<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 18, 1997
REGISTRATION NO. 333-31051
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
AMENDMENT NO. 2 TO
FORM S-11
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
PEOPLE'S PREFERRED CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
5900 WILSHIRE BOULEVARD, LOS ANGELES, CALIFORNIA 90036 (213) 938-6300
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
------------------------
RUDOLF P. GUENZEL
PRESIDENT AND CHIEF EXECUTIVE OFFICER
PEOPLE'S PREFERRED CAPITAL CORPORATION
5900 WILSHIRE BOULEVARD
LOS ANGELES, CALIFORNIA 90036
(213) 938-6300
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------
PLEASE SEND COPIES OF ALL COMMUNICATIONS TO:
<TABLE>
<S> <C> <C>
TIMOTHY B. MATZ, ESQ. WILLIAM S. RUBENSTEIN, ESQ.
NORMAN B. ANTIN, ESQ. Skadden, Arps, Slate, Meagher & Flom LLP
JEFFREY D. HAAS, ESQ. AND 919 Third Avenue
Elias, Matz, Tiernan & Herrick L.L.P. New York, New York 10022
734 15th Street, N.W., 12th Floor (212) 735-3000
Washington, D.C. 20005
(202) 347-0300
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED PROPOSED
MAXIMUM AGGREGATE
AMOUNT BEING OFFERING PRICE OFFERING AMOUNT OF
TITLE OF SECURITIES BEING REGISTERED REGISTERED(1) PER SHARE(1) PRICE(1) REGISTRATION FEE
<S> <C> <C> <C> <C>
% Noncumulative Exchangeable Preferred Stock,
Series A, par value $0.01 per share 1,426,000 shares $25.00 $35,650,000 $10,803.03*
</TABLE>
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(o) of the Securities Act of 1933.
* Previously filed.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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<PAGE>
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
PROSPECTUS SUBJECT TO COMPLETION, DATED SEPTEMBER 18, 1997
1,240,000 SHARES
PEOPLE'S PREFERRED CAPITAL CORPORATION
% NONCUMULATIVE EXCHANGEABLE PREFERRED STOCK, SERIES A
(LIQUIDATION PREFERENCE $25.00 PER SHARE)
EXCHANGEABLE INTO PREFERRED STOCK OF PEOPLE'S BANK OF CALIFORNIA
---------------------
People's Preferred Capital Corporation, a Maryland corporation (the
"Company"), is hereby offering 1,240,000 shares of its % Noncumulative
Exchangeable Preferred Stock, Series A, par value $0.01 per share (the "Series A
Preferred Shares"). Dividends on the Series A Preferred Shares are payable at
the rate of % per annum of the liquidation preference (determined without
regard to accrued and unpaid dividends) (an amount equal to $ per annum
per share), if, when and as authorized and declared by the Board of Directors of
the Company.
(CONTINUED ON NEXT PAGE)
SEE "GLOSSARY" COMMENCING ON PAGE 92 FOR THE DEFINITIONS OF CERTAIN TERMS
USED IN THIS PROSPECTUS. SEE "RISK FACTORS" COMMENCING ON PAGE 15 FOR A
DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE
PURCHASERS OF THE SERIES A PREFERRED SHARES OFFERED HEREBY. AMONG THE RISKS
WHICH PROSPECTIVE INVESTORS SHOULD CONSIDER ARE THE FOLLOWING:
- Lack of prior operating history of the Company;
- Dependence on People's Bank of California (the "Bank") as Advisor and on
the Bank and the Bank's designated Servicing Agent as Servicers;
- A decline in the performance or capital levels of the Bank or the
placement of the Bank into conservatorship or receivership could result in
the automatic exchange of the Series A Preferred Shares for Bank Preferred
Shares; an investment in the Bank involves an investment in a business
that is broader in scope than the business of the Company; it is unlikely
that the Bank would be in a financial position, after the occurrence of an
Automatic Exchange, to make any dividend payments on the Bank Preferred
Shares;
- Possibility that federal regulators of the Bank will impose restrictions
on the operations of the Company or the Company's ability to pay
dividends;
- Possibility that a significant decline in interest rates could have an
adverse effect on the Company's cash flow;
- Since dividends are not cumulative, if no dividend is declared on the
Series A Preferred Shares by the Company for a dividend period, holders of
the Series A Preferred Shares will have no right to receive a dividend for
that period (which would reduce an investor's effective annual yield on
the Series A Preferred Shares under such circumstances);
- Investments in real estate mortgages are subject to price fluctuations
based on changes in interest rates and problems unique to particular
geographic regions where investments may be concentrated;
- Ability of the Company to invest up to 20% of its total assets in
non-mortgage related securities (i.e., other than Residential Mortgage
Loans, Commercial Mortgage Loans and Mortgage-Backed Securities (each, as
described herein)), and in addition cash, cash equivalents and government
securities;
- Possibility of conflicts of interest between the Company and the Bank and
that the ultimate beneficial owners of the Bank's common stock may have
investment goals and strategies that differ from those of the holders of
the Series A Preferred Shares;
- Possibility that the Company will not qualify as a real estate investment
trust for federal income tax purposes; and
- Shares held by any investor in excess of certain ownership limits set
forth in the Company's Articles of Incorporation may be automatically
transferred to a trust.
--------------------------
THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS, DEPOSITS OR OTHER DEBT
OBLIGATIONS OF A BANK OR SAVINGS ASSOCIATION AND ARE NOT INSURED BY
THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE SAVINGS
ASSOCIATION INSURANCE FUND, ANY
GOVERNMENTAL AGENCY OR OTHERWISE
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE TO
PUBLIC UNDERWRITING COMMISSION(1) PROCEEDS TO COMPANY(2)
<S> <C> <C> <C>
Per Share.......................................... $25.00 $ $
Total(3)........................................... $ 31,000,000 $ $
</TABLE>
(1) The Company and the Bank have agreed to indemnify the Underwriters against
certain liabilities, including liabilities under the Securities Act of 1933,
as amended. See "Underwriting."
(2) Before deducting expenses payable by the Company estimated at $825,000 . The
Bank intends to make a capital contribution to the Company equal to such
expenses and the Underwriting Commission. See "Use of Proceeds."
(3) The Company has granted the Underwriters an option for 30 days to purchase
up to an additional 186,000 Series A Preferred Shares, on the same terms and
conditions as set forth above, solely to cover over-allotments, if any. If
such option is exercised in full, the Price to Public, Underwriting
Commission and Proceeds to Company will be $35,650,000, $ and
$ , respectively.
--------------------------
The Series A Preferred Shares are offered by the Underwriters, as specified
herein, subject to receipt and acceptance by them and subject to their right to
reject any order in whole or in part. It is expected that the Series A Preferred
Shares offered hereby will be ready for delivery through the facilities of The
Depository Trust Company in New York, New York, on or about , 1997
against payment therefor in immediately available funds.
SANDLER O'NEILL & PARTNERS, L.P.
----------------
The date of this Prospectus is , 1997.
<PAGE>
Dividends on the Series A Preferred Shares are not cumulative and, if
declared, are payable quarterly in arrears on the last day of March, June,
September and December in each year, commencing , 1997. If no
dividend is declared on the Series A Preferred Shares by the Company for a
quarterly dividend period, holders of the Series A Preferred Shares will have no
right to receive a dividend for that period, and the Company will have no
obligation to pay a dividend for that period, whether or not dividends are
declared and paid for any future period. Dividends in each dividend period shall
accrue from the first day of such period, whether or not declared or paid in the
prior period.
The Series A Preferred Shares are not redeemable prior to , 2002
(except upon the occurrence of a Tax Event or a Change of Control). On and after
, 2002, the Series A Preferred Shares may be redeemed for cash at the
option of the Company, in whole or in part, at any time and from time to time,
at the redemption price of $25.00 per share, plus authorized, declared and
unpaid dividends, if any, to the date fixed for redemption, without interest.
Upon a Change of Control, the Series A Preferred Shares are redeemable at the
option of the Company, in whole, but not in part, at a price per share equal to
(i) $25.00, plus (ii) an amount equal to the authorized, declared and unpaid
dividends, if any, to the date fixed for redemption, without interest, and,
without duplication, an additional amount equal to the amount of dividends that
would be payable on the Series A Preferred Shares in respect of the period from
the first day of the dividend period in which the date fixed for redemption
occurs to the date fixed for redemption (assuming all such dividends were to be
authorized and declared), plus (iii) the Applicable Premium. Any redemption of
Series A Preferred Shares is subject to the prior approval of the Office of
Thrift Supervision (the "OTS"). The Series A Preferred Shares will not be
subject to any sinking fund or mandatory redemption and will not be convertible
into any other securities of the Company.
Each Series A Preferred Share will be exchanged automatically (the
"Automatic Exchange") for one newly issued Series A preferred share (the "Bank
Preferred Shares") of the Bank, if the appropriate federal regulatory agency
directs in writing that an exchange of the Series A Preferred Shares for Bank
Preferred Shares occur because (i) the Bank becomes "undercapitalized" under the
prompt corrective action regulations established pursuant to the Federal Deposit
Insurance Corporation Improvement Act of 1991, as amended ("FDICIA"), (ii) the
Bank is placed into conservatorship or receivership or (iii) the appropriate
federal regulatory agency, in its sole discretion, anticipates the Bank becoming
"undercapitalized" in the near term (an "Exchange Event"). CONSEQUENTLY, AN
INVESTMENT IN SERIES A PREFERRED SHARES COULD BE REPLACED, WITHOUT THE CONSENT
OF THE INVESTOR, BY AN INVESTMENT IN BANK PREFERRED SHARES AT A TIME WHEN THE
BANK'S FINANCIAL CONDITION IS DETERIORATING OR WHEN THE BANK HAS BEEN PLACED
INTO CONSERVATORSHIP OR RECEIVERSHIP. ACCORDINGLY, POTENTIAL INVESTORS IN THE
SERIES A PREFERRED SHARES SHOULD CAREFULLY CONSIDER THE DESCRIPTION OF THE BANK
SET FORTH IN THE OFFERING CIRCULAR, ATTACHED HERETO AS ANNEX I.
In the event of the Automatic Exchange, the Bank Preferred Shares would
constitute a new series of preferred shares of the Bank, would have the same
dividend rights, liquidation preference, redemption options and other attributes
as the Series A Preferred Shares, except that (i) the Bank Preferred Shares
would not be redeemable upon the occurrence of a Tax Event and (ii) the Bank
Preferred Shares would not be listed on a national stock exchange or national
quotation system, and would rank on an equal basis in terms of cash dividend
payments and liquidation preference with any shares of preferred stock of the
Bank outstanding at the time of the Automatic Exchange. Holders of Series A
Preferred Shares cannot exchange their Series A Preferred Shares for Bank
Preferred Shares voluntarily, and, absent the occurrence of the Automatic
Exchange, holders of Series A Preferred Shares will have no dividend, voting,
liquidation preference or other rights with respect to the Bank or any security
of the Bank. See "Description of Series A Preferred Shares--Automatic Exchange."
The Company has been formed for the purpose of acquiring, holding and
managing real estate mortgage assets. The Company expects that all of its
mortgage assets will initially be acquired from the Bank. All of the shares of
the Company's common stock, par value $0.01 per share (the "Common Stock"), are
owned by the Bank. The Bank currently intends that, so long as any Series A
Preferred Shares are outstanding, it will maintain direct or indirect ownership
of at least a majority of the outstanding shares of Common Stock of the Company.
<PAGE>
The Company expects to qualify as a real estate investment trust (a "REIT")
for federal income tax purposes, commencing with the taxable year ending
December 31, 1997, and, as a result, corporate holders of the Series A Preferred
Shares will not be entitled to a dividends received deduction with respect to
any income recognized with respect to the Series A Preferred Shares. Under the
Articles of Incorporation of the Company, as amended and restated (the "Articles
of Incorporation"), subject to certain exceptions, no individual or entity is
permitted to directly or indirectly own more than 7.5% of the aggregate initial
liquidation preference of the issued and outstanding shares of Preferred Stock,
including the Series A Preferred Shares.
Prior to the Offering, there has been no market for the Series A Preferred
Shares. The Company has received approval to list the Series A Preferred Shares
on the Nasdaq National Market, subject to official notice of issuance, under the
symbol "PPCCP." The Bank has registered the Bank Preferred Shares with the OTS,
but does not intend to apply for listing of the Bank Preferred Shares on any
national securities exchange or for quotation of the Bank Preferred Shares
through the Nasdaq System. Consequently, there can be no assurance as to the
liquidity of the trading markets for the Bank Preferred Shares, if issued, or
that an active public market for the Bank Preferred Shares would develop or be
maintained.
IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE SERIES A
PREFERRED SHARES OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE
PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED
AT ANY TIME. CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN
TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE
SERIES A PREFERRED SHARES OFFERED HEREBY. SUCH TRANSACTIONS MAY INCLUDE
STABILIZING THE MARKET PRICE OF THE SERIES A PREFERRED SHARES, THE PURCHASE OF
SERIES A PREFERRED SHARES TO COVER SYNDICATE SHORT POSITIONS AND THE IMPOSITION
OF PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PROSPECTUS SUMMARY........................................................................................ 1
Risk Factors............................................................................................ 1
The Company............................................................................................. 2
The Bank................................................................................................ 4
The Offering............................................................................................ 5
The Formation........................................................................................... 9
Benefits to the Bank.................................................................................... 10
Business and Strategy................................................................................... 11
Tax Status of the Company............................................................................... 14
RISK FACTORS.............................................................................................. 15
The Company's Lack of an Operating History; The Company's Dependence Upon the Bank as Advisor and the
Bank and the Servicing Agent as Servicers............................................................. 15
Potential of Automatic Exchange of Series A Preferred Shares into Bank Preferred Shares When Possibility
of Bank Receivership Exists........................................................................... 15
General............................................................................................... 15
Uncertainty Regarding the Ability of the Bank to Pay Dividends and Make Payments upon Liquidation in
the Event of an Automatic Exchange................................................................... 15
Taxation of Holders of Series A Preferred Shares upon the Occurrence of an Automatic Exchange......... 16
Lack of Liquidity of Bank Preferred Shares in the Event of an Automatic Exchange...................... 16
Concerns Relating to Dividend and Other Regulatory Restrictions with Respect to Operations of the
Company............................................................................................... 16
Oversight by Regulatory Authorities; Ability to Restrict Company Actions.............................. 16
Restrictions Pertaining to Bank Regulatory Capital Requirements....................................... 16
Restrictions Pertaining to Automatic Exchange......................................................... 17
Restrictions Pertaining to Bank Capital Distribution Regulations...................................... 17
Impact of Fluctuations in Interest Rates on the Company's Financial Condition and Results of
Operations............................................................................................ 18
Effect of the Non-Cumulative Nature of the Series A Preferred Shares on the Payment of Dividends........ 18
Credit, Default and Other Risks Associated with Mortgage Loans on the Company's Financial Condition and
Results of Operations................................................................................. 18
Structural Concerns Related to Mortgage Loans......................................................... 18
Real Estate Market Conditions......................................................................... 19
Delays in Liquidating Defaulted Mortgage Loans........................................................ 19
Legal Considerations.................................................................................. 19
Environmental Considerations.......................................................................... 20
Special Considerations Relating to Commercial Mortgage Loans.......................................... 20
Geographic Concentration.............................................................................. 20
Concerns with Respect to the Company's Potential Investment in Mortgage-Backed Securities and Other
Authorized Investments................................................................................ 21
Concerns with Respect to the Purchase of Mortgage Loans from Unaffiliated Third Parties................. 21
Concern as to Possible Future Revisions in Policies and Strategies of the Company's Board of
Directors............................................................................................. 22
Possible Effect of the Company's Use of Leverage on the Company's Financial Condition and Results of
Operations............................................................................................ 22
Relationship with the Bank; Conflicts of Interest....................................................... 22
The Bank as Sole Common Stockholder................................................................... 22
The Bank as Servicer.................................................................................. 22
Potential Conflicts from Parent-Subsidiary Relationship............................................... 22
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Potential Conflicts Concerning Commercial Mortgage Loans.............................................. 23
Parties' Intentions with Respect to Potential Conflicts............................................... 23
Tax Considerations...................................................................................... 23
Adverse Consequences of Failure to Qualify as a REIT.................................................. 23
REIT Requirements with Respect to Stock Ownership..................................................... 24
REIT Requirements with Respect to Stockholder Distributions........................................... 25
Redemption Upon Occurrence of a Tax Event............................................................. 25
Automatic Exchange Upon Occurrence of the Exchange Event.............................................. 25
No Third Party Valuation of the Mortgage Loans; No Arm's-Length Negotiations............................ 25
No Prior Market for Series A Preferred Shares........................................................... 26
THE COMPANY............................................................................................... 27
USE OF PROCEEDS........................................................................................... 28
CAPITALIZATION............................................................................................ 29
BUSINESS AND STRATEGY..................................................................................... 30
General................................................................................................. 30
Dividend Policy......................................................................................... 30
Liquidity and Capital Resources......................................................................... 31
General Description of Mortgage Assets and Other Authorized Investments; Investment Policy.............. 32
Acquisition of Initial Portfolio........................................................................ 34
Management Policies and Programs........................................................................ 35
Description of Initial Portfolio........................................................................ 38
Servicing............................................................................................... 45
Employees............................................................................................... 49
Competition............................................................................................. 49
Legal Proceedings....................................................................................... 49
BENEFICIAL OWNERSHIP OF THE COMPANY....................................................................... 50
MANAGEMENT................................................................................................ 50
Directors and Executive Officers........................................................................ 50
Independent Directors................................................................................... 52
Audit Committee......................................................................................... 53
Compensation of Directors and Officers.................................................................. 53
Limitations on Liability of Directors and Officers...................................................... 53
The Advisor............................................................................................. 53
CERTAIN TRANSACTIONS CONSTITUTING THE FORMATION........................................................... 54
The Formation........................................................................................... 54
Benefits to the Bank.................................................................................... 55
DESCRIPTION OF SERIES A PREFERRED SHARES.................................................................. 57
General................................................................................................. 57
Dividends............................................................................................... 57
Automatic Exchange...................................................................................... 58
Rank.................................................................................................... 59
Voting Rights........................................................................................... 60
Redemption.............................................................................................. 61
Rights Upon Liquidation................................................................................. 63
Independent Director Approval........................................................................... 63
Restrictions on Ownership and Transfer.................................................................. 64
DESCRIPTION OF CAPITAL STOCK.............................................................................. 64
Common Stock............................................................................................ 64
Preferred Stock......................................................................................... 65
Power to Issue Additional Shares of Common Stock and Preferred Stock.................................... 65
Restrictions on Ownership and Transfer.................................................................. 66
Business Combinations................................................................................... 68
</TABLE>
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<TABLE>
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PAGE
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<S> <C>
Control Share Acquisitions.............................................................................. 68
FEDERAL INCOME TAX CONSIDERATIONS......................................................................... 70
Taxation of the Company................................................................................. 70
Failure to Qualify...................................................................................... 74
Tax Treatment of Automatic Exchange..................................................................... 74
Taxation of United States Stockholders.................................................................. 75
Taxation of Foreign Stockholders........................................................................ 76
Information Reporting Requirements and Backup Withholding Tax........................................... 77
Other Tax Consequences.................................................................................. 78
ERISA CONSIDERATIONS...................................................................................... 78
General................................................................................................. 78
Plan Asset Regulation................................................................................... 79
Effect of Plan Asset Status............................................................................. 79
Prohibited Transactions................................................................................. 80
Unrelated Business Taxable Income....................................................................... 80
CERTAIN INFORMATION REGARDING THE BANK.................................................................... 81
General................................................................................................. 81
Ownership Structure..................................................................................... 81
Basis for 1992 Recapitalization......................................................................... 81
Basis for 1995 Recapitalization......................................................................... 82
New Management and Initiatives.......................................................................... 82
Selected Consolidated Financial and Other Data of the Bank.............................................. 85
Risk Factors and Other Considerations................................................................... 87
UNDERWRITING.............................................................................................. 89
EXPERTS................................................................................................... 90
CERTAIN LEGAL MATTERS..................................................................................... 90
ADDITIONAL INFORMATION.................................................................................... 91
GLOSSARY.................................................................................................. 92
INDEX TO FINANCIAL STATEMENT.............................................................................. F-1
ANNEX I--OFFERING CIRCULAR FOR BANK PREFERRED SHARES...................................................... OC-1
</TABLE>
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE DETAILED
INFORMATION APPEARING ELSEWHERE IN THIS PROSPECTUS. SEE "GLOSSARY" COMMENCING AT
PAGE 92 FOR THE DEFINITIONS OF CERTAIN TERMS USED IN THIS PROSPECTUS. THE
OFFERING OF SHARES OF % NONCUMULATIVE EXCHANGEABLE PREFERRED STOCK, SERIES A,
PAR VALUE $0.01 PER SHARE (THE "SERIES A PREFERRED SHARES"), HEREUNDER IS
REFERRED TO HEREIN AS THE "OFFERING." UNLESS OTHERWISE INDICATED, ALL
INFORMATION IN THIS PROSPECTUS ASSUMES THAT THE OVER-ALLOTMENT OPTION DESCRIBED
UNDER THE CAPTION "UNDERWRITING" IS NOT EXERCISED.
RISK FACTORS
Prospective purchasers of the Series A Preferred Shares should carefully
read all of the information set forth in this Prospectus and, in particular,
should evaluate the specific factors under "Risk Factors" commencing on page 15
for risks involved with an investment in the Series A Preferred Shares. Among
such risks are the following:
- The Company is a newly organized corporation with no operating history
and, consequently, no historical financial or operating information is
available for use by prospective purchasers of the Series A Preferred
Shares in making their investment decision.
- The Company will be dependent in virtually every phase of its operations
on the diligence and skill of the officers, employees and agents of the
Bank. The Company believes that the unavailability or the unexpected loss
of the services of such officers, employees and agents could have a
material adverse effect upon the Company.
- A decline in the performance or capital levels of the Bank or the
placement of the Bank into conservatorship or receivership could lead to
an Exchange Event which would require an exchange of the Series A
Preferred Shares for Bank Preferred Shares (which would represent an
investment in the Bank and not in the Company). It is unlikely that the
Bank would be in a financial position, after the occurrence of an
Automatic Exchange, to make any dividend payments on the Bank Preferred
Shares. In addition, an investment in the Bank involves an investment in a
business that is broader in scope than the business of the Company. The
Bank is required to, among other things, maintain certain minimum capital
levels and comply with other federal regulatory requirements applicable to
the Bank. In addition, the Bank's overall profitability depends on the
performance of the Bank's loan portfolio and the Bank's reliance on
non-interest income. See "Risk Factors-- Potential of Automatic Exchange
of Series A Preferred Shares into Bank Preferred Shares When Possibility
of Bank Receivership Exists."
- As a subsidiary of the Bank, the Company is subject to the possibility
that federal regulators will restrict the ability of the Company to
transfer assets, to make distributions to stockholders, including
dividends to the holders of Series A Preferred Shares, or to redeem shares
of Preferred Stock. Under certain circumstances, certain of these
restrictions could result in the Company's failure to qualify as a REIT,
which could have an adverse effect on the Company's financial condition
and results of operations.
- Because the rate at which dividends are required to be paid is fixed, a
significant decline in interest rates might adversely affect the amount of
the Company's interest income on its assets and therefore its ability to
pay dividends on the Series A Preferred Shares.
- Dividends are not cumulative. Consequently, if the Board of Directors does
not authorize and declare a dividend on the Series A Preferred Shares for
any quarterly period, including if prevented by federal regulators from
paying such dividend, the holders thereof would not be entitled to recover
such dividend whether or not funds are or subsequently become available.
The Board of Directors may determine that it would be in the best
interests of the Company to pay less than the full amount of the stated
dividends on the Series A Preferred Shares or no dividends for any
1
<PAGE>
quarter, notwithstanding that funds are available (which would reduce an
investor's effective annual yield on the Series A Preferred Shares under
such circumstances). To remain qualified as a REIT, however, the Company
must distribute annually at least 95% of its REIT taxable income to
stockholders. The Company expects that the Board of Directors will
authorize dividends on the Series A Preferred Shares quarterly.
- Investments in Mortgage Loans generally are subject to price fluctuations
based on changes in interest rates and problems unique to particular
geographic regions, such as California, where the Company's Mortgage Loans
are concentrated, which could adversely affect the (i) value of the
Mortgage Assets held by the Company and thereby the value of the Series A
Preferred Shares and (ii) the ability of the Company to pay dividends on
the Series A Preferred Shares.
- Because of the relationship between the Company and the Bank, conflicts of
interest may arise between the Bank and the Company. These potential
conflicts arise from the Bank's position as the sole holder of outstanding
voting stock of the Company, the fact that the Bank will act as Advisor
and Servicer (with respect to the Company's Commercial Mortgage Loans),
and it may have interests in such capacities that are not identical to
those of the Company. Although it is the intention of the Company and the
Bank that any agreements and transactions between the Company and the Bank
be fair to all parties, no assurance can be made that such agreements and
transactions will, in all cases, be on terms as favorable to the Company
as those that could have been obtained from unaffiliated third parties.
See "Risk Factors--Relationships with the Bank; Conflicts of Interest,"
and "Business and Strategy--Management Policies and Programs."
- If the Company fails to maintain its status as a REIT, distributions to
its stockholders will not be deductible for federal (or California state)
income tax purposes, which could have an adverse effect on the Company's
financial condition and results of operations.
- The Company's Articles of Incorporation provide that, subject to certain
exceptions, no individual or entity is permitted to own, or be deemed to
own by virtue of the attribution rules of the Code (as defined herein),
more than 7.5% of the aggregate initial liquidation value of the issued
and outstanding shares of Preferred Stock of the Company, including the
Series A Preferred Shares. Any Series A Preferred Shares held by any
individual or entity in violation of the foregoing limits will be
automatically transferred to a trust for the exclusive benefit of a
charity to be named by the Company. See "Description of Capital
Stock--Restrictions on Ownership and Transfer."
- Although the Series A Preferred Shares will be listed on the Nasdaq
National Market, the Bank does not intend to apply for listing of the Bank
Preferred Shares upon the occurrence of an Exchange Event on any national
securities exchange or automated quotation system. Consequently, there can
be no assurance as to the liquidity of the trading market for the Bank
Preferred Shares, if issued, or that an active public market for the Bank
Preferred Shares would develop or be maintained. The lack of liquidity and
an active public market could adversely affect prospective investors'
ability to dispose of the Bank Preferred Shares.
THE COMPANY
The Company is a Maryland corporation incorporated in June 1997 for the
purpose of acquiring, holding and managing Mortgage Assets and Other Authorized
Investments. The Company will elect to be subject to tax as a REIT under the
Internal Revenue Code of 1986, as amended (the "Code"), and, as a result,
distributions of its earnings to its stockholders will be deductible by the
Company for federal (as well as California state) income tax purposes to the
extent it maintains its qualification as a REIT. All of the shares of the
Company's Common Stock are owned by the Bank. The Bank currently intends that,
so long as any Series A Preferred Shares are outstanding, it will maintain
direct or indirect ownership of at least a majority of the outstanding shares of
Common Stock of the Company.
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Simultaneously with the consummation of the Offering, the Bank, as owner of
the Company's Common Stock, will make a capital contribution to the Company
equal to approximately $31.3 million. The Bank will also make additional capital
contributions to the Company in an amount equal to the aggregate amount of
underwriting commissions and expenses incurred by the Company in connection with
the Offering (including, without limitation, any underwriting commissions
associated with any exercise by the Underwriters of their over-allotment option)
and all expenses incurred by the Company in connection with its formation in
order to provide the Company with funds sufficient to pay such expenses. The
Company will use the aggregate net proceeds of approximately $62.3 million
received in connection with both the Offering and the capital contribution by
the Bank to purchase the Initial Portfolio from the Bank. The Company will use
the additional proceeds from any such additional sales of Series A Preferred
Shares and capital contributions to purchase additional Mortgage Assets and
otherwise to make Other Authorized Investments. See "Use of Proceeds."
The Company and the Bank are undertaking the Offering for the following
principal reasons: (i) the Offering will strengthen the Bank's regulatory
capital position, as $28.4 million of the proceeds from the Series A Preferred
Shares will qualify as core capital of the Bank under relevant federal
regulatory capital guidelines; (ii) the Offering will provide the Bank with the
opportunity to expand its business and thereby increase its earnings, which
would permit accelerated utilization of existing net operating loss
carryforwards; and (iii) dividends paid on the Series A Preferred Shares will,
as a result of the Company's qualification as a REIT, be tax deductible in
computing the REIT's taxable income. The Bank has determined to organize a REIT,
instead of directly selling mortgage-backed securities, because it believes that
the REIT transaction is a cost-effective way to raise capital and, as referenced
above, to obtain favorable regulatory capital treatment from its federal
regulators. See "Certain Transactions Constituting the Formation--Benefits to
the Bank" and "Pro Forma Regulatory Capital" in the Offering Circular attached
as Annex I hereto.
Upon the occurrence of an Exchange Event, each Series A Preferred Share will
be exchanged automatically for one newly issued Bank Preferred Share.
CONSEQUENTLY, AN INVESTMENT IN SERIES A PREFERRED SHARES COULD BE REPLACED,
WITHOUT THE CONSENT OF THE INVESTOR, BY AN INVESTMENT IN BANK PREFERRED SHARES
AT A TIME WHEN THE BANK'S FINANCIAL CONDITION IS DETERIORATING OR THE BANK HAS
BEEN PLACED INTO CONSERVATORSHIP OR RECEIVERSHIP. ACCORDINGLY, POTENTIAL
INVESTORS IN THE SERIES A PREFERRED SHARES SHOULD CAREFULLY CONSIDER THE
DESCRIPTION OF THE BANK SET FORTH IN THE OFFERING CIRCULAR ATTACHED HERETO AS
ANNEX I. See also "Description of Series A Preferred Shares--Automatic
Exchange."
An Exchange Event is likely to occur if the Bank becomes undercapitalized.
The Bank will be considered to be "undercapitalized" under the current prompt
corrective action regulations if it has (i) a core capital (or leverage) ratio
of less than 4.0%, (ii) a Tier 1 risk-based capital ratio of less than 4.0% or
(iii) a total risk-based capital ratio of less than 8.0%. Core capital generally
consists of common stockholder's equity, noncumulative perpetual preferred
stock, and minority interests in consolidated subsidiaries, less certain
intangible assets and investments in certain subsidiaries. The minimum
risk-based capital requirement represents the ratio of total capital (core
capital plus supplementary capital) to risk-weighted assets (which equals assets
plus the credit risk equivalent of certain off-balance sheet items, each
multiplied by the appropriate risk weight). Supplementary capital includes,
among other things, certain qualifying subordinated debt and a portion of the
general loan loss allowance. For purposes of the prompt corrective action
regulations, the Bank's capital category is determined as of the most recent
date (i) certain quarterly financial reports are required to be filed with the
regulators, (ii) a final report of examination has been delivered to the Bank or
(iii) the Bank is notified in writing by the OTS of its capital category or a
change in such category. At June 30, 1997 and December 31, 1996, 1995 and 1994,
the Bank's core capital (or leverage) ratio was 4.76%, 4.57%, 4.18% and 1.08%,
respectively, its Tier 1 risk-based capital ratio was 9.65%, 9.15%, 7.56% and
2.01%, respectively, and its total risk-based capital ratio was
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<PAGE>
10.91%, 10.38%, 8.43% and 2.76%, respectively. After giving effect to the
Offering, on a pro forma basis, the Bank's core (or leverage) capital, Tier 1
risk-based capital and total risk-based capital ratios at June 30, 1997 would
have been 6.35%, 12.88% and 14.13%, respectively. After the Offering, the Bank's
capital ratios are expected to decrease as the Bank expands its business and,
thus, its total assets. The Bank currently intends, by managing its growth
following the Offering, to maintain its capital ratios in excess of the
"well-capitalized" levels under the prompt corrective action regulations.
However, there can be no assurance that the Bank will be able to maintain such
capital levels. See "Certain Information Regarding the Bank--Risk Factors and
Other Considerations--Regulatory Capital Levels" and "Pro Forma Regulatory
Capital" in the Offering Circular attached as Annex I hereto.
The principal executive offices of the Company are located at 5900 Wilshire
Boulevard, Los Angeles, California 90036, and the telephone number is (213)
938-6300.
THE BANK
The Bank, formerly named Southern California Federal Savings and Loan
Association, is a federally chartered and insured stock savings bank which is
wholly owned by SoCal Holdings, Inc. ("SOCAL"). At June 30, 1997, SOCAL had
total assets of $1.8 billion and total stockholders' equity of $72.5 million.
The common stock of SOCAL is (i) 60% owned by the Trustees of the Estate of
Bernice Pauahi Bishop, also known as Kamehameha Schools Bernice Pauahi Bishop
Estate (the "Bishop Estate"), a charitable educational trust established under
Hawaii law, (ii) 30% owned by BIL Securities (Offshore) Limited ("BIL
Securities"), a wholly owned subsidiary of Brierley Investments Limited, a New
Zealand corporation, and (iii) 10% owned by Arbur, Inc. ("Arbur"), a Delaware
corporation. The preferred stock of SOCAL is owned approximately (i) 67% by the
Bishop Estate, (ii) 24.8% by BIL Securities and (iii) 8.2% by Arbur.
The Bishop Estate operates under the terms of the will (the "Will") of
Bernice Pauahi Bishop, and is one of the largest private landowners in the State
of Hawaii. Under the terms of the Will, revenues in excess of expenses from the
Bishop Estate are used to fund the operations of and maintain The Kamehameha
Schools which are located on the islands of Hawaii.
Brierley Investments Limited is a publicly held investment corporation which
is traded on the New Zealand and Australian stock exchanges. At June 30, 1997,
Brierley Investments Limited had approximately $5.4 billion in total assets,
$2.5 billion in total liabilities and $2.9 billion in total equity (all of which
amounts have been converted into U.S. dollars).
Arbur is a closely held Delaware-chartered corporation which is wholly owned
by William E. Simon and his children. William E. Simon is the former U.S.
Secretary of the Treasury.
At June 30, 1997, the Bank conducted business from 19 full service offices
located primarily in Los Angeles County as well as Orange and Ventura Counties
in Southern California. At June 30, 1997, the Bank had total assets of $1.8
billion, total deposits of $1.3 billion and total stockholder's equity of $84.9
million. As of December 31, 1996, the Bank had $146.7 million of federal net
operating loss carryforwards and $8.7 million of state net operating loss
carryforwards which are available, subject to certain limitations, to offset
federal and state taxable income. See "Taxation" in the Offering Circular
attached as Annex I hereto. For the six months ended June 30, 1997 and the year
ended December 31, 1996, the Bank had net earnings of $6.9 million and $13.6
million and a return on average assets of 0.77% and 0.78%, respectively. See
"Certain Information Regarding the Bank--Selected Consolidated Financial Data."
The Bank Preferred Shares will only be issued upon the occurrence of an
Exchange Event. Pursuant to applicable law, the Bank Preferred Shares will not
be registered with the Securities and Exchange Commission (the "Commission") but
are being registered with the OTS. A copy of the Offering Circular filed with
the OTS relating to the Bank Preferred Shares is affixed to this Prospectus as
Annex I. The principal executive offices of the Bank are located at 5900
Wilshire Boulevard, Los Angeles, California 90036, and the telephone number at
such address is (213) 938-6300.
4
<PAGE>
THE OFFERING
For a more complete description of the terms of the Series A Preferred
Shares specified in the following summary, see "Description of Series A
Preferred Shares."
<TABLE>
<S> <C>
Issuer............................ People's Preferred Capital Corporation, a newly formed
Maryland corporation created for the purpose of
acquiring, holding and managing Mortgage Assets and
Other Authorized Investments.
Securities Offered................ 1,240,000 Series A Preferred Shares. The Company has
granted the Underwriters an option for 30 days to
purchase up to an additional 186,000 Series A Preferred
Shares at the initial public offering price solely to
cover over-allotments, if any.
Ranking........................... With respect to the payment of dividends and amounts
upon liquidation, the Series A Preferred Shares will
rank senior to the Company's Common Stock. As long as
any Series A Preferred Shares remain outstanding,
additional shares of Preferred Stock ranking senior to
the Series A Preferred Shares may not be issued without
the approval of the holders of at least two-thirds of
the Series A Preferred Shares. As long as any Series A
Preferred Shares remain outstanding, additional shares
of Preferred Stock ranking on a parity with the Series A
Preferred Shares may not be issued without the approval
of a majority of the Independent Directors. See
"Description of Series A Preferred Shares--Independent
Director Approval."
Use of Proceeds................... The net proceeds to the Company from the Offering,
together with proceeds received as capital contributions
from the Bank, will be used to purchase the Company's
Initial Portfolio of Mortgage Assets and to pay the
expenses of the Offering and the formation of the
Company (currently estimated by the Company to be
approximately $825,000 in the aggregate). See "Use of
Proceeds."
Dividends......................... Dividends are noncumulative and will be payable at the
rate of % per annum of the initial liquidation
preference (equivalent to $ per share per annum)
if, when and as authorized and declared by the Board of
Directors. If the Board of Directors does not authorize
and declare a dividend with respect to any quarterly
dividend period (each, a "Dividend Period"), holders of
the Series A Preferred Shares will have no right to
receive a dividend on the Series A Preferred Shares in
respect of such Dividend Period. Dividends are payable,
if authorized and declared, quarterly in arrears (pro
rated for any Dividend Period that is other than three
full months based on a 360-day year of twelve 30-day
months) on March 31, June 30, September 30 and December
31 (or, if any such day is not a business day, on the
next business day) in each year, (each such date a
"Dividend Payment Date") beginning , 1997.
Quarterly Dividend Periods will commence on and include
the first day, and end on
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5
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<S> <C>
and include the last day, of the calendar quarter in
which the corresponding Dividend Payment Date occurs.
If any Series A Preferred Shares are outstanding, no
full dividends or other distributions shall be
authorized, declared or paid or set apart for payment on
any Junior Stock for any Dividend Period unless full
dividends have been or contemporaneously are authorized,
declared and paid, or authorized and declared and a sum
sufficient for the payment thereof is set apart for such
payments on the Series A Preferred Shares for the
then-current Dividend Period. When dividends are not
paid in full (or a sum sufficient for such full payment
is not so set apart) for any Dividend Period upon the
Series A Preferred Shares and the shares of any Parity
Stock, all dividends authorized and declared on the
Series A Preferred Shares and the shares of Parity Stock
shall only be authorized or declared PRO RATA based upon
the respective amounts that would have been paid on the
Series A Preferred Shares and any shares of Parity Stock
had dividends been authorized and declared in full.
In addition to the foregoing restriction, the Company
shall not authorize, declare, pay or set apart funds for
any dividends or other distributions (other than in
Common Stock or other Junior Stock) with respect to any
Common Stock or other Junior Stock or repurchase, redeem
or otherwise acquire, or set apart funds for repurchase,
redemption or other acquisition of, any Common Stock or
other Junior Stock through a sinking fund or otherwise,
unless and until (i) full dividends on the Series A
Preferred Shares for the four most recent preceding
Dividend Periods (or such lesser number of Dividend
Periods during which shares of Series A Preferred Shares
have been outstanding) are authorized, declared and paid
or a sum sufficient for payment has been paid over to
the dividend disbursing agent for payment of such
dividends and (ii) the Company has authorized and
declared a cash dividend on the Series A Preferred
Shares at the annual dividend rate for the then-current
Dividend Period, and sufficient funds have been paid
over to the dividend disbursing agent for the payment of
such cash dividend for such then current Dividend
Period.
No dividend shall be paid or set aside for holders of
Series A Preferred Shares for any Dividend Period unless
full dividends have been paid or set aside for the
holders of each class or series of equity securities, if
any, ranking prior to the Series A Preferred Shares as
to dividends for such Dividend Period. The Company
currently does not have any series of equity securities
outstanding that ranks prior to the Series A Preferred
Shares as to dividends and the Company currently has no
intention to issue any such securities. See "Description
of Series A Preferred Shares--Dividends."
</TABLE>
6
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<TABLE>
<S> <C>
Liquidation Preference............ The liquidation preference for each Series A Preferred
Share is $25.00, plus an amount equal to the quarterly
accrued and unpaid dividends, if any, thereon with
respect to the then-current Dividend Payment, but
without accumulation of unpaid dividends for prior
Dividend Periods. See "Description of Series A Preferred
Shares--Rights Upon Liquidation."
Redemption........................ The Series A Preferred Shares are not redeemable prior
to , 2002 (except upon the occurrence of a Tax
Event or a Change of Control). On and after ,
2002, the Series A Preferred Shares may be redeemed for
cash at the option of the Company, in whole or in part,
at any time and from time to time, at the redemption
price of $25.00 per share, plus authorized, declared and
unpaid dividends, if any, to the date fixed for
redemption, without interest.
Upon a Change of Control, the Series A Preferred Shares
are redeemable at the option of the Company, in whole,
but not in part, at a price per share equal to (i)
$25.00, plus (ii) an amount equal to the authorized,
declared and unpaid dividends, if any, to the date fixed
for redemption, without interest, and, without
duplication, an additional amount equal to the amount of
dividends that would be payable on the Series A
Preferred Shares in respect of the period from the first
day of the Dividend Period in which the date fixed for
redemption occurs to the date fixed for redemption
(assuming all such dividends were to be authorized and
declared), plus (iii) the Applicable Premium. Any
redemption of Series A Preferred Shares is subject to
the prior approval of the OTS.
Upon the occurrence of a Tax Event, the Company will
have the right at any time to redeem the Series A
Preferred Shares in whole, but not in part, at a
redemption price of $25.00 per share, plus the accrued
and unpaid dividends, if any, to the date fixed for
redemption, without interest.
Any redemption of Series A Preferred Shares is subject
to compliance with applicable regulatory and other
restrictions, including the prior approval of the OTS.
The Series A Preferred Shares will not be subject to any
sinking fund or mandatory redemption and will not be
convertible into any other securities of the Company.
See "Description of Series A Preferred
Shares--Redemption."
Automatic Exchange................ Each Series A Preferred Share will be exchanged
automatically for one newly issued Bank Preferred Share
if the appropriate federal regulatory agency directs in
writing that an exchange of the Series A Preferred
Shares for Bank Preferred Shares occur because of any of
the following: (i) the Bank becomes "undercapitalized"
under prompt corrective action regulations established
pursuant to FDICIA, (ii) the Bank is placed into
conservatorship or receivership or (iii) the appropriate
federal regulatory agency, in its sole discretion,
anticipates the Bank
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7
<PAGE>
<TABLE>
<S> <C>
becoming "undercapitalized" in the near term. Upon an
Exchange Event, each holder of Series A Preferred Shares
shall be unconditionally obligated to surrender to the
Bank all certificates representing the Series A
Preferred Shares of such holder, and the Bank shall be
unconditionally obligated to issue to such holder, in
exchange for such certificate(s), a certificate or
certificates representing an equal number of Bank
Preferred Shares.
Holders of Bank Preferred Shares would have the same
dividend rights, liquidation preference, redemption
options and other attributes as to the Bank as holders
of Series A Preferred Shares have as to the Company. Any
accrued and unpaid dividends on the Series A Preferred
Shares as of the time of exchange would be deemed to be
accrued and unpaid dividends on the Bank Preferred
Shares. The Bank Preferred Shares would rank on an equal
basis in terms of dividend payments and liquidation
preference with any then-outstanding shares of preferred
stock of the Bank. See "Description of Series A
Preferred Shares-- Automatic Exchange."
Voting Rights..................... Except as described herein or as may be required by law,
holders of Series A Preferred Shares will not have any
voting rights. In any matter on which the Series A
Preferred Shares may vote, each Series A Preferred Share
will be entitled to one vote. See "Description of Series
A Preferred Shares--Voting Rights."
Tax Consequences.................. As long as the Company qualifies as a REIT, corporate
holders of the Series A Preferred Shares will not be
entitled to a dividends-received deduction with respect
to any income recognized with respect to the Series A
Preferred Shares.
Independent Directors............. The Articles of Incorporation provide that, as long as
any Series A Preferred Shares are outstanding, certain
actions by the Company must be approved by a majority of
the Independent Directors. As long as there are only two
Independent Directors, any action that requires the
approval of a majority of Independent Directors must be
approved by both Independent Directors. In order to be
considered "independent," a director must not be a
current employee or officer of the Company or a current
employee, officer or director of the Bank or any other
affiliate of the Bank. In addition, any members of the
Board of Directors of the Company elected by holders of
Preferred Stock, including the Series A Preferred
Shares, will be deemed to be Independent Directors for
purposes of approving actions requiring the approval of
a majority of the Independent Directors.
The actions which require approval of a majority of the
Independent Directors include: (i) the issuance of
additional Preferred Stock ranking on a parity with the
Series A Preferred Shares; (ii) the incurrence of debt
for borrowed money in excess of 20% of the Company's
total stockholders' equity; (iii) the
</TABLE>
8
<PAGE>
<TABLE>
<S> <C>
acquisition of assets other than Mortgage Loans,
Mortgage-Backed Securities or Other Authorized
Investments; (iv) the termination or modification of, or
the election not to renew, the Advisory Agreement or any
Servicing Agreement or the subcontracting of any duties
under the Advisory Agreement or the Servicing Agreements
(other than as specifically contemplated in connection
with the Offering) to third parties unaffiliated with
the Bank; (v) any material amendment to or modification
of either of the Mortgage Purchase Agreements; (vi) the
determination to revoke the Company's REIT status; and
(vii) any dissolution, liquidation or termination of the
Company prior to , 2002. The Articles of
Incorporation provide that the Independent Directors
will consider the interests of holders of both the
Common Stock and the Preferred Stock, including the
Series A Preferred Shares, in determining whether any
proposed action requiring their approval is in the best
interests of the Company.
Ownership Limits.................. In order to reduce the likelihood that the Company's
status as a REIT for federal income tax purposes is
jeopardized, the Articles of Incorporation provide that,
subject to certain exceptions, no individual or entity
may own, or be deemed to own by virtue of the
attribution rules of the Code, more than 7.5% of the
aggregate initial liquidation value of the issued and
outstanding shares of Preferred Stock, including the
Series A Preferred Shares. The transfer of any shares of
Preferred Stock, including the Series A Preferred Shares
(including the occurrence of events other than actual
transfers of Preferred Stock that result in changes in
constructive ownership of Preferred Stock), in violation
of the Ownership Limit will cause the shares of
Preferred Stock owned, or deemed to be owned, by or
transferred to a stockholder in excess of such Ownership
Limit to be automatically transferred to a trust for the
exclusive benefit of a charitable beneficiary to be
named by the Company. All rights to dividends to such
shares will be held by such trust. See "Description of
Capital Stock--Restrictions on Ownership and Transfer."
Trading........................... The Company has received approval to list the Series A
Preferred Shares on the Nasdaq National Market, subject
to official notice of issuance, under the symbol
"PPCCP."
</TABLE>
THE FORMATION
Prior to or simultaneously with the completion of the Offering, the Company
and the Bank will engage in the transactions described under "Certain
Transactions Constituting the Formation--The Formation." These transactions are
designed (i) to facilitate the Offering, (ii) to transfer the ownership of the
Initial Portfolio to the Company and (iii) to enable the Company to qualify as a
REIT for federal income tax purposes commencing with its taxable year ending
December 31, 1997.
9
<PAGE>
The following chart outlines the relationship between the Company and the
Bank following completion of the Offering (without giving effect to the expenses
of the Offering).
[CHART]
BENEFITS TO THE BANK
The Bank expects to realize the following benefits (which are described in
more detail under "Certain Transactions Constituting the Formation--Benefits to
the Bank") in connection with the Offering and other transactions constituting
the formation of the Company:
- The Bank has advised the Company that the Bank expects a portion of the
Series A Preferred Shares to qualify as core capital of the Bank under
relevant regulatory capital guidelines. The increase in the Bank's core
capital and risk-based capital levels will enable the Bank to originate or
acquire additional interest-earning assets, which management expects will
result in incrementally higher related earnings.
- The dividends paid on the Series A Preferred Shares will be deductible for
income tax purposes as a result of the Company's qualification as a REIT,
which provides the Bank with a more cost-effective means of obtaining
regulatory capital than if the Bank were to issue preferred stock.
- The Bank will receive approximately $62.3 million in connection with the
sale of the Initial Portfolio to the Company (approximately $29.0 million
of which represents new funds after giving effect to the Bank's expense of
purchasing the Company's Common Stock and additional capital
contributions).
- The Bank will be entitled to receive annual advisory and servicing fees
and annual dividends in respect of the Common Stock. For the first 12
months following completion of the Offering, these annual fees and
dividends are anticipated to be approximately $234,000 and $ ,
respectively. See "Business and Strategy--Dividend Policy," "--Servicing"
and "Management--The Advisor."
- The Bank also will be entitled to retain any ancillary fees, including,
but not limited to, late payment charges, penalties and assumption fees
collected in connection with the Commercial Mortgage Loans serviced by the
Bank. In addition, the Bank will receive any benefit derived from interest
earned on collected principal and interest payments between the date of
collection and the date of
10
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remittance to the Company and from interest earned on tax and insurance
impound funds with respect to Commercial Mortgage Loans serviced by the
Bank. The Bank's designated Servicing Agent (as defined herein) will be
entitled to receive the fees and other described associated benefits for
servicing the Residential Mortgage Loans held by the Company.
BUSINESS AND STRATEGY
GENERAL. The Company's principal business objective is to acquire, hold and
manage Mortgage Assets and Other Authorized Investments that will generate net
income for distribution to stockholders. The Company expects that all of its
Mortgage Assets will be acquired from the Bank or purchased from unaffiliated
third parties as whole loans ("Mortgage Loans") secured by first mortgages or
deeds of trust on single-family (one- to four-unit) residential real estate
properties ("Residential Mortgage Loans") or by multi-family residential and
commercial properties (collectively, "Commercial Mortgage Loans"). Although the
Company has the authority to acquire an unlimited number of Residential Mortgage
Loans and Commercial Mortgage Loans from unaffiliated third parties, such as
other financial institutions and mortgage banks, all of the Initial Portfolio
will be acquired from the Bank. Nevertheless, the Initial Portfolio is expected
to include 10 loans aggregating $777,900 which were purchased by the Bank from
unaffiliated financial institutions and 51 loans aggregating $3.2 million which
were originated by financial institutions which were subsequently acquired by
the Bank. With respect to Mortgage Loans which were purchased by the Bank from
unaffiliated third parties, the Bank evaluated the documentation relating to
each purchased loan and management believes that each such loan was originated
in a manner consistent with the underwriting standards of the Bank. Such
Mortgage Loans which the Bank acquired through acquisitions of other financial
institutions all have been owned by the Bank for over 10 years and are seasoned
and performing loans. The Company has no present plans or expectations with
respect to purchases from unaffiliated third parties. The Company may also from
time to time acquire mortgage-backed securities either issued or guaranteed by
agencies of the federal government or government sponsored agencies or issued by
third parties (including the Bank) and rated investment grade by at least one
nationally recognized independent rating organization and representing interests
in or obligations backed by pools of Mortgage Loans ("Mortgage-Backed
Securities"). Mortgage Loans underlying the Mortgage-Backed Securities will be
secured by single-family residential, multifamily or commercial real estate
properties located in the United States. The Company also has the ability to
acquire any non-mortgage related securities, in an amount equal to 20% of the
value of the Company's total assets ("Other Authorized Investments.")
The Company expects that all Mortgage Loans to be acquired by the Company
will be whole loans, will represent first lien positions and will be acquired on
a basis consistent with general loan sale transactions conducted in the
secondary market. Management believes that the Mortgage Loans to be included in
the Initial Portfolio have been, and management currently intends that Mortgage
Loans acquired in the future will have been, originated and underwritten in
conformity with standards generally applied by the Bank at the time the Mortgage
Loans were originated. The Company's current policy prohibits the acquisition of
any Mortgage Loan or any interest in a Mortgage Loan (other than an interest
resulting from the acquisition of Mortgage-Backed Securities), in which the
Mortgage Loan (i) is delinquent in the payment of principal or interest; (ii) is
or was at any time during the preceding 12 months (a) Classified, (b) in
Nonaccrual Status, or (c) renegotiated due to financial deterioration of the
borrower; or (iii) has been, more than once during the preceding 12 months, more
than 30 days past due in the payment of principal or interest.
INITIAL PORTFOLIO. The Mortgage Loans expected to be included in the
Initial Portfolio had an aggregate outstanding principal balance of $62.3
million (as of June 30, 1997). As of June 30, 1997, the Initial Portfolio
consisted of approximately 78.2% (measured by outstanding principal balance) of
Residential Mortgage Loans and approximately 21.8% of Commercial Mortgage Loans.
See "Business and
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Strategy--Description of the Initial Portfolio--Residential Mortgage Loans" and
"--Commercial Mortgage Loans." The Bank will enter into a servicing agreement
with respect to the Commercial Mortgage Loans (the "Commercial Servicing
Agreement") pursuant to which it will service the Commercial Mortgage Loans held
by the Company and will be entitled to receive fees in connection with the
servicing of such Commercial Mortgage Loans. In March 1997, the Bank sold the
servicing rights with respect to substantially all of its Residential Mortgage
Loans, including all of the Residential Mortgage Loans to be included in the
Initial Portfolio, to Temple Inland Mortgage Corporation (the "Servicing
Agent"), a wholly owned subsidiary of Guaranty Federal Bank, F.S.B., which is
wholly owned by Temple-Inland Inc., an unrelated third party.
In connection with the Bank's sale of servicing, the Bank in March 1997
entered into a servicing agreement with the Servicing Agent (the "Residential
Servicing Agreement"), pursuant to which the Servicing Agent will service
substantially all of the Bank's Residential Mortgage Loans. Pursuant to an
Assignment, Assumption and Recognition Agreement to be entered into between the
Company, the Bank and the Servicing Agent (the "Residential Assumption Servicing
Agreement"), the Servicing Agent will service the Residential Mortgage Loans
which will be sold by the Bank to the Company, in accordance with the terms of
the Residential Servicing Agreement.
The Servicing Agent will be entitled to receive fees in connection with the
servicing of such Residential Mortgage Loans. The Residential Servicing
Agreement and the Commercial Servicing Agreement are collectively referred to as
the "Servicing Agreements." The Bank, in its role as servicer under the
Commercial Servicing Agreement, and the Servicing Agent, in its role as servicer
under the Residential Servicing Agreement, are hereinafter referred to
individually as the "Servicer" and collectively as the "Servicers." In addition,
the Bank, in its capacity as Servicer under the Commercial Servicing Agreement,
may, from time to time, subject to approval of a majority of the Independent
Directors, subcontract all or a portion of its obligations thereunder. See
"Business and Strategy--Servicing."
The purchase price of the Initial Portfolio will equal the net book value of
the Mortgage Loans included in the Initial Portfolio as of the date of closing
of the transaction. As of June 30, 1997, the book value of such Mortgage Loans
amounted to approximately $62.3 million. However, no independent third party
valuations of the Mortgage Loans constituting the Initial Portfolio have been or
will be obtained for purposes of the Offering. See "Risk Factors--No Third Party
Valuation of the Mortgage Loans; No Arm's-Length Negotiations."
ADVISORY AGREEMENT. The Company will enter into an advisory agreement with
the Bank (the "Advisory Agreement") pursuant to which the Bank will administer
the day-to-day operations of the Company. The Bank in its role as advisor under
the terms of the Advisory Agreement is hereinafter referred to as the "Advisor."
The Advisor will be responsible for, among other things: (i) monitoring the
credit quality of Mortgage Assets and Other Authorized Investments held by the
Company; (ii) advising the Company with respect to the acquisition, management,
financing and disposition of the Company's Mortgage Assets and Other Authorized
Investments; and (iii) representing the Company in its day-to-day dealings with
persons with whom the Company interacts. In performing its duties under the
Advisory Agreement, the Advisor is required to act in a manner that is
consistent with maintaining the Company's qualification as a REIT. The Advisor
may from time to time subcontract all or a portion of its obligations under the
Advisory Agreement to one or more of its affiliates involved in the business of
managing Mortgage Assets and Other Authorized Investments. The Advisor may, with
the approval of a majority of the Board of Directors, as well as a majority of
the Independent Directors, subcontract all or a portion of its obligations under
the Advisory Agreement to unrelated third parties. The Advisor will not, in
connection with the subcontracting of any of its obligations under the Advisory
Agreement, be discharged or relieved in any respect from its obligations under
the Advisory Agreement. The Advisor and its personnel have substantial
experience in mortgage finance and in the administration of Mortgage Loans and
Other Authorized Investments.
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The Advisory Agreement has an initial term of five years, and will be
renewed automatically for additional five-year periods unless notice of
nonrenewal is delivered to the Advisor by the Company. The Advisory Agreement
may be terminated by the Company at any time upon 90 days' prior notice. As long
as any Series A Preferred Shares remain outstanding, any decision by the Company
either not to renew the Advisory Agreement or to terminate the Advisory
Agreement must be approved by a majority of the Board of Directors, as well as
by a majority of the Independent Directors. The Advisor will be entitled to
receive an annual advisory fee equal to $200,000. See "Management--The Advisor."
See "Certain Transactions Constituting the Formation--Benefits to the Bank"
for information regarding the aggregate amounts payable to the Bank in
connection with the Offering and the transactions to be entered into in
connection with the Offering.
MANAGEMENT. The Company's Board of Directors is composed of seven members,
two of whom will be Independent Directors. Certain actions by the Company
require the prior approval of a majority of Independent Directors. As long as
there are only two Independent Directors, any action that requires the approval
of a majority of the Independent Directors must be approved by both Independent
Directors. Pursuant to the Articles of Incorporation, the Independent Directors
are required to take into account the interests of the holders of both the
Preferred Stock, including the Series A Preferred Shares, and the Common Stock
in assessing the benefit to the Company of any proposed action requiring their
approval. The Company currently has four officers. The Company has no other
employees and does not anticipate that it will require additional employees. See
"Management."
ADDITIONAL INVESTMENT. The Company may from time to time purchase
additional Mortgage Loans, Mortgage-Backed Securities or Other Authorized
Investments out of proceeds received in connection with the repayment or
disposition of Mortgage Loans, Mortgage-Backed Securities, Other Authorized
Investments or the issuance of additional shares of Common Stock or Preferred
Stock. Additional shares of Preferred Stock ranking senior to the Series A
Preferred Shares may not be issued by the Company without the approval of the
holders of at least two-thirds of the outstanding Series A Preferred Shares.
Additional shares of Preferred Stock ranking on a parity with the Series A
Preferred Shares may not be issued by the Company without the approval of a
majority of the Independent Directors. See "Description of Series A Preferred
Shares--Voting Rights" and "--Independent Director Approval." The Company does
not currently intend to issue any additional shares of Preferred Stock unless it
simultaneously receives additional capital contributions from the Bank equal to
the sum of the aggregate offering price of such additional Preferred Stock and
the Company's expenses (including any underwriting commissions or placement
fees) incurred in connection with the issuance of such additional shares of
Preferred Stock. The Company anticipates that, prior to its issuance of
additional shares of Preferred Stock, it will take into consideration, among
other things, the Bank's regulatory capital requirements and an assessment of
other available options for raising any necessary capital. The Company currently
anticipates that substantially all of the Mortgage Loans that it may acquire in
the future will be purchased from the Bank, although the Company may acquire
Mortgage Loans from unaffiliated third parties (subject in all cases to
satisfaction of the Company's underwriting standards). See "Certain Transactions
Constituting the Formation--Benefits to the Bank."
NEWLY FORMED ENTITY. As a newly formed entity, the Company has no prior
operating history. Immediately after the issuance by the Company of the Series A
Preferred Shares to the public and the Common Stock to the Bank and the purchase
by the Company of the Initial Portfolio, the Company (assuming that (i) the
Underwriters' over-allotment option is not exercised and (ii) there are $2.0
million in aggregate Offering and organizational expenses) will have
approximately $62.3 million in Mortgage Assets, $12,400 of stated capital
attributable to the Series A Preferred Shares, $100 of stated capital
attributable to the Common Stock and approximately $62.3 million of additional
paid-in capital. See "Capitalization."
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TAX STATUS OF THE COMPANY
The Company will elect to be taxed as a REIT under Sections 856 through 860
of the Code, commencing with its taxable year ending December 31, 1997. As a
REIT, the Company generally will not be subject to federal (as well as
California state) income tax on net income and capital gains that it distributes
to the holders of its Common Stock and Preferred Stock, including the Series A
Preferred Shares.
The Company has received a legal opinion from its counsel, Elias, Matz,
Tiernan & Herrick L.L.P., to the effect that, based upon the Code,
administrative rulings, judicial decisions and regulations, all as in effect as
of the date of such opinion, commencing with the taxable year ending December
31, 1997, the Company will be owned and organized in such a manner as to qualify
as a REIT, and its proposed method of operation will enable it to meet the
requirements for qualification and taxation as a REIT. The opinion received by
the Company is based upon certain factual assumptions relating to the
organization and operation of the Company, and the composition of its assets,
and is conditioned upon certain representations made by the Company as to
factual matters, such as the organization and expected manner of operation of
the Company. The Company's qualification and taxation as a REIT depends upon the
Company's ability to meet, through actual annual operating results, distribution
levels and diversity of stock ownership, the various qualification tests imposed
under the Code. No assurance can be given that the actual results of the Company
for any one taxable year will satisfy the REIT requirements. Notwithstanding
qualification for taxation as a REIT, the Company may be subject to certain
state and/or local taxes on its income and property and federal income and
excise taxes on its undistributed income. See "Risk Factors--Tax Considerations"
and "Federal Income Tax Considerations."
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RISK FACTORS
PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING INFORMATION IN
CONJUNCTION WITH THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS BEFORE
PURCHASING SERIES A PREFERRED SHARES IN THE OFFERING. FOR A DESCRIPTION OF
CERTAIN RISK FACTORS RELATING TO THE BANK AND THE BANK PREFERRED SHARES,
PROSPECTIVE INVESTORS SHOULD CAREFULLY REVIEW AND CONSIDER THE INFORMATION
CONTAINED IN THE SECTION ENTITLED "RISK FACTORS" IN THE ATTACHED OFFERING
CIRCULAR. THIS PROSPECTUS CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS AND
INFORMATION RELATING TO THE COMPANY THAT ARE BASED ON THE BELIEFS OF MANAGEMENT
AS WELL AS ASSUMPTIONS MADE BY AND INFORMATION CURRENTLY AVAILABLE TO
MANAGEMENT. IN ADDITION, IN THOSE AND OTHER PORTIONS OF THIS DOCUMENT, THE WORDS
"ANTICIPATE," "BELIEVE," "ESTIMATE," "EXPECT," "INTEND," "SHOULD" AND SIMILAR
EXPRESSIONS, OR THE NEGATIVE THEREOF, AS THEY RELATE TO THE COMPANY OR THE
COMPANY'S MANAGEMENT, ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. SUCH
STATEMENTS REFLECT THE CURRENT VIEWS OF THE COMPANY WITH RESPECT TO
FUTURE-LOOKING EVENTS AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND
ASSUMPTIONS, INCLUDING THE RISK FACTORS DESCRIBED IN THIS PROSPECTUS. SHOULD ONE
OR MORE OF THESE RISKS OR UNCERTAINTIES MATERIALIZE, OR SHOULD UNDERLYING
ASSUMPTIONS PROVE INCORRECT, ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE
DESCRIBED HEREIN AS ANTICIPATED, BELIEVED, ESTIMATED, EXPECTED OR INTENDED. THE
COMPANY DOES NOT INTEND TO UPDATE THESE FORWARD-LOOKING STATEMENTS.
THE COMPANY'S LACK OF AN OPERATING HISTORY; THE COMPANY'S DEPENDENCE UPON THE
BANK AS ADVISOR AND THE BANK AND THE SERVICING AGENT AS SERVICERS
The Company is a newly organized corporation with no operating history and
no revenues to date and, consequently, no historical financial or operating
information is available for use by prospective purchasers of the Series A
Preferred Shares in making their investment decisions. The Company will be
dependent for the selection, structuring and monitoring of its Mortgage Assets
and Other Authorized Investments on the diligence and skill of its officers (all
of whom are also officers of the Bank) and the officers and employees of the
Bank, as Advisor. The Advisor may, subject to the approval of a majority of the
Independent Directors, subcontract all or a portion of its obligations under the
Advisory Agreement to non-affiliates involved in the business of managing
Mortgage Assets. The Company will also be dependent upon the expertise of the
Bank and the Servicing Agent, as Servicers, for the servicing of its Commercial
Mortgage Loans and Residential Mortgage Loans, respectively. In addition, the
Bank, in its capacity as Servicer under the Commercial Servicing Agreement, may,
from time to time, subject to the approval of a majority of the Independent
Directors, subcontract all or a portion of its obligations thereunder. The
Company will be dependent upon any other subcontractor that may be utilized in
the future. The Company believes that the unavailability or the unexpected loss
of the services of the officers and employees of the Bank, as Advisor and
Servicer, could have a material adverse effect upon the Company. See
"Management--The Advisor" and "Business and Strategy--Servicing."
POTENTIAL OF AUTOMATIC EXCHANGE OF SERIES A PREFERRED SHARES INTO BANK PREFERRED
SHARES WHEN POSSIBILITY OF BANK RECEIVERSHIP EXISTS
GENERAL. The returns from an investment in the Series A Preferred Shares
will be dependant to a significant extent on the performance and capital levels
of the Bank. A decline in the performance and capital levels of the Bank or the
placement of the Bank into conservatorship or receivership could result in the
exchange of the Series A Preferred Shares for Bank Preferred Shares, which would
be an investment in the Bank and not in the Company. As a result, holders of
Series A Preferred Shares would become preferred stockholders of the Bank at a
time when the Bank's financial condition has deteriorated or when the Bank has
been placed into conservatorship or receivership. Potential investors in the
Series A Preferred Shares should carefully consider the risks with respect to an
investment in the Bank set forth under "Certain Information Regarding the
Bank--Risk Factors and Other Considerations." See also "Description of Series A
Preferred Shares--Automatic Exchange."
UNCERTAINTY REGARDING THE ABILITY OF THE BANK TO PAY DIVIDENDS AND MAKE
PAYMENTS UPON LIQUIDATION IN THE EVENT OF AN AUTOMATIC EXCHANGE. An investment
in the Bank involves an investment in a business that
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is broader in scope than the business of the Company. The Bank is required to,
among other things, maintain certain minimum capital levels and comply with
other regulatory requirements applicable to the Bank. In addition, the Bank's
overall profitability depends on the performance of the Bank's loan portfolio
and the Bank's reliance on non-interest income. As with equity investments in
depository institutions generally, in the event of a liquidation of the Bank,
the claims of depositors and creditors of the Bank would be entitled to a
priority of payment over the claims of holders of equity interests such as the
Bank Preferred Shares. As a result of such subordination, if the Bank were to be
placed into receivership (whether before or after the Automatic Exchange), the
holders of the Bank Preferred Shares likely would receive, if anything,
substantially less than the holders of the Series A Preferred Shares would have
received had the Series A Preferred Shares not been exchanged for Bank Preferred
Shares. Furthermore, it is unlikely that the Bank would be in a financial
position, after the occurrence of the Automatic Exchange, to make any dividend
payments on the Bank Preferred Shares.
TAXATION OF HOLDERS OF SERIES A PREFERRED SHARES UPON THE OCCURRENCE OF AN
AUTOMATIC EXCHANGE. An exchange of the Series A Preferred Shares for Bank
Preferred Shares would be a taxable event under the Code to each holder of the
Series A Preferred Shares. Each holder of the Series A Preferred Shares would
incur a gain or loss, as the case may be, measured by the difference between the
basis of such holder in the Series A Preferred Shares and the fair market value
of the Bank Preferred Shares received in the exchange. See "Federal Income Tax
Consequences--Tax Treatment of Automatic Exchange." Potential investors in the
Series A Preferred Shares should carefully consider the risks with respect to an
investment in the Bank set forth under "Certain Information Regarding the
Bank--Risk Factors and Other Considerations." See also "Description of Series A
Preferred Shares--Automatic Exchange."
LACK OF LIQUIDITY OF BANK PREFERRED SHARES IN THE EVENT OF AN AUTOMATIC
EXCHANGE. Although the Series A Preferred Shares will be listed on the Nasdaq
National Market, the Bank does not intend to apply for listing of the Bank
Preferred Shares on any national securities exchange or for quotation of the
Bank Preferred Shares through the Nasdaq National Market. Consequently, there
can be no assurance as to the liquidity of the trading markets for the Bank
Preferred Shares, if issued, or that an active public market for the Bank
Preferred Shares would develop or be maintained. The lack of liquidity and an
active public market could adversely affect prospective investors' ability to
dispose of the Bank Preferred Shares.
CONCERNS RELATING TO DIVIDEND AND OTHER REGULATORY RESTRICTIONS WITH RESPECT TO
OPERATIONS OF THE COMPANY
OVERSIGHT BY REGULATORY AUTHORITIES; ABILITY TO RESTRICT COMPANY
ACTIONS. Because the Company is a subsidiary of the Bank, regulatory
authorities will have the right to examine the Company and its activities. Under
certain circumstances, including any determination that the Bank's relationship
to the Company results in an unsafe and unsound banking practice, such
regulatory authorities will have the authority to restrict the ability of the
Company to transfer assets, to make distributions to its stockholders (including
dividends to the holders of Series A Preferred Shares) or to redeem shares of
Preferred Stock, or even to require the Bank to sever its relationship with or
divest its ownership of the Company. Such actions could potentially result in
the Company's failure to qualify as a REIT, which could have an adverse effect
on the Company's financial condition and results of operations. See "--Tax
Considerations."
RESTRICTIONS PERTAINING TO BANK REGULATORY CAPITAL REQUIREMENTS. Payment of
dividends on the Series A Preferred Shares could also be subject to regulatory
limitations if the Bank becomes "undercapitalized" for purposes of the OTS
prompt corrective action regulations, which is currently defined as having a
total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital
ratio of less than 4.0% and a core capital (or leverage) ratio of less than
4.0%. At June 30, 1997, the Bank's total risk-based capital ratio was 10.91%,
its Tier 1 risk-based capital ratio was 9.65% and its core capital (or leverage)
ratio was 4.76%. Such ratios, on a pro forma basis as of June 30, 1997 after
giving effect to the Offering, would have been 14.13%, 12.88% and 6.35%,
respectively. After the Offering, the Bank's capital ratios are expected to
decrease as
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the Bank expands its business and, thus, its total assets. The Bank currently
intends, by managing its growth following the Offering, to maintain its capital
ratios in excess of the "well-capitalized" levels under the prompt corrective
action regulations. However, there can be no assurance that the Bank will be
able to maintain such capital levels. In addition, federal regulatory
authorities would have the authority to restrict the ability of the Company to
pay dividends to its stockholders if such dividend payments were inconsistent
with the safe and sound operation of the Bank. See "Certain Information
Regarding the Bank--Risk Factors and Other Considerations--Regulatory Capital
Levels" and "Pro Forma Regulatory Capital" in the Offering Circular attached as
Annex I hereto.
RESTRICTIONS PERTAINING TO AUTOMATIC EXCHANGE. If the Automatic Exchange
were to occur, the Bank would likely be prohibited from paying dividends on the
Bank Preferred Shares. In all circumstances following the Automatic Exchange,
the Bank's ability to pay dividends would be subject to various restrictions
under OTS regulations. In addition, in the event of a liquidation of the Bank,
the claims of the Bank's depositors and of its creditors would be entitled to a
priority of payment over the dividend and other claims of holders of equity
interests such as the Bank Preferred Shares issued pursuant to the Automatic
Exchange.
RESTRICTIONS PERTAINING TO BANK CAPITAL DISTRIBUTION REGULATIONS. Under OTS
regulations, the ability of thrift institutions such as the Bank to make
"capital distributions" (defined to include payment of dividends, stock
repurchases, cash-out mergers and other distributions charged against the
capital accounts of an institution) varies depending primarily on the
institution's earnings and regulatory capital levels. While the Company believes
that dividends on the Series A Preferred Shares should not be considered
"capital distributions" for this purpose, there can be no assurances that the
OTS would agree with this position. However, without addressing the issue of
whether dividends on the Series A Preferred Shares are "capital distributions"
subject to the regulations, the Company believes that the OTS would not object
to the Company's payment of quarterly dividends on the Series A Preferred Shares
in an amount up to the amount of the Company's net income for that quarter. The
Company currently expects that its net income will be in excess of amounts
needed to pay dividends on the Series A Preferred Shares. See "Business and
Strategy--Dividend Policy."
Dividends on the Series A Preferred Shares in excess of the Company's net
income could be treated as "capital distributions" by the OTS, in which case the
Company's payment of such dividends would be subject to restrictions under the
OTS capital distribution regulations. Under these regulations, institutions are
divided into three categories, or tiers. Tier 1 institutions are those in
compliance with their "fully phased-in" capital requirements and which have not
been notified by the OTS that they are "in need of more than normal
supervision." Tier 1 institutions may make capital distributions without
regulatory approval of up to the greater of (i) 100% of net income for the
calendar year to date, plus up to one-half of the institution's surplus capital
(i.e., the excess of capital over the fully phased-in requirement) at the
beginning of the calendar year in which the distribution is made or (ii) 75% of
net income for the most recent four quarters. Tier 1 institutions that make
capital distributions under the foregoing rules must continue to meet the
applicable capital requirements on a pro forma basis after giving effect to such
distributions. Tier 1 institutions may seek OTS approval to pay dividends beyond
these amounts.
The category of Tier 2 institutions, which are defined as institutions that
are in compliance with their current, but not their "fully phased-in" capital
requirements, is no longer relevant because all deductions from capital
requirements have been fully phased-in as of July 1, 1996.
Tier 3 institutions have capital levels below their current required minimum
levels and may not make any capital distributions without the prior written
approval of the OTS.
As of June 30, 1997, on the basis of the Bank's capital levels, the Bank was
a Tier 1 institution. However, the OTS retains discretion under its capital
distribution regulations to treat an institution that it believes is in need of
more than normal supervision (after written notice) as a Tier 3 institution.
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The OTS retains general discretion to prohibit any otherwise permitted
capital distribution on general safety and soundness grounds and must be given
30 days advance notice of all capital distributions.
IMPACT OF FLUCTUATIONS IN INTEREST RATES ON THE COMPANY'S FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company's income will consist primarily of interest payments on the
Mortgage Loans held by it. While the Company anticipates that all of the
Residential Mortgage Loans and Commercial Mortgage Loans included in the Initial
Portfolio will bear interest at fixed rates, the Company may purchase Mortgage
Loans in the future which will bear interest at adjustable rates. Adjustable
rate loans decrease the risks to a lender associated with changes in interest
rates but involve other risks, primarily because as interest rates rise, the
payment by the borrower rises to the extent permitted by the terms of the loan,
thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected by higher
interest rates. In a declining interest rate environment, the Company may
experience an increase in prepayments on its Mortgage Loans as borrowers
refinance their mortgages at lower interest rates. Under such circumstances, the
Company may find it more difficult to purchase additional Mortgage Loans bearing
rates sufficient to support payment of the dividends on the Series A Preferred
Shares. In addition, certain Residential Mortgage Loan products which the
Company may purchase in the future could allow borrowers in such an interest
rate environment to convert an adjustable rate mortgage to a fixed rate
mortgage, "locking in" a lower fixed interest rate. Because the rate at which
dividends are required to be paid on the Series A Preferred Shares is fixed,
there can be no assurance that an interest rate environment in which there is a
significant decline in interest rates would not adversely affect the Company's
ability to pay dividends on the Series A Preferred Shares.
EFFECT OF THE NON-CUMULATIVE NATURE OF THE SERIES A PREFERRED SHARES ON THE
PAYMENT OF DIVIDENDS
In order to qualify as Tier 1 capital, dividends on the Series A Preferred
Shares are not cumulative. Consequently, if the Board of Directors does not
authorize and declare a dividend on the Series A Preferred Shares for any
quarterly period, including in the event the Company is prevented from paying
such dividend by the OTS, the holders of the Series A Preferred Shares would not
be entitled to recover such dividend whether or not funds are or subsequently
became available. The Board of Directors may determine that it would be in the
best interests of the Company to pay less than the full amount of the stated
dividends on the Series A Preferred Shares or no dividends for any quarter
notwithstanding that funds are available. Factors that would generally be
considered by the Board of Directors in making this determination are the
Company's financial condition and capital needs, the impact of legislation and
regulations as then in effect or as may be proposed, economic conditions and
such other factors as the Board may deem relevant. Notwithstanding the
foregoing, to remain qualified as a REIT, the Company must distribute annually
at least 95% of its "REIT taxable income" (as defined herein) to stockholders.
See "--Tax Considerations," below and "Federal Income Tax
Considerations--Taxation of the Company-- Organizational Requirements."
CREDIT, DEFAULT AND OTHER RISKS ASSOCIATED WITH MORTGAGE LOANS ON THE COMPANY'S
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
An investment in the Series A Preferred Shares may be affected by, among
other things, a decline in real estate values. In the event the Mortgage Assets
held by the Company become nonperforming, the Company may not have funds
sufficient to pay dividends on the Series A Preferred Shares. Factors that could
affect the value of the Mortgage Assets held by the Company include the
following:
STRUCTURAL CONCERNS RELATED TO MORTGAGE LOANS. The Company generally does
not intend to obtain credit enhancements such as mortgagor bankruptcy insurance
or to obtain special hazard insurance for its Mortgage Loans, other than
standard hazard insurance, which will in each case only relate to individual
Mortgage Loans. Accordingly, during the time it holds Mortgage Loans for which
third party insurance is
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not obtained, the Company will be subject to risks of borrower defaults and
bankruptcies and special hazard losses that are not covered by standard hazard
insurance (such as those occurring from earthquakes). In addition, in the event
of a default on any Mortgage Loan held by the Company resulting from declining
property values or worsening economic conditions, among other factors, the
Company would bear the risk of loss of principal to the extent of any deficiency
between (i) the value of the related mortgaged property, plus any payments from
an insurer (or guarantor in the case of Commercial Mortgage Loans) and (ii) the
amount owing on the Mortgage Loan.
REAL ESTATE MARKET CONDITIONS. The results of the Company's operations will
be affected by various factors, many of which are beyond the control of the
Company, such as: (i) local and other economic conditions affecting real estate
values; (ii) the ability of tenants to make lease payments; (iii) the ability of
a property to attract and retain tenants, which may in turn be affected by local
conditions such as an oversupply of space or a reduction in demand for rental
space in the area, the attractiveness of properties to tenants, competition from
other available space, the ability of the owner to pay leasing commissions,
provide adequate maintenance and insurance, pay tenant improvement costs and
make other tenant concessions; (iv) interest rate levels and the availability of
credit to refinance such loans at or prior to maturity; and (v) increased
operating costs, including energy costs, real estate taxes and costs of
compliance with environmental controls and regulations. The results of the
Company's operations will depend on, among other things, the level of interest
income generated by the Company's Mortgage Assets and Other Authorized
Investments, the market value of such Mortgage Assets and Other Authorized
Investments and the supply of and demand for such Mortgage Assets and Other
Authorized Investments. Further, no assurance can be given that the values of
the properties securing the Mortgage Loans included in the Company's Initial
Portfolio have remained or will remain at the levels existing on the dates of
origination of such Mortgage Loans.
DELAYS IN LIQUIDATING DEFAULTED MORTGAGE LOANS. Even assuming that the
mortgaged properties underlying the Mortgage Loans held by the Company provide
adequate security for such Mortgage Loans, substantial delays could be
encountered in connection with the liquidation of defaulted Mortgage Loans, with
corresponding delays in the receipt of related proceeds by the Company. An
action to foreclose on a mortgaged property securing a Mortgage Loan is
regulated by state statutes and rules and is subject to many of the delays and
expenses of other lawsuits if defenses or counterclaims are interposed,
sometimes requiring several years to complete. Furthermore, in California, an
action to obtain a deficiency judgment is generally not permitted in connection
with a Mortgage Loan, the funds of which were used to purchase an owner-occupied
one-to-four family residence or following a nonjudicial sale of any mortgaged
property. California law also requires the Mortgage Loan beneficiary to exhaust
all real property security in a single action (i.e., a judicial foreclosure)
before a deficiency judgment may be sought against the borrower. In the event of
a default by a mortgagor, these restrictions, among other things, may impede the
ability of the Company to foreclose on or sell the mortgaged property or to
obtain proceeds sufficient to repay all amounts due on the related Mortgage
Loan. In addition, the Servicers will be entitled to deduct from collections
received all expenses reasonably incurred in attempting to recover amounts due
and not yet repaid on liquidated Mortgage Loans, including legal fees and costs
of legal action, real estate taxes and maintenance and preservation expenses,
thereby reducing amounts available to the Company.
LEGAL CONSIDERATIONS. Applicable state laws may regulate interest rates and
other charges and require certain disclosures to borrowers. However, under
California law, financial institutions such as the Bank which originate mortgage
loans secured by property located in California are exempt from California usury
laws. In addition, most states have other laws, public policy and general
principles of equity relating to the protection of consumers, unfair and
deceptive practices and practices which may apply to the servicing and
collection of the Mortgage Loans. Depending on the provisions of the applicable
law and the specific facts and circumstances involved, violations of these laws,
policies and principles may limit the ability of the Company to collect all or
part of the principal of or interest on the Mortgage Loans, may entitle the
borrower to a refund of amounts previously paid and, in addition, could subject
the Company to damages
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and administrative sanctions. For example, the California Civil Code prohibits
the use of threats, harassment, or other deceptive practices in the collection
of consumer debts, which include Residential Mortgage Loans secured by
owner-occupied properties. A violation of the California Fair Debt Collection
Practices could result in the liability of the owner or servicer of a Mortgage
Loan to the debtor for actual damages sustained by the debtor as a result of
such violation, in addition to a penalty of not less than $100 nor greater than
$1,000. In addition, in California, legal and equitable principles require good
faith and fair dealing by lenders and require lenders to exercise their rights
and remedies under the Mortgage Loan documents only in circumstances in which it
is commercially reasonable to do so, in good faith and in a manner that is
lawful and commercially reasonable.
ENVIRONMENTAL CONSIDERATIONS. In the event that the Company is forced to
foreclose on a defaulted Mortgage Loan to recover its investment in such
Mortgage Loan, the Company may be subject to environmental liabilities in
connection with the underlying real property which could exceed the value of the
real property. Although the Company intends to exercise due diligence to
discover potential environmental liabilities prior to the acquisition of any
property through foreclosure, hazardous substances or wastes, contaminants,
pollutants or sources thereof (as defined by state and federal laws and
regulations) may be discovered on properties during the Company's ownership or
after a sale thereof to a third party. If such hazardous substances are
discovered on a property which the Company has acquired in foreclosure or
otherwise, the Company may be required to remove those substances and clean up
the property. There can be no assurance that in such a case the Company would
not incur full recourse liability for the entire cost of any removal and
clean-up, that the cost of such removal and clean-up would not exceed the value
of the property or that the Company could recoup any of such costs from any
third party. The Company may also be liable to tenants and other users of
neighboring properties. In addition, the Company may find it difficult or
impossible to sell the property prior to or following any such clean-up.
SPECIAL CONSIDERATIONS RELATING TO COMMERCIAL MORTGAGE LOANS. Based on the
outstanding principal balance of the Mortgage Loans to be included in the
Initial Portfolio as of June 30, 1997, the Company anticipates that
approximately 21.8% (measured by aggregate outstanding principal amount) of the
Initial Portfolio of Mortgage Assets will consist of Commercial Mortgage Loans.
The Company's current policy is not to acquire any Commercial Mortgage Loan if
such Commercial Mortgage Loan would constitute more than 5.0% of the total book
value of the Mortgage Assets of the Company at the time of its acquisition.
Commercial Mortgage Loans have certain distinct risk characteristics and
generally lack standardized terms, which may complicate their structure.
Commercial real estate properties themselves tend to be unique and are more
difficult to value than single-family residential real estate properties.
Commercial Mortgage Loans also tend to have shorter maturities than Residential
Mortgage Loans and may not be fully amortizing, meaning that they may have a
significant principal balance or "balloon" payment due on maturity. In addition,
commercial real estate properties are generally subject to relatively greater
environmental risks than non-commercial properties and to the corresponding
burdens and costs of compliance with environmental laws and regulations. See
"--Environmental Considerations." Also, there may be costs and delays involved
in enforcing rights of a property owner against tenants in default under the
terms of leases with respect to commercial properties. For example, tenants may
seek the protection of the bankruptcy laws, which could result in termination of
lease contracts.
GEOGRAPHIC CONCENTRATION. Certain geographic regions of the United States
may from time to time experience natural disasters or weaker regional economic
conditions and housing markets, and, consequently, may experience higher rates
of loss and delinquency on Mortgage Loans generally. Any concentration of the
Mortgage Loans in such a region may present risks in addition to those present
with respect to Mortgage Loans generally. Substantially all of the residential
properties underlying the Company's Residential Mortgage Loans and substantially
all of the multi-family residential and commercial properties underlying its
Commercial Mortgage Loans which are included in the Initial Portfolio are
located in California. Consequently, the Mortgage Loans may be subject to a
greater risk of default than other comparable Mortgage Loans in the event of
adverse economic, political or business developments or
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natural hazards that may affect California and the ability of property owners in
California to make payments of principal and interest on the underlying
mortgages. The Company complies with general hazard insurance policy
requirements of the Federal National Mortgage Association ("FNMA") or the
Federal Home Loan Mortgage Corporation ("FHLMC"). The Company will not maintain
any special hazard insurance policies which could mitigate any damages caused by
natural disasters (such as earthquakes and floods) which may occur in
California. In the event of any such natural disaster, the Company's ability to
pay dividends on the Series A Preferred Shares could be adversely affected. See
"Business and Strategy--Description of Initial Portfolio--Geographic
Distribution" herein for further information regarding the geographic
concentration of the Mortgage Loans to be included in the Initial Portfolio.
CONCERNS WITH RESPECT TO THE COMPANY'S POTENTIAL INVESTMENT IN MORTGAGE-BACKED
SECURITIES AND OTHER AUTHORIZED INVESTMENTS
The Company may from time to time acquire Mortgage-Backed Securities
representing interests in or obligations backed by pools of Mortgage Loans. The
Company intends to acquire only investment grade Mortgage-Backed Securities or
those issued or guaranteed by agencies of the federal government or government
sponsored agencies. The Mortgage Loans underlying the Mortgage-Backed Securities
will be secured by single-family residential, multi-family or commercial real
estate properties located throughout the United States. The Company does not
intend to acquire any interest-only, principal-only or high-risk Mortgage-Backed
Securities. In addition, the Company is authorized to invest up to 20% of the
total value of its portfolio in Other Authorized Investments, which may consist
of, among other things, any note, stock, treasury stock, debenture, evidence of
indebtedness, or certificate of interest or participation in any profit sharing
agreement or a group or index of securities. The Company intends to make
investments in financial service-related industries in which Management believes
it has expertise and to make investments generally made by financial
institutions. In addition, the value of any one issuer's securities may not
exceed 5% of the total assets of the Company and the Company may not own more
than 10% of the voting securities of any one issuer.
CONCERNS WITH RESPECT TO THE PURCHASE OF MORTGAGE LOANS FROM UNAFFILIATED THIRD
PARTIES
The Company has the authority to acquire an unlimited number of Residential
Mortgage Loans and Commercial Mortgage Loans from unaffiliated third parties
such as other financial institutions and mortgage banks. Although all of the
Initial Portfolio will be acquired from the Bank, the Initial Portfolio is
expected to include 10 loans aggregating $777,900 which were purchased by the
Bank from unaffiliated financial institutions and 51 loans aggregating $3.2
million which were originated by financial institutions which were subsequently
acquired by the Bank. With respect to Mortgage Loans which were purchased by the
Bank from unaffiliated third parties, the Bank evaluated the documentation
relating to each purchased loan and management believes that each such loan was
originated in a manner consistent with the underwriting standards of the Bank.
Such Mortgage Loans which the Bank acquired through acquisitions of other
financial institutions all have been owned by the Bank for over 10 years and are
seasoned and performing loans. The Company expects to purchase products similar
to those originated by the Bank to the extent that any such purchases from
unaffiliated third parties are undertaken. In order to minimize the risks of
purchasing loans originated by other parties as to whom the Company has no
oversight or control, to the extent that the Company undertakes any future
purchases from unaffiliated third parties, the Company will evaluate the
documentation relating to each loan that is being considered for purchase to
verify whether such loan was originated in a manner that was consistent with the
underwriting standards of the Bank. The Company only intends to purchase loans
originated under substantially similar standards.
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CONCERN AS TO POSSIBLE FUTURE REVISIONS IN POLICIES AND STRATEGIES OF THE
COMPANY'S BOARD OF DIRECTORS
The Board of Directors has established the investment policies and operating
policies and strategies of the Company, which are described in this Prospectus.
These policies may be amended or revised from time to time at the discretion of
the Board of Directors without a vote of the Company's stockholders, including
holders of the Series A Preferred Shares. Such a change could have a material
effect on the business and operations of the Company. The ultimate effect of any
change in the policies and strategies set forth in this Prospectus on a holder
of Series A Preferred Shares may be positive or negative. See "Business and
Strategy--Management Policies and Programs."
POSSIBLE EFFECT OF THE COMPANY'S USE OF LEVERAGE ON THE COMPANY'S FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Although the Company does not currently intend to incur any indebtedness in
connection with the acquisition and holding of Mortgage Loans, the Company may
do so at any time (although indebtedness in excess of 20% of the Company's
stockholders' equity may not be incurred without the approval of a majority of
the Independent Directors of the Company). To the extent the Company were to
change its policy with respect to the incurrence of indebtedness, the Company's
financial condition and results of operations would be subject to changes in
interest rates, prepayment risk and concerns associated with the use of various
hedging strategies. In addition, if the Company were to become predominantly
held by tax-exempt employee pension trusts and to incur indebtedness, then under
certain circumstances, a percentage of distributions to such tax-exempt employee
pension trusts may be treated as unrelated business taxable income. See "Federal
Income Tax Considerations--Taxation of United States Stockholders."
RELATIONSHIP WITH THE BANK; CONFLICTS OF INTEREST
THE BANK AS SOLE COMMON STOCKHOLDER. The Bank is involved in virtually
every aspect of the Company's existence. The Bank is the sole holder of the
Common Stock of the Company and administers the day-to-day activities of the
Company in its role as Advisor under the Advisory Agreement. In addition, other
than the Independent Directors, all of the officers and directors of the Company
are also officers and directors of the Bank. As the holder of all of the
outstanding voting stock of the Company, the Bank will have the right to elect
all directors of the Company, including the Independent Directors, except under
limited circumstances with respect to the Company's failure to pay dividends.
THE BANK AS SERVICER. The Bank is responsible for servicing the Company's
Commercial Mortgage Loans in its role as Servicer under the Commercial Servicing
Agreement. See "Business and Strategy-- Servicing" for a discussion of the
Residential Servicing Agreement with a non-affiliated party with respect to the
Residential Mortgage Loans.
POTENTIAL CONFLICTS ARISING FROM PARENT-SUBSIDIARY RELATIONSHIP. The
Company is dependent on the diligence and skill of its officers and the officers
and employees of the Bank for the selection, structuring and monitoring of its
Mortgage Assets and Other Authorized Investments. In addition, the Company is
dependent on the Bank and the Servicing Agent for the servicing of its Mortgage
Loans. The Bank and the Servicing Agent may have interests which are not
identical to those of the Company and the ultimate owners of the Bank's common
stock may have investment goals and strategies that differ from those of the
holders of the Series A Preferred Shares. Consequently, conflicts of interest
may arise with respect to, among other things, the Company's acquisition of the
Initial Portfolio; future acquisitions of Mortgage Loans from the Bank;
servicing of Mortgage Loans, particularly with respect to Mortgage Loans that
are placed in Nonaccrual Status; future dispositions of Mortgage Loans to the
Bank; and the modification of the Advisory Agreement or the Servicing
Agreements.
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POTENTIAL CONFLICTS CONCERNING COMMERCIAL MORTGAGE LOANS. Conflicts of
interest may arise between the Bank and the Company with respect to the
Commercial Mortgage Loans included in the Initial Portfolio. The Company's
interest will be limited to its interest in the Commercial Mortgage Loans, but
the Bank may have other interests as a result of the Bank's overall relationship
with mortgagors in the course of its commercial lending business as lender with
respect to other outstanding loans to such mortgagors. The Bank in its role as
Advisor and Servicer may be subject to conflicts of interest with respect to
Commercial Mortgage Loans, in the event that any such loan is placed in
Nonaccrual Status. As a result of such potential conflicts, the Company may hold
a Commercial Mortgage Loan for a shorter or longer period of time than would
otherwise be the case if the Bank were not the Servicer of the Commercial
Mortgage Loan or the Advisor to the Company.
PARTIES' INTENTIONS WITH RESPECT TO POTENTIAL CONFLICTS. It is the
intention of the Company and the Bank that any agreements and transactions
between the Company, on the one hand, and the Bank, on the other hand, be fair
to all parties and consistent with market terms, including the prices paid and
received for Mortgage Loans, including those in the Initial Portfolio, on their
acquisition or disposition by the Company or in connection with the servicing of
such Mortgage Loans. The requirement in the Articles of Incorporation that
certain actions of the Company be approved by a majority of the Independent
Directors is also intended to ensure fair dealings between the Company and the
Bank. However, there can be no assurance that such agreements or transactions
will be on terms as favorable to the Company as those that could have been
obtained from unaffiliated third parties. See "Business and Strategy--Management
Policies and Programs--Conflict of Interest Policies."
TAX CONSIDERATIONS
ADVERSE CONSEQUENCES OF FAILURE TO QUALIFY AS A REIT. The Company intends
to operate so as to qualify as a REIT under the Code, commencing with its
taxable year ending December 31, 1997. Although the Company believes that it
will be owned and organized and will operate in such a manner, no assurance can
be given that the Company will be able to operate in such a manner so as to
qualify as a REIT or to remain so qualified. Qualification as a REIT involves
the application of highly technical and complex Code provisions for which there
are only limited judicial or administrative interpretations and involves the
determination of various factual matters and circumstances not entirely within
the Company's control. The Taxpayer Relief Act of 1997 includes several
provisions which liberalize certain of the requirements to qualify as a REIT.
However, these provisions have neither a material beneficial nor adverse effect
on the Company's ability to operate as a REIT. See "Federal Income Tax
Considerations." No assurance can be given, however, that new legislation or new
regulations, administrative interpretations or court decisions will not
significantly change the tax laws in the future with respect to qualification as
a REIT or the federal income tax consequences of such qualification in a way
that would materially and adversely affect the Company's ability to operate.
If the Company were to fail to qualify as a REIT, the dividends on shares of
Preferred Stock, including the Series A Preferred Shares, would not be
deductible by the Company for federal (and California state) income tax purposes
and the Company would likely become part of the consolidated group of which the
Bank is a member. Consequently, the consolidated group would face a greater tax
liability which may result in a reduction in the Bank's net income after taxes.
A reduction in the Bank's net income after taxes could adversely affect the
Bank's ability to raise additional capital (as well as its ability to generate
additional capital internally) and therefore its ability to add interest earning
assets to its portfolio.
If in any taxable year the Company fails to qualify as a REIT, the Company
would not be allowed a deduction for distributions to stockholders in computing
its taxable income and would be subject to federal income tax (including any
applicable alternative minimum tax) on its taxable income at regular corporate
rates. In addition, unless entitled to relief under certain statutory
provisions, the Company would also be disqualified from treatment as a REIT for
the four taxable years following the year during which qualification was lost.
As a result, the amount available for distribution to the Company's stockholders
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would be reduced for the year or years involved. A failure of the Company to
qualify as a REIT would not by itself give the Company the right to redeem the
Series A Preferred Shares. See "Description of Series A Preferred
Shares--Redemption."
Notwithstanding that the Company currently intends to operate in a manner
designed to qualify as a REIT, future economic, market, legal, tax or other
considerations may cause the Company to determine that it is in the best
interest of the Company and the holders of its Common Stock and Preferred Stock
to revoke the REIT election. As long as any Series A Preferred Shares are
outstanding, any such determination by the Company may not be made without the
approval of a majority of the Independent Directors. The tax law would prohibit
the Company from electing treatment as a REIT for the four taxable years
following the year of such revocation. See "Federal Income Tax Considerations."
REIT REQUIREMENTS WITH RESPECT TO STOCK OWNERSHIP. To qualify as a REIT
under the Code, not more than 50% of the value of the Company's outstanding
shares of capital stock may be owned, directly or indirectly, by five or fewer
individuals (as defined in the Code to include certain entities) during the last
half of a taxable year (other than the first year) (the "Five or Fewer Test").
The Code requires that the Five or Fewer Test be applied using constructive
ownership rules which treat certain organizations as one individual.
Consistent with the Company's intention to reduce the likelihood that the
Company's status as a REIT is jeopardized, the Articles of Incorporation provide
that, subject to certain exceptions for Significant Stockholders (as defined
herein), no individual or entity may own, or be deemed to own by virtue of the
attribution rules of the Code, more than 7.5% of the aggregate initial
liquidation value of the issued and outstanding shares of Preferred Stock,
including the Series A Preferred Shares (the "Ownership Limit").
Under the constructive ownership rules which must be used for the Five or
Fewer Test, the Company's Common Stock will be treated as owned by the three
stockholders of SOCAL, which is the sole stockholder of the Bank. The classes of
capital stock of SOCAL, which consists of common and three series of preferred
stock, are held by the three stockholders in varying percentages. The common
stock of SOCAL is owned 60% by the Bishop Estate, 30% by BIL Securities, and 10%
by Arbur. The preferred stock is owned approximately 67% by the Bishop Estate,
24.8% by BIL Securities, and 8.2% by Arbur. (Such percentages are approximate
because they are based on an estimate of the relative values of the three series
of preferred stock.) Since the ownership percentage for the Five or Fewer Test
is based on relative values, the percentage of the Company that would be
attributable to the three stockholders of SOCAL will vary based upon the
relative value of the capital stock of SOCAL. Of these stockholders, only Arbur,
which is closely held by the family of William E. Simon, is considered an
"individual" for purposes of the Five or Fewer Test. Neither the Bishop Estate
nor BIL Securities is considered an "individual" for purposes of the Five or
Fewer Test.
Although the Five or Fewer Test references the aggregate value of all shares
of capital stock of the Company, the Ownership Limit has been established with
reference to the aggregate initial liquidation preference of the outstanding
shares of Preferred Stock. If (i) the relative values of the Company's Common
Stock and any outstanding shares of Preferred Stock, including the Series A
Preferred Shares, or (ii) the relative values of the different series or classes
of Preferred Stock, were to change significantly, there is a risk that the Five
or Fewer Test would be violated notwithstanding compliance with the Ownership
Limit. Although the Company believes that it is unlikely that the relative value
of the Common Stock will decrease by an amount sufficient to cause a violation
of the Five or Fewer Test, there can be no assurance that such a change in value
will not occur.
Because the Ownership Limit does not apply to the Bishop Estate, BIL
Securities or Arbur (the "Significant Stockholders"), ownership of the Company's
Common Stock or the transfer of shares of common stock and/or preferred stock of
SOCAL to an entity which is considered an individual for purposes of the Five or
Fewer Test could, in certain circumstances (e.g., the sale of all SOCAL stock to
an
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individual), cause the Company to fail the Five or Fewer Test and, consequently,
to fail to qualify as a REIT.
The Board of Directors may (but will not be required to), upon the receipt
of a ruling from the Internal Revenue Service (the "IRS") or the advice of
counsel satisfactory to it, waive the Ownership Limit with respect to an
individual or entity if such individual's or entity's proposed ownership will
not then or in the future jeopardize the Company's status as a REIT. The
transfer of any shares of Preferred Stock, including Series A Preferred Shares
(including the occurrence of events other than actual transfers of Preferred
Stock that result in changes in constructive ownership of Preferred Stock), in
violation of such Ownership Limit will cause the shares of any class or series
of Preferred Stock owned, or deemed to be owned, by or transferred to a
stockholder in excess of the Ownership Limit (the "Excess Shares"), to be
automatically transferred to a trust for the exclusive benefit of a charity to
be named by the Company. All rights to dividends to such Excess Shares will be
held by such trust. See "Description of Capital Stock-- Restrictions on
Ownership and Transfer."
REIT REQUIREMENTS WITH RESPECT TO STOCKHOLDER DISTRIBUTIONS. To obtain
favorable tax treatment as a REIT qualifying under the Code, the Company
generally will be required each year to distribute as dividends to its
stockholders at least 95% of its "REIT taxable income" (excluding capital
gains). Failure to comply with this requirement would result in the Company's
income being subject to tax at regular corporate rates. In addition, the Company
would be subject to a 4% nondeductible excise tax on the amount, if any, by
which certain distributions considered as paid by it with respect to any
calendar year are less than the sum of 85% of its ordinary income for the
calendar year, 95% of its capital gains net income for the calendar year and any
undistributed taxable income from prior periods.
REDEMPTION UPON OCCURRENCE OF A TAX EVENT. At any time following the
occurrence of a Tax Event (as defined under "Description of Series A Preferred
Shares--Redemption"), even if such Tax Event occurs prior to , 2002, the
Company will have the right to redeem the Series A Preferred Shares in whole,
but not in part, subject to the prior written approval of the OTS. The
occurrence of a Tax Event will not, however, give the holders of the Series A
Preferred Shares any right to have such shares redeemed. See "Description of
Series A Preferred Shares--Redemption."
AUTOMATIC EXCHANGE UPON OCCURRENCE OF AN EXCHANGE EVENT. Upon the
occurrence of an Exchange Event, the outstanding Series A Preferred Shares will
be automatically exchanged on a one-for-one basis into Bank Preferred Shares.
See "Description of Series A Preferred Shares--Automatic Exchange." The
Automatic Exchange will be taxable, and each holder of Series A Preferred Shares
will have a gain or loss, as the case may be, measured by the difference between
the basis of such holder in the Series A Preferred Shares and the fair market
value of the Bank Preferred Shares received in the Automatic Exchange. Provided
that such holder's Series A Preferred Shares were held as capital assets for
more than 18 months prior to the Automatic Exchange, any gain or loss will be
long-term capital gain or loss. In certain circumstances, holders that are
individuals may be entitled, as a result of recently enacted legislation, to
preferential treatment for net capital gains in the case of a capital asset that
has been held for more than 18 months. See "Federal Income Tax
Considerations--Tax Treatment of Automatic Exchange."
NO THIRD PARTY VALUATION OF THE MORTGAGE LOANS; NO ARM'S-LENGTH NEGOTIATIONS
The purchase price of the Initial Portfolio will equal the net book value of
the Mortgage Loans included in the Initial Portfolio as of the date of closing
of the transaction. As of June 30, 1997, the book value of such Mortgage Loans
amounted to approximately $62.3 million. However, no third party valuations of
the Mortgage Loans constituting the Initial Portfolio have been obtained for
purposes of the Offering, and there can be no assurance that the fair value of
the Initial Portfolio does not differ from the purchase price payable by the
Company.
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In addition, it is not anticipated that third party valuations will be
obtained in connection with future acquisitions and dispositions of Mortgage
Loans even in circumstances where an affiliate of the Company is selling the
Mortgage Loans to, or purchasing the Mortgage Loans from, the Company.
Accordingly, there can be no assurance that the consideration to be paid (or
received) by the Company to (or from) the Bank or any of their affiliates in
connection with future acquisitions or dispositions of Mortgage Loans will not
differ from the fair value of such Mortgage Loans.
NO PRIOR MARKET FOR SERIES A PREFERRED SHARES
Prior to the Offering, there has been no public market for the Series A
Preferred Shares. The Company has received approval to list the Series A
Preferred Shares on the Nasdaq National Market under the symbol "PPCCP," subject
to official notice of issuance. The Company will seek to encourage and assist at
least two market makers to make a market in the Series A Preferred Shares. There
can be no assurance that the Company will be able to obtain two or more market
makers for the Series A Preferred Shares. Sandler O'Neill & Partners, L.P. has
advised the Company that it intends to make a market in the Company's Series A
Preferred Shares. Accordingly, there can be no assurance that an active and
liquid trading market for the Series A Preferred Shares will develop or that, if
developed, it will continue, or that the Series A Preferred Shares may be resold
at or above the Price to Public.
Making a market in securities involves maintaining bid and ask quotations
and being able, as principal, to effect transactions in reasonable quantities at
those quoted prices, subject to various securities laws and other regulatory
requirements. The development of a public trading market depends upon the
existence of willing buyers and sellers, the presence of which is not within the
control of the Company or any market maker. The absence of an active and liquid
trading market for the Series A Preferred Shares would affect the price and
liquidity of the Series A Preferred Shares.
Although the Series A Preferred Shares will be listed on the Nasdaq National
Market, the Bank does not intend to apply for listing of the Bank Preferred
Shares, for which the Series A Preferred Shares will be exchanged automatically
on a one-for-one basis upon the occurrence of an Exchange Event, on any national
securities exchange or automated quotation system. Consequently, there can be no
assurance as to the liquidity of the trading market for the Bank Preferred
Shares, if issued, or that an active public market for the Bank Preferred Shares
would develop or be maintained. The lack of liquidity and an active public
market could adversely effect prospective investors' ability to dispose of the
Bank Preferred Shares.
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THE COMPANY
The Company is a newly formed Maryland corporation created for the purpose
of acquiring, holding and managing Mortgage Assets, Mortgage-Backed Securities
and Other Authorized Investments that will generate net income for distribution
to stockholders. Based on the outstanding principal balance of the Mortgage
Loans to be included in the Initial Portfolio as of June 30, 1997, the Company
anticipates that approximately 78.2% of its portfolio of Mortgage Assets will
represent interests in Residential Mortgage Loans and that approximately 21.8%
of its portfolio of Mortgage Assets will represent interests in Commercial
Mortgage Loans (in each case measured by aggregate outstanding principal
amounts).
Although the Company has the authority to acquire an unlimited number of
Residential Mortgage Loans and Commercial Mortgage Loans from unaffiliated third
parties such as other financial institutions and mortgage banks, all of the
Initial Portfolio will be acquired from the Bank. Nevertheless, the Initial
Portfolio is expected to include 10 loans aggregating $777,900 which were
purchased by the Bank from unaffiliated financial institutions and 51 loans
aggregating $3.2 million which were originated by financial institutions which
were subsequently acquired by the Bank. With respect to Mortgage Loans which
were purchased by the Bank from unaffiliated third parties, the Bank evaluated
the documentation relating to each purchased loan and management believes that
each such loan was originated in a manner consistent with the underwriting
standards of the Bank. Such Mortgage Loans which the Bank acquired through
acquisitions of other financial institutions all have been owned by the Bank for
over 10 years and are seasoned and performing loans. The Company has no present
plans or expectations with respect to purchases from unaffiliated third parties.
The Bank will administer the day-to-day operations of the Company in its role as
Advisor under the Advisory Agreement. The Company will elect to be subject to
tax as a REIT under the Code, and will generally not be subject to federal
income tax to the extent that it distributes its earnings to its stockholders
and maintains its qualification as a REIT.
All of the Common Stock of the Company is owned by the Bank, and all of the
common stock of the Bank is owned by SOCAL. SOCAL is a thrift institution
holding company organized under the laws of Delaware in 1987 and registered
under the Home Owners Loan Act, as amended. The common stock of SOCAL is (i) 60%
owned by the Bishop Estate, (ii) 30% owned by BIL Securities, and (iii) 10%
owned by Arbur. The preferred stock of SOCAL is owned approximately (i) 67% by
the Bishop Estate, (ii) 24.8% by BIL Securities and (iii) 8.2% by Arbur. The
Bank conducts its business through a network of 19 full-service community
banking offices located primarily in Los Angeles County as well as Orange and
Ventura Counties in Southern California. As of June 30, 1997, the Bank had total
assets of $1.8 billion, total deposits of $1.3 billion and stockholder's equity
of $84.9 million. For the six months ended June 30, 1997 and the year ended
December 31, 1996, the Bank had net earnings of $6.9 million and $13.6 million
and a return on average assets of 0.77% and 0.78%, respectively.
The Series A Preferred Shares will be exchanged automatically on a
one-for-one basis for Bank Preferred Shares upon the occurrence of an Exchange
Event. CONSEQUENTLY, AN INVESTMENT IN SERIES A PREFERRED SHARES COULD BE
REPLACED, WITHOUT THE CONSENT OF THE INVESTOR, BY AN INVESTMENT IN BANK
PREFERRED SHARES AT A TIME WHEN THE BANK'S FINANCIAL CONDITION IS DETERIORATING
OR WHEN THE BANK HAS BEEN PLACED INTO CONSERVATORSHIP OR RECEIVERSHIP.
ACCORDINGLY, POTENTIAL INVESTORS IN THE SERIES A PREFERRED SHARES SHOULD
CAREFULLY CONSIDER THE DESCRIPTION OF THE BANK SET FORTH IN THE OFFERING
CIRCULAR ATTACHED HERETO AS ANNEX I. See also "Description of Series A Preferred
Shares--Automatic Exchange."
For a further description of the operations of the Company, see "Business
and Strategy," "Management," "Risk Factors" and "Federal Income Tax
Considerations."
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USE OF PROCEEDS
The gross proceeds to the Company from the sale of the Series A Preferred
Shares offered hereby are expected to be $31.0 million, or $35.65 million if the
Underwriters' over-allotment option is exercised in full. Simultaneously with
the consummation of the Offering, the Bank will make an initial capital
contribution to the Company with respect to its Common Stock equal to
approximately $31.3 million plus an additional capital contribution equal to the
underwriting commissions and expenses of the Offering and the formation of the
Company (currently estimated to be approximately $2.0 million in the aggregate).
The Company will use the aggregate proceeds of approximately $62.3 million
received in connection with both the Offering and the capital contribution by
the Bank to purchase the Initial Portfolio from the Bank. See "Business and
Strategy."
If the Underwriters exercise the over-allotment option in the Offering, the
Bank will make an additional capital contribution equal to the aggregate initial
public offering price of such additional Series A Preferred Shares. The Company
will use the additional proceeds from any such additional sales of Series A
Preferred Shares and capital contributions to purchase additional Mortgage Loans
of the types described in "Business and Strategy--Description of Initial
Portfolio." The Company expects that it will purchase any such additional
Mortgage Loans within six months from the exercise by the Underwriters of their
over-allotment option. Pending such purchase, the Company will invest such
additional proceeds in mortgage-backed securities or short-term money market
investments.
The following table illustrates the source and use of proceeds by the
Company from the sale of the Series A Preferred Shares offered hereby (assuming
the Underwriters' over-allotment option is not exercised) and the capital
contributions by the Bank described above.
SOURCE OF FUNDS
(In Thousands)
<TABLE>
<S> <C>
Gross proceeds from the Offering of Series A Preferred Shares................... $ 31,000
Gross proceeds from the capital contributions by the Bank....................... 33,300(1)
---------
$ 64,300
---------
---------
</TABLE>
- ------------------------
(1) Expenses incurred in connection with the Offering are expected to total $2.0
million. If actual expenses are in excess of the amounts set forth, the Bank
will make additional capital contributions to the Company equal to such
excess.
USE OF FUNDS
(In Thousands)
<TABLE>
<S> <C>
Purchase of Mortgage Assets from the Bank......................................... $ 62,300
Underwriting commissions and other expenses of the Offering....................... 2,000
---------
$ 64,300
---------
---------
</TABLE>
The Bank will not receive any transaction fees upon completion of the
Offering or any advance payment in respect of servicing or advisory fees.
28
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of July
3, 1997 (the date of the most recent audited financial statement of the Company)
and as adjusted to reflect (i) the consummation of the Offering (assuming the
Underwriters' over-allotment option is not exercised) and (ii) the transactions
described in "Certain Transactions Constituting The Formation--The Formation"
and (iii) the use of the net proceeds therefrom as described under "Use of
Proceeds."
<TABLE>
<CAPTION>
JULY 3, 1997
----------------------
<S> <C> <C>
ACTUAL AS ADJUSTED
--------- -----------
<CAPTION>
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
STOCKHOLDERS' EQUITY
Preferred Stock, par value $0.01 per share, 4,000,000 shares authorized, 1,240,000
shares issued and outstanding, as adjusted............................................ $ -- $ 12
Common Stock, par value $0.01 per share(1); 10,000 shares authorized and issued and
outstanding, actual; and 4,000,000 shares authorized, 10,000 shares issued and
outstanding, as adjusted.............................................................. -- --
Additional paid-in capital(1)........................................................... -- 62,288
--------- -----------
Total stockholders' equity.......................................................... -- 62,300
--------- -----------
TOTAL CAPITALIZATION...................................................................... $ -- $ 62,300
--------- -----------
--------- -----------
</TABLE>
- ------------------------
(1) The Company was formed with an initial capitalization of $100. Immediately
prior to the consummation of the Offering, the Bank will make capital
contributions to the Company equal to approximately $31.3 million plus an
amount sufficient to pay the aggregate Offering and organization expenses,
currently estimated by the Company to be approximately $2.0 million.
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<PAGE>
BUSINESS AND STRATEGY
GENERAL
The Company's principal business objective is to acquire, hold and manage
Mortgage Assets that will generate net earnings for distribution to
stockholders. The Company will acquire the Initial Portfolio of Mortgage Loans
from the Bank for an aggregate purchase price equal to the net book value of the
Mortgage Loans included in the Initial Portfolio as of the date of closing of
the transaction. As of June 30, 1997, the book value of such Mortgage Loans
amounted to approximately $62.3 million. See "Certain Transactions Constituting
the Formation."
In order to preserve its status as a REIT under the Code, substantially all
of the assets of the Company will consist of Mortgage Loans, other qualified
REIT real estate assets of the type permitted by the Code and Other Authorized
Investments. See "Federal Income Tax Considerations."
DIVIDEND POLICY
The Company currently expects to distribute annually an aggregate amount of
dividends with respect to its outstanding shares of capital stock equal to
approximately 100% of the Company's "REIT taxable income" (excluding capital
gains). In order to remain qualified as a REIT, the Company must distribute
annually at least 95% of its "REIT taxable income" (excluding capital gains) to
its stockholders.
Dividends will be authorized and declared at the discretion of the Board of
Directors after considering the Company's distributable funds, financial
requirements, tax considerations and other factors. Because (i) the Mortgage
Assets and Other Authorized Investments are interest bearing, (ii) the Series A
Preferred Shares represent only approximately 50% of the Company's
capitalization and (iii) the Company does not anticipate incurring any
indebtedness, the Company currently expects that both its cash available for
distribution and its "REIT taxable income" will be in excess of amounts needed
to pay dividends on the Series A Preferred Shares, even in the event of a
significant drop in interest rate levels. Accordingly, the Company expects that
it will, after paying the quarterly dividends on the Series A Preferred Shares,
pay dividends to holders of its Common Stock in an amount sufficient to comply
with applicable requirements regarding qualification as a REIT.
As of June 30, 1997, the weighted average interest rate of all of the
Mortgage Loans expected to be included in the Initial Portfolio was
approximately 8.530% per annum, the weighted average interest rate of the
Residential Mortgage Loans expected to be included in the Initial Portfolio was
approximately 8.250% per annum and the weighted average interest rate of the
Commercial Mortgage Loans expected to be included in the Initial Portfolio was
approximately 9.538% per annum. See "Description of Initial Portfolio." Assuming
that (i) the Mortgage Assets included in the Initial Portfolio are held for the
12-month period following consummation of the Offering, (ii) principal
repayments are reinvested in additional Mortgage Assets with characteristics
similar to those of the Mortgage Assets included in the Initial Portfolio and
(iii) interest rates remain constant during such 12-month period, net interest
income for the 12-month period following consummation of the Offering would be
approximately $ million, after payment of anticipated servicing and
advisory fees. Because the aggregate annual dividend payment on the Series A
Preferred Shares is approximately $ million, the Company anticipates,
based on the foregoing, that approximately $ million would be available
for payment of dividends on the shares of Common Stock held by the Bank during
such 12-month period. However, there are several limitations which are described
in the following paragraph that restrict the Company's ability to pay dividends
on the Common Stock.
First, no cash dividends or other distributions may be paid on the Common
Stock unless and until (i) the Company has paid full dividends on the Series A
Preferred Shares for the four most recent Dividend Periods (or such lesser
number of Dividend Periods during which the Series A Preferred Shares have been
outstanding) and has declared a cash dividend on the Series A Preferred Shares
at the annual dividend rate for the current Dividend Period, and (ii) the terms
of all other stock of the Company ranking
30
<PAGE>
senior to the Common Stock have been complied with. Second, the Maryland General
Corporation law ("MGCL") provides that dividends and other distributions may not
be paid by a corporation if, after giving effect to the distribution (i) the
corporation would not be able to pay its indebtedness as it becomes due in the
usual course of business or (ii) the corporation's total assets would be less
than the sum of the corporation's total liabilities plus, unless the articles of
incorporation of the corporation permits otherwise (which the Articles of
Incorporation of the Company do not), the amount that would be needed, if the
corporation were to be dissolved at the time of the distribution, to satisfy the
preferential rights on dissolution of stockholders whose preferential rights on
dissolution are superior to those receiving the distribution. Because upon the
consummation of the Offering the aggregate liquidation value of the Series A
Preferred Shares will equal approximately $31.0 million, the amount of dividends
which the Company could legally pay on its Common Stock cannot exceed an amount
which would cause the Company's net assets to be less than $31.0 million.
The OTS prompt corrective action regulations prohibit thrift institutions
such as the Bank from making "capital distributions" (defined to include a
transaction that the OTS or Federal Deposit Insurance Corporation ("FDIC")
determines, by order or regulation, to be "in substance a distribution of
capital") unless the institution is at least "adequately capitalized" after the
distribution. There can be no assurance that either the OTS or the FDIC would
not seek to restrict the Company's payment of dividends on the Series A
Preferred Shares under this provision if the Bank were to fail to maintain its
status as "adequately capitalized." Currently, an institution is considered
"adequately capitalized" if it has a total risk-based capital ratio of at least
8.0%, a Tier 1 risk-based capital ratio of at least 4.0% and a leverage (or core
capital) ratio of at least 4.0%. At June 30, 1997, the Bank's total risk-based
capital ratio was 10.91%, its Tier 1 risk-based capital ratio was 9.65% and core
capital (or leverage) ratio was 4.76%. Such ratios, on a pro forma basis as of
June 30, 1997 after giving effect to the sale of Series A Preferred Shares in
the Offering, would be 14.13%, 12.88% and 6.35%, respectively. After the
Offering, the Bank's capital ratios are expected to decrease as the Bank expands
its business and, thus, its total assets. The Bank currently intends, by
managing its growth following the Offering, to maintain its capital ratios in
excess of the "well-capitalized" levels under the prompt corrective action
regulations. However, there can be no assurance that the Bank will be able to
maintain such capital levels. See "Certain Information Regarding the Bank-- Risk
Factors and Other Considerations--Regulatory Capital Levels" and "Pro Forma
Regulatory Capital" in the Offering Circular attached as Annex I hereto.
If the Automatic Exchange were to occur, the Bank would likely be prohibited
from paying dividends on the Bank Preferred Shares. In all circumstances
following the Automatic Exchange, the Bank's ability to pay dividends would be
subject to various restrictions under OTS regulations. In addition, in the event
of a liquidation of the Bank, the claims of the Bank's depositors and of its
creditors would be entitled to a priority of payment over the dividend and other
claims of holders of equity interests such as the Bank Preferred Shares issued
pursuant to the Automatic Exchange.
Under certain circumstances, including any determination that the Bank's
relationship to the Company results in an unsafe and unsound banking practice,
federal regulatory authorities will have the authority to issue an order which
restricts the ability of the Company to make dividend payments to its
stockholders.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal liquidity need will be to fund the acquisition of
additional Mortgage Loans, Mortgage-Backed Securities or Other Authorized
Investments as Mortgage Loans held by the Company are repaid. The acquisition of
such additional Mortgage Loans, Mortgage-Backed Securities or Other Authorized
Investments will be funded with the proceeds of principal repayments on its
portfolio of Mortgage Loans. The Company does not anticipate that it will have
any other material capital expenditures. The Company believes that cash
generated from the payment of interest and principal on its Mortgage Loan
portfolio will provide sufficient funds to meet both operating requirements and
payment of
31
<PAGE>
dividends by the Company in accordance with the REIT Requirements so as to be
taxed as a REIT for the foreseeable future.
GENERAL DESCRIPTION OF MORTGAGE ASSETS AND OTHER AUTHORIZED INVESTMENTS;
INVESTMENT POLICY
RESIDENTIAL MORTGAGE LOANS. The Company may from time to time acquire both
conforming and nonconforming Residential Mortgage Loans. Conforming Residential
Mortgage Loans comply with the requirements for inclusion in a loan guarantee or
purchase program offered by either the FHLMC or FNMA. Under current regulations,
the maximum principal balance allowed on conforming Residential Mortgage Loans
ranges from $214,600 for one-unit residential loans to $412,450 for four-unit
residential loans. Nonconforming Residential Mortgage Loans are Residential
Mortgage Loans that do not qualify in one or more respects for purchase by FNMA
or FHLMC under their standard programs. The Company and the Bank expect that a
majority of the nonconforming Residential Mortgage Loans to be included in the
Initial Portfolio will be nonconforming because they have original principal
balances which exceed the regulatory limitations for FHLMC or FNMA programs or
generally because they vary in certain other respects from the requirements of
such programs other than the requirements relating to creditworthiness of the
mortgagors or acceptability of the mortgage property. A substantial portion of
the Company's nonconforming Residential Mortgage Loans are expected to meet the
requirements for sale to national private mortgage conduit programs or other
investors in the secondary mortgage market.
Each Residential Mortgage Loan will be evidenced by a promissory note
secured by a mortgage or deed of trust or other similar security instrument
creating a first lien on single-family (one- to four-unit) residential
properties. Residential real estate properties underlying Residential Mortgage
Loans consist of individual dwelling units, individual condominium units, two-
to four-family dwelling units, planned unit developments and townhouses. The
Company currently expects that all of the Residential Mortgage Loans included in
the Initial Portfolio will be fixed rate Mortgage Loans. However, the Company
may from time to time acquire adjustable rate Residential Mortgage Loans.
Since the 1980's, the Bank has also offered a variety of adjustable rate
single-family Residential Mortgage Loans which may be made available to the
Company for purchase in the future. Such loans generally have up to 30 year
terms. Presently, the Bank offers a "5/1 Product," in which the interest rate of
the loan is fixed at origination for a five year period, after which the
interest rate adjusts every year in accordance with a designated index (the
weekly average yield on U.S. Treasury securities adjusted to a constant maturity
of one year, as made available by the Board of Governors of the Federal Reserve
System ("Federal Reserve Board")). Such loans currently have a 2% cap on the
amount of any increase or decrease in the interest rate per year, and a 6% limit
on the amount by which the interest rate can increase or decrease over the life
of the loan. In addition, the Bank's adjustable rate loans are currently not
convertible into fixed rate loans and do not contain prepayment penalties.
The Bank previously offered a variety of adjustable rate programs, which
provided for interest rates which adjusted periodically based on a designated
index (the Eleventh District Cost of Funds ("COFI"), as made available by the
FHLB of San Francisco). Adjustments to the interest rate and/or to the monthly
payment of principal and interest occur either monthly, semi-annually or
annually depending on the loan program selected by the borrower. However, to
protect borrowers from unlimited interest rate and payment increases, the
majority of these adjustable rate loans have a maximum interest rate change
("interest rate cap") from the initial interest rate period and/or over the life
of the loan. Additionally, the interest rate may change within a range of a two
to six percentage point increase or decrease in any given period. In certain
loan programs, these protections for borrowers can result in monthly payments
which are greater or less than the amount required to amortize the loan by its
maturity at the interest rate in effect in any particular month. In the event
that the monthly payment is not sufficient to pay the interest accruing during
the month, the deficiency is added to the loan's principal balance ("negative
amortization"). For further information on the Bank's current lending programs
and the composition of the Bank's loan
32
<PAGE>
portfolio, see "Business of the Bank--Lending Activities" in the Offering
Circular attached hereto as Annex I.
Although the Company has the authority to acquire an unlimited number of
Residential Mortgage Loans and Commercial Mortgage Loans from unaffiliated third
parties such as other financial institutions and mortgage banks, all of the
Initial Portfolio will be acquired from the Bank. Nevertheless, the Initial
Portfolio is expected to include 10 loans aggregating $777,900 which were
purchased from unaffiliated financial institutions and 51 loans aggregating $3.2
million which were originated by financial institutions which were subsequently
acquired by the Bank. With respect to Mortgage Loans which were purchased by the
Bank from unaffiliated third parties, the Bank evaluated the documentation
relating to each purchased loan and management believes that each such loan was
originated in a manner consistent with the underwriting standards of the Bank.
Such Mortgage Loans which the Bank acquired through acquisitions of other
financial institutions all have been owned by the Bank for over 10 years and are
seasoned and performing loans. The Company has no present plans or expectations
with respect to purchases from unaffiliated third parties. The Company expects
to purchase products similar to those originated by the Bank to the extent that
any such purchases are undertaken.
COMMERCIAL MORTGAGE LOANS. The Company may from time to time acquire
Commercial Mortgage Loans secured by multi-family properties of five units or
more, industrial, warehouse and self-storage properties, office buildings,
office and industrial condominiums, retail space and strip shopping centers,
mixed use commercial properties, mobile home parks, nursing homes, hotels and
motels ("Commercial Properties"). The Company expects that substantially all of
the Commercial Mortgage Loans it acquires will be secured by real estate located
in California. Unlike Residential Mortgage Loans, Commercial Mortgage Loans
generally lack standardized terms. Commercial Mortgage Loans may also not be
fully amortizing, meaning that they may have a significant principal balance or
"balloon" payment due on maturity. Moreover, commercial properties, particularly
industrial and warehouse properties, are generally subject to relatively greater
environmental risks than non-commercial properties, generally giving rise to
increased costs of compliance with environmental laws and regulations. See "Risk
Factors--Credit, Default and Other Risks Associated with Mortgage Loans on the
Company's Financial Condition and Results of Operations" and "--Environmental
Considerations." There is no requirement regarding the percentage of any
commercial real estate property that must be leased at the time the Company
acquires a Commercial Mortgage Loan secured by such commercial real estate
property, and there is no requirement that Commercial Mortgage Loans have third
party guarantees.
The credit quality of a Commercial Mortgage Loan may depend on, among other
factors, the existence and structure of underlying leases, the physical
condition of the property (including whether any maintenance has been deferred),
the creditworthiness of tenants, the historical and anticipated level of
vacancies and rents on the property and on other comparable properties located
in the same region, potential or existing environmental risks, the availability
of credit to refinance the Commercial Mortgage Loan at or prior to maturity and
the local and regional economic climate in general. Foreclosures of defaulted
Commercial Mortgage Loans are generally subject to a number of complicating
factors, including environmental considerations, which are generally not present
in foreclosures of Residential Mortgage Loans. See "Risk Factors--Credit,
Default and Other Risks Associated with Mortgage Loans on the Company's
Financial Condition and Results of Operations--Special Risks Relating to
Commercial Mortgage Loans" and "--Environmental Considerations."
MORTGAGE-BACKED SECURITIES. The Company may from time to time acquire
Mortgage-Backed Securities representing interests in or obligations backed by
pools of Mortgage Loans. The Company intends to acquire only investment grade
Mortgage-Backed Securities or those issued or guaranteed by agencies of the
federal government or government sponsored agencies. The Mortgage Loans
underlying the Mortgage-Backed Securities will be secured by single-family
residential, multi-family or commercial real estate properties located
throughout the United States. The Company does not intend to acquire any
interest-
33
<PAGE>
only, principal-only or high-risk Mortgage-Backed Securities. The Company will
not be precluded from investing in Mortgage-Backed Securities where the Bank is
the sponsor or issuer.
OTHER ASSETS. The Company may invest up to 20% of the total value of its
portfolio in assets other than Residential Mortgage Loans, Commercial Mortgage
Loans, Mortgage-Backed Securities eligible to be held by REITs, and cash, cash
equivalents (including receivables) and government securities. While the
foregoing assets must constitute at least 75% of the value of the REIT's total
assets under Section 856(c)(5)(A) of the Code, up to 25% of the value of a
REIT's total assets may be comprised of non-mortgage-related securities as
defined in the Investment Company Act of 1940 (the "Investment Company Act").
Under the Investment Company Act, the term "security" is broadly defined to
include, among other things, any note, stock, treasury stock, debenture,
evidence of indebtedness, or certificate of interest or participation in any
profit sharing agreement or a group or index of securities. The Code requires
that the value of any one issuer's securities may not exceed 5% of the total
assets of the REIT and the REIT may not own more than 10% of the voting
securities of any one issuer.
ACQUISITION OF INITIAL PORTFOLIO
Simultaneously with the consummation of the Offering, the Company will
acquire the Initial Portfolio pursuant to the terms of two mortgage purchase
agreements with the Bank: the Residential Mortgage Loan Purchase and Warranties
Agreement (the "Residential Mortgage Purchase Agreement") and the Commercial
Mortgage Loan Purchase and Warranties Agreement (the "Commercial Mortgage
Purchase Agreement", and, together with the Residential Mortgage Purchase
Agreement, the "Mortgage Purchase Agreements"). The Residential Mortgage Loans
in the Initial Portfolio will be sold to the Company pursuant to the Residential
Mortgage Purchase Agreement. The Commercial Mortgage Loans in the Initial
Portfolio will be sold to the Company pursuant to the Commercial Mortgage
Purchase Agreement. Each Mortgage Loan will be identified in a schedule
appearing as an exhibit to its respective mortgage purchase agreement (each, a
"Mortgage Loan Schedule"). Each Mortgage Loan Schedule will specify, among other
things, with respect to each Mortgage Loan: the applicable loan type, the
applicable interest rate, the original principal balance and the unpaid
principal balance as of the purchase date, the monthly payment, the maturity
date, the mortgagor, the type of mortgaged property, the location of the
mortgaged property and the current interest rate.
At or as soon as practicable following the consummation of the Offering, the
Bank will deliver or cause to be delivered to the Company or its designee,
except to the extent inconsistent with the Residential Loan Servicing
Agreements, all documents contained in the Mortgage Loan file, including but not
limited to: either the mortgage note with respect to each Mortgage Loan
(together with all amendments and modifications thereto) endorsed in blank by
the Bank or a lost-note affidavit, the original or certified copy of the
mortgage (together with all amendments and modifications thereto) with evidence
of recording indicated thereon, if available; the original or a copy of all
intervening assignments of the mortgage, if any, evidencing the assignment of
the Mortgage Loan to the Bank (together with all amendments and modifications
thereto) with evidence of recording indicated thereon, if available; an original
blanket assignment of the mortgages executed by the Bank; the original mortgagee
title policy or, in the event such original title policy is unavailable, a true
copy of the related policy binder or commitment for title; and all insurance
policies relating to the properties underlying the Mortgage Loans and the
proceeds thereof. Such documents will initially be held by the Bank, as Advisor,
acting as custodian for the Company. Although the Company will have the right to
record the blanket assignment of mortgages at any time, it does not currently
anticipate doing so. The Company believes that maintaining record title of the
Mortgage Loans in the name of the Bank will facilitate the servicing of the
Mortgage Loans without adversely affecting the Company's interests in such
Mortgage Loans. However, the Bank will be obligated at the written request of
the Company, or if deemed necessary by the applicable Servicer in connection
with servicing any Mortgage Loan, to execute and record in the appropriate
jurisdiction an individual assignment of mortgage that reflects of record the
ownership of the Mortgage Loan by the Company. See "--Servicing" and
"--Description of Initial Portfolio--General."
34
<PAGE>
The Bank will make certain representations and warranties with respect to
the Mortgage Loans in the Initial Portfolio for the benefit of the Company and
will be obligated to repurchase any Mortgage Loan sold by it to the Company as
to which there is a material breach of any such representation or warranty,
unless the Bank elects to substitute a qualified Mortgage Loan for such Mortgage
Loan. The Bank will also indemnify the Company for damages or costs resulting
from any such breach. The repurchase price for any such Mortgage Loan will be
its outstanding principal amount plus accrued and unpaid interest to the date of
repurchase.
MANAGEMENT POLICIES AND PROGRAMS
In administering the Company's Mortgage Assets and Other Authorized
Investments, the Advisor has a high degree of autonomy. The Board of Directors,
however, has adopted certain policies to guide administration of the Company and
the Advisor with respect to the acquisition and disposition of assets, use of
capital and leverage, credit risk management and certain other activities. These
policies, which are discussed below, may be amended or revised from time to time
at the discretion of the Board of Directors (in certain circumstances subject to
the approval of a majority of the Independent Directors) without a vote of the
Company's stockholders, including holders of the Series A Preferred Shares. See
also "-- Dividend Policy."
ASSET ACQUISITION AND DISPOSITION POLICIES. Subsequent to the acquisition
of the Initial Portfolio, the Company anticipates that it will from time to time
purchase additional Mortgage Loans from the Bank or unaffiliated third parties
on a basis consistent with secondary market standards pursuant to the Mortgage
Purchase Agreements, out of proceeds received in connection with the repayment
or disposition of Mortgage Loans or the issuance of additional shares of Common
Stock and Preferred Stock. The Company anticipates that additional Mortgage
Loans purchased from the Bank will be purchased on terms that are substantially
identical to those that could be obtained by the Company if such additional
Mortgage Loans were purchased from third parties unaffiliated with the Company.
The Company has no present plans or intentions to purchase Mortgage Loans from
unaffiliated third parties, and no arrangements or procedures are currently in
place regarding the purchase of additional Mortgage Loans from unaffiliated
third parties. The Company currently anticipates that additional Mortgage Loans
acquired by the Company will be of the types described in "--Description of
Initial Portfolio," although if the Bank develops additional Mortgage Loan
products, the Company may purchase such additional types of Mortgage Loans and
is not limited as to the amount which may be purchased. The Bank has no current
plans with respect to the development of new Mortgage Loan products. In
addition, the Company may from time to time acquire Mortgage-Backed Securities
representing interests in or obligations backed by pools of Mortgage Loans that
will be secured by single-family residential, multi-family or commercial real
estate properties located throughout the United States as well as a limited
amount of Other Authorized Investments. The Company currently anticipates that
it will not acquire the right to service any Mortgage Loan it acquires in the
future and that the Bank will act as Servicer of any such additional Commercial
Mortgage Loans and the Servicing Agent will act as Servicer of any such
additional Residential Mortgage Loans. The Company anticipates that any
servicing arrangement that it enters into in the future with the Bank will
contain fees and other terms that would be substantially equivalent to those
that would be contained in servicing arrangements entered into with third
parties unaffiliated with the Company.
Although as of June 30, 1997 the Initial Portfolio was comprised of
approximately 78.2% of Residential Mortgage Loans and approximately 21.8% of
Commercial Mortgage Loans (in each case measured by aggregate outstanding
principal balances), the percentages of Residential Mortgage Loans and
Commercial Mortgage Loans may vary in the future. The Company's current policy
is not to acquire any Commercial Mortgage Loan that constitutes more than 5.0%
of the total book value of the Mortgage Assets of the Company at the time of its
acquisition. In addition, the Company's current policy prohibits the acquisition
of any Mortgage Loan or any interest in a Mortgage Loan (other than an interest
resulting from the acquisition of Mortgage-Backed Securities), which Mortgage
Loan (i) is delinquent in the payment of principal or interest at the time of
proposed acquisition; (ii) is or was at any time during the
35
<PAGE>
preceding 12 months (a) Classified, (b) in Nonaccrual Status or (c) renegotiated
due to financial deterioration of the borrower; or (iii) has been, more than
once during the preceding 12 months, more than 30 days past due in the payment
of principal or interest. Mortgage Loans that are in "Nonaccrual Status" are
generally loans that are past due 90 days or more in principal or interest, and
"Classified" Mortgage Loans are generally troubled loans which are deemed
substandard, doubtful or loss with respect to collectibility.
The Bank's Residential Servicing Agreement with the Servicing Agent provides
that the Bank can direct the Servicing Agent to transfer the servicing and
disposition functions with respect to all Residential Mortgage Loans which
become Nonaccrual back to the Bank. The servicing of properties which become REO
will automatically be transferred back to the Bank for the same purpose. The
Residential Mortgage Purchase Agreement and the Residential Assumption Servicing
Agreement provide for the same treatment with respect to Residential Mortgage
Loans sold by the Bank to the Company which become Nonaccrual or REO. Upon
receipt of written direction from the Company, the Servicing Agent is required
to promptly transfer the servicing for any such Nonaccrual Mortgage Loan to the
Bank and will automatically transfer servicing with respect to REO to the Bank.
The Bank will service and charge a servicing fee to the Company with respect to
such Nonaccrual Mortgage Loans for which the servicing has been so transferred.
The Bank will also service and dispose of such REO, as required, on the
Company's behalf. The Commercial Mortgage Purchase Agreement and the Commercial
Servicing Agreement provide that the Bank will service and handle the
disposition of Nonaccrual Commercial Real Estate Loans and REO for the Company.
CAPITAL AND LEVERAGE POLICIES. To the extent that the Board of Directors
determines that additional funding is required, the Company may raise such funds
through additional equity offerings, debt financing or retention of cash flow
(after consideration of provisions of the Code requiring the distribution by a
REIT of at least 95% of its "REIT taxable income" (excluding capital gains) and
taking into account taxes that would be imposed on undistributed taxable
income), or a combination of these methods.
The Company will have no debt outstanding following consummation of the
Offering, and the Company does not currently intend to incur any indebtedness.
However, the organizational documents of the Company do not contain any
limitation on the amount or percentage of debt, funded or otherwise, the Company
might incur, except that the incurrence by the Company of debt for borrowed
money in excess of 20% of the Company's total stockholders' equity will require
the approval of a majority of the Independent Directors. Any such debt incurred
may include intercompany advances made by the Bank to the Company.
The Company may also issue additional series of Preferred Stock. However,
the Company may not issue additional shares of Preferred Stock senior to the
Series A Preferred Shares without the consent of holders of at least two-thirds
of the outstanding shares of Series A Preferred Shares, and the Company may not
issue additional shares of Preferred Stock on a parity with the Series A
Preferred Shares without the approval of a majority of the Company's Independent
Directors. The Company does not currently intend to issue any additional series
of Preferred Stock unless it simultaneously receives additional capital
contributions from the Bank equal to the aggregate offering price of such
additional Preferred Stock plus the Company's expenses (including underwriting
commissions or placement fees) in connection with the issuance of such
additional shares of Preferred Stock. Prior to the issuance of additional shares
of Preferred Stock, the Company will take into consideration, among other
things, the Bank's regulatory capital requirements and an assessment of other
available options for raising any necessary capital. See "Certain Transactions
Constituting the Formation--Benefits to the Bank."
CREDIT RISK MANAGEMENT POLICIES. The Company expects that each Mortgage
Loan acquired in the future will represent a first lien position and will be
originated by the Bank or an unaffiliated third party in the ordinary course of
its real estate lending activities based on the underwriting standards generally
applied by the Bank (at the time of origination) for its own account. See
"--Description of Initial Portfolio--Underwriting Standards." The Company also
expects that all Mortgage Loans held by the Company will be serviced pursuant to
the Servicing Agreements, which require servicing in conformity with
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<PAGE>
any servicing guidelines promulgated by the Company with respect to Commercial
Mortgage Loans and, in the case of Residential Mortgage Loans, with FNMA and
FHLMC guidelines and procedures. The Bank's Residential Servicing Agreement with
the Servicing Agent provides that the Bank can direct the Servicing Agent to
transfer the servicing and disposition functions with respect to all Residential
Mortgage Loans which become Nonaccrual back to the Bank. The servicing of
properties which become REO will automatically be transferred back to the Bank
for the same purpose. The Residential Mortgage Purchase Agreement and the
Residential Assumption Servicing Agreement provide for the same treatment with
respect to Residential Mortgage Loans sold by the Bank to the Company which
become Nonaccrual or REO. Upon receipt of written direction from the Company,
the Servicing Agent is required to promptly transfer the servicing for any such
Nonaccrual Mortgage Loan to the Bank and will automatically transfer servicing
with respect to REO to the Bank. The Bank will service and charge a servicing
fee to the Company with respect to such Nonaccrual Mortgage Loans for which the
servicing has been so transferred. The Bank will also service and dispose of
such REO, as required, on the Company's behalf. The Commercial Mortgage Purchase
Agreement and the Commercial Servicing Agreement provide that the Bank will
service and handle the disposition of Nonaccrual Commercial Real Estate Loans
and REO for the Company.
CONFLICT OF INTEREST POLICIES. Because of the nature of the Company's
relationship with the Bank and the Servicing Agent, it is likely that conflicts
of interest will arise with respect to certain transactions, including, without
limitation, the Company's acquisition of Mortgage Loans from, or disposition of
Mortgage Loans to, the Bank, foreclosure on defaulted Commercial Mortgage Loans
and the modification of the Advisory Agreement or any of the Servicing
Agreements. It is the Company's policy that the terms of any financial dealings
with the Bank will be consistent with those available from third parties in the
mortgage lending industry. In addition, neither the Advisory Agreement nor any
of the Servicing Agreements may be modified or terminated without the approval
of a majority of the Independent Directors.
Conflicts of interest between the Company and the Bank may also arise in
connection with making decisions that bear upon the credit arrangements that the
Bank may have with a mortgagor under a Mortgage Loan. Conflicts could also arise
in connection with actions taken by the Bank as a controlling person in the
Company. It is the intention of the Company and the Bank that any agreements and
transactions between the Company, on the one hand, and the Bank on the other
hand, including without limitation the Mortgage Purchase Agreements and
Servicing Agreements, be fair to all parties and are consistent with market
terms for such types of transactions. The requirement in the Articles of
Incorporation that certain actions of the Company be approved by a majority of
the Independent Directors is also intended to ensure fair dealings between the
Company and the Bank. However, there can be no assurance that any such agreement
or transaction will be on terms as favorable to the Company as would have been
obtained from unaffiliated third parties.
There are no provisions in the Company's Articles of Incorporation limiting
any officer, director, security holder or affiliate of the Company from having
any direct or indirect pecuniary interest in any Mortgage Asset to be acquired
or disposed of by the Company or in any transaction in which the Company has an
interest or from engaging in acquiring, holding and managing Mortgage Assets. As
described herein, it is expected that the Bank will have direct interests in
transactions with the Company (including without limitation the sale of Mortgage
Assets to the Company); however, no officers or directors of the Company will
have any interests in such Mortgage Assets.
OTHER POLICIES. The Company intends to operate in a manner that will not
subject it to regulation under the Investment Company Act. The Company does not
intend to (i) invest in the securities of other issuers for the purpose of
exercising control over such issuers, (ii) underwrite securities of other
issuers, (iii) actively trade in loans or other investments, (iv) offer
securities in exchange for property or (v) make loans to third parties,
including, without limitation, officers, directors or other affiliates of the
Company. The Company may, under certain circumstances, purchase the Series A
Preferred Shares and other shares of its capital stock in the open market or
otherwise. The Company has no present intention of causing the
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<PAGE>
Company to repurchase any shares of its capital stock, and any such action would
be taken only in conformity with applicable federal and state laws and
regulations and the requirements for qualifying as a REIT.
The Company believes that it will not be, and intends to conduct its
operations so as not to become, regulated as an investment company under the
Investment Company Act. The Investment Company Act exempts entities that,
directly or through majority-owned subsidiaries, are "primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate" ("Qualifying Interests"). Under current
interpretations by the Staff of the Commission, in order to qualify for this
exemption, the Company, among other things, must maintain at least 55% of its
assets in Qualifying Interests and also may be required to maintain an
additional 25% in Qualifying Interests or other real estate-related assets. The
assets that the Company may acquire therefore may be limited by the provisions
of the Investment Company Act. The Company has established a policy of limiting
Other Authorized Investments to no more than 20% of the value of the Company's
total assets.
The Company intends to publish and distribute to stockholders, in accordance
with the Securities and Exchange Act of 1934, as amended ("Exchange Act"),
annual reports containing financial statements prepared in accordance with
generally accepted accounting principles and certified by the Company's
independent public accountants. The Articles of Incorporation provide that the
Company shall maintain its status as a reporting company under the Exchange Act
for so long as any of the Series A Preferred Shares are outstanding.
The Company currently intends to make investments and operate its business
at all times in such a manner as to be consistent with the requirements of the
Code to qualify as a REIT. However, future economic, market, legal, tax or other
considerations may cause the Board of Directors, subject to approval by a
majority of Independent Directors, to determine that it is in the best interests
of the Company and its stockholders to revoke its REIT status. The Code
prohibits the Company from electing REIT status for the four taxable years
following the year of such revocation.
DESCRIPTION OF INITIAL PORTFOLIO
Information is provided in this Prospectus regarding the Residential
Mortgage Loans and the Commercial Mortgage Loans that were originated and/or
purchased by the Bank and that are expected to constitute the Initial Portfolio
actually purchased by the Company contemporaneously with the consummation of the
Offering. To the extent the over-allotment option is exercised, the Company
expects to purchase additional Residential Mortgage Loans and/or Commercial
Mortgage Loans from the Bank which have approximately the same characteristics
as those described in this Prospectus.
Information with respect to the Residential Mortgage Loans and the
Commercial Mortgage Loans expected to be included in the Initial Portfolio is
presented as of June 30, 1997. The composition of the Initial Portfolio actually
purchased by the Company contemporaneously with the consummation of the Offering
will differ from the Initial Portfolio as described in this Prospectus to the
extent of scheduled monthly payments or prepayments received subsequent to June
30, 1997 or to the extent it is discovered prior to the consummation of the
Offering that a Mortgage Loan included in the Initial Portfolio described herein
(i) is delinquent in the payment of principal or interest; (ii) is or was at any
time during the preceding 12 months (a) Classified, (b) in Nonaccrual Status or
(c) renegotiated due to financial deterioration of the borrower; or (iii) has
been, more than once during the preceding 12 months, more than 30 days past due
in the payment of principal or interest. In such event, a Mortgage Loan similar
in aggregate outstanding principal balance and product type will be substituted
for such non-purchased Mortgage Loan.
References herein to percentages of Mortgage Loans expected to be included
in the Initial Portfolio refer in each case to the percentage of the aggregate
outstanding principal balance of the Mortgage Loans in the Initial Portfolio as
of June 30, 1997, based on the outstanding principal balances of such Mortgage
38
<PAGE>
Loans as of such date, after giving effect to scheduled monthly payments
received and applied on or prior to such date.
GENERAL. As of June 30, 1997, the Initial Portfolio would have contained
284 Residential Mortgage Loans, representing approximately 78.2% of the unpaid
principal balance of the Mortgage Loans contained in the Initial Portfolio, and
83 Commercial Mortgage Loans, representing approximately 21.8% of the unpaid
principal balance of the Mortgage Loans contained in the Initial Portfolio. On
June 30, 1997, the Mortgage Loans expected to be included in the Initial
Portfolio had an aggregate outstanding principal balance of $62,252,565.
Substantially all of the Residential Mortgage Loans expected to be included
in the Initial Portfolio were originated and/or purchased by the Bank in the
ordinary course of its real estate lending activities. Management believes that
substantially all of the Residential Mortgage Loans expected to be included in
the Initial Portfolio were originated and/or purchased in a manner consistent
with the underwriting policies of the Bank at the time at which such Mortgage
Loans were originated and/or purchased.
All of the Residential Mortgage Loans expected to be included in the Initial
Portfolio were originated and/or purchased between July 1972 and June 1997, and
had original terms to stated maturity of primarily 15, 20, 25 or 30 years. As of
June 30, 1997, the average outstanding principal balance of a Residential
Mortgage Loan was $171,517. The weighted average number of months since
origination of the Residential Mortgage Loans expected to be included in the
Initial Portfolio (calculated as of June 30, 1997) was approximately 47 months
and the weighted average expected remaining maturity was 284 months. The
weighted average Loan-to-Value Ratio (defined below) of the Residential Mortgage
Loans expected to be included in the Initial Portfolio is 71.8%; however, 13.4%
of the Residential Mortgage Loans have Loan-to-Value Ratios of greater than 80%.
"Loan-to-Value Ratio" means the ratio (expressed as a percentage) of the
original principal amount of such Mortgage Loan to the lesser of (i) the
appraised value at origination of the underlying mortgaged property and (ii) if
the Mortgage Loan was made to finance the acquisition of property, the purchase
price of the mortgaged property.
The mortgage notes with respect to most of the Mortgage Loans expected to be
included in the Initial Portfolio contain "due-on-sale" provisions which prevent
the assumption of the Mortgage Loan by a proposed transferee and accelerate the
payment of the outstanding principal balance of the Mortgage Loan. With respect
to a limited number of Mortgage Loans expected to be included in the Initial
Portfolio, the mortgage notes permit assumption of the Residential Mortgage Loan
provided that the proposed transferee satisfies certain criteria with respect to
his ability to repay the Mortgage Loan.
Each Commercial Mortgage Loan expected to be included in the Initial
Portfolio was originated and/ or purchased by the Bank in the ordinary course of
its commercial real estate lending activities. All of the Commercial Mortgage
Loans expected to be included in the Initial Portfolio were originated and/or
purchased between September 1973 and June 1997, and had original terms to stated
maturity of between 10 and 30 years. As of June 30, 1997, the average
outstanding principal balance of a Commercial Mortgage Loan expected to be
included in the Initial Portfolio was $163,153. The weighted average number of
months since origination of the Commercial Mortgage Loans expected to be
included in the Initial Portfolio (calculated as of June 30, 1997) was
approximately 106 months. As of June 30, 1997, the weighted average
Loan-to-Value Ratio of the Commercial Mortgage Loans expected to be included in
the Initial Portfolio was 68.6%. In addition, as of June 30, 1997, no Commercial
Mortgage Loan expected to be included in the Initial Portfolio had a
Loan-to-Value Ratio greater than 80%.
None of the Mortgage Loans expected to be included in the Initial Portfolio
(i) is delinquent in the payment of principal or interest as of June 30, 1997;
(ii) is or was at any time during the preceding 12 months (a) Classified, (b) in
Nonaccrual Status or (c) renegotiated due to financial deterioration of the
borrower; or (iii) was, more than once during the preceding 12 months, more than
30 days past due in the payment of principal or interest. If, prior to the
acquisition of the Initial Portfolio, any Mortgage Loan included in the
description of the Initial Portfolio herein falls within any of the foregoing
categories, the Company will not purchase such Mortgage Loan but will instead
purchase a Mortgage Loan similar in aggregate outstanding principal balance and
product type which does not fall into any of these categories.
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<PAGE>
RESIDENTIAL MORTGAGE LOANS. The following table sets forth as of June 30,
1997 certain information with respect to each type of Residential Mortgage Loan
expected to be included in the Initial Portfolio:
TYPE OF RESIDENTIAL MORTGAGE LOAN PRODUCT
<TABLE>
<CAPTION>
PERCENTAGE OF
AGGREGATE RESIDENTIAL WEIGHTED AVERAGE
PRINCIPAL MORTGAGE LOANS WEIGHTED AVERAGE EXPECTED
BALANCE BY AGGREGATE INITIAL LOAN TO REMAINING
TYPE (IN THOUSANDS) PRINCIPAL BALANCE VALUE RATIO MATURITY (MONTHS)
- --------------------------------------- ---------------- ----------------- ------------------- ---------------------
<S> <C> <C> <C> <C>
7/23 Step Rate......................... $ 8,668 17.8% 77.4% 298
15 Year Fixed Rate..................... 6,202 12.7 62.6 126
30 Year Fixed Rate..................... 33,841 69.5 72.4 310
------- ----- --- ---
Total.............................. $ 48,711 100.0% 71.8% 284
------- ----- --- ---
------- ----- --- ---
</TABLE>
The Residential Mortgage Loans expected to be included in the Initial
Portfolio either bear interest at fixed rates or are "7/23 step rate" loans. The
"7/23 step rate" loan has a fixed initial interest rate for the first seven
years (i.e., 84 monthly payments) and adjusts once thereafter to a rate which
applies for the remaining 23 years (i.e., 276 monthly payments) equal to 150
basis points above the FNMA 30 year commitment rate for delivery as of a date
specified in the related mortgage note. The interest rates of the fixed rate
Residential Mortgage Loans expected to be included in the Initial Portfolio
range from 7.50% per annum to 13.5% per annum. The weighted average interest
rate of the fixed rate Residential Mortgage Loans expected to be included in the
Initial Portfolio is approximately 8.250% per annum.
The following table contains certain additional data as of June 30, 1997
with respect to the interest rates of the Residential Mortgage Loans expected to
be included in the Initial Portfolio:
INTEREST RATE OF RESIDENTIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
INITIAL
RESIDENTIAL
AGGREGATE MORTGAGE LOAN
PRINCIPAL PORTFOLIO BY
NUMBER OF BALANCE AGGREGATE
CURRENT INTEREST RATE MORTGAGE LOANS (IN THOUSANDS) PRINCIPAL BALANCE
- ----------------------------------------------------------- ------------------- ------------------ -----------------
<S> <C> <C> <C>
7.500% - 7.749%............................................ 67 $ 15,213 31.3%
7.750% - 7.999%............................................ 78 15,408 31.7
8.000% - 8.249%............................................ 19 3,528 7.2
8.250% - 8.499%............................................ 11 2,076 4.3
8.500% - 8.749%............................................ 16 2,281 4.7
8.750% - 8.999%............................................ 14 2,240 4.6
9.000% - 9.249%............................................ 15 1,093 2.2
9.250% - 9.499%............................................ 9 620 1.3
9.500% - 9.749%............................................ 4 344 0.7
9.750% - 9.999%............................................ 11 1,423 2.9
10.000% - 10.249%.......................................... 8 494 1.0
10.250% - 10.499%.......................................... 5 367 0.8
10.500% - 10.749%.......................................... 12 2,330 4.8
10.750% - 10.999%.......................................... 3 601 1.2
11.000% - 11.249%.......................................... 2 136 0.3
12.000% - 12.249%.......................................... 1 54 0.1
12.250% - 12.499%.......................................... 2 218 0.4
12.500% - 12.749%.......................................... 3 168 0.3
12.750% - 12.999%.......................................... 2 67 0.1
13.500% - 13.749%.......................................... 2 50 0.1
--- ------- -----
Total.................................................. 284 $ 48,711 100.0%
--- ------- -----
--- ------- -----
</TABLE>
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<PAGE>
Substantially all of the Mortgage Loans expected to be included in the
Initial Portfolio allow the mortgagor to prepay at any time some or all of the
outstanding principal balance of the Mortgage Loan without a fee or penalty.
The Residential Mortgage Loans which are included in the Initial Portfolio
will primarily have original terms to stated maturity of 15, 20, 25 or 30 years.
COMMERCIAL MORTGAGE LOANS. The Commercial Mortgage Loans expected to be
included in the Initial Portfolio will consist of loans secured by the
Commercial Properties located in California. The borrowers of the Commercial
Mortgage Loans expected to be included in the Initial Portfolio are primarily
customers of the Bank to which the Bank has extended such Commercial Mortgage
Loans in the ordinary course of its commercial real estate lending activities.
The outstanding principal balances of the Commercial Mortgage Loans expected to
be included in the Initial Portfolio ranged from $10,265 to $2.19 million as of
June 30, 1997.
The following table sets forth as of June 30, 1997 certain information with
respect to each type of multi-family residential and commercial property
underlying each Commercial Mortgage Loan expected to be included in the Initial
Portfolio:
TYPE OF COMMERCIAL MORTGAGE LOAN
<TABLE>
<CAPTION>
AGGREGATE COMMERCIAL WEIGHTED WEIGHTED
PRINCIPAL MORTGAGE LOANS BY WEIGHTED AVERAGE AVERAGE CURRENT AVERAGE MONTHS
BALANCE AGGREGATE PRINCIPAL INITIAL LOAN TO LOAN TO VALUE REMAINING TO
(IN THOUSANDS) BALANCE VALUE RATIO(1) RATIO(2) MATURITY
---------------- ------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C> <C>
Commercial mortgage-fixed rate
balloon..................... $ 5,425 40.1% 68.3% 67.6% 112
Commercial mortgage-fixed
rate........................ 1,657 12.2 73.1 49.9 127
Multi-family-fixed rate
balloon..................... 2,370 17.5 50.0 49.1 117
Multi-family-fixed rate....... 4,090 30.2 73.4 44.9 110
------- -----
Total..................... $ 13,542 100.0% 68.6% 55.3% 114
------- -----
------- -----
</TABLE>
- ------------------------
(1) Represents the ratio of the outstanding principal amount of each Commercial
Mortgage Loan at the time of loan origination or modification, if any, to
the value of the property securing such Commercial Mortgage Loan at the time
of loan origination or modification, if any.
(2) Represents the ratio of the outstanding principal amount of the Commercial
Mortgage Loan at June 30, 1997 to the value of the property securing such
Commercial Mortgage Loan at the time of loan origination or modification, if
any.
Of the Commercial Mortgage Loans expected to be included in the Initial
Portfolio, approximately 57.6% are not fully amortizing and will have
significant principal balances or "balloon" payments due upon maturity.
All of the Commercial Mortgage Loans expected to be included in the Initial
Portfolio bear interest at fixed rates. The interest rates of the fixed rate
Commercial Mortgage Loans expected to be included in the Initial Portfolio range
from 8.50% per annum to 14.75% per annum.
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<PAGE>
The following table contains certain additional data as of June 30, 1997
with respect to the interest rates of the fixed rate Commercial Mortgage Loans
expected to be included in the Initial Portfolio:
INTEREST RATE OF COMMERCIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF INITIAL
AGGREGATE COMMERCIAL MORTGAGE
PRINCIPAL LOAN PORTFOLIO BY
NUMBER OF BALANCE AGGREGATE
INTEREST RATE MORTGAGE LOANS (IN THOUSANDS) PRINCIPAL BALANCE
- ------------------------------------------------------ ------------------- ------------------ ---------------------
<S> <C> <C> <C>
8.50% - 8.749%........................................ 1 498 3.7%
9.000% - 9.249%....................................... 5 2,232 16.5
9.250% - 9.499%....................................... 19 3,081 22.8
9.500% - 9.749%....................................... 32 4,048 29.9
9.750% - 9.999%....................................... 6 965 7.1
10.000% - 10.249%..................................... 7 1,722 12.7
10.250% - 10.499%..................................... 1 137 1.0
10.500% - 10.749%..................................... 4 344 2.5
10.750% - 10.999%..................................... 3 168 1.2
11.000% - 11.249%..................................... 2 170 1.3
11.500% - 11.749%..................................... 2 117 0.9
14.750% - 14.999%..................................... 1 60 0.4
--
------- -----
Total............................................. 83 $ 13,542 100.0%
--
--
------- -----
------- -----
</TABLE>
UNDERWRITING STANDARDS. The Bank has represented to the Company that all of
the Residential Mortgage Loans and Commercial Mortgage Loans included in the
Initial Portfolio (including those which originated by unaffiliated third
parties) will have been originated generally in accordance with the underwriting
policy customarily employed by the Bank during the period in which the
Residential Mortgage Loans and Commercial Mortgage Loans in the Initial
Portfolio were originated.
RESIDENTIAL MORTGAGE LOANS. The underwriting standards applied at
origination of the Residential Mortgage Loans expected to be included in the
Initial Portfolio were intended to evaluate the borrower's credit standing and
repayment ability, and the value and adequacy of the underlying mortgaged
property as collateral. Generally, each prospective borrower was required to
provide a loan application and other supporting documents describing assets and
liabilities, the borrower's income and expenses, as well as, to the extent
required by applicable state law, an authorization to apply for a credit report
which summarized the borrower's credit history with merchants and lenders and
any record of bankruptcy.
For any prospective borrower, an employment verification was obtained from
the borrower's employer wherein the employer reported the length of employment
with the employer, the employee's current salary, and whether it was expected
that the borrower would continue such employment in the future or the borrower
submitted such other evidence of employment (such as pay stubs) satisfactory to
the Bank. For a self-employed prospective borrower, the borrower was generally
required to submit copies of personal and business federal income tax returns
for the previous two years. For certain prospective borrowers, the borrower
authorized verification of all deposits at financial institutions at which the
borrower had demand or savings accounts.
Once the credit report and the employment and deposit verifications were
received by the underwriting officer considering the loan application, a
determination was made as to whether the prospective borrower had sufficient
monthly income available (i) to meet the borrower's monthly obligations on the
proposed Residential Mortgage Loan (determined on the basis of the monthly
payments due in the year of origination) and other expenses related to the home
(such as property taxes and hazard insurance) and (ii) to meet other financial
obligations and monthly living expenses. In certain instances, exceptions may
42
<PAGE>
have been made to the Bank's underwriting policies (including those applied in
originating the Mortgage Loans in the Initial Portfolio) in cases deemed
appropriate by its underwriting officers.
In determining the adequacy of the property as collateral, an appraisal was
made of each property considered for financing. Each appraiser was selected in
accordance with predetermined guidelines established for appraisers. The
appraiser was required to inspect the property and verify that it was in good
condition and that construction, if new, had been completed. If the appraiser
reported any exceptions to the verification, the Bank or its agent determined
that such property had been substantially completed to its satisfaction. The
appraisal was based on the appraiser's judgment of value giving appropriate
weight to both the market value of comparable properties and the cost of
replacing the property and other factors as appropriate. The Bank's underwriting
standards also required a search of the public records relating to a mortgaged
property for liens and judgments against such mortgaged property, as well as
customary title insurance.
With respect to Residential Mortgage Loans which were purchased by the Bank,
the Bank evaluated the documentation relating to each purchased loan and
management believes that each such loan was originated in a manner that was
consistent with the underwriting standards of the Bank. All Residential Mortgage
Loans acquired by the Company in the future will be originated and/or purchased
under substantially similar standards.
COMMERCIAL MORTGAGE LOANS. The loan underwriting procedures and guidelines
utilized by the Bank in connection with the origination of the Commercial
Mortgage Loans included in the Initial Portfolio were intended to assess the
value of the related mortgaged property, the ability of such mortgaged property
to be used by the borrower or its agents and the financial condition of the
borrower, including its ability to service the Commercial Mortgage Loan.
The underwriting guidelines took into account such factors as suitability of
the mortgaged property for the proposed use; the availability, rental rates and
relative value of comparable properties in the relevant market area and the
anticipated growth or decline in both the immediate and broader geographic areas
in which the mortgaged property is located; the current or projected occupancy
or leasing ratios, if relevant; the condition and age of the mortgaged property;
the management ability of the borrower, including its business experience and
financial soundness; and such other economic, demographic or other factors as in
the judgment of the Bank might affect the value of the mortgaged property and
the ability of the borrower to service the Commercial Mortgage Loan. Each
proposal for a Commercial Mortgage Loan was presented to the appropriate lending
personnel of the Bank, which analyzed the proposed transaction focusing on
economic assumptions and the feasibility of the loan, identified and evaluated
potential risks and made a recommendation to approve or disapprove the loan. The
proposed transaction was then presented to appropriate credit officers of the
Bank for approval.
Once a loan proposal was approved, a loan commitment was issued by the Bank
to the proposed borrower, subject to, among other things, an appraisal report
and, if deemed appropriate or required, environmental engineering reports. The
Bank contracted with approved firms to prepare certain required reports for the
account of the Bank.
With respect to Commercial Mortgage Loans which were purchased by the Bank,
the Bank evaluated the documentation relating to each purchased loan and
management believes that each such loan was originated in a manner that was
consistent with the underwriting standards of the Bank. All Commercial Mortgage
Loans acquired by the Company in the future will be originated and/or purchased
under substantially similar standards.
GEOGRAPHIC DISTRIBUTION. The Company currently anticipates that 100% of the
residential real estate properties underlying the Company's Residential Mortgage
Loans expected to be included in the Initial Portfolio are located in
California. Of the Residential Mortgage Loans expected to be included in the
Initial Portfolio, as of June 30, 1997, approximately 20.8% are secured by real
estate located in Northern
43
<PAGE>
California and 79.2% are secured by real estate located in Southern California.
Consequently, these Residential Mortgage Loans may be subject to a greater risk
of default than other comparable Residential Mortgage Loans in the event of
adverse economic, political or business developments and natural hazards
(earthquakes, wild fires and mud slides, for example) in California that may
affect the ability of residential property owners in California to make payments
of principal and interest on the underlying mortgages. Standard hazard insurance
required to be maintained with respect to Residential Mortgage Loans held by the
Company may not protect the Company against losses occurring from earthquakes
and other natural disasters.
All of the commercial mortgaged properties underlying the Company's
Commercial Mortgage Loans expected to be included in the Initial Portfolio will
be located in California. Of the Commercial Mortgage Loans expected to be
included in the Initial Portfolio as of June 30, 1997, approximately 2.2% are
secured by real estate located in Northern California and 97.8% are secured by
real estate located in Southern California. Consequently, these Commercial
Mortgage Loans may be subject to a greater risk of default than other comparable
Commercial Mortgage Loans in the event of adverse economic, political or
business developments in California that may affect the ability of businesses in
that area to make payments of principal and interest on the underlying
mortgages. Consequently, in the event of a natural disaster, the Company's
ability to pay dividends on the Series A Preferred Shares could be adversely
affected as it is the Company's current intention to not maintain special hazard
insurance to protect against such losses.
LOAN-TO-VALUE RATIOS; INSURANCE. Approximately $6.53 million of the
Residential Mortgage Loans expected to be included in the Initial Portfolio as
of June 30, 1997, had Loan-to-Value Ratios of greater than 80% at the time of
origination. Of such Residential Mortgage Loans, at June 30, 1997, approximately
$5.2 million were insured under primary mortgage insurance policies. The
remaining $1.33 million of such Residential Mortgage Loans at June 30, 1997
expected to be included in the Initial Portfolio with Loan-to-Value Ratios at
origination of greater than 80% did not require primary mortgage insurance
policies because the outstanding principal balances of such loans have been
reduced (due to amortization) to levels which are less than 80% of the lesser of
(i) the appraised value at origination and (ii) the purchase price of the
mortgaged property (the "Current LTV Ratio"). Residential Mortgage Loans
expected to be included in the Initial Portfolio with Loan-to-Value Ratios
greater than 80% and Current LTV Ratios less than 80% that do not require
private mortgage insurance coverage have a weighted average Current LTV Ratio of
68.8% and have a weighted average seasoning since origination (calculated as of
June 30, 1997) of 158 months. As of June 30, 1997, not more than approximately
59.3% of such Residential Mortgage Loans which require private mortgage
insurance are insured by any one primary mortgage insurance policy issuer. At
the time of origination of the Residential Mortgage Loans, each of the primary
mortgage insurance policy insurers was approved by FNMA or FHLMC. A standard
hazard insurance policy is required to be maintained by the mortgagor with
respect to each Residential Mortgage Loan in an amount equal to the maximum
insurable value of the improvements securing such Residential Mortgage Loan or
the principal balance of such Residential Mortgage Loan, whichever is less. If
the residential real estate property underlying a Residential Mortgage Loan is
located in a flood zone, such Residential Mortgage Loan may also be covered by a
flood insurance policy as required by law. No mortgagor bankruptcy insurance
will be maintained by the Company with respect to the Residential Mortgage Loans
in the Initial Portfolio, nor will any Residential Mortgage Loan be insured by
the Federal Housing Administration or guaranteed by the Veterans Administration.
The Company will not maintain any special hazard insurance policy with respect
to any Residential Mortgage Loan which could mitigate damages caused by any
natural disaster.
A standard hazard insurance policy is also required to be maintained by the
mortgagor with respect to each of the Commercial Mortgage Loans expected to be
included in the Initial Portfolio. If the commercial real estate property
securing a Commercial Mortgage Loan is located in a flood zone, such Commercial
Mortgage Loan may be covered by a flood insurance policy as required by law.
However, as with the Residential Mortgage Loans in the Initial Portfolio, no
special hazard insurance or mortgagor bankruptcy
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insurance will be maintained by the Company with respect to the Commercial
Mortgage Loans in the Initial Portfolio.
SERVICING
The Mortgage Loans included in the Initial Portfolio will be sold to the
Company by the Bank on a servicing retained basis.
RESIDENTIAL MORTGAGE LOAN SERVICING. In March 1997, the Bank sold the
servicing rights with respect to substantially all of the Residential Mortgage
Loans held by the Bank at that time, including all of the Residential Mortgage
Loans to be included in the Initial Portfolio, to the Servicing Agent. In
connection with such sale, the Bank entered into the Residential Servicing
Agreement with the Servicing Agent pursuant to which the Servicing Agent will
service substantially all of the Bank's Residential Mortgage Loans, including
all of the Residential Mortgage Loans to be included in the Initial Portfolio.
The Bank also entered into a Forward Production Servicing Purchase and Sale
Agreement in July 1997 ("Forward Production Agreement"), pursuant to which the
Bank will sell to the Servicing Agent the servicing rights associated with (i)
Residential Mortgage Loans owned by the Bank and closed and funded subsequent to
the closing of the Residential Servicing Agreement, and (ii) Residential
Mortgage Loans owned by the Bank prior to such date which were serviced by
others and as to which the Bank has reacquired such servicing rights. Pursuant
to the Residential Assumption Servicing Agreement to be entered into between the
Company, the Bank and the Servicing Agent, the Servicing Agent will service
Residential Mortgage Loans which are sold by the Bank to the Company,
substantially in accordance with the terms of the Residential Servicing
Agreement. Pursuant to the terms of both the Residential Assumption Servicing
Agreement and the Forward Production Agreement, the Servicing Agent will, for so
long as the Forward Production Agreement remains in effect, service any
additional Residential Mortgage Loans which may in the future be originated by
the Bank and sold to the Company.
The Residential Servicing Agreement and the Residential Assumption Servicing
Agreement (collectively, the "Residential Servicing Agreements") provide that
the Servicing Agent will receive an annual servicing fee with respect to each
Residential Mortgage Loan serviced for the Company which shall be equal to the
outstanding principal balance of such Residential Mortgage Loans multiplied by a
fee of 0.25% (in the case of fixed rate Residential Mortgage Loans (including
"7/23 step rate" loans)) and 0.375% (in the case of adjustable rate Residential
Mortgage Loans). The Bank's Servicing Agent, Temple Inland Mortgage Corporation,
is a Nevada corporation and wholly owned subsidiary of Guaranty Federal Bank,
F.S.B., which is wholly owned by Temple-Inland Inc. As of the date of this
Prospectus, Temple-Inland's public debt is rated A- by Standard and Poors and A2
by Moodys. At December 31, 1996, according to public filings, the Servicing
Agent was servicing $17.9 billion in mortgage loans, including loans serviced
for affiliates.
The Residential Servicing Agreements require the Servicing Agent to service
the Company's Residential Mortgage Loans in a manner generally consistent with
servicing guidelines promulgated by the Bank (and previously determined to be
acceptable to the Servicing Agent) and with FNMA and FHLMC guidelines and
procedures and as otherwise set forth in the Residential Servicing Agreements.
The Servicing Agent will collect and remit principal and interest payments,
administer mortgage, custodial and escrow accounts, submit and pursue insurance
claims and initiate and supervise foreclosure proceedings on the Residential
Mortgage Loans it services. The Servicing Agent will also provide accounting and
reporting services to the Company for such Residential Mortgage Loans.
Additionally the Servicing Agent will assume responsibility for payment of
ground rents, taxes, assessments, water rates, mortgage insurance premiums, and
other charges which are or may become a lien upon the mortgaged property. The
Servicing Agent also will be responsible for any late charges or tax penalties
incurred due to its failure to pay such bills. The Residential Servicing
Agreements require the Servicing Agent to follow such collection procedures that
are consistent with the Servicing Agent's procedures for servicing mortgage
loans comparable to the Residential Mortgage Loans and to exercise the degree of
care required by FNMA and FHLMC.
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The Servicing Agent may waive, modify or vary any term of any Residential
Mortgage Loan or consent to the postponement of compliance with any such term or
in any manner grant indulgence to any borrower if in the Servicing Agent's
reasonable and prudent determination such waiver, modification, postponement or
indulgence is not materially adverse to the Company; provided, however, that the
Servicing Agent shall not permit any modification with respect to any
Residential Mortgage Loan that would decrease the mortgage interest rate (other
than by adjustments required by the terms of the mortgage note), defer or
forgive the payment thereof or of any principal or interest payments, reduce the
outstanding principal amount (except for actual payments of principal), make
future advances or extend the final maturity date on such Residential Mortgage
Loan without the Company's prior written consent. However, the Servicing Agent
may permit forbearance or allow for suspension of monthly payments if the
borrower is in default or the Servicing Agent determines in its reasonable
discretion that default is imminent and if the Servicing Agent determines that
granting such forbearance or suspension is in the best interest of the Company.
The Servicing Agent will use its best efforts, consistent with the procedures
that the Servicing Agent would use in servicing loans for its own accounts, to
foreclose upon or otherwise comparably convert the ownership of properties
securing such of the Residential Mortgage Loans as come into and continue in
default and as to which no satisfactory agreements can be made for collection of
delinquent payments.
The Bank's Residential Servicing Agreement with the Servicing Agent provides
that the Bank can direct the Servicing Agent to transfer the servicing and
disposition functions with respect to all Residential Mortgage Loans which
become Nonaccrual back to the Bank. All of such properties which become REO will
automatically be transferred back to the Bank for the same purpose. The
Residential Mortgage Purchase Agreement and the Residential Assumption Servicing
Agreement provide for the same treatment with respect to Residential Mortgage
Loans sold by the Bank to the Company which become Nonaccrual or REO. Upon
receipt of written direction from the Company, the Servicing Agent is required
to promptly transfer the servicing for any such Nonaccrual Mortgage Loan to the
Bank and will automatically transfer servicing with respect to REO to the Bank.
The Bank will service and charge a servicing fee with respect to such Nonaccrual
Mortgage Loans for which the servicing has been transferred. The Bank will also
service and dispose of such REO, as required, on the Company's behalf.
The Residential Servicing Agreements require the Servicing Agent to pay all
expenses related to the performance of its duties under such agreements. For
advances of reimbursable out of pocket costs and expenses, the Servicing Agent
generally will be reimbursed out of proceeds related to such Residential
Mortgage Loan.
In connection with any foreclosure proceedings that the Servicing Agent may
institute, the Servicing Agent may exercise any power of sale contained in any
mortgage or deed of trust, obtain a deed in lieu of foreclosure or otherwise
acquire title to a mortgaged property underlying a Residential Mortgage Loan by
operation of law or otherwise in accordance with the terms of the Residential
Servicing Agreements. In the event that title to the property securing a
Residential Mortgage Loan is acquired in foreclosure or by deed in lieu of
foreclosure, the deed or certificate of sale shall be taken in the name of the
Company with the servicing with respect to such Residential Mortgage Loan to be
transferred back to the Company. It is expected that the Bank will service such
REO on behalf of the Company.
The Company may terminate the Residential Servicing Agreements upon the
happening of one or more events specified in such Residential Servicing
Agreements. Such events relate generally to either (i) the Servicer's proper and
timely performance of its duties and obligations under the Residential Servicing
Agreements, or (ii) the appointment of a conservator, receiver or liquidator in
any insolvency, bankruptcy or similar proceeding. In addition, the Company may
also terminate the Residential Servicing Agreements without cause but will be
required to pay a termination fee which, for the first seven years from June 1,
1997 shall be equal to 1.10% of the aggregate outstanding principal amount of
the loans then serviced and thereafter, 1.0% of the aggregate outstanding
principal amount of the loans then serviced. The Forward Production Agreement
may be terminated upon 60 days notice by either party. As long as any
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Series A Preferred Shares remain outstanding, the Company may not terminate, or
elect not to renew, the Residential Servicing Agreements without the approval of
a majority of the Independent Directors.
As is customary in the mortgage loan servicing industry, the Servicing Agent
will be entitled to retain any late payment charges, penalties and assumption
fees collected in connection with the Residential Mortgage Loans serviced by it.
In addition, the Servicing Agent will receive any benefit derived from interest
earned on collected principal and interest payments between the date of
collection and the date of remittance to the Company and from interest earned on
tax and insurance impound funds with respect to Residential Mortgage Loans
serviced by it. The Residential Servicing Agreements require the Servicing Agent
to remit to the Company no later than the 18th day of each month (or the next
business day if such 18th day is not a business day) all principal and interest
collected from borrowers of Residential Mortgage Loans serviced by it during the
immediately preceding month.
When any mortgaged property underlying a Mortgage Loan is conveyed by a
mortgagor, the Servicing Agent generally will enforce any "due-on-sale" clause
contained in the Residential Mortgage Loan, to the extent permitted under
applicable law and governmental regulations and subject to the Company's prior
approval. The terms of a particular Residential Mortgage Loan or applicable law,
however, may provide that the exercise of the "due-on-sale" clause is prohibited
under certain circumstances. Under such circumstances, the Servicing Agent will
negotiate an assumption agreement with the person to whom the mortgaged property
has been conveyed or is proposed to be conveyed, pursuant to which such person
becomes liable under the mortgage note. Where an assumption is allowed, the
Servicing Agent will be authorized to negotiate a substitution of liability
agreement with the person to whom the mortgage property has been conveyed or is
proposed to be conveyed pursuant to which the original mortgagor is released
from liability and such person is substituted as mortgagor and becomes liable
under the related mortgage note. The Servicing Agent will be authorized to
collect and retain such assumption fees as are permitted by the terms of the
mortgage loan documents and applicable law. Upon any assumption of a Residential
Mortgage Loan by a transferee, a fee equal to a specified percentage of the
outstanding principal balance of the Residential Mortgage Loan is typically
required, which sum will be retained by the Servicing Agent as additional
servicing compensation.
COMMERCIAL MORTGAGE LOAN SERVICING. The Bank will service the Commercial
Mortgage Loans included in the Initial Portfolio pursuant to the terms of the
Commercial Servicing Agreement. The Bank will receive an annual servicing fee
with respect to each Commercial Mortgage Loan serviced for the Company which
shall equal the outstanding principal balance of such Commercial Mortgage Loans
multiplied by a fee of 0.25%.
The Bank may, from time to time, subject to approval of a majority of the
Independent Directors, subcontract all or a portion of its obligations under the
Commercial Servicing Agreement. The Bank will not, to the extent it subcontracts
any of its obligations under the Commercial Servicing Agreement, be discharged
or relieved in any respect from its obligations to the Company to perform
thereunder.
The Commercial Servicing Agreement requires the Bank to service the
Company's Commercial Mortgage Loans in a manner generally consistent with
procedures and practices customarily employed and exercised by the Bank and with
any servicing guidelines promulgated by the Company. The Bank will collect and
remit principal and interest payments, administer mortgage, custodial and escrow
accounts, submit and pursue insurance claims and initiate and supervise
foreclosure proceedings on the Commercial Mortgage Loans it services. The Bank
will also provide accounting and reporting services required by the Company for
such Commercial Mortgage Loans. Additionally, for all Commercial Mortgage Loans,
the Bank will assume responsibility for payment of taxes and other charges which
are or may become a lien upon the mortgaged property. The Bank also will be
responsible for any late charges or tax penalties incurred due to its failure to
pay such bills. The Commercial Servicing Agreement requires the Bank to follow
such collection procedures that are consistent with the Bank's procedures for
mortgage loans comparable to the Commercial Mortgage Loans held for its own
account, including contacting delinquent
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borrowers and supervising foreclosures and property dispositions in the event of
unremedied defaults. The Bank may, in its discretion, arrange with a defaulting
borrower a schedule for the liquidation of delinquencies. The Bank will use its
best efforts, consistent with the procedures that the Bank would use in
servicing loans for its own account, to foreclose upon or otherwise comparably
convert the ownership of properties securing such of the Commercial Mortgage
Loans as come into and continue in default and as to which no satisfactory
agreements can be made for collection of delinquent payments. The Bank also will
use its best efforts to realize upon defaulted Commercial Mortgage Loans in such
manner as will maximize the receipt of principal and interest.
The Commercial Servicing Agreement requires the Bank to pay all expenses
related to the performance of its duties under such Servicing Agreement. For
advances of reimbursable out of pocket costs and expenses, the Bank generally
will be reimbursed prior to the Company out of proceeds related to such
Commercial Mortgage Loan. The Bank also will be entitled to reimbursement by the
Company for expenses incurred by it in connection with the liquidation of
defaulted Commercial Mortgage Loans serviced by it and in connection with the
restoration of mortgaged property.
If claims are not made or paid under applicable insurance policies or if
coverage thereunder has ceased, the Company will suffer a loss to the extent
that the proceeds from liquidation of the mortgaged property, after
reimbursement of the Bank's expenses in the sale, are less than the outstanding
principal balance of the related Commercial Mortgage Loan. The Bank will be
responsible to the Company for any loss suffered as a result of its failure to
make and pursue timely claims or as a result of actions taken or omissions made
by it which cause the policies to be canceled by the insurer.
In connection with any foreclosure proceedings that the Bank may institute,
the Bank may exercise any power of sale contained in any mortgage or deed of
trust, obtain a deed in lieu of foreclosure or otherwise acquire title to a
mortgaged property underlying a Commercial Mortgage Loan by operation of law or
otherwise in accordance with the terms of the Commercial Servicing Agreement.
The Bank will not be permitted under the terms of the Commercial Servicing
Agreement to acquire title to any commercial real estate property underlying a
Commercial Mortgage Loan or take any action that would cause the Company to be
an "owner" or an "operator" within the meaning of certain federal environmental
laws, unless it has also previously determined, subject to the approval of the
Advisor, based on a report prepared by an independent person who regularly
conducts environmental assessments, that (i) the mortgaged property is in
compliance with applicable environmental laws or that it would be in the best
interests of the Company to take such actions as are necessary to cause the
mortgaged property to comply therewith and (ii) there are no circumstances or
conditions present at the mortgaged property relating to the use, management or
disposal of any hazardous substances, hazardous materials, hazardous wastes or
petroleum-based materials for which investigation, testing, monitoring,
containment, clean-up or remediation could be required under any federal, state
or local law or regulation, or, if any such materials are present for which such
action could be required, that it would be in the best interest of the Company
to take such actions with respect to the mortgage property.
The Company may terminate the Commercial Servicing Agreement upon the
happening of one or more events specified in such Commercial Servicing
Agreement. Such events relate generally to (i) the Bank's proper and timely
performance of its duties and obligations under the Commercial Servicing
Agreement or (ii) the appointment of a conservator, receiver or liquidator in
any insolvency, bankruptcy or similar proceeding. In addition, the Company may
also terminate the Commercial Servicing Agreement without cause but will be
required to pay a termination fee that is competitive with that which is
generally payable in the industry, equal to 0.25% of the aggregate outstanding
principal amount of the loans then serviced under the Commercial Servicing
Agreement. As long as any Series A Preferred Shares remain outstanding, the
Company may not terminate or elect not to renew, the Commercial Servicing
Agreement without the approval of a majority of the Independent Directors.
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The Bank will be entitled to retain any late payment charges, prepayment
fees, penalties and assumption fees collected in connection with the Commercial
Mortgage Loans serviced by it. In addition, the Bank will receive any benefit
derived from interest earned on collected principal and interest payments
between the date of collection and the date of remittance to the Company and
from interest earned on tax and insurance impound funds with respect to
Commercial Mortgage Loans serviced by it. The Commercial Servicing Agreement
requires the Bank to remit to the Company no later than the 18th day of each
month (or the next business day if such 18th day is not a business day) all
principal and interest collected from borrowers of Commercial Mortgage Loans
serviced by it on the last day of the immediately preceding month.
When any mortgage property underlying a Commercial Mortgage Loan is conveyed
by a mortgagor, the Bank generally will enforce any "due-on-sale" clause
contained in the Commercial Mortgage Loan, including collection of any mortgage
prepayment penalties, to the extent permitted under applicable law, governmental
regulations and the loan documents.
As a result of the relationship between the Bank, the Servicing Agent and
the Company, certain conflicts of interest may arise. See "Risk
Factors--Relationship with the Bank; Conflicts of Interest."
EMPLOYEES
The Company has four officers, each of whom is described further below under
"Management." The Company does not anticipate that it will require any
additional employees because it has retained the Advisor to perform certain
functions pursuant to the Advisory Agreement described below under
"Management--The Advisor." It is currently anticipated that all of the officers
of the Company will also be officers or employees of SOCAL or the Bank. The
Company will maintain corporate records and audited financial statements that
are separate from those of the Bank. None of the officers, employees or
directors of the Company will have any direct or indirect pecuniary interest in
any Mortgage Asset to be acquired or disposed of by the Company or in any
transaction in which the Company has an interest or will engage in acquiring,
holding and managing Mortgage Assets.
COMPETITION
The Company does not anticipate that it will engage in the business of
originating Mortgage Loans. It does anticipate that it will purchase Mortgage
Loans in addition to those in the Initial Portfolio and that substantially all
of these Mortgage Loans will be purchased from the Bank, although the Company
may purchase Mortgage Loans from unaffiliated third parties. Accordingly, the
Company does not expect to compete with mortgage conduit programs, investment
banking firms, savings and loan associations, banks, thrift and loan
associations, finance companies, mortgage bankers or insurance companies in
acquiring Mortgage Loans.
LEGAL PROCEEDINGS
The Company is not the subject of any litigation. None of the Company, the
Advisor or the Bank is currently involved in nor, to the Company's knowledge,
currently threatened with any material litigation with respect to the Mortgage
Loans to be included in the Initial Portfolio, other than routine litigation
arising in the ordinary course of business, most of which is expected to be
covered by liability insurance.
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BENEFICIAL OWNERSHIP OF THE COMPANY
As of July 3, 1997, there were 10,000 shares of Common Stock of the Company
issued and outstanding, all of which were owned by the Bank. The following table
set forth certain information concerning the ownership of the Company's
outstanding Common Stock as of that date.
<TABLE>
<CAPTION>
PERCENT
NAME AND ADDRESS AMOUNT AND NATURE OF OF
TITLE OF CLASS OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP CLASS
- ----------------- --------------------------------- -------------------- ---------
<S> <C> <C> <C>
Common Stock People's Bank of California 10,000 100%
5900 Wilshire Boulevard
Los Angeles, California 90036
</TABLE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The Company's Board of Directors will initially be composed of seven
members, two of whom are Independent Directors. An "Independent Director" is a
director who is not a current officer or employee of the Company or a current
director, officer or employee of the Bank or any affiliate of the Bank. These
directors will serve until their successors are duly elected and qualified.
There is no current intention to alter the number of directors comprising the
Board of Directors. Pursuant to the Articles of Incorporation, the Independent
Directors are required to consider the interests of the holders of both the
Common Stock and the Preferred Stock, including the Series A Preferred Shares,
in determining whether any proposed action requiring their approval is in the
best interests of the Company. The Company currently has four officers. The
Company has no other employees and does not anticipate that it will require
additional employees. See "Business and Strategy--Employees."
The persons who are directors and executive officers of the Company (ages as
of June 30, 1997) are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION AND OFFICES HELD
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Rudolf P. Guenzel.................................... 57 President, Chief Executive Officer and Director
Henry Peters......................................... 56 Chairman of the Board of Directors
Gerard Jervis........................................ 49 Director
Robert W. MacDonald.................................. 50 Director
John F. Davis........................................ 50 Director
David S. Honda....................................... 56 Director
J. Michael Holmes.................................... 51 Executive Vice President, Chief Financial
Officer, Secretary and Director
John T. Wasley....................................... 35 Senior Vice President
Gerald A. Timpone.................................... 46 Vice President
</TABLE>
Set forth below is information with respect to the principal occupations
during the last five years of the Company's directors and officers.
RUDOLF P. GUENZEL. Mr. Guenzel is President and Chief Executive Officer and
a director of the Company, positions he has held since the Company's inception
in June 1997. Mr. Guenzel has served as President of SOCAL and President, Chief
Executive Officer and a director of the Bank since March 1995. From September
1994 through March 1995, Mr. Guenzel worked as a consultant in the area of bank
profitability analysis. Mr. Guenzel formerly was the President and Chief
Executive Officer and a director of BancFlorida Financial Corp., which was a New
York Stock Exchange listed company, and its subsidiary, Banc Florida, FSB. He
joined the BancFlorida Group in March 1991 when the company was experiencing
serious financial difficulties associated with high non-performing assets
attributable to the national recession and local economic conditions. Mr.
Guenzel directed the Company's attention to problem asset
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resolution and returned BancFlorida to profitability. The price of BancFlorida
Financial's common stock increased from a low of $2.375 per share during the
first quarter of 1991 to $30.00 per share, the price at which the shares were
acquired by First Union Corp. in August 1994. Mr. Guenzel served as Chief
Executive Officer through BancFlorida Financial's merger with First Union Corp.
Prior to BancFlorida Financial, Mr. Guenzel was employed by European American
Bank from 1971 until 1989. Mr. Guenzel started as head of the Credit Division,
worked in problem loan resolutions and eventually was responsible for the
Operations and Systems Division.
HENRY PETERS. Mr. Peters, a director of the Company, the Bank and SOCAL,
has served as a trustee of the Bishop Estate, which owns 60% of the common
equity of SOCAL, since 1984. In addition, he is Chairman of the Board of the
Bishop Estate's property and investment management subsidiary, Royal Hawaiian
Shopping Center, Inc. From 1978 through 1984, Mr. Peters served as Industrial
Division Manager of Dura Constructors, a construction firm located in Honolulu,
Hawaii. From 1974 through 1994, Mr. Peters served as a Representative to the
House of Representatives of the State of Hawaii and from 1981 through 1986, Mr.
Peters served as Speaker of the House.
GERARD JERVIS. Mr. Jervis, a director of the Company, the Bank and SOCAL,
has served as a trustee of the Bishop Estate since 1994. From 1986 through 1994,
Mr. Jervis was partner in the law firm of Jervis, Winer & Meheula located in
Kailua, Hawaii.
ROBERT W. MACDONALD. Mr. MacDonald, a director of the Company and the Bank,
is Managing Director of William E. Simon & Sons, a merchant banking firm, where
he has been employed since 1991. William E. Simon & Sons has an indirect
ownership interest in SOCAL through Arbur, Inc. Mr. MacDonald was with Salomon
Brothers between 1971 and 1979, at which time he started a financial advisory
firm and Catalyst Energy Corporation, a leading developer of independent power
facilities. The company went public in 1984 and was sold to an investor group in
1988. Between 1988 and 1991, Mr. MacDonald created a merchant banking
corporation, East Rock Partners, which invested in alternative energy products
and other projects.
JOHN F. DAVIS. Mr. Davis, a director of the Company, is an attorney who
specializes in federal and state depository institution law and regulation. Mr.
Davis has served as a legal consultant for two local financial institutions
since 1993 and 1995, respectively, during which he was actively involved in
troubled real estate work-outs, foreclosed real estate disposition and related
litigation and, with one of such institutions, a reorganization and
recapitalization. During 1991 and 1992, Mr. Davis served as Of Counsel to
Griffinger, Freed, Heinemann, Cook & Foreman, San Francisco, California.
DAVID S. HONDA. Mr. Honda, a director of the Company, has since 1980 been
President of D.S. Honda Construction, Inc., a general contracting construction,
interior design and space planning firm located in Northridge, California. Mr.
Honda has been responsible for the creation or renovation of millions of square
feet of commercial real estate in Los Angeles and he is actively involved with
economic development and small business organizations generally and with Asian
business associations in particular throughout the city. Mr. Honda has been
extensively involved with civic and service organizations in the community for
many years. His firm has been recognized by local County Board of Supervisors
and Chambers of Commerce. As a result of the Northridge earthquake in 1994, an
office building personally owned by Mr. Honda and his wife was severely damaged,
resulting in a complete tenant vacancy of the property. Because Mr. Honda was
unable to obtain additional financing or an acceptable work-out program on the
damaged property, Mr. Honda filed for personal bankruptcy under the federal
bankruptcy laws in 1995 which was fully discharged in July 1996.
J. MICHAEL HOLMES. Mr. Holmes is the Executive Vice President, Chief
Financial Officer and Secretary of the Company, positions he had held since the
Company's inception in June 1997. Mr. Holmes became a director of the Company in
September 1997. He has served as Secretary and Treasurer of SOCAL and Executive
Vice President and Chief Financial Officer of the Bank since March 1995.
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<PAGE>
Mr. Holmes also serves as Secretary and Treasurer of SOCAL. Prior to SOCAL, Mr.
Holmes joined Banc Florida, FSB in 1974 as Controller and served in various
capacities, culminating as Executive Vice President and Chief Financial Officer
in 1985, a position he held through the company's merger with First Union in
August 1994. Mr. Holmes also served as Secretary, Treasurer and Chief Financial
Officer of the parent holding company, BancFlorida Financial Corp., between 1985
and August 1994.
JOHN T. WASLEY. Mr. Wasley is the Senior Vice President of the Company, a
position he has held since September 1997. He is Senior Vice President of the
Bank and manages the Loan Servicing, Commercial Real Estate Lending, Special
Assets, Corporate Real Estate and General Services Departments of the Bank. Mr.
Wasley joined the Bank in 1992 to establish the Special Assets Department.
During his tenure at the Bank, Mr. Wasley has managed the liquidation of $112
million in non-performing assets. Between 1988 and 1992, Mr. Wasley was
President of Wedgewood Development Company, which was a Los Angeles-based real
estate development company. Between 1984 and 1988, Mr. Wasley was the Chief
Financial Officer of Wedgewood Investment Corporation, which is a Los
Angeles-based real estate investment firm.
GERALD A. TIMPONE. Mr. Timpone is a Vice President of the Company, a
position he has held since September 1997. He is also an Assistant Vice
President of the Bank and its Compliance Manager and Community Reinvestment Act
("CRA")/Fair Lending Officer. Mr. Timpone has held such positions with the Bank
since May 1992. Prior thereto, from December 1991 to May 1992, Mr. Timpone was
Office Manager and Senior Appraiser for Full Service Appraisal Group, San
Bernardino, California.
INDEPENDENT DIRECTORS
The Company's Articles of Incorporation require that, so long as any Series
A Preferred Shares are outstanding, certain actions by the Company be approved
by a majority of the Independent Directors of the Company. See "Description of
Series A Preferred Shares--Independent Director Approval." In addition, although
not restricted from doing so, the Board of Directors does not currently intend
to approve the following transactions without the approval of a majority of the
Independent Directors: (i) the modification of the general distribution policy
or the authorization or declaration of any distribution in respect of Common
Stock for any year if, after taking into account any such proposed distribution,
total distributions on the Series A Preferred Shares and the Common Stock would
exceed an amount equal to the sum of 105% of the Company's REIT taxable income
(excluding capital gains) for such year plus net capital gains of the Company
for that year and (ii) the redemption of any shares of Common Stock. Messrs.
Davis and Honda are the Company's initial Independent Directors. For so long as
there are only two Independent Directors, any action that requires the approval
of a majority of Independent Directors must be approved by both Independent
Directors.
If full dividends on shares of Series A Preferred Shares shall not have been
paid for six Dividend Periods, the maximum authorized number of directors of the
Company shall thereupon be increased by two. Subject to compliance with any
requirement for regulatory approval of (or non-objection to) persons serving as
directors, the holders of Series A Preferred Shares, voting together as a class
with the holders of any Parity Stock upon which the same voting rights as those
of the Series A Preferred Shares have been conferred and are irrevocable, shall
have the exclusive right to elect the two additional directors at the Company's
next annual meeting of stockholders and at each subsequent annual meeting until
full dividends have been authorized, declared and paid or authorized and
declared and a sum sufficient for payment thereof is set apart for payment on
the Series A Preferred Shares for four consecutive Dividend Periods. The term of
such directors elected thereby shall terminate, and the total number of
directors shall be decreased by two, upon the payment or the declaration and
setting aside for payment of full dividends on the Series A Preferred Shares for
four consecutive Dividend Periods. Any member of the Board of Directors elected
by holders of the Company's Preferred Stock will be deemed to be an Independent
Director for purposes of the actions requiring the approval of a majority of the
Independent Directors. See "Description of Series A Preferred Shares--Voting
Rights."
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AUDIT COMMITTEE
The Company has established an audit committee which will review the
engagement and independence of its auditors. The audit committee will also
review the adequacy of the Company's internal accounting controls. The audit
committee will initially be comprised of Messrs. Davis and Honda.
COMPENSATION OF DIRECTORS AND OFFICERS
The Company intends to pay the Independent Directors of the Company fees for
their services as directors. The Independent Directors will receive a fee of
$1,000 for attendance (in person or by telephone) at each meeting of the Board
of Directors or Committee of the Board. However, multiple fees shall not be paid
for two or more meetings attended on the same day. The Company will not pay any
compensation to its officers or employees or to directors who are not
Independent Directors.
LIMITATIONS ON LIABILITY OF DIRECTORS AND OFFICERS
The Company's Articles of Incorporation eliminate, to the fullest extent
permitted by the MGCL, the personal liability of a director to the Company or
its stockholders for monetary damages for breach of such director's fiduciary
duty. The Company's Articles of Incorporation empower the Company to indemnify,
to the fullest extent permitted by the MGCL, any director or officer of the
Company. The Company's Articles of Incorporation also empower the Company to
purchase and maintain insurance to protect any director or officer against any
liability asserted against him or her, or incurred by him or her, arising out of
his or her status as such.
The bylaws of the Company (the "Bylaws") require indemnification of the
Company's directors and officers and specify that the right to indemnification
is a contract right, setting forth certain procedural and evidentiary standards
applicable to the enforcement of a claim under the Bylaws. The Bylaws also
entitle any director or officer to be reimbursed for the expenses of defending
any claim against him or her arising out of his or her status as such. The
Bylaws of the Company also provide that the Company may enter into contracts
with any director or officer in furtherance of the indemnification provisions
contained in the Bylaws and allow the Company to create a trust fund to ensure
payment of amounts indemnified.
THE ADVISOR
In connection with the consummation of the Offering and the formation of the
Company as described herein, the Company will enter into the Advisory Agreement
with the Bank to administer the day-to-day operations of the Company. The Bank
in its role as advisor under the terms of the Advisory Agreement is herein
referred to as the "Advisor." The Advisor will be responsible for, among other
things: (i) monitoring the credit quality of the Mortgage Assets and Other
Authorized Investments held by the Company; (ii) advising the Company with
respect to the acquisition, management, financing and disposition of the
Company's Mortgage Assets and Other Authorized Investments; and (iii)
representing the Company in its day-to-day dealings with persons with whom the
Company interacts. In performing its duties under the Advisory Agreement, the
Advisor is required to act in a manner that is consistent with maintaining the
Company's qualification as a REIT. The Advisor may, from time to time,
subcontract all or a portion of its obligations under the Advisory Agreement,
with the approval of a majority of the Board of Directors as well as a majority
of the Independent Directors, to unrelated third parties. The Advisor will not,
in connection with the subcontracting of any of its obligations under the
Advisory Agreement, be discharged or relieved in any respect from its
obligations under the Advisory Agreement. Notwithstanding the above, the Company
will control the activities of the Advisor and the Company's directors will
maintain the continuing and exclusive authority to manage the operations of the
Company.
The Advisor has substantial experience in the mortgage lending industry,
both in the origination and in the servicing of mortgage loans. At June 30,
1997, the Advisor held approximately $547.1 million of single-family residential
mortgage loans and approximately $442.7 million and $117.9 million of multi-
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family residential and commercial mortgage loans, respectively. In its
residential mortgage loan business, the Advisor originates and purchases
residential mortgage loans and may sell such loans to investors, primarily in
the secondary market. The Advisor has recently sold to the Servicing Agent the
servicing rights with respect to substantially all of its Residential Mortgage
Loans. See "Business and Strategy--Servicing." In its commercial mortgage loan
business, the Advisor typically services the commercial mortgage loans in its
portfolio which it has originated.
The Advisory Agreement has an initial term of five years, and will be
renewed automatically for additional five-year periods unless notice of
nonrenewal is delivered to the Advisor by the Company. The Advisory Agreement
may be terminated by the Company at any time upon 90 days' prior notice. As long
as any Series A Preferred Shares remain outstanding, any decision by the Company
either not to renew the Advisory Agreement or to terminate the Advisory
Agreement must be approved by a majority of the Board of Directors, as well as
by a majority of the Independent Directors. The Advisor will be entitled to
receive an annual advisory fee equal to $200,000 with respect to the advisory
and management services provided by it to the Company.
As a result of the relationship between the Bank and the Company, certain
conflicts of interest may arise. See "Risk Factors--Relationship with the Bank;
Conflicts of Interest."
CERTAIN TRANSACTIONS CONSTITUTING THE FORMATION
THE FORMATION
Prior to or simultaneously with the completion of the Offering, the Company
and the Bank will engage in the transactions described below which are designed
(i) to facilitate the Offering, (ii) to transfer the ownership of the Initial
Portfolio to the Company and (iii) to enable the Company to qualify as a REIT
for federal income tax purposes commencing with its taxable year ending December
31, 1997.
The transactions constituting the formation of the Company will include the
following:
- The Articles of Incorporation of the Company will be amended and restated
to provide for 4,000,000 authorized shares of Preferred Stock and
4,000,000 authorized shares of Common Stock, and to establish the terms of
the Series A Preferred Shares.
- The Company will sell to the public 1,240,000 Series A Preferred Shares in
the Offering (assuming the Underwriters' over-allotment option is not
exercised).
- The Bank has acquired 10,000 shares of Common Stock for an aggregate
purchase price equal to $100. In addition, the Bank will make capital
contributions to the Company equal to the sum of $31.3 million plus the
aggregate amount of underwriting commissions and expenses of the Offering
and the formation of the Company. The Bank currently owns, and following
the completion of the Offering will continue to own, all of the issued and
outstanding shares of Common Stock of the Company. The Bank currently
intends that, so long as any Series A Preferred Shares are outstanding, it
will maintain direct ownership of at least a majority of the outstanding
shares of Common Stock.
- The Bank will sell the Initial Portfolio to the Company for an aggregate
purchase price equal to the net book value of the Mortgage Loans included
in the Initial Portfolio as of the date of closing of the transaction. As
of June 30, 1997, the book value of such Mortgage Loans amounted to
approximately $62.3 million. See "Business and Strategy--Acquisition of
Initial Portfolio."
- The Company will enter into the Advisory Agreement with the Bank pursuant
to which the Bank, as Advisor, will manage the Mortgage Assets held by the
Company and administer the day-to-day operations of the Company. See
"Management--The Advisor."
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- The Company will enter into the Commercial Servicing Agreement with the
Bank pursuant to which the Bank will service the Commercial Mortgage Loans
included in the Initial Portfolio and the Company will, upon purchase of
the Residential Mortgage Loans, enter into the Residential Assumption
Servicing Agreement, pursuant to which the Servicing Agent will service
the Residential Mortgage Loans which the Company acquires from the Bank.
See "Business and Strategy-- Servicing."
In addition to its ownership of 100% of the Common Stock of the Company, the
Bank will also have responsibility for the day-to-day management and custody of
the Company's assets, in its capacity as Advisor under the Advisory Agreement,
and will have responsibility for servicing the Commercial Mortgage Loans as
Servicer under the Commercial Servicing Agreement. See "Management--The Advisor"
and "Risk Factors--Relationship with the Bank; Conflicts of Interest."
The purchase price of the Initial Portfolio will equal the net book value of
the Mortgage Loans included in the Initial Portfolio as of the date of closing
of the transaction. As of June 30, 1997, the book value of such Mortgage Loans
amounted to approximately $62.3 million. However, no third party valuations of
the Mortgage Loans constituting the Initial Portfolio have been or will be
obtained for purposes of the Offering, and there can be no assurance that the
fair value of the Initial Portfolio will not differ from the purchase price to
be paid by the Company. See "Risk Factors--No Third Party Valuation of the
Mortgage Loans; No Arm's-Length Negotiations" and "--Relationship with the Bank;
Conflicts of Interest."
BENEFITS TO THE BANK
The Bank expects to realize the following benefits in connection with the
Offering and the formation of the Company:
- The Bank has advised the Company that the Bank expects a portion of the
Series A Preferred Shares to qualify as core capital of the Bank under
relevant regulatory capital guidelines. The increase in the Bank's core
capital and risk-based capital levels that will result from the treatment
of the Series A Preferred Shares as core capital will enable the Bank to
retain a higher base of interest-earning assets, resulting in
incrementally higher related earnings.
- The dividends paid on the Series A Preferred Shares will be deductible by
the Company for income tax purposes as a result of the Company's
qualification as a REIT, which provides the Bank with a more
cost-effective means of obtaining regulatory capital than if the Bank were
to issue preferred stock.
- The Bank will receive approximately $62.3 million in connection with the
sale of the Initial Portfolio to the Company (approximately $29.0 million
of which represents new funds after giving effect to the Bank's expense of
purchasing the Company's Common Stock and additional capital
contributions).
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- The Bank will be entitled to receive annual advisory and servicing fees
and annual dividends in respect of the Common Stock. For the first full
year following completion of the Offering, these annual fees and dividends
are anticipated to be as follows:
<TABLE>
<S> <C>
Advisory Fee............................................. $ 200,000
Servicing Fee(1)(2)...................................... 34,000
Common Stock Dividend(3)................................. 1,900,000
---------
$2,134,000
---------
---------
</TABLE>
-------------------------------
(1) Assumes that for the first full year following completion of the
Offering, the Company holds Commercial Mortgage Loans with the same
outstanding principal balances as those Commercial Mortgage Loans
expected to be included in the Initial Portfolio. See "Business and
Strategy--Servicing" for a description of the basis upon which the
servicing fees to be paid to the Bank will be calculated.
(2) Does not include an estimated $122,000 of servicing fees to be paid
to the Servicing Agent for the first full year following completion
of the Offering with respect to the Servicing
Agent's servicing of the Residential Mortgage Loans included in the
Initial Portfolio. The estimated amount of servicing fees to be paid
to the Servicing Agent assumes that for the first full year following
completion of the Offering, the Company holds Residential Mortgage
Loans with the same outstanding principal balances as those
Residential Mortgage Loans expected to be included in the Initial
Portfolio. See "Business and Strategy--Servicing" for a description
of the basis upon which the servicing fees to be paid to the
Servicing Agent will be calculated.
(3) The dividends to be paid on the Common Stock are expected to equal
the excess of the Company's "REIT taxable income" (excluding capital
gains) after the payment of dividends
on the Preferred Stock. The aggregate annual dividend amount of the
Series A Preferred Shares is approximately $3.0 million at an assumed
rate of 9.75%. Assuming that (i) the Mortgage Loans included in the
Initial Portfolio are held for the first full year period following
completion of the Offering, (ii) principal repayments are reinvested
in additional Mortgage Loans with characteristics similar to those of
the Mortgage Loans included in the Initial Portfolio and (iii)
interest rates remain constant during such year, the Company
anticipates that the Initial Portfolio will generate "REIT taxable
income" (excluding capital gains) of approximately $4.9 million,
after payment of servicing and advisory fees, during such 12-month
period.
- The Bank and the Servicing Agent will also be entitled to retain any late
payment charges, prepayment fees (except with respect to Commercial
Mortgage Loans) or penalties and assumption fees and conversion fees
collected in connection with the Mortgage Loans serviced by them. In
addition, the Bank and the Servicing Agent will receive any benefit
derived from interest earned on collected principal and interest payments
between the date of collection and the date of remittance to the Company
and from interest earned on tax and insurance escrow funds with respect to
Mortgage Loans serviced by them.
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DESCRIPTION OF SERIES A PREFERRED SHARES
The following summary sets forth the material terms and provisions of the
Series A Preferred Shares, and is qualified in its entirety by reference to the
terms and provisions of the Articles of Incorporation. The Articles of
Incorporation have been filed with the Commission as exhibits to the
registration statement of which this Prospectus forms a part. See "Description
of Capital Stock" below.
GENERAL
The Series A Preferred Shares form a series of the Preferred Stock of the
Company, which Preferred Stock may be issued from time to time in one or more
series with such designations, preferences, conversion or other rights, voting
powers, restrictions, limitations as to dividends or other distributions,
qualifications and terms and conditions of redemption as are determined by the
Company's Board of Directors or, if then constituted, a duly authorized
committee thereof. The Board of Directors has authorized the Company to issue
the Series A Preferred Shares.
When issued, the Series A Preferred Shares will be validly issued, fully
paid and nonassessable. The holders of the Series A Preferred Shares will have
no preemptive rights with respect to any shares of the capital stock of the
Company or any other securities of the Company convertible into or carrying
rights or options to purchase any such shares. The Series A Preferred Shares are
perpetual and will not be convertible into shares of Common Stock or any other
class or series of capital stock of the Company and will not be subject to any
sinking fund or other obligation of the Company for its repurchase or
retirement.
The transfer agent, registrar and dividend disbursement agent for the
Preferred Stock will be Registrar and Transfer Company, Cranford, New Jersey.
The registrar for shares of Preferred Stock will send notices to stockholders of
any meetings at which holders of the Preferred Stock have the right to elect
directors of the Company or to vote on any other matter.
DIVIDENDS
Holders of Series A Preferred Shares will be entitled to receive, if, when
and as authorized and declared by the Board of Directors of the Company out of
assets of the Company legally available therefor, noncumulative cash dividends
at the rate of % per annum of the initial liquidation preference (equivalent
to $ per share per annum). Dividends on the Series A Preferred Shares
will be payable, if authorized and declared, quarterly in arrears on March 31,
June 30, September 30 and December 31 (or, if any such day is not a business
day, on the next business day) of each year, commencing on , 1997.
Quarterly Dividend Periods will commence on and include the first day, and end
on and include the last day, of the calendar quarter in which the corresponding
Dividend Payment Date occurs; provided, however, that the first Dividend Period
(the "Initial Dividend Period") shall commence on and include the original issue
date of the Series A Preferred Shares and shall end on and include , 1997.
Each authorized and declared dividend will be payable to holders of record as
they appear on the stock register of the Company on such record dates, not
exceeding 45 days nor less than 10 days preceding the Dividend Payment Dates
thereof, as shall be fixed by the Board of Directors of the Company or a duly
authorized committee thereof. Dividends payable on the Series A Preferred Shares
for any period greater or less than a full Dividend Period shall be computed on
the basis of twelve 30-day months, a 360-day year and the actual number of days
elapsed in the period; provided, however, that in the event of an Automatic
Exchange, any accrued and unpaid dividends on the Series A Preferred Shares as
of the Time of Exchange (as defined herein) shall be deemed to be accrued and
unpaid dividends on the Bank Preferred Shares.
The right of holders of Series A Preferred Shares to receive dividends is
noncumulative. Accordingly, if the Board of Directors does not authorize or
declare a dividend on the Series A Preferred Shares in respect of any Dividend
Period, then holders of the Series A Preferred Shares will have no right to
receive a dividend for that Dividend Period, and the Company will have no
obligation to pay a dividend for that Dividend Period, whether or not dividends
are declared and paid for any future Dividend Period with
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respect to either the Series A Preferred Shares or the Common Stock. If the
Company fails to pay or declare and set aside for payment full dividends on the
Series A Preferred Shares for six Dividend Periods, holders of the Series A
Preferred Shares will be entitled to elect two directors. See "--Voting Rights."
If any Series A Preferred Shares are outstanding, no full dividends or other
distributions shall be authorized, declared or paid or set apart for payment on
any Junior Stock for any Dividend Period unless full dividends have been or
contemporaneously are authorized, declared and paid, or authorized and declared
and a sum sufficient for the payment thereof is set apart for such payments on
the Series A Preferred Shares for the then-current Dividend Period. When
dividends are not paid in full (or a sum sufficient for such full payment is not
so set apart) upon the Series A Preferred Shares for any Dividend Period and the
shares of any Parity Stock, all dividends authorized and declared on the Series
A Preferred Shares and the shares of Parity Stock shall only be authorized and
declared PRO RATA based upon the respective amounts that would have been paid on
the Series A Preferred Shares and any shares of Parity Stock had dividends been
authorized and declared in full.
In addition to the foregoing restriction, the Company shall not authorize,
declare, pay or set apart funds for any dividends or other distributions (other
than in Common Stock or other Junior Stock) with respect to any Common Stock or
other Junior Stock or repurchase, redeem or otherwise acquire, or set apart
funds for the repurchase, redemption or other acquisition of, any Common Stock
or other Junior Stock through a sinking fund or otherwise, unless and until: (i)
full dividends on the Series A Preferred Shares for the four most recent
preceding Dividend Periods (or such lesser number of Dividend Periods during
which shares of Series A Preferred Shares have been outstanding) are authorized
and declared and paid or a sum sufficient for payment has been paid over to the
dividend disbursing agent for payment of such dividends and (ii) the Company has
authorized and declared a cash dividend on the Series A Preferred Shares at the
annual dividend rate for the then-current Dividend Period, and sufficient funds
have been paid over to the dividend disbursing agent for the payment of such
cash dividend for such then-current Dividend Period.
No dividend shall be paid or set aside for holders of Series A Preferred
Shares for any Dividend Period unless full dividends have been paid or set aside
for the holders of each class or series of equity securities, if any, ranking
prior to the Series A Preferred Shares as to dividends for such Dividend Period.
AUTOMATIC EXCHANGE
Each Series A Preferred Share will be exchanged automatically for one newly
issued Bank Preferred Share if the appropriate federal regulatory agency directs
in writing that an exchange of the Series A Preferred Shares for Bank Preferred
Shares occur because: (i) the Bank becomes "undercapitalized" under prompt
corrective action regulations; (ii) the Bank is placed into conservatorship or
receivership; or (iii) the appropriate federal regulatory agency, in its sole
discretion, anticipates the Bank becoming "undercapitalized" in the near term
(an "Exchange Event"). Upon the occurrence of an Exchange Event, each holder of
Series A Preferred Shares shall be unconditionally obligated to surrender to the
Bank the certificates representing each Series A Preferred Share of such holder,
and the Bank shall be unconditionally obligated to issue to such holder in
exchange for each such Series A Preferred Share a certificate representing one
Bank Preferred Share. Any Series A Preferred Shares purchased or redeemed by the
Company prior to the Time of Exchange (as defined below) shall not be deemed
outstanding and shall not be subject to the Automatic Exchange.
The Automatic Exchange shall occur as of 8:00 a.m. Eastern Time on the date
for such exchange set forth in the Directive, or, if such date is not set forth
in the Directive, as of 8:00 a.m. on the earliest possible date such exchange
could occur consistent with the Directive (the "Time of Exchange"), as evidenced
by the issuance by the Bank of a press release prior to such time. As of the
Time of Exchange, all of the Series A Preferred Shares will be deemed cancelled
without any further action by the Company, all rights of the holders of Series A
Preferred Shares as stockholders of the Company will cease, and such
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persons shall thereupon and thereafter be deemed to be and shall be for all
purposes the holders of Bank Preferred Shares. The Company will mail notice of
the occurrence of an Exchange Event to each holder, and the Bank will deliver to
each such holder certificates for Bank Preferred Shares upon surrender of
certificates for Series A Preferred Shares. Until such replacement stock
certificates are delivered (or in the event such replacement certificates are
not delivered), certificates previously representing Series A Preferred Shares
shall be deemed for all purposes to represent Bank Preferred Shares. All
corporate action necessary for the Bank to issue the Bank Preferred Shares as of
the Time of Exchange will be completed prior to or upon completion of the
Offering. Accordingly, once the Directive is issued, no action will be required
to be taken by holders of Series A Preferred Shares, by the Bank or by the
Company in order to effect the Automatic Exchange as of the Time of Exchange.
Holders of Series A Preferred Shares, by purchasing such shares (whether in
the Offering or in the secondary market after the Offering), will be deemed to
have agreed to be bound by the unconditional obligation to exchange such shares
of Series A Preferred Shares for Bank Preferred Shares upon the occurrence of an
Exchange Event. The Articles of Incorporation provide that the holders of Series
A Preferred Shares shall be unconditionally obligated to surrender such shares
and the Bank shall be unconditionally obligated to issue Bank Preferred Shares
in exchange for Series A Preferred Shares.
Absent the occurrence of an Exchange Event, no shares of Bank Preferred
Shares will be issued. Holders of Series A Preferred Shares cannot exchange
their Series A Preferred Shares for Bank Preferred Shares voluntarily. Upon the
occurrence of an Exchange Event, the Bank Preferred Shares to be issued as part
of the Automatic Exchange would constitute a newly issued series of preferred
stock of the Bank and would have the same terms and provisions with respect to
dividends, liquidation, redemption (except with respect to a Tax Event), voting
rights and Independent Directors as the Series A Preferred Shares, except that
the Bank Preferred Shares would not be listed on any national securities
exchange or national quotation system. Any accrued and unpaid dividends on the
Series A Preferred Shares as of the Time of Exchange would be deemed to be
accrued and unpaid dividends on the Bank Preferred Shares. The Bank Preferred
Shares would rank on an equal basis in terms of dividend payment and liquidation
preference with any then-outstanding shares of preferred stock of the Bank. The
Bank has registered the Bank Preferred Shares with the OTS pursuant to an
Offering Circular, a copy of which is affixed to this Prospectus as Annex I and
incorporated herein by reference. The Bank Preferred Shares will not be
registered with the Commission and will be offered pursuant to an exemption from
registration under Section 3(a)(5) of the Securities Act of 1933, as amended
(the "Securities Act"). Absent the occurrence of an Exchange Event, however, the
Bank will not issue any Bank Preferred Shares, although the Bank will be able to
issue preferred stock in series other than that of the Bank Preferred Stock.
There can be no assurance as to the liquidity of the trading markets for the
Bank Preferred Shares, if issued, or that an active public market for the Bank
Preferred Shares would develop or be maintained.
Absent the occurrence of the Automatic Exchange, holders of Series A
Preferred Shares will have no dividend, voting, liquidation preference or other
rights with respect to any security of the Bank; such rights as are conferred by
the Series A Preferred Shares exist solely as to the Company.
RANK
The Series A Preferred Shares will rank prior to the Common Stock and to all
other classes and series of equity securities of the Company now or hereafter
issued (collectively, "Junior Stock"), other than any class or series of equity
securities of the Company expressly designated as being on a parity with
("Parity Stock") or senior to ("Senior Stock") the Series A Preferred Shares as
to dividend rights and rights upon liquidation, winding up or dissolution. The
Company has the power to create and issue additional Preferred Stock or other
classes of stock ranking on a parity with the Series A Preferred Shares, or that
constitute Junior Stock, without any approval or consent of the holders of
Series A Preferred Shares. So long as any Series A Preferred Shares remain
outstanding, additional shares of Senior Stock may not be issued without the
approval of the holders of at least two-thirds of the Series A Preferred Shares.
See "--
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Voting Rights." So long as any Series A Preferred Shares remain outstanding,
additional shares of Parity Stock may not be issued without the approval of a
majority of the Independent Directors. See "-- Independent Director Approval."
VOTING RIGHTS
Except as expressly required by applicable law, or except as indicated
below, the holders of the Series A Preferred Shares will not be entitled to
vote. In the event the holders of Series A Preferred Shares are entitled to
vote, each Series A Preferred Share will be entitled to one vote.
If full dividends on the Series A Preferred Shares shall not have been paid
for six Dividend Periods (whether or not consecutive), the maximum authorized
number of directors of the Company shall thereupon be increased by two. Subject
to compliance with any requirement for regulatory approval of (or non-objection
to) persons serving as directors, the holders of Series A Preferred Shares,
voting together as a class with the holders of any Parity Stock upon which the
same voting rights as those of the Series A Preferred Shares have been conferred
and are irrevocable, shall have the exclusive right to elect the two additional
directors at the Company's next annual meeting of stockholders and at each
subsequent annual meeting until full dividends have been authorized, declared
and paid or authorized and declared and a sum sufficient for payment thereof is
set apart for payment on the Series A Preferred Shares for four consecutive
Dividend Periods. The term of such directors elected thereby shall terminate,
and the total number of directors shall be decreased by two, upon the first
annual meeting of stockholders after the payment or the authorization or
declaration and setting aside for payment of full dividends on the Series A
Preferred Shares for four consecutive Dividend Periods. Thereafter, the holders
of the Series A Preferred Shares will not be able to elect directors unless
dividends on the Series A Preferred Shares have again not been paid for six
Dividend Periods. Any such director may be removed by, and shall not be removed
except by, the vote of the holders of record of the outstanding Series A
Preferred Shares and Parity Stock entitled to vote, voting together as a single
class without regard to series, at a meeting of the Company's stockholders
called for that purpose. As long as dividends on the Series A Preferred Shares
shall not have been paid for six Dividend Periods, (i) any vacancy in the office
of any such director may be filled (except as provided in the following clause
(ii)) by an instrument in writing signed by any such remaining director and
filed with the Company, and (ii) in the case of the removal of any such
director, the vacancy may be filled by the vote of the holders of the
outstanding Series A Preferred Shares and Parity Stock entitled to vote, voting
together as a single class without regard to series, at the same meeting at
which such removal shall be voted.
So long as any shares of Series A Preferred Shares are outstanding, the
Company shall not, without the consent or vote of the holders of at least
two-thirds of the outstanding Series A Preferred Shares, voting separately as a
class, (i) amend, alter or repeal or otherwise change any provision of the
Articles of Incorporation, including the terms of the Series A Preferred Shares,
if such amendment, alteration, repeal or change would materially and adversely
affect the preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends or other distributions, qualifications or terms or
conditions of redemption of the Series A Preferred Shares, or (ii) authorize,
create or increase the authorized amount of or issue any class or series of any
equity securities of the Company, or any warrants, options or other rights
exercisable for or convertible or exchangeable into any class or series of any
equity securities of the Company, ranking senior to the Series A Preferred
Shares, either as to dividend rights or rights on liquidation, dissolution or
winding up of the Company or (iii) merge, consolidate, reorganize or effect any
other business combination involving the Company, unless the resulting
corporation will thereafter have no class or series of equity securities either
authorized or outstanding ranking senior to the Series A Preferred Shares as to
dividends or as to the distribution of assets upon liquidation, dissolution or
winding up, except the same number of shares of such equity securities with the
same preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends or other distributions, qualifications or terms or
conditions of redemption as the shares of equity securities of the Company that
are authorized and
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outstanding immediately prior to such transaction, and each holder of Series A
Preferred Shares immediately prior to such transaction shall receive shares with
the same preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends or other distributions, qualifications or terms or
conditions of redemption of the resulting corporation as the Series A Preferred
Shares held by such holder immediately prior thereto.
The creation or issuance of Parity Stock or Junior Stock, or an amendment
that increases the number of authorized shares of Preferred Stock, or Series A
Preferred Shares or any Junior Stock or Parity Stock, shall not be deemed to be
a material and adverse change requiring a vote of the holders of Series A
Preferred Shares.
REDEMPTION
The Series A Preferred Shares will not be redeemable prior to , 2002,
(except upon the occurrence of a Tax Event or a Change of Control). On or after
such date, the Series A Preferred Shares may be redeemable for cash by the
Company or its successor or any acquiring or resulting entity with respect to
the Company, including by any parent or subsidiary of the Company, any such
successor, or any such acquiring or resulting entity as applicable, at its
option, in whole or in part, at any time and from time to time, at the
redemption price of $25.00 per share, plus authorized, declared and unpaid
dividends to the date of redemption, without interest.
In the event that fewer than all the outstanding Series A Preferred Shares
are to be redeemed, the number of Series A Preferred Shares to be redeemed shall
be determined by the Board of Directors, and the shares to be redeemed shall be
determined by lot or PRO RATA as may be determined by the Board of Directors or
by any other method as may be determined by the Board of Directors in its sole
discretion to be equitable, provided that such method satisfies any applicable
requirements of any securities exchange on which Series A Preferred Shares are
then listed.
The Company will also have the right at any time, upon the occurrence of a
Tax Event, to redeem the Series A Preferred Shares, in whole, but not in part,
at a redemption price of $25.00 per share, plus all authorized, declared and
unpaid dividends for the then-current Dividend Period to the date of redemption,
without interest. "Tax Event" means the receipt by the Company of an opinion of
a law firm experienced in such matters to the effect that, as a result of: (i)
any amendment to, clarification of, or change (including any announced
prospective change) in, the laws, treaties or any regulations thereunder of the
United States or any political subdivision or taxing authority thereof or
therein affecting taxation, (ii) any Administrative Action or (iii) any
amendment to, clarification of, or change in the official position or the
interpretation of such Administrative Action or any interpretation or
pronouncement that provides for a position with respect to such Administrative
Action that differs from the theretofore generally accepted position, in each
case, by any legislative body, court, governmental authority or regulatory body,
irrespective of the manner in which such amendment, clarification or change is
made known, which amendment, clarification or change is effective, or such
pronouncement or decision is announced, on or after the date of issuance of the
Series A Preferred Shares, there is more than an insubstantial risk that: (a)
dividends paid or to be paid by the Company with respect to the stock of the
Company are not, or will not be, fully deductible by the Company for United
States federal income tax purposes or (b) the Company is, or will be, subject to
more than a de minimis amount of other taxes, duties or other governmental
charges as a result of dividends paid or to be paid by the Company.
Upon a Change of Control, the Series A Preferred Shares are redeemable on or
prior to , 2002, at the option of the Company or its successor or any
acquiring or resulting entity with respect to the Company, including by any
parent or subsidiary of the Company, any such successor, or any such acquiring
or resulting entity, as applicable, in whole, but not in part, at a redemption
price per share equal to (i) $25.00, plus (ii) an amount equal to all
authorized, declared and unpaid dividends, if any, to the date fixed for
redemption, without interest, and without duplication, an additional amount
equal to the amount of
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dividends that would be payable on the Series A Preferred Shares in respect of
the period from the first day of the Dividend Period in which the date fixed for
redemption occurs to the date fixed for redemption (assuming all such dividends
were to be authorized and declared), plus (iii) the Applicable Premium, payable
in cash.
The Company or any such successor or any acquiring or resulting entity will
be entitled to issue a notice of redemption after the Company or a parent
company has entered into a definitive binding agreement with a third party that
will result in a Change of Control, provided that (i) the date fixed for
redemption is not earlier than the date on which the related Change of Control
occurs and (ii) the obligation to effect such redemption is contingent upon the
occurrence of such Change of Control.
"Applicable Premium" means an amount equal to (A) the present value of
(l) the dividends that would be payable on the Series A Preferred Shares in
respect of the period from the date fixed for redemption through ,
2002 (assuming all such dividends were to be authorized and declared) plus
(2) $25.00 (assuming such $25.00 is paid on , 2002), computed using
a discount rate equal to the Treasury Rate plus 75 basis points, divided by
(B) $25.00.
"Change of Control" means the occurrence of any of the following events:
(i) any Person (as defined herein) other than a Permitted Holder (as
defined herein) shall be the "beneficial owner" (as defined in Rules
13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of a
majority in the aggregate of the total voting power of the voting stock
of the Bank or SOCAL, whether as a result of issuance of securities of
the Bank or SOCAL, any merger, consolidation, liquidation or dissolution
of the Bank or SOCAL, any direct or indirect transfer of securities by a
Permitted Holder, or otherwise; or
(ii) a sale, transfer, conveyance or other disposition, in a single
transaction or in a series of related transactions (other than to an
affiliate of the Bank or any of its subsidiaries), in either case
occurring outside the ordinary course of business, of more than 75% of
the assets and 75% of the deposit liabilities of the Bank shown on the
consolidated balance sheet of the Bank as of the end of the most recent
fiscal quarter ending at least 45 days prior to such transaction (or the
first in such related series of transactions).
"Permitted Holder" means the Bishop Estate, BIL Securities or Arbur, or
any Person controlled, directly or indirectly, by the Bishop Estate, BIL
Securities or Arbur.
"Treasury Rate" means the yield to maturity at the time of computation
of United States Treasury securities with a constant maturity (as compiled
and published in the most recent Federal Reserve Statistical Release H.15
(510) which has become publicly available at least two business days prior
to the date fixed for redemption (or, if such Statistical Release is no
longer published, any publicly available source of similar market data))
most nearly equal to the period of time to , 2002; provided, however,
that if such period is not equal to the constant maturity of a United States
Treasury security for which a weekly average yield is given, the Treasury
Rate shall be obtained by linear interpolation (calculated to the nearest
one-twelfth of a year) from the weekly average yields of United States
Treasury securities for which such yields are given, except that, if such
remaining life is less than one year, the weekly average yield on actually
traded United States Treasury securities adjusted to a constant maturity of
one year shall be used.
If redemption is being effected by the Company, on and as of the date fixed
for redemption, dividends shall cease to accrue on the Series A Preferred Shares
called for redemption, and they shall be deemed to cease to be outstanding,
provided that the redemption price (including any authorized and declared but
unpaid dividends to the date fixed for redemption, without interest) has been
duly paid or provided for. If redemption is being effected by an entity other
than the Company, on and as of the redemption date such entity shall be deemed
to own the Series A Preferred Shares being redeemed for all purposes of the
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Articles of Incorporation, provided that the redemption price (including the
amount of any authorized and declared but unpaid dividends to the date fixed for
redemption) has been duly paid or provided for.
Notice of any redemption will be mailed at least 30 days, but not more than
60 days, prior to any redemption date to each holder of Series A Preferred
Shares to be redeemed at such holder's registered address.
The Company's ability to redeem any Series A Preferred Shares, whether as a
result of a Change of Control or otherwise, is subject to compliance with
applicable regulatory requirements, including the prior approval of the OTS,
relating to the redemption of capital instruments. Under current policies of the
OTS, such approval would be granted only if the redemption were to be made out
of the proceeds of the issuance of another capital instrument or if the OTS were
to determine that the conditions and circumstances of SOCAL and the Bank warrant
the reduction of a source of permanent capital.
RIGHTS UPON LIQUIDATION
In the event of any voluntary or involuntary liquidation, dissolution or
winding up of the Company, the holders of the Series A Preferred Shares at the
time outstanding will be entitled to receive in respect of each share, out of
assets of the Company legally available for distribution to its stockholders,
before any distribution of assets is made to holders of Junior Stock and subject
to the rights of the holders of any class or series of equity securities having
preference with respect to distributions upon liquidation and the rights of the
Company's general creditors, liquidating distributions in the amount of $25 per
share, plus the authorized, declared and unpaid dividends for the most recent
quarter thereon, if any, to the date of liquidation.
After payment of the full amount of the liquidating distributions to which
they are entitled, the holders of Series A Preferred Shares will have no right
or claim to any of the remaining assets of the Company. In the event that, upon
any such voluntary or involuntary liquidation, dissolution or winding up, the
available assets of the Company are insufficient to pay the amount of the
liquidation distributions on all outstanding Series A Preferred Shares and the
corresponding amounts payable on any Parity Stock, then the holders of the
Series A Preferred Shares and Parity Stock shall share ratably in any such
distribution of assets in proportion to the full liquidating distributions to
which they would otherwise be respectively entitled.
For such purposes, the consolidation or merger of the Company with or into
any other entity, the consolidation or merger of any other entity with or into
the Company or the sale of all or substantially all of the property or business
of the Company, shall not be deemed to constitute a liquidation, dissolution or
winding up of the Company.
INDEPENDENT DIRECTOR APPROVAL
The Articles of Incorporation require that, so long as any Series A
Preferred Shares are outstanding, certain actions by the Company be approved by
a majority of the Independent Directors. For so long as there are only two
Independent Directors, any action that requires the approval of a majority of
Independent Directors must be approved by both Independent Directors. Messrs.
Davis and Honda are the Company's initial Independent Directors. See
"Management--Independent Directors." In order to be considered "independent", a
director must not be a current director, officer or employee of the Company, or
a current director, officer or employee of the Bank or any affiliate of the
Bank. In addition, any members of the Board of Directors of the Company elected
by holders of Preferred Stock, including the Series A Preferred Shares, will be
deemed to be Independent Directors for purposes of approving actions requiring
the approval of a majority of the Independent Directors.
The actions which may not be taken without the approval of a majority of the
Independent Directors include: (i) the issuance of additional Preferred Stock
ranking on a parity with the Series A Preferred
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Shares, (ii) the incurrence of debt for borrowed money in excess of 20% of the
Company's total stockholders' equity, (iii) the acquisition of assets other than
Mortgage Loans, Mortgage-Backed Securities or Other Authorized Investments, (iv)
the termination or modification of, or the election not to renew, the Advisory
Agreement or any Servicing Agreement or the subcontracting of any duties under
the Advisory Agreement or the Commercial Mortgage Servicing Agreement (other
than as specifically established and as contemplated in connection with the
Offering) to third parties unaffiliated with the Bank, (v) any material
amendment to or modification of either of the Mortgage Purchase Agreements, (vi)
the determination to revoke the Company's REIT status or (vii) any dissolution,
liquidation or termination of the Company prior to , 2002. The Articles of
Incorporation require that, in assessing the benefits to the Company of any
proposed action requiring their consent, the Independent Directors take into
account the interests of holders of both the Common Stock and the Preferred
Stock, including, without limitation, holders of the Series A Preferred Shares.
The Articles of Incorporation provide that in considering the interests of the
holders of Preferred Stock, including, without limitation, the holders of the
Series A Preferred Shares, the Independent Directors shall owe the same duties
which the Independent Directors owe to the holders of Common Stock.
RESTRICTIONS ON OWNERSHIP AND TRANSFER
For information regarding restrictions on ownership of the Series A
Preferred Shares, see "Description of Capital Stock--Restrictions on Ownership
and Transfer."
DESCRIPTION OF CAPITAL STOCK
The following summary of the material terms of the capital stock of the
Company does not purport to be complete and is subject in all respects to the
applicable provisions of the MGCL and the Articles of Incorporation and Bylaws
of the Company.
COMMON STOCK
GENERAL. The Company is authorized by its Articles of Incorporation to
issue up to 4,000,000 shares of Common Stock. Upon consummation of the Offering
and the transactions described in "Certain Transactions Constituting the
Formation," the Company will have outstanding 10,000 shares of Common Stock, all
of which will be held by the Bank. In addition, the Bank currently intends that,
so long as any Series A Preferred Shares are outstanding, it will maintain
direct or indirect ownership of at least a majority of the outstanding shares of
Common Stock of the Company.
DIVIDENDS. Holders of Common Stock are entitled to receive dividends when,
as and if authorized and declared by the Board of Directors out of assets
legally available therefor, provided that, so long as any shares of Preferred
Stock are outstanding, no dividends or other distributions (including
redemptions and purchases) may be made with respect to the Common Stock unless
full dividends on the shares of all series of Preferred Stock, including
accumulations in the case of cumulative Preferred Stock, have been paid and any
other conditions precedent established under the terms of such series of
Preferred Stock have been satisfied. In order to remain qualified as a REIT, the
Company must distribute annually at least 95% of its annual "REIT taxable
income" (not including capital gains) to stockholders. Several limitations exist
which may restrict the Company's ability to pay dividends on the Common Stock.
See "Business and Strategy-- Dividend Policy."
VOTING RIGHTS. Subject to the rights, if any, of the holders of any class
or series of Preferred Stock, including the Series A Preferred Shares, all
voting rights are vested in the Common Stock. The holders of Common Stock are
entitled to one vote per share. All of the issued and outstanding shares of
Common Stock are currently, and upon consummation of the Offering will be, held
by the Bank.
As the holder of all of the outstanding shares of Common Stock of the
Company, the Bank will be able, subject to the terms of the Series A Preferred
Shares and of any other class or series of stock
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subsequently issued by the Company, to elect and remove directors, amend the
Articles of Incorporation and approve other actions requiring stockholder
approval under the MGCL or otherwise.
RIGHTS UPON LIQUIDATION. In the event of the liquidation, dissolution or
winding up of the Company, whether voluntary or involuntary, after there have
been paid or set aside for the holders of all series of Preferred Stock the full
preferential amounts to which such holders are entitled, the holders of Common
Stock will be entitled to share equally and ratably in any assets remaining
after the payment of all debts and liabilities.
PREFERRED STOCK
The Company is authorized by its Articles of Incorporation to issue up to
4,000,000 shares of Preferred Stock. Subject to limitations prescribed by
Maryland law and the Company's Articles of Incorporation, the Board of Directors
or, if then constituted, a duly authorized committee thereof is authorized to
issue, from the authorized but unissued shares of capital stock of the Company,
Preferred Stock in such classes or series as the Board of Directors may
determine and to establish, from time to time, the number of shares of Preferred
Stock to be included in any such class or series and to fix the designation and
any preferences, conversion and other rights, voting powers, restrictions,
limitations as to dividends or other distributions, qualifications and terms and
conditions of redemption of the shares of any such class or series, and such
other subjects or matters as may be fixed by resolution of the Board of
Directors.
Shares of Preferred Stock, upon issuance against full payment of the
purchase price therefor, will be fully paid and nonassessable. The specific
terms of a particular class or series of Preferred Stock will be described in
the Articles of Incorporation or in supplementary articles relating to that
class or series.
The Articles of Incorporation or supplementary articles relating to each
class or series of Preferred Stock will set forth the preferences and other
terms of such class or series, including, without limitation, the following: (i)
the designation and stated value of such class or series; (ii) the number of
shares of such class or series offered and the liquidation preference per share
of such class or series; (iii) the dividend rate(s), period(s), and/or payment
date(s) or method(s) of calculation thereof applicable to such class or series;
(iv) whether dividends on such class or series of Preferred Stock are cumulative
or not and, if cumulative, the date from which dividends on such class or series
shall accumulate; (v) the provision for a sinking fund, if any, for such class
or series; (vi) the provision for redemption, if applicable, of such class or
series; (vii) any limitations on direct or beneficial ownership and restrictions
on transfer, in each case as may be appropriate to preserve the status of the
Company as a REIT or as otherwise deemed appropriate by the Board of Directors;
(viii) any voting rights of such class or series; (ix) the relative ranking and
preferences of such class or series as to dividend rights and rights upon
liquidation, dissolution or winding up of the affairs of the Company; (x) any
limitations on issuance of any class or series of Preferred Stock ranking senior
to or on a parity with such class or series of Preferred Stock as to dividend
rights and rights upon liquidation, dissolution or winding up of the affairs of
the Company; and (xi) any other specific terms, preferences, rights, limitations
or restrictions of such class or series.
As of the date of this Prospectus, no shares of Preferred Stock are
outstanding and the Company has no present plans to issue any Preferred Stock
other than the Series A Preferred Shares.
POWER TO ISSUE ADDITIONAL SHARES OF COMMON STOCK AND PREFERRED STOCK
The Company believes that the power of the Board of Directors to issue
additional authorized but unissued shares of Common Stock or Preferred Stock and
to classify or reclassify unissued shares of Common Stock or Preferred Stock and
thereafter to cause the Company to issue such classified or reclassified shares
of stock will provide the Company with increased flexibility in structuring
possible future financings and acquisitions and in meeting other needs which
might arise. The additional shares of stock will be available for issuance
without further action by the Company's stockholders, unless such action is
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required by applicable law or the rules of any stock exchange or automated
quotation system on which the Company's securities may be listed or traded,
except that as long as any Series A Preferred Shares remain outstanding,
additional shares of Preferred Stock ranking senior to the Series A Preferred
Shares may not be issued without the approval of the holders of at least
two-thirds of the Series A Preferred Shares.
RESTRICTIONS ON OWNERSHIP AND TRANSFER
REIT REQUIREMENTS WITH RESPECT TO STOCK OWNERSHIP. To qualify as a REIT
under the Code, not more than 50% of the value of the Company's outstanding
shares of stock may be owned, directly or indirectly, by five or fewer
individuals (as defined in the Code to include certain entities) during the last
half of a taxable year, other than the first year, (the "Five or Fewer Test").
The Code requires that the Five or Fewer Test be applied using constructive
ownership rules which treat certain organizations as one individual.
Consistent with the Company's intention to reduce the likelihood that the
Company's status as a REIT is jeopardized, the Articles of Incorporation provide
that, subject to certain exceptions for Significant Stockholders, no individual
or entity may own, or be deemed to own by virtue of the attribution rules of the
Code, more than the Ownership Limit.
Under the constructive ownership rules which must be used for the Five or
Fewer Test, the Company's Common Stock will be treated as owned by the three
stockholders of SOCAL, which is the sole stockholder of the Bank. The classes of
capital stock of SOCAL, which consists of common and three series of preferred
stock, are held by the three stockholders in varying percentages. The common
stock of SOCAL is owned 60% by the Bishop Estate, 30% by BIL Securities, and 10%
by Arbur. The preferred stock is owned approximately 67% by the Bishop Estate,
24.8% by BIL Securities, and 8.2% by Arbur. (Such percentages are approximate
because they are based on an estimate of the relative values of the three series
of preferred stock.) Since the ownership percentage for the Five or Fewer Test
is based on relative values, the percentage of the Company that would be
attributable to the three stockholders of SOCAL will vary based upon the
relative value of the capital stock of SOCAL. Of these stockholders, however,
only Arbur, which is closely held by the family of William E. Simon, is
considered an "individual" for purposes of the Five or Fewer Test. Neither the
Bishop Estate nor BIL Securities is considered an "individual" for purposes of
the Five or Fewer Test.
Although the Five or Fewer Test references the aggregate value of all shares
of capital stock of the Company, the Ownership Limit has been established with
reference to the aggregate initial liquidation preference of the outstanding
shares of Preferred Stock. If (i) the relative values of the Company's Common
Stock and any outstanding shares of Preferred Stock, including the Series A
Preferred Shares, or (ii) the relative values of the different series or classes
of Preferred Stock, were to change significantly, there is a risk that the Five
or Fewer Test would be violated notwithstanding compliance with the Ownership
Limit. Although the Company believes that it is unlikely that the relative value
of the Common Stock will decrease by an amount sufficient to cause a violation
of the Five or Fewer Test, there can be no assurance that such a change in value
will not occur.
Because the Ownership Limit does not apply to the Significant Stockholders,
ownership of the Company's Common Stock or the transfer of shares of common
stock and/or preferred stock of SOCAL to an entity which is considered an
individual for purposes of the Five or Fewer Test could, in certain
circumstances, cause the Company to fail the Five or Fewer Test and,
consequently, to fail to qualify as a REIT.
The Board of Directors may (but will not be required to), upon the receipt
of a ruling from the IRS or the advice of counsel satisfactory to it, waive the
Ownership Limit with respect to an individual or entity if such individual's or
entity's proposed ownership will not then or in the future jeopardize the
Company's status as a REIT. The transfer of any shares of Preferred Stock,
including Series A Preferred Shares (including the occurrence of events other
than actual transfers of Preferred Stock that result in changes in
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constructive ownership of Preferred Stock), in violation of such Ownership Limit
will cause the shares of any class or series of Preferred Stock owned, or deemed
to be owned, by or transferred to a stockholder in excess of the Ownership
Limit, including any such shares which have been transferred pursuant to a
waiver of the Ownership Limit (the "Excess Shares"), to be automatically
transferred to a trust for the exclusive benefit of a charity to be named by the
Company. All rights to dividends to such Excess Shares will be held by such
trust.
The capital stock of the Company must also be beneficially owned by 100 or
more persons during at least 335 days of a taxable year or during a
proportionate part of a shorter taxable year (the "One Hundred Persons Test").
The Articles of Incorporation of the Company contain restrictions on the
acquisition of Preferred Stock intended to ensure compliance with the One
Hundred Persons Test. Such provisions include a restriction that if any transfer
of shares of Preferred Stock of the Company would cause the Company to be
beneficially owned by fewer than 100 persons, such transfer shall be null and
void and the intended transferee will acquire no rights to the stock.
The constructive ownership rules of the Code are complex and may cause
Preferred Stock owned, directly or indirectly, by one individual or entity to be
deemed to be constructively owned by other related individuals and/or entities.
Similarly, under the constructive ownership rules, an individual or entity that
owns stock of SOCAL will be deemed to own a proportionate share of the Common
Stock of the Company owned by the Bank. As a result, the acquisition by an
individual or entity of stock of the Company in amounts below the Ownership
Limit (or the acquisition of an entity that owns such shares) may cause that
individual or entity (or another individual or entity) to violate the Ownership
Limit.
The Articles of Incorporation provide that any Excess Shares will
automatically be transferred, by operation of law, to a trust for the benefit of
a charity to be named by the Company as of the day prior to the day the
prohibited transfer took place. Any dividends paid on the Series A Preferred
Shares prior to the discovery of the prohibited transfer are to be repaid by the
original transferee to the Company and by the Company to the trustee; subject to
applicable law, any vote of the shares while the shares were held by the
original transferee prior to the Company's discovery thereof shall be void ab
initio and the original transferee shall be deemed to have given its proxy to
the trustee. Any unpaid distributions with respect to the original transferee
will be rescinded as void ab initio. In liquidation, the original transferee
stockholder's ratable share of the Company's assets would be limited to the
price paid by the original transferee for the Excess Shares or, if no value was
given, the price per share equal to the closing market price on the date of the
purported transfer. The trustee of the trust shall promptly sell the shares to
any person whose ownership is not prohibited, whereupon the interest of the
trust shall terminate. Proceeds of the sale shall be paid to the original
transferee up to its purchase price (or, if the original transferee did not
purchase the shares, the value on its date of acquisition) and any remaining
proceeds shall be paid to a charity to be named by the Company.
All certificates representing shares of Preferred Stock will bear a legend
referring to the restrictions described above.
The Ownership Limit provisions will not be automatically removed even if the
REIT Provisions (as defined herein) are changed so as to eliminate any ownership
concentration limitation or if the ownership concentration limitation is
increased. The Articles of Incorporation may not be amended to alter, change,
repeal or amend any of the Ownership Limit provisions without the prior approval
of a majority of the Independent Directors. The foregoing restrictions on
transferability and ownership will not apply, however, if the Board of
Directors, including a majority of Independent Directors, determines that it is
no longer in the best interests of the Company and its stockholders to attempt
to qualify, or continue to qualify, as a REIT. See "Business and
Strategy--Management Policies and Programs."
The Articles of Incorporation require that any person who beneficially owns
1% (or such lower percentage as may be required by the Code or the Treasury
Regulations) of the outstanding shares of any class or series of Preferred Stock
of the Company must provide certain information to the Company within
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30 days of June 30 and December 31 of each year. In addition, each stockholder
shall upon demand be required to disclose to the Company in writing such
information as the Company may request in order to determine the effect, if any,
of such stockholder's actual and constructive ownership on the Company's status
as a REIT and to ensure compliance with the Ownership Limit.
BUSINESS COMBINATIONS
Under the MGCL, certain "business combinations" (including a merger,
consolidation, share exchange or, in certain circumstances, an asset transfer or
issuance or reclassification of equity securities) between a Maryland
corporation and any person who beneficially owns 10% or more of the voting power
of the corporation's shares or an affiliate of the corporation who, at any time
within the two-year period prior to the date in question, was the beneficial
owner of 10% or more of the voting power of the then-outstanding voting stock of
the corporation (an "Interested Stockholder") or an affiliate of such an
Interested Stockholder are prohibited for five years after the most recent date
on which the Interested Stockholder became an Interested Stockholder.
Thereafter, any such business combination must be recommended by the board of
directors of such corporation and approved by the affirmative vote of at least
(a) 80% of the votes entitled to be cast by holders of outstanding shares of
voting stock of the corporation and (b) two-thirds of the votes entitled to be
cast by holders of voting stock of the corporation other than shares held by the
Interested Stockholder with whom (or with whose affiliate) the business
combination is to be effected, unless, among other conditions, the corporation's
common stockholders receive a minimum price (as defined in the MGCL) for their
shares and the consideration is received in cash or in the same form as
previously paid by the Interested Stockholder for its shares. These provisions
of the MGCL do not apply, however, to business combinations that are approved or
exempted by the board of directors of the corporation prior to the time that the
Interested Stockholder becomes an Interested Stockholder. The Bank beneficially
owns more than 10% of the Company's voting shares and would, therefore, together
with its affiliates (including SOCAL) be subject to the business combination
provision of the MGCL. However, pursuant to the statute, the Company has
exempted any business combinations involving the Bank and any present or future
affiliate thereof and, consequently, the five-year prohibition and the
super-majority vote requirements will not apply to business combinations between
any of them and the Company. As a result, the Bank and any present or future
affiliate thereof may be able to enter into business combinations with the
Company that may not be in the best interest of its stockholders without
compliance by the Company with the super-majority vote requirements and the
other provisions of the statute.
CONTROL SHARE ACQUISITIONS
The MGCL provides that "control shares" of a Maryland corporation acquired
in a "control share acquisition" have no voting rights, except to the extent
approved by a vote of two-thirds of the votes entitled to be cast on the matter,
excluding shares of stock owned by the acquiror, by officers or by directors who
are employees of the corporation. "Control shares" are voting shares of stock
which, if aggregated with all other such shares of stock previously acquired by
the acquiror or in respect of which the acquiror is able to exercise or direct
the exercise of voting power (except solely by virtue of a revocable proxy),
would entitle the acquiror to exercise voting power in electing directors within
one of the following ranges of voting power: (i) one-fifth or more but less than
one-third, (ii) one-third or more but less than a majority, or (iii) a majority
or more of all voting power. Control shares do not include shares the acquiring
person is then entitled to vote as a result of having previously obtained
stockholder approval. A "control share acquisition" means the acquisition of
control shares, subject to certain exceptions.
A person who has made or proposes to make a control share acquisition, upon
satisfaction of certain conditions (including an undertaking to pay expenses),
may compel the board of directors of the corporation to call a special meeting
of stockholders to be held within 50 days of demand to consider the
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voting rights of the shares. If no request for a meeting is made, the
corporation may itself present the question at any stockholders meeting.
If voting rights are not approved at the meeting or if the acquiring person
does not deliver an acquiring person statement as required by the statute, then,
subject to certain conditions and limitations, the corporation may redeem any or
all of the control shares (except those for which voting rights have previously
been approved) for fair value determined, without regard to the absence of
voting rights for the control shares, as of the date of the last control share
acquisition by the acquiror or of any meeting of stockholders at which the
voting rights of such shares are considered and not approved. If voting rights
for control shares are approved at a stockholder meeting and the acquiror
becomes entitled to vote a majority of the shares entitled to vote, all other
stockholders may exercise appraisal rights. The fair value of the shares as
determined for purposes of such appraisal rights may not be less than the
highest price per share paid by the acquiror in the control share acquisition.
The control share acquisition statute does not apply (a) to shares acquired
in a merger, consolidation or share exchange if the corporation is a party to
the transaction or (b) to acquisitions approved or exempted by the charter or
bylaws of the corporation. The Articles of Incorporation contain a provision
exempting from the control share acquisition statute any and all acquisitions of
the Company's shares of stock by the Bank and any present or future affiliates
thereof (including SOCAL). Consequently, the prohibition on voting control
shares will not apply to the Bank or to any present or future affiliates thereof
(including SOCAL).
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FEDERAL INCOME TAX CONSIDERATIONS
The following summary of material federal income tax considerations
regarding the Offering is based upon current law, is for general information
only and is not tax advice. The information set forth below, to the extent that
it constitutes summaries of legal matters or legal conclusions, has been
reviewed by Elias, Matz, Tiernan & Herrick L.L.P., and it is their opinion that
such information insofar as it relates to matters of law or legal conclusions is
accurate in all material respects. The discussion below is based on existing
federal income tax law, which is subject to change, with possible retroactive
effect. The discussion below does not address all aspects of taxation that may
be relevant in the particular circumstances of each stockholder or to certain
types of stockholders (including insurance companies, tax-exempt entities,
financial institutions or broker-dealers, foreign corporations and persons who
are not citizens or residents of the United States, except to the extent
discussed) subject to special treatment under the federal income tax laws.
EACH PROSPECTIVE INVESTOR IS ENCOURAGED TO CONSULT HIS TAX ADVISOR REGARDING
THE SPECIFIC TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND SALE OF THE SHARES
AND OF THE COMPANY'S ELECTION TO BE TAXED AS A REIT, INCLUDING THE FEDERAL,
STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES OF SUCH PURCHASE, OWNERSHIP,
SALE AND ELECTION AND OF POTENTIAL CHANGES IN APPLICABLE TAX LAWS.
TAXATION OF THE COMPANY
GENERAL. The Company believes that, commencing with its taxable year ending
December 31, 1997, it will be owned and organized and will operate in such a
manner as to qualify for taxation as a REIT under the Code, and the Company
intends to continue to operate in such a manner, but no assurance can be given
that it will operate in a manner so as to qualify or remain qualified. The
Company will elect to be taxed as a REIT under Sections 856 through 860 of the
Code and the applicable Treasury Regulations (the "REIT Requirements" or the
"REIT Provisions"), which are the requirements for qualifying as a REIT,
commencing with its taxable year ending December 31, 1997. The REIT Requirements
are technical and complex. The following discussion sets forth only a summary of
the material aspects of those requirements.
In the opinion of Elias, Matz, Tiernan & Herrick L.L.P., commencing with the
Company's taxable year ending December 31, 1997, the Company will be organized
in conformity with the requirements for qualification as a REIT, and its
proposed method of operation will enable it to meet the requirements for
qualification and taxation as a REIT under the Code. It must be emphasized that
this opinion is based on certain factual assumptions relating to the
organization and operation of the Company and is conditioned upon certain
representations made by the Company as to factual matters, such as the
organization and expected manner of operation of the Company. In addition, this
opinion is based upon factual assumptions and representations of the Company
concerning its business and the composition of its assets. Moreover, such
qualification and taxation as a REIT depends upon the Company's ability to meet,
through actual annual operating results, distribution levels and diversity of
stock ownership, the various qualification tests imposed under the Code
discussed below, the results of which will not be reviewed by Elias, Matz,
Tiernan & Herrick L.L.P. on a continuing basis. No assurance can be given that
the actual results of the Company's operations for any particular taxable year
will satisfy such requirements. See "--Failure to Qualify."
If the Company qualifies for taxation as a REIT, it generally will not be
subject to federal corporate income taxes on that portion of its ordinary income
or capital gain that is currently distributed to stockholders. Such treatment
substantially eliminates the federal "double taxation" on earnings (at the
corporate and the stockholder levels) that generally results from investment in
a corporation.
Despite the REIT election, the Company may be subject to federal income and
excise tax as follows:
First, the Company will be taxed at regular corporate rates on any REIT
taxable income, including net capital gains, less distributions to
stockholders.
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Second, if the REIT has a net capital gain, the applicable tax will be
the lower of: (i) the tax imposed on REIT taxable income computed without
regard to net capital gain and the deduction for capital gain dividends, and
(ii) a tax on undistributed net capital gains at the rate provided in
Section 1201(a) of the Code.
Third, under certain circumstances, the Company may be subject to the
"alternative minimum tax" on certain of its items of tax preferences, if
any.
Fourth, if the Company has (i) net income from the sale or other
disposition of "foreclosure property" that is held primarily for sale to
customers in the ordinary course of business or (ii) other nonqualifying net
income from foreclosure property, it will be subject to tax at the highest
corporate rate on such income.
Fifth, if the Company has net income from prohibited transactions (which
are, in general, certain sales or other dispositions of property held
primarily for sale to customers in the ordinary course of business, other
than sales of foreclosure property and sales that qualify for a statutory
safe harbor), such income will be subject to a 100% tax.
Sixth, if the Company should fail to satisfy the 75% gross income test
or the 95% gross income test (as discussed below), but has nonetheless
maintained its qualifications as a REIT because certain other requirements
have been met, it will be subject to a 100% tax on the net income
attributable to the greater of the amount by which the Company fails the 75%
or 95% test, multiplied by a fraction intended to reflect the Company's
profitability.
Seventh, if the Company should fail to distribute, or fail to be treated
as having distributed, with respect to each calendar year at least the sum
of (i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT
capital gain net income for such year and (iii) any undistributed taxable
income from prior periods, the Company would be subject to a 4% excise tax
on the excess of such required distribution over the amounts actually
distributed.
The Company does not now intend to acquire any appreciated assets from a
corporation generally subject to full corporate-level tax in a transaction in
which any gain on the transfer is not fully recognized. However, in the event of
such an acquisition, the Company could, under certain circumstances, be subject
to tax upon disposition of such assets.
ORGANIZATIONAL REQUIREMENTS. The Code defines a REIT as a corporation,
trust, or association (i) that is managed by one or more trustees or directors;
(ii) the beneficial ownership of which is evidenced by transferable shares or by
transferable certificates of beneficial interest; (iii) that would be taxable as
a domestic corporation, but for the REIT Requirements; (iv) that is neither a
financial institution nor an insurance company subject to certain provisions of
the Code; (v) the beneficial ownership of which is held by 100 or more persons;
(vi) not more than 50% in value of the outstanding stock of which is owned,
directly or indirectly, by five or fewer individuals (as defined in the Code to
include private foundations and certain pension trusts and other entities) at
any time during the last half of each taxable year; and (vii) meets certain
other tests, described below, regarding the nature of its income and assets. The
Code provides that conditions (i) through (iv), inclusive, must be met during
the entire taxable year and that condition (v) must be met during at least 335
days of a taxable year of 12 months, or during a proportionate part of a taxable
year of less than 12 months. Conditions (v) and (vi) will not apply until after
the first taxable year for which an election is made to be taxed as a REIT. For
purposes of condition (vi), certain tax-exempt entities described in Sections
501(c)(17) and 509(a) of the Code or a portion of a trust permanently set aside
or used for purposes described in Section 642(c) of the Code, are generally
treated as individuals, and the beneficiaries of a pension trust that qualifies
under Section 401(a) of the Code and that holds shares of a REIT will generally
be treated as holding shares of the REIT in proportion to their actuarial
interests in the pension trust. See "--Taxation of United States
Stockholders--Treatment of Tax-Exempt Stockholders."
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In the opinion of Elias, Matz, Tiernan & Herrick L.L.P., preferred stock is
taken into account for purposes of determining whether a REIT satisfies
conditions (v) and (vi) above. The Company believes that it will issue
sufficient shares pursuant to the Offering to allow it to satisfy conditions (v)
and (vi) above. In addition, the Company's Articles of Incorporation include
certain restrictions regarding transfer of its shares, which restrictions are
intended to reduce the likelihood that the Company will fail to satisfy the
share ownership requirements described in (v) and (vi) above. Such transfer and
ownership restrictions are described under "Description of Capital
Stock--Restrictions on Ownership and Transfer." Elias, Matz, Tiernan & Herrick
L.L.P. is also of the opinion that the Company will not be treated as a bank for
federal income tax purposes by reason of the activities of any stockholder.
In addition, a corporation may not elect to become a REIT unless its taxable
year is the calendar year. The Company satisfies this requirement.
INCOME TESTS. In order to maintain qualification as a REIT, the Company
must annually satisfy three gross income requirements. First, at least 75% of
the Company's gross income (excluding gross income from prohibited transactions)
for each taxable year must be derived directly or indirectly from investments
relating to real property or mortgages on real property (including interest on
obligations secured by mortgages on real property, certain "rents from real
property" or as gain on the sale or exchange of such property and certain fees
with respect to agreements to make or acquire mortgage loans), from certain
types of temporary investments or certain other types of gross income. Second,
at least 95% of the Company's gross income (excluding gross income from
prohibited transactions) for each taxable year must be derived from such real
property investments as aforesaid and from dividends, interest and gain from the
sale or other disposition of stock or securities and certain other types of
gross income (or from any combination of the foregoing). Third, short-term gain
from the sale or other disposition of stock or securities, gain from prohibited
transactions and gain on the sale or other disposition of real property (apart
from involuntary conversions and sales of foreclosure property) held for less
than four years from the date of acquisition must represent less than 30% of the
Company's gross income (including gross income from prohibited transactions) for
each taxable year. The Taxpayer Relief Act of 1997 repealed the 30 percent gross
income test requirement for tax years beginning after August 5, 1997.
For interest to qualify as "interest on obligations secured by mortgages on
real property or on interests in real property," the obligation must be secured
by real property having a fair market value at the time of acquisition at least
equal to the principal amount of the loan. The term "interest" includes only an
amount that constitutes compensation for the use or forbearance of money. For
example, a fee received or accrued by a lender which is in fact a charge for
services performed for a borrower rather than a charge for the use of borrowed
money is not includible as interest; amounts earned as consideration for
entering into agreements to make loans secured by real property, although not
interest, are otherwise treated as within the 75% and 95% classes of gross
income so long as the determination of those amounts does not depend on the
income or profits of any person. By statute, the term interest does not include
any amount based on income or profits of any person except that the Code
provides that (i) interest "based on a fixed percentage or percentages of
receipts or sales" is not excluded and (ii) when the REIT makes a loan that
provides for interest based on the borrower's receipts or sales and the borrower
leases substantially all of its interest in the property securing the loan under
one or more leases based on income or profits, only a portion of the contingent
interest paid by the borrower will be disqualified as interest.
Rents received or deemed to be received by the Company will qualify as
"rents from real property" in satisfying the gross income requirements for a
REIT described above only if certain statutory conditions are met that limit
rental income essentially to rentals on investment-type properties. In the event
that a REIT acquires by foreclosure property that generates income that does not
qualify as "rents from real property," such income will be treated as qualifying
for two years following foreclosure (which period may be extended by the IRS) so
long as (i) all leases entered into after foreclosure generate only qualifying
rent, (ii) only limited construction takes place and (iii) within 90 days of
foreclosure, any trade or business in which the property is used is conducted by
an independent contractor from which the REIT derives no
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income. In the event the special foreclosure property rule applies to qualify
otherwise unqualified income, the net income that qualifies only under the
special rule for foreclosure property may be subject to tax, as described above.
The Company expects to satisfy these requirements.
RELIEF PROVISIONS. If the Company fails to satisfy one or both of the 75%
or 95% gross income tests for any taxable year, it may nevertheless qualify as a
REIT for such year if it is entitled to relief under certain provisions of the
Code. These relief provisions will be generally available if the Company's
failure to meet such tests was due to reasonable cause and not due to willful
neglect, the Company attaches a schedule of the sources of its income to its
return and any incorrect information on the schedule was not due to fraud with
intent to evade tax. It is not possible, however, to state whether in all
circumstances the Company would be entitled to the benefit of these relief
provisions. As discussed above in "--Taxation of the Company--General," even if
these relief provisions were to apply, a tax would be imposed based upon the
greater of the amount by which the Company failed either the 75% or 95% gross
income test for that year.
ASSET TESTS. At the close of each quarter of each taxable year, the Company
must satisfy three tests relating to the nature of its assets. First, at least
75% of the value of the Company's total assets must be represented by real
estate assets (including stock or debt instruments held for not more than one
year that were purchased with the proceeds of a stock offering or long-term (at
least five years) debt offering of the Company), cash, cash items and government
securities. Second, not more than 25% of the Company's total assets may be
represented by securities other than those in the 75% asset class. Third, of the
investments included in the 25% asset class, the value of any one issuer's
securities owned by the Company may not exceed 5% of the value of the Company's
total assets and the Company may not own more than 10% of any one issuer's
outstanding voting securities.
After initially meeting the asset tests at the close of any quarter, the
Company will not lose its status as a REIT if it fails to satisfy the asset
tests at the end of a later quarter solely by reason of changes in asset values.
If the failure to satisfy the asset tests results from an acquisition of
securities or other property during a quarter, the failure can be cured by
disposition of sufficient nonqualifying assets within 30 days after the close of
that quarter. The Company intends to maintain adequate records of the value of
its assets to ensure compliance with the asset tests and to take such action
within 30 days after the close of any quarter as may be required to cure any
noncompliance but no assurance can be given that such asset tests will be met.
ANNUAL DISTRIBUTION REQUIREMENTS. In order to be treated as a REIT, the
Company is required to distribute dividends (other than capital gain dividends)
to its stockholders in an amount at least equal to (A) the sum of (i) 95% of the
Company's "REIT taxable income" (computed without regard to the dividends paid
deduction and the Company's net capital gain) plus (ii) 95% of the net income,
if any, from foreclosure property in excess of the special tax on income from
foreclosure property, minus (B) the sum of certain items of noncash income. Such
distributions must be paid in the taxable year to which they relate or in the
following taxable year if declared before the Company timely files its tax
return for such year and if paid on or before the first regular dividend payment
after such declaration. To the extent that the Company does not distribute (or
is not treated as having distributed) all of its net capital gain or distributes
(or is treated as having distributed) at least 95%, but less than 100% of its
"REIT taxable income," as adjusted, it will be subject to tax thereon at regular
ordinary and capital gains corporate tax rates, as the case may be. For tax
years beginning after August 5, 1997, if the Company elects to retain, rather
than distribute, its net long-term capital gains and to pay the tax on such
gains, then each stockholder must treat a designated amount of undistributed
capital gains as long-term capital gains for his tax year in which the last day
of the Company's tax year falls. The stockholder, however, is also treated as
having paid the capital gains tax imposed on the Company on the designated
amounts included in their long-term capital gains and is allowed a credit or
refund for the tax deemed paid. The Code permits a stockholder, in certain
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circumstances, to be treated for tax purposes as having (i) received a
distribution in the amount specified in the election and (ii) contributed the
amount thereof to the capital of a REIT. In the event the Company fails to
distribute 100% of its income and capital gains, the Bank may, but is not
obligated to, elect to be so treated. Moreover, if the Company should fail to
distribute during each calendar year at least the sum of (i) 85% of its REIT
ordinary income for such year, (ii) 95% of its REIT capital gain net income for
such year and (iii) any undistributed taxable income from prior periods, the
Company would be subject to a 4% excise tax on the excess of such required
distribution over the amounts actually distributed. The Company intends to make
timely distributions sufficient to satisfy the annual distribution requirement.
"REIT taxable income" is the taxable income of a REIT, which generally is
computed in the same fashion as the taxable income of any corporation, except
that (i) certain deductions are not available, such as the deduction for
dividends received, (ii) it may deduct dividends paid (or deemed paid) during
the taxable year, (iii) net capital gains and losses are excluded and (iv)
certain other adjustments are made.
It is possible that, from time to time, the Company may not have sufficient
cash or other liquid assets to meet the 95% distribution requirement due to
timing differences between (i) the actual receipt of income and actual payment
of deductible expenses and (ii) the inclusion of such income and deduction of
such expenses in calculating the taxable income of the Company. In the event
that such an insufficiency or such timing differences occur, in order to meet
the 95% distribution requirement the Company may find it necessary to arrange
for borrowings or to pay dividends in the form of taxable stock dividends if it
is practicable to do so.
Under certain circumstances, the Company may be able to rectify a failure to
meet the distribution requirement for a year by paying "deficiency dividends" to
stockholders in a later year, which may be included in the Company's deduction
for dividends paid for the earlier year. Thus, the Company may be able to avoid
being taxed on amounts distributed as deficiency dividends; however, the Company
will be required to pay interest based upon the amount of any deduction taken
for deficiency dividends.
FAILURE TO QUALIFY
If the Company fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions described above do not apply, the Company will be
subject to tax (including any applicable alternative minimum tax) on its taxable
income at regular corporate rates. Distributions to stockholders in any year in
which the Company fails to qualify will not be deductible by the Company nor
will they be required to be made. In such event, to the extent of current and
accumulated earnings and profits, all distributions to stockholders will be
taxable as ordinary income and, subject to certain limitations of the Code,
corporate distributees may be eligible for the dividends-received deduction.
Unless entitled to relief under specific statutory provisions, the Company will
also be disqualified from taxation as a REIT for the four taxable years
following the year during which qualification was lost, and will not be
permitted to requalify unless it distributes any earnings and profits
attributable to the period when it failed to qualify. In addition, it would be
subject to tax on any built-in gains on property held during the period during
which it did not qualify if it sold such property within 10 years of
requalification. It is not possible to state whether in all circumstances the
Company would be entitled to such statutory relief.
TAX TREATMENT OF AUTOMATIC EXCHANGE
Upon the occurrence of an Exchange Event, the outstanding Series A Preferred
Shares will be automatically exchanged on a one-for-one basis for Bank Preferred
Shares. See "Description of Series A Preferred Shares--Automatic Exchange." The
Automatic Exchange will be a taxable exchange with respect to which each holder
of the Series A Preferred Shares will have a gain or loss, as the case may be,
measured by the difference between the basis of such holder in the Series A
Preferred Shares and the fair market value of the Bank Preferred Shares received
in the Automatic Exchange. Provided that such holder's Series A Preferred Shares
were held as capital assets for more than 18 months prior to the
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Automatic Exchange, any gain or loss will be long-term capital gain or loss.
Long-term capital losses are deductible, subject to certain limitations. In
certain circumstances, holders that are individuals may be entitled, as a result
of recently enacted legislation, to preferential treatment for net capital gains
in the case of a capital asset that has been held for more than 18 months. The
basis of the holder in the Bank Preferred Shares will be their fair market value
at the time of the Automatic Exchange.
TAXATION OF UNITED STATES STOCKHOLDERS
DISTRIBUTIONS GENERALLY. As long as the Company qualifies as a REIT,
distributions to a United States Stockholder up to the amount of the Company's
current or accumulated earnings and profits (and not designated as capital gains
dividends) will be taken into account as ordinary income and will not be
eligible for the dividends-received deduction for corporations. Distributions
that are designated by the Company as capital gain dividends will be treated as
long-term capital gain (to the extent they do not exceed the Company's actual
net capital gain) for the taxable year without regard to the period for which
the stockholder has held its stock. However, corporate stockholders may be
required to treat up to 20% of certain capital gains dividends as ordinary
income, pursuant to Section 291(d) of the Code. A distribution in excess of
current or accumulated earnings and profits will first be treated as a tax-free
return of capital, reducing the tax basis in the United States Stockholder's
Series A Preferred Shares, and a distribution in excess of the United States
Stockholder's tax basis in its Series A Preferred Shares will be taxable gain
realized from the sale of such shares. Dividends declared by the Company in
October, November or December of any year payable to a stockholder of record on
a specified date in any such month shall be treated as both paid by the Company
and received by the stockholder on December 31 of such year, provided that the
dividend is actually paid by the Company during January of the following
calendar year. Stockholders may not claim the benefit of any tax losses of the
Company on their own income tax returns.
The Company will be treated as having sufficient earnings and profits to
treat as a dividend any distribution by the Company up to the amount required to
be distributed in order to avoid imposition of the 4% excise tax discussed under
"--Taxation of the Company--General" and "--Taxation of the Company--Annual
Distribution Requirements" above. As a result, stockholders may be required to
treat as taxable dividends certain distributions that would otherwise result in
tax-free returns of capital. Moreover, any "deficiency dividend" will be treated
as a "dividend" (an ordinary dividend or a capital gain dividend, as the case
may be), regardless of the Company's earnings and profits.
Losses incurred on the sale or exchange of Series A Preferred Shares held
for less than six months will be deemed a long-term capital loss to the extent
of any capital gain dividends received by the selling stockholder with respect
to such stock.
TREATMENT OF TAX-EXEMPT STOCKHOLDERS. Distributions from the Company to a
tax-exempt employee pension trust or other domestic tax-exempt stockholder
generally will not constitute "unrelated business taxable income" ("UBTI")
unless the stockholder has borrowed to acquire or carry its Common Stock.
Qualified trusts that hold more than 10% (by value) of the shares of certain
REITs, however, may be required to treat a certain percentage of such REIT's
distributions as UBTI. This requirement will apply only if (i) the REIT would
not qualify as such for federal income tax purposes but for the application of
the "look-through" exception to the Five or Fewer Test applicable to shares held
by qualified trusts and (ii) the REIT is "predominantly held" by qualified
trusts. A REIT is predominantly held by qualified trusts if either (i) a single
qualified trust holds more than 25% by value of the interests in the REIT or
(ii) one or more qualified trusts, each owning more than 10% by value of the
interests in the REIT, hold in the aggregate more than 50% of the interests in
the REIT. The percentage of any REIT dividend treated as UBTI is equal to the
ratio of (a) the UBTI earned by the REIT (treating the REIT as if it were
qualified trust and therefore subject to tax on UBTI) to (b) the total gross
income (less certain associated expenses) of the REIT. If the Company were to
incur indebtedness to acquire property, the percentage of any REIT dividend
treated as UBTI would be increased to reflect any UBTI earned by the Company
from "debt-financed property." A DE MINIMIS exception applies where the ratio
set forth above is less than 5% for any
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year. For these purposes, a qualified trust is any trust described in Section
401(a) of the Code and exempt from tax under Section 501(a) of the Code. The
provisions requiring qualified trusts to treat a portion of REIT distributions
as UBTI will not apply if the REIT is able to satisfy the Five or Fewer Test
without relying upon the "look-through" exception.
TAXATION OF FOREIGN STOCKHOLDERS
The following is a discussion of certain anticipated U.S. federal income tax
consequences of the ownership and disposition of the Company's stock applicable
to Non-U.S. Holders of such stock. The discussion is based on current law and is
for general information only. The discussion addresses only certain and not all
aspects of U.S. federal income taxation.
ORDINARY DIVIDENDS. The portion of dividends received by Non-United States
Holders payable out of the Company's earnings and profits (which are not
attributable to capital gains of the Company and which are not effectively
connected with a U.S. trade or business of the Non-United States Holder) will be
subject to U.S. withholding tax at the rate of 30% (unless reduced by treaty).
In general, Non-United States Holders will not be considered engaged in a U.S.
trade or business solely as a result of their ownership of stock of the Company.
In cases where the dividend income from a Non-United States Holder's investment
in stock of the Company is (or is treated as) effectively connected with the
Non-United States Holder's conduct of a U.S. trade or business, the Non-United
States Holder generally will be subject to U.S. tax at graduated rates, in the
same manner as a United Sates Stockholder with respect to such dividends (and
may also be subject to the 30% branch profits tax in the case of a Non-United
States Holder that is a foreign corporation).
NON-DIVIDEND DISTRIBUTIONS. Distributions by the Company which are not
dividends out of the earnings and profits of the Company will not be subject to
U.S. income or withholding tax. If it cannot be determined at the time a
distribution is made whether or not such distribution will be in excess of
current and accumulated earnings and profits, the distribution will be subject
to withholding at the rate applicable to dividends. However, the Non-United
States Holder may seek a refund of such amounts from the IRS if it is
subsequently determined that such distribution was, in fact, in excess of
current and accumulated earnings and profits of the Company.
CAPITAL GAIN DIVIDENDS. Under the Foreign Investment in Real Property Tax
Act of 1980 ("FIRPTA"), a distribution made by the Company to a Non-United
States Holder, to the extent attributable to gains from dispositions of United
States Real Property Interests ("USRPIs") will be considered effectively
connected with a U.S. trade or business of the Non-United States Holder and
subject to U.S. income tax at the rate applicable to U.S. individuals or
corporations, without regard to whether such distribution is designated as a
capital gain dividend. Shares of a corporation are treated as a USRPI only if
the fair market value of the USRPIs owned by the corporation equals or exceeds
50% of the fair market value of its total assets. If at no time during the five
years preceding the sale or exchange of shares in the Company, the Series A
Preferred Shares constituted a USRPI, gain or loss on the sale or exchange will
not be treated as effectively connected with a U.S. trade or business by reason
of FIRPTA. While ownership of real property in the U.S. is always a USRPI, a
loan secured by a mortgage on U.S. real property does not constitute a USRPI
unless the amounts payable by the borrower are contingent on the income or
receipts of the borrower or the property or otherwise based on the property.
Because such contingent interest is not likely to be present in Mortgage Loans
to be owned by the Company that are expected to represent approximately % of
the assets of the Company (although such interest is fairly common in commercial
loans), the Company believes that it is unlikely that its shares will be USRPIs
or that it will derive significant gain from USRPIs, although whether its shares
are USRPIs or it derives from USRPIs will depend on the facts as they ultimately
develop. If the shares do constitute USRPIs, the Company will be required to
withhold tax equal to 35% of the amount of dividends to the extent such
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dividends constitute USRPI Capital Gains. Distributions subject to FIRPTA may
also be subject to a 30% branch profits tax in the hands of a foreign corporate
stockholder that is not entitled to treaty exemption.
DISPOSITION OF STOCK OF THE COMPANY. Unless the Company's stock constitutes
a USRPI, a sale of such stock by a Non-United States Holder generally will not
be subject to U.S. taxation under FIRPTA. The stock will not constitute a USRPI
if the Company is a "domestically controlled REIT." A domestically controlled
REIT is a REIT in which, at all times during a specified testing period, less
than 50% in value of its shares is held directly or indirectly by Non-United
States Holders. The Company believes that it is, and it expects to continue to
be, a domestically controlled REIT, and therefore that the sale of the Company's
stock will not be subject to taxation under FIRPTA. Because the Company's stock
will be publicly traded, however, no assurance can be given the Company will
continue to be a domestically controlled REIT.
If the Company does not constitute a domestically controlled REIT, a
Non-United States Holder's sale of stock generally will still not be subject to
tax under FIRPTA as a sale of a USRPI provided that (i) the stock is "regularly
traded" (as defined by applicable Treasury regulations) on an established
securities market (e.g., the Nasdaq National Market, on which the Company
expects to list the Series A Preferred Stock) and (ii) the selling Non-United
States Holder held 5% or less of the Company's outstanding stock at all times
during a specified testing period.
If gain on the sale of stock of the Company were subject to taxation under
FIRPTA, the Non-United States Holder would be subject to the same treatment as a
United States Stockholder with respect to such gain (subject to applicable
alternative minimum tax and a special alternative minimum tax in the case of
nonresident alien individuals) and the purchaser of the stock could be required
to withhold 10% of the purchase price and remit such amount to the IRS.
Capital gains not subject to FIRPTA will nonetheless be taxable in the
United States to a Non-United States Holder in two cases: (i) if the Non-United
States Holder's investment in the stock of the Company is effectively connected
with a U.S. trade or business conducted by such Non-United States Holder, the
Non-United States Holder will be subject to the same treatment as a United
States Stockholder with respect to such gain, or (ii) if the Non-United States
Holder is a nonresident alien individual who was present in the United States
for 183 days or more during the taxable year and has a "tax home" in the United
States, the nonresident alien individual will be subject to a 30% tax on the
individual's capital gain.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING TAX
The Company will report to its stockholders and the IRS the amount of
dividends paid or deemed paid during each calendar year, and the amount of tax
withheld, if any.
UNITED STATES STOCKHOLDERS. Under certain circumstances, a United States
Stockholder of Series A Preferred Shares may be subject to backup withholding at
a rate of 31% on payments made with respect to, or cash proceeds of a sale or
exchange of, Series A Preferred Shares. Backup withholding will apply only if
the holder (i) fails to furnish the person required to withhold with its
Taxpayer Identification Number ("TIN") which, for an individual, would be his or
her Social Security Number, (ii) furnishes an incorrect TIN, (iii) is notified
by the IRS that it has failed to properly report payments of interest and
dividends, or (iv) under certain circumstances, fails to certify, under penalty
of perjury, that it has furnished a correct TIN and has not been notified by the
IRS that it is subject to backup withholding for failure to report interest and
dividend payments. Backup withholding will not apply with respect to payments
made to certain exempt recipients, such as corporations and tax-exempt
organizations. A United States Stockholder should consult with a tax advisor
regarding qualification for exemption from backup withholding and the procedure
for obtaining such an exemption. Backup withholding is not an additional tax.
Rather, the amount of any backup withholding with respect to a payment to a
United States Stockholder will be allowed as a credit against such United States
Stockholder's United States federal income tax liability and may entitle such
United States Stockholder to a refund, provided that the required information is
furnished to the IRS.
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<PAGE>
FOREIGN STOCKHOLDERS. Additional issues may arise pertaining to information
reporting and backup withholding with respect to Non-United States Holder, and a
Non-United States Holder should consult with a tax advisor with respect to any
such information reporting and backup withholding requirements. Backup
withholding with respect to a Non-United States Holder is not an additional tax.
Rather, the amount of any backup withholding with respect to a payment to a
Non-United States Holder will be allowed as a credit against any United States
federal income tax liability of such Non-United States Holder. If withholding
results in an overpayment of taxes, a refund may be obtained provided that the
required information is furnished to the IRS.
OTHER TAX CONSEQUENCES
The Company and its stockholders may be subject to state or local taxation
in various state or local jurisdictions, including those in which it or they
transact business or reside. The state and local tax treatment of the Company
and its stockholders may not conform to the federal income tax consequences
discussed above. The tax laws of the State of California apply the provisions of
the Code relating to REITs with certain modifications which will not have a
material beneficial nor adverse effect on the Company's ability to operate as a
REIT. Prospective stockholders should consult their own tax advisors regarding
the effect of state and local tax laws on an investment in the Company. In
addition, the Taxpayer Relief Act of 1997 includes several provisions which will
liberalize certain of the requirements for qualification as a REIT. However,
these provisions will have neither a material beneficial nor adverse effect on
the Company's ability to operate as a REIT.
ERISA CONSIDERATIONS
GENERAL
In evaluating the purchase of Series A Preferred Shares, a fiduciary of a
qualified profit-sharing, pension or stock bonus plan, including a plan for
self-employed individuals and their employees or any other employee benefit plan
subject to the Employee Retirement Income Security Act of 1974, as amended
("ERISA"), a collective investment fund or separate account in which such plans
invest and any other investor using assets that are treated as the assets of an
employee benefit plan subject to ERISA (each, a "Plan" and collectively,
"Plans") should consider (a) whether the ownership of Series A Preferred Shares
is in accordance with the documents and instruments governing such Plan; (b)
whether the ownership of Series A Preferred Shares is solely in the interest of
Plan participants and beneficiaries and otherwise consistent with the
fiduciary's responsibilities and in compliance with the requirements of Part 4
of Title I of ERISA, including, in particular, the diversification, prudence and
liquidity requirements of Section 404 of ERISA and the prohibited transaction
provisions of Section 406 of ERISA and Section 4975 of the Code; (c) whether the
Company's assets are treated as assets of the Plan; and (d) the need to value
the assets of the Plan annually. In addition, the fiduciary of an individual
retirement arrangement under Section 408 of the Code (an "IRA") considering the
purchase of Series A Preferred Shares should consider whether the ownership of
Series A Preferred Shares would result in a non-exempt prohibited transaction
under Section 4975 of the Code.
The fiduciary investment considerations summarized below provide a general
discussion that does not include all of the fiduciary investment considerations
relevant to Plans and, where indicated, IRAs. This summary is based on the
current provisions of ERISA and the Code and regulations and rulings thereunder,
and may be changed (perhaps adversely and with retroactive effect) by future
legislative, administrative or judicial actions. PLANS AND IRAS THAT ARE
PROSPECTIVE PURCHASERS OF SERIES A PREFERRED SHARES SHOULD CONSULT WITH AND RELY
UPON THEIR OWN ADVISORS IN EVALUATING THESE MATTERS IN LIGHT OF THEIR OWN
PARTICULAR CIRCUMSTANCES.
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PLAN ASSET REGULATION
Under Department of Labor regulations governing what constitutes the assets
of a Plan or IRA ("Plan Assets") for purposes of ERISA and the related
prohibited transaction provisions of the Code (the "Plan Asset Regulation", 29
C.F.R. Sec.2510.3-101), when a Plan or IRA makes an equity investment in another
entity, the underlying assets of the entity will not be considered Plan Assets
if the equity interest is a "publicly-offered security."
For purposes of the Plan Asset Regulation, a "publicly-offered security" is
a security that is (a) "freely transferable", (b) part of a class of securities
that is "widely held," and (c) sold to the Plan or IRA as part of an offering of
securities to the public pursuant to an effective registration statement under
the Securities Act and part of a class of securities that is registered under
the Exchange Act within 120 days (or such later time as may be allowed by the
Commission) after the end of the fiscal year of the issuer during which the
offering of such securities to the public occurred. The Series A Preferred
Shares will be registered under the Securities Act of 1933, as amended (the
"Securities Act"), and the Exchange Act within the time periods specified in the
Plan Asset Regulation.
The Plan Asset Regulation provides that a security is "widely held" only if
it is a part of the class of securities that is owned by 100 or more investors
independent of the issuer and of one another. A security will not fail to be
"widely held" because the number of independent investors falls below 100
subsequent to the initial offering as a result of events beyond the control of
the issuer. The Company expects the Series A Preferred Shares to be "widely
held" upon the completion of the Offering.
The Plan Asset Regulation provides that whether a security is "freely
transferable" is a factual question to be determined on the basis of all the
relevant facts and circumstances. The Plan Asset Regulation further provides
that when a security is part of an offering in which the minimum investment is
$10,000 or less, certain restrictions ordinarily will not, alone or in
combination, affect the finding that such securities are "freely transferable."
The Company believes that any restrictions imposed on the transfer of the Series
A Preferred Shares are limited to the restrictions on transfer generally
permitted under the Plan Asset Regulation and are not likely to result in the
failure of the Series A Preferred Shares to be "freely transferable."
A Plan should not acquire or hold the Series A Preferred Shares if the
Company's underlying assets will be treated as the assets of such Plan. However,
the Company believes that under the Plan Asset Regulation, the Series A
Preferred Shares should be treated as "publicly-offered securities" and,
accordingly, the underlying assets of the Company should not be considered to be
assets of any Plan or IRA investing in the Series A Preferred Shares.
EFFECT OF PLAN ASSET STATUS
ERISA generally requires that the assets of a Plan be held in trust and that
the trustee, or an investment manager (within the meaning of Section 3(38) of
ERISA), have exclusive authority and discretion to manage and control the assets
of the Plan. As discussed above, the assets of the Company under current law do
not appear likely to be assets of the Plans receiving Series A Preferred Shares
as a result of the Offering. However, if the assets of the Company were deemed
to be assets of the Plans under ERISA, certain directors and officers of the
Company might be deemed fiduciaries with respect to the Plans that invest in the
Company and the prudence and other fiduciary standards set forth in ERISA would
apply to them and to all investments.
If the assets of the Company were deemed to be Plan Assets, transactions
between the Company and parties in interest or disqualified persons with respect
to the investing Plan or IRA could be prohibited transactions unless a statutory
or administrative exemption is available. In addition, investment authority
would also have been improperly delegated to such fiduciaries, and, under
certain circumstances, Plan fiduciaries who make the decision to invest in the
Series A Preferred Shares could be liable as co-
79
<PAGE>
fiduciaries for actions taken by the Company that do not conform to the ERISA
standards for investments under Part 4 of Title I of ERISA.
PROHIBITED TRANSACTIONS
Section 406 of ERISA provides that Plan fiduciaries are prohibited from
causing the Plan to engage in certain types of transactions. Section 406(a)
prohibits a fiduciary from knowingly causing a Plan to engage directly or
indirectly in, among other things: (a) a sale or exchange, or leasing, of
property with a party in interest; (b) a loan or other extension of credit with
a party in interest; (c) a transaction involving the furnishing of goods,
services or facilities with a party in interest; or (d) a transaction involving
the transfer of Plan assets to, or use of Plan assets by or for the benefit of,
a party in interest. Additionally, Section 406 prohibits a Plan fiduciary from
dealing with Plan assets in its own interest or for its own account, from acting
in any capacity in any transaction involving the Plan on behalf of a party (or
representing a party) whose interests are adverse to the interests of the Plan,
and from receiving any consideration for its own account from any party dealing
with the Plan in connection with a transaction involving Plan assets. Similar
provisions in Section 4975 of the Code apply to transactions between
disqualified persons and Plans and IRAs and result in the imposition of excise
taxes on such disqualified persons.
If a prohibited transaction has occurred, Plan fiduciaries involved in the
transaction could be required to (a) undo the transaction, (b) restore to the
Plan any profit realized on the transaction and (c) make good to the Plan any
loss suffered by it as a result of the transaction. In addition, parties in
interest or disqualified persons would be required to pay excise taxes or
penalties.
If the investment constituted a prohibited transaction under Section
408(e)(2) of the Code by reason of the Company engaging in a prohibited
transaction with the individual who established an IRA or his beneficiary, the
IRA would lose its tax-exempt status. The other penalties for prohibited
transactions would not apply.
Thus, the acquisition of the Series A Preferred Shares by a Plan could
result in a prohibited transaction if the Underwriters, the Company, the Bank,
SOCAL or any of their affiliates is a party in interest or disqualified person
with respect to the Plan. Any such prohibited transaction could be treated as
exempt under ERISA and the Code if the Series A Preferred Shares were acquired
pursuant to and in accordance with one or more "class exemptions" issued by the
Department of Labor, such as Prohibited Transaction Class Exemption ("PTCE")
75-1 (an exemption for certain transactions involving employee benefit plans and
broker-dealers (such as the Underwriters), reporting dealers and banks), PTCE
84-14 (an exemption for certain transactions determined by an independent
qualified professional asset manager), PTCE 90-1 (an exemption for certain
transactions involving insurance company pooled separate accounts), PTCE 91-38
(an exemption for certain transactions involving bank collective investment
funds), PTCE 95-60 (an exemption for certain transactions involving an insurance
company's general account) and PTCE 96-23 (an exemption for certain transactions
determined by a qualifying in-house asset manager).
A Plan should not acquire the Series A Preferred Shares pursuant to the
Offering if such acquisition will constitute a non-exempt prohibited
transaction.
UNRELATED BUSINESS TAXABLE INCOME
Plan fiduciaries should also consider the consequences of holding more than
10% of the Series A Preferred Shares if the Company is "predominantly held" by
qualified trusts. See "Federal Income Tax Considerations--Taxation of United
States Stockholders--Treatment of Tax-Exempt Stockholders."
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<PAGE>
CERTAIN INFORMATION REGARDING THE BANK
The following is a summary of certain information regarding the Bank. As an
integral part of this Prospectus, a copy of the Bank's Offering Circular filed
with the OTS relating to the Bank Preferred Shares to be issued upon the
occurrence of an Exchange Event, is attached hereto as Annex I and is
incorporated by reference herein. All material information relating to the Bank,
including information relating to the Bank's financial position, can be found in
the Offering Circular. There has been no material change in the Bank's affairs
since the conclusion of the quarter ended June 30, 1997 which has not otherwise
been disclosed by the Bank in the Offering Circular. The information provided
below is a summary of certain information contained in the Offering Circular
attached hereto as Annex I and is qualified in its entirety by the Offering
Circular. Capitalized terms used in the section and not defined in the
Prospectus have the meanings given to them in the Offering Circular.
GENERAL. The Bank is a federally chartered savings bank which was
originally organized in 1887 under California law and which conducts business
from its executive offices located in Los Angeles, California and 19
full-service branch offices located primarily in Los Angeles County as well as
Orange and Ventura Counties in Southern California. At June 30, 1997, the Bank
had total assets of $1.8 billion, total deposits of $1.3 billion and total
stockholder's equity of $84.9 million.
OWNERSHIP STRUCTURE. The Bank is a wholly owned subsidiary of SOCAL, a
Delaware corporation which was organized in 1987 to acquire the Bank in
connection with its conversion from mutual to stock form. The common stock of
SOCAL is currently (i) 60% owned by the Bishop Estate, (ii) 30% owned by BIL
Securities and (iii) 10% owned by Arbur. The preferred stock of SOCAL is owned
approximately (i) 67% by the Bishop Estate, (ii) 24.8% by BIL Securities and
(iii) 8.2% by Arbur.
The following chart sets forth in simplified form the ownership of the
common equity of SOCAL, the Bank and the Company.
[GRAPHIC]
BASIS FOR 1992 RECAPITALIZATION. In connection with SOCAL's acquisition of
the Bank in April 1987, the Bank was permitted to include in its regulatory
capital $217.5 million of supervisory goodwill which resulted from the
acquisition, as well as $79.7 million of goodwill which was recorded under
generally accepted accounting principles ("GAAP"). In August 1989, Congress
enacted FIRREA which provided, among other things, that savings institutions
such as the Bank were no longer permitted to include goodwill in their
regulatory capital (subject to a gradual phaseout which expired on December 31,
1994). Consequently, the Bank was required to write off all of its supervisory
goodwill, which resulted in the Bank failing to comply with its minimum
regulatory capital requirements during 1990 and 1991. The balance of the Bank's
GAAP goodwill was written off as unrealizable in 1992. The Bank has sued the
U.S.
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Government with respect to the required write-off of its supervisory goodwill.
See "Business of the Bank-- Legal Proceedings" in the Offering Circular.
In August 1992, SOCAL issued $48.0 million of senior notes and, after
payment of transaction fees and expenses, contributed $43.5 million of the net
proceeds from such sale to the Bank (the "1992 recapitalization"). As a result
of the 1992 recapitalization, the Bank was able to satisfy its minimum
regulatory capital requirements.
BASIS FOR 1995 RECAPITALIZATION. Notwithstanding the 1992 recapitalization,
the Bank continued to recognize significant credit losses due, in large part, to
the continued deterioration in the Southern California economy which had begun
with the national recession at the start of the decade, together with a decline
in market values of real estate resulting in part from the Northridge earthquake
of 1994. As the real estate that secured the Bank's mortgage loans decreased in
value and as borrowers, particularly developers of, and investors in,
residential and commercial real estate, became less able to meet their debt
service obligations, non-performing assets and troubled debt restructurings
increased dramatically, amounting to $78.7 million or 4.6% of total assets as of
December 31, 1994. The high levels of non-performing assets adversely affected
the Bank's operations in several respects, including a loss of interest income,
increased operating expenses and substantially higher provisions for losses. As
a result of the foregoing, during 1994, the Bank again fell out of compliance
with its regulatory capital requirements. In May 1995, the present stockholders
of SOCAL invested $60.4 million in new debt and equity securities of SOCAL,
substantially all of the proceeds of which were contributed to the Bank in order
to satisfy the Bank's minimum regulatory capital requirements (the "1995
recapitalization"). Beginning September 30, 1997, SOCAL intends to begin making
quarterly interest payments on its senior debt issued in the 1995
recapitalization, which is expected to be funded through dividends from the
Bank. See "Use of Proceeds" in the Offering Circular.
NEW MANAGEMENT AND INITIATIVES. In connection with the 1995
recapitalization, the Bank replaced its former senior managers with a new
management team with considerable experience in commercial banking and problem
asset rehabilitation. Such individuals include a new President and Chief
Executive Officer, a new Executive Vice President and Chief Financial Officer
and a new Executive Vice President-- Retail Banking, all of whom worked together
at BancFlorida Financial Corp. Mr. Rudolf P. Guenzel, President and Chief
Executive Officer of the Bank, was hired by BancFlorida at a time when
BancFlorida was experiencing serious financial difficulties with non-performing
assets. Under Mr. Guenzel's leadership, BancFlorida returned to profitability
and was sold to First Union Corp. in 1994. The price of BancFlorida's common
stock increased from a low of $2.375 during the first quarter of 1991 to $30.00
per share, the acquisition price paid by First Union Corp in August 1994. See
"Management" in the Offering Circular. The Bank under its new management has
changed its name from Southern California Federal Savings and Loan Association
to People's Bank of California, reflecting a new emphasis on providing full
banking services to its customers. Management has also undertaken a number of
initiatives in order to reduce problem assets, reduce operating expenses and the
cost of funds and to maximize profitability while limiting interest rate and
credit risk. With the California banking market undergoing significant
consolidation, management believes that the Bank is positioned to take advantage
of acquisition opportunities that will occur in its market area. Highlights of
the principal elements of the Bank's business strategy are as follows:
- REDUCTION OF NON-PERFORMING ASSETS. The Bank reorganized its asset review
department, implemented an internal asset review system through the creation of
an internal asset review committee and established a credit review department
and a special assets department in order to focus on the early identification of
potential problem assets and the administration, rehabilitation or liquidation
of the Bank's non-performing assets. As a result, non-performing loans and
troubled debt restructurings have declined from $68.3 million or 4.0% of total
assets at December 31, 1994 to $21.6 million or 1.2% of total assets at June 30,
1997. Because of new management's expertise in resolving problem assets, the
Bank has taken an aggressive approach in resolving its non-performing assets,
including converting non-performing loans into
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real estate owned whenever such a strategy, in the opinion of management,
provides a more efficient alternative to avoid further losses. As a result of
these actions, real estate owned has increased during the same period from $10.5
million at December 31, 1994 to $22.8 million at June 30, 1997. Net charge-offs
during this period amounted to $7.1 million, $11.2 million and $5.3 million
during the years ended December 31, 1995 and 1996 and the six months ended June
30, 1997, as management, upon transfer of loans to real estate owned,
charged-off specific valuation allowances which had previously been established
through increased provisions for loan losses in prior periods. Total
non-performing assets and troubled debt restructurings have declined from $78.7
million at December 31, 1994 to $44.4 million at June 30, 1997. Decreases in the
Bank's non-performing assets have resulted in reductions in provisions for loan
losses, which have contributed to improved operating results. During the six
months ended June 30, 1997 and the year ended December 31, 1996, the Bank
recognized net earnings of $6.9 million and $13.6 million, respectively. See
"Business of the Bank--Non-Performing Assets" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Results of
Operations" in the Offering Circular.
- REDUCTION OF OPERATING EXPENSES. The Bank has significantly reduced
operating expenses through staff reductions and the consolidation of certain
operations. From December 31, 1994 through June 30, 1997, the Bank experienced a
net reduction of 60 employees. In addition, due to the high operating expenses
incurred by the Bank in servicing its Residential Mortgage Loans, the sale of a
substantial portion of the Bank's residential loan servicing which was completed
during the first quarter of 1997 is expected to result in further cost savings.
Management believed that such cost savings, coupled with the reinvestment
opportunity associated with the sale proceeds, would be more profitable to the
Bank than retention of such servicing. The ratio of the Bank's operating
expenses to average total assets has steadily decreased, from 2.14% during the
year ended December 31, 1994 to 1.61% and 1.56% during the year ended December
31, 1996 and the six months ended June 30, 1997, respectively. Despite the
Bank's recent cost-cutting efforts, management believes that it has significant
operating leverage and, therefore, continued incremental growth will not cause
the Bank's operating expenses to increase by a corresponding amount. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations" in the Offering Circular.
- REDUCTION OF FUNDING COSTS. Prior to 1995, the Bank relied to a large
extent on wholesale sources of funds, such as non-retail jumbo certificates of
deposits and Federal Home Loan Bank ("FHLB") advances, which resulted in a high
cost of funds and reduced margins. The Bank has reduced its overall cost of
funds by promoting retail deposit growth (particularly transaction accounts) and
by allowing its non-retail jumbo certificates of deposit to run off as they
mature. In addition, new management has replaced higher cost short-term FHLB
advances with lower cost reverse repurchase agreements. As a result of the
foregoing, the Bank's transactional accounts (passbook, NOW and money market
accounts) have increased from $183.2 million or 13.2% of total deposits at
December 31, 1994 to $339.8 million or 25.9% of total deposits at June 30, 1997.
Over such period, non-retail jumbo certificates of deposit declined from $122.2
million to $3.5 million. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations" in the Offering
Circular.
- INCREASED INVESTMENT IN MORTGAGE-BACKED SECURITIES. Since June 1995, the
Bank has significantly increased its investment in adjustable rate U.S.
Government agency mortgage-backed securities. Mortgage-backed securities
increase the credit quality of the Bank's assets by virtue of the insurance or
guarantees of federal agencies that back them, require less capital under
risk-based regulatory capital requirements than non-insured or non-guaranteed
mortgage loans, are more liquid than individual mortgage loans and may be used
to collateralize borrowings or other obligations of the Bank. In addition, the
adjustable rate nature of the loans underlying such securities has assisted the
Bank in managing its interest rate risk exposure. At June 30, 1997, the Bank
held $578.5 million of mortgage-backed securities, $331.4 million of which were
secured by loans with adjustable rates. See "Business of the Bank-- Investment
Activities" in the Offering Circular.
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<PAGE>
- EXPANSION OF COMMERCIAL AND CONSUMER LENDING. The Bank has hired
individuals with significant expertise in commercial and consumer lending and,
since August 1996, has increased its commercial business and consumer loan
originations. During the six months ended June 30, 1997 and the year ended
December 31, 1996, the Bank originated in the aggregate $10.3 million and $9.8
million of commercial business and consumer loans, which amounted to 23.8%, and
15.8% of total loan originations, respectively. Management intends to continue
to place increased emphasis on building these portfolios. Commercial business
and consumer loans generally have shorter terms and higher interest rates than
single-family residential loans but are generally considered to have a higher
level of credit risk. See "Risk Factors-- Multi-Family Residential, Commercial
Real Estate, Commercial Business and Consumer Lending" and "Business of the
Bank--Lending Activities" in the Offering Circular.
- ASSET GROWTH AND ACQUISITIONS. The Bank has and will continue to pursue a
policy of utilizing its existing infrastructure to grow its loan and securities
portfolios as well as its retail franchise. The Bank opened a new de novo branch
office in Buena Park, California in November 1995 and a branch office facility
in Los Angeles, California in April 1996. The Bank will also consider
acquisition opportunities when it perceives that they are advantageous to the
Bank.
As a result of the Offering, the Bank expects to receive $29.0 million in
net proceeds which it intends to initially leverage through the purchase of U.S.
Government agency and mortgage-backed securities or wholesale single-family
residential loans funded primarily through securities sold under agreements to
repurchase. See "Use of Proceeds" in the Offering Circular. Management believes
that leveraging the proceeds raised in the Offering will permit the Bank to
accelerate the utilization of its existing net operating loss carryforwards on a
going forward basis. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations" and "Taxation" in
the Offering Circular.
The Bank, as a federally chartered savings bank, is subject to comprehensive
regulation and examination by the OTS, as its chartering authority and primary
regulator, and by the FDIC, which administers the Savings Association Insurance
Fund ("SAIF"), which insures the Bank's deposits to the maximum extent permitted
by law. The Bank is a member of the FHLB of San Francisco, which is one of the
12 regional banks which comprise the FHLB System. The Bank is further subject to
regulations of the Federal Reserve Board governing reserves required to be
maintained against deposits and certain other matters. See "Regulation" in the
Offering Circular.
The Bank's principal executive offices are located at 5900 Wilshire
Boulevard, Los Angeles, California 90036, and the telephone number is (213)
938-6300.
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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA OF THE BANK
(DOLLARS IN THOUSANDS)
The following selected historical consolidated financial data for the five
years ended December 31, 1996 is derived in part from the audited consolidated
financial statements of the Bank. The historical consolidated financial data for
the six months ended June 30, 1997 and 1996 is derived from unaudited
consolidated financial statements. The unaudited consolidated financial
statements include all adjustments, consisting of normal recurring accruals,
which management of the Bank considers necessary for a fair presentation of the
financial position and the results of operations for these periods. Operating
results for the six months ended June 30, 1997 are not necessarily indicative of
the results that may be expected for any other interim period or the entire year
ending December 31, 1997. The selected historical consolidated financial data
set forth below should be read in conjunction with, and is qualified in its
entirety by, the historical consolidated financial statements of the Bank,
including the related notes, included elsewhere herein.
<TABLE>
<CAPTION>
DECEMBER 31,
JUNE 30, -----------------------------------------------------
1997 1996 1995 1994 1993 1992
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
SELECTED FINANCIAL CONDITION DATA:
Total assets..................................... $1,820,333 $1,747,871 $1,579,751 $1,720,293 $1,829,228 $2,046,644
Cash and cash equivalents........................ 13,388 14,673 7,249 10,960 18,481 13,022
Federal funds sold............................... 3,335 7,200 11,800 -- -- --
Securities purchased under agreements to
resell......................................... -- -- 35,000 -- -- --
Securities available-for-sale.................... 617,038 502,301 241,645 7,677 55,477 35,253
Loans held for sale.............................. -- -- -- 28,946 5,500 1,396
Mortgage-backed securities held-to-maturity...... 10,375 10,971 -- 304,620 306,530 --
Loans receivable, net............................ 1,102,381 1,141,707 1,228,152 1,306,057 1,346,498 1,442,624
Real estate held for investment and sale, net.... 24,737 22,561 16,288 17,514 36,398 43,854
Deposits......................................... 1,314,036 1,371,243 1,473,318 1,384,218 1,388,818 1,606,643
Securities sold under agreements to repurchase... 331,358 192,433 -- -- 46,985 162,218
FHLB advances.................................... 80,000 80,000 31,746 310,000 314,000 187,000
Total non-performing assets and troubled debt
restructurings(1).............................. 44,393 46,218 52,640 78,737 76,951 71,603
Stockholder's equity(2).......................... 84,918 76,610 67,449 17,348 67,740 76,114
</TABLE>
<TABLE>
<CAPTION>
AT OR FOR THE
SIX MONTHS ENDED
JUNE 30, AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------- -----------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1997 1996 1996 1995 1994 1993 1992
--------- --------- --------- --------- --------- --------- ---------
SELECTED OPERATING DATA:
Interest, fees and dividend
income...................... $ 61,418 $ 60,926 $ 122,896 $ 122,926 $ 116,261 $ 134,923 $ 164,746
Interest expense.............. 44,578 44,204 89,631 94,994 88,238 100,899 127,106
--------- --------- --------- --------- --------- --------- ---------
Net interest income........... 16,840 16,722 33,265 27,932 28,023 34,024 37,640
Provision for losses.......... 655 2,213 2,884 8,823 24,443 13,059 14,032
--------- --------- --------- --------- --------- --------- ---------
Net interest income after
provision for losses........ 16,185 14,509 30,381 19,109 3,580 20,965 23,608
Gain on mortgage-backed
securities sales, net....... 122 3,600 3,638 641 485 901 1,705
Gain (loss)on loan and
servicing sales, net........ 3,413 (53) (53) (166) 2,712 2,537 2,380
Income (loss) from other real
estate operations, net...... 112 (197) 1,946 (2,067) (5,398) (180) 2,056
Other noninterest income...... 1,197 1,257 2,593 2,095 2,328 6,272 3,070
Operating expenses............ 14,110 13,171 27,923 30,906 40,878 41,202 36,666
Goodwill write-off............ -- -- -- -- -- -- 53,105
Earnings (loss) before income
tax provision (benefit)..... 6,919 5,945 10,582 (11,294) (37,171) (10,707) (56,952)
Income tax provision
(benefit)................... -- 5 (3,016) (2,646) 11,356 (1,200) --
Cumulative effect (benefit) of
change in accounting
principle................... -- -- -- -- -- -- (12,570)
--------- --------- --------- --------- --------- --------- ---------
Net earnings (loss)........... $ 6,919 $ 5,940 $ 13,598 $ (8,648) $ (48,527) $ (9,507) $ (44,382)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
</TABLE>
85
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE
SIX MONTHS ENDED
JUNE 30, AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------- -----------------------------------------------------
1997 1996 1996 1995 1994 1993 1992
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
KEY OPERATING RATIOS:
PERFORMANCE RATIOS(3):
Return on assets.............. 0.77% 0.69% 0.78% (0.49)% (2.54)% (0.48)% (2.06)%
Return on equity.............. 17.57 17.66 20.20 (16.73) (89.49) (12.76) (55.20)
Interest-earning assets to
interest-bearing
liabilities................. 101.24 101.21 100.91 100.97 99.69 99.63 99.15
Interest rate spread(4)....... 1.87 1.93 1.94 1.57 1.54 1.81 1.90
Net interest margin(4)........ 1.92 1.99 1.99 1.62 1.53 1.80 1.85
Operating expenses to
assets...................... 1.56 1.53 1.61 1.75 2.14 2.07 1.70
ASSET QUALITY RATIOS:
Non-performing loans as a
percent of loans, net....... 1.27 1.76 1.60 2.90 2.10 2.86 1.98
Non-performing assets as a
percent of total
assets(1)................... 2.03 2.97 2.21 2.94 2.21 3.83 3.29
Non-performing assets and
troubled debt restructurings
as a percent of total
assets(1)................... 2.44 3.38 2.64 3.33 4.58 4.21 3.50
Allowance for loan losses as a
percent of loans, net....... 1.69 2.22 2.04 2.57 2.28 1.52 1.28
Allowance for loan losses as a
percent of non-performing
loans and troubled debt
restructurings(1)........... 86.64 94.41 90.30 75.67 43.66 44.99 56.18
Net charge-offs to average
loans, net.................. 0.47 0.64 0.95 0.55 0.95 0.45 0.56
BANK'S REGULATORY CAPITAL
RATIOS(5):
Core leverage capital ratio... 4.76 4.20 4.57 4.18 1.08 4.21 4.49
Tier 1 capital ratio.......... 9.65 8.14 9.15 7.56 2.01 7.41 8.35
Total risk-based capital
ratio....................... 10.91 9.01 10.38 8.43 2.76 8.58 9.30
</TABLE>
- ------------------------------
(1) Nonperforming assets consist of nonaccrual loans and real estate owned.
Nonaccrual loans are loans that the Bank has removed from accrual status
because the loans are 90 or more days delinquent as to principal and/or
interest or, in management's opinion,
full collectibility of the loan is in doubt. Real estate owned consists of
real estate acquired in settlement of loans. A loan is considered a troubled
debt restructuring if, as a result of the borrower's financial condition,
the Bank has agreed to modify the loan by accepting below market terms
either by granting an interest rate concession or by deferring principal or
interest payments. As used in this table, the term "troubled debt
restructuring" means a restructured loan on accrual status. Troubled debt
restructurings on nonaccrual status are reported in the nonaccrual loan
category.
(2) At June 30, 1997 and December 31, 1996 and 1995, stockholder's equity is net
of $4.4 million, $6.1 million and $1.6 million of unrealized losses on
securities available-for-sale, respectively.
(3) With the exception of end of period ratios, all ratios are based on average
daily balances during the respective periods, except for 1993 and 1992 which
use average monthly balances. Operating data are annualized where
appropriate.
(4) Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities; net interest margin represents net interest
income as a percentage of average interest-earning assets.
(5) For information on the Bank's regulatory capital requirements, see "--Risk
Factors and Other Considerations--Regulatory Capital Levels" herein and
"Regulation--Regulation of Federal Savings Banks--Regulatory Capital
Requirements" in the Offering Circular.
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<PAGE>
RISK FACTORS AND OTHER CONSIDERATIONS
Because of the potential for the Automatic Exchange, the purchase of the
Series A Preferred Shares involves a high degree of risk with respect to the
performance and capital levels of the Bank. Prospective investors in the Series
A Preferred Shares should carefully consider the following risk factors and the
other information set forth in the Offering Circular relating to the Bank before
deciding whether to invest in such shares.
EFFECT OF AN INCREASE IN INTEREST RATES ON OPERATING RESULTS. The Bank's
operating results depend to a large extent on its net interest income, which is
the difference between the interest the Bank receives from its loans, securities
and other assets and the interest the Bank pays on its deposits and other
liabilities. Interest rates are highly sensitive to many factors, including
governmental monetary policies and domestic and international economic and
political conditions. Conditions such as inflation, recession, unemployment,
money supply, international disorders and other factors beyond the control of
the Bank may affect interest rates. If generally prevailing interest rates
increase, the "net interest spread" of the Bank, which is the difference between
the rates of interest earned and the rates of interest paid by the Bank, is
likely to contract, resulting in less net interest income.
Although the Bank pursues an asset-liability management strategy designed to
control its risk from changes in market interest rates, the Bank's liabilities
have shorter terms and are more interest-sensitive than its assets. At June 30,
1997, the Bank's one-year interest-sensitivity "gap" (the sum of all interest
earning assets to be re-priced within one year minus all interest-bearing
liabilities to be re-priced within one year, as a percentage of total assets)
was a negative 8.01%. As a result of its gap position, the Bank's net interest
spread will narrow, and its operating results will be adversely affected, during
periods of rising market interest rates if the Bank is unable to reduce its gap.
There can be no assurance that the Bank will be able to adjust its gap
sufficiently to offset any negative effect of changing market interest rates.
REGULATORY CAPITAL LEVELS. As a federal savings association, the Bank is
subject to minimum capital requirements prescribed by federal statute and OTS
regulations. At June 30, 1997, the Bank was in compliance with all of its
regulatory capital requirements under FIRREA, with core, tier 1 risk-based and
total risk-based regulatory capital ratios of 4.76%, 9.65% and 10.91%,
respectively, compared to the regulatory requirements of 3.00%, 4.00% and 8.00%,
respectively.
The OTS' prompt corrective action regulations establish five capital
categories for thrift institutions: well capitalized, adequately capitalized,
undercapitalized, severely undercapitalized and critically undercapitalized.
These categories are determined for the supervisory purposes of Section 38 of
the Federal Deposit Insurance Act (which establishes a system of mandatory and
discretionary supervisory actions which generally become more severe as capital
levels decline) and may not necessarily constitute an accurate measure of the
Bank's current overall financial condition or its future prospects. A thrift
generally will be considered "well capitalized" if it has a core capital (or
leverage) ratio of at least 5.0%, a Tier 1 risk-based capital ratio of at least
6.0% and a total risk-based capital ratio of at least 10.0%. A thrift generally
will be considered "adequately capitalized" if it has a core capital (or
leverage) ratio of at least 4.0%, a Tier 1 risk-based capital ratio of at least
4.0%, and a total risk-based capital ratio of at least 8.0%. The Bank's core (or
leverage), Tier 1 risk-based and total risk-based capital ratios at June 30,
1997 exceeded the capital ratios established for "adequately capitalized"
institutions. The OTS has the discretion to reclassify an institution from "well
capitalized" to "adequately capitalized" and to treat an "adequately
capitalized" institution as an "undercapitalized" institution for purposes of
the prompt corrective action regulations (including imposing restrictions on the
payment of dividends) if, after notice and an opportunity for a hearing, the OTS
determines that the institution (i) is in an unsafe or unsound condition or (ii)
has received and has not corrected a less than satisfactory examination rating
for asset quality, management, earnings or liquidity. See
"Regulation--Regulation of Federal Savings Banks-- Regulatory Capital
Requirements" in the Offering Circular.
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<PAGE>
AVAILABILITY OF NET OPERATING LOSS CARRYFORWARDS. As of December 31, 1996,
the Bank had federal tax net operating loss carryforwards of approximately
$146.7 million that is available to be carried forward to offset against its
taxable income in future years. However, if the Bank undergoes an "ownership
change" in a future year as a result of transactions unrelated to the Offering,
the Bank would be severely limited in its ability to offset its federal taxable
income and federal tax liability with its net operating losses from the period
prior to the ownership change. See "Taxation" in the Offering Circular.
RISKS RELATING TO ELIMINATION OF THRIFT CHARTER. During the past few years,
Congress has been considering legislation in various forms that would require
federal thrifts, like the Bank, to convert their charters to national or state
bank charters. Recent legislation requires the merger of the Bank Insurance Fund
("BIF") and the SAIF into a single deposit insurance fund on January 1, 1999 but
only if the thrift charter is eliminated by that date. In the absence of
appropriate "grandfather" provisions, legislation eliminating the thrift charter
could have a material adverse effect on the Bank. The Bank cannot determine
whether, or in what form, such legislation will eventually be enacted and there
can be no assurance that any such legislation that is enacted will contain
adequate grandfather rights for the Bank.
On October 16, 1996, the FDIC lowered the rates on SAIF-assessable deposits.
The rule established SAIF rates ranging from 0 to 27 basis points as of October
1, 1996. However, as a result of the Bank's financial condition, the Bank made
application to the FDIC for an exemption from paying a one-time special
assessment, which exemption was approved on October 5, 1996. As a result, the
Bank was exempt from paying this special one-time assessment. Instead, the Bank
will continue to pay future assessments through 1999 at the assessment rate
schedule in effect as of June 30, 1995. Therefore, as of June 30, 1997, the
Bank's annual assessment for deposit insurance was 30 basis points of insured
deposits as opposed to 6.4 basis points of insured deposits (which is the rate
which applies to the highest rated savings institutions). See
"Regulation--Regulation of Federal Savings Banks--FDIC Assessments" in the
Offering Circular.
ABSENCE OF A PUBLIC MARKET FOR BANK PREFERRED SHARES. If Bank Preferred
Shares are issued, the Bank does not intend to apply for listing of the Bank
Preferred Shares on any national securities exchange or for quotation of the
Bank Preferred Shares through the Nasdaq System. There can be no assurance as to
the liquidity of the trading markets for the Bank Preferred Shares or that an
active public market for the Bank Preferred Shares would develop or be
maintained.
RESTRICTIONS ON BANK DIVIDENDS. If the Automatic Exchange occurs and the
Bank has not been placed into conservatorship or receivership, the Bank would
likely be prohibited from paying dividends on the Bank Preferred Shares as long
as the Bank remains "undercapitalized" for purposes of the OTS prompt corrective
action regulations or the OTS anticipates the Bank being "undercapitalized" in
the near term. The prompt corrective action regulations prohibit thrift
institutions such as the Bank from making "capital distributions" (defined to
include a cash distribution) unless the institution is at least "adequately
capitalized" after the distribution.
However, if the Automatic Exchange occurs after the Bank has been placed
into conservatorship or receivership, the claims of the Bank's depositors and of
its secured, senior, general and subordinated creditors would be entitled to a
priority of payment over the claims of holders of equity interests such as the
Bank Preferred Shares issued pursuant to the Automatic Exchange.
88
<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in an underwriting agreement
dated , 1997 (the "Underwriting Agreement") among the Company, the Bank
and Sandler O'Neill & Partners, L.P., as representative (the "Representative")
of the underwriters named herein (the "Underwriters"), the Company has agreed
that the Company will sell to the Underwriters, and the Underwriters have
severally agreed to purchase from the Company, the number of shares set forth
opposite their names below:
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
- --------------------------------------------------------------------------------- ----------
<S> <C>
Sandler O'Neill & Partners, L.P..................................................
----------
1,240,000
----------
----------
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all the Series A Preferred Shares
offered hereby, if any are taken.
The Underwriters propose initially to offer the Series A Preferred Shares
directly to the public at the initial public offering price set forth on the
cover page of this Prospectus, and to certain securities dealers at such price
less a concession of $ per share. The Underwriters may allow, and such
dealers may reallow, a concession not in excess of $ per share to
certain brokers and dealers. After the Series A Preferred Shares are released
for sale to the public, the offering price and other selling terms may from time
to time be varied by the Underwriters.
The Company has granted the Underwriters an option exercisable for 30 days
after the date of this Prospectus to purchase up to an aggregate of 186,000
additional Series A Preferred Shares solely to cover over-allotments, if any.
The Company has agreed to pay certain expenses of the Underwriters in connection
with the Offering.
The Company has agreed that, during the period beginning from the date of
this Prospectus and continuing to and including the date 90 days after the date
of this Prospectus, it will not offer, sell, contract to sell or otherwise
dispose of any securities of the Company which are substantially similar to the
Series A Preferred Shares or which are convertible or exchangeable into
securities which are substantially similar to the Series A Preferred Shares
without the prior written consent of the Representative, except for the Series A
Preferred Shares offered in connection with the Offering.
Prior to the Offering, there has been no public market for the Series A
Preferred Shares. The initial public offering price was determined by
negotiations between the Company and the Representative. Among the factors
considered in determining the initial public offering price of the Series A
Preferred Shares, in addition to prevailing market conditions, were the estimate
of the business potential and earnings prospects of the Company, an assessment
of the Company's management, limitations on the voting rights of the Series A
Preferred Shares, the consideration of the above factors in relation to market
valuation of companies in related businesses and other factors deemed to be
relevant.
The Company has received approval to list the Series A Preferred Shares,
subject to official notice of issuance, on the Nasdaq National Market. The
Representative has advised the Company that it intends to make a market in the
Series A Preferred Shares prior to commencement of trading on the Nasdaq
National Market, but is not obligated to do so and may discontinue any such
market making at any time without notice.
The Company and the Bank have agreed to indemnify the Underwriters against
certain liabilities, including liabilities under the Securities Act.
Until the distribution of the Series A Preferred Shares is completed, rules
of the Commission may limit the ability of the Underwriters and certain selling
group members to bid for and purchase the Series A Preferred Shares. As an
exception to these rules, the Underwriters are permitted to engage in certain
89
<PAGE>
transactions that stabilize the price of the Series A Preferred Shares. Such
transactions consist of bids or purchases for the purpose of pegging, fixing or
maintaining the price of the Series A Preferred Shares.
If the Underwriters create a short position in the Series A Preferred Shares
in connection with the Offering, i.e., if they sell a greater aggregate
principal amount of Series A Preferred Shares than is set forth on the cover
page of this Prospectus, the Underwriters may reduce that short position by
purchasing Series A Preferred Shares in the open market. The Underwriters may
also elect to reduce any short position by exercising all or part of the
over-allotment option described above.
The Underwriters may also impose a penalty bid on certain selling group
members. This means that if the Underwriters purchase Series A Preferred Shares
in the open market to reduce the selling group members' short position or to
stabilize the price of the Series A Preferred Shares, they may reclaim the
amount of the selling concession from the selling group members who sold those
Series A Preferred Shares as part of the Offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of a security to the extent that it were
to discourage resales of the security.
Neither the Company nor the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Series A Preferred Shares. In
addition, neither the Company nor the Underwriters makes any representation that
the Underwriters will engage in such transactions or that such transactions,
once commenced, will not be discontinued without notice.
Underwriters and dealers may engage in passive market making transactions in
the Series A Preferred Shares in accordance with Rule 103 of Regulation M
promulgated by the Commission. In general, a passive market maker may not bid
for, or purchase, the Series A Preferred Shares at a price that exceeds the
highest independent bid. In addition, the net daily purchases made by any
passive market maker generally may not exceed 30% of its average daily trading
volume in the Series A Preferred Shares during a specified two month prior
period, or 200 shares, whichever is greater. A passive market maker must
identify passive market making bids as such on the Nasdaq electronic
inter-dealer reporting system. Passive market making may stabilize or maintain
the market price of the Series A Preferred Shares above independent market
levels. Underwriters and dealers are not required to engage in passive market
making and may end passive market making activities at any time.
The Representative has provided from time to time, and expects to provide in
the future, investment banking services to affiliates of the Company, for which
the Representative has received or will receive customary fees and commissions.
EXPERTS
The balance sheet of Peoples Preferred Capital Corporation as of July 3,
1997 has been included herein and in the Registration Statement in reliance upon
the report of KPMG Peat Marwick LLP, independent auditors, appearing elsewhere
herein, and upon the authority of said firm as experts in accounting and
auditing.
CERTAIN LEGAL MATTERS
The validity of the Series A Preferred Shares offered hereby and certain
other legal and certain tax matters described under "Federal Income Tax
Considerations" will be passed upon for the Company by Elias, Matz, Tiernan &
Herrick, L.L.P., Washington, D.C. Certain legal matters will be passed upon for
the Underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New
York.
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ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement (of which
this Prospectus is a part) on Form S-11 (the "Registration Statement") under the
Securities Act, with respect to the Series A Preferred Shares offered hereby.
This Prospectus does not contain all the information set forth in the
Registration Statement, certain portions of which have been omitted as permitted
by the rules and regulations of the Commission. Statements contained in this
Prospectus as to the content of any contract or other document are not
necessarily complete, and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference. For
further information regarding the Company and the Series A Preferred Shares
offered hereby, reference is made to the Registration Statement and the exhibits
thereto.
The Registration Statement and the exhibits forming a part thereof filed by
the Company with the Commission can be inspected at and copies can be obtained
from the Commission, Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549, or at the following regional offices of the Commission:
7 World Trade Center, 13th Floor, Suite 1300, New York, New York 10048 and
Citicorp Center, 500 West Madison Street, 14th Floor, Suite 1400, Chicago,
Illinois 60661. Copies of such materials can be obtained from the Public
Reference Section of the Commission, 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. Such material may also be accessed electronically by
means of the Commission's home page on the Internet at http://www.sec.gov.
The Articles of Incorporation provide that the Company shall maintain its
status as a reporting company under the Exchange Act for so long as any of the
Series A Preferred Shares are outstanding.
This Prospectus incorporates documents by reference which are not presented
herein or delivered herewith. Such documents (other than exhibits to such
documents, unless such exhibits are specifically incorporated by reference) are
available, without charge, to any person, including any beneficial owner, to
whom this Prospectus is delivered, on written or oral request to People's Bank
of California, 5900 Wilshire Boulevard, Los Angeles, California 90036,
Attention: Corporate Secretary, telephone number (213) 938-6300.
The Company's Articles of Incorporation provide that the Company shall
maintain its status as a reporting company under the Exchange Act for as long as
the Series A Preferred Shares are outstanding, and pursuant thereto, the Company
intends to furnish its stockholders with annual reports containing audited
financial statements certified by independent auditors and quarterly reports
containing unaudited financial statements for the first three quarters of each
fiscal year.
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<PAGE>
GLOSSARY
"Administration Action" means any judicial decision, official administrative
pronouncement, published or private ruling, regulatory procedure, notice or
announcement (including any notice or announcement of intent to adopt such
procedures or regulations) relating to the Tax Event.
"Advisor" means the Bank in its role as advisor under the Advisory
Agreement.
"Advisory Agreement" means the agreement between the Bank and the Company
pursuant to which the Bank will, among other things (i) administer the
day-to-day operations of the Company, (ii) monitor the credit quality of the
Mortgage Assets and Other Authorized Investments held by the Company and (iii)
advise the Company with respect to the acquisition, management, financing and
disposition of the Company's Mortgage Assets and Other Authorized Investments.
"Applicable Premium" means an amount equal to (A) the present value of (l)
the dividends that would be payable on the Series A Preferred Shares in respect
of the period from the date fixed for redemption through , 2002 (assuming
all such dividends were to be authorized and declared) plus (2) $25.00 (assuming
such $25.00 is paid on , 2002), computed using a discount rate equal to
the Treasury Rate plus 75 basis points, divided by (B) $25.00.
"Articles of Incorporation" means the Articles of Incorporation of the
Company.
"Automatic Exchange" means the automatic exchange on a share-for-share basis
of Series A Preferred Shares for Bank Preferred Shares upon the occurrence of
the Exchange Event.
"Bank" means People's Bank of California, a thrift institution organized
under the laws of the United States, and the parent of the Company.
"Bank Preferred Shares" means the newly issued series of preferred stock of
the Bank for which the Series A Preferred Shares will be exchanged automatically
upon the occurrence of an Exchange Event.
"Board of Directors" means the board of directors of the Company.
"Bylaws" means the bylaws of the Company.
"Change of Control" shall have the meaning set forth in "Description of
Series A Preferred Shares-- Redemption."
"Classified" means a loan which, for financial institution regulatory
purposes, is designated as "substandard", "doubtful" or "loss." For such
purposes, a substandard asset is one that is deemed inadequately protected by
the current net worth and paying capacity of the obligor or of the collateral
pledged, if any, because the asset has a well-defined weakness or weaknesses
that jeopardize the liquidation of the debt. An asset classified as doubtful has
all the weaknesses inherent in one classified substandard, with the added
characteristic that the weaknesses make collection or liquidation in full, on
the basis of currently existing facts, conditions and values, highly
questionable and improbable. Assets classified as loss are considered
uncollectible.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commercial Mortgage Loan" means a whole loan secured by a first mortgage or
deed of trust on a multi-family residential or commercial real estate property.
"Commercial Mortgage Purchase Agreement" means the Commercial Mortgage Loan
Purchase and Warranties Agreement between the Company and the Bank.
"Commercial Servicing Agreement" means the servicing agreement entered into
by the Company and the Bank with respect to the Commercial Mortgage Loans.
"Commission" means the United States Securities and Exchange Commission.
92
<PAGE>
"Common Stock" means the common stock, par value $0.01 per share, of the
Company.
"Company" means People's Preferred Capital Corporation, a Maryland
corporation.
"Directive" means the writing issued by the appropriate regulatory agency
directing the Automatic Exchange.
"Dividend Payment Date" means each quarterly date upon which dividends are
paid by the Company to the holders of the Series A Preferred Shares.
"Dividend Period" means any quarterly dividend period.
"DOL" means the United States Department of Labor.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"Excess Shares" means the shares of any class or series of Preferred Stock
owned, or deemed to be owned, by or transferred to a stockholder in excess of
the Ownership Limit.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Exchange Event" means the appropriate federal regulatory agency directs in
writing an exchange of the Series A Preferred Shares for Bank Preferred Shares
because (i) the Bank becomes "undercapitalized" under prompt corrective action
regulations established pursuant to FDICIA, (ii) the Bank is placed into
conservatorship or receivership or (iii) the appropriate federal regulatory
agency, in its sole discretion, anticipates the Bank becoming "undercapitalized"
in the near term.
"FDIC" means the Federal Deposit Insurance Corporation.
"FDICIA" means the Federal Deposit Insurance Corporation Improvement Act of
1991.
"Federal Reserve Board" means the Board of Governors of the Federal Reserve
System.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"FIRPTA" means the Foreign Investment in Real Property Tax Act of 1980, as
amended.
"Five or Fewer Test" means the Code requirement that not more than 50% in
value of the Company's outstanding stock may be owned, directly or indirectly,
by five or fewer individuals (as defined in the Code).
"FNMA" means Fannie Mae.
"HOLA" means the Home Owners' Loan Act, as amended.
"Independent Directors" means the members of the Board of Directors who are
not current directors, officers or employees of the Company, SOCAL, the Bank or
any affiliate of the Bank.
"Initial Dividend Period" means the first Dividend Period.
"Initial Portfolio" means the initial portfolio of Mortgage Loans purchased
by the Company from the Bank.
"Interested Stockholder" means any person who beneficially owns, directly or
indirectly, 10% or more of the aggregate voting power of a Maryland corporation.
"Investment Company Act" means the Investment Company Act of 1940, as
amended.
"IRA" means an individual retirement arrangement under Section 408 of the
Code.
"IRS" means the United States Internal Revenue Service.
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"Junior Stock" means Common Stock and all other classes and series of stock
which rank below the Series A Preferred Shares as to dividend rights and rights
upon liquidation, winding up or dissolution.
"Loan-to-Value Ratio" means, with respect to any Mortgage Loan, the ratio
(expressed as a percentage) of the original principal amount of such Mortgage
Loan to the lesser of (i) the appraised value at origination of the mortgaged
property underlying such Mortgage Loan and (ii) if the Mortgage Loan was made to
finance the acquisition of property, the purchase price of the mortgaged
property.
"MGCL" means the Maryland General Corporation Law.
"Mortgage Assets" means real estate mortgage assets.
"Mortgage-Backed Securities" means securities either issued or guaranteed by
agencies of the Federal government or government sponsored agencies or that are
rated by at least one nationally recognized independent rating organization and
that represent interests in or obligations backed by pools of Mortgage Loans.
"Mortgage Loans" means whole loans secured by single-family (one- to
four-unit) residential, multi-family or commercial real estate properties.
"Mortgage Loan Schedule" means the schedule of the Mortgage Loans in the
Initial Portfolio appearing as an exhibit to the Residential Mortgage Purchase
Agreement and the Commercial Mortgage Purchase Agreement.
"Nonaccrual Status" means a loan on which, in the opinion of management,
principal or interest is not likely to be paid in accordance with the terms of
the loan agreement or on which the principal or interest is past due 90 days or
more and collateral, if any, is insufficient to cover principal and interest.
"Non-United States Holder" means holders of Series A Preferred Shares that
are for United States federal income tax purposes (i) non-resident alien
individuals, (ii) foreign corporations and foreign partnerships or (iii) foreign
trusts and estates.
"Offering" means the offering of Series A Preferred Shares pursuant to the
Prospectus.
"Offering Circular" means the offering circular contained in the
registration statement on Form OC pursuant to which the Bank Preferred Shares
are being registered with the OTS.
"One Hundred Persons Test" means the Code requirement that the capital stock
of the Company be owned by 100 or more persons during at least 335 days of a
taxable year or during a proportionate part of a shorter taxable year.
"Other Authorized Investments" means non-mortgage-related securities
authorized by Section 856(c)(5)(B) of the Code, in an amount which shall not
exceed 20% of the value of the Company's total assets. Non-mortgage related
security is defined in the Investment Company Act. Under the Investment Company
Act, the term "security" means, in part, any note, stock, treasury stock,
debenture, evidence of indebtedness, or certificate of interest or participation
in any profit sharing agreement or a group or index of securities.
"OTS" means the Office of Thrift Supervision, Department of the Treasury.
"Ownership Limit" means the provisions in the Company's Articles of
Incorporation limiting, subject to certain exceptions, any person from owning
(including shares deemed to be owned by attribution provisions of the Code) more
than 7.5% of the aggregate initial liquidation value of the issued and
outstanding shares of Preferred Stock, including the Series A Preferred Shares.
"Parity Stock" means any class and series of equity securities of the
Company expressly designated at being on a parity with the Series A Preferred
Shares as to dividend rights and rights upon liquidation, winding up or
dissolution.
94
<PAGE>
"Plan" means a pension, profit-sharing, retirement or other employee benefit
plan.
"Plan Asset Regulation" means the DOL regulations determining the assets of
a Plan for purposes of ERISA and the related prohibited transaction excise tax
provisions of the Code.
"Preferred Stock" means preferred stock, par value $.01 per share, of the
Company.
"Prospectus" means this prospectus, as the same may be amended.
"Registration Statement" means the registration statement filed by the
Company with the Commission on Form S-11 with respect to the Series A Preferred
Shares.
"REIT" means a real estate investment trust as defined pursuant to the REIT
Provisions, or any successor provisions thereof.
"REIT Provisions" and "REIT Requirements" means Sections 856 through 860 of
the Code and the applicable Treasury Regulations.
"REIT taxable income" means the taxable income of a REIT, which generally is
computed in the same fashion as the taxable income of any corporation, except
that (i) certain deductions are not available, such as the deduction for
dividends received, (ii) it may deduct dividends paid (or deemed paid) during
the taxable year, (iii) net capital gains and losses are excluded and (iv)
certain other adjustments are made.
"Residential Mortgage Loan" means a whole loan secured by a first mortgage
or deed of trust on a single-family (one-to four-unit) residential real estate
property.
"Residential Mortgage Purchase Agreement" means the Residential Mortgage
Loan Purchase and Warranties Agreement between the Company and the Bank.
"Residential Servicing Agreements" means the Initial Residential Servicing
Agreement and the Forward Production Servicing Purchase and Sale Agreement
entered into by the Bank and the Servicing Agent with respect to the Residential
Mortgage Loans.
"Residential Assumption Servicing Agreement" means the agreement between the
Company, the Bank and the Servicing Agent pursuant to which the Servicing Agent
shall service the Residential Mortgage Loans sold by the Bank to the Company in
the Initial Portfolio as well as any additional Residential Mortgage Loans sold
by the Bank to the Company in the future where the Servicing Agent services such
loans for the Bank.
"Securities Act" means the Securities Act of 1933, as amended.
"Senior Stock" means any class and series of securities of the Company
expressly designated as being senior to the Series A Preferred Shares.
"Series A Preferred Shares" means the shares of Preferred Stock of the
Company offered hereby.
"Servicer" or "Servicers" means the Bank in its role as Servicer of the
Commercial Mortgage Loans under the Commercial Servicing Agreement and the
Servicing Agent in its role as Servicer of the Residential Mortgage Loans under
the Residential Servicing Agreements.
"Servicing Agent" means Temple Inland Mortgage Corporation, a Nevada
corporation.
"Servicing Agreements" means the servicing agreements entered into by the
Company with respect to the Residential Mortgage Loans and the Commercial
Mortgage Loans.
"7/23 step rate loan" means a Residential Mortgage Loan that has an initial
fixed-rate of interest for the first seven years (i.e., 84 monthly payments) and
adjusts once thereafter to a rate which applies for the remaining 23 years
(i.e., 286 monthly payments) equal to 150 basis points above the FNMA 30 year
commitment rate for delivery as of a date specified in the related mortgage
note.
95
<PAGE>
"SOCAL" means SoCal Holdings, Inc., a Delaware corporation and the parent of
the Bank.
"Significant Stockholders" mean the Bishop Estate, BIL Securities and Arbur,
or any entity controlled, directly, or indirectly by the Bishop Estate, BIL
Securities and Arbur, or their respective successors. Furthermore, any Person
which owns or is deemed to own shares of the Company by reason of the
attribution of shares of the Company (under certain attribution provisions of
the Code) to a Significant Stockholder shall be treated as a Significant
Stockholder.
"Tax Event" means the receipt by the Company of an opinion of a law firm
experienced in such matters to the effect that, as a result of (i) any amendment
to, clarification of, or change (including any announced prospective change) in
the laws or treaties (or any regulations thereunder) of the United States or any
political subdivision or taxing authority thereof or therein affecting taxation,
(ii) any Administrative Action or (iii) any amendment to, clarification of, or
change in the official position or the interpretation of such Administrative
Action or judicial decision or any interpretation or pronouncement that provides
for a position with respect to such Administrative Action or judicial decision
that differs from the theretofore generally accepted position, in each case, by
any legislative body, court, governmental authority or regulatory body,
irrespective of the manner in which such amendment, clarification or change is
made known, which amendment, clarification, or change is effective or such
pronouncement or decision is announced on or after the date of issuance of the
Series A Preferred Shares, there is more than an insubstantial risk that (a)
dividends payable by the Company with respect to the capital stock of the
Company are not, or will not be, fully deductible for United States federal
income tax purposes or (b) the Company is, or will be, subject to more than a de
minimis amount of other taxes, duties or other governmental charges as a result
of dividends paid or to be paid by the Company.
"TIN" means Taxpayer Identification Number.
"Time of Exchange" means the time at which the Automatic Exchange occurs,
deemed to be as of 8:00 a.m. Eastern Time on the date for such exchange set
forth in the Directive, or, if such date is not set forth in the Directive, as
of 8:00 a.m. Eastern Time on the earliest possible date such exchange could
occur consistent with the Directive.
"Treasury Regulations" means the income tax regulations promulgated under
the Code.
"Underwriters" means underwriter to which the Company will sell the Series A
Preferred Shares pursuant to the terms of the Underwriting Agreement.
"Underwriting Agreement" means the underwriting agreement by and among the
Company, the Bank and the Underwriters.
"United States Stockholders" means holders of Series A Preferred Shares that
are for United States federal income tax purposes (i) citizens or residents of
the United States, (ii) corporations, partnerships, or other entities created or
organized in or under the laws of the United States or of any political
subdivisions thereof, or (iii) an estate or trust the income of which is subject
to United States federal income taxation regardless of its source.
"USRPI" means United States real property interest.
96
<PAGE>
INDEX TO FINANCIAL STATEMENT
PEOPLE'S PREFERRED CAPITAL CORPORATION
<TABLE>
<S> <C>
Independent Auditors' Report.......................................................... F-2
Balance Sheet......................................................................... F-3
Note to Financial Statement........................................................... F-4
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
People's Preferred Capital Corporation
We have audited the accompanying balance sheet of People's Preferred Capital
Corporation (the "Company") as of July 3, 1997. This financial statement is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this financial statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the balance sheet is free of material
misstatement. An audit of a balance sheet includes examining, on a test basis,
evidence supporting the amounts and disclosures in that balance sheet. An audit
of a balance sheet also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
balance sheet presentation. We believe that our audit of the balance sheet
provides a reasonable basis for our opinion.
In our opinion, the balance sheet referred to above presents fairly, in all
material respects, the financial position of People's Preferred Capital
Corporation as of July 3, 1997, in conformity with generally accepted accounting
principles.
KPMG PEAT MARWICK LLP
Los Angeles, California
July 7, 1997
F-2
<PAGE>
PEOPLE'S PREFERRED CAPITAL CORPORATION
BALANCE SHEET
JULY 3, 1997
<TABLE>
<S> <C>
ASSETS
Cash............................................................................... $ 100
---------
---------
STOCKHOLDER'S EQUITY
Common Stock, par value $0.01 per share,
10,000 shares authorized and issued and outstanding.............................. $ 100
---------
---------
</TABLE>
See accompanying Note to Balance Sheet.
F-3
<PAGE>
PEOPLE'S PREFERRED CAPITAL CORPORATION
NOTE TO BALANCE SHEET
1. ORGANIZATION
People's Preferred Capital Corporation (the "Company"), a wholly-owned
subsidiary of People's Bank of California (the "Bank"), was incorporated on June
19, 1997 in the State of Maryland.
The Company intends to invest in mortgage-related and other qualified assets
financed by common and preferred stock offerings and expects to generate income
for distribution to its future preferred and common stockholders primarily from
the net interest income derived from its investments in mortgage-related and
other qualified assets. The Company intends to purchase these mortgage-related
and other qualified assets primarily from the Bank and its affiliates at their
estimated fair values. These assets will be recorded in the Company's financial
statements at the Bank's historical cost basis which will approximate their
estimated fair values. The Company intends to operate in a manner that permits
it to elect, and it intends to elect, to be subject to tax as a real estate
investment trust for federal income tax purposes. The Company has not had any
operations as of July 3, 1997.
The Company intends to sell preferred stock in an underwritten public
offering. The cost of this public offering will be paid by the Company out of
additional capital contributions by the Bank. If the public offering is not
consummated, the Bank will pay all offering costs.
F-4
<PAGE>
THIS OFFERING CIRCULAR HAS BEEN FILED WITH THE OFFICE OF THRIFT SUPERVISION, BUT
HAS NOT BEEN AUTHORIZED FOR USE IN FINAL FORM. INFORMATION CONTAINED HEREIN IS
SUBJECT TO COMPLETION OR AMENDMENT. THE SHARES COVERED HEREBY MAY NOT BE SOLD,
NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE OFFERING CIRCULAR IS
DECLARED EFFECTIVE BY THE OFFICE OF THRIFT SUPERVISION. THE OFFERING CIRCULAR
SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR
SHALL THERE BE ANY SALE OF THESE SHARES IN ANY STATE IN WHICH SUCH OFFER,
SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION
UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
ANNEX I
PRELIMINARY OFFERING CIRCULAR
SUBJECT TO COMPLETION, DATED SEPTEMBER 18, 1997
OFFERING CIRCULAR
1,240,000 SHARES(1)
PEOPLE'S BANK OF CALIFORNIA
% NONCUMULATIVE (LIQUIDATION PREFERENCE $25.00 PER SHARE) PREFERRED STOCK
People's Bank of California (formerly Southern California Federal Savings
and Loan Association) (the "Bank"), is hereby offering 1,240,000 shares of its %
Noncumulative Preferred Stock, liquidation preference $25.00 per share (the
"Bank Preferred Shares"). The Bank Preferred Shares are to be issued, if ever,
in connection with an exchange of the % Noncumulative Exchangeable Preferred
Stock, Series A (the "Series A Preferred Shares") of People's Preferred Capital
Corporation (the "Company"), all the common stock of which is owned by the Bank.
Any accrued and unpaid dividends on the Series A Preferred Shares at the time of
the exchange will be deemed to be accrued and unpaid dividends on the Bank
Preferred Shares. Dividends on the Bank Preferred Shares are payable at the rate
of % per annum of the initial liquidation preference (an amount equal to
$ per annum per share), if, when and as declared by the Board of
Directors of the Bank. Dividends are not cumulative and, if declared, are
payable quarterly in arrears. If no dividend is declared on the Bank Preferred
Shares by the Bank for a dividend period, holders of the Bank Preferred Shares
will have no right to receive a dividend for that period. The Bank's ability to
pay cash dividends is subject to regulatory and other restrictions.
Except in the case of a Change of Control (as defined herein), the Bank may
not redeem the Bank Preferred Shares prior to , 2002. On and after ,
2002, the Bank Preferred Shares may be redeemed for cash at the option of the
Bank, in whole or in part, at the redemption price of $25.00 per share, plus
declared and unpaid dividends, if any, thereon without interest. Upon a Change
of Control, the Bank Preferred Shares are redeemable on or prior to ,
2002, at the option of the Bank or its successor or any acquiring or resulting
entity with respect to the Bank (including by any parent or subsidiary of the
Bank or any such successor or any such acquiring or resulting entity), as
applicable, in whole, but not in part, at a price per share equal to (i) $25.00,
plus (ii) an amount equal to the declared and unpaid dividends, if any, to the
date fixed for redemption, without interest, and, without duplication, an
additional amount equal to the amount of dividends that would be payable on the
Bank Preferred Shares in respect of the period from the first day of the
dividend period in which the date fixed for redemption occurs to the date fixed
for redemption (assuming all such dividends were to be declared), plus (iii) the
Applicable Premium (as defined herein). Any redemption of Bank Preferred Shares
is subject to the prior approval of the Office of Thrift Supervision ("OTS").
The Bank Preferred Shares are not subject to any sinking fund or mandatory
redemption and is not convertible into any other securities of the Bank.
The Bank Preferred Shares will constitute a new series of preferred shares
of the Bank and will rank, in priority of payment of dividends and rights upon
the voluntary or involuntary dissolution, liquidation or winding up of the Bank,
junior to all existing and future liabilities of the Bank, including deposits,
indebtedness and trade payables. The Bank Preferred Shares rank superior and
prior to the issued and outstanding common stock, par value $.01 per share, of
the Bank (the "Common Stock") with respect to dividend rights and rights upon
voluntary or involuntary dissolution, liquidation or winding up of the Bank, and
to all other classes and series of equity securities of the Bank hereafter
issued, other than any class or series expressly designated as being on parity
with or senior to the Bank Preferred Shares. The Common Stock of the Bank is the
only class of equity securities currently outstanding.
The Series A Preferred Shares have been registered with the Securities and
Exchange Commission (the "SEC") and the Series A Preferred Shares have been
approved for listing on the Nasdaq National Market, under the symbol "PPCCP." In
the event the Series A Preferred Shares are exchanged for Bank Preferred Shares,
the Bank does not intend to apply for listing of the Bank Preferred Shares on
any national securities exchange or for quotation through the Nasdaq System.
SEE "RISK FACTORS" COMMENCING ON PAGE OC-12 OF THIS OFFERING CIRCULAR FOR A
DISCUSSION OF CERTAIN RISKS RELATING TO THE BANK PREFERRED SHARES.
THESE SECURITIES OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS, DEPOSITS OR OTHER
DEBT OBLIGATIONS OF A BANK OR SAVINGS ASSOCIATION AND ARE NOT INSURED BY
THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE SAVINGS ASSOCIATION
INSURANCE FUND, ANY OTHER GOVERNMENTAL AGENCY OR OTHERWISE.
THESE SECURITIES OFFERED HEREBY HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
OFFICE OF THRIFT SUPERVISION, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE
SECURITIES AND EXCHANGE COMMISSION OR ANY OTHER FEDERAL AGENCY, OR BY ANY
STATE SECURITIES COMMISSION, NOR HAS SUCH OFFICE, OTHER AGENCY OR ANY
STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS OFFERING CIRCULAR. ANY REPRESENTATION TO THE CONTRARY IS
UNLAWFUL.
- ------------------------------
(1) The Company has granted to the underwriters with respect to the initial
public offering of the Series A Preferred Shares (the "Underwriters") an
option for 30 days to purchase up to an additional 186,000 Series A
Preferred Shares at the initial public offering price thereof, solely to
cover over-allotments, if any. In the event that the Underwriters exercise
such option, in whole or in part, this Offering Circular will cover an
additional number of Bank Preferred Shares which is equal to the number of
Series A Preferred Shares issued upon such exercise.
THE DATE OF THIS OFFERING CIRCULAR IS , 1997
<PAGE>
AVAILABLE INFORMATION
The Bank has filed this Offering Circular on Form OC (including any
amendments thereto, the "Form OC") with the Office of Thrift Supervision (the
"OTS"). This Offering Circular does not contain all of the information set forth
in the Form OC, certain items of which are contained in exhibits to the Form OC
as permitted by the rules and regulations of the OTS. For further information
with respect to the Bank and the Bank Preferred Shares offered hereby, reference
is made to the Form OC, including the exhibits filed as a part thereof.
Statements contained in this Offering Circular as to the contents of any
contract or other document referred to are not necessarily complete, and in each
instance reference is made to the copy of such contract or other document filed
or incorporated by reference as an exhibit to the Form OC, each such statement
being qualified in all respects by such reference. The Form OC and the exhibits
thereto may be inspected without charge at the public reference facilities of
the OTS located at 1700 G Street, N.W., Washington, D.C. 20552, or at the OTS
West Regional Office, located at One Montgomery Street, Suite 400, San
Francisco, California 94104. Copies of such materials may be obtained from the
OTS at prescribed rates.
The Bank has requested and received a waiver from the informational
requirements of the Securities and Exchange Act of 1934, as amended (the
"Exchange Act") during the period in which the Company's Series A Preferred
Shares are outstanding. The Bank agrees to become subject to such informational
requirements of the Exchange Act in the event of an Automatic Exchange of the
Company's Series A Preferred Shares for the Bank Preferred Shares. So long as
the Bank is subject to the periodic reporting requirements of the Exchange Act,
it will furnish the reports and other information required thereby to the OTS.
Such reports and other information can be inspected and copied at the public
reference facilities maintained by the OTS at 1700 G Street, N.W., Washington,
D.C. 20552, or at the OTS West Regional Office located at One Montgomery Street,
Suite 400, San Francisco, California 94104.
OC-2
<PAGE>
SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN
CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND THE CONSOLIDATED FINANCIAL
STATEMENTS AND THE NOTES THERETO CONTAINED ELSEWHERE IN THIS OFFERING CIRCULAR.
UNLESS OTHERWISE INDICATED, ALL INFORMATION IN THIS OFFERING CIRCULAR ASSUMES
THAT THE OVER-ALLOTMENT OPTION GRANTED TO THE UNDERWRITERS WITH RESPECT TO THE
SERIES A PREFERRED SHARES IS NOT EXERCISED. AN INDEX OF DEFINED TERMS USED IN
THIS OFFERING CIRCULAR BEGINS ON PAGE OC-78.
THE BANK
GENERAL. The Bank is a federally chartered savings bank which was
originally organized in 1887 under California law and which conducts business
from its executive offices located in Los Angeles, California and 19
full-service branch offices located primarily in Los Angeles County as well as
Orange and Ventura Counties in Southern California. At June 30, 1997, the Bank
had total assets of $1.8 billion, total deposits of $1.3 billion and total
stockholder's equity of $84.9 million.
OWNERSHIP STRUCTURE. The Bank is a wholly owned subsidiary of SoCal
Holdings, Inc. ("SOCAL"), a Delaware corporation which was organized in 1987 to
acquire the Bank in connection with its conversion from mutual to stock form. At
June 30, 1997, SOCAL had total assets of $1.8 billion and total stockholders'
equity of $72.5 million. The common stock of SOCAL is currently (i) 60% owned by
the Trustees of the Estate of Bernice Pauahi Bishop, also known as Kamehameha
Schools Bernice Pauahi Bishop Estate (the "Bishop Estate"), a charitable
educational trust established under Hawaii law, (ii) 30% owned by BIL Securities
(Offshore) Limited ("BIL Securities"), a wholly owned subsidiary of Brierley
Investments Limited, a New Zealand corporation, and (iii) 10% owned by Arbur,
Inc. ("Arbur"), a Delaware corporation. The preferred stock of SOCAL is owned
approximately (i) 67% by the Bishop Estate, (ii) 24.8% by BIL Securities and
(iii) 8.2% by Arbur.
The following chart sets forth in simplified form the ownership of the
common equity of SOCAL, the Bank and the Company.
[GRAPHIC]
The Bishop Estate operates under the terms of the will (the "Will") of
Bernice Pauahi Bishop, and is one of the largest private landowners in the state
of Hawaii. Under the terms of the Will, revenues in excess of expenses from the
Bishop Estate are used to fund the operations of and maintain The Kamehameha
Schools which are located on the islands of Hawaii.
OC-3
<PAGE>
Brierley Investments Limited is a publicly held investment corporation which
is traded on the New Zealand and Australian stock exchanges. At June 30, 1997,
Brierley Investments Limited had approximately $5.4 billion in total assets,
$2.5 billion in total liabilities and $2.9 billion in total equity (all of which
amounts have been converted into U.S. dollars).
Arbur is a closely held Delaware-chartered corporation which is wholly owned
by William E. Simon and his children. William E. Simon is the former U.S.
Secretary of the Treasury.
BASIS FOR 1992 RECAPITALIZATION. In connection with SOCAL's acquisition of
the Bank in April 1987, the Bank was permitted to include in its regulatory
capital $217.5 million of supervisory goodwill, which resulted from the
acquisition, as well as $79.7 million of goodwill which was recorded under
generally accepted accounting principles ("GAAP"). In August 1989, Congress
enacted the Financial Institutions Reform, Recovery, and Enforcement Act of 1989
("FIRREA") which provided, among other things, that savings institutions such as
the Bank were no longer permitted to include goodwill in their regulatory
capital (subject to a gradual phaseout which expired on December 31, 1994).
Consequently, the Bank was required to write-off all of its goodwill, which
resulted in the Bank failing to comply with its minimum regulatory capital
requirements during 1990 and 1991. The balance of the Bank's GAAP goodwill was
written off as unrealizable in 1992. The Bank has sued the U.S. Government with
respect to the required write-off of its supervisory goodwill. See "Business of
the Bank--Legal Proceedings."
In August 1992, SOCAL issued $48.0 million of senior notes and, after
payment of the transaction fees and expenses, contributed $43.5 million of the
net proceeds from such sale to the Bank (the "1992 recapitalization"). As a
result of the 1992 recapitalization, the Bank was able to satisfy its minimum
regulatory capital requirements.
BASIS FOR 1995 RECAPITALIZATION. Notwithstanding the 1992 recapitalization,
the Bank continued to recognize significant credit losses due, in large part, to
the continued deterioration in the Southern California economy which had begun
with the national recession at the start of the decade, together with a decline
in market values of real estate resulting in part from the Northridge earthquake
of 1994. As the real estate that secured the Bank's mortgage loans decreased in
value and as borrowers, particularly developers of, and investors in,
residential and commercial real estate, became less able to meet their debt
service obligations, non-performing assets and troubled debt restructurings
increased dramatically, amounting to $78.7 million or 4.6% of total assets as of
December 31, 1994. The high levels of non-performing assets adversely affected
the Bank's operations in several respects, including a loss of interest income,
increased operating expenses and substantially higher provisions for losses. As
a result of the foregoing, during 1994, the Bank again fell out of compliance
with its regulatory capital requirements. In May 1995, the present stockholders
of SOCAL invested $60.4 million in new debt and equity securities of SOCAL,
substantially all of the proceeds of which were contributed to the Bank in order
to satisfy the Bank's minimum regulatory capital requirements (the "1995
recapitalization"). Beginning on September 30, 1997, SOCAL intends to begin
making quarterly interest payments on its senior debt issued in the 1995
recapitalization, which is expected to be funded through dividends from the
Bank. See "Use of Proceeds."
NEW MANAGEMENT AND INITIATIVES. In connection with the 1995
recapitalization, the Bank replaced its former senior managers with a new
management team with considerable experience in commercial banking and problem
asset rehabilitation. Such individuals include a new President and Chief
Executive Officer, a new Executive Vice President and Chief Financial Officer
and a new Executive Vice President-- Retail Banking, all of whom worked together
at BancFlorida Financial Corp. Mr. Rudolf P. Guenzel, President and Chief
Executive Officer of the Bank, was hired at a time when BancFlorida was
experiencing serious financial difficulties with non-performing assets. Under
Mr. Guenzel's leadership, BancFlorida returned to profitability and was sold to
First Union Corp. in 1994. BancFlorida's common stock increased from a low of
$2.375 during the quarter in which Mr. Guenzel became President and Chief
Executive
OC-4
<PAGE>
Officer to $30.00 per share, the price at which First Union Corp. acquired
BancFlorida. See "Management." The Bank under its new management has changed the
name of the Bank from Southern California Federal Savings and Loan Association
to People's Bank of California, reflecting a new emphasis on providing full
banking services to its customers. Management has also undertaken a number of
initiatives in order to reduce problem assets, reduce its operating expenses and
cost of funds and maximize profitability while limiting interest rate and credit
risk. With the California banking market undergoing significant consolidation,
management believes that the Bank is uniquely positioned to take advantage of
acquisition opportunities that will occur in its market area. Highlights of the
principal elements of the Bank's business strategy are as follows:
- REDUCTION OF NON-PERFORMING ASSETS. The Bank reorganized its asset review
department, implemented an internal asset review system through the creation of
an internal asset review committee and established a credit review department
and a special assets department in order to focus on the early identification of
potential problem assets and the administration, rehabilitation or liquidation
of the Bank's non-performing assets. As a result, non-performing loans and
troubled debt restructurings have declined from $68.3 million or 4.0% of total
assets at December 31, 1994 to $21.6 million or 1.2% of total assets at June 30,
1997. Because of new management's expertise in dealing with problem assets, the
Bank has taken an aggressive approach in dealing with its non-performing assets,
including converting non-performing loans into real estate owned whenever such a
strategy, in the opinion of management, provides a more efficient alternative to
avoid further losses. As a result of these actions, real estate owned has
increased during the same period from $10.5 million at December 31, 1994 to
$22.8 million at June 30, 1997. Net charge-offs during this period amounted to
$7.1 million, $11.2 million and $5.3 million during the years ended December 31,
1995 and 1996 and the six months ended June 30, 1997, as management, upon
transfer of loans to real estate owned, charged-off specific valuation
allowances which had previously been established through increased provisions
for loans in prior periods. Total non-performing assets and troubled debt
restructurings have declined from $78.7 million at December 31, 1994 to $44.4
million at June 30, 1997. Decreases in the Bank's non-performing assets have
resulted in reductions in provisions for losses, which have contributed to
improved operating results. During the six months ended June 30, 1997 and the
year ended December 31, 1996, the Bank recognized net earnings of $6.9 million
and $13.6 million, respectively. See "Business of the Bank--Non-Performing
Assets" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations."
- REDUCTION OF OPERATING EXPENSES. The Bank has significantly reduced
operating expenses through staff reductions and the consolidation of certain
operations. From December 31, 1994 through June 30, 1997, the Bank experienced a
net reduction of 60 employees. In addition, due to the high operating expenses
incurred by the Bank in servicing its residential mortgage loans, the sale of a
substantial portion of the Bank's residential loan servicing which was completed
during the first quarter of 1997 is expected to result in further cost savings.
Management believed that such cost savings coupled with the reinvestment
opportunity associated with the sale proceeds would be more profitable to the
Bank than retention of such servicing. The ratio of the Bank's operating
expenses to average total assets has steadily decreased, from 2.14% during the
year ended December 31, 1994 to 1.61% and 1.56% during the year ended December
31, 1996 and the six months ended June 30, 1997, respectively. Despite the
Bank's recent cost-cutting efforts, management believes that it has significant
operating leverage and, therefore, continued incremental growth will not cause
the Bank's operating expenses to increase by a corresponding amount. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations."
- REDUCTION OF FUNDING COSTS. Prior to 1995, the Bank relied to a large
extent on wholesale sources of funds, such as non-retail jumbo certificates of
deposits and FHLB advances, which resulted in a high cost of funds and reduced
margins. The Bank has reduced its overall cost of funds by promoting retail
deposit growth (particularly transaction accounts) and by allowing its
non-retail jumbo certificates of deposit to run off as they mature. In addition,
new management has replaced higher cost short-term FHLB advances
OC-5
<PAGE>
with lower cost reverse repurchase agreements. As a result of the foregoing, the
Bank's transactional accounts (passbook, NOW and money market accounts) have
increased from $183.2 million or 13.2% of total deposits at December 31, 1994 to
$339.8 million or 25.9% of total deposits at June 30, 1997. Over such period,
non-retail jumbo certificates of deposit declined from $122.2 million to $3.5
million. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations."
- INCREASED INVESTMENT IN MORTGAGE-BACKED SECURITIES. Since June 1995, the
Bank has significantly increased its investment in adjustable rate U.S.
Government agency mortgage-backed securities. Mortgage-backed securities
increase the credit quality of the Bank's assets by virtue of the insurance or
guarantees of federal agencies that back them, require less capital under
risk-based regulatory capital requirements than non-insured or non-guaranteed
mortgage loans, are more liquid than individual mortgage loans and may be used
to collateralize borrowings or other obligations of the Bank. In addition, the
adjustable rate nature of the loans underlying such securities has assisted the
Bank in managing its interest rate risk exposure. At June 30, 1997, the Bank
held $578.5 million of mortgage-backed securities, $331.4 million of which were
secured by loans with adjustable rates. See "Business of the Bank-- Investment
Activities."
- EXPANSION OF COMMERCIAL AND CONSUMER LENDING. The Bank has hired
individuals with significant expertise in commercial and consumer lending and,
since August 1996, has increased its commercial business and consumer loan
originations. During the six months ended June 30, 1997 and the year ended
December 31, 1996, the Bank originated in the aggregate $10.3 million and $9.8
million of commercial business and consumer loans, which amounted to 23.8%, and
15.8% of total loan originations, respectively. Management intends to continue
to place increased emphasis on building these portfolios. Commercial business
and consumer loans generally have shorter terms and higher interest rates than
single-family residential loans but are generally considered to have a higher
level of credit risk. See "Risk Factors-- Multi-Family Residential, Commercial
Real Estate, Commercial Business and Consumer Lending" and "Business of the
Bank--Lending Activities."
- ASSET GROWTH AND ACQUISITIONS. The Bank has and will continue to pursue a
policy of utilizing its existing infrastructure to grow its loan and securities
portfolios as well as its retail franchise. The Bank opened a new de novo branch
office in Buena Park, California in November 1995 and a branch office facility
in Los Angeles, California in April 1996. The Bank will also consider
acquisition opportunities when it perceives that they are advantageous to the
Bank.
As a result of the Offering, the Bank expects to receive $ million in net
proceeds which it intends to initially leverage through the purchase of U.S.
Government agency and mortgage-backed securities or wholesale single-family
residential loans funded primarily through securities sold under agreements to
repurchase. See "Use of Proceeds." Management believes that leveraging the
proceeds raised in the Offering will permit the Bank to fully realize the
benefit of its existing net operating loss carryforwards on a going forward
basis. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations" and "Taxation."
The Bank, as a federally chartered savings bank, is subject to comprehensive
regulation and examination by the Office of Thrift Supervision ("OTS"), as its
chartering authority and primary regulator, and by the Federal Deposit Insurance
Corporation ("FDIC"), which administers the Savings Association Insurance Fund
("SAIF"), which insures the Bank's deposits to the maximum extent permitted by
law. The Bank is a member of the Federal Home Loan Bank ("FHLB") of San
Francisco, which is one of the 12 regional banks which comprise the FHLB System.
The Bank is further subject to regulations of the Board of Governors of the
Federal Reserve System ("Federal Reserve Board") governing reserves required to
be maintained against deposits and certain other matters. See "Regulation."
The Bank's principal executive offices are located at 5900 Wilshire
Boulevard, Los Angeles, California 90036, and the telephone number is (213)
938-6300.
OC-6
<PAGE>
PEOPLE'S PREFERRED CAPITAL CORPORATION
In June 1997, the Bank established the Company for the purpose of acquiring,
holding and managing real estate mortgage assets and other authorized
investments. All of the Company's common stock is owned by the Bank. It is
expected that substantially all of the Company's mortgage assets will be
acquired from the Bank, although the Company may acquire mortgage assets from
unaffiliated third parties.
The Company has filed a registration statement with the SEC with respect to
the Series A Preferred Shares (the "Offering"). Each Series A Preferred Share
will be exchanged automatically for one newly issued Bank Preferred Share being
registered by this Offering Circular if the appropriate federal regulatory
agency directs in writing an exchange of the Series A Preferred Shares for Bank
Preferred Shares because (i) the Bank becomes "undercapitalized" under prompt
corrective action regulations, (ii) the Bank is placed into conservatorship or
receivership or (iii) the appropriate federal regulatory agency, in its sole
discretion, anticipates the Bank becoming "undercapitalized" in the near term.
The exchange feature has been required by the OTS and is intended, in the event
the Bank experiences financial difficulty, to eliminate the prior claim the
holders of the Series A Preferred Shares would otherwise have on the assets of
the Company so that these assets would be available to support the operations of
the Bank on a consolidated basis.
The Company is undertaking the offering of its Series A Preferred Shares and
the Bank is undertaking the offering of its Bank Preferred Shares for three
principal reasons: (i) the Offering will strengthen the Bank's regulatory
capital position as a portion of the Series A Preferred Shares will qualify as
core capital of the Bank under relevant regulatory capital guidelines as a
result of the treatment of the Series A Preferred Shares as a minority interest
in a consolidated subsidiary of the Bank, (ii) the Offering will provide the
Bank with the opportunity to increase its earnings capacity through the
expansion of its current business, thereby accelerating the use of net operating
loss carryforwards, and (iii) the dividends paid on the Series A Preferred
Shares will, as a result of the Company's qualification as a real estate
investment trust ("REIT") for federal income tax purposes, be tax deductible in
computing the Company's taxable income.
THE OFFERING
<TABLE>
<S> <C>
Securities Offered.................. 1,240,000 shares of the Bank's % Noncumulative
Preferred Stock, which may be increased by up to an
additional 186,000 shares if the Underwriters of the
Company's Series A Preferred Shares exercise an over-
allotment option granted in connection with the
Company's public offering of Series A Preferred
Shares.
Exchange............................ The Bank Preferred Shares are to be issued, if ever,
in connection with an exchange of Series A Preferred
Shares. See "Exchange."
Ranking............................. The Bank Preferred Shares rank senior to the Bank's
Common Stock and junior to all existing and future
liabilities of the Bank, including deposits,
indebtedness and trade payables. Additional shares of
preferred stock ranking senior to the Bank Preferred
Shares may not be issued without the approval of
holders of at least two-thirds of each series of
Preferred Stock.
</TABLE>
OC-7
<PAGE>
<TABLE>
<S> <C>
Dividends........................... Dividends on the Bank Preferred Shares are payable at
the rate of % per annum of the initial liquidation
preference (an amount equal to $ per annum
per share), if, when and as authorized and declared
by the Board of Directors of the Bank. If authorized
and declared, dividends are payable quarterly in
arrears on March 31, June 30, September 30 and
December 31 in each year. Dividends will accrue in
each quarterly period from the first day of such
period, whether or not dividends are paid with
respect to the preceding period. Dividends on the
Bank Preferred Shares are not cumulative and,
accordingly, if no dividend is declared on the Bank
Preferred Shares by the Bank for a dividend period,
holders of the Bank Preferred Shares will have no
right to receive a dividend for that period, and the
Bank will have no obligation to pay a dividend for
that period, whether or not dividends are declared
and paid for any future period. Upon the exchange of
Series A Preferred Shares for Bank Preferred Shares,
any accrued and unpaid dividends of the Series A
Preferred Shares at the time of the exchange will be
deemed to be accrued and unpaid dividends on the Bank
Preferred Shares. See "Description of the Bank
Preferred Shares--Dividends." The Bank's ability to
pay cash dividends is subject to regulatory and other
restrictions described herein.
Liquidation Preference.............. The liquidation preference for each Bank Preferred
Share is $25.00, plus an amount equal to declared and
unpaid dividends, if any, thereon. See "Description
of the Bank Preferred Shares--Rights Upon
Liquidation."
Redemption.......................... Except in the case of a Change of Control, the Bank
may not redeem the Bank Preferred Shares before
, 2002. After such date, the Bank Preferred
Shares may be redeemed for cash at the option of the
Bank, in whole or in part, at any time and from time
to time, at the redemption price of $25.00 per share,
plus declared and unpaid dividends, if any, thereon.
Upon a Change of Control, the Bank Preferred Shares
are redeemable on or prior to , 2002, at the
option of the Bank or its successor or any acquiring
or resulting entity with respect to the Bank
(including by any parent or subsidiary of the Bank or
any such successor or any such acquiring or resulting
entity), as applicable, in whole, but not in part, at
a price per share equal to (i) $25.00, plus (ii) an
amount equal to the declared and unpaid dividends, if
any, to the date fixed for redemption, without
interest, and, without duplication, an additional
amount equal to the amount of dividends that would be
payable on the Bank Preferred Shares in respect of
the period from the first day of the dividend period
in which the date fixed for redemption occurs to the
date fixed for redemption (assuming all such
dividends were to be declared), plus (iii) the
Applicable Premium. Any redemption of Bank Preferred
Shares is subject to the prior approval of
</TABLE>
OC-8
<PAGE>
<TABLE>
<S> <C>
the OTS. The Bank Preferred Shares will not be
subject to any sinking fund or mandatory redemption
and will not be convertible into any other securities
of the Bank.
Voting Rights....................... Holders of Bank Preferred Shares will not have any
voting rights, except as expressly provided herein.
On any matter on which holders of the Bank Preferred
Shares may vote, each share of Bank Preferred Shares
will be entitled to one vote. See "Description of the
Bank Preferred Shares--Voting Rights."
Use of Proceeds..................... The Bank Preferred Shares will only be issued in
connection with an exchange for the Series A
Preferred Shares. The proceeds from the sale of the
Series A Preferred Shares will be used by the Company
to purchase a portfolio of mortgage assets from the
Bank. The Bank will not receive any proceeds,
directly or indirectly, from the exchange of Series A
Preferred Shares for Bank Preferred Shares. See "Use
of Proceeds."
Absence of a Public Market.......... In the event the Series A Preferred Shares are
exchanged for Bank Preferred Shares, the Bank has no
intention to list the Bank Preferred Shares on a
national securities exchange or national quotation
system.
</TABLE>
RISK FACTORS
See "Risk Factors" for a discussion of risks relating to the Bank Preferred
Shares.
OC-9
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA OF THE BANK
(DOLLARS IN THOUSANDS)
The following selected historical consolidated financial data for the five
years ended December 31, 1996 is derived in part from the audited consolidated
financial statements of the Bank. The historical consolidated financial data for
the six months ended June 30, 1997 and 1996 is derived from unaudited
consolidated financial statements. The unaudited consolidated financial
statements include all adjustments, consisting of normal recurring accruals,
which management of the Bank considers necessary for a fair presentation of the
financial position and the results of operations for these periods. Operating
results for the six months ended June 30, 1997 are not necessarily indicative of
the results that may be expected for any other interim period or the entire year
ending December 31, 1997. The selected historical consolidated financial data
set forth below should be read in conjunction with, and is qualified in its
entirety by, the historical consolidated financial statements of the Bank,
including the related notes, included elsewhere herein.
<TABLE>
<CAPTION>
DECEMBER 31,
JUNE 30, -----------------------------------------------------
1997 1996 1995 1994 1993 1992
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
SELECTED FINANCIAL CONDITION DATA:
Total assets..................................... $1,820,333 $1,747,871 $1,579,751 $1,720,293 $1,829,228 $2,046,644
Cash and cash equivalents........................ 13,388 14,673 7,249 10,960 18,481 13,022
Federal funds sold............................... 3,335 7,200 11,800 -- -- --
Securities purchased under agreements to
resell......................................... -- -- 35,000 -- -- --
Securities available-for-sale.................... 617,038 502,301 241,645 7,677 55,477 35,253
Loans held for sale.............................. -- -- -- 28,946 5,500 1,396
Mortgage-backed securities held-to-maturity...... 10,375 10,971 -- 304,620 306,530 --
Loans receivable, net............................ 1,102,381 1,141,707 1,228,152 1,306,057 1,346,498 1,442,624
Real estate held for investment and sale, net.... 24,737 22,561 16,288 17,514 36,398 43,854
Deposits......................................... 1,314,036 1,371,243 1,473,318 1,384,218 1,388,818 1,606,643
Securities sold under agreements to repurchase... 331,358 192,433 -- -- 46,985 162,218
FHLB advances.................................... 80,000 80,000 31,746 310,000 314,000 187,000
Total non-performing assets and troubled debt
restructurings(1).............................. 44,393 46,218 52,640 78,737 76,951 71,603
Stockholder's equity(2).......................... 84,918 76,610 67,449 17,348 67,740 76,114
</TABLE>
<TABLE>
<CAPTION>
AT OR FOR THE
SIX MONTHS
ENDED
JUNE 30, AT OR FOR THE YEAR ENDED DECEMBER 31,
---------------- -----------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1997 1996 1996 1995 1994 1993 1992
------- ------- -------- ---------- ---------- ---------- ----------
SELECTED OPERATING DATA:
Interest, fees and dividend
income.................... $61,418 $60,926 $122,896 $ 122,926 $ 116,261 $ 134,923 $ 164,746
Interest expense............ 44,578 44,204 89,631 94,994 88,238 100,899 127,106
------- ------- -------- ---------- ---------- ---------- ----------
Net interest income......... 16,840 16,722 33,265 27,932 28,023 34,024 37,640
Provision for losses........ 655 2,213 2,884 8,823 24,443 13,059 14,032
------- ------- -------- ---------- ---------- ---------- ----------
Net interest income after
provision for losses...... 16,185 14,509 30,381 19,109 3,580 20,965 23,608
Gain on mortgage-backed
securities sales, net..... 122 3,600 3,638 641 485 901 1,705
Gain (loss)on loan and
servicing sales, net...... 3,413 (53) (53) (166) 2,712 2,537 2,380
Income (loss) from other
real estate operations,
net....................... 112 (197) 1,946 (2,067) (5,398) (180) 2,056
Other noninterest income.... 1,197 1,257 2,593 2,095 2,328 6,272 3,070
Operating expenses.......... 14,110 13,171 27,923 30,906 40,878 41,202 36,666
Goodwill write-off.......... -- -- -- -- -- -- 53,105
Earnings (loss) before
income tax provision
(benefit)................. 6,919 5,945 10,582 (11,294) (37,171) (10,707) (56,952)
Income tax provision
(benefit)................. -- 5 (3,016) (2,646) 11,356 (1,200) --
Cumulative effect (benefit)
of change in accounting
principle................. -- -- -- -- -- -- (12,570)
------- ------- -------- ---------- ---------- ---------- ----------
Net earnings (loss)......... $ 6,919 $ 5,940 $ 13,598 $ (8,648) $ (48,527) $ (9,507) $ (44,382)
------- ------- -------- ---------- ---------- ---------- ----------
------- ------- -------- ---------- ---------- ---------- ----------
</TABLE>
OC-10
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE
SIX MONTHS
ENDED
JUNE 30, AT OR FOR THE YEAR ENDED DECEMBER 31,
---------------- -----------------------------------------------------------
1997 1996 1996 1995 1994 1993 1992
------- ------- -------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
KEY OPERATING RATIOS:
PERFORMANCE RATIOS(3):
Return on assets............ 0.77% 0.69% 0.78% (0.49)% (2.54)% (0.48)% (2.06)%
Return on equity............ 17.57 17.66 20.20 (16.73) (89.49) (12.76) (55.20)
Interest-earning assets to
interest-bearing
liabilities............... 101.24 101.21 100.91 100.97 99.69 99.63 99.15
Interest rate spread(4)..... 1.87 1.93 1.94 1.57 1.54 1.81 1.90
Net interest margin(4)...... 1.92 1.99 1.99 1.62 1.53 1.80 1.85
Operating expenses to
assets.................... 1.56 1.53 1.61 1.75 2.14 2.07 1.70
ASSET QUALITY RATIOS:
Non-performing loans as a
percent of loans, net..... 1.27 1.76 1.60 2.90 2.10 2.86 1.98
Non-performing assets as a
percent of total
assets(1)................. 2.03 2.97 2.21 2.94 2.21 3.83 3.29
Non-performing assets and
troubled debt
restructurings as a
percent of total
assets(1)................. 2.44 3.38 2.64 3.33 4.58 4.21 3.50
Allowance for loan losses as
a percent of loans, net... 1.69 2.22 2.04 2.57 2.28 1.52 1.28
Allowance for loan losses as
a percent of non-
performing loans and
troubled debt
restructurings(1)......... 86.64 94.41 90.30 75.67 43.66 44.99 56.18
Net charge-offs to average
loans, net................ 0.47 0.64 0.95 0.55 0.95 0.45 0.56
BANK'S REGULATORY CAPITAL
RATIOS(5):
Core leverage capital
ratio..................... 4.76 4.20 4.57 4.18 1.08 4.21 4.49
Tier 1 capital ratio........ 9.65 8.14 9.15 7.56 2.01 7.41 8.35
Total risk-based capital
ratio..................... 10.91 9.01 10.38 8.43 2.76 8.58 9.30
</TABLE>
- ------------------------------
(1) Nonperforming assets consist of nonaccrual loans and real estate owned.
Nonaccrual loans are loans that the Bank has removed from accrual status
because the loans are 90 or more days delinquent as to principal and/or
interest or, in management's opinion, full collectibility of the loan is in
doubt. Real estate owned consists of real estate acquired in settlement of
loans. A loan is considered a troubled debt restructuring if, as a result of
the borrower's financial condition, the Bank has agreed to modify the loan
by accepting below market terms either by granting an interest rate
concession or by deferring principal or interest payments. As used in this
table, the term "troubled debt restructurings" means a restructured loan on
accrual status. Troubled debt restructuring on nonaccrual status are
reported in the nonaccrual loan category.
(2) At June 30, 1997 and December 31, 1996 and 1995, stockholder's equity is net
of $4.4 million, $6.1 million and $1.6 million of unrealized losses on
securities available-for-sale, respectively.
(3) With the exception of end of period ratios, all ratios are based on average
daily balances during the respective periods, except for 1993 and 1992 which
use average monthly balances. Operating data are annualized where
appropriate.
(4) Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities; net interest margin represents net interest
income as a percentage of average interest-earning assets.
(5) For information on the Bank's regulatory capital requirements, see "--Risk
Factors and Other Considerations--Regulatory Capital Levels" herein and
"Regulation--Regulation of Federal Savings Banks--Regulatory Capital
Requirements" in the Offering Circular.
OC-11
<PAGE>
RISK FACTORS
PRIOR TO MAKING AN INVESTMENT DECISION, PROSPECTIVE HOLDERS OF BANK
PREFERRED SHARES SHOULD CONSIDER CAREFULLY ALL OF THE INFORMATION SET FORTH IN
THIS OFFERING CIRCULAR AND, IN PARTICULAR, SHOULD EVALUATE THE FOLLOWING RISKS.
THIS OFFERING CIRCULAR CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS AND
INFORMATION RELATING TO THE BANK THAT ARE BASED ON THE BELIEFS OF MANAGEMENT AS
WELL AS ASSUMPTIONS MADE BY AND INFORMATION CURRENTLY AVAILABLE TO MANAGEMENT.
SUCH FORWARD LOOKING STATEMENTS ARE PRINCIPALLY CONTAINED IN THE SECTIONS
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS." IN ADDITION, IN THOSE AND OTHER PORTIONS OF THIS DOCUMENT, THE
WORDS "ANTICIPATE," "BELIEVE," "ESTIMATE," "EXPECT," "INTENDS," "SHOULD" AND
SIMILAR EXPRESSIONS, OR THE NEGATIVE THEREOF, AS THEY RELATE TO THE BANK OR THE
BANK'S MANAGEMENT, ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. SUCH
STATEMENTS REFLECT THE CURRENT VIEWS OF THE BANK WITH RESPECT TO FUTURE EVENTS
AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS, INCLUDING THE
RISK FACTORS DESCRIBED IN THIS OFFERING CIRCULAR. SHOULD ONE OR MORE OF THESE
RISKS OR UNCERTAINTIES MATERIALIZE, OR SHOULD UNDERLYING ASSUMPTIONS PROVE
INCORRECT, ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE DESCRIBED HEREIN AS
ANTICIPATED, BELIEVED, ESTIMATED OR EXPECTED. THE BANK DOES NOT INTEND TO UPDATE
THESE FORWARD-LOOKING STATEMENTS.
THE AUTOMATIC EXCHANGE
The Bank Preferred Shares will be issued in an automatic exchange for the
Series A Preferred Shares, only if directed in writing by the appropriate
regulatory agency because (i) the Bank becomes "undercapitalized" under prompt
corrective action regulations, (ii) the Bank is placed into conservatorship or
receivership or (iii) the appropriate federal regulatory agency, in its sole
discretion, anticipates the Bank becoming "undercapitalized" in the near term.
As a result, holders of Series A Preferred Shares would become holders of Bank
Preferred Shares at a time when the Bank's financial condition was deteriorating
or when the Bank had been placed into conservatorship or receivership. In the
event of liquidation of the Bank, the claims of depositors and secured, senior,
general and subordinated creditors of the Bank would be entitled to a priority
of payment over the claims of holders of equity interests such as the Bank
Preferred Shares. Furthermore, there can be no assurance that the Bank would be
in a financial position, after the occurrence of an automatic exchange, to make
any dividend payments on the Bank Preferred Shares. As a result, the holders of
the Bank Preferred Shares likely would receive, if anything, substantially less
than the holders of the Series A Preferred Shares would have received had the
Series A Preferred Shares not been exchanged for Bank Preferred Shares.
PAYMENT OF DIVIDENDS
There is no obligation to declare dividends on the Bank Preferred Shares.
Because dividends on the Bank Preferred Shares are noncumulative, if the Board
of Directors of the Bank does not declare the quarterly dividend payable on the
Bank Preferred Shares, the holders of the Bank Preferred Shares will have no
right to receive a dividend for such period, whether or not dividends on the
Bank Preferred Shares are declared by the Board of Directors for any future
period. The Bank's ability to pay dividends on Bank Preferred Shares would also
be subject to the prior and superior rights, if any, of holders of other classes
or series of equity securities of the Bank issued in the future.
The federal thrift laws, including the regulations of the OTS, limit the
Bank's ability to pay dividends on its capital stock including the Bank
Preferred Shares. The Bank generally may not declare dividends or make any other
capital distribution if, after the payment of such dividend or other
distribution, it would fall within any of the three undercapitalized categories
under the prompt corrective action standards of the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"). Other limitations apply to the
Bank's ability to pay dividends, the magnitude of which depends upon the extent
to which the Bank meets its regulatory capital requirements. In addition, the
HOLA requires every savings association subsidiary of a savings and loan holding
company to give the OTS at least 30 days' advance notice of any proposed
dividends to be made on its guarantee, permanent or other non-withdrawable stock
or else such
OC-12
<PAGE>
dividend will be invalid. Further the OTS may prohibit any capital distribution
that it determines would constitute an unsafe or unsound practice.
As of June 30, 1997, the Bank met the capital requirements of an "adequately
capitalized" institution under the FDICIA prompt corrective action standards.
Although management expects the Bank to become "well capitalized" as a result of
the sale of the Series A Preferred Shares, there can be no assurance that the
Bank will become or continue to be "well capitalized" under applicable OTS
regulations.
BANK PREFERRED SHARES WILL NOT BE LISTED ON THE NASDAQ SYSTEM
Although the Company has received approval to list the Series A Preferred
Shares on the Nasdaq System, the Bank does not intend to apply for listing of
the Bank Preferred Shares, for which the Series A Preferred Shares will be
exchanged automatically on a one-for-one basis upon the occurrence of an
Exchange Event, on any national securities exchange or for quotation through the
Nasdaq System. Consequently, there can be no assurance as to the liquidity of
the trading markets for the Bank Preferred Shares, if issued, or that an active
public market for the Bank Preferred Shares would develop or be maintained.
ECONOMIC CONDITIONS
The Bank's loan portfolio is concentrated in California. As a result, the
financial condition of the Bank will be subject to general economic conditions
and, in particular, to conditions in the California residential real estate
market. Due to the slow recovery of the economy, particularly in California's
market for real estate, the Bank may find it difficult to originate a sufficient
volume of high-quality residential mortgage loans or maintain its asset quality,
either of which could negatively impact future performance. In addition, any
downturn in the economy generally, and in California in particular, could
further reduce real estate values and the volume of mortgages originated. Real
estate values in California could also be affected by earthquakes.
INTEREST RATE AND CREDIT CONCERNS
It is expected that the Bank will continue to realize income primarily from
the differential or "spread" between the interest earned on loans, securities
and other interest-earnings assets, and interest paid on deposits, borrowings
and other interest-bearing liabilities. Net interest spreads are affected by the
difference between the maturities and repricing characteristics of
interest-earning assets and interest-bearing liabilities. In addition, loan
volume and yields are affected by market interest rates on loans, and rising
interest rates generally are associated with a lower volume of loan
originations. It is expected that a substantial majority of the Bank's assets
will continue to be indexed to changes in market interest rates and a
substantial majority of its liabilities will continue to be short term, which
will mitigate the negative effect of a decline in yield on its assets. At June
30, 1997, the Bank had $1.2 billion in assets maturing or repricing within one
year and $1.4 billion in liabilities maturing or repricing within one year. In
addition, the lag in implementation of repricing terms on the Bank's adjustable
rate assets may result in a decline in net interest income in a rising interest
rate environment. There can be no assurance that the Bank's interest rate risk
will be minimized or eliminated. In addition, an increase in the general level
of interest rates may adversely affect the ability of certain borrowers to pay
the interest on and principal of their obligations. Accordingly, changes in
levels of market interest rates could materially adversely affect the Bank's net
interest spread, asset quality, loan origination volume and overall results of
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Asset and Liability Management."
OC-13
<PAGE>
COMPETITION
The Bank experiences significant competition in both attracting and
retaining deposits and in originating real estate and consumer loans.
The Bank competes with other thrift institutions, commercial banks,
insurance companies, credit unions, thrift and loan associations, money market
mutual funds and brokerage firms in attracting and retaining deposits.
Competition for deposits from large commercial banks is particularly strong.
Many of the nation's thrift institutions and many large commercial banks have a
significant number of branch offices in the areas in which the Bank operates.
In addition, there is strong competition in originating and purchasing real
estate and consumer loans, principally from other savings and loan associations,
commercial banks, mortgage banking companies, insurance companies, consumer
finance companies, pension funds and commercial finance companies. The primary
factors in competing for loans are the quality and extent of service to
borrowers and brokers, economic factors such as interest rates, interest rate
caps, rate adjustment provisions, loan maturities, loan-to-value ("LTV") ratios,
loan fees, and the amount of time it takes to process a loan from receipt of the
loan application to date of funding. The Bank's future performance is dependent
on its ability to originate a sufficient volume of loans in its local market
areas. There can be no assurance that the Bank will be able to effect such
actions on satisfactory terms.
REGULATION
The financial institutions industry is subject to extensive regulation,
which materially affects the business of the Bank. Statutes and regulations to
which the Bank and its parent companies are subject may be changed at any time,
and the interpretation of these statutes and regulations is also subject to
change. There can be no assurance that future changes in such statutes and
regulations or in their interpretation will not adversely affect the business of
the Bank.
AVAILABILITY OF NET OPERATING LOSS CARRYOVERS
At December 31, 1996, the Bank had federal tax net operating loss
carryforwards of approximately $146.7 million that can be carried forward to and
offset against its taxable income in future years. However, if the Bank
undergoes an "ownership change" in a future year as a result of transactions
unrelated to the Offering, the Bank would be severely limited in its ability to
offset its federal taxable income and federal tax liability with its net
operating losses from the period prior to the ownership change. See "Taxation."
CONTROL BY CERTAIN STOCKHOLDERS
All of the Bank's Common Stock is owned by SOCAL. SOCAL is 100% owned by the
Bishop Estate, BIL Securities and Arbur. As a result, these stockholders will be
able to direct and control the policies of the Bank and its subsidiaries,
including mergers, sales of assets and similar transactions. See "The Bank."
ASSET QUALITY
The Bank experienced serious financial and operational problems in the early
1990s primarily as a result of the economic recession and a decline in real
estate values in the Bank's market area. These conditions had a material adverse
effect on the quality of the Bank's loan portfolio and contributed to
substantial increases in the Bank's problem assets, including non-accrual loans,
real estate acquired by the Bank through foreclosure proceedings and troubled
debt restructurings. Such problem assets reached $78.7 million or 4.6% of total
assets at December 31, 1994. Since the change in senior management during 1995,
the Bank has focused on improving the credit quality of its assets through the
early identification of potential problem loans and the administration,
rehabilitation or liquidation of the Bank's non-performing
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<PAGE>
assets. Non-performing assets and troubled debt restructurings have since
declined and totaled $44.4 million or 2.4% of total assets at June 30, 1997. In
addition, performing loans delinquent 120 days or less have declined from $8.6
million at June 30, 1996 to $8.3 million at June 30, 1997.
The future success of the Bank is dependent upon the quality of its assets.
Although management of the Bank has devoted substantial time and resources to
the identification, collection and work-out of non-performing assets, the real
estate markets and the overall economy in its market area are likely to be
significant determinants of the quality of the Bank's assets in future periods
and, thus, its financial condition and results of operations. In particular,
although the Bank, through its new management, has been able to reduce the
amount of its non-performing assets and troubled debt restructurings in recent
years, such assets amounted to $44.4 million or 2.4% of total assets at June 30,
1997. The Bank's future results of operations may be adversely affected if the
Bank is unable to work-out or dispose of its non-performing assets on a timely
basis or if the values of such properties decline further. Although management
utilizes its best judgment in providing for losses with respect to its
non-performing assets, there can be no assurance that the Bank will be able to
dispose of such non-performing assets without establishing additional provisions
for losses on loans or further reductions in the carrying value of its real
estate owned.
MULTI-FAMILY RESIDENTIAL, COMMERCIAL REAL ESTATE, COMMERCIAL BUSINESS AND
CONSUMER LENDING
At June 30, 1997, the Bank's multi-family residential and commercial real
estate loans amounted to $560.6 million in the aggregate or approximately 50% of
the Bank's total loans receivable. In addition, commercial business and consumer
loans amounted to only $12.5 million in the aggregate at June 30, 1997 (which
represented 1% of the Bank's total loans receivable). However, such loans
represented 20.7% and 15.8% of the Bank's total loan originations for the six
months ended June 30, 1997 and the year ended December 31, 1996, respectively.
During the next several years, the Bank intends to increase its emphasis on
commercial business and consumer lending. Although multi-family residential,
commercial real estate, commercial business and consumer loans generally provide
for higher interest rates and shorter terms than single-family residential real
estate loans, such loans generally have a higher degree of credit risk. At June
30, 1997, an aggregate of $9.4 million and $18.5 million of the Bank's
multi-family residential and commercial real estate loans were classified
non-accrual or included in real estate owned, respectively, which loans were
originated under prior management. See "Business of the Bank--Lending
Activities" for a discussion of the nature of the risks associated with
multi-family residential, commercial real estate, commercial business and
consumer lending.
INCREASED EMPHASIS ON COMMERCIAL BUSINESS AND CONSUMER LENDING
The Bank under its new management team has been placing increased emphasis
on providing customers with increased banking services. Toward this end, the
Bank has made increased expenditures with respect to its infrastructure and has
hired and trained new commercial and consumer lending personnel, reflecting an
increased emphasis being placed in this lending area. While the Bank originated
$10.3 million and $9.8 million of commercial business and consumer loans during
the year ended December 31, 1996 and the six months ended June 30, 1997,
respectively, which amounted to 23.8% and 15.8% of total originations during
such respective periods, no assurance can be made that the Bank will be
successful in building up these portfolios to levels commensurate with its
investment. See "Business of the Bank--Lending Activities."
LEVERAGE
Based on the Bank's ability to include in its regulatory capital a
substantial amount of the proceeds raised in the Company's Offering of Series A
Preferred Shares, see "Pro Forma Regulatory Capital," the Bank intends to
initially purchase U.S. Government agency and mortgage-backed securities funded
primarily through reverse repurchase agreements. Management's leverage strategy
is premised on the
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<PAGE>
assumption that it will earn a positive spread on the yield generated from its
purchased securities over the rate paid on its incremental borrowings and that
the spread generated from such strategy will assist the Bank in accelerating the
utilization of its existing net operating loss carryforwards. If market rates of
interest fluctuate in such a manner that the Bank is unable to earn a positive
spread as a result of its leverage strategy, the Bank's net interest margin and
net earnings will be adversely affected in future periods.
USE OF PROCEEDS
The Bank Preferred Shares are to be issued, if ever, in connection with an
exchange of the Series A Preferred Shares, which shares were sold pursuant to an
effective registration statement filed with the SEC. The proceeds from the sale
of the Series A Preferred Shares were used by the Company to purchase a
portfolio of mortgage assets from the Bank. The Bank intends to initially
leverage the capital raised in the Offering through the purchase of U.S.
Government agency and mortgage-backed securities funded primarily through
reverse repurchase agreements. The leveraging of such proceeds will provide the
Bank with the opportunity to expand its business and thereby increase its
earnings, which will permit accelerated utilization of existing net operating
loss carryforwards.
In addition, beginning September 30, 1997, SOCAL intends to begin making
quarterly interest payments on its senior debt, which is expected to be funded
through dividends from the Bank. SOCAL is expected to make an initial payment of
$1.8 million (reflecting accruals since the senior debt was issued in 1995) and
quarterly interest payments thereafter beginning with $192,000 for the December
31, 1997 quarter.
The Bank will not receive any proceeds, directly or indirectly, from the
exchange of the Series A Preferred Shares for Bank Preferred Shares.
OC-16
<PAGE>
CAPITALIZATION
The following table sets forth the actual consolidated capitalization of the
Bank at June 30, 1997 and as adjusted to give effect to the issuance of the
Series A Preferred Shares. The following table should be read in conjunction
with the Consolidated Financial Statements of the Bank and the notes thereto
included elsewhere in this Offering Circular.
<TABLE>
<CAPTION>
THE BANK,
THE BANK AS ADJUSTED
------------ ------------
<S> <C> <C>
(IN THOUSANDS)
Deposits.............................................................................. $ 1,314,036 $ 1,314,036
------------ ------------
------------ ------------
Borrowings:
Securities sold under agreements to repurchase...................................... $ 331,358 $ 331,358
Other borrowings (primarily FHLB advances).......................................... 80,000 80,000
------------ ------------
Total............................................................................. $ 411,358 $ 411,358
------------ ------------
------------ ------------
Minority interest--Series A Preferred Shares.......................................... $ -- $ 31,000
------------ ------------
------------ ------------
Stockholder's equity:
Preferred Stock (par value, $0.01 per share; 5,000,000 shares authorized, no shares
issued and outstanding)........................................................... -- --
Common Stock (par value, $0.01 per share; 10,000,000 shares authorized, 100,000
shares issued and outstanding).................................................... 1 1
Additional paid-in capital.......................................................... 142,538 140,538
Net unrealized gain (loss) on securities available for sale........................... (4,402) (4,402)
Minimum pension liability, net(1)..................................................... (293) (293)
Accumulated deficit................................................................... (52,926) (52,926)
------------ ------------
Total stockholder's equity........................................................ 84,918 82,918
------------ ------------
Total capitalization.................................................................. $ 1,810,312 $ 1,839,312
------------ ------------
------------ ------------
</TABLE>
- ------------------------
(1) Reference is made to Note 15 of the Notes to Consolidated Financial
Statements.
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<PAGE>
PRO FORMA REGULATORY CAPITAL
After giving effect to the issuance of the Series A Preferred Shares, at
June 30, 1997, on a pro forma basis, the Bank would have exceeded minimum
regulatory capital requirements and would have qualified for "well-capitalized"
status. The tables reconcile the Bank's pro forma stockholders' equity to
regulatory capital as of June 30, 1997, and illustrate the percentage by which
the Bank will exceed minimum capital requirements. For further information on
the Bank's capital requirements, see "Regulation--Regulation of Federal Savings
Banks--Regulatory Capital Requirements."
<TABLE>
<CAPTION>
TANGIBLE RISK-BASED
CAPITAL CORE CAPITAL CAPITAL
--------------- ------------ -----------------
<S> <C> <C> <C>
(IN THOUSANDS)
Stockholder's equity of the Bank............................... $ 84,918 $ 84,918 $ 84,918
Minority interest--Series A Preferred Shares(1)................ 28,930 28,930 28,930
Unrealized losses on securities available for sale............. 4,402 4,402 4,402
Non-allowable capital:
Direct real estate investments............................... (1,908) (1,908) (1,908)
Intangible assets............................................ (622) (622) (622)
Supplemental capital:
Allowance for loan losses.................................... -- -- 11,257
--------------- ------------ --------
Regulatory capital of the Bank................................. $ 115,720 $ 115,720 $ 126,977
--------------- ------------ --------
--------------- ------------ --------
</TABLE>
- ------------------------
(1) The OTS has indicated that the Series A Preferred Shares cannot exceed 25%
of the Bank's core capital (including the Series A Preferred Shares) and 33
1/3% of the Bank's core capital (excluding the Series A Preferred Shares).
Consequently, $28.9 million of the proceeds of the Offering will constitute
tangible, core and risk-based capital of the Bank.
<TABLE>
<CAPTION>
RISK-BASED
----------------------
<S> <C> <C> <C> <C>
TANGIBLE CORE TOTAL
CAPITAL CAPITAL TIER 1 CAPITAL
RATIO RATIO RATIO RATIO
----------- ----------- --------- -----------
Regulatory capital of the Bank................................... 4.76% 6.35% 12.88% 14.13%
Well-capitalized ratio........................................... 1.50 5.00 8.00 10.00
--- --- --------- -----
Excess above well-capitalized ratio.............................. 3.26% 1.35% 4.88% 4.13%
--- --- --------- -----
--- --- --------- -----
</TABLE>
The amount of adjusted total assets used for the tangible and core capital
ratios was approximately $1.8 billion. Risk-weighted assets used for the
risk-based capital ratios amounted to approximately $899 million.
OC-18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED
FINANCIAL STATEMENTS OF THE BANK AND THE NOTES THERETO INCLUDED ELSEWHERE IN
THIS OFFERING CIRCULAR.
GENERAL
The Bank is a community oriented savings bank which emphasizes customer
service and convenience. As part of this strategy, the Bank has sought to
develop a wide variety of products and services which meet the needs of its
retail customers. On the asset side of the Bank's balance sheet, management has
increased its emphasis on commercial business and consumer lending which
compliments the Bank's existing residential and commercial real estate lending
operations. In addition, the Bank has increased its investment in
mortgage-backed securities with the intention of enhancing net interest income
while limiting credit and interest rate risk. On the liability side of the
Bank's balance sheet, the Bank is focused on accessing cost-efficient funding
sources, including retail deposits, securities sold under agreements to
repurchase and FHLB advances. The Bank's overall goal is to enhance stockholder
value.
The Bank's business strategy focuses on achieving attractive returns
consistent with prudent risk management. The Bank has sought to implement this
strategy by (i) reducing its portfolio of non-performing assets; (ii) developing
new business relationships through an increased emphasis on commercial lending;
(iii) diversifying the Bank's retail products and services, including an
increase in consumer loan originations; (iv) expanding its retail banking
franchise; (v) increasing the Bank's securities portfolio as a means of
enhancing net interest income while minimizing the Bank's credit and interest
rate risk exposure; (vi) reducing funding costs through the utilization of
retail deposits and other borrowings; (vii) maintaining a low level of operating
expenses; and (viii) controlled growth and the pursuit of a variety of
acquisition opportunities when appropriate. In addition, the Bank intends to
leverage the proceeds of the Offering as a means of expanding its business and
thereby increasing its earnings, which will permit the Bank to accelerate
utilization of existing net operating loss carryforwards.
CHANGES IN FINANCIAL CONDITION
GENERAL. Total assets increased by $72.5 million or 4.1% during the six
months ended June 30, 1997 and increased by $168.1 million or 10.6% during the
year ended December 31, 1996. The increase in total assets during the first half
of 1997 and in 1996 primarily reflected an increase in the Bank's investment in
U.S. Government agency mortgage-backed securities and was funded primarily
through the use of securities sold under agreements to repurchase ("reverse
repurchase agreements"). The shift in the composition of the Bank's asset and
liability mix during 1996 reflects the new management's operational philosophy,
discussed above.
CASH, CASH EQUIVALENTS AND OTHER SHORT-TERM INVESTMENTS. Cash, cash
equivalents and other short-term investments (consisting of cash,
interest-bearing deposits in other banks, federal funds sold and securities
purchased under agreement to resell) amounted to $16.7 million, $21.9 million
and $54.0 million at June 30, 1997 and December 31, 1996 and 1995, respectively.
The Bank manages its cash, cash equivalents and other short-term investments
based upon the Bank's operating, investing and financing activities. The Bank
generally attempts to invest its excess liquidity into higher yielding assets
such as loans or securities. At June 30, 1997, the Bank's regulatory liquidity
amounted to 5.15% (which exceeded the minimum OTS requirement of 5.0% by $2.4
million), as compared to 6.66% and 5.14% at December 31, 1996 and 1995,
respectively. See "--Liquidity and Capital Resources."
SECURITIES. The Bank generally emphasizes lending activities (as opposed to
investing activities) in order to enhance the weighted average yield on its
interest-earning assets and, thus, its results of operations. Nevertheless,
since June 1995, the Bank has increased its investment in adjustable rate
mortgage-backed securities which are insured or guaranteed by U.S. Government
agencies or government
OC-19
<PAGE>
sponsored enterprises. At June 30, 1997, the Bank's securities portfolio (both
held-to-maturity and available-for-sale) amounted to $627.4 million or 34.5% of
the Bank's total assets, as compared to $513.3 million or 29.4% and $241.6
million or 15.3% at December 31, 1996 and 1995, respectively. At June 30, 1997,
$578.5 million or 92% of the Bank's securities portfolio consisted of
mortgage-backed securities and $48.9 million or 8% of such portfolio consisted
of U.S. Government agency securities. Although mortgage-backed securities often
carry lower yields than traditional mortgage loans, such securities generally
increase the quality of the Bank's assets by virtue of the securities'
underlying insurance or guarantees, are more liquid than individual mortgage
loans and may be used to collateralize borrowings or other obligations of the
Bank. At June 30, 1997, $10.4 million of the Bank's securities portfolio was
classified as held-to-maturity and reported at historical cost and $617.0
million of such portfolio was classified as available-for-sale and reported at
fair value, with unrealized gains and losses excluded from earnings and instead
reported as a separate component of stockholder's equity. At June 30, 1997, the
Bank's securities classified as available for sale had in the aggregate $4.4
million of unrealized losses. See "Business of the Bank--Investment Activities."
LOANS RECEIVABLE. Net loans receivable decreased by $39.3 million or 3.4%
during the six months ended June 30, 1997 and by $86.4 million or 7.0% during
the year ended December 31, 1996. Several factors contributed to the decrease.
In March 1995, the Bank replaced its former senior management with
new individuals with significant experience in banking and problem asset
rehabilitation. From March 1995 through August 1996, the Bank significantly
reduced its loan origination activity (when compared to 1994 levels) and
discontinued loan purchases. New management took this action in order to focus
on the rehabilitation of the Bank's problem assets, the reorientation of the
Bank's adjustable rate residential and commercial loans to indexes that adjust
more rapidly to changes in market rates of interest (as compared to the FHLB
11th District Cost of Funds Index ("COFI") which had been traditionally utilized
by the Bank), and hiring and training personnel with significant expertise in
commercial and consumer lending. During the six months ended June 30, 1997, the
Bank sold $85.2 million of such COFI-based residential mortgage loans and used
the sale proceeds to purchase $59.0 million of one year adjustable-rate loans
tied to the U.S. Treasury index of comparable maturity. See "Business of the
Bank--Lending Activities-- Origination, Purchase and Sale of Loans." In
addition, the Bank's new management has generally been unwilling to enter into
troubled debt restructurings. In August 1996, the Bank increased its loan
origination activities while increasing its emphasis on commercial and consumer
lending. As a result, management anticipates that the loan portfolio will grow
over the next several years, market conditions permitting. See "The Bank" and
"Business of the Bank--Lending Activities."
NON-PERFORMING LOANS AND TROUBLED DEBT RESTRUCTURINGS. Non-performing loans
(consisting of non-accrual loans) and troubled debt restructurings (consisting
of loans with respect to which the Bank has agreed to grant an interest rate
concession or defer principal or interest payments) increased dramatically in
the early 1990's and amounted to $68.3 million or 4.0% of total assets at
December 31, 1994. Such increase was to a great extent the result of a
deterioration in the economy within Southern California, in particular a decline
in the market values of real estate which secure the Bank's loans, as well as to
continuing problems associated with the Northridge earthquake of 1994. As a
result of more aggressive steps taken by the Bank's new management which are
described below, non-performing loans and troubled-debt restructurings have been
reduced and amounted to $21.6 million or 1.2% of total assets at June 30, 1997,
as compared to $25.8 million or 1.5% and $41.7 million or 2.6% at December 31,
1996 and 1995, respectively. See "--Real Estate Held for Investment and Sale"
below for a discussion of a related increase in real estate owned.
The Bank's future results of operations will be significantly affected by
its ability to continue to reduce its level of non-performing assets without
incurring additional material losses. During 1995 and 1996, the Bank's new
management reorganized the Bank's asset review departments, implemented an
internal asset review system through the creation of an internal asset review
committee, established a credit review department and a special assets
department and revised its loan underwriting, credit, collection and
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<PAGE>
monitoring procedures in an effort to reduce the level of non-performing assets.
Since December 31, 1994, total non-performing assets and troubled debt
restructurings have declined from $78.7 million to $44.4 million at June 30,
1997. See "Business of the Bank--Asset Quality."
REAL ESTATE HELD FOR INVESTMENT AND SALE. Net real estate held for
investment and sale consists of real estate acquired through foreclosure (i.e.,
real estate owned) and real estate held for investment. Real estate owned
increased dramatically in the early 1990's as a result of the deterioration in
the Southern California economy and problems resulting from the Northridge
earthquake, as discussed above, and amounted to $38.7 million at December 31,
1992. From 1992 through 1994, real estate owned declined due to a significant
extent to the Bank financing purchases of such real estate owned through loans
to facilitate (which loans generally carry more favorable terms to the borrower
than what is otherwise obtainable in the market). Since 1995, real estate owned
has increased from $10.9 million at December 31, 1995 to $20.4 million at
December 31, 1996 and increased further to $22.8 million at June 30, 1997.
Because of new management's expertise in resolving problem assets, the Bank has
been unwilling to carry non-performing loans and has aggressively taken steps to
foreclose on non-performing loans whenever such a strategy, in the opinion of
management, provides a more efficient alternative to avoid further losses. To
the extent that new management has financed the disposition of real estate
owned, such loans have been made consistent with market terms and conditions and
cash downpayments to qualify the transaction as a sale under applicable
accounting guidelines. During 1996 and the six months ended June 30, 1997, the
Bank had extended an aggregate of $12.6 million and $5.1 million to finance the
disposition of real estate owned, respectively. See "Business of the Bank--Asset
Quality."
Real estate held for investment has historically consisted of the Bank's
investment (indirectly through subsidiaries of the Bank) in limited partnerships
which were engaged in the acquisition, development, construction and sale of
single-family residential developments. Real estate held for investment amounted
to $1.9 million at June 30, 1997, as compared to $2.1 million and $5.4 million
at December 31, 1996 and 1995, respectively. At June 30, 1997, the Bank's real
estate held for investment consisted of 62 acres of vacant land located in
Corona, California and had a net carrying value of $1.9 million. The Bank is
currently marketing the parcel of land for sale. See "Business of the
Bank--Subsidiaries."
DEPOSITS. Total deposits decreased by $57.2 million or 4.2% during the six
months ended June 30, 1997 and by $102.1 million or 6.9% during the year ended
December 31, 1996. Prior management of the Bank operated under a strategy that
was designed to accumulate large deposits in non-transactional accounts (i.e.,
non-retail jumbo certificates of deposits) by offering attractive interest
rates. Since March 1995, new management has attempted to reduce its overall
funding costs by evaluating all potential sources of funds (including retail and
non-retail deposits and short and long-term borrowings) and identifying which
particular source will result in an all-in cost to the Bank that meets its
funding benchmark. At the same time, the Bank has allowed its brokered deposits
to roll off as they mature and has attempted to price the deposits offered
through its branch system in order to promote retail deposit growth and offer a
wide array of deposit products to satisfy its customers. Management's goal is to
attract new customers who are relationship driven, which management believes
will facilitate cross-selling of additional products. As a result of the
foregoing actions by new management, transaction accounts (consisting of
passbook, NOW and money market accounts) increased from $275.5 million or 18.7%
of total deposits at December 31, 1995 to $339.8 million or 25.9% of total
deposits at June 30, 1997. The Bank's aggregate certificates of deposit declined
from $1.2 billion or 81.3% of total deposits to $974 million or 74.1% of total
deposits as of such respective dates. In addition, of the total decline in
certificates of deposit, non-retail jumbo certificates of deposit declined from
$103.4 million to $3.5 million during such period. See "Business of the
Bank--Sources of Funds--Deposits."
BORROWINGS. Other than deposits, the Bank's primary sources of funds
consist of securities sold under agreements to repurchase (consisting of
agreements to purchase on a specified later date the same securities or
substantially identical securities) ("reverse repurchase agreements") and
advances from the
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<PAGE>
FHLB of San Francisco. At June 30, 1997, reverse repurchase agreements amounted
to $331.4 million, as compared to $192.4 million at December 31, 1996. The Bank
did not utilize reverse repurchase agreements at December 31, 1995. See
"Business of the Bank--Sources of Funds--Borrowings."
Advances from the FHLB of San Francisco amounted to $80.0 million, $80.0
million and $31.7 million at June 30, 1997 and December 31, 1996 and 1995,
respectively. The decrease in borrowings from $310.0 million at December 31,
1994 reflects the actions taken by new management in paying off the Bank's
short-term FHLB advances and utilizing, as needed, reverse repurchase agreements
at more attractive rates. The Bank was able to utilize reverse repurchase
agreements (which were a more cost-efficient source of funds) because of the
increased availability of collateral for such borrowings (i.e., mortgage-backed
securities) and the improvement in the Bank's financial condition. Of the Bank's
$80.0 million of FHLB advances outstanding as of June 30, 1997, $31.0 million
were scheduled to mature during 1997 and $49.0 million were scheduled to mature
during 1998. The Bank's FHLB advances had a weighted average interest rate of
5.91% at June 30, 1997, as compared to 5.91% and 5.84% at December 31, 1996 and
1995, respectively. See "Business--Sources of Funds--Borrowings." At June 30,
1997, the Bank had a collateralized available line of credit of approximately
$325.0 million with the FHLB of San Francisco. See "Liquidity and Capital
Resources."
STOCKHOLDER'S EQUITY. Stockholder's equity increased from $67.4 million at
December 31, 1995 to $76.6 million at December 31, 1996 and further increased to
$84.9 million at June 30, 1997. The $9.2 million or 13.6% increase in
stockholder's equity during the year ended December 31, 1996 reflected the $13.6
million of net earnings recognized during the year, which was partially offset
by a $4.4 million increase in unrealized losses on securities classified as
available for sale. The $8.3 million or 10.8% increase in stockholder's equity
during the six months ended June 30, 1997 reflected a $1.7 million decrease in
unrealized losses on securities classified as available for sale, and the $6.9
million of net earnings recognized during the period.
RESULTS OF OPERATIONS
GENERAL. The Bank's results of operations depend substantially on its net
interest income, which is the difference between interest income on
interest-earning assets, which consist primarily of loans receivable,
mortgage-backed and investment securities and various other short-term
investments, and interest expense on interest-bearing liabilities, which consist
primarily of deposits and borrowings. The Bank's results of operations are also
significantly affected by the net costs of hedging its interest rate exposure;
its provisions for losses on loans resulting from the Bank's assessment of the
adequacy of its allowance for losses on loans; the level of its other income,
including loan service and related fees, net gains on sales of securities, loans
and loan servicing, and net income and losses from real estate operations; the
level of its operating expenses, such as personnel and benefits expense,
occupancy and other office related expense and FDIC insurance premiums; and
income tax expense and benefits.
The Bank reported net earnings (loss) of $6.9 million, $5.9 million, $13.6
million, $(8.6) million and $(48.5) million during the six months ended June 30,
1997 and 1996 and the years ended December 31, 1996, 1995 and 1994,
respectively. Net earnings increased by $979,000 or 16.5% during the six months
ended June 30, 1997, as compared to the same period in the prior year, due to a
$1.6 million decrease in the provision for losses on loans, a $118,000 increase
in net interest income and a $237,000 increase in total other income (primarily
reflecting the sale of servicing rights), which was partially offset by a
$939,000 increase in total operating expenses.
Net earnings increased by $22.2 million during the year ended December 31,
1996 due to a $7.6 million increase in total other income, a $5.9 million
decrease in the provision for losses on loans, a $5.3 million increase in net
interest income, a $3.0 million decrease in total operating expenses and a
$370,000 increase in the income tax benefit recognized during the year.
OC-22
<PAGE>
The Bank recognized a net loss of $8.6 million during the year ended
December 31, 1995, as compared to a net loss of $48.5 million during the year
ended December 31, 1994. The $39.9 million decrease in the Bank's net losses
during 1995 was primarily due to a $15.6 million decrease in the provision for
losses on loans, a $10.0 million decrease in total operating expenses, a
$376,000 increase in total other income and a $2.6 million income tax benefit
recognized during 1995 (as compared to $11.4 million of income tax expense
recognized during 1994).
NET INTEREST INCOME. Net interest income is determined by the Bank's
interest rate spread (i.e., the difference between the yields earned on its
interest-earning assets and the rates paid on its interest-bearing liabilities)
and the relative amounts of interest-earning assets and interest-bearing
liabilities.
Net interest income totaled $16.8 million, $16.7 million, $33.3 million,
$27.9 million and $28.0 million during the six months ended June 30, 1997 and
1996 and the years ended December 31, 1996, 1995 and 1994, respectively. Net
interest income increased by $118,000 or 0.71% during the six months ended June
30, 1997, as compared to the same period in the prior year, due to a $73.6
million increase in interest-earning assets (consisting primarily of a $153.4
million increase in the average balance of mortgage-backed securities, which was
partially offset by an $85.7 million decrease in loans receivable) together with
an decrease in the Bank's interest rate spread of 6 basis points. Net interest
income increased by $5.3 million or 19.1% during the year ended December 31,
1996 due to a 37 basis point increase in the Bank's interest rate spread
(reflecting a 22 basis point increase in the average yield earned on the Bank's
interest-earning assets and a 15 basis point reduction in the average rate paid
on the Bank's interest-bearing liabilities). Net interest income declined
slightly by $91,000 or 0.3% during the year ended December 31, 1995 due to a
$116.7 million decline in interest-earning assets (consisting primarily of a
$86.4 million decrease in the average balance of loans receivable), which was
partially offset by an increase in the Bank's interest rate spread of 3 basis
points.
OC-23
<PAGE>
AVERAGE BALANCES, NET INTEREST INCOME, YIELDS EARNED AND RATES PAID
The following table sets forth, for the periods indicated, information
regarding (i) the total dollar amount of interest income of the Bank from
interest-earning assets and the resultant average yields; (ii) the total dollar
amount of interest expense on interest-bearing liabilities and the resultant
average rate; (iii) net interest income; (iv) interest rate spread; and (v) net
interest margin. Information is based on average daily balances during the
indicated periods:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED DECEMBER
JUNE 30, 31,
-------------------------------------------------------------------- --------------------
1997 1996 1996
--------------------------------- --------------------------------- --------------------
AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST
--------- ----------- --------- --------- ----------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans receivable (1)........... $1,112,787 $ 41,353 7.39% $1,198,511 $ 45,784 7.56% $1,176,944 $ 89,020
Mortgage-backed securities
(2).......................... 493,941 16,197 6.52 340,530 11,552 6.71 387,603 26,136
Other earning assets (3)....... 127,111 3,868 6.05 121,210 3,590 5.86 105,583 7,740
--------- ----------- --------- ----------- --------- ---------
Total interest-earning
assets................... 1,733,839 61,418 7.05% 1,660,251 60,926 7.26% 1,670,130 122,896
----------- --------- ----------- --------- ---------
--------- ---------
Noninterest-earning assets....... 73,682 60,943 65,179
--------- --------- ---------
Total assets............... $1,807,521 $1,721,194 $1,735,309
--------- --------- ---------
--------- --------- ---------
Interest-bearing liabilities:
Deposits:
Transaction accounts (4)..... 363,717 6,604 3.61% 327,666 6,140 3.71% $ 352,853 13,484
Term certificates of
deposit.................... 982,564 27,353 5.54 1,125,398 32,747 5.76 1,069,484 61,652
--------- ----------- --------- --------- ----------- --------- ---------
Total deposits............. 1,346,281 33,957 1,453,064 38,887 1,422,337 75,136
Total borrowings............... 366,403 10,471 5.68 187,302 5,098 5.38 232,668 14,108
Hedging costs.................. -- 150 -- 219 -- 387
--------- ----------- --------- ----------- --------- ---------
Total interest-bearing
liabilities.............. 1,712,684 44,578 5.18% 1,640,366 44,204 5.33% 1,655,005 89,631
----------- --------- ----------- --------- ---------
--------- ---------
Noninterest bearing
liabilities.................... 16,074 13,571 12,998
--------- --------- ---------
Total liabilities.......... 1,728,758 1,653,937 1,668,003
Stockholder's equity............. 78,763 67,257 67,306
--------- --------- ---------
Total liabilities and
stockholder's equity..... $1,807,521 $1,721,194 $1,735,309
--------- --------- ---------
--------- --------- ---------
Net interest-earning assets...... $ 21,155 $ 19,885 $ 15,125
--------- --------- ---------
--------- --------- ---------
Net interest income/interest rate
spread......................... $ 16,840 1.87% $ 16,722 1.93% $ 33,265
----------- --------- ----------- --------- ---------
----------- --------- ----------- --------- ---------
Net interest margin.............. 1.92% 1.99%
--------- ---------
--------- ---------
Ratio of average interest-earning
assets to average
interest-bearing liabilities... 101.24% 101.21%
--------- ---------
--------- ---------
<CAPTION>
1995 1994
------------------------------- ---------------------------------
AVERAGE AVERAGE AVERAGE
YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
COST BALANCE INTEREST COST BALANCE INTEREST COST
--------- --------- --------- --------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1)........... 7.56% $1,284,090 $ 94,473 7.36% $1,370,528 $ 89,293 6.52%
Mortgage-backed securities
(2).......................... 6.74 328,446 21,836 6.65 356,260 22,621 6.35
Other earning assets (3)....... 7.33 108,114 6,617 6.12 110,526 4,347 3.93
--------- --------- --------- ---------
Total interest-earning
assets................... 7.36% 1,720,650 122,926 7.14% 1,837,314 116,261 6.33%
--------- --------- --------- --------- -----------
--------- --------- -----------
Noninterest-earning assets....... 48,945 76,042
--------- ---------
Total assets............... $1,769,595 $1,913,356
--------- ---------
--------- ---------
Interest-bearing liabilities:
Deposits:
Transaction accounts (4)..... 3.82% $ 197,441 5,287 2.68% $ 205,684 $ 3,995 1.94%
Term certificates of
deposit.................... 5.76 1,212,989 69,579 5.74 1,186,191 54,010 4.55
--------- --------- --------- ---------
Total deposits............. 1,410,430 74,866 1,391,875 58,005
Total borrowings............... 6.06 293,606 18,443 6.28 451,205 21,623 4.79
Hedging costs.................. -- 1,685 -- 8,610
--------- --------- --------- ---------
Total interest-bearing
liabilities.............. 5.42% 1,704,036 94,994 5.57% 1,843,080 88,238 4.79%
--------- --------- --------- --------- -----------
--------- --------- -----------
Noninterest bearing
liabilities.................... 13,854 16,048
--------- ---------
Total liabilities.......... 1,717,890 1,859,128
Stockholder's equity............. 51,705 54,228
--------- ---------
Total liabilities and
stockholder's equity..... $1,769,595 $1,913,356
--------- ---------
--------- ---------
Net interest-earning assets...... $ 16,614 $ (5,766)
--------- ---------
--------- ---------
Net interest income/interest rate
spread......................... 1.94% $ 27,932 1.57% $ 28,023 1.54%
--------- --------- --------- --------- -----------
--------- --------- --------- --------- -----------
Net interest margin.............. 1.99% 1.62% 1.53%
--------- --------- -----------
--------- --------- -----------
Ratio of average interest-earning
assets to average
interest-bearing liabilities... 100.91% 100.97% 99.69%
--------- --------- -----------
--------- --------- -----------
</TABLE>
- ----------------------------------
(1) The average balance of loans receivable includes nonperforming loans,
interest on which is recognized on a cash basis.
(2) Includes mortgage-backed securities classified as held to maturity and
available for sale.
(3) Includes short-term investments, securities purchased under agreements to
resell, investment securities and FHLB stock.
(4) Includes passbook, NOW and money market accounts.
OC-24
<PAGE>
RATE/VOLUME ANALYSIS
The following table sets forth the effects of changing rates and volumes on
net interest income of the Bank. Information is provided with respect to (i)
effects on interest income attributable to changes in volume (changes in volume
multiplied by prior rate); (ii) effects on interest income attributable to
changes in rate (changes in rate multiplied by prior volume); and (iii) changes
in rate/volume (change in rate multiplied by change in volume).
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1997 YEAR ENDED DECEMBER
COMPARED TO SIX MONTHS ENDED 31, 1996
JUNE 30, 1996 COMPARED TO 1995
---------------------------------------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
--------------------------------- --------------------
<CAPTION>
TOTAL NET
RATE/ INCREASE
RATE VOLUME VOLUME (DECREASE) RATE VOLUME
--------- --------- ----------- ----------------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable................................. $ (1,245) $ (3,257) $ 71 $ (4,431) $ 2,651 $ (7,883)
Mortgage-backed securities....................... (386) 5,176 (145) 4,645 311 3,933
Other earning assets............................. 98 174 6 278 1,310 (155)
--------- --------- ----- ------- --------- ---------
Total net change in income on interest-earning
assets........................................... (1,533) 2,093 (68) 492 4,272 (4,105)
--------- --------- ----- ------- --------- ---------
Interest-bearing liabilities:
Deposits:
Transaction accounts........................... (191) 672 (17) 464 2,258 4,162
Term certificates of deposit................... (1,418) (4,133) 157 (5,394) 346 (8,232)
--------- --------- ----- ------- --------- ---------
Total deposits............................... (1,609) (3,461) 140 (4,930) 2,604 (4,070)
Borrowings....................................... 255 4,848 270 5,373 (640) (3,828)
Hedging costs.................................... -- -- (69) (69) -- --
--------- --------- ----- ------- --------- ---------
Total net change in expense on interest-bearing
liabilities...................................... (1,354) 1,387 341 374 1,964 (7,898)
--------- --------- ----- ------- --------- ---------
Change in net interest income...................... $ (179) $ 706 $ (409) $ 118 $ 2,308 $ 3,793
--------- --------- ----- ------- --------- ---------
--------- --------- ----- ------- --------- ---------
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
COMPARED TO 1994
-------------------------------
<S> <C>
INCREASE (DECREASE) DUE TO
-------------------------------
TOTAL NET
RATE/ INCREASE RATE/
VOLUME (DECREASE) RATE VOLUME VOLUME
--------- ----------------- --------- --------- ---------
<S> <C>
Interest-earning assets:
Loans receivable................................. $ (221) $ (5,453) $ 11,539 $ (5,632) $ (727 )
Mortgage-backed securities....................... 56 4,300 1,064 (1,766) (83 )
Other earning assets............................. (32) 1,123 2,418 (95) (53 )
--------- ------- --------- --------- ---------
Total net change in income on interest-earning
assets........................................... (197) (30) 15,021 (7,493) (863 )
--------- ------- --------- --------- ---------
Interest-bearing liabilities:
Deposits:
Transaction accounts........................... 1,777 8,197 1,513 (160) (61 )
Term certificates of deposit................... (41) (7,927) 14,032 1,220 317
--------- ------- --------- --------- ---------
Total deposits............................... 1,736 270 15,545 1,060 256
Borrowings....................................... 133 (4,335) 6,720 (7,553) (2,347 )
Hedging costs.................................... (1,298) (1,298) -- -- (6,925 )
--------- ------- --------- --------- ---------
Total net change in expense on interest-bearing
liabilities...................................... 571 (5,363) 22,265 (6,493) (9,016 )
--------- ------- --------- --------- ---------
Change in net interest income...................... $ (768) $ 5,333 $ (7,244) $ (1,000) $ 8,153
--------- ------- --------- --------- ---------
--------- ------- --------- --------- ---------
<CAPTION>
TOTAL NET
INCREASE
(DECREASE)
-----------------
Interest-earning assets:
Loans receivable................................. $ 5,180
Mortgage-backed securities....................... (785)
Other earning assets............................. 2,270
-------
Total net change in income on interest-earning
assets........................................... 6,665
-------
Interest-bearing liabilities:
Deposits:
Transaction accounts........................... 1,292
Term certificates of deposit................... 15,569
-------
Total deposits............................... 16,861
Borrowings....................................... (3,180)
Hedging costs.................................... (6,925)
-------
Total net change in expense on interest-bearing
liabilities...................................... 6,756
-------
Change in net interest income...................... $ (91)
-------
-------
</TABLE>
OC-25
<PAGE>
INTEREST INCOME. Total interest income increased by $492,000 or 0.8% during
the six months ended June 30, 1997, as compared to the same period in the prior
year, decreased slightly by $30,000 during the year ended December 31, 1996 and
increased by $6.7 million or 5.7% during the year ended December 31, 1995.
Interest income on loans receivable, the largest component of the Bank's
interest-earning assets, decreased by $4.4 million or 9.7% during the six months
ended June 30, 1997, as compared to the same period in the prior year, decreased
by $5.5 million or 5.8% during the year ended December 31, 1996 and increased by
$5.2 million or 5.8% during the year ended December 31, 1995. The decrease in
recent periods in interest income on loans receivable is attributable to a
change in the Bank's orientation with respect to lending. Under the Bank's new
management, the origination of mortgage loans by commissioned loan officers
operating from loan production facilities and purchase of broker originated
loans has been discontinued. The Bank's current emphasis is on providing a full
range of services to customers at all of its branch offices, including the
taking of loan applications. This has necessarily involved hiring and training
sufficient personnel, which has been a contributing factor to the decline in
loan originations from historical levels during the early 1990s. See "Business
of the Bank--Lending Activities."
Interest income on mortgage-backed securities increased by $4.6 million or
40.2% during the six months ended June 30, 1997, as compared to the same period
in the prior year, increased by $4.3 million or 19.7% during the year ended
December 31, 1996 and decreased by $785,000 or 3.5% during the year ended
December 31, 1995. Since June 1995, the Bank has increased its investment in
adjustable rate U.S. Government agency mortgage-backed securities in order to
reduce the Bank's exposure to interest rate risk, limit the Bank's credit risk
and earn a positive interest rate spread. See "Business of the Bank-- Investment
Activities."
Interest income on investment securities and other interest-earning assets
(which consist of U.S. Government agency securities, FHLB stock, securities
purchased under agreements to resell and other short-term investments) increased
by $278,000 or 7.7% during the six months ended June 30, 1997, as compared to
the same period in the prior year, and increased by $1.1 million or 17.0% and
$2.3 million or 52.2% during the years ended December 31, 1996 and 1995,
respectively. The increase in such interest income during the six months ended
June 30, 1997 was primarily due to a $5.9 million increase in the average
balance of such investments and, to a lesser extent, an increase in the average
yield earned thereon of 19 basis points. The increase in such interest income
during 1996 and 1995 was due primarily to increases in the weighted average
yield earned on such investments of 121 and 219 basis points, respectively. See
"Business of the Bank--Investment Activities."
INTEREST EXPENSE. Total interest expense increased by $374,000 or 0.8%
during the six months ended June 30, 1997, as compared to the same period in the
prior year, decreased by $5.4 million or 5.6% during the year ended December 31,
1996 and increased by $6.8 million or 7.7% during the year ended December 31,
1995. One of the primary elements of the Bank's business strategy since the
change in management in March 1995 has been to reduce the Bank's overall funding
costs. Interest expense on deposits, the largest component of the Bank's
interest-bearing liabilities, decreased by $4.9 million or 12.7% during the six
months ended June 30, 1997, as compared to the same period in the prior year,
and marginally increased by $270,000 or 0.4% during the year ended December 31,
1996. Since June 1995, the Bank's new management has emphasized transactional
accounts and has allowed the Bank's non-retail jumbo certificates of deposit to
run off as they mature, which has reduced the average rate paid on the Bank's
deposit accounts. Interest expense on deposits increased by $16.9 million or
29.1% in 1995 over the previous year, which was prior to implementation by new
management of its cost containment program. See "Business of the Bank--Sources
of Funds--Deposits."
Interest expense on borrowings consists of reverse repurchase agreements and
FHLB advances. Interest expense on reverse repurchase agreements increased by
$3.9 million or 94.7% during the six months ended June 30, 1997, as compared to
the same period in the prior year, and increased by $3.8 million or 54.3% and
$955,000 or 15.6% during the years ended December 31, 1996 and 1995,
respectively. Since June 1995, the Bank's new management has utilized reverse
repurchase agreements as a short-term
OC-26
<PAGE>
source of funds when the rates on such borrowings are favorable as compared to
its other funding sources. See "Business--Sources of Funds--Borrowings."
Interest expense on advances from the FHLB of San Francisco increased by
$1.4 million or 152% during the six months ended June 30, 1997, as compared to
the same period in the prior year, and decreased by $8.2 million or 71.8% and
$4.1 million or 26.7% during the years ended December 31, 1996 and 1995,
respectively. Since June 1995, the Bank's new management has allowed its
short-term FHLB advances to mature and has generally utilized reverse repurchase
agreements as an alternative source of short-term funds. See "Business--Sources
of Funds--Borrowings."
The Bank's interest expense during the six months ended June 30, 1997 and
1996 and the years ended December 31, 1996, 1995 and 1994 included the costs of
hedging the Bank's interest rate exposure. Such hedging costs amounted to
$150,000, $219,000, $387,000, $1.7 million and $8.6 million during such
respective periods. The Bank has in the past utilized interest rate swaps,
corridors, caps and floors in order to manage its interest rate risk. However,
since the change in management, the Bank has not entered into any such interest
rate contracts and has allowed its remaining contracts to expire as they mature.
As a result, the Bank's hedging costs have declined significantly since 1994. At
June 30, 1997, the Bank had one remaining interest rate swap contract with a
notional amount of $5.8 million and 9 remaining interest rate corridors with an
aggregate notional amount of $57.0 million. See "--Asset and Liability
Management."
PROVISION FOR LOSSES ON LOANS. Provisions for losses on loans are provided
on both a specific and general basis. Specific and general valuation allowances
are increased by provisions charged to expense and decreased by charge-offs of
loans, net of recoveries. Specific allowances are provided for impaired loans
for which the expected loss is measurable. General valuation allowances are
provided based on a formula which incorporates a number of factors, including
economic trends, industry experience, estimated collateral values, past loss
experience, the Bank's underwriting practices, and management's ongoing
assessment of the credit risk inherent in its portfolio. The Bank periodically
reviews the assumptions and formula by which additions are made to the specific
and general valuation allowances for losses in an effort to refine such
allowances in light of the current status of the factors described above.
While management uses the best information available to make the periodic
evaluations of specific and general valuation allowances, adjustments to both
allowances may be necessary if actual future economic conditions differ
substantially from the assumptions used in making such periodic evaluations. In
addition, regulatory examiners may require the Bank to recognize additions to
the allowance based upon their judgments about information available to them at
the time of their examination.
The Bank established provisions for losses on loans of $655,000, $2.2
million, $2.9 million, $8.8 million and $24.4 million during the six months
ended June 30, 1997 and 1996 and the years ended December 31, 1996, 1995 and
1994, respectively. During such respective periods, loan charge-offs (net of
recoveries) amounted to $5.3 million, $7.6 million, $11.2 million, $7.1 million
and $13.0 million, respectively. The allowance for losses on loans as a
percentage of total non-performing loans and troubled debt restructurings was
86.64%, 94.41%, 90.30%, 75.67% and 43.66% at June 30, 1997 and 1996 and December
31, 1996, 1995 and 1994, respectively. The allowance for losses on loans as a
percentage of total loans, net was 1.69%, 2.22%, 2.04%, 2.57%, and 2.28% at June
30, 1997 and 1996 and December 31, 1996, 1995 and 1994, respectively.
Consequently, the decline in the Bank's provisions for losses on loans since
1994 reflects the decline in the Bank's non-performing loans and troubled debt
restructurings as well as the general decline in loan delinquencies over such
periods. The net charge-offs recognized by the Bank during the six months ended
June 30, 1997 and the years ended December 31, 1996 and 1995 primarily reflected
the transfer of loans (particularly multi-family residential loans) to real
estate owned. Such multi-family loans had specific valuation allowances which
had been established through increased provisions for loans in prior periods. At
the time of transfer of the loans to real estate owned, such specific valuation
allowances were charged off. As a result of the transfer of such loans to real
estate owned, the Bank's non-performing loans have declined since 1995, which
has contributed to the decrease in the Bank's provision for losses on
OC-27
<PAGE>
loans. Management believes that its allowance for losses on loans at June 30,
1997 was adequate. Nevertheless, there can be no assurances that additions to
such allowance will not be necessary in future periods, particularly if the
growth in the Bank's commercial and consumer lending continues. See "Business of
the Bank--Allowance for Losses on Loans."
OTHER INCOME. Total other income increased by $237,000 or 5.1% during the
six months ended June 30, 1997, as compared to the same period in the prior
year, and increased by $7.6 million and $376,000 during the years ended December
31, 1996 and 1995, respectively. Loan service and loan related fees amounted to
$402,000, $719,000, $1.4 million, $1.6 million and $2.0 million during the six
months ended June 30, 1997 and 1996 and the years ended December 31, 1996, 1995
and 1994, respectively. The decline in such fees during the periods presented
primarily reflected the reduction in loan balances outstanding in the loan
servicing portfolio due to normal repayments and prepayments.
The Bank recognized net gains on sales of mortgage-backed and other
securities of $122,000, $3.6 million, $3.6 million, $641,000 and $485,000 during
the six months ended June 30, 1997 and 1996 and the years ended December 31,
1996, 1995 and 1994, respectively. During such respective periods, the Bank sold
$41.9 million, $38.4 million, $158.4 million, $184.3 million and $48.9 million
of mortgage-backed securities.
Net gains (losses) on the sale of loans and loan servicing amounted to $3.4
million, $(53,000), $(53,000), $(166,000) and $2.7 million during the six months
ended June 30, 1997 and 1996 and the years ended December 31, 1996, 1995 and
1994, respectively. The Bank sold $27.5 million and $394.6 million of loans
during the years ended December 31, 1995 and 1994, respectively, and $873.6
million and $230.0 million of loan servicing during the six months ended June
30, 1997 and the year ended December 31, 1994, respectively. The sale of loan
servicing during the six months ended June 30, 1997, which involved the majority
of the Bank's residential loan portfolio, was predicated upon new management's
determination that it was costly and inefficient for the Bank to service a
varied collection of loan products which it no longer offered.
Net income (loss) from real estate operations amounted to $112,000,
$(197,000), $1.9 million, $(2.1) million and $(5.4) million during the six
months ended June 30, 1997 and 1996 and the years ended December 31, 1996, 1995
and 1994, respectively. Net income (loss) from real estate operations consists
of (i) losses from real estate operations (rental income less operating
expenses), (ii) gains on sales of real estate owned and real estate held for
investment and (iii) provisions for losses on real estate owned and real estate
held for investment. During the six months ended June 30, 1997 and 1996 and the
years ended December 31, 1996, 1995 and 1994, losses from real estate operations
amounted to $(665,000), $(145,000), $(634,000), $(448,000) and $(845,000),
respectively, gains on sales of real estate owned and real estate held for
investment amounted to $1.0 million, $135,000, $3.3 million, $392,000 and
$196,000, respectively, and provisions for losses on real estate owned and real
estate held for investment amounted to $245,000, $187,000, $766,000, $2.0
million and $4.7 million, respectively. The improving economy in southern
California since 1996 has assisted in new management's efforts to promptly
dispose of it real estate holdings, and has facilitated sales well in excess of
carrying values during 1996 and the first quarter of 1997.
Miscellaneous other income (consisting primarily of fees on deposit
accounts) amounted to $795,000, $538,000, $1.2 million, $513,000 and $360,000
during the six months ended June 30, 1997 and 1996 and the years ended December
31, 1996, 1995 and 1994, respectively.
OPERATING EXPENSES. Total operating expenses increased by $939,000 or 7.1%
during the six months ended June 30, 1997, as compared to the same period in the
prior year, and decreased by $3.0 million or 9.7% and $10.0 million or 24.4%
during the years ended December 31, 1996 and 1995, respectively. From the time
of the change in the Bank's management in March 1995 through 1996, the Bank had
aggressively reduced its operating expenses, as described herein. See also "The
Bank." The increase in operating expenses during the June 1997 period over the
comparable period in 1996 is attributable to hirings made by new management to
further the Bank's commercial lending emphasis as well as to leasing expenses
OC-28
<PAGE>
associated with the Bank's new data processing equipment. During the six months
ended June 30, 1997 and 1996 and the years ended December 31, 1996, 1995 and
1994, total operating expenses as a percentage of average total assets amounted
to 1.56%, 1.53%, 1.61%, 1.75% and 2.14%, respectively.
The principal category of the Bank's operating expenses is personnel and
benefits expense, which amounted to $5.5 million, $5.3 million, $10.8 million,
$12.1 million and $19.1 million during the six months ended June 30, 1997 and
1996 and the years ended December 31, 1996, 1995 and 1994, respectively. The
decline in such expense from 1994 through 1996 is due to new management of the
Bank streamlining its operations, which resulted in a 20% reduction in the
number of full-time and part-time employees from 294 at December 31, 1994 to 234
at June 30, 1997. Personnel and benefits expense increased during the six months
ended June 30, 1997, as compared to the same period in the prior year, primarily
as a result of the hiring and training of new commercial and consumer lending
personnel. Management anticipates a much greater emphasis in these lending areas
during the balance of 1997 and in future years. See "Business of the
Bank--Lending Activities."
Occupancy expense amounted to $3.4 million, $3.1 million, $6.4 million, $7.0
million and $8.8 million during the six months ended June 30, 1997 and 1996 and
the years ended December 31, 1996, 1995 and 1994, respectively. The decline in
occupancy expense from 1994 through 1996 reflected the closing of the Bank's
loan production offices and Operations Center as well as the relocation of the
Bank's corporate headquarters. The increase in such expense during the six
months ended June 30, 1997, as compared to the same period in the prior year,
was primarily due to the data processing equipment lease and expenses associated
with security personnel. The general decline in occupancy expense during the
periods presented occurred notwithstanding the Bank opening a new de novo branch
office in Buena Park, California in November 1995 and a branch office facility
in Los Angeles, California in April 1996. Moreover, management expects occupancy
expense to continue to increase over the next year as the Bank intends to
install and operate ten new automated teller machines ("ATMs") within a chain of
health clubs located in Southern California (and the Bank also has an option to
install and operate up to an additional 15 ATMs within such chain of health
clubs).
FDIC insurance premiums totaled $2.5 million, $2.3 million, $4.4 million,
$4.3 million and $4.1 million during the six months ended June 30, 1997 and 1996
and the years ended December 31, 1996, 1995 and 1994, respectively. FDIC
insurance premiums are a function of the size of the Bank's deposit base.
Pursuant to legislation effective September 30, 1996, SAIF member institutions
were required to pay a one-time special assessment equal to 65.7 basis points
for all SAIF-assessable deposits as of June 30, 1995. As a result of the Bank's
financial condition, the Bank applied for and obtained an exemption from paying
such special assessment, which would have amounted to approximately $9.0
million. During the fourth quarter of 1996, the FDIC lowered the assessment
rates for SAIF members so that the highest rated institutions are currently
paying 6.4 basis points in deposit insurance premiums. However, as a result of
the Bank's exemption from paying the one-time special assessment, the Bank will
continue to pay future assessments through 1999 at the assessment rate schedule
in effect as of June 30, 1995 (i.e. 30 basis points). Consequently, the Bank
does not anticipate any material reductions in its deposit insurance premiums
prior to 1999. See "Regulation--FDIC Assessments."
Professional services expense amounted to $292,000, $85,000, $771,000, $2.1
million and $2.0 million during the six months ended June 30, 1997 and 1996 and
the years ended December 31, 1996, 1995 and 1994, respectively. The significant
expense recognized during 1995 and 1994 reflected legal expenses associated with
problem asset resolution.
Office related expenses have remained relatively stable over the periods
presented and amounted to $1.9 million, $1.8 million, $4.0 million, $4.0 million
and $4.4 million during the six months ended June 30, 1997 and 1996 and the
years ended December 31, 1996, 1995 and 1994, respectively.
Miscellaneous other expense (consisting primarily of regulatory assessments
and, in 1994, Board fees and inspection and other expenses associated with the
Northridge earthquake) amounted to $474,000,
OC-29
<PAGE>
$679,000, $1.6 million, $1.5 million and $2.4 million during the six months
ended June 30, 1997 and 1996 and the years ended December 31, 1996, 1995 and
1994, respectively.
INCOME TAX PROVISION (BENEFIT). During the six months ended June 30, 1997
and 1996 and the years ended December 31, 1996, 1995 and 1994, the Bank
recognized $0, $5,000, $(3.0) million, $(2.6) million and $11.4 million in
income tax provisions (benefits). At December 31, 1996, the Bank had $146.7
million of federal net operating loss carryforwards which expire between 1997
and 2011 and $8.7 million of state net operating loss carryforwards which expire
between 1997 and 2000. The 1992 recapitalization of the Bank resulted in an
"ownership change" for federal income tax purposes. As a result of such
ownership change and pursuant to Section 382 of the Code, the Bank's ability to
utilize its net operating loss carryforwards to offset federal and state taxable
income is limited to approximately $7.7 million per year. Any unused limitation
is available in subsequent years until expiration. As of December 31, 1996, the
total net operating loss carryforwards which are available during 1997 amount to
approximately $38.7 million. See "The Bank," "Risk Factors--Availability of Net
Operating Loss Carryovers," "Taxation" and Note 13 of the Notes to Consolidated
Financial Statements.
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and magnitude of
the repricing of assets and liabilities. It is the objective of the Bank to
attempt to control risks associated with interest rate movements. In general,
management's strategy is to match asset and liability balances within maturity
categories to limit the Bank's exposure to earnings variations and variations in
the value of assets and liabilities as interest rates change over time. The
Bank's asset and liability management strategy is formulated and monitored by
the Asset/Liability Management Committee, which is comprised of senior officers
of the Bank, in accordance with policies approved by the Board of Directors of
the Bank. The Asset/Liability Management Committee meets weekly to review, among
other things, the sensitivity of the Bank's assets and liabilities to interest
rate changes, the book and market values of assets and liabilities, unrealized
gains and losses, including those attributable to hedging transactions, purchase
and sale activity, and maturities of investments and borrowings. The
Asset/Liability Management Committee also approves and establishes pricing and
funding decisions with respect to overall asset and liability composition and
reports regularly to the full Board of Directors.
One of the primary goals of the Bank's Asset/Liability Management Committee
is to effectively increase the duration of the Bank's liabilities and/or
effectively contract the duration of the Bank's assets so that the respective
durations are matched as closely as possible. This duration adjustment can be
accomplished either internally by restructuring the Bank's balance sheet, or
externally by adjusting the duration of the Bank's assets and/or liabilities
through the use of interest rate contracts, such as interest rate swaps,
corridors, caps and floors. Although the Bank has in the past hedged its
interest rate exposure externally through the use of various interest rate
contracts, the Bank's current strategy is to hedge internally through the use of
core transaction deposit accounts which are not as rate sensitive as other
deposit instruments and FHLB advances together with an emphasis on investing in
shorter-term or adjustable rate assets which are more responsive to changes in
interest rates, such as adjustable rate U.S. Government agency mortgage-backed
securities, short-term U.S. Government agency securities and commercial business
and consumer loans. The foregoing strategies are more fully described below.
Internal hedging through balance sheet restructuring generally involves
either the attraction of longer-term or less rate sensitive funds (i.e., core
transaction deposit accounts which are not as rate sensitive as other deposit
instruments or FHLB advances) or the investment in certain types of shorter-term
or adjustable rate assets such as adjustable rate mortgage-backed securities,
shorter-term U.S. Government agency securities and commercial business and
consumer loans. On the asset side of the balance sheet, the Bank's new
management has discontinued the use of adjustable rate mortgage products tied to
a COFI based index, which tends to react more slowly to changes in interest
rates, and has emphasized loan products tied to a U.S. Treasury based index
(which reacts much more quickly to changes in interest rates).
OC-30
<PAGE>
During the six months ended June 30, 1997, the Bank sold $85.2 million of such
COFI-based residential mortgage loans and used the sale proceeds to purchase
$59.0 million of one year adjustable-rate loans tied to the U.S. Treasury index
of comparable maturity. See "Business of the Bank--Lending Activities--
Origination, Purchase and Sale of Loans."
The Bank has also significantly increased aggregate purchases of both
short-term or adjustable rate securities in recent periods, as purchases were
$176.9 million, $216.8 million and $49.7 million during the six months ended
June 30, 1997 and the years ended December 31, 1996 and 1995. At June 30, 1997,
$331.4 million or 57.3% of the Bank's mortgage-backed securities were secured by
adjustable rate loans. In addition, during the six months ended June 30, 1997
and the years ended December 31, 1996 and 1995, the Bank originated in the
aggregate $10.3 million, $9.8 million and $4.5 million of commercial business
and consumer loans, respectively, which amounted to 23.8%, 15.8% and 16.7% of
total loan originations, respectively. The Bank intends to increase its
origination of commercial business and consumer loans which have adjustable
rates of interest and shorter terms. On the liability side of the balance sheet,
new management has decreased the Bank's reliance on shorter-term brokered
deposits, which carry high interest rates and are a volatile funding source, in
favor of longer-term FHLB advances and retail certificates of deposits.
Non-retail jumbo certificates of deposit have declined from $122.2 million at
December 31, 1994 to $3.5 million at June 30, 1997.
External hedging involves the use of interest rate swaps, collars,
corridors, caps and floors. The notional amount of interest rate contracts
represents the underlying amount on which periodic cash flows are calculated and
exchanged between counterparties. However, this notional amount does not
represent the principal amount of loans or securities which would effectively be
hedged by that interest rate contract. In selecting the type and amount of
interest rate contract to utilize, the Bank compares the duration of a
particular contract, or its change in value for a 100 basis point movement in
interest rates, to that of the loans or securities to be hedged. An interest
rate contract with the appropriate offsetting duration may have a notional
amount much greater than the face amount of the securities being hedged.
At June 30, 1997, the Bank was a party to one interest rate swap agreement.
The interest rate swap consists of an agreement whereby the Bank has agreed to
pay a floating-rate of interest on a notional principal amount to a second party
(i.e., a broker) in exchange for receiving from the second party a fixed rate of
interest on the same notional amount for a predetermined period of time. No
actual assets were exchanged and interest payments are netted. This swap
contract was entered into in 1994 in order to limit the interest rate risk
related to the relative repricing characteristics of the Bank's interest-bearing
deposits. The swap agreement has an aggregate notional amount of approximately
$5.8 million and expires in 1999. The Bank pays a floating-rate (based on the
one-month London Interbank Offer Rate ("LIBOR") and receives a fixed rate
amounting to 5.69% at June 30, 1997. At June 30, 1997, one-month LIBOR was
5.69%. The net expense (income) relating to the Bank's interest rate swap
agreements was $(2,900), $35,000, $1.2 million and $8.4 million during the six
months ended June 30, 1997 and the years ended December 31, 1996, 1995 and 1994,
respectively.
At June 30, 1997, the Bank was also a party to nine interest rate corridor
agreements, which agreements expire from 1997 through 2001 and cover an
aggregate notional amount of approximately $57.0 million. An interest rate
corridor consists of an agreement whereby the issuer agrees to pay the
purchaser, in exchange for the payment of a premium, the prevailing rate of
interest in the event interest rates rise above a specified rate on a specified
interest rate index and do not exceed a specified upper rate on the same index.
The Bank entered into interest rate corridors as a means to artificially raise
the interest rate cap on certain loans. As of June 30, 1997, the interest rate
corridors have an average strike price of 6.56% and an average limit rate of
8.21% (the Bank's interest rate corridors are based on either three month LIBOR
or COFI). The aggregate net expense relating to the Bank's interest rate
corridors and floors was $153,000, $352,000, $468,000 and $174,000 during the
six months ended June 30, 1997 and the years ended December 31, 1996, 1995 and
1994, respectively. See Note 14 to the Notes to Consolidated Financial
Statements.
OC-31
<PAGE>
The Asset/Liability Management Committee's methods for evaluating interest
rate risk include an analysis of the Bank's interest rate sensitivity "gap,"
which is defined as the difference between interest-earning assets and
interest-bearing liabilities maturing or repricing within a given time period. A
gap is considered positive when the amount of interest-rate sensitive assets
exceeds the amount of interest-rate sensitive liabilities. A gap is considered
negative when the amount of interest-rate sensitive liabilities exceeds
interest-rate sensitive assets. During a period of falling interest rates, a
negative gap would tend to result in an increase in net interest income, while a
positive gap would tend to affect net interest income adversely. Because
different types of assets and liabilities with the same or similar maturities
may react differently to changes in overall market rates or conditions, changes
in interest rates may affect net interest income positively or negatively even
if an institution were perfectly matched in each maturity category.
The following table summarizes the anticipated maturities or repricing of
the Bank's interest-earning assets and interest-bearing liabilities as of June
30, 1997, based on the information and assumptions set forth in the notes below.
<TABLE>
<CAPTION>
MORE THAN
THREE TO MORE THAN THREE YEARS
WITHIN THREE TWELVE ONE YEAR TO TO FIVE OVER FIVE
MONTHS MONTHS THREE YEARS YEARS YEARS TOTAL
------------ --------- ----------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Interest-earning assets (1):
Loans receivable (2):
Single-family residential loans: Fixed....... $ 6,862 $ 671 $ 805 $ 599 $ 132,711 $ 141,648
Adjustable................................... 252,764 138,739 9,332 -- -- 400,835
Multi-family residential: Fixed.............. 13 174 217 3,513 21,279 25,196
Adjustable................................... 386,788 18,878 307 1,321 1,898 409,192
Commercial, industrial and land: Fixed....... -- 1,107 2,956 117 15,480 19,660
Adjustable................................... 97,860 2,932 3,000 -- -- 103,792
Other loans (3).............................. 951 2,036 2,724 1,686 4,972 12,369
Mortgage-backed and other securities (4)....... 311,147 15,175 -- 20,157 285,336 631,815
Other interest-earning assets (5).............. 3,335 -- -- -- 14,686 18,021
------------ --------- ----------- ----------- ----------- ---------
Total...................................... $1,059,720 $ 179,712 $ 19,341 $ 27,393 $ 476,362 $1,762,528
------------ --------- ----------- ----------- ----------- ---------
------------ --------- ----------- ----------- ----------- ---------
Interest-bearing liabilities:
Deposits:
NOW accounts................................. $ 85,123 $ -- $ -- $ -- $ -- $ 85,123
Passbook accounts............................ 234,953 -- -- -- -- 234,953
Money market accounts........................ 19,766 -- -- -- -- 19,766
Certificates of deposit...................... 198,329 624,651 142,439 8,739 36 974,194
Borrowings..................................... 96,570 125,788 129,000 60,000 -- 411,358
------------ --------- ----------- ----------- ----------- ---------
Total...................................... $ 634,741 $ 750,439 $ 271,439 $ 68,739 $ 36 $1,725,394
------------ --------- ----------- ----------- ----------- ---------
------------ --------- ----------- ----------- ----------- ---------
Excess (deficiency) of interest-earning assets
over interest-bearing........................ $ 424,979 $(570,727) $(252,098) $ (41,346) $ 476,326 $ 37,134
------------ --------- ----------- ----------- ----------- ---------
------------ --------- ----------- ----------- ----------- ---------
Cumulative excess (deficiency) of
interest-earning assets over interest-bearing
liabilities.................................. $ 424,979 $(145,748) $(397,846) $(439,192) $ 37,134
------------ --------- ----------- ----------- -----------
------------ --------- ----------- ----------- -----------
Cumulative excess (deficiency) of
interest-earning assets over interest-bearing
liabilities as a percent of total assets..... 23.35% (8.01)% (21.86 )% (24.13 )% 2.04%
------------ --------- ----------- ----------- -----------
------------ --------- ----------- ----------- -----------
</TABLE>
OC-32
<PAGE>
- ------------------------
(1) Adjustable rate loans are included in the period in which interest rates are
next scheduled to adjust rather than in the period in which they are due,
and fixed rate loans are included in the periods in which they are scheduled
to be repaid, based on scheduled amortization, in each case as adjusted to
take into account estimated prepayments based on assumptions used by the OTS
in assessing the interest rate sensitivity of savings associations in the
Bank's region.
(2) Balances have been reduced for non-performing loans, which amounted to $14.0
million at June 30, 1997.
(3) Comprised of commercial and consumer loans and loans serviced by deposits.
(4) Does not include unrealized loss on securities available for sale of $4.4
million.
(5) Comprised of short-term investments, securities purchased under agreements
to resell, investment securities and FHLB stock.
Although interest rate sensitivity gap is a useful measurement and
contributes toward effective asset and liability management, it is difficult to
predict the effect of changing interest rates based solely on that measure. As a
result, the Asset/Liability Management Committee also regularly reviews interest
rate risk by forecasting the impact of alternative interest rate environments on
net interest income and net portfolio value ("NPV"), which is defined as the net
present value of an institution's existing assets, liabilities and off-balance
sheet instruments, and evaluating such impacts against the maximum potential
changes in net interest income and NPV that is authorized by the Board of
Directors of the Bank.
The following table sets forth as of June 30, 1997 the estimated percentage
change in the Bank's net interest income over a eight-quarter period and NPV
based on the indicated changes in interest rates.
<TABLE>
<CAPTION>
ESTIMATED CHANGE IN
-------------------------------
NET INTEREST INCOME
CHANGE (IN BASIS POINTS) IN (NEXT EIGHT
INTEREST RATES(1) QUARTERS) NPV
- --------------------------------------------------------------------------------- ------------------- ----------
<S> <C> <C>
(IN THOUSANDS)
+400............................................................................. $ 44,490 $ 26,573
+300............................................................................. 56,666 51,769
+200............................................................................. 67,630 71,939
+100............................................................................. 76,333 91,598
0................................................................................ 81,062 107,537
- -100............................................................................. 86,615 116,133
- -200............................................................................. 88,711 120,274
- -300............................................................................. 87,857 140,430
- -400............................................................................. 95,667 168,784
</TABLE>
- ------------------------
(1) Assumes an instantaneous uniform change in interest rates at all maturities.
Management of the Bank believes that the assumptions used by it to evaluate
the vulnerability of the Bank's operations to changes in interest rates
approximate actual experience and considers them reasonable; however, the
interest rate sensitivity of the Bank's assets and liabilities and the estimated
effects of changes in interest rates on the Bank's net interest income and NPV
could vary substantially if different assumptions were used or actual experience
differs from the historical experience on which they are based. See
"Regulation--Regulation of Federal Savings Banks--Regulatory Capital
Requirements" for a discussion of a proposed OTS regulation which would subject
an institution with a greater than "normal" level of interest rate exposure to a
deduction of an interest rate risk ("IRR") component in calculating its total
capital for risk-based capital purposes. Based on the OTS model, at June 30,
1997, the Bank would not have been required to deduct an IRR component in
calculating total risk-based capital had the IRR component of the capital
regulations been in effect.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY. Liquidity refers to the Bank's ability to generate sufficient
cash to meet the funding needs of current loan demand, savings deposit
withdrawals, principal and interest payments with respect to
OC-33
<PAGE>
outstanding borrowings and to pay operating expenses. It is management's policy
to maintain greater liquidity than required in order to be in a position to fund
loan originations, to meet withdrawals from deposit accounts, to make principal
and interest payments with respect to outstanding borrowings and to make
investments that take advantage of interest rate spreads. The Bank monitors its
liquidity in accordance with guidelines established by the Bank and applicable
regulatory requirements. The Bank's need for liquidity is affected by loan
demand, net changes in deposit levels and the scheduled maturities of its
borrowings. The Bank can minimize the cash required during the times of heavy
loan demand by modifying its credit policies or reducing its marketing effort.
Liquidity demand caused by net reductions in deposits are usually caused by
factors over which the Bank has limited control. The Bank derives its liquidity
from both its assets and liabilities. Liquidity is derived from assets by
receipt of interest and principal payments and prepayments, by the ability to
sell assets at market prices and by utilizing unpledged assets as collateral for
borrowings. Liquidity is derived from liabilities by maintaining a variety of
funding sources, including deposits, advances from the FHLB of San Francisco and
other short and long-term borrowings.
The Bank's liquidity management is both a daily and long-term function of
funds management. Liquid assets are generally invested in short-term investments
such as securities purchased under agreements to resell, federal funds sold and
certificates of deposit in other financial institutions. If the Bank requires
funds beyond its ability to generate them internally, various forms of both
short and long-term borrowings provide an additional source of funds. At June
30, 1997, the Bank had $325 million in borrowing capacity under a collateralized
line of credit with the FHLB of San Francisco. Although the Bank has in the past
utilized brokered deposits as a source of liquidity, the Bank does not currently
rely upon brokered deposits as a source of liquidity, and does not anticipate a
change in this practice in the foreseeable future.
At June 30, 1997, the Bank had outstanding commitments (including unused
lines of credit) to originate and/or purchase mortgage and non-mortgage loans of
$46.3 million. Certificates of deposit which are scheduled to mature within one
year totaled $823.0 million at June 30, 1997, and borrowings that are scheduled
to mature within the same period amounted to $222.4 million. The Bank
anticipates that it will have sufficient funds available to meet its current
loan commitments.
Beginning September 30, 1997, SOCAL intends to begin making quarterly
interest payments on its senior debt, which is expected to be funded through
dividends from the Bank. SOCAL is expected to make an initial payment of $1.8
million (reflecting accruals since the senior debt was issued in 1995) and
quarterly interest payments thereafter beginning with $192,000 for the December
31, 1997 quarter.
CAPITAL RESOURCES. Federally insured savings institutions such as the Bank
are required to maintain minimum levels of regulatory capital. See "Regulation -
Regulatory Capital Requirements." The following table reflects the Bank's actual
levels of regulatory capital and applicable regulatory capital requirements at
June 30, 1997.
<TABLE>
<CAPTION>
REQUIRED(4) ACTUAL EXCESS
---------------------- ---------------------- ----------------------
<S> <C> <C> <C> <C> <C> <C>
PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT
----------- --------- ----------- --------- ----------- ---------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Tangible capital....................................... 1.50% $ 27,325 4.76% $ 86,790 3.26% $ 59,465
Core capital(1)........................................ 3.00 54,650 4.76 86,790 1.76 32,140
Risk-based capital(2)(3)............................... 8.00 71,893 10.91 98,047 2.91 26,154
</TABLE>
- ------------------------
(1) Does not reflect amendments which were proposed by the OTS in April 1991,
which would increase this requirement to between 4% and 5%.
(2) Does not reflect the interest-rate risk component to the risk-based capital
requirement, the effective date of which has been postponed.
OC-34
<PAGE>
(3) Tangible and core capital are computed as a percentage of adjusted total
assets of $1.8 billion. Risk-based capital is computed as a percentage of
adjusted risk-weighted assets of $899 million.
(4) Does not reflect the requirements to be met in order for an institution to
be deemed "adequately capitalized" under applicable laws and regulations.
See "Regulation--Prompt Corrective Action."
INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and related data presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars (except with respect to available for sale securities which
are carried at market value), without considering changes in the relative
purchasing power of money over time due to inflation. Unlike most industrial
companies, substantially all of the assets and liabilities of the Bank are
monetary in nature. As a result, interest rates have a more significant impact
on the Bank's performance than the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or in the same
magnitude as the prices of goods and services.
RECENT ACCOUNTING PRONOUNCEMENTS
Set forth below are recent accounting pronouncements which may have a future
effect on the Bank's operations. These pronouncements should be read in
conjunction with the significant accounting policies which the Bank has adopted
that are set forth in the Bank's Notes to Consolidated Financial Statements.
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 125, which was
effective, on a prospective basis, for fiscal years beginning after December 31,
1996. SFAS No. 125 provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishment of liabilities based on
consistent application of a financial-components approach that focuses on
control. SFAS No. 125 extends the "available for sale" and "trading" approach of
SFAS No. 115 to non-security financial assets that can be contractually prepaid
or otherwise settled in such a way that the holder of the asset would not
recover substantially all of its recorded investment. The extension of the SFAS
No. 115 approach to certain non-security financial assets and the amendment to
SFAS No. 115 are effective for financial assets held on or acquired after
January 1, 1997. The adoption of SFAS No. 125 did not have a material adverse
effect on the Bank's financial statements.
In February 1997, the FASB released SFAS No. 128 "Earnings Per Share." SFAS
No. 128 establishes standards for computing and presenting earnings per share
(EPS) and applies to entities with publicly held common stock or potential
common stock. SFAS No. 128 simplifies the standards for computing earnings per
share previously found in APB Opinion No. 15, Earnings Per Share and makes them
comparable to international EPS standards. It replaces the presentation of
primary EPS with a presentation of basic EPS. It also requires dual presentation
of basic and diluted EPS on the face of the numerator and denominator of the
diluted EPS computation.
Basic EPS excludes dilution and is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. Diluted EPS is computed similarly to fully
diluted EPS pursuant to APB Opinion No. 15.
SFAS No. 128 is effective for financial statements issued for periods ending
after December 15, 1997, including interim periods; earlier application is not
permitted. SFAS No. 128 requires restatement of all prior-period EPS data
presented.
In March 1997, the FASB issued SFAS No. 129, "Disclosure of Information
About Capital Structure." Statement 129 continues the existing requirements to
disclose the pertinent rights and privileges of all
OC-35
<PAGE>
securities other than ordinary common stock but expands the number of companies
subject to portions of its requirements.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 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. SFAS No. 130 requires
that all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. SFAS No. 130
requires that an enterprise (a) classify items of other comprehensive income by
their nature in a financial statement and (b) display the accumulated balance of
other comprehensive income separately from retained earnings and additional
paid-in capital in the equity section of a statement of financial position. SFAS
No. 130 is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. Management is in the process of determining
the impact, if any, this statement will have on the Bank.
BUSINESS OF THE BANK
LENDING ACTIVITIES
GENERAL. At June 30, 1997, the Bank's total loan portfolio amounted to $1.1
billion, which represented 60.6% of the Bank's $1.8 billion in total assets at
that date. The Bank has traditionally concentrated its lending activities on
conventional first mortgage loans secured by single-family residential
properties and, to a lesser extent, multi-family residential properties. At June
30, 1997, such loans constituted $547.1 million and $442.7 million, or 48% and
39%, respectively, of the total loan portfolio. Substantially all of the Bank's
loan portfolio consists of conventional loans, which are loans that are neither
insured by the Federal Housing Administration nor partially guaranteed by the
Department of Veterans Affairs. The Bank has also historically originated to a
much lesser extent commercial real estate loans, which amounted to $117.9
million or 10% of the total loan portfolio at June 30, 1997. At June 30, 1997,
commercial business and consumer loans (including loans secured by deposits)
amounted to $7.8 million and $4.7 million, respectively. The Bank's total loan
portfolio also included a small amount of land and other miscellaneous loans,
which amounted to $8.8 million at June 30, 1997.
As a federally chartered savings bank, the Bank has general authority to
originate and purchase loans secured by real estate located throughout the
United States. Notwithstanding this nationwide lending authority, the Bank's
primary market area is Los Angeles County and, to a lesser extent, Orange and
Ventura Counties in Southern California, and the Bank believes that
substantially all of the loans in the Bank's portfolio are secured by properties
located in California.
OC-36
<PAGE>
LOAN PORTFOLIO COMPOSITION. The following table sets forth the composition
of the Bank's loans at the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------
JUNE 30,
1997 1996 1995
-------------------------- -------------------------- --------------------------
PERCENT OF PERCENT OF PERCENT OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
----------- ------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Mortgage loans:
Single-family residential............... $ 547,110 49% $ 595,915 51% $ 658,412 52%
Multi-family residential................ 442,712 39 453,064 39 479,100 38
Commercial and industrial............... 117,906 10 110,931 10 120,109 10
Land and other.......................... 6,630 1 1,639 -- 3,176 --
----------- --- ----------- --- ----------- ---
Total mortgage loans................ 1,114,358 99 1,161,549 100 1,260,797 100
----------- --- ----------- --- ----------- ---
Other loans:
Commercial.............................. 7,792 1 3,523 -- -- --
Consumer................................ 4,741 -- 988 -- -- --
Secured by deposits..................... 2,145 -- 2,132 -- 1,976 --
----------- --- ----------- --- ----------- ---
Total loans receivable.............. 1,129,036 100% 1,168,192 100% 1,262,773 100%
----------- --- ----------- --- ----------- ---
--- --- ---
Less:
Undistributed loan proceeds............. 2,309 473 28
Unamortized net loan discounts and
deferred origination fees and deferred
gain on servicing sold................ 5,663 2,732 3,021
Allowance for loan losses............... 18,683 23,280 31,572
----------- ----------- -----------
Loans receivable, net................... $ 1,102,381 $ 1,141,707 $ 1,228,152
----------- ----------- -----------
----------- ----------- -----------
<CAPTION>
1994 1993 1992
-------------------------- -------------------------- --------------------------
PERCENT OF PERCENT OF PERCENT OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
----------- ------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Single-family residential............... $ 721,801 54% $ 759,157 55% $ 905,981 62%
Multi-family residential................ 480,547 36 457,740 33 403,725 27
Commercial and industrial............... 129,768 10 142,468 11 144,790 10
Land and other.......................... 7,546 -- 11,127 1 10,817 1
----------- --- ----------- --- ----------- ---
Total mortgage loans................ 1,339,662 100 1,370,492 100 1,465,313 100
----------- --- ----------- --- ----------- ---
Other loans:
Commercial.............................. -- -- -- -- -- --
Consumer................................ -- -- -- -- -- --
Secured by deposits..................... 908 -- 724 -- 1,029 --
----------- --- ----------- --- ----------- ---
Total loans receivable.............. 1,340,570 100% 1,371,216 100% 1,466,342 100%
----------- --- ----------- --- ----------- ---
--- --- ---
Less:
Undistributed loan proceeds............. 1,376 1,087 335
Unamortized net loan discounts and
deferred origination fees and deferred
gain on servicing sold................ 3,336 3,205 4,874
Allowance for loan losses............... 29,801 20,426 18,509
----------- ----------- -----------
Loans receivable, net................... $ 1,306,057 $ 1,346,498 $ 1,442,624
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
OC-37
<PAGE>
CONTRACTUAL PRINCIPAL REPAYMENTS AND INTEREST RATES. The following table
sets forth scheduled contractual amortization of the Bank's total loan portfolio
at June 30, 1997, as well as the dollar amount of such loans which are scheduled
to mature after one year which have fixed or adjustable interest rates. Demand
loans, loans having no schedule of repayments and no stated maturity and
overdraft loans are reported as due in one year or less.
<TABLE>
<CAPTION>
PRINCIPAL REPAYMENTS CONTRACTUALLY DUE OR REPRICING
IN YEAR(S) ENDED JUNE 30,
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
TOTAL AT
JUNE 30, 2001- 2003- 2009- THERE-
1997 1998 1999 2000 2002 2008 2014 AFTER
------------ --------- --------- --------- --------- ---------- --------- ----------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Single-family residential........ $ 547,110 $ 7,533 $ 726 $ 79 $ 599 $ 10,672 $ 16,068 $ 511,433
Multi-family residential......... 442,712 269 2,612 1,311 4,618 79,212 28,777 325,913
Commercial, industrial and
land........................... 124,536 6,118 59,810 13,754 2,474 28,960 3,835 9,585
Other loans:
Commercial....................... 6,773 3,489 2 2,341 641 300 -- --
Consumer......................... 3,451 89 -- 96 896 224 1,276 870
Secured by deposits.............. 2,145 1,740 226 60 119 -- -- --
------------ --------- --------- --------- --------- ---------- --------- ----------
Total (1)........................ $ 1,126,727 $ 19,238 $ 63,376 $ 17,641 $ 9,347 $ 119,368 $ 49,956 $ 847,801
------------ --------- --------- --------- --------- ---------- --------- ----------
------------ --------- --------- --------- --------- ---------- --------- ----------
</TABLE>
- ------------------------
(1) Of the $1.1 billion of loan principal repayments contractually due after
June 30, 1998, $188 million have fixed rates of interest and $920 million
have adjustable rates of interest. Commercial, consumer and total loans are
presented net of undistributed loan proceeds.
Scheduled contractual principal repayments do not reflect the actual
maturities of loans. The average maturity of loans is substantially less than
their average contractual terms because of prepayments and, in the case of
conventional mortgage loans, due-on-sale clauses, which generally give the Bank
the right to declare a loan immediately due and payable in the event, among
other things, that the borrower sells the real property subject to the mortgage
and the loan is not repaid. The average life of mortgage loans tends to increase
when current mortgage loan rates are substantially higher than rates on existing
mortgage loans and, conversely, decrease when rates on existing mortgages are
substantially lower than current mortgage loan rates (due to refinancings of
adjustable rate and fixed rate loans at lower rates).
ORIGINATION, PURCHASE AND SALE OF LOANS. The lending activities of the Bank
are subject to the written, non-discriminatory underwriting standards and loan
origination procedures established by the Bank's Board of Directors and
management. Loan originations are obtained by a variety of sources, including
referrals from real estate brokers, existing customers, walk-in customers and
advertising. In its present marketing efforts, the Bank emphasizes its community
ties, customized personal service, competitive rates, and an efficient
underwriting and approval process. With an orientation under new management to
make the branch office network more responsive to customers needs, loan
applications now are taken at all of the Bank's branch offices. The Bank's
centralized underwriting department supervises the obtaining of credit reports,
appraisals and other documentation involved with a loan. Property valuations are
performed by the Bank's staff as well as by independent outside appraisers
approved by the Bank's Board of Directors. The Bank requires title, hazard and,
to the extent applicable, flood insurance on all security property.
Mortgage loan applications are initially processed by loan officers who have
approval authority up to designated limits. Senior officers of the Bank who
serve on the Credit Committee acting together have additional approval
authority. All loans in excess of such designated limits are referred to the
Bank's Credit Committee, comprised of the Bank's Senior Credit Officer, the
Chief Executive Officer, the Chief Financial Officer and the Executive Vice
President of Retail Banking, which has approval authority for all
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loans in excess of delegated authority up to $5.0 million. Any loans exceeding
$5.0 million must be approved by the Board of Directors of the Bank.
The single-family residential loans originated by the Bank are generally
made on terms, conditions and documentation which permit the sale of loans to
the Federal Home Loan Mortgage Corporation ("FHLMC"), the Federal National
Mortgage Association ("FNMA") and other institutional investors in the secondary
market. Prior to new management, the Bank's loan origination program operated
similar to that of a mortgage banking business. The Bank maintained loan
production offices and loans were originated by officers who were partially
compensated on a commissioned basis. A substantial amount of such loans,
primarily fixed rate, were then sold in the secondary market as a means of
generating fee income as well as providing additional funds for lending,
investing and other purposes. During 1995, 1994, 1993 and 1992, the Bank sold
$27.5 million, $394.6 million, $657.5 million and $434.7 million of loans,
respectively, and generated net gains (losses) during such respective years of
($126,000), $95,000, $(878,000) and $2.4 million. In addition, under prior
management, the Bank was an active purchaser of loans secured by single-family,
multi-family and commercial real estate located in both Southern and Northern
California. During 1995, 1994, 1993 and 1992, the Bank purchased $0, $11.9
million, $493,000 and $89.6 million of loans, respectively. New management
discontinued the origination for resale approach which had been employed shortly
after commencing employment in mid-1995. New management also significantly
reduced the Bank's loan purchase activity. The closing of loan production
facilities was completed and the lending orientation was re-directed to the
branches. As a result of this change in emphasis, with the resulting time needed
to effectively train branch personnel, loan originations and purchases declined
significantly between 1994 and 1995, from $595.6 million to $26.8 million, and
loan sales were discontinued.
In order to improve the Bank's balance sheet as well as due to asset and
liability management considerations, during the six months ended June 30, 1997,
the Bank sold $85.2 million of single-family residential mortgage loans tied to
COFI and reinvested $59.0 million of such proceeds in one year adjustable-rate
mortgage loans tied to a U.S. Treasury based index. See "Management's Discussion
and Analysis of Financial Condition and Results of Operation--Asset and
Liability Management." Management used the balance of the sale proceeds to
purchase $4.8 million and $5.0 million of multi-family residential loans and a
land loan, respectively.
In connection with the loan sales undertaken before the change in the Bank's
management, the Bank would sometimes sell the loans with servicing released,
while sometimes it would retain responsibility for collecting and remitting loan
payments, inspecting the properties, making certain insurance and tax payments
on behalf of borrowers and otherwise servicing the loans it sold, for which it
received a fee for performing these services. During 1994, the Bank sold the
servicing rights with respect to residential loans with an aggregate balance of
$230.0 million, and recognized a $2.7 million gain on such sale. During the
first half of 1997, the Bank sold servicing on a variety of its residential
loans which had been originated over the years with a principal balance of
$873.6 million. The Bank recognized a gain on sale of $3.4 million, a deferred
gain of $5.2 million and received $8.6 million in proceeds. Because of the
varied nature of the loan products, most of which are no longer originated by
the Bank, and the expense associated with servicing such loans, management
determined that it would be more profitable to sell the servicing and leverage
the proceeds in alternative investments.
A savings institution generally may not make loans to any one borrower and
related entities in an amount which exceeds 15% of its unimpaired capital and
surplus, although loans in an amount equal to an additional 10% of unimpaired
capital and surplus may be made to a borrower if the loans are fully secured by
readily marketable securities. At June 30, 1997, the Bank's regulatory limit on
loans-to-one borrower was $15.3 million and its five largest loans or groups of
loans-to-one borrower, including related entities, aggregated $12.7 million,
$8.3 million, $7.5 million, $6.3 million and $6.1 million. All of these five
largest
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<PAGE>
loans or loan concentrations were secured by commercial real estate and
multi-family residential properties. All of these loans or loan concentrations
were originated between the late 1980's and early 1990's and were performing in
accordance with their terms at June 30, 1997.
The following table shows the activity in the Bank's loans during the
periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
SIX MONTHS ENDED --------------------------------------------
JUNE 30, 1997 1996 1995 1994
----------------- ------------ -------------- --------------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Gross loans held at beginning of period......... $ 1,168,192 $ 1,262,773 $ 1,369,516(1) $ 1,376,716(1)
Originations of loans:
Mortgage loans:
Single-family residential................... 18,383 37,129 19,593 538,703
Multi-family residential.................... 5,321 7,823 1,120 42,746
Commercial and industrial................... 9,230 6,945 878 299
Land........................................ -- -- 746 150
Other loans:
Commercial.................................. 4,660 4,303 -- --
Consumer.................................... 4,272 1,069 -- --
Secured by deposits......................... 1,380 4,389 4,482 1,778
----------------- ------------ -------------- --------------
Total originations........................ 43,246 61,658 26,819 583,676
----------------- ------------ -------------- --------------
Purchases of loans:
Mortgage loans:
Single-family residential................... 62,230 -- -- 11,069
Multi-family residential.................... 4,834 -- -- 868
Land............................................ 5,000 -- -- --
----------------- ------------ -------------- --------------
Total purchases........................... 72,064 -- -- 11,937
----------------- ------------ -------------- --------------
Total originations and purchases.......... 115,310 61,658 26,819 595,613
----------------- ------------ -------------- --------------
Loans sold:
Single-family residential..................... (85,241) -- (27,174) (419,845)
----------------- ------------ -------------- --------------
Total sold................................ (85,241) -- (27,174) (419,845)
Repayments...................................... (48,770) (113,721) (85,957) (161,690)
Transfers to real estate owned.................. (20,455) (42,518) (20,431) (21,278)
Net activity in loans........................... (39,156) (94,581) (106,743) (7,200)
----------------- ------------ -------------- --------------
Gross loans held at end of period............... $ 1,129,036 $ 1,168,192 $ 1,262,773 $ 1,369,516(1)
----------------- ------------ -------------- --------------
----------------- ------------ -------------- --------------
</TABLE>
- ------------------------
(1) Balances include loans held for sale totaling $28,946 and $5,500 at December
31, 1994 and 1993, respectively.
SINGLE-FAMILY RESIDENTIAL REAL ESTATE LOANS. The Bank has historically
concentrated its lending activities on the origination of loans secured by first
mortgage liens on existing single-family residences. At June 30, 1997, $547.1
million or 48% of the Bank's total loan portfolio consisted of such loans. The
Bank currently offers fixed rate single-family residential loans with terms of
15 or 30 years. Such loans are amortized on a monthly basis with principal and
interest due each month. In addition to these traditional products, the Bank
offers a fixed bi-weekly pay option, which results in 26 payments per year,
thereby permitting a customer to pay off the loan faster than would otherwise be
the case. At June 30, 1997, the Bank had $141.6 million or 13% of fixed rate
single-family residential loans in its portfolio. The Bank previously offered
"7/23" and "5/25" loan products, the interest rates on which is fixed at an
initial rate for the first seven and five years, respectively, and adjusts once
thereafter to a rate which applies for the
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<PAGE>
remaining 23 years and 25 years, respectively, equal to a specified amount above
the FNMA 30 year commitment rate for delivery as of a date specified in the
related mortgage note. As of June 30, 1997, the Bank had $53.8 million and $26.1
million of such respective loans in its loan portfolio.
Since the 1980's, the Bank has also offered a variety of adjustable rate
single-family residential mortgage loans. Such loans generally have up to 30
year terms. Presently, the Bank offers a "5/1 Product," in which the loan is
fixed at origination for a five year period, after which the interest rate
adjusts every year in accordance with a designated index (the weekly average
yield on U.S. Treasury securities adjusted to a constant comparable maturity of
one year, as made available by the Federal Reserve Board). Such loans currently
have a 2% cap on the amount of any increase or decrease in the interest rate per
year, and a 6% limit on the amount by which the interest rate can increase or
decrease over the life of the loan. In addition, the Bank's adjustable rate
loans are currently not convertible into fixed rate loans and do not contain
prepayment penalties.
Under prior management, the Bank's adjustable rate loans were tied to COFI,
which does not adjust as rapidly to changes in interest rates as the U.S.
Treasury constant comparable maturity index now utilized by the Bank. The Bank
has discontinued the use of COFI based loans. As discussed under "--Origination,
Purchase and Sale of Loans," during the six months ended June 30, 1997, the Bank
sold $85.2 million of such loans. Approximately 74% of the single-family
residential loans in the Bank's loan portfolio at June 30, 1997 had adjustable
interest rates. At June 30, 1997, 63% of the Bank's adjustable rate single-
family loans were tied to COFI.
Adjustable rate mortgage loans decrease but do not eliminate the risks
associated with changes in interest rates. Because periodic and lifetime caps
limit the interest rate adjustments, the value of adjustable rate mortgage loans
also fluctuates inversely with changes in interest rates. In addition as
interest rates increase, the required payments by the borrower increase, thus
increasing the potential for default.
The Bank previously offered a variety of adjustable rate programs, which
provided for interest rates which adjusted periodically based on COFI.
Adjustments to the monthly payment of principal and interest occur either
semi-annually or annually depending on the loan program selected by the
borrower. However, to protect borrowers from unlimited interest rate and payment
increases, the majority of these adjustable rate loans have a maximum interest
rate change ("interest rate cap") from the initial reduced interest rate period
and/or over the life of the loan. Additionally, the interest rate may change
within a range of a two to six percentage point increase or decrease in any
given period. In certain loan programs, these protections for borrowers can
result in monthly payments which are greater or less than the amount required to
amortize the loan by its maturity at the interest rate in effect in any
particular month. In the event that the monthly payment is not sufficient to pay
the interest accruing during the month, the deficiency is added to the loan's
principal balance ("negative amortization"). In the event that a loan incurs
significant negative amortization, there is an increased risk that the market
value of the underlying collateral on the loan may be insufficient to fully
satisfy the outstanding principal and interest. In the event that the monthly
payment exceeds the amount necessary to pay the interest accruing during the
month, the excess is applied to reduce the loan's principal balance, which would
result in an earlier payoff of the loan.
Negative amortization may result in an increased risk that the value of the
collateral securing the loan may be insufficient to fully satisfy the
outstanding principal and interest in the case of a default by the borrower.
However, negative amortization also serves to reduce the amount of payment
increase during periods of rising rates. In periods of rapidly rising interest
rates, monthly payments on adjustable rate loans may increase sharply, resulting
in a hardship for borrowers. Negative amortization reduces the increase in the
payments for borrowers. While the outstanding balance of the loan may increase
because of negative amortization, the risk of default may be decreased as
borrowers have a lower debt service burden or a debt service requirement that
increases more slowly than fully amortizing loans. At June 30, 1997, the Bank
had approximately $191.2 million of single-family residential loans with
negative amortization features.
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<PAGE>
The Bank is permitted under applicable law to lend up to 100% of the
appraised value of the real property securing a residential loan (referred to as
the loan-to-value ratio); however, if the amount of a residential loan
originated or refinanced exceeds 90% of the appraised value, the Bank is
required by federal regulations to obtain private mortgage insurance on the
portion of the principal amount that exceeds 80% of the appraised value of the
security property. Pursuant to underwriting guidelines adopted by the Board of
Directors, the Bank will generally lend up to 90% of the appraised value of the
property securing a single-family residential loan. However, the Bank generally
obtains private mortgage insurance on the principal amount that exceeds 80% of
the appraised value of the security property. For properties with an appraised
value in excess of $400,000, the Bank will not lend in excess of 80%. At June
30, 1997, $20.1 million or 3.7% of the Bank's single-family residential loans
had loan-to-value ratios in excess of 80% and did not have private mortgage
insurance.
MULTI-FAMILY AND COMMERCIAL REAL ESTATE LOANS. At June 30, 1997, the Bank
had an aggregate of $442.7 million and $117.9 million invested in multi-family
and commercial real estate loans, respectively, or 39% and 10% of the total loan
portfolio, respectively. The Bank's multi-family loans are secured by multi-
family properties of five units or more, while the Bank's commercial real estate
loans are secured by industrial, warehouse and self-storage properties, office
buildings, office and industrial condominiums, retail space and strip shopping
centers, mixed-use commercial properties, mobile home parks, nursing homes,
hotels and motels. Substantially all of these properties are located in
California. The Bank will presently originate these loans for terms of up to 10
years based upon a 20 to 25 year loan amortization period and up to 15 years for
loans amortized over a period of 15 years or less. The Bank will originate these
loans on both a fixed rate or adjustable rate basis, with the later based on the
one year U.S. Treasury index of constant comparable maturities. Adjustable rate
loans may have an established ceiling and floor, and the maximum loan-to-value
for these loan products is 75%. As part of the criteria for underwriting
commercial real estate loans, the Bank generally requires a debt coverage ratio
(the ratio of net cash from operations before payment of debt service to debt
service) of 1.20:1 or more. It is also the Bank's general policy to seek
additional protection to mitigate any weaknesses identified in the underwriting
process. Additional coverage may be provided through secondary collateral and
personal guarantees from the principals of the borrowers.
Commercial real estate lending entails different and significant risks when
compared to single-family residential lending because such loans typically
involve large loan balances to single borrowers and because the payment
experience on such loans is typically dependent on the successful operation of
the project or the borrower's business. These risks can also be significantly
affected by supply and demand conditions in the local market for apartments,
offices, warehouses or other commercial space. The Bank attempts to minimize its
risk exposure by limiting the extent of its commercial real estate lending
generally. In addition, the Bank imposes stringent loan-to-value ratios,
requires conservative debt coverage ratios, and continually monitors the
operation and physical condition of the collateral.
Origination of multi-family loans declined from $42.7 million in 1994 to
$1.1 million in 1995 as new management sought to deal aggressively with the
non-performing credits in its portfolio. As shown in the schedules included
under "--Asset Quality," an aggregate of $16.8 million and $8.2 million of
multi-family residential loans and commercial loans, respectively, were
classified as non-accrual as of December 31, 1995. Management is moving promptly
to foreclose on such properties so that they may be disposed of, which has
contributed to the increase in real estate owned since 1995. At June 30, 1997,
an aggregate of $19.6 million and $8.3 million of such loans were on a
non-accrual status and in real estate owned, respectively, which constituted 76%
of total non-performing assets at such date. Management has established new
credit policies and underwriting procedures and in 1996 began to increase loan
originations in this area. See "--Asset Quality."
COMMERCIAL BUSINESS AND CONSUMER LOANS. The Bank is placing increased
emphasis on the development of a commercial business and consumer lending
program within the areas serviced by its branches. Toward that end, the Bank has
hired eight individuals with significant expertise in commercial and
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<PAGE>
consumer credit administration and lending. Except for loans secured by
deposits, the Bank during the 1990s did not engage in this type of lending
activity. Both lending programs were initiated in August 1996. During the six
months ended June 30, 1997 and the year ended December 31, 1996, the Bank
originated $10.3 million and $9.8 million, respectively, of commercial business
and consumer loans, which amounted to 23.8% and 15.8% of total originations
during such respective periods.
The Bank is making and intends to make commercial business loans including
working capital lines of credit, inventory and accounts receivable loans,
equipment financing (including equipment leases), term loans and loans
guaranteed by the Small Business Administration ("SBA"). Depending on the
collateral pledged to secure the extension of credit, maximum loan-to-value
ratios are 75% or less. Loan terms may vary from one to 7 years. The interest
rates on such loans are generally variable and are indexed to the WALL STREET
JOURNAL Prime Rate, plus a margin.
The Bank intends to actively grow its SBA lending business, on which loans
are guaranteed up to certain levels by the SBA. The SBA-guaranteed loans bear
adjustable rates tied to the lowest published New York prime rate, adjusted
monthly, plus a margin, which depends on the term of the loan. The loans
generally have amortization schedules of seven to 25 years, depending on the
purpose of the loan. Each loan is reviewed by the SBA and depending on the size
of the loan and the proposed use of proceeds, the SBA establishes what
percentage of the loan it will guarantee. The guarantee cannot exceed 80% of the
loan or $750,000, whichever is less. The guarantee applies not only to the
principal, but also covers accrued interest, foreclosure costs, legal fees and
other expenses. The Bank has established two Small Business Development Centers
within its branches and plans to obtain preferred lender status, which will
permit it to underwrite and close such loans much more promptly. At June 30,
1997, approximately $2.2 million of the Bank's $7.8 million in commercial
business loans were comprised of SBA loans.
The Bank is authorized to make loans for a wide variety of personal or
consumer purposes but has not engaged in any lending other than loans secured by
deposits for most of the 1990s. The Bank began originating home equity loans and
lines of credit and automobile loans in August 1996 in order to provide a wide
range of products and services to its customers. The Bank also offers overdraft
protection and unsecured lines of credit.
At June 30, 1997, home equity loans and lines amounted to $2.3 million. On
owner-occupied homes, these loans and lines are originated by the Bank for up to
80% of the first $350,000 of appraised value plus up to 50% of the remainder,
less the amount of any prior liens on the property. For non-owner occupied
properties, the Bank will lend up to 75% of the first $250,000 of appraised
value plus 50% of the remainder, less the amount of existing liens on the
property. Home equity loans and lines of credit have a maximum term of 25 years
and carry variable interest rates. The Bank will secure each of these types of
loans with a mortgage on the property (generally a second mortgage).
The Bank also originates loans secured by new and used automobiles. The
maximum term for the Bank's automobile loans is 72 months for a new car loan and
60 months with respect to a used car loan. The Bank will lend up to 100% of the
purchase price on new car loans with a purchase price of $25,000 or more, and up
to 80% for new and used vehicles (up to five years). On used vehicles, the Bank
will finance up to 80% of the lower of the total purchase price or 100% of the
National Automobile Dealers' Association Wholesale Blue Book Value. The Bank
requires all borrowers to maintain automobile insurance with the Bank named as
loss payee. At June 30, 1997, the Bank had $1.0 million of automobile loans in
portfolio.
Commercial business and consumer loans generally have shorter terms and
higher interest rates than mortgage loans but generally involve more credit risk
than mortgage loans because of the type and nature of the collateral. In
addition, consumer lending collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be adversely
affected by job loss, divorce, illness and personal bankruptcy. The Bank
believes that the generally higher yields earned on commercial business and
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<PAGE>
consumer loans compensate for the increased credit risk associated with such
loans and the Bank intends to continue to offer such loans in order to provide a
full range of services to its customers.
ASSET QUALITY
LOAN DELINQUENCIES. When a borrower fails to make a required payment on a
loan, the Bank attempts to cure the deficiency by contacting the borrower and
seeking payment. Contacts are generally made following the grace period after a
payment is due, which is generally ten days on commercial loans and 15 days on
residential loans. At such time, a late payment fee is assessed. In most cases,
deficiencies are cured promptly. If a delinquency extends past the applicable
grace period, the loan file and payment history are reviewed and continued
efforts are made to collect the loan. In the event that no contact with the
borrower is made, or no payment is received by the end of the grace period, a
Notice of Intent to Foreclose ("Notice") is sent. Depending upon the scheduled
payment date, this Notice is sent no later than 30 days after the due date; for
residential loans and no later than fifteen days after the due date for
commercial loans.
Under the Bank's new management team, the accounts are monitored on a weekly
basis by the servicing department. With respect to Commercial Loans, a trial
balance is updated weekly, and those accounts that are identified as being past
the due date are assigned to staff to begin the collection process. With respect
to Commercial Loans, delinquent reports and a listing of those accounts for
which a Notice has been issued are sent to senior management and the Special
Assets Department to provide advance information as to potential problems which
may fall under their Department in the coming quarter. No later than when an
account becomes 90 days delinquent, the Bank institutes foreclosure or other
proceedings, as necessary, to minimize any potential loss. Performing loans
delinquent 120 days or less have declined from $8.6 million at June 30, 1996 to
$8.3 million at June 30, 1997.
In March 1997, the Bank sold the servicing rights with respect to
substantially all of its residential mortgage loans to Temple-Inland Mortgage
Corporation (the "Residential Servicing Agent"), a wholly owned subsidiary of
Guaranty Federal Bank, F.S.B., which is wholly owned by Temple-Inland Inc., an
unrelated third party. In connection with the Bank's sale of servicing, the Bank
in March 1997 entered into a servicing agreement with the Residential Servicing
Agent (the "Residential Servicing Agreement"), pursuant to which the Servicing
Agent will service substantially all of the Bank's Residential Mortgage Loans.
The Bank also entered into a Forward Production Servicing Purchase and Sale
Agreement in July 1997 ("Forward Production Agreement"), pursuant to which the
Bank will sell to the Residential Servicing Agent the servicing rights
associated with (i) Residential Mortgage Loans owned by the Bank and closed and
funded subsequent to the closing of the Residential Servicing Agreement, and
(ii) Residential Mortgage Loans owned by the Bank prior to such date which were
serviced by others and as to which the Bank has reacquired such servicing
rights. The Bank's Residential Servicing Agreement with the Servicing Agent
provides that the Bank can direct the Residential Servicing Agent to transfer
the servicing and disposition functions with respect to all Residential Mortgage
Loans which become nonaccrual back to the Bank. All of such properties which
become REO will automatically be transferred back to the Bank for the same
purpose.
NON-PERFORMING ASSETS. As described under "Asset Quality--Loan
Delinquencies," the Bank's residential mortgage loans are handled by the
Residential Service Agent unless and until residential loans which go into
non-accrual status are requested to be transferred back to the Bank. Loans which
become real estate owned are automatically transferred to the Bank.
All commercial loans held in portfolio are reviewed on a regular basis to
determine any potential problems. Monthly committee meetings are held to
identify problem assets and to set forth a strategy for the mitigation of loss
and the resolution of the problem. Loans are placed on a non-accrual status if
management has substantive doubts about payment in full of both principal and
interest, or if principal and interest is contractually in default for a period
of 90 days or more. The Bank provides an allowance for the
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<PAGE>
loss of previously accrued but uncollected interest on all non-accrual loans.
Typically, after a collection problem has necessitated the issuance of a Notice,
the Special Assets Department will review and recommend a selection and an
appointment of a receiver. The Bank's current policy is to have a receiver
appointed at the expiration of the Notice, which is 10 days after issuance,
unless some type of formal, written agreement with the borrower has been
arranged.
The receiver has specific criteria to fulfill with respect to commercial
loans of the property on behalf of the Bank. The first responsibility is to gain
control of the cash generated from the property. The receiver is responsible for
all collection activity. In addition, the receiver is required to prepare
forward forecasting with respect to occupancy and potential rent collections.
Approximately 30 to 60 days after a receiver is appointed, the Bank will order a
third party appraisal report. The information pertaining to the property
operations will be supplied to the appraiser by the receiver. The in-house
appraisal department reviews the third party appraisal report for accuracy and
reasonableness of assumptions.
The receiver and the Bank work together in preparing a budget for potential
repairs and maintenance, as well as capital expenditure items needed at the
property. It is the policy of the Bank to instruct the receiver to utilize all
net operating income available to restore the property or units of current
vacancy to "lease ready" condition.
A review of the collateral value is performed to determine if sufficient
equity exists to repay the indebtedness in the event of a foreclosure and
subsequent sale of the property. The valuation is prepared by the account
officer assigned to review the credit facility. The valuation is performed under
two scenarios. First, a review of the current market conditions of similar
properties within the collateral property's market is completed to ascertain
comparable rent and sale data. Second, a discounted cash flow analysis is
prepared, utilizing current investor return requirements and capitalization
rates. Once a value for the property has been estimated based upon its ability
to generate cash flow, expenses associated with the sale of the property, such
as broker commissions and closing costs are deducted from the estimated value. A
comparison of this amount is made to the loan balance to determine whether a
specific reserve or a write-off is appropriate.
During this on-going process, the Bank and the receiver will identify and
catalogue any potential purchasers who call and express an interest in the
property prior to the Bank taking title. Once title is transferred, the Bank
will then begin the process of contacting those entities that previously
expressed an interest to confirm that interest and proceed with the
qualification stage.
REAL ESTATE OWNED. Real estate acquired through foreclosure is carried at
the lower of the loan's unpaid principal balance (cost) or estimated fair value
less estimated selling expenses at the date of transfer. A loan charge-off is
recorded for any writedown in the loan's carrying value to fair value at the
date of transfer. Real estate loss provisions are recorded if the properties'
estimated fair value subsequently declines below the value determined at the
recording date. In determining the lower of cost or fair value at acquisition,
costs relating to development and improvement of property are considered. Costs
relating to holding real estate acquired through foreclosure, net of rental
income, are charged against earnings as incurred.
In preparing a real estate owned property to be marketed for sale certain
repairs are undertaken and other repair items are left as negotiating points
pertaining to the sale contract. The Bank may offer to adjust the sale price for
such minor repair items, or may offer to deliver the property in a repaired
stated. As part of the disposition strategy, the Bank may offer financing at
current market terms to qualified buyers of the real estate owned. It is a
requirement that the purchaser/borrowing entity provide a minimum of 20% cash
toward the purchase of the property. Terms offered are similar to terms being
offered on other new originations and at comparable rates. The Special Assets
Department makes great efforts to ensure that the underwriting for a loan to
facilitate is comparable to other new loan production, and that the transactions
are viewed as arms-length and fair market.
OC-45
<PAGE>
TROUBLED DEBT RESTRUCTURING. A loan constitutes a troubled debt
restructuring ("TDR") if the Bank, for economic or legal reasons related to the
borrower's financial difficulties, grants a concession to the borrower that it
would not otherwise consider. Among other things, a TDR involves the
modification of terms of the Bank's loan, including a reduction of the interest
rate, an extension of the maturity date at a stated interest rate lower than the
current market for new loans with similar risk, a reduction of the face amount
of the loan or a reduction of accrued interest. The Bank provides an allowance
for the loss of previously accrued but uncollected interest on these, as well as
non-accrual loans. Currently, the Bank's TDR's consist of loans collateralized
by single- and multi-family residential properties. The majority of these
restructures were entered into during the early 1990's when economic conditions
in California were severely depressed or in conjunction with the Northridge
earthquake damage to the collateral properties. Management has indicated that
the decision to provide such restructures was based upon both an internal
assessment of the situation and a consensus of lenders in California who
believed that this resolution would be the most effective mitigating measure.
Management considers all loans formerly treated as TDRs to be impaired loans in
the year of restructuring. Generally, such loans, as well as those previously
placed on non-accrual, are returned to accrual status when the borrower has had
a period of sustained repayment performance for twelve consecutive months.
Under the Bank's new management, the Bank has aggressively focused on
problem asset rehabilitation, and has undertaken a number of initiatives in this
area. The Bank has established an Internal Asset Review Committee, which is
comprised of the Chief Executive Officer, the Chief Financial Officer, the
Senior Vice President in charge of Real Estate, the Senior Credit Officer, the
Assistant Vice President of Internal Assets and the Commercial Loan Officer. The
Committee meets approximately every three weeks and monitors the Bank's assets
to ensure proper classification. All multi-family and commercial assets in
excess of $500,000, regardless of performance, are reviewed at least once each
year. Assets that are classified as special mention are reviewed every six
months and those assets classified as substandard are reviewed every three
months and, if collateral dependent, a market value analysis is performed on the
property to determine whether valuation allowances are required. Loans that are
non-performing, subject to workout or forbearance or classified substandard are
monitored and managed through the Special Assets Department. Assets that are
foreclosed and become real estate owned continue to be managed by the Special
Assets department through its respective resolution.
OC-46
<PAGE>
The following table sets forth information with respect to non-performing
assets identified by the Bank, including non-accrual loans, real estate owned
and troubled debt restructurings at the dates indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AT JUNE 30,
1997 1996 1995 1994 1993 1992
----------- --------- ---------- ----------- --------- ---------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Non-performing loans, net:
Single-family residential.................... $ 4,629 $ 7,947 $ 10,467 $ 14,780 $ 27,310 $ 26,764
Multi-family residential..................... 8,324 9,198 16,840(1) -- 4,138 1,159
Commercial and industrial.................... 1,082 1,093 8,173 8,446 2,001 710
Land......................................... -- -- 112 4,232 5,050 --
----------- --------- ---------- ----------- --------- ---------
Total non-performing loans, net.............. 14,035 18,238 35,592 27,458 38,499 28,633
----------- --------- ---------- ----------- --------- ---------
Real estate owned, net:
Single-family residential.................... 4,046 3,268 6,387 5,322 16,568 19,856
Multi-family residential..................... 11,299 8,310 901 3,999 10,213 7,189
Commercial and industrial.................... 7,240 8,614 3,506 1,095 4,769 11,610
Land......................................... 244 244 121 69 -- --
----------- --------- ---------- ----------- --------- ---------
Total real estate owned, net................. 22,829 20,436 10,915 10,485 31,550 38,655
----------- --------- ---------- ----------- --------- ---------
Total non-performing assets.................. $ 36,864 $ 38,674 $ 46,507 $ 37,943 $ 70,049 $ 67,288
----------- --------- ---------- ----------- --------- ---------
----------- --------- ---------- ----------- --------- ---------
Troubled debt restructurings................. $ 7,529 $ 7,544 $ 6,133 $ 40,794(1) $ 6,902 $ 4,315
----------- --------- ---------- ----------- --------- ---------
----------- --------- ---------- ----------- --------- ---------
Total non-performing assets and troubled debt
restructurings............................. $ 44,393 $ 46,218 $ 52,640 $ 78,737 $ 76,951 $ 71,603
----------- --------- ---------- ----------- --------- ---------
----------- --------- ---------- ----------- --------- ---------
Non-performing loans to total loans, net..... 1.27% 1.60% 2.90% 2.10% 2.86% 1.98%
Non-performing loans to total assets......... 0.77 1.04 2.25 1.60 2.10 1.40
Non-performing assets to total assets........ 2.03 2.21 2.94 2.21 3.83 3.29
Total non-performing assets and troubled debt
restructurings to total assets............. 2.44 2.64 3.33 4.58 4.21 3.50
</TABLE>
- ------------------------
(1) Reflects to a large extent problems associated with 1994 Northridge,
California earthquake.
The interest income that would have been recorded during the six months
ended June 30, 1997 and the years ended December 31, 1996, 1995 and 1994 if the
Bank's non-accrual loans at the end of such periods had been current in
accordance with their terms during such periods was $641,000, $1.4 million, $3.2
million and $2.3 million, respectively.
As shown in the table above, the Bank recognized significant credit losses
in the early 1990's due, in large part, to the continued deterioration in the
Southern California economy which had begun with the national recession at the
start of the decade, together with a decline in market values of real estate
resulting from the Northridge earthquake of 1994. As the real estate that
secured the Bank's mortgage loans decreased in value and as borrowers,
particularly developers of, and investors in, residential and commercial real
estate, became less able to meet their debt service obligations, non-performing
assets and troubled debt restructurings increased dramatically, amounting to
$78.7 million or 4.6% of total assets as of December 31, 1994. As a result of
the focus given by new management to rehabilitate or liquidate the Bank's
problem assets, nonperforming assets and troubled debt restructurings have
declined to $44.4 million or 2.4% of total assets at June 30, 1997.
OC-47
<PAGE>
Of the Bank's $14.0 million of non-performing loans at June 30, 1997, the
largest concentration consisted of four loans on apartment buildings, with a
current carrying value of $5.1 million. These loans have been classified as
collateral dependent, and as of June 30, 1997 were carried at fair value. Based
on recent appraisals, the Bank charged against the allowance for loan losses
$655,000 during the June 1997 quarter. The Bank's $22.8 million of real estate
owned at June 30, 1997 was comprised of 11 multi-family and commercial
properties aggregating $18.8 million and various residential properties
aggregating $4.0 million. The Bank's largest property was a shopping center with
a net book value as of June 30, 1997 of $6.6 million. The second largest
property had a net book value as of June 30, 1997 of $2.1 million.
With the downturn in the California economy experienced during the early
1990s and the problems associated with the Northridge, California earthquake in
1994, prior management entered into a significant number of troubled debt
restructurings. Since the change in the Bank's management, the Bank has not
entered into troubled debt restructurings. In addition, as shown in the table
above, as of December 31, 1995, an aggregate of $16.8 million and $8.2 million
of multi-family residential loans and commercial real estate loans,
respectively, were classified as non-accrual. Management is moving promptly to
foreclose on such properties so that they may be disposed of, which has
contributed to the increase in real estate owned since 1995. At June 30, 1997,
an aggregate of $9.4 million and $18.5 million of such loans were on a non-
accrual status and in real estate owned, respectively, which constituted 75.8%
of total non-performing assets at such date.
ALLOWANCE FOR LOSSES ON LOANS. It is management's policy to maintain an
allowance for estimated losses on loans based on a number of factors, including
economic trends, industry experience, estimated collateral values, past loss
experience, the Bank's underwriting practices, and management's ongoing
assessment of the credit risk inherent in its portfolio. Although management
believes that it uses the best information available to make such
determinations, future adjustments to the allowance may be necessary, and net
income could be significantly affected, if circumstances differ substantially
from the assumptions used in making the initial determinations. The Bank's
Internal Asset Review Committee undertakes a quarterly evaluation of the
adequacy of the allowance for loan losses as well as the allowance with respect
to real estate owned. The Committee will provide allowances to absorb losses
that are both probable and reasonably quantifiable as well as for those that are
not specifically identified but can be reasonably estimated.
Effective December 21, 1993, the OTS, in conjunction with the Office of
Comptroller of the Currency, the FDIC and the Federal Reserve Board, issued an
Interagency Policy Statement on the Allowance for Loan and Lease Losses ("Policy
Statement"). The Policy Statement, which effectively supersedes the proposed
guidance issued in September 1992, includes guidance (i) on the responsibilities
of management for the assessment and establishment of an adequate allowance and
(ii) for the agencies' examiners to use in evaluating the adequacy of such
allowance and the policies utilized to determine such allowance. The Policy
Statement also sets forth quantitative measures for the allowance with respect
to assets classified substandard and doubtful and with respect to the remaining
portion of an institution's loan portfolio. Specifically, the Policy Statement
sets forth the following quantitative measures which examiners may use to
determine the reasonableness of an allowance: (i) 50% of the portfolio that is
classified doubtful; (ii) 15% of the portfolio that is classified substandard;
and (iii) for the portions of the portfolio that have not been classified
(including loans designated special mention), estimated credit losses over the
upcoming twelve months based on facts and circumstances available on the
evaluation date. While the Policy Statement sets forth this quantitative
measure, such guidance is not intended as a "floor" or "ceiling."
OC-48
<PAGE>
The following table sets forth the activity in the Bank's allowance for loan
losses during the periods indicated.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
-------------------- -----------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1997 1996 1996 1995 1994 1993 1992
--------- --------- --------- --------- --------- --------- ---------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Allowance at beginning of period............... $ 23,280 $ 31,572 $ 31,572 $ 29,801 $ 20,426 $ 18,509 $ 19,499
--------- --------- --------- --------- --------- --------- ---------
Provision for loan losses...................... 655 2,213 2,884 8,823 22,330 8,393 8,482
--------- --------- --------- --------- --------- --------- ---------
Charge-offs:
Mortgage loans:
Single-family residential.................... (1,243) (1,400) (2,213) (3,416) (5,428) (3,507) (2,177)
Multi-family residential..................... (9) (2,305) (5,039) (1,854) (1,787) (817) (377)
Commercial and industrial.................... (4,126) (3,373) (3,371) (860) (5,813) (2,392) (5,214)
Land......................................... -- (1,448) (1,478) (956) -- -- --
--------- --------- --------- --------- --------- --------- ---------
Total charge-offs.......................... (5,378) (8,526) (12,101) (7,086) (13,028) (6,716) (7,768)
--------- --------- --------- --------- --------- --------- ---------
Recoveries:
Mortgage loans:
Single-family residential.................... 126 2 16 34 73 235 --
Multi-family residential..................... -- -- 22 -- -- -- --
Commercial and industrial.................... -- 22 2 -- -- 5 --
Land......................................... -- 885 885 -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
Total recoveries........................... 126 909 925 34 73 240 --
Recoveries credited to income.................. -- -- -- -- -- -- (1,704)
--------- --------- --------- --------- --------- --------- ---------
Allowance at end of period..................... $ 18,683 $ 26,168 $ 23,280 $ 31,572 $ 29,801 $ 20,426 $ 18,509
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Allowance for loan losses to total
nonperforming loans at end of period......... 133.12% 143.48% 127.65% 88.71% 108.53% 53.06% 64.64%
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Allowance for loan losses to total
nonperforming loans and restructured loans at
end of period................................ 86.64% 94.41% 90.30% 75.67% 43.66% 44.99% 56.18%
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Allowance for loan losses to total loans, net
at end of period............................. 1.69% 2.22% 2.04% 2.57% 2.28% 1.52% 1.28%
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
</TABLE>
As shown in the table above, loan charge-offs (net of recoveries) amounted
to $5.3 million, $7.6 million, $11.2 million, $7.1 million and $13.0 million,
during the six months ended June 30, 1997 and 1996 and the years ended December
31, 1996, 1995 and 1994, respectively. The net charge-offs recognized by the
Bank during the six months ended June 30, 1997 and the years ended December 31,
1996 and 1995 primarily reflected the transfer of loans (particularly
multi-family residential loans) to real estate owned, as shown in the preceding
non-performing assets table. Such multi-family loans had specific valuation
allowances which had been established through increased provisions for loans in
prior periods. At the time of transfer of the loans to real estate owned, such
specific valuation allowances were charged off. As a result of the transfer of
such loans to real estate owned, the Bank's non-performing loans have declined
since 1995, which has contributed to the decrease in the Bank's provision for
losses on loans. Management believes that its allowance for losses on loans at
June 30, 1997 was adequate. Nevertheless, there can be no assurances that
additions to such allowance will not be necessary in future periods,
particularly if the growth in the Bank's commercial and consumer lending
continues.
OC-49
<PAGE>
The following table sets forth information concerning the allocation of the
Bank's allowance for loan losses by loan category at the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
JUNE 30, 1997 1996 1995 1994
---------------------- ---------------------- ---------------------- ----------------------
<CAPTION>
PERCENT TO PERCENT TO PERCENT TO PERCENT TO
TOTAL TOTAL TOTAL TOTAL
AMOUNT ALLOWANCE AMOUNT ALLOWANCE AMOUNT ALLOWANCE AMOUNT ALLOWANCE
--------- ----------- --------- ----------- --------- ----------- --------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Residential real estate........... $ 3,611 19.3% $ 4,051 17.4% $ 5,109 16.2% $ 7,809 26.2%
Multi-family residential.......... 11,374 60.9 15,753 67.7 18,509 58.6 11,396 38.2
Commercial, industrial and land... 3,527 18.9 3,361 14.4 7,954 25.2 10,084 33.9
Other loans....................... 171 0.9 115 0.5 -- -- 512 1.7
--------- ----- --------- ----- --------- ----- --------- -----
Total............................. $ 18,683 100.0% $ 23,280 100.0% $ 31,572 100.0% $ 29,801 100.0%
--------- ----- --------- ----- --------- ----- --------- -----
--------- ----- --------- ----- --------- ----- --------- -----
</TABLE>
INVESTMENT ACTIVITIES
The Bank's securities portfolio is managed by the Executive Vice President
and Chief Financial Officer in accordance with a comprehensive written
Investment Policy which addresses strategies, types and levels of allowable
investments and which is reviewed and approved annually by the Board of
Directors of the Bank. The management of the securities portfolio is set in
accordance with strategies developed by the Bank's Asset/Liability Management
Committee.
The Bank's Investment Policy authorizes the Bank to invest in U.S. Treasury
obligations (with a maturity of up to five years), U.S. agency obligations (with
a maturity of up to five years), U.S. Government agency mortgage-backed
securities (limited to no more than 50% of the Bank's total assets), bankers'
acceptances (with a maturity of 180 days or less), FHLB overnight deposits,
investment grade commercial paper (with a maturity of up to nine months),
federal funds (with a maturity of one month or less), certificates of deposit in
other financial institutions (with a maturity of one year or less), repurchase
agreements (with a maturity of six months or less), reverse repurchase
agreements (with a maturity of two years or less) and certain collateralized
mortgage obligations (with a weighted average life of less than ten years).
At June 30, 1997, the Bank's securities portfolio consisted of $578.5
million of mortgage-backed securities, $568.1 million of which were classified
as available for sale and $10.4 million of which were classified as held to
maturity, and $48.9 million of U.S. Government agency obligations. Of the Bank's
total investment in mortgage-backed securities at June 30, 1997, $106.4 million
consisted of Government National Mortgage Association ("GNMA") certificates,
$197.5 million consisted of FNMA certificates, $42.8 million consisted of
non-agency certificates and $231.8 million consisted of FHLMC certificates. Of
this $578.5 million of mortgage-backed securities at June 30, 1997, $247.1
million consisted of fixed rate securities and $331.4 million consisted of
adjustable rate securities. Under new management, the Bank has significantly
increased its purchases of primarily adjustable rate mortgage-backed securities
with interest rate adjustments tied to the U.S. Treasury index of constant
comparable maturity. The Bank's aggregate securities portfolio, net of
repayments and prepayments and sales, increased by $271.6 million or 112.4%
between 1995 and 1996, and amounted to $627.4 million at June 30, 1997. The Bank
anticipates significantly leveraging the proceeds of the Offering with similar
investments in mortgage-backed securities. See "Use of Proceeds" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operation."
Mortgage-backed securities (which also are known as mortgage participation
certificates or pass-through certificates) represent a participation interest in
a pool of single-family or multi-family mortgages, the principal and interest
payments on which are passed from the mortgage originators, through
OC-50
<PAGE>
intermediaries (generally U.S. Government agencies and government sponsored
enterprises) that pool and repackage the participation interests in the form of
securities, to investors such as the Bank. Such U.S. Government agencies and
government sponsored enterprises, which guarantee the payment of principal and
interest to investors, primarily include the FHLMC, the FNMA and the GNMA.
The FHLMC is a public corporation chartered by the U.S. Government and owned
by the 12 Federal Home Loan Banks and federally insured savings institutions.
The FHLMC issues participation certificates backed principally by conventional
mortgage loans. The FHLMC guarantees the timely payment of interest and the
ultimate return of principal within one year. The FNMA is a private corporation
chartered by the U.S. Congress with a mandate to establish a secondary market
for conventional mortgage loans. The FNMA guarantees the timely payment of
principal and interest on FNMA securities. FHLMC and FNMA securities are not
backed by the full faith and credit of the United States, but because the FHLMC
and the FNMA are U.S. Government-sponsored enterprises, these securities are
considered to be among the highest quality investments with minimal credit
risks. The GNMA is a government agency which is intended to help finance
government-assisted housing programs. GNMA securities are backed by FHA-insured
and VA-guaranteed loans, and the timely payment of principal and interest on
GNMA securities are guaranteed by the GNMA and backed by the full faith and
credit of the U.S. Government. Because the FHLMC, the FNMA and the GNMA were
established to provide support for low- and middle-income housing, there are
limits to the maximum size of loans that qualify for these programs. For
example, the FNMA and the FHLMC currently limit their loans secured by a
single-family, owner-occupied residence to $214,600. To accommodate larger-sized
loans, and loans that, for other reasons, do not conform to the agency programs,
a number of private institutions have established their own home-loan
origination and securitization programs.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
characteristics of the underlying pool of mortgage, i.e., fixed rate or
adjustable rate, as well as prepayment risk, are passed on to the certificate
holder. The life of a mortgage-backed pass-through security thus approximates
the life of the underlying mortgages.
The following table sets forth information regarding the carrying and market
value of the Bank's securities at the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
JUNE 30,
<CAPTION>
1997 1996 1995 1994
---------------------- ---------------------- ---------------------- ----------------------
CARRYING MARKET CARRYING MARKET CARRYING MARKET CARRYING MARKET
VALUE VALUE VALUE VALUE VALUE VALUE VALUE VALUE
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Available for sale (at
market):
U.S. Government and
federal agency
obligations............ $ 48,945 $ 48,945 $ 38,714 $ 38,714 $ 9,994 $ 9,994 $ -- $ --
Mortgage-backed
securities............. 568,093 568,093 463,587 463,587 231,651 231,651 7,677 7,677
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
$ 617,038 $ 617,038 $ 502,301 $ 502,301 $ 241,645 $ 241,645 $ 7,677 $ 7,677
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Held to maturity:
Mortgage-backed
securities............. $ 10,375 $ 10,324 $ 10,971 $ 10,899 -- -- $ 304,620 $ 289,737
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
$ 10,375 $ 10,324 $ 10,971 $ 10,899 -- -- $ 304,620 $ 289,737
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
</TABLE>
OC-51
<PAGE>
The following table sets forth the activity in the Bank's aggregate
securities portfolio during the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
<S> <C> <C> <C> <C>
SIX MONTHS
ENDED JUNE 30, 1997 1996 1995 1994
------------------- ---------- ---------- ----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Securities at beginning of period....................... $ 513,272 $ 241,645 $ 312,297 $ 362,007
Purchases............................................... 199,531 487,719 212,155 150,985
Sales................................................... (41,761) (158,448) (222,947) (81,620)
Repayments and prepayments.............................. (45,311) (53,207) (58,245) (115,097)
Decrease (increase) in unrealized losses on
available-for-sale securities(1)...................... 1,682 (4,437) (1,615) (1,865)
Charge-offs............................................. -- -- -- (2,113)
-------- ---------- ---------- ----------
Securities at end of period(2)(3)....................... $ 627,413 $ 513,272 $ 241,645 $ 312,297
-------- ---------- ---------- ----------
-------- ---------- ---------- ----------
</TABLE>
- ------------------------
(1) At June 30, 1997, the cumulative unrealized losses on securities classified
as available-for-sale amounted to $4.4 million, which reduces stockholder's
equity.
(2) At June 30, 1997, the book value and market value of the Bank's securities
(including held-to-maturity and available for sale securities) amounted to
$627.4 million and $627.4 million, respectively.
(3) At June 30, 1997, $331.4 million or 52.8% of the Bank's securities portfolio
consisted of adjustable rate securities, as compared to $222.4 million or
43.3%, $115.8 million or 47.9% and $75.9 million or 24.3% at December 31,
1996, 1995 and 1994, respectively.
SOURCES OF FUNDS
GENERAL. The Bank will consider various sources of funds to fund its
investing and lending activities and evaluates the available sources of funds in
order to reduce the Bank's overall funding costs. Deposits, reverse repurchase
agreements, advances from the FHLB of San Francisco, and sales, maturities and
principal repayments on loans and securities have been the major sources of
funds for use in the Bank's lending and investing activities, and for other
general business purposes. Management of the Bank closely monitors rates and
terms of competing sources of funds on a daily basis and utilizes the source
which it believes to be the most cost effective. Products are priced each week
through the Bank's Asset Liability Management Committee.
DEPOSITS. The Bank attempts to price its deposits in order to promote
deposit growth and offers a wide array of deposit products in order to satisfy
its customers' needs. The Bank's current deposit products include passbook
accounts, negotiable order of withdrawal ("NOW") accounts, money market deposit
accounts, fixed rate, fixed-maturity retail certificates of deposit ranging in
terms from 90 days to five years, individual retirement accounts, and non-retail
certificates of deposit consisting of jumbo (generally greater than $100,000)
certificates and public deposits.
The Bank's retail deposits are generally obtained from residents in its
primary market area. The principal methods currently used by the Bank to attract
deposit accounts include offering a wide variety of products and services and
competitive interest rates. The Bank utilizes traditional marketing methods to
attract new customers and savings deposits, including various forms of
advertising. Although the Bank has in the past utilized the services of deposit
brokers to attract non-retail certificates of deposit, the Bank is currently
allowing its brokered deposits to run off as they mature and is not accepting
any new brokered deposits. The Bank has installed ATMs at all of its branch
offices and intends to install between ten to fifteen new ATMs within a chain of
health clubs located in southern California.
OC-52
<PAGE>
The following table presents the average balance of each deposit type and
the average rate paid on each deposit type of the Bank for the periods
indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
JUNE 30, 1997 1996 1995 1994
--------------------------- --------------------------- --------------------------- ------------
<CAPTION>
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE PAID BALANCE RATE PAID BALANCE RATE PAID BALANCE
------------ ------------- ------------ ------------- ------------ ------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Passbook accounts...... $ 261,050 4.42% $ 264,677 4.64% $ 95,335 3.67% $ 68,518
NOW accounts........... 77,555 1.57 58,511 0.77 54,837 0.84 59,427
Money market
accounts............. 22,073 2.60 29,665 2.52 47,269 3.01 77,739
Term certificates...... 982,564 5.61 1,069,484 5.76 1,212,989 5.73 1,186,191
------------ ------------ ------------ ------------
Total deposits..... $ 1,343,242 5.10% $ 1,422,337 5.28% $ 1,410,430 5.31% $ 1,391,875
------------ --- ------------ --- ------------ --- ------------
------------ --- ------------ --- ------------ --- ------------
<CAPTION>
<S> <C>
AVERAGE
RATE PAID
-------------
<S> <C>
Passbook accounts...... 2.32%
NOW accounts........... 0.90
Money market
accounts............. 2.41
Term certificates...... 4.55
Total deposits..... 4.17%
---
---
</TABLE>
The following table sets forth the activity in the Bank's deposits during
the periods indicated.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
----------------- ----------------------------------------
1997 1996 1995 1994
----------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
Beginning balance................................... $ 1,371,243 $ 1,473,318 $ 1,384,218 $ 1,388,818
Net increase (decrease) before interest............. (68,684) (160,804) 35,836 (42,907)
Interest credited................................... 11,477 58,729 53,264 38,307
----------------- ------------ ------------ ------------
Net increase (decrease) in deposits................. (57,207) (102,075) 89,100 (4,600)
----------------- ------------ ------------ ------------
Ending balance...................................... $ 1,314,036 $ 1,371,243 $ 1,473,318 $ 1,384,218
----------------- ------------ ------------ ------------
----------------- ------------ ------------ ------------
</TABLE>
The following table sets forth by various interest rate categories the term
certificates with the Bank at the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------
<S> <C> <C> <C> <C>
JUNE 30, 1997 1996 1995 1994
------------- ------------ ------------ ------------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C> <C>
0.00% to 2.99%........................................... $ 3,481 $ 4,299 $ 3,964 $ 1,637
3.00% to 3.99%........................................... 3,182 3,833 4,900 126,533
4.00% to 4.99%........................................... 34,643 46,771 49,037 459,920
5.00% to 6.99%........................................... 931,538 909,895 1,092,316 597,046
7.00% to 8.99%........................................... 1,350 36,244 47,613 15,898
------------- ------------ ------------ ------------
$ 974,194 $ 1,001,042 $ 1,197,830 $ 1,201,034
------------- ------------ ------------ ------------
------------- ------------ ------------ ------------
</TABLE>
OC-53
<PAGE>
The following table sets forth the amount and remaining maturities of the
Bank's term certificates at June 30, 1997.
<TABLE>
<CAPTION>
OVER SIX
MONTHS OVER ONE OVER TWO
SIX MONTHS THROUGH ONE YEAR THROUGH YEARS THROUGH OVER THREE
AND LESS YEAR TWO YEARS THREE YEARS YEARS
----------- ------------ ------------ ------------- -----------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
0.00% to 1.99%............................. $ 501 $ -- $ 100 $ -- $ --
2.00% to 2.99%............................. 2,226 405 115 -- 134
3.00% to 3.99%............................. 3,160 -- 17 -- 5
4.00% to 4.99%............................. 32,837 1,103 703 -- --
5.00% to 6.99%............................. 434,854 347,003 134,491 6,554 8,636
7.00% to 8.99%............................. 159 732 177 282 --
----------- ------------ ------------ ------ -----------
Total...................................... $ 473,737 $ 349,243 $ 135,603 $ 6,836 $ 8,775
----------- ------------ ------------ ------ -----------
----------- ------------ ------------ ------ -----------
</TABLE>
As of June 30, 1997, the aggregate amount of outstanding time certificates
of deposit in amounts greater than or equal to $100,000, was approximately
$227.6 million. The following table presents the maturity of these time
certificates of deposit at such dates.
<TABLE>
<CAPTION>
JUNE 30, 1997
--------------
<S> <C>
(IN THOUSANDS)
3 months or less.......................................................... $ 50,812
Over 3 months through 6 months............................................ 64,753
Over 6 months through 12 months........................................... 83,318
Over 12 months............................................................ 28,734
--------------
$ 227,617
--------------
--------------
</TABLE>
BORROWINGS. The following table sets forth certain information regarding
the short-term borrowings of the Bank at or for the dates indicated.
<TABLE>
<CAPTION>
AT OR FOR THE SIX
MONTHS
ENDED AT OR FOR THE YEAR ENDED DECEMBER
JUNE 30, 31,
---------------------- ----------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1996 1995 1994
---------- ---------- ---------- ---------- ----------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
FHLB OF SAN FRANCISCO ADVANCES:
Average balance outstanding.................... $ 80,000 $ 35,304 $ 53,666 $ 193,535 $ 310,262
Maximum amount outstanding at any month-end
during the period............................ 80,000 31,746 80,000 310,000 316,000
Balance outstanding at end of period........... 80,000 31,746 80,000 31,746 310,000
Average interest rate during the period........ 5.91% 5.80% 5.49% 6.37% 5.00%
Average interest rate at end of period......... 5.91% 5.84% 5.91% 5.84% 4.99%
SECURITIES SOLD UNDER AGREEMENTS TO PURCHASE:
Average balance outstanding.................... $ 286,410 $ 151,366 $ 179,002 $ 100,071 $ 140,943
Maximum amount outstanding at any month-end
during the period............................ 331,358 177,597 219,229 151,626 154,210
Balance outstanding at end of period........... 331,358 177,597 192,433 -- --
Average interest rate during the period........ 5.62% 5.31% 6.09% 6.25% 4.34%
Average interest rate at end of period......... 5.78% 5.27% 5.49% -- --
</TABLE>
The Bank obtains both fixed and variable rate long- and short-term advances
from the FHLB of San Francisco upon the security of certain of its residential
first mortgage loans and other assets, provided
OC-54
<PAGE>
certain standards related to creditworthiness of the Bank have been met. FHLB of
San Francisco advances are available for general business purposes to expand
lending and investing activities. Borrowings have generally been used to fund
the purchase of mortgage-backed and investment securities or lending activities
and have been collateralized with a pledge of loans, securities in the Bank's
portfolio or any mortgage-backed or investment securities purchased.
Advances from the FHLB of San Francisco are made pursuant to several
different credit programs, each of which has its own interest rate and range of
maturities. At June 30, 1997, the Bank had two fixed rate advances from the FHLB
of San Francisco. At June 30, 1997, the Bank had total FHLB of San Francisco
advances of $80.0 million at a weighted average interest rate of 5.91%, $31.0
million of which matures in 1997 and $49.0 million of which matures in 1998.
Since 1996, the Bank has increasingly relied on obtaining funds from the
sales of securities to investment dealers under agreements to repurchase
("reverse repurchase agreements"). In a reverse repurchase agreement
transaction, the Bank will generally sell a mortgage-backed security agreeing to
repurchase either the same or a substantially identical security on a specified
later date (generally not more than 90 days) at a price greater than the
original sales price. The difference in the sale price and purchase price is the
cost of the use of the proceeds. The mortgage-backed securities underlying the
agreements are delivered to the dealers who arrange the transactions. For
agreements in which the Bank has agreed to repurchase substantially identical
securities, the dealers may sell, loan or otherwise dispose of the Bank's
securities in the normal course of their operations; however, such dealers or
third party custodians safe-keep the securities which are to be specifically
repurchased by the Bank. Reverse repurchase agreements represent a competitive
cost short-term funding source for the Bank. Nevertheless, the Bank is subject
to the risk that the lender may default at maturity and not return the
collateral. The amount at risk is the value of the collateral which exceeds the
balance of the borrowing. In order to minimize this potential risk, the Bank
only deals with large, established investment brokerage firms when entering into
these transactions. Reverse repurchase transactions are accounted for as
financing arrangements rather than sales of securities, and the obligation to
repurchase such securities is reflected as a liability in the Bank's
Consolidated Financial Statements.
SUBSIDIARIES
The Bank is permitted to invest up to 2% of its assets in the capital stock
of, or secured or unsecured loans to, subsidiary corporations, with an
additional investment of 1% of assets when such additional investment is
primarily for community development purposes. In addition, the Bank is permitted
to make an unlimited investment in one or more operating subsidiaries, which are
permitted to engage only in activities that the Bank may undertake directly. As
of June 30, 1997, the Bank maintained four direct subsidiaries and one indirect
subsidiary consisting of SoCal Mortgage Corporation ("SMC"), Direct Investment
Company of Southern California ("DIC"), SCP Investments, Inc. ("SCP"),
Continental Development of California, Inc. ("CDC") and SCS Insurance Services,
Inc. ("SCS"). At June 30, 1997, the Bank's investment in its service corporation
subsidiaries amounted to $2.6 million in the aggregate.
SMC is an inactive corporation which was formed in 1987 to originate
mortgage loans. However, SMC has never conducted any business since it was
organized. DIC was formed in 1987 to acquire, develop, construct and sell real
estate developments and is currently inactive. DIC owns 100% of the capital
stock of SCP which was formed in 1989 to invest in various real estate
development projects. SCP currently holds the Bank's last remaining real estate
development project consisting of 62 acres of vacant land located in Corona,
California. At June 30, 1997, the land had a net carrying value of $1.9 million
and the Bank is currently marketing the property for sale.
CDC was formed in 1969 for the purpose of acquiring, developing,
constructing and selling real estate developments. CDC does not currently hold
any real estate and CDC's sole operation consists of acting as trustee under the
Bank's deeds of trust with respect to its mortgage lending.
OC-55
<PAGE>
SCS was formed in 1984 in order to sell, through the Bank's branch offices,
annuities and various other investments as well as other insurance products to
the Bank's account holders and members of the general public. During the six
months ended June 30, 1997 and the years ended December 31, 1996 and 1995, SCS
recognized net earnings of $99,000, $336,000 and $40,000, respectively.
LEGAL PROCEEDINGS
On January 28, 1993, SOCAL, the Bank and certain current and former
stockholders of SOCAL filed a complaint against the United States in the United
States Court of Federal Claims seeking damages for breach of contract and for
deprivation of property without just compensation and without due process of the
law. The allegations in the complaint arise out of the abrogation of certain
contractual promises made to SOCAL, to certain of its current and former common
stockholders, and to the Bank, by the Federal Home Loan Bank Board and the
Federal Savings and Loan Insurance Corporation in exchange for SOCAL's agreement
to acquire and to operate the Bank which was then a failed thrift institution.
One of the current stockholders of SOCAL (Arbur, Inc.) is also a plaintiff in
the case, entitled SOUTHERN CALIFORNIA FEDERAL SAVINGS AND LOAN ASSOCIATION, ET
AL. V. UNITED STATES, No. 93-52C (the "SOCAL Goodwill Litigation"). The
plaintiffs' claims arose from changes, mandated by FIRREA, with respect to the
rules for computing the Bank's regulatory capital. The SOCAL Goodwill Litigation
was stayed pending the resolution on appeal of the Winstar Cases (defined
below), which present issues similar to those presented by the SOCAL Goodwill
Litigation.
On July 1, 1996, the United States Supreme Court issued its opinion for
UNITED STATES V. WINSTAR CORPORATION, No. 95-865, which affirmed the decisions
of the United States Court of Appeals for the Fourth Circuit and the United
States Court of Federal Claims in various consolidated cases (the "Winstar
Cases") granting summary judgment to the plaintiff thrift institutions on the
liability portion of their breach of contract claims against the United States.
The Supreme Court held that the government breached certain express contracts
when Congress enacted FIRREA, and the Supreme Court remanded the proceedings for
a determination of the appropriate measure and amount of damages, which as of
the date of this Offering Circular have not been finally litigated.
The United States Court of Federal Claims issued a Case Management Order
("CMO") in all of the Winstar Cases, including the Bank's. The CMO sets forth
procedures for all of the plaintiffs and the defendant, the United States, to
follow relating to the exchange of documents, filing of partial summary judgment
motions with respect to liability only, discovery on damages issues and the
timing of all of the Winstar Cases being set for trial. Pursuant to the CMO, the
Bank filed a motion for partial summary judgment as to the government's
liability to the Bank for breach of contract. Pursuant to the CMO, the
government filed its response to the Bank's motion. Based upon the status of the
proceedings in the Winstar Cases and the CMO, the SOCAL Goodwill Litigation is
not expected to be set for trial for at least two years. The amount of damages
the Bank and SOCAL have suffered as a result of the government's breach of
contract has not yet been determined. In addition, although the decision of the
Supreme Court in the Winstar Cases has been rendered, there can be no assurance
that the court will not reach a different conclusion in the SOCAL Goodwill
Litigation.
OC-56
<PAGE>
OFFICE LOCATIONS
The following table set forth certain information with respect to the Bank's
offices at June 30, 1997.
<TABLE>
<CAPTION>
NET BOOK VALUE TOTAL DEPOSITS
LEASE/OWNED OF PROPERTY AT AT
OFFICE LOCATION LEASE EXPIRATION DATE JUNE 30, 1997 JUNE 30, 1997
- ---------------------------------------------------- ------------------------- --------------- ---------------
<S> <C> <C> <C>
(IN THOUSANDS)
EXECUTIVE OFFICE (AND BRANCH):
Los Angeles Leased $ 2,254 $ 3,790
5900 Wilshire Boulevard 04/2006
15th Floor Option: 1 - 5 years
Los Angeles, CA 90036
BRANCH OFFICE:
Beverly Hills Leased 218 128,158
9100 Wilshire Boulevard 03/2000
Beverly Hills, CA 90212 Option: 2 - 10 years
Orange Leased 149 53,960
216 E. Chapman Avenue 01/2001
Orange, CA 92866-1506 Option: 2 - 5 years
Pacific Palisades Leased 112 56,098
15305 Sunset Boulevard 12/2006
Pacific Palisades, CA 90272 Option: 1 - 10 years
Montebello Leased 125 91,496
1300 W. Beverly Boulevard 08/2003
Montebello, CA 90640 Option: 1 - 10 years
Garden Grove Owned 105 79,919
12112 Valley View
Garden Grove, CA 92845-1796
Simi Valley Leased 59 95,617
1445 Los Angeles Avenue 07/1999
Simi Valley, CA 93065 Option: 2 - 30 months
followed by 3 - 5 years
Sylmar Leased 82 45,442
13831 Foothill Boulevard 09/2002
Sylmar, CA 91342 Option: 2 - 10 years
Buena Park Leased 93 10,528
5470 Beach Boulevard 12/2004
Buena Park, CA 90621 Option: 3--5 years
North Hollywood Leased 63 86,966
12848 Victory Boulevard 05/2000
North Hollywood, CA 91606
Beverly/Serrano Leased 124 36,209
4500 W. Beverly Boulevard 01/2006
Los Angeles, CA 90004 Option: 2 - 5 years
Woodland Hills Leased 146 59,022
20259 Ventura Boulevard 11/2009
Woodland Hills 91364 Option: 1 - 10 years
</TABLE>
OC-57
<PAGE>
<TABLE>
<CAPTION>
NET BOOK VALUE TOTAL DEPOSITS
LEASE/OWNED OF PROPERTY AT AT
OFFICE LOCATION LEASE EXPIRATION DATE JUNE 30, 1997 JUNE 30, 1997
- ---------------------------------------------------- ------------------------- --------------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C>
Burbank Leased 373 161,002
240 North San Fernando Road 06/2000
Burbank, CA 91502 Option: 2 - 5 years
Santa Clarita Owned 178 63,214
26425 Sierra Highway
Santa Clarita, CA 91321
Ventura Leased 46 66,867
996 South Seaward Avenue 10/1998
Ventura, CA 93001 Option: 2 - 3 years
Calabasas Leased 89 59,104
23642 Calabasas Road, Bldg. 2 03/2007
Calabasas, CA 91302
Irvine Leased 182 60,024
15475 Jeffrey Road 10/2005
Irvine, CA 92620-4102
Fairfax Leased 78 68,008
145 South Fairfax Avenue 01/2003
Los Angeles, CA 90036 Option: 1 - 5 years
San Pedro Owned 725 88,612
28110 South Western Avenue
San Pedro, CA 80732
------ ---------------
$ 5,201 $ 1,314,036
------ ---------------
------ ---------------
</TABLE>
OC-58
<PAGE>
BENEFICIAL OWNERSHIP OF THE BANK
As of June 30, 1997, there were 100,000 shares of Common Stock of the Bank
issued and outstanding, all of which were owned by SOCAL. The following table
set forth certain information concerning the ownership of the Company's
outstanding Common Stock as of that date.
<TABLE>
<CAPTION>
NAME AND ADDRESS AMOUNT AND NATURE OF
TITLE OF CLASS OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP PERCENT OF CLASS
- ------------------------------------ ------------------------------------ -------------------- -------------------
<S> <C> <C> <C>
Common Stock........................ SoCal Holdings, Inc. 100,000 100%
5900 Wilshire Boulevard
Los Angeles, California 90036
</TABLE>
MANAGEMENT OF THE BANK
DIRECTORS
The following table sets forth certain information regarding the Board of
Directors of the Bank. While the Bank's Bylaws authorize five directors, one
position has remained vacant since December 1995.
<TABLE>
<CAPTION>
POSITIONS HELD WITH
NAME AGE(1) THE BANK DIRECTOR SINCE TERM EXPIRES
- --------------------------------------------- ----------- ----------------------------- --------------- ---------------
<S> <C> <C> <C> <C>
Rudolf P. Guenzel............................ 57 President, Chief Executive 1995 1999
Officer and Director
Henry Peters................................. 56 Chairman of the Board, 1995 1998
Director
Gerard Jervis................................ 49 Director 1995 2000
Robert W. MacDonald.......................... 50 Director 1992 2000
</TABLE>
- ------------------------
(1) As of June 30, 1997.
Set forth below is information with respect to the principal occupations
during at least the last five years for the directors of the Bank.
RUDOLF P. GUENZEL. Mr. Guenzel has served as President of SOCAL and
President, Chief Executive Officer and Director of the Bank since March 1995.
From September 1994 through March 1995, Mr. Guenzel worked as a consultant in
the area of bank profitability analysis. Mr. Guenzel formerly was the President
and Chief Executive Officer and a director of BancFlorida Financial Corp., which
was a New York Stock Exchange listed company, and its subsidiary, Banc Florida,
FSB. He joined the BancFlorida Group in March 1991 when the company was
experiencing serious financial difficulties associated with high non-performing
assets attributable to the national recession and local economic conditions. Mr.
Guenzel directed the Company's attention to problem asset resolution and
returned BancFlorida Financial to profitability. The price of BancFlorida
Financial's common stock increased from a low of $2.375 per share during the
first quarter of 1991 to $30.00 per share, the price at which the shares were
acquired by First Union Corp. in August 1994. Mr. Guenzel served as Chief
Executive Officer through BancFlorida Financial's merger with First Union Corp.
Prior to BancFlorida Financial, Mr. Guenzel was employed by European American
Bank from 1971 until 1989. Mr. Guenzel started as head of the Credit Division,
worked in problem loans resolutions and eventually as responsible for the Bank's
Operations and Systems Division.
HENRY PETERS. Mr. Peters has served as a trustee of the Bishop Estate,
which owns 60% of the common equity of SOCAL, since 1984. In addition, he is
chairman of the board of the Bishop Estate's property and investment management
subsidiary, Royal Hawaiian Shopping Center, Inc. From 1978 through 1984, Mr.
Peters served as Industrial Division Manager of Dura Constructors, a
construction firm
OC-59
<PAGE>
located in Honolulu, Hawaii. From 1974 through 1994, Mr. Peters served as a
Representative to the House of Representatives of the State of Hawaii and from
1981 through 1986, Mr. Peters served as Speaker of the House.
GERARD JERVIS. Mr. Jervis has served as a trustee of the Bishop Estate
since 1994. From 1986 through 1994, Mr. Jervis was partner in the law firm of
Jervis, Winer & Meheula located in Kailua, Hawaii.
ROBERT W. MACDONALD. Mr. MacDonald is Managing Director of William E. Simon
& Sons, a merchant banking firm, where he has been employed since 1991. William
E. Simon & Sons has an indirect ownership in SOCAL through Arbur, Inc. Mr.
MacDonald was with Salomon Brothers between 1971 and 1979 where he eventually
headed the tax-exempt mortgage-backed financing group. In 1980 he left Salomon
Brothers to start a financial advisory firm and Catalyst Energy Corporation, a
leading developer of independent power facilities. The company went public in
1984 and was sold to an investor group in 1988. Between 1988 and 1991, Mr.
MacDonald co-founded a merchant banking corporation, East Rock Partners, which
invested in alternative energy projects.
SENIOR EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
Set forth below is information with respect to the principal occupations
during the last five years for the four senior executive officers who are not
directors.
J. MICHAEL HOLMES. Mr. Holmes has served as Executive Vice President and
Chief Financial Officer of the Bank since March 1995. Mr. Holmes also serves as
Secretary and Treasurer of SOCAL. Prior to SOCAL, Mr. Holmes joined BancFlorida,
FSB in 1974 as Controller and served in various capacities, culminating as
Executive Vice President and Chief Financial Officer in 1985, a position he held
through the company's merger with First Union in August 1994. Mr. Holmes also
served as Secretary, Treasurer and Chief Financial Officer of the parent holding
company, BancFlorida Financial Corp., between 1985 and August 1994.
WILLIAM W. FLADER. Mr. Flader has served as Executive Vice President of
Retail Banking for the Bank since March 1995. Before joining the Bank, Mr.
Flader was employed by Banc Florida, FSB from October 1980 to August 1994 in
various capacities. Mr. Flader served as Senior Vice President of Retail Banking
for BancFlorida from December 1989 to August 1994.
DOREEN J. BLAUSCHILD. Ms. Blauschild came to the Bank as Associate Counsel
in 1988 and was promoted to Vice President, General Counsel in 1989. In 1991,
Ms. Blauschild was promoted to Senior Vice President, General Counsel. Ms.
Blauschild also has served as the Secretary since 1989.
JOHN T. WASLEY. Mr. Wasley is Senior Vice President of the Bank and manages
the Loan Servicing, Commercial Real Estate Lending, Special Assets, Corporate
Real Estate and General Services Departments of the Bank. Mr. Wasley joined the
Bank in 1992 to establish the Special Assets Department. During his tenure at
the Bank, Mr. Wasley has managed the liquidation of $112 million in
non-performing assets. Between 1988 and 1992, Mr. Wasley was President of
Wedgewood Development Company, which was a Los Angeles-based real estate
development company. Between 1984 and 1988, Mr. Wasley was the Chief Financial
Officer of Wedgewood Investment Corporation, which is a Los Angeles-based real
estate investment firm.
SUMMARY COMPENSATION TABLE
The following table includes individual compensation information with
respect to the Chief Executive Officer of the Bank and the other four most
highly compensated officers of the Bank whose total
OC-60
<PAGE>
compensation exceeded $100,000 for services rendered in all capacities during
the fiscal year ended December 31, 1996.
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION ALL OTHER
NAME AND PRINCIPAL POSITION SALARY(1) BONUS AWARDS COMPENSATION (2)
- -------------------------------------------------------- ---------- ---------- --------------- -----------------
<S> <C> <C> <C> <C>
Rudolf P. Guenzel....................................... $ 325,000 $ 243,750(3) N/A $ 4,750
Director, President & Chief
Executive Officer
J. Michael Holmes....................................... 200,000 150,000(3) N/A 3,250
Executive Vice President, Chief
Financial Officer
William W. Flader....................................... 170,000 127,500(3) N/A 3,825
Executive Vice President, Retail
Banking
Doreen J. Blauschild.................................... 150,000 5,000 N/A 2,900
Senior Vice President, General
Counsel
John T. Wasley.......................................... 105,000 5,000 N/A 3,150
Senior Vice President,
Real Estate
</TABLE>
- ------------------------
(1) Does not include amounts attributable to miscellaneous benefits received by
the named officers. The costs to the Bank of providing such benefits to the
named officers during the year ended December 31, 1996 did not exceed the
lesser of $50,000 or 10% of the total of annual salary and bonus reported.
(2) Represents the employers' contribution on behalf of the employee to the
401(k) Plan. See "Benefit Plans."
(3) Amounts were accrued in 1996 and paid in 1997.
EMPLOYMENT AGREEMENTS
On October 21, 1996, the Bank entered into employment agreements with
Messrs. Guenzel, Holmes, and Flader, the President and Chief Executive Officer,
Executive Vice President and Chief Financial Officer and Executive Vice
President, Retail Banking, respectively (individually, the "Executive" and
collectively, the "Executives"). The Bank has agreed to employ the Executives
for a term of three years in their respective positions. The employment
agreements are reviewed annually by the Board of Directors of the Bank, and the
term of the Executives' employment agreements may be extended each year for a
successive additional one-year period on the second anniversary of the
Agreements and on each annual anniversary thereafter, upon approval of the
Bank's Board of Directors, unless either party elects, not less than 30 days
prior to the annual anniversary date, not to extend the employment term. In
addition to a base salary, which amounts to $325,000, $200,000 and $170,000 for
Messrs. Guenzel, Holmes and Flader, respectively, and is reviewed annually, the
Executives are entitled to receive an annual bonus based upon the net income of
the Bank, which begins at 25% of base salary if earnings range from $1.0 million
to $4.9 million, and increases to 100% of base salary if net income equals or
exceeds $15.0 million. In the event that SoCal or the Bank is a party to a
"Capital Transaction," the Executives are also eligible to receive a long-term
bonus based on the gross sales proceeds received pursuant to such a transaction.
A "Capital Transaction" is generally defined to include any one of the
following: (a) the sale of more than 50% of the outstanding voting securities of
SoCal or the Bank; (b) certain mergers or consolidations of SoCal or the Bank in
which more than 50% of the combined voting power of the voting securities of
SoCal or the Bank
OC-61
<PAGE>
change hands; (c) the sale of substantially all of the assets of SoCal or the
Bank; and (d) the liquidation of SoCal or the Bank. Under such circumstances,
the Executives will receive a long term bonus ranging from 3.5% (4.5% in the
case of Mr. Guenzel) of the amount by which gross sales proceeds (as defined)
exceeds between $73.0 million and $138.0 million and 5% (6% in the case of Mr.
Guenzel) of the amount by which gross sales proceeds exceed $138.0 million.
Each of the employment agreements is terminable with or without cause by the
Bank. The Executive shall have no right to compensation or other benefits
pursuant to the employment agreement for any period after voluntary termination
or termination by the Bank for cause, disability, retirement or death, or if the
employment agreement is not continued following a Capital Transaction. In the
event (i) the Executive terminates his employment because of failure of the Bank
to comply with any material provision of the employment agreement, (ii) the
employment agreement is terminated by the Bank other than for cause, disability,
retirement, death, or upon the consummation of a Capital Transaction, or (iii)
the employment agreement is terminated by the Executive for "Good Reason," the
Executive will be entitled to a cash severance amount equal to the Executive's
base salary times the number of years remaining in the term of the employment
agreement up to a maximum of two years. Executives are also entitled to receive
a long-term bonus in the event that a Capital Transaction is consummated within
twelve months of termination. In such an event, any severance amount to which an
Executive is entitled will offset any amount due under the long-term bonus.
"Good Reason" means, without the Executive's express consent, the failure to
reappoint the Executive to his position at the Bank, a material reduction in
base salary, the relocation of the Executive to an office which is more than 50
miles from the current principal executive office of the Bank or a purported
termination which is not effected under the notice provisions of the employment
agreement.
Each employment agreement recognizes that the long-term bonus could
constitute an "excess parachute payment" within the meaning of Section 280G of
the Code if at any time the stock issued by SoCal and/or the Bank becomes
publicly traded or because of some other event, SoCal or the Bank is no longer
entitled to rely upon the exception in Section 280G(d)(5) of the Code for
non-publicly traded corporations. In this event, the employment agreements
provide that the Board of Directors of the Bank will negotiate with the
Executives the granting of a stock option or similar equity based plan of
equivalent value to replace the long-term bonus.
On April 11, 1995, the Bank entered into an employment agreement with Doreen
J. Blauschild. In the event the Bank terminates Ms. Blauschild's employment
after September 11, 1995 without cause or following her resignation due to an
unauthorized reduction in compensation, the employment agreement provides that
Ms. Blauschild shall be entitled to certain benefits including (i) four months
base salary and payment of accrued and unpaid vacation, (ii) a $25,000 lump sum
payment; and (iii) continued coverage under the Bank's group health, dental,
life and disability plans for a period of six months from termination or until
Ms. Blauschild becomes eligible for comparable group benefit coverages,
whichever is earlier. In addition, Ms. Blauschild is also entitled to a payment
equal to 0.25% of the amount by which any net recovery (i.e., gross amount less
attorneys' fees) by and payable to SoCal relating to the SoCal Goodwill
Litigation, whether by judgment or settlement, exceeds $150.0 million. See
"Business of the Bank--Legal Proceedings." The employment agreement generally
defines "cause" as termination because of personal dishonesty, incompetence,
willful misconduct, breach of fiduciary duty involving personal profit,
intentional failure to perform stated duties, willful violation of any law, rule
or regulation (other than traffic violations or similar offenses) or final
cease-and-desist order or material breach of any provision of the employment
agreement.
BENEFIT PLANS
SAVINGS PLUS PLAN. The Bank maintains a 401(k) profit sharing plan (the
"Savings Plan"). The Savings Plus Plan is designed to promote the future
economic welfare of the employees of the Bank and to encourage employee savings.
Employee deferrals of salary and employer contributions made under the
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Savings Plus Plan, together with the income thereon, are accumulated in
individual accounts maintained in trust on behalf of the employee participants,
and is made available to the employee participants upon retirement and under
certain other circumstances as provided in the Savings Plus Plan. Since employee
deferrals of salary and employer contributions made under the Saving Plus Plan
are made on a tax deferred basis, employee participants are able to enjoy
significant income tax savings by participating in the Savings Plus Plan.
Employees are also permitted to direct the investment of their accounts among
six separate funds, including various fixed income and equity investment funds.
An employee of the Bank becomes eligible to participate in the Savings Plus
Plan on the entry date (January 1, April 1, July 1 or October 1) nearest the
date he or she completes a year of service. A year of service is a 12
consecutive month period in which the employee works at least 1,000 hours for
the Bank. Participants may elect to defer amounts up to 15% of their annual
compensation under the Saving Plus Plan, subject to certain limits imposed by
law. The Bank matches 50% of compensation deferred up to 6% and may make
additional discretionary matching contributions. During the years ended December
31, 1996, 1995 and 1994, the Bank contributed $155,000, $159,000 and $245,000,
respectively, to the Savings Plus Plan on behalf of its employees.
PENSION PLAN. The Bank maintains a defined benefit pension plan ("Pension
Plan") covering all employees who were Pension Plan participants as of December
31, 1990. All Pension Plan benefits were frozen as of December 31, 1990. In
general, the Pension Plan provides for annual benefits payable monthly upon
retirement at age 65 in an amount equal to 4.1% of an employee's average annual
salary for the five consecutive years as of December 31, 1990 ("Five Year
Average Compensation") plus 0.65% of Five Year Average Compensation multiplied
by his number of years of service, not in excess of 10 years. Under the Pension
Plan, an employee's benefits are 20% vested after three years of service and
fully vested after seven years of service. A year of service is any year in
which an employee works a minimum of 1,000 hours. Benefits under the Pension
Plan are payable for ten years certain and life thereafter commencing at age 65
and are not subject to Social Security offsets. There was no net periodic
pension cost for 1995 (as the Bank was entitled to a credit of $36,000). The
Bank incurred a net periodic pension cost of $24,000 in 1994. For the year ended
December 31, 1996, there was a net periodic pension cost of approximately
$9,000.
The following table illustrates annual pension benefits for retirement at
age 65 under various levels of compensation and years of service. The figures in
the table assume that the Pension Plan continues in its present form and that
the participant elect a straight life annuity form of benefit.
<TABLE>
<CAPTION>
5 YEARS OF 10 YEARS OF OVER 10 YEARS
FIVE YEAR AVERAGE COMPENSATION SERVICE SERVICE OF SERVICE
- --------------------------------------------------------------------------- ----------- ----------- -------------
<S> <C> <C> <C>
$80,000.................................................................... $ 18,610 $ 37,220 $ 37,220
100,000.................................................................... 23,360 46,720 46,720
120,000.................................................................... 28,110 56,220 56,220
140,000.................................................................... 32,860 65,720 65,720
160,000.................................................................... 37,610 75,220 75,220
180,000.................................................................... 42,360 84,720 84,720
200,000.................................................................... 47,110 94,220 94,220
Over 200,000............................................................... 47,110 94,220 94,220
</TABLE>
The maximum annual compensation which may be taken into account under the
Code (as adjusted from time to time by the Internal Revenue Service) for
calculating contributions under qualified defined benefit plans currently is
$160,000 and the maximum annual benefit permitted under such plans currently is
$125,000.
Ms. Blauschild has 3 years of credited service and her final compensation
earned under such plan as of December 31, 1990 was $95,000. Messrs. Guenzel,
Holmes, Flader, and Wasley are not participants in the Pension Plan and have no
credited service or plan benefits.
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REGULATION
GENERAL
The Bank is a federally chartered and insured stock savings bank subject to
extensive regulation and supervision by the OTS, as the primary federal
regulator of savings associations, and the FDIC, as the administrator of the
SAIF.
The federal banking laws contain numerous provisions affecting various
aspects of the business and operations of savings associations and savings and
loan holding companies. The following description of statutory and regulatory
provisions and proposals, which is not intended to be a complete description of
these provisions or their effects on SOCAL or the Bank, is qualified in its
entirety by reference to the particular statutory or regulatory provisions or
proposals.
REGULATION OF SAVINGS AND LOAN HOLDING COMPANIES
HOLDING COMPANY ACQUISITIONS. SOCAL is a registered savings and loan
holding company. The HOLA and OTS regulations generally prohibit a savings and
loan holding company, without prior OTS approval, from acquiring, directly or
indirectly, the ownership or control of any other savings association or savings
and loan holding company, or all, or substantially all, of the assets or more
than 5% of the voting shares thereof. These provisions also prohibit, among
other things, any director or officer of a savings and loan holding company, or
any individual who owns or controls more than 25% of the voting shares of such
holding company, from acquiring control of any savings association not a
subsidiary of such savings and loan holding company, unless the acquisition is
approved by the OTS.
HOLDING COMPANY ACTIVITIES. SOCAL currently operates as a unitary savings
and loan holding company. Generally, there are limited restrictions on the
activities of a unitary savings and loan holding company and its non-savings
association subsidiaries. If SOCAL ceases to be a unitary savings and loan
holding company, the activities of SOCAL and its non-savings association
subsidiaries would thereafter be subject to substantial restrictions.
The HOLA requires every savings association subsidiary of a savings and loan
holding company to give the OTS at least 30 days' advance notice of any proposed
dividends to be made on its guarantee, permanent or other non-withdrawable
stock, or else such dividend will be invalid. See "--Regulation of Federal
Savings Banks--Capital Distribution Regulation."
AFFILIATE RESTRICTIONS. Transactions between a savings association and its
"affiliates" are subject to quantitative and qualitative restrictions under
Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings
association include, among other entities, the savings association's holding
company and companies that are under common control with the savings
association.
In general, Sections 23A and 23B and OTS regulations issued in connection
therewith limit the extent to which a savings association or its subsidiaries
may engage in certain "covered transactions" with affiliates to an amount equal
to 10% of the association's capital and surplus, in the case of covered
transactions with any one affiliate, and to an amount equal to 20% of such
capital and surplus, in the case of covered transactions with all affiliates. In
addition, a savings association and its subsidiaries may engage in covered
transactions and certain other transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction" is
defined to include a loan or extension of credit to an affiliate; a purchase of
investment securities issued by an affiliate; a purchase of assets from an
affiliate, with certain exceptions; the acceptance of securities issued by an
affiliate as collateral for a loan or extension of credit to any party; or the
issuance of a guarantee, acceptance or letter of credit on behalf of an
affiliate.
In addition, under the OTS regulations, a savings association may not make a
loan or extension of credit to an affiliate unless the affiliate is engaged only
in activities permissible for bank holding
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companies; a savings association may not purchase or invest in securities of an
affiliate other than shares of a subsidiary; a savings association and its
subsidiaries may not purchase a low-quality asset from an affiliate; and covered
transactions and certain other transactions between a savings association or its
subsidiaries and an affiliate must be on terms and conditions that are
consistent with safe and sound banking practices. With certain exceptions, each
loan or extension of credit by a savings association to an affiliate must be
secured by collateral with a market value ranging from 100% to 130% (depending
on the type of collateral) of the amount of the loan or extension of credit.
The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
such subsidiaries as affiliates. The regulation also requires savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail, and provides that certain classes of savings associations may
be required to give the OTS prior notice of affiliate transactions.
REGULATION OF FEDERAL SAVINGS BANKS
REGULATORY SYSTEM. As a federally insured savings bank, lending activities
and other investments of the Bank must comply with various statutory and
regulatory requirements. The Bank is regularly examined by the OTS and must file
periodic reports concerning its activities and financial condition.
Although the OTS is the Bank's primary regulator, the FDIC has "backup
enforcement authority" over the Bank. The Bank's eligible deposit accounts are
insured by the FDIC under the SAIF, up to applicable limits.
FEDERAL HOME LOAN BANKS. The Bank is a member of the FHLB System. Among
other benefits, FHLB membership provides the Bank with a central credit
facility. The Bank is required to own capital stock in an FHLB in an amount
equal to the greater of: (i) 1% of its aggregate outstanding principal amount of
its residential mortgage loans, home purchase contracts and similar obligations
at the beginning of each calendar year, (ii) .3% of total assets, or (iii) 5% of
its FHLB advances (borrowings).
LIQUID ASSETS. Under OTS regulations, for each calendar month, a savings
bank is required to maintain an average daily balance of liquid assets
(including cash, certain time deposits and savings accounts, bankers'
acceptances, certain government obligations and certain other investments) not
less than a specified percentage of the average daily balance of its net
withdrawable accounts plus short-term borrowings (its liquidity base) during the
preceding calendar month. This liquidity requirement, which is currently at
5.0%, may be changed from time to time by the OTS to any amount between 4.0% to
10.0%, depending upon certain factors. OTS regulations also require each savings
association to maintain an average daily balance of short-term liquid assets
equal to not less than 1.0% of the average daily balance of its net withdrawable
accounts and short-term borrowings during the preceding calendar month. The Bank
maintains liquid assets in compliance with these regulations.
REGULATORY CAPITAL REQUIREMENTS. OTS capital regulations require savings
banks to satisfy minimum capital standards: risk-based capital requirements, a
leverage requirement and a tangible capital requirement. Savings banks must meet
each of these standards in order to be deemed in compliance with OTS capital
requirements. In addition, the OTS may require a savings association to maintain
capital above the minimum capital levels. See "--REIT Subsidiary Preferred
Stock."
All savings banks are required to meet a minimum risk-based capital
requirement of total capital (core capital plus supplementary capital) equal to
8% of risk-weighted assets (which includes the credit risk equivalents of
certain off-balance sheet items). In calculating total capital for purposes of
the risk-based requirement, supplementary capital may not exceed 100% of core
capital. Under the leverage requirement, a savings bank is required to maintain
core capital equal to a minimum of 3% of adjusted total assets. (In addition,
under the prompt corrective action provisions of the OTS regulations, all but
the most highly-rated institutions must maintain a minimum leverage ratio of 4%
in order to be adequately
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capitalized. See "--Prompt Corrective Action.") A savings bank is also required
to maintain tangible capital in an amount at least equal to 1.5% of its adjusted
total assets.
Under OTS regulations, a savings bank with a greater than "normal" level of
interest rate exposure must deduct an interest rate risk ("IRR") component in
calculating its total capital for purposes of determining whether it meets its
risk-based capital requirement. Interest rate exposure is measured, generally,
as the decline in an institution's net portfolio value that would result from a
200 basis point increase or decrease in market interest rates (whichever would
result in lower net portfolio value), divided by the estimated economic value of
the savings association's assets. The interest rate risk component to be
deducted from total capital is equal to one-half of the difference between an
institution's measured exposure and "normal" IRR exposure (which is defined as
2%), multiplied by the estimated economic value of the institution's assets. In
August 1995, the OTS indefinitely delayed implementation of its IRR regulation.
Based on internal measures of interest rate risk at June 30, 1997, the Bank
would not have been required to deduct an IRR component in calculating total
risk-based capital had the IRR component of the capital regulations been in
effect.
These capital requirements are viewed as minimum standards by the OTS, and
most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: (1) a
savings association has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, or similar risks or a high proportion of
off-balance sheet risk; (2) a savings association is growing, either internally
or through acquisitions, at such a rate that supervisory problems are presented
that are not dealt with adequately by OTS regulations; and (3) a savings
association may be adversely affected by activities or condition of its holding
company, affiliates, subsidiaries or other persons or savings associations with
which it has significant business relationships. The Bank is not subject to any
such individual minimum regulatory capital requirement.
The Bank's core capital to risk-based assets ratio was 9.65%, its leverage
capital ratio was 4.76% and its total risk-based capital ratio was 10.91% at
June 30, 1997. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Capital Resources."
CERTAIN CONSEQUENCES OF FAILURE TO COMPLY WITH REGULATORY CAPITAL
REQUIREMENTS. A savings bank's failure to maintain capital at or above the
minimum capital requirements may be deemed an unsafe and unsound practice and
may subject the savings bank to enforcement actions and other proceedings. Any
savings bank not in compliance with all of its capital requirements is required
to submit a capital plan that addresses the bank's need for additional capital
and meets certain additional requirements. While the capital plan is being
reviewed by the OTS, the savings bank must certify, among other things, that it
will not, without the approval of its appropriate OTS Regional Director, grow
beyond net interest credited or make capital distributions. If a savings bank's
capital plan is not approved, the bank will become subject to additional growth
and other restrictions. In addition, the OTS, through a capital directive or
otherwise, may restrict the ability of a savings bank not in compliance with the
capital requirements to pay dividends and compensation, and may require such a
bank to take one or more of certain corrective actions, including, without
limitation: (i) increasing its capital to specified levels, (ii) reducing the
rate of interest that may be paid on savings accounts, (iii) limiting receipt of
deposits to those made to existing accounts, (iv) ceasing issuance of new
accounts of any or all classes or categories except in exchange for existing
accounts, (v) ceasing or limiting the purchase of loans or the making of other
specified investments, and (vi) limiting operational expenditures to specified
levels.
The HOLA permits savings banks not in compliance with the OTS capital
standards to seek an exemption from certain penalties or sanctions for
noncompliance. Such an exemption will be granted only
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if certain strict requirements are met, and must be denied under certain
circumstances. If an exemption is granted by the OTS, the savings bank still may
be subject to enforcement actions for other violations of law or unsafe or
unsound practices or conditions.
PROMPT CORRECTIVE ACTION. The prompt corrective action regulation of the
OTS, promulgated under FDICIA, requires certain mandatory actions and authorizes
certain other discretionary actions to be taken by the OTS against a savings
bank that falls within certain undercapitalized capital categories specified in
the regulation.
The regulation establishes five categories of capital classification: "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," and "critically undercapitalized." Under the regulation, the
ratio of total capital to risk-weighted assets, core capital to risk-weighted
assets and the leverage ratio are used to determine an institution's capital
classification. At June 30, 1997, the Bank met the capital requirements of an
"adequately capitalized" institution under applicable OTS regulations.
In general, the prompt corrective action regulation prohibits an insured
depository institution from declaring any dividends, making any other capital
distribution, or paying a management fee to a controlling person if, following
the distribution or payment, the institution would be within any of the three
undercapitalized categories. In addition, adequately capitalized institutions
may accept brokered deposits only with a waiver from the FDIC and are subject to
restrictions on the interest rates that can be paid on such deposits.
Undercapitalized institutions may not accept, renew or roll-over brokered
deposits.
Institutions that are classified as undercapitalized are subject to certain
mandatory supervisory actions, including: (i) increased monitoring by the
appropriate federal banking agency for the institution and periodic review of
the institution's efforts to restore its capital, (ii) a requirement that the
institution submit a capital restoration plan acceptable to the appropriate
federal banking agency and implement that plan, and that each company having
control of the institution guarantee compliance with the capital restoration
plan in an amount not exceeding the lesser of 5% of the institution's total
assets at the time it received notice of being undercapitalized, or the amount
necessary to bring the institution into compliance with applicable capital
standards at the time it fails to comply with the plan, and (iii) a limitation
on the institution's ability to make any acquisition, open any new branch
offices, or engage in any new line of business without the prior approval of the
appropriate federal banking agency for the institution or the FDIC.
The regulation also provides that the OTS may take any of certain additional
supervisory actions against an undercapitalized institution if the agency
determines that such actions are necessary to resolve the problems of the
institution at the least possible long-term cost to the deposit insurance fund.
These supervisory actions include: (i) requiring the institution to raise
additional capital or be acquired by another institution or holding company if
certain grounds exist, (ii) restricting transactions between the institution and
its affiliates, (iii) restricting interest rates paid by the institution on
deposits, (iv) restricting the institution's asset growth or requiring the
institution to reduce its assets, (v) requiring replacement of senior executive
officers and directors, (vi) requiring the institution to alter or terminate any
activity deemed to pose excessive risk to the institution, (vii) prohibiting
capital distributions by bank holding companies without prior approval by the
FRB, (viii) requiring the institution to divest certain subsidiaries, or
requiring the institution's holding company to divest the institution or certain
affiliates of the institution, and (ix) taking any other supervisory action that
the agency believes would better carry out the purposes of the prompt corrective
action provisions of FDICIA.
Institutions classified as undercapitalized that fail to submit a timely,
acceptable capital restoration plan or fail to implement such a plan are subject
to the same supervisory actions as significantly undercapitalized institutions.
Significantly undercapitalized institutions are subject to the mandatory
provisions applicable to undercapitalized institutions. The regulation also
makes mandatory for significantly undercapitalized institutions certain of the
supervisory actions that are discretionary for institutions classified as
undercapitalized, creates a presumption in favor of certain discretionary
supervisory actions,
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and subjects significantly undercapitalized institutions to additional
restrictions, including a prohibition on paying bonuses or raises to senior
executive officers without the prior written approval of the appropriate federal
bank regulatory agency. In addition, significantly undercapitalized institutions
may be subjected to certain of the restrictions applicable to critically
undercapitalized institutions.
The regulation requires that an institution be placed into conservatorship
or receivership within 90 days after it becomes critically undercapitalized,
unless the OTS, with concurrence of the FDIC, determines that other action would
better achieve the purposes of the prompt corrective action provisions of
FDICIA. Any such determination must be renewed every 90 days. A depository
institution also must be placed into receivership if the institution continues
to be critically undercapitalized on average during the fourth quarter after the
institution initially became critically undercapitalized, unless the
institution's federal bank regulatory agency, with concurrence of the FDIC,
makes certain positive determinations with respect to the institution.
Critically undercapitalized institutions are also subject to the
restrictions generally applicable to significantly undercapitalized institutions
and to a number of other severe restrictions. For example, beginning 60 days
after becoming critically undercapitalized, such institutions may not pay
principal or interest on subordinated debt without the prior approval of the
FDIC. (However, the regulation does not prevent unpaid interest from accruing on
subordinated debt under the terms of the debt instrument, to the extent
otherwise permitted by law.) In addition, critically undercapitalized
institutions may be prohibited from engaging in a number of activities,
including entering into certain transactions or paying interest above a certain
rate on new or renewed liabilities.
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may, if the institution is well capitalized,
reclassify it as adequately capitalized; if the institution is adequately
capitalized but not well capitalized, require it to comply with restrictions
applicable to undercapitalized institutions; and, if the institution is
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions.
CONSERVATORSHIP/RECEIVERSHIP. In addition to the grounds discussed under
"--Prompt Corrective Action," the OTS (and, under certain circumstances, the
FDIC) may appoint a conservator or receiver for a savings association if any one
or more of a number of circumstances exist, including, without limitation, the
following: (i) the institution's assets are less than its obligations to
creditors and others, (ii) a substantial dissipation of assets or earnings due
to any violation of law or any unsafe or unsound practice, (iii) an unsafe or
unsound condition to transact business, (iv) a willful violation of a final
cease-and-desist order, (v) the concealment of the institution's books, papers,
records or assets or refusal to submit such items for inspection to any examiner
or lawful agent of the appropriate federal banking agency or state bank or
savings association supervisor, (vi) the institution is likely to be unable to
pay its obligations or meet its depositors' demands in the normal course of
business, (vii) the institution has incurred, or is likely to incur, losses that
will deplete all or substantially all of its capital, and there is no reasonable
prospect for the institution to become adequately capitalized without federal
assistance, (viii) any violation of law or unsafe or unsound practice that is
likely to cause insolvency or substantial dissipation of assets or earnings,
weaken the institution's condition, or otherwise seriously prejudice the
interests of the institution's depositors or the federal deposit insurance fund,
(ix) the institution is undercapitalized and the institution has no reasonable
prospect of becoming adequately capitalized, fails to become adequately
capitalized when required to do so, fails to submit a timely and acceptable
capital restoration plan, or materially fails to implement an accepted capital
restoration plan, (x) the institution is critically undercapitalized or
otherwise has substantially insufficient capital, or (xi) the institution is
found guilty of certain criminal offenses related to money laundering.
ENFORCEMENT POWERS. The OTS and, under certain circumstances, the FDIC,
have substantial enforcement authority with respect to savings associations,
including authority to bring various enforcement actions against a savings
association and any of its "institution-affiliated parties" (a term defined to
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include, among other persons, directors, officers, employees, controlling
stockholders, agents and stockholders who participate in the conduct of the
affairs of the institution). This enforcement authority includes, without
limitation: (i) the ability to terminate a savings association's deposit
insurance, (ii) institute cease-and-desist proceedings, (iii) bring suspension,
removal, prohibition and criminal proceedings against institution-affiliated
parties, and (iv) assess substantial civil money penalties. As part of a
cease-and-desist order, the agencies may require a savings association or an
institution-affiliated party to take affirmative action to correct conditions
resulting from that party's actions, including to make restitution or provide
reimbursement, indemnification or guarantee against loss; restrict the growth of
the institution; and rescind agreements and contracts.
CAPITAL DISTRIBUTION REGULATION. In addition to the prompt corrective
action restriction on paying dividends, OTS regulations limit certain "capital
distributions" by OTS-regulated savings associations. Capital distributions are
defined to include, in part, dividends and payments for stock repurchases and
cash-out mergers.
Under the regulation, an association that meets its fully phased-in capital
requirements both before and after a proposed distribution and has not been
notified by the OTS that it is in need of more than normal supervision (a "Tier
1 association") may, after prior notice to but without the approval of the OTS,
make capital distributions during a calendar year up to the higher of: (i) 100%
of its net income to date during the calendar year plus the amount that would
reduce by one-half its surplus capital ratio at the beginning of the calendar
year, or (ii) 75% of its net income over the most recent four-quarter period. A
Tier 1 association may make capital distributions in excess of the above amount
if it gives notice to the OTS and the OTS does not object to the distribution. A
savings association that meets its regulatory capital requirements both before
and after a proposed distribution but does not meet its fully phased-in capital
requirement (a "Tier 2 association") is authorized, after prior notice to the
OTS but without OTS approval, to make capital distributions in an amount up to
75% of its net income over the most recent four-quarter period, taking into
account all prior distributions during the same period. Any distribution in
excess of this amount must be approved in advance by the OTS. A savings
association that does not meet its current regulatory capital requirements (a
"Tier 3 association") cannot make any capital distribution without prior
approval from the OTS, unless the capital distribution is consistent with the
terms of a capital plan approved by the OTS.
At June 30, 1997, the Bank qualified as a Tier 1 association for purposes of
the capital distribution rule. The OTS may prohibit a proposed capital
distribution that would otherwise be permitted if the OTS determines that the
distribution would constitute an unsafe or unsound practice. The requirements of
the capital distribution regulation supersede less stringent capital
distribution restrictions in earlier agreements or conditions.
The OTS has proposed to amend its capital distribution regulation to conform
its requirements to the OTS prompt corrective action regulation. Under the
proposed regulation, an institution that would remain at least adequately
capitalized after making a capital distribution, and that was owned by a holding
company, would be required to provide notice to the OTS prior to making a
capital distribution. "Troubled" associations and undercapitalized associations
would be allowed to make capital distributions only by filing an application and
receiving OTS approval, and such applications would be approved under certain
limited circumstances.
QUALIFIED THRIFT LENDER TEST. In general, savings associations are required
to maintain at least 65% of their portfolio assets in certain qualified thrift
investments (which consist primarily of loans and other investments related to
residential real estate and certain other assets). A savings association that
fails the qualified thrift lender test is subject to substantial restrictions on
activities and to other significant penalties.
Recent legislation permits a savings association to qualify as a qualified
thrift lender not only by maintaining 65% of portfolio assets in qualified
thrift investments (the "QTL test") but also, in the
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alternative, by qualifying under the Internal Revenue Code as a "domestic
building and loan association." The Bank is a domestic building and loan
association as defined in the Internal Revenue Code.
Recent legislation also expands the QTL test to provide savings associations
with greater authority to lend and diversify their portfolios. In particular,
credit card and educational loans may now be made by savings associations
without regard to any percentage-of-assets limit, and commercial loans may be
made in an amount up to 10 percent of total assets, plus an additional 10
percent for small business loans. Loans for personal, family and household
purposes (other than credit card, small business and educational loans) are now
included without limit with other assets that, in the aggregate, may account for
up to 20% of total assets. At June 30, 1997, under the expanded QTL test,
approximately 89.0% of the Bank's portfolio assets were qualified thrift
investments.
FDIC ASSESSMENTS. The deposits of the Bank are insured by the SAIF of the
FDIC, up to applicable limits, and are subject to deposit premium assessments by
the SAIF. Under the FDIC's risk-based insurance system, SAIF-assessed deposits
have been subject to premiums of between 23 and 31 basis points, depending upon
the institution's capital position and other supervisory factors.
Under legislation enacted in 1996, SAIF-assessable deposits held as of June
30, 1995 were subject to a tax-deductible one-time special assessment at a rate
sufficient to achieve the 1.25% designated reserve ratio of the SAIF as of
October 1, 1996. This special SAIF assessment generally was payable no later
than November 29, 1996. The special assessment amounted to 65.7 cents per $100
of SAIF-assessable deposits and was collected on November 27, 1996. However, as
a result of the Bank's financial condition, the Bank made application to the
FDIC for an exemption from this one-time special assessment, which exemption was
approved on October 5, 1996. As a result, the Bank was exempt from paying the
special one-time assessment (which would have amounted to $9.0 million).
Instead, the Bank will continue to pay future assessments through 1999 at the
assessment rate schedule in effect as of June 30, 1995.
Under the new legislation, institutions with Bank Insurance Fund ("BIF")
deposits are required to share the cost of funding debt obligations issued by
the Financing Corporation ("FICO"), a corporation established by the federal
government in 1987 to finance the recapitalization of FSLIC. However, until the
earlier of December 31, 1999 or the date of elimination of the thrift charter,
the FICO assessment rate for BIF deposits is only 1/5 of the rate applicable to
SAIF deposits. Consequently, the annual FICO assessments to be added to deposit
insurance premiums are expected to equal approximately 6.4 basis points for SAIF
deposits and 1.3 basis points for BIF deposits from January 1, 1997 through
December 31, 1999, and approximately 2.4 basis points for both BIF and SAIF
deposits thereafter. From January 1, 1997, FICO payments will be paid directly
by SAIF and BIF institutions in addition to deposit insurance assessments.
On October 16, 1996, the FDIC lowered the rates on SAIF-assessable deposits.
The rule established SAIF rates ranging from 0 to 27 basis points as of October
1, 1996. However, as a result of the Bank's exemption from paying the one-time
special assessment, the Bank will continue to pay future assessments through
1999 at the assessment rate schedule in effect as of June 30, 1995. Therefore,
as of June 30, 1997, the Bank's annual assessment for deposit insurance was 30.0
basis points of insured deposits as opposed to 6.4 basis points of insured
deposits (which is the rate which applies to the highest rated savings
institutions).
Following the special assessment and the new FICO funding mechanism
effective January 1, 1997, future SAIF assessment rates are expected to depend
primarily on the rate of any new losses from the SAIF insurance fund. Under the
recent legislation, however, the FDIC is not permitted to establish SAIF
assessment rates that are lower than comparable BIF assessment rates.
THRIFT CHARTER. Congress has been considering legislation in various forms
that would require federal thrifts, such as the Bank, to convert their charters
to national or state bank charters. Recent legislation required the Treasury
Department to prepare for Congress a comprehensive study on development of a
common charter for federal savings associations and commercial banks; and, in
the event that the thrift
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charter was eliminated by January 1, 1999, would require the merger of the BIF
and the SAIF into a single Deposit Insurance Fund on that date. In the absence
of appropriate "grandfather" provisions, legislation eliminating the thrift
charter could have a material adverse effect on the Bank and its parent holding
companies because, among other things, these holding companies engage in
activities that are not permissible for bank holding companies and the
regulatory capital and accounting treatment for banks and thrifts differs in
certain significant respects. The Bank cannot determine whether, or in what
form, such legislation may eventually be enacted and there can be no assurance
that any legislation that is enacted would contain adequate grandfather rights
for the Bank and its parent holding companies.
COMMUNITY REINVESTMENT ACT AND THE FAIR LENDING LAWS. Savings associations
have a responsibility under CRA and related regulations of the OTS to help meet
the credit needs of their communities, including low-and moderate-income
neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair
Housing Act (together, the "Fair Lending Laws") prohibit lenders from
discriminating in their lending practices on the basis of characteristics
specified in those statutes. An institution's failure to comply with the
provisions of CRA could, at a minimum, result in regulatory restrictions on its
activities, and failure to comply with the Fair Lending Laws could result in
enforcement actions by the OTS, as well as other federal regulatory agencies and
the Department of Justice.
NEW SAFETY AND SOUNDNESS GUIDELINES. The OTS and the other federal banking
agencies have established guidelines for safety and soundness, addressing
operational and managerial, as well as compensation matters for insured
financial institutions. Institutions failing to meet these standards are
required to submit compliance plans to their appropriate federal regulators. The
OTS and the other agencies have also established guidelines regarding asset
quality and earnings standards for insured institutions.
CHANGE OF CONTROL. Subject to certain limited exceptions, no company can
acquire control of a savings association without the prior approval of the OTS,
and no individual may acquire control of a savings association if the OTS
objects. Any company that acquires control of a savings association becomes a
savings and loan holding company subject to extensive registration, examination
and regulation by the OTS. Conclusive control exists, among other ways, when an
acquiring party acquires more than 25% of any class of voting stock of a savings
association or savings and loan holding company, or controls in any manner the
election of a majority of the directors of the company. In addition, a
rebuttable presumption of control exists if, among other things, a person
acquires more than 10% of any class of a savings association or savings and loan
holding company's voting stock (or 25% of any class of stock) and, in either
case, any of certain additional control factors exist.
Under recent legislation, companies subject to the Bank Holding Company Act
that acquire or own savings associations are no longer defined as savings and
loan holding companies under the HOLA and, therefore, are not generally subject
to supervision and regulation by the OTS. OTS approval is no longer required for
a bank holding company to acquire control of a savings association, although the
OTS has a consultative role with the FRB in examination, enforcement and
acquisition matters.
REIT SUBSIDIARY PREFERRED STOCK. The Bank filed a 30-day notice on June 11,
1997 with the OTS regarding the establishment of the Company as an operating
subsidiary of the Bank. The OTS issued a letter dated September 16, 1997
expressing that it will not object to such establishment.
In conjunction with the operating subsidiary notice, the OTS reviewed among
other things the appropriateness of including the minority interest represented
by the Company's Series A Preferred Shares in the regulatory capital of the
Bank. See "--Regulatory Capital Requirements." In general, as a minority
interest in a consolidated subsidiary, the Series A Preferred Shares are
eligible to be treated as core capital of the Bank, but the OTS may have the
authority to exclude such REIT subsidiary preferred stock from core capital. The
OTS has indicated that it will not exclude REIT subsidiary preferred stock from
the core capital of the parent savings association if the following prudential
standards are met: (i) the REIT subsidiary preferred stock meets all of the same
terms and conditions that preferred stock issued by the
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parent savings association must meet in order to be included in core capital;
(ii) the REIT subsidiary preferred stock cannot be redeemed without the prior
written consent of the OTS; (iii) the REIT subsidiary preferred stock must be
converted into or exchanged for a core capital instrument of the parent savings
association if the OTS directs, in writing, that such a conversion or exchange
should occur because (a) the parent savings association becomes undercapitalized
under prompt corrective action regulations, (b) the parent savings association
is placed in bankruptcy, reorganization, conservatorship or receivership, or (c)
the OTS, in its sole discretion, directs in writing such conversion or exchange
in anticipation of the parent savings association becoming undercapitalized in
the near term; (iv) the amount of the savings association's core capital that is
composed of REIT subsidiary preferred stock does not exceed 25% of core capital
including such REIT subsidiary preferred stock (33 1/3% of core capital
excluding REIT subsidiary preferred stock); and (v) the OTS may exclude REIT
subsidiary preferred stock from core capital if it ceases to provide meaningful
capital support and a realistic ability to absorb losses or otherwise raises
supervisory concerns, including OTS concerns about the capital mix or asset
structure of the REIT subsidiary or the parent savings association. The Bank
expects $28.4 million of the Series A Preferred Shares to be included in the
core capital of the Bank.
TAXATION
FEDERAL TAXATION. The Bank is subject to those rules of federal income
taxation generally applicable to corporations under the Code. The following
discussion of federal taxation is intended only to summarize certain pertinent
federal income tax matters and is not a comprehensive description of the tax
rules applicable to the Bank.
The Bank reports its earnings on a consolidated basis with SOCAL and is
subject to federal income taxation in the same general manner as other
corporations with some exceptions discussed below. The Bank has entered into an
agreement with SOCAL whereby the Bank computes and pays taxes based upon the
Bank's tax position assuming that a separate tax return was filed. However,
while the SOCAL senior debt issued in connection with the 1995 recapitalization
remains outstanding, SOCAL's payment to the Bank is limited to the amount of
consolidated taxes.
METHOD OF ACCOUNTING. For federal income tax purposes, the Bank currently
reports its income and expenses on the accrual method of accounting and uses a
tax year ending December 31 for filing its consolidated federal income tax
returns.
BAD DEBT RESERVES. The Small Business Job Protection Act of 1996 (the "1996
Act") eliminated the use of the reserve method of accounting for bad debt
reserves by savings institutions, effective for taxable years beginning after
1995 and provided for recapture of a portion of the reserves existing at the
close of the last taxable year beginning before January 1, 1996 for institutions
such as the Bank. Prior to the 1996 Act, the Bank was permitted to establish a
reserve for bad debts and to make annual additions to the reserve. These
additions could, within specified formula limits, be deducted in arriving at the
Bank's taxable income. For the tax year 1995, the Bank had a bad debt deduction
of $73 million.
As a further result of the 1996 Act, the Bank must use the specific
chargeoff method in computing its bad debt deduction beginning with its 1996
Federal tax return. Under this method, deductions may be claimed only and to the
extent that loans become wholly or partially worthless.
TAXABLE DISTRIBUTIONS AND RECAPTURE. Prior to the 1996 Act, tax bad debt
reserves were subject to recapture into taxable income should the Bank fail to
meet certain thrift asset definitional tests. New federal legislation eliminated
these thrift related recapture rules. However, under current law, pre-1988
reserves remain subject to recapture should the Bank make certain non-dividend
distributions or cease to maintain a bank charter. The Bank has no pre-1988 bad
debt reserve.
MINIMUM TAX. The Code imposes an alternative minimum tax ("AMT") at a rate
of 20% on a base of regular taxable income plus certain tax preferences
("alternative minimum taxable income" or
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"AMTI"). The AMT is payable to the extent such AMTI is in excess of an exemption
amount. Net operating losses can offset no more than 90% of AMTI. Certain
payments of alternative minimum tax may
be used as credits against regular tax liabilities in future years. As of
December 31, 1996, the Bank had an alternative minimum tax credit carryforward
of approximately $1.2 million.
NET OPERATING LOSS CARRYFORWARDS. The Code allows net operating losses for
tax years beginning before August 5, 1997 to be carried back and deducted from
taxable income for the two preceding taxable years and carried forward and
deducted from taxable income for the 20 succeeding taxable years. The Bank has
federal tax net operating loss carryforwards of approximately $146.7 million at
December 31, 1996.
AVAILABILITY OF NET OPERATING LOSS CARRYFORWARDS. Section 382 of the Code
imposes a limitation on the use of net operating loss carryforwards if there has
been an "ownership change." In general, an ownership change occurs if
immediately after any "owner shift involving a 5% stockholder" or any "equity
structure shift" the percentage of the stock of the corporation owned by one or
more 5% stockholders has increased by more than 50 percentage points over the
lowest percentage of stock of the corporation owned by such stockholders at any
time during the testing period. An "owner shift involving a 5% stockholder" is
defined as any change in the stock ownership of the corporation that affects the
percentage of stock in the corporation owned by any person who is a 5%
stockholder before or after the change. An equity structure shift is defined as
a reorganization other than an "F", divisive "D", or a divisive "G"
reorganization. A 5% stockholder is any stockholder holding 5% or more of the
corporation's stock at any time during the test period. It does not matter
whether that stockholder is a 5% stockholder before the change or after. A 5%
stockholder is defined as any person (or group) holding 5% or more of the
corporation's stock at any time during the testing period. Determinations of
ownership percentages are based upon fair market value. As a general rule,
owners of less than 5% are treated as a single 5% stockholder. All of their
individual stock ownership is aggregated and treated as the ownership percentage
of a single 5% stockholder. The testing period for an ownership change is the
three-year period ending on the day of the owner shift or equity shift.
The 1992 recapitalization resulted in an ownership change as defined by
Section 382 of the Code. As a result, usage of the Bank's net operating loss
carryforwards to offset Federal income tax liability is limited to approximately
$7.7 million per year. Any unused limitation is available in subsequent years
until expiration. The federal tax net operating loss available in 1997 is
approximately $38.7 million.
If the Bank undergoes an "ownership change" in a future year as a result of
transactions unrelated to the Offering, the Bank would be severely limited in
its ability to offset its federal taxable income and federal tax liability with
its net operating losses from the period priors to the ownership change. As of
June 1 ,1995, the Bank had experienced a significant owner shift due to the 1995
recapitalization. Thus, an additional ownership change by a 5% stockholder prior
to June 1, 1998 could impact the Company's ability in the future to utilize its
net operating losses.
STATE TAXATION. The California franchise tax rate applicable to the Bank
equals the franchise tax rate applicable to corporations generally plus an "in
lieu" rate approximately equal to personal property taxes and business license
taxes paid by such corporation (but generally not paid by banks or financial
corporations such as the Bank); however, the total rate cannot exceed 10.84%.
Under California regulations, bad debt deductions are available in computing
California franchise taxes using a three or six year weighted average loss
experience method. The Bank had state tax net operating loss carryforwards of
approximately $8.7 million at December 31, 1996.
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DESCRIPTION OF THE BANK PREFERRED SHARES
The following summary sets forth the material terms and provisions of the
Bank Preferred Shares, and is qualified in its entirety by reference to the
terms and provisions of the Federal Stock Charter of the Bank (the "Charter")
and the First Supplementary Section to Section 5 of the Charter setting forth
the powers, designations, preferences and rights of the Bank Preferred Shares.
GENERAL
The Bank Preferred Shares form a series of the preferred stock of the Bank,
which preferred stock may be issued from time to time in one or more series with
such rights, preferences and limitations as are determined by the Bank's Board
of Directors or, if then constituted, a duly authorized committee thereof. The
Board of Directors has authorized the Bank to issue the Bank Preferred Shares.
When issued, the Bank Preferred Shares will be validly issued, fully paid
and nonassessable. The holders of the Bank Preferred Shares will have no
preemptive rights with respect to any shares of the capital stock of the Bank or
any other securities of the Bank convertible into or carrying rights or options
to purchase any such shares. The Bank Preferred Shares will not be convertible
into shares of Common Stock or any other class or series of capital stock of the
Bank and will not be subject to any sinking fund or other obligation of the Bank
for their repurchase or retirement.
The registrar for the Bank Preferred Shares will send notices to
stockholders of any meetings at which holders of such shares have the right to
elect directors of the Company.
RANKING
The Bank Preferred Shares will rank prior to the Common Stock and to all
other classes and series of equity securities of the Bank now or hereafter
issued, other than any class or series of equity securities of the Bank
expressly designated as being on a parity with or senior to the Bank Preferred
Shares as to dividend rights and rights upon liquidation, winding up or
dissolution. The Bank has the power to create and issue additional preferred
stock or other classes of stock ranking on a parity with the Bank Preferred
Shares, or that constitute junior stock, without any approval or consent of the
holders of Bank Preferred Shares. The rights of holders of the Bank Preferred
Shares will be subordinate to the rights of the Bank's general creditors,
including its depositors.
DIVIDENDS
Holders of Bank Preferred Shares shall be entitled to receive, if, when and
as authorized and declared by the Board of Directors of the Bank out of funds of
the Bank legally available therefor, noncumulative cash dividends at the rate of
% per annum of the initial liquidation preference (equivalent to $
per share per annum). Dividends on the Bank Preferred Shares will be payable, if
declared, quarterly in arrears on June 30, June 30, September 30 and December 31
(or, if such day is not a business day, on the next business day) of each year.
Each declared dividend shall be payable to holders of record as they appear at
the close of business on the stock register of the Bank on such record dates,
not more than 45 calendar days nor less than 10 calendar days preceding the
payment date thereof, as shall be fixed by the Board of Directors of the Bank
provided, however, that if a redemption date for the Bank Preferred Shares
occurs after a dividend is declared but before it is paid, such dividend shall
be paid as part of the redemption price to the person to whom the redemption
price is paid. Upon the exchange of Series A Preferred Shares for Bank Preferred
Shares, any accrued and unpaid dividends of the Series A Preferred Shares at the
time of the conversion will be deemed to be accrued and unpaid dividends on the
Bank Preferred Shares.
The right of holders of Bank Preferred Shares to receive dividends is
noncumulative. Accordingly, if the Board of Directors does not declare a
dividend payable in respect of any dividend period, holders of
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the Bank Preferred Shares will have no right to receive a dividend in respect of
such dividend period, and the Bank will have no obligation to pay a dividend for
such dividend period, whether or not dividends are declared and paid for any
future period.
If any Bank Preferred Shares are outstanding, no full dividends shall be
declared or paid or set apart for payment on any series of capital stock of the
Bank ranking, as to dividends, junior to the Bank Preferred Shares for any
dividend period unless full dividends have been or contemporaneously are
declared and paid or a sum sufficient for the payment thereof is set apart for
such payments on the Bank Preferred Shares for the then-current dividend period.
When dividends are not paid in full (or a sum sufficient for such full payment
is not so set apart) for any dividend period upon the Bank Preferred Shares and
the shares of any parity stock, all dividends declared on the Bank Preferred
Shares and the shares of any other series of capital stock ranking on a parity
as to dividends with the Bank Preferred Shares shall only be declared PRO RATA
based upon the respective amounts that would have been paid on the Bank
Preferred Shares and any shares of parity stock had dividends been paid in full.
In addition to the foregoing restriction, the Bank shall not declare, pay or
set apart funds for any dividends or other distributions (other than in Common
Stock or other junior stock) with respect to any Common Stock or other junior
stock or repurchase, redeem or otherwise acquire, or set apart funds for
repurchase, redemption or other acquisition of, any Common Stock or other junior
stock through a sinking fund or otherwise, unless and until (i) full dividends
on the Bank Preferred Shares for the four (4) most recent preceding dividend
periods (or such lesser number of dividend periods during which shares of Bank
Preferred Shares have been outstanding) are declared and paid or a sum
sufficient for payment has been paid over to the dividend disbursing agent for
payment of such dividends and (ii) the Bank has declared a cash dividend on the
Bank Preferred Shares at the annual dividend rate for the then-current dividend
period, and sufficient funds have been paid over to the dividend disbursing
agent for the payment of such cash dividend for such then-current dividend
period.
No dividend shall be paid or set aside for holders of the Bank Preferred
Shares for any dividend period unless full dividends have been paid or set aside
for the holders of each class or series of equity securities, if any, ranking
senior to the Bank Preferred Shares as to dividends for such dividend period.
REDEMPTION
Except in the case of a Change of Control, the Bank Preferred Shares will
not be redeemable prior to , 2002. On or after such date, the Bank
Preferred Shares will be redeemable in cash by the Bank or its successor or any
acquiring or resulting entity with respect to the Bank (including by any parent
or subsidiary of the Bank, any such successor, or any such acquiring or
resulting entity), as applicable, at its option, in whole or in part, at any
time or from time to time at the redemption price of $25.00 per share, plus
authorized, declared and unpaid dividends to the date of redemption without
interest.
If less than all of the outstanding shares of Bank Preferred Shares are to
be redeemed, the Bank will select those shares to be redeemed pro rata, by lot
or by such other methods as the Board of Directors in its sole discretion
determines to be equitable, provided that such method satisfies any applicable
requirements of any securities exchange on which the Bank Preferred Shares is
then listed.
Upon a Change of Control, the Bank Preferred Shares are redeemable on or
prior to , 2002, at the option of the Bank or its successor or any
acquiring or resulting entity with respect to the Bank (including by any parent
or subsidiary of the Bank or any such successor or any such acquiring or
resulting entity), as applicable, in whole, but not in part, at a price per
share equal to (i) $25.00, plus (ii) an amount equal to the declared and unpaid
dividends, if any, to the date fixed for redemption, without interest, and,
without duplication, an additional amount equal to the amount of dividends that
would be payable on the Bank Preferred Shares in respect of the period from the
first day of the dividend period in which the date fixed for redemption occurs
to the date fixed for redemption (assuming all such dividends were to be
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declared), plus (iii) the Applicable Premium. Any redemption of Bank Preferred
Shares is subject to the prior approval of the OTS.
"Applicable Premium" means an amount equal to (A) the present value of (l)
the dividends that would be payable on the Series A Preferred Shares in respect
of the period from the date fixed for redemption through , 2002 (assuming
all such dividends were to be authorized and declared) plus (2) $25.00 (assuming
such $25.00 is paid on , 2002), computed using a discount rate equal to
the Treasury Rate plus 75 basis points, divided by (B) $25.00.
"Change of Control" means the occurrence of any of the following events:
(i) any Person (as defined herein) other than a Permitted Holder (as
defined herein) shall be the "beneficial owner" (as defined in Rules 13d-3
and 13d-5 under the Exchange Act), directly or indirectly, of a majority in
the aggregate of the total voting power of the voting stock of the Bank or
SOCAL, whether as a result of issuance of securities of the Bank, any
merger, consolidation, liquidation or dissolution of the Bank or SOCAL, any
direct or indirect transfer of securities by a Permitted Holder, or
otherwise; or
(ii) a sale, transfer, conveyance or other disposition, in a single
transaction or in a series of related transactions (other than to an
affiliate of the Bank or any of its subsidiaries), in either case occurring
outside the ordinary course of business, of more than 75% of the assets and
75% of the deposit liabilities of the Bank shown on the consolidated balance
sheet of the Bank as of the end of the most recent fiscal quarter ending at
least 45 days prior to such transaction (or the first in such related series
of transactions).
"Permitted Holder" means the Bishop Estate, BIL Securities or Arbur, or any
Person controlled, directly or indirectly, by the Bishop Estate, BIL Securities
or Arbur.
"Treasury Rate" means the yield to maturity at the time of computation of
United States Treasury securities with a constant maturity (as compiled and
published in the most recent Federal Reserve Statistical Release H.15 (510)
which has become publicly available at least two business days prior to the date
fixed for redemption (or, if such Statistical Release is no longer published,
any publicly available source of similar market data)) most nearly equal to the
period of time to , 2002; provided, however, that if such period is
not equal to the constant maturity of a United States Treasury security for
which a weekly average yield is given, the Treasury Rate shall be obtained by
linear interpolation (calculated to the nearest one-twelfth of a year) from the
weekly average yields of United States Treasury securities for which such yields
are given, except that, if such remaining life is less than one year, the weekly
average yield on actually traded United States Treasury securities adjusted to a
constant maturity of one year shall be used.
Notice of any optional redemption will be mailed at least 30 days, but not
more than 60 days, prior to any redemption date to each holder of shares of Bank
Preferred Shares to be redeemed at its registered address.
If all funds necessary for such redemption are set aside or delivered to the
redemption agent with irrevocable instructions to effect the redemption, then
all shares so called for redemption will be deemed to be no longer outstanding
and all rights with respect to such shares will terminate, except for the right
to receive the funds so deposited, without interest.
The Bank's ability to redeem shares of Bank Preferred Shares is subject to
compliance with applicable regulatory requirements, including those of the OTS,
relating to the redemption of capital instruments.
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VOTING RIGHTS
Except as expressly required by applicable law, or except as indicated
below, the holders of the Bank Preferred Shares will not be entitled to vote. In
the event the holders of Bank Preferred Shares are entitled to vote, each share
of Bank Preferred Shares will be entitled to one vote.
If full dividends on the Bank Preferred Shares have not been paid for six
(6) dividend periods, the maximum authorized number of directors of the Bank
shall thereupon be increased by two (2). Subject to compliance with any
requirement for regulatory approval of (or non-objection to) persons serving as
directors, the holders of the Bank Preferred Shares, voting together as a class
with the holders of any parity stock upon which the same voting rights as those
of the Bank Preferred Shares have been conferred and are irrevocable, will have
the exclusive right to elect the two additional directors at the Bank's next
annual meeting of stockholders and at each subsequent annual meeting until full
dividends have been paid or declared and a sum sufficient for payment thereof is
set apart for payment on the Bank Preferred Shares for four (4) consecutive
dividend periods. The term of such directors elected thereby shall terminate,
and the total number of directors shall be decreased by two (2), upon the first
annual meeting of stockholders after the payment or the declaration and setting
aside for payment of full dividends on the Bank Preferred Shares for four (4)
consecutive dividend periods. Any such director may be removed by, and shall not
be removed except by, the vote of the holders of record of the outstanding Bank
Preferred Shares and parity stock entitled to vote, voting together as a single
class without regard to series, at a meeting of the Bank's stockholders, or of
the holders of Bank Preferred Shares and parity stock so entitled to vote
thereon, called for that purpose. As long as dividends on the Bank Preferred
Shares shall not have been paid for six (6) dividend periods, (i) any vacancy in
the office of any such director may be filled (except as provided in the
following clause (ii)) by an instrument in writing signed by any such remaining
director and filed with the Bank, and (ii) in the case of the removal of any
such director, the vacancy may be filled by the vote of the holders of the
outstanding Bank Preferred Shares and parity stock entitled to vote, voting
together as a single class without regard to series, at the same meeting at
which such removal shall be voted.
So long as any Bank Preferred Share is outstanding, the Bank shall not,
without the consent or vote of the holders of at least two-thirds of the
outstanding Bank Preferred Shares, voting separately as a class, (a) amend,
alter or repeal or otherwise change any provision of the Charter (including the
Supplementary Section establishing the Bank Preferred Shares) if such amendment,
alteration, repeal or change would materially and adversely affect the rights,
preferences, powers or privileges of the Bank Preferred Shares, or (b)
authorize, create or increase the authorized amount of or issue any class or
series of any equity securities of the Bank, or any warrants, options or other
rights convertible or exchangeable into any class or series of any equity
securities of the Bank, ranking prior to the Bank Preferred Shares, either as to
dividend rights or rights on liquidation, dissolution or winding up of the Bank
or (c) merge, consolidate, reorganize or effect any other business combination
involving the Bank, unless the resulting corporation will thereafter have no
class or series of equity securities either authorized or outstanding ranking
prior to the Bank Preferred Shares as to dividends or as to the distribution of
assets upon liquidation, dissolution or winding up, except the same number of
shares of such equity securities with the same rights, preferences, powers and
privileges as the shares of equity securities of the Bank that are authorized
and outstanding immediately prior to such transaction, and each holder of Bank
Preferred Shares immediately prior to such transaction shall receive shares with
the same rights, preferences, powers and privileges of the resulting corporation
as the Bank Preferred Shares held by such holder immediately prior thereto.
The creation or issuance of parity stock or junior stock in respect of the
payment of dividends, or the distribution of assets upon liquidation,
dissolution or winding up of the Bank, or an amendment that increases the number
of authorized shares of Preferred Stock, or Bank Preferred Shares or any junior
stock or parity stock, shall not be deemed to be a material and adverse change
requiring a vote of the holders of the Bank Preferred Shares.
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RIGHTS UPON LIQUIDATION
In the event of any voluntary or involuntary liquidation, dissolution or
winding up of the Bank, the holders of the Bank Preferred Shares at the time
outstanding will be entitled to receive out of assets of the Bank legally
available for distribution to its stockholders, before any distribution of
assets is made to holders of Common Stock or any other class of stock ranking
junior to the Bank Preferred Shares upon liquidation, subject to the rights of
holders of any class or series of equity securities having preference with
respect to distributions upon liquidation and the Bank's general creditors,
including its depositors, liquidating distributions in the amount of $25.00 per
share, plus declared and unpaid dividends thereon, if any, to the date of
liquidation.
After payment of the full amount of the liquidating distributions to which
they are entitled, the holders of the Bank Preferred Shares will have no right
or claim to any of the remaining assets of the Bank. In the event that, upon any
such voluntary or involuntary liquidation, dissolution or winding up, the
available assets of the Bank are insufficient to pay the amount of the
liquidation distributions on all outstanding Bank Preferred Shares and the
corresponding amounts payable on all shares of other classes or series of
capital stock of the Bank ranking on a parity with the Bank Preferred Shares in
the distribution of assets upon any liquidation, dissolution or winding up of
the affairs of the Bank, then the holders of the Bank Preferred Shares and such
other classes or series of capital stock shall share ratably in any such
distribution of assets in proportion to the full liquidating distributions to
which they would otherwise be respectively entitled.
For such purposes, the consolidation or merger or other business combination
of the Bank with or into any other Person, or the sale of all or substantially
all of the assets of the Bank, shall not be deemed to constitute liquidation,
dissolution or winding up of the Bank.
CERTAIN DEFINITIONS
"Applicable Premium" shall have the meaning set forth under "Description of
the Bank Preferred Shares--Redemption.
"Bank" means People's Bank of California and any other obligor upon the Bank
Preferred Shares.
"Change of Control" shall have the meaning set forth under "Description of
the Bank Preferred Shares--Redemption."
"FDIC" means the Federal Deposit Insurance Corporation or any successor
thereto.
"FHLB" means any of the regional Federal Home Loan Banks.
"GAAP" means generally accepted accounting principles, consistently applied.
"OTS" means the Office of Thrift Supervision or any successor thereto.
"Person" means any individual, corporation, limited liability company,
partnership, joint venture, association, joint-stock company, trust,
unincorporated organization or government or any agency or political
subdivisions thereof.
"Regulatory Capital Requirements" means the minimum amount of capital
required to meet each of the industry-wide regulatory capital requirements
applicable to the Bank pursuant to 12 U.S.C. Section 1464(t) and 12 C.F.R.
Section 567 (and any amendment to either thereof) or any successor law or
regulation, or such higher amount of capital as the Bank, individually, is
required to maintain in order to meet any individual minimum capital standard
applicable to the Bank pursuant to 12 U.S.C. Section 1464(s) and 12 C.F.R.
Section 567.3 (and any amendment to either such Section) or any successor law or
regulation.
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EXCHANGE
The Bank Preferred Shares are to be issued, if ever, in connection with an
exchange of the Series A Preferred Shares issued by the Company. The Series A
Preferred Shares are subject to an automatic exchange, in whole and not in part,
on a share-for-share basis, into Bank Preferred Shares if the appropriate
federal regulatory agency directs in writing that an exchange occur because (i)
the Bank becomes "undercapitalized" under prompt corrective action regulations,
(ii) the Bank is placed into conservatorship or receivership or (iii) the
appropriate federal regulatory agency, in its sole discretion, anticipates the
Bank becoming "undercapitalized" in the near term. The Bank has registered with
the OTS a total of 1,426,000 shares of the Bank Preferred Shares to cover the
exchange, if necessary, of the 1,240,000 Series A Preferred Shares offered by
the Company and the 186,000 share over-allotment option granted to the
Underwriters of the Series A Preferred Shares.
LEGAL MATTERS
Certain legal matters with respect to the Bank Preferred Shares will be
passed upon for the Bank by Elias, Matz, Tiernan & Herrick L.L.P.
EXPERTS
The Consolidated Financial Statements of the Bank as of December 31, 1996
and 1995, and for each of the years in the two-year period ended December 31,
1996, have been included herein and in the Offering Circular in reliance upon
the report of KPMG Peat Marwick LLP, independent auditors, appearing elsewhere
herein, and upon the authority of said firm as experts in accounting and
auditing.
The Consolidated Statement of Operations, Changes in Shareholders' Equity
and Cash Flows for the year ended December 31, 1994, included in this Offering
Circular, have been audited by Arthur Andersen LLP, independent public
accountants, as stated in their report appearing herein and has been included in
reliance upon the report of such firm given upon their authority as experts in
accounting and auditing.
OC-79
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Consolidated Financial Statements:
Independent Auditors' Report............................................................................ F-2
Report of Independent Public Accountants................................................................ F-3
Consolidated Statements of Financial Condition at December 31, 1996 and 1995 and June 30, 1997
(unaudited)........................................................................................... F-4
Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994 and the six
month periods ended June 30, 1997 and 1996 (unaudited)................................................ F-5
Consolidated Statements of Changes in Stockholder's Equity for the years ended December 31, 1996, 1995
and 1994 and the six month periods ended June 30, 1997 (unaudited).................................... F-6
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 and the six
month periods ended June 30, 1997 and 1996 (unaudited)................................................ F-7
Notes to Consolidated Financial Statements.............................................................. F-10
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
People's Bank of California:
We have audited the accompanying consolidated statements of financial
condition of People's Bank of California (formerly Southern California Federal
Savings and Loan Association) (a Federal chartered stock association) and
subsidiaries (the Bank) as of December 31, 1996 and 1995 and the related
consolidated statements of operations, changes in stockholder's equity and cash
flows for the years then ended. These consolidated financial statements are the
responsibility of the Bank's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of People's
Bank of California and subsidiaries as of December 31, 1996 and 1995 and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Los Angeles, California
February 21, 1997, except as to note 20 to the
consolidated financial statements,
which is as of July 1, 1997
F-2
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and the Board of Directors of
Southern California Federal Savings and Loan Association:
We have audited the consolidated statements of operations, changes in
shareholders' equity and cash flows of Southern California Federal Savings and
Loan Association (a Federal chartered stock association) and subsidiaries (the
Association) for the year ended December 31, 1994. These consolidated financial
statements are the responsibility of the Association's management. Our
responsibility is to express an opinion on the financial statements based on our
audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of Southern California Federal Savings and Loan Association and
subsidiaries for the year ended December 31, 1994, in conformity with generally
accepted accounting principles.
As more fully discussed in Note 1 to the financial statements included in
the 1994 Annual Report (not included herein), the Association did not meet the
minimum regulatory capital requirements as of December 31, 1994 as set forth by
the Office of Thrift Supervision (OTS) and was operating under a Prompt
Corrective Action Directive and an Accelerated Resolution Plan Agreement (the
Agreements). On May 31, 1995, the OTS and the Federal Deposit Insurance
Corporation (FDIC) approved the recapitalization of the Association in
accordance with the Plan of Reorganization. The OTS stated that upon
consummation of the recapitalization and receipt of written submission by the
Association showing that it was adequately capitalized, the Agreements would be
rescinded. On June 1, 1995, the Association received additional paid in capital
of approximately $60.4 million. Management submitted a filing as of May 31, 1995
which indicated that the Association was adequately capitalized. In connection
with the recapitalization, the Board of Directors and management have
implemented a new strategic plan to return the Association to profitability and
remain in regulatory capital compliance. The achievement of management's
objectives and the ability of the Association to remain in capital compliance is
dependent upon future economic conditions and events which cannot be assured.
Failure of the Association to maintain minimum capital requirements could
subject the Association to regulatory actions. The financial statement impact,
if any, of any regulatory actions that could result from the failure of the
Association to comply with minimum capital requirements is uncertain.
Accordingly, no adjustment that may result from the ultimate resolution of this
uncertainty has been made in the accompanying financial statements.
ARTHUR ANDERSEN LLP
Los Angeles, California
June 9, 1996
F-3
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1996 AND 1995 AND
JUNE 30, 1997 (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
JUNE 30, ----------------------
1997 1996 1995
------------ ---------- ----------
<S> <C> <C> <C>
(UNAUDITED)
ASSETS
Cash and cash equivalents................................................. $ 13,388 14,673 7,249
Federal funds sold........................................................ 3,335 7,200 11,800
Securities purchased under agreements to resell (note 2).................. -- -- 35,000
Securities available-for-sale, at estimated market values (notes 3, 12 and
16)..................................................................... 617,038 502,301 241,645
Mortgage-backed securities held-to-maturity, estimated market values of
$10,324 at June 30, 1997 (unaudited) and $10,899 at December 31, 1996
(notes 5 and 12)........................................................ 10,375 10,971 --
Loans receivable, net (notes 6, 7 and 12)................................. 1,102,381 1,141,707 1,228,152
Real estate held for investment and sale, net (note 8).................... 24,737 22,561 16,288
Premises and equipment, net (note 9)...................................... 5,959 6,262 7,788
Federal Home Loan Bank stock, at cost (note 12)........................... 14,686 15,380 14,527
Accrued interest receivable............................................... 11,829 11,611 9,438
Other assets.............................................................. 16,605 15,205 7,864
------------ ---------- ----------
Total assets........................................................ $ 1,820,333 1,747,871 1,579,751
------------ ---------- ----------
------------ ---------- ----------
LIABILITIES AND STOCKHOLDER'S EQUITY
Deposits (note 10)........................................................ $ 1,314,036 1,371,243 1,473,318
Securities sold under agreements to repurchase (note 11).................. 331,358 192,433 --
Advances from the Federal Home Loan Bank (note 12)........................ 80,000 80,000 31,746
Accrued expenses and other liabilities.................................... 10,021 27,585 7,238
------------ ---------- ----------
Total liabilities................................................... 1,735,415 1,671,261 1,512,302
------------ ---------- ----------
Commitments and contingencies (notes 9 and 16)
Stockholder's equity (notes 1 and 19):
Preferred stock, $.01 par value. Authorized 1,000,000 shares; none
issued or outstanding................................................. -- -- --
Common stock, par value $.01 per share.Authorized 1,000,000 shares;
issued and outstanding 100,000 shares................................. 1 1 1
Additional paid-in capital.............................................. 142,538 142,538 142,538
Unrealized losses on securities available-for-sale...................... (4,402) (6,084) (1,647)
Minimum pension liability, net of tax................................... (293) -- --
Accumulated deficit..................................................... (52,926) (59,845) (73,443)
------------ ---------- ----------
Total stockholder's equity.......................................... 84,918 76,610 67,449
------------ ---------- ----------
Total liabilities and stockholder's equity.......................... $ 1,820,333 1,747,871 1,579,751
------------ ---------- ----------
------------ ---------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND THE
SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
-------------------- -------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1996 1995 1994
--------- --------- --------- --------- ---------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Interest, fees and dividend income:
Short term investments.................................... $ 524 510 1,195 2,498 2,327
Securities purchased under agreements to resell........... 1,551 1,584 3,257 3,157 1,196
Investment securities..................................... 1,335 1,110 2,374 180 --
Mortgage-backed securities................................ 16,197 11,552 26,136 21,836 22,621
Loans receivable.......................................... 41,353 45,784 89,020 94,473 89,293
Federal Home Loan Bank stock.............................. 458 386 914 782 824
--------- --------- --------- --------- ---------
Total interest, fees and dividend
income................................................ 61,418 60,926 122,896 122,926 116,261
--------- --------- --------- --------- ---------
Interest expense:
Deposits (note 10)........................................ 33,957 38,887 75,136 74,866 58,005
Advances from the Federal Home Loan Bank.................. 2,378 942 3,207 11,376 15,511
Securities sold under agreements to repurchase............ 8,093 4,156 10,901 7,067 6,112
Hedging costs, net (note 14).............................. 150 219 387 1,685 8,610
--------- --------- --------- --------- ---------
Total interest expense.................................. 44,578 44,204 89,631 94,994 88,238
--------- --------- --------- --------- ---------
Net interest income..................................... 16,840 16,722 33,265 27,932 28,023
Provision for losses (note 7)............................... 655 2,213 2,884 8,823 24,443
--------- --------- --------- --------- ---------
Net interest income after provision for
losses................................................ 16,185 14,509 30,381 19,109 3,580
--------- --------- --------- --------- ---------
Other income:
Loan service and loan related fees........................ 402 719 1,378 1,582 1,968
Gain on mortgage-backed securities sales, net............. 122 3,600 3,638 641 485
Gain (loss) on loan and loan servicing sales, net
(note 4)................................................ 3,413 (53) (53) (166) 2,712
Income (loss) from real estate operations, net
(note 8)................................................ 112 (197) 1,946 (2,067) (5,398)
Other income.............................................. 795 538 1,215 513 360
--------- --------- --------- --------- ---------
Total other income...................................... 4,844 4,607 8,124 503 127
--------- --------- --------- --------- ---------
Operating expenses:
Personnel and benefits.................................... $ 5,546 5,259 10,763 12,108 19,059
Occupancy................................................. 3,387 3,080 6,389 7,022 8,807
FDIC insurance............................................ 2,499 2,266 4,415 4,290 4,121
Professional services..................................... 292 85 771 2,050 2,007
Office related expenses................................... 1,912 1,802 3,992 3,958 4,441
Other..................................................... 474 679 1,593 1,478 2,443
--------- --------- --------- --------- ---------
Total operating expenses................................ 14,110 13,171 27,923 30,906 40,878
--------- --------- --------- --------- ---------
Earnings (loss) before income tax provision
(benefit)............................................. 6,919 5,945 10,582 (11,294) (37,171)
Income tax provision (benefit) (note 13).................... -- 5 (3,016) (2,646) 11,356
--------- --------- --------- --------- ---------
Net earnings (loss)..................................... $ 6,919 5,940 13,598 (8,648) (48,527)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
AND SIX MONTHS ENDED JUNE 30, 1997 (UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED
GAINS
SERIES B (LOSSES)
SENIOR SERIES A ADDITIONAL ON SECURITIES MINIMUM
PREFERRED PREFERRED COMMON PAID-IN AVAILABLE- PENSION ACCUMULATED
STOCK STOCK STOCK CAPITAL FOR-SALE LIABILITY DEFICIT
----------- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1993......... $ 4 1 1 82,169 1,833 -- (16,268)
Net loss......................... -- -- -- -- -- -- (48,527)
Change in unrealized gains (losses)
on securities
available-for-sale............... -- -- -- -- (1,865) -- --
----------- ----------- ----------- ----------- ------------- ----------- -------------
Balance, December 31, 1994......... 4 1 1 82,169 (32) -- (64,795)
Net loss......................... -- -- -- -- -- -- (8,648)
Redemption of preferred stock and
capital contributions............ (4) (1) -- 60,369 -- -- --
Change in unrealized gains (losses)
on securities
available-for-sale............... -- -- -- (1,615) -- --
----------- ----------- ----------- ----------- ------------- ----------- -------------
Balance, December 31, 1995......... -- -- 1 142,538 (1,647) -- (73,443)
Net earnings....................... -- -- -- -- -- -- 13,598
Change in unrealized gains (losses)
on securities
available-for-sale............... -- -- -- -- (4,437) -- --
----------- ----------- ----------- ----------- ------------- ----------- -------------
Balance, December 31, 1996......... -- -- 1 142,538 (6,084) -- (59,845)
Net earnings (Unaudited)........... -- -- -- -- -- -- 6,919
Change in unrealized gains (losses)
on securities available-for-sale
(Unaudited)...................... -- -- -- -- 1,682 -- --
Minimum pension liability, net of
tax (Unaudited).................. -- -- -- -- -- (293) --
----------- ----------- ----------- ----------- ------------- ----------- -------------
Balance, June 30, 1997
(Unaudited)...................... $ -- -- 1 142,538 (4,402) (293) (52,926)
----------- ----------- ----------- ----------- ------------- ----------- -------------
----------- ----------- ----------- ----------- ------------- ----------- -------------
<CAPTION>
TOTAL
---------
<S> <C>
Balance, December 31, 1993......... 67,740
Net loss......................... (48,527)
Change in unrealized gains (losses)
on securities
available-for-sale............... (1,865)
---------
Balance, December 31, 1994......... 17,348
Net loss......................... (8,648)
Redemption of preferred stock and
capital contributions............ 60,364
Change in unrealized gains (losses)
on securities
available-for-sale............... (1,615)
---------
Balance, December 31, 1995......... 67,449
Net earnings....................... 13,598
Change in unrealized gains (losses)
on securities
available-for-sale............... (4,437)
---------
Balance, December 31, 1996......... 76,610
Net earnings (Unaudited)........... 6,919
Change in unrealized gains (losses)
on securities available-for-sale
(Unaudited)...................... 1,682
Minimum pension liability, net of
tax (Unaudited).................. (293)
---------
Balance, June 30, 1997
(Unaudited)...................... 84,918
---------
---------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
AND THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
----------------------- --------------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1996 1995 1994
----------- ---------- ---------- ------------- -----------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss)........................... $ 6,919 5,940 13,598 (8,648) (48,527)
Adjustments to reconcile net earnings (loss)
to net cash provided by (used in) operating
activities:
Depreciation and amortization............... 617 1,011 1,837 1,770 1,772
Provisions for loan and real estate
losses.................................... 900 2,400 3,650 10,834 29,192
Decrease (increase) in valuation allowance
on net deferred tax asset................. -- -- 10,807 (5,230) (24,394)
(Amortization) write-down for discontinued
lease operations.......................... (57) (62) (150) (309) 1,229
(Decrease) increase in net deferred tax
asset..................................... 280 -- (7,770) 7,880 13,071
Amortization and accretion of premiums,
discounts and deferred fees............... 655 105 515 158 1,354
Amortization of purchase accounting
intangible assets, premiums and discounts,
net....................................... 110 124 (185) (234) (214)
Gain on sale of investment and
mortgage-backed securities................ (122) (3,600) (3,638) (641) (470)
Loss (gain) on sale of loans and loan
servicing................................. (3,413) 53 53 166 (2,712)
Gain on real estate sales................... (1,022) (135) (2,710) (391) (196)
Federal Home Loan Bank stock dividend....... (477) (390) (853) (803) (1,305)
(Increase) decrease in accrued interest
receivable................................ (218) (1,123) (2,173) (176) 815
Increase (decrease) in accrued interest
payable................................... (2,568) 1,515 5,543 (771) (4,025)
Decrease (increase) in other assets......... (1,204) (3,321) (10,317) (1,796) 24,355
Increase (decrease) in accrued expenses..... (15,354) (520) 14,954 (409) (162)
----------- ---------- ---------- ------------- -----------
Net cash provided by (used in) operating
activities.............................. (14,954) 1,997 23,161 1,400 (10,217)
----------- ---------- ---------- ------------- -----------
</TABLE>
(Continued)
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
----------------------- --------------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1996 1995 1994
----------- ---------- ---------- ------------- -----------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from investing activities:
Increase (decrease) in securities purchased under
agreements to resell............................. $ -- 35,000 35,000 (35,000) --
Proceeds from sales of investment and
mortgage-backed securities available-for-sale.... 41,883 51,952 162,087 184,877 49,837
Proceeds from sales of investment and
mortgage-backed securities held-to-maturity...... -- -- -- 38,713 32,253
Proceeds from loan sales including hedging
proceeds......................................... 85,213 -- -- 27,541 394,565
Investment and mortgage-backed security principal
repayments and maturities........................ 43,968 24,395 52,380 58,020 115,156
Loan originations, net of repayments............... 5,411 21,704 41,610 50,391 (439,091)
Purchases of investments and mortgage-backed
securities available-for-sale.................... (199,409) (286,185) (476,748) (212,155) (19,641)
Purchase of mortgage-backed securities
held-to-maturity................................. -- -- (10,971) -- (99,395)
Purchases of loans................................. (68,801) -- -- -- (11,937)
Costs capitalized on real estate................... (546) (1,610) (2,228) (262) (1,026)
Proceeds from sale of real estate.................. 19,602 13,669 40,217 20,299 36,637
Additions to premises and equipment................ (406) (633) (1,081) (886) (1,671)
Sales of premises and equipment.................... -- 559 785 1,027 15
Redemption of FHLB stock........................... 1,171 -- -- 2,914 2,899
----------- ---------- ---------- ------------- -----------
Net cash (used in) provided by investing
activities................................... (71,914) (141,149) (158,949) 135,479 58,601
----------- ---------- ---------- ------------- -----------
</TABLE>
(Continued)
See accompanying notes to consolidated financial statements.
F-8
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
------------------- ---------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1996 1995 1994
--------- -------- -------- ----------- ----------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from financing activities:
Proceeds from capital infusion, net................................. $ -- -- -- 60,384 --
Redemption of preferred stock....................................... -- -- -- (20) --
Net increase (decrease) in deposits................................. (57,207) (42,332) (102,075) 89,100 (4,920)
Net increase (decrease) in securities sold under agreements to
repurchase........................................................ 138,925 177,597 192,433 -- (46,985)
Issuance of FHLB advances........................................... -- 33,900 113,900 12,188,746 2,451,000
Repayment of FHLB advances.......................................... -- (33,900) (65,646) (12,467,000) (2,455,000)
--------- -------- -------- ----------- ----------
Net cash provided by (used in) financing activities............. 81,718 135,265 138,612 (128,790) (55,905)
--------- -------- -------- ----------- ----------
Net increase (decrease) in cash and cash equivalents............ (5,150) (3,887) 2,824 8,089 (7,521)
Cash and cash equivalents at beginning of period...................... 21,873 19,049 19,049 10,960 18,481
--------- -------- -------- ----------- ----------
Cash and cash equivalents at end of period............................ $ 16,723 15,162 21,873 19,049 10,960
--------- -------- -------- ----------- ----------
--------- -------- -------- ----------- ----------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest.......................................................... $ 46,995 42,511 83,691 95,698 83,653
Income taxes...................................................... -- 5 246 4 39
--------- -------- -------- ----------- ----------
--------- -------- -------- ----------- ----------
Supplemental schedule of non cash investing and financing activities:
Securitization of mortgage loans.................................... $ -- -- -- -- 31,997
Foreclosed real estate.............................................. 20,455 28,007 42,518 20,431 21,278
Loans originated in connection with sale of foreclosed real
estate............................................................ 5,078 2,494 12,608 6,412 7,360
--------- -------- -------- ----------- ----------
--------- -------- -------- ----------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-9
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
On May 22, 1995, a plan of reorganization of SoCal Holdings, Inc. (SCH), the
parent company, was adopted by the shareholders of SCH, under which existing
shareholders of SCH agreed to invest an aggregate of $58.5 million in new debt
and equity securities of SCH. Under an existing commitment, one of the
shareholders agreed to purchase from SCH for $1.9 million a Senior Note due 2002
which was also contributed to the capital of SCH. The shareholders also
contributed the SCH Senior Notes due 2002 (including all accrued and unpaid
interest thereon) acquired by them in 1992 to the capital of SCH.
The gross proceeds from the sale of such debt and equity securities less
$36,572 used by SCH to redeem all of the Series A and Series B Preferred Stock
of SCH, or $60.4 million, was contributed by SCH to the capital of People's Bank
of California (the "Bank") on June 1, 1995. Pursuant to a related Plan of
Reorganization of the Bank adopted on May 16, 1995 by the shareholders of the
Bank, the Bank redeemed all outstanding shares of the Bank Series A and Series B
Preferred Stock for an aggregate of $19,688. The remaining net proceeds totaling
$60.4 million were utilized to increase the Bank's capital level. Upon
consummation of the recapitalization of SCH and the Bank, the Bank was
"adequately capitalized."
On May 31, 1995, the Office of Thrift Supervision (OTS) and the Federal
Deposit Insurance Corporation (FDIC) had approved the recapitalization of SCH
and the Bank in accordance with the plans of reorganizations of SCH and the
Bank. Upon written submission to the OTS that the Bank became adequately
capitalized upon consummation of the recapitalization, effective June 1, 1995,
certain regulatory sanctions against the Bank were removed and the Bank was
deemed not subject to 12 C.F.R. Section 565.5 relating to the filing of and
compliance with capital restoration plans.
The following is a description of significant accounting and reporting
policies which the Bank follows in preparing and presenting its consolidated
financial statements.
BASIS OF ACCOUNTING
The consolidated financial statements are prepared in accordance with
generally accepted accounting principles which conform to general practice
within the savings and loan industry. The preparation of these consolidated
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reported periods.
Actual results could differ from these estimates. The consolidated financial
statements as of and for the six-month periods ended June 30, 1997 and 1996 are
unaudited, but in the opinion of management, reflect all necessary adjustments,
consisting only of normal recurring items necessary for fair representation.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Bank and
its subsidiaries, all of which are wholly owned. All significant intercompany
accounts and transactions have been eliminated in consolidation.
F-10
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
FEES ON LOANS AND MORTGAGE-BACKED AND INVESTMENT SECURITIES
The Bank defers origination and related fees on loans and certain direct
loan origination costs. Deferred fees, net of any deferred costs, are recognized
over the life of the related asset as an adjustment of the asset's yield using
the interest method.
Calculation of the yield is done on the aggregate method, and prepayments
are anticipated where there are a large number of similar loans, or similar
loans collateralizing a security, for which prepayments are probable and the
timing and amount of prepayments can be reasonably estimated based on market
consensus prepayment rates. Otherwise, a loan-by-loan or security-by-security
rather than an aggregate approach is used. The yield on adjustable rate loans
and securities is calculated based upon the fully adjusted rate in effect when
the loan or security is originated or purchased, and is not adjusted for
subsequent changes in rates. Initial estimates of prepayment rates are evaluated
periodically against actual prepayment experience and current market consensus
prepayment forecasts, and if significantly different from the original estimate,
the yield is recalculated.
COMMITMENT FEES
Commitment fees received in connection with the origination or purchase of
loans are deferred and recognized over the life of the resulting loans as an
adjustment of yield. If the commitment, or a portion thereof, expires
unexercised, deferred commitment fees are recognized in income upon expiration
of the commitment. There were no expired commitment fees recognized during the
six months ended June 30, 1997 and June 30, 1996 (unaudited) and the years ended
December 31, 1996, 1995 and 1994. Direct costs, if any, to originate a
commitment are expensed as incurred.
Commitment fees paid to an investor in connection with the sale of loans are
expensed and reduce the net sales proceeds at the time of sale.
INVESTMENT SECURITIES AND LOANS
Management determines the appropriate classification of its securities
(mortgage-backed and investment securities) and loans at the time of purchase or
origination.
SECURITIES AVAILABLE-FOR-SALE--Securities to be held for indefinite periods
of time and not intended to be held-to-maturity are classified as
available-for-sale. Assets included in this category are those assets that
management intends to use as part of its asset/liability management strategy and
that may be sold in response to changes in interest rates, resultant prepayment
risk and other factors related to interest rate and resultant prepayment risk
changes. Securities available-for-sale are recorded at fair value. Both
unrealized gains and losses on securities available-for-sale, net of taxes, are
included as a separate component of stockholders' equity in the consolidated
statements of financial condition until these gains or losses are realized.
Gains or losses on sales of securities were based on the specific-valuation
method. If a security has a decline in fair value that is other than temporary,
then the security will be written down to its fair value by recording a loss in
the consolidated statements of operations.
SECURITIES HELD-TO-MATURITY--Securities that management has the intent and
the Bank has the ability at the time of purchase or origination to hold until
maturity are classified as securities held-to-maturity. Securities in this
category are carried at amortized cost adjusted for accretion of discounts and
amortization of premiums using the interest method over the estimated life of
the securities. If a security has a decline in fair value below its amortized
cost that is other than temporary, then the security will be written down to its
new cost basis by recording a loss in the consolidated statements of operations.
F-11
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
LOANS HELD-FOR-SALE--Loans held-for-sale in connection with the Bank's
secondary marketing activities are recorded at the lower of amortized cost or
fair value. Unrealized losses are included in the consolidated statements of
operations.
FEDERAL HOME LOAN BANK (FHLB) STOCK--This asset is owned due to regulatory
requirements and is carried at cost. This stock is pledged as collateral to
secure FHLB advances.
IMPAIRED LOANS
A loan is impaired when it is "probable" that a creditor will be unable to
collect all amounts due (i.e., both principal and interest) according to the
contractual terms of the loan agreement. The measurement of impairment may be
based on (1) the present value of the expected future cash flows of the impaired
loan discounted at the loan's original effective interest rate, (2) the
observable market price of the impaired loan or (3) the fair value of the
collateral of a collateral-dependent loan. The amount by which the recorded
investment of the loan exceeds the measure of the impaired loan is recognized by
recording a valuation allowance.
Interest income on impaired loans is recognized on a cash basis if it is
determined that collection of principal is probable. Loans that are 90 days or
more past due, or when full collection of principal and interest is not
probable, are placed on nonaccrual status and interest income that has been
earned but not collected is reversed. Loans are returned to accrual status when
the borrower has had a period of sustained repayment performance. Management
considers all loans formally treated as troubled debt restructurings to be
impaired loans in the year of restructuring. Impaired loans are valued based
upon the fair value of underlying collateral, if collateral-dependent or
alternatively, the present value of expected cash flows using the loan's
original implicit loan interest rate.
ALLOWANCE FOR LOSSES
Valuation allowances for losses on loans and real estate are provided on
both a specific and general basis. Specific and general valuation allowances are
increased by provisions charged to expense and decreased by charge-offs of loans
and real estate, net of recoveries. Specific allowances are provided for
impaired loans for which the expected loss is measurable. General valuation
allowances are provided based on a formula which incorporates a number of
factors, including economic trends, industry experience, estimated collateral
values, past loss experience, the Bank's underwriting practices, and
management's ongoing assessment of the credit risk inherent in the asset
portfolio. The Bank periodically reviews the assumptions and formula by which
additions are made to the specific and general valuation allowances for losses
in an effort to refine such allowance in light of the current status of the
factors described above.
While management uses the best information available to make the periodic
evaluations of specific and general valuation allowances, adjustments to both
allowances may be necessary if actual future economic conditions differ
substantially from the assumptions used in making such periodic evaluations.
Regulatory examiners may require the Bank to recognize additions to the
allowance based upon their judgments about information available to them at the
time of their examination.
REAL ESTATE HELD FOR INVESTMENT AND FOR SALE
Real estate held for investment consists of investments in limited
partnerships which were acquired for development and sale. Real estate
held-for-sale consists of property acquired in settlement of loans. Real estate
held for investment and for sale is carried at fair value, net of anticipated
selling costs. Fair
F-12
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
value is determined based on recent appraisals or discounted cash flow
calculations. Gains or losses on sales of real estate, net of selling and other
costs, are recognized at the time of sale.
Real estate acquired in settlement of loans is recorded at the date of
acquisition at the lower of the related principal balance upon foreclosure, or
at its fair value, less estimated disposition costs. The excess of the loan
balance over fair value of the asset acquired, if any, is charged to the
allowance for loan losses upon foreclosure. Subsequent to foreclosure,
additional decreases in the carrying value of foreclosed properties are
recognized through a provision charged to operations. An allowance for losses
equal to the excess of the book value over the fair value of the property, less
estimated selling costs is maintained. The allowance for losses is increased or
decreased for subsequent changes in estimated fair market value. Costs of
developing and improving such property to facilitate sale are capitalized.
Expenses related to holding such real estate, net of rental and other income,
are charged against operations as incurred.
GAINS ON THE SALE OF LOANS AND LOAN SERVICING
The Bank services real estate loans for investors that are not included in
the accompanying consolidated financial statements. Fees earned for servicing
loans owned by investors are reported as income when the related mortgage loan
payments are collected. Loan servicing costs are charged to expense as incurred.
Loans or participating interests in loans are sold to others without
recourse. The servicing rights of loans sold may be retained by the Bank, or may
be sold with the loan or sold separately to a third party. Gains or losses from
loan and loan servicing sales are recognized at the time of sale of the loans
and/or the servicing rights.
Gains or losses on sales of loans are recognized at the time of sale and are
determined by the difference between the net sales proceeds and the carrying
value of the loans sold. When servicing is retained, an additional gain or loss
may be recognized based upon the relative fair values of the loan sold and the
present value of expected amounts to be received or paid resulting from the
difference between the contractual interest rates received from the borrowers
and the rates paid to the buyers excluding a normal loan servicing fee,
securitization fees and costs, and considering estimated prepayments on such
loans. The present value of such future receipts creates an asset, the "excess
servicing fee receivable."
The excess servicing fees are amortized using the interest method.
Periodically the excess servicing receivable is evaluated for realizability by
coupon ranges based on current balances of the loans serviced, current market
consensus prepayment rates, and the discount rate used in the original gain
calculation. Amounts determined to be unrealizable are expensed.
DEPRECIATION AND AMORTIZATION
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, which ranges from 3 to 25 years. Leasehold
improvements are amortized using the straight-line method over the lives of the
assets or term of the lease, whichever is shorter. Maintenance and repairs are
expensed as incurred.
TAXES ON INCOME
The Bank uses the asset and liability method for measurement and recognition
of income taxes. The balance sheet amounts of net deferred tax assets or
liabilities are recognized on the temporary differences between the basis of
assets and liabilities as measured by tax laws and their financial statement
basis, plus
F-13
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
available tax operating loss carryforwards and tax credit carryforwards, reduced
by a valuation allowance for that portion of tax assets not considered more
likely than not to be realized. Deferred income tax (benefit) is recognized for
the change in net deferred tax assets or liabilities, plus the valuation
allowance change. Current income tax is the amount of total taxes currently
payable.
DERIVATIVES AND HEDGING ACTIVITIES
The Bank uses interest rate swap (swaps), interest rate cap (caps), interest
rate floor (floors), and interest rate corridor (corridors) contracts in the
management of its interest rate risk. The objective of these financial
instruments is to more closely match the estimated repricing duration and/or
repricing characteristics of specifically identified interest-sensitive assets
and liabilities to reduce interest rate exposure. Such contracts are used to
reduce interest rate risk and are not used for speculative purposes, and
therefore are not marked-to-market. The net interest income or expense, net of
amortization of premiums, discounts and fees, from these contracts is recognized
currently on an accrual basis over their term in interest expense in "hedging
costs, net" in the consolidated statements of operations.
Premiums paid for and discounts associated with, and costs and fees of
interest rate swap, cap, floor and corridor contracts are amortized or accreted
into interest expense on a straight-line basis over the life of the contracts.
CASH AND CASH EQUIVALENTS
For the purposes of the consolidated statements of cash flows, the Bank
considers all highly liquid debt instruments (investments) purchased with a
maturity of three months or less to be cash equivalents. This currently includes
cash and amounts due from banks, Federal funds sold, and time certificates of
deposit.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 125, which was
effective, on a prospective basis, for fiscal years beginning after December 31,
1996. SFAS No. 125 provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishment of liabilities based on
consistent application of a financial-components approach that focuses on
control. SFAS No. 125 extends the "available for sale" and "trading" approach of
SFAS No. 115 to non-security financial assets that can be contractually prepaid
or otherwise settled in such a way that the holder of the asset would not
recover substantially all of its recorded investment. The extension of the SFAS
No. 115 approach to certain non-security financial assets and the amendment to
SFAS No. 115 are effective for financial assets held on or acquired after
January 1, 1997. The adoption of SFAS No. 125 did not have a material adverse
effect on the Bank's financial statements.
In February 1997, the FASB released SFAS No. 128 "Earnings Per Share." SFAS
No. 128 establishes standards for computing and presenting earnings per share
(EPS) and applies to entities with publicly held common stock or potential
common stock. SFAS No. 128 simplifies the standards for computing earnings per
share previously found in APB Opinion No. 15, Earnings Per Share and makes them
comparable to international EPS standards. It replaces the presentation of
primary EPS with a presentation of basic EPS. It also requires dual presentation
of basic and diluted EPS on the face of the numerator and denominator of the
diluted EPS computation.
F-14
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
Basic EPS excludes dilution and is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. Diluted EPS is computed similarly to fully
diluted EPS pursuant to APB Opinion No. 15.
SFAS No. 128 is effective for financial statements issued for periods ending
after December 15, 1997, including interim periods; earlier application is not
permitted. SFAS No. 128 requires restatement of all prior-period EPS data
presented.
In March 1997, the FASB issued SFAS No. 129, "Disclosure of Information
About Capital Structure." Statement 129 continues the existing requirements to
disclose the pertinent rights and privileges of all securities other than
ordinary common stock but expands the number of companies subject to portions of
its requirements.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 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. SFAS No. 130 requires
that all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. SFAS No. 130
requires that an enterprise (a) classify items of other comprehensive income by
their nature in a financial statement and (b) display the accumulated balance of
other comprehensive income separately from retained earnings and additional
paid-in capital in the equity section of a statement of financial position. SFAS
No. 130 is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. Management is in the process of determining
the impact, if any, this statement will have on the Bank.
RECLASSIFICATION
Certain amounts in prior years' financial statements have been reclassified
to conform to the current financial statement presentation.
(2) SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL
The Bank purchases securities under agreements to resell at a later date at
a set price, generally collateralized by AA or higher rated mortgaged-backed
securities. The average outstanding balance was approximately $55,916,000,
$58,919,000 and $51,847,000 during the six months ended June 30, 1997
(unaudited), and the years ended December 31, 1996 and 1995, respectively. The
maximum outstanding balance at any month-end was $25,000,000 and $40,000,000
during 1996 and 1995, respectively. There was no balance outstanding at any
month-end during the six months ended June 30, 1997 (unaudited). The weighted
average interest rate on such agreements was approximately 5.55%, 5.53%, 6.17%
and 4.41% during the six months ended June 30, 1997 (unaudited), and the years
ended December 31, 1996, 1995 and 1994, respectively. The securities pledged are
held by a third-party institution.
F-15
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
(3) SECURITIES AVAILABLE-FOR-SALE
The Bank holds certain securities available-for-sale. The amortized cost,
unrealized gains and losses, and estimated fair value of securities
available-for-sale at June 30, 1997 (unaudited), December 31, 1996 and 1995 were
as follows (dollars in thousands):
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
June 30, 1997 (unaudited):
Debt securities issued by government agency -- due after one
year through five years...................................... $ 50,022 62 (1,139) 48,945
Mortgage-backed securities..................................... 571,418 1,765 (5,090) 568,093
---------- ----------- ----------- -----------
Total securities available-for-sale.......................... $ 621,440 1,827 (6,229) 617,038
---------- ----------- ----------- -----------
---------- ----------- ----------- -----------
December 31, 1996:
Debt securities issued by government agency -- due after one
year through five years...................................... $ 40,023 -- (1,309) 38,714
Mortgage-backed securities..................................... 468,362 170 (4,945) 463,587
---------- ----------- ----------- -----------
Total securities available-for-sale.......................... $ 508,385 170 (6,254) 502,301
---------- ----------- ----------- -----------
---------- ----------- ----------- -----------
December 31, 1995:
Debt securities issued by government agency -- due after five
year through ten years....................................... $ 9,985 9 -- 9,994
Mortgage-backed securities..................................... 233,298 320 (1,967) 231,651
---------- ----------- ----------- -----------
Total securities available-for-sale.......................... $ 243,283 329 (1,967) 241,645
---------- ----------- ----------- -----------
---------- ----------- ----------- -----------
</TABLE>
In November 1995, the Financial Accounting Standards Board issued guidance
to the implementation of SFAS 115, which among other things, allowed for a
one-time reclassification of securities from held-to-maturity to
available-for-sale. In conformity with this guidance, the Bank reclassified
mortgage-backed securities with a book value of approximately $322 million and a
fair value of approximately $321 million to available-for-sale in December 1995.
Additionally, at December 31, 1995, the Bank reclassified mortgage-backed
securities with a book value of approximately $101 million from held-to-maturity
to available-for-sale.
Proceeds from sales of mortgage-backed securities available-for-sale, were
approximately $41,883,000, $51,952,000, $162,087,000, $184,877,000 and
$49,837,000 for the six months ended June 30, 1997 and 1996 (unaudited) and in
each of the years ended December 31, 1996, 1995 and 1994, respectively, and
resulted in gross realized gains of approximately $261,000, $3,657,000,
$3,860,000, $551,000 and $898,000, respectively, and gross realized losses of
approximately $139,000, $57,000, $222,000 and $18,000 for the six months ended
June 30, 1997 and 1996 (unaudited) and in the years ended December 31, 1996 and
1995, respectively. There were no gross realized losses in the year ended
December 31, 1994.
F-16
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
At June 30, 1997 (unaudited), December 31, 1996 and 1995, the amortized cost
and estimated fair value of mortgage-backed securities available-for-sale
pledged to secure borrowings and swap agreements are as follows:
<TABLE>
<CAPTION>
JUNE 30,
1997 1996 1995
----------------------- ------------------------ ------------------------
<S> <C> <C> <C> <C> <C> <C>
AMORTIZED ESTIMATED AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
---------- ----------- ----------- ----------- ----------- -----------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Pledged against:
Securities sold under agreements to repurchase.... $ 355,705 353,801 209,328 206,264 -- --
Advances from Federal Home Loan Bank.............. 87,518 86,542 94,824 93,795 37,503 37,150
Swap and corridor agreements...................... 7,995 7,811 8,442 8,259 6,141 5,987
Treasury tax and loan account..................... 4,822 4,682 5,056 4,874 -- --
Loan servicing custodial deposit accounts......... -- -- 4,614 4,554 5,826 5,812
---------- ----------- ----------- ----------- ----------- -----------
$ 456,040 452,836 322,264 317,746 49,470 48,949
---------- ----------- ----------- ----------- ----------- -----------
---------- ----------- ----------- ----------- ----------- -----------
</TABLE>
(4) LOANS HELD-FOR-SALE
In connection with its secondary marketing activities, the Bank originates
and holds for short time periods certain loans for sale rather than held for
investment. There were no loans held-for-sale at June 30, 1997 (unaudited) and
December 31, 1996 and 1995.
There were no loans sold in 1996. Proceeds from sales of loans held-for-sale
were approximately $85,213,000, $0, $27,541,000 and $394,565,000 in the six
months ended June 30, 1997 and 1996 (unaudited) and in each of the years ended
December 31, 1995 and 1994, respectively, excluding sales of loan servicing
rights and resulted in gross realized gains of approximately $165,000, $0,
$170,000 and $1,270,000 and gross realized losses of approximately $0, $53,000,
$296,000 and $1,175,000 in the six months ended June 30, 1997 and 1996
(unaudited) and in each of the years ended December 31, 1995 and 1994,
respectively. Gains from sales of servicing rights, including flow through and
bulk sales of servicing, were approximately $3,248,000 and $2,951,000 for the
six months ended June 30, 1997 (unaudited) and in the year ended December 31,
1994, respectively. There were no sales of servicing during the years ended
December 31, 1996 and 1995.
In the six months ended June 30, 1997 and 1996 (unaudited) and the years
ended December 31, 1996, 1995 and 1994, write-offs of excess servicing fees
receivable totaled approximately $0, $18,000, $18,000, $40,000 and $45,000,
respectively, and are included in (loss) gain on loan and loan servicing sales
in the accompanying consolidated statements of operations.
F-17
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
(5) MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY
The amortized cost, unrealized gains and losses, and estimated fair value of
mortgage-backed securities at June 30, 1997 (unaudited) and December 31, 1996
are as follows (dollars in thousands):
<TABLE>
<CAPTION>
UNREALIZED UNREALIZED ESTIMATED
AMORTIZED COST GAINS LOSSES FAIR VALUE
-------------- ---------- ------------- -----------
<S> <C> <C> <C> <C>
June 30, 1997 (unaudited)..................................... $ 10,375 -- (51) 10,324
------- ---------- ----- -----------
------- ---------- ----- -----------
December 31, 1996............................................. $ 10,971 -- (72) 10,899
------- ---------- ----- -----------
------- ---------- ----- -----------
</TABLE>
Substantially all mortgage-backed securities are collateralized by
single-family residence secured loans.
There were no sales of mortgage-backed securities in 1996 and for the six
months ended June 30, 1997 (unaudited). Proceeds from sales of mortgage-backed
securities totaled approximately $38,713,000 and $32,253,000 in each of the
years ended December 31, 1995 and 1994, respectively. Such sales resulted in
gross realized gains of approximately $405,000 and $46,000 and gross realized
losses of $297,000 and $459,000 in each of the years ended December 31, 1995 and
1994, respectively.
(6) LOANS RECEIVABLE:
A summary of loans receivable at June 30, 1997 (unaudited) and December 31,
1996 and 1995 is as follows (dollars in thousands):
<TABLE>
<CAPTION>
JUNE 30,
1997 1996 1995
------------ ---------- ----------
<S> <C> <C> <C>
(UNAUDITED)
Real estate loans
Single-family residential:
Fixed rate............................................................ $ 141,645 134,971 122,149
Variable rate......................................................... 405,465 460,944 536,263
Multifamily, primarily variable rate.................................... 442,712 453,064 479,100
Commercial and industrial, primary variable rate........................ 117,906 110,931 120,109
Land, primarily fixed rate.............................................. 6,630 1,639 3,176
------------ ---------- ----------
Real estate loans................................................... 1,114,358 1,161,549 1,260,797
Commercial loans.......................................................... 7,792 3,523 --
Consumer loans............................................................ 4,741 988 --
Secured by deposits....................................................... 2,145 2,132 1,976
------------ ---------- ----------
All loans........................................................... 1,129,036 1,168,192 1,262,773
Less:
Undistributed loan proceeds............................................. 2,309 473 28
Unamortized net loan discounts and deferred origination fees............ 1,545 2,732 3,021
Deferred gain on servicing sold......................................... 4,118 -- --
Allowance for losses.................................................... 18,683 23,280 31,572
------------ ---------- ----------
$ 1,102,381 1,141,707 1,228,152
------------ ---------- ----------
------------ ---------- ----------
</TABLE>
F-18
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
Nonaccrual loans were $14,035,000, $18,238,000, $35,592,000 and $27,458,000
at June 30, 1997 (unaudited) and December 31, 1996, 1995 and 1994, respectively.
If loans which were on nonaccrual at June 30, 1997 and June 30, 1996 (unaudited)
and December 31, 1996, 1995 and 1994 had performed in accordance with their
terms for the period or since origination, if shorter, interest income from
these loans would have been $641,000, $703,000, $1,405,000, $3,154,000 and
$2,257,000, respectively. Interest collected on these loans for these periods
was $175,000, $341,000, $846,000, $1,046,000 and $391,000, respectively.
The Bank's variable rate loans are indexed primarily to the Federal Home
Loan Bank Eleventh District Cost of Funds Index (COFI).
Substantially all real estate collateralized loans are secured by first
trust deeds. The Bank's loan portfolio is concentrated primarily in the state of
California. The commercial real estate secured portfolio is diversified with no
significant industry concentrations of credit risk. Single-family residence,
multifamily, and commercial real estate secured loans are diversified
geographically across the state and by size.
At June 30, 1997 (unaudited) and December 31, 1996, the Bank had loan
applications pending to originate loans of approximately $14,942,000 and
$5,562,000. In addition, the Bank had an outstanding commitment to purchase
$28,900,000 of variable rate single-family residential real estate loans and
$2,446,000 of committed but unused consumer and commercial lines of credit at
June 30, 1997. There were no other outstanding commitments to originate or
purchase loans at December 31, 1996.
(7) ALLOWANCE FOR LOSSES AND PROVISION FOR LOSSES
An analysis of the activity in the allowance for losses for loans and
mortgage-backed securities for the six months ended June 30, 1997 (unaudited)
and each of the years ended December 31, 1996, 1995 and 1994 is as follows
(dollars in thousands):
<TABLE>
<CAPTION>
MORTGAGE-
BACKED
LOANS SECURITIES TOTAL
--------- ----------- ---------
<S> <C> <C> <C>
Balance, December 31, 1993....................................................... $ 20,426 -- 20,426
Provision for losses............................................................. 22,330 2,113 24,443
Charge-offs, net................................................................. (12,955) (2,113) (15,068)
--------- ----------- ---------
Balance, December 31, 1994....................................................... 29,801 -- 29,801
Provision for losses............................................................. 8,823 -- 8,823
Charge-offs, net................................................................. (7,052) -- (7,052)
--------- ----------- ---------
Balance, December 31, 1995....................................................... 31,572 -- 31,572
Provision for losses............................................................. 2,884 -- 2,884
Charge-offs, net................................................................. (11,176) -- (11,176)
--------- ----------- ---------
Balance, December 31, 1996....................................................... 23,280 -- 23,280
Provision for losses (unaudited)................................................. 655 -- 655
Charge-offs, net (unaudited)..................................................... (5,252) -- (5,252)
--------- ----------- ---------
Balance, June 30, 1997 (unaudited)............................................... $ 18,683 -- 18,683
--------- ----------- ---------
--------- ----------- ---------
</TABLE>
The Bank's gross impaired loans were $27,016,000, $31,149,000 and
$44,915,000 as of June 30, 1997 (unaudited) and December 31, 1996 and 1995,
respectively. The average impaired loans for the periods
F-19
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
then ended were $25,438,000, $36,897,000 and $32,386,000. Gross impaired loans
with a valuation allowance totaled $21,082,000 and $23,779,000 and gross
impaired loans without a valuation allowance totaled $5,934,000 and $7,370,000
at June 30, 1997 (unaudited) and December 31, 1996 respectively. Interest income
recognized related to these loans was $1,752,000 and $270,000 for 1996 and 1995,
respectively.
The valuation allowance related to impaired loans was $3,545,000, $6,652,000
and $12,537,000 at June 30, 1997 (unaudited) and December 31, 1996 and 1995,
respectively, and is included in the schedule of the allowance for loan losses
described above.
Troubled debt restructurings totaled $7,529,000, $11,430,000 and $14,729,000
as of June 30, 1997 (unaudited) and December 31, 1996 and 1995, respectively.
The Bank has no commitments to lend additional funds to borrowers whose loans
were classified as troubled debt restructurings at June 30, 1997 and December
31, 1996.
(8) REAL ESTATE HELD FOR INVESTMENT AND FOR SALE
Real estate at June 30, 1997 (unaudited) and December 31, 1996 and 1995,
consisted of the following (dollars in thousands):
<TABLE>
<CAPTION>
JUNE 30,
1997 1996 1995
----------- --------- ---------
<S> <C> <C> <C>
(UNAUDITED)
Acquired for sale or development................................................ $ 8,054 8,641 11,899
Less allowance for losses..................................................... (6,146) (6,516) (6,526)
----------- --------- ---------
Acquired for sale or development............................................ 1,908 2,125 5,373
----------- --------- ---------
Acquired in settlement of loans
Single-family residential..................................................... 4,046 3,309 6,415
Multifamily................................................................... 11,330 8,341 1,274
Commercial and industrial..................................................... 7,457 8,614 4,004
Land.......................................................................... 244 244 682
----------- --------- ---------
23,077 20,508 12,375
Less allowance for losses..................................................... (248) (72) (1,460)
----------- --------- ---------
Acquired in settlement of loans............................................. 22,829 20,436 10,915
----------- --------- ---------
$ 24,737 22,561 16,288
----------- --------- ---------
----------- --------- ---------
</TABLE>
F-20
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
A summary of the components of the income from real estate operations for
the six months ended June 30, 1997 and 1996 (unaudited) and in each of the years
ended December 31, 1996, 1995 and 1994 is as follows (dollars in thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED DECEMBER 31,
------------------------ -------------------------------
<S> <C> <C> <C> <C> <C>
JUNE 1997 JUNE 1996 1996 1995 1994
----------- ----------- --------- --------- ---------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Gross income from real estate operations....................... $ 1,521 2,105 4,761 2,536 3,559
Operating expenses............................................. 2,186 2,250 5,395 2,984 4,404
----------- ----- --------- --------- ---------
Loss from operations......................................... (665) (145) (634) (448) (845)
Gain on real estate sales...................................... 1,022 135 3,346 392 196
----------- ----- --------- --------- ---------
Gain (loss) from real estate operations...................... 357 (10) 2,712 (56) (649)
Provision for losses........................................... (245) (187) (766) (2,011) (4,749)
----------- ----- --------- --------- ---------
Total income (loss) from real estate operations.............. $ 112 (197) 1,946 (2,067) (5,398)
----------- ----- --------- --------- ---------
----------- ----- --------- --------- ---------
</TABLE>
An analysis of the activity in the allowance for losses for real estate
acquired and direct real estate investments for the six months ended June 30,
1997 (unaudited) and for each of the years ended December 31, 1996, 1995 and
1994, respectively, is as follows (dollars in thousands):
<TABLE>
<CAPTION>
DIRECT REAL
REAL ESTATE ESTATE
ACQUIRED INVESTMENTS TOTAL
----------- ----------- ---------
<S> <C> <C> <C>
Balance, December 31, 1993...................................................... $ 2,788 13,260 16,048
Provision for losses............................................................ 4,435 314 4,749
Charge-offs, net................................................................ (2,997) (314) (3,311)
----------- ----------- ---------
Balance, December 31, 1994...................................................... 4,226 13,260 17,486
Provision for losses............................................................ 1,387 624 2,011
Charge-offs, net................................................................ (4,153) (7,358) (11,511)
----------- ----------- ---------
Balance, December 31, 1995...................................................... 1,460 6,526 7,986
Provision for losses............................................................ 396 370 766
Charge-offs, net................................................................ (1,784) (380) (2,164)
----------- ----------- ---------
Balance, December 31, 1996...................................................... 72 6,516 6,588
Provision for losses (unaudited)................................................ 245 -- 245
Charge-offs, net (unaudited).................................................... (69) (370) (439)
----------- ----------- ---------
Balance, June 30, 1997 (unaudited).............................................. $ 248 6,146 6,394
----------- ----------- ---------
----------- ----------- ---------
</TABLE>
F-21
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
(9) PREMISES AND EQUIPMENT
Premises and equipment at June 30, 1997 (unaudited), December 31, 1996 and
1995, consisted of the following (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995
JUNE 30, --------- ---------
1997
-----------
(UNAUDITED)
<S> <C> <C> <C>
Land....................................................... $ 521 521 521
Buildings.................................................. 837 837 746
Furniture, fixtures and equipment.......................... 11,755 11,405 11,594
Leasehold improvements..................................... 4,869 4,906 5,240
----------- --------- ---------
17,982 17,669 18,101
Less accumulated depreciation and amortization............. (12,023) (11,407) (10,313)
----------- --------- ---------
$ 5,959 6,262 7,788
----------- --------- ---------
----------- --------- ---------
</TABLE>
The Bank is committed to operating leases on certain premises. Certain of
these leases require the Bank to pay property taxes and insurance. Some are
subject to annual inflation adjustments, and have renewal options of various
periods at various rates. Lease expense on all property totaled approximately
$1,049,000, $1,127,000, $2,144,000, $3,515,000 and $4,712,000, net of sublease
income of approximately $198,000, $220,000, $452,000, $331,000 and $107,000, in
the six months ended June 30, 1997 and 1996 (unaudited) and in each of the years
ended December 31, 1996, 1995 and 1994, respectively. Included in 1995 lease
expense was a charge of $730,000 for early termination of the lease for the Van
Nuys facilities.
Approximate minimum lease commitments before consideration of the charge for
unused lease property referred to above under noncancelable operating leases at
December 31, 1996 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
YEAR GROSS SUBLEASE NET
- ----------------------------------------------------------------- --------- ----------- ---------
<S> <C> <C> <C>
1997............................................................. $ 2,265 424 1,841
1998............................................................. 2,080 249 1,831
1999............................................................. 2,035 158 1,877
2000............................................................. 1,895 152 1,743
2001............................................................. 5,183 76 5,107
Thereafter....................................................... 2,921 -- 2,921
</TABLE>
F-22
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
(10) DEPOSITS
Deposits at June 30, 1997 (unaudited) and December 31, 1996 and 1995
consisted of the following (dollars in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------
JUNE 30, 1997 1996 1995
------------------------- ------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE AMOUNT RATE
------------ ----------- ------------ ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
(UNAUDITED)
Transaction accounts:
NOW accounts.............. $ 85,123 1.95% 63,776 0.80% 53,866 0.60%
Passbook accounts......... 234,953 4.25 281,907 4.52 185,795 4.49
Money market accounts..... 19,766 2.57 24,518 2.62 35,827 2.32
------------ --- ------------ --- ------------ ---
Transaction accounts.... 339,842 3.57 370,201 3.75 275,488 3.45
------------ --- ------------ --- ------------ ---
Term certificates:
3-month................... 4,353 4.26 5,428 4.05 4,741 4.00
6-month................... 53,290 5.02 75,479 5.02 90,969 5.16
12-month.................. 374,098 5.72 384,211 5.51 226,387 5.78
18-month.................. 145,580 5.63 205,659 5.62 364,970 6.19
24-month.................. 132,578 5.61 108,359 5.99 217,177 5.78
36-month.................. 9,962 6.03 11,409 5.93 15,381 5.44
48-month.................. 1,311 5.76 1,924 5.54 3,265 5.65
60-month.................. 22,466 5.84 44,183 6.23 53,893 6.45
Public funds.............. 2,939 5.87 5,704 6.07 1,671 6.28
$100,000 and over......... 227,617 5.81 158,686 5.70 219,376 6.12
------------ --- ------------ --- ------------ ---
Term certificates....... 974,194 5.67 1,001,042 5.61 1,197,830 5.94
------------ --- ------------ --- ------------ ---
$ 1,314,036 5.13% 1,371,243 5.11% 1,473,318 5.47%
------------ --- ------------ --- ------------ ---
------------ --- ------------ --- ------------ ---
</TABLE>
Term certificates of deposit outstanding by scheduled maturity date at June
30, 1997 (unaudited) and December 31, 1996 are as follows (dollars in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1997 DECEMBER 31, 1996
----------------------- -----------------------
<S> <C> <C> <C> <C>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
---------- ----------- ---------- -----------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Due within 3 months............................ $ 198,329 5.48% 225,614 5.60%
Due within 3 to 6 months....................... 275,408 5.71 262,321 5.44
Due within 6 to 9 months....................... 146,816 5.65 170,454 5.63
Due within 9 to 12 months...................... 202,427 5.83 232,362 5.80
Due within 12 to 24 months..................... 135,603 5.64 78,377 5.69
Due within 24 to 36 months..................... 6,836 6.05 26,705 5.16
Due after 36 months............................ 8,775 5.90 5,209 6.02
---------- --- ---------- ---
Total...................................... $ 974,194 5.67% 1,001,042 5.61%
---------- --- ---------- ---
---------- --- ---------- ---
</TABLE>
F-23
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
The components of deposit interest expense for the six months ended June 30,
1997 and 1996 (unaudited) and in each of the years ended December 31, 1996, 1995
and 1994 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED DECEMBER 31,
---------------------- -------------------------------
<S> <C> <C> <C> <C> <C>
JUNE 30, JUNE 30,
1997 1996 1996 1995 1994
--------- ----------- --------- --------- ---------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
NOW accounts................................................... $ 602 217 449 461 534
Passbook and money market accounts............................. 6,001 5,922 13,035 4,826 3,461
Term certificates--under $100,000.............................. 22,603 27,320 51,809 57,657 43,469
Term certificates--$100,000 and over........................... 4,856 5,531 10,030 12,156 10,759
--------- ----------- --------- --------- ---------
34,062 38,990 75,323 75,100 58,223
Interest forfeitures on early withdrawals...................... (105) (103) (187) (234) (218)
--------- ----------- --------- --------- ---------
$ 33,957 38,887 75,136 74,866 58,005
--------- ----------- --------- --------- ---------
--------- ----------- --------- --------- ---------
</TABLE>
(11) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Bank enters into sales of agency and AA rated mortgage-backed securities
under agreements to repurchase (reverse repurchase agreements) which obligate
the Bank to repurchase the identical securities as those which were sold. Such
transactions are treated as a financing, with the obligations to repurchase
securities sold reflected as a liability and the carrying amount of securities
collateralizing the liability included in mortgage-backed securities in the
consolidated statements of financial condition. There were $331,358,000 and
$192,433,000 outstanding reverse repurchase agreements at June 30, 1997 and
December 31, 1996, respectively.
The maximum repurchase liability balances outstanding at any month-end
during the six months ended June 30, 1997 (unaudited) and years ended December
31, 1996 and 1995 were approximately $331,358,000, $219,229,000 and
$151,626,000, respectively. The average balances outstanding during each of the
six months ended June 30, 1997 (unaudited) and years ended December 31, 1996 and
1995 were approximately $286,410,000, $179,002,000 and $100,071,000,
respectively.
The securities sold under agreements to repurchase identical securities are
held in safekeeping by broker/dealers. It is management's policy to enter into
repurchase agreements only with broker/dealers who are regarded as primary
dealers in these securities and meet satisfactory standards of capitalization
and creditworthiness.
(12) ADVANCES FROM THE FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank of San Francisco at June 30, 1997
(unaudited), December 31, 1996 and 1995 were collateralized by mortgage-backed
agency securities and mortgage loans with a current principal balance of
approximately $86,543,000, $93,795,000 and $37,503,000, respectively, and by the
investment in the stock of the Federal Home Loan Bank of San Francisco with a
carrying value at June 30, 1997 (unaudited), December 31, 1996 and 1995 of
approximately $14,686,000, $15,380,000 and $14,527,000, respectively.
F-24
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
At June 30, 1997 (unaudited) and December 31, 1996, the Bank had a
collateralized available line of credit of approximately $325 million and $352
million with the Federal Home Loan Bank of San Francisco.
The scheduled maturities and weighted average interest rates of advances at
June 30, 1997 (unaudited), December 31, 1996 and 1995 are as follows (dollars in
thousands):
<TABLE>
<CAPTION>
JUNE 30, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
--------------------- -------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
WEIGHTED WEIGHTED WEIGHTED
YEAR OF MATURITY AMOUNT AVERAGE RATE AMOUNT AVERAGE RATE AMOUNT AVERAGE RATE
- ------------------------------------------------------------ ------- ------------ ------ ------------ ------ ------------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
1996........................................................ $ -- --% -- --% 31,746 5.85%
1997........................................................ 31,000 5.76 31,000 5.76 -- --
1998........................................................ 49,000 6.01 49,000 6.01 -- --
------- --- ------ --- ------ ---
$80,000 5.91% 80,000 5.91% 31,746 5.84%
------- --- ------ --- ------ ---
------- --- ------ --- ------ ---
</TABLE>
(13) INCOME TAXES
The Bank and its subsidiaries file a consolidated tax return with SCH. The
Bank entered into a tax sharing agreement with SCH whereby the Bank computes and
pays taxes based upon the Bank's tax position assuming that a separate tax
return was filed. However, while the senior debt is outstanding at SCH, the
payment to the Bank is limited to the amount of consolidated taxes.
The income tax provision (benefit) for the six months ended June 30, 1997
and 1996 (unaudited) and the years ended December 31, 1996, 1995, and 1994
consist of the following (dollars in thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
-------------------------- -------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1996 1995 1994
------------- ----------- --------- --------- ---------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Current:
Federal.................................. $ 95 -- 16 -- --
State.................................... 187 5 5 4 --
----- ----- --------- --------- ---------
Total current.......................... 282 5 21 4 --
----- ----- --------- --------- ---------
Deferred:
Federal.................................. (95) -- (3,037) (2,650) 10,204
State.................................... (187) -- -- -- 1,152
----- ----- --------- --------- ---------
Total deferred......................... (282) -- (3,037) (2,650) 11,356
----- ----- --------- --------- ---------
Total tax.............................. $ -- 5 (3,016) (2,646) 11,356
----- ----- --------- --------- ---------
----- ----- --------- --------- ---------
</TABLE>
F-25
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
The differences between the effective income tax rates and the Federal
statutory rates were as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
-------------------------- -------------------------------
<S> <C> <C> <C> <C> <C>
1997 1996 1996 1995 1994
------------- ----------- --------- --------- ---------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Statutory Federal income tax
rate........................... 34.0% 34.0% 34.0% (34.0)% (34.0)%
Increase (decrease) in taxes:
State franchise tax, net of
Federal benefit................ 7.2 7.5 7.5 (7.5) (7.5)
Change in deferred tax asset
valuation allowance............ (41.2 ) (41.5 ) (70.0) 18.1 72.1
----- ----- --------- --------- ---------
Effective tax rate............... 0.0% 0.0% (28.5)% (23.4)% 30.6%
----- ----- --------- --------- ---------
----- ----- --------- --------- ---------
</TABLE>
Deferred taxes result from "temporary differences" caused by differences in
the periods in which financial statement income and taxable income are reported.
Deferred taxes also result from recognition of future benefits from available
net operating loss carryforwards (NOLs) and tax credit carryforwards whose
probability of realization is determined to be more likely than not.
The realization of tax benefits of deductible temporary differences and NOL
carryforwards depends on whether the Bank has sufficient taxable income within
the carryforward periods as permitted by the tax law to allow for utilization of
the deductible amounts. As of any period-end, the amount of deferred tax asset
that is considered realizable could be reduced if estimates of future taxable
income are reduced. Based on the Bank's projected taxable earnings, management
believes it is more likely than not that the Bank will realize the benefit of
the existing net deferred tax asset at December 31, 1996.
The Bank had the following total Federal and state deferred tax assets and
liabilities computed at the Federal statutory income tax rate and the California
statutory franchise tax rate as of June 30, 1997 (unaudited) and December 31,
1996 and 1995 (dollars in thousands):
<TABLE>
<CAPTION>
JUNE 30, 1997 FEDERAL STATE TOTAL
- ------------------------------------------------------------- ---------- --------- ---------
<S> <C> <C> <C>
(UNAUDITED)
Deductible temporary differences............................. $ 20,666 11,732 32,398
Available NOL carryforwards.................................. 48,268 -- 48,268
AMT tax credit carryforwards................................. 1,296 187 1,483
---------- --------- ---------
Total deferred tax assets.................................. 70,230 11,919 82,149
---------- --------- ---------
Taxable temporary differences................................ (6,804) (797) (7,601)
---------- --------- ---------
Total deferred tax liabilities............................. (6,804) (797) (7,601)
---------- --------- ---------
Deferred tax assets, net of deferred tax liabilities......... 63,426 11,112 74,548
Less deferred tax asset valuation allowances................. (57,739) (11,112) (68,861)
---------- --------- ---------
Net deferred tax assets.................................... $ 5,687 -- 5,687
---------- --------- ---------
---------- --------- ---------
</TABLE>
F-26
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
<TABLE>
<CAPTION>
DECEMBER 31, 1996 FEDERAL STATE TOTAL
- ------------------------------------------------------------- ---------- --------- ---------
<S> <C> <C> <C>
Deductible temporary differences............................. $ 21,322 11,504 32,826
Available NOL carryforwards.................................. 49,876 940 50,816
AMT tax credit carryforwards................................. 1,201 -- 1,201
---------- --------- ---------
Total deferred tax assets.................................. 72,399 12,444 84,843
---------- --------- ---------
Taxable temporary differences................................ (6,614) (746) (7,360)
---------- --------- ---------
Total deferred tax liabilities............................. (6,614) (746) (7,360)
---------- --------- ---------
Deferred tax assets, net of deferred tax liabilities....... 65,785 11,698 77,483
Less deferred tax asset valuation allowances................. (60,098) (11,698) (71,796)
---------- --------- ---------
Net deferred tax assets.................................... $ 5,687 -- 5,687
---------- --------- ---------
---------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1995 FEDERAL STATE TOTAL
- ------------------------------------------------------------- ---------- --------- ---------
<S> <C> <C> <C>
Deductible temporary differences............................. $ 50,337 12,551 62,888
Available NOL carryforwards.................................. 25,591 2,238 27,829
AMT tax credit carryforwards................................. 1,201 -- 1,201
---------- --------- ---------
Total deferred tax assets.................................. 77,129 14,789 91,918
---------- --------- ---------
Taxable temporary differences................................ (6,054) (611) (6,665)
---------- --------- ---------
Total deferred tax liabilities............................. (6,054) (611) (6,665)
---------- --------- ---------
Deferred tax assets, net of deferred tax liabilities....... 71,075 14,178 85,253
Less deferred tax asset valuation allowances................. (68,425) (14,178) (82,603)
---------- --------- ---------
Net deferred tax assets.................................... $ 2,650 -- 2,650
---------- --------- ---------
---------- --------- ---------
</TABLE>
The major components of deferred deductible and taxable temporary
differences before valuation allowances, as of June 30, 1997 (unaudited) and
December 31, 1996 and 1995 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
JUNE 30,
1997 1996 1995
----------- --------- ---------
<S> <C> <C> <C>
(UNAUDITED)
Deductible temporary differences:
Provision for losses on loans and real estate............ $ 16,722 18,744 52,548
Tax gains on sales of loans, net of deferred gains....... 2,314 1,882 2,506
Recognition of interest on nonperforming loans for tax in
excess of book......................................... 3,564 3,122 2,518
Accrued interest on deposits recognized for book but
deferred for tax....................................... 1,499 1,614 1,845
Miscellaneous temporary deductible differences........... 8,299 7,464 3,471
----------- --------- ---------
Total deductible temporary differences................. 32,398 32,826 62,888
----------- --------- ---------
</TABLE>
F-27
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
<TABLE>
<S> <C> <C> <C>
Taxable temporary differences:
Stock dividends from FHLB................................ (2,771) (2,557) (2,169)
Real estate partnership tax losses....................... (253) (253) (256)
Miscellaneous temporary taxable differences.............. (859) (892) (181)
Federal tax effect of state temporary differences, net... (3,718) (3,658) (4,059)
----------- --------- ---------
Total taxable temporary differences.................... (7,601) (7,360) (6,665)
----------- --------- ---------
Total net deductible temporary differences............. $ 24,797 25,466 56,223
----------- --------- ---------
----------- --------- ---------
</TABLE>
The Federal and state tax net operating loss carryforwards December 31, 1996
expire as follows (dollars in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1996
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
YEAR FEDERAL STATE TOTAL
- ---------------------------------------------------- ---------- --------- ---------
1997................................................ $ 1,903 16 1,919
1998................................................ 984 2,282 3,266
1999................................................ 1,113 6,256 7,369
2000................................................ -- 117 117
2001................................................ 510 -- 510
2002................................................ 21,984 -- 21,984
2003................................................ 24,444 -- 24,444
2004................................................ 26 -- 26
2008................................................ 1,946 -- 1,946
2009................................................ 10,650 -- 10,650
2010................................................ 80,307 -- 80,307
2011................................................ 2,828 -- 2,828
---------- --------- ---------
$ 146,695 8,671 155,366
---------- --------- ---------
---------- --------- ---------
</TABLE>
The Bank had Federal alternative minimum tax credit carryforwards of
approximately $1,201,000 at December 31, 1996 and 1995.
In 1992, issuance of preferred stock resulted in a change of control as
defined under Internal Revenue Code Section 382. As a result, usage of the tax
net operating loss carryforwards to offset Federal and state tax return taxable
income is limited to approximately $7.7 million per year. Any unused limitation
is available in subsequent years until expiration. The net operating loss
available in 1997 is approximately $38.7 million.
The Bank is subject to examination by Federal and state taxing authorities
for tax returns filed in previous periods. The results and effects of these
examinations on individual assets and liabilities may require adjustment to the
tax assets and liabilities based on the results of their examinations.
Management believes that the effects of such examinations will not have a
material effect on the Bank.
F-28
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
(14) DERIVATIVES AND HEDGING ACTIVITIES
Hedging costs, net, for the six months ended June 30, 1997 and 1996
(unaudited) and each of the years ended December 31, 1996, 1995 and 1994
consists of the following (dollars in thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED DECEMBER 31,
-------------------------- -------------------------------
<S> <C> <C> <C> <C> <C>
JUNE 1997 JUNE 1996 1996 1995 1994
----------- ------------- --------- --------- ---------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Interest paid on swaps, net of interest received................. $ (3) 40 35 1,217 8,436
Amortization of cost of swaps, caps, floors and corridors, net of
interest received.............................................. 153 179 352 468 174
----- --- --------- --------- ---------
$ 150 219 387 1,685 8,610
----- --- --------- --------- ---------
----- --- --------- --------- ---------
</TABLE>
Interest rate swaps are contracts where the parties agree to exchange fixed
rate for floating rate interest payments, or to exchange floating rate interest
payments upon two different rate indices (basis swap), for a specified period of
time on a specified (notional) amount. The notional amount is used only to
calculate the amount of interest payments to be exchanged and does not represent
credit risk. The notional amount and weighted average pay and receive rates are
shown below in accordance with their contractual dates. The variable repricing
indexes associated with the contracts are three-month London Inter-Bank Offered
Rate (LIBOR), one-month LIBOR and COFI which was 5.78%, 5.69% and 4.86%,
respectively, at June 30, 1997 and 5.56%, 5.5%, and 4.83%, respectively, at
December 31, 1996.
A summary of the swap contract, scheduled maturity date and weighted average
rate received and paid at June 30, 1997 (unaudited) and December 31, 1996 is as
follows (dollars in thousands):
<TABLE>
<CAPTION>
JUNE 30, 1997 YEAR OF NOTIONAL AVERAGE RATE AVERAGE
(UNAUDITED) MATURITY AMOUNT PAID RATE RECEIVED
- ------------------------ ----------- ----------- --------------- ---------------
<S> <C> <C> <C> <C>
Pay floating and receive
fixed................. 1999 $ 5,829 5.69% 5.69%
----------- --- ---
----------- --- ---
</TABLE>
<TABLE>
<CAPTION>
YEAR OF NOTIONAL AVERAGE RATE AVERAGE
DECEMBER 31, 1996 MATURITY AMOUNT PAID RATE RECEIVED
- ------------------------ ----------- ----------- --------------- ---------------
<S> <C> <C> <C> <C>
Pay floating and receive
fixed................. 1999 $ 7,026 5.56% 5.69%
----------- --- ---
----------- --- ---
</TABLE>
Swap contracts were entered into to limit the interest rate risk related to
the relative repricing characteristics of the Bank's interest-bearing deposits.
The floating rate on swap contracts re-prices at intervals of one to three
months based on the current index in effect at that time. If all contracts were
repriced at the current index in effect at each year-end, the weighted average
rate paid and received would be 5.69% and 5.69% at June 30, 1997 (unaudited) and
5.50% and 5.69% at December 31, 1996.
The notional amount of the swap amortizes monthly based upon the performance
of a specific index. The swap is used to reduce interest rate risk associated
with fixed rate term liabilities. The performance of the swap is based upon
interest rates in general. The above table does not include anticipated
amortization
F-29
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
relating to the swap. Excluding this transaction, the Bank does not have any
other positions in complex derivative transactions.
Mortgage-backed securities with book values of approximately $7,995,000,
$8,442,000 and $6,141,000 and market values of approximately $7,811,000,
$8,259,000 and $5,987,000 at June 30, 1997 (unaudited) and December 31, 1996 and
1995, respectively, are pledged as collateral for certain swap agreements.
The Bank has only limited involvement in derivative financial instruments
and does not use them for trading purposes. The instruments are used to manage
interest rate risk.
The Bank has entered into corridor contracts to artificially raise the
interest rate cap on certain loans. The corridor contracts provide for the
payment of interest on the outstanding principal contract amount. Under such
contracts, the Bank receives interest if an interest rate that varies according
to a specified index exceeds a pre-set level (the strike rate) up to an upper
limit (the limit) beyond which additional interest is not received if the rate
increases. The index on the Bank's corridors is COFI or three-month LIBOR. A
summary of corridor contracts and average interest rate ranges at December 31,
1996 is as follows (dollars in thousands):
<TABLE>
<CAPTION>
YEAR OF CONTRACT AVERAGE STRIKE AVERAGE LIMIT
MATURITY AMOUNT PRICE RATE
- ----------- --------- ----------------- ---------------
<S> <C> <C> <C>
1997 $ 20,000 6.64% 8.23%
1998 5,000 6.38 8.13
1999 20,000 6.64 8.23
2000 12,000 6.38 8.13
2001 20,000 6.64 8.23
--------- --- ---
$ 77,000 6.58% 8.21%
--------- --- ---
--------- --- ---
</TABLE>
(15) BENEFIT PLANS
The Bank has had a noncontributory defined benefit pension plan covering
substantially all of its employees (the Plan) hired before 1990. The benefits
are based on years of service and the employee's highest compensation during the
last five consecutive years of employment prior to 1991. The Plan was frozen
effective December 31, 1990, and consequently, employees will no longer earn
additional defined benefits for future services; however, future service may be
counted toward vesting of benefits accumulated based on past service. The Bank's
funding policy has been to contribute annually the minimum amount that can be
deducted for Federal income tax purposes.
F-30
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
The following table sets forth the funded status of the Plan and amounts
recognized in the Bank's consolidated statements of financial condition at
December 31, 1996 and 1995 (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995
--------- ---------
<S> <C> <C>
Actuarial present value of benefit obligation:
Vested benefits............................................................................. $ (4,804) (4,638)
Nonvested benefits.......................................................................... (255) (368)
--------- ---------
Accumulated benefit obligations........................................................... $ (5,059) (5,006)
--------- ---------
--------- ---------
Projected benefit obligation for services rendered to date.................................... $ (5,059) (5,006)
Plan assets at fair value, primarily cash and cash equivalents, listed stocks and U.S.
bonds....................................................................................... 4,492 4,386
--------- ---------
Projected benefit obligation (in excess of) or less than plan assets...................... (567) (620)
Prior service cost not yet recognized in net periodic cost.................................... -- --
Additional minimum liability.................................................................. (1,117) (1,133)
Unrecognized net loss......................................................................... 1,117 1,133
--------- ---------
Pension liability recognized in the consolidated statement of financial condition......... $ (567) (620)
--------- ---------
--------- ---------
</TABLE>
Net periodic cost included the following components (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Service costs/benefits earned during the period........................................... $ -- -- --
Interest cost on projected benefit obligation............................................. 367 332 356
Actual return on plan assets.............................................................. (203) (293) (164)
Net amortization and deferral............................................................. (155) (75) (168)
--------- --- ---
Net periodic pension cost............................................................. $ 9 (36) 24
--------- --- ---
--------- --- ---
Assumptions used:
Discount rate........................................................................... 7.50% 7.25% 8.50%
Expected long-term rate of return....................................................... 9.00 9.00 9.00
--------- --- ---
--------- --- ---
</TABLE>
The Bank adopted a 401(k) plan, effective January 1, 1991. The 401(k) plan
covers employees with one year or more of service, and allows participants to
contribute a portion of their covered compensation, which amount is 100% vested
at the time of contribution. The Bank shall contribute an amount equal to 50% of
the participant's contribution up to 6% of the participant's covered
compensation, which amount vests over a period of five years. The Bank may elect
to make additional contributions on a discretionary basis. The contributions as
directed by the participants are invested by the 401(k) plan's trustee in one or
more of five investment alternatives in trust for the benefit of the
participants. The Bank incurred approximately $117,000, $131,000, $155,000,
$159,000 and $245,000 of expense related to the 401(k) plan, including a
discretionary contribution of approximately $0, $0, $0, $0 and $0, in the six
months ended June 30, 1997 and 1996 (unaudited) and in each of the years ended
December 31, 1996, 1995 and 1994, respectively.
The Bank established a Supplemental Executive Retirement Plan for certain
senior officers (the SERP), effective January 1, 1991 to supplement retirement
income provided by the Plan. The SERP was a
F-31
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
fully funded, non-qualified defined benefit plan. The Bank incurred
approximately $186,000 of expense related to the SERP in 1994. The SERP was
terminated in 1995 and the SERP assets were distributed to participants at no
additional cost to the Bank.
(16) COMMITMENTS AND CONTINGENCIES
The Bank is involved in litigation arising in the normal course of business.
Based on information from internal and external legal counsel, and review of the
facts and circumstances of such litigation, management is of the opinion that
the ultimate resolution of all pending litigation proceedings will not have an
adverse material effect on the Bank.
(17) FAIR VALUE OF ASSETS AND LIABILITIES
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosure of fair value information about financial instruments,
whether or not recognized in the statements of financial condition, for which it
is practicable to estimate that value. In cases where quoted market prices are
not available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent market and, in many cases, could not be realized in
immediate settlement of the instrument. SFAS No. 107 excludes certain financial
instruments and all non-financial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Bank.
The carrying amounts and fair values of the Bank's financial instruments
consisted of the following December 31, 1996 and 1995 (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995
---------------------- ----------------------
<S> <C> <C> <C> <C>
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------- ---------- ---------- ----------
Financial assets:
Cash and cash equivalents................................... $ 21,873 21,873 19,049 19,049
Securities purchased under agreement to resell.............. -- -- 35,000 35,000
Securities available-for-sale............................... 502,301 502,301 241,645 241,645
Mortgage-backed securities held-to-maturity................. 10,971 10,899 -- --
Loans receivable............................................ 1,141,707 1,130,593 1,228,152 1,235,195
Federal Home Loan Bank stock................................ 15,380 15,380 14,527 14,527
Financial liabilities:
Deposits.................................................... 1,371,243 1,387,867 1,473,318 1,479,422
Securities sold under agreements to repurchase.............. 192,433 192,433 -- --
Advances from the Federal Home Loan Bank.................... 80,000 80,000 31,746 31,746
Financial instruments:
Interest rate swaps......................................... -- (5) -- (131)
Interest rate floors........................................ 26 (2) 90 37
Interest rate corridors..................................... 719 458 1,008 510
</TABLE>
F-32
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
The following methods and assumptions were used to estimate the fair value
of each type of financial instrument:
- Cash and Cash Equivalents--The carrying amount approximates the fair value
for cash and short-term investments.
- Securities Purchased under Agreements to Resell--The carrying amount
approximates the fair value.
- Securities Available-for-Sale--Fair value is based on quoted market prices
or dealer quotes.
- Mortgage-Backed Securities--Fair value is based on quoted market prices or
dealer quotes.
- Loans Receivable--For residential real estate loans, fair value is
estimated by discounting projected future cash flows at the current market
interest rates for mortgage-backed securities collateralized by loans of
similar coupon, duration and credit risk, adjusted for differences in
market interest rates between loans and securities. The fair value of
multifamily and commercial real estate loans is estimated by discounting
the future cash flows using the current interest rates at which loans with
similar terms would be made on property and to borrowers with similar
credit and other characteristics and with similar remaining terms to
maturity. Impaired loans are valued based upon the fair value of
underlying collateral, if collateral dependent or alternatively, the
present value of expected cash flows using the loan's original implicit
loan interest rate.
- Federal Home Loan Bank Stock--The carrying amount of Federal Home Loan
Bank Stock approximates its fair value.
- Deposit--The fair values of NOW accounts, passbook accounts and money
market accounts withdrawable on demand without penalty are, by definition,
equal to the amount withdrawable on demand at the reporting date, which is
their carrying amount. The fair value of term certificates of deposit, all
of which are fixed maturity bearing a fixed rate of interest, is estimated
by discounting future projected cash flows at interest rates approximating
interest rates currently offered by the Bank for similar types of
certificates of deposit for similar remaining terms to maturity.
- Securities Sold under Agreements to Repurchase--The carrying amount of
securities sold under agreements to repurchase approximates their fair
value.
- Advances From the Federal Home Loan Bank--The fair value is estimated by
discounting projected future cash flows at the current advance interest
rates available to the Bank for Federal Home Loan Bank advances with
similar terms for similar remaining terms to maturity.
- Interest Rate Swaps, Caps, Floors and Corridors--The fair value of
interest rate swaps is based upon dealer quotes or are estimated by
discounting projected future cash flows at the current market interest
rates for interest rate swaps of similar terms and counter party credit
risk for the same remaining terms to maturity. The fair values of interest
rate caps, floors and corridors are also based upon dealer quotes or
estimated using option pricing models utilizing current market consensus
assumptions for interest rate caps, floors and corridors of similar terms
and strike or floor prices for the same remaining term to maturity.
F-33
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
(18) REQUIRED REGULATORY FINANCIAL INFORMATION
Reconciliation to Regulatory Reports filed with the Office of Thrift
Supervision (dollars in thousands):
<TABLE>
<CAPTION>
NET WORTH NET EARNINGS
----------- -------------
<S> <C> <C>
Balance per quarterly OTS financial report at
December 31, 1996.................................................. $ 76,610 13,598
As reported herein................................................... 76,610 13,598
----------- ------
$ -- --
----------- ------
----------- ------
</TABLE>
(19) REGULATORY CAPITAL REQUIREMENTS
The Bank 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
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank'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 Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and tangible capital (as defined in the regulations) to adjusted
tangible assets (as defined) and Tier I capital (as defined in the regulations)
to risk-weighted assets (as defined), and of Tier I leverage capital (as
defined) to adjusted tangible assets (as defined). Management believes, as of
December 31, 1996, that the Bank meets all capital adequacy requirements to
which it is subject.
As of June 30, 1997 (unaudited) and December 31, 1996, the Bank was
adequately capitalized under the regulatory framework for prompt corrective
action. To be categorized as adequately capitalized the Bank must maintain
minimum total risk-based ratio of 8%, Tier I risk-based ratio of 4% and Tier I
leverage ratio of 4%. There are no conditions or events since that notification
that management believes have changed the institution's category.
Under the framework, the Bank's capital levels do not allow the Bank to
accept brokered deposits without prior approval from regulators. The Bank does
not plan to solicit for such deposits.
While all insured institutions are required by OTS regulations to meet these
minimum regulatory capital requirements, the Bank has regulatory Assistance
Agreements which were entered into with the Federal Savings and Loan Insurance
Corporation (FSLIC) as part of SCH's purchase of the Bank in 1987, and which
provides for an additional $133,400,000 of regulatory capital at December 31,
1996. Until the passage of the Financial Institution Reform Recovery and
Enforcement Act (FIRREA), the Bank met all capital requirements by including the
additional Assistance Agreement capital amount in regulatory capital.
The position of the OTS was and continues to be that under FIRREA,
Assistance Agreements which provide additional regulatory capital, and/or
capital forbearances are no longer in effect as of December 7,
F-34
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
1989. The OTS notified the Bank in 1990 that the additional Assistance Agreement
capital amounts cannot be included in meeting the FIRREA capital requirements,
and as a result thereof the OTS believed the Bank did not meet minimum FIRREA
capital requirements. Management disagreed, and still disagrees, with the OTS,
and attempted to preserve all of its rights and remedies under the Assistance
Agreements. At June 30, 1997 and December 31, 1996, the Bank met all minimum
FIRREA regulatory capital requirements.
To preserve its rights under the Assistance Agreement, in 1994 SCH and the
Bank commenced a lawsuit against the United States Government for breach of
contract and deprivation of property without just compensation or due process of
law. The lawsuit seeks unspecified monetary compensation for damages sustained
in meeting FIRREA mandated capital requirements and for the fair value of
property taken, but does not seek reinstatement of the Assistance Agreement
capital forbearance. While the outcome of the lawsuit cannot be determined at
this time, it is management's opinion, based on the advice of external legal
counsel, that the Bank's position has substantial legal merit.
The Bank's ability to pay dividends is dependent upon its earnings from
operations and the adequacy of its regulatory capital. As an adequately
capitalized institution, the maximum dividend allowable under statute is 75% of
the previous four quarters of net earnings less dividends paid in such quarters.
The OTS director must be notified of the proposed distribution.
F-35
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
At June 30, 1997 (unaudited) and December 31, 1996, the Bank's regulatory
capital calculations, computed by management both with and without inclusion of
the additional capital provided for in the Bank's Assistance Agreements were as
follows (dollars in thousands):
<TABLE>
<CAPTION>
REGULATORY CAPITAL/STANDARD AS OF JUNE 30, 1997
------------------------------------------------
WITHOUT TOTAL RISK-
ADDITIONAL ASSISTANCE TANGIBLE TIER 1 TIER 1 BASED
AGREEMENT CAPITAL CAPITAL LEVERAGE RISK- BASED CAPITAL
- ------------------------------------------ ---------- --------- ----------- ------------
<S> <C> <C> <C> <C>
(UNAUDITED)
Stockholders' equity/GAAP capital......... $ 84,918 84,918 84,918 84,918
Adjustment for unrealized losses on
securities available-for-sale........... 4,402 4,402 4,402 4,402
Deduction for direct real estate
investments............................. (1,908) (1,908) (1,908) (1,908)
Deduction for other intangible assets..... (622) (622) (622) (622)
---------- --------- ----------- ------------
Total Tier I capital................ 86,790 86,790 86,790 86,790
Includable allowance for loan losses...... -- -- -- 11,257
Deduction for real estate held for
investment.............................. -- -- -- --
---------- --------- ----------- ------------
Total capital....................... 86,790 86,790 86,790 98,047
Minimum capital requirement............... 27,325 54,650 -- 71,893
---------- --------- ----------- ------------
Regulatory capital excess........... $ 59,465 32,140 86,790 26,154
---------- --------- ----------- ------------
---------- --------- ----------- ------------
Capital ratios:
Regulatory as reported.................. 4.76% 4.76% 9.65% 10.91%
Minimum capital ratio................... 1.50 3.00 3.00 8.00
---------- --------- ----------- ------------
Regulatory capital excess............... 3.26% 1.76% 6.65% 2.91%
---------- --------- ----------- ------------
---------- --------- ----------- ------------
<CAPTION>
WITH ADDITIONAL ASSISTANCE
AGREEMENT CAPITAL
- ------------------------------------------
<S> <C> <C> <C> <C>
Regulatory capital as adjusted............ $ 220,190 220,190 220,190 231,447
Minimum capital requirement (per above)... 27,325 54,650 -- 71,893
---------- --------- ----------- ------------
Regulatory capital excess........... $ 247,515 165,540 220,190 159,554
---------- --------- ----------- ------------
---------- --------- ----------- ------------
</TABLE>
F-36
<PAGE>
PEOPLE'S BANK OF CALIFORNIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED)
<TABLE>
<CAPTION>
REGULATORY CAPITAL/STANDARD AS OF DECEMBER 31,
1996
------------------------------------------------
WITHOUT TOTAL RISK-
ADDITIONAL ASSISTANCE TANGIBLE TIER 1 TIER 1 BASED
AGREEMENT CAPITAL CAPITAL LEVERAGE RISK- BASED CAPITAL
- ------------------------------------------ ---------- --------- ----------- ------------
<S> <C> <C> <C> <C>
Stockholder's equity/GAAP capital......... $ 76,610 76,610 76,610 76,610
Adjustment for unrealized losses on
securities available-for-sale........... 6,084 6,084 6,084 6,084
Deduction for direct real estate
investments............................. (1,908) (1,908) (1,908) (1,908)
Deduction for other intangible assets..... (714) (714) (714) (714)
---------- --------- ----------- ------------
Total Tier I capital................ 80,072 80,072 80,072 80,072
Includable allowance for loan losses...... -- -- -- 10,986
Deduction for real estate held for
investment.............................. -- -- -- (217)
---------- --------- ----------- ------------
Total capital....................... 80,072 80,072 80,072 90,841
Minimum capital requirement............... 26,270 70,053 35,017 70,034
---------- --------- ----------- ------------
Regulatory capital excess........... $ 53,802 10,019 45,055 20,807
---------- --------- ----------- ------------
---------- --------- ----------- ------------
Capital ratios:
Regulatory as reported.................. 4.57% 4.57% 9.15% 10.38%
Minimum capital ratio................... 1.50 4.00 4.00 8.00
---------- --------- ----------- ------------
Regulatory capital excess............... 3.07% 0.57% 5.15% 2.38%
---------- --------- ----------- ------------
---------- --------- ----------- ------------
<CAPTION>
WITH ADDITIONAL ASSISTANCE
AGREEMENT CAPITAL
- ------------------------------------------
<S> <C> <C> <C> <C>
Regulatory capital as adjusted............ $ 213,472 213,472 213,472 224,241
Minimum capital requirement (per above)... 26,270 70,053 35,017 70,034
---------- --------- ----------- ------------
Regulatory capital excess........... $ 187,202 143,419 178,455 154,207
---------- --------- ----------- ------------
---------- --------- ----------- ------------
</TABLE>
Refer to Note 1 for a discussion of the recapitalization of the Company.
(20) SUBSEQUENT EVENT
Effective July 1, 1997, Southern California Federal Savings and Loan
Association changed its name to People's Bank of California. The Bank is a
Federal-chartered savings bank regulated by the OTS.
F-37
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Prospectus Summary................................... 1
Risk Factors......................................... 15
The Company.......................................... 27
Use of Proceeds...................................... 28
Capitalization....................................... 29
Business and Strategy................................ 30
Beneficial Ownership of the Company.................. 50
Management........................................... 50
Certain Transactions Constituting The Formation...... 54
Description of Series A Preferred Shares............. 57
Description of Capital Stock......................... 64
Federal Income Tax Considerations.................... 70
ERISA Considerations................................. 78
Certain Information Regarding the Bank............... 81
Underwriting......................................... 89
Experts.............................................. 90
Certain Legal Matters................................ 90
Additional Information............................... 91
Glossary............................................. 92
Index to Financial Statement......................... F-1
Annex I--Offering Circular for Bank Preferred
Shares............................................. OC-1
</TABLE>
------------------------
THROUGH AND INCLUDING , 1997 (THE 25TH DAY AFTER THE DATE OF THIS
PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES,
WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
1,240,000 SHARES
PEOPLE'S PREFERRED
CAPITAL CORPORATION
% NONCUMULATIVE
EXCHANGEABLE
PREFERRED STOCK, SERIES A
------------------
PROSPECTUS
, 1997
------------------------
SANDLER O'NEILL & PARTNERS, L.P.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II. INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 30. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
<TABLE>
<S> <C>
SEC registration fee.............................................. $ 10,800
Printing expenses................................................. 125,000
Legal fees and expenses........................................... 300,000
Accounting fees and expenses...................................... 150,000
Investment banking legal fees and expenses........................ 200,000
Miscellaneous expenses............................................ 39,200
---------
Total....................................................... $ 825,000
---------
---------
</TABLE>
ITEM 31. SALES TO SPECIAL PARTIES.
See response to Item 32 below.
ITEM 32. RECENT SALES OF UNREGISTERED SECURITIES
In connection with the formation of People's Preferred Capital Corporation
(the "Company" or the "Registrant"), the Company issued 10,000 shares of Common
Stock, par value $.01 per share, to People's Bank of California (the "Bank").
The description of these transactions in the Prospectus under the heading
"Certain Transactions Constituting The Formation" is incorporated herein by
reference. These shares of Common Stock will be issued in reliance upon the
exemption from registration under Section 4(2) of the Securities Act of 1933
(the "Securities Act").
ITEM 33. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The MGCL permits a Maryland corporation to include in its charter a
provision limiting the liability of its directors and officers to the
corporation and its stockholders for money damages except for liability
resulting from (a) actual receipt of an improper benefit or profit in money,
property or services or (b) active and deliberate dishonesty established by a
final judgment as being material to the cause of action. The Articles of
Incorporation contain such a provision which eliminates such liability to the
maximum extent permitted by Maryland law.
The Articles of Incorporation authorize the Company, to the maximum extent
permitted by Maryland law, to obligate itself to indemnify and to pay or
reimburse reasonable expenses in advance of final disposition of a proceeding to
(a) any present or former director or officer or (b) any individual who, while a
director of the Company and at the request of the Company, serves or has served
another corporation, partnership, joint venture, trust, employee benefit plan or
any other enterprise as a director, officer, partner or trustee of such
corporation, partnership, joint venture, trust, employee benefit plan or other
enterprise from and against any claim or liability to which such person may
become subject or which such person may incur by reason of his or her status as
a present or former director or officer of the Company. The Bylaws of the
Company obligate it, to the maximum extent permitted by Maryland law, to
indemnify and to pay or reimburse reasonable expenses in advance of the final
disposition of a proceeding to (a) any present or former director or officer who
is made a party to the proceeding by reason of his service in that capacity or
(b) any individual who, while a director of the Company and at the request of
the Company, serves or has served another corporation, partnership, joint
venture, trust, employee benefit plan or any other enterprise as a director,
officer, partner or trustee of such corporation, partnership, joint venture,
trust, employee benefit plan or other enterprise and who is made a party to the
proceeding by reason of his service in that capacity. The Articles of
Incorporation and Bylaws also permit the Company to indemnify
II-1
<PAGE>
and advance expenses to any person who served a predecessor of the Company in
any of the capacities described above and to any employee or agent of the
Company or a predecessor of the Company.
The MGCL requires a corporation (unless its charter provides otherwise,
which the Articles of Incorporation do not) to indemnify a director or officer
who has been successful, on the merits or otherwise, in the defense of any
proceeding to which he is made a party by reason of his service in that
capacity. The MGCL permits a corporation to indemnify its present and former
directors and officers, among others, against judgments, penalties, fines,
settlements and reasonable expenses actually incurred by them in connection with
any proceeding to which they may be made a party by reason of their service in
those or other capacities unless it is established that (a) the act or omission
of the director or officer was material to the matter giving rise to the
proceeding and (i) was committed in bad faith or (ii) was the result of active
and deliberate dishonesty, (b) the director or officer actually received an
improper personal benefit in money, property or services or (c) in the case of
any criminal proceeding, the director or officer had reasonable cause to believe
that the act or omission was unlawful. However, under the MGCL, a Maryland
corporation may not indemnify for an adverse judgment in a suit by or in the
right of the corporation. In addition, the MGCL requires the Company, as a
condition to advancing expenses, to obtain (a) a written affirmation by the
director or officer of his good faith belief that he has met the standard of
conduct necessary for indemnification by the Company as authorized by the Bylaws
and (b) a written statement by or on his behalf to repay the amount paid or
reimbursed by the Company if it shall ultimately be determined that the standard
of conduct was not met.
The Underwriting Agreement to be filed as Exhibit 1 to this Registration
Statement will provide for reciprocal indemnification by the Underwriters of the
Company, the Bank and their respective directors, officers and controlling
persons, and by the Company and the Bank of the Underwriters, and its directors,
officers and controlling persons, against certain liabilities under the
Securities Act.
ITEM 34. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not applicable.
ITEM 35. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements
See F-1 of the Prospectus for an index to financial statements included as
part of the Prospectus.
II-2
<PAGE>
(b) Exhibits
<TABLE>
<S> <C>
EXHIBIT
- ---------
1* Form of Underwriting Agreement between the Company, the Bank and the
Underwriters
3(a)(i)* Articles of Incorporation of the Company
3(a)(ii)* Form of Amended and Restated Articles of Incorporation
3(b)* Bylaws of the Company
4* Specimen of certificate representing Series A Preferred Shares
5 Opinion of Elias, Matz, Tiernan & Herrick L.L.P., counsel to the Company,
relating to Series A Preferred Shares
8 Opinion of Elias, Matz, Tiernan & Herrick L.L.P., counsel to the Company,
relating to certain tax matters
10(a)* Form of Residential Mortgage Loan Purchase and Warranties Agreement between the
Company and the Bank
10(b)* Form of Commercial Mortgage Loan Purchase and Warranties Agreement between the
Company and the Bank
10(c)* Residential Mortgage Loan Servicing Agreements between the Bank and the
Servicing Agent
10(d)* Form of Commercial Mortgage Loan Servicing Agreement between the Company and the
Bank
10(e)* Form of Advisory Agreement between the Company and the Bank
10(f)* Form of Assignment, Assumption and Recognition Agreement between the Company,
the Bank and the Servicing Agent
23(a) Consent of KPMG Peat Marwick LLP.
23(b) Consent of Elias, Matz, Tiernan & Herrick, L.L.P. (included in Exhibit 5)
23(c) Consent of Arthur Andersen LPP
24 Power of Attorney (included in Registration Statement signature page)
</TABLE>
- ------------------------
* Previously filed
ITEM 36. UNDERTAKINGS.
The undersigned Registrant hereby undertakes to provide to the Underwriters,
at the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions described under Item 33 above, or
otherwise, the Registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer,
or controlling person of
II-3
<PAGE>
the Registrant in the successful defense of any action, suit or proceeding), is
asserted by such director, officer, or controlling person in connection with the
securities registered, the Registrant will, unless in the opinion of its counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Act, each
post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to
be the initial bona fide offering thereof.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act, the Registrant certifies
that it has reasonable grounds to believe that it meets all of the requirements
for filing on Form S-11 and has duly caused this Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in Los
Angeles, California, on the 15th day of September, 1997.
PEOPLE'S PREFERRED CAPITAL CORPORATION
By: /s/ RUDOLF P. GUENZEL*
-----------------------------------------
Rudolf P. Guenzel
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed by the following persons in the capacities and on the
dates indicated.
NAME TITLE DATE
- ------------------------------ --------------------------- -------------------
President, Chief Executive
/s/ RUDOLF P. GUENZEL* Officer and Director
- ------------------------------ (Principal Executive September 15, 1997
Rudolf P. Guenzel* Officer)
Executive Vice President,
/s/ J. MICHAEL HOLMES Chief Financial Officer,
- ------------------------------ Secretary and Director September 15, 1997
J. Michael Holmes (Principal Accounting
Officer)
/s/ HENRY PETERS*
- ------------------------------ Chairman of the Board of September 15, 1997
Henry Peters* Directors
/s/ GERARD JERVIS*
- ------------------------------ Director September 15, 1997
Gerard Jervis*
/s/ ROBERT W. MACDONALD*
- ------------------------------ Director September 15, 1997
Robert W. MacDonald*
/s/ JOHN F. DAVIS*
- ------------------------------ Director September 15, 1997
John F. Davis*
/s/ DAVID S. HONDA*
- ------------------------------ Director September 15, 1997
David S. Honda*
- ------------------------
* By J. Michael Holmes pursuant to a Power of Attorney.
II-5
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ----------- -------------------------------------------------------------------------------------------------------
<C> <S>
1* Form of Underwriting Agreement between the Company, the Bank and the Underwriters
3(a)(i)* Articles of Incorporation of the Company
3(a)(ii)* Form of Amended and Restated Articles of Incorporation
3(b)* Bylaws of the Company
4* Specimen of certificate representing Series A Preferred Shares
5 Opinion of Elias, Matz, Tiernan & Herrick L.L.P., counsel to the Company, relating to Series A
Preferred Shares
8 Opinion of Elias, Matz, Tiernan & Herrick L.L.P., counsel to the Company, relating to certain tax
matters
10(a)* Form of Residential Mortgage Loan Purchase and Warranties Agreement between the Company and the Bank
10(b)* Form of Commercial Mortgage Loan Purchase and Warranties Agreement between the Company and the Bank
10(c)* Residential Mortgage Loan Servicing Agreements between the Bank and the Servicing Agent
10(d)* Form of Commercial Mortgage Loan Servicing Agreement between the Company and the Bank
10(e)* Form of Advisory Agreement between the Company and the Bank
10(f)* Form of Assignment, Assumption and Recognition Agreement between the Company, the Bank and the
Servicing Agent
23(a) Consent of KPMG Peat Marwick LLP.
23(b) Consent of Elias, Matz, Tiernan & Herrick, L.L.P. (included in Exhibit 5)
23(c) Consent of Arthur Andersen LLP
24 Power of Attorney (included in Registration Statement signature page)
</TABLE>
- ------------------------
* Previously filed
<PAGE>
September 18, 1997
People's Preferred Capital Corporation
5900 Wilshire Boulevard
Los Angeles, California 90036
Re: Registration Statement on Form S-11
(No. 333-31051)
Ladies and Gentlemen:
We have served as counsel to People's Preferred Capital Corporation, a
Maryland corporation (the "Company"), in connection with certain matters of
Maryland law arising out of the registration of up to 1,426,000 shares (the
"Shares") of Noncumulative Exchangeable Preferred Stock, Series A, $.01 par
value per share (the "Series A Preferred Stock"), of the Company (including
186,000 shares of Series A Preferred Stock which the Underwriters have the
option to purchase solely to cover over-allotments, if any), covered by the
above-referenced Registration Statement (the "Registration Statement"), filed by
the Company with the Securities and Exchange Commission (the "Commission") under
the Securities Act of 1933, as amended (the "1933 Act"). Unless otherwise
defined herein, capitalized terms used herein shall have the meanings assigned
to them in the Registration Statement.
In connection with our representation of the Company, and as a basis for
the opinion hereinafter set forth, we have examined originals, or copies
certified or otherwise identified to our satisfaction, of the following
documents (hereinafter collectively referred to as the "Documents"):
1. The Registration Statement and the related form of prospectus included
therein in the form in which it was transmitted to the Commission under the 1933
Act;
2. The Articles of Incorporation of the Company (the "Articles"),
certified as of a recent date by the State Department of Assessments and
Taxation of Maryland (the "SDAT");
3. The Bylaws of the Company, certified as of a recent date by its
Secretary;
4. Resolutions adopted by the Board of Directors of the Company (the
"Board") relating to the sale, issuance and registration of the Shares and the
creation of, and delegation of authority to, a pricing committee thereof (the
"Pricing Committee"), certified as of a recent date by the Secretary of the
Company (the "Resolutions");
5. The form of certificate representing a share of Series A Preferred
Stock, certified as of a recent date by the Secretary of the Company;
<PAGE>
People's Preferred Capital Corporation
September 18, 1997
Page 2
6. A certificate of the SDAT as to the good standing of the Company,
dated as of a recent date;
7. Such other documents and matters as we have deemed necessary or
appropriate to express the opinion set forth in this letter, subject to the
assumptions, limitations and qualifications stated herein.
In expressing the opinion set forth below, we have assumed, and so far as
is known to us there are no facts inconsistent with, the following:
1. Each of the parties (other than the Company) executing any of the
Documents has duly and validly executed and delivered each of the Documents to
which such party is a signatory, and such party's obligations set forth therein
are legal, valid and binding.
2. Each individual executing any of the Documents on behalf of a party
(other than the Company) is duly authorized to do so.
3. Each individual executing any of the Documents, whether on behalf of
such individual or another person, is legally competent to do so.
4. All Documents submitted to us as originals are authentic. All
Documents submitted to us as certified or photostatic copies conform to the
original documents. All signatures on all such Documents are genuine. All public
records reviewed or relied upon by us or on our behalf are true and complete.
All statements and information contained in the Documents are true and complete.
There are no modifications of or amendments to the Documents, and there has been
no waiver of any of the provisions of the Documents, by actions or conduct of
the parties or otherwise.
5. In accordance with the Resolutions, the Board, or the Pricing
Committee or another duly authorized committee of the Board, will duly adopt
resolutions (the "Pricing Resolutions") including all terms and conditions
required by the Maryland General Corporation Law, as amended, prior to the
issuance of the Shares.
6. The Shares will not be issued or transferred in violation of any
restriction or limitation contained in the Articles.
The phrase "known to us" is limited to the actual knowledge, without
independent inquiry, of the lawyers at our firm who have performed legal
services in connection with the issuance of this opinion.
Based upon the foregoing, and subject to the assumptions, limitations and
qualifications stated herein, it is our opinion that:
<PAGE>
People's Preferred Capital Corporation
September 18, 1997
Page 3
1. The Company is a corporation duly incorporated and existing under and
by virtue of the laws of the State of Maryland and is in good standing with the
SDAT.
2. The Shares have been duly authorized and, when and if delivered
against payment therefor in accordance with the Resolutions, the Pricing
Resolutions and any other resolutions of the Board of Directors, or the Pricing
Committee or any other duly authorized committee of the Board of Directors,
authorizing their issuance, the Shares will be duly and validly issued, fully
paid and nonassessable.
The foregoing opinion is limited to the laws of the State of Maryland and
we do not express any opinion herein concerning any other law. We express no
opinion as to compliance with the securities (or "blue sky") laws of any State.
We assume no obligation to supplement this opinion if any applicable law
changes after the date hereof or if we become aware of any fact that might
change the opinion expressed herein after the date hereof.
This opinion is being furnished to you solely for submission to the
Commission as an exhibit to the Registration Statement and, accordingly, is
not to be used, circulated, quoted or otherwise referred to for any other
purpose without our prior written consent.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of the name of our firm therein. In giving
this consent, we do not admit that we are within the category of persons whose
consent is required by Section 7 of the 1933 Act, as amended or the rules and
regulations of the Commission promulgated thereunder.
Very truly yours,
ELIAS, MATZ, TIERNAN & HERRICK, LLP
By: /s/ Norman B. Antin
---------------------------
Norman B. Antin, A Partner
<PAGE>
September 18, 1997
People's Preferred Capital Corporation
5900 Wilshire Boulevard
Los Angeles, California 90036
Re: Registration Statement on Form S-11
Registration No. 333-31051
Ladies and Gentlemen:
We have acted as counsel for People's Preferred Capital Corporation, a
Maryland corporation (the "Company"), and People's Bank of California, a federal
savings bank, in connection with the above-captioned registration statement on
Form S-11 (the "Registration Statement") filed with the Securities and Exchange
Commission (the "Commission") on July 10, 1997 and Amendment No. 1 to the
Registration Statement dated September 5, 1997 for the purpose of registering
Series A Preferred Shares (the "Preferred Shares") of the Company in connection
with the sale of such Preferred Shares to the public.
In this connection, we have examined the Registration Statement, as
amended, and such other documents as we have deemed necessary or appropriate as
a basis for the opinion set forth below, and we have assumed (i) that such
documents will not be amended and (ii) that the parties to such documents will
comply with the terms thereof.
In our examination, we have assumed the genuineness of all signatures, the
authenticity of all documents submitted to us as originals, the conformity to
original documents of all documents submitted to us as certified or photostatic
copies and the authenticity of the originals of such latter documents. As to any
facts material to the opinions expressed herein which were not independently
established or verified, we are relying upon statements, representations, and
certifications of officers and other representatives of the Company.
In rendering our opinion, we have also considered and relied upon the
Internal Revenue Code of 1986, as amended, and administrative rulings, judicial
decisions, regulations, and such other authorities as we have deemed
appropriate, all as in effect as of the date hereof. The statutory provisions,
regulations, interpretations, and other authorities upon which our opinion is
based are subject to change, and such changes could apply retroactively. In
addition, there can be no assurance that positions contrary to those stated in
our opinion will not be taken by the Internal Revenue Service.
We express no opinions as to the laws of any jurisdiction other than the
federal laws of the United States of America to the extent specifically referred
to herein.
<PAGE>
People's Preferred Capital Corporation
September 18, 1997
Page 2
Based upon and subject to the foregoing, and subject to the qualifications
set forth therein, we adopt the opinions expressed in the Registration Statement
under the heading "FEDERAL INCOME TAX CONSIDERATIONS" as our opinion in this
matter.
This opinion is furnished to you solely in connection with the filing of
the Registration Statement and, except as set forth below, is not to be used,
circulated, quoted or otherwise referred to for any other purpose without our
prior written consent. We hereby consent to the use of our name under the
headings "Federal Income Tax Considerations" and "Legal Matters" in the
Registration Statement and the filing of this opinion with the Commission as
Exhibit 8.1 to the Registration Statement. In giving this consent, we do not
thereby admit that we are within the category of persons whose consent is
required under Section 7 of the Securities Act of 1933, as amended, or the
rules and regulations of the Commission promulgated thereunder. This opinion
is expressed as of the date hereof unless otherwise expressly stated and
applies only to the disclosure under the heading "FEDERAL INCOME TAX
CONSIDERATIONS" set forth in the Registration Statement filed as of the date
hereof. We disclaim any undertaking to advise you of any subsequent changes
of the facts stated or assumed herein or any subsequent changes in applicable
law.
Very truly yours,
ELIAS, MATZ, TIERNAN & HERRICK, LLP
By: /s/ Norman B. Antin
----------------------------
Norman B. Antin, A Partner
<PAGE>
Independent Auditors' Consent
The Board of Directors
People's Preferred Capital Corporation:
We consent to the use of our report included herein and to the reference to
our firm under the heading "Experts" in the registration statement.
KPMG Peat Marwick LLP
Los Angeles, California
September 16, 1997
<PAGE>
Independent Auditors' Consent
The Board of Directors
People's Bank of California:
We consent to the inclusion of our report dated February 21, 1997, except as
to Note 20 to the consolidated financial statements, which is as of July 1,
1997, with respect to the consolidated statements of financial condition of
People's Bank of California (formerly Southern California Federal Savings and
Loan Association) as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholder's equity, and cash flows
for the years then ended, which report appears in Annex I of the Preliminary
Offering Circular of Amendment No. 2 to Form S-11 of People's Preferred
Capital Corporation dated September 16, 1997, and to the reference to our firm
under the heading "Experts" in Annex I of the Preliminary Offering Circular.
KPMG Peat Marwick LLP
Los Angeles, California
September 16, 1997
<PAGE>
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
Report of Independent Public Accountants on the financial statements of
Southern California Federal Savings and Loan Association (the Bank) for the
year ended December 31, 1994 and to the reference to our Firm in the Experts
section of the Preliminary Offering Circular of Peoples Bank of California
which is included as Annex I of the Peoples Preferred Capital Corporation
Series A Preferred Stock Form S-11 Registration Statement to be filed with
the Securities and Exchange Commission. It should be noted that we have
performed no audit procedures subsequent to June 9, 1995, the date of our
report. Furthermore, we have not made an audit of any financial statements of
the Bank as of any date or for any period subsequent to December 31, 1994,
the date of the latest financial statements covered by our report.
/s/ Arthur Andersen
--------------------------
Arthur Andersen
Los Angeles, California
September 16, 1997
