SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-------------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
0R
[ ] 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 33-93312
BEAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
TEXAS 75-2583551
(State or other jurisdiction of incorporation (I.R.S. Employer Identification
or organization) Number)
SUITE 300, LB66, 15770 NORTH DALLAS PARKWAY, DALLAS, TEXAS 75248
(Address of principal executive offices) (ZIP code)
Registrant's telephone number, including area code: (972) 404-4000
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 [ ]
As of September 30, 1998, there were 300,000 shares of the Registrant's
common stock issued and outstanding.
BEAL FINANCIAL CORPORATION
INDEX
PAGE
NUMBER
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PART I. FINANCIAL INFORMATION
Item 1. - Financial Statements. . . . . . . . . . . . . . . . . . . 1
Item 2. - Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . 5
PART II. OTHER INFORMATION
SIGNATURES
BEAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands,except share data)
September 30, December 31,
1998 1997
(Unaudited)
------------ ------------
ASSETS
Cash $ 1,761 $ 630
Interest bearing deposits 114,117 150,219
---------- ----------
CASH AND CASH EQUIVALENTS 115,878 150,849
Accrued interest receivable 10,752 13,071
Securities available for sale 98,069 111,376
Net loans receivable 710,732 899,745
Less allowance for losses (10,000) (11,912)
---------- ----------
700,732 887,833
Federal Home Loan Bank stock 6,362 10,203
Real estate held for investment or sale 109,616 176,682
Premises and equipment, net 5,662 6,351
Other assets 11,094 9,389
---------- ----------
$1,058,165 $1,365,754
---------- ----------
---------- ----------
LIABILITIES
Deposit accounts $ 786,534 $1,001,476
Federal Home Loan Bank advances 0 110,000
Senior notes, net 57,268 57,188
Other borrowings 7,135 7,599
Other liabilities 10,199 28,673
---------- ----------
TOTAL LIABILITIES 861,136 1,204,936
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, par value $1 per share
authorized 375,000
issued and outstanding 300,000 300 300
Paid-In capital 2,740 2,740
Unrealized gain (loss) on available for sale
securities 4,790 3,722
Retained earnings 189,199 154,056
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 197,029 160,818
---------- ----------
$1,058,165 1,365,754
---------- ----------
---------- ----------
See notes to consolidated financial statements
1
BEAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
--------- -------- --------- ---------
Interest Income:
Loans, including fees $22,016 $23,411 $ 71,094 $ 83,584
Purchased discount accretion 10,035 8,327 34,544 34,829
Investment securities 2,894 2,524 8,002 8,327
------------------------ --------------------------
TOTAL INTEREST INCOME 34,945 34,262 113,640 126,740
Interest expense:
Deposits 10,836 13,788 35,691 43,197
Federal Home Loan Bank
advances and other borrowings 148 541 1,081 1,635
Senior notes 2,022 1,999 6,049 5,981
------------------------ --------------------------
TOTAL INTEREST EXPENSE 13,006 16,328 42,821 50,813
------------------------ --------------------------
NET INTEREST INCOME 21,939 17,934 70,819 75,927
Provision for loan losses 176 1,764 1,240 2,436
------------------------ --------------------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 21,763 16,170 69,579 73,491
Other income
Gain on sale of loans 0 6 10 544
Gain on real estate transactions 22,017 5,648 34,169 9,396
Other real estate operations, net 994 553 5,224 2,121
Other operating income 154 223 515 417
------------------------ --------------------------
TOTAL NONINTEREST INCOME 23,165 6,430 39,918 12,478
Other expense
Salaries and employee benefits 2,625 2,701 6,200 6,567
Occupancy and equipment 512 566 1,690 1,790
SAIF deposit insurance premium 150 176 467 513
Other operating expenses 1,761 3,047 6,579 7,847
------------------------ --------------------------
TOTAL NONINTEREST EXPENSES 5,048 6,490 14,936 16,717
------------------------ --------------------------
INCOME BEFORE INCOME TAXES 39,880 16,110 94,561 69,252
Income Taxes 954 999 3,819 3,164
------------------------ --------------------------
NET INCOME $38,926 $15,111 $ 90,742 $ 66,088
------------------------ --------------------------
------------------------ --------------------------
Income per common share $129.75 $ 50.37 $ 302.47 $ 220.29
Weighted average number of common shares
outstanding 300 300 300 300
See notes to consolidated financial statements
2
BEAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
UNAUDITED
(In thousands)
Nine Months Months
ended September 30
--------------------------
1998 1997
----------- -----------
OPERATING ACTIVITIES
Net income $ 90,742 $ 66,088
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 1,531 1,809
Accretion of purchased discount (34,544) (34,829)
Provision for loan losses 1,240 2,436
Amortization of bond premium and underwriting costs 551 482
Gains on real estate transactions (34,169) (9,396)
Gain on sales of loans - (544)
Loss on sale of premises and equipment 189 7
Changes in operating assets and liabilities
Accrued interest receivable 1,506 (1,829)
Prepaid expenses and other assets (1,072) (86)
Accrued interest payable-bonds (1,833) (1,833)
Other liabilities and accrued expenses (6,730) (1,031)
----------- -----------
Net cash provided by
operating activities 17,411 21,274
INVESTING ACTIVITIES
Proceeds from sales of loans - 20
Proceeds from paydowns of securities available for sale 14,657 10,718
Proceeds from loan collections, less loan originations and advances 230,977 164,325
Proceeds from sale of FHLB stock 4,181 -
Proceeds from sales of real estate and partnership/JV interests 98,079 29,798
Proceeds from sales of premises and equipment 79 5
Purchases of loans and bid deposits on loan purchases (3,144) (37,100)
Purchases of Federal Home Loan Bank stock (340) (433)
Purchases of real estate held for invest. or sale and
partnership/JV interests (3,020) (14,711)
Purchases of premises and equipment (245) (396)
----------- -----------
Net cash provided by
investing activities 341,224 152,226
FINANCING ACTIVITIES
Net decrease in deposit accounts (214,942) (71,383)
Proceeds from long-term debt - 162
Repayments of long-term debt (464) (5,462)
Repayments of advances from the Federal Home Loan Bank (110,000) (106,000)
Cash dividends paid (68,200) (23,926)
----------- -----------
Net cash used in
financing activities (393,606) (206,609)
----------- -----------
Net decrease in cash and
cash equivalents (34,971) (33,109)
Cash and cash equivalents at beginning of period 150,849 65,940
----------- -----------
Cash and cash equivalents at end of period $ 115,878 $ 32,831
----------- -----------
----------- -----------
Supplemental disclosure of cash flow information
Cash paid during the period for
Interest $ 40,059 $ 52,763
Income taxes 10,386 4,889
Supplemental disclosure of noncash investing and financing activities
Real estate acquired in foreclosure or in settlement of loans $ 9,236 $ 69,833
See Notes to Consolidated Financial Statements
3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A--BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial statements and with instructions to Form 10-Q and Rule 10-1 of
Regulation S-X. The financial statements as of September 30, 1998 and for the
nine months ended September 30, 1998, and 1997 are unaudited and, in the opinion
of management, include all adjustments necessary (which consist of only normal
recurring adjustments) for a fair presentation of the financial position and
results of operations for the interim periods. The results of operations for the
nine month period are not necessarily indicative of the results to be expected
for the full year.
These unaudited financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's annual report
in Form 10-K for the year ended December 31, 1997.
NOTE B--INCOME TAXES
On March 13, 1997, the Company filed an application with the Internal Revenue
Service to elect S Corporation status for federal income tax purposes effective
January 1, 1997. This election covered all subsidiaries of the Company, except
Beal Affordable Housing, Inc. and BRE-N, Inc.
As a result of the aforementioned application, beginning January 1, 1997, the
Company and all of its subsidiaries electing S Corporation status no longer pay
federal income taxes, except for federal taxes related to the recognition of
built-in gains which existed at January 1, 1997. For the nine months ended
September 30, 1998, the Company recorded federal tax expense of $2,175,600,
related to the recognition of built-in gains. Except as discussed above, the
liability for federal income taxes of the Company is the responsibility of its
shareholders.
NOTE C--NEW ACCOUNTING PRONOUNCEMENT
In 1998, the Company adopted Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income", which requires reporting of comprehensive
income in the financial statements. The components of comprehensive income are
as follows:
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
1998 1997 1998 1997
-------------- -------------- -------------- --------------
(In thousands) (In thousands)
Net income $38,926 $15,111 $90,742 $66,088
Other comprehensive income net
unrealized gains on investment
securities - available for sale 892 1,641 1,068 2,373
------- ------- ------- -------
Comprehensive income $39,818 $16,752 $91,810 $68,461
------- ------- ------- -------
------- ------- ------- -------
4
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
WHEN USED IN THIS FORM 10-Q, THE WORDS "BELIEVES", "ANTICIPATES", "EXPECTS", AND
SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD LOOKING STATEMENTS. SUCH
STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES WHICH COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY. READERS ARE CAUTIONED NOT TO PLACE UNDUE
RELIANCE ON THESE FORWARD LOOKING STATEMENTS WHICH SPEAK ONLY AS OF THE DATE
HEREOF, AND TO ADVISE READERS THAT VARIOUS FACTORS INCLUDING REGIONAL AND
NATIONAL ECONOMIC CONDITIONS, CHANGES IN LEVELS OF MARKET INTEREST RATES, CREDIT
RISK OF LENDING ACTIVITIES, AND COMPETITIVE AND REGULATORY FACTORS, COULD AFFECT
THE COMPANY'S FINANCIAL PERFORMANCE AND COULD CAUSE THE COMPANY'S ACTUAL RESULTS
FOR FUTURE PERIODS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED OR PROJECTED. THE
COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY
REVISIONS TO FORWARD LOOKING STATEMENTS WHICH MAY BE MADE TO REFLECT EVENTS OR
CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF
UNANTICIPATED EVENTS.
FINANCIAL CONDITION
Beal Financial Corporation ("Beal Financial" and with it's subsidiaries,
the "Company"), the parent company of Beal Bank, ssb, (the "Bank") had total
assets of $1.1 billion at September 30, 1998 representing a decrease of $307.6
million or 22.5%, from $1.4 billion at December 31, 1997. The decrease resulted
primarily from a decrease in net loans receivable of $189.0 million, a decrease
in real estate held for investment or sale of $67.1 million, a decrease in cash
and cash equivalents of $35.0 million, and a decrease in securities available
for sale of $13.3 million. The decrease in net loans receivable was due
primarily to normal principal repayments of loans, early loan payoffs and
foreclosures of loans. The decrease in securities available for sale was the
result of repayments in the ordinary course of business. The decrease in real
estate held for investment or sale was primarily the result of $72.7 million in
sales of other real estate, and a decrease in real estate and/or interests in
real estate joint ventures of $3.0 million, partially offset by foreclosures of
loans of $9.2 million. The decrease in cash and cash equivalents was the result
of normal operations. (See also - Liquidity and Capital Resources)
Subsequent to quarter end the Bank was the successful bidder on a $329.8
million, net, pool of primarily first lien, performing, single family
residential loans. The average age of the portfolio is approximately 12 years
with an average yield of 8.1%. These loans are located nationwide, however,
California, Florida and Texas represent 11.5%, 15.4% and 12.8%, respectively, of
the pool.
Total liabilities decreased $343.8 million, or 28.5% from $1.2 billion at
December 31, 1997 to $861.1 million at September 30, 1998, primarily due to a
decline in deposits of $214.9 million and a decline in Federal Home Loan Bank,
Dallas ("FHLB") advances of $110.0 million. The decrease in deposits for the
nine months ended September 30, 1998 was primarily due to decreases in brokered
deposits and retail deposits of $127.5 million and $87.4 million, respectively.
The decrease in deposits and the repayment of the advances from the FHLB, was
5
primarily funded with cash flow provided from normal operations. The loan pool
that was purchased subsequent to September 30, 1998 was funded by cash on hand,
$70.0 million in brokered deposits and $171.0 million in FHLB advances.
Stockholders' equity increased $36.2 million from $160.8 million at
December 31, 1997 to $197.0 million at September 30, 1998. The change was due to
net income of $90.7 million, and an increase of $1.1 million related to
unrealized gains on investment securities, partially offset by dividends
declared and paid to shareholders of $55.6 million
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
NET INCOME. For the nine months ended September 30, 1998, net income of
$90.7 million represented an increase of $24.7 million, or 37.3% from the nine
months ended September 30, 1997. As discussed in more detail below, the increase
was primarily due to an increase in noninterest income of $27.4 million which
offset a decrease in net interest income after provision for loan losses of $3.9
million.
INTEREST INCOME. Interest income decreased $13.1 million, or 10.3%, from
$126.7 million at September 30, 1997 to $113.6 million at September 30, 1998.
The majority of the total decrease in interest income was due to a decrease in
interest income on loans including fees, of $12.5 million. The remaining
decrease was as a result of a $285,000 decrease in purchased discount accretion
and a $325,000 decrease in interest income on investment securities. The average
balance of interest-earning assets decreased $170.8 million during this period,
as compared to the same period a year ago, primarily due to a decrease in
average net loans receivable of $170.0 million, a decrease in average holdings
of mortgage-backed securities of $14.2 million and a decrease in the average
balance of FHLB stock of $2.2 million, partially offset by an increase in the
average balance of interest earning deposits of $15.7 million, Net interest
spread, however, increased from 8.7% for the nine months ended September 30,
1997 to 9.4% for the same period ending September 30, 1998 primarily due to an
increase in yield on average interest-earning assets from 14.7% to 15.5% for the
nine month periods ending September 30, 1997 and 1998, respectively, due
primarily to an increase in the amount of discount accretion taken in relation
to the amount of loans outstanding. The Company anticipates that its average
yield will decrease in future periods as a result of the bulk purchase of single
family loans described above.
INTEREST EXPENSE. Interest expense decreased $8.0 million, or 15.7%, from
$50.8 million at September 30, 1997 to $42.8 million at September 30, 1998. The
decrease resulted primarily from the average balance of interest-bearing
liabilities decreasing $176.3 million to $946.4 million at September 30, 1998.
The average rate paid on interest bearing liabilities remained the same at 6.0%
at September 30, 1997 and 1998, respectively. The decrease in average
interest-bearing liabilities was due primarily to a decrease in the average
balance of deposits of $164.7 million, and a decrease in the average balance of
FHLB advances of $23.0 million, partially offset by an increase in the average
balance of borrowings of $11.3 million.
6
PROVISION FOR LOAN LOSSES. The provision for loan losses is determined by
management as an amount sufficient to maintain the allowance for loan losses at
a level considered adequate to absorb future losses inherent in the loan
portfolio in accordance with generally accepted accounting principles. The
provision for loan losses decreased $1.2 million for the nine months ended
September 30, 1998, as compared to the nine months ended September 30, 1997. The
allowance for losses as a percentage of net loans receivable increased slightly
from 1.3% at September 30, 1997 to 1.4% at September 30, 1998.
The Company establishes an allowance for loan losses based upon a
systematic analysis of risk factors in the loan portfolio as well as a specific
analysis of certain impaired loans. This analysis includes an evaluation of the
Company's loan portfolio, past loan loss experience, current economic
conditions, loan volume and growth, composition of the loan portfolio and other
relevant factors. Management's analysis results in the establishment of
allowance amounts by loan type based on allocations by asset classification. The
allowance for loan losses as a percentage of net non-performing loans was 8.4%
at September 30, 1998 as compared to 8.6% at September 30, 1997. Net
non-performing loans decreased $19.0 million from $138.6 million at September
30, 1997 to $119.6 million at September 30, 1998.
Although management believes that it uses the best information available to
determine the allowance for loan losses, unforeseen market conditions could
result in adjustments and net earnings could be significantly affected if
circumstances differ substantially from the assumptions used in making the final
determination. Future additions to the Company's allowance for loan losses will
be the result of periodic loan, property and collateral reviews and thus cannot
be predicted with absolute certainty in advance. In addition, bank regulatory
agencies, as an integral part of the examination process, periodically review
the Company's allowance for loan losses. Such agencies may require the Company
to recognize additions to the allowance level based upon their judgment of the
information available to them at the time of their examination.
NON-INTEREST INCOME. Total non-interest income increased $27.4 million, or
219.9% to $39.9 million at September 30, 1998 from $12.5 million at September
30, 1997. This increase was due primarily to an increase in the income
attributable to the gain on real estate transactions of $24.8 million, and an
increase in the income from other real estate operations, net of $3.1 million.
NON-INTEREST EXPENSE. Non-interest expense decreased $1.8 million, or 10.7%
from $16.7 million for the nine months ended September 30, 1997 to $14.9 million
for the nine months ended September 30, 1998. The decrease was primarily due to
a decrease of other operating expenses of $1.3 million (of which 69.4% or
$902,000 represented a decrease in attorney's fees relating primarily to the
resolutions of non-performing assets), and a decrease of $367,000 in salaries
and employees benefits.
7
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
NET INCOME. For the three months ended September 30, 1998, net income of
$38.9 million represented an increase of $23.8 million, or 157.6% from the three
months ended September 30, 1997. As discussed in more detail below, the increase
was primarily due to an increase in net interest income after provision for loan
losses of $5.6 million, and an increase in noninterest income of $16.7 million.
INTEREST INCOME. Interest income increased $683,000, or 2.0%, from $34.3
million at September 30, 1997 to $34.9 million at September 30, 1998. Of the
total increase in interest income, $1.7 million was due to an increase in
purchased discount accretion and $370,000 was due to an increase in interest
income on investment securities partially offset by a decrease in interest
income on loans, including fees, of $1.4 million. The average balance of
interest-earning assets decreased $157.7 million during this period, as compared
to the same period a year ago, primarily due to a decrease in average net loans
receivable of $189.3 million, a decrease in average holdings of mortgage-backed
securities of $16.9 million and a decrease in the average balance of FHLB stock
of $3.6 million, partially offset by an increase in the average balance of
interest earning deposits of $52.1 million. Net interest spread increased from
6.6% for the three months ended September 30, 1997 to 9.1% for the same period
ending September 30, 1998 primarily due to an increase in yield on average
interest-earning assets from 12.7% to 15.1% for the three month periods ending
September 30, 1997 and September 30, 1998, respectively due primarily to an
increase in the amount of purchased discount accretion taken.
INTEREST EXPENSE. Interest expense decreased $3.3 million, or 20.4%, from
$16.3 million at September 30, 1997 to $13.0 million at September 30, 1998. The
decrease resulted from the average balance of interest-bearing liabilities
decreasing $217.1 million to $854.3 million at September 30, 1998. The average
rate paid on interest bearing liabilities remained the same at 6.1% at September
30, 1997 and 1998, respectively. The decrease in average interest-bearing
liabilities was due primarily to a decrease in the average balance of deposits
of $190.8 million, a decrease in average other borrowings of $2.1 million, and a
decrease in the average balance of FHLB advances of $24.2 million.
PROVISION FOR LOAN LOSSES. The provision for loan losses is determined by
management as an amount sufficient to maintain the allowance for loan losses at
a level considered adequate to absorb future losses inherent in the loan
portfolio in accordance with generally accepted accounting principles. The
provision for loan losses decreased $1.6 million, or 90.0%, for the three months
ended September 30, 1998, as compared to the three months ended September 30,
1997.
NON-INTEREST INCOME. Total non-interest income increased $16.7 million, or
260.3% to $23.2 million at September 30, 1998 from $6.4 million at September 30,
1997. This increase was due primarily to an increase in the income attributable
to the gain on real estate transactions of $16.4 million
8
NON-INTEREST EXPENSE. Non-interest expense decreased $1.4 million, or 22.2%
from $6.5 million for the three months ended September 30, 1997 to $5.0 million
for the three months ended September 30, 1998. The decrease was due primarily to
a decrease of $1.3 million in other operating expenses, $830,900 of which
related to a decrease in legal fees relating primarily to the resolutions of
nonperforming assets.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION. Beal Financial filed with the Internal Revenue Service on
March 13, 1997, to elect Subchapter-S status for federal income tax purposes
effective January 1, 1997. This election covered all subsidiaries of Beal
Financial, including the Bank, except for Beal Affordable Housing, Inc. ("BAH")
and BRE-N, Inc.("BRE-N"), (the "Subchapter-S subsidiaries"). BAH and BRE-N
elected to remain Subchapter-C Corporations for federal tax purposes and will
continue to be responsible to pay federal corporate income taxes. Concurrent
with the change to Subchapter-S status, Beal Financial and all subsidiaries
changed their tax and fiscal year-ends to December 31 from their previous
September 30 year-ends.
Beal Financial and the Subchapter-S subsidiaries generally will not pay any
federal taxes on net income. The only exception to the non-payment of federal
taxes will involve possible Subchapter-C tax liabilities on net built-in gains
for Beal financial as of January 1, 1997, which may have to be recognized during
the 10 year period ending December 31, 2006. Recognition of built-in
gains/losses are also subject to certain limitations. Approximately $1.4 million
of the tax expense for the nine months ended September 30, 1998, related to tax
on recognized built-in gains. It is not anticipated that the tax expense,
related to recognized built-in gains would be material in any given quarter.
Approximately $800,000 of the tax expense for the nine months ended September
30, 1998, related to C Corporation tax for BAH and BRE-N.
The future tax liability for the taxable earnings of Beal Financial and the
Subchapter-S subsidiaries will be the responsibility of the shareholders of Beal
Financial. It is anticipated that future dividends to shareholders will be
declared in an amount equal to at least their tax liability related to the
earnings of Beal Financial.
TEXAS STATE INCOME TAXATION. Beal Financial and each subsidiary currently
file Texas franchise tax returns. Texas imposes a franchise tax on the taxable
income of savings institutions and other corporations. The franchise tax equals
the greater of $2.50 per $1,000 of taxable capital apportioned to Texas, or
$45.00 per $1,000 of net taxable earned surplus apportioned to Texas. Taxable
earned surplus is the federal corporate taxable income of each company within
the corporate group determined on a separate company basis with certain
modifications. Approximately $1.6 million of the tax expense for the nine months
ended September 30, 1998, related to franchise tax, primarily Texas franchise
tax.
9
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds for operations are deposits obtained
from its market area, principal and interest payments on loans, brokered
deposits, and advances from the FHLB of Dallas and to a lesser extent, from the
sale of assets. While maturities and scheduled amortization of loans are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions, and competition.
Historically, the primary investing activity of the Company has been the
purchase of discounted loans from various U.S. government agencies through the
sealed bid process or auctions and from other private sector sellers. During the
three and nine month periods ended September 30, 1998, the Company purchased
$2.0 million and $3.2 million of net loans, respectively as compared to
purchases of $15.0 million and $35.2 million for the same periods ended last
year. Loan origination's for the three and nine months ended September 30, 1998
totaled $17.5 million and $24.9 million, respectively as compared to
origination's of $29.1 million and $57.0 million for the same periods ended last
year.
The Company's primary financing activity has historically been the
attraction of deposits. During the nine months ended September 30, 1998, the
Company experienced a planned net decrease in deposits of $214.9 million,
primarily comprised of a decrease in retail deposits of a $127.5 million and a
decrease of $87.4 million in brokered deposits. The decrease in deposits for the
nine months ended September 30, 1998 was primarily funded by the decrease in
cash and cash equivalents and cash received from principal repayments of loans,
early loan payoffs and the proceeds from the sale of real estate held for
investment or sale. The Company had senior notes, net, of $57.3 million and
other borrowings of $7.1 million at September 30, 1998.
The Company has the ability to borrow additional funds from the FHLB by
pledging assets as collateral, subject to certain restrictions. At September 30,
1998, the Company had an undrawn advance arrangement with the FHLB for $100.2
million, which was subsequently used, along with additional advances to fund the
bulk loan purchase described above. As of the date of this filing the Company
had an undrawn advance arrangement with the FHLB for $31.5 million.
The Bank is required to maintain minimum levels of liquid assets as defined
by the Texas Savings and Loan Department ("Texas Department"). Unless approved
in advance by the Texas Department, a Texas savings bank is required to maintain
a minimum of 10% of the previous quarters average deposits in liquid assets. At
September 30, 1998, the Bank's liquidity ratio was 21.73%, however as a result
of the bulk loan purchase the Banks liquidity ratio, as of the date of this
filing was 16.0%.
The Company's most liquid asset is cash and cash equivalents. The level of
cash equivalents is dependent on the Company's operating, financing, and
investing activities during any given period. At September 30, 1998, the Company
had cash and cash equivalents of $115.9 million.
10
The Company anticipates that it will have sufficient funds available to
meet its current foreseeable commitments. At September 30, 1998, the Company had
commitments to originate loans of $8.1 million and no outstanding commitments to
purchase loans. Certificates of deposits which are scheduled to mature in one
year or less at September 30, 1998 totaled $587.6 million (excluding $70 million
in brokered deposits received subsequent to September 30, 1998, used to fund the
bulk loan purchase described above). Due to the Company's high interest rate
spread, management has typically relied upon interest rate sensitive short-term
deposits to fund its loan purchases. The Company believes the potential interest
rate risk is acceptable in view of the Company's belief that it can maintain an
acceptable net interest spread.
At September 30, 1998, the Bank exceeded each of its three capital
requirements and is considered well capitalized for regulatory purposes. The
following is a summary of the Bank's regulatory capital position at September
30, 1998.
At September 30, 1998
-----------------------------------------------
Required Actual
-------------------- ---------------------
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in Thousands)
Leverage capital ............ $ 56,339 5.00% $138,202 12.27%
Tier 1 capital .............. 48,511 6.00 138,202 17.09
Total risk-based capital .... 80,852 10.00 148,202 18.33
On October 13, 1997, the Department notified the Bank's Board of Directors that
the Department was rescinding the requirement that the Bank maintain minimum
capital requirements of 9% for Tier I capital and 11% for risked-based capital,
based on a business plan submitted to the Department by the Bank and the
Department's evaluation of the Bank's latest examination as of September 30,
1997. The business plan generally anticipates a decline in total assets, absent
the Company being the successful bidder for additional bulk asset purchases; a
continued improvement in the Company's level of classified assets; the
discontinuation of the Company's foreign lending program; and the Bank
maintaining a Tier I capital ratio of at least 10%. The Department must be
provided with 30 days prior written notice of any actions planned or anticipated
that might reasonably be expected to result in a material deviation from the
business plan. For purposes of such advance notification, material deviation
would include, but not necessarily be limited to, material deviations in capital
levels, total asset growth or bulk asset purchases in any quarter, or any
resumption of foreign lending. On October 16, 1998, the Bank requested and
received approval to deviate from the approved business plan in order to
purchase the $329.8 million, net, of primarily first lien single family
residential loans. After the purchase the Bank continued to exceed each of its
three capital requirements and remains well capitalized for regulatory purposes.
In addition, the Bank is in the process of revising its' business plan. It is
expected that the revised plan will reflect continued growth due to additional
loan purchases.
11
YEAR 2000
The Year 200 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
computer programs used by the Company that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in system failure or miscalculations. Management anticipates
that the enhancements necessary to prepare its systems for the year 2000 will
be completed in a timely manner.
During 1998, the company formulated its plan to address the Year 2000
potential issue. During this time the Company has taken the following steps:
- - Established a Year 2000 Project Team;
- - Inventoried Company applications and system software;
- - Built an internal tracking database for application and vendor software;
- - Developed a time line for completion of Year 2000 project milestones;
- - Reviewed major customers to assess the Year 2000 impact and their effect on
credit quality;
- - Developed a brochure to educate customers on the Year 2000 issue;
- - Tested various application for year 2000 compliance;
- - Submitted to an examination by the FDIC to assess the adequacy of the
Company's plan for addressing the Year 2000 issue. The results of this
examination are confidential as a matter of law.
The Company's Year 2000 project team ensures that all Company systems
are identified, analyzed for Year 2000 compliance, and corrected, if
necessary by September 30, 1999. The Year 2000 project team members represent
all functional areas of the company. The Company's Board of Directors
oversees the year 2000 plan and provides guidance and resources to, and
receives monthly updates from the Year 2000 coordinator.
The Company is expensing the cost of all required system changes and
such costs are funded through operating cash flows. The total estimated cost
of the Year 2000 conversion project is approximately $150,000. The Company
does not expect significant increases in future data processing costs
relating to Year 2000 compliance.
Like most financial service providers, the Company and it operations may
be significantly affected by the Year 2000 issue due to dependence on
technology and date-sensitive data. Computer software, hardware and other
equipment, both within and outside the Company's direct control, and third
parties with whom the Company electronically or operationally interfaces
(including, without limitation, its customers and third party vendors) are
likely to be affected. If computer systems are not modified to identify the
year 2000, computer applications could fail or create erroneous results. Many
calculations reliant on date field information, such as interest, payment or
due dates and other operating functions, could generate erroneous results,
and the Company could experience an inability to process transactions,
prepare statements or
12
engage in similar normal business activities. A failure to adequately address
the Year 2000 issue could adversely affect the viability of the company's
suppliers and creditors, and the creditworthiness of its borrowers. Thus, if
not adequately addressed, the Year 2000 issue could result in a significant
adverse impact on the Company's operations and in turn, its financial
condition and results of operations.
The Company has developed or is developing contingency plans for each of
its mission critical systems. These contingency plans include selecting a new
vendor or service provider of system conversions. In the event a current
vendor's system fails during Year 2000 compliance testing and it is
determined that the system failure cannot be corrected, the Company will
convert to an alternative Year 2000 compliant system.
The Company's core banking system is used by a number of other financial
institutions, however, this system has not been examined for Year 2000
readiness by the Federal Financial Institutions Examination Counsel.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes thereto presented herein
have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars without considering the change in the
relative purchasing power of money over time due to inflation. The impact of
inflation is reflected in the increased cost of the Company's operations.
Nearly all the assets and liabilities of the corporation are financial,
unlike most industrial companies. As a result, the Company's performance is
directly impacted by changes in interest rates, which are indirectly
influenced by inflationary expectations. Since the Company has historically
placed more emphasis on increasing net interest margin rather than on
matching the maturities of interest rate sensitive assets and liabilities,
changes in interest rates may have a greater impact on the Company's
financial condition and results of operations. Changes in investment rates do
not necessarily move to the same extent as changes in the price of goods and
services.
RATIOS OF EARNING TO FIXED CHARGES
The Company's consolidated ratios of earnings to fixed charges for the
three months ended September 30, 1998 are set forth below. Earnings used in
computing the ratios shown consist of earnings from continuing operations
before taxes and interest expense. Fixed charges, excluding interest on
deposits, represent interest expense on borrowings. Fixed charges, including
interest on deposits, represent all of the foregoing items plus interest on
deposits. Interest expense (other than on deposits) includes interest on FHLB
borrowings, the Senior Notes and other borrowed funds.
13
For the Three Months Ended
September 30, 1998
--------------------------
Excluding interest on deposits . . . . . . . 14.3:1
Including interest on deposits . . . . . . . 2.4:1
14
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company is not currently involved in any legal proceedings. The Bank
is involved in various legal proceedings occurring in the ordinary course of
business. Management of the Bank, based on discussions with litigation
counsel, believes that such proceedings will not have a material adverse
effect on the financial condition or operations of the Bank. There can be no
assurance that any of the outstanding legal proceedings to which the Bank is
a party will not be decided adversely to the Company's interests and have a
material adverse effect on the financial position or results of operations of
the Company.
Item 2. CHANGES IN SECURITIES
None.
Items 3. DEFAULTS UPON SENIOR SECURITIES
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Item 5. OTHER INFORMATION
None.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 27--Financial Data Schedule
15
Pursuant to the requirement 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.
BEAL FINANCIAL CORPORATION
Registrant
Date: November 19, 1998
--------------------------------------
D. Andrew Beal, Chairman
Date: November 19, 1998
--------------------------------------
James W. Lewis, Jr.
Chief Accounting Officer
16