SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2003
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 1-31557
Wachovia Preferred Funding Corp.
(Exact name of registrant as specified in its charter)
Delaware |
56-1986430 | |||
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
1620 East Roseville Parkway
Roseville, California 95661
(Address of principal executive offices)
(Zip Code)
(877) 867-7378
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ¨ No ¨
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
As of April 30, 2003, there were 99,999,900 shares of the registrants common stock outstanding.
Forward Looking Statements
Wachovia Preferred Funding Corp. (Wachovia Funding) may from time to time make written or oral forward-looking statements, including statements contained in Wachovia Fundings filings with the Securities and Exchange Commission (including its Annual Report on Form 10-K and this Quarterly Report on Form 10-Q, and the Exhibits hereto and thereto), in its reports to stockholders and in other Wachovia Funding communications, which are made in good faith by Wachovia Funding pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include, among others, statements with respect to Wachovia Fundings beliefs, plans, objectives, goals, guidelines, expectations, financial condition, results of operations, future performance and business of Wachovia Funding, including without limitation, (i) statements regarding certain of Wachovia Fundings goals and expectations with respect to earnings, earnings per share, revenue, expenses and the growth rate in such items, as well as other measures of economic performance, including statements relating to estimates of credit quality trends, and (ii) statements preceded by, followed by or that include the words may, could, should, would, believe, anticipate, estimate, expect, intend, plan, projects, outlook or similar expressions. These forward-looking statements involve certain risks and uncertainties that are subject to change based on various factors (many of which are beyond Wachovia Fundings control). The following factors, among others, could cause Wachovia Fundings financial performance to differ materially from that expressed in such forward-looking statements:
| the strength of the United States economy in general and the strength of the local economies in which Wachovia Funding owns mortgage assets and other authorized investments may be different than expected resulting in, among other things, a deterioration in credit quality of such mortgage assets and other authorized investments, including the resultant effect on Wachovia Fundings portfolio of such mortgage assets and other authorized investments and reductions in the income generated by such assets; |
| the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; |
| inflation, interest rate, market and monetary fluctuations; |
| the impact of changes in financial services laws and regulations (including laws concerning banking, securities and insurance); |
| changes in economic conditions which could negatively affect the value of the collateral securing our mortgage assets; |
| unanticipated losses due to environmental liabilities of properties underlying our mortgage assets through foreclosure actions; |
| unanticipated regulatory or judicial proceedings or rulings; |
| the impact of changes in accounting principles; |
| the impact of changes in tax laws, especially tax laws pertaining to real estate investment trusts; |
| adverse changes in financial performance and/or condition of the borrowers on loans underlying Wachovia Fundings mortgage assets which could impact repayment of such borrowers outstanding loans; |
| the impact on Wachovia Fundings businesses, as well as on the risks set forth above, of various domestic or international military or terrorist activities or conflicts; and |
| Wachovia Fundings success at managing the risks involved in the foregoing. |
Wachovia Funding cautions that the foregoing list of important factors is not exclusive. Wachovia Funding does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of Wachovia Funding.
Wachovia Funding, we, our and us refer to Wachovia Preferred Funding Corp. Wachovia Preferred Holding refers to Wachovia Preferred Funding Holding Corp., the Bank refers to Wachovia Bank, National Association, and Wachovia refers to Wachovia Corporation.
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
WACHOVIA PREFERRED FUNDING CORP.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, 2003 and December 31, 2002
(In thousands, except share data) |
March 31, 2003 |
December 31, 2002 |
|||||
ASSETS |
|||||||
Cash and cash equivalents |
$ |
551,963 |
|
851,692 |
| ||
Loans, net of unearned income |
|
11,584,736 |
|
10,947,583 |
| ||
Allowance for loan losses |
|
(107,180 |
) |
(106,325 |
) | ||
Loans, net |
|
11,477,556 |
|
10,841,258 |
| ||
Interest rate swaps |
|
583,272 |
|
577,684 |
| ||
Accounts receivableaffiliates, net |
|
|
|
158,579 |
| ||
Other assets |
|
29,813 |
|
29,763 |
| ||
Total assets |
$ |
12,642,604 |
|
12,458,976 |
| ||
LIABILITIES AND STOCKHOLDERS EQUITY |
|||||||
Liabilities |
|||||||
Collateral held on interest rate swaps |
|
580,000 |
|
575,820 |
| ||
Deferred income tax liabilities |
|
69,265 |
|
66,934 |
| ||
Accounts payableaffiliates, net |
|
171,901 |
|
|
| ||
Other liabilities |
|
16,816 |
|
16,821 |
| ||
Total liabilities |
|
837,982 |
|
659,575 |
| ||
Stockholders equity |
|||||||
Preferred stock |
|||||||
Series A preferred securities, $0.01 par value per share, $750 million liquidation preference, non-cumulative and conditionally exchangeable, 30,000,000 shares authorized, issued and outstanding in 2003 and 2002 |
|
300 |
|
300 |
| ||
Series B preferred securities, $0.01 par value per share, $1.0 billion liquidation preference, non-cumulative and conditionally exchangeable, 40,000,000 shares authorized, issued and outstanding in 2003 and 2002 |
|
400 |
|
400 |
| ||
Series C preferred securities, $0.01 par value per share, $4.2 billion liquidation preference, cumulative, 5,000,000 shares authorized, 4,233,754 shares issued and outstanding in 2003 and 2002 |
|
43 |
|
43 |
| ||
Series D preferred securities, $0.01 par value per share, $913,000 liquidation preference, non-cumulative, 913 shares authorized, issued and outstanding in 2003 and 2002 |
|
|
|
|
| ||
Common stock, $0.01 par value, 100,000,000 shares authorized, 99,999,900 shares issued and outstanding in 2003 and 2002 |
|
1,000 |
|
1,000 |
| ||
Paid-in capital |
|
11,504,462 |
|
11,504,462 |
| ||
Retained earnings |
|
298,417 |
|
293,196 |
| ||
Total stockholders equity |
|
11,804,622 |
|
11,799,401 |
| ||
Total liabilities and stockholders equity |
$ |
12,642,604 |
|
12,458,976 |
| ||
See accompanying note to consolidated financial statements.
3
WACHOVIA PREFERRED FUNDING CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three Months Ended March 31, 2003 and 2002
(In thousands, except per share data and average shares) |
2003 |
2002 |
||||
INTEREST INCOME |
$ |
98,253 |
42,643 |
| ||
INTEREST EXPENSE |
|
1,801 |
2,504 |
| ||
Net interest income |
|
96,452 |
40,139 |
| ||
Provision for loan losses |
|
2,530 |
46 |
| ||
Net interest income after provision for loan losses |
|
93,922 |
40,093 |
| ||
OTHER INCOME |
||||||
Gain (loss) on interest rate swaps |
|
6,540 |
(99 |
) | ||
Other income |
|
7 |
52 |
| ||
Total other income |
|
6,547 |
(47 |
) | ||
NONINTEREST EXPENSE |
||||||
Loan servicing costs |
|
1,722 |
352 |
| ||
Management fees |
|
618 |
518 |
| ||
Other |
|
355 |
333 |
| ||
Total noninterest expense |
|
2,695 |
1,203 |
| ||
Income before income tax expense (benefit) |
|
97,774 |
38,843 |
| ||
Income tax expense (benefit) |
|
2,331 |
(124,112 |
) | ||
Net income |
|
95,443 |
162,955 |
| ||
Dividends on preferred stock |
|
45,222 |
|
| ||
Net income available to common stockholders |
$ |
50,221 |
162,955 |
| ||
PER COMMON SHARE DATA |
||||||
Basic earnings |
$ |
0.50 |
1.63 |
| ||
Diluted earnings |
$ |
0.50 |
1.63 |
| ||
AVERAGE SHARES |
||||||
Basic |
|
99,999,900 |
99,999,900 |
| ||
Diluted |
|
99,999,900 |
99,999,900 |
| ||
See accompanying note to consolidated financial statements.
4
WACHOVIA PREFERRED FUNDING CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
(Unaudited)
Three Months Ended March 31, 2003 and 2002
(In thousands, except per share data) |
Preferred Stock |
Common Stock |
Paid-in Capital |
Retained Earnings |
Total |
||||||||
Balance, December 31, 2001 |
$ |
|
1,000 |
5,085,674 |
70,746 |
|
5,157,420 |
| |||||
Net income |
|
|
|
|
162,955 |
|
162,955 |
| |||||
Cash dividends paid on common stock |
|
|
|
|
(2 |
) |
(2 |
) | |||||
Balance, March 31, 2002 |
$ |
|
1,000 |
5,085,674 |
233,699 |
|
5,320,373 |
| |||||
Balance, December 31, 2002 |
$ |
743 |
1,000 |
11,504,462 |
293,196 |
|
11,799,401 |
| |||||
Net income |
|
|
|
|
95,443 |
|
95,443 |
| |||||
Cash dividends |
|||||||||||||
Series A preferred securities at $0.45 per share |
|
|
|
|
(13,594 |
) |
(13,594 |
) | |||||
Series B preferred securities at $0.20 per share |
|
|
|
|
(8,025 |
) |
(8,025 |
) | |||||
Series C preferred securities at $5.57 per share |
|
|
|
|
(23,603 |
) |
(23,603 |
) | |||||
Common stock at $0.45 per share |
|
|
|
|
(45,000 |
) |
(45,000 |
) | |||||
Balance, March 31, 2003 |
$ |
743 |
1,000 |
11,504,462 |
298,417 |
|
11,804,622 |
| |||||
See accompanying note to consolidated financial statements.
5
WACHOVIA PREFERRED FUNDING CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended March 31, 2003 and 2002
(In thousands) |
2003 |
2002 |
|||||
OPERATING ACTIVITIES |
|||||||
Net income |
$ |
95,443 |
|
162,955 |
| ||
Adjustments to reconcile net income to net cash provided (used) by operating activities |
|||||||
Provision for loan losses |
|
2,530 |
|
46 |
| ||
Current income taxes, net |
|
|
|
(20,784 |
) | ||
Deferred income tax benefits |
|
2,331 |
|
(124,112 |
) | ||
Interest rate swaps |
|
(5,588 |
) |
157 |
| ||
Other assets and other liabilities, net |
|
(55 |
) |
1,152 |
| ||
Net cash provided by operating activities |
|
94,661 |
|
19,414 |
| ||
INVESTING ACTIVITIES |
|||||||
Increase (decrease) in cash realized from |
|||||||
Loans, net |
|
(638,828 |
) |
(10,293 |
) | ||
Accounts receivable/payableaffiliates, net |
|
330,480 |
|
127,595 |
| ||
Net cash provided (used) by investing activities |
|
(308,348 |
) |
117,302 |
| ||
FINANCING ACTIVITIES |
|||||||
Increase (decrease) in cash realized from |
|||||||
Collateral held on interest rate swaps |
|
4,180 |
|
3,260 |
| ||
Cash dividends paid |
|
(90,222 |
) |
(2 |
) | ||
Net cash provided (used) by financing activities |
|
(86,042 |
) |
3,258 |
| ||
Increase (decrease) in cash and cash equivalents |
|
(299,729 |
) |
139,974 |
| ||
Cash and cash equivalents, beginning of period |
|
851,692 |
|
957,454 |
| ||
Cash and cash equivalents, end of period |
$ |
551,963 |
|
1,097,428 |
| ||
See accompanying note to consolidated financial statements.
6
WACHOVIA PREFERRED FUNDING CORP.
AND SUBSIDIARIES
NOTE TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2003 and 2002, and December 31, 2002
NOTE 1: CONSOLIDATED FINANCIAL STATEMENTS
Wachovia Preferred Funding Corp. (known prior to July 2002 as First Union Real Estate Asset Company of Connecticut) and its subsidiaries are subsidiaries of Wachovia Bank, National Association, formerly named First Union National Bank and its subsidiaries, which is a wholly-owned subsidiary of Wachovia Corporation.
The unaudited consolidated financial statements of Wachovia Preferred Funding Corp. include, in the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary for fair presentation of such financial statements for the periods indicated in accordance with accounting principles generally accepted in the United States of America.
7
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations contains certain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking statements. Please refer to our 2002 Annual Report on Form 10-K for further information related to our accounting policies and risk governance and administration.
For the tax year ending December 31, 2003, we will be taxed as a REIT, and we intend to comply with the relevant provisions of the Internal Revenue Code to be taxed as a REIT. Accordingly, with the exception of the income of our taxable REIT subsidiary, Wachovia Preferred Realty, LLC (WPR), we will not be subject to Federal income tax on net income to the extent we meet these provisions, including distributing the majority of our earnings to shareholders and satisfying certain asset, income and stock ownership tests. As a result of our change in tax status from a taxable corporation to a REIT, due to our January 2002 election to be taxed as a REIT, our net deferred tax liability as of December 31, 2001, was written off as a benefit to income tax expense in January 2002.
Critical Accounting Policies
Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America, and they conform to general practices within the applicable industries. The application of certain of these principles involves a significant amount of judgment and the use of estimates based on assumptions that involve significant uncertainty at the time of evaluation. For more information on our critical accounting policies, please refer to our 2002 Annual Report on Form 10-K.
Results of Operations
For purposes of this discussion, the term loans includes loans and loan participation interests, the term residential loans includes home equity loans and residential mortgages and the term commercial loans includes commercial and commercial real estate loans. See Table 1 in Accounting and Regulatory Matters for certain performance and dividend payout ratios for the quarters ended March 31, 2003 and March 31, 2002.
Although we have the authority to acquire interests in an unlimited number of mortgage and other assets from unaffiliated third parties, the majority of our interests in mortgage and other assets that we have acquired have been acquired from the Bank or an affiliate pursuant to loan participation agreements between the Bank or an affiliate and us. Our remaining assets were acquired directly from the Bank. The Bank either originated the mortgage assets or acquired them as part of the acquisition of other financial institutions.
In December 2001, the Bank contributed commercial loans with a carrying amount of $4.0 billion and a fair market value of $3.7 billion to Wachovia Funding in exchange for the issuance of common stock with a fair value of $3.7 billion and a related increase in paid-in capital of $300 million. Since Wachovia Funding and the Bank are under common control of Wachovia, the contributed commercial loans were recorded at their carrying value of $4.0 billion. The excess of the carrying value of the loans over the fair market value of the loans was recorded as an increase in paid-in capital.
In October 2002, Wachovia Funding paid the Bank $896 million in cash for home equity loans, which reflected a fair value purchase price.
8
In November 2002, the Bank contributed commercial loans with a carrying value of $6.4 billion and a fair market value of $6.0 billion to Wachovia Preferred Holding. Wachovia Preferred Holding then contributed this portfolio to Wachovia Funding in exchange for the issuance of Series A, B and C preferred securities with a fair value of $6.0 billion and a related increase to paid-in capital of $400 million. Since Wachovia Funding, Wachovia Preferred Holding and the Bank are under common control of Wachovia, the contributed commercial loans were recorded at their carrying value of $6.4 billion. The excess of the book value of the loans over the fair market value of the loans was recorded as an increase in paid-in capital.
In December 2002 and February 2003, Wachovia Funding paid the Bank $230 million and $484 million, respectively, in cash for commercial loans, which reflected a fair value purchase price.
In December 2001, the Bank contributed receive-fixed interest rate swaps with a notional amount of $4.25 billion and a fair value of $673 million to us in exchange for common stock. After the contribution of the receive-fixed interest rate swaps, but prior to December 31, 2001, we entered into pay-fixed interest rate swaps with a notional amount of $4.25 billion that serve as an economic hedge of the contributed swaps. All interest rate swaps are transacted with the same unaffiliated third party.
2003 to 2002 Three Month Comparison
Interest Income. Interest income increased $55.6 million from the first quarter of 2002, or 130%, to $98.3 million in the first quarter of 2003. Interest on all commercial loans increased to $80.8 million in the first quarter of 2003 from $30.7 million in the first quarter of 2002 representing three months of interest in 2003 on commercial loans contributed in November 2002 in addition to interest on loans purchased in 2002 and 2003. Interest on residential loans increased $5.7 million, or 67%, to $14.2 million in the first quarter of 2003 from $8.5 million in the first quarter of 2002 as a result of home equity loans purchased in 2002. Interest income on cash invested in overnight eurodollar deposit investments decreased $191,000, or 5%, in the first quarter of 2003 to $3.3 million.
The average balances, interest income and rates related to interest-earning assets for the two quarters ended March 31, 2003 and 2002, are presented below.
Three Months Ended March 31, 2003 |
Three Months Ended March 31, 2002 |
|||||||||||||||
(In thousands) |
Average Balance |
Interest Income |
Rate |
Average Balance |
Interest Income |
Rate |
||||||||||
Loan participations |
||||||||||||||||
Commercial loans |
$ |
3,312,761 |
27,228 |
3.33 |
% |
$ |
2,965,866 |
21,139 |
2.89 |
% | ||||||
Commercial real estate loans |
|
6,697,148 |
53,567 |
3.24 |
|
|
1,084,480 |
9,535 |
3.57 |
| ||||||
Home equity loans |
|
684,414 |
12,948 |
7.67 |
|
|
272,361 |
6,632 |
9.88 |
| ||||||
Total loan participations |
|
10,694,323 |
93,743 |
3.56 |
|
|
4,322,707 |
37,306 |
3.50 |
| ||||||
Residential mortgages |
|
95,604 |
1,208 |
5.05 |
|
|
109,198 |
1,844 |
6.75 |
| ||||||
Interest-bearing deposits in banks and other earning assets |
|
1,059,428 |
3,302 |
1.26 |
|
|
875,203 |
3,493 |
1.62 |
| ||||||
Total interest-earning assets |
$ |
11,849,355 |
98,253 |
3.36 |
% |
$ |
5,307,108 |
42,643 |
3.26 |
% | ||||||
Interest Expense. Interest expense decreased to $1.8 million in the first quarter of 2003 from $2.5 million in the first quarter of 2002 due to the decline in short term market rates paid on the collateral held on the interest rate swaps.
Provision for Loan Losses. The provision for loan losses increased to $2.5 million in the first quarter of 2003 from $46,000 in the first quarter of 2002, as a result of average loans increasing $6.4 billion in the first quarter of 2003 versus the same period in 2002.
9
Gain on Interest Rate Swaps. The gain on interest rate swaps was $6.5 million in the first quarter of 2003 compared with a loss of $99,000 in the first quarter of 2002. The gain is the result of changes in the interest rate environment that increased the fair value of our net investment in the interest rate swaps.
Loan Servicing Costs. Loan servicing costs increased $1.4 million to $1.7 million in the first quarter of 2003 from $352,000 in the first quarter of 2002 due to higher average loans from the loan contributions and purchases in 2002 and 2003. The loans are serviced by the Bank pursuant to our participation and servicing agreements. For commercial loans, the fee is equal to the total committed amount of each loan multiplied by 0.03%.
Management Fees. Management fees were $618,000 in the first quarter of 2003 compared with $518,000 in the first quarter of 2002. Management fees represent reimbursements to Wachovia for general overhead expenses paid on our behalf. Wachovia charges the management fee to affiliates that have over $10 million in assets and over $2 million in estimated annual noninterest expense. If the affiliate qualifies for an allocation, the affiliate is assessed management fees based on its relative percentage of total consolidated assets and noninterest expense plus a 10% markup.
Other Expense. Other expense increased $22,000, or 7%, to $355,000 in the first quarter of 2003. This increase was due largely to franchise fees and other miscellaneous expenses.
Income Tax (Expense) Benefit. Income tax expense was $2.3 million in the first quarter of 2003, based on the net income of our taxable REIT subsidiary WPR. An income tax benefit of $124 million in the first quarter of 2002 reflected the write off of our net deferred tax liability as of December 2001, resulting from the change in tax status from a taxable corporation to a REIT.
Balance Sheet Analysis
March 31, 2003 to December 31, 2002
At March 31, 2003, total assets were $12.6 billion compared with $12.5 billion at December 31, 2002. As of March 31, 2003, $10.7 billion, or 85% of our assets, consisted of a 100% participation interest in commercial loans, and $797 million, or 6% of our assets, consisted of a 100% participation interest in home equity loans, before the allowance for loan losses.
Loans. Net loans increased $636 million to $11.5 billion at March 31, 2003, compared to December 31, 2002, primarily due to an increase in commercial loans as a result of loan advances or purchases in 2003. See Table 2 in Accounting and Regulatory Matters for additional information.
Allowance for Loan Losses. The allowance for loan losses increased $855,000 from December 31, 2002, to $107 million at March 31, 2003, primarily as a result of new loans being purchased by the REIT in February 2003. See Table 3 in Accounting and Regulatory Matters for additional information.
Interest Rate Swaps. Interest rate swaps increased to $583 million at March 31, 2003, from $578 million at December 31, 2002, which represents the fair value of our net position in interest rate swaps.
Accounts Receivable/Payable-Affiliates, Net. Net accounts receivable/payable from affiliates was a net payable position of $172 million at March 31, 2003, compared with a net accounts receivable position of $159 million at December 31, 2002, as a result of intercompany cash transactions related to net loan paydowns, interest receipts and funding.
Other Assets. Other assets increased $50,000 to $29.8 million at March 31, 2003.
Collateral Held on Interest Rate Swaps. Collateral held on interest rate swaps increased to $580 million at March 31, 2003, from $576 million at December 31, 2002, reflecting additional cash received to collateralize the increased fair value of the interest rate swaps.
10
Commitments
Our commercial loan portfolio includes unfunded loan commitments that are provided in the normal course of business. For commercial borrowers, loan commitments generally take the form of revolving credit arrangements to finance customers working capital requirements. These instruments are not recorded on the balance sheet until funds are advanced under the commitment. For lending commitments, the contractual amount of a commitment represents the maximum potential credit risk if the entire commitment is funded and the borrower does not perform according to the terms of the contract. A large majority of these commitments expire without being funded, and accordingly, total contractual amounts are not representative of our actual future credit exposure or liquidity requirements.
Loan commitments create credit risk in the event that the counterparty draws on the commitment and subsequently fails to perform under the terms of the lending agreement. This risk is incorporated into an overall evaluation of credit risk and to the extent necessary, reserves are recorded on these commitments. Uncertainties around the timing and amount of funding under these commitments may create liquidity risk. At March 31, 2003 and December 31, 2002, commitments to extend credit were $1.6 billion and $1.5 billion, respectively.
Liquidity and Capital Resources
Our internal sources of liquidity generally include cash generated from our operations and principal repaid on loans. In addition, any necessary liquidity could be obtained by drawing on the line of credit that we have with the Bank. Under the terms of that facility, we can borrow up to $2.0 billion under a revolving demand note at a rate of interest equal to the Federal funds rate. Further, we could issue additional common or preferred stock, subject to any pre-approval rights of our shareholders. We believe that our existing sources of liquidity are sufficient to meet our funding needs.
Risk Governance and Administration
For additional information on credit risk management, concentration of credit risk, operational risk management, liquidity risk management and financial disclosure, please refer to our 2002 Annual Report on Form 10-K.
Interest Rate Risk Management
Interest rate risk is the sensitivity of earnings to changes in interest rates. Our income consists primarily of interest income on our variable rate loans. If there is a further decline in market interest rates, we may experience a reduction in interest income on our loan portfolio and a corresponding decrease in funds available to be distributed to our shareholders. The reduction in interest income may result from downward adjustments of the indices upon which the interest rates on loans are based and from prepayments of loans with fixed interest rates, resulting in reinvestment of the proceeds in lower yielding assets. In December 2001, the Bank contributed receive-fixed interest rate swaps to us in exchange for common stock. Subsequent to the contribution, we entered into pay-fixed interest rate swaps that serve as an economic hedge to the receive-fixed interest rate swaps. Currently, we do not expect to enter into additional derivative transactions.
At March 31, 2003, approximately 11% of the loans in our portfolio had fixed interest rates. Such loans tend to increase our interest rate risk. We monitor the rate sensitivity of assets acquired. Our methods for evaluating interest rate risk include an analysis of interest-rate sensitivity gap, which is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest-rate-sensitive assets exceeds the amount of interest-rate-sensitive liabilities. A gap is considered negative when the amount of interest-rate-sensitive liabilities exceeds interest-rate-sensitive assets.
During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because different types of assets and liabilities with the
11
same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution is perfectly matched in each maturity category.
As of March 31, 2003, $10.3 billion, or 82% of our assets, had variable interest rates and could be expected to reprice with changes in interest rates. As of March 31, 2003, our liabilities were $838 million, or 7% of our assets, while stockholders equity was $11.8 billion, or 93% of our assets. This positive gap between our assets and liabilities indicates that an increase in interest rates would result in an increase in net interest income and a decrease in interest rates would result in a decrease in net interest income.
The fair value of the $1.3 billion of fixed rate loans and loan participations and the fair value of the $10.3 billion of variable rate loans and loan participations was approximately $10.9 billion at March 31, 2003.
We account for derivative financial instruments in accordance with Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, as subsequently amended by SFAS 137 and SFAS 138, which establishes accounting and reporting standards for derivatives and hedging activities. Under SFAS 133, all of our derivatives (currently consisting of interest rate swaps) are recorded at fair value in the balance sheets. When we have more than one transaction with a counterparty and there is a legally enforceable master netting agreement between the parties, the net of the gain and loss positions are recorded as an asset or a liability on our consolidated balance sheets. Realized and unrealized gains and losses are recorded as a net gain or loss on interest rate swaps on our consolidated statements of operations.
In December 2001, the Bank contributed receive-fixed interest rate swaps with a notional amount of $4.25 billion and a fair value of $673 million to us in exchange for common stock. The unaffiliated counterparty to the receive-fixed interest rate swaps provided cash collateral to us. We pay interest to the counterparty on the collateral at a short-term market rate. After the contribution of the receive-fixed interest rate swaps, but prior to December 31, 2001, we entered into pay-fixed interest rate swaps with a notional amount of $4.25 billion that serve as an economic hedge of the contributed swaps. All interest rate swaps are transacted with the same unaffiliated third party.
At March 31, 2003, our position in interest rate swaps was an asset of $1.2 billion and a liability of $590 million, which is recorded net on our consolidated balance sheet at fair value. The following table presents interest rate swap maturities.
(In thousands) |
1 Year or Less |
1-2 Years |
2-5 Years |
5-10 Years |
After 10 Years |
Total | ||||||||
Interest Rate Swap Assets |
||||||||||||||
Notional amount |
$ |
|
|
|
150,000 |
4,100,000 |
|
4,250,000 | ||||||
Weighted average receive rate (a) |
|
|
% |
|
6.10 |
7.45 |
|
7.41 | ||||||
Weighted average pay rate (a) |
|
|
% |
|
1.34 |
1.26 |
|
1.26 | ||||||
Interest Rate Swap Liabilities |
||||||||||||||
Notional amount |
$ |
|
|
|
150,000 |
4,100,000 |
|
4,250,000 | ||||||
Weighted average receive rate (a) |
|
|
% |
|
1.34 |
1.26 |
|
1.26 | ||||||
Weighted average pay rate (a) |
|
|
% |
|
4.84 |
5.72 |
|
5.69 | ||||||
(a) | All of the interest rate swaps have variable pay or receive rates based on three- to six-month LIBOR, and they are the pay or receive rates in effect at March 31, 2003. |
Market Risk Management
Market risk is the risk of loss from adverse changes in market prices and interest rates. Market risk arises primarily from interest rate risk inherent in lending, investment in derivative financial instruments and borrowing activities.
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At March 31, 2003, our receive-fixed interest rate swaps with a notional amount of $4.25 billion had a weighted average maturity of 9.0 years, weighted average receive rate of 7.41% and weighted average pay rate of 1.26%. Our pay-fixed interest rate swaps with a notional amount of $4.25 billion had a weighted average maturity of 9.0 years, weighted average receive rate of 1.26% and weighted average pay rate of 5.69% at March 31, 2003. All of the interest rate swaps have variable pay or receive rates based on three- or six-month LIBOR, and they are the pay or receive rates in effect at March 31, 2003.
Due to the difference in fixed rates in our interest rate swaps, volatility is expected given certain interest rate fluctuations. If market rates were to decrease 100 basis points or 200 basis points, we would realize short-term net gains on our interest rate swaps of $25.9 million or $53.6 million, respectively. If market rates were to increase 100 basis points or 200 basis points, we would realize short-term net losses on our interest rate swaps of $24.3 million or $47.1 million, respectively. These short-term fluctuations will eventually offset over the life of the interest rate swaps, with no change in cash flow occurring in the net positions. The changes in value of the net swap positions were calculated under the assumption there was a parallel shift in the LIBOR curve using 100 basis point and 200 basis point shifts, respectively.
Transactions with Related Parties
We are subject to certain income and expense allocations from affiliated parties for various services received. In addition, we enter into transactions with affiliated parties in the normal course of business. The nature of the transactions with affiliated parties is discussed below.
The Bank services our loans on our behalf, which includes delegating servicing to third parties in the case of residential mortgage loans. We are subject to Wachovias management fee policy and are allocated a fee from Wachovia for general overhead expenses paid on our behalf if we meet certain asset and expense criteria. We met these criteria in 2003 and 2002 and expect to continue to meet these criteria in the future and therefore expect that we will continue to incur management fee expense. We also have a swap servicing and fee arrangement with the Bank, whereby the Bank provides operations, back office, book entry, record keeping and valuation services related to our interest rate swaps, for which we pay a fee to the Bank.
Eurodollar deposit investments with the Bank are our primary cash management vehicle. In 2003 and 2002, we entered into certain loan participations with affiliates and are allocated a portion of all income associated with these loans.
The Bank acts as our collateral custodian in connection with collateral pledged to us related to our interest rate swaps. For this service, we pay the Bank a fee based on the value of the collateral. In addition, the Bank is permitted to rehypothecate and use as its own the collateral held by the Bank as our custodian. The Bank pays us a fee based on the value of the collateral involved for this right. The Bank also provides a guaranty of our obligations under the interest rate swaps when the swaps are in a net payable position, for which we pay a monthly fee based on the absolute value of the net notional amount of the interest rate swaps.
Accounting and Regulatory Matters
The following information addresses new or proposed accounting pronouncements related to our industry as well as legislation that has had a significant impact on our industry.
Guarantees. In November 2002, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 45, (FIN 45). FIN 45 requires a company to record as a liability the fair value of certain guarantees initiated by the company. The offsetting entry is dependent on the nature of the guarantee with an asset generally being recorded, such as the consideration received for providing a letter of credit or prepaid rent for a residual value guarantee in an operating lease. The liability recorded will typically be reduced by a credit to the results of operations as the guarantee lapses, which generally will occur on a systematic basis over the term of the guarantee or at settlement of the guarantee.
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The initial measurement and recognition provisions of FIN 45 are effective for applicable guarantees written or modified after December 31, 2002. The adoption of these recognition provisions may result in recording liabilities associated with certain guarantees that we provide. The impact of the initial measurement and recognition provisions of FIN 45 is dependent on the number and size of applicable future guarantees that we provide; however, we do not anticipate that the impact will have a material effect on our consolidated financial statements.
In addition, FIN 45 requires disclosures beginning with the December 31, 2002, financial statements of these and other guarantees. We have provided the disclosures required by FIN 45 in Note 7 to Notes to Consolidated Financial Statements in our 2002 Annual Report on Form 10-K, for all applicable guarantees in effect at December 31, 2002.
Regulatory Matters. On July 30, 2002, President Bush signed the Sarbanes-Oxley Act of 2002 into law. The intent of this law is to reform specific matters pertaining to public accounting oversight, auditor independence and corporate responsibility. Requirements in the act will affect certain of Wachovias corporate governance policies and certain of Wachovias business lines, such as securities analysis. We do not believe we will need to make material modifications to our corporate governance policies in response to the act or do we believe the act will negatively affect our financial condition or results of operations.
Various legislative and regulatory proposals concerning the financial services industry are pending in Congress, the legislatures in states in which we conduct operations, and before various regulatory agencies that supervise our operations. Given the uncertainty of the legislative and regulatory process, we cannot assess the impact of any such legislation or regulations on our financial condition or results of operations.
Table 1 PERFORMANCE AND DIVIDEND PAYOUT RATIOS
Three Months Ended March 31, | |||||
2003 |
2002 | ||||
Ratios |
|||||
Return on assets |
3.10 |
% |
10.85 | ||
Return on stockholders equity |
3.27 |
|
12.28 | ||
Stockholders equity to assets |
94.80 |
|
88.36 | ||
Dividend payout ratio |
94.53 |
% |
| ||
Table 2 LOANS
(In thousands) |
March 31, 2003 |
December 31, 2002 | |||
COMMERCIAL |
|||||
Commercial and commercial real estate |
$ |
10,701,968 |
9,914,150 | ||
CONSUMER |
|||||
Residential mortgages |
|
93,574 |
93,897 | ||
Home equity loans |
|
796,882 |
945,598 | ||
Total loans |
|
11,592,424 |
10,953,645 | ||
Unearned income |
|
7,688 |
6,062 | ||
Total loans, net of unearned income |
$ |
11,584,736 |
10,947,583 | ||
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Table 3 LOAN LOSSES AND RECOVERIES
Three Months Ended March 31, |
|||||||
(In thousands) |
2003 |
2002 |
|||||
ALLOWANCE FOR LOAN LOSSES |
|||||||
Balance, beginning of period |
$ |
106,325 |
|
37,158 |
| ||
Provision for loan losses |
|
2,530 |
|
46 |
| ||
Allowance relating to loans sold |
|
|
|
(10 |
) | ||
Net charge-offs |
|
(1,675 |
) |
(1,669 |
) | ||
Balance, end of period |
$ |
107,180 |
|
35,525 |
| ||
as a % of loans, net |
|
0.93 |
% |
0.81 |
| ||
as a % of nonaccrual loans |
|
404 |
% |
691 |
| ||
LOAN LOSSES |
|||||||
Commercial and commercial real estate loans |
$ |
1,743 |
|
1,756 |
| ||
Residential mortgages |
|
|
|
|
| ||
Home equity loans |
|
|
|
|
| ||
Total loan losses |
|
1,743 |
|
1,756 |
| ||
LOAN RECOVERIES |
|||||||
Commercial and commercial real estate loans |
|
|
|
|
| ||
Residential mortgages |
|
|
|
|
| ||
Home equity loans |
|
68 |
|
87 |
| ||
Total loan recoveries |
|
68 |
|
87 |
| ||
Net charge-offs |
$ |
1,675 |
|
1,669 |
| ||
Total net charge-offs as % of average loans, net |
|
0.02 |
% |
0.04 |
| ||
Table 4 NONACCRUAL LOANS |
|||||||
(In thousands) |
March 31, 2003 |
December 31, 2002 |
|||||
Commercial and commercial real estate loans |
$ |
19,846 |
|
10,283 |
| ||
Residential mortgages |
|
351 |
|
351 |
| ||
Home equity loans |
|
6,361 |
|
5,665 |
| ||
Total nonaccrual loans |
$ |
26,558 |
|
16,299 |
| ||
as a % of loans, net |
|
0.23 |
% |
0.15 |
| ||
Accruing loans past due 90 days |
$ |
3,701 |
|
3,182 |
| ||
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Information required by this Item 3 is set forth in Item 2 under the caption Risk Governance and Administration and is incorporated herein by reference.
Item 4. Controls and Procedures.
Within the 90-day period prior to the filing of this report, Wachovia Funding carried out an evaluation, under the supervision and with the participation of Wachovia Fundings management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Wachovia Fundings disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934). Based upon that evaluation, Wachovia Fundings Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective. There have been no significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation.
15
Part II. OTHER INFORMATION
Item 1. Legal Proceedings.
We are not the subject of any litigation. We, Wachovia and the Bank are not currently involved in nor, to our knowledge, currently threatened with any material litigation with respect to the assets included in our portfolio, other than routine litigation arising in the ordinary course of business. Based on information currently available, advice of counsel, available insurance coverage and established reserves, we believe that the eventual outcome of the actions against us and/or our subsidiaries will not, in the aggregate, have a material adverse effect on our consolidated financial position or results of operations. However, in the event of unexpected future developments, it is possible that the ultimate resolution of those matters, if unfavorable, may be material to our results of operations for any particular period.
Item 2. Changes in Securities and Use of Proceeds.
Not applicable.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit No. |
Description | ||
(12 |
)(a) |
Computations of Consolidated Ratios of Earnings to Fixed Charges. | |
(12 |
)(b) |
Computations of Consolidated Ratios of Earnings to Fixed Charges and Preferred Stock Dividends. | |
(99 |
)(a) |
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
(99 |
)(b) |
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
(99 |
)(c) |
Wachovia Corporation and Subsidiaries Supplementary Consolidating Financial Information. |
(b) Reports on Form 8-K.
During the quarter ended March 31, 2003, Wachovia Funding did not file any Current Reports on Form 8-K with the Commission. Wachovia Funding filed a Current Report on Form 8-K dated May 2, 2003 with the Commission.
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
WACHOVIA PREFERRED FUNDING CORP. | ||||||||
By: |
/s/ DAVID M. JULIAN | |||||||
David M. Julian Senior Vice President and Corporate Controller (Principal Accounting Officer) |
Date: May 15, 2003
17
WACHOVIA PREFERRED FUNDING CORP.
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
I, G. Kennedy Thompson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Wachovia Preferred Funding Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
6. The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
/s/ G. Kennedy Thompson |
G. Kennedy Thompson Chief Executive Officer |
Date: May 15, 2003
18
CERTIFICATION
I, Robert P. Kelly, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Wachovia Preferred Funding Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
6. The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
/s/ Robert P. Kelly |
Robert P. Kelly Chief Executive Officer Robert P. Kelly Chief Financial Officer |
Date: May 15, 2003
19
EXHIBIT INDEX
Exhibit No. |
Description | ||
(12 |
)(a) |
Computations of Consolidated Ratios of Earnings to Fixed Charges. | |
(12 |
)(b) |
Computations of Consolidated Ratios of Earnings to Fixed Charges and Preferred Stock Dividends. | |
(99 |
)(a) |
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
(99 |
)(b) |
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
(99 |
)(c) |
Wachovia Corporation and Subsidiaries Supplementary Consolidating Financial Information. |
20