UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) FOR THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly period ended September 30, 1999
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OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 1-11515
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COMMERCIAL FEDERAL CORPORATION
------------------------------
(Exact name of registrant as specified in its charter)
Nebraska 47-0658852
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2120 South 72nd Street, Omaha, Nebraska 68214
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(Address of principal executive offices) (Zip Code)
(402) 554-9200
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
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APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as to the latest praciticable date.
Title of Each Class Outstanding at November 8, 1999
- ----------------------------------- -------------------------------------
Common Stock, Par Value $.01 Per Share 58,987,741 Shares
COMMERCIAL FEDERAL CORPORATION
------------------------------
FORM 10-Q
---------
INDEX
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Part I. Financial Information Page Number
--------------------- -----------
Item 1. Financial Statements:
Consolidated Statement of Financial Condition as of
September 30, 1999 and June 30, 1999 3
Consolidated Statement of Operations for the Three
Months Ended September 30, 1999 and 1998 4-5
Consolidated Statement of Comprehensive Income for the
Three Months Ended September 30, 1999 and 1998 6
Consolidated Statement of Cash Flows for the
Three Months Ended September 30, 1999 and 1998 7-8
Notes to Consolidated Financial Statements 9-14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15-26
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
Part II. Other Information
-----------------
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
Signature Page 28
Exhibit Index 29
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2
COMMERCIAL FEDERAL CORPORATION
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
PART1. FINANCIAL INFORMATION
----------------------------
Item 1. FINANCIAL STATEMENTS
----------------------------
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(Dollars in Thousands) September 30, June 30,
ASSETS 1999 1999
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(Unaudited) (Audited)
Cash (including short-term investments of $11,475 and $39,585) $ 222,505 $ 353,275
Investment securities available for sale, at fair value 74,058 83,811
Mortgage-backed securities available for sale, at fair value 399,483 419,707
Loans and leases held for sale, net 78,426 104,347
Investment securities held to maturity (fair value of $910,910 and $846,805) 937,735 862,760
Mortgage-backed securities held to maturity (fair value of $911,220 and $849,488) 930,234 862,838
Loans and leases receivable, net of allowances of $80,167 and $80,344 9,544,108 9,222,046
Federal Home Loan Bank stock 216,111 194,129
Interest receivable, net of allowances of $370 and $319 77,249 77,513
Real estate, net 36,356 31,513
Premises and equipment, net 182,821 185,302
Prepaid expenses and other assets 154,380 125,544
Intangible assets, net of accumulated amortization of $53,893 and $49,260 250,065 252,677
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Total Assets $ 13,103,531 $ 12,775,462
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LIABILITIES AND STOCKHOLDERS' EQUITY
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Liabilities:
Deposits $ 7,352,906 $ 7,655,415
Advances from Federal Home Loan Bank 4,240,910 3,632,241
Securities sold under agreements to repurchase 128,536 128,514
Other borrowings 209,782 225,383
Interest payable 46,380 48,759
Other liabilities 153,026 118,267
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Total Liabilities 12,131,540 11,808,579
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Commitments and Contingencies -- --
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Stockholders' Equity:
Preferred stock, $.01 par value; 10,000,000 shares authorized; none issued -- --
Common stock, $.01 par value; 120,000,000 shares authorized;
59,162,712 and 59,593,849 shares issued and outstanding 592 596
Additional paid-in capital 354,044 364,320
Retained earnings 632,128 611,529
Accumulated other comprehensive income (loss), net (14,773) (9,562)
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Total Stockholders' Equity 971,991 966,883
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Total Liabilities and Stockholders' Equity $ 13,103,531 $ 12,775,462
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See accompanying Notes to Consolidated Financial Statements.
3
COMMERCIAL FEDERAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
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(Dollars in Thousands Except Per Share Data) Three Months Ended
September 30,
-----------------------------
1999 1998
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Interest Income:
Loans and leases receivable $ 182,138 $ 168,470
Mortgage-backed securities 20,421 17,049
Investment securities 20,978 13,342
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Total interest income 223,537 198,861
Interest Expense:
Deposits 79,751 81,707
Advances from Federal Home Loan Bank 50,312 34,109
Securities sold under agreements to repurchase 1,874 4,961
Other borrowings 3,993 3,464
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Total interest expense 135,930 124,241
Net Interest Income 87,607 74,620
Provision for Loan and Lease Losses (3,300) (3,800)
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Net Interest Income After Provision for Loan and Lease Losses 84,307 70,820
Other Income (Loss):
Loan servicing fees 6,039 5,436
Retail fees and charges 9,988 9,370
Real estate operations (224) (161)
Gain (loss) on sales of loans (122) 1,905
Gain on sales of securities -- 1,688
Other operating income 6,093 5,701
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Total other income 21,774 23,939
Other Expense:
General and administrative expenses -
Compensation and benefits 28,080 23,017
Occupancy and equipment 10,197 8,343
Data processing 4,323 2,614
Regulatory insurance and assessments 1,446 1,448
Advertising 3,545 3,674
Other operating expenses 13,667 7,892
Merger expenses -- 15,963
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Total general and administrative expenses 61,258 62,951
Amortization of intangible assets 4,633 3,255
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Total other expense 65,891 66,206
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Income Before Income Taxes and Cumulative Effect of Change
in Accounting Principle 40,190 28,553
Provision for Income Taxes 13,976 13,430
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Income Before Cumulative Effect of Change in Accounting Principle 26,214 15,123
Cumulative Effect of Change in Accounting Principle, Net of Tax Benefit (1,776) --
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Net Income $ 24,438 $ 15,123
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4
COMMERCIAL FEDERAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS (Continued)
(Unaudited)
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(Dollars in Thousands Except Per Share Data) Three Months Ended
September 30,
-----------------------------
1999 1998
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Weighted Average Number of Common Shares
Outstanding Used in Basic Earnings Per Share Calculation 59,497,331 58,605,879
Add Assumed Exercise of Outstanding Stock Options
as Adjustments for Dilutive Securities 363,545 842,023
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Weighted Average Number of Common Shares
Outstanding Used in Diluted Earnings Per Share Calculation 59,860,876 59,447,902
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Basic Earnings Per Common Share:
Income before cumulative effect of change in accounting principle $ .44 $ .26
Cumulative effect of change in accounting principle (.03) --
------------ -----------
Net income $ .41 $ .26
============ ===========
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Diluted Earnings Per Common Share:
Income before cumulative effect of change in accounting principle $ .44 $ .25
Cumulative effect of change in accounting principle (.03) --
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Net income $ .41 $ .25
============ ===========
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Dividends Declared Per Common Share $ .065 $ .055
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See accompany Notes to Consolidated Financial Statements.
5
COMMERCIAL FEDERAL CORPORATION
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited)
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(Dollars in Thousands) Three Months Ended
September 30,
---------------------
1999 1998
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Net Income $ 24,438 $ 15,123
Other Comprehensive Income (Loss):
Unrealized holding gains (losses) on securities available for sale (5,211) 4,975
Less net gain on securities included in net income -- (1,688)
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Other Comprehensive Income (Loss) Before Income Taxes (5,211) 3,287
Income Tax Provision (Benefit) (1,824) 1,150
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Other Comprehensive Income Loss (3,387) (2,137)
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Comprehensive Income $ 21,051 $ 17,260
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See accompanying Notes to Consolidated Financial Statements.
6
COMMERCIAL FEDERAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
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(Dollars in Thousands) Three Months Ended
September 30,
-----------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES 1999 1998
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Net income $ 24,438 $ 15,123
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of intangible assets 4,633 3,255
Provision for losses on loans and leases and real estate 3,380 4,077
Depreciation and amortization 5,323 3,617
Amortization of deferred discounts and fees, net 664 421
Amortization of mortgage servicing rights 2,928 2,995
Amortization of deferred compensation on restricted
stock and deferred compensation plans and premiums on other borrowings 274 783
Gain on sales of real estate and loans, net (104) (2,267)
Gain on sales of securities -- (1,688)
Stock dividends from Federal Home Loan Bank (3,283) (2,389)
Proceeds from sales of loans 159,101 515,169
Origination of loans held for sale (3,924) (157,072)
Purchases of loans held for resale (86,410) (328,022)
Decrease in interest receivable 264 8,987
Increase in interest payable and other liabilities 32,429 689
Other items, net (44,191) (26,626)
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Total adjustments 71,084 21,929
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Net cash provided by operating activities 95,522 37,052
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CASH FLOWS FROM INVESTING ACTIVITIES
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Purchases of loans (538,302) (119,075)
Repayment of loans, net of originations 157,201 240,428
Principal repayments of mortgage-backed securities available for sale 12,320 30,879
Purchases of mortgage-backed securities available for sale -- (49,756)
Proceeds from sales of mortgage-backed securities available for sale -- 76,114
Principal repayments of mortgage-backed securities held to maturity 75,472 75,148
Purchases of mortgage-backed securities held to maturity (149,138) --
Maturities and repayments of investment securities available for sale 6,731 87,625
Proceeds from sales of investment securities available for sale -- 4,112
Maturities and repayments of investment securities held to maturity 22,479 124,870
Purchases of investment securities held to maturity (96,520) --
Purchases of mortgage loan servicing rights (1,627) (5,569)
Purchases of Federal Home Loan Bank stock (18,699) (2,913)
Proceeds from sale of Federal Home Loan Bank stock -- 5,000
Proceeds from sales of real estate 3,251 3,397
Payments to acquire real estate (1) (116)
Acquisitions, net of cash received (paid) -- (11,067)
Purchases of premises and equipment, net (2,842) (8,949)
Other items, net 5,016 (631)
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Net cash (used) provided by investing activities (524,659) 449,497
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7
COMMERCIAL FEDERAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
(Unaudited)
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(Dollars in Thousands) Three Months Ended
September 30,
----------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES 1999 1998
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Decrease in deposits $ (302,509) $ (234,062)
Proceeds from Federal Home Loan Bank advances 703,000 --
Repayments of Federal Home Loan Bank advances (94,025) (306,135)
Proceeds from securities sold under agreements to repurchase 1,051 25,000
Repayments of securities sold under agreements to repurchase (1,029) (125,000)
Proceeds from issuances of other borrowings 50,000 85,000
Repayments of other borrowings (43,605) (3,770)
Payments of cash dividends on common stock (3,888) (2,313)
Repurchases of common stock (11,925) --
Issuance of common stock 1,297 36,018
Other items, net -- (1,929)
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Net cash provided (used) by financing activities 298,367 (527,191)
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CASH AND CASH EQUIVALENTS
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Decrease in net cash position (130,770) (40,642)
Balance, beginning of year 353,275 217,012
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Balance, end of period $ 222,505 $ 176,370
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
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Cash paid (received) during the period for:
Interest expense $ 138,500 $ 122,513
Income taxes, net (15,573) 1,261
Non-cash investing and financing activities:
Loans transferred to real estate 11,503 3,740
Loans to facilitate the sale of real estate -- 82
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See accompanying Notes to Consolidated Financial Statements.
8
COMMERCIAL FEDERAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1999
(Unaudited)
(Columnar Dollars in Footnotes are in Thousands Except Per Share Amounts)
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A. BASIS OF CONSOLIDATION AND PRESENTATION:
----------------------------------------
The unaudited consolidated financial statements are prepared on an accrual basis
and include the accounts of Commercial Federal Corporation (the Corporation) and
its wholly-owned subsidiary, Commercial Federal Bank, a Federal Savings Bank
(the Bank), and all majority-owned subsidiaries. All significant intercompany
balances and transactions have been eliminated.
The accompanying interim consolidated financial statements have not been audited
by independent auditors. In the opinion of management, all adjustments
(consisting only of normal recurring adjustments and the cumulative effect of a
change in accounting principle) considered necessary to fairly present the
financial statements have been included. The consolidated financial statements
should be read in conjunction with the audited financial statements and notes
thereto included in the Corporation's June 30, 1999, Annual Report to
Stockholders. The results of operations for the three month period ended
September 30, 1999, are not necessarily indicative of the results which may be
expected for the entire fiscal year 2000. Certain amounts in the prior fiscal
year period have been reclassified for comparative purposes.
B. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE:
----------------------------------------------------
Effective July, 1, 1999, the Corporation adopted the provisions of Statement of
Position 98-5 "Reporting the Costs of Start-Up Activities" (SOP 98-5), which
requires that costs of start-up activities and organizational costs be expensed
as incurred. Prior to the adoption of this statement, these costs were
capitalized and amortized over periods ranging from five to 25 years. The effect
of adopting the provisions of SOP 98-5 was to record a charge of $1,776,000, net
of an income tax benefit of $978,000, or $.03 per diluted share, as a cumulative
effect of a change in accounting principle in the accompanying consolidated
statement of operations. These costs consist of organizational costs primarily
associated with the creation of a real estate investment trust subsidiary and
start-up costs of the proof of deposit department for processing customer
transactions following the complete conversion of the Corporation's deposit
system.
C. COMMON STOCK REPURCHASE:
------------------------
Effective April 28, 1999, the Corporation's Board of Directors authorized the
repurchase of up to five percent, or approximately 3,000,000 shares, of the
Corporation's outstanding common stock during the next 18 months. Repurchases
will be made at any time and in any amount, depending upon market conditions and
various other factors. Any repurchase generally would be on the open-market,
although privately negotiated transactions are also possible. In compliance with
Nebraska law, all repurchased shares will be cancelled. During the three months
ended September 30, 1999, the Corporation purchased and cancelled 538,200 shares
of its common stock at a cost of $11,925,000. Through September 30, 1999, a
total of 2,038,200 shares have been repurchased and cancelled at a cost of
approximately $48,143,000. It is anticipated that the remaining shares to be
repurchased will be accomplished no later than December 31, 1999.
9
D. COMMITMENTS AND CONTINGENCIES:
------------------------------
At September 30, 1999, the Corporation issued commitments, excluding undisbursed
portions of loans in process, of approximately $772,300,000 as follows:
$304,426,000 to originate loans, $205,485,000 to purchase loans, $3,004,000 to
purchase mortgage-backed securities and $259,385,000 to provide unused lines of
credit for commercial and consumer use. Loan commitments, which are funded
subject to certain limitations, extend over various periods of time. Generally,
unused loan commitments are canceled upon expiration of the commitment term as
outlined in each individual contract. These outstanding loan commitments to
extend credit do not necessarily represent future cash requirements since many
of the commitments may expire without being drawn upon. In addition, at
September 30, 1999, the Corporation had issued commitments to sell residential
mortgage loans totaling $143,942,000. Loans sold subject to recourse provisions
totaled approximately $15,562,000 which represents the total potential credit
risk associated with these particular loans. Such credit risk would, however, be
offset by the value of the single-family residential properties that
collateralize these loans.
The Corporation is subject to a number of lawsuits and claims for various
amounts which arise out of the normal course of its business. In the opinion of
management, the disposition of claims currently pending will not have a material
adverse effect on the Corporation's financial position or results of operations.
See Note H regarding the settlement agreement with Franklin Mutual Advisors, LLC
on October 29, 1999.
On September 12, 1994, the Bank and the Corporation commenced litigation against
the United States in the United States Court of Federal Claims seeking to
recover monetary relief for the government's refusal to honor certain contracts
that it had entered into with the Bank. The suit alleges that such governmental
action constitutes a breach of contract and an unlawful taking of property by
the United States without just compensation or due process in violation of the
Constitution of the United States. The Corporation and the Bank are pursuing
alternative damage claims of up to approximately $230,000,000. The Bank also
assumed a lawsuit in the merger with a 1998 acquisition, Mid Continent
Bancshares, Inc. (Mid Continent), against the United States also relating to a
supervisory goodwill claim filed by the former Mid Continent. The litigation
status and process of these legal actions, as well as that of numerous actions
brought by others alleging similar claims with respect to supervisory goodwill
and regulatory capital credits, make the value of the claims asserted by the
Bank (including the Mid Continent claim) uncertain as to their ultimate outcome,
and contingent on a number of factors and future events which are beyond the
control of the Bank, both as to substance, timing and the dollar amount of
damages that may be awarded to the Bank and the Corporation if they finally
prevail in this litigation.
E. REGULATORY CAPITAL:
-------------------
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary, actions by
regulators that, if undertaken, could have a direct material effect on the
Corporation's financial position and results of operations. The regulations
require the Bank to meet specific capital adequacy guidelines that involve
quantitative measures of the Bank's assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Bank's capital classification is also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios as set forth in the
following tables of tangible, core and total risk-based capital. Prompt
corrective action provisions pursuant to the Federal Deposit Insurance
Corporation Improvement Act of 1991 (FDICIA) require specific supervisory
actions as capital levels decrease. To be considered well-capitalized under the
regulatory framework for prompt corrective action provisions under FDICIA, the
Bank must maintain minimum Tier I leverage, Tier I risk-based and total
risk-based capital ratios as set forth in the following table. At September 30,
1999, and June 30, 1999, the Bank exceeded the minimum requirements for the
well-capitalized category.
10
E. REGULATORY CAPITAL (Continued)
------------------------------
The following presents the Bank's regulatory capital levels and ratios relative
to its minimum capital requirements:
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As of September 30, 1999
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Actual Capital Required Capital
------------------------ ------------------------
Amount Ratio Amount Ratio
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OTS capital adequacy:
Tangible capital $ 887,529 6.85% $ 194,316 1.50%
Core capital 897,563 6.92 388,933 3.00
Risk-based capital 964,673 13.41 575,521 8.00
FDICIA regulations to be
classified well-capitalized:
Tier 1 leverage capital 897,563 6.92 648,221 5.00
Tier 1 risk-based capital 897,563 12.48 431,641 6.00
Total risk-based capital 964,673 13.41 719,401 10.00
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As of June 30, 1999
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Actual Capital Required Capital
------------------------ ------------------------
Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------------------------
OTS capital adequacy:
Tangible capital $ 880,400 6.97% $ 189,412 1.50%
Core capital 890,967 7.05 379,142 3.00
Risk-based capital 957,676 13.70 559,279 8.00
FDICIA regulations to be
classified well-capitalized:
Tier 1 leverage capital 890,967 7.05 631,903 5.00
Tier 1 risk-based capital 890,967 12.74 419,459 6.00
Total risk-based capital 957,676 13.70 699,099 10.00
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As of September 30, 1999, the most recent notification from
the OTS categorized the Bank as "well-capitalized" under the regulatory
framework for Prompt Corrective Action provisions under FDICIA. There are no
conditions or events since such notification that management believes have
changed the Bank's classification.
F. SEGMENT INFORMATION:
--------------------
The Corporation has identified two distinct lines of business operations for the
purposes of management reporting: Community Banking and Mortgage Banking. These
segments were determined based on the Corporation's financial accounting and
reporting processes with insurance and securities brokerage operations
aggregated with Community Banking. Management makes operating decisions and
assesses performance based on a continuous review of these two primary
operations.
The Community Banking segment involves a variety of traditional banking and
financial services. These services include retail banking services, consumer
checking and savings accounts, and loans for consumer, commercial real estate,
residential mortgage and business purposes. Also included in this segment is
insurance and securities brokerage services. The Community Banking services are
offered through the Bank's branch network, including traditional offices,
supermarkets and convenience stores, ATMs, 24-hour telephone centers and the
Internet. Community Banking is also responsible for the Corporation's investment
and mortgage-backed securities portfolios and the corresponding management of
deposits, advances from the Federal Home Loan Bank and certain other borrowings.
11
F. SEGMENT INFORMATION (Continued):
--------------------------------
The Mortgage Banking segment involves the origination and purchase of
residential mortgage loans, the sale of such mortgage loans in the secondary
mortgage market, the servicing of mortgage loans and the purchase and
origination of rights to service mortgage loans. Mortgage Banking operations are
conducted through the Bank's branches, offices of a mortgage banking subsidiary
and a nationwide correspondent network of mortgage loan originators. The Bank
allocates expenses to the Mortgage Banking operation on terms that are not
necessarily indicative of those which would be negotiated between unrelated
parties. The Mortgage Banking segment also originates and sells loans to the
Bank. Effective July 1, 1999, substantially all loans sold to the Bank from the
Mortgage Banking operation are at net book value, resulting in no gains or
losses. Prviously, these sales were primarily at par such that the Mortgage
Banking operation recorded losses equal to the origination expenses it incurred
net of fees collected. All of these losses are deferred by the Bank and
amortized over the estimated life of the loans the Bank purchased.
The Parent Company includes interest income earned on intercompany cash balances
and intercompany transactions, interest expense on Parent Company debt and
operating expenses for general corporate purposes.
The contribution of the major business segments to the consolidated results for
the three months ended September 30, 1999 and 1998 is summarized in the
following table:
- ---------------------------------------------------------------------------------------------------------------------------------
Community Mortgage Parent Eliminations/ Consolidated
Banking Banking Company Adjustments Total
- ---------------------------------------------------------------------------------------------------------------------------------
September 30, 1999:
Net interest income (loss) $ 80,738 $ 4,721 $ (3,485) $ 5,633 $ 87,607
Provision for loan and
lease losses 2,723 577 -- -- 3,300
Non-interest income 23,564 11,588 26,910 (40,288) 21,774
Total other expense 58,624 7,011 288 (32) 65,891
Net income 28,587 6,036 24,438 (34,623) 24,438
Total revenue 238,729 16,314 26,910 (36,642) 245,311
Intersegment revenue (loss) 11,988 (471) 26,927 (38,444) --
- ---------------------------------------------------------------------------------------------------------------------------------
September 30, 1998:
Net interest income (loss) $ 68,079 $ 4,827 $ (2,944) $ 4,658 $ 74,620
Provision for loan and
lease losses 3,695 105 -- -- 3,800
Non-interest income 25,268 11,320 25,105 (37,754) 23,939
Total other expense 53,164 5,564 7,911 (433) 66,206
Net income 25,756 6,907 15,123 (32,663) 15,123
Total revenue 216,525 16,185 25,320 (35,230) 222,800
Intersegment revenue (loss) 7,709 3,673 25,048 (36,430) --
- ---------------------------------------------------------------------------------------------------------------------------------
12
G. CURRENT ACCOUNTING PRONOUNCEMENTS:
----------------------------------
Accounting for Mortgage-Backed Securities Retained After the Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise:
Effective July 1, 1999, the Corporation adopted the provisions of Statement of
Financial Accounting Standards No. 134 entitled "Accounting for Mortgage-Backed
Securities Retained After the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise, an amendment of FASB Statement No. 65" (SFAS No.
134). FASB Statement No. 65, as amended, requires that after the securitization
of a mortgage loan held for sale, an entity engaged in mortgage banking
activities classify the resulting mortgage-backed security as a trading
security. SFAS No. 134 further amends Statement No. 65 to require that after the
securitization of mortgage loans held for sale, an entity engaged in mortgage
banking activities classify the resulting mortgage-backed securities or other
retained interests based on its ability and intent to sell or hold those
investments. This Statement conforms the subsequent accounting for securities
retained after the securitization of mortgage loans by a mortgage banking
enterprise with the subsequent accounting for securities retained after the
securitization of other types of assets by a nonmortgage banking enterprise.
Management of the Corporation did not reclassify any mortgage-backed securities
upon initial application, therefore, the adoption of SFAS No. 134 did not have
an effect on the Corporation's financial position, liquidity or results of
operations.
Accounting for Derivative Instruments and Hedging Activities:
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 133 entitled "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133). This statement requires the
recognition of all derivative financial instruments as either assets or
liabilities in the statement of financial position and measurement of those
instruments at fair value. The accounting for gains and losses associated with
changes in the fair value of a derivative and the effect on the consolidated
financial statements will depend on its hedge designation and whether the hedge
is highly effective in achieving offsetting changes in the fair value or cash
flows of the asset or liability hedged. Under the provisions of SFAS No. 133,
the method that will be used for assessing the effectiveness of a hedging
derivative, as well as the measurement approach for determining the ineffective
aspects of the hedge, must be established at the inception of the hedge. The
methods must be consistent with the entity's approach to managing risk.
SFAS No. 133 was effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. However, on July 7, 1999, the FASB issued Statement of
Financial Accounting Standards No. 137 entitled "Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133" (SFAS No. 137). This statement delays the effective date of
SFAS No. 133 for one year, or for all fiscal quarters of fiscal years beginning
after June 15, 2000, with initial application as of the beginning of any fiscal
quarter that begins after issuance. On that initial application date, hedging
relationships must be designated anew and documented pursuant to the provisions
of SFAS No. 133. Management of the Corporation has not determined the effect, if
any, that the adoption will have on the Corporation's financial position,
liquidity or results of operations. Management of the Corporation expects to
adopt the provisions of SFAS No.
133 as of July 1, 2001.
Business Combinations and Intangible Assets:
On September 7, 1999 the FASB issued a proposal for public comment that would,
among other items, eliminate the pooling of interests method of accounting for
business combinations. Comments on the proposal are due December 7, 1999. A
final statement may be issued by the end of calendar year 2000. If adopted, this
Statement would be effective for business combinations initiated after the
Statement is published. The main provisions in the Exposure Draft are (i) that
the purchase method should be the only method used to account for all business
combinations, prohibiting the use of the pooling-of-interests method; (ii)
goodwill should be amortized on a straight-line basis over its useful (finite)
life, not to exceed 20 years; (iii) a review of goodwill for impairment should
be performed no later than two years after the acquisition date if certain
factors are present; and (iv) goodwill amortization and impairment charges
should be displayed on a net-of-tax basis as a separate line item within income
from continuing operations. That line item should be preceded by a subtotal such
as "income before goodwill charges" (which would follow the income tax
provision). A per share amount would be permitted to be shown on the face of the
income statement for goodwill charges and the subtotal that precedes that
amount.
13
H. SUBSEQUENT EVENT - SETTLEMENT AGREEMENT:
----------------------------------------
On October 29, 1999, the Corporation entered into an agreement (the Settlement
Agreement) with Franklin Mutual Advisers, LLC (Franklin) to settle all pending
litigation and the proxy contest relating to the election of directors at the
Corporation's 1999 Annual Meeting of Stockholders to be held on November 16,
1999 (the Annual Meeting).
The Settlement Agreement provides that Franklin will immediately cease its
solicitation of proxies in connection with the Annual Meeting and will not vote
any proxies it has solicited at the Annual Meeting. Franklin has also agreed to
vote its shares in favor of the Corporation's reconfigured slate of directors.
The Corporation agreed to include George R. Zoffinger and Joseph J. Whiteside in
place of two of its previously announced nominees and they, together with Robert
F. Krohn and Michael P. Glinsky, will constitute all of the nominees for the
four seats up for election at the Annual Meeting. Robert S. Milligan and Sharon
G. Marvin who had been named in the Corporation's Proxy Statement will no longer
stand for reelection at the Annual Meeting. J. Thomas Burcham and Matthew P.
Wagner, who had been named in Franklin's proxy materials as a nominee and
alternate, respectively, also will not stand for election. In the event that
either Mr. Zoffinger or Mr. Whiteside, or both, are unable or unwilling to stand
for election at the Annual Meeting (an event not now anticipated), the
Corporation has agreed to permit Franklin to select a replacement nominee who is
mutually acceptable to the Corporation and Franklin. The Corporation has agreed
to nominate any such replacement nominee at the Annual Meeting.
All pending litigation between the parties has been dismissed with prejudice.
The Settlement Agreement also provides for mutual releases by all parties to the
litigation of all claims relating to the proxy solicitation, the Annual Meeting
and all related matters.
The parties agreed that the Corporation's recently-announced By-law amendment,
which provides that no person who is a controlling person or management official
of a federally insured depository organization (other than affiliates of the
Corporation) that operates branches in any market in which the Corporation
operates branches shall be eligible to be nominated for service, or to serve, as
a director of the Corporation, shall remain in effect.
Each party agreed to bear its own expenses resulting from the proxy contest and
the related litigation. As of September 30, 1999 the Corporation expensed
$100,000 relating to these issues. The Corporation also represented in the
Settlement Agreement that it had no present intention to increase the size of
the Board of Directors to more than 10 members.
I. SUBSEQUENT EVENT - RESTRUCTURING COSTS:
---------------------------------------
Effective November 5, 1999, the Corporation announced a restructuring plan
pursuant to the integration process of the Corporation's most recent seven
acquisitions and new data processing system to support community banking
operations. This restructuring is aimed at decreasing expenses, increasing
sustainable growth in revenues, and increasing productivity through the
elimination of duplicate or inefficient functions. Major aspects of the plan
include (i) the sale and closing of 22 branches, (ii) the elimination of 129
positions and the consolidation of the correspondent loan servicing operations,
and (iii) the reorganization of community banking operations into urban,
supermarket and non-urban markets. This restructuring plan will be completed in
the quarter ended December 31, 1999 and a non-recurring pre-tax charge expected
to approximate $3.0 million to $4.0 million will be recorded.
14
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
------------------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
The statements in this management's discussion and analysis of financial
condition and results of operations that are not historical fact are forward-
looking statements that involve inherent risks and uncertainties. The
Corporation cautions readers that a number of important factors could cause
actual results to differ materially from those in the forward-looking
statements. Those factors include fluctuations in interest rates, inflation,
government regulations, the effect of pending legislation, the progress of
integrating acquisitions, economic conditions, adequacy of allowance for credit
losses, costs associated with the planned restructuring, the costs or
difficulties associated with the resolution of Year 2000 issues on computer
systems greater than anticipated, technology changes and competition in the
geographic and business areas in which the Corporation conducts its operations.
These statements are based on management's current expectations. Actual results
in future periods may differ materially from those currently expected because of
various risks and uncertainties.
LIQUIDITY AND CAPITAL RESOURCES:
- --------------------------------
The Corporation's principal asset is its investment in the capital stock of the
Bank, and because it does not generate any significant revenues independent of
the Bank, the Corporation's liquidity is dependent on the extent to which it
receives dividends from the Bank. The Bank's ability to pay dividends to the
Corporation is dependent on its ability to generate earnings and is subject to a
number of regulatory restrictions and tax considerations. Effective April 1,
1999, the Office of Thrift Supervision (OTS) issued a final rule revising its
capital distribution regulation. This revised regulation reflects the OTS's
implementation of the system of prompt corrective action established under
FDICIA and conforms the OTS's capital distribution requirements more closely to
those of the other banking agencies. Under the terms of this regulation, the
Bank is permitted to pay capital distributions during a calendar year up to
100.0% of its retained net income (net income determined in accordance with
generally accepted accounting principles less total capital distributions
declared) for the current calendar year combined with the Bank's retained net
income for the preceding two calendar years without requiring an application for
approval to be filed with the OTS. At September 30, 1999, the Bank would be
permitted to pay an aggregate amount approximating $118.1 million in dividends
under this regulation. Should the Bank's regulatory capital fall below certain
levels, applicable law would require approval by the OTS of such proposed
dividends and, in some cases, would prohibit the payment of dividends.
The Corporation manages its liquidity at both the parent company and subsidiary
levels. At September 30, 1999, the cash of Commercial Federal Corporation (the
parent company) totaled $17.4 million. Due to the parent company's limited
independent operations, management believes that its cash balance at September
30, 1999 is sufficient to meet operational needs excluding necessary funds for
interest and principal payments and the repurchase of common stock. The parent
company's ability to make future interest and principal payments on its $50.0
million of 7.95% fixed-rate subordinated extendible notes due December 1, 2006
(the Notes), on its $46.4 million of 9.375% fixed-rate junior subordinated
debentures due May 15, 2027 (the Debentures) and on its promissory notes is
dependent upon its receipt of dividends from the Bank. Accordingly, for the
three months ended September 30, 1999, the parent company received cash
dividends totaling $22.464 million from the Bank. The dividends received were
paid primarily to cover (i) interest payments totaling $2.642 million on the
parent company's debt, (ii) principal payments of $1.813 million on the parent
company's variable rate term note, (iii) common stock cash dividends totaling
$3.8 million paid by the parent company to its shareholders through September
30, 1999, and (iv) the financing, in part, of common stock repurchases totaling
$14.209 million. The Bank will continue to pay dividends to the parent company,
pursuant to regulatory restrictions, to cover future principal and interest
payments on the parent company's debt and quarterly cash dividends on common
stock when and as declared by the parent company. Dividends totaling $18.250
million were paid by the Bank to the parent company during the three months
ended September 30, 1998. The parent company also receives cash from the
exercise of stock options and the sale of common stock under its employee
benefit plans, as well as from the Bank for income tax benefits from operating
losses of the parent company as provided in the corporate tax sharing agreement.
Effective April 28, 1999, the Corporation's Board of Directors authorized the
repurchase up to five percent, or approximately 3,000,000 shares, of its
outstanding common stock during the next 18 months. During the three months
ended September 30, 1999, the Corporation purchased and cancelled 538,200 shares
of its common stock at a cost of $11.9 million. Through September 30, 1999, a
total of 2,038,200 shares have been repurchased and cancelled at a cost of
approximately $48.1 million. It is anticipated that the remaining shares to be
repurchased will be accomplished no later than December 31, 1999.
The Corporation's primary sources of funds are (i) deposits, (ii) principal
repayments on loans, mortgage-backed and investment securities, (iii) advances
from the Federal Home Loan Bank (FHLB) and (iv) cash generated from operations.
As reflected in the Consolidated Statement of Cash Flows, net cash flows
provided by operating activities totaled $95.5 million and $37.1 million,
respectively, for the three months ended September 30, 1999 and 1998. Amounts
fluctuate from period to period primarily as a result of mortgage banking
activity relating to the purchase and origination of loans for resale and the
subsequent sale of such loans.
15
LIQUIDITY AND CAPITAL RESOURCES (Continued):
- --------------------------------------------
Net cash flows used by investing activities totaled $524.7 million for the three
months ended September 30, 1999 and net cash flows provided by investing
activities totaled $449.5 million for the three months ended September 30, 1998.
Amounts fluctuate from period to period primarily as a result of (i) principal
repayments on loans and mortgage-backed securities and (ii) the purchase and
origination of loans, mortgage-backed and investment securities.
Net cash flows provided by financing activities totaled $298.4 million for the
three months ended September 30, 1999 compared to net cash flows used by
financing activities totaling $527.2 million for the three months ended
September 30, 1998. Advances from the FHLB and retail deposits have been
the primary sources to balance the Corporation's funding needs during each of
the periods presented. The Corporation experienced net decreases in retail
deposits of $302.5 million and $234.1 million, respectively, for the three
months ended September 30, 1999 and 1998, primarily due to depositors leaving
for higher interest rates. During the three months ended September 30, 1999, the
Corporation continued to borrow long-term FHLB advances that are callable at the
option of the FHLB. Such advances provide the Corporation with lower interest-
bearing liabilities than other funding alternatives and at September 30, 1999
totaled $2.9 billion. The one-year notes for $40.0 million from the AmerUs Bank
(AmerUs) acquisition on July 31, 1998 were paid in full on July 30, 1999. The
$32.5 million term note due July 31, 2003 was refinanced on July 1, 1999. The
proceeds to pay the $40.0 million note in full and the refinancing came from a
term note for $72.5 million due June 30, 2004, unsecured, with quarterly
principal payments of $1.8 million and interest payable quarterly at 100 basis
points below the lender's national base rate. At September 30, 1999, this term
note had a remaining principal balance of $70.7 million. In addition, on August
30, 1999, the Corporation borrowed $10.0 million from the same lender on a
revolving line of credit. This revolving credit note has a balance of $10.0
million as of September 30, 1999 and is unsecured with interest terms the same
as the term note. The proceeds were used to help finance the Corporation's
repurchase of its common stock. During the quarter ended September 30, 1999, the
Corporation had repurchased 538,200 shares at a cost of $11.9 million. See Note
C for addition informational regarding the repurchase of common stock.
At September 30, 1999, the Corporation issued commitments totaling approximately
$772.3 million to fund and purchase loans and mortgage-backed securities as
follows: $271.8 million of single-family fixed-rate mortgage loans, $179.5
million of single-family adjustable-rate mortgage loans, $259.4 million of
unused lines of credit for commercial and consumer use, $58.6 million of
commercial real estate loans and $3.0 million of mortgage-backed securities.
These outstanding loan commitments to extend credit in order to originate loans
or fund commercial and consumer loans lines of credit do not necessarily
represent future cash requirements since many of the commitments may expire
without being drawn. The Corporation expects to fund these commitments, as
necessary, from the sources of funds previously described. In addition, at
September 30, 1999, the Corporation had approximately $143.9 million in
mandatory forward delivery commitments to sell residential mortgage loans.
The maintenance of an appropriate level of liquid resources to meet not only
regulatory requirements but also to provide funding necessary to meet the
Corporation's current business activities and obligations is an integral element
in the management of the Corporation's assets. The Bank is required by federal
regulation to maintain a minimum average daily balance of liquid assets in each
calendar quarter of not less than 4.0% of net withdrawable deposits plus
short-term borrowings or 4.0% of the average daily balance of net withdrawable
accounts plus short-term borrowings during the preceding quarter. The Bank's
liquidity ratio was 10.55% at September 30, 1999. Liquidity levels will vary
depending upon savings flows, future loan fundings, cash operating needs,
collateral requirements and general prevailing economic conditions. The Bank
does not foresee any difficulty in meeting its liquidity requirements.
16
FINANCIAL LEGISLATION:
- -----------------------
On November 12, 1999, President Clinton signed into law legislation which could
have a far-reaching impact on the financial services industry. The
Gramm-Leach-Bliley Act (GLB Act) authorizes affiliations between banking,
securities and insurance firms and authorizes bank holding companies and
national banks to engage in a variety of new financial activities. Among the new
activities that will be permitted to bank holding companies are securities and
insurance brokerage, securities underwriting, insurance underwriting and
merchant banking. National bank subsidiaries will be permitted to engage in
similar financial activities but only on an agency basis unless they are one of
the 50 largest banks in the United States. National bank subsidiaries will be
prohibited from insurance underwriting, real estate development and merchant
banking. The Federal Reserve Board, in consultation with the Department of
Treasury, may approve additional financial activities. The GLB Act, however,
prohibits future affiliations between existing unitary savings and loan holding
companies, like the Corporation, and firms which are engaged in commercial
activities and prohibits the formation of new unitary holding companies.
The GLB Act imposes new requirements on financial institutions with respect to
customer privacy. The GLB Act generally prohibits disclosure of customer
information to non-affiliated third parties unless the customer has been given
the opportunity to object and has not objected to such disclosure. Financial
institutions are further required to disclose their privacy policies to
customers annually. Financial institutions, however, will be required to comply
with state law if it is more protective of customer privacy than the GLB Act.
The GLB Act contains significant revisions to the Federal Home Loan Bank System,
among them, making membership in the Federal Home Loan Bank voluntary for
federal savings associations. The GLB Act contains a variety of other provisions
including a prohibition against ATM surcharges unless the customer has first
been provided notice of the imposition and amount of the fee.
The Corporation is unable to predict the effect of the GLB Act on its operations
and competitive environment at this time. Although the GLB Act reduces the range
of companies with which the Corporation may affiliate, it may facilitate
affiliations with companies in the financial services industry.
RESULTS OF OPERATIONS:
- ----------------------
Net income for the three months ended September 30, 1999, was $24.4 million, or
$.41 per basic and diluted share, compared to net income of $15.1 million, or
$.25 per diluted share ($.26 per basic share) for the three months ended
September 30, 1998. The net increase in net income for the three months ended
September 30, 1999, compared to the three months ended September 30, 1998, is
primarily due to net increases of $13.5 million in net interest income after
provision for loan and lease losses and a decrease of $1.7 million in general
and administrative expenses. These increases to net income were partially offset
by net decreases of $2.2 million in other income, $1.8 million from the
cumulative effect of a change in accounting principle, $1.4 million in
amortization of intangible assets and $546,000 in the provision for income
taxes.
17
RESULTS OF OPERATIONS (Continued):
- ----------------------------------
Net Interest Income:
- --------------------
Net interest income was $87.6 million for the three months ended September 30,
1999, compared to $74.6 million for the three months ended September 30, 1998,
resulting in an increase of approximately $13.0 million, or 17.4%. The interest
rate spread was 2.74% at September 30, 1999 compared to 2.86% at September 30,
1998, a decrease of 12 basis points. During the three months ended September 30,
1999 and 1998, interest rate spreads were 2.89% and 2.71%, respectively, an
increase of 18 basis points; and the yield on interest-earning assets was 2.93%
and 2.89%, up 4 basis points over the same respective periods of time. The
average balance of interest-earning assets increased $1.637 billion for the
three months ended September 30, 1999 compared to the same period ended
September 30, 1998, while the average balance of interest-bearing liabilities
increased $1.833 billion over the same respective period of time. The increases
in these average balances are due to the acquisitions of AmerUs on July 31, 1998
and Midland First Financial Corporation (Midland) on March 1, 1999 both of which
were accounted for as purchases with their account balances reflected as of the
respective acquisition dates. Net interest income increased for the three months
ended September 30, 1999 compared to 1998 due to the volume increases in these
average balances and in the rate on interest-bearing liabilities decreasing more
(41 basis points) than the yields on interest-earning assets (23 basis points).
The future trend in interest rate spreads and net interest income will be
dependent upon such factors as the composition and balances of the Corporation's
interest-earning assets and interest-bearing liabilities, the interest rate risk
exposure of the Corporation and the maturity and repricing activity of interest-
sensitive assets and liabilities, as influenced by changes in and levels of both
short-term and long-term market interest rates.
The following table presents certain information concerning yields earned on
interest-earning assets and rates paid on interest-bearing liabilities during
and at the end of each of the periods presented:
- -----------------------------------------------------------------------------------------------------------------------
For the Three
Months Ended At
September 30, September 30,
-------------------------- --------------------------
1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------------------------------
Weighted average yield on:
Loans and leases 7.71% 8.00% 7.70% 8.04%
Mortgage-backed securities 6.29 6.16 6.34 6.43
Investments 6.79 6.58 6.62 6.49
- -----------------------------------------------------------------------------------------------------------------------
Interest-earning assets 7.46 7.69 7.43 7.78
- -----------------------------------------------------------------------------------------------------------------------
Weighted average rate paid on:
Savings deposits 2.94 3.00 2.96 2.96
Other time deposits 5.13 5.59 5.29 5.62
Advances from FHLB 5.07 5.76 5.15 5.60
Securities sold under agreements
to repurchase 5.72 5.95 5.73 5.81
Other borrowings 7.41 8.90 7.71 7.90
- -----------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities 4.57 4.98 4.69 4.92
- -----------------------------------------------------------------------------------------------------------------------
Interest rate spread 2.89% 2.71% 2.74% 2.86%
- -----------------------------------------------------------------------------------------------------------------------
Net annualized yield on
interest-earning assets 2.93% 2.89% 2.86% 3.02%
- -----------------------------------------------------------------------------------------------------------------------
18
Net Interest Income (Continued):
- --------------------------------
The table below presents average interest-earning assets and average
interest-bearing liabilities, interest income and interest expense, and average
yields and rates during the three months ended September 30, 1999. The following
table includes nonaccruing loans averaging $76.9 million for the three months
ended September 30, 1999, as interest-earning assets at a yield of zero percent:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended
September 30, 1999
----------------------------------------------
Annualized
Average Yield/
Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Loans and leases $ 9,434,210 $ 182,138 7.71%
Mortgage-backed securities 1,297,893 20,421 6.29
Investments 1,236,218 20,978 6.79
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets 11,968,321 223,537 7.46
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-earning liabilities:
Savings deposits 3,128,259 23,210 2.94
Other time deposits 4,374,493 56,541 5.13
Advances from FHLB 3,880,891 50,312 5.07
Securities sold under
agreements to repurchase 128,298 1,874 5.72
Other borrowings 215,576 3,993 7.41
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities 11,727,517 135,930 4.57
- ------------------------------------------------------------------------------------------------------------------------------------
Net earnings balance $ 240,804
===============
Net interest income $ 87,607
===========
Interest rate spread 2.89%
- ------------------------------------------------------------------------------------------------------------------------------------
Net annualized yield on
interest-earnings assets 2.93%
- ------------------------------------------------------------------------------------------------------------------------------------
The net earnings balance (the difference between average interest-bearing
liabilities and average interest-earning assets) decreased by $196.0 million for
the three months ended September 30, 1999, compared to the three months ended
September 30, 1998. Such decrease is primarily due to the acquisition of Midland
that was financed entirely by existing cash totaling $83.0 million, the
repurchases of the Corporation's common stock totaling $48.1 million and, in
part, to the acquisition of AmerUs requiring the outlay of cash totaling $53.2
million.
19
Net Interest Income (Continued):
- --------------------------------
The table below presents the dollar amount of changes in interest income and
expense for each major component of interest-earning assets and interest-bearing
liabilities, respectively, and the amount of change in each attributable to: (i)
changes in volume (change in volume multiplied by prior year rate), and (ii)
changes in rate (change in rate multiplied by prior year volume). The net change
attributable to change in both volume and rate, which cannot be segregated, has
been allocated proportionately to the change due to volume and the change due to
rate. The following table demonstrates the effect of the increased volume of
interest-earning assets and interest-bearing liabilities, the changes in
interest rates and the effect on the interest rate spreads previously discussed:
- ----------------------------------------------------------------------------------------------------------------
Three Months Ended
September 30, 1999 Compared
to September 30, 1998
-----------------------------------
Increase (Decrease) Due to
- ----------------------------------------------------------------------------------------------------------------
Volume Rate Net
- ----------------------------------------------------------------------------------------------------------------
Interest income:
Loans and leases $ 20,127 $ (6,459) $ 13,668
Mortgage-backed securities 2,991 381 3,372
Investments 7,191 445 7,636
- ----------------------------------------------------------------------------------------------------------------
Interest income 30,309 (5,633) 24,676
- ----------------------------------------------------------------------------------------------------------------
Interest expense:
Savings deposits 3,603 (1,079) 2,524
Other time deposits 639 (5,119) (4,480)
Advances from FHLB 20,642 (4,439) 16,203
Securities sold under agreements to repurchase (2,901) (186) (3,087)
Other borrowings 1,176 (647) 529
- ----------------------------------------------------------------------------------------------------------------
Interest expense 23,159 (11,470) 11,689
- ----------------------------------------------------------------------------------------------------------------
Effect on net interest income $ 7,150 $ 5,837 $ 12,987
- ----------------------------------------------------------------------------------------------------------------
The net improvement due to changes in volume and rates for the three months
ended September 30, 1999, compared to September 30, 1998, reflect the net growth
the Corporation has experienced, both internally and from acquisitions, and the
decreases in rates on interest-earning assets that were more than offset by
decreases in rates on interest-bearing liabilities, primarily other time
deposits and FHLB advances.
20
Provision for Loan and Lease Losses and Real Estate Operations:
- ---------------------------------------------------------------
The Corporation recorded loan and lease loss provisions totaling $3.3 million
for the three months ended September 30, 1999, compared to $3.8 million for the
three months ended September 30, 1998. The provision for the three months ended
September 30, 1998 includes a $1.0 million loss reserve recorded to conform the
reserve positions of First Colorado Bancorp, Inc. (a pooled acquisition) to the
policies of the Corporation. Loss provisions recorded in the three months ended
September 30, 1999 and 1998 covered net loans and leases charged-off, totaling
$3.2 million and $2.6 million, respectively. The allowance for loan and lease
losses is based upon management's continuous evaluation of the collectibility of
outstanding loans and leases, which takes into consideration such factors as
changes in the composition of the loan and lease portfolios and economic
conditions that may affect the borrower's ability to pay, regular examinations
by the Corporation's credit review group of specific problem loans and leases
and of the overall portfolio quality and real estate market conditions in the
Corporation's lending areas. The allowance for credit losses totaled $80.2
million at September 30, 1999, or 113.1% of total nonperforming loan and leases,
compared to $80.4 million, or 114.9% of total nonperforming loans and leases at
June 30, 1999.
The Corporation recorded net losses from real estate operations totaling
$224,000 and $161,000 for the three months ended September 30, 1999 and 1998,
respectively. Real estate operations reflect provisions for real estate losses,
net real estate operating activity, and gains and losses on dispositions of real
estate. The net decrease in real estate operations for the three months ended
September 30, 1999 compared to 1998 is due primarily to a decrease in net gains
on dispositions of real estate in the current fiscal year of approximately
$106,000 and a net increase in operating expenses of approximately $154,000
partially offset by a net decrease in provisions for real estate losses.
Although the Corporation believes that present levels of allowances for loan
losses are adequate to reflect the risks inherent in its portfolios, there can
be no assurance that the Corporation will not experience increases in its
nonperforming assets, that it will not increase the level of its allowances in
the future or that significant provisions for losses will not be required based
on factors such as deterioration in market conditions, changes in borrowers'
financial conditions, delinquencies and defaults.
21
Provision for Loan and Lease Losses and Real Estate Operations (Continued):
- ---------------------------------------------------------------------------
Nonperforming assets are monitored on a regular basis by the Corporation's
internal credit review and problem asset groups. Nonperforming assets increased
$3.8 million at September 1999, compared to June 30, 1999, resulting from net
increases of $4.7 million in real estate and $930,000 in nonperforming loans and
leases partially offset by a net decrease of $1.9 million in troubled debt
restructurings. Nonperforming assets as of the dates indicated are summarized as
follows:
- --------------------------------------------------------------------------------------------------------------------
September 30, June 30,
1999 1999
- --------------------------------------------------------------------------------------------------------------------
Nonperforming loans and leases:
Residential real estate loans $ 51,253 $ 49,891
Commercial real estate loans 9,393 11,390
Consumer loans 6,934 4,859
Leases and other loans 3,365 3,875
- --------------------------------------------------------------------------------------------------------------------
Total 70,945 70,015
- --------------------------------------------------------------------------------------------------------------------
Real estate:
Commercial 10,103 7,657
Residential 16,686 14,384
- --------------------------------------------------------------------------------------------------------------------
Total 26,789 22,041
- --------------------------------------------------------------------------------------------------------------------
Troubled debt restructurings:
Commercial 7,661 9,534
Residential 178 195
- --------------------------------------------------------------------------------------------------------------------
Total 7,839 9,729
- --------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 105,573 $ 101,785
- --------------------------------------------------------------------------------------------------------------------
Nonperforming loans and leases to total loans and leases .72% .73%
Nonperforming assets to total assets .81% .80%
- --------------------------------------------------------------------------------------------------------------------
Allowance for loan and lease losses (1) $ 80,217 $ 80,419
- --------------------------------------------------------------------------------------------------------------------
Allowance for loan and lease losses to total loans and leases .81% .84%
Allowance for loan and lease losses to total nonperforming assets 75.98% 79.01%
- --------------------------------------------------------------------------------------------------------------------
(1) Includes $50,000 and $75,000 at September 30, 1999 and June 30, 1999,
respectively, in general allowance for losses established primarily to cover
risks associated with borrowers' delinquencies and defaults on loans held
for sale.
22
Provision for Loan and Lease Losses and Real Estate Operations (Continued):
- ---------------------------------------------------------------------------
Nonperforming loans and leases at September 30, 1999, increased by $930,000
compared to June 30, 1999, primarily due to increases of $2.1 million and $1.4
million, respectively, in delinquent consumer and residential loans, offset by
net decreases of $2.0 million and $510,000, respectively, in delinquent
commercial loans and leases and other loans. The net increase in real estate of
$4.7 million at September 30, 1999, compared to June 30, 1999, is due primarily
to the transfer of a delinquent commercial loan totaling $3.8 million to
nonperforming commercial real estate. The net decrease of $1.9 million in
troubled debt restructurings at September 30, 1999, compared to June 30, 1999,
is due primarily to the reclassification of a commercial troubled debt
restructuring to nonperforming loan status.
The ratio of nonperforming loans and leases to total loans and leases decreased
compared to June 30, 1999, due primarily to the net increase in loans and leases
at September 30, 1999, compared to June 30, 1999. The ratio of nonperforming
assets to total assets increased compared to June 30, 1999 due to the increase
in total nonperforming assets partially offset by the net increase in total
assets. The percentage of allowance for loan and lease losses to total loans and
leases decreased compared to June 30, 1999, due primarily to the net increase in
loan and leases over the same periods of time. The allowance for loan and lease
losses to total nonperforming assets decreased at September 30, 1999 compared to
June 30, 1999 due primarily to the net increase in total nonperforming
assets.
Loan Servicing Fees:
- --------------------
Fees from loans serviced for other institutions totaled $6.0 million for the
three months ended September 30, 1999 compared to $5.4 million for the three
months ended September 30, 1998. The amount of revenue generated from loan
servicing fees, and changes in comparing fiscal periods, is primarily due to the
average size of the Corporation's portfolio of mortgage loans serviced for other
institutions and the level of rates for service fees collected. At September 30,
1999 and 1998, the Corporation's mortgage servicing portfolio approximated
$7.290 billion and $7.321 billion, respectively.
Effective July 1, 1999, the amortization expense of mortgage servicing rights
was reclassified from general and administrative expenses to a reduction of loan
servicing fees. Such reclassification was primarily for presentation purposes to
be more in line with other financial institutions. For the three months ended
September 30, 1999 and 1998, gross loan servicing fees totaled $9.0 million and
$8.4 million, respectively, which were reduced by the amortization expense and
hedging activity of mortgage servicing rights totaling approximately $3.0
million for both periods.
The value of the Corporation's loan servicing portfolio increases as mortgage
interest rates rise and loan prepayments decrease. It is expected that income
generated from the Corporation's loan servicing portfolio will increase in such
an environment. However, this positive effect on the Corporation's income is
offset, in part, by a decrease in additional servicing fee income attributable
to new loan originations, which historically decrease in periods of higher, or
increasing, mortgage interest rates, and by an increase in expenses from loan
production costs since a portion of such costs cannot be deferred due to lower
loan originations. Conversely, the value of the Corporation's loan servicing
portfolio will decrease as mortgage interest rates decline.
Retail Fees and Charges:
- ------------------------
Retail fees and charges totaled $10.0 million for the three months ended
September 30, 1999 compared to $9.4 million for the three months ended September
30, 1998. The net increase results primarily from the AmerUs and Midland
acquisitions accounted for as purchases and included in operations since their
respective dates of consummation, contributing $1.1 million in retail fees and
charges for the three months ended September 30, 1999. Increases in certain
checking account fees and related ancillary fees for overdraft and insufficient
funds charges and a reduction in the amount of waiver of retail fees are all
reasons for the increase over 1998.
23
Gain (Loss) on Sales of Loans:
- ------------------------------
The Corporation sold loans to third parties through its mortgage banking
operations resulting in a net pre-tax loss of $122,000 for the three months
ended September, 30, 1999 compared to net pre-tax gains of $1.9 million for the
three months ended September 30, 1998 on loans sold totaling $159.2 million and
$513.3 million, respectively. Mortgage loans are generally sold in the secondary
market with loan servicing retained and without recourse to the Corporation.
Gain on Sales of Securities:
- ----------------------------
The Corporation sold securities available for sale resulting in net pre-tax
gains of $1.7 million for the three months ended September 30, 1998, on sales of
mortgage-backed securities totaling $78.5 million acquired in the AmerUs
acquisition. During the three months ended September 30, 1999, there were no
sales of securities available for sale.
Other Operating Income:
- -----------------------
Other operating income totaled $6.1 million for the three months ended September
30, 1999, compared to $5.7 million for the three months ended September 30,
1998. The major components of other operating income are brokerage commissions,
credit life and disability commissions, insurance commissions and leasing
operations. The net increase for the three months ended September 30, 1999,
compared to the prior year period is primarily attributable to increases in
brokerage and insurance commissions.
General and Administrative Expenses:
- ------------------------------------
General and administrative expenses totaled $61.3 million for the three months
ended September 30, 1999, compared to $63.0 million for the three months ended
September 30, 1998. Excluding merger-related expenses totaling $16.2 million
incurred in the quarter ended September 30, 1998, associated with the First
Colorado Bancorp, Inc. acquisition, general and administrative expenses totaled
$46.8 million.
Excluding the merger-related charges totaling $16.2 million, the net increase of
$14.5 million for the three months ended September 30, 1999, compared to the
three months ended September 30, 1998, is primarily due to net increases in
other operating expenses of $5.8 million, compensation and benefits of $5.1
million, occupancy and equipment of $1.9 million and data processing of $1.7
million. The AmerUs and Midland acquisitions, which were accounted for under
the purchase method of accounting, contributed a net increase of approximately
$4.0 million in additional general and administrative expenses for the three
months ended September 30, 1999. These acquisitions result in increased
personnel wages and benefits and costs of operating additional branches, as
well as other expenses incurred on an indirect basis attributable to these
acquisitions. General and administrative expenses also increased for the three
months ended September 30, 1999 compared to 1998 due to higher costs associated
with the new data processing computer systems, higher item processing costs
from the customer deposit delivery system implemented after September 30, 1998
and to a decrease in deferred costs associated with loan originations due to
lower loan origination volumes.
24
Amortization of Intangible Assets:
- ----------------------------------
Amortization of intangible assets totaled $4.6 million for the three months
ended September 30, 1999, compared to $3.3 million for the three months ended
September 30, 1998. The net increase for the three months ended September 30,
1999 compared to 1998 is due to the AmerUs and Midland acquisitions consummated
July 31, 1998 and March 1, 1999, respectively. Amortization of the intangible
assets from these two purchase acquisitions totaled $2.8 million for the three
months ended September 30, 1999 compared to $1.2 million for the three months
ended September 30, 1998.
Provision for Income Taxes:
- ---------------------------
For the three months ended September 30, 1999, the provision for income taxes
totaled $14.0 million compared to $13.4 million for the three months ended
September 30, 1998. The effective income tax rates for both quarters were 34.8%
and 47.0%, respectively. The effective tax rates for both periods vary from the
statutory rate primarily due to the nondeductibility of amortization of
intangible assets in relation to the level of taxable income for the respective
periods and, for the three months ended September 30, 1998, to the
nondeductibility of certain merger-related expenses and other nonrecurring
charges.
Cumulative Effect of Change in Accounting Principle:
- ----------------------------------------------------
Effective July, 1, 1999, the Corporation adopted the provisions of Statement of
Position 98-5 "Reporting the Costs of Start-Up Activities" (SOP 98-5), which
requires that costs of start-up activities and organizational costs be expensed
as incurred. Prior to the adoption of this statement, these costs were
capitalized and amortized over periods ranging from five to 25 years. The effect
of adopting the provisions of SOP 98-5 was to record a charge of $1,776,000, net
of an income tax benefit of $978,000, or $.03 per diluted share, as a cumulative
effect of a change in accounting principle in the accompanying consolidated
statement of operations. These costs consist of organizational costs primarily
associated with the creation of a real estate investment trust subsidiary and
start-up costs of the proof of deposit department for processing customer
transactions following the complete conversion of the Corporation's deposit
system.
25
Year 2000:
- ----------
The year 2000 poses an important business issue regarding how existing
application software programs and operating systems can accommodate this date
value. Many computer programs that can only distinguish the final two digits of
the year entered are expected to read entries for the year 2000 as the year
1900. Like most financial service providers, the Corporation may be
significantly affected by the Year 2000 issue due to the nature of financial
information. Software, hardware and equipment both within and outside the
Corporation's direct control and with whom the Corporation electronically or
operationally interfaces are likely to be affected. If computer systems are not
adequately changed to identify the Year 2000, many computer applications could
fail or create erroneous results. As a result, many calculations that rely on
data field information, such as interest, payment or due dates and other
operating functions, may generate results that could be significantly misstated,
and the Corporation could experience a temporary inability to process
transactions and engage in normal business activities.
All of the significant computer programs of the Corporation that could be
affected by this problem are provided by major third party vendors. The
Corporation has completed the process of replacing/upgrading its computer
systems and programs, as well as most equipment, in order to provide
cost-effective and efficient delivery of services to its customers, information
to management, and to provide additional capacity for processing information and
transactions due to acquisitions. The total cost of the Year 2000 project is
estimated to approximate $14.0 million which will be funded through cash flows
from operations. Most of the total project cost was capitalized since it
involved the purchase of computer systems, programs and equipment. During the
three months ended September 30, 1999 and for fiscal year 1999, approximately
$282,000 and $4.4 million, respectively, was expensed that related to systems
conversion costs, internal staff costs as well as consulting and other Year 2000
expenses. In addition, during fiscal year 1998 the Corporation expensed $4.3
million due to accelerated amortization of certain computer systems and software
necessitated by Year 2000 compliance and the related planned systems
conversions. The adjusted carrying amount of these computer systems and software
was depreciated until their disposal at the date of conversion.
The third party vendors have advised the Corporation that all such mission
critical computer systems and programs are Year 2000 compliant. The Corporation
tested all such systems for Year 2000 compliance before integration into its
computer environment. The Corporation scheduled certain operations that began
conversions in October 1998. These conversions allowed the Corporation to
resolve application and conversion problems that arose and to do further testing
to enhance software programs and future conversions. Final conversions that are
Year 2000 compliant were completed by the end of fiscal year 1999. Other mission
critical systems were tested in conjunction with certain nationwide financial
industry test programs. All Year 2000 testing was substantially completed June
30, 1999. In addition, as a financial services institution, the Corporation is
under the supervision of federal regulatory agencies with Year 2000 guidelines.
These agencies performed special examinations and monitored the progress of the
Corporation's Year 2000 readiness. The Corporation has met all of the Year 2000
requirements set by the federal regulations.
The Corporation continues working with non-mainframe software and hardware
vendors to determine the extent to which the Corporation's interface systems may
be vulnerable to those third parties' failure to remediate their own Year 2000
issues. If the third party vendors are unable to resolve Year 2000 issues in
time, the conversion is delayed significantly or major problems arise as a
result of the conversion, the Corporation would likely experience significant
data processing delays, mistakes or failures. These delays, mistakes or failures
could have a significant adverse impact on the financial condition and results
of operations of the Corporation. In addition, there can be no assurance that
the systems of other companies on which the Corporation's systems rely will be
timely converted, or that a failure to convert by another company, or a
conversion that is incompatible with the Corporation's systems, would not have a
material adverse effect on the Corporation. The Corporation has developed and
tested a Year 2000 contingency plan that addresses, among other issues, critical
operations and potential failures thereof, and strategies for business
continuation such as contracting with alternative vendors and re-deployment of
internal staff as needed in critical areas. The Corporation has also evaluated
non-technical systems that rely on imbedded technology in their critical
processes so that such systems will continue to operate without interruption.
Item 3. QUANTITATIVE AND QUALITATIVE
-------------------------------------
DISCLOSURES ABOUT MARKET RISK
-----------------------------
Information concerning the Corporation's exposure to market risk, which has
remained relatively unchanged from June 30, 1999, is incorporated by reference
from the text under the caption "Market Risk" in the Form 10-K for the
Corporation's fiscal year ended June 30, 1999.
26
PART II. OTHER INFORMATION
--------------------------
Item 5. Other Information
-----------------
On September 28, 1999, the Corporation's Board of Directors adopted an
amendment to the Corporation's By-laws which provides that in order to
qualify to serve as a member of the board of the Corporation, such
individual must not also serve as a management official of another
federally insured depository organization that operates branches in any
market in which the Corporation operates branches. The By-law amendment
will prevent in the future an individual from serving on the Board of
Directors of the Corporation who would lack the ability to act in the
best interests of the Corporation's stockholders given the inherent
conflict of interest present when an individual serves as a director of
two competitors. On October 5, 1999, the Corporation filed a Form 8-K
regarding the adoption of this amendment with the amended By-laws
included as an exhibit.
On October 29, 1999, the Corporation entered into an agreement with
Franklin Mutual Advisers, LLC to settle all pending litigation and the
proxy contest relating to the election of directors at the
Corporation's 1999 Annual Meeting of Stockholders to be held on
November 16, 1999. See Note H "Subsequent Event - Settlement Agreement"
to the Notes to Consolidated Financial Statements for additional
information.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a). Exhibits:
Exhibit 27. Financial Data Schedules
(b). Reports on Form 8-K:
There were no reports filed on Form 8-K during the quarter ended
September 30, 1999.
27
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COMMERCIAL FEDERAL CORPORATION
------------------------------
(Registrant)
Date: November 15, 1999 /s/ James A. Laphen
----------------- --------------------------------------------
James A. Laphen, President and Chief
Operating Officer (Duly Authorized
and Principal Financial Officer)
Date: November 15, 1999 /s/ Gary L. Matter
----------------- --------------------------------------------
Gary L. Matter, Senior Vice President,
Controller and Secretary
(Principal Accounting Officer)
28
EXHIBIT INDEX
-------------
Exhibit 27. Financial Data Schedules
29