=============================================================================== SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 FORM 10-Q MARK ONE: /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter ended SEPTEMBER 30, 1995 / / TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________. Commision File No. 0-11160 HOME INTERSTATE BANCORP (Exact Name of Registrant as Specified in its Charter) CALIFORNIA 95-3657758 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 2633 CHERRY AVENUE, SIGNAL HILL, CALIFORNIA 90806 - 2033 (address of Principal Executive Offices) (ZIP Code) Registrant's Telephone Number, Including Area Code: (310) 988-9600 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed the Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Applicable only to Corporate issuers: Indicate the number of shares oustanding of each of the issuer's classes of Common Stock as of the latest practicable date. Common Stock -- Authorized 20,000,000 shares of non par value; issued and outstanding 3,980,782 at October 27, 1995. =============================================================================== PART I ITEM 1. FINANCIAL STATEMENTS Following are the unaudited consolidated statements of financial condition of Home Interstate Bancorp (the "Company") and its wholly owned subsidiary, Home Bank (the "Bank") as of September 30, 1995, and December 31, 1994, and the consolidated statements of income for the quarters ended September 30, 1995, and September 30, 1994, and cash flows for the nine months ended September 30, 1995, and September 30, 1994. It is management's opinion that these statements present fairly, in all material respects, the financial condition, results of operations and cash flows of Home Interstate Bancorp and its subsidiary in conformity with generally accepted accounting principles. The accompanying notes are considered an integral part of these consolidated financial statements. 2 HOME INTERSTATE BANCORP AND SUBSIDIARY CONSOLIDATED BALANCE SHEET (Unaudited) (Dollars in thousands) SEPTEMBER 30, DECEMBER 31, 1995 1994 ------------- ------------ ASSETS: Cash and due from banks $ 44,415 $ 42,196 Federal funds sold 18,000 6,800 -------- -------- Total of cash and cash equivalent 62,415 48,996 Securities held to maturity (Approximate market value at September 30, 1995 was $4,230,000) 4,247 0 Securities available for sale 127,337 167,880 -------- -------- Securities, net 131,584 167,880 Loans 204,710 198,649 Less: Allowance for possible loan losses 3,146 2,818 -------- -------- Loans, net 201,564 195,831 Real estate owned 5,643 2,175 Premises, furniture and equipment, net 14,511 13,534 Accrued interest receivable and other assets 9,703 11,216 -------- -------- TOTAL ASSETS $425,420 $439,632 ======== ======== LIABILITIES: Deposits: Demand deposits, non-interest bearing $132,138 $135,409 Savings and interest bearing demand deposits 157,031 173,854 Time certificates of deposit of $100,000 and over 16,168 12,652 Other time deposits 66,455 70,354 -------- -------- Total Deposits 371,792 392,269 Securities sold under agreements to repurchase 0 100 Accrued interest payable and other liabilities 3,659 1,609 -------- -------- TOTAL LIABILITIES 375,451 393,978 -------- -------- Commitments and contingencies SHAREHOLDERS' EQUITY: Common stock (no par value) Authorized 20,000,000 shares; issued and outstanding 3,980,782 shares in 1995 and 3,976,722 shares in 1994 40,493 40,454 Retained earnings 9,459 8,156 Unrealized gains (loss) on securities available for sale, net of deferred taxes 17 (2,956) -------- -------- TOTAL SHAREHOLDERS' EQUITY 49,969 45,654 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $425,420 $439,632 ======== ======== The accompanying notes are an integral part of these consolidated statements of financial condition. 3 HOME INTERSTATE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited) (Dollars in thousands except for earnings per share) For the periods ended September 30, 1995 and 1994 NINE MONTHS ENDED THREE MONTHS ENDED ----------------- ------------------ 1995 1994 1995 1994 ------- ------- ------- ------- REVENUE FROM EARNING ASSETS: Interest and fees on loans $16,843 $14,720 $ 5,596 $ 5,235 Interest on securities: taxable 6,241 4,963 1,859 2,033 non-taxable 230 568 51 177 Interest on Federal funds sold 346 630 259 376 ------- ------- ------- ------- TOTAL REVENUE FROM EARNING ASSETS 23,660 20,881 7,765 7,821 ------- ------- ------- ------- COST OF FUNDS: Interest on savings and interest bearing demand deposits 2,554 2,680 861 1,000 Interest on time certificates of deposit of $100,000 and over 492 279 192 104 Interest on other time deposits 2,211 1,637 769 650 Interest on securities sold under agreements to repurchase 27 5 1 0 ------- ------- ------- ------- TOTAL COST OF FUNDS 5,284 4,601 1,823 1,754 ------- ------- ------- ------- Net revenue from earning assets before provision for possible loan losses 18,376 16,280 5,942 6,067 Provision for possible loan losses 1,025 450 100 150 ------- ------- ------- ------- Net revenue from earning assets 17,351 15,830 5,842 5,917 ------- ------- ------- ------- OTHER OPERATING REVENUE: Service charges and fees 3,017 2,441 1,025 876 Securities gains, net 46 9 4 0 Other operating revenue 832 985 277 288 ------- ------- ------- ------- TOTAL OTHER OPERATING REVENUE 3,895 3,435 1,306 1,164 ------- ------- ------- ------- OTHER OPERATING EXPENSES: Salaries and employee benefits 8,016 7,384 2,625 2,503 Occupancy expense, net 2,272 1,902 763 715 Other operating expenses 6,974 6,570 2,145 2,246 ------- ------- ------- ------- TOTAL OTHER OPERATING EXPENSES 17,262 15,856 5,533 5,464 ------- ------- ------- ------- Income before provision for income taxes 3,984 3,409 1,615 1,617 Provision for income taxes 1,389 980 609 392 ------- ------- ------- ------- NET INCOME $ 2,595 $ 2,429 $ 1,006 $ 1,225 ======= ======= ======= ======= EARNINGS PER SHARE(1) $ .65 $ .61 $ .25 $ .30 ======= ======= ======= ======= (1) Earnings per share adjusted for a five percent stock dividend issued in 1994. The accompanying notes are an integral part of these consolidated statements of financial condition. 4 HOME INTERSTATE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) FOR THE PERIODS ENDED SEPTEMBER 30, 1995 AND 1994 (Dollars in thousands) 1995 1994 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,595 $ 2,429 -------- -------- Adjustments to reconcile net income to net cash provided by operating activities: Provision for depreciation and amortization 676 528 Provision for possible loan losses 1,025 450 Amortization of securities premiums 1,247 971 Accretion of securities discounts (84) (62) Amortization of deferred loan fees and costs (646) (768) Net gain on sale of securities (46) (9) Net (gain) loss on sale of premises, furniture and equipment 26 (3) Net (gain) loss on real estate owned 564 443 Net (increase) decrease in accrued interest receivable and other assets 1,513 (3,654) Net increase (decrease) in accrued interest payable and other liabilities (62) 2,986 -------- -------- Total adjustments 4,213 882 -------- -------- Net cash provided by operating activities 6,808 3,311 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of securities 30,337 102 Proceeds from maturities of securities 19,555 20,572 Purchase of securities (9,626) (85,873) Net (increase) decrease in loans (6,112) 556 Proceeds from sale of real estate owned 2,668 1,909 Acquisition of real estate owned (6,700) (1,227) Proceeds from sale of premises, furniture and equipment 11 3 Purchase of premises, furniture and equipment (1,691) (1,275) -------- -------- Net cash provided by (used in) investing activities 28,442 (65,233) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in demand deposits non-interest bearing, savings and interest bearing demand deposits (20,094) 63,930 Net decrease in time certificates of deposit of $100,000 and over 3,516 1,023 Net increase (decrease) in other time deposits (3,899) 11,947 Net decrease in securities sold under agreements to repurchase (100) (3,900) Proceeds from stock options exercised 39 0 Cash dividends declared (1,293) (1,137) -------- -------- Net cash provided by (used in) financing activities (21,831) 71,863 -------- -------- Net increase (decrease) in cash and cash equivalents 13,419 9,941 Cash and cash equivalents at beginning of year 48,996 49,449 -------- -------- Cash and cash equivalents at end of year $ 62,415 $ 59,390 ======== ======= 5 HOME INTERSTATE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS CONTINUED (UNAUDITED) FOR THE PERIODS ENDED SEPTEMBER 30, 1995 AND 1994 (Dollars in thousands) 1995 1994 ---------- ---------- SUPPLEMENTAL DISCLOSURES: Supplemental disclosure of non-cash investing and financing activities: Adjustment of FASB 115: (Increase) decrease in unrealized gains/ losses on securities available for sale $ (5,086) $ 5,112 Increase (decrease) in deferred tax liabilities related to unrealized gains/losses on securities available for sale 2,112 (2,267) Increase (decrease) in shareholders' equity for unrealized gains/ losses, net of deferred taxes 2,974 (2,845) Supplemental disclosure of cash flow information Cash paid during the year for: Interest expense $ 5,245 $ 4,490 Income taxes 1,945 657 6 HOME INTERSTATE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1995 (Unaudited) PRINCIPLES OF CONSOLIDATION The consolidated financial statements of Home Interstate Bancorp include the accounts of the Company and its wholly owned subsidiary, the Bank. All material intercompany balances and transactions have been eliminated in consolidation. PRINCIPLES OF PRESENTMENT The accompanying unaudited consolidated financial statements have been prepared in condensed format and, therefore do not contain all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been reflected in the financial statements. ACCOUNTING CHANGES The Company adopted Statement of Financial Accounting Standard ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118. These standards require that impaired loans be measured based on the present value of expected future cash flows, the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The statement was adopted as of January 1, 1995. The initial impact to the provision for possible loan losses in the first quarter of 1995 was an addition of $150,000. Additional adjustments to the provision for possible loan losses were not made during the second and third quarters of 1995. The aggregate total provision for loan loss at September 30, 1995, was $1,025,000. EARNINGS PER SHARE Earnings per share are based upon the weighted average number of shares outstanding during each period. The affect of stock options outstanding are not materially diluting and are not, therefore, included for the purpose of earnings per share calculations. The average weighted number of shares used was, 3,976,722 at September 30, 1995, 3,976,388 at December 31, 1994, and 3,976,271 at September 30, 1994. STATEMENT OF CASH FLOWS For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks and Federal funds sold. Generally, Federal funds are sold for one-day periods. The Company made cash payments of $5,245,000 and $4,490,000 for interest paid on deposit accounts and $1,945,000 and $657,000 for income taxes for the periods ended September 30, 1995, and 1994, respectively. 7 ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION GENERAL The Company's consolidated assets of $425,420,000 at September 30, 1995, decreased 3.23% from December 31, 1994, which had consolidated assets of $439,632,000. Cash and cash equivalents increased 27.39% or $13,419,000, of which $11,200,000 was related to an increase in federal funds sold. Securities held to maturity purchased during the nine months ended September 30, 1995, totaled $4,247,000 and $0 at December 31, 1994. Securities available for sale, net of unrealized gains / (losses) decreased 24.15% or $40,543,000 and loans increased 3.05% or $6,061,000 when comparing September 30, 1995, to December 31, 1994. Deposits decreased 5.22% or $20,477,000 when comparing the same periods. The reduction in securities available for sale was partially utilized in the funding of a contraction in deposits, primarily in the area of savings and interest bearing demand deposits as deposit customers sought alternatives for higher yields on their investment dollars. The reduction in securities available for sale also replenished overnight federal funds that had experienced a drop earlier in the year as a result of the contraction in deposits. Management utilizes overnight federal funds as a vehicle that allows immediate funding for loan commitments and potentially large deposit withdrawals while earning interest income. In October 1995, the Bank entered into a deposit purchase agreement with Southern California Bank to purchase the deposits of their Signal Hill office, subject to regulatory approval. The transaction would be approximately one percent of the Bank's total deposits and less than one percent of total assets. The transaction is expected to be completed in the first quarter of 1996. The Bank has applied for membership in the Federal Reserve System. Approval of this application was received in the fourth quarter and is expected to be finalized by the end of November 1995. As a member of the Federal Reserve System, the Bank will be subject to supervision, periodic examination and regulation by the Board of Governors of the Federal Reserve System. The deposits of the Bank will continue to be insured under the Bank Insurance Fund ("BIF") of the FDIC. ACQUISITIONS OF FAILED FINANCIAL INSTITUTIONS In April and July of 1994, the Bank entered into Purchase and Assumption Agreements ("P & A Agreements") with the Federal Deposit Insurance Corporation ("FDIC"). Under the terms of the P & A Agreement for the Mechanics National Bank ("MNB") and the FDIC Consortium Agreement effective April 1, 1994, the Bank was named as lead bank. Two branch operations of MNB were acquired creating a new Paramount office facility. The Bank then merged its existing Paramount office into the new Paramount office facility. The MNB Torrance office was merged into the Bank's existing Torrance office. The Bank purchased approximately $21,700,000 of certain assets consisting principally of cash and cash equivalents, securities and Fed funds sold and assumed approximately $17,100,000 of certain liabilities consisting of insured deposit liabilities and accrued interest from the FDIC. The Bank's old Paramount office is currently being used as a warehouse facility and the Bank opted not to keep the Torrance Facility of MNB. Under the terms of the P & A Agreement for the Bank of San Pedro effective July 15, 1994, the Bank was the sole institution involved. The Bank of San Pedro originally had six branch locations of which the Bank opted to keep two facilities open and merged the other four into other offices. Some of the employees of the Bank of San Pedro were hired to staff the two new locations. The Bank purchased $12,884,000 of certain assets consisting principally of loans, cash and cash equivalents and investment securities, and assumed approximately $74,200,000 of certain liabilities consisting of insured deposit liabilities and accrued interest from the FDIC. 8 CAPITAL RESOURCES The Company's strategic plan centers around continued growth where conservative opportunities present themselves. Capital strength is a prerequisite for such growth. The Company's internal growth rate of capital was 9.45% while assets decreased by 3.23% from year-end December 31, 1994. The increase in ending total capital reflects the improvement in unrealized gains (losses) on securities available for sale, net of deferred taxes from a loss of $2,956,000 at December 31, 1994 to a gain of $17,000 at September 30, 1995. The following schedule reflects specific capital related information and ratios: (DOLLARS IN THOUSANDS) SEPTEMBER 30, 1995 DECEMBER 31, 1994 % CHANGE ------------------ ----------------- --------- Ending total capital $49,969 $45,654 9.45 Risk based capital-to-assets ratios: REGULATORY REQUIREMENT ----------- Tier 1 capital 16.82 16.25 4.00 Total capital 17.99 17.30 8.00 Leverage ratio 10.81 10.17 3.00 -- 5.00 LIQUIDITY AND BALANCE SHEET MANAGEMENT The asset/liability management process determines the size and composition of the balance sheet and focuses on the management of liquidity and interest rate exposures. The purpose of liquidity and balance sheet management is to reflect the Company's ability to provide funds for day-to-day operations, meet customer needs, take advantage of interest rate market opportunities and meet the financial commitments of the Company. Funding of loan requests and commitments, purchase of attractive securities opportunities, providing for liability outflow, and management of interest rate risk requires continuous analysis in order to match the maturities of categories of loans and securities with the maturities of deposits and bank related borrowings. The Company's ability to obtain funds to replace maturing liabilities and to finance asset growth depends upon its reputation as well as the diversity and liquidity of the markets in which it participates. The Company's liquidity is normally viewed in terms of the nature and composition of the Company's sources and uses of funds. Cash, maturing securities, reductions in Federal funds sold and loan maturities and repayments provide liquidity. Purchase of Federal funds, sale of securities, sale of loan participations or sale of the Company's loans on the secondary market and utilization of other short-term borrowing facilities are all available to provide additional liquidity vehicles. Liquid assets are comprised of cash and cash equivalent assets (cash, cash due from other financial institutions and Federal funds sold), U. S. Treasury securities and U. S. Government agencies securities. The increase in cash and cash equivalents was due to the sale of some securities available for sale to subsidize the contraction in deposits which management believes was due to customers seeking alternatives for higher yields on their investment dollars (see "General" herein). The following schedule reflects specific liquidity information and ratios: (DOLLARS IN THOUSANDS) SEPTEMBER 30, 1995 DECEMBER 31, 1994 % CHANGE ------------------ ----------------- -------- Gross loans $204,710 $198,649 3.05 Total deposits $371,792 $392,269 (5.22) Gross loan-to-deposit ratio 55.06 50.64 Gross loan-to-total assets ratio 48.12 45.19 Cash and cash equivalent assets as a percentage of total assets 14.67 11.14 9 SECURITIES The portfolio is made up of U. S. Treasury securities, obligations of other U.S. Government agencies, obligations of state and political subdivisions, and other debt and equity securities. Under the terms of FASB 115 these securities are required to be classified as held to maturity, available for sale or trading. The Company does not maintain a trading account and classifies securities as either held to maturity or available for sale. Securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and accounted for at cost, adjusted for amortization of premium and accretion of discount. During 1995, $4,247,000 of securities were purchased and added to the held to maturity portfolio. Under the terms of FASB 115, securities classified available for sale are required to be marked to market. Due to the improved market valuations and changes in volume of outstanding securities, the unrealized gains (losses) on these securities, net of deferred taxes, were $17,000 at September 30, 1995, compared to ($2,956,000) at December 31, 1994. The activity in the available for sale portfolio had securities sold of $30,337,000 and securities matured/called of $19,555,000 during the first nine months ended September 30, 1995. The proceeds from these securities were used to fund the decrease in deposits during the same period. The net gains on these securities were $46,000. Purchases added to the available for sale portfolio were $5,379,000 during the same period. NONPERFORMING LOANS AND REAL ESTATE OWNED (DOLLARS IN THOUSANDS) SEPTEMBER 30, 1995 DECEMBER 31, 1994 % CHANGE ------------------ ----------------- -------- Non-accrual loans $4,875 $6,593 (26.06) Loans 90 days past due 232 52 346.15 Real estate owned 5,643 2,175 159.45 The Bank's non-accrual loans showed a decrease of 26.06% for the nine months ended September 30, 1995. Of the $6,593,000 at December 31, 1994, $478,000 was charged off, $3,437,000 was transferred to real estate owned and $1,345,000 was received in payments. The $4,875,000 in non-accrual on September 30, 1995, includes $3,542,000 added since December 31, 1994. Of the $4,875,000 in non-accrual loans $4,606,000 is secured by deeds of trust, $54,000 is secured by other collateral and one loan in the amount of $215,000 is unsecured. The largest group of loans in non-accrual status are to related entities and total in aggregate $2,668,000 of which $2,399,000 is secured by real estate, having an approximate loan to value of 81%. Management has set a specific reserve of $729,000 on the $2,668,000 and it is believed to be sufficient to absorb any anticipated loss. The next largest non-accrual loan had a balance of $925,000 at September 30, 1995, which was paid down from $1,576,000 at year end December 31, 1994. This loan is secured by real estate and has a loan to value ratio of approximately 95%. This loan has a specific reserve of $102,000 and is expected to be paid in full by December 31, 1995. Management feels that the current allowance for loan loss is adequate for the recognizable losses in the nonperforming loans. Under the provisions of SFAS No. 114, a loan is considered impaired when, based on current information 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 the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The Bank has defined Impaired Loans as individual loans or relationships of $250,000 or more and not currently accruing interest. As permitted by these standards, the Bank excludes from their calculations smaller balance, homogenous loans such as consumer installment loans, lines of credit, direct finance leases and loans on which it expects to collect all amounts of principal and interest. The Bank measures impairment on a loan-by-loan basis using either the present value of expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral if the loan is collateral dependent. 10 Accrual of interest on loans and leases is discontinued when management believes, after considering economic and business conditions, and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful; whereas, loans are considered impaired when it is probable that the Bank will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the loan agreement. Interest income is subsequently recognized on non-accrual loans only to the extent cash payments are received or until, in management's judgment, the borrower's ability to make periodic interest and principal payments is no longer doubtful, in which case the credit is returned to accrual status. At September 30, 1995, the Bank had $4,598,000 in impaired loans and a related loss allowance of $1,077,000. Of the $4,598,000 of impaired loans, $1,242,000 was measured using the present value method and $3,356,00 was measured using the fair value of collateral. Loans that are 90 days or more past due increased by 346.15% during the nine months ended September 30, 1995. The total comprises one commercial loan in the amount of $174,000, an installment loan in the amount of $9,000 and 29 overdraft protection lines totaling $49,000. The Bank's total real estate owned increased 159.45% to $5,643,000 at September 30, 1995, from $2,175,000 at December 31, 1994. The increase is primarily due to the foreclosure of five properties. Two of these foreclosure actions resulted in properties representing 59% of the total real estate owned balance at September 30, 1995. One is a 60 unit manufactured housing complex valued at $2,300,000 and the other is made up of three theaters valued at $1,008,000. The 60 unit manufactured housing complex and one of the three theaters are in escrow. Both are expected to close escrow by the end of the year. Reductions in real estate owned during the third quarter came from the sale of a four unit condominium project in Venice Beach and an auto repair facility in San Pedro which resulted in a net gain of approximately $8,700. Writedowns of $550,000 were recognized for the nine months ended September 30, 1995, due to deterioration in value of certain properties. Other real estate owned properties in the amount of $2,335,000 consists of 161 acres of unimproved land in Orange County, a commercial property in Lawndale, Ca., a gas station in Chino, Ca. and a single family residence in Westchester, Ca. The commercial property in Lawndale and the single family residence in Westchester are in escrow and are expected to close escrow prior to year end. Real estate owned is carried at the lower of cost or fair market value less estimated carrying costs and costs of disposition. Cost is determined at the date of acquisition as the result of a foreclosure sale and is equal to the receivable balance at that date. If the cost (plus any liabilities assumed at foreclosure) exceeds the appraised value, the carrying value of the property is written down to its fair value. During the time the property is held, all related carrying costs and losses on revaluation are expensed as incurred. Gains or losses on sales are recorded in conformity with standards that apply to the accounting for sales of real estate. DEPOSITS Strong rallies in the equities markets and related strength in the mutual funds markets has continued to attract customer deposits away from financial institutions as evidenced by the significant outflow of funds from savings and interest bearing demand deposits. The Bank offered slightly higher rates in time certificate of deposits of $100,000 and over which was attractive to some deposit customers. The following schedule reflects specific deposit information and percent change: (DOLLARS IN THOUSANDS) SEPTEMBER 30, 1995 DECEMBER 31, 1994 % CHANGE ------------------ ----------------- -------- Demand deposits, non-interest bearing $132,138 $135,409 (2.42) Savings and interest bearing demand deposits 157,031 173,854 (9.68) Time certificates of deposit of $100,000 and over 16,168 12,652 27.79 Other time deposits 66,455 70,354 (5.54) -------- -------- Total deposits $371,792 $392,269 (5.22) 11 RESULTS OF OPERATIONS NET INCOME Net income increased 6.83% or $166,000 for the nine months ended September 30, 1995, and decreased 17.88% or $219,000 for the three months ended September 30, 1995, compared to the same periods in 1994. Revenue from earning assets increased $2,779,000 for the nine months ended September 30, 1995, compared to the same period in 1994 (see "Interest Income" herein) and was the primary reason for the increase in net income, however, revenue from earning assets decreased $56,000 for the three months ended September 30, 1995, compared to the same period in 1994. The annualized yield increased from 7.86% for the nine months ended September 30, 1994, to 8.71% for the nine months ended September 30, 1995, and increased from 7.96% for the three months ended September 30, 1994, to 8.62% for the three months ended September 30, 1995. During the nine months ended September 30, 1995, the Company provided $1,025,000 for possible loan losses compared to $450,000 during the nine months ended September 30, 1994, and provided $100,000 for possible loan losses during the three months ended September 30, 1995, compared to $150,000 during the three months ended September 30, 1994 (see "Provision for Loan Losses" herein). Interest expense increased $683,000 for the nine months ended September 30, 1995, and $69,000 for the three months ended September 30, 1995, compared to the same periods in 1994 and other operating expenses increased $1,406,000 for the nine months ended September 30, 1995, and $69,000 for the three months ended September 30, 1995, when comparing the same periods in 1994 (see "Interest Expense" and "Other Expense" herein). Provision for income taxes increased $217,000 for the three months ended September 30, 1995, compared to the same period in 1994, and was a contributing factor for the decrease in net income during this period (see "Provision for Income Taxes" herein). INTEREST INCOME Interest income increased 13.31% during the nine months ended September 30, 1995, compared the same period in 1994 and decreased .72% during the three months ended September 30, 1995 compared to the same period in 1994. The yield on average earning assets increased for both periods, largely due to increases in the yield on loans and the yield on the securities portfolio. The yield on loans was 10.90% for the nine months ended September 30, 1995, compared to 9.86% for the nine months ended September 30, 1994, and 10.76% for the three months ended September 30, 1995, compared to 10.43% for the three months ended September 30, 1994. The increase in the loan yield resulted from an increase in interest and fees on loans of $2,123,000 for the nine months ended September 30, 1995, and $361,000 for the three months ended September 30, 1995, when comparing the same periods in 1994. The yield on the securities portfolio resulted from an increase in interest on securities of $940,000 for the nine months ended September 30, 1995, however the securities volume decrease resulted in a decrease in interest on securities of $300,000 for the three months ended September 30, 1995, when comparing the same periods in 1994. Interest income on federal funds sold decreased $285,000 for the nine months ended September 30, 1995 and decreased $177,000 for the three months ended September 30, 1995, compared to the same periods in 1994. The decrease in interest on federal funds sold was specifically due to the average volume decrease during these periods. The average earning assets increased 2.24% for the nine months ended September 30, 1995, compared to 1994 as a result of the purchase and assumption of two banks (see "Acquisitions of Failed Financial Institutions" herein.) However, due to reduction in securities available for sale (see "Securities" herein) average earning assets decreased 8.31% for the three months ended September 30, 1995, compared to same period in 1994. The following schedule provides specific information regarding the components of interest income from earning assets: (DOLLARS IN THOUSANDS) NINE MONTHS ENDED THREE MONTHS ENDED ---------------------------------- ------------------------------------ SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER 30, 1995 30, 1994 % CHANGE 30, 1995 30, 1994 % CHANGE ---------- ---------- -------- --------- --------- -------- Average earning assets $363,324 $355,356 2.24 $357,239 $389,631 (8.31) Interest income $ 23,660 $ 20,881 13.31 $ 7,765 $ 7,821 (.72) Annualized yield on average earning assets 8.71% 7.86% 8.62% 7.96% 12 INTEREST EXPENSE Interest expense increased 14.85% for the nine months ended September 30, 1995, and 3.93% for the three months ended September 30, 1995, compared to the same periods in 1994. These increases were mostly due to an increase in the time deposit interest rates. The increase in interest expense on time deposits for the nine months ended September 30, 1995, was $787,000 and for the three month period ended September 30, 1995, was $207,000 compared to the same periods in 1994. The percent of lower cost non-interest bearing demand deposits, savings deposits and interest bearing demand deposits to total deposits at September 30, 1995, was 77.78% compared to 79.25% at September 30, 1994, while the percent of time deposits to total deposits at September 30, 1995, was 22.22% compared to 20.75% at September 30, 1994. Cost of funds increased to 2.93% for the nine months ended September 30, 1995, compared to 2.53% for the nine months ended September 30, 1994, and to 3.04% for the three months ended September 30, 1995, compared to 2.58% for the three months ended September 30, 1994. The average interest-bearing liabilities decreased for both the nine months and three months ended September 30, 1995 compared to 1994. This is a result of a contraction of deposits experienced earlier this year (see "Deposits" herein.) The Bank maintains a favorable net interest margin as a result of the increase in the annualized yield in average earning assets which more than offsets the increase in cost of funds for average interest-bearing liabilities. The following schedule provides specific information regarding the components of interest expense from interest-bearing liabilities: NINE MONTHS ENDED THREE MONTHS ENDED --------------------------------- ---------------------------------- (DOLLARS IN THOUSANDS) SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER 30, 19995 30, 1994 % CHANGE 30, 1995 30, 1994 % CHANGE --------- --------- -------- ---------- ---------- -------- Average interest-bearing liabilities $241,335 $242,783 (.60) $238,073 $269,940 (11.81) Interest expense $ 5,284 $ 4,601 14.85 $ 1,823 $ 1,754 3.93 Annualized cost of funds for average interest- bearing liabilities 2.93% 2.53% 3.04% 2.58% Net interest margin (net interest income divided by average earning assets) 6.76% 6.13% 6.60% 6.18% 13 PROVISION FOR LOAN LOSSES The purpose of the provision for possible loan losses is to maintain reserves at a level sufficient to cover possible future loan losses. Management exercises its judgment in establishing loss reserves for loans which borrowers may not be able to repay in the future. The Bank's current provision for loan losses reflects an ongoing detailed evaluation of the known risks in the portfolio and the risks inherent in the present general economic outlook. The Bank maintains a problem loan list in order to better monitor these risks. This list includes those loans that are identified as having varying degrees of risk in excess of loans having a normal amount of risk. As of September 30, 1995, the problem loan list contained loans totaling $12,973,000 compared to $14,355,000 as of September 30, 1994. Management has a grading system that designates a grade for each loan depending on the degree of risk and possibility of loss inherent in each loan. This grading system drives the loan loss reserve calculations. A percentage allocation of each loan balance is reserved depending on the designated grade. Nonperforming loans (those loans on non-accrual or 90 days or more past due) are contained in the problem loan list. As of September 30, 1995, the allowance for loan loss reserve represented 62% of nonperforming loans and 24% of total problem loans as compared to 47% and 21% at September 30, 1994, respectively. SFAS No. 114, which was adopted January 1, 1995, and required certain calculations be prepared on impaired loans, resulted in an additional $150,000 to the provision for loan loss during the first quarter of 1995. No addition for SFAS No. 114 was required for the second and third quarters of 1995. The aggregate total provision for possible loan loss was $1,025,000 for the nine months ended September 30, 1995. Management felt the increase in the provision was necessary in light of the activity in non-accrual loans (see "Nonperforming Loans and Real Estates Owned" herein), charged off loans and problem loans. Gross loan loss recoveries for the nine months ended September 30, 1995, totaled $655,000 with gross loan charge offs totaling $1,352,000 resulting in net loan charge offs of $697,000. Gross loan loss recoveries for the quarter ending September 30, 1995, totaled $55,000 with gross loan charge offs totaling $573,000 resulting in net loan charge offs of $518,000. The following schedule provides more specific information relative to the provision and allowance for possible loan loss: NINE MONTHS ENDED THREE MONTHS ENDED ----------------------------------- ---------------------------------- (DOLLARS IN THOUSANDS) SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER 30, 1995 30, 1994 % CHANGE 30, 1995 30, 1994 % CHANGE ---------- --------- -------- --------- --------- -------- Net charge-offs/(recoveries) $ 697 $ 992 (29.74) $ 518 $ 375 38.13 Provision for possible loan losses $1,025 $ 450 127.78 $ 100 $ 150 (33.33) Allowance for loan losses $3,146 $3,031 3.79 $3,146 $3,031 3.79 Allowance for loan losses as a percentage of gross loans 1.54% 1.52% 1.54% 1.52% Allowance for loan losses as a percentage of nonperforming loans 61.60% 46.80% 61.60% 46.80% Provision as a percentage of net interest income 5.58% 2.76% 1.68% 2.47% The following table displays the stratification of the $3,146,000 contained in Allowance for possible loan losses at September 30, 1995: (DOLLARS IN THOUSANDS) LOAN CATEGORY SEPTEMBER 30, 1995 ------------- ------------------ Real estate - construction and other $1,047 Commercial 521 Installment 72 General loan reserves 1,506 ------ Total $3,146 ====== 14 OTHER REVENUE Other operating revenue is comprised of income from service charges and other types of fees on deposit accounts, net gains and losses on the sale of securities, net gains and losses on the sale of real estate owned, and fees on non-deposit account services. Service charges and fees increased due to an increase in the charges assessed on certain deposit account activities. Other operating revenues had increases in other non-deposit account service charges and safe deposit box fees as well as a decrease in insurance commissions earned. The following schedule reflects the composition of other income and its percent of change from the same period in 1994: NINE MONTHS ENDED THREE MONTHS ENDED ------------------------------------- ----------------------------------- (DOLLARS IN THOUSANDS) SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER 30, 1995 30, 1994 % CHANGE 30, 1995 30, 1994 % CHANGE --------- --------- -------- --------- --------- --------- Service charges and fees $3,017 $2,441 23.60 $1,025 $ 876 17.01 Securities gains 46 9 411.11 4 0 Other operating revenue 832 985 (15.53) 277 288 (3.82) ------ ------ ------ ----- Total other revenue $3,895 $3,435 13.39 $1,306 $1,164 12.20 ====== ====== ====== ====== OTHER EXPENSES Other operating expenses are primarily non-interest expenses and are comprised of several major categories: salaries and employee benefits, net occupancy expense, furniture, fixtures and equipment expense and various other operating expenses. Salaries and benefits increased as well as occupancy, net due to the addition of two offices from the purchase and assumption of two banks in 1994 (see "Acquisitions of Failed Financial Institutions" herein). During September the Bank completed a restructuring program designed to improve productivity. Through further centralization of repetitive tasks the Bank eliminated 41 full time equivalent positions of the 277 full time equivalent positions at December 31, 1994. Approximately $1,500,000 in annual salaries and employee benefits savings are projected for 1996, with a restructuring cost of less than $250,000 taken in the third quarter of 1995. Other operating expenses increased 6.15% from the nine months ended September 30, 1994, and decreased 4.50% from the three months ended September 30, 1994, due to several factors. Contributing factors for the nine month period were: costs on real estate owned, the backroom outsourcing contract, postage expense and losses on capital assets. The losses on capital assets were directly related to the new Torrance facility that opened in January of this year and required obsolete assets from the old Torrance facility to be disposed. A retroactive refund on FDIC's insurance premiums was received in the third quarter of 1995. This was a result of the FDIC's BIF becoming fully funded this year. The BIF refunded overpayments to financial institutions based on their reduced premium rates. The Bank's insurance premium rates went from 23 cents per $100 on deposit to 4 cents per $100 on deposit. The following schedule reflects the composition of other expenses and its percent of change from the same period in 1994: NINE MONTHS ENDED THREE MONTHS ENDED ------------------------------------- ----------------------------------- (DOLLARS IN THOUSANDS) SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER 30, 1995 30, 1994 % CHANGE 30, 1995 30, 1994 % CHANGE --------- --------- -------- --------- --------- --------- Salaries and employee benefits $ 8,016 $ 7,384 8.56 $2,625 $2,503 4.87 Occupancy, net 2,272 1,902 19.43 763 715 6.71 Other operating expenses 6,974 6,570 6.15 2,145 2,246 (4.50) ------- ------- ------- ------ Total other expenses $17,262 $15,856 8.87 $5,533 $5,464 1.26 ======= ======= ======= ====== 15 PROVISION FOR INCOME TAXES The following schedule provides specific information on the provision for income taxes: NINE MONTHS ENDED THREE MONTHS ENDED ------------------------------------- ----------------------------------- (DOLLARS IN THOUSANDS) SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER 30, 1995 30, 1994 % CHANGE 30, 1995 30, 1994 % CHANGE --------- --------- -------- --------- --------- --------- Provision for income taxes $1,389 $ 980 41.74 $ 609 $ 392 55.36 Net income before provision $3,984 $3,409 16.87 $1,615 $1,617 (.12) Effective tax rate 34.86% 28.75% 37.71% 24.24% PERFORMANCE RATIOS There are several key ratios that are indications of performance, a few of these ratios are presented as follows: NINE MONTHS ENDED ----------------------------------------------------------------- SEPTEMBER 30, 1995 SEPTEMBER 30, 1994 ------------------------------ ---------------------------- ANNUALIZED PERIOD TO DATE ANNUALIZED PERIOD TO DATE ---------- -------------- ---------- -------------- Return on average assets .82% .61% .77% .58% Return on average equity 7.28% 5.44% 6.94% 5.19% Dividends as a percentage of net income -- 49.83% -- 46.81% THREE MONTHS ENDED ----------------------------------------------------------------- SEPTEMBER 30, 1994 SEPTEMBER 30, 1994 ------------------------------ ---------------------------- ANNUALIZED PERIOD TO DATE ANNUALIZED PERIOD TO DATE ---------- -------------- ---------- -------------- Return on average assets .94% .24% 1.05% .26% Return on average equity 8.06% 2.03% 10.29% 2.59% Dividends as a percentage of net income -- 33.60% -- 23.27% 16 PART II ITEM 1. LEGAL PROCEEDING Due to the nature of the business of Home Interstate Bancorp and its subsidiary it is subject to legal actions threatened or filed which arise from the normal course of business. Management believes that the eventual outcome of all currently pending legal proceedings against the Bancorp or its subsidiary will not be material to the Company's or the subsidiary's financial position or results of operations. ITEM 2. CHANGES IN SECURITIES Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS Not applicable. 17 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this form to be signed on its behalf by the undersigned, thereunto duly authorized. Dated NOVEMBER 10, 1995 HOME INTERSTATE BANCORP (Registrant) By /S/ KEITH W. BARNES ---------------------------- Keith W. Barnes Senior Vice President and Chief Financial Officer Chief Accounting Officer 18