<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 1998 Commission file number: 1-12639
------------- -------
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C>
Maryland 94-3254883
- -------------------------------------------------------------------------------------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
200 Crescent Court, Suite 1350, Dallas, Texas 75201
- -------------------------------------------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
</TABLE>
214-871-5131
- ------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
N/A
- ------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
The number of shares outstanding of registrant's $0.01 par value common
stock, as of the close of business on August 10, 1998: 1,000 shares.
Page 1 of 19 pages
Exhibit index on page 16
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
SECOND QUARTER 1998 REPORT ON FORM 10-Q
TABLE OF CONTENTS
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Balance Sheets
June 30, 1998 and December 31, 1997.................... 3
Unaudited Statements of Income
Six months ended June 30, 1998 and 1997................ 4
Unaudited Statements of Income
Three months ended June 30, 1998 and 1997.............. 5
Unaudited Statements of Cash Flows
Six months ended June 30, 1998 and 1997................ 6
Notes to Unaudited Financial Statements................ 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......... 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................... 16
Item 6. Exhibits and Current Reports on Form 8-K............... 16
2
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
Balance Sheets
June 30, 1998 and December 31, 1997
(Unaudited)
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---- ----
<S> <C> <C>
ASSETS
Residential mortgage loans, net $ 954,225 $ 969,423
Cash and cash equivalents 21,379 6,382
Due from affiliates 32,181 19,800
Accrued interest receivable 5,596 5,399
Foreclosed real estate, net 1,493 491
---------- ----------
TOTAL ASSETS $1,014,874 $1,001,495
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Due to affiliates $ 643 $ --
Accounts payable and accrued liabilities 170 349
---------- ----------
Total Liabilities 813 349
---------- ----------
Commitments and contingencies
Stockholders' Equity:
Preferred stock, par value $0.01 per share, liquidation preference $500,000,
30,000,000 shares authorized, 20,000,000 shares
issued and outstanding 500,000 500,000
Common stock, par value $0.01 per share, 30,000,000 shares authorized,
1,000 shares issued and outstanding -- --
Additional paid-in capital 500,000 500,000
Retained earnings 14,061 1,146
Total Stockholders' Equity 1,014,061 1,001,146
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,014,874 $1,001,495
========== ==========
</TABLE>
See accompanying notes to unaudited financial statements.
3
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
STATEMENTS OF INCOME
Six Months Ended June 30, 1998 and 1997
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
NET INTEREST INCOME
Residential mortgage loans $ 38,186 $ 29,319
Less: servicing fee expense (1,826) (1,492)
-------- --------
36,360 27,827
Short-term investments 527 414
-------- --------
Net interest income 36,887 28,241
Provision for loan losses (1,050) (1,050)
-------- --------
Net interest income after provision for loan losses 35,837 27,191
-------- --------
NONINTEREST EXPENSE
Director fees 44 34
Professional fees 40 23
Foreclosed real estate operations, net (6) --
Other 31 20
-------- --------
Total noninterest expense 109 77
-------- --------
NET INCOME 35,728 27,114
Preferred stock dividends 22,813 19,137
-------- --------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 12,915 $ 7,977
======== ========
</TABLE>
See accompanying notes to unaudited financial statements.
4
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
STATEMENTS OF INCOME
Three Months Ended June 30, 1998 and 1997
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
NET INTEREST INCOME
Residential mortgage loans $ 18,657 $ 17,780
Less: servicing fee expense (914) (928)
-------- --------
17,743 16,852
Short-term investments 329 347
-------- --------
Net interest income 18,072 17,199
Provision for loan losses (630) (630)
-------- --------
Net interest income after provision for loan losses 17,442 16,569
-------- --------
NONINTEREST EXPENSE
Director fees 34 --
Professional fees 30 16
Foreclosed real estate operations, net (6) --
Other 9 20
-------- --------
Total noninterest expense 67 36
-------- --------
NET INCOME 17,375 16,533
Preferred stock dividends 11,407 11,406
-------- --------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 5,968 $ 5,127
======== ========
</TABLE>
See accompanying notes to unaudited financial statements.
5
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 1998 and 1997
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 35,728 $ 27,114
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of deferred loan fees and direct origination costs and purchase
discounts and premiums, net 51 97
Provision for loan losses 1,050 1,050
Gain on sales of foreclosed real estate, net (13) --
Increase in due from affiliates (469) --
Decrease in accrued interest receivable 569 733
Increase/(decrease) in accounts payable and accrued liabilities (179) 268
Increase in due to affiliates 643 10
----------- -----------
Net cash provided by operating activities 37,379 29,272
----------- -----------
INVESTING ACTIVITIES:
Purchase of mortgage loans (166,224) (1,019,491)
Mortgage loan principal repayments 166,929 52,391
Purchase of accrued interest receivable (766) (6,187)
Proceeds from sales of foreclosed real estate 635 --
Foreclosed real estate advances funded (144) --
----------- -----------
Net cash provided by (used in) investing activities 430 (973,287)
----------- -----------
FINANCING ACTIVITIES:
Proceeds from capital contributed by Bank -- 500,000
Proceeds from preferred stock issued -- 500,000
Preferred stock dividends paid (22,813) (19,137)
----------- -----------
Net cash provided by (used in) financing activities (22,813) 980,863
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 14,997 36,848
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 6,382 --
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 21,379 $ 36,848
=========== ===========
</TABLE>
See accompanying notes to unaudited financial statements.
6
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
(1) Basis of Presentation
The accompanying financial statements of California Federal Preferred
Capital Corporation (the "Company") were prepared in accordance with
generally accepted accounting principles for interim financial information
and with the instructions for meeting the requirements of Regulation S-X,
Article 10 and therefore do not include all disclosures necessary for
complete financial statements. In the opinion of management, all
adjustments have been made that are necessary for a fair presentation of
the financial position and results of operations and cash flows as of and
for the periods presented. All such adjustments are of a normal recurring
nature. The results of operations for the three and six months ended June
30, 1998 are not necessarily indicative of the results that may be
expected for the entire fiscal year or any other interim period. Certain
amounts for the three and six month periods in the prior year have been
reclassified to conform with the current period's presentation.
The accompanying financial statements should be read in conjunction with
the financial statements included in the Company's Annual Report on Form
10-K for the year ended December 31, 1997. All terms used but not defined
elsewhere herein have meanings ascribed to them in the Company's Annual
Report on Form 10-K.
As the Company's common stock is wholly owned by California Federal Bank,
A Federal Savings Bank (the "Bank"), earnings per share data is not
presented.
(2) Cash, Cash Equivalents and Statements of Cash Flows
For purposes of the statement of cash flows, cash and cash equivalents
include cash and amounts due from banks, and other short-term investments
with original maturities of three months or less.
During the six months ended June 30, 1998, noncash activity included
transfers of $1,480,000 from residential mortgage loans to foreclosed real
estate. No such transfers occurred during the six months ended June 30,
1997.
In accordance with the servicing agreement, certain principal repayments
are not remitted by First Nationwide Mortgage Corporation ("FNMC"), in its
capacity as servicer, to the Company until the month following FNMC's
receipt of such repayments from mortgagors. The Company records mortgage
loan principal repayments during the period such repayments are received
by FNMC. During the six months ended June 30, 1998 and 1997, the Company
recorded principal reductions to residential mortgage loans which exceeded
cash received from FNMC for mortgage loan principal repayments by
$11,912,000 and $14,110,000, respectively. An equal offsetting increase to
due from affiliates was also recorded during each period.
(3) Residential Mortgage Loans, Net
At June 30, 1998 and December 31, 1997, residential mortgage loans, net,
consisted of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
--------- ----------
<S> <C> <C>
1-4 unit residential mortgage loans $ 960,274 $ 976,155
Deferred loan fees and direct origination costs and purchase
discounts and premiums, net 1,385 578
Allowance for loan losses (7,434) (7,310)
--------- ---------
Total residential mortgage loans, net $ 954,225 $ 969,423
========= =========
</TABLE>
7
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
Residential mortgage loans consist primarily of adjustable rate mortgages
("ARMs") which adjust periodically based on changes in various indices
including the FHLB Eleventh District Cost of Funds, the one-year Treasury
rate and the six-month Treasury rate. Certain types of residential
mortgage loans contain an option for the mortgagor to convert the ARM to a
fixed rate loan for the remainder of the term.
(4) Dividends
Holders of Series A Preferred Shares are entitled to receive, if, when and
as authorized and declared by the Board of Directors of the Company out of
funds legally available, noncumulative dividends at a rate of 9.125% per
annum of the initial liquidation preference ($25.00 per share). Dividends
on the Series A Preferred Shares, if authorized and declared, are payable
quarterly in arrears on the last day of March, June, September and
December. Dividends paid during the six months ended June 30, 1998 and
1997 to the holders of the Series A Preferred Shares totalled
approximately $22,813,000 and $19,137,000, respectively.
Dividends on common stock are paid when, as and if authorized and declared
by the Board of Directors out of funds legally available after all
preferred dividends have been paid. There were no common dividends paid
during the six months ended June 30, 1998 and 1997.
(5) Related Party Transactions
The Company entered into a servicing agreement with FNMC pursuant to which
FNMC performs the actual servicing of the residential mortgage loans held
by the Company in accordance with normal industry practice (the "Servicing
Agreement"). The Servicing Agreement can be terminated without cause with
at least 30 days prior written notice to FNMC and payment to FNMC of a
termination fee equal to 2% of the outstanding principal balances of the
loans. The servicing fee ranges from 0.25% to 0.50% per year of the
outstanding principal balances. Servicing fee expense paid totalled
$1,826,000 and $1,492,000 for the six months ended June 30, 1998 and 1997,
respectively. Servicing fee expense paid totalled $914,000 and $928,000
for the three months ended June 30, 1998 and 1997, respectively. FNMC is
also entitled to a 1% disposition fee on the aggregate proceeds obtained
in the sale of a defaulted residential mortgage loan. The Company recorded
such disposition fees totalling approximately $8,000 and $11,000 during
the three and six months ended June 30, 1998, respectively. No disposition
fees were recorded during the three and six months ended June 30, 1997.
In its capacity as servicer, FNMC holds mortgage loan payments received on
behalf of the Company in a custodial account at the Bank. The balance of
this account totalled approximately $32,181,000 and $19,640,000 at June
30, 1998 and December 31, 1997, respectively, and is included in due from
affiliates. Substantially all of such payments were passed through to the
Company in July 1998 and January 1998, respectively, as provided in the
servicing agreement. At June 30, 1998 and December 31, 1997, trust funds
of approximately $1,976,000 and $1,425,000, respectively, representing
escrows received from borrowers, were on deposit in a trust account at the
Bank and are not included in the accompanying financial statements.
As of June 30, 1998 the Company owed the Bank approximately $643,000 in
connection with the settlement of loans purchased from the Bank, advances
related to foreclosed real estate and expenses incurred by the Company to
be reimbursed to the Bank. This amount was paid to the Bank during July
and August 1998.
As of December 31, 1997 the Bank owed the Company approximately $160,000
in connection with proceeds from the Company's sale of a foreclosed real
estate property, offset by amounts related to the settlement of loans
purchased from the Bank and expenses incurred by the Company to be
reimbursed to the Bank. This amount was included in due from affiliates on
the balance sheet. The Bank paid this amount to the Company during January
1998.
8
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
(6) Newly Issued Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS No. 133"). SFAS No. 133 establishes standards for derivative
instruments and for hedging activities, and 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. Under
SFAS No. 133, an entity that elects to apply hedge accounting is required
to establish at the inception of the hedge the method it will use for
assessing the effectiveness of the hedging derivative and the measurement
approach for determining the ineffective aspect of the hedge. SFAS No. 133
applies to all entities and amends FASB Statement No. 107, Disclosures
About Fair Values of Financial Instruments, to include in Statement 107
the disclosure provisions about concentrations of credit risk from
Statement 105. SFAS No. 133 supersedes FASB Statements No. 80, Accounting
for Futures Contracts, No. 105, Disclosure of Information about Financial
Instruments with Off-Balance Sheet Risk and Financial Instruments with
Concentrations of Credit Risk, and No. 119, Disclosure about Derivative
Financial Instruments and Fair Value of Financial Instruments. SFAS No.
133 also nullifies or modifies the consensuses reached in a number of
issues addressed by the Emerging Issues Task Force. SFAS No. 133 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 entity's fiscal quarter; on that date, hedging relationships must be
designated anew and documented pursuant to the provisions of this
statement. Earlier application of all of the provisions of SFAS No. 133 is
encouraged, but is permitted only as of the beginning of any fiscal
quarter that begins after issuance of this statement. SFAS No. 133 should
not be applied retroactively to financial statements of prior periods.
Management has not yet completed its analysis of SFAS No. 133 and is
unable to determine the effect, if any, implementation may have on the
Company's financial statements.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The statements contained in this Report on Form 10-Q that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including statements regarding the Company's expectations, intentions,
beliefs or strategies regarding the future. Forward-looking statements include
the Company's statements regarding liquidity, provision for loan losses,
capital resources and investment activities in "Management's Discussion and
Analysis of Financial Condition and Results of Operations." In addition, in
those and other portions of this document, the words "anticipate," "believe,"
"estimate," "deem," "expect," "intend," and other similar expressions, as they
relate to the Company or the Company's management, are intended to identify
forward-looking statements. Such statements reflect the current views of the
Company with respect to future events and are subject to certain risks,
uncertainties and assumptions. It is important to note that the Company's
actual results could differ materially from those described herein as
anticipated, believed, estimated or expected. Among the factors that could
cause results to differ materially are the risks discussed in the "Risk
Factors" section included in the Company's Registration Statement on Form
S-11(File No. 333-11609), with respect to the Series A Preferred Shares
declared effective by the Securities and Exchange Commission on January 24,
1997. The Company assumes no obligation to update any such forward-looking
statement.
FINANCIAL HIGHLIGHTS
The following information is presented as of June 30, 1998 and for the six and
three months ended June 30, 1998 and 1997 (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Statements of Income - Six Months Ended June 30:
Net interest income $ 36,887 $ 28,241
Net interest income after provision for loan losses $ 35,837 $ 27,191
Net income $ 35,728 $ 27,114
Average yield on mortgage loans 7.32% 7.01%
Statements of Income - Three Months Ended June 30:
Net interest income $ 18,072 $ 17,199
Net interest income after provision for loan losses $ 17,442 $ 16,569
Net income $ 17,375 $ 16,533
Average yield on mortgage loans 7.17% 6.91%
Balance Sheet as of June 30, 1998:
Residential mortgage loans, net $ 954,225
Total assets $1,014,874
Total stockholders' equity $1,014,061
</TABLE>
OVERVIEW
The Company's principal business objective is to acquire, hold and manage
residential mortgage loans that will generate net income for distribution to
stockholders. The Company currently intends to invest in residential mortgage
loans only. The Company's current policy prohibits the acquisition of any
mortgage loan which is delinquent at the time of the proposed acquisition or
which meets certain criteria for non-performance during the preceding 12
months. The Company currently expects that substantially all of the residential
mortgage loans to be acquired will be adjustable rate loans; however, the
Company may from time to time acquire fixed interest rate residential mortgage
loans. The Company anticipates it will continue to acquire all of its
residential mortgage loans from the Bank or affiliates of the Bank as whole
loans secured by first mortgages or deeds of trust on single-family
(one-to-four-unit) residential real estate properties, although mortgage loans
may be acquired from unaffiliated third parties. The Company may from time to
time acquire
10
<PAGE>
fixed rate or variable rate mortgage-backed securities issued or guaranteed by
agencies of the federal government or government sponsored agencies. The
mortgage loans underlying the mortgage-backed securities will be secured by
single-family residential, multifamily or commercial real estate properties
located throughout the United States.
On January 31, 1997, the Company commenced its operations upon the initial
public offering of 20,000,000 shares of the Company's 9.125% Noncumulative
Exchangeable Preferred Stock, Series A (the "Series A Preferred Shares"), which
raised $500,000,000. The Series A Preferred Shares are traded on the New York
Stock Exchange under the trading symbol "CFP." Concurrent with the sale of the
Series A Preferred Shares, the Bank contributed additional capital of
$500,000,000 to the Company. All common shares are held by the Bank.
RESULTS OF OPERATIONS
Six Months ended June 30, 1998 versus Six Months ended June 30, 1997
Net Income. The Company reported net income for the six months ended June 30,
1998 of $35,728,000 compared with net income of $27,114,000 for the
corresponding period in 1997. This increase in 1998 over 1997 is attributable
to an increase in interest income and reflects six months of operations in 1998
versus five months of operations in 1997, as the Company commenced its
operations on January 31, 1997.
During the six months ended June 30, 1998 and 1997, the Company declared and
paid dividends of $22,813,000 and $19,137,000, respectively, on the outstanding
Series A Preferred Shares. Net income available to the common stockholder for
the six months ended June 30, 1998 and 1997 totalled $12,915,000 and
$7,977,000, respectively.
Interest Income. The Company reported net interest income of $36,887,000 for
the six months ended June 30, 1998, an increase of $8,646,000 over the
$28,241,000 net interest income reported for the corresponding period in 1997.
Of this increase in interest income, $8,533,000 is attributed to residential
mortgage loans and $113,000 is attributed to short-term investments. The
increase in residential mortgage loan interest income is attributed primarily
to an increase in the average outstanding balance of the portfolio, accounting
for $7,252,000 of the increase, while $1,281,000 relates to a higher average
yield on the portfolio. The average outstanding balance of residential mortgage
loans during the six month period ended June 30, 1998 was $198,754,000 higher
than during the same period in 1997, principally due to one less month of
operations in 1997 than in 1998. The higher yield of 7.32% on residential
mortgage loans during the six month period ended June 30, 1998 as compared to
7.01% for the same period in 1997 primarily reflects an increase in the
weighted average coupon of the portfolio. The Company experienced a shift in
the portfolio such that a larger proportion of the loans have coupon rates
based on the one-year Treasury rate index and a smaller proportion have coupons
based on the FHLB Eleventh District Cost of Funds ("COFI") index. Loans based
on the one-year Treasury rate index generally have coupons that are higher than
those of COFI loans. This yield increase also reflects comparatively higher
rates on COFI loans during the six month period ended June 30, 1998 versus the
same period in 1997. Net interest income during the six months ended June 30,
1998 is comprised of $36,360,000 ($38,186,000 gross interest less $1,826,000
servicing fee expense) from residential mortgage loans and $527,000 from
short-term investments, representing an average yield after servicing fees on
residential mortgage loans of 7.32% and on earning assets of 7.27%, based on
average outstanding asset balances of $992,820,000 and $1,014,527,000,
respectively. Net interest income after a $1,050,000 provision for loan losses
was $35,837,000. Net interest income during the six months ended June 30, 1997
is comprised of $27,827,000 ($29,319,000 gross interest less $1,492,000
servicing fee expense) from residential mortgage loans and $414,000 from
short-term investments, representing an average yield after servicing fees on
residential mortgage loans of 7.01% and on earning assets of 6.95%, based on
average outstanding asset balances of $794,066,000 and $812,652,000,
respectively. Net interest income after a $1,050,000 provision for loan losses
was $27,191,000.
The computations of the average yields above on residential mortgage loans and
on earning assets is based on daily average outstanding asset balances that
include nonaccruing loans and the amount of principal payments collected by
FNMC but not yet remitted to the Company, which is included in due from
affiliates on the balance sheets.
11
<PAGE>
Three months ended June 30, 1998 versus three months ended June 30, 1997
Net Income. The Company reported net income for the three months ended June
30, 1998 of $17,375,000 compared with net income of $16,533,000 for the
corresponding period in 1997. This increase in 1998 over 1997 is attributable
to an increase in interest income.
During the three months ended June 30, 1998 and 1997, the Company declared and
paid dividends of $11,407,000 and $11,406,000, respectively, on the outstanding
Series A Preferred Shares. Net income available to the common stockholder for
the three months ended June 30, 1998 and 1997 totalled $5,968,000 and
$5,127,000, respectively.
Interest Income. The Company reported net interest income of $18,072,000 for
the three months ended June 30, 1998, an increase of $873,000 over the
$17,199,000 net interest income reported for the corresponding period in 1997.
Of this increase in interest income, $891,000 is attributed to residential
mortgage loans, offset by an $18,000 decrease in interest on short-term
investments. The increase in residential mortgage loan interest income is
attributed primarily to a higher average yield on the portfolio, accounting for
$639,000 of the increase, while $252,000 relates to an increase in the average
outstanding portfolio balance. The higher yield of 7.17% on residential
mortgage loans during the three month period ended June 30, 1998 as compared to
6.91% for the same period in 1997 primarily reflects an increase in the
weighted average coupon of the portfolio. The Company experienced a shift in
the portfolio such that a larger proportion of the loans have coupon rates
based on the one-year Treasury rate index and a smaller proportion have coupons
based on the COFI index. Loans based on the one-year Treasury rate index
generally have coupons that are higher than those of COFI loans. This yield
increase also reflects comparatively higher rates on COFI loans during the
three month period ended June 30, 1998 versus the same period in 1997. The
average outstanding balance of residential mortgage loans during the three
month period ended June 30, 1998 was $14,497,000 higher than during the same
period in 1997 due to the timing of reinvestment of payoffs in new loans. Net
interest income during the three months ended June 30, 1998 is comprised of
$17,743,000 ($18,657,000 gross interest less $914,000 servicing fee expense)
from residential mortgage loans and $329,000 from short-term investments,
representing an average yield after servicing fees on residential mortgage
loans of 7.17% and on earning assets of 7.12%, based on average outstanding
asset balances of $989,394,000 and $1,015,142,000, respectively. Net interest
income after a $630,000 provision for loan losses was $17,442,000. Net interest
income during the three months ended June 30, 1997 is comprised of $16,852,000
($17,780,000 gross interest less $928,000 servicing fee expense) from
residential mortgage loans and $347,000 from short-term investments,
representing an average yield after servicing fees on residential mortgage
loans of 6.91% and on earning assets of 6.84%, based on average outstanding
asset balances of $974,897,000 and $1,006,563,000, respectively. Net interest
income after a $630,000 provision for loan losses was $16,569,000.
The computations of the average yields above on residential mortgage loans and
on earning assets is based on daily average outstanding asset balances that
include nonaccruing loans and the amount of principal payments collected by
FNMC but not yet remitted to the Company, which is included in due from
affiliates on the balance sheets.
RESIDENTIAL MORTGAGE LOANS
During the six months ended June 30, 1997, the Company used the proceeds from
its offering of Series A Preferred Shares, coupled with a capital contribution
from the Bank, to purchase the Company's initial portfolio of residential
mortgage loans. The Company reinvests principal collections in additional
residential mortgage loans purchased from either the Bank or its affiliates on
a periodic basis.
It is the Company's policy to place a loan on nonaccrual when a borrower is 90
days or more delinquent. There were no accruing loans contractually past due 90
days or more at June 30, 1998 or December 31, 1997.
12
<PAGE>
The following table reflects residential mortgage loans with past due principal
and interest payments as of June 30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
June 30, 1998 December 31, 1997
-------------------------------------- --------------------------------------
Principal Balance Percent Principal Balance Percent
(in thousands) of Total Loans (in thousands) of Total Loans
------------------ -------------- ----------------- --------------
<S> <C> <C> <C> <C>
30 to 59 days past due $ 2,699 0.28% $ 1,427 0.15%
60 to 89 days past due $ 1,718 0.18% $ 1,490 0.15%
90 days or more past due $ 2,363 0.25% $ 3,591 0.37%
</TABLE>
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is available to absorb potential loan losses from
the entire residential mortgage loan portfolio. The Company deems its allowance
for loan losses as of June 30, 1998 to be adequate. Although the Company
believes that it has sufficient allowances to absorb losses which currently may
exist in the portfolio, but are not yet identifiable, the precise loss is
subject to continuing review based on quality indicators, industry and
geographic concentrations, changes in business conditions, and other external
factors such as competition, legal and regulatory requirements. The Company
will continue to periodically reassess the adequacy of the allowance for loan
losses.
The following table reflects the activity in the Company's allowance for loan
losses for the six months ended June 30, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Balance - January 1 $7,310 $ --
Allowance attributable to loans purchased from the Bank -- 5,000
Provision for loan losses 1,050 1,050
Charge-offs (926) --
Recoveries -- --
------ ------
Balance - June 30 $7,434 $6,050
====== ======
</TABLE>
The Company's allowance coverage ratio (allowance for loan losses to loans) at
June 30, 1998 and December 31, 1997 was 0.77% and 0.75%, respectively, while
the Company's ratio of allowance for loan losses to nonaccruing loans at June
30, 1998 and December 31, 1997 was 315% and 204%, respectively.
INTEREST RATE RISK
The Company's income consists primarily of interest payments on residential
mortgage loans. The Company anticipates that most of its residential mortgage
loans will bear interest at adjustable rates. If there is a decline in interest
rates (as measured by the indices upon which the interest rates of the
residential mortgage loans are based), then the Company will experience a
decrease in income available to be distributed to its stockholders. In such an
interest rate environment the Company may experience an increase in prepayments
on its residential mortgage loans and may find it more difficult to purchase
additional residential mortgage loans bearing rates sufficient to support
payment of the dividends on the Series A Preferred Shares. In addition, certain
residential mortgage loan products which the Company holds will allow borrowers
in such an interest rate environment to convert an adjustable rate mortgage to
a fixed rate mortgage, thus "locking in" a lower fixed interest rate. Because
the dividend rate on the Series A Preferred Shares is fixed, there can be no
assurance that an interest rate environment in which there is a significant
decline in interest rates would not adversely affect the Company's ability to
pay such dividends.
In addition, approximately 37% of the residential mortgage loans held by the
Company at June 30, 1998 have the potential to negatively amortize, while
approximately 8% of such loans have negatively amortized such that the current
principal balance of the loan exceeds the original principal balance. The
current principal balance exceeded the original principal balance by
approximately $1.8 million as of June 30, 1998. If there is an increase in
interest rates on such residential mortgage loans (as measured by the indices
upon which the interest rates of the residential mortgage loans are based), the
13
<PAGE>
Company may experience a decrease in cash available to be distributed to its
common stockholder where such increase in the interest rate does not coincide
with a corresponding adjustment of the borrowers' monthly payments.
SIGNIFICANT CONCENTRATION OF CREDIT RISK
Certain geographic regions of the United States from time to time may
experience natural disasters or weaker regional economic conditions and housing
markets and, consequently, may experience higher rates of loss and delinquency
on residential mortgage loans generally. Any concentration of the residential
mortgage loans in such a region may present risks in addition to those
generally present with respect to residential mortgage loans.
The Company's exposure to geographic concentrations directly affects the credit
risk of the residential mortgage loans within the portfolio. The following
table shows the residential mortgage loan portfolio by geographical area as of
June 30, 1998:
<TABLE>
<CAPTION>
Book Value
(in thousands) Percent
-------------- --------
<S> <C> <C>
California $810,856 84.3%
Florida 39,655 4.1
New York 23,560 2.5
Other states (36 states and Washington, D.C.; no state has more than 2%) 87,588 9.1
-------- -----
$961,659 100.0%
======== =====
</TABLE>
The 84.3% of the Company's total residential mortgage loan portfolio comprised
of loans secured by residential real estate properties located in California
may be subject to a greater risk of default than other comparable residential
mortgage loans in the event of natural hazards or other adverse conditions in
California that may affect the ability of residential property owners in
California to make payments of principal and interest on underlying mortgages.
LIQUIDITY RISK MANAGEMENT
The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all of the Company's financial commitments and to
capitalize on opportunities for the Company's business expansion. In managing
liquidity, the Company takes into account various legal limitations placed on a
Real Estate Investment Trust ("REIT"). See " -- Other Matters."
The Company's principal liquidity needs are to maintain the current portfolio
size through the acquisition of additional residential mortgage loans and to
pay dividends on the Series A Preferred Shares. The acquisition of additional
residential mortgage loans is funded with the proceeds obtained from repayment
of principal balances by individual mortgagees. The payment of dividends on the
Series A Preferred Shares will be made from legally available funds,
principally arising from the operating activities of the Company. The Company's
cash flows from operating activities principally consist of the collection of
interest on the residential mortgage loans. The Company does not have and does
not anticipate having any material capital expenditures.
In order to remain qualified as a REIT, the Company must distribute annually at
least 95% of its adjusted REIT taxable income, as provided for under the
Internal Revenue Code ("IRC"), to its common and preferred stockholders. The
Company currently expects to distribute dividends annually to satisfy these
REIT requirements.
The Company anticipates that cash and cash equivalents on hand and the cash
flow from the residential mortgage loans will provide adequate liquidity for
its operating, investing and financing needs.
As presented in the accompanying statement of cash flows, the primary sources
of funds during the six months ended June 30, 1998 were $37,380,000 provided by
operating activities and $166,929,000 provided by mortgage loan principal
repayments. The primary uses of funds were $166,224,000 in purchases of
mortgage loans, and $22,813,000 in preferred stock dividends paid.
14
<PAGE>
OTHER MATTERS
As of June 30, 1998, the Company believes that it was in full compliance with
the REIT tax rules and that it will continue to qualify as a REIT under the
provisions of the IRC. The Company calculates:
a. its Qualified REIT Assets, as defined in the Code, to be 98% of its
total assets, as compared to the Federal tax requirements that at
least 75% of its total assets must be Qualified REIT assets; and
b. that 99% of its revenue qualifies for the 75% source of income test
and 100% of its revenue qualifies for the 95% source of income test
under the REIT rules.
The Company also met all REIT requirements regarding the ownership of its stock
and anticipates meeting the annual distribution requirements.
For a detailed discussion of these REIT tax requirements, see the Company's
Registration Statement on Form S-11 (File No. 333-11609), with respect to the
Series A Preferred Shares declared effective by the Securities and Exchange
Commission on January 24, 1997. Effective for tax years beginning after August
5, 1997, the 30% income limitation was repealed.
YEAR 2000
The Bank is responsible for addressing issues related to required changes in
computer systems for the year 2000 ("Year 2000") for the Bank and the Company.
During the year ended December 31, 1997, the Bank finalized its plan to address
such issues. Issues arise because computer systems and related software may
have been designed to recognize only dates that relate to the 20th century.
Accordingly, if no changes are implemented, some computer systems would
interpret "01/01/00" as January 1, 1900 instead of January 1, 2000.
Additionally, some equipment, being controlled by microprocessor chips, may not
deal appropriately with a year "00."
The Bank has developed and is currently executing a comprehensive plan to make
the Bank's and the Bank's affiliates' computer systems, applications and
facilities Year 2000 ready. The plan covers four stages including (i)
inventory, (ii) assessment, (iii) remediation and (iv) testing and
certification. At year end 1997, the Bank had completed virtually all of the
inventory and assessment stages for systems and applications owned by the Bank
and the Bank's affiliates. The remediation process is currently underway and
the Bank is utilizing both internal and external resources to reprogram, or
replace where necessary, and test the software for Year 2000 modifications. The
remediation process is targeted for completion by year ended 1998, while
testing and verification of these systems and applications are currently
targeted for completion by March 31, 1999.
The Bank has initiated communications with its critical external relationships
to determine the extent to which the Bank and the bank's affiliates may be
vulnerable to such parties' failure to remediate their own Year 2000 issues.
Where practicable, the Bank will assess and attempt to mitigate the Bank's and
the Bank's affiliates' risks with respect to the failure of these entities to
be Year 2000 ready. The effect, if any, on the Company's results of operations
from the failure of such parties to be Year 2000 ready is not reasonably
estimable.
It is expected that, by December 31, 1998, all issues related to Year 2000 will
be addressed, either by programming changes to the Bank's and the Bank's
affiliates' custom software, by programming changes implemented by third party
vendors to purchased systems, or through the upgrading or purchase of Year
2000-compliant hardware and equipment. Extensive testing is expected to occur
during 1999. Year 2000 is the highest priority project within the Information
and Technology Services unit of the Bank. All costs related to Year 2000 will
be expensed on the books of the Bank. Management believes there is no material
risk that the Bank and the Company will fail to address Year 2000 issues in a
timely manner.
DISCLOSURES ABOUT MARKET RISK
There have been no material changes in reported market risks faced by the
Company since the Company's report in Item 7A of its Form 10-K for the year
ended December 31, 1997.
15
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not the subject of any material litigation. None of the Company,
the Bank or any of its affiliates is currently involved in nor, to the
Company's knowledge, is currently threatened with, any material litigation with
respect to the residential mortgage loans included in the portfolio other than
routine litigation arising in the ordinary course of business, most of which is
covered by liability insurance.
Item 6. Exhibits and Current Reports on Form 8-K
(a) Exhibits:
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
No Current Reports on Form 8-K were filed during the quarter
ended June 30, 1998.
16
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
California Federal Preferred Capital Corporation
/s/ Richard H. Terzian
-----------------------------------------------
By: Richard H. Terzian
Executive Vice President, Chief Financial
Officer and Director
(Signing on behalf of the Registrant and as the
Principal Financial Officer)
August 13, 1998
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from the Balance
Sheet and Statement of Income included in the Company's Form 10-Q for the
period ended June 30, 1998.
</LEGEND>
<CIK> 0001027283
<NAME> CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
<MULTIPLIER> 1,000
<CURRENCY> US
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<EXCHANGE-RATE> 1
<CASH> 0
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 21,379
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 961,659
<ALLOWANCE> 7,434
<TOTAL-ASSETS> 1,014,874
<DEPOSITS> 0
<SHORT-TERM> 0
<LIABILITIES-OTHER> 813
<LONG-TERM> 0
0
500,000
<COMMON> 0
<OTHER-SE> 514,061
<TOTAL-LIABILITIES-AND-EQUITY> 1,014,874
<INTEREST-LOAN> 36,360
<INTEREST-INVEST> 527
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 36,887
<INTEREST-DEPOSIT> 0
<INTEREST-EXPENSE> 0
<INTEREST-INCOME-NET> 36,887
<LOAN-LOSSES> 1,050
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 109
<INCOME-PRETAX> 35,728
<INCOME-PRE-EXTRAORDINARY> 35,728
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 37,528<F1>
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<YIELD-ACTUAL> 7.27
<LOANS-NON> 2,363
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 7,310
<CHARGE-OFFS> 926
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 7,434
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 7,434
<FN>
<F1>
Net income available to common stockholders: $12,915
</FN>
</TABLE>
