<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
<TABLE>
<CAPTION>
<S> <C>
For the quarterly period ended: September 30, 1998 Commission file number: 1-12639
------------------ -------
</TABLE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
Maryland 94-3254883
- ------------------------------------------------------------- -----------------------------------
<S> <C>
(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 November 9, 1998: 1,000 shares.
Page 1 of 24 pages
Exhibit index on page 18
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CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
THIRD QUARTER 1998 REPORT ON FORM 10-Q
TABLE OF CONTENTS
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<CAPTION>
PAGE NO.
PART I. FINANCIAL INFORMATION --------
<S> <C>
Item 1. Financial Statements
Balance Sheets
September 30, 1998 (unaudited) and December 31, 1997....................3
Unaudited Statements of Income
Nine months ended September 30, 1998 and 1997...........................4
Unaudited Statements of Income
Three months ended September 30, 1998 and 1997..........................5
Unaudited Statement of Stockholders' Equity
Nine months ended September 30, 1998 ...................................6
Unaudited Statements of Cash Flows
Nine months ended September 30, 1998 and 1997...........................7
Notes to Unaudited Financial Statements ................................8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations .........................11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .....................................................18
Item 6. Exhibits and Current Reports on Form 8-K ..............................18
</TABLE>
2
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CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
Balance Sheets
September 30, 1998 (unaudited) and December 31, 1997
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS 1998 1997
---- ----
<S> <C> <C>
Residential mortgage loans, net $ 955,952 $ 969,423
Cash and cash equivalents 7,135 6,382
Due from affiliates 31,265 19,800
Accrued interest receivable 5,564 5,399
Foreclosed real estate, net 1,449 491
----------- -----------
TOTAL ASSETS $ 1,001,365 $ 1,001,495
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Due to affiliates $ 201 $ --
Note payable to Bank 11,406 --
Accounts payable and accrued liabilities 116 349
----------- -----------
Total Liabilities 11,723 349
----------- -----------
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 (deficit) earnings (10,358) 1,146
----------- -----------
Total Stockholders' Equity 989,642 1,001,146
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,001,365 $ 1,001,495
=========== ===========
</TABLE>
See accompanying notes to unaudited financial statements.
3
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CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
STATEMENTS OF INCOME
Nine Months Ended September 30, 1998 and 1997
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
NET INTEREST INCOME
Residential mortgage loans $ 56,852 $ 48,869
Less: servicing fee expense (2,746) (2,410)
-------- --------
54,106 46,459
Short-term investments 827 787
-------- --------
Net interest income 54,933 47,246
Provision for loan losses (1,680) (1,680)
-------- --------
Net interest income after provision for loan losses 53,253 45,566
-------- --------
NONINTEREST EXPENSE
Director fees 48 34
Professional fees 55 37
Foreclosed real estate operations, net (99) --
Other 40 32
-------- --------
Total noninterest expense 44 103
-------- --------
Income before income taxes 53,209 45,463
Income tax expense 44 --
-------- --------
NET INCOME 53,165 45,463
Preferred stock dividends 34,219 30,543
-------- --------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 18,946 $ 14,920
======== ========
</TABLE>
See accompanying notes to unaudited financial statements.
4
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
STATEMENTS OF INCOME
Three Months Ended September 30, 1998 and 1997
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
NET INTEREST INCOME
Residential mortgage loans $ 18,666 $ 19,550
Less: servicing fee expense (920) (918)
-------- --------
17,746 18,632
Short-term investments 300 373
-------- --------
Net interest income 18,046 19,005
Provision for loan losses (630) (630)
-------- --------
Net interest income after provision for loan losses 17,416 18,375
-------- --------
NONINTEREST EXPENSE
Director fees 4 --
Professional fees 15 14
Foreclosed real estate operations, net (93) --
Other 9 12
-------- --------
Total noninterest expense (65) 26
-------- --------
Net income before income taxes 17,481 18,349
Income tax expense 44 --
-------- --------
NET INCOME 17,437 18,349
Preferred stock dividends 11,406 11,406
-------- --------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER $ 6,031 $ 6,943
======== ========
</TABLE>
See accompanying notes to unaudited financial statements.
5
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
STATEMENT OF STOCKHOLDERS' EQUITY
Nine Months Ended September 30, 1998
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Additional Retained Total
Preferred Common Paid-in (Deficit) Stockholders'
Stock Stock Capital Earnings Equity
----------- --------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1997 $ 500,000 $ -- $ 500,000 $ 1,146 $ 1,001,146
Net income -- -- -- 53,165 53,165
Dividends paid on 9-1/8% noncumulative
exchangeable preferred stock, series A -- -- -- (34,219) (34,219)
Dividends paid on common stock -- -- -- (30,450) (30,450)
----------- ---------- ----------- ----------- -----------
BALANCE AT SEPTEMBER 30, 1998 $ 500,000 $ -- $ 500,000 $ (10,358) $ 989,642
=========== ========== =========== =========== ===========
</TABLE>
See accompanying notes to unaudited financial statements.
6
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 1998 and 1997
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 53,165 $ 45,463
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 183 120
Provision for loan losses 1,680 1,680
Gain on sales of foreclosed real estate, net (107) --
Increase in due from affiliates (556) (342)
Decrease in accrued interest receivable 1,047 858
Increase/(decrease) in accounts payable and accrued liabilities (233) 286
Increase in due to affiliates 201 77
----------- -----------
Net cash provided by operating activities 55,380 48,142
----------- -----------
INVESTING ACTIVITIES:
Purchase of mortgage loans (264,556) (1,117,112)
Mortgage loan principal repayments 263,081 126,976
Purchase of accrued interest receivable (1,212) (6,569)
Proceeds from sales of foreclosed real estate 1,455 --
Foreclosed real estate advances funded (132) --
----------- -----------
Net cash used in investing activities (1,364) (996,705)
----------- -----------
FINANCING ACTIVITIES:
Proceeds from note payable to Bank 11,406 --
Proceeds from capital contributed by Bank -- 500,000
Proceeds from preferred stock issued -- 500,000
Common stock dividends paid (30,450) --
Preferred stock dividends paid (34,219) (30,543)
----------- -----------
Net cash (used in) provided by financing activities (53,263) 969,457
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 753 20,894
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 6,382 --
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 7,135 $ 20,894
=========== ===========
</TABLE>
See accompanying notes to unaudited financial statements.
7
<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 nine months ended
September 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 nine 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 nine months ended September 30, 1998 and 1997, noncash activity
included transfers of $2,174,000 and $262,000, respectively, from
residential mortgage loans to foreclosed real estate.
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 nine months ended September 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
$10,909,000 and $23,555,000, respectively. An equal offsetting increase to
due from affiliates was also recorded during each period.
(3) Residential Mortgage Loans, Net
At September 30, 1998 and December 31, 1997, residential mortgage loans,
net, consisted of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
--------- ---------
<S> <C> <C>
1-4 unit residential mortgage loans $ 961,850 $ 976,155
Deferred loan fees and direct origination costs and purchase
discounts and premiums, net 1,978 578
Allowance for loan losses (7,876) (7,310)
--------- ---------
Total residential mortgage loans, net $ 955,952 $ 969,423
========= =========
</TABLE>
8
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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 nine months ended September 30, 1998
and 1997 to the holders of the Series A Preferred Shares totalled
approximately $34,219,000 and $30,543,000, 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. Common stock dividends paid during the
nine months ended September 30, 1998 totalled approximately $30,450,000.
There were no common stock dividends paid during the nine months ended
September 30, 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
$2,746,000 and $2,410,000 for the nine months ended September 30, 1998 and
1997, respectively. Servicing fee expense paid totalled $920,000 and
$918,000 for the three months ended September 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 $9,000 and $20,000 during the three and nine months ended
September 30, 1998, respectively. No disposition fees were recorded during
the three and nine months ended September 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 $31,265,000 and $19,640,000 at
September 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 October 1998 and January 1998, respectively, as
provided in the Servicing Agreement. At September 30, 1998 and December
31, 1997, trust funds of approximately $2,799,000 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 September 30, 1998 the Company owed the Bank approximately $201,000
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 October 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.
9
<PAGE>
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
On September 29, 1998, the Company borrowed $11,406,000 from the Bank for
the purpose of paying a portion of the common stock dividends paid during
September 1998. The note is unsecured, matures September 29, 1999 and
bears interest at 5% per annum, compounded annually. The outstanding
balance of this note was $11,406,000 at September 30, 1998. No interest
expense was recorded with respect to this note during the three and nine
months ended September 30, 1998.
(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
September 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.
In October 1998, the FASB issued Statement of Financial Accounting
Standards No. 134, "Accounting for Mortgage-Backed Securities Retained
after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise" ("SFAS No. 134"), an amendment of Statement of
Financial Accounting Standards No. 65. SFAS No. 65, as amended by SFAS No.
115, requires that after the securitization of a mortgage loan held for
sale, an entity engaged in mortgage banking activities classify the
resulting mortgage-backed security as a trading security. SFAS No. 134
further amends SFAS No. 65 to require that after the securitization of a
mortgage loan held for sale, an entity engaged in mortgage banking
activities classify the resulting mortgage-backed securities or other
retained interests based on its ability to sell or hold those investments.
SFAS No. 134 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 nonmortgage banking
enterprise. SFAS No. 134 is effective for the first fiscal quarter after
December 15, 1998. Early application is encouraged and is permitted as of
the issuance of this statement. Management does not expect that adoption
of SFAS No. 134 will have a material impact on the financial condition or
results of operations of the Company.
10
<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 September 30, 1998 and for the
nine and three months ended September 30, 1998 and 1997 (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Statements of Income - Nine Months Ended September 30:
Net interest income $ 54,933 $ 47,246
Net interest income after provision for loan losses $ 53,253 $ 45,566
Net income $ 53,165 $ 45,463
Average yield on mortgage loans 7.27% 7.22%
Statements of Income - Three Months Ended September 30:
Net interest income $ 18,046 $ 19,005
Net interest income after provision for loan losses $ 17,416 $ 18,375
Net income $ 17,437 $ 18,349
Average yield on mortgage loans 7.16% 7.55%
Balance Sheet as of September 30, 1998:
Residential mortgage loans, net $ 955,952
Total assets $1,001,365
Total stockholders' equity $ 989,642
</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 fixed rate or variable rate mortgage-backed securities issued or
guaranteed by agencies of the federal government or
11
<PAGE>
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
Nine Months ended September 30, 1998 versus Nine Months ended September
30, 1997
Net Income. The Company reported net income for the nine months ended September
30, 1998 of $53,165,000 compared with net income of $45,463,000 for the
corresponding period in 1997. This increase in 1998 over 1997 is attributable
to an increase in net interest income and reflects nine months of operations in
1998 versus eight months of operations in 1997, as the Company commenced its
operations on January 31, 1997. During the nine months ended September 30,
1998, the Company reported income tax expense of $44,000 related to net gains
on the sale of foreclosed real estate.
During the nine months ended September 30, 1998 and 1997, the Company declared
and paid dividends of $34,219,000 and $30,543,000, respectively, on the
outstanding Series A Preferred Shares. Net income available to the common
stockholder for the nine months ended September 30, 1998 and 1997 totalled
$18,946,000 and $14,920,000, respectively. During the nine months ended
September 30, 1998, the Company declared and paid dividends of $30,450,000 to
the Bank as common stockholder. This common stock dividend reflects anticipated
net income available to the common shareholder for 1998 plus approximately
$4,400,000 of tax basis net income available from 1997 which was not
distributed to the common shareholder during 1997. There were no common stock
dividends paid during the nine months ended September 30, 1997.
Interest Income. The Company reported net interest income of $54,933,000 for
the nine months ended September 30, 1998, an increase of $7,687,000 over the
$47,246,000 net interest income reported for the corresponding period in 1997.
Of this increase in interest income, $7,647,000 is attributed to residential
mortgage loans and $40,000 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 $7,322,000 of the increase, while $325,000 relates to a higher average
yield on the portfolio. The average outstanding balance of residential mortgage
loans during the nine month period ended September 30, 1998 was $133,737,000
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 7.27% on residential
mortgage loans during the nine month period ended September 30, 1998 as
compared to 7.22% 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 nine month period ended September 30, 1998
versus the same period in 1997. Net interest income during the nine months
ended September 30, 1998 is comprised of $54,106,000 ($56,852,000 gross
interest less $2,746,000 servicing fee expense) from residential mortgage loans
and $827,000 from short-term investments, representing an average yield after
servicing fees on residential mortgage loans of 7.27% and on earning assets of
7.22%, based on average outstanding asset balances of $992,171,000 and
$1,014,536,000, respectively. Net interest income after a $1,680,000 provision
for loan losses was $53,253,000. Net interest income during the nine months
ended September 30, 1997 is comprised of $46,459,000 ($48,869,000 gross
interest less $2,410,000 servicing fee expense) from residential mortgage loans
and $787,000 from short-term investments, representing an average yield after
servicing fees on residential mortgage loans of 7.22% and on earning assets of
7.16%, based on average outstanding asset balances of $858,434,000 and
$880,238,000, respectively. Net interest income after a $1,680,000 provision
for loan losses was $45,566,000.
12
<PAGE>
The computation of the average yield 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.
Three months ended September 30, 1998 versus three months ended September
30, 1997
Net Income. The Company reported net income for the three months ended
September 30, 1998 of $17,437,000 compared with net income of $18,349,000 for
the corresponding period in 1997. This decrease in 1998 compared with 1997 is
attributable to a decrease in net interest income. During the three months
ended September 30, 1998, the Company reported income tax expense of $44,000
related to net gains on the sale of foreclosed real estate.
During each of the three month periods ended September 30, 1998 and 1997, the
Company declared and paid dividends of $11,406,000 on the outstanding Series A
Preferred Shares. Net income available to the common stockholder for the three
months ended September 30, 1998 and 1997 totalled $6,031,000 and $6,943,000,
respectively. During the three months ended September 30, 1998, the Company
declared and paid dividends of $30,450,000 to the Bank as common stockholder.
This common stock dividend reflects anticipated net income available to the
common shareholder for 1998 plus approximately $4,400,000 of tax basis net
income available from 1997 which was not distributed to the common shareholder
during 1997. There were no common stock dividends paid during the three months
ended September 30, 1997.
Interest Income. The Company reported net interest income of $18,046,000 for
the three months ended September 30, 1998, a decrease of $959,000 over the
$19,005,000 net interest income reported for the corresponding period in 1997.
Of this decrease in interest income, $886,000 is attributed to residential
mortgage loans and $73,000 is attributed to short-term investments. The
decrease in residential mortgage loan interest income is attributed to a lower
average yield on the portfolio, accounting for a $955,000 decrease, which was
offset by a $69,000 increase related to an increase in the average outstanding
portfolio balance. The lower yield of 7.16% on residential mortgage loans
during the three month period ended September 30, 1998 as compared to 7.55% for
the same period in 1997 primarily reflects the effect of certain adjustments
made during the third quarter of 1997. The yield for the three months ended
September 30, 1997 before such adjustments was 7.22%. The remaining difference
is primarily due to higher amortization of deferred loan fees and direct
origination costs and net purchase discounts and premiums during the 1998
period. The average outstanding balance of residential mortgage loans during
the three month period ended September 30, 1998 was $3,702,000 higher than
during the same period in 1997. Net interest income during the three months
ended September 30, 1998 is comprised of $17,746,000 ($18,666,000 gross
interest less $920,000 servicing fee expense) from residential mortgage loans
and $300,000 from short-term investments, representing an average yield after
servicing fees on residential mortgage loans of 7.16% and on earning assets of
7.11%, based on average outstanding asset balances of $990,873,000 and
$1,014,532,000, respectively. Net interest income after a $630,000 provision
for loan losses was $17,416,000. Net interest income during the three months
ended September 30, 1997 is comprised of $18,632,000 ($19,550,000 gross
interest less $918,000 servicing fee expense) from residential mortgage loans
and $373,000 from short-term investments, representing an average yield after
servicing fees on residential mortgage loans of 7.55% and on earning assets of
7.49%, based on average outstanding asset balances of $987,171,000 and
$1,015,306,000, respectively. Net interest income after a $630,000 provision
for loan losses was $18,375,000.
The computation of the average yield 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 nine months ended September 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.
13
<PAGE>
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 September 30, 1998 or December 31, 1997.
The following table reflects residential mortgage loans with past due principal
and interest payments as of September 30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
September 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 $ 1,296 0.13% $ 1,427 0.15%
60 to 89 days past due $ 1,263 0.13% $ 1,490 0.15%
90 days or more past due $ 1,654 0.17% $ 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 September 30, 1998 to be adequate. Although the Company
believes that it has sufficient allowances to absorb losses which currently
exist in the portfolio, 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 nine months ended September 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 1,680 1,680
Charge-offs (1,114) --
Recoveries -- --
------- -------
Balance - September 30 $ 7,876 $ 6,680
======= =======
</TABLE>
The Company's allowance coverage ratio (allowance for loan losses to loans) at
September 30, 1998 and December 31, 1997 was 0.82% and 0.75%, respectively,
while the Company's ratio of allowance for loan losses to nonaccruing loans at
September 30, 1998 and December 31, 1997 was 476% 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 33% of the residential mortgage loans held by the
Company at September 30, 1998 have the potential to negatively amortize, while
approximately 7% of such loans have negatively amortized such that the current
14
<PAGE>
principal balance of the loan exceeds the original principal balance. The
current principal balance exceeded the original principal balance by
approximately $1.7 million as of September 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
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
September 30, 1998:
<TABLE>
<CAPTION>
Book Value
(in thousands) Percent
-------------- -------
<S> <C> <C>
California $805,011 83.5%
Florida 39,293 4.1
New York 24,761 2.6
Other states (37 states and Washington, D.C.;
no state has more than 2%) 94,763 9.8
-------- -----
$963,828 100.0%
======== =====
</TABLE>
The 83.5% 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.
The Company's primary source of cash to pay interest on and principal of its
note payable to the Bank (the "Note") is expected to be operating earnings.
Interest on the Note, which is payable at maturity, will approximate $570,000.
The Note matures on September 29, 1999. Although the Company expects that
operating earnings will be sufficient to pay interest when due and the
principal amount of the Note at maturity, there can be no assurance that
operating earnings will be sufficient to make such distributions to the Bank.
In addition, there can be no assurance that such distributions will be
permitted by the terms of any class of preferred stock issued by the Company.
15
<PAGE>
As presented in the accompanying statement of cash flows, the primary sources
of funds during the nine months ended September 30, 1998 were $55,380,000
provided by operating activities, $263,081,000 provided by mortgage loan
principal repayments and $11,406,000 proceeds from a note payable to the Bank.
The primary uses of funds were $264,556,000 in purchases of mortgage loans,
$30,450,000 in common stock dividends paid and $34,219,000 in preferred stock
dividends paid.
OTHER MATTERS
As of September 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 99% 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 or renovation 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 to be substantially complete
by year end 1998 and to be completed by March 31, 1999, while testing and
verification of these systems and applications are currently targeted for
completion by March 31, 1999. The Bank is currently assessing risks related to
the potential failure of material third parties to be ready for Year 2000.
The Bank has completed its inventory and assessment of electrical and
electronic equipment which may be controlled by microprocessor chips, including
automatic teller machines, telecommunications systems, building management
systems, security equipment and systems, telecommunications equipment, vehicles
and office equipment. All such equipment and systems not certified as Year 2000
ready are planned to be upgraded, discarded or replaced by March 31, 1999. In
addition, the Bank has completed its inventory of business forms to identify
those containing a preprinted "19__". All such forms have been redesigned and
replacement supplies have been ordered.
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.
The Bank has obtained written statements from its critical service providers
indicating they will be Year 2000-ready. However, through the testing and
certification stage, the Bank will continue to assess and attempt to mitigate
the Bank's and the
16
<PAGE>
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.
The Bank has completed its risk assessment of each of the Bank's and the Bank's
affiliates' loan portfolios and identified material borrowers which are most
likely to experience Year 2000 related problems. In an effort to educate
borrowers and further assess Year 2000 preparedness, material borrowers have
been contacted through questionnaires, surveys, or loan officer phone calls and
visits. Educational materials have been sent to the majority of borrowers not
categorized as material customers for Year 2000 purposes. Ongoing efforts to
mitigate potential Year 2000 problems in higher-risk portfolios include
incorporating Year 2000 compliance requirements in loan documents and assessing
Year 2000 readiness in the Bank's and the Banks' affiliates underwriting
process for new loans and renewals.
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.
In light of normal ongoing field visits by Bank regulatory examiners, there is
little chance of enforcement action on the Bank's Year 2000 project. The
Company does not anticipate material loan losses or acceleration of
pre-payments due to Year 2000.
The Bank is currently developing a contingency plan which will be completed by
December 31, 1998. This plan will address the issue of what the Bank and the
Bank's affiliates will do if they or their vendors and/or business partners are
not ready for Year 2000.
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.
17
<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:
10.1 Promissory Note, entered into as of September 29,
1998, between California Federal Bank, A Federal
Savings Bank, lender, and California Federal
Preferred Capital Corporation, borrower.
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
No Current Reports on Form 8-K were filed during the quarter
ended September 30, 1998.
18
<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
By: /s/ Richard H. Terzian
-------------------------------
Richard H. Terzian
Executive Vice President,
Chief Financial Officer and Director
(Signing on behalf of the Registrant and as
the Principal Financial Officer)
November 12, 1998
19
<PAGE>
EXHIBIT 10.1
PROMISSORY NOTE
September 29, 1998
$11,406,250 U.S. Dollars San Francisco, California
California Federal Bank, A Federal Savings Bank ("Lender"), and California
Federal Preferred Capital Corporation ("Borrower") hereby agree to the
following terms and conditions:
1. Lender hereby agrees to lend to Borrower an amount equal to Eleven Million
Four Hundred Six Thousand Two Hundred Fifty Dollars ($11,406,250).
2. The term of this Promissory Note shall be one (1) year from the date
hereof.
3. Interest shall be computed at an interest rate of five percent (5%) per
annum, compounded annually.
4. Borrower promises to repay to Lender the amount borrowed by Borrower under
this Promissory Note, and to pay interest on such amount from the date
such funds are received by Borrower until the date that Borrower repays
the funds, with interest calculations to exclude the date of repayment.
The outstanding amount is due and payable upon expiration of the term of
this Promissory Note.
5. At the option of Borrower, all borrowing hereunder may be repaid in whole
or in part at any time without penalty.
LENDER
CALIFORNIA FEDERAL BANK, A FEDERAL SAVINGS BANK
By: /s/ Laurence Reed
-------------------------------
BORROWER
CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
By: /s/ Richard H. Terzian
-------------------------------
<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 September 30, 1998.
</LEGEND>
<CIK> 0001027283
<NAME> CALIFORNIA FEDERAL PREFERRED CAPITAL CORPORATION
<MULTIPLIER> 1
<CURRENCY> USD
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 0
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 7,135
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 963,828
<ALLOWANCE> 7,876
<TOTAL-ASSETS> 1,001,365
<DEPOSITS> 0
<SHORT-TERM> 11,406
<LIABILITIES-OTHER> 317
<LONG-TERM> 0
0
500,000
<COMMON> 0
<OTHER-SE> 489,642
<TOTAL-LIABILITIES-AND-EQUITY> 1,001,365
<INTEREST-LOAN> 54,106
<INTEREST-INVEST> 827
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 54,933
<INTEREST-DEPOSIT> 0
<INTEREST-EXPENSE> 0
<INTEREST-INCOME-NET> 54,933
<LOAN-LOSSES> 1,680
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 44
<INCOME-PRETAX> 53,209
<INCOME-PRE-EXTRAORDINARY> 53,165
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 53,165<F1>
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<YIELD-ACTUAL> 7.22
<LOANS-NON> 1,654
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 7,310
<CHARGE-OFFS> 1,114
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 7,876
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 7,876
<FN>
<F1> Tag 43-Net income available to common stockholders: $18,946
</FN>
</TABLE>
