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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended June 30, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
COMMISSION FILE NUMBER 0-22528
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QUAKER CITY BANCORP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4444221
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
7021 GREENLEAF AVENUE 90602
WHITTIER, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (562) 907-2200
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
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.
[X] Yes [_] 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 the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the average bid and asked price of its Common Stock,
$.01 par value, on September 18, 1997, on the Nasdaq National Market System
was approximately $89,006,000.
At September 18, 1997, 4,673,102 shares of the Registrant's Common Stock
were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement to be filed with the Securities
and Exchange Commission in connection with the Annual Meeting of Stockholders
to be held November 19, 1997 are incorporated by reference in Part III hereof.
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TABLE OF CONTENTS
PAGE
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PART I
ITEM 1. BUSINESS..................................................... 1
General...................................................... 1
Lending Activities........................................... 3
Delinquencies and Classification of Assets................... 10
Nonperforming Assets and Restructured Loans.................. 11
Impaired Loans............................................... 13
Allowances for Loan and Real Estate Losses................... 13
Investment Activities........................................ 16
Sources of Funds............................................. 18
Subsidiary Activities........................................ 20
Competition.................................................. 20
Personnel.................................................... 21
Federal Taxation............................................. 21
State and Local Taxation..................................... 22
Regulation and Supervision................................... 23
General..................................................... 23
Activities Restrictions..................................... 23
Deposit Insurance........................................... 24
FIRREA Capital Requirements................................. 25
Prompt Corrective Action Requirements....................... 27
Enforcement................................................. 27
Savings and Loan Holding Company Regulation................. 27
Classification of Assets.................................... 30
Community Reinvestment Act.................................. 31
Federal Home Loan Bank System............................... 31
Required Liquidity.......................................... 31
Federal Reserve System...................................... 32
Pending Legislation......................................... 32
ITEM 2. PROPERTIES................................................... 34
ITEM 3. LEGAL PROCEEDINGS............................................ 35
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......... 35
ITEM 4A. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........... 35
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.......................................... 36
ITEM 6. SELECTED FINANCIAL DATA...................................... 37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................... 39
General...................................................... 39
Problem Assets............................................... 39
Results of Operations........................................ 39
Financial Condition.......................................... 41
Capital Resources and Liquidity.............................. 42
Market Risk.................................................. 45
Asset/Liability Management................................... 47
Average Balance Sheet........................................ 50
Impact of Inflation and Changing Prices...................... 52
Impact of New Accounting Standards........................... 52
PAGE
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................. F-1
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE..................................... II-1
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........... II-1
ITEM 11. EXECUTIVE COMPENSATION....................................... II-1
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................... II-1
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............... II-1
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K.................................................. II-2
SIGNATURES................................................... II-5
This Annual Report on Form 10-K contains forward-looking statements,
including but not limited to statements regarding, among other items, (i) the
realization of the Company's business strategy, (ii) general economic
conditions and the condition of the real estate market in Southern California,
(iii) the adequacy of the Company's allowance for loan and real estate losses,
(iv) interest rate risk and (v) anticipated trends in the thrift industry.
Forward-looking statements are typically identified by the words "believes,"
"expects," "anticipates," "intends," "estimates" and similar expressions.
These forward-looking statements are subject to a number of risks and
uncertainties, many of which are beyond the Company's control. Actual results
could differ materially from those contemplated by these forward-looking
statements. There can be no assurance that the results and events contemplated
by the forward-looking information contained in this Annual Report on Form 10-
K will in fact transpire. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of their dates. The
Company undertakes no obligation to update or revise any forward-looking
statements.
PART I
ITEM 1. BUSINESS
GENERAL
Quaker City Bancorp, Inc. (the "Company"), incorporated in Delaware, is
primarily engaged in the savings and loan business through its wholly owned
subsidiary Quaker City Federal Savings and Loan Association (the
"Association"). The Company was organized on September 13, 1993, for the
purpose of acquiring all of the capital stock of the Association issued in the
conversion of the Association from mutual to stock form effective December 30,
1993. The Association was originally founded in 1920 as the Mutual Building
and Loan Association of Whittier, and in 1938 became a federally chartered
mutual savings and loan association. The Company's principal business is
serving as the holding company for the Association. Historical information
presented throughout this report at and for periods ended prior to the
Company's commencement of operations on December 30, 1993, is that of the
Association. The executive offices of the Company are located at 7021
Greenleaf Avenue, Whittier, California 90602, telephone number (562) 907-2200.
The Association operates eight retail full service branches in the Southern
California communities of Whittier (2), La Habra (2), Brea, Fullerton, La
Mirada and Hacienda Heights. The Company plans to open at least one new retail
banking branch during the 1998 fiscal year.
The Company is a savings and loan holding company and as such is subject to
examination and regulation by the Office of Thrift Supervision ("OTS"). The
deposits of the Association are insured by the Savings Association Insurance
Fund ("SAIF") of the Federal Deposit Insurance Corporation (the "FDIC"). The
Association is regulated by the Director of the OTS and the FDIC. The
Association is a member of the Federal Home Loan Bank ("FHLB") of San
Francisco, which is one of the twelve regional banks comprising the Federal
Home Loan Bank System. The Association is also subject to certain regulations
of the Board of Governors of the Federal Reserve System (the "Federal Reserve
Board") with respect to reserves required to be maintained against deposits
and certain other matters. See "--Regulation and Supervision--General."
The Company's principal business has been and continues to be attracting
retail deposits from the general public in the area surrounding its offices
and investing those deposits, together with funds generated from operations
and borrowings. Through its wholly owned subsidiary, Quaker City Financial
Corporation ("QCFC"), the Company also engages in the sale of insurance and
investment products on an agency basis. See "--Subsidiary Activities." The
Company originates predominantly one-to-four family loans and multifamily
loans within its primary market area and emphasizes multifamily lending in low
and moderate income communities, specifically in the Los Angeles metropolitan
area. To a
1
lesser extent, the Company invests in commercial real estate loans. At June
30, 1997, the Company's gross mortgage loan portfolio (including loans held
for sale) totaled approximately $659.7 million, of which approximately 45.47%
was secured by one-to-four residential properties, 45.77% was secured by
multifamily (five or more units) properties and 8.39% was secured by
commercial properties. See "--Lending Activities." At that same date,
approximately 84.94% of the one-to-four family, 95.17% of the multifamily and
92.29% of the commercial mortgage portfolios consisted of adjustable rate
mortgage ("ARM") loans.
In addition to originating loans to hold in portfolio, the Company also
originates loans for sale. The Company also purchases loans for investment and
for sale. Loan sales come from loans held in the Company's portfolio
designated as being held for sale or originated during the period and being so
designated. Historically, the Company has generally retained the servicing
rights on most loans sold, however, some loans are sold servicing released. In
addition, the Company invests in securities issued by the U.S. Government and
agencies thereof, mortgage-backed securities ("MBS") and other permitted
investments under applicable federal laws and regulations. The Company's
revenues are derived principally from interest on its mortgage loans, and to a
lesser extent, mortgage loan servicing activities, and interest and dividends
on its investment securities and MBS.
The Company's primary sources of funds are deposits, borrowings from the
FHLB of San Francisco ("FHLB advances"), securities sold under agreements to
repurchase, principal and interest payments on loans and proceeds from the
sale of loans. At June 30, 1997, the Company had deposits of approximately
$553.2 million, including approximately $78.3 million in time deposits of
$100,000 or more. At that date, the Company's borrowings included $157.7
million in FHLB advances. See "--Sources of Funds."
On April 24, 1997, the Board of Directors of the Company declared a 25%
common stock dividend paid on May 30, 1997, to shareholders of record on May
12, 1997. The dividend was intended as a distribution of retained earnings to
the Company's shareholders and to enhance both the marketability and liquidity
of the Company's stock. Total stockholders' equity was unchanged by the stock
dividend and all historical earnings per share data herein reflect the
increased number of shares of the Company's stock outstanding after the
dividend. At June 30, 1997, the Company had stockholders' equity of $70.2
million, representing 8.77% of total assets.
For the year ended June 30, 1997, the Company reported net earnings of $2.8
million, $0.61 per share. This compares to net earnings of $3.6 million, $0.74
per share and $2.3 million, $0.48 per share for the years ended June 30, 1996
and 1995, respectively. The reduction in fiscal 1997 earnings over fiscal 1996
was primarily due to the special assessment paid by the Association as part of
the recapitalization of the Savings Association Insurance Fund. During the
quarter ended September 30, 1996, the Association accrued $3.1 million in
expense for this special assessment and paid this amount during the second
quarter of fiscal 1997. Excluding the impact of the one-time special
assessment, net earnings for the fiscal year ended June 30, 1997, would have
been $4.6 million, $1.00 per share.
Total assets of the Company were $801.4 million at June 30, 1997, an
increase of $76.3 million during the fiscal year. The increase in assets was
primarily in residential loans with loans on multifamily properties increasing
$43.0 million and one-to-four loans decreasing $3.3 million, and with
investment securities and mortgage-backed securities increasing $33.6 million.
The asset growth was funded by an increase in deposits of $40.7 million and
borrowings of $22.1 million. At June 30, 1997, the Company had total deposits
of $553.2 million and total borrowings of $157.7 million.
The Southern California economy and real estate market in the Company's
primary lending area have shown improvement during the year, especially in
income property values. The Company's level of nonperforming assets declined
from June 30, 1996. The Company includes nonaccruing loans, troubled debt
restructured loans and real estate acquired through foreclosure ("REO") in
determining
2
its level of nonperforming assets. At June 30, 1997, the Company reported
$10.5 million in nonperforming assets in the Company's portfolio compared to
$13.1 million and $13.2 million at June 30, 1996 and 1995, respectively. The
Company recorded provisions for loan losses of $3.0 million for the year ended
June 30, 1997 compared to $2.1 million and $998,000 for the years ended June
30, 1996 and 1995, respectively. See "--Allowances for Loan and Real Estate
Losses" and "Management's Discussion and Analysis ("MD&A")--Results of
Operations."
LENDING ACTIVITIES
General. Since 1982, the Company has emphasized the origination of ARM loans
for retention in its portfolio. This practice has enabled the Company to
reduce its interest rate risk exposure by concentrating its loan portfolio in
assets with either shorter terms or more frequent repricing, or both. The
Company originates fixed rate loans in response to customer demand as well.
The type of loans the Company originates is dependent upon the relative
customer demand for fixed-rate or ARM loans, which in turn is affected by the
current and expected level of interest rates. Historically, the Company has
sold fixed rate loans in the secondary market to the Federal National Mortgage
Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC") and
others. During 1997, the Company retained certain fixed rate loans in its
portfolio.
Loan and Mortgage-Backed Securities Portfolio Composition. The Company's
loan portfolio consists primarily of conventional first mortgage loans secured
by one-to-four family and multifamily (five or more units) residences. At June
30, 1997, the Company had gross loans outstanding of $659.7 million, of which
$300.0 million, or 45.47%, were one-to-four family mortgage loans. At the same
date, multifamily mortgage loans totaled $302.0 million, or 45.77% of gross
loans. The remainder of the loan portfolio consists of $55.3 million of
commercial real estate loans, or 8.39% of gross loans, $1.4 million of land
loans, or 0.21% of gross loans, and other loans of $1.1 million, or 0.16% of
gross loans. Included in these amounts at June 30, 1997 were $623,000 of loans
held for sale, comprising 0.09% of gross loans. At that same date, 84.94% of
the Company's one-to-four family, 95.17% of its multifamily and 92.29% of its
commercial mortgage loans had adjustable interest rates.
The Company invests in MBS, including securities guaranteed by GNMA, FNMA
and FHLMC. To a limited extent the Company also invests in privately issued
MBS which typically have received a "AA" or "AAA" credit rating from at least
one nationally recognized rating service. The Company invests in both
adjustable rate and fixed rate MBS. In an effort to reduce the potential
interest rate risk inherent in fixed rate assets, the Company purchases fixed
rate MBS with a variety of coupon rates, maturities, and prices. Furthermore,
the assets are typically purchased with fixed rate FHLB advances of various
terms to maturity primarily ranging from 1 month to 5 years in order to
mitigate the Company's exposure to changes in interest rates. The adjustable
rate MBS portfolio typically have life caps that will prevent the MBS from
further upward adjustments in rate should interest rates rise above the cap
limit. Prior to purchase, management considers the Company's overall tolerance
to interest rate risk and invests accordingly. At June 30, 1997, the Company's
MBS portfolio totaled $74.1 million or 9.25% of total assets. MBS are
comprised of $48.1 million of agency securities, $4.6 million issued by other
financial institutions and $21.4 million in collateralized mortgage
obligations (CMO's). Of the $21.4 million in CMO's 97.20% or $20.8 million are
agency guaranteed. For all years presented, the CMO's represent non-equity
senior interests in mortgage pass-through certificates and were of investment
grade. At June 30, 1997, all MBS were classified as held to maturity.
The following table sets forth the composition of the Company's loan and MBS
portfolios in dollar amounts and percentages of the respective portfolio at
the dates indicated.
3
AT JUNE 30,
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1997 1996 1995 1994 1993
------------------- -------------------- -------------------- -------------------- --------------------
PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL
-------- ---------- -------- ---------- -------- ---------- -------- ---------- -------- ----------
(DOLLARS IN THOUSANDS)
Loans:
Residential:
One-to-four
units.......... $299,979 45.47% $303,273 48.54% $288,664 51.85% $234,709 49.51% $201,617 46.25%
Multifamily..... 301,965 45.77 258,970 41.45 205,731 36.95 177,539 37.46 174,025 39.92
Commercial........ 55,331 8.39 60,822 9.74 60,709 10.91 60,617 12.79 58,975 13.53
Land.............. 1,352 0.21 1,038 0.17 1,046 0.19 691 0.15 720 0.17
Other............. 1,070 0.16 627 0.10 546 0.10 412 0.09 595 0.13
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Loans, gross.... 659,697 100.00% 624,730 100.00% 556,696 100.00% 473,968 100.00% 435,932 100.00%
====== ====== ====== ====== ======
Less:
Undisbursed loan
funds............ 441 378 187 183 215
Unamortized
discounts........ 2,404 2,864 2,815 1,999 2,385
Deferred loan
fees, net........ 3,493 3,093 2,442 2,184 2,014
Allowance for
loan losses...... 7,772 7,833 12,108 13,660 5,079
-------- -------- -------- -------- --------
Loans, net...... 645,587 610,562 539,144 455,942 426,239
Less:
Loans held for
sale:
One-to-four
units.......... 623 1,455 400 5,415 8,989
Multifamily..... -- 1,435 1,266 -- 3,683
-------- -------- -------- -------- --------
Net loans held
for investment. $644,964 $607,672 $537,478 $450,527 $413,567
======== ======== ======== ======== ========
Mortgage-backed
securities:
FNMA.............. $ 13,240 17.87% $ 11,129 26.70% $ 11,367 27.77% $ -- -- % $ -- -- %
FHLMC............. 1,298 1.75 1,697 4.07 2,117 5.17 119 0.80 192 1.40
GNMA.............. 33,577 45.32 7,885 18.92 -- -- -- -- -- --
Issued by other
financial
institutions..... 4,554 6.15 5,781 13.87 11,451 27.97 12,659 84.64 11,495 83.98
Collateralized
mortgage
obligations...... 21,423 28.91 15,185 36.44 16,004 39.09 2,178 14.56 2,001 14.62
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
74,092 100.00% 41,677 100.00% 40,939 100.00% 14,956 100.00% 13,688 100.00%
====== ====== ====== ====== ======
Plus (Less):
Unamortized
premium
(discount)....... 47 (502) (946) (247) (115)
-------- -------- -------- -------- --------
Mortgage-backed
securities,
net............ 74,139 41,175 39,993 14,709 13,573
Less:
Mortgage-backed
securities
available for
sale............. -- -- -- 5,997 6,660
-------- -------- -------- -------- --------
Net mortgage-
backed
securities held
to maturity.... 74,139 41,175 39,993 8,712 6,913
-------- -------- -------- -------- --------
Total net loans and
mortgage-backed
securities held
for investment or
to maturity....... $719,103 $648,847 $577,471 $459,239 $420,480
======== ======== ======== ======== ========
4
Loan Maturity. The following table shows the maturity of the Company's gross
loans and MBS at June 30, 1997. The table includes loans held for sale of
$623,000. The table does not include principal repayments. Principal
repayments on loans totaled $54.5 million, $48.0 million and $39.3 million for
the years ended June 30, 1997, 1996 and 1995, respectively. Principal
repayments on MBS totaled $7.3 million, $11.2 million, and $2.9 million for
the years ended June 30, 1997, 1996, and 1995, respectively.
AT JUNE 30, 1997
-------------------------------------------------------------------------
ONE- TOTAL MORTGAGE-
TO-FOUR MULTI- LOANS BACKED
FAMILY FAMILY COMMERCIAL LAND OTHER RECEIVABLE SECURITIES TOTAL
-------- -------- ---------- ------ ------ ---------- ---------- --------
(IN THOUSANDS)
Amounts due:
One year or less....... $ 578 $ 6,631 $ 3,358 $1,002 $ 310 $ 11,879 $ -- $ 11,879
-------- -------- ------- ------ ------ -------- ------- --------
After one year:
More than one year to
three years........... 1,257 4,812 2,045 -- 78 8,192 326 8,518
More than three years
to five years......... 10,448 10,179 7,085 291 1 28,004 -- 28,004
More than five years to
10 years.............. 11,796 37,493 11,627 -- 2 60,918 2,228 63,146
More than 10 years to
20 years.............. 42,150 214,427 29,910 -- 206 286,693 5,572 292,265
More than 20 years..... 233,750 28,423 1,306 59 473 264,011 65,966 329,977
-------- -------- ------- ------ ------ -------- ------- --------
Total due after one
year................. 299,401 295,334 51,973 350 760 647,818 74,092 721,910
-------- -------- ------- ------ ------ -------- ------- --------
Total amounts due..... $299,979 $301,965 $55,331 $1,352 $1,070 $659,697 $74,092 $733,789
======== ======== ======= ====== ====== ======== ======= ========
The following table sets forth at June 30, 1997, the dollar amount of all
loans due after June 30, 1998, and whether such loans have fixed or adjustable
interest rates.
AT JUNE 30, 1997
---------------------------
FIXED ADJUSTABLE TOTAL
------- ---------- --------
(IN THOUSANDS)
Real estate loans:
One-to-four family................................ $44,609 $254,792 $299,401
Multifamily....................................... 9,981 285,353 295,334
Commercial real estate............................ 2,020 49,953 51,973
Land.............................................. 350 -- 350
Other loans......................................... 726 34 760
------- -------- --------
Total loans....................................... $57,686 $590,132 $647,818
======= ======== ========
Origination, Purchase, Sale and Servicing of Loans. The Company's mortgage
lending activities are conducted primarily through its executive and branch
offices. The Company originates both fixed rate and ARM loans. Its ability to
originate ARM loans as opposed to fixed rate loans is dependent upon the
relative customer demand, which is affected by the current and expected future
level of interest rates.
Additionally, the Company purchases or participates in loans originated by
other institutions. The determination to purchase loans is based upon the
Company's investment needs and market opportunities. All loan types may be
purchased. The determination to purchase specific loans or pools of loans is
subject to the Company's underwriting policies, which require consideration of
the financial condition of the borrower and the appraised value of the
property, among other factors. The Company has purchased loans from
independent parties in various transactions. During the year ended June 30,
1997, $12.5 million, or 9.82% of the Company's total new loans were purchased.
5
At origination or time of purchase, the Company designates loans as held for
investment or held for sale. Historically, loans held for sale have been sold
in the secondary market to FNMA, FHLMC and other investors. The Company
generally retains the servicing rights on most loans sold, however, certain
loans are sold servicing released. The determination to sell a specific loan
or pool of loans is made based upon the Company's investment needs, growth
objectives and market opportunities.
In an attempt to further minimize interest rate risk associated with fixed
rate loans designated as held for sale, the Company may enter into commitments
with FNMA and other investors (known as forward commitments) to sell loans at
a future date at a specified price. The Company will then simultaneously
process and close the loans, thereby attempting to protect the price of loans
in process from interest rate fluctuations that may occur from application to
sale. There is risk involved in this forward commitment activity. In a
declining interest rate environment, borrowers may choose not to close loans,
but the Company would remain obligated to fulfill its forward commitments. The
inability of the Company to originate or acquire loans to fulfill these
commitments may result in the Company being required to pay non-delivery fees.
In an increasing interest rate environment, the Company is subject to interest
rate risk in the event its commitments to make loans to borrowers exceeds its
commitments to sell loans. The Company does not intend to enter into forward
commitments on ARM loans.
The Company sells loans and participations in loans with yield rates to the
investors based upon current market rates. Gain or loss is recognized to the
extent that the selling prices differ from the carrying value of the loans
sold based on the estimated relative fair values of the assets sold and any
retained interests, less any liabilities incurred. The assets obtained on sale
are generally loan servicing assets. Liabilities incurred in a sale may
include recourse obligations or servicing liabilities. Historically, the
Company has not established servicing assets or liabilities, although the
Company has retained the servicing rights on loans sold, because management
has determined that the benefits from the contractually specified servicing
fees and other ancillary sources are offset by the cost the Company incurs in
servicing.
In addition to retaining the servicing rights for originated loans, the
Company may also purchase mortgage servicing rights related to mortgage loans
originated by other institutions. The Company's current loan policies provide
that the aggregate amount of purchased mortgage servicing shall not exceed 75%
of the total loans in the Company's portfolio that are serviced for others. At
June 30, 1997, the Company had no purchased mortgage servicing rights asset.
6
The following table sets forth activity in the Company's loan and MBS
portfolios for the periods indicated:
AT OR FOR THE YEAR ENDED
JUNE 30,
--------------------------
1997 1996 1995
-------- -------- --------
(IN THOUSANDS)
Gross loans:
Beginning balance................................. $624,730 $556,696 $473,968
Loans originated:
One-to-four family.............................. 32,092 51,383 60,915
Multifamily..................................... 79,541 70,841 39,177
Commercial...................................... 3,081 122 6,172
Land............................................ 292 -- --
-------- -------- --------
Total loans originated.......................... 115,006 122,346 106,264
Loans purchased................................. 12,521 27,789 24,792
Loans to facilitate the sale of REO............. 4,847 5,580 7,407
-------- -------- --------
Total.......................................... 132,374 155,715 138,463
Less:
Transfer to REO................................. 8,313 7,764 8,593
Principal repayments............................ 54,465 48,032 39,295
Sales of loans.................................. 33,870 27,662 10,321
Other, net...................................... 759 4,223 (2,474)
-------- -------- --------
Ending balance.................................... $659,697 $624,730 $556,696
======== ======== ========
Gross mortgage-backed securities:
Beginning balance................................. $ 41,677 $ 40,939 $ 14,956
Mortgage-backed securities purchased............ 40,228 13,766 28,102
Less:
Principal repayments............................ 7,305 11,157 2,906
Other, net...................................... 508 1,871 (787)
-------- -------- --------
Ending balance.................................... $ 74,092 $ 41,677 $ 40,939
======== ======== ========
One-to-Four Family Mortgage Lending. The Company offers both fixed-rate
mortgage loans and ARM loans secured by one-to-four family residences,
including, to a lesser extent, condominium units, located in the Company's
primary market area, with maturities up to 30 years. Substantially all of such
loans are secured by property located in Southern California. Loan
originations are generally obtained from existing or past customers, members
of the local communities and loan brokers. Included in one-to-four family
loans are $12.5 million of adjustable rate home equity credit lines tied to
the Wall Street Prime index. These loans are generally secured by a first or
second trust deed, with maturities up to 25 years.
At June 30, 1997, the Company's gross loans outstanding were $659.7 million,
of which $300.0 million, or 45.47%, were one-to-four family mortgage loans. Of
the one-to-four family mortgage loans outstanding at that date, 15.06% were
fixed-rate loans, and 84.94% were ARM loans. The Company's policy is to
originate one-to-four family mortgage loans in amounts generally up to 80% of
the lower of the appraised value or the selling price of the property securing
the loan and up to 95% of the appraised value or selling price if private
mortgage insurance is obtained. In recent years, declines in the real estate
values in the Company's primary lending area have resulted in increases in the
loan-to-value ratio on some mortgage loans subsequent to origination.
Multifamily Lending. The Company originates multifamily mortgage loans
generally secured by 5-to-36 unit apartment buildings located in the Los
Angeles metropolitan area. In originating a
7
multifamily mortgage loan, the Company considers the qualifications of the
borrower as well as the underlying security. Some of the foremost factors to
be considered are the net operating income of the mortgaged premises before
debt service and depreciation, the debt service ratio (the ratio of net
operating income to debt service) and the ratio of the loan amount to
appraised value. Pursuant to the Company's underwriting policies, a
multifamily ARM loan generally may only be made in an amount up to 80% of the
appraised value of the underlying property. The Company also generally
requires a debt service coverage ratio of at least 110%. Properties securing a
loan are appraised by an independent appraiser and title insurance is required
on all loans. The average outstanding loan balance on multifamily mortgage
loans at June 30, 1997 was approximately $314,000, with the largest loan, as
discussed below, being $1.8 million. Declines in the real estate values in the
Company's primary lending area have resulted in an increase in the loan-to-
value ratio on some mortgage loans subsequent to origination.
When evaluating the qualifications of the borrower for a multifamily loan,
the Company considers the financial resources and income level of the
borrower, the borrower's experience in owning or managing similar property,
and the Company's lending experience with the borrower. The Company's
underwriting policies require that the borrower be able to demonstrate strong
management skills and the ability to maintain the property with current rental
income. The borrower should also present evidence of the ability to repay the
mortgage and a history of making mortgage payments on a timely basis. In
assessing the creditworthiness of the borrower, the Company generally reviews
the financial statements, employment and credit history of the borrower, as
well as other related documentation. The Company's largest multifamily loan at
June 30, 1997 had an outstanding loan balance of $3.6 million, of which the
Company owns $1.8 million and has participated the remaining balance to
another financial institution, and is secured by a residential hotel located
in the Los Angeles metropolitan area. This loan was classified as Substandard
at June 30, 1997 (for definition of Substandard, see "Delinquencies and
Classification of Assets--Classification of Assets" below). During the year
ended June 30, 1997, the Company originated $79.5 million of multifamily
loans. At June 30, 1997, the multifamily loan portfolio totaled $302.0 million
or 45.77% of gross loans. Of the $302.0 million in multifamily loans, 4.83%
were fixed-rate loans and 95.17% were ARM loans.
Multifamily loans are generally considered to involve a higher degree of
credit risk and to be more vulnerable to deteriorating economic conditions
than one-to-four family residential mortgage loans. These loans typically
involve higher loan principal amounts and the repayment of such loans
generally depend on the income produced by the operation or sale of the
property being sufficient to cover operating expenses and debt service.
Recessionary economic conditions of the type that prevailed in the Company's
primary lending market area in recent years tend to result in higher vacancy
and reduced rental rates and net operating incomes from multifamily
residential properties. Of the Company's $3.0 million of charge-offs in fiscal
1997, $2.2 million, or 73.33%, were for multifamily loans. See "--Allowances
for Loan and Real Estate Losses."
Commercial Real Estate Lending. The Company originates commercial real
estate loans that are generally secured by properties used for business
purposes such as small office buildings or a combination of residential and
retail facilities and mobile home parks located in the Association's primary
market area. At June 30, 1997, the commercial real estate loan portfolio
aggregated $55.3 million. Of the $55.3 million, 7.71% were fixed-rate loans
and 92.29% were ARM loans. The Company originated $3.1 million of commercial
real estate loans during the year ended June 30, 1997. The Company's
underwriting procedures provide that commercial real estate loans generally
may be made in amounts up to 70% of the appraised value of the property. These
loans may be made with terms up to 30 years for ARM loans. The Company's
underwriting standards and procedures are similar to those applicable to its
multifamily loans, wherein the Company considers the net operating income of
the property and the borrower's expertise, credit history and profitability.
The Company has generally required that the properties securing commercial
real estate loans have debt service coverage ratios of at least 110%. The
largest commercial real estate loan in the Company's portfolio
8
is secured by a mobile home park located in El Monte, California and had an
outstanding principal balance at June 30, 1997 of $1.5 million and was not
classified.
Commercial real estate loans are generally considered to involve a higher
degree of credit risk and to be more vulnerable to deteriorating economic
conditions than one-to-four family residential mortgage loans. These loans
typically involve higher loan principal amounts and the repayment of such
loans generally depend on the income produced by the operation or sale of the
property being sufficient to cover operating expenses and debt service.
Recessionary economic conditions of the type that prevailed in the Company's
primary lending market area in recent years tend to result in higher vacancy
and reduced rental rates and net operating incomes from commercial properties.
Of the Company's $3.0 million of charge-offs in fiscal 1997, $165,000, or
5.42%, were for commercial real estate loans. See "--Allowances for Loan and
Real Estate Losses."
Certain Loan Terms. The interest rates for the majority of the Company's ARM
loans in portfolio are indexed to the 11th District Cost of Funds Index
("COFI"). The Company currently offers a number of ARM loan programs with
interest rates tied to treasury based and COFI indices which adjust monthly,
semi-annually or annually, some of which have payment caps. Because of payment
caps and the different times at which interest rate adjustments and payment
adjustments are made, in periods of rising interest rates monthly payments may
not be sufficient to pay the interest accruing on some of the Company's ARM
loans. The amount of any shortfall ("negative amortization") is added to the
principal balance of the loan to be repaid through future monthly payments,
which could cause increases in the amount of principal owed to the Company
over that which was originally lent. The Company currently has approximately
$384.4 million in mortgage loans that may be subject to negative amortization.
During the years ended June 30, 1997, 1996 and 1995, the negative amortization
associated with these loans totaled $618,000, $994,000 and $430,000,
respectively. Significant negative amortization can increase the associated
risk of default on loans, particularly for loans originated with relatively
high loan-to-value ratios. Based on historical experience, management does not
believe that the loss experience on the loans that are subject to negative
amortization is materially different from the loss experience on the balance
of its portfolio.
Mortgage loans originated by the Company, generally include due-on-sale
clauses which provide the Company with the contractual right to deem the loan
immediately due and payable in the event the borrower transfers ownership of
the property without the Company's consent. Due-on-sale clauses are an
important means of adjusting the rates on the Company's fixed rate multifamily
and commercial mortgage loan portfolios and the Company has generally
exercised its rights under these clauses.
Loan Approval Procedures and Authority. The Company's Board of Directors has
a standing Loan Committee. The Loan Committee is primarily responsible for
establishing the lending policies of the Company and reviewing properties
offered as security. The Board of Directors has authorized the following
persons to approve loans up to the amounts indicated: mortgage loans in
amounts of $750,000 and below may be approved by the Loan Division Manager or
his designate; mortgage loans in excess of $750,000 and up to $1.5 million
require the approval of the President or any member of the Loan Committee; and
mortgage loans in excess of $1.5 million requires the approval of at least two
members of the Loan Committee.
9
For all loans originated by the Company, upon receipt of a completed loan
application from a prospective borrower, a credit report is ordered and
certain other information is verified by an independent credit agency and, if
necessary, additional financial information is required. Appraisals of the
real estate intended to secure proposed loans over $150,000 are required,
which appraisals currently are performed by independent appraisers designated
and approved by the Company. The Company's Board annually approves the
independent appraisers used by the Company and approves the Company's
appraisal policy. The Company's policy is to obtain title and hazard insurance
on all real estate loans. If the original loan amount exceeds 80% of the
underlying property's value on a sale or refinance of a first trust deed loan,
private mortgage insurance is required and the borrower will be required to
make payments to a mortgage impound account from which the Company makes
disbursements for property taxes and mortgage insurance.
DELINQUENCIES AND CLASSIFICATION OF ASSETS
Delinquent Loans. Management performs a monthly review of all delinquent
loans and reports to the Company's Board of Directors regarding the same. The
procedures taken by the Company with respect to delinquencies vary depending
on the nature of the loan and period of delinquency.
The Company's policies generally provide that delinquent mortgage loans be
reviewed and that a written late charge notice be mailed no later than the
11th or 16th day of delinquency for mortgage loans with 10 day or 15 day grace
periods, respectively. The Company's policies provide that telephone contact
will be attempted to ascertain the reasons for delinquency and the prospects
of repayment. When contact is made with the borrower at any time prior to
foreclosure, the Company will attempt to obtain full payment or work out a
repayment schedule with the borrower to avoid foreclosure. See also "--
Nonperforming Assets and Restructured Loans."
At June 30, 1997, 1996 and 1995, delinquencies in the Company's loan
portfolio were as follows:
1997 1996 1995
--------------------------------- --------------------------------- ---------------------------------
60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE
---------------- ---------------- ---------------- ---------------- ---------------- ----------------
NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL
OF BALANCE OF BALANCE OF BALANCE OF BALANCE OF BALANCE OF BALANCE
LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS
------ --------- ------ --------- ------ --------- ------ --------- ------ --------- ------ ---------
(DOLLARS IN THOUSANDS)
One-to-four
family.......... 4 $ 442 25 $3,011 3 $ 246 12 $1,467 3 $ 144 9 $1,359
Multifamily...... 3 1,045 4 348 5 2,220 11 3,991 5 3,293 7 2,804
Commercial....... 5 3,648 3 1,054 1 1,087 7 3,155 2 1,111 4 2,757
Other loans...... -- -- -- -- -- -- 4 105 -- -- -- --
--- ------ --- ------ --- ------ --- ------ --- ------ --- ------
Total........... 12 $5,135 32 $4,413 9 $3,553 34 $8,718 10 $4,548 20 $6,920
=== ====== === ====== === ====== === ====== === ====== === ======
Delinquent loans
to total gross
loans........... 0.78% 0.67% 0.57% 1.40% 0.82% 1.24%
The loans in the above table have been considered in connection with the
Company's overall assessment of the adequacy of its allowance for loan losses.
However, there can be no assurance that the Company will not have to establish
additional loss provisions for these loans in the future. See "--Allowances
for Loan and Real Estate Losses" and "MD&A--Problem Assets."
Classification of Assets. Federal regulations and the Company's
Classification of Assets Policy require that the Company utilize an internal
asset classification system as a means of reporting problem and potential
problem assets. The Company has incorporated the OTS internal asset
classifications as a part of its credit monitoring system. The Company
currently classifies problem and potential problem assets as "Substandard,"
"Doubtful" or "Loss" assets. An asset is considered "Substandard" if it is
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. "Substandard" assets include
those characterized by the "distinct possibility" that the insured institution
will sustain "some loss" if the deficiencies are not corrected. Assets
classified as "Doubtful" have all of the
10
weaknesses inherent in those classified "Substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full", on the basis of currently existing facts, conditions, and values,
"highly questionable and improbable." See "--Regulation and Supervision--
Classification of Assets." The Company's Internal Asset Review Committee
monthly reviews and classifies the Company's assets and reports the results of
its review to the Company's Board of Directors.
The following table sets forth information with respect to the classified
assets of the Company at June 30, 1997.
AT JUNE 30, 1997
----------------------------
SUBSTANDARD DOUBTFUL TOTAL
----------- -------- -------
(IN THOUSANDS)
Real estate loans:
One-to-four family.............................. $ 6,865 $-- $ 6,865
Multifamily..................................... 8,289 -- 8,289
Commercial and Land............................. 3,419 -- 3,419
REO............................................... 1,720 -- 1,720
Investment in subsidiaries(1)..................... 119 -- 119
Securities........................................ 18 -- 18
------- ---- -------
Total Classified Assets........................... $20,430 $-- $20,430
======= ==== =======
- --------
(1) At June 30, 1997, the Company classified as Substandard 61% of the
Company's equity investment in subsidiaries. At such date, QCFC reported
total assets of $1.2 million. See "--Subsidiary Activities."
Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 114,
"Accounting by Creditors for Impairment of a Loan", the Company recognizes
impairment on troubled collateral dependent loans by creating a specific
valuation allowance. At June 30, 1997 and 1996, the specific valuation
allowance totaled $1.5 million and $2.2 million, respectively. The loans for
which a specific valuation allowance was established are in the process of
collection. At such time that these loans are deemed uncollectible the
specific valuation allowance is charged-off.
In addition to adversely classified assets, assets which do not currently
expose the Company to sufficient risk to warrant adverse classification but
possess weaknesses are designated "Special Mention." According to OTS
guidelines, Special Mention assets are not adversely classified and do not
expose an institution to sufficient risk to warrant adverse classification. At
June 30, 1997, $10.0 million of assets were graded as Special Mention,
compared to $9.1 million at June 30, 1996.
These assets have been considered in connection with the Company's overall
assessment of the adequacy of its allowance for loan losses; however, there
can be no assurance that the Company will not establish additional loss
provisions for these assets in the future. See "--Allowances for Loan and Real
Estate Losses" and "MD&A--Problem Assets."
NONPERFORMING ASSETS AND RESTRUCTURED LOANS
After 60 days, the Company ceases the accrual of interest on loans and any
previously accrued interest is reversed. In addition, the Company may
restructure a loan due to the debtor's financial difficulty and grant a
concession which the Company would not have otherwise considered. REO is
recorded at fair value less estimated costs of disposition.
11
The following table sets forth information regarding nonaccrual loans,
troubled debt restructured loans and REO. There were no accruing loans past
due 60 days or more for any of the periods presented below.
AT JUNE 30,
-------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Real estate loans:
One-to-four family.............. $ 3,226 $ 1,614 $ 1,269 $ 2,033 $ 2,960
Multifamily..................... 2,387 4,949 3,999 4,429 2,369
Commercial and land............. 2,926 3,781 2,510 3,359 713
Other:
Loans secured by savings
deposits....................... -- 105 -- 35 32
------- ------- ------- ------- -------
Total nonaccrual loans(1)....... 8,539 10,449 7,778 9,856 6,074
Troubled debt restructured loans.. 229 234 3,387 5,352 3,611
------- ------- ------- ------- -------
Total nonperforming loans....... 8,768 10,683 11,165 15,208 9,685
Real estate acquired through
foreclosure...................... 1,720 2,435 2,045 2,154 2,458
------- ------- ------- ------- -------
Total nonperforming assets...... $10,488 $13,118 $13,210 $17,362 $12,143
======= ======= ======= ======= =======
Ratios:
Net charge-offs to average
loans.......................... 0.47% 1.13% 0.75% 0.34% 0.03%
General Valuation Allowance
(GVA) on loans as a percentage
of total nonaccrual loans(1)... 72.81 54.72 99.00 87.13 70.27
GVA on loans as a percentage of
gross loans.................... 0.94 0.92 1.38 1.81 0.98
GVA on loans as a percentage of
total nonperforming loans(2)... 70.91 53.52 68.97 56.47 44.07
Total GVA as a percentage of
total nonperforming assets(3).. 60.95 44.92 59.61 50.13 35.93
Total nonaccrual loans as a
percentage of gross loans(1)... 1.29 1.67 1.40 2.08 1.39
Nonperforming loans as a
percentage of gross loans(2)... 1.33 1.71 2.01 3.21 2.22
Nonperforming assets as a
percentage of total assets(4).. 1.31 1.81 2.06 3.39 2.49
- --------
(1) Nonaccrual loans are net of specific allowances of $1.5 million, $2.2
million, $4.3 million, $5.1 million and $811,000 for the years ended June
30, 1997, 1996, 1995, 1994 and 1993, respectively.
(2) Nonperforming loans include nonaccrual and troubled debt restructured
loans. Gross loans include loans held for sale.
(3) Total GVA includes loan and REO general valuation allowances.
(4) Nonperforming assets include nonperforming loans and REO.
The gross amount of interest income on nonaccrual loans that would have been
recorded during the years ended June 30, 1997, 1996 and 1995 if the nonaccrual
loans had been current in accordance with their original terms was $782,000,
$1.1 million and $920,000, respectively. For the years ended June 30, 1997,
1996 and 1995, $469,000, $565,000 and $497,000, respectively, was actually
earned on nonaccrual loans and is included in interest income on loans in the
consolidated statements of operations for such years included in this report.
Interest income earned on nonaccrual loans is generally recorded utilizing the
cash-basis method of accounting. See "Financial Statements and Supplementary
Data."
12
IMPAIRED LOANS
A loan is considered impaired when based on current circumstances and
events, it is probable that a creditor will be unable to collect all amounts
due according to the contractual terms of the loan agreement. Creditors are
required to measure impairment of a loan based on any one of the following:
(i) the present value of expected future cash flows from the loan discounted
at the loan's effective interest rate, (ii) an observable market price or
(iii) the fair value of the loan's underlying collateral. The Company measures
impairment based on the fair value of the loan's underlying collateral
property. Impaired loans exclude large groups of smaller balance homogeneous
loans that are collectively evaluated for impairment. For the Company, loans
collectively reviewed for impairment include all loans with principal balances
of less than $300,000.
Factors considered as part of the periodic loan review process to determine
whether a loan is impaired, as defined under SFAS 114, address both the amount
the Company believes is probable that it will collect and the timing of such
collection. As part of the Company's loan review process the Company will
consider such factors as the ability of the borrower to continue to meet the
debt service requirements, assessments of other sources of repayment, the fair
value of any collateral and the Company's prior history in dealing with the
particular type of loan involved. In evaluating whether a loan is considered
impaired, insignificant delays (less than twelve months) in the absence of
other facts and circumstances would not alone lead to the conclusion that a
loan was impaired.
At June 30, 1997 and 1996, the Company had a gross investment in impaired
loans of $8.0 million and $8.6 million, respectively. During the year ended
June 30, 1997 and 1996, the Company's average investment in impaired loans was
$8.2 million and $11.8 million, respectively, and for the years then ended,
interest income on such loans totaled $704,000 and $611,000, respectively.
Interest income on impaired loans which are performing is generally recorded
utilizing the cash-basis method of accounting. Payments received on impaired
loans which are performing under their contractual terms are allocated to
principal and interest in accordance with the terms of the loans. Impaired
loans totaling $4.3 million and $6.4 million were not performing in accordance
with their contractual terms at June 30, 1997 and 1996, and have been included
in nonaccrual loans at that date.
The Company recognizes impairment on troubled collateral dependent loans by
creating a specific valuation allowance. The loans for which a specific
valuation allowance was established are in the process of collection. At such
time that these loans are deemed uncollectible, the specific valuation
allowance is charged-off.
Impaired loans at June 30, 1997, include $5.5 million of loans for which
specific valuation allowances of $1.2 million had been established and $2.5
million of loans for which no specific valuation allowance was considered
necessary. At June 30, 1996, the Company had $6.7 million of impaired loans
for which specific valuation allowances of $1.6 million had been established
and $1.9 million of such loans for which no specific valuation allowance was
considered necessary. All such provisions for losses and related recoveries
are recorded as part of the total allowance for loan losses.
ALLOWANCES FOR LOAN AND REAL ESTATE LOSSES
The Company's allowance for loan losses is comprised of specific valuation
allowances as well as a general valuation allowance (GVA). As discussed above,
specific valuation allowances are generally established to recognize
impairment on troubled collateral dependent loans. The GVA is maintained in an
amount that management believes will be adequate to absorb reasonably
anticipated losses that may be realized on existing loan-related assets and
off-balance sheet items.
The allowance for loan losses is established through a provision for loan
losses based on management's evaluation of the risks inherent in its loan
portfolio. The allowance for loan losses is
13
maintained at an amount management considers adequate to cover estimated
losses in loans receivable which are deemed probable and estimable. The
allowance is based upon a number of factors, including asset classifications,
economic trends, industry experience and trends, industry and geographic
concentrations, estimated collateral values, management's assessment of the
credit risk inherent in the portfolio, historical loan loss experience, the
Company's underwriting policies and the regulatory environment. It is the
Company's general policy to obtain appraisals on the underlying property for
loans 90 days or more past due and over $500,000. If the loan amount is under
$500,000, appraisals are obtained at the time of foreclosure.
The Company's allowance for loan losses remained unchanged at $7.8 million,
or 1.18% of gross loans, at June 30, 1997 compared to $7.8 million, or 1.25%
of gross loans, at June 30, 1996. The allowance for loan losses at June 30,
1997 reflects management's evaluation of the risks inherent in its loan
portfolio in consideration of various factors, including trends in its
nonperforming assets, the regional economy and relevant real estate values.
The Company's ratio of nonperforming loans to gross loans decreased to 1.33%
at June 30, 1997 from 1.71% at June 30, 1996. The Company's ratio of
nonperforming assets to total assets decreased during this period to 1.31% at
June 30, 1997 from 1.81% at June 30, 1996. As of June 30, 1997, the Company's
total GVA to nonperforming assets, was 60.95% as compared to 44.92% at June
30, 1996.
The Company recorded a provision for loan losses of $3.0 million for the
year ended June 30, 1997, compared to $2.1 million, $998,000, $10.2 million
and $3.7 million for the years ended June 30, 1996, 1995, 1994 and 1993,
respectively. Management believes that the increases in the provisions for
1997 and 1996 were necessary to replenish the allowance for loan losses to
what management believes is an adequate level due to charge-offs taken during
these years. The decrease in the provision in 1995 as compared to 1994 was
primarily a result of the reduction in nonperforming assets during 1995. The
increase in the provision in 1994, reflected management's assessment of the
loan portfolio in consideration of various factors, including the trends in
the Company's nonperforming assets, continued declines in the Southern
California economy, the January 1994 Northridge earthquake and the regulatory
environment. The increase in charge-offs in 1994 through 1996 was primarily a
result of acquiring title to or resolve properties damaged in the January 1994
Northridge earthquake as well as continued declines in the Southern California
economy.
Although the Company believes that the allowance for loan losses at June 30,
1997 is adequate, there can be no assurance that the Company will not have to
establish additional loss provisions based upon future events. The Company
will continue to monitor and modify its allowances for loan losses as
conditions dictate. In addition, the OTS and the FDIC, as an integral part of
their examination process, periodically review the Company's valuation
allowance. These agencies may require the Company to establish additional
allowances, based on their judgments of the information available at the time
of the examination. See "Regulation and Supervision--Classification of
Assets."
It is the policy of the Company to "charge-off" consumer loans when it is
determined that they are no longer collectible. The policy for loans secured
by real estate, which comprise the bulk of the Company's portfolio, is to
establish an allowance for loan losses in accordance with the Company's asset
classification process, based on generally accepted accounting principles
("GAAP"). It has generally been the practice of the Company to "charge-off"
losses after acquiring title to a property securing the loan. Prior to
acquiring title to REO, losses are recognized through the establishment of
valuation allowances. It is the policy of the Company to obtain an appraisal
on all REO upon acquisition by the Company.
REO is initially recorded at fair value at the date of acquisition, less
estimated costs of disposition. Thereafter, if there is a further
deterioration in value, the Company writes down the REO directly for the
diminution in value. Real estate held for investment is carried at the lower
of cost or net realizable value. All costs of anticipated disposition are
considered in the determination of net realizable value.
14
The following table sets forth activity in the Company's total allowance for
loan losses and allowance for losses on REO.
AT OR FOR THE YEAR ENDED JUNE 30,
------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- ------
(IN THOUSANDS)
Accumulated through a charge to
earnings:
Balance at beginning of year.... $ 6,542 $10,614 $13,458 $ 4,833 $1,307
Provision for loan losses....... 3,001 2,103 998 10,200 3,657
Charge-offs:
One-to-four family............ (699) (968) (160) (57) --
Multifamily................... (2,182) (3,896) (3,252) (1,198) (131)
Commercial and land........... (165) (1,309) (428) (304) --
Non-mortgage.................. (1) (2) (2) (16) --
Recoveries...................... -- -- -- -- --
------- ------- ------- ------- ------
Subtotal charge-offs, net...... (3,047) (6,175) (3,842) (1,575) (131)
------- ------- ------- ------- ------
Balance at end of year.......... 6,496 6,542 10,614 13,458 4,833
Valuation allowance for portfolios
acquired:
Balance at beginning of year.... 1,291 1,494 202 246 286
Purchases....................... -- 294 1,308 -- --
Charge-offs:
Multifamily................... -- (471) -- -- --
Reductions credited............. (15) (26) (16) (44) (40)
------- ------- ------- ------- ------
Balance at end of year.......... 1,276 1,291 1,494 202 246
------- ------- ------- ------- ------
Total allowance for loan losses. $ 7,772 $ 7,833 $12,108 $13,660 $5,079
======= ======= ======= ======= ======
Allowance for REO losses:
Balance at beginning of year.... $ 175 $ 175 $ 115 $ 95 $ 81
Additions charged to operations. -- -- 60 20 14
------- ------- ------- ------- ------
Balance at end of year.......... $ 175 $ 175 $ 175 $ 115 $ 95
======= ======= ======= ======= ======
15
The following table sets forth the Company's allowance for loan losses to
total loans and the percentage of loans to total loans in each of the
categories listed.
AT JUNE 30,
------------------------------------------------------------------------------------------
1997(1) 1996(1) 1995(1)
----------------------------- ----------------------------- ------------------------------
PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE
OF OF LOANS OF OF LOANS OF OF LOANS
ALLOWANCE IN EACH ALLOWANCE IN EACH ALLOWANCE IN EACH
TO TOTAL CATEGORY TO TO TOTAL CATEGORY TO TO TOTAL CATEGORY TO
AMOUNT ALLOWANCE TOTAL LOANS AMOUNT ALLOWANCE TOTAL LOANS AMOUNT ALLOWANCE TOTAL LOANS
------ ---------- ----------- ------ ---------- ----------- ------- ---------- -----------
(DOLLARS IN THOUSANDS)
One-to-four family...... $1,709 21.99% 45.47% $1,306 16.67% 48.54% $ 1,338 11.05% 51.85%
Multifamily............. 3,318 42.69 45.77 4,744 60.56 41.45 6,499 53.68 36.95
Commercial.............. 1,085 13.96 8.39 1,288 16.44 9.74 2,475 20.44 10.91
Land.................... 210 2.70 0.21 199 2.54 0.17 344 2.84 0.19
Other................... -- -- 0.16 -- -- 0.10 -- -- 0.10
Unallocated............. 1,450 18.66 -- 296 3.79 -- 1,452 11.99 --
------ ------ ------ ------ ------ ------ ------- ------ ------
Total allowance
for loan losses....... $7,772 100.00% 100.00% $7,833 100.00% 100.00% $12,108 100.00% 100.00%
====== ====== ====== ====== ====== ====== ======= ====== ======
AT JUNE 30,
------------------------------------------------------------
1994(1) 1993(1)
------------------------------ -----------------------------
PERCENTAGE PERCENTAGE
PERCENTAGE OF LOANS PERCENTAGE OF LOANS
OF IN EACH OF IN EACH
ALLOWANCE CATEGORY ALLOWANCE CATEGORY
TO TOTAL TO TO TOTAL TO
AMOUNT ALLOWANCE TOTAL LOANS AMOUNT ALLOWANCE TOTAL LOANS
------- ---------- ----------- ------ ---------- -----------
(DOLLARS IN THOUSANDS)
One-to-four family...... $ 989 7.24% 49.51% $ 637 12.54% 46.25%
Multifamily............. 8,613 63.05 37.46 2,932 57.72 39.92
Commercial.............. 2,220 16.25 12.79 1,066 20.99 13.53
Land.................... 407 2.98 0.15 13 0.26 0.17
Other................... 2 0.02 0.09 -- -- 0.13
Unallocated............. 1,429 10.46 N/A 431 8.49 N/A
------- ------ ------ ------ ------ ------
Total allowance
for loan losses....... $13,660 100.00% 100.00% $5,079 100.00% 100.00%
======= ====== ====== ====== ====== ======
- --------
(1) In 1997, 1996, 1995, 1994 and 1993, total specific allowances amounted to
$1.6 million, $2.2 million, $4.3 million, $5.1 million and $811,000,
respectively.
The increase in the unallocated allowance at June 30, 1997 as compared to
June 30, 1996, is a result of a decrease in the allocated allowance required
on multifamily loans as a result of a decline in multifamily charge-offs and
nonaccrual multifamily loans during the year.
INVESTMENT ACTIVITIES
Federally chartered savings institutions such as the Association have the
authority to invest in various types of liquid assets, including United States
Treasury obligations, securities of various federal agencies, certain
certificates of deposit of insured banks and savings institutions, certain
bankers' acceptances, repurchase agreements and federal funds. Subject to
various restrictions, federally chartered savings institutions may also invest
their assets in commercial paper, investment grade corporate debt securities
and mutual funds whose assets conform to the investments that a federally
chartered savings institution is otherwise authorized to make directly.
Additionally, a federally chartered savings institution such as the
Association must maintain minimum levels of investments that qualify as liquid
assets under OTS regulations. See "--Regulation and Supervision--Required
Liquidity." The Association currently manages liquid assets at the minimum
level required under OTS requirements in an effort to maximize overall yield
on its investment portfolio.
The investment policy of the Company attempts to provide and maintain
liquidity, generate a favorable return on investments without incurring undue
interest rate and credit risk, and complement
16
the Company's lending activities. Specifically, the Company's policy generally
limits investments to government and federal agency-backed securities and
other non-government guaranteed securities, including corporate debt
obligations, that are investment-grade. The Company's policy authorizes
investment in marketable equity securities meeting the Company's guidelines.
The policy requires that all investment purchases be ratified by the Board of
Directors of the Company. At June 30, 1997, the Company had federal funds sold
and other short-term investments and investment securities in the aggregate
amount of $51.0 million with a fair value of $50.9 million.
The following table sets forth certain information regarding the amortized
cost and fair values of the Company's federal funds sold and other short-term
investments and investment securities portfolio at the dates indicated:
AT JUNE 30,
-----------------------------------------------------
1997 1996 1995
----------------- ----------------- -----------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
--------- ------- --------- ------- --------- -------
(IN THOUSANDS)
Federal funds sold and
other short-term
investments............. $12,950 $12,950 $ 6,400 $ 6,400 $ 9,450 $ 9,450
======= ======= ======= ======= ======= =======
Investment securities:
Held to maturity:
U.S. Government and
Federal agency
obligations.......... $36,303 36,142 $37,048 $36,437 $23,509 $23,531
Municipal bonds....... 351 351 371 371 389 389
------- ------- ------- ------- ------- -------
Total held to
maturity........... 36,654 36,493 37,419 36,808 23,898 23,920
Available for sale:
Mutual funds.......... -- -- -- -- 150 150
Marketable Equity
Securities........... 1,200 1,432 -- -- -- --
------- ------- ------- ------- ------- -------
Total investment
securities......... $37,854 $37,925 $37,419 $36,808 $24,048 $24,070
======= ======= ======= ======= ======= =======
The table below sets forth certain information regarding the amortized cost,
weighted average yields and contractual maturities of the Company's federal
funds sold and other short-term investments and investment securities as of
June 30, 1997.
AT JUNE 30, 1997
----------------------------------------------------------------------------------------------------------------
MORE THAN ONE MORE THAN FIVE MORE THAN TEN
NO MATURITY ONE YEAR OR LESS YEAR TO FIVE YEARS YEARS TO TEN YEARS YEARS TOTAL
------------------ ------------------ ------------------ ------------------ ------------------ ----------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE
COST YIELD COST YIELD COST YIELD COST YIELD COST YIELD COST YIELD
--------- -------- --------- -------- --------- -------- --------- -------- --------- -------- -------- -------
(DOLLARS IN THOUSANDS)
Federal funds sold
and other short-
term investments. $ -- -- % $12,950 5.90% $ -- -- % $ -- -- % $ -- -- % $12,950 5.90%
====== === ======= ==== ======= ==== ====== ==== ====== ==== ======= ====
Investment
securities:
Held to maturity:
U.S. Government
and Federal
agency
obligations..... $ -- -- % $ 1,500 5.53% $25,811 6.55% $4,000 7.23% $4,992 7.42% $36,303 6.70%
Municipal bonds.. -- -- -- -- -- -- -- -- 351 7.00(1) 351 7.00
------ ------- ------- ------ ------ -------
Total held to
maturity....... -- -- 1,500 5.53 25,811 6.55 4,000 7.23 5,343 7.39 36,654 6.70
Available for
sale:
Equity
securities...... 1,200 N/A -- -- -- -- -- -- -- -- 1,200 N/A
------ ------- ------- ------ ------ -------
Total investment
securities..... $1,200 N/A $ 1,500 5.53% $25,811 6.55% $4,000 7.23% $5,343 7.39% $37,854 6.70%
====== ======= ======= ====== ====== =======
- -------
(1) This rate represents the coupon rate on the investment and has not been
computed on a tax equivalent basis.
17
SOURCES OF FUNDS
General. Deposits, FHLB advances, securities sold under agreements to
repurchase, loan repayments and prepayments, proceeds from sales of loans, and
cash flows generated from operations are the primary sources of the Company's
funds for use in lending, investing and for other general purposes.
Deposits. The Company offers a variety of deposit accounts with a range of
interest rates and terms. The Company's deposits consist of passbook savings,
checking accounts and certificates of deposit. The flow of deposits is
influenced significantly by general economic conditions, changes in money
market rates, prevailing interest rates and competition. The Company's
deposits are obtained predominantly from the areas in which its branch offices
are located. The Company relies primarily on customer service and long-
standing relationships with customers to attract and retain these deposits;
however, market interest rates and rates offered by competing financial
institutions significantly affect the Company's ability to attract and retain
deposits. Certificate of deposit accounts in excess of $100,000 are not
actively solicited by the Company nor does the Company use brokers to obtain
deposits. Management continually monitors the Company's certificate accounts
and historically the Company has retained a large portion of such accounts
upon maturity. See "MD&A--Capital Resources and Liquidity--Sources of Funds
and Liquidity."
The following table presents the deposit activity of the Company for the
periods indicated.
FOR THE YEAR ENDED JUNE 30,
-------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
Deposits....................................... $ 651,616 $ 579,878 $ 556,933
Withdrawals.................................... (636,318) (572,111) (519,991)
--------- --------- ---------
Net deposits................................... 15,298 7,767 36,942
Interest credited on deposits.................. 25,371 23,592 20,256
--------- --------- ---------
Total increase in deposits................... $ 40,669 $ 31,359 $ 57,198
========= ========= =========
The following table presents the amount and weighted average rate of time
deposits equal to or greater than $100,000 at June 30, 1997:
FOR THE YEAR ENDED
JUNE 30, 1997
--------------------
MATURITY PERIOD WEIGHTED
AMOUNT AVERAGE RATE
- --------------- ------- ------------
(DOLLARS IN
THOUSANDS)
Three months or less....................................... $17,660 5.55%
Over three through six months.............................. 17,753 5.63
Over six through 12 months................................. 23,150 5.73
Over 12 months............................................. 19,728 6.07
-------
Total...................................................... $78,291 5.75
=======
18
The following table sets forth the distribution of the Company's deposit
accounts for the periods indicated and the weighted average interest rates on
each category of deposits presented.
FOR THE YEAR ENDED JUNE 30,
--------------------------------------------------------------------------------------
1997 1996 1995
---------------------------- ---------------------------- ----------------------------
PERCENTAGE PERCENTAGE PERCENTAGE
OF TOTAL WEIGHTED OF TOTAL WEIGHTED OF TOTAL WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE
-------- ---------- -------- -------- ---------- -------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
Money market deposits... $ 83,372 15.72% 4.20% $ 75,176 15.12% 3.99% $ 56,251 12.26% 3.19%
Passbook deposits....... 17,899 3.38 1.98 21,028 4.23 1.99 25,572 5.57 1.96
NOW and other demand
deposits............... 24,011 4.53 1.16 23,006 4.63 1.20 23,698 5.16 1.11
Non-interest bearing
deposits............... 7,718 1.46 -- 6,296 1.46 -- 7,032 1.53 --
-------- ------ -------- ------ -------- ------
Total.................. 133,000 25.09 126,766 25.49 112,553 24.52
-------- ------ -------- ------ -------- ------
Certificate accounts:
Three months or less.... 99,718 18.81 5.43 86,940 17.49 5.60 64,327 14.01 4.15
Over three through six
months................. 88,175 16.63 5.43 82,662 16.63 5.73 73,917 16.10 4.72
Over six through 12
months................. 110,972 20.93 5.61 121,386 24.40 5.77 98,100 21.37 5.16
Over one to three years. 68,637 12.94 5.76 43,524 8.75 5.89 70,879 15.44 6.07
Over three to five
years.................. 29,683 5.60 6.15 35,961 7.23 6.20 39,223 8.55 5.69
Over five years......... 6 -- 5.23 42 0.01 7.06 11 0.01 7.96
-------- ------ -------- ------ -------- ------
Total certificates..... 397,191 74.91 5.59 370,515 74.51 5.78 346,457 75.48 5.12
-------- ------ -------- ------ -------- ------
Total deposits......... $530,191 100.00% 4.97 $497,281 100.00% 5.05 $459,010 100.00% 4.43
======== ====== ======== ====== ======== ======
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
contractual maturity of the certificate accounts outstanding at June 30, 1997.
AT JUNE 30, CERTIFICATE AMOUNTS MATURING IN THE YEAR ENDING JUNE 30,
-------------------------- --------------------------------------------------------
2002 AND
1995 1996 1997 1998 1999 2000 2001 THEREAFTER TOTAL
-------- -------- -------- -------- ------- ------- ------- ---------- --------
(IN THOUSANDS)
Certificate accounts:
0 to 4.00%.............. $ 3,987 $ 720 $ 167 $ 167 $ 0 $ 0 $ 0 $ 0 $ 167
4.001 to 5.00%.......... 72,194 59,878 38,622 38,622 0 0 0 0 38,622
5.001 to 6.00%.......... 137,191 249,461 229,085 224,791 3,465 13 37 779 229,085
6.001 to 7.00%.......... 130,687 72,907 97,347 37,600 44,149 6,278 4,915 4,405 97,347
7.001 to 8.00%.......... 12,722 6,520 35,834 59 5,585 22,805 5,178 2,207 35,834
8.001 to 9.00%.......... 3,821 57 344 0 6 338 0 0 344
Over 9.001%............. 140 12 20 0 20 0 0 0 20
-------- -------- -------- -------- ------- ------- ------- ------ --------
Total.................. $360,742 $389,555 $401,419 $301,239 $53,225 $29,434 $10,130 $7,391 $401,419
======== ======== ======== ======== ======= ======= ======= ====== ========
Borrowings. From time to time the Company has obtained advances from the
FHLB and may do so in the future as an alternative to retail deposit funds.
FHLB advances may also be used to acquire certain other assets as may be
deemed appropriate for investment purposes. These advances are collateralized
by the capital stock of the FHLB held by the Company and certain of the
Company's mortgage loans. See "--Regulation and Supervision--Federal Home Loan
Bank System." Such advances are made pursuant to several different credit
programs, each of which has its own interest rate and range of maturities. The
maximum amount that the FHLB will advance to member institutions, including
the Company, for purposes other than meeting withdrawals, fluctuates from time
to time in accordance with the policies of the OTS and the FHLB. During 1997,
the Company periodically borrowed advances to provide needed liquidity and to
supplement retail deposit gathering activity. See "MD&A--Capital Resources and
Liquidity--Sources of Funds and Liquidity." At June 30, 1997, the Company had
$157.7 million in outstanding advances from the FHLB. During fiscal 1997, the
maximum amount of FHLB advances that the Company had outstanding at any month-
end
19
was $166.6 million. As anticipated by management, the Company's total
borrowing from the FHLB increased in fiscal 1997 comprising 100% of borrowings
compared to 99.78% and 73.66% in fiscal 1996 and 1995, respectively.
The following table sets forth certain information regarding the Company's
borrowed funds at or for the periods ended on the dates indicated:
AT OR FOR THE YEAR ENDED JUNE 30,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
FHLB advances:
Average balance outstanding............. $148,312 $ 96,789 $46,029
Maximum amount outstanding at any month-
end during the period.................. $166,600 $135,300 $63,950
Balance outstanding at end of period.... $157,700 $135,300 $63,950
Weighted average interest rate during
the period............................. 5.77% 5.76% 5.64%
Weighted average interest rate at end of
period................................. 6.10% 5.87% 6.63%
Securities sold under agreements to
repurchase:
Average balance outstanding............. $ 72 $ 8,283 $11,342
Maximum amount outstanding at any month-
end during the period.................. $ 300 $ 17,146 $23,848
Balance outstanding at end of period.... $ -- $ 300 $22,873
Weighted average interest rate during
the period............................. 5.56% 5.92% 5.25%
Weighted average interest rate at end of
period................................. N/A 5.57% 6.08%
SUBSIDIARY ACTIVITIES
QCFC, a wholly owned subsidiary of the Association, is currently engaged, on
an agency basis, in the sale of casualty insurance, mutual funds and annuity
products primarily to the Association's customers and members of the local
community and as a trustee of the Association's deeds of trust. In the past,
QCFC has been involved in real estate development projects. Currently, the
only real estate development project in which QCFC has an investment is an
apartment building in Pasadena, California. The apartment building is managed
by the general partner. QCFC has a limited partner interest in the project,
with a carrying value of $65,000 at June 30, 1997. It is anticipated that the
building will be sold as market conditions permit. The Association does not
currently intend to engage in any future real estate development projects
through QCFC or otherwise. As of June 30, 1997, and for the year then ended,
QCFC had $1.2 million in total assets and net income of $59,000.
The Company incorporated Quaker City Neighborhood Development, Inc.
("QCND"), a wholly owned community development subsidiary, during the first
quarter of fiscal 1994. The purpose of QCND is to engage in community lending
and development activities including affordable housing loans to low-and
moderate-income individuals in the Company's lending communities. The
subsidiary complements the Company's community reinvestment activities and its
"Outstanding" Community Reinvestment Act rating. The Company funded operations
for the subsidiary on June 30, 1994 in the amount of $2.4 million. QCND, in
turn, invested those funds in a short-term note to the city of Whittier for
the purpose of facilitating community development projects consistent with the
goals of the subsidiary. In fiscal 1997, this short-term note was paid off by
the City of Whittier.
COMPETITION
Savings associations face strong competition both in attracting deposits and
making real estate loans. The Company's most direct competition for deposits
has historically come from other savings associations and from commercial
banks located in its principal market areas of Los Angeles and
20
Orange Counties in California, including many large financial institutions
which have greater financial and marketing resources available to them. In
addition, particularly during times of high interest rates, the Company has
faced significant competition for investors' funds from short-term money
market securities and other corporate and government securities and mutual
funds which invest in such securities. Periods of low interest rates have made
the attraction and retention of deposits difficult as savers seek higher rates
of return in alternative investments. The ability of the Company to attract
and retain savings deposits depends on its ability to generally provide a rate
of return, liquidity and risk comparable to that offered by competing
investment opportunities. Furthermore, management considers the Company's
reputation for financial strength and quality service provided through its
contiguous branching network to local customers to be a major competitive
advantage in attracting and retaining savings deposits.
The Company experiences strong competition for real estate loans principally
from other savings associations, commercial banks and mortgage banking
companies. It competes for loans principally through the interest rates and
loan fees it charges and the efficiency and quality of services it provides
borrowers. Management considers the Company's focus in multifamily and low-
to-moderate income lending in the Los Angeles area to be a competitive
advantage also. Competition may increase as a result of the continuing
reduction in restrictions on the interstate operations of financial
institutions.
Under legislation adopted by Congress in 1994, bank holding companies based
in any state generally are allowed to acquire banks in California and banks
based in any state generally are allowed to acquire by merger banks based in
California. Under OTS regulations, federal savings associations have been
generally able to branch nationwide as long as the association's assets
attributable to each state outside of its home state in which it operates
branches are predominantly housing-related assets. The increased authority of
bank holding companies and banks to engage in interstate banking will allow
them to compete more effectively with savings associations.
PERSONNEL
As of June 30, 1997, the Association had 118 full-time employees and 47
part-time employees. The employees are not represented by a collective
bargaining unit and the Association considers its relationship with its
employees to be good.
FEDERAL TAXATION
General. The Company reports its income for tax purposes on a calendar year
basis using the accrual method of accounting and will be subject to federal
income taxation in the same manner as other corporations with some exceptions,
including particularly the Association's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary
and does not purport to be a comprehensive description of the tax rules
applicable to the Company.
Tax Bad Debt Reserve. Prior to 1996, savings institutions such as the
Association which meet certain definitional tests primarily relating to their
assets and the nature of their business ("qualifying thrifts") were permitted
to establish a reserve for bad debts and to make annual additions thereto,
which additions, within specified formula limits, were deducted in arriving at
their taxable income. The Association's deduction with respect to "qualifying
loans," generally loans secured by certain interests in real property, was
computed using the Association's actual loss experience, or 8% of the
Association's taxable income. Use of the percentage of taxable income method
of calculating its deductible addition to its loss reserve had the effect of
reducing the maximum marginal rate of federal tax on the Association's income
to 31.28%, exclusive of any minimum or environmental tax, as compared to the
general maximum corporate federal income tax rate of 34%.
21
Pursuant to certain provisions appended to the Small Business Job Protection
Act signed into law in August 1996 (the "Act"), the above-described bad debt
deduction rules available to thrifts such as the Association have been
repealed. Under the Act, the Association has changed its method of accounting
for bad debts from the reserve method formerly permitted under section 593 of
the Internal Revenue Code of 1986, as amended (the "Code") to the "specific
charge-off" method. Under the specific charge-off method, which is governed by
section 166 of the Code and the regulations thereunder, tax deductions may be
taken for bad debts only if loans become wholly or partially worthless.
Although the Act generally requires that qualifying thrifts recapture (i.e.,
include in taxable income) over a six-year period a portion of their existing
bad debt reserves equal to their "applicable excess reserves," the Association
does not have applicable excess reserves subject to recapture. However, the
Association's tax bad debt reserve balance of approximately $10.9 million as
of June 30, 1997 will, in future years, be subject to recapture in whole or in
part upon the occurrence of certain events, such as a distribution to
stockholders in excess of the Association's current and accumulated earnings
and profits, a redemption of shares, or upon a partial or complete liquidation
of the Association. The Association does not intend to make distributions to
stockholders that would result in recapture of any portion of its bad debt
reserve. Since management intends to use the reserve only for the purpose for
which it was intended, a deferred tax liability of approximately $3.7 million
has not been recorded.
Distributions. To the extent that the Association makes "non-dividend
distributions" to stockholders that are considered to result in distributions
from the tax bad debt reserve for losses on qualifying real property, then an
amount based on the amount distributed will be included in the Association's
taxable income. Non-dividend distributions include distributions in excess of
the Association's current and accumulated earnings and profits, distributions
in redemption of stock and distributions in partial or complete liquidation.
However, dividends paid out of the Association's current or accumulated
earnings and profits, as calculated for federal income tax purposes, will not
be considered to result in a distribution from the Association's tax bad debt
reserves. Thus, any dividends to the Company that would reduce amounts
appropriated to the Association's tax bad debt reserves and deducted for
federal income tax purposes may create a tax liability for the Association.
The amount of additional taxable income created from a distribution from the
tax bad debt reserve is an amount that when reduced by the tax attributable to
the income is equal to the amount of the distribution. The result is to tax
distributions from the tax bad debt reserve at approximately 51%. See "--
Regulation and Supervision--Savings and Loan Holding Company Regulation--
Payment of Dividends and Other Capital Distributions by Association" and
"Market for the Registrant's Common Equity and Related Stockholder Matters"
for limits on the payment of dividends of the Association. The Association
does not intend to pay dividends that would result in a recapture of any
portion of its tax bad debt reserve.
The date of the Company's last complete Internal Revenue Service (IRS) tax
audit was December, 1985. There is a three-year statute of limitations for
federal tax filings. Tax years 1994 through 1996 are considered open tax years
for IRS audit purposes.
Dividends Received Deduction and Other Matters. The Company may exclude from
its income 100% of dividends received from the Association as a member of the
same affiliated group of corporations. The corporate dividends received
deduction is generally 70% in the case of dividends received from unaffiliated
corporations with which the Company and the Association will not file a
consolidated tax return, except that if the Company and the Association own
more than 20% of the stock of a corporation distributing a dividend 80% of any
dividends received may be deducted.
STATE AND LOCAL TAXATION
State of California. The California franchise tax rate applicable to the
Company equals the franchise tax rate applicable to corporations generally
plus an "in lieu" rate approximately equal to personal property taxes and
business license taxes paid by such corporations (but not generally paid
22
by banks or financial corporations such as the Association); however, the
total tax rate currently applicable to the Company cannot exceed 11.30% for
the 1997 calendar year. Under California regulations, bad debt deductions are
available in computing California franchise taxes using a three or six year
weighted average loss experience method. The Company and its California
subsidiary file California state franchise tax returns on a combined basis.
The Company is currently under examination by the California Franchise Tax
Board for tax years ending December 1990-1993. No adjustments have been
proposed at this time.
Delaware Taxation. As a Delaware holding Company not earning income in
Delaware, the Company is exempted from Delaware Corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
REGULATION AND SUPERVISION
GENERAL
The Association is a federally chartered savings association, a member of
the FHLB of San Francisco, and is subject to regulation by the OTS and the
FDIC. The Association's deposits are insured by the FDIC through the SAIF. As
a result of its ownership of the Association, the Company is a savings and
loan holding company subject to regulation by the OTS. As described in more
detail below, statutes and regulations applicable to the Association govern
such matters as the investments and activities in which the Association can
engage; the amount of capital the Association must hold; mergers and changes
of control; establishment and closing of branch offices; and dividends payable
by the Association. Statutes and regulations applicable to the Company govern
such matters as changes of control of the Company and transactions between the
Association and the Company.
The Company and the Association are subject to the examination, supervision
and reporting requirements of the OTS, their primary federal regulator,
including a requirement for the Association of at least one full scope, on-
site examination every year. The Director of the OTS is authorized to impose
assessments on the Association to fund OTS operations, including the cost of
examinations. The Association is also subject to examination, when deemed
necessary, and supervision by the FDIC, and the FDIC has "back-up" authority
to take enforcement action against the Association if the OTS fails to take
such action after a recommendation by the FDIC. The FDIC may impose
assessments on the Association to cover the cost of FDIC examinations. The
FDIC is no longer able to conduct separate examinations of the Association
except in exigent circumstances. In addition, the Association is subject to
regulation by the Board of Governors of the Federal Reserve System ("FRB")
with respect to certain aspects of its business. The descriptions set forth
below and elsewhere in this document of the statutes and regulations that are
applicable to the Company do not purport to be a complete description of such
statutes and regulations and their effects on the Company, or to identify
every statute and regulations that may apply to the Company.
ACTIVITIES RESTRICTIONS
Qualified Thrift Lender Test. The qualified thrift lender ("QTL") test
requires that, in at least nine out of every twelve months, at least 65% of a
savings bank's "portfolio assets" must be invested in a limited list of
"qualified thrift investments," primarily investments related to housing
loans. If the Association fails to satisfy the QTL test and does not requalify
as a QTL within one year, the Company must register and be regulated as a bank
holding company, and the Association must either convert to a commercial bank
charter or become subject to restrictions on branching, business activities
and dividends as if it were a national bank. At June 30, 1997, approximately
92.45% of the Association's portfolio assets constituted qualified thrift
investments and the Association met the QTL test each month in fiscal 1997.
23
Investment and Loan Limits. In general, federal savings institutions such as
the Association may not invest directly in equity securities, debt securities
that are not rated investment grade, or real estate, other than real estate
used for the institution's offices and related facilities. Indirect equity
investment in real estate through a subsidiary is permissible, but subject to
limitations based on the amount of the institution's assets, and the
institution's investment in such a subsidiary must be deducted from regulatory
capital in full or (for certain subsidiaries owned by the institution prior
toApril 12, 1989) phased out of capital by no later than July 1, 1996.
Loans by a savings institution to a single borrower are generally limited to
15% of the institution's "unimpaired capital and unimpaired surplus," which is
similar but not identical to total capital. Aggregate loans by the Association
that are secured by nonresidential real property are generally limited to 400%
of the institution's total capital. Commercial loans not secured by real
property may not exceed 10% of the Association's total assets, and consumer
loans may not exceed 35% of the Association's total assets. At June 30, 1997,
the Association was in compliance with the above investment limitations.
Activities of Subsidiaries. A savings institution seeking to establish a new
subsidiary, acquire control of an existing company or conduct a new activity
through an existing subsidiary must provide 30 days prior notice to the FDIC
and OTS. A subsidiary of the Association may be able to engage in activities
that are not permissible for the Association directly, if the OTS determines
that such activities are reasonably related to the Association's business, but
the Association may be required to deduct its investment in such a subsidiary
from capital. The OTS has the power to require a savings institution to divest
any subsidiary or terminate any activity conducted by a subsidiary that the
OTS determines to be a serious threat to the financial safety, soundness or
stability of such savings institution or to be otherwise inconsistent with
sound banking practices.
Safety and Soundness Standards. The Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") required the OTS to prescribe for savings
associations minimum acceptable operational and managerial standards, and
standards for asset quality, earnings, and stock valuation. The standards
cover internal controls, loan documentation, credit underwriting, interest
rate exposure, asset growth, and employee compensation. Any institution that
fails to meet the OTS regulations promulgated under the safety and soundness
requirements must submit an acceptable plan for compliance or become subject
to the ability of the OTS, in its discretion, to impose operational
restrictions similar to those that would apply to a failure to meet minimum
capital requirements as discussed below.
Real Estate Lending Standards. The OTS and the other federal banking
agencies have adopted regulations which require institutions to adopt and at
least annually review written real estate lending policies. The lending
policies must include diversification standards, underwriting standards
(including loan-to-value limits), loan administration procedures, and
procedures for monitoring compliance with the policies. The policies must
reflect consideration of guidelines adopted by the banking agencies that
discuss certain loan-to-value and percentage of capital limits.
DEPOSIT INSURANCE
Deposit Insurance Premium Assessments. Pursuant to FDICIA, the FDIC has
established a risk-based system for setting deposit insurance assessments on
BIF and SAIF deposits. Under the risk-based assessment system, an
institution's insurance assessment will vary depending on the level of capital
the institution holds and the degree to which it is the subject of supervisory
concern to the FDIC. During most of calendar 1996, the assessment rate for
SAIF deposits varied from 0.23% of covered deposits for well-capitalized
institutions that were deemed to have no more than a few minor weaknesses, to
0.31% of covered deposits for less than adequately capitalized institutions
that posed substantial supervisory concern. The Association's assessment rate
was 0.23%. During this time, the lowest assessment rate for BIF deposits was
$2,000 per year for well-capitalized institutions that were
24
deemed to have no more than a few minor weaknesses, to 0.27% of covered
deposits for less than adequately capitalized institutions that posed
substantial supervisory concern.
This premium structure provided institutions whose deposits were exclusively
or primarily BIF-insured (such as almost all commercial banks) certain
competitive advantages over institutions whose deposits were primarily SAIF-
insured. The BIF assessment rates were lower than the SAIF rates because the
BIF had reached its designated reserve ratio of 1.25% and the SAIF had not. In
addition, the SAIF was responsible for making interest payments on debt
incurred to provide funds to the ESLIC ("FICO Debt").
The Deposit Insurance Funds Act of 1996 ("DIFA") required institutions with
SAIF-insured deposits to pay a special assessment designed to increase the
SAIF's reserves to the required 1.25% of insured deposits. During the quarter
ended September 30, 1996, the Association accrued $3.1 million in expense for
this special assessment and paid this amount during the second quarter of
fiscal 1997. Because the reserves of both the SAIF and the BIF now equal or
exceed the required minimum amount and FICO Debt assessments are collected
separately from deposit insurance assessments, SAIF-insured and BIF-insured
deposits are assessed for deposit insurance according to the same schedule.
This eliminated the disparity between deposit insurance assessments for SAIF-
insured deposits and BIF-insured deposits discussed above. The Association is
now assessed at the minimum deposit insurance assessment rate.
DIFA also altered the obligation to make interest payments on the FICO Debt
so that assessments to collect the necessary funds are imposed separately from
the deposit insurance premium and are now assessed on BIF-insured deposits,
although at a lower rate, as well as on SAIF-insured deposits. Currently, the
Association's FICO Debt assessment rate is 0.0645%. Until December 31, 1999
or, if earlier, the date on which the last savings institution ceases to
exist, SAIF deposits are assessed to pay interest on the FICO Debt at five
times the rate at which BIF deposits are assessed to pay such interest.
Institutions whose deposits are exclusively or primarily BIF-insured (such as
almost all commercial banks) therefore have certain competitive advantages
over institutions whose deposits are primarily SAIF-insured, although the
extent of the advantage is less than the deposit insurance premium advantage
which existed prior to the enactment of DIFA. Currently, all of the
Association's deposits are SAIF-insured. See "Business--Federal Taxation" for
a discussion of recent changes concerning bad debt deductions historically
available to qualifying thrift institutions.
FIRREA CAPITAL REQUIREMENTS
The OTS's capital regulations, as required by FIRREA, include three separate
minimum capital requirements for the savings institution industry--a "tangible
capital requirement," a "leverage limit" (also referred to as the "core
capital ratio"), and a "risk-based capital requirement." These capital
standards must be no less stringent than the capital standards applicable to
national banks. In addition, institutions whose exposure to interest rate risk
is deemed to be above normal are required to deduct a portion of such exposure
in calculating their risk-based capital requirements. The OTS also has the
authority, after giving the affected institution notice and an opportunity to
respond, to establish individual minimum capital requirements ("IMCR") for a
savings institution which are higher than the industry minimum requirements,
upon a determination that an IMCR is necessary or appropriate in light of the
institution's particular circumstances. Savings institutions that do not meet
their capital requirements are subject to a number of sanctions similar to but
less restrictive than the sanctions under the Prompt Corrective Action system
described below, and to a requirement that the OTS be notified of any changes
in the institution's directors or senior executive officers.
The three industry minimum capital requirements are as follows:
Tangible capital of at least 1.5% of adjusted total assets. Tangible
capital is composed of (1) an institution's common stock, perpetual non-
cumulative preferred stock, and related earnings or surplus (excluding
unrealized gains and losses on securities classified as available-for-
sale), (2) certain nonwithdrawable accounts and pledged deposits and
(3) the amount, if any, of equity
25
investment by others in the institution's subsidiaries, after deducting (a)
the institution's investments in and extensions of credit to subsidiaries
engaged as principal in activities not permissible for national banks, net
of any reserves established against such investments and (b) certain non-
qualifying intangible assets. Deferred tax assets whose realization depends
on the institution's future taxable income or on the institution's tax
planning strategies must also be deducted from tangible capital to the
extent that such assets exceed the lesser of (1) 10% of core capital, or
(2) the amount of such assets that can be realized within one year, unless
such assets were reportable as of December 31, 1992, in which case no
deduction is required.
In general, adjusted total assets equal the institution's consolidated total
assets, minus any assets that are deducted in calculating the amount of
capital. At June 30, 1997, the Association's ratio of tangible capital to
adjusted total assets was 7.34%.
Core capital of at least 3% of adjusted total assets. Core capital
consists of tangible capital plus (1) qualifying intangibles such as
certain mortgage servicing rights and purchased credit card relationships
and (2) any core deposit premium in existence on March 4, 1994 whose
inclusion in core capital is grandfathered by the OTS. At June 30, 1997,
the Association's core capital ratio was 7.34%.
Total capital of at least 8% of risk-weighted assets. Total capital
includes both core capital and "supplementary" capital items deemed less
permanent than core capital, such as subordinated debt and general loan
loss allowances (subject to certain limits). At least half of total capital
must consist of core capital. Risk-weighted assets are determined by
multiplying each category of an institution's assets, including certain
assets sold with recourse and other off balance sheet assets, by an
assigned risk weight based on the credit risk associated with those assets,
and adding the resulting sums. The amount of risk-based capital, however,
that may be required to be maintained by the institution for recourse
assets cannot be greater than the total of the recourse liability. The four
risk-weight categories include zero percent for cash and government
securities, 20% for certain high-quality investments, 50% for certain
qualifying one-to-four family and multifamily mortgage loans and 100% for
assets (including past-due loans and real estate owned) that do not qualify
for preferential risk-weighting. At June 30, 1997, the Association's risk-
based capital ratio was 12.64%, and accordingly the Association exceeded
all three of the industry minimum capital requirements.
FDICIA required the OTS and the federal bank regulatory agencies to revise
their risk-based capital standards to ensure that those standards take
adequate account of interest-rate risk, concentration of credit risk, and
risks of nontraditional activities. The regulations of the OTS and the other
federal banking agencies provide that an institution may be required to hold
risk-based capital in excess of regulatory minimums to the extent that it is
determined either that (i) the institution has a high degree of exposure to
interest-rate risk, prepayment risk, credit risk, certain risks arising from
nontraditional activities or similar risks, or a high proportion of off-
balance sheet risk or (ii) the institution is not adequately managing these
risks. For this purpose, however, the agencies have stated that, in view of
the statutory requirements relating to permitted lending and investment
activities of savings institutions, the general concentration by such
institutions in real estate lending activities would not, by itself, be deemed
to constitute an exposure to concentration of credit risk that would require
greater capital levels.
26
PROMPT CORRECTIVE ACTION REQUIREMENTS
FDICIA required and the OTS has established five capital categories to
implement a "prompt corrective action" system. These categories are:
"well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized," and "critically undercapitalized."
An institution is treated as well capitalized if its risk-based capital
ratio is at least 10.0%, its ratio of core capital to risk-weighted assets
(the "Tier 1 risk-based capital ratio") is at least 6.0%, its leverage ratio
is at least 5.0%, and it is not subject to any order or directive by the OTS
to meet a specific capital level. At June 30, 1997, the Association had a
risk-based capital ratio of 12.64%, a Tier 1 risk-based capital ratio of
11.42%, and a core capital ratio of 7.34%, which qualified the Association for
the well-capitalized category. The Association's capital category under the
prompt corrective action system may not be an accurate representation of the
Association's overall financial condition or prospects.
An institution will be adequately capitalized if its risk-based capital
ratio is at least 8.0%, its Tier 1 risk-based capital ratio is at least 4.0%,
and its core capital ratio is at least 4.0% (3.0% if the institution receives
the highest rating on the CAMEL financial institutions rating system). An
institution whose capital does not meet the amounts required in order to be
adequately capitalized will be treated as undercapitalized. If an
undercapitalized institution's capital ratios are less than 6.0%, 3.0%, or
3.0% respectively, it will be treated as significantly undercapitalized.
Finally, an institution will be treated as critically undercapitalized if its
ratio of "tangible equity" (core capital plus cumulative preferred stock minus
intangible assets other than supervisory goodwill and purchased mortgage
servicing rights) to adjusted total assets is equal to or less than 2.0%.
An institution that is undercapitalized or lower must submit a capital
restoration plan to the OTS within 45 days after becoming undercapitalized,
and the plan can be accepted only if the institution's performance under the
plan is guaranteed, up to a maximum of 5% of the institution's assets, by
every company that controls the institution. An institution that is
undercapitalized is also subject to mandatory stringent limits on expansion
and on the ability to make capital distributions, and is prohibited from
accepting, renewing or rolling over brokered deposits and certain benefit plan
deposits. In addition, an undercapitalized institution is subject to numerous
other restrictions which the OTS may impose in its discretion, including
restrictions on transactions with affiliates and interest rates, and to the
ability of the OTS to order a sale of the institution, the replacement of
directors and management, and the appointment of a conservator or receiver. A
significantly undercapitalized institution is subject to additional sanctions
and a critically undercapitalized institution generally must be placed into
conservatorship or receivership.
ENFORCEMENT
All depository institutions, including savings associations, and
"institution affiliated parties" such as directors, officers, employees,
agents and controlling stockholders of depository institutions, including
holding companies, are subject to regulatory agency enforcement authority. An
institution or institution-affiliated party may be subject to a three-tier
penalty regime that ranges from a maximum penalty of $5,000 per day for a
simple violation to a maximum penalty of $1 million per day for certain
knowing violations including the failure to submit, or submission of
incomplete, false or misleading, reports. An institution-affiliated party may
also be subject to loss of voting rights with respect to the stock of
depository institutions.
SAVINGS AND LOAN HOLDING COMPANY REGULATION
Activities of the Company. As a savings and loan holding company, the
Company must file periodic reports with the OTS, and is subject to OTS
examination. As a savings and loan holding
27
company that controls only one savings association, the Company generally is
not restricted under existing laws as to the types of business activities in
which it may engage, provided that the Association continues to be a QTL. See
"Regulation--Activities Restrictions--QTL Test" for a discussion of the QTL
requirements. If the Association ceases to be a QTL, or if the Company were to
acquire another savings association and hold such association as a subsidiary
separate from the Association, the Company would be subject to extensive
restrictions on the types of business activities in which it could engage.
Such restrictions would limit the Company to specified finance-, real estate-
and insurance-related activities.
The Home Owners' Loan Act ("HOLA") prohibits a savings and loan holding
company such as the Company, directly or indirectly, or through one or more
subsidiaries, from (a) acquiring control of another savings institution or
savings and loan holding company without prior written approval of the OTS;
(b) acquiring or retaining, with certain exceptions, more than 5% of a non-
subsidiary savings institution or a non-subsidiary savings and loan holding
company; or (c) acquiring or retaining control of a depository institution
that is not insured by the FDIC. In evaluating applications by holding
companies such as the Company to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and
competitive factors.
Affiliate and Insider Transactions. The ability of the Company and its non-
depository subsidiaries to deal with the Association is limited by the
affiliate transaction rules, including Sections 23A and 23B of the Federal
Reserve Act which also govern BIF-insured banks. With very limited exceptions,
these rules require that all transactions between the Association and an
affiliate must be on arms' length terms. The term "affiliate" covers any
company that controls or is under common control with the Association, but
does not include individuals and generally does not include the Association's
subsidiaries.
Under Section 23A and section 11 of HOLA, specific restrictions apply to
transactions in which the Association provides funding to its affiliates: the
Association may not purchase the securities of an affiliate, make a loan to
any affiliate that is engaged in activities not permissible for a bank holding
company, or acquire from an affiliate any asset that has been classified, a
nonaccrual loan, a restructured loan, or a loan that is more than 30 days past
due. As to affiliates engaged in bank holding company-permissible activities,
the aggregate of (a) loans, guarantees, and letters of credit provided by the
savings bank for the benefit of any one affiliate, and (b) purchases of assets
by the savings bank from the affiliate, may not exceed 10% of the savings
bank's capital stock and surplus (20% for the aggregate of permissible
transactions with all affiliates). All loans to affiliates must be secured by
collateral equal to at least 100% of the amount of the loan (130% if the
collateral consists of equity securities, leases or real property).
Loans by the Association to its directors, executive officers, and 10%
shareholders of the Association, the Company, or the Company's subsidiaries
(collectively, "insiders"), or to a corporation or partnership that is at
least 10% owned by an insider (a "related interest") are subject to limits
separate from the affiliate transaction rules. All loans to insiders and their
related interests must be underwritten and made on non-preferential terms;
loans in excess of $500,000 must be approved in advance by the Association's
Board of Directors; and the Association's total of such loans may not exceed
100% of the Association's capital. Loans by the Association to its executive
officers are subject to additional limits which are even more stringent.
Limits on Change of Control. Subject to certain limited exceptions, control
of the Association or the Company may only be obtained with the approval (or
in the case of an acquisition of control by an individual, the nondisapproval)
of the OTS, after a public comment and application review process. Under OTS
regulations defining "control," a rebuttable presumption of control arises if
an acquiring
28
party acquires more than 10% of any class of the Association or the Company
(or more than 25% of any class of stock, whether voting or non-voting) and is
subject to any "control factors" as defined in the regulation. Control is
conclusively deemed to exist if an acquirer holds more than 25% of any class
of voting stock of the Association or the Company, or has the power to control
in any manner the election of a majority of directors.
In addition, federal regulations governing conversions of mutual savings
institutions to the stock form of organization generally require an acquiror
to obtain prior OTS approval in order to acquire, or offer to acquire,
directly or indirectly, more than 10% of any equity security of a savings
institution within three years of the savings institution's conversion to
stock form. Because the Association converted from the mutual to the stock
form on December 30, 1993, this limitation applied until December 30, 1996 to
acquisitions or offers to acquire, directly or indirectly, more than 10% of
the stock of the Association.
Payment of Dividends and Other Capital Distributions by Association. The
payment of dividends, stock repurchases, and other capital distributions by
the Association to the Company is subject to regulation by the OTS. Currently,
30 days prior notice to the OTS of any capital distribution is required. The
OTS has promulgated a regulation that measures a savings institution's ability
to make a capital distribution according to the institution's capital
position. The rule establishes "safe-harbor" amounts of capital distributions
that institutions can make after providing notice to the OTS, but without
needing prior approval. Institutions can distribute amounts in excess of the
safe harbor only with the prior approval of the OTS. If an institution does
not meet its capital requirements, the prior approval of the OTS is necessary
before paying a capital distribution. The OTS retains discretion to subject
institutions that meet their capital requirements to the more stringent
capital distribution rules applicable to institutions with less capital if the
OTS notifies the institution that it is in need of more than normal
supervision. The OTS retains the authority to prohibit any capital
distribution otherwise authorized under its regulations if the OTS determines
that the distribution would constitute an unsafe or unsound practice.
For institutions such as the Association that meet their capital
requirements, the safe harbor capital distribution amount is the greater of
(a) 75% of net income for the prior four quarters, or (b) the sum of (1) the
current year's net income and (2) the amount that causes the excess of the
institution's total capital-to-risk-weighted assets ratio over 8% to be only
one-half of such excess at the beginning of the current year. The OTS has
proposed an amendment to its capital distribution regulation to replace the
current approach summarized above with one that would allow an institution to
make capital distributions that would not result in the institution falling
below the prompt corrective action "adequately capitalized" capital category.
In connection with a conversion from mutual to stock form, a savings
institution is required to establish a liquidation account in an amount equal
to the converting institution's net worth as of a practicable date prior to
the conversion. The liquidation account is maintained for the benefit of
certain eligible accountholders maintaining accounts at or prior to the date
of conversion. In the event of a complete liquidation of the converted savings
institution (and only in such event), each such accountholder is entitled to
receive a distribution from the liquidation account equal to the then current
adjusted balance of the holder's savings accounts with the savings
institution.
Additionally, as of June 30, 1997, the Association had a tax bad debt
reserve balance of approximately $10.9 million. Any distribution by the
Association to the Company that exceeds the Association's current or
accumulated earnings and profits as calculated for federal income tax purposes
would be treated as a distribution of the bad debt reserve and would be
subject to recapture taxes of up to 51%. See "Business--Federal Taxation"
regarding recently enacted changes relating to bad debt reserve recapture. The
Association does not intend to make distributions to stockholders that would
result in recapture of any portion of its bad debt reserve. Since management
intends to use the reserve only for the purpose for which it was intended, a
deferred tax liability of approximately $3.7 million has not been recorded.
29
Enforcement. Whenever the OTS has reasonable cause to believe that the
continuation by a savings and loan holding company of any activity or of
ownership or control of any non FDIC-insured subsidiary constitutes a serious
risk to the financial safety, soundness, or stability of a savings and loan
holding company's subsidiary savings institution and is inconsistent with the
sound operation of the savings institution, the OTS may order the holding
company, after notice and opportunity for a hearing, to terminate such
activities or to divest such noninsured subsidiary. FIRREA also empowers the
OTS, in such a situation, to issue a directive without any notice or
opportunity for a hearing, which directive may (i) limit the payment of
dividends by the savings institution, (ii) limit transactions between the
savings institution and its holding company or its affiliates, and (iii) limit
any activity of the association that creates a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings institution.
In addition, FIRREA includes savings and loan holding companies within the
category of person designated as "institution-affiliated parties." An
institution-affiliated party may be subject to significant penalties and/or
loss of voting rights in the event such party took any action for or toward
causing, bringing about, participating in, counseling, or aiding and abetting
a violation of law or unsafe or unsound practice by a savings institution.
CLASSIFICATION OF ASSETS
Savings institutions are required to classify their assets on a regular
basis, to establish appropriate allowances for losses and report the results
of such classification quarterly to the OTS. A savings institution is also
required to set aside adequate valuation allowances to the extent that an
affiliate possesses assets posing a risk to the institution, and to establish
liabilities for off-balance sheet items, such as letters of credit, when loss
becomes probable and estimable. The OTS has the authority to review the
institution's classification of its assets and to determine whether and to
what extent (a) additional assets must be classified, and (b) the
institution's valuation allowances must be increased.
Troubled assets are classified into one of three categories as follows:
Substandard Assets. An asset is considered "Substandard" if it is
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. Prudent general valuation
allowances are required to be established for such assets.
Doubtful Assets. Assets classified as "Doubtful" have all of the
weaknesses inherent in those classified "Substandard" with the added
characteristic that the weaknesses present make "collection or liquidation
in full," on the basis of currently existing facts, conditions, and values,
"highly questionable and improbable." Prudent general valuation allowances
are required to be established for such assets.
Loss Assets. Assets classified as "Loss" are those considered
"uncollectible" and of such little value that their continuance as bankable
assets is not warranted.
General valuation allowances for loan and lease losses are included within
regulatory capital for certain purposes and up to certain limits, while
specific allowances and other general allowances are not included at all.
The OTS and the other federal banking agencies have adopted a statement of
policy regarding the appropriate levels of general valuation allowances for
loan and lease losses that institutions should maintain. Under the policy
statement, examiners will generally accept management's evaluation of adequacy
of general valuation allowances for loans and lease losses if the institution
has maintained effective systems and controls for identifying and addressing
asset quality problems, analyzed in a reasonable manner all significant
factors that affect the collectibility of the portfolio, and established an
30
acceptable process for evaluating the adequacy of general valuation
allowances. However, the policy statement also provides that OTS examiners
will review management's analysis more closely if general valuation allowances
for loan and lease losses do not equal at least the sum of (a) 15% of assets
classified as Substandard, (b) 50% of assets classified as Doubtful, and (c)
for the portfolio of unclassified loans and leases, an estimate of credit
losses over the upcoming twelve months based on the institution's average rate
of net charge-offs over the previous two or three years on similar loans,
adjusted for current trends and conditions.
COMMUNITY REINVESTMENT ACT
The Community Reinvestment Act ("CRA") requires each savings institution, as
well as other lenders, to identify the communities served by the institution's
offices and to identify the types of credit the institution is prepared to
extend within such communities. The CRA also requires the OTS to assess the
performance of the institution in meeting the credit needs of its community
and to take such assessment into consideration in reviewing applications for
mergers, acquisitions, and other transactions. An unsatisfactory CRA rating
may be the basis for denying such an application.
In connection with its assessment of CRA performance, the OTS assigns a
rating of "outstanding," "satisfactory," "needs to improve," or "substantial
noncompliance." Based on an examination conducted during 1996, the Association
was rated outstanding.
The OTS and the other federal banking agencies adopted substantive
amendments to their CRA regulations on May 4, 1995, effective July 1, 1995.
Evaluation under the amended regulations becomes mandatory on July 1, 1997,
while related data collection and reporting requirements are effective on
January 1, 1996 and January 1, 1997, respectively. The regulations replace the
current assessment system, which is based on the adequacy of the processes
that an institution has established to comply with the CRA, with a new system
based on the institution's performance in making loans and investments and
maintaining branches in low- and moderate-income areas within the communities
that it serves.
FEDERAL HOME LOAN BANK SYSTEM
The Federal Home Loan Banks provide a credit facility for member
institutions. As a member of the FHLB of San Francisco, the Association is
required to own capital stock in the FHLB of San Francisco in an amount at
least equal to the greater of 1% of the aggregate principal amount of its
unpaid residential loans, residential purchase contracts and similar
obligations at the end of each calendar year, assuming for such purposes that
at least 30% of its assets were residential mortgage loans, or 5% of its
advances from the FHLB of San Francisco. At June 30, 1997 the Association was
in compliance with this requirement. Furthermore, FHLB advances must be
collateralized with certain types of assets. Accordingly, the Association has
pledged certain loans to the FHLB of San Francisco as collateral for its
advances. See "--Pending Legislation," below regarding legislation proposing
changes in the operation of the Federal Home Loan Bank system.
REQUIRED LIQUIDITY
OTS regulations require savings institutions to maintain, for each calendar
month, an average daily balance of liquid assets (including cash, certain time
deposits, bankers' acceptances and specified United States government, state
and federal agency obligations) equal to at least 5% of the average daily
balance of its net withdrawable accounts plus short-term borrowings during the
preceding calendar month. The OTS may change this liquidity requirement from
time to time to an amount within a range of 4% to 10% of such accounts and
borrowings depending upon economic conditions and the deposit flows of member
institutions, and may exclude from the definition of liquid assets any item
other than cash and the balances maintained in satisfaction of FRB reserve
requirements, described below.
31
OTS regulations also require each member institution to maintain, for each
calendar month, an average daily balance of short-term liquid assets
(generally those having maturities of 12 months or less) equal to at least 1%
of the average daily balance of its net withdrawal accounts plus short-term
borrowings during the preceding calendar month. Monetary penalties may be
imposed for failure to meet liquidity ratio requirements. The Association's
average liquidity and average short-term liquidity ratios exceeded the
applicable requirements at all times during fiscal 1997.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board requires savings institutions to maintain reserves
against certain of their transaction accounts (primarily deposit accounts that
may be accessed by writing unlimited checks). For the calculation period
including June 30, 1997, the Association was not required to maintain reserves
with the Federal Reserve Board because it maintains certain levels of cash on
hand at its branches and with the requisite custodian. If balances are
maintained to meet the reserve requirements imposed by the Federal Reserve
Board, they do not earn interest but may be used to satisfy the Association's
liquidity requirements discussed above.
As a creditor and a financial institution, the Association is subject to
certain regulations promulgated by the Federal Reserve Board, including,
without limitation, Regulation B (Equal Credit Opportunity Act), Regulation D
(Reserves), Regulation E (Electronic Funds Transfers Act), Regulation F
(limits on exposure to any one correspondent depository institution),
Regulation Z (Truth in Lending Act), Regulation CC (Expedited Funds
Availability Act), and Regulation DD (Truth in Savings Act). As creditors of
loans secured by real property and as owners of real property, financial
institutions, including the Association, may be subject to potential liability
under various statutes and regulations applicable to property owners,
including statutes and regulations relating to the environmental condition of
the property.
PENDING LEGISLATION
Legislation enacted in 1996 provides that the BIF and SAIF will merge on
January 1, 1999, if there are no savings associations, as defined, in
existence on that date. Pursuant to that legislation, the Department of
Treasury in May 1997 recommended in a report to Congress that the separate
charters for thrifts and banks be abolished. Various proposals to eliminate
the federal thrift charter, create a uniform financial institutions charter,
conform holding company regulation and abolish the OTS have been introduced in
Congress. During the current session of Congress, the House Committee on
Banking and Financial Services has considered and reported H.R. 10 ("H.R.
10"), the Financial Services Competition Act of 1997, including Title III, the
"Thrift Charter Transition Act of 1997" ("Title III"). In addition, the House
Subcommittee on Finance and Hazardous Materials of the Commerce Committee on
September 15, 1997, released a substitute for H.R. 10 (the "Substitute"),
which substantially adopts Title III with certain exceptions.
Savings Association Amendments. Title III will require federal savings
associations to convert to a bank within two years of enactment. On the
earlier of January 1, 2000, or two years after the date of enactment, the BIF
and SAIF will merge. Two years after enactment, the HOLA will be repealed and
the OTS will be combined with the Office of the Comptroller of the Currency.
Converted federal thrifts generally will retain all present powers and be
permitted to continue to engage in any activity, including the holding of any
asset, lawfully conducted on the date prior to enactment and to retain all
branches established or pending at enactment The Substitute would grandfather
all activities conducted at enactment, but otherwise limit the converted
institution to bank activities.
Savings and Loan Holding Company Amendments. Under H.R. 10, a holding
companies for a savings association converted to a bank generally will become
subject to the same regulation as a bank holding company, unless it opts to
operate under a grandfather provision for former savings and
32
loan holding companies. Title III permits grandfathered companies to establish
affiliations with any type of company and to acquire additional insured
depository institutions, as long as any acquired depository institution is
merged into its converted savings association and such institution continues
to comply with both the qualified thrift lender test and certain asset and
investment limitations to which it was subject as a federal savings
association. Such a converted holding company would be subject to the same
capital requirements (if any) applicable under OTS regulation if it were a
savings and loan holding company on June 19, 1997, and for three years after
conversion would be subject to substantially similar regulation, reporting,
and examination as implemented by the OTS as of January 1, 1997. The
Substitute parallels Title III but includes a far more limited grandfathering.
It would grandfather only affiliations established (or applied for) as of
September 15, 1997, and only activities conducted as of date of enactment. It
would generally bar acquisition of any other bank after enactment, with
certain limited exceptions.
Federal Home Loan Bank Amendments. H.R. 10 also makes significant changes in
the operation of the Federal Home Loan Bank system, including the types of
stock that may be issued by Federal Home Loan Banks ("FHL Banks") to members
and borrowers and FHL Bank capitalization, management, investments and
lending. Under H.R. 10, effective January 1, 1999, the FHL Bank Act would be
amended to permit federal savings associations to be voluntary members and
stockholders of an FHL Bank.
The Company and the Association are unable to predict whether H.R. 10 or any
other such legislation will be enacted, what provisions any enacted
legislation may contain, or the extent to which such legislation would effect
their operations.
33
ITEM 2. PROPERTIES.
At June 30, 1997, the Company conducted its business through an
administrative office located in Whittier and eight retail full service branch
offices. The Company believes that its current facilities are adequate to meet
the present and immediately foreseeable needs of the Company.
NET BOOK VALUE OF
ORIGINAL PROPERTY OR
DATE DATE OF LEASEHOLD
LEASED OR LEASED OR LEASE IMPROVEMENTS AT
LOCATION OWNED ACQUIRED EXPIRATION JUNE 30, 1997
-------- ------------- --------- ---------- -----------------
7021 Greenleaf Avenue Owned 7/65 None $ 913,412
Whittier, CA 90602
(Administration)
7355 Greenleaf Avenue Owned 8/18/85 None $1,237,779
Whittier, CA 90608
(Main Office)
15335 Whittier Blvd. Owned/Bldg 4/1/70 None $ 108,542
Whittier, CA 90603 Leased/Land 3/31/05
(Branch)
401 E. Whittier Blvd. Owned 12/72 None $ 343,505
La Habra, CA 90631
(Branch)
220 S. State College Leased/Bldg/ 1/31/92 12/31/02 $ 126,898
Blvd. Common Area
Brea, CA 92821
(Branch)
1701 N. Euclid Avenue Owned/Bldg 7/6/76 None $ 96,892
Fullerton, CA 92835 Leased/Land 11/30/97
(Branch)
12333 S. La Mirada Blvd. Owned/Bldg 1/31/92 None $ 239,947
La Mirada, CA 90638 Leased/Land 7/9/01
(Branch)
3160 Colima Road Leased 1/17/92 12/31/99 $ 101,676
Hacienda Heights, CA
91745
(Branch)
1921 W. Imperial Hwy. Leased/Office 12/1/94 11/30/01 $ 40,783
Suite A
La Habra, CA 90631
(Branch)
12525 Beverly Blvd. Owned 2/27/86 None $ 139,546
Whittier, CA 90601
(Training Center)
Wardman and Comstock Leased/Land 1/2/70 Month --
Whittier, CA 90602 to
(Parking Lot) Month
34
ITEM 3. LEGAL PROCEEDINGS.
The Company is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business. Such
routine legal proceedings in the aggregate are believed by management to be
immaterial to the Company's financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No items were submitted to a vote of stockholders during the quarter ended
June 30, 1997.
ITEM 4A. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth the names and principal occupations of the
directors and executive officers of the Company as of June 30, 1997.
NAME PRINCIPAL OCCUPATION
---------------------------- -------------------------------------------------
DIRECTORS:
D. W. Ferguson Director Emeritus of the Company and of the
Association
J. L. Thomas Chairman of the Board of the Company and of the
Association
Frederic R. (Rick) McGill President and Chief Executive Officer of the
Company and of the Association
David T. Cannon D.T. Cannon Associates, a marketing and
management consulting firm; retired Western
Regional Director for Industrial Relations of
Eastman Kodak Company
Wayne L. Harvey C.P.A., Managing Partner, Harvey & Parmelee,
certified public
accountants
Edward L. Miller Partner, law firm of Bewley, Lassleben & Miller
David K. Leichtfuss President, Broadview Mortgage, a mortgage banking
company
Alfred J. Gobar President and Chairman, AJGA, Inc., an economics
consulting firm
EXECUTIVE OFFICERS(1):
D. W. Ferguson Director Emeritus
J. L. Thomas Chairman of the Board
Frederic R. (Rick) McGill President and Chief Executive Officer
Kathryn M. Hennigan Corporate Secretary and Senior Vice President,
Administrative Services
Harold L. Rams Senior Vice President, Lending of the Association
Karen A. Tannheimer Senior Vice President, Loan Service of the
Association
Robert C. Teeling Senior Vice President, Retail Banking of the
Association
Dwight L. Wilson Senior Vice President, Treasurer and Chief
Financial Officer
- --------
(1) Unless otherwise noted, the indicated principal occupation of the
executive officers is with the Company and the Association.
35
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's common stock is traded on the National Market System of the
National Association of Securities Dealers, Inc. Automated Quotation System
("NASDAQ-NMS") under the symbol QCBC. At September 18, 1997, the Company had
approximately 346 stockholders of record (not including the number of persons
or entities holding stock in nominee or street name through various brokerage
firms) and 4,673,102 outstanding shares of common stock. The following table
sets forth for the fiscal quarters indicated the range of high and low bid
information per share of the common stock of the Company as reported on the
NASDAQ-NMS as adjusted for the 25% stock dividend that took effect in May
1997.
FISCAL 1997 FISCAL 1996
----------------------------------- ----------------------------------
4TH 3RD 2ND 1ST 4TH 3RD 2ND 1ST
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- -------- -------- ------- -------- --------
High.... 17 9/16 16 13/32 15 13/64 12 11 51/64 11 1/2 11 19/64 11 45/64
Low..... 14 13/32 14 13/64 12 13/64 10 19/64 10 29/32 10 10 13/64 8 29/32
The Company's ability to pay dividends is limited by certain restrictions
generally imposed on Delaware corporations. In general, dividends may be paid
only out of a Delaware corporation's surplus, as defined in the Delaware
General Corporation Law, or net profits for the fiscal year in which the
dividend is declared and/or the preceding fiscal year. "Surplus" is defined
for this purpose as the amount by which a corporation's net assets (total
assets minus total liabilities) exceed the amount designated by the Board of
Directors of the corporation in accordance with Delaware law as the
corporation's capital. The Company may pay dividends out of funds legally
available therefor at such times as the Board of Directors determines that
dividend payments are appropriate, after considering the Company's net income,
capital requirements, financial condition, alternate investment options,
prevailing economic conditions, industry practices and other factors deemed to
be relevant at the time. The Company has not paid cash dividends in the past
and does not presently intend to pay cash dividends.
The Company's principal source of income in fiscal 1997 was interest from
investments. Dividends from the Association are a potential source of income
for the Company. The payment of dividends and other capital distributions by
the Association to the Company is subject to regulation by the OTS. Currently,
30 days' prior notice to the OTS is required before any capital distribution
is made. The OTS has promulgated a regulation that measures a savings
institution's ability to make a capital distribution according to the
institution's capital position. The rule establishes "safe-harbor" amounts of
capital distributions that institutions can make after providing notice to the
OTS, but without needing prior approval. Institutions can distribute amounts
in excess of the safe harbor only with the prior approval of the OTS. For
institutions such as the Association that meet their capital requirements, the
safe harbor amount is the greater of (a) 75% of net income for the prior four
quarters, or (b) the sum of (1) the current year's net income and (2) the
amount that causes the excess of the institution's total capital-to-risk-
weighted assets ratio over 8% to be only one-half of such excess at the
beginning of the current year. See "Business--Regulation and Supervision--
Savings and Loan Holding Company Regulation--Payment of Dividends and Other
Capital Distributions by Association."
The Association's ability to pay dividends to the Company is also subject to
restriction arising from the existence of the liquidation account established
upon the conversion of the Association from mutual to stock form in December
1993. The Association is not permitted to pay dividends to the Company if its
regulatory capital would be reduced below the amount required for the
liquidation account. See "Business--Regulation and Supervision--Savings and
Loan Holding Company Regulation--Payment of Dividends and Other Capital
Distributions by Association."
36
ITEM 6. SELECTED FINANCIAL DATA
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
AT OR FOR THE YEAR ENDED JUNE 30,
---------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SELECTED FINANCIAL DATA:
Total assets........... $801,402 $725,085 $641,173 $512,102 $487,020
Total liabilities...... 731,159 657,159 574,732 447,464 445,186
Loans receivable, net.. 644,964 607,672 537,478 450,527 413,567
Loans receivable held
for sale.............. 623 2,890 1,666 5,415 12,672
Investment
securities(1)......... 38,086 37,419 24,048 19,413 19,900
Mortgage-backed
securities(2)......... 74,139 41,175 39,993 14,709 13,573
Deposits............... 553,186 512,517 481,158 423,960 436,340
Federal Home Loan Bank
(FHLB) advances....... 157,700 135,300 63,950 13,000 2,000
Securities sold under
agreements to
repurchase............ -- 300 22,873 7,019 --
Stockholders' equity... 70,243 67,926 66,441 64,638 41,834
SELECTED OPERATING DATA:
Interest income........ $ 58,668 $ 52,646 $ 41,042 $ 35,286 $ 40,660
Interest expense....... 34,901 31,151 23,503 17,456 20,483
-------- -------- -------- -------- --------
Net interest income
before provision for
loan losses......... 23,767 21,495 17,539 17,830 20,177
Provision for loan
losses................ 3,001 2,103 998 10,200 3,657
-------- -------- -------- -------- --------
Net interest income
after provision for
loan losses......... 20,766 19,392 16,541 7,630 16,520
-------- -------- -------- -------- --------
Other income:
Loan servicing
charges and other
fees................ 1,828 1,629 1,490 1,675 1,035
Gain on sale of loans
held for sale....... 356 175 86 511 502
Commissions.......... 555 606 420 481 331
Other................ 30 79 84 189 166
-------- -------- -------- -------- --------
Total other income. 2,769 2,489 2,080 2,856 2,034
-------- -------- -------- -------- --------
Other expense:
Compensation and
employee benefits... 7,829 7,565 7,371 6,411 5,808
Occupancy, net....... 1,946 1,970 1,894 1,833 1,818
Federal Deposit
Insurance premiums.. 855 1,254 1,115 1,101 928
Data Processing...... 707 641 561 591 599
Other general and
administrative
expense............. 3,036 3,350 3,143 3,086 3,581
-------- -------- -------- -------- --------
Total general and
administrative
expense............. 14,373 14,780 14,084 13,022 12,734
Savings Association
Insurance Fund
special assessment.. 3,100 -- -- -- --
Real estate
operations, net..... 775 656 646 1,105 1,933
Amortization of core
deposit intangible.. 264 303 303 303 267
-------- -------- -------- -------- --------
Total other
expense........... 18,512 15,739 15,033 14,430 14,934
-------- -------- -------- -------- --------
Earnings (loss) before
income taxes.......... 5,023 6,142 3,588 (3,944) 3,620
Income taxes
(benefit)............. 2,203 2,573 1,267 (1,613) 1,394
-------- -------- -------- -------- --------
Net earnings (loss).... $ 2,820 $ 3,569 $ 2,321 $ (2,331) $ 2,226
======== ======== ======== ======== ========
Net earnings (loss)
per share............. $ 0.61(3) $ 0.74(3) $ 0.48(3) $ (0.53)(4) N/A
======== ======== ======== ======== ========
- --------
(1) Includes $1,432,000, $150,000, $470,000 and $10,508,000 of investment
securities available for sale at June 30, 1997, 1995, 1994 and 1993,
respectively. No investment securities were available for sale at June 30,
1996.
(2) Includes $5,997,000 and $6,660,000 of mortgage-backed securities available
for sale at June 30, 1994 and 1993, respectively. No mortgage-backed
securities were available for sale in 1997, 1996 or 1995.
(3) Earnings per share in 1997, 1996 and 1995 were calculated based on
weighted average shares outstanding of 4,633,813, 4,839,063 and 4,812,904,
respectively. The weighted average shares have been adjusted for all years
presented to reflect the 25% stock dividend paid on May 30, 1997.
(4) Earnings per share data has been calculated based on the Company's net
loss of $2,745,000 for the period December 30, 1993 through June 30, 1994
and 5,175,000 shares of common stock of the Company outstanding; the
Company completed its initial public stock offering and commenced
operations on December 30, 1993. The weighted average shares have been
adjusted for all years presented, to reflect the 25% stock dividend paid
on May 30, 1997.
37
AT OR FOR THE YEAR ENDED JUNE 30,
---------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
SELECTED FINANCIAL RATIOS AND OTHER
DATA:
PERFORMANCE RATIOS:
Return on average assets(1)......... 0.37% 0.53% 0.39% (0.46)% 0.45%
Return on average equity(1)......... 4.11 5.25 3.53 (4.13) 5.38
Average equity to average assets.... 9.02 10.04 11.18 11.24 8.32
Equity to total assets.............. 8.77 9.37 10.36 12.62 8.59
Interest rate spread during the
period(2).......................... 2.74 2.68 2.56 3.20 3.67
Net interest margin(3).............. 3.22 3.24 3.07 3.66 4.06
Average interest-earning assets to
average interest-bearing
liabilities........................ 110.17 111.47 112.31 113.02 109.17
General and administrative expense
to average assets.................. 1.89 2.18 2.39 2.59 2.56
Other expense to average assets(1).. 2.44 2.32 2.55 2.87 3.00
Dividend pay-out ratio.............. -- -- -- -- N/A
REGULATORY CAPITAL RATIOS:
Tangible capital.................... 7.34 7.67 8.11 9.88 8.25
Core capital........................ 7.34 7.67 8.11 9.88 8.25
Risk-based capital.................. 12.64 12.74 14.07 16.09 14.24
ASSET QUALITY RATIOS:
Nonperforming loans as a percentage
of gross loans(4).................. 1.33 1.71 2.01 3.21 2.22
Nonperforming assets as a percentage
of total assets(5)................. 1.31 1.81 2.06 3.39 2.49
GVA on loans as a percentage of
gross loans........................ 0.94 0.92 1.38 1.81 0.98
GVA on loans as a percentage of
total nonperforming loans.......... 70.91 53.52 68.97 56.47 44.07
Total GVA as a percentage of total
nonperforming assets(6)............ 60.95 44.92 59.61 50.13 35.93
NUMBER OF:
Deposit accounts.................... 37,603 37,628 38,000 35,298 37,337
Mortgage loans in portfolio......... 4,546 4,485 4,185 3,685 3,767
Mortgage loans serviced for others.. 1,717 1,710 1,661 1,919 2,022
Total full-service customer
facilities......................... 8 8 8 7 7
- --------
(1) Includes one-time special SAIF assessment of $3.1 million in fiscal 1997.
(2) The interest rate spread represents the difference between the weighted-
average rate on interest-earning assets and the weighted-average rate on
interest-bearing liabilities.
(3) The net interest margin represents net interest income as a percentage of
average interest-earning assets.
(4) Nonperforming loans are net of specific allowances and include nonaccrual
and troubled debt restructured loans. Gross loans include loans held for
sale.
(5) Nonperforming assets include nonperforming loans and REO.
(6) Total GVA includes loan and REO general valuation allowances.
38
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
At June 30, 1997 the Company had total assets of $801.4 million, total
deposits of $553.2 million and stockholders' equity of $70.2 million,
representing 8.77% of total assets. This compares to total assets of $725.1
million, total deposits of $512.5 and stockholders' equity of $67.9 million at
June 30, 1996. This represents a 10.53% increase in total assets and a 3.41%
increase in stockholders' equity during the 1997 fiscal year. All historical
earnings per share data herein reflect a 25% common stock dividend paid to
shareholders on May 30, 1997.
The Southern California economy and real estate markets in the Company's
primary lending area have shown improvement during the year, especially in
income property values. The Company's level of nonperforming assets declined
from June 30, 1996, both in dollars and as a percentage of total assets. The
Company currently includes nonaccrual loans 60 or more days past due (less any
specific allowances on these loans), troubled debt restructured loans and REO
in determining its level of nonperforming assets. Although many financial
institutions do not consider a loan nonperforming until it is 90 or more days
past due, the Company ceases to accrue interest after loan payments are
60 days past due in an effort to recognize problem assets sooner. At June 30,
1997, the Company reported $10.5 million in nonperforming assets in the
Company's portfolio compared to $13.1 million and $13.2 million at June 30,
1996 and 1995, respectively. The Company recorded provisions for loan losses
of $3.0 million for the year ended June 30, 1997 compared to $2.1 million and
$998,000 for the years ended June 30, 1996 and 1995, respectively. See
"Business--Allowances for Loan and Real Estate Losses."
PROBLEM ASSETS
Nonperforming assets have been reduced by more than 50% since the peak
levels following the Northridge earthquake in 1994. The Company's ratio of
nonperforming loans to total loans was 1.33%, 1.71%, and 2.01% at June 30,
1997, 1996, and 1995, respectively. The Company attributes the decrease in its
nonperforming loans primarily to the disposition of real estate acquired
through foreclosure. This includes some real estate properties damaged in the
Northridge earthquake in January 1994. Although the Company has been able to
reduce nonperforming assets over the last several quarters, there are no
assurances that nonperforming assets will not increase in the future resulting
in possible increases in provisions for loan losses.
RESULTS OF OPERATIONS
General. The Company reported net earnings of $2.8 million, $0.61 per share,
for the year ended June 30, 1997, compared to net earnings of $3.6 million,
$0.74 per share and $2.3 million, $0.48 per share for the years ended June 30,
1996 and 1995, respectively. This decrease in earnings for fiscal 1997
compared to fiscal 1996 was primarily attributable to the one-time SAIF
special assessment offset by an increase in net interest income. The special
assessment resulted in the Association accruing $3.1 million in operating
expenses during the first quarter of fiscal 1997 and paying this amount during
the second quarter. Excluding the effects of the special SAIF assessment, net
earnings for fiscal 1997 would have been $4.6 million, $1.00 per share. The
increase in earnings in fiscal 1996 over 1995 is primarily due to an increase
in the net interest margin during fiscal 1996.
Interest Income. Interest income was $58.7 million, $52.6 million and $41.0
million for the years ended June 30, 1997, 1996, and 1995, respectively. The
$6.1 million increase in interest income in 1997 compared to 1996 resulted
from an increase in the average balance of interest-earning assets of $76.1
million while the average yield on interest-earnings assets remained
unchanged. The $11.6 million increase in interest income in 1996 compared to
1995 resulted from an increase in the
39
average balance of interest-earning assets of $90.9 million, and an increase
in the average yield on interest-earning assets of 0.77% to 7.94%.
Interest Expense. Interest expense was $34.9 million, $31.2 million, and
$23.5 million for the years ended June 30, 1997, 1996, and 1995, respectively.
The $3.7 million increase in 1997 compared to 1996 resulted from an increase
in the average balance of interest-bearing liabilities of $76.1 million
partially offset by a reduction in the average cost on interest-bearing
liabilities of 0.06% to 5.20%. The $7.7 million increase in 1996 compared to
1995 resulted from an increase in the average balance of interest-bearing
liabilities of $85.5 million, as well as an increase in the average cost on
interest-bearing liabilities of 0.65% to 5.26%.
Net Interest Income Before Provision for Loan Losses. Net interest income
before provision for loan losses was $23.8 million, $21.5 million, and $17.5
million for the years ended June 30, 1997, 1996, and 1995, respectively. The
increase in 1997 compared to 1996 was primarily a result of the increase in
interest-earning assets relative to interest-bearing liabilities during the
year. The increase in 1996 compared to 1995 was primarily a result of the net
interest margin increasing to 3.24% from 3.07% during the year.
Provision for Loan Losses. During 1997, 1996, and 1995 the Company
established $3.0 million, $2.1 million and $998,000, respectively, of
provisions for losses on loans. The increase of $900,000 in 1997 compared to
1996 and the increase of $1.1 million in 1996 compared to 1995 was necessary
in order to replenish the allowance for loan losses to a level that management
believes to be adequate due to charge-offs taken during those years.
Management considers the level of nonperforming assets, the regional economic
conditions and relevant real estate values and other factors when assessing
the adequacy of the allowance for loan loss. The Southern California economy
and real estate markets in the Company's primary lending area has shown
improvement during the year, especially in income property values and
management considers the level of allowance for loan losses at June 30, 1997
to be adequate. However, even though the local economy is showing signs of
improvement, there can be no assurance that nonperforming assets will not
increase and that the Company may have to establish additional loss provisions
in the future.
Other Income. Other income increased by $280,000, or 11.25%, in 1997 to $2.8
million as compared to 1996. There were increases in transactional fee income
for deposits and loans due to a larger loan and deposit base. Gains on the
sale of loans and fees received for servicing loans increased during the year
as well. Other income increased by $409,000 or 19.66% in 1996 to $2.5 million
as compared to 1995. Fee income for deposits and loans serviced increased due
to a larger loan and deposit base in fiscal 1996. In addition, commissions
from the sale on noninsured deposit products increased due to improved sales
volumes.
Other Expense. Other expense increased $2.8 million, or 17.62%, from $15.7
million in 1996 to $18.5 million in 1997. This increase is primarily due to
the $3.1 million one-time special SAIF assessment during the fiscal year. In
September 1996, federal legislation which recapitalized the SAIF fund through
a one-time special assessment for all thrifts was enacted. SAIF is a part of
the Federal Deposit Insurance Corporation. The special assessment was based on
the Association's deposits as of March 31, 1995 at an assessment rate of 65.7
basis points. During the quarter ended September 30, 1996, the Association
accrued $3.1 million in expense for this special assessment and paid this
amount during the second quarter of fiscal 1997. Beginning January 1, 1997,
the annual amount the Association pays for deposit insurance was reduced to
6.45 basis points from 23.00 basis points. Compensation and employee benefits
increased $264,000 or 3.49% in 1997 as compared to 1996 due to increases in
salaries and expenses related to the Employees Stock Ownership Plan (ESOP).
Companies that established an ESOP after 1992 are required to account for the
expense of the ESOP at the fair value of the related shares released. Due to
the overall increase in the fair value of the QCBC stock during the past few
quarters, ESOP expense has shown a corresponding increase. The
40
expense related to the ESOP was $715,000, $583,000, and $470,000 for the
fiscal years ended June 30, 1997, 1996, and 1995, respectively. FDIC insurance
decreased $399,000 in 1997 compared to the previous year due to the reduction
of the deposit insurance premium that went into effect January 1997.
The following is a summary of other general and administrative expenses for
the fiscal years ended:
JUNE 30,
--------------------
1997 1996 1995
------ ------ ------
(IN THOUSANDS)
Professional fees...................................... $ 236 $ 219 $ 215
Advertising and promotional............................ 573 513 464
Bank service charges................................... 270 380 375
Miscellaneous loan expenses............................ 368 630 660
Consulting fees........................................ 437 350 250
Other.................................................. 1,152 1,258 1,179
------ ------ ------
$3,036 $3,350 $3,143
====== ====== ======
Income Taxes. Income taxes decreased by $370,000 from $2.6 million in 1996
to $2.2 million in 1997. The decrease in taxes is due to the lower net
earnings before income taxes in 1997 compared to 1996 due to the one-time SAIF
special assessment during fiscal 1997. Income taxes increased by $1.3 million
from $1.3 million in 1995 to $2.6 million in 1996. The increase is due to the
increase in earnings before income taxes. The effective tax rate was 43.86%,
41.89% and 35.31% for the years ended June 30, 1997, 1996 and 1995,
respectively. The increase in the effective tax rate in 1997 as compared to
1996 is primarily a result of the increase in the fair value of QCBC stock
over the year. This resulted in the aforementioned increase in ESOP expense
for financial statement purposes relative to the income tax deduction which is
required to be taken at the cost basis of the shares released. The increase in
the effective tax rate in 1995 as compared to 1996 is a result of a State of
California tax benefit allowed for the Los Angeles Revitalization Zone.
FINANCIAL CONDITION
The Company's consolidated assets totaled $801.4 million at June 30, 1997,
compared to $725.1 million at June 30, 1996. Stockholders' equity totaled
$70.2 million at June 30, 1997 compared to $67.9 million June 30, 1996. The
increase in assets is primarily attributable to the implementation of the
Company's growth strategies funded by retail deposit promotions and FHLB
advances.
Loans and MBS (including assets held or available for sale) increased to
$719.7 million at June 30, 1997, from $651.7 million at June 30, 1996. Loans
originated and purchased for investment decreased to $95.9 million for the
year ended June 30, 1997, compared to $121.2 million for the same period the
previous year. MBS purchased for investment increased to $40.2 million at June
30, 1997, from $13.8 million for the same period the previous year.
At June 30, 1997, the Company's multifamily loan portfolio totaled $302.0
million or 45.77% of total loans. Of the Company's $3.0 million of charge-offs
in fiscal 1997, $2.2 million or 73.33% were for multifamily loans. See
"Business--Allowances for Loan and Real Estate Losses." Multifamily loans are
generally considered to involve a higher degree of credit risk and to be more
vulnerable to deteriorating economic conditions than one-to-four family
residential mortgage loans. These loans typically involve higher loan
principal amounts and the repayment of such loans generally depend on the
income produced by the operation or sale of the property being sufficient to
cover operating expenses and debt service. Even though the southern California
real estate market is showing signs of improvement, recessionary economic
conditions of the type that have prevailed in recent years in
41
the Company's primary lending market area tend to result in higher vacancy and
reduced rental rates and net operating incomes from multifamily properties.
Loan sales increased to $33.9 million for the year ended June 30, 1997,
compared to $27.7 million for the same period ended June 30, 1996. The
increase in loan sales is primarily a result of an increase in funding of
fixed rate loans that were generally held for sale during this period. Loans
serviced for others increased to $227.9 million at June 30, 1997 from $212.6
million at June 30, 1996 primarily due to the increase in fixed rate loans
sold servicing retained.
CAPITAL RESOURCES AND LIQUIDITY
Regulatory Capital Requirements
FIRREA and implementing OTS capital regulations require the Association to
maintain certain minimum tangible, core and risk-based regulatory capital
levels.
The following table summarizes the regulatory capital requirements for the
Association at June 30, 1997. As indicated in the table, the Association's
capital levels exceed all three of the currently applicable minimum capital
requirements.
JUNE 30, 1997
-----------------------------------------
TANGIBLE RISK-BASED
CAPITAL CORE CAPITAL CAPITAL
------------ ------------ -------------
AMOUNT % AMOUNT % AMOUNT %
------- ---- ------- ---- ------- -----
(DOLLARS IN THOUSANDS)
Regulatory capital................ $57,903 7.34% $57,903 7.34% $64,120 12.64%
Required minimum.................. 11,829 1.50 23,658 3.00 40,574 8.00
------- ---- ------- ---- ------- -----
Excess capital.................... $46,074 5.84% $34,245 4.34% $23,546 4.64%
======= ==== ======= ==== ======= =====
In addition, FDICIA required the OTS to implement a system of regulatory
sanctions against institutions that are not adequately capitalized, with the
sanctions growing more severe the lower the institution's capital. Under
FDICIA, the OTS issued regulations establishing five separate capital
categories: "well capitalized." "adequately capitalized," "undercapitalized,"
"significantly undercapitalized," and "critically undercapitalized,"
differentiated by core capital ratio, level of core capital to risk-weighted
assets and risk-based capital ratio. See "Business--Regulation and
Supervision--Prompt Corrective Action Requirements."
An institution is treated as "well capitalized" if its core capital ratio is
at least 5%, its ratio of core capital to risk-based assets is at least 6% and
its risk-based capital ratio is at least 10%. The following table summarizes
the capital ratios of the "well capitalized" category and the Association's
regulatory capital at June 30, 1997 as compared to such ratios. As indicated
in the table, the Association's capital levels exceeded the three minimum
capital ratios of the "well capitalized" category.
JUNE 30, 1997
--------------------------------------------
CORE CAPITAL
TO RISK- RISK-
CORE CAPITAL WEIGHTED ASSETS BASED CAPITAL
------------ --------------- -------------
AMOUNT % AMOUNT % AMOUNT %
------- ---- ------- ------ ------- -----
(DOLLARS IN THOUSANDS)
Regulatory capital............. $57,903 7.34% $57,903 11.42% $64,120 12.64%
Well capitalized requirement... 39,431 5.00 47,317 6.00 50,717 10.00
------- ---- ------- ------ ------- -----
Excess capital................. $18,472 2.34% $10,586 5.42% $13,403 2.64%
======= ==== ======= ====== ======= =====
42
During the first quarter of fiscal year 1997, the Company received approval
from the OTS to repurchase in the open market up to 5% of the Company's
outstanding stock or 236,000 shares. At June 30, 1997, a total of 118,750
shares had been repurchased at prices ranging from $13.40 to $17.125 per
share. In 1996, 197,000 shares had been repurchased under a previous
repurchase plan. The Company may complete the repurchase of shares over the
next several months. During the fourth quarter of fiscal 1997, the Company
announced a 25% common stock dividend paid to shareholders on May 30, 1997.
The decrease in the Company's book value per share reflects the effect of the
25% stock dividend, partially offset by the reduced number of shares
outstanding resulting from the stock repurchase program and the Company's
earnings.
Sources of Funds and Liquidity
Sources of capital and liquidity for the Company include distributions from
the Association and borrowings, such as repurchase transactions. Dividends and
other capital distributions from the Association are subject to regulatory
restrictions. See "Business--Regulation and Supervision--Savings and Loan
Holding Company Regulation--Payment of Dividends and Other Capital
Distributions by Association" and "Market for the Registrant's Common Equity
and Related Stockholder Matter."
The Association's primary sources of funds are deposits, principal and
interest payments on loans, proceeds from the sale of loans and advances from
the FHLB. While maturities and scheduled amortization of loans are predictable
sources of funds, deposit flows and mortgage prepayments are greatly
influenced by interest rates, economic conditions, and competition. Although
competition for deposits in the Southern California area is substantial, the
Association experienced an increase in deposits in fiscal 1997. The
Association also has other potential sources of liquidity, such as securities
sold under agreements to repurchase and liquidating existing short-term
assets.
The Association has continued to maintain the required minimum levels of
liquid assets as defined by OTS regulations. This requirement, which may be
varied at the direction of the OTS depending upon economic conditions and
deposit flows, is based upon a percentage of deposits and short-term
borrowings. The required ratio is currently 5%. The Association's average
liquidity ratios were 5.18%, 5.37%, and 5.13%, at June 30, 1997, 1996, and
1995, respectively. Management currently attempts to maintain a liquidity
ratio as close to the minimum as possible. Liquidity levels reflect
management's strategy to invest excess liquidity in higher yielding interest-
earning assets such as loans or mortgage-backed securities.
In the second quarter of fiscal 1997, the Association paid $3.1 million for
the one-time special SAIF assessment charged to all thrifts during the fiscal
year. The payment of this assessment did not have a significant impact on the
liquidity and capital resources of the Association. See "Business--Regulation
and Supervision--Deposit Insurance."
The Company's cash flows are comprised of three primary classifications:
cash flows from operating activities, investing activities and financing
activities. Cash flows from operating activities consisted primarily of cash
flows from the sale of loans held for sale which totaled $33.9 million,
$27.7 million, and $10.3 million for fiscal 1997, 1996, and 1995,
respectively. The Company originated loans for sale of $31.6 million, $28.9
million, and $12.2 million during fiscal years 1997, 1996, and 1995,
respectively. Net cash used by investing activities consisted primarily of
loan originations and investment purchases, offset by principal collections on
loans and proceeds from principal reductions on MBS and maturities of other
investment securities. Loans originated and purchased for investment were
$95.9 million, $121.2 million, and $118.8 million for fiscal 1997, 1996, and
1995, respectively. Proceeds from maturities and principal payments of
investment securities were $8.8 million, $31.6 million, and $12.0 million for
fiscal years ended 1997, 1996, and 1995, respectively. Net cash used by
financing activities consisting primarily of net activity in deposit accounts
and proceeds from
43
funding and repayments of FHLB advances. The net change in deposits was an
increase of $40.7 million for fiscal 1997, and increase of $31.4 million for
fiscal 1996, and an increase of $57.2 million for fiscal 1995. The net
proceeds (repayments) from FHLB advances were $22.4 million, $71.4 million,
and $51.0 million for fiscal 1997, 1996, and 1995, respectively.
Due to the Company's growth strategies in fiscal 1997, 1996, and 1995, the
Company's use of FHLB advances increased. At June 30, 1997, the Company had
$157.7 million in advances outstanding from the FHLB advances that the Company
had outstanding at any month-end was $166.6 million. At June 30, 1997, the
amount of additional credit available from the FHLB was $75.3 million.
Management anticipates increased borrowing from the FHLB again in fiscal 1998.
See "Business--Sources and Funds--Borrowings."
Liquidity levels were maintained in fiscal 1997 with a higher level of
reliance on short-term borrowings. The Company's most liquid assets are cash
and short-term investments. The levels of these assets are dependent on the
Company's operating, financing, lending and investing activities during any
given period. At June 30, 1997, cash and short-term investments totaled $20.4
million.
At June 30, 1997, the Company had outstanding commitments to originate loans
of $9.9 million and commitments to purchase loans of $15.0 million. At June
30, 1997, the Company had $18.9 million of approved undisbursed lines of
credit. The Company anticipates that it will have sufficient funds available
to meet its current loan origination and purchase commitments. Certificates of
deposits which have contractual maturities in one year or less from June 30,
1997, totaled $301.2 million. If a significant portion of the maturing
certificates are not renewed at maturity, the Company's other sources of
liquidity include FHLB advances and other borrowings, such as repurchase
transactions. The Company could also choose to pay higher rates to maintain
maturing deposits, which could result in increased cost of funds.
Historically, the Company has maintained a significant portion of maturing
deposits. While management anticipates that there may be some outflow of these
deposits upon maturity due to the current competitive rate environment, these
are not expected to have a material impact on the long-term liquidity position
of the Company.
44
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. The Company's market risk arises primarily from interest rate risk
inherent in its lending and deposit taking activities. To that end, management
actively monitors and manages its interest rate risk exposure.
The Company's profitability is affected by fluctuations in interest rates. A
sudden and substantial increase in interest rates may adversely impact the
Company's earnings to the extent that the interest rates borne by assets and
liabilities do not change at the same speed, to the same extent, or on the
same basis. The Company monitors the impact of changes in interest rates on
its net interest income using several tools. One measure of the Company's
exposure to differential changes in interest rates between assets and
liabilities is shown in the Company's Maturity and Rate Sensitivity Analysis
under the Asset/Liability Management caption. Another measure, required to be
performed by OTS-regulated institutions, is the test specified by OTS Thrift
Bulletin No. 13, "Interest Rate Risk Management." This test measures the
impact on net interest income and on net portfolio value of an immediate
change in interest rates in 100 basis point increments. Net portfolio value is
defined as the net present value of assets, liabilities, and off-balance sheet
contracts. Following are the estimated impacts of immediate changes in
interest rates at the specified levels at June 30, 1997, calculated in
compliance with Thrift Bulletin No. 13:
PERCENTAGE CHANGE IN:
---------------------------------------------
CHANGE IN INTEREST RATES
(IN BASIS POINTS) NET INTEREST INCOME(1) NET PORTFOLIO VALUE(2)
------------------------ ---------------------- ----------------------
+400...................... -8% -45%
+300...................... -6 -32
+200...................... -3 -20
+100...................... -2 -10
-100...................... 2 7
-200...................... 0 13
-300...................... -2 18
-400...................... -4 14
- --------
(1) The percentage change is this column represents net interest income for 12
months in a stable interest rate environment versus the Net Interest
Income in the various rate scenarios.
(2) The percentage change is this column represents net portfolio value of the
Association in a stable interest rate environment versus the net portfolio
value in the various rate scenarios.
The Company's primary objective in managing interest rate risk is to
minimize the adverse impact of changes in interest rates on the Company's net
interest income and capital, while structuring the Company's asset-liability
structure to obtain the maximum yield-cost spread on that structure. The
Company relies primarily on its asset-liability structure to control interest
rate risk.
The Company continually evaluates interest rate risk management
opportunities, including the use of derivative financial instruments.
Management believes that hedging instruments currently available are not cost-
effective, and therefore, has focused its efforts on increasing the Company's
yield-cost spread through wholesale and retail growth opportunities.
45
The following table shows the Company's financial instruments that are
sensitive to changes in interest rates, categorized by expected maturity, and
the instruments' fair values at June 30, 1997. Market risk sensitive
instruments are generally defined as on- and off-balance sheet derivatives and
other financial instruments.
EXPECTED MATURITY/PRINCIPAL REPAYMENT JUNE 30,
AVERAGE -----------------------------------------------------------------------
INTEREST TOTAL FAIR
RATE 1998 1999 2000 2001 2002 THEREAFTER BALANCE(1) VALUE(1)
-------- -------- ------- ------- ------- ------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
Interest-Sensitive
Assets:
Fed funds sold and
other short-term
investments........... 5.50% $ 12,950 $ -- $ -- $ -- $ -- $ -- $ 12,950 $ 12,950
Loans Receivable:
One-to-four family... 7.72 27,171 23,797 22,059 19,668 17,359 186,699 296,753 299,963
Multifamily and Non-
Residential......... 8.16 31,447 20,983 19,788 17,910 16,378 246,388 352,894 354,167
Other................ 8.75 877 72 42 29 20 30 1,070 1,036
Mortgage-Backed
Securities:........... 7.39 8,259 7,007 6,195 5,553 5,017 42,108 74,139 74,596
Investment Securities.. 6.70 1,500 4,499 7,134 10,181 4,000 10,772 38,086 37,925
FHLB stock............. 5.97 9,718 -- -- -- -- -- 9,718 9,718
Interest-Sensitive
Liabilities:
Deposits
Money Market
Deposits............ 4.72 72,373 5,020 5,020 3,359 3,358 13,477 102,607 102,607
Passbook Deposits.... 2.02 2,228 1,949 1,949 1,460 1,460 8,716 17,762 17,762
NOW and other demand
deposits............ 1.19 1,977 1,804 1,804 1,486 1,486 13,902 22,459 22,459
Certificate Accounts. 5.68 316,651 35,717 35,717 6,667 6,667 -- 401,419 399,529
FHLB Advances........ 6.10 76,200 31,500 18,700 12,400 17,800 1,100 157,700 157,659
Interest-Sensitive Off-
balance sheet items:(2)
Loans serviced for
others................ 7.94 225,730 3,652
Commitments to extend
credit................ 7.69 9,900 89
Loans sold with
recourse (including
bond loans)........... 6.50 10,878 (222)
Commitments to
purchase loans........ 7.40 15,000 94
Unused lines of
credit................ 8.50 18,943 250
- --------
(1) Loans are reduced for nonaccrual loans but are not reduced for the
allowance for loan losses.
(2) Total balance equals the notional amount of off-balance sheet items and
interest rates are the weighted average interest rates of the underlying
loans.
Expected maturities are contractual maturities adjusted for prepayments of
principal. The Company uses certain assumptions to estimate fair values and
expected maturities. For assets, expected maturities are based upon
contractual maturity, projected repayments and prepayments of principal. The
prepayment experience reflected herein is based on the Company's historical
experience. The Company's average Constant Prepayment Rate ("CPR") on its
total fixed-rate portfolio is 10%, and 6% on its adjustable-rate portfolio for
interest-earning assets (excluding investment securities, which do not have
prepayment features). For deposit liabilities, in accordance with standard
industry practice and the Company's own historical experience, "decay
factors," used to
46
estimate deposit runoff of 12.5%, 8.8%, and between 8% and 100% for passbook,
checking and money market deposit accounts, respectively. The actual
maturities of these instruments could vary substantially if future prepayments
differ from the Company's historical experience.
ASSET/LIABILITY MANAGEMENT
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and
by monitoring an institution's interest-rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific time period
if it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of interest-
earning assets maturing or repricing within a specific time period and the
amount of interest-bearing liabilities maturing or repricing within that time
period. A gap is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities. A
gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets. During a
period of falling interest rates therefore, the net earnings of an institution
with a positive gap theoretically may be adversely affected due to its
interest-earning assets repricing to a greater extent than its interest-
bearing liabilities. Conversely, during a period of rising interest rates,
theoretically, the net earnings of an institution with a positive gap position
may increase as it is able to invest in higher yielding interest-earning
assets at a more rapid rate than its interest-bearing liabilities reprice. In
addition, a positive gap may not protect an institution with a large portfolio
of ARM loans from increases in interest rates for extended time periods as
such instruments generally have periodic and lifetime interest rate caps.
Additionally, the Company's ARM loans are predominantly tied to COFI, a
lagging market index, and rapid increases in interest rates could have a
negative impact on the Company's earnings. Accordingly, interest rates and the
resulting cost of funds increases in a rapidly increasing rate environment
could exceed the cap levels on these instruments and negatively impact net
interest income. Declining interest rates have, in general, benefited the
Company primarily due to the effect of the lagging market index which has
resulted in interest income declining at a slower rate than interest expense.
This effect of the lagging index has been partially offset by the increase in
refinancings of portfolio loans to lower yielding loans.
The Company has managed its interest rate risk through the aggressive
marketing and funding of ARM loans, which generally reprice at least semi-
annually and are generally indexed to COFI. As a result of this strategy, and
based upon the assumptions used in the table set forth below, at June 30,
1997, the Company's total interest-earning assets maturing or repricing within
one year exceeded its total interest-bearing liabilities maturing or repricing
in the same time by $147.0 million, representing a one year cumulative
positive gap ratio of 18.35%. This compares to $50.1 million at June 30, 1996,
which represented a positive GAP ratio of 6.91%. In the third quarter of
fiscal 1997, the Company ceased its origination of COFI ARM multifamily and
commercial loan origination. New multifamily and commercial loan originations
are tied to a treasury based index or are fixed rate for 5 years then adjusted
to a new 5 year fixed rate also based upon a treasury index.
The Company closely monitors its interest rate risk as such risk relates to
its operational strategies. The Association's Board of Directors has
established an Asset/Liability Committee, responsible for reviewing its
asset/liability policies and interest rate risk position, which generally
meets weekly and reports to the Board of Directors on interest rate risk and
trends on a quarterly basis. The Company's cumulative gap position is at a
level satisfactory to management. There can be no assurances that the Company
will be able to maintain its positive gap position or that its strategies will
not result in a negative gap position in the future. The level of the movement
of interest rates, up or down, is an uncertainty and could have a negative
impact on the earnings of the Company.
The Company does not currently engage in the use of trading activities, high
risk derivatives and synthetic instruments or hedging activities in
controlling its interest rate risk. Such uses are permitted
47
at the recommendation of the Asset/Liability Committee with the approval of
the Board of Directors, however, the Company does not anticipate engaging in
such practices in the immediate future.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at June 30, 1997, which are
anticipated by the Company, based upon certain assumptions, to reprice or
mature in each of the future time periods shown. Except as stated below, the
amount of assets and liabilities shown which reprice or mature during a
particular period were determined in accordance with the earlier of term to
repricing or the contractual terms of the asset or liability. Additionally,
the Company utilized deposit decay rate assumptions of 12.5% for passbook
accounts, 8.8% for checking accounts and 8% to 100% for money market deposit
accounts in the one year or less category. The range of decay rates for money
market deposit accounts is due to the market rate sensitivity of various money
market checking accounts. These decay rates are based upon the Company's
historical experience, but there is no assurance that the assumed rates will
correspond to future rates. For information regarding the contractual
maturities of the Company's loans, investments and deposits, see "Business--
Lending Activities," "--Investment Activities" and "--Sources of Funds."
48
AT JUNE 30, 1997
-----------------------------------------------------------------------------------------------
MORE THAN MORE THAN MORE THAN MORE THAN MORE THAN NON-
3 MONTHS 3 MONTHS TO 6 MONTHS TO 1 YEAR TO 3 YEARS TO 5 YEARS TO MORE THAN INTEREST
OR LESS 6 MONTHS 1 YEAR 3 YEARS 5 YEARS 10 YEARS 10 YEARS BEARING TOTAL
-------- ----------- ----------- --------- ---------- ---------- --------- -------- --------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Interest-earning
deposits............... $ 336 $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 336
Federal funds sold and
other short-term
investments............ 12,950 -- -- -- -- -- -- -- 12,950
Investment securities,
net(3)................. 1,432 1,500 -- 4,499 21,312 4,000 5,343 -- 38,086
Loans
receivable(1)(3)....... 459,061 88,163 22,334 19,477 21,746 18,889 21,047 -- 650,717
Mortgage-backed
securities(3).......... 22,433 3,275 2,485 163 -- 697 45,086 -- 74,139
FHLB stock............. 9,718 -- -- -- -- -- -- -- 9,718
-------- -------- --------- --------- ------- ------- ------- -------- --------
Total interest-
earning assets....... 505,930 92,938 24,819 24,139 43,058 23,586 71,476 -- 785,946
-------- -------- --------- --------- ------- ------- ------- -------- --------
LESS:
Unearned discount and
deferred fees(2)....... 3,960 752 204 162 179 161 479 -- 5,897
Allowance for loan
losses................. -- -- -- -- -- -- -- 7,772 7,772
Net interest-earning
assets................ 501,970 92,186 24,615 23,977 42,879 23,425 70,997 (7,772) 772,277
Non-interest-earning
assets................. -- -- -- -- -- -- -- 29,125 29,125
-------- -------- --------- --------- ------- ------- ------- -------- --------
Total assets......... $501,970 $ 92,186 $ 24,615 $ 23,977 $42,879 $23,425 $70,997 $ 21,353 $801,402
======== ======== ========= ========= ======= ======= ======= ======== ========
INTEREST-BEARING
LIABILITIES:
Money market deposits.. $ 67,876 $ 1,499 $ 2,998 $ 10,040 $ 6,717 $11,234 $ 2,243 $ -- $102,607
Passbook deposits...... 557 557 1,114 3,898 2,920 5,468 3,248 -- 17,762
NOW and other demand
deposits............... 494 494 989 3,608 2,972 6,122 7,780 -- 22,459
Certificate
accounts(4)............ 82,054 98,861 135,736 71,434 13,334 -- -- -- 401,419
FHLB advances(5)....... 49,500 8,800 20,200 63,700 14,400 1,100 -- -- 157,700
-------- -------- --------- --------- ------- ------- ------- -------- --------
Total interest-
bearing liabilities.. 200,481 110,211 161,037 152,680 40,343 23,924 13,271 -- 701,947
Non-interest bearing
liabilities............ -- -- -- -- -- -- -- 29,212 29,212
Stockholders' Equity... -- -- -- -- -- -- -- 70,243 70,243
-------- -------- --------- --------- ------- ------- ------- -------- --------
Total liabilities and
stockholders' equity. $200,481 $110,211 $ 161,037 $ 152,680 $40,343 $23,924 $13,271 $ 99,455 $801,402
======== ======== ========= ========= ======= ======= ======= ======== ========
Interest sensitivity
gap(6).................. $301,489 $(18,025) $(136,422) $(128,703) $ 2,536 $(499) $57,726 $(78,102) $ --
======== ======== ========= ========= ======= ======= ======= ======== ========
Cumulative interest
sensitivity gap......... $301,489 $283,464 $ 147,042 $ 18,339 $20,875 $20,376 $78,102 $ -- $ --
======== ======== ========= ========= ======= ======= ======= ======== ========
Cumulative interest
sensitivity gap as a
percentage of total
assets.................. 37.62% 35.37% 18.35% 2.29% 2.60% 2.54% 9.75%
Cumulative net interest-
earning assets as a
percentage of cumulative
interest-bearing
liabilities............. 252.36% 192.75% 132.21% 103.75% 103.93% 103.75% 111.97%
- ----
(1) For purposes of the gap analysis, mortgage and other loans are reduced for
nonaccrual loans but are not reduced for the allowance for loan losses.
(2) For purposes of the gap analysis, unearned discount and deferred fees are
pro rated for loans receivable.
(3) Includes assets held or available for sale.
(4) Certain certificate accounts have potential repricing dates which are prior
to the contractual maturity dates. The repricing dates were used for
purposes of the gap analysis.
(5) Certain FHLB Advances have call features which are prior to the contractual
maturity dates. The call dates were used for purposes of the gap analysis.
(6) Interest sensitivity gap represents the difference between net interest-
earning assets and interest-bearing liabilities.
49
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates. Additionally, certain assets, such as ARM loans, have
features which restrict changes in interest rates on a short-term basis and
over the life of the asset. Further, in the event of a change in interest
rates, prepayment and early withdrawal levels would likely deviate
significantly from those assumed in calculating the table. Finally, the
ability of many borrowers to service their ARM loans may decrease in the event
of an interest rate increase.
AVERAGE BALANCE SHEET
The following table sets forth certain information relating to the Company
for the years ended June 30, 1997, 1996, and 1995. The yields and costs are
derived by dividing income or expense by the average balance of assets or
liabilities, respectively, for the periods shown except where noted otherwise.
Average balances are derived from average month-end balances. Management does
not believe that the use of average monthly balances instead of average daily
balances has caused any material differences in the information presented. The
average balance of loans receivable includes loans on which the Company has
discontinued accruing interest. The yields and costs include fees which are
considered adjustments to yields.
50
YEAR ENDED JUNE 30,
-------------------------------------------------------------------------------
AT JUNE 30,
1997 1997 1996 1995
----------- ------------------------- ------------------------- -------------------------
YIELD/ YIELD/ YIELD/
RATE END OF AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
PERIOD BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
----------- -------- -------- ------- -------- -------- ------- -------- -------- -------
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning
assets:
Interest-earning
deposits............... 3.81% $ 611 $ 20 3.27% $ 3,281 $ 25 0.76% $ 3,895 $ 43 1.10%
Federal funds sold and
other short-term
investments............ 5.90 8,583 505 5.88 10,203 515 5.05 6,305 317 5.03
Investment securities,
net(1)................. 6.70 37,819 2,503 6.62 25,314 1,717 6.78 24,077 1,373 5.70
Loans receivable(2).... 7.96 631,157 51,411 8.15 577,613 47,078 8.15 502,408 36,953 7.36
Mortgage-backed
securities, net(1)..... 7.39 51,852 3,661 7.06 40,781 3,030 7.43 30,941 2,120 6.85
FHLB stock............. 5.97 9,038 568 6.28 5,814 281 4.83 4,446 236 5.31
-------- ------- -------- ------- -------- -------
Total interest-earning
assets................ 7.77 739,060 58,668 7.94 663,006 52,646 7.94 572,072 41,042 7.17
Non-interest-earning
assets................. 21,013 14,724 16,701
-------- -------- --------
Total assets.......... $760,073 $677,730 $588,773
======== ======== ========
Liabilities and
Stockholders' equity:
Interest-bearing
liabilities:
Money market deposits.. 4.72 $ 83,372 3,498 4.20 $ 75,176 3,000 3.99 $ 56,251 1,794 3.19
Passbook deposits...... 2.02 17,899 355 1.98 21,028 418 1.99 25,572 500 1.96
NOW and other demand
deposits............... 1.19 24,011 278 1.16 23,006 275 1.20 23,698 263 1.11
Certificate accounts... 5.68 397,191 22,201 5.59 370,515 21,396 5.78 346,457 17,755 5.12
-------- ------- -------- ------- -------- -------
Total savings accounts. 5.11 522,473 26,332 489,725 25,089 451,978 20,312
FHLB advances.......... 6.10 148,312 8,565 5.77 96,789 5,572 5.76 46,029 2,596 5.64
Securities sold under
agreements
to repurchase.......... -- 72 4 5.56 8,283 490 5.92 11,342 595 5.25
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities........... 5.31 670,857 34,901 5.20 594,797 31,151 5.26 509,349 23,503 4.61
Non-interest-bearing
liabilities............ 20,667 14,921 13,593
Stockholders' equity... 68,549 68,012 65,831
-------- -------- --------
Total liabilities and
stockholders' equity... $760,073 $677,730 $588,773
======== ------- ======== ------- ======== -------
Net interest rate
spread(3).............. $23,767 2.74% $21,495 2.68% $17,539 2.56%
======= ====== ======= ====== ======= ======
Net interest margin(4). 3.22% 3.24% 3.07%
====== ====== ======
Ratio of interest-
earning assets to
interest-bearing
liabilities............ 110.17% 111.47% 112.31%
====== ====== ======
- ----
(1) Amount includes assets available for sale.
(2) Amount is net of deferred loan fees, loan discounts, loans in process and
loan loss allowances, and includes nonaccrual loans and loans held for
sale.
(3) Net interest rate spread represents the difference between the yield on
average interest-earning assets and the cost of average interest-bearing
liabilities.
(4) Net interest margin represents net interest income divided by average
interest-earning assets.
51
Rate/Volume Analysis. The following table presents the extent to which
changes in interest rates and changes in the volume of interest-earning assets
and interest-bearing liabilities have affected the Company's interest income
and interest expense 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 rate (changes in rate multiplied by prior volume), and (iii) the
net change. The changes attributable to the combined impact of volume and rate
have been allocated proportionately to the changes due to volume and the
changes due to rate.
YEAR ENDED JUNE 30, 1997 YEAR ENDED JUNE 30, 1996
COMPARED TO COMPARED TO
YEAR ENDED JUNE 30, 1996 YEAR ENDED JUNE 30, 1995
----------------------------- ----------------------------
INCREASE (DECREASE) IN NET INCREASE (DECREASE) IN NET
INTEREST INCOME INTEREST INCOME
----------------------------- ----------------------------
DUE TO DUE TO
----------------- ----------------
NET NET
VOLUME RATE CHANGE VOLUME RATE CHANGE
-------- ------- -------- -------- ------- --------
(IN THOUSANDS)
Interest-earning assets:
Interest-earning
deposits.............. $ 36 $ (61) $ (25) $ (4) $ 6 $ 2
Federal funds sold and
other short-term
investments........... (29) 39 10 189 (11) 178
Investment securities,
net(2)................ 827 (41) 786 73 271 344
Loans receivable,
net(1), (2)........... 4,361 (28) 4,333 5,895 4,230 10,125
Mortgage-backed
securities, net(2).... 772 (141) 631 719 191 910
FHLB stock............. 186 101 287 64 (19) 45
------ ----- ------ ------ ------ -------
Total interest-
earning assets...... 6,153 (131) 6,022 6,936 4,668 11,604
------ ----- ------ ------ ------ -------
Interest-bearing
liabilities:
Money market deposits.. 338 160 498 691 515 1,206
Passbook deposits...... (62) (1) (63) (89) 7 (82)
NOW and other demand
deposits.............. 11 (8) 3 (7) 19 12
Certificate accounts... 1,451 (646) 805 1,281 2,360 3,641
FHLB advances.......... 2,976 17 2,993 2,921 55 2,976
Other borrowings....... (457) (29) (486) (143) 38 (105)
------ ----- ------ ------ ------ -------
Total interest-
bearing liabilities. 4,257 (507) 3,750 4,654 2,994 7,648
------ ----- ------ ------ ------ -------
Change in net interest
income................. $1,896 $ 376 $2,272 $2,282 $1,674 $ 3,956
====== ===== ====== ====== ====== =======
- --------
(1) Includes nonaccrual loans.
(2) Includes assets held or available for sale.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes thereto presented herein
have been prepared in accordance with GAAP, which require the measurement of
financial position and operating results in terms of historical dollars
without considering the changes in the relative purchasing power of money over
time due to inflation. The impact of inflation is reflected in the increased
cost of the Company's operations. Unlike industrial companies, nearly all of
the assets and liabilities of the Company are monetary in nature. As a result,
interest rates have a greater impact on the Company's performance than do the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or to the same extent as the price of goods and
services. See "--Asset/Liability Management."
IMPACT OF NEW ACCOUNTING STANDARDS
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share". SFAS
No. 128 provides reporting standards for basic and diluted earnings per share
and is effective for financial statement
52
periods ending after December 15, 1997. Earlier application is not permitted.
Had the Company applied SFAS No. 128 to the accompanying financial statements,
basic earnings per share would have been $0.64, $0.77 and $0.50, and diluted
earnings per share would have been $0.61, $0.74 and $0.48 for the fiscal years
ended June 30, 1997, 1996 and 1995, respectively.
In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information
about Capital Structure". This statement was issued in connection with SFAS
No. 128 and lists the required disclosures about capital structure that had
been included in a number of previously existing separate statements and
opinions. The guidance relative to SFAS No. 129 is applicable to both public
and non-public entities. SFAS No. 129 is effective for financial statements
for periods ending after December 15, 1997. Implementation of SFAS No. 129
will not have a material effect on the Company's financial condition or
results of operations.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". Comprehensive income represents the change in equity of the Company
during a period from transactions and other events and circumstances from non-
owner sources. It includes all changes in equity during a period except those
resulting from investments by owners and distributions to owners. SFAS No. 130
establishes standards for reporting and display of comprehensive income and
its components in a full set of general purpose financial statements. SFAS No.
130 requires all components of comprehensive income, which are required to be
recognized under accounting standards, be reported in a financial statement
that is displayed in equal prominence with the other financial statements.
SFAS No. 130 does not require a specific presentation format, but will require
the Company to display an amount representing total comprehensive income for
the period in the financial statements. SFAS No. 130 is effective for both
interim and annual periods beginning after December 15, 1997. Implementation
of SFAS No. 130 will not have a material effect on the Company's financial
condition or results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information". SFAS No. 131 establishes standards for
the way public business enterprises are to report information about operating
segments in annual financial statements and requires those enterprises to
report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
SFAS No. 131 supercedes numerous requirements in a previously issued
statement--SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise"--but retains the requirement to report information about major
customers. SFAS No. 131 is effective for financial statements for periods
beginning after December 15, 1997. Implementation of SFAS No. 131 will not
have a material effect on the Company's financial condition or results of
operations.
53
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report............................................... F-2
Consolidated Statements of Financial Condition as of June 30, 1997 and
1996...................................................................... F-3
Consolidated Statements of Earnings for Each of the Years in the Three-Year
Period Ended June 30, 1997................................................ F-4
Consolidated Statements of Stockholders' Equity for Each of the Years in
the Three-Year Period Ended June 30, 1997................................. F-5
Consolidated Statements of Cash Flows for Each of the Years in the Three-
Year Period Ended June 30, 1997........................................... F-6
Notes to Consolidated Financial Statements................................. F-7
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Quaker City Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial
condition of Quaker City Bancorp, Inc. (the Company) and subsidiaries as of
June 30, 1997 and 1996 and the related consolidated statements of earnings,
stockholders' equity and cash flows for each of the years in the three-year
period ended June 30, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Quaker
City Bancorp, Inc. and subsidiaries as of June 30, 1997 and 1996 and the
results of their operations and their cash flows for each of the years in the
three-year period ended June 30, 1997 in conformity with generally accepted
accounting principles.
KPMG Peat Marwick llp
July 25, 1997
Los Angeles, California
F-2
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE DATA)
1997 1996
ASSETS --------- -------
Cash and due from banks................................... $ 7,067 2,184
Interest-bearing deposits................................. 336 4,984
Federal funds sold and other short-term investments....... 12,950 6,400
Investment securities held to maturity (fair value of
$36,493 at June 30, 1997 and $36,808 at June 30, 1996)
(notes 2 and 10)......................................... 36,654 37,419
Investment securities available for sale, at fair value
(note 2)................................................. 1,432 --
Loans receivable, net (notes 3 and 9)..................... 644,964 607,672
Loans receivable held for sale (fair value of $623 at June
30, 1997 and $2,890 at June 30, 1996) (note 3)........... 623 2,890
Mortgage-backed securities held to maturity (fair value of
$74,596 at June 30, 1997 and $41,561 at June 30, 1996)
(notes 4 and 10)......................................... 74,139 41,175
Real estate held for sale (note 5)........................ 2,314 3,058
Federal Home Loan Bank stock, at cost (notes 6 and 9)..... 9,718 8,151
Office premises and equipment, net (note 7)............... 4,217 4,176
Accrued interest receivable and other assets (notes 2, 3,
4 and 13)................................................ 6,988 6,976
--------- -------
$ 801,402 725,085
========= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits (note 8)....................................... $ 553,186 512,517
Federal Home Loan Bank advances (notes 3, 6 and 9)...... 157,700 135,300
Securities sold under agreements to repurchase (note
10).................................................... -- 300
Deferred tax liability (note 11)........................ 1,413 1,174
Accounts payable and accrued expenses (note 11)......... 3,543 2,870
Other liabilities (note 8).............................. 15,317 4,998
--------- -------
Total liabilities..................................... 731,159 657,159
========= =======
Stockholders' Equity (note 12):
Common stock, $.01 par value. Authorized 10,000,000
shares; issued and outstanding 4,703,102 shares and
3,813,600 shares at June 30, 1997 and 1996,
respectively........................................... 47 38
Additional paid-in capital.............................. 44,051 27,017
Unrealized gain on securities available for sale........ 136 --
Retained earnings, substantially restricted (note 11)... 28,122 43,515
Deferred compensation (notes 13 and 14)................. (2,113) (2,644)
--------- -------
Total stockholders' equity............................ 70,243 67,926
Commitments and contingent liabilities (notes 3 and 15)...
--------- -------
$ 801,402 725,085
========= =======
See accompanying notes to consolidated financial statements.
F-3
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT SHARE DATA)
1997 1996 1995
--------- --------- ---------
Interest income:
Loans receivable............................... $ 51,411 47,078 36,953
Mortgage-backed securities..................... 3,661 3,030 2,120
Investment securities.......................... 2,503 1,717 1,373
Other.......................................... 1,093 821 596
--------- --------- ---------
Total interest income........................ 58,668 52,646 41,042
--------- --------- ---------
Interest expense:
Deposits (note 8).............................. 26,332 25,089 20,312
Federal Home Loan Bank advances and other
borrowings.................................... 8,569 6,062 3,191
--------- --------- ---------
Total interest expense....................... 34,901 31,151 23,503
--------- --------- ---------
Net interest income before provision for loan
losses...................................... 23,767 21,495 17,539
Provision for loan losses (note 3)............... 3,001 2,103 998
--------- --------- ---------
Net interest income after provision for loan
losses...................................... 20,766 19,392 16,541
--------- --------- ---------
Other income:
Loan servicing charges and other fees.......... 1,828 1,629 1,490
Gain on sale of loans held for sale............ 356 175 86
Commissions.................................... 555 606 420
Other.......................................... 30 79 84
--------- --------- ---------
2,769 2,489 2,080
--------- --------- ---------
Other expense:
Compensation and employee benefits (notes 13
and 14)....................................... $ 7,829 7,565 7,371
Occupancy, net................................. 1,946 1,970 1,894
Federal deposit insurance premiums............. 855 1,254 1,115
Data processing................................ 707 641 561
Other general and administrative expense....... 3,036 3,350 3,143
--------- --------- ---------
Total general and administrative expense..... 14,373 14,780 14,084
Savings Association Insurance Fund special
assessment.................................... 3,100 -- --
Real estate operations, net (note 5)........... 775 656 646
Amortization of core deposit intangible........ 264 303 303
--------- --------- ---------
Total other expense.......................... 18,512 15,739 15,033
--------- --------- ---------
Earnings before income taxes................. 5,023 6,142 3,588
Income taxes (note 11)........................... 2,203 2,573 1,267
--------- --------- ---------
Net earnings................................. $ 2,820 3,569 2,321
========= ========= =========
Net earnings per share (note 1).................. $ .61 .74 .48
========= ========= =========
Weighted average shares outstanding.............. 4,633,813 4,839,063 4,812,904
========= ========= =========
See accompanying notes to consolidated financial statements.
F-4
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
(IN THOUSANDS)
UNREALIZED
GAIN ON RETAINED
ADDITIONAL SECURITIES EARNINGS,
COMMON PAID-IN AVAILABLE SUBSTANTIALLY DEFERRED
SHARES STOCK CAPITAL FOR SALE RESTRICTED COMPENSATION TOTAL
------ ------ ---------- ---------- ------------- ------------ ------
Balance, June 30, 1994.. 4,140 $41 29,083 -- 39,503 (3,989) 64,638
Net earnings............ -- -- -- -- 2,321 -- 2,321
Repurchase and
retirement of stock.... (136) (1) (1,018) -- (387) -- (1,406)
Exercise of stock op-
tions.................. 10 -- 75 -- -- -- 75
Deferred compensation
amortized to expense... -- -- 120 -- -- 693 813
----- --- ------ --- ------- ------ ------
Balance, June 30, 1995.. 4,014 40 28,260 -- 41,437 (3,296) 66,441
Net earnings............ -- -- -- -- 3,569 -- 3,569
Repurchase and
retirement of stock.... (234) (2) (1,756) -- (1,491) -- (3,249)
Exercise of stock op-
tions.................. 34 -- 255 -- -- -- 255
Deferred compensation
amortized to expense... -- -- 258 -- -- 652 910
----- --- ------ --- ------- ------ ------
Balance, June 30, 1996.. 3,814 38 27,017 -- 43,515 (2,644) 67,926
Net earnings............ -- -- -- -- 2,820 -- 2,820
Shares issued in
connection with stock
dividend............... 946 9 17,012 -- (17,021) -- --
Repurchase and
retirement of stock.... (134) (1) (959) -- (1,310) -- (2,270)
Exercise of stock op-
tions.................. 77 1 576 -- 118 -- 695
Unrealized gain on
securities available
for sale,net of tax.... -- -- -- 136 -- -- 136
Deferred compensation
amortized to expense... -- -- 405 -- -- 531 936
----- --- ------ --- ------- ------ ------
Balance, June 30, 1997.. 4,703 $47 44,051 136 28,122 (2,113) 70,243
===== === ====== === ======= ====== ======
See accompanying notes to consolidated financial statements.
F-5
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
(IN THOUSANDS)
1997 1996 1995
--------- -------- --------
Cash flows from operating activities:
Net earnings................................... $ 2,820 3,569 2,321
--------- -------- --------
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Depreciation and amortization................ (14) (634) (219)
Provision for loan losses.................... 3,001 2,103 998
Write-downs and provision for losses on real
estate held for sale........................ 491 252 589
Provision for deferred income taxes.......... 143 1,407 1,406
Gain on sale of loans held for sale.......... (356) (175) (86)
Loans originated for sale.................... (31,598) (28,922) (12,214)
Sale of loans held for sale.................. 33,870 27,662 10,321
Federal Home Loan Bank (FHLB) stock dividend
received.................................... (513) (263) (223)
Increase in accrued interest receivable and
other assets................................ (223) (343) (2,579)
Increase in other liabilities................ 10,319 1,666 1,676
Increase (decrease) in accounts payable and
accrued expenses............................ 673 (549) 1,590
Other........................................ 144 1,502 (2,273)
--------- -------- --------
Total adjustments.......................... 15,937 3,706 (1,014)
--------- -------- --------
Net cash provided by operating activities.. 18,757 7,275 1,307
--------- -------- --------
Cash flows from investing activities:
Loans originated for investment................ $ (83,408) (93,424) (94,050)
Loans purchased for investment................. (12,521) (27,789) (24,792)
Principal repayments on loans.................. 54,465 48,032 39,295
Sale of investment securities available for
sale.......................................... -- 2,550 14,900
Purchases of investment securities available
for sale...................................... (1,199) (2,400) (14,580)
Purchases of investment securities held to
maturity...................................... (7,996) (45,149) (17,055)
Maturities and principal repayments of
investment securities held to maturity........ 8,784 31,638 12,021
Sale of MBS available for sale................. -- 1,754 --
Purchases of MBS held to maturity.............. (40,228) (13,766) (28,102)
Principal repayments on MBS held to maturity... 7,305 11,157 2,906
Sale of real estate held for sale.............. 3,653 1,393 1,139
Purchase of FHLB stock......................... (1,054) (3,152) (314)
Investment in office premises and equipment.... (849) (1,041) (325)
--------- -------- --------
Net cash used by investing activities...... (73,048) (90,197) (108,957)
--------- -------- --------
Cash flows from financing activities:
Increase in deposits........................... 40,669 31,359 57,198
Proceeds from funding of FHLB advances......... 370,000 363,780 309,450
Repayments of FHLB advances.................... (347,600) (292,430) (258,500)
Proceeds from securities sold under agreement
to repurchase................................. -- 74,078 129,683
Repayments of securities sold under agreement
to repurchase................................. (300) (96,651) (113,829)
Repurchase of stock............................ (2,270) (3,249) (1,406)
Common stock options exercised................. 577 255 75
--------- -------- --------
Net cash provided by financing activities.. 61,076 77,142 122,671
--------- -------- --------
Increase (decrease) in cash and cash
equivalents............................... 6,785 (5,780) 15,021
Cash and cash equivalents at beginning of year.. 13,568 19,348 4,327
--------- -------- --------
Cash and cash equivalents at end of year........ $ 20,353 13,568 19,348
========= ======== ========
Supplemental disclosures of cash flow
information:
Interest paid (including interest credited).... $ 34,454 30,987 23,436
Cash paid for income taxes..................... 621 1,155 785
========= ======== ========
Supplemental schedule of noncash investing and
financing activities:
Additions to loans resulting from the sale of
real estate acquired through foreclosure $ 4,847 5,580 7,407
Additions to real estate acquired through
foreclosure................................... 8,313 7,764 8,593
========= ======== ========
See accompanying notes to consolidated financial statements.
F-6
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 AND 1996
(1) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Quaker City Bancorp, Inc., incorporated in Delaware, is primarily engaged in
the savings and loan business through its wholly owned subsidiary, Quaker City
Savings and Loan Association (the Association). At June 30, 1997, the
Association operated eight retail banking offices in Southern California. The
Association is subject to significant competition from other financial
institutions, and is also subject to the regulations of various government
agencies and undergoes periodic examinations by those regulatory authorities.
The following accounting policies, together with those disclosed elsewhere
in the consolidated financial statements, represent the significant accounting
policies of the Company.
Principles of Consolidation and Presentation
The consolidated financial statements include the accounts of Quaker City
Bancorp, Inc., Quaker City Neighborhood Development, Inc., Quaker City Federal
Savings and Loan Association and its wholly owned subsidiary, Quaker City
Financial Corporation. Quaker City Financial Corporation includes the accounts
of FGK, a 92.8%-owned joint venture. All significant intercompany balances and
transactions have been eliminated in consolidation. Certain reclassifications
have been made to the prior years' consolidated financial statements to
conform to the current year's presentation.
These consolidated financial statements have been prepared in conformity
with generally accepted accounting principles. In preparing the consolidated
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the date of
the statement of financial condition, and revenues and expenses for the
periods. The most significant estimate for the Company relates to the
allowance for loan losses. Actual results could differ from those estimates.
Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments" (SFAS No. 107), requires the disclosure of the
fair value of financial instruments, whether or not recognized on the
statement of financial condition, for which it is practicable to estimate the
value. A significant portion of the Company's assets and liabilities are
financial instruments as defined under SFAS No. 107. Fair values, estimates
and assumptions are set forth in note 19, Fair Value of Financial Instruments.
Risks Associated with Financial Instruments
The credit risk of a financial instrument is the possibility that a loss may
result from the failure of another party to perform in accordance with the
terms of the contract. The most significant credit risk associated with the
Company's financial instruments is concentrated in its loans receivable.
Additionally, the Company is subject to credit risk on certain loans sold with
recourse. The Company has established a system for monitoring the level of
credit risk in its loan portfolio and for loans sold with recourse.
Concentrations of credit risk would exist for groups of borrowers when they
have similar economic characteristics that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic or
other conditions. The ability of the Company's borrowers to repay their
F-7
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
commitments is contingent on several factors, including the economic
conditions in the borrowers' geographic area and the individual financial
condition of the borrowers. The Company generally requires collateral or other
security to support borrower commitments on loans receivable. This collateral
may take several forms. Generally, on the Company's mortgage loans, the
collateral will be the underlying mortgaged property. The Company's lending
activities are primarily concentrated in Southern California.
The market risk of a financial instrument is the possibility that future
changes in market prices may reduce the value of a financial instrument or
increase the contractual obligations of the Company. The Company's market risk
is concentrated in its portfolios of loans receivable and real estate acquired
through foreclosure. When a borrower fails to meet the contractual
requirements of their loan agreement, the Company is subject to the market
risk of the collateral securing the loan. Likewise, the Company is subject to
the volatility of real estate prices with respect to real estate acquired by
foreclosure. The Company's securities available for sale are traded in active
markets. The value of these securities is susceptible to the fluctuations of
the market.
Financial instruments are subject to interest rate risk to the extent that
they reprice on a frequency degree or basis that varies from market pricing.
The Company is subject to interest rate risk to the degree that its interest-
earning assets reprice on a different frequency or schedule than its interest-
bearing liabilities. A majority of the Company's loans receivable and
mortgage-backed securities reprice based on the Eleventh District Cost of
Funds Index (COFI). The repricing of COFI tends to lag other interest rate
indices. The Company closely monitors the pricing sensitivity of its financial
instruments.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash
and due from banks, interest-bearing deposits and Federal funds sold and other
short-term investments. Generally, Federal funds sold and short-term
investments are held for one-day periods. The amounts included in cash and
cash equivalents and qualifying investment securities generally constitute the
Company's liquidity portfolio. The Company maintains liquidity to satisfy
regulatory requirements. The liquidity portfolio is managed in a manner
intended to maximize flexibility and yield, while minimizing interest rate
risk, credit risk and the cost of the capital required to be maintained for
such assets.
Assets Held or Available for Sale
The Company identifies those loans, mortgage-backed securities (MBS) and
investment securities for which it does not have the positive intent and
ability to hold to maturity. If management has the positive intent and the
Company has the ability to hold such assets until maturity, they are
classified as held to maturity and are carried at amortized historical cost.
Securities that are to be held for indefinite periods of time and not intended
to be held to maturity are generally classified as available for sale and are
carried at fair value, with unrealized gains and losses excluded from earnings
and reported as a separate component of stockholders' equity, net of income
tax effect. However, if a decline in fair value is determined to be other than
temporary, the cost basis of the individual security is written down to fair
value as a new cost basis, and the amount of the writedown is included in
earnings. Gains and losses from the sales of MBS and investment securities
available for sale are recognized at the time of sale and are determined by
the specific-identification method. Loans held for sale are carried at the
lower of amortized historical cost or fair value as determined on an aggregate
basis. Assets held for indefinite periods of time include assets that
management intends to use as part of its asset/liability management strategy
and that may be sold in response to changes in interest rates, resultant
prepayment risk and other factors.
F-8
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Assets Held to Maturity
Loans, MBS and investment securities, excluding those held or available for
sale, are carried at amortized historical cost, adjusted for amortization of
premiums and discounts utilizing the interest method over the contractual
terms of the assets. The carrying value of these assets is not adjusted for
temporary declines in fair value since the Company has the positive intent and
ability to hold them to maturity. If a decline in the fair value of securities
is determined to be other than temporary, the cost basis of the individual
security is written down to fair value as a new cost basis and the amount of
the writedown is included in earnings.
Interest Income on Loans Receivable
Interest income on loans receivable is accrued as it is earned. The Company
defers and amortizes both loan origination fees and the incremental direct
costs relating to the origination of loans. The deferred origination fees and
costs are amortized into interest income utilizing the interest method over
the lives of the related loans. Loans are placed on nonaccrual status after
being delinquent 60 days, or earlier if the ultimate collectibility of the
accrual is in doubt. Whenever the accrual of interest is stopped, previously
accrued but uncollected interest income is reversed. Thereafter, interest is
recognized only as cash is received until the loan is reinstated. Accretion of
discounts and deferred loan fees is discontinued when loans are placed on
nonaccrual status.
Allowance for Loan Losses
The allowance for loan losses is maintained at an amount management
considers adequate to cover estimated losses on loans receivable which are
deemed probable and estimable. The allowance is based upon a number of
factors, including asset classifications, economic trends, industry experience
and trends, industry and geographic concentrations, estimated collateral
values, management's assessment of credit risk inherent in the portfolio,
historical loss experience and the Company's underwriting practices. As a
result of weaknesses in certain real estate markets, increases in the
allowance for loan losses may be required in future periods. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Association's allowance for loan losses. These
agencies may require the Association to establish additional valuation
allowances, based on their judgments of the information available at the time
of the examination.
Impaired Loans
A loan is considered impaired when based on current circumstances and
events, it is probable that a creditor will be unable to collect all amounts
due according to the contractual terms of the loan agreement. Creditors are
required to measure impairment of a loan based on any one of the following:
(i) the present value of expected future cash flows from the loan discounted
at the loan's effective interest rate, (ii) an observable market price or
(iii) the fair value of the loan's underlying collateral. The Company measures
impairment based on the fair value of the loan's underlying collateral
property. Impaired loans exclude large groups of smaller balance homogeneous
loans that are collectively evaluated for impairment. For the Company, loans
collectively reviewed for impairment include all loans with principal balances
of less than $300,000.
Factors considered as part of the periodic loan review process to determine
whether a loan is impaired, as defined under SFAS 114, address both the amount
the Company believes is probable that it will collect and the timing of such
collection. As part of the Company's loan review process, the Company will
consider such factors as the ability of the borrower to continue to meet the
debt service
F-9
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
requirements, assessments of other sources of repayment, the fair value of any
collateral and the creditor's prior history in dealing with these types of
credits. In evaluating whether a loan is considered impaired, insignificant
delays (less than 12 months) in the absence of other facts and circumstances
would not alone lead to the conclusion that a loan was impaired.
The Company recognizes impairment on troubled collateral dependent loans by
creating a valuation allowance. The valuation allowance is maintained while
the loans are still in process of collection. At such time that the assets are
deemed uncollectible, the valuation allowance is charged off.
Loan Sales and Servicing
The Company sells loans and participations in loans with yield rates to the
investors based upon current market rates. Gain or loss is recognized to the
extent that the selling prices differ from the carrying value of the loans
sold based on the estimated relative fair values of the assets sold and any
retained interests, less any liabilities incurred. The assets obtained on sale
are generally loan servicing assets. Liabilities incurred in a sale may
include recourse obligations or servicing liabilities. Historically, the
Company has not established servicing assets or liabilities, although the
Company retained the servicing rights on loans sold, because management has
determined that the benefits from the contractually specified servicing fees
and other ancillary sources are offset by the cost the Company incurs in
servicing.
Real Estate Held for Sale
Real estate acquired through foreclosure (REO) is initially recorded at fair
value at the date of foreclosure, less costs of disposition. Fair value is
determined by an appraisal obtained at the time of foreclosure. Thereafter, if
there is a further deterioration in value, the Company writes down the REO
directly and charges operations for the diminution in value.
Real estate held for development is carried at the lower of cost or net
realizable value. All costs of anticipated disposition are considered in the
determination of net realizable value.
Revenue recognition on the disposition of real estate is dependent upon the
transaction meeting certain criteria relating to the nature of the property
sold and the terms of sale.
Core Deposit Premium
The Company has acquired customer deposit accounts from financial
institutions in its market area. The core deposit premium amounting to $35,000
and $299,000, respectively, at June 30, 1997 and 1996 relates to the value of
the depositor relationship and is an identifiable intangible which is
amortized over a five-year period using the straight-line method. The core
deposit premium is included in accrued interest receivable and other assets in
the accompanying consolidated statements of financial condition.
Depreciation and Amortization
Depreciation is computed utilizing the straight-line method over the
estimated lives of the assets. Amortization of leasehold improvements is
computed utilizing the straight-line method over the shorter of the estimated
useful life of the assets or the terms of the respective leases.
F-10
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Earnings per Share
Earnings per share in 1997, 1996 and 1995 was calculated by dividing net
earnings by the weighted average number of common stock and common stock
equivalents outstanding. The Company uses the treasury stock method for
converting common stock equivalents to common stock. Earnings per share have
been adjusted to reflect a 25% stock dividend that took effect in May 1997.
For calculating primary earnings per share, the weighted average number of
common and common equivalent shares includes the average number of common
shares outstanding and the average number of shares issuable under employee
compensation plans that have a dilutive effect. For calculating fully diluted
earnings per share, the maximum dilutive effect is computed using the period-
end market price of the Company's common stock, if it is higher than average
market price used in calculating primary earnings per share. If the difference
between and fully diluted earnings per share is immaterial, as it was in the
years presented, it is not reported.
In February 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 128, "Earnings per Share." SFAS No. 128 provides reporting standards
for basic and diluted earnings per share and is effective for financial
statement periods ending after December 15, 1997. Earlier application is not
permitted. Had the Company applied SFAS No. 128 to the accompanying
consolidated financial statements, basic earnings per share would have been
$.64, $.77 and $.50, and diluted earnings per share would have been $.61, $.74
and $.48 for the fiscal years ended June 30, 1997, 1996 and 1995,
respectively.
Income Taxes
A deferred tax liability is recognized for taxable temporary differences
(differences between the tax bases of assets and liabilities and their
reported amounts in the financial statements that will result in future
taxable amounts). A deferred tax asset is recognized for all deductible
temporary differences (differences between the tax bases of assets and
liabilities and their reported amounts in the financial statements that will
result in deductible amounts in future years when the financial statement
carrying amounts of the assets and liabilities are recovered and settled) and
operating loss and tax credit carryforwards. The likelihood of realizing the
tax benefits related to a potential deferred tax asset is evaluated and a
valuation allowance is recognized to reduce that deferred tax asset if it is
more likely than not that all or some portion of the deferred tax asset will
not be realized. Deferred tax assets and liabilities are calculated at the
beginning and end of the year; the change in the sum of the deferred tax
asset, valuation allowance and deferred tax liability during the year
generally is recognized as deferred tax expense or benefit. The effect on
deferred taxes of a change in tax rates is recognized in income in the period
for which the change becomes effective.
Stock Option Plans
Prior to July 1, 1996, the Company accounted for its stock option plans in
accordance with the provisions of Accounting Principles Board Opinion No. 25
(APB No. 25), "Accounting for Stock Issued to Employees," and related
interpretations. As such, compensation expense was recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. Effective July 1, 1996, the Company adopted SFAS No. 123,
"Accounting for Stock-Based Compensation," which permits entities to recognize
as expense over the vesting period the fair value of all stock-based
compensation awards on the date of grant. Alternatively, SFAS No. 123 also
allows entities to continue to apply the provisions of APB No. 25 and provide
pro forma net income and pro forma earnings per share disclosures for employee
stock options grants made in 1995 and future years as if the fair-value-based
method defined in SFAS No. 123 had been applied. The Company has elected to
continue to
F-11
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
apply the provisions of APB No. 25 and to provide the pro forma disclosure
provisions of SFAS No. 123. As of June 30, 1997, pro forma disclosures were
not required as there were no options granted in 1995, 1996 or 1997.
Other Recent Accounting Pronouncements
In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information
about Capital Structure." This statement was issued in connection with SFAS
No. 128 and lists the required disclosures about capital structure that had
been included in a number of previously existing separate statements and
opinions. The guidance relative to SFAS No. 129 is applicable to both public
and nonpublic entities. SFAS No. 129 is effective for financial statements for
periods ending after December 15, 1997. Implementation of SFAS No. 129 will
not have a material effect on the Company's financial condition or results of
operations.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." Comprehensive income represents the change in equity of the Company
during a period from transactions and other events and circumstances from
nonowner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners. SFAS
No. 130 establishes standards for reporting and display of comprehensive
income and its components in a full set of general purpose financial
statements. SFAS No. 130 requires all components of comprehensive income,
which are required to be recognized under accounting standards, to be reported
in a financial statement that is displayed in equal prominence with the other
financial statements. SFAS No. 130 does not require a specific presentation
format, but will require the Company to display an amount representing total
comprehensive income for the periods in the financial statements. SFAS No. 130
is effective for both interim and annual periods beginning after December 15,
1997. Implementation of SFAS No. 130 will not have a material effect on the
Company's financial condition or results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 establishes standards for
the way public business enterprises are to report information about operating
segments in annual financial statements and requires those enterprises to
report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
SFAS No. 131 supersedes numerous requirements in a previously issued statement
D SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise" D
but retains the requirement to report information about major customers. SFAS
No. 131 is effective for financial statements for periods beginning after
December 15, 1997. Implementation of SFAS No. 131 will not have a material
effect on the Company's financial condition or results of operations.
F-12
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(2) INVESTMENT SECURITIES
The following table provides a summary of investment securities with a
comparison of amortized cost and fair values:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ------
(IN THOUSANDS)
June 30, 1997:
Held to maturity:
U.S. Government and Federal
agency obligations............. $36,303 -- (161) 36,142
Municipal bonds................. 351 -- -- 351
------- --- ---- ------
36,654 -- (161) 36,493
Available for sale--marketable
equity securities................ 1,200 232 -- 1,432
------- --- ---- ------
Total......................... $37,854 232 (161) 37,925
======= === ==== ======
June 30, 1996:
Held to maturity:
U.S. Government and Federal
agency obligations............. $37,048 -- (611) 36,437
Municipal bonds................. 371 -- -- 371
------- --- ---- ------
Total......................... $37,419 -- (611) 36,808
======= === ==== ======
At June 30, 1997 and 1996, the Company had accrued interest receivable on
investment securities of $362,000 and $262,000, respectively, which is
included in accrued interest receivable and other assets in the accompanying
consolidated statements of financial condition.
Proceeds from sales of investment securities available for sale were $2.6
million and $14.9 million during 1996 and 1995, respectively. There were no
sales of investment securities available for sale in 1997. There were no gross
gains or losses realized during 1997, 1996 and 1995.
The contractual principal maturities for investment securities held to
maturity as of June 30, 1997 are as follows:
CONTRACTUAL PRINCIPAL MATURITY
---------------------------------------------
MATURING
MATURING 1 YEAR MATURING MATURING
WITHIN TO 5 5 YEARS TO AFTER
TOTAL 1 YEAR YEARS 10 YEARS 10 YEARS
------- -------- -------- ---------- --------
(IN THOUSANDS)
U.S. Government and Federal
agency obligations.......... $36,303 1,500 25,811 4,000 4,992
Municipal bonds.............. 351 -- -- -- 351
------- ----- ------ ----- -----
Total.................... $36,654 1,500 25,811 4,000 5,343
======= ===== ====== ===== =====
F-13
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(3) LOANS RECEIVABLE, NET
The following table presents carrying values of loans receivable at the
dates indicated:
JUNE 30
----------------
1997 1996
-------- -------
(IN THOUSANDS)
Real estate:
Residential:
One to four units....................................... $299,979 303,273
Multifamily............................................. 301,965 258,970
Commercial and land....................................... 56,683 61,860
-------- -------
658,627 624,103
Other....................................................... 1,070 627
-------- -------
659,697 624,730
Less:
Undisbursed loan funds.................................... 441 378
Unamortized discounts..................................... 2,404 2,864
Deferred loan fees, net................................... 3,493 3,093
Allowance for loan losses................................. 7,772 7,833
-------- -------
645,587 610,562
-------- -------
Less:
Held for sale--residential real estate:
One to four units....................................... 623 1,455
Multifamily............................................. -- 1,435
-------- -------
623 2,890
-------- -------
Held to maturity...................................... $644,964 607,672
======== =======
The weighted average interest rate on the Company's loan portfolio was 7.96%
and 8.06% at June 30, 1997 and 1996, respectively.
Certain mortgage loans aggregating $234.7 million and $216.3 million at June
30, 1997 and 1996, respectively, are collateral for FHLB advances.
At June 30, 1997, the Association had loans with an outstanding balance of
$9.4 million under two separate agreements with the City of Los Angeles to
guarantee up to a total of $15 million of multifamily housing revenue bonds
primarily for the acquisition and renovation of earthquake-stricken
properties. In conjunction with these guarantees, standby letters of credit
were issued by the Federal Home Loan Bank. Additionally, the principal
balances of other loans sold with recourse totaled $1.5 million and
$1.9 million at June 30, 1997 and 1996, respectively.
At June 30, 1997 and 1996, the Association had accrued interest receivable
on loans of $4.0 million, which is included in accrued interest receivable and
other assets in the accompanying consolidated statements of financial
condition.
The Company serviced loans for investors totaling $227.9 million, $212.6
million and $204.7 million at June 30, 1997, 1996 and 1995, respectively.
F-14
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Activity in the allowance for loan losses is summarized as follows:
JUNE 30
-----------------------
1997 1996 1995
------- ------ ------
(IN THOUSANDS)
Accumulated through a charge to earnings:
Balance at beginning of year...................... $ 6,542 10,614 13,458
Provision for loan losses......................... 3,001 2,103 998
Charge-offs, net.................................. (3,047) (6,175) (3,842)
------- ------ ------
Balance at end of year............................ 6,496 6,542 10,614
------- ------ ------
Valuation allowance for portfolios acquired:
Balance at beginning of year...................... 1,291 1,494 202
Purchases......................................... -- 294 1,308
Charge-offs....................................... -- (471) --
Reductions credited............................... (15) (26) (16)
------- ------ ------
Balance at end of year............................ 1,276 1,291 1,494
------- ------ ------
Total allowance for loan losses................. $ 7,772 7,833 12,108
======= ====== ======
Since 1990, the Company has purchased loans from independent parties in
various transactions. In some cases, loans were purchased at a discount from
par with a portion of such discount attributed to credit risk associated with
the purchased loans. In such instances, as part of the acquisition, the
Company has recorded a valuation allowance to reflect credit risk inherent in
the purchased portfolio. Such valuation allowances have been specifically
allocated to the corresponding assets purchased and are accounted for
separately from the valuation allowances that have been accumulated through a
charge to earnings. In addition, any discounts on purchased loans applicable
to credit risk are separate and apart from discounts due to yield adjustments.
Credit Risk and Concentration
At June 30, 1997 and 1996, the balances of nonaccrual loans totaled $8.5
million and $10.4 million, respectively, net of specific allowances of $1.5
million and $2.2 million. The Company's nonaccrual policy requires that loans
be placed on nonaccrual status after being delinquent 60 days or earlier if
warranted. There were no accruing loans contractually past due 60 days or more
at June 30, 1997 and 1996.
The gross amount of interest income on nonaccrual loans that would have been
recorded during the years ended June 30, 1997, 1996 and 1995 if the nonaccrual
loans had been current in accordance with their original terms was $782,000,
$1,100,000 and $920,000, respectively. For the years ended June 30, 1997, 1996
and 1995, $469,000, $565,000 and $497,000, respectively, were actually earned
on nonaccrual loans and are included in interest income on loans in the
accompanying consolidated statements of earnings. Interest income earned on
nonaccrual loans is generally recorded utilizing the cash-basis method of
accounting.
Substantially all of the Company's real estate loans are secured by
properties located in Southern California.
Impaired Loans
At June 30, 1997 and 1996, the Company had a gross investment in impaired
loans of $8.0 million and $8.6 million. During the year ended June 30, 1997
and 1996, the Company's average investment in impaired loans was $8.2 million
and $11.8 million, respectively, and for the years then ended,
F-15
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
interest income on such loans totaled $704,000 and $611,000, respectively.
Interest income on impaired loans which are performing is generally recorded
utilizing the cash-basis method of accounting. Payments received on impaired
loans which are performing under their contractual terms are allocated to
principal and interest in accordance with the terms of the loans. Impaired
loans totaling $4.3 million and $6.4 million were not performing in accordance
with their contractual terms at June 30, 1997 and 1996 and have been included
in nonaccrual loans at that date.
Impaired loans at June 30, 1997 included $5.5 million of loans for which
specific valuation allowances of $1.2 million had been established and $2.5
million of loans for which no specific valuation allowance was considered
necessary. At June 30, 1996, the Company had $6.7 million of impaired loans
for which specific valuation allowances of $1.6 million had been established
and $1.9 million of such loans for which no specific valuation allowance was
considered necessary. All such provisions for losses and any related
recoveries are recorded as part of the total allowance for loan losses.
(4) MORTGAGE-BACKED SECURITIES
Summarized below are the amortized cost and estimated fair values of
mortgage-backed securities:
JUNE 30, 1997
--------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ------
(IN THOUSANDS)
Held to maturity:
GNMA, FNMA and FHLMC securities.... $48,557 129 -- 48,686
Issued by other financial
institutions...................... 4,501 2 -- 4,503
Collateralized mortgage
obligations....................... 21,081 326 -- 21,407
------- --- --- ------
Total............................ $74,139 457 -- 74,596
======= === === ======
JUNE 30, 1996
--------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ------
(IN THOUSANDS)
Held to maturity:
GNMA, FNMA and FHLMC securities.... $20,613 14 -- 20,627
Issued by other financial
institutions...................... 5,725 58 -- 5,783
Collateralized mortgage
obligations....................... 14,837 314 -- 15,151
------- --- --- ------
Total............................ $41,175 386 -- 41,561
======= === === ======
The contractual principal maturities for mortgage-backed securities as of
June 30, 1997, all held to maturity, are as follows:
CONTRACTUAL PRINCIPAL MATURITY
----------------------------------------------
MATURITY MATURITY MATURITY MATURITY
WITHIN 1 YEAR TO 5 YEARS TO AFTER
TOTAL 1 YEAR 5 YEARS 10 YEARS 10 YEARS
------- -------- --------- ---------- --------
(IN THOUSANDS)
GNMA, FNMA and FHLMC
securities.................. $48,557 -- -- 698 47,859
Issued by other financial
institutions................ 4,501 -- -- 1,533 2,968
Collateralized mortgage
obligations................. 21,081 326 -- -- 20,755
------- --- --- ----- ------
Total...................... $74,139 326 -- 2,231 71,582
======= === === ===== ======
F-16
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The mortgage-backed securities included in the above table have contractual
terms to maturity, but require periodic payments to reduce principal. In
addition, expected maturities will differ from contractual maturities because
borrowers have the right to prepay the underlying mortgages.
In November 1995, the FASB issued a Special Report as an aid in
understanding and implementing SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." The Special Report included
guidance that allowed the Company to review the appropriateness of the
classifications of all securities held. Any reclassifications would be
accounted for at fair value in accordance with SFAS No. 115. In accordance
with the Special Report, during the second quarter of 1996, the Company
transferred a $1.8 million mortgage-backed security from the held to maturity
portfolio to the available for sale portfolio. This mortgage-backed security
was subsequently sold during 1996 with a realized gain of $41,000.
There were no mortgage-backed securities sold during 1997 and 1995.
The collateralized mortgage obligations held at June 30, 1997 and 1996
represented nonequity interests in mortgage pass-through certificates (Class
A-1 Senior Certificates) and were of investment grade.
The Company had accrued interest receivable on mortgage-backed securities of
$382,000 and $232,000 at June 30, 1997 and 1996, respectively, which is
included in accrued interest receivable and other assets in the accompanying
consolidated statements of financial condition.
(5) REAL ESTATE HELD FOR SALE
The following is a summary of real estate held for sale, net of valuation
allowances:
JUNE 30
-------------
1997 1996
------ -----
(IN
THOUSANDS)
Acquired through foreclosure............................... $1,720 2,435
Held for development....................................... 769 798
Valuation allowances....................................... (175) (175)
------ -----
$2,314 3,058
====== =====
Changes in the valuation allowance on real estate held for sale are
summarized as follows:
JUNE 30
--------------
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
Balance at beginning of year.................................. $175 175 115
Provision for losses.......................................... -- -- 60
---- --- ---
Balance at end of year........................................ $175 175 175
==== === ===
F-17
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table summarizes real estate operations, net:
JUNE 30
--------------
1997 1996 1995
---- ---- ----
(IN THOUSANDS)
Net loss from operations:
Real estate held for development........................... $ 8 46 6
Losses on sales and operations of foreclosed real estate
owned..................................................... 276 358 51
---- --- ---
284 404 57
Provision for losses......................................... -- -- 60
Write-downs.................................................. 491 252 529
---- --- ---
Real estate operations, net.............................. $775 656 646
==== === ===
(6) FEDERAL HOME LOAN BANK (FHLB) STOCK
As a member of the FHLB System, the Association is required to own capital
stock in the FHLB of San Francisco in an amount at least equal to the greater
of 1% of the aggregate principal amount of its unpaid residential mortgage
loans, home purchase contracts and similar obligations at the end of each
year, or 5% of its outstanding borrowings from the FHLB of San Francisco. The
Association was in compliance with this requirement with an investment in FHLB
of San Francisco stock at June 30, 1997 and 1996 of $9.7 million and $8.2
million, respectively. FHLB stock is recorded at historical cost.
(7) OFFICE PREMISES AND EQUIPMENT
The following is a summary of office premises and equipment, net:
JUNE 30
--------------
1997 1996
------- ------
(IN THOUSANDS)
Land.......................................................... $ 720 720
Buildings and leasehold improvements.......................... 6,282 5,796
Furniture, fixtures and equipment............................. 4,718 4,496
------- ------
11,720 11,012
Less accumulated depreciation and amortization................ 7,503 6,836
------- ------
$ 4,217 4,176
======= ======
The Company recorded depreciation and amortization expense on premises,
equipment and leasehold improvements of $805,000, $675,000 and $681,000 during
1997, 1996 and 1995, respectively.
F-18
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(8) DEPOSITS
The following is a summary of deposits:
JUNE 30, 1997 JUNE 30, 1996
----------------- -----------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
RATE AMOUNT RATE AMOUNT
-------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Money market deposits.................... 4.72% $102,607 3.39% $ 72,269
Passbook deposits........................ 2.02 17,762 1.99 18,235
NOW and other demand deposits............ 1.19 22,459 1.10 25,059
Non-interest bearing demand deposits..... -- 8,939 -- 7,399
Certificates of deposit:
3 months or less....................... 5.45 82,054 5.73 106,440
Over 3 through 6 months................ 5.51 98,861 5.59 106,576
Over 6 through 12 months............... 5.74 120,324 5.48 109,616
Over 12 months......................... 5.96 100,180 5.96 66,923
-------- --------
5.11 $553,186 4.91 $512,517
==== ======== ==== ========
The weighted average interest rates are based upon stated interest rates
without giving consideration to daily compounding of interest or forfeiture of
interest because of premature withdrawal.
Certificates of deposit of $100,000 or more accounted for $78.3 million and
$66.1 million of deposits at June 30, 1997 and 1996, respectively.
At June 30, 1997 and 1996, the Company had accrued interest payable on
deposits of $150,000 and $79,000, respectively, which is included in other
liabilities in the accompanying consolidated statements of financial
condition.
Deposits at June 30, 1997 mature as follows (in thousands):
Immediately withdrawable........................................ $151,767
Year ending June 30:
1998.......................................................... 301,239
1999.......................................................... 53,225
2000.......................................................... 29,434
2001.......................................................... 10,130
2002.......................................................... 7,391
--------
$553,186
========
Interest expense by type of deposit account is summarized in the following
table for the periods indicated:
YEAR ENDED JUNE 30
---------------------
1997 1996 1995
------- ------ ------
(IN THOUSANDS)
Money market deposits.................................. $ 3,498 3,000 1,794
Passbook deposits...................................... 355 418 500
NOW and other demand deposits.......................... 278 275 263
Certificates of deposit................................ 22,201 21,396 17,755
------- ------ ------
$26,332 25,089 20,312
======= ====== ======
F-19
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(9) FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank (FHLB) advances are summarized as follows:
JUNE 30
-----------------
1997 1996
-------- --------
(IN THOUSANDS)
FHLB advances, due at various dates through 2003, with
interest rates from 5.47% to 7.10% and a weighted
average rate of 6.10% at June 30, 1997 and from 4.66%
to 8.21% and a weighted average rate of 5.87% at June
30, 1996............................................. $157,700 135,300
======== ========
These advances are secured by the investment in stock of the FHLB and
certain mortgage loans aggregating $234.7 million and $216.3 million at June
30, 1997 and 1996, respectively. At June 30, 1997, the amount of additional
credit available from the FHLB was $75.3 million.
The maturities of FHLB advances are as follows (in thousands):
Year ending June 30:
1998.............................. $ 76,200
1999.............................. 31,500
2000.............................. 18,700
2001.............................. 12,400
2002 and thereafter............... 18,900
--------
$157,700
========
(10) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase are summarized as follows:
JUNE 30
-----------
1997 1996
---- ------
(IN
THOUSANDS)
Balance at year-end, due in September 1996 with an interest
rate of 5.57% at June 30, 1996 $-- 300
Fair value.................................................... -- 300
Average amount outstanding during the year.................... 72 8,283
Maximum amount outstanding at any month-end................... 300 17,146
==== ======
Securities sold under agreements to repurchase are secured by mortgage-
backed securities and U.S. Government and Federal agency obligations with a
carrying value of $1.5 million at June 30, 1996. The securities which are sold
under agreements to repurchase do not remain under the control of the Company.
F-20
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(11) INCOME TAXES
Income taxes for the fiscal years ended June 30, 1997, 1996 and 1995 are
comprised of the following:
FEDERAL STATE TOTAL
------- ----- -----
(IN THOUSANDS)
Year ended June 30, 1997:
Current............................................. $1,551 509 2,060
Deferred............................................ 74 69 143
------ ---- -----
$1,625 578 2,203
====== ==== =====
Year ended June 30, 1996:
Current............................................. $ 961 205 1,166
Deferred............................................ 960 447 1,407
------ ---- -----
$1,921 652 2,573
====== ==== =====
Year ended June 30, 1995:
Current............................................. $ 159 (298) (139)
Deferred............................................ 1,067 339 1,406
------ ---- -----
$1,226 41 1,267
====== ==== =====
A reconciliation from expected Federal income taxes to consolidated
effective income taxes for the periods indicated follows. The statutory
Federal income tax rate for all periods was 34.0%.
YEAR ENDED JUNE 30
--------------------
1997 1996 1995
------ ----- -----
(IN THOUSANDS)
Expected Federal income taxes......................... $1,708 2,088 1,220
Increases (decreases) in computed tax resulting from:
State taxes, net of Federal benefit................. 381 430 27
Interest earned on tax-exempt securities............ (29) (9) (11)
Fair value of ESOP shares over cost................. 138 88 41
Other, net.......................................... 5 (24) (10)
------ ----- -----
$2,203 2,573 1,267
====== ===== =====
On August 20, 1996, the President signed the Small Business Job Protection
Act (the Act) into law. The Act repeals the reserve method of accounting for
bad debts for savings institutions, effective for taxable years beginning
after December 31, 1995. The Company, therefore, will be required to use the
specific charge-off method on its 1996 and subsequent Federal income tax
returns. Prior to 1996, savings institutions that met certain definitional
tests and other conditions prescribed by the Internal Revenue Code were
allowed to deduct, within limitations, a bad debt deduction. The deduction
percentage was 8% for the years ended December 31, 1995 and 1994.
Alternatively, a qualified savings institution could compute its bad debt
deduction based upon actual loan loss experience (the Experience Method). The
Company computed its bad debt deduction utilizing the Experience Method in the
calendar years 1995 and 1994. The Association's tax bad debt reserve balance
of approximately $10.9 million as of June 30, 1997, will, in future years, be
subject to recapture in whole or in part upon the occurrence of certain
events, such as a distribution to stockholders in excess of the Association's
current and accumulated earnings and profit, a redemption of shares or upon a
partial or complete
F-21
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
liquidation of the Association. The Association does not intend to make
distributions to stockholders that would result in recapture of any portion of
its bad debt reserve. Since management intends to use the reserve only for the
purpose for which it was intended, a deferred tax liability of approximately
$3.7 million has not been recorded.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at June 30,
1997 and 1996 are presented below:
1997 1996
------- ------
(IN THOUSANDS)
Deferred tax assets:
Loan valuation allowances................................. $ 2,321 2,105
Subsidiaries.............................................. 350 338
State income taxes........................................ 274 133
Deferred compensation..................................... 712 593
Amortization of core deposit.............................. 382 201
Gain on loan sales........................................ -- 23
Other..................................................... -- 85
------- ------
Total gross deferred tax assets......................... 4,039 3,478
------- ------
Deferred tax liabilities:
Accrued interest income................................... (959) (834)
Deferred loan fees........................................ (2,733) (2,456)
FHLB stock dividends...................................... (1,504) (1,251)
Accelerated tax depreciation.............................. (92) (111)
Unrelated gains on securities available for sale.......... (96) --
Other..................................................... (68) --
------- ------
Total gross deferred tax liabilities.................... (5,452) (4,652)
------- ------
Net deferred tax liability.............................. $(1,413) (1,174)
======= ======
Deferred tax assets are initially recognized for differences between the
financial statement carrying amount and the tax bases of assets and liabilities
which will result in future deductible amounts and operating loss and tax
credit carryforwards. A valuation allowance is then established to reduce that
deferred tax asset to the level at which it is "more likely than not" that the
tax benefits will be realized. Realization of tax benefits of deductible
temporary differences and operating loss or tax credit carryforwards depends on
having sufficient taxable income of an appropriate character within the
carryback and carryforward periods. Sources of taxable income that may allow
for the realization of tax benefits include (1) taxable income in the current
year or prior years that is available through carryback, (2) future taxable
income, exclusive of the reversal of existing temporary differences, that will
result from the reversal of existing taxable temporary differences and (3)
future taxable income generated by future operations. In addition, tax planning
strategies may be available to accelerate taxable income or deductions, change
the character of taxable income or deductions, or switch from tax-exempt to
taxable investments so that there will be sufficient taxable income of an
appropriate character and in the appropriate periods to allow for realization
of the tax benefits. Management believes that the above-described deferred tax
assets are more likely than not to be realized and, accordingly, has not
established a valuation allowance for the years ended June 30, 1997 and 1996.
F-22
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(12) REGULATORY CAPITAL
The Association is required to maintain certain minimum levels of regulatory
capital as set forth by the OTS in capital standards applicable to all
thrifts. These capital standards include a core capital requirement, a
tangible capital requirement and a risk-based capital requirement. The
Association exceeds all capital requirements at June 30, 1997, as shown in the
following table:
TANGIBLE RISK-BASED
CAPITAL CORE CAPITAL CAPITAL
--------------- --------------- ---------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Actual.......................... $57,903 7.34% $57,903 7.34% $64,120 12.64%
Required........................ 11,829 1.50 23,658 3.00 40,574 8.00
------- ---- ------- ---- ------- -----
Excess........................ $46,074 5.84% $34,245 4.34% $23,546 4.64%
======= ==== ======= ==== ======= =====
The Federal Deposit Corporation Improvement Act of 1991 contains prompt
corrective action (PCA) provisions pursuant to which banks and savings
institutions are to be classified into one of five categories, based primarily
upon capital adequacy, and which require specific supervisory actions as
capital levels decrease. The OTS regulations implementing the PCA provisions
define the five capital categories. The following table sets forth the
definitions of the categories and the Association's ratios as of June 30,
1997:
TANGIBLE TOTAL RISK- TIER 1 RISK- TIER 1
CAPITAL CATEGORY CAPITAL RATIO BASED RATIO BASED RATIO LEVERAGE RATIO
---------------- ------------- ----------- ------------ --------------
Well-capitalized........ N/A 10% 6% 5%
Adequately capitalized.. N/A 8% 4% 4%
Undercapitalized........ N/A 8% 4% 4%
Significantly
undercapitalized....... N/A 6% 3% 3%
Critically
undercapitalized....... 2% N/A N/A N/A
Association at June 30,
1997................... 7.34% 12.64% 11.42% 7.34%
==== ===== ===== ====
The OTS also has authority, after an opportunity for a hearing, to downgrade
an institution from well-capitalized to adequately capitalized, or to subject
an adequately capitalized or undercapitalized institution to the supervisory
actions applicable to the next lower category, for supervisory concerns. At
June 30, 1997, the Association was a well-capitalized institution.
Dividends
Savings association subsidiaries of holding companies generally are required
to provide their OTS District Director not less than 30 days' advance notice
of any proposed declaration of a dividend on the association's stock. Under
regulations adopted by the OTS, the insured institution's ability to declare
and pay a dividend to its holding company is subject to certain limitations.
The regulation establishes a three-tiered system of regulation, with the
greatest flexibility being afforded to well-capitalized associations. The
Association is considered a well-capitalized institution for purposes of
dividend declarations. No dividends were declared or paid by the Association
in 1997 or 1996.
(13) RETIREMENT PLANS
Defined Benefit Plan
The Association maintains a noncontributory defined benefit pension plan
(the Plan). Any employee becomes eligible to participate in the Plan upon
attaining the age of 21 and completing one
F-23
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
year of service during which they have served a minimum of 1,000 hours. The
benefits are based on years of service and the three consecutive years of
employment during which the participant earned the highest compensation.
Contributions are intended to provide not only for benefits attributed to
service to date, but also for those expected to be earned in the future.
Effective December 31, 1993, the Plan was frozen for benefit service accrued.
Benefits after December 31, 1993 may still increase due to increases in
compensation.
Plan assets, at fair value, are primarily comprised of government
obligations and short-term investments.
The following table sets forth the Plan's funded status and amounts
recognized in the Association's consolidated statements of financial
condition:
JUNE 30
---------------
1997 1996
------- ------
(IN THOUSANDS)
Actuarial present value of benefit obligations:
Vested benefit obligation................................ $(2,444) (2,342)
Nonvested benefit obligation............................. (47) (107)
------- ------
Accumulated benefit obligations........................ $(2,491) (2,449)
======= ======
Projected benefit obligation for service rendered to date.. $(2,829) (2,941)
Plan assets, at fair value................................. 2,703 2,824
------- ------
Excess of projected benefit obligation over Plan
assets................................................ (126) (117)
Items not yet recognized in earnings:
Unrecognized net loss from past experience different from
that assumed and effects of changes in assumptions...... 410 437
Unrecognized prior service cost being recognized......... (162) (196)
Unrecognized net transition asset at June 30, 1997 and
1996 being amortized over approximately 15 years........ (8) (8)
------- ------
Prepaid pension cost................................... $ 114 116
======= ======
Net pension cost includes the following components:
JUNE 30
----------------
1997 1996
------- -------
(IN THOUSANDS)
Interest cost on projected benefit obligation.............. $ 224 224
Actual return on Plan assets............................... (152) (217)
Net amortization and deferral.............................. (20) (16)
------- -------
Net periodic pension cost................................ $ 52 (9)
======= =======
The discount rate used in determining the actuarial present value of the
benefit obligations was 7.50% and 7.75% as of June 30, 1997 and 1996,
respectively. The rate used to determine the expected long-term rate of return
on assets and the benefit obligations for the net pension cost was 7.00% and
7.50% at June 30, 1997 and 1996, respectively.
Supplemental Executive Retirement Plan
The Association has a supplemental executive defined benefit pension plan
covering specified employees. The benefits are based on employee compensation
and length of service and are offset by benefits provided by Social Security
and the Company's other qualified retirement plans.
F-24
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table sets forth the Plan's funded status and amounts
recognized in the Association's consolidated statements of financial
condition:
JUNE 30
-----------
1997 1996
----- ----
(IN
THOUSANDS)
Actuarial present value of benefit obligations:
Vested benefit obligation.................................... $(258) (242)
Nonvested benefit obligation................................. (16) (16)
----- ----
Accumulated benefit obligations............................ $(274) (258)
===== ====
Projected benefit obligation for service rendered to date...... $(491) (407)
Plan assets, at fair value..................................... - -
----- ----
Excess of projected benefit obligation over Plan assets.... (491) (407)
Items not yet recognized in earnings:
Unrecognized net gain from past experience different from
that assumed and effects of changes in assumptions.......... (472) (502)
Unrecognized prior service cost being recognized............. 352 399
----- ----
Accrued pension cost....................................... $(611) (510)
===== ====
Net pension cost includes the following components:
JUNE 30
---------------
1997 1996
------- -------
(IN THOUSANDS)
Service cost--benefits earned during the period.............. $ 50 38
Interest cost on projected benefit obligation................ 32 38
Net amortization and deferral................................ 19 29
------- ------
Net periodic pension cost.................................. $ 101 105
======= ======
The discount rate used in determining the actuarial present value of the
benefit obligations was 7.50% and 7.75% as of June 30, 1997 and 1996,
respectively.
Employee Stock Ownership Plan (ESOP)
In December 1993, an ESOP was established for all employees who are age 21
or older and have completed one year of service with the Association during
which they have served a minimum of 1,000 hours. The ESOP is internally
leveraged and borrowed $3.1 million from the Company to purchase 414,000
shares of the common stock of Quaker City Bancorp, Inc. issued in the
conversion. The loan will be repaid principally from the Association's
discretionary contributions to the ESOP over a period of 10 years. At June 30,
1997 and 1996, the outstanding balance on the loan was $1.9 million and $2.3
million, respectively. Shares purchased with the loan proceeds are held in a
suspense account for allocation among participants as the loan is repaid.
Contributions to the ESOP and shares released from the suspense account are
allocated among participants on the basis of compensation, as described in the
plan, in the year of allocation. Benefits generally become 100% vested after
five years of credited service. Vesting will accelerate upon retirement, death
or disability of the participant or in the event of a change in control of the
Association or the Company. Forfeitures will be reallocated among remaining
participating employees, in the same proportion as contributions. Benefits may
be payable upon death, retirement, early retirement, disability or separation
from service. Since the annual
F-25
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
contributions are discretionary, the benefits payable under the ESOP cannot be
estimated. The Company accounts for its ESOP in accordance with Statement of
Position 93-6. Accordingly, the Company reports compensation expense equal to
the fair value of the shares allocated, and the allocated shares are
considered outstanding for the computation of earnings per share. The expense
related to the ESOP totaled $715,000, $583,000 and $470,000 for the fiscal
years ended June 30, 1997, 1996 and 1995, respectively. At June 30, 1997 and
1996, unearned compensation related to the ESOP approximated $1.9 million and
$2.3 million, respectively, and is shown as a reduction of stockholders'
equity in the accompanying consolidated statements of financial condition.
The table below reflects ESOP activity for the periods indicated:
YEAR ENDED JUNE
30
----------------
1997 1996
------- -------
Unallocated shares at beginning of period.................. 300,150 343,416
Stock dividend............................................. 67,275 --
Allocated.................................................. (43,987) (43,266)
------- -------
Unallocated shares at end of period........................ 323,438 300,150
======= =======
The fair value of unallocated ESOP shares totaled $5.7 million and $4.1
million at June 30, 1997 and 1996, respectively.
(14) INCENTIVE PLANS
Recognition and Retention Plan (RRP)
As part of the conversion, the Association adopted the RRP as a method of
providing officers, employees and nonemployee directors of the Association
with a proprietary interest in the Company in a manner designed to encourage
such persons to remain with the Association. The Association contributed funds
to the RRP to enable the trust to acquire, in the aggregate, 4% or 165,600 of
the shares of common stock in the conversion. Under the RRP, awards are
granted in the form of shares of common stock held by the RRP. These shares
represent deferred compensation and have been accounted for as a reduction of
stockholders' equity. Shares allocated vest over a period of three to five
years commencing on January 1, 1995 and continuing on each anniversary date
thereafter. Awards are automatically vested upon a change in control of the
Company or the Association. In the event that before reaching normal
retirement, an officer, employee or director terminates service with the
Company or the Association, that person's nonvested awards are forfeited.
The expense related to the RRP for the fiscal years ended June 30, 1997,
1996 and 1995 was approximately $221,000, $327,000 and $343,000, respectively.
At June 30, 1997 and 1996, unearned compensation related to the RRPs was
approximately $172,000 and $393,000, respectively, and is shown as a reduction
to stockholders' equity in the accompanying consolidated statements of
financial condition.
The table below reflects RRP activity for the periods indicated:
YEAR ENDED JUNE
30
----------------
1997 1996
------- -------
Balance at beginning of period............................. 75,315 118,557
Stock dividend............................................. 8,018 --
Distributed................................................ (43,246) (43,242)
------- -------
Balance at end of period................................... 40,087 75,315
======= =======
F-26
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Stock Option Plans
In 1994, the stockholders of the Company ratified two stock option plans,
the 1993 Incentive Stock Option Plan (the Stock Plan) and the 1993 Stock
Option Plan for Outside Directors (the Directors' Plan). Both plans provide
for the grant of options at an exercise price equal to the fair market value
on the date of grant. The Stock Plan and the Directors' Plan are intended to
promote stock ownership by directors and selected officers and employees of
the Company to increase their proprietary interest in the success of the
Company and to encourage them to remain in the employ of the Company or its
subsidiaries. Awards granted under the Stock Plan may include incentive stock
options, nonstatutory options and limited rights which are exercisable only
upon a change in control of the Association or the Company. Awards under the
Directors' Plan are nonstatutory options.
At June 30, 1997, the Company had stock-based compensation plans for
employees and nonemployee directors which are described below. The Company
applies APB Opinion No. 25 and related interpretations for its plans, both of
which are fixed stock option plans. Accordingly, the Company did not recognize
compensation expense in connection with awards of stock options because the
exercise price and the fair market price were the same at the dates of award.
The Directors' Plan authorizes the granting of stock options for a total of
103,500 shares of common stock or 2.5% of the shares issued in the conversion.
The Stock Plan authorizes the granting of stock options for a total of 310,500
shares of common stock or 7.5% of the shares issued in the conversion. All
options granted under both plans in connection with the conversion were
granted at an exercise price of $7.50 per share, which was the offering price
of the common stock on the conversion date.
All options granted under the Directors' Plan became exercisable January 1,
1995; options granted to a subsequently elected outside director will become
exercisable on the first business day of January following that date on which
such subsequent outside director is qualified and first begins to serve as a
director, provided, however, that in the event of death, disability,
retirement or upon a change in control of the Company or the Association, all
options previously granted would automatically become exercisable. Each option
granted under the Directors' Plan expires upon the earlier of ten years
following the date of grant or one year following the date the optionee ceases
to be a director.
All options granted under the Stock Plan are exercisable in three equal
annual installments commencing January 1, 1995 and continuing on each
anniversary date thereafter. All options will be exercisable in the event of
the optionee's death, disability, retirement or upon a change in control of
the Company or the Association. Each option granted under the Stock Plan
expires upon the earlier of ten years following the date of grant or three
months following the date on which the employee ceases to perform services for
the Association or the Company, except that in the event of death, disability,
retirement or upon a change in control of the Company or the Association,
options may be exercisable for up to one year thereafter or such longer period
as determined by the Company.
F-27
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The table below reflects option activity for the periods indicated:
YEAR ENDED JUNE 30
-------------------------
1997 1996 1995
------- ------- -------
Balance at beginning of period.................... 364,825 398,825 408,825
Stock dividend.................................... 71,988 -- --
Exercised......................................... (76,875) (34,000) (10,000)
------- ------- -------
Balance at end of period.......................... 359,938 364,825 398,825
======= ======= =======
Options exercisable............................... 359,938 261,325 191,825
======= ======= =======
Remaining shares available for grant.............. 6,468 5,175 5,175
======= ======= =======
(15) COMMITMENTS AND CONTINGENCIES
The Company leases certain premises and equipment on a long-term basis. Some
of these leases require the Company to pay property taxes and insurance. Lease
expense was approximately $430,000, $501,000 and $473,000 in 1997, 1996 and
1995, respectively. Annual minimum lease commitments attributable to long-term
operating leases at June 30, 1997 were (in thousands):
Year ending June 30:
1998................................................................ $ 354
1999................................................................ 334
2000................................................................ 317
2001................................................................ 300
2002................................................................ 247
Thereafter through 2008............................................. 540
------
$2,092
======
At June 30, 1997 and 1996, the Company had approved commitments to originate
loans of approximately $9.9 million and $26.7 million, respectively,
substantially all of which were for adjustable rate one to four unit
residential loans and multifamily residential loans. Commitments to extend
credit are agreements to lend to a customer as long as there is no violation
of any condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a
fee. Since certain of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Company minimizes its exposure to loss under these
commitments by requiring that customers meet certain conditions prior to
disbursing funds. The amount of collateral, if any, is based on a credit
evaluation of the borrower and generally involves residential real estate.
At June 30, 1997 and 1996, the Company had $18.9 million and $9.2 million of
approved undisbursed lines of credit, respectively.
At June 30, 1997 and 1996, the Company had commitments to sell loans of
$623,000 and $2.9 million, respectively, which are included in loans held for
sale. There were commitments to purchase loans of $15.0 million and $292,000
at June 30, 1997 and 1996, respectively. The Company had no commitments to
sell investment securities or mortgage-backed securities at June 30, 1997 and
1996. There were no commitments to purchase investment securities at June 30,
1997. There were commitments to purchase investment securities of $1.4 million
at June 30, 1996.
The Company is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business. Such
routine legal proceedings in the
F-28
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
aggregate are believed by management to be immaterial to the Company's
financial condition or results of operations.
(16) LOAN SERVICING AND SALE ACTIVITIES
Loan servicing and sale activities are summarized as follows:
AT OR FOR THE YEAR ENDED
JUNE 30
----------------------------
1997 1996 1995
-------- -------- --------
(IN THOUSANDS)
Statement of financial condition information--
loans receivable held for sale................ $ 623 $ 2,890 $ 1,666
======== ======== ========
Statement of operations information:
Loan servicing fees........................... $ 791 $ 715 $ 696
Gain on sale of loans held for sale........... 356 175 86
======== ======== ========
Statement of cash flows information:
Loans originated for sale..................... $(31,598) $(28,922) $(12,214)
Sale of loans held for sale................... 33,870 27,662 10,321
======== ======== ========
The Company originates mortgage loans, which depending upon whether the
loans meet the Company's investment objectives, may be sold in the secondary
market or to other private investors. The servicing of these loans may or may
not be retained by the Company. Direct origination and servicing costs for
loan servicing and sale activities cannot be presented as these operations are
integrated with and not separable from the origination and servicing of
portfolio loans and, as a result, cannot be accurately estimated.
(17) PARENT COMPANY CONDENSED FINANCIAL INFORMATION
This information should be read in conjunction with the other notes to the
consolidated financial statements. The following are the condensed financial
statements for Quaker City Bancorp, Inc. (parent company only) as of June 30,
1997 and 1996 and for the years ended June 30, 1997, 1996 and 1995:
STATEMENTS OF FINANCIAL CONDITION
JUNE 30
---------------
1997 1996
ASSETS ------- -------
(IN THOUSANDS)
Cash....................................................... $ 237 $ 187
Short-term investments..................................... 6,450 1,300
Investment securities held to maturity..................... 5,000 8,395
Investment securities available for sale................... 1,432 --
Mortgage-backed securities held to maturity................ 109 496
Investment in subsidiaries................................. 60,611 57,609
Other assets............................................... 28 109
------- -------
$73,867 $68,096
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities--other liabilities............................. $ 3,624 $ 170
Stockholders' equity....................................... 70,243 67,926
------- -------
$73,867 $68,096
======= =======
F-29
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
STATEMENTS OF EARNINGS
YEAR ENDED JUNE 30
----------------------
1997 1996 1995
------ ------ ------
(IN THOUSANDS)
Interest income............ $ 709 962 981
Interest expense........... -- -- (71)
Other income............... 13 41 15
Other expense.............. (290) (284) (310)
Income taxes............... (210) (297) (253)
------ ------ ------
Earnings before equity
in earnings of
subsidiaries.......... 222 422 362
Equity in earnings of
subsidiaries.............. 2,598 3,147 1,959
------ ------ ------
Net earnings............... $2,820 $3,569 $2,321
====== ====== ======
STATEMENTS OF CASH FLOWS
YEAR ENDED JUNE 30
-------------------------
1997 1996 1995
------- ------- -------
(IN THOUSANDS)
Cash flows from operating activities:
Net earnings...................................... $ 2,820 3,569 2,321
Adjustments to reconcile net earnings to cash
provided by operating activities:
Equity in earnings of subsidiaries.............. (2,598) (3,147) (1,959)
Amortization.................................... (1) 192 53
Decrease in other assets........................ 81 111 396
Increase (decrease) in other liabilities........ 3,454 111 (67)
Other........................................... 553 267 677
------- ------- -------
Total adjustments............................. 1,489 (2,466) (900)
Net cash provided by operating activities..... 4,309 1,103 1,421
------- ------- -------
Cash flows from investing activities:
Purchases of investment securities held to
maturity......................................... -- (11,998) (1,879)
Proceeds from maturity of investment securities
held to maturity................................. 3,400 9,965 8,000
Principal payments on MBS held to maturity........ 383 5,190 522
Purchases of investment securities available for
sale............................................. (1,199) (2,400) (5,580)
Sale of investment securities available for sale.. -- 2,550 5,900
------- ------- -------
Net cash provided by investing activities..... 2,584 3,307 6,963
------- ------- -------
Cash flows from financing activities:
Proceeds from other borrowings.................... -- -- 20,118
Repayment of other borrowings..................... -- -- (27,137)
Repurchase of stock............................... (2,270) (3,249) (1,406)
Proceeds from exercise of stock options........... 577 255 75
------- ------- -------
Net cash used by financing activities......... (1,693) (2,994) (8,350)
------- ------- -------
Net increase in cash and cash equivalents..... 5,200 1,416 34
Cash and cash equivalents, beginning of year...... 1,487 71 37
------- ------- -------
Cash and cash equivalents, end of year............ $ 6,687 1,487 71
======= ======= =======
F-30
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(18) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED
--------------------------------------------
JUNE
30, MARCH 31, DECEMBER 31, SEPTEMBER 30,
1997 1997 1996 1996
------- --------- ------------ ------------- ---
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Interest income............... $15,282 14,838 14,481 14,067
Interest expense.............. 9,215 8,844 8,561 8,281
------- ------ ------ ------
Net interest income......... 6,067 5,994 5,920 5,786
Provision for loan losses..... 500 500 501 1,500
Other income.................. 861 640 659 610
Other expense................. 3,786 3,794 3,887 7,046
------- ------ ------ ------
Earnings (loss) before
income taxes (benefit)..... 2,642 2,340 2,191 (2,150)
Income taxes (benefit)........ 1,153 1,001 932 (883)
------- ------ ------ ------
Net earnings (loss)......... $ 1,489 1,339 1,259 (1,267)
======= ====== ====== ======
Net earnings (loss) per share. $ .32 .29 .26 (.28)
======= ====== ====== ======
The increase in other expense for the three months ended September 30, 1996,
relative to the other quarters presented is due to the $3.1 million accrual
for the SAIF special assessment.
The increase in the provision for loan losses for the three months ended
September 30, 1996, relative to the other quarters presented, is a result of
management's decision to increase the general valuation allowance to keep pace
with the growth in the loan portfolio and an increase in performing loans
which demonstrated some weakness during the quarter.
THREE MONTHS ENDED
--------------------------------------------
JUNE
30, MARCH 31, DECEMBER 31, SEPTEMBER 30,
1996 1996 1995 1995
------- --------- ------------ ------------- ---
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Interest income............... $13,816 13,325 13,114 12,391
Interest expense.............. 7,958 7,805 7,849 7,539
------- ------ ------ ------
Net interest income......... 5,858 5,520 5,265 4,852
Provision for loan losses..... 802 600 500 201
Other income.................. 733 666 591 499
Other expense................. 3,996 3,998 3,936 3,809
------- ------ ------ ------
Earnings before income
taxes...................... 1,793 1,588 1,420 1,341
Income taxes.................. 763 655 589 566
------- ------ ------ ------
Net earnings................ $ 1,030 933 831 775
======= ====== ====== ======
Net earnings per share........ $ .22 .19 .17 .16
======= ====== ====== ======
F-31
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(19) FAIR VALUE OF FINANCIAL INSTRUMENTS
Pursuant to the requirements of SFAS No. 107, "Disclosure about Fair Value
of Financial Instruments", as amended by SFAS No. 119, "Disclosure about
Derivative Financial Instruments," the Company has included information about
the fair values of the Company's financial instruments, whether or not such
instruments are recognized in the accompanying consolidated statements of
financial condition. In cases where quoted market prices are not available,
fair values are estimated based upon discounted cash flows. Those techniques
are significantly affected by the assumptions utilized, including the assumed
discount rates and estimates of future cash flows. In this regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in an immediate sale or
other disposition of the instrument. SFAS No. 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure requirements.
All components of cash and cash equivalents and accrued interest receivable
and payable are presumed to have approximately equal book and fair values
because the periods over which such amounts are realized are relatively short.
As a result of the assumptions utilized, the aggregate fair value estimates
presented herein do not necessarily represent the Company's aggregate
underlying fair value.
The fair values of investment securities and MBS are generally obtained from
market bids for similar or identical securities, or are obtained from quotes
from independent security brokers or dealers.
Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as one to four units,
multifamily, commercial real estate and other. Each loan category is further
segmented into fixed and adjustable rate interest terms and by performing and
nonperforming categories.
The fair value of performing loans is calculated by discounting scheduled
cash flows through the estimated maturity using estimated market discount
rates that reflect the credit and interest rate risk inherent in the loan. The
estimate of maturity is based on the contractual term of the loans to
maturity, adjusted for estimated prepayments.
Fair value for nonperforming loans is based on management's evaluation of
fair value as determined by specific borrower information and, if appropriate,
the fair value of the underlying collateral.
The fair values of deposits are estimated based upon the type of deposit
product. Demand and money market deposits are presumed to have equal book and
fair values. The estimated fair values of time deposits are determined by
discounting the cash flows of segments of deposits having similar maturities
and rates, utilizing a yield curve that approximated the rates offered as of
the reporting date. No value has been estimated for the Company's long-term
relationships with depositors (commonly known as the core deposit premium)
since such intangible asset is not a financial instrument pursuant to the
definitions contained in SFAS No. 107.
The fair values of commitments to extend credit are based on rates for
similar transactions as of the reporting date.
The fair values of borrowings were estimated using current market rates of
interest for similar borrowings.
F-32
QUAKER CITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table presents the carrying amounts and fair values of the
Company's financial instruments at the dates indicated. See note 1 to the
consolidated financial statements for a discussion of the accounting policies
followed in determining fair value information:
JUNE 30
----------------------------------
1997 1996
---------------- ----------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- ------- -------- -------
ASSETS:
Cash and due from banks................. $ 7,067 7,067 2,184 2,184
Interest-bearing deposits............... 336 336 4,984 4,984
Federal funds sold and other short-term
investments............................ 12,950 12,950 6,400 6,400
Investment securities................... 36,654 36,493 37,419 36,808
Investment securities available for
sale................................... 1,432 1,432 -- --
Loans receivable, net................... 644,964 655,310 607,672 609,358
Loans receivable held for sale.......... 623 623 2,890 2,890
Mortgage-backed securities.............. 74,139 74,596 41,175 41,561
Federal Home Loan Bank stock............ 9,718 9,718 8,151 8,151
LIABILITIES:
Deposits................................ 553,186 551,296 512,517 513,460
Federal Home Loan Bank advances......... 157,700 157,659 135,300 134,599
Securities sold under agreements to
repurchase............................. -- -- 300 300
Off-balance sheet:
Commitments to extend credit.......... -- 89 -- 293
Commitments to purchase loans......... -- 94 -- --
Unused lines of credit................ -- 250 -- 120
Loans sold with recourse (including
bond loans).......................... -- (222) -- (84)
======= ======= ======= =======
F-33
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by this reference is the information set forth in the
sections entitled "DIRECTORS AND EXECUTIVE OFFICERS--Directors" and "--
Executive Officers" and SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING
COMPLIANCE contained in the Company's Proxy Statement for its 1997 Annual
Meeting of Stockholders (the "1997 Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by this reference is the information set forth in the
sections entitled "COMPENSATION AND OTHER INFORMATION" and "COMPENSATION
COMMITTEE REPORT ON EXECUTIVE COMPENSATION" contained in the 1997 Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by this reference is the information set forth in the
sections entitled "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS" and
"SECURITY OWNERSHIP OF MANAGEMENT" contained in the 1997 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by this reference is the information set forth in the
section entitled "RELATED PARTY TRANSACTIONS" contained in the 1997 Proxy
Statement.
II-1
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS
PAGE
DESCRIPTION NO.
----------- ----
Independent Auditors' Report........................................... F-1
Consolidated Statements of Financial Condition at June 30, 1997 and
1996.................................................................. F-2
Consolidated Statements of Earnings for Each of the Years in the Three-
Year Period Ended June 30, 1997....................................... F-3
Consolidated Statements of Stockholders' Equity for Each of the Years
in the Three-Year Period Ended June 30, 1997.......................... F-4
Consolidated Statements of Cash Flows for Each of the Years in the
Three-Year Period Ended June 30, 1997................................. F-5
Notes to Consolidated Financial Statements............................. F-7
(A)(2) FINANCIAL STATEMENT SCHEDULES
All schedules are omitted as the required information is inapplicable or the
information is presented in the consolidated financial statements or related
notes.
(A)(3) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 Certificate of Incorporation of Quaker City Bancorp, Inc.(1)
3.2 Bylaws of Quaker City Bancorp, Inc.(1)
10.1 Quaker City Bancorp, Inc. 1993 Incentive Stock Option Plan.*(1)
Quaker City Bancorp, Inc. 1993 Stock Option Plan for Outside
10.2 Directors.*(1)
10.3 Quaker City Federal Savings and Loan Association Recognition and
Retention Plan for Officers and Employees.*(1)
10.4 Quaker City Federal Savings and Loan Association Recognition and
Retention Plan for Outside Directors.*(1)
10.5 Employment Agreements between Quaker City Bancorp, Inc. and Quaker
City Federal Savings and Loan Association, respectively, and
J.L. Thomas as of January 1, 1994 and as amended to September 27,
1994, respectively.*(1)
10.5.1 Quaker City Federal Savings and Loan Association Three Year
Employment Agreement Renewal and Extension Acknowledgment between
Quaker City Federal Savings and Loan Association and J.L. Thomas
dated June 23, 1995.*(2)
10.5.2 Employment Agreements between Quaker City Bancorp, Inc. and Quaker
City Federal Savings and Loan Association, respectively, and J.L.
Thomas as of July 1, 1996.*(3)
10.5.3 Quaker City Federal Savings and Loan Association Three Year
Employment Agreement Renewal and Extension Acknowledgment between
Quaker City Federal Savings and Loan Association and J.L. Thomas
dated July 1, 1997.*
10.6 Employment Agreements between Quaker City Bancorp, Inc. and Quaker
City Federal Savings and Loan Association, respectively, and
Frederic R. (Rick) McGill as of January 1, 1994 and as amended to
September 27, 1994, respectively.*(1)
10.6.1 Quaker City Federal Savings and Loan Association Two Year Employment
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Frederic R. (Rick) McGill
dated June 23, 1995.*(2)
10.6.2 Employment Agreements between Quaker City Bancorp, Inc. and Quaker
City Federal Savings and Loan Association, respectively, and
Frederic R. (Rick) McGill as of July 1, 1996.*(3)
II-2
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.6.3 Quaker City Federal Savings and Loan Association Three Year
Employment Agreement Renewal and Extension Acknowledgment between
Quaker City Federal Savings and Loan Association and Frederic R.
McGill dated July 1, 1997.*
10.7 Change-in-Control Agreements between Quaker City Bancorp, Inc. and
Quaker City Federal Savings and Loan Association, respectively, and
Dwight L. Wilson as of January 1, 1994 and as amended to September 27,
1994, respectively.*(1)
10.7.1 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Dwight L. Wilson dated
September 7, 1995.*(2)
10.7.2 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Dwight L. Wilson dated
July 1, 1996.*(3)
10.7.3 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Dwight L. Wilson dated July
1, 1997.*
10.8 Change-in-Control Agreements between Quaker City Bancorp, Inc. and
Quaker City Federal Savings and Loan Association, respectively, and
Harold L. Rams as of January 1, 1994 and as amended to September 27,
1994, respectively.*(1)
10.8.1 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Harold Rams dated July 1,
1995.*(2)
10.8.2 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Harold Rams dated July 1,
1996.*(3)
10.8.3 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Harold Rams dated July 1,
1997.*
10.9 Change-in-Control Agreements between Quaker City Bancorp, Inc. and
Quaker City Federal Savings and Loan Association, respectively, and
Kathryn M. Hennigan as of January 1, 1994 and as amended to September
27, 1994, respectively.*(1)
10.9.1 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Kathryn M. Hennigan dated
July 1, 1995.*(2)
10.9.2 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Kathryn M. Hennigan dated
July 1, 1996.*(3)
10.9.3 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Kathryn M. Hennigan dated
July 1, 1997.*
10.10 Change-in-Control Agreements between Quaker City Bancorp, Inc. and
Quaker City Federal Savings and Loan Association, respectively, and
Karen A. Tannheimer as of January 1, 1994 and as amended to September
27, 1994, respectively.*(1)
10.10.1 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Karen A. Tannheimer dated
June 23, 1995.*(2)
II-3
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.10.2 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Karen A. Tannheimer dated
July 1, 1996.*(3)
10.10.3 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Karen A. Tannheimer dated
July 1, 1997.*
10.11 Change-in-Control Agreements between Quaker City Bancorp, Inc. and
Quaker City Federal Savings and Loan Association, respectively, and
Robert C. Teeling as of January 1, 1994 and as amended to September
27, 1994, respectively.*(1)
10.11.1 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Robert C. Teeling dated
July 1, 1995.*(2)
10.11.2 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Robert C. Teeling dated
July 1, 1996.*(3)
10.11.3 Quaker City Federal Savings and Loan Association Change in Control
Agreement Renewal and Extension Acknowledgment between Quaker City
Federal Savings and Loan Association and Robert C. Teeling dated
July 1, 1997.*
10.12 The Quaker City Federal Savings and Loan Association Supplemental
Executive Retirement Plan.*(1)
10.13 Quaker City Federal Savings Association Employee Stock Ownership
Trust Loan and Security Agreement between California Central Trust
Bank, as trustee (the "Trustee") and Quaker City Bancorp, Inc. dated
as of December 30, 1993 and related Promissory Note and Security
Agreement Re Instruments or Negotiable Documents to be Deposited of
the Trustee dated December 30, 1993.*(1)
10.14 Quaker City Bancorp, Inc. 1997 Stock Incentive Plan.*
**11.1 Statement Regarding Computation of Earnings Per Share
**21 Subsidiaries of Quaker City Bancorp, Inc.
23 Consent of KPMG Peat Marwick LLP
27 Financial Data Schedule
- --------
* Management contract or compensatory plan or arrangement required to be
filed as an exhibit to the Annual Report on Form 10-K pursuant to Item
14(c) of Form 10-K.
** Reproduced herein for the reader's convenience.
(1) Incorporated by reference to the corresponding exhibit to the Registrant's
Form 10-K as filed with the Securities and Exchange Commission for the
fiscal year ended June 30, 1994.
(2) Incorporated by reference to the corresponding exhibit to the Registrant's
Form 10-K as filed with the Securities and Exchange Commission for the
fiscal year ended June 30, 1995.
(3) Incorporated by reference to the corresponding exhibit to the Registrant's
Form 10-K as filed with the Securities and Exchange Commission for the
fiscal year ended June 30, 1996.
(B) REPORTS ON FORM 8-K
None.
II-4
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.
QUAKER CITY BANCORP, INC.,
a Delaware corporation
By: /s/ Frederic R. (Rick) McGill
___________________________________
Frederic R. (Rick) McGill
President and Chief Executive
Officer
DATE: September 23, 1997
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ J. L. Thomas Chairman of the Board September 23, 1997
--------------------------------------
J. L. Thomas
/s/ Frederic R. (Rick) McGill Director, President and September 23, 1997
-------------------------------------- Chief Executive Officer
Frederic R. (Rick) McGill (Principal Executive
Officer)
/s/ Dwight L. Wilson Senior Vice President, September 23, 1997
-------------------------------------- Treasurer and
Dwight L. Wilson Chief Financial Officer
(Principal Financial
Officer)
(Principal Accounting
Officer)
/s/ David T. Cannon Director September 23, 1997
--------------------------------------
David T. Cannon
/s/ Wayne L. Harvey Director September 23, 1997
--------------------------------------
Wayne L. Harvey
/s/ Edward L. Miller Director September 23, 1997
--------------------------------------
Edward L. Miller
/s/ David K. Leichtfuss Director September 23, 1997
--------------------------------------
David K. Leichtfuss
/s/ Alfred J. Gobar Director September 23, 1997
--------------------------------------
Alfred J. Gobar
II-5