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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
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
|_| THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NO. 0-17224
DORAL FINANCIAL 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: (787) 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
7% NONCUMULATIVE MONTHLY INCOME 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 ___
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. [ ]
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.
$604,657,000 approximately, based on the last sale price of $18 15/16 per
share on the NASDAQ National Market System on March 12, 1999. 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: 40,428,920 shares as of March 12, 1999. (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 incorporated
Registrant. 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 1999 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 incorporated
Owners and Management. 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 Statement.
Item 13 Certain Relationships and Related Information in response to this Item is incorporated
Transactions. into this Annual Report on Form 10-K by reference to
the section entitled "Election of Directors and
Related Matters -- Certain Relationships and
Related Transactions" in the Company's Proxy
Statement.
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DORAL FINANCIAL CORPORATION
1998 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business...............................................................................................1
Item 2. Properties............................................................................................18
Item 3. Legal Proceedings.....................................................................................19
Item 4. Submission of Matters to a Vote of Security Holders...................................................19
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................................19
Item 6. Selected Financial Data...............................................................................20
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...........................................50
Item 8. Financial Statements and Supplementary Data...........................................................50
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..................50
PART III
Item 10. Directors and Executive Officers of the Registrant...................................................50
Item 11. Executive Compensation...............................................................................51
Item 12. Security Ownership of Certain Beneficial Owners and Management.......................................51
Item 13. Certain Relationships and Related Transactions.......................................................51
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.....................................51
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PART I
ITEM 1. BUSINESS
GENERAL.
Doral Financial Corporation ("Doral Financial" or the "Company"), is a bank
holding company which is engaged in a wide range of mortgage banking, commercial
banking and broker dealer activities. Doral Financial was founded in 1972 under
the laws of the Commonwealth of Puerto Rico, and is the leading mortgage banking
institution in Puerto Rico in volume of origination of mortgage loans on
single-family residences and in the volume of mortgage loans serviced. As of
December 31, 1998, Doral Financial had a total servicing portfolio of
approximately $6.2 billion.
Doral Financial's mortgage banking business is principally conducted
through four operating units: Doral Mortgage Corporation ("Doral Mortgage"),
Centro Hipotecario de Puerto Rico, Inc. ("Centro"), both wholly-owned
subsidiaries of Doral Financial, Doral Money, Inc. ("Doral Money"), a wholly
owned subsidiary of Doral Bank and HF Mortgage Bankers Division ("HF Division"),
an operating division within Doral Financial. Doral Financial is also engaged in
the banking business through Doral Bank, a Puerto Rico commercial bank, and in
the securities business through Doral Securities, Inc. ("Doral Securities").
Prior to 1998, substantially all the Company's business had been conducted
in Puerto Rico. During the second and third quarter of 1998, the Company
established a wholesale residential mortgage operation in the Chicago
metropolitan area and a multi-family and commercial lending unit in the New York
metropolitan area. The Company also expects to open a new federal savings
association in the New York metropolitan area during the third quarter of 1999.
The Company's principal 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 the size of its servicing portfolio by relying
primarily on internal loan originations and supplementing such originations with
purchases of loans and mortgage servicing rights from third parties. The Company
seeks to maximize net interest income by holding mortgage-backed securities,
primarily Puerto Rico tax-exempt GNMA securities backed by Puerto Rico FHA/VA
mortgages, 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. The Company also seeks to increase net interest income by
funding and holding for investment, loans and investment securities, consisting
primarily of residential mortgage loans, mortgage-backed securities and United
States government and agency obligations, the interest on which is tax exempt to
the Company for Puerto Rico income tax purposes. The Company's strategy is to
become a more diversified financial services company by offering a broad range
of mortgage products as well as continuing to expand into new areas of business
such as banking and securities brokerage. The Company also intends to pursue
opportunities to expand geographically within the mainland United States,
particularly within the New York City metropolitan area and other areas with
large Hispanic populations, through acquisitions, the establishment of new
operations or a combination of both.
MORTGAGE BANKING BUSINESS
MORTGAGE LOAN ORIGINATION
Mortgage Loan Products. 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. Doral Financial is also qualified to
originate mortgage loans insured by the Federal Housing Administration ("FHA"),
guaranteed by the Veterans Administration ("VA"), or guaranteed by the Rural
Housing Service ("RHS"), formerly Farmers Homes Administration.
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The Company makes available a wide variety of mortgage loan products that
are designed to meet consumer needs and competitive conditions. Doral Financial
has traditionally emphasized 15 to 30 year first mortgage loans secured by
single family residences. The Company generally classifies mortgage loans
between those that are guaranteed or insured by the FHA, VA or RHS and those
that are not. The latter type of loans are referred to as conventional loans.
Conventional loans that meet the underwriting requirements for sale or exchange
with FNMA or FHLMC are referred to as conforming loans, while those that do not
are referred to as non-conforming loans.
The Company's current mortgage loan products can be summarized as follows:
FHA, VA AND RHS LOANS. These are 15 to 30 year first mortgage loans that
qualify for the insurance program of FHA or the guarantee programs of VA or RHS.
As of December 31, 1998, the maximum loan amount for a VA loan was $203,000 and
for FHA and RHS loans the maximum ranged from $86,317 to $152,000 depending on
the location of the mortgaged property.
Conforming conventional loans. These are loans that satisfy the
underwriting criteria for sale or exchange through FNMA or FHLMC. As of December
31, 1998, the maximum loan amount for conforming conventional loans was
$240,000.
Non-conforming loans. These so-called "non-conforming loans" are
conventional mortgage loans that do not qualify for sale or exchange under the
standard programs of FNMA or FHLMC. The principal deviations that do not permit
non-conforming loans to qualify for the sale or exchange programs of FNMA or
FHLMC are relaxed requirements for income verification or credit history or a
loan amount in excess of those permitted by FNMA or FHLMC. The Company uses its
own credit system to evaluate these loans and generally requires lower
loan-to-value ratios. The Company is not actively involved in originating
"sub-prime" mortgage loans to individuals who are deemed to be a relatively high
credit risk.
Second mortgage loans. Included within the Company's non-conforming loan
products are loans secured by second mortgages on single family residences.
Home equity mortgage loans. These loans are generally up to $40,000 and are
secured by first or second mortgages on single family residences. They are
generally made for debt consolidation, home improvements or other individual
credit needs.
Other mortgage loans. To a lesser extent, the Company also originates
construction loans for owner occupied single family residences and real estate
development projects, as well as land loans and loans secured by income
producing residential and commercial properties.
For additional information on the Company's mortgage loan originations,
refer to Table B included in the "Management's Discussion and Analysis of
Financial Condition and Results of Operations" section of this report.
MORTGAGE ORIGINATION CHANNELS
The Company's strategy is to increase the size of its mortgage serving
portfolio by originations primarily through its retail branch network. The
Company supplements retail originations with wholesale originations that
encompass purchases from third parties and referrals from mortgage brokers. In
Puerto Rico, the Company maintains specialized units for the origination of
construction loans and loans to finance purchases of homes in new housing
developments. The Company's principal origination channels are summarized below.
Retail branch network. The Company operates 26 mortgage banking offices on
the Island and one branch office in Miami, Florida. Customers are sought through
aggressive advertising campaigns in local newspapers, as well as direct mail and
telemarketing campaigns. The Company emphasizes quality customer service and
offers extended operating hours to accommodate the needs of customers.
Puerto Rico wholesale activities. Doral Financial purchases primarily FHA
loans and VA loans from other mortgage bankers for securitization and resale to
institutional investors in the form of GNMA securities, and, to a
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lesser extent, purchases conventional mortgage loans for sale to private
investors. The Company purchased approximately $354 million, $65 million and $63
million of loans during the years ended December 31, 1998, 1997 and 1996,
respectively. In addition, the Company also originates mortgage loans referred
to it by mortgage brokers. At the closing of the loan, the borrower is required
to pay the mortgage broker a fee for the services it provided. During the years
ended December 31, 1998, 1997 and 1996, the Company originated approximately
$313 million, $74 million and $34 million, respectively, of mortgage loans
through mortgage brokers. The increase in 1998 was due to the commencement of
the Chicago wholesale operation which accounted for approximately 45% of
originations through mortgage brokers.
New housing unit. In Puerto Rico, the Company maintains a special unit that
works closely with residential developers and specializes in originating
mortgage loans to finance the acquisition of homes in newly developed housing
projects. The Company originated approximately $190 million of mortgage loans to
finance the purchase of homes within new housing projects during the year ended
December 31, 1998 compared to $140 million for the year ended December 31, 1997.
U.S. wholesale operation. During 1998, the Company established a wholesale
residential mortgage operation located in the Chicago metropolitan area. This
wholesale operation originates mortgage loans through a network of approximately
50 independent mortgage brokers approved by the Company. To date, mortgage loans
have been principally originated in the following seven states: Illinois,
Indiana, Ohio, Kansas, Michigan, Kentucky and Missouri. Doral Financial
underwrites each mortgage loan application obtained from participating mortgage
brokers and funds those mortgage loans which meet the Company's underwriting
criteria. The mortgage loans originated by the wholesale unit are generally
single family mortgage loans that qualify for the guarantee programs of FNMA or
FHLMC. However, to a lesser extent, this unit also originates adjustable rate
mortgage loans that are not eligible for the sale or exchange programs of FNMA
or FHLMC. During the year ended December 31, 1998, the wholesale unit originated
approximately $143.0 million in mortgage loans, of which approximately 80% were
mortgage loans that qualified for the guarantee programs of FNMA or FHLMC.
The Company believes that the establishment of a wholesale lending unit is
a cost-effective way for the Company to penetrate the mainland U.S. residential
mortgage market and continue to increase the size of its servicing portfolio. A
wholesale operation allows the Company to penetrate this market without having
to invest in a large retail branch system with the related and overhead costs.
New York multi-family and commercial lending unit. During 1998, the Company
also established a lending operation in the New York City metropolitan area that
specializes in making mortgage loans secured by income producing multi-family
residential and commercial properties. During the year ended December 31, 1998,
this unit originated approximately $106 million in loans. The average amount
of the loan originated was $1.3 million and the largest loan originated was $4.4
million .
Construction Loans. Construction loans on housing projects are originated
by a specialized unit within the Company.
For more information on the Company's loan origination channels, refer to
Table C in the "Management's Discussion and Analysis of Financial Condition and
Results of Operations" section of this report.
LOAN UNDERWRITING
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. Doral Financial's underwriting standards also comply with the
relevant guidelines set forth by HUD, VA, FNMA, FHLMC, federal and Puerto Rico
banking regulatory authorities, private mortgage investment conduits and private
mortgage insurers, as applicable. The Company's underwriting personnel, while
operating within the Company's loan offices, make underwriting decisions
independent of the Company's mortgage loan origination personnel. Under the
Company's quality control plan, Doral Financial 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, Doral
Financial reconfirms employment status, the source of down payment and other key
items.
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Conventional mortgage loans generally (i) do not exceed 80% (85% for
certain qualifying home purchase transactions through Doral Bank) of the
appraised value of the mortgaged property or (ii) are insured by private
mortgage insurance. The maximum loan-to-value ratio on second mortgages
generally does not exceed 80% (including the amount of any first mortgage).
Non-conforming loans, other than jumbo loans to finance home purchases,
generally have a loan-to-value ratio below 70%.
LOAN SERVICING
When the Company sells the mortgage loans it has originated or purchased,
it generally retains the right to service such loans and to receive the related
servicing fees. Doral Financial's principal source of servicing rights has
traditionally been its mortgage loan originations. The Company also seeks to
purchase servicing rights in bulk when it can identify attractive opportunities.
Servicing rights represent a contractual right and not a beneficial
ownership interest in the underlying mortgage loans. Failure to service the
loans in accordance with contract requirements may lead to a termination of the
servicing rights and the loss of future servicing fees. In general, the
Company's servicing agreements are terminable by the investor for cause. With
respect to all mortgage loans funded by Doral Bank after October 1, 1995, under
a Master Loan Servicing agreement with the Company, Doral Bank may terminate
Doral Financial's servicing rights without cause upon notice to the Company.
There has been no termination of servicing rights by any mortgage loan owners
because of the failure by the Company to service in accordance with its
contractual obligations.
At December 31, 1998, 1997, and 1996 approximately $146.8 million, $201.6
million and $256.6 million, respectively, or 2%, 4%, and 8% respectively, of the
Company's total servicing portfolio consisted of mortgage loans securitized by
the Company and sold to grantor trusts or real estate mortgage conduits
("REMICs"). The insurance company insuring the senior certificates issued by
such grantor trusts and other conduits may terminate Doral Financial's servicing
rights if, among other things: (i) the Company becomes ineligible or loses its
rights as an approved servicer for GNMA, FNMA or FHLMC; (ii) the number of loans
included in the trusts which are delinquent 90 days or more (including
properties acquired upon foreclosure) exceeds 8% of the aggregate outstanding
principal balance of the mortgage loans included in the trusts; and (iii)
realized losses with respect to mortgage loans included in the trusts exceed
certain thresholds on an annual basis (1% of the outstanding balance of mortgage
loans) and on a cumulative basis over various periods of time (ranging from
0.45% to 4.00% of the original principal balance of loans in the trusts).
Doral Financial'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. Refer to Table D in the "Management's Discussion and Analysis of
Financial Condition and Results of Operations" section for detailed information
on the composition of the Company's mortgage servicing portfolio.
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 a private investor, insurer or guarantor. Losses on
recourse servicing occur primarily when foreclosure sale proceeds of the
property underlying a defaulted mortgage loan 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. The Company often sells
non-conforming loans on a recourse or partial recourse basis. For additional
information regarding recourse obligations, see "--Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Credit Risks
Related to Loan Activities."
In the ordinary course of business, Doral Financial makes certain
representations and warranties to purchasers and insurers of mortgage loans and
to the purchasers of servicing rights. In connection with any purchases by the
Company of certain servicing rights, the Company may also be exposed to
liability as a successor to the representations and warranties of third party
originators. If a loan defaults and there has been a breach of representations
and warranties, the Company may become liable for the unpaid principal and
interest on defaulted loans. In such a case,
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the Company may be required to repurchase the mortgage loan and bear any
subsequent loss on the mortgage loan. To date, the impact of loans repurchased
as a result of borrower misrepresentations has not been material.
The Company's servicing rights provide it with a significant continuing
source of income. 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 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.
The market value of, and earnings from, Doral Financial'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. 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. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Interest Rate
Management."
HRU, Inc., an entity in which Doral Financial owns a 33% equity interest,
provides mailing and electronic data processing services for the Company's
mortgage servicing operations and earns fees from the Company based on the
volume of mortgage loans serviced. Such fees are determined at fair market value
and amounted to approximately $946,000, $1,012,000 and $900,000, for the years
ended December 31, 1998, 1997 and 1996, respectively.
SALE OF LOANS AND SECURITIZATION ACTIVITIES
Residential Mortgage Loans. Doral Financial customarily sells or
securitizes most of the loans that it originates, except for certain loans
originated primarily by Doral Bank and other specialized units of the Company,
which are held to maturity and classified as loans receivable. As described
below, the Company utilizes various sales channels to sell its mortgage
products. The Company issues GNMA-guaranteed mortgage-backed securities, which
involve the packaging of FHA loans, RHS 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 and other institutional investors. During the years ended
December 31, 1998, 1997 and 1996, the Company issued approximately $543 million,
$497 million and $373 million, respectively, in GNMA-guaranteed mortgage-backed
securities to rank No. 1 in Puerto Rico and No. 4 in the United States in GNMA
securitizations according to the "Mortgage Marketplace."
Certain GNMA-guaranteed mortgage-backed securities sold by the Company 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, RHS loans or
VA loans originated in Puerto Rico. GNMA securities issued under the serial note
program are structured into packages consisting of notes of different yields and
estimated maturities, which range from 1 to 30 years and have a weighted-average
maturity of approximately 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 broker-dealers.
During years ended December 31, 1998, 1997 and 1996, Doral Financial issued GNMA
serial notes totaling approximately $143 million, $269 million and $317 million,
respectively.
Conforming conventional loans, are generally 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 the Company sells to broker-dealers. In
connection with any such exchanges, Doral Financial pays guarantee fees to FNMA
and FHLMC. The issuance of mortgage-backed securities provides the Company 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.
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For the year ended December 31, 1998, Doral Financial securitized
approximately $1.1 billion of loans into GNMA, FNMA and FHLMC mortgage-backed
securities to rank No. 1 in Puerto Rico in securitizations and No. 65 in the
United States according to the "Mortgage Marketplace."
Mortgage loans that do not conform to GNMA, FNMA or FHLMC requirements
(non-conforming loans) are sold in bulk to financial institutions or other
private investors or are securitized into "private label" mortgage-backed
securities through grantor trusts or REMICs that either are organized by the
Company or third parties and sold through broker-dealers.
Most bulk sales of non-conforming loans are made to financial institutions.
Doral Financial's bulk sales generally operate very similar to securitization
transactions in that when the Company sells the loans it retains the servicing
rights and agrees to pay the purchaser a specified pass-through rate for the
entire pool being purchased. Any amounts received on the mortgages above the
pass-through rate are retained by the Company. The present value of the future
cash flow retained by the Company above standard servicing fees for FNMA or
FHLMC are recognized on the Company's Financial Statements as interest only
strips ("IOs") and recognized currently as income. See "Management Discussion
Analysis of Financial Condition and Results of Operations - Amortization of IOs
and Servicing Assets."
The securitization of non-conforming loans involves the creation of a
grantor trust or REMIC which issues mortgage-backed securities to investors.
These mortgage-backed securities normally consist 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 improve the credit rating of the senior certificates and thereby
increase their marketability. During the years ended December 31, 1996 and 1995,
the Company securitized approximately $37 million and $75 million, respectively,
aggregate principal amount of non-conforming mortgage loans. The Company did not
engage in securitizations on non-conforming loans during the years ended
December 31, 1998 and 1997, because it has been able to obtain greater revenues
through the creation of IOs by bulk sales of whole loans to local financial
institutions. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations-- Results of Operations for the Three Years Ended
December 31, 1998, 1997 and 1996 -- Amortization of IOs and Servicing Assets."
Subject to market conditions, the Company may enter into similar securitization
transactions in the future.
Financial Security Assurance, Inc. ("FSA") has insured senior certificates
issued in connection with such securitization transactions during the years
ended December 31, 1996 and 1995, respectively. As part of its arrangement with
FSA, Doral Financial has agreed to retain and pledge to FSA the residual
certificates issued by the respective trusts. The Company also generally retains
the subordinate certificates issued in such transactions. As of December 31,
1998 and 1997, the Company held approximately $11.5 million and $13.7 million,
respectively, in subordinate certificates and $2.8 million and $3.9 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 represents the present value of expected future distributions on
such certificates over the life of the trusts and is subject to substantial
fluctuations as a result of changes in prevailing interest rates.
The decision whether to sell non-conforming loans in bulk to local
financial institutions or to securitize such loans through mortgage conduits
depends on market conditions and the relative pricing and other terms of such
alternative sales channels. Similarly, the relative emphasis on the origination
of FHLMC and FNMA conforming loans versus FHA, RHS and VA loans and
non-conforming loans depends on market conditions, including the needs of
borrowers, 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.
While Doral Financial generally sells conforming loans on a non-recourse
basis, the Company at times also engages in the sale or exchange of mortgage
loans on a recourse basis. The sale of non-conforming loans to local financial
institutions are often made on a recourse or partial recourse basis. Prior to
1997, recourse obligations had decreased, in part, due to the securitization of
non-conforming loans into private label mortgage-backed securities that were
sold on a non-recourse basis. As the Company has shifted from selling
non-conforming loans through securitizations to bulk sales of whole loans to
local financial institutions recourse obligations have increased. As of December
31,
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1998, Doral Financial was servicing mortgage loans with an aggregate principal
amount of $823.6 million on a recourse or partial recourse basis. As of December
31, 1998, 1997 and 1996, the Company's maximum aggregate recourse obligation
relating to its mortgage servicing portfolio was approximately $489.1 million,
$265.5 million and $74.4 million, respectively.
From time to time, Doral Financial sells mortgage-backed securities and
mortgage loans subject to put arrangements. Pursuant to these arrangements, the
Company grants the purchaser of the mortgage-backed securities or loans a put
option that grants the buyer the right to sell, and obligates the Company to
buy, the securities or loans at a future date at a negotiated price. Pursuant to
SFAS No. 125, sales of securities or loans with puts are accounted for as sales
or borrowings based on a financial components approach that focuses on whether
control of the asset has been surrendered. As of December 31, 1998, the Company
had outstanding $91.5 million in mortgage-backed securities and mortgage loans
sold subject to put arrangements, which expire in varying amounts from 1998
through 2002, all of which were accounted for as sales because the Company
believes that control of the asset has been surrendered.
Multi-family Residential and Commercial Loans. The multi-family residential
and commercial mortgage loans originated by the Company's New York City
operation are generally sold to other financial institutions. To date, most
sales have been on a partial recourse basis (up to 10% of the principal amount
of the loan sold) with the recourse provision being eliminated in its entirety
18 to 24 months after sale.
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
investment instruments, and other matters. However, Doral Financial has
benefitted historically from certain tax incentives provided to Puerto Rico
residents to invest in FHA and VA loans and GNMA securities backed by such
loans.
Prior to August 1, 1997, the interest received on FHA and VA loans and on
GNMA mortgage-backed securities backed by these loans was exempt from Puerto
Rico income taxes. This favorable tax treatment has historically permitted the
Company to sell tax-exempt Puerto Rico GNMA mortgage-backed securities to local
investors at higher prices than those at which comparable instruments trade in
the mainland United States, and also to reduce its effective tax rate through
the receipt of tax exempt interest.
On July 22, 1997, the Puerto Rico Internal Revenue Code was amended to
modify the tax exempt treatment of FHA and VA loans secured by real property in
Puerto Rico and GNMA mortgage-backed securities backed by such loans. Under the
terms of the amendment, effective August 1, 1997, only FHA and VA loans used to
finance the original acquisition of newly constructed housing and
mortgage-backed securities backed by such loans qualify for tax-exempt
treatment. The amendment, however, provides a preferential tax rate of 17% for
individuals to be withheld at source with respect to interest received on FHA
and VA loans not qualifying for tax exemption. In addition, the amendment
grandfathered the tax exempt status of FHA and VA loans originated on or prior
to July 31, 1997 and mortgage-backed securities backed by such loans.
COMMERCIAL BANKING ACTIVITIES
As of December 31, 1998, Doral Financial's commercial banking subsidiary,
Doral Bank, operated through 11 branches in Puerto Rico. Similar to the
Company's mortgage banking units, Doral Bank lending activities are concentrated
primarily on the origination of residential mortgage loans. Most of such loans
are classified as held for sale because Doral Bank originates these loans with
the intent of selling them. Mortgage loans are usually sold through the
Company's mortgage banking units. As of December 31, 1998, Doral Bank had a
portfolio of mortgage loans held for sale of approximately $368.2 million.
Doral Bank is a party to a Master Loan Production Agreement with the
Company's mortgage banking units whereby these units are obligated to help Doral
Bank meet its stated mortgage loan production goals by, among other things, (i)
advertising, promoting and marketing to the general public; (ii) interviewing
prospective borrowers and conducting the initial processing of loan
applications, consistent with Doral Bank's underwriting guidelines;
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and (iii) providing personnel and facilities with respect to the execution of
loan agreements. In the future, Doral Bank may determine to engage in direct
mortgage loan originations through its branch network.
Doral Bank is also a party to a Master Servicing and Collection Agreement
(the "Master Servicing Agreement") with the Company's mortgage banking units
whereby these units have agreed to service all of Doral Bank's loans originated
after the date of the Master Servicing Agreement. Under the Master Servicing
Agreement, Doral Financial does not, however, purchase the intangible right to
service these loans. The Company is entitled to receive a servicing fee ranging
from 25 to 50 basis points of the outstanding principal amount of the loans
being serviced. Doral Bank retains the right to terminate the Company's
servicing rights, without cause, upon notice to the Company.
In addition to residential mortgage loans held for sale, Doral Bank also
originates residential mortgage loans, construction loans, commercial loans and
consumer loans for investment. Loans held for investment are classified as loans
receivable. Most commercial and consumer loan are originated directly by Doral
Bank. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Loans Receivable" - for detailed information regarding
the Company's portfolio of loans receivable.
In addition to its lending activities, Doral Bank also earns fee income by
collecting service charges for deposit accounts and other traditional banking
services.
OTHER INVESTMENT ACTIVITIES
As a result of Doral Financial's mortgage securitization activities, the
Company maintains a substantial portfolio of mortgage-backed securities held for
trading. Tax-exempt GNMA securities are generally held by the Company for longer
periods prior to sale in order to maximize the tax-exempt interest received
thereon. Pursuant to SFAS No. 115, securities held for trading are reflected on
the Company's financial statements at their fair market value with unrealized
gains or losses included as part of trading account profit.
As a way of earning interest income, the Company also invests in investment
securities that are classified either as available for sale or held to maturity.
Refer to "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Investment Activities" and to Notes 6, 7 and 8 to the
Company's Consolidated Financial Statements for more detailed information on the
Company's investment activities.
BROKER-DEALER ACTIVITIES
Doral Financial is involved in the securities business through Doral
Securities, a broker-dealer registered with the Securities and Exchange
Commission (the "Commission") and a member of the National Association of
Securities Dealers, Inc. (the "NASD"). Doral Securities provides retail and
institutional brokerage, financial advisory and investment banking services.
Doral Securities' business is generally organized into two units:
institutional and retail. The institutional unit handles the institutional
trading and investment banking activities of the firm. The retail unit, which
employed 22 registered representatives as of December 31, 1998, is responsible
for handling the needs of individual retail clients. Doral Securities is an
introducing broker-dealer for retail transactions with all transactions cleared
through the Pershing Division of Donaldson, Lufkin and Jenrette Securities
Corporation. As of December 31, 1998, Doral Securities had more than 1,110
customer accounts with assets of approximately $138 million in such accounts.
Doral Securities also earns interest revenues by acting as an intermediary
between borrowers, including the Company, and lenders of funds utilizing
repurchase and reverse repurchase agreements. As of December 31, 1998, Doral
Securities had $536.0 million in outstanding reverse repurchase agreements, of
which approximately $415.3 million consisted of funds loaned to the Company and
its subsidiaries and which are eliminated in the preparation of Doral
Financial's Consolidated Financial Statements.
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Under Regulation K of the Federal Reserve, Doral Securities may only
conduct securities activities "outside the United States." For purposes of
Regulation K, Puerto Rico is considered to be outside the United States. In
addition, under Regulation K, Doral Securities may not engage in underwriting or
dealing in equity securities without the prior approval of the Federal Reserve,
which Doral Securities intends to seek.
PUERTO RICO INCOME TAXES
Doral Financial is subject to Puerto Rico income taxes. Pursuant to the
Puerto Rico Internal Revenue Code of 1994 (the "PR Code"), the Company is
subject to a maximum marginal statutory corporation income tax rate of 39%.
The Company is also subject to an alternative minimum tax of 22% on its
alternative minimum taxable income. In computing the Company's alternative
minimum taxable income its interest expense deduction will be reduced in the
same proportion that its exempt obligations (including FHA and VA loans and GNMA
securities) 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 the PR Code, corporations are not permitted to file consolidated
returns with their subsidiaries and affiliates. Effective for taxable year
commencing after June 30, 1995, the Company is entitled to a 100% dividend
received deduction on dividends received from Doral Bank, Doral Mortgage or any
other Puerto Rico subsidiary subject to tax under the PR Code. Effective July 1,
1995, the PR Code also provided for the elimination of the existing 29%
withholding tax applicable on interest paid to non-resident corporations and
individuals as well as a reduction of the withholding tax applicable to
dividends payable to non-resident corporations and individuals from 25% to 10%.
UNITED STATES INCOME TAXES
Doral Financial and its subsidiaries (other than Doral Bank's subsidiary
Doral Money, Inc.) are corporations organized under the laws of Puerto Rico.
Accordingly, the Company and its subsidiaries are subject generally to United
States income tax only on their income, if any, from sources within the United
States (excluding Puerto Rico). Prior to 1992, the Company did not earn any
income that was subject to United States income tax. Doral Mortgage operates a
branch in the State of Florida. Accordingly, Doral Mortgage is subject to both
Florida income and franchise taxes and federal income tax on income effectively
connected with the conduct of the trade or business of this branch. 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 tax credit in Puerto
Rico, subject to certain limitations. During 1998, Doral Bank organized, Doral
Money, a new subsidiary under the laws of the State of Delaware to conduct
operations in the mainland United States. Doral Money is subject to both federal
and state income taxes on the income derived from these operations.
Prior to October 1, 1997, Doral Bank, as a federal savings association, was
also subject to U.S. income taxes. It was entitled to a foreign tax credit for a
portion of income taxes paid to the Puerto Rico Treasury Department. Doral Bank
had elected to qualify for the benefits provided under Section 936 of the
Internal Revenue Code 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. Following the conversion of Doral Bank to a Puerto Rico commercial
bank on October 1, 1997, it is subject to taxation in substantially the same
manner as Doral Financial and the other Puerto Rico subsidiaries of the Company.
EMPLOYEES
At December 31, 1998, the Company employed 1,339 persons. Of these, 1,063
were employed in the mortgage banking units with 512 involved in loan production
activities and 172 involved in loan servicing activities. As of such date, the
Company's commercial banking and broker dealer operations employed 237 and 39
employees, respectively. None of Doral Financial's employees is represented by a
labor union and the Company considers its employee relations to be good.
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REGULATION--MORTGAGE BANKING BUSINESS
The Company's mortgage banking business is subject to the rules and
regulations of FHA, VA, RHS, 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 Doral Financial are required
annually to submit to FHA, VA, RHS, FNMA, FHLMC, GNMA and HUD audited financial
statements, and each regulatory entity has its own financial requirements. The
Company's affairs are also subject to supervision and examination by FHA, VA,
RHS, FNMA, FHLMC, GNMA and HUD 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 Office of the Commissioner of Financial
Institutions of Puerto Rico (the "Office of the Commissioner"), with respect to,
among other things, licensing requirements and establishment of maximum
origination fees on certain types of mortgage loan products. Although the
Company believes that 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.
Each of the Company's mortgage banking subsidiaries that operate in Puerto
Rico is licensed by the Office of the Commissioner as a mortgage banking
institution in Puerto Rico. Such authorization to act as a mortgage banking
institution must be renewed as of January 1 of each year. In the past, the
Company 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 the Company being
unable to receive such authorization in the future. The Company's operations in
the mainland United States are subject to regulation by various state regulators
in those states in which it conducts business.
Section 5 of the Puerto Rico Mortgage Banking Institutions Law (the
"Mortgage Banking Law") requires the prior approval of the Office 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 Office of the
Commissioner is obligated to make such inquiries as it deems necessary to review
the transaction. Under the Mortgage Banking Law, the determination of the Office
of the Commissioner whether or not to authorize a proposed change of control is
final and non-appealable.
REGULATION--BANKING OPERATIONS
FEDERAL REGULATION
General
Doral Financial is a bank holding company subject to supervision and
regulation by the Board of Governors of the Federal Reserve (the "Federal
Reserve") under the Bank Holding Company Act (the "BHC Act"). As a bank holding
company, the Company's activities and those of its banking and nonbanking
subsidiaries are limited to the business of banking and activities closely
related or incidental to banking, and the Company may not directly or indirectly
acquire the ownership or control of more than 5% of any class of voting shares
or substantially all of the assets of any company in the United States,
including a bank, without the prior approval of the Federal Reserve. In
addition, bank holding companies are generally prohibited under the BHC Act from
engaging in nonbanking activities, subject to certain exceptions.
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Doral Bank is subject to supervision and examination by applicable federal
and state banking agencies, including the FDIC and the Office of the
Commissioner. Doral Bank is subject to requirements and restrictions under
federal and state law, including requirements to maintain reserves against
deposits, restrictions on the types and amounts of loans that may be granted and
the interest that may be charged thereon, and limitations on the types of other
investments that may be made and the types of services that may be offered.
Various consumer laws and regulations also affect the operations of Doral Bank.
In addition to the impact of regulation, commercial banks are affected
significantly by the actions of the Federal Reserve as it attempts to control
the money supply and credit availability in order to influence the economy.
Holding Company Structure
Doral Bank and any other insured depository institution (including, federal
savings banks) subsidiaries organized by Doral Financial in the future, are
subject to restrictions under federal law that govern certain transactions
between the Company or other nonbanking subsidiaries of the Company, whether in
the form of loans, other extensions of credit, investments or asset purchases.
Such transactions by the depository institution subsidiary to the Company, or to
any one nonbanking subsidiary of the Company, are limited in amount to 10% of
the depository institution's capital stock and surplus and, with respect to all
of its nonbanking subsidiaries, to an aggregate of 20% of the transferring
institution's capital stock and surplus. Furthermore, such loans and extensions
of credit by the depository institution subsidiary are required to be secured in
specified amounts and must be on terms that are consistent with safe and sound
banking practices. All other transactions between the Company and its nonbanking
subsidiaries and the depository institution subsidiary, while not subject to
quantitative or collateral requirements, are subject to the requirement that
they be on terms and conditions no less favorable to the banking subsidiary than
would be available to unaffiliated third parties.
Under Federal Reserve policy, a bank holding company such as Doral
Financial, is expected to act as a source of financial strength to each of its
subsidiary banks and to commit resources to support each such subsidiary bank.
This support may be required at times when, absent such policy, the bank holding
company might not otherwise provide such support. In addition, any capital loans
by a bank holding company to any of its subsidiary banks are subordinate in
right of payment to deposits and to certain other indebtedness of such
subsidiary bank. In the event of a bank holding company's bankruptcy, any
commitment by the bank holding company to a federal bank regulatory agency to
maintain the capital of a subsidiary depository institution will be assumed by
the bankruptcy trustee and entitled to a priority of payment. Doral Bank is
currently the only subsidiary depository institution of Doral Financial.
However, the Company expects to open a new federal savings bank in the New York
City metropolitan area during the third quarter of 1999. In connection with the
opening of this new thrift institution, the Company has agreed with the Office
of Thrift Supervision to maintain the new savings bank's ratio of Tier 1 Capital
to adjusted total assets at a level of not less than 8% for the first three
years of operation and to maintain an adequate allowance for loan and lease
losses throughout such period.
Because the Company is a holding company, its right to participate in the
assets of any subsidiary upon the latter's liquidation or reorganization will be
subject to the prior claims of the subsidiary's creditors (including depositors
in the case of depository institution subsidiaries) except to the extent that
the Company may itself be a creditor with recognized claims against the
subsidiary.
Under the Federal Deposit Insurance Act (the "FDIA"), a depository
institution (which term includes both banks and savings associations), the
deposits of which are insured by the FDIC, can be held liable for any loss
incurred by, or reasonably expected to be incurred by, the FDIC in connection
with (i) the default of a commonly controlled FDIC-insured depository
institution or (ii) any assistance provided by the FDIC to any commonly
controlled FDIC-insured depository institution "in danger of default." "Default"
is defined generally as the appointment of a conservator or a receiver and "in
danger of default" is defined generally as the existence of certain conditions
indicating that a default is likely to occur in the absence of regulatory
assistance. In some circumstances (depending upon the amount of the loss or
anticipated loss suffered by the FDIC), cross-guarantee liability may result in
the ultimate failure or insolvency of one or more insured depository
institutions in a holding company structure. Any
obligation or liability owned by a subsidiary depository institution to its
parent company is subordinated to the subsidiary bank's cross-guarantee
liability with respect to commonly controlled insured depository institutions.
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Capital Adequacy
Under the Federal Reserve's risk-based capital guidelines for bank holding
companies and state member banks, the minimum guidelines for the ratio of
qualifying total capital ("Total Capital") to risk-weighted assets (including
certain off-balance sheet items, such as standby letters of credit) is 8%. At
least half of the Total Capital is to be comprised of common equity, retained
earnings, minority interests in unconsolidated subsidiaries, noncumulative
perpetual preferred stock and a limited amount of cumulative perpetual preferred
stock, in the case of a bank holding company, less goodwill and certain other
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").
The Federal Reserve has adopted regulations that require most intangibles,
including core deposit intangibles, to be deducted from Tier l Capital. The
regulations, however, permit the inclusion of a limited amount of intangibles
related to readily marketable mortgage servicing rights and purchased credit
card relationships and include a "grandfather" provision permitting the
continued inclusion of certain existing intangibles.
In addition, the Federal Reserve has established minimum leverage ratio
guidelines for bank holding companies and member banks. These guidelines provide
for a minimum ratio of Tier 1 Capital to total assets, less goodwill and certain
other intangible assets discussed below (the "Leverage Ratio") of 3% for bank
holding companies and member banks that meet certain specified criteria,
including that they meet the highest regulatory rating. All other bank holding
companies and member banks will be required to maintain a Leverage Ratio of 3%
plus an additional cushion of at 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" and other indicia 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 average total assets, less all intangibles.
In 1996, the Federal Reserve and other U.S. federal bank regulatory
agencies jointly issued a final rule that amended the risk-based capital
guidelines to incorporate a measure for market risk (the "market risk
amendment"). Although compliance is mandatory in 1998 for banking organizations
with extensive trading activities, the market risk amendment permits the bank
regulatory agencies to exclude institutions from the application of the
amendment if certain criteria are met. Doral Financial has requested the Federal
Reserve to be excluded from the application of the market risk amendment on the
basis that the Company's trading activities are primarily related to its
mortgage securitization activities and that they are not the type of activities
contemplated by the market risk amendment. As of March 22, 1999, the Federal
Reserve had not acted on the Company's request.
The FDIC has established regulatory capital requirements for state
non-member insured banks, such as Doral Bank, that are substantially similar to
those adopted by the Federal Reserve for state member banks.
Set forth below are the Company's and Doral Bank's capital ratios at
December 31, 1998, based on existing Federal Reserve and FDIC guidelines.
THE COMPANY Doral Bank
----------- ----------
Tier 1 capital ratio 16.5% 13.2%
Total capital ratio 16.8% 13.3%
Leverage ratio 9.2% 8.0%
Failure to meet capital guidelines could subject a bank holding company or
an insured bank to a variety of enforcement remedies, including, with respect to
an insured bank, the termination of deposit insurance by the FDIC, and to
certain restrictions on its business. See "FDICIA" below.
Bank regulators have in the past indicated their desire to raise capital
requirements applicable to banking organizations beyond current levels. However,
management is unable to predict whether and when higher capital requirements
would be imposed and, if so, at what levels or on what schedule.
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FDICIA
Under FDICIA, federal banking regulators must take prompt corrective action
in respect of depository institutions that do not meet minimum capital
requirements. 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 1 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 l 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 1 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 capitalization category that is lower than
is indicated by its actual capital position if it receives a less than
satisfactory examination rating in any one of four categories.
At December 31, 1998, Doral Bank 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 the Company or Doral Bank, and should be
considered in conjunction with other available information regarding the Bank'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. Undercapitalized depository institutions are subject to
restrictions on borrowing from the Federal Reserve System. In addition,
undercapitalized depository institutions are subject to growth limitations and
are required to submit capital restoration plans. A depository institution's
holding company must guarantee the capital plan, up to an amount equal to the
lesser of 5% of the depository institution's assets at the time it becomes
undercapitalized or the amount of the capital deficiency when the institution
fails to comply with the plan. 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 were 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 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.
The capital-based prompt corrective action provisions of FDICIA and their
implementing regulations apply to FDIC-insured depository institutions such as
Doral Bank, but they are not directly applicable to holding companies, such as
the Company, which control such institutions. However, federal banking agencies
have indicated that, in regulating holding companies, they may take appropriate
action at the holding company level based on their assessment of the
effectiveness of supervisory actions imposed upon subsidiary insured depository
institutions pursuant to such provisions and regulations.
Interstate Banking Legislation
Effective June 1, 1997, the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Riegle- Neat Act") amended the FDIA and certain
other statutes to permit state and national banks with different home state of a
participating bank had passed legislation prior to May 31, 1997, expressly
prohibiting interstate mergers. Under the Riegle-Neal Act amendments, once a
state or national bank has established branches in a state, that bank may
establish and acquire additional branches at any location in the state at which
any bank involved in the interstate merger transaction could have established or
acquired branches under applicable federal or state law. If a state opts out of
interstate branching within the specified time period, no bank in any other
state may establish a branch in the state which has opted out, whether through
an acquisition or de novo.
For purposes of the Riegle-Neal Act's amendments to the FDIA, Doral Bank is
treated as a state bank and is subject to the same restrictions on interstate
branching as other state banks. However, for purposes of the
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International Banking Act, Doral Bank is considered to be a foreign bank and may
branch interstate by merger or de novo to the same extent as a domestic bank in
Doral Bank's home state. Because Doral Bank does not currently operate in the
mainland United States, it has not designated a "home state" for purposes of the
IBA. It is not yet possible to determine how these statutes will be harmonized,
with respect to which federal agency will approve interstate transactions or
with respect to which "home state" determination rules will apply.
Federal Legislative Proposes
Various other 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. Doral Financial cannot determine the
ultimate effect that such potential legislation, if enacted, or implementing
regulations, would have upon their financial condition or results of operations.
Dividend Restrictions
The payment of dividends by Doral Bank to Doral Financial may be affected
by regulatory requirements and policies, such as the maintenance of adequate
capital. If, in the opinion of the applicable regulatory authority, a depository
institution under its jurisdiction is engaged in, or is about to engage in, an
unsafe or unsound practice (that, depending on the financial condition of the
depository institution, could include the payment of dividends), such authority
may require, after notice and hearing, that such depository institution cease
and desist from such practice. 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, all insured
depository institutions are subject to the capital-based limitations required by
FDICIA. See "--FDICIA."
See "--Regulation--Banking Operations--Puerto Rico Regulation" for a
description of certain restrictions on Doral Bank's ability to pay dividends
under Puerto Rico law.
FDIC Insurance Assessments
The deposits of Doral Bank are insured by the Savings Association Insurance
Fund ("SAIF") administered by the FDIC and, accordingly, Doral Bank is subject
to FDIC deposit insurance assessments.
Pursuant to FDICIA, the FDIC has adopted a risk-based assessment system,
under which the assessment rate for an insured depository institution varies
according to the level of risk incurred in its activities. An institution's risk
category is based partly upon whether the institution is well capitalized,
adequately capitalized or less than adequately capitalized. Each insured
depository institution is also assigned to one of the following "supervisory
subgroups": "A", "B" or "C". Group "A" institutions are financially sound
institutions with only a few minor weaknesses; group "B" institutions are
institutions that demonstrate weaknesses that, if not corrected, could result in
significant deterioration; and group "C" institutions are institutions for which
there is a substantial probability that the FDIC will suffer a loss in
connection with the institution, unless effective action is taken to correct the
areas of weakness.
On September 30, 1996, the Deposit Insurance Funds Act of 1996 ("DIFA") was
enacted and signed into law. DIFA repealed the statutory minimum premium, and
currently premiums related to deposits assessed by both the Bank Insurance Fund
("BIF") and the SAIF are to be assessed at a rate of between 0 cents and 27
cents per $100.00 of deposits. DIFA also provides for a special one-time
assessment imposed on deposits insured by the SAIF to recapitalize the SAIF to
bring it up to statutory required levels. Doral Bank accrued for the one-time
assessment in the third quarter of 1996.
DIFA also separated, effective January 1, 1997, the Financing Corporation
("FICO") assessment to service the interest on its bond obligations from the BIF
and SAIF assessments. The amount assessed on individual institutions by the FICO
is in addition to the amount, if any, paid for deposit insurance according to
the FDIC's risk-related assessment rate schedules. FICO assessment rates for
1998 were set at 1.30 basis points annually for BIF-assessable deposits and 6.48
basis points annually for SAIF-assessable deposits. These rates may be adjusted
quarterly to reflect changes in assessment bases for the BIF and the SAIF. By
law, the FICO rate on BIF-assessable deposits must be
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one-fifth the rate on SAIF-assessable deposits until the insurance funds are
merged or until January 1, 2000, whichever occurs first. As of December 31,
1998, Doral Bank had a deposit base of approximately $516.0 million (consisting
entirely of SAIF assessment deposits).
Brokered Deposits
FDIC regulations adopted under FDICIA govern the receipt of brokered
deposits. Under these regulations, a bank cannot accept, roll over or renew
brokered deposits (which term is defined also to include any deposit with an
interest rate more than 75 basis points above prevailing rates) unless (i) it is
well capitalized or (ii) it is adequately capitalized and receives a waiver from
the FDIC. A bank that is adequately capitalized may not pay an interest rate on
any deposits in excess of 75 basis points over certain prevailing market rates
specified by regulation. There are no such restrictions on a bank that is well
capitalized. The Company does not believe the brokered deposits regulation has
had or will have a material effect on the funding or liquidity of Doral Bank
which is currently a well capitalized institution.
As of December 31, 1998 and 1997, Doral Bank had approximately $96.8
million and $60.3 million, respectively, of brokered deposits. Doral Bank uses
brokered deposits as a source of long-term funding.
PUERTO RICO REGULATION
General
As a commercial bank organized under the laws of the Commonwealth of Puerto
Rico, Doral Bank is subject to supervision, examination and regulation by the
Office of the Commissioner, pursuant to the Puerto Rico Banking Act of 1933, as
amended (the "Banking Law").
Section 27 of the Banking Law requires that at least 10% of the yearly net
income of Doral Bank be credited annually to a reserve fund until such fund
equals 100% of total paid-in capital (preferred and common). As of December 31,
1998, Doral Bank had an adequate reserve fund established.
Section 27 of the Banking Law also provides that when a bank suffers a
loss, it must first be charged against retained earnings, and the balance, if
any, must be charged against the reserve fund. If the balance of the reserve
fund is not sufficient to cover the loss, the difference shall be charged
against the capital account of the bank and no dividend may be declared until
the capital has been restored to its original amount and the reserve fund to 20%
of the original capital of the institution.
Section 16 of the Banking Law requires every bank to maintain a legal
reserve which shall not be less than 20% of its demand liabilities, other than
government deposits (federal, state and municipal) secured by actual collateral.
The Office of the Commissioner can by regulation increase the reserve
requirement to 30% of demand deposits.
Section 17 of the Banking Law generally permits Doral Bank to make loans on
an unsecured basis to any one person, firm, partnership or corporation, up to an
aggregate amount of 15% of the paid-in capital and reserve fund of the bank and
of such other components as the Office of Commissioner may permit from time to
time. As of December 31, 1998, the legal lending limit for Doral Bank under this
provision based solely on its paid-in capital and reserve fund was approximately
$6.4 million. If such loans are secured by collateral worth at least 25% more
than the amount of the loan, the aggregate maximum amount may reach one third of
the paid-in capital of the bank, plus its reserve fund and such other components
as the Office of Commissioner may permit from time to time. There are no
restrictions under Section 17 on the amount of loans that are wholly secured by
bonds, securities and other evidences of indebtedness of the Government of the
United States or the Commonwealth, or by current debt bonds, not in default, of
municipalities or instrumentalities of the Commonwealth.
Section 14 of the Banking Law authorizes Doral Bank to conduct certain
financial and related activities directly or through subsidiaries, including
finance leasing of personal property, making and servicing mortgage loans and
operating a small-loan company. Doral Bank currently operates one subsidiary,
Doral Money, Inc., which engages in mortgage banking activities in the mainland
United States.
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19
The Finance Board, which is a part of the Office of the Commissioner, but
also includes as its members the Secretary of the Treasury, the Secretary of
Commerce, the Secretary of Consumer Affairs, the President of the Planning
Board, and the President of the Government Development Bank for Puerto Rico, has
the authority to regulate the maximum interest rates and finance charges that
may be charged on loans to individuals and unincorporated businesses in the
Commonwealth. The current regulations of the Finance Board provide that the
applicable interest rate on loans to individuals and unincorporated businesses
is to be determined by free competition. The Finance Board also has authority to
regulate the maximum finance charges on retail installment sales contracts,
which are currently set at 21%, and for credit card purchases, which are
currently set at 26%. There is no maximum rate set for installment sales
contracts involving motor vehicles, commercial, agricultural and industrial
equipment, commercial electric appliances and insurance premiums.
CERTAIN REGULATORY RESTRICTIONS ON INVESTMENTS IN COMPANY COMMON STOCK
Because of Doral Financial's status as a bank holding company, owners of
the Company's Common Stock are subject to certain restrictions and disclosure
obligations under various federal laws, including the BHC Act. Regulations
pursuant to the BHC Act generally require prior Federal Reserve 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 to exist subject to rebuttal, if a person
(or persons acting in concert) acquires more than 10% of any class of voting
stock and either (i) the Company has registered securities under Section 12 of
the Securities Exchange Act of 1934, or (ii) no person will own, control or hold
the power to vote a greater percentage of that class of voting securities
immediately after the transaction. 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.
Section 12 of the Puerto Rico Banking Act requires the prior approval of
the Office of the Commissioner with respect to a transfer of voting stock of a
bank that results in a change or control of the bank. Under Section 12, a change
of control is presumed to occur if a person or group of persons acting in
concert, directly or indirectly, acquire more than 5% of the outstanding voting
capital stock of the bank. The Office of the Commissioner has interpreted the
restrictions of Section 12 as applying to acquisitions of voting securities of
entities controlling a bank, such as a bank holding company. Under the Puerto
Rico Banking Act, the determination of the Office of the Commissioner whether to
approve a change of control filing is final and non-appealable.
The provisions of the Mortgage Banking Law also only require regulatory
approval for the acquisition of more than 10% of the Company's outstanding
voting securities. See "--Regulation--Mortgage Banking Business."
The above regulatory restrictions relating to investment in the Company 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.
REGULATION--BROKER-DEALER OPERATIONS
Doral Securities is registered as a broker-dealer with the SEC and the
Office of the Commissioner. Doral Securities is also a member of the NASD. As a
registered broker-dealer, it is subject to regulation by the Commission, the
NASD and the Office of the Commissioner in matters relating to the conduct of
its securities business, including record keeping and reporting requirements,
supervision and licensing of employees and obligations to customers. In
particular, Doral Securities is subject to the SEC's net capital rules, which
specify minimum net capital requirements for registered broker-dealers and are
designed to ensure that broker-dealers maintain adequate regulatory capital in
relation to their liabilities and the size of their customer business. As a
subsidiary of a bank holding company, Doral Securities is also subject to
regulation by the Federal Reserve. Under Regulation K of the Federal Reserve,
Doral Securities activities must generally be conducted outside the United
States, Puerto Rico is considered to be outside the United States for purposes
of Regulation K.
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MARKET AREA AND COMPETITION
Prior to March 1992, Puerto Rico was Doral Financial's exclusive service
area. Although Doral Financial has opened offices in Miami, Florida, New York
and Chicago, Illinois, Puerto Rico remains Doral Financial's predominant service
area. The following table sets forth Doral Financial's loan origination
composition:
DECEMBER 31,
--------------------------------------------------
1998 1997 1996
Puerto Rico:
Metropolitan Area..................................................... 47% 52% 55%
Outside the Metropolitan Area......................................... 42% 47% 44%
United States:
Illinois and adjoining states......................................... 6% --- ---
New York/New Jersey................................................... 5% --- ---
Florida............................................................... (1) 1% 1%
- ----------------------------------
(1) Less than one percent.
The competition in Puerto Rico for the origination of mortgages is
substantial. Competition comes not only from other mortgage bankers but also
from major commercial banks. There are approximately 45 mortgage banks and 17
commercial banks operating in Puerto Rico, including affiliates of banks
headquartered in the United States, Canada and Spain. Doral Financial competes
principally by offering loans with competitive features, by emphasizing the
quality of its service and pricing its range of product at competitive rates.
THE COMMONWEALTH OF PUERTO RICO, USA
General. Puerto Rico, the fourth largest and most economically developed of
the Caribbean islands, is located approximately 1,600 miles southeast of New
York, New York and 1,000 miles southeast of Miami, Florida. The average flying
time from New York City is approximately 3 1/2 hours and from Miami, Florida 2
1/2 hours. Puerto Rico is approximately 100 miles long and 35 miles wide.
According to estimates of the Puerto Rico Planning Board, the population of
Puerto Rico is approximately 3.8 million. The Puerto Rico Planning Board
estimates that the San Juan metropolitan area has a population in excess of
1.0 million. The Caribbean region has a population of over 30 million located
in more than 25 principal islands.
Relationship of Puerto Rico with the United States. Puerto Rico has been
under the jurisdiction of the United States since 1898. The United States and
Puerto Rico share a common defense, market and currency. As a U.S. Commonwealth,
Puerto Rico exercises virtually the same control over its internal affairs as a
state government does. There is a federal district Court in Puerto Rico and most
federal laws are applicable to Puerto Rico. The U.S. mail system operates in
Puerto Rico in the same manner as in the mainland United States. The people of
Puerto Rico are citizens of the United States, but do not vote in national
elections and 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.
The Economy. The economy of Puerto Rico is closely integrated with that of
the mainland United States. During the fiscal year ended June 30, 1998,
approximately 90% of Puerto Rico's exports went to the United States mainland,
which was also the source of approximately 61% of Puerto Rico's imports. For the
fiscal year ended June 30, 1998, Puerto Rico experienced a positive merchandise
trade balance of $8.5 billion.
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21
The economy of Puerto Rico is dominated by the manufacturing and service
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 pharmaceuticals 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.
Gross product increased from $25.1 billion ($24.5 billion in 1992 prices)
for fiscal 1993 to $32.1 billion ($27.7 billion in 1992 prices) for fiscal 1997,
an increase of 27.7% (13.0% in real terms). The preliminary figure for gross
product for fiscal 1998, released by the Puerto Rico Planning Board in November
1998, was $34.7 billion ($28.5 billion 1992 prices), an increase of 8.1% (3.1%
in 1992 prices over fiscal 1997). Since fiscal 1985, personal income per capita
has increased consistently each fiscal year. In fiscal 1997, personal income per
capita was $8,509 ($7,957 in 1992 prices). Average employment increased from
999,000 in fiscal 1993 to 1,128,300 in fiscal 1997. Average unemployment
decreased from 16.8% in fiscal 1993 to 13.1% in fiscal 1997. The reasonally
adjusted unemployment rate for November 1998 was 13.3%.
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.
The Small Business Job Protection Act, which was signed into law on August
20, 1996, provided for the repeal of Section 936 of the Internal Revenue Code,
over a ten year phase out period for corporations with operations in Puerto Rico
as of August 1995. Section 936 has traditionally provided tax incentives for
U.S. corporations to invest in Puerto Rico. In addition, the Act eliminated the
tax credit for corporations that established operations in Puerto Rico after
October 1995. The elimination of the benefits of Section 936, without the
substitution of another fiscal incentive to attract investment 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 long-term impact of the repeal of
Section 936 on the economy of Puerto Rico.
ITEM 2. PROPERTIES
The executive and administrative offices of Doral Financial 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 Mortgage'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. In the
mainland United States, the Company's leases approximately 8,500 square feet of
office space as follows: Florida 1,000 square feet, New York 3,600 square feet
and Illinois 3,900 square feet. The Company's leases are for various terms
expiring through 2005. Annual aggregate rental payments made during the years
ended December 31, 1998, 1997 and 1996 were $3,273,000, $2,518,000 and
$2,084,000, respectively. Except for a two-acre parcel of land located in the
San Juan metropolitan area on which the Company is currently constructing a new
headquarters building and a 2,000 square foot building and underlying real
property where a bank branch is located, the Company does not own any real
property other than OREO acquired in the ordinary course of business. The
proposed site for the new headquarters building was purchased for $3.0 million.
Construction costs are estimated at approximately $40.0 million, including the
$3.0 million cost of the land.
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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
Doral Financial'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 (the "NASDAQ
National Market") under the symbol "DORL." Prior to September 23, 1997, the
Company's Common Stock was traded under the symbol "FRCC." The table below sets
forth, for the calendar quarters indicated, the high and low sales prices on the
NASDAQ National Market and the cash dividends declared on the Common Stock
during such periods. The information in the table has been adjusted to reflect
two-for-one stock splits effective August 28, 1997 and May 20, 1998.
CASH
PRICE RANGE DIVIDEND
CALENDAR ----------- DECLARED
YEAR QUARTER HIGH LOW PER SHARE
---- ------- ---- --- ---------
1998 1st $15.344 $10.500 $0.05
2nd 18.563 15.219 0.06
3rd 19.625 14.625 0.06
4th 22.688 11.625 0.06
1997 1st $7.813 $6.500 $0.04
2nd 8.156 6.063 0.05
3rd 13.500 7.438 0.05
4th 12.875 9.875 0.05
As of March 8, 1999, the approximate number of record holders of the
Company's Common Stock was 772, 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 $18.00 per
share.
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 terms of the Company's 8% Convertible Cumulative Preferred Stock
(liquidation preference $1,000 per share) (the "8% Preferred Stock") and of the
Company's 7% Noncumulative Monthly Income Preferred Stock, Series A (liquidation
preference $50 per share) do not permit the payment of cash dividends on Common
Stock if dividends on the respective series of preferred stock are in arrears.
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 Indenture for its 7.84% Senior
Notes due 2006 (the "Senior Note Indenture") from paying dividends on any
capital stock (other than dividends payable in capital stock or in stock
rights), if an event of default exists under any such agreement 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 October 1,
1996, exceed the sumof: (i) 50% of the Company's Consolidated Net Income (as
defined in the Senior Note Indenture), accrued from October 1, 1996 to the end
of the quarter ending not less than 45 days prior to the dividend payment date;
(ii) $15 million; and (iii) the net proceeds of any sale of capital stock
subsequent to October 15, 1996. In addition, under the Syndicated Credit
Agreement and other debt agreements of Doral Financial, the Company may be
prohibited from paying dividends if it fails to maintain specified minimum
levels of net worth, tangible net worth and certain other financial covenants.
The ability of the Company to pay dividends may also be restricted by
various regulatory requirements and policies of bank regulatory agencies having
jurisdiction over the Company and its subsidiaries. See -- Regulation -- Banking
Operations -- Federal Regulation -- Dividend Restrictions."
19
23
The Puerto Rico Internal Revenue Code generally imposes a 10% withholding
tax on the amount of any dividends paid by Doral Financial to individuals,
whether residents of Puerto Rico or not, trusts, estates, special partnerships
and non-resident foreign corporations and partnerships. 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 except that notwithstanding the making of such election, a 10%
withholding will still be made on the amount of any dividend distribution unless
the individual files with the Company prior to the first distribution date for
the taxable year, a certificate to the effect that 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, in which case dividend distributions
will not be subject to Puerto Rico.
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
This information required by this Item 6 is incorporated by reference from
Table A commencing on page 22 of the "Management's Discussion and Analysis of
Financial Condition and Results of Operation" section of this report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Doral Financial Corporation is a bank holding company that, together with
its wholly-owned subsidiaries, is engaged in mortgage banking, commercial
banking and broker-dealer activities. It is primarily engaged in a wide range of
mortgage banking activities, including the origination, purchase, sale and
servicing of mortgage loans on single-family residences, the issuance and sale
of various types of mortgage-backed securities, the holding of mortgage loans,
mortgage-backed securities and other investment 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 mortgage loans secured by commercial real estate and land (the "mortgage
banking business").
Doral Financial has been engaged in the mortgage banking business since
1972. The Company is the leading originator of mortgage loans on single-family
residences in Puerto Rico. The volume of loans originated and purchased during
the three years ended December 31, 1998, 1997 and 1996, by Doral Financial was
approximately $2.3 billion, $1.04 billion and $817 million, respectively.
Doral Financial's mortgage servicing portfolio has increased to
approximately $6.2 billion as of December 31, 1998, from $4.7 billion as of
December 31, 1997, an increase of 33%. Doral Financial's traditional strategy
has been to increase the size of its mortgage servicing portfolio by relying
principally on internal loan originations.
Doral Financial entered the banking business in September 1993 through the
acquisition of a federal thrift institution, Doral Bank (formerly Doral Federal
Savings Bank). In October 1997, Doral Bank converted its charter to that of a
Puerto Rico commercial bank and currently operates through eleven branches in
Puerto Rico. For the years ended December 31, 1998, 1997 and 1996, Doral Bank's
net income was $8.2 million, $5.0 million and $2.3 million, respectively, which
includes the operations of Doral Money, a wholly-owned subsidiary of Doral Bank.
The increase in net income reflects a substantial increase in interest earning
assets during these periods.
During the second quarter of 1998, Doral Financial expanded into the
mainland United States through the creation of Doral Money, a subsidiary of
Doral Bank, which operates through two divisions, a multi-family and commercial
lending unit in the New York City metropolitan area, and a residential wholesale
mortgage operation in the Chicago metropolitan area. Doral Money contributed
approximately 11% of the Company's total loan production for 1998.
20
24
Doral Financial is also in the process of organizing a new federal savings
association in the New York City metropolitan area, which it anticipates will
open for business during the third quarter of 1999.
In September 1996, Doral Financial also entered the securities business
through the establishment of Doral Securities, a broker-dealer subsidiary that
provides retail and institutional, financial advisory and investment banking
services in Puerto Rico. For the years ended December 31, 1998 and 1997, Doral
Securities' net income was $1.1 million and $138,000, respectively. It had a
loss of $427,000 for the year ended December 31, 1996, its first year of
operation. The increase in net income reflects a substantial increase in
customer accounts and interest earning assets during these periods. Assets in
customer brokerage accounts increased to $138 million as of December 31, 1998,
from $74 million as of the same date a year ago, an increase of 86%.
For information regarding net interest income, non-interest income, net
income and identifiable assets broken down by the Company's mortgage banking,
commercial banking and broker dealer segments, please refer to note 31 to the
Company's Consolidated Financial Statements.
Unlike most bank holding companies, Doral Financial has significant assets
and operations at the holding company level. HF Mortgage Bankers, one of the
Company's principal mortgage units, is organized as an operating division within
the parent company. As of December 31, 1998, Doral Financial had assets of $1.3
billion at the parent company level.
The following table sets forth certain selected consolidated financial data
for Doral Financial on a historical basis for each of the five years ended
December 31, 1998. This information should be read in conjunction with Doral
Financial's Consolidated Financial Statements and related notes thereto.
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TABLE A
SELECTED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ----------- ---------- -------- --------
Selected Income Statement Data:
Interest income $ 148,051 $ 90,131 $ 66,987 $ 61,907 $ 46,508
Interest expense 114,786 61,438 46,443 43,380 23,252
---------- ----------- ---------- -------- --------
Net interest income 33,265 28,693 20,544 18,527 23,256
Provision for loan losses 883 792 797 352 300
---------- ----------- ---------- -------- --------
Net interest income after provision for loan losses 32,382 27,901 19,747 18,175 22,956
Non-interest income 88,340 45,286 40,846 29,930 25,535
Non-interest expense 60,883 35,390 29,314 26,045 29,746
---------- ----------- ---------- -------- --------
Income before taxes, cumulative effect and
extraordinary item 59,839 37,797 31,279 22,060 18,745
Income taxes 7,007 5,249 4,238 2,500 2,530
---------- ----------- ---------- -------- --------
Income before cumulative effect and
extraordinary item 52,832 32,548 27,041 19,560 16,215
Cumulative effect of change in accounting
principle -- -- -- -- 1,215
---------- ----------- ---------- -------- --------
Income before extraordinary item 52,832 32,548 27,041 19,560 17,430
Extraordinary item - non-cash charge on
extinguishment of debt -- 12,317 -- -- --
---------- ----------- ---------- -------- --------
Net income $ 52,832 $ 20,231 $ 27,041 $ 19,560 $ 17,430
========== =========== ========== ======== ========
Cash dividends paid $ 9,975 $ 7,199 $ 6,008 $ 4,374 $ 3,943
========== =========== ========== ======== ========
Per Share Data:(1)
Basic:
Income before cumulative effect and
extraordinary item $ 1.31 $ 0.89 $ 0.75 $ 0.67 $ 0.58
Cumulative effect -- -- -- -- 0.04
Extraordinary item -- (0.34) -- -- --
---------- ----------- ---------- -------- --------
Net income $ 1.31 $ 0.55 $ 0.75 $ 0.67 $ 0.62
========== =========== ========== ======== ========
Diluted:
Income before cumulative effect and
extraordinary item $ 1.26 $ 0.85 $ 0.71 $ 0.64 $ 0.54
Cumulative effect -- -- -- -- 0.04
Extraordinary item -- (0.32) -- -- --
---------- ----------- ---------- -------- --------
Net income $ 1.26 $ 0.53 $ 0.71 $ 0.64 $ 0.58
========== =========== ========== ======== ========
Dividends Declared per Share:
Common Stock $ 0.23 $ 0.20 $ 0.165 $ 0.145 $ 0.13
Series A Preferred Stock -- -- $ 0.3825 $ 1.05 $ 1.05
8% Convertible Cumulative Preferred Stock $ 80.00 $ 15.33 -- -- --
Selected Balance Sheet Data: (2)
Mortgage loans held for sale $ 883,048 $ 404,672 $ 260,175 $243,678 $262,209
Securities held for trading 606,918 620,288 436,125 418,348 327,960
Securities held to maturity 190,778 143,534 107,222 77,945 66,804
Securities available for sale 408,888 240,876 12,007 14,579 --
Loans receivable, net 166,987 133,055 128,766 51,355 34,809
Total assets 2,918,113 1,857,789 1,106,083 917,922 768,019
Loans payable and securities sold under
agreements to repurchase 1,624,032 1,076,912 568,840 573,754 538,740
Notes payable 199,733 164,934 152,126 51,682 17,055
Deposit accounts 533,113 300,494 158,902 95,740 66,471
Stockholders' equity 269,559 186,955 150,531 129,017 90,496
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TABLE A
SELECTED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
+
Year ended December 31,
--------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Weighted average shares outstanding:
Basic 39,941,068 36,680,158 36,266,244 29,231,680 27,770,936
Diluted 41,928,186 38,728,632 38,725,072 31,040,540 30,307,856
Operating Data:
Loan production $ 2,313,000 $ 1,037,000 $ 817,000 $ 636,000 $ 824,000
Mortgage loan servicing portfolio $ 6,186,000 $ 4,655,000 $ 3,068,000 $ 2,668,000 $ 2,644,000
Selected Financial Ratios: (3)(4)
Return on Average Assets 2.17% 1.37% 2.68% 2.32% 2.78%
Return on Average Equity 21.65% 11.99% 19.35% 17.82% 20.82%
Dividend Payout Ratio for Common Stock 18.25% 37.74% 23.24% 22.66% 22.41%
Average Equity to Average Assets 10.00% 11.39% 13.81% 13.02% 13.35%
Interest Rate Spread 1.55% 2.10% 2.17% 2.38% 3.85%
Net Yield on Average Interest Earning Assets 7.21% 7.90% 7.85% 8.35% 8.31%
Net Yield on Average Interest Bearing Liabilities 5.66% 5.80% 5.68% 5.97% 4.46%
- --------------------
(1) Adjusted to reflect two-for-one stock splits effective December 10, 1993,
August 28, 1997, and May 20, 1998.
(2) Certain reclassifications of prior years' data have been made to conform to
1998 classifications.
(3) Return on Average Assets, Average Equity and Dividend Payout Ratio for
Common Stock based on income before an extraordinary item for 1997 would
have been 2.19%, 19.29% and 23.53%, respectively.
(4) Average balances computed on a monthly basis.
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LOAN PRODUCTION
The following table sets forth the number and dollar amount of Doral
Financial's loan production for the periods indicated:
TABLE B
LOAN PRODUCTION
(DOLLARS IN THOUSANDS, EXCEPT FOR AVERAGE INITIAL LOAN BALANCE)
YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---- ---- ----
FHA/VA mortgage loans
Number of loans..................................... 7,217 5,529 5,224
Volume of loans..................................... $571,027 $409,509 $369,609
Percent of total volume............................. 25% 39% 45%
Conventional conforming mortgage loans(1)
Number of loans..................................... 9,755 2,131 676
Volume of loans..................................... $873,540 $178,264 $63,401
Percent of total volume............................. 38% 17% 8%
Conventional non - conforming mortgage loans(2)(3)(4)
Number of loans..................................... 10,735 7,399 8,530
Volume of loans..................................... $642,769 $381,116 $359,882
Percent of total volume............................. 27% 37% 44%
Other(5).................................................
Number of loans..................................... 799 554 369
Volume of loans..................................... $225,551 $68,110 $23,674
Percent of total volume............................. 10% 7% 3%
Total loans
Number of loans(6).................................. 28,506 15,613 14,799
Volume of loans(7).................................. $2,312,887 $1,036,999 $816,566
Average initial loan balance $81,140 $66,420 $55,180
- --------------------
(1) Refers to mortgage loans that qualify for the sale or exchange programs of
FNMA or FHLMC.
(2) Refers to mortgage loans that do not qualify for the sale or exchange
programs of FNMA or FHLMC.
(3) Includes $20 million, $20 million and $29 million, in second mortgages for
the years ended December 31, 1998, 1997 and 1996, respectively.
(4) Includes $36 million, $38 million and $74 million, in home equity or
personal loans secured by real estate mortgages up to $40,000 for the years
ended December 31, 1998, 1997 and 1996, respectively.
(5) Consists of construction loans on residential projects, mortgage loans
secured by multi-family and commercial properties as well as other
commercial, land, and consumer loans.
(6) Includes 5,226, 1,886 and 2,044, of loans funded by Doral Bank pursuant to
the Master Loan Production Agreement for the years ended December 31, 1998,
1997 and 1996, respectively. See "Loan Origination Channels."
(7) Includes $619 million, $169 million and $99 million, principal amount of
loans funded by Doral Bank pursuant to the Master Loan Production Agreement
for the years ended December 31, 1998, 1997 and 1996, respectively. See
"Loan Origination Channels."
A substantial portion of Doral Financial's total mortgage loan originations
has consistently been comprised of refinanced loans. For the years ended
December 31, 1998, 1997, 1996, 1995 and 1994, refinance loans represented
approximately 62%, 51%, 47%, 41% and 59%, respectively, of the total dollar
volume of mortgage loans originated (excluding loans purchased from third
parties). Doral Financial's future results could be adversely affected by a
significant increase in mortgage interest rates that reduces refinancing
activity.
24
28
LOAN ORIGINATION CHANNELS
In Puerto Rico, Doral Financial relies primarily on its extensive retail
mortgage banking and bank branch network to originate loans. It supplements
these originations by wholesale originations consisting primarily of purchases
of FHA and VA loans from other mortgage bankers and, to a lesser extent,
originations through mortgage brokers. The Company, through Doral Bank and other
specialized units, also originates consumer, commercial, construction and land
loans. In 1998, Doral Financial established a new wholesale residential mortgage
operation in Chicago and a multi-family lending unit in the New York
metropolitan area. In Puerto Rico, the Company maintains a specialized unit that
works closely with home builders and originates mortgage loans to finance the
acquisition of homes in new residential projects.
Doral Bank is a party to a Master Loan Production Agreement with the
mortgage banking units of the Company, whereby these are obligated to assist
Doral Bank meet its stated mortgage loan production goals by, among other
things, (i) advertising, promoting and marketing to the general public; (ii)
interviewing prospective borrowers and conducting the initial processing of loan
applications, consistent with Doral Bank's underwriting guidelines; and (iii)
providing personnel and facilities with respect to the execution of loan
agreements. In addition, Doral Bank engages in direct loan originations through
its branch network for other loan products such as consumer, land, and
commercial loans.
Doral Financial customarily sells or securitizes into mortgage-backed
securities substantially all the loans it originates, except for certain
consumer, construction, land, and commercial loans originated by Doral Bank and
construction and land loans originated by other specialized units of Doral
Financial which are held for investment and classified as Loans Receivable. See
"Loans Receivable".
The following table sets forth the sources of Doral Financial's loan
production as a percentage of total loan originations for the periods indicated:
TABLE C
LOAN ORIGINATION SOURCES
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------
1998 1997(1) 1996(1)
------------------------------------- ------------- --------------
PUERTO RICO US TOTAL
Retail............................. 52% -- 52% 63% 59%
Wholesale.......................... 22% 6% 28% 13% 12%
New Housing Developments........... 8% -- 8% 13% 17%
Multi-family....................... -- 5% 5% -- --
Other(2)........................... 7% -- 7% 11% 12%
- --------------------
(1) For years prior to 1998, originations from the mainland United States
represented less than 1% of total loan originations.
(2) Refers to commercial, construction, land, and consumer loans originated
through Doral Bank and other specialized units.
MORTGAGE LOAN SERVICING
Doral Financial's principal source of servicing rights has traditionally
been its mortgage loan production. However, during 1998, Doral Financial
purchased servicing rights to approximately $229.2 million in principal amount
of mortgage loans. Doral Financial intends to continue growing its mortgage
servicing portfolio by internal loan originations and will continue to seek and
consider attractive opportunities for bulk purchases of servicing rights.
25
29
The following table sets forth certain information regarding the total
mortgage loan servicing portfolio of Doral Financial for the periods indicated:
TABLE D
MORTGAGE LOAN SERVICING
(DOLLARS IN THOUSANDS, EXCEPT FOR AVERAGE SIZE OF LOANS PREPAID)
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
---- ---- ----
COMPOSITION OF SERVICING
PORTFOLIO AT PERIOD END
GNMA........................................ $2,281,903 $2,142,345 $1,305,792
FHLMC/FNMA.................................. 1,557,592 915,935 696,139
Doral Financial grantor trusts.............. 146,790 201,585 256,595
Other conventional mortgage loans(1)........ 2,199,774 1,395,270 809,956
---------- ---------- ----------
Total servicing portfolio................... $6,186,059 $4,655,135 $3,068,482
========== ========== ==========
SERVICING PORTFOLIO ACTIVITY
Beginning servicing portfolio............... $4,655,135 $3,068,482 $2,668,260
ADD:
Loans funded and purchased(2).......... 2,243,034 1,036,999 816,566
Bulk servicing acquired................ 229,176 1,040,000 --
LESS:
Servicing sales transferred............ 103,003 -- 102,000
Run-off(3)............................. 838,283 490,346 314,344
---------- ---------- ----------
Ending servicing portfolio.................. $6,186,059 $4,655,135 $3,068,482
========== ========== ==========
SELECTED DATA REGARDING
MORTGAGE LOANS SERVICED
Number of loans............................. 101,760 86,269 62,199
Weighted average interest rate.............. 7.89% 8.35% 8.53%
Weighted average remaining maturity (months) 208 180 221
Weighted average servicing fee rate......... .3762% .3673% .3933%
Average servicing portfolio................. $5,225,921 $3,861,809 $2,868,371
Principal prepayments....................... $ 644,000 $ 279,000 $ 201,000
Prepayments to average portfolio............ 12% 7% 7%
Average size of loans prepaid............... $ 50,300 $ 37,800 $ 35,360
DELINQUENT MORTGAGE LOANS AND
PENDING FORECLOSURES AT PERIOD END
60-89 days past due......................... 1.26% 1.84% 1.77%
90 days or more past due.................... 2.35% 1.92% 2.18%
---------- ---------- ----------
Total delinquencies excluding foreclosures.. 3.61% 3.76% 3.95%
========== ========== ==========
Foreclosures pending 1.08% 1.32% 1.12%
(1) Includes $925 million, $393 million, and $317 million of loans owned by the
Company at December 31, 1998, 1997 and 1996, respectively, which
represented 15%, 8% and 10%, of the total servicing portfolio as of such
dates.
(2) Excludes approximately $70 million of commercial, construction loans and
loans sold with servicing released not included in the Company's mortgage
servicing portfolio.
(3) Run-off refers to regular amortization of loans, prepayments and
foreclosures.
Substantially all of the mortgage loans in Doral Financial's servicing
portfolio are secured by single (one-to-four) family residences. Substantially
all of Doral Financial's mortgage servicing portfolio is composed of mortgages
secured by real estate located in Puerto Rico. At December 31, 1998 and 1997,
less than 5% and 1%, respectively, of Doral Financial's mortgage servicing
portfolio was related to mortgages secured by real property located outside
Puerto Rico.
26
30
LOANS RECEIVABLE
Doral Financial, principally through Doral Bank, and, to a lesser
extent, through other specialized units, originates mortgage loans secured by
income producing residential and commercial properties, construction loans, land
loans and other commercial and consumer loans that are held for investment and
classified as loans receivable. Substantially all of Doral Financial's loans
receivable represent loans made to entities or individuals located in Puerto
Rico. The loans originated by the Company's multi-family lending operation in
the New York City metropolitan area are classified as loans held for sale.
The maximum aggregate amount of unsecured loans that Doral Bank could
make to a single borrower under Puerto Rico banking regulations as of December
31, 1998, was $6.4 million. As of such date the largest loan held for investment
by the Company was $4.9 million, which was held by Doral Bank.
The following table sets forth certain information regarding Doral
Financial's loans receivable as of the dates indicated:
TABLE E
LOANS RECEIVABLE, NET
(DOLLARS IN THOUSANDS)
AS OF DECEMBER 31,
----------------------------------------------------------------------------------------
1998 1997 1996 1995
---- ---- ---- ----
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ ------- ------ ------- ------ -------
Construction loans $ 72,081 33% $ 9,927 7% $ 2,793 2% $ 2,637 5%
Residential mortgage loans 80,902 37% 87,037 65% 91,596 70% 29,481 57%
Commercial real estate 16,443 8% 19,036 14% 18,462 14% 9,205 18%
Consumer--secured by mortgage 5,005 2% 7,828 6% 12,207 9% 7,362 14%
Consumer--other 6,290 3% 2,328 2% 356 (1) 324 (1)
Commercial (non-real estate) 11,051 5% 3,461 2% 2,047 2% 701 1%
Loans on saving deposits 3,676 2% 3,513 3% 1,771 1% 1,940 4%
Land secured 21,418 10% 1,488 1% 814 (1) 330 (1)
-------- ------ -------- ------ -------- ----- ------ -------
Gross loans receivable(2)(3) 216,866 100% 134,618 100% 130,046 100% 51,980 100%
-------- -------- -------- ------
Less:
Undisbursed portion of loans
in process (47,575) - - -
Unearned interest and deferred
loan fees (648) (322) (561) (383)
Allowance for loan losses(4) (1,656) (1,241) (719) (242)
-------- -------- -------- -------
(49,879) (1,563) (1,280) (625)
-------- -------- -------- -------
Loans receivable, net $166,987 $133,055 $128,766 $51,355
======== ======== ======== =======
AS OF DECEMBER 31,
--------------------
1994
----
AMOUNT PERCENT
------ -------
Construction loans $ 1,061 3%
Residential mortgage loans 23,293 66%
Commercial real estate 2,044 6%
Consumer-- secured by mortgage 6,283 18%
Consumer-- other 1,009 3%
Commercial (non-real estate) 421 1%
Loans on saving deposits 956 3%
Land secured 183 (1)
------- -------
Gross loans receivable(2)(3) 35,250 100%
-------
Less:
Undisbursed portion of loans
in process -
Unearned interest and deferred
loan fees (13)
Allowance for loan losses(4) (428)
-------
(441)
-------
Loans receivable, net $34,809
=======
(1) Less than one percent.
(2) Sum of the columns may not add up to the totals due to rounding.
(3) Does not include mortgage loans held for sale by Doral Financial of $883.0
million, $404.7 million, $260.2 million, $243.7 million and $262.2 million,
at December 31, 1998, 1997, 1996, 1995 and 1994, respectively.
(4) Does not include $3.5 million, $1.6 million, $1.4 million, $1.8 million,
and $1.6 million of allowance for loan losses allocated to mortgage loans
held for sale as of December 31, 1998, 1997, 1996, 1995 and 1994,
respectively.
27
31
The following table sets forth certain information as of December 31,
1998, regarding the dollar amount of Doral Financial's loans receivable
portfolio based on the remaining contractual maturity. Expected maturities may
differ from contractual maturities because of prepayments and other market
factors. Loans having no stated schedule of repayments and no stated maturity
are reported as due in one year or less.
TABLE F
LOANS RECEIVABLE BY
CONTRACTUAL MATURITIES
(IN THOUSANDS)
DUE 1 YEAR DUE 1-5 YEARS AFTER DUE 5 OR MORE YEARS
OR LESS DECEMBER 31, 1998 AFTER DECEMBER 31, 1998 TOTAL
---------- ------------------ ----------------------- --------
Construction loans.................... $27,891 $44,190 $ -- $ 72,081
Residential mortgage loans............ 7,693 3,235 69,974 80,902
Commercial real estate................ -- 907 15,536 16,443
Consumer - secured by mortgage........ 440 -- 4,565 5,005
Consumer - other...................... 1,745 3,440 1,105 6,290
Commercial (non-real estate).......... 10,024 1,027 -- 11,051
Loans on saving deposits.............. 750 2,926 -- 3,676
Land secured.......................... 12,603 7,117 1,698 21,418
------- ------- ------- --------
Gross loans receivable............ $61,146 $62,842 $92,878 $216,866
======= ======= ======= ========
Scheduled contractual amortization of loans receivable does not reflect
the expected term of Doral Financial's loans receivable portfolio. The average
life of these loans is substantially less than their contractual terms because
of prepayments and, with respect to conventional mortgage loans, due-on-sale
clauses, which give Doral Financial the right to declare a conventional mortgage
loan immediately due and payable in the event, among other things, that the
borrower sells the real property subject to the mortgage and the loan is not
repaid. The average life of mortgage loans tends to increase when current
mortgage loan rates are higher than rates on existing mortgage loans and,
conversely, decrease when current mortgage loan rates are lower than rates on
existing mortgage loans (due to refinancing of adjustable-rate and fixed-rate
loans at lower rates). Under the latter circumstances, the weighted average
yield on loans decreases as higher-yielding loans are repaid or refinanced at
lower rates.
The following table sets forth the dollar amount of total loans
receivable at December 31, 1998, as shown in the preceding table, which have
fixed interest rates or which have floating or adjustable interest rates.
TABLE G
BREAKDOWN OF LOANS
RECEIVABLE BY FIXED AND
FLOATING RATES
(IN THOUSANDS)
FLOATING OR
FIXED RATE ADJUSTABLE-RATE TOTAL
------------ --------------- -----
Construction loans.................... $ 4,475 $ 67,606 $ 72,081
Residential mortgage loans............ 73,471 7,431 80,902
Commercial real estate................ 16,443 - 16,443
Consumer - secured by mortgage........ 4,565 440 5,005
Consumer - other...................... 6,290 - 6,290
Commercial (non-real estate).......... 1,696 9,355 11,051
Loans on saving deposits.............. 3,676 - 3,676
Land secured.......................... 1,981 19,437 21,418
------------- -------------- ------------
Gross loans receivable........... $ 112,597 $ 104,269 $ 216,866
============= ============== ============
The Company originates adjustable and fixed interest rate loans.
However, given traditional consumer preferences in Puerto Rico for fixed rate
mortgage loans, the Company's principal product, Doral Financial does not
anticipate a significant growth in adjustable rate loans, except in the case of
construction and land loans, mortgage loans secured by commercial properties and
other commercial loans. At December 31, 1998, 1997 and 1996,
28
32
approximately 48%, 10% and 3%, respectively, of the Company's gross loans
receivable were adjustable rate loans. The increase in adjustable rate loans
experienced during 1998 was mainly the result of a higher production of land
loans and loans for construction development projects. 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 the Company pays on the different funding sources used
to finance these loans. Substantially all construction, commercial and land
loans held by the Company are adjustable rate loans maturing within 36 months.
CREDIT RISKS RELATED TO LOAN ACTIVITIES
With respect to mortgage loans originated for sale as part of Doral
Financial's mortgage banking business, the Company is generally at risk for any
mortgage loan default from the time the Company originates the mortgage loan
until the time it sells the loan or packages it into a mortgage-backed security.
With respect to FHA loans, the Company is fully insured as to principal by the
FHA against foreclosure loss. VA loans are guaranteed up to 25% to 50% of the
principal amount of the loan subject to a maximum, ranging from $22,500 to
$50,750. Loan-to-value ratios for residential mortgage loans generally do not
exceed 80% (85% for qualifying home purchase transactions through Doral Bank)
unless private mortgage insurance is obtained.
Loans that do not qualify for the insurance or guarantee programs of
FHA and VA, or the sale or exchange programs of FNMA or FHLMC ("non-conforming
loans"), including loans secured by multi-family projects, are often sold to
investors on a full or partial recourse basis. In such cases, the Company
retains all or part of the credit risk associated with such loan after sale. As
of December 31, 1998, the maximum amount of loans that the Company would have
been required to repurchase if all loans subject to recourse defaulted was
$489.1 million. As of December 31, 1998, the Company maintained a reserve of
$1.4 million for potential losses from such recourse arrangements which is
included in "Accrued expenses and other liabilities" in the Company's
Consolidated Financial Statements.
Loans secured by income producing residential and commercial properties
involve greater credit risk because they are larger in size and more risk is
concentrated in a single borrower. The properties securing these loans are also
more difficult to dispose of in foreclosure.
Doral Financial is also subject to credit risk with respect to its
portfolio of loans receivable. Loans receivable represent loans that the Company
holds for investment and, therefore, the Company is at risk for the term of the
loan. As of December 31, 1998, approximately 37% of Doral Financial's loans
receivable portfolio consisted of residential mortgage loans.
Doral Financial manages credit risk by maintaining sound underwriting
standards, monitoring the quality of the loan portfolio, assessing reserves and
loan concentrations, recruiting qualified credit officers, implementing and
monitoring lending policies and collateral requirements, and instituting
procedures to ensure appropriate actions to comply with laws and regulations.
The Company's collateral requirements for loans depend on the financial strength
of the borrower and the type of loan involved. Acceptable collateral principally
includes cash, deposit and investment accounts and real estate, and, to a lesser
extent, liens on accounts receivable, lease receivables, inventory and personal
property. In the case of non-conforming loans sold subject to recourse, the
Company also generally requires lower loan-to-value ratios to protect itself
from possible losses on foreclosure.
Because most of Doral Financial's loans are made to borrowers located
in Puerto Rico and secured by properties located in Puerto Rico, the Company is
subject to greater credit risks tied to adverse economic, political or business
developments and natural hazards, such as hurricanes, that may affect the
Island. For example, if Puerto Rico's real estate market were to experience an
overall decline in property values, the Company's rates of loss on foreclosure
would probably increase.
NON-PERFORMING ASSETS AND ALLOWANCE FOR LOAN LOSSES
Non-performing assets ("NPAs") consist of loans held for sale past due
90 days and still accruing, loans on a non-accrual basis and other real estate
owned. Doral Bank's policy is to place all loans 90 days or more past due on a
non-accrual basis, at which point a reserve for all unpaid interest previously
accrued is established. Interest
29
33
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
collectibility is reasonably assured. For the years ended December 31, 1998,
1997, 1996, 1995 and 1994, Doral Bank would have recognized $335,000, $201,000,
$114,000, $211,000 and $287,000, respectively, in additional interest income had
all delinquent loans owned by Doral Bank been accounted for on an accrual basis.
Mortgage loans held for sale by Doral Financial's mortgage banking units are not
normally placed on a non-accrual basis following default. Doral Financial
believes that this policy is reasonable because these loans are generally
adequately secured by real estate and the amounts due on the loans are generally
recovered in foreclosure.
The following table sets forth information with respect to Doral
Financial's non-accrual loans, other real estate owned ("OREO") and other
non-performing assets as of the dates indicated. Doral Financial did not have
any troubled debt restructurings as of any of the periods presented.
30
34
TABLE H
NON-PERFORMING ASSETS
(DOLLARS IN THOUSANDS)
AS OF DECEMBER 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
Mortgage Banking Business(1):
Non-accrual loans(2)............................... $ -- $ -- $ -- $ 1,250 $ 4,260
Loans held for sale past due 90 days
and still accruing(3)........................... 49,201 41,793 36,978 25,160 18,996
Other real estate owned ("OREO")................... 2,987 3,025 2,246 2,085 2,029
Other non-performing assets(4)..................... 1,011 1,597 1,833 893 448
------- ------- ------- ------- -------
Total NPAs of Mortgage Banking Business............ 53,199 46,415 41,057 29,388 25,733
------- ------- ------- ------- -------
Other Lending Activities through Doral Bank(5):
Non-accrual loans
Construction................................... 183 -- 125 -- --
Residential mortgage loans..................... 2,382 1,623 1,101 715 459
Commercial real estate......................... 770 775 502 160 --
Consumer....................................... 241 64 -- 71 --
Commercial non-real estate..................... 95 -- -- 3 --
Other.......................................... -- -- -- -- --
------- ------- ------- ------- -------
Total non-accrual loans............................ 3,671 2,462 1,728 949 459
OREO............................................... -- -- -- -- 87
------- ------- ------- ------- -------
Total NPAs of Doral Bank................. 3,671 2,462 1,728 949 546
------- ------- ------- ------- -------
Total NPAs of Doral Financial (consolidated)...... $56,870 $48,877 $42,785 $30,337 $26,279
======= ======= ======= ======= =======
Total NPAs of Doral Bank as a percentage of
Doral Bank's loans receivable, net and OREO.... 2.88% 1.85% 1.34% 1.85% 1.32%
Total NPAs of Doral Financial (consolidated) as a
percentage of consolidated total assets........ 1.95% 2.63% 3.87% 3.31% 3.42%
Ratio of allowance for loan losses to
non-performing assets (consolidated)........... 9.08% 5.86% 5.03% 6.75% 7.58%
(1) Includes mortgage loans held for sale and OREO related to Doral Financial's
mortgage banking business.
(2) Of the amounts shown, $1.25 million and $2.9 million represent loans that
were required to be repurchased by a non-affiliated Puerto Rico government
institution at par on a non-recourse basis as of December 31, 1995 and
1994, respectively.
(3) Does not include approximately $6,495,000, $807,000, $4,059,000,
$1,583,000, and $628,000 of 90 days past due FHA/VA loans for the years
ended December 31 1998, 1997, 1996, 1995 and 1994, respectively, which are
not considered non-performing assets by the Company because the principal
balance of these loans is insured or guaranteed under applicable FHA and VA
programs and interest is, in most cases, fully recovered in foreclosure
procedures.
(4) This amount refers to a mortgage loan to a real estate partnership to which
Doral Financial previously sold OREO. This loan is included in "Receivables
and mortgage servicing advances" in Doral Financial's Consolidated
Financial Statements.
(5) Includes mortgage loans and OREO of Doral Bank.
OREO arises primarily through foreclosure on mortgage loans repurchased
from investors, either because of breach of representations or warranties, or
pursuant to recourse arrangements. Doral Financial believes that the value of
the OREO reflected on its financial statements represents a reasonable estimate
of the properties' fair value, net of cost of disposition. During the past five
years, the impact of losses on loans repurchased as the result of breach of
representations or warranties or pursuant to recourse arrangements has not been
material.
31
35
The following table summarizes certain information regarding Doral
Financial's allowance for loan losses and losses on OREO, for both the Company's
commercial banking and mortgage banking business for the periods indicated.
TABLE I ALLOWANCE FOR LOAN
LOSSES AND OREO
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
OREO:
Balance at beginning of period........ $ 676 $ 356 $ 356 $ 356 $ 525
Provision for losses.................. 1,402 787 305 145 473
Losses charged to the allowance....... (1,067) (467) (305) (145) (642)
------- ------- ------- ------- -------
Balance at end of period................... $ 1,011 $ 676 $ 356 $ 356 $ 356
======= ======= ======= ======= =======
Allowance for Loan Losses(1):
Balance at beginning of period............. $ 2,866 $ 2,152 $ 2,047 $ 1,991 $ 1,680
Provision for loan losses.................. 883 792 797 352 300
------- ------- ------- ------- -------
Charge - offs:
Construction -- -- -- -- --
Residential mortgage loans............ -- -- (617) -- (15)
Commercial real estate -- -- -- -- --
Consumer.............................. (127) (124) (123) (114) --
Commercial non-real estate............ -- -- -- (188) --
Other -- -- -- -- --
------- ------- ------- ------- -------
Total Charge-offs.......................... (127) (124) (740) (302) (15)
------- ------- ------- ------- -------
Recoveries:
Construction.......................... -- -- -- -- --
Residential mortgage loans............ -- -- -- -- --
Commercial real estate................ -- -- -- -- --
Consumer.............................. 76 46 48 6 26
Commercial non-real estate............ -- -- -- -- --
Other................................. -- -- -- -- --
------- ------- ------- ------- -------
Total recoveries........................... 76 46 48 6 26
------- ------- ------- ------- -------
Net charge offs............................ (51) (78) (692) (296) 11
------- ------- ------- ------- -------
Other...................................... 1,468 -- -- -- --
------- ------- ------- ------- -------
BALANCE AT END OF PERIOD................... $ 5,166 $ 2,866 $ 2,152 $ 2,047 $ 1,991
======= ======= ======= ======= =======
Allowance for loan losses as a percentage
of total loans outstanding.............. 0.49% 0.53% 0.55% 0.69% 0.67%
- ---------------
(1) Relates to both mortgage loans held for sale and to loans receivable held
for investment.
32
36
The following table sets forth information concerning the allocation of
Doral Financial's allowance for loan losses by loan category as of the dates
indicated:
TABLE J
ALLOCATION OF ALLOWANCE
FOR LOAN LOSSES
(DOLLARS IN THOUSANDS)
---------------------------------------------------------------------------
AS OF DECEMBER 31,
----------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
PERCENT OF PERCENT OF PERCENT OF
LOANS IN LOANS IN LOANS IN
EACH EACH EACH
CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ ----------- ------ -----------
Mortgage loans held for sale $3,510 67.9% $1,625 56.7% $1,433 66.6%
Loans receivable, net
Construction 117 2.3% 51 1.8% 13 0.6%
Residential mortgage 1,225 23.8% 990 34.5% 510 23.7%
Commercial real estate 81 1.6% 101 3.5% 102 4.7%
Consumer - secured by
mortgage 25 0.5% 42 1.5% 67 3.1%
Consumer - other 31 0.6% 12 0.4% 2 0.1%
Commercial non-real estate 54 1.0% 18 0.6% 11 0.5%
Loans on saving deposits 18 0.3% 19 0.7% 10 0.5%
Land secured 105 2.0% 8 0.3% 4 0.2%
------ ----- ------ ----- ------ -----
Total $5,166 100.0% $2,866 100.0% $2.152 100.0%
====== ====== ======
-----------------------------------------------------
AS OF DECEMBER 31,
-----------------------------------------------------
1995 1994
---- ----
PERCENT OF PERCENT OF
LOANS IN LOANS IN
EACH EACH
CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ -----------
Mortgage loans held for sale $1,806 88.2% $1,563 78.5%
Loans receivable, net
Construction 17 0.8% 7 0.4%
Residential mortgage 87 4.3% 348 17.5%
Commercial real estate 64 3.1% 14 0.7%
Consumer - secured by
mortgage 51 2.5% 42 2.1%
Consumer - other 2 0.1% 7 0.3%
Commercial non-real estate 5 0.2% 3 0.1%
Loans on saving deposits 13 0.7% 6 0.3%
Land secured 2 0.1% 1 0.1%
------ ----- ------ -----
Total $2,047 100.0% $1,991 100.0%
====== ======
The allowance for loan losses relating to loans held by Doral Financial
was $5.2 million at December 31, 1998, compared to $2.9 million as of December
31, 1997. The increase in the allowance was primarily the result of a
reclassification of certain general reserves to allowance for loan losses and to
the increase in the size of the loan portfolio.
The percentage of the allowance for loan losses to non-performing loans
will not remain constant due to the nature of the Company's portfolio of loans,
which are primarily collateralized by real estate. The collateral for each
non-performing mortgage loan is analyzed 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 if economic conditions change substantially from the assumptions
used by Doral Financial in determining the allowance for loan losses.
INVESTMENT ACTIVITIES
As a result of Doral Financial's mortgage securitization activities,
the Company maintains a substantial portfolio of mortgage-backed securities held
for trading. At December 31, 1998, Doral Financial held securities for trading
with a fair market value of $606.9 million, approximately $497.0 million of
which consisted of Puerto Rico tax-exempt GNMA securities and other securities,
the interest on which is tax-exempt to the Company. These tax-exempt securities
are generally held by Doral Financial for longer periods prior to sale in order
to maximize the tax-exempt interest received thereon. Pursuant to SFAS No. 115,
securities held for trading are reflected on Doral Financial's Consolidated
Financial Statements at their fair market value with resulting gains or losses
included as part of trading account profit.
33
37
As part of its strategy to maximize net interest income, Doral
Financial also invests in securities that are classified as available for sale
or held to maturity. As of December 31, 1998, Doral Financial held $408.9
million of investment securities that were classified as available for sale and
reported at fair value, with unrealized gains or losses included in
stockholders' equity and reported as "Accumulated other comprehensive income,
net of taxes," in Doral Financial's Consolidated Financial Statements. As of
December 31, 1998, Doral Financial also held approximately $190.8 million in
securities and other investments that are classified as held to maturity,
because the Company has the intent and ability to hold these securities until
maturity.
The following table summarizes Doral Financial's securities holdings as
of December 31, 1998.
TABLE K
INVESTMENT SECURITIES
(IN THOUSANDS)
HELD
FOR AVAILABLE HELD
TRADING FOR SALE TO MATURITY
------- -------- -----------
Mortgage-backed securities.......... $560,675 $ -- $185,778
Interest only strips................ 42,202 -- --
U.S. Treasury and agencies.......... 202 408,888 --
Puerto Rico government obligations.. -- -- 5,000
Other............................... 3,839 -- --
-------- --------------- --------
Total...................... $606,918 $ 408,888 $190,778
======== =============== ========
For additional information regarding the composition of the Company's
investment securities, please refer to Notes 6, 7 and 8 of the Company's
Consolidated Financial Statements.
BROKER-DEALER ACTIVITIES
Doral Financial is involved in the securities business through Doral
Securities, a broker-dealer firm that provides retail and institutional
brokerage, investment banking, and financial advisory services in Puerto Rico.
The table below shows certain financial information for Doral
Securities for the years ended December 31, 1998 and 1997.
TABLE L
FINANCIAL INFORMATION OF DORAL SECURITIES
BROKER DEALER SUBSIDIARY
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997
-----------------------
Selected Income Statement Data:
Trading account profit....................... $3,196 $1,638
Net interest income.......................... 1,729 836
Investment banking and other fees............ 996 609
Commissions.................................. 759 259
------ ------
Total revenues, net of interest expense.. $6,680 $3,342
====== ======
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38
RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1998, 1997 AND
1996.
GENERAL
Doral Financial's results of operations are primarily influenced by:
(i) the direction of interest rates; (ii) the level of demand for mortgage
credit; (iii) the strength of the economy in Puerto Rico; and (iv) the
relationship between interest rates and the cost of funds.
The principal components of Doral Financial's revenues are: (i) net
interest income; (ii) net gains on mortgage loan sales; (iii) servicing income;
(iv) trading account profit; (v) gain on sale of investment securities; (vi)
gain on sale of servicing assets; and (vii) commissions, fees and other income.
TABLE M
REVENUE SOURCES OF DORAL FINANCIAL
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
-----------------------------------
1998 1997 1996
-------- ------- -------
Interest income.......................... $148,051 $90,131 $66,987
Interest expense......................... 114,786 61,438 46,443
-------- ------- -------
Net interest income...................... 33,265 28,693 20,544
Net gain on mortgage loan sales.......... 49,551 16,883 10,362
Servicing income......................... 21,782 14,995 11,659
Trading account profit................... 6,056 10,129 15,402
Gain on sale of investment securities.... 6,052 1,576 846
Gain on sale of servicing assets......... 1,829 -- 1,813
Commissions, fees and other income....... 3,070 1,703 764
NET INCOME
Doral Financial's net income for the year ended December 31, 1998,
increased to $52.8 million, compared to earnings of $32.5 million before an
extraordinary non-cash charge of $12.3 million for 1997, and net income of $27.0
million for 1996. The extraordinary non-cash charge for 1997 was related to the
exchange by Doral Financial of outstanding convertible subordinated debentures
for convertible preferred stock. See Note 24 and Note 32 to Doral Financial's
Consolidated Financial Statements for additional information regarding this
transaction. Consolidated results include the operations of Doral Bank, the
Company's commercial banking unit, which contributed approximately $8.2 million
to Doral Financial's consolidated net income in 1998, compared to $5.0 million
for 1997 and $2.3 million for 1996, and Doral Securities, the Company's broker
dealer unit, which contributed $1.1 million and $138,000 to consolidated net
income for the years ended December 31, 1998 and 1997, respectively, and a net
loss of $427,000 for the year ended December 31, 1996.
Net gain or mortgage loan sales, servicing income, and net interest
income were the major components of revenues in 1998, with increases of $32.7
million, $6.8 million and $4.6 million, respectively, from 1997 amounts. These
increases reflect the Company's ability to capitalize on favorable interest rate
scenarios and the steady increase in mortgage banking business activities, such
as origination and servicing of loans.
NET INTEREST INCOME
Net interest income is the excess of interest earned by the Company on
its interest earning assets over the interest incurred on its interest bearing
liabilities.
The increase in net interest income for both 1998 and 1997 as compared
to their respective prior years, was principally due to an increase in Doral
Financial's average interest earning assets. Doral Bank contributed
approximately $15.0 million or 45% of the consolidated net interest income of
Doral Financial for the year ended December 31, 1998, compared to $10.1 million
or 35% of consolidated net interest income for the year ended December 31, 1997,
and to $6.9 million or 34% of consolidated net interest income for the year
ended December 31, 1996.
35
39
During each of the three years ended December 31, 1998, Doral
Financial's average earning assets have grown considerably, resulting in a
continuous growth in net interest income. Average interest earning assets grew
by 80% from 1997 to 1998, and by 34% from 1996 to 1997, while net interest
income grew by 16% from 1997 to 1998, and 40% from 1996 to 1997. The growth in
net interest income during 1998 was affected by the reduction of the spread
between long-term and short-term rates, sometimes referred to as the flattening
of the yield curve, a significant increase in investments in AAA- rated
government and government agency securities which tend to have lower yields but
the interest on which is exempt for income tax purposes, and the increase in
financial assets related to Doral Securities' repurchase transactions that are
typically conducted at smaller spreads. The reduced growth also reflected a
decrease in net interest earning assets, which was due in part to the incurrence
of borrowings to finance the Company's servicing assets whose income is not
reflected as interest received on interest earning assets. The Company intents
to continue to diversify its sources of funding in order to reduce interest
costs and maximize net interest income.
The following table presents, for the periods indicated, the Company's
average balance sheet, the total dollar amount of interest from average
interest-earning assets and the related yields, as well as the interest expense
on average interest-bearing liabilities expressed both in dollars and rates, and
the net interest margin. The table does not reflect any effect of income taxes.
All average balances are based on the average of month-end balances for Doral
Financial and its non-banking subsidiaries, and average daily balances for Doral
Bank, in each case during the periods presented.
TABLE N
AVERAGE BALANCE SHEET AND SUMMARY OF NET INTEREST INCOME
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------
1998 1997
------------------------------- -------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/RATE BALANCE INTEREST YIELD/RATE
---------- -------- ---------- --------- -------- ----------
ASSETS:
Interest Earning Assets:
Total Loans(1) $ 679,423 $54,694 8.05% $ 371,099 $32,768 8.83%
Mortgage-Backed Securities 757,841 53,276 7.03% 607,944 45,464 7.48%
Investment Securities 478,895 32,278 6.74% 71,444 5,454 7.63%
Other Interest-Earning Assets(2) 138,576 7,803 5.63% 90,364 6,445 7.13%
---------- -------- ------ ---------- ------- ----
Total Interest Earning Assets/interest income 2,054,735 $148,051 7.21% 1,140,851 $90,131 7.90%
======== ====== ======= ====
Total Non-Interest Earning Assets 385,038 341,085
---------- ----------
Total Assets $2,439,773 $1,481,936
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest Bearing Liabilities:
Loans Payable $ 364,127 $ 26,131 7.18% $ 188,880 $13,325 7.05%
Repurchase Agreements 1,072,760 55,561 5.18% 548,310 31,665 5.78%
Deposits 393,557 17,326 4.40% 229,575 10,014 4.36%
Other Borrowed Funds(3) 197,071 15,768 8.00% 92,706 6,434 6.94%
---------- -------- ------ ---------- ------- ----
Total Interest Bearing Liabilities/Interest Expense 2,027,515 $114,786 5.66% 1,059,471 $61,438 5.80%
Total Non-Interest Bearing Liabilities 168,278 ======== ====== 253,722 ======= ====
---------- ----------
Total Liabilities 2,195,793 1,313,193
Stockholders' Equity 243,980 168,743
---------- ----------
Total Liabilities and Stockholders' Equivalent Basis $2,439,773 $1,481,936
========== ==========
Net Interest Earning Assets $ 27,220 $ 81,380
Net Interest Income on a Non-Taxable Equivalent $ 33,265 $28,693
Interest Rate Spread(4) 1.55% 2.10%
Interest Rate Margin(4) 1.62% 2.52%
Net Interest-Earning Assets Ratio 101.34% 107.68%
YEAR ENDED DECEMBER 31,
-----------------------------------
1996
------------------------------------
AVERAGE AVERAGE
BALANCE INTEREST YIELD/RATE
-----------------------------------
ASSETS:
Interest Earning Assets:
Total Loans(1) $ 341,532 $ 31,410 9.20%
Mortgage-Backed Securities 460,415 32,106 6.97%
Investment Securities 30,009 2,031 6.77%
Other Interest-Earning Assets(2) 20,850 1,440 6.91%
---------- -------- ------
Total Interest Earning Assets/interest income 852,806 $ 66,987 7.85%
======== =====
Total Non-Interest Earning Assets 157,133
----------
Total Assets $1,009,939
==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest Bearing Liabilities:
Loans Payable $ 202,850 $ 13,621 6.71%
Repurchase Agreements 385,710 21,002 5.45%
Deposits 145,590 5,526 3.80%
Other Borrowed Funds(3) 84,120 6,294 7.48%
---------- -------- ------
Total Interest Bearing Liabilities/Interest Expense 818,270 $ 46,443 5.68%
======== =====
Total Non-Interest Bearing Liabilities 51,895
----------
Total Liabilities 870,165
Stockholders' Equity 139,774
----------
Total Liabilities and Stockholders' Equivalent Basis $1,009,939
==========
Net Interest Earning Assets $ 34,536
Net Interest Income on a Non-Taxable Equivalent $ 20,544
Interest Rate Spread(4) 2.17%
Interest Rate Margin(4) 2.41%
Net Interest-Earning Assets Ratio 104.22%
- --------------------------------
(1) Average loan balances include the average balance of non-accruing loans, on
which no interest income is recognized.
(2) Consist of money market instruments, reverse repurchase agreements and
deposits in other banks.
(3) Consist of FHLB-NY advances, notes payable and convertible subordinated
debentures.
(4) Interest rate spread represents the difference between Doral Financial's
weighted average yield on interest-earning assets and the weighted average
rate on interest-bearing liabilities. Interest rate margin represents net
interest income as a percentage of average interest earning assets.
The following table describes the extent to which changes in interest
rates and changes in volume of interest rates on interest earning assets and
interest bearing liabilities have affected Doral Financial's interest income and
interest expense during the periods indicated. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (i) changes in volume (change in volume
multiplied by prior year rate), (ii) changes in rate (change in rate multiplied
by current year volume), and (iii) total change in
36
40
rate and volume. The combined effect of changes in both rate and volume has been
allocated in proportion to the absolute dollar amounts of the changes due to
rate and volume.
TABLE O
NET INTEREST INCOME ANALYSIS
(IN THOUSANDS)
---------------------------------------------------------------
1998 COMPARED TO 1997 1997 COMPARED TO 1996
INCREASE (DECREASE) DUE TO: INCREASE (DECREASE) DUE TO:
VOLUME RATE TOTAL VOLUME RATE TOTAL
-------- --------- ---------- --------- -------- -----------
INTEREST EARNING ASSETS
TOTAL LOANS $27,224 $ (5,298) $21,926 $ 2,719 $(1,361) $ 1,358
MORTGAGE-BACKED SECURITIES 11,210 (3,398) 7,812 10,288 3,070 13,358
INVESTMENT SECURITIES 31,105 (4,281) 26,824 2,804 619 3,423
OTHER INTEREST-EARNING ASSETS 3,439 (2,081) 1,358 4,801 204 5,005
------- --------- ------- ------- ------- -------
TOTAL INTEREST EARNING ASSETS 72,978 (15,058) 57,920 20,612 2,532 23,144
------- --------- ------- ------- ------ -------
INTEREST-BEARING LIABILITIES
LOANS PAYABLE 12,363 443 12,806 (938) 642 (296)
REPURCHASE AGREEMENTS 30,287 (6,391) 23,896 8,854 1,809 10,663
DEPOSITS 7,153 158 7,311 3,188 1,300 4,488
OTHER BORROWED FUNDS 7,243 2,092 9,335 642 (502) 140
------- --------- ------- ------- ------ -------
TOTAL INTEREST -BEARING LIABILITIES 57,046 (3,698) 53,348 11,746 3,249 14,995
------- -------- ------- ------- ------ -------
NET INTEREST-EARNING ASSETS $15,932 $(11,360) $ 4,572 $ 8,866 $ (717) $ 8,149
======= ======== ======= ======= ====== =======
INTEREST INCOME
Total interest income increased from approximately $67.0 million during
1996, to $90.1 million during 1997, and to $148.1 million during 1998. The
increase in interest income is primarily related to the increase in Doral
Financial's total average interest earning assets, which increased by
approximately $913.9 million during 1998 and by approximately $288.0 million
during 1997.
Interest income on loans increased by $21.9 million or 67% during 1998
as compared to 1997, and by $1.4 million or 4% during 1997 as compared to 1996.
The increase during 1998 reflected an increase in the level of loans held by
Doral Financial as compared to 1997, due to the increased volume of loan
originations.
Interest income on mortgage-backed securities increased by $7.8
million or 17% during 1998 as compared to 1997, after increasing by $13.4
million or 42% from 1996 to 1997. The increases during these periods reflected
an increase in the average balance of mortgage-backed securities, which
increased from $460.4 million during 1996 to $607.9 million during 1997 to
$757.8 million during 1998. The increase in mortgage-backed securities reflected
the strategy of Doral Financial to hold tax exempt securities for longer periods
prior to sale in order to maximize tax exempt interest income on such
securities.
Interest income on investment securities increased by $26.8 million or
492% from 1997 to 1998, and by $3.4 million or 169% from 1996 to 1997. The
increase in this category of interest income also reflected Doral Financial's
strategy to increase its tax exempt interest income by investing in U.S.
Treasury and agency securities, the interest on which is tax exempt to the
Company under Puerto Rico law and is not subject to U.S. income taxation because
of Doral Financial's status as a foreign corporation for U.S. income tax
purposes. The average balance of investment securities was $478.9 million for
the year ended December 31, 1998, as compared to $71.4 million and $30.0 million
for the years ended December 31, 1997 and 1996, respectively.
Interest income on other interest earning assets increased by $1.4
million or 21% from 1997 to 1998, as compared to an increase of $5.0 million
from 1996 to 1997. Other interest-earning assets consist primarily of money
market instruments, overnight deposits, term deposits, and reverse repurchase
agreements. The increase from 1997 to 1998 was due primarily to higher liquidity
and the investment of such liquidity in reverse repurchase agreements and term
deposits. The increase in interest income from other interest-earning assets
reflects Doral Financial's strategy to diversify its sources of interest income
by entering into new business segments, such as commercial banking and
broker-dealer services.
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41
INTEREST EXPENSE
Total interest expense increased to $114.8 million during 1998 compared
to $61.4 million for 1997, an increase of 87%, and increased by $15.0 million
from 1996 to 1997, an increase of 32%. The large increase in interest expense
for 1998 was due primarily to the increase in the average amount of
interest-bearing liabilities used to fund the increase in interest earning
assets. Average interest bearing liabilities increased to $2.0 billion at an
average cost of 5.66% for the year ended December 31, 1998, compared to $1.1
billion at an average cost of 5.80% for the year ended December 31, 1997, and
$818.3 million at an average cost of 5.68% for the year ended December 31, 1996.
Interest expense related to loans payable increased by $12.8 million or
96% during 1998, and decreased from 1996 to 1997 by $296,000 or 2.2%. This
increase during 1998 was due to the increase in borrowings used to fund the
Company's increased volume of loan originations. The decrease during 1997, was
largely the result of Doral Financial's efforts to diversify its funding sources
for loan production by obtaining lower cost borrowings as well as longer term
borrowings. The weighted-average interest rate cost for borrowings under Doral
Financial's warehouse lines of credit was 7.18% for 1998, compared to 7.05% for
1997 and 6.71% for 1996.
Interest expense related to securities sold under agreements to
repurchase increased by $23.9 million or 75% during 1998 as compared to 1997,
and $10.7 million or 51% during 1997 as compared to 1996. The increase during
1998 reflected increased borrowings to finance mortgage-backed securities and
other investment securities. The weighted average interest rate of borrowings
under repurchase agreements was 5.18% for 1998, 5.78% for 1997 and 5.45% for
1996.
Interest expense on deposits increased by $7.3 million or 73% during
1998 as compared to 1997, and increased by $4.5 million or 81% during 1997 as
compared to 1996. The increase in interest expense on deposits reflects the
increase in deposits held at Doral Bank to $533.1 million at December 31, 1998,
from $300.5 million as of December 31, 1997 and $158.9 million as of December
31, 1996. The growth in deposits reflects the opening of additional branches by
Doral Bank, which currently operates through eleven branches, and the offering
of competitive rates. Doral Bank intends to continue its branch expansion
program during 1999. Doral Bank's average interest cost of deposits was 4.40%
during 1998, 4.36% during 1997 and 3.80% during 1996.
Interest expense on other borrowed funds increased by $9.3 million or
145% during 1998 as compared to 1997, and increased by $140,000 or 2.2% during
1997 as compared to 1996. Interest expense on other borrowed funds includes
various term notes issued by Doral Bank, Doral Financial's $75 million senior
notes due October 10, 2006, and Doral Bank's advances from the FHLB-NY, as well
as various other borrowings.
PROVISION FOR LOAN LOSSES
The provision for loan losses relates to loans held by Doral Financial.
The provision is charged to earnings to bring the total allowance for loan
losses to a level considered appropriate by management based on Doral
Financial's loss experience, current delinquency rates, known and inherent risk
in the loan portfolio, the estimated value of any underlying collateral, and an
assessment of current economic conditions. While management believes that the
current provision for loan losses is sufficient, future additions to the
allowance for loan losses could be necessary if economic conditions change
substantially from the assumptions used by Doral Financial in determining the
allowance for loan losses.
Doral Financial made provisions to its allowance for loan losses of
$883,000, $792,000 and $797,000, for the years ended December 31, 1998, 1997 and
1996, respectively. The provision increased by $91,000 from 1997 to 1998
primarily as a result of the increase in the size of Doral Financial's loan
portfolio and an increase in the amount of construction loans and commercial
mortgage loans for which Doral Financial provides a higher allowance for loan
losses.
NON-INTEREST INCOME
Net Gains on Mortgage Loan Sales. Net gain from mortgage loan sales
increased by 193% during 1998 and by 63% from 1996 to 1997. The increase in 1998
was the result of increased volume of loan production and
38
42
the ability of the Company to obtain higher profitability on sales of various
loan products, including the creation of interest only strips ("IOs") in
connection with bulk sales of mortgage loans to corporate investors. See
"Amortization of IOs and Servicing Assets."
Servicing Income. Servicing income represents revenues earned for
administering mortgage loans. Loan servicing fees depend on the type of mortgage
loan being serviced and for residential mortgage loans range from 0.25% to 0.50%
of the declining outstanding principal amount of the serviced loan. The size of
Doral Financial's loan servicing portfolio and the amount of its servicing fees
have increased substantially since its inception as a result of increases in
loan originations and bulk purchases of servicing rights. Doral Financial's
strategy is to rely primarily on internal mortgage loan originations to increase
the size of its servicing portfolio. During the second and third quarters of
1997, Doral Financial engaged in several bulk purchases of mortgage servicing
rights, whereby it acquired the rights to service approximately $1.0 billion in
principal amount of loans. During 1998, the Company purchased servicing rights
to approximately $229.2 million of mortgages through bulk purchases. Doral
Financial anticipates that it will continue to make bulk purchases of mortgage
servicing rights in the future to the extent it can identify attractive
opportunities.
Servicing income increased 45% from 1997 to 1998, and 29% from 1996 to
1997. Increases in the amount of loan servicing income for 1998 and 1997 were
primarily due to increases in the principal amount of loans serviced as compared
to prior years. The mortgage servicing portfolio was approximately $6.2 billion
at December 31, 1998, compared to $4.7 billion as of December 31, 1997 and $3.1
billion as of December 31, 1996. At December 31, 1998, less than 5% of Doral
Financial's servicing portfolio was related to mortgages originated outside
Puerto Rico.
The amount of principal prepayments on mortgage loans serviced by Doral
Financial was $644 million, $279 million, and $201 million for the years ended
December 31, 1998, 1997 and 1996, respectively. This represented approximately
12%, 7%, and 7%, respectively, of the average principal amount of mortgage loans
serviced during such periods. The primary means used by Doral Financial to
reduce the sensitivity of its servicing income to increases in prepayment rates
is the maintenance of a strong retail origination network that has allowed it to
increase or maintain the size of its servicing portfolio even during periods of
high prepayments.
Trading Account Profit. Trading account profit includes any unrealized
gains or losses in the market value of its securities held for trading. Trading
account activities for the year ended December 31, 1998 resulted in gains of
$6.1 million, compared to gains of $10.1 million in 1997 and $15.4 million in
1996. For the years ended December 31, 1998, 1997 and 1996, trading account
profits included $5.4 million, $6.6 million and $2.9 million, respectively, of
unrealized gains on the value of its securities held for trading pursuant to
SFAS No. 115. The decrease in trading account profits also reflects a higher
proportion of sales of taxable securities which generally produce smaller gains.
For the years ended December 31, 1998 and 1997, trading account profit
included losses on options and futures contracts used for interest rate
management purposes in the amount of $3.0 million and $1.3 million,
respectively. For the year ended December 31, 1996, such activities produced
gains in the amount of $3.1 million. The losses experienced during 1998 and
1997, were offset by increased gains on mortgage loans sales during such
periods.
Gain on Sale of Investment Securities. Gain on sale of investment
securities represents the impact on income of transactions involving the sale of
securities available for sale. This component of earnings increased 284% from
1997 to 1998, and 86% from 1996 to 1997. The large increase during 1998 was the
result of a more favorable interest rate environment that increased the
Company's volume of sale transactions and also allowed the Company to receive
higher profits on sales.
Gain on Sale of Servicing Assets. During the years ended December 31,
1998 and 1996, Doral Financial sold servicing rights to $103 million and $102
million, respectively, of mortgage loans, realizing pretax gains of
approximately $1.8 million in each period. No such sales were made during 1997.
While Doral Financial's strategy is to continue to increase the size of its
servicing portfolio by retaining the servicing rights on the mortgage loans it
originates, Doral Financial may sell servicing rights in the future when market
conditions are favorable.
39
43
Commissions, Fees and Other Income. Other non-interest income,
commissions and fees increased 80% in 1998 as compared to 1997, and 123% from
1996 to 1997. The increases during 1998 and 1997 were due primarily to increased
commissions and fees earned by Doral Bank and Doral Securities.
AMORTIZATION OF IOS AND SERVICING ASSETS
Doral Financial creates IOs (previously classified as excess servicing
fees receivable) as a result of the sale of loans in bulk or securitization
transactions. See Note 2 to Doral Financial's Consolidated Financial Statements
for more information regarding the accounting treatment of IOs. IOs are created
on the sale of loans with servicing retained, by computing the present value of
the excess of the weighted-average coupon on the loans sold over the sum of: (i)
the pass-through interest paid to the investor and (ii) normal servicing fee,
based on the servicing fee permitted by FNMA and FHLMC, and adjusting such
amount for expected losses and prepayments. The amount of the IOs is recognized
at the time of sale of the related loans as an adjustment to the resulting gain
or loss on sale of loan and is recorded as a component of "Net Gains on Mortgage
Loan Sales" on Doral Financial's Consolidated Statements of Income. Sales of
mortgage loans made during 1998 resulted in the recording of approximately $30.0
million of IOs, compared to $14.5 million and $15.9 million in 1997 and 1996,
respectively. The unamortized balance of the IOs is reflected in Doral
Financial's Consolidated Statement of Condition as a component of "Securities
held for trading."
IOs are amortized over the expected life of the asset and such
amortization is recorded as a reduction of interest income. The amortization of
IOs is based on the amount and timing of estimated future cash flows to be
received with respect to the IOs. Amortization of such IOs for each of the years
ended December 31, 1998, 1997, and 1996, was approximately $3.7 million, $4.0
million and $1.6 million, respectively. The decrease in the amortization is due
to a decrease in the amount of IOs held in the trading portfolio as a result of
sales of $13.2 million and $6.1 million for the years ended December 31, 1998
and 1997, respectively.
Beginning with the second quarter of 1995, following the implementation
by Doral Financial of SFAS No. 122 (later superseded by SFAS No. 125), whenever
Doral Financial originates a mortgage loan, it assigns a fair value to the
related mortgage servicing right (the "servicing asset") associated with such
mortgage loan. The servicing asset represents the present value of the servicing
fees expected to be received on the loan over the expected term of the loan. The
amount of the servicing asset 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 as a component of "Net Gains on Mortgage Loan Sales" on Doral
Financial's Consolidated Statement of Income. During the years ended
December 31, 1998, 1997 and 1996, Doral Financial capitalized $32.9 million,
$28.9 million and $10.8 million respectively, in servicing assets. The increase
in the creation of servicing assets reflects increased mortgage loan production
during such periods and bulk purchases of servicing rights. The unamortized
balance of the servicing asset is reflected on the Consolidated Statement of
Condition of Doral Financial.
Doral Financial's servicing assets are amortized in proportion to, and
over the period of, estimated servicing income. Amortization of servicing assets
is included as a component of "Non-interest expense-Amortization of Servicing
Assets" in Doral Financial's Consolidated Statements of Income. During 1998,
total amortization of servicing assets amounted to $6.7 million versus $3.4
million for 1997 and $1.0 million for 1996.
The following table shows the increase in the Company's mortgage
servicing assets for each of the periods shown:
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44
TABLE P
CAPITALIZATION OF MORTGAGE SERVICING ASSETS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
---- ---- ----
Balance at beginning of period............................. $46,416 $20,969 $11,164
Capitalization of rights................................... 23,244 13,980 10,804
Rights sold................................................ (54) - -
Rights purchased........................................... 9,632 14,904 -
Amortization:
Scheduled......................................... (5,739) (3,437) (999)
Unscheduled....................................... (931) - -
------- ------- -------
Balance at end of period $72,568 $46,416 $20,969
======= ======= =======
Increases in prepayment rates or credit loss rates over anticipated
levels used in calculating the value of IOs and servicing assets can adversely
affect Doral Financial's revenues and liquidity by increasing the amortization
rates for servicing assets and IOs, as well as requiring Doral Financial to
recognize an impairment against income over and above scheduled amortization.
See "Interest Rate Management." The portion of Doral Financial's mortgage
servicing portfolio consisting of the servicing asset that was originated by
Doral Financial prior to the adoption of SFAS No. 122 is not reflected as an
asset on Doral Financial's Consolidated Financial Statements, and is not subject
to amortization or impairment.
NON-INTEREST EXPENSE
Total non-interest expense increased by 72% in 1998 as compared to
1997, and 21% from 1996 to 1997, reflecting additional costs mainly associated
with the expansion of Doral Financial's loan origination and servicing capacity.
During 1998, this expansion included the opening of seven additional branches of
Doral Mortgage and of six additional branches of Doral Bank throughout Puerto
Rico. The increase in expenses also reflected the Company's expansion into the
mainland United States through the opening of a wholesale residential mortgage
and a multifamily lending operation, the establishment of a specialized
construction loan department and additional costs reflecting the increase in the
servicing portfolio.
PUERTO RICO INCOME TAXES
The Puerto Rico maximum statutory corporate income tax rate is 39%. For
1998, the effective income tax rate of Doral Financial was 11.7% as compared to
13.9% for 1997 and 13.5% for 1996. The decrease in effective tax rates for 1998
compared to 1997 and 1996 was mainly due to additional tax exempt income as a
result of a larger portfolio of tax exempt securities.
The lower effective tax rates (as compared to the maximum statutory
rate) experienced by the Company reflect the fact that the portion of the net
interest income derived from certain FHA and VA mortgage loans secured by
properties located in Puerto Rico and on GNMA securities backed by such mortgage
loans is exempt from income tax under Puerto Rico law. The Company also invests
in U.S. Treasury and agency securities that are exempt from Puerto Rico income
taxation. Net income tax savings to Doral Financial attributable to this
exemption amounted to approximately $13.2 million, $8.1 million, and $8.5
million for the years ended December 31, 1998, 1997 and 1996, respectively. See
Note 19 to Doral Financial's Consolidated Financial Statements for 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.
Effective August 1, 1997, the Puerto Rico Internal Revenue Code was
amended to limit tax exemption to those FHA and VA loans and GNMA securities
backed by such loans that are used to finance the original acquisition of newly
constructed homes.
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LIQUIDITY AND CAPITAL RESOURCES
Doral Financial has an ongoing need for capital to finance its lending
and investing activities. This need is expected to increase as the volume of the
loan originations increases. Doral Financial's cash requirements arise from loan
originations and purchases, repayments of debt upon maturity, payments of
operating and interest expenses and servicing advances and loan repurchases.
Servicing agreements relating to the mortgage-backed securities programs of
FNMA, FHLMC and GNMA, and certain other investors and mortgage loans sold to
certain other purchasers, require Doral Financial to advance funds to make
scheduled payments of principal, interest, taxes and insurance, if such payments
have not been received from the borrowers. The Company generally recovers funds
advanced pursuant to these arrangements within 30 days. During the year ended
December 31, 1998, the monthly average amount of funds advanced by Doral
Financial under such servicing agreements was approximately $5.8 million.
Doral Financial's primary sources of liquidity are sales in the
secondary mortgage market of the loans it originates and purchases, short term
borrowings under warehouse, gestation and repurchase agreement lines of credit
secured by pledges of its loans and mortgage-backed securities (in most cases
until such loans are sold and the lenders repaid) and revenues from operations.
In the past, Doral Financial has also relied on privately-placed and publicly
offered debt financing and public offerings of preferred and common stock. Doral
Financial's bank subsidiary also relies on deposits, borrowings from the FHLB-NY
as well as term notes backed by letters of credit of the FHLB-NY.
The following table shows Doral Financial's sources of borrowings and
the related average interest rate as of December 31, 1998 and 1997:
TABLE Q
SOURCES OF BORROWINGS
(DOLLARS IN THOUSANDS)
AS OF DECEMBER 31,
---------------------------------------------------------------------
1998 1997
-------------------------------- --------------------------------
AMOUNT AVERAGE AMOUNT AVERAGE
OUTSTANDING RATE OUTSTANDING RATE
Repurchase Agreements............................... $1,197,328 5.26% $838,142 5.93%
Loans Payable....................................... 426,704 6.69% 238,770 7.20%
Deposits............................................ 533,113 4.30% 300,494 4.36%
Notes Payable....................................... 199,733 7.03% 164,934 7.24%
Advances from FHLB.................................. 32,000 6.34% 32,000 6.25%
Doral Financial is dependent upon its ability to access warehouse,
gestation and repurchase facilities, in addition to its ability to continue to
pool and sell loans in the secondary mortgage market. It borrows money under
warehousing lines of credit to fund its mortgage loan originations and repays
the borrowing as the mortgages are sold or securitized. The warehousing lines of
credit then become available for additional borrowings. Included among Doral
Financial's warehousing line of credit facilities are gestation or pre-sale
facilities that permit the Company to obtain more favorable rates once mortgage
loans are in the process of securitization but prior to actual issuance of the
mortgage-backed securities, as well as to finance such mortgage-backed
securities upon their issuance. Some of Doral Financial's warehousing lines of
credit are subject to termination at the discretion of the lender. Doral
Financial has several warehousing and gestation facilities totaling $626 million
as of December 31, 1998, of which $426.7 million was outstanding as of such
date. See Note 14 to Doral Financial's Consolidated Financial Statements
included elsewhere herein for more information on Doral Financial's warehousing
lines of credit.
Doral Financial also had available repurchase agreements lines of
credit (excluding the gestation lines referred to above) of approximately $2.7
billion at December 31, 1998, of which $1.2 billion was outstanding. Under these
agreements, the Company sells GNMA, FNMA or FHLMC-guaranteed mortgage-backed
securities, collateralized mortgage obligations or other investment securities
and simultaneously agrees to repurchase them at
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46
a future date at a fixed price. Doral Financial uses the proceeds of such sales
to repay borrowings under its warehousing lines of credit and to finance the
cost of carrying its mortgage-backed securities and other investment
securities. The effective cost of funds under repurchase agreements is typically
lower than the cost of funds borrowed under Doral Financial's warehousing lines
of credit. The Company's continued use of repurchase agreements will depend on
the cost of repurchase agreements relative to the cost of borrowing under its
warehousing lines of credit with banks and other financial institutions. See
Note 15 to Doral Financial's Consolidated Financial Statements included
elsewhere herein for more information on Doral Financial's repurchase
agreements.
Doral Bank 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. As of December 31, 1998, Doral Bank
held approximately $533.1 million in deposits (excluding $4.1 million in
deposits from affiliates that are eliminated in the preparation of Doral
Financial's Consolidated Financial Statements) at a weighted-average interest
rate of 4.30%. For additional information regarding Doral Bank's deposit
accounts see Note 17 to Doral Financial's Consolidated Financial Statements
included elsewhere herein.
The following table presents the average balance and the average rate
paid on each deposit type of Doral Bank for the period indicated.
TABLE R
AVERAGE DEPOSIT BALANCE
DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
------- ---- ------- ---- ------- ----
Certificates of deposit................. $232,702 5.77% $147,143 6.01% $82,670 5.87%
Regular passbook savings................ 29,054 4.74% 16,233 4.42% 13,856 4.36%
Now accounts............................ 36,075 5.06% 10,189 4.40% 3,287 3.46%
Non-interest bearing.................... 95,726 - 56,010 - 45,777 -
-------- ---- -------- ---- ------- ----
Total deposits................. $393,557 4.40% $229,575 4.36% $145,590 3.80%
======== ==== ======== ==== ======== ====
The following table sets forth the maturities of Doral Bank's
certificates of deposit having principal amounts of $100,000 or more at December
31, 1998.
TABLE S
DEPOSIT MATURITIES
(IN THOUSANDS)
AMOUNT
--------
Certificate of deposit maturing
Three months or less........................ $ 32,682
Over three through six months............... 19,949
Over six through twelve months.............. 31,793
Over twelve months.......................... 91,906
--------
Total....................................... $176,330
========
As of December 31, 1998 and 1997, Doral Bank had approximately $96.8
million and $60.3 million, respectively, in brokered deposits obtained through
broker-dealers. Doral Bank uses such deposits as a source of long-term funds.
Doral Bank, as a member of FHLB-NY, has access to collateralized
borrowings from the FHLB-NY up to a maximum of 30% of its total assets. Advances
and reimbursement obligations with respect to letters of credit must be secured
by qualifying assets with a market value of 110% of the advances or
reimbursement obligations. At December 31, 1998, Doral Bank had $32 million in
outstanding advances from the FHLB-NY at a weighted average interest rate cost
of 6.34%. In addition, as of December 31, 1998, Doral Bank had $53.1 million
outstanding in term notes secured by FHLB-NY letters of credit at an average
interest rate cost of 6.08%. Approximately $5.0 million principal amount of such
term notes bear interest at a fluctuating rate based on the London Interbank Bid
Rate for
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dollar deposits ("LIBID"). The interest rate on such floating rate notes has
effectively been fixed pursuant to an interest rate swap agreement with a major
brokerage house. The interest rates on all term notes are subject to a one-time
upward adjustment to a rate equal to 100% of LIBID for a term equal to the
remaining term of the note as a result of the recent changes to Section 936 of
the Internal Revenue Code. Because Doral Bank has the right to prepay the notes
upon an upward adjustment of the rate, in all but one of the three cases in
which the investor has requested an upward adjustment, Doral Bank has been
successful in negotiating a rate adjustment below 100% of LIBID.
REGULATORY CAPITAL RATIOS
As of December 31, 1998, Doral Financial and Doral Bank were in
compliance with all the regulatory capital requirements that were applicable to
them as a bank holding company and state non-member bank, respectively (i.e.,
total capital and Tier 1 capital to risk weighted assets of at least 8% and 4%,
respectively, and Tier 1 capital to average assets of at least 4%). Set forth
below are Doral Financial's and Doral Bank's regulatory capital ratios as of
December 31, 1998, based on existing Federal Reserve and FDIC guidelines.
TABLE T
REGULATORY CAPITAL RATIOS
DORAL DORAL
FINANCIAL BANK
--------- ----
Tier 1 Capital Ratio (Tier 1 capital
to risk weighted assets).................. 16.5% 13.2%
Total Capital (total capital to risk
weighted assets).......................... 16.8% 13.3%
Leverage Ratio (Tier 1 capital to
average assets)........................... 9.2% 8.0%
As of December 31, 1998, Doral Bank was considered a well-capitalized
bank for purposes of the prompt corrective action regulations adopted by the
FDIC pursuant to the Federal Deposit Insurance Corporation Improvement Act of
1991. To be considered a well capitalized institution under the FDIC's
regulations, an institution must maintain a Leverage Ratio of at least 5%, a
Tier 1 Capital Ratio of at least 6% and a Total Capital Ratio of at least 10%
and not be subject to any written agreement or directive to meet a specific
capital ratio.
On February 19, 1998, Doral Financial completed the sale of 1,817,000
shares of common stock pursuant to an underwritten public offering at a price to
the public of $24.00 per share, resulting in net proceeds to Doral Financial of
approximately $40.6 million after deducting expenses of the offering. On
February 22, 1999, Doral Financial completed the sale of 1,495,000 shares of its
7% Noncumulative Monthly Income Preferred Stock at a price to the public of
$50.00 per share, resulting in net proceeds to the Company of approximately
$72.1 million, after deducting expenses of the offering.
Doral Financial expects that it will continue to have adequate
liquidity, financing arrangements and capital resources to finance its
operations. Doral Financial 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 Doral Financial will
be successful in consummating any such transactions.
ASSETS AND LIABILITIES
At December 31, 1998, Doral Financial's total assets were $2.9 billion
compared to $1.9 billion at December 31, 1997. The increase in assets was due
primarily to net increases in the securities portfolio of $204.1 million, a net
increase of $512.3 million in the Company's loans held for sale and loans
receivable, and an increase of $155.3 million in money market accounts. The
increase in loans held for sale and loans receivable was due to increased volume
of loan originations. Total liabilities were $2.6 billion at December 31, 1998,
compared to $1.7 billion at December 31, 1997. The increase in liabilities was
largely the result of an increase in securities sold under agreements to
repurchase, deposit
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accounts at Doral Bank, and warehousing loans. At December 31, 1998, deposit
accounts totaled $533.1 million, compared to $300.5 million at December 31,
1997. As of December 31, 1998, Doral Bank had $805 million in assets, compared
to $428 million at December 31, 1997.
INTEREST RATE MANAGEMENT
General. Changes in interest rates can affect the volume of mortgage
loan originations, the net interest income earned on the Company's portfolio of
loans and mortgage-backed securities, the amount of gain on sale of loans, and
the value of Doral Financial's loan servicing portfolio and securities holdings.
Lower interest rates tend to increase demand for mortgage loans for
home purchases, as well as the demand for refinancing of existing mortgages.
Higher interest rates make it more difficult for potential borrowers to purchase
residential properties and to qualify for mortgage loans and reduce demand for
refinance loans. A substantial portion of Doral Financial's total mortgage loan
originations have consistently been comprised of refinance loans. For the years
ended December 31, 1998, 1997 and 1996, refinanced loans represented
approximately 62%, 51% and 47%, respectively, of Doral Financial's total dollar
volume of mortgage loans originated (excluding purchases from third parties). As
a result, higher interest rates may adversely affect the volume of loan
originations and income related to mortgage loan sales. Although Doral Financial
has increased home purchase originations, a significant future increase in
mortgage interest rates in Puerto Rico would adversely affect Doral Financial's
business if it results in a significant decrease in refinancing of mortgage
loans.
If long-term interest rates increase between the time Doral Financial
commits to or establishes an interest rate on a mortgage loan and the time
commitments to purchase the mortgage loan are obtained or the loan is sold,
Doral Financial may realize a reduced gain or loss on such sale. The Company
does not generally hedge conventional loans in the pipeline or in the process of
origination because Doral Financial does not generally permit customers to
lock-in an interest rate prior to closing. Instead, the interest rates on these
loans are generally fixed at closing based on a certain spread over a prevailing
rate that adjusts weekly, based on the FHLMC auction for residential mortgages.
For FNMA and FHLMC conforming loans and FNMA and FHLMC mortgage-backed
securities, Doral Financial seeks to sell or to obtain commitments for the sale
of such loans or mortgage-backed securities as soon as practicable following the
funding of such loans. Conforming loans are normally sold to institutional
investors or to FNMA and FHLMC. To the extent Doral Financial does engage in
offerings of mortgage products which lock-in the interest rate until the closing
date, it attempts to enter into forward commitments to sell such loans at the
time it fixes the rates for the loans. As of December 31, 1998, Doral Financial
had $539.5 million of commitments by third party investors to sell mortgage
loans and mortgage-backed securities.
Non-conforming conventional loans are normally sold in bulk to local
financial institutions. The sale of non-conforming conventional loans normally
takes longer than the sale of conforming mortgage loans. Accordingly, Doral
Financial attempts to manage this market risk through the purchase of listed
options on U.S. Treasury futures contracts, as well as through the purchase of
option contracts in the over-the-counter market on other interest rate sensitive
instruments, which tend to increase in value when interest rates increase.
Options are contracts that grant the purchaser the right to buy or sell the
underlying asset by a certain date for a specified price. Futures are
commitments to either purchase or sell designated instruments (such as U.S.
Treasury Note contracts or Eurodollar certificates of deposit) at a future date
for a specified price. Future contracts are generally traded on an exchange, are
marked to market daily and are subject to initial and maintenance margin
requirements.
In the case of Puerto Rico tax exempt GNMA securities, which Doral
Financial normally holds for longer periods, prices tend to be more stable than
for U.S. taxable GNMA securities because their tax exempt status under Puerto
Rico law makes them more attractive to retail investors. This relative stability
of prices for Puerto Rico GNMA securities allows Doral Financial to carry out a
less aggressive hedging strategy to attempt to protect the value of these assets
than what might otherwise be required. Doral Financial seeks to protect itself
from the market risk associated with its inventory of GNMA securities by
purchasing listed options on treasury bond futures contracts and other interest
rate sensitive instruments, as well as purchasing options on U.S. GNMA
securities in the over-the-counter market.
With respect to GNMA securities that are originated by Doral Financial
and no longer qualify for Puerto Rico tax exemption, Doral Financial implements
a less aggressive hedging strategy because it intends to sell such securities in
the United States market as soon as practicable following completion of the
securitization process.
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Declines in interest rates can adversely affect Doral Financial's
revenues by increasing prepayment rates and causing an increase of the
amortization of servicing assets and IOs, or causing an impairment to be
recognized with respect to such assets. Moreover, increased prepayment rates can
reduce Doral Financial's servicing income by decreasing the size of Doral
Financial's servicing portfolio. To date, Doral Financial has not used synthetic
hedge devices to protect its servicing income or the value of its servicing
assets or IOs from the risks presented by interest rate fluctuations. The
primary means used by Doral Financial to reduce the sensitivity of the Company's
servicing income and the value of its servicing asset due to a possible
reduction of its servicing portfolio has been the development of a strong retail
origination network that has allowed Doral Financial to increase or maintain the
size of its servicing portfolio even during periods of high prepayments, such as
those experienced during 1993 and 1998.
The net interest income of Doral Financial is also subject to interest
rate risk because its interest earning assets and interest bearing liabilities
reprice at different times and at varying amounts. Most of Doral Financial's
interest earning assets, including its mortgage loans and mortgage-backed
securities, are fixed rate interest earning assets that are not subject to
repricing (except for the replacement of assets through repayments, sales and
new originations) while the short-term borrowings used to finance these
positions normally reprice on a periodic basis (e.g., daily, monthly or
quarterly). Doral Financial manages the risk to its net interest income through
a combination of the internal management of the composition of its assets and
liabilities and through the use of hedging instruments. Internal asset/liability
management policies include the attraction of longer term funds through the use
of long-term repurchase agreements and other borrowings such as senior notes,
term notes, and FHLB-NY advances. The Company also attempts to obtain long-term
deposits, including brokered certificates of deposit.
In addition to the use of the internal asset-liability management
policies discussed above, Doral Financial has used interest rate swap agreements
to effectively fix the cost of short-term funding sources which are used to
finance the funding and holding of interest-earning assets with longer
maturities. An interest rate swap is an agreement where one party (in this case,
Doral Financial) agrees to pay a fixed-rate of interest on a notional principal
amount to a second party (generally a securities broker-dealer) in exchange for
receiving a variable rate of interest on the same notional amount for a
pre-determined period of time. No actual assets are exchanged in a swap of this
type and interest payments are generally netted. As of December 31, 1998, Doral
Financial, through Doral Bank, had in place various interest rate swap
agreements with an aggregate notional amount of $105 million. The Company also
purchases put options on futures contracts for Euro-dollar instruments in an
attempt to manage the risk to its net interest income.
Doral Financial maintains a substantial portfolio of mortgage-backed
securities (primarily fixed-rate GNMA certificates) and other investment
securities. Generally, the value of fixed rate securities declines when interest
rates rise, and conversely, increase when interest rates fall. At December 31,
1998, Doral Financial held $606.9 million of mortgage-backed and other
investment securities (all of which carried fixed interest rates) which were
classified as held for trading and reported at fair value, with unrealized gains
and losses included in earnings. In addition, at December 31, 1998, Doral
Financial held $408.9 million of investment securities (all of which carried
fixed interest rates) which were classified as available for sale and reported
at fair value, with unrealized gains or losses reported as a segregated
component of stockholders' equity. Accordingly, declines in the value of Doral
Financial's securities held for trading and available for sale could have a
negative impact on Doral Financial's earnings or financial condition. In order
to hedge the interest rate risk associated with Doral Financial's portfolio of
securities held for trading and available for sale, Doral Financial may use a
variety of hedging instruments including listed put and call options and futures
contracts on financial instruments (primarily Eurodollar certificates of deposit
and U.S. Treasury note contracts). In determining the amount of its portfolio to
hedge, Doral Financial will consider, among other things, the volatility of
prices of its securities. As noted above, the prices for Puerto Rico tax exempt
GNMA securities tend to be more stable than their U.S. counterparts.
In the future, Doral Financial may use alternative hedging techniques
including futures, options, interest rate swap agreements or other hedge
instruments 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 they are not successful, Doral Financial's profitability may be
adversely affected. For additional information on the use of derivatives to
manage interest rate risk, see "Derivatives" below.
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Interest Rate Sensitivity Analysis. The following table summarizes the
expected maturities or repricing of Doral Financial's interest-earning assets
and interest-bearing liabilities as of December 31, 1998. Condensed information
as of December 31, 1997 is also shown. For purposes of this presentation, the
interest-earning components of mortgage loans held for sale and securities held
for trading are assumed to mature within one year. Off balance sheet instruments
represent the notional amounts of interest rate swap agreements. Notional
amounts are used to calculate the contractual amounts to be exchanged under the
swap agreements.
TABLE U
INTEREST RATE SENSITIVITY ANALYSIS
(DOLLARS IN THOUSANDS)
- -----------------------------------------------------------------------------------------------------------------------------------
1 YEAR 1 TO 3 3 TO 5 OVER 5 NON-INTEREST
AS OF DECEMBER 31, 1998 OR LESS YEARS YEARS YEARS RATE BEARING TOTAL
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Money Market Instruments $ 312,751 $ -- $ -- $ -- $ -- $ 312,751
Total Loans 898,048 12,849 9,067 130,071 1,050,035
Securities Held for Trading 606,918 -- -- -- -- 606,918
Securities Available for Sale 213,786 -- 8,040 187,062 -- 408,888
Securities Held to Maturity -- -- 34,541 156,237 -- 190,778
FHLB Stock -- -- -- 6,914 -- 6,914
Other assets -- -- -- -- 341,829 341,829
---------- --------- --------- -------- ----------- ----------
TOTAL ASSETS $2,031,503 $ 12,849 $ 51,648 $480,284 $ 341,829 $2,918,113
========== ========= ========= ======== =========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Loans Payable $ 426,704 $ -- $ -- $ -- $ -- $ 426,704
Repurchase Agreements 1,168,328 10,000 -- 19,000 -- 1,197,328
Deposits 304,389 53,161 57,158 913 117,492 533,113
Other Borrowed Funds 71,048 58,410 10,275 92,000 -- 231,733
Other Liabilities -- -- -- -- 259,676 259,676
Stockholders' equity -- -- -- -- 269,559 269,559
---------- --------- --------- -------- ----------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,970,469 $ 121,571 $ 67,433 $111,913 $ 646,727 $2,918,113
========== ========= ========= ======== =========== ==========
Off Balance Sheet Instruments - Interest
Rate Swaps $ 105,000 ($ 5,000) ($100,000) $ -- $ -- $ --
Interest Rate Sensitivity Gap 166,034 (113,722) (115,785) 368,371 (304,898) --
Cumulative Interest Rate Sensitivity 166,034 52,312 (63,473) 304,898 -- --
Cumulative Gap to Interest Earning Assets 6.44% 2.03% -2.46% 11.83% -- --
CONDENSED INTEREST RATE
SENSITIVITY ANALYSIS 1 YEAR 1 TO 3 3 TO 5 OVER 5 NON-INTEREST
AS OF DECEMBER 31, 1997 OR LESS YEARS YEARS YEARS RATE BEARING TOTAL
- ----------------------------------------- --------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Off-Balance Sheet Instruments - Interest
Rate Swaps $ 55,000 ($ 5,000) ($ 50,000) $ -- $ -- $ --
Interest Rate Sensitivity Gap (947) (35,564) (101,815) 305,562 (167,236) --
Cumulative Interest Rate Sensitivity (947) (36,511) (138,326) 167,236 -- --
Cumulative Gap to Interest Earning Assets -0.06% -2.15% -8.13% 9.83% -- --
Gap analysis measures the volume of assets and liabilities at a point
in time and their repricing during future periods. The volume of assets
repricing is adjusted to take into consideration the expected prepayment of
certain assets such as mortgage loans and mortgage-backed securities, which can
be prepaid before their contractual maturity. The net balance of assets and
liabilities (the "gap") repricing during future periods is an indicator of the
degree of interest rate risk being assumed by the Company. A positive gap
generally denotes asset sensitivity and
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51
that increases in interest rates would have a positive effect on net interest
income while a decrease in interest rates would have a negative effect on net
interest income. A negative gap denotes liability sensitivity and means that an
increase in interest rates would have a negative effect on net interest income
while a decrease in rates would have a positive effect on net-income interest.
As of December 31, 1998, the Company had a one year positive gap of
approximately $166.0 million compared to a negative gap position of $947,000 as
of December 31, 1997. The Company's positive gap within one year is due
primarily to its large portfolio of mortgage loans held for sale and trading
assets which the Company could attempt to sell within a short-time in a rising
interest rate environment and replace them with higher yielding assets. While
static gap analysis is a useful measure for determining short-term risk to
future net interest income, it does not measure the sensitivity of the market
value of assets and liabilities to changes in interest rates. For example, the
value of the Company's mortgage loans held for sale and trading assets would
probably fall in a rising interest rate environment thereby adversely affecting
the Company's revenues from mortgage loan originations and trading account
profit.
Derivatives. As described above, the Company uses derivatives to manage
its interest rate risk. Derivatives include interest rate swaps, futures,
forwards and options. Derivatives are generally either privately-negotiated
over-the-counter ("OTC") or standard contracts transacted through regulated
exchanges. OTC contracts generally consist of swaps, forwards and options.
Exchange traded derivatives include futures and options.
Although the Company uses derivatives to manage market risk, for
financial reporting purposes its general policy is to account for such
instruments on a marked to market basis with gains or losses charged to
operations as they occur, except for interest rate swaps entered into by Doral
Bank which are not reflected on the Company's Consolidated Financial Statements.
Contracts with positive fair values are recorded as assets and contracts with
negative fair values as liabilities after the application of netting
arrangements. For the year ended December 31, 1998, average assets and
liabilities related to derivatives were $2.5 million and $2.4 million,
respectively. The notional amounts of assets and liabilities related to
derivatives which are not recorded on the Company's statement of condition
totaled $3.7 billion and $1.7 billion, respectively, as of December 31, 1998.
Notional amounts indicate the volume of derivatives activity but do not
represent the Company's exposure to market or credit risk. Amounts do not
include interest rate swaps in the aggregate amount of $105 million held at
Doral Bank. For additional information regarding the Company's investment in
derivatives, see Note 30 to the Company's Consolidated Financial Statements.
The use of derivatives involves market and credit risk. The market risk
of derivatives arises principally from the potential for changes in the value of
derivative contracts based on changes in interest rates. The Company generally
manages its risks by taking risk offsetting positions.
The credit risk of derivatives arises from the potential of a
counterparty to default on its contractual obligations. Credit risk related to
derivatives depend on the following: the current fair value of outstanding
contracts with an entity; the potential credit exposure on the derivative over
time; the extent to which legally enforceable netting arrangements allow the
offsetting of contracts with the same entity to be netted against each other;
the extent to which collateral held against the contract reduces credit risk;
and the likelihood of defaults by the counterparty.
To manage this credit risk, the Company deals with counterparties 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 contracts with the same
counterparty in the event of default. The credit risk associated with futures
contracts is also limited due to daily cash settlement of the net change in the
value of open contracts with the exchange on which the contract is traded.
INFLATION
Doral Financial is affected by inflation mainly 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 Doral Financial'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. See "Interest Rate Management" for a discussion of the effects of
changes of interest rates on Doral Financial's operations.
48
52
CHANGES IN ACCOUNTING STANDARDS
Accounting for Derivative and Similar Financial Instruments and for
Hedging Activities. In June 1998, the FASB issued Statement of Financial
Accounting Standards No. 133 "Accounting for Derivative and Similar Financial
Instruments and for Hedging Activities" ("SFAS No. 133"). This new standard,
which becomes effective for all fiscal quarters of all fiscal years beginning
after June 15, 1999, but with earlier application permitted as of the beginning
of any fiscal quarter subsequent to June 15, 1998, establishes accounting and
reporting standards for derivative financial instruments and for hedging
activities, and requires all derivatives to be measured at fair value and to be
recognized as either assets or liabilities in the statement of financial
position. Under this Standard, derivatives used in hedging activities are to be
designated into one of the following categories: (a) fair value hedge; (b) cash
flow hedge; and (c) foreign currency exposure hedge. The changes in fair value
(that is, gains and losses) will be either recognized as part of earnings in the
period when the change occurs, or as a component of other comprehensive income
(outside earnings) depending on their intended use and resulting designation.
Management has determined to adopt this Statement during the third quarter of
1999 and believes that such adoption will not have a material effect on the
Company's financial position or results of operations.
Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held-for- Sale by a Mortgage Banking
Enterprise. At December 31, 1998, Doral Financial adopted the provision of the
Statement of Financial Accounting Standards (SFAS) No. 134," Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held-for-sale by a Mortgage Banking Enterprise," an amendment of FASB Statement
No. 65. On the date this Statement is initially adopted, an enterprise may
reclassify mortgage-backed securities and other beneficial interests retained
after the securitization of mortgage loans held-for-sale from the trading
category, except for those with sales commitments in place. Those securities and
other interests shall be classified based on the entity's ability and intent, on
the date this Statement is initially adopted, to hold those investments.
Transfers from the trading category that result from implementing this Statement
shall be accounted for in accordance with FASB 115. In connection with the
adoption of this Statement, Doral Financial reclassified approximately $115.7
million of securities classified as trading securities to the held-to-maturity
portfolio.
Reclassification. Certain amounts reflected in the Company's
Consolidated Financial Statements for the years ended December 31, 1997 and 1996
have been reclassified to conform to the presentation for 1998.
YEAR 2000 ISSUES
The Year 2000 problem is caused by the situation whereby existing
computer software programs use only the last two digits to identify the year.
Those programs could read "00" as the year 1900, and thus, may not recognize
dates after December 31, 1999. This misinterpretation of data could cause
significant problems with banking and mortgage banking entities, such as the
Company, as the use of date calculations is extensive in daily operations for
matters such as interest accruals, maturity dates, delinquency status, and
customer statements. Year 2000 problems go beyond computer systems and affect
anything that uses an internal microchip such as telephone, fax machines,
security and alarm systems, vaults, elevators, heating and air conditioning.
Doral Financial does not own any proprietary software systems or
applications and relies on those provided by third party vendors. The Company
has completed the assessment of its computer hardware, software programs and
data processing applications, including those provided by third party vendors.
The Company has received revised programs from its third party vendors that have
been modified to address the Year 2000 problem for the principal applications
used in its mortgage banking, commercial banking and securities businesses. The
Company began testing these revised programs and applications during the first
week of October 1998. The testing for most of Company's software systems and
applications including those applicable to mortgage servicing and commercial
banking operations were substantially completed by December 31, 1998. Testing on
certain applications used in mortgage originations that interface with FNMA,
FHLMC and GNMA are expected be completed by June 30, 1999. The Company is using
outside consultants to assist it in verifying all test results. The Company's
mainframe computer, used principally in its commercial banking operations, is
Year 2000 compliant, meaning that it can properly process and calculate
date-related information after January 1, 2000. The Company is replacing other
equipment, primarily desk top computers that are not Year 2000 compliant.
49
53
Doral Financial does not anticipate that the Year 2000 problem will
have a material adverse effect on its financial condition or results of
operations. However, Year 2000 problems suffered by third parties, including
providers of basic services, such as telephone, water, sewer and electricity,
could have an adverse impact on the daily operations of the Company. The Company
has completed contingency plans for its commercial banking operations and is in
the process of modifying its existing business interruption contingency plans
for its other operations to address disruptions that could be caused by the Year
2000 problem. These plans will include, among other things, performing certain
processes manually, contracting third parties to perform certain operations and
reducing or suspending impaired services. The Company intends to continue to
review and modify its contingency plans as it acquires additional information
through its ongoing Year 2000 program.
The Company estimates that the costs of addressing Year 2000 issues
will be approximately $1,000,000, of which $750,000 has already been spent. Most
of such costs are directly related to the costs of replacing existing equipment,
primarily desktop computers, which have been fully depreciated on the Company's
financial statements. The Company has and intends to continue to fund such costs
through operating cash flow.
As a bank holding company, Doral Financial could be subject to
enforcement action by federal banking authorities if it fails to adequately
address the Year 2000 problem.
RECENT DEVELOPMENTS
Expansion into Mainland United States. During the second quarter of
1998, Doral Financial, through Doral Bank, organized a new mortgage banking
subsidiary, Doral Money, Inc., which commenced a wholesale residential mortgage
operation in Chicago and a multi-family and commercial real estate lending unit
in the New York metropolitan area. Doral Money accounted for approximately 11%
of the Company's total loan originations for the year ended December 31, 1998.
The Company is also in the process of opening a new federal savings association
in the New York metropolitan area, which it expects will commence operations
during the third quarter of 1999. Doral Financial intends to continue to search
for new business opportunities in Puerto Rico as well as to explore additional
expansion in the mainland United States.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by this Item 7A is incorporated by reference
to the information included under the caption "Interest Rate Management" in Item
7 of this Form 10-K.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information called 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.
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 1999 Annual Meeting of stockholders
(the "Proxy Statement") to be filed with the Securities and Exchange Commission
on March 22, 1999.
50
54
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.
51
55
EXHIBIT
NUMBER Description
- ------ -----------
3.1(b) Certificate of Designation creating 8% Convertible Cumulative Preferred Stock (Liquidation Preference
$1,000 per Share.)(25)
3.1(c) Second Restated Certificate of Incorporation of Doral Financial.(25)
3(1)(d) Certificate of Designation creating the 7% Noncumulative Monthly Income Preferred Stock, Series A(28)
3(1)(e) Certificate of Incorporation of Doral Financial as currently in effect. (32)
3.2 By-laws of Doral, as amended as of October 19, 1999.(29)
4.1 Common Stock Certificate.(25)
4.2 1997 Employee Stock Option Plan(26)
10.14 Doral Restricted Stock Plan.(3)
10.28 Mortgage Loan Origination and Servicing Agreement among Doral, Puerto Rico Housing Finance
Corporation and Banco Popular de Puerto Rico, dated December 23, 1997 (27)
10.30 Loan Agreement between Doral 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 Doral and Banco Santander Puerto
Rico.(14)
10.33 Loan Agreement dated November 25, 1987 between Doral and Scotiabank de Puerto Rico.(4)
10.35 Employment Agreement dated May 1, 1997 between Doral and Salomon Levis.(23)
10.36 Employment Agreement dated May 1, 1997 between Doral and Zoila Levis.(23)
10.37 Third Amendment to Loan Agreement dated June 5, 1991 between Doral and Scotiabank de Puerto Rico.(2)
10.40 Insurance and Indemnity Agreement dated as of May 28, 1992, between Doral and Financial Security
Assurance Inc.(5)
10.41 Letter Agreement dated August 20, 1992 between Scotiabank de Puerto Rico and Doral confirming the
renewal of the Loan Agreement dated November 25, 1987.(5)
10.42 Financing Agreement dated May 14, 1992, between Doral and Banco Popular de Puerto Rico.(5)
10.43 Employment Agreement dated as of October 1, 1997, between Doral and Richard F. Bonini.(25)
10.44 Addendum to Warehousing Loan Agreement dated August 1, 1991, between Doral and Banco Santander
Puerto Rico.(5)
10.45 Addendum to Warehousing Loan Agreement dated May 29, 1992, between Doral and Banco Santander
Puerto Rico.(5)
10.46 Letter Agreement dated November 28, 1988 amending the Loan Agreement between Doral and Scotiabank
de Puerto Rico dated November 25, 1987.(5)
10.47 Amendment dated June 29, 1989 to the Loan Agreement between Doral and Scotiabank de Puerto Rico
dated November 25, 1987.(5)
10.51 Master Repurchase Agreement, dated March 24, 1993, between Doral and Bear Sterns Mortgage Capital
Corporation.(7)
10.52 Amended and Restated Master Production Agreement, dated as of October 1, 1995, between Doral, Doral
Mortgage and Doral Bank, Master Production Agreement, dated as of October 1, 1995, between Doral,
Doral Mortgage and Doral Bank.(8)
10.53 Master Purchase, Servicing and Collection Agreement, dated as of September 15, 1993, between Doral and
Doral Bank.(9)
10.57 Master Repurchase Agreement among Merrill Lynch Mortgage Capital, Inc., Doral and Doral Mortgage
together with Supplemental Terms to Master Repurchase Agreement, each dated as of January 12, 1995.(14)
10.59 Demand Note dated December 9, 1994.(14)
52
56
EXHIBIT
NUMBER Description
- ------ -----------
10.60 Form of Medium Term Note, 1994 Series Puerto Rico-A.(14)
10.62 Exchange Agreement dated July 9, 1997, between Doral and Popular, Inc..(24)
10.63 Financing Agreement dated October 10, 1995, between Doral and Banco Santander together with related
Assignment and Pledge Agreements.(16)
10.64 Master Servicing and Collection Agreement dated October 1, 1995, between Doral and Doral Bank.(18)
10.65 Employment Agreement, dated as of February 25, 1998, between Doral and Frederick C. Teed.(27)
10.66 First Amendment to Master Servicing and Collection Agreement, dated as of March 1, 1996, between Doral
and Doral Bank.(19)
10.67 First Amendment to Amended and Restated Master Production Agreement, dated as of March 1, 1996,
between Doral, Doral Mortgage Corporation and Doral Bank, respectively.(19)
10.68 First Amended and Restated Credit Agreement, dated as of September 25, 1996, between Doral, Doral
Mortgage, the lenders party thereto and Bankers Trust Company, as Agent, as amended by First Amendment
dated January 7, 1997.(22)
10.69 Indenture, dated as of October 10, 1996, between the Company and Bankers Trust Company, as
trustee, including form of Senior Note. (20)
10.70 Employment Agreement, dated as of December 1, 1998, between Doral Financial and Mario S. Levis.(32)
10.71 Employment Agreement, dated as of December 31, 1996, between Doral Mortgage and Edison Velez.(22)
10.71(a) Amendment, dated March 1, 1997 to Employment Agreement dated as
of December 31, 1996, between Doral Mortgage and Edison
Velez.(23)
10.72 Employment Agreement, dated May 1, 1997 between Doral Bank and Jose G. Vigoreaux.(23)
10.73 Credit Agreement dated November 5, 1997, between Doral, Doral Mortgage, the lender party thereto and
Bankers Trust Company as Agent.(27)
10.74 Second Amendment to First Amended and Restated Credit Agreement, with lenders thereto and Bankers
Trust Company as agent, dated March 28, 1997.(27)
10.75 Third Amendment to First Amended and Restated Credit Agreement, dated as of June 27, 1997.(27)
10.76 Fourth Amendment to First Amended and Restated Credit Agreement, dated November 7, 1997.(27)
10.77 Amendment, dated July 22, 1998, to Employment Agreement dated as of December 31, 1996 between
Doral Mortgage Corporation and Edison Velez.(30)
10.78 Form of Stock Option Agreement for use under 1997 Employee Stock Option Plan.(30)
10.79 First Supplemental Indenture, dated as of October 19, 1998, between the Company and Bankers Trust
Company.(31)
10.80 Fifth Amendment to First Amended and Restated Credit Agreement, dated as of June 6, 1998, among
the Company, Doral Mortgage Corporation, Bankers Trust Company, as agent and lender, and the other
lenders party thereto.(29)
10.81 First Amended and Restated Credit Agreement, dated as of June 26, 1998, between the Company, Doral
Mortgage Corporation, Bankers Trust Company, as agent and lender, and the other lenders party
thereto.(29)
10.82 Sixth Amendment to First Amended and Restated Credit Agreement, dated as of November 23, 1998,
among the Company, Doral Mortgage Corporation, Bankers Trust Company, as agent and lender, and
the other lenders party thereto.(32)
10.83 Employment Agreement with Francisco Rivero dated June 29, 1998.(32)
21 List of Doral's subsidiaries.(32)
23 Consent of PricewaterhouseCoopers LLP.(32)
27 Financial Data Schedule (Edgar version only).(27)
- --------------------
(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).
53
57
(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 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).
(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) Reserved.
(13) Reserved.
(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) Reserved.
(18) 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, 1995.
(19) 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, 1996.
(20) Incorporated herein by reference to the same exhibit number of the
Company's Quarterly Report For 8-K, dated October 10, 1996.
(21) 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,
1996.
(22) 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, 1997.
54
58
(23) 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, 1997.
(24) Incorporated herein by reference to the same exhibit number of the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.
(25) 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,
1998.
(26) Incorporated herein by reference to the same exhibit number of the
Company's Registration Statement on Form S- 8 (No. 333-31283) filed with the
Commission on July 15, 1997.
(27) 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, 1998.
(28) Incorporated herein by reference to the same exhibit number of the
Company's Registration Statement on Form 8-A filed with the Commission on
February 17, 1991.
(29) 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,
1998.
(30) Incorporated herein by reference to the same exhibit number of the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.
(31) Incorporated herein by reference to the same exhibit number of the
Company's Current Report on Form 8-K dated October 19, 1998.
(32) Filed herewith.
(b) Reports on Form 8-K.
(1) Current Report on Form 8-K ("Form 8-K"), dated October 7, 1998,
reporting under Item 5 - "Other Items" the Company's unaudited results for the
quarter ended September 30, 1998.
(2) Form 8-K dated October 19, 1998, responding under the Item 5 - "Other
Items" various amendments to the indenture securing the Company's 7.84% Senior
Notes due 2006 and to the Company's By-laws.
(3) Form 8-K, dated January 12, 1999, reporting under Item 5 - "Other
Items" the Company's unaudited results for the quarter and year ended December
31, 1998.
55
59
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, Doral Financial Corporation has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
DORAL FINANCIAL CORPORATION
By: /s/ Salomon Levis
----------------------------------
Salomon Levis
Chairman of the Board and
Chief Executive Officer
Date: March 22, 1999
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
/s/ Salomon Levis Chief Executive Officer March 22, 1999
- -------------------------------------------------
Salomon Levis
Director and
/s/ Richard F. Bonini Chief Financial Officer March 22, 1999
- -------------------------------------------------
Richard F. Bonini
/s/ Edgar M. Cullman, Jr. Director March 22, 1999
- -------------------------------------------------
Edgar M. Cullman, Jr.
Director
- -------------------------------------------------
John L. Ernst
/s/ Efraim Kier Director March 22, 1999
- -------------------------------------------------
Efraim Kier
/s/ Zoila Levis Director March 22, 1999
- -------------------------------------------------
Zoila Levis
/s/ A. Brean Murray Director March 22, 1999
- -------------------------------------------------
A. Brean Murray
/s/ Victor M. Pons, Jr. Director March 22, 1999
- -------------------------------------------------
Victor M. Pons, Jr.
/s/ Ricardo Melendez Vice President and March 22, 1999
- ------------------------------------------------- Principal Accounting Officer
Ricardo Melendez
56
60
DORAL FINANCIAL 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
61
DORAL FINANCIAL CORPORATION AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
MARCH 5, 1999
Page
---------------
Report of Independent Accountants............................................................................. F-2
Consolidated Financial Statements
Consolidated Statements of Financial Condition as of December 31, 1998 and 1997.......................... F-3
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996 ..................................................................... F-4
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995................ F-5
Consolidated Statements of Changes in Stockholder's Equity for the years ended
December 31, 1998, 1997 and 1996 ..................................................................... F-7
Consolidated Statements of Comprehensive Income.......................................................... F-8
Notes to Consolidated Financial Statements............................................................... F-9
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-1
62
(PricewaterhouseCoopers Logo)
PricewaterhouseCoopers LLP
PO Box 363566
San Juan PR 00936-3566
Telephone (787) 754-9090
Report of Independent Accountants
To the Board of Directors
and Stockholders of
Doral Financial Corporation
In our opinion, the accompanying consolidated statements of financial condition
and the related consolidated statements of income, of changes in stockholders'
equity, of comprehensive income, and of cash flows present fairly, in all
material respects, the financial position of Doral Financial Corporation and
its subsidiaries at December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years ended December 31,
1998, 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.
/s/ PricewaterhouseCoopers LLP
CERTIFIED PUBLIC ACCOUNTANTS
(OF PUERTO RICO)
License No. 216 Expires Dec. 1, 2001
Stamp 1537437 of the P.R. Society of
Certified Public Accountants has been
affixed to the file copy of this report
March 5, 1999
F-2
63
DORAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1998 AND 1997
- ------------------------------------------------------------------------------
(Dollars in thousands, except per share information)
1998 1997
---- ----
ASSETS
Cash and due from banks $ 31,945 $ 17,390
----------- -----------
Money market investments:
Securities purchased under agreements to resell 120,733 44,862
Time deposits with other banks 51,549 50,000
Other short term investments, at cost 140,469 62,542
----------- -----------
Total money market investments 312,751 157,404
----------- -----------
Loans:
Mortgage loans held-for-sale, at lower of cost or market 883,048 404,672
Loans receivable, net 166,987 133,055
----------- -----------
Total loans 1,050,035 537,727
----------- -----------
Investment securities and other instruments:
Trading securities, at fair value 606,918 620,288
Securities available-for-sale, at fair value 408,888 240,876
Securities held-to-maturity, at amortized cost 190,778 143,534
Federal Home Loan Bank of NY (FHLB) stock, at cost 6,914 4,692
----------- -----------
Total investment securities and other instruments 1,213,498 1,009,390
----------- -----------
Receivables and mortgage servicing advances 32,568 24,469
Broker dealers' operations receivable 144,486 20,046
Accrued interest receivable 23,570 13,537
Servicing assets, net 72,568 46,416
Property, leasehold improvements and equipment, net 19,273 10,848
Cost in excess of fair value of net assets acquired, net 5,475 6,203
Real estate held for sale, net 2,987 3,025
Prepaid and other assets 8,957 11,334
----------- -----------
Total assets $ 2,918,113 $ 1,857,789
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Securities sold under agreements to repurchase $ 1,197,328 $ 838,142
Loans payable 426,704 238,770
Deposits 533,113 300,494
Notes payable 199,733 164,934
Advances from FHLB 32,000 32,000
Broker dealers' operations payable 142,002 19,041
Accrued expenses and other liabilities 117,674 77,453
----------- -----------
Total liabilities 2,648,554 1,670,834
----------- -----------
Commitments and contingencies (Note 23)
----------- -----------
Stockholders' equity:
Serial Preferred Stock, $1 par value, 2,000,000 shares
authorized; 20,000 shares of 8% Convertible Cumulative
Preferred Stock, $1 par value (liquidation preference $1,000 per share)
designated, and 8,460 shares issued and outstanding 8 8
Common stock, $1 par value, 50,000,000 shares authorized;
40,484,920 shares issued (1997 - 36,850,920); 40,428,920 shares
outstanding (1997 - 36,794,920) 40,485 36,851
Paid-in capital 70,252 33,294
Legal surplus 2,499 1,704
Retained earnings 156,315 114,253
Accumulated other comprehensive income, net of taxes 56 901
Treasury stock at par value, 56,000 shares held (56) (56)
----------- -----------
Total stockholders' equity 269,559 186,955
----------- -----------
Total liabilities and stockholders' equity $ 2,918,113 $ 1,857,789
=========== ===========
The accompanying notes are an integral part of these financial statements.
F-3
64
DORAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
(Dollars in thousands, except per share information)
1998 1997 1996
-------- ------- -------
Interest income:
Loans $ 54,694 $32,768 $31,410
Mortgage-backed securities 53,276 45,464 32,106
Investment securities 32,278 5,454 2,031
Money market investments 7,803 6,445 1,440
-------- ------- -------
Total interest income 148,051 90,131 66,987
-------- ------- -------
Interest expense:
Loans payable 26,131 13,325 13,621
Securities sold under agreements to repurchase 55,561 31,665 21,002
Deposits 17,326 10,014 5,526
Other borrowed funds 15,768 6,434 6,294
-------- ------- -------
Total interest expense 114,786 61,438 46,443
-------- ------- -------
Net interest income 33,265 28,693 20,544
Provision for loan losses 883 792 797
-------- ------- -------
Net interest income after provision for loan losses 32,382 27,901 19,747
-------- ------- -------
Non-interest income:
Net gain on mortgage loan sales 49,551 16,883 10,362
Trading account profit 6,056 10,129 15,402
Gain on sale of investment securities 6,052 1,576 846
Servicing income 21,782 14,995 11,659
Gain on sale of servicing assets 1,829 -- 1,813
Commissions, fees and other income 3,070 1,703 764
-------- ------- -------
Total non-interest income 88,340 45,286 40,846
-------- ------- -------
Non-interest expense:
Compensation and benefits 21,158 8,111 8,982
Taxes, other than payroll and income taxes 1,747 1,403 1,087
Advertising 5,824 3,554 3,500
Professional services 4,920 3,283 2,671
Telephone 2,780 2,171 1,813
Rent 3,273 2,518 2,083
Amortization of servicing assets 6,670 3,437 999
Depreciation and amortization 2,941 2,298 1,796
Maintenance 1,566 971 694
Other 10,004 7,644 5,689
-------- ------- -------
Total non-interest expense 60,883 35,390 29,314
-------- ------- -------
Income before income taxes and extraordinary item 59,839 37,797 31,279
-------- ------- -------
Income taxes 7,007 5,249 4,238
-------- ------- -------
Income before extraordinary item 52,832 32,548 27,041
Extraordinary item -
non-cash loss on extinguishment of debt -- 12,317 --
-------- ------- -------
Net income $ 52,832 $20,231 $27,041
======== ======= =======
Earnings per share:
Basic:
Income before extraordinary item $ 1.31 $ 0.89 $ 0.75
Extraordinary item -- (0.34) --
-------- ------- -------
Net income $ 1.31 $ 0.55 $ 0.75
======== ======= =======
Diluted:
Income before extraordinary item $ 1.26 $ 0.85 $ 0.71
Extraordinary item -- (0.32) --
-------- ------- -------
Net income $ 1.26 $ 0.53 $ 0.71
======== ======= =======
The accompanying notes are an integral part of these financial statements.
F-4
65
DORAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
(Dollars in thousands)
1998 1997 1996
-------- ------- -------
Cash flows from operating activities:
Net income $ 52,832 $ 20,231 $ 27,041
----------- --------- ---------
Adjustments to reconcile net income to net cash used in operating
activities:
Depreciation and amortization 2,941 2,298 1,796
Amortization of interest only strips held in trading securities 3,738 3,980 1,628
Amortization of cost in excess of fair value of net assets
acquired 728 359 375
Amortization of servicing assets 6,670 3,437 999
Extraordinary item -- 12,317 --
Deferred tax provision 419 1,293 3,277
Gain on sale of servicing assets (1,829) -- (1,813)
Provision for loan losses 883 792 797
Origination and purchases of mortgage loans held for sale (2,275,178) (977,505) (719,886)
Principal repayments and sales of mortgage loans held for sale 621,711 434,487 368,573
Purchases of securities held for trading (1,051,826) (694,120) (156,935)
Increase in interest only strips, net (16,848) (8,395) (15,900)
Principal repayments and sales of securities held for trading 1,765,783 805,575 488,619
Increase in servicing assets (32,876) (28,884) (10,804)
Increase in receivables and mortgage servicing advances (8,099) (6,728) (8,113)
Increase in broker dealers' operations receivable (124,440) (19,239) (807)
Increase in accrued interest receivable (10,033) (3,446) (1,935)
Decrease in payable related to short sales -- (9,983) (12,107)
Increase in interest payable 7,657 1,252 2,388
Increase in broker dealers' operations payable 122,961 19,011 30
Increase in accounts payable and other liabilities 32,685 12,613 7,027
Amortization of unearned compensation under employment -- 97 96
Decrease (increase) in prepaid and other assets 2,377 (2,627) (3,981)
----------- --------- ---------
Total adjustments (952,576) (453,416) (56,676)
----------- --------- ---------
Net cash used in operating activities (899,744) (433,185) (29,635)
----------- --------- ---------
Cash flows from investing activities:
Purchases of securities held-to-maturity (28,919) (158,939) (54,480)
Principal repayments and maturities of securities held-to-maturity 97,352 122,627 25,203
Origination of loans receivable (37,709) (59,494) (98,680)
Principal repayments of loans receivable 3,311 55,205 21,270
Purchases of securities available-for-sale (522,038) (331,052) (4,639)
Principal repayments and sales of securities available-for-sale 724,161 210,850 7,121
Purchase of FHLB stock (2,222) (1,200) (2,040)
Purchase of property, leasehold improvements and equipment (11,366) (3,786) (4,651)
Payments of contingent purchase price of subsidiary -- -- (410)
Decrease (increase) in real estate held for sale 38 (779) (162)
Proceeds from sale of servicing assets 1,883 -- 1,813
----------- --------- ---------
Net cash provided (used) by investing activities 224,491 (166,568) (109,655)
----------- --------- ---------
(Continued)
The accompanying notes are an integral part of these financial statements.
F-5
66
DORAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
(Dollars in thousands)
1998 1997 1996
---- ---- ----
Cash flows from financing activities:
Increase in deposits $ 232,619 $ 141,591 $ 63,161
Increase in securities sold under agreements to repurchase 359,186 450,491 23,923
Increase (decrease) in loans payable 187,934 78,646 (25,957)
Increase (decrease) in common stock, net 40,592 (3) 476
Proceeds from FHLB advances -- 17,000 4,593
Increase in notes payable 34,799 12,808 100,443
Dividends declared and paid (9,975) (7,199) (6,008)
----------- --------- ---------
Net cash provided by financing activities 845,155 693,334 160,631
----------- --------- ---------
Net increase in cash and cash equivalents 169,902 93,581 21,341
Cash and cash equivalents at beginning of year 174,794 81,213 59,872
----------- --------- ---------
Cash and cash equivalents at the end of year $ 344,696 $ 174,794 $ 81,213
----------- --------- ---------
Cash and cash equivalents include:
Cash and due from banks $ 31,945 $ 17,390 $ 10,439
Money market investments 312,751 157,404 70,774
----------- --------- ---------
$ 344,696 $ 174,794 $ 81,213
----------- --------- ---------
Supplemental Schedule of Noncash Activities:
Loan securitizations $ 1,084,568 $ 398,329 $ 375,191
----------- --------- ---------
Reclassification of trading securities to held-to-maturity category $ 115,680 $ -- $ --
----------- --------- ---------
Conversion of subordinated debentures $ -- $ 1,540 $ --
----------- --------- ---------
Conversion of preferred stock $ -- $ -- $ 1,084
----------- --------- ---------
Extinguishment of debt $ -- $ 8,460 $ --
----------- --------- ---------
Supplemental Cash Flows Information:
Cash used to pay interest $ 102,799 $ 60,186 $ 44,055
----------- --------- ---------
Cash used to pay income taxes $ 10,173 $ 1,640 $ 1,132
----------- --------- ---------
The accompanying notes are an integral part of these financial statements.
F-6
67
DORAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
(Dollars in thousands)
1998 1997 1996
---- ---- ----
PREFERRED STOCK:
Balance at beginning of year $ 8 $ -- $ 108
Shares converted (serial) -- -- (108)
Shares issued (8% convertible) -- 8 --
-------- -------- --------
Balance at end of year 8 8 --
-------- -------- --------
COMMON STOCK:
Balance at beginning of year 36,851 36,500 35,536
Common stock issued 3,634 -- 100
Common stock converted -- 351 864
-------- -------- --------
Balance at end of year 40,485 36,851 36,500
-------- -------- --------
PAID-IN CAPITAL:
Balance at beginning of year 33,294 11,340 11,720
Shares issued 36,958 20,768 380
Shares redeemed -- (2) (4)
Shares converted -- 1,188 (756)
-------- -------- --------
Balance at end of year 70,252 33,294 11,340
-------- -------- --------
LEGAL SURPLUS:
Balance at beginning of year 1,704 -- --
Transfer of retained earnings per legal requirements
due to conversion of Doral Bank -- 1,200 --
Transfer from retained earnings 795 504 --
-------- -------- --------
Balance at end of year 2,499 1,704 --
-------- -------- --------
RETAINED EARNINGS:
Balance at beginning of year 114,253 102,925 81,892
Net income 52,832 20,231 27,041
Cash dividends declared on common stock (9,299) (7,069) (5,994)
Cash dividends declared on preferred stock (676) (130) (14)
Transfer to legal surplus (795) (1,704) --
-------- -------- --------
Balance at end of year 156,315 114,253 102,925
-------- -------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME
NET OF TAXES:
Balance at beginning of year 901 (81) 9
Net change in the fair value of investment securities
available-for-sale, net of deferred taxes (845) 982 (90)
-------- -------- --------
Balance at end of year 56 901 (81)
-------- -------- --------
TREASURY STOCK-AT COST: (56) (56) (56)
-------- -------- --------
UNEARNED COMPENSATION UNDER EMPLOYMENT CONTRACTS:
Balance at beginning of year -- (97) (193)
Amortization -- 97 96
-------- -------- --------
Balance at end of year -- -- (97)
-------- -------- --------
Total stockholders' equity $269,559 $186,955 $150,531
-------- -------- --------
The accompanying notes are an integral part of these financial statements.
F-7
68
DORAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
(Dollars in thousands)
1998 1997 1996
---- ---- ----
Net income $ 52,832 $20,231 $27,041
-------- ------- -------
Other comprehensive income, net of tax:
Unrealized net gains (losses) on securities arising during the
period (net of taxes of $12 - 1998, $633 - 1997 and $(47) - 1996) 18 990 (73)
Less: reclassification adjustment for (gains) losses
included in net income (net of taxes of $552 - 1998,
$5 - 1997 and $11 - 1996) (863) (8) (17)
-------- ------- -------
Other comprehensive income (loss) (845) 982 (90)
-------- ------- -------
Comprehensive income, net of taxes $ 51,987 $21,213 $26,951
-------- ------- -------
The accompanying notes are an integral part of these financial statements.
F-8
69
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
1. REPORTING ENTITY
The accompanying consolidated financial statements include the
accounts of Doral Financial Corporation ("DFC" or the "Company"), and
its wholly-owned subsidiaries Doral Mortgage Corporation, Centro
Hipotecario de Puerto Rico, Inc., Doral Bank, Doral Securities, Inc.,
and Doral Money, Inc. All significant intercompany accounts and
transactions have been eliminated in consolidation.
The Company operates under the Bank Holding Company Act (see Note 3)
and its accounting and reporting policies conform with generally
accepted accounting principles. It currently has three lines of
business: 1) mortgage banking; 2) commercial banking; and 3)
broker-dealer business. The Company operates through twenty-six
mortgage banking offices in Puerto Rico, one mortgage banking office
in Florida, one mortgage banking office in Illinois, one mortgage
banking office in New York, eleven commercial banking branches in
Puerto Rico, and one broker-dealer office in Puerto Rico, for a total
of forty-one offices.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company is primarily engaged in the origination, purchase,
securitization and sale of FHA, VA and conventional first and second
mortgage loans and, to a lesser extent, in providing and/or arranging
for interim financing for the construction of residences and other
types of real estate developments. 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"). The Company
services loans for private investors, originates loans for investment
and provides banking services through a Puerto Rico commercial bank,
and provides brokerage services through Doral Securities, Inc. It is
the Company's policy to hold some or all of its loans and securities
for extended periods of time prior to sale.
The following summarizes the most significant accounting policies
followed in the preparation of the accompanying consolidated financial
statements:
Use of Estimates in the Preparation of Financial Statements
The preparation of the consolidated financial statements in conformity
with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amount of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and
the reported amounts of revenues and expenses during the reporting
period. Because of uncertainties inherent in the estimation process,
and due to possible changes in market and economic conditions that
will affect fair values, it is possible that actual results could
differ from those estimates.
F-9
70
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
Securities Held for Trading
Securities that are bought and held principally for the purpose of
selling them in the near term are classified as securities held for
trading and reported at fair value. Realized and unrealized changes in
market value are recorded separately in the trading profit or loss
account in the period in which the changes occur. Interest income and
expense arising from trading instruments are included in the income
statement as part of net interest income rather than in the trading
profit or loss account. The securitization of mortgage loans
held-for-sale is recorded as a sale of mortgage loans and the purchase
of a mortgage-backed security and are classified in accordance with
Statement of Financial Accounting Standards No. 115.
The Company recognizes as interest-only strips (IOs) amounts equal to
the present value of servicing fees to be received in excess of rates
normally paid to federally sponsored secondary market makers. The
amounts recognized are estimated based upon the expected lives of the
loans and using long-term interest rates that reflect the risks of the
assets. The Company includes these IOs as securities held for trading.
The IOs are realized over time through the receipt of the excess
service fees. The Company periodically evaluates the net realizable
value of its IOs based on the present value of the estimated remaining
future excess servicing fees revenue, using current prepayment speed
assumptions determined from market sources for similar type of loans
and the same discount rate used to calculate the original excess
servicing fees receivable asset. The IOs are amortized over a
straight-line basis over their estimated life. The amortization is
recorded as a reduction of interest income. Any impairment in the
recorded value due to acceleration in anticipated prepayment
experience is recognized as a reduction in income.
Securities Held to Maturity
Debt securities which the Company has the ability and intent to hold
until their maturity are classified as securities held-to-maturity and
reported at amortized cost. Premiums and discounts are amortized as an
adjustment to interest income over the life of the related securities
using a method that approximates the interest method.
Securities Available-for-Sale
Securities not classified as either securities held-to-maturity or
trading securities are classified as securities available-for-sale and
reported at fair value, with unrealized gains and losses excluded from
earnings and reported, net of taxes, as a separate component of
stockholders' equity. Cost of securities sold is determined on the
specific identification method.
Securities Transactions of Broker Dealer
Securities transactions of the Company's broker dealer operation are
recorded on the trade date basis. At the end of the period, unsettled
purchase transactions are recorded as part of the Company's position
and as a payable while unsettled sales transactions are deducted from
the Company's position and recorded as a receivable.
F-10
71
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
Mortgage Loans Held for Sale
Mortgage loans held for sale are carried at the lower of cost or
market computed on an aggregate portfolio basis. The amount by which
cost exceeds market value, if any, is accounted for as a valuation
allowance. Changes in the valuation allowance are included in the
determination of income in the period in which the change occurs. Loan
origination fees and direct loan origination costs related to loans
held-for-sale are deferred as an adjustment to the carrying basis of
such loans until these are sold.
Loans Receivable
Loans receivable are held principally for investment purposes. These
mainly consist of residential first and second mortgages, commercial
and consumer loans.
Loans receivable are stated at their unpaid balance, less unearned
interest, net deferred loan fees or costs, and allowance for loan
losses. Unearned interest on consumer loans is amortized using a
method which results in a uniform level rate of return. Loan
origination fees and costs incurred in the origination of loans
held-for-investment are deferred and amortized using the interest
method throughout the life of the loan as a yield adjustment.
Allowance for Losses
An allowance for losses is provided for estimated losses on loans
receivable and real estate held for sale. The allowance for loan
losses is established based upon a review of the loan portfolio, loss
experience, economic conditions and other pertinent factors. Loan
losses are charged and recoveries are credited to the allowance for
loan losses, while increases to the allowance are charged to
operations.
Recognition of interest on loans receivable is discontinued when loans
are more than 90 days in arrears, except on residential mortgage loans
held by the Company's mortgage banking units. At that time, any
interest accrued is reversed against interest income. Such interest,
if ultimately collected, is credited to income in the period of the
recovery. Loans for which the recognition of interest has been
discontinued are designated as non-accruing. Such loans are not
reinstated to accrual status until principal and interest payments are
brought up to date.
The Company measures impairment of a loan 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 Company performs impairment evaluation for
small balance homogeneous loans on a group basis. Loans that are
measured at fair value or at the lower of cost or fair value, are
excluded. Loans are considered impaired when, based on management's
evaluation, a borrower will not be able to fulfill its obligation
under the original terms of the loan.
Servicing Assets
The Company sells or securitizes substantially all of the mortgage
loans it produces 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. These fees are credited to income on a
monthly basis.
F-11
72
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
Servicing rights retained in a sale or securitization are measured by
allocating the carrying value of the loans between the assets sold and
the interest retained, if any, based on their relative fair values, if
practicable, at the date of sale or securitization and are presented
in the accompanying statements of financial condition as servicing
assets.
Purchased servicing assets are initially recorded at their fair value
which equals the amount paid. 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.
Servicing assets are evaluated for impairment. In determining
impairment, servicing assets are disaggregated into pools based on
their predominant risk characteristic, which has been determined to be
interest rates. Impairment is recognized whenever the prepayment
pattern of a particular mortgage pool indicates that the fair value of
the related servicing assets is less than its carrying amount.
Impairment is recognized by charging such excess to income.
Real Estate Held for Sale
The Company acquires real estate through foreclosure procedures. These
properties are held for sale and are stated at the lower of fair
value, less 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 for leasehold improvements and equipment, and forty years
for office building.
The Company measures impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. In performing the review for recoverability, an estimate
of the future cash flows expected to result from the use of the asset
and its eventual disposition must be made. If the sum of the future
cash flows (undiscounted and without interest charges) is less than
the carrying amount of the asset, an impairment loss is recognized.
Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities
The Company recognizes the financial and servicing assets it controls
and the liabilities it has incurred, derecognizes financial assets
when control has been surrendered, and derecognizes liabilities when
extinguished, as required by Statement of Financial Accounting
Standards No. 125 "Accounting for Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities"
("SFAS No. 125").
From time to time, the Company may sell mortgage loans and
mortgage-backed securities subject to put arrangements and/or other
recourse provisions. Pursuant to recourse arrangements, the Company
agrees to retain or share the credit risk with the purchaser of such
mortgage loans. Pursuant to put arrangements, the Company grants the
buyer an option that allows the buyer to sell the securities back to
the Company at a negotiated price but does not restrict the purchaser
from selling such securities to a third party at any time.
F-12
73
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
The Company estimates the fair value of the retained recourse
obligation or any liability incurred at the time of sale and makes an
allocation from the proceeds of the sale. Put options are recorded at
fair value at the time of sale as a liability on the Company's
statement of financial condition, and subsequently carried at fair
value.
Money Market Investments
Money market investments are treated as short-term investments. These
investments are carried at cost. For securities purchased under
agreements to resell, the securities underlying the agreements are not
recorded in the asset accounts of the Company.
Securities Sold under Agreements to Repurchase
From time to time the Company enters into sales of securities under
agreements to repurchase the same or substantially similar securities.
Amounts received under these agreements represent short-term
borrowings and the securities underlying the agreements remain in the
asset accounts. These transactions are carried at the amounts at which
transactions will be settled.
Amortization of Loan Origination Costs and Fees
Loan origination fees and related direct loan origination costs are
deferred and amortized to income as an adjustment of the yield
throughout the average expected life of the related mortgage loan on
loans held for investments. Such fees and costs related to mortgage
loans held for sale are deferred and recognized in income as a
component of the gain on sale of mortgage loans when the related loans
are sold or securitized.
Amortization of Debt Issuance Costs
Costs related to the issuance of debt are amortized under a method
which approximates the interest method, and are shown as deferred
expenses in the prepaid and other assets category.
Interest Rate Risk Management
The Company has various mechanisms to reduce its exposure to interest
rate fluctuations including, among others, entering into transactions
dealing with financial derivatives such as futures contracts, options
and interest rate swaps. Such instruments are purchased as hedges
against future fluctuations in the interest rates and/or market values
of specifically identified assets or liabilities. For financial
reporting purposes, it is the Company's general policy to account for
such instruments on a marked-to-market basis with gains or losses on
such instruments included in the results of operations as part of
trading account profit, as they occur, except for the swaps at Doral
Bank.
From time to time, the Company may designate some of those instruments
as accounting hedges. In such circumstances, the cost of unexpired
options, net of premiums collected on written options, designated as
accounting hedges is capitalized as part of the carrying cost and
charged to income in relation to the life of the underlying security
being hedged.
F-13
74
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
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 with servicing
retained. Under most of the servicing agreements, the Company is
required to advance funds to make scheduled payments to investors, if
payments due have not been received from the mortgagors. The Company
is also required to foreclose on loans in the event of default by the
mortgagor. At December 31, 1998, accounts receivable include advances
to investors of approximately $9,936,000 (1997 - $9,460,000).
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 which, based on
management's evaluation, 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.
Legal Surplus
The Banking Act of the Commonwealth of Puerto Rico requires that a
minimum of 10% of Doral Bank's net income for the year be transferred
to a legal surplus account until such surplus equals paid-in-capital.
The amount to the surplus account is not available for payment of
dividends to the shareholders.
Statement of Cash Flows
Cash and cash equivalents include cash and due from banks, securities
purchased under agreements to resell, time deposits and other short
term investments with a maturity of three months or less when
purchased.
Earnings per Share
Basic net income per share is determined by dividing net income, after
deducting any dividends on preferred stock, by the weighted average
number of shares outstanding during the period. The average number of
shares considers the dilutive effect of restricted stock awards and
stock options grants after giving effect to common stock splits.
Diluted net income per share has been computed based on the assumption
that all of the shares of convertible instruments will be converted
into common stock. The calculation gives effect to the elimination of
interest expense, net of income taxes, applicable to the convertible
subordinated debt.
F-14
75
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
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 may be realized in the future.
Stock Option Plan
Statement of Financial Accounting Standards No.123, "Accounting for
Stock-Based Compensation", ("SFAS No. 123") superseded and amended the
guidance offered by Accounting Principles Board Opinion (APB) No. 25
relating to stock-based compensation. SFAS No. 123, states that the
cost associated with the stock option plan under which certain
employees receive options to buy shares of stock of an entity must be
recognized either by the fair value-based method or the intrinsic
value-based method. Under the fair value-based method, cost is
measured at the grant date based on the fair value of the stock option
cost. Cost is recognized ratably over the service period of the
option, which is usually the vesting period. Under the intrinsic
value-based method, compensation expense is recognized for the excess,
if any, of the quoted market price of the stock at grant date or other
measurement date over the amount an employee must pay to acquire the
stock.
SFAS No. 123, which establishes preference for the use of the fair
value-based method, allows entities to continue reporting its
stock-based compensation arrangements under the intrinsic value-based
method established in APB No. 25. In adopting SFAS No. 123, the
Company continued to account for its stock option plan in accordance
with APB No. 25 (see Note 25).
Reporting Comprehensive Income
In January 1998, the Company adopted the Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
No.130"). This statement established standards for reporting and
displaying comprehensive income and its components (revenue, expenses,
gains and losses) in a full set of general purpose financial
statements. This statement requires an enterprise to classify items of
other comprehensive income by their nature in a financial statement
and display the accumulated balance of other comprehensive income
separately from retained earnings and additional paid-in capital in
the equity section of the statement of financial condition. In the
Company's case, in addition to net income, other comprehensive income
results from the changes in the unrealized gains and losses on
securities that are classified as available for sale.
Disclosures about Segments Information of an Enterprise and Related
Information
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information" ("SFAS No.
131"). This statement established the standards for the way that
public business enterprises report information about operating
segments in annual financial statements and requires that those
enterprises report selected information about operating segments in
interim reports issued to shareholders.
F-15
76
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
As required by SFAS No. 131, a public business enterprise needs to
report financial and descriptive information about its reportable
segments. Operating segments are components of an enterprise about
which separate financial information is available that is evaluated
regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. It also requires
reporting descriptive information about the way that the operating
segments were determined, the products and the services provided by
the operating segments, differences between the measurements used in
reporting segment information and those used in the enterprises
general purpose financial statements, and the changes in the
measurement of segment amount from period to period. DFC's management
determined that the segregation that best fulfills the segment
definition described above is by line of business. The Company
presents the required disclosures in Note 31.
RECENT ACCOUNTING PRONOUNCEMENTS
Accounting for Derivative and Similar Financial Instruments and for
Hedging Activities
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
and Similar Financial Instruments and for Hedging Activities". This
new standard, which becomes effective for all fiscal quarters of all
fiscal years beginning after June 15,1999, established accounting and
reporting standards for derivative financial instruments and for
hedging activities. The SFAS requires all derivatives to be measured
at fair value and to be recognized as either assets or liabilities in
the statement of financial condition. Under this standard, derivatives
used in hedging activities should be designated into one of the
following categories: (a) fair value hedge; (b) cash flow hedge; and
(c) foreign currency exposure hedge. Gains and losses resulting from
the changes in fair value will be either recognized as part of
earnings in the period when the change occurs or as a component of
other comprehensive income (outside earnings) depending on their
intended use and resulting designation. Management believes that such
adoption will not have a material effect on the Company's financial
condition or results of operations.
Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held-for-Sale by a Mortgage Banking
Enterprise
In 1998, the Company adopted the provision of the Statement of
Financial Accounting Standards No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of
Mortgage Loans Held-for-Sale by a Mortgage Banking Enterprise," an
amendment of FASB Statement No. 65. This statement permits mortgage
banking companies to classify mortgage-backed securities and other
beneficial interests retained after the securitization of mortgage
loans held-for-sale, in accordance with SFAS No. 115, except for those
with sales commitments in place. In connection with the adoption of
this statement, the Company reclassified approximately $115,680,000 of
securities classified as trading securities to the held-to-maturity
portfolio.
Reclassifications
Certain amounts reflected in the 1997 and 1996 consolidated financial
statements have been reclassified to conform to the presentation for
1998.
F-16
77
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
3. REGULATORY REQUIREMENTS
Holding Company Requirements
In October 1997, the Company became a bank holding company subject to
the provisions of the Bank Holding Company Act ("BHC Act"). As a bank
holding company, the Company is subject to supervision and regulation
by the Board of Governors of the Federal Reserve System. The Company's
activities and those of its banking and nonbanking subsidiaries are
limited to the business of banking and activities closely related or
incidental to banking, and the Company may not, directly or
indirectly, acquire the ownership or control of more than 5% of any
class of voting shares or substantially all of the assets of any
company in the United States, including a bank, without the prior
approval of the Federal Reserve. In addition, bank holding companies
are generally prohibited under the BHC Act from engaging in nonbanking
activities, subject to certain exceptions.
Banking Charter
Effective October 1, 1997, the Company's banking subsidiary, converted
its charter from a federal savings bank to a Puerto Rico commercial
bank under the laws of the Commonwealth of Puerto Rico. Concurrently,
it changed its name to Doral Bank.
Regulatory Capital Requirements
The Company is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Company. Under capital
adequacy guidelines and the regulatory framework for prompt corrective
action, the Company must meet specific capital guidelines that involve
quantitative measures of it assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting
practices. The Company's capital amounts and classification are also
subject to qualitative judgments by the regulators about components,
risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company to maintain minimum amounts and ratios
(set forth in the following table) of total and Tier I capital (as
defined in the regulations) to risk weighted assets (as defined), and
of Tier I capital (as defined) to average assets (as defined).
Management believes, as of December 31, 1998, that the Company meets
all capital adequacy requirements to which it is subject.
As of December 31, 1998, the most recent notification from the FDIC,
dated as of July 30, 1998, categorized Doral Bank as well capitalized
under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, Doral Bank must maintain minimum
total risk-based, Tier I risk-based, Tier I leverage ratios as set
forth in the following table. There are no conditions or events since
the FDIC notification that management believes have changed Doral
Bank's category.
F-17
78
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
DFC's and Doral Bank's actual capital amounts and ratios are also
presented in the following table. Totals of $12,846,000 (1997 -
$11,717,000) and $307,000 (1997 - $846,000) representing non-allowable
assets, such as goodwill and portions of servicing assets, were
deducted from the capital of DFC and Doral Bank, respectively.
(Dollars in thousands) TO BE WELL
CAPITALIZED
UNDER PROMPT
FOR CAPITAL CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------- ---------------------- --------------------
AMOUNT RATIO (%) AMOUNT RATIO (%) AMOUNT RATIO (%)
As of December 31, 1998:
Total capital (to risk-weighted assets):
DFC Consolidated $ 261,879 16.8 $124,430 > 8.0 N/A N/A
-
Doral Bank only $ 50,025 13.3 $ 30,204 > 8.0 $37,754 > 10.0
- -
Tier I capital (to risk-weighted assets):
DFC Consolidated $ 256,713 16.5 $ 62,215 > 4.0 N/A N/A
-
Doral Bank only $ 49,718 13.2 $ 15,102 > 4.0 $22,653 > 6.0
- -
Tier I capital (to average assets):
DFC Consolidated $ 256,713 9.2 $111,693 > 4.0 N/A N/A
-
Doral Bank only $ 49,718 8.0 $ 24,780 > 4.0 $30,975 > 5.0
- -
As of December 31, 1997:
Total capital (to risk-weighted assets):
DFC Consolidated $ 177,027 18.2 $ 78,044 > 8.0 N/A N/A
-
Doral Bank only $ 32,316 19.0 $ 13,630 > 8.0 $17,037 > 10.0
- -
Tier I capital (to risk-weighted assets):
DFC Consolidated $ 175,238 18.0 $ 39,022 > 4.0 N/A N/A
-
Doral Bank only $ 31,470 18.5 $ 6,815 > 4.0 $10,222 > 6.0
- -
Tier I capital (to average assets):
DFC Consolidated $ 175,238 10.1 $ 69,317 > 4.0 N/A N/A
-
Doral Bank only $ 31,470 9.6 $ 13,173 > 4.0 $16,466 > 5.0
- -
Housing and Urban Development Requirements
The Company's mortgage operation is a U.S. Department of Housing and
Urban Development approved, 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.
SAIF Assessment
During the third quarter of 1996, the Company recorded a nonrecurring
expense of $588,000 related to a special assessment by the Federal
Deposit Insurance Corporation due to the enactment of legislation to
recapitalize the Savings Association Insurance Fund.
F-18
79
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
Registered Broker-Dealer Requirements
Doral Securities is registered as a broker-dealer with the Securities
and Exchange Commission ("SEC") and the Puerto Rico Office of the
Commissioner of Financial Institutions (the "CFI"). Doral Securities
is also a member of the National Association of Securities Dealers
(the "NASD"). As a registered broker-dealer, it is subject to
regulation by the SEC, the NASD and the CFI in matters relating to the
conduct of its securities business, including record keeping and
reporting requirements, supervision and licensing of employees and
obligations to customers. In particular, Doral Securities is subject
to net capital rules, which specify minimum net capital requirements
for registered broker-dealers, and are designed to ensure that such
institutions maintain adequate regulatory capital in relation to their
liabilities and the size of their customer business.
The Company is in compliance with these regulatory requirements.
4. MONEY MARKET INVESTMENTS
At December 31, 1998, money market investments include securities
purchased under agreements to resell in which the collateral is
summarized as follows:
(in thousands)
COLLATERAL
CARRYING ESTIMATED
VALUE MARKET VALUE
------- ------------
Mortgage-backed securities $ 16,527 $ 17,553
US Government securities 63,035 67,291
Other securities 41,171 41,123
-------- --------
$120,733 $125,967
-------- --------
These securities were held on behalf of the Company by the dealers
that arranged the transactions.
5. MORTGAGE LOANS HELD FOR SALE
At December 31, mortgage loans held for sale consisted of the
following:
(in thousands)
1998 1997
---- ----
Conventional single family residential loans $ 640,744 $ 307,329
FHA/VA loans 137,742 81,502
Mortgage loans on residential multifamily 53,074 --
Construction and commercial real estate loans 46,253 13,377
Consumer loans secured by mortgages 5,235 2,464
--------- ---------
$ 883,048 $ 404,672
--------- ---------
F-19
80
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
At December 31, the aggregate amortized cost and approximate market
value of these loans were as follows:
(in thousands)
GROSS UNREALIZED GROSS UNREALIZED APPROXIMATE
AMORTIZED COST HOLDING GAINS HOLDING LOSSES MARKET VALUE
-------------- ---------------- ---------------- ------------
1998 $ 883,048 $ 24,051 $ 2,662 $ 904,437
============ ========== ========== ==========
1997 $ 404,672 $ 8,753 $ 5,843 $ 407,582
------------ ---------- ---------- ----------
6. SECURITIES HELD FOR TRADING
Securities held for trading consisted of:
(in thousands)
DECEMBER 31,
------------
1998 1997
---- ----
Mortgage-backed securities:
GNMA $ 496,973 $ 420,365
CMO certificates 38,593 157,236
FHLMC 4,347 4,954
FNMA 20,762 3,569
Interest-only strips 42,202 29,093
US Treasury Notes 101 --
US Treasury Bills 101 --
Other 3,839 5,071
--------- ---------
$ 606,918 $ 620,288
--------- ---------
CMO certificates included the following:
(in thousands)
DECEMBER 31,
-------------
1998 1997
---- ----
Interest only certificates $ 13,630 $ 14,310
Subordinated certificates, CMO's established
by the Company 5,421 13,699
Residual certificates, CMO's established by
the Company 2,752 3,870
-------- --------
$ 21,803 $ 31,879
-------- --------
Net unrealized holding (losses) gains on trading securities included
in earnings for the year ended December 31, 1998 amounted to
approximately ($2,791,000) (1997 - ($2,427,000), 1996 - $2,796,000).
F-20
81
DORAL FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
Years ended December 21, 1998, 1997 and 1996
- --------------------------------------------------------------------------------
7. SECURITIES HELD TO MATURITY
The amortized cost, unrealized holding gains and losses, approximate
market value, weighted average yield and contractual maturities of
held-to-maturity securities as of December 31, 1998 and 1997 (1996 -
only amortized cost and weighted average yield are presented) were as
follows:
(Dollars in thousands) 1998
---------------------------------------------------------------
WEIGHTED
AMORTIZED UNREALIZED UNREALIZED MARKET AVERAGE
COST GAINS LOSSES VALUE YIELD
MORTGAGE-BACKED
GNMA
Due over ten years $ 31,511 $ 385 $ 19 $ 31,877 6.96%
CMO CERTIFICATES
Due from one to five years 3,030 -- -- 3,030 5.80%
Due from five to ten years 14,084 -- -- 14,084 8.19%
Due over ten years 137,153 983 2 138,134 5.84%
PR HOUSING BANK NOTES
Due over ten years 5,000 -- -- 5,000 6.20%
--------------------------------------------------------
$190,778 $ 1,368 $ 21 $192,125 6.21%
--------------------------------------------------------
1997 1996
--------------------------------------------------------------- ----------------------
WEIGHTED WEIGHTED
AMORTIZED UNREALIZED UNREALIZED MARKET AVERAGE AMORTIZED AVERAGE
COST GAINS LOSSES VALUE YIELD COST YIELD
MORTGAGE-BACKED
GNMA
Due over ten years $ 5,053 $ 24 $ -- $ 5,077 7.00% $ 37,879 6.98%
CMO CERTIFICATES
Due within a year 4,895 118 -- 5,013 5.70% -- --
Due from one to five years 5,871 -- 3 5,868 5.60% 12,488 5.64%
Due from five to ten years 12,483 237 -- 12,720 5.89% 12,483 5.89%
Due over ten years 27,227 661 -- 27,888 4.81% 33,857 4.78%
DEBT SECURITIES
FED FARM CREDIT NOTES
Due from five to ten years 40,000 100 -- 40,100 7.12% -- --
FEDERAL HOME LOAN
BANK NOTES
Due from one to five years -- -- -- -- -- 2,000 7.05%
Due from five to ten years 5,000 13 -- 5,013 7.00% 1,493 7.50%
Due over ten years 30,000 125 -- 30,125 7.44% -- --
P.R. HOUSING BANK NOTES
Due over ten years 5,000 -- 10 4,990 6.20% -- --
U.S. TREASURY NOTES
Due within a year 6,989 -- 11 6,978 5.37% -- --
Due from one to five years -- -- -- -- -- 6,956 5.38%
U.S. TREASURY BILLS
Due within a year 1,016 -- 4 1,012 5.14% 66 5.14%
----------------------------------------------------------------------------------------
$143,534 $1,278 $ 28 $144,784 6.39% $107,222 5.91%
----------------------------------------------------------------------------------------
The weighted average yield is computed based on amortized cost and,
therefore, it does not give effect to changes in fair value.
F-21
82
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
Expected maturities of mortgage-backed securities and certain debt
securities might differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call
or prepayment penalties.
8. SECURITIES AVAILABLE FOR SALE
The amortized cost, unrealized holding gains and losses, approximate
market value, weighted average yield and contractual maturities of
securities available for sale as of December 31, 1998 and 1997 (1996 -
only market value and weighted average yield are presented) were as
follows:
1998
(Dollars in thousands) ---------------------------------------------------------------
WEIGHTED
AMORTIZED UNREALIZED UNREALIZED MARKET AVERAGE
COST GAINS LOSSES VALUE YIELD
DEBT SECURITIES
US TREASURY
Due within a year $ 10,326 $ -- $ -- $ 10,326 4.95%
Due over ten years 26,609 -- 343 26,266 5.50%
FEDERAL HOME LOAN
BANK NOTES
Due within a year 24,928 -- -- 24,928 5.09%
Due from one to five years 25,000 31 -- 25,031 6.75%
Due from five to ten years 45,000 56 -- 45,056 6.67%
Due over ten years 263,933 283 -- 264,216 6.74%
FED FARM CREDIT NOTES
Due from one to five years 8,000 40 -- 8,040 5.95%
Due from five to ten years 5,000 25 -- 5,025 6.22%
-------------------------------------------------------------
$ 408,796 $ 435 $ 343 $ 408,888 6.48%
-------------------------------------------------------------
1997 1996
------------------------------------------------------------------- ----------------------
WEIGHTED WEIGHTED
AMORTIZED UNREALIZED UNREALIZED MARKET AVERAGE MARKET AVERAGE
COST GAINS LOSSES VALUE YIELD VALUE YIELD
MORTGAGE-BACKED
FNMA
Due over ten years $ 2,008 $ -- $ 49 $ 1,959 5.69% $ 2,134 5.67%
FHLMC
Due over ten years 2,155 -- 68 2,087 5.50% 2,277 5.50%
GNMA
Due over ten years 43,375 1,162 -- 44,537 7.01% 7,596 7.00%
DEBT SECURITIES
US TREASURY
Due over ten years 25,661 -- 81 25,580 6.27% -- --
FEDERAL HOME LOAN
BANK NOTES
Due over ten years 166,200 513 -- 166,713 7.37% -- --
------------------------------------------------------------------------------------------
$239,399 $1,675 $198 $240,876 6.48% $12,007 6.46%
------------------------------------------------------------------------------------------
The weighted average yield is computed based on amortized cost and,
therefore, it does not give effect to changes in fair value.
F-22
83
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
Proceeds from sales of securities available for sale during 1998 were
approximately $507,346,000 (1997 - $199,875,000, 1996 - $6,548,000).
Gross gains of $6,556,000 (1997 - $1,576,000, 1996 - $846,000) were
realized on those sales. Gross losses of $504,000 were realized on
sales for 1998. No losses were sustained during 1997 and 1996.
Expected maturities of mortgage-backed securities and certain
debt securities might differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
9. LOANS RECEIVABLE
Loans receivable are related to the Company's commercial banking and
construction loan operations and consisted of:
(in thousands)
DECEMBER 31,
------------
1998 1997
---- ----
Residential mortgage loans $ 80,902 $ 87,037
Commercial real estate mortgage loans 16,443 19,036
Consumer - secured by mortgage 5,005 7,828
Construction loans 72,081 9,927
Loans on savings deposits 3,676 3,513
Commercial 11,051 3,461
Consumer - other 6,290 2,328
Land secured 21,418 1,488
--------- ---------
Gross loans 216,866 134,618
--------- ---------
Less:
Undisbursed portion of loans in process (47,575) --
Unearned interest and deferred loan fees (648) (322)
Allowance for loan losses (1,656) (1,241)
--------- ---------
(49,879) (1,563)
--------- ---------
Total loans
$ 166,987 $ 133,055
--------- ---------
As of December 31, 1998, the Company had loans receivable amounting to
approximately $3,671,000 (1997 - $2,462,000) 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 $335,000 (1997 - $201,000, 1996 - $114,000).
F-23
84
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
The Company mostly originates fixed interest rate loans and, to a
lesser extent, construction and commercial adjustable 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 the Company pays on the short-term deposits that have primarily
funded these loans.
At December 31, 1998, fixed rate loans and adjustable rate loans were
approximately $112,597,000 and $56,694,000, respectively.
The Company evaluated the loans receivable, some individually and
others as a homogeneous group, for purposes of determining impairment.
The Company determined that, individually and as a group of
homogeneous loans, given the characteristics of most of its loans, no
impairment reserve was necessary at December 31,1998 and 1997.
10. ALLOWANCES FOR LOSSES
Changes in the allowances for losses were as follows:
(In thousands)
1998 1997 1996
---- ---- ----
Allowance for real estate held for sale:
Balance at beginning of period $ 676 $ 356 $ 356
Provision for losses 1,402 787 305
Losses charged to the allowance (1,067) (467) (305)
-------- ------- -------
Balance at the end of period $ 1,011 $ 676 $ 356
-------- ------- -------
Allowance for loan losses:
Balance at beginning of period $ 2,866 $2,152 $ 2,047
Provision for loan losses 883 792 797
Recoveries 76 46 48
Other adjustments 1,468 -- --
Losses charged to the allowance (127) (124) (740)
-------- ------- -------
Balance at the end of period $ 5,166 $ 2,866 $ 2,152
-------- ------- -------
In 1998, the Company allocated the allowance for loan losses between
loans held for sale and loans receivable. At December 31, 1998, of the
total allowance for loan losses, approximately $3,510,000 and
$1,656,000, were allocated to loans held for sale and loans
receivable, respectively.
F-24
85
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
11. PROPERTY, LEASEHOLD IMPROVEMENTS AND EQUIPMENT
Property, leasehold improvements and equipment consisted of:
(in thousands)
DECEMBER 31,
------------
1998 1997
---- ----
Office furniture and equipment $ 9,907 $ 8,612
Leasehold improvements 7,929 6,190
Automobiles 579 514
Office building 367 364
--------- ---------
18,782 15,680
Less - Accumulated depreciation and amortization (7,810) (8,039)
--------- ---------
10,972 7,641
Land 4,607 2,957
Construction in progress 3,694 250
--------- ---------
$ 19,273 $ 10,848
--------- ---------
During 1996, the Company acquired a two acre parcel of land for
approximately $3.0 million for the construction of the headquarter
facilities of the Company and it subsidiaries. Total construction costs
of the facilities are estimated at approximately $40 million.
During 1998, the Company entered into an agreement with a contractor in
the amount of $24 million for the construction of the first phase of
the project. At December 31, 1998, construction in progress includes
approximately $2.8 million of costs incurred in the construction of
these facilities. Such costs included approximately $167,000 of
capitalized interest costs.
12. SERVICING ASSETS
The changes in servicing assets are shown below:
(in thousands)
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
---- ---- ----
Balance at beginning of period $ 46,416 $20,969 $11,164
Capitalization of rights 23,244 13,980 10,804
Rights sold (54) -- --
Rights purchased 9,632 14,904 --
Amortization:
Scheduled (5,739) (3,437) (999)
Unscheduled (931) -- --
-------- ------- -------
Balance at the end of period $ 72,568 $46,416 $20,969
-------- ------- -------
The Company's servicing portfolio amounted to approximately $6.2
billion, $4.7 billion, and $3.1 billion at December 31, 1998, 1997, and
1996, respectively, including $925 million, $393 million, and $317
million, respectively, of loans serviced for the Company.
F-25
86
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
During the years ended December 31, 1998 and 1996, the Company sold
rights to service loans amounting to approximately $103 million and
$102 million, respectively. There were no such sales during the year
ended December 31, 1997. During the years ended December 31, 1998 and
1997, the Company purchased rights to service loans amounting to
approximately $229.2 million and $1 billion, respectively. No such
rights were purchased during 1996.
13. ACCOUNTS PAYABLE AND OTHER LIABILITIES
Accounts payable and other liabilities consisted of the following:
(in thousands)
DECEMBER 31,
------------
1998 1997
---- ----
Amounts retained on mortgage loans,
generally paid within 5 days $ 16,696 $ 5,262
Customer mortgages and closing expenses payable 5,580 1,845
Deferred compensation plan 1,838 2,728
Incentive compensation payable 8,339 4,916
Accrued expenses and other payables 75,469 52,828
Deferred tax liability 9,752 9,874
--------- ---------
$ 117,674 $ 77,453
--------- ---------
Accrued expenses and other payables include approximately $44.7
million and $26.5 million of book overdraft at December 31, 1998 and
1997, respectively.
14. LOANS PAYABLE
At December 31, 1998 and 1997, the Company had several mortgage
warehousing lines of credit and gestation or presale facilities
totaling approximately $626 million and $702 million, respectively.
Advances under these facilities are secured by loans held for
subsequent inclusion in GNMA, FNMA , and FHLMC pools or for sale to
financial investors.
Loans payable consisted of the following:
(in thousands)
DECEMBER 31,
------------
1998 1997
---- ----
Loans payable resulting from the use of warehousing lines
of credit and gestation or presale facilities due in 1999,
at various variable rates averaging - 6.69% and 7.20%
at December 31, 1998 and 1997, respectively, and
other financing arrangements $ 426,704 $ 238,770
--------- ---------
F-26
87
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
Maximum borrowings outstanding at any month-end during 1998 and 1997
were $429 million and $240 million, respectively. The approximate
average outstanding borrowings during the periods were $364 million
and $180 million, respectively. The weighted average interest rate of
such borrowings, computed on a monthly basis was 7.18% in 1998 and
7.05% in 1997.
The Company entered into a Syndicated Credit Agreement (the
"Syndicated Credit Agreement"), with five banks providing for credit
facilities totaling up to $167 million. The agreement expires on June
27, 1999. The credit facilities were structured by Bankers Trust
Company as administrative and syndicate agent. The facilities include:
(i) a $157 million secured one-year revolving warehousing credit
facility to finance residential mortgage loans and mortgage-backed
securities; and (ii) a $10 million secured one-year revolving credit
facility to provide financing for receivables and working capital
needs. 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 and receivables
relating to servicing advances and real estate owned for the second
facility. Loans payable include advances from the warehousing credit
facility. Advances from the other facility is included in notes
payable. The Company has also entered into a Credit Agreement dated as
of June 26, 1998 with Bankers Trust Company and four other banks that
provides a revolving credit facility of $45 million for the financing
of mortgage servicing rights and working capital. This credit
facility, which expires on June 27, 1999, is secured by the Company's
servicing portfolio. As of December 31, 1998, the Company had borrowed
$45 million under this credit facility which are reported as 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, 1998, the Company was in compliance with these
requirements.
15. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Company sells mortgage-backed securities and mortgage loans under
agreements to repurchase. The securities underlying the agreements to
repurchase were delivered to, and are being held by, the
counterparties with whom the repurchase agreements were transacted.
The counterparties have agreed to resell to the Company the same or
substantially similar securities at the maturity of the agreements.
The following summarizes significant data about securities sold under
agreements to repurchase for the years ended December 31, 1998 and
1997:
(Dollars in thousands)
1998 1997
---- ----
Carrying amount as of December 31, $1,197,328 $ 838,142
---------- ---------
Average monthly aggregate balance outstanding $1,073,000 $ 550,000
---------- ---------
Maximum balance outstanding at any month-end $1,236,000 $ 850,000
---------- ---------
Weighted average interest rate during the year 5.18% 5.78%
---------- ---------
Weighted average interest rate at year end 5.26% 5.93%
---------- ---------
F-27
88
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
The carrying and market values of securities available-for-sale and
securities held-to-maturity pledged as collateral at December 31, were
as follows:
(Dollars in thousands)
1998 1997
----------------------------------------------- -------------------------------------------------
CARRYING MARKET REPURCHASE REPO CARRYING MARKET REPURCHASE REPO
VALUE VALUE LIABILITY RATE VALUE VALUE LIABILITY RATE
----------------------------------------------- -------------------------------------------------
FHLB Discount Notes
Term up to 30 days $ 96,981 $ 97,130 $ 93,248 5.26% $ 84,000 $ 84,308 $ 81,653 5.80%
Term of 30 to 90 days 56,125 56,240 54,275 5.49% -- -- -- --
Term over 90 days 152,065 152,171 144,469 5.08% -- -- -- --
CMO Certificates
Term up to 30 days 1,373 1,367 1,220 5.85% -- -- -- --
Term of 30 to 90 days 73,119 72,437 65,688 5.34% 51,684 51,489 43,875 5.84%
US Treasury Securities
Term up to 30 days 26,609 26,265 26,375 2.24% 15,450 15,369 15,706 5.88%
PRHB Notes
Term over 90 days 5,000 5,000 4,845 5.29% -- -- -- --
GNMA Mortgage-Backed
Securities
Term up to 30 days -- -- -- -- 10,054 10,190 9,770 6.46%
-------- -------- -------- ---- ------- ------- ------ ----
$411,272 $410,610 $390,120 4.93% $161,188 $161,356 $151,004 6.00%
-------- -------- -------- ---- -------- -------- -------- ----
F-28
89
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
16. NOTES PAYABLE
Notes payable consisted of the following:
(in thousands) DECEMBER 31,
1998 1997
----- -----
Demand note, at 9.00% interest, collateralized by CMO certificates $ 1,000 $ 1,000
Unsecured notes, payable at interest rates ranging from
6.50% to 9.00%, final payment dates ranging from
January 1999 to October 2003 2,710 4,045
Note payable to bank, collateralized by CMO certificates,
at 8.50% interest rate and due on October 10, 1999 8,079 8,756
Note payable to bank, collateralized by CMO certificates,
at 8.00% interest rate and due on February 15, 1999 2,709 2,898
Term-notes payable to corporate investors, collateralized by
stand-by letters of credit issued by the Federal Home Loan
Bank of New York:
at 6.50% maturing on October 13, 2000 8,100 8,100
at a variable rate (5.12% and 5.23% at December 31, 1998
and 1997, respectively) maturing on November 17, 2000 5,000 5,000
at 5.70% maturing on November 27, 2000 5,000 5,000
at 6.05% maturing on May 23, 2001 5,000 5,000
at 5.98% maturing on June 19, 2001 10,000 10,000
at 6.30% maturing on September 18, 2001 10,000 10,000
at 6.28% maturing on September 24, 2001 10,000 10,000
Note payable to bank, at 5.69% (1997 - 7.40%) interest
rate, due June 27, 1999 10,000 3,000
7.84% Senior Notes due on October 10, 2006 75,000 75,000
Mortgage note secured by land at 7.56% (1997 - 7.88%)
interest rate and due on June 30, 1999 2,135 2,135
Note payable to bank, collateralized by mortgage
servicing rights held by the Company, at variable interest rates,
ranging from 6.40% to 6.87%, due on June 27, 1999 45,000 15,000
----------- -----------
$ 199,733 $ 164,934
----------- -----------
F-29
90
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
At December 31, 1998, the scheduled aggregate annual maturities of
notes payable were approximately as follows:
(in thousands)
YEAR ENDING DECEMBER 31,
-----------------------
1999 $ 71,048
2000 18,360
2001 35,050
2002 --
2003 275
2004 and thereafter 75,000
------------
$ 199,733
--------------
17. DEPOSIT ACCOUNTS
At December 31, deposits and their weighted average interest rates are
summarized as follows:
(Dollars in thousands)
1998 1997
---- ----
AMOUNT % AMOUNT %
------ --- ------- ---
Certificates of deposit $ 305,423 5.77 $ 199,326 6.01
Regular savings 46,593 4.74 18,756 4.42
Now accounts 63,605 5.06 15,755 4.40
Non interest-bearing deposits 117,492 -- 66,657 --
--------- ---------
$ 533,113 $ 300,494
--------- ---------
At December 31, 1998 and 1997, certificates of deposit over $100,000
amounted to $176,330,000 and $102,570,000, respectively.
A summary of certificates of deposit by maturity as of December 31,
1998 follows:
(in thousands)
1999 $ 194,191
2000 25,475
2001 27,686
2002 20,666
2003 36,492
2004 913
---------
$ 305,423
---------
F-30
91
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
At December 31, 1998, Doral Bank had brokered certificates of deposit
amounting to $96,840,000 maturing as follows:
(in thousands)
1999 $ 11,236
2000 15,781
2001 24,248
2002 17,556
2003 27,664
2004 and thereafter 355
---------
$ 96,840
---------
At December 31, 1998, the Company had deposits from officers,
directors, employees and stockholders of the Company amounting to
approximately $1,206,000 (1997 - $892,000).
The Company, as a servicer of loans, is required to maintain certain
balances on behalf of the borrowers called escrow funds. At December
31, 1998, escrow funds amounted to approximately $109,825,000 (1997 -
$62,280,000), of which $78,761,000 were deposited with Doral Bank
(1997 - $50,656,000). The remaining escrow funds, $31,064,000 (1997 -
$11,624,000) were deposited with other banks and therefore excluded
from the Company's assets and liabilities.
18. ADVANCES FROM THE FEDERAL HOME LOAN BANK
At December 31, advances from the Federal Home Loan Bank of New York
("FHLB") consisted of the following:
(in thousands)
1998 1997
---- ----
6.307% due on July 21, 2000 $ 5,000 $ 5,000
6.445% due on July 17, 2002 5,000 5,000
5.959% due on January 29, 2003 5,000 5,000
6.454% due on October 10, 2007 10,000 10,000
6.380% due on December 31, 2007 7,000 7,000
---------- ----------
$ 32,000 $ 32,000
---------- ----------
At December 31, 1998, the Company had posted qualified collateral, in
the form of first mortgage notes and mortgage-backed securities with a
market value of $130,365,000 pledged to secure the above advances from
the FHLB and stand-by letters of credit issued by the FHLB as
collateral for term-notes in aggregate amount of $53,100,000 shown
under notes payable.
F-31
92
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
19. INCOME TAXES
Under the provisions of Law No. 38 of May 20, 1983, the Company was
exempt from the payment of Puerto Rico income taxes on the interest
earned on mortgage loans 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. On July 22, 1997,
an amendment to the Puerto Rico Internal Revenue Code was adopted that
modified the tax-exempt treatment of FHA and VA loans secured by real
property in Puerto Rico and GNMA mortgage-backed securities backed by
such loans. Under the terms of the amendment, effective August 1,
1997, only FHA and VA loans for the original acquisition of newly
constructed housing and mortgage-backed securities backed by such
loans qualify for tax-exempt treatment. The amendment grandfathered
the tax-exempt status of FHA and VA loans originated prior to August
1, 1997, and mortgage-backed securities backed by such loans.
Given the tax characteristics of these assets, the Company holds such
loans and mortgage-backed securities for longer periods of time prior
to sale in order to maximize the tax exempt interest produced by these
securities and loans. Therefore, net interest income has generally
represented a greater proportion of the Company's total net income
than that of a typical mortgage banking institution.
The mortgage banking operations of the Company conducted through
Puerto Rico corporations are not subject to United States income tax
for income derived from business 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 is not significant.
Consolidated tax returns are not permitted under the Puerto Rico
Internal Revenue Code, therefore, income tax returns are filed
individually by each entity.
Doral Bank as a Puerto Rico Chartered Commercial Bank
Doral Bank is subject to Puerto Rico income tax on its income derived
from all sources. Doral Bank is also subject to United States income
taxes on certain types of investment income from U.S. sources and also
on income effectively connected with any trade or business from U.S.
sources. However, any federal income tax paid by Doral Bank is,
subject to certain conditions and limitations, creditable as a foreign
tax credit against its Puerto Rico income tax liability.
Prior to its conversion to a Puerto Rico commercial bank, Doral Bank
was a federal thrift organized under the laws of the United States and
thus, subject to United States federal income tax with respect to all
of its income, including income from sources within Puerto Rico (the
"Possession"). For United States income tax purposes, Doral Bank
elected to be treated as a possessions corporation pursuant to Section
936 of the Internal Revenue Code of 1986 (the "Code"). Section 936 of
the Code allowed Doral Bank to claim a credit, (the "Section 936
credit"), subject to qualification of the source and nature of the
income and certain other limitations, against federal income tax on
income derived from sources outside of the United States that was
attributable to the active conduct of a trade or business in Puerto
Rico ("Qualifying Active Income"). The Section 936 credit, as
described, was claimed by Doral Bank for its taxable years beginning
before September 30, 1997 to shelter from United States income
taxation its Qualifying Active Income.
F-32
93
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
For Puerto Rico income tax purposes Doral Federal was taxed as a
foreign corporation engaged in a trade or business in Puerto Rico. As
such, Doral Federal was subject to Puerto Rico income tax on all of
its income from sources within Puerto Rico and income from sources
outside Puerto Rico that was effectively connected with its Puerto
Rico business.
Reconciliation of Effective Tax Rate
The provision for income taxes of the Company differs from amounts
computed by applying the applicable Puerto Rico statutory rate to
income before taxes. A reconciliation of the difference follows:
(Dollars in thousands)
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
Income before income taxes $ 59,839 $ 37,797 $ 31,279
-------- -------- --------
% OF PRETAX % OF PRETAX % OF PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
-------- -------- -------- ----------- -------- ----------
Tax at statutory rates $ 23,337 39.0 $14,741 39.0 $12,199 39.0
Tax effect of exempt interest
income, net of disallowance (13,237) (22.1) (8,118) (21.5) (8,502) (27.2)
Tax effect of capital gains (1,925) (3.2) (840) (2.2) -- --
Other, net (1,168) (2.0) (534) (1.4) 541 1.7
-------- ---- ------- ---- ------- ----
Provision for income taxes $ 7,007 11.7 $5,249 13.9 $4,238 13.5
-------- ---- ------ ---- ------ ----
The components of income tax expense for the years ended December 31,
are summarized below.
(in thousands)
1998 1997 1996
---- ---- ----
Current income tax expense $6,588 $3,956 $ 961
Deferred income tax expense 419 1,293 3,277
------ ------ ------
Total income tax expense $7,007 $5,249 $4,238
------ ------ ------
F-33
94
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
At December 31, the components of the net deferred tax liability were:
(in thousands)
1998 1997
---- ----
Deferred tax liabilities resulting from:
Deferred income for tax purposes $ (23,674) $ (17,294)
Deferred costs for book purposes (785) (3,374)
----------- -----------
(24,459) (20,668)
----------- -----------
Deferred tax assets resulting from:
Unrealized losses 11,244 7,612
Undeducted expenses 1,779 2,305
Others 1,684 877
----------- -----------
14,707 10,794
----------- -----------
Net deferred tax liability $ (9,752) $ (9,874)
----------- -----------
20. RELATED PARTY TRANSACTIONS
Mortgage loans held for sale include approximately $1,590,000 of loans
to officers, directors and stockholders of the Company at prevailing
interest rates (1997 - $200,000).
The Company paid a computer service bureau, in which it holds a 33%
interest, $946,000, $1,012,000 and $900,000 for services rendered
during the years ended December 31, 1998, 1997 and 1996, respectively.
At December 31, 1998 and 1997, the value of the Company's equity
interest in this service bureau was not significant.
At December 31, 1998 and 1997, accounts receivable include
approximately $1.0 million and $1.5 million, respectively, due from a
real estate partnership in which the Company has a minority interest
and in which various executive officers are limited partners.
For the year ended December 31, 1998, the Company purchased
approximately $88 million of conventional loans from a local mortgage
banking institution, which is considered a related party.
F-34
95
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
21. 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 may 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 contractual 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 or for forward sales is represented by
the contractual amount of those instruments. The Company uses the same
credit policies in making these commitments as it does for on-balance
sheet instruments. At December 31, 1998, commitments to extend credit
amounted to approximately $84,333,000 and commitments to sell
mortgage-backed securities and loans amounted to approximately
$539,524,000. 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 loan portfolios
since most of the Company's business activity is with customers
located in Puerto Rico and most of its loans are secured by properties
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 buyers to take a future
position at a stated price. Risks arise from the possible inability of
counterparties 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.
Recourse sales generally involve the sale of non-conforming loans to
local financial institutions and to FHLMC. As of December 31, 1998 and
1997, the Company's recourse obligations relating to its mortgage
servicing portfolio were approximately $489.1 million and $265.5
million, respectively.
F-35
96
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
From time to time the Company may sell loans or mortgage-backed
securities with put options. At December 31, the changes in the
amounts of loans sold under these arrangements were as follows:
(in thousands)
1998 1997
---- ----
Beginning balance $ 175,602 $ 119,570
Puts issued -- 108,400
Puts expired (64,557) (23,865)
Principal repayment of underlying loans (19,550) (28,503)
and mortgage-backed securities ----------- -----------
Ending balance $ 91,495 175,602
=========== ===========
A summary of outstanding put arrangements as of December 31, 1998
follows:
(in thousands)
AMOUNT
DATES ON WHICH PUT OPTIONS EXPIRE OUTSTANDING
--------------------------------- -----------
Within one year $ 12,910
One to two years --
Three years and thereafter 78,585
---------
$ 91,495
=========
If any put option is exercised, the Company would have to buy back
these securities at an agreed price, adjusted for future prepayments.
As required by SFAS No. 125, the put options have been recorded as a
liability in the accompanying consolidated financial statements and
are marked to market every quarter. At December 31, 1998 and 1997, the
market value of the instruments under put options exceed the put
option exercise price.
22. 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 targeted benefit. The
target benefit is based on years of service and 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 made to the Plan during the years ended December 31,
1998, 1997 and 1996 amounted to approximately $998,000, $702,000 and
$613,000, respectively.
F-36
97
DORAL FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------------------------------------------
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, 1998, 1997 and 1996 amounted to approximately
$975,000, $305,000 and $232,000, respectively.
The Company also has incentive compensation arrangements
payable currently with certain employees. The incentive payments are
based on the amount of consolidated net income (adjusted for certain
amounts such as extraordinary gains or losses) in excess of an
established return on stockholders' equity, as defined in the
agreements. The expense under these arrangements for the years ended
December 31, 1998, 1997 and 1996 amounted to approximately $7,442,000,
$4,915,000 and $6,446,000, respectively.
23. 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, 1998 are as follows:
(in thousands)
YEAR AMOUNT
---- --------
1999 $ 2,666
2000 1,716
2001 1,527
2002 1,285
2003 1,048
2004 and thereafter 7,256
-------
$15,498
=======
Total rental expense for the years ended December 31, 1998, 1997 and
1996 amounted to approximately $3,300,000, $2,500,000 and $2,100,000,
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, will not,
in the opinion of management, have a material adverse effect upon the
financial position or results of operations of the Company.
In connection with its mortgage securitization activities, the Company
has entered into the Insurance and Indemnity Agreements (the
"Agreements"), with insurance companies providing for the issuance of
financial guaranty insurance policies. The insurance policies cover
the payment of amounts due with respect to senior certificates issued
by CMO grantor's trusts established by the Company, and provide, among
other things, that the Company cannot sell, transfer or pledge the
residual certificates issued by the trusts, (amounting to
approximately $1,632,000), without the insurance company's approval
because the residual certificates are pledged as collateral to the
insurance company.
F-37
98
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
24. CAPITAL STOCK AND PAID-IN CAPITAL
The authorized number of shares of common stock was increased during
1997 from 20,000,000 to 50,000,000 shares.
On April 23, 1998, the Board of Directors of the Company declared a
two-for-one stock split of the Company's common stock held by
registered shareholders as of May 8, 1998. The stock split was
effective on May 20, 1998. All amounts in the financial statements and
the accompanying notes have been restated to reflect the stock split.
The stock split did not dilute shareholders' voting rights or their
proportionate interest in the Company.
In 1995, the Company issued $10 million of 8.25% Convertible
Subordinated Debenture due on January 1, 2006. Pursuant to the
Debenture Agreement, on April 29, 1997, $1,540,000 of the Convertible
Subordinated Debentures was converted into 352,000 shares of the
Company's common stock at a conversion price of $4.375 (amounts after
giving effect to the stock split). On July 9, 1997, the Company
entered into an agreement to exchange the remaining Convertible
Subordinated Debentures for 8,460 shares of newly issued 8%
Convertible Cumulative Preferred Stock (liquidation preference $1,000
per share) ("8% Preferred Stock"). The 8% Preferred Stock is
convertible into common stock at a conversion price of $4.375 (after
giving effect to the stock split). The 8% Preferred Stock has a
preference in liquidation over the common stock. In addition, the
terms of the agreement prohibit the Company from paying dividends on
the common stock if the dividend of the 8% Preferred Stock is in
arrears. The holder of the 8% Preferred Stock is entitled to receive
cumulative cash dividends when declared by the Board of Directors at
an annual rate 8% of the liquidation preference.
The 8% Preferred Stock is not redeemable prior to January 1, 2001. On
or after that date, the 8% Preferred Stock becomes redeemable at the
option of the Company at the following redemption prices:
REDEMPTION
YEAR PRICE
2001 $1,020
2002 $1,015
2003 $1,010
2004 $1,005
2005 and thereafter $1,000
All other terms of the conversion agreement remained unchanged from
the original agreement. On October 22, 1997, the holder of the
Convertible Subordinated Debentures completed the exchange of the
debentures for 8,460 shares of 8% Preferred Stock with an aggregate
liquidation preference of $8,460,000. In connection with this
conversion, the Company recorded an extraordinary non-cash loss of
$12.3 million (see Note 32).
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 Indenture of the Senior Notes from paying dividends on capital
stock (other than dividends payable in capital stock or in stock
rights) if an event of default under any such agreements
F-38
99
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
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 specified dates exceed a defined
amount. In addition, under the Syndicated Credit Agreement, the Senior
Notes Indenture 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 and dividends ratios, and certain other
financial ratios.
Present regulations limit the amount of dividends that Doral Bank may
pay. Payment of such dividends is prohibited if, among other things,
the effect of such payment would cause the capital of Doral Bank to
fall below the regulatory capital requirements.
In addition, the Federal Reserve Board has issued a policy statement
that provides that insured banks and bank holding companies should
generally pay dividends only out of current operating earnings.
25. STOCK OPTION PLANS
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 1,000,000 shares of common stock to selected
officers. Up to 1994, a total of 711,224 shares were awarded and
issued under the Restricted Stock Plan. No shares have been awarded
since 1994. 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.
On April 16, 1997, the Company adopted a new employee stock option
plan. This plan allows for the granting up to 2,000,000 purchase
options on shares of the Company's common stock to employees,
including officers and directors who are also employees, of the
Company. The Compensation Committee of the Board of Directors has sole
authority and absolute discretion to determine the number of stock
options to be granted, their vesting rights, and the option exercise
price. The vesting rights, however, cannot exceed ten years and the
exercise price may not be lower than the market value at the date of
the grant.
The stock option plan also permits the Compensation Committee to grant
rights to optionees ("stock appreciation rights") under which an
optionee may surrender any exercisable stock option in return for cash
equal to the excess of the fair value of the common stock to which the
option is related at the time of exercise over the option price of the
common stock at grant date. The stock option plan provides for a
proportional adjustment in the exercise price and the number of shares
that can be purchased in the event of a stock split, reclassifications
of stock and a merger or reorganization.
During 1998, the Company granted 452,600 options to buy shares of the
Company's stock that are to be exercisable over a period ranging from
one to ten years. The options granted do not contain stock
appreciation rights. Fifty percent (50%) of the options granted vest
on the first anniversary of the grant and the remaining 50% vest on
the second anniversary. All of the options prices equaled the quoted
market price of the stock at the grant date, therefore, no
compensation cost was recognized.
F-39
100
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
The following table summarizes the exercise price and the weighted
average remaining contractual life of the options outstanding at
December 31, 1998.
WEIGHTED
AVERAGE AVERAGE
EXERCISE OUTSTANDING CONTRACT EXERCISE
PRICE OPTIONS LIFE (YEARS) PRICE
$ 15.22 444,200 9.25 $ 15.22
======= ======= ==== ========
As described in Note 2, the Company uses the intrinsic value-based
method to account for stock options. Accordingly, no compensation cost
has been recognized for the Company's stock option plan. Had the
Company implemented the fair value method described in SFAS No. 123,
it would have recognized compensation expense over the expected life
of the options based on their fair market value, thus the Company's
net income and earnings per common share would have been reduced to
the pro forma amounts indicated below:
(in thousands, except per share information)
1998
----
Compensation and Benefits:
Reported $21,158
Pro forma $21,984
Net Income:
Reported $52,832
Pro forma $52,328
Basic Earnings Per Share:
Reported $ 1.31
Pro forma $ 1.29
Diluted Earnings Per Share:
Reported $ 1.26
Pro forma $ 1.25
The fair value of the options granted in fiscal year 1998 was
estimated using the Black-Scholes option pricing model with the
following assumptions:
- - Stock Price and Exercise Price - The stock price is $15.22 and the
estimated fair value, based on the term of the awards, was $4.92 per
option.
- - Expected Option Term - 4 years
- - Expected Volatility - 36%
- - Expected Dividend Yield - 1.58%
- - Risk-Free Interest Rate - 5.62%
F-40
101
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
26. EARNINGS PER SHARE
The reconciliation of the numerator and denominator of the basic and
diluted earnings-per-share follows:
(in thousands, except per share data)
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
AS OF DECEMBER 31, 1998:
Income before extraordinary item $ 52,832
Less: Convertible preferred stock dividend (676)
--------
Basic EPS
Income available to common
shareholders 52,156 39,941,068 $ 1.31
======== ========== ========
Effect of dilutive securities
Convertible Preferred Stock 676 1,933,714
Incremental Shares Options 53,404
------- ----------
Diluted EPS
Income available to common shareholders
plus assumed conversions $ 52,832 41,928,186 $ 1.26
======== ========== ========
AS OF DECEMBER 31, 1997:
Income before extraordinary item $ 32,548
Less: Serial preferred stock dividend (130)
--------
Basic EPS
Income available to common
shareholders 32,418 36,680,158 $ 0.89
======== ========== ========
Effect of dilutive securities
Convertible Subordinated Debentures 371 1,677,626
Serial Preferred Stock 130 370,848
-------- ----------
Diluted EPS
Income available to common shareholders
plus assumed conversions $ 32,919 38,728,632 $ 0.85
======== ========== ========
AS OF DECEMBER 31, 1996:
Income before extraordinary item $ 27,041
Less: serial preferred stock dividend (14)
--------
Basic EPS
Income available to common
shareholders 27,027 36,266,244 $ 0.75
======== ========== ========
Effect of dilutive securities
Convertible Subordinated Debentures 503 2,285,720
Serial Preferred Stock 14 173,108
-------- ---------- --------
Diluted EPS
Income available to common shareholders
plus assumed conversions $ 27,544 38,725,072 $ 0.71
======== ========== ========
F-41
102
DORAL FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------------------------------------------
27. SUPPLEMENTAL INCOME STATEMENT INFORMATION
Employee costs and other expenses are shown in the Consolidated
Statements of Income net of direct loan origination costs. Pursuant
to SFAS No. 91, direct loan origination costs are capitalized as
part of the carrying cost of mortgage loans and are charged against
mortgage loan sales and fees when the loans are sold.
Set forth below is a reconciliation of the application of SFAS No.
91 to employee costs and other expenses:
(in thousands)
YEAR ENDED DECEMBER 31,
-----------------------------------
1998 1997 1996
---- ---- ----
Employee costs, gross $52,152 $37,430 $31,488
Deferred costs pursuant to SFAS No. 91 30,994 29,319 22,506
------- ------- -------
Employee cost, net $21,158 $ 8,111 $ 8,982
======= ======= =======
Other expenses, gross $15,116 $10,857 $ 9,513
Deferred costs pursuant to SFAS No. 91 5,112 3,213 3,824
------- ------- -------
Other expenses, net $10,004 $ 7,644 $ 5,689
======= ======= =======
28. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The table below presents the carrying amounts and fair values of the
Company's financial instruments at December 31, 1998 and 1997. FASB
Statement No. 107, "Disclosures about Fair Value of Financial
Instruments," defines the fair value of financial instruments 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.
F-42
103
DORAL FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------------------------------------------
(in thousands)
1998 1997
---- ----
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------ ----- ------ -----
Financial assets:
Cash and due from banks $ 31,945 $ 31,945 $ 17,390 $ 17,390
Money market investments 312,751 312,751 157,404 157,404
Mortgage loans held for sale 883,048 904,437 404,672 407,582
Securities held for trading 606,918 606,918 620,288 620,288
Securities held to maturity 190,778 192,125 143,534 144,784
Securities available for sale 408,888 408,888 240,876 240,876
Loans receivable 166,987 169,410 133,055 134,900
Servicing assets 72,568 86,045 46,416 56,036
F-43
104
DORAL FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------------------------------------------
(in thousands)
1998 1997
---- ----
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------ ----- ------ -----
Financial liabilities:
Loans payable $ 426,704 $ 426,704 $238,770 $238,770
Securities sold under agreements to
repurchase 1,197,328 1,196,199 838,142 838,142
Deposit accounts 533,113 532,702 300,494 300,183
Notes payable 199,733 207,249 164,934 173,195
Advances from FHLB 32,000 32,911 32,000 31,928
Off - balance sheet financial instruments -
Interest rate swap agreements in a net
payable position $ (3,491) $ (330)
The following notes summarize the major methods and assumptions
used in estimating the fair values of financial instruments:
Cash and due from banks, money market investments and loans payable:
valued at the carrying amounts in the consolidated statements of
financial condition. The carrying amounts are reasonable estimates
of fair value due to the relatively short period to maturity.
Mortgage loans held for sale, 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.
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 speeds experienced in previous
periods when interest rates were at levels similar to current
levels, adjusted for any differences in the interest rate scenario.
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.
Servicing assets: valued based on the market prices for comparable
servicing sales contracts based on similar types of groups of loans.
To further evaluate the estimated fair value of such servicing
rights, the Company utilizes independent valuations based on present
value calculations of the expected future cash flows associated with
the servicing rights. Such valuations are based on assumptions that
market participants would use in estimating future servicing income
and expense, such as: discount rates, prepayment speeds, estimates
of servicing cost, ancillary income per loan and default rates.
F-44
105
DORAL FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------------------------------------------
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, are 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.
Notes payable, advances from FHLB and securities sold under
agreements to repurchase: valued utilizing discounted cash flow
analysis over the remaining term of the obligation using market
rates for similar instruments.
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.
29. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Financial data showing results for the end of the quarters in 1998
and 1997 is presented below. These results are unaudited. In the
opinion of management all adjustments necessary for a fair
presentation have been included:
(in thousands, except per share data)
1
QUARTERS
----------------------------------------------------
1998 1ST 2ND 3RD 4TH
- ---- --- --- --- ---
Interest income $31,044 $34,962 $38,557 $43,488
Net interest income 7,842 8,721 7,632 9,070
Provision for loan losses 218 93 163 409
Non-interest income 16,470 19,769 22,970 29,131
Net income 11,097 13,004 13,877 14,854
Earnings per common share-Basic 0.29 0.32 0.34 0.36
Earnings per common share-Diluted 0.27 0.31 0.33 0.35
QUARTERS
------------------------------------------------------
1997 1ST 2ND 3RD 4TH
- ---- --- --- --- ---
Interest income $20,386 $20,688 $23,026 $ 26,031
Net interest income 6,321 6,638 7,927 7,807
Provision for loan losses 165 200 244 183
Non-interest income 9,687 9,148 11,379 15,072
Net income-Before extraordinary item 7,121 7,918 8,592 8,917
Net income-After extraordinary item 7,121 7,918 8,592 (3,400)
Earnings per common share-Basic:
Before extraordinary item 0.19 0.22 0.24 0.24
After extraordinary item 0.19 0.22 0.24 (0.10)
Earnings per common share - Diluted:
Before extraordinary item 0.19 0.21 0.22 0.23
After extraordinary item 0.19 0.21 0.22 (0.09)
F-45
106
DORAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
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.
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 interest rates since most of
the Company's assets are of a fixed rate nature. These changes in
interest rate affect 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. Interest-bearing
liabilities reprice more frequently than interest-earning assets
and, therefore, the Company's net interest income is affected by
changes in interest rates and the relation of long-term and
short-term interest rates.
To achieve its risk management objectives, 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.
The following table summarizes the activity in derivative
transactions, other than interest rate swaps, for the year:
(in thousands)
NOTIONAL AMOUNT FAIR VALUE
---------------------------- ------------------------------------------------------------------
AT DECEMBER 31, 1998 AT DECEMBER 31, 1998 AVERAGE FOR THE PERIOD NET GAINS
ASSETS LIABILITIES ASSETS LIABILITIES ASSETS LIABILITIES (LOSSES)
---------- ------------ ------- ----------- ------ ----------- -------
Options on Futures $ 665,000 $ 587,500 $1,757 $2,070 $1,398 $ 606 $(1,883)
Options on
Eurodollars 3,000,000 1,000,000 736 172 115 14 (903)
Forward Contracts -- 98,900 -- -- -- -- (235)
Options on Bonds
and Mortgage-
backed Securities -- 10,000 -- 141 2 358 243
Futures -- -- -- -- -- -- (262)
---------- ---------- ------ ------ ------ ------- -------
$3,665,000 $1,696,400 $2,493 $2,383 $1,515 $ 978 $(3,040)
========== ========== ====== ====== ====== ======= =======
F-46
107
DORAL FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------------------------------------------
(in thousands)
NOTIONAL AMOUNT FAIR VALUE
---------------------------- ------------------------------------------------------------------
AT DECEMBER 31, 1997 AT DECEMBER 31, 1997 AVERAGE FOR THE PERIOD NET GAINS
ASSETS LIABILITIES ASSETS LIABILITIES ASSETS LIABILITIES (LOSSES)
---------- ------------ ------- ----------- ------ ----------- -------
Options on Futures $417,500 $212,000 $1,051 $ 655 $1,541 $ 977 $ 17
Options on
Eurodollars -- -- -- -- -- -- --
Forward Contract 5,000 15,000 -- -- -- -- 59
Options on Bonds
and Mortgage-
backed
Securities 5,000 70,000 3 575 798 2,625 763
Futures -- -- -- -- -- -- (2,150)
-------- -------- ------ ------ ------ ------- -------
$427,500 297,000 $1,054 $1,230 $2,339 $ 3,602 $(1,311)
======== ======== ====== ====== ====== ======= =======
Options are contracts that grant the purchaser the right to buy or
sell the underlying asset by a certain date at a specified price.
The risk involved with option contracts is normally limited to the
price of the options. Interest rate futures contracts are
commitments to either purchase or sell designated instruments, such
as U.S. Treasury securities, at a future date for a specified price.
Futures contracts are generally traded on an exchange, are marked to
market daily, and are subject to initial maintenance margin
requirements. Forward contracts are generally over-the-counter or
privately negotiated contracts to sell a specified amount of certain
instruments such as mortgage-backed securities at a specified price
at a specified future date. Because these contracts are not traded
on an exchange and are not generally marked-to-market on a daily
basis, they are generally subject to greater credit risks than
futures contracts.
The risk that counterparties 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
counterparties 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.
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's banking subsidiary enters into interest 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, 1998, the Company had
outstanding interest rate swap agreements to change the Company's
interest rate exposure. The agreements are for a notional principal
amount of $5,000,000, $50,000,000 and $50,000,000, covering the
Company's interest rate exposure. The interest rate swap for a
notional amount of $5,000,000, covers the exposure of a $5,000,000
floating rate term-note. This agreement ends at the time the related
obligation matures. The interest rate swaps with notional
F-47
108
DORAL FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
Years Ended December 31, 1998, 1997 and 1996
- -------------------------------------------------------------------------------
amounts of $50,000,000 are designed to protect the Company from the
repricing of its short-term liabilities. These agreements end on
November 5, 2002 and January 3, 2016, respectively. The interest
rate to be received on the $5,000,000 swap agreement is 87% of the
three-month LIBOR rate minus .125% (4.84% at December 31, 1998) and
the interest rate to be paid is 4.92%. On the $50,000,000 swap
agreements, the interest rate to be received is 100% of the
three-month LIBOR rate (5.31% and 5.35% at December 31, 1998) and
the interest rate to be paid is 6.125% and 5.495%, respectively.
Non-performance by the counterparty will expose the Company to
interest rate risk.
In 1996, the Company sold short $75 million in futures contract of
the 10 year, 6.5% U.S. Treasury Note, to hedge the funding cost of
the 7.84% Senior Notes due on October 10, 2006 (the "Senior Notes").
The loss incurred in such transaction was deferred as part of the
cost of issuing the Senior Notes and is being amortized throughout
the life of the Senior Notes as an adjustment to the Notes' yield.
Unamortized balance at December 31, 1998 was approximately
$2,008,000.
31. SEGMENT INFORMATION
In 1998, the Company implemented the provisions of SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related
Information," which established standards for reporting information
about a company's operating segments.
The Company has three reportable segments identified by line of
business: mortgage banking, commercial banking and broker dealer
operations. The segments are managed separately since each one
targets different customers and requires different strategies. The
majority of the Company's operations are conducted in Puerto Rico.
The Company monitors the performance of its reportable segments
based on pre-established goals for different financial parameters
such as net income, interest rate spread, loan production and
increase in market share.
The accounting policies followed by the segments are the same as
those described in the Summary of Significant Accounting Policies
(see Note 2).
The information that follows presents, net interest income after
provision for loan losses, non-interest income, net income and
identifiable assets for the Company's reportable segments.
(in thousands)
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
---------------------------------------------------
1998 1997 1996
--------- --------- ---------
Reportable segments:
Mortgage banking $ 16,169 $ 17,588 $ 13,415
Commercial banking 14,484 9,477 6,250
Broker dealer 1,729 836 82
Consolidating eliminations -- -- --
--------- --------- ---------
Consolidated net interest income $ 32,382 $ 27,901 $ 19,747
========= ========= =========
F-48
109
DORAL FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------------------------------------------
NON-INTEREST INCOME
---------------------------------------------
1998 1997 1996
-------- ------- --------
Reportable segments:
Mortgage banking $ 78,293 $39,465 $ 40,694
Commercial banking 5,321 3,380 491
Broker dealer 4,951 2,506 229
Consolidating eliminations (225) (65) (568)
-------- ------- --------
Consolidated non-interest income $ 88,340 $45,286 $ 40,846
======== ======= ========
(in thousands)
NET INCOME (LOSS)
-------------------------------------------
1998 1997 1996
-------- ------ --------
Reportable segments:
Mortgage banking $ 43,672 $14,927 $ 25,720
Commercial banking 8,197 5,043 2,314
Broker dealer 1,141 138 (427)
Consolidating eliminations (178) 123 (566)
-------- ------- --------
Consolidated net income $ 52,832 $20,231 $ 27,041
======== ======= ========
IDENTIFIABLE ASSETS
------------------------------------------------------
1998 1997 1996
----------- ---------- ----------
Reportable segments:
Mortgage banking $ 1,883,628 $1,378,841 $ 900,752
Commercial banking 804,545 428,101 280,678
Broker dealer 831,474 500,768 37,712
Consolidating eliminations (601,534) (449,921) (113,059)
----------- ----------- -----------
Consolidated total identifiable assets $ 2,918,113 $1,857,789 1,106,083
=========== =========== ===========
32. EXTRAORDINARY ITEM
During 1997 in connection with the exchange of the 8.25% Convertible
Subordinated Debentures for 8% Convertible Cumulative Preferred
Stock discussed in Note 24, the Company recorded an extraordinary
non-cash loss of approximately $12.3 million on the extinguishment
of debt. This extraordinary non-cash loss was determined based upon
the difference between the estimated fair market value of the
Preferred Stock and the carrying value of the convertible debentures
at the time of conversion. The fair value of the Preferred Stock was
calculated utilizing the Theorical Model. This model segregates the
Preferred Stock into two different components, the equity portion
and the bond portion, and values the two individually to derive fair
value.
F-49
110
DORAL FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------------------------------------------
Simultaneously with the extraordinary non-cash loss, the Company's
paid-in capital account was increased by $20.8 million. This
increase represents the sum of the extraordinary non-cash loss and
the indebtedness extinguished, represented by the Convertible
Subordinated Debentures, resulting in a net increase to the
Company's stockholders equity of approximately $8.5 million.
33. SUBSEQUENT EVENT
On February 22, 1999, the Company issued 1,495,000 shares of its 7%
Non-Cumulative Monthly Income Preferred Stock, Series A, at a price
of $50 per share. The transaction increased the capital of the
Company by approximately $72.1 million, net of issue costs.
F-50