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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
X THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
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FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
----- THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
COMMISSION FILE NO. 0-17224
FIRST FINANCIAL CARIBBEAN CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Puerto Rico 66-0312162
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
1159 Franklin D. Roosevelt Avenue
San Juan, Puerto Rico 00920
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including are code: (809) 749-7100.
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE.
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $1 PAR VALUE
10- 1/2% CUMULATIVE CONVERTIBLE PREFERRED STOCK, SERIES A
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X . No .
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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 be 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. [ ]
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State the aggregate market value of the voting stock held by
non-affiliates of the registrant. The aggregate market value shall be computed
by reference to the price at which the stock was sold, or the average bid and
asked prices of such stock, as of a specified date within 60 days prior to the
date of filing.
$130,837,015 approximately, based on the last sale price of $19.75 per
share on the NASDAQ National Market System on March 8, 1996. For the purposes
of the foregoing calculation only, all directors and executive officers of the
registrant and certain related parties of such persons have been deemed
affiliates.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date:
Common Stock: 9,005,312 shares as of March 8, 1996. (continued)
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DOCUMENTS INCORPORATED BY REFERENCE
PART III
Item 10 Directors and Executive Officers of the Information in response to this Item is
Registrant. incorporated into this Annual Report on
Form 10-K by reference to the section entitled
"Election of Directors and Related Matters" in
the Company's definitive Proxy Statement for
use in connection with its 1996 Annual Meeting
of stockholders (the "Proxy Statement").
Item 11 Executive Compensation. Information in response to this Item is
incorporated into this Annual Report on
Form 10-K by reference to the section entitled
"Executive Compensation" in the Company's
Proxy Statement.
Item 12 Security Ownership of Certain Beneficial Information in response to this Item is
Owners and Management. incorporated into this Annual Report on
Form 10-K by reference to the section entitled
"Security Ownership of Management and
Principal Holders" in the Company's Proxy Sta-
tement.
Item 13 Certain Relationships and Related Information in response to this Item is
Transactions. incorporated into this Annual Report on
Form 10-K by reference to the section entitled
"Election of Directors and Related Matters" in
the Company's Proxy Statement.
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FIRST FINANCIAL CARIBBEAN CORPORATION
1995 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . .
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters . . . . . . . . . . . . . . . .
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . .
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . . . .
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K . . . . . . . . . . . . . . . . . .
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PART I
ITEM 1. BUSINESS
GENERAL.
First Financial Caribbean Corporation ("FFCC" or the "Company"),
together with its wholly-owned subsidiaries, is primarily engaged in a wide
range of mortgage banking activities, including the origination, servicing,
purchase and sale of mortgages on single-family residences, the issuance and
sale of various mortgage-backed securities, the holding and financing of
mortgage loans and mortgage-backed securities for sale or investment, the
purchase and sale of servicing rights associated with such mortgage loans and,
to a lesser extent, the origination of construction loans and loans secured by
commercial real estate (the "Mortgage Banking Business"). FFCC is the leading
mortgage banking institution in Puerto Rico in terms of the volume of
origination of first mortgage loans on single-family residences. The Company's
Mortgage Banking Business is principally conducted through two operating units:
Doral Mortgage Corporation ("Doral Mortgage"), a wholly-owned subsidiary of the
Company and HF Mortgage Bankers Division ("HF Division"), a division of the
Company. The Company also owns Doral Federal Savings Bank ("Doral Federal"), a
federal savings and loan association which was acquired by FFCC in September
1993 and operates through two branches in Puerto Rico. References herein to the
"Company" or "FFCC" shall be deemed to refer to the Company and its
consolidated subsidiaries, unless the context requires otherwise.
The Company is an approved seller/servicer for the Federal Home Loan
Mortgage Corporation ("FHLMC") and the Federal National Mortgage Association
("FNMA"), an approved issuer for the Government National Mortgage Association
("GNMA") and an approved servicer under the GNMA, FNMA and FHLMC
mortgage-backed securities programs. FFCC is also qualified to originate
mortgage loans insured by the Federal Housing Administration ("FHA") and
guaranteed by the Veterans Administration ("VA"). Prior to 1995, substantially
all of the Company's revenues were derived from its Mortgage Banking Business.
See "Mortgage Banking Business--Sale of Loans; Issuance of Mortgage Backed
Securities" herein.
The Company's strategy is to increase its volume of loan originations
and its servicing portfolio as well as to maximize net interest income. The
Company seeks to increase its volume of loan originations by emphasizing
quality customer service and maintaining the most extensive system of branch
offices of any mortgage banking institution in Puerto Rico. The Company strives
to increase its servicing portfolio by relying primarily on internal loan
originations and supplementing such originations with wholesale purchases of
loans and mortgage servicing rights from third parties. The Company currently
emphasizes the origination of 15-year and 30-year conventional and FHA-insured
or VA-guaranteed mortgage loans on single-family residences. The Company relies
on net interest income for a more significant portion of its earnings than
mortgage banking companies generally do. The Company seeks to maximize net
interest income by holding mortgage-backed securities, primarily GNMA
securities, for longer periods prior to sale than most mortgage banking
companies. This strategy has the effect of reducing the Company's overall
effective tax rate because the interest on GNMA securities backed by Puerto
Rico mortgages is tax exempt under Puerto Rico law.
The Company's thrift subsidiary, Doral Federal, operates through two
branches in the San Juan metropolitan area, which serve primarily as
deposit-taking operations, since to date most loans have been originated
pursuant to the Master Loan Production Agreement with the Company. See "Other
Lending and Investment Activities--Loans held for Investment and Real Estate
Owned" herein. Doral Federal has experienced rapid growth since its acquisition
by the Company, increasing from $13.1 million in assets as
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of September 10, 1993 to $160.4 million in assets as of December 31, 1995. To
date, this growth has been funded primarily through increases in certificate of
deposit accounts and non-interest bearing deposits, consisting primarily of
corporate and custodial accounts. As of December 31, 1995, Doral Federal had
total deposits and net worth of $114.2 million and $16.4 million, respectively.
Custodial accounts associated with the Company's servicing portfolio,
commercial demand deposit accounts of the Company and certificates of deposits
accounts constituted approximately 24%, 16% and 46%, respectively, of Doral
Federal's total deposit accounts. The Company intends to continue to increase
the assets, deposit base and branch network of Doral Federal.
The business and profitability of FFCC depend, to a large degree, on
its ability to sell mortgage loans to investors in the secondary mortgage
market at prices that are higher than the prices at which FFCC originates or
purchases such loans. The growth of the secondary mortgage market is
attributable in large part to programs maintained by the FNMA, FHLMC and GNMA.
In addition, part of the Company's business is affected significantly by the
continuation of various programs administered by the FHA for the United States
Department of Housing and Urban Development ("HUD"), which insures mortgage
loans, and the VA, which partially guarantees mortgage loans. Any
discontinuation of, or significant reduction in, the various programs
administered by FNMA, FHLMC, GNMA, FHA or VA could have a material adverse
effect on the Company's operations. See "Mortgage Banking Business--Sale of
Loans; Issuance of Mortgage Backed Securities" herein.
The Company is subject to the rules and regulations of, and
supervision by, several Federal and Puerto Rico entities, including the Office
of Thrift Supervision (the "OTS"), FNMA, FHLMC, GNMA. FHA. VA, HUD, the
Commissioner of Financial Institutions of Puerto Rico (the "Commissioner") and
the Department of the Treasury of Puerto Rico ("Puerto Rico Treasury"), with
respect to, among other things, licensing requirements, establishment of
maximum interest rates, required disclosure to customers and the origination,
processing, underwriting, selling and securitizing of mortgage loans. See
"Regulation" herein. Doral Federal's operations are subject to regulation by
the OTS and the Federal Deposit Insurance Corporation ("FDIC"). FFCC's
operations in the state of Florida are subject to supervision by the Florida
Department of Banking and Finance. In addition, the Company's operations are
affected by Federal and Puerto Rico laws and regulations designed to promote
economic development in Puerto Rico, particularly the various Puerto Rico
Industrial Incentives Acts (the "Industrial Incentives Acts") and Section 936
of the U.S. Internal Revenue Code ("Section 936"). See "Mortgage Banking
Business - Puerto Rico Secondary Mortgage Market and Favorable Tax Treatment"
herein.
Prior to 1992, FFCC's Mortgage Banking Business was conducted
exclusively in Puerto Rico and currently is conducted in Puerto Rico through 18
branches, 15 of which are operated by Doral Mortgage. Since March 1992, Doral
Mortgage has opened branch offices in Orlando and Miami, Florida. The Florida
offices are staffed by seven employees and originated approximately $11.1
million and $6.3 million in mortgage loans during the years ended December 31,
1995 and 1994, respectively.
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MORTGAGE BANKING BUSINESS
LOAN ORIGINATION AND PURCHASE OF MORTGAGES. FFCC has the most
extensive system of branch offices for originating mortgages loans of any
mortgage banking institution in Puerto Rico. HF operates two branches in the
San Juan Metropolitan area. Doral operates 15 branches in Puerto Rico located
in Arecibo, Bayamon (2 branches), Caguas, Carolina, Cayey, Fajardo, Guayama,
Hato Rey (2 branches), Humacao, Mayaguez, Ponce, Rio Piedras and Vega Baja.
Centro Hipotecario, Inc., a wholly-owned subsidiary of the Company, operates an
additional branch in the San Juan metropolitan area.
FFCC originates both (a) conventional mortgages on single-family
residences, which generally (i) are insured by private mortgage insurers or
(ii) do not exceed 80% of the appraised value of the mortgaged property, and
(b) mortgages on single-family residences, guaranteed by the VA ("VA loans") or
insured by HUD ("FHA loans"). VA loans and FHA loans qualify for inclusion in
the mortgage-backed securities program sponsored by GNMA. A substantial
portion of the conventional loans are conforming loans which qualify for
inclusion in guarantee programs sponsored by FNMA or FHLMC. The Company also
originates construction loans for owner-occupied single family residences and
other real estate developments and mortgage loans on commercial properties.
Construction loans and mortgage loans on commercial properties constituted
approximately 1% of the total dollar volume of loans originated by the Company
during the year ended December 31, 1995.
While the Company makes available a wide variety of mortgage products
designed to respond to consumer needs and competitive conditions, it currently
emphasizes 15-year and 30-year conventional first mortgages and 15-year and
30-year FHA loans and VA loans. Substantially all the loans are fixed rate
mortgages. The average loan size for FHA/VA mortgage loans and conventional
mortgage loans was approximately $66,700 and $57,600, respectively, for the
year ended December 31, 1995.
The Company also offers second mortgages. During 1995, second
mortgages constituted less than 2% of the total loans originated by the
Company. The maximum loan-to-appraised value ratio on second mortgages
permitted by the Company is 80% (including the amount of any first mortgage).
Commencing in 1994, the Company also began to offer personal loans up
to $40,000 secured by mortgages. These loans are generally secured by first or
second mortgages on single-family residences, are payable within three to ten
years and provide for higher interest rates than typical first mortgages.
Loan origination activities performed by FFCC include soliciting,
completing and processing mortgage loan applications and preparing and
organizing the necessary loan documentation. Loan applications are examined
for compliance with underwriting criteria and, if all requirements are met,
FFCC issues a commitment to the prospective borrower specifying the amount of
the loan and the loan origination fees, discount points and closing costs to be
paid by the borrower or seller and the date on which the commitment expires.
FFCC purchases FHA loans and VA loans from Doral Mortgage and other
mortgage bankers for resale to institutional investors in the form of GNMA
securities. The Company's strategy is to increase its servicing portfolio
through internal originations through its branch network. However, in 1994, in
order to diversify its sources of loan production, the Company reentered the
wholesale mortgage loan market. The amount of loans purchased from third
parties was approximately $77 million, $63 million, $1 million, $29 million,
and $48 million for the years ended December 31, 1995, 1994, 1993, 1992, and
1991, respectively.
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In addition to loan originations through its retail branch network and
purchases from third parties, the Company originates mortgage loans referred to
it by mortgage brokers. The mortgage broker receives a fee payable at closing
by the borrower for its services. Approximately, $____ million of mortgage
loans were originated through mortgage brokers in 1995. Purchases of loans
from other mortgage bankers in the wholesale loan market as well as origination
of mortgage loans through loan brokers provides the Company with a source of
low cost production that allows the Company to efficiently increase the size of
its servicing portfolio.
The following table sets forth the number and dollar amount of the
Company's mortgage loan production for the periods indicated:
Year ended December 31,
1995 1994 1993 1992 1991
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(Dollars in thousands, except average initial loan balances)
FHA/VA LOANS:
Number of Loans . . . 4,016 7,037 8,364 3,224 2,182
Volume of Loans . . . $267,909 $433,748 $ 532,654 $207,239 $132,005
Percent of Total Volume
48% 57% 37% 30% 37%
CONVENTIONAL AND OTHER
LOANS:(1)
Number of Loans . . . 5,059 6,285 12,658 7,637 4,856
Volume of Loans . . . $291,537 $326,698 $ 899,794 $486,484 $228,411
Percent of Total Volume
52% 43% 63% 70% 63%
TOTAL LOANS:
Number of Loans . . . 9,075 13,322 21,022 10,861 7,038
Volume of Loans . . . $559,446 $760,446 $1,432,448 $693,723 $360,416
AVERAGE INITIAL LOAN
BALANCE:
FHA/VA Loans . . . . . $ 66,700 $ 61,600 $ 63,700 $ 64,300 $ 60,500
Conventional and other
Loans(1) . . . . . $ 57,600 $ 52,000 $ 71,100 $ 63,700 $ 47,000
REFINANCINGS(2) . . . . . 41% 59% 80% 67% 67%
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(1) Includes second mortgage loans and non-conforming loans
(conventional loans that do not qualify for inclusion in the
guarantee programs sponsored by FNMA or FHLMC). Includes
mortgage loans funded by Doral Federal pursuant to Master
Production Agreement.
(2) As a percentage of the total dollar volume of loans originated.
A substantial proportion of the Company's total mortgage loan
originations has consistently been comprised of refinancing loans. For the
years ended December 31, 1995, 1994 and 1993, refinancing activity represented
approximately 41%, 59% and 80%, respectively, of the Company's total dollar
volume of mortgage loans originated. The high level of refinancings during 1993
was principally due to a decline in average mortgage interest rates which
stimulated demand for refinancing of existing mortgage loans. The
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decrease in refinancing activity during 1994 compared to 1993 was due to the
rise in interest rates experienced during the second half of 1994. The
continued decrease in refinance loans during 1995 reflected the continued
weakness in demand for this product following the unusually high refinance
activity experienced during 1993. A significant future increase in mortgage
interest rates in Puerto Rico could adversely affect the Company's business if
it results in a significant decrease in refinancing of first mortgage loans. In
recent years, the Company, primarily through its HF Division, has increased
relations with realtors and developers in order to increase home purchase loan
originations. The Company believes that by increasing its home purchase loan
originations it may offset, in part, the adverse effects that increasing
interest rates or lower demand for refinancing loans could have on overall
mortgage loan production.
For the years ended December 31, 1995, 1994 and 1993, non-conforming
conventional loans represented approximately 45%, 28% and 15%, respectively, of
the Company's total volume of mortgage loans originated.
All loan originations, regardless of whether originated through the
retail network, obtained through mortgage brokers or purchased from third
parties, must be underwritten in accordance with the Company's underwriting
criteria, including loan-to-value ratios, borrower income qualifications, debt
ratios and credit history, investor requirements, and insurance and property
appraisal requirements. The Company's underwriting standards also comply with
the relevant guidelines set forth by HUD, VA, FNMA, FHLMC, federal savings and
loan regulatory authorities, private mortgage investment conduits and private
mortgage insurers, as applicable. The Company's underwriting personnel, while
operating out of loan offices, make underwriting decisions independent of the
Company's mortgage loan origination personnel. Under the Company's quality
control plan, the Company reverifies a portion of the mortgage loans funded
each month, to provide reasonable assurance that the Company's underwriting
standards have been satisfied. The selection of mortgage loans for
reverification is done on a sampling basis to provide quality control coverage
for all mortgage loan programs and appraisers. In addition, the Company
reconfirms employment status, the source of down payment and other key items.
Typically, when a mortgage loan is originated through the Company's
retail branches, the borrower is required to pay an origination fee to the
Company. These fees are generally in the range of 0% to 6% of the principal
amount of the mortgage loan, and are payable at the closing of such loan. The
Company may also charge discount points depending upon market conditions and
regulatory considerations as well as the Company's objectives concerning
mortgage loan origination volume and pricing. The Company incurs certain costs
in originating mortgage loans, including overhead, out-of-pocket costs and, in
some cases, where the mortgage loans are subject to a purchase commitment from
private investors, related commitment fees. The volume and type of mortgage
loans and of commitments made by investors vary with competitive and economic
conditions, resulting in fluctuations in revenues from mortgage loan
originations. Under Generally Accepted Accounting Principles ("GAAP") it is
required that general operating expenses incurred in originating mortgage loans
be charged to current expense. Direct origination costs and origination income
must be deferred and amortized using the interest method, until the repayment
or sale of the related mortgage loans.
LOAN SERVICING. The Company's principal source of servicing rights is
mortgage loan originations and purchases from third parties. When FFCC sells
the mortgage loans it has originated or purchased, it generally retains the
rights to service such loans and receives the related servicing fees. Loan
servicing includes collecting principal and interest and remitting the same to
the holders of the mortgage loans or mortgage-backed securities to which such
mortgage loan relates, holding escrow funds for the payment of
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real estate taxes and insurance premiums, contacting delinquent borrowers,
supervising foreclosures in the event of unremedied defaults and generally
administering the loans. FFCC receives annual loan servicing fees ranging from
0.25% to 0.50% of the declining principal amount of the loans serviced plus any
late charges. In general, FFCC's servicing agreements are terminable by the
investor for cause.
The Company's mortgage loan servicing portfolio is subject to
reduction by reason of normal amortization, prepayments and foreclosure of
outstanding mortgage loans. Additionally, the Company may sell mortgage loan
servicing rights from time to time to other institutions if market conditions
are favorable.
The following table sets forth certain information regarding the total
loan servicing portfolio of FFCC for the periods indicated:
Year ended December 31,
---------- ---------- ---------- ---------- ----------
1995 1994 1993 1992 1991
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Composition of Servicing
Portfolio at Period
End:
FHA and VA Mortgage
Loans . . . . . . . . $1,117,296 $1,062,108 $ 955,624 $ 851,853 $ 858,261
Conventional and Other
Mortgage Loans . . . 1,550,964 1,581,418 1,420,031 885,571 554,745
---------- ---------- ---------- ---------- ----------
Total Servicing Portfolio $2,668,260 $2,643,526 $2,375,655 $1,737,424 $1,413,006
========== ========== ========== ========== ==========
BEGINNING SERVICING
PORTFOLIO . . . . . . $2,643,526 $2,375,655 $1,737,424 $1,413,006 $1,193,067
ADD:
Loans Funded and
Purchased(1) . . . . 678,330 823,834 1,433,448 722,723 386,695
LESS:
Servicing Sales
Transferred . . . . 310,000 202,000 198,700 53,400 51,460
Run-off(2) . . . . . . 343,596 353,963 596,517 344,905 115,296
---------- ---------- ---------- ---------- ----------
Ending Servicing Portfolio $2,668,260 $2,643,526 $2,375,655 $1,737,424 $1,413,006
========== ========== ========== ========== ==========
SELECTED DATA REGARDING
MORTGAGE LOANS SERVICED:
Number of Loans . . . 54,993 52,515 48,272 39,562 34,897
Weighted Average
Interest Rate . . . . 8.43% 8.21% 8.15% 9.09% 10.06%
Weighted Average
Maturity (months) . . . 181 192 226 204 224
Weighted Average
Servicing Fee Rate . . .3831 .3945 .4195 .4040 .4242
DELINQUENT MORTGAGE LOANS
AND PENDING FORECLOSURES
AT PERIOD END:(3)
60-89 days past due . . 1.78% 1.53% 1.49% 1.39% 2.01%
90 days or more past
due . . . . . . . . . . 2.22% 1.48% 1.62% 1.55% 2.26%
----- ----- ----- ----- -----
Total delinquencies . 4.00% 3.01% 3.11% 2.94% 4.27%
===== ===== ===== ===== =====
Foreclosures Pending . 1.04% 1.19% 1.21% 1.44% 1.47%
===== ===== ===== ===== =====
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Year ended December 31,
-------- ------- ------- ------- --------
1995 1994 1993 1992 1991
-------- ------- ------- ------- --------
(Dollars in thousands)
- --------------------
(1) Loans funded and purchased represent that portion of loans
originated or purchased with respect to which the servicing
rights were retained by the Company. For 1995 and 1991, there
is also included $42.3 million and $49.2 million,
respectively, of servicing rights acquired in bulk from third
parties.
(2) Run-off refers to regular amortization of loans, prepayments and
foreclosures.
(3) Expressed as a percentage of the total number of loans serviced.
Substantially all of the mortgage loans in the Company's servicing
portfolio are secured by single (one-to-four) family residences. Substantially
all of FFCC's mortgage servicing portfolio is composed of mortgages secured by
real estate in Puerto Rico. At December 31, 1995, approximately $42 million of
the Company's mortgage servicing portfolio related to mortgages secured by real
property outside of Puerto Rico, (all of which were secured by real property
located in the State of Florida).
The amount of principal prepayments on mortgage loans serviced by the
Company was $160 million, $281 million and $537 million for the years ended
December 31, 1995, 1994 and 1993, respectively. This represented approximately
6%, 11% and 26% of the aggregate principal amount of mortgage loans serviced
during such periods and the average size of the loans prepaid was $37,800,
$41,800 and $54,600, respectively. Principal prepayments declined during 1995
and 1994 as a result of decreased refinancing activity following the refinance
boom of 1993. The primary means used by the Company to reduce the sensitivity
of its servicing fee income to changes in interest and prepayment rates is the
development of a strong internal origination capability that has allowed the
Company to continue to increase the size of its servicing portfolio even in
times of high prepayments.
Servicing agreements relating to the mortgage-backed securities programs of
FNMA, FHLMC and GNMA, and certain other investors, require FFCC to advance
funds to make scheduled payments of principal, interest, taxes and insurance,
if such payments have not been received from the borrowers. During the year
ended December 31, 1995, the monthly average amount of funds advanced by FFCC
under such servicing agreements was approximately $4.7 million. Funds advanced
by FFCC pursuant to these arrangements are generally recovered by FFCC within
30 days.
The degree of risk associated with a mortgage loan servicing portfolio is
largely dependent on the extent to which the servicing portfolio is
non-recourse or recourse. In non-recourse servicing, the principal credit risk
to the servicer is the cost of temporary advances of funds. In recourse
servicing, the servicer agrees to share credit risk with the owner of the
mortgage loans such as FNMA or FHLMC or with an insurer or guarantor. Losses
on recourse servicing occur primarily when foreclosure sale proceeds of the
property underlying a defaulted mortgage are less than the then outstanding
principal balance and accrued interest of such mortgage loan and the cost of
holding and disposing of such underlying property. At December 31, 1995 and
December 31, 1994, the Company was servicing mortgage loans with an aggregate
principal amount of $85 million and $112 million, respectively, on a recourse
basis. During the last five years, losses incurred due to recourse servicing
have not been significant.
FFCC's servicing rights provide a significant continuing source of income
for FFCC. There is a market in Puerto Rico for servicing rights, which are
generally valued in relation to the present value of the expected income stream
generated by the servicing rights. Among the factors which influence the value
of a servicing portfolio are servicing fee rates, loan balances, loan types,
loan interest rates, expected average
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life of underlying loans (which may be reduced through foreclosure or
prepayment), the value of escrow balances, delinquency and foreclosure
experience, servicing costs, servicing termination rights of permanent
investors and any recourse provisions. During the years ended December 31,
1995, 1994 and 1993, FFCC sold servicing rights on $310 million, $202 million
and $199 million, respectively, of mortgage loans. While the Company's general
strategy is to increase the size of its servicing portfolio by retaining the
servicing rights to the mortgage loans it originates and purchases, FFCC may
from time to time sell additional portions of its servicing portfolio when
market conditions are favorable.
The market value of, and earnings from, the Company's mortgage loan
servicing portfolio may be adversely affected if mortgage interest rates
decline and mortgage loan prepayments increase. In a period of declining
interest rates and accelerated prepayments, servicing income generated from the
Company's mortgage loan servicing portfolio may also decline through increased
amortization and the recognition of impairment of servicing rights. See
"Management's Discussion and Analysis of Financial Conditional and Results of
Operation - New Accounting Standards" herein. Conversely, as mortgage interest
rates increase, the market value of the Company's mortgage loan servicing
portfolio may be positively affected. Increases in the rate of delinquencies
and foreclosures on mortgage loans tend to increase the costs associated with
administering mortgage loans.
Mortgage loan delinquency rates in Puerto Rico are generally higher than in
the mainland United States. At December 31, 1995, 1994 and 1993, 4.00%, 3.01%
and 3.11%, respectively, of the number of loans in FFCC's servicing portfolio
were 60 or more days past due and, in addition, 1.04%, 1.19%, and 1.21%,
respectively, were in foreclosure. During the years ended December 31, 1995,
1994 and 1993, the percentage of loans in FFCC's servicing portfolio which were
over 60 days past due but not in foreclosure at month end varied from 2.86% to
4.07%, 2.88% to 3.26%, and 3.11% to 3.71%, respectively. For the year ended
December 31, 1995, the percentage of the number of serviced loans in
foreclosure ranged from .97% to 1.20%. The percentage of the number of
serviced loans in foreclosure during 1994 and 1993 ranged from 1.14% to 1.31%
and from 1.19% to 3.37%, respectively.
HRU, Inc. provides mailing and electronic data processing services for
FFCC's servicing and earns fees from FFCC based on the volume of mortgage loans
serviced. Such fee are determined at fair market value and amounted to
approximately $860,000, $726,000, and $617,000, for the years ended December
31, 1995, 1994 and 1993, respectively. FFCC owns 33% of HRU, Inc.
FORECLOSURE EXPERIENCE AND REAL ESTATE OWNED. While delinquency rates in
Puerto Rico are generally higher than in the mainland United States, these
rates are not necessarily indicative of future foreclosure rates or losses on
foreclosures. Moreover, because substantially all the mortgage loans in its
servicing portfolio are serviced on an non-recourse basis, foreclosure losses
in connection with the Company's Mortgage Banking Business are generally the
responsibility of the investors or insurer and not of the Company. Real estate
owned as a result of foreclosures ("REO") related to the Company's Mortgage
Banking Business arises primarily through foreclosure on mortgage loans
repurchased from investors either because of breach of representation or
warranties or pursuant to recourse arrangements. As of December 31, 1995 and
1994, FFCC held REO with a book value of approximately $2.1 million for each
year. Sales of REO resulted in net losses to FFCC of approximately $145,000
$473,000 and $1.05 million for the years ended December 31, 1995, 1994 and
1993, respectively. There is no liquid secondary market for the sale of the
Company's REO.
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With respect to mortgage loans securitized through GNMA programs, the
Company is fully insured as to principal by the FHA against foreclosure loss,
while the VA guarantee is subject to a limitation which is generally equal to
25% to 50% of the principal amount of the loan, up to a maximum ranging from
$22,500 to $50,750, depending upon the amount of the loan. As a result of
these programs, foreclosure on these loans had generated no loss of principal
as of December 31, 1995. FFCC, however, incurs about $2,200 per loan
foreclosed in interest and legal charges during the time between payment by
FFCC and FHA or VA reimbursement. For the years ended December 31, 1995, 1994,
and 1993 total expenses related to FHA or VA loans foreclosed amounted to
$75,000, $464,000, and $158,000, respectively. Although FNMA and FHLMC are
obligated to reimburse the Company for principal and interest payments advanced
by the Company as a servicer (except for recourse servicing), the funding of
delinquent payments or the exercise of foreclosure rights involves costs to the
Company which may not be recovered. Such nonrecovered expenses have been
immaterial to date .
Any significant adverse economic developments in Puerto Rico, FFCC's
primary service area, could result in an increase in defaults or delinquencies
on mortgage loans that are serviced by FFCC or held by FFCC pending sale in the
secondary mortgage market, thereby reducing the resale value of such mortgage
loans and increasing the costs of administering loans.
SALE OF LOANS; ISSUANCE OF MORTGAGE-BACKED SECURITIES. FFCC customarily
sells most of the loans that it originates, except for those originated by
Doral Federal which are generally held until maturity, utilizing different
sales channels described below. FFCC issues GNMA-guaranteed mortgage-backed
securities, which involve the packaging of FHA loans or VA loans into pools of
$1 million or more ($2.5 million to $5 million for serial notes) for sale
primarily to broker-dealers in Puerto Rico. During the year ended December
31, 1995, FFCC issued approximately $366 million in GNMA-guaranteed
mortgage-backed securities.
Certain GNMA-guaranteed mortgage-backed securities sold by FFCC are in the
form of GNMA serial notes. GNMA serial notes are sold in pools of $2.5 million
to $5 million. Such pools are composed solely of FHA loans or VA loans
originated in Puerto Rico. GNMA serial notes are structured into packages
consisting of notes of different yields and maturities, which range from 1 to
30 years and have an average maturity of 12 years, taking into account
historical experience with prepayments of the underlying mortgages. The rates
on the serial notes or GNMA pools must be 1/2 of 1% less than the rates on the
mortgages comprising the pool. Upon completion of the necessary processing,
the GNMA-guaranteed mortgage-backed securities are offered to the public
through securities broker-dealers. During the year ended December 31, 1995,
FFCC issued GNMA serial notes totaling approximately $284 million.
With respect to loans securitized through GNMA programs, the Company is
insured against foreclosure losses by HUD with respect to FHA loans or
partially guaranteed against foreclosure loss by the VA (at present, generally
25% to 50% of the loan, up to a maximum amount ranging from $22,500 to $50,750,
depending upon the amount of the loan). According to the applicable VA
guidelines, the maximum amount of a VA loan originated in Puerto Rico is
presently $203,000. According to applicable FHA guidelines, the maximum amount
of a FHA loan ranges from $78,660 to $123,500, depending on the municipality
where the mortgaged property is located.
Conforming conventional loans originated or purchased by FFCC are either
sold directly to FNMA, FHLMC or private investors for cash or are grouped into
pools of $1 million or more in aggregate principal balance and exchanged for
FNMA or FHLMC-issued mortgage-backed securities, which FFCC sells to
9
13
securities broker-dealers. In connection with any such exchanges, the Company
pays guarantee fees to FNMA and FHLMC. The issuance of mortgage-backed
securities provides FFCC with flexibility in selling the mortgage loans that it
originates or purchases and also provides income by increasing the value and
marketability of such loans.
The relative emphasis on the origination of FHLMC and FNMA conforming loans
versus FHA and VA loans is dependent on market conditions, the relative pricing
and return on origination of the different types of mortgage loans and the
maximum loans amounts for the various types of loans.
Mortgage loans that do not conform to GNMA, FNMA or FHLMC requirements
(so-called non-conforming loans) are sold to financial institutions or other
private investors or are securitized into "private label" mortgage-backed
securities through grantor trusts or other mortgage conduits and sold through
broker-dealers. Each issue of mortgage-backed securities normally consists of
several classes of senior, subordinate and residual certificates. The residual
certificates evidence a right to receive payments on the mortgage loans after
payment of all required amounts on the senior and subordinate certificates are
made. To date, credit enhancement, in the form of an insurance policy and
subordination, has generally been used to increase the credit rating of the
senior certificates and thereby improve their marketability. During the years
ended December 31, 1995 and 1994, the Company securitized approximately $75
million and $101 million, respectively, aggregate principal amount of
non-conforming mortgage loans. Financial Security Assurance, Inc. ("FSA")
insured approximately $70 and $96 million of senior certificates issued in
connection with such securitization transactions during 1994 and 1995,
respectively. Subject to market conditions, the Company contemplates entering
into similar securitization transactions in the future. As part of its
arrangement with FSA, the Company has agreed to retain and pledge to FSA the
residual certificates issued in such transactions. As of December 31, 1995 and
1994, the Company held approximately $13.1 million and $11.1 million,
respectively, in subordinate certificates and $8.8 million and $9.4 million,
respectively, in residual certificates issued in securitization transactions
involving the Company. Currently a liquid secondary market for subordinate or
residual certificates does not exist in Puerto Rico. The value of residual
certificates is subject to substantial fluctuations as a result of changes in
prevailing interest rates. In October 1995, the Company entered into a
one-year credit facility with a local financial institution to finance its
portfolio of subordinate certificates. As of December 31, 1995, the
outstanding principal amount of such financing was approximately $9.8 million
and bore interest at a rate of 8.5% per annum.
While the Company's exchanges of mortgage loans into agency securities and
sales of mortgage loans are generally made on a non-recourse basis, the Company
also engages in the sales or exchange of mortgage loans on a recourse basis.
In the past, recourse sales often involved sale of non-conforming loans to
local financial institutions. Recourse sales have decreased in recent years,
in part due to the securitization of non-conforming loans into private label
mortgage- backed securities and increased sales channels that allow the Company
to sell non-conforming loans to investors on a non-recourse basis. The Company
estimates the fair value of the retained recourse obligation at the time
mortgage loans are sold. Normally, the fair value of any retained recourse is
immaterial because the Company has historicaly been successful in reselling
repurchased loans for at least their carrying costs. Accordingly, as of
December 31, 1995, the Company did not deem it necessary to establish reserves
for possible losses related to recourse obligations. At December 31, 1995, the
Company had loans in its servicing portfolio with provisions for recourse in
the principal amount of approximately $85 million, as compared to $112 million
as of December 31, 1994. Of these recourse loans, approximately $16 million
and $18 million, respectively, in principal amount consisted
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of loans sold to FNMA and FHLMC or exchanged into securities of such agencies,
and approximately $69 million and $94 million principal amount, respectively,
consisted of non-conforming loans sold to other private investors as of
December 31, 1995 and 1994, respectively. At December 31, 1995, existing
commitments to sell loans to FHLMC aggregated $3 million, and were on a
non-recourse basis.
In addition to the sale of the "private label" mortgage-backed securities
referred to above, the Company has, from time to time, sold mortgage-backed
securities in bulk to local broker-dealers or financial institutions. These
mortgage-backed securities are often converted into collateralized mortgage
obligations by the purchasers and sold in the local Puerto Rico market.
From time to time, the Company may sell mortgage-backed securities subject
to put arrangements. Pursuant to these arrangements, the Company grants the
purchaser of the mortgage-backed securities a put option that grants the buyer
the right to sell and obligates the Company to buy, the securities at a future
date at a negotiated price. Sales of securities with puts are accounted for as
sales or borrowings based on an assessment of the probability that the put
option will be exercised. If, on the transaction date, the Company determines
that it is probable that the put option will not be exercised, the transaction
is accounted for as a sale. Conversely, if it is determined that it is
probable that the put option will be exercised, the transaction will be
accounted for as a secured borrowing. As of December 31, 1995, the Company had
outstanding $25 million in mortgage-backed securities sold subject to put
arrangements, all of which expire within a year, all of which were accounted
for as sales. In addition, as of such date, the Company had entered into a
commitment to sell $40 million in GNMA mortgage-backed securities subject to a
one-year put option.
MARKET INTEREST RATES AND NET INTEREST INCOME. A greater proportion of the
Company's net income has generally been composed of net interest income than is
typical of mortgage banking institutions in the mainland United States. This
is primarily due to the fact that the Company traditionally has held mortgage
loans and mortgage-backed securities, particularly GNMA certificates, for
longer periods prior to sale than mortgage banking institutions generally do.
For the year ended December 31, 1995, the Company held mortgage loans
(including mortgage-backed securities) prior to sale for an average period of
352 days, as compared to 212 days for the year ended December 31, 1994. The
increase in the number of days mortgage loans and mortgage-backed securities
were held prior to sale is primarily due to the decision made by the Company
commencing during the first quarter of 1994 to hold tax exempt FHA and VA
mortgages and GNMA securities, for longer periods prior to sale, to maximize
tax exempt net interest income produced by these instruments.
Puerto Rico regulatory requirements and the operation of the GNMA serial note
program in Puerto Rico also tend to increase the period during which mortgage
loans are held prior to sale. In order to be able to fund the origination of
mortgage loans with tax-advantaged 936 Funds (see "Puerto Rico Secondary
Mortgage Market and Favorable Tax Treatment" below), mortgages qualifying for
favorable tax treatment must be segregated and separately funded from
non-qualifying mortgages. This requirement, together with the fact that the
GNMA serial note pools consist of a minimum of $2.5 million principal amount of
mortgage loans as compared to $1 million for other GNMA programs, obligates the
Company to hold mortgage loans and mortgage-backed securities for longer
periods prior to sale in order to assemble such pools.
Changes in prevailing market interest rates between the time FFCC funds a
mortgage loan and the time the mortgage loan or mortgage-backed security is
sold to permanent investors could reduce FFCC's net interest income on mortgage
loans held prior to sale and gains from the sale of loans, thereby reducing
FFCC's net income. FFCC attempts to manage these risks by securing commitments
for future delivery
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or engaging in managed hedging transactions such as those described under
"Interest Rate Management" below.
INTEREST RATE MANAGEMENT. The Company's Mortgage Banking Business is
subject to the risk that future changes in interest rates may adversely affect
the value of the Company's portfolio of mortgage loans and mortgage-backed
securities. Interest rate fluctuations may also adversely affect net interest
income. FFCC attempts to minimize these risks through the use of forward
commitments and other hedging techniques.
The Company does not generally hedge conventional loans in the pipeline or
in the process of origination because it does not generally lock in or
guarantee the customer a specific interest rate on such loan prior to closing
but rather offers customers an interest rate that will be based on a prevailing
rate that adjusts weekly based on the FHLMC mortgage auction. In the case of
FNMA and FHLMC conforming loans and FNMA and FHLMC mortgage-backed securities,
the Company seeks to obtain commitments for the purchase of such loans or
mortgage-backed securities following the funding of such loans. These loans
are normally sold to institutional investors or at the FNMA and FHLMC cash
windows. To the extent the Company does engage in offerings of mortgage
products that lock in or guarantee the interest rate through the closing date,
the Company attempts to obtain forward commitments at the time it fixes the
rates for the loans. At December 31, 1995, the amount of outstanding forward
commitments was $44 million.
In the case of GNMA securities, the Company normally holds such securities
for longer periods prior to sale in order to maximize tax exempt net interest
income. Prices for GNMA certificates in Puerto Rico tend to be more stable
than on the mainland U.S. because of the tax exempt status of interest paid on
these securities under Puerto Rico law. This relative stability of prices for
Puerto Rico GNMA securities allows the Company to implement a less aggressive
hedging strategy to attempt to protect the value of these assets than what
might otherwise be required. In the case of nonconforming conventional loans
and GNMA mortgage-backed securities not subject to long-term repurchase
agreements, the Company seeks to protect itself from interest rate risk by
purchasing listed options on treasury bond futures contracts and other interest
rate sensitive instruments. Contracts designated as trading hedges are
marked-to-market on a monthly basis with the resulting gains and losses charged
to operations. Changes in the market value of futures contracts that qualify
as hedges of existing assets and liabilities are recognized as an adjustment to
the value of the asset or liability being hedged. The level of investment in
such options is increased or decreased in relation to interest rates changes
and other market factors.
The Company has in place long-term reverse repurchase agreements secured by
GNMA certificates and CMO certificates backed by GNMA certificates with an
aggregate principal amount of approximately $17.8 million as of December 31,
1995. The Company does not generally hedge or obtain forward commitments for
such GNMA and CMO certificates because they are financed pursuant to long-term
repurchase agreements. The Company has the right to substitute GNMA and CMO
certificates subject to the repurchase agreements with similar securities at
any time.
The operations of the Company are also subject to interest rate risk
because its interest-earning assets and interest-bearing liabilities reprice at
different times and varying amounts. FFCC's loans held for sale and mortgage-
backed securities held for trading inventories are fixed rate interest-earning
assets that are not subject to repricing (except for replacement of assets
through repayments and new originations) while the short-term borrowing used to
finance these positions normally reprice on a quarterly basis. To protect
against major fluctuations in short-term interest rates, the Company purchases
listed put options on financial
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instruments, including Eurodollars contracts. This policy attempts to ensure a
relatively stable short-term cost of funds.
In the future, FFCC may utilize alternative hedging techniques, including
futures, options or other synthetically-created hedge vehicles to help
mitigate interest rate and market risk. However, there can be no assurance
that any of the above hedging techniques will be successful. To the extent
that they are not successful, the Company's profitability may be adversely
affected. For the year ended December 31, 1995, the Company experienced
hedging losses of $5.4 million while for the year ended December 31, 1994, FFCC
experienced hedging gains of $2.2 million. Losses on hedging activities are
generally indicative of higher gains on mortgage loans and mortgage-backed
securities.
PUERTO RICO SECONDARY MORTGAGE MARKET AND FAVORABLE TAX TREATMENT. In
general, the Puerto Rico market for mortgage-backed securities is an extension
of the United States market with respect to pricing, rating of the investment
instruments, and other matters. However, United States and Puerto Rico tax
laws provide an economic incentive for Puerto Rico residents and Section 936
Corporations (defined below) to invest in certain mortgage loans and mortgage-
backed securities originated in Puerto Rico, including FHA and VA loans and
GNMA certificates, thereby tending to increase the secondary market demand for,
and the resale value of, such mortgage loans and mortgage-backed securities.
These tax advantages also favorably affect FFCC's net interest income by
helping create a pool of lower-cost funds that FFCC can access through
financial intermediaries such as banks and broker-dealers and use to fund
mortgage loans and mortgage-backed securities pending sale.
Under the Industrial Incentives Acts, certain investment income earned by
qualified manufacturing entities or service enterprises ("Exempt Companies") is
exempt from Puerto Rico income tax. The Industrial Incentive Acts also
encourage investment in Puerto Rico by allowing Exempt Companies to reduce the
otherwise applicable 10% tax (the "Tollgate Tax") on distributions to
shareholders by investing their exempt industrial development income ("IDI") in
Puerto Rico for fixed periods of time, generally from five years to ten years.
Investments income that qualifies for this exemption includes interest on
certain mortgage loans and mortgage-backed securities and interest on funds of
Exempt Companies ("936 Funds") placed with eligible institutions in Puerto Rico
(primarily savings and loan associations, commercial banks and registered
broker-dealers), provided such funds are invested in certain "eligible
activities" as defined in regulations promulgated by the Commissioner,
including certain mortgage loans and mortgage-backed securities.
Most Exempt Companies are United States corporations which operate in
Puerto Rico under Section 936. Corporations that meet certain requirements and
elect the benefits of Section 936 ("Section 936 Corporations") are entitled to
credit against their United States corporate income tax a portion of such tax
attributable to (i) income derived from the active conduct of a trade or
business within Puerto Rico or from the sale or exchange of substantially all
assets used in the active conduct of such trade or business ("Active Business
Income") and (ii) qualified possession source investment income ("QPSII").
QPSII includes interest derived from mortgage loans secured by real property
located in Puerto Rico and mortgage-backed securities consisting of such
mortgage loans as well as interest on deposits with financial institutions
which in turn use such funds to finance the origination of mortgage loans and
other qualifying assets. The credit provided for QPSII tends to increase the
demand for Puerto Rico mortgage loans and mortgage-backed securities as well as
to reduce funding costs for mortgage funding costs for mortgage banking
institutions.
The Omnibus Budget Reconciliation Act of 1993 amended various provisions of
Section 936. The amendments (the "OBRA Amendments"), which are generally
effective for taxable years beginning after
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December 31, 1993, permit a taxpayer to compute the tax credit available under
Section 936 (the "936 Credit") as under prior law but limit the amount of
credit allowed with respect to Active Business Income under one of two
alternatives to be selected at the option of the taxpayer. Under the first
alternative, the limit is equal to a fixed percentage of the amount of tax
credit allowable under prior law (the "Fixed Percentage Method"). This fixed
percentage commenced at 60% for taxable years beginning in 1994 and is reduced
by 5% per year until 1998. For taxable years beginning in 1998, such
percentage would be 40%. Under the second alternative (the "Economic Activity
Method"), which is based on the amount of economic activity conducted by the
taxpayer in Puerto Rico, the credit may not exceed the sum of the following
three components: (i) 60% of the qualified possession wages and the allocable
fringe benefits paid by the taxpayer, (ii) applicable percentages of certain
depreciation deductions claimed for regular tax purposes by the taxpayer with
respect to qualified tangible property and (iii) a portion of the possession
income taxes paid by the taxpayer except where the taxpayer uses the
profit-split method for determining its income. The OBRA Amendments did not
limit the 100% credit available under Section 936 for QPSII, including income
received from investment in certain Puerto Rico mortgage loans and
mortgage-backed securities.
On November 20, 1995, the United States Congress passed the Seven-Year
Balanced Budget Reconciliation Act of 1995 (the "Budget Bill"), which was
subsequently vetoed by President Clinton on December 6, 1995. The Budget Bill
would have generally repealed the 936 Credit for taxable years beginning after
December 31, 1995. 936 Corporations that were engaged in the active conduct of
trade or business on October 13, 1995 and that qualified for and elected the
benefits of Section 936 for taxable years beginning before December 31, 1995,
would have enjoyed the benefit a ten-year grandfather rule. Under the
grandfather rule, the amount of Active Business Income eligible for the 936
Credit would have been subject to certain caps that would vary depending upon
whether the 936 Corporation computed its 936 Credit under the Economic Activity
Method or under the Fixed Percentage Method. The credit available for QPSII
would not have enjoyed the benefit of the grandfather rule and would have been
eliminated for taxable years beginning after December 31, 1995.
There can be no assurance as to what changes may be made to Section 936 as
part of the ongoing Federal budget process. While the final impact of the
proposed repeal of Section 936 cannot be determined at this time, the repeal of
Section 936 by legislation containing provisions similar to those contained in
the Budget Bill, could have an adverse effect on the general economic condition
of Puerto Rico, the Company's predominant service area, by reducing incentives
for investment in Puerto Rico. Any such adverse effect on the general economy
of Puerto Rico could lead to an increase in mortgage delinquencies and a
reduction in the level of residential construction and demand for mortgage
loans. The elimination of Section 936, particularly the elimination of the
credit for QPSII, could also lead to a decrease in the amount of 936 Funds
invested in Puerto Rico financial assets by 936 Corporations, thereby
increasing funding costs and decreasing liquidity in the Puerto Rico financial
market. The magnitude of the impact of any such changes on the Company's
profitability or financial condition cannot be determined at this time. The
Company has taken steps to attempt to reduce the impact of any such adverse
changes by diversifying its sources of funding and identifying additional
investors for its mortgage products. See "Managements Discussion and Analysis
of Results of Operations and Financial Condition - Liquidity and Capital
Resources." During recent periods, the disparity between the cost of 936 Funds
and other sources of funding such as the Euro-dollar market have decreased,
thereby reducing the adverse effect that the loss of such funding could have on
the profitability of the Company.
In addition to the foregoing incentives, interest derived from FHA loans or
VA loans secured by real property in Puerto Rico originated after June 30,
1983, and, under certain circumstances, on or before
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February 15, 1973, and from GNMA certificates consisting of such mortgages, is
exempt from Puerto Rico income tax. FHA and VA mortgage loans are also exempt
from Puerto Rico gift and estate taxes. Individuals who are bona fide
residents of Puerto Rico are also not subject to United States federal income
tax on income from Puerto Rico sources, including interest income derived from
mortgage loans originated in Puerto Rico whose mortgagors are residents of
Puerto Rico. The exemption for interest earned on FHA loans, VA loans and GNMA
certificates tends to increase the demand for these products and the price the
Company may obtain upon their sale. On October 18, 1995, the Puerto Rico
Finance Board announced that it had completed a review of the tax exempt
treatment of interest on FHA and VA loans and was not recommending any change
in the current treatment. There can be no assurance that the tax exempt
treatment of interest on FHA and VA loans will not be reviewed or modified in
the future.
Any change in Puerto Rico's political status could result in the
elimination or modification of these tax benefits described above. See "The
Commonwealth of Puerto Rico- Relationship of Puerto Rico with the United
States" for a description of legislation introduced into the House of
Representatives regarding the holding of a referendum on the political status
of Puerto Rico.
OTHER LENDING AND INVESTMENT ACTIVITIES
LOANS HELD FOR INVESTMENT AND REAL ESTATE OWNED. The Company, through
Doral Federal, originates for investment mortgage loans secured by residential
real estate, including personal loans up to $40,000 secured by first or second
mortgages. To a lesser extent, Doral Federal also originates development and
construction loans and loans secured by commercial real estate. Prior to being
acquired by the Company in September 1993, Doral Federal also engaged in
unsecured consumer and commercial lending and finance leases. Doral Federal is
considering beginning to offer such products again on a limited basis.
At December 31, 1995, and 1994, loans held for investment which were
originated as part of the Company's other lending activities through Doral
Federal, net totaled $51.4 million and $34.8 million, respectively, and 72% and
85%, respectively, of such loans were secured by mortgages on owner-occupied
single-family residences. While Doral Federal has nationwide lending authority
as a federal savings association, substantially all of its loans are secured by
real property located in Puerto Rico. At December 31, 1995, 99.5% of the
mortgage loans held for investment by Doral Federal were secured by property
located in Puerto Rico. At December 31, 1995, the largest loan held for
investment by Doral Federal was $645,000 and the maximum aggregate amount of
loans that Doral Federal could make to a single borrower under OTS regulations
was $2.4 million. The Company anticipates continued growth in Doral Federal's
portfolio of loans held for investment.
In connection with FFCC's acquisition of Doral Federal, Doral Federal
entered into a Master Loan Production Agreement with the Company whereby the
Company agreed to help the thrift meet its stated production goals by, among
other things, (1) advertising, promoting and marketing to the general public,
(2) interviewing prospective borrowers and initial processing of loan
applications, consistent with Doral Federal's underwriting guidelines, and (3)
providing personnel and facilities with respect to the execution of loan
agreements. The terms of the Master Loan Production Agreement are believed to
be at least as favorable to Doral Federal as those prevailing for comparable
transactions with or involving other non-affiliated companies. In the future,
Doral Federal may determine to engage in direct mortgage loan originations
through its branch network.
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For mortgage loans originated prior to October 1, 1995, Doral Federal has
in effect a Master Purchase, Servicing and Collection Agreement (the "Master
Purchase Agreement") with the Company providing for the sale by Doral Federal
to the Company of the servicing rights to all first and second mortgage loans
secured by residential properties, all loans secured by commercial real estate,
all commercial business loans, consumer and any other loans secured by
mortgages and forming a part of Doral Federal's loan portfolio (the "Loans").
The Master Purchase Agreement further provides that the Company, exclusively,
will service the Loans according to a fee schedule contained in the Master
Purchase Agreement. The fee schedule provides that the purchase price of the
servicing rights with respect to the Loans is a percentage of the outstanding
principal amount of such Loans. The terms of the Master Purchase Agreement are
believed to be at least as favorable to Doral Federal as those prevailing for
comparable transactions with or involving other non-affiliated companies.
For Loans originated after October 1, 1995, the Master Purchase Agreement
was substituted with a Master Servicing and Collection Agreement (the "Master
Servicing Agreement") whereby the Company will contractually agree to service
all Loans originated by Doral Federal after the date of the Master Servicing
Agreement. Under the Master Servicing Agreement, FFCC will not, however,
purchase the intangible right to service such Loans. The Company will be
entitled to receive a servicing fee equal to 25 basis points of the outstanding
principal amount of the Loans being serviced. Doral Federal would retain the
right to terminate the Company's servicing rights, without cause, upon notice
to the Company.
The following table set forth certain information regarding the Company's
loans held for investment as part of its other lending activities through Doral
Federal as of the date indicated:
December 31, Percent December 31, Percent
1995 of Total 1994 of Total
---------------- -------- -------------- --------
(Dollars in Thousands)
Construction loans $ 2,637 5% $ 1,061 3%
Residential mortgage loans 29,481 57 23,293 66
Commercial real estate 9,205 18 2,044 6
Consumer - Secured by mortgage 7,362 14 6,283 18
Consumer - other 324 (1) 1,009 3
Loans on savings deposits 1,940 4 956 3
Commercial non-real estates 698 2 393 1
Leases 3 (1) 28 (1)
Land secured 330 (1) 183 (1)
------- ------- ----
Gross loans $51,980 100% $35,250 100%
------- -------
Less:
Unearned interest and deferred loan (383) (13)
fees(2)
Reserve for loan losses (242) (428)
------- -------
(625) (441)
------- -------
Loans receivable, net $51,355 $34,809
======= =======
_______________
(1) Represents less than one percent.
(2) Net of deferred loan fees resulting from the sale of servicing
rights to affiliates which are eliminated in the preparation of
the Company'Consolidated Financial Statements.
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Doral Federal originates adjustable and fixed interest rate loans.
However, given traditional consumer preferences in Puerto Rico for fixed rate
mortgage loans, Doral Federal's principal product, the Company does not
anticipate significant growth in adjustable rate mortgages. At December 31,
1995 and 1994, approximately 7% and 9%, respectively, of Doral Federal's
mortgage loans held for investment were adjustable rate loans. The adjustable
rate loans have interest rate adjustment limitations and are generally tied to
the prime rate. Future market factors may affect the correlation of the
interest rate adjustment with the rate Doral Federal pays on the short-term
deposits that have primarily funded these loans.
For information as to the time periods during which fixed rate loans
mature and adjustable rate loans reprice with respect to the Company's loans
held for investment through Doral Federal, refer to Note 9 to the Company's
Consolidated Financial Statements.
NON-PERFORMING ASSETS AND ALLOWANCE FOR LOANS LOSSES. Non-performing
assets ("NPAs") consist of loans on a non- accrual basis and other real estate
owned. Doral Federal's policy is to place all loans 90 days or more past due
on non-accrual basis, at which point a reserve for all unpaid interest
previously accrued is established. Interest income is recognized when the
borrower makes a payment, and the loan will return to an accrual basis when it
is no longer 90 or more days delinquent and collectability is reasonably
assured. Mortgage loans held for sale as part of the Company's Mortgage
Banking Business are normally only placed on non-accrual basis upon
commencement of foreclosure proceedings (which normally occurs within six to
eight months following default). For the years ended December 31, 1995 and
1994, the Company would have recognized $211,000 and $287,000, respectively, in
additional interest income had all delinquent loans owned by the Company been
accounted for an accrual basis. See "Business-Regulation-Savings and Loan
Operations -- Doral Federal - Classification of Assets" for additional
information regarding classified assets of Doral Federal.
The following table sets forth information with respect to the Company's
non-accrual loans, REO and other non- performing assets for the years ended
December 31, 1995 and 1994.
At December 31
1995 1994
---- ----
(Dollars in thousands)
Mortgage Banking Business(1):
Non-accrual loans . . . . . . . . . . . . . . . . . . . . . . . . . $1,250(2) $4,260
Other real estate owned . . . . . . . . . . . . . . . . . . . . . . 2,085 2,029
Other nonperforming assets(3) . . . . . . . . . . . . . . . . . . . 893 448
Other Lending Activities:(4)
Non-accrual loans . . . . . . . . . . . . . . . . . . . . . . . . . 949 459
Other real estate owned . . . . . . . . . . . . . . . . . . . . . . - 87
Total NPAs as a percentage of loans receivable, net and other real 1.8% 1.6%
Ratio of allowance for loan receivables to non-performing loans(4) . 25.50% 93.25%
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-----------
(1)Includes mortgage loans held for sale and REO related to the
Company's Mortgage Banking Business. Consist primarily of
construction and commercial loans.
(2) Of the amount shown, a non-affiliated government institution was
required to purchase $1.25 million and $2.9 million at December 31,
1995 and 1994, respectively, at par on a non-recourse basis.
(3)This amount refers to a mortgage loan to a real estate
partnership formed to acquire REO from the Company. This loan is
included in "Securities and investments held to maturity" in the
Company's financial statements.
(4)Limited to mortgage loans and REO of Doral Federal.
The Mortgage Banking Business' other real estate owned arises primarily
through foreclosure on mortgage loans repurchased from investors, either
because or breach of representations or warranties or pursuant to recourse
arrangements. The Company believes that the value of the REO reflected on its
financial statements represent a reasonable estimate of the properties' fair
value, net of cost of sales. During the past five years, the impact of loans
repurchased as the result of breach of representations or warranties or
pursuant to recourse arrangements has not been material.
The percentage of the allowance for loan losses to nonperforming loans
held for investment will not remain constant due to the nature of Doral
Federal's portfolio of mortgage loans, which are primarily collateralized by
real estate. The collateral for each nonperforming mortgage loan is analyzed
by Doral Federal's to determine potential loss exposure, and in conjunction
with other factors, this loss exposure contributes to the overall assessment of
the adequacy of the allowance for loan losses. On an on-going basis,
management monitors the loan portfolio and evaluates the adequacy of the
allowance for loan losses. In determining the adequacy of the allowance for
loan losses, management considers such factors as historical loan loss
experience, known problem loans, evaluations made by bank regulatory
authorities, assessment of economic conditions and other appropriate data to
identify the risks in the loan portfolio. Loans deemed by management to be
uncollectible are charged to the allowance for loan losses. Recoveries on
loans previously charged off are credited to the allowance. Provisions for
loan losses are charged to expense and credited to the allowance in amounts
deemed appropriate by management based upon its evaluation of the known and
inherent risks in the loan portfolio. While management believes that the
current allowance for loan losses is sufficient, future additions to the
allowance may be necessary. For certain information regarding the Company's
allowance for loan losses related to loans held for investment by Doral Federal
and losses on other real estate owned for both Doral Federal and the Company's
Mortgage Banking Business for the three years ended December 31, 1995, 1994 and
1993 refer to Note 10 to the Company's Consolidated Financial Statements.
OTHER INVESTMENTS
As of December 31, 1995, the Company held approximately $78 million of
securities and other investments which are classified as held to maturity
because the Company had the intent to hold these securities until maturity. Of
this amount, approximately $18 million were held by Doral Federal. The $60
million in securities classified as held to maturity included as part of the
Company's Mortgage Banking Business consist of tax exempt GNMA-backed CMO
Certificates. The holding of these securities until maturity is consistent
with the Company's strategy to maximize tax exempt interest income. The
Company does not believe that the holding of these securities will have an
adverse effect on the liquidity of the Company because it believes that it will
be able to obtain continuous financing for these securities under its existing
credit facilities or pursuant to deposits, in the case of securities owned by
Doral Federal. For certain information regarding the composition of the
Company's mortgage-backed securities and other
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investments held to maturity, the contractual or expected maturities thereof
and the aggregate gross unrealized holding gains or losses with respect thereto
as of December 31, 1995 and 1994, refer to Note 7 to the Company's Consolidated
Financial Statements.
As of December 31, 1995, Doral Federal also held approximately $14.6
million in FNMA, FHLMC and GNMA mortgage- backed securities that are clasified
as available for sale. As of December 31, 1995, gross unrealized holding gains
with respect to such securities equalled approximately $95,400 while gross
unrealized losses equalled approximately $86,500. The contractual maturity of
the securities available for sale at December 31, 1995 is generally over ten
years. There were no sales of such securities during the year ended December
31, 1995.
FUNDING
- -------
BORROWING ARRANGEMENTS RELATING TO MORTGAGE BANKING OPERATIONS. Except as
noted below with respect to GNMA securities, historically, a period of two to
four months has normally elapsed between the origination of a mortgage loan by
FFCC and its sale to permanent investors. The Company often holds GNMA
certificates for longer periods to take advantage of tax exempt interest income
on such certificates while conforming loans that qualify for the
mortgage-backed securities programs of FNMA and FHLC are normally sold within
60 days of origination.
Prior to issuance of GNMA or other mortgage-backed certificates, FFCC's
mortgage loans are funded almost entirely by borrowings under warehousing lines
of credit or other financing agreements such as pre-sale, gestation facilities
and repurchase agreements, with financial institutions. FFCC principal short
term facilities include warehousing lines of credit with three local commercial
banks and pre-sale, gestation or repurchase facilities with three affiliates of
major U.S. brokerage houses. Pre-sale or gestation facilities generally permit
the Company to obtain more favorable financing rates once mortgage loans have
been assigned to a pool but prior to securitization. These facilities also
generally allow for the financing of mortgage-backed securities upon issuance.
Typically, FFCC finances between 90% and 95% of the principal amount of its
mortgage loans and secures advances under its lines of credit by pledging such
loans and the servicing agreements relating thereto to such banks or financial
institutions, a practice commonly referred to as "warehousing." The percentage
of principal amount will range from 90% for conventional mortgages (one bank
will only lend up to 80% of the principal amount of conventional mortgages) to
95% for FHA and VA loans. The rates of interest FFCC pays under its
warehousing lines of credit fluctuate depending upon changes in the lender's
cost of funds. FFCC warehousing lines of credit are generally terminable at
the discretion of the lender.
FFCC pays interest on its lines of credit at floating rates which vary
with market conditions. The interest rates on these lines of credit have been
lower than the interest rates which FFCC earns on the mortgage loans pledged to
secure such financing. Amounts borrowed under lines of credit are payable upon
demand and are usually repaid after FFCC packages such mortgage loans into
GNMA, FNMA or FHLMC certificates and receives the proceeds from the sale of
such certificates or the financing of such securities under repurchase
agreements.
FFCC also obtains short-term financing through repurchase agreements with
financial institutions and investment banking firms. Under these agreements,
FFCC sells GNMA, FNMA or FHLMC-guaranteed
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mortgage-backed securities and, to a lesser extent, private label
mortgage-backed securities and simultaneously agrees to repurchase them at a
future date at a fixed price. FFCC uses the proceeds of such sales to repay
borrowings under its bank warehousing lines of credit. The effective cost of
funds under repurchase agreements is typically lower than the costs of funds
borrowed under FFCC's warehousing lines of credit. FFCC's continued use of
repurchase agreements will depend upon the cost of repurchase agreements
relative to the cost of borrowing under lines of credit from banks.
Commencing in 1993, the Company made a strategic decision to diversify its
sources of funding and to obtain funding from sources outside of Puerto Rico.
As of December 31, 1995, the Company's credit facilities included three
pre-sale or gestation facilities with affiliates of major U.S. brokerage houses
and a syndicated multi-bank credit facility described below. Obtaining credit
from financial institutions located outside Puerto Rico generally permits the
Company to obtain larger lines of credit and reduces its dependence on tax
advantaged funding available in the local market.
On June 30, 1995, as part of its strategy to continue to diversify its
sources of funding, FFCC entered into a Syndicated Credit Agreement with six
banks providing for three credit facilities totaling up to $125 million. The
credit facilities were structured by Bankers Trust Company, as administrative
and syndicate agent.
During 1995, the Company also entered into a Debenture Purchase Agreement
dated September 25, 1995, as amended and restated as of December 15, 1995 (the
"Debenture Purchase Agreement") with BanPonce Corporation ("BanPonce") a bank
holding company headquartered in San Juan, Puerto Rico, providing for the
issuance and sale to BanPonce of up to $10,000,000 of 8.25% Convertible
Subordinated Debentures (the "Debentures") in a private placement transaction.
For further information on the terms of the Syndicated Credit Agreement,
the Debenture Purchase Agreement and the other borrowings utilized by the
Company to finance its inventory of mortgage loans and mortgage-backed
securities, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."
FUNDING ARRANGEMENTS RELATING TO SAVINGS AND LOAN OPERATIONS. Deposits
and borrowings, consisting of FHLB-NY advances, term notes and repurchases
agreement, are the primary sources of Doral Federal's funds for use in its
lending, investment and other business activities. In addition, Doral Federal
obtains funds in the form of loan repayments and income from operations as well
as capital contributions from FFCC. FFCC made capital contributions of $8.5
million in Doral Federal during 1995. Loan repayments are a relatively stable
source of funds while net increase in deposits are significantly influenced by
general interest rates and money market conditions. The ability to continue to
raise long term funding through the issuance of term notes to 936 Corporation
as described below is subject to the continued existence of the tax benefits
available under Section 936. See "Mortgage Banking Business-Puerto Rico
Secondary Mortgage Market and Favorable Tax Treatment" for a description of the
benefits available under Section 936 and of certain proposals to repeal Section
936.
Deposits have been the principal source of funds for Doral Federal's
lending activities. At December 31, 1995, Doral Federal held $114 million in
deposits at a weighted average interest rate cost of 3.20%. Doral Federal
offers passbook savings accounts, checking accounts, NOW accounts and fixed
interest rate certificate accounts with varying maturities. A substantial
portion of Doral Federal's deposits consist of non-interest bearing wholesale
deposit accounts such as corporate and custodial accounts. At
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December 31, 1995, $49.6 million or approximately 43% of Doral Federal's total
deposits consisted of non-interest bearing accounts. Approximately 93% of such
amount relates to corporate and custodial accounts of the Company and its
affiliates. This amount includes approximately $18.5 million in corporate
accounts of the Company and its affiliates which are eliminated in the
preparation of the Company's Consolidated Financial Statements. Corporate
accounts of the Company as well as escrow and custodial accounts related to the
Company's Mortgage Banking Business represent a stable source of low cost
funding for Doral Federal. For additional information regarding the
characteristics of Doral Federal's deposit accounts, refer to Note 19 of the
Company's Consolidated Financial Statements.
Doral Federal may also obtain funding through collateralized borrowings
directly from the Federal Home Loan Bank of New York (the "FHLB-NY") and
through borrowings secured by FHLB-NY letters of credit, up to a maximum of 30%
of total assets. Such advances or letter of credit reimbursement obligation
must be secured by qualifying assets with a market value equal to between 105%
and 115% of the outstanding obligation. At December 31, 1995, Doral Federal
had $10.4 million in outstanding advances from the FHLB-NY at a weighted
average interest rate cost of 6.4%.
Doral Federal is licensed as an Eligible Depository Institution ("EDI")
with the Office of the Commissioner and as such is authorized to accept 936
Funds directly from 936 Corporations. As of December 31, 1995, Doral Federal
had issued approximately $18.1 million in five year term notes. Such term
notes have maturities ranging from October, 2000 to November, 2000 and bear
interest at a weighted average cost annual interest rate of 5.3%. Approximately
$13.1 million of such term notes bear interest a fixed rate. With respect to
the $5.0 million of term notes that bears interest at a fluctuating rate, the
Company has effectively fixed the rate on such notes by entering into an
interest rate swap agreement with a major brokerage firm. Because of Doral
Federal's status as an EDI, the interest received on the term notes issued by
Doral Federal is tax exempt when received by a 936 Corporation. Because of
such favorable tax treatment, the interest rates on such notes is less than
what otherwise would be obtained by Doral Federal. The term notes contain
interest "gross-up" provisions that provide for a prospective adjustment on the
interest rates on the notes to a fixed rate equal to 100% of the LIBID, as of
the adjustment date, on the remaining term of the notes, in the event of an
adverse change in the tax treatment of the interest received on the Notes under
Section 936. See "Mortgage Banking Business-Puerto Rico Secondary Mortgage
Market and Favorable Tax Treatment" for a description of certain propos- als to
repeal Section 936.
From time to time, Doral Federal may also obtain funding through the use
of repurchase agreements with brokerage firms and other financial institutions.
As of December 31, 1995, Doral Federal did not have any outstanding borrowings
under repurchase agreements.
MARKET AREA AND COMPETITION.
Prior to March 1992, Puerto Rico was FFCC's exclusive service area.
Although Doral Mortgage has since opened branch offices in Miami and Orlando,
Florida, Puerto Rico remains the predominant service area accounting for 98% of
the Company's loan originations during each of the years ending December 31,
1995 and 1994. Within Puerto Rico, FFCC's primary market area is the
metropolitan San Juan area, which accounted for approximately 45% and 47% of
FFCC loan originations in 1995 and 1994, respectively. The competition in
Puerto Rico for the origination of mortgages is substantial. Competition comes
not only from other mortgage bankers, but also from major banks and savings and
loan associations. There are
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approximately 36 mortgage banks, two savings institutions and 21 commercial
banks operating in Puerto Rico, including affiliates of banks headquartered in
the United States, Canada and Spain. The Company competes principally by
offering loans with competitive features, by emphasizing the quality of its
service and pricing its range of products at competitive rates.
THE COMMONWEALTH OF PUERTO RICO
GENERAL. Puerto Rico, the fourth largest of the Caribbean islands, is
located approximately 1,600 miles southeast of New York, New York and 1,000
miles east-southeast of Miami, Florida. It is approximately 100 miles long and
35 miles wide. The population of Puerto Rico for 1990, as determined by the
United States Census Bureau, was approximately 3.6 million as compared to 3.2
million in 1980. The Puerto Rico Planning Board estimates that the San Juan
metropolitan area has a population in excess of 1.0 million.
RELATIONSHIP OF PUERTO RICO WITH THE UNITED STATES. The Constitution of
Puerto Rico was drafted by a popularly elected constitutional convention,
overwhelmingly approved in a special referendum and approved "as a compact" by
the United States Congress and the President, becoming effective upon
proclamation of the Governor of Puerto Rico on July 25, 1952. Puerto Rico's
relationship to the United States under the compact is referred to herein as
"commonwealth status." The United States and Puerto Rico share a common
defense, market and currency. Puerto Rico exercises virtually the same control
over its internal affairs as a state government does. The people of Puerto
Rico are citizens of the United States, but do not vote in national elections
and they are represented in Congress by a Resident Commissioner who has a voice
in the House of Representatives but only limited voting rights. Most federal
taxes, except those such as social security taxes which are imposed by mutual
consent, are not levied in Puerto Rico. No federal income tax is collected
from Puerto Rico residents on ordinary income earned from sources within Puerto
Rico, except for Federal employees who are subject to taxes on their salaries.
Corporations organized under the laws of Puerto Rico are treated as foreign
corporations for federal income tax purposes. For many years there have been
two major views in Puerto Rico with respect to the island's relationship to the
United States, one essentially favoring the existing commonwealth status and
the other favoring statehood.
On November 14, 1993, a plebiscite was held in Puerto Rico to allow
eligible voters an opportunity to express their preference between statehood,
Commonwealth (with certain changes) and independence for Puerto Rico. The
Commonwealth status obtained the most votes receiving 48.6% of the votes cast,
statehood and independence received 46.3% and 4.4% of the votes casts,
respectively.
On March 6, 1996, legislation was introduced in the United States House of
Representatives providing for a three- stage process to resolve permanently
Puerto Rico's political relationship with the United States. The proposed
legislation ("H.R. 3024") will allow the residents of Puerto Rico to choose
full self government (either integration into the United States leading to
statehood or separate sovereignty in the form of independence (including free
association with the United States, via bilateral treaty). In its current
form, H.R. 3024 provides for three referendum to be held in Puerto Rico
starting not later than 1998 in which the voters can choose initially between
statehood and independence and then can vote twice more to approve the
legislation adopted by the Congress to give effect to the majority preference.
If in any such referendum, a majority is not obtained for either statehood or
independence (or such implementing legislation), then the current Commonwealth
status will continue in force, subject to the authority of the Congress.
Public hearings on H.R. 3024 will be held by the appropriate Congressional
committees prior to its consideration by the full Congress. H.R. 3024 would
have to be approved by both houses of the Congress
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and signed by the President (or his veto overridden) before H.R. 3024 can
become law. It is not possible at this time to determine the ultimate outcome
of H.R. 3024.
A change in the political status of Puerto Rico could result in
modifications to or elimination of Section 936 and of the Puerto Rico laws
providing favorable tax treatment for investment in Puerto Rico mortgages and,
therefore, could have a material adverse effect on the Company's cost of
borrowing, the liquidity of the secondary mortgage market and the financial
performance of FFCC. See "Mortgage Banking Business - Puerto Rico Secondary
Mortgage and Favorable Tax Treatment" herein. It is not possible to predict to
what extent, if any, such adverse effects would be offset by possible
beneficial aspects of a change in status.
THE ECONOMY. Puerto Rico has established policies and programs directed
at the development of manufacturing and the expansion and modernization of the
island's infrastructure. The investment of funds by mainland United States,
foreign and local entities in new factories has been stimulated by selective
tax exemption, development loans, and other financial and tax incentives.
Infrastructure expansion and modernization have been to a large extent financed
by bonds and notes issued by the Commonwealth, its public corporations and
municipalities. Economic progress has been aided by significant increases in
the levels of education and occupational skills of the island's population.
The percentage of the college-age population enrolled in institutions of higher
learning has increased from 16.8% in 1970 to 36.8% in 1993.
The economy of Puerto Rico is closely integrated with that of the mainland
United States. During the fiscal year ended June 30, 1995, approximately 89%
of Puerto Rico's exports went to the United States mainland, which was also the
source of approximately 65% of Puerto Rico's imports. For the fiscal year
ended June 30, 1995, Puerto Rico experienced a positive adjusted merchandise
trade balance of $4.6 billion.
The economy of Puerto Rico is dominated by the manufacturing and services
sectors. The manufacturing sector has experienced a basic change over the
years as a result of increased emphasis on higher wage, high technology
industries such as pharmaceutical and electronics. The service sector also
plays a major role in the economy. It ranks second only to manufacturing in
contribution to the gross domestic product and leads all sectors in providing
employment. In recent years, the service sector has experienced significant
growth in responses to the expansion of the manufacturing sector.
Gross product increased from $22.8 billion ($19.3 billion in 1987 prices)
for fiscal 1991 to $28.4 billion ($21.2 billion in 1987 prices) for fiscal
1995, an increase of 24.4% (10% in 1987 prices). Since fiscal 1985, personal
income, both aggregate and per capita, has increased consistently each fiscal
year. In fiscal 1995, aggregate personal income was $27 billion ($22.5 billion
in 1987 prices) and personal income per capita was $7,296 ($6,074 in 1987
prices). Average employment increased from 977,000 in fiscal 1991 to 1,051,300
in fiscal 1995. Average unemployment decreased from 15.2% in fiscal 1991 to
13.8% in fiscal 1995.
Future growth in the Puerto Rico economy will depend on several factors
including the condition of the United States economy, the relative stability in
the price of oil imports, the exchange value of the U.S. dollars and the level
of interest rates and changes to existing tax incentive legislation as
discussed below.
As part of the ongoing federal budget negotiation, various proposals have
been made to repeal Section 936. The elimination of the benefits of Section
936, without the substitution of another fiscal incentive to attract
investments to Puerto Rico, could have an adverse effect on the future growth
of the Puerto Rico economy. At this point, the Company cannot predict the
impact of a possible repeal of Section 936 on the
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economy of Puerto Rico or on the financial condition or prospects of the
Company. See "Mortgage Banking Business - Puerto Rico Secondary Mortgage
Market and Favorable Tax Treatment".
PUERTO RICO INCOME TAXES.
FFCC is subject to Puerto Rico income taxes. On October 31, 1994, the
Government of Puerto Rico enacted a new comprehensive internal revenue act
known as the Puerto Rico Internal Revenue Code of 1994 (the "PRIRC"). While
the PRIRC incorporates many of the provisions of the prior tax law, it also
provides for various amendments and changes from prior law. Most changes
affecting corporations are effective for taxable years commencing after June
30, 1995.
Among the most important changes introduced by the PRIRC were (i) a
reduction in the maximum marginal statutory corporate tax rate from 42% to 39%,
(ii) the elimination of the deduction for bad debt expense arising from the use
of the reserve method for bad debt reserve and the related prorated recapture
of the outstanding balance of the reserve existing as of June 30, 1995 over a
four year period and (iii) optional use of a new method of accelerated
depreciation for capital assets purchased during taxable years beginning after
June 30, 1995.
The income tax rates range from 22%, on taxable income of $25,000 or less,
to 39% on taxable income in excess of $300,000. Under the PRIRC, the net
interest income derived by FFCC from FHA loans or VA loans secured by
residential properties located in Puerto Rico originated after June 30, 1983
and GNMA securities backed by such loans continues to be excluded from FFCC's
gross income in computing its regular income tax. Therefore, such income is
tax-exempt to FFCC. However, to the extent that FFCC holds obligations on
which the interest is not subject to Puerto Rico income tax, including FHA
loans or VA loans acquired after December 31, 1987 ("Exempt Obligations"),
FFCC's interest expense deduction in computing its regular corporate income tax
will be reduced in the same proportion that said Exempt Obligations bear to its
total assets. Income tax savings of FFCC attributable to this exemption
amounted to $4.6 million, $5.4 million and $2.7 million in 1995, 1994 and 1993,
respectively.
The Company is also subject to an alternative minimum tax of 22% on its
alternative minimum tax net income. In computing the Company's alternative
minimum tax net income its interest expense deduction will be reduced in the
same proportion that its Exempt Obligations (irrespective of the date on which
the same were acquired by the Company) bear to its total assets. Therefore, to
the extent that the Company holds FHA loans or VA loans and other Exempt
Obligations, it may be subject to the payment of the 22% alternative minimum
tax.
Under PRIRC, corporations are not permitted to file consolidated returns
with their subsidiaries and affiliates. Effective for taxable year commencing
after June 30, 1995, FFCC is entitled to a 100% dividend received deduction on
dividends received from Doral Mortgage or any other Puerto Rico corporation
subject to tax under PRIRC. No dividends received deduction is available for
dividends received by FFCC from U.S. Corporations such as Doral Federal.
Effective July 1, 1995, the PRIRC also provided for the elimination of the
existing 29% withholding tax applicable on interest paid to non-resident
corporations and alien individuals as well as a reduction of the withholding tax
applicable to dividends payable to non-resident corporations and individuals
from 25% to 10%.
The Company does not believe that the changes implemented by the PRIRC
will have a material adverse effect on the business or financial condition of
the Company. In fact, the elimination and reduction of the
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withholding tax on interest payments and dividends, respectively, should help
the Company to obtain funding from sources outside Puerto Rico.
UNITED STATES INCOME TAXES.
FFCC and Doral Mortgage are corporations organized under the laws of
Puerto Rico. Accordingly, FFCC and Doral Mortgage are subject generally to
United States income tax only on their income, if any, from sources within the
United States. Prior to 1992, the Company did not earn any income that was
subject to United States income tax. However, in March 1992, Doral Mortgage
opened a branch in Florida. Accordingly, Doral Mortgage is subject to both
Florida income and franchise and federal income tax on income effectively
connected with the conduct of the trade or business of this branch. The
maximum United States corporate income tax rate is presently [35%] and the
Florida income and franchise tax rate is currently 5.5%. In addition, the
United States may impose a branch profits tax of 30% in the event that profits
from the Florida branch are repatriated to Puerto Rico. Both the federal tax
as well as the branch profit tax may be claimed as a credit in Puerto Rico,
subject to certain limitations.
Doral Federal, as a federal savings association, is also subject to U.S.
income taxes. It will be entitled to a foreign tax credit for a portion of
income taxes paid to the Puerto Rico Treasury Department. Doral Federal has
also elected to qualify for the benefits provided under Section 936 which
allows an income tax credit for a portion of the U.S. income taxes attributable
to the earnings derived from sources within Puerto Rico. See "Mortgage Banking
Business- Puerto Rico Secondary Mortgage Market and Favorable Tax Treatment"
for a description of these benefits and of certain proposals to repeal Section
936.
EMPLOYEES.
At December 31, 1995, FFCC employed 699 persons, of whom 337 were
administrative personnel, 112 were loan originators, 91 were involved in
processing of loan applications (including quality control auditors), 14 were
loan underwriters, and 145 were involved in loan servicing activities. None of
FFCC's employees is represented by a labor union and FFCC considers its
employee relations to be excellent.
REGULATION - MORTGAGE BANKING BUSINESS.
The Company's Mortgage Banking Business is subject to the rules and
regulations of FHA, VA, FNMA, FHLMC and GNMA with respect to originating,
processing, selling and servicing mortgage loans and the issuance and sale of
mortgage- backed securities. Those rules and regulations, among other things,
prohibit discrimination and establish underwriting guidelines which include
provisions for inspections and appraisals, require credit reports on
prospective borrowers and fix maximum loan amounts, and with respect to VA
loans, fix maximum interest rates. Moreover, lenders such as the Company are
required annually to submit to FNMA, FHA, FHLMC, GNMA and VA audited financial
statements, and each regulatory entity has its own financial requirements. The
Company's affairs are also subject to supervision and examination by FNMA, FHA,
FHLMC, GNMA, HUD and VA at all times to assure compliance with the applicable
regulations, policies and procedures. Mortgage origination activities are
subject to, among others, the Equal Credit Opportunity Act, Federal
Truth-in-Lending Act and the Real Estate Settlement Procedures Act and the
regulations promulgated thereunder which, among other things, prohibit
discrimination and require the disclosure of certain basic information to
mortgagors concerning credit terms and settlement costs. The Company is also
subject to regulation by the Commissioner, with respect to, among other things,
licensing requirements and establishment of maximum interest rates. Although
the Company believes that
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it is in compliance in all material respects with applicable Federal and Puerto
Rico laws, rules and regulations, there can be no assurance that more
restrictive laws or rules will not be adopted in the future, which could make
compliance more difficult or expensive, restrict the Company's ability to
originate or sell mortgage loans or sell mortgage-backed securities, further
limit or restrict the amount of interest and other fees earned from the
origination of loans, or otherwise adversely affect the business or prospects
of the Company. See "Mortgage Banking Business-General."
FFCC is licensed by the Commissioner as a mortgage banking institution in
Puerto Rico. Such authorization to act a mortgage banking institution must be
renewed as of January 1 of each year. In the past, FFCC has not had any
difficulty in renewing its authorization to act as a mortgage banking
institution, and management is unaware of any existing practices, conditions or
violations which would result in FFCC being unable to receive such
authorization in the future. Doral Mortgage's operations in the State of
Florida are subject to supervision by the Florida Department of Banking and
Finance.
Section 5 of the Puerto Rico Mortgage Banking Institutions Law (the
"Mortgage Banking Law") requires the prior approval of the Commissioner for the
acquisition of control of any mortgage banking institution licensed under the
Mortgage Banking Law. For purposes of the Mortgage Banking Law, the term
"control" means the power to direct or influence decisively, directly or
indirectly, the management or policies of a mortgage banking institution. The
Mortgage Banking Law provides that a transaction that results in the holding of
less than 10% of the outstanding voting securities of a mortgage banking
institution shall not be considered a change of control. Pursuant to Section 5
of the Mortgage Banking Law, upon receipt of notice of a proposed transaction
that may result in change of control, the Commissioner is obligated to make
such inquiries as he deems necessary to review the transaction. Under the
Mortgage Banking Law, the determination of the Commissioner whether or not to
authorize a proposed change of control is final and non-appealable.
REGULATIONS - SAVINGS AND LOAN OPERATIONS.
THE COMPANY
As a result of the acquisition of Doral Federal in September 1993, FFCC
became a savings and loan holding company ("SLHC") subject to the restrictions
and requirements of the Home Owners' Loan Act, as amended (the "HOLA"). FFCC
is registered as an SLHC with the Director (the "Director") of the Office
of Thrift Supervision (the "OTS") and is subject to the various requirements of
Sections 10 and 11 of the HOLA and the regulations thereunder, including
examination, supervision and reporting requirements. Of particular importance,
is the requirement that a subsidiary savings association give the Director at
least 30 days' advance notice of the proposed declaration by its directors of
dividends on its stock. Any such dividend declared within the 30 day notice
period, or declared without giving such notice, is invalid. Payment of cash
dividends by a savings association on shares of its capital stock is also
subject to the limitations on capital distributions imposed by the OTS. See
"Regulation -- Savings and Loan Operations - Doral Federal - Dividends."
Federal law and OTS regulations place certain limits on the types of
activities in which a SLHC and its subsidiaries may engage. However, in
general, these activity restrictions do not apply to a holding company that
controls only one savings and loan association, provided such association meets
the "qualified thrift lender" test which generally requires an association to
have 65% of its portfolio assets in "qualified thrift investments" for nine
months out of the immediately preceding 12 months. For Puerto Rico based
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institutions, these investments include, among other things, home
mortgages, mortgage-backed securities, and personal loans. In the event a
SLHC's subsidiary savings association does not hold sufficient "qualified
thrift assets" to meet the "qualified thrift lender test", an SLHC will be
deemed for regulatory purposes to become a bank holding company. In such
event, the savings association would become subject to additional regulatory
restrictions including the application of the statutes and regulations
governing the payment of dividends by a national bank in the same manner and to
the same extent as though it were a national bank. Under the National Bank
Act, national banks are only permitted to pay dividends out of "net profits"
(as defined therein) subject to the requirement that a certain portion of net
profits must be carried periodically to the bank's surplus fund until the
surplus fund shall equal its common capital. Capital may not be used to pay
dividends. Doral Federal currently is in compliance with the "qualified thrift
lender" test and expects to continue to comply with this requirement.
With certain specific exceptions, a SLHC is prohibited from acquiring
more than 5% of the "voting shares" of a savings association that is not a
subsidiary, or of another SLHC that is not a subsidiary. An association which
is a subsidiary of a SLHC is prohibited from or subject to restrictions upon
engaging in certain transactions involving its affiliates under the provisions
of Sections 23A and 23B of the Federal Reserve Act, which are applicable, to
savings associations under Federal law. In general, the term "affiliate" with
respect to such subsidiary savings association would include the SLHC, its
subsidiaries and companies controlled by it, and would also include a bank
subsidiary of a savings association, but not a non-bank subsidiary thereof
(unless a contrary determination were made pursuant to Section 23A as to such
non-bank subsidiary).
Because of the Company's status as an SLHC, owners of the Company's
Common Stock are subject to certain restrictions and disclosure obligations
under various federal laws, including the Change in Bank Control Act (the
"Control Act") and the Savings and Loan Holding Company Act (the "SLHCA").
Regulations pursuant to the Control Act and the SLHCA generally require prior
OTS approval for an acquisition of control of an insured institution (as
defined) or holding company thereof by any person (or persons acting in
concert). Control is deemed to exist if, among other things, a person (or
persons acting in concert) acquires more than 25% of any class of voting stock
of an insured institution or holding company thereof. Control is presumed
subject to rebuttal if a person (or persons acting in concert) acquires more
than 10% of any class of voting stock or 25% of any class of nonvoting stock
and is subject to any of the "control factors" set forth in such regulations.
The control factors relate, among other matters, to the percentage of such
company's debt or equity owned by the person (or persons acting in concert),
agreements giving the person (or persons acting in concert) influence over a
material aspect of the company's management or policies, and the number of
seats on the board of directors of the company held by the person (or persons
acting in concert). One of the "control factors" is a holder's status as one
of the two largest holders of any class of voting stock. The concept of acting
in concert is very broad and also is subject to certain rebuttable
presumptions, including among others, that relatives, business partners,
management officials, affiliates and others are presumed to be acting in
concert with each other and their businesses. This regulatory requirement may
have the effect of discouraging takeover attempts against the Company and may
limit the ability of persons, other than Company directors duly authorized by
the Company's board of directors, to solicit or exercise proxies, or otherwise
exercise voting rights, in connection with matters submitted to a vote of the
Company's stockholders.
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DORAL FEDERAL
GENERAL. Doral Federal is a federal savings association. Accordingly,
its investments, borrowing, lending, issuance of securities, establishment of
offices and all other aspects of its operation are subject to the jurisdiction
of the OTS.
As a creditor and financial institution, Doral Federal is subject to
certain regulations promulgated by the Federal Reserve Board, including, without
limitations, Regulation B (Equal Credit Opportunity Act), Regulation DD (The
Truth in Savings Act) Regulation E (Electronic Funds Transfer Act), Regulation
F (Limits on Exposure to Other Banks), Regulation Z (Truth in Leading Act),
Regulation CC (Expedited Funds Availability Act), Regulation X (Real Estate
Settlement Procedures Act), Regulation BB (Community Reinvestment Act) and
Regulations C (Home Mortgage Disclosure Act). As a real property lender and as
owner of real property, including real estate owned pursuant to foreclosure,
financial institutions, including Doral Federal may also be subject to
potential liability under various statutes and regulations applicable to
property owners generally, including statutes and regulations relating to the
environmental condition of real property.
As a Eligible Depository Institution licensed to receive 936 Funds
directly from 936 Corporations, Doral Federal is subject to an annual license
renewal and certain regulations promulgated by the Commissioner. The
regulations are designed to require that 936 Funds received by Doral Federal
are channelled into investments that promote employment, production and income
in Puerto Rico.
CAPITAL REQUIREMENTS. FIRREA established capital standards for savings
associations, including three capital requirements; a "leverage limit" or "core
capital requirement," a "tangible capital requirement" and a "risk-based
capital requirement." FIRREA required the Director to promulgate regulations
to proscribe and maintain uniform capital standards for all savings
associations. Pursuant to FIRREA, these capital standards must be no less
stringent than the capital standards applicable to national banks. Current
capital requirements are discussed below.
An institution is required by statute to maintain tangible capital of
not less than 1.5% of adjusted assets. "Tangible Capital" consist of core
capital less any intangible assets, plus purchased mortgage servicing rights
valued in accordance with OTS regulations. Any purchased mortgage servicing
rights over this limit would generally be deducted in calculating tangible
capital.
The Leverage Limit requires savings associations to maintain "core
capital" of not less than 3% of adjusted total assets. The Director has
proposed revisions to the Capital Regulations to provide that only those savings
associations rated a composite of 1 under the OTS MACRO rating system will be
permitted to operate at or near the minimum statutory requirements of 3% of
adjusted total assets, while all others associations are required to meet a
minimum core capital requirement of at least 100 to 200 basis points above the
3% minimum core capital requirement. In determining the amount of additional
capital required, the OTS has indicated that it assesses both the quality of
risk management systems and the level of overall risk in each individual
association. "Core capital" generally includes common stockholders' equity
(including retained earnings), non cumulative perpetual preferred stock and any
related surplus and minority interest
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in the equity accounts of fully consolidated subsidiaries. Intangible
assets (other than purchased mortgage servicing rights includable as tangible
capital and purchased credit card relationships must be deducted from core
capital. Excess servicing fees receivable ("ESFR") are not considered
intangibles and are therefore fully includable in capital calculations. Doral
Federal did not have any qualifying supervisory goodwill or ESFR in its core
capital at December 31, 1995.
The risk-based capital requirement provides that the book value asset
will be adjusted to reflect the degree of credit risk associated with such
asset. The risk-based capital guidelines require the maintenance of capital
against off-balance sheet items, including assets sold with recourse, as well
as assets that are reported on the institution's financial statements. After
determination of an association's qualifying total capital, total risk-weighted
assets are ascertained. Under these guidelines, an association's balance sheet
assets and credit equivalent amounts of off-balance sheet items, such as
letters of credit and outstanding loan commitments, are assigned to one of
several broad risk categories, and the aggregate dollar amount of each category
is then multiplied by the risk weight associated with that category. The
resulting weighted values from each of the categories are then added together
to determine the total risk-weighted assets that comprise the denominator of
the risk-based capital ratio. The OTS regulations assign single family
residential mortgage loans and certain "qualifying multifamily mortgage loans"
to the fifty percent (50%) risk-weight category.
The risk-based capital requirement generally requires savings
associations to maintain "total capital" equal to 8% of risk-weighted assets.
For purposes of the risk-based capital requirement, "total capital" means core
capital (as described above) plus "supplementary capital" (as described below),
provided that the amount of supplementary capital may not exceed the amount of
core capital, less certain assets. Supplementary capital, includes, among
other things, general allowances for loan losses up to a maximum of 1.25% of
risk-weighted assets. Under the risk-based capital requirements, certain
assets must be excluded from total capital. At December 31, 1995, Doral
Federal had no investments, loans or other assets which were required to be
deducted from capital.
At December 31, 1995, Doral Federal complied with each of the then
current tangible capital, core capital, and risk-based capital requirements.
In the event that Doral Federal fails to satisfy any applicable capital
requirements, Doral Federal may be subject to sanctions, and its operations may
be subject to severe regulatory restrictions and limitations. Set forth below
is a description of Doral Federal's actual capital levels relative to its
regulatory capital requirements as of December 31, 1995:
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TANGIBLE CAPITAL: AMOUNT RATIO (1) CORE CAPITAL: AMOUNT RATIO RISK-BASED CAPITAL: AMOUNT Ra-
- ------------------ ------ --------- ------------- ------- --------- ------------------- ------ ----
(Dollars in Thousands)
Capital position $16,011 10% Capital position $16,011 10% Capital position $16,249 25.8
Capital requirement 2,400 1.5 Capital requirement 4,800 3 Capital requirement 5,039 8.0
------- --- ------- -- ------- ----
Excess $13,611 8.5 Excess $11,211 7 Excess $11,210 17.8
======= === ======= == ======= ====
- -----------------------
(1) Ratio of capital to adjusted total assets for tangible and core capital
and ratio of capital to risk-weighted assets for risk-based capital.
OTHER REGULATORY MATTERS
FDICIA. Under the Federal Deposit Insurance Corporation Improvement Act
of 1991 ("FDICIA") federal banking regulators must take prompt corrective
action in respect of depository institutions that do not meet minimum capital
requirements. The FDICIA and regulations thereunder establish five capital
tiers: "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized," and "critically undercapitalized." A
depository institution is deemed well capitalized if it maintains a leverage
ratio of at least 5%, a risk-based Tier I capital ratio of at least 6% and a
risk-based Total capital ratio of at least 10% and is not subject to any
written agreement or directive to meet a specific capital level. A depository
institution is deemed adequately capitalized if it is not well capitalized but
maintains a leverage ratio of at least 4% (or at least 3% if given the highest
regulatory rating and not experiencing or anticipating significant growth), a
risk-based Tier I capital ratio of at least 4% and a risk-based Total capital
ratio of at least 8%. A depository institution is deemed undercapitalized if
it fails to meet the standards for adequately capitalized institutions (unless
it is deemed significantly or critically undercapitalized). An institution is
deemed significantly undercapitalized if it has a leverage ratio of less than
3%, a risk-based Tier I capital ratio of less than 3% or a risk-based Total
capital ratio of less than 6%. An institution is deemed critically
undercapitalized if it has tangible equity equal to 2% or less of total assets.
A depository institution may be deemed to be in a capitalized category that is
lower than is indicated by its actual capital position if it received a less
than satisfactory examination rating in any one of four categories.
At December 31, 1995, Doral Federal was well capitalized. An institution's
capital category, as determined by applying the prompt corrective action
provisions of law, may not constitute an accurate representation of the overall
financial condition or prospects of Doral Federal and should be considered in
conjunction with other available information regarding the Doral Federal's
financial condition and results of operations.
FDICIA generally prohibits a depository institution from making any
capital distribution (including payment of a dividend) or paying any management
fee to its holding company if the depository institution would thereafter be
undercapitalized. In addition, undercapitalized depository institutions are
subject to growth limitations and are required to submit capital restoration
plans. The federal banking agencies may not accept a capital plan without
determining, among other things, that the plan is based on realistic
assumptions and is likely to succeed in restoring the depository institution's
capital. If a depository institution fails to submit an acceptable plan, it is
treated as if it is significantly undercapitalized. Significantly
undercapitalized depository institutions may be subject to a number of
requirements and restrictions, including orders to sell sufficient voting stock
to become adequately capitalized, requirements
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to reduce total assets and cessation of receipt of deposits from correspondent
banks. Critically undercapitalized depository institutions are subject to
appointment of a receiver or conservator.
ENFORCEMENT PROVISIONS. FIRREA's enforcement provisions are applicable
to all depository institutions, not just savings institutions. FIRREA
introduced the new term "institution-affiliated party" to agency enforcement
authority. The term includes: (i) directors, officers, employees, agents, and
controlling stockholders; (ii) persons required to file a change-in-control
notice; (iii) certain persons who participate in the affairs of the savings
institution (which include stockholders, consultants, and joint venture
partners); and (iv) independent contractors (including attorneys' appraisers,
and accountants) who knowingly or recklessly cause or participate in a
violation, breach or duty or unsafe practice likely to cause a loss to the
savings institution. FIRREA includes significantly increased penalties for
violations of cease-and-desist orders and other regulations. At the same time,
the requirements for the issuance of such orders have been lessened.
PAYMENT OF DIVIDENDS. Doral Federal's payment of dividends is subject
to the limitations of the capital distribution regulations promulgated by the
OTS. The OTS' regulation determines a savings association's ability to pay
dividends, make stock repurchases, or enter into other types of capital
distributions, according to the institution's capital position. The rule
establishes "safe-harbor" amounts of capital distributions that institutions
can make after providing notice to the OTS, but without constituting an unsafe
or unsound practice. Associations that do not meet their capital requirements
can make distributions only with the prior approval of the OTS.
For associations such as Doral Federal, that meet all applicable capital
requirements, the safe-harbor amount is the greater of (a) 75% of net income
for the prior four quarters, or (b) the sum of (i) the current year's net
income and (ii) the amount that causes the excess of any component of the
association's capital to be less then one-half of such excess at the beginning
of the year; provided, however, that the association must continue to satisfy
applicable capital requirements after the distribution.
On December 5, 1994, the OTS published a notice of proposed rulemaking to
amend its capital distribution regulation. Under the proposal, institutions
would be permitted to make capital distributions that would not result in their
capital being reduced below the level required to remain "adequately
capitalized," as defined above under FDICIA. In addition, savings association
which have one of the two highest composite CAMEL ratings and are not held by a
savings and loan holding company would not be required to provide advance
notice of the capital distribution to the OTS. The Company does not believe
that the proposal will adversely affect its ability to make capital
distributions if it is adopted substantially as proposed.
DEPOSIT INSURANCE. Doral Federal's deposits are insured to the fullest
extent of the law by the Savings Association Insurance Fund ("SAIF"), which is
managed by the FDIC. The Federal Deposit
Insurance Corporation Improvements Act ("FDICIA") required the FDIC to
implement a risk-based assessment system, under which an institution's
assessment will be based on the probability that the deposit insurance fund
will incur a loss with respect to the institution, the likely amount of any
such loss, and the revenue needs of the deposit insurance fund. Under this
system, the FDIC established premium rates for all FDIC insured institutions
with a range from 0.23% to 0.31% based upon their capital ratios and supervisory
evaluation. Doral Federal's insurance premium assessment was set at 0.23%
effective January 1, 1994.
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The FDIC revised the premium schedule for Bank Insurance Fund ("BIF")
insured banks, effective in the third quarter of 1995, to provide a range of
.04% to .31% of deposits (as compared to the former range of .23% to .31% of
deposits for both BIF and SAIF insured institutions) in anticipation of the BIF
achieving its statutory reserve ratio. Effective January 1, 1996, the schedule
was further revised to provide a range of 0% to .27% with a minimum annual
premium of $2,000. The lower premiums do not apply to SAIF members. It
is anticipated that the SAIF will not be adequately recapitalized until 2002,
absent a substantial increase in premium rates or the imposition of special
assessments or other measure, such as a merger of the SAIF and the BIF. As a
result of this disparity, SAIF members could be placed at a significant
competitive disadvantage to BIF members due to higher costs for deposits
insurance.
Proposals have been introduced in Congress for a one-time assessment to be
imposed on all SAIF assessable deposits, as of March 31, 1995, in order to
recapitalize the SAIF and eliminate the disparity. Under the proposed
legislation, the BIF and the SAIF would be merged effective January 1, 1998.
The special assessment rate is anticipated to be .70% to .90% of deposits.
Based upon Doral Federal's level of SAIF deposits at March 31, 1995, and
assuming a special assessment of .90%, Doral Federal's assessment would be
approximately $861,000 on a pre-tax basis.
CLASSIFICATION OF ASSETS. Savings associations are required to review
their assets on a regular basis and, if warranted, classify them as
"substandard," "doubtful," or "loss." Adequate valuation allowances,
consistent with GAAP, are required to be established for classified assets. If
any assets are classified as substandard or doubtful, the association must
establish a prudent general allowance for possible future loan losses with
respect thereto. If an asset, or a portion thereof, is classified as a loss,
the association must either establish a specific valuation allowance equal to
the amount classified as loss or charge off such amount. In addition, a
savings association is required to set aside adequate valuation allowances to
the extent that any affiliate possesses assets which pose a risk to the savings
and loan association. The association's OTS Regional Director has the
authority to approve, disapprove or modify classification and amount
established as an allowance pursuant to such classification. In addition, a
savings association is required to record as liabilities off balance sheet
items, such as letters of credit, when loss becomes probable and estimable.
The following table sets forth information with respect to Doral
Federal's classified assets as of December 31, 1995:
AT DECEMBER 31, 1995
------------------------------------------------------------------
SUBSTANDARD DOUBTFUL LOSS TOTAL
----------- -------- ---- -----
(DOLLARS IN THOUSANDS)
REAL ESTATE LOANS:
One to four family . . . . . . . . $ 856 $0 $0 $ 856
Commercial . . . . . . . . . . . . 160 0 0 160
REO . . . . . . . . . . . . . . . . . 0 0 0 0
Consumer loans . . . . . . . . . . . 0 0 0 0
Other . . . . . . . . . . . . . . . .
1 0 4 5
---- -- -- -----
Total classified assets . . . . . . . $1017 $0 $4 $1021
===== == == =====
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PROPOSED BANKING LEGISLATION. Various legislation, including proposals
to overhaul the bank regulatory system, expand bank and bank holding company
powers and limit the investments that a depository institution may make with
insured funds, is from time to time introduced in Congress. The Company cannot
determine the ultimate effect that such potential legislation, if enacted, or
implementing regulations, would have upon its financial condition or results of
operations.
POSSIBLE CONVERSION AND REGULATION UNDER THE FEDERAL BANK HOLDING COMPANY ACT
Legislation has been introduced in the United States Congress that would
require, by no later than January 1, 1998, that all federally chartered savings
associations, such as Doral Federal, either convert to a national bank, state
bank or state savings association or liquidate. Any institution not converted
by such date would become a national bank by operation of law. Under such
proposed legislation, the OTS would be abolished and its functions transferred
to the other Federal banking agencies.
Existing savings and loan holding companies, such as the Company, would
become bank holding companies subject to supervision and examination by the
Federal Reserve Board (the "Federal Reserve") under the Bank Holding Company
Act of 1956 (the "BHCA"). The BHCA and Federal Reserve regulations promulgated
thereunder generally place limitations on the types of activities in which a
bank holding company and its subsidiaries may engage. In general, such
activities must be banking services or activities so closely related to the
business of banking as to be a proper incident thereto. Regulation K
promulgated by the Federal Reserve, generally grants bank holding companies and
their subsidiaries somewhat broader powers with respect to activities conducted
"outside the United States" than with respect to activities conducted within
the United States. For purposes of Regulation K, Puerto Rico is considered to
be outside the United States. Notwithstanding the foregoing, under the
provisions of the proposed legislation, any savings and loan holding company
that becomes a bank holding company as a result of such act would be
grandfathered from the bank holding company activity restrictions described
above, provided that: (i) any former savings association subsidiary continues
to meet the "qualified thrift lender test;" (ii) the former savings subsidiary
continues to limit its activities to those permissible under its former Federal
thrift charter, and (iii) the holding company does not acquire any additional
FDIC insured depository institution. At this time, certain aspects of the
proposed legislation remain unresolved and no assurances can be given as to
whether or in what form the legislation will be enacted or its effect on Doral
Federal or the Company.
Independent of the requirements of any pending legislation, the Company is
currently considering the possibility of converting Doral Federal into a Puerto
Rico chartered commercial bank as a result of the reduction in the 936 Credit
introduced by the OBRA Amendments as well as the possible repeal of Section 936
as part of the ongoing federal budget negotiations. To the extent that the
income earned by Doral Federal is not fully covered by the 936 Credit, Doral
Federal would be subject to double taxation on its income earned in Puerto Rico
since it is generally not entitled to a credit under Puerto Rico tax law for
federal income taxes paid with respect to income earned in Puerto Rico. In
addition, dividends payable by a United States corporation, such as Doral
Federal, to a Puerto Rico corporation, such as the Company, are not entitled to
any dividends received deduction and are subject to taxation as ordinary income
at the normal statutory tax rates.
In addition to the activity restrictions discussed above, the BHCA also
imposes various other restrictions on bank holding companies and their
subsidiaries. Many of these restrictions are similar to those currently
imposed on the Company under the SLHCA. For example, the BHCA contains change
of control provisions similar to those contained in the SLHCA. See "Regulation
- - Savings and Loan Operations - The Company". Section 23A and 23B of the
Federal Reserve Act also apply in the same manner to bank holding companies and
their subsidiaries as to savings and loan holding companies.
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As a bank holding company, the Company would, however, be subject to
certain additional regulatory restrictions that are not otherwise applicable to
savings and loan holding companies. For example, unlike savings and loan
holding companies, bank holding companies are subject to certain regulatory
capital requirements. Under the Federal Reserve's risk-based capital
guidelines, a bank holding company must maintain a ratio of total capital (the
"Total Capital") to risk-weighted assets (including certain off-balance sheet
items, such as stand-by letters of credit) equal to 8%. At least half of the
Total Capital is to be comprised of common equity, retained earnings, minority
interests in consolidated subsidiaries, noncumulative perpetual preferred stock
and a limited amount of cumulative perpetual preferred stock, less goodwill and
less certain intangible assets discussed below ("Tier 1 capital"). The
remainder may consist of a limited amount of subordinated debt, other preferred
stock, certain other instruments, and a limited amount of loan and lease loss
reserves ("Tier 2 capital").
In addition, the Federal Bank Reserve has established minimum leverage
ratio guidelines for bank holding companies. These guidelines provide for a
minimum ratio of Tier 1 capital to average quarterly assets of 3% for bank
holding companies that meet certain specified criteria, including that they
have the highest regulatory rating. All other bank holding companies are
required to maintain a leverage ratio of 3% plus an additional cushion of a
least 100 to 200 basis points. The guidelines also provide that banking
organizations experiencing internal growth or making acquisitions will be
expected to maintain strong capital positions substantially above the minimum
supervisory levels, without significant reliance on intangible assets.
Furthermore, the guidelines indicate that the Federal Reserve will continue to
consider a "tangible Tier 1 leverage ratio" (deducting all intangibles) and
other indication of capital strength in evaluating proposals for expansion or
new activities. The tangible Tier 1 leverage ratio is the ratio of a banking
organization's Tier 1 capital, less all intangibles, to total assets less all
intangibles.
The Federal Reserve has adopted regulations with respect to risk-based and
leverage capital ratios that require most intangibles, including core deposit
intangibles, to be deducted from Tier 1 capital. The regulations, however,
permit the inclusion of a limited amount of intangibles related to purchased
mortgage servicing rights and purchased credit card receivables. The Federal
Reserve has also decided to exclude from regulatory capital the amount of net
unrealized gains and losses on securities available-for-sale, except the net
unrealized losses of equity securities with readily determinable fair values.
The Federal Reserve has issued a policy statement that provides that
insured banks and bank holding companies should generally pay dividends only
out of current operating earnings. In addition, under Federal Reserve policy,
a bank holding company is expected to act as a source of financial strength to
each of its subsidiary banks and to commit resources to support each subsidiary
bank. This support may be required at times, when absent such policy, the bank
holding company might not otherwise provide such support.
The Company believes that if it were to become subject to the provisions
of the BHCA it would be in compliance with all of the above regulatory and
capital requirements and would be able to continue to conduct its Mortgage
Banking Business as presently conducted.
The conversion of Doral Federal into a Puerto Rico chartered bank would
also subject Doral Federal to supervision and examination by the Commissioner
and to the provisions of the Puerto Rico Banking Act and the regulations
promulgated thereunder. The Company does not believe that the application of
such laws or regulations would have an adverse effect on the manner in what
Doral Federal currently conducts its operations.
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In addition to the possible conversion of Doral Federal into a Puerto Rico
commercial bank and the possible application of the BHCA to the Company's
operations, the Company may, in the future, consider other changes in corporate
structure or organization that could result in the transfer of all or a part of
the Company's Mortgage Banking Business to Doral Federal or a subsidiary of
Doral Federal. Any such reorganization could subject the Company to additional
regulatory requirements.
ITEM 2. PROPERTIES
The executive and administrative offices of the Company are located at
1159 Franklin D. Roosevelt Avenue, Puerto Nuevo, San Juan, Puerto Rico and
consist of approximately 11,136 square feet of office space. Doral's executive
and administrative offices are located at 650 Munoz Rivera Avenue, San Juan,
Puerto Rico and consist of approximately 33,000 square feet of office space.
Both of these facilities are leased , The Company also leases additional office
space of approximately 31,000 square feet throughout Puerto Rico. These
offices are leased for various terms expiring through 2005. Annual aggregate
rental payments made in the years 1995, 1994 and 1993 were $2,097,000,
$2,004,000 and $1,445,000, respectively. Except for its interest in real
estate held in the ordinary course of business (including REO as a result of
foreclosures), the Company does not own any real property except for the
building and underlying real property where Doral Federal's branch in Catano,
Puerto Rico is located. The building where the branch is located consists of
approximately 2,000 square feet.
ITEM 3. LEGAL PROCEEDINGS
In the opinion of the Company's management, the pending and threatened
legal proceedings of which management is aware will not have a material adverse
effect on the financial condition or results of operations 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
FFCC's Common Stock, $1.00 par value (the "Common Stock"), is traded on
the over-the-counter market and is quoted on the National Association of
Securities Dealers Automated Quotation National Market System ("NASDAQ NMS")
under the symbol "FRCC." The Company's Common Stock began trading on the
NASDAQ NMS on December 19, 1988.
FFCC's 10-1/2% Cumulative Convertible Preferred Stock, Series A, $1.00 par
value (the "Series A Preferred Stock") is traded on the over-the-counter market
and is quoted on the NASDAQ system under the symbol FRCCP. The Company's
Series A Preferred Stock began trading on the NASDAQ system on July 1, 1991.
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The table below sets forth, for the calendar quarters indicated, the high
and low sales prices on the NASDAQ NMS and the high and low bid quotes on the
NASDAQ system, for the Common Stock and Series A Preferred Stock, respectively,
and the dividends declared on the Common Stock and Series A Preferred Stock
during such periods. The quotations for the Series A Preferred Stock represent
inter-dealer prices, without retail mark-up, mark-down or commissions and do
not necessarily represent actual transactions.
MARKET PRICE
COMMON SERIES A PREFERRED DIVIDENDS DECLARED*
CALENDAR -------------------- ------------------ SERIES A
YEAR QUARTER HIGH LOW HIGH LOW COMMON PREFERRED
- ---- ------- ---- --- ---- --- ------ ---------
1994 1st $19 $13 3/4 $36 1/2 $29 1/2 $0.13 $0.2625
2nd 14 3/4 11 29 1/2 23 3/4 0.13 0.2625
3rd 15 10 5/8 28 23 3/4 0.13 0.2625
4th 13 1/2 10 1/2 27 22 0.13 0.2625
1995 1st $13 1/2 $10 1/2 $24 1/2 $22 $0.13 $0.2625
2nd 15 1/2 12 29 1/2 24 1/4 0.15 0.2625
3rd 17 3/4 14 33 1/2 28 0.15 0.2625
4th 20 15 3/4 37 1/4 32 0.15 0.2625
As of March 8, 1996, the approximate number of record holders of the
Company's Common Stock and Series A Preferred Stock was 892 and 65,
respectively, which does not include beneficial owners whose shares are held in
record names of brokers and nominees. The last sales price for the Common
Stock as quoted on the NASDAQ NMS on such date was $19.75 per share. The last
sales price for the Series A Preferred Stock on February 6, 1996 (the last day
such stock traded prior to March 8, 1996) was $40.00 per share.
After becoming a public corporation in December 1988, FFCC did not declare
any dividends until the third quarter of 1989 when the Board of Directors
authorized the payment of a regular quarterly cash dividend of $0.050 per
share. The quarterly cash dividend was increased by the Board of Directors to
$0.0625 per share during the second quarter of 1990, to $0.075 per share during
the fourth quarter of 1991 and increased again to $0.10 per share during the
first quarter of 1993. The cash dividend was further increased to $0.13
effective for the first quarter of 1994 and to $0.15 effective for the second
quarter of 1995. The payment of cash dividends in the future is dependent upon
the earnings, cash position and capital needs of the Company, general business
conditions and other matters deemed relevant by the Company's Board of
Directors.
The ability of the Company to pay dividends in the future is limited by
various restrictive covenants contained in the debt agreements of the Company,
the earnings, cash position and capital needs of the Company, general, business
conditions and other factors deemed relevant by the Company's Board of
Directors. The Company is prohibited under the Debenture Purchase Agreement
from paying dividends on
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any capital stock (other than dividends payable in capital stock or in stock
rights), if an event of default under such agreement exists at such time, or if
the amount of dividends payable by the Company together with the aggregate
amount of dividends paid and other capital distributions made since June 1,
1995, exceed the sum of:(i) 50% of the Company's Consolidated Net Income (as
defined in the Debenture Purchase Agreement), accrued from June 1, 1995 to the
end of the quarter ending not less than 45 days prior to the dividend payment
date; (ii) $20 million; and (iii) the net proceeds of any sale of capital stock
subsequent to June 1, 1995. In addition, under the Debenture Purchase
Agreement, the Syndicated Credit Agreement and other debt agreements of the
Company, the Company is prohibited from paying dividends if it fails to
maintain specified minimum levels of net worth, net earnings to debt service
and dividends ratios, and certain other financial ratios.
The terms of the Company's 101/2% Cumulative Convertible Preferred Stock,
Series A (the "Series A Preferred Stock") do not permit the payment of cash
dividends on Common Stock if dividends on the Series A Preferred Stock are in
arrears. The holders of shares of Series A Preferred Stock are entitled to
receive cumulative cash dividends when, as and if declared by the Board of
Directors, out of assets of the Company legally available therefor at a rate of
$1.05 per share of Series A Preferred Stock. On March 20, 1996, the Company
announced that it will redeem all outstanding shares of the Series A Preferred
Stock on May 10, 1996, at a redemption price of a $10.90 per share, plus
accrued and unpaid dividends from April 1, 1996 through May 10, 1996.
The Puerto Rico Interal Revenue Code, generally imposes a withholding tax
on the amount of any dividends paid by FFCC to individuals, whether residents
of Puerto Rico or not, trusts, estates, special partnerships and non-resident
foreign corporations and partnerships at a special 10% withholding tax.
Prior to the first dividend distribution for the taxable year, individuals
who are residents of Puerto Rico may elect to be taxed on the dividends at the
regular graduated rates, in which case the special 10% tax will not be withheld
from such year's distributions.
United States citizens who are non-residents of Puerto Rico may also make
such an election, and will not be subject to Puerto Rico tax on dividends if
said individual's gross income from sources within Puerto Rico during the
taxable year does not exceed $1,300 if single, or $3,000 if married.
United States income tax law permits a credit against United States income
tax liability, subject to certain limitations, for certain foreign income taxes
paid or deemed paid with respect to such dividends.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected consolidated financial
data for the Company on a historical basis for each of the five years ended
December 31, 1995. This information should be read in conjunction with the
Company's Consolidated Financial Statements and related notes thereto and
"Management's Discussion and Analysis" contained herein.
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Year Ended December 31,
-------------------------------------------------------------------
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
(Dollars in thousands except for per share data)
INCOME STATEMENT DATA:
Revenues $ 91,837 $ 72,043 $ 70,228 $ 49,804 $ 39,430
Interest expense 43,380 23,252 9,710 9,270 12,303
Loan origination costs and
administrative and general
expenses 26,396 30,046 29,597 24,118 17,407
Income before income taxes 22,061 18,745 30,921 16,416 9,720
Income taxes 2,500 2,530 9,601 3,371 2,987
Income before cumulative effect
19,560 16,215 21,320 13,045 6,733
Cumulative effect -- 1,215 - - -
Net income 19,560 17,430 21,320 13,045 6,733
Cash dividends paid 4,374 3,943 3,142 2,182 1,620
BALANCE SHEET DATA:
Mortgage loans held for sale
mortgage-backed securities
held for trading, securities
available for sale, and
mortgage notes receivable, net $ 668,005 $ 582,977 $ 388,232 $ 261,063 $ 230,861
Loans receivable, net and
mortgage-backed securities and
investments held to maturity
129,301 101,613 16,901 None None
Total assets 917,922 768,019 486,431 320,972 270,949
Loans payable and securities
sold under agreements to
repurchase 598,436 569,436 335,994 227,179 210,548
Deposits 95,740 66,471 26,451 - -
Stockholders' Equity 129,017 90,496 76,945 58,467 36,041
PER SHARE DATA:(1)
Net Income- Primary 2.65 2.46 $ 3.15 2.35 1.26
- Fully diluted(2) 2.53 2.30 2.81 2.06 1.25
Cash dividends
Common Stock 0.58 .52 0.40 0.30 0.2625
Series A Preferred 1.05 1.05 1.05 1.05 .525
Stock(2)
Weighted average shares
outstanding:
Primary . . . . . . . . . . . 7,307,946 6,942,734 6,614,854 5,321,600 5,135,206
Fully diluted . . . . . . . . 7,760,135 7,576,964 7,576,964 6,347,392 5,411,744
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Year Ended December 31,
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
(Dollars in thousands except for per share data)
OPERATING DATA:
Mortgage loans originated
purchased . . . . . . . . . . $ 636,000 $ 823,834 $1,433,488 $ 723,723 $ 387,000
Loan Servicing Portfolio . . . $2,668,000 $2,644,000 $2,375,000 $1,700,000 $1,400,000
--------------------
(1) Adjusted to reflect two-for-one stock split effective December 10, 1993.
(2) The Series A Preferred Stock was issued in July 1991.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
FFCC experienced significant growth in its business from 1991 to 1993,
reaching record levels in 1993 as a result of the historically low levels of
interest rates and the increased demand for refinancing loans. Mortgage
production decreased in 1995 and 1994, as compared to 1993, as a result of
decreased demand for refinancing loans. FFCC, nevertheless, continued to be
the leading originator of mortgage loans in Puerto Rico, in terms of the volume
of originations of first mortgages on single family residences. The volume of
loans originated by FFCC was approximately $559 million, $760 million, $1.43
billion, $694 million and $360 million for the years ended December 31, 1995,
1994, 1993, 1992 and 1991, respectively.
The increases in 1992 and 1993 were primarily due to declines in mortgage
interest rates which plunged to their lowest levels in decades during 1993,
thereby stimulating demand for both refinancing loans and loans to finance the
acquisition of new and existing residential units. The decrease in 1994 as
compared to 1993 is attributable to rising interest rates causing a lower level
of loan originations, decreased refinancing activity and increased competition.
The decrease in 1995 as compared to 1994 was the result of continued reduced
demand for mortgage loans, especially refinancing loans. Refinancing loans
comprised 41% of loan originations in 1995 compared to 59% and 80% in 1994 and
1993, respectively.
The Company became active again in the Puerto Rico wholesale mortgage loan
purchase market during the second quarter of 1994 to diversify its sources of
loan production and compensate for the decrease in volume caused by higher
interest rates and increased competition. During 1992 and 1993, the Company's
strategy was to increase its servicing portfolio through internal originations.
As a result of the high volume of loans originated in those years, the Company
was not active in the wholesale loan purchase market during 1992 and 1993. The
amount of loans purchased from third parties was approximately $77 million, $63
million, $1 million, $29 million and $48 million for the years ended December
31, 1995, 1994, 1993, 1992 and 1991, respectively. The Company believes that
the purchase of mortgage loans is a low cost method of increasing mortgage loan
production. Purchases of loans from third parties are generally limited to FHA
and VA loans.
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The Company entered the savings and loan industry in September 1993
through the acquisition of all the outstanding stock of Doral Federal Saving
Bank, which formerly operated under the name of Catano Federal Savings
Bank("Doral Federal"). Doral Federal operates through two branches in Puerto
Rico. During the year ended December 31, 1994, Doral Federal contributed only
$205,000 to the consolidated net income of the Company as a result of the
incurrence of expenses associated with creating the infrastructure necessary to
support bank growth. For the year ended December 31, 1995, Doral Federal's
net income increased to $1.5 million reflecting a substantial increase in
interest earning assets. Doral Federal increased its assets from $86.4 million
as of December 31, 1994 to $160.4 million as of December 31, 1995. This growth
was funded largely through increases in certificate of deposit accounts and,
non-interest bearing deposits, advances from the Federal Home Loan Bank of New
York ("FHLB-NY") and the private placement of five year notes secured by
FHLB-NY letters of credit with corporations ("936 Corporations") electing the
benefits of Section 936 of the Internal Revenue Code ("Section 936").
FFCC's results of operations are primarily influenced by: (i) the
direction of interest rates; (ii) the level of demand for mortgage credit,
which is affected by such external factors as the level of interest rates and
the strength of the economy in Puerto Rico; and (iii) the relationship between
mortgage interest rates and the costs of funds.
The principal components of FFCC's revenues are: (i) loan origination
fees and net gains on sales of mortgage loans and mortgage-backed securities in
the secondary mortgage market; (ii) net interest income; (iii) loan servicing
fees; (iv) gain on sale of servicing rights; and (v) other income.
Year Ended December 31,
------------------------------
1995 1994 1993
---- ---- ----
(Dollars in thousands)
Mortgage loan sales
and fees $13,529 $10,573 $35,230
------- ------- -------
Interest income 61,907 46,508 23,775
Interest expense 43,380 23,252 9,710
------- ------- -------
Net interest income 18,527 23,256 14,065
Loan servicing fees 10,577 11,448 8,627
Gain on sale of servicing rights 5,205 3,003 2,378
Other income 620 511 218
CONSOLIDATED RESULTS OF OPERATIONS FOR EACH OF THE THREE YEARS IN THE PERIOD
ENDED DECEMBER 31, 1995.
NET INCOME. The Company's net income for the year ended December 31,
1995 increased to $19.6 million compared to $17.4 million for 1994.
Consolidated results include the operations of Doral Federal, which was
acquired by the Company in September 1993. Doral Federal contributed
approximately $1.5 million to the Company's consolidated net earnings in 1995,
compared to $205,000 for 1994. Consolidated results for 1995 reflect the
adoption by the Company as of April 1, 1995 of Statement of Financial
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Accounting Standards ("SFAS") No. 122 "Accounting for Mortgage Servicing
Rights." Additional net income of approximately $1.5 million was realized for
the year ended December 31, 1995, as a result of the adoption of SFAS No. 122.
Since SFAS No. 122 does not permit retroactive application, the results for
1995 are not directly comparable to prior years. See "New Accounting
Standards" herein. Results for 1994 include a one time benefit of $1.2 million
from the cumulative effect of the adoption of SFAS No. 115 "Accounting for
Certain Investments in Debt and Equity Securities" as of January 1, 1994. This
pronouncement requires the Company to carry its mortgage-backed securities
inventory at market value. Any gains or losses from market fluctuations are
reflected in the Company's results from operations.
REVENUES FROM MORTGAGE LOAN SALES AND FEES. FFCC sells substantially all
of the loans that it originates, as part of its mortgage banking business,
except for certain mortgage loans originated by Doral Federal, which are
generally held until maturity. When FFCC sells mortgage loans and
mortgage-backed securities, it realizes a gain or loss which is equal to the
difference between FFCC's carrying cost and the selling price of the loans
sold, net of commitment fees paid. Net gain or loss on sale of loans is
affected by interest rate fluctuations on fixed-rate loans and securities, as
well as by the tax status of interest on mortgage loans under Puerto Rico
income tax statutes. Substantially, all the mortgage loans originated by FFCC
are fixed interest rate loans.
Revenues from mortgage loan sales and fees, increased by 28% during 1995
compared to a decrease of 70% in 1994 and an increase of 43% in 1993. The
increase for 1995 was primarily due to the adoption SFAS No. 122 during the
second quarter of 1995 which had the effect of increasing mortgage loans sales
and fees by approximately $2.6 million. SFAS No. 122 has the effect of
increasing the gain on the sale of mortgage loans by requiring that the
carrying costs of mortgage loans be reduced by a proportion of the fair value
of the related mortgage servicing rights. The decrease in 1994 was due to
interest rate increases resulting in a lower level of loan originations, lower
gains on the sale of mortgage loans and pressures on pricing as a result of
increased competition. The increase for 1993 was the result of increased
volume of loan originations due to a sharp decline in interest rates and
increased gains on sale of mortgage loans, as a result of favorable market
conditions which permitted the Company to obtain better prices on sales of
mortgage loans and mortgage-backed securities.
The total volume of loans originated was approximately $559 million for
the year ended December 31, 1995 compared to $760 million for the prior year.
Demand for mortgage loans, especially refinancing loans, continued lower during
1995 notwithstanding a decrease in interest rates during 1995. The increase in
prevailing interest rates during 1994 significantly decreased the unusually
high refinancing activity experienced during 1993. Refinance loans comprised
41% of production for 1995 versus 59% in 1994 and 80% in 1993. During 1995,
decreased demand for mortgage loans in the Puerto Rico market led to increased
competition among mortgage bankers and banks to attract prospective borrowers.
FFCC, however, continues to be the largest originator of mortgage loans in
Puerto Rico. In 1995, the Company issued $366 million of GNMA mortgage backed
securities to rank No. 1 in Puerto Rico and No. 31 in the USA in such issuances
according to the "Mortgage Marketplace."
During 1995, the Company continued its program of pooling non-conforming
conventional loans into collateralized mortgage obligations ("CMOs") to be
issued by grantor trusts for sale to investors. Mortgage loan sales and fees
reflect pretax profits of approximately $253,000, $463,000 and $3.5 million for
the years ended December 31, 1995, 1994 and 1993, respectively, in connection
with the pooling and sale of approximately $75 million, $101 million and $115
million, respectively, in conventional non-conforming mortgage loans to
various grantor trusts. While the Company anticipates that it will enter into
similar
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transactions in the future, especially with non-conforming loans, the frequency
of such transactions and future gains related thereto, if any, will be
dependent on then existing market conditions.
FFCC capitalizes as an asset any excess servicing fees receivable on loans
sold with servicing rights retained whenever the stated servicing fee rate is
materially higher than the servicing fee normally permitted by FNMA or FHLMC.
Bulk sales of mortgages loans made during 1995 resulted in the recording of
approximately $2.6 million of excess servicing compared to $5.8 million and $3
million in 1994 and 1993, respectively. The excess servicing fee receivable is
recognized at the time of sale of the related loan as an adjustment to the
resulting gain or loss on sale of the loan and is recorded in the accompanying
Consolidated Statement of Income and Retained Earnings under "Mortgage loan
sales and fees."
The amortization of excess servicing fees is based on the amount and
timing of estimated future cash flows. See Note 2 to the Notes to Consolidated
Financial Statements. Amortization of such excess servicing fees for each of
the years ended December 31, 1995, 1994 and 1993 was approximately $988,000,
$570,000 and $160,000, respectively. The amortization of excess servicing fee
receivable is recorded as a reduction of servicing income.
For the years ended December 31, 1995 and 1993, increases in mortgage loan
sales and fees were net of losses on options on futures contracts used for
hedging purposes in the amounts of $5.4 million and $1.4 million, respectively,
while in 1994 such hedging activities produced gains in the amount of $2.2
million thereby increasing mortgage loan sales and fees by the same amount.
NET INTEREST INCOME. Net interest income is the difference between the
interest income earned on mortgage loans and mortgage-backed securities held
for trading and for investment, and the interest paid by FFCC on the short-term
warehousing lines of credit with commercial banks, repurchase agreements,
gestation lines of credit, and advances and deposits (in the case of Doral
Federal) and other financing arrangements used to finance the carrying of such
loans and mortgage-backed securities. The conditions that affect net interest
income from period to period include the relationship between prevailing
mortgage rates and the prime rate, the London Interbank Bid Rate for deposit of
U.S. dollars ("LIBID"), the cost of tax-advantaged funds deposited in Puerto
Rico financial institutions ("936 Funds"), interest rates on fixed-rate loans
and the Company's average holding period before mortgage loans are sold.
In each year since FFCC's inception, interest income earned by FFCC on its
mortgage loans and mortgage-backed securities has exceeded interest expense on
FFCC's short-term borrowings and other financing arrangements. Net interest
income decreased by approximately 20% from 1994 to 1995, and increased by
approximately 65% from 1993 to 1994. The decrease in net interest income
reflects lower interest spreads, primarily from mortgage banking operations, as
mortgage interest rates have declined more rapidly than short-term interest
rates payable on warehousing and repurchase agreements lines of credit and the
other funding vehicles used to finance such assets. The Company's weighted
average interest rate spread was approximately 250 basis points during 1995 as
compared with approximately 385 basis points and 411 basis points during 1994
and 1993, respectively. The decrease also reflects additional interest costs
incurred in connection with borrowings not directly related to interest earning
assets, including a servicing secured bank term loan and ten-year convertible
subordinated debentures. See "Liquidity and Capital Resources." The decrease
in the interest rate spread from 1993 to 1994 was due to higher short-term
borrowing costs. The Company has been able to continue to maintain a positive
interest spread due to, among other things, the origination of higher yielding
mortgages and the funding of mortgage loans held by Doral Federal through lower
costing deposits and the availability of low costs 936 Funds. As of December
31, 1995,
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approximately $49.5 million, ($18.5 million of such deposits are not reflected
in the Consolidated Financial Statements of the Company because of
inter-company eliminations), or 43% of total deposits held at Doral Federal of
non-interest bearing accounts, comprised primarily of servicing accounts and
corporate demand accounts maintained by the Company and its affiliates.
Doral Federal contributed approximately $4.3 million of the consolidated
net interest income of the Company for the year ended December 31, 1995
compared to $2.1 million for the year ended December 31, 1994. This increase
reflects an increase in average interest earning assets from $70.8 million for
the year ended December 31, 1994 to $106.8 million for the year ended December
31, 1995 and the maintenance of an average interest rate spread of 407 basis
points for 1995 compared to 430 basis points for 1994.
Net interest income has generally represented a greater proportion of the
Company's total net income than that of typical mortgage banking institutions.
This results primarily from the fact that the Company is able to finance a
substantial portion of the mortgage loans that it originates with lower cost
funds and holds mortgage-backed securities, mainly GNMA certificates, for
longer periods of time prior to sale than is customary for mortgage bankers in
the United States, in order to maximize the interest produced by these
securities. During the year ended December 31, 1995, the Company held mortgage
loans and mortgage-backed securities for an average period of 352 days prior to
sale as compared to 212 days for the year ended December 31, 1994. This
increase in the amount of time mortgage loans and mortgage-backed securities
were held prior to sale was due principally to a decision made by the Company
in the first quarter of 1994 to increase its level of holding of
mortgage-backed securities for future sale and to maximize the interest income
produced by these securities prior to sale, a substantial portion of which is
tax-exempt to the Company under Puerto Rico law. The result was to increase
both the Company's net interest income and its level of assets held for sale,
and to decrease the Company's effective tax rate.
Increases in prevailing interest rates from the time the Company
originates a mortgage loan to the time it is sold in the secondary market may
lead to reductions in the value of the Company's portfolio of mortgage loans
and mortgage-backed securities, thereby reducing gain on sale of mortgage
loans. Interest rate fluctuations can also adversely affect the Company's net
interest income. FFCC attempts to manage these risks through the use of
various hedging techniques, including the purchase of listed put options on
various instruments. There can be no assurance that such hedging techniques
will be successful. To the extent they are not, the Company's profitability
could be adversely affected.
LOAN SERVICING FEES. Loan servicing fees represent revenues earned by
FFCC for administering mortgage loans. FFCC's loan servicing fees depend on
the type of mortgage loan being serviced and ranges from 0.25% to 0.50% of the
declining outstanding principal amount of such loan. The size of FFCC's loan
servicing portfolio and the amount of its servicing fees have increased
substantially since FFCC's inception as a result of increases in loan
originations and the size of its servicing portfolio. Loan servicing fees,
however, decreased 8% from 1994 to 1995. Servicing fees had increased 33% from
1993 to 1994 and 20% from 1992 to 1993. The decrease in loan servicing income
during 1995 was due primarily to sales during 1995 and the last quarter of 1994
of mortgage servicing rights aggregating approximately $512 million. Increases
in the amount of loan servicing fees for 1994 and 1993 were primarily due to
increases in the principal amount of loans serviced as compared to prior years.
The mortgage servicing portfolio was approximately $2.67 billion at December
31, 1995, basically the same level that existed as of December 31, 1994. At
December 31, 1995, less than $32 million of the Company's servicing portfolio
was related to mortgages originated outside Puerto Rico (all of which were
originated in Florida).
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During 1995, total amortization of mortgage servicing rights ("MSRs")
amounted to $562,054 versus $730,059 for 1994. Amortization of MSRs are
reflected as a reduction of servicing fee income in the Company's financial
statements. The Company's traditional strategy has been to increase the size
of its servicing portfolio through internal originations. However, during
1994, the Company reentered the wholesale loan market by purchasing mortgage
loans from third parties as a means of compensating for the decrease in volume.
This strategy has proven to be effective in the past. During the years ended
December 31, 1995 and 1994 the Company capitalized $8.2 million and $581,130,
respectively, of MSRs.
The amount of principal prepayments on mortgage loans serviced by the
Company was $160 million, $281 million and $537 million for the years ended
December 31, 1995, 1994 and 1993, respectively. This represented approximately
6%, 11% and 26% of the aggregate principal amount of mortgage loans serviced
during such periods and the average size of the loans prepaid were $37,800,
$41,800 and $54,600, respectively. Principal prepayments declined during 1995
and 1994 as a result of decreased refinancing activity following the refinance
boom of 1993.
Increases in prepayment rates over anticipated levels will adversely
affect a mortgage company's revenues and liquidity by increasing the
amortization rates for MSRs and excess servicing fees receivable as well as
requiring the Company to recognize an impairment over and above scheduled
amortization. Amortization and impairment of MSRs have the effect of reducing
servicing income. To date, the primary means used by the Company to reduce the
sensitivity of its servicing fee income to changes in interest and prepayment
has been the development of a strong internal retail origination network that
has allowed the Company to increase or maintain the size of its servicing
portfolio even during periods of high prepayment. The portion of the Company's
mortgage servicing portfolio consisting of MSRs that were originated by the
Company prior to the adoption of SFAS No. 122 and therefore, not reflected as
an asset on the Company's Financial Statements are not subject to amortization
or impairment.
GAIN ON SALE OF SERVICING RIGHTS. During the years ended December 31,
1995, 1994 and 1993, the Company sold servicing rights of $310 million, $202
million and $199 million, respectively, realizing pretax gains of approximately
$5.2 million, $3.0 million and $2.4 million, respectively. While the Company's
strategy is to continue to increase the size of its servicing portfolio by
retaining the servicing rights to the mortgage loans it originates, the Company
may continue to sell servicing rights, from time to time, in the future when
market conditions are favorable.
OTHER INCOME AND EXPENSES. Other income increased 21% in 1995 as compared
to 1994, and 134% from 1993 to 1994. The increases during 1995 and 1994 were
due primarily to increased fees earned by Doral Federal.
Aggregate expenses in 1995 increased by $16.5 million compared to the same
period for 1994, as a result of higher interest expense associated with the
financing of the Company's mortgage loans and mortgage-backed securities
portfolios. Telephone and advertising expense decreased 19% and 41%,
respectively, over 1994 levels as a result of cost containment measures
implemented by management commencing in 1994 in connection with the reduction
in volume of mortgage loan originations.
For 1994 compared to 1993 aggregate expenses increased by approximately
36%. This increase reflected increases in interest, telephone and rent
expenses of 139%, 21% and 39%, respectively, as compared to 1993. Professional
services, rent and telephone expenses increases were attributable to the growth
experienced by the Company in both personnel and asset size. Employee costs
in 1994 reflected
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approximately $1.75 million in voluntary reductions taken by the Chief
Executive Officer in salary and incentive compensation.
PUERTO RICO INCOME TAXES. The Puerto Rico maximum statutory corporate
income tax rate is 42%. Such maximum rate was reduced to 39% for taxable years
commencing after June 30, 1995. For 1995, the effective income tax rate of
FFCC was 11.33% as compared to 16.3% for 1994, and 31.0% for 1993. The
decrease in effective tax rates for 1995 and 1994 compared to 1993 was mainly
due to the increase in holdings of tax exempt GNMA mortgage-backed securities.
The decrease for 1995 also reflects a tax deduction for the value of shares
previously granted under employment agreements.
The lower effective tax rates (as compared to the maximum statutory rate)
experienced by FFCC, especially that experienced in 1995 and 1994, reflect the
fact that the portion of the net interest income derived from certain FHA and
VA mortgage loans secured by property located in Puerto Rico and on GNMA
securities backed by such mortgage loans is exempt from income tax under Puerto
Rico law. Income tax savings to FFCC attributable to this exemption amounted
to approximately $4.6 million, $5.4 million and $2.7 million for the years
ended December 31, 1995, 1994 and 1993, respectively. Note 21 to the Company's
Consolidated Financial Statements includes a reconciliation of the provision
for income taxes to the amount computed by applying the applicable Puerto Rico
statutory tax rates to income before taxes.
ASSETS AND LIABILITIES. Total assets were approximately $918 million as
of December 31, 1995, reflecting an increase of approximately $150 million from
December 31, 1994. This increase was primarily due to an increase of $96
million in mortgage loans held for sale and mortgage-backed securities held for
trading and held to maturity. During 1994, the Company made a decision to hold
tax-exempt mortgage-backed securities for longer periods prior to sale in
order to maximize tax exempt net interest income. The increase also reflects
the growth in assets experienced by Doral Federal which grew from $86.4 million
as of December 31, 1994 to $160.4 million as of December 31, 1995. Total
liabilities were approximately $789 million at December 31, 1995 compared to
$678 million at December 31, 1994. This increase reflects additional
borrowings taken during the year such as advances from the FHLB-NY, a servicing
secured term loan and the issuance of convertible subordinated debentures in a
private placement transaction. The increase in liabilities also reflects an
increase in deposits held at Doral Federal from $66.5 million at December 31,
1994 to $95.7 million at December 31, 1995. These amounts are net of $12.8
million and $18.5 million as of December 31, 1995 and 1994, respectively, of
inter-company deposits that are eliminated in the preparation of the Company's
Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES. The Company's principal financing
needs are the financing of loan funding activities, and the financing of its
holdings of mortgage-backed securities held for trading and held to maturity.
To meet these financing needs, the Company primarily relies on repurchase
agreements, pre-sale funding facilities, mortgage warehouse credit facilities,
long-term financing agreements, such as a servicing secured bank term loan and
subordinated convertible debentures and cash flows from operations. From time
to time, the Company has also relied on public offerings of preferred and
common stock, including a 1,510,000 share offering of common stock completed on
December 11, 1995.
During 1995, the Company's operating activities used cash of $11.2 million
which corresponds mainly to cash used to purchase mortgage-backed securities
and for the origination of mortgage loans. Net cash provided by operating
activities was $32.4 million and $9.2 million for 1994 and 1993, respectively.
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Net cash used by investing activities decreased to $67.7 million for 1995
versus $84.8 million for 1994. This decrease was primarily the result of a
decrease in purchases of investments held to maturity from $61.8 million a year
ago to $10.8 million for 1995. Acquisitions of servicing rights during 1995
used cash of $8.2 million, primarily due to the adoption of SFAS 122 in the
second quarter of 1995. Excess servicing fees receivable increased $2.6
million as a result of certain bulk sales of mortgage loans made during 1995.
Net cash provided by financing activities increased to $102.8 million for
1995 from $51.1 million for 1994. This increase was primarily due an increase
of $34.6 million in Notes Payable, consisting principally of $18.1 million in
term notes issued by Doral Federal and a $15.3 million servicing secured bank
term note. This increase also reflected an increase in deposits held at Doral
Federal in the amount of $29.3 million, the issuance of 1,510,000 shares of the
Company's Common Stock at a price to the public of $16.75 per share which
provided $23.3 million of additional capital (after expenses) to the Company
and the issuance of $10 million of convertible subordinated debentures in a
private placement transaction. The Company paid $4.4 million in dividends
during 1995 compared to $3.9 million during 1994, reflecting an increase in the
common stock dividend from $0.13 per share to $0.15 per share effective for the
second quarter of 1995. Net cash provided by financing activities was $51.1
million in 1994 versus use of $10.2 million in 1993.
Total liabilities were approximately 6.1 and 7.5 times stockholders'
equity at December 31, 1995 and 1994, respectively. The decreased leverage at
December 31, 1995 resulted from the issuance of 1,510,000 shares of common
stock on December 11, 1995, which increased stockholders' equity by
approximately $23.3 million.
FFCC borrows money under warehousing lines of credit to fund its mortgage
loan commitments and repays the borrowing as the mortgages are sold. The
warehousing lines of credit then become available for additional borrowing.
Included among FFCC's warehousing facilities are gestation or pre-sale
facilities which permit the Company to obtain more favorable rates once
mortgage loans are in the process of securitization but prior to the actual
issuance of the mortgage-backed securities as well as to finance such
mortgage-backed securities upon their issuance.
FFCC had available warehousing lines of credit and gestation or pre-sale
facilities of $525 million at December 31, 1995 compared to $367 million at
December 31, 1994. At December 31, 1995 and 1994, FFCC had used approximately
$171.6 million and $265.7 million, respectively, of credit available under its
warehousing lines of credit and gestation or pre-sale facilities. FFCC's lines
of credit are generally terminable at the discretion of the lender. Interest
rate spreads on certain mortgage loans and mortgage-backed securities in Puerto
Rico have traditionally been high due to the ability of the Company to finance
its mortgage loans and mortgage-backed securities with lower-cost 936 Funds.
FFCC also obtains short-term financing through repurchase agreement lines
of credit with financial institutions and investment banking firms. Under
these agreements, FFCC sells GNMA, FNMA or FHLMC guaranteed mortgage-backed
securities and, to a lesser extent, private label mortgage-backed securities,
and simultaneously agrees to repurchase them at a future date at a fixed price.
FFCC uses the proceeds of such sales to repay borrowings under its warehousing
lines of credit. The effective cost of funds under repurchase agreements is
typically lower than the cost of funds borrowed under FFCC's warehousing lines
of credit. FFCC's available repurchase agreement lines of credit at December
31, 1995 and amounted to $617 million and $560 million, respectively. At
December 31, 1995 and 1994, FFCC had outstanding repurchase obligations in the
aggregate principal amount of approximately $363.7 million and $404.2
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million, respectively. FFCC's continued use of repurchase agreements will
depend upon the cost of repurchase agreements relative to the cost of borrowing
under its warehousing lines of credit with banks and other financial
institutions.
On June 30, 1995, FFCC entered into a Syndicated Credit Agreement with six
banks providing for three credit facilities totaling up to $125 million. The
credit facilities were structured by Bankers Trust Company, as administrative
and syndicate agent. The three facilities include: (I) a $100 million secured
one-year revolving warehousing credit facility to finance residential mortgage
loans and mortgage-backed securities; (ii) a $7 million secured one-year
revolving credit facility to provide financing for receivables and working
capital needs; and (iii) an $18 million five-year senior secured term loan,
secured with a portion of the Company's servicing portfolio, to finance the
acquisition of additional servicing rights and general working capital
purposes. The amounts available under the Syndicated Credit Agreement are
subject to a borrowing base which consists of mortgage loans and
mortgage-backed securities for the first facility, receivables relating to
servicing advances and real estate owned for the second facility and mortgage
servicing rights for the third facility. At December 31, 1995, FFCC had drawn
$15.3 million of the secured term loan facility which is due and payable in
four equal quarterly installments of $500,000 each, commencing in March 1996,
to be followed by 16 equal quarterly installments, each equal to 1/16th of the
principal outstanding on the first anniversary date and bears interest at a
variable rate which is adjusted periodically and is based on a spread over one
of various indices (including the prime rate and the London Interbank Offered
Rate) to be selected by the Company (8.125% at December 31, 1995).
The Company entered into a Debenture Purchase Agreement dated September
25, 1995, as amended and restated as of December 15, 1995, (the "Debenture
Purchase Agreement") with BanPonce, a bank holding company headquartered in San
Juan, Puerto Rico, providing for the issuance and sale to BanPonce of up to
$10,000,000 of Convertible Subordinated Debentures (the "Debentures") in a
private placement transaction. Approximately $6.6 million of Debentures were
issued on September 25, 1995 and the remaining $3.4 million were issued on
December 22, 1995. The Debentures were not registered under the Securities Act
of 1933 (the "Securities Act") and may not be offered or sold in the United
States absent such registration or an applicable exemption from the
registration requirements of the Securities Act. The Debentures are
convertible into shares of common stock at a conversion price of $17.50 per
share, subject to adjustment in certain events. In order to facilitate the
receipt of all required regulatory approvals, approximately $1.84 million of
the Debentures are not convertible into shares of Common Stock prior to January
1, 1999. The Debentures are subordinated to all existing and future senior
debt (as defined in the Debenture Purchase Agreement) of the Company. If the
entire $8.16 million of the Debentures that are immediately convertible into
shares of Common Stock were converted, they would equal 466,262 shares, or
approximately 4.99% of the Company's total outstanding shares of Common Stock
as of December 31, 1995, as adjusted for the conversion of such Debentures.
Under the terms of the Debenture Purchase Agreement, BanPonce also
obtained the right to acquire up to 200,000 additional shares of Common Stock
at a price of $17.50 per share (subject to adjustment in certain events) to the
extent that the shares of Common Stock issued or issuable upon conversion of
all the Debentures (including the Debentures that are not immediately
convertible) represent less than the 5% of the Company's fully diluted
outstanding shares of Common Stock.
The Company also has entered into servicing agreements relating to the
mortgage-backed securities program of FNMA, FHLMC and GNMA and certain other
investors as well as mortgage loans sold to certain other purchasers. These
agreements require FFCC to advance funds to make scheduled payments
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of principal, interest, taxes and insurance, if such payments have not been
received from the borrowers. Funds advanced by FFCC pursuant to these
arrangements are generally recovered by FFCC within 30 days. During the year
ended December 31, 1995, the monthly average amount of funds advanced by the
Company under such servicing agreements was approximately $4.7 million.
During the year ended December 31, 1995, the Company collected an average
of approximately $880,000 per month as net servicing fees, including late
charges. At December 31, 1995 and 1994 and the servicing portfolio amounted to
approximately $2.67 billion and $2.64 billion, respectively. The small
increase in the size of the servicing portfolio as of December 31, 1995
compared to December 31, 1994, despite of originations and purchases of $636
million during 1995, was due to sales of servicing rights in the amount of
approximately $310 million during 1995 and to portfolio run-offs related to
scheduled amortization and prepayment of mortgage loans in the servicing
portfolio. While the Company's strategy is generally to build and retain its
servicing portfolio, it may, from time to time, determine to sell portions of
its servicing portfolio as well as to purchase servicing rights from third
parties depending on the existing market conditions.
As of December 31, 1995, Doral Federal met all its fully phased-in capital
requirements (i.e., tangible and core capital of at least 1.5 % and 3.0%,
respectively, of weighted assets and risk-based capital and at least 8% of risk
weighted assets). As of December 31, 1995, Doral Federal had tangible capital
and core capital of $16 million or approximately 10% of weighted assets. As of
such date, Doral Federal had risk-based capital of $16.2 million or 25.8% of
risk weighted assets.
Doral Federal obtains funding for its lending activities through the
receipt of deposits, FHLB-NY advances and from other borrowings, such as term
notes backed by FHLB-NY letters of credit and repurchase agreements with
brokerage houses. As of December 31, 1995, Doral Federal held $114.2 million
in deposits at a weighted average interest rate of 3.20%, approximately 43% of
which consisted of non interest-bearing deposits. Approximately $685,000 of
such deposits consisted of brokered certificates of deposit obtained through
broker-dealers. Doral Federal, as a member of FHLB-NY, has access to
collateralized borrowings from the FHLB-NY up to a maximum of 30% of all its
total assets. Advances and reimbursement obligations with respect to letters
of credits must be secured by qualifying assets with a market value equal to
between 105% to 115% of the advances. At December 31, 1995, Doral Federal had
$10.4 million in outstanding advances from the FHLB-NY at a weighted average
interest rate cost of 6.43%. In addition, as of December 31, 1995, Doral
Federal had $18.1 million outstanding in term notes secured by FHLB-NY letters
of credit at an average interest rate cost of 5.31%. Approximately $5.0
million principal amount of such term notes bear interest at a fluctuating rate
based on LIBID. The interest rate on such fluctuating rate note has
effectively been fixed pursuant to an interest rate swap agreement with a major
brokerage house. Such notes have been placed with 936 Corporations operating
in Puerto Rico. These term notes contain interest "gross up" provisions that
provide for a prospective adjustment to the interest rates on the notes to a
fixed rate equal to 100% of LIBID, as of the adjustment date, for the remaining
term of the Note, in the event of an adverse change in the treatment of the
interest received on the notes under Section 936. See "Prospective Trends -
Possible Repeal of Section 936" herein for a description of certain proposals
to repeal Section 936.
Legislation has been proposed by Congress that would, among other things,
recapitalize the FDIC Savings Association Insurance Fund ("SAIF"). The
proposed legislation provides for a one-time assessment to be imposed on all
SAIF-insured deposits as of March 31, 1995, in order to recapitalize the SAIF
and eliminate the disparity of insurance premiums with the Bank Insurance Fund
(the "BIF"). Under such
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proposed legislation, the SAIF and the BIF would be merged effective January 1,
1998. The special assessment rate is anticipated to be between .70% and .90%
of deposits. Based upon Doral Federal's deposits at March 31, 1995 and
assuming a special assessment of .90%, Doral Federal's assessment would be
approximately $861,000.
At times, the Company may have to meet margin requirements to cover
changes in the market value of its mortgage-backed securities. To the extent
that the required collateral levels are higher than the current market prices
of the mortgage-backed securities pledged as collateral, the Company must
deposit cash or certain government securities. In addition, the Company
sometimes sells mortgage-backed securities and loans with puts or with recourse
arrangements. The Company may be required to fund the repurchase of loans or
mortgage-backed securities from time to time under the terms of such puts and
recourse arrangements. As of December 31, 1995, the Company's servicing
portfolio included approximately $85 million in mortgage loans subject to
recourse arrangements. The Company had outstanding approximately $25 million
in mortgage-backed securities sold subject to puts, which expire in one year or
less, compared to $112 million a year ago. See Note 25 to the Company's
Consolidated Financial Statements for more information regarding such puts.
FFCC expects that it will continue to have adequate liquidity and
financing arrangements to finance its operations. The Company will continue to
explore alternative and supplementary methods of financing its operations,
including both debt and equity financing. There can be no assurance, however,
that the Company will be successful in consummating any such transactions.
FFCC, nevertheless, expects that it will continue to have adequate resources to
finance its operations.
INFLATION. FFCC is affected by inflation in the areas of loan production
and servicing fees. General and administrative expenses increase with
inflation. However, the increase in real estate values in Puerto Rico in
recent years has been a positive factor for the Company's Mortgage Banking
Business. The average size of loans originated tends to increase as home
values appreciate, which serves to increase loan origination fees and servicing
income faster than the cost of providing such services. Interest rates
normally increase during periods of high inflation and decrease during periods
of low inflation. Significant increases in interest rates, make it more
difficult for potential borrowers to purchase desirable residential properties
and to qualify for mortgage loans and reduce demand for refinance loans. As a
result, higher interest rates may adversely affect the volume of loan
originations and income related to mortgage production. A high interest rate
environment, however, tends to reduce prepayments extending the average life of
the Company's mortgage loan servicing portfolio and thereby enhancing its value
and earnings to the Company.
PROSPECTIVE TRENDS
MARKET TRENDS. During 1995, particularly the last quarter, interest rates
on mortgage loans declined following increases in rates during 1994. To the
extent such trend continues during 1996, demand and prices for mortgage loans
and mortgage-backed securities should increase thereby favorably impacting gain
on sale of mortgage loans.
A decrease in interest rates should also contribute to an increase in the
amount of originations by stimulating demand for mortgage loans which has
remained stagnant in recent years in Puerto Rico. During the last quarter of
1995 mortgage loan production was $214 million reflecting an increase of $40
million from the comparable period of 1994, the first increase in volume of
mortgage loan production since the beginning of 1994. Increased originations
would allow the Company to increase the size of its servicing
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portfolio. Servicing income should, therefore, continue to provide the Company
with a stable base of revenues. The Company believes that its strong internal
origination capacity will reduce the sensitivity of servicing fee income to any
changes in prepayment rates that may occur as a result of declines in interest
rates.
The Company intends to continue to increase the assets of Doral Federal by
increasing the amount of loans funded and held by Doral Federal as well as to
increase its deposit base and branch network. The Company expects that as
Doral Federal continues to increase the amount of its interest earning assets,
the net interest income earned by Doral Federal will continue to increase as
well as the relative contribution of Doral Federal to the consolidated earnings
of the Company.
POSSIBLE REPEAL OF SECTION 936. In connection with ongoing efforts to
adopt Federal budget legislation, various proposals have been made to eliminate
the tax benefits available to U.S. corporations operating and investing in
Puerto Rico under Section 936. The Omnibus Budget Reconciliation Act of 1993
effective for taxable years beginning in 1994 reduced the benefits previously
available under Section 936. The Seven-Year Balanced Budget Revenue
Reconciliation Bill of 1995 (the "Budget Bill"), passed by the United States
Congress on November 20, 1995 and subsequently vetoed by President Clinton
provided for the repeal of Section 936, subject to a ten-year grandfather rule
that would have benefited 936 Corporations that were engaged in the active
conduct of a trade or business on October 13, 1995 and that qualified for and
elected the benefits of Section 936 for taxable years beginning before December
31, 1995. Under the bill, during the grandfather period, the amount of income
that would benefit from the credit available under Section 936 derived from the
active conduct of a trade or business would be subject to varying caps. The
credit available for investment income would not have been subject to the
grandfather rule and would have been eliminated for taxable years beginning
after December 31, 1995. As noted above, the Budget Bill was vetoed by
President Clinton on December 6, 1995.
It is not possible to predict what changes will be made to Section 936 as
part of the ongoing Federal budget negotiations. While the final impact of a
repeal of Section 936 cannot be determined at this time, the repeal of Section
936 could have an adverse effect on the general economic condition of Puerto
Rico, the Company's predominant service area, by reducing incentives for
investment in Puerto Rico. Any such adverse effect on the general economy of
Puerto Rico could lead to an increase in mortgage delinquencies and a reduction
in the level of residential construction and demand for mortgage loans. The
elimination of Section 936, particularly the elimination of the credit for
investment income, could also lead to a decrease in the amount of 936 Funds
invested in the Puerto Rico financial market, thereby increasing funding costs
and decreasing liquidity for Puerto Rico mortgage products. The magnitude of
the impact of any such changes on the Company's profitability or financial
condition cannot be determined at this time. The Company has taken steps to
attempt to reduce the impact of any such adverse change by diversifying its
sources of funding and identifying additional investors for its mortgage
products. During recent periods, the disparity between the cost of 936 Funds
and other sources of funding such as the Euro-dollar market have decreased,
thereby reducing the adverse effect that the loss of such funding could have on
the profitability of the Company.
NEW ACCOUNTING STANDARDS. On May 12, 1995, the Financial Accounting
Standards Board (the "FASB") issued the SFAS No. 122, an amendment to SFAS No.
65. The Company adopted SFAS No. 122 as of April 1, 1995. SFAS No. 122
requires the recognition of all mortgage servicing rights including internally
originated mortgage servicing rights ("OMSRs") as assets by allocating total
costs incurred
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between the loan and the servicing rights based on their relative fair values.
Under SFAS No. 65, the cost of OMSRs was not recognized as an asset and was
charged to earnings when the related loan was sold. SFAS No. 122 has the
effect of increasing gains on sales of loans by requiring the carrying cost of
the loans to be reduced by a proportion of the fair value of the related OMSRs.
To date, the Company has used sales prices for comparable mortgage servicing
rights to determine the fair value of its servicing rights. For the year ended
December 31, 1995, the Company realized additional net income of approximately
$1.5 million as a result of the adoption of SFAS No. 122. If the Company had
not adopted SFAS No. 122 during the second quarter of 1995, earnings per common
share would have been approximately $2.44 and $2.33 on a primary and
fully-diluted basis, respectively, for the year ended December 31, 1995.
SFAS No. 122 also requires that all capitalized mortgage servicing rights
be evaluated for impairment based on the excess of the carrying amount of
mortgage servicing rights over their fair value. For purposes of measuring
impairment, capitalized mortgage servicing rights are stratified pool-by-pool
on the basis of interest rates. An impairment is recognized whenever the
prepayment pattern of the mortgage pool indicates that the fair value of the
related capitalized servicing rights is less than its carrying amount. An
impairment is recognized by charging such excess to income. The Company
determined that no reserve for impairment was required for the year ended
December 31, 1995. OMSRs that were originated prior to the adoption of SFAS
122 and, therefore, that are not capitalized as an asset on the Company's
Financial Statements are not subject to amortization or impairment.
In October 24, 1995, the FASB issued a Proposed Statement of Financial
Accounting Standards, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities" (the "Proposed Statement"). The
Proposed Statement would provide accounting and reporting standards for
transfers and servicing of financial assets and extinguishment of liabilities.
Under the Proposed Statement after any transfer of financial assets, an entity
would be required to recognize all financial assets and servicing it controls
following such sale and liabilities it has incurred and would be required to
derecognize financial assets when control has been surrendered and liabilities
have been extinguished. This Proposed Statement would provide consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings.
This Proposed Statement would require that liabilities and derivatives
entered into as part of a transfer of financial assets be initially measured at
fair value, if practicable. It also would require that servicing assets and
other retained interests in the transferred assets be measured by allocating
the previous carrying amount between the assets sold, if any, and retained
interests, if any, based on their relative fair values at the date of the
transfer.
A possible impact to the Company of the adoption of the Proposed Statement
would be the potential derecognization from the Company's Financial Statements
of securities sold under long-term repurchase agreements. The Proposed
Statement is expected to be effective for fiscal years commencing after
December 31, 1996.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information call for by this Item 8 is hereby incorporated by
reference from the Company's Consolidated Financial Statements and Auditor's
Report beginning on page F-1 of this Form 10-K.
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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
Information in response to this Item is incorporated herein by reference
to the section entitled "Election of Directors and Related Matters" contained
in Company's definitive Proxy Statement for its 1996 Annual Meeting of
stockholders (the "Proxy Statement") to be filed with the Securities and
Exchange Commission not later than 120 days after the end of the Company's
fiscal year covered by this report.
ITEM 11. EXECUTIVE COMPENSATION
Information in response to this Item is incorporated herein by reference
to the section entitled "Executive Compensation" of the Company's Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information in response to this Item is incorporated herein by reference
to the section entitled "Security Ownership of Management and Principal
Holders" of the Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information in response to this Item is incorporated herein by reference
to the section entitled "Election of Directors and Related Matters -- Certain
Relationships and Related Transactions" of the Company's Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) List of documents filed as part of this report.
(1) Financial Statements.
The information called for by this subsection of Item 14 is set
forth in the Financial Statements and Auditors' Report beginning on
page F-1 of this Form 10-K. The index to Financial Statements is set
forth on page F-2 of this Form 10-K.
(2) Financial Statement Schedules.
All financial schedules have been omitted because they are not
applicable or the required information is shown in the financial
statements or notes thereto.
(3) Exhibits.
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Exhibit
Number Description
- ------ -----------
3.1 Certificate of Incorporation of FFCC, as currently in effect.(1)
3.2 By-laws of FFCC, as amended as of January 30, 1996.(18)
3.3 Amendment to Certificate of Incorporation of FFCC filed with the Department of State of the
Commonwealth of Puerto Rico on May 23, 1991.(2)
3.4 Certificate of Designation creating the Series A Preferred Stock.(2)
3.5 Amendment to Certificate of Incorporation of FFCC filed with the Department of State of the
Commonwealth of Puerto Rico on April 28, 1993(1)
4.1 Common Stock Certificate.(2)
4.2 Series A Preferred Stock Certificate.(2)
10.13 1988 FFCC Stock Option Plan.(3)
10.14 FFCC Restricted Stock Plan.(3)
10.15 Purchase Agreement dated as of September 21, 1988, between FFCC and Culbro Corporation covering
the purchase of RSC Corp. and Doral Mortgage Corporation.(3)
10.18 Form of Contract of Pledge used by FFCC in connection with the Warehousing Loan Agreement dated
November 25, 1987, as amended, with Scotiabank de Puerto Rico.(5)
10.21 Tax Indemnification Agreement between Culbro Corporation and FFCC.(3)
10.22 Purchase Agreement dated as of November 30, 1976, between CMB, Inc. and David Levis, Salomon
Levis, Aida Levis and Carmen Levis covering the purchase of FFCC together with amendments or
supplements dated August 25, 1977, November 1, 1977, January 1, 1982, February 9, 1982, January 1,
1986 and January 1, 1987.(3)
10.23 Purchase Agreement dated as of October 15, 1986, between CMI Inc. and Salomon Levis and Carmen
Maria Serracante covering the purchase of RSC Corp.(3)
10.24 Purchase Agreement dated as of October 15, 1986, between DRL, Inc. and Jesus M. Rodriguez and
Marta Melendez covering the purchase of Doral Mortgage Corporation.(3)
10.28 Agreement among Doral Mortgage Corporation, Banco de Ponce, as trustee, and the Puerto Rico
Housing Finance Corporation dated September 25, 1990.(4)
10.30 Loan Agreement between FFCC and Puerto Rico Island Rental Limited Dividend Partnership S.E., dated
December 27, 1990.(4)
10.32 Warehousing Loan Agreement dated September 8, 1995 between FFCC and Banco Santander Puerto
Rico.(14)
10.33 Loan Agreement dated November 25, 1987 between FFCC and Scotiabank de Puerto Rico.(4)
10.34 (a) Repurchase Agreement, between FFCC and BP Capital Markets, Inc., dated November 10, 1995.
(18)
(f) Repurchase Agreement between FFCC and First Boston (Puerto Rico), Inc., dated November 28,
1989. (4)
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Exhibit
Number Description
- ------ -----------
(k) Master Repurchase Agreement between FFCC and PaineWebber, Inc., dated as of March 24,
1992.(5)
10.35 Employment Agreement dated August 29, 1995 between FFCC and Salomon Levis.(15)
10.36 Employment Agreement dated August 29, 1995 between FFCC and Zoila Levis.(15)
10.37 Third Amendment to Loan Agreement dated June 5, 1991 between FFCC and Scotiabank de Puerto
Rico.(2)
10.39 Mark-to-Market Agreement between FFCC and PaineWebber Incorporated, dated as of March 24, 1992.(5)
10.40 Insurance and Indemnity Agreement dated as of May 28, 1992, between FFCC and Financial Security
Assurance Inc.(5)
10.41 Letter Agreement dated August 20, 1992 between Scotiabank de Puerto Rico and FFCC confirming the
renewal of the Loan Agreement dated November 25, 1987.(5)
10.42 Financing Agreement dated May 14, 1992, between FFCC and Banco Popular de Puerto Rico.(5)
10.43 Employment Agreement dated August 29, 1995, between FFCC and Richard F. Bonini.(15)
10.44 Addendum to Warehousing Loan Agreement dated August 1, 1991, between FFCC and Banco Santander
Puerto Rico.(5)
10.45 Addendum to Warehousing Loan Agreement dated May 29, 1992, between FFCC and Banco Santander Puerto
Rico.(5)
10.46 Letter Agreement dated November 28, 1988 amending the Loan Agreement between FFCC and Scotiabank
de Puerto Rico dated November 25, 1987.(5)
10.47 Amendment dated June 29, 1989 to the Loan Agreement between FFCC and Scotiabank de Puerto Rico
dated November 25, 1987.(5)
10.49 Employment Agreement dated as of April 1, 1993 between FFCC and Luis Alvarad.(13)
10.50 Customer Agreement, dated March 9, 1993, between FFCC and Meridian Capital Markets Inc. relating
to the execution of Forward Contracts.(6)
10.51 Master Repurchase Agreement, dated March 24, 1993, between FFCC and Bear Sterns Mortgage Capital
Corporation.(7)
10.52 Amended and Restated Master Production Agreement, dated as of October 1, 1995, between FFCC, Doral
Mortgage and Doral Federal, Master Production Agreement, dated as of October 1, 1995, between
FFCC, Doral Mortgage and Doral Federal.(8)
10.53 Master Purchase, Servicing and Collection Agreement, dated as of September 15, 1993, between FFCC
and Doral Federal.(9)
10.54 Mortgage Loan Purchase and Interim Servicing Agreement dated as of November 29, 1993 between FFCC
and Nomura Asset Capital Corporation.(13)
10.55 Purchase and Servicing Agreement, dated as of September 1, 1993, between FFCC and Meridian Capital
markets, a Division of Meridian Bank.(13)
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Exhibit
Number Description
- ------ -----------
10.56 Financing Facility Agreement dated March 21, 1994, between Nomura Asset Capital Corporation, FFCC
and Doral.(12)
10.57 Master Repurchase Agreement among Merrill Lynch Mortgage Capital, Inc., FFCC and Doral together
with Supplemental Terms to Master Repurchase Agreement, each dated as of January 12, 1995.(14)
10.58 Swap Agreement dated December 7, 1994, between FFCC and David Levis.(14)
10.59 Demand Note dated December 9, 1994.(14)
10.60 Form of Medium Term Note, 1994 Series Puerto Rico-A.(14)
10.61 Credit Agreement, dated as of June 30, 1995, between FFCC, Doral
Mortgage Corporation, the lenders thereto and Bankers Trust
Company, as Agent.(17)
10.62 Debenture Purchase Agreement dated as of September 25, 1995, and amended restated as of December
15, 1995, between the Company and BanPonce Corporation (including the forms of Series A and Series
Debentures.(15)
10.63 Financing Agreement dated October 10, 1995, between FFCC and Banco Santander together with related
Assignment and Pledge Agreements.(16)
10.64 Master Servicing and Collection Agreement dated October 1, 1995, between FFCC and Doral Federal
Savings Bank.(17)
10.65 Employment Agreement, dated as of February 20, 1996, between FFCC and Frederick C. Teed.(17)
21 List of FFCC's subsidiaries.(13)
27 Financial Data Schedule (Edgar version only).(17)
- --------------------
(1) Incorporated herein by reference to the same exhibit number of the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993
(File No. 0-17224).
(2) Incorporated herein by reference to the same exhibit number of the
Company's Annual Report on From 10-K for the year ended December 31, 1991 (File
No. 0-17224).
(3) Incorporated herein by reference to the same exhibit number as filed
pursuant to Item 15(b) of the Company's Form 10 filed with the Commission on
October 7, 1988, as amended by Form 8 amendments thereto.
(4) Incorporated herein by reference to the same exhibit number of the
Company's Registration Statement on Form S-1 (No. 33-39651) filed with the
Commission on March 29, 1991.
(5) Incorporated herein by reference to the same exhibit number of the
Company's Registration Statement on Form S-2 (No. 33-52292) filed with the
Commission on September 23, 1992.
(6) Incorporated by reference to exhibit number 19.1 of the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1993 (File No.
0-17224).
55
59
(7) Incorporated by reference to exhibit number 19.2 of the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1993 (File No.
0-17224).
(8) Incorporated by reference to exhibit number 19.3 of the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (File
No. 0-17224).
(9) Incorporated by reference to exhibit number 19.4 of the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (File
No. 0-17224).
(10) Incorporated herein by reference to exhibit number 1 of the Company's
Current Report on Form 8-K filed with the Commission on December 16, 1992.
(11) Incorporated herein by reference to Exhibit Number 10.26 of the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994.
(12) Incorporated herein by reference to same exhibit number of the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994.
(13) Incorporated herein by reference to the same exhibit number of the
Company's Annual Report on Form 10-K for the year ended December 31, 1993.
(14) Incorporated herein by reference to the same exhibit number of the
Company's Annual Report on Form 10-K for the year ended December 31, 1994.
(15) Incorporated herein by reference to the same exhibit number of the
Company's Current Report on Form 8-K dated December 22, 1995.
(16) Incorporated herein by reference to the same exhibit number of the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1995.
(17) Incorporated herein by reference to the same exhibit number of the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995.
(18) Filed herewith.
(b) Reports on Form 8-K.
(1) Current Report a Form 8-K ("Form 8-K"), dated September 22, 1995,
reporting under Item 5 - "Other Items" an agreement in principle to enter
into a Debenture Purchase Agreement with BanPonce Corporation.
(2) Form 8-K, dated September 25, 1995, reporting under Item 5 - "Other
Events", the execution of Debenture Purchase Agreement with BanPonce
Corporation and issuance of approximately $6.6 million in convertible
subordinated debentures thereunder.
(3) Form 8-K, dated November 20, 1995, reporting under Item 5 - "Other
Events", passage of the Seven-Year Balanced Budget Revenue Reconciliation
Act of 1995, which provided for the repeal Section 936.
56
60
(4) Form 8-K, dated December 22, 1995, reporting under Item 5 - "Other
Events" execution of an Amended and Restated Debenture Purchase Agreement
with BanPonce Corporation.
57
61
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, First Financial Caribbean Corporation has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
FIRST FINANCIAL CARIBBEAN CORPORATION
By: /s/ Salomon Levis
----------------------------------
Salomon Levis
Chairman of the Board and
Chief Executive Officer
Date: March 28, 1996
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Chairman of the Board and March 28, 1996
/s/ Salomon Levis Chief Executive Officer
- ------------------------------
(Salomon Levis)
Director March 28, 1996
/s/ Richard F. Bonini
- ------------------------------
(Richard F. Bonini)
/s/ Edgar M. Cullman, Jr.
- ------------------------------ Director March 28, 1996
(Edgar M. Cullman, Jr.)
/s/ Frederick M. Danziger
- ------------------------------ Director March 28, 1996
(Frederick M. Danziger)
/s/ John L. Ernst
- ------------------------------ Director March 28, 1996
(John L. Ernst)
/s/ Zoila Levis
- ------------------------------ Director March 28, 1996
(Zoila Levis)
62
/s/ A. Brean Murray
- ------------------------------ Director March 28, 1995
(A. Brean Murray)
/s/ Victor M. Pons, Jr.
- ------------------------------ Director March 28, 1996
(Victor M. Pons, Jr.)
/s/ Luis Alvarado Executive Vice President,
- ------------------------------ Chief Financial Officer March 28, 1996
(Luis Alvarado)
/s/ Ricardo Melendez Vice President and
- ------------------------------ Controller, Principal March 28, 1996
(Ricardo Melendez) Accounting Officer
2
63
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
For Inclusion in Form 10-K
Annual Report Filed with
Securities and Exchange Commission
64
FIRST FINANCIAL CARIBBEAN CORPORATION AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
February 2, 1996
Page
-------
Report of Independent Accountants .................................. F-3
Consolidated Financial Statements
Consolidated Balance Sheet as of December 31, 1995 and 1994...... F-5
Consolidated Statement of Income and Retained Earnings for the
years ended December 31, 1995, 1994 and 1993................... F-6
Consolidated Statement of Changes in Capital Stock for the
years ended December 31, 1995, 1994 and 1993................... F-7
Consolidated Statement of Cash Flows for the years ended
December 31, 1995, 1994 and 1993............................... F-8
Notes to Consolidated Financial Statements....................... F-10
All financial schedules have been omitted because they are not applicable,
or because the information required is included in the consolidated financial
statements or notes thereto.
F-2
65
The Chase Manhattan Bank Building Telephone 809 754 9090
PO Box 363566
San Juan PR 00936-3566
PRICE WATERHOUSE [Price Waterhouse LOGO]
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of
First Financial Caribbean Corporation
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income and retained earnings, of changes in capital
stock and of cash flows present fairly, in all material respects, the financial
position of First Financial Caribbean Corporation and its subsidiaries at
December 31, 1995 and 1994, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1995, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted the provisions of the Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing
Rights, an amendment of FASB Statement No. 65," effective April 1, 1995.
/s/ Price Waterhouse
PRICE WATERHOUSE
San Juan, Puerto Rico
February 2, 1996
Stamp 1327038 of the P.R. Society of
Certified Public Accountants has been
affixed to the file copy of this report
F-3
66
FIRST FINANCIAL CARIBBEAN
CORPORATION
REPORT AND CONSOLIDATED
FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1994
F-4
67
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED BALANCE SHEET
ASSETS
December 31,
----------------------------
1995 1994
---- ----
Cash and cash equivalents $ 59,871,646 $ 35,916,125
Mortgage loans held for sale, net 245,484,255 263,773,383
Mortgage-backed securities held for trading 407,941,495 319,203,574
Securities held to maturity 77,945,425 66,804,426
Securities available for sale 14,578,997 --
Loans receivable, net 51,355,258 34,808,938
Accounts receivable and mortgage servicing advances, net 9,591,627 7,086,045
Accrued interest receivable 8,155,028 7,874,551
Mortgage servicing rights 11,164,065 3,543,032
Excess servicing fees receivable 10,407,297 8,756,589
Property, leasehold improvements and equipment, net 6,504,725 7,466,980
Cost in excess of fair value of net assets acquired 6,526,131 6,609,402
Real estate held for sale, net 2,084,541 2,115,911
Prepaid and other assets 6,311,571 4,060,368
------------ -------------
Total assets $917,922,061 $768,019,324
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Loans payable $234,706,497 $265,705,957
Securities sold under agreements to repurchase 363,728,000 303,730,017
Deposit accounts 95,740,441 66,471,111
Notes payable 51,682,156 17,055,480
Advances from Federal Home Loan Bank of N.Y. 10,407,111 419,245
Convertible Subordinated Debentures 10,000,000 --
Accounts payable and other liabilities 17,376,204 17,792,644
Income tax payable 388,041 2,571,773
Deferred tax liability 4,877,068 3,776,899
------------ ------------
Total liabilities 788.905,518 677,523,126
------------ ------------
Commitments and contingencies (Note 25)
------------ ------------
Stockholders' equity:
10.5% Cumulative Convertible Preferred Stock, Series A,
$1 par value, 2,000,000 shares authorized; 108,397
shares issued and outstanding (1994 - 204,329)(liquidating
preference of $10 per share, aggregating $1,083,970) 108,397 204,329
Common stock, $1 par value, 10,000,000 shares authorized;
8,884,170 shares issued and outstanding (1994 - 7,182,306) 8,884,170 7,182,306
Paid-in capital 38,329,800 16,674,402
Retained earnings 81,892,300 66,706,435
------------ ------------
129,214,667 90,767,472
Unrealized gain on securities available for sale 8,856 --
Treasury stock at par value, 14,000 shares (14,000) (14,000)
Unearned compensation under employment contracts (192,980) (257,274)
------------ ------------
Total stockholders' equity 129,016,543 90,496,198
------------ ------------
Total liabilities and stockholders' equity $917,922,061 $768,019,324
============ ============
The accompanying notes are an integral part of this statement.
F-5
68
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED STATEMENT OF INCOME AND RETAINED EARNINGS
Year ended December 31,
-----------------------
1995 1994 1993
---- ---- ----
Revenues:
Interest income $61,907,114 $46,507,972 $23,774,659
Mortgage loan sales and fees 13,528,534 10,572,734 35,230,405
Servicing income 10,576,826 11,447,772 8,627,024
Gain on sale of servicing rights 5,204,933 3,003,459 2,378,000
Other income 619,923 510,705 218,123
----------- ----------- -----------
91,837,330 72,042,642 70,228,211
----------- ----------- -----------
Expenses:
Interest 43,380,148 23,251,898 9,710,091
Employee cost 6,471,059 6,000,632 7,194,699
Taxes, other than payroll and income taxes 1,150,416 847,856 768,048
Maintenance 654,354 712,627 615,503
Advertising 2,474,638 4,205,312 4,620,177
Professional services 2,867,316 3,658,557 3,611,639
Telephone 1,682,412 2,076,049 1,719,687
Rent 2,096,979 2,004,023 1,444,866
Other 8,999,491 10,540,576 9,622,256
----------- ----------- -----------
69,776,813 53,297,530 39,306,966
----------- ----------- -----------
Income before income taxes and cumulative effect
of change in accounting principle 22,060,517 18,745,112 30,921,245
----------- ----------- -----------
Income taxes:
Current 1,400,044 2,092,696 7,141,681
Deferred 1,100,169 436,899 2,460,000
----------- ----------- -----------
2,500,213 2,529,595 9,601,681
----------- ----------- -----------
Income before cumulative effect of change in
accounting principle 19,560,304 16,215,517 21,319,564
Cumulative effect of change in accounting
principle- adoption of SFAS 115, net of deferred
income taxes of $880,000 - 1,215,000 -
----------- ----------- -----------
Net income 19,560,304 17,430,517 21,319,564
Retained earnings at beginning of year 66,706,435 53,219,178 35,041,903
Less cash dividends:
Convertible preferred stock $1.05 per share 187,639 325,045 496,948
Common stock $.58 per share (1994 -
$.52; 1993 - $.40 per share) 4,186,800 3,618,215 2,645,341
----------- ----------- -----------
Retained earnings at end of year $81,892,300 $66,706,435 $53,219,178
=========== =========== ===========
Earnings per share:
Primary:
Income before cumulative effect of change in
accounting principle $ 2.65 $ 2.29 $ 3.15
Cumulative effect of change in accounting principle - .17 -
----------- ----------- -----------
Net income $ 2.65 $ 2.46 $ 3.15
=========== =========== ===========
Fully diluted:
Income before cumulative effect of change in
accounting principle $ 2.53 $ 2.14 $ 2.81
Cumulative effect of change in accounting principle - .16 -
----------- ----------- -----------
Net income $ 2.53 $ 2.30 $ 2.81
=========== =========== ===========
The accompanying notes are an integral part of this statement.
F-6
69
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN CAPITAL STOCK
Preferred Common Paid-in Treasury
stock stock capital stock
----- ----- ------- -----
Balance at December 31, 1992 $510,895 $3,284,587 $20,258,555 $ (7,000)
Stock split on December 10, 1993 - 3,381,069 (3,374,069) (7,000)
Shares converted (96,482) 96,482 - -
-------- ---------- ----------- --------
Balance at December 31, 1993 414,413 6,762,138 16,884,486 (14,000)
Shares converted (210,084) 420,168 (210,084) -
-------- ---------- ----------- --------
Balance at December 31, 1994 204,329 7,182,306 16,674,402 (14,000)
Shares issued on December 11, 1995 - 1,510,000 21,751,330 -
Shares converted (95,932) 191,864 (95,932)
-------- ---------- ----------- --------
Balance at December 31, 1995 $108,397 $8,884,170 $38,329,800 $(14,000)
======== ========== =========== ========
The accompanying notes are an integral part of this statement.
F-7
70
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
Year ended December 31,
-----------------------
1995 1994 1993
---- ---- ----
Cash flows from operating activities:
Net income $ 19,560,304 $ 17,430,517 $ 21,319,564
------------- ------------- ---------------
Adjustments to reconcile net income to net cash
(used) provided by operating activities:
Depreciation and amortization 1,764,500 1,533,750 698,300
Amortization of excess servicing fees receivable 988,082 566,668 160,785
Amortization of cost in excess of fair value of net assets acquired 376,158 358,097 255,476
Amortization of mortgage servicing rights 562,054 730,059 492,000
Gain on sale of mortgage servicing rights (5,204,933) (3,003,459) (2,378,000)
Cumulative effect of change in accounting principle - (1,215,000) -
Allowances for losses 352,000 299,523 1,012,500
Origination and purchases of mortgage loans held for sale (583,659,000) (797,582,000) (1,432,448,000)
Principal repayments and sales of mortgage loans held for sale
282,477,731 216,918,548 620,387,650
Purchases of mortgage-backed securities held for trading (72,124,000) (265,025,000) (182,883,000)
Principal repayments and sales of mortgage-backed securities
held for trading 357,461,000 653,479,000 860,471,000
Increase in accrued interest receivable (280,477) (3,853,140) (18,979)
(Decrease) increase in loans payable (94,089,007) 72,911,782 98,215,950
Increase in loans payable related to securities sold not yet
purchased 22,089,547 - -
Increase (decrease) in interest payable 382,912 788,079 (149,082)
Increase in securities sold under agreements to repurchase 59,997,983 160,530,375 14,444,412
(Decrease) increase in accounts payable and other liabilities (799,352) (21,838,018) 3,480,563
(Decrease) increase in income tax payable (2,183,732) (1,177,206) 3,365,157
Deferred tax provision 1,100,169 436,899 2,460,000
Amortization of unearned compensation under employment
contracts 64,294 64,294 299,952
------------- ------------- ---------------
Total adjustments (30,724,071) 14,923,251 (12,133,316)
------------- ------------- ---------------
Net cash (used) provided by operating activities (11,163,767) 32,353,768 9,186,248
------------- ------------- ---------------
Cash flows from investing activities:
Redemption of certificates of deposit - - 2,500,000
Purchases of securities held to maturity (10,789,000) (61,789,000) (6,127,850)
Principal repayments of securities held to maturity 3,207,857 799,896 -
Origination of loans receivables (52,341,000) (26,252,000) -
Principal repayments of loans receivable 4,060,159 836,792 756,275
Decrease in mortgage notes receivable - - 6,763,184
(Decrease) increase in accounts receivable and mortgage
servicing advances (2,857,582) 8,112,720 (958,587)
Additions to excess servicing fees receivable (2,638,790) (5,859,312) (3,103,139)
Purchase of property, leasehold improvements and equipment (802,245) (3,229,537) (2,981,977)
Payments of contingent purchase price of subsidiary (292,887) (430,929) (985,900)
Proceeds from disposal of real estate held for sale 1,616,911 3,163,069 4,363,585
Acquisition of real estate held for sale (1,585,541) (2,350,675) (3,699,118)
Increase in mortgage servicing rights (8,207,139) (581,130) (14,943)
Proceeds from sale of mortgage servicing rights 5,228,985 3,306,286 2,378,000
Cash resulting from acquisition of subsidiary, net of purchase
price - - 227,000
(Increase) decrease in prepaid and other assets (2,251,203) (591,019) 166,963
------------- ------------- ---------------
Net cash used by investing activities (67,651,475) (84,864,839) (716,507)
------------- ------------- ---------------
(Continued)
The accompanying notes are an integral part of this statement.
F-8
71
FIRST FINANCIAL CARIBBEAN CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
Year ended December 31,
-----------------------
1995 1994 1993
---- ---- ----
Cash flows from financing activities:
Increase in deposits 29,269,330 40,020,265 18,141,846
Decrease in loans payable related to mortgage notes receivable - - (3,845,899)
Proceeds from convertible subordinated debentures 10,000,000 - -
Proceeds from issuance of common stock, net 23,261,330 - -
Proceeds (repayment) of advances from Federal Home Loan Bank 9,987,866 (2,012,134) (1,003,621)
Increase in notes payable 34,626,676 17,055,480 -
Dividends declared and paid (4,374,439) (3,943,260) (3,142,289)
------------ ------------ ------------
Net cash provided by financing activities 102,770,763 51,120,351 10,150,037
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 23,955,521 (1,390,720) 18,619,778
Cash and cash equivalents at beginning of year 35,916,125 37,306,845 18,687,067
------------ ------------ ------------
Cash and cash equivalents at end of year $ 59,871,646 $ 35,916,125 $ 37,306,845
============ ============ ============
Supplemental Schedule of Noncash Investing and Financing Activities:
Noncash financing activities-conversion of preferred stock $ 959,320 $ 2,100,840 $ 964,820
============ ============ ============
On September 10, 1993, the Company acquired all of the
outstanding capital stock of Doral Federal Savings Bank
(formerly Catano Federal Savings Bank) for $1,200,000
(including transaction costs). In conjunction with
the acquisition, liabilities were assumed as follows:
Fair value of assets acquired - - $ 13,073,000
Cash paid - - 1,200,000
------------ ------------ ------------
Liabilities assumed - - $ 11,873,000
============ ============ ============
Supplemental Cash Flow Information:
Cash used to pay interest $ 43,000,000 $ 22,460,000 $ 9,561,000
============ ============ ============
Cash used to pay income taxes $ 3,360,000 $ 3,260,000 $ 3,780,000
============ ============ ============
The accompanying notes are an integral part of this statement.
F-9
72
FIRST FINANCIAL CARIBBEAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - REPORTING ENTITY:
The consolidated financial statements include the accounts of First Financial
Caribbean Corporation and its wholly-owned subsidiaries ("FFCC" or the
"Company"), Doral Mortgage Corporation ("Doral"), RSC Corp. ("RSC"), Centro
Hipotecario, Inc. and Doral Federal Savings Bank ("Doral Federal"). All
significant intercompany accounts and transactions have been eliminated in
consolidation.
On September 10, 1993, the Company acquired all of the outstanding common stock
of Doral Federal Savings Bank at a price of approximately $1,200,000. This
acquisition was accounted for using the purchase method of accounting. The
consolidated statement of income and retained earnings for the year ended
December 31, 1993 includes the results of operations of Doral Federal from
September 10, 1993. Proforma results of operations for 1993 as though the
acquisition had been made at the beginning of such period are substantially
similar to actual results of operations for the periods and therefore is not
presented.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The Company is primarily engaged in the origination, purchase and sale of FHA,
VA and conventional first and second mortgage loans and in providing and/or
arranging for interim financing for the construction of residences and other
types of real estate developments in Puerto Rico and selected markets in
Florida. The Company, in combination with its subsidiaries, services FHA
insured, VA guaranteed and conventional mortgage loans pooled for issuance of
Government National Mortgage Association (GNMA), Federal National Mortgage
Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC) backed
securities and collateralized mortgage obligations certificates issued by
grantor trusts established by the Company (CMO Certificates). It also services
loans for private investors. The Company also originates loans for investment
and provides banking services through a federal savings bank that operates two
branches located in Puerto Rico.
F-10
73
Page 2
The preparation of financial statements in conformity with generally accepted
accounting principles requires the use of management's estimates. The
following summarizes the more significant accounting policies used by the
Company.
Accounting for Certain Investments In Debt and Equity Securities
In January 1994, the Company adopted Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"). This statement requires the Company to classify and
account for investments on equity securities that have readily determinable
fair values and all investments in debt securities as follows:
- Debt securities that the Company has the positive intent and ability
to hold to maturity are classified as held-to-maturity and reported at
amortized cost.
- Debt and equity securities that are bought and held principally for
the purpose of selling them in the near term are classified as trading
and reported at fair value, with unrealized gains and losses included
in earnings. Mortgage-backed securities held for sale in conjunction
with mortgage banking activities must be classified as trading
securities.
- Debt and equity securities not classified as either held-to-maturity
or trading are classified as available- for-sale and reported at fair
value, with unrealized gains and losses excluded from earnings and
reported in a separate component of stockholders' equity.
The adoption of this standard resulted in the recognition of a gross unrealized
gain of approximately $2.5 million as of January 1, 1994 ($1,215,000 net of
approximately $880,000 in taxes and approximately $405,000 of related
expenses). Unrealized gains and losses on holdings of trading securities after
January 1, 1994, are included in earnings as a component of mortgage loan sales
and fees.
In December 1995, the Company used the one-time opportunity provided in the
Special Report "A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities" ("The Guide") issued by the
Financial Accounting Standards Board ("FASB"), to reassess the appropriateness
of classifications of all of the securities held by the Company as of the date
the Guide was issued. As a result of such reassessment, the Company
transferred approximately $15 million from the "held to maturity" category to
the "available for sale" category. As provided in the Guide, such transfer was
recorded at fair value and resulted in the recording of an unrealized gain of
approximately $9,000 in the stockholders' equity. Also, approximately $18
million was transferred from the "trading category" to the "held to maturity
category". This transfer did not have any effect in current earnings or
stockholders' equity because transferred securities were already at fair value.
F-11
74
Page 3
Mortgage-backed securities held for trading
Mortgage-backed securities held for trading are recorded at fair value.
Changes in fair value are recorded currently in income.
Securities held to maturity
Securities held to maturity are recorded at amortized cost.
Securities available-for-sale
Securities available-for-sale are recorded at fair value, with unrealized gains
and losses excluded from earnings and reported in a separate component of
stockholders' equity.
Mortgage loans held for sale
Mortgage loans held for sale are recorded at the lower of cost or market
computed on an aggregate portfolio basis.
Loans receivable
Loans receivable are held by Doral Federal principally for investment purposes.
These consist of residential first and second mortgages, commercial and
consumer loans with maturity dates ranging from one to twenty years.
Loans receivable are presented at the unpaid balance, less unearned interest
and allowance for loan losses. Unearned interest on commercial and consumer
loans is amortized using a method which results in a uniform level rate of
return on the principal amounts outstanding.
Allowances for losses
Allowances for losses provide for estimated losses on mortgage loans held for
sale, loans receivable, accounts receivable and real estate held for sale based
upon a review of the loan portfolio, loss experience, economic conditions and
other pertinent factors.
F-12
75
Page 4
The Company estimates the fair value of the retained recourse obligation of
loans sold at the time of sale. Ordinarily the amounts involved are minimal
insofar as the recourse obligations are met by substituting loans. The Company
has generally been able to rehabilitate and resell the reacquired loans for at
least their carrying amount. Accordingly, a reserve for possible losses
arising from recourse obligations has not been deemed necessary.
Excess servicing fees receivable
The Company sells substantially all of the mortgage loans it produces (other
than those originated by Doral Federal) and retains the related servicing
rights. These servicing rights entitle the Company to a future stream of cash
flows based on the outstanding principal balance of the mortgage loans and the
contractual servicing fee. Gains and losses on sales of such loans are
adjusted to reflect as income or loss servicing fees that vary from normal
servicing fee rates set by federally sponsored secondary market makers.
Accordingly, the Company has recorded, as excess servicing fees receivable,
amounts equal to the present value of servicing fees to be received in future
years in excess of normal rates based upon the estimated lives of the loans and
using long-term interest rates that reflect the risks of the assets. The
adjustment results in a receivable that is realized through receipt of the
excess service fees over time. The Company evaluates periodically the net
realizable value of its excess servicing fees receivable based on the present
value of the estimated remaining future excess servicing fees revenue, using
the same discount rate used to calculate the original excess servicing fees
receivable asset. Any impairment in the value of the excess servicing fees
receivable due to actual and anticipated prepayment experience, is recognized
currently as a reduction of excess servicing fees receivable. The resulting
excess servicing fees receivable is amortized over the estimated life using a
method approximating the level-yield method. The amortization is recorded as a
reduction of servicing income.
Mortgage servicing rights
In April 1995, the Company adopted Statement of Financial Accounting Standards
No. 122, "Accounting for Mortgage Servicing Rights, an amendment of FASB No.
65, ("SFAS 122"). This statement changed the accounting for servicing rights
related to loans originated by an entity. Previously, the Company followed the
guidance provided by SFAS 65 which, among other things, prohibited the
recognition of servicing rights related to loans originated by an entity. SFAS
122 requires that a portion of the cost of originating a mortgage loan be
allocated to the mortgage servicing right. The allocation is based on the
aggregate fair value of the loan and the related servicing right taken as a
whole. To determine the fair value of the servicing rights, the Company uses
the market prices of comparable servicing sale contracts.
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SFAS 122 also requires that all mortgage servicing rights be evaluated for
impairment. In determining servicing value impairment, mortgage servicing
rights were disaggregated into their predominant risk characteristic. The
Company has determined that risk characteristic to be interest rate. For
purposes of measuring impairment, mortgage servicing rights are stratified by
pool on the basis of interest rates. An impairment is recognized whenever the
prepayment pattern of the mortgage pool indicates that the fair value of the
related mortgage servicing rights is less than its carrying amount. An
impairment is recognized by charging such excess to income. The Company
determined that no reserve for impairment was required as of December 31, 1995.
The adoption of this standard had the effect of increasing net income and
mortgage loan sales and fees by approximately $1,500,000 and $2,600,000,
respectively, for the year ended December 31, 1995, and increasing capitalized
servicing rights at December 31, 1995 by approximately $4,150,000. If the
Company had not adopted SFAS 122, earnings per share would have been
approximately $2.44 and $2.33, on a primary and fully diluted basis,
respectively, for the year ended December 31, 1995. SFAS 122 prohibits
retroactive application, therefore, mortgage servicing rights related to loans
originated prior to April 1, 1995 continue to be unrecognized in the Company's
financial statements.
Purchased mortgage servicing rights are initially recorded at the lower of cost
or present value of estimated future net servicing income stream. The amount
capitalized is amortized in proportion to, and over the period of, estimated
net servicing income. Amortization is adjusted prospectively to reflect
changes in prepayment experience. Any unamortized balance related to rights
sold is charged to income at time of sale.
Cost in excess of fair value of net assets acquired
The cost in excess of fair value of net assets acquired is amortized on the
straight-line basis over their estimated useful lives (30-year period for
acquisitions made before Doral Federal and a 10-year period for the
acquisition of Doral Federal).
Real estate held for sale
The Company acquires real estate through foreclosures. These properties are
held for sale and are stated at the lower of fair value, minus estimated costs
to sell, or cost.
Property, leasehold improvements and equipment
Property, leasehold improvements and equipment are carried at cost.
Depreciation and amortization are provided on the straight-line method over the
estimated useful lives of the assets or the terms of the leases, if shorter,
for leasehold improvements. These range from five to ten years.
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Income and expense recognition
Loan origination fees and related direct loan origination costs are deferred
and amortized to income as an adjustment of the yield throughout the life of
the related mortgage loan. Such fees and costs related to mortgage loans held
for sale are deferred and recognized in income as a component of gain on sale
of mortgage loans when the related loans are sold or securitized.
Sale of securities with put arrangements
From time to time the Company may sell mortgage-backed securities and mortgage
loans with put arrangements. Pursuant to these arrangements the Company grants
the buyer a put option that allows the buyer to sell the securities back to the
Company at a negotiated price. The accounting treatment for these transactions
(as a borrowing or a sale) is based on an assessment of the probability that
the put option will be exercised. If on the transaction date, management
determines that it is probable that the put option will be exercised, the
transaction is accounted for as a borrowing. If it is not judged probable that
the put option will be exercised, the transaction is accounted for as a sale.
The premium collected on such put and any gain on the mortgage loans sold are
deferred until the negotiated net option period expires. When a transaction is
initially recorded as a sale but exercise of the put option later becomes
probable, the Company accrues any losses expected upon the exercise of the put
option and periodically adjusts the estimated loss accrual.
Interest rate risk management
The Company has various mechanisms to reduce its exposure to interest rate
fluctuations, as these affect the value of its portfolio and the prices of
newly generated loans, loans to be originated and sales with put options.
The Company may enter into financial derivatives such as future contracts or
options.
The cost of unexpired options, net of premiums collected on written options, is
capitalized as part of the carrying cost of the mortgage loans and charged to
income when these expire. Unrealized net gains or losses on unexpired options
positions are considered as part of the lower cost or market evaluation made
for mortgage loans.
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Loan servicing
The Company pools FHA insured and VA guaranteed mortgages for issuance of GNMA
mortgage-backed securities. Conventional loans are pooled and issued as FNMA
or FHLMC mortgage-backed securities and CMO certificates as well as sold in
bulk to investors. Mortgages included in the resulting GNMA, FNMA and FHLMC
pools, CMO certificates and certain pools of conventional loans sold to
investors are serviced by the Company. The Company is required to advance
funds to make scheduled payments to investors, if payments due have not been
received from the mortgagors. At December 31, 1995, accounts receivable
include advances to investors of approximately $5,340,000 (1994 - $3,100,000).
The Company is also required to foreclose on loans in the event of default by
the mortgagor. Mortgage loan servicing fees, which are based on a percentage
of the principal balances of the mortgages serviced, are credited to income as
mortgage payments are collected.
Sales of mortgage servicing rights
The Company recognizes gain or loss on the sale of mortgage servicing rights
when the sales contract is executed, all regulatory related approvals are
obtained and the title and all risks and rewards of ownership have been
irrevocably transferred to the buyer.
Income taxes
The Company follows an asset and liability approach that requires the
recognition of deferred tax liabilities and assets for the expected future tax
consequences of temporary differences between the carrying amounts and the tax
bases of other assets and liabilities. A valuation allowance is recognized for
any deferred tax asset for which, based on management's evaluation, it is more
likely than not (a likelihood of more than 50%) that some portion or all of the
deferred tax asset will not be realized.
Accounting for Impairment of a Loan
In January 1995, the Company adopted Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan." This
statement requires that impaired loans that are within the scope of the
statement be measured based on the present value of expected future cash flows
discounted at the loan's effective interest rate or, as a practical expedient,
at the loan's observable market price or the fair value of the collateral if
the loan is collateral dependent.
The adoption of this statement had no effect on the Company's results of
operations or financial position.
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Statement of cash flows
Cash and cash equivalents include cash in banks, overnight deposits and
certificates of deposit (1995 - $25,099,000 and 1994 - $330,000) and other
highly liquid securities with an original maturity of three months or less.
At December 31, 1995, other highly liquid securities include $30,473,141 of
securities purchased under agreements to resell as follows:
Amount Maturity
------ --------
PaineWebber Inc. of Puerto Rico $ 4,016,193 January 2, 1996
BP Capital Markets, Inc. 2,004,448 January 2, 1996
BP Capital Markets, Inc. 1,000,000 January 2, 1996
PaineWebber Inc. of Puerto Rico 10,650,000 January 23, 1996
PaineWebber Inc. of Puerto Rico 10,600,000 January 23, 1996
CS First Boston Corporation 2,202,500 February 22, 1996
-----------
$30,473,141
===========
Earnings per share
Primary net income per share is determined by dividing net income, after
deducting preferred stock dividends, by the weighted average number of common
stock outstanding during the period considering the dilutive effect of
restricted stock awards.
Fully diluted net income per share has been computed based on the assumption
that all of the shares of convertible preferred stock and convertible
subordinated debentures are converted into common stock, and after giving
retroactive effect to the elimination of interest expense, net of income taxes,
applicable to the convertible subordinated debentures.
On October 25, 1993, the Company declared a two for one stock split on its
shares of common stock outstanding. The stock split was effected in the form
of a stock dividend of one additional share of common stock for each share of
common stock held on record date of November 22, 1993. As a result, 3,381,069
shares of common stock were issued on December 10, 1993. As a result of the
stock split referred to above, each outstanding share of the Company's Series A
Preferred Stock became convertible into two shares of common stock at a
conversion price of $5 per share.
The number of shares of common stock used for computing the primary and fully
diluted earnings per share was as follows:
1995 1994 1993
---- ---- ----
Primary 7,307,945 6,942,734 6,614,854
Fully diluted 7,760,135 7,576,964 7,576,964
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Fair value of financial instruments
The reported fair values of financial instruments are based on a variety of
factors. For a substantial portion of financial instruments, fair values
represent quoted market prices for identical or comparable instruments. In a
few other cases, fair values have been estimated based on assumptions
concerning the amount and timing of estimated future cash flows and assumed
discount rates reflecting varying degrees of risk. Accordingly, the fair
values may not represent actual values of the financial instruments that could
have been realized as of year end or that will be realized in the future.
Accounting For Stock-Based Compensation
In October, 1995, the FASB issued Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). This
statement, which the Company must adopt for transactions entered into in the
fiscal years that begin after December 15, 1995, establishes financial
accounting and reporting standards for stock-based employee compensation plans.
Those plans include all arrangements by which employees receive shares of stock
or other equity instruments of the employer or the employer incurs liabilities
to employees in amounts based on the price of the employee's stock. Examples
are: stock purchase plan, stock options, restricted stock and stock
appreciation rights. This statement defines a fair value based method of
accounting for an employee stock option and encourages all entities to adopt
that method of accounting for all of their employee stock compensation plans.
However, it also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed by
APB Opinion No. 25.
No transactions of the nature covered by SFAS 123 have been made, therefore,
disclosure of monetary nature is not deemed appropriate.
Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities
The FASB issued an exposure draft that would provide accounting and reporting
standards for transfers and servicing of financial assets and extinguishment of
liabilities. Such standard would require each party to a transfer to recognize
the financial assets it controls and liabilities it has incurred and
derecognize assets when control over them has been relinquished. A possible
impact to the Company of adopting the proposed standard would be the potential
derecognition from the Company's financial statements of securities sold under
certain long-term repurchase agreements.
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Other
Certain amounts reflected in the 1994 and 1993 consolidated financial
statements have been reclassified to conform to the presentation for 1995.
NOTE 3 - COST IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED:
Doral and RSC were acquired in December 1986, these transactions were accounted
for by the purchase method of accounting resulting in $1,620,000 of cost in
excess of the fair value of net assets acquired. The terms of the Company's
purchase agreement require additional pay-outs to the former stockholder over a
ten-year period ending in 1996. The additional pay-outs are contingent
payments under the purchase agreements, and are accounted for as additional
cost over the fair value of assets acquired. The amount of such pay-outs is
determined based on a percentage ranging from 1/16% to 1/4% of the aggregate
principal amount of mortgage loans closed. The deferred pay-out portion has
been discounted using an imputed interest rate of 8%.
The changes in cost in excess of fair value of net assets acquired are shown
below:
Year ended December 31,
-----------------------
1995 1994 1993
---- ---- ----
Balance at beginning of period $6,609,402 $6,536,570 $5,535,146
Contingent payments under
Doral purchase agreement 292,887 430,929 985,900
Acquisition of Doral Federal
Savings Bank - - 271,000
Amortization expense (376,158) (358,097) (255,476)
---------- ---------- ----------
Balance at end of period $6,526,131 $6,609,402 $6,536,570
========== ========== ==========
Total accumulated amortization relating to cost in excess of fair value of net
assets acquired amounted to $3,351,660, $2,975,502 and $2,617,405 at December
31, 1995, 1994 and 1993, respectively.
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NOTE 4 - REGULATORY REQUIREMENTS:
The Company is a U.S. Department of Housing and Urban Development (HUD)
approved, non supervised mortgagee and is required to maintain an excess of
current assets over current liabilities and minimum net worth, as defined by
the various regulatory agencies. The Company is also required to maintain
fidelity bonds and errors and omission's insurance coverages based on the
balance of its servicing portfolio.
As a result of the acquisition of Doral Federal, the Company became legally a
savings and loan holding company ("SLHC") subject to the restrictions and
requirements of the Home Owners' Loan Act of 1933, as amended (the "HOLA"). As
SLHC, the Company was registered with the Director of the Office of Thrift
Supervision (the "OTS") and is subject to various requirements of the HOLA,
including examination, supervision and reporting requirements. Federal law and
OTS regulations place certain limits on the types of activities in which an
SLHC and its subsidiaries may engage. However, in general, these restrictions
do not apply to a holding company that controls only one savings and loan
association, provided such association meets the "qualified thrift lender" test
which generally requires the association to have 65% of its portfolio assets in
"qualified thrift investments." For Puerto Rico based institutions, these
investments include, among other things, home mortgages, mortgage-backed
securities, and personal loans. Doral Federal is also subject to certain
regulatory capital requirements.
The Company is in compliance with these regulatory requirements.
NOTE 5 - MORTGAGE LOANS HELD FOR SALE:
Mortgage loans held for sale consist of:
December 31,
------------
1995 1994
---- ----
Mortgage Loans:
Conventional loans $138,433,518 $194,208,574
FHA/VA loans 101,627,975 60,275,811
Construction and commercial loans 5,422,762 9,288,998
------------ ------------
$245,484,255 $263,773,383
============ ============
At December 31, 1995, the aggregate amortized cost and approximate market value
of these loans are as follows:
Amortized Gross unrealized Gross unrealized Approximate
cost holding gains holding losses market value
---- ------------- -------------- ------------
$245,484,255 $4,158,015 ($4,142,708) $245,499,562
============ ========== ========== ============
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Proceeds from sales of mortgage loans held for sale and mortgage-backed
securities held for trading during 1995 was approximately $725,236,000 (1994 -
$774,313,000). Gross gains of $42,472,000 (1994 - $56,010,000) and gross
losses of $27,362,000 (1994 - $41,452,000) were realized on those sales.
At December 31, 1995, construction and commercial loans include a loan of
approximately $1,250,000 on which the accrual of interest income had been
discontinued. The Company is contractually entitled to transfer this loan to a
non-related financial institution on a non-recourse basis. If this loan had
been accruing interest, additional interest income would have been realized of
about $125,000.
NOTE 6 - MORTGAGE-BACKED SECURITIES HELD FOR TRADING:
Mortgage-backed securities held for trading consist of:
December 31,
------------
1995 1994
---- ----
Mortgage-backed securities:
CMO certificates $157,535,436 $158,252,188
GNMA 242,327,525 152,494,112
FHLMC 7,091,819 7,217,040
FNMA 986,715 1,240,234
------------ ------------
$407,941,495 $319,203,574
============ ============
CMO certificates include the following:
December 31,
------------
1995 1994
---- ----
Certificates of other issuers $135,572,829 $137,824,467
Residual certificates, CMO's
established by the Company 13,136,055 9,355,934
Subordinated certificates, CMO's
established by the Company 8,826,552 11,071,787
------------ ------------
$157,535,436 $158,252,188
============ ============
At December 31, 1995, CMO certificates include approximately $14,094,000 of
interest only certificates.
Net unrealized holding gains on trading securities included in earnings for the
year ended December 31, 1995 amounted to approximately $4,864,000 (1994 - Net
unrealized holdings losses of $1,485,000).
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The Insurance and Indemnity Agreements (the "Agreements") covering certain
financial guaranty insurance policies that insure the payment of senior
certificates issued by CMO grantors trusts established by the Company, provide,
among other things, that the Company cannot sell, transfer or pledge the
residual certificates issued by the trusts (amounting to approximately
$5,700,000) without the insurance company approval because the residual
certificates are pledged as collateral to the insurance company.
NOTE 7: SECURITIES HELD TO MATURITY:
Securities held to maturity consists of:
December 31,
------------
1995 1994
---- ----
Amortized Fair Amortized Fair
cost Value cost Value
---- ----- ---- -----
Mortgage backed securities:
CMO certificates of other issuers $59,248,183 $59,520,647 $42,052,074 $42,175,115
GNMA 10,744,705 10,918,536 - -
FHLMC - - 4,600,372 4,469,976
FNMA - - 7,747,202 7,308,743
Debt securities:
Federal Home Loan Bank Notes 4,999,354 4,995,300 9,972,150 9,712,450
U.S. Treasury Notes 1,997,436 2,001,880 1,984,296 1,949,360
U.S. Treasury Bills 63,075 63,360 - -
Other investments:
Mortgage notes receivables 892,672 892,672 448,332 448,332
----------- ----------- ----------- -----------
$77,945,425 $78,392,395 $66,804,426 $66,063,976
=========== =========== =========== ===========
Management has the intent to hold these securities and believes it has the
ability to hold them to maturity by obtaining continuing financing under its
existing credit facilities. In addition, part of the above securities are held
by Doral Federal which has the ability to finance these securities with
deposits, advances from Federal Home Loan Bank of N.Y. and other long-term
funding sources.
At December 31, 1995, CMO certificates include approximately $4,800,000 of
interest only certificates.
At December 31, 1995, held to maturity securities include approximately
$2,500,000 pledged to secure public funds deposited in Doral Federal.
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Contractual maturities of securities held to maturity at December 31, 1995 are
as follows:
MBS Debt securities
--- ---------------
Within one year - $7,952,537
After 1 year through five years $12,487,500 -
After 5 years through 10 years 12,483,350 -
After 10 years 45,022,038 -
----------- ----------
$69,992,888 $7,952,537
=========== ==========
Aggregate gross unrealized holding gains and losses are as follows:
December 31,
------------
1995 1994 1995 1994
---- ---- ---- ----
MBS Debt securities
--- ---------------
Gross unrealized holding gains $480,644 $397,026 $4,730 $ -
======== ======== ====== ========
Gross unrealized holding losses $ 34,350 $842,839 $4,054 $294,637
======== ======== ====== ========
NOTE 8 - SECURITIES AVAILABLE FOR SALE:
At December 31, 1995, securities available for sale consists of:
Fair Value Amortized Cost
----------- --------------
FNMA $ 7,132,358 $ 7,164,471
FHLMC 4,381,228 4,413,676
GNMA 3,065,411 2,991,994
----------- -----------
$14,578,997 $14,570,141
=========== ===========
Aggregate gross unrealized holding gains and losses are as follows:
Gross unrealized holding gains $95,406
=======
Gross unrealized holding losses $86,550
=======
The contractual maturity of the securities available for sale at December 31,
1995 is over ten years.
There were no sales of such securities during the year ended December 31, 1995.
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NOTE 9 - LOANS RECEIVABLE:
Loans receivable consist of:
1995 1994
---- ----
Construction loans $ 2,637,523 $ 1,060,528
Residential mortgage loans 29,480,931 23,292,969
Commercial real estate 9,204,612 2,044,120
Consumers - secured by mortgage 7,361,606 6,283,092
Consumers - other 323,744 1,008,704
Loans on savings deposits 1,939,912 956,212
Commercial 698,367 392,940
Leases 3,283 27,727
Land secured 330,345 183,896
----------- -----------
Gross loans 51,980,323 35,250,188
----------- -----------
Less:
Unearned interest and deferred loan fees (382,894) (13,204)
Reserve for loan losses (242,171) (428,046)
----------- -----------
(625,065) (441,250)
----------- -----------
Total loans $51,355,258 $34,808,938
=========== ===========
As of December 31, 1995, Doral Federal had loans amounting to approximately
$949,000 on which the accrual of interest income had been discontinued. If
these loans had been accruing interest, the additional interest income realized
would have been approximately $86,000.
Doral Federal originates adjustable and fixed interest rate loans. The
adjustable rate loans have interest rate adjustment limitations and are
generally tied to various market indexes. Future market factors may affect the
correlation of the interest rate adjustment with the rate Doral Federal pays on
the short-term deposits that have primarily funded these loans. At December
31, 1995, the composition of loans receivable was as follows:
Fixed rates Adjustable rates
----------- ----------------
Term to Book Term to date of Book
maturity value rate adjustment value
-------- ----- --------------- -----
1 month - 1 year $ 1,985,637 1 month - 1 year $3,527,605
1 year - 3 years 1,590,101 Non performing 82,475
3 years - 5 years 4,616,212 ----------
5 years - 10 years 11,744,621
10 years - 20 years 15,487,877 $3,610,080
More than 20 years 12,078,938 ==========
Non performing 866,857
-----------
$48,370,243
===========
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NOTE 10 - ALLOWANCES FOR LOSSES:
The changes in the allowances for losses were as follows:
Year ended December 31,
-----------------------
1995 1994 1993
---- ---- ----
Accounts receivable and mortgage
servicing advances:
Balance at beginning of period $1,563,701 $1,446,563 $1,283,925
Provision for losses 242,000 132,000 889,500
Losses charged to the allowance - (14,862) (726,862)
---------- ---------- ----------
Balance at end of period $1,805,701 $1,563,701 $1,446,563
========== ========== ==========
Real estate held for sale:
Balance at beginning of period $ 356,035 $ 525,000 $ 400,000
Provision for losses - - 100,000
Losses charged to the allowance - (168,965) -
Other - - 25,000
---------- ---------- ----------
Balance at end of period $ 356,035 $ 356,035 $ 525,000
========== ========== ==========
Reserve for bank loan losses:
Balance at beginning of period $ 428,046 $ 234,200 $ 516,200
Provision for loan losses 110,000 167,523 23,000
Recoveries 6,810 26,323 -
Losses charged to the allowance (302,685) - (305,000)
---------- ---------- ----------
Balance at end of period $ 242,171 $ 428,046 $ 234,200
========== ========== ==========
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NOTE 11 - EXCESS SERVICING FEES RECEIVABLE:
The changes in excess servicing fees receivable are shown below:
Year ended December 31,
-----------------------
1995 1994 1993
---- ---- ----
Balance at beginning of period $ 8,756,589 $3,463,945 $ 521,591
Additions 2,638,790 5,859,312 3,103,139
Amortization
Scheduled (988,082) (566,668) (160,785)
Unscheduled - - -
----------- ---------- ----------
Balance at end of period $10,407,297 $8,756,589 $3,463,945
=========== ========== ==========
There was no impairment of excess servicing fees receivable during any of the
above periods.
NOTE 12 - PROPERTY, LEASEHOLD IMPROVEMENTS AND EQUIPMENT:
Property, leasehold improvements and equipment consist of:
December 31,
------------
1995 1994
---- ----
Office furniture and equipment $ 6,076,902 $ 5,984,310
Leasehold improvements 4,634,187 4,243,689
Automobiles 262,428 287,211
Real estate under rental agreements 73,660 73,660
Office building 413,982 406,815
----------- -----------
11,461,159 10,995,685
Less - Accumulated depreciation
----
and amortization (4,956,434) (3,528,705)
----------- -----------
$ 6,504,725 $ 7,466,980
=========== ===========
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NOTE 13 - MORTGAGE SERVICING RIGHTS:
The changes in mortgage servicing rights are shown below:
Year ended December 31,
-----------------------
1995 1994 1993
---- ---- ----
Balance at beginning of period $ 3,543,032 $3,994,788 $4,416,955
Capitalization of rights 7,901,308 581,130 69,833
Rights sold (24,052) (302,827) -
Rights purchased 305,831 - -
Impairments - - -
Amortization:
Scheduled (562,054) (730,059) (492,000)
Unscheduled - - -
----------- ---------- ----------
Balance at end of period $11,164,065 $3,543,032 $3,994,788
=========== ========== ==========
Acquisitions in 1993 include $54,980 of mortgage servicing rights related to
the acquisition of Doral Federal. The Company's servicing portfolio amounted
to approximately $2,668,000,000 and $2,644,000,000 at December 31, 1995 and
1994, respectively, including $85,170,000 and $112,000,000 respectively, of
loans sold with recourse which are not government guaranteed or insured.
During the years ended December 31, 1995, 1994 and 1993, the Company sold
rights to service loans, amounting to approximately $310,000,000, $202,000,000
and $198,700,000, respectively. During the year ended December 31, 1995, the
Company purchased rights to service loans amounting to approximately
$40,000,000. No mortgage servicing rights were purchased in 1994 and 1993.
The carrying amount of mortgage servicing rights approximates its fair value.
NOTE 14 - ACCOUNTS PAYABLE AND OTHER LIABILITIES:
Accounts payable and other liabilities consist of the following:
December 31,
------------
1995 1994
---- ----
Amounts retained on mortgage loans,
generally paid within 5 days $ 3,516,973 $ 3,044,286
Customer mortgages and closing
expenses payable 1,756,931 1,235,655
Deferred compensation plan 1,982,142 2,416,948
Incentive compensation payable 2,162,867 3,302,446
Accrued expenses and other payables 7,957,291 7,793,309
----------- -----------
$17,376,204 $17,792,644
=========== ===========
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NOTE 15 - LOANS PAYABLE:
At December 31, 1995 and 1994, the Company had several mortgage warehousing
lines of credit and gestation or presale facilities totaling $525,000,000 and
$367,000,000, respectively. Advances under these facilities are secured by
loans held for inclusion in GNMA, FNMA and FHLMC pools or for sale to financial
investors.
Loans payable consist of the following:
December 31,
------------
1995 1994
---- ----
Loans payable resulting from use of warehousing lines
of credit and gestation or presale facilities. At various
variable rates averaging 6.77% and 7.17% at December 31, 1995
and 1994, respectively, and other financing arrangements. $171,616,950 $265,705,957
Amount payable in connection with securities previously sold
under put arrangement, due January 1996, at 7.5%, collaterized
by GNMA mortgage-backed securities 41,000,000 -
Securities sold not yet purchased ($19,962,047 at 7.5% and
$2,127,500 at variable rates - 5.5% - at December 31, 1995),
due dates ranging from December 1996 to August 2000. 22,089,547 -
------------ ------------
$234,706,497 $265,705,957
============ ============
Maximum borrowings outstanding at any month-end during 1995 and 1994 were
$280,000,000 and $283,000,000, respectively. The approximate average
outstanding borrowings during the periods were $223,000,000 and $149,000,000,
respectively. The weighted average interest rate of such borrowings, computed
on a monthly basis, was 7.15% in 1995 and 5.70% in 1994.
On June 30, 1995, FFCC entered into a Syndicated Credit Agreement (the
"Syndicated Credit Agreement") with six banks providing for three credit
facilities totaling up to $125 million. The credit facilities were structured
by Bankers Trust Company, as administrative and syndicate agent. The three
facilities include: (i) a $100 million secured one-year revolving warehousing
credit facility to finance residential mortgage loans and mortgage-backed
securities; (ii) a $7 million secured one-year revolving credit facility to
provide financing for receivables and working capital needs; and (iii) a $18
million five-year senior secured term loan, secured with a portion of the
Company's servicing portfolio, to finance the acquisition of additional
servicing rights and general working capital purposes. The amounts available
under the Syndicate Credit Agreement are subject to a borrowing
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base which consists of mortgage loans and mortgage-backed securities for the
first facility, receivables relating to servicing advances and real estate
owned for the second facility and mortgage servicing rights for the third
facility. Loans payable include advances from the warehousing credit facility.
Advances from the other two facilities are included in notes payable. The
existing warehousing credit facilities, the Syndicated Credit Agreement and
other financing arrangements require the Company to maintain certain capital
ratios and to comply with other requirements. At December 31, 1995, the
Company was in compliance with these requirements. At December 31, 1995 the
scheduled aggregate annual maturities of loans payable were approximately as
follows:
Year ending December 31,
------------------------
1996 $222,596,297
1997 9,982,700
2000 2,127,500
------------
$234,706,497
============
NOTE 16 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE:
The Company sells mortgage-backed securities and mortgage loans under
agreements to repurchase. At December 31, 1995 and 1994, the Company had
several repurchase agreement lines of credit, totaling $617,000,000 and
$560,000,000, respectively. At December 31, 1995 and 1994, the Company had a
liability of $363,728,000 and $303,730,017, respectively, relating to such
agreements at interest rates ranging from 5.09% to 6.95% in 1995 and 3.77% to
6.75% in 1994. These agreements mature at various dates as follows: December
31, 1995:
Approximate market
Repurchase and book value of
Type of security liability underlying securities
- ---------------- --------- ---------------------
GNMA (1) $143,475,000 $152,157,723
FHLMC (1) 6,917,000 7,091,819
FNMA (1) 1,001,000 986,515
CMO Certificates (1) 126,630,000 148,223,489
------------ ------------
278,023,000 308,459,546
------------ ------------
GNMA (2) 39,998,000 42,541,205
CMO Certificates (2) 25,554,000 29,707,699
------------- -------------
65,552,000 72,248,904
------------- -------------
GNMA (3) 5,014,000 5,708,786
------------- -------------
CMO Certificates (4) 15,139,000 17,767,400
------------- -------------
$363,728,000 $404,184,636
============ ============
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December 31, 1994:
Approximate market
Repurchase and book value of
Type of security liability underlying securities
- ---------------- --------- ---------------------
GNMA (1) $ 90,648,904 $ 98,448,093
FHLMC (1) 4,360,352 4,995,961
CMO Certificates (1) 144,785,836 166,578,950
------------ ------------
239,795,092 270,023,004
------------ ------------
GNMA (2) 9,399,101 10,461,432
CMO Certificates (2) 14,662,910 16,719,287
------------ ------------
24,062,011 27,180,719
------------ ------------
GNMA (5) 37,058,246 42,735,912
FHLMC (5) 979,260 1,240,234
FNMA (5) 1,835,408 2,221,079
------------ ------------
39,872,914 46,197,225
------------ ------------
$303,730,017 $343,400,948
============ ============
(1) Term up to 30 days
(2) Term over 30 days to 120 days
(3) Term over 120 days to 1 year
(4) Term between 3 to 5 years
(5) Term between 5 to 8 years
Maximum borrowings outstanding at any month-end during 1995 and 1994 under the
agreements to repurchase were $389,000,000 and $353,000,000, respectively. The
approximate average borrowings outstanding during the periods were $368,000,000
and $302,000,000, respectively. The weighted average interest rate of such
borrowings, computed on a monthly basis was 5.90% in 1995 and 4.33% in 1994.
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At December 31, 1995, securities sold under agreements to repurchase are
classified by dealer as follows:
Approximate
Market value of
Balance of borrowing underlying securities
-------------------- ----------------------
Lehman Brothers Puerto Rico, Inc. $ 78,762,000 $ 88,308,589
BP Capital Markets, Inc. 129,545,000 146,783,397
PaineWebber, Inc. of Puerto Rico 48,009,000 53,632,665
Merrill Lynch Government Securities
of Puerto Rico, SA 46,706,000 49,291,901
Bear Stearns Securities Corp. 31,235,000 32,655,279
Bankers Trust Caribe Capital Markets, Inc. 29,471,000 33,512,805
------------ ------------
Total $363,728,000 $404,184,636
============ ============
NOTE 17 - NOTES PAYABLE:
Notes payable consist of the following:
December 31,
------------
1995 1994
---- ----
Demand note payable at 9% interest, collateralized
by CMO certificates $ 1,000,000 $ 3,250,000
Unsecured medium term notes, payable at interest
rates ranging from 9.50% to 13.63%, due
December 31, 1996 1,590,000 3,170,000
Unsecured notes payable at 9% interest rate, final
payment dates ranging from August, 1996 to
September 1998. 5,915,480 6,095,480
Note payable to bank, collateralized by CMO certificates,
at 8.50% interest rate and due on October 16, 1996. 9,776,676 -
Term-notes payable to private investors, collateralized
by stand-by letters of credit issued by the Federal Home
Loan Bank of New York:
at 5.55% maturing on October 13, 2000 8,100,000 -
at variable rate (5.00% at December 31, 1995)
maturing on November 17, 2000 5,000,000 -
at 5.23% maturing on November 27, 2000 5,000,000 -
Loan payable to Bank, collateralized by mortgage
servicing rights held by the Company, at variable rate
(8.125% at December 31, 1995) maturing on June 30, 2000. 15,300,000 -
Due to Bank - 4,540,000
----------- -----------
$51,682,156 $17,055,480
=========== ===========
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At December 31, 1995, the scheduled aggregate annual maturities of notes
payable were approximately as follows:
Year ending December 31,
------------------------
1996 $15,307,156
1997 2,190,000
1998 785,000
2000 33,400,000
-----------
$51,682,156
===========
NOTE 18 - CONVERTIBLE SUBORDINATED DEBENTURES:
The Company entered into a Debenture Purchase Agreement (the "Debenture
Agreement") with BanPonce Corporation ("BanPonce"), providing for the issuance
and sale to BanPonce of up to $10 million of the Company's 8.25% Convertible
Subordinated Debentures due January 1, 2006 (the "Subordinated Convertible
Debentures"). The Subordinated Convertible Debentures are convertible into
shares of common stock of the Company at a conversion price of $17.50 per
share, subject to adjustments in certain events. Approximately $6.6 million
and $3.4 million of Subordinated Convertible Debentures were issued on
September 25 and December 22, 1995, respectively. The Subordinated Convertible
Debentures are subordinated to all existing and future senior debt of the
Company (as defined in the Debenture Agreement). Under the Debenture
Agreement, BanPonce has the right to acquire up to 200,000 additional shares of
the Company's common stock at a price of $17.50 per share (subject to
adjustment in certain events) to the extent that its investment in the Company
is reduced below 5% on a fully-diluted basis. Such right to acquire the
additional shares expires on June 30, 1999 and is subject to termination upon
the occurrence of certain corporate events involving the acquisition of the
Company.
NOTE 19 - DEPOSIT ACCOUNTS:
At December 31, deposits and their weighted average interest rates are
summarized as follows:
1995 1994
------------------------ --------------------------
Amount % Amount %
------ - ------ -
Regular savings $10,271,981 3.68 $ 5,621,092 2.99
NOW accounts 2,046,765 3.35 2,788,200 3.14
Non interest-bearing deposits 31,094,992 - 23,774,402 -
Certificates of deposit 52,326,703 6.12 34,287,417 5.56
----------- ---- ----------- ----
$95,740,441 3.20 $66,471,111 2.73
=========== ==== =========== ====
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Page 24
At December 31, 1995 certificates of deposit over $100,000 in the aggregate
amounted to $12,253,574. A summary of certificates of deposit by maturity as
of December 31 follows:
1995 1994
---- ----
Within one year $40,465,351 $10,591,820
One to three years 5,252,095 18,853,486
Three and thereafter 6,609,257 4,842,111
----------- -----------
$52,326,703 $34,287,417
=========== ===========
A summary of certificates of deposit by interest rate at December 31, 1995
follows:
Rate Amount
---- ------
2.9% or less $ 16,323
From 3.00% to 3.99% 5,000
From 4.00% to 4.99% 1,443,679
From 5.00% to 5.99% 22,095,190
From 6.00% to 6.99% 19,595,638
From 7.00% to 7.99% 9,080,873
From 8.00% to 8.99% 90,000
-----------
Total $52,326,703
===========
At December 31, 1995, Doral Federal has deposits from officers, directors,
employees and major stockholders of the Company amounting to approximately
$1,100,000 (1994 - $1,400,000).
The Company as a servicer of loans is required to maintain certain balances on
behalf of the borrowers, called escrow funds. At December 31, 1995, escrow
funds amounted to approximately $35,377,000 (1994 - $32,125,000), of which
$27,430,000 were deposited with Doral Federal (1994 - $21,132,000). The
remaining escrow funds, $7,947,000 (1994- $10,993,000), were deposited with
other banks and therefore excluded from the Company's assets and liabilities.
NOTE 20 - ADVANCES FROM THE FEDERAL HOME LOAN BANK:
At December 31, 1995, advances from the Federal Home Loan Bank of New York
("FHLB") consist of the following:
7.76% due on August 21, 1996 $ 407,111
6.307% due on July 21, 2000 5,000,000
6.445% due on July 17, 2002 5,000,000
-----------
Total $10,407,111
===========
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At December 31, 1995, the Company had qualified collateral, in the form of
first mortgage notes and mortgage-backed securities with a carrying value of
$38,462,085 which were pledged to secure advances from the FHLB and stand-by
letters of credit issued by the FHLB as collateral for the term-notes.
NOTE 21 - INCOME TAXES:
Under the provisions of Law No. 38 of May 20, 1983, the Company is exempt from
the payment of Puerto Rico income taxes on the interest earned on mortgages on
residential properties located in Puerto Rico which were executed after June
30, 1983, and are insured or guaranteed pursuant to the provisions of the
National Housing Act of June 27, 1934, as amended, and pursuant to the
Provisions of the Servicemen's Readjustment Act of 1944, as amended. As a
result, net interest income has generally represented a greater proportion of
the Company's total net income than that of a typical non-Puerto Rican
mortgage banking institution. The Company holds exempt loans and
mortgage-backed securities for periods of time prior to sale in order to
maximize the tax exempt interest produced by these securities and loans.
Doral Federal, as a federally chartered financial institution operating in
Puerto Rico, is subject to U.S. Federal income taxes. Doral Federal has filed
an election under Section 936 of the U.S. Internal Revenue Code, whereby a
possession tax credit is allowed for part of the federal income taxes
attributable to income from operations in Puerto Rico. The mortgage banking
operation of the Company conducted through Puerto Rico corporations are not
subject to United States income tax for business carried out in Puerto Rico.
Substantially all of the Company's mortgage banking operations are conducted in
Puerto Rico, therefore, the amount of U.S. income taxes with respect to such
operations is not significant.
Consolidated tax returns are not permitted under the Puerto Rico Income Tax
Law, therefore, income tax returns are filed individually by each Company.
The provision for income taxes differs from amounts computed by applying the
applicable Puerto Rico statutory tax rate to income before taxes. A
reconciliation of the difference follows:
Year ended December 31,
-----------------------
1995 1994 1993
---- ---- ----
Income before income taxes $22,060,517 $20,840,112 $30,921,245
=========== =========== ===========
% of pretax % of pretax % of pretax
Amount income Amount income Amount income
------ ------ ------ ------ ------ ------
Tax at statutory rates $ 9,265,417 42.0 $8,752,847 42.0 $12,986,923 42.0
Tax effect of exempt interest
income - net (4,590,485) (20.8) (5,435,541) (26.1) (2,717,262) (8.8)
Tax effect of capital gains (510,588) (2.5) (471,920) (1.5)
Tax effect of amortization of
goodwill, other non-deductible
expenses and other (281,246) (1.3) 602,877 2.9 745,856 2.4
Tax effect of shares issued
under employment contracts (1,893,473) (8.6) (941,916) (3.1)
----------- ---- ---------- ---- ----------- ----
Provision for income taxes $ 2,500,213 11.3 $3,409,595 16.3 $ 9,601,681 31.0
=========== ==== ========== ==== =========== ====
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At December 31, the components of the net deferred tax liability are:
1995 1994
---- ----
Deferred tax liabilities resulting from:
Untaxed income ($6,460,876) ($3,700,899)
Deferred costs (1,986,637) (2,139,000)
----------- -----------
(8,447,513) (5,839,899)
----------- -----------
Deferred tax assets:
Unrealized losses 1,108,105 1,266,000
Deferred income 1,539,361 -
Net operating loss 922,979 797,000
----------- -----------
3,570,445 2,063,000
----------- -----------
Net deferred tax liability ($4,877,068) ($3,776,899)
=========== ===========
Deferred income tax expense for the year ended December 31, 1994 amounted to
$1,316,899 of which $436,899 is presented as current and $880,000 is shown as
part of the cumulative effect of change in accounting principle.
At December 31, 1995 Doral had net operating losses available to offset future
taxable Puerto Rico source income amounting to approximately $2,365,000
expiring in 2001.
NOTE 22 - RELATED PARTY TRANSACTIONS:
Mortgage loans held for sale include approximately $460,000 of loans to various
officers of the Company at prevailing interest rates (1994 - $280,000).
The Company paid a computer service bureau, in which it holds a 33% interest,
$860,000, $726,000 and $617,000 for services rendered during the years ended
December 31, 1995, 1994 and 1993, respectively. At December 31, 1995 and 1994,
the Company's equity in this service bureau was not significant.
The Company has a 15% interest in a real estate partnership amounting to
approximately $135,000 and which is carried at cost because of its lack of
materiality. At December 31, 1995 and 1994, mortgage-backed securities and
investments held to maturity include approximately $890,000 and $450,000,
respectively due from the Partnership. In addition, at December 31, 1995 and
1994, accounts receivable includes approximately $480,000 and $510,000,
respectively, due from the Partnership.
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NOTE 23 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK:
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit and sell mortgage-backed
securities and loans, and options on futures contracts. Those instruments
involve, to varying degrees, elements of credit and interest rate risk in
excess of the amount recognized in the statement of financial position.
The contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
The Company's exposure to credit losses in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. The
Company uses the same credit policies in making commitments as it does for
on-balance sheet instruments. At December 31, 1995, commitments to extend
credit to individuals for residential mortgages amounted to approximately $14
million and commitments to sell mortgage-backed securities and loans amounted
to approximately $44 million. Management believes that the Company has the
ability to meet these commitments and that no loss will result from the same.
Commitments to extend credit are agreements to lend to a customer as long as
the conditions established in the contract are met. Commitments generally have
fixed expiration dates or other termination clauses.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements.
The Company evaluates each customer's credit worthiness on a case-by-case
basis. The amount of collateral, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation of the
counterparty. A geographic concentration exists within the Company's mortgage
loans portfolio since most of the Company's business activity is with customers
located in Puerto Rico.
The Company controls the credit risk of its future contracts through credit
approvals, limits and monitoring procedures. Options on future contracts
confer the right from sellers to buyer to take a future position at a stated
price. Risks arise from the possible inability of counterparts to meet the
terms of their contracts and from movements in securities values and interest
rates. Collateral for securities purchased under agreements to resell is kept
by the seller under custody agreements. Collateral for securities sold under
agreements to repurchase is kept by the purchaser.
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Page 28
NOTE 24 - PENSION AND COMPENSATION PLANS:
The Company has a noncontributory target benefit pension plan ("the Plan").
The Plan generally covers all full time Company employees that have completed
one year of service and have attained age 21.
Under the Plan, the Company contributes annually the funding amount which is
projected to be necessary to fund the target benefit. The target benefit is
based on years of service and the employees' compensation, as defined in the
Plan. The Company has the right to terminate the Plan at any time. Upon
termination, all amounts credited to the participants' accounts will become
100% vested.
Contributions to the Plan during the years ended December 31, 1995, 1994 and
1993 amounted to approximately $640,000, $700,000 and $503,000, respectively.
Plan assets consist principally of mortgage loans and mortgage-backed
securities.
The Company has unfunded deferred incentive compensation arrangements (the
"Deferred Compensation") with certain employees. The Deferred Compensation is
determined as a percentage of net income arising from the mortgage banking
activities, as defined, and is payable to participants after a five-year
vesting period. The expense for the years ended December 31, 1995 and 1993
amounted to approximately $62,000 and $885,000, respectively. For the year
ended December 31, 1994 there was no deferred compensation expense.
The Company also has incentive compensation arrangements with certain employees
payable currently. The incentive payments are based on the amount of
consolidated net income in excess of established return on stockholders'
equity, as defined in the agreements and mortgage loans closed (1993). The
expense under these arrangements for the years ended December 31, 1995, 1994
and 1993 amounted to approximately $2,415,000, $2,721,000 and $7,866,000,
respectively.
NOTE 25 - COMMITMENTS AND CONTINGENCIES:
The Company has several noncancellable operating leases for office facilities
expiring through 2005. Total minimum rental commitments for leases in effect
at December 31, 1995 are as follows:
Year Amount
---- ------
1996 $1,756,000
1997 1,187,000
1998 647,000
1999 239,000
2000 156,000
2001 and thereafter 394,000
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Page 29
Total rental expense for the years ended December 31, 1995, 1994 and 1993
amounted to approximately $2,100,000, $2,000,000 and $1,445,000, respectively.
The Company is subject to legal proceedings and claims which have arisen in the
ordinary course of its business and have not been finally adjudicated. These
actions, when finally concluded and determined, will not, in the opinion of
management, have a material adverse effect upon the financial position or
results of operations of the Company.
From time to time the Company may sell mortgage-backed securities and mortgage
loans with put options. At December 31, 1995, the amount outstanding under
these arrangements amounted to approximately $25,000,000, expiring in July
1996. If the put option is exercised, the Company would have to buy back this
amount at the original sale price, adjusted for prepayments. As part of its
hedging program, the Company includes the risks associated with its put
arrangements.
The Company has a commitment to sell approximately $40,000,000 of 5.5% GNMA
mortgage-backed securities with a one-year put option.
Legislation has been proposed by the U.S. Congress that would, among other
matters, recapitalize the FDIC Savings Association Insurance Fund (the "SAIF").
The proposed legislation provides for a one-time assessment to be imposed on
all SAIF-insured deposits as of March 31, 1995, in order to recapitalize the
SAIF and eliminate the disparity of insurance premiums with the Bank Insurance
Fund (the "BIF"). Under such proposed legislation, the SAIF and the BIF would
be merged effective January 1, 1998. The special assessment rate is
anticipated to be between .70% to .90% of deposits and would be payable in
early 1996. Based upon Doral Federal's deposits at March 31, 1995 and assuming
a special assessment of .90%, Doral Federal's assessment would be approximately
$861,000 on a pre-tax basis.
As part of the ongoing federal budget negotiations, various proposals have been
made that provide for the repeal of Section 936 of the U.S. Internal Revenue
Code ("Section 936"). While the final impact of any such proposals cannot be
determined at this time, the repeal of Section 936 could have an adverse effect
on the general economic condition of Puerto Rico, the Company's predominant
service area. The repeal of Section 936 could also raise funding costs, reduce
demand for mortgage loans and mortgage-backed securities in Puerto Rico and
would likely increase the effective tax rate of Doral Federal. In recent
years, the Company has taken steps to attempt to reduce any adverse impact from
the repeal of Section 936 by diversifying its sources of funding and
identifying additional investors for its mortgage products.
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Page 30
NOTE 26 - CAPITAL STOCKS AND PAID-IN CAPITAL:
The Company has a Restricted Stock Plan (the "Restricted Stock Plan") and a
Stock Option Plan. The Restricted Stock Plan provides for the granting of up
to 250,000 shares of common stock to selected officers at no cost. At December
31, 1995 and 1994, the number of shares awarded and issued under the Restricted
Stock Plan was 177,806 shares, including 88,903 shares issued on December 10,
1993 as result of the stock split. The terms of the Restricted Stock Plan
permit the imposition of restrictions ranging from one to five years on the
sale or disposition of the shares issued. The Stock Option Plan provides for
selected officers and key employees to purchase up to 300,000 shares of common
stock at prices equal to the fair market value on date of grant. No options
have been awarded.
The Company's 10.5% Cumulative Convertible Preferred Stock Series A, has a
liquidation preference of $10 per share plus accrued dividends and is
convertible at the option of the holder into two shares of common stock at a
conversion price of $5 per share. It is redeemable in whole or part at the
option of the Company on or after January 1, 1995 and on or prior to December
31, 1996 at $11 per share, and thereafter, at redemption prices declining to a
minimum of $10.30 per share on January 1, 2002. Dividends are cumulative from
the date of issue and are payable quarterly.
Present regulations limit the amount of dividends that Doral Federal may pay.
Payment of such dividends is prohibited if, among other things, the effect of
such payment would be to cause the capital of Doral Federal to fall below the
regulatory capital requirements.
The Company is prohibited under the Debenture Agreement mentioned in Note 18
from paying dividends on any capital stock (other than dividends payable in
capital stock or in stock rights), when an event of default under such
agreement exist or, if the amount of dividends payable by the Company together
with the aggregate amount of dividends paid and other capital distributions
made since June 1, 1995, exceed an amount defined in the Debenture Agreement.
In addition, the Company cannot pay dividends if it fails to maintain specified
minimum levels of net worth, net earnings to debt service and dividends ratios,
and certain other financial ratios, specified under the Debenture Agreement,
the Syndicated Credit Agreement mentioned in Note 15, and other financing
agreements.
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NOTE 27 - SUPPLEMENTAL INCOME STATEMENT INFORMATION:
Employee costs and other expenses are shown in the Consolidated Statement of
Income and Retained Earnings net of direct loan origination costs. Pursuant to
SFAS-91 direct loan origination costs are capitalized as part of the carrying
cost of mortgage loans and are offset against mortgage loan sales and fees when
the loans are sold. Without the application of SFAS-91, employee costs and
other expenses would have been as follows:
Year ended December 31,
-----------------------
1995 1994 1993
---- ---- ----
Employee costs $24,395,306 $28,537,321 $35,822,728
=========== =========== ===========
Other expenses $12,042,064 $12,802,432 $12,824,650
=========== =========== ===========
Set forth below is a breakdown of direct loan origination costs that were
capitalized as part of the carrying cost of mortgage loans inventory or offset
against mortgage loan sales and fees.
Year ended December 31,
-----------------------
1995 1994 1993
---- ---- ----
Offset against mortgage loan
sales and fees $16,398,038 $21,008,323 $29,220,886
Capitalized as part of loan inventory 5,093,940 5,093,940 2,609,537
----------- ----------- -----------
$21,491,978 $26,102,263 $31,830,423
=========== =========== ===========
NOTE 28 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following table presents the carrying amounts and fair values of the
Company's financial instruments at December 31, 1995 and 1994. FASB Statement
No. 107, Disclosures about Fair Value of Financial Instruments, defines the
fair value of a financial instrument as the amount at which the instruments
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale. Significant differences can arise between the
fair value and carrying amount of financial instruments that are recognized at
historical cost amounts.
1995 1994
---- ----
Carrying Carrying
amount Fair value amount Fair value
------ ---------- ------ ----------
(In thousands)
Financial assets:
Cash and cash equivalents $ 59,872 $ 59,872 $ 35,916 $ 35,916
Mortgage loans held for sale 245,484 245,500 263,773 264,652
Mortgage-backed securities held for trading 407,941 407,941 319,204 319,204
Securities held to maturity 77,945 78,392 66,804 66,064
Securities available for sale 14,579 14,579 - -
Loans receivable 51,355 51,355 34,809 34,809
Accounts receivable and mortgage servicing
advances 9,592 9,592 7,086 7,086
Accrued interest receivable 8,155 8,155 7,875 7,875
Excess servicing fees receivable 10,407 10,407 8,757 8,757
-------- -------- -------- --------
$885,330 $885,793 $744,224 $744,363
======== ======== ======== ========
F-40
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1995 1994
---- ----
Carrying Carrying
amount Fair value amount Fair value
------ ---------- ------ ----------
(In thousands)
Financial liabilities:
Loans payable $234,707 $234,707 $265,706 $265,706
Securities sold under agreements to
repurchase 363,728 363,728 303,730 303,730
Deposit accounts 95,740 95,740 66,471 66,471
Notes payable 51,682 51,682 17,055 17,055
Advances from FHLB 10,407 10,407 419 419
Payables and accrued liabilities 17,376 17,376 17,793 17,793
Convertible Subordinated
Debentures 10,000 10,000 - -
Income tax payable 5,265 5,265 6,349 6,349
-------- -------- -------- --------
$788,905 $788,905 $677,523 $677,523
======== ======== ======== ========
The following notes summarize the major methods and assumptions used in
estimating the fair values of financial instruments:
Cash and cash equivalents: valued at the carrying amounts in the consolidated
balance sheet. The carrying amounts are reasonable estimates of fair value due
to the short period to maturity. This approach applies to cash and cash
equivalents, accounts receivable and mortgage servicing advances, accrued
interest receivables and the majority of short-term financial liabilities.
Excess servicing fees receivable: valued based on the present value of the
estimated remaining future excess servicing fee revenue.
Derivatives: fair value is estimated as the amounts that the Company would
receive or pay to terminate the contracts at the reporting date, taking into
account the current unrealized gains or losses of open contracts. Market or
dealer quotes are available for many derivatives; otherwise, pricing or
valuation models are applied to current market information to estimate fair
value.
Mortgage loans held for sale, mortgage-backed securities held for trading,
securities held to maturity and securities available-for-sale: valued at
quoted market prices if available. For securities without quoted prices, fair
values represent quoted market prices for comparable instruments. In a few
other cases, fair values have been estimated based on assumptions concerning
the amount and timing of estimated future cash flows and assumed discount rates
reflecting varying degrees of risk.
F-41
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Page 33
Loans receivable: valued on the basis of estimated future principal and
interest cash flows, discounted at various rates. Loan prepayments are assumed
to occur at rates experienced in previous periods when interest rates were at
levels similar to current levels, adjusted for any differences in interest rate
outlook. Future cash flows for homogeneous categories of loans, such as
residential mortgage loans, are estimated on a portfolio basis and discounted
at current rates offered for similar loan terms to new borrowers with similar
credit profiles. Quoted market prices for securities backed by similar loans,
adjusted for different loan characteristics, are also used in estimating fair
value.
Deposit accounts: for demand deposits and deposits with no defined maturities,
fair value is taken to be the amount payable on demand at the reporting date.
The fair values of fixed-maturity deposits, including certificates of deposit,
is estimated using rates currently offered for deposits of similar remaining
maturities. The value of long-term relationships with depositors is not taken
into account in estimating the fair values disclosed.
Loans payable and securities sold under agreements to repurchase: The carrying
amounts are reasonable estimates of fair values due to short period to
maturity.
Notes payable, advances from FHLB and convertible subordinated debentures: The
carrying amounts are reasonable estimates of fair values due to recent issuance
date.
NOTE 29 - QUARTERLY RESULTS OF OPERATIONS - (UNAUDITED):
Financial data showing results of the 1995 and 1994 quarters is presented
below. These results are unaudited. In the opinion of management all
adjustments necessary for a fair presentation have been included:
Quarters
----------------------------------------------------
1st 2nd 3rd 4th
--- --- --- ---
(in thousands, except per share data)
1995
- ----
Revenue $20,710 $23,277 $23,365 $24,487
Net income 3,430 6,137 4,928 5,065
Net income per share:
Primary .47 .84 .68 .66
Fully diluted .45 .81 .65 .62
F-42
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Quarters
----------------------------------------------------
1st 2nd 3rd 4th
--- --- --- ---
(in thousands, except per share data)
1994
- ----
Revenue $15,074 $18,967 $17,864 $20,138
------- ------- ------- -------
Income before cumulative effect
of change in accounting principle 3,307 4,785 3,882 4,242
Cumulative effect of change in
accounting principle - adoption of
SFAS 115, net of deferred taxes of $880 1,215 - - -
------- ------- ------- -------
Net income $ 4,522 $ 4,785 $ 3,882 $ 4,242
======= ======= ======= =======
Net income per share:
Primary:
Income before cumulative effect
of change in accounting principle $ .47 $ .68 $ .54 $ .59
Cumulative effect of change in
accounting principle .18 - - -
------- ------- ------- -------
$ .65 $ .68 $ .54 $ .59
======= ======= ======= =======
Fully diluted:
Income before cumulative effect
of change in accounting principle $ .44 $ .63 $ .51 $ .56
Cumulative effect of change in
accounting principle .16 - - -
------- ------- ------- -------
$ .60 $ .63 $ .51 $ .56
======= ======= ======= =======
NOTE 30 - RISK MANAGEMENT ACTIVITIES:
The Company's principal objective in holding derivatives and certain other
financial instruments is the management of interest rate risk arising out of
its portfolio holdings and related borrowings. Risk management activities are
aimed at optimizing realization on sales of mortgage loans and/or
mortgage-backed securities and net interest income, given levels of interest
rate risk consistent with the Company's business strategies.
F-43
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Page 35
Asset/liability risk management activities are conducted in the context of
Company's sensitivity to interest rate changes. This sensitivity arises due to
changes in the value of mortgage loans held for sale and mortgage-backed
securities held for trading from the time such assets are originated to the
time these are sold. In addition interest-bearing liabilities reprice more
frequently than interest-earning assets and, therefore, the Company is affected
by the interrelationships between long-term and short-term interest rates.
To achieve its risk management objective, the Company uses a combination of
derivative financial instruments, particularly, futures and options, as well as
other types of contracts such as forward sales commitments.
As part of the interest rate risk management at December 31, 1995, the Company,
as a purchaser, had unexpired options where it had the right to sell bonds and
GNMA contracts for a notional amount of $450,000,000. It also has rights to
buy bonds and GNMA contracts for a notional amount of $160,000,000. As a
writer or seller of options, the Company had unexpired options where it had the
obligations to sell bonds and GNMA contracts for a notional amount of
$250,000,000, and obligations to buy bonds and GNMA contracts for a notional
amount of $190,000,000. In addition, at December 31, 1995 the Company had
approximately $44 million of forward commitments to sell mortgage-backed
securities and loans.
Generally the options have expired without being exercised. During the years
ended December 31, 1995, 1994 and 1993 net gains (net losses) from these
transactions, designated as hedges, amounted to approximately ($5,400,000),
$2,172,000, and ($1,367,000), respectively. These amounts are presented as
part of mortgage loan sales and fees. At December 31, 1995, mortgage loans
held for sale includes capitalized costs of unexpired options of approximately
$2,300,000. At December 31, 1995, unrealized net losses on open positions
related to unexpired options, including capitalized costs, amounted to
approximately $2,700,000.
The credit risk of futures contracts is limited, due to daily cash settlement
of the net change in value of open contracts with the exchange in which the
instrument is traded. Forwards have a greater degree of credit risk, depending
on the types of counterparts involved, as daily cash settlements are not
required. Options are contracts that grant the purchaser, for a premium
payment, the right to either purchase from or sell to the writer of the option
a financial instrument at a specified price within a specified period of time
or on a specified date.
The risk that counterparts to both derivative and cash instruments might
default on their obligations is monitored on an ongoing basis. To manage the
level of credit risk the Company deals with counterparts of good credit
standing, enters into master netting agreements whenever possible and, when
appropriate, obtains collateral. Master netting agreements incorporate rights
of set off that provide for the net settlement of subject contracts with the
same counterpart in the event of default.
F-44
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All derivative financial instruments are subject to market risk, the risk that
future changes in market conditions may make an instrument less valuable or
more onerous. For example, fluctuations in market prices and interest rates
change the market value of the instruments. If the instruments are recognized
at market value, these changes directly affect reported income. Exposure to
market risk is managed in accordance with risk limits set by senior management
by buying or selling instruments or entering into offsetting positions.
The Company enters into rate swap agreements in managing its interest rate
exposure. Interest rate swap agreements generally involve the exchange of
fixed and floating rate interest payment obligations without the exchange of
the underlying principal.
At December 31, 1995, the Company had outstanding an interest rate swap
agreement with an investment banker to change the Company's interest rate
exposure. The agreement is for a notional principal amount of $5,000,000
covering the Company's interest rate exposure of a $5,000,000 floating rate
term-note. This agreement ends at the time the related obligation matures.
The interest rate to be received is 87% of the three-months LIBOR rate minus
.125% (4.95% at December 31, 1995) and the interest rate to be paid is 4.92%.
Non-performance by the counterparty will expose the Company to an interest rate
risk.
F-45
108
EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
3.1 Certificate of Incorporation of FFCC, as currently in effect.(1)
3.2 By-laws of FFCC, as amended as of January 30, 1996.(18)
3.3 Amendment to Certificate of Incorporation of FFCC filed with the Department of State of the
Commonwealth of Puerto Rico on May 23, 1991.(2)
3.4 Certificate of Designation creating the Series A Preferred Stock.(2)
3.5 Amendment to Certificate of Incorporation of FFCC filed with the Department of State of the
Commonwealth of Puerto Rico on April 28, 1993(1)
4.1 Common Stock Certificate.(2)
4.2 Series A Preferred Stock Certificate.(2)
10.13 1988 FFCC Stock Option Plan.(3)
10.14 FFCC Restricted Stock Plan.(3)
10.15 Purchase Agreement dated as of September 21, 1988, between FFCC and Culbro Corporation covering
the purchase of RSC Corp. and Doral Mortgage Corporation.(3)
10.18 Form of Contract of Pledge used by FFCC in connection with the Warehousing Loan Agreement dated
November 25, 1987, as amended, with Scotiabank de Puerto Rico.(5)
10.21 Tax Indemnification Agreement between Culbro Corporation and FFCC.(3)
10.22 Purchase Agreement dated as of November 30, 1976, between CMB, Inc. and David Levis, Salomon
Levis, Aida Levis and Carmen Levis covering the purchase of FFCC together with amendments or
supplements dated August 25, 1977, November 1, 1977, January 1, 1982, February 9, 1982, January 1,
1986 and January 1, 1987.(3)
10.23 Purchase Agreement dated as of October 15, 1986, between CMI Inc. and Salomon Levis and Carmen
Maria Serracante covering the purchase of RSC Corp.(3)
10.24 Purchase Agreement dated as of October 15, 1986, between DRL, Inc. and Jesus M. Rodriguez and
Marta Melendez covering the purchase of Doral Mortgage Corporation.(3)
10.28 Agreement among Doral Mortgage Corporation, Banco de Ponce, as trustee, and the Puerto Rico
Housing Finance Corporation dated September 25, 1990.(4)
10.30 Loan Agreement between FFCC and Puerto Rico Island Rental Limited Dividend Partnership S.E., dated
December 27, 1990.(4)
10.32 Warehousing Loan Agreement dated September 8, 1995 between FFCC and Banco Santander Puerto
Rico.(14)
10.33 Loan Agreement dated November 25, 1987 between FFCC and Scotiabank de Puerto Rico.(4)
10.34 (a) Repurchase Agreement, between FFCC and BP Capital Markets, Inc., dated November 10, 1995.
(18)
(f) Repurchase Agreement between FFCC and First Boston (Puerto Rico), Inc., dated November 28,
1989. (4)
109
Exhibit
Number Description
- ------ -----------
(k) Master Repurchase Agreement between FFCC and PaineWebber, Inc., dated as of March 24,
1992.(5)
10.35 Employment Agreement dated August 29, 1995 between FFCC and Salomon Levis.(15)
10.36 Employment Agreement dated August 29, 1995 between FFCC and Zoila Levis.(15)
10.37 Third Amendment to Loan Agreement dated June 5, 1991 between FFCC and Scotiabank de Puerto
Rico.(2)
10.39 Mark-to-Market Agreement between FFCC and PaineWebber Incorporated, dated as of March 24, 1992.(5)
10.40 Insurance and Indemnity Agreement dated as of May 28, 1992, between FFCC and Financial Security
Assurance Inc.(5)
10.41 Letter Agreement dated August 20, 1992 between Scotiabank de Puerto Rico and FFCC confirming the
renewal of the Loan Agreement dated November 25, 1987.(5)
10.42 Financing Agreement dated May 14, 1992, between FFCC and Banco Popular de Puerto Rico.(5)
10.43 Employment Agreement dated August 29, 1995, between FFCC and Richard F. Bonini.(15)
10.44 Addendum to Warehousing Loan Agreement dated August 1, 1991, between FFCC and Banco Santander
Puerto Rico.(5)
10.45 Addendum to Warehousing Loan Agreement dated May 29, 1992, between FFCC and Banco Santander Puerto
Rico.(5)
10.46 Letter Agreement dated November 28, 1988 amending the Loan Agreement between FFCC and Scotiabank
de Puerto Rico dated November 25, 1987.(5)
10.47 Amendment dated June 29, 1989 to the Loan Agreement between FFCC and Scotiabank de Puerto Rico
dated November 25, 1987.(5)
10.49 Employment Agreement dated as of April 1, 1993 between FFCC and Luis Alvarado.(13)
10.50 Customer Agreement, dated March 9, 1993, between FFCC and Meridian Capital Markets Inc. relating
to the execution of Forward Contracts.(6)
10.51 Master Repurchase Agreement, dated March 24, 1993, between FFCC and Bear Sterns Mortgage Capital
Corporation.(7)
10.52 Amended and Restated Master Production Agreement, dated as of October 1, 1995, between FFCC, Doral
Mortgage and Doral Federal, Master Production Agreement, dated as of October 1, 1995, between
FFCC, Doral Mortgage and Doral Federal.(8)
10.53 Master Purchase, Servicing and Collection Agreement, dated as of September 15, 1993, between FFCC
and Doral Federal.(9)
10.54 Mortgage Loan Purchase and Interim Servicing Agreement dated as of November 29, 1993 between FFCC
and Nomura Asset Capital Corporation.(13)
10.55 Purchase and Servicing Agreement, dated as of September 1, 1993, between FFCC and Meridian Capital
markets, a Division of Meridian Bank.(13)
110
Exhibit
Number Description
- ------ -----------
10.56 Financing Facility Agreement dated March 21, 1994, between Nomura Asset Capital Corporation, FFCC
and Doral.(12)
10.57 Master Repurchase Agreement among Merrill Lynch Mortgage Capital, Inc., FFCC and Doral together
with Supplemental Terms to Master Repurchase Agreement, each dated as of January 12, 1995.(14)
10.58 Swap Agreement dated December 7, 1994, between FFCC and David Levis.(14)
10.59 Demand Note dated December 9, 1994.(14)
10.60 Form of Medium Term Note, 1994 Series Puerto Rico-A.(14)
10.61 Credit Agreement, dated as of June 30, 1995, between FFCC, Doral
Mortgage Corporation, the lenders party thereto and Bankers Trust
Company, as Agent.(17)
10.62 Debenture Purchase Agreement dated as of September 25, 1995, and amended restated as of December
15, 1995, between the Company and BanPonce Corporation (including the forms of Series A and Series
Debentures.(15)
10.63 Financing Agreement dated October 10, 1995, between FFCC and Banco Santander together with related
Assignment and Pledge Agreements.(16)
10.64 Master Servicing and Collection Agreement dated October 1, 1995, between FFCC and Doral Federal
Savings Bank.(18)
10.65 Employment Agreement, dated as of February 20, 1996, between FFCC and Frederick C. Teed.(17)
21 List of FFCC's subsidiaries.(13)
27 Financial Data Schedule (Edgar version only).(18)
- --------------------
(1) Incorporated herein by reference to the same exhibit number of the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993
(File No. 0-17224).
(2) Incorporated herein by reference to the same exhibit number of the
Company's Annual Report on From 10-K for the year ended December 31, 1991 (File
No. 0-17224).
(3) Incorporated herein by reference to the same exhibit number as filed
pursuant to Item 15(b) of the Company's Form 10 filed with the Commission on
October 7, 1988, as amended by Form 8 amendments thereto.
(4) Incorporated herein by reference to the same exhibit number of the
Company's Registration Statement on Form S-1 (No. 33-39651) filed with the
Commission on March 29, 1991.
(5) Incorporated herein by reference to the same exhibit number of the
Company's Registration Statement on Form S-2 (No. 33-52292) filed with the
Commission on September 23, 1992.
(6) Incorporated by reference to exhibit number 19.1 of the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1993 (File No.
0-17224).
111
(7) Incorporated by reference to exhibit number 19.2 of the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1993 (File No.
0-17224).
(8) Incorporated by reference to exhibit number 19.3 of the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (File
No. 0-17224).
(9) Incorporated by reference to exhibit number 19.4 of the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (File
No. 0-17224).
(10) Incorporated herein by reference to exhibit number 1 of the Company's
Current Report on Form 8-K filed with the Commission on December 16, 1992.
(11) Incorporated herein by reference to Exhibit Number 10.26 of the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994.
(12) Incorporated herein by reference to same exhibit number of the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994.
(13) Incorporated herein by reference to the same exhibit number of the
Company's Annual Report on Form 10-K for the year ended December 31, 1993.
(14) Incorporated herein by reference to the same exhibit number of the
Company's Annual Report on Form 10-K for the year ended December 31, 1994.
(15) Incorporated herein by reference to the same exhibit number of the
Company's Current Report on Form 8-K dated December 22, 1995.
(16) Incorporated herein by reference to the same exhibit number of the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1995.
(17) Incorporated herein by reference to the same exhibit number of the
Company's Quarterly report on Form 10-Q for the quarter ended March 31, 1995.
(18) Filed herewith.
(b) Reports on Form 8-K.
(1) Current Report a Form 8-K ("Form 8-K"), dated September 22, 1995,
reporting under Item 5 - "Other Items" an agreement in principle to enter
into a Debenture Purchase Agreement with BanPonce Corporation.
(2) Form 8-K, dated September 25, 1995, reporting under Item 5 - "Other
Events", the execution of Debenture Purchase Agreement with BanPonce
Corporation and issuance of approximately $6.6 million in convertible
subordinated debentures thereunder.
(3) Form 8-K, dated November 20, 1995, reporting under Item 5 - "Other
Events", passage of the Seven-Year Balanced Budget Revenue Reconciliation
Act of 1995, which provided for the repeal Section 936.
112
(4) Form 8-K, dated December 22, 1995, reporting under Item 5 - "Other
Events" execution of an Amended and Restated Debenture Purchase Agreement
with BanPonce Corporation.