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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended DECEMBER 31, 1997
OR
[ ] Transition Report Pursuant to Section 13 or 15 (d) of
the Securities Exchange Act of 1934
For the Transition Period from _______ to _______
Commission File Number: 0-24526
--------------------------------
COASTAL BANCORP, INC.
---------------------
(Exact name of Registrant as specified in its charter)
Texas 76-0428727
--------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5718 Westheimer, Suite 600
Houston, Texas 77057
------------------------
(Address of principal executive office)
(713) 435-5000
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(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
N/A N/A
Securities registered pursuant to section 12(g) of the Act:
Common Stock, $0.01 par value per share
---------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months 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. [ ]
As of March 13, 1998, the aggregate market value of the 3,989,317 shares of
Common Stock of the Registrant issued and outstanding on such date, excluding
1,045,718 shares held by all directors and executive officers of the Registrant
as a group, was $131,647,461. This figure is based on the closing sale price of
$33.00 per share of the Company's Common Stock on March 13, 1998, as reported in
The Wall Street Journal on March 16, 1998.
- --------------------------
Number of shares of Common Stock outstanding as of March 13, 1998: 5,035,035
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents incorporated by reference and the
Part of Form 10-K into which the document is incorporated:
(1) Portions of the Registrant's Annual Report to Stockholders for the
fiscal year ended December 31, 1997, are incorporated into Part II, Items 5-8 of
this Form 10-K.
(2) Portions of the Registrant's definitive Proxy Statement for its 1998
Annual Meeting of Stockholders are incorporated into Part III, Items 10-13 of
this Form 10-K.
PART I.
ITEM 1. BUSINESS
- ------------------
COASTAL BANCORP, INC.
Coastal Bancorp, Inc. (the "Company") is engaged primarily in the business
of serving as the ultimate holding company for Coastal Banc ssb (the "Bank").
The Company was incorporated in March 1994 in connection with the
reorganization of Coastal Banc Savings Association (the "Association") into the
holding company form of organization. The reorganization occurred in July 1994.
In addition, in July 1994, the Association converted to a Texas-chartered
savings bank operating under the name Coastal Banc ssb. On November 30, 1996,
Coastal Banc Holding Company, Inc. ("HoCo") was created as a Delaware unitary
savings bank holding company in accordance with the terms of an agreement and
plan of reorganization dated August 19, 1996 (the "Agreement"). Pursuant to the
terms of the Agreement, the Bank became a wholly-owned subsidiary of HoCo and
HoCo became a wholly-owned subsidiary of the Company. The reorganizations were
treated as combinations similar to a pooling of interests. Accordingly, the
financial information and references presented herein have been restated to give
effect where appropriate, as if the reorganizations had occurred at the earliest
date presented.
In October 1997, Coastal Banc Capital Corp. ("CBCC") was formed as a
wholly-owned subsidiary of HoCo. CBCC, a registered broker-dealer, was
initially formed to trade secured and unsecured whole loan assets primarily for
the Bank and for other businesses. At December 31, 1997, HoCo's equity
investment in CBCC was $76,000. CBCC had a net loss of $24,000 for the year
ended December 31, 1997.
On June 30, 1995, the Company issued $50.0 million of 10.0% Senior Notes
due June 30, 2002 (the "Senior Notes"). The Senior Notes are redeemable at the
Company's option, in whole or in part, on or after June 30, 2000, at par, plus
accrued interest to the redemption date. Of the proceeds received from the
issuance of the Senior Notes, $44.9 million was used to purchase 11.13%
Noncumulative Preferred Stock, Series B, of the Bank (the "Series B Preferred
Stock") which is now owned by HoCo.
At December 31, 1997, the Company had total consolidated assets of $2.9
billion, total deposits of $1.4 billion, $28.8 million in Series A Preferred
Stock and stockholders' equity of $104.8 million.
The Company is subject to examination and regulation by the Office of
Thrift Supervision (the "OTS") and the Company and the Bank are subject to
examination and regulation by the Texas Savings and Loan Department (the
"Department"). The Company is also subject to various reporting and other
requirements of the Securities and Exchange Commission (the "SEC").
The Company's executive offices are located at Coastal Banc Plaza, 5718
Westheimer, Suite 600, Houston, Texas 77057, and its telephone number is (713)
435-5000.
COASTAL BANC SSB
The Bank is a Texas-chartered, Federally insured state savings bank. It is
headquartered in Houston, Texas and operates through 37 branch offices in
metropolitan Houston, Austin, Corpus Christi and small cities in the south east
quadrant of Texas.
The Bank was originally acquired by an investor group (which includes a
majority of the Board of Directors and the present Chairman of the Board,
President and Chief Executive Officer of the Company) in 1986 as a vehicle to
take advantage of the failures and consolidation in the Texas banking and thrift
industries. The Bank has acquired deposits and branch offices in transactions
with the Federal government and other private institutions, in addition to
acquiring an independent national bank in 1995, as a base for the Bank's ongoing
savings bank business and shift towards commercial banking. At February 28,
1986 (the date of change in ownership), the Bank had one full service office and
total assets of approximately $10.7 million. Accordingly, although originally
organized in 1954, the Bank in its current form effectively commenced operations
with the 1986 change in control. By December 31, 1997, the Bank's total assets
had increased to $2.9 billion, total deposits were $1.4 billion and
stockholders' equity totaled $174.2 million.
The Bank attempts to maximize profitability through the generation of net
interest income and fee income. To meet this objective, the Bank has
implemented a strategy of building its core deposit base while deploying its
funds in assets which provide an attractive return with relatively low credit
risk. In carrying out this strategy and to ultimately provide a respectable
return to the Company's shareholders, the Bank adheres to four operating
principles: (i) continuing to expand its low cost core deposit base; (ii)
minimizing interest rate risk; (iii) minimizing credit risk; and (iv)
maintaining a low level of general overhead expense relative to its peers.
These operating principles are briefly discussed below.
CORE DEPOSITS. The Bank has implemented the first operating principle,
developing and expanding a core deposit base, beginning in 1988 through a series
of transactions with the Federal government and private sector financial
institutions, gaining in the process entry into additional markets in Houston,
Austin, Corpus Christi, San Antonio and south Texas.
In 1988, the Bank became the first acquiror of failed or failing savings
institutions under the Federal government's "Southwest Plan." In this
transaction (the "Southwest Plan Acquisition"), the Bank acquired from the
Federal Savings and Loan Insurance Corporation ("FSLIC"), as receiver for four
insolvent savings associations (the "Acquired Associations"), approximately
$543.4 million of assets and assumed approximately $543.4 million of deposits
and other liabilities. The Bank acquired an aggregate of 14 branch offices from
the Acquired Associations in new and existing markets in southwest Houston, west
of Houston along the Houston-San Antonio corridor and in the Rio Grande Valley.
See "The Southwest Plan Acquisition."
Since completion of the Southwest Plan Acquisition, the Bank has entered
into six branch office acquisitions and one whole bank acquisition: two with an
instrumentality of the Federal government (acting as the receiver of insolvent
financial institutions) and five with other private institutions. In each, the
Bank generally agreed to acquire certain assets in consideration of the
assumption of certain deposit and other liabilities with respect to each
institution. In addition, in 1996 the Bank chose to exit two Texas cities, San
Antonio and San Angelo. The Bank sold its San Angelo branch and exchanged its
three San Antonio branches for one branch in Bay City, Texas.
In the first branch acquisition, completed in 1990, the Bank assumed
deposits of $151.1 million in connection with the acquisition of nine branch
offices, which are primarily located in the northwestern Houston metropolitan
area. The acquisition provided the Bank with further penetration in the Houston
market. In the second branch acquisition, completed in 1991, the Bank assumed
deposits of $71.4 million in connection with the acquisition of an office
located in Victoria, Texas. The acquisition of that office expanded the Bank's
presence in the small cities market southwest of Houston toward Port Lavaca. In
the third branch acquisition, completed in 1993, the Bank assumed deposits of
$386.4 million in connection with the acquisition of nine branches located in
Corpus Christi, San Antonio, Conroe, Brenham and Sealy. The Corpus Christi and
San Antonio branch acquisitions allowed the Bank to enter new markets. In the
fourth branch acquisition, also completed in 1993, the Bank assumed deposits of
$45.7 million and acquired two branches located in Harlingen and McAllen, two
small cities southwest of Houston in the Rio Grande Valley (the "Valley"). As a
result of this acquisition, the Bank increased its presence in the Valley. In
the fifth branch acquisition, which was completed in December 1994, the Bank
assumed deposits of $150.2 million and acquired eight branches located in San
Angelo, Marble Falls, Kingsland, Llano, Giddings, Buchanan Dam, Mason and
Burnet, which allowed the Bank to enter new markets in central Texas.
In 1995, the Bank continued to expand its market presence by opening two de
novo branches in the Houston metropolitan area and by completing its first whole
bank acquisition. On November 1, 1995, the Bank consummated the acquisition of
all of the outstanding capital stock of Texas Capital Bancshares, Inc. ("Texas
Capital"). As a result of the acquisition of Texas Capital, Texas Capital Bank,
N.A., a national banking association, with five branch offices, located in
Houston, Katy, Richmond and Austin and total assets of $170.7 million, was
merged with and into the Bank.
In 1996, the Bank consummated the sale of its San Angelo location which had
$14.9 million in deposits and was acquired in the Bank's December 1994 branch
acquisition. In connection with this sale, the Bank recorded a $521,000 gain
before applicable income taxes. On September 5, 1996, the Bank consummated the
exchange of its three San Antonio branches having deposits of $53.8 million for
a branch in Bay City, Texas having deposits of $79.8 million. In 1997, the Bank
completed the acquisition of a branch in Port Arthur, Texas having deposits of
$54.6 million.
All of these transactions resulted in the net assumption of $1.6 billion of
deposits and the acquisition of 46 branch offices (after the San Angelo branch
sale and the swap of the San Antonio branches). The Bank has also opened six de
novo branches since inception. Since its first acquisition, the Bank has been
able to achieve operating economies and improve efficiency by closing an
aggregate of 16 branch offices and transferring the deposits to other offices
located in the same market areas.
The Bank will continue to pursue acquisitions as vehicles for growth,
although there can be no assurance that the Bank will be able to continue to
grow through acquisitions in the future. In the absence of any available,
cost-effective acquisitions, management will continue to focus on internally
generated earnings growth including the further development of the Bank's
commercial lending and growth of commercial business deposits.
INTEREST RATE RISK. The Bank has implemented the second operating
principle, minimizing interest rate risk, by matching, to the extent possible,
the repricing or maturity of its interest-earning assets to its interest-earning
liabilities as well as the basis or index (for example, the London Interbank
Offered Rate ("LIBOR") or the 11th District Federal Home Loan Bank cost of funds
index ("COFI")) upon which these assets and liabilities reprice. Generally this
is achieved through management of the composition of its assets and liabilities.
The Bank also attempts to achieve an acceptable interest rate spread between
interest-earning assets and interest-bearing liabilities by altering the Bank's
cost of funds, or, at times, the yield on certain assets in its portfolio. To
accomplish this, the Bank has purchased interest rate swaps and caps. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Asset and Liability Management" set forth in Item 7 hereof.
The Bank will originate and purchase for retention in its portfolio only
those loans and investments which provide a positive interest rate spread over
funding liabilities matched with similar maturities. Consistent with this
philosophy, a significant portion of the Bank's assets have been invested in
adjustable-rate high quality mortgage-backed securities. At December 31, 1997,
of the Bank's $1.5 billion of mortgage-backed securities, $1.3 billion or 85.9%,
were invested in adjustable rate mortgage-backed securities. To a lesser
extent, the Bank has purchased first lien mortgages on single-family residences,
a large portion of which are adjustable rate mortgages. At December 31, 1997,
$519.8 million, or 41.2% of the Bank's loans receivable portfolio was comprised
of adjustable rate single-family residential mortgage loans.
The Bank also originates and purchases fixed and adjustable rate long-term,
single-family residential loans primarily for sale into the secondary market.
Prior to 1996, this and certain other lending functions were performed for the
Bank by its wholly-owned mortgage banking subsidiary, CBS Mortgage Corp. ("CBS
Mortgage"). Beginning in 1996, the origination function was performed by the
Bank. By originating such loans for sale and generally obtaining a commitment
for the purchase of such loans at the time that the loan applications are
approved, the Bank avoids a significant portion of the interest rate risk
associated with holding fixed-rate mortgage loans.
CREDIT RISK. The Bank has implemented the third operating principle,
minimizing credit risk, by (i) investing a substantial portion of its assets in
cash and mortgage-backed securities, and (ii) taking a cautious approach to the
development of its direct lending operations, including commercial business
lending. At December 31, 1997, of the Company's $2.9 billion in total assets,
$1.5 billion or 52.0% of total assets consisted of mortgage-backed securities
and $37.1 million or 1.3% of total assets consisted of cash and cash
equivalents. At December 31, 1997, the Company's total net loans receivable
portfolio amounted to $1.3 billion or 43.3% of total assets comprised primarily
of $688.6 million of first lien residential mortgage loans, $178.3 million of
commercial real estate loans and $130.3 million of multifamily mortgage loans,
which constituted 54.6%, 14.1% and 10.3%, respectively, of the net loans
receivable portfolio. The balance of the net loans receivable portfolio, by
dollar amount and percent of the portfolio, was comprised of the following:
$98.4 million (or 7.8%) of commercial loans to residential mortgage originators
("Warehouse loans"), $46.2 million (or 3.7%) of residential construction loans,
$23.4 million (or 1.9%) of consumer and other loans, $23.2 million (or 1.8%) of
real estate acquisition and development loans, $32.5 million (or 2.6%) of loans
secured by mortgage servicing rights ("MSR loans"), $29.7 million (or 2.4%) of
commercial, financial and industrial loans and $10.8 million (or 0.8%) of
commercial construction loans. The Company's non-accrual loans as of such date
were $17.4 million or 1.38% of total loans receivable, and the Company's total
nonperforming assets were $20.5 million, or 0.71% of total assets. See "Lending
Activities-General."
NONINTEREST EXPENSE. The Bank has implemented the fourth operating
principle, maintaining a low level of general overhead expense relative to its
peers, by operating an efficiently staffed branch office system which is able to
administer and deliver its products and services in an economical manner. The
Bank believes that it has significant operating leverage, and that continued
incremental growth will not cause its overhead expenses to increase by a
corresponding amount. The growth achieved from the Bank's acquisitions has
facilitated reduced overhead levels as a proportion of assets and a lower cost
of funds from a more meaningful market share of core deposits. The Company's
ratio of noninterest expense to average total assets on a consolidated basis has
decreased, from 2.71% for the year ended December 31, 1988 to 1.36% for the year
ended December 31, 1997.
On September 30, 1996, the Bank recorded the one-time SAIF insurance
special assessment (the "Special Assessment") of $7.5 million ($4.8 million
after applicable income taxes) as a result of the Federal Deposit Insurance Act,
as amended (the "FDIA") being signed into law. The Special Assessment pursuant
to the FDIA was equal to 65.7 basis points on the SAIF assessment base of
deposits existing as of March 31, 1995. Other provisions of the Act provided
for a reduction of the SAIF deposit insurance premium rates beginning in the
fourth quarter of 1996.
The Bank is subject to regulation by the Department, as its chartering
authority and by the FDIC, which regulates the Bank and insures its deposits to
the fullest extent provided by law. The Bank also is subject to certain
regulation by the Board of Governors of the Federal Reserve System (the "Federal
Reserve Board") and is a member of the Federal Home Loan Bank of Dallas (the
"FHLB"), one of the 12 regional banks which comprise the Federal Home Loan Bank
System.
LENDING ACTIVITIES
GENERAL. The Bank has taken a cautious approach to the development and
growth of its direct lending operations in order to minimize credit risk. In
order to avoid incurring undue credit risk, the Bank historically invested a
significant percentage of its assets in alternative financial instruments,
particularly mortgage-backed securities, most of which have certain repayments
guaranteed by the government or Government Sponsored Enterprises ("GSEs"). See
"Mortgage-Backed Securities." The Bank will originate and purchase for
retention in its portfolio only those loans determined by management to have an
acceptable credit risk and which provide a positive interest rate spread over
funding liabilities matched with similar maturities. This strategy is designed
to achieve an acceptable risk adjusted rate of return, as determined and
continuously evaluated by the Board of Directors.
In November 1995, the Bank completed the acquisition of Texas Capital and
its $103.3 million in loans. The loans acquired from Texas Capital included
first lien residential, multifamily, commercial real estate, residential
construction, real estate acquisition and development, commercial, financial and
industrial and consumer loans. Utilizing this acquisition as a springboard, the
Bank implemented its strategic shift towards building a commercial banking
business, which has continued through 1997. The Bank's new concept for
originating, underwriting and approving all loans over $1.0 million was
implemented during the fourth quarter of 1997. The Portfolio Control Center
("PCC") applies Internet and network computer technology to take a loan from
application to closing in less time and incorporating more comprehensive credit
information. The PCC is also responsible for the day-to-day monitoring and
management of the Bank's assets and liabilities.
The following table sets forth information concerning the composition of
the Bank's net loans receivable portfolio by type of loan at the dates
indicated.
At December 31,
1997 1996 1995
------------ ------------ -----------
Amount Percent Amount Percent Amount Percent
------------ -------- ------------ -------- ----------- --------
(Dollars in thousands)
Real-estate mortgage loans:
First lien residential $ 689,767 52.33% $ 791,337 61.96% $ 742,880 66.38%
Multifamily 131,454 9.97 139,486 10.92 95,297 8.52
Residential construction 83,359 6.33 77,146 6.04 33,935 3.03
Acquisition and development 31,619 2.40 26,132 2.05 15,517 1.39
Commercial 181,315 13.76 119,004 9.32 122,622 10.96
Commercial construction 14,506 1.10 3,963 0.31 -- --
Commercial, warehouse 98,679 7.49 53,573 4.19 48,822 4.36
Commercial, MSR 32,685 2.48 21,380 1.67 21,548 1.93
Commercial, financial and industrial 30,877 2.34 21,965 1.72 19,860 1.77
Loans secured by savings deposits 8,695 0.66 8,849 0.69 8,292 0.74
Consumer and other 15,030 1.14 14,400 1.13 10,316 0.92
------------ -------- ------------ -------- ----------- --------
Total loans 1,317,986 100.00% 1,277,235 100.00% 1,119,089 100.00%
------------ ======== ------------ ======== ----------- ========
Loans in process (47,893) (38,742) (11,526)
Premium (discount) to record
purchased loans, net 1,680 479 (1,366)
Unearned interest and loan fees (2,926) (2,344) (1,939)
Allowance for loan losses (7,412) (6,880) (5,703)
----------- ----------- -----------
Total loans receivable, net $ 1,261,435 $ 1,229,748 $1,098,555
============ ============ ===========
SCHEDULED MATURITIES. The following table sets forth certain
information at December 31, 1997 regarding the principal amount of loans
maturing in the Bank's loans receivable portfolio based on their contractual
terms to maturity. Demand loans, loans having no stated schedule of repayments
and no stated maturity are reported as due in one year or less. First lien
residential mortgage, multifamily mortgage and commercial real estate loans are
based on their contractual terms to maturity assuming no periodic amortization
of principal.
AT DECEMBER 31, 1997
More than More than More than
One year one year to three years five years to
or less three years to five years ten years
--------- ------------ -------------- --------------
(In thousands)
First lien residential mortgage $ 2,408 $ 5,366 $ 9,790 $ 28,934
Multifamily mortgage 73,997 49,975 6,286 1,196
Residential construction 37,124 8,678 352 597
Real estate acquisition and
development 5,645 18,142 -- --
Commercial real estate 19,464 76,874 38,091 12,659
Commercial construction 8,345 -- 483 819
Commercial, other 122,000 17,928 20,439 1,873
Consumer and other 10,785 5,814 5,036 1,096
--------- ------------ -------------- --------------
Total loans $ 279,768 $ 182,777 $ 80,477 $ 47,174
========= ============ ============== ==============
AT DECEMBER 31, 1997
More than Over
ten years to twenty
twenty years years Total
------------- --------- ----------
(In thousands)
First lien residential mortgage $ 157,838 $485,431 $ 689,767
Multifamily mortgage -- -- 131,454
Residential construction -- -- 46,751
Real estate acquisition and
development -- -- 23,787
Commercial real estate 34,228 -- 181,316
Commercial construction 1,406 -- 11,053
Commercial, other -- -- 162,240
Consumer and other 994 -- 23,725
------------- -------- -----------
Total loans $ 194,466 $485,431 $1,270,093
============= ======== ===========
The average maturity of loans is generally substantially less than their
average contractual terms because of prepayments and, in the case of
conventional mortgage loans, due-on-sale clauses, which generally give the Bank
the right to declare a loan immediately due and payable in the event, among
other things, that the borrower sells the real property subject to the mortgage
and the loan is not repaid. The average life of mortgage loans tends to
increase when current mortgage loan rates are substantially higher than rates on
existing mortgage loans and, conversely, decrease when rates on existing
mortgages are substantially lower than current mortgage loan rates (due to
refinancings or adjustable-rate and fixed-rate loans at lower rates). Under the
latter circumstances, the weighted average yield on loans decreases as higher
yielding loans are repaid or refinanced at lower rates.
The following table sets forth the amounts of loans due after one year from
December 31, 1997 by category and which have fixed or adjustable rates.
Interest-Rate
Fixed Adjustable Total
--------- ----------- --------
(In thousands)
First lien residential mortgage $ 167,357 $ 520,002 $687,359
Multifamily mortgage 9,972 47,485 57,457
Residential construction 7,238 2,389 9,627
Real estate acquisition and development -- 18,142 18,142
Commercial real estate 57,089 104,763 161,852
Commercial construction 1,246 1,462 2,708
Commercial, other 13,077 27,163 40,240
Consumer and other 11,575 1,365 12,940
--------- ----------- --------
Total $ 267,554 $ 722,771 $990,325
========= =========== ========
ORIGINATION, PURCHASE AND SALE OF LOANS. The following table sets forth
the loan origination, purchase and sale activity of the Bank during the periods
indicated. The table does not reflect the activity of CBS Mortgage for other
institutions, GSEs or entities during the periods presented. See "Mortgage
Banking Activities."
Year Ended December 31,
1997 1996 1995
----------- ----------- -----------
(In thousands)
First lien mortgage loan originations:
Adjustable rate $ 1,458 $ 3,542 $ 985
Fixed rate 4,849 5,471 746
Adjustable rate by correspondent lenders 26,220 67,461 92,911
Fixed rate by correspondent lenders 686 4,058 --
Residential construction and acquisition
and development loan originations 145,727 154,182 61,713
Warehouse loan originations 1,174,639 887,252 549,628
MSR loan originations 55,259 69,172 67,578
Multifamily loan originations 81,148 67,657 42,366
Commercial real estate loan originations 171,497 41,170 29,595
Commercial construction originations 12,222 3,806 --
Commercial, financial and industrial loan originations 43,497 30,080 5,100
Consumer loan originations 18,679 22,256 12,429
----------- ----------- -----------
Total loan originations 1,735,881 1,356,107 863,051
Purchase of residential mortgage loans 108,226 115,928 298,613
Loans acquired (net) in connection with
acquisition and disposition transactions -- 1,018 103,319
Purchase of multifamily and commercial
real estate loans -- 4,604 25,045
Purchase of consumer loans 70 -- --
----------- ----------- -----------
Total loan originations and purchases 1,844,177 1,477,657 1,290,028
----------- ----------- -----------
Foreclosures 4,226 4,363 3,394
Principal repayments and reductions to
principal balance 1,790,790 1,339,691 776,084
Residential loans sold 12,855 -- 679
----------- ----------- -----------
Total foreclosures, repayments and sales of loans 1,807,871 1,344,054 780,157
----------- ----------- -----------
Amortization of premiums, discounts and fees on loans (2,819) (485) 3,316
Provision for loan losses (1,800) (1,925) (1,664)
----------- ----------- -----------
Net increase in loans receivable $ 31,687 $ 131,193 $ 511,523
=========== =========== ===========
The following table sets forth the number of bulk loan purchases and the
amount of first lien residential mortgage loans acquired by the Bank through
bulk purchases for the periods indicated.
Year Ended December 31,
1997 1996 1995
-------- -------- --------
(Dollars in thousands)
Amount purchased $107,881 $112,395 $296,452
Number of bulk
loan purchases 3 9 24
Personnel from the Bank generally analyze loan bid packages, as they
become available, and the PCC reviews the information in the loan packages to
determine whether to bid (or make an offer) on a package and the price of such
bid (or offer). The pricing with respect to such loan packages is based on a
number of factors, including the ability to create spread income with a funding
source of comparable maturity, the pricing of alternative investments,
particularly mortgage-backed securities, which offer little or no credit risk,
and the credit risk profile of the portfolio offered. The Bank analyzes credit
risk in a whole loan package through its due diligence investigation, which is
designed to provide management with basic underwriting information on each loan
or group of loans, including loan-to-value, payment history, insurance and other
documentation. Because the Bank is purchasing loans in bulk, the Bank prices the
loan packages that it bids on to take into consideration, among other things,
delinquency and foreclosure assumptions based on the risk characteristics of the
loan packages. The Bank intends to continue to make competitive bids on loan
portfolios that meet the Bank's purchase criteria.
Beginning in 1994, the Bank has been originating adjustable rate
residential mortgage loans through correspondent lenders. The correspondents
originate and immediately sell such loans to the Bank. All such loans are
underwritten in accordance with the Bank's policies and procedures. During 1997
(before discontinuing this program), loans purchased from the correspondent
lenders totaled $26.9 million.
The Bank will directly sell mortgage loans and mortgage loan servicing from
time to time in order to replace the loans and servicing with instruments which
have higher credit quality and which generate less interest rate risk. In 1997,
the Bank sold $12.9 million of first lien residential mortgage loans.
While the Bank has the general authority to originate and purchase loans
secured by real estate located anywhere in the United States, the largest
concentration of its residential first lien mortgage and construction loan
portfolios is secured by realty located in Texas.
RESIDENTIAL CONSTRUCTION LENDING. The Bank initiated a construction
lending program with local builders in the latter part of 1989 which has grown
considerably since its inception. At the time of initiation of the program,
management of the Bank surveyed the members of the residential construction
industry in the Bank's Houston market area and targeted those companies which
management believed, based upon its market research, to be financially strong
and reputable. Loans are made primarily to fund residential construction.
Construction loans are made on pre-sold and speculative residential homes only
in well located, viable subdivisions and planned unit developments.
The builders with whom the Bank does business generally apply for either a
non-binding short-term line of credit or for an annual line of credit (subject
to covenants) from the Bank for a maximum amount of borrowing to be outstanding
at any one time. Upon approval of the line of credit, the Bank issues a letter
which indicates to the builder the maximum amount which will be available under
the line, the term of the line of credit (which is generally 90 days to one
year), the interest rate of the loans to be offered under the line (which is
generally set at a rate above the Wall Street Journal prime rate or LIBOR on the
outstanding monthly loan balance) and the loan fees payable. When the builder
desires to draw upon a short-term line of credit, it must make a separate loan
application under the line for a specific loan amount. Each loan commitment
under a short-term line of credit is separately underwritten and approved after
the builder's master file is updated and reviewed. The Bank also funds
construction loans outstanding to builders or individuals under individual
construction loans.
The terms of the Bank's construction loans are generally for nine months or
less, unless extended by the Bank. If a construction loan is extended, the
borrower is generally charged a loan fee for each 90 day extension period. The
Bank reserves the right to extend any loan term, but generally does not permit
the original term and all extensions to exceed 24 months without amortization of
principal either in monthly increments or a lump sum.
The loan-to-value ratio (applied to the underlying property that
collateralizes the loan) of any residential construction loan may not exceed 85%
or 100% of the actual cost. All individual loans are limited in dollar amount
based upon the project proposed by the builder. Draws for lot purchases are
generally limited to the contracted sales price of the lot (to include
escalations) not to exceed 100% of the lot's appraised value. Other special
conditions which the Bank attaches to its construction loans include a
requirement that limits the number and dollar amount of loans which may be made
based upon unsold inventory. The Bank may also, in its sole discretion,
discontinue making any further loans if the builder's unsold inventory exceeds a
certain level from all lending sources or if the builder fails to pay its
suppliers or subcontractors in a timely manner.
The Bank provides construction financing for homes that generally are
priced below $450,000, with most homes priced between $70,000 and $175,000. In
this price range, the Bank has experienced the shortest duration of term, the
highest annualized yield and the least likelihood of defaults because of the
generally high number of pre-completion sales. The Bank will also make
individual construction loans to builders or individuals on single homes or a
panel of homes on substantially the same terms and conditions as loans granted
under the Bank's line of credit program.
At December 31, 1997, the Bank had $46.8 million in outstanding residential
construction loans (net of loans in process). Of the construction loans
outstanding at December 31, 1997, $38.7 million were to 22 builders originated
under the Bank's line of credit program and $8.1 million were to builders or
individuals under individual construction loans. At the present time, the Bank
has approved builders in the Houston, Dallas, and Austin metropolitan areas and
is selectively soliciting new builders for its residential construction lending
program. The Bank intends to continue to do business with the companies
involved in its line of credit program and believes that it will continue to
have construction loan demand from the builders with whom it currently has an
established lending relationship. The Bank does not otherwise actively solicit
construction loans directly or through the mass media.
Construction financing is generally considered to involve a higher degree
of risk than long-term financing on improved, occupied residential real estate,
due to the lender's reliance on the borrower to add to the estimated value of
the property through construction within the budget set forth in the loan
application. The Bank attempts to limit its risk exposure by, among other
things: limiting the number of borrowers to whom it lends and establishing
specific qualification requirements for borrowers generally; continually
monitoring the general economic conditions in the market, recent housing starts
and sales; continually monitoring the financial position of its borrowers
throughout the term of the loan through periodic builder reports and inquiries
to the builder's suppliers and subcontractors; continually monitoring the
progress of the development through site inspections prior to loan
disbursements; utilizing only qualified, approved appraisers; and requiring that
the builder maintain a pre-approved ratio (generally not greater than 50%) of
speculative to pre-sold homes in the development.
MULTIFAMILY MORTGAGE AND COMMERCIAL REAL ESTATE LENDING. The Bank
initiated a program in 1993 to actively seek loans secured by multifamily or
commercial properties (primarily retail shopping centers). Multifamily mortgage
and commercial real estate loans typically involve higher principal amounts and
repayment of the loans generally is dependent, in large part, on sufficient cash
flow being generated by the underlying properties to cover operating expenses
and loan repayments. Market values may vary as a result of economic events or
governmental regulations which are outside the control of the borrower or lender
and which can affect the future cash flow of the properties. The loans are for
a short to medium term of between one to seven years, and have floating rates or
fixed rates based on a spread over similarly fixed borrowings from the FHLB.
The properties securing the loans originated by the Bank are generally located
in Texas. The Bank attempts to limit its risk exposure by, among other things:
lending to proven developers/owners, generally only considering properties with
existing operating performance which can be analyzed, requiring conservative
debt coverage ratios, and continually monitoring the operation and physical
condition of the collateral. At December 31, 1997, multifamily mortgage loans
totaling $131.5 million and commercial real estate loans of $181.3 million were
outstanding. The decision to increase commercial real estate lending resulted
primarily from the improvement in the local economies throughout Texas, which
was reflected in improved occupancy in retail centers together with an
improvement in the quality of the borrowers seeking such loans. At December 31,
1997, the Bank had outstanding commercial real estate loans totaling
approximately $322,000 that were on non-accrual status, $14,000 of which were
acquired from Texas Capital.
The Bank began seeking multifamily and commercial real estate construction
loans in 1996. The Bank will generally underwrite these loans in the same way
it currently underwrites its multifamily mortgage loans and will attempt to
manage the risk of such loans by requiring that the builders provide more equity
in the project than is required in refinancings, lending to those builders with
strong financial statements and requiring that borrowers purchase, if required
by the movement of general market interest rates, interest rate caps for their
loans. At December 31, 1997, commercial construction loans totaling $14.5
million were outstanding, of which $900,000 was on non-accrual status.
WAREHOUSE LENDING. Since 1992, the Bank has provided or participates in
lines of credit to mortgage companies generally for their origination of single
family residential loans which are normally sold no more than 90 days from
origination to the Federal National Mortgage Association (the "FNMA"), Federal
Home Loan Mortgage Corporation ("FHLMC"), Government National Mortgage
Association ("GNMA") or to private investors. The lines of credit are generally
renewable annually. Borrowers pay interest on funds drawn at a floating rate.
In addition, the Bank usually receives a fee for each loan file processed. The
Bank holds the original mortgage loan notes and other documentation as
collateral until repayment of the related lines of credit, except when a third
party bank is acting as the lead bank in the lending relationship.
Warehouse loans are underwritten in accordance with Bank policies and
procedures. Interested loan originators who contact or are contacted by the
Bank are asked to prepare a loan application which seeks detailed information on
the originator's business. After evaluating the application and independently
verifying the applicant's credit history, if the originator appears to be a
likely candidate for approval, Bank personnel will visit the originator and
review, among other things, its business organization, management, quality
control, funding sources, risk management, loan volume and historical
delinquency rate, financial condition, contingent obligations and regulatory
compliance. The originator pays a fee for this review to offset a portion of
the Bank's expense; this amount is deducted from the origination fee if the line
of credit is approved. If the originator meets the established criteria, its
application is submitted for approval.
Bank personnel attempt to minimize the risk of making Warehouse loans by,
among other things, (i) taking physical possession of the originator's
collateral, (ii) directly receiving payment from secondary market investors when
the loans are sold and remitting any balance to the borrower after deducting the
amount borrowed for that particular loan, (iii) visiting the originator's office
from time to time to review its financial and other records and (iv) monitoring
each originator: (a) by periodically reviewing each originator's financial
statements, loan production delinquency and commitment reports; and, (b) on an
annual basis, by reviewing the originator's audited financial statements and the
auditor's letter to the originator's board of directors.
During 1997, the Bank originated $1.2 billion of Warehouse loans and had
such loans outstanding of $98.7 million at December 31, 1997.
MSR LENDING. Since 1992, the Bank has loaned funds to mortgage companies
for their purchase of mortgage servicing rights or to finance the mortgage
companies' ongoing operations to originate and retain mortgage servicing. The
mortgage companies receive fees for servicing mortgage loans which include
collecting and remitting loan payments to FNMA, FHLMC and other investors. Loans
of this nature generally have terms of one to five years, and are generally
limited to 70.0% of the price paid by the mortgage company for servicing rights,
or of the value of the originated servicing rights (subject to the regulatory
maximum for loans to one borrower). MSR loans are made at adjustable rates of
interest tied to LIBOR or the Bank's borrowing rate plus a spread and a
commitment fee. MSR loans are collateralized by purchased or originated
mortgage servicing rights to the remaining cash flows after remittance of
payments to FNMA, FHLMC or other investors on the servicing portfolio. Bank
personnel closely monitor MSR borrowers on a semi-annual basis by, among other
things, reviewing the borrower's financial condition and operations in the same
manner as they do for Warehouse loans and by examining the value of the
borrower's MSR portfolio (through evaluation of the estimated future net cash
flows from the servicing rights) in order to ensure that the loan-to-value ratio
does not exceed 75.0% during the life of the loan. If the continuing
loan-to-value ratio exceeds that amount, the borrower is asked to repay a
portion of the principal balance to maintain the ratio limit. At December 31,
1997, the Bank had $32.7 million in outstanding MSR loans.
REAL ESTATE ACQUISITION AND DEVELOPMENT LENDING. The Bank has increased
the number of loans originated to residential real estate builders and
developers for the acquisition and/or development of vacant land. The proceeds
of the loans are generally used to acquire the land and make the site
improvements necessary to develop the land into saleable lots. The Bank
generally lends only to the major developers with good track records and strong
financial capacity and on property where substantially all of the lots to be
developed are pre-sold. The term of the loans have generally been from 18 to 24
months at a spread over the prime rate, plus an origination fee. Repayment on
the loans is generally made as the lots are sold to builders. Land acquisition
and development loans involve additional risks when compared to loans on
existing residential properties. These loans typically involve relatively large
loan balances to single borrowers, and the repayment experience is dependent
upon the successful development of the land and the resale of the lots. These
risks can be significantly impacted by supply and demand conditions and the
general economic conditions in the local market area. At December 31, 1997, the
Bank had $31.6 million of real estate acquisition and development loans
outstanding.
COMMERCIAL BUSINESS LENDING. Development of a commercial business lending
program is a strategic goal of Bank management. The Texas Capital acquisition
provided the Bank with an established commercial business lending program to
small and medium sized companies primarily in the Houston and Austin
metropolitan areas. In 1997, management continued to develop the infrastructure
for commercial business lending in most of the Bank's major markets. The
commercial, financial and industrial loans ("Commercial Business loans") are
generally made to provide working capital financing or purchase financing to
businesses and are generally secured by the borrower's working capital assets
(i.e. accounts receivable, inventory, etc.) or assets purchased by the borrower
(i.e. operating assets, equipment, etc.). Commercial Business loans generally
have shorter terms (one to five years) at a spread over prime rate and are of
greater risk than real estate secured loans because of the type and nature of
the collateral. In addition, Commercial Business loan collections are more
dependent on the continuing financial stability of the borrower. The Bank
intends to continue to expand the acquired commercial business lending program,
while managing the associated credit risk by monitoring borrowers' financial
position and underlying collateral securing the loans. At December 31, 1997,
Commercial Business loans outstanding totaled $30.9 million, of which $485,000
($336,000 acquired from Texas Capital) was on non-accrual status.
CONSUMER LENDING. The Bank makes available traditional consumer loans,
such as home improvement, new and used car financing, new and used boat and
recreational vehicle financing and loans secured by savings deposits. The
interest rate on loans secured by savings deposits is typically set at a rate
above that paid on the underlying account and adjusts if the rate on the account
changes. At December 31, 1997, the Bank had $23.7 million in consumer loans
outstanding, of which $8.7 million were savings deposit secured loans. At
December 31, 1997, loans totaling $53,000 in this category were on non-accrual
status.
Consumer loans (other than savings deposit secured loans) generally have
shorter terms and higher interest rates than mortgage loans but usually involve
greater credit risk than mortgage loans because of the type and nature of the
collateral. In addition, consumer lending collections are dependent on the
borrower's continuing financial stability, and are thus likely to be adversely
affected by job loss, marital status, illness and personal bankruptcy. In many
cases, repossessed collateral for a defaulted consumer loan will not provide an
adequate source of repayment of the outstanding loan balance because of
depreciation of the underlying collateral. The Bank believes that the generally
higher yields earned on consumer loans compensate for the increased credit risk
associated with such loans and that consumer loans are important to its efforts
to serve the credit needs of the communities that it serves.
The Bank's consumer loan lending territory approximates the markets served
by its retail branches. Persons desiring consumer loans are typically
individuals who have a pre-existing banking relationship with the Bank.
ASSET QUALITY. The Bank, like all financial institutions, is exposed to
certain credit risks related to the value of the collateral which secures loans
held in its portfolio and the ability of borrowers to repay their loans during
the term thereof. Management of the Bank closely monitors the loan portfolio
and the Bank's real estate acquired as a result of foreclosure ("REO") for
potential problems on a weekly basis and reports to the Board of Directors on a
monthly basis. When a borrower fails to make a required loan payment or other
weaknesses are detected in a borrower's financial condition, the Bank attempts
to determine an appropriate course of action by contacting the borrower.
Delinquencies are cured promptly in most cases. If the delinquency on a
mortgage loan exceeds 90 days and is not cured through the Bank's normal
collection procedures, or an acceptable arrangement is not worked out with the
borrower, the Bank will institute measures to remedy the default, including
commencing a foreclosure action. As a matter of policy, the Bank generally does
not accept from the mortgagor a voluntary deed of the secured property in lieu
of foreclosure. If foreclosure is effected, the property is sold at a public
auction in which the Bank may participate as a bidder. If the Bank is the
successful bidder, the foreclosed real estate is then included in the Bank's REO
portfolio until it is sold.
Upon acquisition, REO is recorded at the lower of unpaid principal balance
adjusted for any remaining acquisition premiums or discounts less any applicable
valuation allowance or estimated fair value, based on an appraisal, less
estimated selling costs. All costs incurred from the date of acquisition
forward relating to maintaining the property are recorded as a current expense.
It is the Bank's general policy not to recognize interest income on loans
past due 90 days or more. When a loan is placed on non-accrual status,
previously accrued but unpaid interest is reversed against current interest
income. On a loan-by-loan basis, Bank management may continue to accrue
interest on loans that are past due more than 90 days, primarily if management
believes that the individual loan is in the process of collection and the
interest is fully collectible. At December 31, 1997, 1996 and 1995, the Bank
had the following loans which were 90 days or more delinquent and were on
accrual status:
At December 31,
1997 1996 1995
----- ------- -----
(Dollars in thousands)
First lien single family mortgage $ -- $ 106 $ --
Residential construction 79 52 --
Commercial real estate 91 881 --
Commercial, financial and industrial 120 14 231
Consumer 50 142 --
----- ------- -----
Total $ 340 $ 1,195 $ 231
===== ======= =====
The following table sets forth information regarding the Bank's non-accrual
loans and REO as of the dates shown.
At December 31,
--------------------------------------
1997 1996 1995
----------- ----------- -----------
(Dollars in thousands)
Non-accrual loans:
First lien single family
mortgage $ 15,591 $12,238 $12,925
Residential construction -- -- 353
Commercial real estate 322 32 965
Commercial construction 900 -- --
Commercial, financial and
industrial 485 496 337
Consumer 53 73 42
---------- -------- --------
Total non-accrual loans 17,351 12,839 14,622
Total REO and repossessed assets 3,198 3,161 4,216
---------- -------- --------
Total nonperforming assets $ 20,549 $16,000 $18,838
========== ======== ========
Ratio of nonperforming
assets to total assets 0.71% 0.56% 0.68%
========== ======== ========
Ratio of non-accrual loans to total
loans receivable 1.38% 1.04% 1.33%
========== ======== ========
At December 31, 1997, approximately $925,000 in additional interest income
would have been recorded in the year then ended on the above loans accounted for
on a non-accrual basis if such loans had been current in accordance with their
original terms and had been outstanding throughout the period or since
origination if held for part of the period. For the year ended December 31,
1997, $827,000 in interest income was included in net income for these same
loans prior to the time they were placed on non-accrual status.
At December 31, 1997, the Bank had 236 first lien residential mortgage
loans in non-accrual status, aggregating $15.6 million, with an average balance
of approximately $66,000. A total of 211 of these loans, with an aggregate
balance of $12.9 million, were acquired through bulk loan purchases, 2 of these
loans, with an aggregate balance of $29,000, were acquired through the Southwest
Plan Acquisition and 2 of these loans, with an aggregate balance of $113,000,
were acquired in the Texas Capital acquisition. Of the 211 residential mortgage
loans acquired through bulk purchases, at December 31, 1997, 32 of such loans
totaling $1.3 million were being serviced by other institutions, which
constituted 3.8% of the $35.6 million of aggregate loans serviced by others.
At December 31, 1997, nonperforming assets included REO with an aggregate
book value of $3.2 million and repossessed assets of $12,000. At such date, the
Bank's REO consisted of 36 single family residential properties and 5 commercial
properties (acquired from Texas Capital).
At December 31, 1997, in addition to the loans in non-accrual status, the
Bank had $9.8 million in loans classified as substandard, $42,000 classified as
doubtful and $10.7 million of loans designated as "special mention" for
regulatory purposes. Of these loans, $1.1 million of the substandard loans and
$282,000 of the "special mention" loans were acquired from Texas Capital. Loans
designated as "special mention" are not currently required to be classified for
regulatory purposes but have potential weaknesses or risk characteristics that
could result in future problems.
On January 1, 1995, the Bank adopted the Financial Accounting Standards
Board's (the "FASB") Statement of Financial Accounting Standards No. 114
(Statement 114), "Accounting by Creditors for Impairment of a Loan," as amended
by Statement 118. Under Statement 114, a loan is impaired when it is "probable"
that a creditor will be unable to collect all amounts due (i.e., both principal
and interest) according to the contractual terms of the loan agreement.
Statement 114 requires that the measurement of impaired loans be based on (i)
the present value of the expected future cash flows discounted at the loan's
effective interest rate, (ii) the loan's observable market price, or (iii) the
fair value of the loan's collateral. Statement 114 does not apply to large
groups of smaller balance homogeneous loans that are collectively evaluated for
impairment. The Bank collectively reviews all first-lien residential loans
under $500,000 as a group and all consumer and other loans as a group for
impairment, excluding loans for which foreclosure is probable. The adoption of
Statement 114, as amended by Statement 118, had no material impact on the Bank's
consolidated financial statements as the Bank's existing policy of measuring
loan impairment was generally consistent with methods prescribed in these
standards.
The Bank considers a loan to be impaired when, based upon current
information and events, it is probable that the Bank will be unable to collect
all amounts due according to the contractual terms of the loan agreement. In
determining impairment, the Bank considers, among other things, large
non-homogeneous loans which may include nonaccrual loans or troubled debt
restructurings, and performing loans which exhibit, among other characteristics,
high loan-to-value ratios, low debt coverage ratios, or indications that the
borrowers are experiencing increased levels of financial difficulty. The Bank
bases the measurements of collateral-dependent impaired loans on the fair value
of their collateral. The amount by which the recorded investment in the loan
exceeds the measure of the fair value of the collateral securing the loan is
recognized by recording a valuation allowance. At December 31, 1997, the
carrying value of loans that are considered to be impaired under Statement 114
totaled approximately $2.0 million (all of which were on non-accrual) and the
related allowance for loan losses on those impaired loans totaled $1.1 million.
The average balance of impaired loans during the year ended December 31, 1997
was approximately $897,000. For the year ended December 31, 1997, the Bank did
not recognize interest income on loans considered impaired.
The Bank had loaned $83.4 million at December 31, 1997, under its
residential construction lending program to multiple borrowers who are engaged
in similar activities. These borrowers could be similarly impacted by economic
conditions in Texas. See "Residential Construction Lending." Except for
concentrations in its Warehouse lending lines, the Bank had no other loan
concentrations. At December 31, 1997, the Bank had $98.7 million of Warehouse
loans outstanding. See "Warehouse Lending."
ALLOWANCE FOR LOAN LOSSES. The Bank maintains loan loss allowances to
absorb future losses that may be realized on its loans receivable portfolio.
The following table summarizes activity in the Bank's allowance for loan losses
during the periods indicated.
Year Ended December 31,
----------------------------
1997 1996 1995
-------- -------- --------
(Dollars in thousands)
Balance at beginning of year $ 6,880 $ 5,703 $ 2,158
Charge-offs(1) (1,416) (851) (404)
Recoveries 148 103 17
Provisions for loan losses 1,800 1,925 1,664
Acquisition allowance adjustment(2) -- -- 2,268
-------- -------- --------
Balance at end of the year $ 7,412 $ 6,880 $ 5,703
======== ======== ========
Ratio of net charge-offs during the
period to average net loans
outstanding during the period 0.10% 0.06% 0.05%
======== ======== ========
(1)In 1997, $591,000 of the charge-offs were attributable to single family
residential loans, $472,000 to Commercial Business loans, $349,000 to consumer
and other loans and $4,000 to commercial real estate loans. In 1996, $651,000
of the charge-offs were attributable to single family residential loans,
$142,000 to consumer and other loans and $58,000 to Commercial Business loans.
In 1995, $359,000 of the charge-offs were attributable to single family
residential loans and $45,000 to consumer and other loans.
(2)The acquisition allowance adjustment in 1995 represents the amount allocated
to the allowance for loan losses during the year in connection with (i) a bulk
loan package acquired and (ii) the loans acquired in the Texas Capital
acquisition.
The following table sets forth the allocation of the allowance for loan
losses by type of loan outstanding at the dates indicated.
At December 31,
1997 1996 1995
------- ------- -------
(In thousands)
First lien residential mortgage $ 2,566 $ 2,217 $ 2,992
Multifamily mortgage 511 369 249
Residential construction 251 223 307
Real estate acquisition and development 316 261 130
Commercial real estate 1,468 1,151 1,072
Commercial construction 203 20 --
Commercial, Warehouse and MSR 494 361 230
Commercial, financial and industrial 1,008 985 395
Consumer and other 233 374 177
Unallocated 362 919 151
------- ------- -------
$ 7,412 $ 6,880 $ 5,703
======= ======= =======
The following table sets forth the allocation of the provision (reduction
of allowance)
for loan losses by loan type during the periods indicated.
At December 31,
1997 1996 1995
-------- -------- --------
(In thousands)
First lien residential mortgage $ 908 $ (180) $ 1,032
Multifamily mortgage 142 120 23
Residential construction 28 (84) (67)
Real estate acquisition and development 55 131 (25)
Commercial real estate 321 79 479
Commercial construction 183 20 --
Commercial, Warehouse and MSR 133 131 132
Commercial, financial and industrial 416 618 --
Consumer and other 171 322 90
Unallocated (557) 768 --
-------- -------- --------
$ 1,800 $ 1,925 $ 1,664
======== ======== ========
Provisions for loan losses, currently $450,000 per quarter, are charged to
earnings to bring the total allowance to a level deemed appropriate by
management based on such factors as historical experience, the volume and type
of lending conducted by the Bank, the amount of nonperforming assets, industry
standards, regulatory policies, generally accepted accounting principles,
general economic conditions, particularly as they relate to the Bank's lending
area, and other factors related to the collectibility of the Bank's loan
portfolio.
The Bank periodically reviews its loan loss allowance policy, at a minimum,
annually. As a result of a comprehensive revision of such policy in 1996, the
Bank changed its method of assessing the adequacy of the allowance for loan
losses. The revised policy provides that the Bank will annually establish a
monthly provision amount to be added to the allowance for loan losses and the
resultant allowance will be "tested" monthly for adequacy based on the
allocation methodology described below. The policy provides that any "excess"
based on this calculation will be maintained in the allowance for loan losses as
"unallocated". The minimum allowance allocation to first lien residential
mortgage loans greater than 90 days delinquent is a general allocation of 5% of
the aggregate net book value. All other first lien residential mortgage loans
are allocated a general allowance of 0.10% of the aggregate net book value. The
Bank generally allocates the allowance to multifamily, residential construction,
commercial construction, real estate acquisition and development, commercial
real estate, Warehouse, MSR, Commercial Business and consumer and other loans in
the following percentages of outstanding principal amounts: 0.25%, 0.25%,
0.50%, 1.0%, 0.50%, 0.25%, 0.50%, 1.0% and 1.0%. In addition, a general
allowance allocation is calculated on unfunded commitments and letters of credit
using the general allowance percentages described above for the applicable loan
type. Specific allowances are established by management on specific loans as
considered necessary.
The Bank's management believes that its present allowance for loan losses
is adequate based upon, among other considerations, the factors discussed above,
its low level of nonperforming loans and its historical loss experience.
Management continues to review its loan portfolio to determine whether its loan
loss allowance policy should be altered in light of current conditions and to
make any additional provisions which may be deemed necessary. While management
uses the best information available to make such determinations, additional
provisions for loan losses may be required to be established in the future
should economic or other conditions change substantially. In addition, the FDIC
and the Department, as an integral part of their examination processes,
periodically review the Bank's loan loss allowances. These agencies may require
the Bank to establish additional loan loss allowances, based on their respective
judgments of the information available at the time of the examinations.
MORTGAGE BANKING ACTIVITIES
LOAN ORIGINATIONS AND SALES. Through 1995, the Bank's wholly-owned
subsidiary, CBS Mortgage, originated loans for the Bank and for others secured
by first lien mortgages on completed single family residences located
principally in the Houston metropolitan area and in geographic areas surrounding
the Bank's branch locations. Beginning on January 1, 1996, the origination
function was performed by the Bank, with CBS Mortgage's activities then limited
to primarily loan servicing. The Bank's present policy is to originate or
purchase and then sell to third party investors fixed rate residential mortgage
loans principally to avoid the interest rate and credit risk associated with
holding fixed rate mortgage loans in portfolio. During the years ended 1997,
1996 and 1995, the Bank (in 1997 and 1996) and CBS Mortgage (in 1995) originated
or purchased with the intent to sell $4.1 million, $11.2 million and $8.8
million, respectively, of single family residential mortgage loans and sold $4.4
million, $11.7 million and $8.3 million, respectively, of such loans to
secondary market investors ("SMI"). During 1997, 1996 and 1995, the Bank (in
1997 and 1996) and CBS Mortgage (in 1995) originated residential real estate
loans for portfolio totaling $6.3 million, $9.0 million, and $1.7 million,
respectively.
"Pipeline risk," which is inherent in mortgage lending operations, arises
when the originator of a loan makes an uncovered commitment to lend funds to a
borrower at a locked-in rate of interest over the period of time which is
required for the lender to close and/or sell the loan. The risk is that market
rates of interest will move higher in the period between the time of commitment
and the time of funding the loan, and the lender will thereafter have difficulty
finding a buyer for such loan at a break-even or better price. Management of the
Bank and of CBS Mortgage believe that its loan origination strategy eliminates
to a large extent any "pipeline risk." The majority of applications taken are
accepted on the basis that rates will be set immediately prior to closing.
Applications that carry a locked-in rate are covered for interest rate risk by
the use of the forward sales of mortgage-backed securities or by registering
each loan with an investor that offers loan-by-loan protection until closing and
delivery to the investor.
Through 1995, CBS Mortgage made available a variety of mortgage products
designed to respond to consumer needs and competitive factors. Beginning on
January 1, 1996, with the transfer of the origination function, these mortgage
products were being made available from the Bank, although not actively
solicited. Conventional conforming loans that are secured by first liens on
completed residential real estate are generally originated for amounts up to 95%
of the appraised value or selling price of the mortgaged property, whichever is
less. All loans with loan-to-value ratios in excess of 80% generally require the
borrower to purchase private mortgage insurance from approved third party
insurers. Conventional non-conforming mortgage loans (i.e., loans for single
family homes with an original balance in excess of the maximum loan balance
amount set by FNMA or FHLMC, which is presently $227,150, or loans that do not
otherwise meet the criteria established by FNMA or FHLMC) are also originated.
Such loans are originated based on underwriting guidelines or standards required
by the SMI to whom such loans are intended to be sold. During 1997, fewer than
10% of the mortgage loans originated by the Bank were non-conforming mortgage
loans.
In addition to 15-year and 30-year conventional mortgages, CBS Mortgage
offered and now the Bank offers, special products designed to provide to its
customers lower rates of interest or lower principal and interest payments.
Borrowers may choose from a wide variety of combinations of interest rates and
points on many products so that its customers may elect to pay higher points at
closing and lower interest over the life of the loan, or pay a higher interest
rate and reduce the points payable at closing. In addition, from time to time
mortgages are offered in the following categories: those which allow the
borrower to make lower monthly payments for the first one, two or three years of
the loan; fixed rate mortgages; and adjustable rate mortgages having interest
rate adjustments every one, five or seven years based upon a specified
independent index.
Borrower demand for adjustable rate mortgage loans compared to fixed rate
mortgage loans is a function of interest rate levels, consumer expectations for
changes in interest rate levels and the difference between interest rates and
loan fees offered for fixed rate mortgage loans and for adjustable rate mortgage
loans. The Bank's and CBS Mortgage's loan origination volume has been subject
to some minor seasonal variations, with the heaviest demand in the late spring
and summer months. Loan demand is also affected by the general interest rate
environment and, to a large measure, by the general state of the local economy.
During times of relatively lower market interest rates, demand by previous
borrowers for refinancings increases. Refinancings are not solicited by CBS
Mortgage or the Bank. However, if a request for a refinancing is received,
borrowers are offered current mortgage loan products. Refinancings are processed
in a manner identical to original originations and are charged the same fees as
charged for original originations.
LOAN SERVICING. CBS Mortgage services residential real estate loans owned
by the Bank as well as for others, including FNMA, FHLMC and other private
mortgage investors. Loan servicing includes collecting and remitting loan
payments, accounting for principal and interest, making advances to cover
delinquent payments, making inspections as required of mortgaged premises,
contacting delinquent mortgagors, supervising foreclosures and property
dispositions in the event of unremedied defaults and generally administering the
loans. Funds that have been escrowed by borrowers for the payment of mortgage
related expenses, such as property taxes and hazard and mortgage insurance
premiums, are maintained in non-interest-bearing accounts at the Bank. At
December 31, 1997, the Bank had $6.2 million deposited in such escrow accounts.
CBS Mortgage receives fees for servicing mortgage loans, which generally
range from 0.250% to 0.375% per annum on the declining principal balance of
fixed rate mortgage loans and from 0.375% to 0.500% per annum on the declining
principal balance of adjustable rate mortgage loans. Such fees serve to
compensate CBS Mortgage for the costs of performing the servicing function.
Other sources of loan servicing revenues include late charges and other
ancillary fees. For the years ended 1997, 1996 and 1995, the Bank earned $1.4
million, $1.6 million and $2.0 million, respectively, in conjunction with CBS
Mortgage's loan servicing. Servicing fees are collected by CBS Mortgage out of
the monthly mortgage payments made by borrowers and are net of the amortization
of mortgage servicing rights.
CBS Mortgage's servicing portfolio is subject to reduction by normal
amortization, by prepayment or by foreclosure of outstanding loans. At December
31, 1997, 1996 and 1995, CBS Mortgage had an aggregate loan servicing portfolio
of $1.6 billion, $1.7 billion and $1.7 billion, respectively. Of these amounts
at such respective dates, CBS Mortgage serviced loans for the Bank aggregating
$879.6 million, $958.2 million and $824.6 million and loans for others
aggregating $675.7 million, $776.7 million and $900.7 million. At December 31,
1997, 56.6% of the dollar value of loans being serviced by CBS Mortgage was for
the Bank, 14.9% was being serviced for FHLMC, 26.7% was being serviced for FNMA
and 1.8% was being serviced for others.
Beginning in 1990, in order to increase the size of its loan servicing
portfolio, CBS Mortgage began to purchase bulk packages of mortgage servicing
rights from the Federal government and other institutions on a competitive bid
basis. The purchased mortgage servicing rights which were acquired in 1990 and
1991 were primarily conventional loans secured by real property. The bulk
purchase market for loan servicing was attractive to purchasers in the early
1990s due to the relatively large amounts of such servicing rights that were
being sold by banks and thrift institutions due to the introduction of new
regulatory capital standards, and by the Resolution Trust Corporation as part of
its liquidation function. Prices bid on these bulk offerings ranged from 0.35%
to 1.25% of the principal balance of the underlying mortgages. Between 1992 and
1994, CBS Mortgage pursued the purchase of servicing rights from private
institutions. The packages of servicing rights purchased from the private
institutions during this period were purchased at prices which have generally
ranged between 0.82% to 1.47% on the principal balances of the underlying
mortgages. No servicing rights were purchased by CBS Mortgage in 1997, 1996 or
1995. As of December 31, 1997, an aggregate of $675.7 million of CBS Mortgage's
$1.6 billion servicing portfolio, or 43.4%, was loans serviced for others. At
December 31, 1997, CBS Mortgage had no commitments for further purchases of
mortgage servicing rights.
The amount, if any, by which purchased mortgage servicing rights exceed the
lower of 90% of determinable fair market value, 90% of origination cost or
current amortized book value must be deducted from capital in calculating
regulatory capital. See "Regulation - Regulatory Capital Requirements." At
December 31, 1997, there were no deductions from capital for purchased mortgage
servicing rights valuation adjustments.
The following table sets forth certain information regarding CBS Mortgage's
servicing portfolio of mortgage loans for the periods indicated.
Year Ended December 31,
1997 1996 1995
----------- ----------- -----------
(In thousands)
Beginning servicing portfolio $ 1,735,089 $ 1,725,400 $ 1,511,263
----------- ----------- -----------
Loans originated(1) -- -- 8,810
Bank loan originations 140,673 104,023 68,960
Bank whole loans acquired 126,864 185,176 390,230
----------- ----------- -----------
Total servicing originated
and acquired 267,537 289,199 468,000
----------- ----------- -----------
Loans sold servicing released -- 47 2,602
Amortization and payoffs 430,373 273,219 246,223
Foreclosures 6,249 6,244 5,038
----------- ----------- -----------
Total servicing reductions 436,622 279,510 253,863
----------- ----------- -----------
Ending servicing portfolio $ 1,566,004 $ 1,735,089 $ 1,725,400
=========== =========== ===========
________________________
(1)Loans originated or purchased for the Bank.
MORTGAGE-BACKED SECURITIES
The Bank maintains a significant portfolio of mortgage-backed securities as
a means of investing in housing-related mortgage instruments without the costs
associated with originating mortgage loans for portfolio retention. At December
31, 1997, the Company's mortgage-backed securities portfolio (including $170.0
million of mortgage-backed securities available-for-sale), net of unamortized
premiums and unearned discounts, amounted to $1.5 billion, or 52.0%, of total
assets. By investing in mortgage-backed securities, management seeks to achieve
a positive spread over the cost of funds used to purchase these securities. At
December 31, 1997, the Company's net mortgage-backed securities had an aggregate
market value of $1.5 billion.
The following table sets forth the composition of the Company's
mortgage-backed securities portfolio at the dates indicated.
At December 31,
1997 1996 1995
---------------------- --------------------- ----------------------
Amount Percent Amount Percent Amount Percent
------------ -------- ------------ -------- ----------- ---------
(Dollars in thousands)
Held-to-maturity:
REMICS $ 1,232,219 91.59% $ 1,213,849 90.25% $1,241,999 89.00%
FNMA certificates 69,906 5.20 77,324 5.75 90,061 6.45
GNMA certificates 28,701 2.13 33,900 2.52 39,363 2.82
Non-agency certificates 14,586 1.08 19,826 1.48 24,091 1.73
Interest-only securities 20 -- 38 -- 55 --
------------ -------- ------------ -------- ----------- --------
1,345,432 100.00% 1,344,937 100.00% 1,395,569 100.00%
======== ======== ========
Unamortized premium 2,831 3,153 3,841
Unearned discount (3,173) (3,503) (3,657)
------------ ------------ -----------
Total held-to-maturity $ 1,345,090 $ 1,344,587 $1,395,753
============ ============ ===========
Available-for-sale:
REMICS $ 173,717 100.00% $ 185,651 100.00% $ 186,505 99.52%
Non-agency certificates -- -- -- -- 908 0.48
------------ -------- ------------ -------- ----------- --------
173,717 100.00% 185,651 100.00% 187,413 100.00%
======== ======== ========
Unamortized premium 25 33 44
Unearned discount (247) (255) (284)
Net unrealized loss (3,498) (4,773) (759)
----------- ----------- -----------
Total available-for-sale $ 169,997 $ 180,656 $ 186,414
============ ============ ===========
Total mortgage-backed
securities $ 1,515,087 $ 1,525,243 $1,582,167
============ ============ ===========
The mortgage-backed securities which the Bank purchases and maintains in
portfolio can include FNMA, FHLMC and GNMA certificates, certain privately
issued, credit-enhanced mortgage-backed securities which are rated "A" or better
by the national securities rating agencies, certain types of collateralized
mortgage obligations ("CMOs") and interest-only ("IO") certificates. The FNMA,
FHLMC and GNMA certificates are modified pass-through mortgage-backed
securities, which represent undivided interests in underlying pools of
fixed-rate, or certain types of adjustable rate, single family residential
mortgages issued by these quasi-governmental (GNMA) and private (FNMA and FHLMC)
corporations. FNMA and GNMA provide to the certificate holder a guarantee
(which is backed by the full faith and credit of the U.S. government in the case
of GNMA certificates) of timely payments of interest and scheduled principal
payments, whether or not they have been collected. FHLMC guarantees the timely
payment of interest and the full (though not necessarily timely) payment of
principal. The guarantees of FNMA and FHLMC are not backed by the full faith
and credit of the U.S. government. The mortgage-backed securities acquired by
the Bank that have been pooled and sold by private issuers, generally large
investment banking firms, provide for the timely payments of principal and
interest either through insurance issued by a reputable insurer or the right to
receive certain payments thereunder is subordinated in a manner which is
sufficient to have such mortgage-backed securities generally earn a credit
rating of "A" or better from one or more of the national securities rating
agencies.
A CMO is a special type of pay-through debt obligation in which the stream
of principal and interest payments on the underlying mortgages or
mortgage-backed securities is used to create classes with different maturities
and, in some cases, amortization schedules and a residual class of the CMO
security being sold, with each such class possessing different risk
characteristics. The residual interest sold represents any residual cash flows
which result from the excess of the monthly receipts generated by principal and
interest payments on the underlying mortgage collateral and any reinvestment
earnings thereon, less the cash payments to the CMO holders and any
administrative expenses. As a matter of policy, due to the risk associated with
residual interests, the Bank has never invested in, and does not intend to
invest in, residual interests in CMOs. CMOs and other mortgage-backed
securities may be structured as Real Estate Mortgage Investment Conduits
("REMICs") for U.S. Federal income tax purposes.
Mortgage-backed securities generally yield less than the loans which
underlie such securities because of their payment guarantees or credit
enhancements which reduce credit risk. In addition, mortgage-backed securities
are more liquid than individual mortgage loans and may be used to collateralize
obligations of the Bank. Mortgage-backed securities issued or guaranteed by
FNMA or FHLMC (except IO securities or the residual interests in CMOs) are
weighted at no more than 20% for risk-based capital purposes, compared to a
weight of 50% to 100% for residential loans. See "Regulation - Regulatory
Capital Requirements."
The FDIC has issued a statement of policy which states, among other things,
that mortgage derivative products (including CMOs and CMO residuals and stripped
mortgage-backed securities such as IOs) which possess average life or price
volatility in excess of a benchmark fixed rate 30 year mortgage-backed
pass-through security are "high-risk mortgage securities," are not suitable
investments for depository institutions, and if considered "high risk" at
purchase must be carried in the institution's trading account or as assets held
for sale, and must be marked to market on a regular basis. In addition, if a
security was not considered "high risk" at purchase but was later found to be
"high risk" based on the tests, the security may remain in the held-to-maturity
portfolio as long as the institution has the positive intent to hold the
security to maturity and has a documented plan in place to manage the higher
risk. At December 31, 1997, the Bank had mortgage-backed securities considered
"high risk" with a recorded booked value of approximately $16.8 million. These
securities were not considered "high risk" at purchase, but were later found to
be "high risk" based on the results of the required tests. The Bank has the
positive intent to hold these securities to maturity and has documented the
Bank's plan to manage the higher risk of these securities. If the Bank should
elect to consider a new type of security for its portfolio, the Bank intends to
ascertain in advance that the security does not fail any of the tests that will
qualify it as a "high risk mortgage security." The Bank will not purchase any
security that fails such tests unless it has in place a documented plan to
manage the higher risk of that security and has approval from the Board of
Directors.
The following table sets forth the Company's activities with respect to
mortgage-backed securities (including held-to-maturity and available-for-sale)
during the periods indicated.
Year Ended December 31,
1997 1996 1995
--------- --------- ---------
(In thousands)
Mortgage-backed securities
held-to-maturity purchased $ 56,136 $ -- 52,741
Available-for-sale securities sold(1) (11,308) (864) (72,298)
Amortization of premiums
net of discount accretion (83) (552) (495)
Change in unrealized loss on
mortgage-backed securities
available-for-sale 1,275 (4,013) (24)
Principal repayments on
mortgage-backed securities (56,176) (51,495) (35,845)
--------- --------- ---------
Net decrease in
mortgage-backed securities $(10,156) $(56,924) $(55,921)
========= ========= =========
(1) Securities sold in 1995 after reclassification from held-to-maturity
portfolio pursuant to the FASB's Special Report, "A Guide to Implementation of
Statement 115 on Accounting for Certain Investments in Debt and Equity
Securities."
On January 1, 1994, the Company adopted the FASB Statement of Financial
Accounting Standards No. 115 (Statement 115), "Accounting for Certain
Investments in Debt and Equity Securities." In accordance with Statement 115,
the Company classifies securities as either held-to-maturity or
available-for-sale. Securities are classified as held-to-maturity when the
Company has the positive intent and ability to hold such securities to maturity.
Securities held-to-maturity are recorded at amortized cost. Permanent declines
in the value of held-to-maturity securities are charged to earnings in the
periods in which the declines are determined. Securities available-for-sale are
securities other than those held-to-maturity or for trading purposes and are
recorded at fair value, with unrealized gains and losses excluded from earnings
and recorded as a separate component of stockholders' equity. In connection
with the adoption of Statement 115, in 1994 the Company transferred
approximately $50.8 million of mortgage-backed securities to the
available-for-sale category. Realized gains and losses on securities are
recorded in earnings in the year of sale based on the specific identification of
each individual security sold. Premiums and discounts on mortgage-backed
securities are amortized or accreted as a yield adjustment over the life of the
securities using the interest method, with the amortization or accretion being
adjusted when the prepayments are received.
In November 1995, the FASB issued the Special Report, "A Guide to
Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities." Provisions in this Special Report granted all entities
a one-time opportunity, until no later than December 31, 1995, to reassess the
appropriateness of the classifications of all securities held and to account for
any resulting reclassifications at fair value in accordance with Statement 115.
The provisions of the Special Report also directed that any reclassifications as
a result of this one-time reassessment would not call into question the intent
to hold other debt securities to maturity in the future. In accordance with
this Special Report, on November 20, 1995, the Company reclassified
approximately $226.6 million of mortgage-backed securities to the
available-for-sale category. These mortgage-backed securities reclassified to
the available-for-sale category were primarily COFI securities and gave the
Company the opportunity to somewhat change the composition of the portfolio by
selling certain securities if that was considered necessary. In 1997, 1996 and
1995, the Company sold $11.3 million, $864,000 and $72.3 million, respectively,
of mortgage-backed securities available-for-sale.
INVESTMENT ACTIVITIES
Under the Texas Savings Bank Act (the "Act"), the Bank is permitted to
invest in obligations of, or guaranteed as to principal and interest by, the
United States or the State of Texas, in the stock or in any obligations or
consolidated obligations of the FHLB, and in various other specified
instruments. The Bank holds investment securities from time to time to help
meet its liquidity requirements and as temporary investments until funds can be
utilized to purchase mortgage-backed securities, residential mortgage loans or
to originate other loans for the Bank's portfolio. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources."
SOURCES OF FUNDS
GENERAL. Advances from the FHLB, deposits, sales of securities under
agreements to repurchase and maturities and principal repayments on loans and
mortgage-backed securities have been the major sources of funds for use in the
Bank's lending and investments, and for other general business purposes.
Management of the Bank closely monitors rates and terms of competing sources of
funds on at least a weekly basis and utilizes the source which is the more cost
effective.
DEPOSITS. The Bank's market for deposits is competitive, which has
necessitated the Bank's emphasis on primarily short term certificate accounts
that are more responsive to market interest rates than savings accounts. The
Bank offers a traditional line of deposit products which currently includes
savings, interest-bearing checking, noninterest-bearing checking, money market
demand accounts and certificates of deposit which generally range in terms from
three to 60 months. Included among these deposit products are individual
retirement account certificates. During 1996 and early in 1997, the Bank began
to offer a range of products for commercial businesses including Small Business
Checking, Business Interest Checking, Analysis Checking and Commercial Money
Market Accounts, the amounts of which, in 1997 or 1996, are not material for
separate presentation.
The following table shows the distribution of and certain other information
relating to the Company's deposits by type as of the dates indicated.
At December 31,
--------------------------------------
1997(1) 1996(2) 1995(3)
Percent Percent Percent
of of of
Amount Deposits Amount Deposits Amount Deposits
----------- --------- ----------- --------- ----------- ---------
(Dollars in Thousands)
Demand deposit accounts:
Noninterest-bearing checking $ 101,782 7.40% $ 85,259 6.50% $ 81,207 6.31%
Interest-bearing checking 69,972 5.09 56,862 4.34 47,476 3.69
Savings 25,555 1.86 22,135 1.69 22,374 1.74
Money market demand 165,986 12.07 151,046 11.52 165,214 12.83
----------- --------- ----------- --------- ----------- ---------
Total demand deposit accounts 363,295 26.42 315,302 24.05 316,271 24.57
----------- --------- ----------- --------- ----------- ---------
Certificate accounts:
Within 1 year 781,455 56.83 772,690 58.94 704,966 54.76
1-2 years 186,734 13.58 158,583 12.10 188,400 14.63
2-3 years 30,028 2.18 40,961 3.12 32,556 2.53
3-4 years 7,292 0.53 18,268 1.39 29,717 2.31
4-5 years 6,153 0.45 5,064 0.39 15,210 1.18
Over 5 years 178 0.01 165 0.01 319 0.02
----------- --------- ----------- --------- ----------- ---------
Total certificate accounts 1,011,840 73.58 995,731 75.95 971,168 75.43
----------- --------- ----------- --------- ----------- --------
1,375,135 100.00% 1,311,033 100.00% 1,287,439 100.00%
======== ======= ========
Discount to record
savings deposits at fair value, net. (75) (198) (355)
----------- ----------- -----------
Total $1,375,060 $1,310,835 $1,287,084
=========== =========== ===========
_______________
(1)In 1997, the Bank assumed approximately $54.6 million in deposits in
connection with the acquisition of one branch office of another financial
institution.
(2)In 1996, the Bank assumed approximately $11.1 million in net deposits in
connection with the exchange of three branch offices for one and the sale of
another branch office.
(3)In 1995, the Bank assumed approximately $157.2 million in deposits in
connection with the acquisition of five branch offices of another financial
institution.
The following table sets forth the average balance of each deposit type and
the average rate paid on each deposit type for the periods indicated.
Year Ended December 31,
1997 1996 1995
----------- ----------- -----------
(Dollars in Thousands)
Average Average Average Average Average Average
Balance Rate Paid Balance Rate Paid Balance Rate Paid
----------- ---------- ----------- ---------- ----------- ---------
Demand deposit accounts:
Noninterest-bearing checking $ 91,293 --% $ 85,469 --% $ 62,164 --%
Interest-bearing checking 61,392 1.78 49,181 2.07 29,904 2.06
Savings 23,912 2.29 22,104 2.32 20,162 2.52
Money market demand 158,993 3.63 157,933 3.64 156,730 3.61
Certificate accounts 1,008,845 5.50 970,433 5.42 909,992 5.49
----------- ---------- ----------- ---------- --------- ------
Total deposits $ 1,344,435 4.68% $ 1,285,120 4.66% $ 1,178,952 4.81%
=========== ========== =========== ========== =========== ==========
The following table presents by various interest rate categories the
amounts of certificate accounts at the dates indicated and the amounts of
certificate accounts at December 31, 1997, which mature during the periods
indicated.
Amounts at December 31, 1997 Maturing
(In thousands)
Amounts at December 31, One Year
1997 1996 or Less
-------------------------- --------
(In thousands)
Certificate accounts:
2.00% to 3.99% $ 7,905 $ 14,835 $ 7,422
4.00% to 5.99% 899,205 871,852 743,317
6.00 to 7.99% 102,029 104,092 28,900
8.00 to 9.99% 2,701 4,686 1,816
10.00% to 11.99% -- 266 --
---------- -------- --------
Total $1,011,840 $995,731 $781,455
========== ======== ========
Amounts at December 31, 1997 Maturing
(In thousands)
Greater than
Two Years Three Years Three Years
---------- ---------- -------------
Certificate accounts:
2.00% to 3.99% $ 351 $ 46 $ 86
4.00% to 5.99% 132,851 11,759 11,278
6.00 to 7.99% 52,746 18,223 2,160
8.00 to 9.99% 786 -- 99
10.00% to 11.99% -- -- --
-------- ------- -------
Total $186,734 $30,028 $13,623
======== ======= =======
Certificates maturing within one year consist primarily of six month and
one year certificates. Historically, a majority of such certificate holders roll
over their balances into new certificates with similar terms at the Bank's then
current interest rates. The Bank believes that its pricing strategy will help
the Bank to achieve balance levels deemed appropriate by management on a
continuing basis.
The following table sets forth the net deposit flows of the Bank during the
periods indicated.
Year Ended December 31,
1997 1996 1995
-------- --------- ---------
(In thousands)
Net increase (decrease) before interest
credited(1) $ 2,383 $(34,707) $ 91,052
Interest credited 61,842 58,458 56,410
-------- -------- ---------
Net deposit increase $ 64,225 $ 23,751 $ 147,462
======== ========= =========
(1) For the years ended December 31, 1997, 1996 and 1995, reflects the effect of
the assumption of $54.6 million, $11.1 million and $157.2 million of net deposit
liabilities in connection with branch office transactions in each respective
year. The net deposit outflow in 1997 and 1996 (net of acquired deposits) was
primarily due to financial disintermediation as described below.
The following table sets forth the amount of the Bank's certificates of
deposits which are $100,000 or more by time remaining until maturity as of
December 31, 1997.
At December 31, 1997
-------------------------
Number of Deposit
accounts Amount
--------- ---------
(Dollars in thousands)
Three months or less 273 $ 29,844
Over three through six
months 217 23,106
Over six through twelve
months 349 38,383
Over twelve months 293 31,260
--------- ---------
Total 1,132 $ 122,593
========= =========
The Bank's deposits are obtained primarily from residents of Houston,
Austin, Corpus Christi and small cities in the south east quadrant of Texas.
Currently, the principal methods used by the Bank to attract and retain deposit
accounts include competitive interest rates, having branch locations in
under-served markets and offering a variety of services for the Bank's
customers. The Bank uses traditional marketing methods to attract new customers
and savings deposits, including newspaper advertising. Through 1997, the Bank
has not solicited brokered deposit accounts and generally has not negotiated
rates on larger denomination (i.e., jumbo) certificates of deposit. The Bank
did, however, acquire deposits, classified on the books and records of a prior
entity as brokered, through the branch acquisition in 1994. In addition, in
early 1997, the Bank has begun the solicitation of deposit accounts through a
"money desk." Money desk rates are only offered to institutions (primarily
credit unions and municipal utility districts) and are generally up to 50 basis
points higher than on regular certificate of deposit accounts.
Management of the Bank intensified its deposit product marketing beginning
in 1993 in order to increase its share of core deposits in the markets in which
it operates. Management believes that the combination of the new packaged
deposit products (which generally have higher minimum balance requirements and
which provide value-added incentives to the customer, such as, for example, free
traveler's checks, reduced or waived monthly service charges and free money
orders) plus increased advertising, sales training, branch promotion and
cross-selling of products will help maintain the volume of the Bank's deposits
and strengthen customer relationships without requiring the Bank to alter its
deposit pricing strategy. The Bank's management also believes that such efforts
will assist the Bank in maintaining deposits, particularly during periods of
relatively low deposit rates, which might otherwise flow out of the institution
due to disintermediation (the movement of funds away from savings institutions
and into direct investment vehicles such as government and corporate securities
and mutual funds). Notwithstanding this plan, the ability of the Bank to attract
and maintain deposits and the Bank's cost of funds have been, and will continue
to be, significantly affected by general money market conditions.
The Bank also provides its customers with the opportunity to invest in
mutual funds, including government bond funds, tax-free municipal bond funds,
growth funds, income growth funds, and sector funds specific to an industry,
which are provided through a third party arrangement with another company, which
maintains representatives at the Bank's branch offices. The Bank earns a fee
after the payment of all expenses, which was not material to the Bank's
financial condition.
BORROWINGS. The following table sets forth certain information regarding
the borrowings of the Bank at or for the dates indicated.
At or For the Year
Ended December 31,
1997 1996 1995
--------- ----------- ---------
(Dollars in thousands)
FHLB advances:
Average balance outstanding $ 368,896 $ 387,296 $367,895
Maximum amount outstanding
at any month-end during the
period 540,475 491,930 405,016
Balance outstanding at end of
period 540,475 409,720 312,186
Average interest rate during the
period 5.78% 5.62% 6.01%
Average interest rate at end of
period 5.95% 5.61% 5.88%
Securities sold under agreements
to repurchase:
Average balance outstanding $ 974,136 $ 930,706 $752,427
Maximum amount outstanding
at any month-end during the
period 1,035,576 1,022,085 993,832
Balance outstanding at end of
period 791,760 966,987 993,832
Average interest rate during the
period 5.66% 5.52% 5.98%
Average interest rate at end of
period 6.00% 5.55% 5.78%
Federal funds purchased averaged approximately $161,000 during the year
ended December 31, 1997 with an average interest rate during the period of
5.59%. There were no federal funds purchased outstanding at any month-end
during 1997 and there were no federal funds purchased outstanding during the
years ended December 31, 1996 or 1995.
The Bank obtains long term, fixed rate and short term, variable rate
advances from the FHLB upon the security of certain of its residential first
mortgage loans and mortgage-backed securities, provided certain standards
related to creditworthiness of the Bank have been met. FHLB advances are
generally available for general business purposes to expand lending and
investing activities. Borrowings have generally been used to fund the purchase
of loans receivable and mortgage-backed securities.
Advances from the FHLB are made pursuant to several different credit
programs, each of which has its own interest rate and range of maturities. The
programs of the FHLB currently utilized by the Bank include a variable rate line
of credit, various short-term, variable rate advances and long term, fixed and
variable-rate advances. At December 31, 1997, the Bank had total FHLB advances
of $540.5 million at a weighted average interest rate of 5.95%.
The Bank also obtains funds from the sales of securities to investment
dealers under agreements to repurchase ("reverse repurchase agreements"). In a
reverse repurchase agreement transaction, the Bank will generally sell a
mortgage-backed security agreeing to repurchase either the same or a
substantially identical security on a specified later date at a price less than
the original sales price. The difference in the sale price and purchase price
is the cost of the use of the proceeds. The mortgage-backed securities
underlying the agreements are delivered to the dealers who arrange the
transactions. For agreements in which the Bank has agreed to repurchase
substantially identical securities, the dealers may sell, loan or otherwise
dispose of the Bank's securities in the normal course of their operations;
however, such dealers or third party custodians safe-keep the securities which
are to be specifically repurchased by the Bank. Reverse repurchase agreements
represent a competitive cost funding source for the Bank; however, the Bank is
subject to the risk that the lender may default at maturity and not return the
collateral. In order to minimize this potential risk, the Bank only deals with
large, established investment brokerage firms when entering into these
transactions. At December 31, 1997, the Bank had $791.8 million in borrowings
under reverse repurchase agreements at a weighted average interest rate of
6.00%. At December 31, 1997, the Bank had amounts of securities at risk under
securities sold under agreements to repurchase with three individual
counterparties which exceeded ten percent of stockholders' equity. The amount
at risk with Salomon Brothers Inc. was $12.8 million with an average maturity of
344 days at December 31, 1997. The amount at risk with Credit Suisse First
Boston Corporation was $16.6 million with an average maturity of 27 days at
December 31, 1997. The amount at risk with Goldman, Sachs & Co. was $23.7
million with an average maturity of 8 days at December 31, 1997.
To a lesser extent, beginning in 1997, the Bank utilizes federal funds
purchased from a correspondent bank for overnight borrowing purposes.
The Asset/Liability Subcommittee of the Bank attempts to match the maturity
of reverse repurchase agreements with particular repricing dates of certain
assets in order to maintain a pre-determined interest rate spread. The Bank's
objective is to minimize the increase or decrease in the interest rate spread
during periods of fluctuating interest rates from that which was contemplated at
the time the assets and liabilities were first put on the Bank's books. The
Bank attempts to alter the interest rate risk associated with the reverse
repurchase agreements through the use of interest rate swaps and interest rate
caps purchased from the FHLB and certain large securities dealers. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Asset and Liability Management" in Item 7 hereof.
SUBSIDIARIES OF THE BANK
GENERAL. The Bank is permitted to invest in the capital stock, obligations
and other securities of its service corporations in an aggregate amount not to
exceed 10.0% of the Bank's assets. In addition, the Bank may make conforming
loans in an amount not exceeding 50% of the Bank's regulatory capital to service
corporations of which the Bank owns more than 10% of the stock. At December 31,
1997, the Bank was authorized to have a maximum investment of approximately
$291.0 million in its subsidiaries.
At December 31, 1997, the Bank had two active wholly-owned subsidiaries,
the activities of which are described below. At December 31, 1997, the Bank's
aggregate equity investment in all of its subsidiaries was $8.4 million and the
Bank had a net payable to such subsidiaries totalling $87,000.
CBS MORTGAGE CORP. The Bank is the sole stockholder of CBS Mortgage, a
Texas corporation formed in 1989 to engage in the business of originating,
purchasing, selling and servicing loans secured by first lien mortgages on
completed one-to four-family dwelling units. Beginning on January 1, 1996, the
origination, purchasing and selling functions of CBS Mortgage were performed by
the Bank, with CBS Mortgage's activities then limited to primarily loan
servicing. For a detailed discussion of CBS Mortgage's business operations, see
"Mortgage Banking Activities."
The Bank and CBS Mortgage have entered into a ten year mortgage warehouse
revolving loan agreement pursuant to which the Bank has established a $15.0
million revolving line of credit to be drawn upon from time to time by CBS
Mortgage to finance the acquisition of servicing rights and, prior to 1996, the
origination or acquisition of mortgage loans and the holding of such loans until
they were sold, delivered or pledged to secondary market investors.
The advances drawn by CBS Mortgage are secured by a promissory note payable
upon demand. Interest on the funds advanced by the Bank is payable monthly at
the local prime rate plus 1% per annum. The promissory note between the Bank and
CBS Mortgage provides that CBS Mortgage is credited an amount equal to the local
prime rate less 1% per annum on the average monthly balance of all escrowed
funds held by the Bank. The credit is limited in amount to the interest charged
by the Bank. As a result of such credit, CBS Mortgage made no interest payments
to the Bank under this loan for the year ended December 31, 1997. Principal
balances under the loan are generally repaid through servicing income generated
from servicing rights. At December 31, 1997, the Bank's equity investment in
CBS Mortgage was $8.3 million and had an intercompany payable to CBS Mortgage in
the amount of $106,000. CBS Mortgage had net income of $2.3 million, $2.3
million and $1.3 million for the years ended December 31, 1997, 1996 and 1995,
respectively.
COASTALBANC FINANCIAL CORP. CoastalBanc Financial Corp. ("Financial
Corp.") was formed in 1986 to act as an investment advisor to other insured
financial institutions. The Bank is the sole stockholder of Financial Corp.
Over the past four years, Financial Corp. has been inactive in its investment
advisory capacity. Financial Corp. became active during the last quarter of
1992 in connection with the sale of mutual funds through a third party
intermediary. Fees generated net of expenses, resulted in a net income of
$35,000, $40,000 and $34,000 for the years ended December 31, 1997, 1996 and
1995, respectively.
THE SOUTHWEST PLAN ACQUISITION
During the latter half of the 1980's, severely depressed economic
conditions prevailed in the southwestern United States, and in Texas in
particular, which seriously impaired the operating results of many corporations.
A large number of savings institutions suffered significant losses, which were
attributable to the economic deterioration in the region, as well as, in some
instances, to improper or fraudulent practices by persons affiliated with such
institutions. In an attempt to address the problems of a record number of
savings institution failures, in February 1988 the Federal Home Loan Bank Board
as operating head of the FSLIC, announced the establishment of its "Southwest
Plan," which was designed to consolidate failed or failing savings institutions
located in the southwestern United States with healthy savings institutions,
shrink the number of savings institutions in the Southwest and promote the
infusion of additional capital into the savings industry through financial
assistance and other incentives.
During this period, the Bank developed a business strategy oriented toward
growth and increasing profitability through prudent acquisitions, with
assistance from the Federal government. The strategy was designed to utilize
the deposits obtained in such transactions as an inexpensive source of funds for
growth, which would facilitate reduced overhead levels as a proportion of assets
from economies of scale and lower cost of funds from a more meaningful market
share of core deposits. In order to implement this strategy, the Bank decided
to participate in the Southwest Plan and on May 13, 1988, the Bank became the
first acquiror of failed or failing savings institutions under the FSLIC's
Southwest Plan. The Southwest Plan Acquisition was implemented pursuant to the
terms of an Assistance Agreement, entered into by the FSLIC and the Bank. The
Southwest Plan Acquisition significantly increased the total size and market
penetration of the Bank.
The FSLIC agreed in the Assistance Agreement to provide the Bank with
certain forms of financial assistance, including a guaranteed yield on, and
reimbursement for losses incurred or write-downs directed by the government or
provided by the Bank with respect to, certain assets acquired from the Acquired
Associations (the "Guaranteed Assets") and certain additional forms of financial
assistance.
On April 15, 1994, the Bank and the FDIC announced the early termination of
the Assistance Agreement, effective March 31, 1994. Under the terms of the
agreement, the Bank transferred substantially all of its remaining Guaranteed
Assets to the FDIC in exchange for cash of $37.4 million and also received cash
of $12.7 million for the remaining receivable from the government in order to
record acquired assets at fair value. In addition, the Bank repurchased for
$5.9 million a warrant to purchase Bank common stock that had been granted to
the Federal government. The Federal government will continue to receive the
future federal income tax benefits of the net operating loss carryforwards
acquired from the Acquired Associations. See "Taxation-Federal Taxation" and
Note 17 of the Notes to the Consolidated Financial Statements.
REGULATION
Set forth below is a brief description of certain laws and regulations
which relate to the regulation of the Company and the Bank. The description
does not purport to be complete and is qualified in its entirety by reference to
applicable laws and regulations.
THE COMPANY
REGULATIONS. The Company and HoCo are registered unitary savings and loan
holding companies and are subject to OTS and Department regulation, examination,
supervision and reporting requirements. In addition, because the capital stock
of the Company is registered under Section 12(g) of the Securities Exchange Act
of 1934, the Company is also subject to various reporting and other requirements
of the SEC. As a subsidiary of a savings and loan holding company, the Bank is
also subject to certain Federal and state restrictions in its dealings with the
Company and affiliates thereof.
FEDERAL ACTIVITIES RESTRICTIONS. There are generally no restrictions on
the activities of a savings and loan holding company which holds only one
subsidiary savings bank. However, if the Director of the OTS determines that
there is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings institution (i.e., a
savings association or savings bank), the Director may impose such restrictions
as deemed necessary to address such risk, including limiting (i) payment of
dividends by the savings institution; (ii) transactions between the savings
institution and its affiliates; and (iii) any activities of the savings
institution that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings institution.
Notwithstanding the foregoing, if the savings institution subsidiary of such a
holding company fails to meet the Qualified Thrift Lender ("QTL") test, then
such unitary holding company also shall become subject to the activities
restrictions applicable to multiple savings and loan holding companies and,
unless the savings institution requalifies as a QTL within one year thereafter,
shall register as, and become subject to the restrictions applicable to, a bank
holding company. See "- Regulation of The Bank - Qualified Thrift Lender Test."
If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
test, as set forth below, the activities of the Company and any of its
subsidiaries (other than the Bank or other subsidiary savings institutions)
would thereafter be subject to further restrictions. No multiple savings and
loan holding company or subsidiary thereof which is not a savings institution
shall commence or continue beyond a limited period of time after becoming a
multiple savings and loan holding company or subsidiary thereof any business
activity, other than: (i) furnishing or performing management services for a
subsidiary savings institution; (ii) conducting an insurance agency or escrow
business; (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings institution; (iv) holding or managing properties used
or occupied by a subsidiary savings institution; (v) acting as trustee under
deeds of trust; (vi) those activities authorized by regulation as of March 5,
1987 to be engaged in by multiple savings and loan holding companies; or (vii)
unless the Director of the OTS by regulation prohibits or limits such activities
for savings and loan holding companies, those activities authorized by the
Federal Reserve Board as permissible for bank holding companies. The activities
described in (i) through (vi) above may be engaged in only after giving the OTS
prior notice and being informed that the OTS does not object to such activities.
In addition, the activities described in (vii) above also must be approved by
the Director of the OTS prior to being engaged in by a multiple savings and loan
holding company.
RESTRICTIONS ON ACQUISITIONS. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the Director of the OTS, (i) control of any other savings institution or
savings and loan holding company or substantially all the assets thereof or (ii)
more than 5% of the voting shares of a savings institution or holding company
thereof which is not a subsidiary. Except with the prior approval of the
Director of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may acquire control of any savings institution, other than
a subsidiary savings institution, or of any other savings and loan holding
company.
The Director of the OTS may approve acquisitions resulting in the formation
of a multiple savings and loan holding company which controls savings
institutions in more than one state only if (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office located in the state of the association to be acquired as of March
5, 1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the FDIA, or
(iii) the statutes of the state in which the institution to be acquired is
located specifically permit institutions to be acquired by the state-chartered
institutions or savings and loan holding companies located in the state where
the acquiring entity is located (or by a holding company that controls such
state-chartered savings institutions).
TEXAS REGULATIONS. Under the Texas Savings Bank Act ("TSBA"), each
registered holding company, such as the Company, is required to file reports
with the Department as required by the Texas Savings and Loan Commissioner
("Commissioner") and is subject to such examination as the Commissioner may
prescribe.
REGULATION OF THE BANK
The Bank is required to file reports with the Department and the FDIC
concerning its activities and financial condition, in addition to obtaining
regulatory approvals prior to entering into certain transactions, such as any
merger or acquisition with another institution. The regulatory system to which
the Bank is subject is intended primarily for the protection of the deposit
insurance fund and depositors, not stockholders. The regulatory structure also
provides the Department and the FDIC with substantial discretion in connection
with their supervisory and enforcement functions. The Department and the FDIC
conduct periodic examinations of the Bank in order to assess its compliance with
federal and state regulatory requirements. As a result of such examinations,
the Department and the FDIC may require various corrective actions.
Virtually every aspect of the Bank's business is subject to numerous
federal and/or state regulatory requirements and restrictions with respect to
such matters as, for example, the nature and amounts of loans and investments
that may be made, the issuance of securities, the amount of reserves that must
be established against deposits, the establishment of branches, mergers,
non-banking activities and other operations. Numerous laws and regulations also
set forth special restrictions and procedural requirements with respect to the
extension of credit, credit practices, the disclosure of credit terms and
discrimination in credit transactions.
The description of statutory provisions and regulations applicable to
savings banks set forth in this Form 10-K does not purport to be a complete
description of such statutes and regulations and their effects on the Bank.
Moreover, because some of the provisions of the FDIA, as amended by the FDICIA,
have not yet been fully implemented through the adoption of regulations by the
various federal banking agencies, the Bank cannot yet fully assess the impact of
these provisions on its operations.
In particular, the Bank cannot predict whether it will be in compliance
with such new regulations at the time they become effective. Furthermore, the
Bank cannot predict what other new regulatory requirements might be imposed in
the future.
LIMITATIONS ON TRANSACTIONS WITH AFFILIATES. Transactions between savings
institutions and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of a savings institution is any company or
entity which controls, is controlled by or is under common control with the
savings institution. In a holding company context, the parent holding company
of a savings institution (such as the Company) and any companies which are
controlled by such parent holding company are affiliates of the savings
institution. Generally, Sections 23A and 23B (i) limit the extent to which the
savings institution or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such institution's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable to the institution or subsidiary, as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar transactions. In
addition to the restrictions imposed by Sections 23A and 23B, no savings
institution may (i) loan or otherwise extend credit to an affiliate, except for
any affiliate which engages only in activities which are permissible for bank
holding companies, or (ii) purchase or invest in any stocks, bonds, debentures,
notes or similar obligations of any affiliate, except for affiliates which are
subsidiaries of the savings institution.
In addition, Sections 22(h) and (g) of the Federal Reserve Act place
restrictions on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive officer
and to a greater than 10% stockholder of a savings institution (a "principal
stockholder"), and certain affiliated interests of each of them, may not exceed,
together with all other outstanding loans to such person and affiliated
interests, the savings institution's loans to one borrower limit (generally
equal to 15% of the institution's unimpaired capital and surplus). Section 22(h)
also requires that loans to directors, executive officers and principal
stockholders be made on terms substantially the same as offered in comparable
transactions to other persons and also requires prior board approval for certain
loans. In addition, the aggregate amount of extensions of credit by a savings
institution to all insiders cannot exceed the institution's unimpaired capital
and surplus. Furthermore, Section 22(g) places additional restrictions on loans
to executive officers. At December 31, 1997, the Bank was in compliance with
the above restrictions.
REGULATORY CAPITAL REQUIREMENTS. Federally-insured state-chartered banks
are required to maintain minimum levels of regulatory capital. These standards
generally must be as stringent as the comparable capital requirements imposed on
national banks. The FDIC also is authorized to impose capital requirements in
excess of these standards on individual banks on a case-by-case basis.
Under current FDIC regulations, the Bank is required to comply with three
separate minimum capital requirements: a "Tier 1 capital ratio" and two
"risk-based" capital requirements. "Tier 1 capital" generally includes common
stockholders' equity (including retained earnings), qualifying noncumulative
perpetual preferred stock and any related surplus, and minority interests in the
equity accounts of fully consolidated subsidiaries, minus intangible assets,
other than properly valued mortgage servicing rights up to certain specified
limits and minus net deferred tax assets in excess of certain specified limits.
At December 31, 1997, the Bank did not have any net deferred tax assets in
excess of the specified limits.
TIER 1 CAPITAL RATIO. FDIC regulations establish a minimum 3.0% ratio of
Tier 1 capital to total assets for the most highly-rated state-chartered,
FDIC-supervised banks, with an additional cushion of at least 100 to 200 basis
points for all other state-chartered, FDIC-supervised banks, which effectively
imposes a minimum Tier 1 capital ratio for such other banks of between 4.0% to
5.0%. Under FDIC regulations, highly-rated banks are those that the FDIC
determines are not anticipating or experiencing significant growth and have well
diversified risk, including no undue interest rate risk exposure, excellent
asset quality, high liquidity and good earnings. At December 31, 1997, the
required Tier 1 capital ratio for the Bank was 4.0% and its actual Tier 1
capital ratio was 5.52%.
RISK-BASED CAPITAL REQUIREMENTS. The risk-based capital requirements
contained in FDIC regulations generally require the Bank to maintain a ratio of
Tier 1 capital to risk-weighted assets of at least 4.00% and a ratio of total
risk-based capital to risk-weighted assets of at least 8.00%. To calculate the
amount of capital required, assets are placed in one of four categories and
given a percentage weight (0%, 20%, 50% or 100%) based on the relative risk of
the category. For example, U.S. Treasury Bills and GNMA securities are placed
in the 0% risk category. FNMA and FHLMC securities are placed in the 20% risk
category, loans secured by one-to-four family residential properties and certain
privately-issued mortgage-backed securities are generally placed in the 50% risk
category and commercial and consumer loans and other assets are generally placed
in the 100% risk category. In addition, certain off-balance sheet items are
converted to balance sheet credit equivalent amounts and each amount is then
assigned to one of the four categories.
For purposes of the risk-based capital requirements, "total capital" means
Tier 1 capital plus supplementary or Tier 2 capital, so long as the amount of
supplementary or Tier 2 capital that is used to satisfy the requirement does not
exceed the amount of Tier 1 capital. Supplementary or Tier 2 capital includes,
among other things, so-called permanent capital instruments (cumulative or other
perpetual preferred stock, mandatory convertible subordinated debt and perpetual
subordinated debt), so-called maturing capital instruments (mandatorily
redeemable preferred stock, intermediate-term preferred stock, mandatory
convertible subordinated debt and subordinated debt), and a certain portion of
the allowance for loan losses up to a maximum of 1.25% of risk-weighted assets.
At December 31, 1997, the Bank's Tier 1 capital to risk-weighted assets
ratio was 11.46% and its total risk-based capital to risk weighted assets ratio
was 11.98%.
The following table sets forth information with respect to each of the
Bank's capital requirements as of the dates shown.
As of December 31,
1997 1996 1995
------- ------- -------
Actual Required Actual Required Actual Required
------- --------- ------- --------- ------- ---------
Tier 1 capital to total assets 5.52% 4.00% 5.35% 4.00% 5.30% 4.00%
Tier 1 risk-based capital
to risk weighted assets 11.46 4.00 11.77 4.00 12.36 4.00
Total risk-based capital
risk to risk weighted assets 11.98 8.00 12.30 8.00 12.84 8.00
The following table sets forth a reconciliation between the Bank's
stockholders' equity and each of its three regulatory capital requirements at
December 31, 1997.
Tier 1 Total
Tier 1 Risk-based Risk-based
Capital Capital Capital
--------- ------------ ------------
(Dollars in thousands)
Total stockholders' equity $174,224 $ 174,224 $ 174,224
Unrealized loss on securities
available-for-sale 2,274 2,274 2,274
Less nonallowable assets:
Goodwill (15,717) (15,717) (15,717)
Plus allowances for loan
and lease losses -- -- 7,412
--------- ------------ ------------
Total regulatory capital 160,781 160,781 168,193
Minimum required capital 116,570 56,136 112,271
--------- ------------ ------------
Excess regulatory capital $ 44,211 $ 104,645 $ 55,922
========= ============ ============
Bank's regulatory capital
percentage (1) 5.52% 11.46% 11.98%
Minimum regulatory capital
required percentage 4.00% 4.00% 8.00%
--------- ------------ ------------
Bank's regulatory capital
percentage in excess of
requirement 1.52% 7.46% 3.98%
========= ============ ============
_______________
(1) Tier 1 capital is computed as a percentage of total assets of $2.9 billion.
Risk-based capital is computed as a percentage of adjusted risk-weighted assets
of $1.4 billion.
FDIC INSURANCE PREMIUMS. The deposits of the Bank are insured to the
maximum extent permitted by the SAIF and the Bank Insurance Fund (the "BIF"),
both of which are administered by the FDIC, and are backed by the full faith and
credit of the U.S. Government. As the insurer, the FDIC is authorized to
conduct examinations of, and to require reporting by, FDIC-insured institutions.
It also may prohibit any FDIC-insured institution from engaging in any activity
the FDIC determines by regulation or order to pose a serious threat to the FDIC.
The FDIC also has the authority to initiate enforcement actions against savings
institutions.
The Bank currently pays deposit insurance premiums to the FDIC based on a
risk-based assessment system established by the FDIC for all SAIF-member
institutions. In addition, because the Bank acquired approximately $54.6
million in deposits as a result of the Port Arthur branch acquisition on June
21, 1997, $79.8 million in deposits as a result of the Bay City branch
acquisition on September 5, 1996 and $157.2 million in deposits from Texas
Capital as of November 1, 1995, the Bank became responsible for paying deposit
insurance premiums on such deposits at the BIF premium rate. Under applicable
regulations, institutions are assigned to one of three capital groups based
solely on the level of an institution's capital - "well capitalized,"
"adequately capitalized" and "undercapitalized" - which are defined in the same
manner as the regulations establishing the prompt corrective action system under
Section 38 of the FDIA. These three groups are then divided into three
subgroups which reflect varying levels of supervisory concern, from those which
are considered to be healthy to those which are considered to be of substantial
supervisory concern. The matrix so created results in nine assessment risk
classifications, with rates, prior to the FDIA, as amended, being signed into
law, ranging from .23% for well capitalized, healthy SAIF-member institutions to
.31% for undercapitalized SAIF-member institutions with substantial supervisory
concerns. On November 14, 1995, the FDIC adopted a new assessment rate schedule
of zero to 27 basis points (subject to a $2,000 minimum) for BIF members (or
institutions, like the Bank, having BIF deposits) while retaining the existing
assessment rate schedule for SAIF-member institutions.
On September 30, 1996, amendments to the FDIA were signed into law. The
FDIA and implementing regulations provided that all SAIF-member institutions
would pay a special one time assessment of 65.7 basis points on the SAIF
assessment base as of March 31, 1995 to recapitalize the SAIF, which in the
aggregate, would be sufficient to bring the reserve ratio in the SAIF to 1.25%
of insured deposits. The Bank's special assessment amounted to $7.5 million
($4.8 million after applicable income taxes) pursuant to the FDIA. In addition
to the recapitalization provisions, the FDIA equalized the rate schedule for
SAIF and BIF institutions with the rates ranging from zero to 27 basis points
beginning October 1, 1996. At December 31, 1997, the Bank was categorized as
well capitalized.
The FDIA provided for FICO debt sharing by banks and thrifts with proration
sharing in the year 2000. Prior to the year 2000, SAIF insured institutions will
pay approximately 6.5 basis points for FICO, while BIF insured institutions will
pay approximately 1.3 basis points. The FICO provisions of the FDIA also
prohibit deposit migration strategies to avoid SAIF premiums. The FDIA also
provided for the merger of the BIF and the SAIF on January 1, 1999, with such
merger being conditioned upon the prior elimination of the federal thrift
charter.
Under Section 593 of the Internal Revenue Code, thrift institutions such as
the Bank, which meet certain definitional tests primarily relating to their
assets and the nature of their business, are permitted to establish a tax
reserve for bad debts and to make annual additions thereto, which additions may,
within specified limitations, be deducted in arriving at their taxable income.
The Bank's deduction with respect to "qualifying loans" which are generally
loans secured by certain interests in real property, prior to 1996, could be
computed using an amount based on the Bank's actual loss experience (the
"experience method") or a percentage of taxable income, computed without regard
to this deduction, and with additional modifications and reduced by the amount
of any permitted addition to the non-qualifying reserve. See "Taxation-Federal
Taxation."
Effective January 1, 1996, the Bank is unable to make additions to its tax
bad debt reserve, is permitted to deduct bad debts only as they occur and is
additionally required to recapture (i.e. take into taxable income) over a six
year period, the excess of the balance of its bad debt reserve as of December
31, 1995 over the balance of such reserve as of December 31, 1987. Such
recapture requirements can be suspended for each of two successive taxable years
beginning January 1, 1996, in which the Bank originates a minimum amount of
certain residential loans based upon the average of the principal amounts of
such loans made by the Bank during its six taxable years preceding 1996. At
December 31, 1997, the Bank had approximately $3.9 million of post-1987 tax bad
debt reserves, for which deferred taxes have been provided.
REGULATORY CAPITAL REQUIREMENTS. The FDIA requires the Federal banking
agencies to revise their risk-based capital guidelines to, among other things,
take adequate account of interest rate risk. The Federal banking agencies
continue to consider modification of the capital requirements applicable to
banking organizations. In August 1995, the Federal banking agencies amended
their risk-based capital guidelines to provide that the banking agencies will
include in their evaluations of a bank's capital adequacy an assessment of the
bank's exposure to declines in the economic value of the bank's capital due to
changes in interest rates. The agencies also issued a proposed policy statement
that describes the process that the agencies will use to measure and assess the
exposure of a bank's capital to changes in interest rates. The agencies stated
that after they and the banking industry gain sufficient experience with the
measurement process, the agencies would issue proposed regulations for
establishing explicit charges against capital to account for interest rate risk.
The FDIA also requires the FDIC and the other Federal banking agencies to
revise their risk-based capital standards, with appropriate transition rules, to
ensure that they take into account concentration of credit risk and the risks of
non-traditional activities and to ensure that such standards reflect the "actual
performance and expected risk of loss of multifamily mortgages," of which the
Bank had $131.5 million at December 31, 1997. See "Business - Lending
Activities." In December 1995, the FDIC and the other Federal banking agencies
promulgated final amendments to their respective risk-based capital requirements
which would explicitly identify concentration of credit risk and certain risks
arising from nontraditional activities, and the management of such risks as
important factors to consider in assessing an institution's overall capital
adequacy. The FDIC may now require higher minimum capital ratios based on
certain circumstances, including where the institution has significant risks
from concentration of credit or certain risks arising from non-traditional
activities.
The Federal banking agencies have agreed to adopt for regulatory purposes
Statement 115, which, among other things, generally adds a new element to
stockholders' equity under generally accepted accounting principles by including
net unrealized gains and losses on certain securities. In December 1994, the
FDIC issued final amendments to its regulatory capital requirements which would
require that the net amount of unrealized losses from available-for-sale equity
securities with readily determinable fair values be deducted for purposes of
calculating the Tier 1 capital ratio. All other net unrealized holding gains
(losses) on available-for-sale securities are excluded from the definition of
Tier 1 capital. At December 31, 1997, the Bank had $173.5 million of securities
available-for-sale with $3.5 million of aggregate net unrealized losses thereon.
SAFETY AND SOUNDNESS STANDARDS. Each Federal banking agency is required to
prescribe, for all insured depository institutions and their holding companies,
standards relating to internal controls, information systems and internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset
growth, compensation, fees and benefits and such other operational and
managerial standards as the agency deems appropriate. The compensation
standards would prohibit employment contracts or other compensatory arrangements
that provide excess compensation, fees or benefits or could lead to material
financial loss to the institution. In addition, each Federal banking agency
also is required to adopt for all insured depository institutions and their
holding companies standards that specify (i) a maximum ratio of classified
assets to capital, (ii) minimum earnings sufficient to absorb losses without
impairing capital, (iii) to the extent feasible, a minimum ratio of market value
to book value for publicly-traded shares of the institution or holding company,
and (iv) such other standards relating to asset quality, earnings and valuation
as the agency deems appropriate. On July 10, 1995, the Federal banking
agencies, including the FDIC, adopted final rules and proposed guidelines
concerning safety and soundness required to be prescribed by regulations
pursuant to Section 39 of the FDIA. In general, the standards relate to
operational and managerial matters, asset quality and earnings and compensation.
The operational and managerial standards cover internal controls and information
systems, internal audit systems, loan documentation, credit underwriting,
interest rate exposure, asset growth, and compensation, fees and benefits.
Under the asset quality and earnings standards, which were adopted by the
Federal Banking agencies in October 1996, the Bank would be required to
establish and maintain systems to identify problem assets and prevent
deterioration in those assets and evaluate and monitor earnings to ensure that
earnings are sufficient to maintain adequate capital reserves. If an insured
institution fails to meet any of the standards promulgated by the regulators,
then such institution will be required to submit a plan within 30 days to the
FDIC specifying the steps that it will take to correct the deficiency. In the
event that an insured institution fails to submit or fails in any material
respect to implement a compliance plan within the time allowed by the FDIC,
Section 39 of the FDIA provides that the FDIC must order the institution to
correct the deficiency and may restrict asset growth, require the savings
institution to increase its ratio of tangible equity to assets, restrict the
rates of interest that the institution may pay or take any other action that
would better carry out the purpose of prompt corrective action. The Bank
believes that it has been and will continue to be in compliance with each of the
standards as they have been adopted by the FDIC.
Finally, each Federal banking agency is required to prescribe standards for
the employment contracts and other compensation arrangements of executive
officers, employees, directors and principal stockholders of insured depository
institutions that would prohibit compensation and benefits and arrangements that
are excessive or that could lead to a material financial loss for the
institution. In February 1996, the FDIC adopted final regulations regarding the
payment of severance and indemnification to management officials and other
affiliates of insured institutions (institution affiliated parties or "IAPs").
The limitations on severance or "golden parachute" payments apply to "troubled"
institutions which seek to enter into contracts with IAPs. A golden parachute
payment is generally considered to be any payment to an IAP which is contingent
on the termination of that person's employment and is received when the insured
institution is in a troubled condition. The definition of golden parachute
payment does not include payment pursuant to qualified retirement plans,
non-qualified bona fide deferred compensation plans, nondiscriminatory severance
pay plans, other types of common benefit plans, state statutes and death
benefits. Certain limited exceptions to the golden parachute payment
prohibition are provided for in cases involving the hiring of an outside
executive, unassisted changes of control and where the FDIC provides written
permission to make such payment. The limitations on indemnification payments
apply to all insured institutions, their subsidiaries and affiliated holding
companies. Generally, this provision prohibits such entities from indemnifying
an IAP for that portion of the costs sustained with regard to a civil or
administrative enforcement action commenced by any Federal banking agency which
results in a final order or settlement pursuant to which the IAP is assessed a
civil monetary penalty, removed from office, prohibited from participating in
the affairs of an insured institution or required to cease and desist from
taking certain affirmative actions. Nevertheless, institutions or holding
companies may purchase commercial insurance to cover such expenses (except for
judgments or penalties) and the institutions or holding company may advance
legal expenses to the IAP if its board of directors makes certain specific
findings and the IAP agrees in writing to reimburse the institution if it is
ultimately determined that the IAP violated a law, regulation or other fiduciary
duty.
ACTIVITIES AND INVESTMENTS OF INSURED STATE-CHARTERED BANKS. The activities
and equity investments of FDIC-insured, state-chartered banks are limited by
Federal law to those that are permissible for national banks. An insured state
bank generally may not acquire or retain any equity investment of a type, or in
an amount, that is not permissible for a national bank. An insured state bank
is not prohibited from, among other things, (i) acquiring or retaining a
majority interest in a subsidiary, (ii) investing as a limited partner in a
partnership the sole purpose of which is direct or indirect investment in the
acquisition, rehabilitation or new construction of a qualified housing project,
provided that such limited partnership investments may not exceed 2% of the
bank's assets, (iii) acquiring up to 10% of the voting stock of a company that
solely provides or reinsures directors' and officers' liability insurance, and
(iv) acquiring or retaining the voting shares of a depository institution if
certain requirements are met.
COMMUNITY REINVESTMENT ACT. Under the Community Reinvestment Act ("CRA"),
as implemented by FDIC regulations, a savings institution has a continuing and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA
requires the FDIC, in connection with its examination of a savings institution,
to assess the institution's record of meeting the credit needs of its community
and to take such record into account in its evaluation of certain applications
by such institution. As of the date of its most recent regulatory examination,
the Bank was rated "satisfactory" with respect to its CRA compliance.
In May 1995, the FDIC and other Federal banking agencies promulgated final
revisions to their regulations concerning the CRA. The revised regulations
generally are intended to provide clearer guidance to financial institutions on
the nature and extent of their obligations under the CRA and the methods by
which the obligations will be assessed and enforced. Among other things, the
revised regulations substitute for the current process-based assessment factors
a new evaluation system that would rate institutions based on their actual
performance in meeting community credit needs. In particular, the revised
system will evaluate the degree to which an institution is performing under
tests and standards judged in the context of information about the institution,
its community, its competitors and its peers with respect to (i) lending, (ii)
service delivery systems and (iii) community development. The revised
regulations also specify that an institution's CRA performance will be
considered in an institution's expansion (e.g., branching) proposals and may be
the basis for approving, denying or conditioning the approval of an application.
Management of the Bank currently is unable to predict the effects of the
regulations under the CRA as recently adopted.
QUALIFIED THRIFT LENDER TEST. All savings institutions, including the
Bank, are required to meet a QTL test set forth under Section 10(m) of the Home
Owners Loan Act, as amended, ("HOLA") to avoid certain restrictions on their
operations. Under Section 2303 of the Economic Growth and Regulatory Paperwork
Reduction Act of 1996, a savings institution can comply with the QTL test set
forth in the HOLA and implementing regulations or by qualifying as a domestic
building and loan association as defined in Section 7701(a)(19) of the Code.
The QTL test set forth in HOLA requires that a depository institution must have
at least 65% of its portfolio assets (which consist of total assets less
intangibles, properties used to conduct the savings institution's business and
liquid assets not exceeding 20% of total assets) in qualified thrift investments
on a monthly average basis in nine of every 12 months. Loans and
mortgage-backed securities secured by domestic residential housing, as well as
certain obligations of the FDIC and certain other related entities may be
included in qualifying thrift investments without limit. Certain other
housing-related and non-residential real estate loans and investments, including
loans to develop churches, nursing homes, hospitals and schools, and consumer
loans and investments in subsidiaries engaged in housing-related activities may
also be included. Qualifying assets for the QTL test include investments related
to domestic residential real estate or manufactured housing, the book value of
property used by an institution or its subsidiaries for the conduct of its
business, an amount of residential mortgage loans that the institution or its
subsidiaries sold within 90 days of origination, shares of stock issued by any
FHLB and shares of stock issued by the FHLMC or the FNMA. The Bank was in
compliance with the QTL test as of December 31, 1997, with 86.9% of its assets
invested in qualified thrift investments.
RESTRICTIONS ON CAPITAL DISTRIBUTIONS. The Bank is required to provide to
the OTS not less than 30 days' advance notice of the proposed declaration by its
board of directors of any dividend on its capital stock. The OTS may object to
the payment of the dividend on safety and soundness grounds. The FDIA prohibits
an insured depository institution from paying dividends on its capital stock or
interest on its capital notes or debentures (if such interest is required to be
paid only out of net profits) or distribute any of its capital assets while it
remains in default in the payment of any assessment due the FDIC. Texas law
permits the Bank to pay dividends out of current or retained income in cash or
additional stock.
LEGISLATIVE AND REGULATORY PROPOSALS. Proposals to change the laws and
regulations governing the operations and taxation of, and federal insurance
premiums paid by, savings banks and other financial institutions and companies
that control such institutions are frequently raised in Congress, state
legislatures and before the FDIC and other bank regulatory authorities. The
likelihood of any major changes in the future and the impact such changes might
have on the Bank are impossible to determine. Similarly, proposals to change
the accounting treatment applicable to savings banks and other depository
institutions are frequently raised by the SEC, the FDIC, the IRS and other
appropriate authorities, including, among others, proposals relating to fair
market value accounting for certain classes of assets and liabilities. The
likelihood and impact of any additional future accounting rule changes and the
impact such changes might have on the Bank are impossible to determine.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB of Dallas,
which is one of 12 regional FHLBs that administer the home financing credit
function of savings institutions and commercial banks. Each FHLB serves as a
source of liquidity for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures established by its Board of Directors. As of December
31, 1997, the Bank's advances from the FHLB of Dallas amounted to $540.5 million
or 18.6% of its total assets.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Dallas in an amount equal to the greater of 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year or 5% of total advances. At December 31, 1997, the
Bank had $27.8 million in FHLB stock, which was in compliance with this
requirement.
The FHLBs are required to provide funds for the resolution of troubled
savings associations and to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low- and moderate-income housing projects. These contributions have
adversely affected the level of FHLB dividends paid and could continue to do so
in the future. These contributions also could have an adverse effect on the
value of FHLB stock in the future. For the year ended December 31, 1997,
dividends paid by the FHLB of Dallas to the Bank totaled $1.3 million.
FEDERAL RESERVE SYSTEM. The Federal Reserve Board requires all depository
institutions to maintain reserves against their transaction accounts (primarily
checking accounts) and non-personal time deposits. At December 31, 1997, the
Bank was in compliance with such requirements.
The balances maintained to meet the reserve requirements imposed by the
Federal Reserve Board may be used to satisfy applicable liquidity requirements.
Because required reserves must be maintained in the form of vault cash or a
noninterest-bearing account at a Federal Reserve Bank, the effect of this
reserve requirement is to reduce a bank's earning assets. The amount of funds
necessary to satisfy this requirement has not had a material affect on the
Bank's operations.
TEXAS SAVINGS BANK LAW. As a Texas chartered savings bank, the Bank is
subject to regulation and supervision by the Department under the TSBA. The
TSBA contains provisions governing the incorporation and organization, location
of offices, rights and responsibilities of directors, officers and members as
well as the corporate powers, savings, lending, capital and investment
requirements and other aspects of the Bank and its affairs. In addition, the
Department is given extensive rulemaking power and administrative discretion
under the TSBA, including authority to enact and enforce rules and regulations.
The Bank is required under the TSBA to comply with certain capital
requirements established by the Department. The TSBA also restricts the amount
the Bank can lend to one borrower to that permitted to national banks, which is
generally not more than 15% of the Bank's unimpaired capital and unimpaired
surplus and, if such loans are fully secured by readily marketable collateral,
an additional 10% of unimpaired capital and unimpaired surplus. The Department
generally examines the Bank once every year and the current practice is for the
Department to conduct a joint examination with the FDIC. The Department
monitors the extraordinary activities of the Bank by requiring that the Bank
seek the Department's approval for certain transactions such as the
establishment of additional offices, a reorganization, merger or purchase and
assumption transaction, changes of control, or the issuance of capital
obligations. The Department may intervene in the affairs of a savings bank if
the savings bank, or its director, officer or agent has: engaged in an unsafe
and unsound practice, violated the savings bank's articles of incorporation,
violated a statute or regulation, filed materially false or misleading
information, committed a criminal act or a breach of fiduciary duty, or if the
savings bank is, or is in imminent danger of becoming, insolvent.
TAXATION
FEDERAL TAXATION. The Company, the Bank and its subsidiaries file a
consolidated Federal income tax return on a calendar year basis using the
accrual method. Savings banks are subject to provisions of the Internal Revenue
Code ("Code") in the same general manner as other corporations. However, prior
to 1996, institutions such as the Bank which met certain definitional tests and
other conditions prescribed by the Code, benefited from certain favorable
provisions regarding their deductions from taxable income for annual additions
to their bad debt reserve. In years prior to 1996, the Bank was permitted under
the Code to deduct an annual addition to the reserve for bad debts in
determining taxable income based on the experience method or the percentage of
taxable income method. Due to recently enacted legislation, the Bank will no
longer be able to utilize a reserve method for determining the bad debt
deduction, but will be allowed to deduct actual net charge-offs. Further, the
legislation requires the Bank to recapture, into taxable income, over a six year
period, the excess of the balance of its bad debt reserve as of December 31,
1995 over the balance of such reserve as of December 31, 1987. At December 31,
1997, the Bank had approximately $3.9 million of post-1987 tax bad debt
reserves, for which deferred taxes have been provided.
The Bank is not required to provide deferred taxes on its pre-1988 (base
year) tax bad debt reserve of approximately $900,000. This reserve may be
included in taxable income in future years if the Bank makes distributions to
stockholders (including distributions in redemption, dissolution or liquidation)
that are considered to result in withdrawals from that excess bad debt reserve,
then the amounts considered withdrawn will be included in the savings bank's
taxable income. The amount that would be deemed withdrawn from such reserves
upon such distribution and which would be subject to taxation at the savings
bank level at the normal corporate tax rate would be an amount that, after taxes
on such amount, would equal the amount actually distributed plus the amount
necessary to pay the tax with respect to the withdrawal. Dividends paid out of
a savings bank's current or accumulated earnings and profits as calculated for
Federal income tax purposes, however, will not be considered to result in
withdrawals from its bad debt reserves to the extent of such earnings and
profits, but shall be regarded as taken from such reserves only upon exhaustion
of the earnings and profits accounts; however, distributions in redemption of
stock, and distributions in partial or complete liquidation of a savings bank
will be considered to come first from its loss reserve. The Bank has not
conducted a study to determine with certainty the amount of its accumulated
earnings and profits for Federal income tax purposes.
In addition to regular income taxes, corporations are subject to an
alternative minimum tax which is generally equal to 20% of alternative minimum
taxable income (taxable income, increased by tax preference items and adjusted
for certain regular tax items). The preference items generally applicable to
savings banks include (i) prior to 1996, 100% of the excess of a savings bank's
bad debt deduction computed under the percentage of income method over the
amount that would have been allowable under the experience method and (ii) an
amount equal to 75% of the amount by which a savings bank's adjusted current
earnings (alternative minimum taxable income computed without regard to this
preference, adjusted for certain items) exceeds its alternative minimum taxable
income without regard to this preference. The amounts received by the Bank
pursuant to the Assistance Agreement were included in its adjusted current
earnings. Payment of alternative minimum tax gives rise to alternative minimum
tax credit carryovers which may be carried forward indefinitely. These credits
may be used to offset future regular tax liability to the extent the regular tax
liability exceeds future alternative minimum tax.
In connection with the Assistance Agreement, an instrumentality of the
Federal government was obligated to provide the Bank with financial assistance
in connection with various matters that arose under the Assistance Agreement.
Payments to the Bank pursuant to the Assistance Agreement were taxed under the
applicable provisions of the Code which were in effect in 1988. These
provisions of the Code provide generally that payments from such instrumentality
to the Bank pursuant to the Assistance Agreement were not included in the Bank's
income and the Bank was not required to reduce its basis in the Guaranteed
Assets by the amount of such financial assistance. Accordingly, the Bank was not
required to pay Federal income taxes with respect to any amount of the
assistance payments it received pursuant to the Assistance Agreement.
The Assistance Agreement did, however, require the Bank, in effect, to pay
to such instrumentality 100% of the Federal and state "net tax benefits," as
defined, which are realized by the Bank from excluding from its income the
payments received pursuant to the Assistance Agreement on a tax-free basis. The
amount of assistance payments from that governmental instrumentality was reduced
by the amount of tax benefit realized by the Bank by excluding assistance
payments from its taxable income. Accordingly, the Bank, in effect, was passing
back to that governmental instrumentality the entire tax benefit derived from
the tax exemption provided by the Code provisions which were in effect in 1988.
Further, the tax laws in 1988 which applied to the Southwest Plan
Acquisition provided that generally applicable limitations on the ability of an
acquiring corporation to utilize the net operating loss carryforwards, and
built-in losses, as defined, of acquired financial institutions did not apply in
the case of the acquisition of assets from insolvent savings and loan
associations. The generally applicable rules limit the rate at which the net
operating loss carryforwards and built-in (i.e., previously unrecognized) losses
of an acquired corporation may be used by a corporation which acquires "control"
of the corporation which generated the loss. Pursuant to this exception which
existed in 1988 to the generally applicable law, the Bank is allowed to use the
net operating losses and built-in losses of all of the Acquired Associations
except for one without limitation. The net operating loss of one association is
not available to the Bank because such association's deposits at the time of its
acquisition did not represent at least 20% of the Bank's total deposits and
equity as required by the applicable provisions of the Code in 1988.
The Assistance Agreement required that the tax benefit derived by the Bank
from utilizing net operating loss carryforwards acquired from three of the four
Acquired Associations also be applied to reduce the amount of assistance
payments payable to the Bank by the government instrumentality. The Bank's
Consolidated Statements of Operations, therefore, includes a provision for
Federal income taxes which includes amounts credited to that governmental
instrumentality in lieu of Federal income taxes paid to the Internal Revenue
Service with certain adjustments. Although the termination of the Assistance
Agreement was effective March 31, 1994, that governmental instrumentality will
continue to receive the future federal income tax benefits of the net operating
loss carryforwards acquired from the Acquired Associations.
The Company's Federal income tax returns have not yet been audited by the
United States Internal Revenue Service. The tax returns of the Company (and the
Acquired Associations) since 1988 are subject to review by the Internal Revenue
Service.
STATE TAXATION
The Company pays an annual franchise tax equal to the greater of $2.50 per
$1,000 of taxable capital apportioned to Texas, or $4.50 per $100 of net taxable
earned surplus apportioned to Texas. Taxable earned surplus is the Company's
Federal taxable income with certain modifications, such as the exclusion of
interest earned on Federal obligations.
ITEM 2. PROPERTIES
----------
The Company's business is conducted from 37 offices in Texas. The
following table sets forth the location of the offices of the Company, as well
as certain additional information relating to these offices as of December 31,
1997.
Net Book
Value of
Property
Owned/Leased or Percent of
(with Lease Expiration Leasehold Total
Location Date) Improvements Deposits Deposits
- ------------------------ ---------------------- ------------ -------- ---------
(Dollars in thousands)
BRANCH OFFICES:
- -----------------------------
1329 North Virginia Owned
Port Lavaca, Texas 77979 $ 174 $ 30,537 2.21%
8 Greenway Plaza, Suite 100 Leased;
Houston, Texas 77046 November 1, 1998 21 20,151 1.46
8 Braeswood Square Leased;
Houston, Texas 77096 December 31, 2006 497 63,055 4.57
408 Walnut Owned
Columbus, Texas 78934 301 57,271 4.15
870 S. Mason, #100 Leased;
Katy, Texas 77450 August 31, 2003 51 24,277 1.76
602 Lyons Owned
Schulenburg, Texas 78956 91 32,657 2.37
325 Meyer Street Owned
Sealy, Texas 77474 599 41,499 3.01
116 E. Post Office Owned
Weimar, Texas 78962 42 26,257 1.90
323 Boling Road Owned
Wharton, Texas 77488 134 47,084 3.41
1621 Pine Drive Leased;
Dickinson, Texas 77539 September 30, 1998 -- 43,773 3.17
295 West Highway 77 Owned
San Benito, Texas 78586 240 21,094 1.53
1260 Blalock, Suite 100 Leased;
Houston, Texas 77055 January 20, 1999 50 57,372 4.16
620 W. Main Owned
Tomball, Texas 77375 133 27,628 2.00
915-H North Shepherd Leased;
Houston, Texas 77008 October 31, 2001 182 32,592 2.36
6810 FM 1960 West Leased;
Houston, Texas 77069 September 30, 2000 -- 31,313 2.27
7602 N. Navarro Owned
Victoria, Texas 77904 192 83,485 6.06
2308 So. 77 Sunshine Strip Leased;
Harlingen, Texas 78550 October 31, 1998 622 19,238 1.39
4900 N. 10th St., G-1 Leased;
McAllen, Texas 78504 August 14, 2001 161 16,291 1.18
10838 Leopard Street, Suite B Leased;
Corpus Christi, Texas 78410 December 31, 1998 2 42,358 3.07
4060 Weber Road Leased;
Corpus Christi, Texas 78411 April 30, 1999 4 61,508 4.47
301 E. Main Street Owned
Brenham, Texas 77833 181 63,089 4.57
1192 W. Dallas Leased;
Conroe, Texas 77301 December 31, 1999 -- 51,148 3.71
2353 Town Center Dr. Owned
Sugar Land, Texas 77478 1,112 18,223 1.32
1629 S. Voss Owned
Houston, Texas 77057 1,472 21,671 1.57
531-A Highway 1431 Leased;
Kingsland, Texas 78639 December 31, 1999 -- 20,122 1.46
209 W. Moreland Owned
Mason, Texas 76856 53 17,104 1.24
904 Highway 281 North Owned
Marble Falls, Texas 78654 180 11,329 0.82
101 East Polk Owned
Burnet, Texas 78611 100 19,643 1.42
907 Ford Owned
Llano, Texas 78643 174 16,138 1.17
708 East Austin Owned
Giddings, Texas 78942 280 24,741 1.79
5718 Westheimer, Suite 100 Leased;
Houston, Texas 77057 July 31, 2012 135 38,553 2.80
7909 Parkwood Circle Drive Owned
Houston, Texas 77036 244 11,166 0.81
1250 Pin Oak Road Owned
Katy, Texas 77494 1,185 17,128 1.24
2120 Thompson Highway Owned
Richmond, Texas 77469 492 41,785 3.03
7200 North Mopac Leased;
Austin, Texas 78731 December 31, 2002 8 36,766 2.67
1112 Seventh Street Leased;
Bay City, Texas 77414 April 30, 2002 -- 76,595 5.56
441 Austin Avenue Owned
Port Arthur, Texas 77640 669 50,052 3.63
13695 Research Blvd Under Construction
Austin, Texas 78750 446 -- --
ADMINISTRATIVE OFFICE(1)
- ------------------------------
Coastal Banc Plaza Leased;
5718 Westheimer, Suite 600 July 31, 2012 3,093 64,642 4.69
Houston, Texas 77057
RECORDS & RETENTION OFFICE:
- ------------------------------
227 Meyer St Owned
Sealy, Texas 77474 63 -- -
------------- --------- -----------
Total $ 13,383 $1,379,335 100.00%
============= ========== ===========
______________________
(1)Includes location of administrative, primary lending and mortgage servicing
offices.
The net book value of the Company's investment in premises and equipment
totaled $22.3 million at December 31, 1997. At December 31, 1997, the net book
value of the Company's electronic data processing equipment, which includes its
in-house computer system, local area network and fifteen automatic teller
machines, was $3.9 million.
ITEM 3. LEGAL PROCEEDINGS
------------------
The Company is involved in routine legal proceedings occurring in the
ordinary course of business which, in the aggregate, are believed by management
to be immaterial to the financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
-----------------------------------------------------------
Not applicable.
PART II
- --------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
----------------------------------------------------------------------
The information required herein is incorporated by reference from page 53
of the Company's printed Annual Report to Stockholders for fiscal 1997 ("Annual
Report"), which is included herein as Exhibit 13.
ITEM 6. SELECTED FINANCIAL DATA
-------------------------
The information required herein is incorporated by reference from pages 8
through 11 of the Annual Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
---------------------------------------------------------------
The information required herein is incorporated by reference on pages 11
through 23 of the Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
-------------------------------------------------------------
The information required herein is incorporated by reference from pages 18
through 19 of the Annual Report. The Company's principal market risk exposure
is to interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-----------------------------------------------
The financial statements and supplementary data required herein are
incorporated by reference from pages 25 through 52 of the Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
---------------------------------------------------------------
Not applicable.
PART III
- ---------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------------
The information required herein is incorporated by reference from the
definitive Proxy Statement filed with the Securities and Exchange Commission.
Otherwise, the requirements of this Item 10 are not applicable.
ITEM 11. EXECUTIVE COMPENSATION
-----------------------
The information required herein is incorporated by reference from the
definitive Proxy Statement filed with the Securities and Exchange Commission.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
The information required herein is incorporated by reference from the
definitive Proxy Statement filed with the Securities and Exchange Commission.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------------------------------------------------
The information required herein is incorporated by reference from the
definitive Proxy Statement filed with the Securities and Exchange Commission.
PART IV
- --------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
---------------------------------------------------------------
(a)(1) The following financial statements are incorporated herein by
reference from pages 25 through 52 of the Annual Report.
Report of Independent Certified Public Accountants.
Consolidated Statements of Financial Condition as of December 31, 1997 and
1996.
Consolidated Statements of Operations for each of the years in the
three-year period ended December 31, 1997.
Consolidated Statements of Stockholders' Equity for each of the years in
the three-year period ended December 31, 1997.
Consolidated Statements of Cash Flows for each of the years in the
three-year period ended December 31, 1997.
Notes to Consolidated Financial Statements.
(a)(2) There are no financial statement schedules filed herewith.
(a)(3) The following exhibits are filed as part of this report.
Exhibit No. Page
- ----------- -------
3.1 Articles of Incorporation of the Company . . . . . . . . . *
3.2 Bylaws of Company. . . . . . . . . . . . . . . . . . . . . *
4 Form of Company common stock certificate . . . . . . . . . *
4.1 Form of Indenture dated as of June 30, 1995, with respect
to the Company's 10% Notes, due 2002 . . . . . . . . . . . **
10.1 1991 Stock Compensation Program. . . . . . . . . . . . . . *
10.2 1995 Stock Compensation Program. . . . . . . . . . . . . . ***
10.3 Change-In-Control Severance Agreements . . . . . . . . . . E-1
12 Ratio of earnings to combined fixed charges and preferred
stock dividends (See Exhibit 13)
13 Annual Report to Stockholders. . . . . . . . . . . . . . . E -13
27 Financial Data Schedule (electronically filed)
28 Form of proxy to be mailed to stockholders of the Company. E -73
__________________
* Incorporated by reference to the Company's Registration Statement on
Form S-4 (No. 33-75952) filed on March 2, 1994.
** Incorporated by reference to the Company's Registration Statement on
Amendment No. 6 to Form S-1 (No. 33-91206) filed on June 16, 1995.
*** Incorporated by reference to the Company's Registration Statement
on Form S-1 (No. 33-91206) filed on April 14, 1995.
(b)(1) Form 8-K filed by the Company on May 5, 1997 concerning the
declaration of dividends for the first quarter of 1997.
(b)(2) Form 8-K filed by the Company on October 21, 1997 concerning the
formation of Coastal Banc Capital Corp., a wholly-owned subsidiary of Coastal
Banc Holding Company, Inc.
(b)(3) Form 8-K filed by the Company on March 11, 1998 concerning the
resolution of an outstanding tax benefit issue with the Federal Deposit
Insurance Corporation.
(c) See (a)(3) above for all exhibits filed herewith and Exhibit Index.
(d) All schedules are omitted as the required information is not
applicable or the information is presented in the consolidated financial
statements or related notes.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COASTAL BANCORP, INC.
Date: March 24, 1998 By: /s/ Manuel J. Mehos
-------------------------------
Manuel J. Mehos,
Chairman of the Board and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report is signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
/s/ Manuel J. Mehos Date: March 24, 1998
- -----------------------------
Manuel J. Mehos, Chairman of the
Board and Chief Executive Officer
/s/ R. Edwin Allday Date: March 24, 1998
- ----------------------------
R. Edwin Allday, Director
/s/ D. Fort Flowers, Jr. Date: March 24, 1998
- ----------------------------
D. Fort Flowers, Jr., Director
/s/ Dennis S. Frank Date: March 24, 1998
- ----------------------------
Dennis S. Frank, Director
/s/ Robert E. Johnson, Jr. Date: March 24, 1998
- ----------------------------
Robert E. Johnson, Jr., Director
/s/ James C. Niver Date: March 24, 1998
- -----------------------------
James C. Niver, Director
/s/ Clayton T. Stone Date: March 24, 1998
- -----------------------
Clayton T. Stone, Director
/s/ Catherine N. Wylie Date: March 24, 1998
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Catherine N. Wylie, Chief Financial
Officer (principal financial and
accounting officer)