<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 1996
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File No.: 000-21137
R&G FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Puerto Rico 66-0532217
- -------------------------------- -----------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
280 Jesus T. Pinero Avenue
Hato Rey, San Juan, Puerto Rico 00918
- -------------------------------- -----------------------
(Address of Principal (Zip Code)
Executive Offices)
Registrant's telephone number, including area code: (787) 766-2424
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Class B Common Stock (par value $.01 per share)
- --------------------------------------------------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
As of March 18, 1997, the aggregate value of the 2,659,339 shares of Class B
Common Stock of the Registrant issued and outstanding on such date, which
excludes 76,500 shares held by all directors and officers of the Registrant as a
group, was approximately $67.8 million. This figure is based on the last known
trade price of $25.50 per share of the Registrant's Class B Common Stock on
March 18, 1997.
Number of shares of Class B Common Stock outstanding as of March 18, 1997:
2,735,839
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents incorporated by reference and the
Part of the Form 10-K into which the document is incorporated:
(1) Portions of the Annual Report to Stockholders for the fiscal year ended
December 31, 1996 are incorporated into Parts II and IV.
(2) Portions of the definitive proxy statement for the Annual Meeting of
Stockholders are incorporated into Part III.
<PAGE>
PART I
Item 1. Business
General
R&G Financial Corporation (the "Company" or "R&G Financial") is the
holding company for R&G Mortgage Corp., a Puerto Rico mortgage banking company
("R&G Mortgage") and R-G Premier Bank of Puerto Rico, a Puerto Rico-chartered
commercial bank (the "Bank"). The Company was organized under Puerto Rico law in
March 1996. On July 19, 1996, the Company acquired the 88.1% ownership interest
in the common stock of the Bank and the 100% ownership interest in the common
stock of R&G Mortgage held by the Company's Chairman of the Board and Chief
Executive Officer, Mr. Victor J. Galan, in exchange for shares of Class A common
stock of the Company. On August 27, 1996, the Company sold 2,348,333 shares of
Class B common stock to the general public in an underwritten offering. Mr.
Galan also converted 66,667 of his shares of Class A common stock into shares of
Class B common stock and sold such shares in the public offering. As a result of
such transaction, an aggregate of 2,415,000 shares of Class B common stock were
publicly issued and the Company received gross proceeds of $35.0 million in the
offering, which resulted in net proceeds of $31.1 million after payment of
offering expenses. On December 4, 1996, the Company acquired the remaining 11.9%
ownership interest in the common stock of the Bank and issued 300,839 shares of
Class B common stock to the Bank's stockholders in exchange for such ownership
interest. At December 31 1996, the Company had total consolidated assets of $1.0
billion, total consolidated borrowings of $289.7 million, total consolidated
deposits of $615.6 million, and total consolidated stockholders' equity of
$115.6 million.
Mr. Victor J. Galan, the Chairman of the Board, Chief Executive Officer
and controlling shareholder of R&G Financial, originally organized R&G Mortgage
in 1972. In February 1990, R&G Mortgage acquired a 74.7% interest in a two
branch federal savings and loan association with total assets of $52.9 million,
which was re-named R&G Federal Savings Bank. Recognizing the complementary
operational aspects and cross selling opportunities that are inherent in
operating both a mortgage bank and banking institution, during 1990 Mr. Galan
successfully integrated both the Bank's and R&G Mortgage's operations, which
structure has since been emulated in Puerto Rico. Embarking on a retail branch
expansion strategy, the Bank in 1993 acquired a two branch savings and loan
association with total assets of $78.6 million and, in June 1995, acquired from
a commercial bank $77.2 million in deposits and, after consolidation, six branch
offices. In November 1994, the Bank converted to a Puerto Rico-chartered
commercial bank and took its present name.
R&G Financial competes for business in Puerto Rico by providing a wide
range of financial services to residents of all of Puerto Rico's major cities
through branch offices and mortgage banking facilities at 17 locations. The
operations of both R&G Mortgage and the Bank have expanded substantially during
the 1990's, due in large part to R&G Mortgage's emergence as the second largest
originator of loans secured by single-family residential
<PAGE>
properties in Puerto Rico. During the year ended December 31, 1996, R&G Mortgage
originated approximately 20.5% of all single-family residential loans originated
in Puerto Rico, which has resulted in significant growth in its servicing
portfolio as well as facilitated rapid expansion of the Bank's franchise and
operations. R&G Mortgage's servicing portfolio has increased by 62.6% since
December 31, 1991 and, at December 31, 1996, R&G Mortgage serviced approximately
51,000 accounts with an aggregate loan balance of $2.6 billion. The Bank's asset
size, which amounted to $793.2 million at December 31, 1996, has increased by
$736.8 million since R&G Mortgage became affiliated with the Bank in February
1990, while the branch office network had increased from two to 14 offices.
R&G Financial has generally sought to achieve long-term financial
strength and profitability by increasing the amount and stability of its net
interest income and non-interest income. R&G Financial has sought to implement
this strategy by (i) establishing and emphasizing the growth of its mortgage
banking activities, including growing its loan servicing operation; (ii)
expanding its retail banking franchise in order to achieve increased market
presence and to increase core deposits; (iii) enhancing R&G Financial's net
interest income by increasing R&G Financial's loans held for investment,
particularly single-family residential loans; (iv) developing new business
relationships through an increased emphasis on commercial real estate and
commercial business lending; (v) diversifying R&G Financial's retail products
and services, including an increase in consumer loan originations (such as
credit cards); (vi) meeting the banking needs of its customers through, among
other things, the offering of trust and investment services; and (vii)
controlled growth and the pursuit of a variety of acquisition opportunities when
appropriate.
The Company is subject to regulation and supervision by the Board of
Governors of the Federal Reserve System ("Federal Reserve Board") and is subject
to various reporting and other requirements of the Securities and Exchange
Commission ("SEC").
R&G Mortgage. R&G Mortgage was originally organized in 1972. R&G Mortgage
is engaged primarily in the business of originating first and second mortgage
loans on single family residential properties secured by real estate which are
either insured by the Federal Housing Administration ("FHA") or guaranteed by
the Veterans Administration ("VA"). Pursuant to agreements entered into between
R&G Mortgage and the Bank, non-conforming conventional single-family residential
loans and consumer loans, most of which are secured by real estate, are also
originated by R&G Mortgage for portfolio retention by the Bank. The Bank retains
the non-conforming conventional single-family residential loans because these
loans generally do not satisfy resale guidelines of purchasers in the secondary
mortgage market, primarily because of size or other underwriting technicalities
at the time of origination. Jumbo loans may be packaged into collateralized
mortgage obligations ("CMOs") and sold while loans with underwriting
technicalities may be cured through payment experience and subsequently sold.
During the years ended December 31, 1996, 1995 and 1994, R&G Mortgage originated
a total of $448.1 million, $322.7 million and $488.1 million of loans,
respectively. These aggregate originations include loans originated by R&G
Mortgage directly for the Bank of $211.3 million, $156.3 million and $142.6
million
2
<PAGE>
during such respective periods, or 47.2%, 48.4% and 29.2%, respectively, of
total originations.
R&G Mortgage pools FHA/VA loans into mortgage-backed securities which are
guaranteed by the Government National Mortgage Association ("GNMA"), which
securities are sold to securities broker dealers and other investors.
Conventional loans may either be sold directly to agencies such as the Federal
National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage
Corporation ("FHLMC") or to private investors, or which may be pooled into FNMA-
or FHLMC-backed mortgage-backed securities which are generally sold to
investors. During the years ended December 31, 1996, 1995 and 1994, R&G Mortgage
sold $244.8 million, $195.6 million and $357.4 million of loans, respectively,
which includes loans securitized and sold but does not include loans originated
for the Bank. R&G Mortgage generally retains the servicing function with respect
to the loans which have been securitized and sold. R&G Mortgage is subject to
regulation and examination by the FHA, FNMA, FHLMC, GNMA, VA, the Department of
Housing and Urban Development ("HUD") and the Office of the Commissioner of
Financial Institutions ("OCFI") of Puerto Rico.
R-G Premier Bank. The Bank's principal business consists of attracting
deposits from the general public and tax-advantaged funds from eligible Puerto
Rico corporations and using such deposits, together with funds obtained from
other sources, to originate (through R&G Mortgage) and purchase loans secured
primarily by residential real estate in Puerto Rico, and to purchase
mortgage-backed and other securities. To a lesser extent but with increasing
emphasis over the past few years, the Bank also originates consumer loans,
commercial business loans and loans secured by commercial real estate. Such
loans offer higher yields, are generally for shorter terms and facilitate the
Bank's provision of a full range of financial services to its customers. The
Bank also offers trust services through its Trust Department. Total loan
originations by the Bank during the years ended December 31, 1996, 1995 and 1994
amounted to $122.8 million, $124.6 million and $57.9 million, respectively. The
Bank's deposits are insured by the Federal Deposit Insurance Corporation
("FDIC") and it is regulated and examined by the FDIC as its primary federal
regulatory agency as well as by the OFCI.
Affiliated Transactions. As an integral part of R&G Mortgage's
acquisition of a controlling interest in the Bank in February 1990, R&G Mortgage
and the Bank entered into various agreements which address how the parties would
conduct themselves in specifically delineated affiliated transactions (the
"Affiliated Transaction Agreements"). Under federal law and regulations, certain
transactions between a federally insured financial institution and an affiliate,
such as the Bank and R&G Mortgage, are regulated. Generally, these provisions
regulate extensions of credit to directors, officers and principal shareholders
of the Bank, and establish standards for the terms of, limit the amount of, and
establish collateral requirements with respect to, various transactions between
federally insured financial institutions and its affiliates. See generally
"Regulation - R&G Financial Limitations on Transactions with Affiliates."
3
<PAGE>
The Affiliated Transaction Agreements include a Master Purchase,
Servicing and Collections Agreement (the "Master Purchase Agreement"), a Master
Custodian Agreement, a Master Production Agreement, a Securitization Agreement
and a Data Processing Computer Service Agreement. In accordance with applicable
regulations, the terms of these agreements were negotiated at arm's length on
the basis that they are substantially the same, or at least as favorable to the
Bank, as those prevailing for comparable transactions with, or involving, other
nonaffiliated companies.
Pursuant to the Master Production Agreement, the Bank, on a monthly
basis, determines its loan production targets and goals (the "Loan Production
Goals") and R&G Mortgage assists the Bank to reach its Loan Production Goals by,
among other things: (i) advertising, promoting and marketing to the general
public; (ii) interviewing prospective borrowers and initial processing of loan
applications, consistent with the Bank's underwriting guidelines and Loan
Production Goals previously established; and (iii) providing personnel and
facilities with respect to the execution of any loan agreement approved by the
Bank. In exchange for these services, the Bank remits to R&G Mortgage a
percentage of the processing or originating fees charged to the borrowers under
loan agreements, as set forth in the agreements. See "-Lending Activities of the
Bank - Originations, Purchases and Sales of Loans."
The Master Purchase Agreement provides for the sale by the Bank to R&G
Mortgage of the servicing rights to all first and second mortgage loans secured
by residential properties which become part of the Bank's loan portfolio. The
Master Purchase Agreement further provides that R&G Mortgage will service all
other loans held in the Bank's loan portfolio (including single-family
residential loans retained by the Bank and certain commercial real estate
loans), although R&G Mortgage does not actually acquire such servicing rights.
The Master Purchase Agreement further provides that R&G Mortgage exclusively
will service such loans and that the Bank will process payments of such loans,
all according to a fee schedule. See " - Mortgage Banking Activities - Loan
Originations, Purchases and Sales of Loans."
Under the Securitization Agreement, R&G Mortgage renders securitization
services with respect to the pooling of some of the Bank's mortgage loans into
mortgage-backed securities. With respect to securitization services rendered,
the Bank pays a securitization fee of 25 basis points. The Master Custodian
Agreement provides that the Bank shall be the custodial agent for R&G Mortgage
of certain documentation related to the issuance by R&G Mortgage of GNMA, FNMA
or FHLMC mortgage-backed certificates. In consideration of these services, the
Bank receives a fee for each mortgage note included in a mortgage-backed
certificate per year for which it acts as custodian, as set forth in the
agreement. See "- Mortgage Banking Activities - Loan Originations, Purchases and
Sales of Loans."
4
<PAGE>
Mortgage Banking Activities
Loan Originations, Purchases and Sales. During the years ended December
31, 1996, 1995 and 1994, R&G Mortgage originated a total of $448.1 million,
$322.7 million and $488.1 million of loans, respectively. These aggregate
originations include loans originated by R&G Mortgage directly for the Bank of
$211.3 million, $156.3 million and $142.6 million during the years ended
December 31, 1996, 1995 and 1994, respectively, or 47%, 48% and 29%,
respectively, of total originations. The loans originated by R&G Mortgage for
the Bank are comprised primarily of conventional residential loans and, to a
lesser extent, consumer loans, most of which are secured by real estate.
R&G Mortgage is engaged to a significant extent in the origination of
FHA-insured and VA-guaranteed single-family residential loans which are
primarily securitized into GNMA mortgage-backed securities and sold to
institutional and/or private investors in the secondary market. During the years
ended December 31, 1996, 1995 and 1994, R&G Mortgage originated $222.0 million,
$154.9 million and $332.4 million, respectively, of FHA/VA loans, which
represented 49.5%, 48.0% and 68.1%, respectively, of total loans originated
during such respective periods.
R&G Mortgage also originates conventional single-family residential loans
which are either insured by private mortgage insurers or do not exceed 80% of
the appraised value of the mortgaged property. During the years ended December
31, 1996, 1995 and 1994, R&G Mortgage originated $204.9 million, $151.9 million
and $155.7 million, respectively, of conventional single-family residential
mortgage loans. Substantially all conforming conventional single-family
residential loans are securitized and sold in the secondary market while
substantially all non-conforming conventional single-family residential loans
are originated by R&G Mortgage on behalf of the Bank and either held by the Bank
in its portfolio or subsequently securitized by R&G Mortgage and sold in the
secondary market.
Non-conforming loans generally consist of loans which, primarily because
of size or other underwriting technicalities which may be cured through
seasoning, do not satisfy the guidelines for resale of FNMA, FHLMC, GNMA and
other private secondary market investors at the time of origination. Management
believes that these loans are essentially of the same credit quality as
conforming loans. During the years ended December 31, 1996, 1995 and 1994,
non-conforming conventional loans represented approximately 42%, 43% and 29%,
respectively, of R&G Mortgage's total volume of mortgage loans originated,
substantially all of which were originated by R&G Mortgage on behalf of the
Bank. During the years ended December 31, 1996, 1995 and 1994, 88.9%, 81.0% and
92.4% of loans originated by R&G Mortgage on behalf of the Bank consisted of
single-family residential loans during such respective periods. R&G Mortgage
originates single-family residential, construction and commercial real estate
loans on behalf of the Bank pursuant to the terms of a Master Production
Agreement between R&G Mortgage and the Bank. See "- Lending Activities of the
Bank - Origination, Purchase and Sale of Loans."
5
<PAGE>
While R&G Mortgage makes available a wide variety of mortgage products
designed to respond to consumer needs and competitive conditions, it currently
emphasizes 15-year and 30-year conventional first mortgages and 15-year and
30-year FHA loans and VA loans. Substantially all of such loans consist of
fixed-rate mortgages. The average loan size for FHA/VA mortgage loans and
conventional mortgage loans is approximately $71,200 and $69,300, respectively.
R&G Mortgage also offers second mortgage loans up to $125,000 with a
maximum term of 15 years. The maximum loan-to-appraised value ratio on second
mortgage loans permitted by R&G Mortgage is 75% (including the amount of any
first mortgage). In addition, R&G Mortgage also offers real estate secured
consumer loans up to $40,000 with a maximum term of 10 years. The maximum
loan-to-appraised value ratio on real estate secured consumer loans permitted by
R&G Mortgage is 80%. R&G Mortgage will secure such loans with either a first or
second mortgage on the property.
R&G Mortgage's loan origination activities are conducted out of its
offices and mortgage banking centers. Residential mortgage loan applications are
attributable to walk-in customers, existing customers and advertising and
promotion, referrals from real estate brokers and builders, loan solicitors and
mortgage brokers. At December 31, 1996, R&G Mortgage employed 62 loan
originators who are compensated in part on a commission basis.
Loan origination activities performed by R&G Mortgage include soliciting,
completing and processing mortgage loan applications and preparing and
organizing the necessary loan documentation. Loan applications are examined for
compliance with underwriting criteria and, if all requirements are met, R&G
Mortgage issues a commitment to the prospective borrower specifying the amount
of the loan and the loan origination fees, points and closing costs to be paid
by the borrower or seller and the date on which the commitment expires.
R&G Mortgage also purchases FHA loans and VA loans from other mortgage
bankers for resale to institutional investors and other investors in the form of
GNMA mortgage-backed securities. R&G Mortgage's strategy is to increase its
servicing portfolio primarily though internal originations through its branch
network and, to a lesser extent, purchases from third parties. Purchases of
loans from other mortgage bankers in the wholesale loan market is generally
limited to FHA loans and VA loans and such purchases provide R&G Mortgage with a
source of low cost production that allows R&G Mortgage to continue to increase
the size of its servicing portfolio. R&G Mortgage purchased $43.8 million, $55.6
million and $11.0 million of loans from third parties during the years ended
December 31, 1996, 1995 and 1994, respectively.
6
<PAGE>
The following table sets forth loan originations, purchases and sales by
R&G Mortgage for the periods indicated.
Year Ended December 31,
-----------------------------------
1996 1995 1994
--------- --------- ---------
(Dollars in Thousands)
Loans Originated For the Bank:
Conventional loans(1):
Number of loans ...................... 2,756 2,226 2,204
Volume of loans ...................... $ 190,072 $ 140,363 $ 142,572
FHA/VA loans:
Number of loans ...................... -- -- --
Volume of loans ...................... $ -- $ -- $ --
Consumer loans(2):
Number of loans ...................... 1,004 974 --
Volume of loans ...................... $ 21,208 $ 15,944 $ --
Total loans:
Number of loans ...................... 3,760 3,200 2,204
Volume of loans ...................... $ 211,280 $ 156,307 $ 142,572
Percent of total volume .............. 43% 46% 29%
For Third Parties:
Conventional loans(1):
Number of loans ...................... 214 151 166
Volume of loans ...................... $ 14,835 $ 11,496 $ 13,122
FHA/VA loans:
Number of loans ...................... 3,117 2,313 6,030
Volume of loans ...................... $ 221,967 $ 154,916 $ 332,377
Total loans:
Number of loans ...................... 3,331 2,464 6,196
Volume of loans ...................... $ 236,802 $ 166,412 $ 345,499
Percent of total volume .............. 48% 48% 70%
--------- --------- ---------
Total loan originations ............ $ 448,082 $ 322,719 $ 488,071
========= ========= =========
Loans Purchased For R&G Mortgage:
Number of loans ........................ 583 305 4
Volume of loans (3) .................... $ 45,604 $ 19,525 $ 279
Percent of total volume ................ 9% 6% 1%
--------- --------- ---------
Total loan originations and
purchases .......................... $ 493,686 $ 342,244 $ 488,350
========= ========= =========
7
<PAGE>
Year Ended December 31,
-----------------------------------
1996 1995 1994
--------- --------- ---------
(Dollars in Thousands)
Loans Sold To Third Parties(4):
Conventional loans(1):
Number of loans ...................... 178 151 667
Volume of loans ...................... $ 12,560 $ 11,999 $ 40,902
FHA/VA loans:
Number of loans ...................... 3,564 2,252 6,851
Volume of loans(3) ................... $ 232,254 $ 183,607 $ 316,483
Total loans:
Number of loans ...................... 3,742 2,403 7,518
Volume of loans ...................... $ 244,814 $ 195,606 $ 357,385
Percent of total volume .............. 50% 57% 73%
--------- --------- ---------
Adjustments:
Loans originated for the Bank .......... $(211,280) $(156,307) $(142,572)
Loans amortization ..................... (7,224) (1,960) (1,577)
--------- --------- ---------
Increase (decrease) in loans held for sale $ 30,368 $ (11,629) $ (13,184)
========= ========= =========
Average Initial Loan Origination Balance:
The Bank:
Conventional loans(1) ................ $ 69 $ 63 $ 65
FHA/VA loans ......................... $ -- $ -- $ --
Third Parties:
Conventional loans(1) ................ $ 69 $ 76 $ 79
FHA/VA loans ......................... $ 71 $ 63 $ 55
Total Average Initial Balance:
Conventional loans(1) ................ $ 69 $ 64 $ 66
FHA/VA loans ......................... $ 71 $ 63 $ 55
Refinancings(5):
The Bank ............................... 33% 58% 46%
Third Parties .......................... 24% 26% 38%
- ----------
(1) Includes non-conforming loans.
(2) All but $1.5 million and $3.3 million of such loans were secured by real
estate at December 31, 1996 and 1995, respectively.
(3) Excludes $7.9 million, $36.1 million and $10.7 million loans purchased
from another financial institution, and securitized and sold to the same
financial institution during 1996, 1995 and 1994, respectively.
(4) Includes loans converted into mortgage-backed securities.
(5) As a percent of the total dollar volume of loans originated by R&G
Mortgage for the Bank or third parties, as the case may be. In the case
of the Bank, refinancings do not necessarily represent refinancings of
loans previously held by the Bank.
8
<PAGE>
All loan originations, regardless of whether originated through R&G
Mortgage or purchased from third parties, must be underwritten in accordance
with R&G Mortgage's underwriting criteria, including loan-to-appraised value
ratios, borrower income qualifications, debt ratios and credit history, investor
requirements, necessary insurance and property appraisal requirements. R&G
Financial's underwriting standards also comply with the relevant guidelines set
forth by HUD, VA, FNMA, FHLMC, bank regulatory authorities, private mortgage
investment conduits and private mortgage insurers, as applicable. R&G Mortgage's
underwriting personnel, while operating out of its loan offices, make
underwriting decisions independent of R&G Mortgage's mortgage loan origination
personnel.
Typically, when a mortgage loan is originated, the borrower pays an
origination fee. These fees are generally in the range of 0% to 7% of the
principal amount of the mortgage loan, and are payable at the closing of such
loan. R&G Mortgage receives these fees on mortgage loans originated through its
retail branches. R&G Mortgage may charge additional fees depending upon market
conditions and regulatory considerations as well as R&G Mortgage's objectives
concerning mortgage loan origination volume and pricing. R&G Mortgage incurs
certain costs in originating mortgage loans, including overhead, out-of-pocket
costs and, in some cases, where the mortgage loans are subject to a purchase
commitment from private investors, related commitment fees. The volume and type
of mortgage loans and of commitments made by investors vary with competitive and
economic conditions (such as the level of interest rates and the status of the
economy in general), resulting in fluctuations in revenues from mortgage loan
originations. Generally accepted accounting principles ("GAAP") require that
general operating expenses incurred in originating mortgage loans be charged to
current expense. Direct origination costs and origination income must be
deferred and amortized using the interest method, until the repayment or sale of
the related mortgage loans. Historically, the value of servicing rights which
result from R&G Mortgage's origination activities has exceeded the net costs
attributable to such activities.
R&G Mortgage customarily sells most of the loans that it originates,
except for those originated on behalf of the Bank pursuant to the Master
Production Agreement. See "Lending Activities of the Bank - Origination,
Purchases and Sales of Loans." The loans originated by R&G Mortgage (including
FHA loans, VA loans and conventional loans) are secured by real property located
in Puerto Rico and constitute "eligible investments" which results in favorable
tax treatment under U.S. and Puerto Rico tax laws. See "- Puerto Rico Secondary
Mortgage Market and Favorable Tax Treatment." During the years ended December
31, 1996, 1995 and 1994, R&G Mortgage sold $244.8 million, $195.6 million and
$357.4 million and of loans, respectively, which includes loans securitized and
sold but does not include loans originated by R&G Mortgage on behalf of the
Bank. With respect to such loan sales, $232.3 million or 94.9%, $183.6 million
or 93.9% and $316.5 million or 88.6% consisted of GNMA-guaranteed
mortgage-backed securities of FHA loans or VA loans packaged into pools of $1
million or more ($2.5 million to $5 million for serial notes as
9
<PAGE>
described below). These securities were sold primarily to securities
broker-dealers and other investors in Puerto Rico.
Certain GNMA-guaranteed mortgage-backed securities sold by R&G Mortgage
are in the form of GNMA serial notes which permit the investor to receive
interest monthly and to select among several expected maturity dates of the
notes included in an issue, with each maturity having a specific yield. GNMA
serial notes are sold in pools of $2.5 million to $5 million. GNMA serial notes
are sold to securities broker-dealers in packages consisting of notes of
different yields and maturities, which range from one to 30 years and have an
average maturity of 12 years, taking into account historical experience with
prepayments of the underlying mortgages. The rates on the serial notes or GNMA
pools must be 1/2 of 1% less than the rates on the mortgages comprising the
pool. Upon completion of the necessary processing, the GNMA-guaranteed
mortgage-backed securities are either offered to the public directly through the
Bank's Trust Department or indirectly through securities broker-dealers. During
the years ended December 31, 1996, 1995 and 1994, R&G Mortgage issued GNMA
serial notes totalling approximately $236.4 million, $184.4 million and $228.8
million, respectively.
Conforming conventional loans originated or purchased by R&G Mortgage are
generally sold directly to FNMA, FHLMC or private investors for cash or are
grouped into pools of $1 million or more in aggregate principal balance and
exchanged for FNMA or FHLMC-issued mortgage-backed securities, which R&G
Mortgage sells to securities broker-dealers. In connection with any such
exchanges, R&G Mortgage pays guarantee fees to FNMA and FHLMC. The issuance of
mortgage-backed securities provides R&G with flexibility in selling the
mortgages which it originates or purchases and also provides income by
increasing the value and marketability of the loans.
Mortgage loans that do not conform to GNMA, FNMA or FHLMC requirements
(so-called "non-conforming loans") are generally originated on behalf of the
Bank and either retained in the Bank's portfolio, sold to financial institutions
or other private investors or securitized into "private label" CMOs through
grantor trusts or other mortgage conduits and sold through securities
broker-dealers. Non-conforming loans consist of jumbo loans or loans that do not
satisfy all requirements of FNMA, FHLMC and GNMA at the time of origination of
the loan (such as missing tax returns, slightly higher loan-to-value ratios,
etc.).
Each CMO normally consists of several classes of senior, subordinate and
residual certificates. The residual certificates evidence a right to receive
payments on the mortgage loans after payment of all required amounts on the
senior and subordinate certificates then due. Some form of credit enhancement,
such as an insurance policy, letter of credit or subordination, will generally
be used to increase the credit rating of the senior certificates and thereby
improve their marketability. During the years ended December 31, 1995 and 1994,
R&G Mortgage and the Bank completed sales of approximately $38.2 million and
$201.5 million, respectively, of CMOs in securitization transactions. There were
no sales in 1996. In connection with such transactions, either the Bank or R&G
Mortgage generally
10
<PAGE>
retains the residual certificates issued by the respective trusts as well as the
subordinate certificates issued in such transactions. As of December 31, 1996,
R&G Mortgage held CMOs (which were primarily issued by R&G Mortgage) with a fair
value of $15.1 million and residual certificates issued in CMO transactions
involving R&G Mortgage and the Bank with a fair value of $8.5 million. In
addition, the Bank held CMO subordinated certificates and residual certificates
from one of its issues with a fair value of $8.2 million at December 31, 1996.
See "- Investment Activities." Currently a liquid secondary market for
subordinate or residual certificates does not exist in Puerto Rico. The value of
residual certificates is subject to substantial fluctuations as a result of
changes in prevailing interest rates. However, such residuals often exhibit
elasticity and convexity characteristics which R&G Financial can utilize to
hedge other components of its portfolio. See "Management's Discussion and
Analysis of Financial Condition and Results of Operation" incorporated by
reference in Item 7 hereof.
While R&G Mortgage's exchanges of mortgage loans into agency securities
and sales of mortgage loans are generally made on a non-recourse basis, R&G
Mortgage also engages in the sale or exchange of mortgage loans on a recourse
basis. In the past, recourse sales often involved the sale of non-conforming
loans to FNMA, FHLMC and local financial institutions. R&G Financial estimates
the fair value of the retained recourse obligation at the time mortgage loans
are sold. Normally, the fair value of any retained recourse is immaterial
because R&G Mortgage is able to resell repurchased loans for at least their
carrying costs. Accordingly, as of December 31, 1996, R&G Financial did not deem
it necessary to establish reserves for possible losses related to its recourse
obligations. At December 31, 1996, R&G Mortgage had loans in its servicing
portfolio with provisions for recourse in the principal amount of approximately
$290.9 million, as compared to $238.2 million and $162.9 million as of December
31, 1995 and 1994, respectively. Of the recourse loans existing at December 31,
1996, approximately $241.2 million in principal amount consisted of loans sold
to FNMA and FHLMC and converted into mortgage-backed securities of such
agencies, and approximately $49.7 million in principal amount consisted of
non-conforming loans sold to other private investors.
Pursuant to the terms of the Master Purchase Agreement, R&G Mortgage
renders securitization services with respect to the pooling of some of the
Bank's mortgage loans into mortgage-backed securities. With respect to the
securitization services rendered, the Bank pays a securitization fee of 25 basis
points. In addition, pursuant to the terms of a Master Custodian Agreement
entered into by R&G Mortgage and the Bank, the Bank acts as the custodial agent
for R&G Mortgage of certain documentation related to the issuance by R&G
Mortgage of GNMA or FHLMC mortgage-backed certificates. In consideration of
these services, the Bank receives an annual fee of $5.0 for each mortgage note
included in a mortgage-backed certificate for which it acts as custodian. See
also "- General - Affiliated Transactions" and "Regulation - R&G Financial -
Limitations on Transactions with Affiliates."
11
<PAGE>
Loan Servicing. R&G Mortgage acquires servicing rights through its
mortgage loan originations (including originations on behalf of the Bank) and
purchases from third parties. When R&G Mortgage sells the mortgage loans it has
originated or purchased, it generally retains the rights to service such loans
and receives the related servicing fees. Loan servicing includes collecting
principal and interest and remitting the same to the holders of the mortgage
loans or mortgage-backed securities to which such mortgage loan relates, holding
escrow funds for the payment of real estate taxes and insurance premiums,
contacting delinquent borrowers, supervising foreclosures in the event of
unremedied defaults and generally administering the loans. R&G Mortgage receives
annual loan servicing fees ranging from 0.25% to 0.50% of the declining
outstanding principal balance of the loans serviced plus any late charges. In
general, R&G Mortgage's servicing agreements are terminable by the investor for
cause without penalty or after payment of a termination fee ranging from 0.5% to
1.0% of the outstanding principal balance of the loans being serviced.
R&G Mortgage's servicing portfolio has grown significantly over the past
three years. At December 31, 1996, R&G Mortgage's servicing portfolio totalled
$2.6 billion and consisted of a total of 50,979 loans, as compared to $2.1
billion and 43,572 loans at December 31, 1994. At December 31, 1996, R&G
Mortgage was servicing $323.8 million of loans for the Bank or 12.7% of the
total servicing portfolio, as compared to $290.8 million or 12.7% and $213.9
million or 10.1% at December 31, 1995 and 1994, respectively. Substantially all
of the mortgage loans in R&G Mortgage's servicing portfolio are secured by
single (one-to-four) family residences. All of R&G Mortgage's mortgage servicing
portfolio is comprised of mortgages secured by real estate located in Puerto
Rico.
Pursuant to the terms of a Master Purchase Agreement, the Bank sells to
R&G Mortgage the servicing rights to all first and second mortgage loans secured
by residential properties which become part of the Bank's loan portfolio. The
Master Purchase Agreement further provides that R&G Mortgage will service all
other loans held in the Bank's loan portfolio (including single-family
residential loans retained by the Bank and certain commercial real estate
loans), although R&G Mortgage does not actually acquire such servicing rights.
The Bank pays R&G Mortgage servicing fees with respect to the loans serviced by
R&G Mortgage on behalf of the Bank. In addition, pursuant to the Master Purchase
Agreement, the Bank processes payments of all loans originated by R&G Mortgage
on behalf of the Bank. In connection therewith, R&G Mortgage pays the Bank a fee
equal to between $0.50 and $1.00 per loan. See also "- General - Affiliated
Transactions" and "Regulation - R&G Financial - Limitations on Transactions with
Affiliates."
R&G Mortgage's mortgage loan servicing portfolio is subject to reduction
by reason of normal amortization, prepayments and foreclosure of outstanding
mortgage loans. Additionally, R&G Mortgage may sell mortgage loan servicing
rights from time to time.
12
<PAGE>
The following table sets forth certain information regarding the total
loan servicing portfolio of R&G Mortgage for the periods indicated.
Year Ended December 31,
--------------------------------------
1996 1995 1994
---------- ---------- ----------
(Dollars in Thousands)
Composition of Servicing
Portfolio at End of Period:
Conventional and other
mortgage loans(1) ................. $ 971,327 $ 811,269 $ 634,944
FHA/VA loans ........................ 1,578,842 1,486,931 1,479,799
---------- ---------- ----------
Total servicing portfolio(2) ...... $2,550,169 $2,298,200 $2,114,743
========== ========== ==========
Activity in the Servicing
Portfolio:
Beginning servicing portfolio ....... $2,298,200 $2,114,743 $2,000,530
Add: Loan originations .............. 462,954 325,870 473,821
Servicing of portfolio loans
acquired ............................ 36,478 239,414 27,726
Less: Sale of servicing rights ...... 42,080 196,895(3) --
Run-offs(4) ......................... 205,383 184,932 387,334
---------- ---------- ----------
Ending servicing portfolio .......... $2,550,169 $2,298,200 $2,114,743
========== ========== ==========
Number of loans serviced(5) ......... 50,979 48,240 43,572
Average loan size(5) ................ $ 50 $ 48 $ 49
Average servicing fee rate(5) ....... 0.532% 0.505% 0.558%
- ----------
(1) Includes non-conforming loans.
(2) At the dates shown, included $323.8 million, $290.8 million and $213.9
million of loans serviced for the Bank, respectively, which constituted
12.70%, 12.65% and 10.12% of the total servicing portfolio, respectively.
(3) R&G Mortgage sold servicing rights during 1994 and recognized a gain of
$2.9 million. Pursuant to a subservicing agreement with the purchaser of
the servicing rights, R&G Mortgage continued to service the loans subject
to such sale and they remained in R&G Mortgage's servicing portfolio
until 1995.
(4) Run-off refers to regular amortizations of loans, prepayments and
foreclosures.
(5) At December 31, 1996, R&G Mortgage was servicing 4,974 loans for the Bank
with an average loan size of approximately $65,000 and at an average
servicing rate of 0.214%. Amounts include late and other miscellaneous
charges.
13
<PAGE>
The following table sets forth certain information at December 31, 1996
regarding the number of, and aggregate principal balance of, the mortgage loans
serviced by R&G Mortgage for the Bank and for third parties at various mortgage
interest rates.
<TABLE>
<CAPTION>
At December 31, 1996
---------------------------------------------------------------------------------------------
Loans Serviced Loans Serviced Total Loans
for the Bank for Third Parties Serviced
------------------------------ ----------------------------- ----------------------------
Number of Aggregate Number of Aggregate Number Aggregate
Loans Principal Balance Loans Principal Balance of Loans Principal Balance
Mortgage Interest Rate ---------- ----------------- --------- ----------------- -------- -----------------
(Dollars in Thousands) (Dollars in Thousands) (Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Less than 7.00%....... 56 $ 2,992 2,723 $ 140,061 2,779 $ 143,053
7.00% - 7.49%......... 284 27,047 6,795 396,790 7,079 423,837
7.50% - 7.99%......... 831 68,596 12,147 663,495 12,978 732,091
8.00% - 8.49%......... 895 67,714 6,273 351,655 7,168 419,369
8.50% - 8.99%......... 1,645 106,622 7,900 340,007 9,545 446,629
9.00% - 9.49%......... 519 26,362 3,678 142,179 4,197 168,541
9.50% - 9.99%......... 203 9,598 2,964 89,948 3,167 99,546
10.00% - 10.49%....... 160 4,940 1,211 43,143 1,371 48,083
10.50% - 10.99%....... 195 5,380 739 21,309 934 26,689
11.00% or more........ 186 4,512 1,575 37,819 1,761 42,331
----- -------- ------ ---------- ------ ----------
4,974 $323,763 46,005 $2,226,406 50,979 $2,550,169
===== ======== ====== ========== ====== ==========
</TABLE>
The amount of principal prepayments on mortgage loans serviced by R&G
Mortgage was $72.5 million, $68.2 million and $62.2 million for the years ended
December 31, 1996, 1995 and 1994, respectively. This represented approximately
2.8%, 3.0% and 2.9% of the aggregate principal amount of mortgage loans serviced
during such periods. Principal prepayments have declined since 1993 as a result
of decreased refinancing activity caused by the increase in interest rates
experienced following the refinance boom of 1993. The primary means used by R&G
Mortgage to reduce the sensitivity of its servicing fee income to changes in
interest and prepayment rates is the development of a strong internal
origination capability that has allowed R&G Mortgage to continue to increase the
size of its servicing portfolio even in times of high prepayments.
Servicing agreements relating to the mortgage-backed securities programs
of FNMA, FHLMC and GNMA, and certain other investors, require R&G Mortgage to
advance funds to make scheduled payments of principal, interest, taxes and
insurance, if such payments have not been received from the borrowers. During
the years ended December 31, 1996, 1995 and 1994, the monthly average amount of
funds advanced by R&G Mortgage under such servicing agreements was $1.3 million,
$4.4 million and $6.3 million, respectively. Funds advanced by R&G Mortgage
pursuant to these arrangements are generally recovered by R&G Mortgage within 30
days.
In connection with its loan servicing activities, R&G Mortgage holds
escrow funds for the payment of real estate taxes and insurance premiums with
respect to the mortgage loans it services. At December 31, 1996, R&G Mortgage
held $39.0 million of such escrow funds, $10.6 million of which were deposited
in the Bank and $28.4 million of which were
14
<PAGE>
deposited with other financial institutions. The escrow funds deposited with the
Bank lower its overall cost of funds and is a means of compensating it for
processing mortgages checks received by R&G Mortgage, while the escrow funds
deposited with other financial institutions serve as part of R&G Mortgage's
compensating balances which permit R&G Mortgage to borrow funds from such
institutions (pursuant to certain warehouse lines of credit) at rates that are
lower than would otherwise apply. See "- Sources of Funds -Borrowings."
The degree of risk associated with a mortgage loan servicing portfolio is
largely dependent on the extent to which the servicing portfolio is non-recourse
or recourse. In non-recourse servicing, the principal credit risk to the
servicer is the cost of temporary advances of funds. In recourse servicing, the
servicer agrees to share credit risk with the owner of the mortgage loans such
as FNMA or FHLMC or with an insurer or guarantor. Losses on recourse servicing
occur primarily when foreclosure sale proceeds of the property underlying a
defaulted mortgage are less than the then outstanding principal balance and
accrued interest of such mortgage loan and the cost of holding and disposing of
such underlying property. At December 31, 1996, R&G Mortgage was servicing
mortgage loans with an aggregate principal amount of $290.9 million on a
recourse basis. During the last three years, losses incurred due to recourse
servicing have not been significant.
R&G Mortgage's general strategy is to retain the servicing rights related
to the mortgage loans it originates and purchases. Nevertheless, there is a
market in Puerto Rico for servicing rights, which are generally valued in
relation to the present value of the expected income stream generated by the
servicing rights. Among the factors which influence the value of a servicing
portfolio are servicing fee rates, loan balances, loan types, loan interest
rates, the expected average life of the underlying loans (which may be reduced
through foreclosure or prepayment), the value of escrow balances, delinquency
and foreclosure experience, servicing costs, servicing termination rights of
permanent investors and any recourse provisions. During the year ended December
31, 1995, R&G Mortgage sold servicing rights on $196.9 million of mortgage
loans. Although R&G Mortgage may on occasion consider future sales of a portion
of its servicing portfolio, management does not anticipate sales of servicing
rights to become a significant part of its operations.
The market value of, and earnings from, R&G Mortgage's mortgage loan
servicing portfolio may be adversely affected if mortgage interest rates decline
and mortgage loan prepayments increase. In a period of declining interest rates
and accelerated prepayments, income generated from R&G Mortgage's mortgage loan
servicing portfolio may also decline. Conversely, as mortgage interest rates
increase, the market value of R&G Mortgage's mortgage loan servicing portfolio
may be positively affected. See Note 1 to R&G Financial's Notes to Consolidated
Financial Statements for a discussion of SFAS No. 122 and the treatment of
servicing rights, incorporated by reference into Item 8 hereof.
15
<PAGE>
Mortgage Loan Delinquencies and Foreclosures. The following table shows
the delinquency statistics for R&G Mortgage's servicing portfolio at the dates
indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------
1996 1995 1994
------------------------ ---------------------- ------------------------
Percent of Percent of Percent of
Number of Servicing Number of Servicing Number of Servicing
Loans Portfolio Loans Portfolio Loans Portfolio
---------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Loans delinquent for:
30-59 days................ 2,775 5.44% 3,366 6.98% 2,609 5.99%
60-89 days................ 533 1.05 906 1.88 543 1.25
90 days or more........... 646 1.27 988 2.05 716 1.64
----- ---- ----- ----- ----- ----
Total delinquencies(1).. 3,954 7.76% 5,260 10.90% 3,868 8.88%
===== ==== ===== ===== ===== ====
Foreclosures pending(2)..... 693 1.36% 459 0.95% 401 0.92%
===== ==== ===== ===== ===== ====
</TABLE>
- ----------
(1) Includes at December 31, 1996, an aggregate of $29.8 million of
delinquent loans serviced for the Bank, or 1.17% of the total servicing
portfolio and $1.0 million of delinquent loans held in R&G Mortgage's own
portfolio.
(2) At December 31, 1996, the Bank had foreclosures pending on $8.5 million
of loans being serviced by R&G Mortgage, which constituted 0.33% of the
servicing portfolio. R&G Mortgage had foreclosures pending on $346,000 of
loans it is servicing for its own portfolio at December 31, 1996.
While delinquency rates in Puerto Rico are generally higher than in the
mainland United States, these rates are not necessarily indicative of future
foreclosure rates or losses on foreclosures. Real estate owned as a result of
foreclosures ("REO") related to R&G Mortgage's mortgage banking business arise
primarily through foreclosure on mortgage loans repurchased from investors
either because of breach of representations or warranties or pursuant to
recourse arrangements. As of December 31, 1996, 1995 and 1994, R&G Mortgage held
REO with a book value of approximately $0, $0 and $43,000, respectively. Sales
of REO resulted in net losses to R&G Mortgage of $57,000 for the year ended
December 31, 1996, and gains of $30,000 and $12,000 for the years ended December
31, 1995 and 1994 respectively. There is no liquid secondary market for the sale
of R&G Mortgage's REO.
With respect to mortgage loans securitized through GNMA programs, R&G
Mortgage is fully insured as to principal by the FHA and VA against foreclosure
loans. As a result of these programs, foreclosure on these loans had generated
no loss of principal as of December 31, 1996. R&G Mortgage, however, incurs
about $3,000 per loan foreclosed in interest and legal charges during the time
between payment by R&G Mortgage and FHA or VA reimbursement. For the years ended
December 31, 1996, 1995 and 1994, total expenses related to FHA or VA loans
foreclosed amounted to $281,000, $230,000 and $290,000, respectively. Although
FNMA and FHLMC are obligated to reimburse R&G Mortgage for principal and
interest payments advanced by R&G Mortgage as a servicer
16
<PAGE>
(except for recourse servicing), the funding of delinquent payments or the
exercise of foreclosure rights involves costs to R&G Mortgage which may not be
recouped. Such nonrecouped expenses have to date been immaterial.
Any significant adverse economic developments in Puerto Rico could result
in an increase in defaults or delinquencies on mortgage loans that are serviced
by R&G Mortgage or held by R&G Mortgage pending sale in the secondary mortgage
market, thereby reducing the resale value of such mortgage loans.
Puerto Rico Secondary Mortgage Market and Favorable Tax Treatment. In
general, the Puerto Rico market for mortgage-backed securities is an extension
of the United States market with respect to pricing, rating of the investment
instruments, and other matters. However, United States and Puerto Rico tax laws
provide an economic incentive for Puerto Rico residents and Section 936
Corporations (defined below) to invest in certain mortgage loans and
mortgage-backed securities originated in Puerto Rico, including FHA and VA loans
and GNMA certificates, thereby tending to increase the secondary market demand
for, and the resale value of, such mortgage loans and mortgage-backed
securities. These tax advantages also favorably affect R&G Financial's net
interest income by helping create a pool of lower-cost funds that R&G Financial
can access through financial intermediaries such as banks and broker-dealers and
use to fund mortgage loans and mortgage-backed securities pending sale.
Under various Puerto Rico industrial incentives acts (the "Industrial
Incentives Acts"), certain investment income earned by qualified manufacturing
entities or service enterprises ("Exempt Companies") is exempt from Puerto Rico
income tax. Investment income that qualifies for this exemption includes
interest on certain mortgage loans and interest on funds of Exempt Companies
("936 Funds") placed with eligible institutions in Puerto Rico (primarily
savings and loan associations, commercial banks and registered broker-dealers),
provided such funds are invested in certain "eligible activities" in accordance
with regulations promulgated by the OCFI, including certain mortgage loans and
mortgage-backed securities. The Industrial Incentives Acts also encourage
investment in Puerto Rico by allowing Exempt Companies to reduce the otherwise
applicable 10% tax (the "Tollgate Tax") on distributions to shareholders by
investing their exempt industrial development income ("IDI") in Puerto Rico for
fixed periods of time, generally from five years to ten years.
Most Exempt Companies are United States corporations which operate in
Puerto Rico under Section 936 of the Code. Corporations that meet certain
requirements and elect the benefits of Section 936 ("Section 936 Corporations")
are entitled to credit against their United States corporate income tax a
portion of such tax attributable to (i) income derived from sources outside the
United States from the active conduct of a trade or business within Puerto Rico
or from the sale or exchange of substantially all assets used in the active
conduct of such trade or business ("Active Business Income") and (ii) qualified
possession source investment income ("QPSII"). QPSII generally includes interest
derived from mortgage loans secured by real property located in Puerto Rico and
mortgage-backed
17
<PAGE>
securities consisting of such mortgage loans as well as interest on deposits
with financial institutions in Puerto Rico which in turn use such funds to
finance the origination of mortgage loans and other qualifying assets. The
credit provided for QPSII tends to increase the demand for Puerto Rico mortgage
loans and mortgage-backed securities as well as to reduce funding costs for
mortgage banking institutions.
The Omnibus Budget Reconciliation Act of 1993 (the "OBRA Amendments") and
the Small Business Job Protection Act of 1996 (the "SBJPA") amended various
provisions of Section 936. The OBRA Amendments, which are generally effective
for taxable years beginning after December 31, 1993, permit a taxpayer to
compute the tax credit available under Section 936 (the "936 Credit") as under
prior law but limit the amount of credit allowed with respect to Active Business
Income under one of two alternatives to be selected at the option of the
taxpayer. Under the first alternative, the limit is equal to a fixed percentage
of the amount of tax credit allowable under prior law (the "Fixed Percentage
Method"). This fixed percentage commenced at 60% for taxable years beginning in
1994 and is reduced by 5% per year until 1998. For taxable years beginning in
1998, such percentage would be 40%. Under the second alternative (the "Economic
Activity Method"), which is based on the amount of economic activity conducted
by the taxpayer in Puerto Rico, the credit may not exceed the sum of the
following three components: (i) 60% of the qualified possession wages and the
allocable fringe benefits paid by the taxpayer, (ii) applicable percentages of
certain depreciation deductions claimed for regular tax purposes by the taxpayer
with respect to qualified tangible property and (iii) a portion of the
possession income taxes paid by the taxpayer except where the taxpayer uses the
profit-split method for determining its income. The OBRA Amendments did not
limit the 100% credit available under Section 936 for QPSII, including income
received from investment in certain Puerto Rico mortgage loans and
mortgage-backed securities.
The SBJPA repealed (i) the 936 Credit attributable to QPSII generally for
income received or accrued after June 30, 1996, and (ii) the 936 Credit
attributable to Active Business Income for taxable years beginning after
December 31, 1995. The SBJPA, however, provided grandfather rules under which a
Section 936 Corporation that had elected the benefits of the Section 936 Credit
and which was engaged in active trade or business within Puerto Rico on October
13, 1995 (an "Existing Claimant") would be eligible to claim the 936 Credit
attributable to Active Business Income during a transition period. A corporation
may also qualify as an Existing Claimant if it acquires all the assets of a
trade or business of a corporation that meets the active trade or business
requirement and the election requirement is satisfied.
The amount and computation method of the 936 Credit during the transition
period depends upon whether a Section 936 Corporation is using the Economic
Activity Method or the Fixed Percentage Method. A Section 936 Corporation that
is an Existing Claimant and uses the Economic Activity Method may continue to
determine its 936 Credit attributable to Active Business Income as under present
law for taxable years beginning after December 31, 1995 and before January 1,
2002. For taxable years beginning after
18
<PAGE>
December 31, 2001 and before January 1, 2006, a Section 936 Corporation's Active
Business Income eligible for the 936 Credit is subject to a cap, described
below. A Section 936 Corporation that is an Existing Claimant and is using the
Fixed Percentage Method may continue to determine its 936 Credit attributable to
Active Business Income under the existing rules for taxable years beginning
after December 31, 1995 and before January 1, 1998. For taxable years beginning
after December 31, 1997 and before January 1, 2006, the Section 936
Corporation's Active Business Income that is eligible for the 936 Credit is also
subject to a cap. For taxable years beginning after December 31, 2005, the 936
Credit attributable to Active Business Income is terminated. Under the cap rules
for both the Economic Activity Method and the Fixed Percentage Method, the
income eligible for the 936 Credit is limited to the "adjusted base period
income" of the Section 936 Corporation. Computation of the "adjusted base period
income" involves three steps: (i) the Section 936 Corporation base period years
are determined (which are, generally, three of the Section 936 Corporation's
five most recent years ending before October 14, 1995, determined by
disregarding the taxable years in which the Section 936 Corporation's Active
Business Income was the highest and the lowest); (ii) Active Business Income of
the Section 936 Corporation in each of the base period years is adjusted for
inflation; and (iii) the income in the base period years, as adjusted for
inflation, is averaged.
In response to certain proposals put forth by the Government of Puerto
Rico (the "Puerto Rico Government Proposals"), the SBJPA added Section 30A to
the Code ("Section 30A"). The Puerto Rico Government Proposals included a
ten-year grandfather period for the existing 936 Credit and the creation of a
new tax credit for qualifying corporations that invest in "economically
developing jurisdictions." Section 30A incorporates in part the Puerto Rico
Government Proposals and provides for an income tax credit to domestic
corporations operating in Puerto Rico. This new credit is determined under
guidelines similar to the Economic Activity Method.
The modification of Section 936 as enacted into law could have an adverse
effect on the general economic condition of Puerto Rico, R&G Financial's service
area, by reducing incentives for investment in Puerto Rico. Any such adverse
effect on the general economy of Puerto Rico could lead to an increase in
mortgage delinquencies and a reduction in the level of residential construction
and demand for mortgage loans. The elimination of the credit for QPSII could
also lead to a decrease in the amount of 936 Funds invested in Puerto Rico
financial assets by 936 Corporations, thereby increasing funding costs and
decreasing liquidity in the Puerto Rico financial market. The magnitude of the
impact of any such changes on R&G Financial's profitability or financial
condition cannot be determined at this time. R&G Financial has taken steps to
attempt to reduce the impact of any such adverse changes by diversifying its
sources of funding and identifying additional investors for its mortgage
products. During recent periods, the disparity between the cost of 936 Funds and
other sources of funding such as the Eurodollar market has decreased, thereby
reducing the adverse effect that the loss of such funding could have on the
profitability of R&G Financial.
19
<PAGE>
In the absence of the 936 Credit and as a means of continuing to defer
U.S. income taxation, subsidiaries of multi-national companies operating under
Section 936 of the Code may transfer their operations to a corporation organized
under Puerto Rico law. Generally, a Puerto Rico corporation is not subject to
United States income taxes to the extent it does not derive U.S. source income
and may be entitled to defer U.S. income taxation until dividends are
repatriated to the United States. Under Section 954 of the Code, foreign
subsidiaries of multi-national companies whose parent corporation is
incorporated in the U.S. are not subject to federal income tax on profits on
products which they manufacture. Though a Puerto Rico corporation is subject to
local Puerto Rico taxes, the benefits under the Industrial Incentives Act, which
provide a 90 percent tax exemption on profits for companies that manufacture or
provide services in Puerto Rico, would continue to be available. In addition,
under Section 901 and 902 of the Code and subject to certain limitations and
exceptions, U.S. shareholders of a Puerto Rico corporation would be allowed to
claim a foreign tax credit with respect to income tax paid in Puerto Rico. U.S.
shareholders are also not required to recognize income attributable to
manufacturing operations of a Puerto Rico corporation as a general rule under
Subpart F of the Code. However, under Section 367 of the Code, multi-national
corporations may be required to recognize income upon the transfer of operations
to a Puerto Rico corporation, depending upon the nature and value of the
property transferred. Several multi-national 936 Corporations have taken such
steps since the legislation with respect to Section 936 was first introduced in
the U.S. Congress.
In addition to the foregoing incentives, interest derived from FHA loans
or VA loans secured by real property in Puerto Rico originated after June 30,
1983 and, under certain circumstances, on or before February 15, 1973, and from
GNMA certificates consisting of such mortgages, is exempt from Puerto Rico
income tax. FHA and VA mortgage loans are also exempt from Puerto Rico gift and
estate taxes. Individuals who are bona fide residents of Puerto Rico are also
not subject to United States federal income tax on income from Puerto Rico
sources, including interest income derived from mortgage loans originated in
Puerto Rico whose mortgagors are residents of Puerto Rico. The exemption for
interest earned on FHA loans, VA loans and GNMA certificates tends to increase
the demand for these products and the price R&G Financial may obtain upon their
sale. There can be no assurance that the tax exempt treatment of interest on FHA
and VA loans will not be reviewed or modified in the future.
Any change in Puerto Rico's political status could result in the
elimination or modification of these tax benefits described above.
Lending Activities of the Bank
General. At December 31, 1996, R&G Financial's loans receivable, net
totalled $603.8 million, which represented 58.2% of R&G Financial's $1.0 billion
of total assets. At December 31, 1996, $554.0 million or 91.8% of R&G
Financial's loans receivable, net were held by the Bank. The principal category
of loans in R&G Financial's portfolio are
20
<PAGE>
conventional loans which are secured by first liens on single-family residences.
Conventional residential real estate loans are loans which are neither insured
by the FHA nor partially guaranteed by the VA. At December 31, 1996, $369.5
million or 99.6% of R&G Financial's first mortgage single-family residential
loans consisted of conventional loans. The other principal categories of loans
in R&G Financial's loans receivable, net portfolio are second mortgage
residential real estate loans, construction loans, commercial real estate loans,
commercial business loans and consumer loans.
21
<PAGE>
Loan Portfolio Composition. The following table sets forth the
composition of R&G Financial's loan portfolio by type of loan at the dates
indicated. Except as noted in the footnotes to the table, all of the loans are
held in the Bank's loan portfolio.
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------
1996 1995 1994
----------------- ----------------- ------------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Residential real estate - first
mortgage(1).............................. $370,876 60.75% $282,498 58.23% $194,707 62.14%
Residential real estate - second
mortgage................................. 15,757 2.58 14,372 2.96 13,298 4.24
Residential construction................... 5,351 .88 15,046 3.10 12,039 3.84
Commercial construction and land
acquisition.............................. 5,075 .83 5,523 1.14 1,062 0.34
Commercial real estate..................... 70,139 11.49 61,862 12.74 43,029 13.72
Commercial business........................ 31,063 5.09 27,816 5.74 14,102 4.51
Consumer loans:
Loans secured by deposits................ 9,409 1.54 7,497 1.55 5,829 1.86
Real estate secured consumer loans....... 42,893 7.03 33,381 6.88 29,279* 9.34*
Unsecured consumer loans................. 59,864 9.81 37,180 7.66 * *
-------- ------ -------- ------ -------- ------
Total loans receivable................. 610,427 100.00% 485,175 100.00% 313,345 100.00%
-------- ------ -------- ------ -------- ------
Less:
Allowance for loan losses................ (3,332) (3,510) (2,887)
Loans in process......................... (2,430) (5,727) (5,945)
Deferred loan fees....................... 41 (266) (424)
Unearned interest........................ (955) (1,831) (2,475)
-------- -------- --------
(6,676) (11,334) (11,731)
-------- -------- --------
Loans receivable, net.................... $603,751 $473,841 $301,614
======== ======== ========
<CAPTION>
December 31,
---------------------------------------
1993 1992
----------------- -----------------
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Residential real estate - first
mortgage(1).............................. $137,396 60.95% $ 64,777 50.27%
Residential real estate - second
mortgage................................. 11,135 4.94 7,945 6.17
Residential construction................... 3,940 1.75 13,801 10.71
Commercial construction and land
acquisition.............................. 1,084 0.48 707 0.55
Commercial real estate..................... 30,290 13.44 21,246 16.49
Commercial business........................ 15,417 6.84 4,574 3.55
Consumer loans:
Loans secured by deposits................ 3,815 1.69 1,900 1.47
Real estate secured consumer loans....... 22,355* 9.92* 13,896* 10.78*
Unsecured consumer loans................. * * * *
-------- ------ -------- ------
Total loans receivable................. 225,432 100.00% 128,846 100.00%
-------- ------ -------- ------
Less:
Allowance for loan losses................ (3,029) (1,230)
Loans in process......................... (1,531) (5,776)
Deferred loan fees....................... (456) (452)
Unearned interest........................ (3,796) (3,960)
-------- --------
(8,812) (11,418)
-------- --------
Loans receivable, net.................... $216,620 $117,428
======== ========
</TABLE>
- ----------
(1) Includes $49.7 million and $55.2 million of residential real estate -
first mortgage loans which are held by R&G Mortgage at December 31, 1996
and 1995, respectively.
(2) Does not include mortgage loans held for sale of $54.5 million, $21.3
million, $22.0 million, $174.2 million and $106.4 million at December 31,
1996, 1995, 1994, 1993 and 1992, respectively.
* R&G Financial is unable to distinguish these two sub-categories of
consumer loans during the years ended December 31, 1994, 1993 and 1992.
22
<PAGE>
Contractual Principal Repayments and Interest Rates. The following table
sets forth certain information at December 31, 1996 regarding the dollar amount
of loans maturing in R&G Financial's total loan portfolio based on the
contractual terms to maturity. Loans having no stated schedule of repayments and
no stated maturity are reported as due in one year or less.
<TABLE>
<CAPTION>
Due 1-5 years Due 5 or more
after years after
Due 1 year December 31, December 31,
or less 1996 1996 Total(1)
---------- ------------- ------------- --------
(In Thousands)
<S> <C> <C> <C> <C>
Residential real estate ............. $ 57,506 $159,372 $169,755 $386,633
Residential construction ............ 5,351 -- -- 5,351
Commercial real estate(2) ........... 17,994 16,495 40,725 75,214
Commercial business ................. 7,355(3) 18,188 5,520 31,063
Consumer:
Loans on savings .................. 4,235 4,745 429 9,409
Real estate secured consumer loans 850 11,515 30,528 42,893
Unsecured consumer loans .......... 5,991 53,179 694 59,864
-------- -------- -------- --------
Total(4) ............................ $ 99,282 $263,494 $247,651 $610,427
======== ======== ======== ========
</TABLE>
- ----------
(1) Amounts have not been reduced for the allowance for loan losses, loans in
process, deferred loan fees or unearned interest.
(2) Includes $5.1 million of commercial construction and land acquisition
loans.
(3) Includes $726,000 of past due loans from the Bank's insurance premium
financing portfolio. See "Asset Quality."
(4) Does not include mortgage loans held for sale.
The following table sets forth the dollar amount of total loans due after
one year from December 31, 1996, as shown in the preceding table, which have
fixed interest rates or which have floating or adjustable interest rates.
Floating or
Fixed rate adjustable-rate Total
---------- --------------- -----
(In Thousands)
Residential real estate ................. $329,127 $ -- $329,127
Residential construction ................ -- -- --
Commercial real estate(1) ............... 5,541 51,679 57,220
Commercial business ..................... 16,771 6,937 23,708
Consumer:
Loans on savings ...................... 5,174 -- 5,174
Real estate secured consumer loans .... 42,043 -- 42,043
Unsecured consumer loans .............. 53,873 -- 53,873
-------- -------- --------
Total ................................ $452,529 $ 58,616 $511,145
======== ======== ========
- ----------
(1) Includes $5.1 million of commercial construction and land acquisition
loans.
23
<PAGE>
Scheduled contractual amortization of loans does not reflect the expected
term of R&G Financial's loan portfolio. The average life of loans is
substantially less than their contractual terms because of prepayments and, with
respect to conventional loans originated for the Bank after February 1994,
due-on-sales clauses, which give R&G Financial the right to declare a
conventional loan immediately due and payable in the event, among other things,
that the borrower sells the real property subject to the mortgage and the loan
is not repaid. The average life of mortgage loans tends to increase when current
mortgage loan rates are higher than rates on existing mortgage loans and,
conversely, decrease when rates on existing mortgage loans are lower than
current mortgage loan rates (due to refinancing of adjustable-rate and
fixed-rate loans at lower rates). Under the latter circumstance, the weighted
average yield on loans decreases as higher-yielding loans are repaid or
refinanced at lower rates.
Origination, Purchase and Sales of Loans. The following table sets forth
loan originations, purchases and sales by the Bank for the periods indicated.
Year Ended December 31,
---------------------------------
1996 1995 1994
--------- --------- ---------
(Dollars in Thousands)
Loan originations:
Loans originated by R&G Mortgage:
Residential mortgages .................... $ 187,845 $ 126,599 $ 131,749
Commercial mortgages ..................... -- -- 123
Construction loans ....................... 2,227 13,764 10,700
Consumer loans ........................... 21,208 15,944 --
Total loans originated by R&G
Mortgage ............................. 211,280 156,307 142,572
Other loans originated:
Commercial real estate ................... 36,140 48,497 21,921
Commercial business ...................... 33,318 21,556 13,391
Consumer loans:
Loans on deposit ......................... 13,988 12,546 9,290
Real estate secured consumer loans ....... 80 3,436 9,323
Unsecured consumer loans ................. 39,312 38,589 4,005
Total other loans originated ........... 122,838 124,624 57,930
Loans purchased(1) ....................... 8,047 807 12,837
Total loans originated and
purchased ........................... 342,165 281,738 213,339
Loans sold(2) ............................ (50,687) (75,093) (27,000)
Loan principal reductions ................ (113,831) (78,519) (62,170)
Net increase before other items, net ..... 177,647 128,126 124,169
Loans securitized and transferred to
mortgage-backed securities ............. (43,673) (17,631) (51,492)
Other increases (decreases) .............. -- 179 (2,363)
Net increase in loan portfolio ........... $ 133,974 $ 110,674 $ 70,314
(Footnotes on following page)
24
<PAGE>
- ----------
(1) Comprised of conventional loans purchased from other financial
institutions aggregating $8.1 million, $807,000 and $8.5 million in the
years ended December 31, 1996, 1995 and 1994, and FHA and conventional
loans purchased from R&G Mortgage aggregating $4.3 million during the
year ended December 31, 1994.
(2) Loans sold by the Bank in 1995 include approximately $55.2 million of
loans sold to two commercial banks which have been recognized in R&G
Financial's Consolidated Financial Statements as a transfer of loans with
recourse. Accordingly, the aggregate principal amount of the loans have
been reported as an asset in R&G Financial's Consolidated Financial
Statements. See "Sources of Funds - Borrowings."
R&G Financial, through the Bank, originates for both investment and sale
mortgage loans secured by residential real estate (secured by both first and
second mortgage liens) as well as construction loans (for residential real
estate), commercial real estate loans, commercial business loans and consumer
loans.
Pursuant to the Master Production Agreement, R&G Mortgage will assist the
Bank in meeting its loan production targets and goals by, among other things,
(i) advertising, promoting and marketing to the general public; (ii)
interviewing prospective borrowers and conducting the initial processing of the
requisite loan applications, consistent with the Bank's underwriting guidelines;
and (iii) providing personnel and facilities with respect to the execution of
loan agreements approved by the Bank. R&G Mortgage performs the foregoing loan
origination services on behalf of the Bank with respect to residential mortgage
loans, some commercial real estate loans and construction loans. R&G Mortgage
receives from the Bank 75% of the applicable loan origination fee with respect
to loans originated by R&G Mortgage on behalf of the Bank pursuant to the terms
of the Master Production Agreement. During the years ended December 31, 1996,
1995 and 1994, R&G Mortgage received $4.5 million, $3.6 million and $3.2
million, respectively, of loan origination fees with respect to loans originated
by R&G Mortgage on behalf of the Bank pursuant to the terms of the Master
Production Agreement. These fees are eliminated in consolidation in R&G
Financial's Consolidated Financial Statements. See also "- General - Affiliated
Transactions" and "Regulation - R&G Financial - Limitations on Transactions with
Affiliates."
The Bank originates commercial real estate, commercial business and
consumer loans. Applications for commercial real estate, commercial business and
unsecured consumer loans are taken at all of the Bank's branch offices and may
be approved by various lending officers of the Bank within designated limits,
which are established and modified from time to time to reflect an individual's
expertise and experience. All loans in excess of an individual's designated
limits are referred to an officer with the requisite authority. In addition, the
Management Credit Committee is authorized to approve all loans not exceeding
$400,000, the Credit Committee of the Board of Directors is authorized to
approve real estate secured loans not exceeding $500,000, and the Executive
Committee of
25
<PAGE>
the Board of Directors is authorized to approve all loans exceeding $500,000.
All loans originated or purchased by the Bank must be approved by one of the
three committees set forth above. Management of the Bank believes that its
relatively centralized approach to approving loan applications ensures strict
adherence to the Bank's underwriting guidelines while still allowing the Bank to
approve loan applications on a timely basis.
The Bank also occasionally purchases loans secured by first liens on
single-family residential real estate. The Bank will occasionally purchase FHA
loans from R&G Mortgage and conventional loans from unrelated financial
institutions. Such loan purchases are underwritten by the Bank pursuant to the
same guidelines as direct loan originations. Loans purchased by the Bank are
generally securitized by R&G Mortgage and sold by the Bank. During the years
ended December 31, 1996, 1995 and 1994, the Bank purchased $8.1 million,
$807,000 and $12.8 million of loans, respectively.
During the years ended December 31, 1996, 1995 and 1994, the Bank sold
$50.7 million, $75.1 million and $26.8 million of loans. These loans, which were
primarily nonconforming loans at the time of origination, were generally sold in
packages in privately negotiated transactions with FNMA and FHLMC.
Pursuant to the Master Purchase Agreement, the Bank sells to R&G Mortgage
the servicing rights to all first and second mortgage loans secured by
residential properties which are or will become part of the Bank's loan
portfolio once the Bank has a commitment to sell the loans. The Master Purchase
Agreement further provides that R&G Mortgage will service all other loans held
in the Bank's portfolio (including single-family residential loans retained by
the Bank, commercial real estate, commercial business and consumer loans
(although R&G Mortgage does not actually acquire such servicing rights)). In
addition, pursuant to the Master Purchase Agreement, the Bank processes payments
on all loans serviced by R&G Mortgage on behalf of the Bank. Finally, under the
Master Purchase Agreement, R&G Mortgage renders securitization services with
respect to the pooling of some of the Bank's mortgage loans into mortgage-backed
securities. See "- Mortgage Banking Activities."
At December 31, 1996, R&G Financial's five largest loans-to-one borrower
and their related entities amounted to $1.9 million, $1.9 million, $649,000,
$625,000 and $621,000. The largest loan concentration is primary comprised of
two interim construction loans with an aggregate balance of $1.2 million to a
developer of 110 single family detached residential units in Humaco, with the
balance of the loan concentration comprised of other commercial loans. The
second largest loan concentration is a loan to a developer of a new shopping
center in Carolina. Plans and permits are being developed for various fast food
chains. The third largest loan concentration is primarily comprised of a
commercial loan guaranteed by the Small Business Administration. The fourth
largest loan concentration consist of an interim financing to complete the
purchase of a land lot for the development of low to moderate single family
residences. The fifth largest loan consist of a term loan for the purchase of
a commercial two- story building in an industrial complex in the San Juan
metropolitan area. All of R&G
26
<PAGE>
Financial's five largest loan concentrations were performing in accordance with
their terms as of December 31, 1996.
Single-Family Residential Real Estate Loans. The Bank has historically
concentrated its lending activities on the origination of loans secured by first
mortgage liens on existing single-family residences. At December 31, 1996,
$370.9 million or 60.7% of R&G Financial's total loans held for investment
consisted of such loans, $369.5 million or 99.6% of which consisted of
conventional loans. The Bank's first mortgage single-family residential loans
consist exclusively of fixed-rate loans with terms of between 15 and 30 years.
As evidenced by this statistic, the Puerto Rico residential mortgage market has
not been receptive to long-term adjustable rate mortgage loans.
The Bank's first mortgage single-family residential loans typically do
not exceed 80% of the appraised value of the security property. Pursuant to
underwriting guidelines adopted by the Board of Directors, the Bank can lend up
to 95% of the appraised value of the property securing a first mortgage
single-family residential loan provided the Bank obtains private mortgage
insurance with respect to the top 25% of the loan.
The Bank also originates loans secured by second mortgages on
single-family residential properties. At December 31, 1996, $15.8 million or
2.6% of R&G Financial's total loans held for investment consisted of second
mortgage loans on single-family residential properties. The Bank offers such
second mortgage loans in amounts up to $125,000 for a term not to exceed 15
years. The loan-to-value ratio of second mortgage loans generally is limited to
75% of the property's appraised value (including the first mortgage).
Construction Loans. In recent years, the Bank has been active in
originating loans to construct single-family residences. These construction
lending activities generally are conducted throughout Puerto Rico, although
loans are concentrated in areas contiguous to Bank branches. At December 31,
1996, residential construction loans amounted to $5.4 million or 0.9% of R&G
Financial's total loans held for investment, while commercial construction and
land acquisition loans amounted to $5.1 million or 0.83% of total loans held for
investment.
The Bank primarily offers construction loans to individual borrowers for
the purpose of constructing single-family residences. Substantially all of the
Bank's construction lending to individuals is originated on a
construction/permanent mortgage loan basis. Construction/permanent loans are
made to individuals who hold a contract with a general contractor acceptable to
the Bank to construct their personal residence. The construction phase of the
loan provides for monthly payments on an interest only basis at a designated
fixed rate for the term of the construction period, which generally does not
exceed nine months. Thereafter, the permanent loan is made at then market rates,
provided that such rate shall not be more than 2% greater than the interim
construction rate. R&G Mortgage's construction loan department approves the
proposed contractors and administers
27
<PAGE>
the loan during the construction phase. The Bank's construction/permanent loan
program has been successful due to its ability to offer borrowers a single
closing and, consequently, reduced costs. At December 31, 1996, the Bank's
construction loan portfolio included 45 construction/permanent loans with an
aggregate principal balance of $5.4 million.
The Bank has also originated construction loans to developers on a very
limited basis to develop single family residential properties. The Bank does not
intend to actively engage in this business and will primarily undertake such
investments to accommodate a valued developer client if the Bank determines that
the project is worthy and the risk is acceptable. At December 31, 1996, the Bank
had 3 residential construction loans outstanding to developers aggregating $2.0
million to develop single-family subdivisions, consisting of 58 units in Fajardo
and 110 units in Humaco. The Fajardo project, which involved a $2.3 million
loan, had an outstanding balance of $437,000 as of December 31, 1996. The Humaco
project, which involved a $1.4 million loan for the third phase of the project,
had an outstanding balance of $463,000, and the $1.2 million loan granted for
the fourth phase of the project had an outstanding balance of $770,000 at
December 31, 1996. Each loan is performing in accordance with its terms. The
Humaco project loans are referenced in the discussion of the Bank's largest loan
concentrations above.
In addition to the foregoing, at December 31, 1996, the Bank had three
land acquisition loans amounting to $519,000, $239,000 and $180,000 which were
made in connection with projects to construct single-family residences. The Bank
and the financial institution which made the interim construction loan have
entered into an agreement pursuant to which the Bank is to be paid a percentage
of the proceeds from each home as it is released upon construction and sale. The
Bank expects to make the permanent construction loan on one of these projects.
The Bank does not expect to be active in this business.
The Bank intends to continue to increase its involvement in single-family
residential construction lending. Such loans afford the Bank the opportunity to
increase the interest rate sensitivity of its loan portfolio. Construction
lending is generally considered to involve a higher level of risk as compared to
permanent single-family residential lending, due to the concentration of
principal in a limited number of loans and borrowers and the effects of general
economic conditions on real estate developers and managers. Moreover, a
construction loan can involve additional risks because of the inherent
difficulty in estimating both a property's value at completion of the project
and the estimated costs (including interest) of the project. The nature of these
loans is such that they are generally more difficult to evaluate and monitor.
The Bank has taken steps to minimize the foregoing risks by, among other things,
limiting its construction lending primarily to residential properties. In
addition, the Bank has adopted underwriting guidelines which impose stringent
loan-to-value (80% with respect to single-family residential real estate), debt
service and other requirements for loans which are believed to involve higher
elements of credit risk and by working with builders with whom it has
established relationships or knowledge
28
<PAGE>
thereof. At December 31, 1996, $363,000 of the Bank's construction loans were
classified as non-performing.
Commercial Real Estate Loans. The Bank has also originated mortgage loans
secured by commercial real estate. At December 31, 1996, $70.1 million or 11.49%
of R&G Financial's total loans held for investment consisted of such loans. As
of such date, the Bank's commercial real estate loan portfolio consisted of
approximately 704 loans with an average principal balance of $107,000. At
December 31, 1996, $3.1 million of R&G Financial's commercial real estate loans
were classified as nonperforming.
Commercial real estate loans originated by the Bank are primarily secured
by office buildings, retail stores, warehouses and general purpose industrial
space. Although terms vary, commercial real estate loans generally are amortized
over a period of 7-15 years and have maturity dates of five to seven years. The
Bank will originate these loans with interest rates which adjust monthly in
accordance with a designated prime rate plus a margin, which generally is
negotiated at the time of origination. Such loans will have a floor but no
ceiling on the amount by which the rate of interest may adjust over the loan
term. Loan-to-value ratios on the Bank's commercial real estate loans are
currently limited to 80% or lower. As part of the criteria for underwriting
commercial real estate loans, the Bank generally requires a debt coverage ratio
(the ratio of net cash from operations before payment of debt service to debt
service) of 1.30 or more. It is also the Bank's general policy to seek
additional protection to mitigate any weaknesses identified in the underwriting
process. Additional coverage may be provided through mortgage insurance,
secondary collateral and/or personal guarantees from the principals of the
borrower.
Commercial real estate lending entails different and significant risks
when compared to single-family residential lending because such loans typically
involve large loan balances to single borrowers and because the payment
experience on such loans is typically dependent on the successful operation of
the project or the borrower's business. These risks can also be significantly
affected by supply and demand conditions in the local market for apartments,
offices, warehouses or other commercial space. The Bank attempts to minimize its
risk exposure by limiting the extent of its commercial lending generally. In
addition, the Bank imposes stringent loan-to-value ratios, requires conservative
debt coverage ratios, and continually monitors the operation and physical
condition of the collateral. Although the Bank has begun to increase its
emphasis on commercial real estate lending, management does not currently
anticipate that its portfolio of commercial real estate loans will grow
significantly as a percentage of the total loan portfolio.
Commercial Business Loans. Beginning in 1991, the Bank began emphasizing
commercial business loans, including working capital lines of credit, inventory
and accounts receivable loans, equipment financing (including equipment leases),
term loans, insurance premiums loans and loans guaranteed by the Small Business
Administration. Depending on the collateral pledged to secure the extension of
credit, maximum loan to value ratios are 75% or less, with exceptions permitted
to a maximum of 80%. Loan terms may vary from
29
<PAGE>
one to 15 years. The interest rates on such loans are generally variable and are
indexed to a designated prime rate, plus a margin. The Bank also generally
obtains personal guarantees from the principals of the borrowers. At December
31, 1996, commercial business loans amounted to $31.1 million or 5.1% of total
loans held for investment. Although the Bank has begun to increase its emphasis
on commercial business lending, management does not currently anticipate that
its portfolio of commercial business loans will grow significantly as a
percentage of the total loan portfolio. At December 31, 1996 $1.6 million of R&G
Financial's commercial business loans were classified as non-performing, an
increase of $1.5 million as compared to December 31, 1995. The increase is
primarily related to certain loans related to the Bank's insurance premiums
financing business. See "Management's Discussion and Analysis of Financial
Condition and Results of Operation -- Results of Operation -- Provision for Loan
Losses" incorporated by reference in Item 7 hereof.
Consumer Loans. The Bank has recently begun to emphasize the origination
of consumer loans in order to provide a full range of financial services to its
customers and because such loans generally have shorter terms and higher
interest rates than mortgage loans. At December 31, 1996, $112.2 million or
18.4% of R&G Financial's total loans held for investment consisted of consumer
loans. The consumer loans offered by the Bank include real estate secured
consumer loans (which are originated by R&G Mortgage), loans secured by deposit
accounts, credit card loans and other secured and unsecured consumer loans. Most
of the Bank's consumer loans are secured and have been primarily obtained
through newspaper advertising, although loans are also obtained from existing
and walk-in customers. Although the Bank has begun to increase its emphasis on
consumer lending, management does not currently anticipate that its portfolio of
consumer loans will grow significantly as a percentage of the total loan
portfolio.
The Bank currently offers loans secured by deposit accounts, which
amounted to $9.4 million at December 31, 1996. Such loans are originated
generally for up to 90% of the account balance, with a hold placed on the
account restricting the withdrawal of the account balance. The Bank offers real
estate secured loans in amounts up to 75% of the appraised value of the
property, including the amount of any existing prior liens. Real estate secured
consumer loans have a maximum term of 10 years, which may be extended within the
sole discretion of the Bank, and an interest rate which is set at a fixed rate
based on market conditions. The Bank secures the loan with a first or second
mortgage on the property and will originate the loan even if another institution
holds the first mortgage. At December 31, 1996, real estate secured consumer
loans totalled $42.9 million. In November 1995, the Bank began issuing credit
cards in its own name. At December 31, 1996, credit card receivables totalled
$1.8 million.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. In addition, consumer lending collections are dependent
on the borrower's continuing financial stability, and thus
30
<PAGE>
are more likely to be adversely effected by job loss, divorce, illness and
personal bankruptcy. In many cases, any repossessed collateral for a defaulted
consumer loan will not provide an adequate source of repayment of the
outstanding loan balance because of improper repair and maintenance of the
underlying security. The remaining deficiency may not warrant further
substantial collection efforts against the borrower. At December 31, 1996,
$820,000 of consumer loans were classified as non-performing.
Asset Quality
General. When a borrower fails to make a required payment on a loan, R&G
Financial attempts to cure the deficiency by contacting the borrower and seeking
payment. Contacts are generally made between the 10th and 15th day after a
payment is due. In most cases, deficiencies are cured promptly. If a delinquency
extends beyond 15 days, the loan and payment history is reviewed and efforts are
made to collect the loan. While R&G Financial generally prefers to work with
borrowers to resolve such problems, when the account becomes 90 days delinquent
in the case of mortgage loans, R&G Financial does institute foreclosure or other
proceedings, as necessary, to minimize any potential loss. In the case of
consumer loans, the Bank refers the file for collection action after 60 days.
Loans secured by real estate are placed on non-accrual status when, in
the judgment of management, the probability of collection of interest is deemed
to be insufficient to warrant further accrual. When such a loan is placed on
non-accrual status, previously accrued but unpaid interest is deducted from
interest income. As a matter of policy, the Bank does not accrue interest on
loans past due 90 days or more which are secured by real estate. The Bank
generally takes the same position in the case of consumer loans.
Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure are classified as real estate owned until sold.
Pursuant to a statement of position ("SOP 92-3") issued by the American
Institute of Certified Public Accountants in April 1992, which provides guidance
on determining the balance sheet treatment of foreclosed assets in annual
financial statements for periods ending on or after December 15, 1992, there is
a rebuttable presumption that foreclosed assets are held for sale and such
assets are recommended to be carried at the lower of fair value minus estimated
costs to sell the property, or cost (generally the balance of the loan on the
property at the date of acquisition). After the date of acquisition, all costs
incurred in maintaining the property are expensed and costs incurred for the
improvement or development of such property are capitalized up to the extent of
their net realizable value. The Bank's accounting for its real estate owned
complies with the guidance set forth in SOP 92-3.
31
<PAGE>
The following table sets forth the amounts and categories of R&G
Financial's non-performing assets at the dates indicated. R&G Financial did not
have any troubled debt restructurings at any of the periods presented. Except as
otherwise indicated in the footnotes to the table, the non-performing assets are
assets of the Bank.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------
1996 1995 1994 1993 1992
------- ------- ------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Non-accruing loans:
Residential real estate(1) ................. $12,991 $ 7,921 $ 4,045 $ 2,942 $ 1,939
Residential Construction ................... 363 -- -- -- --
Commercial real estate ..................... 3,141 1,903 789 1,311 141
Commercial business ........................ 823 -- -- -- --
Consumer ................................... 686 40 918 736 221
Other(2) ................................... 726 -- -- -- --
------- ------- ------- ------- -------
Total .................................... 18,730(3) 9,864 5,752 4,989 2,301
------- ------- ------- ------- -------
Accruing loans greater than 90 day
delinquent: ................................ s
Residential real estate .................... -- -- -- -- --
Residential construction ................... -- 611 -- -- 28
Commercial real estate ..................... -- -- -- -- --
Commercial business ........................ 22 8 10 70 --
Consumer ................................... 134 94 -- -- 4
------- ------- ------- ------- -------
Total accruing loans greater than
90 days delinquent ..................... 156 713 10 70 32
------- ------- ------- ------- -------
Total non-performing loans ............... 18,886 10,577 5,762 5,059 2,333
------- ------- ------- ------- -------
Real estate owned, net of reserves(4) ........ 865 654 722 699 21
------- ------- ------- ------- -------
Total non-performing assets .............. $19,751 $11,231 $ 6,484 $ 5,758 $ 2,354
======= ======= ======= ======= =======
Total non-performing loans as a
percentage of total loans .............. 3.55% 2.18% 1.84% 2.24% 1.81%
======= ======= ======= ======= =======
Total non-performing assets as a
percentage of total assets ............. 2.15% 1.32% 1.04% 1.07% 0.80%
======= ======= ======= ======= =======
</TABLE>
- ----------
(1) Includes residential real estate secured by both first and second
mortgage loans.
(2) Comprised of insurance premium financing contracts, primarily
commercial and, to a lesser extent, personal. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operation -- Provision for Loan Losses"
incorporated by reference in Item 7 hereof.
(3) As of December 31, 1996, comprised of 249 loans secured by residential
real estate, 30 loans secured by commercial real estate, 4 construction
loans, 20 commercial business loans and 85 consumer loans.
(4) Includes properties held by R&G Mortgage of $43,000 as of December 31,
1994. As of December 31, 1996, the Bank had 10 residential properties
aggregating $865,000.
While the level of total non-performing assets of R&G Financial has
increased on an absolute basis during the periods presented, from $2.4 million
at December 31, 1992 to $19.8 million at December 31, 1996, R&G Financial's net
loans receivable portfolio has
32
<PAGE>
increased by 414.3% during this period, from $117.4 million at December 31, 1992
to $603.8 million at December 31, 1996. Thus, total non-performing assets as a
percent of total assets increased from 0.80% at December 31, 1992 to 2.15% at
December 31, 1996.
[Need to explain to me increases in single family and commercial real
estate and commercial business loans.]
It is the policy of the Bank to maintain an allowance for estimated
losses on loans and to increase such allowance when, based on management's
evaluation, a loss becomes both probable and estimable (i.e., the loss is likely
to occur and can be reasonably estimated). Major loans and major lending areas
are reviewed periodically to determine potential problems at an early date.
Also, management's periodic evaluation considers factors such as loss
experience, current delinquency data, known and inherent risks in the portfolio,
identification of adverse situations which may affect the ability of debtors to
repay the loan, the estimated value of any underlying collateral and assessment
of current economic conditions. Additions to the allowance are charged to
income. Such provisions are based on management's estimated value of any
underlying collateral, as applicable, considering the current and anticipated
operating conditions of the borrower. Any recoveries are credited to the
allowance.
The following table sets forth an analysis of R&G Financial's allowance
for loan losses during the periods indicated, which is maintained on the Bank's
loan portfolio.
<TABLE>
<CAPTION>
At and For the Year Ended December 31,
---------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period ........ $3,510 $2,887 $3,029 $1,230 $ 892
------ ------ ------ ------ ------
Charge-offs:
Residential real estate ............. 45 53 -- -- 5
Construction ........................ 50 -- -- -- --
Commercial real estate .............. -- -- -- -- --
Commercial business ................. 110 91 3 56 105
Consumer ............................ 1,922 365 139 90 11
Other(1) ............................ 2,535 -- -- -- --
------ ------ ------ ------ ------
Total charge-offs ................. 4,662 509 142 146 121
------ ------ ------ ------ ------
Recoveries:
Residential real estate ............. -- 1 -- -- --
Construction ........................ -- -- -- -- --
Commercial real estate .............. -- -- -- -- --
Commercial business ................. 31 85 -- 20 2
Consumer ............................ 195 96 -- 242 22
------ ------ ------ ------ ------
Total recoveries .................. 226 182 -- 262 24
------ ------ ------ ------ ------
Net charge-offs ....................... 4,436 327 142 (116) 97
------ ------ ------ ------ ------
Allowance for loan losses acquired from
Caribbean Federal ................... -- -- -- 1,683 --
Provision for losses on loans ......... 4,258 950(2) -- -- 435
------ ------ ------ ------ ------
Balance at end of period .............. $3,332 $3,510 $2,887 $3,029 $1,230
====== ====== ====== ====== ======
Allowance for loan losses as a percent
of total loans outstanding .......... .55% 0.72% 0.92% 1.34% 0.95%
====== ====== ====== ====== ======
Allowance for loan losses as a percent
of non-performing loans ............. 15.55% 33.19% 50.10% 59.87% 52.72%
====== ====== ====== ====== ======
Ratio of net charge-offs to average
loans outstanding ................... .86% 0.08% 0.05% (0.06)% 0.07%
====== ====== ====== ====== ======
</TABLE>
33
<PAGE>
- ----------
(1) Comprised of $2.5 million of loans from the Bank insurance premiums
financing portfolio. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Results of Operation --
Provision for Loan Losses" incorporated by reference in Item 7 hereof.
(2) Includes $500,000 transferred to the provision for loan losses which R&G
Financial determined was excess valuation reserves on mortgage loans held
for sale.
34
<PAGE>
The following table sets forth information concerning the allocation of
R&G Financial's allowance for loan losses (which is maintained on the Bank's
loan portfolio) by loan category at the dates indicated.
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
-------------------- -------------------- ------------------- ------------------- -------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in Loans in
Each Each Each Each Each
Category to Category to Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Residential real estate $ 810 24.31% $2,094 59.66% $1,962 67.95% $2,029 66.99% $ 913 74.23%
Construction........... 51 1.53 32 0.90 -- -- -- -- -- --
Commercial real estate. 489 14.68 -- -- -- -- -- -- -- --
Commercial business.... 109 3.27 782 22.28 403 13.96 576 19.02 154 12.60
Consumer............... 1,873 56.21 602 17.16 522 18.09 424 13.99 163 13.17
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total.................. $3,332 100.00% $3,510 100.00% $2,887 100.00% $3,029 100.00% $1,230 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
35
<PAGE>
Investment Activities
General. R&G Financial's securities portfolio is managed by investment
officers in accordance with a comprehensive written investment policy which
addresses strategies, types and levels of allowable investments and which is
reviewed and approved annually by the respective Boards of Directors of the Bank
and R&G Mortgage. The management of the securities portfolio is set in
accordance with strategies developed by the Bank's Interest Rate Risk, Budget
and Investments Committee ("IRRBICO").
As discussed under "- Mortgage Banking Activities," R&G Mortgage is
primarily engaged in the origination of mortgage loans and the securitization of
such loans into mortgage-backed and related securities and the subsequent sale
of such securities to securities broker-dealers and other investors in the
secondary market. As a result of R&G Mortgage's securitization activities, R&G
Mortgage maintains a substantial portfolio of GNMA mortgage-backed securities.
At December 31, 1996, R&G Mortgage held GNMA mortgage-backed securities with a
fair value of $106.4 million which are classified as held for trading. Such
securities generally remain in R&G Mortgage's portfolio for between 90 and 180
days. In addition, during 1994 and 1995, R&G Mortgage sold through grantor
trusts $201.4 million and $38.1 million, respectively, of CMOs and retained a
portion of the residual interests related thereto. In addition, in 1995, R&G
Mortgage purchased from the Bank $4.6 million of mortgage-backed residuals
relating to the Bank's 1993 issuance of CMOs. At December 31, 1996, R&G
Mortgage's CMOs and CMO residuals, which are classified as held for trading, had
an amortized cost of $24.7 million and a fair value of $23.7 million.
The Bank's Investment Policy authorizes the Bank to invest in U.S.
Treasury obligations (with a maturity up to five years), U.S. Agency
obligations, FNMA, GNMA and FHLMC mortgage-backed certificates, investment grade
municipal obligations (with a maturity of up to five years), bankers'
acceptances and Federal Home Loan Bank ("FHLB") notes (with a maturity of up to
five years), investment grade commercial paper (with a maturity of up to 9
months), federal funds (with a maturity of six months or less), certificates of
deposit in other financial institutions (including Eurodollar deposits),
repurchase agreements (with a maturity of six months or less), investment grade
corporate bonds (with a maturity of five years or less) and certain
mortgage-backed derivative securities (with a weighted average life of less than
ten years).
At December 31, 1996, the Bank's securities portfolio consisted of $43.2
million of securities held for investments, consisting of $21.7 million of
tax-free mortgage-backed securities, $16.2 million of other mortgage backed
securities, and $5.3 million of Puerto Rico Government obligations and other
Puerto Rico securities. In addition, at December 31, 1996, the Bank had a
securities portfolio classified as available for sale with a fair value of $81.8
million, consisting of $42.6 million of mortgage-backed securities, $4.3 million
of FHLB stock, $8.2 million of CMOs and CMO residuals and $26.7 million of U.S.
Government agency securities. Finally, at December 31, 1996, $2.5 million of the
Bank's securities were classified as held for trading, consisting of $1.7
million of GNMA certificates and $770,000 of U.S. Treasury Bills.
In February 1996, the Company entered into various agreements with an
independent investment management firm whereby such firm has been appointed as
investment advisor
36
<PAGE>
with respect to a portion of the Company's securities portfolio. Pursuant to
such agreements, this investment advisory firm advises and recommends the
purchase and/or sale of otherwise eligible investments on behalf of the Company
as well as the execution of various hedging strategies. Such firm, which has
been engaged by the Company to, among other things, assist it in achieving the
objectives established by the Company's IRRBICO, receives an annual management
fee of .15% of the average aggregate principal amount under management (payable
quarterly) together with a quarterly performance fee of 25% of the net trading
profits earned during each calendar quarter. At December 31, 1996, this
investment advisory firm was managing assets of the Company with an approximate
fair value of $33.0 million ($19.2 million of which is being utilized for
hedging purposes and $13.8 million of which is being utilized for trading
purposes), which were invested in U.S. Government agency securities, U.S.
Treasury Bills, money market instruments and option contracts. Such firm also
executes hedging strategies on behalf of the Company for a portion of U.S.
Government and agency securities available for sale and mortgage-backed
securities which are available for sale (excluding CMOs) or held for trading. At
December 31, 1996, the Company's securities held for trading and available for
sale for which hedging contracts are made had a fair value of $149.1 million.
Effective January 1, 1997, the Company discontinued hedging activities for its
mortgage backed securities held for trading after management determined that the
relatively low volatility of such securities did not warrant hedging against
such assets.
37
<PAGE>
The following table presents certain information regarding the
composition and period to maturity of R&G Financial's securities portfolio held
to maturity as of the dates indicated below. All of such securities are assets
of the Bank.
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------------------------------------------------
1996 1995 1994
--------------------------------- ------------------------------ ------------------------------
Weighted Weighted Weighted
Carrying Market Average Carrying Market Average Carrying Market Average
Value Value Yield Value Value Yield Value Value Yield
-------- ------ -------- -------- ------ -------- -------- ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities:
GMNA
Due within one year..... $ -- $ -- % $ -- $ -- --% $ -- $ -- --%
Due from one-five years. -- -- -- -- -- -- -- -- --
Due from five-ten years. 97 100 10.00% 118 108 10.00 174 164 10.00
Due over ten years...... 21,591 20,571 6.03 24,617 23,681 6.03 26,619 24,224 5.98
FNMA
Due within one year....... -- -- -- -- -- -- -- -- --
Due from one-five years... -- -- -- -- -- -- -- -- --
Due from five-ten years... -- -- -- -- -- -- -- -- --
Due over ten years........ 15,895 16,124 7.18 16,623 16,623 7.18 16,175 15,267 7.16
FHLMC
Due within one year....... -- -- -- -- -- -- -- -- --
Due from one-five years... -- -- -- -- -- -- -- -- --
Due from five-ten years... -- -- -- -- -- -- 659 678 9.16
Due over ten years........ 317 309 5.38 373 373 5.50 40,495 38,512 7.05
Investment Securities:
Puerto Rico Government
obligations
Due within one year....... -- -- -- 377 377 2.69 460 460 3.49
Due from one-five years... 4,960 4,930 5.38 1,042 1,000 6.25 1,046 982 6.25
Due from five-ten years... -- -- -- -- -- -- -- -- --
Due over ten years........ -- -- -- 627 619 4.25 676 667 4.55
U.S. Government Agency
Due within one year....... -- -- -- -- -- -- -- -- --
Due within one-five years. 310 311 6.13 -- -- -- -- -- --
Due within five-ten years. -- -- -- -- -- -- -- -- --
Due over ten years........ -- -- -- -- -- -- -- -- --
Commercial paper:
Due within one year....... 2,982 2,982 5.55 -- -- -- -- -- --
Due within one-five years. -- -- -- -- -- -- -- -- --
Due within five-ten years. -- -- -- -- -- -- -- -- --
Due over ten years........ -- -- -- -- -- -- -- -- --
Total Securities held for
investment............ $46,152 $45,327 6.34% $43,777 $42,781 6.42% $86,304 $80,954 6.76%
</TABLE>
38
<PAGE>
The following table presents certain information regarding the
composition and period to maturity of R&G Financial's held for trading and
available for sale mortgage-backed and investment securities portfolio as of the
dates indicated below.
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------------------------
1996 1995 1994
---------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Amortized Fair Average Amortized Fair Average Amortized Fair Average
Cost Value Yield Cost Value Yield Cost Value Yield
--------- ------- -------- --------- ------ -------- --------- ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-Backed Securities Available
for Sale(1):
FNMA mortgage-backed securities
Due within one year................... $ -- $ -- --% $ -- $ -- --% $ -- $ -- --%
Due from one-five years............... -- -- -- -- -- -- -- -- --
Due from five-ten years............... -- -- -- -- -- -- -- -- --
Due over ten years.................... 10,563 10,293 6.99 14,846 14,946 7.12 -- -- --
FHLMC mortgage-backed securities
Due within one year................... -- -- -- -- -- -- -- -- --
Due from one-five years............... 56 60 9.01 -- -- -- -- -- --
Due from five-ten years............... 474 487 9.25 1,122 1,180 8.90 -- -- --
Due over ten years.................... 32,454 31,806 6.77 36,353 36,759 6.94 -- -- --
CMO residuals and other mortgage-backed
securities (2)
Due within one year................... -- -- -- -- -- NA -- -- NA
Due from one-five years............... -- -- -- -- -- NA -- -- NA
Due from five-ten years............... -- -- -- -- -- NA -- -- NA
Due over ten years.................... 7,067 8,195 8.125 7,126 8,123 NA 11,684 13,300 NA
Investment Securities Available for Sale(1)
U.S. Government Agency
Due within one year................... 1,500 1,500 6.00 -- -- -- -- -- --
Due from one-five years............... 20,502 20,361 6.18 -- -- -- -- -- --
Due from five-ten years............... 5,026 4,865 6.73 -- -- -- -- -- --
Due over ten years.................... -- -- -- -- -- -- -- -- --
FHLB stock.............................. 4,247 4,247 6.30 3,280 3,280 7.68 1,878 1,878 7.60
-------- -------- ---- -------- -------- ---- -------- -------- ----
$ 81,889 $ 81,814 6.75% $ 62,727 $ 64,288 6.42% $ 13,562 $ 15,178 5.01%
======== ======== ==== ======== ======== ==== ======== ======== ====
Securities held for trading(3):
GNMA certificates....................... 83,848 84,460 6.53 $ 87,656 $ 88,448 6.71% $ 65,813 $ 64,184 6.59%
CMO certificates........................ 16,200 15,147 5.95 16,200 15,570 5.95 54,350 50,241 5.76
CMO residuals(4)........................ 8,489 8,539 8.07 10,248 9,791 8.07 9,500 10,097 8.00
U.S. Treasury Bills..................... 1,370 1,316 5.72 -- -- -- -- -- --
-------- -------- ---- -------- -------- ---- -------- -------- ----
$109,907 $109,462 6.55% $114,104 $113,809 6.72% $129,663 $124,522 6.35%
======== ======== ==== ======== ======== ==== ======== ======== ====
</TABLE>
(Footnotes on following page)
39
<PAGE>
- ----------
(1) All securities are held in the Bank's investment securities portfolio.
(2) Comprised of subordinated tranches and residuals from the Bank's 1992
Grantor Trust.
(3) Except for GNMA Certificates with a fair value of $1.7 million, $1.8
million and $1.9 million during the years ended December 31, 1996, 1995
and 1994 and U.S. Treasury Bills with a fair value of $770,000 at
December 31, 1996, all of such securities are held in R&G Mortgage's
securities portfolio.
(4) Represents residuals purchased from the Bank from its 1993 CMO Grantor
Trust and from R&G Mortgage's CMO Grantor Trust.
A substantial portion of R&G Financial's securities are held in
mortgage-backed securities. Mortgage-backed securities (which also are known as
mortgage participation certificates or pass-through certificates) represent a
participation interest in a pool of single-family or multi-family mortgages, the
principal and interest payments on which are passed from the mortgage
originators, through intermediaries (generally U.S. Government agencies and
government sponsored enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as R&G Financial. Such
U.S. Government agencies and government sponsored enterprises, which guarantee
the payment of principal and interest to investors, primarily include the FHLMC,
the FNMA and the GNMA.
The FHLMC is a public corporation chartered by the U.S. Government and
owned by the 12 Federal Home Loan Banks and federally-insured savings
institutions. The FHLMC issues participation certificates backed principally by
conventional mortgage loans. The FHLMC guarantees the timely payment of interest
and the ultimate return of principal within one year. The FNMA is a private
corporation chartered by the U.S. Congress with a mandate to establish a
secondary market for conventional mortgage loans. The FNMA guarantees the timely
payment of principal and interest on FNMA securities. FHLMC and FNMA securities
are not backed by the full faith and credit of the United States, but because
the FHLMC and the FNMA are U.S. Government-sponsored enterprises, these
securities are considered to be among the highest quality investments with
minimal credit risks. The GNMA is a government agency within HUD which is
intended to help finance government-assisted housing programs. GNMA securities
are backed by FHA-insured and VA-guaranteed loans, and the timely payment of
principal and interest on GNMA securities are guaranteed by the GNMA and backed
by the full faith and credit of the U.S. Government. Because the FHLMC, the FNMA
and the GNMA were established to provide support for low- and middle-income
housing, there are limits to the maximum size of loans that qualify for these
programs. For example, the FNMA and the FHLMC currently limit
40
<PAGE>
their loans secured by a single-family, owner-occupied residence to $214,600. To
accommodate larger-sized loans, and loans that, for other reasons, do not
conform to the agency programs, a number of private institutions have
established their own home-loan origination and securitization programs.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
characteristics of the underlying pool of mortgage, i.e., fixed-rate or
adjustable-rate, as well as prepayment risk, are passed on to the certificate
holder. The life of a mortgage-backed pass-through security thus approximates
the life of the underlying mortgages.
R&G Financial's securities portfolio includes CMOs. CMOs have been
developed in response to investor concerns regarding the uncertainty of cash
flows associated with the prepayment option of the underlying mortgagor and are
typically issued by government agencies, government sponsored enterprises and
special purpose entities, such as trusts, corporations or partnerships,
established by financial institutions or other similar institutions. A CMO can
be collateralized by loans or securities which are insured or guaranteed by the
FNMA, the FHLMC or the GNMA. In contrast to pass-through mortgage-backed
securities, in which cash flow is received pro rata by all security holders, the
cash flow from the mortgages underlying a CMO is segmented and paid in
accordance with a predetermined priority to investors holding various CMO
classes. By allocating the principal and interest cash flows from the underlying
collateral among the separate CMO classes, different classes of bonds are
created, each with its own stated maturity, estimated average life, coupon rate
and prepayment characteristics.
Mortgage-backed securities generally increase the quality of R&G
Financial's assets by virtue of the insurance or guarantees that back them, are
more liquid than individual mortgage loans and may be used to collateralize
borrowings or other obligations of R&G Financial. At December 31, 1996, $44.5
million or 22.6% of R&G Financial's mortgage-backed securities was pledged to
secure various obligations of R&G Financial (excluding repurchase agreements).
The FDIC has issued a statement of policy which states, among other
things, that mortgage derivative products (including CMOs and CMO residuals)
which possess average life or price volatility in excess of a benchmark fixed
rate 30-year mortgage-backed pass-through security are "high-risk mortgage
securities," are not suitable investments for depository institutions, and if
considered "high risk" at purchase must be carried in the institution's trading
account or as assets held for sale, and must be marked to market on a regular
basis. In addition, if a security was not considered "high risk" at purchase but
was later found to be "high risk" based on the tests, it may remain in the
held-to-maturity portfolio as long as the institution has positive intent to
hold the security to maturity and has a documented plan in place to manage the
high risk. At December 31, 1996, the Bank's
41
<PAGE>
CMOs and CMO residuals, which had a fair value of $8.2 million, were designated
as "high-risk mortgage securities" and classified as available for sale.
Sources of Funds
General. R&G Financial will consider various sources of funds to fund its
investment and lending activities and evaluates the available sources of funds
in order to reduce R&G Financial's overall funding costs. Deposits, reverse
repurchase agreements, warehouse lines of credit, notes payable, FHLB advances,
subordinated capital notes and sales, maturities and principal repayments on
loans and securities have been the major sources of funds for use in R&G
Financial's lending and investing activities and for other general business
purposes.
Deposits. Deposits are the major sources of the Bank's funds for lending
and other investment purposes. Consumer and commercial deposits are attracted
principally from within the Bank's primary market area through the offering of a
broad selection of deposit instruments, including passbook, NOW and Super NOW,
checking and commercial checking and certificates of deposit ranging in terms
from 7 days to 10 years. Included among these deposit products are $168.6
million of certificates of deposit with balances of $100,000 or more, which
amounted to 27.4% of the Bank's total deposits at December 31, 1996. Deposit
account terms vary according to the minimum balance required, the time periods
the funds must remain on deposit and the interest rate, among other factors.
The Bank attempts to price its deposits in order to promote deposit
growth. The Bank regularly evaluates the internal costs of funds, surveys rates
offered by competing institutions, reviews the Bank's cash flow requirements for
lending and liquidity and executes rate changes when deemed appropriate. The
Bank does not currently obtain funds through brokers, although at December 31,
1996 it held $10.1 million of deposits acquired from money desks in the United
States.
The principal methods currently used by the Bank to attract deposit
accounts include offering a wide variety of services and accounts and
competitive interest rates. The Bank utilizes traditional marketing methods to
attract new customers and savings deposits, including advertising.
42
<PAGE>
The following table presents the average balance of each deposit type and
the average rate paid one each deposit type of the Bank for the periods
indicated.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------
1996 1995 1994
-------------------- --------------------- ---------------------
Average Average Average Average Average Average
Balance Rate Paid Balance Rate Paid Balance Rate Paid
-------- --------- ------- --------- ------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Passbook................. $ 73,216 3.77% $ 59,860 3.66% $ 45,220 3.60%
NOW and Super NOW accounts 78,183 3.85 65,135 3.82 3.87
Checking................. 20,451 -- 6,050 -- 2,725 --
Commercial checking(1)... 30,173 -- 24,601 -- 22,819 --
Certificates of deposit.. 359,525 6.05 276,187 6.25 197,035 5.20
-------- ---- -------- ---- -------- ----
Total deposits......... $561,548 4.90% $431,833 5.05% $340,461 4.25%
======== ==== ======== ==== ======== ====
</TABLE>
- ----------
(1) Includes $10.6 million, $9.7 million and $10.0 million of escrow funds of
R&G Mortgage maintained with the Bank at December 31, 1996, 1995 and
1994, respectively.
The following table sets forth the maturities of the Bank's certificates
of deposit having principal amounts of $100,000 or more at December 31, 1996.
Amount
--------------
(In Thousands)
Certificates of deposit maturing:
Three months or less...................................... $ 57,711
Over three through six months............................. 21,788
Over six through twelve months............................ 47,706
Over twelve months........................................ 41,410
--------
Total................................................... $168,615
========
Borrowings. R&G Financial's business requires continuous access to
various funding sources, both short and long-term. R&G Mortgage's primary source
of short-term funds is through sales of securities to investment dealers under
agreements to repurchase ("reverse repurchase agreements"). The Bank also from
time to time utilizes reverse repurchase agreements when they represent a
competitive short-term funding source. In a reverse repurchase agreement
transaction, R&G Financial will generally sell a mortgage-backed security
agreeing to repurchase either the same or a substantially identical security on
a specified later date (generally not more than 90 days) at a price less than
the original sales price. The difference in the sale price and purchase price is
the cost of the use of the proceeds. The mortgage-backed securities underlying
the agreements are delivered to the dealers who arrange the transactions. For
agreements in which R&G Financial has agreed to repurchase substantially
identical securities, the dealers may sell, loan or otherwise
43
<PAGE>
dispose of R&G Financial's securities in the normal course of their operations;
however, such dealers or third party custodians safe-keep the securities which
are to be specifically repurchased by R&G Financial. Reverse repurchase
agreements represent a competitive cost funding source for R&G Financial.
Nevertheless, R&G Financial is subject to the risk that the lender may default
at maturity and not return the collateral. The amount at risk is the value of
the collateral which exceeds the balance of the borrowing. In order to minimize
this potential risk, R&G Financial only deals with large, established investment
brokerage firms when entering into these transactions. Reverse repurchase
transactions are accounted for as financing arrangements rather than as sales of
such securities, and the obligations to repurchase such securities is reflected
as a liability in R&G Financial's Consolidated Financial Statements. As of
December 31, 1996, R&G Financial had $97.4 million of reverse repurchase
agreements outstanding, all of which represented borrowings of R&G Mortgage. At
December 31, 1996, the weighted average interest rate on R&G Financial's reverse
repurchase agreements amounted to 5.67%.
R&G Mortgage's loan originations are also funded by borrowings under
various warehouse lines of credit provided by two unrelated commercial banks
("Warehouse Lines"). At December 31, 1996, R&G Mortgage was permitted to borrow
under such Warehouse Lines up to $108.4 million, $40.3 million of which was
drawn upon and outstanding as of such date. The Warehouse Lines are used by R&G
Mortgage to fund loan commitments and must generally be repaid within 180 days
after the loan is closed or when R&G Mortgage receives payment from the sale of
the funded loan, whichever occurs first. Until such sale closes, the Warehouse
Lines provide that the funded loan is pledged to secure the outstanding
borrowings. The Warehouse Lines are also collateralized by certificates of
deposit, a general assignment of mortgage payments receivable, an assignment of
certain mortgage servicing rights and an assignment of key man life insurance
policies on Mr. Victor J. Galan, R&G Financial's Chairman of the Board and Chief
Executive Officer. In addition, some of the Warehouse Lines are personally
guaranteed by Mr. Galan. Certain of these warehousing lines of credit impose
restrictions on R&G Mortgage with respect to the maintenance of minimum levels
of net worth and working capital and limitations on the amount of indebtedness
and dividends which may be declared.
The interest rate on funds borrowed pursuant to the Warehouse Lines is
based upon a specified prime rate less a negotiated amount or a designated
Puerto Rico Section 936 funds rate (which is lower than the prime rate) plus a
negotiated amount. By maintaining compensating balances, R&G Mortgage is able to
borrow funds under the Warehouse Lines at a lower interest rate than would
otherwise apply. These compensating balances are comprised of a portion of the
escrow accounts maintained by R&G Mortgage for principal and interest payments
and related tax and insurance payments on loans its services. At December 31,
1996, the weighted average interest rate being paid by R&G Mortgage under its
Warehouse Lines amounted to 6.48%.
The Warehouse Lines include various covenants and restrictions on R&G
Mortgage's operations, including maintenance of minimum levels of net worth and
working capital,
44
<PAGE>
minimum levels and ratios with respect to outstanding indebtedness and
restrictions on the amount of dividends which can be declared and paid by R&G
Mortgage on its common stock (which is limited to 50% of R&G Mortgage's net
income for the preceding fiscal year). Management of R&G Financial believes that
as of December 31, 1996, it was in compliance with all of such covenants and
restrictions and does not anticipate that such covenants and restrictions will
limit its operations.
Although the Bank's primary source of funds is deposits, the Bank also
borrows funds on both a short and long-term basis. The Bank actively utilizes
936 Notes as a primary borrowing source. The 936 Notes have original terms to
maturity of between five and eight years and are payable semiannually at either
a variable interest rate (84% of the three-month LIBOR rate less .125%, and 96%
of the three month LIBID rate or a fixed interest rate (ranging from 5.50% to
7.15%). The Bank is able to obtain such low cost funds by investing the proceeds
in eligible activities as proscribed under Puerto Rico law, which provide tax
advantages under Puerto Rico tax laws and under U.S. federal tax laws for U.S.
corporations which are operating in Puerto Rico pursuant to Section 936 of the
Code. See " - Mortgage Banking Activities - Puerto Rico Secondary Mortgage
Market and Favorable Tax Treatment." At December 31, 1996, $41.0 million of the
936 Notes were secured by marketable securities, while $45.5 million were
secured by standby letters of credit issued by the FHLB of New York (which are,
in turn, secured by first mortgage loans, securities and cash deposits). The 936
Notes contain certain provisions which indemnify the holders thereof from the
federal tax liability which would be incurred, plus any penalties and interest,
if the Bank did not invest the proceeds as required in eligible activities, and
also provide for a "gross up" provision which permits the Bank to continue the
obligation at an adjusted interest rate based on LIBOR in the event the interest
on the 936 Notes is subject in whole or in part to federal and/or Puerto Rico
income tax. At December 31, 1996, the Bank had $86.5 million of 936 Notes
outstanding, $23.6 million of which matures in 1999, $25.0 million of which
matures in 2000, $35.5 million of which matures in 2001 and $2.4 million of
which matures in 2003.
The Bank obtains both fixed-rate and variable-rate short-term and
long-term advances from the FHLB of New York upon the security of certain of its
residential first mortgage loans, securities and cash deposits, provided certain
standards related to the credit-worthiness of the Bank have been met. FHLB of
New York advances are available for general business purposes to expand lending
and investing activities. Advances from the FHLB of New York are made pursuant
to several different credit programs, each of which has its own interest rate
and range of maturities. At December 31, 1996, the Bank had access to $50.0
million in advances from the FHLB of New York, and had three FHLB of New York
advances aggregating $15.0 million outstanding as of such date, which mature in
1997 and have a weighted average interest rate of 5.75%. In addition, at
December 31, 1996, the Bank maintained $54.3 million in standby letters of
credit with the FHLB of New York, which secured $45.5 million of outstanding 936
Notes payable and $7.0 million of 936 certificates of deposit. At December 31,
1996, the Bank had pledged specific collateral aggregating $100.8 million to the
FHLB of New York under its advances program and to
45
<PAGE>
secure the letters of credit. The Bank maintains collateral with the FHLB of New
York in excess of applicable requirements in order to facilitate any necessary
additional borrowings by the Bank in the future.
In June 1991, the Bank issued $3.3 million of subordinated capital notes
bearing interest at 8% payable on a quarterly basis. The subordinated notes are
guaranteed by R&G Mortgage and by the Chairman of the Board and Chief Executive
Officer of R&G Financial, and are secured by an irrevocable standby letter of
credit issued by an unrelated commercial bank. Pursuant to the terms of the
subordinated notes, the Bank is required to deposit with an established sinking
fund in seven equal annual installments (the first of which began in September
1992 and the last of which is scheduled for June 1998, when the notes mature)
cash or other permitted investments in an amount sufficient to retire
one-seventh ($464,000) of the aggregate principal amount of the subordinated
notes. The standby letter of credit is reduced in equal proportion to the
deposits to such sinking fund.
In December 1995, the Bank sold single-family residential mortgage loans
with an aggregate outstanding balance of approximately $55 million to two
commercial banks. In connection with the foregoing, R&G Mortgage assumed certain
recourse provisions and guaranteed a specific yield to the purchasers of the
loans. In addition, the purchasers of the loans have the right, at their option,
to require R&G Mortgage to purchase the mortgage loans at any time after
December 2000. Management has estimated its liability, if any, under the
foregoing recourse provisions to be immaterial as of December 31, 1996. In R&G
Financial's Consolidated Financial Statements, R&G Financial has recognized the
foregoing transaction as a transfer of loans with recourse. Accordingly, the
proceeds from such transaction (amounting to $50.5 million at December 31, 1996)
have been reported as a secured borrowing in R&G Financial's Consolidated
Financial Statements. Similarly, the aggregate outstanding principal balance of
the related loans (amounting to $49.7 million as of December 31, 1996) have been
reported as an asset in R&G Financial's Consolidated Financial Statements.
46
<PAGE>
The following table sets forth certain information regarding the
short-term borrowings of R&G Financial at or for the dates indicated.
At or For the Year Ended
December 31,
-------------------------------
1996 1995 1994
-------- -------- --------
(Dollars in Thousands)
R&G Mortgage:
Securities sold under agreements to repurchase:
Average balance outstanding ................. $ 94,128 $ 99,145 $ 84,405
Maximum amount outstanding at any month-end
during the period ......................... 108,240 112,507 119,926
Balance outstanding at end of period ........ 97,444 87,958 97,355
Average interest rate during the period ..... 5.58% 5.87% 5.92%
Average interest rate at end of period ...... 5.67% 5.47% 6.06%
Notes Payable:
Average balance outstanding ................. $ 40,279 $ 24,521 $ 61,352
Maximum amount outstanding at any month-end
during the period ......................... 85,135 31,626 134,271
Balance outstanding at end of period ........ 40,342 30,130 22,215
Average interest rate during the period ..... 6.61% 6.92% 6.47%
Average interest rate at end of period ...... 6.48% 6.77% 6.61%
The Bank:
FHLB of New York advances:
Average balance outstanding ................. $ 6,366 $ 11,796 $ 12,060
Maximum amount outstanding at any month-end
during the period ......................... 15,000 13,562 14,592
Balance outstanding at end of period ........ 15,000 6,007 13,568
Average interest rate during the period ..... 5.84% 6.00% 6.06%
Average interest rate at end of period ...... 5.75% 6.74% 5.84%
Securities sold under agreements to repurchase:
Average balance outstanding ................. $ 6,954 $ 7,737 $ 9,724
Maximum amount outstanding at any month-end
during the period ......................... 19,000 14,673 22,272
Balance outstanding at end of period ........ -- 10,525 11,566
Average interest rate during the period ..... 4.74% 5.16% 3.98%
Average interest rate at end of period ...... --% 5.11% 4.91%
Notes Payable:
Average balance outstanding ................. $ 85,365 $ 30,597 $ 4,020
Maximum amount outstanding at any month-end
during the period ......................... 111,500 51,000 23,600
Balance outstanding at end of period ........ 86,500 51,000 23,600
Average interest rate during the period ..... 5.55% 6.42% 6.47%
Average interest rate at end of period ...... 5.82% 5.93% 6.74%
Trust and Investment Services
R&G Financial also provides trust and investment services through the
Bank's Trust Department. Services offered include custodial services, the
administration of IRA accounts and the sale to investors of mortgage-backed
securities guaranteed by GNMA. As of December 31, 1996, the Bank's Trust
Department administered approximately 5,491 trust accounts, with aggregate
assets of $19.2 million as of such date. In addition, during the year ended
December 31, 1996, the Bank's Trust Department sold $24.0 million of GNMA
mortgage-backed securities. The Bank receives fees dependent upon the level and
type of service provided. The administration of the Bank's Trust Department is
performed by the Trust Committee of the Board of Directors of the Bank.
47
<PAGE>
Personnel
As of December 31, 1996, R&G Financial (on a consolidated basis) had 681
full-time employees and 55 part-time employees. The employees are not
represented by a collective bargaining agreement and R&G Financial believes that
it has good relations with its employees.
Regulation
Set forth below is a brief description of certain laws and regulations
which, together with the descriptions of laws and regulations contained
elsewhere herein, are deemed material to an investor's understanding of the
extent to which R&G Financial, R&G Mortgage and the Bank are regulated. The
description of these laws and regulations, as well as descriptions of laws and
regulations contained elsewhere herein, does not purport to be complete and is
qualified in its entirety by reference to applicable laws and regulations.
R&G Financial
General. R&G Financial is a registered bank holding company pursuant to
the Bank Holding Company Act of 1956, as amended (the "BHCA"). The Company
became a bank holding company in July 1996 through its acquisition of Mr. Victor
Galan's 88.1% interest in the Bank (which excludes his required qualifying
shares as a director of the Bank) in exchange for R&G Financial's Class A Common
Stock. R&G Financial acquired the remaining interest in the Bank in December
1996. R&G Financial, as a bank holding company, is subject to regulation and
supervision by the Federal Reserve Board and the OFCI. R&G Financial is required
to file annually a report of its operations with, and is subject to examination
by, the Federal Reserve Board and the OFCI.
BHCA Activities and Other Limitations. The BHCA prohibits a bank holding
company from acquiring direct or indirect ownership or control of more than 5%
of the voting shares of any bank, or increasing such ownership or control of any
bank, without prior approval of the Federal Reserve Board. No approval under the
BHCA is required, however, for a bank holding company already owning or
controlling 50% of the voting shares of a bank to acquire additional shares of
such bank.
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring more than 5% of the voting shares of any company that is not a
bank and from engaging in any business other than banking or managing or
controlling banks. Under the BHCA, the Federal Reserve Board is authorized to
approve the ownership of shares by a bank holding company in any company, the
activities of which the Federal Reserve Board has determined to be so closely
related to banking or to managing or controlling banks as to be a proper
incident thereto. In making such determinations, the Federal Reserve Board is
required to weigh the expected benefit to the public, such as greater
convenience, increased competition or gains in efficiency, against the possible
adverse effects, such as
48
<PAGE>
undue concentration of resources, decreased or unfair competition, conflicts of
interest or unsound banking practices.
The Federal Reserve Board has by regulation determined that certain
activities are closely related to banking within the meaning of the BHCA. These
activities include operating a mortgage company, such a R&G Mortgage, finance
company, credit card company, factoring company, trust company or savings
association; performing certain data processing operations; providing limited
securities brokerage services; acting as an investment or financial advisor;
acting as an insurance agent for certain types of credit-related insurance;
leasing personal property on a full-payout, non-operating basis; providing tax
planning and preparation services; operating a collection agency; and providing
certain courier services. The Federal Reserve Board also has determined that
certain other activities, including real estate brokerage and syndication, land
development, property management and underwriting of life insurance not related
to credit transactions, are not closely related to banking and a proper incident
thereto.
Limitations on Transactions with Affiliates. Transactions between
financial institutions and any affiliate are governed by Sections 23A and 23B of
the Federal Reserve Act. An affiliate of a financial institution is any company
or entity which controls, is controlled by or is under common control with the
financial institution. In a holding company context, the parent holding company
of a financial institution (such as R&G Financial) and any companies which are
controlled by such parent holding company are affiliates of the financial
institution. Generally, Sections 23A and 23B (i) limit the extent to which the
financial institution or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such institution's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the institution or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and other similar transactions. In
addition to the restrictions imposed by Sections 23A and 23B, no financial
institution may (i) loan or otherwise extend credit to an affiliate, except for
any affiliate which engages only in activities which are permissible for bank
holding companies, or (ii) purchase or invest in any stocks, bonds, debentures,
notes or similar obligations of any affiliate, except for affiliates which are
subsidiaries of the financial institution. See "- General - Affiliated
Transactions" for a discussion of the affiliated transactions conducted by R&G
Mortgage and the Bank.
In addition, Sections 22(h) and (g) of the Federal Reserve Act places
restrictions on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a greater than 10% stockholder of a financial institution, and certain
affiliated interests of either, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the financial
institution's loans to one borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus). Section 22(h) also requires that
loans to directors, executive officers and principal
49
<PAGE>
stockholders be made on terms substantially the same as offered in comparable
transactions to other persons and also requires prior board approval for certain
loans. In addition, the aggregate amount of extensions of credit by a financial
institution to all insiders cannot exceed the institution's unimpaired capital
and surplus. Furthermore, Section 22(g) places additional restrictions on loans
to executive officers.
Capital Requirements. The Federal Reserve Board has adopted capital
adequacy guidelines pursuant to which it assesses the adequacy of capital in
examining and supervising a bank holding company and in analyzing applications
to it under the BHCA. The Federal Reserve Board capital adequacy guidelines
generally require bank holding companies to maintain total capital equal to 8%
of total risk-adjusted assets, with at least one-half of that amount consisting
of Tier I or core capital and up to one-half of that amount consisting of Tier
II or supplementary capital. Tier I capital for bank holding companies generally
consists of the sum of common stockholders' equity and perpetual preferred stock
(subject in the case of the latter to limitations on the kind and amount of such
stocks which may be included as Tier I capital), less goodwill and, with certain
exceptions, intangibles. Tier II capital generally consists of hybrid capital
instruments; perpetual preferred stock which is not eligible to be included as
Tier I capital; term subordinated debt and intermediate-term preferred stock;
and, subject to limitations, general allowances for loan losses. Assets are
adjusted under the risk-based guidelines to take into account different risk
characteristics, with the categories ranging from 0% (requiring no additional
capital) for assets such as cash to 100% for the bulk of assets which are
typically held by a bank holding company, including multi-family residential and
commercial real estate loans, commercial business loans and consumer loans.
Single-family residential first mortgage loans which are not past-due (90 days
or more) or non-performing and which have been made in accordance with prudent
underwriting standards are assigned a 50% level in the risk-weighing system, as
are certain privately-issued mortgage-backed securities representing indirect
ownership of such loans. Off-balance sheet items also are adjusted to take into
account certain risk characteristics.
In addition to the risk-based capital requirements, the Federal Reserve
Board requires bank holding companies to maintain a minimum leverage capital
ratio of Tier I capital to total assets of 3.0%. Total assets for this purpose
does not include goodwill and any other intangible assets and investments that
the Federal Reserve Board determines should be deducted from Tier I capital. The
Federal Reserve Board has announced that the 3.0% Tier I leverage capital ratio
requirement is the minimum for the top-rated bank holding companies without any
supervisory, financial or operational weaknesses or deficiencies or those which
are not experiencing or anticipating significant growth. Other bank holding
companies will be expected to maintain Tier I leverage capital ratios of at
least 4.0% to 5.0% or more, depending on their overall condition.
R&G Financial is in compliance with the above-described Federal Reserve
Board regulatory capital requirements.
50
<PAGE>
Financial Support of Affiliated Institutions. Under Federal Reserve Board
policy, R&G Financial will be expected to act as a source of financial strength
to the Bank and to commit resources to support the Bank in circumstances when it
might not do so absent such policy. The legality and precise scope of this
policy is unclear, however, in light of recent judicial precedent. In addition,
any capital loans by a bank holding company to a subsidiary bank is subordinate
in right of payment to deposits and to certain other indebtedness of such
subsidiary bank. In the event of a bank holding company's bankruptcy, any
commitment by the bank holding company to a federal bank regulatory agency to
maintain the capital of a subsidiary bank will be assumed by the bankruptcy
trustee and entitled to a priority of payment.
The Bank
General. The Bank is incorporated under the Puerto Rico Banking Act of
1933, as amended (the "Puerto Rico Banking Law") and is subject to extensive
regulation and examination by the OFCI, the FDIC and certain requirements
established by the Federal Reserve Board. The federal and Puerto Rico laws and
regulations which are applicable to banks regulate, among other things, the
scope of their business, their investments, their reserves against deposits, the
timing of the availability of deposited funds and the nature and amount of and
collateral for certain loans. There are periodic examinations by the OFCI and
the FDIC to test the Bank's compliance with various regulatory requirements.
This regulation and supervision establishes a comprehensive framework of
activities in which an institution can engage and is intended primarily for the
protection of the insurance fund and depositors. The regulatory structure also
gives the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes. Any change in such
regulation, whether by the OFCI, the FDIC or the U.S. Congress or Puerto Rico
legislature could have a material adverse impact on R&G Financial, R&G Mortgage,
the Bank and their operations.
FDIC Insurance Premiums. The Bank currently pays deposit insurance
premiums to the FDIC based on a risk-based assessment system established by the
FDIC for all SAIF-member institutions. Under applicable regulations,
institutions are assigned to one of three capital groups which is based solely
on the level on an institution's capital - "well capitalized," "adequately
capitalized" and "undercapitalized". These three groups are then divided into
three subgroups which reflect varying levels of supervisory concern, from those
which are considered to be healthy to those which are considered to be of
substantial supervisory concern. The matrix so created results in nine
assessment risk classifications, with rates ranging from .23% for well
capitalized, healthy institutions to .31% for undercapitalized institutions with
substantial supervisory concerns. The Bank was classified as a
"well-capitalized" institution as of December 31, 1996.
51
<PAGE>
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of the Bank's deposit insurance.
Recapitalization of SAIF. Both the Savings Association Insurance Fund
("SAIF") and the Bank Insurance Fund ("BIF"), the federal deposit insurance fund
that covers commercial bank deposits, are required by law to attain and
thereafter maintain a reserve ratio of 1.25% of insured deposits. Certain of the
Bank's deposits were required to continue to be insured by the SAIF following
its 1994 conversion from a federally chartered savings bank to a Puerto Rico
chartered commercial bank. The approximately $77.2 million of deposits acquired
by the Bank from a Puerto Rico commercial bank are BIF insured and subject to
deposit insurance assessments at BIF rates. The Bank had previously paid SAIF
assessment rates and, as a result, its deposit insurance assessment from the
FDIC was adjusted beginning with the quarter ended September 30, 1996, and will
continue to be adjusted until the correction has been made in the overpayment of
deposit insurance premiums. In addition to the quarterly adjustments, the Bank
received a set-off from insurance premiums for the September 1996 quarter of
approximately $206,440 (plus interest).
The BIF previously achieved a fully funded status and, therefore, in late
1995, the FDIC approved a final rule regarding deposit insurance premiums which,
effective with respect to the semiannual premium assessment beginning January 1,
1996, reduced deposit insurance premiums for BIF member institutions to zero
basis points (subject to an annual minimum of $2,000) for institutions in the
lowest risk category. Deposit insurance premiums for SAIF members were
maintained at their existing levels (23 basis points for institutions in the
lowest risk category).
On September 30, 1996, President Clinton signed into law legislation
which will eliminate the premium differential between SAIF-insured institutions
and BIF-insured institutions by recapitalizing the SAIF's reserves to the
required ratio. The legislation provides that all SAIF member institutions pay a
one-time special assessment to recapitalize the SAIF, which in the aggregate
will be sufficient to bring the reserve ratio in the SAIF to 1.25% of insured
deposits. The legislation also provides for the merger of the BIF and the SAIF,
with such merger being conditioned upon the prior elimination of the thrift
charter.
Effective October 8, 1996, FDIC regulations imposed a one-time special
assessment of 65.7 basis points on SAIF-assessable deposits as of March 31,
1995, which was collected on November 27, 1996. The Bank's one-time special
assessment amounted to $1.6 million
52
<PAGE>
net of related tax benefits. The payment of such special assessment had the
effect of immediately reducing the Bank's capital by such an amount.
In the fourth quarter of 1996, the FDIC lowered the assessment rates for
SAIF members to reduce the disparity in the assessment rates paid by BIF and
SAIF members. Beginning October 1, 1996, effective SAIF rates generally range
from zero basis points to 27 basis points, except that during the fourth quarter
of 1996, the rates for SAIF members ranged from 18 basis points to 27 basis
points in order to include assessments paid to the Financing Corporation
("FICO"). From 1997 through 1999, SAIF members will pay 6.4 basis points to
FICO, while BIF member institutions will pay approximately 1.3 basis points. The
Bank's insurance premiums, which had amounted to 23 basis points were thus
reduced to 6.4 basis points, effective January 1, 1997. Based upon the $657.2
million of assessable deposits at December 31, 1996, the Bank expects to pay
$241,000 less in insurance premiums per quarter during 1997.
Capital Requirements. The FDIC has promulgated regulations and adopted a
statement of policy regarding the capital adequacy of state-chartered banks
which, like the Bank, will not be members of the Federal Reserve System. These
requirements are substantially similar to those adopted by the Federal Reserve
Board regarding bank holding companies, as described above.
The FDIC's capital regulations establish a minimum 3.0% Tier I leverage
capital requirement for the most highly-rated state-chartered, non-member banks,
with an additional cushion of at least 100 to 200 basis points for all other
state-chartered, non-member banks, which effectively will increase the minimum
Tier I leverage ratio for such other banks to 4.0% to 5.0% or more. Under the
FDIC's regulation, the highest-rated banks are those that the FDIC determines
are not anticipating or experiencing significant growth and have well
diversified risk, including no undue interest rate risk exposure, excellent
asset quality, high liquidity, good earnings and, in general, which are
considered a strong banking organization and are rated composite 1 under the
Uniform Financial Institutions Rating System. Leverage or core capital is
defined as the sum of common stockholders' equity (including retained earnings),
noncumulative perpetual preferred stock and related surplus, and minority
interests in consolidated subsidiaries, minus all intangible assets other than
certain qualifying supervisory goodwill and certain purchased mortgage servicing
rights.
The FDIC also requires that banks meet a risk-based capital standard. The
risk-based capital standard for banks requires the maintenance of total capital
(which is defined as Tier I capital and supplementary (Tier 2) capital) to risk
weighted assets of 8%. In determining the amount of risk-weighted assets, all
assets, plus certain off balance sheet assets, are multiplied by a risk-weight
of 0% to 100%, based on the risks the FDIC believes are inherent in the type of
asset or item. The components of Tier I capital are equivalent to those
discussed above under the 3% leverage capital standard. The components of
supplementary capital include certain perpetual preferred stock, certain
mandatory convertible securities, certain subordinated debt and intermediate
preferred stock and
53
<PAGE>
general allowances for loan and lease losses. Allowance for loan and lease
losses includable in supplementary capital is limited to a maximum of 1.25% of
risk-weighted assets. Overall, the amount of capital counted toward
supplementary capital cannot exceed 100% of core capital. At December 31, 1996,
the Bank met each of its capital requirements.
In August 1995, the FDIC and other federal banking agencies published a
final rule modifying their existing risk-based capital standards to provide for
consideration of interest rate risk when assessing capital adequacy of a bank.
Under the final rule, the FDIC must explicitly include a bank's exposure to
declines in the economic value of its capital due to changes in interest rates
as a factor in evaluating a bank's capital adequacy. In addition, in August
1995, the FDIC and the other federal banking agencies published a joint policy
statement for public comment that describes the process the banking agencies
will use to measure and assess the exposure of a bank's net economic value to
changes in interest rates. In June 1996, the FDIC and other federal banking
agencies adopted a joint policy statement on interest rate risk policy. Because
market conditions, bank structure, and bank activities vary, the agencies
concluded that each bank needs to develop its own interest rate risk management
program tailored to its needs and circumstances. The policy statement describes
prudent principles and practices that are fundamental to sound interest rate
risk management, including appropriate board and senior management oversight and
a comprehensive risk management process that effectively identifies, measures,
monitors and controls risks.
Activities and Investments. The activities and equity investments of
FDIC-insured, state-chartered banks (which under the Federal Deposit Insurance
Act includes banking institutions incorporated under the laws of Puerto Rico)
are generally limited to those that are permissible for national banks. Under
regulations dealing with equity investments, an insured state bank generally may
not directly or indirectly acquire or retain any equity investment of a type, or
in an amount, that is not permissible for a national bank. An insured state bank
is not prohibited from, among other things, (i) acquiring or retaining a
majority interest in a subsidiary, (ii) investing as a limited partner in a
partnership the sole purpose of which is direct or indirect investment in the
acquisition, rehabilitation or new construction of a qualified housing project,
provided that such limited partnership investments may not exceed 2% of the
bank's total assets, (iii) acquiring up to 10% of the voting stock of a company
that solely provides or reinsures directors', trustees' and officers' liability
insurance coverage or bankers' blanket bond group insurance coverage for insured
depository institutions, and (iv) acquiring or retaining the voting shares of a
depository institution if certain requirements are met. In addition, an insured
state-chartered bank may not, directly, or indirectly through a subsidiary,
engage as "principal" in any activity that is not permissible for a national
bank unless the FDIC has determined that such activities would pose no risk to
the insurance fund of which it is a member and the bank is in compliance with
applicable regulatory capital requirements. Any insured state-chartered bank
directly or indirectly engaged in any activity that is not permitted for a
national bank must cease the impermissible activity.
54
<PAGE>
Puerto Rico Banking Law. As a commercial bank organized under the laws of
the Commonwealth, the Bank is subject to supervision, examination and regulation
by the OFCI pursuant to the Puerto Rico Banking Law.
The Puerto Rico Banking Law requires that at least ten percent (10%) of
the yearly net income of the Bank be credited annually to a reserve fund. This
apportionment shall be done every year until the reserve fund shall be equal to
ten percent (10%) of the total deposits or the total paid-in capital, whichever
is greater. As of December 31, 1996, the Bank had credited $1.5 million to such
reserve fund, which was first established in late 1994 in connection with the
Bank's conversion from a federally chartered savings bank to a Puerto Rico
commercial bank.
The Puerto Rico Banking Law also provides that when the expenditures of a
bank are greater than the receipts, the excess of the former over the latter
shall be charged against the undistributed profits of the bank, and the balance,
if any, shall be charged against the reserve fund, as a reduction thereof. If
there is no reserve fund sufficient to cover such balance in whole or in part,
the outstanding amount shall be charged against the capital account and no
dividend shall be declared until said capital has been restored to its original
amount and the reserve fund to 20% of the original capital. In addition, every
bank is required by the Puerto Rico Banking Law to maintain a legal reserve
which shall not be less than 20% of its demand liabilities, except government
deposits (federal, state and municipal) which are secured by actual collateral.
The reserve is required to be made up of any of the following instruments or any
combination of them: (i) legal tender of the United States; (ii) checks on banks
or trust companies located in any part of Puerto Rico, to be presented for
collection during the day following that on which they are received, and (iii)
money deposited in other banks provided said deposits are authorized by the
Commissioner, subject to immediate collection.
Under the Puerto Rico Banking Law, the Bank is permitted to make loans to
any one person, firm, partnership or corporation, up to an aggregate amount of
fifteen percent (15%) of the paid-in capital and reserve fund of the Bank. As of
December 31, 1996, the legal lending limit for the Bank under this provision was
approximately $6.5 million and its maximum extension of credit to any one
borrower, including affiliates thereof, was $1.9 million. If such loans are
secured by collateral worth at least twenty-five percent (25%) more than the
amount of the loan, the aggregate maximum amount may reach one-third of the
paid-in capital of the Bank, plus its reserve fund. There are no restrictions on
the amount of loans that are wholly secured by bonds, securities and other
evidences of indebtedness of the United States or the Commonwealth, or by
current debt bonds, not in default, of municipalities or instrumentalities of
the Commonwealth. The Puerto Rico Banking Law also authorizes the Bank to
conduct certain financial and related activities directly or through
subsidiaries. The Puerto Rico Banking Law also prohibits Puerto Rico banks from
making loans secured by their own stock, and from purchasing their own stock,
unless such purchase is necessary to prevent losses because of a debt previously
contracted
55
<PAGE>
in good faith. The stock so purchased by the bank must be sold in a private or
public sale within one year from the date of purchase.
The rate of interest that the Bank may charge on mortgage and other types
of loans to individuals in Puerto Rico is subject to Puerto Rico's usury laws.
Such laws are administered by the Financing Board, which consists of the
Commissioner of Financial Institutions, the President of the Government
Development Bank, the Chairman of the Planning Board and the Puerto Rico
Secretaries of Commerce, Treasury and Consumer Affairs and three representatives
from the private sector. The Financing Board promulgates regulations which
specify maximum rates on various types of loans to individuals. The Financing
Board has adopted a regulation, Regulation 26-A, which fixes the maximum rate
(which is adjusted on a weekly basis) which may be charged on residential first
mortgage loans. Effective April 1996, the Financing Board eliminated the
regulations that set forth the maximum interest rates that could be charged on
non-federal government guaranteed loans. Interest rates on consumer loans and
commercial loans are not subject to any limitations by Regulation 26-A.
Regulatory Enforcement Authority. Applicable banking laws include
substantial enforcement powers available to federal banking regulators. This
enforcement authority includes, among other things, the ability to assess civil
money penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution-affiliated
parties, as defined. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with regulatory authorities.
R&G Mortgage
The mortgage banking business conducted by R&G Mortgage is subject to the
rules and regulations of FHA, VA, FNMA, FHLMC and GNMA with respect to
originating, processing, selling and servicing mortgage loans and the issuance
and sale of mortgage-backed securities. Those rules and regulations, among other
things, prohibit discrimination and establish underwriting guidelines which
include provisions for inspections and appraisals, require credit reports on
prospective borrowers and fix maximum loan amounts and, with respect to VA
loans, fix maximum interest rates. Moreover, lenders are required annually to
submit to FNMA, FHA, FHLMC, GNMA and VA audited financial statements, and each
regulatory entity has its own financial requirements. R&G Mortgage's affairs are
also subject to supervision and examination by FNMA, FHA, FHLMC, GNMA, HUD and
VA at all times to assure compliance with the applicable regulations, policies
and procedures. Mortgage origination activities are subject to, among others,
the Equal Credit Opportunity Act, Federal Truth-in-Lending Act and the Real
Estate Settlement Procedures Act and the regulations promulgated thereunder.
56
<PAGE>
R&G Mortgage's mortgage loan production activities are subject to the
Federal Truth-in-Lending Act and Regulation Z promulgated thereunder. The
Truth-in-Lending Act contains disclosure requirements designed to provide
consumers with uniform, understandable information with respect to the terms and
conditions of loans and credit transactions in order to give them the ability to
compare credit terms. The Truth-in-Lending Act provides consumers a three day
right to cancel certain credit transactions, including any refinance mortgage or
junior mortgage loan on a consumer's primary residence.
R&G Mortgage is required to comply with the Equal Credit Opportunity Act
of 1974, as amended ("ECOA"), and Regulation B promulgated thereunder, which
prohibit creditors from discriminating against applicants on the basis of race,
color, sex, age or marital status, and restrict creditors from obtaining certain
types of information from loan applicants. It also requires certain disclosures
by lenders regarding consumer rights and requires lenders to advise applicants
of the reasons for any credit denial. In instances where the applicant is denied
credit or the rate or charge for loan increases as a result of information
obtained from a consumer credit agency, another statute, The Fair Credit
Reporting Act of 1970, as amended, requires the lenders to supply the applicant
with the name and address of the reporting agency.
The Federal Real Estate Settlement Procedures Act ("RESPA") imposes,
among other things, limits on the amount of funds a borrower can be required to
deposit with R&G Mortgage in any escrow account for the payment of taxes,
insurance premiums or other charges.
R&G Mortgage is also subject to regulation by the OFCI, with respect to,
among other things, licensing requirements and the record-keeping, examination
and reporting requirements of the Puerto Rico Mortgage Banking Institutions Law
(the "Mortgage Banking Law"). R&G Mortgage is licensed by the OFCI as a mortgage
banking institution in Puerto Rico. Such authorization to act as a mortgage
banking institution must be renewed as of January 1 of each year. In the past,
R&G Mortgage has not had any difficulty in renewing its authorization to act as
a mortgage banking institution, and management is unaware of any existing
practices, conditions or violations which would result in R&G Mortgage being
unable to receive such authorization in the future.
The Mortgage Banking Law requires the prior approval of the OFCI for the
acquisition of control of any mortgage banking institution licensed under the
Mortgage Banking Law. For purposes of the Mortgage Banking Law, the term
"control" means the power to direct or influence decisively, directly or
indirectly, the management or policies of a mortgage banking institution. The
Mortgage Banking Law provides that a transaction that results in the holding of
less than 10% of the outstanding voting securities of a mortgage banking
institution shall not be considered a change of control. Pursuant to the
Mortgage Banking Law, upon receipt of notice of a proposed transaction that may
result in change of control, the OFCI is obligated to make such inquires as it
deems necessary to review the transaction. Under the Mortgage Banking Law, the
determination of the OFCI whether or not to authorize a proposed change of
control is final and non-appealable.
57
<PAGE>
As is the case with the Bank, the rate of interest that R&G Mortgage may
charge on mortgage loans to individuals is subject to Puerto Rico's usury laws.
Such laws are administered by the Financing Board which promulgates regulations
that specify maximum rates on various types of loans to individuals. Regulation
26-A promulgated by the Financing Board fixes the maximum rate (which is
adjusted on a weekly basis) which may be charged on residential first mortgage
loans. Effective April 1996, the Financing Board eliminated the regulations that
set forth the maximum interest rates that could be charged on non-federal
government guaranteed loans.
Item 2. Properties.
The Company's principal executive office is located at 280 Jesus T.
Pinero Avenue, Hato Ray, San Juan, Puerto Rico 00918. The following table sets
forth the net book value (including leasehold improvements and equipment) and
certain other information with respect to the offices and other properties of
R&G Financial at December 31, 1996, all of which properties are leased.
<TABLE>
<CAPTION>
Net Book Value
Description/Address Lease Term Expiration of Property
- ---------------------------------------- -------------------------- ---------------
(In Thousands)
<S> <C> <C>
The Bank:
Hato Rey Branch(1)(2)(3) November 30, 1998 $ 951
280 Jesus T. Pinero Avenue Two (2) five year options
Hato Rey, PR 00919
Los Jardines Branch September 4, 1999 149
Los Jardines de Guaynabo Shopping Center One (1) ten year option
PR Road No. 20
Guaynabo, PR 00969
San Patricio Branch July 31, 2007 147
San Patricio Plaza
Ortegon Street
Guaynabo, PR 00969
Bayamon Branch(2)(3) May 31, 2001 280
42-43 Betances Avenue One (1) ten year option
Urb. Hermanas Davila
Bayamon, PR 00959
Bayamon East(4) January 10, 2001 365
Road #174, Lote 100
Urb. Ind. Minillas
Bayamon, PR 00959
Arecibo Branch(3) December 31, 2001 123
Marginal Vista Azul Two (2) five year options
Corner San Daniel Avenue
Arecibo, PR 00612
</TABLE>
58
<PAGE>
<TABLE>
<CAPTION>
Net Book Value
Description/Address Lease Term Expiration of Property
- ---------------------------------------- -------------------------- ---------------
(In Thousands)
<S> <C> <C>
Manati Branch(3) August 8, 2009 537
Plaza Puerta del Sol Four (4) five year options
PR Road No. 2, Km. 49.7
Manati, PR 00674
Carolina Branch(3) July 31, 2003 280
65th Infantry Avenue
Corner San Marcos Street
Carolina, PR 00985
Trujillo Alto Branch(5) October 31, 2004 142
Trujillo Alto Shopping Center
Trujillo Alto, PR 00976
Santurce Branch April 30, 1999 69
1077 Ponce de Leon Avenue Three (3) six year options
Santurce, PR 00917
Laguna Gardens Branch(5) April 30, 1999 171
Laguna Gardens Shopping Center One (1) five year option
Isla Verde
Carolina, PR 00979
Plaza Carolina Branch(5) May 31, 2000 216
Plaza Carolina Mall
Carolina, PR 00985
Norte Shopping Branch(5) April 30, 2000 73
Norte Shopping Center Two (2) five year options
Baldorioty de Castro Avenue
San Juan, PR 00907
Vega Baja Branch(5) May 31, 2003 240
Cabo Caribe Development One (1) five year option
PR Road No. 2, Marginal
Vega Baja, PR 00693
Mayaguez Branch(3) April 30, 1997 659
McKinley Street Four (4) five year options
Corner Dr. Vady
Mayaguez, PR 00680
Operations Center(2) January 10, 2001 1,367
-----
Road #174, Lote #100
Urb. Ind. Minillas
Bayamon, PR 00959 5,769
-----
</TABLE>
59
<PAGE>
<TABLE>
<CAPTION>
Net Book Value
Description/Address Lease Term Expiration of Property
- ---------------------------------------- -------------------------- ---------------
(In Thousands)
<S> <C> <C>
R&G Mortgage:
Caguas Office July 31, 2000 8
D-9 Degetau Street One (1) five year option
Urb. San Alfonso
Caguas, PR 00725
Ponce Office May 1, 1998 11
25 Las Americas Avenue
Ext. Buena Vista
Ponce, PR 00731
Fajardo Office May 16, 1999 9
51 Celis Aguilera Street One (1) five year option
Fajardo, PR 00738
Los Jardines Office(6) August 1, 2006 28
Los Jardines de Guaynabo Shopping Center One (1) five year option
PR Road No. 20
Guaynabo, PR 00969
San Patricio Office(6) May 1, 1998 16
K-4 Ebano Street One (1) five year option
Ponderosa Building
San Patricio
Guaynabo, PR 00969
Hato Rey Office(2)(3) Month to month basis 1,792
280 Jesus T. Pinero Avenue
Hato Rey, PR 00919
Bayamon Office(2)(3) May 30, 2001 41
42-43 Betances Avenue One (1) ten year option
Urb. Hermanas Davila
Bayamon, PR 00959
Arecibo Office(3) January 1, 2002 19
Marginal Vista Azul Two (2) five year options
Corner San Daniel Avenue
Arecibo, PR 00612
Manati Office(3)(7) October 30, 1998 21
Plaza Puerta del Sol One (1) five year option
PR Road No. 2, Km. 49.7
Manati, PR 00674
</TABLE>
60
<PAGE>
<TABLE>
<CAPTION>
Net Book Value
Description/Address Lease Term Expiration of Property
- ---------------------------------------- -------------------------- ---------------
(In Thousands)
<S> <C> <C>
Carolina Office(3)(7) October 30, 1998 18
65th Infantry Avenue One (1) five year option
Corner San Marcos Street
Carolina, PR 00985
Mayaguez Office(3)(7) October 30, 1998 36
-----
McKinley Street One (1) five year option
Corner Dr. Vady
Mayaguez, PR 00680
1,999
$7,768
</TABLE>
- ----------
(1) Also serves as the main office of R&G Financial.
(2) Leased from VIG Leasing, S.E., which is owned by the family of Victor J.
Galan, Chairman of the Board and Chief Executive Officer of R&G
Financial.
(3) The Bank and R&G Mortgage each maintain separate offices in the same
building.
(4) Application was approved by regulatory authorities in June 1996. The Bank
is operating in a temporary trailer facility at the site beginning July
1, 1996 until improvements to the branch office are completed in March
1997.
(5) Facility includes an R&G Mortgage Banking Center.
(6) The Bank maintains an office at this location in a separate facility.
(7) Office is subleased from the Bank.
Item 3. Legal Proceedings.
The Company is not involved in any pending legal proceedings other than
nonmaterial legal proceedings occurring in the ordinary course of business.
Item 4. Submission of Matters to a Vote of Security-Holders.
Not applicable.
61
<PAGE>
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Shares for the Company's Class B common stock are traded nationally under
the symbol "RGFC" on the NASDAQ National Market. The following table shows
market price information for the Company's Class B common stock. The prices set
forth below represent the high and low prices during the quarterly periods
indicated:
Price Per Share
----------------------- Dividends
High Low Paid
------------ --------- --------------
September 30, 1996(1) $18.75 $16.50 --
December 31, 1996 $25.75 $17.75 $0.0625
- ----------
(1) The Company's Class B common stock commenced trading on August 27, 1996.
There have been no stock dividends, stock splits or reverse stock splits.
At December 31, 1996 the Company had approximately 77 stockholders of
record, which does not take into consideration investors who hold their stock
through brokerage and other firms.
Item 6. Selected Financial Data.
The information required herein is incorporated by reference from page 17
of the Registrant's 1996 Annual Report.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The information required herein is incorporated by reference from pages
20 to 44 of the Registrant's 1996 Annual Report.
Item 8. Financial Statements and Supplementary Data.
The information required herein is incorporated by reference from pages
45 to 86 of the Registrant's 1996 Annual Report.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
Not applicable.
62
<PAGE>
PART III.
Item 10. Directors and Executive Officers of the Registrant.
The information required herein is incorporated by reference from pages
2-6 of the Registrant's Proxy Statement dated March 25, 1997 ("Proxy
Statement").
Item 11. Executive Compensation.
The information required herein is incorporated by reference from pages
12 to 16 of the Registrant's Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required herein is incorporated by reference from pages 8
to 11 of the Registrant's Proxy Statement.
Item 13. Certain Relationships and Related Transactions.
The information required herein is incorporated by reference from pages
17 to 19 of the Registrant's Proxy Statement.
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Documents Filed as Part of this Report
(1) The following financial statements are incorporated by reference from
Item 8 hereof (see Exhibit 13):
Independent Auditors' Report.
Consolidated Statements of Financial Condition as of December 31,
1996 and 1995.
Consolidated Statements of Income for the Years Ended December 31,
1996, 1995 and 1994.
Consolidated Statements of Cash Flows for the Years Ended December
31, 1996, 1995 and 1994.
Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended December 31, 1996, 1995 and 1994.
Notes to Consolidated Financial Statements.
63
<PAGE>
(2) All schedules for which provision is made in the applicable
accounting regulation of the SEC are omitted because of the absence of
conditions under which they are required or because the required information is
included in the consolidated financial statements and related notes thereto.
(3) The following exhibits are filed as part of this Form 10-K, and this
list includes the Exhibit Index.
No. Description
- ------ --------------------------------------------------------------------
2.0 Amended and Restated Agreement and Plan of Merger by and between
R&G Financial Corporation, the Bank and R-G Interim Premier Bank,
dated as of September 27, 1996.(1)
3.1 Certificate of Incorporation of R&G Financial Corporation.(2)
3.2 Certificate of Amendment to Certificate of Incorporation of R&G
Financial Corporation.(2)
3.3 Bylaws of R&G Financial Corporation.(2)
4.0 Specimen of Stock Certificate of R&G Financial Corporation.(2)
10.1 Master Purchase, Servicing and Collection Agreement between R&G
Mortgage and the Bank dated February 16, 1990, as amended on
April 1, 1991, December 1, 1991, February 1, 1994 and July 1,
1994.(2)
10.2 Master Custodian Agreement between R&G Mortgage and the Bank
dated February 16, 1990, as amended on June 27, 1996.(2)
10.3 Master Production Agreement between R&G Mortgage and the Bank
dated February 16, 1990, as amended on August 30, 1991 and March 31,
1995.(2)
10.4 Data Processing Computer Service Agreement between R&G Mortgage
and R-G Premier Bank dated December 1, 1994.(2)
10.5 Securitization Agreement by and between R&G Mortgage and the Bank,
dated as of July 1, 1995.(2)
10.6 R&G Financial Corporation Stock Option Plan.(2)(*)
13.0 1996 Annual Report to Stockholders.
21.0 Subsidiaries of the Registrant - Reference is made to "Item 1.
Business" for the required information.
27.0 Financial Data Schedule.
99.1 Valuation Report on Minority Interest of Bank Stockholders, prepared by
Friedman, Billings, Ramsey & Co., Inc., dated June 13, 1996.(2)
99.2 Update to Valuation on Minority Interest of Bank Stockholders, prepared
by Friedman, Billings, Ramsey & Co., Inc., dated September 27,
1996.(1)
- ----------
(1) Incorporated by reference from the Registration Statement on Form S-4
(Registration No. 333-13199) filed by the Registrant with the Securities
and Exchange Commission ("SEC") on October 1, 1996.
(2) Incorporated by reference from the Registration Statement on Form S-1
(Registration No. 333-06245) filed by the Registrant with the SEC on June
18, 1996, as amended.
(*) Management contract or compensatory plan or arrangement.
(3)(b) Reports on Form 8-K.
None.
64
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
R&G FINANCIAL CORPORATION
By: /s/ Victor J. Galan
-------------------------------------
Victor J. Galan
Chairman of the Board, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Victor J. Galan March 13, 1997
- ----------------------------------
Victor J. Galan
Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
/s/ Ana M. Armendariz March 13, 1997
- ----------------------------------
Ana M. Armendariz
Director, Controller and Treasurer
(principal financial and
accounting officer)
/s/ Ramon Prats March 13, 1997
- ----------------------------------
Ramon Prats
Executive Vice President and Director
<PAGE>
/s/ Enrique Umpierre-Suarez March 13, 1997
- ----------------------------------
Enrique Umpierre-Suarez
Director and Secretary
/s/ Victor L. Galan Fundora March 13, 1997
- ----------------------------------
Victor L. Galan Fundora
Director
/s/ Juan J. Diaz March 13, 1997
- ----------------------------------
Juan J. Diaz
Director
/s/ Pedro Ramirez March 13, 1997
- ----------------------------------
Pedro Ramirez
Director
/s/ Laureno Carus Abarca March 13, 1997
- ----------------------------------
Laureno Carus Abarca
Director
/s/ Eduardo McCormack March 13, 1997
- ----------------------------------
Eduardo McCormack
Director
/s/ Gilberto Rivera-Arrega March 13, 1997
- ----------------------------------
Gilberto Rivera-Arreaga
Director
/s/ Benigno R. Fernandez March 13, 1997
- ----------------------------------
Benigno R. Fernandez
Director
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
OF R&G FINANCIAL
The following table presents selected consolidated financial and other
data of R&G Financial for each of the five years in the period ended December
31, 1996. The selected consolidated financial data should be read in conjunction
with the Consolidated Financial Statements of R&G Financial, including the
accompanying Notes, presented elsewhere herein. In the opinion of management,
this information reflects all adjustments, consisting only of normal recurring
accruals and adjustments, necessary for a fair presentation.
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
---------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ---------- ----------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Selected Balance Sheet Data:
Total assets(1) $ 1,037,798 $ 853,206 $ 622,499 $ 538,069 $ 294,115
Loans receivable, net 603,751 473,841 301,614 216,620 117,428
Mortgage loans held for sale 54,450 21,318 22,021 174,221 106,401
Mortgage-backed and investment securities
held for trading 109,497 113,809 124,522 -- --
Mortgage-backed securities available for sale 50,841 61,008 13,300 10,241 4,763
Mortgage-backed securities held to maturity 37,900 41,731 84,122 39,122 15,557
Investment securities available for sale 30,973 3,280 1,878 -- --
Investment securities held to maturity 5,270 2,046 2,182 4,957 2,267
Cash and cash equivalents(2) 98,856 104,195 45,622 66,958 25,677
Deposits 615,567 518,187 380,148 312,151 169,998
Securities sold under agreements to
repurchase 97,444 98,483 108,922 -- --
Notes payable 126,842 81,130 45,815 133,913 76,372
Other borrowings(3) 50,463 67,315 18,092 14,479 212
Subordinated notes(4) 3,250 3,250 3,250 3,071 3,010
Stockholder's equity 115,633 66,385 55,970 49,531 32,344
Stockholder's equity per share $ 14.72 $ 12.79 $ 10.79 $ 9.55 $ 6.23
Selected Income Statement Data:
Revenues:
Net interest income after provision
for loan losses $ 24,665 $ 20,323 $ 19,137 $ 14,253 $ 8,782
Loan administration and servicing fees 13,029 11,030 11,046 9,326 9,242
Net gain on sale of investments available for
sale 642 -- -- 394 --
Net gain on sale of loans and servicing rights 11,805 6,262 1,566 29,026 9,229
Unrealized gains (losses) on trading
securities (96) 2,122 (4,465) -- --
Other(5) 3,872 4,028 1,667 1,179 1,040
----------- ---------- ----------- ---------- ----------
Total revenue 53,917 43,765 28,951 54,178 28,293
----------- ---------- ----------- ---------- ----------
Expenses:
Employee compensation and benefits 12,380 8,284 5,252 8,590 3,971
Office occupancy and equipment 5,531 4,711 4,488 3,395 1,425
SAIF special assessment 2,508 -- -- -- --
Other administrative and general 13,838 13,731 13,269 14,561 8,424
----------- ---------- ----------- ---------- ----------
Total expenses 34,257 26,726 23,009 26,546 13,820
----------- ---------- ----------- ---------- ----------
Income before minority interest in the Bank
and income taxes 19,660 17,039 5,942 27,632 14,473
Minority interest in the Bank's earnings 538 743 500 812 613
Income taxes 5,922 5,847 856 9,633 5,262
Cumulative effect of change in accounting
principle -- -- 867 -- --
----------- ---------- ----------- ---------- ----------
Net income $ 13,200(6) $ 10,449 $ 5,452 $ 17,187 $ 8,598
=========== ========== =========== ========== ==========
Net income per share $ 2.18(6) $ 2.01 $ 1.05 $ 3.31 $ 1.66
=========== ========== =========== ========== ==========
Selected Operating Data(7):
Performance Ratios and Other Data:
Mortgage loans originated(8) $ 426,874 $ 306,775 $ 488,071 $ 834,680 $ 387,312
Loan servicing portfolio 2,550,169 2,298,200 2,114,743 2,000,530 1,770,246
Return on average assets(6) 1.38% 1.47% 0.91% 4.07% 3.53%
Return on average equity(6) 15.54 17.08 10.34 41.98 31.01
Equity to assets at end of period 11.14 7.78 8.94 9.21 11.00
Interest rate spread(9) 3.00 2.93 3.24 3.66 3.61
Net interest margin(9) 3.24 3.26 3.48 3.92 4.00
Average interest-earning assets to average
interest-bearing liabilities 104.60 106.50 105.60 106.08 107.97
Total other expenses to average total assets 3.59 3.80 3.84 6.29 5.67
Full-service Bank offices 15 14 8 8 5
R&G Mortgage offices(10) 11 12 12 13 12
Cash dividends declared per share 0.25(11) -- -- -- --
</TABLE>
<PAGE>
At or For the Year Ended December 31,
-------------------------------------
1996 1995 1994 1993 1992
----- ----- ----- ----- -----
Asset Quality Ratios(12):
Non-performing loans to total loans
at end of period 3.55% 2.18% 1.84% 2.24% 1.81%
Non-performing assets to total assets
at end of period 2.15 1.32 1.04 1.07 0.80
Allowance for loan losses to total
loans at end of period 0.55 0.72 0.92 1.34 0.95
Allowance for loan losses to total
non-performing loans at end of
period 15.55 33.19 50.10 59.87 52.72
Bank Regulatory Capital Ratios(13):
Tier 1 risk-based capital ratio 13.91% 10.53% 11.03% N/A N/A
Total risk-based capital ratio 14.79 11.66 13.59 N/A N/A
Tier 1 leverage capital ratio 8.45 6.25 5.95 N/A N/A
- ----------
(1) At December 1996, R&G Mortgage and the Bank had total assets of $197.3
million and $793.2 million, respectively, before consolidation.
(2) Comprised of cash and due from banks, securities purchased under
agreements to resell, time deposits with other banks and federal funds
sold, all of which had original maturities of 90 days or less.
(3) Comprised of long-term debt, advances from the Federal Home Loan Bank
("FHLB") of New York and other secured borrowings. See Notes 12 to 14 of
R&G Financial's Notes to Consolidated Financial Statements.
(4) Represents a seven-year subordinated capital note of the Bank issued in
1991, which is subject to an annual sinking fund requirement. See Note
15 of R&G Financial's Notes to Consolidated Financial Statements.
(5) Comprised of change in provision for cost in excess of market value of
loans available for sale, net gain on trading account, and other
miscellaneous revenue sources, including Bank service charges, fees and
other income.
(6) Includes one time special Savings Association Insurance Fund ("SAIF")
assessment of $2,508,380 or $1,642,990 after tax ($.27 per share)
incurred in the September 1996 quarter to recapitalize the SAIF of the
Federal Deposit Insurance Corporation ("FDIC"). Without giving effect to
this one-time special assessment, net income and net income per share
would have been $14,842,507 and $2.45, respectively, and return on
average assets and return on average equity would have been 1.55% and
17.48%, respectively
<PAGE>
(7) With the exception of end of period ratios, all ratios for R&G Mortgage
are based on the average of month end balances while all ratios for the
Bank are based on average daily balances. All ratios are annualized
where appropriate.
(8) Represents total originations by R&G Mortgage for the Bank as well as
loans originated and sold to third parties.
(9) Interest rate spread represents the difference between R&G Financial's
weighted average yield on interest-earning assets and the weighted
average rate on interest-bearing liabilities. Net interest margin
represents net interest income as a percent of average interest-earning
assets. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations of R&G Financial."
(10) R&G Mortgage maintains a total of 11 offices that are separate from Bank
branch offices. A total of seven of these offices are located in the
same building or facility as the Bank branch. The table does not include
an additional six Mortgage Banking Centers which are located in the
Bank's offices.
(11) Includes $500,000 or $0.08 per share paid on the Class A Common Stock in
March 1996 prior to the Company's initial public offering. Amount is
based on weighted average number of shares of Common Stock (Class A and
Class B) outstanding.
(12) Non-performing loans consist of R&G Financial's non-accrual loans and
non-performing assets consist of R&G Financial's non-performing loans
and real estate acquired by foreclosure or deed-in-lieu thereof. The
increase in non-performing loans during 1996 is a function of the
increase in the size of the Bank's loan portfolio. The decrease during
recent years in the ratio of the allowance for loan losses to
non-performing loans is primarily due to the significant increase in the
proportion of residential real estate secured loans. Excluding the
residential loan portfolio, the allowance for loan losses to total
non-performing loans at December 31, 1996 amounted to 60.2%.
(13) All of such ratios were in compliance with the applicable requirements
of the FDIC. Prior to 1994, the Bank operated as a savings and loan
association. As such, the Bank was subject to the capital ratios of the
Office of Thrift Supervision and not those of the FDIC and was at all
times in capital compliance therewith.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OF R&G FINANCIAL
General
R&G Financial, through its subsidiaries, is primarily engaged in a wide
range of real estate secured lending activities, including the origination,
servicing, purchase and sale of mortgages on single-family residences, the
securitization and sale of various mortgage-backed and related securities and
the holding and financing of mortgage loans and mortgage-backed and related
securities for sale or investment. R&G Financial also originates for its
portfolio commercial real estate loans, residential construction loans,
commercial business loans and consumer loans. Finally, R&G Financial provides a
variety of trust and investment services to its customers.
R&G Financial has generally sought to achieve long-term financial
strength and profitability by increasing the amount and stability of its net
interest income and other non-interest income. R&G Financial has sought to
implement this strategy by (i) establishing and emphasizing the growth of its
mortgage banking activities, including growing its loan servicing operation;
(ii) expanding its retail banking franchise (the Bank has expanded its branch
system from two offices at February 1990 to 14 offices at December 31, 1996)
and, without taking into consideration possible branch acquisition
opportunities, the Bank presently anticipates opening approximately two branches
per year during the next several years, all in order to achieve increased market
presence and to increase core deposits; (iii) enhancing R&G Financial's net
interest income by increasing R&G Financial's loans held for investment,
particularly single-family residential loans; (iv) developing new business
relationships through an increased emphasis on commercial real estate and
commercial business lending; (v) diversifying R&G Financial's retail products
and services, including an increase in consumer loan originations (such as
credit cards); (vi) meeting the banking needs of its customers through, among
other things, the offering of trust and investment services; and (vii)
controlled growth and the pursuit of a variety of acquisition opportunities when
appropriate. R&G Financial attempts to control its overall operating expenses,
notwithstanding R&G Financial's recent growth and expansion activities.
Asset and Liability Management
General. Changes in interest rates can have a variety of effects on R&G
Financial's business. In particular, changes in interest rates affect the volume
of mortgage loan originations, the interest rate spread on loans, the amount of
gain on the sale of loans, the value of R&G Mortgage's loan servicing portfolio
and the Bank's net interest income. A substantial increase in interest rates
could also affect the volume of R&G Mortgage's loan originations for both the
Bank and third parties by reducing the demand for mortgages for home purchases,
as well as the demand for refinancings of existing mortgages. Conversely, a
substantial decrease in interest rates will generally increase the demand for
mortgages. To the extent that interest rates in future periods were to increase
substantially, R&G Financial would expect overall originations to decline. A
decrease in the volume of R&G
<PAGE>
Financial's mortgage originations could result in a decrease in the amount of
R&G Mortgage's mortgage origination income and portfolio generated net interest
income to the Bank.
The principal objective of R&G Financial's asset and liability
management function is to evaluate the interest-rate risk included in certain
balance sheet accounts, determine the appropriate level of risk given R&G
Financial's business focus, operating environment, capital and liquidity
requirements and performance objectives, establish prudent asset concentration
guidelines and manage the risk consistent with Board approved guidelines.
Through such management, R&G Financial seeks to reduce the vulnerability of its
operations to changes in interest rates and to manage the ratio of interest rate
sensitive assets to interest rate sensitive liabilities within specified
maturities or repricing dates.
The Bank's asset and liability management function is under the guidance
of the Interest Rate Risk, Budget and Investments Committee ("IRRBICO"), which
is chaired by the Chief Executive Officer and comprised principally of members
of the Bank's senior management and at least three members of the Board of
Directors. The IRRBICO meets once a month to review, among other things, the
sensitivity of the Bank's assets and liabilities to interest rate changes, the
book and market values of assets and liabilities, unrealized gains and losses,
purchase and sale activity and maturities of investments and borrowings. In
connection therewith, the IRRBICO generally reviews the Bank's liquidity, cash
flow needs, maturities of investments, deposits and borrowings, and current
market conditions and interest rates.
The Bank's primary IRRBICO monitoring tool is asset/liability simulation
models, which are prepared on a monthly basis and are designed to capture the
dynamics of balance sheet, rate and spread movements and to quantify variations
in net interest income under different interest rate environments. The Bank also
utilizes market-value analysis, which addresses the change in equity value
arising from movements in interest rates. The market value of equity is
estimated by valuing the Bank's assets and liabilities. The extent to which
assets have gained or lost value in relation to the gains or losses of
liabilities determines the appreciation or depreciation in equity on a
market-value basis. Market value analysis is intended to evaluate the impact of
immediate and sustained interest-rate shifts of the current yield curve upon the
market value of the current balance sheet.
A more conventional but limited IRRBICO monitoring tool involves an
analysis of the extent to which assets and liabilities are "interest rate
sensitive" and measuring an institution's interest rate sensitivity "gap." An
asset or liability is said to be interest rate sensitive within a specific time
period if it will mature or reprice within that time period. The interest rate
sensitivity "gap" is defined as the difference between interest-earning assets
and interest-bearing liabilities maturing or repricing within a given time
period. A gap is considered positive when the amount of interest rate sensitive
assets exceeds the amount of interest rate sensitive liabilities. A gap is
considered negative when the amount of interest rate sensitive liabilities
exceeds interest rate sensitive assets. During a period of rising
2
<PAGE>
interest rates, a negative gap would tend to adversely affect net interest
income, while a positive gap would tend to result in an increase in net interest
income. During a period of falling interest rates, a negative gap would tend to
result in an increase in net interest income, while a positive gap would tend to
affect net interest income adversely. At December 31, 1996, R&G Financial's
interest-bearing liabilities which mature or reprice within one year exceeded
R&G Financial's interest-earning assets with similar characteristics by $5.2
million, or .50% of total assets. While a conventional gap measure may be
useful, it is limited in its ability to predict trends in future earnings. It
makes no presumptions about changes in prepayment tendencies, deposit or loan
maturity preferences or repricing time lags that may occur in response to a
change in the interest rate environment.
R&G Mortgage. The profitability to R&G Mortgage of its mortgage loan
originations is in part a function of the difference between long-term interest
rates, which is the rate at which R&G Mortgage originates mortgage loans for
third parties, and short-term interest rates, which is the rate at which R&G
Mortgage finances such loans until they are sold. Generally, short-term interest
rates are lower than long-term interest rates and R&G Mortgage benefits from the
difference, or the spread, during the time the mortgage loans are held by R&G
Mortgage pending sale. A decrease in this spread would have a negative effect on
R&G Mortgage's net interest income and profitability, and there can be no
assurance that the spread will not decrease. R&G Mortgage generally attempts to
reduce this risk by attempting to limit the amount of mortgage loans held
pending sale and, as market conditions permit, entering into forward commitments
with respect to a portion of its mortgage loan originations. As a general
matter, R&G Mortgage attempts to limit its exposure to this interest rate risk
through the sale of substantially all loans within 180 days of origination.
A mortgage-banking company is generally exposed to interest rate risk
from the time the interest rate on the customer's mortgage loan application is
established through the time the mortgage loan closes, and until the time the
company commits to sell the mortgage loan. In order to limit R&G Mortgage's
exposure to interest rate risk through the time the mortgage loan closes, R&G
Mortgage generally does not lock-in or guarantee the customer a specific
interest rate on such loans through the closing date but rather offers customers
an interest rate that will be based on a prevailing market rate that adjusts
weekly. Moreover, in order to limit R&G Mortgage's exposure to interest rate
risk through the time the loan is sold or committed to be sold, R&G Mortgage
may, depending upon market conditions, enter into forward commitments to sell a
portion of its mortgage loans to investors for delivery at a future time. At
December 31, 1996, R&G Mortgage had $5.0 million of pre-existing commitments by
third-party investors to purchase mortgage loans. To the extent that R&G
Mortgage originates or commits to originate loans without pre-existing
commitments by investors to purchase such loans or is not otherwise hedged
against changes in interest rates ("unhedged loans"), R&G Mortgage will be
subject to the risk of gains or losses through adjustments to the carrying value
of loans held for sale or on the actual sale of such loans (the value of
unhedged loans fluctuates inversely with changes in interest rates).
3
<PAGE>
Finally, R&G Mortgage carries an inventory of mortgage-backed and
related securities (primarily fixed-rate GNMA certificates). Generally, the
value of fixed-rate mortgage-backed securities declines when interest rates rise
and, conversely, increases when interest rates fall. At December 31, 1996, R&G
Mortgage held $106.4 million of mortgage-backed and related securities (all of
which carried fixed interest rates) which were classified as held for trading
and reported at fair value, with unrealized gains and losses included in
earnings. Accordingly, declines in the value of R&G Mortgage's securities held
for trading could have a negative impact on R&G Financial's earnings regardless
of whether any securities were actually sold.
In order to hedge the interest rate risk with respect to R&G Mortgage's
mortgage-backed and related securities portfolio, R&G Mortgage may utilize a
variety of interest rate contracts such as interest rate swaps, collars, caps,
options or futures (primarily Eurodollar certificates of deposit and U.S.
Treasury note contracts). R&G Mortgage will use such hedging instruments based
upon market conditions as well as the level of market rates of interest. Since
April 1996, R&G Mortgage's hedging activities have been conducted through an
outside investment adviser who is compensated based upon the amount of its
portfolio being hedged. At December 31, 1996, R&G Mortgage was a party to
options on futures contracts with notional amounts of $10.0 million, based on
U.S. Treasury securities which expire in February 1997. Mortgage-backed
securities held for trading being hedged had a fair value of $106.4 million at
December 31, 1996. In determining the amount of its portfolio to hedge, R&G
Mortgage considered the volatility of prices of its mortgage-backed and related
securities (Puerto Rican GNMAs are generally less volatile than their U.S.
counterparts). During early 1997, R&G Mortgage discontinued hedging activities
for its mortgage-backed securities held for trading after management determined
that the relatively low volatility of such securities did not warrant hedging
against such assets.
The Bank. The results of operations of the Bank are substantially
dependent on its net interest income, which is the difference between the
interest income earned on its interest-earning assets and the interest expense
paid on its interest-bearing liabilities. At December 31, 1996, the Bank's
interest-earning assets included a portfolio of loans receivable, net (not
including mortgage loans held for sale), of $554.1 million and a portfolio of
investment securities and mortgage-backed securities (both held to maturity,
held for trading and available for sale) of $127.5 million. Because the Bank's
interest-earning assets have longer effective maturities than its
interest-bearing liabilities, the yield on the Bank's interest-earning assets
generally will adjust more slowly than the cost of its interest-bearing
liabilities and, as a result, the Bank's net interest income generally would be
adversely affected by increases in interest rates and positively affected by
comparable declines in interest rates. In addition to affecting net interest
income, changes in interest rates also can affect the value of the Bank's
interest-earning assets, which are comprised of fixed and adjustable-rate
instruments. At December 31, 1996, $2.5 million or 2.0% of the Bank's
mortgage-backed and investment securities were classified as held for trading
(which consisted solely of mortgage-backed and U.S. Treasury securities), and
are reported at fair value, with unrealized gains and losses included in
earnings. Accordingly, declines in the
4
<PAGE>
value of the Bank's securities held for trading could have a negative impact on
R&G Financial's earnings regardless of whether any securities were actually sold
by the Bank. In addition, at December 31, 1996, $81.8 million or 64.2% of the
Bank's mortgage-backed and investment securities were classified as available
for sale and are reported at fair value, with unrealized gains and losses
excluded from earnings and reported net of taxes as a separate component of
stockholders' equity.
The Bank has sought to limit its exposure to interest rate risk both
internally through the management of the composition of its assets and
liabilities and externally through the use of a variety of hedging instruments.
Internal hedging through balance sheet restructuring generally involves the
attraction of longer-term funds (i.e., certificates of deposit, FHLB advances or
936 Notes), the origination of adjustable-rate and/or shorter-term loans (such
as commercial real estate, commercial business and consumer loans) or the
investment in certain types of mortgage-backed derivative securities such as
CMOs and mortgage-backed residuals (which often exhibit elasticity and convexity
characteristics which the Bank can utilize to hedge other components of its
portfolio).
External hedging involves the use of interest rate swaps, collars, caps,
options and futures. The Bank utilizes the services of one outside investment
adviser who assists the Bank in the management of its investment and
mortgage-backed securities portfolio and who advises the Bank with respect to
the use of various financial instruments to reduce interest rate risk. Such
investment adviser, which has been engaged by the Bank to, among other things,
provide assistance in achieving the objectives established by the Bank's
IRRBICO, is compensated based upon both the total amount of assets under
management as well as the performance of the portfolio. At December 31, 1996,
Bank assets with an approximate fair value of $31.6 million were being managed
by its independent investment adviser and were invested in U.S. Government
agency securities and money market instruments. These assets are being hedged
with financial futures contracts and Eurodollars. Such firm also executes
hedging strategies on behalf of the Bank for a portion of its mortgage-backed
securities (excluding CMOs) which are available for sale. At December 31, 1996,
mortgage-backed securities available for sale being hedged had a fair value of
$42.6 million.
The Bank generally uses interest rate swaps, collars, caps, options and
futures to effectively fix the cost of short-term funding sources which are used
to purchase interest-earning assets with longer effective maturities, such as
mortgage-backed securities and fixed-rate residential mortgage loans which do
not meet the criteria for sale to the FNMA or the FHLMC in the secondary market.
Such agreements thus reduce the impact of increases in interest rates by
preventing the Bank from having to replace funding sources at a higher cost
prior to the time that the interest-earning asset which was acquired with such
source matures or reprices and thus can be replaced with a higher-yielding
asset.
At December 31, 1996, the Bank was a party to three interest rate swap
agreements. An interest rate swap is an agreement where one party (generally the
Bank) agrees to pay a fixed-rate of interest on a notional principal amount to a
second party (generally a broker)
5
<PAGE>
in exchange for receiving from the second party a variable-rate of interest on
the same notional amount for a predetermined period of time. No actual assets
are exchanged in a swap of this type and interest payments are generally netted.
The Bank's existing interest rate swap agreements have an aggregate notional
amount of approximately $45.0 million and expire from September 2, 1997 to
October 9, 2001. With respect to such agreements, the Bank makes fixed interest
payments ranging from 5.06% to 6.60% and receives payments based upon the
three-month London Interbank Offer Rate ("LIBOR"). The net expense (income)
relating to the Bank's fixed-pay interest rate swaps amounted to approximately
$61,000, $(187,000) and $65,000 during the years ended December 31, 1996, 1995
and 1994, respectively. Such interest rate contracts have reduced the imbalance
between the Bank's interest-earning assets and interest-bearing liabilities
within shorter maturities, thus, reducing the Bank's exposure to increases in
interest rates that may occur in the future.
As discussed above, the Bank may also enter into interest rate collars,
caps, options and futures. At December 31, 1996, the Bank was a party to options
on futures contracts with notional amounts of $10.0 million based on U.S.
Treasury securities, which expire in February 1997. Options are contracts which
grant the purchaser the right to buy or sell the underlying asset by a certain
date for a specified price. An interest rate cap consists of a guarantee given
by one party, referred to as the issuer (i.e., a broker), to another party,
referred to as the purchaser (i.e., the Bank), in exchange for the payment of a
premium, that if interest rates rise above a specified rate on a specified
interest rate index, the issuer will pay to the purchaser the difference between
the then current market rate and the specified rate on a notional principal
amount for a predetermined period of time. No funds are actually borrowed or
repaid. Similarly, an interest rate collar is a combination of a purchased cap
and a written floor at different rates. Accordingly, an interest rate collar
requires no payments if interest rates remain within a specified range, but will
require the Bank to be paid if interest rates rise above the cap rate or require
the Bank to pay if interest rates fall below the floor rate. Interest rate
futures are commitments to either purchase or sell designated instruments (such
as Eurodollar certificates of deposit and U.S. Treasury note contracts) at a
future date for a specified price. Futures contracts are generally traded on an
exchange, are marked to market daily and subject to initial and maintenance
margin requirements.
6
<PAGE>
The following table summarizes the anticipated maturities or repricing
of R&G Financial's interest-earning assets and interest-bearing liabilities as
of December 31, 1996, based on the information and assumptions set forth in the
notes below.
<TABLE>
<CAPTION>
Four to More Than More Than
Within Three Twelve One Year to Three Years Over Five
Months Months Three Years to Five Years Years Total
------------ ----------- ------------ ------------ ------------ ------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets(1):
Loans receivable:
Residential real estate loans........ $15,284 $42,222 $92,007 $67,365 $168,869 $385,747
Construction loans................... 700 2,221 -- -- -- 2,921
Commercial real estate loans......... 72,320 63 192 239 2,400 75,214
Consumer loans....................... 16,224 33,813 43,040 15,296 3,793 112,166
Commercial business loans............ 28,790 1,548 -- -- -- 30,338
Mortgage loans held for sale........... 13,231 41,219 -- -- -- 54,450
Mortgage-backed securities(2)(3)....... 15,849 47,895 32,265 25,218 75,660 196,887
Investment securities(3)............... 4,768 4,455 7,756 15,501 5,114 37,594
Other interest-earning assets(4)....... 65,306 1,560 -- -- -- 66,866
-------- -------- -------- -------- -------- --------
Total.............................. $232,472 $174,996 $175,260 $123,619 $255,836 $962,183
======== ======== ======== ======== ======== ========
Interest-bearing liabilities:
Deposits(5):
NOW and Super NOW accounts(6)........ $ 4,110 $ 11,506 $ 12,648 $ 10,245 $ 43,676 $ 82,185
Passbook savings accounts(6)......... 1,896 5,496 12,648 10,245 43,680 73,965
Checking and commercial checking(6).. 2,712 7,594 8,348 6,762 28,828 54,244
Certificates of deposit.............. 126,200 178,752 64,462 26,851 7,411 403,676
FHLB advances.......................... 10,000 5,000 15,000
Reverse repurchase agreements.......... 97,444 -- -- -- -- 97,444
Other borrowings(7).................... 40,342 -- 15,000 122,813 2,400 180,555
-------- -------- -------- -------- -------- --------
Total.............................. 282,704 208,348 113,106 176,916 125,995 907,069
-------- -------- -------- -------- -------- --------
Effect of hedging instruments.......... (45,000) 10,000 -- 35,000 -- --
-------- -------- -------- -------- -------- --------
$237,704 $218,348 $113,106 $211,916 $125,995 $907,069
======== ======== ======== ======== ======== ========
Excess (deficiency) of interest-earning
assets over interest-bearing liabilities $(5,232) $(43,352) $62,154 $(88,297) $129,841
======= ======== ======= ======== ========
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities......... $(5,232) $(48,584) $13,570 $(74,727) $55,114
======= ======== ======= ======== ========
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities as a
percent of total assets............. (.50)% (4.68)% 1.31% (7.20)% 5.31%
======= ======== ======= ======== ========
</TABLE>
- ----------
(1) Adjustable-rate loans are included in the period in which interest rates
are next scheduled to adjust rather than in the period in which they are
due, and fixed-rate loans are included in the periods in which they are
scheduled to be repaid, based on scheduled amortization, in each case as
adjusted to take into account estimated prepayments based on forecasts
used by the OTS in their model for market value of portfolio equity
("MVPE") discussed below.
(2) Reflects estimated prepayments in the current interest rate environment.
7
<PAGE>
(3) Includes securities held for trading, available for sale and held for
investment.
(4) Includes securities purchased under agreement to resell, federal funds
sold and time deposits with other banks.
(5) Does not include non-interest-bearing deposit accounts.
(6) Although the Bank's negotiable order of withdrawal ("NOW") and Super NOW
accounts, passbook savings accounts and checking accounts are subject to
immediate withdrawal, management considers a substantial amount of such
accounts to be core deposits having significantly longer effective
maturities based on the Bank's retention of such deposits in changing
interest rate environments. The above table assumes that funds will be
withdrawn from the Bank at annual rates for NOW accounts and for
checking and commercial checking accounts, ranging from 10% for 0-12
months, 19% for 1-5 years, 41% for 5-10 years, 65% for 10-20 years and
100% thereafter; and, for passbook savings accounts, ranging from 5% for
0-12 months, 19% for 1-5 years, 40% for 5-10 years, 65% for 10-20 years
and 100% thereafter.
(7) Comprised of warehousing lines, notes payable, subordinated notes and
other secured borrowings.
Although "gap" analysis is a useful measurement device available to
management in determining the existence of interest rate exposure, its static
focus as of a particular date makes it necessary to utilize other techniques in
measuring exposure to changes in interest rates. For example, gap analysis is
limited in its ability to predict trends in future earnings and makes no
presumptions about changes in prepayment tendencies, deposit or loan maturity
preferences or repricing time lags that may occur in response to a change in the
interest rate environment. As a result, R&G Financial, through simulation
models, also analyzes on a monthly basis the estimated effects on net interest
income and equity under multiple rate scenarios, including increases and
decreases in interest rates amounting to 400, 300, 200 and 100 basis points. The
IRRBICO regularly reviews interest rate risk by forecasting the impact of
alternative interest rate scenarios on net interest income and on R&G
Financial's MVPE, which is defined as the net present value of an institution's
existing assets, liabilities and off-balance sheet instruments, and by
evaluating such impact against the maximum potential changes in net interest
income and MVPE.
8
<PAGE>
The following table sets forth at December 31, 1996 the estimated
percentage change in R&G Financial's MVPE based on the indicated changes in
interest rates.
MVPE(2)
-------------------------------------------------------
Change in Change as a
Interest Rates Percentage Percentage
(in Basis Points)(1) Amount of Change Change of Assets
- -------------------- ---------------------- ---------- -----------
(Dollars in Thousands)
+400 $(28,262) (24.9)% (2.72)%
+300 (22,154) (19.6) (2.14)
+200 (15,330) (13.5) (1.48)
+100 (7,948) (7.0) (.77)
-- -- -- --
-100 14,435 12.7 1.39
-200 30,379 26.8 2.93
-300 50,949 44.9 4.91
-400 86,925 76.5 8.38
- ----------
(1) Assumes an instantaneous uniform change in interest rates at all
maturities.
(2) Based on R&G Financial's pre-tax MVPE of $113.6 million at December 31,
1996, which is approximately $2.0 million below R&G Financial's
stockholders' equity calculated in accordance with generally accepted
accounting principles as of such date.
Management of R&G Financial believes that all of the assumptions used in
the foregoing analysis to evaluate the vulnerability of its operations to
changes in interest rates approximate actual experience and considers them
reasonable; however, the interest rate sensitivity of R&G Financial's assets and
liabilities and the estimated effects of changes in interest rates on R&G
Financial's net interest income and MVPE indicated in the above table could vary
substantially if different assumptions were used or if actual experience differs
from the projections on which they are based.
Changes in Financial Condition
General. At December 31, 1996, R&G Financial's total assets amounted to
$1.0 billion, as compared to $853.2 million at December 31, 1995. The $184.6
million or 21.6% increase in total assets during the year ended December 31,
1996 was primarily the result of a $129.9 million or 27.4% increase in loans
receivable, net, and a $33.1 million or 155.42% increase in mortgage loans held
for sale which are attributable to the origination
9
<PAGE>
of $624.6 million of loans, primarily single-family residential loans, before
reduction for repayments and sales, and a $17.5 million or 27.3% increase in
mortgage-backed and investment securities available for sale, which is primarily
the result of securitization of mortgage loans into mortgage-backed securities,
net of sales.
Cash and Money Market Investments. Cash and money market investments
(consisting of securities purchased under agreements to resell, certificates of
deposit with other financial institutions and federal funds sold) amounted to
$98.9 million and $104.2 million as of December 31, 1996 and 1995, respectively.
The significant amount of cash and money market investments at December 31, 1995
(when compared to 1994) reflected the Bank's June 1995 branch acquisition and
the $75.6 million in cash received in connection therewith.
Loans Receivable and Mortgage Loans Held for Sale. At December 31, 1996,
R&G Financial's loans receivable, net amounted to $603.8 million or 58.2% of
total assets, as compared to $473.8 million or 55.5% as of December 31, 1995.
The growth in R&G Financial's loans receivable, net reflects R&G Financial's
strategy of increasing its loans held for investment, including residential
mortgage, construction, commercial real estate, commercial business and consumer
loans. During the years ended December 31, 1996, 1995 and 1994, total loans
originated and purchased by the Bank (including loans originated by R&G Mortgage
on behalf of the Bank) amounted to $342.2 million, $281.7 million and $213.3
million, respectively.
At December 31, 1996, R&G Financial's allowance for loan losses (all of
which is maintained in the Bank's loan portfolio) totalled $3.3 million, which
represented a $179,000 or 5.1% decrease from the level maintained at December
31, 1995. At December 31, 1996, R&G Financial's allowance represented
approximately 0.55% of the total loan portfolio and 15.55% of total
non-performing loans, as compared to 0.72% and 33.19% at December 31, 1995. The
decrease in the allowance for loan losses is attributable to write-offs during
the year totalling approximately $4.7 million, net of the provision of $4.3
million for loan losses during the year, which was primarily related to certain
potential loan losses related to operation of the Bank's insurance premiums
financing business, as well as, to a lesser extent, the overall growth in the
consumer loan portfolio. See "Results of Operations - Provision for Loan
Losses."
While R&G Financial's allowance for loan losses as a percentage of both
total loans and total non-performing loans has declined since 1994, management
of R&G Financial believes that its allowance for loan losses at December 31,
1996 was adequate, based upon, among other things, the significant level of
single-family residential loans within R&G Financial's portfolio (as compared to
commercial real estate, commercial business and consumer loans, which are
considered by management to carry a higher degree of credit risk) and the low
level of loan charge-offs with respect to R&G Financial's loan portfolio.
However, there can be no assurances that additions to such allowance will not be
necessary in future periods, which could adversely affect R&G Financial's
results of operations.
10
<PAGE>
At December 31, 1996 and 1995, mortgage loans held for sale amounted to
$54.5 million and $21.3 million, respectively. Mortgage loans held for sale
primarily reflects loans which are in the process of being securitized and sold.
The level of mortgage banking activities is highly dependent upon market and
economic factors.
Securities Held for Trading, Available for Sale and Held for Investment.
R&G Financial maintains a substantial portion of its assets in mortgage-backed
and investment securities which are classified as either held for trading,
available for sale or held to maturity in accordance with SFAS No. 115. At
December 31, 1996, R&G Financial's aggregate mortgage-backed and investment
securities totalled $234.5 million or 22.6% of total assets, as compared to
$221.9 million or 26.0% at December 31, 1995, respectively.
Securities held for trading consist primarily of FHA and VA loans which
have been securitized and are being held for sale either to institutions in the
secondary market or private investors through the Bank's Trust Department. At
December 31, 1996 and 1995, securities held for trading amounted to $108.1
million and $113.8 million. At December 31, 1996, all but $1.7 million of such
securities were held by R&G Mortgage. Pursuant to SFAS No. 115, securities held
for trading are reported at fair value with unrealized gains and losses included
in earnings.
Securities available for sale consist of mortgage-backed and related
securities (FNMA and FHLMC certificates as well as CMOs and CMO residuals) and
U.S. Government agency securities, all of which were held by the Bank. At
December 31, 1996 and 1995, securities available for sale totalled $81.8 million
and $64.3 million, respectively. Pursuant to SFAS No. 115, securities available
for sale are reported at fair value with unrealized gains and losses excluded
from earnings, and instead reported as a separate component of stockholders'
equity.
Securities held to maturity consist of mortgage-backed securities (GNMA,
FNMA and FHLMC certificates), Puerto Rico Government obligations and, at
December 31, 1996, other Puerto Rico securities, all of which were held by the
Bank. At December 31, 1996 and 1995, securities held to maturity totalled $43.2
million and $43.8 million, respectively. Securities held to maturity are
accounted for at amortized cost. At December 31, 1996 and 1995, R&G Financial's
securities held to maturity had a market value of $42.3 million and $42.8
million, respectively.
Mortgage Servicing Rights. As of December 31, 1996 and 1995, R&G
Financial reported $12.6 million and $8.2 million of mortgage servicing rights,
respectively. Effective January 1, 1995, R&G Financial adopted SFAS No. 122,
"Accounting for Mortgage Servicing Rights," and, in connection therewith, R&G
Financial is required to recognize both purchased and originated mortgage
servicing rights as assets in its Consolidated Financial Statements. However,
R&G Financial is not permitted to recognize retroactively mortgage servicing
rights originated prior to the date of its adoption of SFAS No. 122. SFAS No.
122 also requires R&G Financial to assess the fair value of its mortgage
servicing rights on a
11
<PAGE>
quarterly basis and to determine any potential impairment. Any future decline in
interest rates which results in an acceleration in mortgage loan prepayments
could have an adverse effect on R&G Financial's mortgage servicing rights, the
value of which is dependent upon the cash flows from the underlying mortgage
loans.
Deposits. At December 31, 1996, deposits totalled $615.6 million, as
compared to $518.2 million at December 31, 1995. The $97.4 million or 18.8%
increase in deposits during the year ended December 31, 1996 was primarily due
to promotions in connection with new accounts and competitive pricing.
Borrowings. Other than deposits, R&G Financial's primary sources of
funds consist of securities sold under agreements to repurchase (consisting of
agreements to purchase on a specified later date the same securities or
substantially identical securities) ("reverse repurchase agreements"). At
December 31, 1996 and 1995, reverse repurchase agreements totalled $97.4 million
and $98.5 million, respectively.
Notes payable consist primarily of warehouse lines of credit (which are
used to fund loan commitments of R&G Mortgage) and Section 936 promissory notes
(which represents a low cost source of short and intermediate-term funds for the
Bank). At December 31, 1996, notes payable amounted to $126.8 million, as
compared to $81.1 million at December 31, 1995. The $45.7 million or 56.3%
increase in notes payable during the year ended December 31, 1996 reflected
$35.5 million and $14.2 million of increased 936 Notes and warehouse lines,
respectively, which was partially offset by a $4.0 million reduction in working
capital lines of credit.
Advances from the FHLB of New York amounted to $15.0 million and $6.0
million at December 31, 1996 and 1995, respectively. At December 31, 1996, all
FHLB advances were scheduled to mature in 1997, with an average interest rate of
5.75%.
Long-term debt consists of long-term (greater than one-year) notes
payable. R&G Financial had no long-term debt at December 31, 1996, compared to
$5.3 million at December 31, 1995.
In December 1995, the Bank sold single-family residential mortgage loans
with an aggregate outstanding balance of approximately $55 million to two
commercial banks. In connection with these transactions and in consideration of
higher servicing fees, R&G Mortgage assumed certain recourse obligations. In
addition, the purchasers of the loans have the right, at their option, to
require R&G Mortgage to purchase the mortgage loans on specified dates beginning
in December 2000. Management has estimated its liability, if any, under the
foregoing recourse provisions to be insignificant as of December 31, 1996. In
R&G Financial's Consolidated Financial Statements, R&G Financial has recognized
the foregoing transaction as a transfer of loans with recourse. Accordingly, the
proceeds from such transaction (amounting to $50.5 million and $56.0 million at
December 31, 1996 and
12
<PAGE>
1995, respectively) have been reported as other secured borrowings in R&G
Financial's Consolidated Financial Statements.
In June 1991, the Bank issued $3.3 million of subordinated capital notes
bearing interest at 8% payable on a quarterly basis. The subordinated notes are
guaranteed by R&G Mortgage and by the Chairman of the Board and Chief Executive
Officer of R&G Financial, and are secured by an irrevocable standby letter of
credit issued by an unrelated commercial bank. Pursuant to the terms of the
subordinated notes, the Bank is required to deposit in an established sinking
fund in seven equal annual installments (the first of which was made in
September 1992 and the last of which is scheduled for June 1998, when the notes
mature) cash or other permitted investments in an amount sufficient to retire
one-seventh ($464,000) of the aggregate principal amount of the subordinated
notes. The standby letter of credit is reduced in equal proportion to the
deposits to such sinking fund.
Stockholders' Equity. Stockholders' equity increased from $66.4 million
at December 31, 1995 to $115.6 million at December 31, 1996. The $49.2 million
or 74.2% increase in stockholders' equity during 1996 was primarily due to the
$31.1 million of capital raised in connection with the Company's August 1996
initial public offering, coupled with the $13.2 million net income for the year.
The increases in stockholders' equity were slightly offset by dividends paid
during the year of $972,000 and by a decline in unrealized gains on securities
available for sale from $952,000 at December 31, 1995 to an unrealized loss of
$102,000 at December 31, 1996.
Results of Operations
General. R&G Financial's results of operations depend substantially on
its net interest income, which is the difference between interest income on
interest-earning assets, which consist primarily of loans, money market
investments and mortgage-backed and investment securities, and interest expense
on interest-bearing liabilities, which consist primarily of deposits and short
and long-term borrowings. R&G Financial's results of operations are also
significantly affected by its provisions for loan losses, resulting from R&G
Financial's assessment of the adequacy of its allowance for loan losses; the
level of its other income, including net gain (loss) on sale of loans,
unrealized gain (loss) on trading securities and loan administration and
servicing fees; the level of its operating expenses, such as employee
compensation and benefits and office occupancy and equipment expense; and income
tax expense.
R&G Financial's major business activities consist of: (i) the
origination by R&G Mortgage of real estate mortgage loans for sale and the
servicing by R&G Mortgage of real estate mortgage loans for the Bank and other
third parties; and (ii) attracting deposits from the general public and using
such deposits, together with other borrowings, for investment principally by the
Bank in loans (single-family residential mortgage loans, construction loans,
commercial real estate loans, commercial business loans and consumer loans), and
in mortgage-backed and investment securities. To a much more limited extent, R&G
Financial
13
<PAGE>
also provides trust and investment services to the public through the Bank's
Trust Department.
The following table reflects the principal revenue sources of the Bank
and R&G Mortgage and the percentage contribution of each component for the
periods presented.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------------
1996 1995 1994
----------------------- ---------------------- -----------------------
Amount Percent Amount Percent Amount Percent
-------- -------- -------- -------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
The Bank:
Net interest income after
provision for loan losses ....... $ 20,884 38.73% $ 17,944 41.00% $ 15,089 52.12%
Net gain on sale of loans ......... 1,355 2.51 632 1.44 202 0.70
Unrealized profit (loss) on
trading securities .............. -- -- 618 1.41 (214) (0.74)
Net gain on sale of
investment securities ............ 642 1.19 -- -- -- --
Market valuation allowance
on loans held for sale .......... -- -- 856 1.96 (856) (2.96)
Other income(1) ................... 3,664 6.80 2,368 5.41 1,737 6.00
-------- -------- -------- -------- -------- --------
26,545 49.23 22,418 51.22 15,958 55.12
-------- -------- -------- -------- -------- --------
R&G Mortgage:
Net interest income ............... 3,781 7.01 2,379 5.44 4,048 13.98
Loan administration and
servicing fees .................. 13,029 24.17 11,030 25.20 11,046 38.15
Net gain (loss) on sale of
loans ........................... 10,450 19.38 5,630 12.86 (1,551) (5.35)
Net gain on sale of servicing
rights .......................... -- -- -- -- 2,915 10.07
Unrealized profit (loss) on
trading securities .............. (96) (0.18) 1,504 3.44 (4,251) (14.68)
Other income(1) ................... 208 0.39 804 1.84 786 2.71
-------- -------- -------- -------- -------- --------
27,372 50.77 21,347 48.78 12,993 44.88
-------- -------- -------- -------- -------- --------
$ 53,917 100.00% $ 43,765 100.00% $ 28,951 100.00%
======== ======== ======== ======== ======== ========
</TABLE>
- ----------
(1) Comprised of service charges, fees and other for the Bank and other
miscellaneous revenue sources for the Bank and R&G Mortgage.
14
<PAGE>
R&G Financial reported net income of $13.2 million, $10.4 million and
$5.5 million during the years ended December 31, 1996, 1995 and 1994,
respectively. Net income increased by $2.8 million or 26.3% during the year
ended December 31, 1996, as compared to 1995, due to a $12.6 million increase in
net interest income and a $5.8 million increase in total other income, which
were partially offset by a $7.5 million increase in total operating expenses,
($5.0 million if the one-time SAIF special assessment were excluded), and a $3.3
million or 348% increase in the provision for loan losses.
Net income increased by $5.0 million or 91.6% during 1995 due to a
$13.6 million increase in total other income and a $2.1 million increase in net
interest income, which were partially offset by a $5.0 million increase in
income tax expense, a $3.7 million increase in total operating expenses, a
$950,000 increase in the provision for loan losses and the absence of $867,000
in income recognized during 1994 due to the cumulative effect of a change in
accounting principles.
Net Interest Income. Net interest income is determined by R&G
Financial's interest rate spread (i.e., the difference between the yields earned
on its interest-earning assets and the rates paid on its interest-bearing
liabilities) and the relative amounts of interest-earning assets and
interest-bearing liabilities.
Net interest income totalled $28.9 million, $21.3 million and $19.1
million during the years ended December 31, 1996, 1995 and 1994, respectively.
Net interest income increased by $7.7 million or 36.0% during the year ended
December 31, 1996, as compared to the year ended December 31, 1995, due to an
increase in R&G Financial's interest rate spread from 2.93% for the year ended
December 31, 1995 to 3.0% for the year ended December 31, 1996, partially offset
by a decrease in the ratio of average interest-earning assets to average
interest-bearing liabilities from 106.5% to 104.6%, respectively. Net interest
income increased by $2.1 million or 11.2% during 1995 due to an increase in the
ratio of average interest-earning assets to average interest-bearing liabilities
from 105.60% for 1994 to 106.50% for 1995, which was partially offset by a
decline in R&G Financial's interest rate-spread from 3.24% for 1994 to 2.93% for
1995.
15
<PAGE>
The following table presents for R&G Financial for the periods indicated
the total dollar amount of interest from average interest-earning assets and the
resultant yields, as well as the interest expense on average interest-bearing
liabilities expressed both in dollars and rates, and the net interest margin.
The table does not reflect any effect of income taxes. All average balances are
based on the average of month-end balances for R&G Mortgage and average daily
balances for the Bank, in each case during the periods presented.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------------
1996 1995
---------------------------------------- ---------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate (1) Balance Interest Rate (1)
----------- ------------ ---------- ----------- ------------ ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Cash and cash equivalents(2) ................ $ 43,072 $ 2,322 5.39% $ 10,000 $ 605 6.05%
Investment securities held for trading ...... 2,271 116 5.11 -- -- --
Investment securities available for sale .... 19,102 1,193 6.25 -- -- --
Investment securities held to maturity ...... 10,069 515 4.35 16,211 972 6.00
Mortgage-backed securities held for trading 136,618 9,258 6.78 130,184 8,595 6.60
Mortgage-backed securities available for sale 50,633 3,602 7.11 16,006 1,193 7.45
Mortgage-backed securities held to maturity 40,403 2,478 6.27 72,173 4,841 6.71
Loans receivable, net(3)(4) ................. 587,730 54,044 9.20 405,784 37,078 9.14
FHLB of New York stock ...................... 3,999 258 6.45 2,976 227 7.63
-------- ------- -------- -------
Total interest-earning assets ............. 893,897 $73,786 8.25% 653,334 $53,511 8.19%
======= ====== ======= ======
Non-interest-earning assets .................. 61,480 50,365
-------- --------
Total assets ................................ $955,377 $703,699
======== ========
Interest-Bearing Liabilities:
Deposits .................................... $561,548 $27,518 4.90% $431,833 $21,829 5.05%
Securities sold under agreements to
repurchase ................................. 100,607 5,024 4.99 107,026 6,437 6.01
Notes payable ............................... 126,171 7,284 5.77 55,118 3,025 5.49
Subordinated debt(5) ........................ 3,250 332 10.21 3,250 339 10.43
Other borrowings(6) ......................... 63,118 4,705 7.45 16,201 609 3.76
-------- ------- -------- -------
Total interest-bearing liabilities ........ 854,694 $44,863 5.25% 613,428 $32,239 5.26%
======= ====== ======= ======
Non-interest-bearing liabilities ............ 15,766 29,093
-------- --------
Total liabilities ......................... 870,460 642,521
Stockholders' equity ........................ 84,917 61,178
-------- --------
Total liabilities and stockholders' equity $955,377 $703,699
======== ========
Net interest income; interest rate spread(7) $28,923 3.00% $21,272 2.93%
======= ====== ======= ======
Net interest margin(7) ...................... 3.24% 3.26%
====== ======
Average interest-earning assets to average
interest-bearing liabilities .............. 104.60% 106.50%
====== ======
<CAPTION>
Year Ended December 31,
--------------------------------------
1994
--------------------------------------
Average Yield/
Balance Interest Rate (1)
------------ --------- ---------
(Dollars in Thousands)
<S> <C> <C> <C>
Interest-Earning Assets:
Cash and cash equivalents(2) ................ $ 9,235 $ 373 4.04%
Investment securities held for trading ...... -- -- --
Investment securities available for sale .... -- -- --
Investment securities held to maturity ...... 9,274 429 4.63
Mortgage-backed securities held for trading 143,090 9,301 6.50
Mortgage-backed securities available for sale 33,357 2,449 7.34
Mortgage-backed securities held to maturity 34,791 2,206 6.34
Loans receivable, net(3)(4) ................. 318,155 27,465 8.63
FHLB of New York stock ...................... 1,852 141 7.61
-------- -------
Total interest-earning assets ............. 549,754 $42,364 7.71%
======= ======
Non-interest-earning assets .................. 49,542
--------
Total assets ................................ $599,296
========
Interest-Bearing Liabilities:
Deposits .................................... $340,461 $14,461 4.25%
Securities sold under agreements to
repurchase ................................. 97,572 4,417 4.53
Notes payable ............................... 63,350 3,439 5.43
Subordinated debt(5) ........................ 3,250 331 10.18
Other borrowings(6) ......................... 15,920 578 3.63
-------- -------
Total interest-bearing liabilities ........ 520,553 $23,226 4.46%
======= ======
Non-interest-bearing liabilities ............ 25,992
--------
Total liabilities ......................... 546,545
Stockholders' equity ........................ 52,751
--------
Total liabilities and stockholders' equity $599,296
========
Net interest income; interest rate spread(7) $19,138 3.24%
======= ======
Net interest margin(7) ...................... 3.48%
======
Average interest-earning assets to average
interest-bearing liabilities .............. 105.60%
======
</TABLE>
(Footnotes on following page)
16
<PAGE>
- ----------
(1) At December 31, 1996, the yields earned and rates paid were as follows:
cash and cash equivalents, 6.33%; investment securities held to
maturity, 5.47%; investment securities available for sale, 6.30%;
mortgage-backed securities held for trading, 6.56%; mortgage loans
available for sale, 7.67%; loans receivable, net, 9.86%; FHLB of New
York stock, 6.61%; total interest-earning assets, 8.69%; deposits,
5.07%; securities sold under agreements to repurchase, 5.67%; notes
payable, 6.61%; other borrowings, 7.39%; subordinated debt, 11.00%;
total interest-bearing liabilities, 5.52%; interest rate spread, 3.17%.
(2) Comprised of cash and due from banks, securities purchased under
agreements to resell, time deposits with other banks and federal funds
sold.
(3) Includes mortgage loans held for sale and non-accrual loans.
(4) Loan fees amounted to $277,000, $578,000 and $472,000 during the years
ended December 31, 1996, 1995 and 1994, respectively or 0.44%, 1.27% and
1.28% of interest income on loans during such respective periods.
(5) Represents a seven-year subordinated capital note of the Bank issued in
1991, which is subject to an annual sinking fund requirement.
(6) Comprised of long-term debt, advances from the FHLB of New York and
other secured borrowings.
(7) Interest rate spread represents the difference between R&G Financial's
weighted average yield on interest-earning assets and the weighted
average rate on interest-bearing liabilities. Net interest margin
represents net interest income as a percent of average interest-earning
assets.
17
<PAGE>
The following table describes the extent to which changes in interest
rates and changes in volume of interest-related assets and liabilities have
affected R&G Financial's interest income and interest expense during the periods
indicated. For each category of interest-earning assets and interest-bearing
liabilities, information is provided on changes attributable to (i) changes in
volume (change in volume multiplied by prior year rate), (ii) changes in rate
(change in rate multiplied by prior year volume), and (iii) total change in rate
and volume. The combined effect of changes in both rate and volume has been
allocated in proportion to the absolute dollar amounts of the changes due to
rate and volume.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------------
1996 vs. 1995 1995 vs. 1994
------------------------------------ ------------------------------------
Increase Increase
(Decrease) (Decrease)
Due to Total Due to Total
---------------------- Increase --------------------- Increase
Rate Volume (Decrease) Rate Volume (Decrease)
-------- -------- -------- -------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Cash and cash equivalents(1) ................... $ (284) $ 2,001 $ 1,717 $ 201 $ 31 $ 232
Investment securities held for trading ......... -- 116 116 -- -- --
Investment securities available for sale ....... -- 1,193 1,193 -- -- --
Investment securities held to maturity ......... (89) (368) (457) 222 321 543
Mortgage-backed securities held for
trading ...................................... 238 425 663 133 (839) (706)
Mortgage-backed securities held to maturity .... (1,298) (1,065) (2,363) 265 2,370 2,635
Mortgage-backed securities available for sale .. (172) 2.581 2,409 18 (1,274) (1,256)
Loans receivable, net(4) ....................... 8,653 8,313 16,966 2,048 7,565 9,613
FHLB of New York stock ......................... (47) 78 31 -- 86 86
-------- -------- -------- -------- -------- --------
Total interest-earning assets ................ $ 7,001 $ 13,274 20,275 $ 2,887 $ 8,260 11,147
======== ======== -------- ======== ======== --------
Interest-Bearing Liabilities:
Deposits ....................................... $ (868) $ 6,557 $ 5,689 $ 3,487 $ 3,881 $ 7,368
Securities sold under agreements to repurchase . (1,027) (386) (1,413) 1,592 428 2,020
Notes payable .................................. 359 3,900 4,259 33 (447) (414)
Subordinated debt(2) ........................... (7) -- (7) 8 -- 8
Other borrowings(3) ............................ 2,332 1,764 4,096 21 10 31
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities ........... $ 789 $ 11,835 12,624 $ 5,141 $ 3,872 9,013
======== ======== -------- ======== ======== --------
Increase in net interest income ................ $ 7,651 $ 2,134
======== ========
</TABLE>
(Footnotes on following page)
18
<PAGE>
- ----------
(1) Comprised of cash and due from banks, securities purchased under
agreements to resell, time deposits with other banks and federal funds
sold.
(2) Represents a seven-year subordinated capital note of the Bank issued in
1991, which is subject to an annual sinking fund requirement.
(3) Comprised of long-term debt, advances from the FHLB of New York and
other secured borrowings.
(4) Includes mortgage loans held for sale.
Interest Income. Total interest income increased by $20.3 million or
37.9% during the year ended December 31, 1996, as compared to December 31, 1995,
and increased by $11.1 million or 26.3% during the year ended December 31, 1995
over the year ended December 31, 1994. Interest income on loans, the largest
component of R&G Financial's interest-earning assets, increased by $17.6 million
or 38.4% during the year ended December 31, 1996, as compared to the year ended
December 31, 1995, and increased by $9.6 million or 35.0% during 1995 over the
year ended December 31, 1994. Such increases were primarily the result of
increases in the average balance of loans receivable of $181.9 million and $87.6
million during the years ended December 31, 1996 and 1995, respectively. One of
R&G Financial's strategies in recent years has been to grow R&G Financial's
loans held for investment.
Interest income on mortgage-backed and investment securities (which, for
purposes of this discussion, includes securities held for trading, available for
sale and held to maturity) increased by $1.6 million or 10.0% during the year
ended December 31, 1996, as compared to the year ended December 31, 1995, and
increased by $1.2 million or 8.5% during the year ended December 31, 1995 over
the year ended December 31, 1994. The increase in interest income on
mortgage-backed and investment securities during the year ended December 31,
1996 was due primarily to an increase in the average balance of investment
securities of $15.2 million, together with an increase of $9.3 million in the
average balance of mortgage-backed securities during the period. The increase in
investment securities reflects the purchase of tax-free short- and medium-term
securities, which were funded with the proceeds from the sale of mortgage-backed
securities and other liquidity sources. The increase in interest income on
mortgage-backed and investment securities during 1995 was primarily due to a
$37.4 million increase in the average balance of mortgage-backed securities held
to maturity, which was largely offset by decreases of $17.4 million and $12.9
million in the average balance of mortgage-backed securities available for sale
and held for trading, which was attributable to sales in the secondary market in
response to favorable market conditions.
19
<PAGE>
Interest income on cash and cash equivalents (consisting of cash and due
from banks, securities purchased under agreements to resell, certificates of
deposit with other financial institutions and federal funds sold) increased by
$1.7 million or 283.80% during the year ended December 31, 1996, as compared to
the year ended December 31, 1995, and increased by $232,000 or 62.2% during the
year ended December 31, 1995. The increase during the year ended December 31,
1996 reflected the increase in the average balance of $33.1 million, which was
partially offset by a decrease in the yield from 6.05% to 5.39%. The increase in
interest earned on money market investments during 1995 was due primarily to an
increase in the average yield earned thereon of 201 basis points. The
fluctuations in yields earned by R&G Financial on its money market investments
reflect the general fluctuations in short-term market rates of interest during
the periods presented.
Interest Expense. Total interest expense increased by $12.6 million or
39.2% during the year ended December 31, 1996, as compared to the year ended
December 31, 1995, and increased by $9.0 million or 38.8% during the year ended
December 31, 1995. Interest expense on deposits, the largest component of R&G
Financial's interest-bearing liabilities, increased by $5.7 million or 26.1%
during the year ended December 31, 1996, as compared to the year ended December
31, 1995, and increased by $7.4 million or 51.0% during the year ended December
31, 1995. The increases in interest expense on deposits during the years ended
December 31, 1996 and 1995 were primarily due to increases in the average
balance of deposits of $129.7 million and $91.4 million during such respective
periods. In June 1995, the Bank acquired $77.2 million in deposits from a
commercial bank. During 1995, the average rate paid on deposits increased by 80
basis points as a result of a general increase in market rates of interest. In
1996, the average rate paid on deposits decreased by 15 basis points as a result
of a general decrease in market rates of interest.
Interest expense on reverse repurchase agreements decreased by $1.4
million or 21.9% during the year ended December 31, 1996, as compared to the
year ended December 31, 1995, and increased significantly by $2.0 million during
the year ended December 31, 1995. The decrease in interest expense on reverse
repurchase agreements during 1996 was primarily due to a decrease in the average
rate paid thereon of 102 basis points. The increase in interest expense on
reverse repurchase agreements during 1995 was due primarily to an increase in
the average rate paid thereon of 148 basis points. R&G Financial generally uses
reverse repurchase agreements to repay warehouse lines of credit which are used
to fund loan originations. The reverse repurchase agreements are collateralized
by mortgage-backed securities held for trading. The fluctuations in the average
balance of reverse repurchase agreements during the periods presented is
therefore a function both of the amount of originations by R&G Financial as well
as the level of mortgage-backed securities held for trading which are available
to collateralize such agreements.
Interest expense on notes payable (consisting of warehouse lines of
credit and promissory notes) increased by $3.9 million or 116.5% during the year
ended December 31, 1996, as compared to the year ended December 31, 1995, and
decreased by $414,000 or
20
<PAGE>
12.0% during the year ended December 31, 1995. The increase during the year
ended December 31, 1996 was due to a $71.1 million increase in the average
balance of notes payable, as the Bank used 936 Notes to fund increased consumer
and commercial lending. The decrease during the year ended December 31, 1995 was
primarily due to an $8.2 million decrease in the average balance of the 936
Notes.
Interest expense on other borrowings (consisting of long-term notes
payable, subordinated notes, advances from the FHLB of New York and other
secured borrowings) increased by $4.4 million or 727.3% during the year ended
December 31, 1996, as compared to the year ended December 31, 1995, and
increased by $39,000 or 4.3% during the year ended December 31, 1995. The
increase during the year ended December 31, 1996 was primarily due to a $46.9
million increase in the average balance of such borrowings together with a 369
basis point increase in the average rate paid thereon. The increases were
primarily due to a $56.0 million transfer of loans with recourse transaction in
December 1995 which is reported as other secured borrowings in R&G Financial's
Consolidated Financial Statements. The increase in interest expense on other
borrowings during 1995 was due primarily to an increase in the average rate paid
thereon.
Provision for Loan Losses. The provision for loan losses is charged to
earnings to bring the total allowance to a level considered appropriate by
management based on R&G Financial's loss experience, current delinquency data,
known and inherent risks in the portfolio, the estimated value of any underlying
collateral and an assessment of current economic conditions. While management
endeavors to use the best information available in making its evaluations,
future allowance adjustments may be necessary if economic conditions change
substantially from the assumptions used in making the initial evaluations.
R&G Financial made provisions (reductions) to its allowance for loan
losses of $4.3 million and $950,000 during the years ended December 31, 1996 and
1995. R&G Financial did not establish any provisions for loan losses during 1994
or 1993 due, in part, to the Bank's acquisition of a federally chartered savings
institution in June 1993 and, in connection therewith, the acquisition of $1.7
million of reserves of such institution.
The increase in the provision for loans losses during 1996 primarily
reflects action taken with respect to certain potential loan losses related to
the operation of the Bank's insurance premiums financing business. The Bank in
late August 1996 uncovered certain irregularities with respect to the
origination and administration of a number of loans in contravention of
established Bank policies by the former loan officer in charge of the
department. Management, based on a review of the collectibility of the loans in
question, believes that the reserve established of approximately $2.5 million is
sufficient to cover estimated losses which may result from this matter.
Notwithstanding the reserve established, management is vigorously pursuing a
claim filed under its fidelity insurance policy with respect to this matter.
21
<PAGE>
The $950,000 provision during 1995 reflected R&G Financial's increased
consumer loan originations and an increase in loan charge-offs related thereto.
Although R&G Financial's allowance for loan losses as a percentage of total
loans and total non-performing loans has declined since December 31, 1994,
management believes that its allowance for loan losses at December 31, 1996, was
adequate based upon, among other things, the significant level of single-family
residential loans within R&G Financial's portfolio (as compared to commercial
real estate, commercial business and consumer loans, which are considered by
management to carry a higher degree of credit risk) and the low level of loan
charge-offs with respect to R&G Financial's loan portfolio. Nevertheless, there
can be no assurances that additions to such allowance will not be necessary in
future periods, particularly if the growth in R&G Financial's commercial real
estate, commercial business and consumer lending continues.
Other Income. The following table sets forth information regarding other
income for the periods shown.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------
1996 1995 1994
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Net gain (loss) on sale of loans ............... $ 11,805 $ 6,262 $ (1,349)
Net profit (loss) on trading securities ........ (96) 2,122 (4,465)
Change in provision for cost in excess of market
value of loans held for sale ................. -- 856 (856)
Net gain on sale of investment securities
available for sale ............................ 641 -- --
Net profit (loss) on trading account ........... (66) -- --
Loan administration and servicing fees ......... 13,029 11,030 11,046
Gain on sale of servicing rights ............... -- -- 2,915
Service charges, fees and other ................ 3,939 3,172 2,523
-------- -------- --------
Total other income ........................... $ 29,252 $ 23,442 $ 9,814
======== ======== ========
</TABLE>
Total other income increased by $5.8 million or 24.8% during the year
ended December 31, 1996, as compared to the prior year and increased by $13.6
million or 138.9% during the year ended December 31, 1995. Net gain (loss) on
sale of loans amounted to $11.8 million, $6.3 million and $(1.3) million during
the years ended December 31, 1996, 1995 and 1994, respectively. Net gain (loss)
on sale of loans reflects the income generated from R&G Financial's origination
and purchase of single-family residential real estate loans and the subsequent
securitization and sale of such loans. During the years ended December 31, 1996
and 1995, the adoption of SFAS No. 122 had the effect of increasing net gain on
sales of loans by approximately $3.8 million and $1.6 million, respectively.
During the years ended December 31, 1996, 1995 and 1994, R&G Mortgage originated
and purchased $282.4 million, $185.9 million and $345.8 million, respectively,
and sold $244.8 million, $195.6 million and $357.4 million of mortgage loans,
respectively. In addition, the Bank sold $50.7 million, $75.1 million and $27.0
million of loans from its portfolio during
22
<PAGE>
such respective periods. R&G Financial's mortgage banking operations are highly
dependent upon market and economic conditions.
During the years ended December 31, 1996, 1995 and 1994, R&G Financial
recognized net profit (loss) on trading securities of $(96,000), $2.1 million
and $(4.5) million, respectively. Such gains and losses reflect fluctuations in
the market value of primarily FHA and VA loans which have been securitized into
GNMA mortgage-backed securities and are being held for sale either to
institutions in the secondary market or private investors through the Bank's
Trust Department. In addition, during the year ended December 31, 1996, R&G
Financial recognized $66,000 of net losses on trading activities and from hedge
positions on certain investment securities available for sale. At December 31,
1996, securities held for trading amounted to $13.7 million.
During the year ended December 31, 1994, R&G Financial established an
$856,000 provision to reflect a decline in the market value of loans held for
sale as a result of the increase in market rates of interest which occurred
during the second half of the year. During the year ended December 31, 1995,
market rates of interest subsequently declined and R&G Financial was able to
sell such mortgage loans without recognizing any losses. As a result, R&G
Financial reversed the prior $856,000 provision during the year ended December
31, 1995. No provision was required in 1996.
During the years ended December 31, 1996, 1995 and 1994, R&G Financial
recognized loan administration and servicing fees (consisting of loan servicing
fees) of $13.0 million, $11.0 million and $11.0 million, respectively. The
increase in loan administration and servicing fees over the periods reflects the
increase in R&G Financial's loan servicing portfolio from 43,572 loans with an
aggregate principal balance of $2.1 billion at December 31, 1994 to 51,000 loans
with an aggregate principal balance of $2.6 billion at December 31, 1996.
Service charges, fees and other amounted to $3.9 million, $3.2 million
and $2.5 million during the years ended December 31, 1996, 1995 and 1994,
respectively. The $766,000 or 24.1% increase during the year ended December 31,
1996 over the prior year was primarily attributable to increased service charges
from deposit accounts, primarily associated with the 1995 branch acquisition.
The $649,000 or 25.7% increase during 1995 was primarily due to increased
service charges in the 1995 branch acquisition plus other fee income from
increases in the loan portfolio.
23
<PAGE>
Operating Expenses. The following table sets forth certain information
regarding operating expenses for the periods shown.
Year Ended December 31,
--------------------------------
1996 1995 1994
------- ------- -------
(In Thousands)
Employee compensation and benefits .......... $12,380 $ 8,284 $ 5,252
Office occupancy and equipment .............. 5,531 4,711 4,488
SAIF special assessment ..................... 2,508 -- --
Other administrative and general ............ 13,838 13,731 13,269
------- ------- -------
Total operating expenses .................. $34,257 $26,726 $23,009
======= ======= =======
Total operating expenses increased by $7.5 million or 28.2% during the
year ended December 31, 1996, as compared to the year ended December 31, 1995
and increased by $3.7 million or 16.2% during the year ended December 31, 1995
over 1994. Without taking into consideration the one-time $2.5 million
assessment to recapitalize the SAIF, total operating expenses would have
increased by $5.0 million or 18.8%. The increase in total operating expenses
during the year ended December 31, 1996 was primarily due to increases in each
major category. The 1995 branch acquisition was the primary reason for the
increases in compensation and benefits and occupancy expenses during 1996.
Employee compensation and benefits expense amounted to $12.4 million,
$8.3 million and $5.3 million during the years ended December 31, 1996, 1995 and
1994, respectively. The $4.1 million or 49.4% increase in such expense during
the year ended December 31, 1996 was due to an increase in employees as a result
of the Bank's June 1995 branch acquisition.
Office occupancy and equipment expense amounted to $5.5 million, $4.7
million and $4.5 million and during the years ended December 31, 1996, 1995 and
1994, respectively. The $820,000 or 17.4% increase in such expense recognized by
R&G Financial during the year ended December 31, 1996 reflects the Bank's
acquisition in June 1995 of six branch offices (after closing and consolidating
one branch office) from a local commercial bank and the opening of a new data
center during the first quarter of 1996 as well as greater branch space for
parking and drive-in tellers.
The Company incurred a special assessment of $2.5 million ($1.6 million
net of taxes) as the result of federal legislation signed into law to
recapitalize the federal deposit insurance fund. The legislation enacted by the
U.S. Congress, which was signed by the President on September 30, 1996,
recapitalized the SAIF by a one-time charge of approximately $0.657 for every
$100 of assessable deposits held at March 31, 1995. Future earnings will be
enhanced due to lower insurance premiums. The Bank's insurance
24
<PAGE>
premiums, which has amounted to $0.23 for every $100 of assessable deposits, was
reduced to $0.064 for every $100 of assessable deposits beginning January 1,
1997. Based upon the $657.2 million of assessable deposits at December 31, 1996,
the Bank expects to pay $241,000 less in insurance premiums per quarter during
1997.
Other administrative and general expenses, which consist primarily of
advertising, license and property taxes, amortization of servicing, insurance,
telephone, printing and supplies and other miscellaneous expenses, amounted to
$13.8 million, $13.7 million and $13.3 million during the years ended December
31, 1996, 1995 and 1994, respectively. The $106,000 or 0.8% increase in such
expense during 1996 was primarily the result of general growth in the operations
of R&G Financial and the addition of new products and services offered.
Income Taxes. R&G Financial's income tax provision amounted to $5.9
million during the year ended December 31, 1996, as compared to income tax
expense of $5.9 million and $856,000 during the years ended December 31, 1995
and 1994, respectively. During 1996, R&G Mortgage and the Puerto Rico Treasury
Department settled all taxes due for the years 1989 through and including 1992
which were under audit. The settlement reached was for $1.6 million. The effect
of this settlement was to record additional income tax expense during the year
of $400,000. The remainder of the settlement was reserved for during prior
periods. R&G Financial's effective tax rate amounted to 31.0%, 35.9%, 15.7%
during the years ended December 31, 1996, 1995 and 1994, respectively. R&G
Financial's low effective tax rate during 1994 was due primarily to the
recognition of a deferred tax benefit of $1.7 million during the year.
Effective January 1, 1994, R&G Financial changed its method of
accounting for its mortgage-backed and investment securities pursuant to the
terms of SFAS No. 115. The cumulative effect of this change in accounting
principle resulted in the recognition of $866,000 of unrealized gains with
respect to R&G Financial's securities portfolio during the year ended December
31, 1994.
Liquidity and Capital Resources
Liquidity. Liquidity refers to R&G Financial's ability to generate
sufficient cash to meet the funding needs of current loan demand, savings
deposit withdrawals, principal and interest payments with respect to outstanding
borrowings and to pay operating expenses. It is management's policy to maintain
greater liquidity than required in order to be in a position to fund loan
purchases and originations, to meet withdrawals from deposit accounts, to make
principal and interest payments with respect to outstanding borrowings and to
make investments that take advantage of interest rate spreads. R&G Financial
monitors its liquidity in accordance with guidelines established by R&G
Financial and applicable regulatory requirements. R&G Financial's need for
liquidity is affected by loan demand, net changes in deposit levels and the
scheduled maturities of its borrowings. R&G Financial can
25
<PAGE>
minimize the cash required during the times of heavy loan demand by modifying
its credit policies or reducing its marketing efforts. Liquidity demand caused
by net reductions in deposits are usually caused by factors over which R&G
Financial has limited control. R&G Financial derives its liquidity from both its
assets and liabilities. Liquidity is derived from assets by receipt of interest
and principal payments and prepayments, by the ability to sell assets at market
prices and by utilizing unpledged assets as collateral for borrowings. Liquidity
is derived from liabilities by maintaining a variety of funding sources,
including deposits, advances from the FHLB of New York and other short and
long-term borrowings.
R&G Financial's liquidity management is both a daily and long-term
function of funds management. Liquid assets are generally invested in short-term
investments such as securities purchased under agreements to resell, federal
funds sold and certificates of deposit in other financial institutions. If R&G
Financial requires funds beyond its ability to generate them internally, various
forms of both short and long-term borrowings provide an additional source of
funds. At December 31, 1996, R&G Financial had $108.4 million in borrowing
capacity under unused warehouse lines of credit and $35.0 million in borrowing
capacity under a line of credit with the FHLB of New York. R&G Financial has
generally not relied upon brokered deposits as a source of liquidity, and does
not anticipate a change in this practice in the foreseeable future.
At December 31, 1996, R&G Financial had outstanding commitments
(including unused lines of credit) to originate and/or purchase mortgage and
non-mortgage loans of $378.4 million. Certificates of deposit which are
scheduled to mature within one year totalled $305.0 million at December 31,
1996, and borrowings that are scheduled to mature within the same period
amounted to $152.8 million. R&G Financial anticipates that it will have
sufficient funds available to meet its current loan commitments.
Capital Resources. The FDIC's capital regulations establish a minimum
3.0% Tier I leverage capital requirement for the most highly-rated
state-chartered, non-member banks, with an additional cushion of at least 100 to
200 basis points for all other state-chartered, non-member banks, which
effectively will increase the minimum Tier I leverage ratio for such other banks
from 4.0% to 5.0% or more. Under the FDIC's regulations, the highest-rated banks
are those that the FDIC determines are not anticipating or experiencing
significant growth and have well diversified risk, including no undue interest
rate risk exposure, excellent asset quality, high liquidity, good earnings and,
in general, which are considered a strong banking organization and are rated
composite 1 under the Uniform Financial Institutions Rating System. Leverage or
core capital is defined as the sum of common stockholders' equity (including
retained earnings), noncumulative perpetual preferred stock and related surplus,
and minority interests in consolidated subsidiaries, minus all intangible assets
other than certain qualifying supervisory goodwill and certain purchased
mortgage servicing rights.
The FDIC also requires that banks meet a risk-based capital standard.
The risk-based capital standard for banks requires the maintenance of total
capital (which is defined as Tier
26
<PAGE>
I capital and supplementary (Tier 2) capital) to risk weighted assets of 8%. In
determining the amount of risk-weighted assets, all assets, plus certain off
balance sheet assets, are multiplied by a risk-weight of 0% to 100%, based on
the risks the FDIC believes are inherent in the type of asset or item. The
components of Tier I capital are equivalent to those discussed above under the
3% leverage capital standard. The components of supplementary capital include
certain perpetual preferred stock, certain mandatory convertible securities,
certain subordinated debt and intermediate preferred stock and general
allowances for loan and lease losses. Allowance for loan and lease losses
includable in supplementary capital is limited to a maximum of 1.25% of
risk-weighted assets. Overall, the amount of capital counted toward
supplementary capital cannot exceed 100% of core capital. At December 31, 1996,
the Bank met each of its capital requirements, with Tier I leverage capital,
Tier I risk-based capital and total risk-based capital ratios of 8.45%, 13.91%
and 14.79%, respectively.
In addition, the Federal Reserve Board has promulgated capital adequacy
guidelines for bank holding companies which are substantially similar to those
adopted by FDIC regarding state-chartered banks, as described above. R&G
Financial is currently in compliance with such regulatory capital requirements.
Inflation and Changing Prices
R&G Financial's Consolidated Financial Statements and related data
presented in this Annual Report 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 (except with
respect to securities which are carried at market value), without considering
changes in the relative purchasing power of money over time due to inflation.
Unlike most industrial companies, substantially all of the assets and
liabilities of R&G Financial are monetary in nature. As a result, interest rates
have a more significant impact on R&G Financial's performance than the effects
of general levels of inflation. Interest rates do not necessarily move in the
same direction or in the same magnitude as the prices of goods and services.
Recent Accounting Pronouncements
Set forth below are recent accounting pronouncements which may have a
future effect on R&G Financial's operations. These pronouncements should be read
in conjunction with the significant accounting policies which R&G Financial has
adopted that are set forth in R&G Financial's Notes to Consolidated Financial
Statements.
In June 1996, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities." Pursuant to SFAS No. 125, after a transfer of
financial assets, an entity would be required to recognize all financial assets
and servicing it controls and liabilities it has incurred and, conversely, would
not be required to recognize financial assets when
27
<PAGE>
control has been surrendered and liabilities when extinguished. SFAS No. 125
provides standards for distinguishing transfers of financial assets that are
sales from transfers that are secured borrowings. SFAS No. 125 will be effective
with respect to the transfer and servicing of financial assets and the
extinguishment of liabilities occurring after December 31, 1996, with earlier
application prohibited. In December 1996, the FASB issued SFAS No. 127 to
postpone the effective date of certain of the requirements of SFAS No. 125 to
December 31, 1997. Based on presently available information, management believes
the application of SFAS No. 125 in future years should not have a material
adverse effect on R&G Financial's financial condition or results of operations.
28
<PAGE>
R&G FINANCIAL CORPORATION
REPORT AND CONSOLIDATED
FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995
Price Waterhouse LLP [LOGO]
29
<PAGE>
[LOGO]
R&G FINANCIAL CORPORATION
REPORT AND CONSOLIDATED
FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995
30
<PAGE>
[Letterhead of Price Waterhouse]
REPORT OF INDEPENDENT ACCOUNTANTS
February 14, 1997
To the Board of Directors of
R&G Financial Corporation and its Stockholders
In our opinion, the accompanying consolidated statements of financial condition
and the related consolidated statements of income, of changes in stockholders'
equity and of cash flows present fairly, in all material respects, the financial
position of R&G Financial Corporation (the Company) and its subsidiaries as of
December 31, 1996 and 1995, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
As discussed in Note 1 to the consolidated financial statements, effective
January 1, 1995 the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 122 - "Accounting for Mortgage Servicing Rights, an amendment of FASB
Statement No. 65."
/s/ Price Waterhouse
PRICE WATERHOUSE
CERTIFIED PUBLIC ACCOUNTANTS (OF PUERTO RICO)
License No. 10 Expires on December 1, 1998
Stamp 1392106 of the P.R. Society of Certified Public
Accountants has been affixed to the file copy of this report
31
<PAGE>
R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
ASSETS
December 31,
------------
1996 1995
---- ----
<S> <C> <C>
Cash and due from banks $ 31,989,944 $ 32,559,429
Money market investments:
Securities purchased under agreements to resell 19,633,178 21,694,675
Time deposits with other banks 33,232,809 44,930,015
Federal funds sold 14,000,000 5,011,048
Mortgage loans held for sale, at lower of cost or market 54,450,159 21,318,340
Mortgage - backed securities held for trading, at fair value 108,146,120 113,808,624
Mortgage - backed securities available for sale, at fair value 50,841,165 61,008,432
Mortgage - backed securities held to maturity, at amortized cost
(estimated market value: 1996 - $37,104,391; 1995 - $40,784,831) 37,899,847 41,730,889
Investment securities held for trading, at fair value 1,350,827 --
Investment securities available for sale, at fair value 30,973,260 3,279,610
Investment securities held to maturity, at amortized cost
(estimated market value: 1996 - $5,241,146; 1995 - $1,996,307) 5,269,850 2,046,046
Loans receivable, net 603,750,621 473,840,637
Accounts receivable, including advances to investors, net 5,764,331 5,578,965
Accrued interest receivable 6,632,250 4,051,702
Mortgage servicing rights 12,595,020 8,209,661
Excess servicing receivable 770,408 847,938
Premises and equipment 7,767,680 6,973,325
Other assets 12,730,060 6,316,826
--------------- ---------------
$ 1,037,797,529 $ 853,206,162
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 615,567,481 $ 518,186,563
Securities sold under agreements to repurchase 97,444,448 98,483,188
Notes payable 126,842,099 81,130,032
Advances from FHLB 15,000,000 6,007,135
Long-term debt -- 5,323,899
Other secured borrowings 50,462,619 55,983,501
Accounts payable and accrued liabilities 9,998,768 12,068,490
Other liabilities 3,599,222 2,431,577
--------------- ---------------
918,914,637 779,614,385
Subordinated notes 3,250,000 3,250,000
--------------- ---------------
Minority interest in the Bank -- 3,956,597
--------------- ---------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value, 10,000,000 shares
authorized, none issued and outstanding -- --
Common stock:
Class A - $.01 par value, 10,000,000 shares authorized,
5,122,377 shares issued and outstanding in 1996 (1995 - 5,189,044) 51,223 51,890
Class B - $.01 par value, 15,000,000 shares authorized,
2,735,839 issued and outstanding in 1996 (none in 1995) 27,360 --
Additional paid-in capital:
Class A common stock 357,377 362,710
Class B common stock 38,053,306 --
Retained earnings 75,784,804 64,351,564
Capital reserves of the Bank 1,460,707 666,767
Unrealized (loss) gains on securities available for sale (101,885) 952,249
--------------- ---------------
115,632,892 66,385,180
--------------- ---------------
$ 1,037,797,529 $ 853,206,162
=============== ===============
</TABLE>
The accompanying notes are an integral part of these statements.
32
<PAGE>
R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Interest income:
Loans $ 63,230,751 $ 45,673,241 $ 36,766,741
Money market and other investments 4,364,861 1,805,345 941,677
Mortgage-backed securities 6,190,107 6,033,069 4,655,376
------------ ------------ ------------
Total interest income 73,785,719 53,511,655 42,363,794
------------ ------------ ------------
Less - interest expense:
Deposits 27,517,852 21,829,433 14,460,943
Securities sold under agreements to repurchase 5,023,794 6,436,327 4,416,824
Notes payable 7,283,593 3,363,930 3,769,855
Secured borrowings 4,189,845 -- --
Other 847,607 608,984 578,685
------------ ------------ ------------
44,862,691 32,238,674 23,226,307
------------ ------------ ------------
Net interest income 28,923,028 21,272,981 19,137,487
Provision for loan losses 4,258,047 950,000 --
------------ ------------ ------------
Net interest income after provision for loan losses 24,664,981 20,322,981 19,137,487
------------ ------------ ------------
Other income:
Net gain (loss) on sale of loans 11,804,945 6,262,460 (1,349,340)
Net unrealized profit (loss) on trading securities (95,971) 2,121,611 (4,464,718)
Change in provision for cost in excess of
market value of loans held for sale -- 855,834 (855,834)
Net profit (loss) on trading account (65,656) -- --
Net gain on sales of investment securities available for sale 641,798 --
Loan administration and servicing fees 13,029,053 11,029,995 11,046,019
Gain on sale of servicing rights -- -- 2,914,850
Service charges, fees and other 3,937,878 3,171,949 2,522,394
------------ ------------ ------------
29,252,047 23,441,849 9,813,371
------------ ------------ ------------
Total revenues 53,917,028 43,764,830 28,950,858
------------ ------------ ------------
Operating expenses:
Employee compensation and benefits 12,380,088 8,283,809 5,251,435
Office occupancy and equipment 5,531,129 4,711,312 4,488,335
SAIF special assessment 2,508,380 -- --
Other administrative and general 13,837,330 13,730,724 13,268,875
------------ ------------ ------------
34,256,927 26,725,845 23,008,645
------------ ------------ ------------
Income before minority interest, income taxes and
cumulative effect of change in accounting principle 19,660,101 17,038,985 5,942,213
Minority interest in the Bank 538,168 742,527 499,928
------------ ------------ ------------
Income before income taxes and cumulative
effect of change in accounting principle 19,121,933 16,296,458 5,442,285
------------ ------------ ------------
Income tax expense (credit):
Current 5,687,865 3,555,868 2,517,465
Deferred 234,552 2,291,478 (1,661,877)
------------ ------------ ------------
5,922,417 5,847,346 855,588
------------ ------------ ------------
Income before cumulative effect of change in
accounting principle 13,199,516 10,449,112 4,586,697
Cumulative effect of change in accounting
principle - adoption of SFAS No. 115,
net of deferred income taxes of $627,210 -- -- 866,147
------------ ------------ ------------
Net income $ 13,199,516 $ 10,449,112 $ 5,452,844
============ ============ ============
Earnings per common share:
Income before cumulative effect of change in accounting principle $ 2.18 $ 2.01 $ .88
Cumulative effect of change in accounting principle -- -- .17
------ ------ ------
Net income $ 2.18 $ 2.01 $ 1.05
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
33
<PAGE>
R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
Common Stock Common Stock Additional
Preferred Stock Class A Class B Paid-in capital Capital
Shares Amount Shares Amount Shares Amount Class A Class B reserves
------ ------ ------ ------ ------ ------ ------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1993 $ -- 5,189,044 $51,890 $362,710
Effect of implementation of
SFAS 115
Net income - 1994
Net change in unrealized gain
on securities available for
sale, net of tax
--------- -------- --------- ------- --------- ------- -------- ----------- ----------
Balances at December 31, 1994 -- 5,189,044 51,890 362,710
Transfer to capital reserves $ 666,767
Net income - 1995
Net change in unrealized gain
on securities available for
sale, net of tax
--------- -------- --------- ------- --------- ------- -------- ----------- ----------
Balances at December 31, 1995 5,189,044 51,890 362,710 666,767
Issuance of common stock
(including 66,667 Class B
shares exchanged for
Class A shares):
August 1996 (66,667) (667) 2,435,000 $24,350 (5,333) $31,344,398
December 1996 300,839 3,010 6,708,908
Transfer to capital reserves 793,940
Cash dividend declared on
common stock
Net income - 1996
Net change in unrealized gain
on securities available
for sale, net of tax
--------- -------- --------- ------- --------- ------- -------- ----------- ----------
Balance at December 31, 1996 $ -- 5,122,377 $51,223 2,735,839 $27,360 $357,377 $38,053,306 $1,460,707
========= ======== ========= ======= ========= ======= ======== =========== ==========
</TABLE>
Unrealized gain
(loss) from securities Retained
available for sale earnings Total
---------------------- -------- -----
Balances at December 31, 1993 $49,116,375 $ 49,530,975
Effect of implementation of
SFAS 115 $ 62,473 62,473
Net income - 1994 5,452,844 5,452,844
Net change in unrealized gain
on securities available for
sale, net of tax 923,707 923,707
----------- ----------- ------------
Balances at December 31, 1994 986,180 54,569,219 55,969,999
Transfer to capital reserves (666,767)
Net income - 1995 10,449,112 10,449,112
Net change in unrealized gain
on securities available for
sale, net of tax (33,931) (33,931)
----------- ----------- ------------
Balances at December 31, 1995 952,249 64,351,564 66,385,180
Issuance of common stock
(including 66,667 Class B
shares exchanged for
Class A shares):
August 1996 31,362,748
December 1996 6,711,918
Transfer to capital reserves (793,940)
Cash dividend declared on
common stock (972,336) (972,336)
Net income - 1996 13,199,516 13,199,516
Net change in unrealized gain
on securities available
for sale, net of tax (1,054,134) (1,054,134)
----------- ----------- ------------
Balance at December 31, 1996 $ (101,885) $75,784,804 $115,632,892
=========== =========== ============
The accompanying notes are an integral part of these statements.
34
<PAGE>
R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 13,199,516 $ 10,449,112 $ 5,452,844
------------- ------------- -------------
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 2,142,275 1,794,454 1,335,505
Amortization of premium on investments and
mortgage - backed securities, net 74,354 89,111 140,411
Amortization of deferred loan origination fees
and accretion of discount on loans purchased (411,219) (366,332) (276,631)
Amortization of excess servicing receivable 77,530 131,067 29,828
Amortization of servicing rights 1,213,606 1,497,803 869,201
Compensation cost on common shares granted 290,000 -- --
Change in provision for cost in excess of
market value of loans held for sale -- (855,834) 855,834
Provision for loan losses 4,258,047 950,000 --
Provision for bad debts in accounts receivable 300,000 572,092 358,442
Gain on sales of mortgage loans (599,935) (264,953) (201,797)
Gain on sales of investment securities available for sale
and held for trading (641,798) -- --
Unrealized loss (gain) on trading securities 95,971 (2,121,611) 4,464,718
Gain on sale of mortgage servicing rights -- -- (2,914,850)
Cumulative effect of change in accounting principle -- -- (866,147)
Minority interest in earnings of the Bank 538,168 742,527 499,928
(Increase) decrease in mortgage loans held for sale (33,131,819) 1,558,060 60,006,212
Net decrease (increase) in mortgage-backed
securities held for trading 5,566,533 17,035,709 (36,782,335)
(Increase) decrease in receivables (3,065,914) 1,148,109 (4,035,534)
(Increase) decrease in other assets (3,606,714) (1,812,808) 3,248,178
Increase (decrease) in notes payable 10,212,067 7,915,435 (111,698,229)
(Decrease) increase in accounts payable
and accrued liabilities (1,542,763) 6,442,758 (14,778,486)
Increase (decrease) in other liabilities 1,167,645 934,566 (693,187)
------------- ------------- -------------
Total adjustments (17,063,966) 35,390,153 (100,438,939)
------------- ------------- -------------
Net cash (used in) provided by operating activities (3,864,450) 45,839,265 (94,986,095)
------------- ------------- -------------
Cash flows from investing activities:
Purchases of investment securities (61,289,365) (377,000) (6,044,808)
Proceeds from sales and maturities of investment securities
available for sale 63,127,623 -- 3,691,493
Proceeds from maturities of investment securities
held to maturity 377,000 -- --
Proceeds from sales and maturities of investment securities
held for trading 12,440,170 --
Principal repayments on mortgage-backed securities 10,554,678 8,636,250 8,521,682
Proceeds from sale of loans 51,287,254 20,201,648 27,201,541
Net originations of loans (228,117,154) (210,377,522) (163,236,567)
Proceeds from sales of mortgage servicing rights -- -- 2,914,850
(Purchases) redemptions of FHLB stock, net (967,700) (1,401,700) (156,700)
Acquisition of premises and equipment (2,592,494) (2,926,306) (2,087,651)
Net (increase) decrease in foreclosed real estate (572,814) 83,488 81,339
Acquisition of servicing rights (5,598,965) (5,289,651) (1,000,166)
------------- ------------- -------------
Net cash used by investing activities (161,351,767) (191,450,793) (130,114,987)
------------- ------------- -------------
</TABLE>
Continued
35
<PAGE>
R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Cash flows from financing activities:
Proceeds from issuance of notes payable $ 60,500,000 $ 27,400,000 $ 23,600,000
Payments on notes payable (25,000,000) -- --
Proceeds from issuance of long-term debt -- 2,000,000 1,732,956
Payments of long-term debt (5,323,899) (1,200,274) --
Increase in deposits - net 97,160,090 137,928,057 67,680,706
(Decrease) increase in securities sold
under agreements to repurchase -net (1,038,740) (10,437,272) 108,750,639
Proceeds from secured borrowings -- 55,983,501 --
Payments on secured borrowings (5,520,882) -- --
Advances from FHLB 16,000,000 -- 5,000,000
Repayment of advances from FHLB (7,000,000) (7,500,000) (3,000,000)
Proceeds from issuance of common
stock to minority shareholders -- 10,321 1,309
Proceeds from issuance of common stock on
initial public offering 31,072,748 -- --
Cash dividends on common stock (972,336) -- --
------------- ------------- -------------
Net cash provided by financing activities 159,876,981 204,184,333 203,765,610
------------- ------------- -------------
Net (decrease) increase in cash and cash equivalents (5,339,236) 58,572,805 (21,335,472)
Cash and cash equivalents at beginning of year 104,195,167 45,622,362 66,957,834
------------- ------------- -------------
Cash and cash equivalents at end of year $ 98,855,931 $ 104,195,167 $ 45,622,362
============= ============= =============
Cash and cash equivalents include:
Cash and due from banks $ 31,989,944 $ 32,559,429 $ 21,158,101
Securities purchased under
agreements to resell 19,633,178 21,694,675 10,232,890
Time deposits with other banks 33,232,809 44,930,015 14,231,371
Federal funds sold 14,000,000 5,011,048 --
------------- ------------- -------------
$ 98,855,931 $ 104,195,167 $ 45,622,362
============= ============= =============
</TABLE>
The accompanying notes are an integral part of these statements.
36
<PAGE>
R&G FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - REPORTING ENTITY AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES:
Reporting entity
The accompanying consolidated financial statements of R&G Financial Corporation
(the "Company") include the accounts of R&G Mortgage Corp. ("R&G Mortgage"), a
Puerto Rico corporation, and R-G Premier Bank of Puerto Rico (the "Bank"), a
commercial bank chartered under the laws of the Commonwealth of Puerto Rico. The
Company was formed in March 1996 for the sole purpose of becoming the parent
corporation and sole stockholder of R&G Mortgage and the Bank. On July 19, 1996
the Company acquired the 88% ownership interest of the Bank and the 100%
ownership interest of R&G Mortgage held by the Company's Chairman of the Board
and Chief Executive Officer (CEO). In consideration of the acquisition of such
interests, the Company issued the CEO 5,189,044 shares of its Class A $.01 par
value newly issued common stock (the Class A Shares), in exchange for his 100%
ownership interest in R&G Mortgage and 88% ownership interest in the Bank.
As a result of this transaction, the accompanying consolidated financial
statements have been restated to reflect the consolidated financial condition as
of December 31, 1995, and the related consolidated statements of income and
retained earnings, and of cash flows for the years ended December 31, 1995 and
1994 as if the above transaction had been consummated as of January 1, 1994. The
transaction has been accounted for at historical cost in a manner similar to
pooling of interests accounting.
On December 2, 1996 the Company also acquired the 12% minority ownership
interest in the Bank which, was held by approximately 200 other stockholders
(the Minority Bank Stockholders) through the issuance of 300,839 Class B $.01
par value common stock (the Class B shares) of the Company. All Minority Bank
Stockholders received, in exchange for their aggregate 12% interest in the
Bank's common stock, an aggregate of 300,839 of shares of the Company's Class B
shares which was determined based on an independent valuation of the Bank. This
transaction was accounted under the purchase method of accounting resulting in
the recognition of goodwill totaling approximately $2,578,000 which is being
amortized over a 15 year period. The above exchange transactions, in which the
Company acquires 100% ownership of the Bank as well as R&G Mortgage, are
hereinafter referred to as the "Bank Stockholder Exchange Transaction".
On August 27, 1996, the Company sold 2,348,333 Class B Shares of its Common
Stock to the general public in an underwritten offering. The Company's CEO also
converted 66,667 of his Class A Shares into Class B Shares and sold such shares
in the public offering. As a result of such transaction, an aggregate of
2,415,000 Class B Shares were publicly issued and are now traded on the NASDAQ
Stock Market. The Company received gross proceeds of $35.0 million in the
transaction, which resulted in estimated net proceeds of $31.1 million after
payment of the underwriting discount and expenses. Immediately following the
Company's initial public offering, the Company issued an additional 20,000 Class
B Shares to the Company's Vice Chairman of the Board in consideration for his
past and ongoing services, which shares were not registered in such offering.
37
<PAGE>
R&G Mortgage is engaged primarily in the business of originating FHA insured, VA
guaranteed, and privately insured first and second mortgage loans on residential
real estate (1 to 4 families). R&G Mortgage pools FHA and VA loans into GNMA
(Government National Mortgage Association) mortgage-backed securities and
collateralized mortgage obligation (CMO) certificates for sale to permanent
investors. After selling the loans, it retains the servicing function. R&G
Mortgage is also a Federal National Mortgage Association (FNMA) and Federal Home
Loan Mortgage Corporation (FHLMC) Seller-Servicer of conventional loans. R&G
Mortgage is licensed by the Secretary of the Treasury of Puerto Rico as a
mortgage company and is duly authorized to do business in the Commonwealth of
Puerto Rico.
The Bank provides a full range of banking services through fourteen branches
located mainly in the northern part of the Commonwealth of Puerto Rico. As
discussed in Note 19 to the consolidated financial statements, the Bank is
subject to the regulations of certain federal and local agencies, and undergoes
periodic examinations by those regulatory agencies. As of the close of business
on November 30, 1994 the Bank was converted from a federally chartered savings
bank to a commercial bank chartered under the laws of the Commonwealth of Puerto
Rico.
The accounting and reporting policies of the Company conform with generally
accepted accounting principles. The following is a description of the
significant accounting policies:
Basis of consolidation
All significant balances and transactions have been eliminated in the
accompanying consolidated financial statements.
Use of estimates in the preparation of financial statements
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Securities purchased under agreements to resell
The Company enters into purchases of securities under agreements to resell the
same securities. Amounts advanced under these agreements represent short-term
loans and are reflected as assets in the consolidated statement of financial
condition.
Investment securities
Effective January 1, 1994, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 115 "Accounting for Certain Investments in Debt and Equity
Securities." This Statement addresses the accounting and reporting for
investments in equity securities that have readily determinable fair values and
for all investments in debt securities. Under SFAS No. 115, investments in debt
and equity securities must be classified at acquisition into one of three
categories:
- Held to maturity- debt securities for which there is a positive intent
and ability to hold to maturity. These securities are carried at
amortized cost.
38
<PAGE>
- Trading- debt and equity securities that are bought and held
principally for the purpose of selling them in the near term. These
securities are carried at fair value, with unrealized gains and losses
included in earnings. Mortgage-backed securities that are held for sale
in conjunction with mortgage banking activities are classified as
trading securities.
- Available for sale- debt and equity securities not classified as either
held-to-maturity or trading. These securities are reported at fair
value, with unrealized gains and losses excluded from earnings and
reported net of taxes in a separate component of stockholders' equity.
Upon adoption of SFAS No. 115 on January 1, 1994, the Bank classified as
securities held for trading $2,599,329 of debt securities, and R&G Mortgage
classified approximately $89,597,000 of mortgage-backed securities as trading
securities, recognizing in earnings unrealized gains on these securities
amounting to approximately $866,000 net of $627,000 in deferred income taxes.
These unrealized gains are shown in the consolidated statements of income and
retained earnings under the "cumulative effect of change in accounting principle
adoption of SFAS No. 115."
Pursuant to the FASB special report, "A Guide for the Implementation of
Statement 115 on Accounting for Certain Investments in Debt and Equity
Securities," on December 29, 1995 the Company reclassified mortgage-backed
securities with an amortized cost of $52,448,077 from its held to maturity to
its available for sale portfolio. The unrealized gains of securities
reclassified as available for sale of $565,132 was reported net of estimated
income tax of $220,401 as a separate component of stockholders' equity in the
consolidated statement of financial condition.
Premiums and discounts are amortized as an adjustment to interest income over
the life of the related securities using a method that approximates the interest
method. Realized gains or losses for securities classified as either available
for sale or held to maturity are reported in earnings. Cost of securities is
determined on the specific identification method.
Loans and allowance for loan losses
Loans are stated at their outstanding principal balance, less unearned interest
and allowance for loan losses. Loan origination and commitment fees and costs
incurred in the origination of new loans are deferred and amortized using the
interest method over the life of the loans as an adjustment of interest yield.
Unearned interest on installment loans is recognized as income under a method
which approximates the interest method. Interest on loans not made on a
discounted basis is credited to income based on the loan principal outstanding
at stated interest rates.
Management believes that the allowance for loan losses is adequate. It is the
policy of the Bank to increase its valuation allowances for estimated losses on
loans when, based on management's evaluation, a loss becomes both probable and
estimable. Major loans and major lending areas are reviewed periodically to
determine potential problems at an early date. Also, management's periodic
evaluation considers factors such as loss experience, current delinquency data,
known and inherent risks in the portfolio, identification of adverse situations
which may affect the ability of debtors to repay, the estimated value of any
underlying collateral and assessment of current economic conditions. Additions
to allowances are charged to income. Any recoveries are credited to the
allowance.
39
<PAGE>
Effective January 1, 1995, the Company adopted SFAS No. 114 - "Accounting by
Creditors for Impairment of a Loan" and SFAS No. 118 - "Accounting by Creditors
for Impairment of a Loan - Income Recognition and Disclosures." SFAS No. 114, as
amended by SFAS No. 118, requires a creditor to measure impairment of a loan
based on the present value of expected future cash flows discounted at the
loan's effective interest rate, or, as a practical method, at the observable
market price of the loan, or the fair value of the collateral if the loan is
collateral dependent. This Statement is applicable to all loans, except large
groups of smaller - balance homogeneous loans that are collectively evaluated
for impairment, leases and loans that are evaluated at fair value or at the
lower of cost or fair value. The Bank considers loans over $500,000 for
individual impairment evaluations. Loans are considered impaired when, based on
management's evaluation, a borrower will not be able to fulfill its obligation
under the original terms of the loan. SFAS No. 118 amends the income recognition
provisions that had been included in SFAS No. 114. The adoption of SFAS No. 114
and SFAS No. 118 on January 1, 1995 had no effect on the Company's financial
condition or results of operations for 1995. No loans were impaired as of
December 31, 1996 or 1995.
Interest income
Recognition of interest on mortgage, consumer and other loans is discontinued
when loans are 90 days or more in arrears on payment of principal or interest or
earlier when other factors indicate that collection of interest or principal is
doubtful. Loans for which the recognition of interest income has been
discontinued are designated as non-accruing. Such loans are not reinstated to
accrual status until interest is received currently or no other factors
indicative of doubtful collection exist.
Discounts and premiums on purchased mortgage loans are accreted (amortized) to
income over the remaining life of the loans.
Mortgage loans held for sale
Mortgage loans intended for sale in the secondary market are carried at the
lower of cost or estimated market, computed on the aggregate method. The amount
by which cost exceeds market value is accounted for as a valuation allowance.
Changes in the valuation allowance are included in the determination of income
in the period in which the change occurs.
Loan servicing fees
Loan servicing fees, which are based on a percentage of the principal balance of
the mortgage loans serviced, are credited to income as mortgage payments are
collected. Late charges and miscellaneous other fees collected from mortgagors
are credited to income when earned, adjusted for estimated amounts not expected
to be collected. Loan servicing costs are charged to expense when incurred.
Allowance for doubtful accounts
The allowance for doubtful accounts is determined based on experience and
results mainly from expenses incurred in the foreclosure of property not
reimbursed by insurers on loans serviced for others.
40
<PAGE>
Servicing rights
During 1995, the Company adopted SFAS No. 122 - "Accounting for Mortgage
Servicing Rights - an amendment of FASB Statement No. 65." Prior to
implementation of this Statement, the Company treated mortgage servicing rights
in accordance with SFAS No. 65, which did not allow the recognition of servicing
rights related to loans originated by an entity. SFAS No. 122 amends SFAS No. 65
to permit prospectively the capitalization of servicing rights acquired through
loan origination activities and requires that a portion of the cost of
originating a mortgage loan be allocated to the mortgage servicing right as a
whole. To determine the fair value of the servicing rights, the Company uses the
market prices of comparable servicing sale contracts.
SFAS 122 also requires that all mortgage servicing rights be evaluated for
impairment. In determining impairment, servicing rights were disaggregated into
their predominant risk characteristic, interest rate. For purposes of measuring
impairment, mortgage servicing rights are stratified by pool on the basis of
interest rates. An impairment is recognized whenever the prepayment pattern of
the mortgage pool indicates that the fair value of the related mortgage
servicing rights is less than its carrying amount. An impairment is recognized
by charging such excess to income. The Company determined that no reserve for
impairment was required as of December 31, 1996 or 1995. As of December 31, 1996
and 1995 the fair value of capitalized mortgage servicing rights was
approximately $15,984,000 and $10,420,000, respectively. In determining fair
value, the Company considers the fair value of servicing rights with similar
risk characteristics.
The adoption of this Statement had the effect of increasing net gain on sales of
loans by approximately $1,553,000 and net income by approximately $1,054,000 for
the year ended December 31, 1995, and increasing capitalized servicing rights at
December 31, 1995 by approximately $2,285,000. SFAS 122 prohibits retroactive
application, therefore, mortgage servicing rights related to loans originated
prior to the adoption of the Statement continue to be unrecognized in the
Company's consolidated financial statements.
The cost of acquiring the rights to service mortgage loans is capitalized and
amortized over the period of net servicing revenue. The cost of loan servicing
rights purchased and amortization thereon is periodically evaluated in relation
to estimated future net servicing revenue.
Sale of servicing rights
The sale of servicing rights is recognized upon executing the contract and title
and all risks and rewards have irrevocably passed to the buyer. Gains and losses
realized on such sales are recognized based upon the difference between the
selling price and the carrying value of the related servicing rights sold.
Excess servicing fees receivable
Excess servicing fees receivable represents the present value of the difference
between the contractual interest rate of loans sold, adjusted for normal
servicing fees, and the agreed yield to investors over the estimated remaining
life of such loans. The receivable is realized through receipt of the excess
service fees over time. The cost of excess servicing and the amortization
thereon is periodically evaluated in relation to estimated future net servicing
revenue as a reduction of servicing income. Any impairment in the value of the
excess servicing fees receivable due to actual or anticipated prepayment
experience
41
<PAGE>
is recognized currently as a reduction of excess servicing fees receivable. The
resulting excess servicing fees receivable is amortized over the estimated life
using a method approximating the level-yield method as a reduction of servicing
income.
Foreclosed real estate held for sale
Other real estate owned comprises properties acquired in settlement of loans and
initially recorded at fair value less estimated costs to sell at the date of
acquisition. Costs relating to the development and improvement of the property
are capitalized, whereas those relating to holding the property are expensed as
incurred.
Valuations are periodically performed by management, and an allowance for losses
is established by a charge to operations if the carrying value of a property
exceeds its estimated net realizable value. In providing allowances for losses,
the cost of holding real estate, including interest costs, are considered. Gains
or losses resulting from the sale of these properties are credited or charged to
income.
Premises and equipment
Premises and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are computed using the straight-line
method over the estimated useful life of each type of asset. Major additions and
improvements which extend the life of the assets are capitalized, while repairs
and maintenance are charged to expense.
Effective January 1, 1996 the Company adopted SFAS No. 121 - "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed." This
Statement establishes accounting standards for the impairment of long-lived
assets, certain identifiable intangibles and goodwill related to those assets,
to be held and used. Under such Statement, long-lived assets and certain
identifiable intangibles to be held and used must be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. In performing the review for recoverability, an
estimate of the future cash flows expected to result from the use of the asset
and its eventual disposition must be made. If the sum of the future cash flows
(undiscounted and without interest charges) is less than the carrying amount of
the asset, an impairment loss is recognized. The application of this Statement
had no effect on the Company's financial condition or results of operations for
1996.
Cost in excess of fair value of net assets acquired
The cost in excess of fair value of net assets acquired results from the
acquisition in December 1996 of the 12% minority interest in the Bank as
described in Note 1 to the consolidated financial statements, and from the
acquisition of a mortgage banking institution and the Bank in prior years, which
is being amortized over a twelve year period. Accumulated amortization amounted
to $1,059,636 and $930,509 as of December 31, 1996 and 1995, respectively.
Securities sold under agreements to repurchase
The Company enters into sales of securities under agreements to repurchase the
same or similar securities. Amounts received under these agreements represent
short-term borrowings and the securities underlying the agreements remain in the
asset accounts.
42
<PAGE>
Transfers of receivables with recourse
Transfers of receivables with recourse are recognized as a sale if the Company
surrenders control of the future economic benefits embodied in the receivables,
its obligation under the recourse provisions can be reasonably estimated and
transferee cannot require the Company to repurchase the receivables except
pursuant to the recourse provisions. Any transfers of receivables with recourse
not meeting all of these conditions are recognized as a liability in the
consolidated financial statements.
Gains and losses realized on the sale of loans are recognized at the time of the
sale of the loans or pools to investors, based upon the difference between the
selling price and the carrying value of the related loans sold as adjusted for
any estimated liability under recourse provision. In most sales, the servicing
function for the loans sold is retained by the Company.
Interest rate risk management
The Company enters into interest rate caps, swaps, options and/or futures
(primarily based on Eurodollar certificates of deposits and U.S. Treasury note
contracts) to manage its interest rate exposure. Such instruments are designated
as hedges against future fluctuations in the interest rates of specifically
identified assets or liabilities. Options and futures are reported at fair value
within investments in the accompanying consolidated statement of financial
condition; related gains or losses are reported in the statement of income.
Interest rate caps and swaps are not recognized in the consolidated statement of
financial condition and are not marked to market. Net interest settlements on
interest rate caps and swaps are recorded as adjustments to interest income or
expense.
Employee benefits
The Company and its subsidiaries have no post retirement benefits plan for its
employees as of December 31, 1996 and 1995.
Income taxes
The Company follows an asset and liability approach in the recognition of
deferred tax liabilities and assets for the expected future tax consequences of
temporary differences between the carrying amounts and the tax bases of assets
and liabilities. A valuation allowance is recognized for any deferred tax asset
for which, based on management's evaluation, it is more likely than not (a
likelihood of more than 50%) that some portion or all of the deferred tax asset
will not be realized.
Capital reserve
The Banking Act of the Commonwealth of Puerto Rico requires that a minimum of
10% of net income of the Bank be transferred to capital surplus until such
surplus equals the greater of 10% of total deposits or paid-in capital.
Stock option plans
As discussed in Note 20 to the consolidated financial statements, the Company
adopted a Stock Option Plan in June 1996 and granted stock options to certain
employees thereunder in conjunction with the Company's initial public offering.
Compensation cost on employee stock option plans is measured and recognized for
any excess of the quoted market price of the Company's stock at the grant date
over the
43
<PAGE>
amount an employee must pay to acquire the stock (intrinsic value-based method
of accounting). The Company adopted in 1996 the disclosure - only provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation."
Fair value of financial instruments
The reported fair values of financial instruments are based on a variety of
factors. For a substantial portion of financial instruments, fair values
represent quoted market prices for identical or comparable instruments. In a few
other cases, fair values have been estimated based on assumptions concerning the
amount and timing of estimated future cash flows and assumed discount rates
reflecting varying degrees of risk. Accordingly, the fair values may not
represent actual values of the financial instruments that could have been
realized as of year end or that will be realized in the future.
Accounting for transfers and servicing of financial assets
and extinguishment of liabilities
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." This
Statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities based on
consistent application of a financial-components approach that focuses on
control. Under that approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the liabilities it
has incurred, and stops recognizing financial assets when control has been
surrendered, and liabilities when extinguished.
This Statement requires that liabilities and derivatives incurred or obtained by
transferors as part of a transfer of financial assets be initially measured at
fair value, if practicable. It also requires that servicing assets and other
retained interests in the transferred assets be measured by allocating the
previous carrying amount between the assets sold, if any, and retained interest,
if any, based on their relative fair values at the date of the transfer.
Servicing assets and liabilities must be subsequently measured by (a)
amortization in proportion to and over the period of estimated net servicing
income or loss and (b) assessment for asset impairment or increased obligation
based on their fair value.
This Statement is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996, and must be
applied prospectively. Earlier or retroactive application is not permitted. In
December 1996, the FASB issued SFAS No. 127 to postpone the effective date of
certain of the requirements of SFAS No. 125 to December 31, 1997. Based on
presently available information, management believes the application of this
Statement in future years should not have a material adverse effect on the
Company's financial condition or results of operations.
Earnings per share
Primary earning per common share is computed by dividing net income for the year
by the weighted average number of shares outstanding during the period (1996 -
6,067,034; 1995 and 1994 - 5,189,044). Outstanding stock options granted under
the Company's Stock Option Plan were excluded from the weighted average number
of shares because their dilutive effect is not significant.
Statement of cash flows
For purposes of reporting cash flows, cash and cash equivalents include cash on
hand and amounts due from banks and other highly liquid securities with an
original maturity of three months or less.
44
<PAGE>
Reclassifications
Certain reclassifications have been made to the 1995 financial statements to
conform to the 1996 financial statements presentation.
NOTE 2 - ACQUISITION OF BRANCHES:
On June 16, 1995, the Bank entered into a Purchase and Sale of Assets and
Assumption of Liabilities Agreement (the Agreement) with a commercial bank. As
provided by the Agreement, the Bank purchased seven branches, including
approximately $2,000,000 in assets (which excludes cash from the deposits
acquired) and approximately $77,340,000 in deposits, including $162,000 interest
payable. The premium paid by the Bank over the value of deposits acquired, which
was determined based on negotiations between the parties to the agreement,
approximated $1,351,000 which is being amortized over a 10 year period.
Accumulated amortization amounted to approximately $204,000 and $68,000 at
December 31, 1996 and 1995, respectively.
NOTE 3 - MORTGAGE LOANS HELD FOR SALE:
Mortgage loans held for sale consist of:
December 31,
------------
1996 1995
---- ----
Conventional loans $ 6,538,190 $11,573,273
FHA/VA loans 47,580,083 9,329,694
Construction loans 331,886 415,373
----------- -----------
$54,450,159 $21,318,340
=========== ===========
The aggregate amortized cost and approximate market value of loans held for sale
as of December 31, 1996 are as follows:
Amortized Gross unrealized Gross unrealized Approximate
cost holding gains holding losses market value
---- ------------- -------------- ------------
$54,450,159 $712,535 $(52,220) $55,110,474
=========== ======== ======== ===========
Substantially all of the loans are pledged to secure various borrowing from
lenders under mortgage warehousing lines of credit (see Note 11).
The following table summarizes the components of gain on sale of mortgage loans
held-for-sale and mortgage-backed securities held-for-trading:
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Proceeds from sales of mortgage
loans and mortgage-backed
securities $ 298,567,973 $ 218,738,872 $ 388,939,866
Mortgage loans and mortgage-
backed securities sold (291,739,107) (215,176,557) (384,385,184)
------------- ------------- -------------
Gain on sales, net 6,828,866 3,562,315 4,554,682
Deferred fees earned, net of
loan origination costs
and commitment fees paid 4,976,079 2,700,154 (5,904,022)
------------- ------------- -------------
Net gain (loss) on sale of
mortgage loans $ 11,804,945 $ 6,262,469 $ (1,349,340)
============= ============= =============
45
<PAGE>
Total gross fees on originated loans totaled approximately $13,210,000,
$9,488,000 and $8,244,000 during the years ended December 31, 1996, 1995 and
1994, respectively.
Gross gains of $7,479,507, $4,058,352 and $10,100,121, and gross losses of
$650,641, $496,037 and $5,545,439 were realized on the above sales during the
years ended December 31, 1996, 1995 and 1994, respectively.
NOTE 4 - INVESTMENT SECURITIES:
The carrying value and estimated fair value of investment securities by category
are shown below. The fair value of investment securities is based on quoted
market prices and dealer quotes, except for the investment in Federal Home Loan
Bank (FHLB) stock which is valued at its redemption value.
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
Investment securities held Amortized Fair Amortized Fair
to maturity cost value cost value
---- ----- ---- -----
<S> <C> <C> <C> <C>
U.S. Treasury securities -
Due from five to ten years $ 309,575 $ 310,871 $ -- $ --
---------- ---------- ---------- ----------
Puerto Rico Government obligations:
Due within one year -- -- 377,000 377,000
Due from one to five years 1,034,998 1,012,500 1,042,239 1,000,000
Due over ten years 574,453 566,951 626,807 619,307
---------- ---------- ---------- ----------
1,609,451 1,579,451 2,046,046 1,996,307
---------- ---------- ---------- ----------
Corporate securities -
Due within one year 3,350,824 3,350,824 -- --
---------- ---------- ---------- ----------
$5,269,850 $5,241,146 $2,046,046 $1,996,307
========== ========== ========== ==========
December 31,
------------
1996 1995
---- ----
Mortgage-backed securities Amortized Fair Amortized Fair
held to maturity cost value cost value
---- ----- ---- -----
GNMA certificates:
Due from five to ten years $ 96,696 $ 99,828 $ 118,268 $ 108,197
Due over ten years 21,590,649 20,571,360 24,616,649 23,680,662
----------- ----------- ----------- -----------
21,687,345 20,671,188 24,734,917 23,788,859
----------- ----------- ----------- -----------
Federal National Mortgage
Association (FNMA) certificates-
Due over ten years 15,895,067 16,124,357 16,622,989 16,622,989
----------- ----------- ----------- -----------
Federal Home Loan Mortgage
Corporation (FHLMC) certificates:
Due from five to ten years 317,435 308,846 -- --
Due over ten years -- -- 372,983 372,983
----------- ----------- ----------- -----------
317,435 308,846 372,983 372,983
----------- ----------- ----------- -----------
$37,899,847 $37,104,391 $41,730,889 $40,784,831
=========== =========== =========== ===========
</TABLE>
46
<PAGE>
Expected maturities on debt securities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or repayment penalties.
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
Mortgage-backed securities Amortized Fair Amortized Fair
vailable for sale cost value cost value
---- ----- ---- -----
<S> <C> <C> <C> <C>
CMO residuals and other
mortgage-backed securities $ 7,066,610 $ 8,195,379 $ 7,126,609 $ 8,122,542
----------- ----------- ----------- -----------
FNMA certificates -
Due over ten years 10,562,799 10,293,218 14,845,760 14,946,338
----------- ----------- ----------- -----------
FHLMC certificates:
Due from five to ten years 529,902 547,027 1,122,434 1,180,194
Due over ten years 32,547,150 31,805,541 36,352,565 36,759,358
----------- ----------- ----------- -----------
33,077,052 32,352,568 37,474,999 37,939,552
----------- ----------- ----------- -----------
$50,706,467 $50,841,165 $59,447,368 $61,008,432
=========== =========== =========== ===========
Investment securities
available for sale:
U.S. Government and
agencies securities:
Due within one year $ 1,500,000 $ 1,500,000 $ -- $ --
Due from one to five years 25,527,679 25,225,950 -- --
----------- ----------- ----------- -----------
27,027,679 26,725,950 -- --
FHLB stock 4,247,310 4,247,310 3,279,610 3,279,610
----------- ----------- ----------- -----------
$31,274,989 $30,973,260 $ 3,279,610 $ 3,279,610
=========== =========== =========== ===========
</TABLE>
Mortgage backed securities available for sale include interest only securities
with an amortized cost of $2,363,941 as of December 31, 1996 and 1995, which are
associated with the sale in prior years of collateralized mortgage obligations
not related to the Company's mortgage banking activities.
Mortgage - backed securities held for trading:
December 31,
------------
1996 1995
---- ----
CMO Certificates $ 15,147,000 $ 15,570,414
CMO Residuals (interest only) 8,539,140 9,790,668
GNMA Certificates 84,459,980 88,447,542
------------ ------------
$108,146,120 $113,808,624
============ ============
During 1996 the Company entered into various agreements with an unrelated
investment management firm whereby such firm has been appointed as investment
advisor with respect to a portion of the Company's securities portfolio.
Pursuant to such agreements, this investment advisory firm advises and
recommends management on the purchase and/or sale of otherwise eligible
investments as well as the execution of various hedging strategies to reduce
interest rate risk, mainly through the use of various financial instruments.
Such firm receives an annual management fee of .15% of the average
47
<PAGE>
aggregate principal amount under management of the advisory firm (payable
quarterly) together with a quarterly performance fee of 25% of the net trading
profits earned during each calendar quarter. At December 31, 1996, this
investment advisory firm was managing Company assets with a market value of
approximately $33.0 million. Such assets were invested as follows:
Held-for-trading securities Amortized cost Fair value
-------------- ----------
U.S. Treasury Bills $ 1,370,446 $ 1,315,726
Money market investments 12,351,180 12,351,180
Option contracts 70,312 70,312
----------- -----------
13,791,938 13,737,218
Available-for-sale securities
U.S. Government and agencies
securities 19,525,767 19,225,950
----------- -----------
$33,317,705 $32,963,168
=========== ===========
The interest rate risk on the above available for sale securities are being
hedged with options and financial futures contracts based on U.S. Treasury
securities and Eurodollars; at December 31, 1996 no futures contracts were
outstanding. Option contracts at December 31, 1996 consists of put and call
options on futures contracts with notional amounts of $10,000,000 and
$10,000,000, respectively, based on U.S. Treasury securities and expiring in
February 1997. Such firm also executes hedging strategies on behalf of the
Company for all mortgage-backed securities held for trading or available for
sale (excluding CMO's). Mortgage-backed securities held for trading and
available for sale for which the Company enters into hedging contracts had a
fair value of approximately $149.1 million at December 31, 1996. Effective
January 1, 1997 the Company discontinued hedging activities for its mortgage
backed securities held for trading.
Unrealized gains and losses of securities held to maturity and available for
sale follows:
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
Gross unrealized Gross unrealized
---------------- ----------------
Securities held to maturity: Gains Losses Gains Losses
----- ------ ----- ------
<S> <C> <C> <C> <C>
Puerto Rico and United States
Government obligations $ 13,795 $ (42,499) $ -- $ (49,739)
Mortgage-backed securities 338,941 (1,134,397) -- (946,058)
----------- ----------- ----------- -----------
$ 352,736 $(1,176,896) $ -- $ (995,797)
=========== =========== =========== ===========
Securities available for sale:
US Government Obligations $ -- $ (301,729) $ -- $ --
Mortgage-backed securities 1,003,887 (869,183) 1,744,790 (183,726)
----------- ----------- ----------- -----------
$ 1,003,887 $(1,170,912) $ 1,744,790 $ (183,726)
=========== =========== =========== ===========
</TABLE>
48
<PAGE>
During 1996 the Company had proceeds from the sale of investment securities held
for trading of approximately $11,440,000 and realized approximately $44,000
gains on such sales; no losses were realized. No investment securities held for
trading were sold in 1995 or 1994. During the year ended December 31, 1996
proceeds from the sale of securities available for sale totaled approximately
$48,950,000; gains realized in those sales totaled approximately $598,000; no
losses were realized. There were no sales of securities held to maturity or
available for sale during 1995. During 1994 proceeds from the sale of securities
available for sale sold at their carrying value amounted to approximately
$3,691,000; there were no sales of securities held to maturity.
During 1995, the Company reclassified investment securities from its available
for sale to its held for trading portfolio with a carrying value of
approximately $4,671,000 at the time of the transfer, resulting in an increase
in net income of $470,092 for 1995 at such time.
As discussed in Notes 9, 10, 11, 13 and 15 to the consolidated financial
statements, investment securities, mortgage loans, and deposits at interest with
banks amounting to approximately $299,146,000 were pledged to secure certain
deposits and securities sold under agreements to repurchase, advances from the
FHLB, notes payable, subordinated notes and irrevocable standby letters of
credit issued by the FHLB as of December 31, 1996.
NOTE 5 - LOANS AND ALLOWANCE FOR LOAN LOSSES:
Loans consist of the following:
December 31,
------------
1996 1995
---- ----
Real estate loans:
Residential - first mortgage $ 370,875,512 $ 282,497,680
Residential - second mortgage 15,757,050 14,371,526
Construction 5,351,115 15,045,844
Commercial 75,214,109 67,385,930
------------- -------------
467,197,786 379,300,980
Undisbursed portion of loans in process (2,429,714) (5,726,693)
Net deferred loan fees 40,555 (265,768)
------------- -------------
464,808,627 373,308,519
------------- -------------
Other loans:
Commercial 31,062,947 27,816,427
Consumer:
Loans secured by deposits 9,408,892 7,496,575
Loans secured by real estate 42,893,213 33,381,540
Other 59,864,037 37,179,182
Unamortized discount (278,320) (383,216)
Unearned interest (677,130) (1,448,139)
------------- -------------
142,273,639 104,042,369
------------- -------------
Total loans 607,082,266 477,350,888
Allowance for loan losses (3,331,645) (3,510,251)
------------- -------------
$ 603,750,621 $ 473,840,637
============= =============
49
<PAGE>
The changes in the allowance for loan losses follow:
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Balance, beginning of year $ 3,510,251 $ 2,887,099 $ 3,028,541
Provision for loan losses 4,258,047 950,000 --
Loans charged-off (4,662,407) (508,946) (100,142)
Recoveries 225,754 182,098 --
Other -- -- (41,300)
----------- ----------- -----------
Balance, end of year $ 3,331,645 $ 3,510,251 $ 2,887,099
=========== =========== ===========
On August 29, 1996, as a result of a review of its loan portfolio, management of
the Bank became aware of certain potential loan losses related to the operation
of its insurance premiums financing business and began an intensive
investigation. The investigation uncovered certain irregularities with respect
to the origination and administration of a number of loans in contravention of
established Bank policies by the former loan officer in charge of the
department. Management has notified the appropriate regulatory enforcement
authorities. Management, based on a review of the collectibility of the loans in
question, believes that the reserves established of approximately $2.5 million
are sufficient to cover estimated losses which may result from this matter.
Notwithstanding the reserve established, management believes it has meritorious
claims under its fidelity insurance policy and is vigorously pursuing a claim
filed thereunder with respect to this matter.
As of December 31, 1996, 1995 and 1994, loans on which the accrual of interest
income had been discontinued amounted to approximately $18,730,000, $10,032,000
and $6,002,000, respectively. The additional interest income that would have
been recognized during 1996, 1995 and 1994 had these loans been accruing
interest amounted to approximately $864,000, $261,000 and $121,000,
respectively. The Company has no material commitments to lend additional funds
to borrowers whose loans were in non-accruing status at December 31, 1996.
NOTE 6 - MORTGAGE LOAN SERVICING:
The Company's fees for servicing mortgage loans generally range from .25% to
.50% on the declining outstanding principal balances of the mortgage loans
serviced. Servicing fees are collected out of payments from mortgagors on a
monthly basis. The servicing agreements are terminable by permanent investors
for cause without penalty or after payment of a termination fee ranging from .5%
to 1% of the outstanding principal balance of the loans. At December 31, 1996
and 1995, the mortgage loans servicing portfolio amounted to approximately
$2,226,406,000 and $2,007,435,000, respectively, excluding approximately
$323,762,000 and $290,765,000, respectively, serviced for the Bank.
The changes in the mortgage servicing rights are as follows:
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Balance at beginning of period $ 8,209,661 $ 4,417,813 $ 4,286,848
Capitalization of rights 4,172,868 2,285,331
Rights purchased 1,426,097 3,004,320 1,000,166
Scheduled amortization (1,213,606) (1,497,803) (869,201)
------------ ------------ ------------
Balance at end of period $ 12,595,020 $ 8,209,661 $ 4,417,813
============ ============ ============
50
<PAGE>
During 1994, the Company sold the servicing rights not recognized in financial
statements for mortgage loans previously originated by the Company, with an
outstanding principal balance of $220,990,000 at a gain of $2,914,850. There
were no sales of servicing rights during the years ended December 31, 1996 or
1995.
Among the conditions established in its various servicing agreements, the
Company is committed to advance from its own funds any shortage of monies
required to complete timely payments to investors in GNMA mortgage-backed
securities issued and in its FHLMC portfolio. At December 31, 1996, the mortgage
loan portfolio serviced for GNMA, FNMA and FHLMC and subject to the timely
payment commitment amounted to approximately $1,543,242,000, $61,565,000 and
$377,252,000, respectively (1995 - $1,427,203,000, $46,961,000, and
$312,082,000).
Total funds advanced as of December 31, 1996 in relation to such commitments
amount to $1,313,000, $787,000 and $344,000 for escrow advances, principal and
interest advances and foreclosure advances, respectively (1995 - $1,119,900,
$95,784 and $522,757).
In connection with mortgage servicing activities, the Company holds funds in
trust for investors representing amounts collected primarily for the payment of
principal, interest, real estate taxes and insurance premiums. Such funds are
deposited in separate custodial bank accounts and are not commingled with the
Company's operating and other funds. At December 31, 1996 and 1995, the related
escrow funds amounting to approximately $38,977,000 and $30,839,000,
respectively, are excluded from the Company's assets and liabilities. These
funds include at December 31, 1996 and 1995 approximately $10,555,000 and
$13,948,000, respectively, deposited in the Bank.
NOTE 7 - EXCESS SERVICING FEES RECEIVABLE:
The changes in excess servicing fees receivable are shown below:
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Balance at beginning of period $ 847,938 $ 979,005 $ 198,920
Additions 809,913
Scheduled amortization (77,530) (131,067) (29,828)
--------- --------- ---------
Balance at end of period $ 770,408 $ 847,938 $ 979,005
========= ========= =========
NOTE 8 - PREMISES AND EQUIPMENT:
Premises and equipment consist of:
December 31,
------------
1996 1995
---- ----
Furniture and fixtures $ 10,135,761 $ 8,420,457
Leasehold improvements 5,186,573 4,500,991
Autos 205,962 27,900
------------ ------------
15,528,296 12,949,348
Less - Accumulated
depreciation and amortization (7,760,616) (5,976,023)
------------ ------------
$ 7,767,680 $ 6,973,325
============ ============
51
<PAGE>
NOTE 9 - DEPOSITS:
Deposits are summarized as follows:
December 31,
------------
1996 1995
---- ----
Passbook savings $ 73,965,054 $ 73,471,042
------------ ------------
NOW accounts 24,555,925 21,233,410
Super NOW accounts 57,629,203 52,405,683
Regular checking accounts
(non-interest bearing) 23,236,975 19,073,123
Commercial checking accounts
(non-interest bearing) 31,007,473 33,925,790
------------ ------------
136,429,576 126,638,006
------------ ------------
Certificates of deposit:
Under $100,000 235,061,722 194,657,528
$100,000 and over 168,614,740 122,144,426
------------ ------------
403,676,462 316,801,954
------------ ------------
Accrued interest payable 1,496,389 1,275,561
------------ ------------
$615,567,481 $518,186,563
============ ============
The weighted average stated interest rate on all deposits at December 31, 1996
and 1995 was 5.07% and 5.03%, respectively.
As of December 31, 1996, the Company had investment securities with a carrying
value of approximately $1,500,000 and market value of approximately $1,505,000
pledged as collateral for public funds deposits of approximately $1,665,000.
NOTE 10 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE:
At December 31, 1996 and 1995, the Company had a liability of $97,444,448 and
$98,483,188, respectively, excluding interest payable amounting to $49,618 and
$169,821 relating to such agreements with interest ranging from 5.48% to 5.75%
in 1996 and 5.11% to 7.5% in 1995. These agreements mature within thirty days.
52
<PAGE>
Information on these agreements follows:
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
Approximate market Approximate market
Repurchase and carrying value of Repurchase and carrying value of
Type of security liability underlying securities liability underlying securities
- ---------------- --------- --------------------- --------- ---------------------
<S> <C> <C> <C> <C>
GNMA $75,710,383 $ 79,627,257 $64,448,500 $ 66,480,368
CMO Tranches 13,576,384 15,147,000 13,576,384 15,570,414
CMO Residuals 8,157,681 8,593,151 9,933,304 9,790,668
FHLMC -- -- 10,525,000 10,872,213
----------- ------------ ----------- ------------
$97,444,448 $103,367,408 $98,483,188 $102,713,663
=========== ============ =========== ============
</TABLE>
Maximum amount of borrowings outstanding at any month-end during 1996 and 1995
under the agreements to repurchase were $127,240,000 and $127,094,000,
respectively. The approximate average aggregate balance outstanding during the
periods were $101,082,000 and $107,026,000, respectively. The weighted average
interest rate of such agreements was 5.67% and 5.33% at December 31, 1996 and
1995, respectively; the average rate during 1996 and 1995 was 5.35% and 5.30%,
respectively.
Since repurchase agreements are short-term commitments to borrow funds, they can
be assumed to reprice at least quarterly. Therefore, the outstanding balance of
repurchase agreements is estimated to be its fair value.
Securities sold under agreements to repurchase are classified by dealer as
follows:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
------------------ -----------------
Approximate market Approximate market
Balance of value of Balance of value of
borrowing underlying securities borrowing underlying securities
--------- --------------------- --------- ---------------------
<S> <C> <C> <C> <C>
Citibank, N.A. $56,330,448 $ 62,150,725 $24,027,858 $ 25,800,678
Merrill Lynch 11,200,000 11,742,604 16,685,000 17,145,249
Paine Webber, Inc. of Puerto Rico 29,914,000 29,474,079 27,495,000 28,668,580
Lehman Brothers Puerto Rico, Inc. -- -- 18,690,000 19,571,548
BP Capital Markets -- -- 7,615,000 7,841,524
Banco Santander of Puerto Rico -- -- 3,970,330 3,686,084
----------- ------------ ----------- ------------
$97,444,448 $103,367,408 $98,483,188 $102,713,663
=========== ============ =========== ============
</TABLE>
The securities underlying such agreements were delivered to, and are being held
by, the dealers with whom the securities sold under agreements to repurchase
were transacted. The dealers may have sold, lent, or otherwise disposed of such
securities to other parties in the normal course of their operations, but have
agreed to resell the Company the same or similar securities at the maturities of
the agreements. All agreements mature within thirty days.
53
<PAGE>
NOTE 11 - NOTES PAYABLE:
Notes payable consist of:
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<S> <C> <C>
Working capital loans, bearing interest averaging 8.88% in 1995 $ -- $ 4,000,000
Warehousing lines, bearing interest at a floating rate of 1.50%
over the bank's cost of funds (6.48% in 1996 and 6.77% in 1995) 40,342,099 26,130,032
Promissory notes maturing in 1999 paying semiannual interest at
fixed annual rates ranging from 6.20% to 7.15% 23,600,000 23,600,000
Promissory notes maturing in 2000 paying semiannual interest at
fixed annual rates ranging from 5.55% to 5.67% 15,000,000 15,000,000
Promissory note maturing in 2000 paying quarterly interest at a
floating rate of 84% of the three month LIBID rate less .125%
(4.62% at December 31, 1996 and 4.88% at December 31, 1995) 10,000,000 10,000,000
Promissory note maturing in 2003 paying semiannual interest at a
fixed annual rate of 5.50% 2,400,000 2,400,000
Promissory note maturing in 2001 paying quarterly interest at a
floating rate of 96% of the three month Libid rate (5.28% at
December 31, 1996) 25,000,000 --
Promissory note maturing in 2001 paying semiannual interest at a
fixed annual rate of 6.52% 10,500,000 --
------------ -----------
$126,842,099 $81,130,032
============ ===========
</TABLE>
As of December 31, 1996, the Company had various credit line agreements
permitting the Company to borrow up to $108,425,000 and $35.0 million in
borrowing capacity under a line of credit with the FHLB of New York (FHLB -NY).
These borrowings are collateralized by approximately $47,912,000 mortgage loans
held for sale, an assignment of key man insurance policies on the Company's
Chairman of the Board and Chief Executive Officer and a general assignment of
mortgage payments receivable. These borrowings bear interest at rates related to
the respective bank's prime rate or the Puerto Rico 936 funds market. Some of
these borrowings are also guaranteed by the Chairman of the Board and Chief
Executive Officer of the Company. Several credit line agreements impose certain
restrictions on the Company of which the most important include maintaining net
worth and working capital over certain defined minimums and limitations on
indebtedness and declaration of dividends. Management believes that at December
31, 1996 the Company was in compliance with the loan agreements.
The following information relates to borrowings of the Company under the credit
line agreements:
1996 1995
---- ----
Maximum aggregate borrowings
outstanding at any month end $85,134,732 $31,625,917
=========== ===========
Approximate average aggregate borrowings
outstanding during the year $40,278,743 $22,020,749
=========== ===========
Weighted average interest rate, during
the year computed on a monthly basis 6.61% 6.92%
==== ====
Weighted average interest rate
at end of year 6.48% 6.77%
==== ====
54
<PAGE>
Certain promissory notes include pledge agreements where the Company has pledged
certain negotiable securities as a guarantee for payment of some of the notes
totaling $41,000,000 at December 31, 1996. The pledge agreements provide that
the value of the pledged securities must not fall below 105% of the principal
balance of the promissory note plus accrued interest on such amount. In the
event that the securities' value falls below the stated percentage, the Company
must deliver additional negotiable securities. At December 31, 1996 securities
pledged in compliance with this requirement consist of mortgage backed
securities with a carrying value of approximately $43,003,000 and approximate
market value of $42,468,000. At December 31, 1996 floating rate notes of
$35,000,000 and fixed rate notes of $10,500,000 are guaranteed by letters of
credit issued by the FHLB -NY.
NOTE 12 - LONG-TERM DEBT:
Long-term debt consisted of the following at December 31, 1995:
Notes payable bearing annual interest ranging from 7.46%
to 10.50%, due in quarterly installments of $41,683 and
maturing in 1996 $ 82,748
Note payable bearing annual interest at 6.95%, due in
monthly installments of $41,667 and maturing on
September 1, 1998 1,374,991
Note payable bearing annual interest at 7.46% due in
quarterly installments of $133,316 beginning on September
1, 1994 through June 1, 1999 1,866,160
Note payable bearing annual interest at 7.50% due in
quarterly installments of $100,000 beginning on October
27, 1995 through October 1, 2000 2,000,000
----------
$5,323,899
==========
During August 1996 all of the above notes were paid.
NOTE 13 - ADVANCES FROM THE FEDERAL HOME LOAN BANK
Advances from the FHLB-NY are as follows:
December 31,
Interest ------------
Maturity Rate 1996 1995
-------- ---- ---- ----
February 28, 1997 5.78% $ 5,000,000 $ --
March 31, 1997 5.73% 5,000,000 --
June 27, 1997 5.74% 5,000,000 --
April 23, 1996 7.21% -- 1,000,000
August 15, 1996 6.65% -- 5,000,000
Market value adjustment -- 7,135
----------- -----------
$15,000,000 $ 6,007,135
=========== ===========
Weighted average stated interest rate 5.75% 6.74%
==== ====
55
<PAGE>
The Bank receives advances from the FHLB - NY under an Advances, Collateral
Pledge and Security Agreement (the "Agreement"). Under the Agreement, the Bank
is required to maintain a minimum amount of qualifying collateral with a market
value of at least 110% of the outstanding advances. In addition, the Bank
maintains standby letters of credit with the FHLB - NY amounting to
approximately $54,269,000 at December 31, 1996. At December 31, 1996 the
specific collateral (in the form of first mortgage notes, securities and cash
deposits) amounting to approximately $100,769,000 were pledged to the FHLB-NY as
part of the Agreement and to secure standby letters of credit. At December 31,
1996, the market value of collateral indicated above was sufficient to comply
with the provisions of the Agreement.
NOTE 14 - OTHER SECURED BORROWINGS:
In December 1995, the Bank sold mortgage loans with an approximate outstanding
balance of $55 million to two commercial banks (buyers). In connection with this
transaction, R&G Mortgage assumed certain recourse provisions and guaranteed a
specific yield of 7.75% to the buyers. In addition, the buyers have the right
(put option) at their option, to require R&G Mortgage to purchase the mortgage
loans in December 2000 or thereafter. Liability, if any, under the recourse
provisions at December 31, 1995 is estimated by management to be insignificant.
As part of the agreement, R&G Mortgage will have the right to repurchase after
December 1996 any group of loans sold. If this option is exercised, R&G Mortgage
will be obligated to pay the buyers 50 basis points over the outstanding balance
of the mortgage loans so repurchased.
The Company has recognized the transaction as a transfer of loans with recourse
not qualifying as a sale. Accordingly, the proceeds from the transaction were
reported as a secured borrowing in the accompanying consolidated financial
statements, with a balance of approximately $55,984,000 and $50,463,000 at
December 31, 1995 and 1996, respectively. The outstanding principal of the
related loans totaling approximately $49,740,000 and $55,156,000 have been
included as assets at December 31, 1996 and 1995, respectively.
NOTE 15- SUBORDINATED NOTES:
On June 14, 1991 the Bank issued $3,250,000 in subordinated capital notes
bearing interest at 8% payable quarterly. These notes are guaranteed by R&G
Mortgage and by the Company's Chairman of the Board and Chief Executive Officer,
and by an irrevocable transferable letter of credit issued by a commercial bank.
The Bank shall deposit in seven equal annual installments (the first of which
was made in September 1992 and the last deposit is scheduled for June 1998) with
a trustee for credit to an established sinking fund, cash or a permitted
investment in an amount sufficient to retire one-seventh (1/7) or $464,286, of
the aggregate principal amount. Likewise, the letter of credit is reduced in
equal proportion to the deposits in such sinking fund.
Investments deposited in the Trust as of December 31, 1996 in compliance with
this requirement consist of FHLMC Participation Certificates with a carrying
value of approximately $1,386,000 and approximate market value of $1,385,000,
and $1,739,000 in special deposit accounts.
56
<PAGE>
NOTE 16 - INCOME TAXES:
Under the Puerto Rico tax law R&G Mortgage's and the Bank's tax liability will
be the greater of the tax computed under the regular tax system or the
alternative minimum tax (AMT) system. The AMT is imposed based on 22% of regular
taxable income after certain adjustments for preference items. An AMT credit may
be claimed for tax paid on an AMT basis in excess of the regular tax basis. R&G
Mortgage and the Bank are separate taxable entities under the Puerto Rico Income
Tax Law and are not entitled to file consolidated tax returns.
Prior to the conversion to a Puerto Rico chartered commercial bank on November
30, 1994, the Bank as a corporation formerly organized under the laws of the
United States, was subject to United States income tax with respect to all of
its income including income from sources within Puerto Rico. For United States
income tax purposes the Bank elected to be treated as a possessions corporation
pursuant to Section 936 of the Internal Revenue Code of 1986 (the "Code").
Section 936 of the Code allowed the Bank to claim a credit, (the "Section 936
Credit"), subject to qualification of the source and nature of the income and
certain other limitations, for the United States income tax on income derived
from sources outside of the United States that was attributable to the active
conduct of a trade or business in Puerto Rico ("Qualifying Active Income").
The credit granted under Section 936 was a full credit against the United States
income tax imposed on Qualifying Active Income. The Section 936 credit, as
described, was claimed by the Bank for its taxable years beginning before
November 30, 1994 therefore resulting in no United States income taxation on its
Qualifying Active Income.
For Puerto Rico income tax purposes prior to the conversion, the Bank was taxed
as a foreign corporation engaged in a trade or business in Puerto Rico. As such,
the Bank was subject to Puerto Rico income tax on all of its income from sources
within Puerto Rico and income from sources outside Puerto Rico that was
effectively connected with its Puerto Rico business.
As a Puerto Rico chartered commercial bank, the Bank is subject to Puerto Rico
income tax on its income derived from all sources. The Bank is also subject to
United States income taxes on certain types of income from such source. However,
any United States income tax paid by the Bank is, subject to certain conditions
and limitations, creditable as a foreign tax credit against its Puerto Rico
income tax liability.
A portion of the Company's interest income arises from mortgage loans and
mortgage-backed securities which are exempt for Puerto Rico income tax purposes.
The elimination of such items from the determination of taxable income results
in a reduction of its income tax liability.
57
<PAGE>
Deferred tax (assets) liabilities are as follows:
December 31,
------------
1996 1995
---- ----
Deferred tax liabilities:
Deferred net loan origination costs $ 385,019 $ 235,910
Collateralized mortgage obligation residuals 921,937 1,310,350
Mortgage servicing rights 1,504,670 462,783
Unrealized gain on securities available for sale -- 608,815
Excess servicing 391,564 444,577
----------- -----------
3,203,190 3,062,435
----------- -----------
Deferred tax assets:
Unrealized loss on securities available for sale (65,140) --
Allowance for loan losses (272,593) --
Reserve for bad debts (11,483) --
Unrealized loss on securities held for trading (124,991) (87,711)
Other foreclosed property reserve (22,805) (12,479)
Deferred gains on sale of loans and investments
securities for book purposes (505,999) (322,663)
----------- -----------
(1,003,011) (422,853)
----------- -----------
Net deferred tax liability $ 2,200,179 $ 2,639,582
=========== ===========
The provision for income taxes of the Company varies from amounts computed by
applying the applicable Puerto Rico statutory tax rate to income before taxes as
follows:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
% of pretax % of pretax % of pretax
Amount income Amount income Amount income
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Computed income tax at statutory rate $ 7,458 39% $ 6,845 42% $ 2,286 42%
Effect on provision of:
Tax-exempt interest (2,352) (12) (1,661) (10) (2,705) (50)
Non-deductible expenses 423 2 663 4 1,275 24
Tax settlement 393 2 -- -- -- --
------- ------- ------- ------- ------- -------
$ 5,922 31% $ 5,847 36% $ 856 16%
======= ======= ======= ======= ======= =======
</TABLE>
On June 29, 1996, the Company settled with the Puerto Rico Treasury Department
(PRTD) an income tax examination of R&G Mortgage's income tax returns for the
years 1989 to 1992. While the Company believes that it had valid defenses for
its positions, management believes that it was in the Company's best interest to
settle the case rather than entering into an expensive, protracted negotiation
with the PRTD. The settlement reached was for approximately $1.6 million
(including interest totaling approximately $510,000). The effect of this
settlement was to record additional income tax expense in 1996 of approximately
$400,000. The remainder of the settlement was reserved for during prior years.
58
<PAGE>
In October 1994, a Puerto Rico Tax Reform Act (the Reform) was approved to amend
existing tax laws into the "1994 Puerto Rico Internal Revenue Code". The Reform,
among other changes, incorporates tax rate reductions for corporations effective
for taxable years beginning after June 30, 1995. The maximum tax rate (normal
and surtax) was reduced from 42% to 39%.
NOTE 17 - OTHER OPERATING EXPENSES:
Other operating expenses consist of the following:
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Advertising $ 2,415,177 $ 1,586,351 $ 2,047,870
Stationary and supplies 895,196 740,666 569,540
Telephone 643,015 597,058 763,433
License and other taxes 1,420,047 1,104,564 758,598
SAIF insurance 652,749 954,537 702,343
Other insurance 544,748 551,407 441,447
Professional services 658,516 890,992 929,906
Amortization of mortgage
servicing rights 1,213,606 1,497,803 869,201
Other 5,394,276 5,807,346 6,186,537
----------- ----------- -----------
$13,837,330 $13,730,724 $13,268,875
=========== =========== ===========
NOTE 18 - RELATED PARTY TRANSACTIONS:
During March 1996, the Company declared and paid $500,000 cash dividends to its
Class A common stockholder.
The Company leases its office facilities from an affiliate on a month-to-month
basis. The annual rental under this agreement is approximately $968,000.
Loans to directors, officers and employees of the Company were made in the
ordinary course of business. Interest rates on such loans were substantially the
same as those prevailing at the time for comparable transactions with unrelated
parties and did not involve more than a normal risk of collectibility. At
December 31, 1996 the aggregate amount of loans outstanding to officers,
directors, and principal stockholders' of the Company and its subsidiaries were
insignificant.
NOTE 19 - REGULATORY REQUIREMENTS:
The Company is approved by the Board of Governors of the Federal Reserve System
(Federal Reserve Board) as a registered bank holding company pursuant to the
Bank Holding Company Act of 1956, as amended. The Company became a bank holding
company in connection with its acquisition of the 88.05% interest in the Bank
held by the Company's Chairman of the Board and Chief Executive Officer (which
excludes his required qualifying shares as a director of the Bank) in exchange
for the Company's Class A Shares.
59
<PAGE>
The Company, as a bank holding company, is subject to regulation and supervision
by the Federal Reserve Board and the Commissioner of the Office of Financial
Institutions of Puerto Rico (the Commissioner). The Federal Reserve Board has
established guidelines regarding the capital adequacy of bank holding companies,
such as the Company. These requirements are substantially similar to those
adopted by the FDIC for depository institutions, as set forth below.
The Bank is incorporated under the Puerto Rico Banking Act, as amended and is
subject to extensive regulation and examination by the Commissioner, the FDIC
and certain requirements established by the Federal Reserve Board.
The mortgage banking business conducted by R&G Mortgage is subject to the rules
and regulations of FHA, VA, FNMA, FHLMC, GNMA and the Commissioner with respect
to originating, processing, selling and servicing mortgage loans and the
issuance and sale of mortgage-backed securities. R&G Mortgage's affairs are also
subject to supervision and examination by FNMA, FHA, FHLMC, GNMA, HUD and VA at
all times to assure compliance with the applicable regulations, policies and
procedures. Mortgage origination activities are subject to, among others, the
Equal Credit Opportunity Act, Federal Truth-in-Lending Act and the Real Estate
Settlement Procedures Act and the regulations promulgated thereunder.
The Company is subject to various regulatory capital requirements administered
by the federal banking agencies. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company must meet
specific capital guidelines that involve quantitative measures of the Company's
assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. The Company's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors. Quantitative measures
established by regulation to ensure capital adequacy requires the Company and
the Bank to maintain minimum amounts and ratios (set forth in the table below)
of total and Tier I capital (as defined in the regulations) to risk-weighted
assets (as defined), and of Tier I capital (as defined) to average assets (as
defined). Failure to meet capital requirements can initiate certain mandatory
and possibly additional discretionary-actions by regulators that, if undertaken,
could have a direct material effect on the Company's financial statements. As of
December 31, 1996, the Company meets all capital adequacy requirements to which
it is subject.
As of December 31, 1996, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the Bank must maintain
minimum total risk-based, Tier I risk-based, Tier I leverage ratios as set forth
in the table below. There are no conditions or events since that notification
that management believes have changed the Bank's category.
60
<PAGE>
The following table reflects the Company's and the Bank's actual capital amounts
and ratios, and applicable regulatory capital requirements at December 31, 1996
and 1995:
<TABLE>
<CAPTION>
To be well capitalized
For capital under prompt corrective
Actual adequacy purposes action provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
($ in thousands)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1996
Total capital (to risk
weighted assets):
Consolidated $113,644 17.45% $52,114 8% N/A N/A
R-G Premier Bank only $ 67,866 14.79% $36,716 8% $45,895 10%
Tier I capital (to risk
weighted assets):
Consolidated $109,627 16.83% $26,057 4% N/A N/A
R-G Premier Bank only $ 63,849 13.91% $18,358 4% $27,537 6%
Tier I capital
(to average assets):
Consolidated $109,627 8.80% $49,847 4% N/A N/A
R-G Premier Bank only $ 63,849 8.45% $30,215 4% $37,769 5%
As of December 31, 1995
Total capital (to risk
weighted assets):
Consolidated $ 67,170 13.36% $40,221 8% N/A N/A
R-G Premier Bank only $ 44,113 11.66% $30,260 8% $37,825 10%
Tier I capital (to risk
weighted assets):
Consolidated $ 62,860 12.50% $20,111 4% N/A N/A
R-G Premier Bank only $ 39,835 10.53% $15,129 4% $22,694 6%
Tier I capital
(to average assets):
Consolidated $ 62,860 6.33% $39,747 4% N/A N/A
R-G Premier Bank only $ 39,835 6.25% $25,478 4% $31,848 5%
</TABLE>
During 1996 the Company incurred a special assessment of approximately $2.5
million ($1.7 million net of taxes) as the result of federal legislation signed
into law to recapitalize the SAIF administered by the FDIC. The legislation,
enacted by the U.S. Congress, recapitalized the SAIF by a one-time charge of
approximately $0.657 for every $100 of assessable deposits held at March 31,
1995. Future earnings will be enhanced due to lower insurance premiums. The
Bank's insurance premiums which has amounted to $0.23 for every $100 of
deposits, will be reduced to $0.064 for every $100 of deposits beginning January
1, 1997.
61
<PAGE>
NOTE 20 - STOCK OPTION PLAN:
In June 1996 the Board of Directors of the Company adopted a Stock Option Plan,
which is designed to attract and retain qualified personnel in key positions,
provide officers and key employees with a proprietary interest in the Company as
an incentive to contribute to the success of the Company, and reward key
employees for outstanding performance and the attainment of targeted goals. The
Stock Option Plan was approved by the Company's sole stockholder in June 1996.
An amount of Company common stock equal to 10% of the aggregate number of Class
B Shares sold in the Company's initial public offering (241,500 shares) were
authorized under the Stock Option Plan, which may be filed by authorized but
unissued shares, treasury shares or shares purchased by the Company on the open
market or from private sources. The Stock Option Plan provides for the grant of
stock options at an exercise price equal to the fair market value of the Class B
shares. Stock options are available for grant to key employees of the Company
and any subsidiaries. No options were issued prior to the public offering. In
connection with the Company's initial offering on August 27,1996, the Company
awarded options for 200,000 shares to 28 employees of R&G Mortgage and the Bank
at the initial public offering price of $14.50 per share. The maximum term of
the options granted are ten years. Under the provisions of the Stock Options
Plan, options can be exercised as follows: 20% after one year, 40% after two
years, 60% after three years, 80% after four years and 100% after five years,
and accordingly, as of December 31, 1996 none of the options granted are
exercisable.
The Company adopted in 1996 the disclosure - only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123). Accordingly, no
compensation cost has been recognized for the Company's Stock Option Plan. Had
compensation cost for the Company's Stock Option Plan been determined based on
the fair value at the grant date for awards in 1996 consistent with the
provisions of SFAS 123, the Company's net earnings and earnings per share for
the year ended December 31, 1996 would have been reduced to the pro forma
amounts indicated below:
Net earnings - as reported $13,199,516
===========
Net earnings - pro forma $13,143,675
===========
Earnings per share - as reported $2.18
=====
Earnings per share - pro forma $2.17
=====
The fair value of the option grants were estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted average
assumptions:
Stock Price and Exercise Price - $14.50 for options granted based on the terms
of the awards.
Expected Option Term - 6 years.
Expected Volatility - 42.54% for options granted calculated using weekly closing
prices of three peer financial institutions given the Company's limited publicly
trading history.
Expected Dividend Yield - Calculated as the annualized quarterly dividend
closest to the grant date divided by the stock price on the grant date.
62
<PAGE>
Risk-Free Interest Rate - 6.48% for options granted determined as the yield, on
the date of grant, on a U.S. Treasury zero coupon bond with a maturity equal to
the expected term of the option.
NOTE 21 - PROFIT SHARING PLAN:
The Company established in 1993 a profit sharing plan which covers substantially
all regular employees. Annual contributions to this plan are based on matching
percentages up to 5% of employee salaries, based on the employee years of
service and on operational income, as defined by the plan, and are deposited in
a trust. Contributions to this plan during the years ended December 31, 1996,
1995 and 1994 amounted to approximately $72,000, $120,000 and $108,000,
respectively.
NOTE 22 - COMMITMENTS AND CONTINGENCIES:
Commitments to developers providing end loans
The Company has outstanding commitments for various projects in the process of
completion. Total commitments amounted to approximately $370,328,500 at December
31, 1996. All commitments are subject to prevailing market prices at time of
closing with no market risk exposure against the Company or with firm
back-to-back commitments extended in favor of the mortgagee.
Loans in process
Loans in process pending final approval and/or closing amounted to approximately
$49,399,000 at December 31, 1996.
Commitments to buy and sell GNMA certificates
As of December 31, 1996, the Company had open commitments to issue GNMA
certificates in the amount of $18,788,000.
Commitments to sell mortgage loans
As of December 31, 1996 the Company had commitments to sell mortgage loans to
third party investors amounting to $5.0 million.
Lease commitments
The Company is obligated under several noncancellable leases for office space
and equipment rentals, all of which are accounted for as operating leases. The
leases expire at various dates with options for renewals.
63
<PAGE>
As of December 31, 1996, minimum annual rental commitments under noncancellable
operating leases for certain office space and equipment including a lease from
an affiliate, were as follows:
Year Amount
---- ------
1997 $ 2,095,987
1998 2,072,050
1999 1,995,743
2000 1,908,056
2001 1,727,964
Later years 4,130,551
-----------
$13,930,351
===========
Rent expenses amounted to approximately $2,171,000 in 1996, $1,914,000 in 1995
and $1,810,000 in 1994.
Litigation
The Company is a defendant in legal proceedings arising from normal business
activities. Management believes, based on the opinion of legal counsel, that the
final disposition of these matters will not have a material adverse effect on
the Company's financial position or result of operations.
Others
At December 31, 1996 the Company is liable under limited recourse provisions
resulting from the sale of loans to several investors principally FHLMC. The
principal balance of these loans at the time of sale, which are serviced by the
Company, amounts to approximately $241,213,000 at December 31, 1996. Liability,
if any, under the recourse provisions at December 31, 1996 is estimated by
management to be insignificant.
The Government of the Commonwealth of Puerto Rico has recently announced that it
plans to eliminate the current income tax exemption available to local investors
on interest income generated on FHA and VA loans secured by residential property
located in Puerto Rico, and mortgage backed securities secured by such mortgage
loans (GNMA's). This proposal, which requires the approval of the Puerto Rico
Legislature, would eliminate the exemption on FHA and VA loans closed after July
1, 1997 except for loans to finance the purchase of homes in low and moderate
income housing projects sponsored by local government housing authorities. The
interest income on such loans would be taxed at a preferential 17% rate, while
interest income for FHA and VA loans closed prior to July 1, 1997, as well as
GNMA's secured by such loans, would continue to be tax exempt. While the Company
has benefited from the current tax exemption, management based on presently
available information, believes that the adoption of this proposal in its
current form would not have a significant adverse effect in its results of
operations. However, the impact of the proposal cannot be fully measured until
the enabling legislation is approved and management has the opportunity to
review it.
64
<PAGE>
NOTE 23 - SUPPLEMENTAL DISCLOSURE ON THE STATEMENT OF CASH FLOWS:
During 1996, 1995 and 1994, the Company paid interest amounting to approximately
$41,750,000, $34,403,000 and $24,179,000, respectively, and income taxes
$7,573,000 (including $1,065,000 on settlement of income tax examination as
discussed in Note 16 to the consolidated financial statements), $1,820,000 and
$5,696,000, respectively.
During 1996, 1995 and 1994 the Company securitized loans from its mortgage loan
portfolio totaling approximately $43,673,000, $17,631,000 and $51,492,000,
respectively.
As discussed in Note 1 to the consolidated financial statements, during 1996 the
Company granted 20,000 Class B common shares to its Vice Chairman of the Board
in consideration for his past and ongoing services, recognizing $290,000 as
compensation cost.
NOTE 24 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS
OF CREDIT RISK:
In the normal course of business, the Company uses various off-balance sheet
financial instruments to satisfy the financing needs of its customers and to
reduce its own exposure to fluctuations in interest rates. These financial
instruments include loan commitments and interest rate exchange agreements
(swaps). These instruments involve, to varying degrees, elements of credit and
interest rate in excess of the amount recognized in the statement of financial
condition. The contract or notional amounts of these instruments, which are not
included in the statement of financial condition, are an indicator of the
Company's activities in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instruments for commitments to extend credit is
represented by the contractual notional amount of those instruments. The Company
uses the same credit policies in making commitments as it does for
on-balance-sheet instruments. For interest rate swap contracts, the contract or
notional amounts do not represent exposure to credit loss. Instead, the amount
potentially subject to credit loss is substantially less.
Contractual commitments to extend credit are legally binding agreements to lend
money to customers at predetermined interest rates for a specified period of
time. Since many of the loan commitments may expire without being drawn upon,
the total commitment amount does not necessarily represent future cash
requirements. To extend credit the Company evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Company upon extension of credit, is based on management's
credit evaluation of the counterparty. A geographic concentration exists within
the Company's mortgage loans portfolio since most of the Company's business
activity is with customers located in Puerto Rico.
Interest rate swap agreements involve the exchange of fixed and floating rate
interest payment obligations without the exchange of the underlying principal.
Entering into interest rate agreements involves the risk of dealing with
counterparties and their ability to meet the terms of the contracts, and also
the interest rate risk associated with unmatched positions.
65
<PAGE>
The total amounts of financial instruments with off-balance sheet risk at
December 31, 1996 follows:
Financial instruments whose contract amounts
represent potential credit risk:
Commitments to extend credit excluding the
undisbursed portion of loans in process:
Unused lines of credit $ 8,082,000
============
Financial instruments whose notional or contractual
amounts exceed the amount of potential credit risk:
Interest rate swap contracts $ 45,000,000
============
Interest rate caps $ --
============
A detail of interest rate swaps at December 31, 1996 follows:
Notional Pay Fixed Receive
Amount Maturity Rate Rate Floating
------ -------- ---- -------------
$10,000,000 September 2, 1997 6.60% 3 months Libor
10,000,000 October 24, 2000 5.20% 3 months Libid
25,000,000 October 9, 2001 5.06% 3 months Libid
The following table summarizes the changes in notional amounts of swaps
outstanding during 1996:
Beginning balance $ 35,000,000
New Swaps 25,000,000
Maturities (15,000,000)
------------
Ending balance $ 45,000,000
============
As of December 31, 1996, interest rate swap maturities are as follows:
1997 $ 10,000,000
2000 10,000,000
2001 25,000,000
------------
$ 45,000,000
============
Net interest settlements on SWAP requirements are recorded as an adjustment to
interest expense on deposits. Net interest received amounted to approximately
$187,000 during 1995; net payments amounted to approximately $61,000 and $65,000
during 1996 and 1994, respectively.
An interest cap is a guarantee given by one party to another party, in exchange
for a premium, to ensure that if interest rates rise above an agreed upon
protected rate (in the Bank's case, the LIBOR rate) the issuer of the cap will
pay to the purchaser the difference between the market rate and the protected
rate. The Bank had interest rate cap contracts outstanding with notional
principal amounts of $3,440,000 which expired during 1995. There are no interest
rates cap contracts outstanding at December 31, 1996.
66
<PAGE>
NOTE 25 - SUPPLEMENTAL INCOME STATEMENT INFORMATION:
Employee costs and other administrative and general expenses are shown in the
Consolidated Statement of Income net of direct loan origination costs. Direct
loan origination costs are capitalized as part of the carrying cost of mortgage
loans and are offset against mortgage loan sales and fees when the loans are
sold or amortized as a yield adjustment to interest income on loans held for
investment. Total employee costs and other expenses before capitalization
follow:
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Employee costs $17,357,977 $13,248,475 $11,506,973
=========== =========== ===========
Other administrative
and general expenses $18,131,559 $16,661,355 $17,174,157
=========== =========== ===========
Set forth below are the direct loan origination costs that were capitalized as
part of the carrying cost of mortgage loans inventory or offset against mortgage
loan sales and fees and interest income.
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Offset against mortgage
loan sales and interest
income or capitalized as
part of loan inventory $9,772,118 $7,895,297 $10,160,820
========== ========== ===========
67
<PAGE>
NOTE 26 - FAIR VALUE OF FINANCIAL INSTRUMENTS:
The estimated fair value of the Company's financial instruments as of December
31, are as follows:
<TABLE>
<CAPTION>
1996 1995
---- ----
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
(In thousands)
<S> <C> <C> <C> <C>
Financial Assets
Cash and due from banks $ 31,990 $ 31,990 $ 32,559 $ 32,559
Money market investments 66,866 66,866 1,636 71,636
Mortgage loans held for sale 54,450 55,110 21,318 21,631
Mortgage-backed securities held for trading 108,146 108,146 113,809 113,809
Investment securities available for sale 77,567 77,567 61,008 61,008
Investment in Federal Home Loan Bank
stock 4,247 4,247 3,280 3,280
Investment securities held to maturity 43,170 42,346 43,777 42,781
Loans, net 603,751 608,455 473,841 492,119
Accounts receivable 13,167 13,167 10,479 10,479
Financial Liabilities
Deposits:
Non interest bearing demand $ 52,244 $ 52,244 $ 52,998 $ 52,998
Savings and NOW accounts 156,150 159,197 147,111 147,111
Certificates of deposit 403,676 391,137 316,802 321,609
Securities sold under agreements to
repurchase 97,444 97,444 98,483 98,483
Notes payable 126,842 128,692 81,130 81,130
Advances from FHLB 15,000 14,986 6,007 6,051
Long-term debt - - 5,324 5,324
Other secured borrowings 50,463 50,712 55,984 55,984
Accounts payable and accrued liabilities 13,598 13,598 14,500 14,500
Subordinated notes 3,250 3,641 3,250 3,741
Unrecognized financial instruments -
Interest rate swap agreements in a net
receivable (payable) position* ($ 44) ($ 551) $ 14 $ 1,215
========= ========= ======== ========
</TABLE>
- ----------
* The amount shown under "carrying amount" represents net accrual arising from
those unrecognized financial instruments.
68
<PAGE>
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments:
Short-term financial instruments
Short-term financial instruments, which include cash and due from banks, money
market investments, accounts receivables, securities sold under agreements to
repurchase, notes payables and accounts payable and accrued interest, have been
valued at their carrying amounts reflected in the Consolidated Statement of
Financial Condition as these are reasonable estimates of fair value given the
relatively short period of time between origination of the instruments and their
expected realization.
Investment securities
The fair value of investment securities is based on quoted market prices or
dealer quotes except for the investments in FHLB stock which is valued at its
redemption value.
Loans
The fair value for loans has been estimated by discounting loans with similar
financial characteristics. Loans were classified by type such as commercial,
commercial real estate, residential mortgage, and consumer. These asset
categories were further segmented into various maturity groups, and by accruing
and non-accruing groups. The fair value of accruing loans was calculated by
discounting scheduled cash flows through the estimated maturity using estimated
market discount rates that reflect the credit and interest rate risk inherent in
the loan. Prepayment experienced in previous periods when interest rates were at
levels similar to current levels was assumed to occur for mortgage loans,
adjusted for any differences in the outlock of interest rates. Other loans
assume little or no prepayments.
Non-accruing loans were assumed to be repaid after one year. Presumably this
would occur either because loan is repaid or collateral has been sold to satisfy
the loan. The value of non-accruing loans was therefore discounted for one year
at the going rate for new loans.
Mortgage loans held for sale, except for loans from the Bank totaling $6,538,190
in 1996 and $9,329,694 in 1995 have been valued based on market quotations or
committed selling prices in the secondary market. Loans held for sale from the
Bank have been valued using the same methodology described in the first
paragraph above.
Deposits
The fair value of deposits with no stated maturity, such as non-interest bearing
demand deposits, savings, and NOW accounts, and money market and checking
accounts, is equal to the amount payable on demand. The fair value of
certificates of deposit is based on the discounted value of contractual cash
flows. The discount rate is estimated using the rates currently offered for
deposits of similar remaining maturities.
The fair value estimates of deposits do not include the fair value of core
deposits intangible.
69
<PAGE>
Long-term debt and other secured borrowings
Long-term debt and other secured borrowings have been valued at their carrying
amounts reflected in the Consolidated Statement of Financial Condition as these
are reasonable estimates of fair value; most of the long-term debt amounts are
at floating market interest rates.
Advances from FHLB and subordinated notes
The fair value of the advances from FHLB and subordinated notes was determined
using discounted cash flow analysis over the remaining term of the obligations
using market rates for similar instruments.
Interest rate swap agreements
The fair value of interest rate swap agreements was determined taking into
account the current interest rates at December 31, 1996. This value represents
the estimated amount the Bank would pay to terminate the contract or agreement
taking into account current interest rates and, when appropriate, the current
credit worthiness of the counterparts.
Limitations
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instruments. These
estimates do not reflect any premium or discount that could result from offering
for sale at one time the Company's entire holdings of a particular financial
instrument. Because no market exists for a significant portion of the Company's
financial instruments, fair value estimates are based on judgments regarding
future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates.
In addition, the fair values presented do not attempt to estimate the value of
the Company's fee generating businesses and anticipated future business
activities, that is, they do not represent the Company's value as a going
concern. Furthermore, the differences between the carrying amounts and the fair
values presented may not be realized since, in the majority of cases, the
Company generally intends to hold these financial instruments to maturity and
realize the recorded values.
Reasonable comparability of fair values among financial institutions is not
likely due to the wide range of permitted valuation techniques and numerous
estimates that must be made in the absence of secondary market prices. This lack
of objective pricing standards introduces a greater degree of subjectivity to
these derived or estimated fair values. Therefore, while disclosure of estimated
fair values of financial instruments is required, readers are cautioned in using
this data for purposes of evaluating the financial condition of the Company.
70
<PAGE>
NOTE 27 - R&G FINANCIAL CORPORATION (HOLDING COMPANY
ONLY) FINANCIAL INFORMATION:
The following condensed financial information presents the financial position of
R&G Financial (the Holding Company) only as of December 31, 1996 and the result
of its operations and its cash flows for the year then ended:
STATEMENT OF FINANCIAL CONDITION
ASSETS
Cash $ 810,920
Investment in R-G Premier Bank, at equity 67,221,293
Investment in R&G Mortgage, at equity 48,411,599
Investment in preferred stock of R-G Premier Bank, at cost 30,100,000
Advances to subsidiaries 290,000
------------
Total assets $146,833,812
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Advances from subsidiaries $ 666,975
Other liabilities and accrued expenses 14,869
Stockholders' equity 146,151,968
------------
Total liabilities and stockholders' equity $146,833,812
============
STATEMENT OF INCOME
Income - Interest on certificates of deposit $ 12,164
------------
Operating expenses 10,811
------------
Income before income taxes and equity
in undistributed earnings of subsidiaries 1,353
Income taxes 338
------------
Income before equity in undistributed earnings
of subsidiaries 1,015
Undistributed earnings of subsidiaries 13,198,501
------------
Net income $ 13,199,516
============
71
<PAGE>
STATEMENT OF CASH FLOWS
Cash flows from operating activities:
Net income $ 13,199,516
------------
Adjustments to reconcile net income to cash
provided by operating activities:
Equity in undistributed earnings of subsidiaries (13,198,501)
Decrease in other liabilities and accrued expenses (357,482)
------------
Total adjustments (13,555,983)
------------
Net cash used in operating activities (356,467)
------------
Cash flows from investing activities:
Purchase of investment in preferred stock in Bank (30,100,000)
------------
Cash flows from financing activities:
Proceeds from issuance of common
stock on initial public offering 31,072,748
Cash dividends on common stock (472,336)
Net advances from subsidiaries 666,975
------------
Net cash provided by financing activities 31,267,387
------------
Net increase in cash, and cash at December 31, 1996 $ 810,920
============
The Holding Company had no operations during the year ended December 31, 1996.
The principal source of income for the Holding Company consists of dividends on
preferred stock held from R-G Premier Bank of Puerto Rico. The payment of
dividends by the Bank to the Holding Company may be affected by certain
regulatory requirements and policies, such as the maintenance of certain minimum
capital levels.
72
<PAGE>
NOTE 28 - INDUSTRY SEGMENTS:
The following summarized financial information presents the results of the
Company's operations for the three year period ended December 31, 1996 for its
traditional banking and mortgage banking activities:
<TABLE>
<CAPTION>
1996 1995
---------------------------------------- ------------------------------------
Bank Mortgage Total Bank Mortgage Total
---- -------- ----- ---- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Net interest
income after
provision of
loan losses $ 20,883,829 $ 3,781,152 $ 24,664,981 $ 17,943,694 $ 2,379,287 $ 20,322,981
Other income:
Net gain (loss)
on sale of loans 1,354,755 10,450,190 11,804,945 631,824 5,630,636 6,262,460
Unrealized profit
(loss) on trading
securities (382) (95,589) (95,971) 617,788 1,503,823 2,121,611
Change in
provision for
cost in excess of
market value of
loans held for sale -- -- -- 855,834 -- 855,834
Net gain on sales
of investment
securities
available for sale 641,798 -- 641,798 -- -- --
Loan administration
and servicing fees -- 13,029,053 13,029,053 -- 11,029,995 11,029,995
Gain on sale of
servicing rights -- -- -- -- -- --
Service charges,
fees and other 3,664,577 207,645 3,872,222 2,368,128 803,821 3,171,949
------------ ------------ ------------ ------------ ------------ ------------
26,544,577 27,372,451 53,917,028 22,417,268 21,347,562 43,764,830
------------ ------------ ------------ ------------ ------------ ------------
Operating expenses:
Salaries and
employee
benefits 6,062,221 6,317,867 12,380,088 4,330,248 3,953,561 8,283,809
Office
occupancy and
equipment 3,551,035 1,980,094 5,531,129 2,860,176 1,851,136 4,711,312
SAIF special
assessment 2,508,380 -- 2,508,380 -- -- --
Other
administrative and
general 7,698,577 6,138,753 13,837,330 6,406,237 7,324,487 13,730,724
------------ ------------ ------------ ------------ ------------ ------------
19,820,213 14,436,714 34,256,927 13,596,661 13,129,184 26,725,845
------------ ------------ ------------ ------------ ------------ ------------
Income before
income taxes,
minority interest
and cumulative
effect of change in
accounting principle $ 6,724,364 $ 12,935,737 $ 19,660,101 $ 8,820,607 $ 8,218,378 $ 17,038,985
============ ============ ============ ============ ============ ============
</TABLE>
1994
---------------------------------------
Bank Mortgage Total
---- -------- -----
Net interest
income after
provision of
loan losses $ 15,089,132 $ 4,048,355 $ 19,137,487
Other income:
Net gain (loss)
on sale of loans 201,797 (1,551,137) (1,349,340)
Unrealized profit
(loss) on trading
securities (214,166) (4,250,552) (4,464,718)
Change in
provision for
cost in excess of
market value of
loans held for sale (855,834) -- (855,834)
Net gain on sales
of investment
securities
available for sale -- -- --
Loan administration
and servicing fees -- 11,046,019 11,046,019
Gain on sale of
servicing rights -- 2,914,850 2,914,850
Service charges,
fees and other 1,736,656 785,738 2,522,394
------------ ------------ ------------
15,957,585 12,993,273 28,950,858
------------ ------------ ------------
Operating expenses:
Salaries and
employee
benefits 3,193,435 2,058,000 5,251,435
Office
occupancy and
equipment 2,315,668 2,172,667 4,488,335
SAIF special
assessment -- -- --
Other
administrative and
general 4,516,158 8,752,717 13,268,875
------------ ------------ ------------
10,025,261 12,983,384 23,008,645
------------ ------------ ------------
Income before
income taxes,
minority interest
and cumulative
effect of change in
accounting principle $ 5,932,324 $ 9,889 $ 5,942,213
============ ============ ============
73
<PAGE>
NOTE 29 - QUARTERLY FINANCIAL DATA (UNAUDITED):
Following is a summary of selected financial information of the unaudited
quarterly results of operations. In the opinion of management, all adjustments
necessary for a fair presentation have been made.
(In thousands, except for per share data)
1996
-----------------------------------------
March 31 June 30 Sept. 30 Dec. 31
-------- ------- -------- -------
Total interest income $15,991 $18,355 $19,459 $19,981
Total interest expense 9,891 11,009 11,689 12,274
Net interest income 6,100 7,346 7,770 7,707
Provision for losses on loans 7 350 2,485 1,416
SAIF special assessment -- -- 2,508 --
Income before income taxes 4,963 4,954 3,696 5,509
Income tax expense 2,035 1,787 1,229 871
Net income 2,928 3,167 2,467 4,638
Net income per common share $ .56 $ .61 $ .40 $ .61
1995
-----------------------------------------
March 31 June 30 Sept. 30 Dec. 31
-------- ------- -------- -------
Total interest income $ 11,526 $ 12,812 $ 14,016 $ 15,158
Total interest expense 7,173 8,051 8,362 8,653
Net interest income 4,353 4,761 5,654 6,505
Provision (credit) for losses on loans (50) -- 500 500
Income before income taxes 2,622 5,506 3,155 5,013
Income tax expense 1,025 1,849 840 2,133
Net income 1,597 3,657 2,315 2,880
Net income per common share $ .31 $ .70 $ .45 $ .55
74
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<CIK> 0001016933
<NAME> R&G FINANCIAL CORPORATION
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 31,989,944
<INT-BEARING-DEPOSITS> 33,232,809
<FED-FUNDS-SOLD> 33,633,178
<TRADING-ASSETS> 109,496,947
<INVESTMENTS-HELD-FOR-SALE> 81,814,425
<INVESTMENTS-CARRYING> 43,169,697
<INVESTMENTS-MARKET> 42,345,537
<LOANS> 658,200,780
<ALLOWANCE> 0
<TOTAL-ASSETS> 1,037,797,529
<DEPOSITS> 615,567,481
<SHORT-TERM> 289,749,166
<LIABILITIES-OTHER> 13,597,990
<LONG-TERM> 0
0
0
<COMMON> 78,583
<OTHER-SE> 115,554,309
<TOTAL-LIABILITIES-AND-EQUITY> 115,632,892
<INTEREST-LOAN> 63,230,751
<INTEREST-INVEST> 10,554,968
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 73,785,719
<INTEREST-DEPOSIT> 27,517,852
<INTEREST-EXPENSE> 44,862,691
<INTEREST-INCOME-NET> 28,923,028
<LOAN-LOSSES> 4,258,047
<SECURITIES-GAINS> 480,171
<EXPENSE-OTHER> 34,256,927
<INCOME-PRETAX> 19,121,933
<INCOME-PRE-EXTRAORDINARY> 13,199,516
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,199,516
<EPS-PRIMARY> 2.18
<EPS-DILUTED> 2.18
<YIELD-ACTUAL> 8.25
<LOANS-NON> 18,730,692
<LOANS-PAST> 156,300
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 18,886,992
<ALLOWANCE-OPEN> 3,510,251
<CHARGE-OFFS> 4,662,407
<RECOVERIES> 225,754
<ALLOWANCE-CLOSE> 3,331,645
<ALLOWANCE-DOMESTIC> 3,331,645
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
