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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the Fiscal Year Ended June 30, 1997
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
Commission File No. 001-12647
ORIENTAL FINANCIAL GROUP INC.
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Incorporated in the Commonwealth of Puerto Rico
IRS Employer Identification No. 66-0259436
PRINCIPAL EXECUTIVE OFFICES:
268 Munoz Rivera Avenue
501 Hato Rey Tower
Hato Rey, Puerto Rico 00918
Telephone Number: (787) 766-1986
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Common Stock ($1.00 par value)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports),and (2) has been subject to
such filing requirements for the past 90 days. Yes X No .
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Indicate by check mark if disclosure of delinquent filings pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part 3 of this Form 10-K or any
amendment to this Form 10-K .
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As of September 15, 1997 the Group had 8,005,347 shares of common stock
outstanding, including 2,032,932 shares held by all directors and officers of
the Registrant and by the Group as treasury shares. The aggregate market
value of the common stock held by non-affiliates of the Group was
$214,291,000, based upon the reported closing price of $35.88 on the New
York Stock Exchange on that date.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the Group's Annual Report to Shareholders for the
fiscal year ended June 30, 1997 are incorporated herein by
reference in response to Item 1 of Part 1.
(2) Portions of the Group's Definitive Proxy Statement relating to
the 1997 Group's Stockholders Annual Meeting are incorporated
herein by reference in response to Items 10 through 13 of Part 3.
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TABLE OF CONTENTS
PAGE
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PART - 1
ITEM - 1 Business 3
ITEM - 2 Properties 7
ITEM - 3 Legal Proceedings 7
ITEM - 4 Submissions to Matters to Vote of Security Holders 8
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PART - 2
ITEM - 5 Market for Registrant's Common Stock and Related
Stockholder Matters 8
ITEM - 6 Selected Financial Data 8
ITEM - 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-23
ITEM - 7A Quantitative and Qualitative Disclosures About
Market Risk 21
ITEM - 8 Financial Statements and Supplementary Data 23-47
ITEM - 9 Submissions to Matters to Vote of Security Holders 48
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PART - 3
ITEM - 10 Directors and Executive Officers of the Registrant 48
ITEM - 11 Executive Compensation 48
ITEM - 12 Security Ownership of Certain Beneficial Owners and
Management 48
ITEM - 13 Certain Relationships and Related Transactions 48
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PART - 4
ITEM - 14 Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 48-49
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PART I
ITEM 1 - BUSINESS
Oriental Financial Group (the "Group", "Oriental") was incorporated under
the laws of the Commonwealth of Puerto Rico (the "Commonwealth" or "Puerto
Rico")on June 1997 in connection with the holding company reorganization of
Oriental Bank and Trust (the "Bank"). On January 24, 1997 the Bank holding
company reorganization, pursuant to which the Group acquired all of the
shares of common stock of the Bank ( except for directors' qualifying
shares), was completed. The holding company reorganization was carried out
pursuant to an Agreement and Plan of Merger dated as of June 18, 1996, by and
between the Group, the Bank and Oriental Interim Bank.
The Bank was founded in 1964 as a federal mutual savings and loan
association, it became a federal mutual savings bank in July 1983 and
converted to a federal stock savings bank in April 1987. Its conversion from
a federally-chartered savings bank to a commercial bank chartered under the
banking laws of the Commonwealth of Puerto Rico, as of June 30, 1994, allows
the Bank to more effectively pursue opportunities in its market and obtain
more flexibility in its businesses, placing the Bank in the main stream of
financial services in Puerto Rico.
The Group provides a wide variety of financial services through a
full-service commercial bank with its main office located in San Juan, Puerto
Rico and sixteen branches located throughout Puerto Rico. The Bank directly
or through its broker-dealer subsidiary, Oriental Financial Services Corp.,
offers commercial and consumer leasing, consumer lending, investment, money
management and brokerage services, corporate and individual trust services
and mortgage lending.
The Group is subject to the provisions of the U.S. Bank Holding Company Act
of 1956 ( the "BHC Act") and, accordingly, subject to the supervision and
regulation of the Board of Governors of the Federal Reserve System ( "the
Federal Reserve Board"). The Bank is regulated by various agencies in the
United States and the Commonwealth of Puerto Rico. Its main regulators are
the Commissioner of Financial Institutions of Puerto Rico ("Commissioner")
and the Federal Deposit Insurance Corporation (the "FDIC"). The Bank's
deposits are insured up to $100,000 per depositor by the Savings Association
Insurance Fund (the "SAIF"), which is administered by the FDIC. The Bank is
further subject to the regulation of the Puerto Rico Finance Board ("Finance
Board"). Other agencies, such as the National Association of Security Dealers
("NASD"), and the Securities and Exchange Commission ("SEC"), regulate
additional aspects of the Bank's operations. (See "Regulation").
The Group is a legal entity separate and distinct from the Bank and the
Bank's subsidiaries. There are various legal limitations governing the
extent to which the Bank may extent credit, pay dividends or other wise
supply funds to, or engage in transactions with, the Group or certain of its
other subsidiaries.
The Group's business is described on pages 1 through 16 of the of the Group's
Annual Report to Shareholders for the year ended June 30, 1997, which
information is incorporated herein by reference.
REGULATION AND SUPERVISION
GENERAL
The Group is a bank holding company subject to the supervision and regulation
of the Federal Reserve Board under the BHC Act. As a bank holding company,
the Group's activities and those of its banking and non-banking subsidiaries
are limited to the business of banking and activities closely related to
banking, and the Group may not directly or indirectly acquire the ownership
or control of more than 5% of any class of voting shares or substantially all
the assets of any company, in the United States including a bank, without the
approval of the Federal Reserve Board. In addition, bank holding companies
are generally prohibited under the BHC act from engaging in non-banking
activities, subject to certain exceptions.
The Bank is subject to extensive regulation and examination by the
Commissioner and by the FDIC, which insures its deposits to the maximum
extent permitted by law, and subject to certain requirements established by
the Federal Reserve Board. The federal and state laws and regulations which
are applicable to banks regulate, among other things, the scope of their
business, their investments, their reserves against deposits, the timing of
the availability of deposited funds and the nature and amount of and
collateral for certain loans. The laws and regulations governing the Bank
generally have been promulgated to protect depositors and not for the purpose
of protecting stockholders. In addition to the impact of the regulations,
commercial banks are affected significantly by the actions of the Federal
Reserve Board as it attempts to control the money supply and credit
availability in order to influence the economy.
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HOLDING COMPANY STRUCTURE
The Bank is subject to restrictions under federal law that limit the
transfer of funds to its affiliates (including the Group), whether in the
form of loans, other extensions of credit, investments or assets purchases.
Such transfers are limited to 10% of the transferring institution's capital
stock and surplus and, with respect to any affiliate (including the Group),
with respect to all affiliates and to an aggregate of 20% of the transferring
institution's capital stock and surplus. Furthermore, such loans and
extensions of credit are required to be secured in specified amounts.
Under the Federal Reserve Board policy, a bank holding company such as the
Group, is expected to act as a source of financial strength to its main
banking subsidiaries and to also commit support to them. This support may be
required at times when, absent such policy, the bank holding company might
not otherwise provide such support. In the event of a bank holding company's
bankruptcy, any commitment by the bank holding company to the federal bank
regulatory agency to maintain capital of a subsidiary bank will be assumed by
the bankruptcy trustee and entitled to a priority of payment. In addition,
any capital loans by a bank holding company to any of its subsidiary banks
must be subordinated in right of payment to deposits and to certain other
indebtedness of such subsidiary bank. The Bank is currently the only
depository institution subsidiary of the Group.
Because the Group is a holding company, its right to participate in the
assets of any subsidiary upon the latter's liquidation or reorganization will
be subject to the prior claims of the subsidiary's creditors except to the
extent (including depositors in the case of depository institution
subsidiaries) that the Group is a creditor with recognized claims against the
subsidiary.
Under the Federal Deposit Insurance Act (FDIA), a depository institution
(which definition includes both banks and savings associations), the deposits
of which are insured by the FDIC, can be held liable for any loss incurred
by, or reasonably expected to be incurred by, the FDIC in connection with (1)
the default of a commonly controlled FDIC-insured depository institution or
(2) any assistance provided by the FDIC to any commonly controlled
FDIC-insured depository institution "in danger of default". "Default" is
defined generally as the appointment of a conservator or a receiver and " in
danger of default" is defined generally as the existence of certain
conditions indicating that a default is likely to occur in the absence of
regulatory assistance. Oriental Bank and Trust is currently the only
FDIC-insured depository institution subsidiary of the Bank. In some
circumstances (depending upon the amount of the loss or anticipated loss
suffered by the FDIC), cross-guarantee liability may result in the ultimate
failure or insolvency of one or more insured depository institutions in a
holding company structure. Any obligation or liability owed by a subsidiary
bank to its parent company is subordinated to the subsidiary bank's
cross-guarantee liability with respect to commonly controlled insured
depository institutions.
DIVIDEND RESTRICTIONS
The principal regular source of cash flow for the Group is dividends from the
Bank. The ability of the Bank to pay dividends on its common stock is
restricted by the Puerto Rico Banking Law, the Federal Deposit Insurance Act
and FDIC regulations. In general terms, the Puerto Rico Banking Law provides
that when the expenditures of a bank are greater than receipts, the excess of
expenditures over receipts shall be charged against the undistributed profits
of the bank and the balance, if any, shall be charged against the required
reserve fund of the bank. If there is no sufficient reserve fund to cover
such balance in whole or in part, the outstanding amount shall be charged
against, the bank's capital account. The Puerto Rico Banking Law provides
that until said capital has been restored to twenty percent (20%) of the
original capital, the bank may not declare any dividends. In general terms,
the Federal Deposit Insurance Act and the FDIC regulations restrict the
payment of dividends when the Bank is undercapitalized, when the bank has
failed to pay insurance assessments, or when there are safety and soundness
concerns regarding such bank.
The payment of dividends by the Bank may also be affected by other regulatory
requirements and policies, such as maintenance of adequate capital. If, in
the opinion of the regulatory authority, a depository institution under its
jurisdiction is engaged in, or is about to engage in, an unsafe or unsound
practice (that, depending on the financial condition of the depository
institution, could include the payment of dividends), such authority may
require, after notice and hearing, that such depository institution cease and
desist from such practice. The Federal Reserve Board has issued a policy
statement that provides that insured banks and bank holding companies should
generally pay dividends only out of current operating earnings. In addition,
all insured depository institutions are subject to the capital-based
limitations required by the FDICIA.
FEDERAL HOME LOAN BANK SYSTEM
The Federal Home Loan Bank ( the "FHLB") system of which the Bank is a
member, consists of 12 regional FHLB's governed and regulated by the Federal
Housing Finance Board ("FHFB"). The FHLB's serve as reserve or credit
facilities for member institutions within their assigned regions. They are
funded primarily from proceeds derived from the sale of consolidated
obligations of the FHLB system. They make loans (i.e., advances) to members
in accordance with policies and procedures established by the FHFB and the
Boards of Directors of the FHLB's.
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As a system member, the Bank is entitled to borrow from the Federal Home Loan
Bank of New York (FHLB-NY) and is required to own capital stock in the
FHLB-NY in an amount equal to the greater of 1% of the aggregate of the
unpaid principal of its home mortgage loans, home purchase contracts, and
similar obligations at the beginning of each fiscal year, which for this
purpose are deemed to be not less than 30% of assets, or 5% of the total
amount of advances by the FHLB-NY to the Bank. The Bank is in compliance with
the stock ownership rules described above with respect to such advances,
commitments and letters of credit and home mortgage loans and similar
obligations. All loans, advances and other extensions of credit made by the
FHLB-NY to the Bank are secured by a portions of the Bank's mortgage loan
portfolio, certain other investments and the capital stock of the FHLB-NY
held by the Bank.
FDICIA
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") the federal banking regulators must take prompt corrective action
in respect of depository institutions that do not meet minimum capital
requirements. FDICIA and regulations thereunder established five capital
tiers: "well capitalized" if it has total risk-based capital of 10.0% or
more, has a Tier I risk-based capital ratio of 6.0% or more, has a Tier I
leverage capital ratio of 5.0% or more and is not subject to any written
capital order or directive; (ii) "adequately capitalized" if it has a total
risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio
of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0%
under certain circumstances) and does not meet the definition of "well
capitalized", (iii) "undercapitalized" if it has a total risk-based capital
ratio that is less than 8.0%, a Tier I risk-based ratio that is less than
4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0% under
certain circumstances), (iv) "significantly undercapitalized" if it has a
total risk-based capital ratio that is less than 6.0%, a Tier I risk-based
capital ratio that is less than 3.0% or a Tier I leverage capital ratio that
is less than 3.0%, and (v) "critically undercapitalized" if it has a ratio
of tangible equity to total assets that is equal to or less than 2.0%. A
depository institution may be deemed to be in a capitalization category that
is lower than is indicated by its actual capital position if it receives a
less than satisfactory examination rating in any one of the four categories.
As of June 30, 1997, the Group is a "well-capitalized" institution.
FDICIA generally prohibits a depository institution from making any capital
distribution (including payment of a dividend) or paying any management fees
to its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are subject to
restrictions on borrowing from the Federal Reserve System. In addition,
undercapitalized depository institutions are subject to growth limitations
and are required to submit capital restoration plans. A depository
institution's holding company must guarantee the capital plan, up to an
amount equal to the lesser of five percent of the depository institution's
assets at the time it becomes undercapitalized or the amount of the capital
deficiency when the institution fails to comply with the plan. The federal
banking agencies may not accept a capital plan without determining, among
other things, that the plan is based on realistic assumptions and is likely
to succeed restoring the depository institution's capital. Significantly
undercapitalized depository institutions may be subject to number of
requirements and restrictions, including orders to sell sufficient voting
stock to become adequately capitalized, requirements to reduce total assets,
and cessation of receipt of deposits from corresponding banks. Critically
undercapitalized depository institutions are subject to appointment of a
receiver or conservator.
INSURANCE OF ACCOUNTS AND FDIC INSURANCE ASSESSMENTS
The Bank's deposits accounts are insured up to the applicable limits by the
SAIF. The insurance of deposit accounts by SAIF subjects the Bank to
comprehensive regulation, supervision, and examination by the FDIC. If the
Bank violates its duties as an insured institution, engages in unsafe and
unsound practices, is in an unsound and unsafe condition, or has violated any
applicable FDIC requirements, insurance of accounts of the Bank may be
terminated by the FDIC.
The Bank is subject to FDIC deposit insurance assessments. Pursuant to
FDICIA, the FDIC has adopted a risk-based assessment system, under which the
assessment rate for an insured depository institution varies according to
the level of risk incurred in its activities. An institution's risk category
is based partly upon whether the institution is well capitalized, adequately
capitalized or less than adequately capitalized. Each insured institution is
also assigned to one of the following "supervisory subgroups" : "A", "B", or
"C". Group "A" institutions are financially sound institutions with only a
few minor weaknesses; Group "B" institutions are institutions that
demonstrate weaknesses that, if not corrected, could result in significant
deterioration; and Group "C" institutions are institutions of which there is
a substantial probability that the FDIC will suffer a loss in connection with
the institution unless effective action is taken to correct the areas of
weakness.
On September 30, 1996, the Deposit Insurance Funds Act of 1996 ("DIFA") was
enacted and signed into law. DIFA repealed the statutory minimum premium and,
currently, premiums related to deposits assessed by both the Bank Insurance
Fund (BIF) and the Savings Association Insurance Fund ("SAIF") are to be
assessed at a rate of 0 to 27 basis points per $100 deposits. DIFA also
provides for a special one-time assessment on deposits insured by SAIF to
recapitalize the SAIF to bring it up to statutory required levels. Oriental
recorded a special reserve of $1.8 million net of taxes of $470,000 during
the first quarter of 1997 to account for its share of the one-time payment of
FDIC insurance premium. Beginning in January 1997 institutions currently
insured under SAIF will pay lower premiums as result of this special
assessment. In the Bank's case, this represents an annual decrease in
insurance premiums expense of approximately $650,000 or $162,500 per quarter.
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REGULATORY CAPITAL REQUIREMENTS
Information about the Group's capital and regulatory capital ratios as of
June 30, 1997 and for four previous years is presented in the selected
financial data table on page 10 of the Management's Discussion and Analysis
of Financial Condition and Results of Operations" (MD&A) (Item 7 herein) and
is incorporated herein by reference.
The Federal Reserve Board has adopted a risk-based capital guidelines for
bank holding companies. Under the guidelines the minimum ratio of qualifying
total capital to risk-weighted assets is 8%. At least half of the total
capital is to be comprised of common equity, retained earnings, minority
interest in unconsolidated subsidiaries, non-cumulative perpetual preferred
stock and the disallowed portion of deferred tax assets ("Tier 1 Capital").
The remainder may consist of a limited amount of subordinated debt, other
preferred stock, certain other investments and a limited amount of loan and
lease loss reserves ("Tier 2 Capital").
The Federal Reserve Board has adopted regulations with respect to risk-based
and leverage capital ratios that require most intangibles, including core
deposit intangibles, to be deducted from Tier 1 Capital. The regulations,
however, permit the inclusion of a limited amount of intangibles related to
originated and purchased mortgage servicing rights, purchased credit card
relationships and include a "grandfathered" provision permitting inclusion of
certain existing intangibles.
In addition, the Federal Reserve Board has established minimum leverage ratio
(Tier 1 Capital to quarterly average assets) guidelines for bank holding
companies and member banks. These guidelines provide for a minimum leverage
ratio of 3% for bank holding companies and member banks that meet certain
specified criteria, including that they have the highest regulatory rating.
All other bank holding companies and member banks are required to maintain a
leverage ratio 3% plus an additional cushion of at least 100 to 200 basis
points. The guidelines also provide that banking organizations experiencing
internal growth or making acquisitions are expected to maintain string
capital positions substantially above the minimum supervisory levels, without
significant reliance on intangible assets. Furthermore, the guidelines
indicate that the Federal Reserve Board will continue to consider a "tangible
Tier 1 leverage ratio" and other indicia of capital strength in evaluating
proposals for expansion or new activities.
Failure to meet the capital guidelines could subject an institution to
variety of enforcement remedies, including the termination deposit insurance
by the FDIC, and to certain restrictions on its business.
Bank regulators have from time to time indicated their desire to raise
capital requirements applicable to banking organizations beyond current
levels. However, management is unable to predict whether and when capital
requirements would be imposed and, if so, at what levels and on what terms.
NEW SAFETY AND SOUNDNESS STANDARDS
Section 39 of the FDIA, amended by the FDICIA, requires each federal banking
agency to prescribe for all insured depository institutions, standards rating
to internal control, information systems and internal audit system, loan
documentation, credit underwriting, interest rate exposure, asset growth,
compensation, fees and benefits and such other operational and managerial
standards as the agency deems appropriate. In addition, each federal banking
agency also is required to adopt for all insured depository institutions and
their holding companies standards that specify (i) a maximum ratio of
classified assets to capital, (ii) minimum earnings sufficient to absorb
losses without impairing capital, (ii) to the extent feasible, a minimum
ratio of market value to book value for publicly-traded shares of the
institution or holding company, and (v) such other standards relating to
asset quality, earnings and valuation as the agency deems appropriate.
Finally, each federal banking agency is required to prescribe standards for
the employment contracts and other compensation arrangements of executive
officers, employees, directors and principal stockholders of insured
depository institutions that would prohibit compensation and benefits and
arrangements that are excessive or that could lead to a material financial
loss for the institution. If an insured depository institution or its
holding company fails to meet any of the standards described above, it will
be required to submit to the appropriate federal banking agency a plan
specifying the steps that will be taken to cure the deficiency. If an
institution fails to submit an acceptable plan or fails to implement the
plan, the appropriate federal banking agency will require the institution to
correct the deficiency and, until it is corrected, may impose other
restrictions on the institution or company, including any of the restrictions
applicable under the prompt corrective action provisions of FDICIA. Pursuant
to FDICIA, regulations to implement these operational standards were required
to become effective on December 1, 1993.
In August 1995, the FDIC and the other federal banking agencies published
Interagency Guidelines Establishing Standards for Safety and Soundness that,
among other things, set forth standards relating to internal controls,
information systems and internal audit systems, loan documentation, credit ,
underwriting, interest rate exposure, asset growth and employee compensation.
ACTIVITIES AND INVESTMENTS OF INSURED STATE-CHARTERED BANKS
Section 24 of the FDIA, as amended by the FDICIA, generally limits the
activities and equity investments of FDIC-insured, state-chartered banks to
those that are permissible for national banks. Under regulations dealing with
equity investments, an insured state bank generally may not directly or
indirectly acquire or retain any equity investment of a type, or in an
amount, that is not permissible for a national bank. An insured state bank
is not prohibited from, among other things, (i) acquiring or retaining a
majority interest in a subsidiary, (ii) investing as a limited partner in a
partnership the sole purpose of which is direct or indirect investment in the
acquisition,
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rehabilitation or new construction of a qualified housing project, provided
that such limited partnership investments may not exceed 2% of the Bank's
total assets, (iii) acquiring up to 10% of the voting stock of a company that
solely provides or reinsures directors', trustees' and officers' liability
insurance coverage or bankers' blanket bond group insurance coverage for
insured depository institutions, and (iv) acquiring or retaining the voting
shares of a depository institution if certain requirements are met.
In addition, an insured state bank (1) that is located in a state which
authorized as of September 30, 1991, investment in common or preferred stock
listed on a national securities exchange ("listed stock") or shares of a
registered investment company ('registered shares"), and (ii) which during
the period beginning September 30 1990 through November 26, 1991
("measurement period") made or maintained investments in listed stocks and
registered shares, may retain whatever shares that were lawfully acquired or
held prior to December 19, 1991 and continues to acquire listed stock and
registered shares, provided that the bank does not convert its charter to
another form or undergo one of four types of specified requirements and which
sets forth the bank's intention to acquire and retain stocks or shares, and
the FDIC must determine that acquiring or retaining the listed stocks or
registered shares will not pose a significant risk to the deposit insurance
fund of which the bank is a member.
In December 1993, the FDIC adopted amendments to its regulations governing
the activities and investments of insured state banks which further
implemented Section 24 of the FDIA, as amended by FDICIA. Under the
amendments, an insured state-chartered bank may not, directly, or indirectly
through a subsidiary, engage as "principal" in any activity that is not
permissible for a national bank unless the FDIC has determined that such
activities would pose no risk to the insurance fund of which it is a member
and the bank is in compliance with applicable regulatory capital
requirements. Any insured state-chartered bank directly or indirectly
engaged in any activity that is not permitted for a national bank must cease
the impermissible activity.
PUERTO RICO BANKING LAW
As a Puerto Rico chartered commercial bank, the Bank is subject to regulation
and supervision by the Commissioner under the Puerto Rico Banking Act of
1933, as amended (the "Banking Law"). The Banking Law contains provisions
governing the incorporation and organization, rights and responsibilities of
directors, officers and stockholders as well as the corporate powers,
savings, lending capital and investment requirements and other aspects of the
Bank and its affairs. In addition, the Commissioner is given extensive
rulemaking power and administrative discretion under the Banking Law. The
Commissioner generally examines the Bank at least once every year.
The Banking Law requires that at least ten percent (10%) of the yearly net
income of the Bank be credited annually to a reserve fund. This appointment
shall be done every year until the reserve fund shall be equal to ten percent
(10%) of the total deposits or the total paid-in capital, whichever is
greater.
The Banking Law also provides that when the expenditures of a bank are
greater that the receipts, the excess of the former over the latter shall be
charged against the undistributed profits of the Bank, and the balance, if
any, shall be charged against the reserve fund, as a reduction thereof. If
there is no reserve fund sufficient to cover such balance in whole or in
part, the outstanding amount shall be charged against the capital account and
no dividend shall be declared until said capital has been restored to its
original amount and the reserve fund to 20% of the original capital.
The Banking Law further requires every bank to maintain a legal reserve which
shall not be less than 20% of its demand liabilities, except government
deposits (federal, state and municipal) which are secured by actual
collateral.
The Banking Law also prohibits loans to any employee of the Bank to exceed
$20,000 unless certain requirements have been met. The Banking Law also
contains certain restrictions on loans to controlling shareholders (owning
20% or more of the capital stock of the Bank) and firms affiliated with the
Bank's lending personnel.
The Banking Law further requires change of control filings. When any person
or entity owns, directly or indirectly, upon consummation of a transfer, 5%
or more of the outstanding voting capital stock of the Bank, the acquiring
parties must inform the Commissioner of the details not less than sixty (60)
days prior to the date said transfer is to be consummated. The transfer
shall require the approval of the Commissioner if it results in a change of
control of the Bank. Under the Banking Law, a change of control is presumed
if the acquirer who did not own more than 5% of the voting capital stock
before the transfer exceeds such percentage after the transfer.
The Banking Law generally restricts the amount the Bank can lend to one
borrower to an amount which may not exceed 15% of the Bank's paid-in capital
and reserve fund. The Bank may also not accept the security of any one
borrower in an amount exceeding 15% of its paid-in capital and reserve fund.
As of June 30, 1997, the maximum amount which the Bank could have loaned to
one borrower was approximately $4.9 million. If such loans are secured by
collateral worth at least twenty-five percent (25%) more than the amount of
the loan, the aggregate maximum amount may reach one third of the
paid-in-capital of the Bank, plus its reserve fund. There no restrictions on
the amount of loans that are wholly secured by bonds, securities and other
evidence of indebtedness of the Government of the United States or the
Commonwealth, or by current debt bonds, not in default, of municipalities or
instrumentalities of the Commonwealth.
The Finance Board, which composed of the of the Commissioner, President of
the Government Development Bank for Puerto Rico, the President of the Puerto
Rico Housing Bank and the Puerto Rico Secretaries of Commerce, Treasury and
Consumer Affairs and three public interest representatives, has the authority
to regulate the maximum interest rates and finance charges that may be
charged on
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loans to individuals and unincorporated business in the Commonwealth. The
Finance Board promulgates regulations which specify maximum rates on various
types of loans to individuals. THE FINANCE BOARD HAS ADOPTED REGULATION 26-A,
AS AMENDED, WHICH FIXES THE MAXIMUM RATE (ADJUSTED ON A WEEKLY BASIS) WHICH
MAY BE CHARGED ON RESIDENTIAL FHA AND VA MORTGAGES. Interest rates on
residential conventional and second mortgages consumer loans and commercial
loans are not subject to any limitations by Regulation 26-A. The Finance
Board also has the authority to regulates maximum finance charges on retail
installment sales contracts and for credit card purchases. There is no
maximum rate for installment sales contracts involving motor vehicles,
commercial, agricultural and industrial equipment, commercial electric
appliances and insurance premiums.
EMPLOYEES
At June 30, 1997 the Group employed 417 persons. None of its employees are
represented by a collective bargaining group. The Group considers its
employee relations to be good. For information about the Group's employee
benefit plans refer to Note 23 of the Group's consolidated financial
statements which appears on page 43 of this report under Item 8.
ITEM 2 - PROPERTIES
As of June 30, 1997 the Bank owned approximately 8 branch premises and other
facilities throughout the Commonwealth. In addition, as of such date, the
Bank leased properties for branch operations and main offices in 8 locations
in Puerto Rico. The Bank's management's believes that each of its facilities
is well-maintained and suitable for its purpose. The principal properties
owned by the Bank for banking operations and other services are described
below:
ORIENTAL CENTER - a four story office building located at 908
State Road, Humacao, Puerto Rico. A branch, the accounting,
auditing and mortgage servicing departments and the computer
center are the main activities conducted at this location.
Approximately 60% of the office space is leased to outside
tenants
LAS CUMBRES BUILDING - two story structure located at 1990 Las
Cumbres Avenue, Rio Piedras, Puerto Rico. A branch, the legal,
leasing and mortgage originating departments are the main
activities conducted at this location.
ITEM 3 - LEGAL PROCEEDINGS
The Group and its subsidiaries are defendants in a number of legal claims
under various theories of damages arising out of, and incidental to its
business. The Group is vigorously contesting those claims. Based upon a
review with legal counsel and the development of these matters to date,
management is of the opinion that the ultimate aggregate liability, if any,
resulting from these claims will not have a material adverse effect on the
Group's financial position or the result of operations.
ITEM 4 - SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART - 2
ITEM 5 - MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
The Group's common stock is traded in the New York Stock Exchange (NYSE)
under the symbol OFG. Information concerning the range of high and low sales
process for the Group's common shares for each quarter during fiscal 1997 and
the previous two fiscal years, is included on page 20 of the Group's Annual
Report for the year ended June 30, 1997 under the Market Prices, Stock Data
and Dividends caption in the MD&A, (Item 7 herein) and is incorporated herein
by reference. Information on cash dividends declared for the last three
fiscal years is also included on page 20 of the Group's Annual Report for the
year ended June 30, 1997 under the Capital caption in the MD&A, (Item 7
herein) and is incorporated herein by reference.
Information concerning legal or regulatory restrictions on the payment of
dividends by the Group and the Bank is contained under the caption Dividend
Restrictions in Item 1 herein.
On August 26, 1996, Oriental declared a six-for-five (20%) stock split on its
6,597,563 shares of common stock outstanding at September 30, 1996. As a
result, 1,308,712 shares of common stock were issued on October 17, 1996 thus
increasing shares to 7,906,275.
As of September 15, 1997 the Group had over 2,000 stockholders of record of
its Common Stock, including all directors and officers of the Registrant,
excluding beneficial owners whose shares are held in record names of brokers
or other nominees. The last sales price for the Group's common stock on such
date, as quoted on the NYSE was $35.88 per share.
8
<PAGE>
The Puerto Rico Internal Revenue Code of 1994, as amended, generally imposes
a withholding tax on the amount of any dividends paid by corporations to
individuals, whether residents of Puerto Rico or not, trusts, estates, and
special partnerships at a special 10% withholding tax rate. If the recipient
is foreign corporation or partnership not engaged in trade or business in
Puerto Rico the rate of withholding is 10%. Prior to the first dividend
distribution for the taxable year, individuals who are residents of Puerto
Rico may elect to be taxed on the dividends at the regular rates, in which
case the special 10% tax will not be withheld from such year's distributions.
United States citizens who are non-residents of Puerto Rico will not be
subject to Puerto Rico tax on dividends if said individual's gross income
from sources within Puerto Rico during the taxable year does not exceed
$1,300 if single, or $3,000 if married, and form AS 2732 of the Puerto Rico
Treasury Department "Withholding Tax Exemption Certificate for the Purpose of
Section 1147" is filed with the withholding agent. U.S. income tax law
permits a credit against U.S. income tax liability, subject to certain
limitations, for certain foreign income taxes paid or deemed paid with
respect to such dividends.
ITEM 6 - SELECTED FINANCIAL DATA
The information required by this item appears on page 10 in the "Selected
Financial Data Table" under Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations, and on page 47 in Note 28
under Item 8 - Financial Statements and Supplementary Data and is
incorporated by reference herein.
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL REVIEW SUMMARY
Fiscal 1997 marked the eighth consecutive year of increased profitability for
Oriental as the Group realized a substantial increase of 21% in net operating
profits. The group's net operating profits for the year ended before the
one-time industry-wide SAIF assessment of $1.3 million (net of tax)
increased to $17.9 million compared from $14.7 million and $12.1 million
reported in 1996 and 1995, respectively. On a per share basis net operating
profits excluding before the one-time industry-wide SAIF assessment amounted
to $2.18, $1.77 and $1.48 for fiscal 1997, 1996 and 1995, respectively. All
per share figures have been retroactively adjusted for the six for five stock
split distributed on October 1996.
Net income for fiscal 1997 increased to $16.6 million or $2.02 per share
compared to $14.7 million or $1.77 per share in fiscal 1996 and $12.1
million or $1.48 per share in fiscal 1995. The Group's earnings growth was
led by increases in net interest income and non-interest income, which were
driven by a solid growth on loans and fee revenues, partially offset by an
increase in the provision for loan losses and by higher operating costs.
The Group's profitability ratios remained strong as return on average assets
increased to 1.84% in fiscal 1997 from 1.82% in fiscal 1996 and 1.77% in
fiscal 1995 and return on average equity improved to 21.17% from 19.30% and
19.05% for the respective periods. This reflects management's sharp focus on
profitability and shareholder value.
Oriental continued to experience a favorable growth in its diversified asset
base which contributed to income expansion across all its business lines.
Fiscal 1997 also saw Oriental reach a milestone in its asset position. Bank
assets passed the $1 billion mark and total assets managed and gathered by
our trust, investment brokerage and servicing operations surpassed $2 billion
by June 30,1997. Total financial assets owned or managed increased 31% to
$3.2 billion at June 30, 1997 from the $2.4 billion owned or managed last
year. As of June 30, 1997, total financial assets consisted of $ 1.07
billion owned by the Bank, $1.09 billion managed by the trust, $ 525 million
gathered by the broker-dealer and $516 million in mortgages serviced for
third parties.
Stockholders' equity at June 30, 1997 reached $89.4 million compared to $79.9
million at June 30, 1996. The Group continues to be a "well capitalized"
institution under regulatory standards. Total risk-based and leverage
capital ratios as of June 30, 1997 were 18.66% and 8.17%, respectively,
which are well above the minimum capital ratios required by regulatory
agencies. During the year, Oriental repurchased 182,400 shares of common
stock under its approved repurchase program.
Management is pleased with the improved earnings performance of fiscal 1997.
The results strongly indicate that the decisive steps undertaken to improve
credit quality, increase fee income, generate higher loan volumes and contain
operating costs are working. Management will continue to push these
initiatives in fiscal 1998 and beyond.
The following pages discuss in detail the different components that resulted
in the Group's continued profitability.
9
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
SELECTED FINANCIAL DATA
FOR THE YEARS ENDED JUNE 30,
- ----------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------
(IN THOUSANDS, EXCEPT FOR PER SHARE RESULTS)
--------------------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------------------------
CONDENSED EARNINGS REPORT:
- ----------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME $ 82,629 $ 70,447 $ 58,143 $ 46,475 $ 36,395
INTEREST EXPENSE 45,098 37,694 30,423 22,843 19,178
---------- ---------- ---------- ---------- ---------
NET INTEREST INCOME 37,531 32,753 27,720 23,632 17,217
PROVISION FOR LOAN LOSSES 4,900 4,600 2,550 2,000 1,575
---------- ---------- ---------- ---------- ---------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 32,631 28,153 25,170 21,632 15,642
---------- ---------- ---------- ---------- ---------
BANK SERVICE CHARGES AND FEES 4,909 3,801 3,272 1,839 1,087
TRUST, MONEY MANAGEMENT AND BROKERAGE FEES 6,750 5,913 4,379 3,570 1,116
MORTAGE BANKING ACTIVITIES 3,972 3,041 2,108 2,821 317
NET GAIN ON SALE OF INVESTMENT SECURITIES AND
TRADING PROFIT 903 1,462 646 1,087 2,104
RENT AND OTHER OPERATING INCOME 818 545 463 655 872
GAIN ON TERMINATION OF PENSION PLAN - - 564 - -
INSURANCE SETTLEMENT - - - - 1,960
NON-INTEREST EXPENSES 28,498 24,608 21,590 18,752 13,274
SAIF ONE-TIME ASSESSMENT 1,823 - - - -
PROVISION FOR INCOME TAXES 3,100 3,571 2,905 3,025 1,877
---------- ---------- ---------- ---------- ---------
NET INCOME 16,562 14,736 12,107 9,827 7,947
---------- ---------- ---------- ---------- ---------
SAIF ADJUSTMENT, NET OF TAXES 1,333 - - - -
---------- ---------- ---------- ---------- ---------
NET INCOME EXCLUDING SAIF $ 17,895 $ 14,736 $ 12,107 $ 9,827 $ 7,947
---------- ---------- ---------- ---------- ---------
INCOME PER SHARE $ 2.02 $ 1.77 $ 1.48 $ 1.51 $ 1.15
NET INCOME PER SHARE EXCLUDING SAIF 2.18 1.77 1.48 1.51 1.15
DIVIDENDS DECLARED PER SHARE $ 0.55 $ 0.38 $ 0.22 $ 0.13 $ 0.07
AVERAGE NUMBER OF SHARES 7,911 8,030 7,648 6,022 5,698
AVERAGE OUTSTANDING EQUIVALENTS 297 319 522 492 449
---------- ---------- ---------- ---------- ---------
TOTAL AVERAGES SHARES AND EQUIVALENTS 8,208 8,349 8,170 6,514 6,147
---------- ---------- ---------- ---------- ---------
Per share figures were retroactively adjusted for the effect of the
six-to-five (20%) stock split distributed on October 17, 1996.
- ----------------------------------------------------------------------------------------------------------------------------
FISCAL END BALANCES:
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL BANK ASSETS $1,068,600 $ 877,400 $ 744,400 $ 655,000 $ 522,400
TRUST ASSETS MANAGED 1,088,600 874,500 699,000 545,400 300,000
LOANS SERVICED TO THIRD PARTIES 515,700 401,300 272,900 153,700 6,300
ASSETS GATHERED BY BROKER-DEALER 524,900 293,100 195,400 153,200 20,000
---------- ---------- ---------- ---------- ---------
TOTAL FINANCIAL ASSETS $3,197,800 $2,446,300 $1,911,700 $1,507,300 $ 848,700
---------- ---------- ---------- ---------- ---------
INVESTMENT AND TRADING SECURITES $ 468,594 $ 350,736 $ 289,106 $ 279,303 $ 219,630
LOANS AND LOANS HELD FOR SALE, NET 532,970 476,110 409,391 339,216 263,234
DEPOSITS 497,542 382,557 313,542 249,192 216,527
BORROWINGS 452,731 387,801 332,809 327,870 258,135
CAPITAL $ 89,394 $ 79,903 $ 69,705 $ 55,684 $ 31,082
- ----------------------------------------------------------------------------------------------------------------------------
REGULATORY CAPITAL RATIOS (IN PERCENT):
- ----------------------------------------------------------------------------------------------------------------------------
LEVERAGE CAPITAL 8.17% 8.71% 8.89% 8.49% 5.93%
TIER 1 RISK-BASED CAPITAL 17.53% 18.07% 17.00% 18.90% 14.12%
TOTAL RISK-BASED CAPITAL 18.66% 19.14% 17.73% 19.92% 15.08%
- ----------------------------------------------------------------------------------------------------------------------------
SELECTED FINANCIAL RATIOS (IN PERCENT):
- ----------------------------------------------------------------------------------------------------------------------------
EXCLUDING INSURANCE CLAIM SETTLEMENT IN 1993, AFTER ISSUANCE 845,000 NEW SHARES
ISSUED IN 1994 AND BEFORE SAIF IN 1997.
RETURN ON AVERAGE CAPITAL 21.17% 19.30% 19.05% 26.52% 26.45%
RETURN ON AVERAGE ASSETS 1.84% 1.82% 1.77% 1.68% 1.55%
AVERAGE EQUITY TO AVERAGE TOTAL ASSETS 8.69% 9.44% 9.31% 6.33% 5.86%
EXPENSE RATIO 1.34% 1.52% 1.61% 1.80% 2.60%
EFFICIENCY RATIO 52.76% 53.43% 59.65% 61.04% 67.12%
- ----------------------------------------------------------------------------------------------------------------------------
OTHER INFORMATION:
- ----------------------------------------------------------------------------------------------------------------------------
NUMBER OF BANKING OFFICES 16 16 15 14 11
</TABLE>
10
<PAGE>
RESULT OF OPERATIONS
As a diversified financial services provider, Oriental's earnings depend not
only on the net interest income generated from its banking activity, but also
from fees and other non-interest income generated from the wide array of
financial services offered. Net interest income is affected by the
difference between rates of interest earned on the Group's interest-earning
assets and rates paid on its interest-bearing liabilities (interest rate
spread) and the relative amounts of its interest-earning assets and
interest-bearing liabilities (interest rate margin). Non-interest income is
affected by the level of trust assets under management, transactions
generated by gathering of financial assets by the broker-dealer subsidiary,
the level of mortgage banking activities, and fees generated from loans and
deposit accounts.
NET INTEREST INCOME
Net interest income for fiscal 1997 increased by $4.8 million or 15% to $
37.5 million from $32.7 million in fiscal 1996. In 1995, net interest income
totaled $27.7 million. The improvement in net interest income was the result
of an increase of $5.0 million due to a higher volume of net interest earning
assets partially offset by an unfavorable effect in rate of $242,000 due to a
lower average yield of interest-earning assets.
The interest rate spread and net interest margin for fiscal 1997 fell to
3.89% and 4.19%, respectively, as compared to 4.03% and 4.38%, respectively,
for fiscal 1996 and 4.04% and 4.36%, respectively, for fiscal 1995. At the
end of fiscal 1997 total average interest-earning assets exceeded total
average interest bearing liabilities by $50.9 million compared to $50 million
and $40 million at the end of fiscal years 1996 and 1995, respectively. The
interest-earning assets to interest-bearing liabilities ratio for fiscal 1997
was 106.02% versus 107.18% and 106.72% in fiscal 1996 and fiscal 1995,
respectively.
The table on page 12 sets forth a detailed analysis of net interest income.
Part one presents the dollar amount of and average rates on Oriental's
interest-earning assets and liabilities, the ratio of net interest-earning
assets over interest-bearing liabilities, the average interest rate spread
and the net yield on average interest-earning assets. Part two describes the
extent to which changes in interest rates and changes in volume of
interest-related assets and liabilities have affected Oriental's interest
income and interest expense during the periods indicated. For each category
of interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (1) changes in volume (changes in volume
multiplied by old rates) and (2) changes in rate (changes in rate multiplied
by old volume). Rate-volume variances (changes in rates multiplied by the
changes in volume) have been proportionally allocated to the changes in
volume and changes in rate based upon their respective percentage of the
combined total.
INTEREST INCOME
Oriental's interest income for fiscal 1997 increased by $12.1 million or 17%
to $82.6 million from $70.4 million posted in fiscal year 1996. In 1995,
interest income totaled $58.1 million.
The growth in interest income results from a rise of $12.6 million due to a
higher average volume of interest-earning assets. Average interest-earning
assets increased to $896 million in fiscal 1997 compared with $746 million in
fiscal 1996 and $635 million in fiscal 1995. To a lesser extent, interest
income was negatively affected by $456,000 due to the lower yields attained
on interest-earning assets.
The increase in the average volume of interest-earning assets for fiscal 1997
relates primarily to rise in mortgage-backed securities of $69 million or 40%
and in real estate loans of $34 million or 16%. The rise in mortgage-backed
securities was due to Oriental's greater use of securitization as a funding
vehicle, packaging most of its loan production into GNMA and FNMA
certificates. The increase in real estate loans was mainly caused by an
increase in the conventional loans portfolio. The growth in this product
which carries a higher interest rate than other real estate loan products
improved the total yield on real estate loans to 9.86% for fiscal 1997 from
9.80% for fiscal 1996.
The yield on interest-earning assets for fiscal 1997 decreased to 9.22% from
9.43% attained in fiscal 1996 and 9.15% in fiscal 1995. The main reason for
this decline was the proportionately higher increase in the total average
investments portfolio, which carries a lower yield than loan portfolio, as a
percentage of total average interest-earning assets. In fiscal 1997, total
average investments was 44% of total average interest-earning assets
compared to 40% in fiscal 1996. During the year the Group created OBT
International Branch as a unit within the Bank under the Puerto Rico
International Banking Center Law which invests primarily in U.S. Government
securities that provide the Group significant tax advantages.
11
<PAGE>
INTEREST EXPENSE
Interest expense for fiscal 1997 increased to $45.1 million from $37.7
million reported in fiscal 1996, an increase of $7.4 million or 20%. In 1995,
interest expense amounted to $30.4 million.
The interest expense increase was the result of a higher volume of
interest-bearing liabilities used to fund the increase in interest-earning
assets. This increase in volume contributed to a rise in total interest
expense of $7.6 million in fiscal 1997. The Group's average
interest-bearing liabilities rose by $149 million or 21% to $845 million in
fiscal 1997 compared with $696 million during fiscal 1996. During fiscal 1995
average interest bearing liabilities amounted to $595 million.
The growth in average volume was mainly attributed to the significant
increase in the average volume of deposits and term notes. For fiscal 1997
the average volume of deposits grew by $85 million or 25% while the average
volume of term notes increased by $49 million or 68%. The increase in
deposits was concentrated in certificates of deposit, mostly customer and
broker CD's, and IRA accounts. The rise in average term notes was attributed
to four new term notes issued during the first half of the fiscal year.
The effect of higher average volume in interest expense was partially offset
by a lower average cost of interest-bearing liabilities. In spite of a
reduction in the volume of the lower-cost 936 funds as a result of the
Section 936 repeal during the first quarter of fiscal 1997, although at a
significantly slower pace than anticipated, the average cost of funds
decreased eight basis points to 5.33% from 5.41% in fiscal 1996. During
fiscal 1995 the average cost of funds was 5.11%. This responds to
improvements in the cost of other borrowings, mainly term notes, and in
certificate of deposits which experienced a lower interest rate environment.
12
<PAGE>
<TABLE>
<CAPTION>
PART I - NET INTEREST INCOME FISCAL 1997 FISCAL 1996 FISCAL 1995
--------------------------------- ------------------------------ ------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
------------ ---------- --------- --------- ---------- --------- ---------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
REAL ESTATE LOANS $ 249,364 $ 24,591 9.86% $ 215,079 $ 21,079 9.80% $ 198,179 $ 18,839 0.51%
CONSUMER LOANS 82,992 10,400 12.53% 72,167 9,115 12.63% 39,736 4,712 11.86%
COMMERCIAL LOANS 8,650 1,204 13.91% 8,382 931 11.10% 7,519 830 11.04%
FINANCING LEASES 156,769 18,575 11.85% 148,786 17,863 12.01% 112,078 14,290 12.75%
------------ ---------- --------- --------- ---------- --------- ---------- ---------- -------
TOTAL LOANS 497,775 54,770 11.00% 444,414 48,988 11.02% 357,512 38,671 10.83%
------------ ---------- --------- --------- ---------- --------- ---------- ---------- -------
------------ ---------- --------- --------- ---------- --------- ---------- ---------- -------
MORTAGE-BACKED SECURITIES 240,828 17,138 7.12% 171,757 12,593 7.33% 115,423 8,469 7.34%
INVESTMENT SECURITIES 134,697 9,642 7.16% 104,856 7,508 7.16% 128,675 9,204 7.15%
OTHER INTEREST-EARNING ASSETS 22,526 1,079 4.72% 25,300 1,358 5.34% 33,530 1,799 5.36%
------------ ---------- --------- --------- ---------- --------- ---------- ---------- -------
TOTAL INVESTMENTS 398,051 27,859 7.00% 301,913 21,459 7.10% 277,628 19,472 7.01%
------------ ---------- --------- --------- ---------- --------- ---------- ---------- -------
------------ ---------- --------- --------- ---------- --------- ---------- ---------- -------
TOTAL INTEREST-EARNING ASSETS $ 895,826 $ 82,629 9.22% $ 746,327 $ 70,447 9.43% $ 635,140 $ 58,143 9.15%
------------ ---------- --------- --------- ---------- --------- ---------- ---------- -------
------------ ---------- --------- --------- ---------- --------- ---------- ---------- -------
INTEREST-BEARING LIABILITIES
DEPOSITS $ 430,966 $ 21,012 4.88% $ 346,344 $ 17,386 5.02% $ 263,623 $ 11,668 4.43%
REPURCHASE AGREEMENTS 225,182 11,340 5.04% 205,748 9,906 4.81% 187,972 8,871 4.72%
LINES OF CREDIT 5,070 398 7.75% 9,683 768 7.82% 14,002 915 6.54%
FHLB ADVANCES 35,822 2,024 5.65% 38,155 2,342 6.14% 63,840 3,537 5.54%
FHLB BORROWINGS 26,000 1,601 6.16% 23,545 1,466 6.23% 13,055 1,048 8.02%
BONDS PAYABLE 721 63 8.75% 1,195 104 8.69% 1,686 147 8.70%
TERM NOTES 121,195 6,387 5.27% 71,640 4,147 5.79% 50,980 3,148 6.54%
INTEREST RATE RISK MANAGEMENT YIELD AJE. 2,273 0.55% YIELD AJE. 1,575 0.45% YIELD AJE. 1,089 0.33%
------------ ---------- --------- --------- ---------- --------- ---------- ---------- -------
TOTAL INTEREST-BEARING LIABILITIES 844,956 45,098 5.33% 696,310 37,694 5.41% 595,158 30,423 5.11%
------------ ---------- --------- --------- ---------- --------- ---------- ---------- -------
------------ ---------- --------- --------- ---------- --------- ---------- ----------
NET INTEREST EARNING ASSETS $ 50,870 $ 37,531 $ 50,017 $ 32,753 $ 39,982 $ 27,720
------------ ---------- --------- ---------- ---------- ----------
INTEREST RATE SPREAD 3.89% 4.03% 4.04%
--------- --------- -------
INTEREST RATE MARGIN 4.19% 4.38% 4.36%
---------- ---------- ----------
NET INTEREST-EARNING ASSETS RATIO 106.02% 107.18% 106.72%
------------ --------- ----------
<CAPTION>
PART II - INTEREST VARIANCE ANALYSIS FISCAL 1997 COMPARED TO 1996 FISCAL 1996 COMPARED TO 1995
--------------------------------- -----------------------------------
INCREASE / (DECREASE) DUE TO: INCREASE / (DECREASE) DUE TO:
VOLUME RATE TOTAL VOLUME RATE TOTAL
--------- ------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
REAL ESTATE LOANS $ 3,381 $ 131 $ 3,512 $ 1,664 $ 576 $ 2,240
CONSUMER LOANS 1,357 (72) 1,285 4,097 306 4,403
COMMERCIAL LOANS 37 236 273 96 5 101
FINANCING LEASES 945 (233) 712 4,407 (834) 3,573
--------- ------- -------- -------- ------- -------
TOTAL LOANS 5,720 62 5,782 10,264 53 10,317
--------- ------- -------- -------- ------- -------
MORTAGE-BACKED SECURITIES 4,911 (366) 4,545 4,137 (13) 4,124
INVESTMENT SECURITIES 2,131 3 2,134 (1,703) 7 (1,696)
OTHER INTEREST-EARNING ASSETS (124) (155) (279) (433) (8) (441)
--------- ------- -------- -------- ------- -------
TOTAL INVESTMENTS 6,918 (518) 6,400 2,001 (14) 1,987
--------- ------- -------- -------- ------- -------
TOTAL INTEREST-EARNING ASSETS $ 12,638 $ (456) $ 12,182 $ 12,265 $ 39 $12,304
--------- ------- -------- -------- ------- -------
INTEREST-BEARING LIABILITIES
DEPOSITS 4,125 (499) 3,626 $ 4,163 $ 1,555 $ 5,718
REPURCHASE AGREEMENTS 979 455 1,434 857 178 1,035
LINES OF CREDIT (363) (7) (370) (326) 179 (147)
FHLB ADVANCES (132) (186) (318) (1,576) 381 (1,195)
FHLB BORROWINGS 151 (16) 135 652 (234) 418
BONDS PAYABLE (42) 1 (41) (43) - (43)
TERM NOTES 2,611 (371) 2,240 1,382 (383) 999
INTEREST RATE RISK MANAGEMENT 289 409 698 88 398 486
--------- ------- -------- -------- ------- -------
TOTAL INTEREST-BEARING LIABILITIES 7,618 (214) 7,404 5,197 2,074 7,271
--------- ------- -------- -------- ------- -------
NET INTEREST EARNING ASSETS $ 5,020 $ (242) $ 4,778 $ 7,068 $(2,035) $ 5,033
--------- ------- -------- -------- ------- -------
--------- ------- -------- -------- ------- -------
</TABLE>
13
<PAGE>
PROVISION FOR LOAN LOSSES
For fiscal 1997 the Group provided $4.9 million for loan losses compared with
$4.6 million for fiscal 1996, an increase of $300,000 or 7%. The Group
provided $2.6 million for fiscal 1995.
The increase in the provision for fiscal 1997 was based mostly on the growth
of the Group's portfolio, as well as a rise in net charge-offs experienced by
the Group and current and expected economic conditions. Net charge-offs for
fiscal 1997 totaled $3.9 million or 0.08% of average loans, compared to $3.2
million or 0.07% in fiscal 1996 and to $3.3 million or 0.09% in fiscal
1995. The level of net charge-offs recorded in fiscal 1997 was primarily
associated to the losses experienced in the consumer loans and financing
leases portfolios. For fiscal 1997 consumer loan net charge-offs rose
$671,000 to $1.6 million from $926,000 in fiscal 1996 and finance lease net
charge-offs increased by $341,000 to $2.2 million from $ 1.96 million
recorded in fiscal 1996.
The following table sets forth an analysis of activity in the allowance for
loan losses and presents selected loan loss statistics for the years ended
June 30, (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE AT BEGINNING OF PERIOD $ 4,496 $ 3,127 $ 3,934 $ 3,504 $ 2,759
--------- --------- --------- --------- ---------
PROVISION FOR LOAN LOSSES 4,900 4,600 2,550 2,000 1,575
LOANS CHARGED-OFF (5,262) (3,979) (3,519) (1,844) (1,129)
RECOVERIES 1,274 748 162 274 299
--------- --------- --------- --------- ---------
NET CHARGE-OFF (3,988) (3,231) (3,357) (1,570) (830)
--------- --------- --------- --------- ---------
BALANCE AT END OF PERIOD $ 5,408 $ 4,496 $ 3,127 $ 3,934 $ 3,504
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
LOANS CHARGED-OFF:
CONSUMER 1,849 1,131 1,594 868 309
REAL ESTATE 53 106 147 163 9
FINANCE LEASES 3,248 2,510 1,566 491 638
COMMERCIAL AND OTHER 112 232 212 1,522 173
--------- --------- --------- --------- ---------
TOTAL 5,262 3,979 3,519 1,844 1,129
--------- --------- --------- --------- ---------
RECOVERIES:
CONSUMER 250 204 59 72 277
REAL ESTATE 30 - 25 202 -
FINANCE LEASES 980 497 - - -
COMMERCIAL AND OTHER 14 47 78 - 23
--------- --------- --------- --------- ---------
TOTAL 1,274 748 162 274 299
--------- --------- --------- --------- ---------
LOANS:
OUTSTANDING $537,881 $480,606 $412,519 $343,150 $266.738
AVERAGE $512,219 $454,777 $366,152 $291,465 $213,267
RATIOS:
RECOVERIES TO CHARGE-OFFS 24.21% 18.79% 4.60% 14.86% 26.48%
--------- --------- --------- --------- ---------
NET CHARGE-OFF TO AVERAGE LOANS 0.08% 0.07% 0.09% 0.05% 0.04%
--------- --------- --------- --------- ---------
ALLOWANCE FOR LOAN LOSSES TO NET CHARGE-OFFS 1.35 1.39 0.93 2.50 4.22
--------- --------- --------- --------- ---------
PROVISION FOR LOAN LOSSES TO NET CHARGE-OFFS 1.23 1.42 0.76 1.27 1.90
--------- --------- --------- --------- ---------
ALLOWANCE FOR LOAN LOSSES TO TOTAL LOANS 1.00% 0.94% 0.76% 1.15% 1.31%
--------- --------- --------- --------- ---------
</TABLE>
The Group maintains an allowance for loan losses on its portfolio at a level
that management considers adequate to provide for potential losses based upon
an evaluation of known and inherent risk. Oriental's allowance for loan
losses policy provides for a detailed quarterly analysis of possible losses.
The analysis includes a review of historical experience, value of underlying
collateral and current economic conditions, among others. Based upon the
results of this quarterly analysis, loan loss reserves are computed for each
portfolio.
14
<PAGE>
NON-INTEREST INCOME
The following table shows the fees and other non-interest income generated by
the Group for the fiscals ended June 30, 1997, 1996 and 1995 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
NON-INTEREST INCOME:
BANK SERVICE FEES & CHARGES $ 4,909 $ 3,801 $ 3,272
TRUST, MONEY MANAGEMENT AND BROKERAGE FEES 6,750 5,913 4,379
MORTGAGE BANKING ACTIVITIES 3,972 3,041 2,108
RENT AND OTHER OPERATING INCOME 818 545 463
--------- --------- ---------
TOTAL RECURRING NON-INTEREST INCOME 16,449 13,300 10,222
TRADING ACCOUNT PROFIT 54 (20) 380
NET GAIN IN SALE OF SECURITIES 849 1,482 266
GAIN ON TERMINATION OF PENSION PLAN - - 564
--------- --------- ---------
TOTAL NON-INTEREST INCOME $ 17,352 $ 14,762 $ 11,432
--------- --------- ---------
--------- --------- ---------
</TABLE>
In fiscal 1997 recurring non-interest income continued to be a major driver
of the Group's earnings improvement as it increased by $3.1 million or 24%
to $16.4 million from $13.3 million reported in the earlier fiscal year. In
fiscal 1995, these revenues totaled $10.2 million. Bank services fees and
charges, which consist primarily of service charges on deposit accounts,
leasing fees and late charges collected on loans, grew to $4.9 million as
compared to $3.8 million in fiscal 1996 due to solid contributions from fees
on deposit accounts and lease handling fees as a result of a larger volume of
loans and deposit accounts.
Trust, money management and brokerage fees, which represented 41% of
recurring non-interest income for fiscal year 1997 grew to $6.7 million from
$5.9 million in fiscal year 1996. This increase was possible to a larger
volume of accounts and assets managed by the trust department and the assets
gathered by the broker dealer subsidiary. Mortgage banking activities which
rose to $4 million from $3 million in fiscal 1996, an increase of $1 million
or 31%, was another category which contributed to the fiscal 1997 increase.
This was mainly attributed to a higher volume of mortgages originated.
Non recurring non-operating interest income, which consists mainly of
securities and trading gains and losses, decreased to $ 903,000 for fiscal
1997 compared to $1.5 million in the earlier fiscal year. This decline was
principally due to a gain on sales of $1.4 million realized during the second
quarter of fiscal 1996 to offset the additional $1.3 million increase in the
provision for loan losses allocated to non-real estate loans during that same
period. Non-real estate loans consisted of finance leases, commercial and
consumer loans.
NON-INTEREST EXPENSES
Total non-interest expenses for the years ended on June 30, 1997, 1996 and
1995, were as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
NON-INTEREST EXPENSES:
COMPENSATION AND BENEFITS $ 14,728 $ 12,732 $ 10,865
OCCUPANCY AND EQUIPMENT 4,295 3,329 3,533
PROFESSIONAL FEES 1,569 1,106 834
ADVERTISING AND PROMOTION 1,987 1,575 1,222
INSURANCE 801 1,039 932
REAL ESTATE OWNED EXPENSES 150 196 527
COMMUNICATIONS 1,283 1,059 855
OTHER OPERATING EXPENSES 3,685 3,572 2,822
--------- --------- ---------
TOTAL RECURRING NON-INTEREST EXPENSES 28,498 24,608 21,590
SAIF CAPITALIZATION ASSESSMENT 1,823 - -
--------- --------- ---------
TOTAL NON-INTEREST EXPENSES $ 30,321 $ 24,608 $ 21,590
--------- --------- ---------
--------- --------- ---------
</TABLE>
Recurring non-interest expenses for fiscal 1997 increased by $3.9 million or
16% to $28.5 million as compared to $24.6 million and $21.6 million for
fiscals 1996 and 1995. The increase results mainly from the ongoing efforts
to improve the Group's managerial and operational support as well as the
expenses related to the Group's expanded branches and services network.
15
<PAGE>
Employee compensation and benefits, the Group's largest expense category,
increased $2 million or 16% to $14.7 million from $12.7 million in fiscal
1996. For fiscal 1995, they amounted $10.9 million. The growth in personnel
cost was led by an increase of $1.5 million or 76% of the total increase due
to the increased headcount in response to the expanded sales force and
services. The Group's full-time equivalent employees amounted to 417 at June
30,1997, up from 372 at June 30, 1996. The rest of the increase of
$480,000 or 24% of the total increase was a result of the greater use of
variable based compensation structure to compensate for higher productivity
and sales efforts and to annual performance merit increases.
All other recurring non-interest expenses for fiscal 1997 grew by $1.9
million or 16% to $13.8 million from $11.9 million in fiscal 1996. For fiscal
1995, they totaled $10.7 million. This increase was mainly attributed to
increases in advertising and promotion of $412,000 or 26% and business
development and general operating costs of $550,000 or 12%. The increase in
advertising and promotion resulted mainly from the ongoing campaign to
promote the Group's image and the launching of new products and services.
Increases in communications and loan servicing expenses were the main
contributors in the growth of business development and general operating
costs.
The performance of the efficiency ratio and the expense ratio, profitability
measurement ratios, which remained at better than the peer-group level over
the past few fiscal years demonstrates the Group's impetus toward improved
operational efficiency and profitability. The efficiency ratio, which is the
ratio of non-interest expense to the sum of net interest income and recurring
non-interest income, improved to 52.76%, for fiscal 1997 compared to 53.43%
and 59.65% for the fiscal years 1996 and 1995, respectively. The expense
ratio, which is the ratio of net recurring operating expenses to average
interest-earning assets, was 1.34% for fiscal 1997, compared to 1.52% and
1.61% for the fiscal years 1996 and 1995, respectively.
On September 30, 1996 the United States Congress approved and President
Clinton signed into law a bill to recapitalize the Savings Association
Insurance Fund. This bill called for a special one-time charge on
institutions holding SAIF deposits on March 31, 1995 of approximately 66
basis points. Accordingly, Oriental recorded a special reserve of $1.8
million net of taxes of $470,000 during the first quarter of 1997 to account
for its share of the one-time payment of FDIC insurance premium. Beginning in
January 1997 institutions currently insured under SAIF will pay lower
premiums as result of this special assessment. In Oriental's case, this
represents an annual decrease in insurance premiums expense of approximately
$650,000 or $162,500 per quarter.
PROVISION FOR INCOME TAXES
The provision for income taxes for fiscal 1997 amounted to $3.1 million
compared with $3.5 million fiscal 1996 and $2.9 million in fiscal 1995. The
effective tax rate was 15.8% in fiscal 1997, 19.5% in fiscal 1996 and 19.3%
in fiscal 1994. The Group has maintained an effective tax rate lower than the
statutory rate of 39% mainly due to interest income earned on certain
investments and loans which is exempt from income taxes, net of the
disallowance of expenses attributable to the exempt income. In addition,
during 1997 the Group created OBT International Branch as a unit of the Bank
to take advantage of additional tax incentives available under the Puerto
Rico International Banking Center law. For additional information relating to
income taxes refer to Note 20 of the attached Group's financial statements
under Item 8 herein which information is incorporated by reference herein.
FINANCIAL CONDITION
ASSETS
Following is a brief summary of the institution's financial assets as of June
30, (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
INVESTMENTS AND TRADING SECURITIES $ 468,594 $ 350,736 $ 299,580
LOANS RECEIVABLE AND LOANS HELD FOR SALE, NET 532,970 476,110 409,391
------------ ------------ ------------
INTEREST EARNING ASSETS 1,001,564 826,846 708,971
NON-INTEREST EARNING ASSETS 67,312 50,578 35,427
------------ ------------ ------------
TOTAL ASSETS $ 1,068,596 $ 877,424 $ 744,398
------------ ------------ ------------
------------ ------------ ------------
TOTAL BANK ASSETS $ 1,068,596 $ 877,424 $ 744,398
TRUST ASSETS MANAGED 1,088,536 874,500 699,000
LOANS SERVICED FOR THIRD PARTIES 515,690 401,300 272,900
ASSETS GATHERED BY BROKER AND DEALER 524,858 293,100 195,400
------------ ------------ ------------
TOTAL FINANCIAL ASSETS $ 3,197,680 $ 2,446,324 $ 1,911,698
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
Oriental's total assets at June 30, 1997 reached $1.07 billion, an increase
of 22% when compared to $877 million at the end of fiscal 1996. Total assets
at June 30, 1995 were $744 million. Average assets for fiscal 1997 were $972
million compared to $804 million for fiscal 1996, an increase of $168
million or 21%. Average assets at June 30, 1995 were $683 million.
16
<PAGE>
At June 30, 1997 interest-earning assets amounted to $1 billion compared to $
827 million at June 30, 1996. This increase was the combination of a growth
in investment and trading securities of $118 million, or 34%, to $ 469
million from $351 million at the end of fiscal 1996, assisted by a higher
volume of loans receivable and loans held for sale, net of the allowance
for loan losses, of $57 million, or 12%, from $476 million at June 30, 1996
to $533 million at June 30, 1997. Interest earning assets amounted to $709
million at June 30, 1995.
Oriental's investment and trading securities, the second largest component of
interest-earning assets, consists mainly of U.S. Treasury notes, U.S.
Government agencies bonds, mortgage-backed securities and P.R. Government
municipal bonds. The investment portfolio is very high quality, approximately
98% is rated AAA at the end of fiscal 1997, and generates a significant
amount of tax exempt interest which lowers the Group's effective tax rate.
Also during fiscal 1997 the Group formed OBT International Branch as a unit
within the Bank under the Puerto Rico International Banking Center Law which
will house U.S. mortgage-backed securities in a tax-advantaged setting.
The increase of $118 million in investment and trading securities was driven
by a growth in mortgage-backed securities of $65 million or 31% to $278
million at June 30, 1997 from $213 million the previous year, as Oriental
continues its strategy of pooling guaranteed real estate loans into
mortgage-backed securities. During fiscal 1997, Oriental converted $148
million of loans held for sale into mortgage-backed securities. To a lesser
extent, the increase in tax exempt U.S. government and agency obligations of
$44 million or 64% contributed to the increase in this earning asset
component. U.S. government and agency obligations, which picks up a higher
after-tax yield since they are exempt from Puerto Rico taxes and have no
prepayment or credit risk are an attractive investment for Oriental.
Loans are the largest category of the Group's earning assets and the most
profitable. At June 30,1997, total loans were $533 million compared with
$476 million at the end of fiscal 1996, for an increase of $57 million or
12%. This rise was led by increases in the real estate and consumer
portfolios of $34 million or 15%, and $10 million or 13%, respectively. The
growth in Group's loan portfolio was mainly attained due to strong marketing
efforts coupled with the launch of new products.
The following table presents the composition of the Group's loan portfolio as
of the end of the last five fiscal years (in thousands):
<TABLE>
<CAPTION>
DESCRIPTION 1997 % 1996 % 1995 % 1994 % 1993 %
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
REAL ESTATE $ 271,249 50.4 $ 236,736 49.2 $ 199,119 48.2 $ 218,609 63.7 $ 195,408 73.3
CONSUMER 89,957 16.7 80,663 16.7 58,729 14.2 28,989 8.4 23,065 8.6
COMMERCIAL 10,512 1.9 7,398 1.5 12,326 3.0 7,222 2.1 4,942 1.9
FINANCE LEASES 166,660 31.0 155,808 32.4 142,303 34.6 88,330 25.8 43,323 17.1
---------- ----- ---------- ----- ----------- ----- ----------- -----
TOTAL GROSS 538,378 100.0 480,606 100.0 412,519 100.0 343,150 100.0 266,738 100.0
----- ----- ----- -----
LOAN LOSSES RESERVE (5,408) (4,496) (3,128) (3,934) (3,504)
---------- ---------- ----------- ----------- ---------
TOTAL NET $ 532,970 $ 476,110 $ 409,391 $ 339,216 $ 262,234
---------- ---------- ----------- ----------- ---------
---------- ---------- ----------- ----------- ---------
</TABLE>
As shown above, at June 30, 1997 the loan portfolio mix was similar to the
one at the end of the preceding fiscal year as real estate loans represented
50.4% of the total portfolio, while lease financing were 31.0%, consumer
loans 16.7%, and commercial loans comprised 1.9%. This compares with 49.2%,
32.4%, 16.7% and 1.5%, respectively, at the end of fiscal 1996 for the same
categories.
TRUST ASSETS MANAGED
Total assets managed by the trust department increased 25% growing to $1.09
billion at June 30, 1997, up from $874 million reported at the end of the
preceding fiscal year. The most significant assets managed are individual
retirement accounts (IRA) which increased to $351 million at June 30, 1997
from $306 million at June 30, 1996. Oriental Trust offers three IRA
products: (1) IRA-Exenta, a tax exempt unit investment trust, (2) Multi-IRA,
a taxable fixed income account and (3) Investors IRA, for which the yield is
tied to the performance of the stock market. Other assets managed include
401 (K) and Keogh retirement plans, custodian and corporate trust accounts.
ORIENTAL FINANCIAL GATHERED ASSETS
Since its inception in April 1993, Oriental's broker-dealer subsidiary has
offered a wide range of investment products to its client base. Total assets
gathered by the broker-dealer from its customer investment accounts expanded
by 79% to $525 million at June 30, 1997 from $293 million at June 30, 1996.
LOANS SERVICED FOR THIRD PARTIES
The Group's loan administration division services mortgage loans for third
parties which include federal agencies such as GNMA, FNMA and FHLMC, as well
as local issuers such as the P.R. Housing Bank. Total loans serviced for
third parties increased 24% to $516 million at June 30, 1997 from $401
million at June 30, 1996.
17
<PAGE>
NON-PERFORMING ASSETS
The Group's non-performing assets consist of the sum of non-performing
loans, real estate owned and repossessed assets. The following table shows
the balance of non-performing assets, as of June 30, (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Real estate loans $ 5,575 $ 4,069 $ 4,211
Financing leases 4,778 3,641 1,539
Commercial loans 814 301 556
Consumer loans 2,118 1,228 318
Construction - 211 926
-------- -------- --------
TOTAL NON-ACCRUING LOANS 13,285 9,450 7,550
-------- -------- --------
-------- -------- --------
Foreclosed real estate 698 842 800
Repossessed vehicles 1,253 831 892
Repossessed equipment 486 486 157
-------- -------- --------
TOTAL REPOSSESSED ASSETS 2,437 2,159 1,048
-------- -------- --------
-------- -------- --------
TOTAL NON-PERFORMING ASSETS $ 15,722 $ 11,609 $ 9,399
-------- -------- --------
-------- -------- --------
NON-ACCRUING LOANS TO TOTAL LOANS 2.47% 2.00% 1.84%
-------- -------- --------
-------- -------- --------
ALLOWANCE TO TOTAL NON-ACCRUING LOANS 40.71% 47.58% 41.43%
-------- -------- --------
-------- -------- --------
NON-PERFORMING ASSETS AS A PERCENTAGE (%) OF:
TOTAL ASSETS 1.47% 1.32% 1.26%
-------- -------- --------
-------- -------- --------
TOTAL CAPITAL 17.79% 14.53% 13.48%
-------- -------- --------
-------- -------- --------
</TABLE>
Detailed information concerning each of the items that comprise
non-performing assets follows:
DELINQUENT REAL ESTATE LOANS
Oriental classifies real estate loans delinquent 90 days or more in
non-accruing status. Due to the limited supply of land in Puerto Rico,
real estate market values have remained stable. Even though these loans are
in non-accruing status, based on the value of the underlying collateral and
the loan to value ratios, management considers that no material losses will
be incurred on this portfolio. The estimated losses have been considered in
the determination of the level of allowances for loan losses as of June 30,
1997, and June 30, 1996. Real estate loans are charged-off based on the
specific evaluation of the collateral underlying the loan.
DELINQUENT COMMERCIAL BUSINESS LOANS
Commercial business loans are placed on non-accrual basis when they become 90
days past due. The Bank's non-accrual commercial business loans at June 30,
1997 consisted of twelve loans amounting to $814,000 (average of $67,800),
with three loans having balances exceeding $100,000. Of the total balance,
$484,000 are guaranteed by real estate. Commercial loans are charged-off
based on the specific evaluation of the collateral underlying the loan.
DELINQUENT FINANCE LEASES
Leases are placed on non-accrual status when they become 90 days past due.
Oriental's non-accrual leases at June 30, 1997 consisted of two hundred and
sixty two auto leases amounting to $3.3 million (average of $12,600), and
one hundred ninety equipment leases amounting to $ 1.5 million (average of $
7,895). At June 30, 1997, there were two non-accrual equipment leases over
$100,000.
DELINQUENT CONSUMER LOANS
Consumer loans are placed on non-accrual status when they become 90 days past
due. The Group's non-accrual consumer loans consisted of three hundred
three loans amounting to $2.1 million (average of $6,930).
18
<PAGE>
REPOSSESSED ASSETS AND FORECLOSED REAL ESTATE (OREO)
As of June 30, 1997 the inventory of repossessed automobiles consisted of
seventy-one units amounting to $ 1.2 million (average of $17,600 ), and the
inventory of repossessed equipment consisted of thirty units amounting to
$486,000 (average of $16,200).
Repossessed assets are initially recorded at estimated net realizable value.
Any additional losses on the disposition of such assets are charged against
the allowance for loan losses at the time of disposition. The estimated loss
on disposition of such assets has been considered in the determination of the
allowance for loan losses.
Foreclosed real estate is initially recorded at the lower of the related
loan balance or fair value at the date of foreclosure. At the time of
acquisition of properties in full or partial satisfaction of loans, any
excess of the loan balance over the estimated fair market value of the
property is charged against the allowance for loan losses. The carrying
value of these properties is estimated to approximate the lower of cost or
fair value less estimated cost to sell. Any excess of the carrying value over
the estimated fair market value is charged to operations. Therefore, no
material losses are expected on the final disposition of OREO's. Management
is actively seeking prospective buyers for these foreclosed real estate
properties.
LIABILITIES AND CAPITAL
LIABILITIES
Following is a brief summary of the institution's liabilities at June 30, (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
--------- ---------- ---------
<S> <C> <C> <C>
DEPOSITS $ 497,542 $ 382,557 $ 313,542
REPURCHASE AGREEMENTS 247,915 242,335 195,337
OTHER BORROWED FUNDS 204,816 145,466 137,472
--------- ---------- ---------
INTEREST BEARING LIABILITIES 950,273 770,358 646,351
NON-INTEREST BEARING LIABILITIES 28,929 27,163 28,342
--------- ---------- ---------
TOTAL LIABILITIES $979,202 $797,521 $674,693
--------- ---------- ---------
--------- ---------- ---------
</TABLE>
At June 30, 1997 Oriental's total liabilities reached $979 million,
reflecting an increase of $181 million or 23% when compared to $798 million
at June 30, 1996. Total liabilities at June 30, 1995 were $674 million.
Average total liabilities for fiscal 1997 were $887 million compared with
$728 million for the same period in fiscal 1996, and increase of $159 million
or 18%. Average total liabilities for the year ended June 30, 1995 were $
637 million.
Interest-bearing liabilities at June 30, 1997 amounted to $950 million, an
increase of $180 million or 23% as compared to $770 million at June 30, 1996.
This significant increase was the result of a growth in deposits of $115
million or 30% and an increase in borrowings of $ 60 million or 41%.
Deposits, the largest category of the Group's interest -bearing liabilities,
showed growth in all areas as they increased to $498 million at June 30,
1997, from $383 million at June 30, 1996. At the end of fiscal 1997 deposits
represented 52% of total interest bearing liabilities versus 50% at the end
of the preceding fiscal year. Demand and saving deposits were up by $20
million or 23%, to $107 million at June 30, 1997, from $87 million at June
30, 1996 and certificates of deposit rose by $94 million or 32%, to $388
million at June 30, 1997, from $294 million at June 30, 1996.
The increase in demand and saving deposits was mainly triggered by two
factors. First, the addition of new branches during the last three fiscal
years provided Oriental a stronger penetration in the island's most populated
areas. Last, but more important, was the wider spectrum of consumer banking
products available at Oriental during the last twelve months. This new array
of services which cater the consumer's most pressing financial and service
requirements have improved Oriental's ability to provide a total financial
relationship to regular customers and attract new clients. The increase in
time deposits was mainly attained through the rise of broker certificates of
deposit and IRA accounts, of $31 million and $24 million, respectively.
As of June 30, 1997 total borrowings amounted to $453 million compared to
$388 million at June 30, 1996. Oriental has a diversified source of funding
through the use of FHLB advances and borrowings, repurchase agreements, term
notes, notes payable and lines of credit. The increase in borrowings was
mainly due to increases in advances from the FHLB-NY and in term notes. The
increase in term notes was due to the issuance of $60 million in term notes
during the first half of this fiscal year. The increase in total borrowings
was necessary to fund the increase in interest-earning assets experienced
during the period. A substantial number of these term notes have floating
rates that are generally hedged through the Group's overall interest rate
risk management process discussed in the Note 19 of the attached Group's
financial statements under Item 8 herein, which information is incorporated
by reference herein.
19
<PAGE>
CAPITAL
The following table sets forth Oriental's capital adequacy data and common
stock performance at June 30, (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
TOTAL CAPITAL $ 89,394 $ 79,903 $ 69,705
-------- -------- --------
-------- -------- --------
DIVIDENDS DECLARED $ 4,369 $ 3,184 $ 1,709
-------- -------- --------
-------- -------- --------
REGULATORY RATIOS:
CORE CAPITAL (LEVERAGE) RATIO 8.17% 8.71% 8.89%
-------- -------- --------
-------- -------- --------
TIER 1 RISK-BASED CAPITAL RATIO 17.53% 18.07% 17.00%
-------- -------- --------
-------- -------- --------
TOTAL RISK-BASED CAPITAL RATIO 18.66% 19.14% 17.73%
-------- -------- --------
-------- -------- --------
</TABLE>
At June 30, 1997 Oriental's total capital increased by $9.5 million or 12% to
$89.4 million, from $79.9 million at June 30, 1996. This increase was the
result of earnings of $16.6 million recorded during the fiscal year increased
by $454 thousand from stock options exercised and a $380 thousand positive
change in the valuation account for investment securities available-for-sale.
This increase was offset by $4.4 million in dividends declared and $3.5
million used repurchase Oriental shares in the open market.
The Bank and the Group continue to be a "well capitalized" institution, the
highest classification available under the capital standards set by the
applicable banking agencies. To be in a "well capitalized" position, bank or
bank holding companies must meet or exceed a leverage ratio of 5%, a Tier 1
risk-based capital ratio of 6% and a total risk-based capital ratio of 10%.
As of June 30, 1997 the Group had a leverage ratio of 8.17%; a Tier 1
risk-based ratio of 17.53%; and a total risk based capital ratio of 18.66%
compared to 8.71%, 18.07% and 19.14%, respectively, at the same date in 1996.
MARKET PRICES, STOCK DATA AND DIVIDENDS
The Group's common stock is traded in the New York Stock Exchange (NYSE)
under the symbol OFG. The following table provides the high and low prices of
the Group's stock for each quarter of the last three fiscal periods. Common
stock prices were adjusted to give retroactive effect to the stock splits
declared on the Group's common stock.
<TABLE>
<CAPTION>
DIVIDEND BOOK DIVIDEND DIVIDEND
QUARTER ENDED HIGH LOW PER SHARE VALUE PAYOUT RATIO YIELD
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
FISCAL 1997 $ 11.19 24.4 % 2.63 %
SEPTEMBER 1996 $ 16.35 $ 16.25 $ 0.125
DECEMBER 1996 22.00 18.25 0.125
MARCH 1997 27.00 20.88 0.15
JUNE 1997 28.25 22.75 0.15
FISCAL 1996 $ 10.04 21.6 % 2.86 %
SEPTEMBER 1995 $ 12.13 $ 10.13 $ 0.08
DECEMBER 1995 14.50 11.57 0.10
MARCH 1996 14.58 13.33 0.10
JUNE 1996 16.15 13.75 0.10
FISCAL 1995 $ 8.71 14.1 % 2.01 %
SEPTEMBER 1994 $ 11.63 $ 11.08 $ 0.03
DECEMBER 1994 10.83 8.25 0.05
MARCH 1995 10.17 8.91 0.05
JUNE 1995 12.92 9.67 0.08
</TABLE>
On August 26, 1996, Oriental declared a six-for-five (20%) stock split on its
6,597,563 shares of common stock outstanding at September 30, 1996. As a
result, 1,308,712 shares of common stock were issued on October 17, 1996 thus
increasing shares to 7,906,275.
The price per share on the reported last sale price on the NYSE on June 30,
1997 was $28.25. This represents an increase of 66% from the last sale price
at June 30, 1996 of $ 15.83, already adjusted for the six-for-five (20%)
stock split. The book value at June 30, 1997 rose to $11.19 from $10.04
reported at the same period of the prior fiscal year.
20
<PAGE>
During fiscal 1997 and 1996, the Group declared dividends amounting to $4.4
million compared to $3.2 million in fiscal 1996, an increase of $1.2 million
or 38%. This represents total dividends declared per common share of $0.55
for fiscal 1997 and $0.38 for fiscal 1996. The Group increased its quarterly
dividend from $0.125 to $.015 per share, a 20% increase, during the third
quarter of fiscal 1997. For fiscal 1997 the dividend payout ratio and
dividend yield amounted to 24.4% and 2.63%, respectively, compared to 21.6%
and 2.86%, respectively, in the preceding fiscal year.
Item 7-A required that oriental supply information required by Item 305 of
Regulation S-K, which in turn provides that the required information
regarding qualitative and quantitative disclosures about market risk must be
provided by the bank holding companies for any fiscal year ending after June
15, 1997. This item is herefore probably applicable to Oriental and the
required information should be included (some of it may already be included
in the discussion on asset/liability management and liquidity included on
pages 21 and 22 of the draft)
ASSET/LIABILITY MANAGEMENT
The Group through its Asset and Liability Management Committee (ALCO) has
developed policies whose primary goal is to enhance profitability while
maintaining an appropriate relationship between the amount of
interest-earning assets and interest-bearing liabilities that mature or
reprice during the same period. This difference is commonly referred to as a
"maturity mismatch" or "gap".
The Group is liability sensitive on a cumulative basis (negative one year
gap) due to its fixed rate asset composition being funded with shorter
repricing liabilities. However, since the traditional static gap
representation does not capture all of the complex factors that influence
asset and liability repricings, the Group places greater emphasis on
simulation analysis. The Group utilizes different rate and growth scenarios
to develop strategies to maintain its net interest income within the
prescribed policy limits. The simulations also include the effect of the
Group's profitability under different rate scenarios.
The Group utilizes interest rate swaps as an interest rate risk hedging
mechanism. Under the swaps, the Group pays a fixed annual cost and receives
a floating ninety-day payment based on LIBOR. Floating rate payments received
from the swap counterparty correspond to the floating rate payments made on
the borrowings or notes thus resulting in a net fixed rate cost to the Group.
See Note 19 of the Group's Financial Statements under Item 8 herein for more
on the Group's overall interest rate risk management process, which
information is incorporated herein by reference.
The interest rate swap agreements are subject to the risk of non-performance
by the counterparty. The Group enters into interest rate swaps only with the
approved investment grade money center banks and major broker/dealers. The
Group has established policies that limit the maximum exposure to any one
counterparty. These policies are reviewed by the Board of Directors on a
yearly basis. At June 30, 1997, the Group had entered into interest rate
swap agreements with ten counterparties with a remaining average life of
approximately two years.
Given the Group's asset/liability position, the Group is exposed to
rising interest rates. At June 30, 1997 given a 200 basis points increase in
interest rates, the Group had at risk 5.7% of its projected next year's net
interest income. During the fiscal year, net interest income at risk
fluctuated between 5% and 5.7%.
The table on page 22 shows the repricing schedule for the Group's total
assets and liabilities at June 30, 1997. The table distributes the assets and
liabilities in the maturity buckets to compute the "Maturity Mismatch" or
"Gap".
LIQUIDITY
Liquidity refers to cash and other investments easily converted into cash
that are available to meet unanticipated requirements. The objective of the
Group's liquidity management is to ensure sufficient cash flow to fund the
origination and acquisition of assets, the repayment of deposit withdrawals
and the wholesale borrowings maturities, and meet operating expenses. The
Group's liquidity position is reviewed and monitored by the ALCO Committee on
a regular basis.
The Group's principal sources of funds are net deposit inflows, loan
repayments, mortgage-backed and investment securities principal and interest
payments, reverse repurchase agreements, FHLB advances and other borrowings.
The Group has obtained long-term funding through the issuance of notes and
long-term reverse repurchase agreements. The Group's principal uses of funds
are the origination and purchase of loans, the purchase of mortgage-backed
and investment securities, the repayment of maturing deposits and borrowings.
During the first quarter of fiscal 1997 President Clinton signed into law a
bill phasing out the tax incentives offered to manufacturing companies
operating in Puerto Rico under Section 936 of the Internal Revenue Code. The
phase out of the manufacturing tax benefits will occur over a ten-year
period, and the benefits related to the passive income (QPSII) were
eliminated effective July 1, 1996. Financial institutions and other eligible
borrowers in Puerto Rico have benefited throughout the years from the lower
cost of these QPSII funds.
21
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------- ------------ ---------------------------------------------------------------------------
ORIENTAL FINANCIAL GROUP NON-INTEREST
INTEREST RATE SENSITIVITY ANALYSIS BALANCE 1 YEAR 1 TO 3 3 TO 5 OVER 5 RATE
AS OF JUNE 30, 1997 JUNE 30,1997 OR LESS YEARS YEARS YEARS SENSITIVITY TOTAL
- ----------------------------------- ------------ ---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and due from banks $ 12,812 $ - $ - $ - $ - $ 12,812 $ 12,812
Securities purchased under
agreements to resell 15,000 15,000 - - - - 15,000
Time deposits with other banks 8,000 8,000 - - - - 8,000
Other short-term investments,
at cost 5,224 5,224 - - - - 5,224
Trading securities, at market 25,276 25,276 - - - - 25,276
Investment securities
available-for-sale, at market 203,261 27,870 35,427 101,040 38,924 - 203,261
Investment securities
held-to-maturity, at cost 201,790 - 1,272 - 200,518 - 201,790
Federal Home Loan Bank (FHLB)
stock, at cost 10,043 - - - - 10,043 10,043
Loans held for sale 29,285 29,285 - - - - 29,285
Loans receivable 509,093 123,337 150,300 70,033 129,710 35,713 509,093
Allowance for loan losses (5,408) - - - - (5,408) (5,408)
Accrued interest receivable 12,350 - - - - 12,350 12,350
Foreclosed real estate, net 698 - - - - 698 698
Premises and equipment, net 19,378 - - - - 19,378 19,378
Other assets, net 21,794 - - - - 21,794 21,794
Swaps and Caps 430,000 430,000 - - - - 430,000
------------ ---------------------------------------------------------------------------
TOTAL ASSETS $ 1,498,596 $ 663,992 $ 186,999 $ 171,073 $ 369,152 $ 107,380 $ 1,498,596
------------ ---------------------------------------------------------------------------
------------ ---------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS'
EQUITY
Deposits $ 497,542 $ 310,610 $ 85,460 $ 17,082 $ 61,584 $ 22,805 $ 497,541
Securities sold under agreements
to repurchase 247,915 247,915 - - - - 247,915
Borrowings under lines of credit - - - - - - -
Advances and borrowings from
Federal Home Loan Bank 89,800 75,800 14,000 - - - 89,800
Term notes and bonds payable 115,016 106,500 8,516 - - - 115,016
Accrued expenses and other
liabilities 28,929 - - - - 28,929 28,929
Stockholders' equity 89,394 - - - - 89,394 89,394
Swaps and Caps 430,000 220,000 200,000 10,000 - - 430,000
------------ ---------------------------------------------------------------------------
TOTAL LIABILITES AND STOCKHOLDERS'
EQUITY 1,498,596 960,825 307,976 27,082 61,584 141,128 1,498,595
------------ ---------------------------------------------------------------------------
------------ ---------------------------------------------------------------------------
Interest Rate Sensitivity Gap (296,833) (120,977) 143,991 307,568 (33,748)
Cummulative Interest Rate
Sensitivity Gap (296,833) (417,810) (273,819) 33,749 0
Gap / Total Assets (20%) (8%) 10% 21% (2%)
Cummulative Gap / Total Assets (20%) (28%) (18%) 2% 0%
</TABLE>
The starting point for the maturity buckets are determined based on the
stated or final maturities of the Group's assets and liabilities. The
following adjustments are then made:
(1) Loans and mortgage-backed securities prepayments are estimated based on the
interest rate of the loan or mortgage-backed security, the prevailing
interest rate for similar loans or securities and past prepayment
experience.
(2) Floating rate assets and liabilities are included in the buckets based on
the next repricing date.
(3) Loans held for sale are included in the one year or less maturity bucket as
they are packed and sold by the Bank in the normal course of business.
(4) Swap floating rate receive and CAP receive notional amounts are included
based on the next repricing date (usually 90 days). Swap fixed rate pay and
CAP notional amounts are included based on the final contractual date.
(5) Bonds payable repay based on the prepayments for the FHLMC participation
certificates which guarantee the debt. Future repayments are based on the
repayment experience to date.
22
<PAGE>
The elimination of the Section 936 tax credit for the Puerto Rico
operations of U.S. companies and benefits to QPSII did not have a significant
impact on the Group's liquidity position. This was mainly due to the fact
that the law change came with plenty of warning, so the Group was able to
replace 936 funding with longer-term obligations. During fiscal 1997 the
Group locked-in about $185,000 million of non-cancelable long-term funding,
with maturities ranging from three to ten years.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented herein have been prepared
in accordance with GAAP, which requires the measurement of financial
positions and operating results in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due
to inflation. Unlike most individual companies, substantially all of the
assets and liabilities of the Group are monetary in nature. As a result,
interest rates have a more significant impact on the Group's performance than
the general level of inflation. Over short periods of time, interest rates
may not necessarily change in the same direction or as much as the prices of
goods and services.
RECENT DEVELOPMENTS
CHANGES TO THE PUERTO RICO TAX CODE
On July 22, 1997 the Governor of Puerto Rico signed into law changes to the
Puerto Rico Internal Revenue Code of 1994, as amended, that will impact the
Group's operations going forward. Under this law effective August 1, 1997,
interest earned on FHA, VA loans and securities backed by such loans
originated after July 31, 1997, which were previously tax exempt
(after-disallowance of related expenses) will begin to pay income taxes
except for FHA mortgages for new construction projects. The legislation does
not alter the tax-exempt status of FHA and VA loans and securities backed by
such loans originated prior to July 31, 1997. This will reduce the amount of
tax-exempt mortgages originated in the Puerto Rico market and decrease the
overall level of tax-exempt interest earned by Group. Management believes
the increased operations of OBT International Branch will mitigate the
expected rise on the Group's income taxes as result of this new bill. Thus,
management does not expect this change to have a significant impact on the
Group's financial condition or results of operations.
The law also allows up to 33% of the IRA funds in Puerto Rico to be invested
in the United States. Prior to August 1, 1997, 100% of these funds had to be
invested in Puerto Rico. Management expects this change will allow the
creation of additional investment products for its IRA clients.
Finally, the law increased the IRA deduction to $3,000 per spouse for
taxable years beginning January 1, 1998. The current IRA deduction is $2,500.
STOCK SPLIT
Subsequent to the close of fiscal 1997, on August 11, 1997, the Group
declared a five-for-four (25%) stock split on common stock held by registered
shareholders as of September 30, 1997. The stock split will be distributed
on October 15, 1997. The pro-forma effect of this stock split on earnings
per share is disclosed in the Consolidated Statements of Income under Item 8
herein.
SALE OF MORTGAGE SERVICING DIVISION
Following a competitive bidding process for the sale of the Group's mortgage
servicing portfolio, including the $516 million serviced for others, on
August 18, 1997, the Group's board of directors instructed management to
negotiate with the two highest bidders. Following negotiations, a sales
contract with Doral Financial was signed. Management expects the mortgage
servicing sale transaction to be completed by October 31, 1997.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Group was given an unqualified opinion for the fiscal year ended June 30,
1997 by its independent accountant ( Price Waterhouse) on a independent's
accountant report signed on August 7, 1997. A copy of the independent
accountant unqualified opinion appears on page 31 of the Group's Annual
Report for the year ended June 30, 1997 and is incorporated herein by
reference.
The following indicates the pages were the documents corresponding Group's
audited financial statements for the year ended June 30, 1997 are located
<TABLE>
<S> <C>
Consolidated Statements of Financial Condition as of June 30, 1997 and 1996 24
Consolidated Statements of Income for each of the years in the three-year period ended June 30, 1997 25
Consolidated Statements of Cash Flows for each of the years in the three-year period ended June 30, 1997 27-28
Consolidated Statements of Changes in Stockholders' Equity for each of the years in the three-year
period ended June 30, 1997 26
Notes to the Consolidated Financial Statements 29-48
</TABLE>
23
<PAGE>
ORIENTAL FINANCIAL GROUP INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED ON JUNE 30, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS
- ---------------------------------------------------------------------------------------------------------------
1997 1996
---------- ---------
<S> <C> <C>
Cash and due from banks $ 12,812 $ 7,089
---------- ---------
MONEY MARKET INVESTMENTS:
Securities purchased under agreements to resell 15,000 7,129
Time deposits with other banks 8,000 7,500
Other short-term investments, at cost 5,224 2,366
---------- ---------
TOTAL MONEY MARKET INVESTMENTS 28,224 16,995
---------- ---------
INVESTMENT SECURITIES AND OTHER INVESTMENTS:
Trading securities, at market 25,276 331
Investment securities available-for-sale, at market 203,261 154,990
Investment securities held-to-maturity, at cost 201,790 171,008
Federal Home Loan Bank (FHLB) stock, at cost 10,043 7,412
---------- ---------
TOTAL INVESTMENT SECURITIES AND OTHER INVESTMENTS 440,370 333,741
---------- ---------
LOANS:
Loans held for sale 29,285 29,624
Loans receivable 509,093 450,982
---------- ---------
TOTAL LOANS 538,378 480,606
Allowance for loan losses (5,408) (4,496)
---------- ---------
TOTAL LOANS, NET 532,970 476,110
---------- ---------
Accrued interest receivable 12,350 10,068
Foreclosed real estate, net 698 842
Premises and equipment, net 19,378 17,935
Other assets, net 21,794 14,644
---------- ---------
TOTAL ASSETS $1,068,596 $ 877,424
---------- ---------
---------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
- ---------------------------------------------------------------------------------------------------------------
Deposits $ 497,542 $ 382,557
Securities sold under agreements to repurchase 247,915 242,335
Borrowings under lines of credit - 10,000
Advances and borrowings from Federal Home Loan Bank 89,800 46,000
Term notes and bonds payable 115,016 89,466
Accrued expenses and other liabilities 28,929 27,163
---------- ---------
TOTAL LIABILITIES 979,202 797,521
---------- ---------
---------- ---------
Commitments and contingencies - -
---------- ---------
STOCKHOLDERS' EQUITY:
Preferred stock, no par value; 5,000,000 shares authorized; none issued
Common stock, $1 par value; 10,000,000 shares authorized; 7,989,787
and 7,960,019 issued and outstanding in 1997 and 1996, respectively 7,990 6,633
Additional paid-in capital 28,631 31,234
Legal surplus 4,002 2,498
Retained earnings 49,694 39,005
Treasury stock, at cost, 81,200 shares at June 30, 1997 (1,836) -
Unrealized gain on securities available-for-sale, net of taxes 913 533
---------- ---------
TOTAL STOCKHOLDERS' EQUITY 89,394 79,903
---------- ---------
---------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,068,596 $ 877,424
---------- ---------
---------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS
24
<PAGE>
ORIENTAL FINANCIAL GROUP INC.
CONSOLIDATED STATEMENT OF INCOME
FOR THE YEARS ENDED ON JUNE 30, 1997, 1996, AND 1995
(IN THOUSANDS, EXCEPT FOR PER SHARE INFORMATION)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
INTEREST INCOME:
Loans $54,770 $48,988 $38,671
Mortgage-backed securities 17,138 12,593 8,469
Investment securities 9,642 7,508 9,204
Other interest-earning assets 1,079 1,358 1,799
------- ------- -------
TOTAL INTEREST INCOME 82,629 70,447 58,143
------- ------- -------
------- ------- -------
INTEREST EXPENSE:
Deposits 21,012 17,386 11,668
Securities sold under agreements to repurchase 11,340 9,906 8,871
Other borrowed funds and interest rate risk management 12,746 10,402 9,884
------- ------- -------
TOTAL INTEREST EXPENSE 45,098 37,694 30,423
------- ------- -------
------- ------- -------
Net interest income 37,531 32,753 27,720
PROVISION FOR LOAN LOSSES 4,900 4,600 2,550
------- ------- -------
Net interest income after provision for loan losses 32,631 28,153 25,170
------- ------- -------
NON-INTEREST INCOME:
Bank service charges and fees 4,909 3,801 3,272
Trust, money management and brokerage fees 6,750 5,913 4,379
Mortgage banking activities 3,972 3,041 2,108
Gain on sale of investment securities 849 1,482 266
Trading account income 54 (20) 380
Gain on termination of pension plan - - 564
Rent and other operating income 818 545 463
------- ------- -------
TOTAL NON-INTEREST INCOME 17,352 14,762 11,432
------- ------- -------
------- ------- -------
NON-INTEREST EXPENSES:
Compensation and benefits 14,728 12,732 10,865
Occupancy and equipment 4,295 3,329 3,533
Professional fees 1,569 1,106 834
Advertising and promotion 1,987 1,575 1,222
Real estate owned expenses 150 196 527
Insurance, including deposit insurance 801 1,039 932
Communications 1,283 1,059 855
Other 3,685 3,572 2,822
SAIF one-time capitalization assessment 1,823 - -
------- ------- -------
TOTAL NON-INTEREST EXPENSE 30,321 24,608 21,590
------- ------- -------
------- ------- -------
INCOME BEFORE INCOME TAXES 19,662 18,307 15,012
Provision for income taxes 3,100 3,571 2,905
------- ------- -------
NET INCOME $16,562 $14,736 $12,107
------- ------- -------
------- ------- -------
WEIGHTED AVERAGE COMMON SHARES AND EQUIVALENTS:
Average common shares outstanding 7,911 8,030 7,648
Average common stock equivalents - options 297 319 522
------- ------- -------
TOTAL 8,208 8,349 8,170
------- ------- -------
------- ------- -------
INCOME PER COMMON SHARE $ 2.02 $ 1.77 $ 1.48
------- ------- -------
------- ------- -------
PRO-FORMA INCOME PER COMMON SHARE AFTER RETROACTIVE
EFFECT OF STOCK SPLIT DECLARED ON AUGUST 11, 1997
(UNAUDITED; NOTE 28) $ 1.61 $ 1.41 $ 1.19
------- -------- ---------
------- -------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS
25
<PAGE>
ORIENTAL FINANCIAL GROUP INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED ON JUNE 30, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------ ------------
<S> <C> <C> <C>
COMMON STOCK:
Balance at beginning of period $ 6,633 $ 5,334 $ 3,663
Six-for-five stock split 1,318 - -
Five-for-four stock split - 1,341 -
Four-for-three stock split - 1,264
Public offering, net - 120
Stock options exercised 120 98 287
Common stock repurchased and retired (88) (140) -
Directors' qualifying shares 7 - -
------------ ----------- -----------
BALANCE AT END OF PERIOD 7,990 6,633 5,334
------------ ----------- -----------
------------ ----------- -----------
ADDITIONAL PAID - IN CAPITAL:
Balance at beginning of period 31,234 34,528 32,467
Six-for-five stock split (1,318) - -
Five-for-four stock split - (1,341) -
Four-for-three stock split - (1,264)
Public offering, net - 2,412
Stock options exercised 341 329 913
Common stock repurchased and retired (1,626) (2,282) -
------------ ----------- -----------
BALANCE AT END OF PERIOD 28,631 31,234 34,528
------------ ----------- -----------
------------ ----------- -----------
LEGAL SURPLUS:
Balance at beginning of period 2,498 1,211 -
Transfer from retained earnings 1,504 1,287 1,211
------------ ----------- -----------
BALANCE AT END OF PERIOD 4,002 2,498 1,211
------------ ----------- -----------
------------ ----------- -----------
RETAINED EARNINGS:
Balance at beginning of period 39,005 28,740 19,554
Net income 16,562 14,736 12,107
Dividends declared and cash paid on fractional shares (4,369) (3,184) (1,710)
Transfer to legal surplus (1,504) (1,287) (1,211)
------------ ----------- -----------
BALANCE AT END OF PERIOD 49,694 39,005 28,740
------------ ----------- -----------
------------ ----------- -----------
TREASURY STOCK:
Balance at beginning of period - - -
Treasury stock purchased (1,836) - -
------------ ----------- -----------
BALANCE AT END OF PERIOD (1,836) - -
------------ ----------- -----------
------------ ----------- -----------
UNREALIZED GAIN (LOSS) ON SECURITIES
AVAILABLE-FOR-SALE, NET OF TAXES:
Balance at beginning of period 533 (108) 259
Net change in fair value of securities
available-for-sale, net of taxes 380 641 (367)
------------ ----------- -----------
BALANCE AT END OF PERIOD 913 533 (108)
------------ ----------- -----------
------------ ----------- -----------
TOTAL STOCKHOLDERS' EQUITY $89,394 $79,903 $69,705
------------ ----------- -----------
------------ ----------- -----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS
26
<PAGE>
ORIENTAL FINANCIAL GROUP INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED ON JUNE 30, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 16,562 $ 14,736 $ 12,107
--------- --------- ---------
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Amortization of deferred loan origination fees and costs (3,165) (2,779) (1,714)
Amortization of premiums and accretion of discounts on
mortgage-backed and investment securities 451 559 (45)
Depreciation and amortization of premises and equipment 2,216 1,544 1,926
Provision for loan losses 4,900 4,600 2,550
Gain on sale of available-for-sale securities (849) (1,482) (266)
Mortgage banking activities (3,972) (3,041) (2,108)
(Increase) decrease in trading securities (24,945) 16,383 (16,714)
Increase in accrued interest receivable (2,282) (2,022) (2,091)
Increase in other assets (7,150) (3,194) (3,904)
Increase (decrease) increase in accrued expenses and liabilities 1,307 (1,501) 6,122
--------- --------- ---------
Total adjustments (33,489) 9,067 (16,244)
--------- --------- ---------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (16,927) 23,803 (4,137)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (decrease) increase in securities purchased under agreements to resell (7,871) 3,871 (1,606)
Purchases of investment securities available for sale (34,920) (85,026) (31,589)
Sales of investment securities available-for-sale 131,885 45,977 157,930
Maturities of investment securities available-for-sale 3,430 26,798 12,747
Purchases of investment securities held-to-maturity (36,775) (3,576) (19,303)
Maturities of investment securities held-to-maturity 5,768 49,481 1,260
Purchases of Federal Home Loan Bank Stock (2,631) (379) (295)
Redemption of Federal Home Loan Bank Stock - 1,824 1,740
Net origination of loans (202,015) (188,079) (178,278)
Capital expenditures (3,659) (4,350) (3,224)
--------- --------- ---------
NET CASH USED IN INVESTING ACTIVITIES $(146,788) $ (153,459) $ (60,618)
--------- --------- ---------
</TABLE>
CONTINUED
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS
27
<PAGE>
ORIENTAL FINANCIAL GROUP INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED ON JUNE 30, 1997, 1996, AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
---------- --------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
<S> <C> <C> <C>
Net increase (decrease) in:
Deposits $ 114,985 $ 69,016 $ 64,350
Securities sold under agreements to repurchase 5,580 46,998 13,507
Borrowings under lines of credit (10,000) 2,500 (6,500)
Advances and borrowings from FHLB 43,800 (20,600) (26,325)
Issuance of term notes 60,000 26,500 30,000
Payment of term notes (34,000) - (5,000)
Principal payments of bonds payable (450) (406) (743)
Proceeds from issuance of common stock - - 2,532
Proceeds from issuance of directors' qualifying stock 7 - -
Proceeds from exercise of stock options 461 429 1,200
Repurchase of common stock (1,714) (2,424) -
Purchase of treasury stock (1,836) - -
Dividends and cash paid on fractional shares (4,037) (3,076) (1,837)
---------- --------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 172,796 118,937 71,184
---------- --------- ----------
---------- --------- ----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 9,081 (10,719) 6,429
Cash and cash equivalents at beginning of period 16,955 27,674 21,245
---------- --------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 26,036 $ 16,955 $ 27,674
---------- --------- ----------
---------- --------- ----------
CASH AND CASH EQUIVALENTS INCLUDE:
Cash and due from banks $ 12,812 $ 7,089 $ 9,474
Time deposits with other banks 8,000 7,500 2,310
Other short-term investments 5,224 2,366 15,890
---------- --------- ----------
$ 26,036 $ 16,955 $ 27,674
---------- --------- ----------
---------- --------- ----------
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 44,261 $ 37,839 $ 27,311
---------- --------- ----------
---------- --------- ----------
Income taxes paid $ 5,031 $ 3,951 $ 3,929
---------- --------- ----------
---------- --------- ----------
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Real Estate foreclosed as payment of loans $ 1,695 $ 905 $ 656
---------- --------- ----------
---------- --------- ----------
Real estate loans securiticized into mortgage-backed securities $ 147,536 $ 122,539 $ 111,110
---------- --------- ----------
---------- --------- ----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
FINANCIAL STATEMENTS
28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - NATURE OF OPERATIONS:
Oriental Financial Group (the "Group", "Oriental") was incorporated on
January 24,1997 under the laws of the Commonwealth of Puerto Rico to serve as
the bank holding company for Oriental Bank and Trust (the "Bank"). As a
result of this reorganization each of the Bank's outstanding shares of common
stock was converted into one share of common stock of the new bank holding
company.
The Group provides a wide variety of financial services through its
subsidiaries. Oriental Bank and Trust, the Group's bank subsidiary, is a
full-service commercial bank with its main office located in San Juan, Puerto
Rico and sixteen branches located throughout Puerto Rico. The Bank directly
or through its broker-dealer subsidiary, Oriental Financial Services Corp.,
offers commercial and consumer leasing, consumer lending, investment, money
management and brokerage services, corporate and individual trust services
and mortgage lending.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The accounting and reporting policies of Oriental Financial Group and its
subsidiaries conform with generally accepted accounting principles and with
practices within the banking industry.
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure
of contingent assets and liabilities at the date of the financial statements
and the reported amount of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Group and its direct and indirect wholly-owned subsidiaries. All
intercompany accounts and transactions have been eliminated in consolidation.
STATEMENT OF CASH FLOWS
For purposes of the statement of cash flows, the Group considers as cash
equivalents all highly liquid debt instruments with original maturities of
three months or less.
INCOME PER COMMON SHARE
Income per common share is calculated by dividing net income by the weighted
average of common shares and common stock equivalent shares outstanding after
giving retroactive effect to common stock dividends and splits. Common stock
equivalents are computed using the Treasury Stock Method. Stock options
outstanding under Oriental's stock option plan for officers and employees are
common stock equivalents and therefore, considered in the computation of
income per common share. The weighted average common shares and common stock
equivalent shares outstanding at June 30, 1997, 1996 and 1995 were 7,910,722,
8,349,574 and 8,170,049, respectively.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share". This
statement simplifies the standards for computing earnings per share
previously found in APB Opinion No. 15, "Earnings Per Share", and makes it
comparable to international EPS standards. It replaces the presentation of
the primary EPS with a presentation of basic EPS. It also requires dual
presentation of basic and diluted EPS computation on the face of the income
statement for all entities with complex capital structures and requires
reconciliation of the numerator and denominator of the diluted EPS
computation.
This Statement is effective for financial statements issued for periods
ending after December 15, 1997, including interim periods; earlier
application is not permitted. This Statement requires restatement of
prior-period EPS data presented. Based on this new standard, Oriental's basic
income per share would amount to $2.09, $1.84 and $1.58 for fiscal years
1997, 1996 and 1995, respectively, while diluted income per share would
amount to $2.02, $1.77, and $1.48 for the same periods, which is equivalent
to the primary EPS currently presented.
29
<PAGE>
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL
The Group enters into agreements to purchase and resell the same securities.
Amounts advanced under these agreements represent short-term loans and are
reflected as assets in the statements of financial condition.
INVESTMENT SECURITIES
Oriental classifies its investments in debt and equity securities into one of
the following three categories:
- - HELD TO MATURITY - Debt securities for which the Group has the positive intent
and ability to hold to maturity are carried at amortized cost.
- - TRADING - Debt and equity securities that are bought and held principally for
the purpose of selling them in the near term are carried at estimated fair
value with realized and unrealized changes in market value recorded
separately in the trading profit or loss account in the period in which the
changes occur. Interest revenue arising from trading instruments are
included in the statement of income as part of net interest income rather
than in the trading profit or loss account.
- - AVAILABLE FOR SALE - Debt and equity securities not classified as either held-
to-maturity or trading securities are reported at fair value, with unrealized
gains and losses excluded from earnings and reported net of deferred taxes as
a separate component of stockholders' equity.
The amortization of premiums is deducted and the accretion of discounts is
added to interest income over the life of the related securities using the
interest method. Net realized gains or losses on sales on investment
securities and unrealized losses considered other than temporary, if any, on
securities classified as either available-for-sale or held-to-maturity are
reported separately in the statement of income. Cost of securities is
determined on the specific identification method.
DERIVATIVE FINANCIAL INSTRUMENTS
The Group enters into interest rate exchange agreements (Swaps and Caps) and
other derivative financial instruments to manage its interest rate exposure.
The net effect of amounts to be paid or received under interest rate swaps is
recorded as adjustments to interest expense in the period in which realized.
Premiums on caps are amortized over the term of the contract.
MORTGAGE BANKING ACTIVITIES
The Group pools FHA insured and VA guaranteed mortgages for issuance of GNMA
mortgage-backed securities. Also, conventional loans are pooled and issued
as FNMA or FHLMC mortgage-backed securities. The Group also engages in the
securitization of mortgage pools into CMO's. Mortgages included in the
resulting GNMA and FNMA pools, CMO certificates and certain pools of
conventional loans sold to investors are serviced by the Group.
Loans held for securitization into mortgage-backed securities are carried at
the lower of cost or estimated market value. These loans are reported as
loans held for sale. When mortgage-backed securities are sold, a gain or
loss is recognized to the extent that sales proceeds exceed, or are less
than, the carrying value of the security sold. The resulting gain or loss is
reported as income from mortgage banking activities. Generally,
mortgage-backed securities are sold with servicing retained. Loan servicing
fees which are based on a percentage of the principal balances of the
mortgages serviced are recognized as income from mortgage banking activities
when earned.
MORTGAGE SERVICING RIGHTS
The Group recognizes the rights to service mortgage loans for others as
separate assets, whether those servicing rights are originated or purchased.
The total cost of mortgage loans to be sold with servicing rights retained is
allocated to the mortgage servicing rights and the loans (without the
mortgage servicing rights), based on their relative fair values. Mortgage
servicing rights are amortized in proportion to and over the period of
estimated net servicing income
All mortgage servicing rights are evaluated for impairment. For purposes of
such an evaluation the Group stratifies such rights based on predominant risk
characteristics of underlying loans, such as loan type, rate and term. The
amount of impairment recognized, if any, is the amount by which the
capitalized mortgage serving rights per stratum exceed its estimated fair
value. Impairment is recognized by charging such excess to income.
30
<PAGE>
LOANS
Loans are stated at their outstanding principal balance, less undisbursed
portion, unearned interest and an allowance for loan losses. Loan origination
fees and costs are deferred and amortized over the estimated life of the
loans as an adjustment of the yield using the interest method. Unearned
interest on installment loans is recognized as income under a method which
approximates the interest method. Interest on loans not made on a discounted
basis is credited to income based on the loan principal outstanding at stated
interest rates.
ALLOWANCE FOR LOAN LOSSES
The Group provides allowances for estimated loan losses based on an
evaluation of the risk characteristics of the loan portfolio, loss
experience, economic conditions and other pertinent factors. Loan losses are
charged and recoveries are credited to the allowance for loan losses.
Recognition of interest on all loans is discontinued when loans are 90 days
or more in arrears on payments of principal or interest or when other factors
indicate that collection of interest or principal is doubtful. Loans on
which the recognition of interest income has been discontinued are designated
as non-accruing. Such loans are not reinstated to accrual status until
interest is received on a current basis and other factors indicative of
doubtful collection cease to exist.
The Group measures impairment of a loan based on the present value of
expected future cash flows discounted at the loan's effective interest rate,
or as a practical expedient, at the observable market price of the loan or
the fair value of the collateral, if the loan is collateral dependent. All
loans are evaluated for impairment, except large groups of small balance,
homogeneous loans that are collectively evaluated for impairment, leases and
loans that are recorded at fair value or at the lower of cost or fair value.
The Group measures for impairment all commercial loans and leases over
$250,000. The portfolios of mortgage and consumer loans and auto loans and
leases are considered homogeneous and are evaluated collectively for
impairment.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost less accumulated depreciation.
Depreciation is provided using the straight-line method over the estimated
useful life of each type of asset. Amortization of leasehold improvements is
computed using the straight-line method over the terms of the leases or
estimated useful lives of the improvements, whichever are shorter.
On July 1, 1996 the Group adopted SFAS 121, "Accounting for Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed of." This
statement requires that long-lived assets and certain identifiable
intangibles to be held and used by an entity be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable. This statement excludes financial
instruments, long-term customer relationships of financial institutions,
mortgage and other servicing rights and deferred tax assets. The adoption of
this statement had no effect on the Group's financial position or results of
operations.
FORECLOSED REAL ESTATE
Foreclosed real estate is initially recorded at the lower of the related loan
balance or its fair value at the date of foreclosure. At the time properties
are acquired in full or partial satisfaction of loans, any excess of the loan
balance over the estimated fair market value of the property is charged
against the allowance for loan losses. The carrying value of these
properties approximates the lower of cost or fair value less estimated cost
to sell. Any excess of the carrying value over the estimated fair market
value is charged to operations.
TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES
In January 1997, the Group adopted SFAS 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities", as amended
by SFAS 127, "Deferral of the Effective Date of Certain Provisions of FASB
Statement No. 125." This Statement provides accounting and reporting
standards for transfers and servicing of financial assets and extinguishment
of liabilities. Those standards are based on consistent application of a
financial components approach that focuses on control. Under that approach,
after a transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities its has incurred,
derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. This Statement is effective for
transfers and servicing of financial assets and extinguishment of liabilities
occurring after December 1996, except for certain provisions related to
repurchase agreements, dollar-roll, securities lending, and similar
transactions, which shall be effective for transfers of financial assets
occurring after December 1997. The adoption of the SFAS 125 had no material
impact on the Group's financial position or results of operations. Management
understands that the adoption of SFAS 127 for the certain provisions
described above will not have a material effect on the Group's financial
position or results of operations.
31
<PAGE>
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Group enters into sales of securities under agreements to repurchase.
Such agreements are treated as financing agreements, and the obligations to
repurchase the securities sold are reflected as a liability. The securities
underlying the financing agreements remain included in the asset accounts.
INCOME TAXES
The Group follows an asset and liability approach to the recognition of
deferred tax assets and liabilities for the expected future tax consequences
of events that have been recognized in the Group's financial statements or
tax returns. Deferred income tax assets and liabilities are determined for
differences between financial statement and tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future.
The computation is based on enacted laws and rates applicable to periods in
which the temporary differences are expected to be recovered or settled.
Valuation allowances are established, when necessary, to reduce deferred tax
assets to the amount expected to be realized.
LEGAL SURPLUS
The Banking Act of the Commonwealth of Puerto Rico requires that a minimum of
10% of net income for the year be transferred to capital surplus until such
surplus equals the greater of 10% of total deposits or paid-in capital.
EMPLOYEE BENEFITS PLAN
Effective November 30, 1994, the Group's defined benefit pension plan was
terminated and the participants' accrued benefits in the plan were
transferred to the Group's cash or deferred arrangement profit sharing plan
401(k) or, at the election of the participants, distributed in cash. A gain
of $564,000 was recognized in the settlement of the defined benefit pension
plan.
STOCK OPTION PLAN
In July 1996, the Group adopted SFAS 123, "Accounting for Stock-Based
Compensation." This statement establishes a fair value-based method of
accounting for stock-based employee compensation plans. It encourages
entities to adopt this method in lieu of the provisions of APB Opinion No.
25, "Accounting for Stock Issued to Employees," for all arrangements under
which employees receive shares of stock or other equity instruments of the
employer or the employer incurs liabilities to employees in amounts based on
the price of its stock.
As allowed by SFAS 123, the Group elected to continue to measure cost for its
stock compensation plans using the intrinsic value based method prescribed by
APB Opinion No. 25. Under the intrinsic value method, cost is the excess, if
any, of the quoted market price of the stock at grant date or other
measurement date over the amount an employee must pay to acquire the stock.
Entities choosing to continue applying APB 25 on employee stock options
granted on or after January 1996 must provide pro forma disclosures of net
income and earnings per share, as if the fair value-based method of
accounting had been applied, if amounts are material. Under this method cost
is measured at the grant date based on the fair value of the employee stock
option and is recognized ratably over the service period of the option, which
is usually the vesting period.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The reported fair values of financial instruments are based on either quoted
market prices for identical or comparable instruments or estimated based on
assumptions concerning the amount and timing of estimated future cash flows
and assumed discount rates reflecting varying degrees of risk. Accordingly,
the fair values may not represent the actual values of the financial
instruments that could have been realized as of year-end or that will be
realized in the future.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1996 and 1995 consolidated
financial statements to conform with the presentation of the 1997
consolidated financial statements.
32
<PAGE>
NOTE 3 - REGULATORY CAPITAL REQUIREMENTS
The Group is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Group's assets, liabilities, and certain off-balance
sheet items as calculated under regulatory accounting practices. The Group's
capital amounts and classification are also subject to qualitative judgments
by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Group to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to
average assets (as defined). Management believes that, as of June 30, 1997,
Oriental meets all capital adequacy requirements to which it is subject.
As of June 30, 1997 the Group was well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well
capitalized the Group must maintain minimum total risk-based, Tier I
risk-based, and Tier I leverage ratios as set forth in the table below.
There are no conditions or events since that notification that management
believes have changed the institution's category.
The Group's actual capital amounts and ratios are also presented in the table
below. Totals of $3,362,000 and $3,208,000 were deducted from capital for
certain non-allowable assets in 1997 and 1996, respectively.
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
(amounts in thousands)
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AS OF JUNE 30, 1997
Total Capital $89,668 18.66% $38,452 8.0% $48,066 10.0%
Tier I Risk-Based $84,259 17.53% $19,226 4.0% $28,839 6.0%
Tier I Capital $84,259 8.17% $41,230 4.0% $51,538 5.0%
AS OF JUNE 30, 1996
Total Capital $80,658 19.14% $33,710 8.0% $42,138 10.0%
Tier I Risk-Based $76,162 18.07% $16,855 4.0% $25,283 6.0%
Tier I Capital $76,162 8.71% $34,969 4.0% $43,711 5.0%
</TABLE>
The Group is a U.S. Department of Housing and Urban Development (HUD)
approved and supervised mortgagor and must maintain an excess of current
assets over current liabilities and a minimum net worth, as defined by HUD,
GNMA, FNMA and FHLMC. The Group is also required to maintain fidelity bond
and errors and omissions insurance coverages based on the balance of its
servicing portfolio.
NOTE 4 - TRADING SECURITIES:
The fair value of trading securities is based on quoted market prices. At
June 30, 1997 and 1996 , the amortized cost and fair market value of
securities held for trading were $25,255,000 and $25,276,000 and $322,000
and $331,000, respectively. At June 30, 1997, gross holding unrealized gains
and gross unrealized losses amounted to $41,400 and $19,800, respectively.
All trading instruments are subject to market risk, the risk that future
changes in market conditions, such as fluctuations in interest rates, may
make an instrument less valuable or more onerous. As the instruments are
recognized at fair value, those changes are reported directly in earnings.
33
<PAGE>
NOTE 5 - INVESTMENT SECURITIES AVAILABLE-FOR-SALE :
The estimated fair value of investment securities is based on quoted market
prices or dealer quotes. Expected maturities of mortgage-backed securities
may differ from contractual maturities because of prepayments and other
market factors. The amortized cost , estimated fair value, weighted average
yield and related contractual maturities of debt and equity securities
available-for-sale by category at June 30, are as follows ( in thousands):
<TABLE>
<CAPTION>
1997 1996
----------------------------------------- ----------------------------------------
AVERAGE AVERAGE
AMORTIZED FAIR WEIGHTED AMORTIZED FAIR WEIGHTED
COST VALUE YIELD COST VALUE YIELD
----------------------------------------- ----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNITED STATES GOVERNMENT OBLIGATIONS:
Average maturity of 5 years and 1 month
for 1997 (1996 - 3 years and 7 months)
Due within one year $10,989 $11,060 6.17%
Due from one to five years $62,847 $63,197 6.76% 28,424 28,718 6.97
Due from five to ten years 47,339 47,435 6.78 30,197 30,479 6.81
--------- --------- ------- --------- --------- -------
110,186 110,632 6.77 69,610 70,257 6.77
--------- --------- ------- --------- --------- -------
PUERTO RICO GOVERNMENT OBLIGATIONS:
Average maturity of 8 years and 4 months
for 1997 (1996 - 15 years and 9 months)
Due from one to five years 5,212 5,170 5.55 5,320 5,190 5.55
Due from five to ten years - - - 8 8 7.00
Due over ten years 28,879 29,107 7.97 33,870 34,259 7.97
--------- --------- ------- --------- --------- -------
34,091 34,277 7.60 39,198 39,457 7.61
--------- --------- ------- --------- --------- -------
MORTGAGE - BACKED SECURITIES:
Average maturity of 20 years and 9 months
for 1997 (1996 - 23 years and 5 months)
Due from one to five years 416 408 5.94 520 500 9.16
Due from five to ten years 797 807 6.98 207 212 8.22
Due over ten years 56,553 57,137 6.91 44,744 44,564 7.24
--------- --------- ------- --------- --------- -------
57,766 58,352 6.90 45,471 45,276 7.24
--------- --------- ------- --------- --------- -------
$202,043 $203,261 6.94% $154,279 $154,990 7.20%
--------- --------- ------- --------- --------- -------
--------- --------- ------- --------- --------- -------
</TABLE>
At June 30, mortgage-backed securities available-for-sale consisted of (in
thousands):
<TABLE>
<CAPTION>
1997 1996
------------------------- ---------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
------------------------- ---------------------------
<S> <C> <C> <C> <C>
MORTGAGE - BACKED SECURITIES:
GNMA $ 47,274 $ 47,832 $ 45,019 $ 44,810
FHLMC 10,438 10,454 394 400
Mortgage Pass Through Certificates 54 66 58 66
----------- ----------- ------------- -----------
$ 57,766 $ 58,352 $ 45,471 $ 45,276
----------- ----------- ------------- -----------
----------- ----------- ------------- -----------
</TABLE>
The Puerto Rico government obligations due over ten years category includes
an AAA-rated mortgage-backed Puerto Rico municipal bond with a fair value of
$28,717,000, which commenced paying down principal on August 1, 1994, and is
expected to be fully collected by 1998.
Investment securities and mortgage-backed securities, including those
available-for-sale, with a carrying value of $398,108,000 and $333,162,000,
at June 30, 1997 and 1996, respectively, serve as collateral for term notes,
reverse repurchase agreements, letters of credit, advances and borrowings
from the Federal Home Loan Bank of New York and interest rate swap
agreements. (See Notes 15, 16, 17 ,18 and 19).
34
<PAGE>
At June 30, 1997, gross unrealized gains and gross unrealized losses amounted
to $1,620,000 and $402,000, respectively. At June 30, 1996, gross unrealized
gains and gross unrealized losses amounted to $1,523,000 and $812,000,
respectively. At June 30, 1997 and 1996 unrealized gains on securities
available-for-sale of $913,000 and $533,000, respectively, net of deferred
income tax of $305,000 and $178,000, respectively, were reported as a
separate component of stockholders' equity.
Proceeds from the sale of investment securities available-for-sale during
1997, 1996 and 1995 were $131,885,000, $45,977,000 and $157,930,000,
respectively. Gross realized gains and losses on those sales during the year
were $958,000 and $109,000, respectively. For fiscals years 1996 and 1995
they were $1,482,000 and $0, respectively, and $785,000 and $519,000,
respectively.
The Government of Puerto Rico was the only issuer, other than the U.S.
Government, of instruments that are payable and secured by the same source of
revenue or taxing authority that exceeded 10% of stockholders' equity at June
30, 1997 and 1996. The amortized cost and fair value of investments from the
Government of Puerto Rico for the periods mentioned above was approximately
$37,677,000 and $37,885,000, respectively, and $42,794,000 and $43,067,000,
respectively. At June 30, 1997 and 1996, $28,717,000 and $ 33,217,000 of these
investments were an AAA-rated Puerto Rico municipal bond collaterized with
mortgage-backed securities. At June 30, 1997 and 1996 the fair value of these
investments represented 42% and 54% of stockholders' equity.
NOTE 6 - INVESTMENT SECURITIES HELD-TO-MATURITY:
Expected maturities of mortgage-backed securities may differ from contractual
maturities because of prepayments and other market factors. The carrying
value, estimated fair value, weighted average yield and related contractual
maturities of debt and equity securities held-to-maturity by category at June
30, are as follows ( in thousands):
<TABLE>
<CAPTION>
1997 1996
---------------------------------------- ----------------------------------------
AVERAGE AVERAGE
AMORTIZED FAIR WEIGHTED AMORTIZED FAIR WEIGHTED
COST VALUE YIELD COST VALUE YIELD
---------------------------------------- ----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PUERTO RICO GOVERNMENT OBLIGATIONS:
Average maturity of 8 years and 3 months
for 1997 (1996 - 9 years and 3 months)
Due from five to ten years $ 1,011 $ 1,020 6.73% $ 1,013 $ 1,020 6.73%
Due over ten years 2,575 2,588 7.69 2,583 2,588 7.69
---------- ---------- --------- ---------- ----------- -------
3,586 3,608 7.41 3,596 3,608 7.41
---------- ---------- --------- ---------- ----------- -------
MORTGAGE - BACKED SECURITIES:
Average maturity of 14 years and 6 months
for 1997(1996 - 15 years and 6 months)
Due from one to five years 261 261 6.27 390 388 7.16
Due from five to ten years 3,285 3,346 6.99 586 597 7.50
Due over ten years 194,658 195,228 6.97 166,436 165,499 7.24
---------- ---------- --------- ---------- ----------- -------
198,204 198,835 6.97 167,412 166,484 7.19
---------- ---------- --------- ---------- ----------- -------
$ 201,790 $ 202,443 6.94% $171,008 $170,092 7.24%
---------- ---------- --------- ---------- ----------- -------
---------- ---------- --------- ---------- ----------- -------
</TABLE>
The mortgage-backed securities due over ten years category includes
approximately $79,700,000 of the short end of certain Puerto Rico GNMA tax
exempt serial certificates with an average expected life of 4 to 6 years. At
June 30, mortgage-backed securities held-to-maturity were comprised of the
following (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------------------------- -------------------------
CARRYING FAIR AMORTIZED FAIR
VALUE VALUE VALUE VALUE
-------------------------- -------------------------
<S> <C> <C> <C> <C>
MORTGAGE - BACKED SECURITIES:
GNMA $ 149,275 $ 149,081 $ 129,608 $ 128,399
FNMA 38,439 38,650 26,876 26,700
FHLMC 7,205 7,369 6,848 6,915
Mortgage Pass Through Certificates 3,285 3,735 4,080 4,470
----------- ----------- ----------- ----------
$ 198,204 $ 198,835 $ 167,412 $ 166,484
----------- ----------- ----------- ----------
----------- ----------- ----------- ----------
</TABLE>
Gross unrealized gains and gross unrealized losses at June 30, 1997 amounted to
$1,652,000 and $999,000, respectively. These amounted to $879,000 and
$1,795,000, respectively, at June 30, 1996.
35
<PAGE>
NOTE 7 - FEDERAL HOME LOAN BANK STOCK:
At June 30, 1997 and 1996 there was an investment in Federal Home Loan Bank
(FHLB) of New York Stock with a book and fair value of $10,043,000 and
$7,412,000, respectively. The fair value of such investment is its redemption
value.
NOTE 8 - INTEREST INCOME ON INVESTMENT AND MORTGAGE-BACKED SECURITIES:
Interest income on investment and mortgage-backed securities at June 30,
consist of the following (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
MORTGAGE-BACKED SECURITIES:
Taxable $ 6,167 $ 5,757 $6,138
Nontaxable 10,971 6,836 2,331
------- ------- ------
$17,138 $12,593 $8,469
------- ------- ------
------- ------- ------
OTHER INVESTMENT SECURITIES:
Nontaxable $ 9,642 $ 7,508 $9,204
------- ------- ------
------- ------- ------
</TABLE>
NOTE 9 - LOANS RECEIVABLE:
The Group's business activity is with consumers located in Puerto Rico.
Oriental's loan transactions include a diversified number of industries and
activities such as individuals, sole proprietorships, partnerships,
manufacturing, tourism, government, insurance and not-for-profit
organizations, all of which are encompassed within four main categories:
mortgage, commercial, consumer and leasing. Oriental's loan portfolio has a
higher concentration of loans to consumers such as auto leases and residential
mortgage loans. The composition of the loan portfolio at June 30, was as
follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
LOANS SECURED BY REAL ESTATE:
Residential $ 225,143 $ 190,904
Commercial 9,087 9,235
Home equity loans 5,436 4,508
Construction, land acquisition and
land improvements 4,391 4,024
---------- ----------
244,057 208,671
Less: undisbursed portion of loans in process (2,093) (1,336)
---------- ----------
LOANS SECURED BY REAL ESTATE, NET 241,964 207,335
---------- ----------
---------- ----------
OTHER LOANS:
Commercial loans 10,512 7,177
Auto loans 14,882 28,233
Personal loans 69,773 51,529
Personal lines of credit 5,190 3,481
Cash collateral loans 2,827 3,685
Financing leases 205,077 188,511
---------- ----------
308,261 282,616
Less: unearned interest (41,131) (38,969)
---------- ----------
OTHER LOANS, NET 267,130 243,647
---------- ----------
---------- ----------
Loans receivable 509,093 450,982
Allowance for loan losses (5,408) (4,496)
---------- ----------
LOANS RECEIVABLE, NET 503,685 446,486
Loans held for sale 29,285 29,624
---------- ----------
TOTAL LOANS, NET $ 532,970 $ 476,110
---------- ----------
---------- ----------
</TABLE>
36
<PAGE>
Loans for which the accrual of interest has been discontinued amounted to
approximately $13,285,000 and $9,450,000 at June 30, 1997 and 1996,
respectively. The gross interest income that would have been recorded if
nonaccrual loans had performed in accordance with their original terms
amounted to approximately $ 1,360,500 in 1997, $1,072,000 in 1996 and
$893,000 in 1995.
Mortgage loans amounting to $153,313,000 and $112,255,000 at June 30, 1997
and 1996 respectively, serve as collateral for advances, borrowings and
letters of credit from the Federal Home Loan Bank of New York (FHLB). (See
Notes 17 and 18).
The components of the net financing leases receivable at June 30, were as
follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Total minimum lease payments $179,407 $164,087
Estimated residual values of leased property 25,670 24,424
-------- --------
Total gross minimum lease payments 205,077 188,511
Less - Unearned financing income (38,417) (32,702)
-------- --------
Net minimum lease payments $166,660 $155,809
-------- --------
-------- --------
</TABLE>
Estimated residual value is generally established at amounts which should be
sufficient to cover Oriental's investment.
At June 30, 1997, future minimum lease payments are expected to be received
as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING JUNE 30,
--------------------
<S> <C>
1998 $ 6,777
1999 21,109
2000 43,460
2001 59,601
2002 and thereafter 35,713
--------
$166,660
--------
--------
</TABLE>
The changes in the allowance for loan losses for the year ended June 30, were
as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
BALANCE AT BEGINNING OF PERIOD $ 4,496 $ 3,127 $ 3,934
Provision for loan losses 4,900 4,600 2,550
Loans charged-off (5,262) (3,979) (3,519)
Recoveries 1,274 748 162
-------- -------- --------
BALANCE AT END OF PERIOD $ 5,408 $ 4,496 $ 3,127
-------- -------- --------
-------- -------- --------
</TABLE>
Over 95% of the Group's loan portfolio is composed of smaller homogenous
loans which are evaluated collectively for impairment. Accordingly, the
balance of impaired commercial loans and leases at June 30, 1997 and 1996 and
their average for the year is not significant.
NOTE 10 - LOAN SERVICING
Servicing loans for others consists of collecting payments, maintaining
escrow accounts, disbursing payments to investors and foreclosure processing.
Mortgage loans serviced for others are not included in the accompanying
financial statements. The Group's servicing portfolio amounted to
approximately $515,690,000 and $401,300,000 at June 30, 1997 and 1996,
respectively. Loan servicing income is recorded on the accrual basis and
amounted to approximately $2,376,000, $1,732,000 and $1,065,000 in 1997,
1996 and 1995, respectively. Custodial escrow balances maintained in
connection with the loans serviced for others were approximately $ 2,193,000
and $1,460,000 at June 30, 1997 and 1996, respectively.
Mortgage servicing rights of $2,526,000 and $1,292,000 were capitalized in
1997 and 1996, respectively. At June 30, 1997 and 1996 purchased and
originated mortgage servicing rights totaled approximately $5,783,000 and
$4,626,000. Amortization of servicing rights was $701,000 and $486,000 in
1997 and 1996, respectively. There were no write-downs of mortgage servicing
rights to fair value in either fiscal year.
37
<PAGE>
NOTE 11 - ACCRUED INTEREST RECEIVABLE:
Accrued interest receivable at June 30, consists of the following (in
thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Loans $ 3,296 $ 2,747
Mortgage-backed securities 5,142 4,743
Other investment securities 3,912 2,578
------- -------
$12,350 $10,068
------- -------
------- -------
</TABLE>
NOTE 12 - PREMISES AND EQUIPMENT:
Premises and equipment at June 30, consists of the following (in thousands):
<TABLE>
<CAPTION>
Useful Life
(Years) 1997 1996
------- -------- --------
<S> <C> <C> <C>
Land - $ 1,385 $ 1,385
Buildings and improvements 20 - 50 11,935 11,125
Leasehold improvements 5 - 10 2,194 1,948
Furniture and fixtures 3 - 7 4,195 3,605
EDP and other equipment 3 - 7 8,161 6,134
-------- --------
27,870 24,197
Less: Accumulated depreciation and amortization (8,492) (6,262)
-------- --------
$19,378 $17,935
-------- --------
-------- --------
</TABLE>
NOTE 13 - OTHER ASSETS:
Other assets at June 30, include the following (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Purchased and originated servicing rights $ 5,783 $ 4,626
Prepaid expenses and deferred costs 5,930 4,379
Accounts receivable 5,665 1,913
Insurance claims 1,190 1,416
Other assets 1,487 993
Other repossessed property 1,739 1,317
-------- --------
$21,794 $14,644
-------- --------
-------- --------
</TABLE>
NOTE 14 - DEPOSITS AND RELATED INTEREST:
Deposits at June 30, is comprised of (in thousands):
<TABLE>
<CAPTION>
1997 1996
---------------- ---------------
AMOUNT % AMOUNT %
-------- ---- -------- ----
<S> <C> <C> <C> <C>
Non-interest bearing deposits $ 20,095 4% $ 13,227 3%
Passbook Savings 72,872 14 62,204 16
Demand and NOW accounts 14,029 3 11,454 3
IRA Accounts 73,846 15 50,299 13
Certificates of deposit 313,990 63 243,377 64
-------- ---- -------- ----
494,832 99 380,561 99
Accrued interest payable 2,710 1 1,996 1
-------- ---- -------- ----
$497,542 100% $382,557 100%
-------- ---- -------- ----
-------- ---- -------- ----
</TABLE>
The weighted average interest rate on total deposits at June 30, 1997 and 1996
was 4.92% and 5.02%, respectively.
38
<PAGE>
At June 30, 1997 and 1996, time deposits in denominations of $100,000 or
higher amounted to approximately $192,741,000 and $137,459,000, respectively,
including brokered certificates of deposit amounting to $61,188,000 and
$30,000,000, respectively, at a weighted average rate of 5.87% and 6.07%,
respectively. Also, included are certificates of deposit held by various tax
exempt (936) corporations aggregating to $38.1 million and $33.7 million,
respectively, with a weighted-average interest rate of 4.87% and 4.42%,
respectively.
Scheduled maturities of certificates of deposit and IRA accounts at June 30,
1997 are as follow (in thousands):
YEAR ENDING JUNE 30, AMOUNT
-------------------- --------
1998 $ 306,150
1999 42,383
2000 9,696
2001 8,520
2002 16,363
Thereafter 4,724
---------
$ 387,836
---------
---------
Interest expense on deposits for the years ended June 30 follows (in
thousands):
1997 1996 1995
--------- ------- -------
NOW Accounts $ 256 $ 224 $ 249
Passbook savings 2,198 1,935 1,844
Certificates of deposit and IRA 18,558 15,227 9,575
--------- ------- -------
$ 21,012 $17,386 $11,668
--------- ------- -------
--------- ------- -------
NOTE 15- SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE:
The securities underlying the agreements to repurchase were delivered to, and
are being held by, the counterparties with whom the repurchase agreements
were transacted. The counterparties have agreed to resell to the Group the
same or similar securities at the maturity of the agreements. At June 30,
1997, substantially all securities sold under agreements to repurchase mature
within 180 days. The following summarizes significant data about securities
sold under agreements to repurchase for the years ended June 30,1997, 1996
and 1995 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Average daily aggregate balance outstanding $ 231,747 $ 205,748 $ 187,972
---------- ---------- ----------
---------- ---------- ----------
Maximum amount outstanding at any month-end $ 264,203 $ 244,398 $ 205,469
---------- ---------- ----------
---------- ---------- ----------
WEIGHTED AVERAGE INTEREST RATE:
During the year 5.04% 4.81% 4.72%
---------- ---------- ----------
---------- ---------- ----------
At year end 5.56% 4.51% 5.18%
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
The carrying and market values of the collateral pledged at June 30 were as
follows (in thousands):
<TABLE>
1997 1996
------------------------- ------------------------
CARRYING MARKET CARRYING MARKET
VALUE VALUE VALUE VALUE
----------- -------- -------- -------
<S> <C> <C> <C> <C>
SECURITIES UNDERLYING AGREEMENTS:
U.S. Government obligations $ 73,705 $ 73,571 $ 29,787 $ 30,047
P.R. Government obligations - - 30,859 30,765
Mortgage-backed securities 163,276 166,769 173,969 173,064
Temporary cash investment 15,000 15,000 1,949 1,949
Certificates of deposit - - 7,500 7,500
--------- -------- --------- ---------
$251, 981 $255,340 $ 244,064 $ 243,325
--------- -------- --------- ---------
--------- -------- --------- ---------
</TABLE>
39
<PAGE>
NOTE 16 - BORROWINGS UNDER LINES OF CREDIT:
The Group maintains lines of credit with other financial institutions.
Advances are drawn as needed from one or more of the seven lines available.
At June 30, 1997 and 1996 these lines totaled $80 million and $85 million,
respectively, of available credit ranging from unsecured Federal Funds-based
lines of credit to one year LIBOR-based secured leasing warehousing
facilities. At June 30, 1997 there were no advances under lines of credit and
at June 30, 1996 they amounted to $10 million. This outstanding amount at
June 30, 1996 matured on July 1996 and bore interest at 5.56%
NOTE 17 - ADVANCES AND BORROWINGS FROM THE FEDERAL HOME LOAN BANK:
At June 30, advances and borrowings from the Federal Home Loan Bank of New
York (FHLB) consist of the following (in thousands):
<TABLE>
<CAPTION>
TYPE 1997 1996 MATURITY DATE INTEREST RATE DESCRIPTION
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ADVANCE $ - $10,000 AUGUST 1996 Fixed - 5.27%
ADVANCE - 10,000 AUGUST 1996 Fixed - 5.63%
ADVANCE 15,000 - JULY 1997 Fixed - 5.79%
ADVANCE 15,000 - AUGUST 1997 Fixed - 5.80%
ADVANCE 10,000 - NOVEMBER 1997 Floating due quarterly - 5.52% at 6/30/97
ADVANCE 10,000 - FEBRUARY 1998 Floating due monthly - 5.48% at 6/30/97
ADVANCE 13,800 - OVERNIGHT LINE OF CREDIT Floating due daily - 6.38% at 6/30/97
BORROWING 12,000 12,000 SEPTEMBER 1997 Fixed - 6.04%
BORROWING 14,000 14,000 JULY 1998 Fixed - 6.28%
---------------------------
$89,800 $46,000
---------------------------
---------------------------
</TABLE>
Advances are received from the FHLB under an agreement whereby Oriental is
required to maintain a minimum amount of qualifying collateral with a market
value of at least 110% of the outstanding advances. At June 30, 1997 and 1996
these advances and borrowings were secured by mortgage loans and investment
securities with an aggregate carrying amount of approximately $ 91.8 million
and $65.3 million, respectively.
NOTE 18 - TERM NOTES AND BONDS PAYABLE:
At June 30, Term Notes and Bonds Payable consist of the following ( in
thousands):
<TABLE>
<CAPTION>
TYPE 1997 1996 MATURITY DATE INTEREST RATE DESCRIPTION
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
TERM NOTE $ - $ 8,000 SEPTEMBER 1996 Fixed - 7.23% (a)
TERM NOTE - 5,000 OCTOBER 1996 Fixed - 7.30% (a)
TERM NOTE - 5,500 APRIL 1997 Fixed - 6.50% (a)
TERM NOTE - 5,500 MAY 1997 Fixed - 6.50% (a)
TERM NOTE 8,000 8,000 OCTOBER 1998 Fixed - 4.81% in 1997 and 4.33% in 1996 (B)
TERM NOTE - 10,000 NOVEMBER 1999 Floating due quarterly - (a) (c) (e)
TERM NOTE 10,000 10,000 DECEMBER 1999 Floating due quarterly - 4.41% at 6/30/97 (a) (c)
TERM NOTE 10,000 10,000 JANUARY 2000 Floating due quarterly - 4.41% at 6/30/97 (a) (c)
TERM NOTE 6,500 6,500 DECEMBER 2000 Floating due quarterly - 4.62% at 6/30/97 (b) (c)
TERM NOTE 20,000 20,000 MARCH 2001 Floating due quarterly - 5.18% at 6/30/97 (b) (c)
TERM NOTE 10,000 - SEPTEMBER 2001 Floating due quarterly - 5.51% at 6/30/97 (b) (c)
TERM NOTE 30,000 - SEPTEMBER 2001 Floating due quarterly - 5.29% at 6/30/97 (b) (c)
TERM NOTE 5,000 - DECEMBER 2001 Floating due quarterly - 4.62% at 6/30/97 (b) (c)
TERM NOTE 15,000 - MARCH 2007 Floating due quarterly - 5.34% at 6/30/97 (b) (c)
BOND 516 966 APRIL 2008 Fixed - 8.38% (d)
------------------------------
$115,016 $ 89,466
------------------------------
------------------------------
</TABLE>
(a) - Guaranteed by letters of credit from the FLHB.
(b) - Collateralized with U.S. government securities and/or mortgage-backed
securities with market value of $98,406,000 (1996 - $77,700,000)
(c) - The floating rate notes are considered generally hedged through the
overall interest rate risk management process discussed in note 19.
(d) - Collaterized with FHLMC certificates with a market value of $1,638,000
(1996 - $1,950,000)
(e) - This note was canceled and repaid in May 1997.
40
<PAGE>
NOTE 19 - INTEREST RATE RISK MANAGEMENT
INTEREST RATE SWAP AGREEMENTS
The following table indicates the types of swaps used and their terms at June
30, 1997 (in thousands):
Pay fixed swaps - notional amount $370,000
Weighted average pay rate - fixed 5.73%
Weighted average receive rate - floating 5.43%
Maturity (in months) 1 to 35
Floating rate - percent of LIBOR 84 to 100%
The agreements were signed to convert short term borrowings into fixed rate
liabilities for longer periods of time and provide protection against
increases in interest rates. The amounts potentially subject to credit loss
are the net streams of payments under the agreements and not the notional
principal amounts used to express the volume of the swaps. The Group controls
the credit risk of its interest rate swap agreements through approvals,
limits, monitoring procedures and collateral, where considered necessary. The
Group does not anticipate nonperformance by the counterparties. At June 30,
1997, interest rate swap maturities by fiscal year are as follows (in
thousands):
YEAR ENDING JUNE 30, AMOUNT
----------------------- ---------------
1998 $ 190,000
1999 170,000
2000 10,000
-------------
$ 370,000
-------------
-------------
The following table summarizes the changes in notional amounts of swaps
outstanding during year ended on June 30, 1997 (in thousands):
Balance at June 30, 1996 $ 300,000
New swaps 205,000
Maturities (135,000)
----------
Balance at June 30, 1997 $ 370,000
----------
----------
INTEREST RATE PROTECTION AGREEMENTS (CAPS)
The Group also uses interest rate protection agreements (Caps) to limit its
exposure to rising interest rates. Under these agreements, Oriental pays an
up front premium or fee for the right to receive cash flow payments in excess
of the predetermined cap rate; thus, effectively capping its interest rate
cost for the duration of the agreement. The following table indicates the
agreements outstanding at June 30, 1997 (in thousands):
Cap agreements - notional amount $60,000
Cap rate 6.50%
Current 90 day LIBOR 5.75%
Maturity (in months) 16 to 21
S&P INTEREST RATE SWAP
In January 1994, the Group introduced new certificates of deposit called
Investors' CD and Investors' IRA which have their yields tied to the
performance of a stock market index. At the end of five years, the depositor
will receive a specified percent of the average increase of the month-end
value of the Standard & Poor's 500 stock index. If such index decreases, the
depositor receives the principal without any interest. The Group has entered
into interest rate swap/hedge agreements with a notional amount of
$27,882,000 (1996 - 14,582,000) with major money center banks to manage the
Investors' CD and IRA exposure to the stock market. Under the terms of the
agreements, Oriental will receive the average increase of the month-end value
of the Standard and Poor's index in exchange for a semiannual fixed interest
cost. Thus, the Group has exchanged the variable interest payment for a known
fixed rate semiannual interest payment. At June 30, 1997 total Investors' CD
and IRA deposits amounted to $29,201,000.
41
<PAGE>
NOTE 20 - INCOME TAXES:
The Group is subject to Puerto Rico income tax on all its income. The net
interest income derived from United States and Puerto Rico government
obligations, FHA loans or VA loans secured by residential properties located in
Puerto Rico originated after June 30, 1983, GNMA securities backed by such
loans and loans secured by the Puerto Rico Housing Bank is excluded from the
Group's taxable income in computing its regular income tax, since such income
is tax-exempt.
In October 1994, the 1994 Puerto Rico Internal Revenue Code was enacted into
law. The Code, among other changes, incorporates tax rate reductions for
corporations effective for taxable years beginning after June 30, 1995. The
normal tax rate was reduced from 22% to 20% and the maximum combined tax rate
(normal and surtax) from 42% to 39%. In addition, the Reform incorporated new
accelerated methods of depreciation, repealed the reserve method for bad debts
deduction, and changed the rules for income tax withholdings at source for
certain payments.
A reconciliation of the provision for income taxes computed by applying the
Puerto Rico income tax statutory rate to the tax provision as reported for each
of the last three fiscal years ended June 30, follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
----------------------- ----------------------- -----------------------
AMOUNT % AMOUNT % AMOUNT %
------------ ------- ----------- -------- ----------- -------
<S> <C> <C> <C> <C> <C>
Income tax computed at P.R.
statutory rate $ 7,668 39.0% $ 7,139 39.0% $ 6,305 42.0%
Effect on provision of:
Exempt interest income, net of
related expenses (4,349) (22.1) (2,565) (14.0) (2,415) (16.0)
Other reconciling items, net 9 (.1) (939) (5.1) (985) (6.6)
------------ ------- ----------- -------- ----------- -------
Current income tax expense 3,310 16.8 3,635 19.9 2,905 19.4
Deferred income tax expense (210) (1.0) (64) (0.4) -- --
------------ ------- ----------- -------- ----------- -------
Provision for income taxes $ 3,100 15.8% $ 3,571 19.5% $ 2,905 19.4%
------------ ------- ----------- -------- ----------- -------
------------ ------- ----------- -------- ----------- -------
</TABLE>
The components of the deferred tax asset and liability at June 30, are as
follows (in thousands):
1997 1996
---------- ----------
Deferred tax asset:
Allowance for loan losses, net $1,499 $ 839
Other 166 219
Gross deferred tax asset 1,665 1,058
Deferred tax liability:
Net deferred loan origination costs (82) (398)
Unrealized gain on trading securities ( 16) ( 4)
Unrealized gain on available for sale securities (288) (178)
Mortgage servicing rights (1,140) (549)
---------- ----------
Gross deferred tax liability (1,526) (1,129)
---------- ----------
Net deferred tax (liability) asset $139 $ (71)
---------- ----------
---------- ----------
NOTE 21 - STOCKHOLDERS' EQUITY:
STOCK SPLITS
On August 26, 1996, Oriental declared a six-for-five (20%) stock split on
common stock held by registered shareholders as of September 30, 1996. As a
result, a total of 1,308,712 shares of common stock were issued on October 17,
1996. In addition, on August 14, 1995, Oriental declared a five-for-four (25%)
stock split of its common stock held by registered shareholders as of
September 8, 1995. As a result 1,341,316 shares of common stock were
distributed on October 2, 1995. For purposes of the computation of income
per common share, the stock splits were retroactively recognized for all
periods presented in the accompanying consolidated financial statements.
42
<PAGE>
STOCK OPTIONS
Under the Group's Incentive Stock Option Plan, key officers and employees
may receive stock options. The Compensation Committee of the Board of
Directors has sole authority and absolute discretion as to the number stock
options to be granted, their vesting rights, and the option's exercise price.
The exercise price, however, may not be lower than the market value at the
date of grant. The Stock Option Plan provides for a proportionate adjustment
in the exercise price and the number of shares that can be purchased in the
event of a stock split, reclassification of stock and a merger or a
reorganization. Stock options vest upon completion of specified years of
service.
The following table summarizes the range of exercise prices and the weighted
average remaining contractual life of the options outstanding and the range
of exercise prices for options exercisable at June 30, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------ --------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF OUTSTANDING CONTRACTUAL EXERCISE VESTED EXERCISE
EXERCISE PRICES JUNE 30, 1997 LIFE (IN YEARS) PRICE JUNE 30, 1997 PRICE
- --------------- -------------- --------------- -------- ------------- --------
<S> <C> <C> <C> <C> <C>
$2.99 - $4.95 125,086 0.98 $4.22 8,103 $ 3.86
6.17 - 7.51 171,187 1.63 7.35 801 6.17
10.00 77,100 3.83 10.00 13,500 10.00
11.50 - 15.81 65,397 3.15 13.74 6,797 11.99
------- ---- ----- ------ -------
438,770 2.29 $7.88 29,202 $ 8.95
------- ---- ----- ------ -------
------- ---- ----- ------ -------
</TABLE>
The activity in outstanding options for the year ended June 30, 1997 and 1996
is summarized below. Weighted average prices for the year ended June 30, 1996
were restated to reflect the six-for-five (20%) stock split on common stock
as of September 30, 1996.
<TABLE>
<CAPTION>
1997 1996
------------------------- ----------------------
WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE
OPTIONS PRICE OPTIONS PRICE
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Options outstanding at beginning of year 478,072 $ 6.02 453,634 $5.46
Five-for -four (25%) stock split - - 114,659 6.14
Six-for -five (20%) stock split 91,874 7.18 - -
Options granted ( * ) - - 32,000 15.21
Options exercised (120,226) 3.84 (105,578) 3.30
Options canceled or forfeited ( 10,950) 10.28 (16,643) 8.53
--------- ------- --------- -----
Options outstanding at end of year 438,770 $ 7.88 478,072 $6.02
--------- ------- --------- -----
--------- ------- --------- -----
</TABLE>
(*) - In November 1996, the Group's Board of Directors approved, subject to
the stockholders' ratification, the granting of approximately 200,000
options. These options are contingent on Group's net income equaling or
exceeding $25 million in fiscal 1999 and are to be exercisable over a period
ranging from five to of ten years. These options vest upon completion of
specified years of service.
COMMON STOCK REPURCHASE PROGRAM
The Board of Directors of the Group authorized management, subject to the
required shareholder and regulatory approvals, to retire up to 490,000 shares
of its issued and outstanding common stock. The authority granted by the
Board of Directors does not require the Group to repurchase any shares. The
repurchase of the shares would be made in the open market at such times and
prices as market conditions shall warrant, and in full compliance with the
terms of applicable federal and Puerto Rico laws and regulations. During
fiscal 1997 and 1996 the Group repurchased 182,400 and 168,000 shares,
respectively, of its common stock at a cost of $3,552,000 and $2,424,000,
respectively. Of a total of 350,400 shares repurchased as of June 30, 1997,
269,200 shares were retired from circulation and 81,200 shares with a cost
of $1,836,000 are held by the Group's treasury.
43
<PAGE>
NOTE 22 - SAIF ASSESSMENT
On September 30, 1996 the United States Congress approved and President
Clinton signed into law a bill to recapitalize the Savings Association
Insurance Fund. This bill called for a special one-time charge on
institutions holding SAIF deposits on March 31, 1995 of approximately 66
basis points. Accordingly, the Group recorded a special reserve of $1.8
million net of taxes of $470,000 during the first quarter of 1997 to account
for its share of the one-time payment of FDIC insurance premium. Beginning in
January 1997, institutions currently insured under SAIF will pay lower
premiums as result of this special assessment. In Oriental's case, this
represents an annual decrease in insurance premiums expense of approximately
$650,000.
NOTE 23 - EMPLOYEE BENEFITS PLAN:
The Group has a cash or deferred arrangement profit sharing plan 401(k).
Under this plan, the Group contributes shares of its common stock to match
employee contributions up to $1,040. The plan is entitled to acquire and
hold qualified employer securities as part of its investment of the trust
assets pursuant to ERISA Section 407. During fiscal 1997, 1996 and 1995, the
Group contributed 4,312, 6,337, and 7,031 shares, respectively, of its common
stock with a market value of approximately $122,000, $111,000 and $110,000,
respectively, at the time of the contribution. The Group's contribution
becomes 100% vested once the employee attains five years of participation in
the plan.
NOTE 24 - FAIR VALUES OF FINANCIAL INSTRUMENTS:
The estimated fair value and carrying value of the Group's financial
instruments at June 30, follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------------------- -------------------
FAIR CARRYING FAIR CARRYING
VALUE VALUE VALUE VALUE
----- -------- ----- --------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $ 26,036 $ 26,036 $ 16,955 $ 16,955
Securities purchased under agreements to resell 15,000 15,000 7,129 7,129
Investment securities 441,022 440,370 332,875 333,791
Loans (including loans available for sale) 539,537 532,970 486,544 476,110
Mortgage servicing rights 9,051 5,783 6,936 4,626
Liabilities:
Deposits $497,371 $497,542 $382,178 $382,557
Securities sold under agreements to repurchase 247,915 247,915 242,335 242,335
Borrowings under lines of credit - - 10,000 10,000
Advances and borrowings from FHLB 89,787 89,800 45,964 46,000
Term notes and bonds payable 115,212 115,016 89,698 89,466
Off-Balance Sheet Financial instruments:
Interest rate swaps-In a net payable position $ (1,104) $ (616)
Commitments to extend credit 2,156 1,605
</TABLE>
The fair value estimates are made at a point in time based on a variety of
factors. Quoted market prices are used for financial instruments in which an
active market exists. However, because no market exists for a portion of the
Group's financial instruments, fair value estimates are based on judgments
regarding the amount and timing of estimated future cash flows, assumed
discount rates reflecting varying degrees of risk, and other factors.
Because of the uncertainty inherent in estimating fair values, these
estimates may vary from the values that would have been used had a ready
market for these financial instruments existed. These estimates are
subjective in nature and involve uncertainties and matters of significant
judgment. Changes in assumptions could affect these fair value estimates.
The fair value estimates do not take into consideration the value of future
business and the value of assets and liabilities that are not financial
instruments. Other significant tangible and intangible assets that are not
considered financial instruments are the value of long-term customer
relationships of the retail deposits, and premises and equipment.
44
<PAGE>
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate
that value.
CASH AND CASH EQUIVALENTS AND SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL
For cash and cash equivalents and securities purchased under agreements to
resell, the carrying amount is considered to be a reasonable estimate of fair
value due to the short-term nature of the instruments.
INVESTMENT AND MORTGAGE-BACKED SECURITIES
The fair value of investment and mortgage-backed securities is estimated
based on bid quotations from securities dealers. If a quoted market price is
not available, fair value is estimated using quoted market prices for similar
securities.
LOANS RECEIVABLE
Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type, such as commercial, real
estate mortgage and consumer. Each loan category is further segmented into
fixed and adjustable interest rates and by performing and nonperforming
categories.
The fair value of performing loans is calculated by discounting contractual
cash flows, adjusted for prepayment estimates, if any, using estimated
current market discount rates that reflect the credit and interest rate risk
inherent in the loan. The fair value for significant nonperforming loans is
based on specific evaluations of discounted expected future cash flows from
the loans' or its collateral using current appraisals and market rates.
DEPOSITS
The fair value of non-interest bearing demand deposits, savings and NOW
accounts is the amount payable on demand at the reporting date. The fair
value of fixed-maturity certificates of deposits is based on the discounted
value of the contractual cash flows, using estimated current market discount
rates for deposits of similar remaining maturities.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
For short-term borrowings, the carrying amount is considered a reasonable
estimate of fair value.
ADVANCES AND BORROWINGS FROM THE FEDERAL HOME LOAN BANK
The fair value of long-term borrowings is based on the discounted value of
the contractual cash flows, using current estimated market discount rates for
borrowings with similar terms and remaining maturities.
TERM NOTES AND BONDS PAYABLE
The fair value of term notes and bonds payable is based on discounted cash
flows using rates currently available to the Bank for debt with similar terms
and remaining maturities.
INTEREST RATE SWAP AND CAP AGREEMENTS
The fair value of interest rate swap and cap agreements is based on dealer
quotes. The values represent the estimated amount the Group would receive or
pay to terminate the contracts or agreements at the reporting date, taking
into account current interest rates and the credit-worthiness of the
counterparties.
COMMITMENTS TO EXTEND CREDIT
The fair value of commitments to extend credit is calculated by discounting
scheduled cash flows at market discount rates that reflect the credit and
interest rate risk inherent in the commitments to extend credit guarantees
and letters of credit. Assumptions regarding credit risks, cash flows and
discount rates are judgmentally determined using market and specific borrower
information.
NOTE 25 - RELATED PARTY TRANSACTIONS:
The Group grants loans to its directors, executive officers and to certain
related individuals or organizations in the ordinary course of the business.
These do not involve more than the normal risk of collectibility or present
other unfavorable features. The outstanding balance of these loans at June
30, 1997 and 1996 amounted to approximately $1,722,000 and $2,300,000,
respectively.
45
<PAGE>
NOTE 26 - COMMITMENTS AND CONTINGENCIES:
LEASE COMMITMENTS
The Group has entered into various operating lease agreements for branch
facilities and administrative offices. Rent expense for the years ended June
30, 1997, 1996 and 1995 was $705,000 and $575,000 and $510,000,
respectively. As of June 30, 1997, future rental commitments under the terms
of the leases, exclusive of taxes, insurance and maintenance expenses payable
by the Bank, are summarized as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING JUNE 30, AMOUNT
-------------------- ------
<C> <C>
1998 $ 687
1999 703
2000 703
2001 703
2002 703
Thereafter 1,404
------
$4,903
------
------
</TABLE>
LOAN COMMITMENTS
At June 30, 1997 there were $9,470,000 of unused lines of credit provided to
individual customers and $2,093,000 of commitments to originate loans.
Commitments to extend credit are agreements to lend to customers as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates and may require payment of
a fee. Since the commitments may expire unexercised, the total commitment
amounts do not necessarily represent future cash requirements. The Group
evaluates each customer's credit-worthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Group upon
extension of credit, is based on management's credit evaluation of the
customer.
CONTINGENCIES
The Group and its subsidiaries are defendants in a number of legal claims
under various theories of damages arising out of, and incidental to its
business. The Group is vigorously contesting those claims. Based upon a
review with legal counsel and the development of these matters to date,
management is of the opinion that the ultimate aggregate liability, if any,
resulting from these claims will not have a material adverse effect on the
Group's financial position or the result of operations.
NOTE 27 - SUBSEQUENT EVENTS (UNAUDITED):
STOCK SPLIT
Subsequent to the close of fiscal 1997, on August 11, 1997, the Group
declared a five-for-four (25%) stock split on common stock held by registered
shareholders as of September 30, 1997. The stock split will be distributed
on October 15, 1997. The pro-forma effect of this stock split on income per
common share is disclosed in the Consolidated Statements of Income. The
pro-forma information on common stock issued and outstanding and related
stockholders' equity accounts after the stock dividend is as follows (in
thousands):
<TABLE>
<CAPTION>
<S> <C>
COMMON STOCK ISSUED AND OUTSTANDING 9,988 shares
COMMON STOCK $ 9,988
RETAINED EARNINGS $47,696
</TABLE>
SALE OF MORTGAGE SERVICING
Following a competitive bidding process for the sale of the Group's mortgage
servicing portfolio, including the $516 million serviced for others, on
August 18, 1997, the Group's board of directors instructed management to
negotiate with the two highest bidders. Management expects the mortgage
servicing sale contract and the transaction to be completed by October 31,
1997.
46
<PAGE>
At June 30, 1997 purchased and originated mortgage servicing rights
capitalized in connection with the $516 million serviced for others totaled
approximately $5,783,000. At June 30, 1997 the Group held borrower's escrow
balances amounting to $2,193,000 in connection with loans serviced for
others. Loan servicing fees amounted to $2,376,000 in fiscal year 1997.
The divestiture of the mortgage servicing operation is part of a Group's
strategy to maximize future earnings. This is indicative of a wider strategy
guiding the Group to concentrate only on trust, money management and
brokerage and bank products with the highest earnings potential and disregard
marginally profitable services. Management expects to realize savings of
approximately $2,300,000 from loan servicing operation costs as result of the
divestiture.
NOTE 28 - SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
The following quarterly financial information is unaudited. However, in the
opinion of management, all adjustments necessary to present fairly the
results of operations of such periods, are reflected therein (in thousands,
except per shares amounts):
<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30 TOTAL
------------ ----------- -------- ------- -----
<S> <C> <C> <C> <C> <C>
1997
- ----
Total interest income $19,317 $20,158 $21,164 $21,990 $82,629
Total interest expense 10,401 11,010 11,484 12,203 45,098
Net interest income 8,016 7,948 9,680 9,787 35,531
Provision for loan losses 900 1,200 1,300 1,500 4,900
Net income 2,852 4,397 4,605 4,708 16,562
Net income per share .35 (*) .54 .56 .58 2.02
1996
- ----
Total interest income 16,426 17,416 17,853 18,752 70,447
Total interest expense 8,923 9,426 9,508 9,837 37,694
Net interest income 7,503 7,990 8,345 8,915 32,753
Provision for loan losses 700 2,000 850 1,050 4,600
Net income 3,322 3,580 3,810 4,024 14,736
Net income per share .40 .43 .46 .48 1.77
</TABLE>
(*) Net income per common share for the first quarter of fiscal 1997
excluding the after tax effect of the one-time SAIF assessment was $.51 per
share.
NOTE 29 - RECENT ACCOUNTING PRONOUNCEMENTS:
SFAS 130 - "REPORTING COMPREHENSIVE INCOME"
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income".
This Statement establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and
losses ) in a full set of general-purpose financial statements. This
statement requires that an enterprise classify items of other comprehensive
income by their nature in a financial statement and display the accumulated
balance of other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of the statement of
financial position. In Oriental's case, unrealized gains and losses on
certain investments in debt and equity securities will be the only other
comprehensive income item to be included in comprehensive income.
This statement is effective for fiscal years beginning after December 15,
1997. Reclassification of financial statements for earlier periods provided
for comparative purposes is required. This statement affects only financial
statement presentation and, therefore, management understands that its
adoption will not have a material effect, if any, on the Group's financial
position or results of operations.
SFAS 131 - "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION"
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information". This Statement establishes standards
for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
reports issued to shareholders.
47
<PAGE>
This statement requires that a public business enterprise report financial
and descriptive information about its reportable segments. Operating segments
are components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating decision maker
in deciding how to allocate resources and in assessing performance. Also
requires reporting descriptive information about the way that the operating
segments were determined, the products and the services provided by the
operating segments, differences between the measurements used in reporting
segment information and those used in the enterprise's general purpose
financial statements, and the changes in the measurement of segment amount
from period to period. In Oriental's case, management has preliminarily
determined that the Bank's operations and the trust and money management
operations are the Group's business lines that fulfill the segment
definition describe above.
This statement is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. This statement affects only financial
statement presentation and disclosure and therefore management understands that
its adoption will not have a material effect, if any, on the Group's financial
position or results of operations.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART - III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained under the captions " Information with respect to
Directors Whose Terms Continue and Executive Officers", and "Section 16(a)
Beneficial Ownership Reporting Compliance" of the Group's definitive proxy
statement filed with Securities and Exchange Commission on September 19,
1997, (the "Proxy Statement"), is incorporated herein by reference.
ITEM 11 - EXECUTIVE COMPENSATION
The information under the captions "Executive Compensation" "Report of the
Compensation Committee on Executive Compensation,"Performance Graph" and
"Proposal 2: Adoption of the Bank's 1996 Stock Option Plan" of the Proxy
Statement is incorporated herein by reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption "Security Ownership of Certain Beneficial
Owners and Management" of the Proxy Statement is incorporated herein by
reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption "Executive Compensation-Certain
Transactions" of the Proxy Statement is incorporated herein by reference.
PART - IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
A - FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
The following financial statements are incorporated by reference to Item 8
- -Financial Statements and Supplementary Data on pages 22 through 48 of this
report.
- - Independent Auditors' Report
- - Consolidated Statements of Financial Condition as of June 30, 1997 and
1996
- - Consolidated Statements of Income for each of the years in the three-year
period ended June 30, 1997
- - Consolidated Statements of Cash Flows for each of the years in the three-
year period ended June 30, 1997
- - Consolidated Statements of Changes in Stockholders' Equity for each of the
years in the three-year period ended June 30, 1997
- - Notes to the Consolidated Financial Statements
48
<PAGE>
FINANCIAL STATEMENTS SCHEDULES
No schedules are presented because the information is not applicable or is
included in the Consolidated Financial Statements or in the notes thereto
described in 14 (A) above.
B - REPORTS ON FORM 8-K
No current reports on Form 8-K were filed with the Securities and Exchange
Commission during the quarter ended June 30,1997.
C - EXHIBITS
Exhibits are filed as part of this Form 10-K
<TABLE>
<CAPTION>
NO. EXHIBITS PAGE
----------- ------------------------------------------------------------ ----------------
<S> <C> <C>
2.0 Agreement and Plan of Merger dated as of June 18, 1996 by and *
between the Registrant, the Bank and Oriental Interim Bank
3.1 Amended and Restated Certificate of Incorporation of Registrant *
3.2 By-laws of Registrant *
10.1 Employment Agreement between Jose E. Fernandez and the Bank *
10.2 Bank 1988 Stock Option Plan *
10.3 Bank's Amended and Restated 1996 Stock Option Plan **
13.0 Registrant's Annual Report to Shareholders for fiscal year ending E-1 to E-18***
June 30, 1997
21.0 List of Subsidiaries E-19
27.0 Financial Data Schedule E-20
</TABLE>
* - Incorporated by reference from Registration Statement on Form 8-B
filed by Registrant on January 10, 1997.
** - Incorporated by reference from Definitive Proxy Statement (Attachment A)
for the Registrant's 1997 Annual Meeting of Shareholders filed by the
Registrant on September 19, 1997.
*** - Those pages of the Registrant's Annual Report to Shareholders for the
fiscal year ending June 30, 1997 (the "Annual Report" incorporated by
reference into this Annual Report From 10-K are being filed in
electronic format as an exhibit herein, and the Annual Report,
including the remaining portions which are not incorporated by
reference into this annual Report on Form 10-K, is specifically
incorporated by reference herein as an exhibit from the filing of such
Annual Report in paper format by the Registrant on or about September
22, 1997 pursuant to Commission Rule 14a-3(c).
49
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
ORIENTAL FINANCIAL GROUP INC.
(Registrant)
By: /S/JOSE E. FERNANDEZ
--------------------
Jose E. Fernandez
Chairman of the Board, President
and Chief Executive Officer
Dated: 09-25-97 (Principal Executive Officer)
--------
By: /S/RICARDO N. RAMOS
-------------------
Ricardo N. Ramos
Senior Vice President Finance
and Administration
Dated: 09-25-97 (Principal Financial Officer)
--------
By: /S/ROBERTO A. FERNANDEZ
-----------------------
Roberto A. Ferna'ndez
Senior Vice President Loan
Administration and Accounting
Dated: 09-25-97 (Principal Accounting Officer)
--------
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
the Registrant in the capacities and on the dated indicated.
BY: /S/JOSE E. FERNANDEZ
- --------------------------
Jos[caad 214]e E. Fernandez
Chairman of the Board, President
and Chief Executive Officer Dated: 09-25-97
BY: /S/PABLO I. ALTIERI
- -------------------------
Dr.. Pablo I. Altieri
Director Dated: 09-25-97
BY: /S/DIEGO PERDOMO
- ----------------------
Diego Perdomo
Director Dated: 09-25-97
BY: /S/EFRAIN ARCHILLA
- ------------------------
Efrain Archilla
Director Dated: 09-25-97
BY: /S/JULIAN INCLAN
- ----------------------
Julian Inclan
Director Dated: 09-25-97
BY: /S/EMILIO RODRIGUEZ, JR.
- ------------------------------
Emilio Rodriguez, Jr.
Director Dated: 09-25-97
BY: /S/ALBERTO RICHA
- ----------------------
Alberto Richa
Director Dated: 09-25-97
50
<PAGE>
(Logo) E-1
ORIENTAL
FINANCIAL GROUP
MANAGING CHANGE FOR FINANCIAL GROWTH
BANK-TRUST-FINANCIAL SERVICES-MORTGAGE-LEASING
OUR MISSION
MANAGING CHANGE FOR GROWTH THROUGH QUALITY FINANCIAL SERVICES FOR THE
ECONOMIC BENEFIT OF OUR CLIENTS AND OUR STOCKHOLDERS, ACHIEVING CONSTANT
IMPROVEMENT IN PERFORMANCE AS AN AGILE FRONTRUNNER IN FINANCIAL PLANNING.
TABLE OF CONTENTS
Financial Highlights.............1 Oriental Consumer Bank..................12
Managing Change..................2 Oriental Leasing........................13
Message to Stockholders..........4 Oriental Mortgage.......................15
Oriental Financial Group Management Discussion
Core Business Chart..............8 and Analysis of Financial Condition
and Results of Operations
Oriental Trust and
& Money Management...............9 Consolidated Audited
Financial Statements....................17
Investment Brokerage
& Advisory Services.............10
<PAGE>
(Logo) E-2
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Percent
$ in thousands (except for per share results) Increase 1997 1996 1995
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
AT YEAR END
Total bank assets 22% $1,068,600 $ 877,400 $ 744,400
Trust assets managed 25% 1,088,600 874,500 699,000
Assets gathered by broker dealer 79% 524,900 293,100 195,400
Loans serviced for third parties 24% 515,700 401,300 272,900
Total financial assets 31% $3,197,800 $2,446,300 $1,911,700
Capital 12% $ 83,394 $ 79,903 $ 69,705
- ------------------------------------------------------------------------------------------
PER COMMON SHARE
Outstanding common shares at year end 7,990 7,960 8,002
Dividends declared 38% $ 4,369 $ 3,184 $ 1,709
Income per share (excluding SAIF) 24% 2.18 1.77 1.48
Book value 11% 11.19 10.04 8.71
Price at year end 78% $ 28.25 $ 15.83 $ 12.67
- ------------------------------------------------------------------------------------------
OPERATING RESULTS
Net interest income 15% $ 37,531 $ 32,753 $ 27,720
Provision for loan losses 7% 4,900 4,600 2,550
Non-interest income
(excluding securities gain) 24% 16,449 13,300 10,222
Non-interest expenses (excluding SAIF) 16% 28,498 24,608 21,590
Net Income (excluding SAIF) 21% 17,895 14,736 12,107
</TABLE>
<PAGE>
MANAGING CHANGE
E-3
The paradigm shift, started in the early 1990s, to create a more agile
financial institution that anticipates and manages change, continues to
challenge our vision of the requirements for the future.
In order to sustain that vision, important organizational adjustments were
made in fiscal 1997 that focused our operations on fortifying core
competencies for greater profitability, while seeking to eliminate
non-essential functions that do not contribute to enhanced performance.
First, Oriental Financial Group, our bank holding company, was established as
the parent company of Oriental Bank & Trust, to achieve greater management
flexibility. Second, an international banking entity, O.B.T. International
Bank, was organized to take advantage of Puerto Rico's tax incentives on
offshore banking transactions.
At the same time, management is in the process of selling off the mortgage
loan servicing portfolio to focus more sharply on the profitability of our
core businesses.
Our key business strengths continue to reside in the areas of: Trust and
Money Management. - Investment Brokerage and Advisory Services. - Consumer
Lending and Banking. - Automobile and Equipment Lease Financing - Mortgage
Originations.
The emphasis on these primary business areas enabled Oriental Financial Group
to become a $3 billion financial institution in fiscal 1997 and continued
concentration in developing new and improved products in these areas will
allow Oriental to reach its objective of $3 billion in total financial assets
by the year 2000, excluding servicing.
Our strong capital position, which is recognized by respected financial
rating agencies, makes that projection
[photo]
THE BOARD OF DIRECTORS STANDING LEFT TO RIGHT: JULIAN INCLAN, JOSE ENRIQUE
FERNANDEZ (CHAIRMAN), AND EFRAIN ARCHILLA, SEATED: DR. IVAN ALTIERI, DIEGO
PERDOMA (CPA), AND ENG. ALBERTO RICHA. EMILIO RODRIQUEZ NOT PICTURED.
<PAGE>
COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN
E-4
entirely feasible. In fiscal 1997, Duff & Phelps, a leading credit rating
company, issued favorable investment grade ratings of "D2" on the short-term
and "BBB" on the long-term debt of the bank. In addition, we maintained a
highly favorable "T8W2" ranking from Thomson BankWatch, which is the second
highest rating granted to commercial banks worldwide.
Such recognition is indicative of the outstanding rate of return on our
common stock (see accompanying chart), compared to the overall performance of
the stock market.
We consider these ratings to be a reaffirmation of the solid financial
position of the bank and other affiliated operations of Oriental Financial
Group, whose stock trades on the New York Stock Exchange under the symbol
"OFG."
[graph]
[logo]
[photo]
SENIOR VICE PRESIDENTS STANDING LEFT TO RIGHT: DENNIS SOTO, ELI E. DIAZ, ANDY
MUNIZ, JOSE R. FERNANDEZ, AND ANDRES MORGADO (CPA). SEATED: RICHARDO RAMOS
(CPA), ROBERTO A. FERNANDEZ (CPA) AND GEORGE JOYNER.
<PAGE>
MESSAGE TO STOCKHOLDERS
E-5
Fiscal 1997 was a year of record earnings performance for Oriental Financial
Group and a period of strong emphasis on finding better ways to deliver our
services to clients.
Net income (excluding the one-time industry-wide SAIF charge of $1.3 million,
net of taxes) grew by 21 percent to reach $17.9 million, compared to $14.7
million in the previous fiscal year. On a per share basis, earnings rose to
$2.18 a share, against $1.77 a share in fiscal 1996 for a 24 percent gain.
This substantial increase in earnings improved our return on assets to 1.84
percent, compared to 1.82 percent the previous fiscal year and the return on
equity rose to 21.17 percent from 19.30 percent in fiscal 1996.
Fiscal 1997 also saw Oriental reach a milestone in its asset position. Bank
assets passed the $1 billion mark and total assets managed and gathered by
our trust, investment brokerage and servicing operations surpassed $2 billion
by June 30, 1997.
Having achieved our $3 billion goal in total assets on target with our
projections, certainly a period of self-indulgence could be justified.
However, while we sincerely appreciate the market support and dedicated
performance of our people, who made this achievement possible, our view of
market requirements does not permit complacency on the part of management.
MANAGEMENT FLEXIBILITY
[graph]
We, therefore, restructured our organization to streamline functions for
greater profitability. Oriental Financial Group was established as a bank
holding company in January 1997 to enhance management flexibility in
realizing growth targets in trust services, investment brokerage, banking,
lease financing and mortgage lending operations.
To achieve those targets we have established a quality sales culture based on
variable compensation models that better motivate our teams in each business
unit to provide quality financial services.
The establishment of O.B.T. International Bank, in March 1997, represents
another important step in our efforts to improve profitability. Operating as
a division of Oriental Bank & Trust, the International Banking Entity (IBE)
holds the potential to generate substantial tax-exempt income from offshore
transactions.
Under Puerto Rico's International Banking Center Regulatory Act of 1989, the
income earned by IBEs is exempt from Puerto Rico income taxes, branch profit
taxes and municipal license taxes. Similarly, distribution of dividends,
profit participation or other distributions to shareholders, partners or
owners of the IBE are completely exempt from all withholding taxes.
The ability to generate tax-exempt income from operations outside of Puerto
Rico through the international banking division will contribute to the
profitability of the Group, which is positioned to take advantage of broader
bank-related business opportunities.
As we ended fiscal 1997, the prospect of national and local banking reform
was still very much on the horizon. Eventually, measures that will further
blur the lines separating various traditional financial services will become
a reality.
<PAGE>
E-6
How those reforms ultimately play out remains to be seen. However, the test
for financial institutions in coming years will be how effectively they deal
with the emerging financial environment in Puerto Rico and the world.
Oriental Financial Group is not waiting for those changes to take place
before it finds the right solutions. We are aggressively managing change
within our own organization to anticipate financial planning requirements for
our clients and growth opportunities for our stockholders.
OUR CLIENT-SERVER CULTURE
Increasingly, Oriental is zeroing in on improving its client-server culture.
Therefore, how we do business is subject to constant review and change for
better performance within tight cost controls. Cost containment and greater
efficiency is an on-going goal throughout the organization.
That process brought us to the realization that our human resources are
better utilized in developing and delivering innovative financial services,
rather than servicing existing loan portfolios. In addition, we continue to
emphasize what we regard as our responsibility to inform the market and our
own personnel on the varied, and often complex, alternatives available in
financial planning.
As a result, we brought our marketing strengths into harmony with our
internal training and external communications initiatives. Those efforts saw
Oriental offer regularly scheduled seminars throughout the 16-branch network
for clients and prospects on various financial strategies, which also gave
valuable new tools to our platform personnel, who have daily contact with our
customers.
At the same time, we continued to improve our management information systems
to more closely monitor performance and encourage convergence in business
development. This approach enables us to first identify and then satisfy the
total financial needs of our clients.
That operating philosophy required us to beef up training for our personnel
as we placed more responsibility for client satisfaction on our expanding
professional staff. Our growing computer capabilities also are being employed
to increase the flow of information as a tool for managing, training and
marketing more effectively.
[GRAPH]
TOTAL FINANCIAL SERVICES
Oriental views the branch platform as the showcase for its complete line of
financial products, where clients can map out their financial objectives. For
example, our clients now have access to investment planning services through
investment advisors, who are assigned to branches in Mayaguez, Ponce, Arecibo
and Las Cumbres, as well as the Hato Rey headquarters of Oriental Financial
Services Corp., our full service investment broker/dealer subsidiary.
Now, in addition to arranging for personal loans and mortgages, our clients
also can arrange for their 401(k) or Keogh plan to build retirement income.
Now, in addition to making deposits in checking and savings accounts, lease
payments or certificates of deposit and IRA purchases, our clients can invest
in stocks, bonds, mutual funds and annuities at the branch nearest to them
without having to go to a separate office in Hato Rey.
<PAGE>
E-7
Hato Rey, in the heart of San Juan's financial district, continues to be the
nerve center for our trust and investment services, as well as a branch
location of the bank. The Hato Rey office also will play a larger role as a
center for administrative activities as the supporting operations that are
presently conducted in Humacao are moved to San Juan.
This move will substantially contribute to closer administrative coordination
between our key business units to assure new efficiencies in serving our
clients and expanding product profitability.
We, therefore, expect that the growth patterns established over the past
eight fiscal years will continue into the forseeable future. That trend saw
income from our core businesses grow significantly in fiscal 1997.
CORE BUSINESS GROWTH
Fee income, which represents approximately 33 percent of total income, rose
by 24 percent to $16.4 million in fiscal 1997, compared with $13.3 million a
year earlier. Fees earned from the trust, money management and investment
brokerage operations showed a significant gain, increasing to $6.8 million in
fiscal 1997 from $5.9 million in fiscal 1996, up 14 percent. At the same
time, bank service fees rose from $3.8 million in fiscal 1996 to $4.9 million
in fiscal 1997, an increase of 29 percent.
[GRAPH]
As the most important component of fee income, trust and investment brokerage
activities will continue to lead our product mix. An established innovator in
retirement planning, our trust division leads in developing IRAs, 401(k) and
Keogh programs that are uniquely tailored to the demands of an increasingly
sophisticated market.
Similarly, net interest income, after provision for loan losses, grew by 16
percent in fiscal 1997, reaching $32.6 million from $28.2 million in the
previous fiscal year. The increase in net interest income was largely due to
increased financing activity, primarily in mortgage, leasing and consumer
loans.
Mortgage lending continues to be an important part of our loan portfolio mix,
representing 50 percent of total loans as of June 30, 1997. However, as lease
financing and consumer lending activities grow, we anticipate that the share
of mortgage lending will reduce, balancing the mix more evenly.
Still, Oriental is committed to maintaining an active presence in mortgage
origination through its nine convenient mortgage centers throughout the
island. Those centers are fully integrated within the communities they serve
and our Mortgage Account Executives are motivated to work closely with real
estate brokers and developers to provide highly competitive mortgage
financing for the homebuying market.
Such motivation also drives our lease financing operations, which represent a
growing share of our lending activity. Focused on client service through the
major dealer outlets for autos and equipment, our leasing specialists work
largely in the field through eight leasing centers. As the second largest
leasing operation in Puerto Rico, with approximately 30 percent of the
market, Oriental Leasing is proving that a direct approach at the point of
sale works best.
<PAGE>
E-8
AGGRESSIVE MARKETING STRATEGIES
This aggressive marketing strategy relies heavily on a closely-watched credit
scoring system that assures the quality of our leasing portfolio, which has
substantially reduced credit risk.
Consumer banking operations likewise seek to build relations with clients
based on a total service approach. As our branch network is maturing, we find
increasing acceptance of Oriental as a one-stop financial center. Total
deposits, therefore, have shown encouraging growth, reaching $498 million as
of June 30, 1997, compared with $383 million a year earlier, an increase of
30 percent. Our specially-tailored accounts, such as the Oriental-Pro
checking account and the FaxCash and TeleCash consumer loans, also have
received broader market support.
The sharp focus on expanding profitability from every business unit has made
it possible to maintain high returns for the benefit of our stockholders. As
of June 30, 1997, our return on assets was 1.84 percent and the return on
equity was 21.17 percent, with total capital increasing to $89.4 million, up
12 percent from $79.9 million in the previous fiscal year. In addition, the
common stock repurchase program authorized by the Board of Directors in
fiscal 1996, continues to be an effective capital management tool.
Oriental declared dividends amounting to $4.4 million during fiscal 1997,
compared with $3.2 million in fiscal 1996, an increase of 38 percent. This
represents a per common share dividend of $0.55 for fiscal 1997, up from
$0.38 per common share in fiscal 1996.
[PHOTO] [GRAPHIC]
/s/ Jose Enrique Fernandez
Jose Enrique Fernandez
Chairman of the Board
President and Chief Executive Officer
We fully expect that a highly favorable rate of return on investment in
Oriental Financial Group will be maintained well into the future as our
institution continues to take advantage of growth opportunities within a
changing financial environment.
To harvest that environment profitably, we are tapping the best available
resources to test our skills and build our competence as financial
service-providers, who hold client satisfaction and stockholder gain above
all else.
The management of Oriental Financial Group deeply appreciates your support in
that endeavor and promises to meet the challenge of managing change for
financial growth.
[LOGO]
<PAGE>
E-9
Oriental Financial Group is the bank holding company under which Oriental
Bank & Trust is focusing its marketing initiatives to gather assets and grow
income through the development of financial products that satisfy the needs
of clients.
[GRAPHIC]
MANAGING CHANGE FOR FINANCIAL GROWTH
[LOGO]
<PAGE>
E-10
[GRAPHIC]
ORIENTAL TRUST & MONEY MANAGEMENT
With more than $1 billion in funds under management, Oriental Trust
contributed substantially to the asset growth of the Group in fiscal 1997.
As of June 30, 1997, Oriental Trust had increased its assets under management
to $1.09 billion, up from $874.5 million at June 30, 1996, an increase of
24 percent. We anticipate that the ability to grow assets through our trust
division will enhance measurably in the years to come for various reasons.
Most significantly, 1998 will see the whole spectrum of trust and money
management services in Puerto Rico expand tremendously and our trust and
money management services are positioned to take full advantage of the
liberalization of laws governing how financial resources are put to work for
greater growth.
New laws provide that individuals seeking to build retirement income can take
a larger deduction on their income tax returns for contributions to
individual retirement accounts (IRAs), increasing the limit from $2,500 per
individual account to $3,000 per individual. In addition, how those funds can
be invested has been expanded to include up to 33 percent in U.S. securities.
As a leader in the IRA market, Oriental Trust is ready to offer its clients
more options to take advantage of these reforms for a higher potential return
on investment. For example, the established "IRA-Plazos" account makes it
possible for investors in the "IRA-Fund" to make regular monthly
contributions to reach their desired annual investment target, without having
to make one lump sum contribution.
Oriental Trust has effectively proselytized the market to sell the concept of
saving for retirement, providing the most diverse IRA products to serve every
financial objective.
- Our "Multi-IRA" assures clients the safety of an account insured by
the FDIC, up to $100,000, and a fixed rate of interest for a fixed term.
[PHOTO]
ORIENTAL TRUST
SPECIALISTS WORK CLOSELY
WITH CLIENTS TO STRUCTURE
401(k) PROGRAMS
ORIENTAL
FINANCIAL GROUP
1997 ANNUAL REPORT
9
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TRUST ASSETS MANAGED
- Our "Investor's IRA," which also is insured up to $100,000 of principal
by the FDIC and was the first retirement account offered in Puerto Rico to
link its return to the performance of a stock market index, gives clients an
opportunity to benefit from the growth of equities. At last count, the growth
in value of the "Investor's IRA" was 79 percent as measured by the Standard &
Poor's 500 Stock Index.
- Our "IRA-Exenta," also the first of its kind in Puerto Rico, offers
clients the best return of any of the tax exempt funds in the market with an
outstanding yield performance over the life of the product.
The mix of IRA products marketed by Oriental will be adapted over the months
ahead to give clients the full advantages of the reforms in law that promise
to further improve income expectations. Likewise, we are working on
developing alternative product delivery approaches that will make it easier
for clients to integrate their retirement planning objectives with their
total financial planning needs.
Those needs are already served by trust products, such as the tailored 401(k)
and Keogh programs developed by Oriental, which cater to the particular
requirements of employees, employers and self-employed professionals.
In addition, Oriental structures deferred compensation plans, which benefit
top money-earners and their employers by providing the necessary investment
management to reach the objectives of both parties.
At the same time, our trust officers work closely with individuals and
corporations to structure money management strategies as a custodian,
trustee, registrar, paying agent and an investment manager of funds.
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INVESTMENT BROKERAGE & ADVISORY SERVICES
"Investment planning for your future" is more than a marketing slogan at
Oriental Financial Services Corp., the Group's full-service investment
broker/dealer subsidiary. In just four years since its inception in 1993,
Oriental Financial Services has established investment planning as a highly
successful strategy for building the wealth of its clients and contributing
to the fee income of the Group.
That strategy was responsible for attracting assets to the Group at an
accelerated pace in fiscal 1997. Financial assets gathered by the
broker/dealer operation rose by an astounding 79 percent in the fiscal year,
reaching $524.9 million from $293.1 million in the previous 12-month period.
The growth in assets gathered was the result of a calculated effort that
first closely analyzed the needs of the market, then added new investment
alternatives to satisfy those needs and further developed skilled investment
advisors, who are capable of delivering investment vehicles that effectively
address a broad variety of financial objectives.
The delivery approach also became more user-oriented. The investment
executives at Oriental Financial Services were
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[Graph]
encouraged to become more than traders of securities. Instead, they seek to
establish long-term client relationships by providing the full range of
options available in the market.
To accomplish that task 48 financial planning seminars were given, in
conjunction with our trust division, in fiscal 1997 at the Bank's 16
branches. At the same time, the sales force of licensed investment executives
was increased by five to a team of 16, who cover the island. That sales force
is expected to grow to 40 in the month's ahead, as Oriental Financial
Services increasingly brings its resources to investors where they live and
work.
Those resources are now being delivered directly through investment centers
at the Bank's branches in Ponce on the south coast. Mayaguez on the west
coast, Arecibo in the north-central region and Las Cumbres in the suburbs of
San Juan, as well as the main offices in Hato Rey's financial district.
This regional approach to providing investment planning services makes it
more convenient for investors to consult our advisors in a familiar
environment without having to travel to a stock broker in San Juan to make
transactions. Moreover, our investment executives are armed with desktop
computer access to the best information available in the market.
Based on that information and the recommendations of our advisors, the
investor can establish an appropriate investment strategy to meet particular
financial objectives. Oriental Financial Services offers a wide array of
investment vehicles to meet those objectives. They include : - Fixed and
Variable Annuities. - Tax-advantaged Fixed Income Securities. - Mutual Funds.
- - Stocks and Bonds.
We anticipate that the investment market in Puerto Rico will continue to
respond favorably to the broad range of investment alternatives offered by
Oriental Financial Services. Those alternatives will expand further in the
month's ahead as Puerto Rico moves toward establishing a viable local capital
market with attractive incentives for investing.
The synergies between our brokerage operation and the money management
capabilities of our trust division enables us to create vehicles that will
effectively serve an increasingly sophisticated market with financial growth
opportunities. In addition, our 16 branch locations provide a highly
desirable delivery network through which the complete financial requirements
of our clients can be served with greater efficiency at competitive costs.
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[Photo]
AN ORIENTAL INVESTMENT ADVISOR EXPLAINS THE DETAILS OF FINANCIAL PLANNING
ALTERNATIVES.
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ORIENTAL CONSUMER BANK
There is a entrepreneurial spirit overtaking the 16 branches of Oriental,
where platform associates are eager to serve the total financial requirements
of the Bank's clients. Our platforms are becoming increasingly efficient in
launching long-term client relationships by tapping the full range of
services available to them.
As a result, the Bank has grown impressively on both sides of the balance
sheet. Total deposits grew to $498 million as of June 30, 1997, compared to
$383 million at June 30, 1996, an increase of 30%. High-yielding certificates
of deposit were a strong magnet in attracting the deposits of new clients to
the Bank's branches.
At the same time, uniquely structured saving and checking accounts also
contributed to bringing in new deposits. Saving and checking deposits rose
by 30 percent in the fiscal 1997, reaching $107 million from the previous
year's $87 million. Meanwhile, consumer time deposits were up 26 percent to
$331 million at the end of fiscal 1997 from $262 million on June 30, 1996.
The islandwide branch network was largely responsible for the growth,
presenting our highly attractive consumer banking products to new
communities. Among those products is the Oriental-Pro account, which provides
free checking on a minimum maintained balance of $500, plus savings and
pre-approved credit features.
In addition, the Bank has aggressively pursued direct deposits through its
automatic clearing house system, giving clients the convenience of making
direct payroll deposits and assigning deductions for payment to other
accounts, such as 401(k) contributions, automatically.
Fiscal 1997 also saw a major recovery in consumer loan originations, which
grew to $53 million from the previous
[photo]
THE LAS CUMBRES BRANCH SERVES THE TOTAL-FINANCIAL NEEDS OF ITS CLIENTS.
ORIENTAL
FINANCIAL GROUP
1997 ANNUAL REPORT
12
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year's $32 million, an increase of 66 percent that was built around the
market support for our FaxCash and TeleCash personal loans.
Consumer lending has shown consistant growth over the last four years,
doubling to reach 17 percent of the Group's total loan portfolio in fiscal
1997. This substantial increase in consumer lending activity was accomplished
without increasing the risk of delinquency or default because of careful
credit analysis. The Fair Isaac Credit Scoring System installed in 1995,
which is one of the most reliable in the business, has kept the Bank's loan
production at the highest possible quality.
In addition to the reliability of the credit scoring system, it also is fast,
providing credit authorizations within a matter of hours to satisfy the
client's borrowing requirements in a most convenient fashion. The speed with
which credit can be issued is of the utmost importance to our total quality
approach to consumer banking.
That approach has given our branch personnel greater responsibility for client
satisfaction in all aspects. Along with that responsibility, our
client-servers are given incentives that encourage improved efficiencies. Our
efficiency ratio compared to banks of similar size is improving because we
are investing in skill and attitudinal training, as well as product delivery
systems.
The emphasis is on reaching out to serve the communities around our branches
with the wide array of outstanding financial services the Group offers. While
we already reach across the island with the 16 branches currently
in operation, Oriental will soon expand that network with three new branches
in strategic locations. These include another major shopping center location
at San Patricio Plaza, a Caguas Hospital branch and a branch in Fajardo to
serve the northeastern region of the island. By extending the Bank's reach
into new communities, we will bring the concept of total financial services
to a larger market, further growing the potential for profitability in years
to come.
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ORIENTAL LEASING
Oriental continues to view the leasing market as a strong component of its
financial services and has taken the necessary steps to assure reasonable
growth.
Concentrating on restructuring the controls for better credit quality,
Oriental Leasing reduced financing originations in fiscal 1996, while highly
efficient systems could be fully applied to the energetic marketing efforts
already in place. With reliable and rapid credit scoring installed by January
1996, Oriental set out to rebuild its lease financing portfolio based on the
potential for growth in the market.
In spite of the increasing popularity of lease financing, especially in the
auto market, only 20 percent of the cars sold in Puerto Rico are currently
leased. The potential for growth, therefore, is almost unlimited for the
forseeable future.
ORIENTAL
FINANCIAL GROUP
1997 ANNUAL REPORT
13
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FINANCE LEASES
ORIGINATION
AND PURCHASES
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Oriental Leasing was able to realize a good share of that potential during
fiscal 1997, with lease financing originations climbing to $74.8 million for
the $61.8 million produced in fiscal 1996, an increase of 29 percent.
Automobile leases represent the bulk of Oriental's lease financing portfolio
and Oriental is the second largest producer of such financing with a market
share of about 30 percent.
While auto leasing is the most active segment of the market, Oriental also
provides lease financing for the purchase of equipment for individuals and
small and medium-sized businesses, as well as for professional and office
systems.
Both segments of the lease market are served by specialists who are motivated
to deal directly with clients at the point of sale through dealerships. They
are supported by a centralized authorization and processing system that frees
them to seek out new business and maintain a high level of customer service.
The leasing business can be highly volatile. Therefore, our credit analysis
[photo]
AN ORIENTAL AUTO LEASING SALES MANAGER DELIVERS THE KEYS TO ANOTHER SATISFIED
CUSTOMER.
ORIENTAL
FINANCIAL GROUP
1997 ANNUAL REPORT
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capabilities are of the utmost importance to maintaining the quality of the
lease financing portfolio, which grew to 1 percent of the total lending
portfolio for the Group in fiscal 1997.
As a result, considerable effort must go into preparing our Lease Account
Executives in the fine points of dealing with each segment of the market to
provide the best possible service within a framework of conservative credit
policies. Our industry-specific credit scoring technology is central to that
process.
Working closely with dealers and their customers, Oriental Leasing quickly
processes a lease application for the benefit of all concerned. Customer
satisfaction is essential in the leasing business and our real-time computer
authorizations facilitate sales for the benefit of the dealer and the
consumer.
As the consumer increasingly realizes the advantages of lease financing,
Oriental expects to grow its lease financing activities to serve the market.
We, therefore, seek to orient prospective clients through our eight leasing
centers that are proving to be a valuable resource in generating new business.
ORIENTAL MORTGAGE
The origination of mortgages is the largest single lending activity of the
Group, representing 50 percent of the total loan portfolio in fiscal 1997.
While the share of mortgage loans is still sizable, it has reduced
substantially from 71 percent of the lending mix in fiscal 1993, a decrease
of 42 percent.
This gradual reduction is the result of calculated efforts to balance the
revenue sources of the Group by greatly expanding other business units.
However, mortgage originations continue to be a vital part of our business
growth strategy, increasing to $192.8 million in fiscal 1997, up 11 percent
from the $179.4 million produced in fiscal 1996.
Oriental expects to maintain a reasonable level of growth in mortgage
originations well into the future. We, therefore, continue to emphasize
client service through our nine mortgage lending centers, where Mortgage
Accounts Executives, who are skilled in every aspect of the origination
process, carry each loan through to fruition, from the initial application to
the disbursement of the final check.
We consider the origination process to be so important to our role in
providing the best possible client service that management has refocused its
attentions in this area exclusively and will sell off its mortgage servicing
portfolio.
There is no question that mortgage servicing can represent a lucrative source
of fee income for any financial institution. However, it also represents a
sizable investment in human resources and capital to carry out the many
accountability functions associated with mortgage ser-
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ORIENTAL
FINANCIAL GROUP
1997 ANNUAL REPORT
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vicing. The economies of scale realized from concentrating on mortgage
originations will enable Oriental to further improve it's return on
investment in this area.
In our view, those resources would be better utilized in the development and
growth of Oriental's other core competencies, namely meeting the total
financial needs of our growing client base with innovative services, such as
broader participation in the orientation of real estate brokers and
homebuyers by offering seminars.
Mortgage banking continues to be an important part of that growth strategy,
contributing to the income stream of the. However, the concentration will be
in the origination area, where Oriental has developed valuable market
relationships with real estate brokers and developers to serve homebuyers
better.
[photo]
MORTGAGE SPECIALISTS GO OVER THE PLANS FOR A PROJECT WHERE ORIENTAL
WILL PROVIDE SINGLE-FAMILY PERMANENT FINANCING TO BUYERS.
ORIENTAL
FINANCIAL GROUP
1997 ANNUAL REPORT
16
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PRICE WATERHOUSE
REPORT OF INDEPENDENT ACCOUNTANTS
August 7, 1997
To the Board of Directors and Stockholders of
Oriental Financial Group, Inc.
In our opinion, the accompanying consolidated statement of financial
condition and the related consolidated statements of operations, of changes
in stockholders' equity and of cash flows present fairly, in all material
respects, the financial position of Oriental Financial Group and its
subsidiaries at June 30, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
1997, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Group's management; our
responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ Price Waterhouse
CERTIFIED PUBLIC ACCOUNTANTS
(OF PUERTO RICO)
License No. 10 Expires Dec. 1, 1998
Stamp 1457439 of the P.R. Society of
Certified Public Accountants has been
affixed to the file copy of this report.
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LIST OF REGISTRANT'S SUBSIDIARIES
1. ORIENTAL BANK AND TRUST-commercial bank organized and existing under the
laws of the Commonwealth of Puerto Rico.
Subsidiaries of Oriental Bank and Trust:
a. Oriental Financial Services Corp.-corporation organized and existing
under the laws of the Commonwealth of Puerto Rico.
b. Eastern Services Corporation-corporation organized and existing under
the laws of the Commonwealth of Puerto Rico.
c. Oriental Funding Corporation-corporation organized and existing under
the laws of the Commonwealth of Puerto Rico.
d. Eastern Funding Corporation-corporation organized and existing under
the laws of the Commonwealth of Puerto Rico.
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ORIENTAL FINANCIAL GROUP
SELECTED FINANCIAL DATA EXHIBIT
PURSUANT TO ITEM 601(c)(2)(i) OF REGULATION S-K AND S-B
1 RESTATED NO
2 CIK # 1030469
3 NAME ORIENTAL FINANCIAL GROUP
4 MULTIPLIER 1,000
5 CURRENCY U.S.$
6 PERIOD START 1-JUL-96
7 EXCHANGE-RATE -
8 FISCAL YEAR END 30-JUN-97
9 PERIOD-END 12-MONTHS
10 CASH 12,812
11 INTEREST-BEARING DEPOSITS 8,000
12 FEDERAL FUNDS SOLD/REVERSE REPOS 15,000
13 TRADING ASSETS 25,276
14 INVESTMENTS AVAILABLE-FOR-SALE 203,260
15 INVESTMENTS HTM-AT COST 201,790
16 INVESTMENTS HTM-AT FAIR VALUE 202,443
17 LOANS 538,378
18 ALLOWANCE 5,408
19 TOTAL ASSETS 1,068,596
20 DEPOSITS 497,542
21 SHORT-TERM BORROWINGS 337,715
22 OTHER LIABILITIES 28,929
23 LONG-TERM BORROWINGS 115,016
24 PREFERRED MANDATORY STOCK -
25 PREFERRED STOCK -
26 COMMON STOCK 7,990
27 OTHER STOCKHOLDERS EQUITY 81,404
28 TOTAL LIABILITIES AND EQUITY 1,068,596
29 INTEREST LOAN 54,770
30 INTEREST INVESTMENTS 26,780
31 INTEREST OTHER 1,079
32 TOTAL INTEREST 82,629
33 INTEREST DEPOSITS 21,012
34 TOTAL INTEREST EXPENSE 45,098
35 NET INTEREST INCOME 37,531
36 PROVISION FOR LOAN LOSSES 4,900
37 SECURITIES GAINS 903
38 EXPENSE-OTHER 30,321
39 INCOME-PRETAX 19,662
40 INCOME-PRE-EXTRAORDINARY 19,662
41 EXTRAORDINARY -
42 CHANGES -
43 NET INCOME 16,562
44 EPS-PRIMARY 2.02
45 EPS-DILUTED 2.01
46 YIELD-ACTUAL 3.89%
47 LOANS-NON ACCRUAL 13,285
48 LOANS-PAST -
49 LOANS-TROUBLED -
50 LOANS-PROBLEM -
51 ALLOWANCE BEGINNING OF YEAR 4,496
52 CHARGE-OFFS 5,262
53 RECOVERIES 1,274
54 ALLOWANCE CLOSE OF YEAR 5,408
55 ALLOWANCE DOMESTIC 5,408
56 ALLOWANCE FOREIGN -
57 ALLOWANCE UNALLOCATED
