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10K/A
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, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File No.: 0-21137
R&G FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Puerto Rico 66-0532217
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(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
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(Address of Principal (Zip Code)
Executive Offices)
Registrant's telephone number, including area code: (787) 758-2424
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)
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(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.
As of March 20, 1998, the aggregate value of the 4,777,285 shares of Class B
Common Stock of the Registrant issued and outstanding on such date, which
excludes 147,189 shares held by all directors and officers of the Registrant as
a group, was approximately $149.0 million. This figure is based on the last
known trade price of $31.19 per share of the Registrant's Class B Common Stock
on March 20, 1998.
Number of shares of Class B Common Stock outstanding as of March 20, 1998:
4,924,474
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, 1997 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.
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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. In July 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. In August 1996, the Company conducted an underwritten public
offering of Class B common stock. In December 1996, the Company acquired the
remaining 11.9% ownership interest in the common stock of the Bank. At December
31 1997, the Company had total consolidated assets of $1.5 billion, total
consolidated borrowings of $627.9 million, total consolidated deposits of $722.4
million, and total consolidated stockholders' equity of $138.1 million. After
taking into consideration an 80% stock dividend paid in 1997, as of December 31,
1997, the Company had 9,220,278 Class A shares of common stock outstanding, all
of which were owned by Mr. Galan, and 4,924,474 publicly held Class B shares of
common stock outstanding.
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 18 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 properties in Puerto
Rico. During the year ended December 31, 1997, R&G Mortgage originated
approximately 28.4% 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 91.3% since December 31, 1991
and, at December 31, 1997, R&G Mortgage serviced approximately 56,400 accounts
with an
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aggregate loan balance of $3.0 billion. The Bank's asset size, which amounted to
$996.3 million at December 31, 1997, has increased by $943.4 million since R&G
Mortgage became affiliated with the Bank in February 1990, while the branch
office network had increased from two to 15 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"). To a lesser extent, R&G
Mortgage is also engaged in the origination of subprime--credit
quality--residential mortgage loans through a wholly owned subsidiary ("Champion
Mortgage Corporation") which commenced operations in October 1997. Pursuant to
agreements entered into between R&G Mortgage and the Bank, non-conforming
conventional single-family residential loans and consumer loans 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, 1997, 1996 and 1995, R&G
Mortgage originated a total of $598.2 million, $448.1 million and $322.7 million
of loans, respectively. These aggregate originations include loans originated by
R&G Mortgage directly for the Bank of $285.8 million, $211.3 million and $156.3
million during such respective periods, or 47.8%, 47.2% and 48.4%, respectively,
of total originations.
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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, 1997, 1996 and 1995, R&G Mortgage
sold $246.1 million, $244.8 million and $195.6 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, 1997, 1996 and 1995
amounted to $89.0 million, $122.8 million and $124.6 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 OCFI.
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."
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
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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."
Mortgage Banking Activities
Loan Originations, Purchases and Sales. During the years ended December
31, 1997, 1996 and 1995, R&G Mortgage originated a total of $598.2 million,
$448.1 million and $322.7 million of loans, respectively. These aggregate
originations include loans originated by R&G Mortgage directly for the Bank of
$285.8 million, $211.3 million and $156.3 million during the years ended
December 31, 1997, 1996 and 1995, respectively, or 48%, 47% and 48%,
respectively, of total originations. The loans originated by R&G Mortgage for
the Bank are
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comprised primarily of conventional residential loans and, to a lesser extent,
consumer loans 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, 1997, 1996 and 1995, R&G Mortgage originated $280.1 million,
$222.0 million and $154.9 million, respectively, of FHA/VA loans, which
represented 46.8%, 49.5% and 48.0%, 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, 1997, 1996 and 1995, R&G Mortgage originated $265.9 million, $204.9
million and $151.9 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, 1997, 1996 and 1995,
non-conforming conventional loans represented approximately 39%, 42% and 43%,
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, 1997, 1996 and 1995, 77.5%, 88.9% and
81.0% 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."
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 $68,200 and $73,000, respectively.
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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, 1997, R&G Mortgage employed 66 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 $158.5 million,
$45.6 million and $19.5 million of loans from third parties during the years
ended December 31, 1997, 1996 and 1995, respectively.
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The following table sets forth loan originations, purchases and sales by
R&G Mortgage for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
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1997 1996 1995
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(Dollars in Thousands)
<S> <C> <C> <C>
Loans Originated For the Bank:
Conventional loans(1):
Number of loans ..................... 3,390 2,756 2,226
Volume of loans ..................... $233,488 $190,072 $140,363
FHA/VA loans:
Number of loans ..................... -- -- --
Volume of loans ..................... -- $ -- $ --
Consumer loans(2):
Number of loans ..................... 2,318 1,004 974
Volume of loans ..................... $ 52,287 $ 21,208 $ 15,944
Total loans:
Number of loans ..................... 5,708 3,760 3,200
Volume of loans ..................... $285,775 $211,280 $156,307
Percent of total volume ............. 35% 43% 46%
For Third Parties:
Conventional loans(1):
Number of loans ..................... 444 214 151
Volume of loans ..................... $ 32,419 $ 14,835 $ 11,496
FHA/VA loans:
Number of loans ..................... 4,107 3,117 2,313
Volume of loans ..................... $280,053 $221,967 $154,916
Total loans:
Number of loans ..................... 4,551 3,331 2,464
Volume of loans ..................... $312,472 $236,802 $166,412
Percent of total volume ............. 39% 48% 48%
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Total loan originations ........... $598,247 $448,082 $322,719
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Loans Purchased For R&G Mortgage:
Number of loans ....................... 2,052 583 305
Volume of loans (3) ................... $158,456 $ 45,604 $ 19,525
Percent of total volume ............... 20% 9% 6%
GNMA Pools Purchased for R&G Mortgage:
Volume of loans ....................... $ 51,537 -- --
Percent of total volume ............... 6% -- --
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Total loan originations and purchases $808,240 $493,686 $342,244
======== ======== ========
</TABLE>
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<TABLE>
<CAPTION>
Year Ended December 31,
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1997 1996 1995
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(Dollars in Thousands)
<S> <C> <C> <C>
Loans Sold To Third Parties(4):
Conventional loans(1):
Number of loans ...................... 429 178 151
Volume of loans ...................... $ 39,495 $ 12,560 $ 11,999
FHA/VA loans:
Number of loans ...................... 2,775 3,564 2,252
Volume of loans(3) ................... $ 206,643 $ 232,254 $ 183,607
Total loans:
Number of loans ...................... 3,204 3,742 2,403
Volume of loans ...................... $ 246,138 $ 244,814 $ 195,606
Percent of total volume .............. 30% 50% 57%
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Adjustments:
Loans originated for the Bank .......... $(285,775) $(211,280) $(156,307)
Loans amortization ..................... (5,086) (7,224) (1,960)
--------- --------- ---------
Increase (decrease) in loans held for sale $ 271,241 $ 30,368 $ (11,629)
========= ========= =========
Average Initial Loan Origination Balance:
The Bank:
Conventional loans(1) ................ $ 69 $ 69 $ 63
FHA/VA loans ......................... -- -- --
Third Parties:
Conventional loans(1) ................ $ 73 69 76
FHA/VA loans ......................... 68 71 63
Total Average Initial Balance:
Conventional loans(1) ................ 69 69 64
FHA/VA loans ......................... 68 71 63
Refinancings(5):
The Bank ............................... 30% 33% 58%
Third Parties .......................... 31% 24% 26%
</TABLE>
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(1) Includes non-conforming loans.
(2) All but $1.6 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 and $36.1 million of loans purchased from another
financial institution and securitized and sold to the same financial
institution during 1996 and 1995, 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.
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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, 1997, 1996 and 1995, R&G Mortgage sold $246.1 million, $244.8 million and
$195.6 million 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, $206.6 million or 83.9%, $232.3 million or
94.9% and $183.6 million or 93.9% 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 described below). These
securities were sold primarily to securities broker-dealers and other investors
in Puerto Rico.
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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, 1997, 1996 and 1995, R&G Mortgage issued GNMA
mortgage-backed securities totalling approximately $397.2 million,
$236.4 million and $201.6 million, respectively, including $335.5 million,
$235.5 million and $184.4 million GNMA serial notes, 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 year ended December 31, 1995, R&G
Mortgage and the Bank completed sales of approximately $38.2 million of CMOs in
securitization transactions. There were no sales in 1997 or 1996. In connection
with such transactions, either the Bank or R&G Mortgage generally retains the
residual certificates issued by the respective trusts as well as the subordinate
certificates issued in such transactions. As of December 31, 1997, R&G Mortgage
held CMOs (which were primarily issued by R&G Mortgage) with a fair value of
$15.2 million and residual certificates issued in CMO transactions involving R&G
Mortgage and the Bank with a fair value of $7.9 million. In addition, the Bank
held CMO subordinated certificates and
10
<PAGE>
residual certificates from one of its issues with a fair value of $8.4 million
at December 31, 1997. 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, 1997, R&G Financial did not deem
it necessary to establish reserves for possible losses related to its recourse
obligations. At December 31, 1997, R&G Mortgage had loans in its servicing
portfolio with provisions for recourse in the principal amount of approximately
$374.4 million, as compared to $290.9 million and $238.2 million as of December
31, 1996 and 1995, respectively. Of the recourse loans existing at December 31,
1997, approximately $340.5 million in principal amount consisted of loans sold
to FNMA and FHLMC and converted into mortgage-backed securities of such
agencies, and approximately $33.9 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."
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
11
<PAGE>
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
several years. At December 31, 1997, R&G Mortgage's servicing portfolio totalled
$3.0 billion and consisted of a total of 56,442 loans. At December 31, 1997, R&G
Mortgage's servicing portfolio included $448.9 million of loans serviced for the
Bank or 15.0% of the total servicing portfolio. 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.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------
1997 1996 1995
---------------- ---------------- ----------------
(Dollars in Thousands)
<S> <C> <C> <C>
Composition of Servicing Portfolio at End of Period:
Conventional and other mortgage loans(1)................... $1,148,739 $ 971,327 $ 811,269
FHA/VA loans............................................... 1,852,149 1,578,842 1,486,931
---------- ---------- ----------
Total servicing portfolio(2)............................. $3,000,888 $2,550,169 $2,298,200
========== ========== ==========
Activity in the Servicing Portfolio:
Beginning servicing portfolio.............................. $2,550,169 $2,298,200 $2,114,743
Add: Loan originations and purchases....................... 778,126 506,696 325,870
Servicing of portfolio loans acquired............... 5,301 36,478 239,414
Less: Sale of servicing rights............................. -- 42,080 196,895(3)
Run-offs(4)......................................... 332,708 249,125 184,932
---------- ---------- ----------
Ending servicing portfolio................................. $3,000,888 $2,550,169 $2,298,200
========== ========== ==========
Number of loans serviced(5)................................ 56,442 50,979 48,240
Average loan size(5)....................................... $ 53 $ 50 $48
Average servicing fee rate(5).............................. 0.532% 0.532% 0.505%
</TABLE>
- --------------
(1) Includes non-conforming loans.
(2) At the dates shown, included $448.9 million, $323.8 million and $290.8
million of loans serviced for the Bank, respectively, which constituted
15.0%, 12.70% and 12.65% 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 amortization of loans, prepayments and
foreclosures. Includes one-time transfer in 1997 of $49.0 million of
mortgage loans to a financial institution who acquired a commercial bank
whose loans were being serviced by R&G Mortgage.
(5) At December 31, 1997, R&G Mortgage was servicing 6,507 loans for the
Bank with an average loan size of approximately $69,000 and at an
average servicing rate of 0.284%. Amounts include late and other
miscellaneous charges.
13
<PAGE>
The following table sets forth certain information at December 31, 1997
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, 1997
------------------------------------------------------------------------------
Loans Serviced Loans Serviced
for the Bank for Third Parties
---------------------------------- -----------------------------------
Number of Aggregate Number of Aggregate
Loans Principal Balance Loans Principal Balance
Mortgage Interest Rate ------------- -------------------- -------------- --------------------
(Dollars in Thousands) (Dollars in Thousands)
<S> <C> <C> <C> <C>
Less than 7.00%............ 51 $ 2,646 2,734 $ 136,804
7.00% - 7.49%.............. 260 24,693 8,325 520,445
7.50% - 7.99%.............. 562 57,188 15,127 833,118
8.00% - 8.49%.............. 2,732 201,968 7,442 454,494
8.50% - 8.99%.............. 1,818 119,252 7,803 338,867
9.00% - 9.49%.............. 478 24,183 3,102 114,954
9.50% - 9.99%.............. 167 7,380 2,445 68,646
10.00% - 10.49%............ 135 3,964 981 33,224
10.50% - 10.99%............ 154 4,146 596 16,801
11.00% or more............. 150 3,438 1,380 34,677
----- -------- ------ ----------
6,507 $448,858 49,935 $2,552,030
===== ======== ====== ==========
<PAGE>
<CAPTION>
At December 31, 1997
---------------------------------
Total Loans
Serviced
---------------------------------
Number of Aggregate
Loans Principal Balance
Mortgage Interest Rate ------------ --------------------
(Dollars in Thousands)
<S> <C> <C>
Less than 7.00%............ 2,785 $139,450
7.00% - 7.49%.............. 8,585 545,138
7.50% - 7.99%.............. 15,689 890,306
8.00% - 8.49%.............. 10,174 656,462
8.50% - 8.99%.............. 9,621 458,119
9.00% - 9.49%.............. 3,580 139,137
9.50% - 9.99%.............. 2,612 76,026
10.00% - 10.49%............ 1,116 37,188
10.50% - 10.99%............ 750 20,947
11.00% or more............. 1,530 38,115
------ ----------
56,442 $3,000,888
====== ==========
</TABLE>
The amount of principal prepayments on mortgage loans serviced by R&G
Mortgage was $87.2 million, $72.5 million and $68.2 million for the years ended
December 31, 1997, 1996 and 1995, respectively. This represented approximately
2.9%, 2.8% and 3.0% of the aggregate principal amount of mortgage loans serviced
during such periods. 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, 1997, 1996 and 1995, the monthly average amount of
funds advanced by R&G Mortgage under such servicing agreements was $1.4 million,
$1.3 million and $4.4 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, 1997, R&G Mortgage
held $58.8 million of such escrow funds, $50.2 million of which were deposited
in the Bank and $8.6 million of which were deposited with other financial
institutions. The escrow funds deposited with the Bank lower its overall cost of
funds
14
<PAGE>
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, 1997, R&G
Mortgage was servicing mortgage loans with an aggregate principal amount of
$374.4 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,
----------------------------------------------------------------------------------------
1997 1996 1995
-------------------------- -------------------------- --------------------------
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.......................... 2,531 4.48% 2,775 5.44% 3,366 6.98%
60-89 days.......................... 572 1.01 533 1.05 906 1.88
90 days or more..................... 778 1.38 646 1.27 988 2.05
----- ---- ----- ---- ----- -----
Total delinquencies(1)............ 3,881 6.87% 3,954 7.76% 5,260 10.90%
===== ==== ===== ==== ===== =====
Foreclosures pending(2)............... 681 1.21% 693 1.36% 459 0.95%
===== ==== ===== ==== ===== =====
</TABLE>
- -----------------
(1) Includes at December 31, 1997, an aggregate of $26.4 million of
delinquent loans serviced for the Bank, or .88% of the total servicing
portfolio and $2.7 million of delinquent loans held in R&G Mortgage's
own portfolio.
(2) At December 31, 1997, the Bank had foreclosures pending on $12.2 million
of loans being serviced by R&G Mortgage, which constituted 0.41% of the
servicing portfolio. R&G Mortgage had foreclosures pending on
$2.1 million of loans it is servicing for its own portfolio at
December 31, 1997.
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, 1997, 1996 and 1995, R&G Mortgage held
REO with a book value of approximately $165,000, $0 and $0, respectively. Sales
of REO resulted in gains to R&G Mortgage of $145,000 and $30,000 for the years
ended December 31, 1997 and 1995, respectively, and a net loss to R&G Mortgage
of $57,000 for the year ended December 31, 1996. 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, 1997. 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, 1997, 1996 and 1995, total expenses related to FHA or VA loans
foreclosed amounted to $189,000, $323,000 and $230,000, respectively. Although
FNMA and FHLMC are obligated to reimburse R&G Mortgage for principal and
interest payments advanced
16
<PAGE>
by R&G Mortgage as a servicer (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 that have grants of tax exemption issued
thereunder ("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.
A new Industrial Incentive Act was approved by the Government of Puerto
Rico effective January 1, 1998: the Tax Incentive Act of 1998 (the "1998 TIA").
Grants issued under the 1998 TIA will provide for a flat rate of tax on the
operating income of Exempt Companies. The same types of investment income that
qualified for exemption under the Industrial Incentive Acts will continue to be
exempt under the 1998 TIA. Because grantees of tax exemption under the 1998 TIA
will not be subject to Tollgate Taxes, they will not have an incentive to invest
their IDI in qualifying investments in Puerto Rico, as grantees under the
Industrial Incentive Acts presently do in order to reduce their Tollgate Taxes.
It should be noted, however, that Exempt Companies currently operating pursuant
to grants issued under the Industrial Incentives Acts generally will not be
affected by the provisions of the 1998 TIA. Although such Exempt Companies may
renegotiate their grants under the 1998 TIA, an amount of IDI equal to the IDI
derived in the taxable year preceding the change to the 1998 TIA (or, if
greater, the average annual IDI by
17
<PAGE>
taking the three years, out of the previous five years, where the highest amount
of IDI is derived) will continue to be subject to the tax treatment, including
Tollgate Taxes, provided in the Industrial Incentive Act under which their grant
was originally issued.
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 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
18
<PAGE>
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 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
19
<PAGE>
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.
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, or under the laws of foreign countries. Generally, a
non-U.S. 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, or
a foreign corporation operating in Puerto Rico, is subject to local Puerto Rico
taxes, the benefits under the Industrial Incentives Acts and the 1998 TIA 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 or other
non-U.S. corporation would be allowed to claim a foreign tax credit with respect
to income tax paid in Puerto Rico. United States shareholders are also not
required to recognize income attributable to manufacturing operations of a
Puerto Rico or other non-U.S. 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 or other non-U.S. 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 July 1997, the Government of Puerto Rico amended the tax law that
provided Puerto Rico income tax exemption on interest income generated by FHA
and VA loans secured by real estate property located in Puerto Rico and
mortgage-backed securities secured by such mortgage loans ("GNMAs"). Under the
amended law, FHA and VA loans closed prior to August 1, 1997 will continue to be
exempt. The interest income on FHA and VA mortgage loans originated on or after
August 1, 1997 for purposes other than to finance the acquisition of new
housing, and GNMAs secured by such loans, are no longer exempt, and are taxable
at a preferential 17% tax rate to individuals and certain taxpayers other than
corporations. FHA and VA loans to finance the purchase of new housing, and GNMAs
secured by such loans, continue to be exempt. 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 qualifying 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 further
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.
20
<PAGE>
Lending Activities of the Bank
General. At December 31, 1997, R&G Financial's loans receivable, net
totalled $765.1 million, which represented 50.6% of R&G Financial's $1.5 billion
of total assets. At December 31, 1997, $733.1 million or 95.8% 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 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, 1997, $475.5 million or 99.7% 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,
------------------------------------------------------------------------------
1997 1996 1995
----------------------- ---------------------- ----------------------
Amount Percent Amount Percent Amount Percent
----------- ---------- ------------ --------- ------------ ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Residential real estate - first
mortgage(1)....................................... $476,729 61.25% $370,876 60.75% $282,498 58.23%
Residential real estate - second
mortgage.......................................... 17,831 2.29 15,757 2.58 14,372 2.96
Residential construction............................ 13,367 1.72 5,351 .88 15,046 3.10
Commercial construction and land
acquisition....................................... 5,785 .74 5,700 .93 5,523 1.14
Commercial real estate.............................. 81,722 10.50 69,514 11.39 61,862 12.74
Commercial business................................. 38,069 4.89 31,063 5.09 27,816 5.74
Consumer loans:
Loans secured by deposits......................... 12,472 1.60 9,409 1.54 7,497 1.55
Real estate secured consumer loans................ 81,252 10.44 42,893 7.03 33,381 6.88
Unsecured consumer loans.......................... 51,162 6.57 59,864 9.81 37,180 7.66
------- ------ ------- ------ ------- ------
Total loans receivable.......................... 778,389 100.00% 610,427 100.00% 485,175 100.00%
------- ------ ------- ------ ------- ------
Less:
Allowance for loan losses......................... (6,772) (3,332) (3,510)
Loans in process.................................. (6,218) (2,430) (5,727)
Deferred loan fees................................ 172 41 (266)
Unearned interest................................. (512) (955) (1,831)
------- ------- -------
(13,330) (6,676) (11,334)
------- ------- -------
Loans receivable, net(2).......................... $765,059 $603,751 $473,841
======== ======== ========
<PAGE>
<CAPTION>
December 31,
----------------------------------------------------------
1994 1993
--------------------------- --------------------------
Amount Percent Amount Percent
------------- ------------- -------------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Residential real estate - first
mortgage(1)....................................... $194,707 62.14% $137,396 60.95%
Residential real estate - second
mortgage.......................................... 13,298 4.24 11,135 4.94
Residential construction............................ 12,039 3.84 3,940 1.75
Commercial construction and land
acquisition....................................... 1,062 0.34 1,084 0.48
Commercial real estate.............................. 43,029 13.72 30,290 13.44
Commercial business................................. 14,102 4.51 15,417 6.84
Consumer loans:
Loans secured by deposits......................... 5,829 1.86 3,815 1.69
Real estate secured consumer loans................ 29,279* 9.34* 22,355* 9.92*
Unsecured consumer loans.......................... * * * *
------- ------ ------- ------
Total loans receivable.......................... 313,345 100.00% 225,432 100.00%
------- ------ ------- ------
Less:
Allowance for loan losses......................... (2,887) (3,029)
Loans in process.................................. (5,945) (1,531)
Deferred loan fees................................ (424) (456)
Unearned interest................................. (2,475) (3,796)
------- -------
(11,731) (8,812)
------- -------
Loans receivable, net(2).......................... $301,614 $216,620
======== ========
</TABLE>
(1) Includes $33.9 million, $49.7 million and $55.2 million of residential
real estate - first mortgage loans which are held by R&G Mortgage at
December 31, 1997, 1996 and 1995, respectively.
(2) Does not include mortgage loans held for sale of $46.9 million, $54.5
million, $21.3 million, $22.0 million and $174.2 million at December 31,
1997, 1996, 1995, 1994 and 1993, respectively.
* R&G Financial is unable to distinguish these two sub-categories of
consumer loans during the years ended December 31, 1994 and 1993.
22
<PAGE>
Contractual Principal Repayments and Interest Rates. The following
table sets forth certain information at December 31, 1997 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 1997 1997 Total(1)
----------- ------------- -------------- ----------
(In Thousands)
<S> <C> <C> <C> <C>
Residential real estate........................... $ 77 $ 683 $493,800 $494,560
Residential construction.......................... 13,367 -- -- 13,367
Commercial real estate(2)......................... 21,342 25,296 40,869 87,507
Commercial business............................... 6,224 25,305 6,540 38,069
Consumer:
Loans on savings................................ 6,572 5,320 580 12,472
Real estate secured consumer loans.............. 2,342 8,741 70,169 81,252
Unsecured consumer loans........................ 3,677 41,213 6,272 51,162
------- -------- -------- --------
Total(3).......................................... $53,601 $106,558 $618,230 $778,389
======= ======== ======== ========
</TABLE>
- ---------------
(1) Amounts have not been reduced for the allowance for loan losses, loans
in process, deferred loan fees or unearned interest.
(2) Includes $5.8 million of commercial construction and land acquisition
loans.
(3) Does not include mortgage loans held for sale.
23
<PAGE>
The following table sets forth the dollar amount of total loans due
after one year from December 31, 1997, as shown in the preceding table, which
have fixed interest rates or which have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Floating or
Fixed rate adjustable-rate Total
-------------------- ----------------------- -----------------------
(In Thousands)
<S> <C> <C> <C>
Residential real estate..................... $494,407 $ -- $494,407
Residential construction.................... -- -- --
Commercial real estate(1)................... 4,652 61,513 66,165
Commercial business......................... 23,613 8,232 31,845
Consumer:
Loans on savings.......................... 5,900 -- 5,900
Real estate secured consumer loans........ 78,910 -- 78,910
Unsecured consumer loans.................. 47,485 -- 47,485
-------- -------- --------
Total.................................... $654,967 $ 69,745 $724,712
======== ======== ========
</TABLE>
- ---------------
(1) Includes $5.8 million of commercial construction and land acquisition
loans.
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.
24
<PAGE>
Origination, Purchase and Sales of Loans. The following table sets
forth loan originations, purchases and sales by the Bank for the periods
indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------
1997 1996 1995
------------------ ----------------- ------------------
(Dollars in Thousands)
<S> <C> <C> <C>
Loan originations:
Loans originated by R&G Mortgage:
Residential mortgages................................ $221,451 $187,845 $126,599
Commercial mortgages................................. 555 -- --
Construction loans................................... 11,482 2,227 13,764
Consumer loans....................................... 52,287 21,208 15,944
Total loans originated by R&G Mortgage............. 285,775 211,280 156,307
Other loans originated:
Commercial real estate............................... 37,129 36,140 48,497
Commercial business.................................. 15,393 33,318 21,556
Consumer loans:
Loans on deposit..................................... 19,711 13,988 12,546
Real estate secured consumer loans................... -- 80 3,436
Unsecured consumer loans............................. 16,742 39,312 38,589
Total other loans originated....................... 88,975 122,838 124,624
Loans purchased(1)................................... 60,646 8,047 807
Total loans originated and purchased............... 435,396 342,165 281,738
Loans sold(2)........................................ (118,234) (49,726) (75,093)
Loan principal reductions............................ (134,166) (114,792) (78,519)
Net increase before other items, net................. 182,996 177,647 128,126
Loans securitized and transferred to
mortgage-backed securities......................... -- (43,673) (17,631)
Other increases (decreases).......................... -- -- 179
Net increase in loan portfolio....................... $182,996 $133,974 $110,674
</TABLE>
- --------------
(1) Comprised of conventional, commercial real estate and secured consumer
loans purchased from other financial institutions aggregating $54.0
million, $4.6 million and $2.0 million, respectively, in the year ended
December 31, 1997, and conventional loans of $8.1 million and $807,000
in the years ended December 31, 1996 and 1995.
(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
25
<PAGE>
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, 1997,
1996 and 1995, R&G Mortgage received $5.2 million, $4.5 million and $3.6
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
$2.5 million, and the Executive Committee of the Board of Directors is
authorized to approve all loans exceeding $2.5 million. 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 purchases conventional loans secured by first liens on
single-family residential real estate 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 from time to time
securitized by R&G Mortgage and sold by the Bank. During the years ended
December 31, 1997, 1996 and 1995, the Bank purchased $60.6 million, $8.1 million
and $807,000 of loans, respectively.
During the years ended December 31, 1997, 1996 and 1995, the Bank sold
$107.2 million, $49.7 million and $75.1 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.
26
<PAGE>
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, 1997, R&G Financial's five largest loans-to-one
borrower and their related entities amounted to $1.5 million, $1.3 million, $1.2
million, $800,000 and $711,000. The largest loan concentration is a loan to a
developer of a new shopping center in Carolina. The project is in its final
stages of completion. The second largest loan concentration consists of a
commercial loan for the financing of new equipment for a medical laboratory
located in Bayamon. The third largest loan concentration is an interim
construction loan with an aggregate balance of $681,000 to a developer of 55
single family detached residential units located in Humacao with the balance
comprised of other commercial loans. The fourth largest loan concentration
represents a cash collateral personal loan at the Bank's Mayaguez branch. The
fifth largest loan consist of a commercial working capital line of credit
secured by the assignment of lease contracts. All of R&G Financial's five
largest loan concentrations were performing in accordance with their terms as of
December 31, 1997.
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, 1997,
$476.7 million or 61.3% of R&G Financial's total loans held for investment
consisted of such loans, $475.5 million or 99.7% 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, 1997, $17.8 million or
2.3% 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
27
<PAGE>
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,
1997, residential construction loans amounted to $13.4 million or 1.7% of R&G
Financial's total loans held for investment, while commercial construction and
land acquisition loans amounted to $5.8 million or 0.7% 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 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, 1997, the Bank's construction loan portfolio included 127
construction/permanent loans with an aggregate principal balance of $12.7
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, 1997, the Bank
had one residential construction loan outstanding to develop a single-family
subdivision, consisting of 55 units in Humaco. The loan, which involved a $1.2
million credit facility for the fourth phase of the project, had an outstanding
balance of $681,000 at December 31, 1997. The loan is performing in accordance
with its terms. This loan is referenced in the discussion of the Bank's largest
loan concentrations above.
In addition to the foregoing, at December 31, 1997, the Bank had seven
land acquisition loans with outstanding balances ranging from $186,000 to
$650,000, and an aggregate balance of $2.9 million, 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 some of these projects. The
Bank does not expect to be active in this business.
28
<PAGE>
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 thereof. At December 31, 1997,
$368,000 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, 1997, $81.7 million or
10.5% 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 775 loans with an average principal balance of
$105,000. At December 31, 1997, $6.0 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
29
<PAGE>
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 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, 1997,
commercial business loans amounted to $38.1 million or 4.9% 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.
Consumer Loans. The Bank has begun to emphasize the origination of real
estate secured 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 other mortgage loans. At December 31, 1997,
$144.9 million or 18.6% of R&G Financial's total loans held for investment
consisted of consumer loans. This amount is comprised mostly of real estate
secured consumer loans (which are originated by R&G Mortgage), but the Bank also
offers 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 collateralized 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 $12.5 million at December 31, 1997. 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, 1997, real estate secured consumer
loans totalled $81.2 million. In November 1995, the Bank began issuing credit
cards in its own name. At December 31, 1997, credit card receivables totalled
$2.3 million.
30
<PAGE>
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 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, 1997, $4.0 million 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,
------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------- ---------------- ----------- ------------- --------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Non-accruing loans:
Residential real estate(1)............ $21,619 $12,991 $7,921 $4,963 $3,678
Residential construction.............. 368 363 -- -- --
Commercial real estate................ 6,000 3,141 1,903 789 1,311
Commercial business................... 765 823 -- -- --
Consumer.............................. 1,217 686 40 -- --
Other (2) ............................ 117 726 -- -- --
------ ------ ----- ----- -----
Total............................... 30,086(3) 18,730 9,864 5,752 4,989
------ ------ ----- ----- -----
Accruing loans greater than 90 days
delinquent:
Residential real estate............... -- -- -- -- --
Residential construction.............. -- -- 611 -- --
Commercial real estate................ -- -- -- -- --
Commercial business................... 54 22 8 10 70
Consumer.............................. 172 134 94 -- --
------ ----- ------ ------- ------
Total accruing loans greater than
90 days delinquent................ 226 156 713 10 70
------ ------ ----- ------ ------
Total non-performing loans.......... 30,312 18,886 10,577 5,762 5,059
------ ------ ------ ----- -----
Real estate owned, net of reserves(4)... 1,715 834 654 722 699
Other repossessed assets................ 85 31 -- -- --
-- -- -- -- --
1,800 865 654 722 699
-------
Total non-performing assets......... $32,112 $19,751 $11,231 $6,484 $5,758
======= ======= ======= ====== ======
Total non-performing loans as a
percentage of total loans......... 3.89% 3.09% 2.18% 1.84% 2.24%
======= ======= ======= ====== ======
Total non-performing assets as a
percentage of total assets........ 2.12% 1.90% 1.32% 1.04% 1.07%
======= ======= ======= ====== ======
</TABLE>
- -------------
(1) Includes residential real estate secured by both first and
second mortgage loans. Also includes $2,610,000, $1,118,000, $882,000,
$918,000, and $736,000 consumer loans secured by first and second
mortgages on residential real estate at December 31, 1997, 1996, 1995,
1994 and 1993, respectively.
(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, 1997, comprised of 365 loans secured by residential
real estate, 47 loans secured by commercial real estate, 8 construction
loans, 59 commercial business loans and 143 consumer loans.
32
<PAGE>
(4) Includes properties held by R&G Mortgage of $165,000 and $43,000 as of
December 31, 1997 and 1994, respectively. As of December 31, 1997, the
Bank had 20 residential properties aggregating $1,550,000.
While the level of total non-performing assets of R&G Financial has
increased on an absolute basis during the periods presented, from $5.8 million
at December 31, 1993 to $32.1 million at December 31, 1997, R&G Financial's net
loans receivable portfolio has increased by 253% during this period, from $216.6
million at December 31, 1993 to $765.1 million at December 31, 1997. Thus, total
non-performing assets as a percent of total assets increased from 1.07% at
December 31, 1993 to 2.12% at December 31, 1997.
Non-performing residential loans increased by $8.6 million or 64.6%
from December 31, 1996 to December 31, 1997. The average loan balance on
non-performing mortgage loans amounted to $60,000 at December 31, 1997. As of
such date, 174 loans with an aggregate balance of $12.5 million (including 9
consumer loans secured by real estate with an aggregate balance of $250,000)
were in the process of foreclosure. The total delinquency ratio on residential
mortgages, including loans past due less than 90 days, slightly increased from
4.87% in 1996 to 4.93% in 1997. The Company's loss experience on such portfolio
has been minimal over the last several years.
Non-performing commercial real estate loans increased by $2.9 million
or 91.0% from December 31, 1996 to December 31, 1997. The number of loans
delinquent over 90 days amounted to 47 loans at December 31, 1997, with an
average balance of $99,000. The largest non-performing commercial real estate
loan as of December 31, 1997 had a balance of $550,000.
Non-performing commercial business loans consist of 14 loans which are
90% guaranteed by the Small Business Administration with an aggregate balance of
$1.5 million and 42 commercial leases amounting to $731,000. These loans have a
combined average loan size of $39,000. The majority of loans in this portfolio
were originated during 1995 and 1996. The largest non-performing commercial
business loan as of December 31, 1997 had a $270,000 balance.
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.
33
<PAGE>
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,
---------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------------- -------------- -------------- -------------- --------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period......... $ 3,332 $3,510 $2,887 $3,029 $1,230
------- ------ ------ ------ ------
Charge-offs:
Residential real estate.............. 13 45 53 -- --
Construction......................... -- 50 -- -- --
Commercial real estate............... 170 -- -- -- --
Commercial business.................. 480 110 91 3 56
Consumer............................. 3,953 1,922 365 139 90
Other ............................... 761 2,535(1) -- -- --
------- ------ ------ ------ ------
Total charge-offs.................. 5,377 4,662 509 142 146
------- ------ ------ ------ ------
Recoveries:
Residential real estate.............. 21 -- 1 -- --
Construction......................... -- -- -- -- --
Commercial real estate............... 50 -- -- -- --
Commercial business.................. 32 31 85 -- 20
Consumer............................. 344 195 96 -- 242
Other................................ 2,000(2) -- -- -- --
------- ------ ------ ------ ------
Total recoveries................... 2,447 226 182 -- 262
------- ------ ------ ------ ------
Net charge-offs........................ 2,930 4,436 327 142 (116)
------- ------ ------ ------ ------
Allowance for loan losses acquired from
Caribbean Federal.................... -- -- -- -- 1,683
Provision for losses on loans.......... 6,370 4,258 950(3) -- --
------- ------ ------ ------ ------
Balance at end of period............... $ 6,772 $ 3,332 $3,510 $2,887 $3,029
======= ======= ====== ====== ======
Allowance for loan losses as a percent
of total loans outstanding........... .87% .55% 0.72% 0.92% 1.34%
======= ======= ====== ====== ======
Allowance for loan losses as a percent
of non-performing loans.............. 22.34% 17.64% 33.19% 50.10% 59.87%
======= ======= ====== ====== ======
Ratio of net charge-offs to average
loans outstanding.................... 0.40% 0.75% 0.08% 0.05% (0.06)%
======= ======= ====== ====== ======
</TABLE>
- ------------------
(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 Operations -- Results of Operations
-- Provision for Loan Losses" incorporated by reference in Item 7
hereof.
(2) Corresponds to $2.0 million received on January 15, 1998 from the
Company's fidelity insurance carrier accounted for as a recovery of
loans previously charged-off as of December 31, 1997. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Provision for Loan Losses"
incorporated by reference in Item 7 hereof.
(3) 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,
--------------------------------------------------------------------------------------------
1997 1996 1995
--------------------------- ----------------------------- -------------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Each Each Each
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------------ -------------- ----------- ----------------- ---------- --------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Residential real estate..... $ 593 8.76% $ 810 24.31% $2,094 59.66%
Construction................ 7 0.10 51 1.53 32 0.90
Commercial real estate...... 1,386 20.47 489 14.68 -- --
Commercial business......... 806 11.90 109 3.27 782 22.28
Consumer.................... 3,980 58.77 1,873 56.21 602 17.16
------ ------ ------ ------ ------ ------
Total....................... $6,772 100.00% $3,332 100.00% $3,510 100.00%
====== ====== ====== ====== ====== ======
<PAGE>
<CAPTION>
December 31,
--------------------------------------------------------
1994 1993
------------------------- --------------------------
Percent of Percent of
Loans in Loans in
Each Each
Category to Category to
Amount Total Loans Amount Total Loans
---------- -------------- ---------- --------------
<S> <C> <C> <C> <C>
Residential real estate..... $1,962 67.95% $2,029 66.99%
Construction................ -- -- -- --
Commercial real estate...... -- -- -- --
Commercial business......... 403 13.96 576 19.02
Consumer.................... 522 18.09 424 13.99
------ ------ ------ ------
Total....................... $2,887 100.00% $3,029 100.00%
====== ====== ====== ======
</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, 1997, R&G Mortgage held GNMA mortgage-backed securities with a
fair value of $375.7 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, 1997, R&G
Mortgage's CMOs and CMO residuals, which are classified as held for trading, had
an amortized cost of $23.8 million and a fair value of $23.1 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, 1997, the Bank's securities portfolio consisted of
$44.0 million of securities held for investments, consisting of $18.4 million of
tax-free mortgage-backed securities, $14.9 million of other mortgage backed
securities, and $10.4 million of Puerto Rico Government obligations and other
Puerto Rico securities, and $310,000 U.S. Treasury securities. In addition, at
December 31, 1997, the Bank had a securities portfolio classified as available
for sale with a fair value of $121.9 million, consisting of $37.6 million of
mortgage-backed securities, $4.9 million of FHLB stock, $8.4 million of CMOs and
CMO residuals, $30.9 million U.S. Treasury securities and $40.1 million of U.S.
Government agency securities. Finally, at December 31, 1997, $1.7 million of the
Bank's securities were classified as held for trading, consisting of $1.7
million of GNMA certificates.
36
<PAGE>
In February 1996, the Company entered into various agreements with an
independent investment management firm whereby such firm has been appointed as
investment advisor with respect to a portion of the Company's securities
portfolio for trading purposes. Such firm had also been engaged by the Company
to, among other things, assist it in achieving the objectives established by the
Company's IRRBICO through the execution of various hedging strategies. During
1997, the Company discontinued hedging activities for its mortgage backed
securities held for trading and available sale after management determined that
the relatively low volatility of such securities and current market conditions
did not warrant hedging against such assets. In late 1997, the Company also
discontinued trading activities through the advisory firm; the Bank's Treasury
Department continues from time to time to conduct certain trading activities
mainly through investments in U.S. Treasury securities.
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,
-----------------------------------------------------------------------------------------
1997 1996
---------------------------------------- ------------------------------------------
Weighted Weighted
Carrying Market Average Carrying Market Average
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....... 49 50 10.00 -- -- --
Due from five-ten years....... -- -- -- 97 100 10.00%
Due over ten years............ 18,321 17,705 6.05 21,591 20,571 6.03
FNMA
Due within one year............. -- -- -- -- -- --
Due from one-five years......... -- -- -- -- -- --
Due from five-ten years......... -- -- -- -- -- --
Due over ten years.............. 14,675 15,164 7.17 15,895 16,124 7.18
FHLMC
Due within one year............. -- -- -- -- -- --
Due from one-five years......... -- -- -- -- -- --
Due from five-ten years......... -- -- -- -- -- --
Due over ten years.............. 281 266 6.00 317 309 5.50
Investment Securities:
Puerto Rico Government
obligations
Due within one year............. 4,433 4,439 6.22 3,351 3,351 5.12
Due from one-five years......... -- -- -- 1,035 1,012 6.25
Due from five-ten years......... 5,920 5,910 5.85 -- -- --
Due over ten years.............. 30 30 8.37 574 567 5.11
U.S. Government Agency
Due within one year............. 310 311 6.13 -- -- --
Due from one-five years......... -- -- -- 310 311 6.13
Due from five-ten years......... -- -- -- -- -- --
Due over ten years.............. -- -- -- -- -- --
Commercial paper:
Due within one year............. -- -- -- 2,982 2,982 5.55
Due from one-five years......... -- -- -- -- -- --
Due from five-ten years......... -- -- -- -- -- --
Due over ten years.............. -- -- -- -- -- --
Total Securities held for
investment.................. $44,019 $43,875 6.18% $46,152 $45,327 6.34%
<PAGE>
<CAPTION>
December 31,
--------------------------------------
1995
--------------------------------------
Weighted
Carrying Market Average
Value Value Yield
---------- ----------- -----------
(Dollars in Thousands)
<S> <C> <C> <C>
Mortgage-backed securities:
GMNA
Due within one year........... $ -- $ -- --%
Due from one-five years....... -- -- --
Due from five-ten years....... 118 108 10.00
Due over ten years............ 24,617 23,681 6.03
FNMA
Due within one year............. -- -- --
Due from one-five years......... -- -- --
Due from five-ten years......... -- -- --
Due over ten years.............. 16,623 16,623 7.18
FHLMC
Due within one year............. -- -- --
Due from one-five years......... -- -- --
Due from five-ten years......... -- -- --
Due over ten years.............. 373 373 5.50
Investment Securities:
Puerto Rico Government
obligations
Due within one year............. 377 377 2.69
Due from one-five years......... 1,042 1,000 6.25
Due from five-ten years......... -- -- --
Due over ten years.............. 627 619 4.25
U.S. Government Agency
Due within one year............. -- -- --
Due within one-five years....... -- -- --
Due within five-ten years....... -- -- --
Due over ten years.............. -- -- --
Commercial paper:
Due within one year............. -- -- --
Due within one-five years....... -- -- --
Due within five-ten years....... -- -- --
Due over ten years.............. -- -- --
Total Securities held for
investment.................. $43,777 $42,781 6.42%
</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,
--------------------------------------------
1997
--------------------------------------------
Weighted
Amortized Fair Average
Cost Value Yield
--------------- ----------- -----------
<S> <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.............................. $9,468 9,670 7.00
FHLMC mortgage-backed securities
Due within one year............................. -- -- --
Due from one-five years......................... 71 70 9.00
Due from five-ten years......................... 360 368 9.38
Due over ten years.............................. 27,104 27,513 6.86
CMO residuals and other mortgage-backed
securities (2)
Due within one year............................. -- -- --
Due from one-five years......................... -- -- --
Due from five-ten years......................... -- -- --
Due over ten years.............................. 7,007 8,382 8.125
Investment Securities Available for Sale(1)
U.S. Treasury
Due within one year............................. 773 772 5.22
Due from one-five years......................... 30,010 30,100 5.85
Due from five-ten years......................... -- -- --
Due over ten years.............................. -- -- --
U.S. Government Agency
Due within one year............................. -- -- --
Due from one-five years......................... 35,145 35,105 6.06
Due from five-ten years......................... 5,023 4,981 6.73
Due over ten years.............................. -- -- --
FHLB stock........................................ 4,906 4,906 7.05
-------- -------- ----
$119,867 $121,867 6.59%
======== ======== ====
Securities held for trading(3):
GNMA certificates................................. $367,177 $377,362 6.78%
CMO certificates.................................. 16,200 15,228 5.95
CMO residuals(4).................................. 7,630 7,868 8.00
U.S. Treasury Bills............................... 581 581 5.23
-------- -------- ----
$391,588 $401,039 6.77%
======== ======== ====
<PAGE>
<CAPTION>
December 31,
-----------------------------------------
1996
----------------------------------------
Weighted
Amortized Fair Average
Cost Value Yield
----------- ------------ ------------
(Dollars in Thousands)
<S> <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
FHLMC mortgage-backed securities
Due within one year............................. -- -- --
Due from one-five years......................... -- -- --
Due from five-ten years......................... 530 547 9.30
Due over ten years.............................. 32,547 31,806 6.87
CMO residuals and other mortgage-backed
securities (2)
Due within one year............................. -- -- --
Due from one-five years......................... -- -- --
Due from five-ten years......................... -- -- --
Due over ten years.............................. 7,067 8,195 8.125
Investment Securities Available for Sale(1)
U.S. Treasury
Due within one year............................. -- -- --
Due from one-five years......................... -- -- --
Due from five-ten years......................... -- -- --
Due over ten years.............................. -- -- --
U.S. Government Agency
Due within one year............................. 1,500 1,500 6.00
Due from one-five years......................... 25,528 25,226 6.18
Due from five-ten years......................... -- -- --
Due over ten years.............................. -- -- --
FHLB stock........................................ 4,247 4,247 6.30
------- ------- ----
$81,889 $81,814 6.75%
======== ======== ====
Securities held for trading(3):
GNMA certificates................................. 83,848 84,460 6.53%
CMO certificates.................................. 16,200 15,147 5.95
CMO residuals(4).................................. 8,489 8,539 8.00
U.S. Treasury Bills............................... 1,370 1,316 5.72
------- ------- ----
$109,907 $109,462 6.55%
======== ======== ====
<PAGE>
<CAPTION>
December 31,
-----------------------------------------
1995
----------------------------------------
Weighted
Amortized Fair Average
Cost Value Yield
-------------- ---------- ----------
(Dollars in Thousands)
<S> <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.............................. 14,846 14,946 7.12
FHLMC mortgage-backed securities
Due within one year............................. -- -- --
Due from one-five years......................... -- -- --
Due from five-ten years......................... 1,122 1,180 8.90
Due over ten years.............................. 36,353 36,759 6.94
CMO residuals and other mortgage-backed
securities (2)
Due within one year............................. -- -- NA
Due from one-five years......................... -- -- NA
Due from five-ten years......................... -- -- NA
Due over ten years.............................. 7,126 8,123 8.125
Investment Securities Available for Sale(1)
U.S. Treasury
Due within one year............................. -- -- --
Due from one-five years......................... -- -- --
Due from five-ten years......................... -- -- --
Due over ten years.............................. -- -- --
U.S. Government Agency
Due within one year............................. -- -- --
Due from one-five years......................... -- -- --
Due from five-ten years......................... -- -- --
Due over ten years.............................. -- -- --
FHLB stock........................................ 3,280 3,280 7.68
-------- -------- ----
$ 62,727 $ 64,288 6.42%
======== ======== ====
Securities held for trading(3):
GNMA certificates................................. $ 87,656 $ 88,448 6.71%
CMO certificates.................................. 16,200 15,570 5.95
CMO residuals(4).................................. 10,248 9,791 8.00
U.S. Treasury Bills............................... -- -- --
-------- -------- ----
$114,104 $113,809 6.72%
======== ======== ====
</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, $1.7
million and $1.8 million as of December 31, 1997, 1996 and 1995, 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 in 1995 from its 1993 CMO
Grantor Trust, and from R&G Mortgage's CMO Grantor Trusts.
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 their loans
secured by a single-family, owner-occupied residence to $227,150. 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.
40
<PAGE>
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, 1997, $40.2
million or 8.6% 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, 1997, the Bank's CMOs and CMO residuals, which had a
fair value of $8.4 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
41
<PAGE>
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 $197.0 million of certificates of deposit with balances of $100,000 or more,
which amounted to 27.0% of the Bank's total deposits at December 31, 1997.
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,
1997 it held $7.5 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.
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,
----------------------------------------------------------------------------------
1997 1996 1995
------------------------- ------------------------ ------------------------
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...................... $75,958 3.79% $73,216 3.77% $ 59,860 3.66%
NOW and Super NOW
accounts 86,843 3.84 78,183 3.85 65,135 3.82
Checking...................... 23,859 -- 20,451 -- 6,050 --
Commercial checking(1)........ 46,301 -- 30,173 -- 24,601 --
Certificates of deposit....... 435,743 6.02 359,525 6.05 276,187 6.25
-------- ---- -------- ---- -------- ----
Total deposits.............. $668,704 4.85% $561,548 4.90% $431,833 5.05%
======== ==== ======== ==== ======== ====
</TABLE>
- ----------------
(1) Includes $50.2 million, $10.6 million and $9.7 million of escrow funds
of R&G Mortgage at December 31, 1997, 1996 and 1995, respectively,
maintained with the Bank.
42
<PAGE>
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, 1997.
<TABLE>
<CAPTION>
Amount
----------------------
(In Thousands)
<S> <C>
Certificates of deposit maturing:
Three months or less.............................................. $59,977
Over three through six months..................................... 30,802
Over six through twelve months.................................... 56,249
Over twelve months................................................ 49,934
-------
Total........................................................... $196,962
=======
</TABLE>
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 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, 1997, R&G
Financial had $382.3 million of reverse repurchase agreements outstanding,
$334.2 million of which represented borrowings of R&G Mortgage. At December 31,
1997, the weighted average interest rate on R&G Financial's reverse repurchase
agreements amounted to 5.81%.
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, 1997, R&G Mortgage was permitted to borrow
under such Warehouse Lines up to $138.4 million, $75.2 million of which was
drawn upon and outstanding as of such date. The
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<PAGE>
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, if available, 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, 1997, the weighted average interest rate being paid by R&G
Mortgage under its Warehouse Lines amounted to 5.85%.
The Warehouse Lines include various covenants and restrictions on R&G
Mortgage's operations, including maintenance of minimum levels of net worth and
debt service, 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. Management of R&G Financial believes that as
of December 31, 1997, 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 seven 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 5.55% 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, 1997, $38.6 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
44
<PAGE>
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, 1997, the Bank had $84.1
million of 936 Notes outstanding, $23.6 million of which matures in 1999, $25.0
million of which matures in 2000 and $35.5 million of which matures in 2001.
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, 1997, the Bank had access to $223.4
million in advances from the FHLB of New York, and had two FHLB of New York
advances aggregating $42.0 million outstanding as of such date, which mature in
January 1998 and have a weighted average interest rate of 6.03%. In addition, at
December 31, 1997, the Bank maintained $51.3 million in standby letters of
credit with the FHLB of New York, which secured $45.5 million of outstanding 936
Notes payable and $4.1 million of 936 certificates of deposit. At December 31,
1997, the Bank had pledged specific collateral aggregating $112.9 million to the
FHLB of New York under its advances program and to 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, 1997. 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 $34.4
45
<PAGE>
million at December 31, 1997) 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 $33.9 million
as of December 31, 1997) have been reported as an asset in R&G Financial's
Consolidated Financial Statements.
The following table sets forth certain information regarding the
short-term borrowings of R&G Financial at or for the dates indicated.
<TABLE>
<CAPTION>
At or For the Year Ended
December 31,
----------------------------------------------------
1997 1996 1995
------------------ --------------- ----------------
(Dollars in Thousands)
<S> <C> <C> <C>
R&G Mortgage:
Securities sold under agreements to repurchase:
Average balance outstanding....................... $187,682 $ 93,653 $ 99,145
Maximum amount outstanding at any month-end
during the period............................... 334,203 108,240 112,507
Balance outstanding at end of period.............. 334,203 97,444 87,958
Average interest rate during the period........... 6.03% 5.00% 5.87%
Average interest rate at end of period............ 5.85% 5.67% 5.47%
Notes Payable:
Average balance outstanding....................... $67,558 $40,805 $ 24,521
Maximum amount outstanding at any month-end
during the period............................... 93,523 85,135 31,626
Balance outstanding at end of period.............. 75,204 40,342 30,130
Average interest rate during the period........... 5.92% 5.32% 5.46%
Average interest rate at end of period............ 5.85% 4.97% 5.27%
The Bank:
FHLB of New York advances:
Average balance outstanding....................... $23,524 $ 6,366 $ 11,796
Maximum amount outstanding at any month-end
during the period............................... 42,200 15,000 13,562
Balance outstanding at end of period.............. 42,200 15,000 6,007
Average interest rate during the period........... 5.80% 5.84% 6.00%
Average interest rate at end of period............ 6.03% 5.75% 6.74%
Securities sold under agreements to repurchase:
Average balance outstanding....................... $39,090 $ 6,954 $ 7,737
Maximum amount outstanding at any month-end
during the period............................... 63,088 19,000 14,673
Balance outstanding at end of period.............. 48,080 -- 10,525
Average interest rate during the period........... 5.55% 4.74% 5.16%
Average interest rate at end of period............ 5.56% --% 5.11%
Notes Payable:
Average balance outstanding....................... $85,034 $85,365 $ 30,597
Maximum amount outstanding at any month-end
during the period............................... 86,500 111,500 51,000
Balance outstanding at end of period.............. 84,100 86,500 51,000
Average interest rate during the period........... 6.60% 5.55% 6.42%
Average interest rate at end of period............ 5.97% 5.82% 5.93%
</TABLE>
46
<PAGE>
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, 1997, the Bank's Trust
Department administered approximately 6,135 trust accounts, with aggregate
assets of $23.3 million as of such date. In addition, during the year ended
December 31, 1997, the Bank's Trust Department sold $39.9 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.
Personnel
As of December 31, 1997, R&G Financial (on a consolidated basis) had
809 full-time employees and 42 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 OCFI. 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 OCFI.
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
47
<PAGE>
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 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
48
<PAGE>
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 stockholders be made on
terms substantially the same as offered in comparable transactions to other
persons unless the loans are made pursuant to a benefit or compensation program
that (i) is widely available to employees of the institution and (ii) does not
give preference to any director, executive officer or principal stockholder, or
certain affiliated interests of either, over other employees of the savings
institutions. Section 22(h) 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
49
<PAGE>
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.
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 OCFI, 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 OCFI 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 OCFI, 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 Savings Association Insurance Fund ("SAIF") and Bank Insurance Fund
("BIF") 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"
50
<PAGE>
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 .0% for well capitalized, healthy
institutions to .27% for undercapitalized institutions with substantial
supervisory concerns. The Bank was classified as a "well-capitalized"
institution as of December 31, 1997. An additional assessment is added to the
regular SAIF-assessment and the regular BIF-assessment, respectively, until
December 31, 1999 in order to cover Financing Corporation debt service payments.
Such additional assessments amount to 6.3 basis points and 1.3 basis points for
SAIF insured deposits and BIF insured deposits, respectively.
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 SAIF and the 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 in 1995 from a Puerto Rico commercial bank are BIF
insured and subject to deposit insurance assessments at BIF rates.
Both the SAIF and the BIF are required by law to attain and thereafter
maintain a reserve ratio of 1.25% of insured deposits. The BIF has achieved the
required reserve ratio, and as a result, the FDIC reduced the average deposit
insurance premium paid by BIF-insured banks to a level substantially below the
average premium previously paid by savings institutions. Banking legislation was
enacted on September 30, 1996 to eliminate the premium differential between
SAIF-insured institutions and BIF-insured institutions. The legislation provided
that all insured depository institutions with SAIF-assessable deposits as of
March 31, 1995 pay a special one-time assessment to recapitalize the SAIF.
Pursuant to this legislation, the FDIC promulgated a rule that established the
special assessment necessary to recapitalize the SAIF at 65.7 basis points of
SAIF-assessable deposits held by affected institutions as of March 31, 1995. The
Bank's one-time special assessment amounted to $1.6 million 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 and reducing future assessment
rates for the Bank, effective January 1, 1997, to those previously applicable to
BIF insured institutions.
51
<PAGE>
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 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,
1997, 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
52
<PAGE>
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.
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 OCFI 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
the sum of the Bank's paid-in common and preferred stock capital. As of December
31, 1997, the Bank had credited $2.2 million to such reserve fund.
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
53
<PAGE>
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; (iii) money deposited in other banks provided said deposits are
authorized by the Commissioner, subject to immediate collection; and (iv)
federal funds sold and securities purchased under agreements to resell, provided
such funds are repaid on or prior to the close of the next business day.
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, 1997, the legal lending limit for the Bank under this provision
was approximately $6.6 million and its maximum extension of credit to any one
borrower, including affiliates thereof, was $1.5 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 to subsidiaries of banks, and loans to non-banking
affiliates of the Bank, which are subject however to the lending limitations set
forth in Sections 23A and 23B of the Federal Reserve Act; or loans that are
secured by mortgages by real estate, or 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 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,
54
<PAGE>
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.
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.
55
<PAGE>
R&G Mortgage is also subject to regulation by the OCFI, 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
OCFI 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 OCFI 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 OCFI is obligated to make such inquires as it
deems necessary to review the transaction. Under the Mortgage Banking Law, the
determination of the OCFI whether or not to authorize a proposed change of
control is final and non-appealable.
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.
56
<PAGE>
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, 1997, 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 $1,056
280 Jesus T. Pinero Avenue Two (2) five year options
Hato Rey, PR 00919
Los Jardines Branch September 4, 1999 125
Los Jardines de Guaynabo Shopping Center One (1) ten year option
PR Road No. 20
Guaynabo, PR 00969
San Patricio Branch July 31, 2007 107
San Patricio Plaza
Ortegon Street
Guaynabo, PR 00969
Bayamon Branch(2)(3) May 31, 2001 251
42-43 Betances Avenue One (1) ten year option
Urb. Hermanas Davila
Bayamon, PR 00959
Bayamon East January 10, 2001 478
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
Manati Branch(3) August 8, 2009 492
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 154
65th Infantry Avenue
Corner San Marcos Street
Carolina, PR 00985
</TABLE>
57
<PAGE>
<TABLE>
<CAPTION>
Net Book Value
Description/Address Lease Term Expiration of Property
- -------------------------------------------------------- -------------------------------------- -------------------
(In Thousands)
<S> <C> <C>
Trujillo Alto Branch(4) October 31, 2004 121
Trujillo Alto Shopping Center
Trujillo Alto, PR 00976
Santurce Branch April 30, 1999 362
1077 Ponce de Leon Avenue Three (3) six year options
Santurce, PR 00917
Laguna Gardens Branch(4) April 30, 1999 147
Laguna Gardens Shopping Center One (1) five year option
Isla Verde
Carolina, PR 00979
Plaza Carolina Branch(4) May 31, 2000 197
Plaza Carolina Mall
Carolina, PR 00985
Norte Shopping Branch(4) April 30, 2000 69
Norte Shopping Center Two (2) five year options
Baldorioty de Castro Avenue
San Juan, PR 00907
Vega Baja Branch(4) May 31, 2003 365
Cabo Caribe Development One (1) five year option
PR Road No. 2, Marginal
Vega Baja, PR 00693
Mayaguez Branch(3) April 30, 1997 636
McKinley Street Four (4) five year options
Corner Dr. Vady
Mayaguez, PR 00680
Branch locations to be -- 318
opened in early 1998
Operations Center(2) January 10, 2001 2,328
-----
Road #174, Lote #100
Urb. Ind. Minillas
Bayamon, PR 00959 7,329
</TABLE>
58
<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 6
D-9 Degetau Street One (1) five year option
Urb. San Alfonso
Caguas, PR 00725
Ponce Office May 1, 1998 7
25 Las Americas Avenue
Ext. Buena Vista
Ponce, PR 00731
Fajardo Office May 16, 1999 8
51 Celis Aguilera Street One (1) five year option
Fajardo, PR 00738
Los Jardines Office(5) August 1, 2006 19
Los Jardines de Guaynabo Shopping Center One (1) five year option
PR Road No. 20
Guaynabo, PR 00969
San Patricio Office(5) May 1, 1998 12
K-4 Ebano Street One (1) five year option
Ponderosa Building
San Patricio
Guaynabo, PR 00969
Hato Rey Office(2)(3) December 31, 2002 2,050
280 Jesus T. Pinero Avenue Two (2) five year options
Hato Rey, PR 00919
Bayamon Office(2)(3) May 30, 2001 28
42-43 Betances Avenue One (1) ten year option
Urb. Hermanas Davila
Bayamon, PR 00959
Arecibo Office(3) January 1, 2002 10
Marginal Vista Azul Two (2) five year options
Corner San Daniel Avenue
Arecibo, PR 00612
Manati Office(3)(6) October 30, 1998 17
Plaza Puerta del Sol One (1) five year option
PR Road No. 2, Km. 49.7
Manati, PR 00674
</TABLE>
59
<PAGE>
<TABLE>
<CAPTION>
Net Book Value
Description/Address Lease Term Expiration of Property
- -------------------------------------------------------- -------------------------------------- -------------------
(In Thousands)
<S> <C> <C>
Carolina Office(3)(6) October 30, 1998 15
65th Infantry Avenue One (1) five year option
Corner San Marcos Street
Carolina, PR 00985
Mayaguez Office(3)(6) October 30, 1998 27
-----
McKinley Street One (1) five year option
Corner Dr. Vady
Mayaguez, PR 00680
</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) Facility includes an R&G Mortgage Banking Center.
(5) The Bank maintains an office at this location in a separate facility.
(6) 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.
60
<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 as adjusted for an 80% stock split paid in September 1997:
<TABLE>
<CAPTION>
Price Per Share
-----------------------------------------------
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
d------------------------- -------------------------
<S> <C> <C> <C>
September 30, 1996(1) $10.42 $ 9.17 $ --
December 31, 1996 $14.31 $ 9.86 $0.0347
March 31, 1997 $15.55 $12.64 $0.0382
June 30, 1997 $14.44 $12.92 $0.0417
September 30, 1997 $22.50 $14.17 $0.0431
December 31, 1997 $22.00 $18.875 $0.0457
</TABLE>
(1) The Company's Class B common stock commenced trading on August 27, 1996.
At December 31, 1997 the Company had approximately 97 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 pages
23 to 24 of the Registrant's 1997 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
26 to 40 of the Registrant's 1997 Annual Report.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information required herein is incorporated by reference from pages
29 to 30 of the Registrant's 1997 Annual Report.
61
<PAGE>
Item 8. Financial Statements and Supplementary Data.
The information required herein is incorporated by reference from pages
42 to 77 of the Registrant's 1997 Annual Report.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
Not applicable.
PART III.
Item 10. Directors and Executive Officers of the Registrant.
The information required herein is incorporated by reference from pages
2 to 7 of the Registrant's Proxy Statement dated March 23, 1998 ("Proxy
Statement").
Item 11. Executive Compensation.
The information required herein is incorporated by reference from pages
12 to 15 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
15 to 18 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, 1997 and 1996.
62
<PAGE>
Consolidated Statements of Income for the Years Ended December
31, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995.
Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended December 31, 1997, 1996 and 1995.
Notes to Consolidated Financial Statements.
(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.
63
<PAGE>
(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 1997 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 27, 1998
- --------------------------
Victor J. Galan
Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
/s/ Joseph R. Sandoval March 27, 1998
- -----------------------------
Joseph R. Sandoval
Vice President and Chief Financial
Officer (principal financial and
accounting officer)
/s/ Ana M. Armendariz March 27, 1998
- -------------------------
Ana M. Armendariz
Director and Treasurer
/s/ Ramon Prats March 27, 1998
Ramon Prats
Executive Vice President and Director
<PAGE>
/s/ Enrique Umpierre-Suarez March 27, 1998
- ----------------------------
Enrique Umpierre-Suarez
Director and Secretary
/s/ Victor L. Galan Fundora March 27, 1998
- ----------------------------
Victor L. Galan Fundora
Director
/s/ Juan J. Diaz March 27, 1998
- ----------------------------------
Juan J. Diaz
Director
/s/ Pedro Ramirez March 27, 1998
Pedro Ramirez
Director
/s/ Laureno Carus Abarca March 27, 1998
- ------------------------------
Laureno Carus Abarca
Director
/s/ Eduardo McCormack March 27, 1998
Eduardo McCormack
Director
/s/ Gilberto Rivera-Arrega March 27, 1998
Gilberto Rivera-Arreaga
Director
/s/ Benigno R. Fernandez March 27, 1998
- --------------------------------
Benigno R. Fernandez
Director
<PAGE>
1997 Annual Report
R-G Financial Corporation
25 Years Providing Customer Satisfaction
<PAGE>
Financial Highlights
(In Thousands, except for Per Share Data)
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Loan Production $906.3 $624.6 $467.7
Revenues 77.6 58.2 44.7
Net Earnings 23.5 13.2 10.4
Total Assets 1,511 1,038 853
Servicing Portfolio 3,001 2,550 2,298
Common Shareholders' Equity 138.1 115.6 70.3
Diluted Earnings per Share 1.62 1.19 1.12
Common Shareholders' Equity per Share 9.76 8.17 7.11
</TABLE>
<PAGE>
Mission Statement
We will strive for long-term financial strength and profitability by centering
our strategy on customer satisfaction.
We seek to be a high-performance financial organization that delivers one-stop
financial services to its clients; that is recognized as the best provider of
value-added, service oriented financial services; and that offers services of
unmatched quality in terms of accessibility, responsiveness and turnaround time.
We will achieve these goals by making available a growing number of services and
products within an environment that is both technologically advanced and
friendly.
1
<PAGE>
The beginning of the company, 25 years ago was based on mortgage lending. At the
time this represented a large opportunity for growth, being a market where
commercial banks had not ventured into home lending, the economy was strong and
the people's needs were pressing for new homes and facilities. R-G began with
that vision and commitment.
Less than 10 years ago, customers focused on personal service and traditional
branches. Now satisfaction is redefined by advanced technologies, more products,
faster services and the convenience of electronic banking. Our emphasis is on
people. We offer innovative concepts, leading edge technologies and a
knowledgeable personnel able to handle different situations, make decisions and
solve problems. This customer focus defines all our areas of business. We not
only focus on when and where we provide services, but on how fast and how well
we do this.
Listening to customers and addressing their needs, directs and defines the way
R-G delivers its array of products and services. Learning from 25 years of
experience and being able to foresee and take action on market changes and
trends has kept the Company ahead of its competitors in customer satisfaction.
2
<PAGE>
Our 25th Anniversary
Last year we celebrated our 25th year of operations. The quality that has
defined R-G throughout this quarter of a century has been its dedication to
customer satisfaction. Providing superior products and services to our customers
is a challenge we have undertaken with passion and commitment, and we have met
the challenge through the professionalism and knowledge of our skilled
employees. They are the people who, every day, deliver excellent service to each
and every one of our customers. Listening to our customers, addressing their
needs and anticipating how these needs will change is the way R-G has kept ahead
of its competitors. Customer satisfaction will continue to be our guiding
principle as we embark on our next 25 years.
3
<PAGE>
[BLANK]
4
<PAGE>
Board of Directors
of R-G Financial Corporation:
[GRAPHIC - PHOTO OF BOARD OF DIRECTORS]
(From left to right)
Gilberto Rivera Arreaga
Eduardo McCormack
Laureano Carus Abarca
Juan J. Diaz
Enrique Umpierre Suarez
Victor L. Galan
Pedro Ramirez
Benigno R. Fernandez
Ramon Prats,
Victor J. Galan
Ana M. Armendariz (not pictured)
5
<PAGE>
About the Company
R-G Financial Corporation -the holding company for R-G Mortgage Corporation and
R-G Premier Bank of Puerto Rico- is a financial services company with 25 years
of operations and a history of outstanding growth in Puerto Rico.
Since its inception in 1972 as R-G Mortgage, the Company has succeeded in its
highly competitive market by focusing on customer satisfaction. Decisions about
technology, pricing, services and facilities are all driven by customers' needs
and expectations. R-G now provides a complete range of financial services
through branch offices and mortgage banking facilities in 18 different locations
throughout the island.
R-G Mortgage has become the leading residential mortgage lender and servicer on
the island. Innovation in services, products and technology has been key to the
growth of the Company. R-G originates FHA, VA and conventional mortgages,
conforming to Freddie Mac and Fannie Mae guidelines; non-conforming products and
credit quality subprime first-lien mortgages; consumer mortgage loans; and
second mortgage loans.
R-G Financial securitizes and sells its loan production to investors or holds
such loans in its banking portfolio, retaining the right to service these loans.
R-G Financial has a loan servicing operation which serves nearly 60,000
homeowners. Its rapidly expanding banking operation offers a variety of
complementary financial products, including all types of deposit and savings
accounts. A Private Banking department sells investment products to individuals,
including GNMA pools and mutual funds.
6
<PAGE>
The Company has surpassed the expectations of competitors and knowledgeable
financial experts. During the year ended December 31, 1997, R-G Mortgage
originated 28.4% of all single-family residential loans in Puerto Rico,
resulting in significant growth in its servicing portfolio.
In 1990 R-G began its banking operation with R-G Premier Bank. The Bank offers a
variety of financial products and services, including residential loans,
commercial mortgage loans, leases on commercial properties and equipment,
consumer loans and credit cards.
At R-G
we continuously
invest in leadership, encouraging
innovation and embracing change.
7
<PAGE>
[GRAPHIC -- PHOTO of Victor J. Galan]
LETTER TO STOCKHOLDERS
1997
The Year in Review
During 1997 we celebrated our 25th anniversary. We commenced operations in 1972
with five employees and the minimum amount of capital ($100,000) required to be
licensed as an FHA/VA Approved Mortgagee at that time. Since then, our capital
has grown more than 1,300 times. After a quarter of a century of work and
dedication to mortgage lending and banking, our Company has become a financial
leader in Puerto Rico. We are ready to continue our expansion either within or
outside of the island.
We are currently serving more than 125,000 customers through our mortgage and
commercial banking operations. The retention of this clientele is the best
recognition of these 25 years of hard work and dedication.
The Company has grown continuously since its inception, through both internal
and external expansion. We have opened new branches, acquired mortgage
operations , (for example United Mortgage in 1987) and acquired other banks
(such as Guaynabo Federal Savings in 1990 and Caribbean Federal Savings in
1993). In 1995 we added new locations by purchasing seven branches from another
bank. We now have a total of 18 branches, counting both our banking and our
mortgage company locations.
8
<PAGE>
Our corporate structure also has been expanded and revamped. In a 1996
restructuring, R-G Financial Corporation was organized as the holding company
for R-G Premier Bank, which had previously been converted from a thrift
institution into a commercial bank under the supervision of the FDIC and Puerto
Rico's Commissioner of Financial Institutions. Also in 1996, R-G Mortgage was
made a subsidiary of R-G Financial, and R-G Financial became a public company.
In 1997 we organized Champion Mortgage as a subsidiary of R-G Mortgage,
dedicated to the origination of residential non-conforming and subprime loans.
Champion Mortgage commenced operations in the last quarter of 1997 and has
already originated a substantial number of new loans. These loans are presently
in portfolio, and will be securitized and sold in the secondary market in the
near future.
These 25 years have shown us that the only formula for achieving growth in
banking is providing superior service to our clients. This is the reason why we
have made customer satisfaction the theme of our Annual Report. We believe that
without superior service, there is no reason for a banking operation of any size
to survive. We have attained a leadership position because we have the key
quality necessary for successful competition with larger local and multinational
operations established in Puerto Rico - "a passion for service."
Last year, our strategy of expansion supported by superior service produced the
following accomplishments:
[GRAPHIC -- PHOTO of Victor J. Galan and Ramon Prats]
9
<PAGE>
o Earnings rose to a record of $23.5 million, increasing 78% from 1996
earnings of $13.2 million. On a per share basis, R-G Financial earned $1.62
in 1997, compared to $1.19 the previous year, an increase of 36%. Our
compound annual growth rate for the period 1972-1997 was 1,380%.
o The Board of Directors declared an 80% stock split in August 1997 which
became effective in September of the same year. Total shares outstanding as
of December 31, 1997 increased to 14,144,752. During 1997 we completed the
stock exchange with minority stockholders of Guaynabo Federal. Based on the
closing price of R-G Financial's stock at February 28, 1998, Guaynabo
shareholders who had invested $1,000 in 1987 would have achieved an average
annual return of 19.4% after completion of the conversion. The decision to
split the Company's common stock was part of our ongoing effort to increase
the liquidity of R-G's stock.
o We increased dividends to $0.13 per share from $0.09 per share in 1996. For
the quarter ended December 31, 1997, the dividend was increased to $0.20 on
an annual basis, a 9% increase from the annualized rate of 0.183% of the
prior quarterly dividend. This was our fifth consecutive increase since the
Company went public in August 1996. We plan to continue increasing our
future dividend payments proportionately to our increases in profit.
o Our stock price climbed from $8.05 (as adjusted for our stock split) at the
time of our initial public offering on August 22, 1996, to $27.25 at the
close of operations on February 28, 1998, representing an increase of 238%.
Our market capitalization increased proportionately to $385.4 million as of
the latter date.
10
<PAGE>
o Total revenues for our operation amounted to $71.3 million compared to
$53.9 million for 1996. Our net interest income of $30.2 million
represented a significant portion of our total revenues. The balance, in
the amount of $41.1 million, consisted of fees generated mostly from the
servicing of our mortgage portfolio, the origination and sale of loans and
banking services.
o Net interest income grew by 22% in 1997, while total fee income grew by
40%.
o Loan production, including residential and commercial mortgage lending,
plus consumer and commercial business lending, reached an all time high of
$906.3 million in 1997. This represented a 45% increase from the $624.6
million of 1996. We achieved this substantial growth through a very strong
advertising effort and investment in media.
o Our residential and commercial mortgage originations translated into a
market share of 26.6%, based on an estimated total mortgage market of $3.2
billion in Puerto Rico last year. Our 1997 market share represented a 670
basis point increase from 1996.
o We increased our servicing portfolio to 56,400 loans with a total balance
of $3.0 billion, an increase of $451 million or 18%. We estimate the total
value of our servicing portfolio at $54 million as of December 31, 1997, or
$33 million above the value reflected in our books under Statement of
Financial Accounting Standards No. 125. Our servicing portfolio continues
to be a strong source of revenue. Servicing income increased to $13.2
million in 1997, from $13.0 million in 1996. Revenues from servicing were
to some extent affected by a decrease in delinquencies, which reduced
income from late charges.
11
<PAGE>
o Credit quality remained stable in our mortgage portfolio. Our delinquency
rate (loans past due more than 30 days) was reduced to 3.47% from 3.68%,
mainly through the use of new credit scoring systems in the loan
application process. We achieved this decline in spite of a 45% rise in
bankruptcy cases (to 15,636) in Puerto Rico last year.
o Charge-offs for the year increased to $5.4 million, consisting mostly of
losses in the consumer loans portfolio. Delinquencies in our Consumer Loan
Division increased by 207 basis points to 4.15%; net charge-offs increased
11.1%.
o We strengthened our credit loss reserves during the year, increasing the
provision for loan losses to $8.4 million. (This amount includes $2.0
million received from our insurance carrier as settlement of a claim we
filed related to certain irregularities discovered in our insurance premium
financing business during the third quarter of 1996.) Reserves approximate
to 60% of total non-performing loans as of December 31, 1997, excluding our
residential loan portfolio, in which losses have historically been minimal.
o Loans sold during 1997 were substantial totaling $364.3 million. These
sales consisted of $206.6 million of residential FHA mortgage loans and
$157.7 million of residential conventional loans. The Company was cited in
1997, by the Mortgage Marketplace magazine, as the number one seller of
mortgage loans in the secondary market in Puerto Rico and number 72 in the
nation.
o Our securities portfolio increased by 141% in 1997, growing to $566.9
million from $235.2 million in 1996. These investments represented 38% of
total assets as of December 31, 1997, and with a yield of 6.68% generated
revenues of $26.8 million. Since most of these securities are tax-free
GNMAs, the Company was able to reduce its taxes for 1997 to an effective
tax rate of 27% from 31% in 1996.
12
<PAGE>
o Deposits increased by 17% to $722.4 million in 1997 from $615.6 million in
1996. This growth was mainly due to a very strong promotional campaign
designed to generate core deposits and to expand our Private Banking
business. New deposits with our Private Banking Group rose substantially,
and these accounts will lead to additional business in 1998 as the Private
Banking Group provides other products and services to these customers. The
overall increase in deposits was also due to the introduction of new
accounts - the "Global" which provides access to various products such as
credit cards and Automatic Teller Machines (ATMs); the "Esencial," which is
a basic savings account with access to ATMs; and the "Conveniente," which
is designed for the customers who have a small volume of transactions and
use a minimum amount of checks. Early in 1998 we plan to introduce the
"Dinoro," a special account for children. The average per branch deposit
size increased 17% to $48.1 million in 1997, versus $40.9 million in 1996.
o During 1997 we completed the remodeling of the seven branches acquired from
another bank in a prior year. We also completed our 13,000 square foot
Operations Center in Bayamon, and expanded our main building in Hato Rey by
about 10,000 square feet. As part of the Hato Rey work, we constructed a
parking facility for approximately 350 cars. In January 1998 we began a new
expansion of our central offices to increase their total size to 68,000
square feet.
13
<PAGE>
o Shareholders' equity of $138.1 million as of December 31, 1997, was up 19%
from $115.6 million in 1996. Core capital represented 9.16% of our total
assets, and risk based capital 17.85% (on a consolidated basis),
substantially exceeding the minimums required by our regulators.
We are pleased with the Company's results for 1997. We significantly increased
loan originations and added to our inventory $446.1 million of unsold loans on
our balance sheet to expand our earning-assets base, resulting in record total
assets of $1.5 billion. These accomplishments led to strong growth in revenues
and net income, and should also translate into future increased profitability.
We believe that the Company's dominant position in the mortgage sector, combined
with its rapidly expanding banking operation and subprime business, will
continue producing asset and earnings growth in the future. This will boost the
value of our shares . The future is bright for R-G. Market demand is strong
accross all our business lines, and we have the internal and external financial
resources we need to continue our planned growth.
As always, I am grateful for the support of our shareholders, customers and
employees, and the guidance of our Board of Directors. R-G Financial intends to
remain a leader in banking and mortgage banking in Puerto Rico, and a leader in
providing customer satisfaction, as has been during these initial 25 years. We
expect 1998 to be another very good year for R-G in 1998, which will translate
into long-term value for our stockholders.
Very truly yours,
/s/Victor J. Galan
Victor J. Galan
14
<PAGE>
Providing Customer Satisfaction Through
Diverse Locations
A good branch network is critical for any institution which offers community and
mortgage banking in Puerto Rico. During 1997, R-G continued to expand the number
of its branches.
During 1998 we will extend our existing branch structure in three important
markets within the metropolitan San Juan area- Guaynabo, where we will open one
additional branch at Pinero and Martinez Nadal Avenues; Rio Piedras with another
branch at El Senorial; and Bayamon, with one branch in Plaza del Sol Shopping
Center. We will also open branch offices outside of metropolitan San Juan -in
Ponce, Caguas and Fajardo.
These six additional branches will give us a market presence in 21 different
locations after we consolidate certain existing branches. In addition, we are
planning to remodel our present branches in San Patricio and Bayamon (Betances
Avenue branch), providing additional space and drive-in facilities for our
clients. We are in the process of building new locations or acquiring existing
facilities to continue expanding at our current rate of five new branches per
year on average.
Home Office: Mayaguez
Hato Rey McKinley Street
280 Jesus T. Pinero Dr. Vady Corner
Branches: Vega Baja
Hato Rey Cabo Caribe Development
280 Jesus T. Pinero Road #2 Marginal
San Patricio Norte Shopping Center
Gonzalez Giusti Ave. Baldorioty de Castro Ave.
Guaynabo Santurce #1077 Ponce de Leon Ave.
Los Jardines Shopping Center
Plaza Carolina
Bayamon Plaza Carolina Mall
#42-43 Betances Ave.
Hermanas Davila Caguas
Degetau D-9
Trujillo Alto San Alfonso Development
Trujillo Alto Plaza
Fajardo
Carolina #51 Celis Aguilera Street
65 Infantry Ave.
San Marco Ponce
Las Americas Ave.
Manati #25 Buena Vista Exit
Puerta del Sol Plaza
Road #2, km. 49.7 Bayamon II
Aguas Buenas Ave.
Arecibo Lot #40
Vista Azul Marginal Minillas Industrial Development
San Daniel Ave. Corner
Laguna Gardens
Laguna Gardens Shopping Center
15
<PAGE>
Providing Customer Satisfaction Through
Technological Advances
We want customers to have the most convenient service possible, no matter how
and where they bank with us. As the world speeds up, there is less time for
routine tasks such as banking. Technology enables customers to bank with R-G
virtually any hour of the day, from almost anywhere. Electronic tools allow
funds to be managed nearly at the speed of thought.
R-G's effective management of support operations depends largely on how it
approaches technology. For R-G, therefore, technology creates another
competitive advantage.
We believe that a sophisticated technology platform is essential to support our
continued growth. Our strong technological systems will enable us to increase
our revenues, run our operations more effectively and better serve our
customers. Continually expanding and improving these systems, therefore, is an
important priority for our Company.
For example, we are continuing to expand the use of technology in our credit
card, personal loan and mortgage-refinancing operations. We have improved the
software supporting our inbound and outbound telemarketing efforts. And we have
organized an Electronic Branch responsible for marketing point-of-sale
terminals, cash management systems for commercial operations, and PC and
Internet banking services.
During 1997 we installed credit-scoring systems in our mortgage and banking
subsidiaries. One of these systems, which we created, consists of proprietary
scoring cards that allow our Underwriting Department to approve or reject any
type of loan in a very short period of time. Other credit-scoring systems are
the ones used by Fannie Mae and Freddie Mac. Additionally, all our branches have
been interconnected with our Consumer Department.
16
<PAGE>
With these technological advances, we have improved the efficiency of our
operations and expedited the processing of new loan applications. Most loan
approvals, for example, are now extended in no more than one hour. By using
technology, we have also expedited the sale of conforming loans in the secondary
market.
We provide full service electronic banking support to all our customers. Our
remote banking system can process customer transactions (such as account
inquiries and statement downloads) through a telephone automatic response
system, through dedicated PC banking and through the Internet. Last year, the
automatic voice response system was expanded to handle bill payments. And we are
also providing interactive banking services via Internet and PC Banking.
In 1997 we completed the installation of our Imaging system, which automatically
reads all transactions that are processed in our Proof and Transit Department.
We also installed special touch-screen terminals in all our branches to give
customers access to information about their bank accounts. Since June 1997, all
clients have been receiving photocopies of their checks in their monthly
statements or on a diskette from which they can copy the image of checks
processed onto their personal computers.
17
<PAGE>
Providing Customer Satisfaction Through
Electronic Banking
We live in a world of ever-changing technology, which directly affects the
banking business. Opportunities arise rapidly, and we are constantly challenged
to determine which ones offer the best prospects for growth and customer
satisfaction.
We continuously search for new ways to provide superior service by staying ahead
of technology and staying ahead of market needs. For example, as a complement to
our electronic transfers system, in 1996 we introduced Cash Management, a
state-of-the-art software package through which commercial customers can execute
certain transactions from their own premises directly into their account. In
1997 the Company also introduced a proprietary PC Banking software package which
has exceeded expectations.
The ATM card introduced in 1995 is now being used by 19,000 account holders. The
card gives customers the flexibility to have their purchases automatically
debited to their checking accounts. Over 960,000 purchases have been made
through this method.
In 1997 we gave customers the added convenience of paying bills by phone ("Phono
Pago"). The number of such transactions has grown to more than 3,000 per month
and continues to increase.
18
<PAGE>
Providing Customer Satisfaction Through
Personal Service
With less time than ever for routine tasks, and faced with a barrage of
competitive messages, consumers look for banking companies they can trust and
with whom they can build long-lasting relationships. They want the
highest-quality service, and one-stop-shop access to a full array of banking
services: checking, savings, loans, mortgages, credit cards. Satisfying all
these needs is our mission and passion. We provide not only convenience, speed
and competitive prices - but personal attention as well.
Residential mortgage lending remains the bedrock of our business. Over the last
25 years we have provided satisfaction to 150,000 customers by helping them
purchase their homes. We have constantly applied the knowledge gained during
those years to make our service even better - through extended hours,
drive-through branches, deposit slots for mortgage payments and additional
locations. Through the use of technology, we have shortened the time it takes to
get a mortgage and close on a purchase. By continuously improving and innovating
in our mortgage programs and branch services, we have remained at the forefront
of the mortgage business in Puerto Rico.
19
<PAGE>
Providing Customer Satisfaction Through
New Housing
New housing was our initial pillar. In our early years we arranged interim
financing for builders with local and US banks or REITS (real estate investment
trusts), and provided the end loans after completion of construction. Today we
offer the full gamut of services to builders and developers of new housing,
including land and development loans, construction loans and permanent loans for
residential and commercial properties.
1. Altamira
Fajardo, PR
58 units o Average selling price of $93,500 Provided interim
construction loan and permanent financing in the amount of $3,939,000.
2. Ciudad Cristiana
Humacao , PR
158 units o Average selling price of $47,000.
Providing interim construction loan for the rehabilitation and site
improvements and permanent financing in the amount of $4,450,000.
Obtained affordable Housing Program Grant from the Federal Home Loan
Bank of New York in the amount of $455,000 for downpayment and closing
cost assistance.
3. Villas de Cambalache
Rio Grande , PR
254 units o Average selling price of $95,000 Participating in the
interim financing and providing permanent financing in the amount of
$23,000,000
4. Valle Costero
Santa Isabel, PR
281 units o Average selling price of $65,000 Providing permanent
financing in the amount of $17,500,000
5. Ciudad Real
Vega Baja, PR
320 units o Average selling price of $90,000. Providing permanent
financing in the amount of $28,000,000.
6. Alborada, El Condominio
Bayamon , PR
252 units o Average selling price of $110,000 Providing permanent
financing in the amount of $26,500,000.
7. Villas de Buenaventura
Yabucoa, PR
500 units o Average selling price of $64,000
Providing permanent financing in the amount of $31,000,000. Affordable
housing units with downpayment and interest subsidies from the Puerto
Rico Housing Bank.
20
<PAGE>
8. Berwind Beach Resort
Rio Grande, PR
104 units o Average selling price of $150,000. Provided land acquisition
loan and permanent financing in the amount of $14,000,000.
9. Los Flamboyanes
Gurabo, PR
315 units o Average selling price of $85,000
Providing permanent financing in the amount of $28,000,000
10. Borinquen Valley
Caguas, PR
188 units o Average selling price of $60,000
Participating in the interim financing and providing permanent financing
in the amount of $11,200,000.
11. Montecasino Heights
Toa Alta, PR
497 units o Average selling price of $110,000 Providing permanent
financing
in the amount of $50,000,000.
12. Chalets de Cupey
Rio Piedras, PR
96 units o Average selling price of $115,000 Providing permanent
financing in the amount of $11,000,000.
21
<PAGE>
[BLANK]
22
<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, 1997.
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,
1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, except for per share data)
<S> <C> <C> <C> <C> <C>
Selected Balance Sheet Data:
Total assets(1) $1,510,746 $1,037,798 $ 853,206 $622,499 $538,069
Loans receivable, net 765,059 603,751 473,841 301,614 216,620
Mortgage loans held for sale 46,885 54,450 21,318 22,021 174,221
Mortgage-backed and investment securities held for trading 401,039 110,267 113,809 124,522 --
Mortgage-backed securities available for sale 46,004 50,841 61,008 13,300 10,241
Mortgage-backed securities held to maturity 33,326 37,900 41,731 84,122 39,122
Investment securities available for sale 75,863 30,973 3,280 1,878 --
Investment securities held to maturity 10,693 5,270 2,046 2,182 4,957
Cash and cash equivalents(2) 68,366 98,856 104,195 45,622 66,958
Deposits 722,418 615,567 518,187 380,148 312,151
Securities sold under agreements to repurchase 382,283 97,444 98,483 108,922 --
Notes payable 159,304 126,842 81,130 45,815 133,913
Other borrowings(3) 86,359 65,463 67,315 18,092 14,479
Subordinated notes(4) 3,250 3,250 3,250 3,250 3,071
Stockholders' equity 138,054 115,633 66,385 55,970 49,531
Stockholders' equity per share(5) $ 9.76 $ 8.17 $ 7.11 $ 5.99 $ 5.30
Selected Income Statement Data:
Revenues:
Net interest income after provision for loan losses $ 30,160 $ 24,665 $ 20,323 $ 19,137 $ 14,253
Loan administration and servicing fees 13,214 13,029 11,030 11,046 9,326
Net gain on sale of investments available for sale 107 642 -- -- 394
Net gain on sale of loans and servicing rights 24,033 11,709 8,384 2,899 29,026
Other(6) 3,751 3,872 4,028 1,667 1,179
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Total revenue 71,265 53,917 43,765 28,951 54,178
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Expenses:
Employee compensation and benefits 13,653 10,794 8,284 5,252 8,590
Office occupancy and equipment 7,131 5,531 4,711 4,488 3,395
SAIF special assessment -- 2,508 -- -- --
Other administrative and general 18,252 15,424 13,731 13,269 14,561
- ------------------------------------------------------------------------------------------------------------------------------------
Total expenses 39,036 34,257 26,726 23,009 26,546
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<PAGE>
<CAPTION>
At or For the Year Ended December 31,
1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income before minority interest in the Bank and income
taxes 32,229 19,660 17,039 5,942 27,632
Minority interest in the Bank's earnings -- 538 743 500 812
Income taxes 8,732 5,922 5,847 856 9,633
Cumulative effect of change in accounting principle -- -- -- 866 --
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 23,497 $ 13,200(7) $ 10,449 $ 5,452 $ 17,187
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share(5) $ 1.62 $ 1.19(7) $ 1.12 $ 0.58 $ 1.84
- ------------------------------------------------------------------------------------------------------------------------------------
Selected Operating Data(8):
Performance Ratios and Other Data:
Mortgage loans originated(9) $ 545,960 $ 426,874 $ 306,775 $ 488,071 $ 834,680
Loan servicing portfolio 3,000,888 2,550,169 2,298,200 2,114,743 2,000,530
Return on average assets(8) 1.85% 1.38% 1.47% 0.91% 4.07%
Return on average equity(8) 18.69 15.54 17.08 10.34 41.98
Equity to assets at end of period 9.13 11.14 7.78 8.94 9.21
Interest rate spread(10) 2.88 3.00 2.93 3.24 3.66
Net interest margin(10) 3.12 3.24 3.26 3.48 3.92
Average interest-earning assets to average
interest-bearing liabilities 104.61 104.60 106.50 105.60 106.08
Total other expenses to average total assets 3.08 3.59 3.80 3.84 6.29
Full-service Bank offices 15 15 14 8 8
R&G Mortgage offices(11) 11 11 12 12 13
Cash dividends declared per share .13 .14(12) -- -- --
Asset Quality Ratios(13):
Non-performing loans to total loans at end of period 3.89% 3.09% 2.18% 1.84% 2.24%
Non-performing assets to total assets at end of period 2.12 1.90 1.32 1.04 1.07
Allowance for loan losses to total loans at end of period 0.87 0.55 0.72 0.92 1.34
Allowance for loan losses to total non-performing loans
at end of period 22.34 17.64 33.19 50.10 59.87
Bank Regulatory Capital Ratios(14):
Tier 1 risk-based capital ratio 13.10% 13.91% 10.53% 11.03% N/A
Total risk-based capital ratio 14.00 14.79 11.66 13.59 N/A
Tier 1 leverage capital ratio 7.34 8.45 6.25 5.95 N/A
</TABLE>
24
<PAGE>
- ------------------
(1) At December 1997, R&G Mortgage and the Bank had total assets of $489.3
million and $996.3 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 10 and 11 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 12
of R&G Financial's Notes to Consolidated Financial Statements.
(5) As adjusted to reflect stock split declared by the Company effective
September 25, 1997. See Note 14 of R&G Financial's Notes to Consolidated
Financial Statements.
(6) 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.
(7) Includes one time special Savings Association Insurance Fund ("SAIF")
assessment of $2,508,380 or $1,642,990 after tax ($0.15 per share on a
diluted basis) 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 diluted earnings
per share would have been $14,842,507 and $1.34, respectively, and return
on average assets and return on average equity would have been 1.55% and
17.48%, respectively.
(8) 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.
(9) Represents total originations by R&G Mortgage for the Bank as well as loans
originated and sold to third parties.
(10) 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."
(11) 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 seven Mortgage Banking Centers which are located in the Bank's
offices.
(12) Includes $500,000 or $0.05 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.
(13) 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 1997 is a function of the increase in the
size of the Bank's loan portfolio, as well as to a significant increase in
recent years in the level of non-performing residential real estate loans
due to delays in the foreclosure process. Excluding the residential loan
portfolio, the allowance for loan losses to total non-performing loans at
December 31, 1997 amounted to 60.5%.
(14) 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.
25
<PAGE>
Management 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 15 offices at December 31, 1997) and, without taking
into consideration possible branch acquisition opportunities, the Bank presently
anticipates opening approximately three 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 held for sale, 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 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
26
<PAGE>
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 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, 1997, 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 $202.2 million, or
13.38% 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, 1997, R&G Mortgage had $17.8 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).
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, 1997, R&G
Mortgage held $398.8 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. In
determining the amount of its portfolio to hedge, R&G Mortgage will consider the
volatility of prices of its mortgage-backed and related securities (Puerto Rican
tax-exempt GNMAs are generally less volatile than their U.S. counterparts). For
taxable GNMAs, R&G Mortgage enters into forward sales commitments for 30, 60 and
90 days to reduce its interest rate risk. At December 31, 1997, R&G Mortgage was
not a party to any interest rate swaps, collars, caps, floors, options or
futures.
27
<PAGE>
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, 1997, the Bank's interest-earning
assets included a portfolio of loans receivable, net (not including mortgage
loans held for sale) of $733.1 million and a portfolio of investment securities
and mortgage-backed securities (including held to maturity, held for trading and
available for sale) of $167.5 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, 1997, $1.6 million or
1.0% of the Bank's mortgage-backed and investment securities were classified as
held for trading (which consisted solely of mortgage-backed and related
securities), and are reported at fair value, with unrealized gains and losses
included in earnings. In addition, at December 31, 1997, $121.9 million or 72.7%
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 to reduce interest rate risk on all mortgage-backed securities
(excluding CMOs) which are available for sale. At December 31, 1997,
mortgage-backed securities available for sale had a fair value of $46.0 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, 1997, 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) 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 $50.0
million and expire from September 17, 1999 to October 9, 2001. With respect to
such agreements, the Bank makes fixed interest payments ranging from 5.06% to
5.79% and receives payments based upon the three-month London Interbank Offer
Rate ("LIBOR") and Libid. The net expense (income) relating to the Bank's
fixed-pay interest rate swaps amounted to approximately $293,000, $61,000 and
$(187,000) during the years ended December 31, 1997, 1996 and 1995,
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. However, at December 31, 1997, the Bank was not a party to
any such interest rate contracts. 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. Options are contracts
which grant the purchaser the right to buy or sell the underlying asset by a
certain date for a specified price.
28
<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, 1997, 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 $ 34,807 $ 67,276 $ 109,729 $ 81,473 $ 200,416 $ 493,701
Construction loans 1,567 5,582 -- -- -- 7,149
Commercial real estate loans 84,522 72 219 271 2,428 87,512
Consumer loans 21,873 43,179 53,351 18,852 7,104 144,359
Commercial business loans 38,481 117 -- -- -- 38,598
Mortgage loans held for sale 7,272 21,707 17,693 -- -- 46,672
Mortgage-backed securities(2)(3) 63,013 179,139 130,547 51,478 44,405 468,582
Investment securities(3) 27,785 54,062 1,477 1,660 2,137 87,121
Other interest-earning assets(4) 35,759 -- -- -- -- 35,759
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 315,079 $ 371,134 $ 313,016 $ 153,734 $ 256,490 $1,409,453
====================================================================================================================================
Interest-bearing liabilities:
Deposits(5):
NOW and Super NOW accounts(6) $ 4,764 $ 13,340 $ 14,666 $ 11,880 $ 50,644 $ 95,294
Passbook savings accounts(6) 2,073 5,917 13,611 11,025 47,003 79,629
Checking and commercial checking(6) 4,575 12,809 14,082 11,407 48,631 91,504
Certificates of deposit 129,485 218,321 69,994 27,539 9,054 454,393
FHLB advances 42,000 -- -- -- -- 42,000
Reverse repurchase agreements(7) 392,283 -- -- -- -- 392,283
Other borrowings(8) 92,214 20,599 84,100 -- -- 196,913
- ------------------------------------------------------------------------------------------------------------------------------------
Total 667,394 270,986 196,453 61,851 155,332 1,352,016
- ------------------------------------------------------------------------------------------------------------------------------------
Effect of hedging instruments (50,000) -- 10,000 40,000 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
$ 617,394 $ 270,986 $ 206,453 $ 101,851 $ 155,332 $1,352,016
====================================================================================================================================
Excess (deficiency) of interest-earning
assets over interest-bearing liabilities $ (302,315) $ 100,148 $ 106,563 $ 51,883 $ 101,158 --
====================================================================================================================================
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities $ (302,315) $ (202,167) $ (95,604) $ (43,721) $ 57,437 --
====================================================================================================================================
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities as a
percent of total assets (20.01)% (13.38)% (6.33)% (2.89)% 3.80% --
====================================================================================================================================
</TABLE>
29
<PAGE>
- ----------------
(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.
(3) Includes securities held for trading, available for sale and held to
maturity.
(4) Includes securities purchased under agreement to resell, time deposits with
other banks and federal funds sold.
(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) Includes $10,000,000 federal funds purchased.
(8) Comprised of warehousing lines and 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 review 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.
<PAGE>
The following table sets forth at December 31, 1997 the estimated percentage
change in R&G Financial's MVPE based on the indicated changes in interest rates.
<TABLE>
<CAPTION>
MVPE(2)
- --------------------------------------------------------------------------------
Change in Change as a
Interest Rates Percentage Percentage
(in Basis Points)(1) Amount of Change Change of Assets
- --------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C>
+400 $(33,853) (25.8)% (2.24)%
+300 (24,997) (19.1) (1.65)
+200 (16,371) (12.5) (1.08)
+100 (8,127) (6.2) (.54)
-- -- -- --
-100 15,367 11.7 1.02
-200 30,577 23.3 2.02
-300 47,891 36.5 3.17
-400 88,716 67.7 5.87
</TABLE>
- --------------
(1) Assumes an instantaneous uniform change in interest rates at all
maturities.
(2) Based on R&G Financial's pre-tax MVPE of $131.1 million at December 31,
1997, which is approximately $7.0 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, 1997, R&G Financial's total assets amounted to $1.5 billion, as
compared to $1.0 billion at December 31, 1996. The $473 million or 45.6%
increase in total assets during the year ended December 31, 1997 was primarily
the result of a $161.3 million or 26.7% increase in loans receivable, net, and a
$291.5 million or 267.7% increase in mortgage-backed securities held for
trading, which are attributable to the origination of $906.3 million of loans,
primarily single-family residential loans, before reduction for repayments and
sales, and a $40.1 million increase in securities available for sale, which is
primarily the result of purchases during the year of approximately $42.0 million
of such securities, net of maturities and sales.
30
<PAGE>
Cash and Money Market Investments.
Cash and money market investments (consisting of cash and due from banks,
securities purchased under agreements to resell, time deposits with other
financial institutions and federal funds sold) amounted to $68.4 million and
$98.9 million as of December 31, 1997 and 1996, respectively.
Loans Receivable and Mortgage Loans Held for Sale.
At December 31, 1997, R&G Financial's loans receivable, net amounted to $765.1
million or 50.6% of total assets, as compared to $603.8 million or 58.2% as of
December 31, 1996. 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 and commercial
business loans. During the years ended December 31, 1997, 1996 and 1995, total
loans originated and purchased by the Bank (including loans originated by R&G
Mortgage on behalf of the Bank) amounted to $435.4 million, $342.2 million and
$281.7 million, respectively.
At December 31, 1997, R&G Financial's allowance for loan losses (all of which is
maintained in the Bank's loan portfolio) totalled $6.8 million, which
represented a $3.4 million or 103.2% increase from the level maintained at
December 31, 1996. At December 31, 1997, R&G Financial's allowance represented
approximately 0.87% of the total loan portfolio and 22.34% of total
non-performing loans, as compared to 0.55% and 17.64% at December 31, 1996. The
increase in the allowance for loan losses is attributable to the provision of
$6.4 million for loan losses during the year, which was primarily attributable
to the overall growth in the loan portfolio, and to a lesser extent, an increase
in consumer loan delinquencies during the year, offset by net write-offs during
the year totalling approximately $2.9 million. Net write-offs are net of $2.0
million received as settlement of an insurance claim filed by the Company in
1996 accounted for as a recovery of loans previously charged off. See "Results
of Operations - Provision for Loan Losses."
Management of R&G Financial believes that its allowance for loan losses at
December 31, 1997 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 normally experienced by the Company with
respect to its 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.
At December 31, 1997 and 1996, mortgage loans held for sale amounted to $46.9
million and $54.5 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, 1997, R&G Financial's aggregate mortgage-backed and investment
securities totalled $566.9 million or 37.5% of total assets, as compared to
$235.3 million or 22.7% at December 31, 1996, respectively.
Securities held for trading consist primarily of FHA and VA loans which have
been securitized as GNMA pools 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, 1997 and 1996, securities held for trading
amounted to $400.4 million and $108.9 million, respectively. At December 31,
1997, all but $1.6 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, 1997 and 1996, securities available for sale totalled $121.9 million and
$81.8 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 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 other Puerto
Rico securities, all of which were held by the Bank. At December 31, 1997 and
1996, securities held to maturity totalled $44.0 million and $43.2 million,
respectively. Securities held to maturity are accounted for at amortized cost.
At December 31, 1997 and 1996, R&G Financial's securities held to maturity had a
market value of $43.8 million and $42.3 million, respectively.
Mortgage Servicing Asset.
As of December 31, 1997 and 1996, R&G Financial reported $21.2 million and $12.6
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 until the related loans are sold. SFAS No. 122 also
requires R&G Financial to assess the fair value of its mortgage servicing rights
on a 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, 1997, deposits totalled $722.4 million, as compared to $615.6
million at December 31, 1996. The $106.8 million or 17.4% increase in deposits
during the year ended December 31, 1997 was primarily due to promotions in
connection with new accounts and competitive pricing. One of the Bank's
strategies is to increase its core deposits, which provide a source of fee
income and the ability to cross-sell other products and services. As a result,
core deposits (consisting of passbook, NOW and Super NOW and checking and
commercial checking accounts) increased from $210.4 million or 34.2% of total
deposits at December 31, 1996 to $266.4 million or 36.9% of total deposits at
December 31, 1997.
31
<PAGE>
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 or substantially identical
securities) ("repurchase agreements"). At December 31, 1997 and 1996, reverse
repurchase agreements totalled $382.3 million and $97.4 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, 1997, notes payable amounted to $159.3 million, as compared to
$126.8 million at December 31, 1996. The $32.5 million or 25.6% increase in
notes payable during the year ended December 31, 1997 reflected $34.9 million of
increased warehouse lines, which was partially offset by a $2.4 million
reduction in 936 Notes.
Advances from the FHLB of New York amounted to $42.0 million and $15.0 million
at December 31, 1997 and 1996, respectively. At December 31, 1996, all FHLB
advances were scheduled to mature within 30 days, with an average interest rate
of 6.03%.
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 beginning on specified dates in December
2000. Management has estimated its liability, if any, under the foregoing
recourse provisions to be immaterial as of December 31, 1997. 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 $34.4 million and $50.5 million at December 31,
1997 and 1996, 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 $115.6 million at December 31, 1996 to
$138.1 million at December 31, 1997. The $22.5 million or 19.5% increase in
stockholders' equity during 1997 was primarily due to the $23.5 million net
income for the year and an increase in unrealized gains on securities available
for sale from a $102,000 loss at December 31, 1996 to an unrealized gain of $1.2
million at December 31, 1997. The increases in stockholders' equity were
slightly offset by dividends paid during the year of $2.4 million.
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 also provides trust and investment services to the public through the
Bank's Trust Department.
32
<PAGE>
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,
1997 1996 1995
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 $25,544 35.84% $20,884 38.73% $17,944 41.00%
Net gain on sale of loans 5,436 7.63 1,355 2.51 1,250 2.85
Net gain on sale of
investment securities 107 0.15 642 1.19 -- --
Market valuation allowance
on loans held for sale -- -- -- -- 856 1.96
Other income(1) 2,915 4.09 3,664 6.80 2,368 5.41
- ------------------------------------------------------------------------------------------------------------------------------------
34,002 47.71 26,545 49.23 22,418 51.22
- ------------------------------------------------------------------------------------------------------------------------------------
R&G Mortgage:
Net interest income 4,616 6.48 3,781 7.01 2,379 5.44
Loan administration and servicing fees 13,214 18.54 13,029 24.17 11,030 25.20
Net gain on origination and sale of loans 18,597 26.10 10,354 19.20 7,134 16.30
Other income(1) 836 1.17 208 0.39 804 1.84
- ------------------------------------------------------------------------------------------------------------------------------------
37,263 52.29 27,372 50.77 21,347 48.78
- ------------------------------------------------------------------------------------------------------------------------------------
$71,265 100.00% $53,917 100.00% $43,765 100.00%
</TABLE>
- ----------------
(1) Comprised of service charges, fees and other for the Bank and other
miscellaneous revenue sources for the Bank and R&G Mortgage.
R&G Financial reported net income of $23.5 million, $13.2 million and $10.4
million during the years ended December 31, 1997, 1996 and 1995, respectively.
Net income increased by $10.3 million or 78.01% during the year ended December
31, 1997, as compared to 1996, due to a $7.6 million increase in net interest
income and a $11.9 million increase in total other income, which were partially
offset by a $7.3 million increase in total operating expenses, (excluding the
one-time SAIF special assessment of $2.5 million in 1996), and a $2.1 million or
49.6% increase in the provision for loan losses.
Net income increased by $2.8 million or 26.3% during the year ended December 31,
1996, as compared to 1995, due to a $7.6 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 a
348% increase in the provision for loan losses.
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 $36.5 million, $28.9 million and $21.3 million
during the years ended December 31, 1997, 1996 and 1995, respectively. Net
interest income increased by $7.6 million or 26.3% during the year ended
December 31, 1997, as compared to the year ended December 31, 1996, due to an
increase in R&G Financial's average net interest earning assets of $12.3 million
during the year, offset by a decrease in the Company's interest rate spread from
3.00% in 1996 to 2.88% in 1997. Net interest income increased by $7.7 million or
36.0% during 1996 due to an increase in R&G Financial's interest rate-spread
from 2.93% for 1995 to 3.00% for 1996, which was partially offset by a decrease
in the ratio of average interest-earning assets to average interest-bearing
liabilities from 106.5% for 1995 to 104.6% for 1996.
33
<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 R&G Mortgage and the average daily balances for the Banm+pin each case
during the periods presented.
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996
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) $30,967 $1,674 5.41% $43,072 $2,322 5.39%
Investment securities held for trading 5,466 328 6.00 2,271 116 5.11
Investment securities available for sale 51,105 3,205 6.27 19,102 1,193 6.25
Investment securities held to maturity 15,095 777 5.15 10,069 515 5.11
Mortgage-backed securities held for trading 249,930 17,174 6.87 136,618 9,258 6.78
Mortgage-backed securities available for sale 44,693 3,200 7.16 50,633 3,602 7.11
Mortgage-backed securities held to maturity 35,642 2,152 6.04 40,403 2,478 6.13
Loans receivable, net(3)(4) 732,064 68,514 9.36 587,730 54,044 9.20
FHLB of New York stock 4,710 311 6.60 3,999 258 6.45
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 1,169,672 $97,335 8.32% 893,897 $73,786 8.25%
====================================================================================================================================
Non-interest-earning assets 98,880 61,480
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $1,268,552 $955,377
====================================================================================================================================
Interest-Bearing Liabilities:
Deposits $668,704 $32,434 4.85% $561,548 $27,518 4.90%
Securities sold under agreements to
repurchase 226,771 13,483 5.95 100,607 5,024 4.99
Notes payable 151,440 9,616 6.35 126,171 7,284 5.77
Subordinated debt(5) 3,250 324 9.97 3,250 332 10.21
Other borrowings(6) 67,973 4,948 7.28 63,118 4,705 7.45
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 1,118,138 $60,805 5.44% 854,694 $44,863 5.25%
====================================================================================================================================
Non-interest-bearing liabilities 24,680 15,766
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 1,142,818 870,460
Stockholders' equity 125,734 84,917
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $1,268,552 $955,377
====================================================================================================================================
Net interest income; interest
rate spread(7) $36,530 2.88% $28,923 3.00%
====================================================================================================================================
Net interest margin(7) 3.12% 3.24%
====================================================================================================================================
Average interest-earning assets to
average interest-bearing liabilities 104.61% 104.60%
====================================================================================================================================
<PAGE>
<CAPTION>
Year Ended December 31,
1995
Average Yield/
Balance Interest Rate (1)
- -------------------------------------------------------------------------------------------
(Dollars in Thousands)
<C> <C> <C> <C>
Interest-Earning Assets:
Cash and cash equivalents(2) $10,000 $605 6.05%
Investment securities held for trading -- -- --
Investment securities available for sale -- -- --
Investment securities held to maturity 16,211 972 6.00
Mortgage-backed securities held for trading 130,184 8,595 6.60
Mortgage-backed securities available for sale 16,006 1,193 7.45
Mortgage-backed securities held to maturity 72,173 4,841 6.71
Loans receivable, net(3)(4) 405,784 37,078 9.14
FHLB of New York stock 2,976 227 7.63
- -------------------------------------------------------------------------------------------
Total interest-earning assets 653,334 $53,511 8.19%
===========================================================================================
Non-interest-earning assets 50,365
- -------------------------------------------------------------------------------------------
Total assets $703,699
===========================================================================================
Interest-Bearing Liabilities:
Deposits $431,833 $21,829 5.05%
Securities sold under agreements to
repurchase 107,026 6,437 6.01
Notes payable 55,118 3,025 5.49
Subordinated debt(5) 3,250 339 10.43
Other borrowings(6) 16,201 609 3.76
- -------------------------------------------------------------------------------------------
Total interest-bearing liabilities 613,428 $ 32,239 5.26%
===========================================================================================
Non-interest-bearing liabilities 29,093
- -------------------------------------------------------------------------------------------
Total liabilities 642,521
Stockholders' equity 61,178
- -------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $703,699
===========================================================================================
Net interest income; interest
rate spread(7) $ 21,272 2.93%
===========================================================================================
Net interest margin(7) 3.26%
===========================================================================================
Average interest-earning assets to
average interest-bearing liabilities 106.50%
===========================================================================================
</TABLE>
(Footnotes on following page)
34
<PAGE>
- -----------------
(1) At December 31, 1997, the yields earned and rates paid were as follows:
cash and cash equivalents, 5.54%; investment securities held to maturity,
5.67%; investment securities available for sale, 6.01%; mortgage-backed
securities held for trading, 6.77%; mortgage loans held for sale, 8.39%;
loans receivable, net, 9.31%; FHLB of New York stock, 7.05%; total
interest-earning assets, 8.09%; deposits, 4.82%; securities sold under
agreements to repurchase, 5.81%; notes payable, 6.45%; other borrowings,
6.89%; subordinated debt, 9.46%; total interest-bearing liabilities, 5.43%;
interest rate spread, 2.66%.
(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) Interest income on loans include loan fees amounting to $334,000, $277,000
and $578,000 during the years ended December 31, 1997, 1996 and 1995,
respectively or .49%, .51% and 1.56% 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.
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.
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
1997 vs. 1996 1996 vs. 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Increase Total Increase Total
(Decrease) Increase (Decrease) Increase
Due to (Decrease) Due to (Decrease)
- ------------------------------------------------------------------------------------------------------------------------------------
Rate Volume Rate Volume
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Cash and cash equivalents(1) $ 5 $ (653) $ (648) $ (284) $ 2,001 $ 1,717
Investment securities held for trading 49 163 212 -- 116 116
Investment securities available for sale 12 2,000 2,012 -- 1,193 1,193
Investment securities held to maturity 5 257 262 (89) (368) (457)
Mortgage-backed securities held for trading 131 7,785 7,916 244 419 663
Mortgage-backed securities held to maturity (34) (292) (326) (261) (2,102) (2,363)
Mortgage-backed securities available for sale 26 (428) (402) (135) 2,544 2,409
Loans receivable, net(4) 1,191 13,279 14,470 564 16,402 16,966
FHLB of New York stock 7 46 53 (47) 78 31
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets $ 1,392 $ 22,157 $ 23,549 $ (8) $ 20,283 $ 20,275
====================================================================================================================================
Interest-Bearing Liabilities:
Deposits $ (335) $ 5,251 $ 4,916 $ (868) $ 6,557 $ 5,689
Securities sold under agreements to repurchase 2,163 6,296 8,459 (1,027) (386) (1,413)
Notes payable 853 1,479 2,332 359 3,900 4,259
Subordinated debt(2) (8) -- (8) (7) -- (7)
Other borrowings(3) (124) 367 243 2,332 1,764 4,096
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 2,549 $ 13,393 15,942 $ 789 $ 11,835 12,624
====================================================================================================================================
Increase (decrease) in net interest income $ 7,607 $ 7,651
====================================================================================================================================
</TABLE>
(Footnotes on following page)
35
<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 $23.5 million or 31.9% during the year ended
December 31, 1997, as compared to December 31, 1996, and increased by $20.3
million or 37.9% during the year ended December 31, 1996 over the year ended
December 31, 1995. Interest income on loans, the largest component of R&G
Financial's interest-earning assets, increased by $14.4 million or 26.7% during
the year ended December 31, 1997, as compared to the year ended December 31,
1996, and increased by $17.0 million or 46.0% during 1996 over the year ended
December 31, 1995. Such increases were primarily the result of increases in
the average balance of loans receivable of $144.3 million and $181.9 million
during the years ended December 31, 1997 and 1996, 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 $9.7 million or 56.4% during the year
ended December 31, 1997, as compared to the year ended December 31, 1996, and
increased by $1.6 million or 10.0% during the year ended December 31, 1996 over
the year ended December 31, 1995. The increase in interest income on
mortgage-backed and investment securities during the year ended December 31,
1997 was due primarily to an increase in the average balance of investment
securities of $40.2 million, together with a $102.6 million increase in the
average balance of mortgage-backed securities during the period. The increase in
investment securities reflects purchases of approximately $50.2 million during
the year, net of maturities and sales, with excess liquidity during the year;
the increase in mortgage backed securities is primarily associated with a 63.9%
increase in FHA/VA mortgage loan originations (which are subsequently converted
into GNMA mortgage backed securities) during 1997. The increase in interest
income on mortgage-backed and investment securities during 1996 was primarily
due to a $15.2 million increase in the average balance of investment securities
together with an increase of $9.3 million in the average balance of
mortgage-backed securities during the period.
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) decreased by $648,000
or 27.9% during the year ended December 31, 1997, as compared to the year ended
December 31, 1996, and increased by $1.7 million or 283.8% during the year ended
December 31, 1996. The decrease during the year ended December 31, 1997 was due
primarily to a decrease in the average balance of cash and cash equivalents
during the period of $12.1 million. The increase in interest earned on money
market investments during 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 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 $15.9 million or 35.5% during the year ended
December 31, 1997, as compared to the year ended December 31, 1996, and
increased by $12.6 million or 39.2% during the year ended December 31, 1996.
Interest expense on deposits, the largest component of R&G Financial's
interest-bearing liabilities, increased by $4.9 million or 17.9% during the year
ended December 31, 1997, as compared to the year ended December 31, 1996, and
increased by $5.7 million or 26.1% during the year ended December 31, 1996. The
increases in interest expense on deposits during the years ended December 31,
1997 and 1996 were primarily due to increases in the average balance of deposits
of $107.2 million and $129.7 million during such respective periods. During
1997, the average rate paid on deposits decreased by 5 basis points as a result
of a general decrease in market rates of interest. In 1996, the average rate
paid on deposits decreased by 15 basis points as a result of general decrease in
market rates of interest.
Interest expense on repurchase agreements increased significantly by $8.5
million or 168.4% during the year ended December 31, 1997, as compared to the
year ended December 31, 1996, and decreased by $1.4 million or 21.9% during the
year ended December 31, 1996. The increase in interest expense on repurchase
agreements during 1997 was due primarily to an increase in the average balance
of repurchase agreements outstanding of $126.2 million, together with an
increase in the average rate paid thereon of 96 basis points. R&G Financial
generally uses repurchase agreements to repay warehouse lines of credit which
are used to fund loan originations. The repurchase agreements are collateralized
by mortgage-backed securities held for trading. The fluctuations in the average
balance of 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. The decrease in interest expense on repurchase
agreements during 1996 was primarily due to a decrease in the average rate paid
thereon of 102 basis points.
Interest expense on notes payable (consisting of warehouse lines of credit and
promissory notes) increased by $2.3 million or 32.0% during the year ended
December 31, 1997, as compared to the year ended December 31, 1996, and
increased by $3.9 million or 116.5% during the year ended December 31, 1996. The
increase during the year ended December 31, 1997 was primarily due to an $25.6
million increase in the average balance of warehousing lines as R&G Mortgage
made increased use of such lines due to increased mortgage loan originations.
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 converted short
term 936 funds to medium term 936 Notes to fund increased consumer and
commercial lending.
Interest expense on other borrowings (consisting of subordinated notes, advances
from the FHLB of New York and other secured borrowings) increased by $234,000 or
4.6% during the year ended December 31, 1997, as compared to the year ended
December 31, 1996, and increased by $4.4 million or 727.2% during the year
36
<PAGE>
ended December 31, 1996. The increase in interest expense on other borrowings
during 1997 was due primarily to an increase in the average balance of such
borrowings due to increased use of FHLB advances for short term funding needs.
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.
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 to its allowance for loan losses of $6.4 million,
$4.3 million and $950,000 during the years ended December 31, 1997, 1996 and
1995, respectively.
The increase in the provision for loan losses taken by the Company during 1997
was primarily based on the increase of the Company's loan portfolio during the
period, as the Company experienced a 45% increase in the volume of loan
originations during 1997 as well as to increased net charge-offs associated
primarily with consumer loans. Puerto Rico financial institutions, including the
Company, experienced increased bankruptcies and resulting delinquencies over the
past year. During the year, management adopted more stringent consumer
underwriting procedures to address problems experienced generally in the market
for personal loans, and has determined to emphasize collateralized consumer
lending instead of personal loans.
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. As previously
reported, the Bank believes that there were irregularities with respect to the
Bank's former insurance premium financing business. Management, based on a
review of the collectibility of the loans in question, established reserves of
approximately $2.5 million in 1996 to cover estimated losses expected to result
from this matter at the time. On January 15, 1998, the Company received $2
million as part of a settlement of a claim filed by the Company in late 1996
with its fidelity insurance carrier. The settlement was recorded as a recovery
of loans previously charged-off and reflected as an addition to the Company's
allowance for loan losses as of December 31, 1997.
The $950,000 provision during 1995 reflected R&G Financial's increased consumer
loan originations and an increase in loan charge-offs related thereto.
Management believes that its allowance for loan losses at December 31, 1997, 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 normally experienced by the Company with respect to its 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 real estate lending, including commercial lending, as well as
the increased bankruptcies and resulting delinquencies, continue.
<PAGE>
Other Income.
The following table sets forth information regarding other income for the
periods shown.
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996 1995
- -----------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Net gain on origination and sale of loans $ 24,033 $ 11,709 $ 8,384
Change in allowance for cost in excess of market value
of loans held fmasale -- -- 856
Net gain on sale of investment securities available for sale 107 642 --
Net loss on trading account (854) (66) --
Loan administration and servicing fees 13,214 13,029 11,030
Service charges, fees and other 4,605 3,938 3,172
- -----------------------------------------------------------------------------------------------
Total other income $ 41,105 $ 29,252 $ 23,442
===============================================================================================
</TABLE>
37
<PAGE>
Total other income increased by $11.9 million or 40.5% during the year ended
December 31, 1997, as compared to the prior year and increased by $5.8 million
or 24.8% during the year ended December 31, 1996. Net gain on sale of loans
amounted to $24.0 million, $11.7 million and $8.4 million during the years ended
December 31, 1997, 1996 and 1995, respectively. Net gain 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, 1997, 1996 and 1995,
R&G Mortgage originated and purchased $470.9 million, $282.4 million and $185.9
million, respectively, and sold $246.1 million, $244.8 million and $195.6
million of mortgage loans, respectively. In addition, the Bank sold $118.2
million, $49.7 million and $75.1 million of loans from its portfolio during such
respective periods. R&G Financial's mortgage banking operations are highly
dependent upon market and economic conditions.
During the years ended December 31, 1997, 1996 and 1995, R&G Financial
recognized net profit (loss) on trading securities of $9.7 million, $(96,000)
and $2.1 million, respectively, which are included in net gains on sales of
loans. 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. The increase in
net profits in trading securities in 1997 is primarily related to a $170.9
million or 63.9% increase in the origination and purchase of FHA and VA loans
during the year. In addition, during the years ended December 31, 1997 and 1996,
R&G Financial recognized $854,000 and $66,000, respectively, of net losses on
trading activities and from hedge positions on certain investment securities
available for sale. The loss experienced during 1997 is primarily related to an
increase in hedging activities as well as increased volatility in market
interest rates during the period.
In 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 1997 or 1996.
During the years ended December 31, 1997, 1996 and 1995, R&G Financial
recognized loan administration and servicing fees (consisting of loan servicing
fees) of $13.2 million, $13.0 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 January 1, 1995 to 56,442 loans
with an aggregate principal balance of $3.0 billion at December 31, 1997.
Service charges, fees and other amounted to $4.6 million, $3.9 million and $3.2
million during the years ended December 31, 1997, 1996 and 1995, respectively.
The $667,000 or 16.9% increase during 1997 was primarily due to increased
service charges associated with new deposit products and an increasing deposit
base, as well as increases in the loan portfolio. 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 certain branch acquisitions during 1995.
Operating Expenses.
The following table sets forth certain information regarding operating expenses
for the periods shown.
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996 1995
- --------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Employee compensation and benefits $13,653 $10,793 $ 8,284
Office occupancy and equipment 7,131 5,531 4,711
SAIF special assessment -- 2,508 --
Other administrative and general 18,252 15,424 13,731
- --------------------------------------------------------------------------------
Total operating expenses $39,036 $34,257 $26,726
================================================================================
</TABLE>
Total operating expenses increased by $4.8 million or 13.9% during the year
ended December 31, 1997, as compared to the year ended December 31, 1996 and
increased by $7.5 million or 28.2% during the year ended December 31, 1996 over
1995. Without taking into consideration the one-time $2.5 million assessment to
recapitalize the SAIF, total operating expenses would have increased by $7.3
million or 23.0% in 1997 and by $5.0 million or 18.8% in 1996. The increase in
total operating expenses during the year ended December 31, 1997 reflects a 45%
increase in total loan production during the year as well as increased costs
associated with the opening of a new branch office in Bayamon in June 1997 and
the remodeling work at six branch locations acquired in June 1995 from another
financial institution in Puerto Rico. 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, occupancy and other miscellaneous
expenses during 1996.
Employee compensation and benefits expense amounted to $13.6 million, $10.8
million and $8.3 million during the years ended December 31, 1997, 1996 and
1995, respectively. The $2.9 million or 26.5% increase in such expense during
the year ended December 31, 1997 is primarily associated with increased bonus
payments due to greater loan production during the year. The $2.5 million or
30.3% 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 $7.1 million, $5.5 million
and $4.7 million during the years ended December 31, 1997, 1996 and 1995,
respectively. The $1.6 million or 28.9% increase in office occupancy and
equipment expenses during 1997 were related to the opening of the new branch in
Bayamon and to the completion of remodeling work at the six branches acquired in
1995. 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 1995 branch
acquisition.
The Company incurred a special assessment in 1996 of $2.5 million ($1.5 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
38
<PAGE>
recapitalized the SAIF by a one-time charge of approximately $0.657 for every
$100 of assessable deposits held at March 31, 1995. As a result, the Bank's
insurance premiums, which had 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.
Other administrative and general expenses, which consist primarily of
advertising, license and property taxes, amortization of servicing asset,
insurance, telephone, printing and supplies and other miscellaneous expenses,
amounted to $18.3 million, $15.4 million and $13.7 million during the years
ended December 31, 1997, 1996 and 1995, respectively. The $2.8 million or 18.3%
increase in such expenses during the year ended December 31, 1997 is also
primarily associated with increased loan production during the year. The $1.7
million or 12.3% increase in such expenses 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 $8.7 million during the year
ended December 31, 1997, as compared to income tax expense of $5.9 million and
$5.8 million during the years ended December 31, 1996 and 1995, 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 1996 of $400,000. The remainder
of the settlement was reserved for during prior periods. R&G Financial's
effective tax rate amounted to 27.1%, 31.0% and 35.9% during the years ended
December 31, 1997, 1996 and 1995, respectively. The decrease in R&G Financial's
effective tax rate during the last several years is due primarily to an increase
in the Company's exempt interest income.
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 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,
1997, R&G Financial had $63.2 million in borrowing capacity under unused
warehouse lines of credit and $223.4 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, 1997, R&G Financial had outstanding commitments (including
unused lines of credit) to originate and/or purchase mortgage and non-mortgage
loans of $443.6 million. Certificates of deposit which are scheduled to mature
within one year totalled $368.6 million at December 31, 1997, and borrowings
that are scheduled to mature within the same period amounted to $512.7 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 to 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 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,
1997, 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 7.34%,
13.10% and 14.00%, respectively.
39
<PAGE>
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.
Year 2000 Issue
The Company has already reviewed all computer-based applications and has
developed a company-wide action plan for the century change for the year 2000.
The Company's goal is to have all systems and applications compliant with the
century change by late 1998. The Company has completed a preliminary cost
estimate totaling $300,000 related to the year 2000 project. Costs incurred in
1997 related to updating the Company's computer application systems in
preparation for the year 2000 were insignificant. The Company expects to
continue to incur costs related to this project through the year 1999, however,
none of these costs are expected to have a significant impact in the results of
operations of the Company in any single period. The Company estimates that costs
associated with upgrading or modifying existing internal use software for the
year 2000 should be minimal. In the Company's case, most of the costs are
related to purchases of hardware (mostly desktop computers) to replace existing
equipment, and such equipment is almost fully depreciated at this time.
Accordingly, based on presently available information, the Company expects that
costs associated with the year 2000 issue should not have a significant effect
in the results of operations of the Company.
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 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income."
This Statement requires (1) the classification of items of other comprehensive
income by their nature in a financial statement; (2) the display of the
accumulated balance of other comprehensive income by their nature in a financial
statement; and (3) the display of the accumulated balance of other comprehensive
income separately from retained earnings and additional paid-in capital in the
equity section of the statement of financial position. For the Company,
unrealized gains and losses on certain investments in debt securities will be
the only other comprehensive income item to be included in comprehensive income.
This Statement is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. This Statement affects only financial
statement presentation and, therefore, management believes that its adoption
will not have material effect if any, on the Company's financial position or
results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." This Statement requires that a public
business enterprise report financial and descriptive information about its
reportable segments. Operating segments are components of an enterprise about
which separate financial information is available that is evaluated regularly by
the chief operating decision maker in deciding how to allocate resources and in
assessing performance. It also requires reporting descriptive information about
the way that the operating segments were determined, the products and the
services provided by the operating segments, differences between the
measurements used in reporting segment information and those used in the
enterprise's general purpose financial statements, and the changes in the
measurement of the segment amount from period to period. Management has not yet
made a determination on the business lines of the Company that fulfill the
segment definition described above.
This Statement is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. This Statement affects only financial
statement presentation and disclosure and therefore management believes it will
not have a material effect, if any, on the Company's financial position or
results of operations.
40
<PAGE>
Report OF INDEPENDENT
ACCOUNTANTS
To the Board of Directors and Stockholders of
R&G Financial Corporation
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, 1997 and 1996, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1997, 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.
/s/Price Waterhouse
Price Waterhouse
San Juan, Puerto Rico
February 2, 1998
Certified Public Accountants
(of Puerto Rico)
License No. 10 Expires on December 1, 1998
Stamp 1457911 of the P.R. Society
of Certified Public Accountants has been affixed
to the file copy of this report
41
<PAGE>
<TABLE>
<CAPTION>
R&G Financial Corporation
Consolidated Statements of Financial Condition
December 31, 1997 and 1996
1997 1996
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and due from banks $ 32,607,001 $ 31,989,944
Money market investments:
Securities purchased under agreements to resell 16,000,000 19,633,178
Time deposits with other banks 16,758,722 33,232,809
Federal funds sold 3,000,000 14,000,000
Mortgage loans held for sale, at lower of cost or market 46,885,323 54,450,159
Mortgage - backed securities held for trading, at fair value 400,457,456 108,916,528
Mortgage - backed securities available for sale, at fair value 46,003,849 50,841,165
Mortgage - backed securities held to maturity, at amortized cost
(estimated market value: 1997 - $33,185,672; 1996 - $37,104,391) 33,326,472 37,899,847
Investment securities held for trading, at fair value 581,332 1,350,827
Investment securities available for sale, at fair value 75,863,353 30,973,260
Investment securities held to maturity, at amortized cost
(estimated market value: 1997 - $10,655,981; 1996 - $5,241,146) 10,692,802 5,269,850
Loans receivable, net 765,059,419 603,750,621
Accounts receivable, including advances to investors, net 7,358,663 5,764,331
Accrued interest receivable 10,345,722 6,632,250
Servicing asset 21,212,998 12,595,020
Premises and equipment 9,527,559 7,767,680
Other assets 15,064,845 12,730,060
- ---------------------------------------------------------------------------------------------------------------
$ 1,510,745,516 $ 1,037,797,529
===============================================================================================================
Liabilities and Stockholders' Equity
Liabilities:
Deposits $ 722,418,494 $ 615,567,481
Federal funds purchased 10,000,000 --
Securities sold under agreements to repurchase 382,282,810 97,444,448
Notes payable 159,304,315 126,842,099
Advances from FHLB 42,000,000 15,000,000
Other secured borrowings 34,359,168 50,462,619
Accounts payable and accrued liabilities 15,871,770 9,998,768
Other liabilities 3,205,043 3,599,222
- ---------------------------------------------------------------------------------------------------------------
1,369,441,600 918,914,637
- ---------------------------------------------------------------------------------------------------------------
Subordinated notes 3,250,000 3,250,000
- ---------------------------------------------------------------------------------------------------------------
Commitments and contingencies -- --
- ---------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized, none issued -- --
Common stock:
Class A - $.01 par value, 10,000,000 shares authorized,
9,220,278 issued and outstanding in 1997 (1996 - 5,122,377) 92,203 51,223
Class B - $.01 par value, 15,000,000 shares authorized,
4,924,474 issued and outstanding in 1997 (1996 - 2,735,839) 49,245 27,360
Additional paid-in capital 38,347,818 38,410,683
Retained earnings 96,129,140 75,784,804
Capital reserves of the Bank 2,215,172 1,460,707
Unrealized gain (loss) on securities available for sale, net 1,220,338 (101,885)
- ---------------------------------------------------------------------------------------------------------------
138,053,916 115,632,892
- ---------------------------------------------------------------------------------------------------------------
$ 1,510,745,516 $ 1,037,797,529
===============================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
42
<PAGE>
<TABLE>
<CAPTION>
R&G Financial Corporation
Consolidated Statements of Income
Years Ended December 31, 1997, 1996 and 1995
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans $ 68,513,571 $ 54,081,908 $ 37,039,388
Money market and other investments 6,295,443 4,364,861 1,805,345
Mortgage-backed securities 22,525,876 15,338,950 14,666,922
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest income 97,334,890 73,785,719 53,511,655
- ------------------------------------------------------------------------------------------------------------------------------------
Less - interest expense:
Deposits 32,434,559 27,517,852 21,829,433
Securities sold under agreements to repurchase 13,483,500 5,023,794 6,436,327
Notes payable 9,615,560 7,283,593 3,363,930
Secured borrowings 3,583,471 4,189,845 --
Other 1,688,034 847,607 608,984
- ------------------------------------------------------------------------------------------------------------------------------------
60,805,124 44,862,691 32,238,674
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income 36,529,766 28,923,028 21,272,981
Provision for loan losses 6,370,000 4,258,047 950,000
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 30,159,766 24,664,981 20,322,981
- ------------------------------------------------------------------------------------------------------------------------------------
Other income:
Net gain on origination and sale of loans 24,032,714 11,708,974 8,384,071
Change in allowance for cost in excess of
market value of loans held for sale -- -- 855,834
Net profit (loss) on trading account (853,700) (65,656) --
Net gain on sales of investment securities
available for sale 107,430 641,798 --
Loan administration and servicing fees 13,213,948 13,029,053 11,029,995
Service charges, fees and other 4,604,670 3,937,878 3,171,949
- ------------------------------------------------------------------------------------------------------------------------------------
41,105,062 29,252,047 23,441,849
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues 71,264,828 53,917,028 43,764,830
- ------------------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Employee compensation and benefits 13,652,754 10,793,301 8,283,809
Office occupancy and equipment 7,131,497 5,531,129 4,711,312
SAIF special assessment -- 2,508,380 --
Other administrative and general 18,251,497 15,424,117 13,730,724
- ------------------------------------------------------------------------------------------------------------------------------------
39,035,748 34,256,927 26,725,845
- ------------------------------------------------------------------------------------------------------------------------------------
Income before minority interest and
income taxes 32,229,080 19,660,101 17,038,985
Minority interest in the Bank -- 538,168 742,527
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 32,229,080 19,121,933 16,296,458
- ------------------------------------------------------------------------------------------------------------------------------------
Income tax expense:
Current 6,263,549 5,687,865 3,555,868
Deferred 2,468,319 234,552 2,291,478
- ------------------------------------------------------------------------------------------------------------------------------------
8,731,868 5,922,417 5,847,346
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 23,497,212 $ 13,199,516 $ 10,449,112
====================================================================================================================================
Earnings per common share:
Basic $ 1.66 $ 1.21 $ 1.12
====================================================================================================================================
Diluted $ 1.62 $ 1.19 $ 1.12
====================================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
43
<PAGE>
<TABLE>
<CAPTION>
R&G Financial Corporation
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1997, 1996 and 1995
Common Stock Common Stock Additional
Class A Class B Paid-in Capital
Shares Amount Shares Amount Class A Class B
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 5,189,044 $51,890 $362,710
Transfer to capital reserves
Net income
Net change in unrealized gain (loss) on
securities available for sale, net of tax
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 5,189,044 51,890 362,710
Issuance of common stock (including
66,667 Class B shares exchanged for
Class A shares in August):
August (66,667) (667) 2,435,000 $ 24,350 (5,333) $ 31,344,398
December 300,839 3,010 6,708,908
Transfer to capital reserves
Cash dividends declared on common stock
Net income
Net change in unrealized gain (loss) 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
Transfer to capital reserves
Common stock split on September 25, 1997:
Stock split 4,097,901 40,980 2,188,635 21,885 (40,980) (21,885)
Cash paid in lieu of fractional shares
Cash dividends declared on common stock
Net income
Net change in unrealized gain on
securities available for sale, net of tax
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 9,220,278 $92,203 4,294,474 $49,245 $316,397 $38,031,421
====================================================================================================================================
<PAGE>
<CAPTION>
R&G Financial Corporation
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1997, 1996 and 1995
Unrealized gain
Capital (loss) on securities Retained
reserves available for sale earnings Total
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1994 $ 986,180 $ 54,569,219 $55,969,999
Transfer to capital reserves $666,767 (666,767)
Net income 10,449,112 10,449,112
Net change in unrealized gain (loss) on
securities available for sale, net of tax (33,931) (33,931)
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 666,767 952,249 64,351,564 66,385,180
Issuance of common stock (including
66,667 Class B shares exchanged for
Class A shares in August):
August 31,362,748
December 6,711,918
Transfer to capital reserves 793,940 (793,940)
Cash dividends declared on common stock (972,336) (972,336)
Net income 13,199,516 13,199,516
Net change in unrealized gain (loss) on
securities available for sale, net of tax (1,054,134) (1,054,134)
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 1,460,707 (101,885) 75,784,804 115,632,892
Transfer to capital reserves 754,465 (754,465)
Common stock split on September 25, 1997:
Stock split
Cash paid in lieu of fractional shares (12,659) (12,659)
Cash dividends declared on common stock (2,385,752) (2,385,752)
Net income 23,497,212 23,497,212
Net change in unrealized gain on
securities available for sale, net of tax 1,322,223 1,322,223
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $2,215,172 $1,220,338 $96,129,140 $138,053,916
===================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
44
<PAGE>
<TABLE>
<CAPTION>
R&G Financial Corporation
Consolidated Statements of Cash Flows
Years Ended December 31, 1997, 1996 and 1995
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 23,497,212 $ 13,199,516 $ 10,449,112
- ------------------------------------------------------------------------------------------------------------------------------------
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 2,659,888 2,142,275 1,794,454
Amortization of premium (accretion of discount) on
investments and mortgage - backed securities, net (371,816) 199,955 89,111
Amortization of deferred loan origination fees
and accretion of discount on loans purchased (258,324) (411,219) (366,332)
Amortization of excess servicing receivable -- 77,530 131,067
Amortization of servicing rights 1,837,414 1,213,606 1,497,803
Compensation cost on common shares granted -- 290,000 --
Change in allowance for cost in excess of
market value of loans held for sale -- -- (855,834)
Provision for loan losses 6,370,000 4,258,047 950,000
Provision for bad debts in accounts receivable 300,000 300,000 572,092
Gain on sales of mortgage loans (2,721,154) (599,935) (264,953)
Gain on sales of investment securities
available for sale (107,430) (641,798) --
Minority interest in earnings of the Bank -- 538,168 742,527
Decrease (increase) in mortgage loans held for sale 7,564,836 (33,131,819) 1,558,060
Net (increase) decrease in mortgage-backed
securities held for trading (291,540,928) 5,662,504 14,914,098
Net decrease (increase) in investment securities
held for trading 769,495 (1,350,827) --
(Increase) decrease in interest and
accounts receivable (5,607,804) (3,065,914) 1,148,109
Other increases in other assets (1,986,644) (3,606,714) (1,812,808)
Increase in notes payable 34,862,216 10,212,067 7,915,435
Increase (decrease) in accounts payable
and accrued liabilities 5,128,545 (1,542,763) 6,442,758
(Decrease) increase in other liabilities (394,179) 1,167,645 934,566
- ------------------------------------------------------------------------------------------------------------------------------------
Total adjustments (243,495,885) (18,289,192) 35,390,153
Net Cash (used in) provided by
operating activities (219,998,673) (5,089,676) 45,839,265
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of investment securities available for
sale and held to maturity (83,021,527) (47,623,969) (377,000)
Proceeds from sales and maturities of investment
securities available for sale 36,265,089 63,127,623 --
Proceeds from maturities of investment securities
held to maturity -- 377,000 --
Principal repayments on mortgage-backed securities 9,475,202 10,554,678 8,636,250
Proceeds from sale of loans 120,955,837 50,326,054 20,201,648
Net originations of loans (285,970,693) (227,155,954) (210,377,522)
Purchases of FHLB stock, net (658,757) (967,700) (1,401,700)
Acquisition of premises and equipment (3,914,192) (2,592,494) (2,926,306)
Net (increase) decrease in foreclosed real estate (853,716) (572,814) 83,488
Acquisition of servicing rights (10,455,392) (5,598,965) (5,289,651)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (218,178,149) (160,126,541) (191,450,793)
- ------------------------------------------------------------------------------------------------------------------------------------
45
<PAGE>
R&G Financial Corporation
Consolidated Statements of Cash Flows
Years Ended December 31, 1997, 1996 and 1995 (continued)
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from financing activities:
Proceeds from issuance of notes payable $-- $ 60,500,000 $ 27,400,000
Payments on notes payable (2,400,000) (25,000,000) --
Proceeds from issuance of long-term debt -- -- 2,000,000
Payments of long-term debt -- (5,323,899) (1,200,274)
Increase in deposits - net 106,750,114 97,160,090 137,928,057
Increase (decrease) in securities sold
under agreements to repurchase - net 284,838,362 (1,038,740) (10,437,272)
Increase in federal funds purchased 10,000,000 -- --
Proceeds from secured borrowings -- -- 55,983,501
Payments on secured borrowings (16,103,451) (5,520,882) --
Advances from FHLB 161,700,000 16,000,000 --
Repayment of advances from FHLB (134,700,000) (7,000,000) (7,500,000)
Proceeds from issuance of common
stock to minority shareholders -- -- 10,321
Proceeds from issuance of common stock on
initial public offering -- 31,072,748 --
Cash dividends on common stock (2,385,752) (972,336) --
Payment of cash in lieu of fractional shares
on stock split (12,659) -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 407,686,614 159,876,981 204,184,333
- ------------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (30,490,208) (5,339,236) 58,572,805
Cash and cash equivalents at beginning of year 98,855,931 104,195,167 45,622,362
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 68,365,723 $ 98,855,931 $ 104,195,167
====================================================================================================================================
Cash and cash equivalents include:
Cash and due from banks $ 32,607,001 $ 31,989,944 $ 32,559,429
Securities purchased under agreements to resell 16,000,000 19,633,178 21,694,675
Time deposits with other banks 16,758,722 33,232,809 44,930,015
Federal funds sold 3,000,000 14,000,000 5,011,048
- ------------------------------------------------------------------------------------------------------------------------------------
$ 68,365,723 $ 98,855,931 $ 104,195,167
====================================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
46
<PAGE>
R&G FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
December 31, 1997 and 1996
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 interests. The transaction was accounted for at historical cost in a
manner similar to pooling of interests accounting.
On December 2, 1996 the Company also acquired the remaining 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. The
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 for 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.
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 NASDAQ. 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.
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. Upon selling the loans, it retains the rights to service the loans.
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.
47
<PAGE>
The Bank provides a full range of banking services through fifteen branches
located mainly in the northern part of the Commonwealth of Puerto Rico. As
discussed in Note 17 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.
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 intercompany 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 and the reported amounts
of revenues and expenses during the reporting period, and the disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements. Actual results could differ from those estimates.
Securities purchased under agreements to resell
The Company purchases 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
Investments in debt and equity securities are classified at the time of purchase
into one of three categories:
Held to maturity- debt securities which the Company has a positive intent and
ability to hold to maturity. These securities are carried at amortized cost.
Trading- debt and equity securities that are bought by the Company 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.
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 sold
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.
The Company measures impairment of individual loans, except for loans that are
valued at fair value or at the lower of cost or fair value, 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. The
Company considers loans over $500,000 for individual impairment evaluations. The
Company collectively performs impairment evaluations for large groups of small -
balance homogeneous loans. 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.
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 and 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 in the aggregate. 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.
48
<PAGE>
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.
Servicing rights
During 1995, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 122 - "Accounting for Mortgage Servicing Rights - an amendment of
FASB Statement No. 65," which permits the prospective 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. Previously, only servicing rights acquired through
purchases were capitalized. To determine the fair value of the servicing rights,
the Company uses the market prices of comparable servicing sale contracts. SFAS
122 prohibits retroactive application, therefore, mortgage servicing rights
related to loans originated prior to the adoption of the Statement are not
recognized in the Company's consolidated financial statements until the related
loans are sold.
The cost of acquiring the rights to service mortgage loans is capitalized and
amortized in proportion to and over the period of net servicing income. SFAS 122
also requires that all mortgage servicing rights be evaluated for impairment. In
determining impairment, servicing rights were disaggregated by interest rate,
the latter considered their predominant risk characteristic.
For purposes of measuring impairment, mortgage servicing rights are stratified
by loan on the basis of interest rates. An impairment is recognized whenever the
prepayment pattern of the mortgage loan 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, 1997
or 1996. As of December 31, 1997 and 1996 the fair value of capitalized mortgage
servicing rights was approximately $24,566,000 and $15,984,000, respectively. In
determining fair value, the Company considers the fair value of servicing rights
with similar risk characteristics.
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," amending SFAS
122. SFAS 125 requires the recognition of financial assets and servicing assets
controlled by the reporting entity, the derecognition of financial assets when
control is surrendered, and the derecognition of liabilities when they are
extinguished. Specific criteria are established for determining when control has
been surrendered in the transfer of financial assets.
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 adjusted by (a)
amortization in proportion to and over the period of estimated net servicing
income and loss and (b) assessment for asset impairment or increased obligation
based on their fair values.
SFAS 125 modifies the accounting for interest-only strips ("IOs") or retained
interests in securitizations, such as excess servicing fees receivable, that can
be contractually prepaid or otherwise settled in such a way that the holder
would not recover substantially all of its recorded investment, and requires
that they be classified as available for sale or as trading securities.
Management has determined that excess servicing fees receivable retained by the
Company as a result of securitization transactions or bulk sales will be held as
trading securities IOs if made in connection with its mortgage banking
activities, and available for sale if not made in connection with such
activities. In addition, all residual interests and mortgage-backed securities
previously retained by the Company as part of its mortgage banking activities
securitization transactions will also be held as trading securities.
The provisions of this Statement, except as indicated below, were effective for
transfers and servicing of financial assets and extinguishment of liabilities
occurring on or after January 1, 1997, and must be applied prospectively.
Earlier or retroactive application is not permitted. In connection with the
adoption of SFAS 125 effective January 1, 1997, the Company reclassified the
asset previously shown on the Company's Consolidated Balance Sheet as "Mortgage
Servicing Rights" to "Servicing Asset." In addition, the asset previously shown
as "Excess Servicing Fees Receivable" was reclassified as "Interest Only Strips"
and is now included in the Company's Consolidated Balance Sheet as a component
of "Mortgage-Backed Securities held for trading."
In December 1996, the FASB issued SFAS No. 127 to defer until January 1, 1998
the effective date applicable to the provisions of SFAS 125 that deal with
secured borrowings and collateral. Additionally, the deferment provision would
apply to transfers of financial assets for repurchase agreements, dollar rolls
and securities lending. Based on presently available information management
believes the application of those provisions of SFAS 125 effective in 1998
should not have a material adverse effect on the Company's financial condition
or results of operations.
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.
49
<PAGE>
Foreclosed real estate held for sale
Other real estate owned comprises properties acquired in settlement of loans and
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 Of."
Under this 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 for the difference, if any, between the discounted
future cash flows and the carrying value of the asset. The application of this
Statement had no effect on the Company's financial condition or results of
operations for 1996.
Goodwill and other intangibles
Goodwill 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 fifteen year period.
Accumulated amortization amounted to $1,363,045 and $1,059,636 as of December
31, 1997 and 1996, respectively.
In addition, the Company has recorded as a deposit intangible the premium paid
by the Bank over the value of deposits acquired resulting from the purchase of
certain branches from a commercial bank in 1995. The premium paid, which
approximated $1,351,000, was determined based on negotiations between the
parties to the agreement and is being amortized over a 10 year period.
Accumulated amortization amounted to approximately $342,000 and $204,000 at
December 31, 1997 and 1996, respectively.
Securities sold under agreements to repurchase
The Company sells 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.
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 the
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 provisions. In most sales, the right to
service the loans sold is retained by the Company.
Interest rate risk management
The Company enters into interest rate caps, swaps, options and/or futures
contracts (primarily based on Eurodollar certificates of deposits and U.S.
Treasury Notes) 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 swaps are not recognized in the consolidated statement of
financial condition and are not marked to market. Net interest settlements on
interest rate swaps are recorded as adjustments to interest income or expense.
Employee benefits
The Company and its subsidiaries have no post retirement benefit plans for its
employees as of December 31, 1997.
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.
50
<PAGE>
Capital reserve
The Banking Act of the Commonwealth of Puerto Rico, as amended, requires that a
minimum of 10% of net income of the Bank be transferred to capital surplus until
such surplus equals the sum of the Bank's paid-in common and preferred stock
capital.
Stock option plans
As discussed in Note 18 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 amount an employee must pay to acquire the stock (intrinsic value-based
method of accounting). Generally, stock options are granted with an exercise
price equal to the face value of the stock at the date of the grant and,
accordingly, no compensation cost is recognized. The Company adopted in 1996 the
disclosure 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.
Earnings per share
Basic earnings per common share is computed by dividing net income for the year
by the weighted average number of shares outstanding during the period.
Outstanding stock options granted under the Company's Stock Option Plan are
included in the weighted average number of shares for purposes of the diluted
earnings per share computation pursuant to SFAS No. 128 - "Earnings per Share."
SFAS 128 replaces the presentation of primary EPS with a presentation of basic
EPS. It also requires dual presentation of basic and diluted EPS computation on
the face of the income statement for all entities with complex capital
structures and requires reconciliation of the numerator and denominator of the
diluted EPS computation. SFAS 128, which also applies to interim periods, was
adopted by the Company in December 31, 1997. This Statement requires the
restatement of all prior-period EPS data presented. Prior to the adoption of
SFAS 128 the Company's capital structure was such that the presentation of the
fully diluted EPS data was not necessary, and the prior period presentation of
primary EPS data excluded outstanding stock options granted under the Company's
stock option plan from the weighted average number of shares outstanding because
their dilutive effect was insignificant. Accordingly, the basic EPS data
presented under SFAS 128 is equivalent to the primary EPS data previously
presented.
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.
Changes in accounting standards
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income."
This Statement requires (1) the classification of items of other comprehensive
income by their nature in a financial statement; (2) the display of the
accumulated balance of other comprehensive income by their nature in a financial
statement; and (3) the display of the accumulated balance of other comprehensive
income separately from retained earnings and additional paid-in capital in the
equity section of the statement of financial position. For the Company,
unrealized gains and losses on certain investments in debt securities will be
the only other comprehensive income item to be included in comprehensive income.
This Statement is effective for fiscal years beginning after December 15, 1997.
This Statement affects only financial statement presentation and, therefore,
management believes that its adoption will not have a material effect, if any,
on the Company's financial position or results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." This Statement requires that a public
business enterprise report financial and descriptive information about its
reportable segments. Operating segments are components of an enterprise about
which separate financial information is available that is evaluated regularly by
the chief operating decision maker in deciding how to allocate resources and in
assessing performance. Management has not yet made a determination on the
business lines of the Company that fulfill the segment definition described
above.
This Statement is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. This Statement affects only financial
statement presentation and disclosure and, therefore, management believes it
will not have a material effect, if any, on the Company's financial position or
results of operations.
Reclassifications
Certain reclassifications have been made to the 1996 and 1995 financial
statements to conform to the 1997 financial statement presentation.
51
<PAGE>
2. Mortgage Loans Held for Sale
Mortgage loans held for sale consist of:
<TABLE>
<CAPTION>
December 31,
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Conventional loans $25,003,291 $ 9,254,440
FHA/VA loans 21,882,032 44,863,833
Construction loans -- 331,886
- --------------------------------------------------------------------------------
$46,885,323 $54,450,159
================================================================================
</TABLE>
The aggregate amortized cost and approximate market value of loans held for sale
as of December 31, 1997 are as follows:
<TABLE>
<CAPTION>
Amortized Gross unrealized Grosss unrealized Approximate
cost holding gains holding losses market value
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
$46,885,323 $1,465,427 $(5,498) $48,345,252
================================================================================
</TABLE>
Substantially all of the loans are pledged to secure various borrowings from
lenders under mortgage warehousing lines of credit (see Note 9).
The following table summarizes the components of gain on sale of mortgage loans
held-for-sale and mortgage-backed securities held-for-trading:
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Proceeds from sales of mortgage loans
and mortgage-backed securities $ 370,121,097 $ 297,606,773 $ 218,738,872
Mortgage loans and mortgage-
backed securities sold (359,001,427) (290,777,907) (215,176,557)
- ---------------------------------------------------------------------------------------
Gain on sales, net 11,119,670 6,828,866 3,562,315
Deferred fees earned, net of loan
origination costs and commitment
fees paid 3,235,381 4,976,079 2,700,145
- ---------------------------------------------------------------------------------------
14,355,051 11,804,945 6,262,460
Net unrealized profit (loss) on
trading securities 9,677,663 (95,971) 2,121,611
- ---------------------------------------------------------------------------------------
Net gain on origination and
sale of mortgage loans $ 24,032,714 $ 11,708,974 $ 8,384,071
=======================================================================================
</TABLE>
Total gross loan origination fees totaled approximately $13,614,000, $13,041,000
and $9,488,000 during the years ended December 31, 1997, 1996 and 1995,
respectively.
Gross gains of $11,532,566, $7,479,507 and $4,057,352, and gross losses of
$412,896, $650,641 and $496,037 were realized on the above sales during the
years ended December 31, 1997, 1996 and 1995, respectively.
52
<PAGE>
3. Investment Securities
The carrying value and estimated fair value of investment securities by category
and contractual maturities 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,
1997 1996
Amortized Fair Amortized Fair
cost value cost value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment securities held to
maturity
U.S. Treasury securities:
Due within one year $ 309,839 $ 310,775 $ -- $ --
Due from one to five years -- -- 309,575 310,871
- ------------------------------------------------------------------------------------------------------------------------------------
309,839 310,775 309,575 310,871
- ------------------------------------------------------------------------------------------------------------------------------------
Puerto Rico Government and Agencies
obligations:
Due within one year 4,433,177 4,439,474 -- --
Due from one to five years -- -- 1,034,998 1,012,500
Due from five to ten years 5,920,000 5,910,000 -- --
Due over ten years 29,786 29,786 574,453 566,951
- ------------------------------------------------------------------------------------------------------------------------------------
10,382,963 10,379,260 1,609,451 1,579,451
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate securities -
Due within one year -- -- 3,350,824 3,350,824
- ------------------------------------------------------------------------------------------------------------------------------------
$10,692,802 $10,690,035 $ 5,269,850 $ 5,241,146
====================================================================================================================================
Mortgage-backed securities held
to maturity
GNMA certificates:
Due from one to five years $ 49,347 $ 50,128 $ -- $ --
Due from five to ten years -- -- 96,696 99,828
Due over ten years 18,321,595 17,704,769 21,590,649 20,571,360
- ------------------------------------------------------------------------------------------------------------------------------------
18,370,942 17,754,897 21,687,345 20,671,188
- ------------------------------------------------------------------------------------------------------------------------------------
Federal National Mortgage
Association (FNMA) certificates-
Due over ten years 14,674,783 15,164,453 15,895,067 16,124,357
- ------------------------------------------------------------------------------------------------------------------------------------
Federal Home Loan Mortgage
Corporation (FHLMC) certificates-
Due over ten years 280,747 266,322 317,435 308,846
- ------------------------------------------------------------------------------------------------------------------------------------
$33,326,472 $33,185,672 $37,899,847 $37,104,391
====================================================================================================================================
</TABLE>
53
<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 prepayment penalties.
<TABLE>
<CAPTION>
December 31,
1997 1996
Amortized Fair Amortized Fair
cost value cost value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities available
for sale
CMO residuals and other
mortgage-backed securities $ 7,006,610 $ 8,381,982 $ 7,066,610 $ 8,195,379
- ------------------------------------------------------------------------------------------------------------------------------------
FNMA certificates -
Due over ten years 9,468,141 9,670,108 10,562,799 10,293,218
- ------------------------------------------------------------------------------------------------------------------------------------
FHLMC certificates:
Due from one to five years 70,584 70,452 -- --
Due from five to ten years 359,980 368,203 529,902 547,027
Due over ten years 27,104,346 27,513,104 32,547,150 31,805,541
- ------------------------------------------------------------------------------------------------------------------------------------
27,534,910 27,951,759 33,077,052 32,352,568
- ------------------------------------------------------------------------------------------------------------------------------------
$44,009,661 $46,003,849 $50,706,461 $50,841,165
====================================================================================================================================
Investment securities available for sale
US Treasury securities:
Due within one year $ 773,156 $ 771,593 $ -- $ --
Due from one to five years 30,009,771 30,100,000 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
30,782,927 30,871,593 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. Government and Agencies
securities:
Due within one year -- -- 1,500,000 1,500,000
Due from one to five years 35,145,089 35,104,828 25,527,679 25,225,950
Due from five to ten years 5,022,904 4,980,865 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
40,167,993 40,085,693 27,027,679 26,725,950
- ------------------------------------------------------------------------------------------------------------------------------------
70,950,920 70,957,286 27,027,679 26,725,950
FHLB stock 4,906,067 4,906,067 4,247,310 4,247,310
- ------------------------------------------------------------------------------------------------------------------------------------
$75,856,987 $75,863,353 $31,274,989 $30,973,260
====================================================================================================================================
</TABLE>
Mortgage backed securities available for sale include interest only securities
with an amortized cost of $2,363,942 as of December 31, 1997 and 1996, which are
associated with the sale in prior years of collateralized mortgage obligations
not related to the Company's mortgage banking activities.
54
<PAGE>
Mortgage - backed securities held for trading:
<TABLE>
<CAPTION>
December 31,
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
CMO Certificates $ 15,228,000 $ 15,147,000
CMO Residuals (interest only) 7,867,662 9,309,548
GNMA Certificates 377,361,794 84,459,980
- --------------------------------------------------------------------------------
$400,457,456 $108,916,528
================================================================================
</TABLE>
Unrealized gains and losses on securities held to maturity and available for
sale follows:
<TABLE>
<CAPTION>
December 31,
1997 1996
Gross unrealized Gross unrealized
Gains Losses Gains Losses
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Securities held to maturity:
Puerto Rico and United States
Government obligations $ 936 $ (37,757) $ 13,795 $ (42,499)
Mortgage-backed securities 504,349 (645,149) 338,941 (1,134,397)
- ------------------------------------------------------------------------------------------------------------------------------------
$ 505,285 (682,906) $ 352,736 $(1,176,896)
====================================================================================================================================
Securities available for sale:
US Government obligations $ 113,223 $ (106,857) $ -- $ (301,729)
Mortgage-backed securities 2,043,941 (49,753) 1,003,887 (869,183)
- ------------------------------------------------------------------------------------------------------------------------------------
$ 2,157,164 $ (156,610) $ 1,003,887 $(1,170,912)
====================================================================================================================================
</TABLE>
During 1997 and 1996 the Company had proceeds from the sale of investment
securities held for trading of approximately $10,083,000 and $11,440,000,
respectively; gains realized on such sales totaled approximately $31,000 and
$44,000, respectively; no losses were realized. No investment securities held
for trading were sold in 1995. During the years ended December 31, 1997 and 1996
proceeds from the sale of securities available for sale totaled approximately
$7,915,000 and $48,950,000, respectively; gains realized in those sales totaled
approximately $107,000 and $642,000, respectively; no losses were realized.
There were no sales of securities available for sale during 1995.
During 1997 the Company reclassified $773,000 investment securities held for
trading to available for sale. 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 at such time.
As discussed in Notes 7, 8, 9, 10, 11 and 12 to the consolidated financial
statements, investment and mortgage-backed securities, mortgage loans, and
deposits at interest with banks amounting to approximately $696.0 million as of
December 31, 1997 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.
55
<PAGE>
4. Loans and Allowance for Loan Losses
Loans consist of the following:
<TABLE>
<CAPTION>
December 31,
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Real estate loans:
Residential - first mortgage $ 476,652,596 $ 370,875,512
Residential - second mortgage 17,831,079 15,757,050
Land 76,400 --
Construction 13,367,513 5,351,115
Commercial 87,506,802 75,214,109
- --------------------------------------------------------------------------------
595,434,390 467,197,786
Undisbursed portion of loans in process (6,218,039) (2,429,714)
Net deferred loan fees 172,019 40,555
- --------------------------------------------------------------------------------
589,388,370 464,808,627
- --------------------------------------------------------------------------------
Other loans:
Commercial 38,598,227 31,062,947
Consumer:
Loans secured by deposits 12,471,772 9,408,892
Loans secured by real estate 81,251,989 42,893,213
Other 50,632,418 59,864,037
Unamortized discount (151,460) (278,320)
Unearned interest (360,195) (677,130)
- --------------------------------------------------------------------------------
182,442,751 142,273,639
- --------------------------------------------------------------------------------
Total loans 771,831,121 607,082,266
Allowance for loan losses (6,771,702) (3,331,645)
- --------------------------------------------------------------------------------
$ 765,059,419 $ 603,750,621
================================================================================
</TABLE>
The changes in the allowance for loan losses follow:
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, beginning of year $ 3,331,645 $ 3,510,251 $ 2,887,099
Provision for loan losses 6,370,000 4,258,047 950,000
Loans charged-off (5,376,573) (4,662,407) (508,946)
Recoveries 2,446,630 225,754 182,098
- --------------------------------------------------------------------------------
Balance, end of year $ 6,771,702 $ 3,331,645 $ 3,510,251
================================================================================
</TABLE>
As of December 31, 1997 the Company had three commercial loans classified as
impaired totaling $1,570,642 in aggregate. Based on presently available
information, the Company has determined that no reserves for impairment were
necessary as of such date since the fair value of the collaterals securing such
loans exceed their outstanding balances. No individual loans were impaired as of
December 31, 1996.
As of December 31, 1997, 1996 and 1995, loans on which the accrual of interest
income had been discontinued amounted to approximately $29,968,000, $18,730,000
and $10,032,000, respectively. The additional interest income that would have
been recognized during 1997, 1996 and 1995 had these loans been accruing
interest amounted to approximately $1,095,000, $864,000 and $261,000,
respectively. The Company has no material commitments to lend additional funds
to borrowers whose loans were in non-accruing status at December 31, 1997.
56
<PAGE>
5. 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 on a monthly basis out of payments from
mortgagors. 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, 1997 and
1996, the mortgage loans servicing portfolio amounted to approximately
$2,552,030,000 and $2,226,406,000, respectively, excluding approximately
$448,858,000 and $323,763,000, respectively, serviced for the Bank.
The changes in the servicing asset of the Company follows:
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of period $ 12,595,020 $ 8,209,661 $ 4,417,813
Rights originated 8,057,574 4,172,868 2,285,331
Rights purchased 2,397,818 1,426,097 3,004,320
Scheduled amortization (1,837,414) (1,213,606) (1,497,803)
- --------------------------------------------------------------------------------
Balance at end of period $ 21,212,998 $ 12,595,020 $ 8,209,661
================================================================================
</TABLE>
Among the conditions established in its various servicing agreements, the
Company is committed to advance from its own funds any shortage of moneys
required to complete timely payments to investors in GNMA mortgage-backed
securities issued and in its FNMA and FHLMC portfolio. At December 31, 1997, the
mortgage loan portfolio serviced for GNMA, FNMA and FHLMC and subject to the
timely payment commitment amounted to approximately $1,779,252,000, $53,760,000
and $474,079,000, respectively (1996 - $1,543,242,000, $61,565,000, and
$377,252,000).
Total funds advanced as of December 31, 1997 in relation to such commitments
amount to $782,000, $1,688,000 and $530,000 for escrow advances, principal and
interest advances and foreclosure advances, respectively (1996 - $787,000,
$1,313,000 and $344,000).
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, some of which are deposited in
the Bank. At December 31, 1997 and 1996, the related escrow funds include
approximately $50,163,000 and $10,555,000, respectively, deposited in the Bank;
these funds are included in the Company's consolidated financial statements.
Escrow funds also include approximately $8,654,000 and $28,422,000 at December
31, 1997 and 1996, respectively, deposited with other banks and excluded from
the Company's assets and liabilities.
57
<PAGE>
6. Premises and Equipment
Premises and equipment consist of:
<TABLE>
<CAPTION>
December 31,
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Furniture and fixtures $ 13,026,459 $ 10,135,761
Leasehold improvements 6,073,038 5,186,573
Autos 375,826 205,962
- --------------------------------------------------------------------------------
19,475,323 15,528,296
Less - Accumulated
depreciation and amortization (9,947,764) (7,760,616)
- --------------------------------------------------------------------------------
$ 9,527,559 $ 7,767,680
================================================================================
</TABLE>
7. Deposits
Deposits are summarized as follows:
<TABLE>
<CAPTION>
December 31,
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Passbook savings $ 79,628,833 $ 73,965,054
NOW accounts 27,644,104 24,555,925
Super NOW accounts 67,650,384 57,629,203
Regular checking accounts
(non-interest bearing) 32,720,996 23,236,975
Commercial checking accounts
(non-interest bearing) 58,783,328 31,007,473
- --------------------------------------------------------------------------------
186,798,812 136,429,576
- --------------------------------------------------------------------------------
Certificates of deposit:
Under $100,000 257,431,730 235,061,722
$100,000 and over 196,961,831 168,614,740
- --------------------------------------------------------------------------------
454,393,561 403,676,462
- --------------------------------------------------------------------------------
Accrued interest payable 1,597,288 1,496,389
- --------------------------------------------------------------------------------
$722,418,494 $615,567,481
================================================================================
</TABLE>
The weighted average stated interest rate on all deposits at December 31, 1997
and 1996 was 4.82% and 5.07%, respectively.
As of December 31, 1997, the Company had delivered investment securities with an
amortized cost of approximately $1,500,000 and market value of approximately
$1,490,000 as collateral for public funds' deposits of approximately $852,000.
58
<PAGE>
8. Securities Sold Under Agreements to Repurchase
At December 31, 1997 and 1996, the Company had repurchase agreements outstanding
with interest ranging from 5.10% to 6.00% in 1997 and 5.48% to 5.75% in 1996.
These agreements mature within thirty days.
Information on these agreements follows:
<TABLE>
<CAPTION>
December 31,
1997 1996
Approximate market Approximate market
Repurchase and carrying value of Repurchase and carrying value of
liability underlying securities liability underlying securities
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Type of security
U.S. Treasury securities $ 30,095,287 $ 30,326,667 $ -- $ --
U.S. Government and
Agencies securities 5,580,000 5,995,405 -- --
GNMA 312,463,863 321,440,226 75,710,383 79,627,257
CMO Tranches 13,576,380 15,228,000 13,576,384 15,147,000
CMO Residuals 8,162,280 7,264,420 8,157,681 8,593,151
FHLMC 12,405,000 12,954,146 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
$382,282,810 $393,208,864 $ 97,444,448 $103,367,408
====================================================================================================================================
</TABLE>
Maximum amount of borrowings outstanding at any month-end during 1997 and 1996
under the agreements to repurchase were $382,309,000 and $127,240,000,
respectively. The approximate average aggregate balance outstanding during the
periods were $226,771,000 and $100,607,000, respectively. The weighted average
interest rate of such agreements was 5.81% and 3.99% at December 31, 1997 and
1996, respectively; the weighted average rate during 1997 and 1996 was 5.95% and
4.99%, 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,
1997 1996
Approximate market Approximate market
Repurchase and carrying value of Repurchase and carrying value of
liability underlying securities liability underlying securities
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Citibank, N.A $197,112,165 $203,113,664 $ 56,330,448 $ 62,150,725
Merrill Lynch of
Puerto Rico Inc. 152,493,000 156,861,232 11,200,000 11,742,604
Smith Barney
Puerto Rico, Inc. 12,512,358 12,927,611 -- --
Paine Webber, Inc. of
Puerto Rico -- -- 29,914,000 29,474,079
Popular Securities, Inc. 10,215,287 10,293,857 -- --
Prudential Securities, Inc. 9,950,000 10,012,500 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
$382,282,810 $393,208,864 $ 97,444,448 $103,367,408
====================================================================================================================================
</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.
59
<PAGE>
9. Notes Payable
Notes payable consist of:
<TABLE>
<CAPTION>
December 31,
1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Warehousing lines, bearing interest at a floating rate of 1.50%
over the counterparty's cost of funds (5.85% in 1997 and 4.97% in 1996) $ 75,204,315 $ 40,342,099
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%
(4.73% at December 31, 1997 and 4.62% at December 31, 1996) 10,000,000 10,000,000
Promissory note maturing in 2003 paying semiannual interest at a
fixed annual rate of 5.50% (prepaid in 1997) -- 2,400,000
Promissory note maturing in 2001 paying quarterly interest at a
floating rate of 96% of the three month Libid rate (5.34% at
December 31, 1997 and 5.28% at December 31, 1996) 25,000,000 25,000,000
Promissory note maturing in 2001 paying semiannual interest at a
fixed annual rate of 6.52% 10,500,000 10,500,000
- ------------------------------------------------------------------------------------------------------------------------------------
$159,304,315 $126,842,099
====================================================================================================================================
</TABLE>
As of December 31, 1997, the Company had various credit line agreements
permitting the Company to borrow up to $138,425,000 in warehousing lines with
banks; the unused portion of warehousing lines totaled approximately $63.2
million. Warehousing lines at December 31, 1997 are collateralized by
approximately $111,727,000 in mortgage loans, 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 counterparty's cost of funds or the
Puerto Rico 936 funds market when available. 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 debt
service over certain defined minimums, and limitations on indebtedness and
declaration of dividends. Management believes that at December 31, 1997 the
Company was in compliance with the loan agreements.
The following information relates to borrowings of the Company under the credit
line agreements:
<TABLE>
<CAPTION>
December 31,
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Maximum aggregate borrowings
outstanding at any month end $ 93,523,091 $ 85,134,732
================================================================================
Approximate average aggregate borrowings
outstanding during the year $ 68,159,621 $ 40,805,743
================================================================================
Weighted average interest rate during
the year computed on a monthly basis 5.92% 5.32%
- --------------------------------------------------------------------------------
Weighted average interest rate
at end of year 5.85% 4.97%
- --------------------------------------------------------------------------------
</TABLE>
60
<PAGE>
Certain promissory notes totaling $38,600,000 at December 31, 1997 include
pledge agreements where the Company has pledged certain negotiable securities as
a guarantee for payment of some of the notes. 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, 1997 securities
pledged in compliance with this requirement consist of investment and
mortgage-backed securities with an amortized cost of approximately $38,950,000
and approximate market value of $39,010,000. At December 31, 1997 floating rate
notes in the aggregate amount of $35,000,000 and fixed rate notes of $10,500,000
are guaranteed by letters of credit issued by the FHLB -NY.
Promissory notes by maturity as of December 31, 1997 follows:
1999 $ 23,600,000
2000 25,000,000
2001 35,500,000
- --------------------------------------------------------------------------------
$ 84,100,000
================================================================================
10. Advances from The Federal Home Loan Bank of New York
Advances from the FHLB are as follows:
<TABLE>
<CAPTION>
December 31,
Interest
Maturity Rate 1997 1996
- ------------------------------------------------------------------------------------
<S> <C> <C> <C>
January 7, 1998 6.15% $10,000,000 $ --
January 15, 1998 6.00% 32,000,000 --
February 28, 1997 5.78% -- 5,000,000
March 31, 1997 5.73% -- 5,000,000
June 27, 1997 5.74% -- 5,000,000
- ------------------------------------------------------------------------------------
$42,000,000 $15,000,000
- ------------------------------------------------------------------------------------
Weighted average stated interest rate 6.03% 5.75%
====================================================================================
</TABLE>
The Bank receives advances from the FHLB under an Advances, Collateral Pledge
and Security Agreement (the "Agreement"), which allows the Company to borrow up
to $223.4 million. As of December 31, 1997 the unused portion under such line of
credit was approximately $181.4 million. 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 amounting to approximately
$51,300,000 at December 31, 1997. At December 31, 1997 the specific collateral
(in the form of first mortgage notes) amounting to approximately $112,866,000
were pledged to the FHLB as part of the Agreement and to secure standby letters
of credit. At December 31, 1997, the market value of the collateral indicated
above was sufficient to comply with the provisions of the Agreement.
61
<PAGE>
11. 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 limited 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, 1997 is estimated by management to be
insignificant. As part of the agreement, R&G Mortgage has the right to
repurchase after December 1996 any group of loans sold. For any loan
repurchases, R&G Mortgage is obligated to pay the buyers 50 basis points over
the outstanding balance of the mortgage loans repurchased.
The Company 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 $34,359,000 and $50,463,000 at
December 31, 1997 and 1996, respectively. The outstanding principal of the
related loans totaling approximately $33,868,000 and $49,740,000 have been
included as assets at December 31, 1997 and 1996, respectively.
12. 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 permitted
investments 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, 1997 in compliance with
this requirement consist of FHLMC Participation Certificates with an amortized
cost of approximately $1,205,000 and approximate market value of $1,230,000, and
$2,633,000 in special deposit accounts.
62
<PAGE>
13. 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 in future years 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.
The Bank is subject to Puerto Rico income tax on its income derived from all
sources within and outside Puerto Rico. 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 exempt income, net of related expenses, from the
determination of taxable income results in a reduction of its income tax
liability.
Deferred tax (assets) liabilities are as follows:
<TABLE>
<CAPTION>
December 31,
1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax liabilities:
Deferred net loan origination costs $ 346,286 $ 385,019
Unrealized gain on securities held for trading 3,696,685 --
Reserve for bad debts 45,885 --
CMO residuals (IOs) 1,096,090 1,313,501
Servicing assets 1,424,600 1,504,670
Unrealized gain on securities available for sale 780,216 --
- -------------------------------------------------------------------------------------
7,389,762 3,203,190
- -------------------------------------------------------------------------------------
Deferred tax assets:
Unrealized loss on securities available for sale -- (65,140)
Allowance for loan losses (1,176,463) (272,593)
Reserve for bad debts -- (11,483)
Unrealized loss on securities held for trading -- (124,991)
Other foreclosed property reserve (11,232) (22,805)
Recourse contingency (61,653) --
Discount on tax credits purchased (247,960) --
Deferred gains on sale of loans and
investment securities (378,600) (505,999)
- -------------------------------------------------------------------------------------
(1,875,908) (1,003,011)
- -------------------------------------------------------------------------------------
Net deferred tax liability $ 5,513,854 $ 2,200,179
=====================================================================================
</TABLE>
63
<PAGE>
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>
($ in thousands)
Year ended December 31,
1997 1996 1995
% 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 $ 12,569 39% $ 7,458 39% $ 6,845 42%
Effect on provision of:
Tax-exempt interest (2,947) (9) (2,352) (12) (1,661) (10)
Non-deductible expenses 116 -- 423 2 663 4
Discount on tax credits
purchased (1,006) (3) -- -- -- --
Tax settlement -- -- 393 2 --
- ------------------------------------------------------------------------------------------------------------------------------------
$ 8,732 27% $ 5,922 31% $ 5,847 36%
====================================================================================================================================
</TABLE>
In early February 1998, the Puerto Rico Treasury Department began an income tax
examination of R&G Mortgage's and the Bank's income tax returns for the year
1995. Management believes that no significant deficiencies should result from
such examination, and accordingly, this matter should not have any significant
adverse effect on the Company's financial condition or results of operations.
In July 1997 the Government of Puerto Rico amended the tax law that provided tax
exemption on interest income generated by FHA and VA loans secured by real
estate property located in Puerto Rico and mortgage-backed securities secured by
such mortgage loans (GNMAs). Under the amended law, FHA and VA loans closed
prior to August 1, 1997, will continue to be exempt. The interest income on FHA
and VA mortgage loans originated on or after August 1, 1997 for purposes other
than to finance the acquisition of new housing, and GNMAs secured by such loans,
are no longer exempt, and are taxable at a preferential 17% tax rate to
individuals and certain other taxpayers other than corporations. FHA and VA
loans to finance the purchase of new housing, and GNMAs secured by such loans,
continue to be exempt. While the Company has benefited from the previously
available tax exemption, management believes based on currently available
information that the adoption of the enacted changes should not have a
significant adverse effect in the results of operations of the Company.
64
<PAGE>
14. Stockholders' Equity
On July 15, 1997 the Company's Board of Directors authorized a nine-for-five
stock split of the Company's $.01 par value Class A and Class B common stock
(the "common stock"). The stock split was effected on September 25, 1997 in the
form of a stock dividend of four shares of common stock for each five shares
held of record on September 15, 1997. Prior to the declaration of the stock
split, the Company had 7,858,216 shares of common stock outstanding. As a result
of the split, 6,286,536 shares were issued and $62,865 were transferred from
additional paid-in-capital to common stock. The stock split did not dilute
shareholders' voting rights or their proportionate interest in the Company. All
per share data included herein has been adjusted to reflect the stock split. The
Company's average number of common shares outstanding used in the computation of
basic earnings per common share was 14,144,752 (1996 - 10,920,661; 1995 -
9,340,279); the weighted average number of shares outstanding for the
computation of diluted earnings per share was 14,521,252 (1996 - 11,049,866;
1995 - 9,340,279) after giving effect to outstanding stock options granted under
the Company's Stock Option Plan. During 1997, cash dividends of $0.16875 (1996 -
$0.03472) per common share amounting to $2,385,752 (1996 - $472,336) were paid.
No cash dividends were paid in 1995.
15. Other Operating Expenses
Other operating expenses consist of the following:
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Advertising $ 3,154,189 $ 2,415,177 $ 1,586,351
Stationary and supplies 1,640,131 1,332,108 740,666
Telephone 871,029 751,518 597,058
License and other taxes 1,595,276 1,247,505 1,104,564
Deposit insurance 346,625 652,750 954,537
Other insurance 590,066 538,825 551,407
Legal and other professional services 2,193,687 1,304,967 890,992
Amortization of mortgage
servicing asset 1,837,414 1,213,606 1,497,803
Guaranty fees 1,246,300 1,068,750 934,162
Other 4,776,780 4,898,911 4,873,184
- --------------------------------------------------------------------------------
$18,251,497 $15,424,117 $13,730,724
================================================================================
</TABLE>
16. Related Party Transactions
During March 1996, the Company declared and paid $500,000 cash dividends to its
Class A common stockholder.
The Company leases some of its facilities from an affiliate, mostly on a
month-to-month basis. The annual rentals under these agreements are
approximately $1,420,000.
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, 1997 the aggregate amount of loans outstanding to officers,
directors, and principal stockholders' of the Company and its subsidiaries were
insignificant.
65
<PAGE>
17. 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.
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 the Commonwealth 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. R&G
Mortgage is a U.S. Department of Housing and Urban Development (HUD) approved
non-supervised mortgagee.
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 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,
1997, the Company meets all capital adequacy requirements to which it is
subject.
As of December 31, 1997, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To beaction. To be categorized as well capitalized the Bank
must maintain minimum total risk-based, Tier I risk-based and 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.
66
<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, 1997
and 1996:
<TABLE>
<CAPTION>
To be well capitalized
For capital under prompt corrective
Actual adecuacy purposes action provisions
Amount Ratio Amount Ratio Amount Ratio
($ in thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1997
Total capital (to risk weighted assets):
Consolidated $139,411 17.85% $ 62,493 8% N/A N/A
R-G Premier Bank only $ 74,822 14.00% $ 42,766 8% $ 53,457 10%
Tier I capital (to risk weighted assets):
Consolidated $132,639 16.98% $ 31,247 4% N/A N/A
R-G Premier Bank only $ 70,050 13.10% $ 21,383 4% $ 32,074 6%
Tier I capital (to average assets):
Consolidated $132,639 9.16% $ 57,935 4% N/A N/A
R-G Premier Bank only $ 70,050 7.34% $ 38,162 4% $ 47,702 5%
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%
</TABLE>
During 1996 the Company received a special assessment of approximately $2.5
million ($1.7 million net of taxes) as the result of federal legislation 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. As a
result, the Bank's insurance premiums, which had amounted to $0.23 for every
$100 of deposits, were reduced to $0.064 for every $100 of deposits beginning
January 1, 1997.
67
<PAGE>
18. 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 at the time 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, equivalent to 434,700 shares after giving effect to stock split) were
authorized under the Stock Option Plan, which may be filled 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 at the date of the grant. 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 (360,000 shares as
adjusted for stock split) to 28 employees of R&G Mortgage and the Bank at the
initial public offering price of $14.50 per share. In January 1997 the Company
awarded options for an additional 10,000 shares (18,000 shares as adjusted for
stock split) to a certain employee. The maximum term of the options granted are
ten years. Under the provisions of the Stock Option 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. As of December 31, 1997
none of the options granted have been exercised.
The Company adopted in 1996 the disclosure 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 of the options at the grant date consistent with the provisions
of SFAS 123, the Company's net earnings and earnings per share for the years
ended December 31, 1997 and 1996 would have been reduced to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Net earnings - as reported $ 23,497,212 $ 13,199,516
- --------------------------------------------------------------------------------
Net earnings - pro forma $ 23,342,698 $ 13,143,675
- --------------------------------------------------------------------------------
Basic earnings per share - as reported $ 1.66 $ 1.21
- --------------------------------------------------------------------------------
Basic earnings per share - pro forma $ 1.65 $ 1.20
- --------------------------------------------------------------------------------
Diluted earnings per share - as reported $ 1.62 $ 1.19
- --------
Diluted earnings per share - pro forma $ 1.61 $ 1.19
- --------------------------------------------------------------------------------
</TABLE>
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.
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.
68
<PAGE>
19 Profit Sharing Plan
The Company has a profit sharing plan (the Plan) which covers substantially all
regular employees. Annual contributions to the Plan are based on matching
percentages up to 5% of employee salaries, based on the employee's years of
service and on operational income, as defined by the Plan, and are deposited in
a trust. Contributions to the Plan during the years ended December 31, 1997,
1996 and 1995 amounted to approximately $79,000, $72,000 and $120,000,
respectively.
20. 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 $443.6 million at
December 31, 1997. All commitments are subject to prevailing market prices at
time of closing with no market risk exposure for 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
$98.8 million at December 31, 1997.
Commitments to buy and sell GNMA certificates
As of December 31, 1997, the Company had open commitments to issue GNMA
certificates in the amount of $119.0 million.
Commitments to sell mortgage loans
As of December 31, 1997 the Company had commitments to sell mortgage loans to
third party investors amounting to $17.8 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.
As of December 31, 1997, minimum annual rental commitments under noncancellable
operating leases for certain office space and equipment, including leases with
an affiliate, were as follows:
Year Amount
- -------------------------------------
1998 $ 2,106,792
1999 2,049,407
2000 1,935,473
2001 1,707,945
2002 1,505,233
Later years 3,031,047
- -------------------------------------
$12,335,897
=====================================
Rent expense amounted to approximately $2,483,000 in 1997, $2,171,000 in 1996
and $1,914,000 in 1995.
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 results of operations.
On January 15, 1998 the Company received $2 million as part of a settlement with
its fidelity insurance carrier on a claim filed by the Company in late 1996 as a
result of certain irregularities discovered by the Company with respect to its
former insurance premiums financing business. Based on a review of the
collectibility of the loans in question at the time, management wrote-off loans
amounting to approximately $2.5 million in 1996. The settlement was recorded as
a recovery of loans previously charged-off and reflected as an addition to the
Company's allowance for loan losses as of December 31, 1997.
Others
At December 31, 1997 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, which are serviced by the Company, amounts to
approximately $340.5 million at December 31, 1997. Liability, if any, under the
recourse provisions at December 31, 1997 is estimated by management to be
insignificant.
21. Supplemental Disclosure on the Statements of Cash Flows
During 1997, 1996 and 1995, the Company paid interest amounting to approximately
$60,846,000, $45,939,000 and $34,403,000, respectively, and income taxes of
approximately $9,699,000, $7,573,000 (including $1,065,000 on settlement of a
1992 income tax examination) and $1,820,000, respectively.
During 1997, 1996 and 1995 the Company securitized loans from its mortgage loan
portfolio totaling approximately $11,346,000, $43,673,000 and $17,631,000,
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.
22. 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 statements of financial
condition. The contract or notional amounts of these instruments, which are not
included in the statements of financial condition, are an indicator of the
Company's activities in particular classes of financial instruments.
69
<PAGE>
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.
The total amounts of financial instruments with off-balance sheet risk at
December 31, 1997 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 $ 8,876,000
================================================================================
Financial instruments whose notional or contractual
amounts exceed the amount of potential credit risk:
Interest rate swap contracts $50,000,000
================================================================================
A detail of interest rate swaps at December 31, 1997 follows:
Notional Pay Fixed Receive
Amount Maturity Rate Rate Floating
- --------------------------------------------------------------------------------
$15,000,000 September 17, 1999 5.79% 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 1997:
Beginning balance $ 45,000,000
New Swaps 15,000,000
Maturities (10,000,000)
- --------------------------------------------------------------------------------
Ending balance $ 50,000,000
================================================================================
As of December 31, 1997, interest rate swap maturities are as follows:
1999 $ 15,000,000
2000 10,000,000
2001 25,000,000
- --------------------------------------------------------------------------------
$ 50,000,000
================================================================================
Net interest settlements on Swap agreements 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 $293,000 and
$61,000 during 1997 and 1996, respectively.
70
<PAGE>
23. Supplemental Income Statement Information
Employee costs and other administrative and general expenses are shown in the
Consolidated Statements 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:
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Employee costs $21,368,723 $17,357,976 $13,248,477
================================================================================
Other administrative
and general expenses $22,662,971 $18,916,546 $16,661,353
================================================================================
</TABLE>
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.
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Offset against mortgage
loan sales and fees $2,973,820 $7,173,028 $5,382,186
================================================================================
Offset against interest
income on loans $2,122,727 $1,937,403 $1,470,128
================================================================================
Capitalized as part of
loans held for sale and
loans held for investment $7,030,896 $ 946,673 $1,042,983
================================================================================
</TABLE>
As part of the carrying costs in 1997 of the Company's mortagage loans inventory
held for investment, the Company deferred loan origination fees totaling
approximately $5,213,000.
71
<PAGE>
24. Fair Value of Financial Instruments
The estimated fair value of the Company's financial instruments as of December
31 are as follows:
<TABLE>
<CAPTION>
1997 1996
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
(In thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial Assets
Cash and due from banks $ 32,607 $ 32,607 $ 31,990 $ 31,990
Money market investments 35,759 35,759 66,866 66,866
Mortgage loans held for sale 46,885 48,345 54,450 55,110
Mortgage-backed securities held for trading 400,457 400,457 108,917 108,917
Investment securities held for trading 581 581 1,351 1,351
Investment and mortgage-backed securities
available for sale 116,961 116,961 77,567 77,567
Investment in Federal Home Loan Bank
stock 4,906 4,906 4,247 4,247
Investment and mortgage-backed securities
held to maturity 44,019 43,876 43,170 42,346
Loans, net 765,059 791,309 603,751 608,455
Accounts receivable 17,704 17,704 12,397 12,397
====================================================================================================================================
Financial Liabilities
Deposits:
Non-interest bearing demand $ 91,504 $ 91,504 $ 54,244 $ 54,244
Savings and NOW accounts 174,923 156,859 156,150 141,813
Certificates of deposit 454,394 460,001 403,676 408,521
Securities sold under agreements to
repurchase 392,283 392,283 97,444 97,444
Notes payable 159,304 161,418 126,842 128,692
Advances from FHLB 42,000 41,971 15,000 14,986
Other secured borrowings 34,359 35,019 50,463 50,712
Accounts payable and accrued liabilities 15,872 15,872 13,598 13,598
Subordinated notes 3,250 3,304 3,250 3,641
Unrecognized financial instruments -
Interest rate swap agreements in a net
receivable (payable) position* $ (14) $ 370 $ (44) $ (551)
====================================================================================================================================
</TABLE>
* The amount shown under "carrying amount" represents net accrual arising from
those unrecognized financial instruments.
72
<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 receivable, securities sold under agreements to
repurchase, warehousing lines included in notes payable and accounts payable and
accrued interest, have been valued at their carrying amounts reflected in the
Consolidated Statements 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 for groups of 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 outlook 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 the 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
$10,413,322 in 1997 and $6,538,190 in 1996, 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.
Borrowings
The fair value of promissory notes included in notes payable, advances from
FHLB, subordinated notes and other secured borrowings 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, 1997. 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 counterparties.
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 many 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 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.
73
<PAGE>
25. R&G Financial Corporation (Holding Company Only)
Financial Information
The following condensed financial information presents the financial position of
R&G Financial Corporation (the Holding Company) only as of December 31, 1997 and
1996 and the results of its operations and its cash flows for the years then
ended (since inception in 1996).
<TABLE>
<CAPTION>
Statements of Financial Condition
December 31,
Assets 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Cash $ 622,478 $ 810,920
Investment in R-G Premier Bank, at equity 47,407,575 3,417,333
Investment in R&G Mortgage, at equity 59,542,059 47,696,483
Investment in preferred stock of
R-G Premier Bank, at cost 30,100,000 30,100,000
Accounts receivable - subsidiaries 423,178 290,000
- --------------------------------------------------------------------------------
Total assets $138,095,290 $116,314,736
================================================================================
Liabilities and Stockholders' Equity
- --------------------------------------------------------------------------------
Advances from subsidiaries $ -- $ 666,975
Other liabilities and accrued expenses 41,374 14,869
Stockholders' equity 138,053,916 115,632,892
- --------------------------------------------------------------------------------
Total liabilities and stockholders' equity $138,095,290 $116,314,736
================================================================================
<CAPTION>
Statements of Income
December 31,
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Income:
Dividends on Bank preferred stock $ 2,953,225 $ --
Management fees 423,178 --
Interest on certificates of deposit -- 12,164
- --------------------------------------------------------------------------------
3,376,403 12,164
- --------------------------------------------------------------------------------
Operating expenses 384,707 10,811
- --------------------------------------------------------------------------------
Income before income taxes and equity
in undistributed earnings of subsidiaries 2,991,696 1,353
Income taxes 8,079 338
- --------------------------------------------------------------------------------
Income before equity in undistributed
earnings of subsidiaries 2,983,617 1,015
Equity in undistributed earings of
subsidiaries 20,513,595 13,198,501
- --------------------------------------------------------------------------------
Net income $ 23,497,212 $ 13,199,516
================================================================================
</TABLE>
The Holding Company had no operations during the years ended December 31, 1997
and 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.
74
<PAGE>
Statements of Cash Flows
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 23,497,212 $ 13,199,516
Adjustments to reconcile net income to cash provided by operating
activities:
Equity in undistributed earnings of subsidiaries (20,513,595) (13,198,501)
Increase in accounts receivable - subsidiaries (423,178) --
Increase (decrease) in other liabilities and accrued expenses 26,505 (357,482)
- ------------------------------------------------------------------------------------------------------------------------------------
Total adjustments (20,910,268) (13,555,983)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 2,586,944 (356,467)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Collections of advances to subsidiaries 290,000 --
Purchase of investment in preferred stock of the Bank -- (30,100,000)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash provided by (used in) investing activities 290,000 (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 (2,385,752) (472,336)
Net advances from subsidiaries -- 666,975
Repayment of advances from subsidiaries (666,975) --
Payment of cash in lieu of fractional shares on stock split (12,659) --
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (3,065,386) 31,267,387
- ------------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash (188,442) 810,920
Cash at beginning of year 810,920 --
- ------------------------------------------------------------------------------------------------------------------------------------
Cash at end of year $ 622,478 $ 810,920
====================================================================================================================================
</TABLE>
75
<PAGE>
26. Industry Segments
The following summarized financial information presents the results of the
Company's operations for the three year period ended December 31, 1997 for its
traditional banking and mortgage banking activities:
<TABLE>
<CAPTION>
1997 1996
Bank Mortgage Total Bank Mortgage Total
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net interest
income after
provision of
loan losses $25,543,992 $ 4,615,774 $30,159,766 $20,883,829 $ 3,781,152 $24,664,981
Other income:
Net gain on
origination
and sale
of loans 5,436,030 18,596,684 24,032,714 1,354,373 10,354,601 11,708,974
Change in
allowance for
cost in excess of
market value of
loans held for sale -- -- -- -- -- --
Net gain on sales
of investment securities
available for sale 107,430 -- 107,430 641,798 -- 641,798
Loan administration
and servicing fees -- 13,213,948 13,213,948 -- 13,029,053 13,029,053
Service charges,
fees and other 2,915,328 835,642 3,750,970 3,664,577 207,645 3,872,222
- ----------------------------------------------------------------------------------------------------------------
34,002,780 37,262,048 71,264,828 26,544,577 27,372,451 53,917,028
- ----------------------------------------------------------------------------------------------------------------
Operating expenses:
Salaries and
employee benefits 7,654,668 5,998,086 13,652,754 6,062,221 4,731,080 10,793,301
Office
occupancy and
equipment 4,660,583 2,470,914 7,131,497 3,551,035 1,980,094 5,531,129
SAIF special assessment -- -- -- 2,508,380 -- 2,508,380
Other 8,803,210 9,448,287 18,251,497 7,698,577 7,725,540 15,424,117
- ----------------------------------------------------------------------------------------------------------------
21,118,461 17,917,287 39,035,748 19,820,213 14,436,714 34,256,927
- ----------------------------------------------------------------------------------------------------------------
Income before
income taxes (and
minority interest in
1996 and 1995) $12,884,319 $19,344,761 $32,229,080 $ 6,724,364 $12,935,737 $19,660,101
================================================================================================================
<PAGE>
<CAPTION>
1995
Bank Mortgage Total
- --------------------------------------------------------------------
<S> <C> <C> <C>
Net interest
income after
provision of
loan losses $17,943,694 $ 2,379,287 $20,322,981
Other income:
Net gain on
origination
and sale
of loans 1,249,612 7,134,459 8,384,071
Change in
allowance 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 -- 11,029,995 11,029,995
Service charges,
fees and other 2,368,128 803,821 3,171,949
- --------------------------------------------------------------------
22,417,268 21,347,562 43,764,830
- --------------------------------------------------------------------
Operating expenses:
Salaries and
employee benefits 4,330,248 3,953,561 8,283,809
Office
occupancy and
equipment 2,860,176 1,851,136 4,711,312
SAIF special assessment -- -- --
Other 6,406,237 7,324,487 13,730,724
- --------------------------------------------------------------------
13,596,661 13,129,184 26,725,845
- --------------------------------------------------------------------
Income before
income taxes (and
minority interest in
1996 and 1995) $ 8,820,607 $ 8,218,378 $17,038,985
====================================================================
</TABLE>
76
<PAGE>
27. 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.
<TABLE>
<CAPTION>
(In thousands, except for per share data)
1997
March 31 June 30 Sept. 30 Dec. 31
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total interest income $ 20,408 $ 22,764 $ 26,213 $ 27,950
Total interest expense (12,355) (14,173) (16,427) (17,850)
Net interest income 8,053 8,591 9,786 10,100
Provision for loan losses (1,250) (1,695) (1,700) (1,725)
Income before income taxes 7,650 7,536 8,402 8,641
Income tax expense (2,615) (2,158) (2,351) (1,608)
Net income 5,035 5,378 6,051 7,033
Net income per common share - Basic $ .36 $ .38 $ .43 $ .49
Net income per common share - Diluted $ .35 $ .37 $ .42 $ .48
<CAPTION>
1996
March 31 June 30 Sept. 30 Dec. 31
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
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 loans losses (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 - Basic $ .31 $ .34 $ .22 $ .34
Net income per common share - Diluted $ .31 $ .34 $ .21 $ .33
</TABLE>
77
<PAGE>
[BLANK]
78
<PAGE>
Corporate Information
Board of Directors of R-G Financial Corporation:
Victor J. Galan, Chairman of the Board and
Chief Executive Officer
Ramon Prats, Vice Chairman of the Board and
Executive Vice President of RGM
Ana M. Armendariz, Treasurer of the Board and
Senior Vice President of Finance RGM
Enrique Umpierre Suarez, Secretary of the Board
and Attorney in private practice
Benigno R. Fernandez, Senior Partner of
Fernandez, Perez, Villariny & Co., CPA
firm in Hato Rey, P.R.
Eduardo McCormack, Retired Businessman.
Previously worked for Bacardi Corp. in
various functions of the business.
Gilberto Rivera Arreaga, Executive Director and Administrator of the National
College of Business & Technology, educational center in Bayamon, P.R.
Juan J. Diaz, Senior Vice President-Loan
Administration RGM
Laureano Carus Abarca, Chairman of Alonso Carus Iron Works in Catano, P.R.,
manufacturers of metal products
Pedro Ramirez, President & CEO of Empresas Nativas, Inc., local real estate
development firm
Victor L. Galan, Vice President Marketing Department
of RGM
Officers of R-G Financial Corporation:
Senior Management Team:
Victor J. Galan, Chairman, President and CEO
Ramon Prats, Excecutive Vice President
Juan J. Diaz, Senior Vice President Loan Administration
Ana M. Armendariz, Senior Vice President Finance RGM
Mario Ruiz, Senior Vice President Secondary Market
Jose Sandoval, Vice President and Chief Financial Officer
Jose L. Ortiz, Vice President Finance RGPB
Ivan Velez, Vice President Operations
William Martinez, Vice President Administration
Sonia I. Vazquez, General Auditor
Production Group:
Dennis C. Tristani, Senior Vice President
Commercial Loans RGPB
Roberto Cordova, Senior Vice President Loan
Production RGM
Steven Velez, Senior Vice President Underwriting and
Technology RGM
Jeannette Miro, Vice President Marketing RGPB
Ismenia Isidor, Vice President Closing Department RGM
Edwin Reyes, Vice President Branch
Administration RGPB
Ricardo Agudo, Vice President New Housing RGM
Victor L. Galan, Vice President Branch
Administration RGM
Stockholder Information
Corporate Office
R-G Plaza
280 JT Pinero Ave.
San Juan, PR 00918
Telephone (787) 758-2424
Annual Meeting:
April 23, 1998, at R-G Plaza , Hato Rey, PR
Transfer Agent and Registrar:
American Stock Transfer & Trust Co.
40 Wall Street- 46th Floor
New York, NY 10005
Independent Public Accountants:
Price Waterhouse
Chase Manhattan Bldg. - 9th Fl.
San Juan, PR 00918
Special Counsel:
Elias, Matz, Tiernan & Herrick L.L.P.
734 15th Street N.W. - 12th Floor
Washington , DC 20005
Mc Connell & Valdes
270 Munoz Rivera Ave.
San Juan, PR 00918
Market Makers:
Friedman Billings Ramsey & Co.
1001 19th Street North
Arlington, VA 22209
PaineWebber Incorporated of PR American International Plaza Penthouse Floor 250
Munoz Rivera Ave.
San Juan, PR 00918
Internet Website :
http://www.rgonline.com (in Spanish and English)
General Inquiries & Reports:
R-G Financial is required to file an annual report on Form 10K for its fiscal
year ended December 31, 1997 with the Securities and Exchange Commission. Copies
of its Annual Report and quarterly reports may be obtained without charge by
contacting:
Sonia Colon , Administrative Assistant
Telephone (787) 756-2801
Stock Listing:
Symbol: RGFC-NASDAQ
At December 31, 1997, the Company had 97 stockholders of record, which does not
take into consideration investors who hold their stock through brokerage and
other forms. The high and low prices and dividends paid per share (as adjusted
for the Company's 80% stock split paid in 1997) for the Company's common stock
during each quarter since the Company began trading on August 22, 1996 is as
follows:
<TABLE>
<CAPTION>
September 30 December 31 March 31 June 30 September 30 December 31
1996 1996 1997 1997 1997 1997
<S> <C> <C> <C> <C> <C> <C>
High $10.42 $14.31 $15.55 $14.44 $22.50 $22.0
Low 9.17 9.86 12.64 12.92 14.17 18.875
Dividends Paid - .0347 .0382 .0417 .0431 .0457
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 32,607,001
<INT-BEARING-DEPOSITS> 16,758,722
<FED-FUNDS-SOLD> 3,000,000
<TRADING-ASSETS> 400,435,545
<INVESTMENTS-HELD-FOR-SALE> 121,867,202
<INVESTMENTS-CARRYING> 44,019,274
<INVESTMENTS-MARKET> 43,841,653
<LOANS> 765,059,419
<ALLOWANCE> 6,771,702
<TOTAL-ASSETS> 1,510,745,516
<DEPOSITS> 722,418,494
<SHORT-TERM> 631,196,293
<LIABILITIES-OTHER> 19,076,813
<LONG-TERM> 0
0
0
<COMMON> 38,489,266
<OTHER-SE> 99,564,650
<TOTAL-LIABILITIES-AND-EQUITY> 1,510,745,516
<INTEREST-LOAN> 68,513,571
<INTEREST-INVEST> 28,821,319
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 97,334,890
<INTEREST-DEPOSIT> 32,434,559
<INTEREST-EXPENSE> 60,805,124
<INTEREST-INCOME-NET> 36,529,766
<LOAN-LOSSES> 6,370,000
<SECURITIES-GAINS> 9,785,093
<EXPENSE-OTHER> 39,035,748
<INCOME-PRETAX> 32,229,080
<INCOME-PRE-EXTRAORDINARY> 32,229,080
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 23,497,212
<EPS-PRIMARY> 1.66
<EPS-DILUTED> 1.62
<YIELD-ACTUAL> 8.32
<LOANS-NON> 29,968,266
<LOANS-PAST> 226,727
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 33,583,021
<ALLOWANCE-OPEN> 3,331,645
<CHARGE-OFFS> 5,376,573
<RECOVERIES> 2,446,630
<ALLOWANCE-CLOSE> 6,771,702
<ALLOWANCE-DOMESTIC> 6,771,702
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
