UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| x | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. |
For the fiscal year ended December 31, 2006
OR
| ¨ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to .
Commission File Number: 0-23513
WEBSTER PREFERRED CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
| | |
| Connecticut | | 06-1478208 |
(State or other jurisdiction of incorporation or organization) | | (I. R. S. Employer Identification Number) |
| |
| 145 Bank Street, Waterbury, Connecticut | | 06702 |
| (Address of principal executive offices) | | (Zip Code) |
Registrant’s telephone number, including area code: (203) 465-4366
Securities registered pursuant to Section 12(b) of the Act: Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
| | |
| Title of Class | | Exchange where listed |
Preferred Stock, $1 par value | | NASDAQ |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933. Yes ¨ No x.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes ¨ No x.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Exchange Act Rule 12B-2). Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12B-2). Yes ¨ No x.
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of June 30, 2006. N/A
The number of shares outstanding of each of the registrant’s classes of common stock, as of February 28, 2007 is: 100 shares.
WEBSTER PREFERRED CAPITAL CORPORATION
2006 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PART I
Item 1. Business
General
Webster Preferred Capital Corporation (the “Company” or “WPCC”) is a Connecticut corporation incorporated in March 1997. The Company acquires, holds and manages real estate mortgage related assets. Real estate mortgage related assets consist of mortgage-backed securities and residential mortgage loans. Although the Company may acquire and hold a variety of mortgage assets, its present intention is to acquire only residential mortgage loans and mortgage-backed securities. The Company intends to hold such assets to generate net income for distribution to its shareholders based on the spread between the interest income earned on the mortgage assets and the cost of its capital and operations. The Company may invest up to 5% of the total value of its portfolio in assets other than residential mortgage loans and mortgage-backed securities eligible to be held by real estate investment trusts (“REITs”).
All of the Company’s common stock is owned by Webster Bank, National Association (“Webster Bank”). Webster Bank has indicated to the Company that, for as long as any of the Company’s preferred shares are outstanding, Webster Bank intends to maintain direct ownership of 100% of the outstanding common stock of the Company. Pursuant to the Company’s Certificate of Incorporation, the Company cannot redeem, or make any other payments or distributions with respect to shares of its common stock to the extent such redemptions, payments or distributions would cause the Company’s total shareholders’ equity (as determined in accordance with U.S. generally accepted accounting principles, or “GAAP”) to be less than 250% of the aggregate liquidation value of the issued and outstanding preferred shares. The preferred shares are not exchangeable into capital stock or other securities of the Company, Webster Bank or Webster Financial Corporation (“Webster”), the parent company of Webster Bank, and do not constitute regulatory capital of either Webster Bank or Webster. The Company has no subsidiaries.
The Company operates a single segment – acquiring, holding and managing real estate mortgage assets.
The Company has elected to be treated as a REIT under the Internal Revenue Code, as amended (the “Code”). The Company generally will not be subject to federal and state income tax to the extent that it distributes its earnings to its shareholders and maintains its qualification as a REIT.
Total assets of the Company were $512.0 million at December 31, 2006, an increase of $0.2 million compared to $511.8 million at December 31, 2005. The changes were a result of increases in cash of $53.0 million, $3.0 million of interest-bearing deposits and other assets of $1.5 million, offset by reductions in residential mortgage loans of $15.9 million and mortgage-backed securities of $41.3 million. There were $27.0 million of dividend payments to common and preferred shareholders, which exceeded net income by $0.3 million. Shareholder’s equity was $511.8 million at December 31, 2006 as compared to $511.6 million a year earlier.
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Residential Mortgage Loans
The Company may, from time to time, acquire both conforming and nonconforming residential mortgage loans. Conventional, conforming residential mortgage loans comply with the requirements for inclusion in a loan guarantee program sponsored by either Freddie Mac or Fannie Mae. Nonconforming residential mortgage loans do not qualify for these programs in one or more aspects. The nonconforming residential mortgage loans that the Company acquires generally have original principal balances which exceed the limits for these programs. The Company’s nonconforming residential mortgage loans are expected to meet the requirements for sale to national private mortgage conduit programs or other investors in the secondary mortgage market. Loans represent assets that the Company acquires from Webster Bank at carrying value. There were $117.7 million in loans acquired from and $73.3 million in loans transferred to Webster Bank during 2006. There were no loan acquisitions from or loan transfers to Webster Bank in 2005 . While the loan acquisitions represent legal sales by Webster Bank, Webster Bank may not record the transactions as sales for GAAP accounting purposes because of its 100% direct ownership interest in the Company. Accordingly, the Company’s assets for GAAP purposes represent non-recourse receivables from Webster Bank which are fully collateralized by the underlying loans. The underlying loans are whole loans secured by first mortgages or deeds of trust on single family (one-to-four unit) residential real estate properties located primarily in Connecticut. The assets continue to be classified as residential loans in the Company’s financial statements because the returns on and the recoverability of these non-recourse receivables are entirely dependent on the performance of the underlying residential loans.
Residential mortgage loans are evidenced by a promissory note secured by a mortgage or deed of trust or other similar security instrument creating a first lien on a single family (one-to-four unit) residential property, including stock allocated to a dwelling unit in a residential cooperative housing corporation. Residential real estate properties underlying residential mortgage loans consist of individual dwelling units, individual cooperative apartment units, individual condominium units, two- to four-family dwelling units, planned unit developments and townhouses.
Investment Activities
Mortgage-backed securities. The Company may, from time to time, acquire fixed-rate or adjustable-rate mortgage-backed securities representing interests in pools of residential mortgage loans. A portion of any of the mortgage-backed securities that the Company purchases may have been originated by Webster Bank by exchanging pools of mortgage loans for the mortgage-backed securities. The mortgage loans underlying the mortgage-backed securities are secured by single family residential properties located throughout the United States.
The Company intends to acquire only investment-grade mortgage-backed securities issued or guaranteed by Fannie Mae, Freddie Mac and Government National Mortgage Association (“GNMA”). The Company does not intend to acquire any interest-only, principal-only or high-risk mortgage-backed securities. Further, the Company does not intend to acquire any residual interests in real estate mortgage conduits or any interests, other than as a creditor, in any taxable mortgage pools.
Other real estate assets. Although the Company presently intends to invest only in residential mortgage loans and mortgage-backed securities, the Company may invest up to 5% of the total value of its portfolio in assets other than residential mortgage loans and mortgage-backed securities eligible to be held by REITs. In addition to commercial mortgage loans, such assets could include cash and cash equivalents. The Company does not intend to invest in securities or interests of persons primarily engaged in real estate activities. At December 31, 2006 and 2005, the Company did not hold any commercial mortgage loans.
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Regulation
The Company is a wholly-owned subsidiary of Webster Bank, a wholly owned subsidiary of Webster. Webster Bank is subject to extensive regulation, supervision and examination by the Office of the Comptroller of the Currency (the “OCC”) as its primary federal regulator. Webster Bank also is subject to regulation, supervision and examination by the Federal Deposit Insurance Corporation (the “FDIC”) and Webster is subject to oversight by the Board of Governors of the Federal Reserve System. These federal banking regulatory authorities have the right to examine the Company and its activities as a subsidiary of Webster Bank.
If Webster Bank were to become “undercapitalized” under “prompt corrective action” initiatives, the OCC has the authority to require, among other things, that Webster Bank or the Company alter, reduce or terminate any activity that they determine poses an excessive risk to Webster Bank. The Company does not believe that its activities currently pose, or in the future will pose, such a risk to Webster Bank; however, there can be no assurance in that regard. The regulators also could restrict transactions between Webster Bank and the Company, including the transfer of assets, or require Webster Bank to divest or liquidate the Company. Webster Bank could further be directed to take prompt corrective action if federal regulators determined that Webster Bank was in an unsafe or unsound condition or engaging in an unsafe or unsound practice. In light of Webster Bank’s control of the Company, as well as the Company’s dependence and reliance upon the skills and diligence of Webster Bank’s officers and employees, some or all of the foregoing actions and restrictions could have an adverse effect on the operations of the Company, including causing the Company to fail to qualify as a REIT.
Pursuant to OCC regulations and the Company’s Certificate of Incorporation, the Company maintains a separate corporate existence from Webster Bank. In the event Webster Bank should be placed into receivership or conservatorship by federal bank regulators, such federal bank regulators would control Webster Bank. There can be no assurance that these regulators would not cause Webster Bank, as sole holder of the common stock of the Company, to take action adverse to the interest of holders of the preferred shares of the Company.
Taxation
The Company has elected to be treated as a REIT under Sections 856 through 860 of the Code. As a REIT, the Company generally will not be subject to federal and Connecticut income taxes on its net income and capital gains that it distributes to the holders of its common stock and preferred stock.
To maintain REIT status, an entity must meet a number of organizational and operational requirements, including a requirement that it currently distribute to stockholders at least 90% of its “REIT taxable income” (not including capital gains and certain items of non-cash income). If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal and Connecticut state income tax at regular corporate rates. Notwithstanding qualification for taxation as a REIT, the Company may be subject to federal, state and/or local tax, on undistributed REIT taxable income and net income from prohibited transactions.
Employees
The Company has three officers. The executive officers are described further below in Item 10, “Directors, Officers and Corporate Governence”. The Company does not anticipate that it will require any additional employees because it has retained an advisor to administer the day-to-day activities of the Company pursuant to an Advisory Agreement.
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Competition
The Company does not engage in the business of originating mortgage loans. While the Company does intend to acquire additional mortgage assets, it anticipates that these additional mortgage assets will be obtained from Webster Bank. Accordingly, the Company does not compete or expect to compete with mortgage conduit programs, investment banking firms, savings and loan associations, banks, thrift and loan associations, finance companies, mortgage bankers or insurance companies in obtaining our mortgage assets. Webster Bank, from which the Company expects to continue to obtain most or all of its mortgage assets in the future, will face competition from these organizations.
Item 1A. Risk Factors
The material risks and uncertainties that management believes affect the Company are described below. The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations. This report is qualified in its entirety by these risk factors. If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected.
Control by Webster Bank
The Company was organized as a wholly-owned subsidiary of Webster Bank, and continues to be controlled by and, through advisory and servicing agreements, is totally reliant on, Webster Bank. The Company’s Board of Directors consists entirely of Webster Bank employees and through advisory and servicing agreements, Webster Bank and its affiliates are involved in every aspect of the Company’s existence. Webster Bank administers the day-to-day activities of the Company in its role as (“Advisor”) under an (“Advisory Agreement”), and acts as (“Servicer”) of the Company’s mortgage loans under a (“Servicing Agreement”). In addition, all of the officers of the Company are also officers of Webster Bank. As the holder of all of the outstanding voting stock of the Company, Webster Bank generally will have the right to elect all of the directors of the Company.
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Dependence Upon Webster Bank as Advisor and Servicer
The Company is dependent on the diligence and skill of the officers and employees of Webster Bank as its Advisor for the selection, structuring and monitoring of the Company’s mortgage assets. See “Management.” In addition, the Company is dependent upon the expertise of Webster Bank as its Servicer for the servicing of the mortgage loans. The personnel deemed most essential to the Company’s operations are Webster Bank’s loan servicing and administration personnel, and the staff of its finance department. The loan servicing and administration personnel will advise the Company in the selection of mortgage assets, and provide loan servicing oversight. The finance department will assist in the administrative operations of the Company. The Advisor may subcontract all or a portion of its obligations under the Advisory Agreement to one or more affiliates, and under certain conditions to non-affiliates, involved in the business of managing mortgage assets. The Advisor may assign its rights or obligations under the Advisory Agreement, and the Servicer may assign its rights and obligations under the Servicing Agreement, to any affiliate of the Company involved in the business of managing real estate mortgage assets. Under the Advisory Agreement, the Advisor may subcontract out its obligations to unrelated third parties with the approval of the Board of Directors of the Company. In the event the Advisor or the Servicer subcontracts or assigns its rights or obligations in such a manner, the Company will be dependent upon the subcontractor or affiliate to provide services. Although Webster Bank has indicated to the Company that it has no plans in this regard, if Webster Bank were to subcontract all of its loan servicing to an outside third party, it also would do so with respect to mortgage assets under the Servicing Agreement. Under such circumstances, there may be additional risks as to the costs of such services and the ability to identify a subcontractor suitable to the Company. The Servicer does not believe it would subcontract these duties unless it could not perform such duties as efficiently and economically itself. See “–Item 13. Certain Relationships, Related Transactions and Director Independence”.
Conflicts of Interest
Webster Bank and its affiliates may in the future have interests which are not necessarily identical to those of the Company. Consequently, conflicts of interest may arise with respect to transactions, including without limitation, future acquisitions of mortgage assets from Webster Bank and/or affiliates of Webster Bank; servicing of mortgage loans; future dispositions of mortgage loans to Webster Bank or affiliates of Webster Bank; and the modification of the Advisory Agreement or the Servicing Agreement. Under each of the foregoing circumstances, Webster Bank, as sole holder of the common stock, may, or may cause the directors and officers of the Company (each of whom is an employee of Webster Bank) to, take actions adverse to the interests of holders of Preferred Shares. It is the intention of the Company and Webster Bank that any agreements and transactions between the Company, on the one hand, and Webster Bank and/or its affiliates, on the other hand, are fair to all parties and consistent with market terms, including the prices paid and received for mortgage assets on their acquisition or disposition by the Company or in connection with the servicing of mortgage loans. Also, the Advisory Agreement provides that nothing contained in such agreement shall prevent Webster Bank, its affiliates, or an officer, director, employee or stockholder from engaging in any activity, including without limitation, purchasing and managing real estate mortgage assets, rendering services and investment advice with respect to real estate investment opportunities to any other person (including other REITs) and managing other investments (including the investments of Webster Bank and its affiliates). Although it is the intent of the Company and Webster Bank that the dealings between the two be fair, there can be no assurance that agreements or transactions will be on terms as favorable to the Company as those that could have been obtained from unaffiliated third parties.
7
Risk of Future Revisions in Policies and Strategies by Board of Directors
The Board of Directors of the Company has established the investment policies, operating policies and strategies of the Company. These policies may be amended or revised from time to time at the discretion of the Board of Directors without a vote of the Company’s stockholders, including holders of the preferred shares. The ultimate effect of any change in the policies and strategies of the Company on a holder of Preferred Shares may be positive or negative. For example, although the Company currently intends to maintain substantially all of its assets in a combination of residential mortgage loans and mortgage-backed securities, the Company may in the future acquire other mortgage assets, such as commercial mortgage loans, which have a different and distinct risk profile.
Impact Government Supervision & Regulation
Webster Bank, which owns 100% of the Company’s common stock, is subject to supervision and regulation by, among others, the OCC and the FDIC. Because the Company is a subsidiary of Webster Bank, such federal banking regulatory authorities will have the right to examine the Company and its activities. If Webster Bank becomes “undercapitalized” under “prompt corrective action” initiatives of the federal bank regulators, such regulatory authorities will have the authority to require, among other things, Webster Bank or the Company to alter, reduce or terminate any activity that the regulator determines poses an excessive risk to Webster Bank. The Company does not believe that its activities presently do, or in the future will, pose a risk to Webster Bank; however there can be no assurance in that regard. The regulators also could restrict transactions between Webster Bank and the Company including the transfer of assets; require Webster Bank to divest or liquidate the Company; or require that Webster Bank be sold. Webster Bank could further be directed to take any other action that the regulatory agency determines will better carry out the purpose of prompt corrective action. Webster Bank could be subject to these prompt corrective action restrictions if federal regulators determined that Webster Bank was in an unsafe or unsound condition or engaging in an unsafe or unsound practice. In light of Webster Bank’s control of the Company, as well as the Company’s dependence and reliance upon the skill and diligence of Webster Bank officers and employees, some or all of the foregoing actions and restrictions could have an adverse effect on the operations of the Company, including causing the Company’s failure to qualify as a REIT.
Adverse Tax Consequences of Failure to Qualify as a REIT
The Company intends to operate so as to qualify as a REIT under the Code. Although the Company believes that it is owned, organized and operates in such a manner as to qualify as a REIT, no assurance can be given as to the Company’s ability to remain qualified as a REIT. Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial or administrative interpretations. The determination of various factual matters and circumstances, not entirely within the Company’s control, may affect the Company’s ability to qualify as a REIT. Although the Company is not aware of any proposal in Congress to amend the tax laws in a manner that would materially and adversely affect the Company’s ability to operate as a REIT, no assurance can be given that new legislation, regulations, administrative interpretations or court decisions will not significantly change the tax laws in the future with respect to qualification as a REIT or the federal income tax consequences of such qualification.
If, in any taxable year, the Company fails to qualify as a REIT, the Company would not be allowed a deduction for distributions to shareholders in computing its federal taxable income and would be subject to federal and Connecticut state income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates. As a result, the amount available for distribution to the Company’s stockholders would be reduced for the year or years involved. In addition, unless entitled to relief under certain statutory provisions, the Company would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost. A failure of the Company to qualify as a REIT would not by itself give the Company the right to redeem the preferred shares, nor would it give the holders of the preferred shares the right to have their shares redeemed.
8
Notwithstanding that the Company currently intends to operate in a manner designed to qualify as a REIT, future economic, market, legal, tax or other considerations may cause the Company to determine that it is in the best interest of the Company and the holders of its common stock and preferred stock to revoke the REIT election. The tax law prohibits the Company from electing treatment as a REIT for the four taxable years following the year of such revocation.
In the event that the Company has insufficient available cash on hand or is otherwise precluded from making dividend distributions in amounts sufficient to maintain its status as a REIT or to avoid imposition of an excise tax, the Company may avail itself of consent dividend procedures. A consent dividend is a hypothetical dividend, as opposed to an actual dividend, declared by the Company and treated for U.S. federal tax purposes as though it had actually been paid to stockholders who were the owners of shares on the last day of the year and who executed the required consent form, and then recontributed the dividend to the Company. The Company would use the consent dividend procedures only with respect to its common stock.
Geographic Concentration
Certain geographic regions of the United States may from time to time experience natural disasters or weaker regional economic conditions and housing markets, and, consequently, may experience higher rates of loss and delinquency on mortgage loans generally. Any concentration of the mortgage loans in such a region may present risks in addition to those present with respect to mortgage loans generally. Substantially all of the residential properties underlying the mortgage assets presently are located in Connecticut. These mortgage assets may be subject to a greater risk of default than other comparable mortgage assets in the event of adverse economic, political or business developments or natural hazards that may affect such region and the ability of property owners in such region to make payments of principal and interest on the underlying mortgages.
Risks Related to Changes in Interest Rates
The results of the Company’s operations will be affected by various factors, many of which are beyond the control of management. Because the Company does not intend to incur any borrowings, the Company’s net income will be dependent primarily upon the yield on its mortgage assets. Accordingly, income over time will vary as a result of changes in interest rates, the behavior of which involve various risks and uncertainties, and the supply of and demand for mortgage assets. Prepayment rates and interest rates depend upon the nature and terms of the mortgage assets, the geographic location of the real estate securing the mortgage loans included in or underlying the mortgage assets, conditions in financial markets, the fiscal and monetary policies of the United States government and the Board of Governors of the Federal Reserve System, competition and other factors, none of which can be predicted with any certainty. While increases in interest rates will generally increase the yields on the Company’s adjustable-rate mortgage assets, decreasing rates typically would decrease such yields and also may result in increased levels of prepayments. Under such circumstances, the Company may not be able to reinvest at a favorable yield.
Real Estate Market Conditions
The results of the Company’s operations will be affected by various factors, many of which are beyond the control of the Company, such as local and other economic conditions affecting the values of the properties underlying the mortgage assets and the ability of mortgagees to make payments of principal and interest on their mortgage loans. A decline in the value of properties underlying the mortgage assets may cause a higher level of defaults on mortgage loans. There can be no assurance that a decline in local or other economic conditions will not adversely affect mortgage assets currently owned by the Company or acquired by the Company in the future.
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Delays in Liquidating Defaulted Mortgage Loans
Even assuming that the mortgaged properties underlying the mortgage loans held by the Company provide adequate security for such mortgage loans, substantial delays could be encountered in connection with the liquidation of defaulted mortgage loans, with corresponding delays in the receipt of related proceeds by the Company. An action to foreclose on a mortgaged property securing a mortgage loan is regulated by state statutes and rules and is subject to many of the delays and expenses of other lawsuits if defenses or counterclaims are interposed, sometimes requiring several years to complete. In some states, an action to obtain a deficiency judgment is not permitted following a non-judicial sale of a mortgaged property. In Connecticut, where substantially all of the properties currently securing the Company’s mortgage loans are located, foreclosures are judicial and an action to obtain a deficiency judgment is only permitted following a judicial foreclosure of a mortgaged property. In the event of a default by a mortgagor, these restrictions, among other things, may impede the ability of the Company to foreclose on or sell the mortgaged property or to obtain proceeds sufficient to repay all amounts due on the related mortgage loan. In addition, the servicer of the Company’s mortgage loans will be entitled to deduct from collections received all expenses reasonably incurred in attempting to recover amounts due and not yet repaid on liquidated mortgage loans, including legal fees and costs of legal action, real estate taxes and maintenance and preservation expenses, thereby reducing amounts available to the Company.
No Credit Enhancement or Special Hazard Insurance
The Company generally does not intend to obtain credit enhancements such as mortgagor bankruptcy insurance or to obtain special hazard insurance for its mortgage loans, other than standard hazard insurance, which will in each case only relate to individual mortgage loans. Accordingly, during the time it holds mortgage loans for which third party insurance is not obtained, the Company will be subject to risks of borrower defaults and bankruptcies and special hazard losses that are not covered by standard hazard insurance (such as those occurring from earthquakes or floods). In addition, in the event of a default on any mortgage loan held by the Company resulting from declining property values or worsening economic conditions, among other factors, the Company would bear the risk of loss of principal to the extent of any deficiency between (i) the value of the related mortgaged property, plus any payments from an insurer (or guarantor in the case of commercial mortgage loans) and (ii) the amount owing on the mortgage loan.
Risk Associated with Leverage
Although the Company does not currently intend to incur any indebtedness in connection with the acquisition and holding of mortgage assets, the Company may do so at any time. Under the Company’s Certificate of Incorporation and other corporate governance documents, there are no limitations on the Company’s ability to incur additional indebtedness. To the extent the Company were to change its policy with respect to the incurrence of indebtedness, the Company would be subject to risks associated with leverage, including, without limitation, changes in interest rates and prepayment risk.
A leveraging strategy may create instability in the Company’s operations and reduce income under adverse market conditions. A decline in the market value of mortgage assets could limit the Company’s ability to borrow. The Company could be required to sell mortgage assets under adverse market conditions in order to maintain liquidity. If these sales were made at prices lower than the carrying value of the mortgage assets, the Company would experience losses. A default by the Company under its collateralized borrowings could also result in a liquidation of the collateral, resulting in a loss of the difference between the value of the collateral and the amount borrowed. To the extent the Company is compelled to liquidate mortgage assets to repay borrowings, its compliance with the REIT rules regarding asset and sources of income requirements could be negatively affected, ultimately jeopardizing the Company’s status as a REIT.
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In addition, if the Company were to rely on short term borrowings, it also would be subject to interest rate risk to the extent of a mismatch between the long term yield of its mortgage asset portfolio and the short term costs of its borrowings. Developing an effective interest rate risk management strategy is complex and no management strategy can completely insulate the Company from risks associated with changes in interest rates. In addition, any hedges of interest rate risk would involve transaction costs, which generally increase significantly as the period covered by the hedge increases as well as during periods of volatile interest rates. To the extent the Company hedges against interest rate risks, the Company may substantially reduce its net income. Further, the federal tax laws applicable to REITs may limit the Company’s ability to hedge fully its interest rate risks. Such federal tax laws may prevent the Company from effectively implementing hedging strategies that, absent such restrictions, would best insulate the Company from the risks associated with changing interest rates.
| Item 1B. Unresolved | Staff Comments |
The Company has no unresolved comments from the SEC staff.
Item 2. Properties
Not Applicable.
Item 3. Legal Proceedings
There are no material pending legal proceedings, other than ordinary routine litigation incident to the registrant’s business, to which the Company is a party or of which any of its property is subject.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of 2006, no matters were submitted to a vote of the Company’s security holders.
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PART II
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
All of the Company’s common stock is owned by Webster Bank, and consequently there is no established public trading market for such securities. The Company’s Series B 8.625% Cumulative Redeemable Preferred Stock (the “Series B Preferred Stock”) is traded on the NASDAQ Stock Market’s National Market Tier under the symbol “WBSTP”.
The Series B Preferred Stock is currently redeemable at the option of the Company, at a redemption price of $10 per share, plus any accrued and unpaid dividends. At this time, management has no plans to redeem the Series B Preferred Stock.
Dividends are declared and paid at least annually on the common stock. Dividends paid in 2006 and 2005 totaled $26.1 million and $25.6 million, respectively. Dividends are declared and paid quarterly on the Series B Preferred Stock. Dividends paid in 2006 and 2005 totaled $862,500 for each year.
The following table provides information concerning the market price of the Series B Preferred Stock. At December 31, 2006, the closing market price was $10.73.
| | | | | |
| | | For Year ended December 31, |
| | | 2006 | | 2005 |
Average | | $ | 10.74 | | 11.04 |
High | | | 11.51 | | 13.90 |
Low | | | 10.16 | | 10.24 |
Dividends will be declared at the discretion of the Board of Directors after considering the Company’s distributable funds, financial requirements, tax considerations and other factors. The Company’s distributable funds will consist primarily of interest and principal payments on the mortgage assets held by it, and the Company anticipates that a significant portion of such assets will bear interest at adjustable rates. Accordingly, if there is a decline in interest rates, the Company may experience a decrease in income available to be distributed to its shareholders. However, the Company currently expects that both its cash available for distribution and its “REIT taxable income” will exceed the amount needed to pay dividends on the Series B Preferred Stock, even in the event of a significant decline in interest rate levels, because (i) the Company’s mortgage assets are interest-bearing, (ii) the Series B Preferred Stock is not expected to exceed 15% of the Company’s capitalization, and (iii) the Company does not anticipate incurring any indebtedness.
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Item 6. Selected Financial Data
The selected financial data set forth below should be read in conjunction with the Company’s audited financial statements and notes thereto appearing elsewhere in this document.
Balance Sheet Data
| | | | | | | | | | | |
| | | At December 31, |
| (In thousands) | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 |
Total assets | | $ | 511,990 | | 511,761 | | 537,346 | | 538,471 | | 631,237 |
Available for sale securities | | | - | | 41,335 | | 20,709 | | 46,116 | | 110,061 |
Residential mortgage loans, net | | | 372,201 | | 388,136 | | 475,879 | | 426,251 | | 379,590 |
Interest-bearing deposits | | | 80,000 | | 77,000 | | 29,000 | | 52,000 | | 110,500 |
Total shareholders’ equity | | | 511,774 | | 511,571 | | 537,160 | | 538,235 | | 630,992 |
| |
Income Statement Data
| | | | | | | | | | | | | |
| | | For the Year Ended December 31, | |
| (In thousands) | | 2006 | | | 2005 | | 2004 | | 2003 | | 2002 | |
Total interest income | | $ | 27,669 | | | 26,708 | | 26,450 | | 28,249 | | 42,255 | |
Provision for loan losses | | | - | | | - | | - | | - | | - | |
(Loss)gain on sale of securities | | | (117 | ) | | - | | 536 | | 268 | | - | |
Loss on write-down of securities available for sale to fair value | | | (526 | ) | | - | | - | | - | | - | |
Noninterest expenses | | | 329 | | | 294 | | 399 | | 329 | | 310 | |
| | | | |
Net income | | | 26,697 | | | 26,414 | | 26,587 | | 28,188 | | 41,945 | |
Preferred stock dividends | | | 863 | | | 863 | | 863 | | 863 | | 863 | |
| | | | |
Net income available to common shareholder | | | 25,834 | | | 25,551 | | 25,724 | | 27,325 | | 41,082 | |
| | | | |
Significant Statistical Data
| | | | | | | | | | | |
| | | For the Year Ended December 31, |
| | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 |
Net income per common share | | | | | | | | | | | |
Basic | | $ | 258,399 | | 255,505 | | 257,244 | | 273,254 | | 410,816 |
Dividends declared per common share | | | 264,099 | | 255,503 | | 257,253 | | 274,366 | | 412,272 |
| |
13
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The Company has elected to be treated as a REIT under the Code and will generally not be subject to federal and Connecticut income tax for as long as it maintains its qualification as a REIT, requiring among other things, that it currently distribute to stockholders at least 90% of its “REIT taxable income” (not including capital gains and certain items of noncash income). The following discussion of the Company’s financial condition and results of operations should be read in conjunction with the Company’s financial statements and other financial data included elsewhere herein.
Summary
WPCC’s net income for 2006 increased to $26.7 million compared to $26.4 million in 2005. Total interest income increased $1.0 million in 2006 primarily due to the increased yield on short term investments. The overall yield on earning assets increased to 5.46% in 2006 compared to 4.97% in 2005 as short-term market rates continued to rise throughout 2006. This was offset, in part, by the downward pricing of adjustable rate mortgages combined with the lower replacement yield on new mortgage assets. Additionally, the 2006 results included a $0.5 million write-down of securities available for sale to fair value and $0.1 million in losses on the subsequent sale of those securities. There were no corresponding losses in the 2005 results.
Critical Accounting Policies
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that our most critical accounting policy upon which our financial condition depends, and which involves the most complex or subjective decisions or assessments, is the allowance for loan losses.
Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. The Company’s allowance for loan losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio. Management uses historical information to assess the adequacy of the allowance for loan losses as well as the prevailing business and economic environment; as it is affected by changing economic conditions and various other external factors, subsequent changes in these factors may impact the portfolio in ways currently unforeseen. The allowance is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off.
Financial Condition
Total assets, consisting primarily of residential mortgage loans and mortgage-backed securities, were $512.0 million at December 31, 2006, an increase of $0.2 million compared to $511.8 million at December 31, 2005. Residential mortgages decreased by $14.8 million as a result of $73.3 million in loans transferred to Webster Bank and $60.0 million in principal repayments, partially offset by $117.7 million in new loans acquired from Webster Bank.
In October 2006, Webster Financial Corporation announced the repositioning of its available for sale securities portfolio and management’s decision to sell all mortgage-backed securities classified as available for sale. The Company took similar action with respect to its available for sale portfolio. As a result, the Company recognized a loss on the write-down of available for sale mortgage-backed securities to fair value of $526,000 as of September 30, 2006. The Company’s entire mortgage-backed securities portfolio was subsequently sold in October 2006. With the increased cash flow, the Company increased short term investments by $3.0 million compared to 2005. Cash increased to $56.0 million primarily as a result of loan transfers to Webster Bank of $46.1 million late in the fourth quarter of 2006.
14
A summary of the Company’s residential mortgage loans by original maturity for the last five years follows:
| | | | | | | | | | | | | | | | |
| | | At December 31, | |
| (In thousands) | | 2006 | | | 2005 | | | 2004 | | | 2003 | | | 2002 | |
Fixed-rate loans: | | | | | | | | | | | | | | | | |
15 yr. loans | | $ | 29,401 | | | 50,842 | | | 63,747 | | | 71,217 | | | 55,956 | |
20 yr. loans | | | 6,652 | | | 7,218 | | | 8,083 | | | 8,261 | | | 3,132 | |
25 yr. loans | | | 2,857 | | | 3,718 | | | 4,037 | | | 4,414 | | | 2,542 | |
30 yr. loans | | | 198,172 | | | 232,742 | | | 273,028 | | | 190,888 | | | 138,008 | |
| | |
| | | | | |
Total fixed-rate loans | | | 237,082 | | | 294,520 | | | 348,895 | | | 274,780 | | | 199,638 | |
| | |
Variable-rate loans: | | | | | | | | | | | | | | | | |
15 yr. loans | | | 877 | | | 666 | | | 1,009 | | | 2,351 | | | 1,605 | |
20 yr. loans | | | 559 | | | 1,241 | | | 5,246 | | | 3,176 | | | 3,127 | |
25 yr. loans | | | 1,012 | | | 1,183 | | | 1,382 | | | 1,843 | | | 2,680 | |
30 yr. loans | | | 133,265 | | | 89,951 | | | 118,287 | | | 144,728 | | | 173,482 | |
| | |
| | | | | |
Total variable-rate loans | | | 135,713 | | | 93,041 | | | 125,924 | | | 152,098 | | | 180,894 | |
| | |
| | | | | |
Total residential mortgage loans | | | 372,795 | | | 387,561 | | | 474,819 | | | 426,878 | | | 380,532 | |
Residential mortgage loan costs | | | 1,428 | | | 2,597 | | | 3,082 | | | 1,479 | | | 1,164 | |
Less: allowance for loan losses | | | (2,022 | ) | | (2,022 | ) | | (2,022 | ) | | (2,106 | ) | | (2,106 | ) |
| | |
| | | | | |
Residential mortgage loans, net | | $ | 372,201 | | | 388,136 | | | 475,879 | | | 426,251 | | | 379,590 | |
| | |
Asset Quality
The Company maintains asset quality by acquiring residential real estate loans that have been conservatively underwritten and by aggressively managing nonperforming assets. During 2006 all loans acquired by the Company were transferred to it from Webster Bank. There were $117.7 million in acquired loans and $73.3 million in loan transfers to Webster Bank in 2006. As such, the Company’s asset quality is dependent upon Webster Bank’s ability to maintain conservative underwriting standards. At December 31, 2006, residential real estate loans comprised the entire loan portfolio. The Company also invests in mortgage-backed securities issued by government agencies or government-sponsored enterprises.
15
Nonperforming Assets and Delinquencies
The following table details the Company’s nonperforming assets for the last five years:
| | | | | | | | | | | | |
| | | At December 31, |
| (Dollars in thousands) | | 2006 | | | 2005 | | 2004 | | 2003 | | 2002 |
Loans accounted for on a nonaccrual basis: | | | | | | | | | | | | |
Residential fixed-rate loans | | $ | - | | | - | | - | | 185 | | 247 |
Residential variable-rate loans | | | 211 | | | 97 | | 179 | | 173 | | 209 |
| |
Total nonperforming loans | | | 211 | | | 97 | | 179 | | 358 | | 456 |
Other real estate owned | | | - | | | - | | - | | 104 | | 79 |
| |
Total nonperforming assets | | $ | 211 | | | 97 | | 179 | | 462 | | 535 |
| |
| | | | | |
Allowance for loan losses | | $ | 2,022 | | | 2,022 | | 2,022 | | 2,106 | | 2,106 |
Allowance / nonperforming loans | | | 958 | % | | 2,085 | | 1,130 | | 588 | | 462 |
Allowance / total mortgage loans | | | 0.54 | | | 0.52 | | 0.43 | | 0.49 | | 0.55 |
| |
The following table sets forth information as to the Company’s loans past due 30-89 days and still accruing:
| | | | | | | | | | | |
| | | At December 31, |
| (In thousands) | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 |
Past due 30-89 days: | | | | | | | | | | | |
Residential fixed-rate loans | | $ | 204 | | 723 | | 279 | | 287 | | 643 |
Residential variable-rate loans | | | 250 | | 539 | | 266 | | 491 | | 1,176 |
| |
Total | | $ | 454 | | 1,262 | | 545 | | 778 | | 1,819 |
| |
Allowance for Loan Losses
An allowance for loan losses is established based upon a review of the loan portfolio, loss experience, specific problem loans, current and anticipated economic conditions and other pertinent factors which, in management’s judgment, deserve current recognition in estimating probable loan losses.
Management believes that the allowance for loan losses is adequate. While management believes it uses the best available information to recognize losses on loans, future additions to the allowance may be necessary based on actual results or changes in information used. In addition, various regulatory agencies, as an integral part of their examination process of Webster Bank, periodically may review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses based on judgments different from those of management.
A detail of the change in the allowance for loan losses for the periods indicated follows:
| | | | | | | | | | | | | |
| | | For the Year Ended December 31, | |
| (In thousands) | | 2006 | | 2005 | | 2004 | | | 2003 | | 2002 | |
Balance at beginning of the year | | $ | 2,022 | | 2,022 | | 2,106 | | | 2,106 | | 2,139 | |
Provision charged to operations | | | - | | - | | - | | | - | | - | |
Charge-offs | | | - | | - | | (84 | ) | | - | | (33 | ) |
| | |
Balance at end of the year | | $ | 2,022 | | 2,022 | | 2,022 | | | 2,106 | | 2,106 | |
| | |
16
Liquidity and Capital Resources
The primary sources of liquidity for the Company are principal and interest payments from the residential mortgage loans and mortgage-backed securities portfolios. The primary uses of liquidity are purchases of residential mortgage loans and mortgage-backed securities and the payment of dividends on the common and preferred stock.
While scheduled loan amortization, maturing securities, short-term investments and securities repayments are predictable sources of funds, loan and mortgage-backed security prepayments can vary greatly and are influenced by factors such as general interest rates, economic conditions and competition. One of the inherent risks of investing in loans and mortgage-backed securities is the ability of such instruments to incur prepayments of principal prior to maturity at prepayment rates different than those estimated at the time of purchase. This generally occurs because of changes in market interest rates.
Dividends on the Series B Preferred Stock are payable at the rate of 8.625% per annum (an amount equal to $.8625 per annum per share), in all cases if, when and as declared by the Board of Directors of the Company. Dividends on the preferred shares are cumulative and, if declared, payable on January 15, April 15, July 15 and October 15 in each year. The Company periodically makes dividend payments on its common stock in accordance with Company by-laws. Common stock dividends are paid to comply with REIT qualification rules. REIT qualification rules require that at least 90% of net taxable income for the year be distributed to shareholders. Accelerated prepayments beginning in 2002 and continuing throughout 2006 resulted in increased cash levels for the Company. In 2002, 2003 and 2005, WPCC declared return of capital dividends in order to return a portion of the available cash to the Company’s common shareholder.
In the event that principal and interest payments on its mortgage assets are insufficient to meet its operating needs, WPCC has the ability to raise additional funds. The Company’s residential mortgage loans are underwritten to meet secondary market requirements and could be sold or securitized as mortgage-backed securities and used as borrowing collateral.
Asset/Liability Management
The goal of the Company’s asset/liability management policy is to manage interest-rate risk so as to maximize net interest income over time in changing interest rate environments while maintaining acceptable levels of risk. The Company prepares estimates of the level of prepayments and the effect of such prepayments on the level of future earnings due to reinvestment of funds at rates different than those that currently exist. The Company is unable to predict future fluctuations in interest rates. The market values of the Company’s financial assets are sensitive to fluctuations in market interest rates. The market values of fixed-rate loans and mortgage-backed securities tend to decline in value as interest rates rise. If interest rates decrease, the market value of loans and mortgage-backed securities generally will tend to increase with the level of prepayments also normally increasing. The interest income earned on the Company’s variable-rate, interest-sensitive instruments, which represent primarily variable-rate mortgage loans, may change due to changes in quoted interest-rate indices. The variable-rate mortgage loans generally reprice based on a stated margin over U.S. Treasury Securities indices of varying maturities, the terms of which are established at the time that the loan is closed. At December 31, 2006, 36.4% of the Company’s residential mortgage loans were variable-rate loans.
Results of Operations
Net income was $26.7 million for the year ended December 31, 2006 compared to $26.4 million in 2005 and $26.6 million in 2004. The increase of $0.3 million in 2006 compared to 2005 is primarily due to an increase in interest income on interest earning assets partially offset by the write-down of securities available for sale to fair value and the loss on the subsequent sale of those securities. The decline in net income for 2005 compared to 2004 is primarily due to a decline in the gain on sale of securities.
17
The increase in interest income of $1.0 million, or 3.6% in 2006 compared to 2005 was due to increases in the average yields of short term investments. The increase in interest income of $0.3 million, or 1%, in 2005 compared to 2004 was primarily due to an increase in average yields for short-term investments, as short-term market rates continued to rise throughout 2006. Due to the lower interest rate environment during 2004 and 2005, mortgage asset prepayments accelerated. The decline in balances over the three-year period was due to these accelerated prepayments in a low interest rate environment.
| | | | | | | | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, | |
| | | 2006 | | | 2005 | | | 2004 | |
| (Dollars in thousands) | | Average
Balance | | Interest
Income | | Average
Yield | | | Average
Balance | | Interest
Income | | Average
Yield | | | Average
Balance | | Interest
Income | | Average
Yield | |
Mortgage loans net of deferred costs | | $ | 393,205 | | 22,020 | | 5.60 | % | | $ | 435,078 | | 23,052 | | 5.30 | % | | $ | 455,756 | | 24,206 | | 5.31 | % |
Mortgage-backed securities | | | 31,098 | | 1,543 | | 4.96 | | | | 19,218 | | 882 | | 4.59 | | | | 29,927 | | 1,491 | | 4.98 | |
Interest-bearing deposits | | | 82,296 | | 4,106 | | 4.99 | | | | 82,609 | | 2,774 | | 3.36 | | | | 59,121 | | 753 | | 1.27 | |
| | |
Total | | $ | 506,599 | | 27,669 | | 5.46 | % | | $ | 536,905 | | 26,708 | | 4.97 | % | | $ | 544,804 | | 26,450 | | 4.85 | % |
| | |
Net interest income also can be understood in terms of the impact of changing rates and changing volumes. The following table describes the extent to which changes in interest rates and changes in volume of interest-earning assets have impacted interest income during the periods indicated. Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior rate), (ii) changes attributable to changes in rates (changes in rates multiplied by prior volume) and (iii) the net change. The change attributable to the combined impact of volume and rate has been allocated proportionately to the change due to volume and the change due to rate.
| | | | | | | | | | | | | | | | | | | |
| | | Years ended December 31,
2006 v. 2005 | | | Years ended December 31,
2005 v. 2004 | |
| | | Increase (decrease) due to | | | Increase (decrease) due to | |
| (In thousands) | | Rate | | Volume | | | Total | | | Rate | | | Volume | | | Total | |
Interest on interest-earning assets: | | | | | | | | | | | | | | | | | | | |
Loans, net | | $ | 440 | | (1,472 | ) | | (1,032 | ) | | $ | (46 | ) | | (1,108 | ) | | (1,154 | ) |
Mortgage-backed securities | | | 77 | | 584 | | | 661 | | | | (109 | ) | | (500 | ) | | (609 | ) |
Interest-bearing deposits | | | 1,332 | | - | | | 1,332 | | | | 1,628 | | | 393 | | | 2,021 | |
| | |
Net change in net interest income | | $ | 1,849 | | (888 | ) | | 961 | | | $ | 1,473 | | | (1,215 | ) | | 258 | |
| | | | |
There was no provision for loan losses for the years ended December 31, 2006, 2005 and 2004. The absence of a provision for loan losses is reflective of the continued low level of nonperforming loans and charge-offs, as well as the solid economic performance of the local area where the collateral for the majority of the loans reside.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.
Unlike most industrial companies, virtually all of the assets and liabilities of a real estate investment trust are monetary in nature. As a result, interest rates have a more significant impact on a real estate corporation’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services. In the current interest rate environment, the maturity structure of the Company’s assets is critical to the maintenance of acceptable performance levels.
18
Recent Accounting Standards
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157,“Fair Value Measurements” (“SFAS 157”), which is effective for fiscal years beginning after November 15, 2007 and for interim periods within those years. This statement defines fair value, establishes a framework for measuring fair value and expands the related disclosure requirements. The adoption of SFAS 157 is not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
In June 2006, the FASB issued FASB Interpretation No. 48,“Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements by prescribing a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 and are to be applied to all tax positions upon initial adoption of this standard. Tax positions must meet the more-likely-than-not recognition threshold at the adoption date in order for the related tax benefits to be recognized or continue to be recognized. The adoption of FIN 48 is not expected to have any effect on the Company’s consolidated financial position, results of operations or cash flows.
In March 2006, the FASB issued SFAS No. 156,“Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140”(“SFAS 156”), which is effective for fiscal years beginning after September 15, 2006. This statement was issued to simplify the accounting for servicing rights and to reduce the volatility that results from using different measurement attributes. The adoption of SFAS 156 is not expected to have any effect on the Company’s consolidated financial position, results of operations or cash flows.
In February 2006, the FASB issued SFAS No. 155,“Accounting for Certain Hybrid Financial Instruments” (“SFAS 155”), which eliminates the exemption from applying SFAS 133 to interests in securitized financial assets so that similar instruments are accounted for similarly regardless of the form of the instruments. SFAS 155 also allows the election of fair value measurement at acquisition, at issuance, or when a previously recognized financial instrument is subject to a remeasurement event. Adoption is effective for all financial instruments acquired or issued after the beginning of the first fiscal year that begins after September 15, 2006. The adoption of SFAS 155 is not expected to have any effect on the Company’s consolidated financial position, results of operations or cash flows.
Forward Looking Statements
This Annual Report contains forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended. Actual results, performance or developments may differ materially from those expressed or implied by such forward-looking statements as a result of market uncertainties and other factors. Some important factors that could cause actual results to differ from those in any forward-looking statements include changes in interest rates and general economics in the Connecticut market area where a substantial portion of the real estate securing the Company’s loans is located, legislative and regulatory changes, changes in tax laws and policies, and changes in accounting policies, principles or guidelines. Such developments, or any combination thereof, could have an adverse impact on the Company’s financial position and results of operations.
19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Because the majority of our assets are sensitive to changes in interest rates, our most significant form of market risk is interest rate risk. An effective asset/liability management process must balance the risks and rewards from both short and long-term interest rate risks in determining management strategy and action. The primary goal of managing this risk is to maximize net income (short-term risk) and net economic value (long-term risk) over time in changing interest rate environments.
The following table summarizes the estimated market values of the Company’s interest-sensitive assets at December 31, 2006 and 2005, and the projected change to market values if interest rates instantaneously increase or decrease by 100 basis points. The Company had no interest-sensitive liabilities at December 31, 2006 and 2005.
| | | | | | | | | | |
| | | | | | | Estimated Market Value Impact | |
| (In thousands) | | Amortized Cost | | Market Value | | -100 BP | | +100 BP | |
At December 31, 2006 | | | | | | | | | | |
Mortgage-backed securities | | $ | - | | - | | - | | - | |
Variable-rate residential loans | | | 237,082 | | 236,076 | | 6,399 | | (10,210 | ) |
Fixed-rate residential loans | | | 135,713 | | 135,948 | | 1,806 | | (2,064 | ) |
| | |
At December 31, 2005 | | | | | | | | | | |
Mortgage-backed securities | | $ | 41,835 | | 41,335 | | 521 | | (580 | ) |
Variable-rate residential loans | | | 93,041 | | 92,557 | | 1,168 | | (1,262 | ) |
Fixed-rate residential loans | | | 294,520 | | 293,051 | | 8,892 | | (12,363 | ) |
| | |
Interest-sensitive assets, when shocked by a minus 100 basis point rate change, results in a favorable $8.2 million change in market values for 2006 compared to a favorable $10.6 million market value change in 2005. These changes represent 2.4 % of interest-sensitive assets in 2006 and 2.5% in 2005. A plus 100 basis point rate change results in an unfavorable $12.3 million, or 3.1%, change in 2006, compared to an unfavorable $14.2 million or 3.3%, change in 2005.
Based on the Company’s asset/liability mix at December 31, 2006, management estimates that a gradual 200 basis point increase in interest rates would increase net income over the next twelve months by 4.5%. A gradual 200 basis point decline in interest rates is projected to decrease net income by 5.0%.
The Company’s interest rate sensitive assets are subject to prepayment risk. Prepayment risk is inherently difficult to estimate and is dependent upon a number of economic, financial and behavioral variables. The Company uses a sophisticated mortgage prepayment modeling system to estimate prepayments and the corresponding impact on market value and net interest income. The model uses information that includes the instrument type, coupon spread, loan age and other factors in its projections.
These assumptions are inherently uncertain and, as a result, the simulation analyses cannot precisely estimate the impact that higher or lower rate environments will have on net income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes, changes in cash flow patterns and market conditions, as well as changes in management’s strategies. Management believes that Company’s interest-rate risk position at December 31, 2006 represents a reasonable level of risk.
20
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Webster Preferred Capital Corporation:
We have audited the accompanying statements of condition of Webster Preferred Capital Corporation (a subsidiary of Webster Bank, N.A.) as of December 31, 2006 and 2005, and the related statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Webster Preferred Capital Corporation as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Hartford, Connecticut
March 29, 2007
21
WEBSTER PREFERRED CAPITAL CORPORATION
STATEMENTS OF CONDITION
| | | | | | |
| | | |
| (In thousands, except share and per share data) | | December 31, 2006 | | | December 31, 2005 |
Assets | | | | | | |
| | |
Cash | | $ | 56,356 | | | 3,402 |
Interest-bearing deposits | | | 80,000 | | | 77,000 |
Mortgage-backed securities available for sale, at fair value | | | - | | | 41,335 |
Residential mortgage loans, net | | | 372,201 | | | 388,136 |
Accrued interest receivable | | | 1,859 | | | 1,784 |
Prepaid expenses and other assets | | | 1,574 | | | 104 |
| |
Total assets | | $ | 511,990 | | | 511,761 |
| |
| | |
Liabilities and Shareholders’ Equity | | | | | | |
| | |
Accrued dividends payable | | $ | 180 | | | 180 |
Accrued expenses and other liabilities | | | 36 | | | 10 |
| |
Total liabilities | | | 216 | | | 190 |
| |
| | |
Shareholders’ Equity | | | | | | |
| | |
Series B 8.625% cumulative redeemable preferred stock, liquidation preference $10 per share; par value $1.00 per share: | | | | | | |
1,000,000 shares authorized, issued and outstanding | | | 1,000 | | | 1,000 |
Common stock, par value $.01 per share: | | | | | | |
Authorized - 1,000 shares | | | | | | |
Issued and outstanding - 100 shares | | | 1 | | | 1 |
Paid-in capital | | | 513,799 | | | 513,799 |
Distributions in excess of accumulated earnings | | | (3,026 | ) | | (2,729) |
Accumulated other comprehensive loss | | | - | | | (500) |
| |
Total shareholders’ equity | | | 511,774 | | | 511,571 |
| |
Total liabilities and shareholders’ equity | | $ | 511,990 | | | 511,761 |
| |
See accompanying notes to financial statements.
22
WEBSTER PREFERRED CAPITAL CORPORATION
STATEMENTS OF INCOME
| | | | | | | | |
| | | Years Ended December 31, |
| (In thousands, except per share data) | | 2006 | | | 2005 | | 2004 |
Interest income: | | | | | | | | |
Loans (Note 5) | | $ | 22,020 | | | 23,052 | | 24,206 |
Securities and interest-bearing deposits | | | 5,649 | | | 3,656 | | 2,244 |
| |
Total interest income | | | 27,669 | | | 26,708 | | 26,450 |
| | | |
Provision for loan losses | | | - | | | - | | - |
| |
Interest income after provision for loan losses | | | 27,669 | | | 26,708 | | 26,450 |
| | | |
Noninterest (loss) income: | | | | | | | | |
Loss on write-down of securities available for sale to fair value | | | (526 | ) | | - | | - |
(Loss) gain on sale of securities | | | (117 | ) | | - | | 536 |
| |
Total noninterest (loss) income | | | (643 | ) | | - | | 536 |
| |
| | | |
Noninterest expenses: | | | | | | | | |
Advisory fee expense paid to parent | | | 202 | | | 195 | | 195 |
Other noninterest expense | | | 127 | | | 99 | | 204 |
| |
Total noninterest expense | | | 329 | | | 294 | | 399 |
| |
| | | |
Net income | | | 26,697 | | | 26,414 | | 26,587 |
Preferred stock dividends | | | 863 | | | 863 | | 863 |
| |
Net income available to common shareholder | | $ | 25,834 | | | 25,551 | | 25,724 |
| |
| | | | | | | | |
| |
Basic net income per common share | | $ | 258,340 | | | 255,505 | | 257,244 |
| |
STATEMENTS OF COMPREHENSIVE INCOME
| | | | | | | | | | |
| | | Years Ended December 31, | |
| (In thousands) | | 2006 | | | 2005 | | | 2004 | |
| | | |
Net income | | $ | 26,697 | | | 26,414 | | | 26,587 | |
Other comprehensive income (loss): | | | | | | | | | | |
Unrealized net holding loss on securities
available for sale arising during the year | | | (143 | ) | | (521 | ) | | (431 | ) |
Reclassification adjustment for loss on sale and write-down of
securities available for sale included in net income | | | 643 | | | - | | | - | |
Reclassification adjustment for gains realized during the year | | | - | | | - | | | (536 | ) |
| | |
Other comprehensive income (loss) | | | 500 | | | (521 | ) | | (967 | ) |
| | |
Comprehensive income | | $ | 27,197 | | | 25,893 | | | 25,620 | |
| | |
See accompanying notes to financial statements.
23
WEBSTER PREFERRED CAPITAL CORPORATION
STATEMENTS OF SHAREHOLDERS’ EQUITY
| | | | | | | | | | | | | | | | | |
| (In thousands, except per share data) | | Preferred
Stock | | Common
Stock | | Paid-In
Capital | | | Distributions
in Excess of
Accumulated
Earnings | | | Accumulated
Other
Comprehensive
Income (Loss) | | | Total | |
Balance, December 31, 2003 | | $ | 1,000 | | 1 | | 538,799 | | | (2,553 | ) | | 988 | | | 538,235 | |
| | | | | | |
Net income | | | - | | - | | - | | | 26,587 | | | - | | | 26,587 | |
Other comprehensive loss | | | - | | - | | - | | | - | | | (967 | ) | | (967 | ) |
Dividends declared and paid: | | | | | | | | | | | | | | | | | |
Common stock ($258,319 per share) | | | - | | - | | - | | | (25,832 | ) | | - | | | (25,832 | ) |
Series B Preferred stock | | | - | | - | | - | | | (863 | ) | | - | | | (863 | ) |
| | |
Balance, December 31, 2004 | | | 1,000 | | 1 | | 538,799 | | | (2,661 | ) | | 21 | | | 537,160 | |
| | | | | | |
Net income | | | - | | - | | - | | | 26,414 | | | - | | | 26,414 | |
Other comprehensive loss | | | - | | - | | - | | | - | | | (521 | ) | | (521 | ) |
Dividends declared and paid: | | | | | | | | | | | | | | | | | |
Return of capital dividend on common stock | | | - | | - | | (25,000 | ) | | - | | | - | | | (25,000 | ) |
Common stock ($256,184 per share) | | | - | | - | | - | | | (25,619 | ) | | - | | | (25,619 | ) |
Series B Preferred stock | | | - | | - | | - | | | (863 | ) | | - | | | (863 | ) |
| | |
Balance, December 31, 2005 | | | 1,000 | | 1 | | 513,799 | | | (2,729 | ) | | (500 | ) | | 511,571 | |
| | | | | | |
Net income | | | - | | - | | - | | | 26,697 | | | - | | | 26,697 | |
Other comprehensive income | | | - | | - | | - | | | - | | | 500 | | | 500 | |
Dividends declared and paid: | | | | | | | | | | | | | | | | | |
Common stock ($261,310 per share) | | | - | | - | | - | | | (26,131 | ) | | - | | | (26,131 | ) |
Series B Preferred stock | | | - | | - | | - | | | (863 | ) | | - | | | (863 | ) |
| | |
Balance, December 31, 2006 | | $ | 1,000 | | 1 | | 513,799 | | | (3,026 | ) | | - | | | 511,774 | |
| | |
See accompanying notes to financial statements.
24
WEBSTER PREFERRED CAPITAL CORPORATION
STATEMENTS OF CASH FLOWS
| | | | | | | | | | | |
| | | Years ended December 31, | |
| (In thousands) | | 2006 | | | 2005 | | | 2004 | |
Cash flow from operating activities: | | | | | | | | | | | |
Net income | | $ | 26,697 | | | 26,414 | | | $ | 26,587 | |
Adjustments to reconcile net income to net cash provided by
operating activities: | | | | | | | | | | | |
Net amortization and accretion | | | 389 | | | 878 | | | | 570 | |
Loss on write down of securities available for sale to fair value | | | 526 | | | - | | | | - | |
Loss (gain) on sale of securities | | | 117 | | | - | | | | (536 | ) |
(Increase) decrease in accrued interest receivable | | | (75 | ) | | (1,504 | ) | | | 71 | |
Increase (decrease) in accrued expenses and other liabilities | | | 26 | | | 4 | | | | (50 | ) |
(Increase) decrease in prepaid expenses and other assets | | | (1,470 | ) | | 1,049 | | | | 520 | |
| | |
Net cash provided by operating activities | | | 26,210 | | | 26,841 | | | | 27,162 | |
| | |
Cash flow from investing activities: | | | | | | | | | | | |
Purchase of mortgage-backed securities | | | - | | | (24,658 | ) | | | - | |
Principal repayments on mortgage-backed securities | | | 4,393 | | | 3,441 | | | | 9,270 | |
Proceeds from sale of mortgage-backed securities | | | 36,769 | | | - | | | | 15,600 | |
(Increase) decrease in interest-bearing deposits | | | (3,000 | ) | | (48,000 | ) | | | 23,000 | |
Decrease (increase) in residential mortgage loans | | | 15,576 | | | 86,935 | | | | (50,083 | ) |
Proceeds from other real estate owned sales | | | - | | | - | | | | 95 | |
| | |
Net cash provided by (used in) investing activities | | | 53,738 | | | 17,718 | | | | (2,118 | ) |
| | |
Cash flow from financing activities: | | | | | | | | | | | |
Dividends paid on common and preferred stock | | | (26,994 | ) | | (26,482 | ) | | | (26,695 | ) |
Return of capital dividend | | | - | | | (25,000 | ) | | | - | |
| | |
Net cash used by financing activities | | | (26,994 | ) | | (51,482 | ) | | | (26,695 | ) |
| | |
Increase (decrease) in cash and cash equivalents | | | 52,954 | | | (6,923 | ) | | | (1,651 | ) |
Cash and cash equivalents at beginning of year | | | 3,402 | | | 10,325 | | | | 11,976 | |
| | |
Cash and cash equivalents at end of year | | $ | 56,356 | | | 3,402 | | | $ | 10,325 | |
| | |
| | | |
Supplemental Schedule of Non-Cash Investing Activity: | | | | | | | | | | | |
Transfer of residential mortgage loans to other real
estate owned | | $ | - | | | - | | | | 60 | |
| | |
See accompanying notes to the financial statements.
25
WEBSTER PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 1: Summary of Significant Accounting Policies
a) Business
Webster Preferred Capital Corporation (the “Company”) is a Connecticut corporation incorporated in March 1997 and a subsidiary of Webster Bank, National Association, (“Webster Bank”), which is a wholly-owned subsidiary of Webster Financial Corporation (“Webster”). The Company acquires, holds and manages real estate related mortgage assets.
The Company has elected to be treated as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”), and will generally not be subject to federal income tax to the extent that it distributes its earnings to its stockholders and maintains its qualification as a REIT. All of the shares of the Company’s common stock, par value $0.01 per share, are owned by Webster Bank, which is a federally-chartered and federally-insured commercial bank. Webster Bank has indicated to the Company that, for as long as any of the Company’s preferred shares are outstanding, Webster Bank intends to maintain direct ownership of 100% of the outstanding common stock of the Company.
b) Basis of Financial Statement Presentation
The financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP). In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, as of the date of the financial statements, and revenues and expenses for the periods presented. The actual results of the Company could differ from those estimates. An example of a material estimate that is susceptible to near-term changes is the allowance for loan losses.
c) Residential Mortgage Loans
Loans represent assets that the Company acquires from Webster Bank at carrying value. While these transfers represent legal sales by Webster Bank, Webster Bank may not record the transfers as sales for GAAP accounting purposes because of its 100% direct ownership interest in the Company. Accordingly, the Company’s assets represent non-recourse receivables from Webster Bank which are fully collateralized by the underlying loans. The underlying loans are whole loans secured by first mortgages or deeds of trust on single family (one-to-four unit) residential real estate properties located primarily in Connecticut. The assets continue to be classified as residential loans in the Company’s financial statements because the returns on and the recoverability of these non-recourse receivables are entirely dependent on the performance of the underlying residential loans.
Loans are stated at the principal amounts outstanding, adjusted by deferred loan costs, and the allowance for loan losses. Interest on loans is credited to income as earned based on the rate applied to principal amounts outstanding. Interest which is more than 90 days past due is not accrued. Such interest ultimately collected, if any, is credited to income in the period received. Deferred loan fees/costs on loans acquired are recognized in interest income over the lives of the loans using a method approximating the interest method. Servicing fees paid to the Servicer are charged against interest income.
The Company’s residential mortgage loans are not within the scope of Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS No. 118, since these are homogenous loans with relatively small balances that are collectively evaluated for impairment.
26
d) Allowance for Loan Losses
The allowance for loan losses is established based upon a review of the loan portfolio, loss experience, specific problem loans, economic conditions and other pertinent factors which, in management’s judgment, deserve current recognition in estimating probable loan losses.
Management believes that the allowance for loan losses is adequate. While management believes it uses the best available information to recognize probable losses on loans, future additions to the allowance may be necessary based upon actual results or changes in the above mentioned factors. In addition, various regulatory agencies, as an integral part of their examination process of Webster Bank, periodically may review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses based on judgments different from those of management.
e) Mortgage-Backed Securities
Mortgage-backed securities are issued by U.S. government agencies or government-sponsored enterprises and were classified as available for sale. Available for sale securities were carried at fair value with unrealized gains and losses recorded as adjustments to shareholders’ equity. The adjustment to shareholders’ equity was not tax-effected, as the Company is generally not subject to federal and state income tax. Realized gains and losses on sales of securities are recorded using the specific identification method. Unrealized losses on securities are charged to earnings when the decline in fair value is judged to be other than temporary.
f) Net Income Per Common Share
Basic net income per common share is calculated by dividing net income available to common shareholders by the weighted-average number of shares of common stock outstanding. Diluted net income per common share does not apply since the Company has issued no options or other instruments representing potential common shares. The weighted-average number of shares used in the computation of basic earnings per common share for the years ended December 31, 2006, 2005 and 2004 was 100.
g) Comprehensive Income
The purpose of reporting comprehensive income is to report a measure of all changes in equity of an enterprise that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. Comprehensive income includes net income and certain changes in equity from non-owner sources that are not recognized in the income statement (such as net unrealized gains and losses on securities available for sale).
h) Statement of Cash Flows
For purposes of the Statement of Cash Flows, the Company defines cash in banks to be cash and cash equivalents.
i) Reclassifications
Certain financial statement balances as previously reported have been reclassified to conform to the 2006 Consolidated Financial Statements presentation.
Note 2: Mortgage-Backed Securities Available for Sale
The following table sets forth certain information regarding the mortgage-backed securities at December 31, 2005:
| | | | | | | | | | |
| (In thousands) | | Amortized
Cost | | Gross
Unrealized
Gains | | Gross
Unrealized
Losses | | | Estimated Fair
Value |
December 31, 2005 | | | | | | | | | | |
Available for Sale Portfolio | | $ | 41,835 | | - | | (500 | ) | | 41,335 |
| |
27
Mortgage-backed securities were written down to fair value in September 2006, resulting in a loss of $526,000. The entire portfolio of $36.2 million was sold in October 2006, generating a loss on sale of $117,000. During 2005, there were no sales of mortgage-backed securities. Mortgage-backed securities sold for proceeds of $15.6 million generated a gain of $536,000 during 2004.
Note 3: Residential Mortgage Loans, Net
A summary of residential mortgage loans, net, by type and original maturity follows:
| | | | | | | |
| | | At December 31, | |
| (In thousands) | | 2006 | | | 2005 | |
Fixed-rate loans: | | | | | | | |
15 yr. loans | | $ | 29,401 | | | 50,842 | |
20 yr. loans | | | 6,652 | | | 7,218 | |
25 yr. loans | | | 2,857 | | | 3,718 | |
30 yr. loans | | | 198,172 | | | 232,742 | |
| | |
Total fixed-rate loans | | | 237,082 | | | 294,520 | |
| | |
Variable-rate loans: | | | | | | | |
15 yr. loans | | | 877 | | | 666 | |
20 yr. loans | | | 559 | | | 1,241 | |
25 yr. loans | | | 1,012 | | | 1,183 | |
30 yr. loans | | | 133,265 | | | 89,951 | |
| | |
Total variable-rate loans | | | 135,713 | | | 93,041 | |
| | |
| | |
Total residential mortgage loans | | | 372,795 | | | 387,561 | |
Residential mortgage loan costs | | | 1,428 | | | 2,597 | |
Less: allowance for loan losses | | | (2,022 | ) | | (2,022 | ) |
| | |
| | |
Residential mortgage loans, net | | $ | 372,201 | | | 388,136 | |
| | |
Loans transferred to the Company by Webster Bank totaled $117.7 million in 2006 and $149.5 million in 2004 (None in 2005). Loans transferred by the Company to Webster Bank totaled $73.3 million in 2006. (None in 2005 and 2004).
A detail of the change in the allowance for loan losses follows:
| | | | | | | | |
| | | Years Ended December 31, | |
| (In thousands) | | 2006 | | 2005 | | 2004 | |
Balance at beginning of year | | $ | 2,022 | | 2,022 | | 2,106 | |
Provision charged to operations | | | - | | - | | - | |
Charge-offs | | | - | | - | | (84 | ) |
| | |
Balance at end of year | | $ | 2,022 | | 2,022 | | 2,022 | |
| | |
No loans were considered impaired at either December 31, 2006 or 2005. Nonaccrual loans totaled $211,000 and $97,000 at December 31, 2006 and 2005, respectively.
Note 4: Redeemable Preferred Stock
In December 1997, 1,000,000 shares of Series B 8.625% cumulative redeemable preferred stock were issued at $10 per share, raising $10.0 million less issuance costs. The Series B preferred stock is redeemable solely at the option of the Company, which has no current plans to redeem the preferred stock. The redemption price is $10 per share.
28
Note 5: Servicing
The mortgage loans owned by the Company are serviced by Webster Bank pursuant to the terms of a servicing agreement. Webster Bank in its role as servicer under the terms of the servicing agreement is herein referred to as the “Servicer.” The Servicer receives fees at an annual rate of (i) 8 basis points for fixed-rate loan servicing and collection, (ii) 8 basis points for variable-rate loan servicing and collection and (iii) 5 basis points for all other services to be provided, as needed, in each case based on the daily outstanding balances of all the Company’s loans for which the Servicer is responsible. The services provided to the Company by Webster Bank are at the level of a sub-servicing agreement. As such, the Company estimates that the fees paid to Webster Bank for servicing approximates fees that would be paid if the Company operated as an unaffiliated entity. Servicing fees paid for the years 2006, 2005 and 2004 were $313,000, $345,000 and $355,000, respectively. Servicing fees are netted against interest income in the Statements of Income, as they are considered a reduction in yield to the Company.
The Servicer is entitled to retain any late payment charges, prepayment fees, penalties and assumption fees collected in connection with residential mortgage loans serviced by it. The Servicer receives the benefit, if any, derived from interest earned on collected principal and interest payments between the date of collection and the date of remittance to the Company and from interest earned on tax and insurance escrow funds with respect to mortgage loans serviced by it. At the end of each calendar month, the Servicer is required to invoice the Company for all fees and charges due to the Servicer.
Note 6: Advisory Services
Advisory services are being provided pursuant to an agreement with Webster Bank to provide the Company with the following types of services: administer the day-to-day operations, monitor the credit quality of the mortgage assets, advise with respect to the acquisition, management, financing, and disposition of mortgage related assets and provide the necessary executive administration, human resource, accounting and control, technical support, record keeping, copying, telephone, mailing and distribution, investment and funds management services. Webster Bank received an annual fee for advisory services provided to the Company of $202,500 in 2006 compared to $195,000 in 2005 and 2004. The Company estimates that the fees paid to Webster Bank for advisory services approximate fees that would be paid for such services if the Company were an unaffiliated entity.
Operating expenses outside the scope of the advisory agreement are paid directly by the Company. Such expenses include, but are not limited to, fees for third party consultants, attorneys and external auditors, and any other expenses incurred that are not directly related to the advisory agreement.
Note 7: Income Taxes
The Company has elected to be treated as a REIT under Sections 856 through 860 of the Code, and believes that its organization and method of operation meet the requirements for qualification as a REIT. As a REIT, the Company generally will not be subject to federal income tax on net income and capital gains that it distributes to the holders of its common and preferred stock. Therefore, no provision for federal income taxes has been included in the accompanying financial statements.
To maintain REIT status, an entity must meet a number of organizational and operational requirements, including a requirement that it currently distributes to stockholders at least 90% of its “REIT taxable income” (not including capital gains and certain items of non-cash income). If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax at regular corporate rates.
29
Note 8: Summary of Estimated Fair Values of Financial Instruments
A summary of estimated fair values of financial instruments follows:
| | | | | | | | | | | | | | |
| | | At December 31, | |
| (In thousands) | | 2006 | | | 2005 | |
| | | Carrying
Amount | | | Estimated
Fair Value | | | Carrying
Amount | | | Estimated
Fair Value | |
Assets: | | | | | | | | | | | | | | |
Cash | | $ | 56,356 | | | 56,356 | | | $ | 3,402 | | | 3,402 | |
Interest-bearing deposits | | | 80,000 | | | 80,000 | | | | 77,000 | | | 77,000 | |
Mortgage-backed securities | | | - | | | - | | | | 41,335 | | | 41,335 | |
| | | | |
Residential mortgage loans | | | 374,223 | | | 372,024 | | | | 390,158 | | | 385,608 | |
Less: allowance for loan losses | | | (2,022 | ) | | (2,022 | ) | | | (2,022 | ) | | (2,022 | ) |
| | |
Residential mortgages, net | | | 372,201 | | | 370,002 | | | | 388,136 | | | 383,586 | |
The Company uses Webster’s Asset/Liability simulation model to estimate the fair value of its residential mortgage loans. Fair value is estimated by discounting the average expected cash flows over multiple interest rate paths. An arbitrage-free trinomial lattice term structure model generates the interest rate paths. The month-end LIBOR/Swap yield curve and swap option volatilities are used as the input for deriving forward rates for future months. Cash flows for all instruments are created for each rate path using product specific behavioral models and account specific system data. Discount rates are matched with the time period of the expected cash flow. The Asset/Liability simulation software is enhanced with a mortgage prepayment model and a Collateralized Mortgage Obligation database provided by two leading financial software companies. Instruments with explicit options (i.e., caps, floors, puts and calls) and implicit options (i.e., prepayment and early withdrawal ability) require such a rate and cash flow modeling approach to more accurately quantify value. A spread is added to the discount rates to reflect credit and option risks embedded in each instrument. Spreads and prices are calibrated to observable market instruments when available or to estimates based on industry standards.
The carrying amounts for interest-bearing deposits approximate fair value since they mature in 90 days or less and do not present unanticipated credit concerns. The fair value of mortgage-backed securities (see Note 2) is estimated based on prices or quotations received from third parties or pricing services.
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings or any part of a particular financial instrument. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These factors are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
30
Note 9: Selected Quarterly Financial Data (unaudited)
| | | | | | | | | | | |
2006 | | | | | | | | | | | |
| (In thousands, except share data) | | First Quarter | | Second Quarter | | Third Quarter | | | Fourth Quarter | |
Interest income | | $ | 6,647 | | 6,882 | | 6,983 | | | 7,157 | |
Noninterest income | | | - | | - | | (526 | ) | | (117 | ) |
Noninterest expenses | | | 79 | | 115 | | 83 | | | 52 | |
| | | | | | | | | | | |
Net income | | | 6,568 | | 6,767 | | 6,374 | | | 6,988 | |
Preferred dividends | | | 216 | | 215 | | 216 | | | 216 | |
| | | | | | | | | | | |
Net income available to common shareholder | | $ | 6,352 | | 6,552 | | 6,158 | | | 6,772 | |
| | | | | | | | | | | |
| | | | |
Basic net income per common share | | $ | 63,520 | | 65,520 | | 61,580 | | | 67,720 | |
| | | | | | | | | | | |
| | | | |
2005 | | | | | | | | | | | |
Interest income | | $ | 6,670 | | 6,732 | | 6,693 | | | 6,613 | |
Noninterest expenses | | | 57 | | 79 | | 80 | | | 78 | |
| | | | | | | | | | | |
Net income | | | 6,613 | | 6,653 | | 6,613 | | | 6,535 | |
Preferred dividends | | | 216 | | 215 | | 216 | | | 216 | |
| | | | | | | | | | | |
Net income available to common shareholder | | $ | 6,397 | | 6,438 | | 6,397 | | | 6,319 | |
| | | | | | | | | | | |
| | | | |
Basic net income per common share | | $ | 63,970 | | 64,380 | | 63,970 | | | 63,185 | |
| | | | | | | | | | | |
31
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
The Company had no changes in or disagreements with its independent registered public accounting firm on accounting and financial disclosures.
Item 9A. Disclosure Controls and Procedures
The Company’s management, including the Company’s principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of December 31, 2006. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that the Company’s disclosure controls and procedures were effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
There was no change made in the Company’s internal controls over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B. Other Information
None
32
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The Company’s Board of Directors currently consists of three members. Directors are elected for a one-year term. The Company currently has three officers and no other employees.
The persons who are current directors and executive officers of the Company are as follows:
| | | | |
| Name | | Age at December 31, 2006 | | Position and Offices Held |
| | |
William T. Bromage | | 61 | | President and Director |
| | |
Harriet Munrett Wolfe | | 53 | | Director |
| | |
Gerald P. Plush | | 48 | | Director |
| | |
Gregory S. Madar | | 44 | | Senior Vice President, Chief Accounting Officer and Assistant Secretary |
| | |
Mark S. Lyon | | 46 | | Secretary |
The following is a summary of the experience of the officers and directors of the Company:
William T. Bromage is President, Chief Operating Officer and a director of Webster and Webster Bank and Vice Chairman of Webster Bank. Mr. Bromage was elected President in April 2000 and Chief Operating Officer in January 2002. From September 1999 to April 2000, he served as Senior Executive Vice President, Business Banking and Corporate Development of Webster and Webster Bank. Mr. Bromage serves on the boards of MetroHartford Alliance, Connecticut Public Broadcasting and Junior Achievement of Southwest New England.
Harriet Munrett Wolfe has been a director of the Company since 1997. She is also the Executive Vice President, General Counsel and Secretary of Webster and Webster Bank. Ms. Wolfe joined Webster and Webster Bank in March 1997 as Senior Vice President and Counsel, was appointed Secretary in June 1997 and General Counsel in September 1999. In January 2003, she was appointed Executive Vice President of Webster.
Gerald P. Plush is Executive Vice President and Chief Financial Officer of Webster and Webster Bank. Prior to joining Webster in July 2006, Mr. Plush was employed at MBNA America in Wilmington, Delaware. In his most recent position with MBNA, he was Senior Executive Vice President and Managing Director of Corporate Development and Acquisitions. Prior to this position, Mr. Plush was Senior Executive Vice President and Chief Financial Officer of MBNA’s North American Operations, and prior to that he was Senior Executive Vice President and Chief Financial Officer of U.S. Credit Card. Mr. Plush serves on the board of directors of Ronald McDonald House of Delaware and the board of trustees of Upland Country Day School in Kennett Square, Pennsylvania.
Gregory S. Madar has been the Senior Vice President, Principal Financial and Accounting Officer and Assistant Secretary of the Company since April 2003. He also served as the Treasurer of the Company from 2001 to 2003, as Secretary of the Company from March 1997 to March 1999 and as Assistant Secretary of the Company since 1999. He is also Senior Vice President and Controller of Webster Bank. Mr. Madar, a Certified Public Accountant, joined Webster Bank in 1995 as Vice President and Tax Manager and was elected Senior Vice President and Assistant Controller in January 2000. In February 2002, he was promoted to Senior Vice President and Controller of Webster.
Mark S. Lyonhas been the Secretary of the Company since December 2005. He is also Assistant Secretary of Webster and Senior Vice President and Assistant Secretary of Webster Bank. Mr. Lyon joined Webster in November 2005. Previously Mr. Lyon was Assistant Secretary for Praxair, Inc., an industrial gases company in Danbury, CT.
33
Code of Ethics
The Company has a code of ethics that applies to all employees, as well as each member of the Company’s Board of Directors. The code of ethics is available at Webster Bank’s website at www.websteronline.com.
Audit Committee Matters
The entire Board of Directors serves as the audit committee of the Company. The Company, as an indirect subsidiary of Webster Financial Corporation (NYSE: WBS), is relying on the exemption provided in Section10A-3(c)(2) of the Securities Exchange Act of 1934.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s directors and executive officers and persons who own more than 10% of its Series B Preferred Stock to file with the SEC initial reports of ownership of the Company’s equity securities and to file subsequent reports when there are changes in such ownership. Based on a review of reports submitted to the Company, the Company believes that during the fiscal year ended December 31, 2006, all Section 16(a) filing requirements applicable to the Company’s officers, directors and more than 10% owners were complied with on a timely basis.
Item 11. Executive Compensation
The Company currently has three officers, none of whom receive compensation as employees of the Company. The Company has never issued options or warrants to officers or directors of the Company. The Company does not have any stock option plan or similar plan, retirement or pension plan or any other form of employee compensatory plan. The Company has retained an advisor to perform certain functions pursuant to an Advisory Service Agreement described below under “The Advisor.” Each officer of the Company currently is also an officer of Webster Bank. The Company maintains corporate and accounting records that are separate from those of Webster Bank and any of Webster Bank’s affiliates.
It is not currently anticipated that the officers, directors or employees of the Company will have any pecuniary interest in any mortgage asset to be acquired or disposed of by the Company or in any transaction in which the Company has an interest.
The Company does not pay the directors of the Company fees for their services as directors. Although no direct compensation is paid by the Company, under the Advisory Services Agreement, the Company reimburses Webster Bank for its proportionate share of the salaries of such person for services rendered.
The Advisor
The Company has entered into an Advisory Service Agreement (the “Advisory Agreement”) with Webster Bank to administer the day-to-day operations of the Company. Webster Bank in its role as advisor under the terms of the Advisory Agreement is herein referred to as the “Advisor.” The Advisor is responsible for (i) monitoring the credit quality of the mortgage assets held by the Company, (ii) advising the Company with respect to the acquisition, management, financing and disposition of the Company’s mortgage assets, and (iii) maintaining custody of the documents related to the Company’s mortgage assets. The Advisor may at any time subcontract all or a portion of its obligations under the Advisory Agreement to one or more of its affiliates involved in the business of managing mortgage assets. If no affiliate of the Advisor is engaged in the business of managing mortgage assets, the Advisor may, with the approval of a majority of the Board of Directors, subcontract all or a portion of its obligations under the Advisory Agreement to unrelated third parties. The Advisor may assign its rights or obligations under the Advisory Agreement to any affiliate of the Company. The Advisor will not, in connection with the subcontracting of any of its obligations under the Advisory Agreement, be discharged or relieved in any respect from its obligations under the Advisory Agreement.
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The Advisory Agreement had an initial term of two years, and has been renewed for additional one-year periods. It will continue to be renewed until notice of nonrenewal is delivered by either party to the other party. The Advisory Agreement may be terminated by the Company at any time upon 90 days’ prior written notice. The Advisor is entitled to receive an advisory fee equal to $205,000 per year beginning May 1, 2006 with respect to the advisory services provided by it to the Company, as per the amended agreement adopted on April 19, 2006. The fee may be revised to reflect changes in the actual costs incurred by the Advisor in providing services.
The Advisory Agreement provides that the liability of the Advisor to the Company for any loss due to the Advisor’s performing or failing to perform the services under the Advisory Agreement shall be limited to those losses sustained by the Company which are a direct result of the Advisor’s negligence or willful misconduct. It also provides that under no circumstances shall the Advisor be liable for any consequential or special damages and that in no event shall the Advisor’s total combined liability to the Company for all claims arising under or in connection with the Advisory Agreement be more than the total amount of all fees payable by the Company to the Advisor under the Advisory Agreement during the year immediately preceeding the year in which the first claim giving rise to such liability arises. The Advisory Agreement also provides that to the extent that third parties make claims against the Advisor arising out of the services provided thereunder, the Company will indemnify the Advisor against all loss arising therefrom.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
The following table sets forth, as of December 31, 2006, the number and percentage of the outstanding shares of either our Common Stock or Series B Preferred Stock beneficially owned by (i) all persons known by the Company to own more than five percent of such shares, (ii) each director of the Company, and (iii) each executive officer of the Company, and (iv) all executive officers and directors of the Company as group.
| | | | |
Name and Address of Beneficial Owner | | Amount of Beneficial Ownership | | Percent of Class of Outstanding Shares |
Webster Bank 145 Bank Street Waterbury, CT 06702 | | 100 shares | | Common – 100% |
| | |
William T. Bromage President and Director | | -0- | | -0- |
| | |
Harriet Munrett Wolfe Director | | -0- | | -0- |
| | |
Gerald P. Plush Director | | -0- | | -0- |
| | |
Gregory S. Madar Senior Vice President,
Chief Accounting Officer and Assistant Secretary | | 300 shares | | Series B Preferred Stock* |
| | |
Mark S. Lyon Secretary | | -0- | | -0- |
| | |
All Officers and Directors as a group | | 300 shares | | Series B Preferred Stock* |
The Company does not maintain any compensation plans pursuant to which equity securities of the Company may be issued.
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Item 13. Certain Relationships and Related Transactions and Director Independence
The Company is organized as a subsidiary of Webster Bank, is controlled by, and through advisory and servicing agreements and is totally reliant on, Webster Bank. The Company’s Board of Directors consists entirely of Webster Bank employees and, through the advisory and servicing agreements, Webster Bank and its affiliates are involved in every aspect of the Company’s existence. Webster Bank administers the day-to-day activities of the Company in its role as Advisor under the Advisory Agreement and acts as Servicer of the Company’s Mortgage Loans under the Servicing Agreement. In addition, all of the officers of the Company are also officers of Webster Bank. As the holder of all of the outstanding voting stock of the Company, Webster Bank generally will have the right to elect all of the directors of the Company. For a description of the fees Webster Bank is entitled to receive under the advisory and servicing agreements, see Notes 5 and 6 to the Company’s Financial Statements included in Item 8.
Dependence upon Webster Bank as Advisor and Servicer
The Company is dependent on the diligence and skill of the officers and employees of Webster Bank as its Advisor for the selection, structuring and monitoring of the Company’s mortgage assets. In addition, the Company is dependent upon the expertise of Webster Bank as its Servicer for the servicing of the mortgage loans. The personnel deemed most essential to the Company’s operations are Webster Bank’s loan servicing and administration personnel, and the staff of its finance department. The loan servicing and administration personnel advise the Company in the selection of mortgage assets, and provide loan-servicing oversight. The finance department assists in the administrative operations of the Company. The Advisor may subcontract all or a portion of its obligations under the Advisory Agreement to one or more affiliates, and under certain conditions to non-affiliates, involved in the business of managing mortgage assets. The Advisor may assign its rights or obligations under the Advisory Agreement, and the Servicer may assign its rights and obligations under the Servicing Agreement, to any affiliate of the Company involved in the business of managing real estate mortgage assets. Under the Advisory Agreement, the Advisor may subcontract its obligations to unrelated third parties with the approval of the Board of Directors of the Company. In the event the Advisor or the Servicer subcontracts or assigns its rights or obligations in such a manner, the Company will be dependent upon the subcontractor or affiliate to provide services. Although Webster Bank has indicated to the Company that it has no plans in this regard, if Webster Bank were to subcontract all of its loan servicing to an outside third party, it also would do so with respect to mortgage assets under the Servicing Agreement. Under such circumstances, there may be additional risks as to the costs of such services and the ability to identify a subcontractor suitable to the Company. The Servicer does not believe it would subcontract those duties unless it could not perform such duties efficiently and economically itself.
Because Webster bank owns more than 50% of the voting power of our common stock, we are considered a “controlled company” for the purposes of NADAQ listing requirements, and we qualify for, and rely on, the “controlled company” exception to the board of directors and committee composition requirements under the Marketplace Rules of the NASDAQ Stock Market. Pursuant to this exception, we are exempt from the rules that require our board of directors to be comprised of a majority of “independent directors”.
Policies and Procedures Regarding Transactions with Related Persons
The Company is covered under Webster’s Code of Conduct. Pursuant to Webster’s Code of Conduct, all related party transactions must be conducted at arm’s length. Any consideration paid or received in such a transaction must be on terms no less favorable than terms available to an unaffiliated third party under similar circumstances.
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Item 14. Principal Accountant Fees and Services
Audit and Non-Audit Fees
The following table presents fees for professional audit services rendered by KPMG LLP for the audit of the Company’s annual financial statements for the years ended December 31, 2006 and 2005, and fees billed for other services rendered by KPMG LLP during those periods.
| | | | | |
| | | 2006 | | 2005 |
Audit Fees(1) | | $ | 31,000 | | 29,000 |
Audit Related Fees | | | - | | - |
Tax Fees | | | - | | - |
Other Fees | | | - | | - |
| | | | | |
Total | | $ | 31,000 | | 29,000 |
| | | | | |
| | (1) | Audit Fees consist of fees billed for professional services rendered for the audit of the Company’s annual financial statements and review of the interim financial statements included in quarterly reports, and services that are normally provided in connection with statutory and regulatory filings or engagements. |
| | | Before the principal accountant is engaged by the Company to render audit or non-audit services, the engagement is approved by the Company’s Board of Directors. |
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PART IV
Item 15. Exhibits and Financial Statement Schedules
| (a)(1) | The financial statements of the registrant are included in Item 8 of Part II of the report. |
| (a)(2) | All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. |
| (a)(3) | A list of the exhibits to this Form 10-K is set forth on the Exhibit Index immediately preceding such exhibits and is incorporated herein by reference. |
| (b) | Exhibits to this Form 10-K are attached or incorporated herein by reference as stated above. |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | |
WEBSTER PREFERRED CAPITAL CORPORATION Registrant |
| |
| BY: | | /s/ William T. Bromage |
| | William T. Bromage, President and Director |
| |
| Date: | | March 29, 2007 |
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 indicated as of March 29, 2007.
| | |
| By: | | /s/ William T. Bromage |
| | William T. Bromage, President and Director (Principal Executive Officer) |
| |
| By: | | /s/ Gregory S. Madar |
| | Gregory S. Madar, Senior Vice President, Treasurer and Assistant Secretary (Principal Financial and Accounting Officer) |
| |
| By: | | /s/ Gerald P. Plush |
| | Gerald P. Plush, Director |
| |
| By: | | /s/ Harriet M. Wolfe |
| | Harriet Munrett Wolfe, Director |
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| | |
| Exhibit Number | | Description |
| 3.1 | | Amended and Restated Certificate of Incorporation of Webster Preferred Capital Corporation (the “Company”) (incorporated herein by reference from Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997). |
| |
| 3.3 | | Certificate of Amendment for the Series B 8.625% Cumulative Redeemable Preferred Stock of the Company (incorporated herein by reference from Exhibit 3.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997). |
| |
| 3.4 | | Amended and Restated By-Laws of the Company (incorporated herein by reference from Exhibit 3.4 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997). |
| |
| 4.2 | | Specimen of certificate representing the Series B 8.625% Cumulative Redeemable Preferred Stock of the Company (incorporated herein by reference from Exhibit 4.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997). |
| |
| 10.1 | | Mortgage Assignment Agreement, made as of March 17, 1997, by and between Webster Bank and the Company (incorporated herein by reference from Exhibit 10.1 to the Company’s Registration Statement on Form S-11 (File No. 333-38685) filed with the Securities and Exchange Commission (the “SEC”) on October 24, 1997). |
| |
| 10.2 | | Amended and Restated Master Service Agreement, dated March 31, 2006, between Webster Bank and the Company (incorporated herein by reference from Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q) filed with the SEC on August 8, 2006. |
| |
| 10.3 | | Amended and Restated Advisory Service Agreement, made as of March 31, 2006, by and between Webster Bank and the Company (incorporated herein by reference from Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q) filed with the SEC on August 8, 2006. |
| |
| 31.1 | | Certificate of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
| 31.2 | | Certificate of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
| 32.1 | | Written Statement pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by the Company’s Principal Executive Officer. |
| |
| 32.2 | | Written Statement pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by the Company’s Principal Financial Officer. |
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