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, 1998
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)
(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.
<PAGE>
As of March 19, 1999, the aggregate value of the 9,747,017 shares of Class B
Common Stock of the Registrant issued and outstanding on such date, which
excludes 399,074 shares held by all directors and officers of the Registrant as
a group, was approximately $184.6 million. This figure is based on the last
known trade price of $18.9375 per share of the Registrant's Class B Common Stock
on March 19, 1999.
Number of shares of Class B Common Stock outstanding as of March 19, 1999:
10,146,091
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, 1998 are incorporated into Parts II and IV.
(2) Portions of the definitive proxy statement for the Annual Meeting of
Stockholders are incorporated into Part III.
<PAGE>
PART I
Item 1. Business
General
R&G Financial Corporation (the "Company" or "R&G Financial") is the
holding company for R&G Mortgage Corp., a Puerto Rico mortgage banking company
("R&G Mortgage") and R-G Premier Bank of Puerto Rico, a Puerto Rico-chartered
commercial bank (the "Bank"). The Company was organized under Puerto Rico law in
March 1996. 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 1998, the Company had total consolidated assets of $2.0 billion, total
consolidated borrowings of $784.2 million, total consolidated deposits of $1.0
billion, and total consolidated stockholders' equity of $221.2 million. As of
December 31, 1998, the Company had 18,440,556 Class A shares of common stock
outstanding, all of which were owned by Mr. Galan, and 10,146,091 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, in June 1995, acquired from a
commercial bank $77.2 million in deposits and, after consolidation, six branch
offices and, in 1998, acquired a one branch federal savings bank. 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 23 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, 1998, R&G Mortgage originated
approximately 27.9% 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 307.8% since December 31, 1991 and,
at December 31, 1998, R&G Mortgage serviced approximately 95,946 accounts with
an aggregate loan
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balance of $4.8 billion. The Bank's asset size, which amounted to $1.4 billion
at December 31, 1998, has increased by $1.36 billion since R&G Mortgage became
affiliated with the Bank in February 1990, while the branch office network had
increased from two to 20 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. Approximately
20% of loan originations made by Champion Mortgage consist of subprime
residential mortgage loans. 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, 1998, 1997 and 1996, R&G Mortgage originated
a total of $914.1 million, $598.2 million and $448.1 million of loans,
respectively. These aggregate originations include loans originated by R&G
Mortgage directly for the Bank of $450.6 million, $285.8 million and $211.3
million during such respective periods, or 49.3%, 47.8% and 47.2%, respectively,
of total originations.
R&G Mortgage pools FHA/VA loans into mortgage-backed securities which
are guaranteed by the Government National Mortgage Association ("GNMA"), which
securities are sold to
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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, 1998, 1997 and 1996, R&G Mortgage sold $493.0 million, $246.1
million and $244.8 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, 1998, 1997 and 1996
amounted to $129.1 million, $89.0 million and $122.8 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 favorable to the
Bank, as those prevailing for comparable transactions with, or involving, other
nonaffiliated
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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, 1998, 1997 and 1996, R&G Mortgage originated a total of $914.1 million,
$598.2 million and $448.1 million of loans, respectively. These aggregate
originations include loans originated by R&G Mortgage directly for the Bank of
$450.6 million, $285.8 million and $211.3 million during the years ended
December 31, 1998, 1997 and 1996, respectively, or 49%, 48% and 47%,
respectively, of total originations. The loans originated by R&G Mortgage for
the Bank are comprised primarily of conventional residential loans and, to a
lesser extent, consumer loans secured by real estate.
4
<PAGE>
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, 1998, 1997 and 1996, R&G Mortgage originated $255.6 million,
$280.1 million and $222.0 million, respectively, of FHA/VA loans, which
represented 28.0%, 46.8% and 49.5%, 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, 1998, 1997 and 1996, R&G Mortgage originated $610.4 million, $265.9
million and $204.9 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. All non-conforming conventional loans
originated by R&G Mortgage through Champion Mortgage are held by Champion
Mortgage in its portfolio or subsequently 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, 1998, 1997 and 1996,
non-conforming conventional loans represented approximately 44%, 39% and 42%,
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, 1998, 1997 and 1996, 85.5%, 77.5% and
88.9% 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 $78,000 and $70,000,
respectively.
R&G Mortgage also offers second mortgage loans up to $125,000 with a
maximum term of 15 years. The maximum loan-to-appraised value ratio on second
mortgage loans permitted by R&G Mortgage is 75% (including the amount of any
first mortgage). In addition, R&G Mortgage also offers real estate secured
consumer loans up to $40,000 with a maximum term of 10 years. The maximum
loan-to-appraised value ratio on real estate secured consumer loans permitted by
R&G Mortgage is 80%. R&G Mortgage will secure such loans with either a first or
second mortgage
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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, 1998, R&G Mortgage employed 65 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 $207.1 million,
$158.5 million and $45.6 million of loans from third parties during the years
ended December 31, 1998, 1997 and 1996, 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,
------------------------------------------
1998 1997 1996
---------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C>
Loans Originated For the Bank:
Conventional loans(1):
Number of loans 4,918 3,390 2,756
Volume of loans $ 402,447 $ 233,488 $ 190,072
FHA/VA loans:
Number of loans -- -- --
Volume of loans -- -- --
Consumer loans(2):
Number of loans 2,268 2,318 1,004
Volume of loans $ 48,155 $ 52,287 $ 21,208
Total loans:
Number of loans 7,186 5,708 3,760
Volume of loans $ 450,602 $ 285,775 $ 211,280
Percent of total volume 40% 35% 43%
For Third Parties:
Conventional loans(1):
Number of loans 2,989 444 214
Volume of loans $ 207,937 $ 32,419 $ 14,835
FHA/VA loans:
Number of loans 3,298 4,107 3,117
Volume of loans $ 255,601 $ 280,053 $ 221,967
Total loans:
Number of loans 6,287 4,551 3,331
Volume of loans $ 463,538 $ 312,472 $ 236,802
Percent of total volume 41% 39% 48%
---------- ---------- ----------
Total loan originations $ 914,140 $ 598,247 $ 448,082
========== ========== ==========
Loans Purchased For R&G Mortgage:
Number of loans 2,506 2,052 583
Volume of loans (3) $ 207,070 $ 158,456 $ 45,604
Percent of total volume 19% 20% 9%
GNMA Pools Purchased for R&G Mortgage:
Volume of loans $ -- $ 51,537 $ --
Percent of total volume -- 6% --
---------- ---------- ----------
Total loan originations and purchases $1,121,210 $ 808,240 $ 493,686
========== ========== ==========
</TABLE>
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<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1998 1997 1996
----------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C>
Loans Sold To Third Parties(3):
Conventional loans(1):
Number of loans.................................. 2,513 429 178
Volume of loans.................................. $194,909 $39,495 $ 12,560
FHA/VA loans:
Number of loans.................................. 4,413 2,775 3,564
Volume of loans ................................. $298,108 $206,643 $232,254
Total loans:
Number of loans.................................. 6,926 3,204 3,742
Volume of loans.................................. $493,017 $246,138 $244,814
Percent of total volume.......................... 44% 30% 50%
----------- -------- --------
Adjustments:
Loans originated for the Bank...................... ($450,602) $(285,775) $(211,280)
Loans amortization................................. (1,479) (5,086) (7,224)
----------- -------- --------
Increase in loans held for sale...................... $ 176,112 $271,241 $ 30,368
======== ======= ========
Average Initial Loan Origination Balance:
The Bank:
Conventional loans(1)............................ $ 82 $ 69 $ 69
FHA/VA loans..................................... -- -- --
Third Parties:
Conventional loans(1)............................ $ 70 $ 73 $ 69
FHA/VA loans..................................... 78 68 71
Total Average Initial Balance:
Conventional loans(1)............................ $ 77 $ 69 $ 69
FHA/VA loans..................................... 78 68 71
Refinancings(5):
The Bank........................................... 74% 70% 67%
Third Parties...................................... 44% 31% 24%
</TABLE>
<PAGE>
(1) Includes non-conforming loans.
(2) All such loans were secured by real estate except for $1.6 million in 1996.
(3) Includes loans converted into mortgage-backed securities.
(4) As a percent of the total dollar volume of mortgage loans originated by R&G
Mortgage for the Bank (excluding consumer loans) 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, 1998, 1997 and 1996, R&G Mortgage sold $493.0 million, $246.1 million and
$244.8 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, $298.1 million or 60.5%, $206.6 million or
83.9% and $232.3 million or 94.9% 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.
Certain GNMA-guaranteed mortgage-backed securities sold by R&G Mortgage
are in the
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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, 1998, 1997 and 1996, R&G Mortgage issued GNMA mortgage-backed securities
totaling approximately $371.1 million, $397.2 million and $236.4 million,
respectively, including $160.0 million, $335.5 million and $235.5 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. R&G Mortgage and the Bank have made no sales of
CMOs in securitization transactions during 1996 through 1998. When such
transactions are made, 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, 1998, R&G Mortgage
held residual certificates issued in CMO transactions involving R&G Mortgage and
the Bank with a fair value of $7.1 million. In addition, the Bank held CMO
subordinated certificates and residual certificates from one of its issues with
a fair value of $9.7 million at December 31, 1998. See "-
10
<PAGE>
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, 1998, R&G Financial did not deem
it necessary to establish reserves for possible losses related to its recourse
obligations. At December 31, 1998, R&G Mortgage had loans in its servicing
portfolio with provisions for recourse in the principal amount of approximately
$507.4 million, as compared to $374.4 million and $290.9 million as of December
31, 1997 and 1996, respectively. Of the recourse loans existing at December 31,
1998, approximately $416.1 million in principal amount consisted of loans sold
to FNMA and FHLMC and converted into mortgage-backed securities of such
agencies, and approximately $91.3 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 declining
11
<PAGE>
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, 1998, R&G Mortgage's servicing portfolio totaled $4.8
billion and consisted of a total of 95,946 loans. These amounts include a $1.1
billion servicing portfolio acquired from another financial institution in
November 1998 comprised of approximately 32,400 loans. At December 31, 1998, R&G
Mortgage's servicing portfolio included $754.6 million of loans serviced for the
Bank or 15.6% 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,
------------------------------------------
1998 1997 1996
---------- ---------- -----------
(Dollars in Thousands)
<S> <C> <C> <C>
Composition of Servicing Portfolio at End of Period:
Conventional and other mortgage loans(1) $2,105,290 $1,148,739 $ 971,327
FHA/VA loans 2,722,508 1,852,149 1,578,842
---------- ---------- ----------
Total servicing portfolio(2) $4,827,798 $3,000,888 $2,550,169
========== ========== ==========
Activity in the Servicing Portfolio:
Beginning servicing portfolio $3,000,888 $2,550,169 $2,298,200
Add: Loan originations and purchases 1,285,570 778,126 506,696
Servicing of portfolio loans acquired (3) 1,109,825 5,301 36,478
Less: Sale of servicing rights -- -- 42,080
Run-offs(4) 568,485 332,708 249,125
---------- ---------- ----------
Ending servicing portfolio $4,827,798 $3,000,888 $2,550,169
========== ========== ==========
Number of loans serviced(5) 95,946 56,442 50,979
Average loan size(5) $ 50 $ 53 $ 50
Average servicing fee rate(5) 0.526% 0.532% 0.532%
</TABLE>
- --------------
(1) Includes non-conforming loans.
(2) At the dates shown, included $754.6 million, $448.9 million and $323.8
million of loans serviced for the Bank, respectively, which constituted
15.6%, 15.0% and 12.70% of the total servicing portfolio, respectively.
(3) Includes a $1.1 billion servicing portfolio acquired from another
financial institution in Puerto Rico in November 1998 comprised of
approximately 32,400 loans.
(4) Run-off refers to regular amortization of loans, prepayments and
foreclosures. Includes transfers in 1998 and 1997 of $67.7 million and
$49.0 million, respectively, of mortgage loans to financial
institutions who acquired certain commercial banks whose loans were
being serviced by R&G Mortgage.
(5) At December 31, 1998, R&G Mortgage was servicing 10,285 loans for the
Bank with an average loan size of approximately $73,000 and at an
average servicing rate of 0.263%. Amounts include late and other
miscellaneous charges.
13
<PAGE>
The following table sets forth certain information at December 31, 1998
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, 1998
-------------------------------------------------------------------------------------------------
Loans Serviced Loans Serviced Total Loans
for the Bank for Third Parties Serviced
-------------------------------- ------------------------------ -----------------------
Number of Aggregate Number of Aggregate Number of Aggregate
Mortgage Interest Rate Loans Principal Balance Loans Principal Balance Loans Principal Balance
----- ----------------- ----- ----------------- ----- ---------------
(Dollars in Thousands) (Dollars in Thousands) (Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Less than 7.00%............ 182 $ 19,476 5,756 $ 401,867 5,938 $ 421,343
7.00% - 7.49%.............. 3,077 260,333 18,223 969,935 21,300 1,230,268
7.50% - 7.99%.............. 4,219 310,808 22,091 1,205,890 26,310 1,516,698
8.00% - 8.49%.............. 1,183 89,362 13,455 667,753 14,638 757,115
8.50% - 8.99%.............. 777 45,544 13,319 484,507 14,096 530,051
9.00% - 9.49%.............. 293 12,798 4,578 131,498 4,871 144,296
9.50% - 9.99%.............. 169 6,572 3,781 95,970 3,950 102,542
10.00% - 10.49%............ 116 3,151 1,520 41,498 1,636 44,649
10.50% - 10.99%............ 141 3,442 929 24,198 1,070 27,640
11.00% or more............. 128 3,137 2,009 50,059 2,137 53,196
------ --------- ------- ----------- ------ -----------
10,285 $ 754,623 85,661 $ 4,073,175 95,946 $4,827,798
====== ========= ====== =========== ====== ==========
</TABLE>
The amount of principal prepayments on mortgage loans serviced by R&G
Mortgage was $96.5 million, $87.2 million and $72.5 million for the years ended
December 31, 1998, 1997 and 1996, respectively. This represented approximately
2.6%, 2.9% and 2.8% 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, 1998, 1997 and 1996, the monthly average
amount of funds advanced by R&G Mortgage under such servicing agreements was
$2.1 million, $1.4 million and $1.3 million, respectively. Funds advanced by R&G
Mortgage pursuant to these arrangements are generally recovered by R&G Mortgage
within 30 days.
In connection with its loan servicing activities, R&G Mortgage holds
escrow funds for the payment of real estate taxes and insurance premiums with
respect to the mortgage loans it services. At December 31, 1998, R&G Mortgage
held $116.6 million of such escrow funds, $109.9 million of which were deposited
in the Bank and $6.7 million of which were deposited with other financial
institutions. The escrow funds deposited with the Bank lower its overall cost of
funds and is a means of compensating it for processing mortgages checks received
by R&G Mortgage, while the escrow funds deposited with other financial
institutions serve as part of R&G Mortgage's compensating
14
<PAGE>
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, 1998, R&G
Mortgage was servicing mortgage loans with an aggregate principal amount of
$507.4 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. 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. 125 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,
-------------------------------------------------------------------------------------
1998 1997 1996
-------------------------- -------------------------- --------------------------
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> <C>
Loans delinquent for:
30-59 days.......................... 6,276 6.54% 2,531 4.48% 2,775 5.44%
60-89 days.......................... 1,545 1.61 572 1.01 533 1.05
90 days or more..................... 1,696 1.77 778 1.38 646 1.27
----- ---- ----- ---- ----- ----
Total delinquencies(1)............ 9,517 9.92% 3,881 6.87% 3,954 7.76%
===== ---- ===== ==== ===== ====
Foreclosures pending(2)............... 993 1.03% 681 1.21% 693 1.36%
====== ---- ===== ==== ===== ====
</TABLE>
- -----------------
(1) Includes at December 31, 1998, an aggregate of $66.4 million of
delinquent loans serviced for the Bank, or 1.38% of the total servicing
portfolio and $9.7 million of delinquent loans held in R&G Mortgage's
own portfolio.
(2) At December 31, 1998, the Bank had foreclosures pending on $11.4
million of loans being serviced by R&G Mortgage, which constituted
0.24% of the servicing portfolio. R&G Mortgage had foreclosures pending
on $2.7 million of loans it is servicing for its own portfolio at
December 31, 1998.
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, 1998, 1997 and 1996, R&G Mortgage held
REO with a book value of approximately $128,000, $165,000 and $0, respectively.
Sales of REO resulted in gains to R&G Mortgage of $26,000 and $145,000 for the
years ended December 31, 1998 and 1997, 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.
<PAGE>
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, 1998. 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, 1998, 1997 and 1996, total expenses related to FHA or VA loans
foreclosed amounted to $286,000, $189,000 and $323,000, respectively. Although
FNMA and FHLMC are
16
<PAGE>
obligated to reimburse R&G Mortgage for principal and interest payments advanced
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 encourage investment
in Puerto Rico by allowing Exempt Companies to reduce the otherwise applicable
dividend withholding tax of 10% (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
17
<PAGE>
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 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 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").
The tax credit available under Section 936 (the "936 Credit") is
limited by 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
was reduced by 5% per year until 1998. For taxable years beginning on or after
January 1, 1998, such percentage is 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 SBJPA repealed Section 936, but provided grandfather rules under
which a Section 936 Corporation that had elected the benefits of the Section 936
Credit and which was engaged in active trade or business within Puerto Rico on
October 13, 1995 (an "Existing Claimant") would be eligible to claim the 936
Credit attributable to Active Business Income during a transition period. A
corporation may also qualify as an Existing Claimant if it acquires all the
assets of a trade or business of a corporation that meets the active trade or
business requirement and the election requirement is satisfied.
The amount and computation method of the 936 Credit during the
transition period depends upon whether a Section 936 Corporation is using the
Economic Activity Method or the Fixed Percentage Method. A Section 936
Corporation that is an Existing Claimant and uses the Economic Activity Method
may continue to determine its 936 Credit attributable to Active Business Income
as under present law for taxable years beginning after December 31, 1995 and
before January 1, 2002. For taxable years beginning after 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
18
<PAGE>
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 by the SBJPA could also lead to a decrease in the amount of 936 Funds
invested in Puerto Rico financial assets by 936 Corporations, thereby increasing
funding costs and decreasing liquidity in the Puerto Rico financial market. The
magnitude of the impact of any such changes on R&G Financial's profitability or
financial condition cannot be determined at this time. R&G Financial has taken
steps to attempt to reduce the impact of any such adverse changes by
diversifying its sources of funding and identifying additional investors for its
mortgage products. During recent periods, the disparity between the cost of 936
Funds and other sources of funding such as the Eurodollar market has decreased,
thereby reducing the adverse effect that the loss of such funding could have on
the profitability of R&G Financial.
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
19
<PAGE>
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.
Lending Activities of the Bank
General. At December 31, 1998, R&G Financial's loans receivable, net
totaled $1.1 billion, which represented 52.5% of R&G Financial's $2.0 billion of
total assets. At December 31, 1998, $1.1 billion or 99.9% 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, 1998, $734.8 million or 99.9% 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.
20
<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,
---------------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- -----------------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Residential real estate - first
mortgage(1)............................
Residential real estate - second $ 735,795 66.87% $476,729 61.25% $370,876 60.75%
mortgage...............................
Residential construction................. 18,634 1.69 17,831 2.29 15,757 2.58
Commercial construction and land 23,280 2.12 13,367 1.72 5,351 .88
acquisition............................
Commercial real estate................... 15,353 1.39 5,785 .74 5,700 .93
Commercial business...................... 117,151 10.65 81,722 10.50 69,514 11.39
Consumer loans: 46,532 4.23 39,128 5.03 31,063 5.09
Loans secured by deposits..............
Real estate secured consumer loans..... 17,225 1.56 12,472 1.60 9,409 1.54
Unsecured consumer loans............... 85,055 7.73 81,252 10.44 42,893 7.03
41,381 3.76 50,103 6.43 59,864 9.81
--------- ------ ------- ------ ------- ------
Total loans receivable............... 1,100,406 100.00% 778,389 100.00% 610,427 100.00%
--------- ------ ------- ------ ------- ------
Less:
Allowance for loan losses.............. (8,055) (6,772) (3,332)
Loans in process....................... (18,170) (6,218) (2,430)
Deferred loan fees..................... (166) 172 41
Unearned interest...................... (347) (512) (955)
---------- -------- --------
(26,738) (13,330) (6,676)
---------- -------- --------
Loans receivable, net(2)............... $1,073,668 $765,059 $603,751
========== ======== ========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------
1995 1994
---------------------- ----------------------
Amount Percent Amount Percent
------ ------- ------ -------
<S> <C> <C> <C> <C>
Residential real estate - first
mortgage(1)............................ $282,498 58.23% $194,707 62.14%
Residential real estate - second
mortgage............................... 14,372 2.96 13,298 4.24
Residential construction................. 15,046 3.10 12,039 3.84
Commercial construction and land
acquisition............................ 5,523 1.14 1,062 0.34
Commercial real estate................... 61,862 12.74 43,029 13.73
Commercial business...................... 27,816 5.74 14,102 4.51
Consumer loans:
Loans secured by deposits.............. 7,497 1.55 5,829 1.86
Real estate secured consumer loans..... 33,381 6.88 29,279* 9.34*
Unsecured consumer loans............... 37,180 7.66 * *
------- ------ -------- --------
Total loans receivable............... 485,175 100.00% 313,345 100.00%
------- ------ -------- --------
Less:
Allowance for loan losses.............. (3,510) (2,887)
Loans in process....................... (5,727) (5,945)
Deferred loan fees..................... (266) (424)
Unearned interest...................... (1,831) (2,475)
------- --------
(11,334) (11,731)
------- --------
Loans receivable, net(2)............... $473,841 $301,614
======= ========
</TABLE>
(1) Includes $33.9 million and $49.7 million of residential real estate
- - first mortgage loans which are held by R&G Mortgage at December 31, 1997 and
1996, respectively.
(2) Does not include mortgage loans held for sale of $117.1 million, $46.9
million, $54.5 million, $21.3 million and $22.0 million at December 31,
1998, 1997, 1996, 1995 and 1994, respectively.
* R&G Financial is unable to distinguish these two sub-categories of consumer
loans during the year ended December 31, 1994.
21
<PAGE>
Contractual Principal Repayments and Interest Rates. The following
table sets forth certain information at December 31, 1998 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 1998 1998 Total(1)
---------- ---------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C>
Residential real estate $ 197 $ 4,711 $ 749,521 $ 754,429
Residential construction 23,269 11 -- 23,280
Commercial real estate(2) 32,671 60,581 39,252 132,504
Commercial business 17,763 23,327 5,442 46,532
Consumer:
Loans on savings 12,013 4,915 297 17,225
Real estate secured consumer loans 2,309 6,904 75,842 85,055
Unsecured consumer loans 12,318 25,278 3,785 41,381
---------- ---------- ---------- ----------
Total(3) $ 100,540 $ 125,727 $ 874,139 $1,100,406
========== ========== ========== ==========
</TABLE>
(1) Amounts have not been reduced for the allowance for loan losses, loans in
process, deferred loan fees or unearned interest.
(2) Includes $15.4 million of commercial construction and land acquisition
loans. (3) Does not include mortgage loans held for sale.
22
<PAGE>
The following table sets forth the dollar amount of total loans due
after one year from December 31, 1998, 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..................... $754,429 $ -- $754,429
Construction................................ 23,280 -- 23,280
Commercial real estate(1)................... 49,119 83,385 132,504
Commercial business......................... 39,091 7,441 46,532
Consumer:
Loans on savings.......................... 17,225 -- 17,225
Real estate secured consumer loans........ 85,055 -- 85,055
Unsecured consumer loans.................. 38,964 2,417 41,381
---------- ------- -----------
Total.................................... $1,007,163 $93,243 $1,100,406
========== ======= = =========
</TABLE>
- ---------------
(1) Includes $15.4 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.
23
<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,
-------------------------------------------------
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
(Dollars in Thousands)
Loan originations:
Loans originated by R&G Mortgage:
Residential mortgages................................ $ 385,416 $221,451 $187,845
Commercial mortgages................................. 265 555 --
Residential construction............................. 16,766 11,482 2,227
Consumer loans....................................... 48,155 52,287 21,208
Total loans originated by R&G Mortgage............. 450,602 285,775 211,280
Other loans originated:
Commercial real estate............................... 54,426 37,129 36,140
Commercial business.................................. 26,191 15,393 33,318
Construction and development......................... 11,365 -- --
Consumer loans:
Loans on deposit..................................... 27,172 19,711 13,988
Real estate secured consumer loans................... -- -- 80
Unsecured consumer loans............................. 9,970 16,742 39,312
Total other loans originated....................... 129,124 88,975 122,838
Loans purchased(1)................................... 175,735 60,646 8,047
Total loans originated and purchased............... 755,461 435,396 342,165
Loans sold........................................... (282,005) (118,234) (49,726)
Loan principal reductions............................ (142,560) (134,166) (114,792)
Net increase before other items, net................. 330,896 182,996 177,647
Loans securitized and transferred to
mortgage-backed securities......................... -- -- (43,673)
Net increase in loan portfolio....................... $ 330,896 $182,996 $133,974
</TABLE>
- --------------
(1) Comprised of conventional, commercial real estate and secured consumer
loans purchased from other financial institutions aggregating $164.4
million, $8.7 million and $2.6 million, respectively, in the year ended
December 31, 1998, and 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 in the
year ended December 31, 1996.
R&G Financial, through the Bank, originates for both investment and
sale mortgage loans secured by residential real estate (secured by both first
and second mortgage liens) as well as construction loans (for residential real
estate), commercial real estate loans, commercial business loans and consumer
loans.
24
<PAGE>
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, 1998,
1997 and 1996, R&G Mortgage received $7.5 million, $5.2 million and $4.5
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, 1998, 1997 and 1996, the Bank purchased $175.7 million, $60.6
million and $8.1 million of loans, respectively.
During the years ended December 31, 1998, 1997 and 1996, the Bank sold
$282.0 million, $118.2 million and $49.7 million of loans. These loans, which
were primarily nonconforming loans at the time of origination, were generally
sold in packages in privately negotiated transactions with FNMA and FHLMC.
Pursuant to the Master Purchase Agreement, the Bank sells to R&G
Mortgage the servicing rights to all first and second mortgage loans secured by
residential properties which are or will
25
<PAGE>
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 31,1998, R&G Financial's five largest loans-to-one borrower
and their related entities amounted to $9.4 million, $4.8 million, $3.9 million,
$3.0 million and $2.1 million. The largest loan concentration is a loan with a
maximum amount outstanding of $5.0 million to a developer of 188 low income
residential units in Caguas, with a balance of $3.6 million as of December 31,
1998. The second largest loan concentration consists of a commercial loan
participation with a commercial bank for the financing of an income producing
office building in the San Juan metropolitan area. The third largest loan
concentration is a commercial loan for the purchase of an office building for
the headquarters of a local contractor. The fourth largest loan concentration
represents a refinancing of various income producing properties for fast food
businesses. The fifth largest loan is a loan to a developer of a new shopping
center in Carolina which is in the final stages of completion.
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, 1998,
$735.8 million or 66.9% of R&G Financial's total loans held for investment
consisted of such loans, $734.8 million or 99.9% 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, 1998, $18.6 million or
1.7% of R&G Financial's total loans held for investment consisted of second
mortgage loans on single-family residential properties. The Bank offers such
second mortgage loans in amounts up to $125,000 for a term not to exceed 15
years. The loan-to-value ratio of second mortgage loans generally is limited to
75% of the property's appraised value (including the first mortgage).
26
<PAGE>
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,
1998, residential construction loans amounted to $23.3 million or 2.12% of R&G
Financial's total loans held for investment, while commercial construction and
land acquisition loans amounted to $15.4 million or 1.39% 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, 1998, the Bank's construction loan portfolio included 242
construction/permanent loans with an aggregate principal balance of $23.3
million.
The Bank also originates construction loans to developers to develop
single family residential properties. During 1998, the Company organized a
Construction Loan Department to work primarily with real estate developers. At
December 31, 1998, the Bank had two residential construction loans outstanding
to develop single-family residences with an aggregate principal balance of $11.1
million. Commitments for future funding approximate $7.4 million. The loans are
performing in accordance with their terms at December 31, 1998.
In addition to the foregoing, at December 31, 1998, the Bank had eight
land acquisition loans with outstanding balances ranging from $190,000 to
$1,236,000, and an aggregate balance of $4.2 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.
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
27
<PAGE>
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, 1998,
$441,000 of the Bank's construction loans were classified as non-performing.
Commercial Real Estate Loans. The Bank also originates mortgage loans
secured by commercial real estate. At December 31, 1998, $117.2 million or
10.65% 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 942 loans with an average principal balance of
$124,000. At December 31, 1998, $6.5 million of R&G Financial's commercial real
estate loans were classified as nonperforming.
Commercial real estate loans originated by the Bank are primarily
secured by office buildings, retail stores, warehouses and general purpose
industrial space. Although terms vary, commercial real estate loans generally
are amortized over a period of 7-15 years and have maturity dates of five to
seven years. The Bank will originate these loans with interest rates which
adjust monthly in accordance with a designated prime rate plus a margin, which
generally is negotiated at the time of origination. Such loans will have a floor
but no ceiling on the amount by which the rate of interest may adjust over the
loan term. Loan-to-value ratios on the Bank's commercial real estate loans are
currently limited to 80% or lower. As part of the criteria for underwriting
commercial real estate loans, the Bank generally requires a debt coverage ratio
(the ratio of net cash from operations before payment of debt service to debt
service) of 1.30 or more. It is also the Bank's general policy to seek
additional protection to mitigate any weaknesses identified in the underwriting
process. Additional coverage may be provided through mortgage insurance,
secondary collateral and/or personal guarantees from the principals of the
borrower.
Commercial real estate lending entails different and significant risks
when compared to single-family residential lending because such loans typically
involve large loan balances to single borrowers and because the payment
experience on such loans is typically dependent on the successful operation of
the project or the borrower's business. These risks can also be significantly
affected by supply and demand conditions in the local market for apartments,
offices, warehouses or other commercial space. The Bank attempts to minimize its
risk exposure by limiting the extent of its commercial lending generally. In
addition, the Bank imposes stringent loan-to-value ratios, requires conservative
debt coverage ratios, and continually monitors the operation and physical
condition of the collateral. Although the Bank has begun to increase its
emphasis on commercial real estate lending, management does not currently
anticipate that its portfolio of commercial real estate loans will grow
significantly as a percentage of the total loan portfolio.
Commercial Business Loans. Beginning in 1991, the Bank began
emphasizing commercial business loans, including working capital lines of
credit, inventory and accounts receivable loans,
28
<PAGE>
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, 1998, commercial business loans amounted to $46.5
million or 4.2% 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, 1998,
$143.7 million or 13.1% 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 $17.2 million at December 31, 1998. 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, 1998, real estate secured consumer
loans totaled $85.1 million. In November 1995, the Bank began issuing credit
cards in its own name. At December 31, 1998, credit card receivables totaled
$3.6 million.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. In addition, consumer lending collections are dependent
on the borrower's continuing financial stability, and thus 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
29
<PAGE>
against the borrower. At December 31, 1998, $6.7 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.
30
<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,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- ------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Non-accruing loans:
Residential real estate(1)............ $32,973 $21,619 $12,991 $7,921 $4,963
Residential construction.............. 441 368 363 -- --
Commercial real estate................ 6,463 6,000 3,141 1,903 789
Commercial business................... 3,224 765 823 -- --
Consumer unsecured.................... 1,358 1,217 686 40 --
Other................................. 67 117 726 -- --
-------- ------- ------- ------ ------
Total............................... 44,526(2) 30,086 18,730 9,864 5,752
-------- ------- ------- ------ ------
Accruing loans greater than 90 days
delinquent:
Residential real estate............... -- -- -- -- --
Residential construction.............. -- -- -- 611 --
Commercial real estate................ -- -- -- -- --
Commercial business................... 61 54 22 8 10
Consumer.............................. 357 172 134 94 --
-------- ------- ------- ------ ------
Total accruing loans greater than
90 days delinquent................ 418 226 156 713 10
-------- ------- ------- ------ ------
Total non-performing loans.......... 44,944 30,312 18,886 10,577 5,762
-------- ------- ------- ------ ------
Real estate owned, net of reserves(3)... 4,041 1,715 834 654 722
Other repossessed assets................ 237 85 31 -- -
-------- ------- ------- ------ ------
4,278 1,800 865 654 722
-------- ------- ------- ------ ------
Total non-performing assets......... $ 49,222 $32,112 $19,751 $11,231 $6,484
======== ======= ======= ======= ======
Total non-performing loans as a
percentage of total loans......... 4.11% 3.89% 3.09% 2.18% 1.84%
==== ==== ==== ==== ====
Total non-performing assets as a
percentage of total assets........ 2.41% 2.12% 1.90% 1.32% 1.04%
==== ==== ==== ==== ====
</TABLE>
- -------------
(1) Includes residential real estate loans secured by both first and second
mortgages held by the Bank, except for $4.3 million and $2.8 million
held by R&G Mortgage at December 31, 1998 and 1997, respectively. Also
includes $5.3 million, $2.6 million, $1.1 million, $882,000 and
$918,000 consumer loans held by the Bank secured by first and second
mortgages on residential real estate at December 31, 1998, 1997, 1996,
1995 and 1994, respectively.
(2) As of December 31, 1998, comprised of 652 loans secured by residential
real estate, 67 loans
31
<PAGE>
secured by commercial real estate, 7 construction loans, 109 commercial
business loans and 183 consumer loans.
(3) Includes properties held by R&G Mortgage of $128,000, $165,000 and
$43,000 as of December 31, 1998, 1997 and 1994, respectively. As of
December 31, 1998, the Bank had 30 residential properties and 10
commercial properties aggregating $3.9 million.
While the level of total non-performing assets of R&G Financial has
increased on an absolute basis during the periods presented, from $6.5 million
at December 31, 1994 to $49.2 million at December 31, 1998, R&G Financial's net
loans receivable portfolio has increased by 256% during this period, from $301.6
million at December 31, 1994 to $1.1 billion at December 31, 1998. Thus, total
non-performing assets as a percent of total assets increased from 1.04% at
December 31, 1994 to 2.41% at December 31, 1998.
Non-performing residential loans increased by $11.4 million or 52.5%
from December 31, 1997 to December 31, 1998. The average loan balance on
non-performing mortgage loans amounted to $51,000 at December 31, 1998. As of
such date, 270 loans with an aggregate balance of $14.0 million (including 111
consumer loans secured by real estate with an aggregate balance of $2.6 million)
were in the process of foreclosure. The total delinquency ratio on residential
mortgages, including loans past due less than 90 days, slightly increased from
4.93% in 1997 to 5.49% in 1998. The Company's loss experience on such portfolio
has been minimal over the last several years.
Non-performing commercial real estate loans increased by $463,000 or
7.7% from December 31, 1997 to December 31, 1998. The number of loans delinquent
over 90 days amounted to 67 loans at December 31, 1998, with an average balance
of $96,000. The largest non-performing commercial real estate loan as of
December 31, 1998 had a balance of $385,000.
Non-performing commercial business loans consist of 23 loans which are
90% guaranteed by the Small Business Administration with an aggregate balance of
$2.1 million and 86 commercial leases amounting to $1.1 million. These loans
have a combined average loan size of $30,000. The majority of loans in this
portfolio were originated during 1995 and 1996. The largest non-performing
commercial business loan as of December 31, 1998 had a $445,000 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,
32
<PAGE>
considering the current and anticipated operating conditions of the borrower.
Any recoveries are credited to the allowance.
The following table sets forth an analysis of R&G Financial's allowance
for loan losses during the periods indicated, which is maintained on the Bank's
loan portfolio.
<TABLE>
<CAPTION>
At and For the Year Ended December 31,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- ------- ------- ------ ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period......... $6,772 $ 3,332 $3,510 $2,887 $3,029
-------- ------- ------- ------ ------
Charge-offs:
Residential real estate.............. 73 13 45 53 --
Construction......................... -- -- 50 -- --
Commercial real estate............... -- 170 -- -- --
Commercial business.................. 1,485 480 110 91 3
Consumer............................. 4,455 3,953 1,922 365 139
Other ............................... -- 761 2,535(1) -- --
-------- ------- ------- ------ ------
Total charge-offs.................. 6,013 5,377 4,662 509 142
-------- ------- ------- ------ ------
Recoveries:
Residential real estate.............. -- 21 -- 1 --
Commercial real estate............... -- 50 -- -- --
Commercial business.................. 20 32 31 85 --
Consumer............................. 312 344 195 96 --
Other................................ -- 2,000(2) -- -- --
-- -- --
-------- ------ ------ ----- -----
Total recoveries................... 332 2,447 226 182 --
-------- ------ ------ ----- -----
Net charge-offs........................ 5,681 2,930 4,436 327 142
-------- ------ ------ ----- -----
Allowance for loan losses acquired from
Fajardo Federal....................... 364 -- -- -- --
Provision for losses on loans.......... 6,600 6,370 4,258 950(3) --
-------- ------ ------ ----- -----
Balance at end of period............... $ 8,055 $6,772 $3,332 $3,510 $2,887
======== ====== ====== ===== ======
Allowance for loan losses as a percent
of total loans outstanding........... .74% .87% .55% 0.72% 0.92%
======== ====== ====== ====== ======
Allowance for loan losses as a percent
of non-performing loans.............. 17.92% 22.34% 17.64% 33.19% 50.10%
======== ====== ====== ====== ======
Ratio of net charge-offs to average
loans outstanding.................... .55% 0.40% 0.75% 0.08% 0.05%
======== ====== ====== ====== ======
</TABLE>
- ------------------
<PAGE>
(1) Comprised of $2.5 million of loans from the Bank insurance premiums
financing portfolio. See "Management's Discussion and Analysis of
Financial Condition and Results of 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.
33
<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,
------------------------------------------------------------------------------
1998 1997 1996
------------------------ ----------------------- ---------------------
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..... $1,272 15.79% $ 593 8.76% $ 810 24.31%
Construction................ 46 0.57 7 0.10 51 1.53
Commercial real estate...... 2,655 32.96 1,386 20.47 489 14.68
Commercial business......... 1,033 12.82 806 11.90 109 3.27
Consumer.................... 3,049 37.86 3,980 58.77 1,873 56.21
----- ----- ------ ------ ----- -----
Total....................... $8,055 100.00% $6,772 100.00% $3,332 100.00%
===== ====== ===== ====== ===== ======
<CAPTION>
1995 1994
----------------------- ------------------------
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..... $2,094 59.66% $1,962 67.95%
Construction................ 32 0.90 -- --
Commercial real estate...... -- -- -- --
Commercial business......... 782 22.28 403 13.96
Consumer.................... 602 17.16 522 18.09
----- ------ ----- ------
Total....................... $3,510 100.00% $2,887 100.00%
===== ====== ===== ======
</TABLE>
34
<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, 1998, R&G Mortgage held GNMA mortgage-backed securities with a
fair value of $443.4 million which are classified as held for trading. Such
securities generally remain in R&G Mortgage's portfolio for between 90 and 180
days. In addition, during 1994 and 1995, R&G Mortgage sold through grantor
trusts $201.4 million and $38.1 million, respectively, of CMOs and retained a
portion of the residual interests related thereto. In addition, in 1995, R&G
Mortgage purchased from the Bank $4.6 million of mortgage-backed residuals
relating to the Bank's 1993 issuance of CMOs. At December 31, 1998, R&G
Mortgage's CMO residuals, which are classified as held for trading, had an
amortized cost and a fair value of $7.1 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, 1998, the Bank's securities portfolio consisted of
$34.6 million of securities held for investments, consisting of $15.4 million of
tax-free mortgage-backed securities, $12.8 million of other mortgage backed
securities, and $5.9 million of Puerto Rico Government obligations and other
Puerto Rico securities, $195,000 U.S. Treasury securities and $204,000 U.S.
Government obligations. In addition, at December 31, 1998, the Bank had a
securities portfolio classified as available for sale with a fair value of
$154.5 million, consisting of $55.2 million of tax-free mortgage-backed
securities, $30.2 million of other mortgage-backed securities, $11.4 million of
FHLB stock, $9.7 million of CMOs and CMO residuals, $5.0 million U.S. Treasury
securities and $43.1 million of U.S. Government agency securities.
The Bank's Treasury Department from time to time conducts certain
trading activities mainly through investments in U.S. Treasury securities.
However, at December 31, 1998 no securities for trading were held by the Bank.
35
<PAGE>
The following table presents certain information regarding the
composition and period to maturity of R&G Financial's securities portfolio held
to maturity as of the dates indicated below. All of such securities are assets
of the Bank.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------- ------------------------------- -----------------------------
Weighted Weighted Weighted
Carrying Market Average Carrying Market Average Carrying Market Average
Value Value Yield Value Value Yield Value Value Yield
----- ----- ----- ----- ----- ----- ----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities:
GMNA
Due within one year..........$ -- $ -- --% $ -- $ -- --% $ -- $ -- --%
Due from one-five years...... 27 29 10.00 49 50 10.00 -- -- --
Due from five-ten years...... 13,025 12,752 6.04 -- -- -- 97 100 10.00
Due over ten years........... 2,360 2,306 6.05 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............. 12,608 12,944 7.13 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............. 236 230 6.15 281 266 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........ 5,945 5,979 5.80 5,920 5,910 5.85 -- -- --
Due over ten years............. -- -- -- 30 30 8.37 574 567 5.11
U.S.Treasury and Government
Agency
Due within one year............ 399 400 5.27 310 311 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................. $34,600 $34,640 6.39% $44,019 $43,875 6.18% $46,152 $45,327 6.34%
</TABLE>
36
<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,
-----------------------------------------------------------------------------
1998 1997
------------------------------------- -----------------------------------
Weighted Weighted
Amortized Fair Average Amortized Fair Average
Cost Value Yield Cost Value Yield
---- ----- ----- ---- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage-Backed Securities Available for Sale(1):
GNMA
Due within one year........................... $ -- $ -- --% $ -- $ -- --%
Due from one-five years....................... -- -- -- -- -- --
Due from five-ten years....................... -- -- -- -- -- --
Due over ten years............................ 55,159 55,159 6.41 -- -- --
FNMA mortgage-backed securities
Due within one year........................... - -- -- -- -- --
Due from one-five years....................... -- -- -- -- -- --
Due from five-ten years....................... -- -- -- -- -- --
Due over ten years............................ 8,092 8,161 6.96 9,468 9,670 7.00
FHLMC mortgage-backed securities
Due within one year........................... -- -- -- -- -- --
Due from one-five years....................... 89 91 9.00 71 70 9.00
Due from five-ten years....................... 240 244 9.37 360 368 9.38
Due over ten years............................ 21,369 21,724 6.85 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............................ 7,845 9,661 8.125 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....................... 4,995 4,991 4.57 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....................... 38,100 38,106 5.61 35,145 35,105 6.06
Due from five-ten years....................... 5,010 5,000 6.73 5,023 4,981 6.73
Due over ten years............................ -- -- -- -- -- --
FHLB stock...................................... 11,405 11,405 7.21 4,906 4,906 6.61
------ ------ ---- ------- ------- ----
$152,304 $154,542 6.41% $119,867 $121,867 6.59%
======= ======= ==== ======= ======= ====
Securities held for trading(3):
GNMA certificates............................... $427,915 $443,399 6.69% $367,177 $377,362 6.78%
CMO certificates................................ -- -- -- 16,200 15,228 5.95
CMO residuals(4)................................ 7,134 7,147 8.00 7,630 7,868 8.00
U.S. Treasury Bills............................. -- -- -- 581 581 5.23
------ ------ ---- ------- ------- ----
$ 435,049 $450,546 6.71% $391,588 $401,039 6.77%
======== ======= ==== ======= ======= ====
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Weighted
Amortized Fair Average
Cost Value Yield
---- ----- -----
<S> <C> <C> <C>
Mortgage-Backed Securities Available for Sale(1):
GNMA
Due within one year $ -- $ -- -- %
Due from one-five years -- -- --
Due from five-ten years -- -- --
Due over ten years -- -- --
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
-------- -------- ------
$ 81,982 $ 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%
======== ======== ======
</TABLE>
(Footnotes on following page)
37
<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 and $1.7
million as of December 31, 1997 and 1996, respectively, 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 $240,000 To accommodate
larger-sized loans, and loans that, for other reasons, do not conform to the
agency programs, a number of private
38
<PAGE>
institutions have established their own home-loan origination and securitization
programs.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
characteristics of the underlying pool of mortgage, i.e., fixed-rate or
adjustable-rate, as well as prepayment risk, are passed on to the certificate
holder. The life of a mortgage-backed pass-through security thus approximates
the life of the underlying mortgages.
R&G Financial's securities portfolio includes CMOs. CMOs have been
developed in response to investor concerns regarding the uncertainty of cash
flows associated with the prepayment option of the underlying mortgagor and are
typically issued by government agencies, government sponsored enterprises and
special purpose entities, such as trusts, corporations or partnerships,
established by financial institutions or other similar institutions. A CMO can
be collateralized by loans or securities which are insured or guaranteed by the
FNMA, the FHLMC or the GNMA. In contrast to pass-through mortgage-backed
securities, in which cash flow is received pro rata by all security holders, the
cash flow from the mortgages underlying a CMO is segmented and paid in
accordance with a predetermined priority to investors holding various CMO
classes. By allocating the principal and interest cash flows from the underlying
collateral among the separate CMO classes, different classes of bonds are
created, each with its own stated maturity, estimated average life, coupon rate
and prepayment characteristics.
Mortgage-backed securities generally increase the quality of R&G
Financial's assets by virtue of the insurance or guarantees that back them, are
more liquid than individual mortgage loans and may be used to collateralize
borrowings or other obligations of R&G Financial. At December 31, 1998, $42.9
million or 7.7% 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, 1998, the Bank's CMOs and CMO residuals, which had a
fair value of $9.7 million, were designated as "high-risk mortgage securities"
and classified as available for sale.
39
<PAGE>
Sources of Funds
General. R&G Financial will consider various sources of funds to fund
its investment and lending activities and evaluates the available sources of
funds in order to reduce R&G Financial's overall funding costs. Deposits,
reverse repurchase agreements, warehouse lines of credit, notes payable, FHLB
advances, subordinated capital notes and sales, maturities and principal
repayments on loans and securities have been the major sources of funds for use
in R&G Financial's lending and investing activities and for other general
business purposes.
Deposits. Deposits are the major sources of the Bank's funds for
lending and other investment purposes. Consumer and commercial deposits are
attracted principally from within the Bank's primary market area through the
offering of a broad selection of deposit instruments, including passbook, NOW
and Super NOW, checking and commercial checking and certificates of deposit
ranging in terms from 7 days to 10 years. Included among these deposit products
are $294.3 million of certificates of deposit with balances of $100,000 or more,
which amounted to 29.1% of the Bank's total deposits at December 31, 1998.
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,
1998 it held $15.1 million of deposits acquired from money desks in the United
States.
The principal methods currently used by the Bank to attract deposit
accounts include offering a wide variety of services and accounts and
competitive interest rates. The Bank utilizes traditional marketing methods to
attract new customers and savings deposits, including advertising.
40
<PAGE>
The following table presents the average balance of each deposit type
and the average rate paid one each deposit type of the Bank for the periods
indicated.
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------------------------
1998 1997 1996
---------------------- --------------------- ----------------------
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...................... $88,754 3.75% $ 75,958 3.79% $ 73,216 3.77%
NOW and Super NOW
accounts................... 99,336 3.93 86,843 3.84 78,183 3.85
Checking...................... 39,052 -- 23,859 -- 20,451 --
Commercial checking(1)........ 77,329 -- 46,301 -- 30,173 --
Certificates of deposit....... 522,016 5.98 435,743 6.02 359,525 6.05
------- ---- --------- ---- --------- ----
Total deposits.............. $826,487 4.65% $668,704 4.85% $561,548 4.90%
======= ==== ======= ==== ======= ====
</TABLE>
- ----------------
(1) Includes $109.9 million, $50.2 million and $10.6 million of escrow
funds of R&G Mortgage at December 31, 1998, 1997 and 1996,
respectively, maintained with the Bank.
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, 1998.
<TABLE>
<CAPTION>
Amount
---------------
(In Thousands)
Certificates of deposit maturing:
<S> <C>
Three months or less..................................... $ 92,656
Over three through six months............................ 51,621
Over six through twelve months........................... 42,534
Over twelve months....................................... 53,705
--------
Total.................................................. $240,516
========
</TABLE>
<PAGE>
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
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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, 1998, R&G Financial had $471.4 million of reverse
repurchase agreements outstanding, $396.2 million of which represented
borrowings of R&G Mortgage. At December 31, 1998, the weighted average interest
rate on R&G Financial's reverse repurchase agreements amounted to 5.42%.
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, 1998, R&G Mortgage was permitted to borrow
under such Warehouse Lines up to $209.0 million, $107.6 million of which was
drawn upon and outstanding as of such date. The Warehouse Lines are used by R&G
Mortgage to fund loan commitments and must generally be repaid within 180 days
after the loan is closed or when R&G Mortgage receives payment from the sale of
the funded loan, whichever occurs first. Until such sale closes, the Warehouse
Lines provide that the funded loan is pledged to secure the outstanding
borrowings. The Warehouse Lines are also collateralized by a general assignment
of mortgage payments receivable and an assignment of certain mortgage servicing
rights. 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, 1998, the weighted average interest rate being paid by R&G
Mortgage under its Warehouse Lines amounted to 6.43%.
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, 1998, it was in compliance with all of such covenants and
restrictions and does not anticipate that such covenants and restrictions will
limit its operations.
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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 5.60% 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, 1998, $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 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, 1998, 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, 1998, the Bank had access to $533.5
million in advances from the FHLB of New York, and had 13 FHLB of New York
advances aggregating $121.0 million outstanding as of such date, which mature at
various dates commencing in January 1999 through March 2008 and have a weighted
average interest rate of 5.25%. In addition, at December 31, 1998, 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, 1998, the Bank had pledged specific
collateral aggregating $217.4 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.
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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,
--------------------------------------------
1998 1997 1996
-------- --------- ---------
(Dollars in Thousands)
R&G Mortgage:
Securities sold under agreements to repurchase:
<S> <C> <C> <C>
Average balance outstanding....................... $354,786 $187,682 $ 93,653
Maximum amount outstanding at any month-end
during the period............................... 415,960 385,054 108,240
Balance outstanding at end of period.............. 415,960 385,054 97,444
Average interest rate during the period........... 5.73% 6.03% 5.00%
Average interest rate at end of period............ 5.46% 5.85% 5.67%
Notes Payable:
Average balance outstanding....................... $102,047 $66,405 $40,805
Maximum amount outstanding at any month-end
during the period............................... 161,060 93,523 85,135
Balance outstanding at end of period.............. 107,648 24,353 40,342
Average interest rate during the period........... 7.07% 6.03% 5.32%
Average interest rate at end of period............ 6.43% 5.85% 4.97%
The Bank:
FHLB of New York advances:
Average balance outstanding....................... $94,025 $23,524 $ 6,366
Maximum amount outstanding at any month-end
during the period............................... 160,100 42,200 15,000
Balance outstanding at end of period.............. 121,000 42,200 15,000
Average interest rate during the period........... 5.55% 5.80% 5.84%
Average interest rate at end of period............ 5.25% 6.03% 5.75%
Securities sold under agreements to repurchase:
Average balance outstanding....................... $55,915 $39,090 $ 6,954
Maximum amount outstanding at any month-end
during the period............................... 79,513 63,088 19,000
Balance outstanding at end of period.............. 75,222 48,080 --
Average interest rate during the period........... 5.57% 5.55% 4.74%
Average interest rate at end of period............ 5.35% 5.56% --%
Notes Payable:
Average balance outstanding....................... $84,100 $85,034 $85,365
Maximum amount outstanding at any month-end
during the period............................... 84,100 86,500 111,500
Balance outstanding at end of period.............. 84,100 84,100 86,500
Average interest rate during the period........... 6.45% 6.60% 5.55%
Average interest rate at end of period............ 5.74% 5.97% 5.82%
</TABLE>
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, 1998, the Bank's Trust
Department administered approximately 6,945 trust accounts, with aggregate
assets of $28.2 million as of such date. In addition, during the year ended
December 31, 1998, the
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Bank's Trust Department sold $47.9 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, 1998, R&G Financial (on a consolidated basis) had
1,054 full-time employees and 39 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 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
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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 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
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<PAGE>
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 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 are 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.
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<PAGE>
Financial Support of Affiliated Institutions. Under Federal Reserve
Board policy, R&G Financial will be expected to act as a source of financial
strength to the Bank and to commit resources to support the Bank in
circumstances when it might not do so absent such policy. The legality and
precise scope of this policy is unclear, however, in light of recent judicial
precedent. In addition, any capital loans by a bank holding company to a
subsidiary bank is subordinate in right of payment to deposits and to certain
other indebtedness of such subsidiary bank. In the event of a bank holding
company's bankruptcy, any commitment by the bank holding company to a federal
bank regulatory agency to maintain the capital of a subsidiary bank will be
assumed by the bankruptcy trustee and entitled to a priority of payment.
The Bank
General. The Bank is incorporated under the Puerto Rico Banking Act of
1933, as amended (the "Puerto Rico Banking Law") and is subject to extensive
regulation and examination by the 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" 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, 1998. 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
49
<PAGE>
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.
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 increases 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
49
<PAGE>
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,
1998, the Bank met each of its capital requirements.
The FDIC and the other federal banking agencies have published a joint
policy statement 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. The FDIC and other federal banking agencies have also adopted a
joint policy statement on interest rate risk policy. Because market conditions,
bank structure, and bank activities vary, the agencies concluded that each bank
needs to develop its own interest rate risk management program tailored to its
needs and circumstances. The policy statement describes prudent principles and
practices that are fundamental to sound interest rate risk management, including
appropriate board and senior management oversight and a comprehensive risk
management process that effectively identifies, measures, monitors and controls
risks.
Activities and Investments. The activities and equity investments of
FDIC-insured, state-chartered banks (which under the Federal Deposit Insurance
Act includes banking institutions incorporated under the laws of Puerto Rico)
are generally limited to those that are permissible for national banks. Under
regulations dealing with equity investments, an insured state bank generally may
not directly or indirectly acquire or retain any equity investment of a type, or
in an amount, that is not permissible for a national bank. An insured state bank
is not prohibited from, among other things, (i) acquiring or retaining a
majority interest in a subsidiary, (ii) investing as a limited partner in a
partnership the sole purpose of which is direct or indirect investment in the
acquisition, rehabilitation or new construction of a qualified housing project,
provided that such limited partnership investments may not exceed 2% of the
bank's total assets, (iii) acquiring up to 10% of the voting stock of a company
that solely provides or reinsures directors', trustees' and officers' liability
insurance coverage or bankers' blanket bond group insurance coverage for insured
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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, 1998, the Bank had credited $3.5 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 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,
plus 15% of 50% of undistributed earnings for "well capitalized" institutions.
As of December 31, 1998, the legal lending limit for the Bank under these
provisions was approximately $16.3 million and its maximum extension of credit
to any one borrower was $9.4 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, 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.
Loans to non-banking affiliates of the Bank are subject however to the lending
limitations set forth in Sections 23A and 23B of the Federal Reserve Act.
51
<PAGE>
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 Bank may repurchase its own
stock for the purpose of reducing its capital, subject to the approval of the
OCFI.
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 eliminated the regulations that set forth the maximum interest rates that
could be charged on consumer loans, mortgage loans and commercial loans. The
origination charges on residential mortgage loans may not exceed 6% of the loan
amount.
Regulatory Enforcement Authority. Applicable banking laws include
substantial enforcement powers available to federal and Puerto Rico banking
regulators. This enforcement authority includes, among other things, the ability
to assess civil money penalties, to issue cease-and-desist or removal orders and
to initiate injunctive actions against banking organizations and
institution-affiliated parties, as defined. In general, these enforcement
actions may be initiated for violations of laws and regulations and unsafe or
unsound practices. Other actions or inactions may provide the basis for
enforcement action, including misleading or untimely reports filed with
regulatory authorities.
R&G Mortgage
The mortgage banking business conducted by R&G Mortgage is subject to
the rules and regulations of FHA, VA, FNMA, FHLMC and GNMA with respect to
originating, processing, selling and servicing mortgage loans and the issuance
and sale of mortgage-backed securities. Those rules and regulations, among other
things, prohibit discrimination and establish underwriting guidelines which
include provisions for inspections and appraisals, require credit reports on
prospective borrowers and fix maximum loan amounts and, with respect to VA
loans, fix maximum interest rates. Moreover, lenders are required annually to
submit to FNMA, FHA, FHLMC, GNMA and VA audited financial statements, and each
regulatory entity has its own financial requirements. R&G Mortgage's affairs are
also subject to supervision and examination by FNMA, FHA, FHLMC, GNMA, HUD and
VA at all times to assure compliance with the applicable regulations, policies
and procedures. Mortgage origination activities are subject to, among others,
the Equal Credit Opportunity Act, Federal Truth-in-Lending Act and the Real
Estate Settlement Procedures Act and the regulations promulgated thereunder.
52
<PAGE>
R&G Mortgage's mortgage loan production activities are subject to the Federal
Truth-in-Lending Act and Regulation Z promulgated thereunder. The
Truth-in-Lending Act contains disclosure requirements designed to provide
consumers with uniform, understandable information with respect to the terms and
conditions of loans and credit transactions in order to give them the ability to
compare credit terms. The Truth-in-Lending Act provides consumers a three day
right to cancel certain credit transactions, including any refinance mortgage or
junior mortgage loan on a consumer's primary residence.
R&G Mortgage is required to comply with the Equal Credit Opportunity
Act of 1974, as amended ("ECOA"), and Regulation B promulgated thereunder, which
prohibit creditors from discriminating against applicants on the basis of race,
color, sex, age or marital status, and restrict creditors from obtaining certain
types of information from loan applicants. It also requires certain disclosures
by lenders regarding consumer rights and requires lenders to advise applicants
of the reasons for any credit denial. In instances where the applicant is denied
credit or the rate or charge for loan increases as a result of information
obtained from a consumer credit agency, another statute, The Fair Credit
Reporting Act of 1970, as amended, requires the lenders to supply the applicant
with the name and address of the reporting agency.
The Federal Real Estate Settlement Procedures Act ("RESPA") imposes,
among other things, limits on the amount of funds a borrower can be required to
deposit with R&G Mortgage in any escrow account for the payment of taxes,
insurance premiums or other charges.
R&G Mortgage is also subject to regulation by the 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.
53
<PAGE>
As is the case with the Bank, the rate of interest that R&G Mortgage may charge
on mortgage loans to individuals is subject to Puerto Rico's usury laws. Such
laws are administered by the Financing Board which promulgates regulations that
specify maximum rates on various types of loans to individuals. Regulation 26-A
promulgated by the Financing Board fixes the maximum rate (which is adjusted on
a weekly basis) which may be charged on residential first mortgage loans.
Effective April 1996, the Financing Board eliminated the regulations that set
forth the maximum interest rates that could be charged on non-federal government
guaranteed loans.
54
<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, 1998, 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) December 31, 2003 $1,547
280 Jesus T. Pinero Avenue One (1) five year option
Hato Rey, PR 00919
Los Jardines Branch September 4, 1999 97
Los Jardines de Guaynabo Shopping Center One (1) ten year option
PR Road No. 20
Guaynabo, PR 00969
San Patricio Branch(4) June 30, 2013 257
San Patricio Plaza
Ortegon Street
Guaynabo, PR 00969
Bayamon Branch(2)(3) May 31, 2001 265
42-43 Betances Avenue One (1) ten year option
Urb. Hermanas Davila
Bayamon, PR 00959
Bayamon East Branch(4) January 10, 2001 432
Road #174, Lot 100 Two (2) five year options
Urb. Ind. Minillas
Bayamon, PR 00959
Arecibo Branch(3) December 31, 2001 110
Marginal Vista Azul Two (2) five year options
Corner San Daniel Avenue
Arecibo, PR 00612
Manati Branch(3) August 8, 2009 448
Plaza Puerta del Sol Four (4) five year options
PR Road No. 2, Km. 49.7
Manati, PR 00674
</TABLE>
55
<PAGE>
<TABLE>
<CAPTION>
Net Book Value
Description/Address Lease Term Expiration of Property
------------------- --------------------- -----------
(In Thousands)
<S> <C> <C>
Carolina Branch(4) July 31, 2003 349
65th Infantry Avenue
Corner San Marcos Street
Carolina, PR 00985
Trujillo Alto Branch(4) October 31, 2004 101
Trujillo Alto Shopping Center
Trujillo Alto, PR 00976
Santurce Branch(4) April 30, 1999 323
1077 Ponce de Leon Avenue Three (3) six year options
Santurce, PR 00917
Laguna Gardens Branch(4) April 30, 1999 119
Laguna Gardens Shopping Center One (1) five year option
Isla Verde
Carolina, PR 00979
Plaza Carolina Branch(4) May 31, 2000 163
Plaza Carolina Mall
Carolina, PR 00985
Norte Shopping Branch(4) April 30, 2000 128
Norte Shopping Center Two (2) five year options
Baldorioty de Castro Avenue
San Juan, PR 00907
Vega Baja Branch(4) May 31, 2003 332
Cabo Caribe Development One (1) five year option
PR Road No. 2, Marginal
Vega Baja, PR 00693
Mayaguez Branch(3) April 30, 2002 582
McKinley Street Three (3) five year options
Corner Dr. Vady
Mayaguez, PR 00680
Fajardo I Branch(2)(4) March 15, 2003 381
Garrido Morales Street Two (2) Five Year Options
Corner San Rafael
Fajardo, PR 00738
Martinez Nadal Branch(4) June 14, 2003 627
Paradise Mall Two (2) Five Year Options
Corner Jesus T. Pinero Ave.
Rio Piedras, PR 00925
</TABLE>
56
<PAGE>
<TABLE>
<CAPTION>
Net Book Value
Description/Address Lease Term Expiration of Property
------------------- --------------------- -----------
(In Thousands)
<S> <C> <C>
Ponce Branch(4) March 31, 2000 292
Lifetime Building Lot 5 Three (5) Year Options
Urb. Industrial San Rafael
Ponce, PR 00731
Fajardo II Branch(4) September 30, 1999 41
Celis Aguilera #161 One (1) Seven Year Option
Fajardo, PR 00738
Plaza del Sol Branch(4) November 15, 2010 724
Plaza del Sol Mall Two (2) Four Year Options
725 West Main Ave.
Bayamon, PR 00961
Operations Center(2) January 10, 2001 2,443
Road #174, Lote 100 Two (2) five year options
Urb. Ind. Minillas
Bayamon, PR 00959
Branch locations to be -- 609
---
opened in 1999
10,370
------
Champion Mortgage:
Hato Rey Branch June 30, 2003 53
295 Jesus T. Pinero One (1) five year option
San Juan, PR 00918
Ponce Branch May 1, 2003 26
--
Las Americas Ave
Ext. Buena Vista #25
Ponce, PR 00731 79
----- --
</TABLE>
57
<PAGE>
<TABLE>
<CAPTION>
<CAPTION>
Net Book Value
Description/Address Lease Term Expiration of Property
------------------- --------------------- -----------
(In Thousands)
<S> <C> <C>
R&G Mortgage:
Caguas Office July 31, 2000 8
D-9 Degetau Street One (1) five year option
Urb. San Alfonso
Caguas, PR 00725
Los Jardines Office(5) August 1, 2006 18
Los Jardines de Guaynabo Shopping Center One (1) five year option
PR Road No. 20
Guaynabo, PR 00969
Hato Rey Office(2)(3) December 31, 2002 2,364
280 Jesus T. Pinero Avenue Two (2) five year options
Hato Rey, PR 00919
Bayamon Office(2)(3) May 30, 2001 78
42-43 Betances Avenue One (1) ten year option
Urb. Hermanas Davila
Bayamon, PR 00959
Arecibo Office(3) January 1, 2002 7
Marginal Vista Azul Two (2) five year options
Corner San Daniel Avenue
Arecibo, PR 00612
Manati Office(3)(6) October 30, 2003 12
Plaza Puerta del Sol One (1) five year option
PR Road No. 2, Km. 49.7
Manati, PR 00674
</TABLE>
58
<PAGE>
<TABLE>
<CAPTION>
<CAPTION>
Net Book Value
Description/Address Lease Term Expiration of Property
------------------- --------------------- -----------
(In Thousands)
<S> <C> <C>
Mayaguez Office(3)(6) October 30, 2003 26
-----
McKinley Street One (1) five year option
Corner Dr. Vady
Mayaguez, PR 00680
2,513
$12,962
</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.
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.
59
<PAGE>
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The information required herein is incorporated by reference from page
75 of the Registrant's 1998 Annual Report.
Item 6. Selected Financial Data.
The information required herein is incorporated by reference from pages
25 to 27 of the Registrant's 1998 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
28 to 40 of the Registrant's 1998 Annual Report.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information required herein is incorporated by reference from pages
31 to 32 of the Registrant's 1998 Annual Report.
Item 8. Financial Statements and Supplementary Data.
The information required herein is incorporated by reference from pages
41 to 74 of the Registrant's 1998 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
3 to 8 of the Registrant's Proxy Statement dated March 30, 1999 ("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.
60
<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required herein is incorporated by reference from pages
9 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
16 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, 1998 and 1997.
Consolidated Statements of Income for the Years Ended December
31, 1998, 1997 and 1996.
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996.
Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended December 31, 1998, 1997 and 1996.
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.
61
<PAGE>
(3) The following exhibits are filed as part of this Form 10-K, and
this list includes the Exhibit Index.
<TABLE>
<CAPTION>
No. Description
- ------------ -------------------------------------------------------------------------------------------------
<S> <C>
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)
3.4 Form of Certificate of Resolutions designating the terms of the Series A Preferred Stock
(defined below).(3)
4.0 Specimen of Stock Certificate of R&G Financial Corporation.(2)
4.1 Form of Series A Preferred Stock (defined below) Certificate of R&G Financial
Corporation.(3)
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 1998 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)
</TABLE>
(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.
(3) Incorporated by reference from the Registrant's Registration Statement
on Form S-3 (Registration No. 333-60923), as amended, filed with the
SEC on August 7, 1998.
(*) Management contract or compensatory plan or arrangement.
62
<PAGE>
(3)(b) Reports on Form 8-K.
None.
63
<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
March 30, 1999 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 30, 1999
- -------------------
Victor J. Galan
Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
/s/ Joseph R. Sandoval March 30, 1999
- ----------------------
Joseph R. Sandoval
Senior Vice President and Chief Financial
Officer (principal financial and
accounting officer)
/s/ Ana M. Armendariz March 30, 1999
- ---------------------
Ana M. Armendariz
Director and Treasurer
/s/ Ramon Prats March 30, 1999
Ramon Prats
Executive Vice President and Director
<PAGE>
/s/ Enrique Umpierre-Suarez March 30, 1999
Enrique Umpierre-Suarez
Director and Secretary
/s/ Victor L. Galan Fundora March 30, 1999
- ----------------------------
Victor L. Galan Fundora
Director
/s/ Juan J. Diaz March 30, 1999
- ----------------
Juan J. Diaz
Director
/s/ Pedro Ramirez March 30, 1999
- -----------------
Pedro Ramirez
Director
/s/ Laureno Carus Abarca March 30, 1999
- ------------------------
Laureno Carus Abarca
Director
/s/ Eduardo McCormack March 30, 1999
- ---------------------
Eduardo McCormack
Director
/s/ Gilberto Rivera-Arrega March 30, 1999
- --------------------------
Gilberto Rivera-Arreaga
Director
/s/ Benigno R. Fernandez March 30, 1999
- ------------------------
Benigno R. Fernandez
Director
/s/Ileana M. Colon-Carlo March 30, 1999
- ------------------------
Ileana M. Colon-Carlo
Director
/s/Roberto Gorbea March 30, 1999
- -----------------
Roberto Gorbea
R-G FINANCIAL CORPORATION
1998 ANNUAL REPORT
Investing in People Toward the New Century [GRAPHIC-LOGO FOR R&g FINANCIAL]
<PAGE>
Table of Contents
1 Financial Highlights
3 Sources of our Success
5 Letter to Stockholders -1998 Year in Review
16 Investing for the Future
17 Our Branches
18 Our People as a Competitive Advantage
25 Corporate Information
Cover: R&G Mortgage and R-G Premier Bank managers service our customers in over
20 branch locations throughout the island. Many of our employees have grown with
R&G having over 20 years of service in the Company and over 450 years of
combined experience.
<PAGE>
<TABLE>
<CAPTION>
Financial Highlights
(Dollars in Thousands, except for per Share Data)
Percent
Increase 1998 1997 1996
vs. 1997
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Loan Production 57% 1,426,069 906,324 624,570
Gross Revenues 31 180,767 138,440 103,038
Net Earnings 45 34,034 23,497 13,200
Total Assets 35 2,044,781 1,510,745 1,037,798
Return on Assets 5 1.95% 1.85% 1.38%
Servicing Portfolio 61 4,827,798 3,000,888 2,550,169
Efficiency Ratio 3 48.55% 50.28% 58.89%
Spread Income 20 43,973 36,530 28,923
Fee Income 37 56,470 41,105 29,252
Shareholders Equity 60 221,162 138,054 115,633
Common Shareholders
Equity per Share 23 5.99 4.88 4.09
Return on Common Equity 14 21.32% 18.69% 15.54%
Diluted Earnings
per Common Share 38 1.12 0.81 0.59
Cash Dividends Declared
per Common Share 71 0.111 0.065 0.069
Market Value per Share 218% 2.00 9.63 6.60
</TABLE>
[GRAPHIC- GRAPH DEPICTING REVENUES]
[GRAPHIC- GRAPH DEPICTING NET INCOME]
[GRAPHIC- GRAPH DEPICTING ASSETS]
<PAGE>
We will strive for long-term financial strength and profitability by centering
our strategy on customer satisfaction- on becoming our customers' first choice
for service and solutions.
We seek to be a high-performance organization that delivers one-stop financial
services to its clients; that is recognized as the best provider of value-added,
financial services; and that offers services
Mission Statement
of unmatched quality in terms of accessibility, responsiveness and turnaround
time. The key to our success is effective execution, every day, everywhere. By
everyone.
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, and by creating a work environment where all team members care and are
committed individually and as a team to do their best.
What makes us a leader is not what we say, but what we do and the way we do it.
<PAGE>
R&G: Sources of Our Success
- --------------------------------------------------------------------------------
A Super Community Bank and a Leading Mortgage Banking Operation Working in
Tandem.
R&G Financial Corporation, with more than $2.0 billion in assets, is the holding
company for R&G Mortgage Corporation and R-G Premier Bank of Puerto Rico. The
Company is a financial services provider with 26 years of experience and a
history of outstanding growth in Puerto Rico.
When the Company was founded in 1972, its business was based on mortgage
lending. At the time, mortgage lending represented a large opportunity for
growth, since there was minimal competition, the economy was strong, and people
were pressing for new homes and business facilities.
In 1990, R&G began its banking operation with R&G Premier Bank, offering a
variety of financial products and services. The Company has since grown and
diversified further. It now offers a complete range of financial services
through bank offices and mortgage banking facilities through 22 different
locations throughout the island. R&G will continue to grow as a diversified
financial services company, constantly reengineering itself as customer needs
and market conditions change.
R&G is now regarded not only as one of the top- performing companies in the
financial services industry, but also among all companies in Puerto
[GRAPHIC-GRAPH DEPICTING LOAN PORTFOLIO]
[GRAPHIC-GRAPH DEPICTING DEPOSITS]
3
<PAGE>
Rico. For example, last year marked the 26th year of record earnings. And in the
two and a half years since becoming a public company, R&G has seen its market
value grow by 421%.
Committed to Exceptional Service
- --------------------------------
The Company also is considered one of the top private-sector employers. In 1998
R&G employed over 1,000 people, all sharing the same vision, values and
philosophy. R&G believes that its most valuable asset is its people, and that
the service they deliver is critical to its success. We understand that given a
convenient location, a customer will decide between competing banking companies
on the basis of quality service. That is something we never forget - and
something our expert management team never ceases to remind each and every one
of our staff.
Our management team has over 20 years of combined experience in different areas
of the banking and financial industries, providing the knowledge and expertise
necessary to comply with the most demanding client's requirements. However, what
keeps us ahead of the competition is the motivation, satisfaction and skills of
our employees. These are key to customer satisfaction and retention.
Our financial products are commodities. The only way to differentiate a
commodity is by the way we deliver it - the way we sell and price the product,
but also the quality of the service we provide. In our business, we have to try
harder to attract new customers; but once they are with us, they tend to stay.
Because our 1,000 people are our most valuable asset - the source of our success
- - we dedicate this annual report to them.
[GRAPHIC-GRAPH DEPICTING STOCKHKOLDERS' EQUITY]
4
<PAGE>
LETTER TO STOCKHOLDERS
1998 Year in Review
Dear Fellow Stockholders:
By all accounts 1998 was a remarkable year for R&G. Among other accomplishments,
we added a substantial number of new customers, and each of our earnings,
assets, deposits and capital increased to record levels. The strategies
underlying these achievements are equally notable because they form the basis of
our business plan for future growth, which we will continue to implement.
For the first time since our Company was founded 26 years ago, we have increased
our work force to more than 1,000 employees. In view of this achievement, we
have decided to make our people and their contribution the theme of this annual
report.
[GRAPHIC-PHOTO FO VICTOR J. GALAN, R&G FINANCIAL CORPORATION
CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER]
5
<PAGE>
After many years in retail banking, I have yet to hear a customer's compliment
that does not revolve around the quality of service delivered by our employees.
Great people provide exceptional results, but the retention of our quality staff
has been as a result of our belief in the following rules:
That employee satisfaction and skills, coupled with excellent services and
internal processes, create superior performance in banking and mortgage banking.
That offering performance incentives throughout the organization - from senior
management down to loan processors and tellers - spurs all our employees to new
accomplishments and rewards them for their efforts.
That banking and mortgage banking still depend upon people, and that technology
is simply an enabler. Technology is half the game and people skills are the
rest. We think that marketing and staff training, along with improved
integration of internal processes, are the best strategies for meeting the needs
of our customers. We want our team members to act as if they own the Company,
because to a large extent they do!
That our employees will be loyal to us because we are loyal to them. We promote
a climate of loyalty and trust by providing job security, promoting from within,
and offering salaries, benefits and incentives that are perceived as fair.
People who are treated as if they are the key to the Company's success, become
just that.
Record Financial Results
- ------------------------
Financially, 1998 was a banner year for R&G. Our profits, volume of loan
originations and assets all reached new highs. In addition, we increased our
loan servicing portfolio to $4.8 billion, a record amount for the Company. We
are currently serving more than 180,000 customers through our mortgage and
commercial banking operations. The retention of this clientele will depend on
the motivation, satisfaction and skills of our work force. We are sure our staff
has what it takes not only to keep these clients but also to substantially
increase their relationships with R&G in the future.
Earnings for 1998 rose to a record $34.0 million, increasing 45% from 1997
earnings of $23.5 million. On a per share basis (diluted), R&G Financial earned
$1.12, compared to $0.81 the previous year, an increase of 38%. Our compounded
annual growth rate in total assets was 38.8% for the period 1978-1998, and 34.4%
for the period since August 22, 1996 when we became a public company. We believe
that this rapid growth is attributable to three strategies in particular - our
investment in technology, promotional campaigns and advertising; geographical
expansion through the opening of new branches; and development of a strong sales
culture. This has resulted in improved market share in mortgage, commercial and
consumer lending, as well as banking deposits.
Total gross revenues for 1998 amounted to $180.8 million compared to $138.4
million for 1997. Net
6
<PAGE>
revenues after deducting our cost of interest were $100.4 million compared to
$77.6 million in 1997. A significant portion of our 1998 net revenues consisted
of net interest income totaling $44.0 million. Net interest income for 1998 was
up by 20% from the 1997 level. The balance of our net revenues, amounting to
$56.4 million, consisted of fees generated primarily from the servicing of our
mortgage portfolio, the origination and sale of loans, and banking services.
The level of fee income in 1998 was 37% higher than in 1997. The Company
achieved solid gains in fee income in virtually all categories - mortgage and
banking operations, electronic banking, trusts, commercial loans and credit
cards - as a direct result of providing a unique line of banking products and
personalized services.
Also in 1998, the Board of Directors declared a two-for-one stock split that
became effective in June. Total shares outstanding as of December 31, 1998
increased to 28,586,647. The decision to split the Company's common stock was
part of our ongoing effort to increase the stock's liquidity.
We increased dividends to $0.111 per share from $0.065 per share in 1997. For
the quarter ended December 31, 1998, the dividend was raised to $0.132 on an
annualized basis, a 29% increase from the annualized rate of $0.123 for the
prior quarterly dividend. This was our ninth consecutive increase since the
Company went public. We plan to continue
[GRAPHIC-GRAPH DEPICTING MORTGAGE SERVICING PORTFOLIO]
7
<PAGE>
increasing our future dividend payments proportionately to our increases in
profit.
Our stock price climbed from $4.03 (as adjusted for our stock splits) at the
time of our initial public offering on August 22, 1996 to $21.00 at the close of
operations in December 1998, representing an increase of 421%. Our market
capitalization increased proportionately to $600.3 million as of the latter
date. (If the stock splits had not happened, the value of a share of R&G stock
would have been $75.60 on December 31, 1998, compared with $14.50 at the time of
our public offering.) We are optimistic that the strong upward trend in our
revenues, plus the synergies between our banking and mortgage banking
operations, will provide meaningful earning increases in the coming years and
beyond.
In August 1998 we completed a public offering in the local market of $50 million
of preferred stock with a gross return to investors of 7.40%. The proceeds of
this stock issue were allocated to increase the capital of our bank and mortgage
company by $20 million and $30 million, respectively. Most of the proceeds
provided to the mortgage company were used to finance the acquisition of a
servicing portfolio purchased from a local commercial bank; the balance was
retained in the mortgage company for working capital.
Shareholders equity of $221.2 million as of December 31, 1998 was up 60% from
$138.1 million in 1997. Core capital represented 10.88% of our total assets, and
risk-based capital represented 14.28% (on a consolidated basis), substantially
exceeding the minimums required by our regulators.
We were successful in improving our efficiency ratio (expenses to revenues) for
1998 to 48.55% from 50.28% in the prior year. The improvement in the ratio was
achieved in spite of a 25% increase, to $48.8 million, in non-interest expenses.
These expenses were primarily related to the opening of four new branches; the
addition of another branch through the mid-1998 acquisition of Fajardo Federal
Savings Bank; increased loan originations and servicing; and increased
administrative costs to handle the additional volume of loans and other assets.
Branch Expansion
- ----------------
During 1998 we opened new branches in Fajardo, Ponce, San Juan and Bayamn. We
also added another branch in Fajardo with the acquisition of Fajardo Federal
Savings Bank.
In our market, branch availability and location still influence consumers'
decisions on which bank to do business with. Branches are also important to many
of our commercial customers, who, to a large extent, still value and need
physical access. All our branches are strategically located and are designed to
be selling platforms for cross-selling and relationship building. We are
creating, in fact, a network of physical sites where we can interact with our
customers. This
8
<PAGE>
personal presence allows us to strengthen our franchise in banking and mortgage
banking.
At the close of the year we had 20 branches of R-G Premier Bank, 21 branches of
R&G Mortgage and 2 branches of Champion Mortgage (a subsidiary of R&G Mortgage),
each working in tandem in 22 different locations. In addition, we had 6 more
branches under construction and 10 more committed for future opening. About 710
employees were assigned to branches, loan origination and processing, 52 to
operations, 204 to loan administration, and the balance to general
administration and finance, which results in a total of 1,054 employees. We are
continuing to open new branches in strategic locations across Puerto Rico. At
the current pace of growth, we expect to have about 75 bank and mortgage company
branches in 35 locations by the end of 2001. At that time, we should cover the
northeastern part of the island (from Arecibo to Fajardo), the markets of Caguas
and Humacao in the southeast, and the markets of Ponce, Mayaguez and Aguadilla
in the western half of Puerto Rico. After that expansion, we are planning to
cover the rest of Puerto Rico via additional satellite offices or through our
virtual banking operation, which should be fully developed by that time.
Record Assets and Loan Production
- ---------------------------------
Loan production - comprised of residential and commercial mortgage lending,
consumer and
[GRAPHIC-PHOTO OF VICTOR J. GALAN, R&aG FINANCIAL CORPORATION CHAIRMAN OF THE
BOARD AND CHIEF EXECUTIVE OFFICER, AND RAMON PRATS, VICE CHAIRMAN OF THE BOARD
AND EXECUTIVE VICE PRESIDENT OF RGM.
9
<PAGE>
business lending - reached an all time high of $1.4 billion in 1998. This
represented a 57% increase from the $906.3 million of production in 1997. We
achieved this substantial growth through a very strong advertising effort using
print and broadcast media, a substantial expansion in branches and increased
telemarketing.
Our residential and construction mortgage originations translated into a market
share of 28%, based on an estimated total residential mortgage market of $4.7
billion in Puerto Rico last year. Significant opportunities remain for even
greater market share growth in mortgage lending. The more banking relationships
a household or business has with us, the more loyal that customer is to R&G.
Champion Mortgage, a subsidiary of R&G Mortgage, achieved excellent results,
producing a record volume of loan originations. We organized Champion in 1997
for the purpose of originating residential non-conforming and sub-prime loans.
In view of the initial success of this operation, we expanded its scope of
business to include a full line of mortgage products. Our intention is to
separate this part of our business in order to focus on the requirements of this
very special market niche. During 1998 we opened a new Champion Mortgage office
in Hato Rey and a new branch in Ponce; our plans for 1999 include a new branch
in Bayamn to open in February and a new branch in Caguas to open in June. In
addition, we are presently evaluating five other locations.
[GRAPHIC-GRAPH DEPICTING TOTAL LOAN PRODUCTION]
10
<PAGE>
Our residential portfolio in 1998 totaled $765.8 million, a 53% increase from
$501.6 million in 1997. The average yield for 1998 was 7.76%. The portfolio
included $747.2 million of residential first-mortgage loans and $18.6 million of
second mortgage loans.
During 1998 we expanded our services by organizing a Construction Loan
Department to work primarily with real estate developers. Previously, we had
focused exclusively on financing individual residential construction. As of
December 31, 1998, the new department had outstanding loans of $16.2 million,
plus commitments for future funding of $18.2 million.
Our commercial loans portfolio, including commercial mortgages and leases,
increased to $167.9 million at year-end, an increase of 33% from the prior year.
This increase was due mostly to the introduction of customized commercial loans
structured to fit borrowers needs. Most of this portfolio is structured with
interest rates floors, so our portfolio yield has not been affected by the
reductions in the prime lending rate during late 1998.
Our consumer portfolio, which includes collateralized consumer loans and credit
cards, amounted to $143.3 million at the end of 1998. This portfolio generated
an average yield of 10.37% which improved the average return of our total
portfolio and our spread income.
We expanded our servicing portfolio to 96,000 loans with a total balance of $4.8
billion, an increase of $1.8 billion, or 61%, from 1997. We estimate the total
value of our servicing portfolio at $84.4 million as of December 31, 1998, or
$26.2 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 $16.0 million in 1998
from $13.2 million in 1997.
On November 30, 1998, we completed the acquisition of a servicing portfolio from
a local commercial bank. This acquisition, consisting of 32,400 loans with an
outstanding balance of $1.1 billion, has expanded our client base and will
increase our income from servicing during future years. Most of the portfolio is
already mature, providing opportunities for our refinancing program. We
publicize this program through advertisements, telemarketing and face-to-face
contact in the 23 branches of our mortgage company.
We strengthened our credit loss reserves during the year, increasing the reserve
for loan losses to $8.1 million, a 19.0% increase from $6.8 million the previous
year. Reserves approximate 67.3% of total non-performing loans as of December
31, 1998, excluding our residential loan portfolio, where losses have
historically been minimal.
Loans sold during 1998 were substantial, totaling $775.0 million. These sales
consisted of $298.1 million of residential FHA and VA mortgage loans securitized
and sold in GNMA pools, and $476.9
11
<PAGE>
million of residential conventional loans mainly sold to the government
sponsored agencies (Fannie Mae and Freddie Mac). Our ability to sell
conventional mortgage loans was made easier by the installation of scoring
systems directly connected with both entities. The direct connection allows for
faster response about loan approvals, shorter processing time, and immediate
delivery to the secondary market once the loans are closed.
Our securities portfolio increased by 13% in 1998, growing to $639.7 million
from $566.9 million in 1997. These investments represented 31% of total assets
as of December 31, 1998, and with an average yield of 6.14%, generated revenues
of $33.3 million. Most of these securities were tax-free GNMAs, which enabled
the Company to reduce its taxes for 1998 to an effective tax rate of 24.5% from
27% in 1997.
Liquid assets constituted 19.2% of total assets at year-end, even though we
closed new loans for more than $1.4 billion during the year. Assets grew by
$534.0 million during 1998, to a record $2.0 billion. This growth was financed
by a $284.5 increase in deposits plus a $200.6 million increase in lines of
credit with banks and the Federal Home Loan Bank of New York. The balance was
financed through profits, loan payoffs, and funds generated by our preferred
stock issue. At year-end, our unused lines of credit (including lines of credit
with the Federal Home Loan Bank) totaled $513.8 million. We had $397.4 million
of excess collateral available to cover advances from these lines, with the
collateral primarily available from our residential mortgage portfolio.
Record Deposits --------------- Deposits exceeded the billion-dollar mark,
increasing by 39% to $1.0 billion in 1998 from $722.4 million in 1997. This
growth was mainly due to three initiatives: a very strong promotional campaign
designed to generate core deposits and to expand our Private Banking business;
the opening of new branches; and the expansion of our existing locations. New
deposits with our Private Banking Group rose substantially, and these accounts
will lead to additional business in 1999 as the Private Banking Group provides
other products and services to these customers. The overall increase in deposits
was also due to new deposit products introduced in 1997, such as 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 customers who have a
small volume of transactions and use a minimum amount of checks. Early in 1998
we introduced the "Dinoro", a special account for children.
With the successful introduction of these new accounts, we are providing a
unique line of banking products and personalized services in "niche" savings
programs. These programs are designed for customers who seek high yields,
diversity of products and access to electronic banking services,
12
<PAGE>
but who also want their accounts to be FDIC-insured. The average per branch
deposit size increased 4.6% to $50.3 million in 1998 from $48.1 million in 1997,
even though we opened five new branches during the year. Our average per branch
deposit size exceeds the average per branch deposits of Puerto Rico by $7.3
million or 17%. Core deposits, primarily consisting of saving and direct deposit
accounts, represented 39.2% of our total deposits (only 6% below the average for
the banking industry in Puerto Rico), and increased from the prior year by
48.4%. Brokered deposits were only 1.4% of our total deposits. Our share of the
total deposit market in Puerto Rico increased to 4.34% from 3.74% in 1997, while
our share of the primary markets we serve (northeastern Puerto Rico plus Ponce
and Mayaguez) increased to 5.39% from 4.02% .
Technology
- ----------
Last June we introduced Interactive Internet Banking (including bill paying),
moving a step closer to creating a true virtual bank. With a virtual bank, most
of the transactions done at a physical branch can instead be performed from
one's home or office via computer. The introduction of this new product means
that we now offer customers the full gamut of technological services -
electronic commerce, home banking and Internet, as well as our voice response
system, ATMs and platform branch automation. With a push of a button, click of a
mouse, or phone call, our customers can access their accounts and Company
information 24 hours a day, 7 days a week. During 1999 we are
[GRAPHIC-PHOTO]
13
<PAGE>
planning to expand our Internet system to download digital cash onto a card
straight from a banking account. We also plan to complete our fiber optic system
interconnecting all our branches. Another project is to expand our call center,
which includes developing customer profiling analysis.
As has been widely reported, computers worldwide are programmed to read only the
last two digits of a calendar year, to save computer memory. Now thousands of
lines of computer code must be rewritten to stop computers from reading "1900"
instead of "2000".
The Company is on schedule in making changes in software coding needed to fix
this "Year 2000" problem. The estimated cost of this work is only $300,000,
which includes the investment in equipment and software. As of the date of this
report, we have completed the assessment of our Year 2000 Plan, plus most of the
remediation, testing and validation phases of the Plan. We are on schedule with
the steps called for in our Year 2000 Plan and no delays have been experienced.
The most important computer applications used by the mortgage company - those
related with loan originations and servicing - are already being approved by the
Mortgage Bankers Association of America as Year 2000-compliant under the
Inter-System Readiness Test.
Other Developments
- ------------------
Last December we increased the size of our central office in Hato Rey to 60,000
square feet and 398 parking spaces. We are planning to expand this facility
further by constructing a twenty-story office tower next to our existing
building. This new tower will add 124,000 square feet of office space, 7,000
square feet of commercial space, and parking facilities for 387 cars (See
rendering of the proposed building elsewhere in this report). Combined, both
buildings will have total office space of 184,000 square feet and parking
facilities for 785 cars - enough space to meet our future needs. At the
completion of this expansion, our facilities will be about 60 times the size of
the Companys original building, which had only 3,000 square feet when it was
built in 1979.
Last September the island was affected by Hurricane Georges, probably one of the
greatest disasters ever to strike Puerto Rico. The economy of the island was
severely affected, but has now returned to pre-hurricane levels - thanks to the
strong assistance provided by the Commonwealth and the federal government, and
to the efforts and sacrifices made by all of the islands people. Most of the
main business sectors, such as manufacturing, tourism and construction, are
already in full gear. At the end of November, Puerto Rico reached a level of
employment that implied that the damage caused by the hurricane had basically
been overcome.
We are pleased with the Company's results for 1998. We significantly increased
loan originations and added $478 million of unsold loans to our balance
14
<PAGE>
sheet, expanding our earning-assets base. As a result, total assets grew to a
record $2.0 billion, and our servicing portfolio increased to a record $4.8
billion. Total assets under administration (including our servicing portfolio),
grew to $6.9 billion during 1998, rising 52% from the prior year. All of these
accomplishments led to a strong improvement in revenues and net income for 1998.
We are optimistic that these accomplishments will translate into increased
profitability in the future.
The Company will continue to emphasize strong capital ratios, good asset
quality, expense control and increased fee income as key financial sources of
future success. Our competitive advantage is a talented, motivated and highly
trained staff that is compensated through carefully designed incentive programs.
Employees are committed to delivering exceptional products and services to our
customers. We are a unique financial company, focused on a limited number of
well-crafted financial products coupled with old-fashioned personalized service.
This focus, and our values, provide the foundation for improving our return on
equity, achieving consistent top performance, and rapidly building shareholder
value.
The future is bright for R&G. We believe that the Company's strong position in
the mortgage sector, combined with its rapidly expanding banking operation, will
continue producing asset and earnings growth in the future, which should boost
the value of our shares. Moreover, market demand is strong across all our
business lines, and we have the internal and external financial resources we
need to continue our planned growth. R&G is already a widely recognized
financial brand with a significant franchise in the Puerto Rico market.
I wish to express my appreciation to our valued customers for their patronage,
to our great people for being the very best at what they do, to our directors
for their exceptional dedication to the Company's success, and to our owners for
their confidence and support. We are optimistic that 1999 will be another good
year for the Company.
/S/Victor J. Galan
- -----------------
Victor J. Galan
Chairman of the Board and
Chief Executive Officer
R&G Financial Corporation
15
<PAGE>
Investing for the Future
- ------------------------
As we approach the year 2000, we see two challenges in particular affecting the
banking industry: consolidation and technological change. More than ever,
staying ahead means being prepared. It is essential that R&G maintain its
leadership not only in banking and mortgage products, but also in technology. We
must keep pace with technology if we are to provide the most complete and
advanced services to our customer.
Our strategic plan for 1999 consists of the following key elements:
1. Continue to expand the Company's branch network into desirable locations in
Puerto Rico in order to gain access to additional retail funding sources and
loan business.
2. Retain a portion of our residential, commercial and consumer loan production
volume and the associated servicing (thereby benefiting from economies of
scale).
3. Continue to utilize advanced technology and automated processes throughout
the Company's business to improve customer service, reduce the costs of loan
production and servicing, and increase efficiencies.
4. Cross-sell retail banking services to the Company's large base of mortgage
customers.
As time becomes an increasing valued commodity in daily life, customers will
increasingly demand faster, more convenient service. Only the latest technology
will be able to satisfy these expectations. Technology will become an enabler
for new products and services that will be offered with the quality personal
service that has given R&G a competitive edge in the market.
Right: Over one thousand employees form the R&G work force. People who work as a
team sharing a common vision and a commitment to quality service to each and
every customer.
16
<PAGE>
[GRAPHICS-MAPS]
17
<PAGE>
Our People as a Competitive Advantage
- -------------------------------------
At R&G, the most important value we hold is our belief in people as a
competitive advantage. Our products can be copied and our training and
technology duplicated. Nobody, however, can match our corps of talented, highly
motivated people who care.
To maintain this advantage, we must do even better in training, rewarding and
recognizing all our team members. We must build an inclusive work environment
and a diverse organization. All members of our team should know that they are
valued, that they can go as far as their ability and desire to work hard will
take them. We have created a process to provide the right kind of training for
the right kind of skills rewarding and recognizing the right behaviors. We have
identified the outstanding skills of our best managers. We want to extend those
winning attributes across the Company. R&G's success has much more to do with
attitude than with aptitude... with what is in our hearts, not just our heads.
Our team members care for their customers, for each other, for our communities
and for our stockholders. Because we believe in people as our competitive
advantage, we will continue to invest in our "human capital". It is the most
important, valuable investment we can make.
Building people skills is the way R&G will grow and excel in an age of
lightning-fast technological change, intense competition and volatile markets.
Our portfolio of people skills built around core competencies - not our
portfolio of changing businesses and products - will be critical to our success
regardless of economic conditions.
The best financial services companies must do literally hundreds of things well.
In doing most of these things, we need only be as good as the competition. In
the following core competencies however, our performance must be outstanding,
clearly superior to that of the competition:
A QUALITY WORK FORCE: We must attract, develop, retain and motivate a diverse
group of the most talented people.
SELLING ABILITY: We must recognize that we are all salespeople, and be proud of
it!
QUALITY SERVICE: Superb salespeople know the importance of service. There is no
sale without ongoing excellent service from our entire team - from the front
office to the operations center and everywhere in between. We need to provide
such great service that our customers become "raving fans".
18
<PAGE>
[GRAPHIC-PHOTOS OF R&G EMPLOYEES]
19
<PAGE>
[GRAPHIC-PHOTOS OF R&G EMPLOYEES]
20
<PAGE>
Risk management: To be the best in financial services, we must be the best at
managing risk.
Technological competence: We must quickly and effectively develop and use the
latest technology.
Positive work environment: We must ensure that our people enjoy their work. We
will not be better than our competitors in sales and service unless the
environment our team members work in is enjoyable and fun. The attitude of our
team members - their commitment to customers, co-workers, stockholders and the
community - is the single most important factor in making us a great financial
services company, not merely a good one.
21
<PAGE>
[GRAPHIC-PHOTO OF BOARD OF DIRECTORS]
22
<PAGE>
Corporate Information
Board of Directors of R&G Financial Corporation
Vctor J. Galn,
Chairman of the Board and
Chief Executive Officer
Ramn Prats,
Vice Chairman of the Board and
Executive Vice President of RGM
Ana M. Armendriz,
Treasurer of the Board and
Senior Vice President of Finance RGM
Enrique Umpierre Surez,
Secretary of the Board and
Attorney in private practice
Benigno R. Fernndez,
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 capacities 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. Daz,
Senior Vice President-Loan
Administration RGM
Laureano Cars Abarca,
Chairman of Alonso Carus Iron Works in Catao, P.R.,
manufacturers of metal products
Pedro Ramrez,
President & CEO of Empresas Nativas, Inc.,
local real estate development firm
Vctor L. Galn,
Vice President Branch Administration
RGM and Champion Mortgage
Ileana Coln Carlo,
CPA
Former Comptroller of the Commonwealth of Puerto Rico
Roberto Gorbea,
Engineer
President & CEO of Lord Electric Company of Puerto Rico, Inc.
23
<PAGE>
Officers of R-G Financial Corporation
Senior Management Team
Vctor J. Galn, Chairman, President and CEO
Ramn Prats, Executive Vice President of RGM
Joseph R. Sandoval, Senior Vice President and CFO
Juan J. Daz, Senior Vice President Loan Administration RGM
Mario Ruiz, Senior Vice President Secondary Market, RGM
Ana M. Armendriz, Senior Vice President Finance RGM
Ivn Vlez, Senior Vice President Operations RGPB
Jose L. Ortz, Vice President Finance RGPB
William Martnez, Vice President Administration RGM
Sonia I. Vzquez, Vice President and General Auditor
Production Group
Dennis C. Tristani, Senior Vice President Commercial Lending RGPB
Felipe Franco, Senior Vice President Consumer Lending RGPB
Roberto Crdova, Senior Vice President Loan Production RGM
Steven Vlez, Senior Vice President Underwriting & Technology RGM
Edwin Reyes, Vice President Branch Administration RGPB
Vctor L. Galn, Vice President Branch Administration RGM & Champion Mortgage
Ricardo Agudo, Vice President New Housing RGM
Jeannette Mir, Vice President Marketing RGPB
Ismenia Isidor, Vice President Closings Department RGM
24
<PAGE>
Stockholder Information
Corporate Office
R&G Plaza
280 JT Pi-ero Ave.
San Juan, PR 00918
Telephone (787) 758-2424
Annual Meeting
April 29, 1999, 10:00 a.m. Atlantic time
Bankers Club, Hato Rey, PR
Transfer Agent and Registrar
American Stock Transfer & Trust Co.
40 Wall Street- 46th Floor
New York, NY 10005
Independent Public Accountants
PricewaterhouseCoopers, LLP
BBV Tower - 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 & Valds
270 Mu-oz 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 Mu-oz 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, 1998 with the Securities and Exchange Commission. Copies
of its Annual Report and quarterly reports may be obtained without charge by
contacting:
<PAGE>
[GRAPHIC-GRAPH DEPICTING STOCK PERFORMANCE COMPARED WITH PUERTO RICO PEER GROUP]
[GRAPHIC-GRAPH DEPICTING STOCK PRICE BEHAVIOR]
Sonia Coln, Investor Relations
Telephone (787) 756-2801
Stock Listings
Symbol: RGFC-NASDAQ
RGFCP-NASDAQ
At December 31, 1998, the Company had 145 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 stock splits paid in 1998 and 1997) for the Company's stock during each
quarter during the last two fiscal years is as follows:
<TABLE>
<CAPTION>
Mar 31 Jun 30 Sep 30 Dec 31 Mar 31 Jun 30 Sep 30 Dec 31
1997 1997 1997 1997 1998 1998 1998 1998
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
High 7.778 7.222 11.25 11.00 17.25 21.50 21.25 21.50
Low 6.319 6.458 7.083 9.3125 9.625 16.407 15.0625 12.25
Dividends Paid 0.01910 0.02083 0.02153 0.02287 0.02500 0.02687 0.02875 0.03075
</TABLE>
<PAGE>
SELECTED CONSOLIDATED FINANCIAL
AND OTHER DATA OF R&G FINANCIAL December 31, 1998
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, 1998.
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,
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ---------
(Dollars in Thousands, except for per share data)
<S> <C> <C> <C> <C> <C>
Selected Balance Sheet Data:
Total assets(1) $2,044,781 $1,510,746 $1,037,798 $ 853,206 $ 622,499
Loans receivable, net 1,073,668 765,059 603,751 473,841 301,614
Mortgage loans held for sale 117,126 46,885 54,450 21,318 22,021
Mortgage-backed and investment securities held for trading 450,546 401,039 110,267 113,809 124,522
Mortgage-backed securities available for sale 95,040 46,004 50,841 61,008 13,300
Mortgage-backed securities held to maturity 28,255 33,326 37,900 41,731 84,122
Investment securities available for sale 59,502 75,863 30,973 3,280 1,878
Investment securities held to maturity 6,344 10,693 5,270 2,046 2,182
Cash and cash equivalents(2) 103,728 68,366 98,856 104,195 45,622
Deposits 1,007,297 722,418 615,567 518,187 380,148
Securities sold under agreements to repurchase 471,422 433,135 97,444 98,483 108,922
Notes payable 191,748 108,453 126,842 81,130 45,815
Other borrowings(3) 121,000 86,359 65,463 67,315 18,092
Stockholders equity 221,162 138,054 115,633 66,385 55,970
Common Stockholders equity per share(4) $ 5.99 $ 4.88 $ 4.09 $ 3.55 $ 3.00
Selected Income Statement Data:
Revenues:
Net interest income after provision for loan losses $ 37,373 $ 30,160 $ 24,665 $ 20,323 $ 19,137
Loan administration and servicing fees 15,987 13,214 13,029 11,030 11,046
Net gain on sale of investments available for sale 278 107 642 -- --
Net gain (loss) on sale of loans(5) 34,663 24,033 11,709 8,384 (2,899)
Other(6) 5,542 3,751 3,872 4,028 1,667
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue 93,843 71,265 53,917 43,765 28,951
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Expenses:
Employee compensation and benefits 17,095 13,653 10,794 8,284 5,252
Office occupancy and equipment 8,987 7,131 5,531 4,711 4,488
SAIF special assessment -- -- 2,508 -- --
Other administrative and general 22,687 18,252 15,424 13,731 13,269
Total expenses 48,769 39,036 34,257 26,726 23,009
Income before minority interest in the Bank and income
taxes 45,074 32,229 19,660 17,039 5,942
Minority interest in the Bank's earnings -- -- 538 743 500
Income taxes 11,040 8,732 5,922 5,847 856
Cumulative effect of change in accounting principle -- -- -- -- 866
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 34,034 $ 23,497 $ 13,200 $ 10,449 $ 5,452
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share (4) $ 1.12 $ 0.81 $ 0.59 $ 0.56 $ 0.29
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
1998 1997 1996 1995 1994
----------- ---------- ---------- ---------- ----------
Selected Operating Data(7): (Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Performance Ratios and Other Data:
Mortgage loans originated and purchased $ 1,237,415 $ 758,486 $ 480,525 $ 327,107 $ 501,187
Mortgage servicing portfolio 4,827,798 3,000,888 2,550,169 2,298,200 2,114,743
Return on average assets(7) 1.95% 1.85% 1.38% 1.47% 0.91%
Return on average common equity(7) 21.32 18.69 15.54 17.08 10.34
Equity to assets at end of period 10.82 9.13 11.14 7.78 8.94
Interest rate spread(8) 2.43 2.88 3.00 2.93 3.24
Net interest margin(8) 2.72 3.12 3.24 3.26 3.48
Average interest-earning assets to average
interest-bearing liabilities 105.93 104.61 104.60 106.50 105.60
Total non-interest expenses to average total assets 2.80 3.08 3.59 3.80 3.84
Full-service Bank offices 20 15 15 14 8
R&G Mortgage offices(9) 23 19 16 13 13
Cash dividends declared per common share(4) .111 .065 .069(9) -- --
Asset Quality Ratios(11):
Non-performing loans to total loans at end of period 4.11% 3.89% 3.09% 2.18% 1.84%
Non-performing assets to total assets at end of period 2.41 2.12 1.90 1.32 1.04
Allowance for loan losses to total loans at end of period 0.74 0.87 0.55 0.72 0.92
Allowance for loan losses to total non-performing
loans at end of period 17.92 22.34 17.64 33.19 50.10
Net charge-offs to average loans outstanding 0.55 0.40 0.75 0.08 0.05
Bank Regulatory Capital Ratios(12):
Tier 1 risk-based capital ratio 13.41% 13.10% 13.91% 10.53% 11.03%
Total risk-based capital ratio 14.46 14.00 14.79 11.66 13.59
Tier 1 leverage capital ratio 8.04 7.34 8.45 6.25 5.95
</TABLE>
(footnotes on following page)
26
<PAGE>
1) At December 1998, R&G Mortgage and the Bank had total assets of $652.9
million and $1.412 billion, 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.
(4) Per share information for all periods presented takes into consideration a 2
for 1 stock split paid in June 1998 and an 80% stock dividend paid in September
1997.
(5) Includes $2.9 million gain on sale servicing rights in 1994.
(6) Comprised of change in provision for cost in excess of market value of loans
held for sale, net gain on trading account, and other miscellaneous revenue
sources, including Bank service charges, fees and other income.
(7) With the exception of end of period ratios, all ratios for R&G Mortgage are
based on the average of month end balances while all ratios for the Bank are
based on average daily balances.
(8) 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".
(9) Includes 2 branches of Champion Mortgage Corporation, R&G Mortgages wholly
owned subsidiary. Also includes 14 R&G Mortgage banking facilities which are
located within the Banks offices.
(10) Includes $500,000 or $0.025 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.
(11) 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 1998 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, 1998 amounted to
67.29%.
(12) All of such ratios were in compliance with the applicable requirements of
the FDIC.
27
<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 20 offices at December 31, 1998) and, without taking
into consideration possible branch acquisition opportunities, the Bank presently
anticipates opening from three to five 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.
<PAGE>
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 and off-balance sheet commitments, determine the appropriate level of
risk given R&G Financial's business focus, operating environment, capital and
liquidity requirements and performance objectives, establish prudent asset
concentration guidelines and manage the risk consistent with Board approved
guidelines. Through such management, R&G Financial seeks to reduce the
vulnerability of its operations to changes in interest rates and to manage the
ratio of interest rate sensitive assets to interest rate sensitive liabilities
within specified maturities or repricing dates.
The Bank's asset and liability management function is under the guidance of the
Interest Rate Risk, Budget and Investments Committee ("IRRBICO"), which is
chaired by the Chief Executive Officer and comprised principally of members of
the Bank's senior management and at least three members of the Board of
Directors. The IRRBICO meets once a month to review, among other things, the
sensitivity of the Bank's assets and liabilities to interest rate changes, the
book and market values of assets and liabilities, unrealized gains and losses,
purchase and sale activity and maturities of investments and borrowings. In
connection therewith, the IRRBICO generally reviews the Bank's liquidity, cash
flow needs, maturities of investments, deposits and borrowings and current
market conditions and interest rates.
The Bank's primary IRRBICO monitoring tool is asset/liability simulation models,
which are prepared on a monthly basis and are designed to capture the dynamics
of balance sheet, rate and spread movements and to quantify variations in net
interest income under different interest rate environments. The Bank also
utilizes market-value analysis, which addresses the change in equity value
arising from movements in interest rates. The market value of equity is
estimated by valuing the Bank's assets and liabilities. The extent to which
assets have gained or lost value in relation to the gains or losses of
liabilities determines the appreciation or depreciation in equity on a market
value basis. Market value analysis is intended to evaluate the impact of
immediate and sustained interest-rate shifts of the current yield curve upon the
market value of the current balance sheet. A more conventional but limited
IRRBICO monitoring tool involves an analysis of the extent to which assets and
liabilities are interest rate sensitive and measuring an institutions 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, 1998, 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
$241.2 million, or 11.80% 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.
<PAGE>
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 Mortgag'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 customers 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
28
<PAGE>
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, 1998, R&G Mortgage had $93.2
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, 1998, R&G
Mortgage held $450.5 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. On January 1,1999 R&G Mortgage
reclassified $427.4 million of mortgage-backed securities from trading to
available for sale upon adoption of a new accounting pronouncement. See Recent
Accounting Pronouncements.
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. R&G Mortgage may also use interest
rate swaps, caps, collars, options and futures to effectively fix the cost of
short-term funding sources which are used to originate and or purchase
interest-earning assets with longer effective maturities, such as
mortgage-backed securities and fixed rate residential mortgage loans held prior
to sale in the secondary market. Such agreements thus reduce the impact of
increases in interest rates by preventing R&G Mortagage from having to replace
funding sources at a higher cost prior to the time that the interest-earning
asset which was originated or purchased with such source matures, reprices or is
sold, and thus can be replaced with a higher-yielding asset.
At December 31, 1998 R&G Mortgage was a party to four interest rate swap
agreements. An interest rate swap is an agreement where one party (generally the
Company) 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
<PAGE>
predetermined period of time. No actual assets are exchanged in a swap of this
type and interest payments are generally netted. R&G Mortgage's existing
interest rate swap agreements have an aggregate notional amount of approximately
$100.0 million and expire from June 8 to June 17, 2008. With respect to such
agreements, R&G Mortgage makes fixed interest payments ranging from 5.00% to
5.17% and receives payments based upon the three-month London Interbank Offer
Rate (Libor). The net interest received relating to R&G Mortgages fixed-pay
interest rate swaps amounted to approximately $248,000 during the year ended
December 31, 1998. Such interest rate contracts have reduced the imbalance
between R&G Mortgage's interest-earning assets and interest-bearing liabilities
within shorter maturities, thus reducing R&G Mortgage's exposure to increases in
interest rates that may occur in the future.
As discussed above, R&G Mortgage may also enter into interest rate collars,
caps, options and futures. However, at December 31, 1998 R&G Mortgage 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 Company), 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.
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, 1998, the Bank's interest-earning
assets included a portfolio of loans receivable, net of $1.1 billion and a
portfolio of investment securities and mortgage-backed securities (including
held to maturity and available for sale) of $189.1 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, 1998, $154.5 million or 81.7% of the Bank's
mortgage-backed and investment securities were classified as available for sale
and reported at fair value, with unrealized gains and losses excluded from
earnings and reported net of taxes in other comprehensive income, a separate
component of stockholders' equity.
<PAGE>
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, 1998,
mortgage-backed securities available for sale had a fair value of $95.0 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
29
<PAGE>
sale to the FNMA or the FHLMC in the secondary market. Such agreements 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, 1998, the Bank was a party to eight interest rate swap
agreements. The Bank's existing interest rate swap agreements have an aggregate
notional amount of approximately $105.0 million and expire from October 24, 2000
to September 15, 2003. With respect to such agreements, the Bank makes fixed
interest payments ranging from 4.70% to 6.09% and receives payments based upon
the three-month Libor and Libid. The net expense relating to the Bank's
fixed-pay interest rate swaps amounted to approximately $198,000, $293,000 and
$61,000 during the years ended December31, 1998, 1997 and 1996, 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 31,1998 the Bank was not a party to
any such interest rate contracts. 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, 1998, based on the information
and assumptions set forth in the notes below.
30
<PAGE>
<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 $ 25,768 $ 72,414 $ 163,489 $ 127,299 $ 365,459 $ 754,429
Construction loans 3,934 12,287 -- -- -- 16,221
Commercial real estate loans 119,336 49 152 188 1,668 121,393
Consumer loans 20,480 43,936 52,860 18,598 7,787 143,661
Commercial business loans 21,714 11,368 11,794 1,618 38 46,532
Mortgage loans held for sale 31,258 85,868 -- -- -- 117,126
Mortgage-backed securities(2)(3) 46,058 130,774 153,974 123,186 119,851 573,843
Investment securities(3) 22,845 32,745 6,472 1,664 2,120 65,846
Other interest-earning assets(4) 51,922 -- -- -- -- 51,922
Total $ 343,315 $ 389,441 $ 388,741 $ 272,553 $ 496,923 $1,890,973
Interest-bearing liabilities:
Deposits(5):
NOW and Super NOW accounts(6) $ 5,823 $ 16,307 $ 17,927 $ 14,521 $ 61,905 $ 116,483
Passbook savings accounts(6) 2,730 7,908 18,193 14,737 62,825 106,393
Checking and commercial checking(6) 8,625 24,147 26,546 21,501 91,664 172,483
Certificates of deposit 170,690 320,134 60,930 46,969 11,189 609,912
FHLB advances 10,000 10,000 52,000 10,000 39,000 121,000
Securities sold under agreements to repurchase 471,422 -- -- -- -- 471,422
Other borrowings(7) 107,648 23,600 60,500 -- -- 191,748
Total 776,938 402,096 236,096 107,728 266,583 1,789,441
Effect of hedging instruments (205,000) -- 50,000 55,000 100,000 --
$ 571,938 $ 402,096 $ 286,096 $ 162,728 $ 366,583 $1,789,441
Excess (deficiency) of interest-earning
assets over interest-bearing liabilities $ (228,623) $ (12,655) $ 102,645 $ 109,825 $ 130,340
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities $ (228,623) $ (241,278) $ (138,633) $ (28,808) $ 101,532
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities as a
percent of total assets (11.18)% (11.80)% (6.78)% (1.41)% 4.96%
</TABLE>
31
<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 Office of Thrift
Supervision ("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 table assumes that funds will be withdrawn from the Bank at annual rates for
NOW accounts and for checking and commercial checking accounts, ranging from 10%
for 0-12 months, 19% for 1-5 years, 41% for 5-10 years, 65% for 10-20 years and
100% thereafter; and, for passbook savings accounts, ranging from 5% for 0-12
months, 19% for 1-5 years, 40% for 5-10 years, 65% for 10-20 years and 100%
thereafter.
(7) Comprised of warehousing lines and notes payable.
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 assumptions about
changes in prepayment tendencies, deposit or loan maturity preferences or
repricing time lags that may occur in response to a change in the interest rate
environment. As a result, R&G Financial, through simulation models, also
analyzes on a monthly basis the estimated effects on net interest income and
equity under multiple rate scenarios, including increases and decreases in
interest rates amounting to 400, 300, 200 and 100 basis points. The IRRBICO
regularly reviews interest rate risk by forecasting the impact of alternative
interest rate scenarios on net interest income and on R&G Financial's MVPE,
which is defined as the net present value of an institutions existing assets,
liabilities and off-balance sheet instruments, and by evaluating such impact
against the maximum potential changes in net interest income and MVPE.
The following table sets forth at December 31, 1998 the estimated percentage
change in R&G Financial's MVPE based on the indicated changes in interest rates.
<PAGE>
MVPE(2)
- --------------------------------------------------------------------------------
Change in Change as a
Interest Rates Amount Percentage Percentage
(in Basis Points)(1) of Change Change of Assets
- --------------------------------------------------------------------------------
(Dollars in Thousands)
+400 $ (59,840) (27.5)% (2.93)%
+300 (44,671) (20.5) (2.18)
+200 (29,436) (13.5) (1.44)
+100 (14,416) (6.6) (.70)
-- -- -- --
-100 28,960 13.3 1.42
-200 59,405 27.3 2.90
-300 118,500 54.4 5.79
-400 193,757 89.0 9.47
(1) Assumes an instantaneous uniform change in interest rates at all maturities.
(2) Based on R&G Financial's pre-tax MVPE of $217.7 million at December 31,
1998, which is approximately $3.5 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, 1998, R&G Financial's total assets amounted to $2.0 billion, as
compared to $1.5 billion at December 31, 1997. The $534.0 million or 35.3%
increase in total assets during the year ended December 31, 1998 was primarily
the result of a $308.6 million or 40.3% increase in loans receivable, net, a
$99.1 million or 22.2% increase in mortgage-backed securities held for trading
and available for sale, and a $70.2 million or 149.8% increase in mortgage loans
held for sale, which are attributable to the origination of $1.4 billion of
loans, primarily single-family residential loans, before reduction for
repayments and sales. In addition the Company had a $37.0 million or 174.5%
increase in its servicing asset, which is primarily the result of loan
originations during the year net of repayments, and the purchase of a
residential mortgage loans servicing portfolio of approximately $1.1 billion
from another financial institution in Puerto Rico.
<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 $103.7 million and
$68.4 million as of December31, 1998 and 1997, respectively.
Loans Receivable and Mortgage Loans Held for Sale.
At December 31, 1998, R&G Financial's loans receivable, net amounted to $1.1
billion or 52.5% of total assets, as compared to $765.1 million or 50.6% as of
December31, 1997. 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, 1998, 1997 and 1996, total
loans originated and purchased by the Bank (including loans originated by R&G
Mortgage on behalf of the Bank) amounted to $755.1 million, $435.4 million and
$342.2 million, respectively.
At December 31, 1998, R&G Financial's allowance for loan losses (all of which is
maintained in the Bank's loan portfolio) totalled $8.1 million, which
represented a $1.3 million or 18.9% increase from the level maintained at
December31, 1997. At December 31, 1998, R&G Financia's allowance represented
approximately 0.74% of the total loan portfolio and 17.92% of total
non-performing loans, as compared to 0.87% and 22.34% at December31, 1997. The
increase in the allowance for loan losses is attributable to the provision of
$6.6 million for loan losses during the year, which was primarily attributable
to the overall growth in the loan portfolio.
Management of R&G Financial believes that its allowance for loan losses at
December 31, 1998 was adequate, based upon, among other things, the significant
level of single-family residential loans
32
<PAGE>
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, 1998 and 1997, mortgage loans held for sale amounted to $117.1
million and $46.9 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. At December 31, 1998, R&G Financials
aggregate mortgage-backed and investment securities totaled $639.7million or
31.3% of total assets, as compared to $566.9 million or 37.5% at December 31,
1997, 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 Banks
Trust Department. At December 31, 1998 and 1997, securities held for trading
amounted to $450.5 million and $400.4 million, respectively. At December 31,
1998, all such securities were held by R&G Mortgage. 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 December31,
1998 and 1997, securities available for sale totaled $154.5 million and $121.9
million, respectively. Securities available for sale are reported at fair value
with unrealized gains and losses excluded from earnings, and reported in other
comprehensive income, 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, 1998 and
1997, securities held to maturity totaled $34.6 million and $44.0 million,
respectively. Securities held to maturity are accounted for at amortized cost.
At December 31, 1998 and 1997, R&G Financials securities held to maturity had a
market value of $34.6 million and $43.8 million, respectively.
Mortgage Servicing Asset.
As of December 31, 1998 and 1997, R&G Financial reported servicing assets of
$58.2 million and $21.2 million, respectively. R&G Financial recognizes both
purchased and originated mortgage servicing rights as assets in its Consolidated
Financial Statements. R&G Financial evaluates the fair value of its servicing
asset on a quarterly basis 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 the value of R&G Financial's
mortgage servicing rights, which is dependent upon the cash flows from the
underlying mortgage loans.
<PAGE>
Deposits.
At December 31, 1998, deposits totaled $1.0 billion, as compared to $722.4
million at December 31, 1997. The $284.9 million or 39.4% increase in deposits
during the year ended December 31, 1998 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 $266.4 million or 36.9% of total
deposits at December 31, 1997 to $395.4 million or 39.2% of total deposits at
December 31, 1998.
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, 1998 and 1997, repurchase
agreements totaled $471.4 million and $433.1 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, 1998, notes payable amounted to $191.7 million, as compared to
$108.4 million at December 31, 1997. The $83.3 million or 76.8% increase in
notes payable during the year ended December 31, 1998 reflected $83.3 million or
342.0% of increased warehousing lines.
Advances from the FHLB of New York amounted to $121.0 million and $42.0 million
at December 31, 1998 and 1997, respectively. At December 31, 1998, FHLB advances
were scheduled to mature at various dates commencing on January 7, 1999 until
March 10, 2008, with an average interest rate of 5.25%.
At December 31, 1997, R&G Financial reported approximately $34.4 million of
other secured borrowings, representing the outstanding principal at such date of
certain mortgage loans sold by the Bank in prior years which had been accounted
as a transfer of loans with recourse in the Company's Consolidated Financial
Statements. In such transaction, the purchasers of the loans had the right, at
their option, to require R&G Mortgage to purchase the loans. In January 1998 the
Company repurchased the loans.
Stockholder' Equity.
Stockholders' equity increased from $138.1 million at December31, 1997 to $221.2
million at December31, 1998. The $83.1 million or 60.2% increase in stockholders
equity during 1998 was primarily due to the issuance of $50 million of 7.40%
non-cumulative, perpetual Monthly Income Preferred Stock, Series A (the "Series
A Preferred Stock"), the $34.0 million net income for the year, and an increase
in unrealized gains on securities available for sale from $1.2 million at
December 31, 1997 to $1.4 million at December 31, 1998. The increases in
stockholders' equity were slightly offset by dividends paid during the year of
$4.4 million on common and preferred stock.
<PAGE>
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 non-interest 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 non-interest 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 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 Banks Trust
Department.
33
<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,
--------------------------------------------------------------------------
1998 1997 1996
-------------------- --------------------- --------------------
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 $31,193 33.24% $25,544 35.84% $20,884 38.73%
Net gain on sale of loans 12,191 12.99 5,436 7.63 1,355 2.51
Net gain on sale of investment securities 278 0.30 107 0.15 642 1.19
Other income(1) 4,780 5.09 2,915 4.09 3,664 6.80
------------------------------------------------------------------------
48,442 51.62 34,002 47.71 26,545 49.23
------------------------------------------------------------------------
R&G Mortgage:
Net interest income 6,180 6.58 4,616 6.48 3,781 7.01
Loan administration and servicing fees 15,987 17.04 13,214 18.54 13,029 24.17
Net gain on origination and sale of loans 22,472 23.95 18,597 26.10 10,354 19.20
Other income(1) 762 0.81 836 1.17 208 0.39
------------------------------------------------------------------------
45,401 48.38 37,263 52.29 27,372 50.77
------------------------------------------------------------------------
$93,843 100.00% $71,265 100.00% $53,917 100.00%
========================================================================
</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 $34.0 million, $23.5 million and $13.2
million during the years ended December 31, 1998, 1997 and 1996, respectively.
Net income increased by $10.5 million or 44.8% during the year ended December
31, 1998, as compared to 1997, due to a $7.4 million increase in net interest
income and a $15.4 million increase in total other income, which were partially
offset by a $9.7 million increase in total operating expenses. 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 a 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 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.
<PAGE>
Net interest income totaled $43.9 million, $36.5 million and $28.9 million
during the years ended December 31, 1998, 1997 and 1996, respectively. Net
interest income increased by $7.4 million or 20.4% during the year ended
December 31, 1998 as compared to the year ended December 31, 1997, due to an
increase in the ratio of average interest-earning assets to average
interest-bearing liabilities from 104.61% for 1997 to 105.93% for 1998, which
was partially offset by a decrease in R&G Financials interest rate-spread from
2.88% for 1997 to 2.43% for 1998. Net interest income increased by $7.6 million
or 26.3% during the year ended December 31, 1997, 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.
34
<PAGE>
The following table presents for the periods indicated R&G Financial's total
dollar amount of interest from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities
expressed both in dollars and rates, and the net interest margin. The table does
not reflect any effect of income taxes. All average balances are based on the
average of month-end balances for R&G Mortgage and average daily balances for
the Bank in each case during the periods presented.
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997
Average Yield/ Average Yield/
Balance Interest Rate (1) Balance Interest Rate (1)
------- -------- -------- ------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Cash and cash equivalents(2) $ 25,731 $ 1,341 5.21 $ 30,967 $ 1,674 5.41%
Investment securities held for trading 344 19 5.52 5,466 328 6.00
Investment securities available for sale 57,042 3,338 5.85 51,105 3,205 6.27
Investment securities held to maturity 9,485 544 5.74 15,095 777 5.15
Mortgage-backed securities held for trading 406,123 24,876 6.13 249,930 17,174 6.87
Mortgage-backed securities available for sale 38,608 2,645 6.85 44,693 3,200 7.16
Mortgage-backed securities held to maturity 31,095 1,877 6.04 35,642 2,152 6.04
Loans receivable, net(3)(4) 1,037,829 89,044 8.58 732,064 68,514 9.36
FHLB of New York stock 8,517 614 7.21 4,710 311 6.60
--------------------------------------------------------------------------
Total interest-earning assets 1,614,774 $ 124,298 7.70 1,169,672 $ 97,335 8.32%
--------------------------------------------------------------------------
Non-interest-earning assets 129,498 98,880
--------------------------------------------------------------------------
Total assets $1,744,272 $1,268,552
==========================================================================
Interest-Bearing Liabilities:
Deposits $ 826,487 $ 38,439 4.65 $ 668,704 $ 32,434 4.85%
Securities sold under agreements to
repurchase(5) 416,249 23,876 5.74 226,771 13,483 5.95
Notes payable 186,147 12,641 6.79 151,440 9,616 6.35
Subordinated debt(6) 1,469 148 10.07 3,250 324 9.97
Other borrowings(7) 94,025 5,220 5.55 67,973 4,948 7.28
--------------------------------------------------------------------------
Total interest-bearing liabilities 1,524,377 $ 80,324 5.27% 1,118,138 $ 60,805 5.44%
--------------------------------------------------------------------------
Non-interest-bearing liabilities 46,025 24,680
Total liabilities 1,570,402 1,142,818
Stockholders equity 173,870 125,734
--------------------------------------------------------------------------
Total liabilities and stockholders' equity $1,744,272 $1,268,552
==========================================================================
Net interest income; interest rate spread(8) $ 43,974 2.43% $ 36,530 2.88%
==========================================================================
Net interest margin(8) 2.72% 3.12%
==========================================================================
Average interest-earning assets to average
interest-bearing liabilities 105.93% 104.61%
==========================================================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
1996
Average Yield/
Balance Interest Rate (1)
------- -------- --------
<S> <C> <C> <C>
Interest-Earning Assets:
Cash and cash equivalents(2) $ 43,072 $ 2,322 5.39%
Investment securities held for trading 2,271 116 5.11
Investment securities available for sale 19,102 1,193 6.25
Investment securities held to maturity 10,069 515 5.11
Mortgage-backed securities held for trading 136,618 9,258 6.78
Mortgage-backed securities available for sale 50,633 3,602 7.11
Mortgage-backed securities held to maturity 40,403 2,478 6.13
Loans receivable, net(3)(4) 587,730 54,044 9.20
FHLB of New York stock 3,999 258 6.45
------------------------------------
Total interest-earning assets 893,897 $ 73,786 8.25%
-----------------------------------
Non-interest-earning assets 61,480
-----------------------------------
Total assets $ 955,377
------------------------------------
Interest-Bearing Liabilities:
Deposits $561,548 $ 27,518 4.90%
Securities sold under agreements to
repurchase(5) 100,607 5,024 4.99
Notes payable 126,171 7,284 5.77
Subordinated debt(6) 3,250 332 10.21
Other borrowings(7) 63,118 4,705 7.45
-----------------------------------
Total interest-bearing liabilities 854,694 $ 44,863 5.25%
-----------------------------------
Non-interest-bearing liabilities 15,766
-----------------------------------
Total liabilities 870,460
Stockholders equity 84,917
-----------------------------------
Total liabilities and stockholders' equity $955,377
==================================
Net interest income; interest rate spread(8) $ 28,923 3.00%
Net interest margin(8) 3.24%
==================================
Average interest-earning assets to average
interest-bearing liabilities 104.60%
==================================
</TABLE>
(Footnotes on following page)
35
<PAGE>
(1) At December 31, 1998, the yields earned and rates paid were as follows: cash
and cash equivalents, 5.33%; investment securities held to maturity, 4.54%;
investment securities available for sale, 5.88%; mortgage-backed securities held
for trading, 6.71%; mortgage loans held for sale, 7.50%; loans receivable, net,
8.40%; FHLB of New York stock, 7.00%; total interest-earning assets, 7.64%;
deposits, 4.50%; securities sold under agreements to repurchase, 5.42%; notes
payable, 6.13%; other borrowings, 5.25%; total interest-bearing liabilities,
4.97%; interest rate spread, 2.67%.
(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 $367,000, $366,000
and $277,000 during the years ended December31, 1998, 1997 and 1996,
respectively or .41%, .53% and .51% of interest income on loans during such
respective periods.
(5) Includes federal funds purchased.
(6) Represents a seven-year subordinated capital note of the Bank issued in
1991, which was subject to an annual sinking fund requirement and matured in
1998.
(7) Comprised of long-term debt, advances from the FHLB of New York and other
secured borrowings.
(8) 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,
--------------------------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
--------------------------------------------------------------------------
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) $ (50) $ (283) $ (333) $ 5 $ (653) $ (648)
Investment securities held for trading (2) (307) (309) 49 163 212
Investment securities available for sale (239) 372 133 12 2,000 2,012
Investment securities held to maturity 56 (289) (233) 5 257 262
Mortgage-backed securities held for trading (3,031) 10,733 7,702 131 7,785 7,916
Mortgage-backed securities held to maturity -- (275) (275) (34) (292) (326)
Mortgage-backed securities available for sale (119) (436) (555) 26 (428) (402)
Loans receivable, net(2) (8,087) 28,617 20,530 1,191 13,279 14,470
FHLB of New York stock 52 251 303 7 46 53
--------------------------------------------------------------------------
Total interest-earning assets $(11,420) $ 38,383 $ 26,963 $ 1,392 $ 22,157 $ 23,549
======== ======== ======== ======== ======== ========
Interest-Bearing Liabilities:
Deposits $ (1,648) $ 7,653 $ 6,005 $ (335) $ 5,251 $ 4,916
Securities sold under agreements to repurchase (873) 11,266 10,393 2,163 6,296 8,459
Notes payable 821 2,204 3,025 853 1,479 2,332
Subordinated debt(3) 2 (178) (176) (8) -- (8)
Other borrowings(4) (1,624) 1,896 272 (124) 367 243
--------------------------------------------------------------------------
Total interest-bearing liabilities $ (3,322) $ 22,841 $ 19,519 $ 2,549 $ 13,393 $ 15,942
======== ======== ======== ======== ======== ========
Increase in net interest income $ 7,444 $ 7,607
======== ======== ======== ======== ======== ========
</TABLE>
(Footnotes on following page)
36
<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) Includes mortgage loans held for sale.
(3) Represents a seven-year subordinated capital note of the Bank issued in
1991, which was subject to an annual sinking fund requirement and matured in
1998.
(4) Comprised of long-term debt, advances from the FHLB of New York and other
secured borrowings.
Interest Income.
Total interest income increased by $27.0 million or 27.7% during the year ended
December31, 1998 as compared to the year ended December 31, 1997, and increased
by $23.5 million or 31.9% during the year ended December 31, 1997 over the year
ended December 31, 1996. Interest income on loans, the largest component of R&G
Financial's interest-earning assets, increased by $20.5 million or 30.0% during
the year ended December 31, 1998 as compared to the year ended December 31,
1997, and increased by $14.4 million or 26.7% during 1997 over the year ended
December 31, 1996. Such increases were primarily the result of increases in the
average balance of loans receivable of $305.8 million and $144.3 million during
the years ended December31, 1998 and 1997, 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 $6.5 million or 24.1% during the year
ended December 31, 1998 as compared to the year ended December 31, 1997, and
increased by $9.7 million or 56.4% during the year ended December 31, 1997 over
the year ended December 31, 1996. The increase in interest income on
mortgage-backed and investment securities during the year ended December 31,
1998 was primarily due to a $156.2 million increase in the average balance of
mortgage-backed securities during the period. The increase in interest income on
mortgage-backed and investment securities during 1997 was due primarily to an
increase in the average balance of mortgage-backed securities of $102.6 million,
together with a $40.2 million increase in the average balance of investment
securities during the period. The increase in mortgage-backed securities during
1997 is primarily associated with a 63.9% increase in such year of FHA/VA
mortgage loan originations (which are subsequently converted into GNMA mortgage-
backed securities); the increase in investment securities reflects purchases of
approximately $50.2 million during such year, net of maturities and sales.
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 $333,000
or 19.9% during the year ended December31, 1998 as compared to the year ended
December 31, 1997, and decreased by $648,000 or 27.9% during the year ended
December 31, 1997. The decrease in interest earned on money market investments
during 1998 reflected a decrease in the average balance of $5.2 million,
together with a decrease in the yield from 5.41% to 5.21%. 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. The decrease during 1997 was due primarily to a decrease in the
average balance of cash and cash equivalents during the period of $12.1 million.
<PAGE>
Interest Expense.
Total interest expense increased by $19.5 million or 32.1% during the year ended
December 31, 1998, as compared to the year ended December 31, 1997, and
increased by $15.9 million or 35.5% during the year ended December 31, 1997.
Interest expense on deposits, the largest component of R&G Financial's
interest-bearing liabilities, increased by $6.0 million or 18.5% during the year
ended December 31, 1998, as compared to the year ended December 31, 1997, and
increased by $4.9 million or 17.9% during the year ended December31, 1997. The
increases in interest expense on deposits during the years ended December 31,
1998 and 1997 were due primarily to increases in the average balance of deposits
of $157.8 million and $107.2 million during such respective periods. During
1998, the average rate paid on deposits decreased by 20 basis points as a result
of a general decrease in market rates of interest. In 1997, the average rate
paid on deposits decreased by 5 basis points as a result of general decreases in
market rates of interest.
Interest expense on repurchase agreements increased significantly by $10.4
million or 77.1% during the year ended December 31, 1998, as compared to the
year ended December 31, 1997, and increased by $8.5 million or 168.4% during the
year ended December31, 1997. The increase in interest expense on repurchase
agreements during 1998 was due primarily to an increase in the average balance
of repurchase agreements outstanding of $189.5 million, which was partially
offset by a decrease in the average rate paid thereon of 21 basis points. The
increase in interest expense on repurchase agreements during 1997 was primarily
due 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. These
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 mainly a function both of the amount of
originations by R&G Financial as well as the level of mortgage-backed securities
held for trading which are available to collateralize such agreements.
Interest expense on notes payable (consisting of warehouse lines of credit and
promissory notes) increased by $3.0 million or 31.5% during the year ended
December 31, 1998, as compared to the year ended December 31, 1997, and
increased by $2.3 million or 31.5% during the year ended December 31, 1997. The
increases during the years ended December 31, 1998 and 1997 were primarily due
to increases in the average balance of warehousing lines of $35.6 million and
$25.6 million, respectively, as R&G Mortgage made increased use of such lines
due to increased mortgage loan originations in such years.
Interest expense on other borrowings (consisting of subordinated notes, advances
from the FHLB of New York and other secured borrowings) increased by $96,000 or
1.8% during the year ended December 31, 1998, as compared to the year ended
December 31, 1997, and increased by $234,000 or 4.6% during the year ended
December 31, 1997. The increase in interest expense on other borrowings during
1998 and 1997 was due primarily to an increase in the average balance of such
borrowings due to an increased use of FHLB advances to fund increased loan
production in the Bank.
<PAGE>
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 $6.6 million,
$6.4 million and $4.3 million during the years ended December 31, 1998, 1997 and
1996, respectively.
The increase in the provision for loan losses taken by the Company during 1997
was primarily based on the increase of the Companys loan portfolio during the
period, as R&G Financial experienced a 45.1% 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 during
1997. During 1997, management adopted more stringent consumer underwriting
procedures to address problems experienced generally in the market for personal
loans, and determined to emphasize collateralized consumer lending instead of
personal loans.
37
<PAGE>
The provision for loan losses taken by the Company during 1998 was based
primarily on the increase in the Companys loan portfolio during the period as a
result of a 57.3% increase in loans originated. In spite of an 11.4% increase in
bankruptcies in Puerto Rico during 1998, the provision for loan losses increased
by $200,000 during 1998.
Management believes that its allowance for loan losses at December 31, 1998, 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.
Non-Interest Income.
The following table sets forth information regarding non-interest income for the
periods shown.
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Net gain on origination and sale of loans $ 34,663 $ 24,033 $ 11,709
Net gain on sale of investment securities available for sale 278 107 642
Net profit (loss) on trading account 14 (854) (66)
Loan administration and servicing fees 15,987 13,214 13,029
Service charges, fees and other 5,528 4,605 3,938
Total other income $ 56,470 $ 41,105 $ 29,252
-------- -------- --------
</TABLE>
Total non-interest income increased by $15.4 million or 37.4% during the year
ended December 31, 1998, as compared to the prior year and increased by $11.9
million or 40.5% during the year ended December31, 1997. Net gain on sale of
loans amounted to $34.7 million, $24.0million and $11.7 million during the years
ended December31, 1998, 1997 and 1996, 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 December31, 1998, 1997 and 1996,
R&G Mortgage originated and purchased $670.6 million, $470.9 million and $282.4
million, respectively, and sold $493.0 million, $246.1 million and $244.8
million of mortgage loans, respectively. In addition, the Bank sold $282.0
million, $118.6 million and $49.7 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.
<PAGE>
During the years ended December 31, 1998, 1997 and 1996, R&G Financial
recognized net profit (loss) on trading securities of $6.0 million, $9.7 million
and $(96,000), respectively, which are included in net gains on sale of loans.
Such gains and losses primarily reflect fluctuations in the market value of 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 Banks Trust Department. The decrease in net
profits in trading securities in 1998 is primarily related to a $25.6 million or
5.8% decrease in the origination and purchase of FHA and VA loans in such year,
which is primarily related to the changes in the tax exemption on the interest
generated by such loans which went into effect on August 1, 1997, resulting in a
larger proportion of conventional loans from the Companys total loans originated
and purchased. 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.
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.
During the years ended December 31, 1998, 1997 and 1996, R&G Financial
recognized loan administration and servicing fees of $16.0 million, $13.2
million and $13.0 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 48,240 loans with an aggregate principal balance of
$2.3 billion at January 1, 1996 to 95,946 loans with an aggregate principal
balance of $4.8 billion at December 31, 1998, which includes the purchase in
November 1998 of a mortgage loans servicing portfolio from another financial
institution, comprised of approximately 33,000 loans with an aggregate principal
balance of $1.1 billion.
Service charges, fees and other amounted to $5.5 million, $4.6 million and $3.9
million during the years ended December 31, 1998, 1997 and 1996, respectively.
The $993,000 or 20.0% and the $667,000 or 16.9% increases during 1998 and 1997,
respectively, were
38
<PAGE>
primarily due to increased service charges associated with new deposit products
and an increasing deposit base, as well as increases in the loan portfolio
during such years.
Non-Interest Expenses.
The following table sets forth certain information regarding non-interest
expenses for the periods shown.
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
------- ------- -------
(In Thousands)
<S> <C> <C> <C>
Employee compensation
and benefits $17,095 $13,653 $10,793
Office occupancy and
equipment 8,987 7,131 5,531
SAIF special assessment -- -- 2,508
Other administrative and
general 22,687 18,252 15,424
------- ------- -------
Total non-interest expenses $48,769 $39,036 $34,256
======= ======= =======
</TABLE>
Total non-interest expenses increased by $9.7 million or 24.9% during the year
ended December 31, 1998, as compared to the year ended December 31, 1997, and
increased by $4.8 million or 13.9% during the year ended December31, 1997 over
1996. Without taking into consideration a one-time $2.5 million assessment to
recapitalize the SAIF, total non-interest expenses would have increased by $7.3
million or 23.0% in 1997. The increase in total non-interest expenses during the
years ended December 31, 1998 and 1997 reflect increases in total loan
production during such years as well as increased costs associated with the
opening of new branch offices and the completion in late 1997 of the remodeling
work at six branch locations acquired in June 1995 from another financial
institution in Puerto Rico. Employee compensation and benefits expense amounted
to $17.1 million, $13.6 million and $10.8 million during the years ended
December31, 1998, 1997 and 1996, respectively. The $3.4 million or 25.2%
increase in such expense during the year ended December 31, 1998 is primarily
associated with an increase in the number of employees to accomodate higher loan
production during the year, as well as to increased bonus payments associated
with the increased loan production. 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.
Office occupancy and equipment expense amounted to $9.0 million, $7.1 million
and $5.5 million during the years ended December31, 1998, 1997 and 1996,
respectively. The $1.9 million or 26.0% increase in office occupancy and
<PAGE>
equipment expenses during the year ended December 31, 1998 is primarily related
to the opening of five additional branches during the year and the completion in
late 1997 of the remodeling work of six branches aquired in 1995 from another
financial institution. The $1.6 million or 28.9% increase in expenses during
1997 is related to the opening of a new branch in Bayamon and to the completion
of remodeling work at the six branches acquired in 1995.
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 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 Banks insurance premiums, which had amounted to $0.23 for every $100
of assessable deposits, were 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 $22.7 million, $18.3 million and $15.4 million during the years
ended December31, 1998, 1997 and 1996, respectively. The $4.4 million or 24.3%
and the $2.8 million or 18.3% increase in such expenses during the years ended
December 31, 1998 and 1997, respectively, is also primarily associated with
increased loan production and new additional branch offices during such years,
as well as 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 $11.0 million during the year
ended December 31, 1998, as compared to income tax expense of $8.7 million and
$5.9 million during the years ended December 31, 1997 and 1996, respectively.
R&G Financial's effective tax rate amounted to 24.5%, 27.1% and 31.0% during the
years ended December 31, 1998, 1997 and 1996, respectively. The decrease in R&G
Financials effective tax rate during the last several years is due primarily to
an increase in the Companys 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 managements 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 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.
<PAGE>
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, 1998, R&G Financial had $101.4 million in borrowing capacity under
unused warehouse lines of credit and $533.5million 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, 1998, R&G Financial had outstanding commitments (including
unused lines of credit) to originate and/or purchase mortgage and non-mortgage
loans of $510.1 million. Certificates of deposit which are scheduled to mature
within one year totaled $491.7 million at December 31, 1998, and borrowings that
are scheduled to mature within the same period amounted to $622.7 million. R&G
Financial anticipates that it will have sufficient funds available to meet its
current loan commitments.
Capital Resources.
The FDICs 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
39
<PAGE>
ratio for such other banks to 4.0% to 5.0% or more. Under the FDICs 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,
1998, the Bank met each of its capital requirements, with Tier I leverage
capital, Tier I risk-based capital and total risk-based capital ratios of 8.04%,
13.41% and 14.46%, respectively.
In addition, the Federal Reserve Board has promulgated capital adequacy
guidelines for bank holding companies which are substantially similar to those
adopted by FDIC regarding state-chartered banks, as described above. R&G
Financial is currently in compliance with such regulatory capital requirements.
Inflation and Changing Prices
R&G Financial's Consolidated Financial Statements and related data presented in
this Annual Report have been prepared in accordance with generally accepted
accounting principles, which require the measurement of financial position and
operating results in terms of historical dollars (except with respect to
securities which are carried at market value), without considering changes in
the relative purchasing power of money over time due to inflation. Unlike most
industrial companies, substantially all of the assets and liabilities of R&G
Financial are monetary in nature. As a result, interest rates have a more
significant impact on R&G Financial's performance than the effects of general
levels of inflation. Interest rates do not necessarily move in the same
direction or in the same magnitude as the prices of goods and services.
<PAGE>
Year 2000 Issue
The Year 2000 problem is caused by the situation where computers worldwide were
programmed to read only the last two digits of a calendar year to save computer
memory. Those programs could read 00 as the year 1900 instead of the year 2000,
and thus may not recognize dates after December 31, 1999. This misinterpretation
of data could cause significant problems to banking and mortgage banking
entities, such as the Company, as the use of date calculations is extensive in
daily operations for matters such as interest accruals, maturity dates,
delinquency status, and customer statements. Year 2000 problems go beyond
computer systems of the Company, and affect anything that uses an internal
microchip such as telephones, fax machines, security and alarm systems, vaults,
elevators and air conditioning systems.
The Company does not own any proprietary software systems or applications and
relies on those provided by third party vendors. The Company has completed the
assessment of its computer hardware, software programs and data processing
applications, including those provided by third party vendors. The Company has
received revised programs from its third party vendors that have been modified
to address the Year 2000 problem for the principal applications used in its
mortgage banking and banking businesses. The Company completed the testing and
implementation of these revised programs and applications during the fourth
quarter of 1998 ascertaining that they adequately deal with the Year 2000
problem. The Companys main computer, used principally in banking and mortgage
banking operations, is Year 2000 compliant, meaning that it can properly process
and calculate date-related information after January 1, 2000. The Company is in
the process of replacing other equipment, primarily desktop computers that are
not Year 2000 compliant. The Company is also developing a Business Resumption
Contingency Plan to ascertain continuity of daily operations after December 31,
1999 in the event that a given application which has been duly tested and
implemented does not function adequately after such date. The Company's
contingency plan is expected to be completed by March 31, 1999.
The Company does not anticipate that the Year 2000 problem will have a material
adverse effect on its financial condition or results of operations. However,
Year 2000 problems suffered by third party providers of basic services, such as
telephone, waste, sewer and electricity, could have an adverse impact on the
daily operations of the Company. The Company would attempt to deal with any
disruption of such basic services caused by the Year 2000 problem with its
existing business interruption contingency plans. Under the Companys contingency
plans, most office branches of the Company are presently equipped with power
plants and/or generators.
The Company estimates that the cost of addressing the Year 2000 issue will be
approximately $300,000, most of which will be incurred during 1999. Most of such
costs are directly related to the costs of replacing existing equipment,
primarily desktop computers, which have been fully depreciated on the Company's
financial statements.
As a bank holding company, the Company could be subject to enforcement action by
federal banking authorities if it fails to adequately address Year 2000 issues.
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 Financia's Notes to Consolidated Financial
Statements.
<PAGE>
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS
No.133- Accounting for Derivative Instruments and Hedging Activities. This
Statement requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
accounted as a hedge . The accounting for changes in fair value of a derivative
(that is, gains and losses) depends on the intended use of the derivative and
the resulting designation.
This Statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Initial application of this Statement should be as of the
beginning of an entitys fiscal quarter; on that date, hedging relationships must
be designated anew and documented pursuant to the provisions of this Statement.
Management is evaluating its hedging strategy in light of this new pronouncement
to establish the initial designation of its hedging activities and determine the
effect and timing of adoption. However, due to the relatively limited extent to
which the Company is using derivative instruments and the simple nature of the
instruments used, management does not expect the impact of adoption to be
significant.
In October 1998, the FASB issued SFAS No.134 - Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise. This Statement amends SFAS No.65 to require that
after the securitization of mortgage loans held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed securities or
other retained interest based on its ability and intent to sell or hold those
investments. This Statement conforms the subsequent accounting for securities
retained after the securitization of mortgage loans by a mortgage banking
enterprise with the subsequent accounting for securities retained after the
securitization of other types of assets by a non-mortgage banking enterprise.
This Statement is effective for the first fiscal quarter beginning after
December 15, 1998. In connection with the adoption of this Statement on January
1, 1999, the Company reclassified approximately $427.4 million of
mortgage-backed securities from trading to available for sale.
40
<PAGE>
[LETTERHEAD PRICEWATERHOUSECOOPERS]
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 comprehensive 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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in comformity with generally accepted accounting principles.
These financial statements are the responsability of the Companys management;
our responsability is to express an opinion on theses 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/PricewaterhouseCoopers, LLP
- ------------------------------
PricewaterhouseCoopers, LLP
San Juan, Puerto Rico
February 10, 1999
Certified Public Accountants
(of Puerto Rico)
License No. 216 Expires on December 1, 2001
Stamp 1537391 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, 1998 AND 1997
1998 1997
-------------- --------------
<S> <C> <C>
Assets
Cash and due from banks $ 51,804,750 $ 32,607,001
Money market investments:
Securities purchased under agreements to resell 11,544,123 16,000,000
Time deposits with other banks 30,361,527 16,758,722
Federal funds sold 10,018,048 3,000,000
Mortgage loans held for sale, at lower of cost or market 117,126,040 46,885,323
Mortgage - backed securities held for trading, at fair value 450,546,034 400,457,456
Mortgage - backed securities available for sale, at fair value 95,040,331 46,003,849
Mortgage - backed securities held to maturity, at amortized cost
(estimated market value: 1998 - $28,260,925; 1997 - $33,185,672) 28,255,518 33,326,472
Investment securities held for trading, at fair value -- 581,332
Investment securities available for sale, at fair value 59,502,140 75,863,353
Investment securities held to maturity, at amortized cost
(estimated market value: 1998 - $6,378,634; 1997 - $10,655,981) 6,343,929 10,692,802
Loans receivable, net 1,073,668,278 765,059,419
Accounts receivable, including advances to investors, net 9,665,290 7,358,663
Accrued interest receivable 12,505,431 10,345,722
Servicing asset 58,221,052 21,212,998
Premises and equipment 12,962,435 9,527,559
Other assets 17,216,602 15,064,845
-------------- --------------
$2,044,781,528 $1,510,745,516
-------------- --------------
Liabilities and Stockholders' Equity
Liabilities:
Deposits $1,007,297,304 $ 722,418,494
Federal funds purchased -- 10,000,000
Securities sold under agreements to repurchase 471,421,726 433,134,506
Notes payable 191,747,956 108,452,619
Advances from FHLB 121,000,000 42,000,000
Other secured borrowings -- 34,359,168
Accounts payable and accrued liabilities 28,020,080 15,871,770
Other liabilities 4,132,603 3,205,043
-------------- --------------
1,823,619,669 1,369,441,600
-------------- --------------
Subordinated notes -- 3,250,000
-------------- --------------
Commitments and contingencies -- --
-------------- --------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Stockholders' equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized:
7.40% Monthly Income Preferred Stock, Series A, $25 liquidation
value, 2,000,000 shares authorized, issued and outstanding 50.000,000 --
Common stock:
Class A - $.01 par value, 40,000,000 shares authorized,
18,440,556 issued and outstanding in 1998 and 1997 184,406 92,203
Class B - $.01 par value, 20,000,000 shares authorized,
10,146,091 issued and outstanding in 1998 (1997 - 9,848,948) 101,461 49,245
Additional paid-in capital 41,544,378 38,347,818
Retained earnings 124,418,278 96,129,140
Capital reserves of the Bank 3,547,798 2,215,172
Accumulated other comprehensive income 1,365,538 1,220,338
-------------- --------------
221,161,859 138,053,916
-------------- --------------
$2,044,781,528 $1,510,745,516
-------------- --------------
</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, 1998, 1997 and 1996
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Interest income:
Loans $ 89,043,798 $ 68,513,571 $ 54,081,908
Money market and other investments 5,855,157 6,295,443 4,364,861
Mortgage-backed securities 29,397,985 22,525,876 15,338,950
------------ ------------ ------------
Total interest income 124,296,940 97,334,890 73,785,719
------------ ------------ ------------
Less - interest expense:
Deposits 38,439,016 32,434,559 27,517,852
Securities sold under agreements to repurchase 23,875,744 13,483,500 5,023,794
Notes payable 12,641,438 9,615,560 7,283,593
Secured borrowings -- 3,583,471 4,189,845
Other 5,367,631 1,688,034 847,607
------------ ------------ ------------
80,323,829 60,805,124 44,862,691
------------ ------------ ------------
Net interest income 43,973,111 36,529,766 28,923,028
Provision for loan losses 6,600,000 6,370,000 4,258,047
------------ ------------ ------------
Net interest income after provision for loan losses 37,373,111 30,159,766 24,664,981
------------ ------------ ------------
Non-interest income:
Net gain on origination and sale of loans 34,662,975 24,032,714 11,708,974
Net profit (loss) on trading account 14,580 (853,700) (65,656)
Net gain on sales of investment securities available for sale 278,028 107,430 641,798
Loan administration and servicing fees 15,986,831 13,213,948 13,029,053
Service charges, fees and other 5,527,860 4,604,670 3,937,878
------------ ------------ ------------
56,470,274 41,105,062 29,252,047
------------ ------------ ------------
Total revenues 93,843,385 71,264,828 53,917,028
------------ ------------ ------------
Non-interest expenses:
Employee compensation and benefits 17,094,783 13,652,754 10,793,301
Office occupancy and equipment 8,986,953 7,131,497 5,531,129
SAIF special assessment -- -- 2,508,380
Other administrative and general 22,687,336 18,251,497 15,424,117
------------ ------------ ------------
48,769,072 39,035,748 34,256,927
------------ ------------ ------------
Income before minority interest and income taxes 45,074,313 32,229,080 19,660,101
Minority interest in the Bank -- -- 538,168
------------ ------------ ------------
Income before income taxes 45,074,313 32,229,080 19,121,933
------------ ------------ ------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Income tax expense:
Current 6,814,496 6,263,549 5,687,865
Deferred 4,226,020 2,468,319 234,552
------------ ------------ ------------
11,040,516 8,731,868 5,922,417
------------ ------------ ------------
Net income $ 34,033,797 $ 23,497,212 $ 13,199,516
============ ============ ============
Earnings per common share:
Basic $ 1.15 $ .83 $ .60
============ ============ ============
Diluted $ 1.12 $ .81 $ .59
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements
43
<PAGE>
<TABLE>
<CAPTION>
R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS oF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net income $ 34,033,797 $ 23,497,212 $ 13,199,516
Other comprehensive income, before tax:
Unrealized gains (losses) on securities:
Arising during period 516,061 2,275,009 (1,086,291)
Less: Reclassification adjustments for gains included in
net income (278,028) (107,430) (641,798)
------------ ------------ ------------
238,033 2,167,579 (1,728,089)
Income tax (expense) benefit related to items of other
comprehensive income (92,833) (845,356) 673,955
------------ ------------ ------------
Other comprehensive income (loss), net of tax 145,200 1,322,223 (1,054,134)
------------ ------------ ------------
Comprehensive income, net of tax $ 34,178,997 $ 24,819,435 $ 12,145,382
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
44
<PAGE>
<TABLE>
<CAPTION>
R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Preferred Stock Common Stock Common Stock
Series A Class A Class B Additional
Shares Amount Shares Amount Shares Amount Paid-in Capital
------ ------ ------ ------ ------ ------ ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
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 31,339,065
December 300,839 3,010 6,708,908
Transfer to capital reserves
Cash dividends declared on common stock
Net income
Other comprehensive income, net of tax
--------- ----------- ---------- --------- ---------- --------- ------------
Balance at December 31, 1996 5,122,377 51,223 2,735,839 27,360 38,410,683
Transfer to capital reserves
Common stock split on September 25, 1997:
Stock split 4,097,901 40,980 2,188,635 21,885 (62,865)
Cash paid in lieu of fractional shares
Cash dividends declared on common stock
Net income
Other comprehensive income, net of tax
--------- ----------- ---------- --------- ---------- --------- ------------
Balance at December 31, 1997 9,220,278 92,203 4,924,474 49,245 38,347,818
Transfer to capital reserves
Common stock split on June 25, 1998 9,220,278 92,203 4,924,474 49,245 (141,448)
Issuance of common stock on
July 31,1998 to acquire Fajardo Federal 297,143 2,971 5,258,874
Issuance of Series A
Preferred Stock 2,000,000 $50,000,000 (1,920,866)
Cash dividends declared:
Common stock
Preferred stock
Net income
Other comprehensive income, net of tax
Balance at December 31, 1998 2,000,000 $50,000,000 18,440,556 $ 184,406 10,146,091 $ 101,461 $ 41,544,378
--------- ----------- ---------- --------- ---------- --------- ------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Accumulated
Capital other comprehensive Retained
reserves income earnings Total
-------- ------ -------- -----
<S> <C> <C> <C> <C>
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)
Common stock split on June 25, 1998 (972,336) (972,336)
Cash dividends declared on common stock 13,199,516 13,199,516
Net income (1,054,134) (1,054,134)
Other comprehensive income, net of tax
---------- ---------- ------------ ------------
1,460,707 (101,885) 75,784,804 115,632,892
Balance at December 31, 1996
754,465 (754,465)
Transfer to capital reserves
Common stock split on September 25, 1997:
Stock split (12,659) (12,659)
Cash paid in lieu of fractional shares (2,385,752) (2,385,752)
Cash dividends declared on common stock 23,497,212 23,497,212
Net income 1,322,223 1,322,223
Other comprehensive income, net of tax 2,215,172 1,220,338 96,129,140 138,053,916
---------- ---------- ------------ ------------
Balance at December 31, 1997
1,332,626 (1,332,626)
Transfer to capital reserves
Issuance of common stock on
July 31,1998 to acquire Fajardo Federal 5,261,845
Issuance of Series A
Preferred Stock 48,079,134
Cash dividends declared:
Common stock (3,168,422) (3,168,422)
Preferred stock (1,243,611) (1,243,611)
Net income 34,033,797 34,033,797
Other comprehensive income, net of tax 145,200 145,200
---------- ---------- ------------ ------------
Balance at December 31, 1998 $3,547,798 $1,365,538 $124,418,278 $221,161,859
========== ========== ============ ============
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 34,033,797 $ 23,497,212 $ 13,199,516
Adjustments to reconcile net income to net cash
provided by (used in)
operating activities:
Depreciation and amortization 3,059,742 2,659,888 2,142,275
(Accretion of discount) amortization of premium on
investments and mortgage - backed securities, net (86,761) (371,816) 199,955
Amortization of deferred loan origination costs (fees) 350,114 (258,324) (411,219)
Amortization of excess servicing receivable -- -- 77,530
Amortization of servicing rights 2,994,307 1,837,414 1,213,606
Compensation cost on common shares granted -- -- 290,000
Provision for loan losses 6,600,000 6,370,000 4,258,047
Provision for bad debts in accounts receivable 300,000 300,000 300,000
Gain on sales of mortgage loans (7,785,630) (2,721,154) (599,935)
Gain on sales of investment securities available for sale (278,028) (107,430) (641,798)
Minority interest in earnings of the Bank -- -- 538,168
(Increase) decrease in mortgage loans held for sale (70,240,717) 7,564,836 (33,131,819)
Net (increase) decrease in mortgage-backed
securities held for trading (105,247,419) (291,540,928) 5,662,504
Net decrease (increase) in investment securities held for trading 581,332 769,495 (1,350,827)
Increase in interest and accounts receivable (4,590,500) (5,607,804) (3,065,914)
Decrease (increase) in other assets 1,678,184 (2,840,360) (4,179,528)
Increase in notes payable 83,295,337 (15,989,480) 10,212,067
Increase (decrease) in accounts payable
and accrued liabilities 11,545,874 5,128,545 (1,542,763)
Increase (decrease) in other liabilities 702,593 (394,179) 1,167,645
------------- ------------- -------------
Total adjustments (77,121,572) (295,201,297) (18,862,006)
------------- ------------- -------------
Net cash used in operating activities (43,087,775) (271,704,085) (5,662,490)
------------- ------------- -------------
Cash flows from investing activities:
Purchases of investment securities available for sale and
held to maturity (72,532,667) (83,021,527) (47,623,969)
Proceeds from sales and maturities of investment
securities available for sale 92,867,182 36,265,089 63,127,623
Proceeds from maturities of investment securities held to maturity 4,715,420 -- 377,000
Principal repayments on mortgage-backed securities 13,955,086 9,475,202 10,554,678
Proceeds from sale of loans 254,011,245 120,955,837 50,326,054
Net originations of loans (574,007,391) (285,970,693) (227,155,954)
Purchases of FHLB stock, net (6,211,400) (658,757) (967,700)
Net assets acquired, net
of cash received 4,287,492 -- --
Acquisition of premises and equipment (5,936,102) (3,914,192) (2,592,494)
Acquisition of servicing rights (40,002,361) (10,455,392) (5,598,965)
------------- ------------- -------------
Net cash used in investing activities (328,853,496) (217,324,433) (159,553,727)
------------- ------------- -------------
</TABLE>
(continued)
46
<PAGE>
<TABLE>
<CAPTION>
R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (continued)
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from financing activities:
Proceeds from issuance of notes payable $ -- $ -- $ 60,500,000
Payments on notes payable -- (2,400,000) (25,000,000)
Payments of long-term debt -- -- (5,323,899)
Increase in deposits, net 263,311,675 106,750,114 97,160,090
Increase (decrease) in securities sold
under agreements to repurchase, net 38,287,220 335,690,058 (1,038,740)
(Decrease) increase in federal funds purchased (10,000,000) 10,000,000 --
Payments on secured borrowings -- (16,103,451) (5,520,882)
Advances from FHLB 133,700,000 161,700,000 16,000,000
Repayment of advances from FHLB (58,400,000) (134,700,000) (7,000,000)
Repayment of subordinated notes (3,250,000) -- --
Net proceeds from issuance of Series A
Preferred Stock 48,079,134 -- --
Proceeds from issuance of common stock on initial public offering -- -- 31,072,748
Capital contribution to subsidiary (12,000) -- --
Cash dividends (4,412,033) (2,385,752) (972,336)
Payment of cash in lieu of fractional shares on stock split -- (12,659) --
------------- ------------- -------------
Net cash provided by financing activities 407,303,996 458,538,310 159,876,981
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents 35,362,725 (30,490,208) (5,339,236)
Cash and cash equivalents at beginning of year 68,365,723 98,855,931 104,195,167
------------- ------------- -------------
Cash and cash equivalents at end of year $ 103,728,448 $ 68,365,723 $ 98,855,931
------------- ------------- -------------
Cash and cash equivalents include:
Cash and due from banks $ 51,804,750 $ 32,607,001 $ 31,989,944
Securities purchased under agreements to resell 11,544,123 16,000,000 19,633,178
Time deposits with other banks 30,361,527 16,758,722 33,232,809
Federal funds sold 10,018,048 3,000,000 14,000,000
------------- ------------- -------------
$ 103,728,448 $ 68,365,723 $ 98,855,931
------------- ------------- -------------
</TABLE>
47
<PAGE>
R&G FINANCIAL CORPORATION Notes to Consolidated Financial Statements December
31, 1998, 1997 and 1996
1. Reporting Entity and 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 Companys 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). 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. 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 Companys CEO also
converted 66,667 of his Class A shares into Class B shares and sold such shares
in the public offering. As a result of such transaction, an aggregate of
2,415,000 Class B shares were publicly issued and are now traded on the NASDAQ
Stock Market. The Company received gross proceeds of $35.0 million in the
transaction, which resulted in estimated net proceeds of $31.1 million after
payment of the underwriting discount and expenses. Immediately following the
Companys 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
Government National Mortgage Association (GNMA) 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.
The Bank provides a full range of banking services through twenty branches
located mainly in the northern part of the Commonwealth of Puerto Rico. As
discussed in Note 15 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.
<PAGE>
Significant Accounting Policies
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 disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Securities purchased under agreements to resell
The Company 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. It is
the Companys policy to take possession over the securities that guarantee such
loans. However, the counterparties to these agreements retain effective control
over such collateral.
Investment securities
Investments in debt and equity securities are classified at the time of purchase
into one of three categories and accounted for as follows:
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
other comprehensive income.
All residual interests such as excess servicing fees receivable, and
interest-only strips (IOs) retained by the Company as a result of securitization
transactions or bulk sales are held as trading securities IOs if made in
connection with mortgage banking activities, and available for sale if not made
in connection with such activities. In addition, all mortgage-backed securities
retained by the Company as part of its mortgage banking activities
securitization transactions are also held as trading securities.
<PAGE>
Premiums are amortized and discounts are accreted 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 on 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.
In October 1998, the Financial Accounting Standards Board (FASB) issued SFAS No.
134 -Accounting for Mortgage-Backed Securities Retained after the Securitization
of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. This Statement
amends SFAS No. 65 to require that after the securitization of mortgage loans
held for sale, an entity engaged in mortgage banking activities classify the
resulting mortgage-backed securities or other retained interest based on its
ability and intent to sell or hold those investments. This Statement conforms
the subsequent accounting for securities retained after the securitization of
mortgage loans by a mortgage banking enterprise with the subsequent accounting
for securities retained after the securitization of other types of assets by a
non-mortgage banking enterprise. This Statement is effective for the first
fiscal quarter beginning after December 15, 1998. In connection with the
adoption of this Statement on January 1, 1999, the Company reclassified
approximately $427.4 million of mortgage-backed securities from trading to
available for sale.
Loans and allowance for loan losses
Loans are stated at their outstanding principal balance, less unearned interest,
deferred loan origination fees and allowance for loan losses. Loan origination
and commitment fees and costs incurred in the origination of new loans are
deferred and amortized over the life of
48
<PAGE>
the loans as an adjustment of interest yield using the interest method. 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 managements 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, managements 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 loans 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
managements 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. 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.
<PAGE>
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
The Company capitalizes servicing rights acquired through loan origination
activities by allocating a portion of the cost of originating mortgage loans to
the mortgage servicing right for those loans for which there is a definite plan
to sell or securitize. The allocation is based on the relative fair value of the
loans and the servicing rights at the date of origination.
If the Company does not have a definite plan to sell or securitize the loans at
the time of origination, a portion of the amortized cost of the loans is
allocated to the mortgage servicing right at the time of sale or securitization
based on the relative fair values at such date. To determine the fair value of
the servicing rights, the Company uses the market prices of comparable servicing
sale contracts.
Mortgage servicing rights related to loans originated prior to 1995 are not
recognized in the Companys consolidated financial statements until the related
loans are sold. Prior to 1995 only servicing rights acquired through purchases
were capitalized.
The capitalized cost of acquiring the rights to service mortgage loans is
amortized in proportion to and over the period of net servicing income. Mortgage
servicing rights are evaluated for impairment.
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, 1998
or 1997. As of December 31, 1998 and 1997, the fair value of capitalized
mortgage servicing rights was approximately $59,880,000 and $24,566,000,
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
The Company recognizes on its financial statements financial assets and
servicing assets controlled by the Company, and derecognizes financial assets
when control has been surrendered. The Company follows the specific criteria
established in SFAS No. 125- Accounting for Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities, to determine when control has been
surrendered in a transfer of financial assets. Liabilities are derecognized when
they are extinguished.
Liabilities and derivatives incurred or obtained by the Company as part of a
transfer of financial assets are initially measured at fair value, if
practicable. Servicing assets and other retained interests in the transferred
assets are measured by allocating the previous carrying amount between the
assets sold, if any, and retained interests, if any, based on their relative
fair values at the date of the transfer. Servicing assets and liabilities are
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.
<PAGE>
Transfers of receivables with recourse
Transfers of receivables with recourse are recognized as a sale if the Company
surrenders control of the future economic benefits embodied in the receivables,
its obligation under the recourse provisions can be reasonably estimated and 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.
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.
The Company evaluates for impairment long-lived assets and certain identifiable
intangibles held and used 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.
Goodwill and other intangibles
On July 31, 1998, the Company acquired Fajardo Federal Savings Bank, F.S.B.
(Fajardo Federal) at a cost of approximately $5.9 million. The acquisition was
accounted under the purchase method of accounting, resulting in the recognition
of goodwill of approximately $3.1 million. Total assets of Fajardo Federal at
the time of acquisition were approximately $28.9 million.
Goodwill also resulted 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.
Goodwill is amortized over a fifteen year period. Accumulated amortization
amounted to $1,757,000 and $1,363,000 as of December 31, 1998 and 1997,
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 $477,000 and $342,000 at
December 31, 1998 and 1997, respectively.
Securities sold under agreements to repurchase
The Company sells securities under agreements to repurchase the same or similar
securities. The Company retains effective control over the securities pledged as
<PAGE>
collateral on these agreements. Accordingly, amounts received under these
agreements represent short-term borrowings and the securities underlying the
agreements remain in the asset accounts.
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, 1998.
Income taxes
The Company follows an asset and liability approach to 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 managements evaluation, it is more likely than not (a
likelihood of more than 50%) that some portion or all of the deferred tax asset
will not be realized.
Capital reserve
The Banking Act of the Commonwealth of Puerto Rico, 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 plan
As discussed in Note 16 to the consolidated financial statements, the Company
adopted a Stock Option Plan in June 1996 and granted stock options thereunder to
certain employees 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 complies with 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
<PAGE>
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 Companys Stock Option Plan are
included in the weighted average number of shares for purposes of the diluted
earnings per share computation.
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.
Accounting for derivative instruments and hedging activities
In June 1998, the FASB issued SFAS No.133-Accounting for Derivative Instruments
and Hedging Activities.
50
<PAGE>
This Statement requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically accounted as a hedge. The accounting for changes in fair value of a
derivative (that is, gains and losses) depends on the intended use of the
derivative and the resulting designation.
This Statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Management is evaluating its hedging strategy in light of
this new pronouncement to establish the initial designation of its hedging
activities and determine the effect and timing of adoption. However, due to the
relatively limited extent to which the Company is using derivative instruments
and the simple nature of the instruments used, management does not expect the
impact of adoption to be significant.
Adoption of new accounting standards
On January 1,1998, the Company adopted 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
was the only other comprehensive income item to be included in comprehensive
income, which is now reported with the statement of comprehensive income. The
adoption of this Statement affected only financial statements presentation.
On January 1, 1998 the Company also adopted 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.
The adoption of this Statement affected only financial statement presentation
and disclosure. The required disclosures are provided in Note 24 to the
consolidated financial statements.
Reclassifications
Certain reclassifications have been made to the 1997 and 1996 financial
statements to conform to the 1998 financial statement presentation.
51
<PAGE>
2. Mortgage loans held for sale
Mortgage loans held for sale consist of:
<TABLE>
<CAPTION>
December 31,
1998 1997
------------ ------------
<S> <C> <C>
Conventional loans $ 93,021,032 $ 25,003,291
FHA/VA loans 24,105,008 21,882,032
------------ ------------
$117,126,040 $ 46,885,323
============ ============
</TABLE>
The aggregate amortized cost and approximate market value of loans held for sale
as of December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Amortized Gross unrealized Gross unrealized Approximate
cost holding gains holding losses market value
-------------- ------------ ----------- --------------
<S> <C> <C> <C>
$ 117,126,040 $ 1,543,907 $ (214,798) $ 118,455,149
-------------- ------------ ----------- --------------
</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,
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Proceeds from sales of mortgage loans
and mortgage-backed securities $ 783,899,858 $ 370,121,097 $ 297,606,773
Mortgage loans and mortgage-
backed securities sold (761,449,308) (359,001,427) (290,777,907)
------------- ------------- -------------
Gain on sales, net 22,450,550 11,119,670 6,828,866
Deferred fees earned, net of loan origination costs
and commitment fees paid 6,207,098 3,235,381 4,976,079
------------- ------------- -------------
28,657,648 14,355,051 11,804,945
Net unrealized profit (loss) on
trading securities 6,005,327 9,677,663 (95,971)
------------- ------------- -------------
Net gain on origination and
sale of mortgage loans $ 34,662,975 $ 24,032,714 $ 11,708,974
------------- ------------- -------------
</TABLE>
<PAGE>
Total gross loan origination fees totaled approximately $20,270,000, $13,683,000
and $13,041,000 during the years ended December 31, 1998, 1997 and 1996,
respectively.
Gross gains of $25,430,599, $11,532,566 and $7,479,507, and gross losses of
$2,980,049, $412,896 and $650,641 were realized on the above sales during the
years ended December 31, 1998, 1997 and 1996, respectively.
52
<PAGE>
3. Investment Securities
Mortgage-backed securities held for trading
<TABLE>
<CAPTION>
December 31,
1998 1997
------------ ------------
<S> <C> <C>
CMO Certificate $ -- $ 15,228,000
CMO Residuals (interest only) 7,146,762 7,867,662
GNMA Certificates 443,399,272 377,361,794
------------ ------------
$450,546,034 $400,457,456
------------ ------------
</TABLE>
The carrying value and estimated fair value of investment securities available
for sale and held to maturity 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. Expected maturities on debt
securities will differ from contractual maturities because borrowers may have
the right to call or repay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
December 31,
1998 1997
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 $ 7,845,382 $ 9,661,171 $ 7,006,610 $ 8,381,982
----------- ----------- ----------- -----------
FNMA certificates -
Due over ten years 8,091,335 8,161,704 9,468,141 9,670,108
----------- ----------- ----------- -----------
FHLMC certificates:
Due from one to five years 89,209 90,765 70,584 70,452
Due from five to ten years 240,394 244,140 359,980 368,203
Due over ten years 21,368,689 21,723,711 27,104,346 27,513,104
----------- ----------- ----------- -----------
21,698,292 22,058,616 27,534,910 27,951,759
----------- ----------- ----------- -----------
GNMA certificates-
Due over ten years 55,158,840 55,158,840 -- --
----------- ----------- ----------- -----------
$92,793,849 $95,040,331 $44,009,661 $46,003,849
=========== =========== =========== ===========
</TABLE>
<PAGE>
Mortgage-backed securities available for sale include interest only securities
with an amortized cost of $2,363,942 as of December 31, 1998 and 1997, which are
associated with the sale in prior years of collateralized mortgage obligations
not related to the Company's mortgage banking activities.
53
<PAGE>
<TABLE>
<CAPTION>
December 31,
1998 1997
Amortized Fair Amortized Fair
cost value cost value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Investment securities available for sale
U.S. Treasury securities:
Due within one year $ -- $ -- $ 773,156 $ 771,593
Due from one to five years 4,995,028 4,990,625 30,009,771 30,100,000
----------- ----------- ----------- -----------
4,995,028 4,990,625 30,782,927 30,871,593
----------- ----------- ----------- -----------
U.S. Government and Agencies
securities:
Due from one to five years 38,100,000 38,106,648 35,145,089 35,104,828
Due from five to ten years 5,010,140 5,000,000 5,022,904 4,980,865
----------- ----------- ----------- -----------
43,110,140 43,106,648 40,167,993 40,085,693
----------- ----------- ----------- -----------
FHLB stock 11,404,867 11,404,867 4,906,067 4,906,067
----------- ----------- ----------- -----------
$59,510,035 $59,502,140 $75,856,987 $75,863,353
----------- ----------- ----------- -----------
</TABLE>
Mortgage-backed securities held to maturity
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
GNMA certificates:
Due from one to five years $ 27,227 $ 29,201 $ 49,347 $ 50,128
Due from five to ten years 13,024,960 12,751,640 -- --
Due over ten years 2,359,713 2,306,529 18,321,595 17,704,769
----------- ----------- ----------- -----------
15,411,900 15,087,370 18,370,942 17,754,897
----------- ----------- ----------- -----------
FNMA certificates-
Due over ten years 12,607,700 12,944,020 14,674,783 15,164,453
----------- ----------- ----------- -----------
FHLMC certificates-
Due over ten years 235,918 229,535 280,747 266,322
----------- ----------- ----------- -----------
$28,255,518 $28,260,925 $33,326,472 $33,185,672
----------- ----------- ----------- -----------
</TABLE>
54
<PAGE>
<TABLE>
<CAPTION>
December 31,
1998 1997
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 $ 194,892 $ 196,000 $ 309,839 $ 310,775
----------- ----------- ------------ -----------
U.S. Government and Agencies securities-
Due within one year 204,167 204,167 -- --
----------- ----------- ------------ -----------
Puerto Rico Government and Agencies
obligations:
Due within one year -- -- 4,433,177 4,439,474
Due from five to ten years 5,944,870 5,978,467 5,920,000 5,910,000
Due over ten years -- -- 29,786 29,786
5,944,870 5,978,467 10,382,963 10,379,260
----------- ----------- ------------ -----------
$ 6,343,929 $ 6,378,634 $ 10,692,802 $10,690,035
----------- ----------- ------------ -----------
</TABLE>
Unrealized gains and losses on securities held to maturity and available for
sale follows:
<TABLE>
<CAPTION>
December 31,
1998 1997
Gross unrealized Gross unrealized
Gains Losses Gains Losses
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Securities held to maturity:
Puerto Rico and United States
Government obligations $ 39,705 $ (5,000) $ 936 $ (37,757)
Mortgage-backed securities 338,294 (332,887) 504,349 (645,149)
----------- ----------- ----------- -----------
$ 377,999 $ (337,887) $ 505,285 $ (682,906)
----------- ----------- ----------- -----------
Securities available for sale:
U.S. Government obligations $ 6,648 $ (14,543) $ 113,223 $ (106,857)
Mortgage-backed securities 2,276,566 (30,084) 2,043,941 (49,753)
----------- ----------- ----------- -----------
$ 2,283,214 $ (44,627) $ 2,157,164 $ (156,610)
----------- ----------- ----------- -----------
</TABLE>
<PAGE>
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. There were no sales of
investment securities held for trading during 1998. During the years ended
December 31, 1998, 1997 and 1996, proceeds from the sale of securities available
for sale totaled approximately $45,917,000, $7,915,000 and $48,950,000,
respectively; gains realized on such sales totaled approximately $278,000,
$107,000 and $642,000, respectively; no losses were realized.
During 1998, the Company reclassified $55,159,000 (1997- $773,000) securities
held for trading to available for sale.
As discussed in Notes 7, 8, 9 and 10 to the consolidated financial statements,
as of December 31, 1998 the Company had investment securities, mortgage-backed
securities and mortgage loans amounting to approximately $836.7 million pledged
to secure certain deposits, securities sold under agreements to repurchase,
advances from the FHLB, notes payable, 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,
1998 1997
--------------- ---------------
<S> <C> <C>
Real estate loans:
Residential - first mortgage $ 735,457,756 $ 476,652,596
Residential - second mortgage 18,633,916 17,831,079
Land 337,250 76,400
Construction 34,391,170 13,367,513
Commercial 121,393,030 87,506,802
910,213,122 595,434,390
Undisbursed portion of loans in process (18,170,178) (6,218,039)
Net deferred loan (fees) costs (166,056) 172,019
--------------- ---------------
891,876,888 589,388,370
--------------- ---------------
Other loans:
Commercial 46,532,311 39,127,363
Consumer:
Loans secured by deposits 17,225,437 12,471,772
Loans secured by real estate 85,054,815 81,251,989
Other 41,381,304 50,103,282
Unamortized discount (163,499) (151,460)
Unearned interest (183,546) (360,195)
--------------- ---------------
189,846,822 182,442,751
--------------- ---------------
Total loans 1,081,723,710 771,831,121
Allowance for loan losses (8,055,432) (6,771,702)
--------------- ---------------
$ 1,073,668,278 $ 765,059,419
--------------- ---------------
</TABLE>
<PAGE>
The changes in the allowance for loan losses follow:
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997 1996
--------------- --------------- ---------------
<S> <C> <C> <C>
Balance, beginning of year $ 6,771,702 $ 3,331,645 $ 3,510,251
Provision for loan losses 6,600,000 6,370,000 4,258,047
Acquired reserves 364,064 -- --
Loans charged-off (6,012,792) (5,376,573) (4,662,407)
Recoveries 332,458 2,446,630 225,754
--------------- --------------- ---------------
Balance, end of year $ 8,055,432 $ 6,771,702 $ 3,331,645
--------------- --------------- ---------------
</TABLE>
Recoveries during the year ended December 31, 1997 include $2 million received
from the Companys fidelity insurance carrier as part of a settlement of a claim
filed by the Company in late 1996. The amount received was recorded as a
recovery of loans previously charged-off. During 1996, as a result of certain
irregularities discovered by the Company with respect to its former insurance
premiums financing business, management wrote-off loans amounting to
approximately $2.5 million.
As of December 31, 1998 and 1997 the Company had commercial loans classified as
impaired totaling $1,020,642 and $1,570,642, respectively. No reserves for
impairment were necessary as of such dates since the fair value of the
collaterals securing such loans exceeded their outstanding balances.
56
<PAGE>
As of December 31, 1998, 1997 and 1996, loans on which the accrual of interest
income had been discontinued amounted to approximately $44,526,000, $30,086,000
and $18,730,000, respectively. The additional interest income that would have
been recognized during 1998, 1997 and 1996 had these loans been accruing
interest amounted to approximately $1,408,000, $1,095,000 and $864,000,
respectively. The Company has no material commitments to lend additional funds
to borrowers whose loans were in non-accruing status at December 31, 1998.
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, 1998 and
1997, the mortgage loans servicing portfolio amounted to approximately
$4,827,798,000 and $3,000,888,000, respectively, including approximately
$754,623,000 and $448,858,000, respectively, serviced for the Bank.
The changes in the servicing asset of the Company follows:
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Balance at beginning of period $ 21,212,998 $ 12,595,020 $ 8,209,661
Rights originated 11,845,775 8,057,574 4,172,868
Rights purchased 28,156,586 2,397,818 1,426,097
Scheduled amortization (2,994,307) (1,837,414) (1,213,606)
Unscheduled amortization -- -- --
------------ ------------ ------------
Balance at end of period $ 58,221,052 $ 21,212,998 $ 12,595,020
------------ ------------ ------------
</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, 1998, the
mortgage loan portfolio serviced for GNMA, FNMA and FHLMC and subject to the
timely payment commitment amounted to approximately $2,575,794,000, $219,178,000
and $831,184,000, respectively (1997 - $1,779,252,000, $53,760,000, and
$474,079,000).
Total funds advanced as of December 31, 1998 in relation to such commitments
amount to $1,458,000, $3,429,000 and $757,000 for escrow advances, principal and
interest advances and foreclosure advances, respectively (1997 - $782,000,
$1,688,000 and $530,000).
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, 1998 and 1997, the related escrow funds include
<PAGE>
approximately $109,857,000 and $50,163,000, respectively, deposited in the Bank;
these funds are included in the Company's consolidated financial statements.
Escrow funds also include approximately $6,732,000 and $8,654,000 at December
31, 1998 and 1997, respectively, deposited with other banks and excluded from
the Companys assets and liabilities.
6. Premises and Equipment
Premises and equipment consist of:
<TABLE>
<CAPTION>
Estimated
useful lives December 31,
(Years) 1998 1997
-------------------------------------------
<S> <C> <C> <C>
Furniture and fixtures 5 $ 17,588,015 $ 13,026,459
Leasehold improvements 10 7,966,402 6,073,038
Autos 5 487,562 375,826
-------------------------------------------
26,041,979 19,475,323
Less - Accumulated
depreciation and amortization (13,079,544) (9,947,764)
-------------------------------------------
$ 12,962,435 $ 9,527,559
-------------------------------------------
</TABLE>
57
<PAGE>
7. Deposits
Deposits are summarized as follows:
<TABLE>
<CAPTION>
December 31,
1998 1997
-------------- --------------
<S> <C> <C>
Passbook savings $ 106,389,879 $ 79,628,833
-------------- --------------
NOW accounts 34,954,647 27,644,104
Super NOW accounts 81,511,705 67,650,384
Regular checking accounts
(non-interest bearing 46,328,445 32,720,996
Commercial checking accounts
(non-interest bearing) 126,171,795 58,783,328
-------------- --------------
288,966,592 186,798,812
-------------- --------------
Certificates of deposit:
Under $100,000 315,641,230 257,431,730
$100,000 and over 294,270,322 196,961,831
-------------- --------------
609,911,552 454,393,561
Accrued interest payable 2,029,281 1,597,288
$1,007,297,304 $ 722,418,494
-------------- --------------
</TABLE>
The weighted average stated interest rate on all deposits at December 31, 1998
and 1997 was 4.50% and 4.82%, respectively.
As of December 31, 1998, the Company had delivered investment securities held to
maturity with an amortized cost and market value of approximately $1.5 million
as collateral for public funds deposits.
At December 31, 1998 scheduled maturities of certificates of deposit are as
follows:
1999 $ 490,932,867
2000 39,417,301
2001 21,295,061
2002 15,481,443
2003 31,596,339
Thereafter 11,188,541
--------------
$ 609,911,552
==============
<PAGE>
8. Securities Sold Under Agreements to Repurchase
At December 31, 1998 and 1997, the Company had repurchase agreements outstanding
with interest ranging from 5.02% to 5.60% in 1998 and 5.10% to 6.00% in 1997.
These agreements mature within thirty days, except for repurchase agreements
totaling $100,000,000 at December 31, 1998, maturing in June 1999.
Information on these agreements follows:
<TABLE>
<CAPTION>
December 31,
1998 1997
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 6,967,000 7,151,947 5,580,000 5,995,405
GNMA 443,380,446 450,812,190 363,315,559 397,598,925
CMO Tranches -- -- 13,576,380 15,228,000
CMO Residuals 4,742,280 3,769,137 8,162,280 7,264,420
FHLMC 12,682,000 12,983,712 12,405,000 12,954,146
FNMA 3,650,000 3,216,694 -- --
------------ ------------ ------------ ------------
$471,421,726 $477,933,680 $433,134,506 $469,367,563
------------ ------------ ------------ ------------
</TABLE>
58
<PAGE>
Maximum amount of borrowings outstanding at any month-end during 1998 and 1997
under the agreements to repurchase were $471,422,000 and $433,135,000,
respectively. The approximate average aggregate borrowings outstanding during
the periods were $410,701,000 and $226,771,000, respectively. The weighted
average interest rate of such agreements was 5.42% and 5.81% at December 31,
1998 and 1997, respectively; the weighted average rate during 1998 and 1997 was
5.74% and 5.95%, respectively.
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.
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.
9. Notes Payable
Notes payable consist of:
<TABLE>
<CAPTION>
December 31,
1998 1997
------------ ------------
<S> <C> <C>
Warehousing lines, bearing interest at floating rates ranging from 1.25% to
1.50% over the counterpartys cost
of funds (6.43% in 1998 and 5.85% in 1997) $107,647,956 $ 24,352,619
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 5.60% to 6.30% 15,000,000 15,000,000
Promissory note maturing in 2000 paying quarterly interest at a
floating rate of 84% of the three month Libor rate less .125%
(4.36% at December 31, 1998 and 4.73% at December 31, 1997) 10,000,000 10,000,000
Promissory note maturing in 2001 paying quarterly interest at a
floating rate of 96% of the three month Libid rate (4.95% at
December 31, 1998 and 5.34% at December 31, 1997) 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
------------ ------------
$191,747,956 $108,452,619
------------ ------------
</TABLE>
As of December 31, 1998, the Company had various credit line agreements
permitting the Company to borrow up to $209.0 million in warehousing lines with
banks; the unused portion of warehousing lines totaled approximately $101.4
million. Warehousing lines at December 31, 1998 are collateralized by
approximately $103.9 million in mortgage loans, mortgage servicing rights with a
fair value of $8 million, 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.
<PAGE>
Several credit line agreements impose certain requirements 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. At December 31, 1998 the Company was in compliance with the loan
requirements.
59
<PAGE>
The following information relates to borrowings of the Company under the credit
line agreements:
<TABLE>
<CAPTION>
December 31,
1998 1997
<S> <C> <C>
Maximum aggregate borrowings
outstanding at any month-end $ 161,060,146 $ 93,523,091
Approximate average aggregate borrowings
outstanding during the year $ 102,047,157 $ 66,404,621
Weighted average interest rate during
the year computed on a monthly basis 7.07% 6.03%
Weighted average interest rate
at end of year 6.43% 5.85%
</TABLE>
Certain promissory notes 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, 1998 securities pledged in relation to this requirement consist of
investment and mortgage-backed securities with an amortized cost of
approximately $35.9 million and approximate market value of $35.8 million. At
December 31, 1998 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, 1998 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
<PAGE>
Advances from the FHLB are as follows:
<TABLE>
<CAPTION>
December 31,
Interest
Maturity rate 1998 1997
---- ------------ ------------
<S> <C> <C> <C>
January 7, 1998 6.15% $ -- $ 10,000,000
January 15, 1998 6.00% -- 32,000,000
January 26, 1999 5.66% 10,000,000 --
July 30, 1999 5.14% 10,000,000 --
January 26, 2000 5.74% 10,000,000 --
August 28, 2000 4.22% 10,000,000 --
August 28, 2000 5.60% 15,000,000 --
January 26, 2001 5.54% 12,000,000 --
August 27, 2001 5.67% 5,000,000 --
December 18, 2003 4.54% 10,000,000 --
June 9, 2005 5.25% 4,000,000 --
June 17, 2005 5.25% 15,000,000 --
February 27, 2008 5.15% 10,000,000 --
February 19, 2008 5.16% 5,000,000 --
March 10, 2008 5.23% 5,000,000 --
$121,000,000 $ 42,000,000
----------------------------------------------
Weighted average stated interest rate 5.25% 6.03%
----------------------------------------------
</TABLE>
60
<PAGE>
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
$533.5 million as of December 31, 1998. The unused portion under such line of
credit was approximately $412.5 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
$51.3 million at December 31, 1998. At December 31, 1998 the specific collateral
(principally in the form of first mortgage notes) amounting to approximately
$217.4 was pledged to the FHLB as part of the Agreement and to secure standby
letters of credit. At December 31, 1998, the market value of the collateral
indicated above was sufficient to comply with the provisions of the Agreement.
11. 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,
1998 1997
------------ ------------
<S> <C> <C>
Deferred tax liabilities:
Deferred net loan origination costs $ -- $ 346,286
Unrealized gain on securities held for trading 6,038,762 3,696,685
Reserve for bad debts 19,371 45,885
CMO residuals (IOs) 1,778,693 1,096,090
Servicing assets 4,839,238 1,424,600
Unrealized gain on securities available for sale 873,049 780,216
------------ ------------
13,549,113 7,389,762
------------ ------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Deferred tax assets:
Deferred loan origination income, net (313,111) --
Allowance for loan losses (2,799,369) (1,176,463)
Contingency reserve (234,000) --
AMT credits (124,937) --
Other foreclosed property reserve -- (11,232)
Recourse contingency (61,653) (61,653)
Discount on tax credits purchased -- (247,960)
Deferred gains on sale of loans and investment securities (183,336) (378,600)
------------ ------------
(3,716,406) (1,875,908)
------------ ------------
Net deferred tax liability $ 9,832,707 $ 5,513,854
------------ ------------
</TABLE>
61
<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>
Year ended December 31,
1998 1997 1996
% of pretax % of pretax % of pretax
Amount income Amount income Amount income
------ ------ ------ ------ ------ ------
($ in thousands)
<S> <C> <C> <C> <C> <C> <C>
Computed income tax at
statutory rate $ 17,579 39% $ 12,569 39% $ 7,458 39%
Effect on provision of:
Tax-exempt interest (7,084) (14) (2,947) (9) (2,352) (12)
Non-deductible expenses 931 1 116 -- 423 2
Discount on tax credits
purchased (385) (1) (1,006) (3) --
Tax settlement -- -- -- -- 393 2
-------- -- -------- -- -------- --
$ 11,041 25% $ 8,732 27% $ 5,922 31%
-------- -- -------- -- -------- --
</TABLE>
In early February 1998, the Puerto Rico Treasury Department began an income tax
examination of R&G Mortgages and the Bank's income tax returns for the year
1995. Management believes that this examination should not result in any
significant adverse effect on the Company's financial condition or results of
operations.
12. Stockholders' Equity
On April 16, 1998 the Companys Board of Directors authorized a two-for-one 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 June 25, 1998 in the form of a
stock dividend of one share for each share held of record on June 12, 1998.
Prior to the declaration of the stock split, the Company had 14,144,752 shares
of common stock outstanding. As a result of the split, 14,144,752 shares were
issued and $141,448 were transferred from additional paid-in-capital to common
stock. On July 15, 1997 the Company's Board of Directors authorized a
nine-for-five stock split of the Company's 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 splits 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 splits.
The Company's average number of common shares outstanding used in the
computation of basic earnings per common share was 28,413,314 (1997-28,289,504;
1996-21,841,322); the weighted average number of shares outstanding for the
computation of diluted earnings per share was 29,169,314 (1997 -29,042,504; 1996
- -22,099,732) after giving effect to outstanding stock options granted under the
Company's Stock Option Plan. During 1998, cash dividends of $.111375 (1997
- -$0.084375; 1996 -$0.01736) per common share amounting to $3,168,422 (1997
- -$2,385,752; 1996 -$472,336) were paid.
62
<PAGE>
13. Non-interest Expenses
Non-interest expenses consist of the following:
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Advertising $ 4,277,685 $ 3,154,189 $ 2,415,177
Stationary and supplies 1,548,459 1,640,131 1,332,108
Telephone 1,004,213 871,029 751,518
License and other taxes 2,074,144 1,595,276 1,247,505
Deposit insurance 401,933 346,625 652,750
Other insurance 661,951 590,066 538,825
Legal and other professional services 2,169,209 2,193,687 1,304,967
Amortization of mortgage servicing asset 2,994,307 1,837.414 1,213,606
Guaranty fees 1,366,296 1,246,300 1,068,750
Other 6,189,139 4,776,780 4,898,911
----------- ----------- -----------
$22,687,336 $18,251,497 $15,424,117
----------- ----------- -----------
</TABLE>
14. 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 during 1998
where approximately $1,566,000 (1997- $ 1,245,000).
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, 1998 the aggregate amount of loans outstanding to officers,
directors, and principal stockholders of the Company and its subsidiaries were
insignificant.
15. 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, 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.
<PAGE>
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 Mortgages 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.
63
<PAGE>
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
classifications 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,
1998, the Company meets all capital adequacy requirements to which it is
subject.
As of December 31, 1998, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the Bank must maintain
minimum total risk-based, Tier I risk-based 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.
The following table reflects the Company's and the Bank's actual capital amounts
and ratios, and applicable regulatory capital requirements at December 31, 1998
and 1997:
<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>
As of December 31, 1998 Total capital (to risk weighted assets):
Consolidated $215,287 14.28% $120,638 8% N/A N/A
R-G Premier Bank only $110,501 14.46% $ 61,124 8% $ 76,405 10%
Tier I capital (to risk weighted assets):
Consolidated $207,232 13.74% $ 60,319 4% N/A N/A
R-G Premier Bank only $102,446 13.41% $ 30,562 4% $ 45,843 6%
Tier I capital (to average assets):
Consolidated $207,232 10.88% $ 76,172 4% N/A N/A
R-G Premier Bank only $102,446 8.04% $ 50,993 4% $ 63,741 5%
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%
</TABLE>
<PAGE>
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 Banks insurance premiums, which had amounted to $0.23 for every $100
of deposits, were reduced to $0.064 for every $100 of deposits beginning on
January 1, 1997.
64
<PAGE>
16. 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 869,400 shares after giving effect to stock splits) 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 (720,000 shares as
adjusted for stock splits) 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 (36,000 shares as adjusted for
stock splits) 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, 1998
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 Companys 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,
1998 and 1997 would have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Net earnings - as reported $ 34,033,797 $ 23,497,212
- --------------------------------------------------------------------------------
Net earnings - pro forma $ 33,879,283 $ 23,342,698
- --------------------------------------------------------------------------------
Basic earnings per share - as reported $ 1.15 $ 0.83
- --------------------------------------------------------------------------------
Basic earnings per share - pro forma $ 1.15 $ 0.82
- --------------------------------------------------------------------------------
Diluted earnings per share - as reported $ 1.12 $ 0.81
- --------------------------------------------------------------------------------
Diluted earnings per share - pro forma $ 1.12 $ 0.80
- --------------------------------------------------------------------------------
</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:
<PAGE>
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.
65
<PAGE>
17. 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 employees 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, 1998,
1997 and 1996 amounted to approximately $103,000, $79,000, and $72,000
respectively.
18. 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 $474.9 million at
December 31, 1998. 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
$134.1 million at December 31, 1998.
Commitments to buy and sell GNMA certificates
As of December 31, 1998, the Company had open commitments to issue GNMA
certificates in the amount of $45.6 million.
Commitments to sell mortgage loans
As of December 31, 1998 the Company had commitments to sell mortgage loans to
third party investors amounting to $93.2 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,
1998, minimum annual rental commitments under noncancellable operating leases
for certain office space and equipment, including leases with an affiliate, were
as follows:
Year Amount
1999 $ 2,896,728
2000 2,633,542
2001 2,388,548
2002 2,186,479
2003 1,804,035
Later years 11,176,722
-----------------
$ 23,086,054
=================
<PAGE>
Rent expense amounted to approximately $3,097,000 in 1998, $2,483,000 in 1997
and $2,171,000 in 1996.
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 Companys financial position or results of operations.
Others
At December 31, 1998 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 $507.4 million at December 31, 1998. Liability, if any, under the
recourse provisions at December 31, 1998 is estimated by management to be
insignificant.
19. Supplemental Disclosure on the Statements of
Cash Flows
During 1998, 1997 and 1996, the Company paid interest amounting to approximately
$79,576,000, $60,846,000, and $45,939,000 respectively, and income taxes of
approximately $4,306,000, $9,699,000, and $7,573,000 (including $1,065,000 in
1996 on settlement of a 1992 income tax examination), respectively.
During 1997 and 1996 the Company securitized loans from its mortgage loan
portfolio totaling approximately $11,346,000 and $43,673,000, 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.
20. 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.
66
<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 customers 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 managements credit evaluation
of the counterparty. A geographic concentration exists within the Companys
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, 1998 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 $ 17,021,109
----------------
Financial instruments whose notional or contractual amounts exceed the amount of
potential credit risk:
Interest rate swap contracts $ 205,000,000
----------------
A detail of interest rate swaps by contractual maturity December 31, 1998
follows:
<TABLE>
<CAPTION>
Notional Pay Fixed Receive
Amount Maturity Rate Rate Floating
------------- ----------------- ---- --------------------
<S> <C> <C> <C>
$ 10,000,000 October 24, 2000 5.20% 84% of 3 month Libid
25,000,000 September 10, 2001 6.09% 96% of 3 month Libid
15,000,000 January 26, 2001 5.59% 3 month Libor
15,000,000 September 17, 2002 5.79% 3 month Libid
15,000,000 June 15, 2003 5.29% 3 month Libor
15,000,000 August 13, 2003 5.16% 3 month Libor
10,000,000 September 15, 2003 4.70% 3 month Libor
50,000,000 June 8, 2008 5.17% 3 month Libor
20,000,000 June 12, 2008 5.09% 3 month Libor
25,000,000 June 15, 2008 5.04% 3 month Libor
5,000,000 June 17, 2008 5.00% 3 month Libor
</TABLE>
<PAGE>
The following table summarizes the changes in notional amounts of swaps
outstanding during 1998:
<TABLE>
<CAPTION>
<S> <C>
Beginning balance $ 50,000,000
New swaps 155,000,000
Maturities -
------------
Ending balance $205,000,000
</TABLE>
As of December 31, 1998, interest rate swap maturities are as follows:
2000 $ 10,000,000
2001 40,000,000
2002 15,000,000
2003 40,000,000
2008 100,000,000
------------------
$ 205,000,000
==================
Expected maturities will differ from contracted maturities because counter
parties to the agreements may have the right to call the swaps. As of December
31,1998 swap agreements with a notional amount of $155,000,000 had call options
at various dates commencing on June 1999 through September 2000.
67
<PAGE>
Net interest settlements on swap agreements are recorded as an adjustment to
interest expense on notes payable and repurchase agreements. Net interest
received during 1998 amounted to approximately $50,000; net payments amounted to
approximately $293,000 and $61,000 during 1997 and 1996, respectively.
21. 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,
1998 1997 1996
------------------ ------------------ ------------------
<S> <C> <C> <C>
Employee costs $ 30,013,967 $ 21,368,723 $ 17,357,976
------------------ ------------------ ------------------
Other administrative
and general expenses $ 25,906,635 $ 22,662,971 $ 18,916,546
------------------ ------------------ ------------------
</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,
1998 1997 1996
<S> <C> <C> <C>
Offset against mortgage
loan sales and fees $ 2,623,316 $ 2,931,394 $ 7,173,028
----------------- ----------------- -----------------
Offset against interest
income on loans $ 3,113,946 $ 2,122,727 $ 1,937,403
----------------- ----------------- -----------------
Capitalized as part of
loans held for sale and
loans held for investment $ 10,401,221 $ 7,073,322 $ 946,673
----------------- ----------------- -----------------
</TABLE>
68
<PAGE>
22. Fair Value of Financial Instruments
The estimated fair value of the Company's financial instruments as of December
31 are as follows:
<TABLE>
<CAPTION>
1998 1997
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
----------- ----------- ------------ -----------
(In thousands)
<S> <C> <C> <C> <C>
Financial Assets
Cash and due from banks $ 51,805 $ 51,805 $ 32,607 $ 32,607
Money market investments 51,924 51,924 35,759 35,759
Mortgage loans held for sale 117,126 117,126 46,885 48,345
Mortgage-backed securities held for trading 450,546 450,546 400,457 400,457
Investment securities held for trading -- -- 581 581
Investment and mortgage-backed securities
available for sale 143,137 143,137 116,961 116,961
Investment in Federal Home Loan Bank stock 11,405 11,405 4,906 4,906
Investment and mortgage-backed securities
held to maturity 34,599 34,640 44,019 43,876
Loans, net 1,073,668 1,108,435 765,059 791,309
Accounts receivable 22,171 22,171 17,704 17,704
----------- ----------- ------------ -----------
Financial Liabilities
Deposits:
Non-interest bearing demand $ 172,500 $ 172,500 $ 91,504 $ 91,504
Savings and NOW accounts 222,856 212,797 174,923 156,859
Certificates of deposit 609,912 620,383 454,394 460,001
Securities sold under agreements to
repurchase 471,422 471,422 443,134 443,134
Notes payable 191,748 194,191 108,453 110,567
Advances from FHLB 121,000 118,856 42,000 41,971
Other secured borrowings -- -- 34,359 35,019
Accounts payable and accrued liabilities 28,020 28,020 15,872 15,872
Subordinated notes -- -- 3,250 3,304
Unrecognized financial instruments -
Interest rate swap agreements in a net
receivable (payable) position* $ (111) $ 1,855 $ (14) $ 370
----------- ----------- ------------ -----------
</TABLE>
* The amount shown under carrying amount represents net accrual arising
from those unrecognized financial instruments.
69
<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, 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.
<PAGE>
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, 1998. 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 made in the absence of secondary market prices. This lack
of objective pricing standards introduces a greater degree of subjectivity to
these derived or estimated fair values. Therefore, while disclosure of estimated
fair values of financial instruments is required, readers are cautioned in using
this data for purposes of evaluating the financial condition of the Company.
70
<PAGE>
23. 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, 1998 and
1997 and the results of its operations and its cash flows for each of the three
years ended on December 31,1998 (since inception in 1996):
<TABLE>
<CAPTION>
Statements of Financial Condition
December 31,
1998 1997
------------ ------------
<S> <C> <C>
Assets
Cash $ 145,314 $ 622,478
Investment in R-G Premier Bank, at equity 114,706,236 47,407,575
Investment in R&G Mortgage, at equity 106,307,634 59,542,059
Investment in preferred stock of R-G Premier Bank, at cost -- 30,100,000
Accounts receivable - subsidiaries 69,828 423,178
Other assets 32,234 --
------------ ------------
Total assets $221,261,246 $138,095,290
------------ ------------
Liabilities and Stockholders' Equity
Other liabilities and accrued expenses $ 99,387 $ 41,374
Stockholders' equity 221,161,859 138,053,916
------------ ------------
Total liabilities and stockholders equity $221,261,246 $138,095,290
------------ ------------
</TABLE>
Statements of Income
<TABLE>
<CAPTION>
December 31,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Income:
Dividends from subsidaries $ 2,404,787 $ 2,953,225 $ --
Management fees 384,638 423,178 --
Interest on certificates of deposit -- -- 12,164
----------- ----------- -----------
2,789,425 3,376,403 12,164
----------- ----------- -----------
Operating expenses 349,669 384,707 10,811
----------- ----------- -----------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Income before income taxes and equity
in undistributed earnings of subsidiaries 2,439,756 2,991,696 1,353
Income taxes 9,477 8,079 338
----------- ----------- -----------
Income before equity in undistributed earnings of subsidiaries 2,430,279 2,983,617 1,015
Equity in undistributed earnings of subsidiaries 31,603,518 20,513,595 13,198,501
----------- ----------- -----------
Net income $34,033,797 $23,497,212 $13,199,516
----------- ----------- -----------
</TABLE>
The Holding Company had no operations during the years ended December 31, 1998,
1997 and 1996.
The principal source of income for the Holding Company consists of dividends
from R-G Premier Bank of Puerto Rico and R-G Mortgage Corp. 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.
71
<PAGE>
<TABLE>
<CAPTION>
Statements of Cash Flows
Year ended December 31,
Cash flows from operating activities: 1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net income $ 34,033,797 $ 23,497,212 $ 13,199,516
Adjustments to reconcile net income to cash provided by operating
activities:
Equity in undistributed earnings of subsidiaries (31,603,518) (20,513,595) (13,198,501)
Decrease (increase) in accounts receivable - subsidiaries 353,350 (423,178) --
Increase in other assets (32,234) -- --
Increase (decrease) in other liabilities and accrued expenses 58,013 26,505 (357,482)
------------ ------------ ------------
Total adjustments (31,224,389) (20,910,268) (13,555,983)
------------ ------------ ------------
Net cash provided by (used in) operating activities 2,809,408 2,586,944 (356,467)
------------ ------------ ------------
Cash flows from investing activities:
Capital contribution to subsidiary (12,000) -- --
Cash investments in R-G Premier Bank
pursuant to acquisition of Fajardo Federal (639,322) -- --
Investment in Bank common stock (19,370,000) -- --
Investment in R-G Mortgage common stock (29,055, 000) -- --
Collections of advances to subsidiaries -- 290,000 --
Dividends on common stock from subsidiaries 2,122,649 -- --
Purchase of investment in preferred stock of the Bank -- -- (30,100,000)
------------ ------------ ------------
Cash (used in) provided by investing activities (46,953,673) 290,000 (30,100,000)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of common
stock on initial public offering -- -- 31,072,748
Net proceeds from issuance of Series A preferred stock 48,079,134 -- --
Cash dividends (4,412,033) (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 provided by (used in) financing activities 43,667,101 (3,065,386) 31,267,387
------------ ------------ ------------
Net (decrease) increase in cash (477,164) (188,442) 810,920
Cash at beginning of year 622,478 810,920 --
------------ ------------ ------------
Cash at end of year $ 145,314 $ 622,478 $ 810,920
------------ ------------ ------------
</TABLE>
72
<PAGE>
24. Industry Segments
The following summarized financial information presents the results of the
Company's operations for the three year period ended December 31,1998 for its
traditional banking and mortgage banking activities:
<TABLE>
<CAPTION>
1998 1997
Segment Segment
Bank Mortgage Totals Bank Mortgage
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Revenues:
Net interest income after provision for
loan losses $31,279,733 $ 6,093,378 $37,373,111 $25,543,992 $ 4,615,774
Non-interest income:
Net gain on origination and sale of loans 12,542,960 22,120,015 34,662,975 5,436,030 18,596,684
Net gain on sales of investment securities
available for sale 278,028 - 278,028 107,430 --
Loan administration and servicing fees -- 17,340,415 17,340,415 -- 14,079,644
Service charges, fees and other 5,433,556 1,383,042 6,816,598 3,431,241 1,142,014
----------- ----------- ----------- ----------- -----------
49,534,277 46,936,850 96,471,127 34,518,693 38,434,116
Non-interest expenses:
Salaries and employee benefits 9,169,292 7,925,491 17,094,783 7,654,668 5,998,086
Office occupancy and equipment 5,917,063 3,069,890 8,986,953 4,660,583 2,470,914
SAIF special assessment -- -- -- -- --
Other 11,232,822 13,420,625 24,653,447 9,564,598 9,799,853
----------- ----------- ----------- ----------- -----------
26,319,177 24,416,006 50,735,183 21,879,849 18,268,853
----------- ----------- ----------- ----------- -----------
Income before income taxes (and minority
interest in 1996) $23,215,100 $22,520,844 $45,735,944 $12,638,844 $20,165,263
----------- ----------- ----------- ----------- -----------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1996
Segment Segment
Totals Bank Mortgage Totals
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Net interest income after provision for $30,159,766 $20,883,829 $ 3,781,152 $24,664,981
loan losses
Non-interest income: 24,032,714 1,364,373 10,344,601 11,708,974
Net gain on origination and sale of loans
Net gain on sales of investment securities 107,430 641,798 -- 641,798
available for sale 14,079,644 -- 13,696,224 13,696,224
Loan administration and servicing fees 4,573,255 4,140,238 436,385 4,576,623
Service charges, fees and other
----------- ----------- ----------- -----------
72,952,809 27,030,238 28,258,362 55,288,600
----------- ----------- ----------- -----------
Non-interest expenses:
13,652,754 6,062,221 4,731,080 10,793,301
Salaries and employee benefits 7,131,497 3,551,035 1,980,094 5,531,129
Office occupancy and equipment -- 2,508,380 -- 2,508,380
SAIF special assessment 19,364,451 8,537,206 8,155,520 16,692,726
Other
----------- ----------- ----------- -----------
40,148,702 20,658,842 14,866,694 35,525,536
----------- ----------- ----------- -----------
Income before income taxes (and minority
interest in 1996) $32,804,107 $ 6,371,396 $13,391,668 $19,763,064
----------- ----------- ----------- -----------
</TABLE>
The following is a reconciliation of reportable segment revenues and income
before income taxes to the Company's consolidated amounts:
Revenues:
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Total revenues for reportable segments $ 96,471,127 $ 72,952,809 $ 55,288,600
Elimination of intersegment revenues (2,627,742) (1,687,981) (1,371,572)
------------ ------------ ------------
Total consolidated revenues $ 93,843,385 $ 71,264,828 $ 53,917,028
------------ ------------ ------------
</TABLE>
73
<PAGE>
Income before income taxes:
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Total income before income taxes for reportable segments $ 45,735,944 $ 32,804,107 $ 19,763,064
Elimination of intersegment profits (311,962) (190,320) (92,152)
Unallocated corporate expenses (349,669) (384,707) (10,811)
------------ ------------ ------------
Income before income taxes, consolidated $ 45,074,313 $ 32,229,080 $ 19,660,101
------------ ------------ ------------
</TABLE>
Total assets of the Company among its industry segments and a reconciliation of
reportable segment assets to the Company's consolidated total assets as of
December 31, 1998 and 1997 follows:
<TABLE>
<CAPTION>
December 31,
1998 1997
--------------- ---------------
<S> <C> <C>
Assets:
Bank $ 1,413,439,195 $ 1,032,117,561
Mortgage 656,598,961 485,674,090
--------------- ---------------
Total assets for reportable segments 2,070,038,156 1,517,791,651
Parent company assets 32,234 --
Elimination of intersegment balances (25,288,862) (7,046,135)
--------------- ---------------
Consolidated total assets $ 2,044,781,528 $ 1,510,745,516
--------------- ---------------
</TABLE>
<PAGE>
25. 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)
1998
March 31 June 30 Sept. 30 Dec. 31
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Interest income $ 27,776 $ 29,946 $ 33,179 $ 33,395
Interest expense (17,790) (19,134) (21,443) (21,956)
Net interest income 9,986 10,812 11,736 11,439
Provision for loan losses (1,500) (1,500) (1,500) (2,100)
Income before income taxes 10,736 9,994 12,347 11,997
Income tax expense (3,256) (2,023) (3,810) (1,951)
Net income 7,480 7,971 8,537 10,046
Net income per common share - Basic $ .26 $ .28 $ .29 $ .32
Net income per common share - Diluted $ .26 $ .27 $ .28 $ .31
<CAPTION>
1997
March 31 June 30 Sept. 30 Dec. 31
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Interest income $ 20,408 $ 22,764 $ 26,213 $ 27,950
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 $ .18 $ .19 $ .21 $ .25
Net income per common share - Diluted $ .17 $ .19 $ .21 $ .24
</TABLE>
74
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 51,804,750
<INT-BEARING-DEPOSITS> 41,905,650
<FED-FUNDS-SOLD> 10,018,048
<TRADING-ASSETS> 450,546,034
<INVESTMENTS-HELD-FOR-SALE> 154,542,471
<INVESTMENTS-CARRYING> 34,599,447
<INVESTMENTS-MARKET> 34,639,559
<LOANS> 1,073,668,278
<ALLOWANCE> 8,055,432
<TOTAL-ASSETS> 2,044,781,528
<DEPOSITS> 1,007,297,304
<SHORT-TERM> 784,169,682
<LIABILITIES-OTHER> 32,152,683
<LONG-TERM> 0
0
50,000,000
<COMMON> 41,830,245
<OTHER-SE> 129,331,614
<TOTAL-LIABILITIES-AND-EQUITY> 2,044,781,528
<INTEREST-LOAN> 89,043,798
<INTEREST-INVEST> 29,397,985
<INTEREST-OTHER> 5,855,157
<INTEREST-TOTAL> 124,296,940
<INTEREST-DEPOSIT> 38,439,016
<INTEREST-EXPENSE> 80,323,829
<INTEREST-INCOME-NET> 43,973,111
<LOAN-LOSSES> 6,600,000
<SECURITIES-GAINS> 6,297,935
<EXPENSE-OTHER> 48,769,072
<INCOME-PRETAX> 45,074,313
<INCOME-PRE-EXTRAORDINARY> 34,033,797
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 34,033,797
<EPS-PRIMARY> 1.15
<EPS-DILUTED> 1.12
<YIELD-ACTUAL> 7.70
<LOANS-NON> 44,525,936
<LOANS-PAST> 418,157
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 46,611,494
<ALLOWANCE-OPEN> 6,771,702
<CHARGE-OFFS> 6,012,792
<RECOVERIES> 696,522
<ALLOWANCE-CLOSE> 8,055,432
<ALLOWANCE-DOMESTIC> 8,055,432
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
