential financial impacts of the earthquake
include additional personnel costs, property inspection costs, and others.
Based upon the information gathered to date, the total estimated cost to the
Company for these items is not expected to be material.
Pending Litigation
On March 4, 1994, The Chase Manhattan Bank, N.A. ("Chase"), one of four
lenders under Fidelity's $60 million subordinated loan agreement of 1990 (the
"Subordinated Loan Agreement"), sued Fidelity, Citadel and Citadel's Chairman
of the Board, alleging, among other things, that the transfer of assets
pursuant to the Restructuring would constitute a breach of the Subordinated
Loan Agreement, and seeking to enjoin the Restructuring and to recover damages
in unspecified amounts. In addition, the lawsuit alleges that past responses of
Citadel and Fidelity to requests by Chase for information regarding the
Restructuring violate certain provisions of the Subordinated Loan Agreement and
that such alleged violations, with the passage of time, have become current
defaults under the Subordinated Loan Agreement. While the other three lenders
under the Subordinated Loan Agreement hold $25 million of the subordinated
notes (the "Notes"), none of them has joined Chase in this lawsuit. The Company
is evaluating the lawsuit and, based on its current assessment, the Company
does not believe that the allegations have merit. The impact of this lawsuit on
the capital position of the Bank, cross default provisions under the Bank's
other debt agreements and the guarantee by Citadel is uncertain. See Notes 10
and 14.
F-41
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by this reference is the information set forth in the
sections entitled "ELECTION OF DIRECTORS" and "MANAGEMENT" contained in the
Company's Proxy Statement for its 1994 Annual Meeting of Stockholders (the
"1994 Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by this reference is the information set forth in the
section entitled "EXECUTIVE COMPENSATION" contained in the 1994 Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by this reference is the information set forth in the
sections entitled "ELECTION OF DIRECTORS" and '"PRINCIPAL HOLDERS OF CITADEL
COMMON STOCK" contained in the 1994 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by this reference is the information set forth in the
section entitled "RELATED PARTY TRANSACTIONS" contained in the 1994 Proxy
Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS
DESCRIPTION PAGE NO.
----------- --------
Independent Auditors' Report........................................ F-1
Consolidated Statements of Financial Condition at December 31, 1993
and 1992........................................................... F-2
Consolidated Statements of Operations for Each of the Three Years in
the Period Ended December 31, 1993................................. F-3
Consolidated Statements of Stockholders' Equity for Each of the
Three Years in the Period Ended December 31, 1993.................. F-4
Consolidated Statements of Cash Flows for Each of the Three Years in
the Period Ended December 31, 1993................................. F-5
Notes to Consolidated Financial Statements for Each of the Three
Years in the Period Ended December 31, 1993........................ F-7
(A)(2) FINANCIAL STATEMENT SCHEDULES
All schedules are omitted as the required information is inapplicable or the
information is presented in the consolidated financial statements or related
notes.
(B) REPORTS ON FORM 8-K
The Company filed a Report on Form 8-K on January 11, 1994 reporting on
Item 5. "Other Events."
II-1
(C) EXHIBITS
3.1 Certificate of Amendment of Restated Certificate of Incorporation of the
Company (filed as Exhibit 3.1(a) to the Company's Form 10-K for the year
ended December 31, 1988, and incorporated herein by reference).
3.2 Restated By-laws of the Company (filed as Exhibit 3.2 to the Company's
Form 10-K for the year ended December 31, 1988, and incorporated herein
by reference).
4.1 Indenture dated as of March 1, 1985, between Fidelity and First
Interstate Bank of California, as trustee (filed as Exhibit 4 to the
Company's Form 10-K for the year ended December 31, 1984, and
incorporated herein by reference).
4.2 The Company agrees to provide the Securities and Exchange Commission,
upon request, copies of instruments defining the rights of holders of
long-term debt of the Company and all of its subsidiaries for which
consolidated or unconsolidated financial statements are required to be
filed with the Commission.
10.1 Fidelity Federal Savings and Loan Association Key Employee Stock Option
Program (filed as Exhibit A to the Company's Registration Statement on
Form S-8 (No. 2-96207) filed on March 4, 1985, and incorporated herein
by reference).
10.2 Loan Agreement between Fidelity and Royal Shore Associates Limited
Partnership, dated February 17, 1984 (filed as Exhibit 10.10 to the
Company's Form 10-K for the year ended December 31, 1984, and
incorporated herein by reference).
10.3 Agreement, dated August 2, 1984, between Fidelity and Marine Midland
Bank, N.A. (filed as Exhibit 10.13 to the Company's Form 10-K for the
year ended December 31, 1984, and incorporated herein by reference).
10.4 Indemnity Agreement, dated August 13, 1987, between the Company and the
Directors and Officers of the Company (filed as Exhibit 10.15 to the
Company's Form 10-K for the year ended December 31, 1987, and
incorporated herein by reference).
10.5 Indemnity Agreement dated August 26, 1987 between Fidelity and the
Directors and Officers of Fidelity (filed as Exhibit 10.16 to the
Company's Form 10-K for the year ended December 31, 1987, and
incorporated herein by reference).
10.6 Citadel Holding Corporation 1987 Stock Option and Stock Appreciation
Rights Plan (filed as Exhibit A to the Company's definitive Proxy
Statement dated May 29, 1987, and incorporated herein by reference).
10.7 Form of Incentive Stock Option Agreement (filed as Exhibit 10.18 to the
Company's Form 10-K for the year ended December 31, 1987, and
incorporated herein by reference).
10.8 Form of Indemnity agreement approved June 27, 1990, between Citadel and
directors and certain officers of Citadel terminating and replacing that
certain Indemnity Agreement dated August 22, 1987 (filed as Exhibit
10.15 to the Company's Form 10-K for the year ended December 31, 1987,
and incorporated herein by reference).
10.9 Form of Indemnity Agreement approved June 27, 1990, between Fidelity and
directors and certain officers of Fidelity terminating and replacing
that certain Indemnity Agreement dated August 22, 1987 (filed as Exhibit
10.16 to the Company's Form 10-K for the year ended December 31, 1987,
and incorporated herein by reference.
10.10 Loan agreement dated as of May 15, 1990, between Fidelity, the Company
and certain lenders as defined in said Loan Agreement regarding the
issuance by Fidelity of $60 million of Fidelity's 11.68% subordinated
notes (filed as Exhibit 10.24 to the Company's Form 10-K for the year
ended December 31, 1990, and incorporated herein by reference).
II-2
10.11 Letter agreement dated May 1, 1991 summarizing the terms and conditions
of employment between Philip R. Sherringham and Fidelity (filed as
Exhibit 10.18 to the Company's Form 10-K for the year ended December 31,
1991, and incorporated herein by reference).
10.12 Letter agreement dated as of June 29, 1992 with Walter H. Morris, Jr.
with respect to employment (filed as Exhibit 10.12 to the Company's Form
10-K for the year ended December 31, 1992, and incorporated herein by
reference).
10.13 Consulting Agreement with Scott A. Braly dated as of August 3, 1992, and
amendments thereto dated as of August 26, 1992 and November 30, 1992
(filed as Exhibit 10.13 to the Company's Form 10-K for the year ended
December 31, 1992, and incorporated herein by reference).
10.14 Form of Severance Agreement and related Guaranty Agreement to be entered
into with Kirk S. Sellman, Walter H. Morris, Jr., Godfrey B. Evans, and
other company executives (filed as Exhibit 10.14 to the Company's Form
10-K for the year ended December 31, 1992, and incorporated herein by
reference).
10.15 Executive Employment Agreement dated as of June 2, 1992 between Richard
M. Greenwood and Fidelity and Amendment No. 1 thereto dated March 24,
1993 (filed as Exhibit 10.15 to the Company's Form 10-K for the year
ended December 31, 1992, and incorporated herein by reference).
10.16 Letter agreement of employment and guaranty dated as of June 2, 1992
between Richard M. Greenwood and Citadel Holding Corporation and
Amendment No. 1 thereto dated January 24, 1993 (filed as Exhibit 10.16
to the Company's Form 10-K for the year ended December 31, 1992, and
incorporated herein by reference).
10.17 Dealer agreement, Letter of Credit Reimbursement Agreement and
Depository Agreement dated as of July 31, 1992 relating to the
commercial paper of Fidelity (filed as Exhibit 10.17 to the Company's
Form 10-K for the year ended December 31, 1992, and incorporated herein
by reference).
10.18 Data Processing Agreement by and between Systematics Financial Services,
Inc. and Fidelity dated May 1, 1993, with exhibits and First Amendment
thereto (filed herewith).
10.19 Letter agreement dated January 4, 1994 summarizing the terms and
conditions of employment between James E. Stutz and Fidelity (filed
herewith).
10.20 Letter agreement dated December 14, 1993 summarizing the terms and
conditions of employment between Steve Wesson and Citadel (filed
herewith).
22 Subsidiaries of the Company (filed herewith).
27 Financial Data Schedule (filed herewith).
II-3
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
Citadel Holding Corporation
By /s/ James J. Cotter
___________________________________
James J. Cotter
Chairman of the Board
Date: March 30, 1994
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF REGISTRANT
AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ James J. Cotter Director, Chairman of the March 30, 1994
- ------------------------------------ Board, Citadel Holding
James J. Cotter Corporation
/s/ Richard M. Greenwood President and Chief March 30, 1994
- ------------------------------------ Executive Officer, Citadel
Richard M. Greenwood Holding Corporation;
Chairman of the Board,
President and Chief
Executive Officer, Fidelity
Federal Bank
/s/ Donald R. Boulanger Director March 30, 1994
- ------------------------------------
Donald R. Boulanger
/s/ Peter W. Geiger Director March 30, 1994
- ------------------------------------
Peter W. Geiger
/s/ Mel Goldsmith Director March 30, 1994
- ------------------------------------
Mel Goldsmith
/s/ Zelbie Trogden Director March 30, 1994
- ------------------------------------
Zelbie Trogden
/s/ S. Craig Tompkins Director March 30, 1994
- ------------------------------------
S. Craig Tompkins
/s/ Alfred Villasenor, Jr. Director March 30, 1994
- ------------------------------------
Alfred Villasenor, Jr.
/s/ Andre S.W. Shih Treasurer, March 30, 1994
- ------------------------------------ Senior Vice President--
Andre S.W. Shih Acting Chief Financial
Officer (Principal
Financial Officer)
/s/ Heidi Wulfe Senior Vice President-- March 30, 1994
- ------------------------------------ Controller and Chief
Heidi Wulfe Accounting Officer
(Principal Accounting
Officer)
II-4